Documentof The World Bank FOROFFICIAL,USEONLY ReportNo. P7536-BH INTERNATIONAL,DEVELOPMENT ASSOCIATION PROGRAMDOCUMENT FORA PROPOSEDSECOND SOCIAL SECTORADJUSTMENT CREDIT INTHEAMOUNT OFSDR34.7 MILLION (US$5 1.O MILLIONEQUIVALENT) TO BOSNIAAND HERZEGOVINA MAY 17,2004 South East Europe Country Unit Human Development Sector Unit Europe and Central Asia Region This document has arestricteddistribution and maybe usedbyrecipientsonly inthe performance of their official duties. Its contents maynototherwise bedisclosed without World Bank authorization. CURRENCY EUUIVALENTS (as o fMay 12,2004) Unitofcurrency: KonvertibleMarka(KM) 1KM=US$0.61; 1KM=EURO.51 FISCAL YEAR January 1-December 31 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS ALP Active Labor Programs MOF MinistryofFinance BAC Business Environment Adjustment Credit MTDS MediumTerm Development Strategy BH Bosnia and Herzegovina MTEF MediumTerm Economic Framework CAS Country Assistance Strategy PER Public Expenditure and Institutional CFAA Country Financial Accountability Review Assessment PFs Pension Funds CPAR Country Procurement Assessment Report P I 0 Pension and InvalidFund csw Centers for Social Work PFSAC Public Finance Structural DFID Department for International Adjustment Credit Development, UnitedKingdom PRSP Poverty Reduction Strategy Paper EDS Economic Development Strategy RS Republika Srpska EMSAC Economic Management Structural SAA StabilizationandAssociationAgreement Adjustment Credit SAP Stabilizationand Associationprocess ERC-ZIP0 Electronic Accounting Center SBA Stand-by Arrangement EIs Employment Institutes SDRs Special DrawingRights EU European Union SESP Second Employment Support Project FBH Federation o fBosnia and Herzegovina SFRY Socialist FederalRepublic o f FRY Federal Republic of Yugoslavia Yugoslavia GDP Gross Domestic Product SITAP Social Insurance Technical IDA International Development Association Assistance Credit IMF InternationalMonetary Fund SOSAC I First Social Sector Adjustment Credit JSA Joint Staff Assessment SOSAC II Second Social Sector Adjustment Credit KM Konvertible Marka SOTAC Social Sector Technical Assistance Credit LFS Labor Force Survey SWCP Social Welfare and Child Protection LSMS LivingStandardsMeasurement Survey USAID United States Agency for International MFTER Ministryfor ForeignTrade and Development Economic Relations Vice President: Shigeo Katsu Country Director: Orsalia Kalantzopoulos Sector Director: Charles Griffin Sector Manager HermannVon Gersdorff Task TeamLeader: Philip O'Keefe FOROFFICIAL USEONLY Staffand consultantswho contributedduringpreparationinclude:PhilipOKeefe (TTL), Jean-LucBemasconi, MilanVodopivec, CsabaFeher, DenaRingold, ImeldaMueller, Jeanine Braithwaite,AugustinaNikolova, SimonGray, Kinnon Scott, Dirk Reinemann,Mark Walker, SanjayVani, Jacob Gammelgaard,CharlesCragin, andZeljka Meheljic. Peerreviewers are Louise Fox (AFSVP) andJohn Blomquist (HDDSP). Annette DixonandMichal Rutkowski(ECSHD) were the SectorDirectorand SectorManagerrespectivelyduring the bulk ofpreparation, andHermannVon Gersdorffthe Sector Managersince appraisaland CharlesGriffin the Sector Director since negotiations. The teamwould also like to acknowledgethe support ofaPHRDgrant from the Governmentof Japan, andthe contributionsof consultantsChristianBodewig, KendraGregsonand Alan Abrahart underthe grant to preparatorywork by the Government. This document hasa restricteddistribution andmay be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed lwithout World Bank authorization. 7 SecondSocialSector AdjustmentCredit CREDIT SUMMARY Borrower: Bosnia and Herzegovina, with sub-credit Agreements with the Federationof Bosnia and Herzegovinaandthe Republica Srpska. Amount: SDR34.7 million(equivalent to US$51.O million) Terms: Modified IDA terms of 20 years maturity with 10 year grace period Commitment Fee: 0.5 percent per annum Objectives: The objective o f the Second Social Sector AdjustmentCredit (SOSAC II)isto support reformsincashtransfer andlaborprogramsand institutions inBHwhich reorient socialprotection towards programs which protect the poorest andmost disabled ina fiscally sustainable manner. This is consistent with broader efforts to reduce public spending and focus it on priorityneeds, and to addressregonal imbalances within each Entity. These objectives are key elements of the recently approved MediumTerm Development Strategy (PRSP). Specifically, the priority program goals are to: (i) ensure that protection for disabled veterans and survivor families i s better focused on the most disabled, while gradually reducingpublic spendingon veterans' programs; (ii) improve the impact and efficiency of the social safety net for the poorest, inparticular social welfare benefits and services, including a strengthenedrole for the non-govemment sector; (iii)consolidate an appropriate institutional structure for employment services at State and Entitylevels, andreorient active labor policies to increase cost effectiveness, transparency and employment outcomes; (iv) improve the efficiency and equity ofpensionand disability programs, includingpensions policy harmonizationbetween the Entities o f BH; and (v) ensure that social policy reforms are done on the basis of better information, withinthe system and to the public, andthat living standards monitoringi s more effective and timely. Benefits: The mainbenefits of the operation would be: (i)ReorientationofthestructureofsocialtransferspendinginBH away from entitlement-based programs for those frequentlynot in need (particularly inveterans' programs) to those most inneed (particularly those receiving social welfare benefits and services). (ii)Reductioninthefiscalpressurefromtransferprograms,which shouldpromote more sustainable social protection spending. (iii)Contribution-particularlyinFBH-toamoreeffectivedivision o f roles and responsibilities insocial protection ineachEntity,by promoting financing and institutional arrangements where financing and implementation capacities are more closely aligned. (iv) Promotingequity of coverage ofsocialprotection programs withinthe Entities andharmonizationof entitlement structures betweenEntities. (v) Promotingaccountabilityofthe Government to the generalpublic on social protection issues, including greater involvement of NGOs and civil society insocial welfare provision; and (vi) Encouraging a more direct role for the Statelevel insocial policy, inparticular inthe labor andNGOfields. Risks: The mainrisks o f the proposed operation are: (i)The political economy o fthe reforms supported i s challenging. The veteran populationwho are perceivedas "losers" are a well- organized lobby, as are firms who have benefited from allocation o f credit from employment programs. Incontrast, beneficiaries such as social welfare clients, the unemployed, and severely disabled veterans are often fragmented and without political voice, The implementationrisks cannot be eliminated and will remain significant. However, they are being mitigatedby continued engagementwithveterans' organizations by Entity govemments, public information on the motivation for social policy reforms, and closely coordinatedpolicy support fromkey actors inthe internationalcommunity. The reformagenda is also consistent with the MTDS. (ii)ThemacroeconomicpositionofBHremainsfragile,and vulnerable to external shocks, such as lower than expected foreign investment, slower than expectedrecovery among trading partners, and insufficient supply response from the domestic economy to rising export opportunities. The macroeconomic risks are compoundedby fiscal risks, among others related to the pending settlement of domestic claims. (iii) technicalcapacityoflocalcounterpartssuggeststhatthere The will be an ongoingneed for technical support fromBankteams. (iv) Forparts ofthe agenda, coordinationbetweenEntitiesandefforts to havejoint or harmonizedpolicies may face challenges. This riskisbeingmitigatedby strongefforts to havejoint or parallel policy development through initiatives such asjoint worlung groups andregular inter-Entity consultation. Thejoint MTDS implementationmonitoring provides an ongoing focus for these efforts. Scheduleof Disbursements: Two tranches Poverty Category: N/A Rate ofReturn: N/A Project IDNumber: PO70992 Map IBRD32760 PROGRAMDOCUMENTOF THE INTERNATIONALDEVELOPMENTASSOCIATION ONA PROPOSED SECOND SOCIAL SECTORADJUSTMENTCREDIT TO BOSNIAAND HERZEGOVINA Table of Contents I.TmECONOMY 1 11. THECOUNTRY'S STRUCTURALREFORMPROGRAM 8 111. THEPROPOSEDSOSACI1OBJECTIVESANDRATIONALE 9 IV. SOCIALPOLICYREFORMPROGRAMSUPPORTEDBY SOSACI1 12 A. Social Welfare andChildProtection 12 B. Veterans Programs 14 C. ProgramsandBenefits for the Unemployed 17 D. PensionsandDisabilityPrograms 19 E. Frameworkfor OperationofNGOsR'hird Sector 21 F. Living StandardsMonitoring 21 G. Public Informationon SocialPolicy 22 V. THEPROPOSEDCREDIT 22 A. Rationale for Bank Involvement 22 B. Benefits andRisks 23 C. Coordination withthe LMFandOther Donors 24 D. Negotiations andBoardConditions,TrancheTriggers andSupervision 24 1, Negotiations andBoardConditions 2. SecondTranche Conditions E. Project ManagementIssues 27 1. Administrative Arrangements 2. Disbursement 3. Monitoring Arrangements F. Poverty Implications 28 G. Environmental Impact 29 Annex 1. KeyEconomicIndicators 30 Annex 2. Statementof Loans andCredits 32 Annex 3. IFCPortfolioinBosnia andHerzegovina 33 Annex 4. Timetableof KeyProcessingEvents 34 Annex 5. Letter of DevelopmentPolicy 35 Annex 6. PolicyReformProgramMatrix 47 Annex 7. Additional monitoringindicatorsfor mediumterm SOSACI1program 53 Annex 8. Summaryof communityassessment findings 55 Annex 9. Outlineof SocialSector TechnicalAssistance Credit (SOTAC) 57 Annex 10. Summaryof PovertyAssessment Findings 59 Annex 11. Country at a Glance 61 Map BosniaandHerzegovina (IBRD 32760) 63 PROGRAMDOCUMENTOFTHE INTERNATIONAL DEVELOPMENTASSOCIATION ONA PROPOSEDSECONDSOCIALSECTORADJUSTMENT CREDIT TO ]BOSNIAAND HERZEGOVINA 1. This ProgramDocument describes a proposed secondSocial Sector Adjustment Credit (SOSAC 11) to Bosnia andHerzegovina (BH) inthe amount o f SDR 34.7 million (UStS5 1.O million equivalent) to support the Government's structuralreform program. The Credit would be providedonmodifiedIDA terms of20 years maturity with 10years graceperiod. 2, This ProgramDocument i s hlly consistent, and should be read inconjunction, with the Country Assistance Strategy (CAS) of the World BankGroup for Bosnia andHerzegovina, ReportNo. 20592, dated July 12,2000, andthe CAS ProgressReportNo. 24978, datedOctober 15,2002. The proposed SOSAC 11 i s also consistent with BH's social policy reformprogram inthe recently approved MediumTerm Development Strategy (PRSP), which emphasizesthe need for reducingthe country's highunemployment rate, reducing the aggregateburden o f the cashtransfer systemwhile reorienting it to programs targeted to those most inneed, and improving efficiency and transparency inthe operationo f socialprograms. The proposed SOSAC IIalso buildsupon the BH's achievementsunder the predecessor Social Sector Adjustment Credit (SOSAC I), and Public Finance Structural Adjustment Credits (PFSACs). I.THEECONOMY A. Institutionaland Political Background 3. Followinga devastating conflict andthe DaytonPeaceAgreement in 1995, BHhas madeprogress inestablishing itselfas amodem andviable state, includingby:(i) enhancing internal harmonization ofthe relatively autonomous sub-national entities while strengthening the coordination functions ofBH's central state; and (ii) increasingexternal integrationby engaging into the Stabilizationand Associationprocess (SAP)with the EuropeanUnion(EU)as well as pursuingother avenues of international integration (Council of Europemembership, WTO accession, etc.). However, the integration agenda i s far from complete, and the designand implementation o freforms still has to overcome the complex political and institutional situation which arose from the DaytonPeace Agreement 4. Betweenearly 2001 and late 2002, reform-orientedcoalitions at the level o f State and Entitieswere able to acceleratereforms and consolidate macroeconomic stability through sound fiscal and monetary policies. Progresswas also made instrengthening cooperation betweenthe two Entities, by strengthening Giventhat BHqualifies for IDA borrowing but lies above the IDA cut-off, the terms o fthe Credit are subject to exceptionallyhardened IDA terms, as agreed during the IDA XI11replenishment. See MTDS, submittedto the Bank and FundinApril 2004. The DaytonPeaceAgreement (DPA) provides for four levels ofGovernment. The State ofBH(theState) is at the highest level, while the next level is constituted bytwo Entities, the Federationo f BH(FBH), mainlyinhabitedbythe Bosniak (Muslim) and Croat ethnic groups, andthe predominantly Serb Republika Srpska (RS).The FBHis a highly decentralized Entity, divided inten cantons andeighty municipalities. Incontrast, the RS is organized around a unitary concept o fgovernment, and consists of sixty-two municipalities. Since 2000, BHalso includes an autonomous territory, Brcko District. The DPA also established the Office o fthe HighRepresentative ( O m )with a mandate to overseethe implementation o fthe peace accords, with executive powers oncivilian matters, including legislative veto and impositionpowers, as well as laws on the capacity to remove officials from office. 2 state-level institutions to enforce country-wide standards, and by harmonizinginter-entity policies (e.g., reforms of indirect taxation ).4 Inparticular, reformswere achievedinthe defensesector, with the centralizationo f command and control structures at the level o f the State. However, the Governments failed to make significant progress on some of the most important structuralreforms such as strategic privatizations or reformof the socialprotection system. Elections inOctober 2002 saw the retumof the parties that hadbeen inpower for most o fthe post-war period. Since taking office, the Governments have reaffirmedthe common overarchingobjective o f EUassociation and membership. Policy statementsand reformplans approved since then also signal a recognition that the pathto EUaccession involves deepening reforms. A feasibility study released by the EuropeanCommissioninNovember 2003, concludes that opening o fnegotiationsfor a Stabilization and AssociationAgreement (SAA) in2004 can be envisaged, on the condition that BHmakes significant progress inanumber o f areas identifiedby the Commissionas priorities for action.' 5. Encouragingly, Entityand State government officials regularly discuss and coordinate the formulation ofreformpolicies. Among other factors, the MTDS process has proven to be an effective vehicle to facilitate and institutionalize national policy dialogue and consensusbuilding.The reform programi s comprehensively presented inthe recently approved MTDS,which was officially forwardedby the authorities to the World Bank inApril 2004 (see paragraphs 24-26 below). B. Recent Economic Developments 6. BHhasrecordedimpressive growthrates since the war (an average21percent inrealGDP growth between 1996and 2002 -see Table l), when compared to other post-conflict economies. Inthe even immediate aftermatho f the conflict, growth was mainly spurredby reconstructionandrehabilitation investment inpublic infrastructureandprivatehousing. Spending has been predominantly financed by large and sustainedaid flows. Private transfers, estimated to have averaged 12percent o f GDP over the last five years, have also played an important role infueling domestic spending. More recently, while remaining positive (an estimated 3.5 percent in2002), growth slowed, mirroringdeclining official aid and stagnating manufacturing activity. The trendo f decreasing aid flows i s likely to continue, as the focus underpinning donor commitments shifts from reconstruction financing and support o frefugee return, to providing technical assistance insupport of structuraland administrativereforms. 7. Money and credit. Due to strict adherenceto the currency boardintroducedin 1997,inflation has rapidly decelerated to single digit levels and has remainedbelow one percent in2002 and 2003. The inflation differential betweenthe two Entitieshas also beenreduced. Inthe aftermatho f the introductiono f the euro and the reverse currency substitution it triggered 6, as well as the successful restructuringand modernizationo f the banking sector, non-government deposits grown significantly between 2000 and 2002 (from 6.5 percent o f GDP to 9.5 percent), leadingto a credit boomin2002, especially credits to the household sector which more than doubled that year. Measures to tighten credit policy were taken in2003 inthe framework ofthe IMFStand-By Arrangement reviews. These measuresappear to have achieved See Implementation Completion Report o fPFSAC11, Report No. P-7318. These 16priority areas include compliance with existing conditionality and international obligations; more effective governance; more effective public administration; Europeanintegration; effective humanrights provisions; effective judiciary; tackling crime, especially organized crime; managingasylum and migration; customs and taxation reform; budgetlegislation; budget practice; reliable statistics; consistent trade policy; integrated energy market; BHsingle economic space andpublic broadcasting. Households exchanged large amounts o fDeutschmarkhoarded against KMdeposits inthe domestic banking system. 3 deceleration incredit growth. Inappropriate indexationmechanisms have allowed accrued and paid wage growth to exceed productivity, with an adverseimpact on employment and corporate profitability inboth Entities. 8. Fiscal outcomes. The post-conflict growth Performance was accompanied inthe initial phaseby large fiscal and external deficits. Onthe fiscal side, the imbalance was inpart causedby the donor-funded public investment programs. Inaddition, post-conflict recovery indomestic revenue collectiontriggered increasesinrecurrent spending, especially on the public sector wage bill, the defense sector and veterans' programs. Since 2000, fiscal stabilization efforts have led, however, to an elimination of the budgetary deficit, which hadpeaked at over 9 percent o f GDP in 1999, while the preliminary fiscal accountsposted a small surplus in2003 worth 0.4 percent of GDP. The reduction intotal spending from close to 70 percent o f GDP in 1999to less than 50 percent in2003 (excluding municipal spending) was significant, even if most o fthe adjustment inexpenditure reflectsthe decline inexternally financed public investment. Similarly, accumulationof new arrears was curtailed to less than one percent o f GDP in2001, leadingthe way to a net reduction inoutstanding payment arrears since 2002. At the same time, expenditure shares on defense and veterans' programs has remained high, squeezingspending on other priorities. 9. External accounts. While fiscal imbalances have beenbrought under control, the widening external current account deficit representsperhaps the single most important challenge facedby BH.Large import volumes that accompaniedthe reconstructionperiod were only partially covered by a subdued export performance. While they have grown faster than overall merchandise imports innominal (euro) terms since 2002, exports still account for only 10percent of GDP. Merchandise imports, representing about a thirdo f GDP, have more recently been spurredby the growth innon-reconstructionrelatedinflows, whichhave accelerated sharply over the past three years. These types o fimports, believedto be largely consumer goods and construction material (inaddition to oil products), surged in2002. As a result, the current account deficit balloonedto close to 19percent of GDP in2002, and was mainly financed by aid flows (about halfthe gap), foreign direct investment andprivate capital and a small drawdown onreserves. In2003, thetighteningofcreditpolices appearsto haverestrainedimport growth, leadingto aslighteasing inthecurrent accountdeficit to about 17percent ofGDP. Encouragingly, foreign direct investment increasingly representsan alternative to aid financing of the balance o fpayments, signaling increased international investor interest inresponseto continuedmacroeconomic stability. Net FDIinflowshave posted consecutive increases in2002 and 2003, reachingover 4 percent o f GDP. 10. Public debt. At the end o f 2003, BH's external debt i s estimated to be sustainable. BHauthorities were able to achieve successivereschedulingagreements as well as the regularizationand cancellation of old debts denominated innon-convertible currencies, while pursuingprudent externalborrowing policies. As aresult, external debt was brought downfrom 70percent ofGDP in 1998to below40 percent at end- 2003. Bank staff estimate the net present value of total external debt at end 2003 to be equivalent to 25 percent o f GDP or 91percent o f exports o f goods and services. As such, BHis classified as a moderately indebtedmiddleincomecountry. Virtually all BHexternal debt ispublic debt, denominated mainly ineuros andU S dollars. The highlyconcessional terms o f donor assistanceprovided to BHhave helped ensure a relatively comfortable position with respect to externaldebt servicing. Inthe full reform scenario described below, the external liquidityratio is expected to decrease below 5 percent by 2007. Inaddition, assuming the continuationof prudentexternal borrowing, the external debt to GDP ratio would decline below 30 percent over the projection period. The trade data for 2003 are beingrevised andpreliminaryestimates suggest a substantial downward revision in imports, resulting ina reduction o fthe current account deficit o fthree percentage points of GDP. 4 11. The public debt situation i s complicated however, by a large overhang o f domestic claims on BH's governments. According to recent IMFestimates, potentialdomestic claims are inexcess o f 200 percent of GDP. The majority of this potential debt relates to the breakup o f former SFRY and the war, including claims against the government for the freeze o f foreign exchange deposits immediately before the war (equivalent to 18 percent o f 2003 GDP) and war claims relatedto material losses as well as non-material damages suffered by families o f veterans and other war victims (13 1percent o f GDP). Additional claims and contingent liabilities originated after the conflict, such as unusedprivatization vouchers that were issued to citizens that have not expired andpublic spendingarrears accumulated before 2002. Table 1. BosniaandHerzegovina: SelectedEconomic Indicators, 1999-2003 1999 2000 2001 2002 2003 Est. Est. Est. Est. Est. (annual percentagechange) Real GDP growth 9.6 5.5 4.4 5.5 3.5 Industrialproductionindex 11.9 9.3 -2.0 11.5 3.8 CPI inflation 2.8 5.0 3.2 0.3 0.1 Grosswages 11.4 12.9 6.8 6.9 9.4 Creditto the privatesector -2.3 8.7 10.9 25.7 22.4 (inpercentofGDP unless othenvisenoted) Total Investment 21.0 20.6 18.9 20.4 19.9 National Savings 12.8 7.6 2.7 1.9 2.5 Governmentrevenues 57.7 53.7 49.7 48.1 46.7 Total Public Expenditure 65.5 60.7 53.1 50.4 46.3 oiw CapitalExpenditure 14.8 10.9 9.2 6.3 4.5 Overallbalance(accruals, incl. -7.8 -7.0 -3.3 -2.2 0.4 grants) Current accountbalance -8.2 -13.1 -16.2 -18.5 -17.4 Totalpublic externaldebt 65.7 58.8 48.2 42.2 34.0 Extemaldebt service (in% of 9.4 7.3 6.3 8.5 7.8 exportsof goods and services) Gross official reserves (in 1.9 2.2 5.1 4.6 5.1 monthso fimports) Source:IMF, FourthSBA review, February2004; Bankstaffestimates. 12. As aresult, boththe State and bothEntityGovernments have recently committed, inthe framework of the IMF Stand-By Arrangement, to implement domestic claims settlement plans that wouldreduce the outstanding burden o f domestic claims to no more than 10percent o f 2003 GDP inNPV terms. Quantitative frameworks for settlingthe claims have been established for bothEntities, including combinations o f cashpayments, debt write-offs or securitizationinvery long-termbonds (20 to 50 years) withextendedgrace periods andvirtually no coupon. Inparallel, laws onmoratoria on the enforcement of pendingcourt lawsuits relatedto war damageswere passedby State andEntityparliaments. While the moratoriaare inplace and claims verification progresses, entity laws that would enshrine the govemments settlement strategy are being drafted and are expected to be adoptedbefore the Summer o f 2004. While 5 these actions are essential first steps inresolving this important issue, uncertainties around the implementation o f the settlement programremain, rangingfrom possible legal challenges to the debt write- offs to politicalresistance delaying the passage of the domestic claims settlement laws. Ifthe plan is implementedas currently envisaged, including the issuanceo f government bonds to settle part of the claims would add some 30 percent of GDP to the existingburden, so that total public debt (domestic and external) would represent about 60 percent o f GDP at end 2004. C. Track Recordin StructuralandInstitutionalReforms 13. Since the end of the war, progress instructural and institutionalreforms has beenthe most striking inthe financial sector andtrade policy, as well as inpublic finance. Anchored inthe currency board, financial sector reforms have focused sequentially on dismantling of the payment bureaus and the establishment o f amodem payment system, divestiture from the banking sector and the successful entry of strategc investors, the consolidation o f the banlung sector at low fiscal cost, as well as the establishment and gradual strengthening o f the prudential andregulatory framework. Minimumcapital requirements are being strictly enforcedand the prerequisites for participationinthe recently established deposit insurance systemmay leadto further consolidation inthe sector. Many o f these reforms were supported by the Bank's Enterprise andBank PrivatizationAdjustment Credit (EBPAC).* Trade policy reforms have been very pronounced, with the negotiationo fbilateral trade agreementsinthe region that are compliant with Stability Pact principles andthe adoptiono f the most liberal trade regime inthe region. The perceived lack o f success o f these trade reforms to translate into improved trade performance has, however, raised concerns among some policy-makers about the desirability o f further liberalization, while protectionist lobbieshave called for more restrictivepolicies. 14. Withrespect to public finance, the introduction o fmoderntreasury system at all levelsof government above municipalities has contributed to improved spendingdiscipline. Significant progress was also achieved withrespect to tax policy and administration including countrywide harmonization, and improvedcollection enforcement. Initial administrativereforms inthe area o fpublic finance were accomplished, mainly under the program supportedby two Public Finance Structural Adjustment Credits (PFSAC I & n).More recently, BHhas enacted anew legal framework for indirect tax and customs administration, establishing a single, state-level indirect revenue administration that will manageunified customs collection. On the expenditure side, significant reforms to the pensionand healthinsurance systemswere carried out under PFSAC II, butare inneedof further consolidation, Also, significant spending consolidationandstaff downsizing innon-productive functions o f government arebeing implemented. 15. Further reforms inthe public sector will focus onpreparatory work for the introduction o f VAT in 2005 or early 2006, areformthat is widely anticipatedto yieldpositive externalities for the corporate sector, as it would improve the competitive and governance environment. In addition, revenue gains that would emerge from the introductiono f VAT shouldbe used, at least inpart, to reduce the overall tax and contributionburden. On the expenditure side, the pace and scope further rationalization o f a costly multi- layer government structure, which still absorbs above 50 percent o f GDP, will be critical. 16. The modest supply responseto the favorabletrade regime signals areas where structuralreforms havebeenless successful, mainly related to enterprise and labor market reforms. While an important mass * ReportNo. P-7257-BH. BHhas signedbilateral flee trade agreementswith Croatia, Slovenia, Serbia andMontenegro, Macedonia, Turkey, Romania, Albania, Moldova, and Bulgaria. 6 privatizationo f small-scale businesseshasbeenundertaken shortly after the war, itresulted, as inother transition countries, indiluted ownership and weak corporate govemance structures. The privatization of larger state-owned enterprises has lagged, due to the war and lukewarmpoliticalcommitment after the war. 17. The business environment, while modestly improving inrecent years, remains characterized by highbarriers to marketentry for newbusinesses, proliferationofbureaucratic interference andvirtually no formal market exit. The MTDScalls for an acceleration of strategic privatizations, and improvements inthe business and investment climate. Importantly, harmonizedbankruptcy legislationhas beenrecentlyenacted inbothEntities.Thispackageofreformsis supportedbytheBank's BusinessAdjustment Credit (BAC)." 18. Finally, labor market rigidities have persisted, despite important changes inlabor legislationwhich introducedsubstantially greater flexibility into the labor relations framework, including facilitation of more varied and flexible forms o f employment, simplifyingprocedures and entitlements relatedto hiringand dismissal o f workers, and the formal termination of the "wait listing" process inheritedfrom former SFRY. The remainingrigiditiesare primarily driven by practices enshrined incollective agreements and firm-level policy, which retain outdated practices with respect to wage determination and work conditions. ''The full impact o f earlier reforms therefore remains to be felt inthe labor market. D. Current Macroeconomic Policy Framework 19. As outlined inthe MTDS, BH's macroeconomic strategy aims at preservinga stable environment that i s conducive to the implementation of structural reforms that will promote private domestic savings and investment. The authorities have committed to maintainthe currency board andpursue the associated prudentmonetary polices. The fiscalpolicy stance is gearedat further consolidation ofpublic spendingto generatethe public sector savings required. This strategy is fully consistent with the programthat received the support o fthe most recent IMF Stand-By Arrangements (SBA), approvedinAugust 2002 and completed inFebruary2004. The macroeconomic performance under the SBA has been satisfactory with respectto growth, inflation, the fiscal balance and reservesbuild-up.The current account developments have not met expectations however. In addition to observing the program's quantitative and structural performance criteria, important structuralbenchmarks were met, including the preparationo f the domestic claims settlement plan, adherenceto cashmanagementrules o f the pension funds, or the strengthening of banking supervision rules. 20. The BHauthorities have requested further IMF support and it i s envisaged that successful completiono f the SBA will leadto an agreement on a successormedium-term program inthe course of 2004, The programwould focus onkey macroeconomic challenges, includingincreasingcorporate profitability through enterprise restructuring, and the establishment o f a coherent fiscal architecture geared towards coordinated policy formulation. The macroeconomic projections inthe following section are based onthe most recent framework approved at the time o fthe last review o f the SBA. lo No,P-7530-BIH. Report l1A hrtherimportantreformoftheLaborLawswastodiscontinue themandatoryapplicationofcollective agreementsto parties not represented inthe bargaining process. However, the response from employers indeveloping more decentralized bargaining has beenweak to date. 7 E. Macroeconomic Prospects and External FinancingRequirement 21. The medium-term macroeconomic challenge facedby the BHauthorities is to regainpre-war output levels by the end o f the decade, while movingfrom aid dependency to fiscal self-reliance, The medium-term macroeconomic programenvisagedunder the SBA,reproducedbelow, i s generally consistent with the MTDS,and aims to reach a robust and sustainable growthpathwith a strong emphasis on continued fiscal discipline to ensure policy consistency with the currencyboard. Under this scenario of full implementation o freforms (and absence o f exogenous shocks), the share o f investments inGDP would remainhigh, although the nature of capital formation would shift from reconstructionto productive investment. Growth, which would steadily acceleratetowards 6 percent inreal terms until2007, would be mainly driven by foreign direct investment and stronger domestic investment, as well as positive spillovers fromreal export growth. Inthe face o f steadily declining aid flows, BHwill have to achieve an adjustment of its external imbalance and establish creditworthiness inorder to attract commercial financing inthe mediumterm. Exports would grow considerably faster than imports, as private consumptiongrowth would remainmoderate, resulting ina markedimprovement o f the current account. Table 2 below highlightssome o f the key projections inthe fullreformscenario. The scenario ispredicateduponthe acceleration of structural reforms inthe corporate sector, which would boost domestic savings and investment. Table 2. Bosnia and Herzegovina: MacroeconomicFramework, 2003-2007 2003 2004 2005 2006 2007 Est. Proj. Proj.. Proj. Proj. (annual percentage change) Real GDP growth 3.5 5.1 5.7 5.9 6.2 CPI Inflation 0.1 0.9 1.7 2.0 2.1 (inpercentofGDP) Total Investment 19.9 20.3 20.9 21.4 21.9 National Savings 2.5 4.6 6.0 8.2 10.9 Privateconsumption 88.7 86.1 84.9 83.3 81.4 Current accountbalance -17.4 -15.8 -14.8 -13.1 -11.0 Total Govemment revenues 46,7 45.8 44.4 43.0 41.7 Govemment Expenditure' 46.3 45.9 44.4 42.9 41.6 Current Expenditure' 41.9 41.1 39.9 38.7 37.5 Capital Expenditure' 4.5 4.8 4.5 4.2 4.1 Overall fiscal balance 0.4 -0.1 0.0 0.1 0.1 (accruals, incl. grants) 'Excludes municipal spending. Source:IMF, Second and Third SBA review, April 2003 for 2002 data; Bank staff estimates for projections. 22. The MTDS also presents a low-case scenario, inwhich implementationo freforms i s slower or yields a less favorable supply response.Real growth couldinthis case stagnate at around 2 percent, translating into revenue losses and a more pronounced need for fiscal adjustment. 23. Ifthepositivemacroeconomic scenario laidoutabove materializes, BHwill stillneedsizeable, although diminishing,external inflows to support its balance o f payments (see Table 3 ).For the period 8 2004-2005, the total financing requirement would averageabout US$l.4 billion annually. Assuminga gradual decline inproject-relatedfinancing, the increaseof FDIinflows to 6 percent of GDP by 2005, and persistently highlevels o fremittances, a financing gap of US$161would emerge for 2004-2005, that would be coveredby about two-thirds by the World Bankthrough adjustment lending (the proposed EMSAC and SOSAC 2, as well as the remainingtranche o fthe BAC), with the remainder financed by the European Commissionmacroeconomic assistance. Table 3. Bosnia and Herzegovina: ExternalFinancingRequirements, 2004-2007 2004 2005 2006 2007 (inmillionUS$) Requirements 1,367 1,478 1,419 1,277 Olw current account deficit (excl. 1,338 1,346 1,288 1,169 grants) olw debt amortization 94 85 82 58 olw change innet foreign assets -65 47 49 50 Resources 1,259 1,425 1,381 1,240 ofw official transfers 235 188 137 103 olw official loans 105 94 85 81 olw private capital andFDI(net) 914 1,135 1,151 1,044 olw debt relief 5 8 8 11 Financinggap 108 53 39 37 Source: IMF, FourthSBA review, February 2004; Bank staff estimates. 11. THECOUNTRY'S STRUCTURALREFORMPROGRAM The Medium Term Development Strategy (PRSP) 24. Bosnia and Herzegovina's first MediumTerm Development Strategy (PRSP) was adopted byboth State and EntityGovernments inearly 2004, as well as presented to and supported bythe State level Parliament. The BHauthorities formulate three key objectives ofthe country's development program: 0 Create conditions for sustainable growth andbalanced economic development. a Ensure social stability by reducingpoverty and unemployment. a Create the conditions for full membership inthe EUbefore the end o f the decade; and 25. Inorder to achieve these development objectives, the MTDSidentifiesa set ofpolicypriorities including: (i)maintaining macroeconomic stability; (ii) implementing a fiscal reformprogram; (iii) implementpublic administration reform; and (iv) establishing sustainable systems o f social welfare and services. The other policy priorities include achieving politicalconsensus on the reformprogram, promotingprivate sector growth, maintaining financial sector stability, actively pursuingthe SA process .^ IL!The full MTDS document is available inEnglishat www.prsp,info. 9 withthe EU, andjoining the WTO. A key cross-cutting aspect ofthese reforms is the establishmentof reliable yet fiscally affordable and sustainable social safety nets. Reform proposals are basedon the diagnosis o f public expenditure trends which fully reflects the findings o f the Public Expenditure and InstitutionalReview (PER) undertaken with the support of the World Bank. l3 Inparticular, theMTDS,in coherence withthe PER, refersto the following important social sector reformissuesto be addressedin the program: 0 A rationalizationof the systemof the war veteransprotectionwould accommodate some increasesin spending onmore effective and better targetedsocial welfare and childprotectionwhich i s diagnosed as very low byregional standards. Structural reforms are to be initiated to improve andlor maintainthe financial stability of extra- budgetary pension and unemployment funds which hadinsome cases been very weak inthe past. 0 Redistributionwithin socialprotection spending i s to be achievedthrough a modem legislative framework for social protection as well as institutional and budget mechanisms for the strategc development o f social policy, includingtransparent horizontal and vertical coordination between the governmental and non-governmental sectors. 26. As a consequence, the MTDSoutlines anumber ofkey objectives ofthe social sector reform program: (i) rationalizing the veterans benefit system; (ii) introducinglegal and institutionalreform of the social protection system ensuring fiscal sustainability o f and equal access to benefits acrossthe two Entities; (iii)improving the relations between the two Entitypension funds and the inter-Entityportability of pension rights; and (iv) improving the financial position o fthe pension funds inparticular through improvements incontribution collection to ensure stability o fpensionpayments. 111. THE PROPOSEDSOSACI1OBJECTIVESAND RATIONALE 27. Objectives: The overall objective o f SOSAC 11wouldbe to support reforms incashtransfer and labor programs and institutions which reorient social protection towards programs which protect the poorest and most disabled ina fiscally sustainable manner. This i s consistent with broader efforts to reduce public spending and focus it on priority needswhich promote poverty reduction. Iti s also consistent with the needto addressregional imbalances withineachEntity. As outlinedabove, these objectives are key elements of the MTDS. 28. Proposedpolicy agenda and rationale: The proposed policy reformagenda to be supported by the Credit iscentered on four key areas relatedto policy and institutional arrangements for cashtransfers and social services, as well as complementary reforms. The broad agenda was initially outlined as the mediumterm social policy strategy for bothState and EntityGovernments inthe Letter ofDevelopment Policy (LDP) for SOSAC Iinlate 2000. Further development o f the policy agenda was donejointly with a rangeof local counterparts, initially duringa workshop inJune 2001, and subsequently onmissions in2001 and 2002. l4 Policy discussions were put onholdinthe first half o f 2002 and subsequently postponeduntil after October 2002 elections. Re-engagement with new State and Entitygovernments commenced immediately after their formation inearly 2003. This was complemented by a community assessment l3 andHerzegovina:FromAidDependencytoFiscalSelfReliance, ReportNo.24297-BIH, October2002. Bosnia l4Proceedings o f the inter-Entity workshop are on file. The workshop hadparticipation fromaround 120 participants, mostly nationals o fBHfromvarious levels of Government, civil society andacademia, as well as donor andNGO partners, including the Office o f the HighRepresentative (OHR), IMF, DFID, EU,UNICEFand Save the Children. 10 carried out in2002-2003 to assess public understanding of and attitudes towards social policy reforms. 15 The assessment formed the basis for apublic campaign bybothEntityGovernments in2003 titled "40 Days o fDialogue on Social Reforms" which continued the dialogue with civil society on social policy. These consultations have complemented broader efforts within the MTDSprocess to consult widely on social policy and builda consensusaround key reform directions. 29. Coming out o f these processes, the key elements of the SOSAC 11policy agenda are: reforms and rationalizationof veterans`benefits andprograms, to ensure adequate support for the most disabled veterans and families o flulled soldiers, while reducing the unsustainable burdeno f veterans' programs on the budget. This would also facilitate reorientationo f transfer spending to social welfare programs targeted on those most inneed. reforms o f social welfare and childprotectionpolicies, administration and financing, inorder to reduce sharp disparities incoverage inthe current safety net. This would be accomplished by supporting financing reforms for core benefits within eachEntity, adjustinginheritedentitlements to focus on core programs more consistent with existing fiscal andinstitutional capacity, and strengthening the role of the non-government sector inwelfare service provision. buildingonSOSACI, operationwould support consolidationo fthe institutional structure for the delivery of unemploymentbenefits and active labor market programs, as well as improvedbusiness processesinEmployment Institutes. Inaddition, it would support reorientation of active programs away from the current ineffective and non-transparent reliance on credit programs to more cost effective and properly monitored active labor programs. promoting more efficient and equitable functioning o f the PAYGOpension system, throughresolution of inter-Entitypension issues, development of harmonizedpensions policy for all parts of BH,and consolidationo f FBHinstitutional arrangementsfor pensions and social contributions reporting. This would be complemented byreforms o f the disability assessment process to improve the predictability, transparency and fairness o f disability determination for pensions and social welfare programs. 30. Apart from these core elements, it is proposed that other areas be addressedunder SOSAC 11which are consistent with the MTDS and buildon the SOSAC Iprogram, They have inseveral casesbeen supported by technical assistanceunder a TA credit, the Social Sector Technical Assistance Credit (SOTAC, see Annex 9), and include: 0 improvedlivingstandardsmonitoring for social policy making, through carrying out a Household Budget Survey andpanel surveys o f the earlier LSMS and feeding results into policy development. This would also be supported by submission o f the first Law on Statistics at the State level. e improvingpublic information on social policy, by strengthening the ability o f Governments effectively to communicate the goals and trade-offs o freforms to the general population. e data and information system implementation issues insocial programs. e issuesrelatedto institutional roles andresponsibilities insocial policy. 31 The rationale for the proposed SOSAC IIat this point inBH'stransition is: e the overall structure o f cash transfer entitlements and spending has failed to adjust to reflect the fiscal and administrative capacity o f BHas it moves from post-war reconstructionto longer term development. BothEntitiesallocate major shares o f public spending to veterans' benefits, while l5SeeReportofKPMGConsulting:AnalyticalReport onPublicInformation Campaign,2003. 11 devoting lessresources than any other country inthe regionto social welfare andthe needsof the most vulnerable populations. Both Governments acknowledge the need for controlling the aggregateburden o f the cashtransfer system, while reorientingthe structure and focus of transfer spending. This i s in many respects a "belated transition" reform of the inheritedcashtransfer system, the shortcomings of which have been exacerbatedby the increaseinveterans' spending. The technical and financial support o f the SOSAC 11i s considered an important tool to help leverage such change. the limitedguidance provided by the DaytonAgreement on institutionalroles andresponsibilities in socialprotection i s increasinglyrevealing its limitations, as broad and overlapping mandatesto different levels o f government have createdimportant gaps inthe system o f social protectionprograms. Inaddition, thepublicsectorneedsto strengthenitsengagementwithNGOsandcivilsocietyactorsin social policy implementation, as it has yet to transform from a relationship appropriate to a humanitarianphaseto one which reflects apartnership-basedrelationship; and BHhasreacheda stage initspost-war recovery wherethe ongoinglackofreliable datafor policy making, program implementation and monitoring, and public awarenesscan no longer bejustified. The lack o freliable data not only hampers efforts to develop and monitor policy, but contributes to significant lack o f transparency inthe operations ofpublic socialpolicy institutions. 32. Itis important to see SOSAC llinthe context ofbackwardandforward linkages withthe Bank programo f support to BH.The SOSAC 11follows SOSAC I, single tranche operation which supported in a particular reforms o f the labor relations framework inBH. The decisionto sequencethe operations inthis manner was driven by the need at the time o f SOSAC Ifor supportingpolicies to enhance broad-based growth ina period when poverty was widespread inthe aftermath o f the war. Itwas also apparent that the informational and analytical base on the social protection systemwas too under-developed at that time to develop concrete social protectionreforms on a well-informed basis. Both factors suggestedan initial focus within the social policyreformagendaon liberalizing the labor market, complemented bypolicy development for future reforms o f social protection programs and further analytical and capacity building work. This emphasiswas complemented by the Business Environment Adjust Credit (BAC). SOSAC Ihas been satisfactorilycompleted. l6 33. Inparallelwith SOSACI,smalltechnicalassistancecredit, the SOTACwas also approved. This a has since financed detailed analytical work onthe socialprotection system, and helped informdesignof SOSAC II. Project-financedwork was complemented by Bank analytical work under the Public l7 Expenditure and Institutional Review andthe Poverty Assessment. Thiswork combinedwith further technical work with counterparts duringproject preparation to provide a firmer base for development of the SOSAC II policy agenda. 34. SOSAC 11is also complementary to the Economic Management Structural Adjustment Credit (EMSAC), which focuses on structural issues inpublic expenditure management such as the dominance of spendingonpublic sector wages andinter-governmental fiscal relations. The operations intandem thus focus on two critical areas o f the fiscal adjustment needs o fBH: EMSAC on the heavy burden o f spending l6SeeImplementationCompletionReportfor SOSACI, No.23841, April9,2002. Report "Inparticular,analyticalworkandtechnicalassistancehasbeencarriedoutonthesocialandchildprotectionsystem, the businessprocesses and policies of the Employment Institutes, disability policy and administration, and the institutional roles and responsibilities across the social protectionsystem. There was also technical assistanceto support public information efforts and to pilot innovations inNGOdelivery o f social services (see Annex 9). The following PEIR background papers are on file: (i) Veterans'Benefits and Programs in BH; (ii) Social Assistance and ChildProtection in BH, and (iii) Employment Benefits and Programs in BH (all 2002). 12 on public administration and SOSAC onthe highlevel and inappropriatecomposition o ftransfer spending. Moreover, bothoperations support reforms ininter-govemmental fiscal relations: while SOSAC 11supports a re-assignment o f expenditure responsibility from the Canton to the Entityinthe field o f social welfare, EMSAC focuses on higher education and supportsreforms o f expenditure responsibilitiesacross levels of govemment. Apart from EMSAC, the Pilot Emergency Labor Redeployment Project provides complementary support to SOSAC 11through support for employment opportunities for veterans. Finally, the recentlynegotiatedSecondEmployment Support Project (SESP) will support design and implementationo freformed active labor policies. 35. The rationale for a two tranche operation i s threefold: (i)effective execution of the Govemments' social policy reformagenda relies onprior reformof veterans' benefits inorder to free upresourcesfor strengthening o f the social welfare system; (ii) while there is clear commitment to the reforms supported underthe secondtranche (as reflectedinthe MTDS),the technical demandsoffinalizing reformssuch as new social welfare legislation, active labor programs, and disability assessment procedures are significant and requiretime to deliver new policies and practice which are well designed and well understood by those who will implement programs; and (iii) the implementationperiod o f a two tranche operation should allow for more sustainedpolicy dialogue onthe range o f social policy items covered by the operation. This i s particularly important inlight o f a reduced IDA envelope and smaller lendingprogrammoving forward. 36. The agendaproposedto be supported by SOSAC IIhas a direct impact on most households inBH. I t has involvedpolitically and socially difficult choices. Overall, the operation should help leverage a numberofimportant refoms insocialpolicy, particularly as itlinkedto the policy agendas ofkey actors such as the IMF and OHR. IV: SOCIAL POLICYREFORMPROGRAMSUPPORTEDBY SOSAC11: 37. The proposed policy agenda under SOSAC 11is summarized inthe attached policymatrix (Annex 6) and Letter of Development Policy (Annex 5). While the operationhas clear risks, these have been reducedto the extent possible through closely linkage inkey areas such as veterans' benefit reforms to commitments under the IMFSBA program, the Govemments' MTEFs, and the MTDS. The key proposed areas for support are as follows: A. Social Welfare andChildProtection: l9 38. Currentsituation: The social welfare and childprotection (SWCP) system inBH particularly in - FBH-hasbeenina state ofcrisis inrecent years, for the mostpart unableto make the transition from humanitarian reliefto a more coherent and sustainable system. Although the entitlements inEntity legislation apply equally to all sub-Entityauthorities inprinciple, implementation varies enormously by region due to the decentralizationo f financing. Social welfare suffers from a characteristic separationof policy making and implementationresponsibilities, with legislated entitlements which inmany areas canno longer be afforded. This is partly a product o f failure to adjust entitlements to an affordable core, and partly due to under-funding o f social welfare as a share o f GDP and govemment spendingrelative to regional standards, with the extent o f under-fundingmore pronounced inFBH. With the exception ofthe RSChildren's Fund,this hasresulted ina safety net that i s very patchy, functioning properly only ina limited number o f areas, and with no clear policy priorities or divisiono f responsibilities. l 9 For detaileddiscussion, see the SocialWelfare andChildProtectionchapter of PEIR(October 2002), and Social and ChildProtection Report, IOSlFACSConsultants(May 2003). 13 39. Many problems insocial welfare are common to bothEntities. They include: separation ofpolicy development and~nancing,which hasresultedinprogram mandatesto the local levels which can not be financed inmost areas. This reflects the failure at Entity level to adjust inheritedentitlements from SFRY to current fiscal and institutionalrealities. Entitylegislation fails to set programpriorities or identify financing for core benefits. aggregate under-~undingof SWCPand lack of understandingof theproblem. BH and inparticular - FBH- spends less onSWCP as a share ofGDPthan any country inthe region. InFBH,social and childprotection spending in2002 accounted for only 0.8-0.9 percent o f EntityGDP, and around 1.4-1.6 percent o ftotal public spending byEntityand cantonal Governments, including EBFs. Inthe RS, spending by the Children's Fundimproves the situationbut total social welfare spending in2002 was estimated at around 1.3 percent o f EntityGDP and 2.7 percent o f total public spending, including EBFs. Byregional standards, spendingon social andchildprotectioninRSis at the low end, andin FBHis lower thanany country inSEEICEE. high variation within each Entity in safety net coverage. Inmany areas, regular social assistance benefits andchild allowances have not beenpaid to the poorest for years. At the same time, better-off areasprovide a safety net which - while not generous - is relatively comprehensive. As examples: Sarajevo canton in2000 accounted for around two thirds o f all SWCP inFBHbut only 16percent of the Entitypopulation; inRS, per capita spending on social assistancebeneficiariesin2002 rangedfrom only 11KMinthe lowest municipality to as highas 2,400 KPviinthe highest. The outcome is a social welfare system that i s poorly targeted. lack ofpredictability in social assistancecoverage. The responseinmost areas to lack of financinghas been to reduce safety net coverage to "one-time help", which i s paid irregularly and on a discretionary basis incases o f extreme hardship. This is not a sustainable position for the very poorest withno alternative sources o f income. the lack of core benefit~s~~nancedby theEntity budget or by a designated source of funding. In neither Entitypresently i s there a social assistancebenefit financed by the Entitybudget. Financingo f social assistance i s entirely from the sub-Entity(typically municipal) level, resultingin"vicious circles" o f highpoverty areas with limitedfiscal bases for financing the safety net, The example of Entitylevel fundingofchildprotectioninRSthroughthe Children's Funddemonstratesthe benefits of partially pooled funding. Policymakers inBHconsider it important to expand Entitylevel fundingof social welfare benefits. institutional arrangementsfor social welfare and ch~ldprotectionwhich do not give prominence to the sub-sector. This relates bothto allocation o froles and responsibilitiesinSWCP withinand between levels o f government ineach Entity, At the Entitylevel, SWCP inRS comes under the healthportfolio and is relatively neglected as a result. InFBH, the situationhas improved somewhat since 2002 with the split of a combined labor, socialpolicy, refugee and DP Ministry. ineffective and inefficient administration of social welfareprograms. Thishas beenwell documented in recent TA supported under SOTAC. 2o 40. Reform objectivesand SOSACIImeasures: The operationsupports reforms inthe policy, institutional and financing frameworks for SWCP inbothEntities. This builds on social protection reforms strategiesapproved bybothGovernments as part of the SOSAC Iprogramand elaborated during2002 - LUSee report of 10s Partners. 14 work which has also fed into social welfare policies inthe MTDS. 21 There would also be support for implementationmeasuresidentified by local counterparts as critical to effective operationof SWCP programs. The objective of the reforms i s to promote a fiscally sustainable social welfare programs ineach Entitywith clearly identifiedandreliable financing sources. While thismaybe supplementedbysub- Entityauthorities inbetter-offareas, it should ensure aminimumandaffordable safety net for the poorest wherever resident. The conditions and actionprogrammeasures summarized inthe policy matrix include: On overallpolicy,new laws would be enactedbyParliaments inbothEntities prior to secondtranche, and would include at a minimum:(i) clear definition ofroles and responsibilities insocial welfare financing and provision at different levels o f system; (ii) rationalized scope ofrights inEntitylaw to focus on "core" social welfarelchild protection benefits and services capable o fprovision throughout the Entity; (iii) financing identified for at least one core social welfare benefit to bepaid from the Entitybudget ineachEntity; (iv) revision oftargetingcriteria for benefit eligibility incoreprograms; and (iv) provisionsto require andpromotepartnership between public andnon-government sectors in social services provision. These plannedreforms havebeenpreceded by amendments to existing social protectionlegislation inbothEntities prior to Boardpresentation which have improved the impact of social welfare programs pending fuller reforms. On in~tit~tionaland i ~ p l e ~ e n t a t ~ o n issues: (i) of a databaselclient registry of social welfare roll-out beneficiaries and expenditures inall localities inbothEntities, with the system linkedto the Entity Ministryfor reliable andtimely reporting; (ii) completion o f a fuflctional review o f socialprotection activities ineach Entity, and proposals developed by each EntityGovernment to address the institutionalproblems identified; (iii) Operational Manuals (OM) developed for use inall Centersfor Social Work, the local level social welfare offices; and (iv) roll out o f municipal level SocialPolicy Boards, as successfully tested under pilot projects supported byDFIDandthe FinnishGovernment in select municipalities across BH, which would coordinate strategic development o f social welfare at the local level, and include representatives from acrosslocal administration, ministries and outside the public sector. B. Veterans' programs: 22 41. Currentsituation: Fiscalpressure from veterans' programs is a major issue inBH. The level of spending on veterans'programs diverts resources from better targeted transfer programs and other spending needs. Inboth Entities, direct spending on veterans' benefits from Entitybudgets alone has consumedfrom 3.5 to over 4 percent o f EntityGDP inrecent years. InFBH, around 30 percent of the Entitylevel budget (without externally-financed projects) or 25 percent o f the total Entitybudget was spent on veterans' benefits in2003. In addition, several cantons spend significant amounts on additional programs, with combined Entity and cantonal spending equal to 4 percent EntityGDP inFBHin2003. InRS, around 12 percent of the Entitybudget was allocatedto veterans' benefits and programs in2002. Inaddition, inboth Entities, there are substantial foregone revenues from tax and customs exemptions for veterans, and other fiscal and quasi-fiscal spending targeted to veterans and their families (e.g. reductions on electricity bills, 21 See RS Government: Social Protection Development Strategy, November 2000; Social Protection Development Strategyfor FBH FederationGovernment, October 2000. BothGovernmentsalso approved social protection expenditureframeworksfor the period2001-2003. In2002, bothEntity Governmentsalso approvedmore detailed socialwelfarereformstrategies: Social Welfare Strategyfor FBH,May 2002; Program of Social Welfare Transformatio~in the RS, April 2002. All strategiesare on file. LLFor a detaileddiscussion, see the Veterans' Benefitsbackgroundpaper for the PEIR(October 2002). 15 which inthe RS in2002 were estimated at around 22 mln.KM,or 0.6 percent ofGDP), While consolidated estimates are difficult due to the opacity of veterans' spending at the sub-Entitylevel, total spendingand foregone revenues at all levels within eachEntityis estimated to be inthe order o f 5-6 percent o fGDP. Thiscompares with spending of aroundhalfapercentagepoint of GDP onveterans' benefit systemsin Croatia and Serbia and Montenegro. Eventhis very high figure excludes arrears and claims thoughthe court system for benefit entitlements under existing legislation inbothEntities which have notbeenpaid. 23 42. A specific feature ofall veterans' programs inBHis the existence ofparallel legislationand special decrees mandatingadditional rights.24 Inaddition, inFBHthe situationhas been made more complicated bythe existence o ftwo legal frameworks: one for Bosniakareas and one for Croats, the latter financed in significant measure to date from the Republic o f Croatia proper. This has resultedinsignificant disparities inregionalcoverage andentitlements withFBH,aswell as diminishedtransparency inimplementation. Suchparallelismbothwithin andbetweenthe different systems can no longer bejustified nearly eight years after the cessation o fhostilities, and has been increasingly an anomaly inthe cash transfer system following reforms to the pension andunemployment programs in2000-2001. 43. Policy makers inbothEntities acknowledge that current veterans`legislation isnot realistic andhas never beenproperly implemented. At the same time, the political and social sensitivity surrounding veterans' benefit reforms is high.This was an area identifiedas a key problem insocial and fiscal policy under SOSAC I, butthe politicalclimate at the time wasnot conducive to significant movement. However, the ongoing fiscal pressure from veteransprograms i s simply unsustainable, andthe Governments have committed to real reductions inveterans' spending, includingstrict adherenceto budgetary availability. 44. Despitethe large allocations to veterans'benefits, core benefits for the most disabled veterans and survivor families o f lulledsoldiers are inarrears inbothEntities, so that those reallyinneed among the beneficiaries are not able to have secureprotection. This is due to the wide scope ofbeneficiaries and benefits, whichreflects no prioritization bypolicy makers. InFBH, ithas also led to a major contingent fiscal problem, with total arrears estimated to be inthe order of 1.5 billion KM-around one and ahalf times the entire Entitybudget in2002. 45. InbothEntities, themajorcausesoffiscalpressurefiomveterans'programs include: 0 benefits are extended to veterans' and their survivor families down to minor levels o f disability, so that significant amounts are allocated to those whose injuries do not significantly impact their ability to work and are for the most part no more vulnerable than the general population. 0 disability or death o f a veterangenerating entitlements need not be linkedto military service. 0 benefits are indexed to the average wage and are high. Aggregate benefits from the veterans' systems canrunas highas 4-5 times the average wage. 23 Inthe RS, these are primarily claims for "non-material damage" and court awards have been up to 200,000 KMfor single cases. Inthe Federation, they relate primarilyto freezing o fthe benefit base since 1996. As o fmid-2003, awarded claims totaled around 2 mln.KMand there is a large stock o fpending cases. 24 For the Bosniak component, the legal framework untilrecent reforms was based on that o f SFRY. This was adopted bywartime Decree inApril 1992. The basic regime was supplemented by aparallelDecree in 1995. For the Croat component, the governing legal framework untilrecently has beenthe Law on the Protectionof Military Invalids andFamilies o f Killedand Missing Soldiers o f 1994, amended 1995. For the RS, the legislationuntilrecently was from January 1999, supplemented by a 1998 decree which gave additional benefits for disabled veterans. 16 survivor families are definedinsome cases to include grandparents, relatives and parents. Inaddition, there are limitedrestrictions on family beneficiaries with alternative sources o f income, so that spending i s poorly targeted on those most inneed inthe group. there are exemptions for veterans and their families on customs and taxes, some of which -suchas the exemption on car import duty-have beenabusedto createunwarranted profits for veteran households. insomeprograms, benefitsareextendedto non-disabledveterans, thoughinpractice these haveusually notbeen affordable inrecent years. mechanisms for rationing spending to available budgetary resourcesare only partially effective, so that arrears exist inall systems. This i s underlinedby the emerging backlogo f legal claims inFBHagainst the Government for failure to adjust benefits as anticipated incurrent legislation, with court awards already granted o f over 2 mln. KM:likely to be a fraction o ftotal liabilities. there i s substantial anecdotal evidence o f misclassificationof bothdisabled and other veterans, particularly duringthe war when assessment systems were less than accountable; and inRSspecifically, non-disabled veteransarelegallyentitledto benefits, andthere isprovision for "non- material" damage to families who lost a member duringthe war (equivalent to "emotional pain and suffering"). This is compensatedaccordingto court awards and can runto 200,000 KMfor an individual family. Thispossibility creates a major contingent liability for the RS budget. 46. Reform objectives and SOSACIImeasures: Both Governments have recognized that the current situationwith veterans' benefits can not continue. The mainobjective o fveterans' benefitsreforms is to promote arationalizedstructure o f entitlements that adequately supports veterans and families o f deceased soldiers who have beenmost severely affectedby injury or loss of primary income earner. At the same time, compensation must be tailored to limitedfiscal resources, and not squeeze out other policypriorities. Reform of veterans' legislationinbothEntities should result ina more fiscally sustainable set ofbenefits that will free resources for social protectionprograms that target the most needy. The scope of beneficiaries and benefitsmustbe rationalized substantially, including privilegeswhich result inforegone budgetary revenues. An important additional goal is to promote, to the maximumextent possible, harmonizationo fthe veterans' legal framework acrossbothEntities, particularly consideringreturn issues. 47. Definingthe SOSAC 11agendainthis area involved serious political economy considerations, as veterans' benefits are a socially andpolitically sensitive issue. While bothEntityGovernments developed veterans' reform strategies in2002, the timingfor implementing them was not appropriate intherun-upto elections. Since the formation of new governments for four year terms, bothEntities have engaged veterans' associations and representatives o f survivor families indrafting o fnew legislation and consultations surroundingMTDS development. There has also been a focus onnarrowing the range o f entitlements and institutingre-certification processes to reduce unjustified claimants. Despitethe natural resistanceof veterans andtheir families to reforms, there i s an increased appreciationthat the current systemis unsustainable. Reformcan therefore happen ina managedway, or bydefault through increasing non-performance o f the system. The SOSAC IIprogramsupports a combination o f legislative reform of entitlements, followed by support for measuresthat should improve the efficiency and transparency o f the administrationof veterans' programs. The community assessment undertaken with SOTAC financing in 2002-2003 indicates significant public support for such an agenda, and this is reflected inthe MTDS and the MTEFfor 2004-2007. The specific measuressupported by SOSAC 11are: on thepolicy side: (a) bothEntities have engagedwithrepresentatives o f veterans and other interested parties to produce new veterans' benefit laws which are consistent with the 2002 reformstrategies, and are reflectedinthe MTDS. These laws were passedby EntityParliaments inmid-2004. The new laws: (i) thenumberofbeneficiariesinlowercategories;(ii) forrevisionofbeneficiariesto control provide exclude unjustified claimants; (iii) introduceprovisions inlegslationto ensure that benefit obligations 17 cannot exceed available budgetary resources; (iv) ensure indexationo fbenefits does not exceedthe increaseinthe cost o f living, subject to budgetary resources; (v) eliminate customs or tax exemption rightsinEntityinveterans' legislation; (vi) require disability or death o fthe veteran be directly related to military service for militaryinvalidand survivor family benefits; (vii) reduce parental benefits where other means o f support exist (e.g. pension; employment); (viii) narrow the definition of survivor families, and strengthen conditions for discontinuation ofnuclear family benefits where alternative means of support exist; (ix) nobudget-financed monthly benefits and entitlements for non-disabled veterans granted by Entityveterans' legislation; (x) provide for healthinsurance and co-payment exemptions only inmanner consistent with healthinsurance legislation; (xi) eliminate of incremental claims for non-material damage; and (xi) inFBH,unify the veterans' benefit regime and administration for bothmilitary components. The parallelism inthe FBHveterans' system hadbeenone of the key residual elements o fthe war-time system. The new laws have been challenging to develop andenact, butcanbe considered amajor reformo fthe social protection systeminbothEntities. Interms ofimFle~entatio~: -prior to Board: (i) FBH,maintaininga unifiedaccount through which Entitybudget transfers would in flow to veterans' and survivor families from botharmy components. This ensures greater transparency and budgetary scrutiny inthe system, incontrast to the previous system o f split administrationand financing o f benefits for each military component; and (ii) satisfactory progress on veterans' program beneficiary database. RS inparticular has madegoodprogress incompleting an Entity-wideclient register during2002-2003. -prior to second tranche inbothEntities: (i) beneficiary databases to be inplace whichrecord beneficiary and expenditure data for all programbeneficiaries, and consolidate dataregularly to the EntityMinistry;(ii) promulgation o f implementingregulations for the new Laws; and (iii) completion of the revision process for military invalids and survivor families to weed out unjustifiedclaimants. In FBH,thiswouldbe supervisedbya Commissionwithrepresentation ofBosniac andCroatcomponents, C. Proerams and benefits for the unemployed: 48. Current situation: Unemployment inBHis very high. Registered unemployment is over 40 percent inbothEntities, and ILO-defined unemployment is estimated between 16 and 25 percent. 25 Supportedby SOSAC I, legal frameworks governingthe activities o f the Employment Institutes which the - administer unemployment benefits andactive labor programs for the unemployed-have been overhauled inbothEntities. InbothEntities, newlawscameinto force in2000. The newlawsreducedunemployment benefits to sustainable levels. They also legislatedanew institutional framework inFBHto eliminate ethnically-based employment services. InFBH, the Law requires establishment o f a single Federationlevel Employment Institute and separate Cantonal Employment Services. Ofthe resources collected, 70 percent are administered bythe cantons and30 percent by the Entity(with Entityfunds available for redistribution to the cantons on aneeds basis). 49. There i s an unfinished agenda with implementation o f the institutional and financing framework at State and FBHlevels, and a needinbothEntities to improve the effectiveness o fALPS. The mainissues are: 25 See TheLabor Market in Bosnia and Herzegovina: Improving Job Creation and Worker Mobility (World Bank, 2002). the Employment Bureaufor the SFRY Bosnia-Herzegovina Republic continuedto exist untilrecently, withnodefinedfunctionor financing source. Itsfailure to cooperatewithanextemal auditin2003 also confirmed concerns o f improprietiesinmanagemento f funds and assets. At the same time, there was untilrecently no genuine State level body which could legally deal with the internationallabor obligations of BH, ILO obligations andbilateral agreementswith other countries. as o f 2002, only a few cantons hadestablished cantonal Employment Services, so that the majority of cantonal programs had continuedto operate as part of an ethnically-based fund. Preparation of the SOSAC 11has involved intensive work to support establishment o f employment services inall cantons. an audit andbusiness processreview o f the Entity EIsidentified poor businessprocessesand lax financial management inbothEntities, inaddition to a serious lack o f monitoringo f internal operations and evaluation o f E1programs. The resultinglack o f accountability for resource use hasbeen an issue of serious concern, particularly inFBH,exacerbateduntilrecently by lack o f appropriate regulations. the current mix o f active labor programs (ALPS) inbothEntities is very limited,and with an emphasis on programs such as subsidized credits to firms and wage subsidies which internationalevidence suggests are the least cost effective, At the sametime, simpler andmore cost effectiveprograms such asjob counselingandbasic job brokerage functions are non-existent or seriously neglected. In particular, funds for active programs have beendirectedto favored state firms withnegligible monitoring or accountability for use of funds. The situation i s confirmedby surveys o f the unemployed which indicate low faith inpublic employment services to provide them with a useful service when lookingfor work. 27 Giventhat FBHinparticular spends significant public resources on suchprograms (around 1percent o f EntityGDP in2003, with an additional 0.4 percent o f GDP inreserves), this i s an unsatisfactory outcome, and one that EntityGovernments recognize inthe MTDSmust improve given the highlevels o funemploymentinBH. 50. Reform objectives and SOSACIImeasures: Overall, the objective o f SOSAC 11supported measures inthe employmentfield is to ensurethat the legislatedinstitutional andfinancingarrangementsfor programs for the unemployed work inpractice, including at the State level. Addressing these problems is important, given the large pool of unemployedand likely additional demands on the E1system as enterprise restructuringgathers pace. The SOSAC 11agenda-with implementation support under the proposed SecondEmployment Support Project (SESP) - supportsthe following: 0 for bothEntities, completion o f the extemal audit andbusinessprocess review o f EntityEmployment Institutes. Thishas been followed byrevisedinternalprocedures inthe EntityEIswhich respondthe shortcomings identified inthe audits. a inFBH,establishment andoperationalizingofcantonal EIsineachcanton(including staffingand establishment o f separate bank accounts for cantonal ES). This has been accomplished recently and eliminates ethnically based employment services, allowinga truly Entity-wide network to function for the first time since the war. The Federation E1has also approved procedures for allocating the portion of unemployment insurance contributions which go to the Entitylevel, allowing reallocation of a share of Entityfunds to the cantons on a needs basis. a both Entities are developingmore effective policies on ALPS. The SOSAC 11would support development and approval o frevised ALP policies for bothEntities prior to secondtranche which are See Betcherman, Olivas, and Dar: "Impactsof Active Labor Market Programs: New Evidencefrom Evaluations, withparticular reference to Developingand Transition Countries" (World Bank, 2004). 27 See Birks Sinclair: Labor Markets in Bosnia and Herzegovina, 2002 for survey results of the unemployedfromboth Entities. The results are supportedby the community assessmentcarried out with SOTACfinancing in2002-2003. 19 consistent with fiscal realities and administrative capacity of the employment services. A framework for revisedprograms has been developed with Entityand cantonal employment services, and they are usingthis as abasis for further programdevelopment. 28 the State o f BHhas enacted legislationto establish a State level Labor Agency with mandateto handle the international obligations of BHinthe labor field. The legislation outlines its mandate and organizational structure, identifies financing sourcesfor the Agency, andprovides for closure of the former BHEmployment Bureau. Staffing has been done and the Agency has commenced operations. D. PensionandDisabilityprograms: *' 5 1. Current situation: With support under the PFSACs, EntityGovernments have gradually reformed the entitlements within the PAYGOpension systems inBH. At the same time, cashrationing introducedinto the pensions systems in2001remains the key policy tool for ensuring that core pensions spending doesnot exceed pensioncontributions. This is particularly the case inRS, where monthly pensions are 78 percent o f legal entitlements currently. While there i s need for structuralpolicyreform in the pensionsystem, work onmedium-term reforms only started inlate 2003, supportedunder the Social Insurance Technical Assistance Project (SITAP). Inthe meantime, there are a range o f implementation issues inthe current pensionand disability systems which are inneed o f urgent attention. 52. Inadditionto entitlementreforminthePAYGOsysteminrecent years, institutionalreforms ofthe FBHpensionsystemwere introducedfrom2001, withthe consolidationofthe previously ethnically-based pension systems into a unifiedFederationPensionand InvalidFund(PIO). However, while significant consolidationhas beenachieved, parallelism has continuedinpensions administration, including in employer reporting on social contributions and IT systems. Inaddition, administrative control of the database o f social contributions for all BHfi-om 1970-1992 and for Bosniak areas o fFBHfrom 1992 was lost, as aresult of an illegal transfer to private ownership o f the agency (ERC-ZPO) which manages the social contributions IT systems and database. As aresult, the extra-budgetary funds which financed all investments inthe agency and have full share ownership have beenrequiredto pay hundreds of thousands of KMmonthly for access to their own data. 53. A further issue inthe BHpensionsystemis howto handle inter-Entity pension issues. This is particularly important for pensionpayment obligations for pensioners who have made pension contributions duringtheir workmg lives inone Entity(or, before the war, on the territory o f one o ftoday's Entities), but are now resident inthe other Entityor have receivedtheir initial pensionauthorizationfrom the other Entity. The problem i s not an easy one to resolve, given that the current Entitypension jurisdictions were handledon a unifiedbasis pre-war under the SFRY BosnianRepublic pension system. At the same time, they arenot legally separatejurisdictions inthe manner regulatedbyinternational social security agreements. To date, the problem hasbeenhandledby the pension authorities o f the ethnic group of the pensioner paying the pensionwithin that Entity's system. However, with the continuing disparity in Entitypensionlevels, there havebeensuccessful claims inthe court system andthrough the BHHuman RightsChamber for compensationbythose who made their contributions onthe territory ofwhat is now the Federationbut are receiving (lower) RS pensions. The solution o f a unifiedBHpension system-while desirable ina number o f ways -does not appear to be a realistic possibility inthe short term, though 28 See BosniaandHerzegovinaLabor Market Programs:Information to Users (June 2003). 29 For more information, see PEIRpensions section; Disability Programs and Policies in BH (World Bank, 2001), and modeling results from 2002; and "Policiesfor Persons withDisabilities", report o f 10sPartners (May 2003). 20 harmonizationo f Entitysystems and the formulation o f ajoint pensionstrategy may facilitate sucha reform inthe mediumterm. 54. An additional emergingissue inbothEntitiesis social contributions arrearsfrom firms, with pensions contributions the biggest item. As privatization and enterprise restructuringprogress, concerns are growing on the pension entitlements o f dismissedworkers inbankruptedfirms whose social contributionshavenot beenmade insome cases since before the war. They are not entitled to accrual of work history andpensionrights for the periods of unpaidcontributions, even incases where non-payment bythe employer occurredwithout the workers' knowledge. BothGovernments aretryingto addressthe situation as an urgent social and economic matter as part o f finalizing Social Programs for dismissed workers, which is a key union demand for supporting bankruptcies. 55. Disability programs inBHinclude cashand in-kindbenefits, as well as services. The programmix comprises: (i) insurance benefits under pension and invalidinsurance; (ii) social programs and benefits for disabled war veterans; (iii) benefits for civil victims o f war; and (iv) benefits for children and adults with disabilities inthe social assistance system. As a result of the war, the total proportion o fpersonswith disabilities i s higher inBHthan inany other country inEurope. Overall, about one out o f every 10potential workers have a disability. Despite this, the system for assessingdisability is outdated and implemented in inconsistent fashion acrossprograms and across different areas o f each Entity. There i s also substantial anecdotal evidence o f abuses inthe system, with informal payments to assessingdoctors considered to be common. The result i s a series o f disability programs which consume significant resources but continue to include unjustifiedbeneficiariesand may exclude deservingclaimants. 56. Reform objectives and SOSACIImeasures: SOSAC 11supports improved functioning o f the existing pension and disability systems, including improvedcoordination betweenthe Entities. It also supports mediumterm policyreforms towards a harmonized pensions policies throughout BH, with technical support under the Social Insurance Technical Assistance Project (SITAP). 57. The keypension and disability measures supported under SOSAC I1are as follows: for bothEntities, an important short-termmeasurehas been arriving at an inter-entity agreement on pensions-in-service which i s then adheredto. Giventhe growing number o f legal cases, the Entity authorities have agreed a Memorandum ofUnderstanding on the basic principles guidingthe cross- Entitypension entitlements. Regardless ofthe choice made it mustbethe recognizedthat some benefits will be unavoidably lower thanpensioners' expectation andlor rightfulentitlement. an inventory of social contribution arrears inagreedpriority enterprises has beenprepared inorder to establish the stock o f dues collectable. Based on this, bothEntityGovernments are tryingto formulate policy on the treatment o f work periods uncovered by employer contributions. The policy should minimize adverse incentives to future compliance. inFBH,there aretwo additionalmeasuressupported: (i) approval o f the Statute o f the mergedFBH PIO, which allows for regularizationo f staffing and other organizational aspects o f the Fund; and (ii)clarification o f the legal status and ownership o f ERC-ZIP0 inthe form o f a Government decision. The purpose o f the decision i s to increase government control over the data ERC-ZIPO manages and the institution's operational decisions. the specific category o f civil victims o f war - who FBHare in a group that presently "falls between the cracks" of different levels o f government wouldbe apriority group for Entitylevel financing of - benefits, as is already the case inthe RS. As their number is limited, this i s a sustainable fiscal burden. The FBHGovernment has approvedand submitted to Parliamentamendments to the relevant legislationto reformthe entitlements structure and financing arrangements for this group. 21 the second tranche program for SOSAC I1supports development and approval o f new disability assessmentrulebooks for veterans'lcivil victims o f war programs and childhood disability. This has beenpreceded by formation o fworking groups and technical reference groups. E. Frameworkfor oDerationofNGOslthirdsector: 58. Inthe socialprotectionsysteminBH,therole ofthe thirdsector isevolving fromahumanitarian role to that o f more typical civil society organizations which are increasingly local. There are a multitude o f third sector organizations registered inBH,ranging fi-om NGOs to veterans associations to humanrights advocacy groups to service providers. These groups are recognized for their ability to service the population, often with programs than can be tailored to the needs of different beneficiary groups. This work i s being supported under the SOTAC, through NGOlCSW activities designed to promote cooperation between the municipal Centers for Social Work and local thirdsector organizations. However, there remainquestions about the sustainability o f the local third sector, particularly as donor support scales back. 59. Reform objectives and SOSACIImeasures: The objective o freforms supported under SOSAC IIistoensureaclearandsupportivelegalframeworkfortheoperationofNGOslthirdsectororganizations inBH. This includesappropriate tax provisionsto promote sustainabilityofthe domestic thirdsector. Important steps were taken inthis process duringSOSAC IIpreparationwith approval o f harmonized legislation by the State of BHand bothEntities for registration and mutual recognitiono f NGOs throughout BH. 30 SOSAC IIsupports the following additional measures: e both Entitieshave approved satisfactory implementing regulations for their NGOlegislation. 0 withinthe broader overhaulof profit tax legislation, bothEntitieswould includeprovisions inthe new legislationon taxation o f third sector organizations which allow for favorable tax treatment inline with that commonly found for the not-for-profit sector inEuropean countries. This would provide that economic activities o fNGOslthirdsector organizations which are relatedto their core activities receive favorable tax treatment, and that donations to such organizations attract favorable treatment. Such provisions shouldpromote more sustainable financing o f the thirdsector. F. Livingstandards monitoring: 60. Current situation: The ability to produce statistics needed for design, implementation and evaluation of economic and social policy inBHhas been damagedby the war andtransition. Three institutions are formally responsible for statistics inthe country, two entity level institutes and a State level agency. The statistical offices have limited capacity to produce the range o f statistics necessaryfor policy- makers, and coordination betweenthem has beenhamperedbylack o f a legal framework. The areathat has been especially hardhitby the war is data collection at the householdlevel. Finally, the linkbetween data generation and policy formulation i s underdeveloped andinneedo f strengthening. 61. Reform objectives and SOSACIlprogram: With support from the Bank and other donors, the Statistical Institutes have made major progress inimplementation of a representative household survey, basedon the LivingStandards Measurement Surveys (LSMS). The first representative post-war survey was completed in2001.The profile and data analysis have been critical inputsto MTDS development. 30 See consultant report of Bater and Golubovic: Bosnia and Herzegovina: Report on NGO Fiscal Framework (2002). 22 62. SOSAC 11supports improvedhousehold level data inseveral ways. First, the programsupports initiation by the Statistical Instituteso f a Household Budget Survey in2004 and the completion o f field work prior to second tranche. Second, the SOSAC IIacknowledges completion o f the first and second panelrounds of the LSMS. Third, the program supports household survey results from the Statistical Institutes beingfreely available to the public for researchand analysis. Thishas been done with the LSMS under a DataUsers Agreement, and is expected with subsequentsurvey data. Fourth, the programsupports the ongoing work o f the Data User Groups, inorder to maximize the links betweendata collection, data users, andpolicy development. Fifth, the programsupports preparations for the first post-war Labor Force Survey, expected to be initiated inlate 2005. Finally, the State level cabinet o f Ministers has recently approved the first post-war Law on Statistics, which will regulate data collection and inter-Entity cooperation on statistics. This i s expected to be approved by the BHparliamentprior to secondtranche. G. PublicInformationon socialpolicv: 63. Current situation: Untilrecently, effortsbyGovernment inbothEntitiesto consult withand familiarize the population about policy objectives and trade-offs insocialpolicy reformhave been limited and uncoordinated. Thishas often allowed specific interest groups to dominate public debate with biased or factually incorrect information. Ifcomprehensive social protection reformis to succeed, the Governments needto informand persuadethe public of their reformobjectives more effectively. Just as importantly, policy formulation needs to be better informedbypublic opinion andpriorities. 64. Reform objectives and SOSACIlprogram: The Governments o fbothEntitieshave made significant steps inthe past year to improve the situation. First,the MTDS process has involved widespread consultationwith a range o f civil society actors onboththe general direction o f Government policy and specific areas o f social policy such as pensions, veterans' programs, and employment programs. As a result, different stakeholders are increasinglyaware that Governments mustbalancemultipledemands on limitedpublic resources. Intandem with the MTDSconsultations, the Governments carriedout in2003 a public consultation and information campaign on social policyreformtitled "40 Days o fDialogue on Social Reforms". The key issues and messages for the campaign were based on a community assessment to understand community priorities and concerns insocial policy reform. The findings of the community assessment are outlined inAnnex 8, and show a strong degree of consistency with the policy directions of the MTDS,and are supported under SOSAC II. 65. While these arepositive developments, the more important mediumterm needi s for sustained capacity withinGovernment andkey ministries for public information and consultation. This has inthe past beennon-existent inline ministries. New Laws on Ministries inbothEntities require an external relations capacity to be established inall ministries, butthis has been slow to happen inpracticeinthe social policy area. SOSAC 11supports appointment o f designated staff for this purpose inthe relevant line ministries prior to second tranche, and there i s TA under SITAP to strengthen the skills o f these staff. V. THE PROPOSEDCREDIT A. Rationale for Bank Involvement: 66. The Bank has beenclosely involved in social policyreforms inBHsince the conflict. Initially this was done under the Emergency Recovery Credit, which supported an interimcash transfer mechanism for the poorest. SOSAC Isupported preliminary steps inreformof the safety net through promoting greater transparency insafety net operation and information, and initial policy development. However, it was 23 consideredthat support for reforms inlabor markets were the more urgentpriority at the time in 1999-2000, inlightofhighunemploymentlevels, strongrigiditiesinthelabormarket, andthe needto makelabor policy more conducive to attractingdomestic and foreign investment. Given the progress on that agenda, it wasjudged by the State and Entitygovernments and the Bankthat the time was appropriate under SOSAC 11to focus onacoherent reformofcashtransfer programs. 67. The Bank is considered an importantpartner indesign and implementation o freforms inthe social protectionfield. The comparative advantage i s drivenby: (i) analytical capacity for understanding transfer programs and their linkage to the wider fiscal agenda and poverty profile, as seen inthe P E E andPoverty Assessment; (ii) mix oflendinginstruments which allow parallelsupport for rationalizationofveterans' benefits, andpromotion o f employment opportunities for demobilized soldierslveterans under the Pilot Emergency Labor RedeploymentProject; (iii) the close partnership with the Bank inthe context of MTDS preparationand implementation; (iv) the capacity of the Bank to mobilize support form other donors behind policy reforrns which are politicallychallenging; and (v) complementarity with the IMFprogram, ensuring that proposed reforms are consistent with the evolving fiscal stance. 68. SOSAC IIpreparationhasbeen supportedbythe Social Sector Technical Assistance Credit (SOTAC) o fUS$3.9 million equivalent. The Credit was approved at the same time as SOSAC Ito provide support to the implementation agenda under SOSAC1and technical assistanceto informdesign of SOSAC II.TheuseofcompanionTAcreditsforsocialpolicyadjustmentloansisincreasinglycommonthroughout the ECA region, and the BHauthorities endorsedsuch an approach inBank adjustment lendingduringthe last CAS discussions. Details of the SOTAC are provided inAnnex 9. B. Benefits andRisks 69. BeneJils: The mainbenefits of the operation would be: 0 Reorientationo f the structure o f social transfer spending inBHaway from entitlement-based programs for those frequently not inneed (particularly inveterans' programs) to those most inneed (particularly those receiving social welfare benefits and services). 0 Reductioninthe fiscal pressure from transfer programs, which shouldpromote more sustainable social protection spending. 0 Contribution- particularly inFBH- to a more effective division o froles and responsibilitiesinsocial protection ineach Entity,by promoting financing and institutional arrangements where financing and implementationcapacities are more closely aligned. 0 Promotingequity of coverage o f social protectionprograms within the Entities and harmonizationof entitlement structures betweenEntities. e Promoting accountability o f the Government to the general public on social protectionissues, including greater involvement o fNGOs and civil society insocial welfare provision. 0 Encouraging a greater role for the State level insocialpolicy, inparticular inthe labor and NGO fields, 70. Risks: SOSAC 11is a highriskoperation. The mainrisks o f the proposedoperation are: 0 The political economy o f the reforms supported i s challenging. The veteran populationwho are perceived as "losers" are a well-organized lobby, as are firms who have benefitedfrom credit from employment programs. Incontrast, beneficiaries such as social welfare clients, the unemployed, and severely disabled veterans are often fragmented andwithout political voice. The implementation risks o f the reforms can not be eliminatedand will remain significant. However, they arebeingmitigatedby continued engagementwith veterans' organizations by Entity 24 governments and the Bank, public informationon social policy reforms, and closely coordinated policy support from key actors inthe internationalcommunity. The reformagenda i s also consistent with the MTDS. The macroeconomic position of BHremains fragile, and vulnerable to external shocks, such as lower than expected foreign investment, slower than expectedrecoveryamong trading partners, and insufficient supply response fromthe domestic economy to rising export opportunities. The macroeconomic risks are compounded by fiscal risks, among others relatedto the pending settlement o f domestic claims. The technical capacity o f local counterparts suggests that there will be an ongoing need for technical support from Bank teams. Forparts o fthe agenda, coordination betweenEntitiesand efforts to havejoint or harmonized policies may face challenges. This riski s beingmitigatedby strong efforts to havejoint or parallelpolicy development through initiatives such asjoint working groups andregular inter- Entityconsultation. The MTDSmonitoringprovides anongoing focus for these efforts. C. Coordinationwith the IMFandother donors 71. The SOSAC 11has benefitedthroughout its preparation from close collaboration with the TMF. The SBA program, worth 94.2 million SDR, was recently concluded. Uponthe authorities' request, it is envisaged that the Fundwouldprovide further support to BH's medium-termmacroeconomic program through an ExtendedFundFacility. The Programsupported by the SOSAC IIi s fully consistent and coordinated with the reforms proposed to be supportedby the EFF. 72. Several bilateral donors, most notably DFID, areproviding technical assistanceto BHinthe area of social policy. The Bankhas liaised closely with donors to ensure broadagreement onreformpriorities, including parallel financing from bilaterals on SOTAC activities. Donorpartners agreedat the identification workshop that SOSAC I1would provide a framework for channelingthe efforts of donors towards priority reforms and institutional strengthening insocial policy. Duringpreparation, close links have beenmaintained with partners, inparticular DFIDand the OHR. OHR has lent considerable political support to the authorities inimplementingthe politicallychallengingreforms supported by SOSAC II. D. NepotiationsandBoardConditions. Tranche Triggers andSuDervision 73. The overall programsupported by the proposed Credit i s outlined inthe Letter o fDevelopment Policy (Annex 5), andperformance benchmarks are set out inthe PolicyReformMatrix (Annex 6). The conditions which have been met prior to Negotiations andBoard Presentation andto be met prior to second tranche release are outlined below. Inaddition to the specific Conditions, the State andbothEntities must maintainan adequate macroeconomic framework for release o fboththe first and second tranches. 1. Conditions to be met prior to BoardPresentation(including Condition ofNegotiations): (a) Condition of Negotiations: Both Entities: 31 0 Enactment by EntityParliaments o fnew veterans' benefit legislation satisfactory to the Association. 31 Satisfactory legislation would: (i) control the number o fbeneficiaries inlower categories; (ii) for revision o f provide beneficiaries to exclude unjustifiedclaimants; (iii) introduce provisions inlegislation to ensure that benefit obligations cannot exceed available budgetaryresources; (iv) ensure indexation o fbenefits does not exceedthe 25 @) Conditions of BoardPresentation: Stateof BH: Enactment by BHParliament o f Law on Labor and Employment Agency o f BHwhich establishes State level Labor Agency, satisfactory to the Association. 32 Both Entities: 0 External financial audit andbusinessprocessreviewof EntityEmployment Institute completed in manner satisfactory to the Association. 0 Employment InstituteBoard to adopt new internal procedures o f EntityEmployment Instituteswhich respondto findings o f the audit and businessprocessreview ina manner satisfactory to the Association. 0 EntityEmployment Institutenot administeringnewenterprise credit programs. 0 EntitylineMinistries to approve and submit to theirrespective Governments aMemorandumof Understanding satisfactory to the Association for mutual recognitiono fpensionpayment obligations whenbeneficiaries' contribution history andresidenceor placeofpensionauthorizationdiffer. 0 Public information and consultation campaign on objectives and directions o f social policy reform completed. 0 Representative Household Budget Survey initiated incooperation with State StatisticalAgency. Federation of BH: 0 Cantonal employment services established inall cantons and fully operational. 0 Government to approve decision satisfactory to the Association which resolves status of ERC-ZIP0 and asserts Government ownership and control o f social insurance contributions data. 0 Submission to Parliamento f amendmentsto the Law on Social Protection, Protection of Civil Victims o fWar and Protection o f Families with Children which are satisfactory to the Ass~ciation.~~ RepublikaSrpska: increase inthe cost o fliving and is subject to budgetary resources; (v) eliminate customs or tax exemptionrights in Entitybasedonveterans' legislation; (vi) require disability or death ofthe veteran be directly relatedto military service for military invalid and survivor family benefits; (vii) reduce parentalbenefits where other means o f support exist (e.g. pension; employment); (viii) a narrower definition o f survivor families, and strengthenconditions for discontinuation o fnuclear family benefits where alternative means o f support exist; (ix) no budget-financed monthly benefits and entitlements for non-disabled veterans to be granted by Entity veterans' legislation; (x) provide for healthinsurance and co-payment exemptions only inmanner consistent with health insurance legislation; (xi) eliminate incrementalclaims for nonmaterial damage; and (xii) inFBH, unifythe veterans' benefit regime and admirustration for both military components. 32 This would require appropriate provisions on: (i) mandate o fbody; (ii) proposed financing source and scale; and(iii) proposed organization and staffing; and (iv) clear termination o fthe former BHEmployment Bureau. 33 Satisfactory amendments to include: (i) assuming financing o f core civil victims o fwar benefits, with Entity possibility for cantonal extension; (ii)provisions for survivor family benefits, that the death o f a military invalidbe directly related to the injury, and reduction o f survivor family benefits where other means o f support exist; (iii) provisions imposing a sustainable fiscal burden on Entitybudget andnot assuming cantonal arrears; (iv) provisions ensuring that all benefit payments are final and generate no arrears; (v) indexation provisions limitingbenefit growth to changes inthe cost o fliving, subject to budgetaryavailability; and(vi) entitlement structure inline with new veterans' benefit legislation. 26 e Parliamentto enact amendmentsto Law on Social Protectionwhich are satisfactory to the Association.34 2. Second tranche conditions: State and both Entities: e Joint PensionPolicy adoptedby State and EntityGovernments which i s satisfactory to the A~sociation.~~ Both Entities: Enactment o f social protection legislation which is satisfactory to the A~sociation.~~ The database and client registry of social welfare beneficiaries and expenditures i s operational inall areas andlinkedto EntityMinistry. Entities implementing the approved MOUfor recognition o fpensionpayment obligations when beneficiaries' contributions history and residence or place o fpensionauthorization are different ina manner satisfactory to the Association. 31 Average monthly budgetary execution for veterans'benefits in first half2005 Entitybudgets does not exceedthe nominal averagemonthly execution for 2004. Revisiono f status o f military invalids and family beneficiaries inveterans' benefit system completed in a manner satisfactory to the Association. 38 External audits o f EntityPension and InvalidInsurance Funds completed on 2004 accounts inmanner satisfactory to the Association. Government to approve new Policy on Active Labor Market Programs which is satisfactory to the Association. 39 34 Satisfactory would include: (i) adequate share o f municipal budgets allocatedto social welfare; (ii) sector NGO included as potential service provider; (iii) guaranteedhealth coverage for regular social assistancebeneficiaries; and (iv) adjustment o fbase for social assistancebenefits to fiscally supportable level. 35 Satisfactory to include: (i) goals o fthe pension system; (i) method o f assessingbenefitsbased onpast and the the future contribution histories; (iii) the methods and timeframe o fharmonizing pensionassessment rules; and (iv) the mainprinciples guiding the formation of the hturepension system. 36 Satisfactory law would include: (i) d e f i t i o n o froles andresponsibilities insocial welfare fmancing and clear provision at different levels of system; (ii)rationalized scope o frights inEntitylaw to focus on core social welfareichild protectionbenefits and services capable ofprovision throughout the Entity; (iii) financing identified for at least one social welfare benefit to be paidfrom the Entitybudget ineach Entity, and this obligation reflected inlegislation; (iv) revisedtargeting criteria for benefit eligibility incore programs; (v) provisions to require and promotepartnership betweenpublic andnon-government sectors insocial welfare service provision; and (vi) provisions oncivil victims o fwar that are consistent inFBHwith amendments submittedto Parliament for first tranche, and inRS consistent both withother relevant parts o fRS social programs. 37 Satisfactory would include: (i) discontinuing the 2000 inter-Entity pension agreement by January 2005; (ii) binding arrangementsfor returnee pension payments functioning effectively; and (iii) adequateprogress on arrangementsfor State Compensation Scheme for pensions. 38 Satisfactory would include: (i) verification o f entitlement to receive benefits inaccordance withthe relevant Entity Law; (ii) hctioningintegrated beneficiary database inplace withup-to-date revised beneficiary data; (iii) FBH, in review of first instance decisions inaccordance withprocedures o fthe Supervision Commission; (iv) inFBH, first and secondinstance revisionbodies to revise decisions based on Supervision Commission findings. 27 Adoption o f new rulebooks for assessmentof disability inveterans and civil victims of war programs and programs for children with disabilities which are satisfactory to the Association. 40 Provisionsenacted inprofit tax legislation for favorable tax treatment o fNGOsinspecified circumstances which are satisfactory to the Association. 41 E. Project ManaPementIssues 74. Administrative Arrangements: The State Ministryo f Trade and Foreign Economic Relations (MFTER) would beresponsible for overallprogramcoordinationofthe Credit onbehalf ofBH,the Borrower, with financial management at the State level handledby the BHMinistry o f Finance and Treasury. EachEntity'sMinistryo f Finance would beresponsible for administeringthe pre-allocated funds from the Credit. Inorder to promote coherenceinthe agenda, overall work on socialprotection has been coordinated by the highlevel Steering Group which was responsible for developing the MTDS. This includes representatives fiom bothEntitiesandthe State and a working group on social sector reforms. 75. Disbursement: The Creditwouldbe disbursed intwo tranches of SDR 16.3 million (equivalent to USD24 million) and SDR 18.4million(equivalent to USD27 million) to aDepositAccount ofthe Stateat the Central Bank o f BH. Disbursement would be made inEuros equivalent to the SDR amount of the above tranches. The equivalent inEuro will be deposited into a dedicated Deposit Account of the State at the CentralBank o fBH.The entire amount o f all disbursements will be transferred from the StateDeposit Account to the deposit account sub-accounts o f the Entities inthe Central Bank and then transferred to budgetary accounts o f the Entities incommercial banks, following apercentage split between the Entities agreedat Negotiations. Fundrelease would be subject to satisfactory reviewby IDA o f the implementation o f the adjustment programas a whole, and the fulfillment o f specific tranche conditions. Disbursements will notbe linked to specific purchases, thus evidence will notbe neededto support disbursements,nor will procurement requirements be necessary. Ifafter the Credit proceeds are deposited inthe CentralBank account, the proceeds are usedfor ineligible purposes as defined inthe credit agreement, IDA will require the borrower to either: (a) returnthat amount to the Deposit Account for use for eligible purposes or (b) refundthe amount directly to IDA.Proceedsofthe Credit will beusedfor approved usesonly. The Borrower will comply with standard reporting requirements o f adjustment credits. The Associationwill exercise its right to receive audit reports on the Deposit Account after each disbursement. 76. MonitoringArrangements: Implementationo fthe programwould be monitoredby a Committee composedo f the representatives o f the StateMFTER, Ministryo f Civil Affairs, and Finance and Treasury andthe EntityMOFs. The MTDSsocial sector working groupwould also act as a key inter-Entity body for monitoring and coordinating implementation o f the reformagenda supportedby SOSAC II.Monitoring 39 Satisfactory policy would promote mix o fALP which prioritize cost-effective interventions, discontinue credit programs, and allow for regular monitoringand evaluationo fprogram impact. 40 Satisfactory rulebooks would provide for: (i) discretion to assessors; (ii) little minimise medical evidence to be collectedprior to assessment; (iii) detailed information and examples onmedical conditions andrules on provide diagnosis, andhow to conduct assessments. (iv) require use o fthe International Classificationo fFunctioning, Disability and Health; (v) contain specific requirements that assessors declare any conflicts o f interest andmake the assessor withdraw where conflict exists; and (vi) provide severepenalties for applicants who provide false pathology and assessorswho are provento be corrupt. 41 Satisfactory would provide that economic activities o fNGOsJthird sector organizations which are relatedto their core activities receive favorable tax treatment, and that donations to such organizations attract favorable treatment. 28 and evaluation o f progress would bebasedon inputs from participatingministries and institutions. IDA would monitor performancethrough review of Committee reports and regular supervision missions. 77. In terms o f financial monitoring, the Bankhas guidelines on financial managementrequirements in adjustment operations which are to be appliedto the proposed Credit. The Government will maintain accountsand records, or ensure that such items are maintained, showing that credit disbursementswere in accordance with provisions o f the Credit Agreement. Such accounts andrecords will be maintained ina form acceptable to the Association. The external auditor will conduct an annual audit of the deposit account openedby the Borrower inthe Central Bank to exclusively holdthe Credit proceeds. The terms of reference o f the audit were agreedat negotiations. The audit will examine andreport on the disbursements &om the deposit account until such time that all the credit proceeds have been fully utilized. Such audits will be submitted to the Association as soon as they are completed. The Association may require a more extensive audit o f such records by independent auditors. The Bank will complement its increasedemphasis on borrower public financial management inits analybc work and lending programwith stronger reporting and auditing arrangements over the disbursements of adjustment loan proceeds. These controls arenot intendedto restrict or prescribe the usesto whichadjustment loanproceeds funds may be appliedby borrowers. They are rather intendedto provide assurance that Bank funds have arrived at their intended destination, have been used inthe first instance for their intendedpurpose of providing balance of payments and fiscal support, andwill be subject to Borrower processesfor managingpublic resources which are knownto and can be reviewedbyboththe Bank and the Fund. 78. Inrecognitionofthe perceptionthat corruptionisrelatively highinBHandstudiesthat indicate weak financial accountability and controls, the authorities have initiated action to addresstransparency issues. Both the National Anticomption Action Plan, adopted in2002, andthe anticorruption chapter inthe MTDShighlightthe regulationofconflict ofinterest. 42 Among the priority areas that were highlightedby the BEEPS-2, public procurementemerged as an area needingurgent attention. Support for the public expenditure management reformbasedupon CFAA, PEIR and CPAR findings is an important element of the companion EMSACcredit. 79. Interms ofallocation ofCreditproceeds,discussionsbetweenthe two Entitiesandthe State at Negotiations agreedan allocation betweenthe EntityGovernments of two thirds to the Federation and one thirdto RS. Entityallocationswould be managedthrough sub-credit agreementsbetweenthe Statelevel MinistryofFinance andTreasury, andthe MOFofeachEntity. 80. The ClosingDate for the project would be June 30,2006. F. PovertvImplications: 81. The reforms supported by the proposed SOSAC IIshould have an important effect on poverty alleviation inBH, primarilythrough supporting a major reorientationof cash transfer programs. The programwould support rationalization and expenditure control on veterans' programs, which on average are poorly targeted and not coordinated with other parts o f the safety net. This would be accompaniedby an increasedemphasis on social welfare and childprotectionprograms which with the necessaryfinancing and targeting reforms supported under SOSAC 11will bebetter targeted on the most needy, including the disabled. Inaddition to these reforms, the ongoing work on survey data would contribute to the ability of 42 Both the NationalAction Planand the MTDS drew heavily on the results ofBosnia and Herzegovina-Diagnostic Surveys of Corruption,undertakenwith the supportofthe World Bank. 29 the authorities to monitor living standardsand adjust public programs inlight of the evolving poverty profile and incidence analysis o f the safety net. 82. Itis important to notethat redistributionofspendingaway fromwar veteranswith low levels of disability and survivor families with other means of support i s likely to have apositive distributional effect. The Poverty Assessment notes that beneficiaries of the veterans' system on average are better of than the rest of the populationwith the current benefit system, At the same time, itnotes that segments of the beneficiary population would be significantly worse off than average without the support of the benefit system. 43The reform supportedunder SOSAC 11i s designed with this situation inmindby focusing the rationalization o f the benefit system on those segments o fthe beneficiary populationwho are least disabled (andtherefore least likely to be poor), andthose who have alternatives meansof support. While the LSMS data do not allow for a fine-tuned simulation o fthe impact o fthe veterans' benefitreforms, the available analysis is reassuring on the poverty impact o fthe reform. To the extent that fiscal reallocationoccurs towards social welfare programs -as it shouldas a result o f the social welfare financing reforms supported under SOSAC 11 - the positive effect on the incidence o f transfer programs shouldbe more pronounced. 83. The operation should also contribute ina more targeted manner to alleviatepoverty, through supporting the policy and institutional framework andprograms for more effective socialprotection systems inboth Entities. Available poverty data suggestthat variations inliving standards between and withinEntitiesareconsiderable, withthepovertyheadcount inthe RSmorethantwice that ofthe Federation, andpoverty rates insome cantons withinthe Federation several times higher than inothers. There is therefore a strong case for partial equalization ofbasic social assistancebeing supported under the operation. While ideally this shouldalso happenacross Entities as well as within them, this i s notjudged bylocal counterparts to be feasible at thispoint. The work initiated under SOSAC IIondisability programs should also support a process o f better targeting o fresources within selected programs, so that the most vulnerable within groups o f special needreceive improved socialprotection. G. EnvironmentalImpact: 84. The proposed project is not expected to result inany negative environmental impact. For the purposes o f OperationalDirective 4.01, it hasbeenreviewed as a category C project, not requiring an environmental assessment. 43 See Annex 10 which summarizes the relevant Poverty Assessment findings. 30 Annex 1: Key Economic Indicators Bosnia and Herzegovina - Key Economic Indicators ~ ~~~ ~ ~ Actual Estimate Projected Indicator 1999 2000 2001 2002 2003 2004 2005 2006 2007 National accounts (as YOof GDP) Gross domestic product' 100 100 100 100 100 100 100 100 100 Agriculture 17 14 13 18 17 17 17 17 17 Industry 30 30 28 37 35 35 36 36 36 Services 53 57 58 45 49 48 47 47 46 Total Consumption 113 109 113 113 112 111 108 105 102 Grossdomestic fixed investment 21 21 19 20 20 20 21 21 22 Government investment 11 9 6 5 5 5 4 4 Privateinvestment 10 10 14 15 16 16 17 18 EXPO* (GNFS)~ 26 26 26 26 26 28 29 30 31 Imports (GNFS) 58 56 58 59 58 59 57 55 54 Grossdomestic savings -13 -9 -13 -13 -12 -11 -8 -5 -2 Grossnational savings' 13 8 3 2 3 5 6 8 11 Memor~ndumitems Gross domestic product 4692 4740 5006 5600 7034 8348 9006 9740 10509 (US$ millionat current prices) GNIpercapita(US%, Atlas method) 1240 1270 1280 1310 1540 1740 1940 2050 2180 Realannual growthrates (%callculated from 1999prices) Gross domestic product at marketprices 9.6 5.5 4.4 5.5 3.5 5.1 5.7 5.9 6.2 Gross DomesticIncome 9.6 4.5 3.1 1.8 3.3 4.4 4.9 5.5 5.5 Realannualper capita growthrates (%, calculated &om 1996prices) Gross domestic productat marketprices 6.5 2.8 2.4 2.4 2.6 3.7 4.8 4.4 4.4 Total consumption 2.0 -3.5 Privateconsumption Balance of Payments (US%millions) EXPO& (GNFS)~ 1296 1288 1296 1466 1894 2248 2460 2760 '3123 Merchandise FOB 744 832 870 1046 1407 1715 1937 2210 2546 ~mports(GNFS)~ 2770 2742 2899 3316 4083 4630 4863 5148 5460 Merchandise FOB 2542 2547 2701 3122 3845 4322 4532 4805 5100 Resourcebalance -1474 -1454 -1603 -1850 -2189 -2382 -2403 -2388 -2337 Net factor income 300 253 245 248 332 380 401 454 513 Net currenttransfers 284 580 547 566 631 684 670 660 667 Current accountbalance -890 -874 -1056 -1284 -1558 -1698 -1733 -1728 -1670 Net private foreigndirect investment 90 150 130 230 320 420 540 570 600 Long-termloans (net) 147 68 89 84 31 149 108 80 69 Official 147 68 89 84 31 149 108 80 69 Private Other capital(net, incl. errors& omissions) 915 1369 878 1431 1226 1226 1175 1137 1051 Changeinreserves(increase, -ld -262 -713 -41 -461 -19 -97 -90 -59 -50 Memorandum items Resourcebalance(% ofGDP) -31.4 -30.7 -32.0 -33.0 -31.1 -28.5 -26.7 -24.5 -22.2 Real annualgrowthrates ( YR96 prices) Merchandiseexports (FOB) PriltlaIy Manufactures Merchandiseimports (CIF) (Continued) 31 Bosnia and Herzegovina Key EconomicIndicators - (Continued) Actual Estimate Projected Indicator 1999 2000 2001 2002 2003 2004 2005 2006 2007 Publicfinance (as % of GDP at marketprice# Current revenues 57.7 53.7 49.7 48.1 46.7 45.8 44.4 43.0 41.7 Current expenditures 50.7 49.8 43.9 44.1 41.8 41.1 39.9 38.7 37.5 Current account surplus (+) or deficit (-) -8.2 -13.1 -16.2 -18.5 -17.4 -15.8 -14.8 -13.1 -11.0 Capital expenditure 14.8 10.9 9.2 6.3 4.5 4.8 4.5 4.2 4.1 Foreign financing 14.0 9.7 7.9 5.5 4.2 4.3 1.8 1.1 0.9 Monetary indicators M2IGDP 25.2 25.6 42.6 43.0 44.5 45.9 43.1 41.2 39.5 Growtho fM2 ("3) 39.9 13.9 89.3 7.0 8.3 6.2 4.4 2.5 2.7 Private sector credit growthI 193.9 91.6 213.1 110.1 98.3 99.2 99.2 99.2 99.2 total credit growth(%) Price indices( YR96 =loo) Merchandise export price index Merchandise import price index Merchandiset e r m o ftrade index Real exchange rate (US$/LCU)f Real interestrates Consumer price index (% change) 2.8 5.0 3.2 0.3 0.1 0.9 1.7 2.0 2.1 GDP deflator ("hchange) 3.8 5.8 2.4 2.1 1.1 1.3 1.9 2.0 2.0 a. GDP at factor cost b. "GNFS" denotes "goods andnonfactor services." c. Includes net unrequited transfers excluding official capital grants. d. Includes useo fIMFresources. e. Consolidatedcentral government. f. "LCU" denotes "local currency units." AnincreaseinUS$ILCUdenotes appreciation. ht m 0 .. c1 33 Annex 3: IFCPortfolioinBosniaandHerzegovina Bosnia and Herzegovina StatementofIFC's HeldandDisbursedPortfolio As of2/29/2004 Held Disbursed FYApproval Company Loan Equity Quasi Partic Loan Equity Quasi Partic 1997199101102 Bosnia Micro 3.79 0 0 0 3.79 0 0 0 2001104 CPB 12.64 5.18 0 0 0 0 0 0 1997 Enterprise Fund 0 1.95 0 0 0 1.26 0 0 2002 FCL 12.64 0 0 3.16 12.64 0 0 3.16 2001 PBS-SPV 13.69 2.31 0.13 0 13.69 2.31 0.13 0 2002 Raiffeisen-BOS 18.35 0 0 0 10.76 0 0 0 1998 SEFAkova 1.23 0 0 0 1.23 0 0 0 1999101 SEF Bosnalijek 1.87 0 0 0 1.87 0 0 0 1998 SEF Lignosper 2.68 0 0 0 2.33 0 0 0 1999 SEF Lijanovici 1.45 0 0 0 1.45 0 0 0 1997 Sarajevska 0.83 0 0 0 0.83 0 0 0 1998 Wood Agency-AL 5.77 0 0 0 0 0 0 0 Wood Inga 2.04 0 0 0 0.41 0 0 0 Wood Konjuh 2.9 0 0 0 2.57 0 0 0 Wood Kozara 2.04 0 0 0 1.71 0 0 0 Wood Podgradci 1.39 0 0 0 1.14 0 0 0 Wood Vrbas 2.04 0 0 0 0.41 0 0 0 Total Portfolio: 85.35 9.44 0.13 3.16 54.83 3.57 0.13 3.16 Approvals PendingCommitment ~ Loan Equity Quasi Partic 2002 Lukavac 9.93 0 0 2.48 Total Pending Commitment: 9.93 0 0 2.48 34 Annex 4: Timetable of Key Processing Events SOSAC IIidentification workshop: June 2001 Identification Mission: September 2001 ICMreview: December 2001 Pre-Appraisal: May 2003 ROSDecisionMeeting: September, 2003 Appraisal departure: September 2003 Negotiations: April 2004 Boardpresentation: June 2004 35 ANNEX 5: Letter of SectoralDevelopmentPolicy Second Social Sector Adjustment Credit to Bosnia and Herzegovina May 12,2004 Mr.J. Wolfensohn President World Bank 1818HSt. NW Washington DC, 20433, U.S.A. LETTER OF SECTORALDEVELOPMENTPOLICY Dear Mr.Wolfensohn: This Letter ofDevelopmentPolicy describesthe maintenets o fthe economic reformprogramo fBosnia and Herzegovina, including the macroeconomic fi-amework that complements the program, as underscored inthe recentlycompletedStandby Arrangement withthe InternationalMonetary Fund. Italsooutlines in detail specific measureswe intendto undertake inthe area o f social policy reform, including veterans' benefits, social welfare and childprotection, employment programs, pensionand disability programs, and social statistics. Finally, it outlines the Governments' mediumterm reformplans inthe sector. The reforms outlined are consistent with our MediumTermDevelopment Strategy (PRSP) recently approved by State andEntityGovernments. To support implementationof our socialpolicyreforms, the Governments o f Bosnia and Herzegovina, the Federation o f Bosnia and Herzegovinaand Republika Srpska request financial assistancefrom the International DevelopmentAssociation under the proposed Second Social Sector Adjustment Credit. I. MacroeconomicFramework: Followinga devastating conflict and the signature o f the Dayton PeaceAgreement inDecember 1995, BH has made progress inestablishingitselfas amodemandviable state, among others pursuingintegrationon dual tracks: (i)intemally, through increasedharmonization o f relatively autonomous sub-national entities while strengthening the coordinatingfunctions o f the BH's institutions; and (ii) externally, by actively engaging into the Stabilizationand Association Process (SAP)with the EuropeanUnion (EU) as well as pursuingother avenues o f international integration (Council o fEurope membership, WTO accession, etc.). While the objectives o f post-conflict reconstruction areperceivedas havingbeen achieved to a large extent, many challenges relating to economic transition are yet to be fully addressed, inorder for BHto regain sustainedgrowth inthe economy and reduce unemployment andpoverty. Our agenda for macroeconomic managementand structural reforms i s detailed inthe MediumTerm Development Strategy (PRSP) that the State and Entity Governments have recently approved. 36 BHhaspostedimpressive growthrates since the war (an average 21percent inrealGDP growthbetween 1996and 2003) andper capita GDPhas doubled since the end of the war, buti s still estimated to be only at two-thirds o f its pre-war level. Immediately following the conflict, growth was mainly spurred by intense reconstructionandrehabilitation investment inpublic infrastructure andprivate housing. Activity hasbeen predominantly financedby large and sustainedaid flows. Privatetransfers, which are estimated to have averaged 13 percent o f GDP over the last five years, have also played an important role infueling domestic spending. Recent growth has remainedpositive, buthas been falling, mirroringdeclining official aid and stagnating manufacturing activity. The trend of decreasingaid flows i s likely to continue. BHhasmanagedto achieve solid growthwithout compromisingmacroeconomic stability. Prudent fiscal management, and strict adherence to a currency boardarrangementhave been the mainpillars of the Government's macroeconomic policy, supported by two IMFStandby Arrangements, the secondof which we successfully completed inFebruary2004. Anchored inthe currency board arrangement, monetary policy hasbeen successful inrapidly stabilizing inflation, bringingit even below averageEUlevels in recent years. Regarding fiscal policies, we have been able over the past few years to increase our revenue collectionperformance, while alleviating the heavy burdenof public spending inthe economy. However, despite the fiscal adjustment and the decline inreconstructionaid, BH's trade and current account imbalances remain at unsustainable levels. While we will continue to implementprudent macroeconomic policies, restoringthe country's competitiveness and reducingthe current account deficit will imperatively require further progress instructuralreforms. To date, progress with respect to structuraland institutionalreforms has been achieved mainly inthe areas o fpublic finance, the financial sector, and foreign trade policy. With respect to public finance, the introductionof modemtreasury systems at all levels o f government short o fmunicipalities has contributed to improvedspending discipline. Significant progress was also achieved intax policy andadministration (including countrywide harmonization and improvedcollection enforcement), andwe have initiated deep institutionalreforms to prepare the introduction of VAT. We have also increasingly resorted to policy co- ordination mechanisms between the State and the Entities informulating our policies, For instance, this cooperationhas greatly facilitated the preparationo f harmonized plans to settle reduce the large overhang o f domestic claims on our governments. Similarly, State and Entityauthorities have worked closely together to adopt fundamental reforms insuch areas as defense. However, there remains significant scope to further rationalize a costly multi-layer government structure, which still absorbs above half of GDP, with a particular focus on controlling the wage bill inorder to free resources for operations and maintenance and domestically financed public investment, as well as redirecting our social protection programs to those who need it the most. Financial sector reformsuccesses have includedthe early replacement o f payment bureaus with a modem payment system, the privatization andrestructuring o f most banks at low fiscal cost, the entry ofnew strategic investors inthe banking sector, and the establishment and gradual strengthening o f the prudential andregulatory framework. Finally, our trade policy reforms have ledto the adoption o f the most liberal trade regime in South-Eastem Europe and we have signed bilateral free trade agreementswithnine inthe Region. However, we remain concerned that this favorable trade environment has not yet materializedin increasedprivate sector growth and investment or inemployment creation. As we have emphasizedinour MTDS,this signals the needto accelerate reforms inother areas, inparticular the business environment, enterprise restructuringand the labor market, where our progress to date has been slower. While legal frameworks for foreign investment andprivatizationhave been established, enforcement has beenhamperedby weak implementationcapacity. Privatizationo f small and mediumscale enterprises was accomplished, buthas resulted indiluted ownership and weak corporate governance. Most o f the large companies that could attract strategic investors are still state-owned. The business environment has 37 improved, but obstacles to enterprise creation and bureaucratic hasslesto companies needto be fwher eliminated. Corporate governance rules needto be changedinorder to provide the right incentives and obligations to company owners and managers.Finally, BHhas only very recently enactedmodem bankruptcylegislation so that many loss-making corporations can only now undergo restructuringor liquidation, and free space for fresh investment and employment growth. Inthiscontext, our strategic macroeconomic objective isto preserve a stableenvironment that is conducive to the implementationof the structuralreforms aimedat promoting private domestic savings and investment. We will continue to implement the currency boardand the associatedprudentmonetary polices, while our fiscal stance will generatethe necessarypublic sector savings. We will aimat further reducingthe share ofpublic spending to GDP, by continuing to rationalize programs innon-productive sectors, while reallocating expenditures to productive investments inhuman and physical capital as well as targeted social transfers. We will also strictly adhere to the implementation o f the domestic debt settlement plan inorder to eliminate contingentrisks on our budgets, and free the necessaryfiscal space to accompany potential short-term social costs of the neededstructural reforms. These structuralreforms will focus on accelerated enterprise restructuring, including throughprivatization andbankruptcy, and on labor market reforms, which will bothcontribute to improvedcompetitiveness andthe generation o fproductivejobs. 11. Key Social Policy Reforms A key objective o four reforms is to promote moreeffective socialpolicy inBH,bothin terms ofequity andefficiency o fpublicprograms. This is an areawhere the transition fromthe humanitarianphaseof post-war recovery to sustainable development presentsacute challenges. Itwill require a significant reorientationo f our social safety net andother socialprograms to ensure that the needs ofthe poorest are met ina manner that doesnotjeopardize fiscal discipline. Achieving morepro-poor public spendingwill requirereforms onmany fronts, and the policy agenda supportedunder the Second SocialProtection Adjustment Credit (SOSAC II) supports several key measures. These are outlined below, and include: withinthe broader context ofimplementing our first MediumTermDevelopment Strategy (PRSP), we intendto focus more closely onreformof cashtransfer programs, overhaulingour social welfare and childprotectionprograms, to ensure that they are given adequate funding, that entitlements arerestructured andprioritizedinamanner consistent with current fiscal realities, andthat financing arrangements are re-designed to ensure basic protection for the poorest wherever resident. reforming our veterans' benefit programs, to reduce their share inpublic spendingwhile continuingto protect the needs o f the most disabled veterans and vulnerable survivor families. promoting effective andtransparent employment services, through institutional andpolicy reformof employment programs, from international cooperation at the State leveldown to the operations of local services. consolidatingthe policy framework for operationof the public pension and disability systems inboth Entities,including improvedfunctioning o f inter-Entity pensionrelations andreviseddisability assessmentprocedures. increasing our engagement with civil society insocial policy throughbetter public information and consultation, and promoting sustainable partnerships betweenpublic and non-government sectors in social services for the most vulnerable. ensuringthat living standardsmonitoring i s done more effectively and informs policy making. 38 Poverty focused economic policy The Governments o f the State andbothEntities approved our first MTDSinearly 2004. This forms the basis o f ourjoint medium term economic development strategy for BH. The MTDSemphasizesthe need for employment intensive growth as the primary vehicle ofpoverty alleviation. At the same time, it acknowledges that public spendingmust continue to be directed towards those unable to benefit from growth for a variety of reasons. A key messageof the MTDSi s the needto reform the existing systemof cash transfers towards greater emphasisonprograms for the most poor and vulnerable. BothEntities presently spend a large share on cashtransfers. These need to be bothreduced inthe aggregate, and better targeted on the poor across the board. This also involves aredistribution from spending on veterans programs to social welfare and childprotection which i s relatively underfunded, and adoptingnew legislationwithrealistically financeable entitlements. Untilrecently, our effortsto consultwithandfamiliarize thepopulationaboutpolicyobjectives andkey trade-offs insocial policy reformhave beenlimitedand uncoordinated. This has often allowed specific interest groups to dominate public debatewith biased or factually incorrect information. We realize the needto informthe public o f the key objectives o f social policyreforms more effectively ifcomprehensive socialprotectionreformis to succeed. Just as importantly, policy formulation needs to bebetter informed bypublic opinion andpriorities. We have recently made significant steps to improve the situation. First,the MTDSprocesshas involved widespread consultation with a range o f civil society actors onboththe general direction o f Government policy and specific areas o f social policy such as pensions, veterans' programs, and employment programs. Itis clear that different stakeholders areincreasinglyawarethat Governmentsmustbalance multiple demands on limitedpublic resources. Intandem with the MTDSconsultations, we also carried out in2003 a public consultationand information campaign on social policy reformtitled "40 Days o f Dialogue on Social Reforms". This provedto be a useful process for informingthe public o f the directions o f and constraints upon reforms, and for members o f EntityGovernments to develop a deeper understanding of the main concerns o f the public with respect to social policyreform. While these are positive developments, our more important mediumterm need i s for sustainedcapacity within Government andministries for public information and consultationand external relations. New laws on ministries inbothEntities now require an external relations capacity to be established inall ministries, butthis has been slow to happeninpractice inthe social policy area. We are committed to ensuring appointment o f designated staff for this purpose inthe relevant line ministries, andto strengthen their skills over time with technical support from donors. B. Social Welfare and ChildProtection Reforms C0ntext: The social welfare and childprotection (SWCP) system inBHhas been ina state o f crisis inrecentyears, for the mostpart unable to makethe transitionfromhumanitarianreliefto acoherent and sustainable system. Although entitlements inEntity legislationapply equally to all sub-Entityauthorities in principle, implementationvaries enormously by region due to decentralization o f financing. Social welfare suffers from a separation o fpolicy making and implementation responsibilities, with legislatedentitlements that reflect the Socialist FederalRepublic o f Yugoslavia (SFRY) inheritance, but inmany areas can no longer be afforded. This i s partly a product o f failure to adjust entitlements to an affordable core, and partly due to under-fundingo f social welfare as a share o f total government spending relative to regional standards. 39 The mainproblems confronting the sector include: (i) separation of policy development andjnancing, which has resultedinprogram mandatesto the local levels which can not be financed inmost areas. Entity legislationretains the standard menu of SFRY erabenefits and programs, without settingprogrampriorities or identifyingfinancing for core benefits; (ii) aggregate under-funding ofSWCP. BiHspends less on SWCP as a share o f GDP than any country inthe region. Byregional standards, RS is at the low end, and FBHhasalower allocationto SWCP than any country inSEEICEE, This is inpart drivenbydecentralized financing, but also byhighallocations to other cashtransfers such as veterans' benefits which are less well targeted; (iii) variation within each Entity in safety net coverage. Inmany areas, regular benefits have high not beenpaidto the poorest for some time. At the same time, better-off areas provide a safety net which i s relatively comprehensive. As a result, the situationofthe poorest varies significantly depending onwhere inthe Entitythey live. The responseinsome areasto lackoffinancing hasbeentoreduce safetynet coverageto "one-time help", which i s paidirregularly and on a discretionary basis incases of extreme hardship. Inother areas, those who shouldbe eligible for social welfare benefits are not registereddue to inability to finance payments. This i s not a sustainableposition for the very poorest withno alternative sources of income; (iv) the lack ofcore benejt~s~jnancedby the Entity budget or by a designated source of funding. Inneither Entitypresentlyisthere a social assistancebenefit financedor supportedbythe Entity budget. InFBH,the same is true for childallowances. Financingof social assistance is entirely fromthe sub-Entity (typically municipal) level, resultingin"vicious circles" ofhighpoverty areas withvery limited fiscal bases for financing the safety net; (v) institutional arrangementsfor social welfare and child protection which do not give prominenceto the sub-sectors. This relates bothto allocation ofroles and responsibilitiesinSWCP withinandbetween levels of govemment ineach Entity;and (vi) ineffective and inefjcient administration of social welfareprograms, reflectingprogram andmanagement practices which are increasinglyoutdated. Priority reforms: We have already initiated and intendto continue reforms inthe policy, institutional and financing frameworks for SWCP inbothEntities. We would also implement measures to ensure more effective administration o f SWCP programs. Our reforms will buildupon social protectionpolicy development work inbothEntities in2000 and 2002, and the MTDS. The objective o f the reforms i s to promote a fiscally sustainable core social welfare programineach Entitywith clearly identified and reliable financing sources. While this may be supplemented by sub-Entityauthorities inbetter-off areas, it should ensure a minimumand affordable safety net for the poorest wherever resident. SOSAC 11would support several elements o f our program, including: e we have undertaken initial steps ineachEntityto reformour social welfare systems, pendingmore comprehensive reformduring2005. Inthe Federation, the initial measuresinvolve reforms of civil victims of war legislation, inparticular movingfinancing responsibility for selectedbenefitsto the Entity level inorder to make basic benefits available throughout the Entity. Inthe RS, we have legislated reforms which promote increased and more predictable financing o f social welfare benefits bymunicipalities, healthinsurance coverage for social assistancebeneficiaries, fiscally supportable benefit levels, and stronger cooperationinsocial welfare service provision betweenthe public andnom govemment sectors. e as the next step inour policy reforms, the social welfare strategy development carriedout as part of the MTDS(PRSP processandduringpreparationofSOSAC 11would informdevelopment ofnew legal frameworks for social welfare which would be approvedby Parliaments inbothEntities in2005 prior to secondtranche release o f SOSAC II, and include: (i) definition o f roles andresponsibilities in clear social welfare financing andprovision at different levels o f system; (ii)rationalized scope of rightsin Entity law to focus on "core" social welfarelchild protectionbenefits and services capable ofprovision throughout the Entity; (iii)financing identified for at least one core social welfare benefit to bepaid 40 from the Entitybudget ineachEntity,and this obligation reflected inlegislation; (iv) review of targeting criteria for benefit eligibility incore programs; and (v) provisions to require and further promote effective partnerships between public and non-government sectors insocial service provision. on institutional and implementationissues inSWCP, we intend to undertake the following measures: (i) roll-out o f a databaselclient registry of social welfare beneficiaries and expenditures inall localities in bothEntities, with the system linkedto the EntityMinistry for reliable andtimelyreporting, This has not existed since the conflict; (ii)completion of a functional reviewof socialprotection activities in each Entity, leadingto proposals from eachof our EntityGovernments to address the institutional problems identified; (iii) developing guidelines for Operational Manuals (OM) for use inall Centers for Social Work, the local level social welfare offices, to improve their efficiency and client responsiveness; and (iv) introduction inmost localities of Social Policy Boards which would help set strategic directions at the local level for the social welfare systems. Designand implementationof these reforms is beingsupportedby the Social Sector Technical Assistance Credit. C. Reformof Veterans' Benefits andPrograms Context: Fiscalpressure from veterans' programs i s a major issue inBiH. The level of spending on veterans' programs crowds out public investment anddiverts resources from transfer programs which are better targeted on the poorest. InbothEntities, spending from Entitybudgets alone on veterans' programs has consumed from 3.5 to over 4 percent o f GDP inrecent years. Inaddition, inbothEntities,there are substantial foregone revenues from tax and customs exemptions for veterans, and significant spendingat the sub-Entitylevel on veterans' benefits and programs, includinghousing, healthcare, and employment. We estimate that around 5 percent of GDP i s consumed at all levelsby direct spending and foregone revenueson veterans' programs andbenefits. There are also a large number o f claims by injured veterans and survivor families inthe court systems o fbothEntities whichpresent a significant contingent liability on our budgets. Finally, inFBHthe situation i s mademore complicatedby the existence of two legal frameworks: one for Bosniak areas and one for Croats, the latter also benefiting from significant financial support from Croatia. This has resultedinsignificant disparities inregional coverage and entitlements with FBH,as well as diminishedtransparency inimplementation. Despite the large allocations to veterans'benefits, benefits for the most disabledveterans and survivor families ofkilled soldiers are inarrears inbothEntities, so that those most inneed are not able to have securereliable protection. This is due to the wide scope o f beneficiaries andbenefits, which reflectsno prioritization inexisting legislation. InbothEntities, the major causes o f fiscal pressure from veterans' programs include: 0 disability or death o f a veteran generating entitlementto benefitsneednot be linkedto military service. e benefits are indexed to the average wage and are high. Aggregate benefits from the veterans' systems can runas highas 4-5 times the average wage. e survivor families are defined insome cases to include grandparents, relatives and parents. Inaddition, there are very limited restrictions on family beneficiarieswith alternative sources o f income, so that spendingis poorlytargeted onthose most inneedinthe group. e there are a range o f exemptions for veterans and their families on customs and tax liabilities, some of which -such as the exemptionon car import duty-have been abusedto create unwarranted profits for veteran households. 0 insomeprograms, benefits are extendedto non-disabled veterans, thoughinpracticethesehaveusually not been affordable inrecent years. 41 mechanisms for rationing spending to available budgetary resourcesare only partially effective, so that arrears exist inall systems. This is underlinedby the emerging backlogo f legal claims inFBHagainst the Government for failure to adjust benefits as anticipated incurrent legislation, with court awards already granted of over 2 mln.KMlikely to be a fraction o f total liabilities, as well as increasing benefit arrears (estimated to reach 18mln. KMin2004). there i s anecdotal evidence o f fraudulent misclassificationofbothdisabled and other veterans, particularly duringthe war when assessment systems were less than accountable. benefits are extendedto veterans' and their survivor families down to minor levels of disability, so that significant amounts are allocated to those whose injuries do not significantly impact their ability to work and are for the most part nomore vulnerable than the general population; and inRSspecifically, non-disabled veteransare legallyentitledto benefits, andthere isprovisionfor "non- material" damage to families who lost a member duringthe war (equivalent to "emotional pain and suffering"). This is compensatedaccordingto court awards and canrunto 200,000 KMfor an individual family. This possibility creates a major contingent liability for the RSbudget. Priority reforms: We recognize that the current situationwithveterans' benefits i s unsustainable. MTDSconsultations andthe social surveys which informedour 40 Days ofDialogue campaignalso indicatethat this understanding i s sharedby a large cross-section of society. The main objective of our veterans' benefits reforms is to promote a rationalized structure of entitlements that adequately supports veterans and families o f deceasedsoldiers who have been most severely affectedby injury or loss of primary income earner. At the same time, compensation mustbe tailored to limited fiscal resources. Reformo f veterans' legislation inbothEntities should result ina more fiscally sustainable set o fbenefits that will free resources for social protectionprograms that target the most needy. The scope o f beneficiaries andbenefits must be rationalized substantially. An important additional goal i s to promote, as far as possible, harmonization o f the veterans' legal framework acrossbothEntities. While reformo f veterans' benefits i s a highfiscal and social priority, we stress that it i s a socially and politically sensitive subject. To this end, we have ensured close consultationthroughout design o f new legislation with veterans' organizations andrepresentatives o f survivor families. Consistent with our MTDSandveterans' reformstrategies developed during2002, we have recently enacted inbothEntities new veterans' benefit legislation. The new lawsprovide for a comprehensive beneficiaryrevisionprocess intended to weed out unjustified claimants; rationalize the range o fbenefits available to different categories of beneficiaries; eliminate customs or tax exemptions inEntityentitlements; require disability or death of the veteran be directly relatedto military service for military invalidand survivor family benefits; reduce parental benefits where other means o f support exist (e.g. pension; employment); provide a narrower definition o f survivor families, and strengthen conditions for discontinuation o f nuclear family benefits where altemative means o f support exist; introduce provisions inlegislationto ensure that benefit obligations cannot exceed available budgetary resources; ensure that indexation o fbenefits does not exceed the increaseinthe cost o f living; limit spending onbeneficiariesinlower disability categories; eliminate monthly benefitsand entitlements financed from the Entitybudgets for non-disabledveterans where they exist; provide for healthinsurance and co-payment exemptions for the most seriously disabled veterans and nuclear survivor families; and eliminate o f claims for non-material damage. Inthe Federation, the new law would for the first time since the war introduce a unifiedveterans' benefit regime for the entire Entity, replacingthe existingethnically basedparallel entitlement structures and administrations. Inorder to ensurethat thesecomprehensive policy changes feed through into implementation, we arealso committedto specific spending targets and execution inour 2005 budgets which are consistent with the rationalizedsystem outlined above. We would therefore ensure that the 2005 executed budgetineach Entity would involve no increase innominal allocations for veterans benefits from the 2004 core budget. 42 We also intend to take significant steps to improve the transparencyand efficiency o f implementation of veterans' programs. InFBH, we have already initiated improvements through establishment of a unified account at Entity levelthrough which all Entitylevelbudgetary funds for veterans' benefits flow. This introduces additional transparency and possibilitiesfor budgetary scrutiny inthe system, and we intendto maintain and improve this system. InRepublika Srpska, we have from 2003 established a database for veterans' beneficiaries, based on a complete inventory ofbeneficiaries. A similar database would be developed inFBHin2004-05 as part o f the plannedrevisiono fbeneficiaries. Inorder to increase transparency inthe reformed system and ensure its timely implementation, we would also ensure prior to the secondtranche o f SOSAC 11:(i) approval of implementingregulations for new veterans' legislation; and (ii) basicinformationsystemswouldbeputinplaceineachEntitytoupdateregularlybeneficiaryand that expenditure data for all programbeneficiaries, and consolidate data with the responsible Entity Ministry. I). ImplementingEmployment Programs more effectively Context: The legal frameworks governingthe activities o f the Employment Institutes - which administer unemploymentbenefits and active labor programs for the unemployed were overhauledinboth - Entities in2000 with support under the first SOSAC. The new laws have significantly reduced the cost of unemployment benefits. They also introduced anew institutional framework inFBHto eliminate ethnically-based employment services. These reforms are considered critical inan environment where registeredunemployment inbothEntities is over 40 percent, and even survey-based E O measures of unemployment produce estimates from 16-25 percent. Despite this progress, we continue to implement an unfinishedagenda o f new institutional and financing frameworks for employment services and labor issues including: the successorto the Employment Bureaufor the Bosnia-Herzegovina Republic o f SFRY continued untilvery recentlyto exist, withnodefinedlegalbasis, function or financing source. Its failure to cooperate with external audits also confirmed concems identified inprevious financial police investigations of improprieties inmanagement of funds and assets. This has resultedinan institutional vacuum at the BHlevel, with no genuine State levelbody to deal legally with the internationallabor obligations o f BH, E O obligations andbilateral agreementswith other countries. as of end-2002, not all cantons had formally established cantonal Employment Services, so that some cantonal programs continued to operate as part o f a larger ethnically-based fund. an audit and businessprocess review o f the EntityEIs completedin2003 identified poor business processesand lax financial management inbothEntities, inaddition to a serious lacko f accountability and monitoring of internal operations and evaluation o f E1programs. the current mix o f active labor programs (ALPS)inbothEntities is very limited, with an emphasison programs such as subsidized credits to firms and wage subsidies which are not cost-effective, and in some cases have beenprovided ina non-transparent manner. At the same time, more cost effective programs such asjob counseling andbasic job brokerage functions are non-existent or seriously neglected. Inaddition, the unemployed insurveys indicate low faith inpublic employment servicesto provide them with a useful service when looking for work. Given that FBHinparticular spends significant public resources on suchprograms (around 1percent o f EntityGDP in2003), these are unsatisfactory outcomes, and ones that must improve given the highlevels o f unemployment inBHand emerging demandson employment services as enterprise restructuringproceeds. 43 Priority Reforms: Overall, our objective inthe area of employment services i s to ensurethat the legislatedinstitutional and financing arrangements work inpractice, that ALPs are reformed to provide an effective service to the large pool o f unemployed, and that the remainingissues relatedto a State levelbody are resolved. Addressing these problems is important, giventhe likely additional demands on the E1system as enterprise restructuring gatherspace. Inorder to meet these objectives, we have taken or propose to take the following measures: for both Entities, we have recently completed external audits andbusiness processreviews of the Entity Employment Institutes. This has been followed byrevisedinternalprocedures inthe EntityEIswhich respond to the shortcomings identified inthe audits. inFBH,we havenowcompleted establishment andoperationalizingofcantonal EIsineachcanton, witha clear recognitionoftherole ofthe FederationEmploymentInstitute. Thisallows anEntity-wide network to function for the first time since the war. The Federation E1has also approved and i s implementingnew procedures for allocating the portion o f unemployment insurance contributions which go to the Entity level, inparticular the framework for reallocationo f a share of Entity funds to the cantons on aneedsbasis. the State o f BHhas approved legislationto establish a small State level Labor Agency with a core mandate to handle the international obligations o f BHinthe labor field. This outlines the mandateof the new Agency and identifies o f financing sources its operation. Italso provides for final closure of the former BHEmployment Bureau, andwe have taken action to ensure closure and liquidation o fthat institution. Both Entities are committedto developinga more effective mix o f active labor programfor the unemployed. To this end, we would develop and approve bythe time o f secondtranche of the SOSAC I? ALPpolicyforbothEntitieswhichisconsistentwithfiscalrealitiesandtheadministrative revised capacity o f the employment services. A framework for revisedprograms has been developed basedon discussions with Entityand cantonal employment services, and the EntityEIsare usingthis as a basis for further program development. Implementationo fmore effective set of ALPs will be supported by the Second Employment Support Project, which we expect to be presented to the Bank's Board inmid- 2004. E. Improvingthe Operationof PensionandDisabilityprograms Context: Inrecent years, we have gradually reformedentitlements within the PAYGOpension systemsin BH. At the sametime, cashrationingintroducedintothe pensions systems in2001remains the keypolicy tool for ensuring that pensions spending does not exceed pensioncontributions. While there is need for more structuralpolicy reform inthe pension system, preparatory work for medium-term reformis only expectedto start in2004. While policy development continues, there are a range o f implementationissues inthe current pensionanddisability systemswhichare inneedofurgentattention. Inaddition to entitlementreform inthe PAYGO systeminrecent years, institutional reforms ofthe FBH pension systemwere introducedfrom 2001, with the consolidation o f the pension systems into a unified Federation Pension andInvalidFund(PIO). However, while significant consolidation has been achieved, parallelism continues inimportant aspects o fpensions administration, including employer reporting on social contributions and IT systems. Inaddition, public sector control o f the database o f social contributionswas lost, as a result o f the transfer of ERC-ZIP0to private ownership in 1999. As a result, the extra-budgetary funds which financed all investments inthe agency and technically had full share ownership were required to pay hundreds o f thousands o f KMmonthly for access to their own data. 44 A pressingissue is howto handle inter-Entitypensionissues. This is important for pensionpayment obligations for pensioners who have made pension contributions during their working lives onthe territory of one o f today's Entities, but are now resident inthe other Entity or have receivedtheir initialpension authorizationfrom the Entityother than that where they contributed. To date, the problemhas beenhandled bythe pensionauthorities o fthe Entityofthe pensioner granting entitlement to andpayingthe pension withinthat Entity's system. However, with the continuing disparity inEntitypensionlevels, there have already been successful legal claims for compensation bythose who made their contributions on the territory o fwhat is now the Federation but arereceiving lower RSpensions. Previous efforts to resolve the issue have resultedinstalemate, to the detriment o f significant numberso fpensioners. An additional emergingissue inboth Entitiesis social contributionsarrears, with pensions contributions the biggest item. As privatization, enterprise restructuringandbankruptcyprogresses, concerns are growing on the pensionentitlements of dismissed workers andthose inbankrupted firms whose social contributions have not been made inmany cases for years. We are tryingto addressthe situation as an urgent social and economic matter. A key first step i s consolidating an inventory of social contributions arrears inorder to calculate the outstanding liabilities to the system. These are important data for designing realistic social programs to mitigate the negative social consequencesof enterprise restructuring andbankruptcy. Disability programs inBHinclude cash and in-kindbenefits, as well as services. As a result o f the war, the total proportion o fpersons with disabilities is higher inBHthan inany other country inEurope. Although BHdoes not have ahigher overall dependencyrate than other countries inthe region, the dependency burdenfrom disability itself is high. The greatest dependencyburdenstems from disabled war veterans and their families, who alone account for around 4percent ofthepopulation. Overall, about one out ofevery 10potentialworkers has a disability. Despitethis, the systemfor assessingdisability i s outdated and implemented ininconsistent fashion acrossprograms and across different parts o f each Entity. There is also substantial anecdotal evidence o f abuses inthe system, with informal payments to assessingdoctors considered to be common. The result i s a series o f disability programs which consume significant resourcesbut continue to include unjustifiedbeneficiaries and probably exclude more deserving claimants. Priority reforms: The keypensionand disability reforms which we have [recently undertaken] andplanto carry out inthe comingperiod are as follows: approving an inter-entity agreement onpensions-in-service. Given the risk o f a growing number of legal cases, the Entity line Ministries have recently approved and submittedto their respective Governments a Memorandum o f Understandingon the basic principles guidingthe applicable legislationinorder to ensure that pensioners wherever resident inBHget the pensionto which they are entitled. This will be approved bythe EntityGovernments inthe nearest future. we have prepared an inventory of social contribution arrears inpriority debtor companies inorder to evaluate the fiscal implications o f different options for dealing with the massive arrears stock. This will informdesign of public support programs for workers laid off without pay-in of contributions, an issue of particular complexity for the pension systems. a inthe Federation, we haveapprovedthe Statute ofthe mergedFBHPIO, whichallows for regularizationo f staffingand other organizational aspectso f the new Fund. As part of our efforts to regularize pensions administration, we have also approved a Government Decision which clarifies the legal status, function, ownership, reporting and other requirements relatedto ERC-ZIPO.The purpose of the decision i s to re-focus ERC's activities onproviding services to public agencies and thus reduce the potential for conflicts o f interest, and increase government control over the social insurance contributionsdata ERCmanages and the institution's operational decisions. 45 the specific category of civil victims o f war who inFBHare a group that presently "falls betweenthe - cracks" o f different levels o f government - would be a priority group for Entitylevel financing of benefits, as i s already the case inthe RS. As their number i s limited, this i s a sustainable fiscal burden. development and approval o fnew disability assessment rulebooks for veterans'/civil victims ofwar programs and childhood disability. We will determine whether this revision shouldalso cover workmg ability disability assessmentsunder the pension system. Inorder to advancethis work, we [have recently] formed working groups and technical reference groups to prepare newrulebooks, a task we are committed to completingprior to the SOSAC 11secondtranche. buildingonthe cooperation oninter-Entitypensionsissues, we are committedto developing a statewide Pensions Policy during2005 and prior to secondtranche, which would provide an agreed framework for medium term structuralreforms ofpension systems inBH. This effort i s supported under the Social Insurance Technical Assistance Credit. F. Improving the framework for operation of NGOs and third sector organizations: Context: Inthe social protection system inBH, the third sector is evolving into civil society organizations which are also increasingly local. There are amany thirdsector organizations registered inBH,ranging fromNGOsto veterans associations to human rights advocacy groups to service providers. These groups are recognized for their ability to service the population, often with programs than can be specifically tailored to the needs o f different beneficiary groups. However, there remain questions about the sustainability of the local third sector, particularly as donor support scalesback. Priority reforms: Our objective inthis areais to ensurea clear and supportive legal framework for the operation o fNGOslthirdsector organizations inBH, inparticular domestic organizations. This includes appropriate tax provisions to promote sustainability o f the third sector. Important steps were taken inthis process in2001-2002with approval o fharmonized legislation by the State o f BHandbothEntities for registrationand mutualrecognition o fNGOsthroughout BH. Inorder to promote the sustainable operation of third sector organizations, we have taken the following additional measures: a inorder to ensureeffectiveimplementationofthe newlegalframework for thirdsectororganizations, we have subsequently approved satisfactory implementingregulations for our NGOlaws. 0 withinthe broader overhaul ofprofit tax legislation, we propose to includeprovisions ontaxationof thirdsector organizations which allow for favorable tax treatment inlinewiththat commonly found for the not-for-profit sector inEuropean countries. This would provide that economic activities of NGOslthird sector organizations which are relatedto their core activities receive favorable tax treatment, and that donations to such organizations also attract favorable treatment. Such provisions should promote more sustainable self-financing o f the thirdsector, andwould be inplace prior to the SOSAC IIsecondtranche. G. Living Standards monitoring Context: The ability to produce statistics needed for design, implementationand evaluation of economic and social policy inBHhas beendamagedbythe war and transition. The statistical offices have limitedcapacity to produce the range o f statistics necessaryfor policy-makers. The areathat hasbeen especially hardhit is that o f data collection at the household level. A relatedissue is that of administrative data invarious parts o fthe social protection system, and the needto promote coordinationo f data and information systems as databasesare implemented. Finally, the linkbetween statistical data generation and policy formulation i s underdevelopedand inneed of strengthening. 46 Priority reforms: With support from donors, the Statistical Institutes havemade major progressin developing anew representative household survey for monitoring livingstandards, basedon the Living StandardsMeasurement Surveys (LSMS). The first representative post-war survey was completed in2001. The profile and data analysis have been critical inputsto MTDSdevelopment. We are buildingon the progress already made to improve household level data inseveral ways. First,the BHGovemment hasrecently approvedthe draft LawonStatistics, which for the first time provides aclear legal framework for organizationand distribution of statistical information, includingregulatingrelations between the State and Entity Statistical Institutes. This should be enactedby the BHParliament thisyear. Second, the Statistical Institutes initiated a HouseholdBudget Survey inearly 2004 and will complete field work by the end o f the year. Third, we have completed the first and the secondpanel rounds of the LSMS. Fourth, the StatisticalInstitutes are makinghousehold survey results freely available to the public for further research and analysis. This has beendone with the LSMS under a DataUsers Agreement, and will continue with subsequent survey data. Fifth,we intend to conduct a Labor Force Survey in2005, the first since the war, for which we have fundingidentified. Finally, we will support the ongoing work of the Data User Groups, which we consider an effective forum to maximize the linksbetween data collection, data users, andpolicy development. 111. Conclusion We hope that the above elaborationo f the programfor social policy reformhas clearly expressedour commitment to improving the welfare o fhouseholds throughout Bosnia andHerzegovina. The proposed agenda includes a number o f challenging and important steps inwhat we view as a fundamental and ongoing reformof social protectionpolicies inBiH. Itis also complementary to our reformefforts inother areas, including the business environment, macroeconomic and fiscal adjustment, and other areas of social and labor policy as outlined inour MTDS. Over the mediumterm, we hope to realize more fully the goals of this ambitious agenda as a core element o f MTDSimplementation. The continuedcontribution of the InternationalDevelopment Association and the rest o f the international community i s an essential part o f this challengingtask. 1I 0 aQ Y e, 3 .3 m I I - .B c1 0 E m m :I 4 8 N vr ml 0 53 Annex 7: Additionalmonitoringindicatorsfor mediumtermSOSACI1program Area Indicatorslmonitoringbenchmarks Veterans' benefitsand Spending on veterans' benefits and programs as: (i) of Entity share programs budgets; (ii) ofEntityGDP; and(iii) o f cantonal share share budgetsinFBH. Numberofbeneficiaries ofveterans' benefitsandprograms by beneficiary category. Number o fregions with fully functional and up-to-date beneficiary database. Socialand childprotection Level and share of Entitybudget spending on social assistanceand child protection. Total number ofhouseholds and people inreceipt of regular social assistanceand child allowances. Levelo fregular social assistancebenefitsby region relative to cost of livingbenchmark(s). Share ofbeneficiary households below poverty line. Pensionsanddisability 0Number o fpensioners for whom pensionpayment is switched from one EntityPI0 to the other. 0 Share of entity budget on civil victim o f war benefits. Stock o f outstanding pensioncontribution arrears. Annual reports of ERC-ZIP0 to Government andlor Parliament. Employment programs Budgets of State level Labor Agency and number o f international labor agreements concluded by Agency. Share of long-term unemployed(more than 2 years). Annual rate o fre-entry to workforce o fregisteredunemployed. Spending level and share o f Employment Institutes on active labor programs, and withinALPSonjob brokerage andrelated informational services. 0Financial management o f Employment Institutesmeasuresagainst action program for improvement. 0InFBH,annualreports ofcantonal employment services. NGOand civilsociety Number o fregistered local NGOs. participationinsocialpolicy Number ofmunicipalities where local CSW has partnership or contracting out arrangement withNGO. 0Number o f clients served byNGOs financed from public funds. Monitoringlivingstandards 0Analysis, publication andpublic access to the HouseholdBudget and informingsocialpolicy Survey. Status o fLabor Force Survey preparations. 54 Public information on social 0Fulltime equivalent staff engaged inpublic infonnatiodextemal policy relations functions inrelevant social line ministries. 0Frequency o fpublic consultation between highlevel ministerial officials and civil society. 55 Annex 8: SummaryoffindingsfromCommunityAssessment44 1. This summarizes results from anumber of focus group discussions on social safety netreform carried out with financing under the SOTAC duringlate 2002 and early 2003. Eleven focus group discussions were held inbothruraland urban areas, with groups consisting o f a cross section ofpeople comprisingboth employed and unemployed personsof all ages, of which some receivedbenefits and some didnot. The main viewsloutcomes from those discussions are very much inline with the broader SOSAC IIagenda. 2. General Findings: People are aware o f impending social reforms butunclear o f the specifics and how they would be affected individually. They generally agree on the need for change, and that progress has been too slow, and generally tend to be cynical about the nature of the reformprocess to date. There i s a general perceptionthat many current social cashtransfer beneficiaries are "double- dipping", or receivingbenefits for whichthey arenot elipble. People realizethe need for tough choices inlightofvery limitedresourcesavailable for social protection. Themajority ofparticipantsagreed that: 0 social welfare reforms areneeded, becausemanypeople inneeddo not receive anything or those who receive something do not receive enough, while some people who are able to work receive benefits. 0 more emphasis on employmentpromotion i s neededto allow governments to target social assistanceto those unable to work. 0 more money mustbe spent on child support. 0 handicapped, pensioners and children are considered priority groups. 0 Centers for Social Work (CSW) are the bodies most trusted and seen as best able tojudge real levels o f need, as opposed to higher authorities. Disability benefits: Many participants felt that: 0 many disabled persons are not receiving the assistancethey need, while others (such as some war veterans) receive disability benefits without actually being disabled. 0 thelabor market shouldabsorb those able to work to free upresources for those too disabledto work. Veterans: Many participants (butnot all) said that: 0 while war veterans deserve compensation andrecognition for their contribution and suffering duringthe war, there are manywho are gettingmore than their "fair share" or are receivingbenefits they arenot entitled to (such as those who are claiming disability as result of the war without actually being disabled). 0 there i s aneed for a beneficiary audit, especially for family beneficiaries. 0 the labor market should absorb those veterans who are able to work, to save disability benefitsfor those who cannot work. ~~ 44Fordetailed results and discussionofthe methodology ofthe communityassessment, see KPMG:Final Analytical Reportfor BHSocialProtection Public Information Campaign. (February 2003). 56 Pensions: Most participants felt that: tax and labor laws should be enforced so that companies are accountable for paying social contributions for employees. many people are not registered inthe systemand fear not receivingadequate pensions after retirement. e current pension levels are too low. Labor market:There i s a general feelingthat: e Employment Institutes are ineffective inhelpingpeople find employment. e employment practices are corrupt and only those with "connections" have opportunities. e labor market reform and improvedjob creation are the single most important steps to change people's lives. 57 Annex 9: Outline Of Social Sector TechnicalAssistanceCredit (SOTAC) 1. The following outlines components o fthe SOTAC, approved inDecember 2000, and which will complete implementation in2004. The objective of the SOTAC i s to provide technical assistanceand other capacity buildinginareas which are key to the policy agenda supported by SOSAC Iand SOSAC If,andalsoto enablemorecontinuity inthepolicy dialoguewiththe authorities. Where feasible,the aimhas been to coordinate activities closely between Entities, e.g. commonprocurement of consultancy which would be implemented inbothEntities, This supports the objective o fpromoting harmonization betweenthe different systems, Maincomponents of SOTAC: a Client registries for Centers for Social Work. This has been identified as a clear priorityby social welfare officials inbothEntities, There are a range o fneeds inorder to put the systemin place, and ensure that it i s effective, including equipmenb`networking, training o f staff inuse o f systems, review o f the existing database to ensure that it covers informational needs without putting unnecessarydemands on CSW staff etc. a N G O l C S Winnovation activities: The objective of this component i s to support innovative collaborationsbetween local NGOs andCSWs, e.g. on contracting out o f service provision for particular services such as home-basedelderly care. The component reviews fundingapplications local NGOsendorsed by CWSs, and finances service contracts with the NGOsfor successful applicants, who are assessedaccordingto agreedcriteria. a Technical Assistance on Social Protection: This supports anumber ofareas: (i) Functional review of Social Protection in both Entities. This not only reviews existing roles and responsibilities across the socialprotection sector, but also aims to identify key skills development and institutional strengtheningneeds inthe mainministries and agencies involved in social protection. This work hasbeen co-financed byUKDFID. (ii)Public information campaigns on objectives and nature of labor market and socialprotection reforms: SOTAC supported the design and imp~emen~tiono fthe "40 Days o f Dialogue on Social Reforms" public information campaign on labor market and social protectionreforms, completed in2003. (iii)Socialassistancetechnicalassistance: Thishas supported technical assistanceinarange o f areas associatedwith social assistanceincluding operationo f future entity-level funds; assessment and improvement o fprocedures inCSW; assessment o f existing social work methods, which are frequently outdated by Europeanstandards etc. Consultant reports were finalized after Entity workshops in2003. (iv) Special reviews of EmploymentInstitutes: This supports special reviews, including audits, ofall Employment Institutes inBH(State, Federation, Mostar andRS). Work on the audits was completed in2003. (v) TechnicalAssistanceon disabili~prog~ams: This sub-component supports technical assistance and workshops to expose staff to international practice, and support reforms inthe systemof disability inBH. The reports o f the consultants were submittedto Governments in2003. 58 Social Protection Expenditure Strategy: This supportsthe SPES exercise initiated in2000, in order to prepare SPES for the 2003 and 2004budgets, as part of the overall BudgetFramework Papers. Training: There is training for social protection staff at different levels inorder to expose them further to international practice inkey areas where reforms are being designed or implemented. This would involve workshops, study tours and other training. Project implementation: This covers costs of the PELRPPrUsto cany out basic project management functions for SOTAC, including procurement and financial management. Given the small size o f SOTAC, it was not feasible to have a separate PIU. 59 Annex 10: Summary of Poverty Assessment Findings 1. The Bosnia and Herzegovina Poverty Assessment was completed in2003, usingas itsprimary source the LSMS from late 2001. Overall, the study found significant levels ofpoverty inBH, though no measuredextreme poverty. Italso found significant variations inpoverty rates, bothbetween and within Entities. Overall, around one fifthofthe populationwas below the poverty line, butwitha further significant shareclusteringnot far abovethe line. Consistent with this finding, inequalityinBH was not high,though this i s likely to be more aproduct of the general decline inliving standardsas a result o fthe war. The key results onpoverty and inequality inBHfrom the Poverty Assessment are outlined inTable 1below. 2. The LSMS also allows incidence analysis of different parts of the public transfer system. The first beneficiary group o f interest with respect to the SOSAC 11-supportedpolicy agenda is recipients of veterans'benefits. The key findings on this group are presentedbelow. I t i s notable that ex-post, veterans' benefit beneficiaries are better off than the average for the population. This raises obvious questions about the incidence o f the "targeted" program. The second graph o f ex-ante incidence i s therefore o f great interest. The important feature o f the ex-ante incidence i s that there is such a notable kinkinthe Lorenzcurve, indicating the great importance ofveterans' benefits for movingthe lowest quintile andto a lesser extent the secondandthirdquintiles out ofpoverty. Thisisvery consistent with the reforms supported inbothEntities, which focus the reformed systems on the lower income groups, bothaccordingto level o f disability and accordingto prevalence o f other non-transfer sources o f income. Ex-post concentration curve for Ex-ante concentration curve for veteran's benefits veteran's benefits 1 0.8 0.6 0.4 0.2 0 0 1 2 3 4 5 I 0 1 2 3 4 5 Quintiles (from POOT to rich) Quintiles (from poor to rich) 3, Withrespect to social welfare transfers, the LSMS-while not as precisely formulated for incidence analysis -indicates that targeting in2001 was very poor. Only 4 percent o f the poor received some targeted financial assistance. At the same time, around 75 percent o f beneficiaries were not poor. The "targeted" social welfare therefore performed little better than a randomdistribution o f benefits. 60 The analysis also confirmed that some recipienthouseholdsreceived significantly morethan neededto alleviate poverty, while many others received almost nothing. The incidence of "over-payment" seems to be highest among those displacedby the war, and subject to strong geographical concentration consistent with decentralizedfiscal arrangements. 4. Overall, it i s very clear from the PovertyAssessment analysis that the small amount currently spent on social welfare inBHare is not usedefficiently. Comparisons with other CEE and SEE countries reveal that the efficiency (measure oftargeting) o fthe systeminBHi s among the lowest in the region, with only Russianbeing less efficient. Effectiveness o f the system interms o f poverty reduction i s even lower, with lessthan 5 percent o f the poverty gap inBHeliminated by targeted transfers. The analysis suggests not only that aggregate allocations needto be increased, butthat reforms o fboth financing and targetingo fbenefits needto be part o f the reformpackage. This is consistent with the direction of reforms supported under SOSAC II. 5. Apart from these two key beneficiary groups andprograms, there are several other findings which were relevant indefining the reformagendaoutline inthe MTDSand supportedby SOSAC II. These are: Households with no employedadult member had an average poverty rate o f 25 percent, which was almost 30 percent higher than average. This reinforces the importance o fpromoting re-entry to the labor force, a key objective o f the reforms inemployment services and active labor policies supported by the operation. Poverty rates o f households with 2 or more children were significantly higher than average, with 27 percent o f two childhouseholds livinginpoverty and 56 percent of households with 3 or more childrenbeingpoor. Harmonizing and improvingthe social welfare system, including child protection, is consistent with addressing the needs of these groups. Households with one or more elderly people were on average no poorer than the general population. 61 Annex 11: CountryAt a Glance Bosnia and Herzegovina at a glance 5117104 Bosnia EuroDe8 Lower- POVERNand SOCIAL and Central middle- Herzegovina Asia income Developmentdiamond' 2003 Population,mid-year (millions) 4.2 473 2.408 Lifeexpectancy GNI percapita (Atlas method, US$) 1,540 2,160 1,400 T GNI (Atlas method, US$billions) I 6.4 1,023 3,372 Average annual growth, 199743 Population (%j 2.2 0.0 0.9 Laborforce (%j 2.4 0.5 1.2 GNI per Most recent estimate (latest year available, 1997-03) capita Poverty(% ofpopulationbelownationalpovertyline) 20 Urbanpopulation(% of~ota/populafi~) 44 64 49 Lifeexpectancyat birth(yeam) 74 69 69 Infantmortality (per 1,000 live bifths) 15 31 32 Childmalnutrition(% of childrenunder5) 4 9 Access to improvedwater source Access to an improvedwater source I%ofpopulafion~ 91 61 Illiteracy (% ofpopulation age 15+) 3 13 Gross primaryenrollment (% of school-agepopulation) 103 112 -Bosnia and Herzegovina Male 104 113 __Lower-middle-incomegroup Female 102 111 KEY ECONOMIC RATIOSand LONG-TERMTRENDS 1983 1993 2002 2003 Economic ratios' GDP (US$ billions) 5.6 7.0 Grossdomestic investmenffGDP 20.4 19.9 Trade Exportsof goods and serviceslGDP 26.2 26.0 Grossdomestic savingslGDP -13.4 -12.5 Gross nationalsavingslGDP Currentaccount balanceiGDP -18.5 -17.4 Domestic InterestpaymentslGDP 1.2 0.7 Investment savings Total debffGDP 42.2 34.0 Totaldebt servicelexports 8.5 7.6 Presentvalue of debffGDP Presentvalue of debffexports Indebtedness 1983-93 1993-03 2002 2003 2003.07 I (average annualgrowth) GDP ,. 17.8 3.9 3.5 4.7 -Bosnia andHerzegovina GDP per capita .. 15.4 2.4 2.6 4.4 Lower-middle-incomeorou~ Exportsof goods and services .. 23.7 5.3 11.5 6.1 -~ STRUCTURE of the ECONOMY (% of GDPj Agriculture 17.9 16.7 40 Industry 37.2 34.7 30 Manufacturing 22.6 21.0 2o Services 44.9 48.6 j0 0 Privateconsumption 98 94 W 01 02 03 Generalgovernment consumption importsof goods and services 59.2 57.9 -GDI -GDP I 1983-93 1993-03 2002 Growthof exports and imports (%) (average annualgrowth) Agriculture 8.0 8o T Industry .. 26.2 60 Manufacturing .. 17.0 .. 40 Services .. 37.2 .. 20 Privateconsumption 0 Generalgovemment consumption .. -20 Gross domesticinvestment .. 35.6 -Exports *Imports Importsof goods and services .. 11.2 -1.9 10.6 Note:2003 data are preliminaryestimates. Groupdata are for 2002 The diamondsshow four key indicatorsin the country(in bold)comparedwith its incomegroup average. If data are missing, the diamondwill be incomplete. . 62 Bosnia and Herzegovina PRICES and GOVERNMENTFINANCE 1983 1993 2002 2003 Domesticprices (% change) Consumer prices 0.3 0.1 ImplicitGDP deflator 2.1 1.1 Govemment finance (% of GDP, includes" e n f grants) I Current revenue 48.1 46.7 Current budget balance 6.3 4.5 -GDP deflator &CPl Overallsumlusldeficit -2.2 0.4 TRADE I 1983 1993 2002 2003 (US$ mi//ions) Exportand import levels (US$ mill.) Totalexports (fob) 1,046 1,407 4 . m T Commodity1 4.m Commodity2 3.m Manufactures 3," 2,500 Total imports (cifl 3,122 3,845 2.m Food 1,500 Fueland energy 1,wO 5w I Capitalgoods 0 97 98 f4 W 01 02 Export price index (1995=100) Importpriceindex (1995=700) WExports Wlmports Terms of trade (1995=100) BALANCEof PAYMENTS 1983 1993 2002 2003 (US$miiiions) Currentaccount balanceto GDP(%) c Exports of goodsand services 1,786 2,277 0 Importsof goods and services 3,387 4,132 -5 Resource balance -1,601 -1,855 -10 Net income 248 -15 Net currenttransfers 566 631 -20 Currentaccount balance -1,035 -1,224 -25 Financingitems (net) 977 798 -30 Changesin net reserves 58 446 -35 Memo: Reservesincludinggold (US$ mi//iOnSl 1,416 Conversionrate (DEC,iocaVUS$) 2.1 1.7 EXTERNALDEBTand RESOURCEFLOWS I 1983 1993 2002 2003 (US$miiiions) Compositionof 2003 debt(US$ mill.) Totaldebtoutstandingand disbursed 2,502 2,536 IBRD 424 538 515 G:65 IDA 0 570 613 Totaldebt service 150 191 IBRD 0 45 42 IDA 0 4 4 Compositionof net resourceROWS Official grants 32 Officialcreditors 70 51 B 613 Privatecreditors 16 -30 Foreigndirect investment Portfolioequity C 141 I World Bank program Commitments 0 A IBRD - E Bilateral Disbursements 0 97 35 B - IDA D -Other multilateral F Private -- Principal repayments 0 23 23 C IMF G Short-term ~ ~ Netflows 0 74 12 Interestpayments 0 26 23 Nettransfers 0 40 -11 DevelopmentEconomics 5117104