Page  1
Document 
of 
The 
World 
Bank 
FOR 
OFFICIAL 
USE 
ONLY 
Report 
No. 
25430-KOS 
PROGRAM DOCUMENT 
OF 
THE 
INTERNATIONAL 
DEVELOPMENT ASSOCIATION 
TO 
THE EXECUTIVE 
DIRECTORS 
ON 
A 
PROPOSED 
FOURTH 
ECONOMIC 
ASSISTANCE 
GRANT 
IN 
THE 
AMOUNT 
OF 
SDR 
3.7 
MILLION 
(US$5 
MILLION 
EQUIVALENT) 
TO 
UNITED NATIONS 
INTERIM 
ADMINISTRATION MISSION 
IN 
KOSOVO 
FOR 
THE 
BENEFIT 
OF 
KOSOVO 
May 
19,2003 
Poverty 
Reduction 
and 
Economic 
Management 
Unit 
Europe 
and 
Central 
Asia 
Region 
This 
document 
has 
a 
restricted 
distribution 
and 
may 
be 
used 
by 
recipients 
only 
in 
the 
performance 
of 
their 
official 
duties. 
Its 
contents 
may 
not 
otherwise 
be 
disclosed 
without 
World 
Bank 
authorization. 
Page  2
CURRENCY 
EOUIVALENTS 
(as 
of 
April 
30,2003) 
Unit 
of 
currency: 
Euro (EUR) 
1 
EUR=US$l 
.lo3900 
DM 
EAR 
EU 
FRY 
GDP 
GFS 
IBRD 
IDA 
KEK 
KFOR 
LDP 
MESP 
MFE 
MTEF 
MTI 
PA 
PIP 
WEIGHTS 
AND 
MEASURES 
Metric 
System 
FISCAL 
YEAR 
January 
1 
- 
December 
31 
ABBREVIATIONS 
AND 
ACRONYMS 
German 
Marks 
European 
Agency 
for 
Reconstruction 
PISG 
Provisional 
Institutions 
of 
Self-Government 
POE 
Publicly-Owned 
Enterprise 
European 
Union 
PRIP 
Public 
Reconstruction and 
Investment 
Program 
Federal 
Republic 
of 
Yugoslavia 
PSAG 
Private 
Sector 
Advisory Group 
Gross 
Domestic Product 
SAM 
Serbia 
and Montenegro 
Government 
Finance 
Statistics 
SDR 
Special 
Drawing 
Right 
Intemational 
Bank 
for 
Reconstruction and Development 
Intemational 
Development Association 
SME 
Small 
and 
Medium 
Enterprise 
Power 
Corporation 
of 
Kosovo 
SOEs 
Socially-Owned 
Enterprises 
Kosovo 
Force 
SRSG 
Special Representative 
of 
the 
UN 
Secretary-General 
Letter 
of 
Development 
Policy 
TOR 
Terms 
of 
Reference 
Ministry 
of 
Environment and Special 
Planning 
TSS 
Transitional 
Support Strategy 
SFRY 
Socialist 
Federal 
Republic 
of 
Yugoslavia 
Ministry 
of 
Finance and 
Economy 
Medium-Term 
Expenditure Framework 
Ministry 
of 
Trade and 
Industry 
Pristina 
Airport 
Public 
Investment 
Program 
UN 
United 
Nations 
UNMIKUN 
Interim 
Administration 
Mission 
in 
Kosovo 
UR 
UNMIK 
Railways 
VAT 
Value 
Added 
Tax 
Vice 
President: 
Sector 
Director: 
Cheryl 
Gray, 
ECSPE 
Sector 
Manager 
Bemard 
Funck, 
ECSPE 
Marina 
Wes, 
ECSPE 
Johannes 
F. 
Linn, 
ECAVP 
Country Director: 
Orsalia 
Kalantzopoulos, 
ECCU4 
Task 
Team 
Leader: 
This 
operation 
was 
prepared 
by 
a 
Team 
including Marina 
Wes 
(Team Leader), 
Tracey Lane, 
Nand 
Shani (ECSPE), 
Stuart 
Bell 
(ECSPF), 
Shaun 
Moss 
(ECSPS), and Jeanine 
Braithwaite 
(ECSHD). 
Legal, 
disbursement, and 
financial 
management 
support 
were 
provided 
by 
Mark 
Walker 
(LEGEC), 
Joseph 
Formoso 
(LOAG3), 
and 
Hiran 
Herat 
(ECSPF). 
The 
team also 
benefited 
from 
inputs 
of 
Cheryl 
Gray 
and 
Bemard 
Funck, 
the 
Sector 
Director 
and 
Sector 
manager 
respectively, 
as 
well 
as 
from Sidi 
Boubacar 
(Country 
manager) and 
Tim 
Gilbo 
(Country 
Officer). Useful 
guidance 
from 
Christiaan 
Poortman, 
Kyle 
Peters, 
and 
Andras 
Horvai 
was 
highly 
valued 
at 
the 
early 
stage 
of 
the 
Operation’s 
preparation. 
The 
peer 
reviewers 
were 
Linda 
Van 
Gelder 
(SASPR), Steven Symansky 
(IMF), 
and 
Tatiana 
Proskuryakova 
(OPCPG). 
Processing 
assistance 
from 
Nancy Davies-Cole 
and 
Kathryn Rivera 
is 
gratefully 
acknowledged. 
Page  3
FOR 
OFFICIAL, 
USE 
ONLY 
FOURTH 
ECONOMIC 
ASSISTANCE 
GRANT 
TO 
THE UNITED 
NATIONS 
INTERIM 
ADMINISTRATION MISSION 
IN 
KOSOVO 
FOR 
THE 
BENEFIT 
OF 
KOSOVO 
GRANT SUMMARY 
Recipient: 
Amount: 
Terms: 
Objectives: 
Benefits: 
United 
Nations 
Interim 
Administration 
Mission 
in 
Kosovo, 
for 
the 
benefit 
of 
Kosovo. 
SDR 
3.7 
million 
(US$5 
million 
equivalent). 
Grant 
The 
main 
objective 
of 
the proposed 
fourth 
budget 
support 
grant 
is 
to 
assist 
Kosovo 
in 
the 
implementation 
of 
a 
structural 
reform 
agenda 
aimed 
at 
enhancing 
medium-term 
macro-fiscal 
sustainability,  sustaining 
adequate 
public 
service 
delivery 
in 
the 
face 
of 
declining 
donor 
support, 
and 
promoting 
private-sector 
driven 
growth. 
The 
reform 
program 
to 
be 
supported 
by 
the 
proposed 
grant 
works 
to 
achieve these 
objectives 
through 
specific 
reforms 
in 
the 
areas 
of 
budget 
management 
and 
the 
business 
environment. 
In 
the 
area 
of 
budget 
management, 
the proposed 
grant 
would 
support  concrete 
measures 
towards 
improving 
the 
transparency 
and 
accountability 
of 
public 
spending 
and 
the 
allocation 
of 
resources 
in 
line 
with 
medium-term 
priorities. 
In 
the 
area 
of 
private 
sector  development, 
the  grant 
would 
help 
to 
improve 
the 
business 
environment 
by 
making 
further 
progress 
on 
designing 
and 
implementing 
the 
private 
sector 
regulatory 
framework, 
and 
taking 
first 
steps 
to 
improve 
the 
efficiency 
of 
publicly-owned 
enterprises. 
The 
proposed 
grant 
would 
provide 
several 
benefits.  First, 
it 
would 
help 
to 
stabilize 
the 
economy 
by 
promoting 
reforms 
which 
will 
enhance 
medium-term 
fiscal  sustainability 
and 
adequate 
service 
delivery 
in 
the 
face 
of 
declining 
donor 
support. 
Second, 
it 
would 
assist 
the 
authorities 
in 
articulating 
a 
mutually 
reinforcing 
sectoral 
reform 
agenda 
backed 
by 
a 
consistent 
macroeconomic 
framework. 
Policy 
measures 
to 
promote 
private 
sector 
development 
and 
growth 
will 
be 
a 
key 
component 
of 
the 
overall 
reform 
package. 
This 
document 
has 
a 
restricted 
distribution 
and 
may 
be 
used 
by 
recipients 
only 
in 
the 
performance 
of 
their 
official 
duties. 
Its 
contents 
may 
not 
be 
otherwise 
disclosed 
lwithout 
World 
Bank 
authorization. 
Page  4
- 
11 
- 
PRF 
- 
Financial 
Restructuring Program 
(Progrumu 
de 
Reudecuacidn 
Financieru) 
PRSC 
- 
Poverty Reduction 
Support 
Credit 
PRSP 
- 
Poverty 
Reduction 
Strategy 
Paper 
PSAC 
- 
Programmatic Structural Adjustment 
Credit 
SAFCO 
- 
Law 
of 
Government 
Control 
and Management 
SDR 
- 
Special 
Drawing 
Rights 
SIGMA 
- 
Support 
for 
Improvement 
in 
Governance and 
Management 
SIN 
- 
National 
Tax 
Service 
(Sewicio 
de 
Impuestos 
Nucionales) 
TOC 
- 
Community 
Based 
Territories 
(Territorios 
de 
Origen Comuniturio) 
TOR 
- 
Terms 
of 
Reference 
UDF 
- 
Fiscal 
Decentralization 
Unit 
(Unidud 
de 
Descentrulizucidn 
Fiscal) 
UNDP 
- 
United 
Nations 
Development 
Program 
USAID 
- 
United 
States 
Agency 
for 
International 
Development 
VC 
- 
Vigilance 
Committee 
VMMD 
- 
Vice-Ministry 
of 
Municipal 
Development 
Page  5
Risks: 
The 
proposed 
grant 
would 
also 
entail 
risks. 
The 
operation 
tackles 
difficult political 
reforms 
in 
a 
complicated 
institutional 
setting. 
There 
are 
risks 
associated 
with 
the 
implementation 
of 
the 
economic 
reform 
effort 
itself 
that 
largely 
are 
linked to 
weak 
local 
capacity. 
There 
are 
also 
various 
risks 
of 
policy 
implementation. 
Budgetary 
systems 
and 
mechanisms, 
including 
tax administration 
and 
collection, 
are 
still 
at 
a 
formative 
stage. 
Strong 
pressures 
also 
are 
being felt 
to 
raise 
wages, 
maintain 
over-manning 
in 
public 
services 
and 
utilities 
and 
increase 
overall 
spending 
to 
amounts 
that 
would 
not 
be 
sustainable 
in 
the 
medium 
term. 
Continued 
tensions 
in 
relations between 
the 
ethnic 
communities 
of 
Kosovo 
could 
hamper 
the 
emergence 
of 
a 
firm 
foundation 
for 
structural 
reforms. 
There 
is 
considerable 
uncertainty 
about 
growth 
prospects 
and 
the 
macroeconomic 
scenario 
is 
associated 
with 
substantial risks. 
The 
basis 
macroeconomic 
scenario 
for 
a sustained 
rebound 
in 
growth 
and 
living 
standards 
assumes 
(i) 
implementation 
of 
a coherent 
medium-term 
program 
of 
institutional 
strengthening 
and 
reform; 
(ii) 
continued, 
well-targeted donor 
support 
for 
Kosovo; 
and 
(iii) 
a 
relatively 
favorable external 
environment. 
Kosovo 
has 
very 
little 
cushion 
to 
absorb 
the 
consequences 
of 
any 
significant 
downward 
deviation 
in 
one 
or 
more 
of 
these 
areas. 
Continuing 
uncertainty 
regarding 
KOSOVO’S 
final 
status 
will 
also 
inhibit 
badly 
needed 
private 
investment 
and 
constrain growth. 
Schedule 
of 
Disbursements: 
Onemtranche 
Poverty 
Category: 
N/A 
Rate 
of 
Return: 
N/A 
Project 
ID 
Number: 
PO78380 
Page  6
I. 
11. 
111. 
IV. 
INTERNATIONAL 
DEVELOPMENT 
ASSOCIATION 
PROGRAM 
DOCUMENT 
FOR A 
PROPOSED 
ECONOMIC 
ASSISTANCE 
GRANT 
TO 
THE 
UNITED 
NATIONS 
INTERIM 
ADMINISTRATION 
MISSION 
IN 
KOSOVO 
FOR 
THE 
BENEFIT 
OF 
KOSOVO 
TABLE 
OF 
CONTENTS 
BACKGROUND 
.................................................................................................................. 
1 
THE 
ECONOMY 
............................................................................................................... 
.4 
KOSOVO: 
THE 
POLICY 
AGENDA 
AND 
ADJUSTMENT 
PROGRAM 
.................... 
9 
A. 
Public Expenditure Management 
........................................................................ 
11 
B. 
Private 
Sector 
Development 
................................................................................. 
17 
THE 
PROPOSED 
GRANT 
.............................................................................................. 
21 
A. 
Project 
Management 
Issues 
.................................................................................. 
21 
B. 
Coordination 
with 
the 
IMF 
and 
other 
donors 
.................................................... 
22 
C. 
Poverty Implications 
............................................................................................. 
23 
D. 
Benefits 
and 
Risks 
................................................................................................. 
24 
TEXT 
TABLES 
Table 
1 
: 
Medium-Term 
Fiscal 
Financing Requirements 
.............................................. 
7 
Table 
2: 
External 
Financing 
Needs 
and 
Sources, 
2000-2005 
(€ 
millions) 
................... 
8 
Table 
3: 
Key 
Policies 
and 
Reforms 
........................................................................... 
10 
ANNEXES 
Annex 
1 
: 
Annex 
2: 
Annex 
3: 
Annex 
4: 
Annex 
5: 
Annex 
6: 
Key 
Economic 
Indicators 
Status 
of 
Association 
Group 
Operations 
Timetable 
of 
Key 
Processing 
Events 
Letter 
of 
Development Policy 
Policy 
Matrix 
for 
the 
Proposed 
Fourth 
Economic 
Assistance 
Grant 
Kosovo 
at 
a 
Glance 
Page  7
Page  8
INTERNATIONAL 
DEVELOPMENT 
ASSOCIATION 
PROGRAM 
DOCUMENT 
FOR 
A 
PROPOSED 
FOURTH ECONOMIC 
ASSISTANCE 
GRANT 
TO 
THE 
UNITED 
NATIONS 
INTERIM 
ADMINISTRATION MISSION 
IN 
KOSOVO 
FOR 
THE 
BENEFIT 
OF 
KOSOVO 
1. 
This 
document  constitutes  the 
Program 
Document 
on 
a  proposed 
Fourth 
Economic 
Assistance 
Grant 
to 
the 
United 
Nations 
Interim 
Administration 
Mission 
in 
Kosovo' 
(UNMIK) 
for 
the 
benefit 
of 
Kosovo 
of 
SDR 
3.7 
million 
(US$5 
million 
equivalent) 
to 
support 
key 
policies 
promoting 
fiscal 
sustainability 
and 
the 
improvement 
of 
the 
business 
environment. 
This 
Program 
Document 
should 
be 
read 
in 
conjunction 
with 
the 
Transitional 
Support Strategy 
(TSS) 
of 
the 
World 
Bank 
Group 
for Kosovo 
(IDA/R2002-0132,  discussed 
at 
the 
Board 
on 
July 
25,2002). 
I. 
BACKGROUND 
2. 
Since 
the 
end 
of 
the 
conflict 
in 
June 1999, 
there 
has 
been 
considerable progress 
on 
all 
fronts 
towards 
peace 
and 
economic 
recovery 
in 
Kosovo. 
On 
the 
basis 
of 
the 
UN 
Security 
Council 
Resolution 
1244, 
the 
Secretary General established 
UNMIK 
as 
the 
transitional administration 
of 
Kosovo, 
to 
be 
replaced over 
time 
with 
self-governing 
local 
institutions. 
When 
UNMIK 
arrived 
in 
Kosovo 
in 
mid-1 
999, 
it 
faced 
the 
massive task 
of 
reconstruction 
in 
a 
post-conflict 
environment, 
restarting 
the 
basic 
institutions 
of 
government  and economic 
activity, 
as 
well 
as 
overseeing 
the 
rapid 
return 
of 
the 
nearly 
1.3 
million 
refugees 
and 
internally 
displaced 
persons. 
3. 
The 
combination 
of 
sound economic 
policies, 
institution 
building 
and 
large-scale 
donor 
assistance  has 
yielded 
impressive 
results 
in 
Kosovo 
over 
the 
past 
four 
years. 
KOSOVO~S 
reconstruction 
has 
proceeded 
well, 
due 
to 
the 
initiatives 
of 
the 
population 
and 
the 
speedy 
commitment 
of 
donor 
support. Since 
1999, 
donor commitments 
in 
the 
order 
of 
€ 
2.5 
billion 
have 
been 
made, 
of 
which 
about 
€2 
billion 
was 
disbursed 
by 
end-2002, 
well 
in 
line 
with 
the 
requirements 
of 
the 
medium-term 
Reconstruction 
and 
Recovery 
Program 
of 
November 
1 
999.2 
Economic 
growth 
has 
been 
strong, 
driven 
by 
reconstruction 
spending, 
private 
transfers 
from 
Kosovars 
living 
abroad, 
and 
the 
presence 
of 
some 
50,000 
expatriates 
in 
Kosovo. 
According 
to 
recent 
estimates, 
current 
GDP per 
capita 
is 
about 
twice 
as 
high 
as 
- 
the 
officially 
recorded 
level 
- 
in 
the 
mid- 
1990s. 
4. 
Kosovo 
has 
been 
gradually 
progressing towards self-government. 
Following 
the adoption 
of 
the 
Constitutional Framework 
in 
May 
2001 
and 
the 
Kosovo-wide 
elections 
in 
November 
2001, 
responsibility 
for 
administering 
the 
territory 
is 
now 
shared 
between 
UNMIK 
and 
a 
provisional 
Kosovar 
Government. 
While 
the 
Provisional  Institutions 
of 
Self 
Government  (PISG) 
have 
significant responsibility 
in 
governing 
Kosovo, 
the 
Special 
Representative 
of 
the 
UN 
Secretary 
' 
Kosovo, 
Serbia 
and 
Montenegro;  hereinafter 
Kosovo. 
On 
February 
4, 
2003, 
the 
official 
name 
of 
what 
was 
formerly 
the 
Federal Republic 
of 
Yugoslavia 
(FRY) 
changed 
to 
Serbia 
and 
Montenegro 
(SAM). 
In 
this 
document, 
all 
references 
to 
SAM 
whch 
predate 
the 
change 
of 
name 
should 
be 
understood 
to 
refer 
to 
FRY. 
This 
program 
was 
prepared 
by 
the 
European Commission and 
the 
World 
B 
ank 
in 
support 
oft 
he 
United 
Nations 
Mission 
in 
Kosovo. 
It 
outlined 
a 
recovery 
strategy, 
set 
overall 
goals 
and priorities, and 
provided 
an 
estimate 
of 
donor 
funding 
requirements 
for 
1999-2002. 
Page  9
2 
General 
(SRSG) 
retains the 
power 
to 
ensure 
security 
(in 
coordination 
with 
KFOR), 
exercise 
a 
number 
of 
specific 
reserve 
powers, 
and 
set 
the 
broad 
parameters 
of 
fiscal 
policy. 
5. 
The 
setting 
in 
Kosovo 
remains 
unique 
and 
complex 
in 
a 
number 
of 
ways: 
0 
The 
governance structure 
required 
to 
implement 
power 
sharing 
between 
UNMIK 
and 
the 
PISG 
is 
highly 
intricate 
and 
fluid. 
There 
is 
uncertainty 
as 
to 
the 
precise 
interim 
institutional 
arrangements 
between 
UNMIK 
and 
the 
PISG. 
In 
addition, 
the 
approval 
of 
any 
legislation 
entails 
a 
lengthy 
pro~ess.~ 
More 
generally, 
the 
political 
circumstances 
affecting 
Kosovo 
and 
the 
Balkan region 
also 
remain 
complex, 
and 
there 
has 
been 
no 
significant 
progress 
towards  a 
resolution 
of 
KOSOVO~S 
final 
status. 
UNMIK 
is 
still 
facing significant 
difficulties 
in 
asserting 
its 
authority 
in 
the 
mainly 
Serbian 
populated 
northern 
part 
of 
Kosovo. 
The 
legacy 
of 
destruction related 
to 
the 
conflict, 
the 
withdrawal 
of 
Kosovar 
Serbs 
from 
public 
administration 
after 
1999, 
and  a 
decade 
of 
absence 
of 
Kosovar 
Albanians 
from 
the 
management 
of 
public 
institutions 
has 
hampered 
local 
capacity 
building. 
Local 
capacity 
is 
very 
limited, 
and 
key 
positions, 
including 
at some 
of 
the 
ministries 
transferred 
to 
the 
PISG, 
remain 
occupied 
by 
internationals. 
The 
transition 
towards  a 
market 
economy 
in 
Kosovo only 
started 
in 
1999, 
and 
market-oriented 
legislation 
and 
behaviors 
are 
still 
developing. 
There 
remains  an 
overwhelming 
nostalgia 
for 
1989, 
the 
last 
year 
in 
which 
Kosovo 
was 
an 
autonomous 
republic, 
and 
the 
view 
remains 
among 
some 
that govemment institutions, 
utilities 
and 
enterprises 
ought 
to 
be 
restored 
to 
what they 
were 
in 
that 
year. 
Infrastructure remains 
dilapidated, 
following 
the 
1999 
conflict 
and 
a 
more 
general 
neglect 
of 
operations 
and 
maintenance 
spending 
during 
the 
1990s. 
0 
0 
0 
0 
6. 
Rationale 
for 
ZDA 
involvement. 
Following 
the 
conflict, 
a 
Transitional 
Support  Strategy 
(TSS) 
was 
presented 
to 
the 
IDA 
Board 
of 
Executive Directors 
on 
October 
7, 
1999 (R99-178). 
The 
TSS proposed 
an 
assistance 
strategy 
to 
support 
post-conflict reconstruction 
and 
economic 
recovery 
as 
part 
of 
a 
broader 
international 
effort, 
as 
well 
as 
the 
establishment 
of 
the 
Trust 
Fund 
for 
Kosovo, 
with 
two 
allocations 
totaling US$60 
million 
from 
IBRD’s 
net 
income. 
The 
TSS Progress 
Report 
of 
June 
27, 
2000 
(R2000-130) 
took 
stock 
of 
the 
initial 
implementation 
of 
this 
strategy 
and 
set 
out 
an 
assistance 
program 
for 
the October 
2000-September 
2001 
period, 
making 
the 
case 
for 
the 
second 
tranche 
of 
the 
net 
income 
all~cation.~ 
A 
second TSS 
for Kosovo 
was considered 
by 
the 
IDA 
Board 
on 
July 
2, 
2002, 
which 
outlined 
a 
US$15 
million 
program 
of 
targeted 
adjustment 
and 
investment 
operations 
in 
Kosovo 
funded 
by 
IDA 
grants. 
This 
TSS 
program 
is 
designed 
to 
focus 
the 
Association’s 
involvement 
in 
Kosovo 
in 
particular 
on 
strengthening 
the 
capacity 
of 
the 
developing 
local 
government 
institutions, 
building 
on 
the 
broad 
based 
reconstruction 
support 
provided 
under 
the 
first 
TSS. 
The 
recent 
establishment 
of 
a 
Transfer 
Council 
was designed 
to 
speed 
up 
the 
pace 
of 
the 
transfer 
of 
power 
from 
UNMIK 
to 
the 
PISG. 
The 
two 
tranches were: 
US$25 
million 
and 
US$35 
million, 
respectively. 
The 
Trust 
Fund 
for 
Kosovo 
has generated 
some 
US$2.8 
million 
in 
investment income, 
which 
has 
also 
been 
committed 
for 
projects. 
Page  10
3 
7. 
The 
proposed Operation 
would 
be 
financed 
within 
the 
IDA 
grant envelope 
presented 
in 
the 
second 
TSS, 
under 
the 
category 
of 
post-conflict 
grants. 
Kosovo 
remains a 
post-conflict 
territory, 
within 
a 
member 
country, 
and 
under 
UN 
administration 
on 
an 
interim 
basis. 
Following 
the 
dramatic 
change 
in 
Government 
in 
Belgrade 
in 
the 
fall 
of 
2000, 
Serbia 
and 
Montenegro 
(SAM) 
became 
a 
member 
of 
the 
Association 
in 
May 
2001. 
However, 
there 
continues 
to 
be 
no 
progress 
in 
reaching 
agreement 
on 
KOSOVO’S 
final 
status. 
The 
nature 
and 
timing 
o 
fa 
p 
olitical 
settlement 
i 
s 
unclear, 
and 
a 
separate assistance 
program 
for 
Kosovo 
remains 
necessary. 
Kosovo 
thus 
continues 
to 
be 
a 
special 
case 
when 
it 
comes 
to 
the 
provision 
of 
Bank 
assistance; 
under 
the 
current 
circumstances 
the 
use 
of 
regular 
resources, 
either 
in 
the 
form 
of 
direct 
lending 
to 
Kosovo 
or 
through 
SAM, 
is 
not 
feasible. 
Continued 
Bank 
support 
to 
Kosovo 
is 
important 
because 
it 
contributes 
to 
peace 
and 
stability, 
and 
thus 
economic development 
in 
the 
Balkans. 
8. 
As 
was 
the 
case 
of 
the 
previous 
economic 
assistance 
grants, 
the proposed 
fourth 
Economic 
Assistance 
Grant 
(EAG 
IV) 
facilitates 
World 
Bank 
engagement 
in 
the 
policy 
dialogue 
with 
UNMIK, 
the 
PISG 
and 
other 
donors. 
The current 
grant 
will 
help 
to 
ensure 
sustainable 
and 
adequate 
public 
service 
delivery 
through 
the 
Kosovo 
general budget 
and 
will 
support 
key 
reforms 
aimed 
at 
improving 
KOSOVO’S 
macro-fiscal 
sustainability 
and 
promoting private 
sector development, 
as 
have 
the 
previous 
three 
Economic 
Assistance Grants 
the 
Bank 
has 
extended 
to 
Kosovo. 
The 
first 
two 
grants supported 
the 
establishment 
of 
a 
fiscal 
system 
and 
helped 
to 
provide 
basic 
services 
in 
a post- 
conflict 
setting. 
Most 
notably, 
they 
supported 
the 
creation 
of 
a budget 
management 
system, 
with 
modern 
standards 
of 
public 
expenditure management and transparent 
fiscal 
operations. The 
first 
two 
grants 
have 
also 
played 
an 
important 
role 
in 
assisting 
the 
authorities 
in 
the 
design 
and 
implementation 
of 
a 
hnctioning 
tax 
and 
tariff 
system 
minimizing 
distortions. The 
main 
objective 
of 
the 
third 
grant 
was 
to 
support 
Kosovo’s 
private 
sector 
development 
program 
by 
supporting 
the 
enactment 
of 
four 
key 
commercial 
regulations, 
on 
(i) 
business 
organizations; 
(ii) 
the 
contract 
for 
sale 
of 
goods; 
(iii) 
pledges; 
and 
(iv) 
foreign 
investment. 
9. 
Rationale 
of 
Operation. 
This 
one-tranche 
operation 
builds 
on 
the Authorities” 
recent 
track 
record 
on 
reforms. 
Based 
in 
part 
on 
progress 
under 
the 
previous 
three 
operations, 
the 
package 
of 
measures 
which 
the 
EAG 
IV 
supports 
aim 
to 
achieve 
two 
broad 
objectives 
- 
sustaining 
adequate 
public 
spending 
in 
the 
face 
of 
declining 
donor 
support 
and 
supporting 
private 
sector 
development. 
The 
program, 
which 
builds 
on 
the 
agenda 
outlined 
in 
the 
Association  Report 
Kosovo, 
FRY: 
Medium-Term 
Public 
Expenditure 
Priorities 
(Report 
No. 
24880-KOS, 
October 
2002), 
is 
described 
in 
the 
attached 
Letter 
of 
Development 
Policy 
(Annex 
4) 
and 
Policy 
Action Matrix 
(Annex 
5). 
In 
the 
current 
Kosovar 
context, 
these 
specific 
measures 
support 
narrow, 
yet 
critically 
important 
objectives. 
A 
lthough 
the 
Bank’s 
available 
resources 
to 
back reforms 
with 
the 
required 
technical 
assistance are 
highly 
limited, 
the 
Bank 
continues 
to play 
an 
important 
role 
in 
assessing 
technical 
assistance 
n 
eeds, 
and 
in 
p 
roviding 
s 
ignals 
t 
o 
d 
onors. 
S 
pecific 
efforts have 
been made 
to 
ensure 
sufficient 
TA 
is 
available 
in 
the 
reform 
areas 
supported 
by 
the 
proposed Operation 
(see 
Section 
IV.B). 
Given 
the power-sharing 
arrangements 
currently 
in 
place 
in 
Kosovo, 
the 
‘Authorities’ 
refers 
to 
both 
UNMIK 
and 
PISG 
structures, 
with 
each 
having responsibility 
in 
those 
areas 
delineated 
by 
the 
Constitutional 
Framework. 
Page  11
4 
11. 
THE 
ECONOMY 
10. 
Kosovo 
was 
traditionally 
the 
poorest 
part 
of 
the 
former  Socialist  Federal 
Republic 
of 
Yugoslavia 
(SFRY). 
In 
1988-the 
last 
full 
year 
of 
autonomy 
under 
the 
SFRY 
constitution- 
recorded output 
per 
head 
was 
28 percent 
of 
the 
SFRY 
average. 
Over 
the 
succeeding 
six 
years, 
GDP 
contracted 
by 
50 
percent, 
falling to 
less 
than 
US$400 
per 
head 
by 
1995, 
according 
to official 
statistics. 
This 
was  correlated 
with 
massive  neglect 
of 
industry, 
mining 
and 
infrastructure 
in 
Kosovo 
during 
the 
nineties. 
1 
1. 
The 
deteriorating 
economic 
conditions 
of 
the 
1990s 
were 
significantly 
accelerated 
during 
the 
crisis 
of 
the 
late-l990s, 
which 
culminated 
in 
the 
conflict 
of 
1999. 
Industrial 
output 
collapsed. 
Agricultural 
production, 
upon 
which 
a 
majority 
of 
the 
Kosovar population 
depended, 
plummeted; 
livestock 
herds 
were 
lost 
or 
killed; 
and, 
a 
planting 
season 
was 
missed. 
Moreover, 
virtually 
all 
social 
services and government 
systems 
were 
brought 
to 
a complete 
standstill. 
There was also 
significant 
damage 
to 
infrastructure, especially 
the 
stock 
of 
private 
housing. 
12. 
The 
dearth 
of 
economic  statistics makes 
it 
difficult 
to 
assess 
the 
state 
of 
the 
economy. 
Preliminary 
estimates 
suggest 
that 
GDP 
in 
2002 
reached 
around 
€2 
billion 
equivalent 
to 
around 
$1000 
per 
capita. 
Following 
double-digit 
growth 
rates 
in 
2000 
and 
2001, 
estimates show that 
real 
GDP 
growth 
has 
fallen 
to 
less 
than 
5 
percent 
in 
2003. 
It 
continues 
to 
be 
driven 
by 
reconstruction 
spending, 
private 
transfers 
from 
K 
osovars 
1 
iving 
a 
broad, 
and 
the 
presence 
of 
a 
large 
number 
of 
expatriates 
in 
Kosovo. 
According 
to 
IMF 
estimates, 
as 
a 
first 
approximation, 
official 
transfers 
and 
the 
local 
spending 
of 
expatriates together 
generate 
currently 
about 
one-fourth 
of 
value 
added 
in 
the 
economy. 
This 
not only 
creates 
distortions 
- 
mainly 
an 
expansion 
of 
the 
public 
sector 
at 
the 
expense 
of 
the 
private 
sector 
and 
of 
services 
at 
the 
expense 
of 
traded goods 
- 
but 
also 
makes 
the 
economy especially 
sensitive 
to 
cutbacks 
in 
donor 
support. 
13. 
Indicators 
of 
disposable 
income 
and 
consumption 
suggest 
a 
strong 
recovery 
of 
aggregate 
demand 
since 
1999. 
In 
2002, 
consumption and 
investment 
combined were almost 
twice 
as 
high 
as 
2002 GDP, 
reflecting 
the 
magnitude 
of 
foreign 
assistance, 
largely 
spent 
on 
imports. 
Furthermore, 
with 
remittances 
over 
the 
past 
three 
years 
estimated at 
some 
25-30 
percent 
of 
GDP 
annually, 
national 
income 
i 
s s 
ignificantly 
higher 
than 
GDP. 
Due 
to 
massive 
official 
and 
private 
transfers, 
imports 
of 
goods 
and 
non-factor 
services 
are 
estimated 
to 
have 
reached 
around 100 
percent 
of 
GDP 
in 
2002, 
albeit 
down 
from 
145 
percent 
in 
2000. 
These 
large 
official 
and 
private 
transfers 
have 
helped 
to 
cover 
the 
trade 
deficit, 
and 
thus 
generate 
a 
roughly 
balanced 
current 
account.6 
14. 
Kosovo 
has 
also 
made 
impressive 
progress 
in 
macroeconomic 
stabilization. 
Following 
the 
adoption 
of 
the 
German 
Mark 
in 
1999, 
prices 
are 
estimated 
to 
have 
grown 
at 
an 
average 
rate 
of 
2-3 
percentage 
points 
per 
quarter 
in 
2000 
and 
2001, 
reflecting 
the 
gradual 
removal 
of 
exemptions 
from 
sales 
tax, 
VAT 
and 
customs 
duties. 
Kosovo 
successfully 
converted 
to 
the 
use 
of 
the 
euro 
in 
early 
2002, 
and 
inflation 
has 
now 
declined 
to 
less 
than 
5 
percent 
per 
year. 
While 
the 
adoption 
of 
a 
hard 
currency 
has 
been 
critical 
in 
helping 
to 
establish macroeconomic 
stability, 
it 
is 
also 
placing 
a 
relatively 
heavy 
burden 
on 
fiscal 
policy. 
Transfers associated 
with 
the 
activities 
of 
the 
Kosovo 
Force 
(KFOR) 
are 
not 
included 
in 
any 
of 
these 
figures. 
Page  12
5 
15. 
Despite 
the 
impressive economic 
recovery, 
poverty 
is 
still 
widespread, 
with 
survey results 
suggesting 
that 
over 
half 
of 
the 
population 
was 
poor 
in 
late 
2000.7 
Moreover, 
this 
analysis also 
found 
that 
about 
12 
percent 
of 
the 
population 
lived 
in 
extreme 
poverty, 
Le. 
had insufficient income 
to 
afford 
food 
consumption 
above the 
minimum 
daily 
caloric 
requirements.  Furthermore,  there 
remain 
also 
significant problems 
in 
education and 
health. 
In 
education, 
striking 
inequalities 
exist 
across 
income, 
ethnic 
groups 
and 
gender. 
Problems 
are 
especially 
apparent 
at 
the 
secondary 
school 
level, 
where 
only 
one-half 
of 
Albanian 
girls 
between the 
ages 
of 
15-18 
were 
enrolled 
in 
school 
in 
end-2000. 
Enrolment 
is 
even 
lower 
for 
the 
non-Albanian, 
non-Serb 
children'. 
The 
limited 
health 
data 
suggest 
that 
Kosovo 
ranks 
the 
lowest 
in 
Europe 
on 
virtually 
every health 
indicator. 
Infant 
mortality, maternal health 
and 
immunization 
coverage are 
areas 
of 
particular 
concern. 
16. 
UNMIK 
and 
the 
Kosovars 
have 
made good 
progress 
in 
putting 
in 
place  the  enabling 
environment 
for 
a 
market 
economy. 
This 
effort 
was 
assisted 
by 
the implementation 
of 
a 
massive 
donor 
assistance 
program, 
which 
started 
in 
1999, 
and 
which 
helped 
set 
the 
stage 
for 
economic 
reconstruction 
and 
recovery. 
These 
broad-ranging 
and 
coordinated 
efforts have been 
implemented 
on 
a 
fast 
track 
to 
help 
Kosovo 
make 
up 
for 
lost 
time. 
Key 
achievements 
in 
the 
sphere 
of 
economic 
policy 
include: 
e 
Fiscal policy. 
The 
institutional 
framework 
for 
fiscal 
policy 
has 
been 
established 
and 
the budget 
is 
increasingly financed 
through 
local 
taxation. 
e 
Private 
sector 
development. 
A 
reformed framework 
for 
encouraging the 
growth 
of 
private, 
small 
and 
medium 
enterprises 
and 
the  transfer 
of 
viable 
existing 
public 
enterprises 
into 
private 
hands 
has 
been 
created. 
e 
Banking 
reform. 
An 
institutional 
and 
regulatory 
framework 
for 
banking 
in 
line 
with 
international 
standards 
has 
been 
established. 
e 
Social 
reform. 
Basic 
social 
assistance 
and 
pension 
schemes 
have 
been 
put 
in 
place. 
e 
Health 
and 
education. 
Health 
and 
education 
services 
have 
been 
restarted; 
education 
enrolment 
is 
significantly higher 
than 
it 
was 
in 
the pre-conflict 
parallel 
system. 
17. 
Medium-Term 
Prospects 
and 
Financing 
Requirements. 
If 
the 
authorities 
make 
continued 
progress 
on 
the 
structural 
reform 
agenda, 
economic 
prospects 
are 
good 
in 
the 
medium 
term. 
Real 
GDP 
could 
be 
expected 
to 
grow 
by 
an 
average 
of 
around 
5 
percent 
in 
the 
period 
2003-05. 
The 
two 
major 
sources 
of 
growth 
in 
Kosovo 
today 
are 
aid-related 
activities 
(primarily 
government 
and 
other 
services) 
and 
other domestic activities 
(notably 
agriculture,  construction, 
light 
industry, 
and 
trade). 
The 
base 
scenario 
outlined 
below 
assumes 
that 
the 
share 
of 
the 
latter 
will 
increase 
gradually 
over 
~ 
Recent 
findings 
based 
on 
Household 
Budget 
Survey 
data 
from 
June-November 
2002 
of 
a 
sample 
of 
1200 
households 
suggest 
that 
there 
has 
been 
very 
little 
change 
in 
the 
poverty 
profile 
since 
late-2000. 
This 
Survey 
is 
being 
conducted 
by 
the 
Statistical 
Office 
of 
Kosovo, 
with 
Technical 
Assistance 
from 
the 
World 
Bank. 
* 
This 
category 
comprises 
a 
variety 
of 
peoples, 
often 
very 
different 
in 
their 
characteristics, 
ranging 
from 
Muslim 
Slav 
(including 
Bosniac 
and Gorani) 
to 
Roma, 
and 
including 
Turk, 
Croat and Montenegrin. 
Page  13
6 
time, 
driven 
by 
successful 
and 
deep 
reforms. 
However, 
this 
base 
scenario 
is 
associated 
with 
very 
significant 
risks 
(see 
para. 
26). 
18. 
In 
the near 
term 
the 
contribution 
of 
domestic 
activities 
may 
not 
be 
sufficient 
to 
offset 
the 
impact 
of 
the decline 
in 
aid, 
as 
official 
transfers 
are 
expected 
to fall from 
over 
50 
percent 
of 
GDP 
in 
2002, 
to 
23 
percent 
by 
2004. 
This 
is 
expected 
to 
cause 
a 
slowdown 
in 
growth 
to 
4-4.5 
percent. 
Performance 
in 
later years 
w 
ould 
d 
epend c 
rucially 
o 
n 
the 
success 
o 
f 
s 
tructural reforms, 
n 
amely 
setting 
up 
effective 
economic institutions, 
repairing 
the 
infrastructure, 
and 
creating 
an 
environment 
conducive 
to 
productive private 
sector 
investment. 
These 
reforms 
will 
be 
critical 
in 
bringing 
about 
a sustainable 
supply 
response, 
and 
stimulating private 
sector 
development 
and 
export 
performance. 
Inflation 
is 
projected 
to 
decrease 
from 
more 
than 
10 
percent 
in 
2001 
to 
3 
percent 
by 
2005. 
Low 
inflation 
will 
be 
supported 
by 
the 
continued 
use 
of 
the 
euro, 
prudent 
fiscal policy, 
and 
the gradual 
reduction 
of 
aid 
flows 
and 
the 
international 
presence 
in 
Kosovo. 
19. 
Local 
revenues 
will 
finance 
an 
increasing 
share 
of 
fiscal 
expenditures. 
Continued efforts 
to 
strengthen 
tax 
administration 
and broaden 
the 
tax 
base are 
expected 
to 
further 
increase 
the 
ratio 
of 
locally 
generated  revenues 
to 
KOSOVO’S 
GDP. 
However, 
as 
most 
measures 
to 
achieve 
large 
increases 
in 
such 
revenues 
have 
already 
been 
implemented,  the 
potential 
for 
further 
increases 
will 
be 
more 
limited. 
Estimates 
suggest 
that 
this 
ratio 
will 
be 
increased 
to 
22 
percent 
of 
GDP 
by 
2005, 
up 
from 
9 
percent 
in 
2000. 
20. 
Total 
public 
spending 
in 
Kosovo 
has 
been 
in 
excess 
of 
50 
percent 
of 
GDP 
in 
both 
2000 
and 
2001. 
Around 
75 
percent 
of 
this 
spending 
has 
been donor-financed, 
with 
the 
remainder covered 
by 
locally 
generated revenues. 
Most 
donor 
funds 
have 
financed 
capital 
projects 
in 
the context 
of 
the 
Public 
Investment 
Program 
(PIP). 
As 
KOSOVO~S 
immediate 
reconstruction 
effort 
is 
phasing 
down, 
investment 
- 
and 
public 
spending 
- 
needs  are 
declining.  However, 
Kosovo 
is 
also 
facing the 
challenges 
of 
development 
and 
transition 
to 
a 
market 
economy, 
a 
challenge 
complicated 
by 
particularly 
pronounced 
underinvestment 
during 
the 
nineties. 
2 
1. 
Investment 
levels, 
declining 
from 
68 percent 
of 
GDP 
in 
2000 
to 
around 
23 
percent 
by 
2005, 
are 
n 
eeded 
t 
o 
m 
eet 
remaining 
p 
ost-conflict 
and 
transition 
n 
eeds, 
t 
o 
m 
ake 
up 
for 
the 
backlog 
of 
maintenance, 
and 
underpin 
the 
5 
percent 
growth 
scenario. 
Given 
the 
large 
remaining 
investment 
needs 
and 
the 
relative 
paucity 
of 
private 
investment, 
exacerbated 
b 
y 
c 
ontinued 
uncertainty 
o 
ver 
KOSOVO~S 
final 
status, 
public 
investment 
needs  are 
forecast 
to 
remain 
higher 
than 
in 
other 
economies 
in 
the 
region, 
equivalent 
to 
around 
10 
percent 
of 
GDP 
by 
2005. 
22. 
Estimating 
the 
economy’s 
public 
investment 
requirements 
and 
the  appropriate 
level 
of 
recurrent  spending 
against 
international 
comparators,  suggests 
that 
a 
spending 
to 
GDP 
level 
of 
roughly  30 
percent 
would 
be 
necessary 
in 
the 
medium 
term 
to 
underpin 
the 
growth 
scenario 
outlined 
above. 
A 
ratio 
of 
recurrent 
spending 
to 
GDP 
around 
20 
percent 
would 
appear 
appropriate 
by 
2005. 
Over 
the 
medium 
term 
recurrent 
budget 
spending 
should 
stay 
relatively 
lower 
in 
Kosovo 
than 
in 
other 
regional 
and 
European 
economies. 
In 
the 
presence 
of 
KFOR 
and 
UNMIK, 
a 
number 
of 
functions  that 
normally 
require 
budget 
financing 
are 
covered 
by 
alternative 
funding 
sources. 
As 
KFOR 
and 
UNMIK 
withdraw,  further  non-discretionary  recurrent 
cost 
items 
will 
have 
to 
be 
absorbed 
by 
the 
budget, 
driving 
the 
spending 
to 
GDP 
ratio 
up 
at 
that 
stage. 
Further 
spending 
pressure 
may 
also 
emerge 
from 
debt 
service 
payments. 
Page  14
7 
23. 
Financing 
needs. 
Donor 
assistance 
will 
remain 
crucial 
for 
achieving 
sustainable 
public 
finances 
in 
Kosovo. 
The 
fiscal financing 
gap 
will 
decline 
but 
remain 
large 
as 
additional 
revenues 
will 
remain insufficient 
to 
cover 
all 
of 
Kosovo’s 
fiscal 
expenditure 
needs 
over 
the 
2003-05 
period. 
(Table 
1) 
As 
Kosovo 
currently 
has 
no 
access 
to 
external 
borrowing, 
and 
has 
little 
if 
any 
ability 
to 
borrow 
domestically, 
the 
resulting 
financing 
gap 
will 
need 
to 
be 
covered 
by 
donors. 
At 
a 
donor 
meeting 
in 
Brussels 
in 
November 
2002, 
a 
remaining 
financing 
gap 
of 
€500 
million 
of 
new 
donor 
commitments over 
the three-year 
period 
2003-05 
was 
presented, 
of 
which 
about 
€50 
million 
were 
for 
general 
budgetary 
support. 
Although locally 
generated 
revenues 
will 
roughly 
be 
able 
to 
cover 
recurrent 
costs, 
increased 
capital 
expenditure 
will 
need 
to 
be 
absorbed 
by 
the 
general budget. 
Table 
1: 
Medium-Term 
Fiscal 
Financing 
Requirements 
(€ 
millions) 
I/ 
2000 
(act) 
2001 
(act.) 
2002 
(proj.) 
2003 
(proj.) 
2004 
(proj.) 
2005 
(proj.) 
2003-2005 
Central Government 
(CG) 
Domestic 
revenues 
127 
298 
405 
448 
483 
525 
CG 
expenditure 
2/ 
220 
276 
527 
473 
498 
535 
CG Budget 
Balance 
-93 
22 
-1 
22 
-25 
-1 5 
-10 
CG financing 
needs 
25 
15 
10 
50 
Public 
Investment Program 
(PIP) 
Already 
identified 
financing 
PIP 
expenditure 
PIP balance 
PIP 
disb. from 
new 
commitments 
628 
551 
41 
1 
220 
130 
90 
41 
1 
280 
220 
200 
0 
-60 
-90 
-110 
0 
60 
90 
110 
260 
TOTAL financing 
needs 
85 
105 
120 
31 
0 
Total New 
Donor Commitments, 
2003-2005 
PIP 
new commitments 
CG Budget 
Support 
200 
165 
135 
500 
175 
150 
125 
450 
25 
15 
10 
50 
Note: 
This implies 
new 
commitments 
of 
about 
€500 
million 
over the 
2003-2005 
period, 
including 
€50 
million 
for 
budgetary 
support. 
New 
PIP commitments decline from 
€175 
million 
in 
2003 
to 
€125 
million 
in 
2005. 
I/ 
Data 
were presented 
at 
the November 
2002 
Kosovo Donor 
Meeting. 
No update is 
available 
as 
of 
mid-May 
2003. 
21 
Policy adjustments will still be required to bring currently 
proposed 
spending patterns 
to 
this level 
of 
spending. 
Source: IMF, 
MFE, 
World Bank 
Staff Estimates. 
24. 
Going 
forward, 
KOSOVO’S 
external 
financing 
requirements 
will 
be 
significantly 
lower 
than 
in 
the 
1999-2002 
period. 
As 
Kosovo 
holds 
no official 
foreign 
exchange 
reserves 
and 
will 
have 
very 
limited 
inflows 
of 
equity 
and 
debt 
capital, 
its 
current account 
deficit 
will 
by 
definition 
be 
close 
to 
balance. 
Given 
KOSOVO’S 
reliance 
on 
donor 
grant  financing, 
a 
reasonable 
indicator 
of 
its 
total 
financing 
needs 
is 
its 
current account balance 
net 
of 
official 
transfers. 
There 
is 
a 
rapid 
reduction 
of 
these 
financing 
needs 
from 
2001 
to 
2005, 
primarily 
reflecting 
the 
winding 
down 
of 
the 
main 
emergency 
reconstruction 
phase. 
Donor-financed 
spending 
on 
the 
Public 
Investment 
Program 
has 
Page  15
8 
declined 
from 
€628 
million 
in 
2000 
to 
€220 
million 
in 
2003. 
Remittances 
as 
a 
share 
of 
GDP 
are 
forecast 
to 
decline 
slightly 
o 
ver 
the 
m 
edium-term, 
b 
ut 
e quivalent 
t 
o 
an 
e 
stimated 
1 
7 
p 
ercent 
o 
f 
GDP 
by 
2005, 
they 
will 
continue 
to 
have 
a 
considerable 
impact 
on 
the 
Kosovo 
economy. 
25. 
With 
extemal 
aid 
financing projected to 
decline 
rapidly 
over 
the 
coming 
years, 
imports 
are 
forecast 
to 
decrease 
from 
145 
percent 
of 
GDP 
in 
2002 
to 
around 
45 
percent 
of 
GDP 
by 
2005 
(see 
Table 
2). 
This 
decline 
will 
test 
the 
sustainability 
of 
Kosovo’s  economic recovery. 
Exports 
will 
also 
decrease 
slightly 
over 
the 
forecasting period, 
driven 
by 
lower 
exports 
of 
services 
reflecting 
the 
declining 
presence 
of 
internationals. 
However, 
exports 
of 
goods  are 
expected 
to 
increase 
as 
structural 
reform 
leads 
to 
increased economic 
activity 
and 
productivity 
in 
Kosovo. 
Such 
an 
increase 
in 
exports 
will 
be 
pivotal 
in 
stimulating 
growth 
and 
creating the 
basis 
for 
a 
sustainable 
supply 
response. 
It 
will 
also 
require 
further 
and 
deeper 
structural 
reforms, 
as 
discussed 
in 
Section 
III, 
Table 
2: 
Kosovo: 
External Financing Needs 
and Sources, 
2000-2005 
(6 
millions) 
I/ 
Net exports of goods and services 
2l 
Factor income from donor-related employment 
Workers remittances 
Ofticial grants 
Current account balance 
(including 
grants) 
Current account balance 
(excluding 
grants) 
Financing needs 
Already 
identified 
PIP 
funding 
Already 
idenfitied 
undesignated 
budget funds 
Humanitarian assistance 
Other 
31 
Financing sources 
Financing 
gap 
o/w 
required central 
government 
financing 
o/w 
disbursement from 
new 
PIP 
commitments 
2000 
2001 
2002 
2003 
(act.) 
(act.) 
(proj)  (proj.) 
-1333 
-1158 
-1128 
-934 
177 
163 
132 
107 
472 
524 
526 
507 
766 
629 
430 
310 
82 
158 
-40 
-10 
-684 
-471 
-470 
-320 
684 
471 
470 
320 
542 
551 
411 
220 
102 
60 
10 
0 
36 
ia 
9 
5 
-83 
-159 
40 
10 
597 
470 
470 
235 
85 
25 
60 
2004 
(Proj.) 
-767 
71 
44 
1 
235 
-20 
-255 
255 
130 
0 
0 
20 
150 
105 
15 
90 
2005 
(proj.) 
-722 
50 
437 
21 
0 
-25 
-235 
235 
90 
0 
0 
25 
115 
120 
10 
110 
I/ 
Data 
were 
presented 
at the 
November 
2002 
Kosovo 
Donor 
Meeting. 
No 
update 
is available 
as 
of 
mid-May 
2003 
2/ 
Excludes imputed services 
provided 
by 
donors. 
3/ 
Includes net capital 
flows, changes 
in 
cash balances, and errors 
and 
omissions. 
Source: 
IMF, MFE, 
World 
Bank Staff 
Estimates. 
26. 
Risks. 
The 
macroeconomic 
scenario 
outlined 
above 
is 
associated 
with 
very 
substantial 
risks, 
especially 
in 
the 
outer 
years. 
The 
above 
scenario 
of 
a 
sustained 
rebound 
in 
growth 
and 
living 
standards 
assumes 
(i) 
implementation 
of 
a 
coherent 
medium-term  program 
of 
institutional 
strengthening 
and 
reform; 
(ii) 
continued, 
well-targeted  donor  support 
for 
Kosovo; 
and 
(iii) 
a 
relatively 
favorable 
extemal 
environment. 
Kosovo 
has 
very 
little 
cushion 
to 
absorb 
the 
consequences 
of 
any 
significant 
downward 
deviation 
in 
one 
or more 
of 
these 
areas. 
If 
the 
reform 
effort 
is 
weaker 
than 
expected, 
for 
instance 
because 
of 
the 
PISG’s 
untested capacity 
or 
resistance 
to 
Page  16
9 
reforms 
from 
vested 
interests, 
private 
sector 
development 
as 
well 
as 
the 
willingness 
of 
donors 
to 
support 
Kosovo 
would 
be 
negatively 
affected. 
Real 
GDP 
growth 
under 
this 
scenario 
would 
be 
lower. 
On 
the 
other 
hand, 
lower 
GDP 
growth could 
also 
arise 
from 
developments 
exogenous 
to 
Kosovo, 
including 
an 
inadequate 
level 
of 
extemal 
financing. 
Lack 
of 
progress 
in 
resolving 
Kosovo’s 
final 
status 
is 
also 
likely 
to slow 
down 
private 
investment 
and 
growth. 
111. 
KOSOVO: 
THE 
POLICY 
AGENDA 
AND 
ADJUSTMENT 
PROGRAM 
27. 
The 
proposed 
policy 
agenda 
under 
EAG 
IV 
is 
summarized 
in 
the  attached 
draft 
policy 
matrix 
(Annex 
5). 
It 
is 
reflected 
more 
fully 
in 
the 
Letter 
of 
Development 
Policy 
(LDP, 
Annex 
4). 
After 
taking 
the 
early 
actions 
and 
achieving the 
initial 
outcomes 
described 
in 
Section 
II, 
UNMIK 
and 
the 
PISG 
have 
now 
developed 
a 
more 
comprehensive  adjustment 
and 
reform 
program. 
Priorities 
of 
this 
reform 
program 
center around: 
(a) 
Fostering 
private-sector 
driven growth 
and 
creating 
the  basis 
for 
a  sustainable 
supply 
response; 
(b) 
Developing 
an 
effective 
and 
sustainable 
public 
sector capable 
of 
delivering 
adequate 
services, 
especially 
to 
the 
poor 
and 
vulnerable, 
and 
in 
the 
face 
of 
declining 
donor 
support. 
28. 
The 
Authorities 
in 
Kosovo 
have 
requested 
the 
Association’s 
support 
for 
these 
two 
key 
elements 
of 
this 
program. 
Together 
with 
the 
maintenance 
of 
a sustainable 
macro 
framework, 
and 
in 
close 
consultation 
with 
the 
IMF 
and 
donors, 
the 
reform 
program 
supported 
by 
EAG 
IV 
is 
designed 
to 
set 
Kosovo 
on 
a 
path 
for 
deeper 
structural reform, 
well 
beyond the 
horizon 
of 
EAG 
IV. 
29. 
Sustaining 
public 
expenditures. 
The 
conduct 
of 
fiscal 
policy 
will 
be 
critical 
to 
the 
adequate 
delivery 
of 
p 
ublic 
s 
ervices, 
a c 
limate 
c 
onducive 
t 
o 
d 
omestic 
and 
foreign 
i 
nvestment, 
as 
w 
ell 
as 
improvements 
in 
living 
conditions 
among 
the 
most 
vulnerable 
members 
of 
society. 
While 
the 
adoption 
of 
a 
hard 
currency 
has 
played 
a 
critical 
role 
in 
bringing 
about 
macroeconomic 
stability, 
it 
also 
puts 
a 
larger 
burden 
on 
fiscal 
policy. 
There 
are 
political 
and 
legal 
uncertainties surrounding 
borrowing, 
both 
domestic 
and 
extemal, 
as 
well 
as 
an 
inadequate 
institutional framework 
to 
support 
it. 
Thus, 
without 
a 
monetary 
policy 
instrument, 
the 
fiscal 
policy 
stance 
will 
depend 
on 
a 
strong 
domestic revenue 
effort, 
a 
careful calibration 
of 
expenditures 
for 
both 
public 
investment 
and 
social 
expenditures, 
and 
importantly, 
continuing 
donor 
support. 
The 
public 
sector 
policy 
agenda 
is 
focused 
on 
improving 
the 
efficiency  and  administration 
of 
the 
tax  and 
customs  collections, 
ensuring 
fiscal discipline 
and 
the 
allocative 
efficiency 
and 
effectiveness 
of 
public 
spending. 
30. 
Promoting 
growth. 
Experience 
elsewhere 
indicates 
that 
in 
post-conflict 
settings, 
where 
there 
is 
a 
prevalence 
of 
high 
unemployment 
and 
large, 
shallow 
poverty,  the 
principal focus 
for 
promoting 
growth 
should 
be 
aimed 
at 
stimulating private 
sector 
activity, 
particularly 
in 
the 
small 
and 
medium 
enterprise 
(SME) 
sector. 
This 
requires  conditions 
conducive 
to  new 
investment. 
Facilitating 
access 
to 
credit 
is 
obviously 
a 
key 
priority, 
and 
numerous 
donors 
active 
in 
Kosovo 
in 
the 
aftermath 
of 
the 
conflict 
established 
credit facilities 
which 
contributed 
to 
a 
dramatic 
surge 
in 
economic 
activity. 
Nevertheless, 
ensuring 
that 
financial 
intermediation 
(and 
further 
investment) 
Page  17
10 
occurs 
in 
a 
sustainable, 
market-driven  manner 
ultimately 
requires 
the 
creation 
of 
a 
stable 
and 
predictable 
legal 
environment 
that  defines 
and 
protects 
property 
rights, 
establishes 
security 
of 
transactions, 
and 
imposes 
market 
discipline. 
Barriers 
against 
efficient 
entry, 
operation 
and 
exit 
of 
firms 
must 
also 
be 
identified 
and 
disbanded. 
Furthermore, 
efficient 
provision 
of 
infrastructure 
services 
is 
hdamental 
to 
reducing investment risks 
and 
operating 
costs 
of 
firms. 
Table 
3: 
Key 
Policies 
and 
Reforms 
Reform 
Objective 
Budget 
planning 
To 
sustain 
adequate 
service 
delivery 
in 
the 
face 
of 
declining 
donor 
support. 
To 
strengthen the 
allocation 
of 
resources 
in 
line 
with 
medium-term 
government 
policies 
and 
spending 
priorities. 
Budget implementation 
Increase 
public 
sector 
accountability 
for public 
resources 
to 
both 
the 
people 
of 
Kosovo 
and 
the 
external donor community. 
Establish 
sound 
financial 
management 
and 
limit 
opportunities 
for 
corruption. 
To 
increase the 
efficiency 
of 
spending 
and 
return 
on 
public 
investment. 
Improving 
the 
business 
environment 
Ensure 
protection 
of 
creditor 
rights 
and 
establish 
a 
more efficient framework 
for exit 
of 
fi 
in 
financial 
distress. 
Reduce 
barriers 
to 
entry. 
Improve 
access 
to 
capital. 
Validate and 
enforce 
property rights 
Reforming 
public 
utilities 
~ 
Improving 
the 
efficiency 
and 
service 
delivery 
of 
publicly-owned 
enterprises. 
_____~ 
Core 
Reform 
benchmarks 
by 
Board 
Presentation 
The 
Kosovo 
Consolidated 
Budget 
for 
calendar year 2003, 
satisfactory 
to 
the Association, 
has 
been approved 
by 
the 
SRSG, 
acting 
on 
the 
advice 
of 
the 
Economic and 
Fiscal 
Council. 
The 
2004-06 
macro and 
revenue 
forecasts 
for 
the 
medium-term 
budget 
framework 
and 
the 
budget 
calendar 
have been produced 
by 
the 
MFE 
and, 
upon 
the 
advice 
given 
by 
the 
EFC, agreed 
by 
the 
SRSG 
as 
indicative 
ceilings 
to 
start the 
2004 
budget 
process; 
and 
the 
2004 
draft 
budget 
circular 
has 
been 
issued 
by 
the 
MFE. 
The 
SRSG 
has 
promulgated 
a 
regulation 
establishing the 
Office 
of 
the 
Auditor 
General 
and 
the 
Audit 
Office, 
satisfactory 
to 
the 
Association, 
and 
the 
Audit 
Office 
has 
been 
established. 
The 
Assembly 
has 
adopted 
and 
the 
SRSG 
has 
promulgated 
a 
law 
on 
mortgages 
and 
a 
law 
on 
bankruptcy, 
both 
satisfactory 
to 
the 
Association. 
The 
Assembly 
has 
adopted 
and 
the SRSG 
has 
promulgated 
a 
law 
on 
the 
establishment 
of 
an 
immovable property rights 
register, 
and 
supplementary 
legislation 
necessary 
to 
render 
such 
law 
effective 
has 
been submitted 
by 
the 
Government 
to 
the 
Assembly, 
both 
satisfactory 
to 
the 
Association. 
Audits, 
conducted 
pursuant 
to 
terms 
of 
reference satisfactory 
to 
the Association, 
have been 
completed, 
by 
independent auditors 
of 
recognized 
standing,  acceptable 
to 
the  Association, 
of 
the 
four 
principal 
publicly-owned 
enterprises 
operating 
within 
Kosovo 
(KEK; 
PTK; 
PA; 
and 
UR), 
as 
well 
as 
of 
each 
of 
the 
Water and 
Waste 
POEs. 
Page  18
11 
A. 
PUBLIC 
EXPENDITURE 
MANAGEMENT 
Background 
31. 
Given 
the 
preeminence 
of 
fiscal 
policy 
in 
the 
government’s 
policy 
options, 
and 
the 
tight 
overall 
resource constraints 
in 
Kosovo, 
difficult 
choices 
and trade-offs 
need 
to 
be 
made. 
Following 
the 
inception 
of 
the 
UNMlK 
administration 
in 
1999 
a 
number 
of 
institutional 
arrangements 
were 
put 
in 
place 
to 
manage 
both 
domestic and 
donor-generated 
resources. 
The 
initial 
priority 
was 
to 
develop 
a 
basic 
system 
for 
the 
management 
of 
public 
finances 
in 
line 
with 
internationally 
accepted 
budget 
and 
financial 
management 
best 
practice. 
Over 
the 
last 
four 
years 
a 
sound 
framework 
for 
budget management 
has 
been 
established, 
with 
the 
following 
elements: 
(a) 
Adoption 
of 
a 
budget 
classification 
system 
and 
treasury chart 
of 
accounts consistent 
with 
the 
IMF’s 
Government Finance Statistics 
(GFS) 
methodology 
(b) 
A 
Treasury 
Single 
Account 
(the 
Kosovo 
Consolidated 
Fund) 
(c) 
Basic 
tax 
and 
customs administrations; 
and 
(d) 
Basic macro 
and 
revenue 
forecasting 
capability. 
32. 
As 
outlined 
in 
the 
Bank’s 
Medium-Term 
Public 
Expenditure 
Priorities 
Report 
(Report 
No:24880-KOS) 
notwithstanding 
the progress 
made, 
public 
expenditure 
management 
suffers 
from 
the 
following 
key 
weaknesses: 
A 
comprehensive resource 
framework 
for 
the 
budget 
remains 
absent. 
Considerable 
effort 
needs 
to 
be 
made 
to 
progress 
the 
integration 
of 
the donor-financed 
Public 
Investment 
Program 
(PIP), 
and 
the 
Kosovo 
general 
budget. 
In 
addition, mechanisms 
to 
include 
and 
account 
for 
donor 
funds 
need 
to 
be 
strengthened, 
and 
the 
reporting 
of 
project 
financial  information 
needs 
to 
be 
made  consistent 
with 
the 
budget 
classification 
structure. 
Policy 
formulation 
and 
decision-making 
processes 
remain 
fragmented, 
and 
a 
coherent 
vision 
of 
public 
sector 
policy 
and 
budget 
development 
still 
needs 
to 
be 
developed. 
The 
effectiveness 
of 
the 
budget 
as 
a 
policy 
tool 
can 
be 
improved, 
building 
on 
progress 
with 
the 
medium-term 
approach 
and 
the 
sectoral-level  comprehensive 
development 
frameworks 
initiated 
in 
the 
2003 
budget 
process. 
There 
are 
data 
limitations 
which 
hamper 
the 
development 
of 
good 
macro 
and 
revenue 
forecasts. 
33. 
The 
environment 
for 
tackling 
these 
reforms 
is 
not only 
one 
of 
post-conflict 
reconstruction, 
and 
a 
public 
sector 
facing transition 
from 
the 
state-planning 
former Yugoslavia 
to 
a 
market-based 
Page  19
12 
economy, 
but 
also 
one 
where 
there 
is 
no 
recent 
tradition 
of 
public 
sector 
institutions 
at 
the 
Kosovo- 
level. 
Public 
sector 
capacity 
and 
institution 
building 
are 
key 
to 
addressing 
these weaknesses. 
Reform 
Objectives 
34. 
The 
main 
medium-term 
public 
finance  challenge 
for 
the 
authorities 
is 
to 
ensure 
the 
provision 
of 
adequate 
public 
services, 
while 
managing  the  transition 
from 
reliance 
on 
donor 
finance, 
to 
an 
increased 
role for 
own 
source 
revenues. 
Although 
domestically 
generated 
revenues 
will 
continue 
to 
increase, 
the domestic 
revenue 
base 
is 
likely 
to 
remain 
weak 
for 
the 
foreseeable 
future. 
Donor 
finance 
will 
continue 
to 
be 
crucial 
to 
maintain 
service 
delivery 
and 
public 
investment 
over the 
medium 
term. 
35. 
There 
is 
also 
a 
considerable 
institutional 
challenge 
as 
the 
management 
of 
public 
resources 
shifts 
from 
the 
UNMIK 
administration 
to 
the 
local 
government 
institutions, 
and 
financial 
accountability 
must 
be not 
only 
to 
the external 
donors 
but 
also 
to 
the people 
of 
Kosovo. 
This 
leads 
to 
a 
particularly 
complicated 
and 
fluid 
governance structure. 
The 
political 
layer 
of 
the executive 
branch 
includes the 
Prime 
Minister 
and 
the 
coalition 
government 
of 
the 
elected 
PISG; 
it 
also 
includes 
the 
SRSG 
who, 
while 
a 
representative 
of 
the 
UN, 
acts 
as 
a 
political 
decision 
maker. 
The 
institutional 
arrangements 
for 
decision-making 
are 
evolving 
to 
accommodate 
a 
role 
for 
all 
the 
players. 
The 
Economic 
and 
Fiscal 
Council 
(EFC) 
includes 
representatives 
of 
the 
UNMIK, 
PISG 
and 
Assembly 
and 
plays 
a 
“cabinet” 
role 
in 
advising 
the 
SRSG 
on 
budget and economic 
issues. 
In 
addition, there 
is 
an 
Assembly 
of 
elected 
representatives, 
headed 
by 
the 
President. 
36. 
achieve the 
following 
goals: 
The 
main 
objectives 
of 
the 
reform 
measures 
supported 
by 
the 
EAG 
IV 
are 
intended 
to 
(a) 
S 
trengthen 
budget 
management 
to 
ensure 
the 
sustainable 
delivery 
o 
fa 
dequate 
p 
ublic 
services 
through 
improved 
allocation 
of 
resources 
to 
agreed 
priorities; 
and 
(b) 
Improve 
efficiency 
of 
resource use 
and 
combat 
corruption 
through 
better oversight 
and 
public 
financial 
accountability. 
37. 
Objective 
I: 
Strengthening 
Budget 
Management. 
The 
key 
to 
medium-term 
fiscal 
sustainability 
is 
current  expenditure  discipline.  Faced 
with 
a 
limited 
resource 
envelope 
for 
the 
foreseeable  future, 
this 
will 
require  careful 
policy 
choices 
and 
the  effective 
prioritization 
of 
expenditures 
in 
a 
medium-term context. 
A 
start 
was 
made 
as 
part 
of 
the 
2003 
budget 
cycle, 
when 
elements 
of 
a 
medium-term 
expenditure 
framework 
(MTEF) 
approach 
were 
introduced, 
with 
the 
assistance 
of 
the 
Bank 
and 
other 
donors. 
This 
is 
being 
taken 
forward 
in 
the 
2004-06 
medium 
term 
budget framework 
that 
is 
currently 
under 
preparation. 
The 
process 
includes 
a 
number 
of 
elements 
consistent 
with 
international 
practice. 
For 
example, 
it 
attempts 
to 
bring 
all 
outflows 
and 
inflows 
on 
budget, 
it 
requires 
spending 
plans 
to 
be 
based 
on 
strategic 
objectives 
and 
planning, 
and 
it 
bases 
budget 
requests 
on 
policy 
changes. 
The 
2004 
budget 
process 
aims 
to 
address weaknesses 
identified 
last 
year. 
These 
include 
(i) 
the uneven 
treatment 
across 
sectors, 
(ii) 
the failure 
to 
provide 
guidance 
on 
expenditure 
ceilings, 
(iii) 
limited 
involvement 
of 
the 
sector 
ministries, 
and 
(iv) 
limited 
progress 
Page  20
13 
with 
integrating  the 
investment 
and 
recurrent 
spending  proposals. 
It 
is 
also 
important 
for 
the 
improved 
management 
of 
resources 
to 
strengthen 
the revenue 
and 
macro-forecasts. 
3 
8. 
Maintaining 
expenditure 
discipline 
and 
allocating 
limited 
resources 
among  competing 
demands 
requires 
hard 
policy 
choices. 
These 
trade-offs 
have 
been 
complicated 
in 
Kosovo 
by 
difficulties 
in 
finalizing 
the 
details 
of 
the 
interim 
institutional 
arrangements. 
The 
institutional 
environment 
for 
fiscal 
policy 
remains 
complex 
and 
there 
is 
scope 
to 
improve 
policy 
coordination. 
Policy 
formulation 
and 
decision-making 
mechanisms 
in 
Kosovo 
remain 
fragmented, 
and 
a 
coherent 
vision 
of 
budget 
development 
is 
still 
to 
emerge 
among different 
stakeholders. 
There 
are 
plans 
to 
address 
this 
by 
establishing 
a 
Budget Commission 
and Grants 
Commission 
to 
steer 
the 
2004 
budget 
process. 
These 
Commissions 
will 
consist 
of 
representatives 
of 
the 
UNMIK, 
the 
PISG 
and 
Budget 
Committee 
of 
the Assembly. 
39. 
EAG 
IV 
measures 
to 
improve 
budget 
management. 
EAG 
n/ 
has supported 
the 
formulation 
and 
adoption 
of 
the 
2003 
budget, 
through 
a 
process 
in 
which 
the 
B 
ank’s 
M 
edium-Term 
P 
ublic 
Expenditure  Priorities 
Report  played 
a 
significant 
role 
(No. 
24880-KOS). 
The 
2003 
Budget 
Regulation 
(2002/23) 
was 
promulgated 
by 
the 
SRSG, 
within 
the 
31 
December 
2002 
deadline, 
and 
based 
on 
the 
draft 
schedules 
submitted 
by 
the 
Minister 
of 
Finance 
and 
Economy 
and reviewed 
by 
the Assembly. 
The 
2003 
budget 
has 
improved public 
spending 
allocation 
in 
line 
with 
medium-term 
priorities. 
Relative 
to 
2002, 
2003 budgeted 
changes 
reflect the need 
to 
increase 
the allocation 
of 
resources 
to 
the 
still 
much 
needed 
public 
investments 
for 
reconstruction, 
ensure adequate resources 
are 
available 
to 
improve 
tax 
administration, 
and 
address 
concerns 
that 
adequate 
wages 
are 
paid 
to 
attract 
well-qualified 
civil 
servants. 
For 
instance: 
(a) 
General budget-financed 
capital 
expenditure 
as 
a 
percentage 
of 
GDP 
has 
increased 
from 
1 
.29 
percent 
to 
3.0 
percent; 
(b) 
Expenditure 
on 
non-wage 
goods 
and 
services 
has 
increased 
from 
6.7 
percent 
to 
7.1 
percent 
of 
GDP 
in 
2003; 
and 
(c) 
The 
budget 
for 
the 
tax 
administration 
has 
doubled 
between 
2002 
and 
2003. 
40. 
Wages-and-salaries 
spending 
as 
a share 
of 
GDP 
has 
risen 
from 
5.8 
percent 
to 
6.5 
percent, 
between 
2002 
and 
2003. 
This 
is 
largely the 
result 
of 
the 
transfer 
of 
powers 
and 
the 
establishment 
of 
the 
PISG 
budget 
organizations. Nevertheless, 
the 
increase 
in 
the 
wage 
bill 
is 
a 
source 
of 
concern. 
The 
authorities 
are 
moving 
ahead 
with 
proposed 
review 
of 
the 
pay, 
employment 
and 
civil 
service 
structure 
with 
a 
view 
to 
revising 
the conditions 
within 
a 
sustainable 
resource 
envelope. 
41. 
A 
continuing 
cause 
of 
concern 
is 
also 
the 
amount 
allocated 
in 
subsidies 
to 
public 
sector 
enterprises. 
In 
the 
2003 
budget 
these 
have 
increased 
to 
the Trepca 
mines 
(by 
43 
percent) 
and 
transport 
enterprises 
(airport 
and railways 
by 
108 
percent) 
and 
fell 
by 
just 
over one 
third 
in 
the 
case 
of 
heating, 
and 
water 
and 
waste. 
As 
discussed 
below, 
measures are 
underway 
that 
will 
investigate 
the 
financial 
situation 
of 
the 
enterprises, 
including 
issues 
of 
corruption, 
and 
initiate 
the 
Comparison 
is 
made 
with 
the 
2002 
mid-year 
revision 
data. 
Page  21
14 
restructuring 
process 
of 
the 
publicly-owned 
enterprises 
with 
a 
view 
to 
reducing 
subsidies 
over the 
medium-term. 
42. 
The 
2004 
budget 
preparation 
process 
has 
started, 
taking 
into 
consideration the 
weaknesses 
identified 
with 
last 
year’s 
MTEF 
approach. 
A 
budget 
strategy 
report 
was 
issued 
by 
the 
MFE 
and 
agreed 
by 
the 
SRSG 
upon 
the 
advice 
of 
the 
EFC. 
This 
report 
sets 
out 
the 
overall 
vision 
and 
timetable 
for 
the budget 
process 
in 
2004. 
Importantly, 
it 
establishes 
a 
single 
budgetary 
process 
for 
both 
the 
institutions 
under 
P 
ISG 
and 
UNMIK 
control, 
under the 
stewardship 
of 
the 
Ministry 
of 
Finance 
and 
Economy. 
As 
part 
of 
the 
reform 
agenda, 
the 
MFE 
will 
move 
toward 
the integration 
of 
the 
PIP 
and 
Kosovo 
Consolidated 
Budget. 
This 
year, 
budget 
organizations 
will 
be 
required 
to 
prepare 
budget 
requests 
that integrate recurrent 
and 
capital 
expenditures, 
and 
are 
based 
on 
sectoral 
medium-term 
strategic  plans.  These 
plans 
will 
be 
integrated 
into 
the 
Medium 
Term 
Budget 
Framework 
for 
2004-06. 
Macro 
and 
revenue 
forecasts 
have 
also 
been 
produced 
and 
discussed 
as 
the basis 
for 
the 
medium 
term 
budget 
framework 
and 
the 
setting 
of 
the 
medium 
term 
objectives. 
The 
limited 
access 
to 
finance 
and 
resources, 
entails that 
at 
this 
stage 
it 
is 
difficult 
to 
go beyond 
the 
current 
framework 
to 
use 
the 
Medium 
Term 
Budget 
Framework 
as 
a 
tool 
for 
discussing 
shifting 
priorities 
over the 
medium-term. 
43. 
As 
the 
institutional 
governance 
arrangements 
for 
fiscal 
policy 
remain 
complex 
and 
fluid, 
a 
Law 
on 
Public Financial 
Management 
and Accountability, 
has 
been drafted 
as 
the 
Kosovo 
Organic 
Budget 
Law. 
This 
legislation 
is 
an 
important 
tool 
for 
improving 
the 
budget 
process 
in 
Kosovo. 
It 
has 
been 
approved 
by 
the 
Assembly 
and 
promulgated 
by 
the 
SRSG. 
Given 
the 
complexity 
of 
the 
institutional 
arrangements 
in 
Kosovo 
considerable 
attention 
has 
been 
paid to 
the 
timing 
of 
the 
budget 
process 
to 
ensure 
that 
all 
players 
are 
appropriately consulted 
and 
given 
adequate 
time 
to 
deliver 
their 
input. 
The 
key 
aspects 
of 
the legislation 
are: 
It 
provides 
a 
legal 
basis 
for 
the roles 
and 
responsibilities 
of 
budget 
players, 
thus 
clarifylng 
the 
complex 
institutional 
environment 
and 
establishing 
the 
rules 
for 
a 
comprehensive 
budgetary 
process 
across 
the 
institutions 
of 
both 
the 
PISG 
and 
UNMIK 
and 
ensuring  that 
there 
are 
checks 
and 
balances 
in 
place 
for 
prudent 
financial 
management; 
It 
lays  the 
framework 
for 
the  annual 
budget 
process 
and 
articulates 
a 
budget 
timetable, 
thus 
providing 
the 
basis 
for 
a 
more 
strategic 
approach 
to 
budgeting; 
and 
It 
provides 
the 
basis 
for 
ensuring 
that 
resources 
are 
allocated  according 
to 
a 
contestable 
process, 
and 
are 
expended 
according 
to 
that 
allocation 
or 
changed 
through 
a 
transparent 
process. 
44. 
Medium-term 
reform 
objectives. 
The 
budget 
process 
for 
2004 
will 
need 
to 
build 
on 
the 
progress 
made 
during 
2003 
to 
develop 
a 
medium-term framework 
for 
the 
budget, 
to 
integrate 
the 
process 
for 
the 
PISG 
and 
SRSG 
reserved 
powers, 
and 
to 
strengthen 
the capacity 
of 
the 
MFE 
to 
lead 
the 
process. 
As 
a 
priority 
there 
is 
a 
need 
to 
review 
the 
public 
sector 
wage 
and 
employment 
issue 
to 
ensure 
that 
any 
restructuring 
will 
be 
sustainable 
over 
the 
medium-term. 
Page  22
15 
45. 
The capacity 
for 
budget 
preparation 
in 
Kosovo 
remains 
weak, 
and 
the 
administration 
is 
heavily 
reliant 
on 
external 
assistance. 
The 
MFE 
is 
in 
the 
process 
of 
recruiting 
additional 
local staff 
to 
the 
budget 
department, 
to 
work 
alongside 
technical 
advisors 
funded 
by 
a 
USAID 
technical 
assistance 
project. 
Budget 
capacity 
in 
the 
line 
ministries 
is 
even 
more 
limited, 
particularly 
in 
the 
area 
of 
formulating 
govement 
policies, 
strategies 
and 
prioritization. 
This 
is 
symptomatic 
of 
the 
generic 
challenge 
facing 
KOSOVO, 
of 
building 
a 
public 
service 
where 
the 
much 
of 
the 
local 
population 
has 
been 
excluded 
from 
public 
sector 
employment 
during 
the 
nineties; 
and 
engendering 
notions 
of 
a 
modem 
public 
sector 
in 
an 
early 
transition 
economy. 
Improvements 
in 
the 
capacity 
of 
the 
public 
sector 
to 
generate 
policies 
and strategic 
plans 
will 
be 
a 
necessary 
counterpart 
to 
sound 
budget 
management 
to 
foster 
a 
positive 
investment 
climate, 
deliver 
services 
and 
ultimately, 
to 
achieve 
aspirations 
of 
growth 
and 
poverty 
reduction.  Technical 
assistance 
will 
be 
required 
to 
develop 
capacity 
for 
overall 
and 
sectoral 
policy 
and 
strategy 
making 
in 
the 
public 
sector, 
and 
the 
Association 
will 
work 
with 
other donors 
to 
assist 
in 
the 
provision 
of 
such 
assistance. 
46. 
Objective 
2: 
Improving 
budget 
execution 
and 
accountability 
for 
public 
finances. 
While 
the 
establishment 
of 
good 
financial 
management 
systems 
within 
the 
four  post-conflict 
years 
is 
laudable, 
critical 
gaps 
remain. 
Until 
recently 
budget 
management 
in 
Kosovo 
has 
been compliance- 
focused, 
with 
a 
greater 
emphasis 
on 
spending 
discipline 
rather 
than 
on 
mechanisms 
to 
enhance 
the 
efficiency 
and 
effectiveness 
of 
public 
spending. 
Alongside 
improvements 
in 
budget 
management, 
control 
of 
commitments 
and 
improving 
the 
capacity 
of 
line 
Ministries 
to plan 
and 
execute 
spending 
plans, 
is 
important for 
fiscal discipline 
and 
ensuring 
that 
budget 
outtum's reflect 
the 
allocation. 
47. 
The 
outcome 
of 
the 
2002 
budget 
causes 
concerns about the 
capacity 
of 
the 
Kosovo 
budget 
institutions 
to 
develop 
and 
implement 
spending 
plans and 
to 
commit 
the 
budget 
as 
appropriated. 
The 
capacity 
is 
likely 
to 
be 
further 
constrained 
by 
the 
need 
for 
tight 
cash 
control 
in 
Kosovo. 
There 
is 
a 
well-functioning 
Treasury 
system, 
although 
commitments, expenditures, and 
requests 
for 
data 
are 
m 
ade 
manually 
to 
the 
Treasury 
from 
the 
spending 
ministries. 
In 
order 
to facilitate 
spending 
plans, 
the 
Treasury 
intends 
to 
issue 
warrants 
on 
a quarterly 
basis 
in 
2003, 
rather 
than 
bi-monthly, 
to 
give 
budget 
holders 
better 
flexibility 
to 
manage the 
planning 
and 
execution 
of 
commitments 
and 
expenditures. 
Going 
forward, 
there 
are 
also 
plans 
to 
automate 
the 
links 
between 
spending 
ministries 
and 
the 
Treasury 
system 
to 
speed 
up 
transactions 
and 
to 
improve 
the 
accuracy 
and 
timeliness 
of 
financial 
information 
available 
to 
them. 
In 
addition, the 
Municipalities 
have 
recently 
undertaken 
financial 
management 
training 
and 
also 
due 
to 
be 
connected 
to 
the 
automated Treasury 
system. 
48. 
While 
almost 
one 
third 
of 
the 
appropriated 
budget 
remained 
unspent 
at 
the 
end 
of 
2002, 
the 
vast 
majority 
of 
this 
was 
for 
funds 
committed 
for 
procurement 
activities 
but 
not 
yet 
spent. 
Some 
€30 
million 
was 
either 
unallocated 
or 
allocated 
but 
not 
committed. 
This 
was 
the result 
of 
(i) 
necessary 
revenue 
cautiousness 
with 
sums 
appropriated 
to 
"reserves" 
budget 
lines, 
and 
(ii) 
limited 
capacity 
by 
agencies 
to 
execute 
programs. 
The 
need 
to 
manage 
cash 
resources 
in 
an 
optimal 
way 
is 
a 
priority 
in 
Kosovo 
and 
there 
is 
scope 
to 
improve 
the management 
of 
cash 
reserves. 
The 
MFE 
are 
taking 
steps 
to 
review 
the 
2002 
process 
to 
see 
where 
potential 
improvements 
can 
be 
made 
in 
budget 
execution 
capacity 
and 
have 
already 
begun 
to 
investigate 
Treasury 
policies 
and 
procedures 
to 
identify 
potential 
improvements 
to 
cash management. 
Page  23
16 
49. 
There 
is 
scope 
for improving 
value-for-money 
of 
public 
spending 
and 
retum on 
public 
investment 
through  improved 
procedures 
for  public 
procurement. 
A 
new 
law 
on 
public 
procurement 
has 
been approved 
by 
the 
Government 
and 
is 
now 
being 
considered 
by 
the 
Assembly. 
Furthermore, 
staff 
will 
need 
to 
be 
trained 
in 
the 
new 
guidelines 
and 
new 
oversight 
institutions 
for 
public 
procurement should 
be 
established. 
Intemal 
audit 
is 
still 
at 
a 
very 
early 
stage 
and 
much 
needs 
to 
be 
done 
to 
improve 
financial 
management 
and 
establish 
a 
culture 
that 
limits 
opportunities 
for 
private 
rent-seeking. 
50. 
Budget 
management 
arrangements 
need 
to 
support 
the 
development 
of 
an 
accountability 
relationship between 
the 
PISG 
structures 
and 
the people 
of 
Kosovo, 
and 
provide 
a 
level 
of 
comfort 
to 
the 
international 
community 
that there 
is 
sound 
public 
financial 
management. 
In 
2002 
the 
SRSG 
promulgated the Regulation 
Establishing 
the 
Office 
of 
the 
Auditor 
General. 
The 
Auditor 
General’s 
position 
and 
deputy 
positions 
have 
been 
advertised 
and 
technical 
assistance 
from 
the 
European 
Agency 
for 
Reconstruction 
has 
been 
secured. 
The 
Audit 
Office 
has 
been 
established 
and 
now 
needs 
to 
become operational. 
The 
strengthening 
of 
the 
extemal 
audit 
function 
will 
help 
to 
strengthen 
the 
oversight 
role 
of 
the 
Assembly. 
While 
the 
budget 
process 
is 
largely 
open and 
information 
is 
often 
publicly 
available 
on 
the 
UNMIK 
website, 
there 
is 
still 
a 
need 
for 
greater 
transparency 
and 
timeliness 
of 
available 
information 
with 
respect 
to 
audit 
and 
budget 
data, 
and 
raising 
awareness 
of 
the 
public more 
generally should 
be 
encouraged. 
5 
1. 
EAG 
IV 
measures 
to improve 
Budget Execution and Accountability 
of 
Public 
Finances. 
The 
UNMIK 
Regulation 
(2002118) 
on 
the 
establishment 
of 
the 
Ofice 
of 
the 
Auditor 
General 
of 
Kosovo 
and 
the 
Audit 
Office 
of 
Kosovo 
was 
promulgated 
in 
October 
2002. 
The 
Regulation provides 
for 
the 
establishment 
of 
the 
Office 
and 
defines 
the 
role 
of 
the 
Auditor-General. 
Over 
the 
medium 
term 
it 
will 
be 
a 
priority 
to 
establish 
the 
office 
and 
make 
it 
fully 
operational. 
There 
may 
also 
be 
a 
need 
to 
amend 
the 
regulation 
in 
due 
course 
to 
strengthen 
the 
role 
of 
Assembly 
in 
financial 
oversight. 
52. 
A 
new 
Public 
Procurement 
Law 
has 
been 
submitted 
to 
the 
Assembly 
and 
needs 
to 
be 
promulgated 
by 
the 
SRSG and 
implemented 
as 
a 
matter 
of 
priority. 
The 
Association 
has 
provided 
extensive comments 
on 
earlier 
drafts 
of 
the 
law. 
The 
law 
is 
a 
marked 
improvement over 
the 
current 
situation, 
and 
stipulates 
the 
requirement 
for 
the 
use 
of 
competitive 
procurement 
methods 
in 
most 
cases. 
The 
law 
also contains strong 
anti-corruption 
provisions 
and 
establishes 
new 
institutions 
to 
oversee 
the 
enforcement 
of 
the 
law. 
Following 
a  consultative 
drafting 
process, 
the 
Law 
was 
adopted 
by 
the 
Provisional 
Government 
on 
April 
30 
and submitted 
to 
the 
Assembly 
in 
early 
May 
2003. 
The 
oversight 
institutions 
for public 
procurement, 
which 
will 
be 
created 
by 
the 
new 
law, 
will 
need 
to 
be 
promptly 
established, 
in 
order 
to 
ensure 
enforcement 
of 
the 
law. 
53. 
Medium-term 
r 
eform 
o 
biectives. 
0 
ver 
the 
m 
edium 
term 
the 
objective 
is 
to 
establish 
the 
institutions 
that 
will 
hold 
the 
executive 
(PISG 
and 
UNMIK 
organizations) 
accountable 
for 
performance.  Considerable 
efforts 
will 
be 
required 
to 
move 
beyond the  legal 
framework, 
to 
establish 
the 
organizations, 
and 
ensure 
that they 
are 
appropriately staffed 
and 
equipped, 
and 
that 
there 
is 
on-going 
access 
to 
technical 
support. Furthermore, 
there 
needs 
to 
be 
political 
support 
to 
developing 
an 
environment 
where 
the 
budget 
process 
is 
open 
and 
transparent, 
and 
the 
public 
sector 
is 
accountable 
to 
the people 
of 
Kosovo. 
This 
will 
require 
not 
only 
technical 
fixes, 
e.g. 
using 
Page  24
17 
technology 
to 
reduce the 
scope 
for 
inefficient 
or 
irregular 
financial 
management, 
but 
also 
a 
political 
commitment 
to 
transparency 
of 
the 
public 
sector, 
including 
publicly 
owned 
enterprises, 
and 
a 
commitment 
that 
corruption 
will 
not 
be 
tolerated. 
B. 
PRIVATE 
SECTOR 
DEVELOPMENT 
Background 
54. 
Promoting 
economic 
growth 
through 
development 
of 
the 
emerging 
private 
sector 
is 
a 
second 
key 
element 
of 
KOSOVO’S 
overall 
reform 
program. 
Over 
the 
last 
three 
years 
UNMK 
and 
the 
PISG 
have 
worked 
to 
build 
the 
foundations 
of 
a 
market-based 
economy, 
focusing  efforts 
on 
promulgation 
of 
a 
sound 
commercial legal 
framework and 
development 
of 
the 
institutional 
capacity 
necessary 
to 
enforce 
legislation 
and 
ensure 
security 
of 
property 
rights 
and 
commercial 
transactions. 
The 
Authorities 
have 
also 
put 
in 
place 
the  elements necessary 
to 
implement 
the 
program 
for 
privatization 
of 
socially-owned 
enterprises 
(SOEs). 
While 
privatization 
will 
promote 
more 
efficient 
use 
of 
these 
assets, 
the 
experience 
of 
other 
transition 
economies 
indicates 
that 
the 
main 
contributor 
to 
economic 
growth 
and 
job 
creation 
will 
most 
likely 
be 
an 
expanding 
small 
and 
medium 
enterprise 
sector. 
55. 
Like 
other 
transition 
economies, 
Kosovo 
began 
its 
transition 
with 
a 
legal 
framework 
inherited 
from 
the 
socialist 
system. 
Basic 
commercial 
laws 
and 
institutions 
necessary 
for 
a 
functioning 
market 
economy 
were 
absent. 
Thus, 
promulgation 
of 
a 
comprehensive 
set 
of 
market- 
based 
laws 
and 
development 
of 
supporting 
institutions 
have 
been 
top  priorities.  The 
primary 
objective 
of 
a 
prior 
budget 
support 
operation 
(EAG 
111) 
was 
to 
strengthen 
the 
business 
environment 
in 
Kosovo 
by 
creating 
the 
conditions 
under 
which 
investors’ 
confidence 
could 
be 
restored, 
creditor 
and 
property 
rights 
could 
be 
protected,  contracts 
could 
be 
executed, 
and 
secured 
lending 
transactions performed. 
Toward 
that 
end, 
the 
Authorities 
made 
significant 
progress 
over 
the 
last 
two 
years, 
passing 
legislation 
on 
business 
organizations, 
foreign 
investment, business registration, 
accounting 
standards, 
p 
ledge 
registry 
( 
for 
movable 
property), 
regulation 
of 
insurance, 
and 
profit 
taxes. 
56. 
To 
support 
implementation 
of 
these 
laws, 
UNMK 
and 
the 
PISG 
also 
worked 
to 
build 
the 
implementation 
capacity 
to 
enforce 
the 
legal  framework 
by 
establishing  a 
modem 
business 
registration 
system, 
a pledge 
registry, 
and 
a credit 
information 
bureau. 
Additionally, 
the 
authorities 
have  supported 
the 
development 
of 
a 
non-profit 
accounting 
association 
to  train 
and 
certify 
accountants 
and 
auditors 
and 
promote 
the 
adoption 
of 
modern 
accounting 
standards. 
Finally, 
recognizing 
the 
importance 
of 
an 
efficient 
and 
independent 
judicial 
system 
to 
ensure 
enforcement 
of 
this 
legislation 
and 
the 
integrity 
of 
commercial 
contracts and 
other 
transactions, 
the 
Authorities 
are 
launching a 
major 
capacity-building program 
for 
the 
commercial 
courts, 
including 
training 
for 
judges 
and 
lawyers and 
legal 
assistance 
to 
small 
and 
medium 
enterprises. 
57. 
These 
measures, 
combined 
with 
recent 
growth 
of 
the 
banking 
sector, 
have 
helped 
promote 
a 
significant 
expansion 
of 
private 
economic 
activity 
since 
the 
end 
of 
the 
conflict. 
However, 
in 
spite 
of 
this 
progress, 
an 
adequate 
business 
environment 
necessary 
to 
fully 
protect 
and 
enforce 
property 
rights 
and 
contracts, 
facilitate 
stable 
entry 
and 
exit 
of 
firms, 
and 
promote 
increased 
private 
sector 
Page  25
18 
access 
to 
financing, 
remains 
to 
be 
established. 
This 
environment 
increases 
risks 
for 
private 
investors, 
inhibits 
entry 
and 
expansion 
of 
firms, 
and 
encourages 
firms 
to 
remain 
in 
the 
informal 
economy.  These  constraints 
are 
compounded 
by 
inadequate 
and 
inefficient 
provision 
of 
key 
infrastructure 
services, 
which 
in 
turn 
increase 
operating 
and 
transaction 
costs 
to 
the 
private 
sector. 
In 
their 
totality, 
these 
conditions 
both 
constrain 
growth 
of 
fiscal 
revenues 
by 
encouraging 
firms 
to 
remain 
in 
the 
informal 
economy and require 
a 
significant 
portion 
of 
public 
expenditures 
to 
be 
directed 
to 
public 
utilities 
through 
subsidies 
for 
recurrent 
costs. 
Reform 
Objectives 
58. 
The 
reform 
measures 
supported 
by 
EAG 
IV 
are 
aimed 
at 
promoting 
economic 
growth 
through 
expansion 
of 
private 
sector 
activity 
and 
enhancement 
of 
budget 
revenues. 
The 
specific 
actions 
the authorities 
are 
taking 
in 
the context 
of 
EAG 
IV 
build 
upon 
those 
begun 
under 
EAG 
ID, 
and 
recognize  that 
significant 
gaps 
remain 
in 
the 
commercial legal 
framework, 
compounding 
uncertainty 
in 
the 
business 
environment. 
Therefore, 
the 
objectives 
in 
the 
area 
of 
private 
sector 
development 
are 
to: 
(a) 
Establish 
an 
adequate 
commercial 
legal 
framework. 
This 
will 
be 
critical 
for 
the 
emergence 
of 
a 
modem 
business 
sector. 
The 
bankruptcy, 
mortgage 
and 
immovable 
property rights 
registration 
laws 
are 
further 
key 
components 
of 
the 
package. 
(b) 
Create 
a 
business 
environment 
that 
is 
conducive 
to 
investment. 
This 
will 
be 
a 
fundamental 
element 
of 
the 
growth 
strategy. 
Identifylng 
and 
reducing the regulatory 
and 
administrative 
barriers 
to 
firms, 
particularly 
at 
the 
municipal 
level, 
will 
be key 
to 
maintaining 
the rate 
of 
growth 
of 
new 
firms 
witnessed 
in 
recent 
years. 
Elements 
of 
the 
reform 
package 
to 
achieve 
this 
objective  include: 
establishment 
of 
a 
modem 
and 
efficient 
business 
registration 
system; 
formation 
of 
a 
Private 
Sector 
Advisory Group 
to 
facilitate dialogue between 
government 
and the 
private 
sector 
on 
business 
environment 
constraints; 
resolution 
of 
the 
legal framework 
for 
use-rights 
of 
land 
held 
by 
socially- 
owned 
enterprises; 
and 
preparation 
of 
interim 
spatial 
plans 
for 
commercial 
activities 
within 
municipalities. 
(c) 
P 
romote 
restructuring 
of 
publicly-owned 
enterprises 
(POEs). 
Restructuring 
of 
POEs 
in 
infrastructure 
sectors 
is 
necessary 
both 
to 
reduce 
their  fiscal burden 
and 
to 
ensure 
reliable 
and 
efficient 
delivery 
of 
services 
to 
the emerging 
private 
sector. 
Completing the 
restructuring 
program 
will 
be 
a 
complex, 
and 
time-consuming 
task. 
EAG 
IV 
will 
support 
the 
first 
steps 
in 
this 
process 
by 
ensuring the 
completion 
of 
external audits 
of 
all 
five 
POEs, 
followed 
by 
the 
preparation 
of 
comprehensive 
restructuring 
strategies. 
59. 
to improve 
the commercial 
legal 
framework, 
the Authorities’ 
objectives 
are 
to: 
Objective 
I: 
Strengthening 
Commercial Legislation. 
With 
regard 
to 
short-term 
measures 
(a) 
ensure 
protection 
of 
creditor 
rights 
and 
establish 
a 
more 
efficient framework 
for 
exit 
of 
firms 
in 
financial 
distress 
(by 
adoption 
of 
a 
Bankruptcy 
Law); 
(b) 
improve 
private 
sector 
access 
to 
capital 
(by 
adoption 
of 
a 
Mortgage 
Law); 
and 
Page  26
19 
(c) 
validate 
and 
enforce 
property 
rights 
(by 
adoption 
of 
a 
Law 
on 
Establishment 
of 
an 
Immovable Property 
Rights Register). 
60. 
Promulgation 
of 
the 
Bankruptcy 
law 
is 
a 
priority 
as 
there 
is 
currently 
no 
applicable 
legal 
basis 
to 
enforce 
market discipline 
on 
firms. 
The 
Bankruptcy 
law, 
which 
was 
recently 
passed 
by 
the 
Assembly  and 
signed 
by 
the 
President, 
is 
expected 
to 
create 
a 
more 
predictable  and 
stable 
environment 
by 
establishing 
the 
basis 
for 
the rights 
and obligations 
of 
both 
creditors 
and 
firms 
in 
financial 
distress 
and 
allow 
for 
the 
efficient exit 
of 
failing 
firms. 
The 
Mortgage 
law, 
which 
is 
now 
in 
effect, 
will 
improve 
private 
sector 
access 
to 
capital 
by 
addressing 
the 
current 
legal gap 
with 
regard 
to 
collateralization 
of 
immovable 
property. 
The 
Mortgage 
law 
defines the 
basis 
for 
pledges 
of 
immovable 
property, 
and 
includes 
means 
by 
which 
pledges 
of 
commercial property 
by 
business 
organizations 
may 
be 
enforced 
through 
non-judicial 
foreclosure 
in 
cases 
of 
default. 
The 
Law 
on 
Establishment 
o 
fan 
Immovable 
P 
roperty 
R 
ights 
Register 
(recently 
p 
assed 
by 
the Assembly 
and 
signed 
by 
the 
President), 
establishes 
mechanisms 
to 
implement 
and validate 
real 
property rights 
in 
Kosovo, 
and 
supports 
implementation 
of 
the 
Mortgage law. 
Together,  these 
laws 
advance 
the 
Authorities’ 
goal 
of 
defining 
and 
protecting 
the 
rights 
of 
both 
creditors 
and 
debtors, 
and 
are 
expected 
to 
expand 
private 
sector 
access 
to 
commercial 
credit. 
Enforcement 
of 
these 
laws 
will 
be 
supported 
by 
technical 
assistance 
provided 
to 
judges 
of 
Kosovo’s 
commercial 
courts 
by 
the 
Association’s 
Private 
Sector 
Development 
TA 
project. 
61. 
Medium-term 
measures. 
Over 
the 
course 
of 
the 
next 
year, 
the 
Authorities 
will 
need 
to 
continue 
their 
efforts 
to 
put 
in 
place 
a 
comprehensive 
commercial legal framework 
by 
drafting 
and 
promulgating 
a 
Law 
on 
Obligations 
(contract 
law), 
a 
Company 
law 
(expanding 
on 
the 
now 
limited 
coverage 
provided 
by 
the 
existing Regulation 
on 
Business 
Organizations), 
and 
a 
Competition 
law. 
62. 
Implementation 
of 
the 
medium-term 
legal 
agenda 
will 
be 
supported 
by 
USAID 
and 
EAR- 
funded  legal 
assistance 
provided 
to 
the 
Legal 
Office 
oft 
he 
P 
rime 
M 
inister 
and 
the 
Ministry 
o 
f 
Trade 
and Industry 
(MTI). 
These 
two 
donors, 
and 
MTI 
(which 
will 
be 
responsible 
for 
submitting 
PSD-related 
draft  legislation 
to 
the 
Prime 
Minister’s 
office), 
have coordinated 
closely 
with 
the 
Association 
on 
defining 
the 
agenda 
and 
ensuring 
that 
resources 
will 
be 
available 
to 
implement 
it. 
63. 
Objective 
2: 
Identifiing 
and Reducing 
Constraints 
in 
the 
Business 
Environment. 
With 
regard 
to 
short-term 
measures 
to 
identi@ 
and 
remove 
constraints 
on 
investment 
and 
expansion 
of 
firms, the 
Authorities’ 
objectives 
are 
to: 
(a) 
reduce 
barriers 
to 
entry 
(by 
establishment 
of 
a 
modern 
enterprise 
registration 
system); 
and 
(b) 
identi@ 
and 
remove 
constraints 
on 
entry 
and 
operation 
of 
businesses 
(by 
establishing a 
Private 
Sector 
Advisory 
Group 
(PSAG) 
to 
report 
to 
the 
Economic 
Policy 
Roundtable). 
64. 
One 
of 
the 
principal 
priorities 
with 
regard 
to 
improving 
the 
business 
environment 
is 
to 
ensure 
that 
its 
regulatory 
policies 
and 
administrative 
procedures 
do 
not 
impose 
a 
significant 
constraint 
on 
entry 
of 
new 
small 
and 
medium 
firms 
into 
the market, 
as 
such 
firms 
will 
be 
key 
drivers 
of 
job 
creation 
and 
future 
sources 
of 
tax 
revenue. 
Toward 
this 
end, 
the 
Provisional 
Government 
has 
recently 
established 
an 
independent 
Business 
Registry 
(under 
the 
Ministry 
of 
Page  27
20 
Trade 
and 
Industry) 
which 
is 
expected 
to 
process 
business 
registration 
applications 
within 
a 
timeframe 
that 
is 
comparable 
to 
European 
standards. 
Re-registration 
of 
enterprises 
(from 
the 
interim 
system 
to 
this 
new 
system) 
will 
be 
implemented 
during 
Spring 
2003. 
Arrangements 
are 
in 
place 
to 
regularly 
share 
registration 
data 
with 
the 
Tax 
Administration 
to 
enable 
improved 
enforcement 
of 
tax 
regulations. 
65. 
UNMIK 
and 
the 
PISG 
also 
recognize  that 
they 
must 
deepen 
their 
understanding 
of 
the 
existing 
business 
environment 
in 
K 
osovo 
b 
y 
working 
more 
c 
losely 
w 
ith 
the 
p 
rivate 
s 
ector 
o 
n 
a 
regular 
basis 
to 
identify 
and 
overcome 
constraints 
faced 
by 
SMEs. 
To 
facilitate 
this, 
the authorities 
have 
established 
a 
public-private 
consultative 
body 
(the 
Private 
Sector 
Advisory 
Group, 
or 
PSAG) 
that 
will 
report 
directly 
to 
the 
Economic 
Policy 
Roundtable. 
Membership 
in 
PSAG 
includes 
representatives 
of 
the 
private 
sector, 
municipalities 
and 
relevant 
central 
authorities. 
PSAG 
will 
work 
with 
donors 
and 
the 
private 
sector 
to 
periodically 
undertake 
assessments 
of 
the 
business 
environment 
(through 
surveys 
and 
other 
tools), 
identify 
policies, 
regulations 
and 
administrative 
procedures that 
impose 
high 
costs 
of 
compliance 
and 
hinder 
investment, 
entry, 
operation 
and 
exit 
of 
firms 
(including 
firms 
operating 
in 
the 
gray 
economy), 
and 
develop 
recommendations 
for 
removing 
these 
constraints. 
66. 
Medium-term 
measures. 
After 
completion 
of 
a 
first 
set 
of 
business 
environment 
surveys, 
the 
PSAG 
will 
review 
the 
results 
and 
develop 
recommendations 
for 
policy, 
legal and 
procedural 
reforms, 
as 
appropriate, 
to 
address 
the 
key 
constraints.  These 
recommendations 
will 
then 
be 
submitted 
to 
the 
Economic 
Policy 
Roundtable 
for 
determination 
of 
appropriate actions 
to 
overcome 
barriers 
to 
entry 
and 
operation 
of 
SMEs. 
67. 
Another 
key 
constraint 
to 
the 
entry 
of 
new 
enterprises 
is 
lack 
of 
access 
to 
land. 
Socially- 
owned 
enterprises 
(SOEs) 
currently occupy approximately 
20 
percent 
of 
all 
land 
in 
Kosovo, 
much 
of 
it 
in 
excess 
of 
their 
operational 
needs. 
As 
UNMIK 
prepares 
to 
launch 
the 
privatization program 
for 
SOEs, 
it 
has 
promulgated 
a 
regulation 
allowing 
for 
transfer 
of 
land 
use 
rights 
associated 
with 
going 
concerns 
under 
99-yearY transferable 
leases. 
However, 
there 
is 
uncertainty 
as 
to 
whether 
this 
regulation 
addresses 
the 
basis 
for 
transfer 
of 
land 
use 
rights 
associated 
with 
SOE 
liquidation 
candidates." 
Therefore, 
if 
necessary, 
in 
the 
medium-term, 
UNMIK 
will 
promulgate 
a 
regulation 
on 
use 
rights 
of 
socially-owned 
land 
associated 
with 
all 
SOEs 
to 
be 
liquidated 
under terms 
that 
include 
long-term,  freely-transferable 
leases. 
68. 
Related 
to 
the 
constraint 
of 
lack 
of 
access 
to 
land 
is 
the 
absence 
of 
municipal 
spatial 
plans 
throughout 
Kosovo. 
Entrepreneurs 
intending 
to 
start 
a 
business 
find 
that 
municipal 
authorities 
are 
unable 
to 
administer 
building 
permits,  business licenses 
and 
other 
regulatory 
hnctions 
due 
to 
the 
absence 
of 
spatial 
plans 
for 
land 
use. 
This 
condition 
inhibits 
new 
investment 
and 
creates 
an 
incentive 
for 
entrepreneurs 
to 
operate 
within 
the 
informal 
economy. 
Comprehensive 
spatial 
plans 
for 
all 
thirty 
municipalities 
will 
require 
several 
years 
to 
complete. 
However, 
to 
overcome 
this 
constraint 
in 
the medium-term,  the 
Ministry 
of 
Environment 
and 
Spatial 
Planning 
will 
work 
with 
local 
authorities 
to 
ensure 
that 
all 
municipalities 
prepare 
and 
approve 
interim 
spatial 
plans 
for 
commercial 
activities 
by 
mid-2004. 
lo 
The 
majority 
of 
socially-owned 
land 
resides 
with 
the 
SOEs 
to 
be 
liquidated. 
Page  28
21 
69. 
Objective 
3: 
Reforming 
Public 
Utilities. 
Restructuring 
publicly-owned 
enterprises 
(POEs) 
to 
improve 
their 
efficiency 
and 
service 
delivery 
is 
the 
third 
key 
reform 
objective 
in 
supporting 
private 
sector development.  The POEs pose 
a 
significant  financial 
and 
economic 
burden. 
Poor 
service 
delivery, 
especially 
with 
respect 
to 
KEK, 
imposes 
high 
operating 
costs 
on 
firms 
(particularly 
in 
the 
manufacturing 
sector), 
as 
firms 
must 
secure 
alternative 
power 
sources 
with 
high 
marginal 
costs. 
The 
costs 
of 
delaying 
reform 
are 
thus 
significant. 
70. 
The restructuring program 
will 
be 
a 
complex 
and 
time-consuming 
process. 
As 
a 
first 
step 
in 
this 
process, 
it 
is 
necessary 
to 
undertake audits 
of 
the 
POEs. 
As 
a 
prior 
action, 
UNMIK 
has 
recently 
completed 
audits 
of 
the 
principal 
publicly-owned 
companies 
(KEK, 
PTK, 
water and 
waste, 
airport 
and railways). 
Five 
international 
firms 
were 
selected 
in 
late 
2002 
following 
UNMIK’s 
competitive 
procurement 
requirements; 
the 
selected 
lead 
firms 
were 
of 
recognized 
international 
standing. 
The 
auditors  were 
responsible 
for 
auditing 
three 
aspects 
of 
each 
POE: 
(i) 
financial 
accounts 
(in 
accordance 
with 
International 
Standards 
on 
Auditing) 
for 
the 
years 
1999, 
2000, 
2001, 
and 
2002 
to 
end 
June; 
(ii) 
review 
of 
operational 
aspects 
of 
the 
POEs 
(including 
identification 
of 
weaknesses 
and 
recommendations 
for 
improvements 
to 
internal 
controls, 
organizational 
structure, 
valuation 
of 
assets, 
management  culture,  management 
information 
systems, 
and  strategic 
plans); 
and 
(iii) 
forensic audits, 
especially 
with 
regard 
to 
past 
procurement. 
71. 
Medium-term 
measures. 
In 
the 
medium-term, 
the 
Authorities 
intend 
to 
prepare 
comprehensive 
restructuring 
strategies 
for 
all 
POEs, 
drawing upon 
the 
results 
of 
these 
audits. 
These 
strategies 
will 
define 
the 
key 
measures 
necessary 
to 
improve 
the 
financial 
and 
operational 
performance 
of 
the 
POEs, 
and 
should 
include 
specific 
business 
plans 
for 
the  various 
units, 
separation 
of 
commercial 
and 
non-commercial 
functions, 
incorporation 
of 
units, 
labor 
rationalization 
and 
other 
cost 
reduction 
measures, 
improved 
accounting 
and 
corporate governance 
practices, 
and 
opportunities 
to 
introduce 
private 
sector 
participation 
in 
the 
sectors. 
This 
must 
also 
be 
accompanied 
by 
development 
of 
the 
regulatory framework 
and 
institutional 
capacity 
to 
enforce 
the 
regulatory 
regime. 
Implementation 
of 
these 
strategies 
over 
the 
course 
of 
2004 
will 
be 
one 
of 
the 
most 
significant 
set 
of 
reforms 
the 
Authorities 
can 
undertake. 
IV. 
THE 
PROPOSED 
GRANT 
72. 
This 
section provides a 
summary 
of 
the proposed 
Grant 
including: 
(a) 
details 
on 
the 
Grant 
and 
its 
implementation; 
(b) 
coordination 
with 
the 
IMF 
and 
other 
donors; 
(c) 
poverty 
implications; 
and 
( 
d) 
b 
enefits 
and 
risks. 
The 
b 
road 
rationale 
and 
o 
bjectives 
o 
f 
t 
he 
Grant, 
and 
i 
ts 1 
inks 
t 
o 
the 
Association’s 
TSS, 
were 
discussed 
in 
Section 
I. 
A. 
PROJECT 
MANAGEMENT 
ISSUES 
73. 
Grant 
amount, beneficiary,  terms, 
tranching. 
The 
proposed 
budget 
support 
operation 
will 
be 
disbursed 
to 
UNMIK, 
for 
the 
benefit 
of 
Kosovo. 
The 
Grant 
will 
be 
in 
the 
form 
of 
an 
IDA 
Grant. 
It 
will 
be 
released 
in 
one 
tranche 
following 
approval 
of 
the 
Grant  and 
notification 
by 
the 
Association 
of 
Grant 
effectiveness. 
The 
full 
completion 
of 
the 
core 
measures 
in 
Table 
3 
are 
sufficient 
to 
justify 
the 
release 
of 
this 
tranche. 
Page  29
22 
74. 
Implementation, 
Monitoring 
and  Supervision. 
During 
preparation 
of 
the 
Grant, 
the 
Association 
has assisted 
the 
authorities 
to 
ensure 
timely 
implementation 
of 
the 
agreed 
reforms. 
To 
assess 
the 
impact 
of 
the proposed 
operation, 
the 
Association 
will 
monitor 
progress 
in 
achieving 
the 
medium-term 
outcome benchmarks described 
in 
the 
Letter 
of 
Development 
Policy. 
75. 
Loan 
Management. 
A 
Deposit Account 
will 
be 
established 
at 
the 
Commerzbank, 
in 
the 
name 
of 
UNMIK 
and  managed 
by 
the 
MFE, 
on 
terms 
and 
conditions  satisfactory 
to 
the 
Association. 
The 
only 
funds 
paid 
into 
this 
account 
would 
be 
the 
proceeds 
of 
the 
Grant. 
76. 
Disbursements. 
Upon 
notification 
by 
the 
Association 
of 
Grant 
effectiveness, 
and 
with 
the 
submission 
by 
the 
Recipient 
of 
a 
withdrawal 
application, 
the 
proceeds 
of 
the 
Grant 
will 
be 
deposited 
by 
the 
Association 
into 
the 
Deposit Account 
of 
the 
Recipient. 
If, 
after 
deposit 
into 
the 
Deposit 
Account, 
the 
proceeds 
of 
the 
Grant 
are 
used 
for 
ineligible 
expenditures 
( 
i.e. 
to 
finance 
items 
imported 
from 
non-member 
countries, 
or 
goods 
and 
services 
from 
the 
Association’s 
standard 
negative 
list), 
the 
Association 
will 
require 
the 
Recipient 
to 
either: 
(i) 
retum 
the 
amount 
to 
the 
account 
for 
use 
for 
eligible 
purposes; 
or 
(ii) 
refund 
the 
amount 
directly 
to 
the 
Association. 
Eligible 
expenditures 
would 
include 
payments 
by 
Kosovo 
to 
meet 
the 
external 
debt 
service 
obligations 
of 
Kosovo, 
provided 
that 
there 
are 
legal 
agreements 
that 
establish  such 
extemal 
debt  service 
obligations. 
77. 
Reporting, 
Accounting, 
Auditing. 
On 
behalf 
of 
UNMIK, 
the 
MFE 
would 
maintain 
records 
of 
all 
transactions 
under 
the 
Grant 
in 
accordance 
with 
sound 
accounting 
practices. 
The 
MFE 
would 
prepare 
a 
sources 
and 
uses 
of 
hnds 
report 
indicating 
the 
budget 
items 
on 
which 
the 
Grant 
would 
be 
spent. 
The 
MFE 
would 
ensure 
that 
the 
Deposit Account 
would 
be 
audited 
by 
auditors 
acceptable 
to 
the 
IDA, 
and 
based 
on 
TORS 
acceptable 
to 
the 
IDA, 
agreed 
during 
Negotiations. 
The 
MFE 
would 
furnish 
an 
audit report 
through 
the 
Recipient 
not 
later 
than 
four 
months 
after 
the 
closing 
of 
the 
Deposit 
Account. 
78. 
Closing Date. 
The 
expected 
closing 
date 
of 
the 
Grant 
will 
be 
January 31,2004. 
79. 
Environmental Impact. 
The 
proposed Grant 
is 
not 
expected 
to 
result 
in 
any 
negative 
impact 
on 
the 
environment. 
For 
the 
purposes 
of 
Operational 
Directive 
4.01, 
it 
has 
been 
placed 
in 
Category 
Cy 
which 
does 
not 
require 
an 
environmental 
assessment. 
B. 
COORDINATION 
WITH 
THE 
IMF 
AND 
OTHER 
DONORS 
80. 
The  achievement 
of 
reform 
objectives 
will 
be 
supported 
by 
the 
Association’s 
close 
collaboration 
with 
the 
IMF 
and 
donors. 
The authorities’ 
overall 
reform 
program 
has 
been 
designed 
within 
a 
macroeconomic 
framework 
agreed 
with 
the 
IMF 
in 
September 
2002. 
EAG 
IV 
incorporates 
this 
macroeconomic 
framework. 
Many 
donors 
are 
active 
in 
the 
main 
reform 
areas 
covered 
by 
the 
proposed Operation, 
including 
the 
DFID, 
EAR, 
USATD. 
8 
1. 
In 
public 
expenditure 
management, 
the 
Team 
has 
worked particularly 
closely 
with 
the 
EAR 
and 
USAID. 
The 
EAR’S 
program 
of 
technical 
support 
to 
Kosovo,  includes 
assistance 
to 
establish 
and make 
operational 
the 
new 
Office 
of 
the 
Auditor 
General, 
and 
provision 
to 
assist 
with 
the 
internal 
audit 
function 
and 
capacity. 
In 
addition, 
together 
with 
targeted 
assistance 
from 
the 
Bank, 
Page  30
23 
the 
EAR 
and 
DFID 
are 
working 
with 
the 
MFE 
and 
the 
Ministry 
of 
Public 
Services 
to 
review 
public 
employment 
and 
wages, 
and 
consider 
options 
for 
decompressing 
the 
scale 
and 
revising 
wages 
which 
can 
be 
sustained 
over the 
medium-term. 
82. 
USAID 
has 
a  large  capacity 
building 
project 
with 
the 
MFE. 
The 
Ministry 
is 
highly 
dependent 
upon 
the 
USAID 
resident 
technical 
advisors, 
who 
occupy 
principal 
positions 
in 
the 
Ministry, 
including 
the 
Budget 
Department. 
Efforts 
to 
ensure 
skills 
and 
knowledge 
transfer 
to local 
counterparts 
is 
critical 
for 
the  sustainability 
of 
these 
technical 
assistance 
projects. 
Efforts 
are 
underway 
to 
expand 
local 
capacity, 
to 
hire 
local 
staff 
to 
work 
alongside 
the 
international 
advisors, 
and 
to 
move 
to 
suitable 
office 
accommodation. 
83. 
In 
the 
area 
of private 
sector 
development, 
the 
team 
has 
maintained 
close 
coordination 
with 
EAR, 
USAID, 
and 
the 
Prime 
Minister’s 
legal 
office. 
For 
2003/04 
EAR 
will 
be 
a 
close 
partner 
in 
assisting 
to 
develop 
and 
implement 
business 
environment 
surveys 
and 
other 
empirical 
studies 
to 
support 
the 
work 
of 
the 
PSAG. 
The 
EAR 
will 
also 
provide 
legal 
support 
on 
preparation 
of 
commercial 
legislation 
to 
both 
the 
Ministry 
of 
Trade 
and 
Industry 
and 
the 
Prime 
Minister’s 
legal 
office 
(particularly 
in 
the 
areas 
of 
company 
and 
contract laws). 
C. 
POVERTY 
IMPLICATIONS 
84. 
Although poverty 
in 
Kosovo 
remains 
widespread, 
a 
significant 
proportion 
of 
the 
poor 
are 
relatively 
close 
to 
the 
poverty 
line 
and 
not 
subject 
to 
severe 
poverty. 
A 
center 
pillar 
of 
the 
Authorities’ 
poverty 
reduction 
strategy 
is 
therefore 
a 
focus 
on 
the 
renewal 
of 
sustainable 
private 
sector 
driven 
e 
conomic 
growth. 
The 
first 
channel 
b 
y 
which 
the 
proposed Operation 
will 
have 
a 
positive 
impact 
on 
s 
ustained 
p 
overty 
a 
lleviation 
i 
s 
b 
y 
p 
romoting 
m 
easures 
aimed 
at 
s 
timulating 
private 
sector 
development 
and 
employment. 
85. 
While 
the 
living 
standards 
of 
most 
of 
Kosovo’s 
poor 
can 
be 
expected 
to 
rebound gradually 
from 
poverty 
as 
the 
economy grows 
and 
job 
opportunities 
increase, 
the 
living 
standards 
of 
the 
extreme 
poor 
may 
not. 
Specific 
anti-poverty interventions 
will 
continue 
to 
be 
needed 
to 
ensure 
a 
minimum 
standard 
of 
living 
for 
this 
group. 
KOSOVO’S 
social 
assistance 
systems 
was 
developed 
under 
emergency 
immediate post-conflict 
conditions, 
and 
measures are 
underway 
to 
improve 
the 
social 
protection 
system 
more 
generally, 
in 
consultation 
with 
the 
Bank 
and 
other 
donors. 
86. 
The 
Authorities 
have 
demonstrated 
a 
clear concern 
for 
social 
issues. 
Through 
improving 
the 
allocation 
of 
resources 
in 
line 
with 
medium 
term 
priorities 
and 
ensuring 
adequate 
and 
sustainable 
service 
delivery, 
this 
Operation 
will 
have 
positive 
impacts 
on 
poverty alleviation 
by 
helping 
to 
ensure 
that 
public 
spending 
should progressively 
be 
targeted 
more, 
and 
more 
effectively, 
towards 
improving 
access 
to 
and 
the 
quality 
of 
services 
to 
the 
poor. 
In 
this 
context, 
the 
Association 
and 
the 
Authorities 
have 
intensified 
their 
dialogue 
to 
develop data 
and the 
analytical 
capacity 
required 
to 
ground 
future 
policy 
decisions 
in 
a 
deeper 
understanding 
oft 
he 
i 
mpact 
o 
f 
e 
conomic 
and 
s 
ocial 
policy on 
the 
livings 
standards 
of 
the 
poor. 
With 
the 
Association’s 
assistance, 
recent 
steps 
have 
been 
undertaken 
to  introduce 
poverty 
monitoring 
on 
a 
regular 
basis 
to 
facilitate 
measuring 
the 
outcomes 
from 
changes 
in 
social protection 
programs and 
to 
contain 
targeting 
errors. 
A 
household 
survey 
has 
been 
introduced 
and 
will 
be 
repeated 
as 
affordable, 
to 
track 
trends 
in 
living 
standards 
Page  31
24 
and 
to 
provide 
estimates 
of 
the 
number 
of 
poor 
and 
extremely 
poor 
and 
the 
poverty 
gap. 
Other 
social indicators 
are 
also 
being 
monitored. 
In 
particular, 
a 
labor 
force 
survey 
has 
been 
introduced 
to 
track 
changes 
in 
employment  and economic 
activity, 
which 
will 
be 
repeated 
quarterly. 
Based 
on 
these 
data, 
the 
Association 
and 
the 
Authorities 
are 
also 
intensifjmg 
their 
dialogue 
on 
the 
equity 
impact 
of 
public 
spending. 
D. 
BENEFITS 
AND 
RISKS 
87. 
The 
proposed 
EAG 
IV 
will 
provide 
a range 
of 
potential 
benefits, 
in 
addition 
to 
the 
positive 
impacts 
on 
poverty 
described 
above. 
First, 
it 
will 
assist 
the authorities 
in 
articulating 
a 
coordinated 
economic 
policy 
reform 
agenda 
backed 
by 
a consistent 
macroeconomic framework. 
Second, 
it 
will 
support 
reforms 
aimed 
to 
improve 
transparency 
in 
public 
finances 
and 
better 
target 
public 
expenditures. 
Third, 
policy 
measures 
to 
promote 
private 
sector 
development 
and 
thus 
drive 
productivity 
and 
growth 
will 
be 
a 
key 
component 
of 
the 
overall 
reform 
package. 
88. 
The 
proposed 
EAG 
IV 
also 
entails 
external, 
political 
and 
implementation 
risks. 
The 
operation 
would 
tackle 
difficult political 
reforms 
in 
a 
complicated 
institutional 
setting. 
There 
are 
risks 
associated 
with 
the 
implementation 
of 
the economic 
reform 
effort 
itself 
that 
largely 
are 
linked 
to 
weak 
local 
capacity. There 
are 
also 
various 
risks 
of 
policy 
implementation. 
Budgetary 
systems 
and 
mechanisms, 
including 
tax 
administration 
and 
collection, 
are 
still 
at 
a 
formative 
stage. 
Strong 
pressures 
also 
are 
being 
felt 
to 
raise 
wages, 
maintain 
over-manning 
in 
public 
services 
and 
utilities 
and 
increase 
overall 
spending 
to 
amounts 
that 
would 
not 
be 
sustainable 
in 
the 
medium 
term. 
Continued tensions 
in 
relations 
b 
etween 
the 
ethnic 
communities 
of 
Kosovo, 
as 
well 
as 
between 
UNMIK 
and 
the 
PISG, 
could 
hamper 
the 
emergence 
of 
a 
firm 
foundation 
for 
structural reforms. 
There 
is 
also 
considerable 
uncertainty 
about 
growth 
prospects 
and 
the 
macroeconomic 
scenario 
is 
associated 
with 
substantial 
risks, 
as 
outlined 
in 
Section 
II. 
Finally, 
the 
EAG 
IV 
tackles 
issues 
which 
have 
proved 
difficult 
in 
other 
economies 
in 
transition. 
Page  32
Annex 
1 
Page 
1 
of 
2 
Kosovo 
- 
Key 
Economic 
Indicators 
Estimate 
Projected 
Indicator 
2000 
2001 
2002 
2003 
2004 
2005 
National 
accounts 
(as 
YO 
of 
GDP) 
Total 
Consumption 
163.9 
147.3 
141.2 
131.0 
119.0 
110.8 
Gross domestic 
investment 
67.8 
54.1 
43.7 
32.7 
24.6 
23.1 
Other 
23.4 
20.4 
23.0 
19.8 
15.2 
15.2 
Donor-Financed Public 
Investment 
Program 
(PIP) 
44.4 
33.7 
20.7 
12.9 
9.4 
7.9 
Exports 
(GNFS)a 
Imports 
(GNFS) 
Gross 
domestic savings 
Gross 
national 
savings 
Memorandum 
items 
Gross 
domestic 
product 
(Euro 
million 
at 
current 
prices) 
10.5 
13.2 
12.4 
11.3 
9.4 
8.9 
145.1 
117.4 
99.3 
76.8 
54.8 
44.4 
1414 
1747 
1990 
2163 
2339 
2530 
Real 
annual 
growth 
rates 
(%, 
calculated 
from 
2000 
prices) 
Real 
annual 
per 
capita 
growth 
rates 
(“h, 
calculated 
from 
2000 prices) 
Gross 
domestic 
product 
at 
market prices 
11.0 
7.0 
4.5 
4.5 
5.5 
Gross 
domestic 
product 
at 
market prices 
Total 
consumption 
Private 
consumption 
Balance 
of 
Payments 
(US% 
millions) 
Exports 
(GNFS)a 
Merchandise 
FOB 
Imports 
(GNFS) 
Merchandise 
FOB 
Resource balance 
Net 
current 
transfers 
Current 
account balance 
Net 
private foreign direct 
investment 
Long-term 
loans (net) 
Official 
Private 
Other capital 
(net, 
inci. 
errors 
& 
omissions) 
Change 
in 
reserves‘ 
Memorandum 
items 
Resource balance 
(% 
of 
GDP) 
Annual 
dollar-value 
growth 
rates 
Merchandise exports 
(FOB) 
Merchandise 
imports 
(CIF) 
148 
231 
247 
244 
220 
225 
2051 
2050 
1977 
1661 
1281 
1124 
-1903 
-1819 
-1730 
-1417 
-1061 
-899 
1336 
1290 
1032 
794 
528 
386 
83 
159 
-40 
-10 
-20 
-25 
0 
5 
IO 
30 
40 
45 
-234 
71 
-10 
-IO 
-10 
-134.6 
-104.1 
-86.9 
-65.5 
-45.4 
-35.5 
Page  33
Annex 
1 
Page 
2 
of 
2 
(Continued) 
Estimate 
Projected 
Indicator 
2000 
2001 
2002 
2003 
2004 
2005 
Public 
finance 
(as 
% 
of 
GDP 
at market 
prices)d 
Current 
revenues 
and 
grants 
17.0 
20.8 
21.4 
22.8 
22.8 
22.8 
Current 
expenditures 
15.7 
16.0 
27.0 
22.8 
22.8 
22.8 
Current 
account 
surplus 
(+) 
or 
deficit 
(-) 
4.9 
-5.6 
0.0 
0.0 
0.0 
Capital 
expenditure 
33.7 
20.7 
12.9 
9.4 
7.9 
Overall 
balance 
-28.8 
-26.3 
-12.9 
-9.5 
-8.0 
Monetary 
indicators 
M2lGDP 
0.086 
0.274 
Price 
indices 
(2000 
=loo) 
Real 
exchange 
rate 
(US$/LCU)e 
Retail 
price 
index 
(YO 
change)f 
11.3 
6.5 
4.0 
3.5 
2.5 
a. 
"GNFS" 
denotes 
"goods 
and 
nonfactor 
services." 
b. 
Includes imputed 
services 
provided by 
donors. 
c. 
On a 
gross 
basis. 
d. 
Consolidated 
general government. 
e. 
"LCU" 
denotes 
"local 
currency 
units." 
An 
increase 
in 
US$/LCU 
denotes 
appreciation. 
f. 
Increase 
in 
GDP 
deflator 
is 
used 
as 
a 
proxy 
for 
Retail 
price Index 
Page  34
Annex 
2 
Status 
of 
Association 
Group 
Operations 
Difference 
between 
expected 
and 
actual 
Original 
Amount 
in 
US$ 
Millions 
disbursementsa 
Project 
FY 
Purpose 
ID 
P 
0 
7 2 4 
0 
5 
PO72814 
PO71265 
PO70365 
PO70295 
PO70046 
PO69629 
PO69325 
PO695 
16 
2002 
2001 
200 
1 
200 
1 
200 
1 
2001 
200 
1 
2000 
2000 
SOC 
PROT 
(KOSOVO 
TF) 
COMM DEV 
FUND 
(KOSOVO 
TF) 
PSD 
TA 
(KOSOVO 
TF) 
PILOT 
WS 
(KOSOVO 
TF) 
URG 
ROAD 
(KOSOVO 
TF) 
ENERGY 
SECTOR 
TA 
(KOSOVO 
TF) 
SME CREDIT (KOSOVO 
TF) 
EMG 
FARM 
RECONSTR. 
(KOSOVO 
TF) 
EDUC/HEALTH 
(KOSOVO 
TF) 
IBRD 
IDA 
SF 
Cancel. 
Undisb. 
Orig 
Frm 
Rev'd 
0.00 
0.00 
4.20 
0.00 
0.00 
5.00 
0.00 
0.00 
3.00 
0.00 
0.00 
4.60 
0.00 
0.00 
5.00 
0.00 
0.00 
2.50 
0.00 
0.00 
5.00 
0.00 
0.00 
10.00 
0.00 
0.00 
4.44 
0.00 
3.73 
2.16 
0.00 
0.00 
1.41 
-3.59 
0.00 
0.00 
0.66 
0.66 
0.00 
0.00 
3.47 
-1.13 
0.00 
0.00 
1.15 
1.15 
0.00 
0.00 
0.75 
0.62 
0.00 
0.00 
0.36 
5.77 
0.00 
0.00 
0.41 
-3.69 
0.41 
0.00 
0.95 
-0.09 
0.00 
Total 
0.00 
0.00 
43.74 
0.00 
12.13 
1.23 
0.41 
Page  35
Annex 
3 
Timetable 
of 
Key 
Processing 
Events 
Identification 
Mission: 
ICM 
Review: 
Preparation 
Mission: 
Pre-Appraisal: 
ROS 
meeting: 
Appraisal: 
Negotiations: 
Board 
presentation: 
July 
2002 
November 
2002 
December 2002 
February 
2003 
April 
2003 
April 
2003 
May 
58,2003 
June 
17,2003 
Page  36
UNITED 
NATIONS 
United Nations 
Mission 
in 
Kosovo 
ANNEX 
4 
Page 
1 
of 
14 
NATIONS UNIES 
Mission 
des 
Nations 
Unier au 
Kosovo 
UNMIK 
14 
May 
2003 
Dear 
Mr. 
Wolfensohn, 
I 
refer 
to 
the 
request 
of 
the 
United 
Nations 
Interim 
Administration 
Mission 
in 
Kosovo 
(UNMIK) 
for 
an 
economic 
assistance 
grant 
amounting 
to 
US 
$5 
million 
from 
the 
International 
Development Association 
(IDA 
or 
-4ssociation). 
It 
is 
my 
pleasure 
to 
transmit 
herewith 
the  attached 
Letter 
of 
Development 
Policy 
(LDP) 
describing 
the core elements 
of 
the economic 
refom 
program 
to 
be 
supported 
by 
the 
Economic 
Assistance 
Grant 
IV 
from 
IDA. 
This 
program 
builds 
on 
progress achieved 
under 
the 
previous policy-based 
budget support operations 
financed 
by 
the 
Association 
and attempts 
to 
integrate 
key 
policies 
related 
to 
fiscal sustainability 
and 
improvement 
of 
the 
business 
environment 
in 
Kosovo. 
The 
Govemment 
of 
Kosovo 
has 
been 
involved 
in 
discussions 
with 
UNMIK 
on 
this 
matter 
and 
has 
reviewed 
the 
content 
of 
the 
Letter 
of 
Development 
Policy. 
UNMIK 
has 
received 
assurances 
from 
the 
Prime 
Minister 
that the 
Govemment 
is 
fully 
committed 
to 
implementing 
the 
economic 
program 
and 
to 
fulfilling 
the 
objectives 
set 
out 
in 
the 
LDP 
(please 
see 
attached 
letter 
from 
Prime 
Minister 
Rexhept 
dated 
8 
May 
2003, 
which 
was 
copied to 
IDA). 
Accordingly, 
unless 
stated 
otherwise, references 
to 
“we” 
in 
the 
LDP 
should 
be 
understood 
to 
refer  collectively 
to 
UNMIK 
and  the 
Provisional Institutions 
of 
Self-Govemment 
in 
Kosovo. 
I 
greatly 
appreciate 
your 
support 
of 
UNMIK’s 
mandate and 
I 
look 
forward 
to 
pursuing the 
reforms 
outlined 
in 
the 
LDP 
in 
cooperation 
with 
the 
World 
Bank. 
Michael 
Steiner 
Special Representative 
of 
the Secretary-General 
Mr. 
James 
Wolfensohn 
President 
The 
World 
Bank 
1818 
H 
Street, 
NW 
Washington. 
DC 
20433 
michaelsteiner@un.org 
Page  37
ANNEX 
4 
Page 
2 
of 
14 
Economic 
Assistance 
Grant 
IV 
- 
Kosovo 
Letter 
of 
Development Policy 
I. 
Introduction 
1. 
The 
United Nations Interim Administration Mission 
in 
Kosovo 
(UNMIK) 
has 
requested 
for 
the 
benefit 
of 
Kosovo 
an 
economic 
assistance 
grant 
amounting 
to 
US$ 
5 
million 
equivalent 
from 
the 
International 
Development Association 
(IDA). 
This 
Letter 
of 
Development 
Policy 
(LDP) 
describes 
the 
core 
elements 
of 
the 
economic 
reform 
program 
to 
be 
supported 
by Economic 
Assistance 
Grant 
IV 
(EAG 
IV) 
provided by 
IDA. 
This 
program, 
building 
on 
progress 
achieved 
under 
the 
previous policy-based 
budget support 
operations 
by 
the 
Association, 
will 
attempt 
to 
integrate 
key 
policies 
related 
to 
fiscal  sustainability 
and 
improvement 
of 
the 
business 
environment. 
2. 
The 
contents 
of 
this 
Letter 
of 
Development 
Policy 
have 
been shared 
with 
the 
Government 
of 
Kosovo, 
which 
has 
been 
involved 
with 
UNMIK 
in 
discussions 
on 
this 
matter. 
UNMIK 
has 
received 
assurances 
from 
the Prime 
Minister 
that  the 
Government 
is 
fully 
committed 
to 
the 
execution 
of 
the 
program 
and 
to 
hlfillment 
of 
the 
objectives 
set 
out 
in 
the 
LDP 
(see 
the attached 
letter 
from 
the 
Prime Minister). 
Accordingly, 
in 
this 
letter, 
unless the 
context otherwise 
requires, 
references 
to 
“we”  should 
be 
understood 
to 
refer 
collectively to 
UNMIK 
and 
the 
Provisional 
Institutions 
of 
Sel 
f-Govemment 
(PISG). 
3. 
Since 
the  end 
of 
the 
conflict 
Kosovo 
has 
been 
gradually 
progressing 
towards 
self- 
government. 
This 
political 
process 
has 
been 
taking 
place 
within 
the 
framework 
of 
UN 
Security 
Council 
Resolution 
1244. 
Following 
the 
adoption 
of 
the 
Constitutional 
Framework 
in 
May 
2001 
and the 
Kosovo-wide 
elections 
in 
November 
200 
I, 
responsibility for 
administering 
the 
territory 
is 
now 
shared 
between 
UNMIK 
and 
the 
PISG.  The  recent  establishment  by  the 
Special 
Representative 
of 
the 
UN 
Secretary General (SRSG) 
of 
a 
Transfer 
Council 
was 
designed 
to 
speed 
up 
the 
transfer 
of 
power 
from 
UNMIK 
to 
the 
PISG. 
4. 
Both 
UNMIK 
and  the 
PISG 
realize 
that 
to 
reach 
beyond  recovery 
to 
longer  term 
sustainable 
growth, 
Kosovo 
will 
need 
to 
make 
further 
progress 
in 
fundamentally 
reforming its 
economy 
and 
its public 
finances. 
Achieving 
the 
authorities’ 
objectives 
of 
a rapidly 
growing 
economy 
with 
increased 
private 
sector 
employment 
and 
an 
overall 
improvement 
in 
living 
standards 
will 
require decisive 
implementation 
of 
a 
broad-ranging structural 
reform 
agenda. 
These 
reforms 
will 
also 
enhance the 
economy’s 
flexibility 
and 
resilience 
to 
shocks. 
This reform 
program 
will 
need 
to 
include 
measures 
to 
support 
(i) 
fiscal 
sustainability, 
adequate 
service 
delivery, 
and 
improved 
budgetary 
outcomes; 
and 
(ii) 
measures 
to 
foster 
private-sector 
driven 
Page  38
ANNEX 
4 
Page 
3 
of 
14 
growth. 
Our 
reform program 
also 
pays 
particular 
emphasis 
to 
capacity 
building 
and 
improving 
the 
well-being 
of 
the 
most vulnerable. 
11. 
Macroeconomic 
Framework 
5. 
Kosovo 
was 
traditionally 
the 
poorest part 
of 
the 
former 
Socialist 
Republic 
of 
Yugoslavia 
(SFRY).  The 
deteriorating 
economic 
conditions 
of 
the 
1990s 
were 
significantly 
accelerated 
during 
the 
crisis 
of 
the 
late-1990s. 
During 
the 
conflict 
of 
1999, 
industrial 
output 
collapsed; 
agricultural 
production, upon 
which 
a 
majority 
of 
the 
Kosovar 
population 
depend, 
plummeted; 
livestock 
herds 
were 
lost 
or 
killed; 
and, 
a 
planting 
season was 
missed. 
Moreover, 
virtually 
all 
social 
services 
and 
government 
systems were 
brought 
to 
a complete standstill. 
There 
was 
also 
significant 
damage 
to 
infrastructure, 
especially 
the 
stock 
of 
private 
housing. 
6. 
During 
the 
past 
three-and-a-half 
years, 
the 
combination 
of 
sound 
economic 
policies, 
institution 
building 
and 
large-scale donor 
assistance has 
yielded 
impressive 
results. 
GDP 
growth, 
has 
run 
at 
double-digit 
levels 
since 
1999, 
driven 
by 
reconstruction 
spending. 
At 
about 
US$ 
1000, 
GDP 
per 
capita 
in 
2002 
was 
more 
than 
twice 
as 
high 
as 
the 
officially 
recorded 
levels 
in 
the 
mid- 
1990s. 
Driven 
by massive 
private 
and 
oficial 
transfers, 
indicators 
of 
disposable 
income 
and 
consumption 
suggest 
an 
even 
stronger recovery 
of 
aggregate 
demand 
since 
1999. We have also 
made 
impressive 
progress 
in 
macroeconomic 
stabilization. 
Following 
the 
adoption 
of 
the German 
Marks 
in 
1999, 
inflation 
has 
fallen to single-digit 
levels. 
Kosovo 
successfully converted 
to 
the 
use 
of 
the euro 
in 
early 
2002. 
7. 
While 
the 
adoption 
of 
a  hard 
currency 
has 
been 
critical 
in 
helping 
to 
establish 
macroeconomic 
stability, 
we 
realize 
that 
it 
is 
also 
placing 
a 
relatively 
heavy 
burden 
on fiscal 
policy. Given 
the 
political 
and 
legal 
uncertainties 
surrounding borrowing,  both 
domestic 
and 
extemal, 
and 
without 
a 
monetary 
policy 
instrument, 
the 
fiscal 
policy 
stance 
will 
depend 
critically 
on 
a 
strong domestic 
revenue 
effort, 
a careful 
calibration 
of 
expenditures 
to 
support 
both public 
investment 
and 
critical 
social 
expenditures, 
and 
continuing 
donor support, 
albeit 
at 
a 
lower 
level. 
8. 
Local 
tax 
revenues 
have 
performed 
impressively since 
1999, 
increasing 
from 
9 
percent 
of 
GDP 
in 
2000 
to 
18 
percent 
in 
2002. 
KOSOVO’S 
overall 
tax 
revenues 
as 
a 
share 
of 
GDP, 
as 
well 
as 
its 
tax 
rates, 
remain 
low 
relative 
to 
other 
economies 
in 
the 
region, 
and 
we 
will 
continue 
our 
efforts 
to strengthen 
tax 
administration 
and 
broaden 
the 
tax 
base. 
Local 
revenues 
will 
finance 
an 
increasing 
share 
of 
our 
public 
spending, 
although 
they 
will 
remain 
insufficient to 
cover 
all 
of 
KOSOVO’S 
fiscal 
expenditure 
needs 
over 
the 
medium term. 
9. 
As for 
tax 
policy, 
and 
as 
recommended 
by 
the 
IMF, 
we 
are 
planning 
to 
keep 
the 
existing 
simple but well-designed tax 
system 
largely 
unchanged. 
We 
plan 
to 
maintain 
a 
uniform 
rate 
on 
both 
consumer 
and 
capital imports 
at present, 
while studying 
alternative 
trade 
policy 
options, 
with 
the 
aim 
of 
lowering 
the 
tariff 
level 
in 
the 
future after 
further 
examination 
of 
the 
possibility 
of 
compensating 
the  revenue 
loss 
through 
an 
increase 
in 
the 
VAT 
rate. 
We 
will 
focus 
our 
attention 
instead 
on improving 
tax 
administration 
and 
nurturing 
a 
culture 
of 
tax 
compliance. 
As 
a 
matter 
of 
urgency, 
the 
draft Regulation on 
Customs Services Procedures 
will 
be 
promulgated. 
Page  39
ANNEX 
4 
Page 
4 
of 
14 
10. 
Despite 
the 
impressive 
economic recovery, 
poverty 
in 
Kosovo 
remains widespread. The 
consequences 
of 
the 
1999 
conflict 
on 
the 
living 
standards 
of 
the 
population 
were 
severe. 
Recent 
estimates 
suggest 
that 
about 
half 
of 
the 
population 
continues 
to 
live 
in 
poverty. 
Although 
poverty 
is 
widespread, 
a significant 
proportion 
of 
the 
poor 
live 
relatively 
close 
to 
the 
poverty line. A 
center 
pillar 
of 
our 
poverty reduction 
strategy 
is 
therefore 
a 
focus 
on 
the 
renewal 
of 
private-sector 
driven 
economic 
growth. 
Our 
reform 
program 
to 
foster 
a 
sustainable 
supply 
response and 
private- 
sector 
growth 
is 
discussed 
below. 
1 
1. 
We 
also 
have 
a 
social 
assistance 
scheme 
in 
place 
which 
was 
developed 
under 
emergency 
immediate 
post-war 
conditions. 
We 
are 
currently 
considering 
several 
measures 
to 
improve 
social 
protection. First, 
it 
should 
be 
recognized that 
we 
have 
already 
both 
successfully 
reformed 
the 
first 
pillar 
of 
our 
pension 
system 
(the old-age pension) 
and 
started 
to 
introduce 
the 
second 
pillar 
of 
funded 
pensions 
through 
the 
Kosovo 
Pension 
Savings 
Trust. 
Given 
the 
extensive 
needs, 
and 
keeping 
in 
mind 
the 
dual 
challenge 
of 
affordability 
and 
administrative 
capacity, 
we 
realize 
we 
cannot 
institute 
a 
social 
assistance scheme 
in 
Kosovo 
right 
now 
that 
would 
meet 
all 
needs. 
Instead, 
we 
look  to  improving 
the 
emergency 
system 
gradually, 
with 
the 
advice 
of 
the 
international community. 
We 
are 
also 
strengthening social 
care 
provision. 
12. 
With 
the 
Bank’s 
assistance, 
we  have  also 
taken 
recent 
steps 
to 
introduce 
poverty 
monitoring 
on 
a 
regular 
basis 
to 
measure 
outcomes 
from 
changes 
in 
social protection 
programs 
and 
to 
contain 
targeting 
errors. 
A 
household 
survey 
has 
been 
introduced 
and 
will 
be 
repeated 
regularly, 
to 
track 
trends 
in 
living 
standards 
and 
to 
provide 
estimates 
of 
the number 
of 
poor 
and 
extreme 
poor 
and 
the 
poverty 
gap. 
The 
availability 
of 
these 
data 
will 
also 
enable 
us 
to 
start 
analyzing 
in 
greater 
depth 
the 
equity 
impact 
of 
public 
spending. 
Other 
social indicators 
are 
also 
being monitored. 
In 
particular, 
a 
labor 
force 
survey 
has 
been 
introduced 
to track 
changes 
in 
employment 
and 
economic 
activity, which 
will 
be 
repeated 
quarterly. 
Finally, 
our 
labor 
code 
has 
been adopted 
and 
we 
do 
not 
have 
any 
encumbrances 
in 
the 
labor 
market 
from 
any 
inherited 
Employment 
Institutes, 
so 
we 
feel 
confident 
in 
the 
flexibility 
and 
functioning 
of 
the 
labor market 
as 
a 
contributor 
to 
economic 
growth. 
111. 
Public Expenditure Management 
Reform 
Context 
and 
challenges 
13. 
Given 
the 
initial 
institutional 
starting position, 
and 
the 
hard 
budget 
constraint, ensuring 
a 
robust 
system 
of 
public financial 
management 
has 
been 
both 
one 
of 
our 
most 
important 
priorities 
and 
challenges. 
We have 
developed 
a 
basic 
system 
for 
the management 
of 
public 
finances 
in 
line 
with 
internationally 
accepted 
budget 
and 
financial 
management  best 
practice. 
In 
the 
face 
declining 
donor 
resources, 
the 
principal 
challenge 
over 
the 
coming 
years 
will 
be 
to 
provide 
adequate 
public 
services 
while 
keeping 
spending 
in 
line 
with 
available 
resources. 
Although 
domestically 
generated 
revenues 
will 
continue 
to 
increase, 
the 
domestic 
revenue 
base 
is 
likely 
to 
remain 
weak 
for 
the foreseeable 
future. 
Donor 
finance 
will 
continue 
to 
be 
crucial 
to 
maintain 
service 
delivery 
and 
public 
investment over 
the 
medium 
term. 
There 
is 
also 
a 
considerable 
institutional 
challenge 
as 
the 
management 
of 
public 
resources 
shifts  from 
the 
UNMIK 
Page  40
ANNEX 
4 
Page 
5 
of 
14 
administration 
to 
the 
local 
govemment 
institutions, 
and 
financial accountability must 
be 
not only 
to 
the 
external 
donors 
but 
also 
to 
the 
people 
of 
Kosovo. 
14. 
Nearly 
four 
years 
after 
the 
end 
of 
the 
conflict, 
many 
of 
the 
technical 
principles 
of 
sound 
budget management 
are 
in 
place. 
Basic 
tax 
and 
customs 
administrations 
have 
been 
established; 
funds 
are spent 
in 
accordance 
with 
a 
pre-formulated, 
publicized, 
and 
authorized 
annual 
plan, 
and 
spending 
plans 
have 
been 
increasingly 
cast 
within 
medium-term macroeconomic 
and revenue 
forecasts; 
a 
treasury 
function 
has 
been 
established, 
with 
a 
consolidated 
fund 
and 
appropriate 
checks 
and 
balances; 
a 
budget 
classification 
system 
has 
been adopted, 
and 
the 
treasury chart 
of 
accounts 
is 
consistent 
with 
the 
IMF’s 
Government 
Finance Statistics 
(GFS) 
methodology; regular 
internal 
and 
external reporting 
routines 
are 
in 
place, 
and 
external audits 
have 
been 
conducted 
for 
the 
1999 
and 
2000 
budgets, 
with 
work 
in 
progress 
on 
the 
2001 
audit. 
15. 
Despite 
good 
progress, 
a 
number 
of 
challenges remain both 
in 
budget 
management 
and 
implementation. 
A 
comprehensive resource 
framework for 
the 
budget 
remains 
absent, 
policy 
formulation 
and 
decision 
making 
processes 
remain 
fragmented, 
and 
the 
effectiveness 
of 
the 
budget 
as 
a 
policy tool 
needs 
to 
be 
further improved. 
In 
the short 
run 
we 
plan 
to 
consolidate 
progress 
with 
budget 
management, 
improve 
cash management, 
and 
ensure 
an 
adequate system 
of 
accountability for public 
finances. 
16. 
Our 
challenge 
over 
the 
next 
3-5 
years 
will 
be 
to 
move beyond 
a budgeting 
approach 
focused 
on 
controlling 
cash, 
to 
one 
where the  budget 
process 
is 
instrumental 
in 
achieving 
a 
medium-term 
strategy 
for 
economic 
development 
and 
poverty 
reduction, 
and 
one 
that 
optimizes 
the 
allocation 
of 
resources 
to priorities. 
We 
face 
this 
challenge 
in 
the 
context 
of 
the 
fiscal 
constraint, 
declining 
donor 
grant-financing 
and 
an 
increased 
reliance 
on 
locally 
generated 
tax 
and 
customs 
receipts. 
17. 
The reform 
measures 
supported 
by 
EAG 
IV 
are 
aimed 
at 
sustaining 
public 
spending, 
increasing 
its 
transparency 
and 
accountability, 
and 
improving 
the 
allocation 
of 
resources 
in 
line 
with 
medium-term 
priorities. 
The 
specific 
actions 
we 
intend to 
take 
under 
the 
course 
of 
this 
operation 
build 
upon 
those 
begun under 
EAG 
I 
and 
11, 
which 
focused 
on 
the 
establishment 
of 
key 
public  institutions 
and 
the 
provision 
of 
essential 
public 
services. 
To 
this 
end, 
EAG 
IV 
has 
supported 
the 
reform 
efforts 
of 
the 
authorities 
in 
addressing key 
bottlenecks 
in 
the 
areas 
of 
budget management 
and 
implementation. 
Policy 
Measures 
to 
Improve 
Budget 
Management 
18. 
Budget 
management 
in 
Kosovo 
faces 
a  particular 
institutional 
challenge 
as 
the 
management 
of 
public 
resources 
is 
shifting  from 
the 
UNMIK 
administration 
to 
the 
local 
govemment 
institutions. 
The 
Constitutional Framework 
provides 
for 
the 
PISG 
to 
have 
certain 
responsibilities 
in 
the 
fields 
of 
economic 
and 
financial policy 
and 
fiscal 
and 
budgetary 
issues, 
but 
the 
final 
authority to 
set 
the 
financial 
and 
policy 
parameters 
for, 
and 
to 
approve,  the 
Kosovo 
Consolidated Budget, 
remains 
in 
the hands 
of 
the 
SRSG. 
We 
have 
worked 
hard 
over 
the 
past 
year 
towards 
establishing 
a 
workable 
and 
coherent 
system 
in 
which 
the 
Government 
and 
the 
Assembly 
play 
an 
important 
role 
in 
formulating 
and 
managing 
the  budget, 
while 
the 
SRSG 
Page  41
ANNEX 
4 
Page 
6 
of 
14 
fulfills 
his 
responsibilities 
under 
UN 
Security 
Council 
Resolution 
1244 and 
the 
Constitutional 
Framework. 
19. 
The 
year 
2002 
was 
particularly 
significant for public 
expenditure management 
in 
KOSOVO, 
with 
the 
establishment 
of 
the 
MFE following 
the 2001 
elections, 
as 
set 
out 
in 
the 
Constitutional 
Framework. 
Many 
budget 
management 
responsibilities 
and 
other 
functions have 
been 
transferred 
from 
the 
UNMIK 
Central Fiscal 
Authority 
(CFA) 
to 
the 
MFE. 
The  need 
to 
ensure 
that 
the 
provisions 
of 
UNSC 
1244 and 
the 
Constitutional 
Framework 
are 
respected, 
whilst 
transferring 
real 
authority 
and 
the 
accompanying 
accountability to 
the PISG, 
has 
created some 
difficulties 
in 
implementing 
the 
handover. 
However, 
we 
believe 
good 
progress 
is 
now 
being 
made. 
20. 
The 
2003 
Budget 
Regulation 
(2002/23) 
was 
promulgated 
by 
the 
SRSG, 
within 
the 
31 
December 
2002 
deadline, 
and based 
on 
the 
draft 
schedules 
submitted 
by 
the 
Minister 
of 
Finance 
and 
Economy 
(WE), 
and 
reviewed 
by 
the Assembly. 
This 
was 
the 
first 
budget 
coordinated by 
the 
PISG, 
and 
elements 
of 
a 
Medium-Term 
Expenditure 
Framework 
were 
incorporated 
into 
the 
budget 
preparation 
process 
to 
improve 
the 
allocative efficiency 
of 
public 
spending. 
As part 
of 
the 
2003 
budget preparation 
process, 
and 
with 
the 
assistance 
of 
the 
World 
Bank, 
we 
also 
prepared 
sector 
strategy frameworks establishing 
policy 
objectives 
for 
the 
sectors and 
linking 
these 
to 
resources. 
As  part 
of 
this 
same 
exercise, 
we 
further 
developed 
medium-term 
revenue 
and 
expenditure 
forecasts 
based 
on 
macro 
framework projections. 
21. 
public 
spending allocations 
in 
line 
with 
medium-term 
spending 
priorities. 
For 
instance: 
As 
a result, 
we 
believe 
that 
the 
2003 budget 
has 
made 
significant 
strides 
in 
strengthening 
(a) 
General budget-financed 
capital 
expenditure 
as 
a 
percentage 
of 
GDP 
has 
increased 
from 
1.2' percent 
to 
3.0 
percent 
as 
we 
realize 
that 
greater 
capital 
spending 
will 
have 
to 
be 
financed 
by 
local 
revenues 
in 
the 
face 
of 
considerable 
remaining 
investment 
needs 
and 
declining 
donor 
finance; 
In 
recognition 
of 
the 
fact 
that expenditure 
on 
non-wage goods 
and services 
is 
currently 
inadequate 
to  maintain  public 
assets, 
we 
are 
planning 
to 
increase 
expenditures 
to 
7.1 
percent 
of 
GDP 
in 
2003. 
This 
will 
help to 
address 
the 
biased 
prioritization 
of 
wage-and-salary 
spending  over 
operation-and-maintenance 
spending; 
and 
As 
a 
critical 
part 
of 
our 
strategy 
to 
broaden the tax 
base, 
we 
have 
doubled 
the 
budget 
for 
the 
tax 
administration 
between 2002 
and 
2003. 
(b) 
(c) 
22. 
Wages-and-salaries spending 
as 
a 
share 
of 
GDP 
has 
risen from 
5.8 
percent 
to 
6.5 
percent, 
between 
2002 
and 
2003. 
This 
is 
largely 
the 
result 
of 
the 
transfer 
of 
powers 
and 
the establishment 
of 
the 
PISG 
budget 
organizations. 
Nevertheless, 
the 
increase 
in 
the 
wage 
bill 
is 
a 
source 
of 
concern. 
We  are 
moving 
ahead 
quickly 
with 
the 
proposed 
review 
of 
pay, 
employment 
and 
structure 
in 
the 
civil 
service. 
Comparison 
is 
made 
with 
the 
2002 
mid-year revision 
data. 
Page  42
ANNEX 
4 
Page 
7 
of 
14 
23. 
A 
cause 
of 
concern 
is 
also 
the 
continuing 
need 
to 
allocate 
funds 
for 
subsidies 
to 
public 
sector 
enterprises. 
In 
the 
2003 budget 
these 
have increased 
to 
the 
Trepca 
mines (by 
43 
percent) 
and 
transport 
enterprises 
(airport 
and 
railways 
by 
108 
percent) although 
they 
also 
fell 
by 
just 
over 
one 
third 
in 
the 
case 
of 
heating, 
and 
water 
and waste. 
The 
financial 
situations 
of 
our 
major public 
utilities 
are 
a 
continuing 
source 
of 
contingent 
liabilities, 
as 
discussed 
below. 
Following 
the 
completion 
of 
the 
audits, 
we are 
planning 
measures 
that 
will 
clarify 
the 
financial situation 
and 
initiate 
the 
restructuring 
process 
of 
the 
publicly-owned 
enterprises 
with 
a 
view 
to 
reducing 
subsidies 
over 
the 
medium-term. 
24. 
The 
2004 
budget 
preparation 
process 
has 
commenced under 
the 
stewardship 
of 
the 
MFE. 
The 
medium-term 
(2004-2006) 
budget 
framework 
with 
indicative 
expenditure 
ceilings 
and 
revenue 
forecasts 
has 
been 
discussed 
at 
the  EFC 
and 
accepted by 
the 
SRSG 
as 
a 
basis 
for 
proceeding 
with 
the 
2004 
budget 
process. 
The 
budget 
circular 
is 
presently 
being 
discussed 
between 
the 
MFE 
and 
UNMIK 
and 
anticipated 
to 
be 
issued 
no later 
than 
Friday, 
May 
16, 
2003. 
Importantly, a 
single 
budgetary 
process 
is 
established, 
for 
both 
the 
institutions 
under 
PISG 
and 
UNMIK 
control, 
under 
the 
stewardship 
of 
the 
MFE. 
25. 
For 
the 2004 
budget 
preparation 
process, 
a 
number 
of 
reforms 
are 
envisaged, 
building 
on 
the 
progress 
made 
last 
year. 
Our 
reform 
agenda 
for this 
year 
includes 
improving 
sector-spending 
plans, 
which 
are 
prioritized 
and 
cast 
within 
expenditure ceilings, 
and 
strengthening 
the 
links 
to 
the 
final 
resource 
allocation. 
We 
will 
develop 
the 
2002 
‘comprehensive development 
framework’ 
approach, 
which 
we 
introduced to 
improve 
sectoral 
level 
links 
between 
policy 
objectives, 
budgets and 
service 
delivery. 
In 
addition, 
we 
intend 
to 
strengthen 
the 
dialogue 
between the 
MFE 
and 
the 
sector 
Ministries 
and 
improve 
guidance 
for 
budget preparation 
with 
respect 
to 
sector 
allocations 
and 
priorities. 
26. 
We 
also 
plan to 
integrate 
the 
Kosovo 
Consolidated 
Budget 
and 
the 
Public Reconstruction 
and 
Investment Program 
(PRIP). 
To 
date 
the 
PRIP 
has 
been 
developed separately 
and 
largely 
as 
a 
tool 
for  channeling 
donor 
resources 
in 
the 
reconstruction 
effort. 
As 
we 
move 
to 
a 
more 
comprehensive 
budgeting 
approach, 
and 
Kosovo 
moves beyond 
the 
reconstruction 
phase, 
it 
is 
important 
to 
integrate capital 
and 
recurrent 
spending 
to 
ensure 
that 
our 
medium-term objectives 
are 
fully 
realized 
and 
sustainable 
through 
well-integrated capital 
projects. 
27. 
In 
the 
medium 
term 
we 
will 
develop 
the 
basis 
for  a 
full 
MTEF 
approach 
to 
budget 
planning. 
As 
the 
institutional 
environment evolves 
and the PISG 
institutions 
strengthen 
capacity 
for  policy 
development 
and 
service 
delivery, 
the 
budget 
process 
will 
be 
more 
effective 
in 
ensuring 
our 
policy 
choices 
and 
service 
delivery 
targets 
are 
achieved. 
The 
development 
of 
performance 
indicators 
is 
also on 
our 
agenda 
for 
the 
medium-term. 
This 
will 
include 
sector-level 
indicators 
to aid 
in 
the 
monitoring 
of 
progress 
with 
respect 
to 
outputs 
and 
outcomes. 
28. 
In 
an 
effort 
to 
further 
strengthen the 
new 
institutions 
of 
budget 
management 
and 
to 
clarify 
the 
institutional 
mechanisms 
for 
economic 
govemance, 
an 
important 
priority 
is 
the 
promulgation 
of 
the 
law 
on 
public financial 
management and 
accountability. This 
Law 
lays 
the 
framework 
for 
the annual 
budget 
process, 
provides a legal 
basis 
for 
the 
roles 
and 
responsibilities 
of 
budget 
Page  43
ANNEX 
4 
Page 
8 
of 
14 
players, 
and 
articulates  a 
budget 
timetable. 
The 
Law  clarifies 
the  complex 
institutional 
environment 
and  establishes 
the 
rules 
for 
a 
comprehensive  budgetary 
process  across 
the 
institutions 
of 
both 
the 
PISG 
and 
UNMIK. 
Our 
principal 
challenge 
looking 
forward 
will 
be 
to 
strengthen 
these 
institutional 
arrangements. The 
Law 
also 
ensures 
that 
there 
is 
only 
one 
process 
within 
which 
decisions 
are 
made 
with 
respect 
to 
the 
allocation 
of 
public 
resources across 
programs, 
be 
they 
under 
PISG 
or 
UNMIK 
responsibility. 
It 
also 
provides 
the basis 
for 
a more 
strategic approach 
to 
budgeting 
as 
Kosovo 
begins 
to 
move 
beyond 
the 
immediate 
post-conflict 
period 
characterized 
by 
revenue 
instability 
and need 
for tight 
cash-control. 
In 
short, the 
Law 
will 
provide 
a 
sound 
legislative 
framework 
for 
ensuring 
fiscal 
discipline 
and 
optimizing 
resource 
allocation. 
Policy Measures 
to 
Improve 
Budget 
Execution 
And 
Accountability 
For 
Public Finances 
29. 
The strength 
of 
a 
public 
expenditure 
management 
system 
in 
maintaining 
aggregate 
fiscal 
discipline 
and 
allocating 
resources 
efficiently 
depends 
to 
an 
important 
extent 
on 
how 
well 
the 
institutions for financial 
management 
and 
accountability function. 
The 
challenge 
we 
face 
is 
to 
establish 
these 
institutions, 
and 
to  encourage 
an 
environment 
where 
public 
officials 
fully 
implement 
their responsibilities 
for 
prudent 
management 
of 
public 
resources. 
Over the 
medium 
term 
our 
main objective 
is 
to 
ensure 
that 
budgets 
are 
executed 
in 
the 
most 
efficient 
and 
effective 
way. Faced 
with 
a 
tight 
cash 
flow 
environment 
our experience over 
the 
last 
two 
budget 
cycles 
demonstrates the need 
to 
build 
capacity 
to 
plan 
expenditures, strengthen 
Treasury 
operations 
to 
ensure 
sound 
cash 
management, 
and 
to 
avoid 
excessive 
surpluses 
while 
at 
the 
same 
time 
obviously 
making 
sure 
all 
commitments 
can 
be 
met. 
30. 
There 
are 
a 
number 
of 
technical solutions 
that 
we 
are 
pursuing 
in 
the 
short 
term. 
This 
includes 
linking 
the spending 
agencies 
to 
the 
electronic 
Treasury 
system, 
thereby 
strengthening 
the 
controls 
over 
expenditure 
and 
improving 
the 
availability 
and 
timeliness 
of 
data 
so 
that budget 
holders 
can 
plan 
and execute 
their 
budgets 
effectively. 
By 
June 
2003, 
we 
anticipate 
that 
all 
Municipalities 
will 
be 
connected 
to 
the automated 
Treasury 
system. 
Over 
the 
medium-term 
we 
intend 
to 
roll 
out 
to 
all 
spending 
agencies  the 
modified 
cash 
accounting 
system 
and 
the 
Freebalance 
FMISl 
expenditure 
control 
system. 
Currently, commitment 
requests and 
intemal 
financial reporting 
are 
undertaken 
manually. 
Our 
reform 
agenda 
includes 
a plan 
to 
create 
a 
government-wide 
network 
connecting 
the 
spending 
agencies 
including Municipalities to 
the 
Treasury 
system, 
and 
to 
establish 
a 
new 
monitoring 
and 
reporting unit 
in 
the 
MFE 
capable 
of 
producing 
accurate 
and 
timely 
monthly 
and 
quarterly reports. 
31. 
We 
are 
also 
developing 
the 
role 
of 
internal audit 
and 
control 
and 
ensuring 
that 
those 
responsible 
for 
public 
resources, 
whether 
at 
central 
or 
municipal 
levels, 
are 
trained 
in 
sound 
financial 
management. 
Now 
that 
an 
internal 
audit 
unit 
has 
been 
established 
in 
the 
Ministry 
of 
Finance, and 
internal 
auditors 
have been 
recruited 
in 
a 
number 
of 
line 
Ministries, 
we 
plan 
to 
move 
ahead 
by developing 
guidance 
and 
manuals 
for 
internal 
audit functions 
in 
line 
with 
IAS 
and 
IASB 
standards. 
We 
plan to 
recruit intemal 
auditors 
for 
all 
first 
level 
spending 
units. 
32. 
In 
the 
past 
regular 
audits 
of 
the budget have 
been 
carried 
out 
by 
external auditors. 
The 
external audit 
function 
is 
critical 
to 
the 
transparency and 
reliability 
of 
public 
sector 
financial 
Page  44
ANNEX 
4 
Page 
9 
of 
14 
management 
systems. 
With 
the 
institution 
of 
the 
new 
assembly 
and 
the 
inclusion 
of 
designated 
public 
entities 
under 
the 
authority 
of 
the 
Auditor 
General 
the 
need 
to 
establish 
the 
independent 
Auditor 
General 
that 
the 
Constitutional 
Framework 
(CF) 
calls for 
is 
even 
more urgent. 
Following 
the 
promulgation 
by 
the 
SRSG 
of 
a regulation establishing 
the 
Ofice 
of 
the 
Auditor 
General and 
the 
Audit 
Office, 
the 
Audit 
Office 
has 
been 
established. 
This 
puts 
in 
place 
a 
key 
institution 
in 
the 
overall 
system 
of 
public financial 
management. 
Terms 
of 
reference 
for 
the 
Auditor 
General 
and 
Deputy 
Auditor 
General 
have 
been 
drafted 
with 
interviews 
to 
be 
held 
before 
the end 
of 
May. 
An 
agreement 
has 
now 
been 
signed 
with 
the 
EAR 
for 
TA 
in 
training 
and 
development. Funds 
have 
been 
allocated 
in 
the 
2003 
Kosovo 
budget, 
local staff 
was 
hired, 
and 
office 
space has 
been 
allocated. 
33. 
Over the 
medium 
term, 
we 
plan 
to 
build 
up the 
Auditor-General's 
Office, 
including 
hiring 
and 
training 
local 
audit 
staff, 
determining a program 
of 
audits for 
the 
forthcoming 
year. 
In 
addition, 
we 
will 
recruit 
and 
train 
internal 
auditors 
for 
all 
first-level 
spending 
units. 
34. 
Until 
recently, 
procurement 
in 
Kosovo 
was 
managed 
under 
the 
terms 
of 
an 
outdated 
administrative 
instruction which did 
not 
provide sufficient control 
over the 
quality 
and 
economy 
of 
the 
goods 
procured 
due 
to 
inadequate 
provision for monitoring, 
analysis 
and 
oversight. 
A 
new 
law 
on 
public 
procurement 
has 
been 
adopted 
by the Government 
and 
submitted 
to 
the 
Assembly. 
The 
new 
law 
upgrades 
legislation 
on 
public 
procurement 
in 
line 
with 
international 
standards and 
moves 
Kosovo 
towards alignment 
with 
European 
law 
in 
this 
area. 
The 
law 
will 
strengthen the 
institutions to 
oversee 
its 
enforcement, 
including 
a 
Public 
Procurement 
Regulatory 
Body 
and 
a 
Public 
Procurement Agency. 
All 
contracting authorities 
governed by 
the 
law 
are 
required 
to 
designate 
a 
Procurement 
Officer, 
who 
will 
be 
required 
to 
undergo 
formal 
training 
in 
the 
correct 
application 
of 
the 
law. 
IV. 
Private 
Sector 
Development 
Reform 
Context 
and 
Challenges 
35. 
Promoting 
economic 
growth 
through development 
of 
the emerging 
private 
sector 
has 
been 
and 
remains 
a 
key 
element 
of 
our 
overall reform 
program. 
Over 
the 
last 
three 
years 
we 
have 
worked 
to 
build 
the 
foundations 
of 
a 
market-based  economy, 
focusing 
our 
efforts  on 
promulgation 
of 
a 
sound 
commercial 
legal 
framework 
and 
development 
of 
the 
institutional 
capacity 
necessary 
to 
enforce 
legislation 
and ensure 
security 
of 
property rights 
and 
commercial 
transactions. 
We have also 
put 
in 
place 
the elements 
necessary 
to 
implement 
the 
program 
for 
privatization 
of 
socially-owned 
enterprises 
(SOEs). 
While 
we expect 
privatization 
will 
promote 
more 
efficient 
use 
of 
these 
assets, 
we 
know from 
the 
experience 
of 
other 
transition 
economies 
that 
the 
main contributor to 
economic 
growth 
and 
job 
creation 
will 
most 
likely 
be 
an 
expanding 
small 
and 
medium 
enterprise 
sector. 
36. 
Like 
other 
transition 
economies, 
Kosovo 
began 
its 
transition 
with 
a 
legal 
framework 
inherited 
from 
the 
socialist 
system. 
Basic 
commercial 
laws 
and 
institutions 
necessary 
for 
a 
functioning market 
economy 
were 
absent. Thus, 
promulgation 
of 
a 
comprehensive 
set 
of 
market- 
based 
laws 
and 
development 
of 
supporting 
institutions 
has  been 
a 
top 
priority. 
The 
primary 
Page  45
ANNEX 
4 
Page 
10 
of 
14 
objective 
of 
the 
prior 
budget  support 
operation 
(EAG 
111) 
was 
to 
strengthen the 
business 
environment 
in 
Kosovo by 
creating 
the 
conditions 
under 
which 
investors' confidence 
could 
be 
restored, 
creditor 
and 
property 
rights could 
be 
protected, 
contracts 
could 
be 
executed,  and 
secured 
lending 
transactions performed. 
Toward 
that 
end, 
we 
have 
made 
significant 
progress 
over 
the 
last 
two 
years, 
passing 
legislation 
on 
business 
organizations, 
foreign 
investment, 
business 
registration, accounting 
standards, 
pledge 
registry 
(for 
movable property), 
regulation 
of 
insurance, 
and 
profit 
taxes. 
37. 
To 
support 
implementation 
of 
these 
laws, 
we 
have  also 
worked 
to 
build 
the 
implementation 
capacity 
to 
enforce  the 
legal 
framework 
by 
establishing a 
modem 
business 
registration 
system, 
a 
pledge 
registry, 
and 
a 
credit 
information 
bureau. 
Additionally, 
we 
have 
supported 
the 
development 
of 
a 
non-profit 
accounting 
association 
to train 
and 
certify 
accountants 
and 
auditors 
and 
promote 
the 
adoption 
of 
modem 
accounting 
standards. 
Finally, 
recognizing 
the 
importance 
of 
an 
efficient 
and 
independent 
judicial 
system 
to 
ensure 
enforcement 
of 
this 
legislation 
and 
the 
integrity 
of 
commercial 
contracts 
and 
other 
transactions, 
we 
have 
launched 
a 
major 
capacity-building 
program 
for 
the 
commercial 
courts, 
including training 
for 
judges 
and 
lawyers 
and 
legal 
assistance 
to 
small 
and 
medium 
enterprises. 
38. 
These  measures, 
combined 
with 
recent 
growth 
of 
the 
banking 
sector, 
have 
helped 
promote a 
significant 
expansion 
of 
private 
economic 
activity 
over 
the 
past 
two 
years. 
However, 
in 
spite 
of 
this 
progress, we have yet 
to 
establish 
an 
adequate 
business 
environment to 
fully 
protect 
and 
enforce property 
rights 
and contracts, 
facilitate 
stable 
entry 
and 
exit 
of 
firms, 
and 
promote 
increased 
private 
sector 
access 
to financing. 
This environment 
increases 
risks 
for private 
investors, 
inhibits 
entry 
and 
expansion 
of 
firms, 
and 
encourages 
firms to 
remain 
in 
the 
informal 
economy. 
These 
constraints 
are 
compounded by 
inadequate and 
inefficient provision 
of 
key 
infrastructure 
services, 
which, 
in 
tum, 
increase 
operating 
and 
transaction 
costs 
to 
the 
private 
sector. 
In 
their 
totality, 
these 
conditions 
both 
constrain 
growth 
of 
fiscal 
revenues 
(by encouraging 
firms 
to 
remain 
in 
the 
informal 
economy) 
and 
require 
a 
significant portion 
of 
public 
expenditures 
to 
be 
directed 
to public 
utilities 
through 
subsidies 
for 
recurrent 
costs. 
39. 
The 
reform 
measures 
supported 
by 
EAG 
IV 
are 
aimed 
at 
promoting 
economic 
growth 
through 
expansion 
of 
private 
sector 
activity 
and enhancement 
of 
budget 
revenues. The 
specific 
actions 
we 
intend 
to 
take under 
the 
course 
of 
this 
operation 
build 
upon 
those begun 
under 
EAG 
111, 
which 
recognized  that 
significant 
gaps 
remain 
in 
the 
commercial 
legal  framework, 
compounding uncertainty 
in 
the 
business 
environment. 
Therefore, 
in 
the 
medium 
term, 
our 
main 
objectives 
are 
to: 
(i) 
continue efforts 
to 
establish 
a 
business 
environment 
which 
is 
conducive 
to 
expansion 
(and 
formalization) 
of 
private 
sector 
activity, 
and; 
(ii) 
improve 
efficiency 
of 
public 
utilities, 
thereby 
reducing 
their 
need 
for 
continued 
subsidies. 
To 
this 
end, 
EAG 
IV 
will 
support 
our 
reform efforts 
in 
the 
three 
priority 
areas 
of: 
(i) 
improvements 
to 
the 
commercial  legal 
framework; 
(ii) 
strengthening 
the business 
environment; 
and 
(iii) 
reform' 
of 
public utilities. 
Policy 
Measures to Strengthen 
Commercial 
Legislation 
40. 
objectives 
are 
to: 
With 
regard 
to 
short-term 
measures 
to 
strengthen 
commercial legislation, 
our 
specific 
Page  46
ANNEX 
4 
Page 
11 
of 
14 
i. 
ensure 
protection 
of 
creditor  rights 
and 
establish 
a 
more 
efficient 
framework 
for exit 
of 
firms 
in 
financial 
distress 
(by 
promulgation 
of 
a 
bankruptcy 
law); 
ii. 
improve private 
sector 
access 
to 
capital 
(by 
promulgation 
of 
a 
mortgage 
law); 
and 
iii. 
validate 
and 
enforce 
property 
rights 
(by 
promulgation 
of 
a 
law 
on 
registration 
of 
real 
property rights, 
and 
submission 
by 
the 
Government 
to 
the 
Assembly 
of 
supplementary 
legislation 
necessary 
to 
render 
such 
law 
effective). 
41. 
We expect 
the 
Bankruptcy 
Law 
to 
enforce 
market 
discipline 
on 
firms, 
create 
a 
more 
predictable 
and stable 
environment 
by 
establishing 
the 
basis 
for 
the 
rights 
and 
obligations of 
both 
creditors 
and 
firms 
in 
financial 
distress  and 
allow  for 
the 
efficient  exit 
of 
failing 
firms. 
Promulgation 
of 
the Mortgage 
Law 
is 
expected 
to 
improve private 
sector 
access 
to 
capital by 
addressing 
a 
legal 
gap 
with 
regard 
to 
collateralization 
of 
immovable property. The 
Mortgage 
Law 
defines the 
basis 
for 
pledges 
of 
immovable 
property, 
and 
includes 
means 
by 
which 
pledges 
of 
commercial 
property 
by 
business 
organizations 
may 
be 
enforced through 
non-judicial 
foreclosure 
in 
cases 
of 
default. 
We 
have 
also 
promulgated 
the 
Law 
on 
Establishment 
of 
an 
Immovable 
Property 
Rights 
Register, 
which 
establishes 
mechanisms 
to implement 
and 
validate real 
property 
rights 
in 
Kosovo, 
and thus supports 
implementation 
of 
the 
Mortgage 
Law. 
Together, 
these 
laws 
advance 
our 
goal 
of 
defining 
and 
protecting 
the 
rights 
of 
both 
creditors 
and 
debtors, 
and are 
expected 
to 
promote 
further 
private 
sector 
access 
to 
commercial credit. 
42. 
In 
the 
medium-term, 
we 
intend 
to 
continue 
our 
efforts  toward 
putting 
in 
place 
a 
comprehensive 
commercial 
legal 
framework by 
drafting 
and 
promulgating 
a law 
on 
obligations 
(contract law), 
a 
company 
law (expanding 
on 
the 
now 
limited 
coverage 
provided by 
the 
existing 
Regulation 
on 
Business Organizations), 
and 
a competition law. 
Policy 
Measures 
to 
Improve 
the 
Business 
Environment 
43. 
and 
expansion 
of 
businesses, 
our 
specific objectives 
are 
to: 
With 
regard 
to 
short-term 
measures 
to 
identify 
and 
remove 
constraints 
on 
investment 
i. 
reduce 
barriers 
to 
entry 
(by 
establishment 
of 
a 
modern 
enterprise 
registration 
system); 
and 
ii. 
identify 
and 
remove 
constraints 
on 
entry 
and 
operation 
of 
businesses 
(by 
establishing 
a 
Private 
Sector 
Advisory 
Group  (PSAG) 
to 
report 
to 
the 
Economic 
Policy 
Roundtable). 
44. 
One 
of 
our 
principal priorities 
with 
regard 
to improving 
the 
business 
environment 
is 
to 
ensure 
that 
our 
regulatory 
policies 
and 
procedures 
do 
not 
impose 
a 
significant constraint 
on 
entry 
of 
new 
small 
and 
medium firms 
into 
the 
market, 
as 
such 
firms 
will 
be 
key 
drivers 
ofjob 
creation 
. 
and 
future 
sources 
of 
tax 
revenue. 
Toward 
this 
end, 
in 
the 
short-term 
we 
have ensured 
that 
the 
Business 
Register 
is 
fully 
operational 
and 
that satisfactory 
arrangements 
are 
in 
place 
to 
share 
data 
with 
the 
tax 
authorities 
to 
enable 
improved 
enforcement 
of 
tax 
regulations.  The 
Business 
Page  47
ANNEX 
4 
Page 
12 
of 
14 
Register 
is 
expected 
to 
process 
business 
registration 
applications 
within 
a 
timeframe 
that 
is 
comparable 
to 
European 
standards. 
45. 
We 
also recognize 
that 
we 
must 
deepen 
our 
understanding 
of 
the 
existing 
business 
environment 
in 
Kosovo 
by 
working 
more closely 
with 
the 
private 
sector 
on 
a 
regular 
basis 
to 
identify 
and 
overcome 
constraints 
faced 
by 
SMEs. 
Therefore, 
we 
have 
established 
a public- 
private 
consultative body 
(the 
Private 
Sector 
Advisory 
Group, 
or 
PSAG) that 
will 
report 
directly 
to 
the 
Economic 
Policy 
Roundtable. 
Membership 
in 
PSAG includes 
representatives 
of 
the 
private 
sector, 
municipalities 
and 
relevant central authorities. The 
PSAG 
will 
work 
with 
donors 
and 
other 
organizations 
to 
periodically 
undertake 
assessments 
of 
the business 
environment 
(through 
surveys 
and 
other tools), 
identify 
policies, 
regulations 
and 
administrative 
procedures that 
impose 
high 
costs 
of 
compliance 
and 
hinder 
investment, entry, 
operation 
and 
exit 
of 
firms (including 
firms 
operating 
in 
the 
gray 
economy),  and 
develop  recommendations 
for 
removing 
these 
constraints. 
One survey, 
focused 
on 
business 
environment 
issues 
facing 
larger enterprises, 
has 
recently 
been 
completed 
by 
EAR. 
46. 
As a 
complement 
to 
the 
EAR-funded 
study, 
we 
expect that 
a 
second assessment 
will 
soon 
be 
undertaken 
to 
assess 
the  costs 
of 
compliance 
with 
regulatory 
and 
administrative 
requirements imposed 
on 
small 
and 
medium 
enterprises 
(SMEs) 
at 
the 
central 
and 
municipal 
levels. 
As 
follow-up 
to 
these 
studies, 
the 
PSAG 
will 
review 
the 
results 
of 
completed 
surveys 
and 
develop recommendations 
for policy, 
legal 
and 
procedural reforms, 
as 
appropriate, 
to 
address 
the 
key  constraints. 
These 
recommendations 
will 
then 
be 
submitted 
to 
the 
Economic 
Policy 
Roundtable 
as 
to 
appropriate 
actions 
to 
overcome 
barriers to entry 
and 
operation 
of 
SMEs. 
47. 
In 
the 
medium-term, 
we 
intend 
to 
continue 
our 
efforts 
to 
improve 
the 
business 
environment 
by 
undertaking 
measures 
to 
improve private 
sector 
access 
to land 
and 
to 
overcome 
bottlenecks 
in 
the 
municipal 
regulatory 
process. 
48. 
One 
key 
constraint 
to 
the 
entry 
of 
new 
enterprises 
is 
lack 
of 
access 
to 
land. 
Socially- 
owned 
enterprises 
(SOEs) 
currently 
occupy 
approximately 
20 
percent 
of 
all 
land 
in 
Kosovo, 
much 
of 
it 
in 
excess 
of 
their 
operational 
needs. 
As 
we 
prepare 
to 
launch 
the 
privatization 
program 
for 
SOEs, 
we 
are 
preparing 
a 
regulation 
allowing for 
transfer 
to 
the 
private 
sector 
of 
use 
rights 
to 
land 
associated 
with 
the 
“spin-off” 
approach under 
long-term, freely-transferable 
leases. 
However, 
there 
is 
uncertainty 
as 
to 
whether 
this 
regulation 
addresses the 
basis 
for 
transfer 
of 
use 
rights 
to land 
associated 
with 
SOE 
liquidation 
candidates. 
(The 
majority 
of 
socially-owned land 
resides 
with 
the 
SOEs 
to 
be 
liquidated.)  Therefore, 
if 
necessary, 
in 
the 
medium-term, 
we 
will 
promulgate 
a regulation 
on 
use 
rights 
of 
socially-owned land 
associated 
with 
all 
SOEs 
under 
terms that 
include 
long-term, freely-transferable 
leases. 
49. 
Related 
to 
the 
constraint 
of 
lack 
of 
access 
to 
land 
is 
the 
absence 
of 
municipal 
spatial 
plans 
throughout  Kosovo. 
Entrepreneurs 
wishing  to 
start 
a 
business 
find 
that 
municipal 
authorities 
are 
unable 
to 
administer 
building 
permits, 
business  licenses 
and 
other 
regulatory 
functions 
due 
to 
the 
absence 
of 
spatial 
plans 
for 
land 
use. 
This condition inhibits 
new investment 
and 
creates 
an 
incentive for 
entrepreneurs 
to 
operate 
within 
the “gray” 
economy. 
Comprehensive 
zoning 
plans 
for 
all 
30 
municipalities 
will 
require 
several 
years 
to 
complete. 
However, 
to 
Page  48
ANNEX 
4 
Page 
13 
of 
14 
overcome 
this 
constraint 
by 
mid-2004, 
the 
Ministry 
of 
Environment 
and 
Spatial 
Planning 
(MESP) 
will 
work 
with 
local 
authorities 
to 
ensure 
that 
all 
municipalities 
will 
prepare and 
approve 
interim 
spatial 
plans 
for 
commercial 
activities. 
Policy 
Measures 
to 
Reform 
Public 
Utilities 
50. 
Restructuring 
publicly-owned 
enterprises 
(POEs) 
to 
improve 
their 
efficiency 
and 
service 
delivery, 
while 
reducing their 
need 
for 
continued 
budget 
subsidies, 
is 
also 
one 
of 
our 
principal reform 
objectives. 
The 
restructuring 
program 
will 
be 
a 
complex 
and 
time-consuming 
process, 
including 
development 
of 
business 
plans, 
separating 
commercial 
and 
non-commercial 
functions, 
incorporation 
of 
various units, labor 
rationalization 
and 
other 
cost 
reduction 
measures, 
improved 
accounting practices, 
and 
development 
of 
the 
regulatory 
framework 
and 
institutional 
capacity. 
As a 
first 
step 
in 
this 
process, 
it 
is 
necessary 
to 
undertake audits 
of 
the 
POEs. 
Thus, 
in 
the 
short-term 
we 
have 
completed 
audits 
of 
the principal 
publicly-owned 
companies 
(KEK, 
PTK, 
water 
and 
waste, 
airport and 
railways). 
51. 
In 
the 
medium-term, 
our 
objective 
is 
to 
prepare 
and 
approve 
comprehensive 
restructuring 
strategies 
for 
all 
POEs, 
drawing 
upon 
the 
results 
of 
the 
audits. 
These 
strategies 
will 
define 
the 
key 
measures necessary 
to improve 
the 
financial 
and 
operational performance 
of 
the 
POEs, 
and 
define opportunities 
to 
introduce 
private 
sector 
participation 
in 
the 
sectors. 
V. 
Conclusion 
52. 
The 
last several 
decades 
have 
left 
Kosovo facing 
considerable economic challenges. 
We 
believe 
that 
the 
measures 
outlined 
above 
demonstrate the 
joint 
commitment 
by 
UNMIK 
and 
the 
PEG 
in 
confronting 
structural 
obstacles 
to 
fiscal sustainability 
and 
private 
sector 
development. 
We 
realize 
the 
importance 
of 
taking 
further 
steps 
towards 
the 
establishment 
of 
institutions 
and 
systems 
that 
will 
allow 
us 
to 
manage 
public 
resources 
efficiently 
and 
transparently. 
At 
the 
same 
time, 
we 
need 
to 
ensure 
that 
the 
poorest 
segments 
of 
society 
are 
adequately 
protected. 
In 
particular given 
the 
poverty 
profile 
in 
Kosovo, 
supporting private 
sector 
development 
will 
be 
a 
core component 
of 
this 
strategy. 
53. 
The 
Association 
has 
provided 
support 
to 
UNMIK 
in 
setting 
up the 
basic 
institutions 
of 
macroeconomic 
management, 
has 
given extensive 
advice 
with 
respect 
to 
the 
preparation 
and 
implementation 
of 
the 
Kosovo 
Consolidated 
Budget, 
and 
has 
worked closely 
with 
UNMIK 
in 
the 
design 
and 
implementation 
of 
the 
commercial framework. 
We 
look 
forward 
to 
the 
continued 
engagement 
of 
the 
World 
Bank 
in 
assisting 
us 
with 
our 
economic 
policies. 
Pristina, 
12 
May 
2003 
Page  49
ANNEX 
4 
Page 
14 
of 
14 
UNMIK 
PROVISIONAL INSTITUTIONS 
OF 
SELF-GOVERNMENT 
INSTITUCIONET 
E PERKOHSHME 
TR 
VETEQEVERISJES 
PRIVREMENE INSTITUCIJE 
SAMOUPFWVLANJA 
PRIME 
MIMSTER 
KRYEMINISTRI 
PREMIJER 
Dear 
Mr. 
Steinm, 
8 
May 
2003 
This 
is 
to  confirm 
that 
the 
Government 
of 
Kosovo 
has 
been closely 
involved 
with 
UNMIK 
in 
discussions 
on 
the 
policy 
reform 
package 
backed 
by 
the 
Economic 
Assistance 
Grant 
4 
(EAG 
4). 
The 
preparation 
of 
the 
EAG 
4 
has 
taken place 
in 
close 
consultation 
with 
representatives 
from 
a 
number 
of 
Ministries. 
Representatives 
of 
the Government 
were 
also 
part 
of 
the Delegation 
that  negotiated this 
Operation, 
and 
the 
Minister 
of 
Finance 
and 
Economy 
and 
the 
Minister 
of 
Trade 
and 
Tndustry 
have 
initialed 
the 
Agreed 
Minutes 
of 
Negotiation. 
We 
are 
fully 
committed 
to 
the 
execution 
of 
the 
program 
and 
to 
hlfillment 
of 
the objectives 
set 
out 
in 
the 
Letter 
of 
Development 
Policy. 
,/' 
With 
iespect, 
Prime 
Minister 
of 
Kosovo 
v 
To: 
Mr. 
Michael 
Steiner 
Special 
Representative 
of 
the 
Secretary 
General 
cc: 
The 
International 
Development 
Association 
Page  50
vrm 
8% 
a, 
a 
Y 
9 
5 
Page  51
c 
.- 
x 
P 
Page  52
Page  53
Annex 
6 
Page 
1 
of 
2 
Kosovo 
at 
a 
glance 
5/15/03 
POVERTY 
and 
SOCIAL 
2001 
Population, mid-year 
(millions) 
GNP 
per 
capita 
GNP 
Average 
annual 
growth, 
199541 
Population 
(%) 
Labor force 
(Sa) 
Most 
recent 
estimate (latest year available, 
199541) 
Poverty 
(% 
of 
population below national poverty 
line) 
I/ 
Urban 
population 
(% 
oftotalpopulation) 
Life 
expectancy at birth 
(years) 
Infant 
mortality 
(per 
1,000 
live 
births) 
Child malnutrition 
(% 
ofchildren under5) 
Access 
to an 
improved water source 
(% 
ofpopulation) 
illiteracy 
(Sa 
ofpopulation 
age 
15+) 
Gross primary enrollment 
(% 
ofschwl-age 
population) 
Male 
Female 
KEY 
ECONOMIC 
RATIOS 
and 
LONG-TERM TRENDS 
GDP 
(Euro 
€ 
millions) 
Gross domestic investmenVGDP 
Exports 
of 
gwds 
and 
services/GDP 
Gross domestic savings/GDP 
Gross national savings/GDP 
Current account balance/GDP 
Interest payments/GDP 
Total 
debVGDP 
Total debt 
servicdexports 
21 
Present value of 
debUGDP 
Present value of debVexports 
(average 
annual 
growth) 
GDP 
GDP 
per capita 
Exports 
of 
gwds 
and 
services 
Kosovo 
Fed. Rep. 
2.4 
50.3 
37 
74 
35 
54 
7 
2000 
Europe 
8 
Central 
Asia 
475 
1,960 
930 
0.1 
0.6 
53 
59 
20 
90 
3 
102 
103 
101 
2000 
1,414 
58 
10 
5.07 
0.0 
2001 
23.6 
18.4 
56.1 
Lower- 
mlddle- 
Income 
2,164 
1,240 
2,677 
1 
.o 
1.2 
46 
59 
33 
11 
80 
15 
107 
107 
107 
2001 
1,747 
54 
13 
9.10 
200145 
6.5 
~ 
Life 
expectancy 
GNI 
Gross 
1 
capita 
nrollment 
primary 
1 
Access 
to 
improved water source 
1 
---Kosovo 
1 
~ 
Lower-middle-income 
m" 
~ 
Economic 
ratios' 
Trade 
~ 
Indebtedness 
-Kosovo 
I- 
Lowermiddleincome 
group 
STRUCTURE 
Or 
the 
ECONOMY 
(Sa 
of 
GDP) 
Agriculture 
Industry 
Services 
Private 
consumption 
General government consumption 
Imports of 
goods 
and 
services 
Manufacturing 
(average 
annual 
growth) 
Agriculture 
Industry 
Services 
Pnvate consumption 
General government consumption 
Gross domestic investment 
Imports 
of 
goods 
and services 
3/ 
Manufacturing 
1988 
1998 
20.4 
28.8 
47.4 
33.8 
1981-91 
199141 
2000 
2001 
113.0 
102.8 
51.5 
48.7 
91.5 
88.7 
2000 
2001 
* 
The diamonds 
show 
four 
key indicatorr in 
the country 
(in bold) 
compared with 
its 
income-group 
average. 
If 
data are 
missing, 
the diamond will 
1/ 
Share of population below 
food 
poverty 
line 
of 
US$0.813/day 
is 
11.9%. 
be 
incomplete. 
Page  54
Annex 
6 
Page 
2 
of 
2 
Kosovo 
PRICES 
and 
GOVERNMENT 
FINANCE 
Domestic 
prices 
(% 
change) 
Consumer prices 
Implicit 
GDP 
deflator 
Government 
finance 
(% 
of 
GDP, 
includes 
current 
grants) 
Current revenue 
2/ 
Current budget 
balance 
Overall surplusldeficit 
TRADE 
(Euro 
E 
millions) 
Total 
exports (fob) 
Food 
Other 
fuel 
Manufactures 
Total 
imports 
(fob) 
Food 
Fuel 
and energy 
Capital 
goods 
Export price index 
(1995=100) 
Import 
price 
index 
(1995=100) 
Terms 
of 
trade 
(i995=100) 
BALANCE 
of 
PAYMENTS 
(Euro 
€ 
miilions) 
Exports 
of 
goods and services 
Imports 
of 
goods and 
services 
Resource balance 
Net 
income 
Net current transfers 
Current account balance 
Financing items 
(net) 
Changes 
in 
net 
reserves 
Memo: 
Reserves including gold 
(US$ 
millions) 
Conversion rate 
(DEC, 
localNS$) 
2000 
16.91 
1.35 
2000 
148 
1,116 
2000 
148 
1,116 
-968 
1,336 
83 
... 
2001 
11.0 
0.0 
20.65 
1.4 
2001 
231 
1.058 
2001 
231 
1,058 
-827 
1,290 
159 
75 
-234 
Export 
and 
import 
levels 
(US$ 
mill.) 
1,200 
800 
- 
95 
96 
97 
98 
99 
w 
01 
Exports 
mlmports 
Current account 
balance 
to 
GDP 
(%) 
10 
- 
9- 
8- 
7- 
6- 
5- 
k- 
3- 
95 
$6 
97 
sa 
99 
w 
01 
5/16/03 
2/ 
Includes current grants.