The World Bank North Macedonia Public Finance and Competitiveness DPL (P171851) Program Information Document (PID) Appraisal Stage | Date Prepared/Updated: 10-Aug-2019 | Report No: PIDA27658 Page 1 of 6 The World Bank North Macedonia Public Finance and Competitiveness DPL (P171851) BASIC INFORMATION A. Basic Project Data OPS TABLE Country Project ID Project Name Parent Project ID (if any) North Macedonia Public Finance and North Macedonia P171851 Competitiveness DPL (P171851) Region Estimated Board Date Practice Area (Lead) Financing Instrument Macroeconomics, Trade Development Policy EUROPE AND CENTRAL ASIA 19-Sep-2019 and Investment Financing Borrower(s) Implementing Agency Ministry of Finance Ministry of Labor and Social Policy, Ministry of Finance Proposed Development Objective(s) The proposed DPO supports reforms to strengthen public finances, improve market competition, and reduce the regulatory burden in North Macedonia. Financing (in US$, Millions) FIN_SUMM_PUB_TBL SUMMARY Total Financing 139.25 DETAILS -NewFin3 Total World Bank Group Financing 139.25 World Bank Lending 139.25 Decision The review did authorize the team to appraise and negotiate Page 2 of 6 The World Bank North Macedonia Public Finance and Competitiveness DPL (P171851) B. Introduction and Context Country Context North Macedonia has had a good track record of conducting macroeconomic policies and business environment reforms. Prudent macroeconomic policies prior to the global financial crisis enabled the country to create fiscal space for a countercyclical fiscal policy–centered around stimuli for public employment, pensions, and public works–that largely mitigated the crisis impact in 2008-09 and 2011-12. These measures helped the economy to grow at an average of 2.7 percent 2012-17, increase employment and reduce poverty. While the fiscal stimulus measures of 2009-16 helped keep growth and jobs in North Macedonia, they came with fiscal costs. The public and publicly guaranteed debt-to-GDP ratio doubled since 2008 to 47.8 percent in 2017, while fiscal deficit averaged 2.2 percent of GDP (or 3.6 percent of GDP once the off-budget road agency finances are included). Further fiscal risks stemmed from pressures on pensions from aging population, re-accumulation of public sector arrears and the high level of state-owned enterprise indebtedness. The efficiency of public spending as well as revenues by improving tax collection, which is characterized by broad tax exemptions, compliance challenges, and informality are also among the fiscal challenges. Additionally, the political turmoil of 2015-17 adversely affected investors’ expectations, leading to a slowdown in FDI and under-execution of the public investment program that brought growth down to almost zero in 2017. Despite the country being ranked among the top 10 countries for the ease of doing business, economic activity was limited by the lack of private sector dynamism due to barriers to entry and competition in product markets and in critical backbone service sectors such as energy and education. Against this backdrop, the authorities have started a new wave of reforms to reinvigorate economic growth and ensure sustainability of public finances. Relationship to CPF The proposed operation is fully consistent with the FY19–23 Country Partnership Framework. The proposed policy program helps the authorities strengthening its public finance management, strengthen the macro stability, and unlock the private sector growth. By supporting fiscal sustainability and promoting market competition—among the top priorities identified in the 2018 Systematic Country Diagnostic—the operation enforces critical elements for sustained shared prosperity. Such reforms are necessary to avoid abrupt adjustments that could reverse welfare gains for the population. C. Proposed Development Objective(s) The proposed DPO supports reforms to strengthen public finances, improve market competition, and reduce the regulatory burden in North Macedonia. Key Results Indicator Name Baseline Target Overall PAYG pension deficit reduced. 4.8 percent of GDP in 4.45 percent of GDP in 2017 2019 Increased social assistance coverage of the bottom 33 and 22.6 percent, 50 and 40 percent, quintile overall and for female-led households. respectively in 2016 respectively in 2019 General government arrears reduced. 3.5 percent of GDP in Below 2.7 percent of GDP 2017 in 2019 Personal income tax revenues increased. 2.5 percent of GDP in 2.7 percent of GDP in 2017 2019 Page 3 of 6 The World Bank North Macedonia Public Finance and Competitiveness DPL (P171851) Share of fossil fuel consumption subject to excise 57.5 percent in 2017 92.9 percent in 2019 taxation. Percentage of electricity consumers able to choose an electricity supplier at the open market increased. 50 percent in 2017 100 percent in 2019 Average number of bidders per competitive procurement procedure increased. 3.41 in 2017 Above 3.41 In at least three No inspectorates have Risk-based inspection introduced. inspectorates relevant for risk-based inspection. businesses by mid-2020 D. Project Description This operation supports North Macedonia’s efforts to strengthen public finances, improve market competition, and reduce the regulatory burden. The proposed operation is organized under two pillars: (i) strengthening public finances and (ii) improving market competition and reducing regulatory burden. The proposed operation supports reforms to improve efficiency of public finances in the areas of tax policy, pensions, social benefits, and public finance management that would contribute to the medium-term fiscal sustainability. Reducing the deficit and stabilizing debt over the medium-term will reassure financial markets ahead of the 2020-21 refinancing surge at 8 percent of GDP a year. These reforms are consistent with the government’s Fiscal Strategy 2019-22. Furthermore, this operation supports reforms aiming to boost competitiveness through energy, procurement and inspections reforms. The government’s Economic Reform Program 2018-21 aims to strengthen revenues, improve public financial management, increase market competition, further ease the environment for doing business, strengthen labor market and social protection. The DPL support key reforms that aim to safeguard fiscal sustainability and support private sector competitiveness reforms. The operation has been closely coordinated with international partners (including the IMF, EC, USAID and other bilateral partners) to ensure complementarities in policy support and technical assistance. E. Implementation Institutional and Implementation Arrangements The Ministry of Finance is responsible for coordinating the proposed operation. The line ministries, and in particular the Ministry of Labor and Social Policy, have major roles in implementing the actions set forth in the policy matrix and have been coordinating the technical support requirements with development partners. The results indicators set out in the Policy matrix will be used to monitor progress. The Bank, in collaboration with the authorities from North Macedonia, will monitor and evaluate the program’s achievement of these results. F. Poverty and Social Impacts and Environmental Aspects Poverty and Social Impacts This operation is expected to have high social and gender, and strong positive environmental impacts. The social benefit reform will have the highest positive impact. The introduction of the better-targeted Guaranteed Minimum Income with an increased threshold and a benefit will have positive direct social impact on the poor. The expansion of the child allowance program will be complemented with the strengthened targeting of the parental allowance program for families with three children. The energy law introduces the obligation to the government to develop annual energy poverty programs, while pension reform aims to safeguard replacement rates from declining in the future. The personal Page 4 of 6 The World Bank North Macedonia Public Finance and Competitiveness DPL (P171851) income tax reform will have positive, though very small impact on reducing income inequality. The proposed introduction of progressive rate will affect only top 1 percent of tax payers, while the increase in the non-taxable part of the income will boost incomes of the bottom 40. In addition, reforming social benefits that discourage employment is expected to have positive impacts in particular on female labor market engagement and labor income, the most important channel for sustainable poverty reduction. Environmental Aspects This operation is expected to have positive environmental impact. Direct positive impact on the environment is expected through three prior actions related to the introduction of the excises on coal, gas and electricity, social benefit reform, and the energy law. The reforms supported by the PBG will have high positive environmental impacts and will contribute to mitigation and adaptation measures to combat adverse climate impacts. G. Risks and Mitigation The assessed risk for the proposed operation is substantial. These risks stem from political pressures associated with the implementation of the supported reforms in a current coalition government that came in power in May 2017. The resolved country name dispute in February 2019 opened up NATO accession process and is likely to unlock the EU accession negotiation process stalled since 2009. These processes should alleviate political risks. Despite the country’s relatively moderate indebtedness, macroeconomic risks include: (i) growth shock related to the deterioration in the external (including EU) prospects and political tensions; and (ii) potential delays in the implementation of consolidation measures, and accumulation of new contingent liabilities. Support provided by all international partners should help ensure commitment for implementing the ambitious reform program. . CONTACT POINT World Bank Sanja Madzarevic-Sujster Senior Economist Borrower/Client/Recipient Ministry of Finance Suzana Peneva State Advisor suzana.stoimceva@finance.gov.mk Implementing Agencies Ministry of Labor and Social Policy Sanela Shkrijelj Secretary General SSanela@mtsp.gov.mk Ministry of Finance Page 5 of 6 The World Bank North Macedonia Public Finance and Competitiveness DPL (P171851) Suzana Peneva State Advisor suzana.stoimceva@finance.gov.mk FOR MORE INFORMATION CONTACT The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 473-1000 Web: http://www.worldbank.org/projects APPROVAL Task Team Leader(s): Sanja Madzarevic-Sujster Approved By APPROVALTBL Country Director: Lada Strelkova 05-Aug-2019 Page 6 of 6