Ukraine - Programmatic Adjustment Loan Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-7473-UA REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED FIRST PROGRAMMATIC ADJUSTMENT LOAN (PAL I) IN THE AMOUNT OF US$250 MILLION TO UKRAINE August 23, 2001 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization  UKRAINE FIRST PROGRAMMATIC ADJUSTMENT LOAN Currency Equivalents (Exchange Rate Effective as of 01/01/01) Currency U)nit =Hryvnia UAH 1.00 = US$ 0.1838 US$ 1.00 = UAH 5.44 Government Fiscal Year January 1- December 31 Weights and Measures Metric System Abbreviations and Acronyms BTI - Bureau of Technical Inventory CAS - Country Assistance Strategy CIS - Commonwealth of Independent States CoM - Cabinet of Ministries DKZ - State Committee on Land EBRD - European Bank for Reconstruction and Development EFF - Extended Fund Facility EU - European Union EUTACIS - European Union - Technical Assistance for CIS FDI - Foreign Direct Investment FSU - Former Soviet Union GDP - Gross Domestic Product IDF - Institutional Development Fund IFI - International Financial Institutions IMF - International Monetary Fund NBFS - Non-Banking Financial Institutions NGOs - Non-governmental organizations PAL - Programmatic Adjustment Loan PER - Public Expenditure Review PSD - Private Sector Development PWG - Privatization Working Group SIDA - Swedish International Development Agency SME - Small and medium enterprises SOE - State owned enterprises TA - Technical Assistance UAH - Ukrainian Hryvnia USAID - US Agency for International Development WTO - World Trade Organization Vice President: Johannes F. Linn Country Director: Luca Barbone Sector Director: Pradeep Mitra Team Leader: Dusan Vuovic  FOR OFFICIAL USE ONLY REPORT AND RECOMMENDATION OF THE PRESIDENT OF THIE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED FIRST PROGRAMMATIC ADJUSTMENT LOAN TO UKRAINE Table of Contents Loan and Program Summary ..............................i I. ECONOMIC AND POLITICAL DEVELOPMENTS . . A. Background .I B. Medium-Term Economi. Prospects and Creditworthiness .5 C. Addressing Poverty Through Systemic Reforms .6 II. THE REFORM PROGRAM .................... 10 A. Fiscal and Financial Discipline .12 B. Regulatory Reform .15 C. Creating and Protecting Property Rights .18 D. Public Sector Accountability .22 E. Management of Social and Environmental Risks .27 [II. BANK GROUP STRATEGY ............................. 32 A. The World Bank ............................. 32 B. Coordination with the IMF ............................. , 33 C. Coordination with Other Donors ............................. 33 IV. THE PROPOSED LOAN .................................. 34 A. Program Design .34 B. Actions Taken Prior to Board Presentation .35 C. Actions Taken Prior to the Second Tranche .39 D. Loan Administration .41 E. Benefits and Risks .42 F. Arrangements for Implementation and Monitoring .43 V. RECOMMENDATION ................ 44 ANNEXES: Annex 1: Key Economic Indicalors (1995-2002) Annex 2. Status of Bcnk Group Operations and Status of IFC Operations Annex 3. Timetable qf'Key Processing Events Annex 4: Letter of Developmnent Policy Annex 5. Matrix of Inslinutional and Policy Outcomes Annex 6: Country at a Glance This document has a restricted distribution and may be used by recipiertts only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.   UKRAINE FIRST PROGRAMMATIC ADJUSTMENT LOAN LOAN AND PROGRAM SUMMARY Borrower: Ukraine Amount: US $250,000,000 Terms: Variable Spread Loan (VSL) in US Dollars under standard Bank terms. Commitment Fee: Standard Bank terms. Front End Fee One percent of the loan amount payable with the firsi: tranche. Objectives and The proposed Loan of US$250 million equivalent is a Description: Progranmmatic Adjustment Loan (PAL) that will support the Medium-Term Econiomic Development and Reforn Program of the Government of Ukraine. It is envisaged that over FYOI-03, there could be up to three PAL operations tco support the implementation of the Government Program. PAL I will have two tranches: the first based on past achievements and the second linked to the track-record of the new Cabinet appointed in May 2001. Subsequent PALs are expected to be single-tranche operations based on results. Ukraine's reform program aims to set the basis for sustained economic growth, poverty reduction and improved environmental protection. It seeks to build key missing institutions of a market economy and improve public and private sector governance, while maintaining macroeconomic stability. The first PAL operation rewards the progress already accomplished and continued reform efforts in the following five thematic areas of the medium-term Government Program: * Improved fiscal and financial discipline through elimination of non-transparent budget offsets, reduction of budget arrears and an increase in cash collections for energy; in the medium run, the objective is to resolve the non-payment problem and reduce the stock of arrears from 90 to 20 percent of GDP; * Better regulatory framework for entry and operation of enterpris-s through shorter and more efficient registration and licensing procedures and rationalized business inspections; in the medium term, the objective is to improve fiurther corporate  governance and introduce modern regulatory functions in critical sectors (including telecom, energy and finance); * Creation and protection of clear property rights has already produced initial results in advancing transparent privatizations of large industrial and energy companies, Ukrtelecom and agricultural land, and the start of bankruptcy procedures for the largest indebted enterprises and banks; in the medium run, improved property rights will be the basis for the revival of economic growth coming from private investment and FDI; * Strengthened public sector accountability through greater fiscal transparency, rule-based intergoverrnental transfers, improved procurement procedures, advances in streamlining the government and reforming the public administration; in the medium run, the Government is committed to completing the reform of the fiscal system and meeting international fiscal transparency and special data dissemination standards; and * Improved social and environmental risk management is based on strengthening the effectiveness and inclusiveness of social benefits and social care services, improving old-age income security through pension and social protection reform, and on reducing the risks of poverty and further environmental d gra('4tion; in the medium run, the implementation of the govertiment program will help complete the pension reform, streamline social assistance, provide a basis for better delivery of health and education services, and put in place a viable system of environmental protection. The financial support under PAL I will help Ukraine meet its budget resource needs, increase foreign exchange reserves and rebuild its creditworthiness in international markets. The resources of the first tranche will be made available upon achieving real reform outcomes on the ground, while the release of the second-tranche would be linked to establishing and sustaining a track record of the new Government in areas supported by PAL. Benefits: The benc.1ts already achieved under PAL I are: (1) reduced budget arrears and improved cash collections in the energy sector; (2) reduced cost of entry and operation of businesses; (3) discontinuation of Kolkhozes and issuance of 6.5 million land ownership certificates and 1.3 million land titles to former Kolkhoz members; (4) a more transparent transfer of budget resources from the center to the regions based on a clear formula; (5) streamlined public administration with reduced number of ministries and scaled-down Cabinet of Ministers; and (6)  rationalized system of social benefits. Additionally, PAL I has helped the Government markedly improve policy coordination and engage the cooperation of civil society in the design and implementation of reforms. These benefits woulcl be sustained and expanded through the second tranche of PAL I and subsequent operations in the PAL series. Risks: The substantive reform results supported by PAL :[ have already been achieved on the ground. There are, however, important risks to the medium-term program, stemming, as discussed in the FY01 - 03 CAS, from the highly volatile political and socioeconomic environment. While these risks must not be undeirestimated, the reform orientation and the results already attained over the past 18 months merit support by the Bank. Were the reform program to go off-track at any time during or after the first operation, so that the medium-term program goals were jeopardized, built-in safeguards would be activated and further Bank exposure would be automatically stopped. Schedule of US$150,000,000 upon loan effectiveness (expected in late Disbursements: September/early October 2001); and US$100,000,000 million upon meeting the second tranche conditions (expected by the end of 2001). Poverty Category: Not ipplicable Rate of Return: Not .mppicable.. Project ID Number: UA-PE-70693 The task team includes: Dusan Vujovic, Deborah Wetzel, Larisa Leshchenko, Svetlana Budagovskaya, Joel Hellman, Katerina Petrina, Andriy Storozhuk, Valeriy Gladkiy (ECSPE); Luis Alvaro Sanchez, (consultant); Luca Barbone, Lilia Burunciuc, Eugenia Marinova (ECC II); Csaba Csaki (RDV); lain Shuker, Aleksander Kaliberda (ECSSD); Adriana Damianova, Alexei Slenzak (ECSSD); Carolyn Gochenour, Yuri Miroshnichenko, Vakhtang Kvekvetsia (ECSEG); William Porter (COCPO); Jordan Schwartz, Philip Gray (PSAPP); Vlado Kreacic, Andrei Mikhnev, Alex Fleming, Khaled Sherif, Katalin Forgacs, Angela Prigozhina (ECSPF); Galina Sotirova, Laura Rose, Peter Darvas, Yelena Fadeyeva (ECSHD); Zoran Anusic (CCC05); Miroslav Ruzica (ECSSD); Gregory Jedrzejczak, Natalia Cherevatova, Anna Musakova, Maria Koreniako (ECCUA); Carlo Maria Rossotto (CITPO); Sanjay Vani (ECSCS). Peer Reviewers include: Victoria Elliot (OEDCM) and Charles Humphreys (AFTM4). The project has benefited from quality control feedback by Samuel Otoo, Pervaiz Rashid (ECSPE); Michal Rutkowski (ECSHD); Ira Lieberman (ECSPF); Alex Fleming (ECSPF); David Craig (ECSEG); Laura Tuck (ECSSD); Richard Westin, John Hegarty (ECSCS).   REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED FIRST PROGRAMMATIC ADJUSTMENT LOAN TO UKRAINE 1. I submit for your approval this Report and Recommendations on a proposed Programmatic Adjustment Loan to Ukraine for US$250 million to support the Medium-Term Economic Development and Reform Program of the Government of Ukraine, approved by Parliament. This loan is the first operation of the three under the Base Case scenario envisaged in the CAS discussed by the Board on September 12, 2000. This document and the accompanying Letter of Development Policy discuss the three-year program framework, as well as the specific benchmarks applying to this first operation. I. ECONOMIC AND POLITICAL DEVELOPMENTS A. Background 2. Nation building. After independence Ukraine faced two main tasks: to build a new country and to make the transition from a command to a market economy. On the first count, Ukraine has avoided conflicts that have beset other CIS countries and has managed to develop a working political system, based on a new constitution and the emergence of a democratic, albeit still imperfect, political culture. However, within the task of building a new nation, limited priority was given to setting up the necessary institutions of a market economy. Ukraine's initial efforts to introduce new legislative and executive agencies of an independent nation state were hampered by the obsolete Soviet institutional framework still in place. Thus, the resulting state rules and procedures lacked transparency and gave old-fashioned bureaucrats an opportunity to capture power from within. Partially in response to these developments, the 1996 Constitution gave Parliament considerable oversight power over the executive. The result was a stalemate between the Parliament and the Government that effectively blocked all reform initiatives for almost two years, up until the presidential elections held in late 1999. The presidential elections changed the balance Qf political power and led to the creation of a pro-Presidential majority in Parliament. In December 1999 President Kuchma appointed Victor Yushchenko as Prime Minister, who assembled the most reformist Government since independence. The 'Yushchenko Government and the parliamentary majority worked constructively for over a year making important advances in completing the institutional and legal basis for sustained reforms in Ukraine. In the aftermath of the political crisis triggered by the "tape scandal", the Presidential majority in Parliament disintegrated, and the new ad hoc coalition of communists and oligarchs forced Yushchenko out of office despite a long list of impressive reforms and very solid macroeconomic performance achieved over the previous sixteen months. 3. Anatoliy Kinakh, who was appointed new Prime Minister in late May, has retained twelve ministers from the previous Government (including all key economic posts) and pledged to continue the institutional and structural reforms as well as promote social programs and address the issues of poverty. The new Prime Minister has made a strong commitment to  - 2 - increase transparency of Government operations, disseminate on a regular basis information on Government activities to the civil society at large as well as fight corruption. 4. Economic Outcomes. Over the last decade, up until the beginning of the year 2000, the limited attention given by post-independence governments to economic reform had detrimental consequences for the economy and society more generally. As discussed in section C below, slow progress in economic and institutional reform, lack of protection of property rights, abusive behavior on the part of the state apparatus against private business and the resulting rent-seeking behavior on the part of powerful insiders led to a situation in which few incentives existed for private business to flourish. Not surprisingly, economic performance during the first decade of independence was disappointing. Official GDP per capita is now around US$750 (Atlas methodology), and official GDP in real terms is only 40 percent of its 1990 level (although these figures do not take into account the rapid growth of the informal economy, thought to be as high as 50 percent of the official one). Economic diversification has been limited and the country continues to depend on former Soviet Union countries for a large portion of its international trade. Agriculture has shrunk dramatically. Only tertiary activities expanded in relative terms. Foreign direct investment has been among the lowest in the region. 5. Increase in absolute and relative poverty. The incidence of poverty has increased considerably in Ukraine to the point that 29 percent of the population now lives below the poverty line, but only 3 percent in extreme poverty.' A fifth of the population is working part- time or is on administrative leave; formal unemployment has risen to 11 percent of the economically active population. (For further detail on Ukraine's poverty profile, see Box 1). At the same time, the human and physical capital stock has deteriorated. The underlying reasons for these developments are: * Significant decline in real earnings since 1989. Official statistics indicate that, between 1991 and 1999, measured national income declined about 60 percent, on a cumulative basis.2 There is widespread dissatisfaction with the standard of living, and a deep sense of a sharp decline in real incomes. One reason is a significant shift of the sources of incomes from the official sector of public enterprises and institutions to the private sector--mostly in the shadow economy. The new structure of incomes is inherently less reliable than the old one, and makes decisions about spending patterns less stable. In addition, the shift from the "economy of shortages" to the "economy of full shops" made households' budget constraints more acute and visible. Therefore, for many families the level of consumption has dropped; they can no longer compensate for the lack of purchasing power by spending more time waiting for goods, bartering for them, or acquiring them on the black market. Ample anecdotal evidence suggests that inequality has increased, with the emergence of a small I The results are based on the 1999 household survey, in which, following international standards, "poor' is defined as having daily consumption equal to $4.30 per person or less, and "extremely poor" as having consumption of $2.15 per person or less. 2 At the same time, the size of the shadow economy has grown significantly. However, the size of the informal economy has yet to be established with some certainty, but by all accounts it is reportedly substantial, ranging up to 50 percent of measured GDP. The last country CEM established the size at around 40 percent. But household surveys, for instance, do not pick up evidence of massive unreported employment The bulk of the estimated informal economy is largely a reflection of underreporting by officially-registered firms to subtract income from SOEs and avoid taxes.  -3 - class of very wealthy individuals that have benefited from the initial stages of the transformation. BOX 1: POVERTY IN UKRAINE More than one out of four people--some 29.4 percent of the population--is poor (defined as having consumption equal to $4.30 per person per day or less), based on results of 1999 household survey. By international standards, only 3 percent of the households are extremely poor as they have consumptiion of less than $2.15 per person per day. At the same time 18 percent of the households are spending 4/5 oiftheir total expenditures on food. While valid comparisons between the results of the latest survey and earlier surveys are complicated by problems related to survey methodology and determination of the poverty line, it is generally agreed that poverty in Ukraine has increased during the 1990s. This trend has been fueled mainly by a decline in real incomes during the transition period. Who are the poor in Ukraine? As in many other countries of the Former Soviet Union (FSU), they are, in particular, families with children (especially those with three and more children, and those with children under the age of three); the elderly living alone, especially pensioners that cannot supplement their pensions with some form of paid work; the unemployed; and-increasingly--the working poor. Households headed by females appear to be at higher risk as are single mothers/providers or widows. Key facts are as follows: * Poverty is not confined to those with low/limited opportunities for outside employment. Because of low real wages and wage arrears, the share of poor households with a formally-employed head is more than 40 percent. * At the same time, there is a strong correlation between unemployment status of head of household, and poverty. The poverty rate of households with an unemployed head was 37 percent, and 20 percent of such households were very poor. * Poverty rates are much higher among the single elderly, especially those above age 75. However, more generally poverty among pensioners is tempered by the fact that a large number of such people keep working. Some 22 percent of males and 13 percent of females aged 60 to 70 work. * Households with children are more likely to be poor, and the likelihood of poverty increases with the number of children. * Poverty is correlated with lack of education and occupational skills: the higher the education level of the head of household, the less likely the household is to be poor. . Poverty is differentiated by regions and related to residence outside growth areas (Kyiv city, Chernihiv, Kharkiv and Transcarpathia show the lowest poverty rates). * While owning a plot of land will mitigate poverty, plot size plays an important role in determining poverty. On average, the plots of poor households are half the size of those of the non-poor. All this indicates a complex, structurally-based picture of poverty, with a significant share of poor and very poor people, differentiation in poverty by region and status of human capital and asset ownership/access. Poverty is clearly linked to lack of progress in creating an economy that can offer productive jobs. Source: Ukraine CAS, September 2000 and Ukraine: Social Safety Nets and Poverty, December 2000, ECA Region. * Areas of structural poverty. Changes in relative prices imply that many of t.he activities carried out under the old system are no longer viable. One-factory cities, industrially- specialized areas such as the coal mining areas, and the rural areas are particularly affected by such structural poverty. Certain groups such as single old people and single mothers also continue to be particularly vulnerable. * Poor delivery of social services. Shrinking budgetary resources and unclear definition of responsibilities have led to deterioration in social service delivery. In Soviet times, large  - 4 - state enterprises were responsible for the provision of many social facilities including kindergartens, schools, hospitals, sports and social welfare facilities. With the onset of reforms, many of these responsibilities were passed on to local governments that lacked the resources to take on these functions. In some cases, communities have simply curtailed the provision of such services. In others, providers of social services (such as health care and education) exploit the relatively stable demand and charge "informal fees" for access to these services. Poor health status. Deterioration in service delivery and increasing poverty has led to poor general health status of the population. The situation is worsened by recent, as yet uncontrolled, epidemics of tuberculosis and HIV/AIDS. By 1998, the number of TB cases had reached 27.8 thousand, an increase of almost 73 percent since 1990. HIV/AIDS had been relatively unknown in central and Eastern Europe until the mid-1990s. In recent years, however, the pace at which HIV has begun to spread has become astronomical. While the total number of reported cases was 398 for the whole 1987-1994 period, UNAIDS now estimates that there are between 200 and 240 thousand HIV-infected persons in the country. Ukraine is believed to have the highest adult prevalence of HIV in the region, about 1 percent of all adults. Although the epidemic continues to be fueled by high-risk behaviors, Ukraine may be the first country in the region to face the eminent spread of HIV into the general population. 6. Poverty in Ukraine has been artificially mitigated by open and hidden subsidies for basic consumer goods and services (such as bread, housing, public transportation, electricity tariffs) and a tacit approval of non-payment for housing and utilities. Although these subsidies alleviate the immediate poverty impact, they are very inefficient and could block reforms to remove them as they involve painful social and increasingly difficult political choices. However, the current system of significant implicit subsidies to supply basic goods to the population is not economically sustainable and limits the possibilities for economic renewal. 7. Reversing the decline As a response to these outcomes, for the first time since independence, the Ukrainian Government in the year 2000 prepared a medium-term program that signaled a clear departure from the past and secured endorsement of the Verhovna Rada. Against the negative background of the performance of the 1990s, the economic situation turned around in the year 2000. Led by robust double digit industrial growth , particularly in food- processing, light industry, and metallurgy, GDP grew by 6 percent in 2000 and recorded 8.5 percent for the first five months of 2001. In recent months, robust industrial growth has been further augmented by increased output in agriculture, long the weakest sector of the economy. These positive developments would represent a clear break from the past only if institutional and structural reforms are continued at an accelerated pace. 8. The economic rebound began as a result of the combined effects of the Hryvnia devaluation, strong economic growth revival in the Russian Federation and other trading partners, and the increase in domestic demand following an improved pension and wage payment record. The large unused capacity existing in the country allowed a quick supply response and the pick-up in economic activity. However, all observers recognize that for sustained growth in the medium term an increase in private capital investment will be required: this is unlikely to materialize if the momentum for reform is not maintained and if the systemic issues that have prevented private sector growth in the past are not addressed.  -5 - B. Medium-Term Economic Prospects and Creditworthiness 9. An improving external position. Since the interest of private investors in lJkraine's domestic debt market sagged in late 1997-early 1998, the country has been struggling to defend its foreign exchange position and prevent a balance of payments crisis. At times, the level of official foreign exchange reserves dipped below one week of imports. The threat of the Russian contagion to the exchange rate and macroeconomic stability in 1998-1999 were prevented through: (a) a strong support from international financial institutions; (b) significant turn-around in the balance of payments; (c) rescheduling of a number of domestic and external debts; and (d) a temporary introduction of administrative foreign exchange restrictions. IFI's support included a substantial resource inflow including, for example, a disbursement of more than US$700 million in adjustment lending between September 1998 and September 1999 by the World Bank alone. Improvements in the trade and current account balance were due to the real devaluation and strong external demand. The current account deficit that gradually went down from US$1.5 billion in 1997 to US$ 1.3 billion in 1998, rapidly turned into a surplus of US$834 million in 1999, and US$1.5 billion in 2000. 10. The swap of privately-held debt carried out in March 2000 spread US$2.3 billion in Eurobonds maturing in 2000-2001 over the subsequent seven years. The debt-servi.ce burden was further eased by a stay on Paris Club debt although its formal rescheduling is still pending. The debt relief and a large current account adjustment has allowed the National Bank to purchase substantial amounts of foreign exchange for its reserves and debt service since the Spring of 1999 and yet maintain a stable nominal exchange rate (following a strong devaluation in the aftermath of the Russian financial crisis). Through much of the year 2000 Ukraine maintained foreign exchange reserves at around US$1 billion and gradually increased them to US$1.8 billion during the first half of 2001 while remaining current in its obligations with IFIs. 11. Based on recent positive economic developments, the prospects for revival presented in the 2001-03 CAS document remain a valid medium-term framework. That framework assumed a medium-term scenario in which the economy slows down somewhat following the 2000 revival to gradually approach a 3.3 percent longer-run annual equilibrium growth rate by 2003. The somewhat higher transition growth rates (4.0 and 3.5 percent) projected in 2001-2002 can be attributed to the reforms already undertaken as well as the continued, albeit gradually fading, impact of: (a) strong economic performance in Russia; (b) presence of idle industrial capacity; and (c) favorable price developments on international markets. 12. The higher rate of economic growth in 2000 and early 2001, and Government's ability to initiate the build up of foreign exchange reserves indicate that a more ambitious growth path may be achievable if the Government succeeds in: (a) maintaining a sound macro-economic environment; (b) further advancing institutional reforms; (c) securing sustained IFI sapport; and (d) building creditworthiness in international capital markets. If this is accomplished, the economy could embark on a growth path 1 to 2 percent above the previous projections. To sustain increased growth rates, the country would also require substantial investmLent in new capital and upgrading of existing capacities, which takes time to yield a return and puts strain on the balance of payments in the interim. 13. Thus, in 2001, the country faces an opportunity to consolidate its reforms, farther build up foreign exchange reserves, change the profile of its external debt, further consolidate the  - 6 - fiscal position of the Government and finance the capital imports necessary to propel growth. The Government expects to increase the level of reserves and gradually approach the pre-1998 crisis levels (2-3 months of imports) while maintaining a sustainable presence on the domestic foreign exchange market. To consolidate its fiscal position the Government needs to (a) reduce the share of short term domestic and foreign debt; and (b) gradually eliminate budget arrears and restore its revenue capacity. This will not be possible unless there is renewed budget and balance of payments support from the IFIs. The resources provided under PAL are precisely intended to support these efforts in 2001 and subsequent years. Based on the actual budget performance data for the first half of 2001, it appears that the Government will experience an estimated 2.4 billion UAH shortfall in privatization proceeds due to lower effective sale prices caused by country risk perception factors, exacerbated by an apparent lack of IFIs financial support to Ukraine for almost two years now. Partially, this revenue shortfall has been compensated through improved tax revenue performance and expenditure management measures. A timely financial support from IFIs would be indispensable to avoid harsh sequestration measures, continue the reduction of budget arrears, improve the debt profile, including a repayment of short-term domestic debt that would effectively reverse the crowing-out effect of past years. If a similar strategy is pursued through the remainder of the CAS period the country would be ready to increase investment, sustain economic growth and meet its increasing debt service obligations in year 2002 and beyond when payments from rescheduled private sovereign debt start to come due. 14. If the country succeeds in maintaining macroeconomic stability and sustains implementation of the reform agenda supported under the PAL program, by the end of year 2002, it will have met the first set of conditions to restore its creditworthiness in international capital markets. Thereafter, the improved economic fundamentals and creditworthiness will set in motion the process of increased foreign and domestic investment, thereby strengthening the basis of economic growth and competitiveness of Ukrainian economy. C. Addressing Poverty Through Systemic Reforms 15. Fundamental to the Bank's mission in Ukraine is to assist the Government in reaching its strategic objective of reducing poverty and improving the welfare of its citizens. Against the backdrop of a decade of negative growth and increasing inequality, and in spite of recent improvements in performance, a clear question is how to more effectively address these issues. Recent work at the World Bank3 suggests three critical elements for addressing poverty: creating opportunities for the poor through the creation of an environment for new employment and growth, and improved human capital based on better access to education and health services; empowerment of the poor, through institutional reform, stronger public accountability and increased efficiency in the use of public resources based on greater involvement of civil society; and improved security for the poor, through the use of direct instruments to reach the most vulnerable, and by helping the poor to deal with volatility and hardship caused by the transition process. Our understanding of poverty in Ukraine, as set out in Box 1, suggests that creating an economy that can offer productive jobs, building human capital, strengthening the voice of the 3 See the World Development Report 2000/2001: Attacking Poverty. Washington D.C.: The World Bank, and Making Transition Workfor Everyone: Poverty and lnequality in Europe and Central Asia. Washington, D.C.: The World Bank.  7- - 7 - poor and improving the security of citizens are all important aspects of a strategy for poverty reduction. 16. However, as discussed in the 2001-2003 CAS, progress in pursuing the policies that would lead to greater opportunity, empowerment and security has been blocked by systemic obstacles. Institutional weakness and poor governance have hampered the effective implementation of policy and are at the root of the unsatisfactory performance of the 1990s. Weakness of institutions and poor governance are reflected in the gap between written rules and regulations and actual behaviors, particularly in the public sector. These systemic issues lead to a variety of behavior patterns that have a negative impact on all aspects of economic and social life. Among the most damaging have been the following: * Poor fiscal and financial discipline leading to serious non-payments problemns and soft budget constraints in the public and private sectors. The budgetary arrears of the Govemment have been a major source of non-payment problems in the economy, while the use of offsets among budgetary units and with state enterprises appears to be at the core of non-transparent, barter-type transactions and a major source of corruption. Unprofitable enterprises continue to operate on the basis of direct and indirect government transfers, fail to pay taxes, and create a very uneven playing field that prevents entry/exit and competition. 3 Weakly-defined and poorly-protected property rights. Some important laws necessary for stable commerce are either still missing (for instance, protection of investment rights and mortgaging), provide an inappropriate legislative base (for instance, leasing, banking and collateral legislation), or lack proper enforcement (for instance, the Law on Bankruptcy). The lack of adequate property rights in agriculture has reduced economic incentives and led to significant drops in productivity. Also, poor control of state-owned enterprises has resulted in considerable asset stripping and other loss of state property. * Capture of public institutions by private interests, as observed, for instance, in the way in which disposition of public assets has been implemented in the energy sector. * A highly complex and non-transparent regulatory environment, which has been a major source of corruption--with many agencies still entitled to "inspect" business and demand payments, particularly at the local levels. The weak and incomplete regulatory environment for natural monopolies, particularly the energy sector, has led to poor operating practices, deteriorating performance, and reduced operating capacity. * Non-transparent and poor management of public monies, as epitomized by concerns about the management of foreign exchange reserves of the NBU and a multitude of extra-budgetary funds, which have only recently been eliminated. * Increasing exclusion of the poor and weak cooperation with civil society. Dwindling public resources and poor institutional structures for the delivery of health, education and social protection (especially lack of proper definition of responsibilities among different levels of government) have led to the exclusion and impoverishment of increasing numbets of people. Civil society has only played a very marginal role in complementing public efforts to properly address critical emerging social problems.  - 8 - 17. The consequences of an incomplete institutionalframework and weak governance. In the context of these fundamental systemic issues, economic policies have not had the desired outcomes and traditional market mechanisms have been highly limited in their effectiveness. Under a culture of non-payments or barter transactions, for instance, economic agents do not have clear and transparent signals to guide their actions, thereby increasing transaction costs, and precluding rapid responses to market incentives. Likewise, weak property rights lower confidence in market operations and lead to the development of alternative enforcement mechanisms or outright exit from the markets. All of these developments have hindered private sector development and growth in Ukraine and have undermined the effective provision of social services. Moreover, they have contributed to delays in the restructuring of existing industry and have weakened the financial sector. The limited investment that has occurred has been allocated to activities with very low or even negative economic returns. Declining production has led to underemployment and contributed to increased poverty. These systemic issues are indeed significant obstacles to poverty reduction and reduced inequality. 18. The Nature of Ukraine's Development Challenge. The challenge for the country is to define concrete actions that address these systemic issues and, in doing so, help to support the elements of a broad poverty reduction strategy. The objective of the PAL is to support the Government in these efforts. Addressing systemic weaknesses in institutions and governance will remove critical obstacles to growth and opportunity, public accountability, strengthened civil society, and security. They will, therefore, help to pave the way for poverty reduction and reduced inequality in the future. 19. First, the program underlying the PAL provides the foundation for sustainable growth, with attendant job creation and higher incomes, which over time will lead to greater opportunities for the poor. By addressing the institutional and governance bottlenecks that have prevented private investment from taking a strong hold, it will be possible to capitalize on the present favorable economic juncture and create the conditions for sustainable, job-creating growth especially in small and medium enterprises. This requires addressing the key causes of the fiscal and financial non-payment problems, which have made it difficult for economically viable enterprises to operate and easy for bankrupt or financially non-responsible units to survive and remain active. It also requires a reduction in the transaction costs that are caused by excessive government regulation (registration, licensing, operation and bankruptcy) and strengthening of the necessary regulatory framework to facilitate the proper operation of critical sectors such as energy, telecommunications, banking, and pensions. Clear definition and protection of property rights, advances in transparent privatization, and effective implementation of bankruptcy procedures will all help to spur development of the private sector. Together, these elements will help to create an environment in which all enterprises and businesses face the same opportunities and constraints, and will thus reinforce the broad-based growth necessary for poverty reduction. 20. Second, the program strongly emphasizes the need to increase public sector accountability through increased participation in decision-making of citizens and NGOs at all levels of government. In order to broaden the reform constituency, the strategy has been developed with the active participation of NGOs and their associations and it assumes the involvement of broader civil society in the design and implementation of critical institutional reforms in the future. To secure the involvement of civil society, the Government plans to make  -9 - use of the existing large network of NGOs to disseminate the key features of its medium-term reform agenda and its main accomplishments thus far. The initial step in this process was to embrace the concept of developing an in-house capacity to communicate effectively with the NGO community and civil society. The next steps will build a specific work program to engage civil society participation in components of the Government Program that benefit from their participation in design, implementation, evaluation or oversight.4 These efforts to engage civil society in the reform process, combined with the specific measures to improve public sector accountability described in Section It, help to reinforce the effects of growth on poverty by empowering all citizens and giving voice to their concerns and needs. 21. Third, the program aims to support the security of the poor by undertaking a pro-poor restructuring of the existing social protection programs. This requires the consolidation and abolition of many "privileges" for a variety of special groups that are no longer justifiable on equity grounds. It also requires the reform of social security, comprising the elimination of pension arrears and the strengthening of the finances of the first pillar, as well as the development of the regulatory framework that will allow a more modem and sustainable system to be put in place as conditions warrant. The strategy also seeks to contain arnd reverse environmental degradation, which creates a different type of insecurity by adversely affecting the health and the well-being of the population. These elements support poverty redluction by addressing immediate concerns related to the quality of life. 22. Monitoring of poverty developments will be carried out in a continuous manner by the Government, with the help and assistance of the Bank. A household survey is now in place and capable of tracking shifting indicators of poverty across socio-economic and geographic groups. In conjunction with the preparation of the PAL, the Government has refined its ability to forecast the effects of changes in government policies on the poorer segments of the population, and is using this to refine its strategies of reform in the social sectors. 23. As suggested in the above paragraphs, key systemic reforms are needed to put Ukraine on the path to poverty reduction and reduced inequality. The joint Government-Bank strategy therefore focuses on systemic reforms in five areas that address critical institutional and governance issues: (a) Improvement of fiscal and financial discipline in the economy; (b) Development of a regulatory environment that encourages an even playing-field for economic activity; (c) Creation and protection of property rights; (d) Assurance of public sector accountability; and (e) Improved management of social and environmental risks. Some examples are: (a) evaluation of the regulatory framework for business; (b) evaluation of public budget outcomes; (c) feedback on government performance in critical revenue functions (Tax/Customs); (d) delivery of social services; and (e) progress in improving the environment. At present, this strategy was made feasible by extensive donor support channel to support numerous civil society initiatives. The challenge for the future will be to provide a stable legal and regulatory framework for non-profit organizations to secure income sources other than donations through the provision of regular services. This will also require NGOs to start working closely with local goveniments and public sector institutions that implement a large portion of the public budget.  - 10- Progress in dealing with these issues will help to close the gap between formal rules and informal behaviors and will thus help to create an environment that supports greater opportunities, empowerment and security for the poor. Section II examines these reforms in detail. I. TBE REFORM PROGRAM 24. Since January 2000, when the Yushchenko Government took office, there has been a substantial change in the conduct of economic and social policies, and in the attitude towards economic reform. The Government signaled clearly its readiness and determination to take bold reform steps and move the country out of the stalemate of the previous years. It focused its attention on the most critical policy and reform issues that had the broadest economic and social impact and would pave the way for further reforms in the future. The objective was to help sustain the nascent economic recovery and strengthen the pro-reform constituency in the country. The Government's efforts produced substantial payoffs (see Box 2). 25. In parallel, an intense effort was launched to formulate a medium-term reform program that addresses the key issues of reviving economic growth, reducing poverty, and phasing out social inequities linked to the transition. The main thrust of the Government Program was to identify and remove critical bottlenecks that obstruct economic restructuring efforts, increase transaction costs in the economy, weaken property rights, favor soft-budget constraints, and hinder the effectiveness of the state in the provision of social services and the protection of the poor. Thus, the Program a clear intent to advance cross-cutting, systemic reforms as a first step in a longer-term effort to achieve sustainable economic growth, improve economic welfare, eradicate poverty, and move the country to modern institutional and governance standards. 26. The actions already taken during 2000 and early 2001, as well as those proposed for the next two to three years are detailed in the Letter of Development Policy (LDP) and Matrix of Institutional and Policy Outcomes (Annex 5). The LDP provides the medium-term vision of the Government and details the process of institutional change, including the detailed milestones used to measure progress and interim policy inputs for each component of the program. The proposed PAL will support these efforts and assist the Government in reaching its reform objectives. Annex I sets out the PAL benchmarks agreed with the Government for measuring performance and determining disbursements. Resources under PAL would be made available to as the reform outcomes are obtained and in accordance with Ukraine's resource needs. The design provides sufficient flexibility to respond to any unforeseen circumstance that may arise. 27. The new Prime Minister Kinakh and his Government have made a strong pledge to preserve the results achieved thus far and to continue key institutional and structural reforms initiated by the previous team, as well as promote social programs and strive to alleviate poverty. The credibility of this commitment will be established through decisive reform and policy action and a build-up of a positive track record for the new Government. 28. As discussed above, the Government Program will pursue systemic reforms designed to help overcome impediments in five key areas: fiscal and financial discipline; regulatory reform; creating and protecting property rights; public sector accountability; and management of social and environmental risks. Each of these areas consists of a number of components which are discussed in turn below.  Box 2: POLICY AND REFORM ACHIEVEMENTS DURING 2000 - 2001 Despite the lack of foreign external financing through most of the year and the very difficult country image problem, inherited from the past and further aggravated by the emergence of new financial and political scandals, the Government can take credit for an impressive list of macroeconomic policy achievements since January 2000. MACROECONOMIC POLICY ACHIEVEMENTS . Achieving strong GDP growth in 2000 and the first half of 2001 for the first time since independence while maintaining a sound macroeconomic stance with improving price stability (CPI inflation declined from 25.8% in 2000 to less than 5% in January-May 2001), a balanced budget in 2000, and a growing current account surplus (estimated at US$1.5 billion for 2000); * Averting the contagion effect of the Russian crisis and an extemal debt crisis by successfully reprogramming private sovereign debt in excess of US$2.3 billion; * Servicing maturing external debt obligations of more than US$1 billion; * Getting relations with the IMF, the World Bank and other IFIs back on track; * Maintaining the level of foreign exchange reserves above US$1 billion throughout 2000 and increasing them to over $1.7 billion by late April 2001 in the absence of full financial support from the IFIs; and . Meeting its commitment to close the Chemobyl nuclear power station. INSTITUTIONAL AND STRUCTURAL REFORM ACHIEVEMENTS In addition to building a broad consensus for reform, the Government made important advances in implementing important elements of its medium-term programi, (as detailed below in Section II); In improving payment discipline signif cant improvements include: * Elimination of netting budget operations (resulting in increasing share of cash revenues from 80% in 1999 to almost 100% in 2000), declining use of barter (from 32.7% in 1999 to 17.1% in 2000); and ieduced budgetary arrears through elimination of pension arrears and reduced arrears on wages (by 60%) and energy (by 75%/o); . Increased cash collection for electricity from 15% in January 2000 to 58% of bills for the six months ending in April 2001; and gas which averaged 50% in the year 2000 and increased to 87% in April and 68% in May 2001. Improved business environment through: * Easier entry based on one-stop shop registration with reduced cost (from US$192 in 1997 to US$67 in 1999) and shorter registration time (from 34.7 days in 1997, to 11.6 days in 1999, and an expected 5 days in mid- 2000); * Streamlined business licensing procedures allowing single-license for multiple economic activities. * Reduced number of business inspections (from 30 during 1998, to 16 during 1999, and 10 in 2000). Progress in WTO accession negotiations signaling commitment to liberalize trade and change relevant legislation. Improved protection of property rights including: . Elimination of state ownership of land and the issuance of 6.5 million land certificates to former Kolkhoz members, on the basis of which almost 1.3 million land title deeds will be issued in 2001. * Completed transparent privatizations of nine large industrial enterprises, mostly in metallurgy and oil processing, and six electricity distribution companies (Oblenergos). Greaterfiscal transparency and more efficient public administration through: * The implementation of the new procurement law which led to a 29-fold increase in the nurnber of announced tenders compared to 1999 and produced a 20% estimated savings to the budget; * The introduction of a formula-based system of allocating resources to the Oblasts and from the Oblasts to rayons in the 2001 budget yielding more transparent fiscal relations. * The elimination of 256 Cabinet orders granting individual tax and customs exemptions. * Reduced number of central state bodies (from 80 to 50) and downsized Cabinet from over 50 to 20 members; * Creation of specialized Cabinet Committees, downsizing and reorganizing the Cabinet Secretariat. In the broad social area key accomplishments thusfar include: * In pension reform: introduction of personal pension accounts and transfer of pension determination function to the Pension Fund; * In social insurance reform: introduction of social insurance database; administrative consolidation, move to unified targeting methodology, and expansion of the social care network (750 enters /10,000 out-reach persons). . Elimination of professional and other privileges that are notjustified on poverty and equity grounds. . In health sector, efforts to improve control of public health risks, better allocate resources; and foster primary health care through family medicine centers and university specialization. . In education, adoption of a national 12-year compulsory education program.  - 12 - A. Fiscal and Financial Discipline 29. Lack of fiscal and financial discipline during the past decade led to a large accumulation of fiscal and inter-enterprise arrears with negative consequences on contract compliance and the overall business environment, thus affecting the level of economic activity and employment, real incomes, and timely payment of wages and pensions. Predictably, the social groups most adversely affected by these developments included the elderly, the underprivileged, and those reliant on incomes and transfers financed from the budget, e.g., those most likely to be poor. 30. The medium-term vision of the Government Program in this area is to foster financial discipline, correct the weaknesses that underlie present macroeconomic imbalances, attract FDI and promote sustainable growth. More specifically, the medium-term objective is to gradually eliminate the non-payment problem by substantially reducing the stock of accumulated arrears over the next three years to levels comparable to international and regional standards (i.e., from about 90 percent of GDP presently to the regional average of around 20 percent of GDP). The Government has decided to lead this process by: (i) addressing budget and tax arrears, and (ii) by focusing on the resolution of energy sector arrears as the nexus of the inter-enterprise payment problem in the economy. 31. Budget and tax arrears. The Government has begun to create the conditions necessary to eliminate the chronic non-payment problem including fiscal (budget, tax) and inter-enterprise arrears. The first step has been to control the use of veksels (promissory notes) and budgetary offsets. Veksels were introduced to allow budget-spending units to continue procurement of goods and services in the absence of regular budget revenues. Recipients of veksels could use them to settle tax obligations. However, veksels were issued as promissory notes in order to facilitate offset operations, rather than as a tradable financial instrument (government bonds or treasury bills). As a consequence, veksels had no clear market value. This provided an opportunity for budget spending units and providers of goods and services to engage in non- transparent exchanges and misreport related transactions. Over time, this eroded budget and tax discipline and provided an opportunity for corrupt practices resulting in: (a) higher effective prices for goods and services procured under the budget; and (b) lower effective cash collections. 32. In June 2000, the Cabinet issued an order discontinuing the use of veksels, except for a very limited number of special cases. In the budget for the year 2001, the Government completely disallowed the use of offsets. The policy actions of the Government to improve fiscal discipline during 2000 have been an important first step to increase budget transparency and to reduce the scope for corruption. They have already had effective results on the ground: * Cash revenues of the consolidated budget have increased substantially (from 78.3 percent of total revenue in 1998 and 82.7 percent in 1999, to 99.4 percent in 2000). * The use of barter by industrial enterprises has decreased substantially from 42.5 percent in 1998 to 32.7 percent in 1999, and 17.1 percent in 2000. Preliminary data indicate further reduction to less than 15 percent during the first quarter of 2001.  - 13 - * The Government has also selectively reduced budgetary arrears-beginning with pensions. By mid-September 2000, the Government had completely eliminated pension arrears that stood at 1.3 billion UAH at the beginning of the year; it has remained current ever since. * During 2000 and early 2001, the wage arrears payablefrom the budget have been reduced by almost 60 percent to less than 470 million UAH, while social protection arrears have been reduced by 26 percent and stood at about 700 million UAH at the end of the firsi; quarter of this year. * During the year 2000 and the first two months of 2001, the outstanding amount: of energy arrearsfrom the budget has been reduced by 4.2 billion UAH or almost 75 percent. 33. To address the remaining fiscal non-payment problems on a more permaneni. basis over the next three years, the Government has committed to developing a comprehensive strategy to settle the stock of budget and tax arrears in a consistent and definite manner. The objective of this strategy is to close the gap between expenditures and revenues on a cash and a commitment basis in the context of a sustainable medium-term fiscal framework, taking into account hidden contingent liabilities. A range of workout mechanisms (including debt conversion, securitization and bankruptcy procedures) will be considered to resolve overdue obligations and settle fiscal imbalances. The end result will be a realistic timetable to reduce the remaining budget and tax arrears, which will allow the Government to stay current thereafter. The Bank will support the Government in the implementation of that strategy. 34. Inter-enterprise arrears. The budget arrears and lack of financial discipline in the productive sectors led over time to mounting inter-enterprise arrears. By the end of 1999, past due inter-enterprise arrears (payables) in Ukraine reached 93 percent of GDP. This is very high compared to Russia (60 percent) and peak levels of comparable arrears in Central European economies (20-30 percent). The alignment of payment practices in the productive sectors with Central European standards will have significant positive effects on the business environment and FDI. 35. To address this critical problem, the Government program has chosen to focus first on the energy sector, particularly electricity and gas sectors. Although energy arrears (estimated in January at UAH 10 billion for electricity and another UAH 5 billion for gas) represent a small part of the overall inter-enterprise non-payment problem, the electricity arrears still represent more than half of the annual average electricity sales of UAH 15 billion in the wholesale electricity market (Energomarket). In addition, the energy sector is a net lender to the rest of the economy and improved collection of energy payments is expected to have significant demonstration and positive multiplier effects. Increased internal financial discipline will enable timely payments for energy imports 5 and help reduce the energy intensity of the country. 36. Progress has been remarkable: 5 Internal debts to the gas sector directly contribute to the outstanding external debt for gas estimated at around US$1.5 billion.  - 14- * A growing proportion of cash payments for electricity has been secured through an improved legal and regulatory framework that effectively broadens the scope of electricity cut-offs as an effective means of enforcement, eliminates non-cash forms of payment, and streamlines the handling of cash payments from consumers. Last year, 23,000 non-paying electricity consumers (mostly enterprises) were cut off, sending a truly remarkable message on the credibility of budget constraints. * As a result, cash payments from the Oblenergos to the Energomarket increased dramatically, from 15 percent of electricity bills in January 2000 to an average of 58 percent of bills for the last six months ending April 30, 2001. * Cash collections in the gas sector improved and averaged 50 percent for the year 2000 and continued to improve during the first five months of this year (reaching 87 percent in April and 68 percent in May). 37. This performance in the electricity sector allowed the Government to reach the target envisaged under PAL 1 (i.e., at least 50 percent cash collections for the electricity sector during the last six months) and bodes well for achieving the more ambitious targets set by the Government for the second (65 percent over nine months) and third PAL (full collection adjusted for the billing cycle). In the gas sector, the same 50 percent cash collection target has been established for all consumers purchasing gas from Naftogas, but it will be measured over the last three months. Like in electricity, for the second PAL the target for cash collections over nine months will be increased to 65 percent, and in the third PAL to full collection (again, adjusted for the billing cycle). 38. The Government strategy also addresses the outstanding stock of past electricity and gas debts. To deal with the stock of outstanding electricity debts, the Ministry of Fuel and Energy has already identified all debts of enterprises and budgetary organizations to each of the 26 Oblenergos (electricity distribution companies), including the seven already privatized ones. The debt of each electricity consumer has been stated as of January 1, 2001, and the Ministry is monitoring any changes to this debt and the corresponding legal actions and physical disconnection. 39. The Government has launched debt restructuring programs for each of the state-owned Oblenergos prior to their proposed privatization. Under the proposed arrangement, the debt of state-owned Oblenergos to the Energomarket outstanding on January 1, 2001 will be converted into a new five-year medium-term debt, with a two-year grace period followed by quarterly payments thereafter. Pursuant to the regulations for the Oblenergos' privatization, the newly- privatized Oblenergos will be required to pay in cash the full amount due to the Energomarket for their current power purchases. In case of non-compliance, the Oblenergos will be subject to corresponding legal actions. The 2.9 billion UAH debt to the Energomarket owed by the 7 Oblenergos privatized earlier will be resolved through existing legal means, including sanctions by the regulator and court actions. 40. The full chain of debts from the Energomarket to electricity generators and further to fuel suppliers will be restructured concurrently. This comprehensive approach to debt restructuring will give Oblenergos an incentive to classify their debtors into three categories: (i) solvent debtors with accumulated arrears due to previous liquidity problems; (ii) insolvent debtors who  - 15 - cannot be cut off due to their strategic importance or environmental concerns; and (iii) large insolvent debtors who will likely be bankrupt. Only consumers in the first would qualify for debt restructuring. For the second group, the Government will develop a mechanism within the state budget to secure timely financing of electricity bills for strategic entities. This regionally- administered mechanism will be in place for the second PAL. For the third group of debtors, the Oblenergos will undertake the necessary steps to either collect the outstanding debts during bankruptcy procedures or write them off. 41. To deal with the outstanding stock of gas debts by its domestic consumers, Naftogas will identify the major debtors and prepare a detailed debt rescheduling program to resolve the problem. Naftogas has also sought judicial recourse against one large indebted company. 42. Moreover, to secure a sustainable improvement in fiscal and financial discipline, the Government Program also seeks to resolve the outstanding issues regarding agricultural sector debts either directly to the budget or deriving from state loan guarantees. This will promote sound financial discipline and help reduce the risk of sequestration of agricultural output, thus helping farms obtain private finance. 43. Lastly, in order to support fiscal and financial discipline, the Government Program includes cleaning the debts from the budget to the banking sectors to help strengthen the financial sector. This will include developing an agreement with the banking sector to securitize government liabilities to commercial banks by issuing government marketable securities. Specifically, this will include a concrete timetable to handle overdue and restructured government debt on the books of state banks (Savings and EXIM banks). B. Regulatory reform 44. Ukraine has long been beset by a highly complex and non-transparent regulatory environment, which has hampered growth, biased transactions and provided a major source of corruption. Many agencies (particularly at the local level) are still entitled to "inspect" business and demand payments. The weak and incomplete regulatory environment for natural monopolies, particularly the energy sector, has led to poor operating practices, deteriorating performance, and reduced operating capacity. The net effect of such problems in the regulatory framework is that entry for new and especially small and medium enterprises is stifled and economic opportunities are limited. Addressing these issues is therefore a critical component of obtaining sustained growth and poverty reduction. 45. The medium-term vision. As part of the overall vision to best utilize national resources and improve the productive capacity of the country, the Government Program seeks to remove obstacles to the creation and operation of businesses and to provide clear rules cf the game through better and more independent regulators in critical sectors. In order to achieve this, its efforts are focused on: (i) facilitating entry and operation of business; (ii) facilitating accession to WTO; (iii) strengthening corporate governance; and iv) improving regulatory systems in key sectors (including telecom, energy and finance). 46. Facilitafing entry and operation of business. The Government Program plans to accelerate on-going efforts to create favorable conditions for opening and operating business, which will lead to substantial increases in the number of SMEs over the next three years. SME  - 16 - growth will be an important tool for job creation necessary to reduce poverty over time. Accomplishments to date include: * Improvements in new business registration. First improvements were introduced in 1998 through amendments to the Law on Entrepreneurship. The Government fine-tuned these changes in 1999 and developed a separate Law on Registration in 2000 to encapsulate the principles of one-stop shop registration. This law takes into account implementation lessons and prepares the ground for future improvements in registration and post-registration procedures. It is expected to be passed during the next session of Parliament. Independent surveys conducted annually by USAID and IFC show that there has already been a significant reduction in the official costs and time of registration. The official cost of registration has gone down from US$192 in 1997 to US$67 in 1999; while the time needed to register a new business (i.e., obtain a new registration certificate) has decreased from 34.7 days in 1997, to 11.6 days in 1999, and an expected 5 days in mid- 2000. * As a result, according to periodic IFC surveys, the number of licenses needed per enterprise has gone down from 3 in 1997 to 1.6 in 1999. Second, in June 2000, Parliament has approved a new licensing law further streamlining licensing procedures and allowing a single license to cover multiple (similar) economic activities. This allows a further reduction in cost and time of procuring business licenses and lowers a significant obstacle to doing business in Ukraine. The complementary regulations have since been prepared and adopted, and the implementation of the new law has started in October 2000.