Document of The World Bank

Report No: 30460

IMPLEMENTATION COMPLETION REPORT(TF-50512 IDA-37370 TF-52789)

ON A

CREDIT No. 37370-AM

IN THE AMOUNT OF US$40 MILLION

TO THE

REPUBLIC OF ARMENIA

FOR A

FIFTH STRUCTURAL ADJUSTMENT CREDIT

December 27, 2004

Poverty Reduction and Economic Management UnitEurope and Central Asia Region

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CURRENCY EQUIVALENTS

(Exchange Rate Effective December 27, 2004)

Currency Unit = Dram US$1.00 = 484.37 Drams

FISCAL YEAR

January 1 – December 31

ABBREVIATIONS AND ACRONYMS

ADA Armenian Development Agency CAS Country Assistance Strategy CBA Central Bank of Armenia CIS Commonwealth of Independent States DFID Department for International Development, U.K. EBRD European Bank for Reconstruction and Development EDC Energy Distribution Company FDI Foreign Direct Investment FSAP Financial Sector Assessment Program FSU Former Soviet Union GOA Government of Armenia GDP Gross Domestic Product IAS International Accounting Standards IDA International Development Association IMF International Monetary Fund MSS Ministry of Social Security MTEF Medium Term Expenditure Framework PRGF Poverty Reduction and Growth Facility PRSP Poverty Reduction Strategy Paper SAC Structural Adjustment Credit SATAC Structural Adjustment Technical Assistance Credit SME Small and Medium Enterprises SOE State-Owned Enterprise USAID United States Agency for International Development WTO World Trade Organization

Vice President Shigeo Katsu Country Director / Manager Donna Dowsett-Coirolo/Roger Robinson Sector Director / Manager Cheryl Gray/Samual Otoo Task Team Leader M.R. Ghasimi

ARMENIAFifth Structural Adjustment Credit

CONTENTS

Page No.1. Project Data 12. Principal Performance Ratings 13. Assessment of Development Objective and Design, and of Quality at Entry 24. Achievement of Objective and Outputs 105. Major Factors Affecting Implementation and Outcome 166. Sustainability 177. Bank and Borrower Performance 188. Lessons Learned 209. Partner Comments 2010. Additional Information 22Annex 1. Key Performance Indicators/Log Frame Matrix 23Annex 2. Project Costs and Financing 30Annex 3. Economic Costs and Benefits 31Annex 4. Bank Inputs 32Annex 5. Ratings for Achievement of Objectives/Outputs of Components 33Annex 6. Ratings of Bank and Borrower Performance 34Annex 7. List of Supporting Documents 35

Project ID: P075758 Project Name: Armenia Structural Adjustment Credit VTeam Leader: Mohammad Reza Ghasimi TL Unit: ECSPEICR Type: Core ICR Report Date: December 27, 2004

1. Project DataName: Armenia Structural Adjustment Credit V L/C/TF Number: TF-50512; IDA-37370;

TF-52789Country/Department: ARMENIA Region: Europe and Central Asia

Region

Sector/subsector: Other social services (30%); General industry and trade sector (25%); General public administration sector (25%); General energy sector (10%); General finance sector (10%)

Theme: Macroeconomic management (P); Public expenditure, financial management and procurement (P); Legal institutions for a market economy (P); Education for all (P); Health system performance (P)

KEY DATES Original Revised/ActualPCD: 05/22/2002 Effective: 04/17/2004

Appraisal: 12/17/2002 MTR:Approval: 03/13/2003 Closing: 06/30/2004 06/30/2004

Borrower/Implementing Agency: GOVERNMENT OF THE REPUBLIC OF ARMENIA/MINISTRY OF FINANCEOther Partners:

STAFF Current At AppraisalVice President: Shigeo Katsu Johannes LinnCountry Director: D-M Dowsett-Coirolo D-M Dowsett-CoiroloSector Director: Cheryl W. Gray Cheryl W. GrayTeam Leader at ICR: M.R. Ghasimi Lev Freinkman and M.R. GhasimiICR Primary Author: Richard J. Carroll

2. Principal Performance Ratings

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible)

Outcome: S

Sustainability: L

Institutional Development Impact: SU

Bank Performance: S

Borrower Performance: S

QAG (if available) ICRQuality at Entry: S S

Project at Risk at Any Time: No

3. Assessment of Development Objective and Design, and of Quality at Entry

3.1 Original Objective:

Background

Armenia is a landlocked country of 3.2 million people with few natural resources. As such, it must rely on the development of its human resources ti achieve economic growth. As with other former Soviet Union (FSU) countries, Armenia’s real output dropped sharply (60 percent) following independence, 1991-93. Since then, growth has averaged a robust 5.5 percent. More recently, growth has exceeded 10 percent. In addition, poverty declined from 55.0 to 48.9 percent and extreme poverty fell by 7 percentage points in the three years leading up to SAC5. Recovery in agriculture and energy and expansion in construction and service sectors carried the economy. The positive results may be partly due to the fact that Armenia has among the best indicators of reform progress of any Confederation of Independent States (CIS) country.

Despite the strong growth and poverty reduction leading up to SAC5, there was still concern about the sustainability of Armenia’s growth. Although previous operations had focused on private sector development (PSD), the manufacturing sector was not performing up to expectations, nor was employment generation adequate. The November 2001 World Bank Study “Armenia Growth Challenges and Government Policies” concluded that the business environment did not develop adequately. There were also significant fiscal problems related to expenditure and revenue management in public utilities and infrastructure. In addition, there was a low level of financing for core social services. SAC5 was designed to address these priorities. SAC5 was actually the sixth adjustment type operation with the first being a Rehabilitation Credit, approved in 1994. Armenia has had a steady commitment to reform over these six adjustment operations. Up to and including SAC3, the Government of Armenia (GOA) focused on securing macroeconomic stability. Since SAC4, it has focused its reforms on development of the private sector. Through SAC4 and SAC5, efforts have steadily increased to create employment and spread the benefits of growth throughout the population. As will be shown in section 4, this strategy proved successful, though it took longer than expected. The Government has made adjustments where necessary, especially to ensure that growth is more evenly distributed and the Bank has continued to support Armenia's reform program.

Objective

The original objectives of Armenia’s SAC5, as stated in the Program Document, dated February 12, 2003, were to support the Government’s efforts in: (i) developing the private sector and accelerating public enterprise reform; (ii) promoting public sector reforms; and (iii) advancing social sector reforms (including education, health, social protection and pensions). SAC5’s objectives focused on the priority needs in Armenia as identified through economic and sector work (ESW), in cooperation with the GOA, including the above mentioned growth study and the Public Expenditure Review (PER-2003). SAC5’s objectives were consistent with the program expressed in the Interim Poverty Reduction Strategy Paper, which was discussed by the Executive Board on May 22, 2001, and, later, with the themes of the full PRSP, discussed by the Executive Board on November 20, 2003, and jointly assessed positively by the World Bank and IMF. SAC5 was also designed to disburse quickly to help ease Armenia’s budgetary needs.

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3.2 Revised Objective:

No revisions

3.3 Original Components:

The components of SAC5 reflected the five themes of the PRSP: (i) promoting sustainable economic growth through macroeconomic stability and private sector development; (ii) enhancing human development and improving social safety nets; (iii) implementing prudent fiscal policies and reforming the tax system; (iv) improving public infrastructure; and (v) improving core public sector functions. SAC5 also followed the Country Assistance Strategy (CAS) for FY2002-2004, which was discussed by the Executive Board in April 2001, and was consistent with 2005-08 CAS discussed by the Board in June 2004. SAC5’s components were:

1. Maintaining Macroeconomic Stability,2. Developing Private Sector and Accelerating Public Enterprise Reform,3. Promoting Public Sector Reforms, and4. Advancing Social Sector Reforms (including education, health, social protection and pension).

A summary of their rationale follows:

Maintaining Macroeconomic Stability. As is typical for a structural adjustment operation, policies consistent with macro stability were a general condition. The GOA’s main objectives were to continue improvement of fiscal control and to pursue the targets of GDP growth of 6 percent, inflation below 3 percent and gross international reserves of at least three months of imports in 2003.

Developing Private Sector and Accelerating Public Enterprise Reform. PSD has been the core of Armenia’s reform program since SAC4. Under SAC5, the focus was to help SMEs create employment. To achieve job creation, SAC5 supported the removal of, as well as the simplification of, the remaining administrative barriers to private sector entry and expansion. This included support to PSD in five areas: (1) the business and legal environment; (2) public enterprise reform; (3) public infrastructure; (4) tax and customs administration and (5) the financial sector. Key measures included developing the new Labor Code to increase labor market flexibility that is needed for job creation, implementing a wide-ranging action plan emphasizing reforms of Tax and Customs Administration, accelerating the liquidation of non-viable state-owned enterprises (SOEs), establishing a single utility regulator, improving property tax administration, increasing the tax yield from retail businesses and reducing rent-seeking in the importation of petrol, tobacco, etc., closing non-viable banks and strengthening financial oversight by the Central Bank.

Promoting Public Sector Reforms. In line with the PRSP’s priorities, the GOA placed a high priority on improving public administration and reducing corruption. The Armenia PER provided a comprehensive agenda to achieve these goals. Major recommended measures included completing the anti-corruption strategy, developing a more comprehensive MTEF for 2003-05

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that covered more sectors and spelled out strategic priorities for budget allocations, especially in the context of the PRSP, and implementing a number of measures to upgrade budget management systems.

Advancing Social Sector Reforms. Social sector priorities were articulated in the PRSP. For education, the GOA planned to improve quality and better reflect the requirements of the new economy. To accomplish this goal, the GOA was to create a national curriculum with standards and a testing regime. SAC5 supported increases in teachers’ salaries as well as an overall increased budget allocation to the education and health sectors. Rationalization to address inefficiencies and over-capacity was also needed and was part of the core SAC5 program. In health, public expenditure was extremely low, about 1.4 percent of GDP, yet there was also substantial inefficiency. SAC5 supported higher primary health expenditures (a target of 30 percent of outlays in the 2003 budget), introducion of a formal co-payment scheme and carrying out additional rationalization of the sector with greater emphasis on primary health care and improved efficiency through means testing the Poverty Family Benefit (PFB),.

SAC5 components, their objectives and results are provided in Table 1.

TABLE 1: SAC5 Components, Targets and Major Outputs/Outcomes

COMPONENT/OBJECTIVE

OUTCOME/OUTPUT TARGETS ACTUAL OUTCOMES/OUTPUTS

I. MACROECONOMIC STABILITY1. Maintaining Macroeconomic Stability

1. Real GDP Growth of 6%, inflation at no more than 3% and level of gross international reserves of not less than 3 months of imports in 2003.

1. In 2003, real GDP grew by 13.9%, export growth was 34.2%, inflation was confined to 4.7% despite massive increase in oil and other commodity import prices and level of gross international reserves remained at 4.8 months of imports in the end of 2003.

II. PRIVATE SECTOR DEVELOPMENT AND PUBLIC ENTERPRISE REFORM2. Improving Business and Legal Environment

2. Reduced the average time necessary to get construction and building renovation permits from 310 days in 2001 to less than 100 days by July 1, 2003.

3. Reduced the number of goods that are subject to mandatory certification at the border from 2001 level of 80 by 20 (i.e. by about 25%) by July 1, 2003.

4. Made the Register of movable property fully operational with at

2. The average time necessary to get construction and building renovation permits was reduced from 310 days in 2001 to 76 days by the end of 2003.

3. The number of goods subject to mandatory certification at the border was reduced from 2001 level of 80 by 25% to 60 by the end of 2003.

4. The Register of movable property did not operate because the basis for

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least 10 registered transactions per month by July 1, 2003.

5. Increased the number of newly established legal business entities with foreign participation by at least 10 percent (i.e., by about 200 firms) from January 1, 2002 to July 1, 2003.

6. Increased the volume of FDI (outside the energy sector) from the average level of US$75 million in 2001-02 by 20 percent during 2003.

7. Increased the number of registered business transactions with agricultural land plots from about 2,850 in 2001 to 4,700 in 2003.

8. Increased the number of land certificates issued to family farmers from 313,000 at the end of 2001 to 525,000 by the end of 2003.

registration was optional (non-obligatory). New legislation was prepared to make registered transactions obligatory.

5. The number of registered joint ventures with foreign participation increased by 29.0% from January 1, 2002 to December 31, 2003.

6. The volume of FDI (outside the energy sector) was US$ 121.2 million an increase of 9.5% in 2003 as compared with the 2002.

7. The number of registered business transactions with agricultural land plots increased from 2,850 at the end of 2001 to 4,600 by end 2003.

8.The number of land certificates issued to family farmers increased from 313,000 at the end of 2001 to 580,000 by end 2003.

3. Strengthening Public Enterprise Reform

9. Decreased the average time necessary to complete the liquidation procedures (before initiating assets sales) of the SOEs from 210 days in 2002 to 150 days in 2003.

9. The average time necessary to complete the liquidation procedures (before initiating assets sales) of the SOEs decreased from 210 days in 2002 to 125 days in 2003.

4. Advancing Public Infrastructure Reform

10. Accumulated no energy payment arrears by state enterprises in the water sector and metro that derive from delays in budget financing in 2003.

11.Increased the average daily number of hours when water supply is available to dwellers of multi-apartment buildings in Yerevan from 3.1 hours in 2001 to

10. Accumulated energy payment arrears by state enterprises in the water sector and the metro, that derive from delays in budget financing in 2003, were AMD25.0 million.

11.The average daily number of hours when water supply was available to dwellers of multi-apartment buildings in Yerevan increased from 3.1 hours in 2001 to 9.3 hours in 2003.

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6.2 hours in 2003.

12. Increased domestic budget financing of road maintenance from AMD 1.2 billion in 2002 to AMD 2.5 billion in 2003.

13. Increased the irrigation tariff from average 3.9 Dram per cubic meter in 2001 to 4.2 Dram per cubic meter in 2003.

12. Domestic budget financing of road maintenance in the first ten months of 2003 was AMD2,036.3 million compared with the AMD995.5 million in 2002 January-October.

13. The irrigation tariff was increased from average 3.9 Dram per cubic meter in 2001 to 4.2 Dram per cubic meter in 2003.

5. Improving Tax and Customs Administration

14. Increased the rate of presumptive tax for liquid gas from 2002 level of AMD 500,000 per month to AMD 1,000,000 per month in 2003.

15. Increased revenue yields in 2003 compared with the 2001 levels from: (i) the largest retail markets in Yerevan by at least 15.0%; (ii) the main excisable goods, such as petrol and tobacco, by at least 10.0%; and (iii) car importation by at least 20.0 percent.

16. Increased the number of employees registered as active payroll taxpayers from the 2002 level of 260,000 by at least 10% by July 1, 2003.

17. Reduced the outstanding VAT balances due to the exporters by at least 10% at the end of the first half of 2003 relative to the end of the first half 2002.

18. Improved communications with the private sector and general public

14. The presumptive tax for liquid gas increased from 2002 level of AMD 500,000 per month to AMD 1,000,000 per month in 2003.

15. (i) The revenue yields from the largest retail markets in Yerevan in 2003 was AMD1,780 million, an increase of by 26.4 % from the level of 2001, (ii) The revenue from the main excisable goods, such as petrol and tobacco, in 2003 was AMD 32,148 million, an increase of 25.5% compared with 2001, and (iii). The revenue from car importation in 2003 was US $ 14.1 million, 3.3 times the level of 2001.

16. The number of employees registered as active payroll taxpayers increased from December 31, 2002 level by 16.0% in December 31, 2003.

17. The outstanding VAT balances due to the exporters amounted to AMD2,843 million at the end of October 2003, a reduction of 51.4% compared with the end of October 2002.

18. The website of the State Tax Service did not register the number of

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resulting in an increased number of references to the websites of the State Tax Service, the State Customs Committee, and the Ministry of Finance and Economy by at least 500 per month for each of these websites.

references as of December 5, 2003. The number of references to the websites of the State Customs Committee per month reached 467 during January-December 5, 2003. The website of the Ministry of Finance and Economy did not register the number of visits as of December 5, 2003.

6. Strengthening the Financial Sector

19. Increased the total collected insurance premiums (in real terms) by at least 10% in July 2003 compared with the July 2001 level.

20. Increased the total paid capital of the banking system by at least 25% by July 1, 2003, compared with the end 2001 level of AMD 37.7 billion.

21. Increased the minimum capital requirements for commercial banks from US$1.15 million to US$1.825 million from July 2001 to July 2003.

19. The total collected insurance premiums amounted to AMD2,657.5 million in 2003, an increase of 25.5% compared with 2001.

20. The total paid capital of the banking system (19 banks) was AMD 41.5 billion by July 1, 2003, compared with the end 2001 level of AMD 37.7 billion (30 banks). Thus, per bank capital increased, but total banking capital decreased slightly with the closure of 11 banks.

21.The minimum capital requirements for commercial banks increased from US$1.15 million to US$2 million from July 2001 by the end of 2003.

III. PROMOTING PUBLIC SECTOR REFORMS7. Improving budget management systems

22. Increased budget transparency by reducing the share of non-classified budget expenditures in total expenditures from 25% in the 2002 budget to less than 13% in 2003.

22. The share of non-classified budget expenditures in total expenditures was reduced from 25% in 2002 to 9% in 2003.

IV. ADVANCING SOCIAL SECTOR REFORMS8. Increasing the Budget Financing of Core Social Services

23. Increased the level of budget financing for health and education in 2003 budget compared with the 2002 budget by 27% and 14%, respectively.

23. The level of budget financing for health and education in 2003 budget compared with the 2002 budget increased by 23% and 22%, respectively.

9. Achieving higher efficiency in General

24. Reduced the number of schools due to consolidation by at least 5

24. The number of schools due to consolidation was reduced by 2.7%

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Education by mid-2003 and reduced the number of staff on school payroll by at least 8-10% relative to the level of 2001/02 educational year of 48,950 staff members

25. Increased the average teacher salary by at least 20% (from the average level of AMD15,400) and school managers by more than 100% in 2003 relative to 2002.

26. Maintained the enrollment rates in elementary education of at least 95% in 2003.

27. Accumulated no new budget arrears in education, and fully paid the stock of outstanding arrears (arrears of previous years) by July 2003 compared with the 2002 stock of budget arrears of AMD1.9 billion.

by mid-2003 compared with the level of 2001/02 educational year and number of staff on school payroll by about 21%.

25. The average teacher salary increased by 18% from the average level of AMD15,400 in 2002 to AMD 18,195 during 2003 and the average monthly wage of school managers increased by 110% from the average level of AMD8,300 in 2002 to AMD17,430 in 2003. The average teacher’s and principal’s salaries increased by a further 67% in 2004.

26. The enrollment rates in elementary education of 2002/03 educational year was 97%.

27. Budget arrears in education by the end of 2003 was AMD411.1 million compared with the end of 2002 level of AMD489.2 million with stock of outstanding arrears fully paid.

10. Advancing Health Sector Reform

28. Reduced capacity in the public health sector by at least 10.0% (estimated through both the number of hospital beds and total occupied space by public hospitals) in 2003, relative to the end-2001 level of 16,000 beds.

29. Accumulated no new budget arrears in health and fully paid stock of outstanding arrears (arrears of previous years) by July 2003 relative to the 2002 stock of budget arrears of AMD7.3 billion.

30. Increased the share of

28. The number of hospital beds decreased to 14,208 in 2003.

29. Budget arrears in health as of November 1, 2003 was zero and during January-October 2003 AMD130 million of arrears were paid. Stock of outstanding arrears fully paid.

30. The share of government health

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government health budget for primary health from 19% in 2001 to more than 30% in 2003.

31. Increased proportion of one-year old children immunized against measles to at least 90.0% in mid-2003 from 2001 level of 85 %.

budget for primary health increased from 19% in 2001 to 33% in 2003.

31. Proportion of one-year old children immunized against measles in 2003 was 94%.

11. Deepening Social Protection Reforms

33. Increased the size of average monthly family poverty benefit by at least 11% in the second part of 2003 relative to 2002.

32. The average monthly family poverty benefit for 2003 was AMD7,600, an increase of 14 % compared with the annual average level of 2002.

12. Launching Implementation of Pension System Reforms

33. Increased the average monthly old-age pension by at least 20% in July 2003 relative to 2002 level of AMD5,400.

33. In 2003 the average monthly old-age pension was 7,453 AMD and increased by 30% relative to 2002 level. Pensions increased 20% in 2004.

3.4 Revised Components:

No revisions

3.5 Quality at Entry:

ICR – Satisfactory. The preparation of SAC5 benefited from Armenia’s substantial experience of working with the World Bank, especially in adjustment operations. There was support from a PHRD grant for preparation, and, to a lesser extent, from the Second Structural Adjustment Technical Assistance Credit (SATAC2), that had supported previous adjustment operations, for implementation. The Bank offered a high level of support for Armenia as the CAS lending envelope was US$150 million for the three-year period of which SAC5 was a part. The main risks and mitigation presented in the Program Document are presented in Table 2 below.

As stated, SAC5, like SAC4, differed from its predecessors, SAC3 and SAC2, which had focused more on a macro agenda. The policy priorities shifted under SAC4, for example, toward improving the business environment by aiming at a set of issues such as procedures for registering and licensing businesses and other steps in order to decrease the cost of doing business. These priorities continued under SAC5. SAC5's design also incorporated some of the main lessons from previous adjustment operations. These included for example higher budget allocations to social sectors, and providing strong TA resources for successful program implementation, particularly during the second and more detailed phase of reforms. SAC5 also pursued the 2001 CAS objectives of improving public sector services and rebuilding human capital.

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TABLE 2: Risks and MitigationRisk Mitigation

Weakening Government commitment to SAC5 reforms.

Government commitment to macroeconomic stability including agreements under the PRGF program.

Macro instability deriving from poor revenue performance.

Close working relationship between the Bank and the Government on economic and sector work, including the Armenian Growth Study, which deepened Government understanding of and capacity to identify strategic priorities.

Capacity to implement reforms such as customs and tax administration.

Mobilization of multi-donor technical assistance package to carry out SAC5.

Potential political instability. Strong up-front conditionality.

Quality at entry was enhanced through preparation of specific action plans for major components, including improving the business and investment environment, tax and customs administration and budget management systems (see Annex 8). These plans gave greater specificity to the more broad core conditions. The education component was aided by the simultaneous preparation of the Education Quality and Relevance Project (EQRP), which went to the Board just before SAC5. The EQRP was the first of a three-phase APL. Also, in the health sector, a Health System Modernization project was prepared which has helped achieve efficiency through hospital consolidation with the associated savings on hospital infrastructure and staff.

The quality at entry is also supported by a detailed set of monitorable indicators. These indicators were worked out collaboratively between Bank sector staff and the Government local experts. The targets were ambitious, but achievable, and provided good pilot preparation for the follow-up series of PRSCs which was approved by the Board on November 18, 2004. Prospects for achieving SAC5 targets were enhanced by their link to the GOA budget cycle.

QAG – N.A.

4. Achievement of Objective and Outputs

4.1 Outcome/achievement of objective:

The available outcome indicators clearly show that SAC5 was satisfactory in achieving its objectives. The main indicators are all going in the right direction, with poverty falling, the business environment improving, foreign investment and employment rising as well. Table 1, above, provides these outcome indicators. The individual sections below provide evidence on achievement of objectives.

Objective 1: Maintaining Macroeconomic Stability - Satisfactory

Real GDP growth has steadily increased since 1999. Growth soared to 12.9 percent in 2002 and to13.9 percent in 2003 as shown in Table 3. The CPI remained in single digits, although it has

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recently crept upward to over 5 percent because of the increase in international prices of oil and wheat. The unemployment rate has continued to decline, as has the government deficit. The accumulation of international reserves reached 4.8 months of imports compared with the SAC5 target of 3 months.

TABLE 3: Macroeconomic Indicators 1998-2003

Indicators 1998 1999 2000 2001 2002 2003Real GDP Growth (Percent change) 7.2 3.3 6.0 9.6 12.9 13.9CPI, percent (end period) -1.2 2.1 0.4 2.9 3.8 5.4Official Unemployment rate (%) 9.4 11.2 11.7 10.4 9.4 9.1Government Cash Balance (% of GDP) -4.7 -5.5 -4.6 -4.0 -3.3 -0.9Exchange Rate (drams/US$) 505 535 540 560 565 587Current Acct. Balance (US$m) -403 -401 -381 -268 -150 NAMerchandise Exports (fob, US$m) 220.5 231.7 300.5 341.8 507.2 249Gross International Reserves (US$m) 298 305 314 330 439 461Gross International Reserves (months of imports)

3.9 3.8 3.8 3.9 4.5 4.8

Source: World Bank, IMF, and Ministry of Finance

Objective 2: Developing the private sector and accelerating public enterprise reform - Satisfactory

This objective was to be met, in part, by further reducing administrative barriers and developing institutions for PSD. Some of the main output indicators that were achieved or exceeded include: the reduction in the average time necessary to get construction and building renovation permits from 310 days in 2001 to 76 days by the end of 2003; and reduction in the number of goods subject to mandatory certification at the border 80 (2001) to 60 by the end of 2003. There was also an increase in the volume of FDI (outside the energy sector) to US$121.2 million, exceeding the target of US$90 million for 2003. In the area of land registration, the number of registered business transactions with agricultural land plots increased from 2,850 at the end of 2001 to 4,600 in 2003, and the number of land certificates issued to family farmers increased from 313,000 to 580,000 during 2001-03. The time necessary to complete liquidation procedures (before assets sales) fell from 210 days in 2002 to 125 days in 2003. Responses from private firms, directly and through the Business Council, which is a liaison for the private sector to the Government, show increased satisfaction with the business environment and a reduced incidence of bribes to officials.

Improvements in tax and customs administration also led to strong outcomes, which met or exceeded targets in all cases. The revenue yields from the largest retail markets in Yerevan in 2003 increased to AMD1,780 million or 26.4 percent from the level of 2001. Revenue from the main excisable goods, such as petrol and tobacco in 2003 increased to AMD32,148 million (25.5 percent) compared with the same period of 2001. Car importation revenue increased US$14.1 million, a 3.3 fold increase between 2001 and 2003. The number of employees registered as active payroll taxpayers increased by 16.0 percent during from December 2002 to December 2002-03. And the outstanding VAT balances due to exporters was reduced by the end of

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October 2003 to AMD2,843 million, a reduction of 51.4 percent compared with the end of October 2002.

Measures relating to improving the operating environment in the power and utility sectors also produced generally good results. The average daily number of hours when water supply was available to dwellers of multi-apartment buildings in Yerevan increased from 3.1 hours in 2001 to 9.3 hours in 2003, exceeding the target of 6.2 hours. Domestic budget financing of road maintenance in the first ten months of 2003 was AMD2,036.3 million compared with the AMD995.5 million in 2002 January-October, which was on a course to come close to, but not quite meet the target of AMD2.5 billion for the entire year. The irrigation tariff was increased from AMD3.9 per cubic meter in 2001 to AMD4.2 per cubic meter by the end of 2003, which met the target. The accumulated energy payment arrears by state enterprises in the water sector and metro were AMD25.0 million against a target of zero arrears. However, these arrears reportedly derived from delays in budget financing in 2003.

There were also measures in the financial sector that were important to private sector development. Reforms in the financial sector had been lagging to the extent that the sector was not fulfilling an effective intermediary role for SMEs to operate and invest. Measures in insurance and banking helped improve the environment for SMEs. Some of the outcome indicators included : a 25.5 percent increase in total collected insurance premiums during 2001-03; the total paid capital of the banking system increased by 10.0 percent to AMD41.5 billion by July 2003, compared with the end 2001 level of AMD37.7 billion (below the targeted increase of 25 percent). This increase is magnified, however, when considering that 11 banks were closed, so the per bank capital increased significantly; the minimum capital requirements for commercial banks also increased from US$1,150 million to US$2,000 million from July 2001 by the end of 2003. Non-Performing Loans (NPLs) also declined. The percentage of NPLs in 2001 was 6.0 percent, in 2002 and 2003, 4.9 percent, and the first quarter of 2004, 4.4 percent.

Objective 3: Promoting public sector reforms – Satisfactory

Activities to achieve this objective focused on better budget management. The main progress in public expenditure management (PEM), institutionally, was in budget consolidation, better accounting and reporting (transparency) and a more strategic budgeting approach through the MTEF. The main outcome indicator was the share of non-classified budget expenditures in total expenditures. This share was reduced from 25.0 percent in 2002 to 9.0 percent in 2003, against a target of 13.0 percent. As further evidence of the achievement of this objective, the GOA ensured that PRSP assumptions matched the MTEF for social sectors.

Objective 4: Advancing social sector reforms, including education, health, social protection and pensions—Satisfactory

SAC5 increased emphasis relative to its predecessor operations on the social sectors. The 2003 Household Survey showed overall substantial reductions in poverty. The poverty incidence declined from 48.9 percent in 2002 to 42.9 percent in 2003. Extreme poverty also fell sharply from 13.0 percent to 7.4 percent during the same period.

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Key outcome indicators in the health sector include the elimination of budget arrears in health as of 2003, with a payoff of AMD130 million during January-October 2003. The share of the government health budget going to primary health increased from 19.1 percent in 2001 to 33.2 percent in 2003. The overall budget for health increased 23.0 percent during 2002-03. Both indicators exceeded the target. Taking into account the hospital consolidation that has taken place, especially under the hospital optimization in Yerevan, there has also been significant capacity reduction, with the decline in hospital beds from 16,000 to 14,208, and increased utilization. The immunization target for one-year olds for measles of 90 percent was exceeded in 2003 as the rate reached 94 percent of one year-olds.

In the education sector, school rationalization targets were exceeded, which was a positive outcome because the target set did not represent all schools that needed to be rationalized. School staff on school payroll was reduced by 21 percent. The average teacher salary increased by 18 percent during 2003 and by 67 percent in 2004. The average monthly wage of school managers increased by 110 percent and a further 67 percent in 2004. The enrollment rate in elementary education of 2002/03 educational year was 97 percent, exceeding the target of 95 percent. Budget arrears were reduced from AMD489.2 million in 2002 to 411.1 million in 2003. The overall budget for education increased 22 percent during 2002-03.

In social protection, the average monthly Family Poverty Benefit for 2003 was AMD7, 600, an increase of 14.0 percent compared with the annual average level of 2002, and by and additional 26.3 percent in 2004. The average monthly old-age pension increased by 30.0 percent relative to the 2002 level, and another 20.0 percent in 2004. Another objective was improving efficiency in benefits targeting. The efficiency of targeting has been improved for some categories of privileged benefits.

4.2 Outputs by components:

Many of the actual outputs were listed in the three Government Action Plans: Budget Management Systems (Promoting Public Sector Reforms component), Tax and Customs Administration and Improving the Business and Investment Environment (Private Sector Development and Public Enterprise Reform component). These action plans were annexes to the Program Document for SAC5, and were an effective vehicle for creating mini-reform programs in key areas of PSD and public sector reform. These Action Plans are included as Annex 8 to this report.

Developing Private Sector and Accelerating Public Enterprise Reform

Tax and customs administration was implemented somewhat slowly, mainly because of the struggle with entrenched interests that benefited from the customs regime. Particularly in question was the import market for gasoline, which operated as a rationed market with economic rent seeking. Still, the conditions were met and were a major achievement for the MOF, and the major targets were reached, as shown in section 4.1.

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Labor market. The overhaul of the labor code was a lagging agenda item in an otherwise advanced reform program. The labor code still consisted mainly of Soviet era labor regulations that were too rigid and benefits that were too generous and, therefore, not conducive to a growing private sector. One reason that the labor code reform came late was that there were other priorities, mainly infrastructure, in Armenia, such as fixing water and energy delivery. These were in a crisis condition and, to an extent, displaced the implementation of labor reform. The new labor code was submitted to the National Assembly in December 2003 and was approved in 2004. The new labor code reinforces the principles of freedom of association and collective bargaining, clarifies and simplifies the basic conditions for employment contracts, reduces minimum annual leave entitlements, removes existing declaratory privileges to particular groups of employees and imposes labor dispute resolution.

Land registration. Land privatization was carried out early in the reform process (1991), but no process for land markets was established until recently. The rural land market advanced as title and construction permits became easier to obtain. In the urban land market, the reforms reduced the time to obtain a construction permit by 80 percent.

Financial sector. Financial Sector Development (FSD) recorded important outputs. Under SAC5, the GOA was able to close three larger and five smaller banks, which, based on quarterly reports and audit data, had been judged to be a drain on the sector. A diagnostic study was performed with USAID funds for Armcommunication (one of the larger banks). A foreign investor signed an agreement for the rehabilitation and sale of the Armcommunication bank. The financial rehabilitation plan was approved and it was confirmed that the CBA would initiate liquidation of this bank if there were deviations from the rehabilitation plan. Following a least cost study, the license of the Credit Yerevan was revoked. The Economic Court has appointed a liquidator for this bank. The CBA also organized a purchase and assumption transaction for some of the assets and liabilities of Ardshinbank. A new bank, Ardshin Investment Bank, acquired these assets and a liquidator was appointed to liquidate the remainder of the Ardshinbank.

Promoting Public Sector Reforms

The main action was the satisfactory implementation of the medium term Action Plan for Improving Budget Management Systems. This action plan comprises 15 action items (see Annex 8) ranging from further strengthening of the MTEF to general transparency improvement measures such as improving procedures for the government reserve fund, establishing a data base in the MOFE required for budget programming and measures dealing with the road maintenance fund, irrigation tariffs and program budgeting for the social sectors. The Government made satisfactory progress on its action plan, which the outcome indicators support.

Advancing Social Sector Reforms

Social sector reforms were emphasized more in SAC5 than in previous operations. This was partly because previous operations had envisioned more of a trickle down approach to poverty reduction. In SAC5 there was more active targeting of expenditures. School and hospital rationalization were key fiscal objectives, which, along with service delivery measures, would

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benefit the sectors by making better use of social sector resources.

Education. SAC5 was to pick up portions of financial management that were not covered by the EQRP. The two operations also reinforced each other in major areas such as school rationalization. SAC5, for example, helped downsized teachers to find new jobs, which helped the Government carry through a politically difficult measure. SAC5 covered financial management of schools, which was not in the EQRP. The education reform also covered public universities. SAC5 supported greater transparency of their financial operations, in particular requiring universities to document their expenditures. Universities receive public funding, so it was also an effort to improve public accountability.

School rationalization exceeded some targets. For example, the number of schools merged was 37 vs. a target of 5. 3,500 primary and secondary teachers were downsized. At the start of the rationalization, the student teacher ratio was 10 to 1, with the goal at the eventual end of 14 to 1. These measures were significant also in that they were the first time that GOA implemented a real reduction of excess schools and teachers. Under the program, criteria were developed for teacher dismissal with the first cut being those who were of retirement age and those who were in a temporary employment status. It was also important to establish minimum expenditure levels on education because Armenia spent only 2.5 percent of its GDP on education. In higher education, an accreditation process was laid out. Financial reporting requirements were also laid out and a strategy for further rationalization was also developed.

Health. The GOA made progress in implementing the Hospital Optimization Plan for Yerevan as well as in implementing the financial management action plan that was satisfactory to IDA. To reduce hospital capacity, the Government agreed to merge 34 public hospitals in Yerevan into 12 hospital networks and take the necessary steps to restructure them. The Government submitted a time-bound hospital optimization action plan. The plan identified 4 hospital networks to be optimized during the first phase and appoint directors for the four networks. The government also submitted a functional analysis of the first two hospital networks along with an evaluation of the potential for functional improvement and a socio economic impact assessment of the mergers. The optimization plan also included planned hospital configurations and a timetable for subsequent phases.

Social Protection/Pensions. The government adopted the Law on Pensions and developed the supporting legislation needed to carry out the new law. Specifically, the supporting legislation provides (i) instructions for implementing identification numbers; (ii) rules for computing and making partial payments to those with less than requisite insurance history; (iii) terms and procedures for recording pension insurance history for awarding pensions; (iv) listing of documents required for awarding pensions; (v) procedures for payments of the survivor’s pension to children under full state custody; (vi) procedures for payments of the survivor’s pension to pensioners under the full state custody; and (vii) awarding, computing and making payments for “privileged” pensions. A Pension Law Implementation Committee was established at the MOSS to oversee implementation.

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TABLE 3: Tranche Releases

Tranche Expected Date Actual DateAmount

(m. SDRs)Amount

(m. US$ equiv.)1 3-31-2003 4-17-2003 15.1 20.02 6-30-2003 12-17-2003 15.1 20.0

Total 30.2 40.0

4.3 Net Present Value/Economic rate of return:

Not applicable.

4.4 Financial rate of return:

Not applicable.

4.5 Institutional development impact:

Substantial. IDI depends to an extent on sector ownership of the reforms. The Government-owned IPRSP and subsequently the PRSP were closely linked to the SAC5-supported reform program. The strongest indication of overall Government ownership was the integration of annual budget with the MTEF. This link is a substantial step forward in that, although the MTEF was introduced several years earlier, for the first time, under SAC5, the MTEF, became a major instrument in preparing the annual budget. The central role of the MTEF was accompanied by improvements in public expenditure management (PEM) that were assisted by a Bank Public Expenditure Review (PER). The Government has successfully integrated the MTEF based on the PRSP process in the annual budget in order to strengthen the links between policies and expenditure allocations. This link also facilitates and makes more explicit the expenditure rationalization process. Increased ownership extended to other aspects of the program as well. For example, on the cadaster side (land registration), ownership was high and good use was made of substantial TA to develop the foundation for land markets. Measures to improve the legal framework for labor were carried out, which are expected to lead to further IDI in the areas of collective bargaining and job placement services. Rationalization in the education and health sectors has instituted principles of operational efficiency and financial flexibility. Improved social services, financial sector operations and utility and energy services, documented in Section 4, have all contributed to substantial IDI.

5. Major Factors Affecting Implementation and Outcome

5.1 Factors outside the control of government or implementing agency:

Factors Outside Government or Implementing Agency control

One negative external factor was the surge in the prices of key imports, oil and wheat. Armenia maintained its reform agenda, but inflation exceeded 5 percent and therefore the target of 3

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percent.

5.2 Factors generally subject to government control:

Attitudinal factors also affected implementation, both positively and negatively. One positive factor that has benefited the reform program throughout its stages can be described as Armenians’ high receptivity to outside ideas. Though entrenched interests have at times slowed reforms, the Government has seldom challenged the rationale of reforms that have changed the Government’s way of doing business.

A factor that may impede reform is a degree of complacency, which may have developed because Armenian growth has been so successful (double digits). One example is that it could be doing a better job of encouraging FDI, in particular, tapping the resources and expertise of the diaspora. This would enhance the sustainability of economic growth. Given its challenging geographic position and other constraints, Armenia does need to be more proactive in encouraging FDI.

5.3 Factors generally subject to implementing agency control:

As in the previous operation (SAC4), there were a couple of factors related to concern over the impact of rationalization program that, to some extent, slowed implementation. These could be seen in the health and education sectors with concern over downsizing. Implementation was also somewhat slower in the Tax and Customs Administration component as an ambitious Government action plan challenged entrenched interests. The MOF helped reduce the impact of these factors by improving support to and coordination among ministries and agencies. There were also effective efforts to find dismissed teachers other employment.

5.4 Costs and financing:

The total original credit amount was SDR30.2 million (US$40 million equivalent). The entire credit amount was disbursed in two tranches. The credit was made on standard IDA terms with a term of 40 years, a 10-year grace period, and an IDA service charge of 75 basis points on the undisbursed balance. The borrower was the Republic of Armenia. In December 2003, the Government of Netherlands co-financed SAC5 with a grant for Euro 4.666 million (US$5.7 million equivalent).

6. Sustainability

6.1 Rationale for sustainability rating:

The sustainability of the SAC5 is rated likely. The GOA satisfactorily completed all tranche conditions and continued its long history of successful reform with the preparation of a follow-on PRSC (Board date, November 18, 2004). Many of the reforms may prove difficult to reverse, such as preparation and execution of the budget within the medium term expenditure framework, the labor code reforms and the rationalization programs in the education and health sectors. Transparency and accountability in tax and customs administration will be engrained processes contributing to private sector development. The further improvements in the business climate along with better-targeted social investments have also helped achieve substantial gains in poverty

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reduction. These achievements have strengthened sustainability by winning wider support from the public. Despite these favorable factors, there continue to be concerns about regional stability that could affect the reform program, and which makes Armenia less attractive to investors. Other factors include a heavy reliance on donor funding and a narrowly based manufacturing sector. Improved service delivery, including utilities, energy and social services, combined with the substantial reduction in poverty have won the support of the public. This support, greater fiscal discipline and the Government’s strong record of reform, suggests that sustainability of achievements of SAC5 is likely.

6.2 Transition arrangement to regular operations:

SAC5 was a kind of transition adjustment operation for the upcoming PRSCs. Armenia has graduated to a new level where the major adjustment actions have been carried out. “Big ticket items” like privatization and an enabling legal framework have already been implemented. Reforms in improving the business environment have deepened. The basic labor reform has been passed along with further improvements in registration and licensing.

The three-year follow-up reform program that is supported by the PRSCs, is anchored in the PRSP objectives, and further bolsters sustainability. The PRSC will begin its first of three phases in FY05. The PRSC focuses on four critical reform themes: (i) consolidating macroeconomic discipline and strengthening of governance, (ii) sharpening competition and entrenching property rights, (iii) mitigating of social and environmental risks, and (iv) modernizing the rural economy. These PRSCs are front-loaded, single tranche operations. To ensure sustainability, the PRSCs are based on verifiable outcomes.

7. Bank and Borrower Performance

Bank7.1 Lending:

Satisfactory. The project design was a good response to the need to improve the business climate and bolster the social sectors. The design was optimistic in gauging how quickly the program could be implemented, but it was appropriate because it challenged Armenia’s capabilities in key areas of reform. (See Quality at Entry section).

The IMF was a good partner in the reform program with particularly strong support for the financial sector reforms. SAC5-supported reform measures were aligned closely with the IMF PRGF, approved by the Executive Board of the IMF in 2001. Supporting measures aimed at strengthening public finance, maintaining a monetary policy consistent with price stability, improving regulation of the banking sector and eliminating losses by state-owned enterprises.

7.2 Supervision:

Satisfactory. The Bank PREM and HD had good links and the SAC5, Health System Modernization Project and EQRP (education project) together helped achieve a politically difficult school and hospital rationalization. Close coordination of technical assistance from bilateral and multilateral donors provided a critical mass of high-quality expertise. The Bank also

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worked well with the IMF, cooperating on the politically difficult financial reforms. The combined influence of the two institutions helped reform the financial sector by closing banks that were losing money.

7.3 Overall Bank performance:

Satisfactory. The Bank performed well and supported a meaningful program in priority areas that was fully implemented and produced strong outcomes.

Borrower7.4 Preparation:

Satisfactory. The GOA was fully supportive of the reform program at the highest levels. The Borrower worked well with the Bank in design of the operation and in identifying measures in a wide range of areas that would have substantial impact on improving the business climate and on social service delivery. SAC5 was closely tied to the PRSP and to the budget process, a strong indicator of substantial institutional development.

7.5 Government implementation performance:

Satisfactory. The GOA met all conditions for the release of all tranches. Government ownership was good, as in previous operations, and the Government improved cross-ministerial coordination of the program, which helped achieve the main reform targets on time. Strong reform advocates, especially the Minister of Finance and the Prime Minister, strengthened government implementation. The Minister of Finance has helped guide previous adjustment operations as well. At times the GOA went beyond core conditions to implement a broader reform program. And in most cases, the GOA exceeded the benchmarks associated with the core conditions.

During implementation, the Bank had some concern regarding financial sector legislation. After strengthening oversight and regulation of banking institutions, the GOA passed a law for non-bank financial institutions (NBFIs). The NBFI law was sufficiently vague to concern the Bank and IMF that it might encourage regulatory arbitrage. NBFIs, which were not as closely regulated as banks at the time, could have been allowed to take deposits and expose depositors to considerable risks. The Bank and the Fund stepped in when the secondary regulations were being drafted to ensure that NBFIs could not take deposits.

7.6 Implementing Agency:

Satisfactory. The MOF performed well with good coordination with other ministries in implementing SAC5 conditions. One example of good IA performance was the State Committee of the Real Property Cadastre. This entity performed well in moving the land registration process forward making good use of TA and accelerating the titling process. The Armenian Development Agency strengthened its capacity and became a focal point for government’s investment and export promotion activities and identifying bottlenecks in the business environment. The Ministry of Justice did a particularly good job in its role in reforming the legal framework for business and infrastructure and design of the labor code. Other IAs, especially social sector line ministries, performed satisfactorily as well and utilized the TA support and related investment operations to

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develop the capacity to implement reforms.

7.7 Overall Borrower performance:

Satisfactory. Except for the few areas cited that can be improved under the PRSCs, borrower performance on the whole was strong.

8. Lessons Learned

Establishing macroeconomic fundamentals before focusing on improving the business environment is an effective development strategy. Improvements to the business environment will not be effective until macro fundamentals are in place. The overall strategy of the reform program from the Rehabilitation Credit to SAC5 of first establishing macroeconomic fundamentals, and then focusing on improving the business environment has succeeded. There was concern up to the preparation of SAC4 when rapid growth was not well distributed, but growth benefits eventually spread more evenly as new data reveal.

Focusing on improving the business environment vs. more targeted interventions in health, education and social protection is not necessarily an either/or proposition. With rapid growth and fiscal savings through social sector rationalization, higher social expenditures were possible simultaneously with continued business environment improvements. Thus, the social sectors could also be adequately funded.

Monitoring instruments and taking into account feedbacks can play an important role in design and implementation of an effective reform program. The use of monitoring instruments and the incorporation of their feedback help improve both design and implementation of a reform program. The Government closely monitored and evaluated SAC 5 through periodic surveys and assessments. This M&E process significantly improved the effectiveness of supervision and provided insights for the design of structural reforms, which are supported under the PRSC. The Government closely monitored and evaluated through periodic surveys and assessments implementation of the SAC5. This process guided the supervision and impact assessments of the reform program and provided insights for the design of structural reforms which are supported under the PRSC.

9. Partner Comments

(a) Borrower/implementing agency:

The fifth consecutive Structural Adjustment Credit (SAC V), provided to Armenia by the IDA like the SAC IV somewhat differed from its predecessors, SAC III, SAC II and SACI, and aimed to increase employment and spread the benefits of growth throughout the population. The credit represented a significant source of budget deficit financing, and was crucial in terms of development impact directed to the developing of private sector and the delivery of social services. Taking into consideration Armenia's limited access to alternative sources of budget support SAC V was of crucial importance to avoid contraction of and even increase the level of public expenditures in the socially sensitive areas.

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The Government of Armenia holds the view that SAC V was in accordance with the Poverty Reduction Strategy Paper adopted by the Government as the components of SAC V focused on: (i) promoting sustainable economic growth through macroeconomic stability and private sector development; (ii) enhancing human development and improving social safety nets; (iii) implementing prudent fiscal policies and reforming the tax system; (iv) improving public infrastructure; and (v) improving core public sector functions.

In Government's opinion, the project supported by SAC V was especially successful in the following directions:

(i) Developing private sector by reducing administrative barriers and developing institutions for private sector development,

(ii) Promoting public sector reforms by improving budget management through improving public expenditures management and developing strategic budgeting approach, reducing corruption, and

(iii) Advancing social sector reforms by improving service delivery, which is essential for poverty reduction and human development.

At the same time, the Government realizes that further success in implementation of poverty reduction and sustainability in reform process is dependent on continuous capacity building in governmental structures. Armenia faced negative external factors during SAC V implementation due to rising oil and wheat prices, which impacted the economy because Armenia is an oil and wheat importer.

However, Government's strengthening fiscal discipline and strong support of reforms made achievements of SAC V sustainable. The Government appreciates the flexibility and understanding displayed by the Bank in the light of factors outside the Government's control that hampered proper implementation of specific elements of the SAC V program.

The three-year follow-up reform program supported by the Poverty Reduction Support Credit (PRSC) is anchored in the PRSP objectives, and further bolsters sustainability of reforms. The PRSC will be focused on such critical reform areas as: (i) consolidating macroeconomic discipline and strengthening of governance, (ii) sharpening competition and entrenching property rights, (iii) mitigating of social and environmental risks, and (iv) modernizing the rural economy.

(b) Cofinanciers:

No comments provided

(c) Other partners (NGOs/private sector):

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10. Additional Information

TABLE 3: Summary of PSR Ratings for SAC5

Category 6/03 11/03 5/04PDO S S SImplementation S S SProject Management S S SFinancial Management S S SOther Legal Covenants S S SM&E S S S

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Annex 1. Key Performance Indicators/Log Frame Matrix

REFORM PROGRAM MATRIX

Core conditions are in BOLD

Sectoral Area Board Presentation Second Tranche Outcome/Output

I. Macroeconomic Stability1. Maintaining Macroeconomic Stability

Satisfactory macroeconomic performance.

Satisfactory macroeconomic performance.

Real GDP Growth of 6 percent, inflation at no more than 3 percent and level of gross international reserves of not less than 3 months of imports in 2003.

II. Private Sector Development and Public Enterprise Reform2. Improving Business and Legal Environment

1. The GOA adopted the action plan for improving the business and investment environment (see Annex III).

2. The GOA submitted the new Bankruptcy Law to the National Assembly.

3. The GOA submitted the Public Auction Law to the National Assembly.

4. The GOA drafted and submitted a number of amendments to various laws to facilitate leasing activities.

5. The GOA strengthened protection of intellectual property rights and developed regulatory procedures to implement the 1999 Law on Intellectual Property.

1. The GOA has demonstrated satisfactory progress in implementation of the medium-term action plan for improving the business and investment environment.

2. The GOA has prepared implementation regulations for the Bankruptcy Law.

3. The GOA has prepared implementation regulations for the Public Auction Law.

4. The GOA has submitted to the National Assembly a new Labor Code in substance as agreed with the Association.

5. The GOA has adopted the Concession Law and prepared its implementation regulations.

Reduced the average time necessary to get construction and building renovation permits from 310 days in 2001 to less than 100 days by July 1, 2003.

Reduced the number of goods that are subject to mandatory certification at the border from 2001 level of 80 by 20 (i.e. by about 25%) by July 1, 2003.

Made the Register of movable property fully operational with at least 10 registered transactions per month by July 1, 2003.

Increased the number of newly established legal business entities with foreign participation by at least 10 percent (i.e. by about 200 firms) from January 1, 2002 to July 1, 2003.

Increased the volume of FDI (outside the energy sector) from the average level of

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6. The GOA promoted privatization of urban land used by commercial entities.

7. The GOA simplified the procedures for real estate and land registration.

8. The GOA simplified the procedures for sales of collateral to reduce implicit costs of lenders.

US$75 million in 2001-02 by 20 percent during 2003.

Increased the number of registered business transactions with agricultural land plots from about 2,850 in 2001 to 4,700 in 2003.

Increased the number of land certificates issued to family farmers from 313,000 at the end of 2001 to 525,000 by the end of 2003.

3. Strengthening Public Enterprise Reform

1. The GOA developed and approved a plan to accelerate reorganization and liquidation of non-viable SOEs, and selected a group of 20 medium and large SOEs for liquidation within the plan.

2. The GOA made satisfactory progress to initiate the liquidation of the 20 medium and large SOEs according to the plan, including adoption of Government decisions on liquidation of at least 2 enterprises from this group.

1. The GOA has completed bankruptcy/liquidation procedures for at least 10 of the medium and large SOEs included in the plan, which would include appointment of the liquidation commissions for these enterprises and approval of action plans for the commissions.

Decreased the average time necessary to complete the liquidation procedures (before initiating assets sales) of the SOEs from 210 days in 2002 to 150 days in 2003.

4. Advancing Public Infrastructure Reform

1. The GOA made adequate provisions in 2003 budget to support the financial recovery plan of the water and transport sectors to ensure their full payments to the energy sector.

1. The VIP customers have made satisfactory payments to the energy sector.

2. The GOA has sustained a satisfactory environment for operations of the privatized firms in the power and utility sectors as indicated by: (i) establishing a single utility regulator, adopting the

Accumulated no energy payment arrears by state enterprises in the water sector and metro that derive from delays in budget financing in 2003.

Increased the average daily number of hours when water supply is available to dwellers of multi-apartment buildings

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necessary legal framework to ensure its financial autonomy and transferring economic regulations of energy, water and telecom sectors to the single regulator; (ii) carrying out the agreed Performance Monitoring and Public Dissemination Program; and (iii) ensuring the privatized power distribution company (ArmElNet)'s compliance with its License.

in Yerevan from 3.1 hours in 2001 to 6.2 hours in 2003.

Increased domestic budget financing of road maintenance from ADR 1.2 billion in 2002 to ADR 2.5 billion in 2003.

Increased the irrigation tariff from 3.9 Dram per cub.m in 2001 to 4.2 Dram per cub m in 2003.

5. Improving Tax and Customs Administration

1. The GOA adopted the action plan for reforming tax and customs administration (see Annex IV).

1. The GOA has demonstrated satisfactory progress in implementation of the medium-term action plan for reforming tax and customs administration.

Increased the rate of presumptive tax for liquid gas from 2002 level of ADR 500,000 per month to ADR 1,000,000 per month in 2003.

Increased revenue yields in 2003 compared with the 2001 levels from: (i) the largest retail markets in Yerevan by at least 15 percent; (ii) the main excisable goods, such as petrol and tobacco, by at least 10 percent; and (iii) car importation by at least 20 percent.

Increased the number of employees registered as active payroll taxpayers from the 2002 level of 260,000 by at least 10 percent by July 1, 2003.

Reduced the outstanding VAT balances due to the exporters by at least 10 percent at the end of the first half of 2003 relative to the end of the first half 2002.

Improved communications with the private sector and general public resulting in an increased number of references to the websites of

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the State Tax Service, the State Customs Committee, and the Ministry of Finance and Economy by at least 500 per month for each of these websites.

6. Strengthening the Financial Sector

1. The GOA established an adequate regulatory and supervisory environment for the non-bank financial institutions.

2. The GOA developed specific strategic proposals for resolution of all three large problem banks under temporary administration (Credit Yerevan, Ardshin and Armcommunication bank) and initiated a diagnostic/least-cost study for them.

3. The GOA revoked the licenses and appointed liquidators for three small banks under temporary administration.

4. The GOA amended the Insurance Law.

1. The GOA has: (i) completed a diagnostic/least-cost study for the Credit Yerevan, Ardshin and Armcommunication banks and made satisfactory progress with implementation of the resolution strategy formulated for these banks; and (ii) revoked the licenses and appointed liquidators for the remaining (United and Credit Service) banks under temporary administration.

2. The GOA has prepared implementing regulations for the new insurance law, increased the minimum capital requirements for insurance companies, refrained from introducing new compulsory insurance schemes before approval of the implementing regulations, and strengthened the capacity of the Insurance Inspectorate.

Increased the total collected insurance premiums (in real terms) by at least 10 percent in July 2003 compared with the July 2001 level.

Increased the total paid capital of the banking system by at least 25 percent by July 1, 2003, compared with the end 2001 level of ADR 37.7 billion.

Increased the minimum capital requirements for commercial banks from US$1.150 million to US$1.825 million from July 2001 to July 2003.

III. Promoting Public Sector Reforms7. Promoting Public Administration

1. The GOA adopted regulations to support implementation of the Civil Service Law and the Law on Remuneration of Civil Servants.

1. The GOA has rationalized the roles and responsibilities of internal and external auditing functions and passed a law to increase the independence of the Chamber of Control (COC) in performing external audits.

2. The GOA has made

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improvements in the regulatory framework of public procurement, based on recommendations of the Country Procurement Assessment Report (CPAR).

3. The GOA has developed and adopted an action plan for implementation of the anti-corruption strategy and made satisfactory progress in carrying out the anti-corruption strategy.

8. Improving budget management systems

1. The GOA approved an action plan for improving budget management systems (see Annex V).

1. The GOA has demonstrated satisfactory progress in implementation of the medium-term action plan for improving budget management systems.

2. The GOA has amended the Budget System Law to introduce changes in the budget calendar that would make annual MTEF updates an integral part of the budget cycle.

Increased budget transparency by reducing the share of non-classified budget expenditures in total expenditures from 19 percent in the 2002 budget to less than 13 percent in 2003.

VI. Advancing Social Sector Reforms9. Increasing the Budget Financing of Core Social Services

1. The GOA increased the level of budget financing of health, education and social protection.

1. The GOA has refrained from accumulation of new budget arrears in the social sector.

Increased the level of budget financing for health and education in 2003 budget compared with the 2002 budget by 27 percent and 14.4 percent respectively.

10. Achieving higher efficiency in General Education

1. The GOA adopted the School Rationalization Program with specific targets for 2002 and 2003.

2. The GOA increased the state budget allocation for primary and secondary education and improved teachers’ salaries.

1. The GOA has: (i) made satisfactory progress in implementation of the School Rationalization Program for 2003; and (ii) made satisfactory progress in implementation of the medium-term action plan for improving the financial management, accounting and financial reporting for higher education.

Reduced the number of schools due to consolidation by at least 5 by mid-2003 and reduced the number of staff on school payroll by at least 8-10 percent relative to the level of 2001/02 educational year of 48,950 staff members (to become effective on September 1, 2003).

Increased the average teacher

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3. The GOA developed an action plan for clearing the accumulated arrears in the education sector and prevented further arrears in this sector.

salary by at least 20 percent (from the average level of 15,400 ADR) and school managers by more than 100 percent in 2003 relative to 2002.

Maintained the enrollment rates in elementary education of at least 95 percent in 2003.

Accumulated no new budget arrears in education, and fully paid stock of outstanding arrears (arrears of previous years) by July 2003 compared with the 2002 stock of budget arrears of ADR 1.9 billion.

11. Launching Reforms in University Education

1. The GOA prepared a plan to introduce accounting and reporting requirements for higher education institutions.2. The GOA submitted the draft Higher Education Law to the National Assembly, developed amendments to the Law on State Non-commercial Organizations to make it consistent with the requirements of the new Higher Education Law.

1. The GOA has developed and approved a new Government strategy on Higher Education reform, which would address issues of greater autonomy for Higher Education Institutions, the accreditation system, rationalization of the Higher Education Institutions system and provision of incentives for their consolidation, and reforming the admission procedures to the third level of education.

12. Advancing Health Sector Reform

1. The GOA adopted the Hospital Optimization Plan for Yerevan with specific targets for capacity reduction.

2. The GOA developed a draft action plan to improve public hospital financial management, accounting, and financial reporting and prepared a package of necessary regulatory amendments.

1. The GOA has: (i) made satisfactory progress in the implementation of the Hospital Optimization Plan for Yerevan; and (ii) adopted, and subsequently demonstrated satisfactory progress in implementation of the medium-term action plan for improving the financial management, accounting and financial reporting for public hospitals satisfactory to the Association.

Reduced capacity in the public health sector by at least 10 percent (estimated through both the number of hospital beds and total occupied space by public hospitals) in 2003, relative to the end-2001 level of 16,000 beds.

Accumulated no new budget arrears in health and fully paid stock of outstanding arrears (arrears of previous years) by July 2003 relative to the 2002 stock of budget

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3. The GOA developed an action plan for clearing the accumulated arrears in the health sector and prevented further arrears in this sector.

4. The GOA adopted a Decision to introduce further reforms in the Basic Benefit Package in the health sector.

2. The GOA has started a pilot for a co-payment mechanism in the health sector.

arrears of ADR 7.3 billion.

Increased the share of government health budget for primary health from 19.1percent in 2001 to more than 30 percent in 2003.

Increased utilization rates in public health by the poor (among families eligible for poverty benefits) from 2001 level of 46.5 percent to at least 50 percent in 2003.

Increased proportion of one-year old children immunized against measles to at least 90 percent in mid-2003 from 2001 level of 85 percent.

13. Deepening Social Protection Reforms

1. The GOA improved targeting of the poverty-benefits.

2. The GOA improved poverty monitoring by introducing a regular household survey.

1. The GOA has developed and adopted a state strategic program for reforming childcare institutions.

2. The GOA has piloted an expansion in community and regional – based social services.

Increased the size of average monthly family poverty benefit by at least 11 percent in the second part of 2003 relative to 2002.

14. Launching Implementation of Pension System Reforms

1. The GOA adopted a new pension law.

2. The GOA established an action plan and launched a pilot for implementation of Personal Identification Numbers (PINs).

3. The GOA moved financing of social pensions from the Social Insurance Fund to the regular budget.

1. The GOA has demonstrated satisfactory progress in implementation of the new Pension Law, including promulgation of implementing regulations, establishing individual pension accounts, and improving enforcement of regulations on pension contributions.

Increased the average monthly old-age pension by at least 20 percent in July 2003 relative to 2002 level of ADR 5,400.

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Annex 2. Project Costs and Financing

Project Cost by Component (in US$ million equivalent)

AppraisalEstimate

Actual/Latest Estimate /a

Percentage of Appraisal /a

Project Cost By Component US$ million US$ millionBOP/Budget Support 40.0 40.0 100%

Total Costs 40.0 40.0 100%

Total Financing Required 40.0 40.0 100%

Project Costs by Procurement Arrangements (Appraisal Estimate)(in US$ million equivalent)

Expenditure Category ICB Procurement

NCB MethodOther /a

N.B.F. Total Cost

1. BOP/Budget Support 40.0 40.0 Total Costs 40.0 40.0 Total Financed by IDA 40.0 40.0/a Or SDR30.2 million.

Project Costs by Procurement Arrangements (Actual/Latest Estimate) (in US$ million equivalent)

Expenditure Category ICB Procurement

NCB Method

Other /bN.B.F. Total Cost

1. BOP/Budget Support 40.0 40.0Total Costs 40.0 40.0Total Financed by IDA 40.0 40.0/b Or SDR 30.2 million.

Project Financing by Component (in US$ million equivalent)Component Appraisal Estimate Actual/Latest

Estimate/aPercentage of Appraisal /a

IDA Govt. CoF. IDA Govt. CoF. IDA Govt. CoF.BOP/Budget Support

40.0 40.0 100%

Total 40.0 40.0 100%

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Annex 3. Economic Costs and Benefits

Not applicable.

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Annex 4. Bank Inputs

(a) Missions:Stage of Project Cycle Performance Rating No. of Persons and Specialty

(e.g. 2 Economists, 1 FMS, etc.)Month/Year Count Specialty

ImplementationProgress

DevelopmentObjective

Identification/PreparationDecember 2001 3 TTL, E S SApril 2002 3 TTL, E S S

Appraisal/NegotiationJanuary 2003 4 TTL, E S S

SupervisionJune 2003 3 TTL, E S SNovember 2003 3 TTL, E S SMay 2004 2 TTL, E S S

ICRNo Mission 2 TTL, E S S

TTL-Task Team Leader, E-Economist.

(b) Staff:

Stage of Project Cycle Actual/Latest EstimateNo. Staff weeks US$ ('000)

Identification/Preparation 46.17 201,789Appraisal/Negotiation 38.50 120,193Supervision 15.42 48,174ICR 4.50 20,596Total 104.59 390,752

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Annex 5. Ratings for Achievement of Objectives/Outputs of Components(H=High, SU=Substantial, M=Modest, N=Negligible, NA=Not Applicable)

RatingMacro policies H SU M N NASector Policies H SU M N NAPhysical H SU M N NAFinancial H SU M N NAInstitutional Development H SU M N NAEnvironmental H SU M N NA

SocialPoverty Reduction H SU M N NAGender H SU M N NAOther (Please specify) H SU M N NA

Private sector development H SU M N NAPublic sector management H SU M N NAOther (Please specify) H SU M N NA

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Annex 6. Ratings of Bank and Borrower Performance

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HU=Highly Unsatisfactory)

6.1 Bank performance Rating

Lending HS S U HUSupervision HS S U HUOverall HS S U HU

6.2 Borrower performance Rating

Preparation HS S U HUGovernment implementation performance HS S U HUImplementation agency performance HS S U HUOverall HS S U HU

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Annex 7. List of Supporting Documents

1. Armenia: Country Assistance Evaluation, OED.

2. Country Assistance Strategy for the Republic of Armenia, April 25, 2001.

3. Development Credit Agreement March 14, 2003.

4. Interim Poverty Reduction Strategy Paper and Joint IDA-IMF Staff Assessment of the IPRSP, April 27, 2001.

5. Program Document For a Proposed Fifth Structural Adjustment Credit in the Amount of SDR 30.2 million (US$40 million equivalent) to the Republic of Armenia, February 12, 2003.

6. Project Status Reports from supervision missions (Project File).

7. World Bank Study “Armenia Growth Challenges and Government Policies,” November 2001.

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