Program information document (pid) appraisal stage



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PROGRAM INFORMATION DOCUMENT (PID)

APPRAISAL STAGE

Report No.: AB3416



Operation Name

Fourth Poverty Reduction Support Credit

Region

EUROPE AND CENTRAL ASIA

Sector

Development Policy Lending

Project ID

P101486

Borrower(s)

Republic of Armenia

Implementing Agency

Ministry of Finance and Economy

Republic of Armenia

Government House 1

Republic Square, 375010

Yerevan, Armenia

Phone: 374-1-595304



Date PID Prepared

October 29, 2007

Date of Appraisal Authorization

October 8, 2007

Date of Board Approval

November 27, 2007




  1. Country and Sector Background

(This section should describe the country and sector background.)

Armenia has a creditable record of economic stability. The Armenian authorities continue carrying out a successful stabilization and structural reform program following the hyperinflation, fiscal crisis and severe economic contraction immediately after independence in 1991-93. Reforms accelerated after 2000 with trade and prices liberalized and most small and medium-sized enterprises privatized. Macroeconomic stability was maintained, inflation was low, structural reforms were carried out and economic recovery began. Successful implementation of economic reforms contributed to an average growth of 5.5 percent per year during 1994-2000 given the focus of reform on improving the business environment and public utilities management, strengthening governance, competition and financial intermediation as well as promoting structural changes in public service delivery.

Deepening structural and institutional reforms resulted in a stellar annual average growth rates in double digits for the last 5 year in a row, averaging 12.9 per cent were achieved over 2001-06, peaking at 14 percent in 2005. Such high rates of sustained growth have led to a fall in poverty from over half of the population in 1999 to less than 30 percent in 2005, and an even sharper fall in severe poverty from 21 percent to less than 5 per cent. Growth has recently begun to dent unemployment which stands at nearly one-third of the labor force. During this time, economic growth was driven for the first time by a high rate of export expansion, which tripled in 2001-2005. In 2001-2006 the average inflation remained at around 3.5 percent.

Monetary policy is intended to be geared to keeping inflation low; the central bank has announced that inflation targeting will be formally adopted as soon as preparations are completed. The exchange rate regime is assumed to be a floating one, with the dram likely to continue to appreciate in real terms in parallel with high rates of productivity growth in the economy. The external debt and debt service burden is low and is expected to remain comfortably low. By the standards of CIS or of emerging economies, the economic record and the medium term outlook are enviable.


The government continues to be committed to the reform program and macroeconomic performance continues to be most impressive. In governance, tax administration reforms have been persistent with steady progress in designing self assessment of taxes and the strengthening of the functioning of the large tax payer unit. Direct trader input systems have been introduced in the major custom houses and implementation will continue to be monitored closely in the coming months. Risk-based systems are being adapted to support rules-based selectivity in import examinations, but will require a further year to be fully functional to international standards. In the area of public management reforms, substantial gains have been realized. Budgets follow GFS classification standards, with integrated charts of accounts and reporting standards. Programme budgeting has been piloted in key spending ministries. Staff performance appraisal in the civil service is being adapted to allow for a merit based wage and bonus system.
Second generation reforms to sharpen competition and entrench property rights have been undertaken consisting of a cluster of crucial micro-economic reforms to reduce costs and raise efficiency. The authorities have adopted a policy of liberalizing international civil aviation, telecommunication and public utilities. To strengthen property rights and create the conditions for an efficient loans market, steps have been taken to strengthen creditor rights and make secured transactions possible. Further more reforms also focused on mitigating social and environmental risks. In education and health, reforms were directed at re-ordering priorities in spending, whilst spending in real terms were raised very substantially. Environmental risks have been reduced by the adoption of a national forestry policy and codes and by an increased role for environmental impact assessment and supervision in public policy. Reforms directed at modernizing the rural economy centered on stimulating farm incomes through implementing effective programmes for agricultural extension, research, the adoption of best practice seeds law and certification procedures and steps towards harmonizing food safety legislation to international standards. A major focus remains the development of rural infrastructure development plan


  1. Operation Objectives

(This section should describe the operation, including a clear, succinct statement of development objectives. It discusses the expected benefits of the proposed operation, expected impacts, and linkages to the Government’s program. A description of the prior actions, i.e., conditions, for Board presentation should also be included in this section. )

Scope and objectives of the operation. The three main areas of focus for the operation are: (i) consolidating macroeconomic discipline and strengthening public and corporate governance, (ii) strengthening competition; and (iii) reducing environmental risks. In addition to the fact that the proposed PRSC builds on the Government’s PRSP themes, it is also closely linked to the FY05-08 Country Assistance Strategy (CAS) which focuses on three main objectives: (i) promoting private sector led growth; (ii) making growth more pre-poor; and (iii) reducing non-income poverty. 2007 CAS-PR also envisions the proposed PRSC as the key elements of supporting PRSP implementation. The PRSC preparation is also closely coordinated with the IMF Poverty Reduction and Growth Facility (PRGF) and activities of other donors in Armenia.

Linkages to Government reform program and expected benefits. The proposed PRSCIV is an extension to the set of three annual PRSCs rooted in the medium term Poverty Reduction Strategy Paper (PRSP) of the authorities. The credit is proposed to be extended on the basis of policy and institutional reform actions taken by the authorities as agreed with IDA. Given substantial progress made, PRSC-IV will be made available as the agreed triggers of policy and institutional reforms have all been satisfied. The main benefits of the proposed credit are to help sustain economic growth and poverty reduction by deepening Government’s high priority reforms and channeling financial and policy assistance in support of the implementation of the PRSP objectives to improve business environment, advance social sector reforms, and strengthen the rural economy

Full description of prior actions is given below:




PRSC IV Policy and Institutional Reform Actions




Maintaining macroeconomic stability.

In line with MTEF targets (2007), growth projected at 9 per cent, inflation at 4 per cent, and fiscal deficit below 2.5 per cent of GDP. Continued strong improvement in fiscal and debt sustainability.




Strengthening tax administration
Strengthening customs administration

Implement self-assessment in tax administration in line with action plan;

Implement institutional reforms of the large taxpayer units in line with action plan.


Implement comprehensive post-release review program destined to support full scale DTI introduction, and develop a guarantee mechanism supporting an approved importer scheme

Corporate governance


Registration law revised to provide for public access to key company records, including internet access to business registry; and plan adopted for public disclosure of owners of traded companies

Strengthening competition

In international civil aviation, sound progress towards meeting the end-2007 target of amending all air service agreements with EU nations to replace "national" airlines with "EU" airlines and with implementation of all actions necessary to signing a new air services agreement with the US, consistent with Armenian legislation, by end-2007
In telecommunications, the government will adopt the Armenian Table of Frequency Allocations to conform to the International Telecommunications Union Table of Frequency Allocations




Reducing risks in natural resource management for sustainable livelihoods

Implement the illegal logging monitoring system, with autonomy built into the operations of the monitoring institution.

Expected outcomes and operation impact. In macroeconomic area it is expected that the national output will grow by 65 percent over the 2004-09/10 period, with income per head approximating $2300 in constant 2004 dollars. Inflation is expected to be kept below 3 percent throughout 2004-07, consistent with fiscal deficits in the 2-3 percent of GDP range, on the basis of tax revenues rising from the equivalent of 14 percent of GDP in 2003 to 16 percent of GDP in 2008.

Key institutional outcomes are expected to include attainment of international standards in customs control and in tax administration. Under PRSC-IV, risk-based selectivity will be used throughout customs by the introduction of the Asycuda selectivity module at networked customs locations. The introduction of Asycuda World will make possible a single window approach for all imports, strengthen the transit process and facilitate the elaboration of a proper import valuation system. These reforms would lead to greater automaticity and predictability in clearance of goods, will reduce discretion and lower business costs. The two key reform actions in tax administration – self-assessment and large taxpayer units - have been chosen on the basis of the expected impact on the criteria outlined above – efficiency, probity, and business impact.


The improved competition environment will be evident in a fall in transport costs in aviation, rail services and in quality gains in utilities services in line with quantitative indicators set as minimum service quality standard for frequency and duration of available service. A new telecommunication and aviation policy statements are planned which would provide pre-conditions for the entry of new operators.

Strengthened corporate governance via increasing transparency and accountability will be assisted by: (i) establishing internet access to the business registry; (ii) developing a plan for public disclosure of the ultimate owners of publicly traded companies; and (iii) conducting an Accounting and Auditing ROSC to identify ways of strengthening financial reporting practices. Accountability will be promoted by preparing a model charter that will strengthen the responsibilities of supervising boards of directors and ensure that they maintain minimum levels of qualifications. It is expected that these measures will be a critical underpinning to a vibrant and competitive market economy, with strong governance increasing transparency and reducing opportunities for corruption.

Strengthening illegal logging authority in Armenia will have a tremendous effect on natural resource management systems. The impact of PRSC supported forestry reforms and illegal logging in Armenia is also likely to have a substantial impact on sustainable livelihoods. Forests serve as the safety nets for rural population. Forests served as safety net during the period of harsh economic and energy crises in early 1990s. Wild food and fuel-wood were by far the two most important forest products harvested from forests. The over-exploitation of forests continues, which will result in considerable negative impact of sustainable livelihoods in Armenia. To avoid degradation of its already scarce forest resources, Armenia must maintain efficient forest management institutions




  1. Rationale for Bank Involvement

(This section might consider whether there has been good progress on important institutional and structural reforms. Highlight specific measures taken by the government and supported by this proposed operation. Note recent macroeconomic performance and poverty reduction efforts, if supported by sustainable policies. Also note whether a broad consensus has developed in the country to maintain sound fundamental macroeconomic and poverty reduction policies in the medium- and long-run. Describe mutually supporting efforts by the IMF, regional development bank lending, or bilateral assistance, if important.)
The Armenian authorities continue carrying out a successful stabilization and structural reform program. Considerable efforts were put into 4 main PRSP and PRSC 4 areas as described above in section 2 Table of key policy and institutional reforms undertaken.
Annual average growth rates of 12 percent were achieved over 2001-06. The economy continued its strong performance during the first half of 2007. Preliminary data indicate that as of July 2007 real GDP increased by 11.2 percent, driven mainly by construction and growth in services and trade. As of August 2007 the rate of 12-month inflation stood at 1.6 percent, significantly lower than 2007 target of 4 percent. Fiscal stance was prudent in recent years. The average fiscal deficit for 2001-2006 was 2.3 percent of GDP with 2006 deficit shrinking to 1.6 percent of GDP. Tax revenues improved slightly since 2003, with the tax to GDP ratio rising by 0.4 percentage point. External sector performance was favorable in 2001-2005, with exports more than doubling since 2001 and diversifying to some extent. In 2006 export growth slowed substantially, which is largely related to difficulties in diamond cutting industry and trade disruption due to Georgia-Russia border closure. Import grew by 21 percent in reflection of buoyant domestic demand. Preliminary export data for the first half of 2007 indicates that export growth will recover in 2007. Import growth will also be strong, which largely related to increase in imports of mineral products, cars and capital goods.
By 2005, all consumption based measures of poverty and extreme poverty declined compared to their levels in 1998/99 (Table 2). Extreme poverty incidence fell considerably faster than the over­all poverty rate: (78 and 47 percent respectively). At the same time, poverty became shallower and less severe. In absolute figures, over half a million people – out of 850,000 – escaped extreme poverty. However, despite these remarkable achievements, almost 30 percent of the population – slightly less then a million people – are still poor, including around 150,000 of extremely poor population. Although declining, income inequality is still relatively high: the 2005 Gini coefficient of 0.36. Consumption inequality is much lower (a Gini coefficient of 0.26) and has been relatively stable in the observed period.
PRSC preparation and implementation is closely coordinated with the IMF Poverty Reduction and Growth Facility (PRGF), as well as other multilateral and bilateral donors.
The authorities are preparing a second poverty reduction strategy paper (PRSP II) through a wide participatory process within the government, civil society and the donor community. In the upcoming months the document will be enriched by final comments and inputs from various stakeholders. The final document will be approved by the government in December 2007. It would offer a comprehensive poverty reduction program and contain an extensive poverty analysis for the period of 2003-2006 and a well-defined strategy with short and long-term perspectives with the main aim to sustain sound fundamental macroeconomic and poverty reduction policies


  1. Financing

(This section should contain the following information:
Loan/Credit Amount: SDR 12.00 mln (equivalent of US$18.5 mln)

Number of tranches: single tranch

Amount of each tranche: SDR 12.0 mln


  1. Institutional and Implementation Arrangements

(This section should list the ministry that will be responsible for overall implementation of the proposed operation and for reporting progress and coordinating actions among other concerned ministries and agencies.

It should also discuss how Bank staff will monitor actions and review progress of the implementation of the proposed operation, as well as the subsequent actions of the Government’s program. In particular, this paragraph could mention that Bank staff will focus on the impact outcomes of the program and the adjustments that need to be made to the operation as it evolves, to take into account the latest country developments, stakeholder support, and feasible options for realizing the intended development goals. Moreover, it could note that the review will be largely based on the monitoring indicators (benchmarks) and the goals of the program. At the same time, the overall status of the Government’s program will be monitored to determine whether country conditions and the specific conditions of the proposed operation have been met.)

Upon effectiveness of the Financing Agreement, the proposed single-tranche credit will be made to the Republic of Armenia, represented by the Ministry of Finance and Economy (MOFE) which is the main responsible party for implementation of the proposed operation, reporting and coordination within the Government. The proposed credit will be on hardened IDA terms, including 20-year maturity and a 10-year grace period


The Borrower will report to the Bank (in a format acceptable to the Bank) on the amounts deposited in the foreign currency account and credited to the budget management system. The administration of the Credit will be the responsibility of the MOFE. Considering the Bank’s knowledge of the public finance management systems and the ongoing improvements of these systems, considering the recent positive assessment of the CBA made by IMF, and the previous audit of deposit account under PRSC-I (Dutch grant TF 054431) was unqualified and acceptable to the Bank, as well as clean opinions issued by the CBA’s auditor on the recent years financial statements, no audit will be necessary of the deposit account.
Given the nature of the PRSC-supported program and following the appraisal of the PRSC4 confirming that all core conditions have already been satisfied, no formal monitoring and/or review of proposed actions is needed. However, given some forward-looking actions indicated by the Government of Armenia in LDP and the upcoming PRSP2, local economic team and the PRSC TTL will closely follow-up on the progress against the outcome matrix that has been developed for the PRSC and a range of monitoring indicators that are also part of the program matrix. .

6. Benefits and Risks


Benefits

(This section should have a concise description of the main benefits, noting the macroeconomic policy areas and structural reforms that will be supported by the proposed loan. For example, fiscal adjustment, institutional strengthening, private sector development, privatization, transparency and good governance, etc.)
Armenia has a creditable record of economic stability. Over the medium term, the macroeconomic program underlying the PRSP and MTEF calls for growth rates of between 7-8 percent, inflation at around 3 percent and fiscal deficits in the range of the equivalent of 2½ percent of GDP, i.e., what can be financed by concessional borrowing from IDA and other donors. Monetary policy is intended to be geared to keeping inflation low; the central bank has announced that inflation targeting will be formally adopted as soon as preparations are completed. The exchange rate regime is a floating one, with the dram likely to continue to appreciate in real terms in parallel with high rates of productivity growth in the economy and continuing substantial foreign exchange inflows. The external debt and debt service burden is low and is expected to remain comfortably low. By the standards of CIS or of emerging economies, the economic record and the medium term outlook are enviable
Over the past few years, the record on governance performance has been mixed. The current official strategy is generally sound and consistent with the Bank’s recommended best practices on combating corruption The PRSC program has provided support to the governance strategy. The government’s principal measures included public administration reforms directed at the two principal revenue-raising agencies, tax and customs administrations, reforms in the judiciary, actions to build a competitive private sector and higher public financial audit and accounting standards
Key institutional outcomes are expected to be the attainment of international standards in customs control and in tax administration, the adoption of GFS 2001 budget classifications and IPSAS cash basis standards in all ministries, budget execution reports to contain both financial and non-financial performance indicators, staff performance appraisal system in implementation in pilot ministries, adherence to the international standards and best practices in internal and external auditing, the internal audit system being fully in place in pilot ministries, non-commercial organizations complying with financial reporting requirements, and electronic procurement introduced. The efficiency of capital markets, the volume of listing of companies and of share trading will benefit from stricter corporate governance standards
The improved competition environment will be evident in a sharp fall in transport costs in aviation and rail services and in quality gains in utilities services in line with quantitative indicators set as minimum service quality standard for frequency and duration of available service. A new telecommunication policy would make possible the entry of a third GSM operator. The entrenchment of property rights is expected to lead to an expansion of financial intermediation with increases in credit extended and in deposit mobilization by banks. A near four-fold rise in insurance activities is expected over a three year period

Risks

(This section should discuss the risks that the proposed operation faces. Risks should be assessed as high, medium, or low. For each risk, government policy statements and actions aimed at mitigation should be highlighted. This section should also note how actions by the Bank, including under the proposed operation, the presence of an IMF program, and/or actions of others donors reduce the risks. In addition, it should be noted how the risks are, on balance, offset by the expected benefits of the proposed operation.)

The proposed credit is subject to several risks. First, although the authorities have demonstrated most impressive, single-minded efforts at pursuing difficult reforms over a sustained period, attention will begin to shift to the presidential election campaign that is expected to begin towards the end of 2007. Second, as the reform agenda advances deep into difficult terrain – the fight against corruption, adopting modern standards in regulatory reform, reductions in health labor force and facilities, making contentious choices in designing the pensions system – reform fatigue could set in, especially under conditions of easy and large donor grant funding. Third, external price shocks (energy, commodities) could intensify or a fall in remittances if growth in Russia and the world slows significantly could take place; these would pose a risk to growth and inflation if not met with appropriate macroeconomic policy responses.

These set of risks require pro-active management. On the political front, dialogue with the Bank will continue to be intense and it is encouraging that over the direction of economic reforms there is broad consensus. The wide participation through which the PRSP was formulated and the continuing involvement of civic organs in its implementation offers some protection against reform fatigue. Donors should also remain alert as to the quality of projects and absorption constraints when deciding on commitments. The Bank will remain in active dialogue with the client and with donors on all these matters. The comfortable fiscal and debt positions and the willingness of the authorities to use fiscal and monetary instruments to counter possible shocks are notable.


  1. Poverty and Social Impacts and Environment Aspects


Poverty and Social Impacts

(The Bank determines whether specific country policies supported by the operation are likely to have significant poverty and social consequences, especially on poor people and vulnerable groups. For country policies with likely significant effects, this section should discuss any relevant analytic knowledge of these effects and of the borrower’s systems for reducing adverse effects and enhancing positive effects associated with the specific policies being supported.)
The analysis suggests that sustaining high rates of growth will remain a decisive factor for continued poverty reduction in Armenia with macroeconomic stability and reforms stimulating private investment being the central part of the government’s poverty reduction agenda. The government can affect the poverty reduction in two main areas: (i) reforms that sustain and diversify sources of growth, including the measures that encourage incomes of the poorest households, and (ii) reforms that strengthen public transfer programs and improve public service delivery. An attempt has been made to review the potential links of the PRSC supported programs to the poverty reduction and simulate the PRSC supported reform impact. No adverse social impacts are expected from the actions to be taken.
Growth will continue be channeled to the households through multiple sources increasing both factor and non-factor income. Strong growth in factor income from both labor and capital will be accompanied by consistent improvement in public transfer programs and sharp rise in old-age pensions in 2008-2012. The country will also continue to depend on remittances but to a lesser extent as the growth will become the main driver of job-creation and poverty reduction. Domestic savings will continue to grow. Such multiplicity of income sources will benefit various types of households and resulted in broad based poverty reduction as well as reduce the economic vulnerability of Armenian population.
Environment Aspects

(The Bank determines whether specific country policies supported by the operation are likely to cause significant effects on the country’s environment, forests, and other natural resources. For country policies with likely significant effects, this section should discuss any relevant relevant country-level or sectoral environmental analysis of the borrower’s systems for reducing such adverse effects and enhancing positive effects.)

The PRSC supports several policy and institutional reforms in the environment and forestry sector by focusing on environmental supervision, national forest policy, combating illegal logging, establishing community forestry, and institutional restructuring in the forestry sector. Key government policies and programs that are addressed through the PRSC cover (i) environmental impact assessment and supervision and (ii) policy and institutional reforms in the forest sector. These actions are partially supported by the ongoing Natural Resources Management and Poverty Reduction Project (NRMPRP), which aim to support sustainable natural resource management in mountainous areas of Armenia, where degradation of natural resources is reaching a critical point. Actions under the PRSC are expected to have a substantial beneficial impact on environmental management. Key environmental risks in the country are expected to be reduced by creation of community forestry programs and reduction of illegal logging, and improvement in water supply


  1. Contact point


(This section should indicate the Task Team Leader(s) information)
Contact: Saumya Mitra

Title: Lead Economist

Tel: (202) 458-9713

Fax: (202) 522-2753



Email: Smitra@worldbank.org



  1. For more information contact:


(This section describes the Infoshop information as follows:
The InfoShop

The World Bank

1818 H Street, NW

Washington, D.C. 20433

Telephone: (202) 458-5454

Fax: (202) 522-1500

Web: http://www.worldbank.org/infoshop)

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