Document o f The World Bank

FOR OFFICIAL USE ONLY

Report No. 38441-AL

INTERNATIONAL DEVELOPMENT ASSOCIATION

PROGRAM DOCUMENT

FOR A PROPOSED CREDIT IN THE AMOUNT OF SDR 6.8 MILLION (US$lO MILLION EQUIVALENT)

FOR A

FIRST DEVELOPMENT POLICY OPERATION

TO

ALBANIA

February 28,2007

Poverty Reduction and Economic Management Unit South Eastern Europe Country Unit Europe and Central Asia Region

This document has a restricted distribution and may be used by recipients only in the performance o f their off icial duties. I t s contents may not otherwise be disclosed without W o r l d Bank authorization.

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CURRENCY AND EQUIVALENT UNITS

Currency Unit = Albania LEK

US$1 = 97.08 LEK 1 = 0.0103 US$

ARCS BEEPS

BERIS

BOA

CAS C E M C F A C F A A C P A R

csc

C S L DFID D P I M

D S D C

EA

EU F I A S F S A

FSAP HI1 H R M I S

ICR IDA IFC I P s IPSIS

I P R A L D P

GOVERNMENT FISCAL YEAR (January 1 - December 3 1)

WEIGHTS AND MEASURES Metr ic System

ABBREVIATION AND ACRONYMS

Administrative and Regulatory Cost Survey Business Environment and Enterprise Performance Survey Business Environment Reform and Institutional Strengthening Bank o f Albania

Country Assistance Strategy Country Economic Memorandum Country Fiduciary Assessment Country Financial Accountabil ity Assessmenl Country Procurement Assessment Report

Civil Service Commission

Civil Service L a w Department for International Development Department o f Public Investment Management Department o f Strategy and Donor Coordination Extended Agreement

European U n i o n Foreign Investment Advisory Services Financial Supervisory Authority

Financial Sector Assessment Program Health Insurance Institute Human Resources Management Information System Implementation Completion Report International Development Association International Finance Corporation Integrated Planning System Integrated Planning System Information Systems Immovable Property Registration Agency Letter o f Development Pol icy

METE MOE

MOH

M O L S A

M T B P MTEF M W W P NE N S D I

NSSED

O&M OBL OSCE

P A W

PEFA

PEIR P H C P H R D

P I M PPA PPP

PRGF PRSC PSIA RIA ROSC

S A A SDC

Ministry o f Economy, Trade and Energy Ministry o f Education

Ministry o f Health

Ministry o f Labor and Social Affairs and Equal Opportunities Medium Term Budgetary Program Medium-Term Expenditure Framework Munic ipa l Water and Wastewater Project Ndihma Ekonomike National Strategy for Development and Integration National Strategy for Social and Economic Development Operation and Maintenance Organic Budget L a w Organization for Security and Cooperation in Europe Public Administration Reform Project

Public Expenditure and Financial Accountabil ity Assessment Public Expenditure and Institutional Review Primary Health Care Japan Policy and Human Resources Development (Trust Fund) Public Investment Management Public Procurement Agency Public Private Partnership

Poverty Reduction and Growth Faci l i ty Poverty Reduction Support Credit Poverty and Social Impact Analysis Regulatory Impact Assessment Report o n the Observance o f Standards and Codes Stabilization and Association Agreement Swiss Development Corporation

FOR OFFICIAL USE ONLY

LG Local Government TFP Total Factor Productivity LSMS Living Standards Measurement Survey UNDP United Nations Development Program SIDA Swedish International Development Agency USAID Unites States Agency for International

SPEM Strengthening Public Expenditure WHO World Health Organization

SSA State Supreme Audit Institution SSDP Social Services Development Project

Development

Management

Vice President: Shigeo Katsu, E C A V P

Sector Manager: Bernard Funck, ECSPE Country Director: Orsalia Kalatzopoulos, ECCU4

Task Team Leader: Sanjay Kathuria, ECSPE

This document has a restricted distribution and may be used by recipients only in the performance o f their off icial duties. I t s contents may not be otherwise disclosed without Wor ld Bank authorization.

i

TABLE OF CONTENTS

A . B . C .

V I . A . B . C . D .

VI1 . A . B . C . D . E . F .

CREDIT AND PROGRAM SUMMARY .............................................................................................................. v11

I . INTRODUCTION ............................................................................................................................................. 1

I1 . COUNTRY CONTEXT .................................................................................................................................... 1

A . B . POVERTY UPDATE ................................................................. ....................................................... 4 C .

RECENT ECONOMIC DEVELOPMENTS IN ALBANIA

MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY ................................................... THE GOVERNMENT’S PROGRAM ........................................................................................................ 6

LINK TO THE COUNTRY ASSISTANCE STRATEGY (CAS) ............................................................ 7

THE PROPOSED DEVELOPMENT POLICY OPERATION (DPO) PROGRAM .................................. 8

I11 . I V . V .

DEVELOPMENT OBJECTIVES .................................................................. .............................................. 8

OPERATION DESCRIPTION ..................................................................... ............................................ 10

UNDERPINNINGS OF THE OPERATION ........................................................................................... 31

RELATIONSHIP To OTHER BANK OPERATIONS . ........................................................... ................. 32 LESSONS LEARNED ................................................................................ .................................................. 33 ANALYTICAL UNDERPINNINGS ...................................................................................................................... 35

DIAGNOSTICS FOR DPO OBJECTIVES .................................................... .............................................. 9

COLLABORATION WITH THE IMF AND OTHER DONORS .................................................................................. 31

OPERATION IMPLEMENTATION ....................................................................................................... 35

POVERTY AND SOCIAL IMPACTS ................................................................ .............................................. 35 IMPLEMENTATION, MONITORING AND EVALUATION ................................. .............................................. 37 FIDUCIARY ASPECTS ..................................................................................................................................... 37 DISBURSEMENT AND AUDITING .................................................................................................................... 39 ENVIRONMENTAL ASPECTS ........................................................................................................................... 40 R I S K S AND RISK MITIGATION .............................................. .................................................................... 41

TABLES

TABLE 1: ALBANIA: KEY ECONOMIC INDICATORS. 2003-2010 ..................................................................................... 3

TABLE 3: FINANCING REQUIREMENTS (IN MILLIONS OF USD) ....................................................................................... 6 TABLE 2: POVERTY IN ALBANIA (PERCENT OF INDIVIDUALS) ........................................................................................ 4

FIGURES

FIGURE 1: DECOMPOSITION OF CHANGE IN POVERTY. 2002-05 ..................................................................................... 4 FIGURE 2: EVOLUTION AND DISTRIBUTION OF POVERTY, 2002-05 ................................................................................ 4

BOXES B O X 1 : THE WORLD BANK-SUPPORTED PROGRAM TO IMPROVE GOVERNANCE AND REDUCE CORRUPTION IN THE

HEALTH SECTOR ............................................................................................... ........................................... 18 BOX 2: ADDRESSING GOVERNANCE ISSUES IN THE PROPOSED DPO SERIES ................................................................. 22 BOX 3: INDICATIVE TRIGGERS FOR DP02 ................................................................................................................... 30 B O X 4: GOOD PRACTICE PRINCIPLES ON CONDITIONALITY ......................................................................................... 34

V

ANNEXES

ANNEX 1: DIAGNOSTICS ON SOURCES OF AND CONSTRAmTS TO GROWTH IN ALBANIA ............................................. 43 ANNEX 2: LETTER OF DEVELOPMENT POLICY ............................................................................................................. 45

ANNEX 4: DPO MONITORING INDICATORS AND DEVELOPMENT OUTCOMES .............................................................. 64 ANNEX 3: DPO POLICY MATRIX ................................................................................................................................. 57

ANNEX 5: FUND RELATIONS NOTE .............................................................................................................................. 69 ANNEX 6: ALBANIA: KEY ECONOMIC INDICATORS .................................................................................................. 70 ANNEX 7: ALBANIA: KEY EXPOSURE INDICATORS ............................................................. ANNEX 8: COUNTRY AT A GLANCE ..................... ............................................. ................................................. 73 ANNEX 9: ALBANIA INTERVENTION MATRIX IN KEY AREAS FOR IMPROVED GROWTH, SERVICE DELIVERY AND

GOVERNANCE .................................................................................................................................................... 75

M a p IBRD 33359

The Credit/Loan was prepared by an IDA team consisting o f Sanjay Kathuria (Task Team Leader), A l i a Moubayed, Er jon Luci, Silvia Minotti, Greta Minxhozi, Lorena Kostallari, Wael Zakout, Junghun Cho, Ani ta M. Schwarz, Dominic S. Haazen, Caryn Bredenkamp, Artan Guxho, Devesh Chandra Mishra, Olav Rex Christensen, Belita Manka, Andrew L. Dabalen, Michael John Webster, Gary J. Reid, Giul io de Tommaso, Piet Hein van Heesewijk, La l i t Raina, Monika Huppi, Kirsten Burghardt Propst (country lawyer), Joao C. Oliveira (former staff), Jolanda Trebicka (former staff), and Nand Shani (former staff). Peer reviewers are Alma Kanani, Phil ip B. O’Keefe, Andrew Stone, and Edward Mountfield. Logistical support was provided by Mismake Galatis, Ekaterina Georgieva Stefanova and Enkelejda Karaj. The team thanks Bernard Funck, Nadir Mohammed, Ardo Hansson, M. Wi l lem van Eeghen and Nancy Cooke for comments and support, and Orsalia Kalantzopoulos and Cheryl Gray for providing strategic focus and advice.

v1

CREDIT AND PROGRAM SUMMARY

Borrower Implementing Agency Amount Terms Tranching Description

Benefits

ALBANIA FIRST DEVELOPMENT POLICY OPERATION (DPO1)

Albania

Ministry o f Finance, Albania

SDR 6.8 mill ion, USlSlO mi l l ion equivalent IDA terms, 20 years with 10 years grace period Single tranche, to be disbursed in full upon effectiveness o f the credit. The operation i s the f i rs t in a programmatic series o f three Development Policy Operations, designed to support key aspects o f the Government program. I t focuses on inter-related objectives with significant synergies-improving the investment climate for private sector-led growth, and fostering fiscally sustainable and effective service delivery, both built around the governance edifice o f improving public finances and public administration, as explained below:

Improving the investment climate for private sector-led growth. The focus on growth continues from the previous Poverty Reduction Support Credit (PRSC) program, and also follows from the new Government’s priorities. I t s validity as the key goal has been reinforced by the strong impact o f growth on poverty reduction-average GDP growth over 2000-05 was 5.7 percent, while the poverty headcount f e l l f rom 25 to 19 percent between 2002 and 2005. The government program, supported through a series o f proposed DPOs, will support some o f the major actions to reduce constraints to growth, by strengthening the regulatory environment for business, improving the oversight o f the non-bank financial sector, and improving the functioning o f land markets. Private sector growth will also be impacted significantly by the other pillars o f the proposed DPO, such as service delivery in water and health, public investment programs, public expenditure management in general, and public administration.

Improving fiscal sustainability and effectiveness of public service delivery. The focus here will be on the health, social insurance and water sectors. Actions will address health financing, the health sector regulatory framework, the pension pol icy and i t s implementation, and the policy and incentive framework in the water sector.

Improving government effectiveness. This follows the governance principles enumerated in the CAS, including improving public financial management, furthering reforms in public administration, and advancing decentralization through support to strengthening o f local finances. These apart, many other elements o f the program above also support improved governance.

Apart f rom the direct results o f pol icy actions that are expected (and will be monitored) as outcomes o f the government program supported through the series o f proposed DPOs, a number o f other benefits are also anticipated:

Signaling effect and continuity o f engagement. The continuity o f Bank engagement in strategic policy dialogue in a country where governance and capacity are at a premium can provide benefits wel l beyond the f low o f funds. Approval o f the DPO

vi i

Risks

program will provide strong signaling effects and credibility for the new Government, in terms o f i t s structural policy agenda, both to other development partners and to private sector investors.

Prioritization and sequencing. The Government has a very ambitious development program. The DPO i s expected to help focus this program in terms o f strategic priorities for sustaining growth and improving service delivery, and the programmatic nature o f the operation will help sequence policy actions.

Coordination. The DPO i s providing a forum for policy coordination across different agencies o f Government. A core Government D P O team has been formed, and i s reinforcing the Government’s nascent Integrated Planning System.

EU Integration. The DPO priorities support a core set o f actions that wil l enhance Albania’s prospects for eventual integration into the EU, a key goal for Albania. Risks o f reversal and/or political stalemate. There i s a risk that hard-won gains in the institutional framework such as c iv i l service reforms could be reversed. There are also significant risks in other areas singled out by the CAS. Political stalemates, especially at times o f local or national elections, can also threaten reform progress as well as passage o f legislation. All these can affect the outcomes o f the D P O program, while also subjecting the Bank to reputational risk. T o reduce such risks, and improve the chances o f positive development outcomes, the first DPO has singled out strong prior action in these areas, including legal reforms in procurement and concessions and improved compliance with the c i v i l service law. Workshops in early 2006 and again in 2007 between the Bank’s team and senior Government teams in Albania also demonstrated significant Government ownership for the reform process.

Capacity concerns. While the PRSC program and complementary programs o f donors had helped to build up capacity across a broad spectrum, there i s concern that some of this improvement has been undermined by the new Government’s management changes in several key agencies (however, at least in taxes and customs, there have been significant improvements in revenue collection despite large-scale changes in staffing). T o the extent possible, this concern i s being mitigated by pr ior action on compliance with the c iv i l service framework, as wel l as capacity enhancement and knowledge generation before and during the DPO program. Thus, as recommended by the PRSC Implementation Completion Report (ICR), the DPO i s being twinned with investment operations andor technical assistance in many critical areas, including the business environment project (a lacuna in the PRSC program), a financial sector TA, projects in land, health and water, a governance TA (in keeping with the CAS governance f i l ter approach), and a public administration project (until mid-December 2006). In addition, knowledge products before and during the DPOs include a programmatic Public Expenditure and Institutional Review, a Social Insurance Review, a Country Financial Accountability Assessment, a Public Expenditure and Financial Accountability Assessment (PEFA) analysis, and a programmatic poverty analysis including a Poverty Assessment. A PHRD grant to help prepare D P 0 2 has been provided to the Albanian authorities by the Japanese government. Finally, development partners’ support in several critical areas wil l also help shore up capacity.

Macroeconomic stability. The macroeconomic framework for 2006-20 10 foresees average annual export growth in euro terms o f about 15 percent per year, which could

... V l l l

be difficult to sustain. The current account deficit i s forecast to decline gradually over the period, f rom about 6.5 percent in 2005 to about 5.3 percent. An increasing part o f this deficit i s expected to be financed by FDI, forecast to increase from 3.3 to 3.8 percent o f GDP. Both attracting FDI and sustaining exports will require a significant improvement in the investment climate for the private sector, and are the biggest challenges on the macroeconomic front. The DPO program, along with other Bank operations, seeks to address those issues. An additional concern arises f rom the fast credit growth over the last two years, albeit f i o m a very l o w base. However, the banking system i s considered to be well-capitalized, and i s resilient as indicated by recent simulated stress tests. Also, the DPO program, whi le focusing o n the still-small non-bank financial sector, i s also accompanied by a flexible financial sector TA, which can respond to an emerging situation. In addition, Bank staff i s cooperating closely with colleagues in the IMF who keep a close watch on the macroeconomic situation. Finally, periodic recurrence o f electricity crises (as occurred in 2005 and 2006) can affect the sustainability o f growth if fundamental reforms in the energy sector are not accelerated. In the short term, the current crisis could widen the current account deficit to higher than forecast levels, i f increased imports o f electricity at higher than planned prices dampen the positive impact f rom sustained export growth noted earlier.

Operation ID Number M a p

PO96205

IBRD No. 33359

ix

INTERNATIONAL DEVELOPMENT ASSOCIATION (IDA) PROGRAM DOCUMENT FOR A PROPOSED FIRST DEVELOPMENT POLICY OPERATION (DPO1)

TO ALBANIA

I. INTRODUCTION

1. This Program Document presents the first in a series o f three proposed programmatic Development Policy Operations (DPOs) to the Republic o f Albania for SDR 6.8 mi l l ion (US$ 10 mi l l ion equivalent). The proposed program i s a centerpiece o f the Bank's FY06-09 CAS, presented to the Board in January 2006, and i s expected to be complemented by investment operations and a focused program o f analytical work and technical assistance.

2. Over 1996-2005, Albania grew at an average rate o f 5.7 percent, one o f the highest among transition economies, accompanied by macroeconomic stability through most o f the period. Social sector outcomes have improved, albeit modestly. Growth has also had a major impact on poverty reduction, with the poverty headcount declining f rom 25 percent in 2002 to 19 percent in 2005. However, sustaining this fast growth wi l l require continuation o f significant reforms in several areas. Improving delivery o f public services, a poverty and human development imperative, will also need significant pol icy and institutional changes.

3. The government program supported through a series o f proposed DPOs wil l tackle these twin challenges o f sustaining growth (primarily through private sector development), and improving delivery o f public social services. A third objective, improving governance and strengthening accountability mechanisms, will be the main cross-cutting goal o f the DPO. These objectives mirror the objectives o f the CAS,' and are based on Albania's National Strategy for Social and Economic Development (NSSED), 'the needs o f the European integration process, the Government's development program, and consultations with stakeholders in Albania.

4. The government program supported through a series o f proposed DPOs builds o n the successful engagement with Albania as part o f the three programmatic PRSCs during 2002-04. I t takes into account the lessons from that engagement, spelled out in a recent ICRS2 The proposed series i s expected to provide Albania with a credible mechanism to underscore the seriousness o f i t s reform effort.

5. The proposed DPO program has been developed jo int ly with the Government o f Albania, and has been coordinated closely with other development partners, especially the IMF, to ensure consistency with the Poverty Reduction and Growth Facil ity (PRGF) and Extended Arrangement (EA) program, initiated in February 2006, the second review o f which was completed in February 2007.

11. COUNTRY CONTEXT

A. RECENT ECONOMIC DEVELOPMENTS IN ALBANIA

6. Rebounding from the financial collapse of 1997, Albania did very well to sustain high rates of economic growth. Economic activity recovered and real Gross Domestic Product (GDP) growth rates

' Albania CAS, FY06-09, Report no. 34329-AL (IBRD, IDA and IFC). Implementation Completion Report (ICR) on the Third PRSC, June 30, 2006, Report no. 36524, 2

accelerated to an average annual rate o f 7 percent over the period 1999-2005, allowing Albania’s per capita GDP to approach the average for middle income country levels. This growth record has been one o f the highest among transition economies. Since i t s transition, Albania’s growth has been driven primarily by improvements in the allocation o f resources from low-productivity sectors, f irms, and activities (for example, subsistence agriculture) to high-productivity ones (for example, export manufacturing). As a result, total factor productivity (TFP) growth explains almost a l l growth in the 1993-2003 period, 6.1 percent o f the annual average o f GDP growth o f 6.3 percent.

7. Meanwhile, the contribution o f factor mobilization and accumulation o f both labor and capital has only picked up modestly and faces constraints. Investment rates rose after the financial crisis o f 1997, but, after 1999, have declined and stagnated. This reflects, in part, sluggish foreign direct investment, which at 3.3 percent o f GDP in 2005 (estimated at 3.8 percent in 2006), i s l o w compared to other transition and high growth economies. With consumption persistently high, domestic savings have declined after 200 1. Both the migration o f young workers and the l o w savings rate will continue to limit the growth o f factors o f production, and reiterate the need for finding new sources o f TFP growth.

8. Much o f this economic performance has been underpinned by sustained fiscal consolidation and macroeconomic stability. Successive governments have overseen the reduction o f the overall deficit f rom 13 percent o f GDP in 1997 to 3.7 percent in 2005, and a decline in the primary deficit f rom 8 to 0.5 percent o f GDP during the same period. Lower public sector borrowing requirements resulting f rom fiscal consolidation sustained the downward trend in interest rates. Inflation, although slightly higher towards the end o f 2006 compared to a year earlier, stayed within the Bank o f Albania’s target range o f 2-4 percent. There has also been further tightening o f fiscal policy, partly as a result o f revenue over-performance and partly as a result o f under-execution o f capital investment projects.

9. Recurrent energy crises can affect the sustainability o f growth and the external account if fundamental reforms in the energy sector are not accelerated. Fol lowing a long period o f dry weather, Albania i s facing severe energy shortages for the second consecutive year. The reasons are not very different f rom those o f the 2005/06 crisis: i.e. poor management and planning, high international energy prices and energy supply shortages in the region. This crisis could reverse the export-driven, improvements in the current account deficit that have been estimated for 2006. If increased imports o f electricity at higher than planned prices dampen the positive impact f rom exports, the actual outcome could be a higher 2006 deficit than the estimated 5.9 percent o f GDP (6.5 percent in 2005). I t s impact on short-term growth i s more uncertain, but i t could have some negative effect if not contained. More importantly, the factors behind the crises, i f not addressed, could affect the sustainability o f growth.

10. The ongoing rapid growth of private sector credit i s creating a rapid demand impulse and requires further strengthening o f financial sector prudential regulation and supervision. The 2004 Savings Bank privatization, along with other structural measures and easing o f monetary policy, contributed to a rapid p ick up in private sector credit growth, albeit f rom a l o w base. The BOA, in agreement with the IMF, has been undertaking a series o f steps to strengthen prudential regulation and bank supervision, to safeguard the soundness o f the financial system and slow credit growth.

11. Together with high energy prices, credit growth also contributed to a higher current account deficit in 2005, in the face o f a low and undiversified export base. The current account deficit rose from nearly 5.8 percent o f GDP in 2001 to about 6.5 percent o f GDP in 2005. This owed to an increase in the already high trade deficit (on goods and services) f rom 22.5 percent o f GDP in 2001 to 24 percent o f GDP in 2005. This increase, in turn, was the combined effect o f high international o i l prices, surging private sector demand fuelled partly by credit growth, and a decline in the growth o f exports.

2

12. Notwithstanding efforts to reduce it, the public debt stock remains at 57 percent o f GDP, another source of vulnerability. Macroeconomic stabilization contributed to a sustained decline in public debt f rom 80 percent at end 1997 to 57 percent in 2005. The decline was a result o f deficit reduction, sound monetary pol icy that put interest rates on a downward path, and settlement and rescheduling o f arrears with external creditors. The use o f privatization proceeds to retire a part o f the domestic debt in 2004 also helped. As access to concessional borrowing declines, reducing public sector debt and improving debt management capacity will become increasingly important. Albania does not have yet a sovereign credit rating but expects to have one around MarcWApri l2007.

actual

Table 1: Albania: Key Economic Indicators, 2003-2010

projections National Accounts GDP (US$ mill ions) Real GDP growth (%) Gross domestic investment (% o f GDP)

Public Private

Gross national savings (% o f GDP) Private sector credit growth (in YO)

Public Sector Balance Revenue (YO o f GDP) li Expenditures (% o f GDP) Primary balance (% o f GDP) li Overall balance (YO o f GDP) li Total Public Debt (% o f GDP)

of which domestic debt

External Accounts Exports o f goods (YO growth in Euro) Imports o f goods (% growth in Euro) Exports o f Goods and Services as % o f GDP Imports o f Goods and Services as % o f GDP Current account balance (% o f GDP) 1/ Foreign direct investment (% o f GDP) Gross Reserves (months o f imports)

External Indebtedness TDOiXGS (%) 2/3/ TDOiGDP (%)2/ TDSiXGS (%) 31

Prices Retail price inf lat ion (YO, end o f period) l i Includes grants.

5652 5.7

23.4 4.6 18.8 17.3 31.1

24.5 29.0 -0.2 -4.5 62.1 41.4

13.4 1.1

20.6 45.9 -5.6 3.1 3.8

56.3 21.3 2.6

7464 5.9

23.8 5 .o 18.8 20.4 37.0

24.0 29.3 -1.5 -5.2 56.6 38.0

22.8 11.5 21.5 43.3 -3.8 4.6 3.9

48.0 18.3 2.5

8376 5.5

23.6 4.6 19.0 15.9 74.1

24.4 28.0 -0.5 -3.7 56.7 39.1

9.1 14.6 22.3 46.3 -6.5 3.3 3.9

46.4 18.1 2.6

9135 5.0

25.3 5.7 19.5 18.1 50.0

25.7 28.9 -0.1 -3.2 55.1 38.8

20.4 13.3 23.6 47.0 -5.9 3.8 4.0

45.2 18.2 3.1

10161 6.0

26.0 6.2 19.8 18.5 33.7

25.9 29.6 -0.6 -3.8 54.7 37.5

16.0 8.5

24.4 47.7 -6.1 3.7 3.9

43.9 17.9 2.8

11130 6.0

27.1 6.7

20.4 19.7 24.2

26.2 30.1 -0.6 -3.9 53.9 36.6

12.9 8.0

24.9 47.7 -6.1 3.8 4.0

43.1 17.6 3.2

12158 6.0

27.5 6.5

21.0 20.7 22.7

26.4 30.0 -0.5 -3.6 52.9 35.8

13.0 6.7

25.1 47.0 -5.8 3.9 4.1

42.0 17.1 3.2

13362 6.0

28.3 6.8

21.5 22.1 18.1

26.5 30.0 -0.6 -3.5 50.7 34.8

13.0 7.0

25.4 46.3 -5.3 3.8 4.1

39.0 15.8 4.3

3.3 2.2 2.0 2.4 3.4 3.0 3.0 3.0

21 TDO refer to gross debt. Includes public and publicly guaranteed debt, private non-guaranteed debt, use o f IMF credits and net short te rm capital. 31 "XGS" denotes exports o f goods and services, including workers' remittances. Includes nonfactor income but excludes remittances. Source: IMF, World Bank staff and authorities' estimates.

3

B. POVERTY UPDATE

13. Since 2002, poverty has declined significantly, a result of sustained recent growth and urbanization? The absolute poverty headcount rate declined from 25 percent in 2002 to 19 percent in 2005, or 6.8 percentage points, lifting 221,000 people out o f poverty (Table 2). This decline i s higher than witnessed recently in most E C A countries and other middle income c o ~ n t r i e s . ~ The decomposition o f changes in poverty reveals that the poverty reducing effect was growth-driven, with the increase in mean consumption being responsible for a drop o f 9 percentage points in the poverty headcount, outweighing the marginally adverse distributional change that contributed to increasing poverty by 2 percentage points (Figure 1). The elasticity o f poverty reduction to GDP growth i s -3.6, higher than the average -2.5 for Southeastern Europe, suggesting that Albania’s poverty i s much more responsive to GDP growth than i s the case in the neighboring countries. As a result, further reforms to sustain fast-paced growth, along with improved access to social services, are critical in order to sustain the momentum o f Albania’s poverty reduction including rural poverty reduction.

Table 2: Poverty in Albania (percent o f individuals) Tirana Other Urban Rural Total

Poor Extreme Poor Extreme Poor Extreme Poor Extreme poor poor poor poor

Headcount 2002 17.8 2.3 20.1 4.8 29.6 5.2 25.4 4.7 Headcount 2005 8.1 1 .o 12.4 2.7 24.2 4.5 18.5 3.5 Source: LSMS 2002 and 2005.

14. Urban poverty has declined faster than rural poverty. Overall, the headcount measure o f urban poverty f e l l f rom 19.5 percent to 11.2 percent (or by 43 percent). By contrast, rural headcount decreased from 29.6 percent to 24.2 percent (or 18 percent). M u c h o f the growth has taken place in and around urban areas, drawing migrants f rom the countryside. Tirana, for instance, managed to slash i t s poverty rate by more than ha l f (Figure 2). T o see the scope o f these differential reductions in poverty, note that the poverty gap measure for urban areas f e l l f rom 4.5 percent to 2.3 percent, while the same measure for rural areas fel l f rom 6.6 percent to 5.3 percent. This means that while the income shortfall, relative to the poverty line, for urban poor fe l l by 49 percent o n average, i t f e l l only by 20 percent (again o n average) for the rural poor.

Figure 1: Decomposition of Change in Poverty, Figure 2: Evolution and Distribution of Poverty, 2002-05

0 I

Total Ccartal Central Muntain hrana &ban other Rural

Source LSMS 2002 and 2005

2 0 0 2 - 0 5 Poverty and Inequality Evolution

Albania, 2002-2005

I

02 05 02 05 02 05 02 05 02 05 02 05 02 05 Nbuntain Tirana Mher urban Rural Total Central Coast

Source LSMS Mo2 and LSMS 2005

This draws on World Bank (2006) Albania Poverty Update note. See World Bank (2005), Growth, Poverty and Znequality, Chapter 2. 4

4

15. Although poverty rates have come down, the population remains vulnerable to poverty. Vulnerability i s the net effect o f shocks, household endowments and their coping networks. The Poverty Update estimates that a hypothetical shock which reduced income by 50 percent would have increased absolute poverty f rom 18.5 percent to 45 percent in 2005.5

16. Most o f the poor are only educated up to the primary level, and have large family sizes. They also’tend to be outside the formal sector, defined here as wage workers. Households headed by elderly people also tend to be poor. This underscores the important role that sk i l ls and secure jobs play in protecting individuals f rom poverty. In the rural areas, even more o f the poor have l o w sk i l ls .

The poor are primarily less skilled and non-wage workers.

c. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY

17. Although the current account deficit warrants concern, Albania’s medium-term macroeconomic prospects are favorable. Despite stiffer international competition, the prospects for high and sustained growth are positive, provided that structural reforms continue their momentum. Macroeconomic performance i s assumed to be sustained, predicated on : (i) continued fiscal consolidation and improvements in the quality o f fiscal adjustment; (ii) acceleration o f structural (including financial sector) reforms directed at improving competition and the investment climate, the quality o f infrastructure and public sector governance; and (iii) a relatively favorable external environment that would help boost export growth. These reforms are projected to facilitate a rise in gross domestic investment (both public and private) f rom 23.6 percent o f GDP in 2005 to 28.3 percent in 2010, supported by higher public and private domestic savings.

18. The government’s fiscal strategy aims at keeping government small while channeling improved revenue performance to reduce debt and lessen the burden of distortionary taxation. In the medium term, the Government intends to increase spending slightly, but cap it at around 30 percent o f GDP. The public sector contribution to growth would result f rom a gradual reduction in interest payments, broadly matched by an expansion in capital expenditure, f rom around 5 percent o f GDP in 2005 to around 7 percent in 2010. Expenditure policies would also focus on adjusting the expenditure composition by increasing the share o f priority expenditures, improving efficiency in the use o f resources, and better prioritizing investments. All this i s expected to be possible owing to predicted improvements in tax collections and a gradual expansion o f the tax base (the major thrust o f the program o f the new government), which are expected to increase revenues by at least 2 percentage points o f GDP by 2010. The overall fiscal deficit i s projected to decline very gradually, f rom 3.7 percent in 2005 to 3.5 percent in 2010 (Table 1). Revenue gains f rom improved tax administration (around 2 percentage points o f GDP) are expected to be used to reduce the debt burden and further reduce the tax burden in an effort to reduce informality.

19. The current account balance i s expected to improve gradually, but hinges on rapid export growth and sustained inflow of remittances. The current account deficit i s projected to fa l l f rom 6.5 to 5.3 percent o f GDP over 2005-10, mainly as a result o f a sustained export performance that would accompany higher FDI levels, and structural reforms in the areas o f governance and the investment climate.

20. Still, financing needs are projected to increase slightly but the path o f debt remains sustainable. Total gross external financing needs are projected at around US$ 5.5 b i l l ion during 2006- 2010 (Table 3). These are required to finance: (i) large annual current account deficits amounting to

With the relative poverty line, the vulnerability would be even higher.

5

roughly US$ 3.9 b i l l ion over the period; (ii) amortization o f external debt o f around US$ 600 mill ion, and (iii) US$ 948 mi l l ion o f increases in net foreign reserves. Steadily increasing inflows o f FDI are expected to fund these needs, although such inflows will depend critically on maintaining privatization efforts and further improving the environment for doing business. Net FDI i s projected to finance up to 39 percent o f total financing needs in 2006-20 10, while long-term loans f rom multilateral, bilateral, and other creditors are projected to account for around 15 percent (Table 2). The remainder i s expected to be covered by other capital inflows including short t e r m credits.

Table 3: Financing Requirements (in millions of USD) 2005 2006 2007 2008 2009 2010

Financing Requirements (incl IMF) Current account deficit Long t e r m amortizations (excl. IMF) Reserves Changes o f Monetary Auth./l IMF Credit (net)

Off ic ia l capital grants Private investment (net) Long term Disbursements excl IMF Adjustments to scheduled debt service/2

Financing sources incl. gap fill

779.0 643.3 46.0 92.2 -2.5

779.0 95.9 279

126.0 -2 1

954.6 653.4

79.2 218.0

4.0 954.6 116.7 342.7 112.3

-8.7

964.3 760.4

90.2 107.0

6.7 964.3 135.9 376.8 191.5 -83.9

1146.5 822.9 122.2 194.3

7.1 1146.5

139 424.8 23 1.5

0

1171.2 834.2 142.7 184.4

9.9 1171.2

126.7 476.9 225.7

0

1274.0 828.4 170.5 263 .O

12.1 1274.0

114.5 511

243.7 0

Other capital flows 299.1 356.5 252 327.7 333.5 394.3 1iValuation effects are netted out in ‘Other capital flows’, 2/Reconciliation o f arrears which are expected to be covered by arrears rescheduling and prospective privatization receipts

111. THE GOVERNMENT’S PROGRAM

21. Against this backdrop, the Government’s program i s appropriately ambitious. The Government that came to power in September 2005 articulated a very ambitious and wide-ranging program. I t s major goals are comprehensive, rapid and sustainable growth; integration o f Albania into the EU and NATO; the development and consolidation o f democracy; and restoration o f the rule o f law. In order to achieve these, the government foresees the need for improvements in governance and institution- building, the investment climate for the private sector, public health, education and poverty reduction, and in access to core public services; preventing environment degradation; and, moving faster towards European and Euro-Atlantic integration.

22. The NSSED articulates a medium-term development strategy, with a focus on pro-poor growth. The polit ical programs o f the government have been translated into a medium-term development strategy, the NSSED, first adopted in 2001. The NSSED represents a serious effort to move away f rom short-term crisis management, seeking to lay the foundations o f a long-term development strategy. I t i s built around three pillars-improving governance, promoting private sector development, and fostering human resource development. An Annual Progress Report o f the NSSED was adopted in July 2005, which highlighted progress to date, but also focused on the need to continue structural reforms for maintaining economic stability and improving public service delivery. A third annual progress report o f

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the NSSED was issued in July 2006. The recent JSAN on the NSSED progress report concluded that the latter provided a good basis for a deepening o f the NSSED process.6

23. The recently-signed SAA also brings with it a series of reform commitments. Successive governments have articulated the goal o f jo in ing the EU as a top priority for Albania. The most recent development in this context was the signing o f the Stabilization and Association Agreement (SAA) between the E C and the Government o f Albania in June 2006, a process that began in January 2003. The S A A entails a series o f commitments in different areas, including enhanced regional cooperation and reduced barriers to trade and foreign investment, a prospective free trade agreement with the EU within ten years o f the entry into force o f the agreement, a commitment by Albania to approximate i t s legislation to that o f the EU in key areas o f the internal market, provisions on movement o f capital and labor and freedom o f establishment and supply o f services, and provisions for greater cooperation in areas including justice, freedom and security.

24. The Integrated Planning System (IPS) seeks to integrate all the different policy frameworks into one strategic and integrated whole. In November 2005, the Government, with the support o f development partners, introduced a new Integrated Planning System to bring together different policy frameworks (EU integration, NSSED, NATO, MDGs, along with regional and decentralization strategies) into one strategic and coherent framework, the National Strategy for Development and Integration (NSDI). The IPS also seeks to better integrate the medium t e r m budgetary process and the NSDI.

25. The government program supported through a series o f proposed DPOs will support key areas in the N S D I and Government development program. In doing this, the proposed DPOs wil l also support the IPS process.

IV. LINK TO THE COUNTRY ASSISTANCE STRATEGY (CAS)

26. Consistent with the government’s program laid out in the NSSED and European integration process, the CAS aims to support the Government around two core pillars: (i) continued economic growth through support to private sector development; and (ii) improving public service delivery. A third element, improving governance and strengthening accountability mechanisms, i s the main cross-cutting objective o f the CAS. T o help deliver this agenda, the CAS envisages a series o f programmatic Development Policy Operations (DPOs) as i t s core instrument. “The DPO program (FY07-FY09), building on the achievements o f the PRSC series o f the previous CAS, i s a microcosm o f the whole CAS, supporting most o f i t s major policy goals and results” (CAS FY06-09, p. 31, Report N o . 34329-AL, discussed at the Board on January 10,2006).

27. The DPO objectives mirror the twin pillars o f the CAS-private sector led growth, and improved service delivery-and i t s third objective, the cross-cutting governance actions, mirror the governance filter o f the CAS. Moreover, given the CAS focus on governance, the D P O i s an appropriate instrument to respond flexibly to evolving issues in a country where governance remains a challenge. The overall CAS objectives (and also D P O objectives) are envisaged to be delivered by the series o f DPOs, investment projects, and a focused program o f analytical support.

28. DPOl - IDA, $ 10 million. The CAS envisaged a flexible lending envelope, depending on the pace o f policy reforms. The proposed DPOl responds to and supports critical reforms to (i) enhance the environment for private sector activity by reducing administrative barriers, and strengthening the

Albania- Joint IDA-IMF Staff Advisory Note (JSAN) on the Poverty Reduction Strategy Paper, Third Annual 6

Progress Report, January 11,2006, Report no. 34930-ALB.

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frameworks for concessions and supervision o f the non-bank financial sector; (ii) improve service delivery and safeguard fiscal sustainability in health, pensions and water; and (iii) implement core governance reforms in public expenditure management, c iv i l service, and reform the procurement law to ensure transparent and competitive practices.

29. Once sufficient progress has been made in the program, the indicative triggers proposed in B o x 3 will be specified as prior actions for DP02 . The exact specification o f such prior actions will be done at the time o f preparation o f DP02, and wil l take into account the evolving situation and progress in the program (see Section VI1 B). D P 0 2 wil l be processed once the specified prior actions have been met and provided the macroeconomic framework continues to be satisfactory. The indicative triggers encompass many o f the key CAS areas for assessing whether Albania’s progress continues to allow lending within the envisaged base lending scenario. If progress on pol icy reform i s stronger than expected under the base scenario, the Bank may consider a higher amount for DP02, provided additional IDA resources are available.

DP02 - IDA, $ 10 million.

30. DP03 - IBRD, $ 15 million, high case scenario. D P 0 3 wil l also have i t s own set o f indicative triggers, which will be specified in the D P 0 2 program document -- a preliminary indication i s provided in the policy matrix in Annex 3. However, as discussed in the CAS, and given that this will be an IBRD operation, greater progress wi l l be expected in macroeconomic areas, to demonstrate greater creditworthiness. Apart f rom the general criteria for macroeconomic stability, high case lending would be accompanied, among other criteria specified in the CAS, by an annual decline in the public debt to GDP ratio, clearance o f external debt arrears, and sustained economic growth (subject to exigencies). The CAS Progress Report (FY08) will review the milestones for enhanced lending (of which D P 0 3 would be a part) and IBRD creditworthiness.

V. THE PROPOSED DEVELOPMENT POLICY OPERATION (DPO) PROGRAM

A. DEVELOPMENT OBJECTIVES

31. fo l low directly f rom the government program and the CAS objectives, and are:

The key objectives o f the government program supported through a series o f proposed DPOs

Improving the investment climate for private sector-led growth. The focus on growth continues f rom the previous PRSC program, and also follows from the new Government’s priorities. I t s validity as the key goal has been reinforced by the strong impact o f growth on poverty reduction. The proposed DPOs will support some o f the major actions to reduce constraints to growth by strengthening the regulatory environment for business, improving the functioning o f land markets, and improving the oversight o f the non-bank financial sector.

Improving fiscal sustainability of public service delivery, in the health, social insurance and water sectors. Actions would address health financing, the health sector regulatory framework, the pension pol icy and i t s implementation, and the pol icy and incentive framework in the water sector.

Improving government effectiveness, following the governance principles enumerated in the CAS. These would include improving public financial management, furthering reforms in public administration, and advancing decentralization through support to strengthening o f local finances. Apart f rom this, it should be noted that governance i s also affected by other actions in the program, such as actions relating to concessions, health, and private sector development (see B o x 2 for an elaboration).

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B. DIAGNOSTICS FOR DPO OBJECTIVES

32. The impressive growth performance since 1993 has been based on factors that are unlikely to provide the same impetus to growth in the future. Past growth has been dependent mostly on non- tradable sectors, and almost solely on reallocation-based TFP growth as opposed to factor accumulation. A continuation o f such dependence i s unlikely to y ie ld high growth. Also, while macroeconomic stability and a decline in the fiscal deficit have underpinned recent growth, the quality o f fiscal adjustment has been weak. A further boost to growth f rom this source will require improved fiscal adjustment including better investment management and public expenditure management in general.

33. Sustaining past growth will need significant increases in factor accumulation and continuation, albeit from alternative sources, o f TFP growth. Annex 1 presents a possible way o f looking at the constraints to growth based on the need to increase factor accumulation and find new sources o f TFP growth. The figure shows that:

K e y constraints to capital accumulation would appear to l ie, for example, in l o w domestic savings, in turn due to l o w enterprise savings. Enterprise savings are l o w owing to l o w profitability o f f i rms , especially in tradables (one reason for which i s the time and money spent in dealing with corruption and tax harassment), which also restricts the supply o f savings to this sector. Inadequacies in land titling and collateral execution also restrict the supply o f savings to the enterprise sector.

Key constraints to labor demand l ie in high labor taxes which encourage informalization o f economic activity, and in inadequate sk i l l s and education o f the work force.

TFP growth in the private sector i s constrained by the cost and quality o f government services (such as education, health, roads, energy, etc; the quality o f public investments i s a particularly important issue), the quality o f the regulatory environment (investment climate) provided by government, and the mechanisms for allocation and reallocation o f resources.

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0

0

34. Governance problems, broadly defined, are at the heart of the development agenda. This i s equally true for business and for private citizens. Major concerns o f Albanian businesses in 2005 relate to governance issues, with corruption, tax rates, anti-competitive practices, contract violations, tax administration, and functioning o f the judiciary being particularly prominent.’ For private citizens, corruption i s a foremost concern, and affects their daily lives in many ways-with customs officials, tax officials and doctors being perceived as among the more corrupt groups. More than 40 percent o f the sampled public i s reported to have paid bribes to doctors or nurses in 2005.’

35. Although continuously improving, the accountability framework needs further work to increase the effectiveness of public spending. A more effective public financial management system would improve the quality o f services and the efficiency o f spending, and hold public spending up to higher standards o f accountability. Current constraints in the system include inadequate linkages between pol icy priorities and annual budgets, lack o f rigorous public investment management, and weaknesses in procurement.

See BEEPS (2005) Business Environment and Enterprise Performance Survey for Albania, EBRD and W o r l d Bank; and W o r l d B a r k (2006), Anti Corruption in Transition 3, Europe and Central Asia region.

“Corruption in Albania: Perception and Experience, Survey 2005,” Institute for Development Research and Alternatives, June 2006 (sponsored by USAID). In another survey in December 2004 by MSI, corruption, economic development and unemployment, in that order, were among the top three concerns o f private citizens.

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36. While there have been significant improvements since 2000, public administration continues to pose a constraint to more effective service delivery. The long-term goal i s o f an efficient, meritocratic, depoliticized and well-paid c iv i l service that i s able to spearhead reforms and provide effective public services, including those delivered to the private sector. Continued efforts are needed in order for Albania to get closer to that goal.

37. Finally, further progress in decentralization could help to make local investments more sustainable. Albania has made much progress in this field, but major results in terms o f service delivery are only expected once implementation o f the substantial agenda gains further momentum. K e y remaining bottlenecks have to do with inadequate autonomy and empowerment o f local governments; lack o f a predictable framework for local revenue mobilization and a transparent transfer system; absence o f a tax-sharing mechanism; and a lack o f legal, regulatory and administrative arrangements for local government borrowing.

38. The growth agenda (as seen in Annex 1) i s therefore vast. While some o f i t s key elements wi l l be supported by the proposed DPOs, the latter wil l be complemented by other Bank operations, as well as by other development partners (see Annex 9 - donor matrix).

39. The governance agenda, by its nature, i s a long-term one? Improvements in governance and the resultant impact on corruption can only be expected to occur on an incremental basis. Thus, the work started in the previous PRSC program and carried forward in this proposed DPO program can, if done well, be expected to yield significant results in terms o f improving governance and thereby reducing corruption, over the course o f the next decade (see Box 2). It will also require continuous support by the development community, even as the Albanian government i s expected to add capacity for taking an ever- greater role in setting i t s own agenda.

C. OPERATION DESCRIPTION

40. The results framework for the operation has been laid out in Annex 4. The operation i s likely to contribute to higher order indicators, such as increased exports and private sector investment, sustainable growth, and reduced corruption (over a much longer time frame). However, these indicators are not part o f the results framework o f the DPO program-the latter includes specific outcomes which can be attributed to the actions taken as part o f the program. The operation policy matrix i s la id out in Annex 3, with actions in bold representing pr ior actions for DPO1, indicative triggers for D P 0 2 and a l i s t o f possible key actions for DP03. Similarly, in the description o f the operation below, actions in bold under D P O l represent prior actions.

Cl. Improving the Investment Climate for Private Sector-led Growth

41. As seen above, private sector development and growth i s affected by corruption and lack o f transparency, tax harassment, unfair competition, inadequate infrastructure, the level o f direct payroll taxation, access to finance, and so on. I t i s also affected by low-impact public investment programs and a generally weak public expenditure management capacity. Public services such as water supply and primary and secondary health care also affect the productivity o f the work force, as well as incentives to invest. In other words, private sector development i s affected by the entire DPO program, and not just by the actions fall ing under the rubric o f ‘improving the investment climate.’ In addition, Bank support in other areas, especially energy, transport,

The private sector agenda i s inherently cross-cutting.

See ICR on the Third PRSC, 2006, Report no. 36524, for an exposition. 9

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and education, i s also important to relieve infrastructure constraints and sustain long-term growth (see Annex 9).

a) Strengthen the regulatory environment for business

42. While private sector participation i s essential to meet infrastructure needs, the procedure for government concessions needs to become more transparent and competitive, and i s a critical policy measure to address governance concerns. Public-private partnerships (PPPs) can play a major role in infrastructure development, provided the government i s able to attract high-quality bidding through a fair, transparent and competitive process. As o f 2005, however, the concession law (a key area for PPPs) allowed significant room for government discretion in treatment o f unsolicited bids, and as such was vulnerable to abuse. It often gave the initially-bidding firm the contract, or gave i t an unfair advantage over f i r m s who did not make the init ial bid. The size o f contracts can be very large under concessions, and as such a non-competitive procedure can cost the country heavily in terms o f foregone revenue and better service quality. Reform o f the Concessions L a w i s thus an essential element in the government’s drive for better governance and reduced corruption, and in reducing anti-competitive aspects o f policy-making. Further, if implemented well, an improved concessions l aw and i t s related procedures can significantly increase the impact o f the awarded concessions on service quality, cost and ultimately economic growth.

.

43. Regulatory constraints to business operations and inadequate infrastructure are among the key barriers to business operations. Albania faces two key challenges in fostering sustainable private sector growth and increased investment. One relates to the removal o f regulatory and administrative constraints affecting business entry and operations. The 2005 Administrative and Regulatory Cost Survey (ARCS) indicates that the most problematic areas affecting business entry and operations are anti- competitive practices (79 percent), electricity (70 percent), tax rates (72 percent), corruption (69 percent), macroeconomic instability (68 percent), economic and regulatory pol icy uncertainty (59 percent), and information o n laws and regulations (53 percent). The 2005 BEEPS survey points to similar problem areas. The second challenge relates to the creation o f suitable infrastructure that would enable businesses to export to regional and European Union (EU) markets. Addressing this agenda will help to encourage new source o f TFP growth as well as capital accumulation in the private sector.

44. Unnecessary administrative rules and procedures create obstacles to entry into markets and discourage growth of foreign investors and local entrepreneurs. The business licensing regime offers a clear example o f difficulties affecting business entry. In Albania, about 30 institutions are involved in the issuance and administration o f over 120 licenses, permits, authorizations, certificates or consents which are regulated under different laws, decrees, guidelines, regulations and instructions issued by different ministries and government entities. In the Wor ld Bank’s 2007 Doing Business report, Albania ranked at 120 in 2006 in the overall ease o f doing business, and as l o w as 161 in terms o f the specific issue o f ‘dealing with licenses’.

45. A new Concessions L a w has been enacted. In December 2006, Parliament approved a new and significantly improved Concessions L a w as part o f i t s DPO-supported reforms. The Government i s n o w in the process o f preparing and fine-tuning implementing regulations and establishing a specialized concessions unit. Whi le recognizing this major improvement, especially in relation to the treatment o f unsolicited bids and competitive procedures, the Bank has some ongoing concerns, especially relating to the introduction o f the ‘One Euro’l’ initiative in concessions. In addition, the government needs to staff

The Albania One Euro Program consists o f two main activities aimed at encouraging foreign investors to enter the Albanian market: a) Grant publ ic assets as concessions at a symbolic price o f one euro according to the ru les and procedures set out in the newly adopted Concession Law; and b) Reduce cost o f services to investors to around one

I O

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up the PPA in a timely manner, to enable i t to fulfil i t s additional role, as proposed by the concessions law, o f being the administrative review body for concessions and supervising the enforcement of concession procedures." While some o f the concerns relating to the One Euro Program will be partly addressed in DPOl,'* a review o f the implementation experience o f the law will be supported by subsequent DPOs and action taken to address current and emerging concerns.

46. Reforms o f the regulatory framework are under way. The Government has recognized the need to further strengthen the regulatory capacity over the (formal) market, remove administrative barriers and tackle informal activities. T o ensure sustainability o f reforms, i t also seeks a more institutionalized approach and stronger capacity to deal with regulatory reforms. Accordingly, fo l lowing Foreign Investment Advisory Service (FIAS) recommendations, the Government has established a Regulatory Reform Task Force, chaired by the Prime Minister, for the formulation and monitoring of regulatory reform plans. The Prime Minister has given the Minister o f Economy, Trade and Energy the mandate to implement these regulatory reforms. This agenda wil l be coordinated and implemented by the Trade Facilitation Unit within the Ministry o f Economy, Trade and Energy (METE), which has been further strengthened by additional staff working exclusively on regulatory reforms. With support f rom sevefi technical working groups, the Task Force has developed a Regulatory Reform Act ion Plan, endorsed by the Council o f Ministers, to guide implementation o f reform actions in the next three years. The new institutional framework will help to reduce regulatory and administrative barriers through the adoption o f methodology such as the guillotineI3 and the regulatory impact assessment (RIA). Already, the framework has yielded reforms o f several laws and reg~lat ions, '~ and in some cases implementation has begun. For example, self-declarations have substituted for state licensing in the case o f professional services, and multiple documentation submission has been eliminated in the public works and transportation sector.

47. Actions supported by DPO1:

Improve the framework for government concessions. The DPO supports the passing o f a new concessions law that embraces the principles o f transparency and a competitive bidding process, and very strictly define the conditions under which' sole sourcing would be admissible.

Strengthen the capacity o f the Trade Facilitation Unit within the METE to implement regulatory reforms with proper consultation mechanisms with the business sector. This wil l be done with the help o f the Business Environment Reform and Institutional Strengthening (BERIS) project, and will help ensure sustainability o f the regulatory reform process.

euro. These services include some permits, procedures, visa fees for foreign investors, border taxes and other minor taxes, etc.

The Bank also has a number o f other concerns, which, if added up, could help to improve implementation and clarify provisions o f the law, and it has been agreed that these wil l be addressed, as necessary, in DP02.

Under DPO1, existing implementing regulationis to the L a w o n Concessions, approved by the Counci l o f Ministers, wil l be amended as follows: the value o f royalties wil l be included in the l i s t o f evaluation criteria for a l l proposals, whether or not in the one euro scheme. In addition, the METE will issue approved criteria for inclusion o f assets in the 'One Euro' initiative.

The Guillotine approach, used by countries such as Sweden, Hungary and Mexico, i s based on a quick and automatic review and reform o f regulatory measures with the automatic elimination o f unjustif ied ones.

Reviews and recommendations for elimination o f superfluous licensing requirements have been completed in hydrocarbons, mining, road and sea transport, public works, health, education, agriculture, environment, fishing, forestry, water administration, f ire safety and customs.

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Prepare recommendations for eliminating superfluous licensing requirements in selected sectors. Assistance for implementation o f these measures would be made available by the BERIS project.

48. Subsequent DPOs would support improved systems and their implementation, i.e., the adoption and implementation o f a regulatory management system for improving quality o f new and existing reg~lat ions, '~ and the review and streamlining o f regulatory regimes in licensing and inspections. l6 They would also support the review o f implementation experience o f the new concessions l aw and subsequent incorporation o f these and any other concerns into any required amendments to the law.

49. Expected Results (see Annex 4):

Improvement vis-a-vis 2005 baseline data in starting a business: number o f procedures (1 l), time taken (41 days in Doing Business, 26 days ARCS), and cost (31 percent o f income per capita in Doing Business, 20 percent ARCS).

All concession contracts to which the new Concessions L a w applies to be fully compliant with provisions o f the law.

b) Improve the functioning of land markets

50. The development o f land markets i s a critical input into private sector development and growth, including for financial sector development. In Albania, inadequacies in land markets have hindered credit f low to the private sector, and have also been a key factor in the high level o f informality in the economy. The 2005 ARCS cites procedures for access to land and services as the third biggest administrative obstacle to business operation in Albania, after tax administration and customs regulation.

51. In this context, much progress has been made in improving land market functioning. Albania has carried out land and property administration reforms since 199 1, with substantial progress in transfer of ownership and recognition o f property rights. Issues o f land privatization, registration o f ownership rights and land-use planning have been addressed by the government with support f rom several donors, mainly USAID, the EU and the OSCE, as well as IDA. The government recently initiated an ambitious program to legalize informal settlements.

52. Despite this progress, land and property markets are not operating efficiently. The remaining challenges include the following: First, land and property rights are not fully secure. About 600,000 urban and 300,000 rural parcels remain unregistered. Second, the cost for registering property transactions i s high, owing to lengthy transactions and high informal fees; this often pushes property transactions into informal markets. Third, the slow pace in resolving restitution claims has prevented the registration o f land and properties in high value regions such as coastal areas as wel l as some urban areas. Fourth, large numbers o f illegal land subdivisions and construction projects have taken place, primarily in

This would include the introduction o f a customized, simple and operational system to assess qualityiimpact of business regulations (RIA system) against internationally recognized benchmarks and criteria. Regulations must satisfy the fol lowing principles: (i) clari ty (legal security, consistent respect for market solutions, predictable enforcement); (ii) transparency (clear and simple rules, openness through the entire po l icy process, reduction in corruption indicators); (iii) legitimacy (must protect safety, health, environment, consumers, public interest; (iv) efficiency (low-cost rules, orderly and t imely decisions, move swiftly to meet market needs); and (v) expertise (good regulatory sk i l l s and understanding o f markets and technologies).

After the review, regulatory regimes should be streamlined, with regulatory interventions moving away f r o m universal ex-ante authorization (acting as a barrier to entry) to alternatives based o n notif ication and ex-post verification.

I S

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peri-urban areas and in tourism zones, mainly as a result o f lack o f land use plans or because o f lack of enforcement o f such plans. Fifth, while the government has devolved many functions to local governments, including land use planning and management control, as well as property taxes, local authorities often do not have the capacity or financial resources to undertake these functions effectively.

53. The government needs to address three areas to ensure efficient functioning of land and property markets: (i) improve the security o f tenure and enhance the efficiency and transparency of the Immovable Property Registration Agency (IPRA) by transforming it into an autonomous and self- financing entity; (ii) strengthen local government capacity in land use planning and control o f land development, and revise the spatial planning law to streamline the requirements for approval o f regulatory plans and building permits; and (iii) restructure property taxes to encourage formal registration and discourage under-utilization o f land and properties. The specific measures outlined in the matrix, coupled with the investment support which will be provided under the proposed Land Administration and Management Project, will enable the government to address many o f these challenges over the next few years.

54. ground for pol icy action on these fronts under D P 0 2 and DP03 .

The land management project wi l l provide technical assistance in order to help prepare the

55. Subsequent DPOs would support:

A new law on property valuatiodtaxation. The objectives o f the new law would be to provide the legal framework for property valuation and taxation in accordance with international valuation standards. This would enable municipalities to convert the existing occupation tax to a property tax that i s based on fair market value. I t wil l also enable taxation o f vacant land that would discourage speculation and holding o f vacant properties in prime urban locations.

Adoption o f a revised Spatial Planning Law. The objectives o f revision in this law are to streamline the requirements for the preparation and approval o f regulatory plans as wel l as the requirements for issuance o f building permits.

Transformation o f IPRA by the law on property registration into an autonomous, self- financing agency so as to ensure de-politicization o f appointments o f senior staff, and improvements in delivery o f i t s services, including the time i t takes to register a property transaction.

56. Expected results (see Annex 4 for details):

Increase in property tax collections.

0 Reduction in time to register property transaction f rom an average o f 37 days to less than 20 days at the time o f DP03.

c) Improve oversight o f non-bank financial sector

57. While Albania has made significant progress in setting up a modern financial sector, dominated by banks, the overall access to finance and diversity of products s t i l l needs to be improved. The banking system has been completely privatized. The legal, supervisory and institutional framework for the banking system i s substantially in l ine with international standards. With the support from the Bank and the IMF, the Bank o f Albania (BOA) has also taken important steps to strengthen supervision. Though there i s significant growth in the credit to total assets ratio in recent years, i t i s starting f rom a small base. The enterprise sector’s access to finance i s s t i l l poor, restricted to relatively basic financial products and constrained by weak competition.

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58. The insurance sector i s s t i l l underdeveloped and weak and needs to be strengthened through better regulation and supervision. The 2005 Financial Sector Assessment Program (FSAP) recommends additional efforts to further strengthen regulation and supervision o f the Non-Banking Financial Institutions (NBFI), especially in the insurance sector. A stronger insurance sector would help to improve financial product diversity and hence create incentives for more private savings. While a new insurance law was enacted in 2004, regulations in the areas o f licensing, solvency margins, financial reporting, governance, transparency and investments are not yet in compliance with international best practices. Weak supervision and unfair practices f rom insurance companies in cutting premiums for Motor Third Party Liabi l i ty (MTPL) insurance are undermining solvency o f some insurance companies, resulting in non-payment o f claims and loss in public confidence.

59. The Government i s addressing the weaknesses in NBFI supervision by creating and empowering a new integrated Financial Supervisory Authority (FSA) for NBFI supervision. Fol lowing the 2005 FSAP recommendations, the Government decided to create an integrated regulator for the non-bank financial sector, and strengthen supervision and regulation o f insurance, pensions and securities. In July 2006, Parliament approved the law establishing the new FSA, responsible for supervision and .regulation o f insurance, private pensions and securities. The F S A was created in September 2006 as an independent regulator accountable to Parliament. A strategy to guide the establishment o f the F S A has been prepared and i s being implemented. The FSA, with assistance from the Bank, has begun: (i) a comprehensive off-site and on-site examination o f insurance companies, to determine their level o f regulatory compliance and to enable necessary corrective action; (ii) an assessment o f the institutional infrastructure needed to provide reliable insurance services to the population; and (iii) a review o f the existing regulatory and supervisory framework for insurance and pensions. Based on in i t ia l assessments, an Institutional Development Act ion Plan (IDP) to strengthen the supervision and enforcement capacity o f F S A and to introduce risk-based supervision i s being prepared and starting to be implemented.

60. These ongoing assessments reveal several weaknesses. The assessments reveal weaknesses and required improvements in claims administration and risk retention practices, institutional arrangements for Motor Third Party Liabi l i ty (MTPL) and the Green Card Regime, and Reinsurance:

Net Premium and Risk Retention are too high as a result of inadequate reinsurance and need to be corrected. Net premium retention ratios in the sector were between 84-96 percent in 2005 and 83-100 percent as o f September 30, 2006, implying excessive r isks on Albanian insurance companies’ own books. This situation requires reform o f the insurance law and other corrective action.

Low claims and high expense ratios indicate weak claims administration practices and likely under-provisioning for claims by insurance companies. The claim ratios reported by Albanian companies are rather l o w (20-60 percent in 2006, quarter three), often point to poor claims handling practices (including active avoidance o f legitimate claims) or to a weakening o f claims provisions. Expense ratios, on the other hand, are high (35-75 percent in 2006, quarter three), owing to the relatively small size o f the insurance companies (so high fixed costs) and excessive competition to gain market share. The under-pricing o f MTPL business means that the difference between the official and actual premiums i s booked as an expense. All this requires F S A to review and r e f o m claims accounting practices and claims administration structures.

The existing M T P L Bureau and Green Card Regime administration i s not satisfactory and needs to be reformed to strengthen both the claims administration and the

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reinsurance practices.” Albania has a less than satisfactory Green Card claims history. Also, Green Card premium rates in Albania have not been increased for many years, and in practice there appears to be a cross subsidy f rom border policies to Green Cards. Finally, because Albania does not issue Green Card policies for less than 2 weeks, many Albanian drivers are tempted to take out short-term border policies issued at other countries’ border posts. Corrective action includes reconstitution o f the Motor Bureau as an independently governed entity, removed from the insurance association’s direct administration.

61. Actions supported by DPO1: 0 Enactment of the law establishing the Financial Supervisory Authority (FSA) as an

integrated regulator for insurance, private pensions, and securities.

Init iation o f a comprehensive off-site and on-site examination o f a l l insurance companies. 0

62. Subsequent DPOs would support follow-up to earlier measures-taking corrective actions based o n the comprehensive examination o f insurance companies and the existing institutional arrangements. In i t ia l results indicate that corrective action would need to include satisfactory enforcement, especially o n ‘reinsurance contracts’ and ‘claims administration.’ The DPOs would also support the adoption and implementation o f the institutional development plan (IDP) for insurance and pension supervision. The IDP will guide the shift towards a more effective supervisory approach and will promote stronger governance o f insurance and private pension funds, including recommendations for amendments to legislation o n insurance, private pensions, and securities which could be incorporated in the IDP and/or in the DPO program at a later date.

63. Expected results (see Annex 4):

0 Creation o f a more soundly regulated insurance sector, as measured by (i) improved claims management performance; (ii) reduced expense ratio; (iii) improved quality o f reinsurance; and (iv) satisfactory solvency o f the insurance sector.

C2. Improving Fiscal Sustainability and Effectiveness of Public Service Delivery

a) Strengthen financial sustainability and effectiveness of social insurance

64. The social insurance system i s facing fiscal pressures. In part, i t was inherited f rom the past and was designed to provide comprehensive insurance against the r isks o f o ld age, disability, death, short- t e r m il lnesses, poor health, and unemployment, based on contributions made by both employers and employees. This type o f system works reasonably wel l in the context o f high formal sector labor force participation. However, post-transition, participation in formal labor markets has fallen dramatically in Albania, raising questions o f whether the social insurance framework i s in fact the appropriate structure for providing social protection benefits in the future for the entire population. As elsewhere in Central Europe, the historical labor force participation rates o f nearly 100 percent for both men and women result in a large fraction o f the elderly receiving pensions, whi le the post-transition r ise in informality reduces

Compulsory Third Party Mo to r Insurance, mediated under 1992 legislation along with subsequent amendments, covers: (i) the death and injury o f third parties within Albania caused by domestic vehicles; (ii) injuries caused by Albanian drivers in other countries that are members o f the Counci l o f Bureaux-the Green Card business and (iii) border insurance, for the potential liabilities o f foreign drivers who do not have Green Cards while they are in Albania. Al l three schemes are administered in Albania by a Mo to r Bureau, although the r i sks are underwritten by licensed local insurers. Eight insurers are currently licensed to underwrite M T P L and four o f these to underwrite Green Card risks (a fifth recently had i t s Green card license revoked).

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the contributors among the working age population. This imbalance between contributors and beneficiaries typically leads to fiscal problems in financing the benefits.

65. I n the case o f pensions, fiscal balance has been maintained by a combination of measures: (i) by retaining a very high contribution rate, amongst the highest in Europe; (ii) by compressing benefits such that maximum benefits are twice minimum benefits, while the salaries on which contributions are paid are allowed to diverge fivefold between the minimum and maximum thresholds; (iii) by not formally linking increases in benefits to specific variables and allowing them to be specified annually, based on what i s affordable; and (iv) by legislating various contributions and revenues to come directly f rom the budget. For example, in the case o f rural contributors, more than ha l f o f a l l contributors, the state makes 85 percent o f the contribution. These measures have made a bad situation worse, undermining the incentive to comply and de facto converted the pension system into a non-contributory one.

66. The system’s high contribution rates contribute to informality, tax evasion and unfair competition. The program involves high contribution rates, which were (until mid 2006) set at 41.9 percent o f payroll, o f which the largest share o f 29.9 percent was for pensions; 5 percent for unemployment insurance; 0.8 percent for sickness; 2.3 percent for maternity; 3.4 percent for health insurance; and 0.5 percent for occupational injury. This has contributed to high levels o f informality (three-fourths o f the labor force), as employers have sought to avoid the high payroll taxes, and has led to many complaints o f unfair competition by the formal business sector. New legislation implemented in July 2006 reduced the total contribution by 9 points, reducing unemployment insurance by 3 percentage points and employers’ pension contribution by 6 percentage points. However, at 33 percent, the overall rate remains high, especially compared to countries which may be competing with Albania, and may, in itself, be insufficient to have a significant impact on the high levels o f informality in the labor force.

67. There i s general agreement in Government that the social insurance system i s not working well and needs to be fixed. The Government has announced a number o f measures in this regard, such as further reducing the contribution rates for employers (subject to meeting overall revenue targets) in the hope o f reducing the high rates o f informality. I t had also previously committed to reducing the differences in pension levels between the rural and urban sectors and continues to raise rural pensions more than urban ones to achieve this goal. However, these policies increase the expenditures o f the social insurance system while making revenue prospects more uncertain, putting the long run fiscal sustainability o f the system into jeopardy. The current system also embeds a highly redistributive benefit system within a contributory pension system, undermining incentives for contribution. The Government needs to decide whether i t wants a truly contributory system with positive contribution incentives complemented by alternative social assistance provided by the Government; or whether i t wants to provide a flat benefit to al l citizens with consumption smoothing provided by voluntary savings plans. The current system neither provides benefits to al l since it requires some contributors to earn eligibility, nor provides incentives for individuals to contribute, with the result that most o f the private sector under- declares i t s earnings. T o address these concerns, the Government has committed to preparing a new pension pol icy options paper, looking for ways to improve the fiscal sustainability o f the system, to attain better coverage o f the working population, while reducing the payroll tax and other impediments to formalization.

68. Actions supported by DPO1: 0 Begin preparation o f new pension policy options paper, analyzing different options: including

either a flat benefit to all, along with voluntary savings; or a truly contributory system complemented by social transfers to take care o f those who cannot contribute. The goal would be to inform pol icy choices, given the goals o f fiscal sustainability, better coverage,

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and reducing labor taxation ( a goal with a high weight) to reduce unfair competition and improve incentives for formal employment.

69. policy, and the start o f i t s implementation.

Subsequent DPOs would support the adoption and subsequent legislation o f the revised pensions

70. Expected results:

0 Reduction in the payroll contribution rate. W h i l e the targets will depend on the pension pol icy choices the government makes, the DPO will support the government’s plans to reduce the overall contribution rates within the parameters o f fiscal sustainability.

Reduction in number o f pensioners, resulting f rom better pension administration.

b) Improve fiscal sustainability and effectiveness of health financing

71. Current health outcomes are in line with comparators, but the poor are not well-protected from health expenditure-induced poverty, or from corruption in the sector. Albania’s health outcomes compare favorably with those o f lower middle income countries outside the Europe and Central Asia Region, but lag behind those o f other countries in South East Europe. However, while the 6 per cent o f GDP that Albania spends on health care i s in line with the average for lower middle income countries, the public sector contributes a below average share o f these expenditures. Moreover, physical and human resources in the sector are ill-aligned with the population’s health needs, productivity in the health sector i s l o w and resources are used inefficiently. The health financing system i s also fragmented and fails to give providers incentives for efficiency and quality improvements, nor does it establish clear l ines o f accountability. There are many small hospitals with l o w utilization and occupancy rates which points to a sub-optimal hospital structure. The quality o f health care i s low, particularly at the primary care level. All this results in serious inequities in access, with the poor not well-protected from health-expenditure induced poverty, and facing catastrophic shocks when they have to undergo hospitalization. The health sector has also been repeatedly identified as one o f the most corrupt in Albania, thus requiring specific remedial efforts (see B o x 1).

Box 1: The World Bank-supported Program to improve Governance and reduce Corruption in the Health Sector

The Government o f Albania is committed to addressing corruption and governance in the health sector, but has asked for help in implementation. In addition to the measures contained in the DPO, which focus primari ly on pharmaceuticals and assurance o f an appropriate legal framework, the Bank i s also supporting activities to:

build capacity for harmonizing the legal, financial and governance bases o f the health system with the overall government strategy (IDF grant support);

improve provider payment methods to ensure the appropriate incentives for transparency and good governance (this activity and a l l others - supported by the HSMP);

develop suitable policies to define formal user fees (with exemptions for the poor and vulnerable), as a pre- requisite for driving out informal payments;

enhance quality and access to primary health care services (exempt f r o m user fees), to encourage patients to seek most o f their care f r o m P H C physicians, rather than more costly specialists or hospitals;

improve management training and accountability for P H C physicians and hospital managers;

enhance information systems for pharmaceuticals and provider payments to al low the monitoring o f services and help identify corrupt practices.

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72. The payroll tax for health insurance contributes very little to the overall health budget. As seen earlier, the payroll tax for health i s 3.4 percent. This covers only about 7 percent o f the overall public expenditure on health, with the rest coming f rom budget financing. Given the concerns o n the impact o f high payroll taxes, and the l o w revenue collections f rom the health contribution, recent Bank analytical work (Health Policy Note, P E R ) has recommended eliminating the health contribution and relying fully on budgetary resources. While studying this recommendation, the government i s seeking options to ensure predictable financing for the Health Insurance Inst i tu te (HII) (whose expenditure i s a part o f overall public health expenditure), which relies o n the payroll tax for about 40 percent o f i t s resources.

73. The Government has identified three strategic approaches to start addressing the identified health sector problems: (i) improving efficiency o f the system through better planning and resource allocation; (ii) investing in a priority health delivery system to improve access to care and quality o f services; and (iii) targeting public resources for priority public health programs that have the greatest impact on health outcomes. I t has also developed a long-term health care strategy, and i s working with the Bank (including through the Health Sector Modernization Project) and other development partners in implementing this strategy.

74. The reform process has begun. As part o f i t s health sector reforms, the government i s pursuing a move to “sole source” financing through the HII, which would involve the use o f performance-based contracts with increasingly independent health care providers. For example, effective January 1, 2007, the HI1 has assumed responsibility for funding al l operating costs for primary health care, and has received an appropriate budget transfer f rom the MOH to cover these costs. The new financing arrangements with PHC providers include performance incentives. Steps are being taken to improve health sector management and governance, with a v iew to allowing health care providers increasing autonomy in resource allocation decision-making. The government i s also putting additional emphasis on developing primary health care services, which can be the most cost-effective approach to getting high quality services to a large proportion o f the population, especially the poor and vulnerable. In addition, the government i s addressing concerns relating to the sustainability o f H I I ’ s finances.

75. Actions supported by DPOl :

Action taken to stem the HI1 deficit and curb pharmaceutical expenditures. The actions include adoption o f a revised positive l i s t o f HII-reimbursable drugs; introduction o f co- payments for prescription drugs for al l beneficiaries; adoption o f a revised policy limiting reimbursement to drugs that have similar therapeutic effects and are the cheapest available.

76. Subsequent DPOs would support the enactment and implementation o f the health finance law, including definition o f a package o f basic health services commensurate with resources,18 and o f the health care l aw (which defines the overall governance o f the sector), addressing, inter alia, the revised legal status o f health care provider^.'^ Among other things, these laws would specifically address the overall package o f benefits which would be provided to every citizen, the process for setting of f ic ia l levels o f formal co-payments for these services, the process for determining exemptions f rom co- payments for the poor and vulnerable groups, and the measures for reporting any payments that are requested in excess o f the official amounts. The laws will also formally amend and reflect the competencies o f the Drug Commission and Drug Pricing Commission, including the authority o f HI1 to review new drug coverage proposals o f the Drug Commission and delay reimbursement until adequate

Other elements o f the package would include PHC, out-patient specialist care, and hospital care and drugs. The law would al low HI1 to contract directly with primary care providers.

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financing i s available. This latter measure will formally separate the decision to approve a drug for use in Albania -wh ich should be the competency o f the MOH - from the inclusion o f drugs o n the positive drug l i s t for reimbursement, which requires HI1 input regarding i t s fiscal impact and affordability. A base-line survey wil l also be conducted to measure transparency in the pharmaceutical sector (based on WHO guidelines), which will allow the impact o f these measures to be assessed as the DPO process continues. Based on these and subsequent results, additional measures will be added in future DPOs, as necessary, to further improve transparency in this sector. The activities would also involve a review o f options for further reducing payroll taxes, by preparing a policy options paper on possibilities for replacing health payroll taxes with general revenue financing, with a view to implementing the resulting approach pr ior to DP03 if this i s found to be feasible. Other actions would include government adoption o f a health services (hospitals and primary health care) network plan, to rationalize resource use and inform investment decision-making.

77. Expected results (see Annex 4 for details):

Continued effective control o f HI1 operating costs

0

Improve fiscal sustainability of water services

Improved transparency in the pharmaceutical sector

Incidence and impact o f informal payments in the health sector systematically measured

c)

78. The performance of the Albanian water sector has improved over the past few years; however, it needs to improve further in order to contribute to the growth agenda. Access to water supply i s 78 percent (from about 50 percent in 1990) and sanitation 50 percent (from about 25 percent in 1990) compared with regional averages o f 91 percent and 82 percent respectively. Service quality has improved; however consumers s t i l l receive less than 13 hours o f water per day compared with a regional average o f 19 hours. Water utility” revenues have doubled over the past f ive years, but s t i l l do not recover even the cost o f operation and maintenance (O&M), let alone any capital cost. Water and wastewater services impact economic growth, particularly as they relate to tourism. Adequate service delivery-such as the continuity o f water supply, drinking water quality, and sea water quality in beaches used by tourists for bathing-impact the quantity and quality o f tourism and in turn, tourism revenues. Poor water services can also be an impediment to foreign investment.

79. The water utilities have been unable so far to meet the challenges posed; instead, they continue to rely on a high and increasing operating subsidy from the central government. The central government finances the gap between the O & M costs and the utilities’ own revenues. O&M costs have r isen over time due to increased electricity and staff costs. Ut i l i t i es ’ revenues have not kept pace with these increases, as tariffs are too l o w (on average around 79 percent o f the O&M cost), collection rates are l o w (70 percent) and losses are extremely high (69 percent non-revenue water, the highest in the region). High losses are due to both high leakage rates (due to the o ld and deteriorating infrastructure and insufficient allocation to maintenance), and high administrative losses due to i l legal connections and unregistered consumers. L o w metering levels, covering only 20 percent o f households, create incentives for excessive water consumption, with per capita consumption being up to five times Western European levels. That said, there i s significant variation across Albanian utilities in terms o f efficiency and financial performance, and some utilities have achieved close to international standards in both service delivery and efficiency.

2o Water utilities refer to the 56 water supply and wastewater companies that supply a l l urban areas and some rural areas (in total, a service area in which about 70 percent o f the population reside). The remaining rural areas are under the jurisdiction o f the Communes.

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80. To contribute to growth, the sector needs to invest more in wastewater collection and treatment. Currently, allocations to operating subsidy limit the government's abil ity to invest in capital works. Also, the poor performance o f utilities renders them unattractive for private investment. In order to contribute to economic growth, investments need to shift out o f water supply and into wastewater collection and treatment; however, this can only be done once basic rehabilitation o f the water network i s undertaken.

81. The Government i s addressing these challenges through i t s Water Sector Strategy. The strategy envisions increased investments in the sector, particularly in wastewater; further decentralization (transferring the financing and management o f the water ut i l i t ies f rom central to local government); consolidation and commercialization o f the water utilities (including the increased use o f private sector participation); and improving utility financing through liberalizing tariff-setting and demand management. While the strategy provides a good vision for the sector, some issues require further elaboration and clarification, while implementation i s inadequate in a few other areas. The DPO will assist the government in clarifying some o f the outstanding pol icy issues and in implementing the strategy. In particular, the D P O wil l support the government to improve the budget allocation system to water utilities in order to provide incentives for improvements in their technical and financial performance. I t wi l l also assist in implementing the decentralization pol icy by clarifying issues around asset transfer and utility management.

82. Actions supported by DPO1. The Government has a long-term program to reform the sector, which i s takmg o f f gradually, and which wil l be supported by the DPO. The actions supported by the proposed DPO are intended to set the sector on a path to long-run sustainability, wherein operational subsidies would be largely phased out during the medium-term, al lowing fiscal space to invest in wastewater collection and treatment, and thereby allowing a stronger link to economic growth. Accordingly, DPO 1 supports the following action:

0 Prepare a f i rst draft o f water sector policy options paper, including proposed actions to: (i) transfer water assets f rom the central to local government; (ii) reduce or remove operating subsidies for water ut i l i t ies over the next 4 years (which implies phased increases in cost recovery and improved efficiency by water companies); (iii) design a performance-based pol icy for investment transfers to water ut i l i t ies. The pol icy options note will be a strategic document for decentralization o f the water sector to ensure financially self-sustaining water utilities, and will also lay out a long-term vision for the sector. This options paper would then feed into an update o f the GOA Water Sector Strategy.

83. Subsequent DPOs will support adoption o f the water sector pol icy options paper, followed by revision and adoption o f a revised Water Sector Strategy. This would be followed by the commencement o f implementation o f the revised Strategy, and transfer o f an increasing number o f water assets to Local Governments (LGs), as wel l as the signing o f an agreement2' with each LG and utility. In addition, the Monitoring and Benchmarking Unit needs to be scaled up to cover the whole country and data quality needs improvement. The DPOs would support government monitoring and benchmarking o f the whole sector and making al l the results public.

The agreement should commit the three key stakeholders (MoPWTT, Loca l Government Unit and Utility) to the transfer o f assets based o n declining transfers o f operating subsidy over 4 years and investment subsidy based o n priorities established in the Sector Strategy and technical and financial performance targets. The agreement should also detail the transfer o f management (and membership o f the Supervisory Board), and could also mention that the ut i l i t ies serve the same customers for a defined period (say 2 years).

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84. Expected results: 0 Reduction in utility operating subsidies by 10 percent per year (national average).

Performance contracts signed with an increasing number o f ut i l i t ies (which would be a critical input into the revised scheme o f operating subsidies and investment subsidies).

C3. Improving Government Effectiven ess

85. The governance agenda i s at the heart o f development, and i s cross-cutting, but institutions take time to build. The proposed DPO series wi l l focus o n improvements in public spending (especially public investments) and i t s oversight, budgetary processes and treasury reform, and the critical issue o f the public procurement law. The proposed DPOs wil l also support continued c iv i l service reforms, and further strengthening o f the framework for local finances. These reforms, supplemented by the reform o f the concessions law (section Cla) would help to increase the impact o f government expenditure in a resource-constrained and governance-challenged environment. M u c h o f this agenda represents a continuation o f the PRSC-supported reforms, given the long-term nature o f governance reforms and institution-building. While some o f the outcomes o f the governance interventions wi l l be captured through the results matrix, any significant impact on, say, perceptions o f corruption or incidence o f bribery in the provision o f public services may have to wait for a longer period than covered by the proposed D P O program.

Box 2: Addressing Governance issues in the proposed DPO series

The proposed D P O series i s heavily focused o n governance issues, with most actions either directly or indirectly impacting governance. Fol lowing the CAS governance f i l ter approach, the DPOs propose to support the fol lowing measures:

Principle I. Seek greater transparency in the use o f public resources. This area i s a strong focus o f the proposed DPOs. Areas supported include public investment planning and monitoring; a new Organic Budget L a w to support the Medium Term Budgetary Framework; a new Treasury system to improve budget execution and reporting; a new concessions l a w for stronger competition in the use o f public assets and improving returns; a new procurement l a w where competition i s the default procedure; improved governance and resource use in the health and water sectors; and IPS Information Systems to improve evidence-based pol icy making.

Principle 11. Support increased autonomy and depoliticization of key public sector organizations. The proposed DPOs focus on further strengthening o f meritrocracy and depoliticization in the c i v i l service; compliance with c i v i l service and subsidiary legislation; improved evaluation o f performance; improvements in the c i v i l service law; rationalization o f subordinate institutions; and institutionalization o f the H R M I S function.

Principle 111. Support more effective decentralization. The proposed D P O series seeks to support the next steps o n the road to decentralization, by focusing o n local government finance issues. These include a new law o n local government finance; a l aw on local government borrowing and insolvency procedures; in water, a framework for decentralization o f water u t i l i t i es to local governments, with attention to monitoring and improved incentives for performance.

These apart, the proposed DPOs also support the governance principle o f a more competitive private sector. Programs supported include regulatory reform, reducing opportunities for discretion and corruption; reducing payrol l taxes (pensions and possibly health, depending o n chosen strategy); reforms in land markets to improve land t i t l ing and property valuation and taxation; and reducing unfair competition by helping to reduce informality.

The Bank’s development partners are also active in many o f these areas, as can be seen in Section VI A and Annex 9. Strong support has been forthcoming in strategic budgeting and planning, public expenditure management, publ ic administration and pay reform, tax administration and reform, procurement reform, decentralization, information systems, and water systems. Apart f rom these, some partners, notably KfW, USAID, UNDP, are active in the area encapsulated as Principle IV o f the CAS, Le., strengthen c i v i l society monitoring and involvement to encourage improved service delivery and policy-making

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a) Increase efficiency and accountability of public spending2*

86. Strengthening public financial management (PFM) systems and fiscal institutions i s critical for ensuring high quality fiscal adjustment and promoting growth-enhancing and poverty-reducing public spending. P F M reforms in Albania have progressed steadily since 200 1. Nevertheless, an unfinished agenda undermines the effectiveness o f resource allocation and spending: (i) the NSSED priorities are not fully reflected in concrete spending plans through the M T B P and annual budgets within an explicit medium-term macro-fiscal framework; (ii) public investment planning and budgeting i s yet to be fully integrated with the MTBP, and investment decisions are not subject to rigorous evaluation and prioritization; and (iii) weaknesses o f the existing procurement and external audit systems are hindering transparency and accountability in resource utilization. The recent formal adoption o f the Integrated Planning System (IPS) should allow for better alignment o f the NSSED (NSDI in the future) with the MTBP and the annual budget process; stronger integration o f public investment programming within the MTBP; and strengthening donor coordination and the management o f external assistance.

87. Given scarce resources and a governance-challenged environment, there wil l be significant payoffs to focusing on improving the overall and within-sector impact o f government spending, and enhancing accountability. Key elements o f this agenda would include: a) integrating and improving the quality o f policies and budget decision-making; and b) improving efficiency and transparency in resource utilization.

a (i) making

Improve the quality of public investment planning and execution and budget decision-

88. Poor quality public investment planning and execution i s a critical weakness in Albania’s public expenditure management system. Domestic resources are currently spread thinly across an excessive number o f small projects, with litt le strategic focus or prioritization. There i s evidence that this has contributed both to excessive costs and poor standards o f construction. Moreover, the PEIR confirmed that in most o f the sectors, and particularly infkastructure, capital spending i s inefficient due to institutional weaknesses and inadequate allocation o f O&M. The absence o f a single register o f approved investment projects in which annual allocations and expenditures are recorded against the total estimated cost o f each project also undermines realistic expenditure planning and execution. Also, procedures for project identification, appraisal and approval were lacking-external ly financed projects are subject to more rigorous selection and appraisal than domestically financed projects. These procedures are also not fully integrated within the M T B P procedures for program expenditure and investment planning.

89. The Government has taken several actions to redress the situation. First, in late 2005, i t transferred the responsibility for Public Investment Management (PIM) f rom the Ministry o f Economy to the Ministry o f Finance, where a new Department for Public Investment Management (DPIM) has been established in the General Directorate o f Budget. This decision reflects a comprehensive and integrated approach to overall budgeting and planning which has been laclung so far. The newly established DPIM i s now operational but with only three staff in place. Second, an action plan for P I M improvement has been prepared by the department and approved by the Council o f Ministers.23 Third, the M o F has

*’ This section draws heavily on the Bank’s 2006 reports: the PEIR [Albania: A Public Expenditure and Institutional Review, Report Number 36453-AL]; the CFA [Albania: Country Fiduciary Assessment]; and the PEFA [Albania: Public Expenditure and Financial Accountabil ity Assessment]. 23 The action p lan has four objectives: (i) strengthening the institutional arrangements for publ ic investment management, including the staffing o f the D P I M and establishment o f working rules and relationships with l ine ministries and agencies; (ii) improving procedures for public investment cycle management. This includes the introduction o f instructions by the Ministry o f Finance to identify, formulate, and appraise and approve investment

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prepared interim PIM procedures that it has applied during the preparation o f the supplementary budget 2006 and budget 2007. I t i s also finalizing the new full P I M procedures for the 2008 budget. In 2006, as part o f the M T B P process, most ministr ies submitted public investment requests that demonstrate relevance to sector priorities and display full cost information. The D P I M i s also in the process of revamping the public investment projects register that was developed as a part o f the earlier PRSC program but has since been neglected, to capture all public investment projects. All this has been closely supported by the DFID/SIDA/Dutch financed technical assistance, and the Bank’s P E R .

90. The DPO program aims to support strengthening o f public investment management. This would include the consideration o f a l l projects in a common fiscal framework with the use o f rigorous procedures to evaluate a l l investment projects regardless o f source o f financing (debt, concessional lending or current revenue). A strengthened D P I M could, in time, play a key role in the Ministry of Finance’s clearances o f potential public-private partnerships (PPPs), including assessment o f future or contingent liabilities and evaluation o f fiscal costs.

91. The government also aims to strengthen evidence-based policy-making. The government has started the preparation o f the design o f the Integrated Planning System Information System (PSIS), under the umbrella o f the IPS. The hub o f the system will be hosted by the Department o f Strategy and Donor Coordination (DSDC), and wil l be fed by individual systems in different agencies that are consistent with the overall design. The approach wil l be modular, focusing init ially o n high priority information needs that wi l l help to improve the quality o f decision-making.

92. Actions supported by DPO1:

Take a series o f measures aimed at improving Public Investment Management V I M ) procedures and practices.24

Start preparation o f design o f the Integrated Planning System Information System (PSIS).

93. Under subsequent DPOs, this agenda wil l be furthered by: (i) formally adopting full P I M procedures and issuing a P I M procedures manual for project identification, appraisal and approval, and implementing the procedures and practices mandated by that manual; (ii) progressive rolling-out of appraisal procedures for al l investment projects; (iii) ensuring that a l l ministries submit public investment proposals in full compliance with the Budget preparation instructions; (iv) starting the design and implementation o f an electronic register o f projects and establishing link with the new Treasury System; and (v) undertaking quarterly reporting under P S I S , set against Ministry monitoring plans.

projects using objective and transparent criteria; (iii) upgrading the information systems for recording, monitoring and reporting on public investment and i t s integration with IPS information systems; and (iv) consolidating human resources and capacities o f staff at M o F and line agencies dealing with public investment management.

These include: (i) M o F prepares instructions for the P I M procedure that i s applicable to both domestic and foreign financed investment projects; (ii) al l new public investment requests for 2006 Supplementary budget use the new ‘Project Investment Identif ication Form’; (iii) at least four l ine ministries submit public investment proposals through full version o f M T B P Expenditure Request; (iv) start inventory and establish electronic register o f a l l publ ic investment projects, in wh ich summary project details and financing requirements are recorded. Any changes to the l i s t o f projects approved by the Counci l o f Ministers (COM) should only include: a) projects started in 2006 but not included in the budget 2007 proposals; b) new projects opened in December 2006 for wh ich disbursements have started in 2006; and c) any other project in l ine with the M T B P 2007-2009. All changes in appropriations shall remain within the l i m i t s defined in line with the Organic Budget Law. In 2008, the new full P I M procedures to be issued with the new Budget preparation instruction shall be applied.

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94. Expected results:

A systematic recording o f and a progressive increase in the fi-action o f new public investment projects prepared and approved according to the new full Public Investment Management (PIM) procedures, reaching 100 percent by D P 0 3 .

Continuously improving grouping and classification o f public investment projects according to P I M procedures, measured by a gradual increase in the median size o f projects over time.*’

Progressive increase in the fraction o f projects with full cost estimates registered in the MTBP software, reaching full coverage by DP03, and yearly expenditures fully tracked through Treasury system software.

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a (ii) Improve efficiency and transparency in resource utilization

95. Improving efficiency and transparency in resource utilization under the overall umbrella o f the I P S would require: (i) devising new rules and regulations for budget preparation, execution, monitoring and evaluation as set out in the Organic Budget L a w (OBL); (ii) continuing and completing the set up o f the N e w Treasury System; and (iii) amending the Public Procurement L a w (PPL).

96. The existing Organic Budget Law (OBL) does not support a contestable and strategic budgeting process. The MoF, with the support o f a multi-donor project for Strengthening Public Expenditure Management (SPEM), has been introducing new procedures and processes for better linking policies and programs with budgets. Whi le the existing OBL provides a general framework that can accommodate the M T B P process and timetable, i t does not elaborate on the requirements o f a strategic budgeting process, especially the effective linking o f pol icy and programs with the budget, or using the M T B P as the basis for determining inter-sectoral and intra-sectoral resource allocations. It also does not require monitoring the performance o f programs financed by the budget against these objectives, and does not provide the National Assembly with a significant role and responsibility for ensuring budget oversight and improving the accountability o f the executive for the management and execution o f budgetary resources. Similarly, the Treasury regulations have become outdated and are no longer compatible with the new business practices being introduced under the new Treasury Modernization Program. The M o F has initiated a process o f revision o f the OBL, primarily to reflect better the new procedures underlying the MTBP and annual budget processes and the new treasury management procedures, and to establish a stronger role for the Assembly in the policy and planning process.

97. Continuing treasury system reform i s an important priority. M o F has been modernizing the treasury system through the Wor ld Bank funded Public Administration Reform Project (PARP). Good progress has been made towards the implementation o f Treasury computerization, in the direct recording o f tax receipts into the Treasury and in developing the Treasury General Ledger. As o f January 2007, the central Treasury system i s functioning with a GFS compatible budget classification and chart o f accounts. I t i s particularly important that the Treasury system connect to the new Human Resources Management Information System (HRMIS). W h i l e the main element, i.e. the connection between the employee r o l l and payroll i s established, so far only 1600 out o f 83000 records have been entered into the system. Another key weakness remains the coverage and quality o f budget reporting. The reporting o f expenditures on externally financed projects i s particularly inadequate, as the majority o f grant- financed investment projects are s t i l l not recorded in government accounts.

25 The criteria for regrouping and reclassification include: a) identif ication and reclassification o f maintenance spending; b) consolidation o f related construction and engineering works into single investment projects; and c) closing dormant projects.

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98. The procurement process suffered from serious deficiencies. Many weaknesses related to implementation o f the law. Shortcomings identified in the Bank’s Country Fiduciary Assessment (CFA) (2006) included attempts at high levels o f government to bypass the law, and lack o f capacity in both the public procurement agency and the implementing ministries. Excessive use o f direct procurement was continuing for several reasons-weakness in the law, the unavailability o f funds until late in the year, and attempts by procuring entities to break up procurement into small values. The public procurement agency (PPA) has n o reliable data on the use o f noncompetitive methods or the use o f open tendering. A public procurement information system does not as yet exist. The complaints review mechanism was inadequate; as a result, private sector confidence in the Albanian public procurement system i s low. As in the case o f concessions, procurement reform i s critical for the overall reform program o f the government, and i s vital for improving efficiency and transparency in the use o f government resources.

99. A new Public Procurement Law (PPL) has been enacted to rectify existing weaknesses. The Public Procurement Agency (PPA) has been involved in revising the public procurement law to make it more transparent and effective and compatible with EU standards and international best practice.26 In November 2006, Parliament enacted a new PPL as part o f i t s DPO-supported reform program, and this became effective as o f January 1, 2007. Among key changes that the new public procurement l aw has mandated are: i) establishing improved complaints review; ii) granting c iv i l servant status to the head o f the PPA; iii) making open tenders the default procedure and specifying conditions under which direct procurement will be allowed; iv) allowing multi-year contracting to a wider range o f ministr ies and agencies; and v) publishing o f bidding documents and award results o n the PPA website on a timely basis. The Government has already begun implementation o f the new law, and has issued implementing regulations and made the head o f the PPA a c iv i l servant. Since July 2006, the PPA has been publishing an online bulletin with information on tenders and award results. Whi le recognizing major improvements in the law, the Bank has some ongoing concerns, including overlapping review functions between the PPA and the new ‘Public Procurement Advocate’, Also, i t s new mandate to review concessions needs the timely establishment o f a separate and staffed-up concessions unit within the PPA. These and any other emerging concerns would be addressed in subsequent DPOs.

100. Actions supported by DPO1:

Government prepares draft and begins consultations on new Organic Budget Law.

Enact the new Public Procurement Law that incorporates, inter alia: improved complaints review, makes open tenders the default procedure, grants c i v i l servant status to head o f PPA, increases applicability o f multi-year contracting, and mandates publishing of tender documents and outcomes o n a timely basis.

Start implementation o f segments o f the procurement law, including publishing tender notices and award results on a website.

101. Under subsequent DPOs, this agenda will be furthered by: (i) enacting the new Organic Budget L a w and undertaking a phased implementation o f the Law, including issuing implementing regulations; (ii) full implementation o f the new Treasury System (initially without payroll module and later with the module) at M o F and al l 35 regional/district Treasury Offices for budget execution and reporting,*’ and

26 The EU, through the CARDS program, has been providing technical support to the revision o f the public procurement l aw and upgrading o f the P P A website. Since the latter part o f 2006, this work i s being continued under the aegis o f the US Mi l l enn ium Challenge Account.

This would include the fol lowing actions: 21

Appoint required number o f qualif ied IT staff in MoF, DOPA and CoM. Finalize a l l hardware generalization and software parameterization activities according to schedule.

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(iii) full implementation o f the amended public procurement law. They would also support the review o f implementation experience o f the new public procurement l a w and subsequent incorporation o f these and other concerns into any required amendments to the law.

102. Expected results: 0 Statements o f Revenue and Expenditure for a l l spending unit are produced and published

online every month by DP03 ,

PEFA Indicator on stock and monitoring o f expenditure payment arrears has improved (PEFA Indicator 4 improves from D to B) by DP03 .

Consolidated Financial Statement for General Government produced and published annually

PEFA Indicator o n public procurement has improved f rom D+ to grade B by the end o f DP03.28

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b) Improve efficiency and continue de-politicization of public administration

103. Albania has made significant progress in the public administration reform agenda. Having an effective and stable c i v i l service system i s the most critical foundation for efficient public service delivery. In the past five years, Albania has taken several steps aimed at establishing a more depoliticized c iv i l service, establishing independent checks and balances mechanisms for c iv i l service management actions, and increasing the attractiveness o f the c iv i l service. Thus, a new C iv i l Service L a w (CSL) was enacted in 1999, a cadre o f c iv i l servants was recruited into senior management and specialist positions, and a C iv i l Service Commission (CSC) was established. Moreover, empirical evidence on the management o f c iv i l servants suggests that progress was being made o n creating a depoliticized, meritocratically managed c i v i l service (CS). Over the 2000-2003 period, quarterly turnover rates o f c i v i l servants averaged 2.7 percent, about one-fourth the 11.7 percent level o f quarterly turnover rates o f political appointees.

104. The law i s facing challenges which have tested its resilience. The change in ruling parties following the 2005 elections has posed a serious test to the depth and resilience o f these reforms. Some measure o f friction i s to be expected with any change o f government, especially in a country with no long-standing traditions o f a professional c iv i l service. However, developments o n three major fronts have hampered the depoliticization o f the c iv i l service and strained the credibility o f the law: (i) the restructuring and retrenchments, mostly affecting the c iv i l service; (ii) an increase in the resort to contract filling o f vacant c iv i l service positions; and (iii) the appeals o f retrenched civil servants to the C iv i l Service Commission (CSC) and the latter's rulings on those appeals.29 Additionally, the restructuring effort has highlighted important weaknesses in the implementation o f the CS L a w and i ts subsidiary

PEFA indicator o n procurement addresses a) the use o f open competition, b) extent o f justif ication o f less competitive procurement methods, and c) existence and operation o f a procurement complaint mechanism.

Thus, between January and April 2006, c i v i l servants constituted 80 percent o f the overall reduction o f 615 in the number o f employees, while c i v i l servants constituted only 3.4 percent o f a l l publ ic administration employment. The 2006 Annual Report o f the C i v i l Service Commission to Parliament provides more recent statistics on appeals. In 2006, there were 737 appeals to the CSC, compared to 337 in 2005. In 2006, the CSC decided o n 702 cases, and accepted 68 percent o f them. Subsequent appeals have been made by the c i v i l servants as we l l as the administration to the Court o f Appeals o f Tirana. O f the 52 central government c i v i l servant cases-the only ones that the Department o f Personnel Administration administers-that were appealed to this Court, the government institutions w o n in 10 cases; o f the other 42 verdicts in favor o f the c i v i l servants, the government settled with the c i v i l servant in 5 cases, has challenged the verdict in the Supreme Court in 26 cases, and fo l lowing up in the remaining 11 cases.

Finalize the national communication network for Treasury operations according to schedule. 28

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legislation, particularly in the annual performance appraisal process for c iv i l servants. Also, the slow progress in the completion o f the HRMIS (human resource management information system), that contains payroll and personnel information, will constrain the envisaged reform in salary structures, and requires strong political and organizational support and a big training effort to put it back o n track.

105. Nonetheless, setbacks on depoliticization are to be expected. Establishing meritocratic, rather than politicized, human resource management practices i s never easy, and i s rarely accomplished without some setbacks. Changes in polit ical leadership that fo l low the establishment o f due process protections for c iv i l servants almost inevitably lead to concerns about whether c iv i l servants confirmed by the previous polit ical leadership were really confirmed based o n merit or on polit ical loyalty grounds. Given such concerns, some backsliding on enforcement o f due process protection i s probably unavoidable, albeit troubling. The challenge i s to prevent such backsliding f rom being so large that it leads to a cycle o f increasing backsliding with each change o f polit ical leadership. Successful c iv i l service reforms typically exhibit a pattern o f decreasing amplitude o f such backsliding fo l lowing changes in polit ical leader~hip.~'

106. The reform agenda largely involves getting back on track. Given these challenges, the proposed DPO will support the public administration reform program by including measures aimed at safeguarding progress made so far and ensuring improved compliance with the procedures and codes associated with the C iv i l Service Law. In addition, i t will support efforts to improve the annual performance review process, essential for meritocratic management o f the c iv i l service. Also, to improve pay and establishment control beyond the c iv i l service, and provide basic institutional infrastructure required for more effective and fiscally sound management o f human resources throughout Albania's public administration, the reform program will support completion o f the ongoing development o f a Human Resource Management Information System. This will encompass the entire central administration and be linked to the Treasury system being developed simultaneously. Finally, the program will support the rationalization o f the executive (subordinate institutions), where there i s great room for efficiency gains.

107. Actions supported by DPO1:

The Government provides evidence, satisfactory to IDA, o f consistency of specific personnel actions falling within the scope o f the Civil Service Law (CSL), its subsidiary legislation and rules regulating human resource management of civil servants in central government. These actions are: a) following due process on dismissals o f personnel; b) identifying al l temporary hiring, with the intention o f reducing the incidence of this phenomenon; c) reducing turnover; and d) improving evaluation process outcomes.

108. Under subsequent DPOs, this agenda wil l be furthered by: (i) demonstrating continued improvement in implementing the CSL consistent with i t s underlying objectives; (ii) establishing a mechanism to monitor, first, central government c iv i l servants, and later, a l l personnel cases related to dismissals that are adjudicated by the C iv i l Service Commission and/or other courts o f appeal; (iii) government undertaking a comprehensive review o f the C S L and i t s implementation; (iv) determining, on the basis o f this review and the buy-in o f all-stakeholder, whether the law needs to be amended and i t s coverage expanded; (v) ensuring that the c iv i l servants annual performance review process leads to more

30 When the Uni ted States, for instance, enacted i t s first c i v i l service law, the Pendleton A c t (1883), i t s application was gradually extended to additional sets o f personnel. Those extensions more often than not occurred immediately after a change in poli t ical leadership, and apparently allowed new Administrations to incorporate a modest number o f their appointees into the coverage o f the Pendleton Act's due process protections. The scope o f such backsliding was, however, limited and tended to s h r i n k over the years.

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accurate evaluations o f performance; (vi) HRMIS becoming fully operational; (vii) adopting policy criteria and an institutional framework for rationalization o f executive (subordinate) institutions.

109. Expected results (with the recognition that c iv i l service reform i s a long-term process, and while the long-run direction o f reform could be positive, there could be short-term fluctuations in reform indicators. The DPO program should therefore be judged on i t s long-run impact, and not necessarily on possible temporary setbacks in the reform process):

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Sustained reduction in CS quarterly turnover rates to their pre-2006 levels; i.e., 2.7 percent.

Decline in incidence o f temporary hiring in civil service positions.

Compliance with processes la id out in the CS law regarding appeals and decisions o f CSC, particularly in cases o f dismissals.

Reduction in the fraction o f CS staff receiving the top two performance ratings.

b) Strengthening local finance

1 10. Much progress has been made since 2000. Strengthening intergovernmental fiscal relations and local government finances constitute a key part o f the broader public expenditure management reform agenda aimed at improved governance and service delivery at the local level. Since 2000, Albania has taken steps to establish the basic institutions and elements o f the legal framework needed to advance fiscal decentralization. These actions have included: (i) enactment o f a fi-amework l aw on local government (Law 8652 o f 2000) defining, in broad terms, the functions, revenues, and administrative organization o f local governments; (ii) adoption o f a Policy Paper which established principles for assignment o f specific responsibilities on shared functions (including education, health, and social assistance), and delineated an action plan for setting minimum standards o f services and criteria for measuring local government performance on service delivery; (iii) the establishment o f a provisional formula-based system for distributing non-conditional recurrent transfers (partially replacing a complex system o f conditional, earmarked transfers); and (iv) the an expansion o f local government taxes to include a local small business tax, the simplified prof i t tax, and taxes on property transfer and motor vehicles. In addition, the Government took a decision to shift investment in primary education and primary health care to local governments, on a conditional b lock grant basis, effective January 2005.

11 1. However, the system of local government finance still suffers from several problems. The f i rs t i s the absence o f a stable mechanism for determining the overall level o f central government transfers to local government. At present, the level o f general, non-conditional transfers i s largely determined on the basis o f the previous year’s allocation, adjusted on the margin though annual bargaining. The second i s the excessive complexity o f the system used to distribute the transfer^.^' The third i s the lack of rules and regulations governing local borrowing or providing for the resolution o f local insolvencies. The fourth i s the non-transparent and fragmented local budgeting process.32 Local budgets lack predictability, and their fiscal reporting system i s not comprehensive or transparent. This situation has negatively impacted fiscal autonomy, transparency and accountability o f local governance.

This includes the particular risk that the Government’s recent decision to al low local governments to administer certain local taxes wil l undermine the formula’s fiscal equalization component. 32 There are several deficiencies in the local budgeting process in Albania: (i) the preparation process i s insufficiently strategic, and not l inked to the M T B P process; (ii) local governments prepare two (rather than one) detailed budgets each year; (iii) the timetable for preparation o f local budgets does not satisfy good public financial management principles, since local governments do not receive f inal approval o f their budgets until the end of M a r c h or even April; and (iv) Treasury Procedures undermine the Local Budget Process since conditional transfers f r o m the State budget are not recorded as part o f the local budget revenuesifinancing.

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112. To strengthen local government finances, the program o f the Government calls for continuation o f the reform measures already started, including the introduction o f a transparent mechanism for determining the level and distribution o f intergovernmental transfers; new legislation governing municipal debt and insolvency; and the introduction o f a distinct, comprehensive, transparent and accountable local budget process.33 This program, which continues f rom the foundation built with the support o f the earlier PRSCs, i s being supported by an ongoing IDF grant, and wil l be supported by the programmatic P E R (starting in 2007) which i s expected to focus on local government finances.

113. Actions supported by DPO1:

Complete analytical work to inform formulation o f Local Government Finance (LGF) Law

Prepare draft legislation on local borrowing and insolvency.

Box 3: Indicative Triggers for DP02

These indicative triggers agreed at negotiations o f D P O l wil l be reviewed at the time o f preparation o f D P 0 2 and an agreed specification o f prior actions wil l be done at that time:

Review o f implementation experience to date, especially until stage o f selection o f winners, and amend Concessions Law, as necessary, and satisfactory to IDA, based on this review as wel l as concerns identif ied at the time o f D P O 1.

Adopt a regulatory management system for improving quality o f new and existing regulations, and i t s satisfactory implementation; and satisfactory implementation o f streamlining in regulatory regimes for licensing and inspections.

Launch satisfactory enforcement o f required corrective actions for insurance as determined f rom the comprehensive examination, especially o n "reinsurance contracts" and "claims administration."

Enact and start implementation o f health care and health finance laws satisfactory to IDA.

Prepare and adopt satisfactory water sector po l icy options paper as outl ined in DPO1.

Transfer water assets for at least 5 water utilities to local governments. Af ter transferring the assets, sign new performance based agreement between Central Government, Local Government Units and Ut i l i t i es for at least 5 utilities.

Make progress satisfactory to IDA o n improved P I M procedures (including development o f manual and adoption o f procedures by Strategic Planning Committee), as we l l as practices.

Enact the new Organic Budget Law.

Review implementation o f public procurement l aw including i t s mechanisms for dealing with complaints, administrative review, and judicial review. Amend the law, as necessary, satisfactory to IDA, based o n this review as we l l as concerns identif ied at the time o f the previous DPO.

Continue successful implementation o f the C iv i l Service Law, focusing especially o n addressing issues o f turnover, temporary h i r ing and fol lowing due process on dismissals o f personnel.

Establish mechanism to monitor dismissals o f c i v i l servants in central government that are adjudicated by the Civil Service Commission and/or other courts o f appeal.

Currently, the Local Government Budget L a w (Law # 7776/93) i s neither aligned with the Organic L a w o n Organization and Functioning o f Local Self-Government (#8652/2000), nor with the Organic Budget L a w (#8379/98).

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114. Subsequent DPOs wil l support the implementation o f these measures. Measures may include: the enactment o f the law on municipal borrowing and insolvency and a l aw o n local government finance, and the drafting o f regulation and establishment o f administration arrangements to ensure that they are implemented successfully. The specifics and breadth o f the actions supported by future DPOs may be redefined, depending on the findings o f the work supported by the IDF grant and the forthcoming programmatic P E R

115. Expected results:

Progress towards putting in place an inter-governmental transfer system, debt controls, and reforms in financial management and reporting, to ensure sustainable local investments-as the key steps towards the goal o f a stable, transparent, and macro-economically sustainable system for financing the services provided by local governments.

VI. UNDERPINNINGS OF THE OPERATION

A. COLLABORATION WITH THE IMF AND OTHER DONORS

116. The Bank maintains close working contacts with the IMF for the purposes o f harmonizing pol icy recommendations, seeking synergies among the respective operations, and avoiding overlaps. The IMF’s pol icy dialogue with the Government takes place in the context o f the ongoing three-year Poverty Reduction and Growth Facil ity (PRGF) and Extended Arrangement (EA) in the amount o f SDR 17.045 mill ion, initiated in February 2006. The second review under the current Arrangements was completed in February 2007. The DPO has been prepared in conjunction with the PRGF/EA to ensure the consistency o f the macroeconomic and structural policy reforms supported by both programs. The IMF i s tahng the lead on macroeconomic issues while the Bank takes the lead on structural and social issues. In a number o f areas where the mandates o f the two institutions overlap, such as public finance, and public financial management, the work i s being closely coordinated to ensure that consistent advice i s provided to the authorities. The existence o f an IMF program i s an important input for the determination o f the adequacy o f the macroeconomic pol icy framework.

117. Consultation and coordination with other donors i s regular, given their critical role in supporting the implementation o f the NSSED and DPO program agenda (see Annex 9). Several donors are active in the broader area o f governance, but in the more narrowly defined area o f public administration reform, the Wor ld Bank and the E C have the most comprehensive engagement. DFID (recently joined by S IDA and the Netherlands) has been an active development partner in public expenditure management, while the E C and, more recently, USAID, and have been focusing on supporting procurement system reform. The E C provides support in the areas o f pay reform and development o f a performance-based c iv i l service evaluation system. U N D P has been active in supporting improvements in information management in government. Moreover, the Bank has taken the lead in orchestrating a Multi-Donor Trust Fund (MDTF) to support the Government’s efforts to coordinate and better manage i t s major strategies, through i t s Integrated Planning System. The MTDF i s expected to be finalized during FY07. The Bank also coordinates with U S A I D on the broader decentralization agenda, in partnership with the Urban Institute.

11 8. Support to reforming the business environment and the financial sector i s provided by the Swiss Government, EC, SIDA, and USAID. SIDA, the OSCE, the E C and Japan are key partners on land administration and management reform. Tax administration and reform i s being supported by the Millenium Challenge Account and the IMF. In the health sector, other key agencies involved include

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USAID,34 the Swiss Development Cooperation, and In the water sector, the proposed measures fol low ongoing consultation with key donors such as Kreditanstalt fur Wiederaufbau (KfW), European Investment Bank and Islamic Development Bank, and various bilateral donors including Austria, Italy, Luxembourg, and Norway. The GOA has received a PHRD grant f rom the Government o f Japan for the preparation o f the DPO program.

B. RELATIONSHIP To OTHER BANK OPERATIONS

1 19. Policy-based lending to Albania’s economic and institutional reform program since 200 1 has been carried out through a series o f three Poverty Reduction Support Credits (PRSCs), the first o f which was approved in June 2002, and the third in December 2004. Many o f the key reforms to be supported under the DPO represent a continuation o f the reforms under the PRSCs, namely, promoting sustainable growth and private sector development, supporting sectoral reforms to improve the delivery o f social services, improving the transparency and accountability o f public expenditure management, depoliticizing the c iv i l service and building an accountable public administration.

120. The recently approved Business Environment Reform and Institutional Strengthening (BERIS) Project will assist the government in the area o f improving the business environment. It will, inter alia, support the developing o f a regulatory reform strategy, building institutional capacity for deregulation, and introducing a methodology o f Regulatory Impact Assessments (RIAs) to in form regulatory reform. Improvement in land tenure and security o f property rights will be supported by the Land Administration and Management Project, which will provide technical assistance for completing land registration, reforming the system o f property taxation and adopting and implementing the Urban Planning Law. Also, while not a part o f the DPO program, the Bank Group’s extensive interventions in the energy sector are providing support to help Albania address a critical constraint to business operations.

121. The Bank also supports a number o f activities aimed at improving the efficiency and accountability o f public sector resource use. The Public Administration Reform Project (PARP- 200 1) which closed on December lSth, 2006 has contributed to the computerization o f the Treasury System and the introduction o f the payroll module, which aim at improving budget reporting and execution. The IDF grant for fiscal decentralization (2004) follows up on the Fiscal Decentralization Study (2003) to assist the Government in developing key legislations that govern local government finances and local borrowing.

122. Bank operations have also focused on improving resource use in specific sectors. The DPO supports the ongoing Health Sector Modernization Project, which focuses on improvements in primary health care delivery, health financing and health sector governance and management. New health financing and health care legislation will institutionalize the legal framework that i s necessary to realize this project’s development objectives. At the same time, the DPO i s being supported by the IDF Grant for Health Governance and Financial Accountability Framework, which wil l help to identify and resolve discrepancies between the health care laws, health financing legislation and the overall governance and

U S A I D i s currently implementing a program with key interventions which are related to health care financing and systems strengthening, health information systems, and improved PHC service delivery and access in 5 prefectures. SDC i s f inalizing a new work program which wil l focus o n establishing a Center o f Continuing Education for the health sector (subject to f inal approval). WHO will address health financing, performance management, and stewardship o f the health sector.

The Bank has been designated to lead donor coordination in the area o f socio-economic development, in close cooperation with the Government, and shares this role with WHO in the health sector, offering the opportunity for general donor agreement o n the overall strategy and the potential for more sector-wide approaches in the future.

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accountability framework in the health sector. The recently approved Albania Transport Project will provide support to the enhancement in the quality o f public investment management. also represents road transport project represents

123. The DPO complements the two active projects in the water sector (The Municipal Water and Wastewater Project (MWWP) and the Integrated Water and Ecosystem Management Project ) as the incentives created in the four ut i l i t ies in the M W W P to improve their performance can now be scaled up to the national level (to 54 utilities), using budgetary investment resources. In addition, measures to mitigate the impact o f tar i f f increases on poor customers piloted under the MWWP can inform further tar i f f increases at the national level and the design o f targeted subsidies.

C. LESSONS LEARNED

124. A Country Assistance Evaluation (2005)36 reviewed the Bank’s assistance program from FY98 to FY04. I t recommended, inter alia, that the Bank should move to an outcome-oriented approach in project design, establish monitorable and realistic targets for those outcomes, and increase selectivity in i t s interventions. All these and several other themes were echoed by the recent I C R on the PRSCs (a series o f three operations over 2002-04), which have direct relevance for the proposed DPOs, and are summarized below:

125. Complementarity with investment operations should continue to be pursued. The twinning o f investment and policy-based operations worked wel l in the PRSCs. In a country with limited capacity, the investment operations provide the capacity building, transfer o f resources, and implementation support, while the PRSC provides the impetus to the cross-cutting and policy agenda. The lack o f investment operations was one reason for slow progress in some areas such as the business environment. Accordingly, the broader pol icy and institutional reform efforts supported by the D P O are being complemented by ongoing investment projects for public administration reform (closed 15 December 2006), health modernization, business environment enhancement, water sector reform, and land management.

126. Conditionality should be focused, and adequate attention should be paid to quantifiable monitoring indicators. Given capacity bottlenecks, and the fact that conditionality cannot be substituted for ownership, conditionality should be strategically focused. Focused conditionality also helps in devising a set o f monitoring indicators that are strongly l inked to pol icy actions and are quantifiable.

127. Given the long-term nature of the development agenda, institutional development i s slow and incremental, and policy reforms need to be persisted with. The proposed DPO series thus supports a continuation o f reforms supported by the PRSCs, as mentioned above.

128. Analytical work should continue through the program. The PRSC program was informed by a strong foundation o f analytical work at the start o f the program, but gaps had emerged in some areas, such as in health and in the business environment. The proposed D P O series wi l l continue analytical work through the program (see section D below).

Albania: Country Assistance Evaluation (March 2005), Independent Evaluation Group. 36

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Box 4: Good Practice Principles on Conditionality

Principle 1: Reinforce Ownership

The proposed operation i s based o n the PRSP, the National Strategy for Social and Economic Development (NSSED), and supports the newly created Integrated Planning System (IPS), which seeks to integrate different pol icy frameworks into one unified framework, the National Strategy for Development and Integration (NSDI). By supporting the N S D I and the IPS, the new Government (the erstwhile opposition) that took office in September 2005 has demonstrated i t s commitment to continue and strengthen the PRSP process. Albania’s success with the previous PRSC program demonstrates a track record o f success with earlier budget-support operations. Also, a jo in t Government-Bank workshop o n the process and content for the future D P O program, in early 2006, demonstrated significant Government ownership for the reform process. Such commitment was reinforced in another j o in t workshop, this time on governance, in January 2007. Finally, the Government has been very keen to learn f rom recent analytical work such as the Bank’s PEIR, the Social Insurance Review, the Country Fiduciary Assessment, and the Health Policy Note, and has incorporated some o f the pol icy advice into i t s D P O program.

Principle 2: Agree up front with the government and otherfinancial partners on a coordinated accountability framework

The Government’s D P O program i s summarized in an agreed pol icy matrix in Annex 3, and in a results matr ix in Annex 4. The D S D C has assigned responsibility for monitoring each agreed indicator to relevant government agencies. The D S D C i s itself in charge o f coordinating and developing further the Government’s capacity to conduct evidence- based policy-making through the IPS Information System-an area supported by the proposed DPO. The Bank works closely with other donors in an environment where a id coordination i s fair ly effective. The Government, through the DSDC, i s also taking increasing ownership o f the aid coordination process, which should help to further improve aid effectiveness.

Principle 3: Customize the accountability framework and modalities of Bank support to country circumstances

The new Government came to power on the back o f a strong anti-corruption campaign, and has welcomed Bank support in areas, among others, that wil l strengthen i t s efforts against corruption. Recent Bank analytical work (CFA, PEIR, I C R for the PRSCs, PEFA) as wel l as the work done for the 2006 CAS demonstrated the crit ical importance o f strengthening governance in Albania-hence the development o f the CAS ‘governance pil lar. ’ Thus, the Government has welcomed support for crucial areas o f governance that are part o f the proposed DPO-such as reforms in the concessions and procurement laws, public financial management, c i v i l service management, and so on. In other areas where there could be distributional impacts (such as in reforms in water, health, pensions), the Bank i s supporting the Government in evaluating the l ike ly impact and in proposing mitigating measures. The proposed D P O series i s being set up as three single-tranche operations, to be disbursed according to the pace o f reforms set out in the pol icy matrix.

Principle 4: Choose only actions critical for achieving results as conditions for disbursement

The proposed D P O l operation consists o f 7 prior actions and 8 benchmarks, while the currently foreseen l i s t o f triggers for D P 0 2 consists o f 11 actions. Al l these are part o f the agreed framework set out in the pol icy matrix and the results matrix.

Principle 5: Conduct transparent progress reviews conducive to predictable andperformance-basedfinancial support

As the D S D C become more effective in coordinating the agreed DPO policy reform matrix, i t wil l be able to better manage and predict the f l ow o f D P O resources. D P O resource flows are dependent o n the pace o f agreed pol icy reforms and progress towards meeting agreed outcome targets. The proposed D P O l lending volume has been taken into account, for example, in the Government’s 2007 macroeconomic framework, given the expectation that the momentum o f pol icy reforms wil l enable the approval o f D P O l well before June 2007 and the disbursement o f funds soon thereafter.

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D. ANALYTICAL UNDERPINNINGS

129. The proposed DPO series rests on a wide program o f analytic work carried out by the Government, the Bank and other donors that have helped inform the design o f the DPO. The Albania Country Economic Memorandum (2004) and Poverty Assessment Update (2006) provide in-depth analysis and recommendations related to growth and poverty reduction in support o f the implementation o f the NSSED. They will also serve to inform the design o f the National Strategy for Development and Integration. The CEM, the ARCS Surveys and the BEEPS (2005), supplemented by the Bank’s annual Doing Business reports, provide a detailed analysis o f the business environment, providing recommendations to reduce regulatory and administrative costs. The 2005 FSAP focused on bank regulation and supervision, and issues o f governance in the non-bank financial sector. A number o f important analytical studies which wil l begin this fiscal year (Access to Credit Review) and next fiscal year (Investment Climate Assessment) are likely to provide recommendations which could be incorporated into following DPOs. Poverty and Social Impact Analysis will inform the design o f water tar i f f reforms and subsidy schemes to mitigate their impact on the poor. Also, programmatic work on the Public Expenditure and Institutional Review (PEIR) will continue to in form future DPOs as necessary.

130. The PEIR (2006) examined public expenditures in the social sectors - education, health, social assistance and pensions - as wel l as in infrastructure sectors - water, transport and electricity. I t highlights the need to restructure public expenditure composition, both within and across sectors, and outlines the reforms that may be necessary in order to increase efficiency and free public resources for more growth-enhancing spending. The Health Policy Note (2006) and Social Insurance Review (2007) provide recommendations on improved public sector resource use and improved financing mechanisms to achieve better outcomes in health and pensions. Moreover, the Bank’s Country Fiduciary Assessment (CFA, 2006) has focused on the Government’s financial and procurement systems, and has been complemented by a recent Public Expenditure and Financial Accountability Assessment (PEFA, 2006). These studies provide an integrated assessment o f public financial management, the impact o f weaknesses in this area, and recommendations for reform, and have informed the preparation o f the DPO in these areas.

VII. OPERATION IMPLEMENTATION

A. POVERTY AND SOCIAL IMPACTS

131. Some key pol icy measures that wi l l be supported by the DPO are expected to have a distributional impact. Among these are proposed tar i f f increases in water, introduction o f co-payments for drugs, and revisions to the level and coverage o f health insurance and pensions.

132. In the medium-term, the government plans to eliminate central government subsidies to water utilities f rom their current rate o f 0.3 percent (operational subsidies) o f GDP. The action i s expected to reduce the fiscal burden o n central government finances, transfer control o f pricing power to the utilities, generate more revenues, free up resources for critical investments, and improve the efficiency o f the water utilities.

133. At present, there are large disparities in access to water between rural and urban households. While more than 87 percent o f urban households have running water inside their dwellings, only 27 percent o f rural households have such access, while another 25 percent have running water outside their dwelling. Moreover, many households do not pay their water bills, partly because o f administrative inefficiencies and lack o f penalty for non-payment. Furthermore, many water connections to households are not metered, so the utilities use a flat monthly fee for such households regardless o f how much they consume.

However, increased water tariffs could have some adverse distributional consequences.

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Therefore, i t i s expected that impending tar i f f increases and efforts to improve bill collection wi l l have adverse effects o n the poor, especially the rural poor who currently have access and do not pay their bills.

134. A poverty and social impact analysis o f the water sector reforms in 8 cities, conducted by the Wor ld Bank and the U N D P in 2004, showed that tar i f f increases will have adverse consequences on the welfare o f the most vulnerable populations. An on-going PSIA, using the latest household survey, quantifies the welfare loss for three tar i f f options: a) a 20 percent tar i f f increase for a l l consumers, b) a 20 percent tar i f f increase for all, except the poorest quintile, and c) providing for free the first 2.5 cubic meters o f water per household per month, but imposing a flat fee o f 70 LeWcubic meter (estimated to be the cost recovery tar i f f level) thereafter. Scenario c) assumes a long-term horizon where metering i s nearly universal. In reality, i f this were to be done now, only households with meters will get such a benefit. In a l l three scenarios, the estimated welfare losses appear modest, and the estimated water budget shares for al l quintiles also seem to be below the affordability range o f the 3 percent o f expenditures set by EU.

135. T o improve fiscal sustainability o f health financing, the government has introduced co-payments for prescription drugs for al l beneficiaries. Other reforms include a more controlled l i s t o f drugs eligible for coverage. T o minimize the burden o f co-payments and uncovered drugs on their budgets, the poor may be forced either to reduce health care consumption, or substitute away from other consumption, or both, which could lead to adverse welfare consequences. Therefore, there i s need to think o f mitigation measures including the possibility o f raising the benefit levels for the cash transfer program (Ndihma Ekonomike) to compensate poor households for increased health care costs.

136. Proposals to strengthen financial sustainability and effectiveness o f pensions include (a) establishing a truly contributory system which ties benefits to contributions, or (b) abolishing the contributory system and providing o ld age grants to individuals above a certain age. The distributional consequences will depend on how eligibil i ty rules and the benefits levels are defined under each one of the broad reform areas. For instance, i f the system became significantly more contributory than it i s now, there would be a clear need to discontinue the current rural pension scheme where the government pays 85 percent o f contributions, and replace i t with o ld age grants. Providing old age grants to rural residents may lead to wider poverty reduction, depending o n the benefit level, since it i s l ikely to increase coverage. Similarly, the impact on the welfare o f urban populations depends on the menu available on levels o f contributions and age cutoffs for benefits.

137. The Bank i s assisting the government to better assess the distributional consequences of reforms and in design of mitigation mechanisms, though various instruments. With the support of the ongoing Social Services Development Project (SSDP), the Ministry o f Labor and Social Affairs and Equal Opportunities (MOLSA) i s currently reviewing the NE program for: efficiency in targeting the poor; administrative hurdles that discourage the poor f rom participating; and strengthening the monitoring and evaluation system. An ongoing programmatic poverty assessment wi l l continue detailed analytical work o n poverty issues, following the recent updating o f our knowledge base on the size, depth and distribution o f poverty in Albania, and wil l provide or supplement critical PSIA work. The 2008 LSMS and, where possible, interim surveys, will track the poverty impact o f changes in policies, in particular in water, pensions and health. An ongoing programmatic P E R wil l help to assess the fiscal consequences o f mitigation measures. One central question in poverty mitigation i s to assess the potential o f the NE program to serve as the main instrument for alleviating anticipated hardships on the poor f rom ongoing or anticipated reforms in water, health, pensions, and also electricity. The Bank plans to help the Government to lay out the options for establishing a modern, flexible, and efficient NE program that includes an adequate level of fiscally sustainable benefits, as wel l as efficient targeting. I t also plans to help government assess and address, as necessary, any possible short-term distribution effects of the ongoing reforms.

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B. IMPLEMENTATION, MONITORING AND EVALUATION

138. Overall implementation, coordination and monitoring for the proposed DPO program will be done by the Ministry of Finance and the Department of Strategy and Donor Coordination (DSDC). A core Government DPO team was constituted in M a y 2006, co-chaired by the Deputy Minister o f Finance and the Director o f the Department o f Strategy and Donor Coordination. Each sector supported by the DPO i s represented by a senior official o f the relevant ministry/institution. This group meets regularly to discuss strategy and implementation issues, and produces implementation updates which i t shares with the Bank.

139. The Government i s cognizant of the need for monitoring and outcome evaluation. The DPO will support the design and implementation o f the government’s Integrated Planning System Information Systems (PSIS). The DSDC has taken full ownership o f the PSIS. This will help in the evaluation o f the D P O outcomes la id out in Annex 4 o f this document. Specific responsibility for monitoring each outcome indicator i s being assigned to the respective ministries/institutions, under the coordination o f the DSDC.

140. The Bank team will focus on outcomes, taking the evolving situation into account. The first proposed DPO i s being presented to the Board with al l core prior actions having been implemented. At the same time, the policy matrix sets out benchmarks and proposed triggers for future operations. The Bank will focus on these benchmarks and triggers, and take into account evolving country developments and stakeholder support as i t assesses progress towards the impact outcomes o f the program. Necessary adjustments wi l l be made to the future program to take account o f these reviews. Whi le using the inherent f lexibil i ty o f the programmatic DPO instrument, future DPOs, which will also require approval by the Bank’s Board o f Executive Directors, will seek to continue to maintain the momentum o f progress towards the overall outcomes o f the program.

c. FIDUCIARY ASPECTS

Public Financial Management and Procurement

14 1. The 2002 Country Financial Accountability Assessment (CFAA) made several key policy recommendations, including: (i) implement the treasury automation project; (ii) computerize the central employee database with linkage to payroll, (iii) strengthen the cash management function including reconciliation between agent banks, treasury and the Bank o f Albania, (iv) build government capacity to prepare consolidated financial statements; (v) harmonize and integrate accounting and reporting in budget spending entities; (vi) establish internal audit and then develop i t s capacity; (vii) strengthen internal controls including internal controls in Treasury; (viii) strengthen internal audit in the Social Insurance Inst i tute (SII) and introduce a computerized pension and accounting system in districts; (ix) strengthen the Parliamentary commission on Economic, Finance, and Privatization issues; and (x) strengthen the capacity o f the State Supreme Audit institution (SSA) through twinning arrangements. The recent series o f PRSCs has supported most o f these recommendations, with notable achievements including the formation o f the internal audit unit. The recently concluded Public Administration Reform Project (PARP) supported the automated treasury system and the central employee database. The EC has assisted capacity-building for internal audit after i t was formed. I t i s also supporting the init ial stages o f building a Public Internal Financial Control framework in line with EU financial regulations and assisting the supreme audit through twinning arrangements. A continuation o f the twinning arrangement between the SSA and the British National Audit Office has recently been agreed.

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142. The 2001 CPAR also made recommendations in several key areas: (i) continue legislative reforms in procurement; (ii) improve transparency and access to information; (iii) increase competition; (iv) improve procurement practices and procedures; (v) combat corruption and strengthen enforcement; and (vi) build capacity o f institutions and procurement staff. The PRSCs have also supported the development o f the legal framework and the PARP and E C have supported capacity-building in public procurement.

143. A Country Fiduciary Assessment (CFA) covering both financial management and procurement has recently been finalized. The report focuses mainly on procurement but i t includes follow-up to the analytical work in the 2002 CFAA. In parallel, and in conjunction with the PEIR, a broader assessment o f public financial management using the PEFA framework has been prepared, and a report has been delivered to the Government along with the CFA.

144. The PEFA assessment demonstrates that although considerable improvements in the P F M framework, including the legal framework in procurement, have taken place, a number o f weaknesses remain. Both the C F A and the PEIR noted that the budget i s s t i l l not an adequate managerial tool to manage government’s priorities and secure smooth operational performance. The budget i s not implemented as planned owing to unpredictability o f investment spending, and poor cash planning. Other weaknesses identified include lack o f information on grant-funded donor assistance, and significant reallocations during budget implementation, resulting in ad-hoc spending, including in procurement. On the other hand, Albania seems to be doing relatively well on accounting, recording and reporting in the public sector. The Bank intends to work with the government to strengthen budget credibility by improving macro and fiscal forecasting, the budget preparation process (particularly in procurement), and considerably strengthen cash f l ow planning before and during budget execution, in order to set realistic and manageable cash allotment ceilings as wel l as enforce these ceilings. Similarly, the government wi l l exercise discipline in budget execution by committing expenditure based on available resources, and continue to strengthen accountability through the follow-up by Parliament and government on the findings o f the State Supreme Audit institution.

145. Although the existing controls on budget execution are weak, controls on payroll, cash and debt management and reporting would be improved with the implementation and progressive rollout o f an ongoing modernization o f the Treasury system, which has started functioning as o f January 2007.

146. In procurement, the C F A diagnosed that the government has made serious efforts to improve the procurement l aw by preparing implementing regulations and tender documents. However, the application of the law i s s t i l l seriously lacking because o f attempts to bypass the l aw and because o f the lack of capacity in both the Public Procurement Agency (PPA) and the implementing ministries. The PPA has n o reliable data on the use o f noncompetitive methods or the use o f open tendering. A public procurement information system does not yet exist. The complaints review mechanism i s inadequate. The government i s committed to address these weaknesses by passing a new law-an action which i s in fact a core area for support by this proposed DPO. The Mi l lennium Challenge Corporation (MCC) i s now assisting the PPA and the government in furthering reform and implementation.

147. The new Public Procurement L a w (PPL), passed by Parliament o n November 20, 2006, and effective on January 1, 2007, represents Government’s serious efforts to address weaknesses in the earlier law. However, some concerns remain: (i) the complaints review mechanism remains within the PPA, which lacks capacity for such tasks and i s understaffed; (ii) the envisaged role o f the Public Procurement Advocate (instead o f an independent complaints review body) has created an overlap with the tasks o f the PPA; (iii) the new PPL may have become effective too soon, given the lack o f training and coaching o f procuring entities to implement the new law. O n the positive side, the MCC, starting in November 2006, i s helping the PPA with finalization o f Procurement Regulations and Standard Bidding Documents, which

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have been approved by the Council o f Ministers in early January 2007. Initially, the M C C will assist the PPA to prepare the procurement manual and users' guide, develop the IT strategy in line with GOA'S E- government strategy, and prepare a training plan for procurement officials.

148. This proposed DPO also supports improvements in public financial management affecting fiduciary areas and issues identified in the C F A and PEFA assessments. I t supports a new Organic budget law and i t s implementation, that would address a number o f the issues identified. I t also supports a continuation o f the full rollout o f the new treasury system. Other donors are also continuing support in key areas o f P F M including budget management, internal control, internal audit, supreme audit, and procurement.

149. The overall fiduciary risk associated with the government budget system i s considered to be significant, but i s being targeted for improvement by the Government, with support from the Bank and other development partners. Albania's poor ranking in international country surveys on perceptions and control o f corruption; the r isks associated with the public procurement system, suggesting a significant level o f official corruption; the extent o f unreported government operations; the extent o f expenditure arrears; the composition o f expenditure out-turn compared to the original budget; and competition, value for money and control in the procurement system. The government i s committed to improve procurement-related weaknesses with assistance f rom the M C C and the Wor ld Bank. Budget management wil l be improved with support f rom the Bank as wel l as continued support f rom other donors. Finally, consensus has been built among the Government, Wor ld Bank and other development partners that the control o f corruption i s the most pressing governance challenge for Albania-and many o f the actions supported by the proposed DPO will address this issue.

Review of Central Bank and Foreign Exchange Management

150. The IMF's safeguard assessment o f the Bank o f Albania i s favorable. Under the Fund's safeguards assessment policy, the Bank o f Albania (BOA) was subject to a full safeguards assessment with respect to the PRGF arrangement, which was finalized in July 2006. The BOA'S control environment includes a well-defined organizational structure and formalized institutional policies. The B O A has embarked on a program to strengthen the foreign reserves management function. Management o f foreign reserves i s conducted in accordance with approved investment policy. However, the assessment noted some weaknesses in the central bank's safeguards framework. The audited financial statements for the year 2005 had a clean opinion from the auditors. But the IMF was concerned about the quality o f the external audit and the lack o f oversight o f the external and internal audit functions. Seven recommended actions were agreed with the BOA to address these weaknesses. Some progress has been made since the previous assessment in 2002, but certain recommendations have not been fully implemented.

D. DISBURSEMENT AND AUDITING

15 1. Borrower and credit amount: The Borrower i s Albania, represented by the Ministry o f Finance. The proceeds o f the credit wi l l be made available to Albania following the enactment o f the Financing Agreement. This operation i s a single-tranche credit o f US$10 mi l l ion equivalent. The credit proceeds would be made available to the Borrower upon the effectiveness o f the Financing Agreement between the Bank and Albania.

152. Disbursement: Upon approval o f the credit and notification by the Bank o f the effectiveness o f the Financing Agreement between the Bank and Albania, the Borrower will submit a withdrawal application to the International Development Association (IDA). IDA wil l deposit the proceeds of the credit into a foreign currency account designated by the Borrower that forms part o f the Single Treasury Account o f the country and acceptable to IDA, such account to be held at the Bank o f Albania (BOA).

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This account i s available for budget financing and will be managed by and subject to the control o f the MoF. The Borrower will report to the Bank on the amounts deposited in the foreign currency account and conf i rm i t s availability to finance budget expenditures, within 30 days o f receiving such funds.

153. If, after depositing funds in this BOA account, the proceeds o f the credit are used for ineligible purposes as defined in the Credit Agreement, the Bank wil l require the Recipient to either: (i) return that amount to the account for use for eligible purposes; or (ii) refund the amount directly to the Bank, in which case the Bank wil l cancel an equivalent un-disbursed amount o f the credit.

154. Accounts, auditing and closing date: The M o F will be required to maintain accounts and records showing that disbursements f rom the above account were in accordance with the provisions o f the Credit Agreement. Such accounts and records wi l l be maintained in a form acceptable to the Bank.

155. Considering the Bank’s knowledge o f the public finance management systems, the ongoing improvements o f these systems and considering the positive assessment o f the BOA made by IMF, no audit will be necessary o f the deposit account.

156. The closing date o f the credit i s December 3 1, 2007.

E. ENVIRONMENTAL ASPECTS

157. The DPO team has reviewed the likelihood o f possible significant effects o f DPO-supported policies on the environment, natural resources, and forests, and made an assessment o f the government’s systems that may mitigate adverse effects and enhance positive effects. The analysis suggests that there are not l ikely to be any significant effects on the environment, forests and other natural resources. However, three areas o f the proposed operation may require further attention with respect to environmental issues and wil l be taken-up by the team during further discussions with the Government. These are: (i) reducing the regulatory burden; (ii) raising water tariffs; and (iii) introducing cost-benefit analysis in public investment planning.

158. Reducing the regulatory burden. The proposed DPO supports ongoing efforts to reduce the regulatory and administrative costs o f business regulation and promote private sector development. The DPO builds on the Government’s recent Regulatory Reform Act ion Plan, endorsed by the Council o f Ministers, to guide implementation o f reform actions in the next three years. The Act ion Plan includes removing regulatory and administrative barriers through the adoption o f methodologies such as the ‘Guillotine’ and the ‘regulatory impact a s ~ e s s m e n t ’ ~ ~ (RIA), which requires a comprehensive review o f business regulations to help identify those regulations that are unnecessary or without any legal basis. This exercise would also help identify those regulations affecting business entry and operations that do not offer sufficient safeguards with respect to safety, health, environment, consumers and the public interest. A rigorous implementation o f the RIA system would help ensure that environmental matters are taken into account in the preparation o f business regulations. The Business Environment Reform and Institutional Strengthening project i s providing the assistance necessary to implement the Act ion Plan and monitor progress in regulatory reforms.

159. Raising water tariffs. The government, with the support o f the Wor ld Bank, i s implementing a reform o f the existing scheme o f operating subsidies to water utilities, in parallel with an increase in water tariffs, with a view to gradually achieving cost recovery in the sector. The impact o f increased tariffs i s expected to be offset by targeted subsidies to protect poor customers. This measure, by allowing water tariffs to better reflect their real cost, i s aimed at encouraging metered consumers to rationalize water

See section C1 for an elaboration on Guillotine and RIA. 37

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consumption, save water, and use i t more efficiently. The reduction in operating subsidies would also help free public resources to support investments in wastewater collection and wastewater treatment in the medium-term. These investments wi l l have a positive effect on the environment. First, people are l ikely to reduce the usage o f septic tanks which pollute ground water as they connect directly to the wastewater system. Second, with only a small fraction o f collected wastewater being treated in Albania, further investment in wastewater treatment will have a significant positive environmental impact. Third, per capita water consumption will fa l l as the percentage o f metering increases, which will also be beneficial for the environment.

160. In the short-run, however, some negative effect i s possible. I t i s possible that despite the targeted subsidies to protect poor customers f rom rising water tariffs, households move to cheaper and often dirtier water resources (such as hand-dug wells) which would have a negative public health impact. This will be monitored more carefully during program implementation.

16 1. Introducing economic analysis in public investment planning. The proposed DPO series supports strengthening o f the capacity to carry out public investment planning by gradually introducing cost-benefit accounting. While major infrastructure investments may indeed have environmental and social impacts, the rationale for introducing economic analysis to the planning process and into the environment impact assessment procedure i s to assess the broader costs o f any major public investment, including i t s longer term environmental and social costs.

F. RISKS AND RISK MITIGATION

162. Risks of reversal and/or political stalemate. There i s a risk that hard-won gains in the institutional framework, such as c iv i l service reforms, can be at least partially reversed. There are also significant r isks in other areas singled out by the CAS. Political stalemates, especially at times o f local or national elections, can also threaten reform progress as well as passage o f legislation. All these can affect the outcomes o f the DPO program, while also subjecting the Bank to reputational risk. The Bank, as a development institution, needs to confront this risk. At the same time, to reduce such risks, and improved the chances o f positive development outcomes, the proposed f i r s t DPO has singled out strong prior action in these areas, including legal reforms in procurement, concessions, and budgetary management and improved compliance with the c iv i l service law. A two day workshop in early 2006 between the Bank’s DPO team and a senior Government team in Albania also demonstrated significant Government ownership for the reform process; a subsequent workshop on governance between the Bank and the Government demonstrated further commitment to reforms supported by the proposed DPO series.

163. Capacity concerns. While the PRSC program and complementary programs o f donors had helped to build up capacity across a broad spectrum, there i s concern that some o f this improvement has been undermined by the new Government’s management changes in several key agencies (however, at least in taxes and customs, there have been significant improvements in revenue collection despite large- scale changes in staffing). To the extent possible, this concern i s being mitigated by prior action on compliance with the c i v i l service framework, as wel l as capacity enhancement and knowledge generation before and during then D P O program. Thus, as recommended by the PRSC ICR, the proposed DPO i s being twinned with investment operations andor technical assistance in many critical areas, including the business environment project (a lacuna in the PRSC program), a financial sector TA, projects in land, health and water, a governance TA (in keeping with the CAS governance filter approach), and a public administration project (until December 2006). In addition, knowledge products before and during the DPOs include a programmatic public expenditure and institutional review, a social insurance review, a country financial accountability assessment, a PEFA analysis, and a programmatic poverty analysis including a poverty assessment. A PHRD grant to help prepare D P 0 2 has been provided to the Albanian

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authorities by the Japanese government. Finally, development partners’ support in several critical areas will also help shore up capacity.

164. Macroeconomic stability. The macroeconomic framework for 2006-20 10 foresees average annual export growth in euro terms o f about 15 percent per year, which could be diff icult to sustain. The current account deficit i s forecast to decline gradually over the period, f rom about 6.5 percent in 2005 to about 5.3 percent. An increasing part o f this deficit i s expected to be financed by FDI, forecast to increase from 3.3 to 3.8 percent o f GDP. Bo th attracting FDI and sustaining exports will require a significant improvement in the investment climate for the private sector, and are the biggest challenges on the macroeconomic front. The DPO program, along with other Bank operations, seeks to address those issues. An additional concern arises f rom the fast credit growth over the last two years, albeit f rom a very l o w base. However, the banking system i s considered to be well-capitalized, and i s resilient as indicated by recent simulated stress tests. Also, the DPO program, while focusing on the still-small non-bank financial sector, i s also accompanied by a flexible financial sector TA, which can respond to an emerging situation. In addition, Bank staff i s cooperating closely with colleagues in the IMF who keep a close watch on the macroeconomic situation. Finally, periodic recurrence o f electricity crises (as occurred in 2005 and 2006) can affect the sustainability o f growth i f fundamental reforms in the energy sector are not accelerated. In the short term, the current crisis could widen the current account deficit to higher than forecast levels, if increased imports o f electricity at higher than planned prices dampen the positive impact f rom sustained export growth noted earlier.

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Annex 2

REPUBLIC OF ALBANIA COUNCIL OF MINISTERS

Tirana, February 2lSt, 2007

Letter of Development Policy

h4r. Paul Wolfowitz President The World Bank 18 I 8 H Street, N. W. Washington DC, 20433

The Council of Ministers of Albania sets great store by the possibility of cooperating with the World Bank. The government also appreciates the World Bank’s support given to poverty reduction, service delivery improvement and especially to the government programme of September 2005. Key parts o f the government agenda are embodied to the Development Policy Operation (DPO) Program. The government is firmly convinced that the DPO Program for 2006-2009 will contribute to the long term growth of Albania and increasing job creation potentials through private sector investment, broadening of the export base, fostering human capital formation and strengthening governance structures. This confidence i s based on the recent development since our government came in power and the comprehensive reform agenda and actions planned to be undertaken in the future.

The government programme o f September 2005 specifies several reforms to take place in the period 2006-2009 and aims to achieve the following goals:

to develop and consolidate the democratic state to restore the rule o f law and uproot corruption to achieve rapid, balanced and sustainable growth o f economic and human resources to integrate Albania in the European Union and NATO

The progress made so far in the economic development area lead to an assessment o f the economic growth above 5% in 2006. The economic growth in 2006 has been driven by the construction sector and that o f industry, while the sectors o f agriculture, transport and services are expected to mark modest progress of economic growth. With the recovery o f exports, our underlying external balance has improved considerably. The current account deficit is expected to narrow by about 0.6 percentage points to 5.9 percent o f GDP in 2006.

Fiscal developments this year were dominated by the success o f revenue administration reforms, which significantly increased our resource envelope, and allowed an increase in infrastructure investment and maintenance expenditures o f about 0.8 percentage points of GDP; and a lowering o f the employers’ share o f the social security tax from 29 percent to 20 percent of taxable wages. While inflation exhibited a rising trend in 2006, it remained within the 3*1 percent target range. Price pressures originated with strengthening domestic demand, higher food prices, and an administered increase in the cost o f electricity.

Poverty has declined significantly, a result of sustained recent growth. The absolute poverty headcount rate declined from 25 percent in 2002 to 19 percent in 2005, or 6.8 percentage points, lifting 221,000 people out o f poverty. This decline i s higher than witnessed recently in most ECA countries and other middle income

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Annex 2

countries. Meanwhile, the fight against poverty is far from over. While the rapid growth in incomes was the key contributor to poverty reduction, i t was partially offset by increasing inequality, especially in the coastal and central areas. Rural poverty remains high, with the headcount st i l l at 24 percent in 2005, compared to 11 percent for urban areas. Furthermore, the poor are primarily less skilled, with only primary education, and have less access to education in urban areas. They also tend to be employed in the informal sector without the protection of formal sector regulations. Wide variations in health and educational status as well as in access to services among regions are mirrored by variations in spending at the local level

To maintain the rapid growth rate, the GOA has developed a broad reform agenda which aims to strengthen governance and also support economic growth through an increase in public investment with priority to infrastructure and social sectors, an improved business environment, other structural reforms and promotion o f Public-Private Partnership in public utilities, infrastructure and public service delivery. Business confidence also i s improving steadily, as a result o f progress towards EW integration and continued macroeconomic stability. This progress will be maintained through the Government Program, the National Strategy for Development and Integration (NSDI) and the National Plan for the Implementation o f the Stabilization and Association Agreement (SAA).

Implementation o f the reform agenda will be facilitated by the Integrated Planning System (IPS), a rigorous framework that links the core policy and financial planning systems of the government, including NSDI, the medium-term budget programme (MTBP), European integration, public investment, external assistance and the Government Programme. Replacing the fiagmented, disconnected system o f the past, NSDI is introducing a new strategic planning process by developing a comprehensive set o f medium to long-term sector and cross- cutting strategies. These will serve as reference documents for each ministry’s 3-year Medium-Term Budget Programme (MTBP). The policies described below will be reflected in the respective sector strategies and line ministry MTBP submissions. IPS implementation i s overseen by the Strategic Planning Committee, chaired by the Prime Minister, the Government Modernization Committee, chaired by the Deputy Prime Minister, and collectively by the Council of Ministers..

Objective 1: Improve the investment climate for private sector led-growth

Strengthen regulatory environment for business

The regulatory and administrative cost for business i s a key concern to sustainable private sector development. The 2005 Administrative and Regulatory Cost Survey (ARCS) shows that the most problematic areas affecting business are anti-competitive practices, tax rates, corruption, macroeconomic instability, economic and regulatory policy uncertainty. The Government recognised the need to improve business climate and is undertaking a regulatory reform under the guidance o f a Task Force established in October 2005. An Action Plan determines the main areas: management system o f regulatory reform, improvement o f existing legal framework through removal of administrative barriers for business (business registration, licensing, customs, tax, land and construction, inspection, and administrative appeals), improvement in the quality of the regulatory framework, and monitoring and evaluation of the reform. This reform wi l l provide the basis for a sustainable and predictable regulatory environment leading to increased business competitiveness. Government i s committed to improve the business climate through the implementation of two key policies:

First, licensing procedures are being facilitated. The Ministry o f Economy, Trade and Energy along with other ministries is responsible for preparing reports on streamlining the licensing procedures for specific sectors. A licensing group has been set up to review all licenses: update the inventory of licenses and authorisations; analyse and understand the reasons behind each license; prepare a report o f findings and recommendations for the simplification of procedures; present proposals to the business community; and draft the legal and sub-legal acts in accordance with the recommendations to eliminate any inconsistencies.

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The licensing system will be based on a self-declaration made by businesses for their compliance to the licensing requirements. This shall reduce the time needed for document preparation and processing fee, and strengthen the accountability of both businesses and institutions for the accuracy of declared information. Upon submission of the self-declaration, businesses will start their activities and licensing authorities will then validate the information. Businesses will be penalised or deprived o f the license in case of false declarations.

Review reports o f procedures in some sectors have already been completed by the licensing group, approved by the Task Force, and presented to the business community. Several other reports are currently being drafted. Reports on agriculture, environment, fishing, forestry, water administration, and fire defence have been finalised. Apart fiom the latter, all have been approved by the Task Force. In the areas of mining, hydrocarbons and public works legal acts have already been approved, while in the areas of health, road and maritime transport draft legal acts are at the consultation stage. The monitoring o f the recommendations of the licensing group will be coordinated by the Ministry of Economy, Trade and Energy. For that purpose, the capacities of the Department of Trade Policies are being strengthened.

Second, a new law on concessions (no. 9663) was ratified in Parliament in December 2006, and is effective as o f February 2007. The law, prepared with the assistance o f the International Financial Corporation, i s a major improvement, especially in relation to the treatment of unsolicited bids and to ensuring that al l concessions are awarded based on a competitive process. The Council of Ministers wi l l only be able to authorise a concession without competition for reasons of national security, following prior approval by the National Security Council, or when a specific concession agreement is interrupted and the need to continuously provide a service does not leave suficient time for a full tender process to take place. It ensures also that the processes will adhere to international best practices. The new law specifies that public authorities must announce the rules and the criteria under which the bids will be evaluated in advance.

As the Government values creative and innovative ideas to promote the development of specific sectors, a special case of unsolicited proposals has also been envisaged as a basis for public-private partnerships. In particular, following a thorough examination of the proposal by the authorities, the Government can issue a call for proposals awarding up to 10 percent of the points for the tender to the company that first proposed the idea.

A new unit will be established to provide technical assistance for strengthening capacities o f public administration responsible for concession contract initiation and negotiation. The law provides for an administrative appeal process, general terms and conditions o f the concession agreement as well as monitoring process. The Ministry of Economy, Trade and Energy is working on implementing regulations that will be approved by the Council of Ministers shortly. In preparing the implementing regulations, the Ministry is mindful of the concerns expressed, including by the World Bank, regarding the introduction of the ‘one euro’ initiative in the Concessions Law. This apart, the government also realizes that the new law i s not perfect, and will seek to learn from the experience of its implementation and also seek comments fiom World Bank Group experts, and introduce amendments, as may be necessary, supported by subsequent DPOs.

The implementation o f this law will contribute to establish an attractive environment for public-private partnerships and wi l l help achieve the following Government objectives: infrastructure and service provision, promotion o f competition and transparency, public participation with minimum cost in these developments, higher efficiency o f private investment in the public sector, and promotion of new business ideas. The Government recognizes however the need to limit fiscal risks fiom concessions and will ensure that the Ministry of Finance will clear any concession contracts before they are approved by the Council of Ministers.

Improve functioning of land markets

Immovable property rights are yet to be f i l ly secured in Albania. This i s widely considered one of the major constraints of economic development and the Government Program defines all necessary steps to resolve uncertainties through integrating and completing the parallel processes of: restitution or compensation o f private

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property nationalized by the communist regime; registration of all property; and legalisation o f properties developed in the surrounding areas o f the largest cities during the transition. The Government is currently in the process of articulating its vision in a crosscutting strategy of property rights that will be part of the NSDI. Some of the key components of the strategy are the following:

First, land valuation i s considered critical for all three parallel processes (restitutiodcompensation, registration and legalization). In the fiamework of the Land Administration and Management Project financed from the World Bank, technical assistance will be provided to the Urban Planning Department at the Ministry of Public Works, Transport and Telecommunications for the development of the immovable property tax based on the market value. Following procedures similar to those used for the preparation of the law on spatial planning (see below), a policy document will be prepared through a participatory process with stakeholders to determine the methodology and the next steps for the implementation of the immovable property tax. Property valuation in intended to be the responsibility of local government and in order to enable the use o f market value for property valuation by local government, new legislation on property valuation wili be enacted. Property tax wi l l be a critical source of revenues for local government. Currently, in its absence, population increase i s not translated into an expanded financial basis and many local governments lack the resources to fund infrastructure.

Second, it is recognised that a well-finctioning Immovable Property Registration Agency (IPRA) i s critical for building trust among al l potential participants in the land market. The Government i s working to improve the quality o f service and rationalise user fees for property registration. As part of transforming it into an efficient, transparent and effective organisation, the Government will consider changes in the law on property registration to turn IPRA into an autonomous and self-financing office, with the Chief Registrar reporting to a Board of Directors. The changes will be specified in IPRA’s business plan currently under preparation. In addition, there will be renewed emphasis on the management of ofice functions, information technology will be introduced and data will be shared with other land market institutions to improve the accuracy and completeness of the registry data, and service standards will be monitored internally and externally.

Third, the Government wi l l ensure that the positive outcomes expected from the completion of the restitution, registration and legalisation processes will be put to good use through a revised spatial planning (‘planifkimi hupesinor’) framework. While many hnctions o f urban land management have been gradually devolved to local governments, local authorities often have neither the capacity nor the resources to undertake these hnctions effectively. The complementary public contribution o f local public goods and services has not kept up with the private efforts. In the absence o f recent, applicable urban regulatory plans, most development i s being undertaken without any consideration for pressures on existing infrastructure and the environment, especially in peri-urban areas. The Government has recently completed extensive consultations for a new spatial planning fiamework. The new approach takes a comprehensive and integrated view that goes beyond urbanization and land management to take into account social and economic issues. The new legal framework will allow the building permit processes to be streamlined and will ensure that new development i s in compliance with regulatory plans designed and approved in a transparent and participatory process. Together with training provided to local governments as well as the new law for building inspection, these measures will significantly influence the implementation of regulatory plans and will shorten procedures for issuing building permits.

In the framework of the Land Administration and Management Project, financial and technical support wi l l be provided to the preparation o f regulatory plans for eight cities. In addition to eight cities, Tirana i s on the process of preparing its regulatory plan, while Elbasan and Fier are in the last phase. Regulatory plans will be approved by the commune and municipality councils. The Ministry of Public Works, Transport and Telecommunications and selected municipalities will be supported to monitor implementation o f the spatial planning law and compliance with the new regulatory plans, and to put into practice the following:

territorial planning and development control that are demand-responsive and better serves the dynamic of the market; public participation and pubIicity o f the plans and regulations, to ensure general support and transparency of the process; and

0

0

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0 more streamlined permitting process that encourages builders to obtain appropriate approvals with minimal transactions costs and discourages corrupt behaviour o f officials.

Improve oversight of non-bank financial sector

In the course o f the period 2006-2009, the Albanian authorities shall continue with implementing further reforms in the financial system, for the banking and non-banking sectors building on the recommendation o f the 2005 Financial Sector Assessment Program (FSAP). During 2006 non-banking supervisory functions were unified under one institution, the Financial Supervision Authority (FSA), which includes the former Securities Commission, Insurance Supervisory Authority and Private Pensions Inspectorate. In order to support the independence o f this new institution, the director and the steering board of the institution are appointed by the Parliament. Some steps have already been taken to improve supervision and regulatory control over the insurance sector, such as the submission to Parliament o f legislation aimed at raising capital requirements to European standards and the introduction o f prudential ratios in assessing the activities and financial health o f the insurance companies. Moreover, The FSA, with assistance fiom the Bank, has begun a comprehensive off-site and on-site examination o f insurance companies, to determine their level o f regulatory compliance and to enable necessary corrective action. Enforcement o f these actions wil l be the focus o f the FSA’s attention under DP02;

The main objectives for the coming years are to: 0

0

0

strengthen the institutional capacities o f the FSA; strengthen the credibility o f the Motor Third Party Liability (MTPL) claims administration and restructure the Albanian insurance Bureau; assess risk retention policies and the quality o f reinsurance; and introduce institutional arrangements for reinsurance

Objective 2: Improve fiscal sustainability and effectiveness o f public service delivery

Our fiscal strategy i s based on the premise that a small, but increasingly efficient, government would be most effective in promoting economic development. With our fiscal strategy containing expenditure at the range o f 30 percent o f GDP, tackling current expenditure inefficiency in the social and water sectors, and using our existing--conservative-revenue projections, the government anticipates a reduction o f public debt as a percent of GDP and a lowering o f annual domestic borrowing to 2% percent o f GDP by 2010. Over this time period, and within the expenditure envelope, a further diversion of resources to capital uses wi l l increase sufficiently our current surplus. However, with ongoing reform o f revenue administration, the government considers additional revenue gains likely. After their permanent nature has been demonstrated they wi l l be used to reduce the tax burden, which wi l l further improve our business climate.

The Government recognizes the need to proceed with the implementation of legal, regulatory and institutional reforms in the social and infrastructure sectors in order to reduce their reliance on budgetary transfers, to increase the efficiency o f spending in these sectors, and ensure a wider access o f the population to these services.

Improve fiscal sustainability o f the social insurance system

Since April 2006, the overall coordination o f social insurance policy has been transferred from the Ministry o f Labour, Social Affairs, and Equal Opportunities to the Ministry o f Finance. The September 2005 Government Program has outlined a vision for a social insurance system that is sustainable, offers good coverage, and does not create disincentives in the labour market.

Thanks to the relatively wide coverage o f pension beneficiaries, the social insurance system in Albania has a high impact on poverty, even though pensions, as contributory systems with consumption smoothing objectives, do not have poverty reduction as their primary objective. With respect to its main objective o f catering for

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elderly citizens and mobilising savings, the key indicators of the social insurance system suggest that there are important challenges ahead. For example, the dependency ratio, in other words the ratio between beneficiaries and contributors, i s among the highest among transition countries despite the fact that the demographic situation i s favourable. This has been attributed to a number of reasons:

0

0

the number o f people employed in the formal labour market has been stagnant; high contribution rates have encouraged employers and employees to evade the social insurance system; the administration’s enforcement practices are insufficient to prevent evasion; certain special categories of pensions were being covered under the main social insurance scheme

The risks of the current system have been identified by the Social Insurance Review prepared by the World Bank, notably the concern about the long-term sustainability of the system in view of the proportion o f the population that will not be covered in the future and the fact that the replacement rate, in other words the value o f the pension in comparison to the average wage, wi l l continue to decline.

The Government has already reduced the contribution rate and plans further, fiscally sustainable, reductions. It also plans to better link contributions and benefits to increase the number of contributors and ease the burden of the social insurance deficit to the budget. Strengthening the enforcement of the current law through a unique identification number for individuals and businesses and through improved inspection i s a short-term priority. A stable environment i s a condition for considering, in the mid- to long-term, the possibility o f a multi-pillar pension system. The other branches of the actual social insurance system are usually set apart and administered separately from the pension system and this is part of the strategy of the Government in this area.

At the end of 2006, the Ministry o f Finance and the Social Insurance Institute have started preparing a new pension policy options paper with goals of fiscal sustainability, better coverage, and reducing labor taxation to reduce unfair competition and improve incentives for formal employment. The Ministry of Finance will finalise in the course of 2007 a social insurance sector strategy that will be an input into the final NSDI document. The strategy will identify priorities, propose and evaluate policies that will support the realisation of the vision, define the resource needs and preconditions to implement these policies, and develop a comprehensive set of performance indicators and standards. The envisaged reform will cover both the taxation as well as the benefit side. Once the policy decision has been taken, implementation will be done in a careful and phased manner, keeping in mind the interests of both the government as well as individuals.

Any reforms to the social insurance system will be coordinated with an overall review of the social protection system in general, and Ndihma Ekonomike, which is the main social assistance programme, in particular, to ensure that the poor are not adversely affected.

Improve fiscal sustainability of the health system

The Government is cornmined to improve the fiscal sustainability o f the health system. Starting with the pharmaceutical secfor, the Health Insurance Institute received permission to implement various cost control measures following substantial overruns in the 2005 budget. Such measures included the removal of certain drugs from the reimbursement l ist and the introduction of a flat prescription charge of Lek 100. These measures have met with success in 2006, with the result that the operating deficit of approximately $10 million equivalent in 2005 was turned into a slight operating surplus in 2006. However, there is scope for further systemic improvements in the transparency of the decision-making and review process over the reimbursement list in order to achieve a coherent and transparent drug policy. This is particularly the case in view of the possible expansion of the group o f beneficiaries. Future cost containing measures are likely to include: changing the role and procedures of the reimbursement commission (especially in the case o f new drugs), clarifying procedures to resolve conflicts between medical and economic arguments, strengthening the drug agency’s role in assessing the quality of drugs, introducing impact and benefit analyses, assessing the margins enjoyed by distributors, and further tightening the l i s t of reimbursable drugs. The possibility o f splitting the reimbursement l ist into one basic list o f mainly generic drugs (for which vulnerable groups would be h l l y reimbursed) and one l is t of more

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expensive but not essential drugs that require co-payments wi l l also be examined. In all, the financial accountability and decision-making processes for drugs wil l be better aligned. To evaluate the impact o f these measures, the Government wi l l conduct an assessment o f the transparency o f the pharmaceutical sector on a regular basis, using a WHO-sponsored assessment tool.

Moving on to the hospital sector, a map wil l be used as an instrument to guide future investment in the hospital infrastructure. During its preparation, a set o f issues related to efficiency, quality assurance and accessibility wil l be examined, such as the low utilisation and poor physical condition o f a large number o f small hospitals. Greater autonomy for hospitals wi l l be introduced in parallel with the development o f accountability mechanisms.

Both sets o f improvements wi l l be part o f a more general attempt to address the fragmentation and inefficiency o f the overall health financing system. First, financing responsibilities have been changing relatively frequently resulting in unclear lines of accountability. So far the Ministry o f Health has been paying for hospital care, the salaries o f non-physicians, and other operating costs for primary care, while the Health Insurance Institute has been paying the salaries o f primary care physicians, prescription drugs, and high-end diagnostics. Second, it i s recognised that the current health financing system needs to better protect the most vulnerable groups from health shocks. A clearly defined package of benefits with formal user fees and exemptions for the poor and vulnerable should increase transparency and help to root out informal payments, which are a major contributor to corruption in the sector. Despite the fact that health insurance i s mandatory, the informal character o f the labour market means that only people living in urban areas and those better-off actually contribute to and benefit from health insurance. A very small share o f public spending on health care comes currently from health insurance contributions. Finally, health financing i s input-based and does not give incentives to improve efficiency and quality. In addition, poorer regions end up receiving fewer per capita public resources for health.

The Government is committed to examine the available alternatives and develop a clear health financing policy that wil l address these problems. In particular, it wi l l examine carefully the proposed option o f pooling budget and health insurance funds under the Health Insurance Institute, which wi l l purchase health care services from health care providers. Payments to providers wil l incorporate performance-based elements, possibly through capitation-based payments for primary care and global budgets for hospitals. The Government wi l l also examine the case for shifting to general taxation as the main source o f public funding for health care. The intention o f such a change would be to overcome problems faced by those segments o f the population that do not benefit from the current health insurance system and to bypass the administrative weaknesses o f the collection system.

In the course o f these reforms it i s clear that the Ministry o f Health wi l l be assuming a policy making role and at the same time gradually withdraw from service provision and health care financing. Instead, the Health Insurance Institute wi l l be assuming the responsibility for the latter and wil l contract health care providers for explicitly specified services. To some extent this i s already taking place through the rolling out at the national level o f a pilot scheme for primary health care. These changes are in line with the Government’s commitment to strengthen the regulatotyji-amework and sectoral stewardship. Changes to the legal status of private health care service providers and health insurers are envisaged. Monitoring and accountability structures will be developed: the regulatory functions o f the Ministry o f Health and the Health Insurance Institute wil l be reviewed, consulted and reflected in the law. In all, these substantial changes in the roles and responsibilities o f various actors wi l l require management and technical training, particularly in accounting and reporting.

These findamental changes in the way health care is financed, delivered, and organised wi l l be addressed first in policy studies and wi l l be then reflected in the revised health sector strategy that wi l l form part o f the National Strategy for Development and Integration. Finally, the changes wi l l be reflected in the draft laws on health care and health finance.

In addition to improving the overall fiscal sustainability and efficiency o f the system, these and other measures wil l also increase transparency, reduce corruption and improve the governance o f health sector institutions. The

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government i s clear in its intention to address these issues and i s looking to the World Bank and other development partners for assistance in implementing the necessary actions.

Improve fiscal sustainability of water services

The performance of the water sector has improved over the past few years. Access to water supply has increased from 50 to 78 percent since 1990 and access to sewerage has increased from 25 to 50 percent. Despite the fact that water services have improved:

(i) (ii)

(iii)

consumers still receive on average less than 13 hours of water per day; water utility revenues have doubled over the past five years, but still do not recover the costs of operation and maintenance (O&M), as well as, capital cost; service delivery--such as the hours of water supply, water quality, wastewater treatment, and sea water quality-is inadequate, and this negatively impacts tourism.

Until now, the water companies have been unable to meet these challenges. They continue to rely on a high and increasing operating subsidy from the central government. On the one hand, O&M costs have risen over time due to increased electricity and staff costs, while the utility revenues have not kept pace with these increases because:

(i) (ii) (iii)

low tariffs (on average around 79 percent o f the O&M cost); low collection rates (70 percent); and extremely high losses (69 percent unaccounted-for-water).

In order to contribute to economic growth, together with the basic rehabilitation of the water supply networks, investments need to shift toward wastewater collection and treatment. First, the increasing government allocations to operating subsidy limit its ability to invest more in capital works. Second the poor performance of water companies renders them unattractive for private investment.

The government’s vision for the sector i s to support the development of locally owned, managed and financed water companies. In order to reach this vision, the government will revise its water sector strategy, focusing on:

(i) further decentralisation; (ii)

(iii) (iv)

consolidation and commercialisation of the water companies (including the increased use of private sector participation where appropriate); improved efficiency, and cost recovery through user tariffs; and increased investments in the sector, particularly in wastewater.

Over time, as a greater share of operating costs is met through utilities’ own revenues, government intends to reduce its operating subsidy and improve its allocation between different utilities. In addition, in order to leverage improved utility performance, government wi l l re-design its investment allocation formula to reward utilities that improve performance. In order to adequately assess performance, the government wi l l improve the quality o f the monitoring system that already exists within the General Directorate.

The Government expects the DPO to assist in clarifj4ng outstanding policy issues through a water sector policy options paper, which will feed into the revision o f the water sector strategy, and subsequently support implementation o f the strategy.

Objective 3: Improve government effectiveness

The Government considers corruption as a major problem affecting all dimensions of public l i f e from poverty to organized crime and i s seen as a violation of human rights. The government i s also aware that a better future for the country depends on its efforts and determination to fight corruption. I t has started addressing corruption by increasing transparency in the fknctioning o f public institutions. The government has reduced by 40 percent the operational costs o f the central administration. It approved a law on conflict o f interest for all senior officers,

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including cabinet members, and has encouraged the public to participate and contribute to this campaign by denouncing every case of corruption. It has moved away from allocating resources to small projects, and consolidated spending in a few large projects in key sectors that meet its objectives for development and integration o f the country. The government has also approved a new law on public procurement, a new law on concessions and other laws that secure transparency such as, a new auditing law, a new law on compensation o f property etc.

Weak governance continues to plague AI bania’s public sector, because o f weak fiduciary arrangements that constrain the efficiency of resource use, notably in procurement, and public financial management systems; slow progress in depoliticizing the civil service and establishing a merit-based recruitment system; and capacity weaknesses across government institutions. Even though the government has achieved a lot in the fight against corruption, it i s aware that a lot st i l l remains to be done in the future. It i s committed to focus its efforts on improving public expenditure institutions and rules for public spending and procurement; support continued civil service reforms, and firther strengthening o f the framework for local finances. These reforms, supplemented by the reform o f the concessions law, would help to increase the impact o f government expenditure in a resource- constrained and governance-challenged environment.

Integrate and improve quality of public investment planning and execution and budget decision-making

The experience of recent years indicates that, in general, the quality o f public investment project proposals was poor, investments have been fragmented and the capacity to implement them has often lead to under-execution of the capital budget. A new Department o f Public Investment has been established in the Ministry of Finance to play an important role in the management and coordination of the public investment budgeting process. In mid- 2006, some new requirements for public investment proposals were introduced and used for the 2006 supplementary budget and 2007 budget requests. Later in 2006, the Government, supported by foreign technical assistance, prepared a new complete set of procedures for the management o f public investment projects, which will be introduced with the MTBP 2008-2010 preparation process. The application o f the new procedures is intended to improve public investment management, increase value for money of investments, lead to better integration of recurrent and investment budgets, and better preparation of public investment project proposals in the MTBP through their full costing. Capacities of line ministries and other budget institutions will be strengthened through training on new PIM procedures.

The government wi l l also improve its capacity to execute capital spending by introducing a mid-year budgetary review of investment projects, with the aim o f strengthening monitoring and of redirecting investment allocations to sectors which show higher implementation capacity. In addition, the government will further improve our implementation capacity by increasing the average size of projects in i t s budget and significantly decreasing their number.

Performance monitoring and reporting on public investment management wi l l be a part of the envisaged External Assistance Management Information System (EAMIS), a major component o f the overall Integrated Planning System Information System (IPSIS). The development of these systems has begun with the initial phase focusing on the identification of business flows, processes and information requirements, and the identification and selection of alternative technical solutions. The systems will be linked to, but not duplicate, financial management systems. They are to be developed according to a phased and modular approach, focusing initially on meeting high priority needs. I t is currently planned that high priority components ,will be developed and implemented during 2007, with other components developed and implemented over the course o f 2008. The overall objectives of the systems are to provide summary information that will help support decisions by the Council o f Ministers.

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Improve efliciency and transparency in resource utilisation

Good progress was made during 2006 in establishing and completing the MTBP process. For the first time al l ministries and their programs were incorporated in the MTBP submissions, including public investments. The Public Expenditure and Institutional Review, conducted by the World Bank, has provided many recommendations for improving resource allocation, which have been partly considered in 2007 budget submissions. An action plan for their full implementation in subsequent years has been prepared in close cooperation between the Ministry of Finance, line ministries, and the World Bank.

Actions to improve resource allocation and utilization will be supported through the envisaged Integrated Planning System Trust Fund that will become effective during 2007. A draft of the new organic budget law has been completed and sent to international organisations for comments in December 2006. This law shall constitute the MTBP as a legally required budgeting tool, and will improve many other areas o f budget management by ensuring greater accountability and enhancing efficiency and value for money of public expenditure.

With World Bank support, the government has developed and completed a new modern treasury system, which i s the first comprehensive system in the public administration of Albania. It government has started using this system, and during the first half o f 2007, the new system shall be fully functional at the Ministry of Finance and 35 district treasury offices for budget execution and reporting. I ts design enables the government to improve transparency in budget execution and reporting, strengthen budget execution monitoring and increase efficiency and effectiveness in the use of public funds.

During 2006 the Public Procurement Agency, with the assistance of the SPPS project in the framework of the CARDS program, drafted the new public procurement law (no. 9643). The draft was closely discussed with the World Bank staff, and was approved by Parliament in November 2006, and the new law became effective on January 1, 2007. Secondary legislation and the format for tender documents have also been since approved. Having in place the new legislation significantly improves the transparency of tender procedures. Open tender i s the preferred procedure. Every procurement procedure from 2007 onwards will begin with the new legislation. The Public Procurement Agency i s providing training and assistance for contracting authorities and will focus on ensuring implementation of the new legislation. The government seeks to learn from the implementation experience of the new law, and make any legal amendments as may be necessary, to address remaining and emerging concerns, supported by subsequent DPOs.

Improve efficiency and continue de-politicization of public administration

The Government is committed to continue and enhance the steps undertaken in public administration reform and, more specifically, in civil service reform. Through the implementation of the Civil Service Law, the government created a system of competitive recruitment, based on equal opportunities for participants to be employed in core institutions of public administration. In terms of the institutional framework, the Department of Public Administration manages and supervises the management of the civil service and the Civil Service Commission functions as an independent institution with the duty to resolve the appeals of civil servants. The processes o f job description and evaluation have been implemented successfully in the pilot institutions and have been extended to all ministries and other important institutions. The salary reform put in place created a competitive reward for the civil servants and a modern salary structure was implemented. With the financial assistance of the World Bank the government undertook a broad functional review reform in the past two years that resulted in improved organisational structures for ministries and a better allocation of functions.

During the next several years government intends to build upon its successes while learning from its mistakes. To begin with, it intends to focus on improving the implementation of the Civil Service Law, to address the issues that have arisen in the past several years: (i) ensuring further independence and de-politicization of the civil service through the application of all measures that are currently included in the law; and (ii) improving the evaluation process to ensure that evaluations reflect performance more accurately.

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To address these implementation issues, the Government will, first, resolve cases of civil servants who have been dismissed over the past several months and have appealed to the courts to seek redress. Due process wi l l be followed in a l l cases, viz., which would mean applying the court decisions, or appealing the decision if applicable. Second, the Government will reduce the extent of recruitment falling outside the scope of the civil service law, especially through temporary hiring. To ensure that institutions are able to hire new manpower consistent with the process identified in the Civil Service Law, the government intends to encourage improved HR planning in line ministries. Third, the Government will continue to address the issue of evaluations in the civil service, so as to improve its credibility. To do so, the government will train higher management, focusing on carefilly explaining the evaluation process and the expectations regarding the process. This is expected to increase the capacities of the managers to run the process efficiently. Fourth, the Government is also committed to attract and maintain in the public administration qualified professionals that have graduated in renowned international universities or that have a Master or PhD qualification

To improve management of its human resources, the government recognizes the need to improve core service infrastructure. Accordingly, over the short term, the government will focus on completing the implementation of the Human Resource Management Information System (HRMIS). Afier resolving some technical and logistical issues, the Department of Public Administration will present to the Government Modernization Committee a comprehensive plan for the implementation of HRMIS, together with an evaluation of its costs.

Once the government has addressed these issues associated with implementation, it will focus on improving the law and expanding its scope, if found to be necessary. It will proceed in a phased and deliberate way, to ensure maximum buy-in of al l concerned parties and containment of the fiscal impact of these measures. To do so, the government wil l review ‘the Civil Service Law and its implementation to determine whether and what kind of changes, are needed in the law. Starting from this review, the government will focus on building consensus on required changes to the law, if any, by involving all stakeholders.

The review would also cover issues relating to expanding coverage of the law. At a suitable time, subject to the advice o f this review as well as of all stakeholders, the government would like to apply the same standards and principles proper for the civil service to a set o f institutions that for the moment are out of the scope o f the civi l service law (CSL). The government believes that uniform requirements of professionalism and stability should be applied in all the institutions which perform essential and priority public functions in the Albanian public administration. Already, since July 2006, staff of subordinate agencies have been receiving salaries equivalent to those of civil servants. Subject to the findings of the review, the Government intends, in a phased fashion, to include within the scope o f the CSL all the subordinate agencies after these institutions go through the functional review process.

Being aware that a meritocratic public administration is necessary to improve service delivery to the public and that only professionals can support the fight against corruption, the Government f i l ly supports the Department of Public Administration in its efforts to implement public administration reform and wil l work to strengthen it, through any and all necessary means, to ensure that it i s able to undertake the functions which have been entrusted to it by the Civil Service Law

Strengthen local finance

Decentralization has experienced significant progress in Albania, towards the direction of increasing taxing and spending powers of local government. Some of the most important steps include membership of the European Charter on Local Self-government, adoption of the national strategy for decentralization, and adoption of the law on “Organization and functioning o f local government”. Functions and responsibilities have been transferred to the local government in areas such as infrastructure and public services, regional economic development, public order and social protection.

55

Annex 2

The transfer o f responsibilities and functions has implied additional transfer o f resources from the central government and increased authority o f local government bodies to raise and mobilize revenues. The main sources o f local budget revenues come from unconditional transfers from the central government and own local revenues from taxes and tariffs. Progress has been made in the allocation formula for unconditional general- purpose transfer grants relative compared to past years. In 2006, unconditional general transfers reached Lek 12 billion, and for the f i rst time it includes a general transfer for local investments and i t is significantly higher compared to the year before. Funds for rural and urban roads were included in that transfer for the first time. An analysis o f the distribution o f investments among different regions, communes and municipalities for the years 2000-2005 reveals absence o f rules and objective criteria for distribution, unpredictability and lack of transparency, the consequence being a huge disparity o f per capita investment. In the 2006 budget, the size distribution o f the investment grant for urban and rural roads was considerably increased and its distribution made formula based.

Starting from January 2007, responsibility for collection and management o f small business tax revenues belongs to local administration. If managed properly, this wi l l be a positive step towards increased fiscal autonomy o f local govemment. The new legislative provisions increase local government power and flexibility to raise revenues and increase scope for tax policy formulation to introduce incentives, aimed at regional development in different levels.

The GOA is fully determined to deepen and improve the decentralization process by improving the framework for local government finances. Since great progress has been made in devolving responsibilities and adequate financing sources from central to local governments, the objective for the future remains improvement o f efficiency, predictability, fairness and accountability in local finance. The Ministry o f Interior has completed the analytical work to inform the formulation o f local government finance law and the law on local borrowing. These new laws wi l l significantly improve the transfer system, increase potentials for local investments and strengthen local financial management.

Mitigate the poverty impact of reforms

The government has outlined above several reforms to take place in the future, which are likely to impact the poor. While the government wi l l push institutions to move ahead in the reform process, it will, on the other hand, continuously monitor the impact o f reforms on the poor, and take appropriate actions to mitigate that impact. These actions include an overall diagnosis o f the social protection system, and a reform o f the system, as necessary, including improving the efficiency and appropriate package o f benefits in the social safety net program. The government wil l work closely with the World Bank and other donors in order to ensure a structured and well-integrated approach to social protection and social assistance reforms.

MINISTER OF FINANCE PRIME MINISTER

56

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*

Annex 5: Fund Relations Note

Press Release No. 07119- February 2,2007

IMF Executive Board Completes Second Review Under PRGF Arrangement and Second Review Under EFF Arrangement with Albania and Approves US%3.6 Million Disbursement

The Executive Board o f the International Monetary Fund (EMF) today completed the second review o f Albania's performance and financing assurances under the three-year Poverty Reduction and Growth Facil ity (PRGF) arrangement and the Extended Fund Facil ity (EFF) arrangement. The completion o f the reviews enables the release o f an amount equivalent to SDR 2.4 mi l l ion (about U S 3 . 6 million), which wil l bring the total disbursement under both arrangements to SDR 7.3 mi l l ion (about USSl0.9 million).

The concurrent three-year arrangements under the Poverty Reduction and Growth Facil ity (PRGF) and the Extended Fund Facility (EFF) amounting to the equivalent o f SDR 17.045 mi l l ion (about US$25.5 mill ion) were approved effective f rom February 1, 2006 (see Press Release No . 06/17).

Fol lowing the Executive Board's discussion o f Albania, Mr. Mur i l o Portugal, Deputy Managing Director and Acting Chair, stated:

"Albania's macroeconomic performance has remained strong. Inflation i s low, the external position has improved, and economic growth has picked up. These favorable developments owe much to sound macroeconomic policies and continued strong commitment to program implementation. Looking forward, maintaining these gains alongside further reduction in poverty will require additional growth- enhancing structural reforms.

"The authorities are committed to fiscal discipline, and are implementing a fiscal program that aims to reduce public debt while providing adequate funding for priority projects in infrastructure, health, and education. The planned safeguard measures to contain the fiscal risks related to large-proj ect execution are appropriate. I t will be crucial to implement these measures fully to protect other priority expenditures in case o f cost overruns in large road projects.

"The existing monetary pol icy framework, including an independent central bank and a floating exchange rate, remain appropriate, and the authorities stand ready to adjust policies to maintain l o w inflation-as evidenced by the increase in the policy rate last November. The recent measures taken by the Bank o f Albania to strengthen the regulatory and prudential frameworks will further reduce the r isks posed by rapid credit growth. In the nonbank financial sector, the establishment o f a unified and independent supervisory authority i s an important step to improve the quality o f supervision and prudential oversight. Continued efforts are needed to quickly increase capacity at the new authority, including through the allocation o f sufficient resources.

"Structural reforms are progressing, particularly in tax administration. As a next step, the authorities will review the functions o f the Tax Police. In the energy sector, the International Finance Corporation has been selected as an advisor for the privatization o f the distribution arm o f the national electricity company (KESH). Concerted efforts are needed to ensure stable energy supply and further improve the financial performance o f KESH. Accelerating privatization in other sectors, such as telecommunication and insurance, would also be important. The authorities are encouraged to work toward eliminating the weaknesses in official statistics," Mr. Portugal said.

69

Annex 6: ALBANIA: Key Economic Indicators

Estimate Projected Indicator 2003 2004 2005 2006 2007 2008 2009 2010

National accounts (as % of GDP)

Tota l Consumption 100 96 100 98 97 96 94 93 Gross domestic f ixed investment 23 24 24 25 26 27 28 28

Government investment 5 5 5 6 6 7 7 7 Private investment 19 19 19 20 20 20 21 22

E X P O ~ ~ S (GNFS)~ Imports (GNFS)

21 22 22 24 24 25 25 25 46 43 46 47 48 48 47 46

Gross national savings' 17 20 16 18 18 20 21 22

Memorandum items Gross domestic product 5652 7464 8376 9135 10161 11130 12158 13362 (US$ m i l l i on at current prices) GNI per capita (US$, Atlas method) 1660 2100 2590 2930 3180 3470 3800 4 140

Real annual growth rates (%, calculated f rom 96 prices)

Gross domestic product at market prices 5.7 5.9 5.5 5.0 6.0 6.0 6.0 6.0 Gross Domestic Income 6.1 7.4 5.3 7.6 8.1 7.1 6.3 7.6

Real annual per capita growth rates (%, calculated f rom 96 prices)

Gross domestic product at market prices 5.2 5.3 4.9 4.4 5.4 5.4 5.4 5.4

Private consumption 5.7 4.3 8.5 4.0 6.2 4.9 4.0 4.7 Tota l consumption 6.8 4.6 7.7 3.9 6.5 4.7 4.3 4.8

Balance of Payments (US$ millions) E X ~ O ~ ~ S (GNFS)~ 1165 1608 1866 2158 2476 2774 3048 3398

Merchandise FOB 447 604 661 798 946 1074 1218 1383 Imports (GNFS)~ 2578 3233 3881 4292 4846 5314 5711 6193

Merchandise FOB 1778 2178 2500 2842 3153 3423 3666 3941

N e t current transfers 782 1032 1207 1305 1437 1547 1655 1771 Resource balance -1413 -1625 -2015 -2134 -2370 -2540 -2663 -2794

Current account balance (incl. grants) -463 -41 1 -643 -653 -760 -823 -834 -828

N e t private foreign direct investment 178 344 279 343 377 425 477 511

Of f ic ia l 110 113 79 205 201 134 102 98 Private -26 -29 -4 -29 -2 12 29 -5

Change in reservesd 165 248 151 218 107 194 184 263

Long-term loans (net) 85 84 76 177 200 146 131 93

Other capital (net, incI. errors & ommissions) 35 -265 138 -84 77 57 42 -39

70

Memorandum items Current account balance (incl. grants- % GDP) Current account balance (excl. grants- % GDP) Resource balance (% o f GDP) Real annual growth rates ( YR96 prices)

Merchandise exports (FOB) Merchandise imports (CIF)

Public finance (as % of GDP at market prices)e

Current revenues Current expenditures Current account surplus (+) or deficit (-) Capital expenditure Foreign financing

Monetary indicators M2/GDP Growth o f M2 (%) Private sector credit growth /Total credit

Private sector credit growth growth

Price indices( YR96 =loo) Merchandise export price index Merchandise import price index Merchandise terms o f trade index

Real exchange rate (US$/LCU)f

Real interest rates Consumer price index (% change)

-5.6

-8.2 -25.0

19.9 7.5

24.5 24.6 -0.1 4.5 1.5

51.5 9.2

45.6 31.1

92.1 88.7

103.8 101.8

3.3

-3.8

-5.5 -21.8

24.4 7.2

24.0 24.0 0.0 5.2 1 .o

51.3 12.0

64.1 37.0

100.0 101.4 98.6

107.0

2.2 GDP deflator (% change) 3.4 6.0 3.5 2.4 3.0 3.3 3.2 3.7

-6.5

-7.7 -24.1

2.3 9.0

24.4 23.2

1.1 4.8 0.8

51.0 8.4

90.3 74.1

106.9 106.8 100.1 102.6

2.0

-5.9

-7.2 -23.4

2.6 11.5

24.9 23.1

1.8 5.7 1.3

52.4 10.6

76.3 50.0

125.8 108.8 115.6 102.2

2.4

-6.1

-7.5 -23.3

4.3 9.5

25.2 23.4

1.7 6.2 1.2

53.4 11.3

85.6 33.7

143.0 110.3 129.6 98.2

3.4

-6.1

-7.4 -22.8

4.1 7.0

25.6 23.4

2.1 6.7 1.6

55.0 12.8

77.4 24.2

156.0 111.9 139.3 95.8

3.0

-5.8

-6.9 -2 1.9

4.1 5.5

25.8 23.5

2.3 6.5 1.5

56.1 11.6

80.5 22.7

169.9 113.6 149.5 93.8

3.0

-5.3

-6.2 -20.9

4.0 5.9

26.0 23.2

2.8 6.8 1.4

57.3 12.2

73.8 18.1

185.5 115.4 160.8 91.2

3.0

a. GDP at factor cost b. "GNFS" denotes "goods and nonfactor services." c. Includes net unrequited transfers excluding official capital grants. d. Includes use o f IMF resources. e. Consolidated central government. f . "LCU" denotes "local currency units." An increase in US$/LCU denotes appreciation

71

Annex 7: ALBANIA: Key Exposure Indicators

Actual Estimate Projected Indicator 2003 2004 2005 2006 2007 2008 2009 2010

Total debt outstanding and disbursed (TDO) (US$m)a

Net disbursements (US$m)a

Total debt service (TDS) (US$m)a

Debt and debt service indicators (%)

TDOIXGS~ TDOIGDP

TDWXGS

ConcessionaliTDO

IBRD exposure indicators (%) IBRD DS/public DS Preferred creditor DS/public

DS (%)' IBRD DS/XGS

IBRD TDO (US$m)d

1201

120

55

56.3 21.3 2.6 88.5

58.9

1364

180

70

48.0 18.3 2.5 88.8

57.1

677

1516

171

85

46.4 18.1 2.6

78.3

57.0

65 5

1666

266

115

45.2 18.2 3.1 86.1

0.0 47.7

0.0

0 816

1816

280

117

43.9 17.9 2.8 87.9

0.0 51.4

0.0

1

898

1962

173

148

43.1 17.6 3.2

87.3

0.2 49.8

0.0

5 982

2075

123

156

42.0 17.1 3.2

85.6

0.6 50.6

0.0

16

1036

2112

80

234

39.0 15.8 4.3 84.8

1.2 40.1

0.0

50

1065 ~~ IDA TDO (US$m)d 583 .. . . ~ .

a. Includes public and publicly guaranteed debt, private non guaranteed, use o f IMF credits and net short- term capital. b. "XGS" denotes exports o f goods and services, including workers' remittances. c. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the IMF, and the Bank for International Settlements. d. Includes present value o f guarantees. e. Includes equity and quasi-equity types o f both loan and equity instruments.

72

Annex 8: Country at a Glance

POVERTY and SOCIAL

2005 Population mid-year (millions) GNI per capita (Atlas method, US$) GNi (Atlas method US$ billions)

Average annual growth, 199905

Population (%) Labor force (Xi

Most recent estimate (latest year available, 1499.05)

Poverty (% of population below national poverty line) Urban population (% of total population) Life expectancy at birth (years) Infant mortality (per 1,000 hve births) Child malnutrition (% of children under 5) Access to an improved water source Literacy (% of population age f5+) Gross primary enrollment

(% ofpopulation)

(% of school-age population) Male Female

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

GDP (US% billions) Gross capital formation1GDP Exports of goods and serviceslGDP Gross domestic savingslGDP Gross national savingslGDP

Current account balancelGDP Interest paymentslGDP Totai debWGDP Totai debt servicelexports Present vaiue of debWGDP Present value of debVexports

1985

32 8 16 2 30 5 30 6

1985-95 1995-05 (average annual growth) GDP - 3 6 5 8

Exports of goods and services (in USD)l1 26 0 GDP per capita -4 1 5 7

Albania

3 1 2 590

8 1

0 4 0 0

25 45 74 17 14 96 99

104 105 104

1995

2 4 21 0 12 5 -0 7 14 0

-0 5 0 4

18 8 1 2

2004

5 9 5 3

38 0

Europe a Central

Asia

473 4 113 1945

0 0 0 6

64 69 28

5 92 97

104 105 102

2004

7 5 23 8 21 5

4 2 20 5

-5 5 0 3

18 3 2 6

2005

5 5 4 9

16 0

Lower- middle- income

2 475 1918 4 747

1 0 1 4

49 70 33 12 82 89

114 115 113

2005

8 4 23 6 22 3 -0 5 15 9

-7 7 0 4

18 1 2 5

2005-09

5 8 5 2

13 7

Development diamond*

Life expectancy ~

~ T GNI Gross per primary capita enrollment

1

Access to improved water source

! -Albania

~ Lower-middle-income a row

Economic ratios.

Trade

T

Indebtedness

-Albania

__ Lower-middle-income a row

STRUCTURE of the ECONOMY

(% of GDP) Agriculture 3 4 6 5 5 8 Industry 4 3 3 2 2 5

Services 22 1 21 7 5 5 3 5 5 7

Household final consumption expenditure 6 0 2 87 1 8 6 3 91 1 -60-

Imports of goods and services 1 8 4 3 4 5 4 3 3 463

lgg5 *Oo4 IGrowth of capital and GDP (%)

Manufacturing

General gov t final consumption expenditure 9 3 1 3 6 9 5 9 3

1985-95 1995-05 Growth of exports and imports ( O h ) (average annual growth) Agriculture 3 1 1 2 3 6 industry -11 4 7 1 8 2

Manufacturing 5 8 0 0

Household final consumption expenditure 1 9 5 1 4 9

Gross capital formation 1 3 5 1 2 1 7 3

Services -2 9 8 2 6 3

General gov't final consumption expenditure -78 1 5 6 6 2

Imports of goods and services (in USD)II 17 6 254 2 0 0

11BoP based estimates

'The diamonds show four key indicators in the country (in bold) compared with its income-group average If data are missing, the diamond will be incomplete

73

1985

0 3

50 .j 24 4

t%SS

333

344

1.985

318 35: -44

1

' 8

1985

0

0

0 0

2004

2 2 BC

2004

GU3 3)

135 420

2 178 Sd7 245 837

123 128 $44

2004

1608 3 2:3 1625

182 1032

"4?1

6.3 3 8

2004

J

6'7

75

8

125 '113 30

344 0

Intintcon

Currlant account balance to GOP (%j

c e7

74

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Nor th Albanian Alps

P i nd

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T R O P O J ËT R O P O J Ë

S H K O D Ë RS H K O D Ë RP U K ËP U K Ë

K U K Ë SK U K Ë S

D I B R AD I B R A

M I R D I T ËM I R D I T Ë

LAÇLAÇ

K R U J ËK R U J Ë

M ATM AT

BULQIZËBULQIZË

T I R A N ËT I R A N Ë

PEQINPEQIN

E L B A S A NE L B A S A N

LIBRAZHDLIBRAZHD

G R A M S HG R A M S H

POGRADECPOGRADEC

DEVOLLDEVOLLK O R Ç ËK O R Ç Ë

SKRAPARSKRAPAR

KUÇOVËKUÇOVË

B E R ATB E R AT

TEPELENËTEPELENË

P Ë R M E TP Ë R M E T

GJIROKASTËRGJIROKASTËR

V L O R ËV L O R Ë

SARANDËSARANDË

DELVINËDELVINË

F I E RF I E R

LUSHNJËLUSHNJË

KOLONJËKOLONJË

MALLA-MALLA-KASTERKASTER

KAVAJËKAVAJË

L E Z H ËL E Z H Ë

H A SH A S

MALSI EMALSI E

MADHEMADHE

DURRËSDURRËS

RubikRubikShëngjinShëngjin

Zall-RecZall-Rec

Han i HotiHan i Hoti

ValbonValbona

KalimashKalimash

Fushë KugeFushë KugeShkopetShkopet

UlëzUlëz

KurbneshiKurbneshi

FushFushArrëzArrëz

FierzëFierzë

KrrabëKrrabë

ShijakShijakVoVorërë

FushëFushëKrujëKrujë

MamurasiMamurasi

IbëIbë

KakavijaKakavija

KelcyrëKelcyrë

PatosPatos MaliqMaliq

CërrikCërrik

SeleniceSelenice

KrahësKrahës

KafarajKafaraj

MarinzëMarinzë

KajanKajan

VidVidhëshës

MavrovëMavrovë

PerrenjasPerrenjas

KomanKoman

KoplikKoplik

PukëPukë KukësKukës

PeshkopiPeshkopi

RrëshenRrëshen

KrujëKrujë

KavajëKavajë

PeqinPeqin

ElbasanElbasan

KorçëKorçë BilishtBilisht

ErsekëErsekë

ÇorovodëÇorovodë

PërmetPërmet

VlorëVlorë

GjirokastërGjirokastër

SarandëSarandë

TepelenëTepelenë

DelvinëDelvinë

DurrësDurrës

LushnjëLushnjë

FierFier

BurrelBurrel

BulquizëBulquizë

LibrazhdLibrazhd

GramshGramsh PogradecPogradec

KuçovëKuçovë

BallshBallsh

BeratBerat

LezhëLezhë

LaçLaç

KrumëKrumë

ShkodërShkodër(Scutari)(Scutari)

BajramBajramCurriCurri

TIRANËTIRANË(TIRANA)(TIRANA)

T R O P O J Ë

S H K O D Ë RP U K Ë

K U K Ë S

D I B R A

M I R D I T Ë

LAÇ

K R U J Ë

M AT

BULQIZË

T I R A N Ë

PEQIN

E L B A S A N

LIBRAZHD

G R A M S H

POGRADEC

DEVOLLK O R Ç Ë

SKRAPAR

KUÇOVË

B E R AT

TEPELENË

P Ë R M E T

GJIROKASTËR

V L O R Ë

SARANDË

DELVINË

F I E R

LUSHNJË

KOLONJË

MALLA-KASTER

KAVAJË

L E Z H Ë

H A S

MALSI E

MADHE

DURRËS

RubikShëngjin

Zall-Rec

Han i Hoti

Valbona

Kalimash

Fushë KugeShkopet

Ulëz

Kurbneshi

FushArrëz

Fierzë

Krrabë

ShijakVorë

FushëKrujë

Mamurasi

Ibë

Kakavija

Kelcyrë

Patos Maliq

Cërrik

Selenice

Krahës

Kafaraj

Marinzë

Kajan

Vidhës

Mavrovë

Perrenjas

Koman

Koplik

Pukë Kukës

Peshkopi

Rrëshen

Krujë

Kavajë

Peqin

Elbasan

Korçë Bilisht

Ersekë

Çorovodë

Përmet

Vlorë

Gjirokastër

Sarandë

Tepelenë

Delvinë

Durrës

Lushnjë

Fier

Burrel

Bulquizë

Librazhd

Gramsh Pogradec

Kuçovë

Ballsh

Berat

Lezhë

Laç

Krumë

Shkodër(Scutari)

BajramCurri

TIRANË(TIRANA)

GREECE

GREECE

FYRMACEDONIA

M O N T E N E G R O

S E R B I A

A d r i a t i c

S e a

Drinit Bay

Rodonit Bay

LalëzitBay

DurrësitBay

KaravastasëBay

VlorësBay

LakeUlzës

LakeOhrid

LakePrespa

LittleLake Prespa

Drin

i Zi

LakeScutari

Vjosë

Vjosë

Bunë

Drin

ToPodgorica

To Prizren

ToStruga

ToIoánina

Nor th Albanian Alps

P i nd

us M

ou

nt a

i ns

Maja Jezercë(2693 m)

42°N

41°N

40°N 40°N

41°N

42°N

20°E 21°E19°E

20°E 21°E

19°E

ALBANIA

This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other informationshown on this map do not imply, on the part of The World BankGroup, any judgment on the legal status of any territory, or anyendorsement or acceptance of such boundaries.

0 10 20 30

0 10 20 30 Miles

40 Kilometers

IBRD 33359R

JULY 2006

ALBANIASELECTED CITIES AND TOWNS

DISTRICT CAPITALS

NATIONAL CAPITAL

RIVERS

MAIN ROADS

RAILROADS

DISTRICT BOUNDARIES

INTERNATIONAL BOUNDARIES