Ukraine - First Programmatic Adjustment Loan Project

Report No. PID9871 Project Name Ukraine-First Programmatic Adjustment Loan Region Europe and Central Asia Region Sector Institutional and governance issues in multiple sectors: Public Sector, Agriculture, Energy, Privatization, Financial Sector, Social Protection, Environment Project ID UAPE70693 Borrower Government of Ukraine Implementing Agency Ministry of Finance 12/2, M Hrushevskoho Str., Kyiv 01008 Tel. No.: (380) (44) 293-5363 / 226- Fax: No.: (380) (4) 293-8243 Environment Category C Date This PID Prepared January 10, 2001 Date Initial PID Prepared October 18, 2000 Projected Appraisal Date February 7, 2001 Projected Board Date May 1, 2001 Country Background 1. During the first decade of independence Ukraine devoted most of its efforts to the task of building a new nation, while giving limited priority to setting up the necessary institutions of a market economy. Reliance on the obsolete Soviet institutional framework gave old-fashioned bureaucrats an opportunity to capture power from within and created a strong anti-reform constituency. The 1996 Constitution introduced stronger parliamentary oversight over the executive, but resulted in a stalemate that effectively blocked all reform initiatives for almost two years. 2. This political stalemate thwarted the effectiveness of an ambitious stabilization program launched in 1995-1996 with the help of the IMF. While the program succeeded in curbing hyperinflation, it failed to carry through fiscal and institutional reforms in the absence of Parliamentary support. Hesitant economic restructuring led to an increasingly hostile business environment, and to the emergence of a class of insiders that actively engaged in rent-seeking. 3. The political situation considerably improved after the re-election of President Kuchma for a second term in late 1999 and the formation of a working majority in Parliament supporting Yushchenko's new reformist government. For a year now this majority has been supporting the Government's program of reforms aimed at restoring Ukraine's external credibility and laying the foundations for durable growth based on sound economic management, improved institutions and good governance. 4. The Government's medium-term program, launched April 2000, signaled a clear departure form the past both in the choice of instruments and of strategic goals that include: (i) human development; (ii) poverty reduction and increased welfare of the population; (iii) improved competitiveness of Ukraine's economy; (iv) protection of human rights and improved integrity of  the state; and (v) promotion of EU integration. 5. In addition to re-launching medium term economic reforms the Government succeeded in turning around the economic situation in the year 2000. Led by the robust 12 percent growth in industry, GDP in year 2000 grew at almost 6 percent. The economic rebound was based on the combined effects of the Hryvnia devaluation, strong growth in Russia and other trading partners, and the revival of domestic demand following payment of pension and wage arrears in the presence of large unused industrial capacity. These positive developments will break past trends and generate sustainable growth only with continued and accelerated reforms that attract private capital investment, as a in country where one can do business. The Government Program seeks to do just that. The Proposed Loan/Credit 6. The proposed Loan of US$250 million equivalent is a Programmatic Adjustment Loan (PAL) that will support the Government of Ukraine's Medium- Term Economic Development and Reform Program. It is envisaged that over FY01-03 there could be up to three single-tranche PAL operations to support the implementation of the Government program. Objectives The main objective of this operation is to support the efforts the Government has already made in departing from the previous reform stalemate. Improvements in fiscal and financial management and the business environment that have been obtained are an important part of creating conditions that will sustain economic growth in the mid-term. The results on the ground supported by the proposed loan, have been possible because of the priority assigned by the Government to these reforms and the significant preparatory work with the cooperation of various donors, the Bank included. Ukraine's reform program aims to build key missing institutions of a market economy and improve public and private sector governance, while maintaining macroeconomic stability and setting the basis for sustained economic growth, poverty reduction and improved environmental protection. The objective of PAL is to identify and help remove critical institutional bottlenecks that presently hamper economic reforms, increase transaction costs, weaken property rights, favor soft-budget constraints, and lower the effectiveness of the state in the provision of social services and protecting the poor. To achieve that, PAL will seek to complete and streamline the institutional framework and significantly improve public and private sector governance. The first PAL operation targets critical interventions already accomplished in the following five thematic areas leading to the achievement of medium- term goals set in the government program: ? Improved fiscal and financial discipline through elimination of non- transparent budget offsets, reduction of budget arrears and an increase in cash collections for energy; in the medium run the objective is to resolve the non-payment problem and reduce the stock of arrears from 90 to 20 percent of GDP; ? Better regulatory framework for entry and operation of enterprises through shorter and more efficient registration and licensing procedures and rationalized business inspections; in the medium term, the objective is to improve further corporate governance and introduce modern regulatory functions in critical sectors (including telecom, energy and finance); ? Creation and protection of clear property rights has already produced initial results in transparent privatizations of large industrial and energy companies, Ukrtelecom and agricultural land, and the start of bankruptcy procedures for the largest indebted enterprises and banks; in the medium run, improved property rights will be the basis for the revival - 2 -  of economic growth based on private investment and FDI. ? Strengthened public sector accountability through greater fiscal transparency, rule-based intergovernmental transfers, improved procurement procedures, advances in streamlining the government and reforming the public administration; in the medium run, the Government is committed to completing the reform of the fiscal system and meeting international fiscal transparency and special data dissemination standards; and ? Improved social inclusiveness is based on streamlining and rationalizing the system of social benefits and advancing the reform of the pension and social protection systems; in the medium run, the implementation of the Government program will help complete the pension reform, provide a basis for better delivery of health and education services, and put in place a viable system of environmental protection. The financial support under the first PAL operation will help Ukraine meet its resource needs and rebuild its creditworthiness in international markets. The resources will be made available upon achieving real reform outcomes on the ground, i.e. completion of prior actions. Lessons learned from past operations 7. The PAL design takes into account the lessons learned from past Bank assistance to Ukraine. As recounted in the 2001-03 CAS, one of the key problems that emerged with separate sector adjustment operations was Bank disbursement of resources when agreements were met in one sector, while policy reversals were taking place in another. PAL solves this problem by pooling the key institutional agenda under one umbrella, so that successive PAL operations will only be available, if the key reform agenda is maintained. Another issue with multi-tranched adjustment operations has been the pressure to extend deadlines and to grant waivers in order to disburse resources after the allocation of the first tranche even if the overall reform environment is not satisfactory. The PAL solves this difficulty by limiting itself to single tranche operations. In this way, the Bank can stop processing later operations if the overall reform environment changes significantly. Also, the PAL, to the extent possible, will focus on outcomes on the ground, so that the individual operations will not be taken to the Board if significant measurable progress has not already been made in advancing the reform agenda. The PAL will also emphasize intermediate outputs (passage of laws and adoption of strategies) as a way of setting the basis for outcomes on the ground later on. It will be outcomes that mostly determine the availability of resources. Poverty Category 8. The proposed PAL will have an important effect on poverty alleviation because it will promote reduction in budget arrears often directly benefiting the poor, as well as better targeting of social assistance programs and improved delivery and better quality of social services. Environmental Aspects 9. The loan will have no direct impact on the environment (in line with World Bank operational directive 4.01). Policies and reforms supported by PAL will have a substantial positive contribution to improved environmental management as this is one of important sub-component of the PAL operation. PAL will support better environmental management through improved environmental legislation, better collection of environmental fees and fines, capacity building at the Ministry of Environment and the implementation of a permit system based on actual emissions. Benefits and Risks The benefits already achieved under PAL 1 are: (1) Reduced budget arrears and improved cash collections in the energy sector; (2) Reduced cost of entry and -3 -  operation of businesses; (3) Discontinuation of Kolkhozes and issuance of land ownership certificates to more than 6 million former Kolkhoz members; (4) A more transparent transfer of budget resources from the center to the regions based on a clear formula; (5) Streamlined public administration with reduced number of ministries and scaled-down Cabinet of Ministers; and (6) Rationalized system of social benefits. Additionally, PAL 1 has helped the government markedly improve policy coordination and engage the cooperation of the civil society in the design and implementation of reforms. Since, by design, PAL is based on reform results on the ground, there are no risks associated with the achievement of benchmarks. The risk related to political, institutional and policy sustainability of past reforms are mitigated by the creation of broader pro-reform constituency as a result of earlier reform successes. This risk, moreover, will continue to diminish over time as economic growth takes hold, macroeconomic environment remains stable, external position improves, and the country completes the institutional framework of a modern market economy. Contact Point: Mr. Dusan Vujovic, ECSPE The World Bank 1818 H Street N.W. Washington, DC 20433 Telephone No.: (202) 473-6339 Fax No.: (202) 522-2753 Note: This is information on an evolving project. Certain components may not necessarily be included in the final project. - 4 -