Ukraine - Country assistance strategy

Document of The World Bank Report No. 20723-UA MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND OF THE INTERNATIONAL FINANCE CORPORATION TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY FOR UIKRAINE August 16, 2000  Currency Equivalents Currency Unit = Hryvnia (UAH) July 2000: US$1=UAH5.43 Abbreviations and Acronyms AIDS Acquired Immune Deficiency Syndrome APL Adaptable Program Lending BoP Balance of Payments CAR Country Assistance Review CAS Country Assistance Strategy CEM Country Economic Memorandum CIDA Canadian Intemational Development Agency DFI Direct Foreign Investment DOD Deb, Outstanding and Disbursed EBRD European Bank for Reconstruction and Development EDAL Enterprise Development Adjustment Loan EFF Extended Fund Facility ESW Economnic and sector work EU-TACIS European Union - Technical Assistance for the CIS Countries FSAL Financial Sector Adjustmnent Loan FSU Former Soviet Union FY Fiscal Year GDP Gross Domestic Product GEF Global Environment Facility GOU Government of Ukraine HIV Human Immune Deficiency Virus IBRD International Bank for Reconstruction and Development IDF Institutional Development Fund IFC International Finance Corporation IFI International Finance Institution IMCAR Inter-Ministerial Committee for Agrarian Reform IMF International Monetary Fund LIL Learning Innovation Loan MIGA Multilateral Investment Guarantee Agency MOJ Ministry of Justice NGO Non-governmental Organization NBU National Bank of Ukraine OED Operations Evaluation Department PAL Programmatic Adjustment Loan PGF Pre-Export Guarantee Facility PSD Private Sector Development SECAL Sector Adjustment Loan SMEs Small and Medium Size Enterprises TA Technical Assistance TACIS Technical Assistance for the CIS (EU Technical Assistance program) TB Tuberculosis UK DFID United Kingdom Department for Intemational Development UNDP United Nations Development Program USAID United States Agency for International Development Fiscal Year Government: January I - December 31 The World Bank Group Team IBRD IFC Vice President: Johannes F. Linn Vice President: Assaad J. Jabre Country Director: Luca Barbone Director: Edward Nassim Task Team: Luca Barbone, Lilia Burunciuc, Gregory IJedrzejczak, Vesna Petrovic, Dusan Vujovic, Luis-Alvaro Sanchez. Kutlay Ebiri. Andriy Storozhuk, Deborah Wetzel  TABLE OF CONTENTS EXECUTIVE SUMMARY ....... ............................................................. i I. COULNTRY CONTEXT ......................................1 A. INTRODUCTION..I B. KEY POLITICAL AND ECONOMIC DEVELOPMENTS ............................................... 1 C. WORSENING SOCIAL OUTCOMES, INSTITUTIONAL WEAKNESSES, AND GOVERNANCE ................... 2 Worsening Social and Environmental Outcomes .................................................................... 3 The Root Problems of Institutional Weaknesses and Poor Governance ............................................................. 6 D. DEVELOPMENT CHALLENGES AND THE GOVERNMENT PROGRAM ............................. ..................................... 7 E. ECONOMIC PROSPECTS, EXTERNAL ENVIRONMENT AND EXTERNAL FINANCING .......................................... 10 11. BANK GROUP ASSISTANCE STRATEGY .................................................................... 13 A. ASSESSMENT OF THE LATEST CAS ................................................................................... 13 B. BANK GROUP'S PORTFOLIO PERFORMANCE .1................................... .... .. 16 IBRD Portfolio ................................... 16 IFC and MIGA Programs ................................... 16 D. COUNTRY ASSISTANCE STRATEGY, FYO0-03 .18 Lessons Learned from the Most Recent CAS .18 Objectives of the Country Assistance Strategy, FY01 -03.18 Proggram Strategy.18 Proggram Content..9 Supporting Institution-Building Activities. 25 Triggers and Lending Levels .27 Benchmarking and Indicators of Success .28 Selectivity and Partnerships .28 Financial Management and Fiduciary Responsibility .30 E. RISKS .. . . . . . . . . . . . . . . . . . 30 I'-. CONCLUSION ............... 33 Boxes: Tables: Box 1: Recent Macroeconomic Developments Table 1: Altemative Macroeconomic Scenarios, Box 2: Poverty in Ukraine, 2000-2003 Box 3: Update of Sector Reforms Table 2: IBRD Exposure in Ukraine Box 4: Bank Activity in Ukraine Table 3: IBRD Tentative Lending Program - FY2001/03 Box 5: Country Assistance Review (CAR) Table 4: Triggers and Lending Levels Box 6: IFC Activities in Ukraine Table 5: Key Exposure and Burden Sharing Indicators, Box 7: The People's Voice Project 1999-2003 ANNEXES: Annex A2 Ukraine at a Glance Annex B2 Selected Indicators of Bank Portfolio Performance and Management Annex B3 Bank Group Program Summary Annex B3 (IFC & MIGA) Annex B4 Summary of Non-lending Services Annex B5 Social Indicators Annex B6 Key Economic Indicators Annex B7 Key Exposure Indicators Annex B8 Status of Bank Group Operations Annex B8 (IFC) Annex B9 Ukraine Country Assistance Strategy Framework Annex B 10 CAS Summary of Development Priorities ATTACHMENTS: Attachment 1: CAS Consultations with Stakeholders   EXECUTIVE SUMMARY i. This second Country Assistance Strategy document of the World Bank Group for Ukraine comes at a crucial time. At the beginning of the year 2000 the appointment of a pro-reform administration, with the support of a newly-established parliamentary majority, opened a window of opportunity for Ukraine to reverse the weak performance of the past years. But there are difficult challenges in the short term, beginning with the still uncertain picture for external financing. Beyond that, it has become increasingly clear that the problems faced by Ukraine are of a long-term nature, linked to the historic lack of pro- development institutions, i.e. institutions that can support socially and environmentally sustainable economic growth. This suggests that there are two key developmental challenges to obtaining sustained growth and poverty reduction in Ukraine: ensuring good governance, transparency and accountability in the public sector; and developing inclusive, market-oriented institutions. The World Bank Group assistance strategy, built around these themes, will have a two-legged approach: it will help build demand for better governance, and it will seize opportunities, when these present themselves, to increase the supply of better and development-oriented institutions. It will also protect the Bank by relating comtmitment of Bank resources to the pace of reform. The Lost Decade ii. Despite the great prospects that Ukraine held at the time of the first CAS, and the undeniable successes in nation-building in a difficult environment, the period since independence must be considered one of strong disappointment from the economic and social points of view. Only this year has growth returned to the country, yet recorded output is 60 percent below its 1991 value. Meanwhile, poverty has increased and 27 percent of Ukrainians are poor (consumption equal to or less than 75 percent of the median). Other social indicators have also deteriorated. iii. These poor economic and social outcomes are due to the lack of pro-development institutions, and to the still-limited voice that civil society has in influencing its own destiny. The institutional framework is in transition, with old (Soviet) and new rules operating side by side; the result has been poor governance in the public and private sectors. Thus, transaction costs are excessive because of anti- competitive practices and corruption. Property rights are not adequately defined or protected. While government strategic thinking and management have improved, weaknesses remain. In this environment, the logical choice, for those who can, is rent-seeking and private investment is at a disadvantage. Opportunities and Challenges for Ukraine and the World Bank Group iv. This poor performance can be reversed. Recent political events have been favorable to reform. After his decisive victory in the run-off of the presidential elections last November, President Kuchma appointed a Prime Minister and a cabinet largely composed of officials with a progressive track record. In addition, for the first time in years parliamentary factions were able to coalesce into a pro-Presidential majority, which approved a strong budget for 2000 and endorsed a pro-reform Govemment Program. v. There is thus a sense of momentum that, if maintained, could lead to substantially better performance and to measurable changes in the quality of govemance. However, Ukraine's own recent history, as well as intemational experience, strongly suggest that in the absence of an increased voice from civil society and pressure for greater accountability of public officials, true institutional change is unlikely to be sustained for long. Such greater involvement of civil society will have to emerge from within, but the intemational community can have an important role in both supporting reform efforts at the top and facilitating the emergence of a stronger demand for good government from the bottom. vi. At present, the IMF EFF arrangement, suspended since September 1999, has not yet resumed disbursements. Following the allegation of improprieties in handling of IMF resources by the National Bank of Ukraine (NBU), two audits of the NBU were carried out over the past few months. While they  ii Executive Summary uncovered some discrepancies in reporting foreign exchange reserves, they did not find improprieties in the use of IMF resources. Nevertheless, at the present writing, Ukraine has yet to meet some of the prior conditions for resumption of disbursements under the EFF. Discussions between the IMF and the Ukrainian government are ongoing. Lessons from the Implementation of the Bank Group Assistance Strategy vii. In the past few years, the World Bank Group has mounted an important effort to assist the economic and social transition in Ukraine. However, given the difficult environment, and despite some successes, the assistance strategy envisaged under the CAS that was approved in 1996 did not materialize as expected. The main factors underlying poor performance were lack of true government ownership and ability to deliver, symptoms of institutional weakness and political paralysis. viii. Additionally, the design of the adjustment assistance, based on separate sector adjustment operations, proved to be a major shortcoming. Stand-alone operations had difficulties in addressing cross-sectoral institutional and governance issues. This led to a situation in which reforms were reversed or stalled in some areas while Bank resources were being disbursed in others. Weak institutional capacity in key government agencies further hampered implementation. With the benefit of hindsight, the Bank program was caught in a vicious circle resulting from the difficulties of addressing institutional weaknesses using a sectoral approach. Over time it has become clear that changing institutions is a process that entails addressing systemic weaknesses and typically involves an effort broader than a single sector. Country Assistance Strategy ix. Objectives. The Country Assistance Strategy for Ukraine for the period FY01-03 aims to assist Government and civil society in the implementation of a broad-based poverty reduction strategy and in attaining job-creating, sustainable economic growth. To do so, the strategy directly addresses the institution-building challenges faced by Ukraine both from the demand side (civil society) and supply side (Government). The strategy seeks to move Ukraine closer to European Union standards, fostering environmentally sustainable development. x. Program Features: A Two-legged Strategy. To be of most effective assistance to Ukraine, the World Bank Group's strategy is composed of two key elements: the first (under the Low Case) aims to support civil society in its denand for better government; the second (which would be added under a Base Case) aims to support opportunities to strengthen institutions that foster sustainable development, when these opportunities present themselves. The strategy emphasizes program ownership, results on the ground, and increased attention to material improvements in delivery of social services. xi. During FYO1-03, first leg activities would provide the core of World Bank Group assistance if there were no progress towards meeting the benchmarks for the Base Case. IBRD lending (of up to US$456 million equivalent) and non-lending activities (including the IFC technical assistance program) would have to meet two crucial tests, which the Government supports: First, they would have to demonstrably help civil society increase its voice for better government and social services provision, or provide tangible benefits in globally sensitive areas. Second, they would have to be sufficiently shielded from possible paralysis at the center of government so as to stand a good chance of success-even under less-than-favorable conditions. xii. If the triggers for meeting the Base Case are achieved, World Bank assistance could draw on the second leg, with additional IBRD lending of up to US$1.4 billion for the three-year period (under the Base Case), with a mixture of adjustment lending under a Programmatic Adjustment Loan (PAL) sequence and a number of institution-building operations, in addition to non-lending activities. Moving to such a scenario would require, in addition to a sustainable macroeconomic framework, achievement of agreed-upon benchmarks in five cross-cutting areas based on a comrnon vision of a three-year program of progress in institution-building. These areas are: financial discipline in public and private sectors,  Executive Summary iii improved regulatory framework for business, transparent definition and protection of property rights, public sector accountability and effectiveness, mitigation of the social costs of transition and improvements in the delivery of social services. Upon reaching the first set of agreed benchmarks, the first., one-tranche Programmatic Adjustment Loan (PAL) would be presented to the Executive Board for approval. Attaining benchmarks for PAL II and PAL III will be required for continuation of the Base Case scenario into the second and third years of the strategy. Thus, other projects in the Base Case scenario are linked to the respective PALs going forward. xiii. More specifically, the benchmarks for the first operation will include: (a) an improvement in financial discipline through full elimination of non-transparent budget offsets, a major reduction in budget arrears and energy payment debts; (b) easier business entry and operation confirmed through independent surveys; (c) enhanced property rights in agriculture through abolition of Kolkhozes, transparent privatization of large industrial enterprises and legislation enabling privatization of at least 25 percent of the telecom company; (d) better public sector accountability through transparent budget process (including a formula-based transfer system), sufficient progress in public administration reform, and significant reduction of tax exemptions; and (e) improved social sustainability through a review of special privileges currently extending surrogate social protection and progress in preparing the pension reform. Two subsequent PAL operations would be presented to the Board depending on meeting the agreed benchmarks for each tranche and on the overall pace of implementation of reforms (probably at one-year intervals). A programmatic instrument is proposed as a vehicle for adjustment lending because the PAL design explicitly addresses two of the main lessons of the previous CAS implementation. It emphasis on program ownership and attainment of results on the ground, and by linking enhanced financial assistance to attainment of cross-cutting results, rather than sectoral reform that can be accompanied by backsliding in other sectors. xiv. Self-regulating Program Structure. As it is performance-based, the assistance program will automatically relate the commitment of Bank resources to the pace of reform. Slow implementation of reforms, and consequently slow achievement of the agreed performance benchmarks, would lead to delayed presentation to the Board of individual adjustment and investment operations, resulting in lower commitments and disbursements over the CAS period. The government might be able to execute the agreed three-year program in a shorter time-frame. In this case, the resulting increased creditworthiness might warrant higher levels of Bank exposure, particularly to deal with problems in areas in which private capital would be unlikely to flow. This scenario-a high case-is rather hypothetical at this time. However, were it to occur, it would be documented in an update to this CAS. xv. Increased IFC Direct Investments. Complementing this approach, IFC will aggressively pursue investment operations in cooperation with international and Ukrainian private partners. These are more likely to arise as the business environment continues to improve. In addition, IFC will carry on with and extend its current technical assistance activities, which will continue to be coordinated with present and planned IBRD interventions in assistance to business, both on the policy and the technical assistance sides. IFC will be strongly involved, on the policy dialogue side, in providing feedback and indications relevant to the improvement of the regulatory framework and the protection of property rights. xvi. Selectivity and Partnerships. The program is also designed to capitalize on the Bank's comparative advantages and maximize synergies with other donors and international financial institutions. Accordingly, the strategy contemplates a major expansion of assistance to reforms in the social sectors, building on recent encouraging openings and the Government's stated priorities. On the other hand, the Bank will withdraw from further investment in areas in which investment operations have proven unable to achieve the hoped-for systemic results or demonstration effects, and will substitute appropriate non- lending vehicles to conduct policy dialogue (infrastructure, power). xvii. The proposed program critically depends on two factors: the Bank's ability to take advantage of opportunities offered by existing and prospective programs of partners in development, and its ability to capitalize on civil society's activities. These steps will ensure that the Bank's comparative advantage is  iv Executive Summary fully utilized. The Bank has discussed the CAS with all partners, and has taken great care to ensure that no duplication of efforts occur. Our partners have indicated that they appreciate the Bank's policy leverage, which helps in making their programs successful and effective. Issues for Board Discussion xviii. Executive Directors may wish to address the following questions: * Does the proposed strategy's emphasis on institution-building and good governance appropriately take into account the lessons learned on the difficulties of transition in post-Soviet countries? * Does the Bank Group's assistance strategy for Ukraine take into account the lessons learned from the implementation of the previous CAS, and in particular the shortcomings of the adjustment lending experience? * Does the proposed two-legged program structure provide a balanced mix of sustained support to Ukraine's reform program, while limiting Bank exposure when required?  MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND THE INTERNATIONAL FINANCE CORPORATION TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY FOR UKRAINE I. COUNTRY CONTEXT A. INTRODUCTION 1. This document is being presented at a time when a window of opportunity appears to exist for substantial advances in establishing more development-oriented and inclusive institutions in Ukraine. It is the second World Bank Group's stand-alone Country Assistance Strategy (CAS) document for Ukraine, that follows a Country Assistance note discussed together with the Ukraine Rehabilitation Loan (report P- 6466-UA, November 30, 1994), the first stand-alone CAS (Report No. 15674-UA), reviewed by the Board of Executive Directors on June 3, 1996, a CAS Update (SEC M98-425) discussed on May 21, 1998, and a subsequent CAS Progress Report (Report No. 19225) reviewed by the Board on May 20, 1999. This document has been prepared by a joint IBRD and IFC team, and has benefited from thorough discussions with MIGA on the role of guarantees in Ukraine. The outlines of the assistance strategy have been discussed with the Government of Ukraine and with an unprecedented cross-section of civil society. The strategy views a stronger civil society as a key component for progress in institutional reform and poverty reduction. Thus the World Bank Group team consulted with members of the Verkhovna Rada (parliament), representatives of the business community and local governments, civic organizations and NGOs. Over 200 interested groups have participated in the discussions, held both in Kyiv and across Ukraine. The results of the discussions have been incorporated in the strategy and are summarized in Attachment 1. B. KEY POLITICAL AND ECONOMIC DEVELOPMENTS 2. The Lost Decade. Ukraine re-established its independence in 1991, after more than 70 years of Soviet rule. As a nation of almost 50 million people, Ukraine is strategically located at a crossroads between east and west, with a great endowment of human and physical capital. For all the potential that the country holds, the first decade of independence must be considered one of missed opportunities and great disappointments on the economic and social fronts, despite many achievements on the political side. 3. After an initial period when economic reform took a back seat to political and nation-building imperatives, expectations were set very high in 1994-96, when a new President and Government came to power and seemed able to embark on an ambitious program of reform. The Bank reacted to the reform opening by offering a commensurate assistance program, as set out in the 1996 CAS. Bank assistance was broad by design, reflecting the need for reform in several sectors of the economy. It was also designed to provide a graduated response to progress in the execution of the reform program. 4. Initial results were encouraging, particularly in the area of small-scale privatization, mass privatization and legal reforms, such as bankruptcy procedures. Very soon, however, the Government began displaying a lack of sustained commitment to the reform agenda. This was coupled with growing paralysis in decision-making in the legislature and rising encroachment of the patrimonial state and the oligarchs-worsening the capture of the state by vested interests. These negative tendencies were noted  2 Ukraine: Country Assistance Strategy 2001-03 on the Bank side, in the April 1999 CAS Progress Report. This document set out to protect the Bank by limiting its exposure to an unwilling reformer through the establishment of performance-based triggers for resumption of adjustment lending and for the further appraisal of investment operations. As a result, Bank operations in Ukraine were sharply curtailed. 5. An Opportunity for Improvement. This situation can be reversed. The power of the interest groups, while formidable, is not irreversibly engrained in society. It still depends mostly on opportunities for graft and private enrichment stemming from transaction and trade privileges obtained through cronyism, rather than from consolidated ownership of productive sector assets. But the anti-reform camp is strong. For a reform initiative to succeed and be sustainable in Ukraine, Government must develop a broad coalition to reduce the influence of those political and social forces that seek to preserve the status quo. This coalition is not likely to emerge unless civil society feels empowered and increases its demands for better govemment. 6. Recent political events have been favorable to reform. After his decisive victory in the run-off of the presidential elections last November, President Kuchma appointed a Prime Minister and a cabinet largely composed of officials with a more progressive track record. More important, for the first time in years, parliamentary factions have coalesced into a pro-presidential majority that approved a strong budget for 2000 and endorsed the pro-reform Government program. These events create great potential for moving forward on reform, but there are reasons to remain vigilant. Prime Minister Yushchenko's Government will need to withstand pressures to maintain the status quo, particularly as the reform program starts biting into the vested interests of the more powerful oligarchs, who have deep connections within the legislative and the executive. In addition, the external financing outlook is still clouded by the aftermath of the alleged mismanagement of National Bank of Ukraine (NBU) reserves during 1997-98, despite the relatively favorable second audit report. 7. Economic performance has improved in the past few months. Industrial production rose at double-digit rates in the first half of 2000, with a reported annualized growth in GDP of 5 to 6 percent, as a delayed reaction to the devaluation of the Hryvnia and strong external demand. It now appears likely that growth might return to Ukraine for the first time in the past ten years (see Box 1 for a review of recent macroeconomic developments). In addition, the Yushchenko Government successfully re- negotiated the privately held bond debt contracted in the past few years that had short maturity and high interest rates. Thus, although the year 2001 is still likely to be somewhat difficult for Ukraine's external position, the country could look forward to a relatively favorable environment for an ambitious program of economic reform. 8. A Note of Caution. However, short-term successes and uncertainties should not distract from the fundamental, long-term problems that affect Ukraine's development prospects. The opportunities lost over the past ten years will not be easy to recoup unless major advances in establishing legitimate, pro- development institutions take place. These issues are discussed in the next section. C. WORSENING SOCIAL OUTCOMES, INSTrrUTIONAL WEAKNESSES, AND GOVERNANCE 9. Understanding the root causes of the unfavorable political and economic developments of the past few years requires an analysis of the evolution of the underlying political economy. An incomplete institutional framework and poor governance have contributed to poor economic performance and increased poverty. Poor governance has also created favorable conditions for the emergence of early winners of the transition period-oligarchs and a large part of the bureaucracy that are now trying to prevent further reforms as they profit from the status quo. These factors have also worsened the distribution of income. Successful reform will have to address these intertwined relationships.  Ukraine: Country Assistance Strategy 2001-03 3 Box 1: Recent Macroeconomic Developments Following successful stabilization between 1996 and 1997, Ukraine has maintained a relatively stable macroeconomic environment. In the past seven/eight months, signs of economic recovery have appeared. However their sustainability over the medium term is questionable, in view of the insufficient restructuring in the economy. Among the highlights of recent macroeconomic performance: * Real GDP (officially measured), after declining cumulatively by 60 percent over nine years, shows signs of having bottomed out. Following a modest 1.9 percent decline in 1998, and an even smaller 0.4 percent decline in 1999, GDP has grown by some 6 percent in the first five months of the year 2000, with industrial production recording sharply higher double-digit growth rates. The rebound is the result of the combined effects of the devaluation of the Hryvnia, the strong growth in the Russian economy, and the revival of domestic demand following an improved pension and wages payment record. * Annual CPI inflation which was cut from hyperinflationary levels in 1992-1994 to 10 percent in 1997, picked up again to 19-29 percent in 1998-1999, as a result of the Hryvnia depreciation triggered by the Russian crisis in 1998 and looser fiscal/monetary policies in the run-up presidential elections in the fall of 1999. Inflation reached 18.7 percent during the first half of 2000. Policies to bring inflation back to its declining path are envisaged by the Central Bank and the Government. * The trade and current account balance have improved due to real devaluation and strong external demand. The Hryvnia suffered a series of devaluations in the wake of the Russian crisis losing 60 percent of its value against the dollar between the fall of 1999 and early 2000. Since then it has remained relatively stable in nominal terms, yet the effective exchange rate is almost 20 percent below its pre-Russian crisis level with real devaluation against the world's leading currencies even bigger. The current account deficit, which remained virtually unchanged at US$1.3 billion in 1997 and 1998, turned into an US$834 million surplus in 1999. A mild US$300 million current account deficit is expected in the year 2000. * The cash deficit of the general government has been reduced from 5.6 percent of GDP in 1997, to 2.8 percent in 1998 and 2.4 percent in 1999. The Budget for the year 2000 called for a further reduction in the cash deficit to 2.7 percent. This would be based on: improved budget discipline; tighter expenditure controls; elimination of budget offsets; and cuts in tax privileges and social subsidies; while also lowering the tax burden on the business sector. * Despite these recent advances, the macroeconomic situation continues to be fragile. The main difficulties continue to come from weak fiscal and debt management. Meeting the deficit objective will require in particular strict expenditure control during the rest of this year. The measured deficit on an accrual basis has been declining and in fact the Government has succeeded in reducing the stock of outstanding wage and pension arrears. However, the stock of other budgetary arrears is not measured with precision and, jointly with contingent liabilities, represents a risk whose net effect has not yet been fully determined. Efforts are under way to improve the measurement of arrears and government contingent liabilities in the economy. * Debt management continues to be challenging. The successful rescheduling of the private external debt in March 2000, as well as the increased demand for Hryvnias of the past few months, have allowed the National Bank of Ukraine (NBU) to service official obligations while maintaining international reserves close to US$1 billion at the end of June. In the absence of disbursements from international financial institutions, the NBU extensively relied on open market purchases to replenish reserves. So far, this has not had a visible impact on the exchange rate, which remains stable at the level reached in February 2000. Worsening Social and Environmental Outcomes 10. The transition from the command-and-control socialist state, with its cradle-to-grave social protection system, to a pseudo-market economy has resulted in substantial dislocations, amplified by the weakness of institutions and emergence of rent-seeking behavior. Three phenomena are worth highlighting: the growth of poverty, the disparity of the impact of the transition based on gender, and environmental degradation.  4 Ukraine: Country Assistance Strategy 2001-03 Box 2: Poverty In Ukraine More than one out of four people---some 27 percent of the population---is poor (defined as having consumption equal to 75 percent or less of median), based on results of a recent household survey covering the first three quarters of 1999. Some 18 percent of the households are extremely poor: they are spending 80 percent or more of their 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 whole period of the 1990s. This trend has been fueled mainly by a decline in real income 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 wage arrears and low wage levels, 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. 11. Increase in absolute and relative poverty. The incidence of poverty has increased considerably in Ukraine to the point that 27 percent of the population now lives below the poverty line, and 18 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 poverty profile, see Box 2). At the same time, the human and physical capital stock has deteriorated. The underlying reasons for these developments are: I These results are based on a household survey covering the first three quarters of 1999, in which "poor' is defined as having consumption equal to 75 percent or less of the median. Data presented in Annex A2 represent data from the World Bank database that reflect an earlier survey and have been adjusted to be comparable across countries.  Ukraine: Country Assistance Strategy 2001-03 5 * 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 basis2. There is massive and popular 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 class of very wealthy individuals that have benefited from the initial stages of the transformation. * Areas of structural poverty. Changes in relative prices imply that many of the 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 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 government 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. 12. 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. These subsidies alleviate the immediate poverty impact. At the same time, they make reforms requiring removal of these subsidies more painful socially and increasingly difficult politically. 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. 13. The Emerging Gender Dimension. Gender disparities in Ukraine have become increasingly acute over the years, despite a widespread lack of recognition of their existence. Although the difference between the situation for women and that for men as far as educational achievements, access to job market, and the like is not as evident as in other regions of the world, worrisome trends have emerged that raise serious concerns. As in many areas of the former Soviet Union, male life expectancies have declined compared to women, largely because lifestyles have deteriorated--including an increase in drinking problems. Perhaps as a consequence of looser family relations in strata that are most hit by the social transformation, freedom of travel and increased pressure for ostentatious consumption, trafficking of young women has reached an unprecedented level even when compared to other FSU countries. In 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.  6 Ukraine: Country Assistance Strategy 2001-03 addition, women have been the prime target for job cuts because of redundancies, when these have occurred. The reduction of social assets in enterprises leads to a greater burden on women who cannot afford privately provided child care. Access to credit-now sharply limited and linked to insider knowledge-appears to be skewed against women. 14. Environmental Challenges. Ukraine is one of the most environmentally damaged countries in the world, both regarding the environmental consequences of the Chernobyl accident and the environmental degradation caused by the heavy industries (e.g., metallurgy, chemicals, coal mines). However, despite the great number of ecological problems, Ukraine has preserved a number of typical and unique natural ecosystems which have already been lost in most other European countries. The challenge ahead is to create an adequate institutional and regulatory framework and find the necessary resources to deal with the increasing problems of pollution while preserving the valuable ecosystems in place. Despite the advances in legislation and the establishment of agencies formally charged with protection of the environment, the gap between the objectives to which the country is commnitted and the reality on the ground remains wide. The Root Problems of Institutional Weaknesses and Poor Governance 15. Fundamental institutional weakness is at the root of the unsatisfactory performance and worsening social outcomes. Institutional weakness is not to be construed in technological terms, such as lack of physical means or educational standards. Rather, weakness of institutions is felt in the gap between written rules and regulations and actual behaviors, particularly in the public sector. The informal rules that are now established reduce certainty over property rights, increase transaction costs and uncertainty, and contribute to low levels of private investment and risk-taking. Rent-seeking appears to be the logical choice in this environment. It is not surprising that Ukraine ranks among the worst performers in phenomena such as business harassment and corruption, and that foreign investment has been disappointing. 16. Under current conditions, the public sector still represents a hindrance to economic activity, and is not recognized by civil society as a means for its empowerment. This in part reflects a historical tradition. Efforts to reform the formal aspects of institutions have had mixed results due to a fundamental lack of consensus on direction. As a result, the following observations are made: * Non-enforcement of contracts and soft budget constraints in the public and private sectors. The government budgetary arrears are a major source of non-payments in the economy (the use of offsets, among budgetary units and with state enterprises is a major source of corruption). Unprofitable enterprises continue to operate on the basis of direct and indirect government transfers and fail to pay taxes; * Poor contract enforcement and lack of fair settlement mechanisms, including an operating judicial system. Key laws necessary for commerce are either missing (for instance, protection of investment rights and mortgaging) or inappropriate (for instance, leasing, banking and collateral legislation) or badly enforced (for instance, bankruptcy); * 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; * Obsolete public administration, with unclear distribution of responsibilities between agencies and levels of government; * A civil service that still clings to an old way of looking at the world and state intervention; * A highly complex regulatory environment, which is a major source of corruption-with many agencies still entitled to "inspect" business and demand payments, particularly at the local level; and  Ukraine: Country Assistance Strategy 2001-03 7 * Poor management of public moneys, as epitomized by the inquiries into the management of foreign exchange reserves. 17. A New Political Economy of Crony Capitalism. The growth of private interests around rent- seeking and corruption has redefined the political economy of the country---not as expected, from "plan to market" but from bureaucratic socialism to crony capitalism3. These developments can be attributed to incomplete and partial reforms, rather than hasty ones. The emergence of new vested interests has reduced the Government's margin of maneuverability to implement further reforms. The groups that have arisen have an inherent interest in preserving the current power-sharing arrangements, and will oppose reforms that curtail their influence. The losers in this process are relatively unorganized and- unless mobilized-do not have the power to change the direction of the process. 18. On the positive side, potential gains from rent-seeking are shrinking, reducing the available resources for graft and introducing rifts between various groups. Also, true liberalization of the economy is likely to weaken the power of these groups, as their clout is based on trade and transaction privileges and not asset ownership. However, Government has to prevent the capture of the future privatization process by these groups and find ways to limit their control of key strategic sectors. These groups extend in some cases beyond Ukrainian borders and may involve far more powerful players from neighboring countries. D. DEVELOPMENT CHALLENGES AND THE GOVERNMENT PROGRAM 19. The Nature of Ukraine's Development Challenge. The preceding discussion highlights the issue that Ukraine's development challenge is of a medium-term nature, and chiefly involves building up legitimate pro-development institutions, that can deliver on their commnitments in an environment in which major actors have strong incentives for maintaining the status quo. It is unlikely that poverty- reducing, broad-based growth will occur if a more legitimate and efficient institutional environment is not put in place. This is a problem that affects all traditional "sectors," as the reach of the state and the culture of rent-seeking are pervasive across Ukrainian society (for a review of sectoral developments, see Box 3). For instance, the culture of non-payments or barter transactions has effectively prevented private sector development in agriculture, in energy, in industry and in services, and undermines the provision of social services. Uncertainty over formal enforcement mechanisms affects investment in the financial sector and prevents the emergence of appropriate markets that could favor restructuring of industrial enterprises as well as agribusiness. It is thus important to stress that, while putting the right policies in place remains important, it is the gap between formal rules and informal behaviors that is at the root of unsatisfactory performance. 20. These considerations suggest caution in extending assistance to Ukraine, and realism with respect to the timeframe in which it should be reasonable to expect results. There are however moments in a country's history when the presence of pro-reform leadership and a convergence of forces in favor of a 3 This has occurred because an environment characterized by an incomplete and non-transparent institutional design, regulations that foster rent-seeking by public officials and weak oversight has created opportunities for corruption. An example of this has been the extension of trade monopolies in critical sectors of the economy, such as energy, that has led to privileged groups amassing fortunes, despite the reported decline in economic activity. But even the privatization process and energy distribution reforms, which were designed to reduce the waste of public resources and resolve conflicts between ownership and regulatory responsibilities, have in practice created open-ended opportunities for graft and private enrichment.  8 Ukraine: Country Assistance Strategy 2001-03 Box 3: Update on Sector Reforms Private Sector. To date, Ukraine has privatized more than 63,000 mostly small and medium enterprises, which are an important source of private sector growth. However, a significant number of large enterprises are still owned by the state, and a number of large privatization transactions resulted in consolidation of insiders' interests. The new Government started the process- of transparent case-by-case privatizations, and since the beginning of this year, several such privatizations have taken place. Major achievements of the past years also include adoption of accounting standards compatible with IAS and adoption of a bankruptcy law. Nascent capital markets today have an independent Securities and Stock Market Commission. Efforts have also been made to improve the regulatory environment and facilitate entrepreneurial activity - simplification of registration process and elimination of a number of unnecessary licenses as well as some reduction in business inspections. However, these changes have had only limited effects on the business environment and foreign direct investment still remains among the lowest in the region. Fiscal Reforms. Over the past few years, significant improvements have been made in fiscal management, including progress in the adoption of a new budget classification system, prohibition of central bank direct financing of the government, the implementation of a treasury system, creation of the external audit function, introduction of simplified taxation for small business and reduction of payroll taxes, and improved availability of fiscal information. Nonetheless, much more remains. The definition of basic fiscal functions and the allocation of responsibilities across different branches and levels of government and across different ministries is not sufficiently transparent. The new Budget Code, which has already passed two readings in the Verkhovna Rada and, the new Tax Code, scheduled for deliberations in the coming months, address these issues. Public Administration. As this document makes clear, public administration reform is an important but difficult long-term objective for Ukraine. Some progress has been registered in the past few years. The excessive fragmentation of public institutions (large number of ministerial and inter-ministerial bodies) has been addressed through restructuring of key ministries and reductions in cabinet posts. However, the bureaucratic behavior, which relies on the rules from the past, and lack of transparency as to where decisions are made, still remain to be addressed. The civil service is filled with people in top positions, vying for power and influence, and poorly trained in modem methods of administration. The relationships between the central and the regional govemments are unclear, with dual subordination creating confusion about duties and responsibilities, as is the case of the Oblasts in relation to the central govemment and the municipal authorities. Agriculture. Performance in agriculture has been disappointing for a country like Ukraine, that can rely on very fertile land and an experienced labor force. There has been some progress with the elimination of price and margin controls on agricultural products and the removal of remaining trade restrictions but there have also been reversals in the trade regime, e.g., the introduction of an export duty on sunflower seeds. The current Govemment's program of reform in agriculture, discussed in the main text, would represent a welcome acceleration of a process that has stalled. Despite positive events (such as the abolition of Kholkozes as a form of farm organization, and the beginning of distribution of property certificates to farmers), true property reformn and trade liberalization have proven difficult, as the struggle between conservative and pro-reform forces has often brought the process to a standstill. The state retains control of a major share of the storage facilities in the country, effective control of about 85 percent of the agricultural land, and influence over about 90 percent of the trade in agricultural commodities. A new Land Code that should resolve the land privatization issue is currently under the Verkhovna Rada's consideration. Energy. Ukraine has been grappling with reform in the energy sector with some success, but also a considerable amount of work remains. Some progress has been achieved in the coal sector-50 uneconomic mines (out of 280) have been closed and their social impact mitigated. In the power sector, some advances have been made in developing an efficient energy market. However, like other sectors, poor governance, political interference, and in particular the culture of non-payment have slowed down progress. Over the next few months, a new round of privatization of regional distribution companies will provide a crucial test of the Government's ability to implement reform. Financial sector. Despite having avoided the meltdown that could have been possible in the wake of the Russia crisis, the Ukrainian financial sector remains very weak. The capital of the banking system represents only 3.3 percent of GDP; overall monetization is low compared to even other CIS countries, and little credit is available for the business sector. A number of reforms, supported by World Bank and other donor assistance, have been introduced in the past few years, and key pieces of legislation are under discussion at present. The weak financial system further enhances the tendency to trade in barter or make payments outside the banking system. The Bank's involvement in the financial sector has helped to bring improvements in banking supervision, regulation enforcement, accounting, and payment system. Environment. Progress in this area continues to be good, although challenges in the environmental area remain substantial. Improvements in environmental policies and environmental management have been supported through two Bank IDFs. Progress has also been made in promoting biodiversity and wetlands in the Azov and Black Sea regions.  Ukraine: Country Assistance Strategy 2001-03 9 reform direction may lead to rapid advances in institutional development and achievement of milestones in the country's transfornation agenda. Although President Kuchma has been in power for many years, his recent re-election has been accompanied by the first-ever working parliamentary majority that supports the Government. On these bases, the present Government has set about to forge a consensus on critical reform steps, which has included an effort to reach out to the population for support, and has resulted in the preparation and initial implementation of a multi-year reform plan (see next section). The present juncture in Ukraine may indeed be a defining moment, despite the fact that many reasons for qualification and prudence remain. 21. The Government Program. As indicated above, there are reasons to believe that greater progress is now possible. For the first time since independence, the Ukrainian Government has prepared a medium term (five-year) program that signals a clear departure from the past, Soviet-type programs. It received the Verkhovna Rada's backing on April 6, 2000. 22. The Government Program establishes five strategic goals: (i) developing human resources, (ii) reducing poverty and increasing the prosperity of the Ukrainian nation, (iii) increasing the competitiveness of Ukraine's economy, (iv) protecting human rights, freedoms, personal security and the integrity of the state, and (v) promoting Ukraine's integration with the European Union. For the first time, the program was prepared in a participatory manner. Representatives of civil society (including academia, NGOs, and business associations) were invited to help in its preparation. Moreover, the program envisages widening the consultations with the civil society. The Government has pledged to provide regular information about its policies and communicate the results of its activities to the public. 23. The Government has requested the Bank's assistance in formulating, for the first time in Ukraine, a comprehensive anti-poverty strategy. A poverty study is currently under preparation with Bank assistance. This study will be used to formulate a poverty reduction strategy and will help redesign the social assistance mechanisms to better target benefits and reach the most needy segments of the population. Local communities are to be involved in the delivery of such assistance. 24. In the area of governance, the Government proposes continued reform of public administration to transform it into a smaller and more efficient bureaucracy. Decentralization and development of a sustainable system of intergovernmental finance are also high on the Government's agenda. Corruption is explicitly recognized as a significant problem and anti-corruption measures are identified, including civil service reform aimed at increasing the accountability and meritocracy, along with training and pay reform. The reform of the legal and judicial system is foreseen as an important complement of the enhanced governance strategy. 25. Social sector reforms are at the top of the Government's reform agenda, also for the first time. The Government program has proposed to strengthen primary health care on the basis of family medical practice, develop a system of health insurance, introduce the concept of family doctors and create conditions for private medical practice. In education, the curriculum and the textbooks will be revised along with the restructuring of the school system to meet the demands of a new labor force for the market system. In social protection, the Government intends to restructure social assistance to provide targeted support, through means-testing, to the neediest and gradually introduce a three-pillar pension system. 26. Important steps are envisaged in the area of budget reform. The Government intends to run low- deficit budgets from 2000, streamline the tax system, reform the system of budgetary transfers between levels of government, improve expenditure management, and introduce an open competitive public procurement system. 27. To improve the business environment and make Ukraine more attractive to investors, the Government will pay particular attention to enhancing and protecting property rights, securing contract enforcement and the application of well-defined bankruptcy rules, streamnline the tax system and its  10 Ukraine: Country Assistance Strategy 2001-03 administration, and introduce transparent procedures for case-by-case privatization. In the financial sector, the Government intends to complete the reform of the legal and regulatory environment initiated in the past few years (through the adoption of the Banking Law, the Deposit Insurance Law, and laws on mortgages, leasing, and land) and follow through with effective implementation. 28. Important reform measures are envisaged in the energy sector. Elimination of non-payments and payment arrears, transparent privatization of energy distribution companies, development of energy- saving programs and diversification of energy supply markets are proposed in this sector. 29. In agriculture, the Govemnment plans to continue the on-going land reform: liquidation of collective farms started in late 1999, approval of a new land code and development of a title registration system as well as supportive legislation and market institutions. 30. There is thus a sense of momentum that, if maintained, could lead to substantially better performance and to measurable changes in the quality of governance. On the other hand, Ukraine's own recent history, as well as international experience, strongly suggest that in the absence of an increased voice from civil society and pressure for greater accountability of public officials, true institutional change is unlikely to be sustained for long. And while such greater involvement of civil society will have to emerge from within, the international community can have an important role in both supporting reform efforts at the top and facilitating the emergence of a stronger demand for good government from the bottom. E. ECONOMIC PROSPECTS, EXTERNAL ENVIRONMENT AND EXTERNAL FINANCING 31. As far as economic developments are concerned, the CAS period opens on a positive note. Measured GDP is on the rise, and growth is expected to be at least 2.0 percent in 2000. The Parliament recently approved in the first or second reading a series of critical bills, including a Land Code that envisions private land ownership, a Budget Code that streamlines budgetary process and procedure, and a Tax Code that substantially cuts tax burdens, improving chances that the current recovery will be sustained and augmented by a real broad- based private sector growth. On the fiscal side, government revenues have increased and mutual settlements have been eradicated from the central budget. This may call for extra budgetary tightening on the expenditure side in order to meet the Government's target deficit of 2.7 percent for 2000. Finally, due to a combination of cost-push and monetary factors, inflation has edged up to 3.7 percent for the month of June or 18.7 percent for the first half of the year. While the economic situation has improved, it will continue to require close attention. 32. The external payments outlook is more robust than just a few months ago, even in the absence of any external financing from official sources. The real depreciation of the currency, especially against non- CIS countries and economic revival in nearby countries has led to strong export performance, allowing the country to maintain around $1 billion in reserves while servicing its external debt obligations. This performance is expected to continue should the present circumstances continue to hold. However, the events of 1998 have shown that Ukraine's economic performance can be severely affected by down-turns in nearby economies. The Government is making efforts to diversify trade and reduce the energy intensity of the economy. In this regard, Ukraine has already initiated preliminary discussions for accelerated accession to the World Trade Organization (WTO). When effective, WTO membership should allow the country to further diversify its export and import markets. Reduction of energy intensity will be an important by-product of the institutional and governance measures supported by this CAS. Overall, it is expected that the strengthening of the external sector will continue during the CAS period. 33. The country's current 40.9 percent debt-to-GDP ratio is not very high by international standards, although the rate at which it has increased in recent years has been rapid. Also, due to the exceptionally short term-structure and high cost of external debt, Ukraine was on the brink of a debt crisis earlier this  Ukraine: Country Assistance Strategy 2001-03 11 Table 1: Alternative Macroeconomic Scenarios, 2000-2003 1 Base Case I Low Case 1 19991 20001 2001 2002r 2003 _ 19991 20001 2001 2002 2003 National accounts (real annual change, %) GDP at narket prices -0.4 2.0 2.3 2.6 3.0 -0.4 2.0 1.8 1.2 1.0 Gross domestic investment -5.4 7.7 5.9 5.7 5.5 -5.4 3.9 2.0 1.4 1.0 Exports (GNFS) -7.9 8.5 5.0 5.4 5.7 -7.9 5.2 3.2 2.2 1.5 Inports (GNFS) -19.1 18.7 6.3 5.5 5.5 -19.1 13.9 1.9 1.3 0.9 GDP Inflation 24.4 29.0 18.0 15.0 10.0 24.4 29.0 25.0 25.0 25.0 External financing requirement (mn.$)' -470 580 1,341 1,141 1,175 -470 231 232 -44 -186 oJw Current account deficit2 -834 311 744 851 870 -834 138 82 -109 -244 (% of GDP) 2.7 -1.0 -2.3 -2.5 -2.4 2.7 0.4 0.3 -0.4 0.8 External financing plan (mn. $) Private investment (net)3 551 850 1,000 1,200 1,375 551 785 785 625 525 Net long-term lending -196 -15 736 146 -45 -196 -424 -423 -539 -581 01w World Bank 420 259 264 294 324 420 109 -10 -47 -22 Other capital fows -825 -255 -395 -205 -155 -825 -130 -130 -130 -130 Foreign exchange reserves excl. gold 0.8 0.8 1.2 1.3 1.4 0.8 0.8 0.8 0.9 0.9 (months of GS imports4) IBRD DOD/Total DOD % s 16.1 19.9 20.9 23.0 25.8 16.1 19.9 19.9 20.5 21.5 "Current account deficit plus increase in foreign exchange reserves 2'Negative = surplus 3 Direct plus portfolio investment 4'Including factor payments 5' Includes present value of guarantees Source: 1999 actuals and World Bank staff projections year until a private debt swap was endorsed by creditors in mid-March4. The recent swap spread payments on US$2.3 billion of privately held sovereign debt maturing in 2000-2001 over the next five to six years. The external liquidity relief provides a favorable window of opportunity over the next two to three years, during which the country should reprogram its debt with the Paris Club5, resume its relations with the IMF, and engage the Bank and other IFIs in supporting the implementation of the Government's medium-term reforms. 34. Status of the IMF Program. The IMF approved a three-year Extended Fund Facility (EFF) program (about US$2.6 billion) in September 1998. This program has been on hold since September 1999, when it went off track due to poor program implementation in the context of the Presidential elections in October/November 1999. In early 2000, an issue emerged related to allegations of mismanagement of the central bank's reserves. The two audit reports concluded thus far have confirmed that the central bank over-reported its reserves but have not revealed any evidence of misuse of IMF resources6. Although this issue is no longer an obstacle to resumption of the EFF, a range of issues are still outstanding, including the approval of fiscal measures to keep the budget deficit to 2.7 percent of GDP in 2000, initiation of liquidation procedures against a major troubled bank, increase in cash 4 The year 2000 external liquidity crisis arose from the decision in late 1997 and early 1998 to raise substantial funds on international financial markets using short-term bonds with excessive interest rates and heavily concentrated repayments in 2000 and early 2001. The partial rescheduling of the foreign obligations in late 1998 and mid-1999 using additional bond issues against the same maturity dates further exacerbated the problem. 5 The reprogramming of the Paris Club debt under similar conditions has tentatively been agreed, but the finalization remains contingent on the resumption of the IMF program. 6 The period between January 1998 and September 1998 is yet to be audited.  12 Ukraine: Country Assistance Strategy 2001-03 collection for energy, elimination of the export tax on sunflower seeds, increase in utility tariffs, and identification of a US$1.5 billion privatization program for 2001. The Bank and Fund teams continue to work closely, especially on the agenda of structural reform. 35. A Base Case Scenario. The central macroeconomic scenario underlying this proposed CAS -assumes specifically: (i) a full resumption and timely subsequent implementation of IMF's EFF program (the undisbursed amount is about US$1.6 billion); (ii) successful reprogramming of the Paris Club debt; (iii) continued enhanced support from the Bank and other multilateral/bilateral sources of long-term lending; and (iv) increase in privatization proceeds and other direct foreign investment. 36. Following an initial period of successful reforms and improved economic performance, it is expected that the image of the country and its credit rating will gradually improve, leading to a re-entry in the international capital markets in the medium term. Moreover, strategic investors are also expected to come to Ukraine in critical sectors, including telecommunications and energy, and, thus, enable the country increasingly to rely on direct foreign investment to meet its longer-run external financing needs. Consequently, the initial higher relative dependence on IFIs for long-term external financing is expected to decline over time. 37. Regarding GDP and balance of payments dynamics, the Base Case scenario builds on the most recent World Bank medium-term macroeconomic projections (Table 1). Recent revival of economic growth observed in the second half of 1999 and the first six months of the year 2000 is assumed to carry over through the rest of the year, yielding the first positive annual growth since independence. This growth, currently conservatively estimated at around 2 percent, is assumed to further increase to 2.3 percent in the year 2001, 2.6 percent in the year 2002, and to reach 3 percent during the last year of the CAS period. This growth is built upon improved fiscal performance and a reduction in the role of the public sector (see Annex Table B6) as well as a resolution of the systemic constraints that have hindered both domestic and foreign private investment. The projected growth path is below Ukraine's ability to revive production through better capacity utilization under existing technology in the medium run, as well as below its longer-term growth potential. To sustain increasing growth rates in later years of the CAS period and move on to higher growth thereafter, continued progress of institutional and policy reforms supported by Bank adjustment and other IFI operations is assumed. As described below, the main thrust of Bank adjustment operations will be to put together a consolidated reform effort yielding an improved business environment and higher investment for growth. 38. The Low Case Scenario. The Low Case scenario assumes that the Government continues to muddle through and has either difficulties or delays in implementing its program of reforms. Specifically, it assumes: (i) no resumption of the IMF's EFF program; (ii) no reprogramming of the Paris Club Debt; and (iii) no further adjustment lending. It also assumes, however, that Ukraine continues to make payments on its financial obligations. Without the measures necessary to produce a more effective government and better management of public resources the fiscal situation remains tenuous. Absent the reforms necessary to address systemic issues such as non-payments, property rights, regulatory interference, better public sector accountability and improved social sector sustainability, both domestic and private investment remain weak and growth unsustainable. Such a scenario would rnaterialize if the Government is unable to mobilize and maintain the needed political support and domestic ownership to push ahead on key aspects of its reform agenda or if the Government is unable to move forward with the IMF program. 39. In this case, growth would peak at two percent in 2000 and then fall to one percent by 2003. Gross domestic investment would fall sharply and imports plummet. Looser fiscal policy would imply somewhat higher inflation. Access to external finance would be considerably cut back with direct private investment estimated to be less than half of its potential under the Base Case in 2003. In this case, Ukraine's net flows on external long-term lending would be negative throughout the CAS period.  Ukraine: Country Assistance Strategy 2001-03 13 40. In both the Base Case scenario and the Low Case scenario, the Bank has an important role to play. In the Base Case, there are a wide range of activities that the Bank can support to help the Government meet the challenges of intensive economnic reform. In a Low Case environment, the Bank can best assist the Government by helping to lay the groundwork necessary for effective reforms by strengthening civil society and addressing key social concerns. In either case, it is critical for the Bank to stay engaged in order to promote dialogue and better understanding of the need for reforms. II. BANK GROUP ASSISTANCE STRATEGY A. ASSESSMENT OF THE LATEST CAS 41. The assistance strategy presented in the 1996 Bank CAS document was framed on optimistic assumptions, which seemed reasonable during the successful 1996 economic stabilization. It was cast as a "graduated approach", providing for lending of up to US$3.1 billion, depending on the Government's capacity to deliver on ambitious reform plans in agriculture, energy, privatization, and public sector reform. The achievements and shortcomings of the Bank Group experience in the past four years have taught valuable lessons for the future. 42. Achievements of the Assistance Program. The assistance program that emerged from the 1996 CAS (and that of the international community at large) can rightfully claim a number of successes and positive lessons, particularly considering that the transformation process in Ukraine was "uncharted territory." Perhaps the most important achievement is that many of the formal institutions of a market- based democracy were put in place, or at least their need identified and their build-up initiated. Particularly important were price reform, trade liberalization, and opening of the economy to external competition. Although, as noted, the functionality and legitimacy of these formal institutions has been weak, their existence provides the basis on which to build. Thus, many of the codes and laws affecting property rights and commerce have been modernized or created ex-novo, and important amounts of technical assistance from the donor community have been instrumental in incorporating international best-practice in their design. Mass privatization of small and medium enterprises, while not free from flaws, led to the emergence of an entrepreneurial class that represents Ukraine's greatest asset for the future. 43. Headway was made in handling the social consequences of the transformation into a market economy. For instance, the experience gained in assisting the restructuring of the coal industry has been encouraging, contributing to and benefiting from the regional experience in dealing with socially sensitive, regionally concentrated issues. The lessons learned in this respect are being incorporated into follow-up operations, and have helped the Ukrainian Government focus on the need for integrated strategies to deal with the social consequences of market reforms (see Box 3 for sector highlights). 44. The Bank secured strong cooperation from other donors around the Bank projects, leveraging donor activities and taking the leading role in many cases (for example, in the IBRD's programs for the financial sector and for enterprise privatization and restructuring and in IFC's technical assistance work). 45. Finally, early experiences in providing support to the growth of civil society have been encouraging. These are very much at the basis of the proposed new strategy. Donor efforts to facilitate the emergence of NGOs have proved fruitful in many cases, leading to greater accountability for civil servants and greater input of civil society in decisions that directly affect its welfare. The Bank was able to maintain a good dialogue with stakeholders outside the Government - through regular round-tables on reform topics organized by the Resident Mission or discussions with entrepreneurs on the business environment in Ukraine. Slowly a more participatory style of work has been evolving, engaging civil society at the national, regional and municipal levels in the consideration of the economic and political  14 Ukraine: Country Assistance Strategy 2001-03 Box 4: IBRD Activity in Ukraine During 1994-1999 the Bank took the lead in helping the authorities define and implement structural reforms (price liberalization, trade reform, privatization, financial and energy sector reform). This involved a number of large adjustment loans beginning with the general Rehabilitation Loan approved in December 1994, and followed by five SECALs, which account for the bulk (67 percent) of all loan commitments to date. Investment lending---envisaged in the 1996 CAS to be an important part of the Bank program---has been relatively modest. Sixteen operations have been launched (and twelve' are currently under implementation). Disbursements have amounted to less than US$200 million. Resources disbursed during the period 1997/1999 amounted to US$1.1 billion, thereby increasing total Bank exposure to over US$2 billion (see Table 2). At end-1999, the amount of undisbursed loans stood at US$629 million, with US$170 million in quick-disbursing loans. Table 2: IBRD Exposure in Ukraine (US$millions, CY) 1995 1996 1997 1998 1999 Exposure - Debt outstanding and disbursed 502.6 908.6 1,214.1 1,599.4 2,021.8 New Commitments 146.0 1,332.4 220.0 816.4 0.0 Committed Undisbursed 170.4 1,096.4 992.7 1,304.3 629.4 Net Disbursements 101.6 406.0 305.5 385.3 422.4 Bank Exposure to Total Public Debt 6.0% 9.8% 11.6% 13.5% 16.3% Total Public Debt to GDP 22.9% 21.4% 22.1% 30.0% 40.8% Due to slow progress of institutional and structural reforms since the beginning of 1998, the Bank formally moved to a low- case lending scenario, with the adoption of the latest CAS Progress Report in May 1999. The Low Case for new lending incorporated a very limited number of investment projects (five in FY00, and four in FY01, including Global Environment Facility projects) which could continue to be implemented even if the IMF program went off track. The Bank has continued disbursements under three previously approved adjustment loans - EDAL II, FSAL and the Coal SECAL - subject to an overriding disbursement limitation program. lncludes one GEF and one guarantee operation. reform agenda. The People's Voice Project (see Box 7) is a good example of an initiative in which World Bank, donors (CIDA), local communities and NGOs are working together to improve provision of local services and the functionality of local administration. 46. Weaknesses in Program Performance. However, in many other respects the evolution of the political and socio-economic situation in Ukraine proved unfavorable, affecting economic growth and the pace of reform. Under those circumstances, although several Bank loans were processed and disbursement conditions met---including substantial adjustment lending (increasing World Bank exposure to over US$2 billion)---limited sustainable results were obtained, and policy reversals were not uncommon (see Box 4 for description of Bank activity). Operational difficulties marred the approval and execution of several investment operations. This unsatisfactory situation was reflected in the 1999 CAS  Ukraine: Country Assistance Strategy 2001-03 15 Box 5: Country Assistance Review (CAR) The World Bank Group's assistance to Ukraine since 1992 was evaluated in the 1999 Country Assistance Review (CAR) (CODE99-37). The CAR found that given the circumstances at that time, the country assistance strategy was relevant in terms of proposing a "graduated approach." It noted that some progress had been made in privatization and trade and price liberalization, but progress in other areas had been limited. The CAR concludes that the Bank has often overestimated the Government's implementation capacity and the speed with which the economy would respond to changes in the incentive structure and policy environment. As a result--- despite the Bank's efforts---the fundamental principles of a market economy have not found their way into the Ukrainian economy. Moreover, in the vacuum that arose because the old rules no longer applied while the new ones were not yet established, corruption spread, and has become pervasive. This has contributed not only to a considerable increase in transaction costs but also has pushed a large portion of the economy "underground." The following lessons emerged from the review: * The essence of the reform agenda in Ukraine is to change and re-orient the role of government and public administration in the economy. * The Bank should promote public education about reform in order to build social consensus. * Reforms may not realize their intended supply response because of counter-activities by vested interests. * The scope of Bank assistance should be scaled according to the reform results. * In the case of limited consensus for reform, it should be targeted toward the poorest groups or demonstration projects. * The Bank should broaden the range of partners and stakeholders involved in its activities. These lessons have been used to refine the current country assistance strategy and strengthen the Bank's assistance efforts. For example, the CAS proposes to focus on building demand for good institutions, which will include a series of operations at the grass roots of the civil society. This approach will help build social consensus and support for reform, as well as develop bottom-up pressure for better governance. Another important lesson incorporated in the proposed assistance strategy is scaling the level of assistance to the delivery of reform results. The focal CAS operation - the PAL - is structured to award outcomes. If the Gcvernment's reform response is not adequate, the Bank's assistance will be scaled down to activities that would help build demand for better institutions. The CAR's recommendation for wider participation of the civil society in Bank activities has also been incorporated in the Bank's work. The preparation of the CAS itself has been done in a very participatory way, with participation of a broad range of stake holders and has attracted considerable interest and support from NGOs and other civil society representatives. update, which made official the "low case" status of the Bank assistance, and set strong conditions for processing of adjustment operations7 and for any further appraisal of investment operations8. 47. As noted in the 1999 Country Assistance Review (see Box 5), the main factors underlying poor performance were lack of government ownership and capacity to deliver. The Government often acted as if it had its agenda separate from the program agreed with the Bank. Retrospectively, it appeared that the main driving force behind these agreements was the Government's need for resources rather than genuine interest in reforms. As to its own plans, the Government was hostage to its political compromises and could not commit to a clear strategic direction and a comprehensive framework for advancing reforms. 48. Most importantly, the design of the adjustment assistance, based on a number of separate sector adjustment operations, proved to be a major shortcoming. Stand-alone operations were not well suited to address cross-sectoral institutional and governance issues. This led to a situation in which reforms were 7 These are (i) reform of the Apparat of the Cabinet of Ministers, as a critical step for creating a more efficient government structure; (ii) substantial enterprise deregulation and creation of a business-friendly environment; and (iii) large-scale privatization based on transparent and efficient procedures, generating cash proceeds of US$] billion. 8 No new operations could be appraised until a satisfactory solution to the backlog in ratification of loans by the Rada was found.  16 Ukraine: Country Assistance Strategy 2001-03 reversed or stalled in some areas while Bank resources were disbursed in others. Because the design of the operations focused mostly on inputs rather than effective results on the ground, adjustment loans focused on the Government producing satisfactory laws and regulations, but did not wait for proper implementation. 49. Weak institutional capacity in key government agencies further hampered implementation. Ukraine civil service has a limited number of professional policy analysts or managers, and their experience is mainly based on the Soviet regime rather than market systems. Moreover, managers and policy makers often give priority to addressing short term emergencies rather than putting in place the systemic reforms required to build the foundations for long-term growth. B. BANK GROUP'S PORTFOLIO PERFORMANCE IBRD Portfolio 50. In the context just reviewed, the performance of the IBRD lending portfolio has also been rnixed. At present, 5 out of 12 projects under supervision are rated unsatisfactory in terms of their development objectives and/or implementation performance. This is partly due to the fact that the country team has been very transparent in its assessment of these realities: the portfolio currently reflects a Realism Index of 83 percent and a Proactivity Index of 100 percent9. Twice-yearly, in-depth portfolio reviews have been conducted for some time, and have helped focus the attention of the Government on specific and systemic problems of implementation. 51. The currently unsatisfactory projects are Hydropower Rehabilitation (FY95, US$114 million); Agriculture Seed Development (FY96, US$32 million); Export Development (FY97, US$70 million); Ozone Depleting Substances (FY98, US$23.2 million); and Financial Sector Adjustment Loan (FY99, US$300 million). They were discussed in detail at the Country Portfolio Meeting, which was conducted with the Government in June 2000. As a result, corrective actions were defined for improving the performance of specific projects in the current portfolio, as well as for successful processing of new projects. In addition, the Government has established a working group to identify best practice from other countries in the region to develop new procedures that would streamline project processing. Further, it was agreed that a study of Project Implementation Units identifying the most effective project implementation arrangements be undertaken as well. 52. The long-standing project ratification problem was also discussed. The project effectiveness backlog was eliminated over the last year, and the processing of the Kyiv Energy Efficiency Project has provided the Government with a good test case to simplify internal procedures. From the outdated guidelines that mandated no less than five reviews by the Council of Ministers for already-negotiated projects, the Government is now setting in place much more simplified procedures, which will ensure that the projects of the World Bank (and other international financial institutions) can become effective in more reasonable timeframes than in the past. Presence of a viable mechanism for Bank project processing and effectiveness remains an important trigger for both Low and Base Case lending. IFC and MIGA Programs 53. In the past few years, IFC has mounted a mnajor technical assistance operation in Ukraine, aiming at improving the business environment and at facilitating the emergence of small and medium-sized 9 It should be noted that implementation ratings are expected to improve for three of these projects (Hydropower Rehabilitation, Export Development, and Ozone Depleting Substances) by early October 2000 as the implementation actions agreed upon with the project teams are shown to be sustainable. Another unsatisfactory project - Seeds Development - will close in September 2000.  Ukraine: Country Assistance Strategy 2001-03 17 Box 6: IFC Activities in Ukraine IFC has been supporting private sector development in Ukraine through a variety of direct investments and technical assistance. Direct Investments Since 1994, IFC has approved investments totaling over US$66.0 million, these include: . Two separate equity investments in a venture capital fund, totaling US$3.5 million; . Support to the First Ukrainian International Bank (FUIB), including a US$6.5 million equity investment and a US$10 million credit line; . An investment in Creditanstalt Ukraine, consisting of US$2.3 million in equity and a loan of US$5 million; * An investment in a new microfinance bank, including US$2.4 million in equity and a loan of US$5 million; * Backing for Finansbank Ukraine, a proposed new bank with Turkish capital for US$2.2 million equity and a US$5 million credit line (this investment has been on hold since the Russian crisis). Technical Assistance IFC has over 180 staff in the field in Ukraine assisting with corporate governance, land reform, small business development, and privatization of unfinished construction sites and other underutilized assets. The technical assistance program is evolving to meet the country's needs: * The successful auction model from the small-scale privatization program is now used for the privatization of unfinished construction sites. . After implementing its farm reorganization model in four regions, IFC is advising the central government on the land code, working with more farms, and establishing local institutions to undertake training in other regions. . The business development project is assisting in a new national deregulation campaign and providing advice on leasing. . IFC is also currently providing advice to the Ukrainian Securities and Exchange Commission. enterprises (Box 6). Major contributions have been made to the growth of a new class of entrepreneurs, and to improving governance in newly privatized, but inexperienced enterprises. In addition, the technical assistance program in agriculture has provided a wealth of experience in ways to build market relationships in the sector, while ensuring that the suspension of state-directed credit flows does not lead to output disruptions, by fostering relationships between primary producers and agro-processors. 54. Given the institutional weaknesses already discussed, IFC has had great difficulty in attracting strong foreign industrial partners to Ukraine, and has therefore focused its investments on the financial sector. IFC's experience has nevertheless provided considerable information about the difficulties that newly established businesses have to face in the context of the Ukrainian environment, and through its technical assistance operations the Corporation has provided important inputs into the policy dialogue, as well as establishing a monitoring mechanism which is well trusted by business, government and the international community. 55. IFC's experience in Ukraine confirms that working in tandem with IBRD and other donors to support business awareness and to demand a better regulatory framework is a precondition for increased investment activity. This is particularly true in the early stages of reform, when an appropriate business environment is not yet in place. As this framework improves, and as transparent privatization methods take hold, IFC is expected to move toward more direct work with private partners. 56. The Multilateral Investment Guarantee Agency. MIGA has equally been affected by the unfavorable investment climate and unstable legal environment. At present, it only has one operation active in Ukraine. However, MIGA is closely watching the development of the economic and investment situation and will be ready to increase its presence when conditions improve. Currently MIGA is  18 Ukraine: Country Assistance Strategy 2001-03 considering a new small guarantee operation and may also be a potential partner with IFC in a program to help re-convert the high technology industrial sector. 57. The Ukrainian privatization program was one of the first participants in MIGA's PrivatizationLink investor information service, and officials have reported that their use of Internet-based marketing, via MIGA's online service and their own Web site, has substantially benefited their outreach efforts, both domestically and with foreign investors, and contributed to the transparency of the privatization process. D. COUNTRY ASSISTANCE STRATEGY, FYO1-03 Lessons Learned from the Most Recent CAS 58. The experience gained in program implementation and portfolio management has yielded a number of important lessons that can help shape future Ukraine-World Bank relationships. Notably, with regard to: * Policy-based lending and dialogue: Concentrate on effective results on the ground. When supporting economic reform, ensure that policy-based operations fully reflect government ownership, cover the most critical systemic elements affecting the quality of public and private institutions, and prevent partitioning of reforms that would allow backtracking; * The time-frame to implement refonns: Assume achieving results will take longer than it would appear necessary or as promised by counterparts; * Sustainability of outcomes: Seek a greater involvement of, and tailor activities toward, civil society, in order to increase the demand for accountability of public officials and for well- functioning institutions; * Investment operations: Embark on "pilot" projects only when full understanding of the institutional weaknesses in the sectors concerned is obtained, and when clarity exists as to how pilot projects will modify the distorted systems of incentives. In addition, fully factor into their design the likelihood that administrative capacity and bureaucratic simplification will take a long time to show improvements; * Overall program effectiveness: Take full advantage of the presence of other donors, by facilitating their efforts in the areas of their comparative advantage; * Financial integrity. Ensure that all available safeguards against misuse of funds, both investment and adjustment lending, are in place. Objectives of the Country Assistance Strategy, FY01-03 59. The Country Assistance Strategy for Ukraine for the period FY01-03 builds on the lessons of implementing the previous CAS, as well as on the knowledge gained on Ukraine's socio-political challenges. The CAS aims to assist government and civil society in implementing a broad-based poverty- reduction strategy and in attaining job-creating sustainable economic growth. To do so, the strategy will directly address the institution-building challenges faced by Ukraine, both from the demand (civil society) and supply (Government) sides. Program Strategy 60. A Two-legged Strategy. To be of effective assistance to Ukraine, the World Bank Group's strategy will be articulated into two legs: the first (under the Low Case) will aim to support civil society in its demandfor better government; the second (which would be added under the Base Case) would aim to  Ukraine: Country Assistance Strategy 2001-03 19 support opportunities to strengthen institutions that foster sustainable development, when these opportunities present themselves. The strategy will emphasize program ownership, results on the ground, and increased attention to material improvements in delivery of social services. 61. Non-lending activities will be a strong component of the Bank Group's assistance under either assistance scenario (Annex B4). In keeping with the emphasis on increased reliance on and participation from civil society, the Bank group will ensure that stakeholders are informed, consulted and actively involved in these activities. 62. Complementing this approach, IFC will aggressively pursue investment operations, which are more likely to come into existence as the business environment continues to improve. In addition, IFC will carry on with and extend its current technical assistance activities, which will continue to be coordinated with present and planned IBRD interventions in assistance to business, both on the policy and the technical assistance sides. IFC will be strongly involved, on the policy dialogue side, in providing feedback and indications relevant to the improvement of the regulatory framework and the protection of property rights. Program Content Supporting Civil Society's Demandfor Better Government 63. As agreed with the Government, the participatory process of CAS preparation will be extended into its implementation. This will enable the Government and its development partners to benefit from the voice of civil society. Specifically, the Bank will seek to be a partner in facilitating increased accountability of public officials, reducing corruption and assisting in developing mechanisms that will enable the views of the population to be adequately taken into account. Activities under this heading must meet two crucial tests. First they must demonstrably help civil society increase its voice for better government and social services provision, or provide tangible benefits in globally sensitive areas. Secondly, they will have to be sufficiently shielded from possible paralysis at the center of government, so as to stand a good chance of success-even under less-than-favorable conditions. 64. The Bank will work in close collaboration with donors that have a greater ability to work directly with non-governmental partners. For its part, the Bank Group will engage in lending and non-lending activities that can directly increase the voice of civil society, while leading to better provision of social services. The main vehicles for increased attention to civil society and gender issues in our program will be: * The "People's Voice" Project (FYOI-03, see Box 7). This technical assistance effort has led to increased citizen's involvement in local affairs and greater accountability for elected officials. The Bank plans to expand this successful assistance. * The Municipal Development Fund (FY02 LIL(APL)) will help local governments strengthen their capacity for financial management and effective delivery of basic services using open and participatory budgetary methods. In the Low Case the project is included as a LIL because of its capacity building component. Should the Government move to a Base Case it will be included in the Program as an APL with a corresponding framework for intergovernmental and local finance reforms. * The Social Investment Fund (FY02) builds on the experience gained in the region and elsewhere. It will aim at reducing the passivity and dependence on the center of many of the poorer communities, and will crucially depend on collaboration with local governments, NGOs and citizen's groups.  20 Ukraine: Country Assistance Strategy 2001-03 Box 7: The People's Voice Project Through the People's Voice Project, the World Bank has initiated a new generation of Bank programs in Ukraine that focus on the development of civil society. This program is aimed at building integrity at the municipal level through strengthening the voice of citizen groups demanding better governance and services, and by facilitating more responsive public organizations. It is a pilot program supported by the Canadian International Development Agency (CIDA) and covers three cities in Ukraine. The project's strategy is to bring the supply and demand sides of reform together. Through surveys, information is gathered on the problems associated with major services. This information is then used by citizen groups to exercise pressure from below (civil society) on local leaders to improve service delivery. The project is also supplying technical assistance to municipal agencies (suppliers of services) that should enable them to be more responsive. In addition, the information gathered through the project is provided in the form of feedback to the central authorities, as well as to the Bank's teams that operate at the central level of government. Project implementation began in Ternopil. Surveys were conducted among: (i) households, to collect feedback on services, corruption and related matters; (ii) the business community, on their interactions with local governments, and (iii) public officials, to get their side of the story. Not surprisingly, in addition to the citizens' dissatisfaction with the quality of public services, surveys also revealed that 93 percent of citizens had never filed any complaints, as they believed that this was worthless. The survey information has been widely disseminated through media, public discussions, conferences, and NGOs. Initial implementation results are encouraging. The municipal officials in Ternopil reacted to the survey results by creating several task groups to work on the most critical problems revealed by surveys. These groups are currently developing proposals on how to deal with the identified problems. An interesting initiative has emerged in the city in response to the citizen's demands: Service centers, a one-stop shop where citizens can pay for all municipal services. The Service Centers might be used for filing and monitoring the citizen complaints. Surveys are currently being conducted in Ivano-Frankivsk and will soon start in a third pilot city. The People's Voice initiative has found support among donors, namely CIDA. In addition to providing support to the project itself, they are also planning on starting similar activities in other cities throughout Ukraine. * A Gender Dimension of Transition studyl'. This study, conducted in collaboration with Ukrainian NGOs and other donors, will review the emerging trends with respect to gender- specific problems during the transition, identify possible policy options, and suggest a better integration of gender issues in Bank assistance, particularly with respect to access to finance, identification of formal and informal obstacles to economic activity, and incorporation of gender issues in Bank group projects. 65. The implementation of the Global Distance Learning Initiative (FY01-03) and the Global Gateway (FY01), now in a pilot phase, will provide a vehicle for increased dissemination of information and best practice around the country. On the basis of suggestions from the NGO community, the Bank is exploring the possibility of a project that would provide support to open internet access for library users across Ukraine. The Government has also requested the World Bank's help in making its Anti- Corruption initiative more effective. The Bank will work to this end in partnership with stakeholders and will incorporate benchmarks of increased transparency and accountability in its operations. Finally, together with the NGO conmmunity, the Bank has been reviewing the legislative and regulatory 10 Gender issues have not received enough coverage in the Bank's programs in Ukraine with the exception of a recent initiative under the People's Voice Project - a gender audit. However, this issue has received significant coverage in other donor programs. UNDP has conducted an in-depth study of gender issues, which is discussed in the 1999 Human Development Report. Other donors, such as USAID, Renaissance Foundation, CIDA, etc. have financed programs aimed at helping women to start-up businesses, training targeted to women, building capacity of female-led NGOs, etc.  Ukraine: Country Assistance Strategy 2001-03 21 framework regulating non-governmental activities and will work with Government to remove unnecessary obstacles. 66. Strengthening Property Rights. The Title Registration and Distribution operation (FY02) will support the creation of an efficient and trustworthy ownership framework for land and property transactions. This effort is critical for building a demand for better governance because ownership and clear title to property are at the very foundation of promoting accountability and moving toward market reforms. 67. Building a Basis for Sustainable Private Enterprise. The Bank Group (IBRD, IFC and MIGA) will work jointly to support the business community to put in place the conditions for growth and employment on a sustainable basis, with emphasis on creating the conditions for increased growth of small and medium enterprises (SMEs). This includes: (a) reducing the cost of uncertainty and bribes related to government oversight and regulation; (b) improving access to finance; (c) reducing the costs of entry and access to internal and external markets, and (d) better management training. The Government has already established a State Committee for Entrepreneurial Development that focuses on issues of deregulation, entry, licensing and standards. The Bank Group will support Government efforts to develop entrepreneurial and managerial capacity for SMEs through a Private Sector Development Project (FY02), under which participating local authorities and businessmen will work together to improve the regulatory environment and the utilization of idle capacity by new small and medium enterprises, and so on. LFC is planning to expand its technical assistance work considerably, with additional initiatives in Ukraine using its local staff and in-country experience. IFC' s strategy is to strengthen the SME sector through technical assistance work and to support the entry of foreign strategic investors to Ukraine by linking technical assistance projects with IFC investment initiatives. IFC is working to secure the additional resources necessary to expand its TA work in Ukraine. This may include: * an asset restructuring project, to help privatized companies divest their non-core activities; * a leasing project, to provide advisory services, market-building, skills transfer, and a public awareness campaign; * a mortgage finance project, to help financial institutions develop mortgage services; a an advisory program, to assist SMEs in their efforts to reach regional and international markets; * a financial re-engineering project, to help banks develop SME credit lines. 68. Public Services for Human Development. As a consequence of the economic crisis and lack of restructuring, Ukraine has neglected its human development, as witnessed by worsened health status, decreasing life expectancy, and reduced student enrollment rates. The Government Program stresses the need for substantial improvements in the areas of health, education and social protection. Increasingly, communities are becoming more active partners in decision-making and service provision. The Bank intends to increase its assistance in these areas substantially. Improved provision of health and education services will require significant changes in the current financing mechanisms and delivery structures. The Bank will support the Government in the development of health and education strategies that will bring together all stakeholders (Government, beneficiaries, NGOs, civil society, and donors). The Bank will also assist in the reform of the existing pension scheme into an effective and sustainable old age security system. 69. Basic Social Services. To begin, Bank assistance will focus on addressing critical emergencies and strengthening community involvement in the provision of improved basic social services to the most vulnerable groups. The TBIHIV/AIDS control operation FY(01) will attempt to contain the spread of these public health threats. The Social Investment Fund FY(02) will build on existing demand driven initiatives to improve community-based social services targeted at the poor and vulnerable.  22 Ukraine: Country Assistance Strategy 2001-03 70. The Bank will assist the Government in the development of health, education, and social protection reform strategies. Additionally, the Bank will help build capacity to implement these strategies through a Social Sector Technical Assistance/Capacity-Building loan (FY03) for education and/or health. 71. Social Dimensions of Adjustment in the Coal Sector. The Bank will pay increased attention to the social consequences associated with coal sector reform, though an investment operation (FY01) that will expand on the gains obtained so far, to help in the closure of fifty uneconomic and unsafe coal mines, ensure payments of back wages and severance to the affected miners, and set up a regionally based job retraining and stimulation program. In addition, a Methane Safety Learning Innovation Loan (LIL) (FY02) will be processed to gain relevant experience on reducing the risk of explosions from the accumulation of methane. 72. Environment. Bringing Ukraine to European environmental standards would require miany years and billions of dollars. The Government has already begun to address the most serious and immediate environmental problems that beset Ukraine in biodiversity: land, water, solid waste management and industrial pollution. During the next CAS period the Bank will aim to: (i) help the Government develop the legal and institutional framework for environmental regulation; (ii) improve the capacity of the Ministry of the Environment and related agencies; and (iii) efficiently prepare and implement larger environmental investment projects in the clean-up of air pollution, protection of biodiversity, and improvement of land, water, and solid waste management. 73. Bank assistance includes the Wetlands (FY01) project, funded by GEF, for the recuperation of the wetlands between the Black and Azov Seas. In parallel, the Bank would support the development of the environment institutional and regulatory framework, as discussed in the next section. Further strengthening of the environmental institutions to implement policies will also come from a thorough public expenditure review in the environment sector, which will be carried out by FY02. Later in the CAS period, as the institutional capacity increases in the environment sector, the Bank could support the Government with a sector-specific operation geared to abate serious air pollution problems in the industrial belt and other major environmental concerns - Environmental Pollution (FY03). Of more immediate concern is the management of Ukraine's Black Sea coastal areas, which are under significant environmental pressure from inland pollution and poor management of coastal resources. This issue will be tackled by initiating a Coastal Zone Management Institutional Development Fund (IDF) (FY02) in Crimea and by mobilizing the resources made available by the Danube and Black Sea Strategic Partnership. Lastly, the Bank will continue to use Global Environment Facility (GEF) resources to address immediate environmental needs in line with the agreed priorities in the Climate Change National Strategy Study (NSS) (FY01). Additional work in the areas of climate change and environmental issues in the energy sector will be carried out following the completion of the NSS and implementation of the recommended investments. 74. Finally, in the early period of CAS implementation, the Bank will also complete the processing of two operations already in advanced stage of preparation. Sevastopol District Heat (FY01) will introduce a more efficient decentralized heating system based on gas-fired mini-boilers in order to reduce the huge wastage of energy and improve affordability of an essential service. In the water sector, the Bank will complete the Lviv Water Project (FY01) under preparation, which has benefited from considerable technical assistance from several donors. 75. Due Diligence - Economic and Sector Work. The Bank's knowledge of key economic sectors and cross-sectoral issues is being kept up-to-date. A participatory Country Economic Memorandum was prepared in FY99 and a Poverty Update (FY01) is in its final stage of preparation. An in-depth assessment of the financial sector is currently being carried out and will be reflected in the Financial Sector Note (FY01). An in-depth public expenditure and institutional review is planned for FY01, which will help us to prioritize our bottom-up institution building programs. Moreover, the Bank monitors continuously macroeconomic developments and risks. In terms of fiduciary assessments, the  Ukraine: Country Assistance Strategy 2001-03 23 procurement and financial accountability assessments are planned for FY01. The results of these assessments will allow the Bank and the Government to put in place mechanisms that will assure adequate management of resources and competitive procurement practices. Supporting the Supply of Pro-Development Institutions 76. Addressing Bottlenecks. To support the "supply" of pro-development institutions, the Bank will center its assistance on breaking critical bottlenecks that have hampered reform in the past. The main across-the-board bottlenecks, as mentioned above, are incomplete institutional designs and poor governance. These have permitted the granting of monopoly rents and other privileges, which, in turn, have fostered rent-seeking, skewed the distribution of income, and resulted in poor delivery of social services. Effective assistance in this area will require true ownership of the reform program by Government, Parliament and a sufficiently large segment of civil society. It also calls for verifiable results on the ground. Assistance efforts will identify a range of lending and non-lending instruments. These will center on redefining the role of Government, curtailing opportunities for corruption, introducing hard budget constraints in the public and private sectors, liberalizing economic activity, reducing transaction costs, and enhancing property rights. 77. A Sequential Approach, with a Three-Year Vision. To bring about genuine reform in a realistic manner, the Government and the Bank would define a three-year program of reform and institutional action, based on the Government's own recently approved program. The flagship operation for the Base Case scenario would be a series of Programmatic Adjustment Loans (PALs). These are conceived as a sequence of three separate operations, totaling up to US$750 million, with disbursements depending entirely on performance. 78. The PAL sequence will be grounded on a shared "vision" for Ukraine at the end of the three-year time of implementation. The overall vision, based on the Government program discussed above, is one of Ukraine as a friendlier place to do business, where private investment is in a better position to take place, and where social service delivery has considerably improved. This vision will be presented to the Executive Board at the time of the first PAL board presentation, in the form of a Letter of Development Policy which would provide the "umbrella" for the PAL sequence. Meaningful indicators of success in execution of the program would be agreed, and each single-tranche adjustment loan would be presented to the Board upon achievement of the agreed objectives. The PAL would be accompanied by Bank assistance to the Government to explain the reforms to the civil society and create a momentum to sustain the process over the medium and long term. It is expected that successive PALs will be one year apart, but the actual time may be shorter or longer depending on government implementation performance and effectiveness. 79. The main rationale for introducing a programmatic adjustment operation in Ukraine is to address the shortcomings of sector adjustment operations as described above. In addition, single tranche operations based on achieved benchmarks would set a clear mechanism for measuring Government's reform performance, thus protecting the Bank from committing resources before results on the ground are attained. More specifically, the PAL design would include the following five characteristics, derived from the lessons from the past: * The program would be based on increased reform ownership by the Government and society at large; * It would concentrate on results; * It would explicitly take into account inter-sectoral linkages and cross-cutting issues; * It would be sufficiently flexible to reward meaningful overall progress, or to decrease Bank exposure if performance is not adequate; and  24 Ukraine: Country Assistance Strategy 2001-03 Table 3: IBRD Tentative Lending Program-FY2001/03 (US$Million) Low Case Lending FY01 FY02 FY03 TB/AIDS 40 Private Sector Development 40 Social Sector TA 50 Coal Restructuring 100 Social Investment Fund 30 (Education/Health) Wetlands (GEF) [8] Title Registration and Distribution 100 Environmental Pollution 20 Lviv Water 24 Environmental TA (GEF) [15] Statistics Modernization 30 Sevastopol Heat 17 Methane Safety LIL 5 Municipal Development Loan LIL* 5 Subtotal 181 Subtotal 175 Subtotal 100 Base Case Lending Low Case lending 181 Low Case lending 175 Low Case lending 100 plus plus plus Programmatic Adjustment PAL (2"d loan) 250 PAL (3"d loan) 250 Loan (PAL) (15' loan) 250 Public Administration Incentives Social Sector Tax Administration Reform 60 AdjustmentlAPL 100 Modernization 100 Pre-Export Guarantee Facility 100 Rural Finance/Farm [Municipal Development APL]* [150] Restructuring 100 Total 531 Total 735* Total 550 *If Base Case proceeds Municipal Development Loan will become APL for 150, Total reflects Base Case. * It would help the Government foster its internal capacity to implement the reform program. 80. Thematic Areas. Given the cross-cutting nature of the institutional and governance problems affecting Ukraine's performance, the PAL's benchmarks and milestones will concentrate on the following thematic areas: * Financial discipline in public and private sectors. The PALs will help develop and implement a comprehensive strategy to eliminate the chronic non-payment problem in budget, tax obligations, and inter-enterprise arrears. The objective is to improve contract enforcement and bring about hard budget constraints. Particular attention would be given to the energy sector, including gas, seeking to curtail corruption in the financial relations in this complex and complete its institutional design; * Improvements in the regulatory frameworks for business. The PALs will focus on regulations facilitating the entry and operation of business and providing clear rules of the game in critical sectors such as telecommunications, energy, finance, land, and pensions. Moreover, the PALs will work to reduce the number of required licenses, the registration process, and inspections. * Transparent definition and protection of property rights. This is a cornerstone of the development of the market system and the definition of the role of the state. The PALs will support Government's intent to transfer state property to private owners in a transparent manner and to create adequate institutions to protect property rights. Specifically, the PALs will focus on the comprehensive registration and titling of land and the implementation of the privatization law in industry. Critical sectors that will receive special attention will be energy and telecommunications. * Public sector accountability and effectiveness. The PALs will foster open and transparent budget processes following adoption of a transparent fiscal code, comprehensive tax reform in line with international standards, and the continued reform of the public administration and the system of intergovernmental finance.  Ukraine: Country Assistance Strategy 2001-03 25 Mitigation of the social cost of transition and improvements in the delivery of social services. In pensions, the main objective will be the reform of the basic pension system (first pillar) and preparing the groundwork for the introduction of a funded compulsory (second pillar) and voluntary (third pillar) personal savings schemes. The chief objective in the reform of the social assistance program will be the introduction of a targeted system that improves the effectiveness of Government in reaching those most in need. Health and education sector strategies would focus on mobilizing private resources and improving financial management. 81. In the short-term the specific policy measures under these thematic areas foreseen for the first PAL seek to remove the most damaging constraints hampering business operation and economic growth. Thus, improving energy payments will result in improved tax performance and timely servicing of foreign and domestic energy debts. Improved tax performance will help Government clear budget arrears, leading to further improvements in financial discipline throughout the economy. Similarly improving compliance in the financial sector will help revert the existing non-payment trend in the economy and enable healthy borrowers to acquire financing needed for investment and growth. Also, an improved fiscal performance will give an additional impetus to growth and give the poor access to improved social services. Supporting Institution-Building Activities 82. There is a tight link between advances in policy reform under PAL and the availability of resources to the Government for technical assistance and/or investment in the Base Case. Investment projects that require removal of critical bottlenecks will be considered only upon reaching the corresponding benchmarks under PAL. 83. The Bank plans to supportfiscal reform and reforrn of the state through various lending and non- lending instruments. Economic and sector work (Public Expenditure Review (FY01-02)) will provide a basis for policy advice and improving the management of public resources and streamlining public expenditure supported by more detailed social sector studies and programs. Reform of key central institutions of the .public sector is supported by the ongoing implementation of the Treasury Modernization (FY98) project, the proposed Tax Administration Modernization project (FY01) and a Public Administration Incentives Reform project (FY02). These operations will help improve revenue generation, budgetary management, national statistics, and civil service, while increasing accountability of public officials and public scrutiny. In the Base Case, the Municipal Development LIL (FY02) will become a full-fledged APL in order to help build capacity of sub-national governments and support key reforms in intergovernmental and local government finance. 84. In the social sectors, as the capacity of Government is strengthened (see the Base Case), the Bank will support full implementation of the reform programs through either an Adjustment or Adaptable Program Lending operation (FY03). The choice of instrument will be determined as the dialogue develops and the degree of Government commitment becomes clear. 85. In Ukraine's agricultural sector, as indicated, many elements of a pro-market institutional framework are still missing. The Bank Group will build on the Title Registration work discussed in the Low Case by supporting the introduction of the necessary legislation and regulation, and will help ensure that the pro-market institutions are effectively functioning. This will include completing the legal and regulatory reform (land code and cadastre laws) that is necessary for the issuance of transactions in land, using land as a collateral for financing; solving the problem of indebtedness of the former state farms, and the devolution of social infrastructure to municipalities. The next phase will focus on setting up the market infrastructure needed for successful agriculture in Ukraine. This would include the establishment of commodity exchanges, access to agricultural credit, job creation in agricultural services. The Pre- export Guarantee Facility (FY02) will enable Ukrainian agricultural producers and importers of agricultural inputs to insure against non-commercial risks. A Rural Finance operation (FY03) will  26 Ukraine: Country Assistance Strategy 2001-03 capitalize on the legal market infrastructure put in place under the PAL (cadasters, movable, collateral, leasing). It will pilot the establishment of a market-based system of rural finance. IFC, building on the experience gained through its technical assistance operations, is planning to invest in a number of agribusiness enterprises, establishing close links with primary producers, and fortifying the market institutions under construction. 86. The Bank will also extend specific support to achieving the environmental benchmarks set forth in the PAL, in particular by strengthening the capacity of government environmental agencies. The Public Administration Incentives Reform project (FY02) would support capacity-building in the Ministry of Environment and related institutions. Other support would be provided through a small, targeted environmental investment loan to ensure that adequate environmental monitoring is in place to support policy implementation. At the local level, it is expected that the Municipal Development APL (FY02) may benefit small municipal infrastructure projects with positive environmental impact. 87. The Business Environment. The Bank Group (IBRD, IFC and MIGA) will work jointly to help Government advance its private sector development (PSD) agenda. It will support government plans to take the privatization process into large state-owned enterprises and critical sectors of the economy, such as energy, telecommunications, industry, and agro-industry. At the same time the PAL would support the development and implementation of a business-friendly legal framework and progress in deregulation. 88. As the business environment improves, EFC will play a reinforcing role by more actively pursuing the investment opportunities that can be expected to emerge. Among the new opportunities, IFC will continue to work with well-known, highly visible foreign investors and identify projects where Ukraine has a comparative advantage. Such projects would include export projects, particularly in natural resource-based industries. IFC will also put significant emphasis on financial market development, which will focus on institution-building such as leasing companies, with strong technical assistance components and, where possible, with foreign sponsors. 89. Currently, EFC is targeting the following projects in Ukraine: a cellular (and later a fixed line) telephone project; a food processing project; a brewery; a soda ash plant in Crimea, soon to be privatized; two carbon black plants; a potato processing facility; renovation of a hotel in Kyiv; and a leasing company. The Government intends to carry out an in-depth reform of the telecommunication sector through the creation of a firm regulatory framework and the sale of controlling blocks of shares of the telecommunication companies to strategic investors. EFC, working with EBRD, is planning to support privatization through an investment operation. 90. Expressions of interest on possible sovereign guarantees have emerged recently, and could become substantial if the improvement of the business environment continues. MIGA stands ready to respond in an appropriate fashion. 91. Closely linked and complementary to the PSD agenda, the Bank program also foresees further support to the development of the financial sector. This will be achieved by assisting the Government in developing a reform agenda on three fronts. First, Bank assistance will focus on specific policy reforms aimed at improving the environment under which financial institutions operate. Assistance in this area will emphasize the consolidation of earlier gains in the use of proper enterprise accounting standards, and will target distortions created by tax privileges and non-cash payments practices. Second, the Bank will support ongoing efforts to enlarge gains in the regulatory environment of banking institutions into a coherent legal, regulatory and supervisory framework of the entire financial sector. On this front, Bank assistance will support ongoing efforts to set up an adequate regulatory environment for non-bank financial institutions. Third, Bank assistance will aim at consolidating gains in structural reforms in the financial sector by intensifying support to ongoing efforts to deal with the resolution and restructuring of large problem banks, such as Bank Ukraina and the Savings Bank.  Ukraine: Country Assistance Strategy 2001-03 27 Table 4: Triggers and Lending Levels Lending Scenarios Triggers Low Case 1. No major deterioration in portfolio performance Exclusive concentration on activities that increase (less than 20 percent unsatisfactory ratings) demand for good and legitimate institutions. No 2. Presence of a viable mechanism for Bank loan adjustment lending. FYO1-03 lending to total up to approvals and effectiveness. US$461 million. 3. Strict adherence to financial and fiduciary obligations. Base Case 1. Same as above. Activities extended to support the supply of 2. Consistent and sustainable macroeconomic legitimate institutions from the center. FYOI-03 framework in place. lending up to a total of US$1.8 billion. Adjustment 3. Meeting of PAL-specific triggers conceraing lending through performance-based PAL. One financial accountability, regulatory framework, guarantee operation in agriculture. A number of property rights, public sector accountability and capacity-building operations aimed at central social sustainability (see para 94). government institutions. Triggers and Lending Levels 92. The Low Case. Ukraine remains at present in the Low Case assistance mode as defined by the 1999 CAS progress report. While the Government has made progress in meeting the triggers set out in the 1999 report (see footnote 5), this progress has been insufficient for movement to a higher case. These triggers will now be superseded by the benchmarks to be met for the Base Case set out below. As discussed above, should the Government be unable to move forward on reforms, the Bank's Low Case assistance program will focus on activities defined as critical for stimulating the demand for good and legitimate institutions. Full commitments under this Low Case scenario would amount to US$461 million over FY01-03 (see Table 3). This scenario will also include non-lending activities, including the lFC technical assistance program. As agreed with the Government, these activities would have to meet two crucial tests: First, they would have to demonstrably help civil society increase its voice for better government and social services provision, or provide tangible benefits in globally sensitive areas. Second, they would have to be sufficiently shieldedfrom possible paralysis at the center of government so as to stand a good chance of success-even under less-than-favorable political and economical outcomes. Moreover, even the Low Case lending could be significantly curtailed if portfolio performance deteriorates significantly, and/or the loan effectiveness issue re-emerges, and/or financial accountability issues arise (see Table 4). In the event of an economic outcome significantly worse than those presented in the Low Case scenario of Table 1, the low case lending would also be curtailed and presented in the CAS update. 93. The Base Case. If conditions warrant, the World Bank assistance could move into the Base Case, with total IBRD lending of up to US$1.8 billion for the three-year period, and a number of non- lending activities aimed at enhancing pro-development institutions, increasing the capacity of the Government to design and implement reforms, and facilitating the attainment of results on the ground. Moving to the Base Case scenario would require, in addition to a sustainable macroeconomic framework (e.g. full resumption and timely subsequent implementation of IMF's Extended Financing Facility (EFF) program), achievement of agreed upon PAL benchmarks in the five cross-sectoral issues discussed above. These will also be the conditions for the first, one-tranche PAL to be presented to the Executive Board for approval. Attaining benchmarks for PAL II and IIn sequence will be required for continuation of the Base Case scenario into the second and third years of the strategy. Thus, other projects in the Base Case scenario are linked to the respective PAL going forward. 94. The specific benchmarks under the first PAL, currently under discussion with the Government, will include: (a) an improvement in financial discipline through full elimination of non-transparent budget  28 Ukraine: Country Assistance Strategy 2001-03 offsets, a major reduction in budget arrears and energy payment debts; (b) easier business entry and operation confirmed through independent surveys; (c) enhanced property rights in agriculture through abolition of Kolkhozes, transparent privatization of large industrial enterprises and legislation enabling privatization of at least 25 percent of the telecom company; (d) better public sector accountability through implementation of a formula-based transfer system, sufficient progress in public administration reform, and significant reduction of tax exemptions, and (e) improved social sustainability through a review of special privileges currently extending surrogate social protection and progress in preparing the pension reform. Two subsequent PAL operations would be presented to Board depending on meeting the agreed benchmarks for each tranche and on the overall pace of implementation of reforms (probably at one-year intervals). 95. Self-regulating Program Structure. As it is performance-based, the proposed assistance program will automatically relate the commitment of Bank resources to the pace of reform. Slow implementation of reforms, and consequently slow achievement of the agreed performance benchmarks, would lead to delayed presentation to the Board of individual adjustment and investment operations, resulting in lower commitments and disbursements over the CAS period. It is possible that the Government might be able to execute the agreed three-year program in a shorter time frame. In this case, the resulting increased creditworthiness might warrant higher levels of Bank exposure, particularly to deal with problems in areas in which private capital would be unlikely to flow. This scenario-a High Case- is rather hypothetical at this time. However, were it to occur, it would be documented in a suitable update to this CAS. Benchmarking and Indicators of Success 96. Success in the implementation of the CAS will depend in large part on the ability of Ukraine's leadership to rise to the challenge that it faces, and break the vicious circle of bad institutions and bad economic outcomes. Thus, if the Base Case prevails for the duration of the CAS period, indicators of success should be measurable in terms of increased growth, reduced poverty and greater social cohesion (indicators of success benchmarks are illustrated in Annex B9). If the Bank is unable to move to the Base Case, or will have to return to a Low Case during CAS implementation, in addition to the performance benchmarks related to the projects in our low case lending program (Annex B9), our success should be measured by the extent to which the Bank's contribution may have helped civil society's voice to be heard. Accordingly, during the CAS implementation period, the World Bank will conduct an annual survey of attitudes toward the Bank and toward reform. These surveys will be the Bank's main vehicle for appraising the effectiveness of our interventions, as well as the perception within the population at large of our role in Ukraine's society. Selectivity and Partnerships 97. The program is also designed to capitalize on the Bank's comparative advantages and maximize synergies with other donors and international financial. institutions. Accordingly, a major expansion of assistance to reforms in the social sectors is contemplated, building on recent encouraging openings and the Government's stated priorities. On the other hand, IBRD will withdraw from further investment in areas in which investment operations have proven unable to achieve the hoped-for systemic results or demonstration effects, or where other IFIs are providing sufficient funding (e.g., infrastructure and transport or large energy plant rehabilitation). In small-scale energy plant rehabilitation, the Bank will complete the processing of two projects now in advanced stage of preparation, and that are expected to lead to a better understanding of the incentive systems faced by public agents in the utility sector. The lessons learned will be incorporated into our policy dialogue and the municipal development activities. 98. The proposed program critically depends on two factors: the Bank's ability to take advantage of opportunities offered by existing and prospective programs of partners in development, and its ability to  Ukraine: Country Assistance Strategy 2001-03 29 capitalize on civil society's activities. These steps will ensure that the Bank's comparative advantage is fully utilized. The Bank has discussed the proposed CAS with all partners, and the Bank has taken great care at ensuring that no duplication of efforts occurs. Our partners have indicated that they appreciate the Bank's policy leverage, which is required for their programs to be successful and effective. 99. Major assistance programs covering a wide range of areas are provided by the U.S. and Canadian governments. EU-TACIS is also very active, as are many other bilateral European donors (including the United Kingdom, Germany, Netherlands, and Italy) and UNDP. An overview of donor activities in Ukraine is presented in the "Partners" column of the CAS matrix (Annex B9). 100. Tighter cooperation with our donor partners has become even more critical as the Bank's future assistance efforts will focus simultaneously on the demand for reforms aimed at achieving better governance (bottom-up pressure) and their supply from government (top-down initiatives). 101. Activities to Foster the Demand for Better Government. Donors are already active in implementing a range of programs aimed at building civil society, strengthening citizen groups, supporting reforms at the local level, improving the system of assistance to the poor, providing public economic education, offering gender programs, and the like. Mobilization and coordination of expanded donor support at the grassroots level has become an important part of the Bank's work. Bilateral donors are clearly better positioned to act at the decentralized level. In particular, activities at the municipal/community level by the U.S. Agency for International Development (USAID) and UK's Department for International Development (DFID) have been providing valuable complementary support to the Bank's program of municipal development and intergovernmental finance, which will be continued and expanded. In addition, DFID's support to community development and assistance in social mitigation in areas affected by coal mine closures will enable the Bank to provide assistance in coal mine restructuring in a more efficient and socially sustainable manner. The Canadian International Development Agency (CIDA) has also been an important partner and is supporting such initiatives as the People's Voice Project and the creation of a Distance Learning Center in Ukraine. Important activities are provided by international NGOs. These include Soros and Renaissance Foundation, in the area of civil society and training, and Transparency International, in the area of anti-corruption. The Bank's role is to leverage the above mentioned assistance and provide a framework so that our programs achieve maximum effect. 102. Activities to Increase the Supply of Pro-development Institutions. A notable example is the Energy Task Force, which has exerted concerted donor activity to foster greater transparency and better governance in the energy sector. Conceived as the main vehicle for channeling international support for the efforts to close the Chernobyl power plant, the task force has provided an important forum for discussions with Government on measures to increase viability of the sector and reduce the culture of non-payments. The task force wili remain the main vehicle for policy support in these crucial areas. 103. Bilateral donors have a clear advantage in providing technical assistance targeted at building institutional capacity, especially in government agencies. Capacity-building requires the presence of multiple teams in the field and daily monitoring, and is resource-intensive. This is an area where bilateral donors clearly are better able to handle the demands and also have the capacity to provide support of the required magnitude. For example, DFID, CIDA, USAID and TACIS assistance to public sector reform will be continued to help deepen the reforrn agenda in this area. TACIS will continue its assistance with the preparation of enterprises for transparent case-by-case privatizations. TACIS will also provide assistance on legal and judicial reform-an area which the Bank has not concentrated but which is essential for achieving better governance. The EBRD's business plan for Ukraine emphasizes support to privatization in key strategic areas (notably energy and telecom), interventions in the financial sector, and support to SMEs, chiefly through the provision of lines of credit and the stimulation of business associations. The IMF has likewise been active in providing technical assistance in the monetary, fiscal policy, treasury, tax, statistics and other areas envisaged in its mandate.  30 Ukraine: Country Assistance Strategy 2001-03 104. Coordination with the IMF. The Bank and Fund teams work in tandem and excellent working relationships have been maintained. The Bank has provided the IMF with expertise in designing and monitoring the structural conditions of the EFF. The IMF has had a key role in ensuring that the macroeconomic program is consistent and fully funded. The Bank and the Fund teams will continue to work as complements with the PAL and related institution building activities and investments continuing to strengthen our perspectives on key fiscal and structural issues. Financial Management and Fiduciary Responsibility 105. Financial management in Ukraine is weak. However, the Government is steadily improving its management of public funds. The Bank and the Fund are jointly assisting the Government in setting up a transparent and comprehensive treasury system with a single account in the central bank. The Bank's Treasury Systems project (US$16.4 million), which became effective in July 1999, provides resources for technical assistance, training and computer systems. It aims to improve public expenditure management and control, resource planning, cash management, and budgeting. It also supports efforts to provide timely, accurate and consistent financial information and to enhance transparency and accountability in the fiscal process. In addition, the Government has recently put in place a Law on Public Procurement that was developed in close cooperation with the World Bank. The Bank is planning to provide further assistance through an Institutional Development Grant to strengthen the institutional capacity in the public procurement area. 106. Ensuring the Proper Use of Bank Funds. The Bank has focused additional attention on the proper use of its adjustment money (in view of the recent allegations about possible misuse of IMF resources). An audited review of the use of World Bank resources under adjustment operations did not find evidence of any improper use. For future adjustment lending, the Bank will use a tracking mechanism that would provide the Ukrainian authorities and the Bank with a greater degree of assurance and transparency on the proper use of Bank funds. 107. Given the co-mingling of adjustment funds with borrower resources, the Bank recognizes that the focus on the borrower's overall use of foreign exchange and budget resources is more tenable than on its specific use of Bank funds. To that end, in order to understand the perfornance of key public institutions and functions and the risks they pose to development effectiveness and Bank funds, a Public Expenditure Review and a Country Financial Accountability Assessment are planned for FY01 delivery. 108. At the investment project level, additional resources are provided to assess the financial management framework instituted for project implementation. This practice ensures that systems in place are in accordance with standard international practices and fiduciary responsibility and accountability. The Country Procurement Assessment Review planned for October 2000 will, taken together with the measures above, provide a greater level of assurance that the Bank's resources are being utilized in the manner intended. E. RISKS 109. Creditworthiness. Ukraine's creditworthiness is currently limited as a result of difficulties with debt and fiscal management (see Box 1 and paragraph 33) and low foreign exchange reserves (equivalent to less than one month of imports). This level of creditworthiness is reflected in lack of access to external financing and by either weak or no ratings at all by the international rating agencies". Ukraine's external I I S&P does not rate Ukraine. Moddy's has a Caal rating for long-term currency bonds and notes, and a Caa3 rating for long-term foreign currency deposits. (FYI grades below Ba are classified as "speculative investment"). Short-term foreign currency banks/notes, and bank deposits are rated "Not Prime Borrower" which means that in Moody's opinion, in a period of market stress the issuer may not have sufficient access to firm bank lines of credit or other forms of back-up funding to meet all of its obligations maturing within one year.  Ukraine: Country Assistance Strategy 2001-03 31 debt has grown rapidly, with debt outstanding and disbursed as a share of GDP increasing from 15.2 percent in 1994 to 40.9 percent in 1999. Although debt service as a share of exports of goods and services was moderate in 1999 at 15.5 percent, Ukraine was unable to meet its obligations to private creditors in full and on time. The private debt restructuring endorsed by creditors in mid-March, which spread payments on US$2.3 billion of privately held sovereign debt maturing in 2000-2001 over the next five to six years, has helped to reduce the pressure on the country's liquidity position. In the event of agreement on an IMF program, further relief would be provided by a rescheduling of Paris Club obligations. 110. Improving creditworthiness over the medium term will require strong macroeconomic management and progress on the structural reforms discussed above (paras 78-81) to lay the basis for growth and ensure debt and fiscal sustainability. Thus, with sustained implementation of reforms as envisaged under the base case, Ukraine is not expected to experience further debt servicing difficulties. However, as discussed below, the risks to preferred creditors will remain high in the near term. This is particularly true in the case of the Bank, as its share of total public debt is projected to increase over the CAS period, while the share of other preferred creditors is projected to decline. 111. Although the base case scenario assumes more than US$3.3 billion in gross resource inflows from IFIs over the CAS period, on a net basis the exposure of IFIs would increase only by US$1 billion. This level of net resource inflow will: (a) help Ukraine maintain a stable macroeconomic environment supported by a comfortable level of reserves; and (b) undertake critical public sector reforms and bridge the financing gap before budget, expenditure and tax reforms take hold. Under this scenario, Bank exposure is projected to increase up to US$1.1 billion and level off at under US$3.1 billion in year 2003, equivalent to roughly one-fourth of total projected external public debt (Table 5). Over the long-term, inflows of foreign direct investment and private financial lending will provide the financing necessary to support higher levels of growth and reduce the relative exposure of official creditors, including the Bank. 112.. Ukraine's creditworthiness would remain limited under the low scenario. High liquidity risk, coupled with concerns about debt and fiscal sustainability, would preclude any improvement in external perceptions of country risk. In this environment, Ukraine will remain dependent on official financing, particularly from the IFIs. Under the low case lending program, while net disbursements from the Bank would be negative, Bank debt outstanding and disbursed as a share of public debt would increase to 21.5 percent from its current level of 19.9. 113. Risks. The Base Case scenario faces several sources of political and economic risks. The political risks arise from the opposition to reform either from those seeking a return to a command economy or those who want to maintain a partial-reform status to benefit from unclear rules of the game and access to positions of power. Those who seek a return to the past were soundly defeated during the past presidential elections and do not pose a major political risk by themselves. A greater political risk is associated with the possibility that the common political and economic interests, which are keeping the current parliamentary majority together, disappear, possibly caused, among other things, by strong political interests and/or deterioration in economic performance. Such developments could well force this Government to resign and be replaced by another, possibly less committed to reform. If this happens, a stop-and-go or muddle through policy situation is likely to arise, with mixed reforms and reversals. To prevent this possibility, the President is seeking to amend the constitution based on the April, 2000 referendum results that would give him power to dissolve the Parliament should it fail to form a working majority. It is as yet unclear if this political solution is feasible. Debt and fiscal sustainability are key issues under a muddle through or stop-and-go approach as progress on structural reforms may be insufficient to lay the groundwork for strong growth. And with less favorable economic outturns than projected under the base case, renewed liquidity problems are possible under such a scenario. 114. The collapse of the reform initiatives could also come after the Government has succeeded in normalizing relations with the Fund, reprogramming of the Paris Club debt, and resuming Bank  32 Ukraine: Country Assistance Strategy 2001-03 Table 5: Key Exposure and Burden Sharing Indicators, 1999-2003 (Base Case Assistance Levels) 1999 2000 2001 2002 2003 Debt Outstanding and Disbursed (US$m) a 12,588 11,473 12,209 12,354 12,310 Total DOD/GDP (%) 40.9 37.0 37.6 36.1 34.1 IBRD DOD/Total DOD (%) b 16.1 19.9 20.9 23.0 25.8 IBRD DOD/Preferred creditor DOD (%) 39.4 43.7 41.6 43.0 44.9 Total Debt Service (US$m) 2,600 1,608 1,545 1,788 2,096 Total DS/XGS (%) d 15.5 9.1 8.3 9.1 10.1 IBRDDSiPublicDS(%) 4.8 11.9 15.9 18.6 16.6 IBRD DS/Preferred creditor DS (%) 12.2 13.9 22.3 37.2 36.5 Memo: IBRD DOD (inn. $) 2,030 2,289 2,553 2,847 3,171 a. Includes public and publicly guaranteed debt, private non-guaranteed, use of IMF credits and net short- tern capital. b. Includes present value of guarantees. c. Preferred creditors are defined as IBRD, IDA. the regional multilateral development banks, the IMF, and the Bank for International Settlements. d. "XGS" denotes exports of goods and services, including workers' remittances. adjustment lending, with the disbursement of the pending tranches under SECALs and the first PAL operation, and before the present reform initiatives have taken hold. Then, following a full resource inflow from the IFIs in the year 2000 (equal to the Base Case scenario), a downward adjustment in mid- term commitments of the IFIs would most likely follow if the reform process stalls. The present design of the CAS, which commits resources only when meaningful reforms on the ground have been obtained, would certainly imply no further resource availability from adjustment lending and significant curtailing of investment lending. 115. In the Low Case, Ukraine might not be able to generate sufficient external financial inflows in the medium term, particularly if a collapse in the reforn government and/or a significant reversal in reform initiatives were to take place before agreements with the IFIs are obtained. Without significant resources from the IFIs and limited access to international markets, the only recourse would be tightening of exchange controls and an increasing reliance on the inter-bank foreign exchange market, combined with private capital inflows from the near abroad. Should such scenario materialize, Ukraine could face problems in servicing its debt to creditors. Under such a scenario debt servicing problems to preferred creditors, including the World Bank, cannot be ruled out. In this case, the triggers for the Low Case (Table 4) would not be met and the Bank's program would be significantly curtailed. 116. Clearly, there are also economic risks in the external environment. Ukraine's international trade continues to depend on other CIS countries. The 1998 Russia crisis already showed that the Ukrainian economy is vulnerable, even though the country managed to somewhat contain the effects of the financial contagion. Poor economic performance in nearby countries could frustrate the process of economic revival during the CAS period. An economic downturn could adversely affect Ukraine not only through lower demand for its products but also through worsening financial conditions under which energy is being made available to Ukrainian consumers. Ukraine is particularly vulnerable to developments in the energy sector given the high energy intensity of its industry, large import dependence and the chronic non-payment problems. 117. Key elements of a proper response to these risks are significantly improved energy efficiency, reorientation of exports to hard currency areas, and a conscious move to transparent trade (including energy) transactions based on world market prices. Equally, the present CAS emphasis on improving  Ukraine: Country Assistance Strategy 2001-03 33 fiscal and financial discipline will provide strong incentives to reduce energy intensity and develop a transparent framework of international trade. The investment needed to improve energy efficiency and move to world prices, however, will put pressure on the balance of payments in the medium term. III. CONCLUSION 118. The potential for increased global and regional stability from a wealthier and socially more cohesive Ukraine cannot be underestimated. There appears to be a window of opportunity for substantial advances in establishing more legitimate and inclusive institutions in Ukraine. At the same time, realism must be the keyword. The legacy of three generations of Soviet dominance is not easy to shake, and it may take several attempts before a credible and durable break-through is accomplished. The proposed strategy tries to position the World Bank Group so that it will be able to respond to opportunity, when this presents itself, and will also be able to increase its long-term partnership with Ukrainian society---which will ultimately be the arbiter of its own destiny. James D. Wolfensohn President By: Sven Sandstrom By: Peter Woicke Washington, D.C. August 16, 2000   Attachment 1 Page 1 of 6 CAS Consultations with Stakeholders 1. This attachment presents a summary of the consultations with the civil society held during CAS preparation. Within the framework of the CAS consultations-and with full support from Government, which has encouraged this open and participatory process-Bank staff met with parlamentarians, members of local governments, and with over 200 representatives of non-governmental organizations, academia, professional associations, think-tanks, business circles, mass media, and agricultural workers. A series of round-tables were held during missions held in April and May/June in Kyiv, Zhytomir, Dnipropetrovsk and Donetsk with the participation of sector managers and task team leaders who briefed those present on the respective sector strategies, on-going or planned projects and programs, and instruments for their implementation. Additional discussions were held by the Resident Mission in Kyiv as well as in the regions. Written comments on the proposed strategy were provided by a number of NGOs. Background information about the proposed strategy was made available in Ukrainian and circulated widely. 2. The round-tables generated great interest and attracted a variety of participants from organizations representing intellectuals, youth groups, business professionals, the media, handicapped, disabled, retired, academicians, small and medium enterprises, charities, scientific circles, environmentalists, etc. The thematic discussions focused on the most pertinent issues of the reform agenda: poverty alleviation, human development, social welfare, environmental protection, good governance and anti-corruption. Participants appreciated the fact that they could freely express their concerns, provide information and give suggestions directly to representatives of the World Bank. It was agreed that regular consultations would be a good vehicle for civil society at large to get acquainted with Bank-related activities and their impact on the ground. Those attending the round-tables expressed their desire to be fully involved in the preparation, implementation and especially in the monitoring of Bank programs in Ukraine. 3. A special web-site has been set up in English, Ukrainian and Russian which will further facilitate the consultation process by providing regular updates of key information about the CAS, PAL, etc., posting minutes from relevant meetings, and summaries of the feedback received as well as by inviting the submission of comments (http://www.worldbank.org./ukrainecas). The meetings were open, selection of invitees was random and totally unbiased on the part of the Bank, and the conference rooms during all meetings were packed to capacity testifying to the interest in the discussions. International donors and government officials were also invited to attend. Written comments were also solicited. Comments received and their posting on the web-site will assure full transparency and accessibility. 4. The CAS public consultations are a relatively new tool and will need some fine-tuning to achieve its ultimate objective of constructive interactions with all stakeholders'. Nevertheless, they have provided a good opportunity to exchange opinions with a large number of people, with various professional and education backgrounds and interests, representing different geographic regions and communities. The initiative was very well received and all participants expressed their satisfaction with the fact that the World Bank had engaged in direct dialogue with civil society. 5. NGOs expressed their strong desire to be part of the working groups in preparing the CAS and PAL as well as discussing specific activities and projects. Participants pointed out that implementation of WB projects should be transparent and carefully monitored with the involvement of NGOs. 6. A special Contact Group of NGO representatives was set up in late May. It will be the main advisory body, instrumental in working with the Ukraine World Bank team on organizing future I For example, the Bank has received a complaint from the NGOs in Dnipropetrovsk who apparently were restricted from attending the meeting with the Country Director by the municipal officials due to the limited space in the meeting room. Several suggestions were received by the Bank on how to improve the consultation mechanism and procedures as well as clarifying the format for future discussion. The NGOs also mentioned that usage of the internet has its drawbacks because only six percent of the Ukrainians has access to internet.  Attachment 1 Page 2 of 6 consultations, and drawing on the expertise and experience of professionals across the country, thus mobilizing civil society for all-inclusive participation. Several meetings have been held with this group and the following recommendations emerged as a result: * Development of an informational bulletin on World Bank projects and other activities in Ukraine with a description of potential opportunities for NGO participation. This bulletin will also contain information on how to contact the World Bank staff in charge of these activities; * Development of a system of public consultations on government policies; * Review of the legal framework for NGOs and development of recommendations for its improvement; * Development of a communication strategy with the civil society. 7. Observations and commentaries on the main topics are indicated below. Progress of Reforms in Ukraine 8. A round-table was held with the representatives of the Verkhovna Rada (Parliament), central and local government officials, business and NGO representatives to discuss the status and implementation of current reformns. It was acknowledged that the only way to secure successful reforms is through joint cooperation of all stakeholders together with popular support. In that respect the Bank's initiative to broaden its consultations on the country assistance strategy through wider participation was highly appreciated. Following are the main comments: * The reforms are not yet noticeable, in particular in budget decentralization, privatization, the energy sector, administrative reform, land reform and agriculture. Transparency was seen as an imperative for the structural reforms which are the backbone to the transition. * It was noted that public involvement is not customary in Ukraine and civil society should be stimulated and encouraged to participate, especially at the local level. * It was suggested that good self-governance at the regional and local level would require intersectoral cooperation, interaction between authorities, businesses and civil society, intellectual support for reform and training of personnel to carry out the programs and public monitoring at every stage. * NGOs also suggested that they would like to prepare a report on the implementation of the previous CAS, including the implementation of individual projects, and its effectiveness. They would like to circulate this report widely. The Role of the NGOs 9. Comments from the NGOs suggest that they would like to become partners of the Bank. They specifically mentioned that: * The NGOs could play a special role in "increasing public knowledge" about the World Bank and Government initiatives; in increasing public participation through public hearings, information dissemination, and preparation and distribution of printed material; as well as in monitoring the implementation of government policy decisions that impact civil society. * The NGOs can be engaged in providing environmental assessments and social services. The World Bank could support the creation of a system in which the NGOs could openly compete on an equal footing with public institutions in the bidding for various programs, including those financed under Bank projects.  Attachment 1 Page 3 of 6 * The World Bank should support the establishment of a mechanism for public consultations on policy decisions which concern social and economic issues. The NGO community can play an important role in this process. * The CAS should envisage assistance from the World Bank for the development of the capacity of NGOs through supporting the development of their infrastructure as well as supporting their program of activities (especially their research programs and programs directed at work with the public). * The Bank should promote the creation of a favorable legislative environment for the NGO sector. Good Governance and Anti-corruption 10. Good governance and anti-corruption is a topic which cuts across themes and was mentioned during all discussions, as it is perceived as the major obstacle to the country's development. Two separate round- tables on the subject were held in Kyiv: one with representatives of the Government, the Presidency, and parliamentarians linked by videoconference with Bank WBI headquarters; the second was jointly organized with the Embassy of Canada, other donors, and non-governmental organizations. The Bank also received additional comments through written correspondence. Following is a synopsis of comments and suggestions: * The causes for corruption are deeply rooted and further aggravated by low civil servant salaries, the fall in living standards of the population, and the general disregard of the law. The laws are in place but their implementation is lax and there are many of loopholes that encourage violations. - Another reason for rampant corruption is said to be the apathy of the population and its somewhat indifferent attitude toward unlawful practices. Most people would rather pay a bribe than report violations or file complaints. - The governance issue is seen as especially acute in the energy sector and was addressed at the special round-table devoted to energy sector reform. * The following issues need to be addressed in the fight against corruption: regulatory reform that would cut red-tape; strict observance of the existing laws; need to understand the issue of conflict of interests, especially among businessmen; need for advocacy and civil education to make citizens aware of their rights and voice in order to prevent abuse by corrupt officials. * The measures that were suggested are: implementation of the Concept of National Integrity Program approved by the President; establishing a joint commission (comprising government and non- government representatives) to review the implementation of regulations and anti-corruption decrees and make public its findings at a national conference; developing an anti-corruption program addressing shadow economy problems and introducing a sound monitoring system, including capacity building, for NGOs to perform monitoring tasks. * The Bank should help promote the establishment of public relations units in government agencies. * An NGO anti-corruption coalition has been formed which launched an initiative -- "Public Resistance to Corruption." The working group of this coalition has drafted a National Anti- corruption Program which includes a large number of activities including monitoring corruption at the local level, providing free legal advice to victims of corrupt practices and legal education to citizens, organizing public hearings, publication of educational materials, etc. Currently the group is studying laws that contain clauses that give leeway for corrupt practices and will prepare drafts for amendments to be submitted to Parliament. This exercise will be a good test for cooperation between all members of civil society since its implementation envisages joint activities among NGOs, public officials, businessmen and ordinary citizens. The World Bank's role is mostly seen as advisory, as well as providing some specific training and assistance in structural reforms, especially that which relates to civil service reform.  Attachment 1 Page 4 of 6 Social Sector, Human Development and Poverty Reduction 11. The NGOs pointed out that the CAS has rightfully put an emphasis on poverty reduction. Poverty has become a very sensitive issue according to responses received from a sociological survey conducted in the country indicating that 90 percent of Ukrainians perceive themselves as poor. Deterioration of basic services, especially in healthcare, were highlighted (a survey carried out under the Khrakiv/Lviv/Donetsk anticorruption initiative showed the highest level of perceived corruption in medical services). Following are the specific comments received: * Some stakeholders disagreed with the draft CAS evaluation of the failing quality of education and suggested an analysis of the education sector [Dniepropetrovsk oblast]. Nevertheless, most expressed the opinion that the Bank should attach more importance to education and vocational training that would guarantee better job opportunities in the new labor markets. * A representative of the Ukrainian Roma Forum raised the issue of the vulnerability of the gypsy minority who often face social exclusion and having the worst living standards. * The Deputy Minister of Labor and Social Services, present at a round-table, stressed the importance for a systemic approach and acquainted the audiences with the instruments that the Govemment envisages for poverty reduction, such as programs for labor market development, self-protection, targeted social assistance, social insurance schemes, adoption of European level social standards, and human resource development. - The advisor to the President of Ukraine on social issues suggested that the existing system of social protection should be taken into account when designing the new poverty reduction strategy and should be coupled with a transition to community-based social care, active employment and self- employment programs, and measures for dealing with persisting multi-generational poverty. A survey indicating that 36 percent of Ukrainians have informal incomes brought forth the difference between rural and urban poverty and the coping skills people have developed for survival. * The NGOs stressed that demand for reforms and for high quality services should stem from the people and NGOs should help mobilize the society to that end. * Development of alternative types of social service was suggested with NGOs at the forefront in organizing communities. NGOs are active in providing some social services, such as support for AIDS prevention, care for invalids, street children, handicapped, orphans, training courses for re- qualification, etc. NGOs all see a necessity for changing regulations to give them legal rights (through the introduction of a new law on social order and partnership) to compete on an equal footing with public institutions for provision of services. It was pointed out that laws alone are not the magic wand that would resolve the issues. Implementation capacity, good institutions, trained personnel, and investments are necessary. * Civil society-government cooperation is seen as imperative in the provision of social services and implementation of the social reforms. * Technical assistance and investment for reforms was requested from the WB in the support of: (a) creating territorial communities and comrmunal funds to help the development of small and medium enterprises; (b) provision of micro-credits through credit unions; (c) special training for women entrepreneurs; (d) business management training for NGOs to run social services; (e) support for youth movements; and (f) information on the reforms in the regions. Environment 12. Environment was discussed at the regional meetings and in Kyiv. Numerous written comments were also received from the environmental NGOs. It was discussed that pollution is extremely severe in some  Attachment 1 Page 5 of 6 regions (e.g., Dniepropetrovsk region, Chornobyl). However, despite the great number of ecological problems, Ukraine, one of the largest European states by its territory, has preserved a number of typical and unique natural ecosystems which have already been lost in most other European countries. The NGOs believe that it is time to look at Ukraine as the guardian of the European animal and vegetable genetic fund, and as a possible donor for restoration of many important elements of the biological and landscape diversity of Europe. Following are the NGOs' recommendations: * As far as the new CAS is concerned, they would like to see a greater emphasis on environmental protection, linking it to the improvement in the quality of peoples' lives. * The World Bank should grant loans to Ukraine only if environmental issues are appropriately dealt with, including: - conducting environmental assessments during the preparation of all projects, - promoting development of ecological businesses, - encouraging the introduction of modem environment-friendly technologies in industry, - developing appropriate informational activities from those who receive credits, and - improving conditions for activities of public non-government organizations, in particular, ecological ones. * The lending program should include more projects on environment. For example, a pilot project to protect the Ros River Basin and a project on preserving biodiversity, ecosystems, and creation of an ecological network in the steppe and forest-steppe zones of Ulkraine should be explored. * Regional representatives are convinced that World Bank staff should consult more often at the local level especially on matters concerning the environment. * Environmental monitoring should be made a priority. The legislation regarding monitoring should be changed to avoid duplication and make it more efficient. * Public access to environmental data. * The World Bank should support the establishment of a National Environment Fund. * The CAS should envisage studies on alternative energy sources and public transportation with regards to its effect on environment. * Attention was drawn to environmental problems in agriculture and the fact that the new Land Code should address issues of land planning and environment. * NGOs would like to promote environmental education at schools and look for support from the World Bank. * The Ministry of Ecology and Natural Resources is one of the most progressive regarding dialogue with NGOs. However, the NGOs are concerned that the liquidation of the Ministry's Department for Public Contacts might limit the opportunities for such dialogue in the future. Agriculture 13. The World Bank's involvement in the agriculture sector is seen as assistance in managing debt restructuring; providing agriculture education in new farming methods and farm management; and eliminating the state monopoly on export taxes of some agricultural produce (e.g. sunflower seeds). Energy Sector 14. A round-table was held to discuss energy sector reform and the Bank's role in this process:  Attachment 1 Page 6 of 6 * While some progress has been noted, all those present shared the concern that reform is severely lagging and even donors are not unanimous on how to address the problems. The main obstacles are the huge arrears in collecting electricity fees; lack of a common government approach for improving the situation; the inefficient and ineffective spot market; lack of transparency (making the sector the biggest source of corruption and unattractive for prospective investors); poor management at the local and oblast levels which prevents procurement on a competitive basis; lack of clear ownership rights; and inefficient operations and tariffs (which do not reflect decommissioning costs, replacement costs, etc.). * Industrial enterprises are the biggest debtors but there is no mechanism to cut them off from electrical supply for unpaid fees. Private consumers in general have a much better record for paying electricity bills and are in effect subsidizing bankrupt industries. Some participants expressed the opinion that poor households should be subsidized, while others feel that social problems should be separated from energy issues. * NGOs are indignant that there is no system to punish violators and feel that civil society has a big role to play in imposing a fair system on the energy sector. Business Environment 15. This is an area where the Bank has been conducting extensive consultations with the business community for several years. Regular meetings with businesses and business associations, round tables and conferences, have helped to develop the deregulation program supported by the Bank as well as to give a greater voice to the business community in their demand for a better business environment. During the CAS discussions, entrepreneurs mentioned that: * The Bank should continue facilitating the dialogue between the government and the business community in order to achieve stable business laws and good legal protection of businesses. * The NGOs see the need for an Ukrainian Agency for International Development that would promote and attract foreign investments to the country. * It was pointed out that while SME credit lines from the World Bank would be valuable, assistance in training entrepreneurs and enterprise managers has an even greater priority. General Comments * The NGOs suggested that a discussion on the results of the implementation of the previous Bank strategy be conducted. * The World Bank should ensure that representatives of non-government organizations are included in the working groups on project preparation as well as monitoring of project implementation. * Local specialists should be more widely used for project preparation and implementation. 16. Finally, it is important to mention that the Government has endorsed public participation as an important aspect of its new development policy and has shown commitment for cooperation with the population by setting up a special unit for coordination and work with civil society at the Ministry of Economy.  Annex A2 Page 1 of 2 Ukraine at a glance 7P6/00 Europe & Lower- POVERTY arnd SOCIAL Central middle- Ukraine Asia income Development diamond 1999 Population, mid-year (millions) 50.0 475 886 Life expectancy GNP per capita (Atlas method, USS) 750 2,200 1,740 GNP (Atlas method, US$ billions) 37.5 1,044 1,541 Average annual growth, 1993-99 Population (%) -0.7 0.2 1.1 GNP Gross Labor force (