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PROGRAM INFORMATION DOCUMENT (PID)
APPRAISAL STAGE
Report No.: AB1266
Serbia and Montenegro Second Structural Adjustment Credit
Operation Name
(Republic of Montenegro)
EUROPE AND CENTRAL ASIA
Region
Financial Sector (25%); Energy Sector (25%); Pension and Health
Sector
Reform (25%); Public Administration Reform (25%)
P074908
Project ID
SERBIA AND MONTENEGRO
Borrower(s)
REPUBLIC OF MONTENEGRO
Implementing Agency
December 12, 2004
Date PID Prepared
March 15, 2004
Date of Appraisal
Authorization
September 16, 2004
Date of Board Approval
1. Country and Sector Background
Under the present federal structure of SaM, the two constituent republics—the Republic of Serbia
and the Republic of Montenegro—are macroeconomically autonomous and are responsible for nearly all
aspects of economic policy. The proposed operation will focus on Montenegro, the smaller of the two
republics.
The 1990s was a lost decade for SaM. Although the country started the period relatively well
integrated with the world economy and with higher standards of living than most other transition
economies, the SaM economy was devastated as a result of armed conflicts, international sanctions, and
trade shocks stemming from the break-up of the SFRY during the 1990s.
By the time of the Federal elections and Serbian parliamentary elections in the last quarter of 2000,
which brought to office reform-oriented governments with a mandate to bring greater democracy,
modernization and integration with the international economy, Montenegro had already made significant
progress in stabilizing the economy and implementing a reform program. In November 1999 the
Montenegrin Government declared the German mark (DM) an official parallel currency. One year later
the new Central Bank of Montenegro (CBM) declared the DM the sole legal tender in the republic.
During 1999 and 2000, the Government of Montenegro financed its budget deficit with substantial
foreign grants.
The Montenegrin Government has made significant progress in structural reforms since 1998.
Montenegro had gradually obtained de facto autonomy in foreign trade, adopted its own customs
administration and established a liberal trade regime. By mid-2000, the Government of Montenegro
reduced the average tariff to about 3 percent. The Montenegrin Government has also liberalized prices;
undertaken a mass privatization program; restructured and privatized nearly all commercial banks; and
enhanced the transparency and management of public expenditure.
Montenegro’s stabilization efforts succeeded in laying the foundation for economic recovery by
curtailing inflation which fell to 25 percent in 2000 from 128 percent in 1999 (and well below the 115
percent recorded in Serbia in 2000). By 2002, inflation in Montenegro had fallen to single digits. Real
GDP rebounded from the steep 9 percent decline in 1999 (which reflected the impact of the Kosovo
conflict), growing by 4 percent in 2000.
Nevertheless, subsequent economic performance has been disappointing. While most
macroeconomic statistics in Montenegro are either not available or are unreliable, available estimates
indicate that GDP growth has been modest in the past 3 years, unemployment has remained high, and
job creation has been negligible. In addition, external and fiscal imbalances have remained
unsustainably large.
While transition reforms have progressed, they are incomplete, were not always planned in an
integrated fashion and were introduced with inadequate attention to implementation capacity. The size
and scope of Government intervention in the economy remains large and the capacity of public sector
institutions to implement reforms remains weak. The reform effort of recent years has improved
governance, public sector transparency and financial discipline, but more needs to be done in each of
these areas. One of the key challenges the Government now faces is building strong institutions with the
capacity and incentives to carry out the recently adopted formal elements of reform.
The authorities realize the significance of the satisfactory progress in these policy areas for placing
the country on a sustainable growth path and are determined to collaborate with international financial
institutions towards successful implementation of their reform agenda. To this end, the Government in
cooperation with the IMF and the World Bank has formulated a medium-term stabilization and reform
program for 2002-05, which has been supported by a three-year Extended Arrangement approved in
May 2002. Attaining sustainable growth and improved living standards, low inflation, and a viable
external position constitute the main objectives of the program. As was envisioned in the Transitional
Support Strategy agreed with the Government, the proposed operation will focus on key medium-term
structural and institutional reforms and complement the macroeconomic program supported by the IMF.
2. Operation Objectives
The proposed Second Structural Adjustment Credit (SAC 2) aims to support the Government of the
Republic of Montenegro, in the implementation of key structural reforms to promote growth and to
support further fiscal consolidation. The program to be supported by the proposed operation intends to
achieve these objectives through specific reforms in the areas of: (i) the financial sector; (ii) the energy
sector; (iii) pension and health; and (iv) public administration.
In the financial sector, the Government program supported by SAC 2 will: (i) begin to resolve the
assets carved-out from Montenegrobank and transferred from the failed banks; (ii) divest a majority
stake in the remaining large state-owned bank; and (iii) implement measures to further restrict off-shore
banking and money laundering activities.
In the energy sector, the Government is now focusing on effective implementation of the provisions
of the Energy Law and extending the reform of power tariffs to the largest consumer of electricity in
Montenegro. The SAC 2 program would: (i) strengthen the financial viability of EPCG; (ii) support
EPCG commercialization; and (iii) ensure affordability for poor energy consumers.
SAC 2 will support reforms in both the pension and health sectors. The key objectives of the
pensions reform are (i) to ensure the effective implementation of the reforms introduced in 2003 aimed
at improving the transparency and management of public finances; and (ii) to further lay the ground
work for the next stage of pension reform envisaged in the Law on Pension Insurance, through the
drafting of new legislation to regulate voluntary pension funds. The Government is also launching
reforms in the health sector in accordance with the Montenegro Health Sector Development Strategy
adopted in November 2003. This strategy seeks to put in place a framework to strengthen the financial
sustainability, efficiency, quality and governance for health insurance and health care. The
Government’s health reforms would also seek to introduce transparency and improved management of
pharmaceutical expenditures.
Finally, in public administration, the reforms supported by SAC 2 would (i) depoliticize top level
posts and establish a merit-based civil service system; (ii) reform the policy process to control the fiscal
cost of the public administration; and (iii) develop the accountability system, by strengthening an
independent internal control function in the state administration (administrative accountability), by
developing of the administrative court system (judicial accountability) and by improving external
oversight through the Ombudsman institution (parliamentary accountability).
3. Rationale for Bank Involvement
The Transitional Support Strategy (TSS – Report 22090-YU, June 26, 2001) for the Federal
Republic of Yugoslavia (FRY, now the Serbian and Montenegro (SAM)) proposed a broad program of
support for FY02-04 focused heavily on policy reform. Up to US$540 million in IDA resources have
been allocated over the FY02-FY04 period, with actual lending determined by policy performance. The
TSS envisaged up to 80 percent of commitments in the form of adjustment credits to support critical
policy reforms. Due to the highly devolved nature of SAM and the different starting points and pace of
reforms in the two constituent republics, the reform agenda areas described in the TSS entail
differentiated reform programs in each republic. Thus, the TSS Updates of July, 18 2002 and February
18, 2004 confirmed the approach whereby the policy reform program – and the Bank’s planned
adjustment lending – is structured to address the specific needs of each republic. This approach
envisions credits provided to SAM and on-lent to the republics, to back primarily republic-level reforms.
Such a differentiated approach addresses the different starting points, reform challenges and pace of
reforms in the two republics and avoids the risk of delaying disbursements to one republic due to a
lagged reform effort in the other.
Progress in stabilization and structural reform has been substantial in both republics and the Bank
has supported the reform agenda through a number of adjustment operations. Consistent with the
strategy laid out in the TSS, by end-June 2004 US$315 million for Serbia and US$15 million for
Montenegro has been directed toward adjustment credits. These quick disbursing funds have been
crucial for closing the financing gap in both republics while facilitating the design and implementation
of a critical set of structural reforms. The Bank has supported the reform program in the Republic of
Montenegro thus far by a single multi-sector adjustment operation (Montenegro SAC 1). Montenegro
SAC 1 closed on January 30, 2004.
4. Financing
The operation will be in the amount of around US$18 million equivalent disbursed in two equal
tranches.
5. Institutional and Implementation Arrangements
As a result of the highly devolved nature of SaM and the different starting points and pace of
reforms in the two constituent republics, the proposed operation will focus on the Republic of
Montenegro. The Ministry of Finance of Montenegro will serve as the main Government counterpart
which will ensure the overall coordination among several other agencies involved in the program: the
Ministry of Labor and Social Affairs, the Pension Fund, the Ministry of Economy, the Electric Power
Company of Montenegro (EPCG), the Ministry of Health, and the Health Insurance Fund. Reforms to be
supported under the Bank operation will be implemented through a variety of mechanisms, including
inter-agency working groups. Bank experts will assist the relevant officials and working groups.
6. Benefits and Risks
SAC 2 builds on and consolidates reforms supported by Montenegro SAC 1. The two-tranche
operation, focuses on two broad themes (i) reforms to promote growth and (ii) reforms to support further
fiscal consolidation. The financial sector reforms would help to promote growth through increased (and
increasingly efficient) financial intermediation. Pension, health and public administration reform would
ultimately support ongoing fiscal consolidation. Energy sector reforms would support both growth and
fiscal consolidation by overcoming episodes of supply shortfall and ensuring the financial selfsufficiency of energy utilities. Increased institutional transparency and accountability and increased
focus on implementation capacity are themes thread through each of the five policy areas. SAC 2 will
also provide crucial financing to help close Montenegro’s budgetary gap.
The proposed SAC 2 also comes with a number of potential risks. Despite recent progress in
implementing structural reforms and stabilization policies, the size and scope of Government
intervention in the economy remains large while the capacity of public sector institutions to implement
an ambitious reform agenda, while much improved over the past few years, remains relatively weak.
The process of building strong institutions with the capacity and incentives to carry out the formal
elements of reform is a medium-term endeavor. The ability of the Government to stay the course as they
implement the reform program will be challenging. The risks involved with the weak policy making
capacity are exacerbated by the uncertain political environment. The present constitutional arrangements
in the union of Serbia and Montenegro require harmonization of trade, customs, and excise regimes of
the two republics. This has proven challenging thus far. The constitutional arrangements also allow
either republic the possibility to hold a referendum on opting out of the union. Other potential risks are
posed by the lack of reliable macroeconomic statistics including national accounts, balance of payments,
monetary, and other statistics needed to guide macroeconomic policy making. Given Montenegro’s
exchange rate regime, unforeseen external imbalances would lead to downward pressure on the money
supply which could have a deflationary impact. Various external shocks could strain Montenegro’s
ability to maintain a sustainable macroeconomic framework. Any interruptions in donor flows would
exacerbate the fragility both of the balance of payments and the financing of the budget deficit.
On balance, the risks are outweighed by the potential benefits to be derived by continuing to
improve the strengthen the economy, by providing needed budgetary support, and by creating a more
secure and consistent foundation for other donors to provide similar support. Recovery will remain
difficult and will not be possible without adequate and timely support from the Bank and other donors.
These benefits will be felt not only in Montenegro and SAM, but also in the wider South East European
region, as a more rapid and sustainable recovery in SAM would enhance its ability to become a
stabilizing force in the region
7. Poverty and Social Impacts and Environment Aspects
The Government’s structural reform program supported by SAC 2 will have an important impact on
poverty and will support the goals set out in Montenegro’s recent PRSP. The Government of
Montenegro has demonstrated a clear concern for managing any negative social impacts of reforms. In
recent years the Government has implemented a number of measures to improve the targeting of social
welfare programs. The PRSP process has been a collaborative effort between the Government and
NGOs. The authorities are also working with the Bank and other donors to develop the data and
analytical capacity required to ground future adjustment operations in a deeper understanding of various
policies on the living standards of the poor. One area where Montenegro’s PRSP needs further
strengthening is its lack of alignment with the budget process. The implementation of SAC 2 will
coincide with Bank assistance in strengthening this alignment.
Each of the reform areas to be supported in SAC 2 are included in Montenegro’s PRSP. As the
Poverty Assessment emphasized, the shallowness of poverty in Montenegro suggests that even small
economic shocks can have potentially large effects on poverty. A positive shock, such as sustained
economic growth, is likely to result in a disproportional decline in poverty, while a negative shock, such
as a recession, is likely to result in a disproportional increase in poverty. The financial sector and energy
sector reforms in the SAC 2 program will enhance prospects for growth and thus poverty reduction by
improving access to finance and overcoming episodes of energy supply shortfalls. The energy sector,
pension and health, and public administration reforms should contribute to a reduction in non-poverty
related public expenditure which would should help ensure that the process of fiscal consolidation does
not rely on reductions in social transfers to the poor. Successful fiscal consolidation would leave the
Government in a better position to mitigate negative external shocks and thus cushion their effects poor.
Health reforms should eventually lead to more affordable pharmaceutical prices. Public administration
reform should contribute to a more efficient Government increasingly capable of implementing well
targeted social welfare programs.
The proposed SAC 2 is not expected to result in any negative impact on the environment.
Contact point
Contact: Bruce J. Courtney
Title: Senior Country Economist
The World Bank
1818 H Street, N.W.
Washington, D.C. 20433
Tel: (202) 458-5242
Fax: (202) 614-7776
Email: [email protected]
For more information contact:
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