BULGARIA: Mapping Bulgaria’s Future by World Bank in Bulgaria

BULGARIA

Mapping Bulgariaâ&#x20AC;&#x2122;s Future

Inclusive Growth & Productive Jobs Policy Notes

Europe and Central Asia Region December, 2009

THE WORLD BANK

REPORT No 55597‐BG

BULGARIA Mapping Bulgaria’s Future Inclusive Growth and Productive Jobs

Policy Notes

December, 2009

Europe and Central Asia Region The World Bank

Copyright ©2010 The International Bank for Reconstruction and Development / The World Bank 1818 H Street, N.W. Washington, D.C. 20433, U.S.A All rights reserved Manufactured in the Republic of Bulgaria First printing: July, 2010 Report No. 55597-BG World Bank Policy Notes are among the many reports originally prepared for internal use as part of the continuing analysis by the Bank of the economic and related conditions of its developing member countries and to facilitate its dialogues with the government. Some of the reports are published in this series with the least possible delay for the use of governments, and the academic, business, financial, and development communities. The typescript of this paper therefore has not been prepared in accordance with the procedures appropriate to journal printed texts, and the World Bank accepts no responsibility for errors. Some sources cited in this paper may be informal documents that are not readily available. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and do not necessarily reflect the views of the Board of Executive Directors of the World Bank or the governments they represent. The World Bank cannot guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply on the part of the World Bank any judgment of the legal status of any territory or the endorsement or acceptance of such boundaries. The material in this publication is copyrighted. The World Bank encourages dissemination of its work and normally will grant permission for use. Permission to photocopy items for internal or personal use, for the internal or personal use of specific clients, or for education classroom use, is granted by World Bank, provided that the appropriate fee is paid. Please contact the Copyright Clearance Center before photocopying items. Copyright Clearance center, Inc. 222 Rosewood Drive Danvers, MA 01 923, U.S.A Tel: 978-750-8400 Fax: 978-750-4470

TABLE OF CONTENTS EXECUTIVE SUMMARY................................................................................................ i MACROECONOMIC POLICY................................................................................................ 1 FINANCIAL SECTOR ............................................................................................................ 5 PUBLIC FINANCIAL MANAGEMENT ................................................................................... 9 PRIVATE SECTOR DEVELOPMENT ................................................................................... 16 LABOR MARKET............................................................................................................... 21 INFORMATION AND COMMUNICATION TECHNOLOGIES ................................................. 27 AGRICULTURE AND RURAL DEVELOPMENT ................................................................... 29 FORESTRY ......................................................................................................................... 35 ENERGY SECTOR .............................................................................................................. 40 ROAD INFRASTRUCTURE .................................................................................................. 44 RAILWAYS ........................................................................................................................ 49 ENVIRONMENT ................................................................................................................. 53 EDUCATION....................................................................................................................... 58 HEALTH CARE .................................................................................................................. 64 PENSIONS REFORM ........................................................................................................... 68 SOCIAL SAFETY NET ........................................................................................................ 71

ACKNOWLEDGEMENTS These policy notes were prepared, under the general direction of Florian Fichtl, Bulgaria Country Manager, by a core team led by Kaspar Richter and Stella Ilieva and supported by Eugen Scânteie. The specific notes were prepared by, as follows: Kaspar Richter, Eugen Scânteie (Executive Summary); Kaspar Richter, Stella Ilieva, and Iglika Vassileva (Macroeconomic Policy), Bernard Myers, Stella Ilieva (Public Financial Management), John Pollnеr, Evgeni Evgeniev, and John Gabriel Goddard (Financial Sector), Christian Bodewig, Juan Manuel Moreno, and Lars Sondergaard (Bulgaria: Improving the Quality and Relevance of Education), Kari Hurt, Owen Smith (Health Sector), Christian Bodewig and Boryana Gotcheva (Labor), Asta Zviniene (Pensions), Lire Ersado and Christian Bodewig (Povery Monitoring and Social Assistance), Evgeni Evgeniev, John Pollner (Private Sector Development), Deepak Bhatia (Information and Communications Technology), Holger Kray and Anna Georgieva (Agriculture), Andrew Mitchel and Anna Georgieva (Forestry), Peter Johansen, Claudia Ines Vasquez Suarez, Henk Busz, Eolina Milova (Energy), Mohammed Essakali, Antti Talvitie, and Eolina Milova (Roads and Railroads), Adriana Damianova and Anna Georgieva (Environment).

Executive Summary

EXECUTIVE SUMMARY I. NEED AND OPPORTUNITY FOR REFORM 1. The newly elected government takes office at a time of stark economic challenges. The outfall of the global economic crisis threatens to undo many of the achievements of the recent past, derail convergence with the EU, and heighten social vulnerability. The election of a strong government offers a timely opportunity to restore and broaden the economic reform agenda which had been initiated before EU accession and but lost some momentum since 2007. Decisive action could shorten the length and reduce the depth of the crisis by restoring market confidence and improving economic prospects. 2. Restoring the health of the economy and returning to the convergence path requires concerted policy actions to unwind economic imbalances and advance much needed structural reforms. The two-way policy response would aim to: • Bring about fiscal consolidation and restructure public finances, strengthen financial stability, and mitigate the social impact of the crisis in the short-run. • Step up structural reform to address deep seated economic problems which both magnify the impact of the international crisis and hamper longer-term convergence prospects in the mediumrun. 3. The World Bank stands ready to support the structural transformation of Bulgaria. Collaboration with partners could strengthen market confidence in the stability of the financial system and support Government’s commitment to the currency board by boosting the foreign exchange reserve cover, and anchor the fiscal consolidation and structural reform strategies. 4. The immediate focus is to shore up market confidence in the currency board. The Government is strongly committed to maintaining the currency board with the euro adoption as an exit strategy. Yet, a continued worsening in private and public sector balance sheets could trigger a loss of confidence in the currency board. As international investors take a closer look at the vulnerabilities of emerging economies, there is a large premium on strong domestic policies. While financial markets may have under-priced the risks relative to the fundamentals in Bulgaria and other countries in the region prior to the crisis, this under-pricing has now disappeared. The pendulum is now likely to swing into the opposite direction. 5. As the recession gives way to recovery, Bulgaria can build the foundations for an economy centered on inclusive growth with productive jobs. Restructuring public finances and structural reforms are crucial to protect priority spending that improves prospects for jobs and growth. In addition, it includes building on the recent advances in education reform to raise labor productivity; and to increase labor market flexibility to support the reallocation of resources from the non-traded to the traded goods and services sectors. 6. Institutional reforms with regard to transparency, accountability and good governance are also critical. Weak public administration, ineffective oversight of regulatory authorities and inefficient judiciary systems hinder Bulgaria’s economic and social development. Tackling the issue of corruption is vital for promoting a competitive business environment and equitable access to quality public services.

Executive Summary

Reflecting ambitions embraced as part of the Lisbon agenda, this requires: Improved economic management through a more effective and transparent public administration; • Enhanced economic competitiveness through more knowledge-based and innovative businesses operating in a business-friendly environment; • Enhanced network through greater investments in sustainable infrastructure and energy; • Improved access and quality to public services. •

8. A successful implementation of such an ambitious program relies on strong economic management to leverage the strong linkages and synergies across the policy dimensions. This requires: • Strong leadership, coordination and harmonization of reform; • Transparent formulation and broad political commitment; and • Outcome-orientation through performance monitoring and evaluation. 9.

This executive summary highlights key challenges and policy options to: Mitigate the economic crisis and support the recovery, the urgent priority over the shortterm; and • Bring about sustainable recovery and economic convergence with the leading economies in the European Union over the medium-term. These policy options are neither exhaustive nor definitive, but they may contribute to the articulation of the Government’s own program for reform in consultation with other stakeholders. •

EXECUTIVE SUMMARY

MAIN REPORT

Need and Opportunity for Reform

Improved Economic Management Macroeconomic Policy

Policies to Mitigate Crisis and Support Recovery

Financial Sector Public Financial Management

Consolidating the Public Sector Restoring Financial Market Confidence

Unlocked Business Potential

Mitigating the Social Costs

Private Sector Development

Policies to Underpin Structural Change

Labor Market Information and Communication Technologies Agriculture and Rural Development Forestry

Improving Public Financial Management Unlocking Business Potential Upgrading Infrastructure and Mitigating Climate Change Investing in People

Enhanced Networks of Infrastructure and Energy Policy Vision, Coordination and Partnership

Energy Sector Road Infrastructure Railways Environment

Improved Public Services Education Health Care Pensions Reform Social Safety Net

Executive Summary

II. POLICIES TO MITIGATE CRISIS AND SUPPORT RECOVERY A. Consolidating the Public Sector 10. With fewer resources, the government faces the difficult challenge to protect priority economic and social programs while ensuring medium-term fiscal consolidation. The recession is undermining the health of the public sector. During the boom years, Bulgaria could accelerate spending and accumulate a fiscal reserve thanks to rapidly rising revenues. Now, during the crisis, revenues are falling requiring cuts in expenditures in order to limit the impact on the fiscal balance. 11. Reconciling these objectives will require embedding fiscal policies in a medium-term fiscal consolidation strategy: •

There is no room for discretionary fiscal stimulus beyond the operation of automatic stabilizers in view of the large increase in expenditures and the sharp decline in revenues in the first five months.

• Expenditures will have to deliver the bulk of the fiscal adjustment, as Bulgaria’s revenueto-GDP ratio (39 percent of GDP in 2008) is already relatively high given Bulgaria’s per capita income level. • One the expenditure side, the new government will have to adjust expenditure policies for 2009 and 2010 in order to restructure public spending to improve the structural balance and safeguard priority economic and social programs:  The 90 percent rule to limit non-interest and non-social transfer public spending is likely to be insufficient to maintain the 2009 and 2010 fiscal deficits below the Maastricht criterion of 3 percent of GDP.  Moving beyond across-the-board-cuts towards expenditure prioritization will improve the quality of the fiscal adjustment.  Over the medium- to long-term, the government has to address the fiscal impact of demographic change – the EU projects that age-related public spending in Bulgaria will increase by close to 4 percentage points of GDP between 2007 and 2060. • One the revenue side, the government could take measures to limit the drop in revenues due to weak economic activity and dwindling tax bases:  Improving the utilization of EU funds can help to protect vital growth-related public spending, and to boost the transparency of public spending.  Introducing compensating measures, including the broadening of revenue bases, to mitigate any negative fiscal impact of reductions in tax and social security contribution rates.  Raising compliance by strengthening the Large Taxpayers and Contributors Unit, increasing e-filing of tax and social contributions, and accelerating the implementation of the second phase of the Revenue Management System can contribute to stabilizing revenue collection. Improving the information flows and coordination between the NRA and the Customs Agency is likely to contribute to reducing non-compliance and tax fraud in the medium term. • In the trade-off between protection of priority programs and fiscal consolidation, strengthening fiscal rules and institutions through performance-based budgeting, medium-term expenditure frameworks and promoting public-private partnerships provides scope to improve

iii

Executive Summary difficult choices. Such reforms can help build fiscal policy credibility and predictability, bring greater focus on the results from government spending, ease fiscal pressures and improve spending efficiency. • Presenting a euro-adoption timetable that is ambitious yet realistic could support market confidence. The credibility of such a timetable will depend on progress towards meeting the economic and fiscal conditions for the introduction of the common currency.

B. Restoring Financial Market Confidence 12. The economic crisis poses significant risks to the private sector. This includes a rise in non-performing loans (NPLs) on the back of the recession; uneven funding of banks’ operations, including the rollover of external debt; and high foreign indebtedness of the corporate sector. As the slowdown in economic activity reduces profit margins of the corporate sector and incomes of households, non-performing loans will increase. This could affect capital adequacy ratios of the banking system, which in turn would further curtail credit to the private sector. The reliance on cross-border funding has exposed banks in Bulgaria, just as in the Baltic countries, Hungary and Romania, to potential balance sheet pressures of their parent banks in their home markets, even though, to date, subsidiaries of foreign banks have largely maintained their exposure. Nevertheless, as foreign capital inflows will remain more modest in future, credit growth to the enterprise sector will slow down. 13. The recovery from the economic crisis depends foremost on restoring financial market confidence. This requires a forceful and coordinated policy response aimed at providing financial institutions with access to liquidity, , ensuring adequate capitalization of all institutions, facilitating corporate debt restructuring and resolution, and stepping up supervision, regulation and consumer protection. In view of the large foreign ownership of the banking system, this requires close coordination with authorities and banks from EU15 countries. Key actions include the following: • The authorities could stress-test the likely capital reduction of the banking system to incorporate the worse economic outlook. For foreign-owned bank subsidiaries, this would require close coordination with overseas home country regulatory authorities, in order to conduct joint simulation exercises. At the same time, the BNB could continue to develop its modeling capabilities to independently evaluate at a high frequency the risks and capital contingencies required of banks. • While parent bank commitments are welcome to maintain liquidity in the sector, the authorities should continue to strengthen transparency provisions in corporate law to ensure full and reliable identification of interconnected exposures with banks, shareholders and owners. • The legal and regulatory framework of non-bank financial institutions is consistent with EU Directives, but enforcement and risk management is lagging. Given the depreciation of the pension funds assets, the authorities could review investment regulations to facilitate the adoption of life cycle and multiple fund types to reduce market risk for near-retirees; and consider the design of the pay-out phase including defining the retirement products and their regulation while taking into account market, credit and longevity risks to beneficiaries and the industry. •

The Government could assess whether the legal and regulatory framework provides flexibility for debt workouts as well as corporate restructuring windows without formal bankruptcy procedures that typically clog up the judiciary system to allow firms to continue

Executive Summary viable operations and service existing debt while the supply, price, and maturity of credit remain constrained. It would be useful to carry out Insolvency and Creditor Rights Report on the Observance of Standards and Codes. • In order to smooth the impact of economic crisis on employment and in investment the Government could consider supporting credit lines to viable enterprises under temporary credit constraints consistent with the EC framework for State aid measures to support access to finance in the current financial and economic crisis.

C. Mitigating Social Costs 14. Targeted government spending can provide effective relief to vulnerable households affected by the economic crisis. The recession will lower household income through rising unemployment, a contraction of the informal economy, and cutbacks in wages. The global crisis will also affect remittances from Bulgarians working abroad. Overall poverty is projected to increase by end-2010 by 2.9 percent (i.e., an estimated 182,000 people falling below the poverty threshold), while the number of extreme poor could increase by 14 percent and exceed 400,000. A guiding principle for the social policy should be to protect people rather than industries, firms or jobs. Scaling up Bulgaria’s anti-poverty programs that are well targeted but have low coverage will support household income of poor and vulnerable people. It will also support the recovery of the economy, as cash-strapped households are most likely to transfer higher assistance into higher spending. While for the chronic poor and those employed in the informal sector the support would be offered through social assistance benefits, unemployment benefits and short-working hours schemes would offer the necessary protection for those losing formal employment. 15. The Guaranteed Minimum Income (GMI) could provide the most effective response to rising poverty and increased demand for social safety net benefits due to the crisis. • The modest GMI budget allocation could be maintained but fully executed. The budget allocation has been kept at BGN85.8 million since 2006, but actual expenditure fell from 97 percent of the budget in 2006 to only 45 percent in 2008. This suggests that there is fiscal space for an increase in beneficiary numbers expected in the wake of the economic crisis. • GMI eligibility criteria could be simplified with a view to maintaining the GMI primary objective of a last resort social safety net. • The introduction of a temporary GMI top-up benefit could be considered without raising the eligibility threshold permanently to address transient poverty risks. • The monitoring of GMI could be strengthened to scale-up the most effective tools and experiences. 16. Labor market measures in response to the crisis could include the following: • Provide subsidies for short-working hours schemes. • Consider extending the duration of unemployment benefits as a temporary measure combined with support of the beneficiaries in finding jobs through job search assistance and training in return for intense job search effort. • Provide fiscal incentives for re-training laid-off workers and workers on short-working hour schemes. • Promote part-time and flexible work arrangements. • Public works programs of employment offices could be continued.

Executive Summary

III. POLICIES TO UNDERPIN STRUCTURAL CHANGE 17. The European Economic Recovery Plan and the Lisbon agenda highlight the need to maintain attention on longer-term development issues and invest in the future. Short-term measures to mitigate the impact of the crisis should be coupled with medium-term actions to promote sustainable growth with productive employment. After all, the economic crisis has put a greater onus on countries to innovate. Countries that fail to reform face the risk of lower living standards, marked by anemic growth, weak investment, and poor social services. Sustainable growth with equity entails further structural transformation of the Bulgarian economy. The crisis offers an opportunity to question, remove or alleviate longer term constraints to economic growth, unlock new sources of productivity to enhance competitiveness, and ensure that the benefits of growth are shared more equitably.

A. Improving Public Financial Management 18. Raising efficiency and effectiveness of public spending is key to economic recovery and to advancing productivity enhancing reforms. Important steps in that direction have already been undertaken with the introduction of medium-term expenditure framework (MTEF), the rollout of performance based budgeting to all line ministries and the efforts to strengthen management and budgeting of public investment projects. Consolidating these major public finance reforms has the potential to result in large improvements in the management and allocation of public resources, instill performance-oriented culture in public administration, and increase accountability and transparency of public spending. Progress in this area would represent a major contribution towards transparent governance and for prevention and counteraction of corruption. Therefore, it is important that these reforms are continued and benefit from support at a senior political level. 19. In the short-term, it is important to reinvigorate the implementation of the MTEF and demonstrate potential positive effects of performance budgeting to all participants. This would require: • Institutionalize the performance based budgeting in the organic budget law. • Improve the quality of performance information and tailor it to the needs of different audiences. Introduce formal feedback from MOF to line ministries on their program budget. • Strengthen MOF’s authority to protect efficiency and effectiveness of public expenditure and revise MOF’s internal structure to address fragmentation of budget management responsibilities. • Review the current allocation of functions and responsibilities of state bodies to identify redundant functions and overlapping responsibilities and develop plan for a phased approach to address identified weaknesses. 20. In the medium term, performance based budgeting and public investment management would need to be further enhanced. Important steps would be to: • Institutionalize sector expenditure reviews and program evaluations followed by agreement with MOF and Parliament on performance improvement plan. • Introduce systematic process for monitoring the implementation of public investment projects, including through mid-term and ex-post evaluations of projects. • Establish and build capacity for policy planning units close to the Minister’s Office to better integrate strategic planning and budgeting.

Executive Summary B. Unlocking the Business Potential and Investing in Knowledge and Innovation 21. While unlocking Bulgaria’s business potential requires actions on many fronts, this section highlights issues that present the Government with an opportunity for quick returns: the excessive and unpredictable business regulation; the low rate of innovation and technology absorption; the lag in the area of information and communication technologies (ICT); and the transformation of agriculture. 22. Bulgaria’s productivity gap with the rest of the EU is partly due to the poor quality of business regulation and its enforcement. Undisputable progress towards reforming regimes dealing with paying taxes, enforcing contracts and granting construction permits helped attract high FDI inflows and boosted exports. At the same time, excessive, unpredictable and at times discretionary regulations foster unfair competition from informal business and encourage corruption; exit procedures for firms are long and onerous; state fees are established on an ad-hoc basis and are unfair and non-transparent; and regulations issued by local administrations ignore national legislation and burden business in terms of cost and time. 23. In the short-term, policy options to improve regulations include the following: • Extend the Better Regulation Program. • Review regulatory regimes adopted not in compliance with the Law to simplify or eliminate them. • Eliminate systematically abusive or redundant regulatory regimes applied by central and local authorities; amend the Limiting Administrative and Control on Economic Activities Act to ensure compliance by State authorities and adopt principle of silent consent; implement Better Regulation Units in all ministries and their coordination by the central unit in the PM’s office. • Submit to Parliament a new Law on Normative Acts mandating Regulatory Impact Assessments (RIA). • Develop State fee policy. • Amend legislation to speed up firm exit, on the basis of Insolvency and Creditor Rights Report on the Observance of Standards and Codes. 24. In the medium-term, important steps would be to: • Reduce the administrative burden of regulatory regimes by 20 percent through 2012 in consultation with business and public; adopt a new State Fees Act based on the principle of cost recovery and enforce its application. • Eliminate illegal application of regulatory regimes by municipalities in coordination with the National Association of Municipalities. • Convert municipal registration and permission regimes into simple notification. • Review provision of administrative services by municipalities. • Implement Action Plan to streamline them and reduce the time and cost of compliance by firms. 25. In the labor market there is a mismatch between available skills and the needs of the economy; barriers hamper access of women and low-skilled workers; older workers leave prematurely; and life-long learning opportunities are inadequate. Short-term labor market policies are crucial for the crisis response, as already discussed. In the medium term, labor market reforms could: • Pilot apprenticeships, internships and wage subsidy programs for young workers. • Develop a mandatory youth-centered activation approach focused on youth who are not in employment, education or training (NEET).

vii

Executive Summary • Facilitate the participation of women to the job market through improved child and elderly care services. • Promote “second chance” education programs for low-skilled adults. 26. Productivity gains are also linked to higher innovation and technology absorption. Bulgaria lags in this respect compared to other EU members and competitors in the region. Its exports are mostly in low technology sectors, and there is little FDI in manufacturing. The main issue is low investment in research and development (R&D) in general, and by the private sector in particular: Bulgaria’s R&D expenditure was 0.48 percent of GDP in 2006, against the Lisbon Agenda target of 3 percent by 2010, and private R&D was only 0.16 percent of GDP, compared to the Lisbon target of 2 percent. The modest public funding of R&D is further diluted by nontransparent allocation of resources, and lack of explicit performance indicators. 27. In the short-term, policy options include the following: • Develop an integrated National Strategy on Innovation and Research under the guidance of high-level consultative council representing Government, research and industry. • Increase the use of competitive award of public R&D funds and performance metrics. • Adopt a new R&D and Innovation Law and related regulation governing the operation of the merged National Innovation and Science funds. 28. In the medium-term, priority measures are to: • Conduct consultative annual evaluation of the national innovation system; creation of business angle network. • Expand the network of technology transfer centers. • Use matching grants and loans to facilitate the access of SMEs to new technology. • Promote supplier development programs to enhance transfer of knowledge and technology from buyers. • Enforce intellectual property rights; and stronger links between research institutions, universities and industry. 29. Bulgaria lags in the area of ICT despite the strong performance of its information technology (IT) industry and IT-enabled services. Only 28 percent of households have broadband access, compared with 49 percent on average in EU27, and the implementation of the Government’s 2006 Strategy for the Information Society has been slow. The Government’s policy options must address the regulation of market dominance by the Bulgarian Telecommunications Company (BTC) which controls 97 percent of the wireline market, the shortage of skills, the digital literacy gap, and the insufficient investment in broadband infrastructure. 30. In the short-term, policy options include the following: • Implement advanced regulatory reform to enable the CRC (Communications Regulations Commission) to play its role. • Support the development of broadband infrastructure in partnership with providers, including Government financing through funding of a consortium or competitively allocated subsidies. • Implement a “quick win” programs to design and implement ICT programs in public institutions, starting with a Public Financial Management Information System. 31. In the medium-term, policy options could be to: • Leverage development of e-government services by the local IT industry within EU competition guidelines.

viii

Executive Summary • • •

Implement “quick-win” e-services for citizens. Review and update of National Information Society Strategy. Mainstream ICT in national strategies and programs.

32. The transformation of agriculture is central to Bulgaria’s European convergence. The contribution of agriculture to sustainable growth and poverty reduction is well below its potential, despite considerable public expenditure and access to EU funds. Land ownership is fragmented and farms are highly polarized, with 75.4 percent of holdings cultivating only 6.6 percent of the agricultural area, and 0.8 percent of holdings cultivating 78.5 percent in large farms; EU payments for farmers’ support benefit only a little more than one-quarter of the agricultural population; the emergence of competitive intermediate farms faces multiple obstacles, public financing is not well targeted to competitiveness and equity objectives, is poorly planned and executed, is nontransparent, may overlap with EU funding, and sometimes may undermine goals for increased competitiveness; policy formulation and its articulation with public expenditure is weak; and the mobilization of EU resources is slow. 33. In the short-term, Government actions could include: • Limit application of CNDP to 30% of EU15 average to respond to fiscal constraints. • Assess fiscal space to address additional resource requirements related to the end of the reverse modulation of EAFRD funds to CNDPs. • Assess the need for sub-sectoral adjustments such as, for instance, further shift of CNDP resources from crop to livestock schemes. • Consider improved awareness campaigns for RDP measures experiencing limited uptake • Establish high level policy unit within MAF that provides for strategic analysis and coordination, and informs budgeting and medium-term sector planning, including monitoring of performance information • Finalize programming for discontinuation of Existing State Aid under the sunset clause and definition of Registered State Aid for accreditation by the EC. 34. In the medium-term, the Government could: • Monitor adequacy of registered reference area for SAPS payments in light of mediumterm sector development trends to avoid potential absorption losses or underdeclaration • Consider gradual annual reduction of CNDPs and shift of released financial resources to National Program funding public investment priorities not funded by the EU. • Ensure timely initiation of the programming of RDP 2014-20 to allow for adequate analysis, stakeholder consultation, and EC accreditation process • Develop strategies for MAF support to voluntary land consolidation and investments in hydro-amelioration. • Elaborate concept and provide adequate funding for provision of more quality-oriented, client-responsive advisory services • Mainstream incentives for climate change adaptation and mitigation into sector support programs (Pillar 2 and National Programs). 35. Reforms in the forestry sector would need to focus on strengthening the policy framework and effectiveness of forest sector institutions and on improving the commercial viability of forest enterprises. The National Strategy for Sustainable Development of the Forest Sector in Bulgaria, 2003-2013 was never adopted by the National Assembly while the Strategic Plan of Action for Forest Sector Development in Bulgaria (2007 to 2011), which was formally adopted by COM, was severely underfunded. Roles and responsibilities of forestry institutions overlap and undermine the reform; forest consolidation policy has suffered from serious

Executive Summary deficiency in implementation; and there is deeply held perception amongst society that corruption in the sector is endemic. The commercial viability of the state forest enterprises and hunting areas is questionable while environmental and biodiversity risks have not been fully taken into account. 36. In the short-term, Government actions could include: • Developing a road map for reform in the sector. • Rationalizing the network of state forest and hunting enterprises to ensure their financial sustainability, including institutional incentives for environmentally sustainable forest management. • Apply a moratorium on land use change following the swap or sale of State or municipally owned forests, to ensure the continuing provision of environmental and social goods and services. 37. In the medium-term, the Government could: • Improve the institutional and legal framework for management of privately owned forests to place them on equal footing with state forest and hunting enterprises. • Make more competitive the sale of state owned timber. • Improve the transparency in all dimensions of forest management, particularly with respect to markets, land transfers, revenue collection, etc. • Develop a comprehensive Forest Monitoring and Management Information System that integrates forest management plans, and supply it with real-time information on harvests and markets.

Upgrading Infrastructure and Energy and Mitigating Climate Change

38. Improving productivity hinges on developing adequate transport infrastructure and ensuring security of energy supplies, including through energy efficiency and renewable energy, supported by environmental mitigation policies and programs. In all these areas Bulgaria has moved forward, but important challenges remain. 39. The energy sector has gone through important institutional, regulatory and structural reforms that need to be consolidated to address the remaining challenges. Energy efficiency is five times lower than in Western Europe, and half the level in Central European countries in part because energy losses are high. The electricity market is not truly competitive, with generation and distribution dominated by the National Electricity Company (NEK). The creation of the Bulgarian Energy Holding (BEH EAD) could potentially put at risk competition in the gas and power markets. Energy prices cannot meet investment and (in the case of district heating) service costs and does not provide incentives for reducing demand for energy. Mitigation of the impact of energy tariff reform on the poor should be further strengthened. There is major untapped renewable energy potential. Natural gas use should be increased but alternative sources and routes should be identified and opened up. 40. In the short-term, policies need to: • Ensure strategic selection of new investments in generation capacity based on a thorough analysis of costs and benefits of such investments. • Step up market regulation to deter anti-competitive behavior and improve access to the electricity market. • Implement a comprehensive price reform. • Expand gas storage capacity. • Promote energy efficiency and the use of renewable resources. 41. In the medium term, priorities are to: • Lift gradually the obligation of generators to sell power to the public supplier (NEK).

Executive Summary • Diversify gas supply sources and routes and further increase underground gas storage. • Promote high-efficiency cogeneration plants in areas with high demand for district heating and set up regulations that encourage efficient technologies and management in generation, transmission, distribution and use of energy. 42. Road infrastructure modernization has been delayed by weaknesses in governance and management and funding uncertainties. State financing doubled over the last three years and is projected to reach EUR 600-700 million per year in 2009-2013. However, road safety continues to exact a heavy economic and human toll while road rehabilitation and maintenance needs are high. The institutional framework for road management remains fragmented with responsibilities shared by at least 5 agencies (including local governments). The governance and management structure of the National Road Infrastructure Agency (NRIA) is not conducive of effective road infrastructure development as NRIA’s capacity to evaluate, prioritize and implement large projects is limited. 43. In the short-term, actions could: • Clarify the roles and responsibilities of all key actors in road infrastructure. • Develop a business plan and strategy for NRIA and entering into performance agreement with the State that sets key performance targets. • Enhance NRIA’s governance structure and strengthen its planning and monitoring functions. The NRIA needs to continue the development of the Road Asset Management Systems and remove obstacle to project implementation. 44. In the medium-term, road infrastructure could continue the reorganization of NRIA including by optimizing its regional structures. 45. Railway reforms need to move to developing a flexible and nimble railway industry that can adapt to rapidly changing business environment. This means that Government and the State-owned railway companies should embark on a cultural change program to clarify Government roles in the railways sector and boost the organizational performance of the companies to enable them to develop a market-driven business strategy, analyze where efficiency and productivity gains are needed and where investments would be most productive, and balance State-supported public policy choices with available fiscal space. 46. In the short-term, priority actions relate to enhancing viability and productivity of railway companies and refining the role of the government. Measure could include to: • Adjust staff and assets to demand. • Increase private sector participation in freight services and adjustment of the level of passenger services to budget constraints. • Improve strategic planning, selection and programming of investments and capacity to implement large investment projects. • Enforce decisions based on sound business considerations. 47. In the medium term, measure to modernize the railways could include the following: • Expand the use of ICT for train control, signaling and interlocking and modernizing infrastructure maintenance. • Strengthen management and governance of state-owned companies. 48. Environmental and climate change mitigation challenges include the management of protected areas and Natura 2000 sites; conservation and rehabilitation of wetlands, natural habitats

Executive Summary and the Black Sea coast; and management of waste water treatment, of solid waste, and of industrial pollution, including emissions from coal-fired power plants. 49. In the short term, environmental and climate change mitigation could envisage to: • Develop a national network of protected areas to link it to Natura 2000. • Improve operational efficiency of water companies--decrease administrative losses, increase bill collection rates; implement a comprehensive network leak detection program. • Provide incentives for solid waste reduction and sorting at source (including raising fees for waste collection and gate fees). 50. In the medium term, Government could: • Consider the creation of an environmental police force. • Prepare a National Strategy for preserving and restoring wetlands; including management plans for key wetlands (e.g. Danube flood plain, coastal and Maritza river wetlands, Ramsar and Natura 2000 sites, and bird sanctuaries). • Develop a system for monitoring habitats and species and provide adequate financing of activities for species and habitats preservation.

D. Investing in People 51. The productivity gains essential to reaching income and standards of living EU convergence hinge on reforms in education, health, labor market, and pensions. Bulgaria faces important challenges in all these areas. 52. In education, many students leave school early, or insufficiently prepared for the knowledge economy; student performance is highly unequal; the relevance of vocational education and training (VET) to the labor market demand is often low; student assessments have yet to be linked to school performance; progress towards introducing performance and career development incentives for teachers needs to continue; curriculum content needs to be redefined; pre-primary education leaves behind children from marginalized households; introduction of per student financing has left open many operational issues, including accountability aspects; and tertiary education lags behind the rest of the EU, does not meet the needs of a modern economy, and has low efficiency. 53. In the short-term, Government could: • Upgrade the student assessment system to enhance school accountability, incentives and career development opportunities for teachers and school principals. • Eliminate the 7th grade examination to improve access to and relevance of secondary education. • Review the curriculum towards a competency-based approach. • Consolidate the New Matura Examination for university admissions, introduce student loans, and adopt a renewed VET strategy. • Complete recent reforms for per student financing with additional measures to increase the responsibility and accountability of local administrations and schools. 54. In the medium term, actions could be to: • Introduce combined training and work programs for youth beyond compulsory school age. • Implement the new VET strategy.

xii

Executive Summary • Establish the National Qualification Authority and a National Qualification Framework, including with a view of recognizing and formalizing prior non-formal and informal learning. • Provide incentives and recognition of life-long learning, early education and development initiatives. • Shift the funding from enrolled to graduating students. • Promote competition among tertiary education institutions. 55. In health, hospitals consume a disproportionate share of resources, putting at risk the sustainability of the system; primary care is under-performing; and the pharmaceutical policy is financially unsustainable, and inequitable. 56. • • •

In the short-term, the Government could Protect health care financing during the economic downturn. Adopt a Hospital Rationalization Master Plan. Develop a comprehensive policy for long-term care.

57. In the medium-term, health sector reforms could aim to: • Restructure hospitals in line with the Master Plan. • Establish an independent entity responsible for licensing and accrediting hospitals. • Develop and monitor performance indicators for hospitals. • Develop a strategy for financing the large investment needs in the sector. • Strengthen pay-for-performance in primary care. • Introduce more cost-effective drug procurement models. • Redefine the benefits package covered by the National Health Insurance Fund (NHIF). • Revise the NHIF negotiations with providers to link them better with the State budget, and associate other stakeholders.

58. In pension system issues include the attrition of the labor force through disability retirement and distorted incentives for early retirement, and because women retire at a younger age than men. 59. • • •

In the short-term pensions, the Government could Refrain from ad-hoc pension increases. Strengthen further disability certification procedures. Consider an exit strategy for formalized Government contribution to the scheme.

60. • • •

In the medium term pension reform could Align the retirement age to EU levels. Eliminate gender differences in retirement age. Discourage early or unjustified disability retirement.

61. Beyond the provision of social assistance as part of the crisis response, as already discussed, the objectives and instruments of the social assistance system need to be revisited. In the medium term, the main considerations are as follows • Define objectives in line with the EU approach of active inclusion (poverty reduction, activation and social inclusion including of the next generation);

xiii

Executive Summary â&#x20AC;˘

Better link benefits with services, e.g. employment counseling and purposeful requalification, to create an employment activation gateway towards sustainable employment and better life chances for the next generation. â&#x20AC;˘ Improve the interaction of benefits.

IV. Policy Vision, Coordination and Partnership 62. The need for a consistent and broad-based policy vision is a common thread in virtually all sectors reviewed by the Policy Notes. The experience of the two past decades of transition is that successful reform hinges on continuity, political commitment, and broad popular support. While EU strategic plans can and should offer guidance on common objectives, Bulgaria must also articulate its own strategic vision for sustainable and equitable development, and this vision must be complemented by long-term plans in all sectors. Equally important, development of strategies and action plans cannot be done by administrative fiat, but must bring together all stakeholders â&#x20AC;&#x201C; the legislature, decentralized administrations, business, NGOs, academia, trade unions, the media, associations, etc. Partnership must also continue during implementation, at a minimum to inform stakeholders and associate them in updating strategies, and if possible to enroll their help in carrying out actions. 63. The need for strengthening coordination within the Government has also emerged as a general challenge. Enhanced coordination is necessary both for the Government as a whole, and at inter-agency level. Central coordination could benefit from a dedicated mechanism which could be set up in the Council of Ministers (CoM). Inter-agency coordination at sector level may require specific institutional arrangements (e.g., public administration and financial management, agricultural transformation, business development, transports, energy, ICT, environment, etc.). A particular challenge is presented by the management of the economic downturn, which would require close coordination between the Executive, the legislature, the National Bank, and key stakeholders (business, trade unions, and the civil society). 64. Partnership is essential to ensure acceptance of reforms, and their sustainability. The timely engagement of all key stakeholders on the design, phasing, mitigation and monitoring of the reform program is essential. This engagement would be based on an extensive and permanent information-education-communication (IEC) process, and on clear outcomes and results expected from reforms. External partners could play an important role in sharing international best-practice, helping build national capacities, and financing the implementation of programs and projects.

xiv

MAIN REPORT

Macroeconomic Policy

MACROECONOMIC POLICY I. CONTEXT 1. The global economic crisis has ended abruptly Bulgaria’s fast economic expansion over the recent years. On the back of strong market confidence linked to rapid convergence with the EU, parent banks in Western Europe provided cheap funding to their subsidiaries in Bulgaria which translated into rapid credit growth to households and non-financial firms. This credit went largely into financing of non-tradables, in particular financial services, real estate and construction, and imports. The result was very rapid growth, marked by large capital inflows, large current account deficits, and high inflation. 2. In spite of tight fiscal policies, Bulgaria’s economic policies have ultimately been unable to prevent overheating of the economy. Fiscal policies have been very prudent, providing crucial support to the currency board – the fiscal surplus averaged around 3 percent of GDP from 2005 to 2008 (Bulgaria was the only EU10 country with a fiscal surplus in 2008); the fiscal reserve reached 13 percent of GDP in 2008, and gross public and publicly guaranteed debt fell from 31 percent of GDP in 2005 to 16 percent of GDP in 2008. However, these policies were inadequate to halt the built-up of large imbalances: • With net capital inflows rising from around 18 percent of GDP in 2005 to 33 percent in 2008, the current account deficit widened from 6 percent of GDP in 2003 to 25 percent in 2008. • External debt increased from 71 percent of GDP in 2005 to 108 percent of GDP 2008, even though public external debt declined from 24 percent of GDP to 12 percent over this period. At the same time, foreign currency mismatches accumulated in the non-financial corporate sector. • Private credit to GDP ratio climbed from 44 percent in 2005 to 74 percent in 2008. • Annual growth of prices and wages peaked at 12 percent and 22 percent, respectively in 2008. 3. Since late 2008, Bulgaria, along with its neighbors, has been hit by two shocks: the recession in high-income countries, which hurt external demand for exports; and the global financial crisis, which has reduced capital inflows and thereby lowered domestic demand. These two shocks have led to a sharp downturn and noticeable rise in unemployment because of the Bulgaria’s deep trade, capital and labor market integration with the EU and the world economy. 4. The economy is set to contract sharply this year, and is likely to resume growth only in 2011. Forecasts continue to be revised downwards since fall 2008. For example, the IMF revised downwards its GDP projections from a growth of 4.3 percent in October 2008 to a decline of 7 percent recently. 5. The crisis has affected Bulgaria through the channels of trade, capital and labor. First, the contraction in global spending on capital goods and durables has curtailed exportoriented foreign direct investment and manufacturing. In the first five months of 2009, industrial production has contracted by 19 percent year-on-year. Second, private sector capital inflows, which have financed much of Bulgaria’s recent economic growth, have dropped sharply. Net capital inflows declined from EUR3.3 billion in the last quarter of 2008 to EUR1.3 billion in the first quarter of 2009. Third, the economic recession is increasing unemployment. Registered unemployment rate rose from 6 percent in June 2008 to 7.3 percent in June 2009. Higher joblessness is likely to translate into lower household incomes and consumer demand with

Macroeconomic Policy negative feedback loops to economic activity and the financial sector. As EU15 labor markets deteriorate, return migration is set to reduce remittances, which amounted to 6.4 percent of GDP in 2008. 6. The drop in domestic demand and the decline in international commodity prices have helped to launch the much needed unwinding of economic imbalances. Imports declined by 31 percent in the first five months of 2009 year-on-year, and the current account deficit dropped to 5.8 percent of annual GDP in the first five months of 2009. The harmonized index of consumer prices declined from 14.4 percent in July 2008 to only 2.6 percent in June 2009.

II. KEY CHALLENGES 7. The economic crisis poses significant risks to the private sector. As the slowdown in economic activity reduces profit margins of the corporate sector and incomes of households, nonperforming loans are likely to increase. This would deteriorate capital adequacy ratios of the banking system, which in turn would further curtail credit to the private sector. The reliance on cross-border funding has exposed banks in Bulgaria, just as in the Baltic countries, Hungary and Romania, to potential balance sheet pressures of their parent banks in their home markets. Fortunately, to date, subsidiaries of foreign banks have largely maintained their exposure, and credit default swap spreads of parent banks have come down significantly. Nevertheless, as foreign capital inflows will remain more modest in future, credit growth will slow down and depend more on domestic deposits mobilization. 8. The recession is also undermining the health of the public sector. In January to May 2009, budget revenues declined year-on-year by 6 percent, whereas budget expenditures increased by 25 percent in the run-up to the parliamentary elections. This brought down the budget surplus to 0.8 percent of annual GDP, compared to 5 percent of GDP in the same period last year, making impossible meeting the 2009 fiscal surplus target of 3 percent of GDP. In addition, gross official reserves are falling as capital inflows decline faster than the current account improves and as a result of easing of bank regulations aimed at increasing liquidity. Gross official reserves declined by EUR0.8 billion from January to June 2009 after falling by around EUR1.5 billion in the last quarter of 2008. 9. The continued worsening in private and public sector balance sheets could trigger a loss of confidence in the stability of the banking sector and the currency board. The Government is committed to maintaining the currency board to ensure euro adoption at the earliest possible date; and hence is determined to prevent large balance sheet mismatches arising from exchange rate adjustments, which in turn would trigger corporate bankruptcies and undermine capital adequacy ratios of the banking sector through a sharp rise in non-performing loans.

III. POLICY RECOMMENDATIONS 10. The recovery from the economic crisis depends foremost on fully restoring market confidence. This requires a two-way response from the government: â&#x20AC;˘ Domestic policies have to bring about a fiscal consolidation and strengthen financial stability, and step up structural policies. Fiscal policies are discussed below, while financial policies are discussed in the financial sector note and structural policies in the other policy notes. â&#x20AC;˘ Assistance from international partners could help to support fiscal consolidation and government commitment to the currency board by boosting the reserve coverage.

Macroeconomic Policy

Fiscal Policies 11. Fiscal policy has to manage a difficult balancing act between cyclical and sustainability considerations. During the boom years, Bulgaria could afford to accelerate spending and accumulate a fiscal reserve thanks to rapidly rising revenues. Now, during the crisis, revenues are falling sharply requiring substantial cuts in expenditures in order to limit the fiscal deficit. Allowing a large fiscal deficit this year could erode confidence in the currency board and would require a large adjustment in the coming years. Yet, a sharp fiscal adjustment this year would exacerbate the economic recession. For example, while public infrastructure investment is often viewed to be an ineffective stimulus during a normal business downturn due to delays in project implementation, it can play a role in the current environment in view of the depth and duration of the recession. 12. Reconciling these objectives will require embedding the 2009 fiscal policies in a medium-term fiscal consolidation strategy. 13. First, there is no room for discretionary fiscal stimulus beyond the operation of automatic stabilizers in view of the large increase in expenditures and the sharp decline in revenues in the first five months. The collapse in revenues, and public spending to support increasing social entitlements ranging from unemployment benefits and pensions, are already imposing a heavy burden on the government budget. 14.

Second, expenditures will have to deliver the bulk of the fiscal adjustment: The 90 percent spending restriction is not likely to be sufficient to maintain the 2009 fiscal deficit below the Maastricht criterion of 3 percent of GDP and to keep the fiscal reserve buffer. Further corrective action will also be needed to keep the deficit below 3 percent of GDP in 2010. • Moving beyond across-the-board-cuts towards selective expenditure reductions in line with government policies will improve the quality of the fiscal adjustment. In particular, a review of public expenditure programs would help identify high-priority social and economic programs that should be shielded from expenditure cuts. • Addressing the fiscal outfall of demographic change – the EU projects that age-related public spending in Bulgaria will increase by close to 4 percentage points of GDP between 2007 and 2060 – is important. •

15. Third, the government could consider measures to limit the drop in revenues due to weak economic activity and dwindling revenue bases: • Improving voluntary compliance and enforced collection of revenues (tax, customs’, and social contributions) by strengthening the Large Taxpayers and Contributors Unit, increasing efiling of tax and social contributions, and accelerating the implementation of the second phase of the Revenue Management System. It is important also to restore confidence in the National Revenue Agency (NRA) and increase motivation of staff. The intention of the new Government to improve the information flows between the NRA the Customs Agency is likely to contribute to reducing non-compliance and tax fraud in the medium term if supported by further reforms in the Customs Agency, and in the prosecution, and judiciary as whole. • Introducing compensating measures, including the broadening of revenue bases, to mitigate any negative fiscal impact of reductions in tax and social security contribution rates. • Improving the utilization of EU funds can make a crucial contribution to protect vital growth-related public spending.

Macroeconomic Policy 16. Fourth embedding fiscal policy within a framework of medium-term fiscal consolidation will reassure markets. Strengthening of the medium-term fiscal frameworks can help build fiscal policy credibility and predictability, strengthening performance-based budgeting can bring greater focus on the results from government spending, and promoting public-private partnerships can ease fiscal pressures and improve spending efficiency. 17. Fifth, presenting a euro-adoption timetable that is ambitious yet realistic could support market confidence. The exit strategy of euro-adoption is central in view of Government commitment to the currency board. The credibility of such a timetable will depend on progress towards meeting the economic conditions for the introduction of the common currency and advancing structural transformation of the economy.

International Support 18. The international community can provide important support, if needed, for economic recovery, fiscal adjustment and the protection of vulnerable households. This could be crucial to strengthen market confidence in the currency board and the financial system by boosting the foreign exchange reserve cover and anchor the fiscal consolidation strategy.

Financial Sector

FINANCIAL SECTOR I. CONTEXT 1. After years of high profitability, the economic crisis is weakening the financial sector. In spite of unprecedented action by governments and central banks around the world, global financial markets remain under stress. The crisis has affected financial markets in Bulgaria, and in other new EU member states, through concerns about negative spillovers from troubled EU15 banks — assets of foreign-owned banks in Bulgaria exceeded 80 percent of GDP at the end of 2008 — and exposed homegrown vulnerabilities, ranging from currency mismatches on borrowers balance sheets, weak risk management, and poor underwriting standards. 2. Bulgaria’s banking sector has remained stable during the ongoing financial crisis, although profitability is declining and non-performing loans are increasing. At the end of the first quarter 2009, banks were well capitalized (at 16.49 percent, about one quarter above Bulgaria’s regulatory minimum and over twice the EU’s regulatory minimum). Profitability, while falling, remains high. The policy of not distributing profits in 2008, which continued in 2009, gives banks additional capital cushioning provided portfolio quality can be maintained. Non-performing and restructured loans more than doubled year-on-year in June 2009 despite relatively strong GDP growth in the second half of 2008 and easing of provisioning regulation. A sharp increase in bad restructured loans has been concentrated increasingly in the corporate sector where these loans represented already 6 percent of total loans compared to 2.6 percent a year ago. Domestic interbank market borrowing also rebounded from a late2008 decline. Last but not least, parent bank funding increased by 25 percent from midyear 2008 through the first quarter of 2009, reflecting strong commitment to Bulgarian subsidiaries. 3. Central Bank measures helped ensure financial stability. The BNB has actively monitored and tried to mitigate the impact of the global financial crisis. Actions taken to increase banks’ capital and liquidity cushion include releasing existing prudential “buffers”, for example by lowering the reserve requirements, and working with parent banks to ensure credit lines to foreign-owned subsidiaries remained available and profits are recapitalized. The BNB intensified its monitoring, strengthened stress testing capabilities and reviewed the crisis management framework as a contingency measure. 4. The Government and BNB took steps to build up confidence in the financial sector. In line with EU decisions, the deposit insurance was increased to €50,000 per depositor per bank. Overall, the contagion effects have been appropriately managed, sustaining confidence in the BNB and its role as a policy anchor in a time of external uncertainty and elections at home. Foreign creditors have been comforted by the Government’s policies, as proven by Fitch’s decision to confirm Bulgaria's long-term foreign currency rating at 'BBB-' and long-term local currency rating at 'BBB'. 5. However, the economic crisis and credit crunch will test the financial sector to the limit. The sharp decline in economic activity and the reduction in net capital inflows have worsened the outlook for Bulgaria’s private and financial sector. GDP declined in the first quarter of 2009 by 3.5 percent year-onyear and net capital inflows declined from EUR3.3 billion in the last quarter of 2008 to EUR1.3 billion in the first quarter of 2009. 6. Credit has been falling in tandem with the shrinking economy. During the first quarter of 2009 credit growth decelerated, as demand for credit weakened and credit risks increased. Investment, one of the main drivers of growth over the last few years, fell by 20 percent as companies scaled back investment plans and stocks were depleted. Credit to manufacturing industries, representing 13 percent of private sector borrowing, increased by only 1 percent during this period, while credit to the trade and

Financial Sector motor sector (20 percent of private sector borrowing) declined by 2 percent, and the outstanding stock of loans to the real estate sector (7 percent of the private sector borrowing) and declined by 1.4 percent. The volume of incremental newly issued loans in local currency to corporations showed a decline of 58 percent between July 2008 and April 2009, and new borrowing denominated in euro declined by 35 percent during the same period. 7. Pension funds have been adversely affected by the decline in the stock market. Global deleveraging by foreign institutional investors led to a withdrawal of their holdings from the Sofia stock exchange, leading to a collapse of stock market prices. The SOFIX index declined by 69 percent between June 2008 and June 2009, the largest drop in stock prices of all Europe and Central Asia exchanges. The share of foreign investors fell under 30 percent at the end of 2008. Domestic investors divested to a lower extent. The movements in the equity market led to losses in pension funds which held close to the 25 percent portfolio limit in equity investments highly concentrated in Bulgarian shares. The total net assets of the voluntary pension funds declined by 29 percent in 2008, while their investment in equity shrunk by over 53 percent. The rate of return on the assets of the pension funds, of around 8 percent at end-March 2008, turned negative at between -6.4 percent and -9.3 percent a year later. The losses do not have an immediate impact on the fund beneficiaries, as the first payout wave under universal mandatory pension schemes is set to begin around 2020-2023.

II. KEY CHALLENGES 8. The risks and challenges faced by the financial sector are linked to: (i) the rise in NPLs on the back of the recession; (ii) uneven funding of banks’ operations, including the need to ensure rollovers of private external debt, though to-date parent banks have maintained funding; (iii) high foreign indebtedness of the corporate sector; (iv) difficult access to finance for firms; and (v) the need for increased regulation. 9. While banks so far have remained well capitalized, the deep economic recession could trigger a significant rise in NPLs, which could affect banks’ capital adequacy ratios. For example, the 2008 FSAP update suggested that a decline of GDP by one percent and a 30 percent drop in property prices could increase NPLs by 12 percentage points. Given Bulgarian banks’ high capitalization levels, however, even an increase in NPLs to 16 percent would still appear to allow banks to count on capital above the regulatory minimum.

10. The funding of bank’s operations, including the rollover of corporate private external debt, remains a structural challenge. Credit growth has been extremely fast since 2002, with annualized rates at times exceeding 50 percent. By May 2009 external debt stood at 107.9 percent of GDP, most of it owed by the private sector and channeled via the banking system. Short-term external debt (deposits and borrowings) of banks almost doubled within a year in 2008 and account for close to 80 percent of banks’ external debt. Continuing rollover of the private debt is absolutely essential to maintaining a sound banking system. The share of long-term funding in total liabilities has declined, even while funding from parent banks to domestic subsidiaries has increased. In part due to global conditions, bond market funding for banks declined substantially since the first half of 2008, and third party (non parent) foreign banks and investors reduced most funding to the domestic banking sector. 11. The private sector in Bulgaria has high direct foreign currency exposure. The credit boom over the last few years benefitted in particular the corporate sector. The debt of the non-financial private sector in foreign currency amounts to about 70 percent of GDP, and almost 40 percent of the total debt is short-term (under one year maturity).

Financial Sector 12. Firms’ access to finance is difficult and increasingly dominated by short-term borrowing. The most recent Enterprise Survey of the World Bank (January-June 2009), has found that access to finance is once again the greatest concern for firms in Bulgaria, reversing 2005-2008 trends. Banks have become much more conservative in extending new loans, and demand has been damped by the economic slowdown. Only 35 percent of firms reported using banks to finance investment dropped in 2009, compared to 40.5 percent in 2007 and 42 percent in 2005, or with 48.7 percent in Hungary, 50.1 percent in Poland, or 52.2 percent in Slovenia. 14 percent of the firms surveyed consider that the interest rates are too high. Most firms reported that their most recent loan was of very short-term maturity — over 60 percent of loans given to firms in 2007 were for less than a year (financing short-term working capital needs) and only 5 percent were over 5 years (for investment). Almost all firms used either real estate or the owner’s own assets as collateral for the loan, with very limited use of either movable property or accounts receivable as collateral. Even before the financial crisis access to credit was more difficult for SMEs. Small firms (1-19 employees) ranked access to finance strongly as a major concern for their operations. One in five medium-sized firms (20-99 employees) also reported this as a major concern. 13. The financial market requires strong regulatory oversight and supervision, including consumer protection. This includes a vast agenda, ranging from enhanced financial prudential regulation and oversight, financial sector governance, business conduct regulation and supervision, and financial consumer protection. Financial consumer protection supports and complements the regulatory process by addressing power, information, and resource imbalances which place consumers at a disadvantage vis-à-vis financial institutions. Well-informed and well-empowered consumers provide an important source of market discipline to the financial sector. In addition, financial consumer protection builds trust in financial systems, helps broaden and diversify the depositors’ base, and reduces risks to the banking sector.

III. POLICY RECOMMENDATIONS 14. The recovery from the economic crisis depends foremost on restoring financial market confidence. This requires a forceful and coordinated policy response aimed at providing financial institutions with access to liquidity where needed, facilitating corporate debt restructuring, and stepping up supervision, regulation and consumer protection. In view of the large foreign ownership of the banking system, this requires close coordination with authorities and banks from EU15 countries which the BNB has done in the context of maintaining agreements for funding from parent banks to domestic subsidiaries in Bulgaria.

In the Short Term

• Continue stress-testing and monitoring at high frequency. The capital adequacy of banks could deteriorate sharply in view of the strong economic downturn. The authorities could re-evaluate the likely capital shortfall of the banking system to incorporate the worse economic outlook. For foreignowned bank subsidiaries, this would require close coordination with overseas home country regulatory authorities, in order to conduct joint simulation exercises. At the same time, the BNB could continue to develop its internal modeling capabilities to independently evaluate at a high frequency the risks and capital contingencies required of banks, to be used as a benchmark vis-à-vis banks’ models and provide an objective assessment of future trends in credit quality. • Preparing contingency plans to address capital shortages. The BNB could develop plans to address any capital shortages identified as part of the stress tests. For subsidiaries of foreign banks, the authorities, in collaboration with international partners, could continue to seek assurances from parent banks to maintain their exposure, and provide capital if needed, to their subsidiaries, in line with the initiatives in other crisis affected CEE countries.

Financial Sector • Monitoring changes in bank funding sources and corporate funding relationships. While parent bank commitments are welcome to maintain liquidity in the sector, the authorities should continue to strengthen transparency provisions in corporate law. The objective would be to ensure full and reliable identification of interconnected exposures with banks, shareholders and owners, and that changes or expansion of funding sources follow proper accounting rules that meet liquidity and solvency requirements from a regulatory and prudential perspective, and are based on a more consolidated scope. • Facilitate corporate debt restructuring. It would be useful to carry out an assessment of the judicial and out of court debt workout procedures to identify which issues could be resolved in the shortterm, and how to best implement an out-of-court system if this became necessary for expeditious debt resolution. While the focus to date has been on risk management and liquidity of the banks, the Government needs to begin to assess the solvency of the corporate sector and determine whether the legal and regulatory framework provides flexibility for debt workouts if these are needed, as well as corporate restructuring windows (without formal bankruptcy procedures) to allow firms to continue viable operations and service existing debt while the supply, price, and maturity of credit remain constrained. • Support enterprise credit lines to mitigate the impact of the credit crunch and smooth the impact of economic crisis on employment and in investment. One option is to provide credit lines to viable enterprises under temporary credit constraints consistent with the EC framework for State aid measures to support access to finance in the current financial and economic crisis. Any such program should ensure that lending maturities can serve both business working capital needs as well as fixed investment funding that goes beyond the five year maturity range, necessary for generating returns on investment and corporate sustainability in the medium term. However, while the Government has recently tapped EUR250 million from the fiscal reserve to provide credit lines to commercial banks, any expansion of such credit lines would have to be financed from alternative sources in view of the reduction of the fiscal reserve. Any such credit lines should not be used to direct lending to any particular economic sector, but rather to supply longer maturity credits at reasonable cost for viable companies (assessed as such by the commercial banks) and that are struggling with working capital and investment financing needs. • Strengthening the supervision of non-bank financial institutions. Review investment regulations for pension funds to facilitate the adoption of life cycle and multiple fund types to reduce market risk for near-retirees. Consider the design of the pay-out phase including defining the retirement products and their regulation, such as annuities, phased withdrawals and other options, while taking into account market, credit and longevity risks to beneficiaries and the industry.

In the Medium Term

• Improve the institutional structure for financial consumer protection. The supervision of compliance with consumer protection legislation for financial services by the Consumer Protection Commission (CPC) should include mortgages, leasing, insurance, securities investments, private pension plans, and credit reporting in addition to consumer credits and payments. This would require substantial capacity-building within the CPC, secondment of staff by BNB and the Financial Supervision Commission, and establishment of a specialized department for financial services. Under this option, conciliation committees could be established as permanent standing committees for each type of financial service (along the lines of the Conciliation Committee for Payment Disputes) and their operations should be improved.

Public Financial Management

PUBLIC FINANCIAL MANAGEMENT I CONTEXT 1. Control of aggregate expenditures has been one of the strong points of Bulgaria’s public financial management (PFM) in recent years, but much less attention has been given to improving the impact of public spending. The global financial crisis has validated the Ministry of Finance’s

prudence in maintaining tight fiscal control over government’s finances, including budget surpluses in years of rapid growth. Establishment of a limit on public spending at 40% of GDP has provided a useful mechanism to make important policy trade-offs. But despite benefits to macro-economic stability that such a policy provided, more emphasis could have been given to improve the effectiveness and efficiency of spending. For most Bulgarian citizens, the important question to ask is whether the quality of public services improved with the increase in overall government spending. Until recently, there were few mechanisms for government and the public to assess the relationship between spending and public service outcomes. The introduction of medium-term expenditure framework (MTEF) and of the performance based budgeting in Bulgaria are key public finance reforms that need to be consolidated to improve allocative efficiency but also enhance transparency and accountability of public expenditure management. 2. The Ministry of Finance has achieved substantial progress in implementing program budgeting and is ahead of most of its peers from the new member states. Program budgets have been introduced in a phased manner since 2003, and in 2008 all ministries and other first line spending units (FLSU) were obliged to submit program budgets together with the annual budget law. The ministries that have been included in the program budgeting early on have also prepared implementation reports in program format. In a relatively short period of time, clear guidance has been provided to line ministries in terms of the appropriate program structure for these ministries. The ministries seem generally to have responded to this guidance by identifying logical program structures, and presenting their expenditures consistent with this program structure with performance measures identified for each program. 3. The development of program budgeting in Bulgaria represents an important reform effort that needs to be sustained and elevated to support a functioning performance budgeting system. This system has the potential to result in large improvements in the management and allocation of resources. Therefore, it is important that this reform is continued and benefits from support at a senior political level. Demonstrating potential positive effects of performance budgeting to all participants is crucial to its further enhancement and sustainability. 4. Weak public administration processes in public investment budgeting and management have important fiscal impact. Public investment expenditures have increased over the last several years to take advantage of available EU resources and address key investments that were neglected in the first decade of transition. In 2008 public investment accounted for 6.4% of GDP and was budgeted to reach 7.1% in 2009. Higher budget resources require increased attention to the allocative efficiency and effectiveness of public investments. There is a substantial scope for the Government to improve both the selection of projects and the monitoring of them – especially in the context of nationally-financed projects. The public loses when ministries select projects to be initiated that are either not needed or too costly for the benefits that come from 9

Public Financial Management them. It loses again if the project implementation is not monitored and supervised to contain costs and assure timeliness and quality. The MOF has already recognized the potential risks to poor public investment management and has taken steps to bring the processes for national projects more closely aligned with that for EU-financed projects. However, line ministries continue to manage their public investment portfolios in ways that undermine the effectiveness and efficiency of spending. 5. This note draws on findings of the ongoing World Bank Technical Assistance on Public Finance Management which focuses on improving performance based budgeting and public investment budgeting and management.

II. KEY CHALLENGES A. Linking Budgets to Results 6. Performance based (programmatic) budgeting has yet to have an impact on the quality of decision-making or the effectiveness of program implementation. Over the past decade many governments around the world have taken steps to introduce performance information into the annual budget process, and Bulgaria is no exception. The Ministry of Finance has worked with the Parliament to establish program budgets at all ministries, as well as implementation reports to monitor progress against the agreed performance indicators. This is an important accomplishment and one that Bulgaria will be well-served by. A strong relationship has been established between the MOF and line ministries in how to define budget programs, with technical guidance given on developing performance measures. Yet, the current process could be viewed as nothing more than an administrative exercise, with little real impact on the effectiveness of program implementation. 7.

Annual budget planning remains largely incremental, with performance information used only marginally by policy makers in their decisions. The annual budget process still focuses on

economic inputs and discussion of the level to be accorded. Data on the outputs to be achieved is not well-integrated into the discussion of the budget either at the technical level or broadly at a political level. Ideally, the non-financial information should be as important to the line ministry as to the MOF, but there is little evidence of its widespread use by budget officials in the line ministries. As a result Bulgarian policy makers miss out on opportunity to use the annual budget process to incentivize managers to improve the effectiveness and efficiency of their programs. 8.

Fragmentation or overlap of responsibilities makes policy coordination difficult and reduces public sector effectiveness and accountability for results. Examples of such fragmentation can be

found across all government institutions with responsibilities shared between several ministries and agencies as well as across departments within ministries and agencies. Although sector performance may ultimately be shared among ministries and agencies, who each contribute in different ways, a single minister should be responsible for coordinating policy that affects the sector. One ministry can report on the outputs that they produce toward sector outcomes, as well as reporting on how other ministries contribute as well. Existing regional structures further complicate effective policy implementation and may lead to inefficiencies if demand for public services across the 27 regions is not equally distributed. Functional reviews that have been under preparation for some time by consultants and led by the Ministry of State Administration can provide useful insights how to address inefficiencies in public administration functions. 10

Public Financial Management

9. Quality of performance information is poor and is not differentiated for the needs of the audience. Sector objectives are often elaborated in general terms, while performance indicators are very detailed and focus more on input and output rather than on outcomes. There is little or no prioritization of performance indicators. Though detailed indicators may be useful for internal program management, the senior policy makers in the line ministry, the MOF, and the Parliament, will need different types of reporting. Indicators need to be at a sufficiently high level, attention should be focused on where the major variances are, and what the implications are for policy planning and/or management. 10. There are few incentives to produce and use performance information. Program budgets are prepared but not used actively in budget negotiations or budget deliberations in the Parliament and therefore, may be perceived by line ministries as an additional reporting burden. The Ministry of Finance has taken some very preliminary steps to provide feedback to line ministries on the substance and quality of the program budgets but the large number of indicators are generally not used substantially by any other institution, including the National Audit Office. There is no external review of the baseline indicators or accountability for performance targets. The voluminous performance reports are not well-suited to capture the interest of the media or the public at large. Public reporting of selected sector indicators can provide important incentive to line ministries if presented in a way that is easily understandable to the media and the public. Example of such simpler but effective presentation is shown in Box 1. 11. Sectoral reviews and/or program evaluations have not been institutionalized. Public expenditure reviews have been conducted for a small number of sectors by the Ministry of Finance (education and labor) and by other institutions or consultants (including by the World Bankâ&#x20AC;&#x201D;with the most recent ones focusing on judiciary and agriculture) to improve understanding of the Cabinet, the MOF and the public at large on the challenges facing the sector and policy options to address these challenges. However, follow-up on the policy recommendations have been fragmented and inconsistent. In addition to sector reviews, targeted evaluations of programs would provide important information to policymakers on whether the program is having an impact on the intended beneficiaries or whether the program could be managed more cost-effectively if redesigned. Such evaluations are well institutionalized in Chile, for example, where the MOF decides on the programs that will need to be evaluated during the year while the agency overseeing the program develops a performance improvement plan and is accountable to the Parliament for its implementation. 12. The link between strategic planning and budgeting is weak. Program budgets are usually prepared by accountants or financial specialists in line ministries with little guidance from senior officials that have the strategic view of sector priorities and needs. Better integration of strategic planning and budgeting could be achieved by establishing high-skilled, policy planning units close to the Ministerâ&#x20AC;&#x2122;s Office. The unit could be staffed with economists and policy specialists who can provide a high level of expertise focusing on the economic trade-offs from program options, and coordinating internal performance reviews. It may also help internally, if responsibility were assigned to specific individuals for program performance, instead of having it split across department heads. 11

Public Financial Management 13. The budget process would benefit from greater continuity between the MTEFs from one cycle and the next, with the ceilings set in the previous year serving as a starting point for the next yearâ&#x20AC;&#x2122;s submission. This is intended in the Bulgarian process, but seems not to be rigorously enforced. The current requirement for submission of needs-based budget requests towards the beginning of the process (after the macro-fiscal framework has been established) could be improved. While there has to be room in any budget system for some negotiation over resources, it is inefficient to start this process on the basis of open-ended requests. Baseline expenditure could be established at the beginning of the process before entering into negotiations over new initiatives, thus imposing an explicit separation into the baseline request and the new initiative request. In the case of capital spending, baseline would be the expenditure required for the efficient completion of ongoing projects. Only once agreement has been reached on the baseline should attention shift to the allocation for new initiatives.

Box 1: Example of US State of Virginia Performance Reporting System

Public Financial Management B. Improving the Selection and Implementation of Public Investment Projects 14. MOF has limited authority to intervene directly in decisions relating to public investment expenditures and cannot, in practical terms, stop poor quality projects from proceeding or protect the budgets of ongoing projects from dilution by new projects. Capital investment decisions reflect a relatively high degree of autonomy on the part of line ministries, without the MOF exercising an adequate “challenge” function. Provided that line ministries keep within their capital ceilings, insistent ministries can push through their desired investment plans even if these have evident limitations. MOF should be identifying projects with inadequate analytical justification and asking tough questions about value for money. MOF must also have the ability to prevent the budgets of ongoing projects from being diluted by new projects that are added (long, delayed implementation typically drives up cost). The existing public investment portfolio in Bulgaria contains projects that have gone on for decades, and where the costs to complete are far higher than initially planned. 15. The internal organization of MOF also presents challenges for effective monitoring as responsibilities are shared between at least two directorates under two separate deputy ministers. While all directorates strive for excellent coordination, the data needs of the two are likely to be different. For example, the Management of EU Funds Directorate needs information relevant for preparation of the medium-term capital expenditure framework and the annual capital budget. It also should identify problem projects where efficiency and effectiveness might be compromised. The database managed by the State Expenditures Directorate provides some useful information for monitoring purposes, but it is not a sufficient base for MOF to rely on for creation of an effective and reliable monitoring system. 16. The separation between the budgeting of recurrent and capital spending with the MOF’s structure is not conducive of increased focus on results. Although the MOF implements a medium term expenditure framework (MTEF), the future funding commitments of individual projects are not well integrated. Line ministries essentially manage a block funding for capital and determine during the year how they will allocate it that year. This funding “flexibility” can produce ad hoc decisions that are incompatible with the cost-effective implementation of ongoing projects. Funding needs of individual projects should be specified and controlled over the multi-year period. Moreover, because the budgeting processes for capital and recurrent expenditure tend to be separately managed within MOF, it is harder to take a comprehensive view of each expenditure program and to determine the right balance between capital and recurrent needs. There is also greater risk that recurrent consequences of completed capital projects are not fully budgeted. 17. The incentive for ministries to improve project management is weak because there is very limited central oversight by MOF and little consequence from poor performance. The monitoring that is done by MOF tends to focus on financial compliance and reporting requirements for accounting purposes. There is no systematic process by which MOF reports on whether ministries are implementing projects within the timeframes and budget envelopes planned when the project was started. Even when there are large delays or overruns in cost, the MOF has few tools with which to encourage accountability or to draw lessons learned. Ex-post evaluations of some completed projects would also generate lessons that could improve future project management – e.g., to improve original cost estimations, better project cycle management, and/or better resource planning. 13

Public Financial Management

18. Technical guidance on project preparation for nationally-financed projects does not provide incentives for more strategic approach to capital investment. Currently, ministries frequently apply for funding year-by-year for small “projects” that would normally be components of a larger project concept. This dilutes the level of management scrutiny that can be given to individual project proposals and makes monitoring of results substantially more difficult. The degree and sophistication of pre-project analysis is not proportional to the risk and does not take into account capacities available. Cost-benefit analysis would not be appropriate for some smaller value, more routine types of projects. Nevertheless, MOF must get ministries to submit larger, more multi-year projects concepts in lieu of project components that they see each year. Once the concept is approved (with appropriate analytical tools), funding for individual project tranches should be safeguarded so that project can be completed in the most timely and costefficient manner.

III. POLICY RECOMMENDATIONS In the Short Term • Include requirement for performance based budgeting in the organic budget law. • Ministers should be accountable for performance of the sector, not merely their ministry. • Improve quality of performance information and tailor it to the needs of different audiences. This would involve revisions to guidance on preparation of the 2009 implementation reports and 2010 program budget plans and identification of sources of technical assistance to line ministries for developing high-level indicators of sector outcomes to be included with 2010 budget documentation. • Introduce formal feedback from MOF to line ministries on their program budget. • Improve and simplify program budgets presented to the general public to enhance transparency and accountability. • Revise organic budget law to provide MOF with more authority to challenge line ministries to comply with agreed standards for economic justification and value-for-money in public investment management. Such authority could include stopping poor quality projects from proceeding or protecting the budgets of ongoing projects from dilution by new projects. • Revise MOF internal structure to address fragmentation of budget management responsibilities across a number of departments reporting to different deputy ministers. • Improve technical guidance on project preparation for nationally-financed projects to simplify reporting requirements and encourage more strategic approach to capital investment. • Implement (or use the results of existing) functional review of state bodies to identify redundant functions and overlapping responsibilities and develop plan for a phased approach to address the identified weaknesses. In the Medium Term • Institutionalize sector expenditure reviews. • Introduce program evaluations followed by agreement with MOF and Parliament on performance improvement plan. 14

Public Financial Management • Introduce systematic process by which MOF reports on whether ministries are implementing projects within the timeframes and budget envelopes planned when the project was started. • Establish high-skilled, policy planning units close to the Minister’s Office in line ministries to better integrate strategic planning and budgeting. Assign responsibility to specific individuals for program performance, instead of having it split across department heads. • Initiate mid-term and ex-post evaluations to strengthen incentives for ministries to consider value-for-money in project planning. • Implement the recommendations from the functional review.

Private Sector Development

PRIVATE SECTOR DEVELOPMENT I. CONTEXT 1. Over the last decade important reforms have been initiated to improve the regulatory environment for doing business in Bulgaria. Bulgaria became one of the top 10 reformers in Doing Business 2008 due to successful reforms in the regimes dealing with construction permits, paying taxes, and enforcing contracts. 1 Improved business environment supported high inflows of FDIs and sustained growth in exports. 2. However, the large productivity gap that Bulgaria has with the rest of the EU, points to the need for a dramatic improvement in the quality of business regulation and its enforcement. Small steps in easing regulation are not likely to have marked impact on labor productivity, employment, or investment growth. International assessments and comparative studies suggest that Bulgaria still has to align its written norms and regulations to those of best performing OECD or EU countries, and more importantly, ensure compliance with the regulations, both by businesses, and by government institutions. Bulgaria ranks last among the EU27 countries on competitiveness and innovation, in spite of the favorable macroeconomic environment, low corporate taxes, and improvements in the regulatory environment. These findings were confirmed by The Global Competitiveness Report 2008-2009, The Lisbon Review 2008, and The European Innovation Scoreboard 2008. 3. The Government adopted the Better Regulation Program (2008-2010) in compliance with the EC “Better Regulation Agenda”, and created a Better Regulation Unit. Initial results are encouraging: in consultation with the national business associations, think tanks and the public, 25 regulatory regimes were removed or simplified; an Internet Portal for Public Consultations and an Administrative Register were put in place; 181 illegal Municipality regimes were abolished; 14 Regulatory Impact Assessments (RIAs) were conducted for important legislation; over 250 bureaucrats were trained in applying RIAs; and the Government adopted a target of reducing administrative burden for the business by 20% through 2012. 4. The global financial crisis presents Bulgaria with window of opportunity to increase the competitiveness of the economy by encouraging innovation & technology absorption, and continue to ease the regulatory burden. The economic boom preceding the crisis had masked these issues, as economic growth was fueled by large direct foreign investment and buoyant expectations of consumers, producers and the Government. The more subdued global economic environment places increasing emphasis on the fundamentals of sustainable growth, which include, among others, the regulatory framework and innovation. 5. This note focuses on the excessive and unpredictable regulation, and the low rate of innovation and technology absorption. Other general issues that hamper competitiveness and private investment – including corruption, inefficient government bureaucracy and low-skilled labor force - are discussed by several World Bank reports, including the July 2007 report on Accelerating Bulgaria’s Convergence: the Challenge of Raising Productivity, the October 2008 Investment Climate Assessment, and the September 2008 Doing Business 2009 and the November 2008 Bulgaria: Raising employment and human capital for growth and convergence Policy Note.

World Bank & IFC (2007). Doing Business 2008. Washington D.C.

Private Sector Development

II. KEY CHALLENGES A. Improve Regulation and Access to Credit 6. Excessive regulation and unpredictable enforcement are one of the major obstacles to doing business in Bulgaria. Over 70% of businesses considered that interpretation and enforcement of laws and regulations is unpredictable and erratic, according to a World Bank Enterprise Survey conducted in 2007 (Figure 1). Senior managers estimated that they spent 17% of their time dealing with government regulations such as taxes, customs, labor regulations, licensing and registration, far longer than in most other middle-income countries. Although the 2009 Enterprise Survey registered a major improvement in this indicator to 10.6% of managers, this remains however higher than in other new EU member states. Figure 1: Percentage of firms concerned with the predictability and the consistent interpretation of laws and regulations

Source: World Bank Enterprise Surveys. Note: Data for comparators is from BEEPS Survey (2005).

7. Heavy and unpredictable regulations foster corruption and unfair competition from informal business. The level of corruption and unfair competition from informal firms are perceived by senior managers as being very high with over 45% of firm managers considered corruption as a major constraint. Two years later one out of three firms reports that corruption is a major business obstacle. Unfair competition from the informal sector was the third most important constraint (after corruption and policy instability) on the firmsâ&#x20AC;&#x2122; activity in 2007, and moved up to the second position in 2009. One out of five medium-size firms and one out of four large firms now consider that unfair competition from the informal sector is the most important impediment for their business activities. 8. Regulations issued by local administrations undermine regulatory reform. The Limiting Administrative Regulation and Control on Economic Activities Act adopted in 2003 provided incentives to simplify administrative regimes and controls. The provisions of the Act, however, are often ignored, primarily by municipalities, which issue superfluous regulations that burden the business in terms of cost and time. 2 9. Exit procedures for firms are long and onerous and might complicate restructuring of firms during the economic downturn. While the nominal cost of exit proceedings in Bulgaria, at about 9% of the estate, was comparable to most new EU members in 2008, the actual final cost is much higher because 2

World Bank (2008). Bulgaria: Investment Climate Assessment, Washington, D.C.

Private Sector Development of the depreciation of assets during the long time it takes to complete these proceedings. Resolving a bankruptcy takes 3.3 years on average in Bulgaria, about eight times longer than in best-practice EU member states (i.e., Ireland, 0.4 years). As a result, the recovery rate (cents per dollar claimants recover from the insolvent firm) was only 32.1% in 2008, lower than in most other recent EU members. 3 10. State fees are established on an ad hoc basis, and are unfair and non-transparent. State fees increased by 60% between January 2005 and November 2008, 4 and provided BGN850 million to the state budget in 2008. 5 A recent World Bank report noted that absence of a policy for setting state fees encourages the ad hoc development of tariffs that include state fees. 6 The report also highlighted the weak institutional capacity to monitor the setting and approval of state fees by executive agencies and ministries; distorted incentives (focus on the revenue generating function of fees and fines rather than on cost recovery); lack of transparency in setting fees and distributing fee revenues; “restrictive” fees and revenue generating fees 7 are both applied by various institutions and appear to be common feature of the system of tariffs, which is not what the State Fees law prescribes. 11. With the unfolding of global financial and economic crisis, access to credit is again becoming an important constraint to doing business. Until recently firms were not facing significant constraints to finance their activities and investments as credit to the private sector increased significantly between 2005 and 2008. However, the most recent 2009 Enterprise Survey of the World Bank suggests that limited access to credit re-emerges as one of the biggest concerns of firms in Bulgaria. The percentage of firms that reported using banks to finance investment dropped to 35% in 2009 from around 42% in 2005 and 2007 with small and medium-sized firms being the most hit by the credit crunch.

B. Strengthen Innovation and Technology Absorption 12. Low technology absorption hampers productivity gains. The 2007 Enterprise Survey highlights the significantly higher productivity of firms that license foreign technologies, have ISO certification, or innovate – in that order. The highest gains come from licensing of foreign technology, and Bulgaria lags in this respect compared with other new EU members and other competitors in the region. Only 12.5% of the Bulgarian firms use licensed technology compared, for example, with 25% in Lithuania and Estonia, 28-29% in Latvia and Slovakia, 41% in Macedonia FYR, and 60% in Albania. Bulgaria fares better with respect to ISO certification, which is similar to the average level in Eastern Europe and Central Asia. Bulgaria’s exports are mostly in low technology sectors. In addition, although FDI has increased rapidly, only a small and diminishing share flows into the manufacturing sector. 13. Innovation suffers from low investment, mainly private, in research and development (R&D). Lisbon goals call for all EU member states to increase their R&D spending to three percent of GDP by 2010, of which two-thirds—two percent of GDP—is expected to be financed by the private sector. To achieve these goals, member states are to improve the environment for private research investment, R&D partnerships, and high-technology start-ups. However, as can be expected, the quantity and quality of R&D investment varies significantly across EU countries. Bulgaria’s total R&D expenditure declined from 0.57% of GDP in 1998 to 0.48% of GDP in 2006, and is now lower than in most new EU member states. The private sector finances only a small share of R&D, estimated at 0.16% 3

World Bank & IFC (2008). Doing Business 2009. Washington, D.C. Excluding the Health Tariff, with the highest increase. Analysis of State Fees, Administered at the Central Level and Proposals for Undertaking of Measures, Draft report of Working Group under the Ministry of State Administration and Administrative Reform, 2009. 5 Report of the consolidated state budget as of 31 December 2008, Ministry of Finance. 6 World Bank (2009). Bulgaria: Reforming the Regime of State Fees, Document of the World Bank, July 2009. 7 Revenue generating fees are perceived as a moneymaker and are used to balance the budget. This is particularly possible because the state has a monopoly on public services and can set the fees freely. “Restrictive fees” are used to penalize a certain behavior. However, the penalty function of administrative fees is often prohibited since fines are used as a special instrument for this function. 4

Private Sector Development of GDP, while public investment is predominantly financing the activities of the Bulgarian Academy of Sciences (producing mainly basic research). Moreover, Bulgaria is relatively inefficient in applying R&D results in production, and the cost of patenting its innovations is higher than in most EU countries.

III. POLICY RECOMMENDATIONS 14. To face the challenge and use the crisis as an opportunity, the Bulgarian economy needs to increase its competitiveness by furthering progress in the regulatory reform area and by providing incentives for innovation and transfer of technologies.

In the Short Term

• Ensure a continued flow of credit to the enterprise sector to help smooth the effects of the external shocks on employment and in investment. The Government’s credit reactivation program and consideration of its expansion seems justified. • Review, update and extend the Better Regulation Program for 2008-2010 until 2013. • Review by national parliament of regulatory regimes adopted by COM decision to abolish or simplify most of them. • Prepare a post-regulatory impact assessment of the Limiting Administrative Regulation and Control on Economic Activities Act to propose revisions to the law that address non-compliance by municipalities and central authorities, principle of silent consent, among others. • Submit to the Parliament a new Law on Normative Acts, introducing RIA as a mandatory tool. • Abolish abusive or redundant application of regulatory regimes by municipalities and central authorities. • Set annual targets for elimination of regulatory regimes and report to the public on meeting these targets. • Implement Better Regulation Units in all line ministries, and improve their coordination with the central Better Regulation Unit in the Prime Minister’s Office. • Develop a state fee policy to reduce the number of existing state fees and regulate the setting of new fees. • Carry out Insolvency and Creditor Rights Report on the Observance of Standards and Codes to identify steps for speeding up firm-exit. Propose necessary changes to legislation. • Develop an integrated national Strategy on Innovation and Research under the guidance of a single high level consultative council representing Government, research, and industry. • Increase the share of public R&D funding extended on a competitive basis, and establish clear performance metrics and agreed strategic plans for public funding of R&D to research institutions and universities. • Consider consolidating the National Innovation Fund and the National Science Fund.

In the Medium Term

• Extend the list of regulatory regimes, in consultation with business and public, to be revoked or simplified to meet the target of reducing the administrative burden by 20% through 2012. • Adopt a new State Fees Act based on the principle of cost recovery, and establish an institutional framework to monitor and enforce its application by ministries and executive agencies. • Monitor the elimination of illegal application of regulatory regimes by municipalities through the better Regulation Unit at COM in coordination with the national Association of Municipalities. • Convert municipal registration and permission regimes into simple notification. • Review the provision of administration services by municipalities, and propose Action Plan to streamline them, reduce the time and cost of compliance by firms, and introduce a ranking system of municipalities based on the ease of doing business.

Private Sector Development • Carry out an annual evaluation of the national innovation system, and review it in consultation with industry, research and universities. • Strengthen linkages between research institutions, universities, and industry, and establish bridging institutions. • Encourage the creation of a business angel network. • Strengthen the enforcement of intellectual property rights through capacity building and better coordination of enforcement agencies. • Expand the network of technology transfer centers. • Use a combination of matching grants (Operational Program “Competitiveness”) and loans to facilitate the access of SMEs to technology-intensive manufacturing equipment. • Introduce supplier development programs to help domestic suppliers position themselves in global value chains, and thus benefit from knowledge and technology transfers from buyers. .

Labor Market

LABOR MARKET I CONTEXT 1. Bulgaria’s labor market has improved over the last few years, but the global economic crisis has interrupted and reversed progress. Rapid economic growth led to strong job creation and low unemployment rates for upper secondary and tertiary graduates. Employment rates in Bulgaria, at 64 percent overall in 2008 remain below the Lisbon target of 70 percent by 2010, though this is set to decline in the context of the crisis. While the employment and activity rates for the adult population (aged 25-64) in Bulgaria are now just above EU averages – a remarkable achievement for Bulgaria – there are big deficits for young people (Figure 1). In fact, activity and employment gaps among the youth explain the entire differences in overall labor market outcomes between Bulgaria and the EU averages. Coinciding vacancies and low employment and activity rates suggest that there are skills mismatches – an excess supply of low-skilled workers in the face of an excess demand for high skilled workers. This suggests that Bulgaria has large underutilized pools of labor among the youth, and the challenge is to find ways to activate and ready them to fill the vacancies. Figure 1: Bulgaria’s labor market outcomes are on par with the EU 15 for workers aged 25-54 and 5564, but there are major lags for young workers

Source: Eurostat

2. Existing labor market challenges are magnified by Bulgaria’s steadily declining and ageing population. Bulgaria faces the most dramatic population decline among the new EU member states and is projected to lose about 18% of its population, or 1.5 million people between 2000 and 2025 population 8. This will have major implications for the labor market. Labor market projections through 2035 indicate that increased activity rates could not compensate fully for the decline in population, and that long-term growth prospects will therefore hinge on Bulgaria’s ability to raise skills and productivity. 3. The benign environment for job creation is now changing, as the global economic crisis impacts on labor demand in Bulgaria. Growth in sectors that have been the engine of job creation until now—construction, industry, real estate, and trade—is declining. This has been driving up unemployment since late 2008, although the demand for highly skilled workers is likely to remain strong. Indeed, despite the crisis, there continue to be many available vacancies that remain unfilled. While much of the upsurge in unemployment is therefore cyclical, there is a strong structural element to unemployment and underemployment, much of which appears to be driven by skill mismatches. 8

Red to Gray: The “Third Transition” of Aging Populations in Eastern Europe and the Former Soviet Union, World Bank: Washington, D.C., 2007

Labor Market 4. The economic crisis is an opportune moment to address skills shortages both to tackle unemployment and to help the recovery in the short-term and to promote the foundation for medium-term economic growth and convergence. Lacking skills reduce employability of the unemployed and may hold back a quick return to employment of the newly laid-off. The key ingredient to boosting employment in the course of the crisis is to promote skills upgrading of laid-off workers and those at risk of lay-off through new training programs designed together with employers’ representatives and through incentive schemes for companies and individuals. 5. This note builds on the November 2008 World Bank analysis Bulgaria: Raising employment and human capital for growth and convergence” to examine the challenges related to raising skills and productivity, and some policy options available to the Government. Bulgaria is facing both cyclical (driven by low demand overall) and structural (driven by demand and supply mismatches) unemployment and under-employment – the latter already visible before the onset of the crisis, when youth, older workers and certain groups of adult workers had difficulty joining the workforce despite high labor demand. The note focuses on structural unemployment and policy issues that address the supply of labor, in particular the mobilization of the inactive working age population. It does not address the promotion of overall demand through countercyclical measures, such as Bulgaria’s short working hour scheme.

II. KEY CHALLENGES A. Untapped Labor Reserves 6. Youth participation in the labor market is low. While youth employment in Bulgaria has increased over the last several years, it still remains one of the lowest in the EU including among the New Member States. At the same time, Bulgaria has one of the highest rates of early school leavers which means that many youth drop out of school early but do not join the work force. Close to 25% of the Bulgarian 15-24 year old were neither in employment, education nor training (NEET) in 2005 while in Netherlands, for example, 35% of the youth were both in the labor market and education at the same time. Many advanced EU economies have successfully adopted measures to promote youth employment, such as apprenticeships, internships, wage subsidies for young workers, intensive counseling and aggressive job placement services, remedial education, etc. 7. Non-standard forms of employment are not widely used in Bulgaria. Part-time and temporary jobs are a key entry point into the labor market in many OECD countries, including for young workers and in particular for low-skilled youth. They can also facilitate access to employment during the crisis, as employers may refrain from making full-time and permanent hiring decisions. Experience from across West European countries shows that an initially high share of school leavers in temporary jobs typically declines substantially after several years of work experience, suggesting that they serve as stepping stones into more permanent employment 9. Bulgaria has recently made part-time and temporary work arrangements more flexible but barriers remain, in particular with respect to the ease of contracting. 8. Certain adult groups face barriers to the labor market. The most affected are adult women and low-skilled workers 10. Women have child care and family obligations which in Bulgaria cannot be easily reconciled with remunerated employment, due to the limited availability of child and elder care institutions. Low-skilled workers – many of whom come from the large excess rural labor and from Roma population – have difficulty finding employment in an economy which must compete in with advanced economies in the EU and elsewhere and requires significantly higher educational achievements than in the past. Around 50% of the inactive population has seven grades or less, and many are functionally illiterate, often among the Roma population. 9

OECD (2008) Employment Outlook 2008, Chapter 1, “Off to a Good Start? Youth Labor Market Transitions in OECD Countries, OECD: Paris World Bank (2008), Bulgaria: Raising employment and human capital for growth and convergence

Labor Market 9. Older workers leave the labor market prematurely. While in the short-term more limited employment opportunities may trigger the early exit of older workers from the labor market, in the medium- to long-term Bulgaria’s demographic decline suggests the need to prolong the working lives of its population, following the trend set by other EU member states. Figure 2 presents population charts for Bulgaria for 2005 (left panel) and 2035 (right panel), broken down by labor force status for each age bracket. It clearly shows the shares of the inactive (dark red), and 2035 projections are based on the assumptions of constant activity and employment shares compared to 2005. The figure clearly shows the need to activate substantially the increasingly ageing population of Bulgaria. As the analysis of the financial sustainability of the pension system is showing in a separate policy note, Bulgaria will need to further raise the retirement age to align it with other EU Member States. Some, for example Germany, have introduced measures to raise the retirement age above 65. Bulgaria may wish to explore policies adopted in the Baltic States to discourage early retirement by reducing pension benefit and encourage deferred retirement through higher accrual factors. In addition, justifying the separate retirement ages for men and women is especially hard to justify, as life expectancy of women at age 60 stands at 20.32 years and is more than 4 years longer than that of men at the same age. Figure 2: Stemming Bulgaria’s demographic decline requires activating the working age population and raising human capital, Age distributions in 2005 (left) and 2035 (right) Age distribution in year 2005

Age distribution in year 2035

100

Male

Pre-school Primary Secondary Tertiary Not enrolled Unemployed Employed Not in labor force

Female

Age

Pre-school Primary Secondary Tertiary Not enrolled Unemployed Employed Not in labor force

Female

0 -4

Male

-3

-2

-1

Population in each age group (x 105)

0 -4

-3

-2

-1

Population in each age group (x 105)

x 10

4 5

x 10

Source: Bank staff calculations

B. Skill Shortages 10. Increasing activity rates will need to go hand in hand with improving the skills of the labor force to make up for the population decline and convergence of labor productivity to EU levels. As Figure 3 shows, the decline in population is so dramatic that an increase in activity rate alone will not be sufficient to make for the population decline. To raise labor productivity and compete on the global markets, increasingly based on knowledge economy, Bulgaria will need to have a labor force with the capacity to innovate—absorb, adapt, and develop new technologies and processes. Research indicates that tertiary education investment increases a country’s ability to make leading-edge innovations, while primary and secondary education impact the country’s ability to implement existing technologies. 11. However, few young Bulgarians are staying on in education, and many who do stay in education do not acquire the necessary skills and competencies to compete in a high innovation economy. Drop-out rates from secondary education are relatively high, while participation in tertiary education is one of the lowest among the new member states. The learning content in vocational education and training appears to lack generic, transferable skills increasingly needed in an era of fast technological change. The international student assessments PISA 2006, shows that more than 50% of the 15-year-olds face difficulty reading to understand scientific content – a significantly higher share than their peers elsewhere in the EU – new and old Member States alike – and other developed economies.

Labor Market This suggests that Bulgarian youth may be graduating from school unprepared for the needs of the knowledge economy. 12. Lacking skills prevent the unemployed from reintegrating the labor market and hamper labor mobility. Around 50 percent of the inactive in Bulgaria has low levels of education (7th grade and below) 11. Second chance education, starting from basic literacy and opening a path back into the formal vocational training system with recognition of competencies, will help getting unskilled inactive back into the labor force. The Government has undertaken initial steps to re-open the formal training system to early school leavers through literacy courses managed by the Employment Agency. Successful completion of literacy courses now result in the recognition of attainment of 4th grade equivalent. Moreover, minimum entry requirements for vocational training has been lowered from 6th grade to 4th grade, thereby enabling graduates from literacy courses to get back into formal education and training. The key is now to take measures to promote this program among the low-skilled long-term unemployed, for example socially excluded Roma, to ensure strong take-up. 13. Skills matter even more during the crisis. While the extent of the skills barrier to employment during the crisis cannot be rigorously quantified, the fact that vacancies remain unfilled suggests that skills do matter. If skills were a key concern before the crisis, they are likely to be an even bigger concern as the economy rebounds. A key ingredient to preserving employment during the crisis is to upgrade the skills of laid-off workers and those at risk of lay-off. In this context, continuous learning has a particular importance. Bulgaria has one of the lowest shares in the EU of adults participating in life-long learning (LLL). The LLL participation rate is only 1.4% of adult population aged 25-64 compared with an EU average of about 10% and rates of 30% or more in some Scandinavian countries.

III. POLICY RECOMMENDATIONS 14. The following presents a partial and tentative agenda of policy options for consideration by the Government. This agenda could be further deepened on the basis of consultations with the Authorities and other stakeholders.

In the Short Term

• Short-term measures during the economic crisis ideally combine efforts to keep workers in employment through temporary publicly subsidized short-working hour schemes as well as the use of unemployment benefits and measures to accelerate transitions from old to new jobs, to avoid a loss in employability for newly laid-off workers. Short working hours, however, are only a short-term measure to avoid adjustment costs of lay-off in case of short-lived demand slumps and will become increasingly inadequate as the crisis persists. The government could, therefore, consider gradually shifting attention to enhanced employment services and strategic retraining and up-skilling of workers. The government could also consider, on a temporary basis, to extend unemployment benefit eligibility duration, should labor demand remain low. Moreover, it will be important that well-targeted social safety net programs, such as Guaranteed Minimum Income, are well-resourced and can be scaled up during the course of the crisis as needed • Promote demand-driven training programs for laid-off workers and workers on short working hours in close consultation with employers’ representatives to reflect views on which sectors are going to drive Bulgaria’s recovery and what kind of skills will be required as the economy rebounds. Access to programs need to be handled flexibly, e.g. through the use of vouchers as currently piloted by the Employment Agency with EU financing. • Promote incentives for training aimed at both employers and individuals: The government may wish to consider making access to financing for the short working hour allowance program 11

Ibid.

Labor Market conditional on measures to retrain workers during the freed-up non-working time. Equally, the period of unemployment benefit eligibility could be extended for up to three months per worker conditional on being enrolled in a training course. The individuals’ idle time resulting from the crisis should be used for strategic up-skilling. • Introduce simpler forms for contracting for part-time and temporary employment. Other EU countries have introduced simpler short-term and limited employment contracts with reduced tax and social insurance obligations (e.g., Germany’s “Mini-Jobs” and “Midi Jobs”). • Introduce legislation for temporary work agencies. The recent adoption of the EU Temporary Agency Workers Directive may facilitate the adoption of relevant legislation in Bulgaria. • Eliminate the minimum contribution thresholds by profession and branches to reduce barriers to part time labor.

In the Medium Term

• Pilot apprenticeships, internships and wage subsidy programs for young workers, in partnership with employers and trade unions. It will also be important to develop a National Qualifications Framework or a similar mechanism to recognize the qualifications of people trained through non-formal and informal education. • Develop a mandatory and intensive youth-centered employment activation approach focused on those that are neither in employment nor in education or training. Employment interventions have to be early and sustained, focused on retaining youth in formal education and training, and putting the accent on career counseling and job search assistance 12. Programs that explicitly target disadvantaged youth are more likely to be effective than non-targeted programs 13. The UK and other EU countries have introduced a youth activation regime called “New Deal for Young People”. Based on this model, Bulgaria’s Employment Services could offer a menu of services centered on intensive counseling, with job placement services, training and remedial or second chance education for older youth, and back-toschool programs for the younger. It could also entail outsourcing of the full range of activation services to qualified agencies, e.g. in working with disadvantaged youth such as socially excluded Roma. • Facilitate the participation of women to the job market through improved provision of child care services. The responsibility in this area rests with municipalities, and financial implications are important. Bulgaria could qualify for financing under the EU Structural Funds, through the Operational Program Regional Development. • Promote “second chance” education programs aimed at unskilled and poorly educated inactive adults, mostly rural and Roma. Such programs would start with basic literacy and continue with vocational training. The Government has already lowered minimum entry requirements for vocational training to completion of the 4th grade. • Strengthen incentives for keeping older workers active. Align retirement age on international practice and equalize the retirement age for men and women, discourage early retirement by reducing pension benefits, control strictly eligibility to disability pensions, and encourage deferred retirement through higher accrual of benefits. • Promote early childhood education and development (ECED), particularly for children from marginalized backgrounds such as Roma. There is strong international evidence that investments in ECED improve subsequent outcomes in primary and secondary schooling and yield greater returns than later investments 14. ECED typically aims at developing cognitive, motor, behavioral, and language skills through educational, nutrition and health components. Bulgaria has already introduced one year of free 12

Quintini and Martin (2006), Starting Well and losing Their Way? The Position of Youth in the Labor Market in OECD Countries, OECD Social, Employment and Migration Working Papers No. 39, OECD: Paris 13 Betcherman et al (2007), A Review of Interventions to Support Young Workers: Findings of the Youth Employment Inventory, World Bank Social Protection Discussion Paper No. 715, World Bank: Washington, D.C. 14 Cunha, F., Heckman, J., Lochner, L. & Masterov, D. (2005), Interpreting the evidence on life cycle skill formation (North Holland, Amsterdam).

Labor Market and mandatory pre-school but the mandatory year is not yet fully implemented, in particular among the more marginalized children such as Roma. The ECED agenda should also include developing new child welfare services aimed at children aged 0-3 focused on community outreach and parental training, as well as expanding the availability of crèches/nurseries, and kindergartens for the 3-6 year old. • Discourage early school leaving and boost retention in education and training. Possible incentives may include cash incentives for youth from low income families, such as the Education Maintenance Allowance (EMA) Program in the UK, or the extension of mandatory schooling until the completion of upper secondary education or until the age of 18, as recently introduced in the Netherlands. Cash incentives could be provided through raising the individual eligibility threshold for Guaranteed Minimum Income (GMI) for those youth between 15 and 18 who remain in school beyond compulsory schooling 15. School counseling and professional orientation needs to be provided to youth at risk of dropout. The experience of the UK “Connexions” service which provides guidance to the 13-19 year old, in particular disadvantaged youth may be relevant. • Complete the ongoing process of modernizing primary and secondary education, including vocational education and training. This would include the development of monitoring systems to track performance at school level, the recruitment, training and motivation of quality teachers, and the introduction of a competency-based approach in curriculum and learning. 16 • Expand higher education and its relevance to the job market. Specific measures may include financial support for students (e.g., student loans), the introduction of pathways from vocational secondary schools to universities, the expansion of occupationally-oriented colleges to provide more programs in applied and vocational subjects, and increased competition of higher education institutions by promoting their accountability for results. • Expand life-long learning opportunities. The Bulgarian Employment Agency has launched a program to provide matching grants to employers for training their workforce, with financing from the European Social Fund (ESF) under the Operational Program Human Resources Development (OP HRD). While this is a step in the right direction, additional measures are needed, such as widening the offer of distance education, and facilitating the access of adults to continuing education programs and normal programs offered by universities.

However, given the large variance in schooling outcomes between schools (as opposed to within schools), as documented in the OECD PISA 2006 assessment, Bulgaria needs to also focus on improving school quality, in particular for children from marginalized backgrounds. If schools are bad, efforts to keeping young people in school for longer will not result in improvements in education outcomes and skills. 16 See also Policy Note on Education.

Information and Communication Technologies

INFORMATION AND COMMUNICATION TECHNOLOGIES I. CONTEXT 1. Bulgaria lags behind other EU countries in the area of information and communication technologies (ICT) such as broadband and Internet services. Bulgaria has the lowest level of broadband Internet services in the EU. Only 28% of households subscribed to broadband Internet in 2008, well below the EU27 average of 49%. Limited access to broadband is a missed opportunity to increase productivity and accelerate economic growth: a World Bank study found that for every 10% increase in broadband penetration there is a 1.3% increase in economic growth. Low broadband access also restricts domestic and international trade, slows down the modernization of government processes, hampers the transparency and efficiency of public sector management, and the access of population to public services. 2. Bulgaria’s information technology (IT) industry and IT-enabled services (ITES) are strong performers. A.T. Kearney has ranked Bulgaria’s business-process outsourcing sector first in Europe and ninth worldwide out of 40 countries. The 5,000 IT companies operating in Bulgaria generate revenues of over EUR450 million, 80% of which come from exports to Europe and the U.S. The same survey, however, estimated the proportion of R&D software at only 4% of the total IT market in 2007, which indicates a limited pool of the skilled labor who drives innovation. 3. The implementation of the Strategy for the Information Society Development adopted by the Government in 1999 and revised in 2006 has been slow. Bulgaria ranks lower than most European countries in the UN e-Government rankings. The main causes for this lag can be found in the low level of digital literacy (user skill), the limited mainstreaming of ICT across sectors (e.g., mobile phone based financial transactions, e-health applications, access to commodity price information, etc.).

III. KEY CHALLENGES 4. Inability to regulate the dominant Bulgarian Telecommunications Company (BTC). BTC controls 97% of the wireline market. The Bulgarian Communications Regulation Commission (CRC) is unable to regulate BTC effectively. The access of independent and competitive providers of broadband Internet services is undermined by the high charges applied by BTC for the use of its facilities. BTC dominance allows it to crowd out potential competitors and thus control 99% of the market for broadband services delivered over the wireline telephone network. This slows down progress towards greater broadband penetration, ICT convergence, and international connectivity. 5. Limited availability of skilled labor reflecting lack of relevant vocational education and training opportunities, and weak tertiary and continuing education opportunities. The talent pool is the driving force behind innovation, and Bulgaria’s failure to match the performance of international competitors in the area of research and development (R&D) can dampen growth. 6. Limited broadband network and lack of its integration with other infrastructure. Access to broadband services is hampered by higher costs, especially in rural and remote areas.

Information and Communication Technologies Broadband infrastructure is not routinely rolled out as other infrastructure is developed. Its separate construction raises costs, and discourages investment. 7. ICT development has not been mainstreamed in the Government’s agenda to enhance economic growth, competitiveness, governance, and social inclusion. The importance of informing and educating managers and staff on the ICT potential and its effective use is often overlooked – the acquisition of equipment taking precedence over human capital. There is limited mainstreaming of ICT across sectors, to promote it as a transformational tool that supports expansion and improvement of services.

III. POLICY RECOMMENDATIONS 8. The following policy agenda is tentative and could be completed and validated during consultations with the Government and other stakeholders:

In the Short Term

• Strengthen CRC functions for regulating competition to impose specific, justified and actionable regulations on the dominant firms in each market segment. Related interventions would include revisions to the interconnection charging regime and to the access policy, to enable fair sharing of essential network facilities in all market segments. • Design a program to roll out a national broadband infrastructure in consultation with all telecommunications service providers and other infrastructure developments (e.g., roads, power) in order to reduce costs through economies of scale. The Government may participate in the financing of the program, either as a member of a consortium created to develop the network, or by competitively allocating subsidies for network rollout. The Government’s participation would be particularly critical in bringing broadband facilities to rural and remote areas, currently underserved because of the higher costs and lower returns. • Strengthen existing and develop new ICT applications offered in the e-Government portal.

In the Medium Term

• Implement “quick-win” services from the EU list of basic e-services for citizens. The Government could select from the EU common list of twenty basic public services a number of initial actions, either to provide services which are currently not available (e.g., applications for building permits, or announcements of moving), or to improve the quality of services being already provided. • Review the implementation of national information society strategy and update it. • Mainstream ICT development in national strategies and programs. The Government could leverage the benefits of ICT in sectors such as education, health, social assistance (including welfare of the Roma population), power and others, and integrate the ICT programs developed for the respective sectors within the national strategy.

Agriculture and Rural Development

AGRICULTURE AND RURAL DEVELOPMENT I. CONTEXT 1. Transforming agriculture is central to Bulgaria’s European convergence and social cohesion objectives. The modernization of the Bulgarian economy, and progress towards higher living standards over the past two decades, have by and large bypassed the rural economy. . With about 8% of the workforce employed in agriculture, Bulgaria ranges in the middle of the New EU Member States in Central Europe (EU8+2) 17.Within the EU EU27, however, Bulgaria has among the highest incidence of (absolute) rural poverty -, most pronounced gaps in living and social standards between rural and urban areas, and among the lowest in labor productivity levels in agriculture. 2. The contribution of Bulgarian agriculture to sustainable growth and poverty reduction is below its potential. Agricultural land occupies almost half of Bulgaria’s surface, and almost twothirds of it is arable. Properly exploited, this endowment would allow employing far more productively rural labor while at the same time releasing labor to other sectors, help reduce rural poverty and income disparities within the rural sector as well as with urban areas, and contribute far more effectively to growth, public savings, and a more sustainable trade balance. 3. With public spending of over 1 percent of GDP, Bulgaria’s spending on agriculture is higher than most of the other EU countries, including most of the new member states. Mainly as a function of investment needs in the run up to EU Membership, national public spending for agriculture in Bulgaria more than doubled between 2003 and 2008 in nominal terms, without evident improvement in effectiveness of this spending. In GDP terms, expenditure on agriculture increased from 1.1 percent of GDP in 2003 to 1.2 percent in 2008 (with real GDP growing rapidly). When adding net 18 payments on direct payments to farmers, market measures, and payments under the Rural Development Program; indirect outlays of MAF for activities not technically counted as spending under the agriculture function; and foregone revenues (tax credits, and preferential tax treatments and social security contributions), total expenditure for agriculture was estimated to reach 1.9% of GDP in 2008. 4. The conditions for accelerating the restructuring of agriculture and sustainable rural development are favorable. The world is facing an increasing demand for food while the supply is relatively inelastic, Bulgaria can benefit from opportunities offered by integration into the EU market, enhanced stability and predictability within the Common Agriculture Policy (CAP) framework, and financing under the CAP. The country has gained access to EUR 7.2 billion in EU support for agricultural and rural development during 2007-2013.

II. KEY CHALLENGES 5. The mobilization of Bulgaria’s agricultural potential hinges on addressing a number of challenges: (i) institutional and administrative bottlenecks, and building a more efficient public administration; (ii) the efficient and transparent management of public expenditure; (iii) the fragmentation of agricultural land use and large number of semi-subsistence farms and (iv) climate change mitigation and management of natural calamities. Addressing these challenges will help Bulgaria achieve the strategic aims of building an effective and competitive agriculture sector, and supplying high quality and safe food products to domestic and international markets. The Bulgaria Public Expenditure Review for Agriculture and Rural Development conducted by the World Bank in mid-2009 provides detailed diagnostics of the underlying reasons for the still suboptimal performance of agriculture, and proposes strategies and implementation programs for addressing them.

According to EUROSTAT, agricultural employment in the EU8+2 ranges from 4.6% in Hungary to 29.5% in Romania. Payments made by the budget at the expense of the EU on direct payments, market measures and rural development less reimbursements by the EU on these payments. 18

Agriculture and Rural Development A. Institutional and Administrative Bottlenecks 6. Overall sector policy formulation and its articulation into a comprehensive public expenditure framework are wanting. Since accession to the EU, most of Bulgaria’s agricultural policy is determined by the CAP, but MAF plays a pivotal role in defining strategic priorities for agriculture and rural development. In this context, it must provide strategic coordination for the formulation and execution of the related annual budget(s). In practice, however, budgeting is largely incremental and implemented as a technical exercise while accountability for the performance of the sector is missing. The institutional structure and management processes of the MAF so far did not encourage a strong integration between strategic planning and the resource allocation decisions. Particularly for those national programs not financed by the EU, there are numerous budget performance indicators for very narrow outputs produced through specific activities and no higher level outcome measures by which policy makers could track performance of the programs. However, the new administration’s initiative to set up a strategic analysis and planning unit within MAF represents a first adequate move in addressing these weaknesses. 7. And also in policy execution, there is significant scope for improvement The recent Rural Development Program (RDP) programming experience has shown the need to better inform policymakers and making through a modern management information system. In its absence, programming of support measures would continue to focus on improving farm liquidity rather than farm profitability. The lack of standard gross margin, profitability and price information for representative farm types and products on a national, regional and sub-regional basis, impedes the preparation of well-founded investment proposals and adequate investment risk assessments, and the ability of SFA to adequately evaluate investment proposals against a verifiable set of representative comparators. 8. Access to EU funds by the rural population would benefit from more quality-oriented, client-responsive advisory services. While many farmers are aware of the support programs currently available, knowledge is extremely limited about upcoming inbuilt medium-term changes to their support environment. Many farmers are not aware of the forthcoming mandatory annual increase of Single Area Payments (SAPS) over the next seven years, about RDP measures foreseen for implementation after 2009, about the ‘farm standards’ they will have to observe in order to meet the future EU cross compliance obligations of farmers. It is critical, that Bulgaria improves the range and quality of specialized rural advisory services, and that it revisits the currently fundamentally insufficient financial allocation under the national Advisory Services Program budget line in MAF.

B. Public Expenditure Management 9. Public expenditure policies face several challenges: (i) optimization of CAP implementation in light of competitiveness and equity objectives; (ii) management of increasing claims on the State budget (iii) implementation capacity constraints; (iv) phasing out of programs financed by national resources on a transitional basis; and (v) weak and nontransparent public expenditure planning, budgeting, and administration. 10. Direct payments do little to raise competitiveness and may even discourage farmers from restructuring, consolidating or modernizing their holdings. Direct payments unquestionably contribute to raising and stabilizing agricultural incomes. But if inefficient farmers have a guaranteed income source such as the Single Area Payment they may be less inclined to sell or, more importantly, lease their land to more productive farmers. The pronounced structural challenges of Bulgaria’s farm sector will therefore be more effectively addressed through investment-type support (such as core RDP measures), as these contribute to farm modernization competitiveness enhancement. 11. Bulgaria has forgone about EUR 10 million annually because it registered too large a reference area for Single Area Payment’s Scheme (SAPS) payments. While the determination of a larger area t might have been motivated by avoidance of a public perception that portions of the agricultural holdings would be excluded from income support, in practice, some 15 percent of

Agriculture and Rural Development Bulgarian agricultural land fails to meet the EU’s eligibility criteria for income support and therefore should not be registered as part of the reference area. In 2008, out of the 3.8 million ha of registered agricultural land, support could only be granted to users of about 3.2 million ha and payments for about 0.6 million ha remained “unabsorbed.” However, first corrective action has been taken: Effective June 2009, Bulgaria’s obtained the European Commission’s approval for a reduction of the reference area to 3.492 million hectares. 12. Starting in 2010, changes in the EC implementation rules for Complementary National Direct Payments (CNDP) might impose substantial additional pressure on the State budget. First, the transitional Pillar 2-sourced EU support for CNDPs (reverse modulation) will be eliminated starting in 2010, resulting in a potential impact of EUR 40-50 million on the domestic budget if maintained as is. Second, another EUR 160 million in State budget would be needed should MAF decide to take advantage of the possibility, only recently granted by the EC, of increasing CNDP from 30 to 50 percent of the EU15 average. As State Aid schemes (see paragraph 14) also terminate at the end of 2009, former beneficiaries may lobby for compensation via CNDPs. However, given prevailing fiscal constraints MAF should resist such potential lobbying pressures. 13. Failure to match the relatively ambitious National Rural Development Program (RDP) with sufficient capacities has lead to initial implementation bottlenecks. Bulgaria has a coherent RDP for the period 2007-2013, but lacked adequate synchronization of implementation timetable vis-à-vis the available staff resources of the State Fund for Agriculture (SFA), the agricultural paying agency. Attempting to address a wide range of previously identified rural development needs, the RDP ambitiously selected 30 measures out of the about 40 available on the EU’s rural development menu. Although the RDP implementation started with 23 measures instead of all 30 programmed, the State Fund for Agriculture (SFA) faced serious strains on their administrative capacity. As a result, the initial RDP implementation saw –and still sees– substantial backlogs in the processing of applications for support. This compromises the SFA’s ability to comply with the legally mandated response deadline to applicants of three months, risks of which are twofold - loss of trust among potential applicants, and deterioration in the quality of application appraisals and approvals. The latter case may have a financial impact if the EC were to determine that Bulgaria does not comply with funding guidelines. MAF has recently initiated first corrective measures to address these bottlenecks: Applications are now accepted under a “window” approach, and the staff of the SFA has been supplemented. However, further improvements in the management of applications might be needed, but should clearly be based on a rapid functional review of the RDP application/contracting process. 14. Existing State Aid programs are fragmented and non-transparent and (most) must be phased out by end-2009. Within tight limits, many State Aid programs existing before accession were permitted by the EC to be maintained on a transitional basis for the first three years of EU membership (“sunset clause” for Pre-Existing State Aid) They are clustered into a complex set of 9 categories, further subdivided into 100 measures. The real amount of spending is not monitored systematically because of the fragmented policy development and budgeting system in place. These programs are spread throughout various government agencies, who each submit their requests and forecasts through the normal budgetary process. Expenditure for only 45 measures under two of the nine categories (grossly underestimating total spending) amounted to almost EUR 105 million in 2008. Most State Aid programs are subsidies non-compliant with the CAP and the European Competition Policy and must be discontinued by end-2009, the complex planning for which was delayed and hence represents a substantial short-term task for the new administration. It is welcomed, that MAF now conducts this exercise based on the principle of limiting the future application of registered State Aid mainly to investment-type measures for public goods, representing priorities not funded by the EU, but central to facilitating further integration into the EU Single Market. 15. Reviewing the efficiency and effectiveness of MAF’s National Programs must represent a priority in optimizing the use of national State Budget resources. MAF finances 17 programs, plus a general one for overall administration, counting for 33% of the resources allocated to agriculture function. In 2008 MAF’s budget allocations for national programs amounted to about

Agriculture and Rural Development EUR 220 million. Many programs are mandated and regulated by the EU, or are obligations assumed under the CAP (e.g., veterinary or advisory services, organization of markets, agro-statistics, phytosanitary and plant protection, animal breeding, rural natural resources, crop breeding, fisheries and aquaculture, agricultural machinery). A first important step towards a review of these programs has been initiated by the new administration: A review of current implementation arrangements in the food safety and quality domains is being conducted with a potential aim of creation of a designated Food Safety Agency. Given their central importance in sector development and budget, the following should represent priorities for further designated assessments: (a) Programs aiming to address central structural constraints to sector development such as Land Consolidation and Hydro-Amelioration to ensure systemic strategy development, institutional upgrade, and integration of climate change adaptation incentives (see below); (b) Programs aiming to address human resource and knowledge constraints such as Rural Advisory Services (see paragraph 8) or Agricultural Education (to assess options for increasing the efficiency of the educational process and analyze whether the transfer of operation of schools from MAF to the Ministry of Education, Youth and Science (MEYS) could i) improve the quality of the common policies pursued in the field of education and ii) result in an optimization of MAF administrative costs).. 16. There are wide fluctuations between the planned and the actual budget allocations realized during the year. Total spending of MAF is consistently higher than planned in the budget law with most of the overspending directed to the administrative functions of MAFâ&#x20AC;&#x201D;for staff payments and operations and maintenance. Controls on capital spending have been the most relaxed of all, with actual spending in 2008 almost double the amount envisaged in the budget law. Budget estimates of the SFA are based on overly optimistic assumptions and do not take into account capacity constraintsâ&#x20AC;&#x201D;the SFA executed only half of its planned expenditures in 2008.

C. Fragmentation of Land Ownership and Polarized Farm Structure 17. Land use fragmentation and large number of semi-subsistence farms. Fragmentation is due to land restitution which aimed at restoring historical patterns. While land fragmentation is more pronounced for land ownership than for land use, it still prevents economies of scale and the introduction of modern farm practices to a larger degree. For those who wish to lease land, that task is made more difficult by the numerous owners that have to be identified and contacted. This hampers long-term investments in agriculture and related CAP funding, access to credit, land improvements, and efficient use of agricultural machinery. The development of a land consolidation strategy, law and facilitating actions (institution building, coverage of transaction costs) towards voluntary land consolidation by the government will further stimulate the consolidation process. 18. Bulgaria has the highest incidence of subsistence and semi-subsistence farming in the EU. Over 500,000 holdings cultivate only 9% of agricultural land, but account for 61% of the agricultural employment. Most of them are not eligible for income support via Singe Area Payments as they are under the minimum eligibility size of one hectare as established by Bulgaria. They hardly have access to credit, do not use modern inputs, and have little chance of becoming competitive. While a special measure in the National Program for Development of Agriculture and the Rural Areas focuses especially on semi-subsistence farms, a large portion of these farms will never become professional and market oriented. There is a need to more actively stimulate intergenerational asset transfer in agriculture and alternative employment opportunities in rural areas to raise living standards. 19. At the same time the emergence of more competitive intermediate farms faces multiple obstacles, from access to markets to severe generational, excess labor and skills problems. Most farmers cannot pre-finance and co-finance CAP-funded investments under Pillar 2 Rural Development. Access to credit, especially in primary agriculture, is insufficient and this is compounded by the current global financial crisis.

Agriculture and Rural Development D. Climate Change 20. Climate change will exacerbate the impact of natural calamities and addressing vulnerabilities to adverse agro-climatic phenomena will be key to ensuring agricultural sustainability (as demonstrated by recent droughts and floods). Climate change will impact Bulgaria’s agriculture, and adaptation efforts would help to mitigate the effects of future weather extremes. Equally important, climate change mitigation represents, in a variety of ways, a significant opportunity for the agricultural sector: Through its carbon sequestration potential, agricultural soils –if properly managed- represent an important sink for emissions from other sectors. If adequately incentivized by agricultural policies (under the RDP and National Programs) and advisory services, Bulgaria could generate additional agricultural revenue from trading carbon emission rights on international markets. For the latter, potential especially exist regarding carbon sequestration under permanent grasslands..

21. III.

POLICY RECOMMENDATIONSThe following highlights selected policy recommendation. A comprehensive list of policy and operational recommendations on policy formulation and execution in the agriculture and rural development is provided in the Bulgaria Public Expenditure Review for Agriculture and Rural Development prepared by the World Bank

In the Short Term CAP Pillar I – Income Support

• Assess fiscal space to address additional resource requirements related to the end of the reverse modulation of EAFRD funds to CNDPs • Limit application of CNDP to 30% of EU15 average to respond to fiscal constraints • Based on analysis of income disparities, assess need for sub-sectoral adjustments such as, for instance, further shift of CNDP resources from crop to livestock schemes

CAP Pillar 2 – Rural Development: • Conduct a rapid functional review of the application/contracting process to verify sufficiency of recent corrective measures and/or identify further action needs • Consider improved awareness campaigns for RDP measures experiencing limited uptake State Aid: • In close cross-departmental coordination and under reliance on the principle of investment in public goods, finalize programming for discontinuation of Existing State Aid under the sunset clause and definition of Registered State Aid for accreditation by the EC National Programs: • Conduct designated functional reviews for National Programs aiming at addressing critical structural, human resource, and knowledge constraints Institutional and Administrative Capacity: • Establish high level policy unit within MAF that provides for strategic analysis and coordination, and informs budgeting and medium-term sector planning, including monitoring of performance information

In the Medium Term CAP Pillar 1 – Income Support: • Monitor adequacy of registered reference area for SAPS payments in light of medium-term sector development trends to avoid potential absorption losses or underdeclaration • Based on analysis of income trends, consider gradual annual reduction of CNDPs and shift of released financial resources to National Program funding public investment priorities not funded by the EU, but central to facilitating further integration into the EU Single Market • Better inform sector about upcoming inbuilt medium-term changes to their support environment (SAPS phasing-in, CNDP phasing-out, cross compliance provisions)

Agriculture and Rural Development CAP Pillar 2 – Rural Development: • Ensure strong participation of concerned administrative units and stakeholders in 2010 midterm review of the RDP and timely, targeted program adjustment in light of MTR findings • Ensure timely initiation of the programming of RDP 2014-20 to allow for adequate analysis, stakeholder consultation, and EC accreditation process National Programs: • Develop strategies for MAF support to voluntary land consolidation and investments in hydro-amelioration; initiate potentially required legal amendments; and implement pilot projects to ‘field-test’ procedural provisions before mainstreaming into national policies. • Elaborate concept and provide adequate funding for provision of more quality-oriented, client-responsive advisory services • In RDP and National Programs, mainstream incentives for climate change adaptation and mitigation into sector support programs (Pillar 2 and National Programs) and evaluate related additional revenue potentials from CAP Pillar 2 and from trading carbon emission rights on international markets.

Forestry

FORESTRY I. CONTEXT 1. Bulgariaâ&#x20AC;&#x2122;s forests have high commercial and conservation value. They cover around 4.1 million ha, three quarters State owned, and the balance is owned by individuals, municipalities, and institutions. Recorded annual timber removals are around 5 million m3, two-thirds of which come from state forests. The annual increment is estimated at 14.1 million m3/year. Approximately 73% of the current harvest is for the forest industry; the balance meets the needs of the local population for firewood and construction. 2. State management of the forest sector is undertaken by the State Forestry Agency (SFA), an independent agency subordinated to the Council of Ministers. The SFA was created in mid-2007 to take over this responsibility from the Ministry of Agriculture and Forestryâ&#x20AC;&#x2122;s National Forestry Board. The institutional changes maintained the 3-tier structure for forest management, i.e., the State Forestry Agency, 16 Regional Forestry Directorates, 141 State Forest Enterprises (SFE), and 37 State Hunting Areas (SHA). The forest enterprises and the hunting areas operate under contract to the State Forestry Agency as commercial, financially independent companies but (as state companies) are unable to be declared insolvent. Regional forestry directorates exercise control functions, as well as some management and oversight responsibilities. 3. The general principles behind the reforms which are underway in Bulgaria are sound: the ideas that forestry units should and can be financially self-sufficient; that regulatory functions should be separated from day-to-day management operations; and that forestry units should be encouraged to improve their efficiency and service delivery orientation by adopting commercial business practices are common among many European forestry agencies. . 4. The main objective of the institutional change has been to transform a forest organization from a centrally planned, financially secure, and vertically integrated institution with strong regulatory and production functions, to an organization with roles which are fundamentally service delivery and for which expenditures (public and otherwise) have to be mobilized from increasingly constrained sources. While the recent institutional reforms were evidently carried out with this objective in mind, their implementation raises a number of issues and challenges. 5. This note draws on the World Bank Policy Note issued in March 2009, and seeks to highlight some of the most important challenges faced by the Government in managing the forestry sector, as well as policy options which could be considered by the Bulgarian Authorities. The cooperation between the World Bank and the Bulgarian forestry administration dates back to 1990 and has continued successfully through the years. The State Forest Agency have requested continuing support from the Bank.

II. KEY CHALLENGES A. Strengthen Forest Policy Framework 6. The policy and strategic framework for the sector needs to be strengthened. The National Strategy for Sustainable Development of the Forest Sector in Bulgaria, 2003-2013 was approved by the Council of Ministers (later revised for 2006-2015) but it was never adopted by the National Assembly. There is no consensus on a road map for the future, on the sequence of reforms, on arbitration of divergences, and on institutional and organizational responsibilities. The Strategic Plan of Action for Forest Sector Development in Bulgaria (2007 to 2011) was not formally adopted by the Government, and was not funded (it received only about 10% of the funding needed). The reforms launched in 2007 are

Forestry incomplete but were not well understood by stakeholders when first introduced. Without a clear vision of objectives and monitorable outcomes there is no way to assess progress and fine-tune reforms, state institutions cannot be adequately motivated and held responsible, and other stakeholders cannot exercise their legitimate concerns with the transparency and accountability of the Governmentâ&#x20AC;&#x2122;s actions. 7. The consultation of stakeholders outside state forestry institutions has been limited. Important legislation and institutional restructuring have been done with little if any consultation. This has led to failure to identify potential problems and solutions, build the trust needed to achieve credible and durable outcomes, and foster confidence in the positive results of the reforms.

B. Improve Commercial Viability of Forest Enterprises 8. The commercial viability of state-owned forest and hunting enterprises is uncertain. The 141 forest enterprise and 37 hunting areas were created, without sufficient evaluation of their financial viability and institutional capacity to manage operations on commercial terms. They were set-up without consideration to balancing assets and operations: some of them may manage young plantations with high fixed costs and low revenues, and are unlikely to be profitable and reinvest in their operations, while others may be profitable, as they manage productive forests and have access to diversified income from hunting operations. These enterprises are â&#x20AC;&#x153;ring-fencedâ&#x20AC;? and profits and losses cannot be transferred among them. Moreover, these enterprises must comply strictly with the harvesting and development plans laid out by the Forest Management Plans, based on silvicultural, rather than business principles. Enterprises must therefore fund public investments at the risk of compromising their financial viability. 9. In light of the questionable financial viability of some of the SFEs, it is likely that a significant number will need to be either wound up or merged with larger more viable SFEs. Staff of some of the less viable SFEs appeared to be simply waiting to see how things would develop. There is the impression that, as the SFEs cannot go bankrupt, salaries would still be paid regardless of whether the SFEs can generate enough revenue or not. The process of liquidation and consolidation needs to be carefully planned. If it is left to evolve naturally, significant problems could arise. These could include problems associated with the accrual of debts, an inability to pay staff their salaries, labor disputes, increased incidence of illegal logging and/or corruption, failures to meet contractual obligations to other stakeholders, and weaknesses in the ability of SFEs to provide public goods and services and protection functions. 10. The priority given to commercial viability may put at risk environmental and biodiversity objectives. Some forests cannot be commercially exploited because of their importance as natural habitats or watershed catchments. These considerations were not properly factored in when the SFEs and SHAs were created. About two-thirds of the SFEs and SHAs are responsible for the management of Natura 2000 sites. Given the weak regulatory framework of Natura 2000, there are problems with the boundary definition with respect to ownership. It is also unclear whether state-owned enterprises qualify for compensation payments from the Rural Development Funds for Natura 2000 site protection. 11. The current marketing of timber from state owned forests lacks competition, and transparency, and is unable to meet the demand of the major industrial consumers (and hence the main employers in the timber industry). The supply of industrial roundwood is hampered by: the use of frequent yard auctions where small quantities of timber are offered at sites scattered throughout Bulgaria; the reliance on one method of competitive timber sale (and it ignores other viable alternatives such as long term contracts, standing sales, delivered sales, etc); storage depots/yards which cannot hold large enough volumes; and, ineffective market regulation, leading to a lack of transparency, and possible collusion. At the same time the current methods of timber sales discourage investment in new economically efficient and more environmentally friendly harvesting technology.

Forestry 12. The emerging markets for carbon and certified timber present an important opportunity. Bulgaria could develop projects for carbon sequestration through afforestation, improved forest management and for use of wood waste to replace fossil fuels. EU demand for certified timber is increasing. In 2006 Bulgaria made a commitment to certify at least 30% of the stateâ&#x20AC;&#x2122;s forests. To date only 3% of the states forests are certified to an internationally recognized standard.

C. Enhance Institutional Arrangements and Effectiveness 13. Institutional roles and responsibilities may overlap and undermine reform. While forest enterprises and hunting areas were ostensibly set-up as independent commercial entities, SFA and the Regional Forest Directorates de facto control their day-to-day operations. This may undermine the objectives of reform: for example, SFA collects a much higher proportion of the timber taxes on timber sold on-the-stump than of revenue obtained from the sale of timber by an SFE from a storage depot, even though this is based on the observation that selling timber from a depot yields higher revenues and lower leakages, these are decisions that should be made by the SFEs/SHAs. 14. Control and regulatory functions are insufficiently defined and enforced. SFEs and SHAs must protect their assets, manage their operations in a competitive, open and transparent market, and exert control over their own business; The SFA and Regional Forest Directorates are responsible for the implementation of the Forest Management Plans, the collection of state taxes, the efficient operation of the market, and the fight against illegal logging, poaching, corruption and collusion â&#x20AC;&#x201C; regardless of the forest ownership, public or private. At present the SFEs are reported to control private sector activities, which gives them an unfair competitive advantage, and interferes with the responsibilities of SFA. 15. The Forest Fund cannot meet the financing needs of the state forest enterprises, and its role is misconstrued. The Fundâ&#x20AC;&#x2122;s resources can finance only a fraction of needed investment, and some of this investment (e.g., afforestation, or forest roads) may actually increase the financial burden of loss-making state forest enterprises as it adds to their fixed costs for guarding, management and maintenance. Some SFEs perceive (incorrectly) the Fund as a reallocating mechanism between profit-making and loss-making enterprises. 16. Forest consolidation policy has suffered from serious deficiencies in its implementation. Recently, in an effort to encourage consolidation of fragmented forest ownership in non-state owned forests, the government has allowed the swap of small blocks of non-state owned forest for alternative larger contiguous blocks of state forest of the same total area or nominal value. This has been abused by some entrepreneurs who have swapped private forest for state forest adjacent to areas with high development potential in seaside and ski resort areas. Once acquired, formal zoning changes in land use have been sought, and the property is then either developed or sold off for development purposes. Clearly the state forest sector is either losing significant sums (estimated by NGOs to be in the region of Euro 0.5 billion) or ecologically important areas of forest are being destroyed. The principle of consolidating forest ownership is a pragmatic and sensible one. However the practice of allowing a change in land use, post consolidation should be stopped. If state forests are to be sold for development purposes then it should be sold to benefit the state and should be subject to a proper review and publicly available environmental assessment. 17. Many forest boundaries are not clearly defined either in the terms of maps, or in title definitions. With increased commercial activity of both SFEs/SHAs and of private forest owners, border and ownership disputes are bound to increasingly occur. A forest cadastre should be completed as a matter of urgency, to ensure that there is clarity about which institution or owner is responsible for managing which forests. While the issuance of title per se to holdings managed by SFEs and SHAs, is problematic (because SFEs are only management institutions, rather than ownership institutions), it

Forestry remains a clear need for private forest owners, who would be able to purchase and sell holdings for consolidation purposes and to improve scale economies. 18. There is a deeply held perception amongst civil society organizations that corruption in the forest sector is endemic. Although diagnostic work about the incidence of illegal logging has not been carried out, there is a perception that it is widespread. There are also concerns about the legitimacy of socalled land swaps, which appear to be legal, but which undermine the viability of important natural habitats. For institutional reforms to be successful and to be perceived by the public and stakeholders as successful, it will be necessary to address the issues of illegal logging and corruption in an aggressive, open and transparent manner.

III.

POLICY RECOMMENDATIONS

In the Short Term

• Develop a vision and road map for reform in the sector with extensive and comprehensive consultation and engagement of all stakeholders, public and private. • Rationalize the network of state forest and hunting enterprises in a way that ensures resources are allocated where they are most needed and that the institutional framework is financially sustainable. • Consolidation of the 141 forest enterprises and of the 37 hunting enterprises in view of achieving the financial independence of the enterprises and an optimization of their staff numbers and costs. • Closure of the "Bulgarian Forest" Fund, because its investment activity overlaps with that of the State Forestry Agency. • Develop funding mechanisms to ensure that the public good functions (e.g. erosion control, protection of fragile environments, provision of clean drinking water, provision of tourism and recreation opportunities etc.) of forest management are adequately (and if necessary publicly) resourced and protected; • Allow the SFEs and SHAs to take full responsibility for, and reduce the involvement of the SFA and RFDs in, the day to day management of SFE and SHA operations and activities. • Put in place institutional incentives for environmentally sustainable forest management. This measure may entail arbitrating between the commercial and environmental preservation roles of SFEs and SHAs in areas where natural habitats are threatened by overexploitation. Provide critically needed investments in key areas such as forest roads, fire control, afforestation, forest management and management information systems and nature protection. • Inform stakeholders on the scope for using the Forest Fund and related constraints, and develop alternative financing mechanisms to meet needs that cannot be serviced by the Fund. • Prevent changes in land use without full and independent Environmental Assessments, subject to full and transparent public review, and improved mechanisms for valuation. • Apply a moratorium on land use change following the swap or sale of State or municipally owned forests, to ensure the continuing provision of environmental and social goods and services.

In the Medium Term

• Undertake a comprehensive and consultative forest policy and strategy process, which would identify the outcomes expected of the reform process. • Continue the institutional change process which could include limiting the responsibilities of Regional Forest Directorates to the control of state forests and hunting enterprises, not private sector activities and establish an independent institution with civil society participation, to oversee both public and private forest. • Improve the institutional and legal framework for management of privately owned forests to place them on equal footing with state forest and hunting enterprises.

Forestry • The marketing system for the sale of state owned timber needs to be made far more competitive and transparent, and it should utilize all appropriate methods of sale (e.g. standing, roadside, depot, delivered, etc.) to become a more reliable source of timber for industrial development and revenue generation for the sector. The current constraints on investment in timber harvesting need to be removed and new economically efficient and more environmentally friendly harvesting techniques adopted • Forest management planning should become more multi-purpose, further developing social and environmental factors as well as the more traditional timber and reforestation aspects. There should also be greater involvement of civil society in the forest management planning process. Forest management decisions should be based on an accurate inventory of all the forest resources (e.g. biodiversity, environmental, social and recreational functions, non-timber products, etc. as well as timber). Forest management planning needs to take into account the business requirements of the newly emerging State Forest Enterprises/Hunting Areas, and there need to be methods of ensuring that virgin and/or forests with high conservation value within the productive forest landscape are protected and managed appropriately; Encourage the uptake of forest certification in private and state forest through possible changes in the tax code, public procurement legislation, and subsidies for the certification process. Encourage group certification to achieve economies of scale. • Improve the transparency in all dimensions of forest management, particularly with respect to markets, land transfers, revenue collection, etc. Improve forest governance along the principles of international agreements such as the St. Petersburg Declaration. • Develop a master plan for the rehabilitation and development of forest roads and mobilize adequate financing. Improve engineering standards of forest road design, with a special focus on the environmental and social impact. • Develop and implement a comprehensive and centrally financed program for fire control. • Develop and implement a national flood management program, based on the preservation of forest in flood plains, and the restoration of natural river-side forests. • Establish clear thresholds above which Environmental Assessments are required in cases of land conversion or initial afforestation or deforestation, consistent with the EC regulation on EA (article 2). • Consider budget subsidies for SFEs and SHAs with responsibilities for managing important natural habitats. • Tap more fully EU CAP Pillar 2 financing for better management of natural habitats by private forest owners. • Develop a comprehensive Forest Monitoring and Management Information System that integrates forest management plans, and supply it with real-time information on harvests and markets.

Energy Sector

ENERGY SECTOR I. CONTEXT 1. Bulgaria’s energy sector has gone through profound institutional, regulatory and structural reforms during the past five years, driven partly by Bulgaria’s obligations in relation to its EU accession. Significant progress has been achieved in solving medium-term issues of transition toward a financially stable and market-oriented energy sector. 2. The draft Energy Strategy by 2020 19 states as its objective ‘achieving the national targets set by the European energy policy and guaranteeing that Bulgaria’s interests are protected’. The national targets for Bulgaria are consistent with the broader goals of the EU’s energy policy to reduce the negative climate change impact of the energy sector, curbing the EU’s dependence on imported energy resources and promoting economic growth and employment, thus ensuring secure and affordable energy for consumers. Some specific objectives that can be derived from the strategy are: (i) providing reliable and competitively priced energy to consumers; (ii) maintaining the competitiveness of the economy within the European market through efficient use of energy in all sectors of the economy; (iii) reducing the environmental impact from energy production and use; and (iv) protecting poor and vulnerable groups from the impact of rising energy prices.

II. KEY CHALLENGES 3. Bulgaria will need to consolidate previous reform efforts and address the following major energy sector challenges: (i) improve governance of its energy market by finalizing market reform; (ii) ensure the security of energy supply despite increasing import dependency while managing the environmental impact of the sector; and (iii) achieve a sustainable use of energy resources by increasing energy efficiency and deployment of renewable energy technologies.

A. Improve Governance of the Energy Market by Finalizing Market Reform 4. Bulgaria does not yet have a truly competitive electricity market despite major transformation of the sector. Over the past decade, the Bulgarian energy sector has gone through a major reform process to meet key requirements of EU membership. The electricity sector was profoundly restructured. The state-owned National Electricity Company (NEK) was unbundled and some of its distribution and production companies were privatized. The electricity market model was changed and since July 01, 2007 all final consumers are in principle allowed to freely choose their supplier. However, competition in the electricity market remains comparatively low: the generation and supply segments are highly concentrated and NEK remains the dominant player. Furthermore, there are no developed regulatory, organizational and technical mechanisms for small end-users to gain market access. 5. There is a risk of stalling and possibly reversing progress establishing a truly sustainable and competitive energy market. In September 2008, the state-owned Bulgarian Energy Holding (BEH EAD) was created with the goal of: “achieving a centralized and efficient management of participating business with adequate market behavior and functioning under single strategic management”. The holding consists of: i) Maritza–Iztok EAD (major coal mines), ii) Maritza-Iztok II EAD (thermal power plant), iii) Kozloduy EAD (sole nuclear power plant), iv) NEK EAD, v) Electricity System Operator EAD, vi) Bulgargaz EAD, vii) Bulgartransgaz EAD, and viii) Bulgartel EAD. The creation of the ‘national energy champion’ with its subsidiaries being dominant players with significant market power in their respective markets, 19

“Draft Bulgarian Energy Strategy by 2020”, Government of Bulgaria, November 2008.

Energy Sector may reduce the chances that consumers will get real choice in the gas or power market anytime soon 20. 6. Energy pricing is an obstacle to improved sector performance. Bulgaria is now part of the internal European energy market and has in principle fully opened its electricity and gas sectors to competition. Over time this will undoubtedly tend to align Bulgarian prices with the internal market level. However, electricity and gas prices to households and industry in Bulgaria are currently significantly below this level 21, which hampers attempts to modernize and improve service. Furthermore, district heating tariffs are not high enough to fully cover the cost-of-service. Thus, DH companies continue to accumulate losses and under-invest, leading to further infrastructure deterioration and diminishing service quality. Introducing comprehensive price reform would generate significant benefits: (i) ensure financial viability of energy companies, thus facilitating investment in generation, transport and distribution of energy and, in particular, in more efficient and environmentally friendly technologies; (ii) provide a very important incentive for energy conservation on the demand side; (iii) reduce distortions in demand for electricity and in the pattern of demand in different applications (e.g., extensive use of electricity for heating). 7. The mitigation of the impact of tariff reform on the poor needs to be strengthened. Increased energy prices will cause a financial burden for many poor and vulnerable households, and may also lead to other negative effects such as switching to unsafe and environmentallyunsound alternatives. The main social safety net program to mitigate increases in energy prices during the heating season is the Heating Allowance. This program is well-targeted and amongst the best performers regionally. However, while this program provides a significant cushion to the poor, the size of the benefits is not large enough to lift the beneficiaries above the poverty threshold. As a result, its commendable poverty targeting is not translated into poverty reduction. Given that the benefit size and the coverage are low, the heating allowance can be scaled up by: (i) expanding coverage, and (ii) increasing the value of benefits. Thus, the heating allowance could become a key instrument to support energy tariff reforms by protecting vulnerable consumers from price shocks and securing the social and political acceptability of tariff reform.

B. Security of Supply 8. The main fuels used for electricity generation in Bulgaria are nuclear and coal. Bulgariaâ&#x20AC;&#x2122;s role as an electricity exporter in the region has diminished somewhat following the closure of four out of six of its nuclear reactors at the Kozloduy plant as part of the EU accession agreement. Coal (mostly low quality lignite) dominates electricity production, although its environmental impact is likely to reduce the available capacity. Coal-fired power plants are old (65% of capacity is more than 30 years old), operate at a relatively low efficiency (about 30-35% depending on the age), and have a high environmental cost. Thermal power plants are the largest emitters of greenhouse gasses in the country. Compliance with stringent EU pollutant emission requirements for lignite-fired power plants has put significant pressure on some of the facilities, which would either need to cease operations or operate at lower capacity and for limited periods of time to adhere to the requirements for reduced emissions. 9. Planned construction of new electricity generation capacity need to be based on rigorous cost-benefit analysis. The Energy Strategy by 2020 sets ambitious goals for the construction of new electricity generation capacity, including: (i) the Belene nuclear power plant (2,000 MW); (ii) a fourth lignite power plant in the Maritza complex; and (iii) the commissioning 20

The EC started an infringement procedure against Bulgaria because it considers that the rules requiring major electricity producers to sell a portion of their production at a regulated price to NEK will lead to distortions in the opening of the electricity market. 21 In 2007, household and industrial electricity prices were 19% and 39% below EU average, respectively. Gas prices were also lower for households (38%) and industry (40%), compared to EU average gas prices.

Energy Sector of several hydropower plants. Overall, gross installed capacity is expected to increase by 7,000 MW by 2020. However, little or nothing is said about the criteria used to choose such major and capital intensive projects. If these criteria are not sufficiently rigorous these projects might become stranded assets in a truly competitive regional market. 10. Increasing the use of renewable energy, which has large untapped potential. The contribution of new renewable energy sources (biomass and hydro) in Bulgaria’s gross final energy consumption has increased in recent years. In 2005 it was of 9.4%, higher than the EU average of 8.5%. According to the National Long-term Program to Promote the Use of Renewable Energy 2005-2015, the available potential of different renewable energy sources is estimated at about 6 million tons of oil equivalent per year. Realizing this untapped renewable energy potential could not only help Bulgaria enhance its position as a major electricity producer and supplier to the South East Europe Region, but also reduce its dependency on imported energy, thus increasing the country’s security of supply. The sources of renewable energy with the greatest potential are: • Wind: it is estimated that total wind capacity of 2,200 to 3,400 MWe could be installed; • Biomass: at least 300 MWe (60% of land consists of agricultural land, and about 30% is forested); • Geothermal: about 200 MWe could be generated from geothermal sources; • Solar: significant potential exists in the east and south of Bulgaria. 11. Bulgaria is highly dependent on imported natural gas but has currently only one gas sources and supply route. Bulgaria depends on imports for about 90% of its gas requirements. Like most Balkan countries, it receives its gas supplies exclusively from Russia via Ukraine. Furthermore, the country has only one relatively small underground gas storage facility, at Chiren. This facility is used to balance seasonal demand fluctuations and for strategic gasstorage. However, the maximum daily withdrawal rate cannot cover the average daily demand during the winter season and highlights the country’s vulnerability to supply disruptions. During the 2009 gas price conflict between Russia and Ukraine, Bulgaria was among the worst hit EU countries, at great loss to the economy. The Energy Strategy by 2020 calls for an increased penetration of natural gas in the country’s domestic consumption and in the heating sector (only 1.5% of Bulgarian households are connected to gas distribution networks). While this makes sense from an energy efficiency point of view, increased use of natural gas must be combined with source and route diversification to mitigate security of supply concerns.

C. Energy Efficiency 12. Despite a substantial decrease in energy intensity in the past decade, energy efficiency is low. In 2007 Bulgaria used close to 5 times more energy than economies in Western Europe to produce one Euro of GDP and about two times more than central European economies. High energy intensity is driven by: (i) low efficiency in energy conversion to generate electricity and heat due to obsolete technologies plus high losses in the transmission of energy; (ii) extensive use of electricity for heating by residential consumers (resulting from low electricity prices and limited choice of alternatives such as direct gas heating or high quality district heating service; and (iii) low energy prices for end consumers, which does not encourage energy conservation. Bulgaria has set itself ambitious energy efficiency targets, aimed at reducing the energy intensity of total domestic energy consumption by 50% by 2020–which is significantly higher than the 20% target set for the EU. The recent adoption of specific legislation, a coherent set of medium and long-term strategies and concrete action plans have already yielded positive results by enabling implementation of some energy efficiency programs. The main challenge for the government is to ensure effective implementation of the above policy measures and coherence among the various instruments to achieve Bulgaria’s full energy savings potential.

Energy Sector 13. Energy losses are huge and require investments in energy efficient technologies. The large share of primary energy supplies used for energy conversion (mainly for electricity and heat), coupled with the low average efficiency of power generation plants, results in huge energy losses. The participation of electricity plants in the EU’s greenhouse gas Emission Trading System (ETS) will be key to encourage market-oriented investments in energy efficient technologies with low environmental impact in the power sector. Large energy losses in district heating systems also must be addressed through targeted investments.

III. POLICY RECOMMENDATIONS In the Short Term

• Undertake a thorough analysis to determine strategic choices for new investments in generation capacity in order to avoid that they could become stranded assets in a competitive market. The analysis should, inter alia, take into account relative reductions in demand arising from increased energy efficiency, capacity rehabilitation options, and expected developments on the supply and demand side in the regional market. • Take strong regulatory measures to monitor the development of the electricity and gas markets, deter anti-competitive behavior and increase transparency in the operations of all energy market players, including the companies within the new energy holding, and enable medium and low voltage consumers to access the electricity market. • Allow energy prices to increase gradually by: (i) phased reduction in the volume of electricity and natural gas sold on the regulated market, (ii) reviewing the regulatory system to allow district heating tariffs to cover costs, while ensuring that there are no distortions on an energy equivalent basis between district heat, gas and electricity end-user prices. • Expand the capacity of the existing underground storage facility at Chiren and consider the conversion of the Galata gas field into an underground storage facility. • Promote the utilization of renewable energy such as wind, biomass, waste, geothermal and solar. This includes (i) setting a clear, transparent set of principles for the integration of RE into the electricity grid, and (ii) lifting administrative barriers by introducing simplified licensing procedures for producers and for the construction of relevant facilities. • Promote energy efficiency, inter alia by increasing coordination between national and municipal authorities, scaling-up the application of public-private partnerships and ESCOs, and strengthening data collection and monitoring systems for energy efficiency actions. Initiate a study of national energy efficiency priorities and barrier alleviation.

In the Medium Term

• Gradually lift the obligation of generators to sell power to the public supplier consistent with EU requirements. This would send a strong signal about Bulgaria’s intention to have an increasingly transparent and open market and would foster the development of the wholesale market. • Increase energy security in the natural gas sector by exploring options to diversify gas supply sources and routes. Options could include, among others: (i) development of the Nabucco and/or South Stream pipelines; (ii) supporting the construction of a new LNG terminal; and (iii) strengthening interconnections with Turkey, Greece, Serbia and Romania. • Promote high-efficiency cogeneration plants in areas with high heat demand. This includes limiting consumers’ incentive to switch to electricity for heating purposes—when district heating is economically the least-cost option—by setting prices between fuels correctly and by increasing the efficiency and service quality of the district heating systems. • Set up a regulatory environment that encourages energy companies and industry to improve energy management and invest in energy-efficient technologies in generation, transmission, distribution and use of energy.

Road Infrastructure

ROAD INFRASTRUCTURE I. CONTEXT 1. The Bulgarian road infrastructure sector has made good progress and achieved some ambitious targets—implementation of several programs to bring road infrastructure to European technical and quality standards; an action plan to improve road traffic safety; reorganization of the National Road Infrastructure Agency (NRIA) to rectify deficiencies in internal governance; clear ownership and organization of the road network; a functioning road user charge system (vignette); complete outsourcing of construction and maintenance of roads to private sector; a willingness to approach modern road maintenance contracting practices found useful in other EU countries; and a systematic approach to road data collection. 2. However, road safety remains a serious problem in Bulgaria entailing considerable economic losses and a human tragedy. Each year nearly 1,000 persons die and around 10,000 are injured in road crashes some of whom may be crippled or disabled for the rest of their lives. This is equivalent to almost 3 fatalities and 30 injuries per day due to road traffic crashes. There has been an annual increase of 4-5 percent in road casualties (fatalities and injuries) during the last 6 years while in all EU member states fatality rates have declined by more than 20% over the same time period. Apart from the human losses the accidents result in losses to the economy of around EUR 500 million annually in Bulgaria. 3. Improving expenditure management and governance structure of road infrastructure would be key to deal with the backlog of road maintenance and rehabilitation of national roads. Nearly 30-40% of Class I-III roads in Bulgaria are in poor condition and require periodic maintenance or rehabiliation. If 25-30% of the road network requires rehabilitation, around EUR150-200 million per year will be required to clear the maintenance backlog over the next 10 years. This is in addition to the new investments in motorway construction, mainly financed by the EU funds. The larger scale infrastructure projects, priority projects of common European interest were expected to start in 2008 but have experienced start-up problems. 4. Investment decisions during a financial crisis intensify the onus on Government and the NRIA to use available funds wisely. In the past five years or so have in particular witnessed a steady flow of public funds to the road infrastructure sector—after a period of underinvestment—that led to development of growing domestic road construction and engineering industries. Going forward, however, would require careful prioritization of invetsments and together with the strongest governance and management model possible for the efficient utilization of resources and the timely implementation of projects. 5. This policy note builds on the analytical and advisory services provided by the World Bank in the context of the Road Rehabilitation Project. Most of the diagnostics and policy options presented in the note refer to the National Road Infrstructure Agency which is the implementing agency of the Project.

II. KEY CHALLENGES A. Road Safety 6. The NRIA’s roles and responsibilities in improving road safety are not clearly defined. Road traffic safety is not an explicit organizational objective of the NRIA and there have been limited or non-existent technical, human and budgetary resources allocated to address this important issue entailing human and financial losses to economy. The Ministry of Transport

Road Infrastructure (MT) has endorsed Action Plan for road safety that needs to be implemented with the necessary funding and institutional coordination. A training program is underway for the NRIAâ&#x20AC;&#x2122;s experts on road accident black spot improvement and road safety audits. However, there is little institutional commitment and there is no unit responsible for road safety issues.

B. Financing of Road Infrastructure 7. State budget resources flowing to road infrastucture have almost doubled over the last three years but a large part of the investment needs have remained unmet. Budget transfers to NRIA, including co-financing of projects, reached Euro 240 million in 2008, while revenues from vignettes were close to Euro 90 million. Increased resources have financed mainly higher investments in routine (winter and summer) maintenance and to a lesser extent construction of new roads and by-passes. Investments for rehabilitation and major repairs have remained practically unchanged and are much below the estimated resources needed to bring the road network to maintainable condition. It is estimated that around25-30% of the network requires rehabilitation and about Euro150-200 million annually over a period of 10 years would be required for rehabilitation and major repairs. The ongoing work to develop the Road Asset Management System (RAMS) should provide more accurate estimates of the funding needed to bring the road network to maintainable condition.

Table 1: Uses and Sources of Funds for the National Roads (EUR million) Use of Funds Administration Winter and Summer Maintenance, Medium Repair Rehabilitation and Major Repairs New Roads and By-passes Loan Repayment (Interests) Loan Repayment (Principal) Total Expenditures on Republican Roads Sources of Funds Vignette Other Own Revenues State Budget Disbursements from Loans Disbursements from EU Pre-accession Funds (ISPA, PHARE, etc.) Disbursements from EU Accession Funds (Cohesion, Regional Development) Other - State Budget for cofinancing projects with loans, interest and principal payments Other â&#x20AC;&#x201C; National Fund - Ministry of Finance

Total

2005 20.0 119.4 47.1 73.1 8.4 14.8 282.7

2006 * 21.3 107.8 76.6 88.7 9.0 16.8 320.1

2007 * 22.2 215.3 43.9 89.7 9.2 18.2 398.5

2008 * 19.1 203.1 66.2 102.8 10.0 19.2 420.3

68.6 9.0 67.8 26.4 21.2

76.3 14.2 85.8 38.7 17.2

94.3 18.0 182.6 37.7 6.4

95.7 35.0 191.8 36.9 6.0

55.4 6.9

66.5 5.7

57.3 2.0

53.0 2.0

282.7

320.1

398.4

420.3

Source: NRIA. (*) PHARE projects excluded

8. If expected motorway construction is implemented, road spending is likely to increase to Euro 600-700 million per year in 2009-2013. Considerable increase in funding is envisaged with EU cohesion and regional development funds. The larger scale infrastructure projects, the priority projects of common European interest, financed under European funds were expected to start in 2008, but they have experienced start-up problems. For roads other than motorways and Class I funding may be expected from the European Regional Development Fund (ERDF). It should be noted, however, that overreliance on EU funding may distract from covering other important programs such as maintenance. That may be even more so under the current economic downturn as budget resources are being scaled back. 9. While the NRIA has to implement large investment projects, its capacity to prioritize and evaluate road investments is limited. The NRIA does not have evaluative

Road Infrastructure method to develop a multi-annual road budget and program and its distribution between functional road classes and regions. Road programs are made “bottom-up” with budget and political economy as the principal criteria with slow and cumbersome planning or control structures. The NRIA lacks road management and data systems to develop effective budgetconstrained programs for maintenance and rehabilitation of roads and bridges for the entire national road network and to calculate the benefits from such programs using up-to-date data. A planning-programming process and technical systems for multi-year road programs are currently being developed by NRIA with the assistance of international consultants. Concurrently, road data are being collected and data should be available for the entire road network in three years. There are other efforts underway to add-on new road management or monitoring systems. 10. While the NRIA has technical norms and technical specifications, many of which conform to international standards, no standards for routine maintenance can be imposed due to funding uncertainty. Currently, routine maintenance is carried out by numerous 3-year contracts unit-cost whose content is determined, daily or weekly, by the NRIA’s regional offices. A consultancy work is underway to introduce, in three pilot areas, area wide performance-based maintenance and management of roads contracts whose duration would be 3 to 5 years. Should these types of contracts be successful and cost-efficient—as they have been elsewhere—the objective is to expand the concept to cover the entire national road network. Early evidence indicates that about 25 percent of the network needs to have periodic maintenance or rehabilitation actions before they can be included in the performance-based routine maintenance contracts, or the scope of these contracts need to be widened to include periodic maintenance. There is no technical difficulty in either approach, the difficulty is funding.

C. Governance and Management 11. The institutional framework for road management remains fragmented. The managerial autonomy of NRIA is unclear and the road management decisions seem to be separated from road financing. Despite the changes in the Road Act in 2006 and then in 2008, the fragmentation of responsibilities still remains with road infrastructure, which is managed by the NRIA, separated from transport and traffic regulations and safety which are functions of the Ministry of Transport. Moreover, the status of the NRIA has changed several times with the NRIA being moved from under one ministry to another. There are other actors involved in road infrastructure-Ministry of Regional Development and Public Works and municipalities are responsicle for local roads, while the Ministry of Environement and Waters is approving environmental assessments of road projects. This fragmentation has led to duplicate reviews of final road designs for the construction permit, while intergovernmental coordination has not functioned effectively in complex transport issues: traffic safety, urban transport, investments in large and small projects (motorways and Class IV roads). The NRIA bypasses the Ministry of Transport in the budget, oversight, and key decision-making functions. There can be no doubt that Bulgaria’s current road sector institutional framework and also the internal organization of the NRIA are transitory arrangements. 12. The NRIA organization has two options, centralized and decentralized. The choice, which needs to be implemented using a change management process, will affect subsequent decisions. Whatever choice is made, the responsibilities and the competencies at the NRIA’s Headquarters (HQ) and the Regional Offices need to be written down. The principal reorganization issues concern (i) the number of Regional Offices (possibly to coincide with the (six) Planning Regions); (ii) decision-making processes and the responsibilities of the management teams in HQ and the Regional Offices; (iii) Special Implementation Units (SIU) for large investment projects; (iv) management and supervision of the road investment program; and (v) risk management.

Road Infrastructure 13. The current governance structure of the NRIA—the Supervisory Board—is a good beginning and further improvements should be pursued. An enhanced governance structure for the NRIA should (i) support efficient use of staff and assets; (ii) ensure that management decisions are based on effectiveness and financial measures, not political patronage; (iii) enable the Supervisory Board to measure management performance; and (iv) offer a system of incentives for managers who improve effectiveness and financial outcomes. As a first and immediate step, the oversight role of the Supervisory Board should be strengthened. For example, the establishment of specialized and independent committees that report directly to the Supervisory Board could be explored. This could include an Audit Committee and Risk Management Committee, among others. Additionally, the NRIA should be subjected to mandatory annual external financial and management audits that cover all the activities of the Agency. 14. The Government needs to develop a Performance Agreement to be entered into between the State and the NRIA. The Performance Agreement defines the performance indicators and their target values with which the NRIA’s performance will be appraised annually. The performance indicators must be consistent with the Government policies and the budget allocated to the NRIA. They need to be clear and measurable. Examples of relevant possible performance indicators that are already becoming high on the NRIA’s agenda could include targets on road safety measures or on the adoption of performance-based maintenance contracts covering the entire national road network. Similarly, the NRIA could also propose a Performance Agreement between the NRIA’s Headquarters and its Regional Offices. 15. To successfully implement road infrastructure sector reforms in Bulgaria, the NRIA needs to implement a radical cultural change focused on increased accountability. This change should begin with implementing a performance-based management linked to pay incentives, enforcing a merit-based manager selection process, and establishing an institutional management development program to train management. The NRIA does not have a Business Plan and Strategy for the NRIA with a clear mission statement to focus the NRIA’s work and activities. It seems there is no systematic approach to listening to customers or mechanisms in place to esnure accountability to the state or public in general. 16. The planning and decision-making processes in the NRIA need to be streamlined and speeded up. The NRIA may occasionally be over-optimistic about project readiness or its completion. Perception of risks and chances for delays due to financing or design readiness are not included in the road programs. Greater realism in information flow between relevant actors is required. Delays in project implementation point to defficiencies in project preparation, mangement, and monitoring that need to be addressed urgently if the planned large investments in motorway construction and road rehabilitation are to take place. Project prepration capacity remains limited, hindered by cumbursome procedures with a number of unnecessary steps and permits required. It is recommended that annual monitoring of project readiness is institutionalized and that responsibility vested with an office at NRIA to identify problems and likely delays and to find remedial measures. A small surplus of projects needs to be programmed to offset any delays. 17. Functional classification of roads seems to be outdated and might complicate road management. Current grouping of roads into 4 classes serves multiple uses including assigning jurisdictional responsibility, system planning, distribution of road budget funds, evaluation of road space needs, access management, design standards, and data collection, to name the most important ones. Based on international experience, the Bulgarian road network is somewhat overclassified. Given the planned motorway program, and the ongoing road rehabilitation and upgrade programs a review of the functional classification might reveal the need for reducing the number of road classes.

Road Infrastructure

III. POLICY RECOMMENDATIONS 18. For many of the suggested policy options, NRIA should establish a Steering Committee, possibly chaired by the Supervisory Board, with participation of the Executive Director, the Deputy Executive Directors, and representation from the regional offices to guide the change process. The Steering Committee should inform the staff and the general public about the changes and the reasons for them in due course.

In the Short Term

• Develop a Performance Agreement between the State (the Council of Ministers) and the NRIA including key performance indicators. Similarly, NRIA could also propose a Performance Agreement between the NRIA’s Headquarters and its Regional Offices. • Develop a Business Plan and Strategy for the NRIA with a clear mission statement to focus the NRIA’s work and activities. Publish an Annual Report, which includes a narrative and quantitative information of the results achieved in the past year and a description the medium term (rolling) and long-term (10 yr) road program. • Implement a performance-based management linked to pay incentives, enforcing a meritbased manager selection process, and establishing an institutional management development program to train management. • Enhance the NRIA’s Governance Structure. • Make road traffic safety an explicit objective of the NRIA. Establish a small dedicated unit in the NRIA to address road safety issues. • Strengthen the NRIA’s planning and monitoring function to ensure that: (i) the road sector policies, including road safety, are translated into long-range, rolling 5-year, and annual programs; (ii) the strategy, public consultations, and economic analyses govern project implementation priorities; and (iii) the project preparation and implementation are actively managed. • Clarify and agree on the roles between the NRIA, the MOT, and the MRDPW, and the approving entities such as the Ministry of Environmentand Waters. For example, NRIA prepares the financially constrained planning and programming documents, including environmental assessments, conducts public consultations, and sends appropriate documents to other entities for comment; and finally to the Supervisory Board, the Council of Ministers, the MOT for comment or approval as defined by the process. • Improve project preparation process to eliminate unnecessary steps and required permits. • Continue to develop Road Asset Management Systems and ensure data services to support decision-making and monitoring. • Review the functional classification of the road system

In the Medium to Long Term • Continue the process of the NRIA’s reorganization, including the regional office structures. Consider consolidating the 27 regional offices into 6 to imporve management and efficiency.

Railways

RAILWAYS I. CONTEXT 1. Sustained reform of Bulgaria’s railways sector aligned its institutional and legal framework with that of the EU, achieved stable traffic volumes, and cleared arrears. By end-2007 the Bulgarian Railway Operating Company BDZ EAD showed net profits, and its hardwon financial stability has been endorsed by investor confidence during a recent bond issuance for EUR 120 million. Reform achievements were impressive: vertical unbundling of services separated public railway infrastructure from operation of railway transport services; track access charges opened market access to rail infrastructure and allowed cost recovery; and public service contracts were laid out to clarify government contributions to the sector. Equally impressive were the results of measures to improve operating efficiency: railway company staff was reduced by 40%; a holding company structure with three legally independent subsidiaries and business lines—freight, passengers, and traction services was created, and the relationship between the parent company and the subsidiaries was based on commercial contractual arrangements, eliminating implicit cross subsidies between freight and passenger services, improving cost control and accounting transparency, and helping prepare BDZ EAD to compete in an open railway transport market. 2. The overarching goal of the next phase of railway reforms in Bulgaria should be to develop a flexible and nimble railway industry that can adapt to the rapidly changing business environment—without resorting to constant policy interventions. To achieve this goal, it is essential that the railways be run like a business. This means that Government and the Stateowned railway companies should embark on a cultural change program to clarify Government roles in the railways sector and boost the organizational performance of the companies to enable them to develop a market-driven business strategy, analyze where efficiency and productivity gains are needed and where investments would be most productive, and balance State-supported public policy choices with available fiscal space. 3. The economic downturn will have implications both the traffic volumes and on the availability of state resources to address chronic underinvestments in infrastructure and rolling stock assets. Bulgarian rail industry requires major investment programs in infrastructure, locomotives, wagons, and coaches to achieve an acceptable level of business efficiency for the benefit of its freight and passenger customers. To address the high investment needs in a fiscally sustainable way, reform efforts should focus on enhancing the viability and productivity of the railway sector and strengthening the governance and management structures in the sector. 4. This note summarizes the findings and recommendations of the World Bank’s March 2009 Railways Policy Note.

II. KEY CHALLENGES A. Enhancing Viability and Productivity 5. Current low levels of productivity in Bulgaria (Figure 1) suggest that NRIC and BDZ EAD can begin immediately to improve their productivity in areas where obvious gains can be achieved quickly. NRIC’s current productivity in infrastructure maintenance is only one-quarter of the EU average. Until NRIC improves the productivity of staff and assets, it has little chance to compete in the market. Therefore NRIC should continuously adapt staff size to business demands and rationalize assets according to current market needs. This means that

Railways NRIC needs to expand utilization Figure 1. Bulgariaâ&#x20AC;&#x2122;s Rail Performance, % of EU-27 of information, technology and average communication systems for train (EC-27=100) control, signaling, and interlocking; and acquire modern Network Density (km/sq km) track mechanization equipment Utilization of passenger fleet for infrastructure maintenance, Utilization of locomotives and maximize its efficiency. Utilization of freight fleet Finally, NRIC needs to adopt the Traffic Density (Traffic Unit per route-km) modern concept of conditionStaff productivity based maintenance of infrastructure, which will GDP per capita PPS significantly reduce its operating 0 10 20 30 40 50 60 70 80 90 100 costs. BDZ staff productivity is around 40 percent of the EU-27 average; asset productivity is less than 50 percent, which positions it poorly to compete in the open European transport market. Therefore BDZ must adjust staff size to business demands and liquidate excess or depreciated rolling stock. BDZ needs to improve maintenance procedures and increase the efficiency of fleet operation to avoid unnecessary investment. 6. The participation of the private sector in railways needs to be encouraged. Thirdparty freight operators are already taking advantage of track access rights. However, they operate in an environment which is not entirely market-driven, and have yet to deliver passenger traffic services. BDZ cannot continue to operate as a fully State-owned and managed operation without jeopardizing its profitability and its future development.

B. Addressing Investment Needs 7. The investment program for railways has been underfinanced and has not been always driven by strategic considerations. Chronic underinvestment has resulted in todayâ&#x20AC;&#x2122;s significantly degraded infrastructure and rolling stock, and inadequate business processes and technology. The poor condition of the railway assets have led to speed restrictions on almost 75% of the rail network. Over the past the past 15 years, an annual average of 25-30 km were renewed and 30-40 km repaired, which is less than 1% of the total network. These low levels of repair and renewals increase operating costs for the railway infrastructure company and these costs are passed on to the railway operators through the track access chargesâ&#x20AC;&#x201D;higher track access fees for lower quality services. The railways have an exceptionally low capital base which holds back the productivity gains needed to compete on the market, and generates a mismatch between assets and staffing. The challenge is to move from ad hoc, often emergency-driven investment to forward-looking capital spending driven by strategic considerations.

C. Refine the Role of Government in the New Business Model 8. The roles of the State in the railways sector need to undergo a radical cultural change. As policymaker, the Government needs to reach agreement on what size of network is affordable and then to manage the social and financial consequences. As regulator, the role of the Government is safeguarded by strict EU regulations, mainly to guarantee open access to infrastructure and fair competition, issue and monitor safety standards, and act as arbiter for any discrimination in the market. As owner, the Government needs to enhance governance mechanisms and supervise adequately its companies, by defining challenging annual business targets and holding management accountable to performance outcomes, but without meddling in management decisions. As a client, the Government needs to promote transparent contractual relationships with the railway operators that provide public services. Local governments are an

Railways important stakeholder in this process; they should be consulted on their needs and they may have to consider financial contributions for services they deem necessary. When services are identified, public service contracts should be competitively awarded to railway operators, which will minimize State compensation. 9. Railway business development must be commercially driven—responding to market demands, this means when the State intervenes with policy-driven demands, it should compensate the railways, accordingly. Bulgaria has implemented the contractual relationship between the State and NRIC and between the State and BDZ, according to EU regulations. Multiannual Public Service Contracts (PSC) and Long-term Infrastructure Maintenance Contracts should be strengthened to increase the railways’ accountability. Public funds should be transferred only when contractual obligations are fulfilled, including specific targets for punctuality, maintenance standards, and productivity. For the successful implementation a transparent relationship with railways, the Ministry of Transport should strengthen its capacity to develop, negotiate, and monitor multi-annual contracts.

D. Enhance NRIC and BDZ EAD Governance and Management 10. The current railway companies’ governance structure is a good beginning and further improvements should be pursued. An enhanced NRIC and BDZ EAD governance structure should (i) support efficient use of staff and assets; (ii) ensure that management decisions are based on financial and efficiency measures, not political patronage; (iii) enable a revamped Board of Directors to measure management performance; and (iv) offer a system of incentives for managers who improve financial and efficiency outcomes. 11. The management of NRIC and BDZ-EAD must also undergo changes in culture in order to radically improve their operational performance. Performance-based management needs to be implemented and linked to pay incentives with a merit-based manager selection process, and an institutional management development program to train management. 12. The internal organization of BDZ EAD is not yet well aligned with a market-based approach to railways. BDZ EAD, as a holding structure must begin to shift its role away from control of production to strategic leadership and financial oversight. The BDZ EAD asset ownership is a sensitive issue; the tariff structure for BDZ Freight and BDZ Passengers to lease rolling stock from the holding company should be carefully analyzed to avoid transport price market distortions. The freight and passenger subsidiaries now must be fully responsible for assessing transport demand trends, setting up competitive tariff levels, and evaluating client needs, and based on these must develop business plans—including estimating investment needs to acquire new rolling stock. Since BDZ EAD owns the assets, its role in policy decision-making poses a serious risk of diminishing the subsidiaries’ autonomy and eroding their ability to respond to their respective markets. 13. The regional structure does not stimulate the commercial behavior of freight transport services and long distance passengers. Many European railways and the North American railroad companies have successfully implemented a new business model based on vertically integrated profit centers that manage each major type of commodity. The data for 2006 show that 86 percent of the freight transport volume in Bulgaria was achieved by only seven commodities. It is highly recommended for BDZ Freight in particular to assess the possibility of structuring based on customer service centers for each of these products, which will create a stronger relationship with the main clients and a better allocation of resources in line with the needs of the market. NRIC can also consider its restructuring according to cost centers. In a similar way, NRIC should organize some of its activities as profit centers (traffic management, power, and telecommunication) oriented to attract more clients for its services.

Railways

III. POLICY RECOMMENDATIONS The policy agenda that could be considered by the Government when updating its railways strategy was articulated in greater detail by the World Bank’s March 2009 Railways Policy Note. The following will summarize the main policy options.

In the short-term

• Adjust staff size to business demands and rationalize assets according to current market needs. • Conduct regular and systematic market research to evaluate existing products and services and develop new ones, and design complementary marketing strategies. NRIC should examine the competitive international routes to develop competitive strategies to attract business. • Increase private sector participation in freight services. • Adjust the level of public passenger services to budget constraints. • Ensure that management decisions in NRIC and BDZ are based on financial and efficiency measures, rather than political patronage. • Strengthen performance monitoring mechanisms for railway managers to enable linking State support to efficiency improvements. Establish Institutional Management Development Program, to improve skills among mid- and upper-level managers in NRIC, BDZ EAD, the Ministry of Transports (MoT), and the regulator. • Encourage private sector participation in freight and passenger service. • Prioritize investment projects according to their rate of return, proven cost effectiveness, and satisfactory safety standards. • Extend long-term strategic planning beyond the current 2013 or 20015 horizon. • Strengthen the capacity to implement large investment projects.

In the Medium Term

• Expand utilization of information, technology and communication systems (ITC) for train control, signaling, and interlocking; and acquire modern track mechanization equipment for infrastructure maintenance, and maximize its efficiency. • Enforce transparent and merit-based manager selection to strengthen management of NRIC and BDZ. • Implement performance contracts for managers.

Environment

ENVIRONMENT I. CONTEXT 1. Bulgariaâ&#x20AC;&#x2122;s fast economic growth over the last decade has been accompanied by steady progress towards raising environmental standards. Nonetheless, environmental challenges loom large and they have important financial and socio-economic implications. 2. Challenges range from inadequate management of environment and natural resources to lack of infrastructure to meet demand for municipal services. Water pollution, especially along the Black Sea coast, is increasing as a result of poor treatment and ineffective regulation of urban expansion. Absence of management plans for protected areas and development pressure threatens the prospects of the tourism industry. Progress towards regulating industrial pollution through the system of integrated permits needs to be supplemented by measures to improve environmental parameters of individual facilities through institutional and market incentives for adoption of best available and cleaner technologies. The public sector at the central and local levels will continue to play an important part in the strategic planning and financing of investments in order to address these challenges, will improve its capacity to prioritize public investments, mobilize EU and other financing, and prepare viable and economically-justified projects needs to be strengthened. 3. This note reviews some of the challenges which need to be addressed to ensure sustainable economic growth while preserving countryâ&#x20AC;&#x2122;s environmental assets and natural resources, and suggests a number of policy options.

II. KEY CHALLENGES 4. The key challenges faced by the Government include: (i) management of protected areas and Natura 2000 sites; (ii) conservation and rehabilitation of wetlands, natural habitats and the Black Sea coast; (iii) management of waste water treatment; (iv) solid waste management; and (v) management of industrial pollution without compromising competitiveness.

A. Management of Protected Areas 5. Bulgaria is one of the richest countries in Europe in biodiversity, but preserving biodiversity remains a challenge. Many protected areas are under stress from development pressure. Protected areas including national parks and nature parks constitute 5% of the territory. Many protected areas lack management plans (except for areas in Natura 2000 sites), and existing management plans for the national parks are not sufficiently operational in order to be effective. The administration of protected areas has insufficient staffing and equipment, lacks special infrastructure, and is unable to suppress poaching. The Government has yet to mobilize NGO engagement to raise awareness of local communities in the economic value of biodiversity for sustaining their livelihoods, and provide alternative sources of employment and income.

B. Conservation and Rehabilitation of Wetlands, Natural Habitats, and the Black Sea Coast 6. Bulgaria contributes a significant share of the pollution load to the Black Sea according to the Transboundary Diagnostic Analysis carried out under the Black Sea Environmental Program. The Northwestern shelf of the Black Sea at the Danube River delta has suffered particular deterioration of water quality, natural habitats, and fish populations due to the

Environment effects of eutrophication from high nutrient loads. Wetlands and floodplain were drained thus reducing wetlands to about 10% of their original size and diminishing their ecological capacity. 7. The Wetlands Restoration and Pollution Reduction Project (supported by a World Bank grant of US$7.5 million) piloted restoration on 4,035 ha of former marshes (more than the original target of 2,340 ha) and brought under improved management and protection at least 27,700 ha of protected areas in Persina Nature Park (PNP) and Kalimok Brushlen Protected Site, with globally significant biodiversity habitats. Local communities applied for EU funding to implement replication projects to restore three more wetlands in the area. 8. The ecological integrity of the Black Sea coast is under tremendous pressure. Pollution from untreated effluents and poorly regulated urban sprawl at the coast contributes to significant deterioration of quality of coastal waters and offshore fisheries. Furthermore, increased rates and intensity of hypoxia (“dead zones”) and contamination from heavy metals and organic substances affect the quality of bathing waters and beaches, that are thus increasingly out of compliance with health norms and threaten the viability of the vital tourism industry. Fisheries are endangered by heavy metals accumulated in the seabed and higher nutrient loads. For instance, the phenol levels recorded in all monitored locations in the South are 33% above permissible levels, and present serious public health hazards. 9. Coastal wastewater treatment facilities have severe capacity problems. These facilities provide mostly mechanical (primary) treatment, with inadequate capacity to handle effluents from new construction and seasonal spikes from tourism. Facilities have significant hydraulic capacity problems and cannot reduce the nitrogen and phosphorus loads 22 which are critical for fisheries. Nutrient pollution is a result of non-point runoff from agricultural production. Pollution from landfills (most of which do not have leachate treatment facilities), and storm water runoff affect many water bodies in the coastal region and therefore are considered “at risk” of failing to meet the requirements of the Water Frame Directive for establishing ‘good ecological status’ by 2015. 10. Overlaps and deficiencies in institutional arrangements of agencies responsible for environmental planning, coordination, and regulation need to be addressed in order to reduce pollution in the coastal region. The MOEW manages and coordinates the development and implementation of state policy in environmental protection. However, local level authorities also have responsibilities and could be more directly involved in planning, preparing, and implementing environmental projects, fostering wider public participation and ownership. This is particularly applicable in preparing projects to secure funding from the EU and other sources. In terms of policy setting, there is need to integrate socio-economic and the environment aspects, and expand public involvement in setting the objectives of various initiatives. The establishment of an inter-ministerial council is a possibility for improving coordination between MOEW and the ministries of transport, agriculture, the National Tourist Agency and the Council of Ministers.

C. Management of Waste Water Treatment 11. Financing needs of waste water treatment are high and would require strategic planning. As a new EU member, Bulgaria set as a strategic goal the rehabilitation and construction of water supply and sewerage networks to improve service delivery and reduce 22

Nitrogen and phosphorus contribute to the risk of eutrophication. These nutrients increase biological (e.g. algal) growth significantly resulting in depleted oxygen leading to overall reduction in biological activity in the sea. In addition, as the Black Sea coast has been designated a ‘sensitive zone’ under the Urban Wastewater Treatment Directive more ‘stringent’ treatment of wastewater is expected to reduce the threat of eutrophication. In practice this requires the removal of nitrogen and phosphorus through tertiary treatment.

Environment health risks, and wastewater treatment in line with the EU directives. The Strategy for Water Supply and Sewerage Management and Development (March 2004) presents a comprehensive cost and financing plan for the sector. The analysis completed in April 2005 with Bank assistance proposed a 2004-2014 program and financing plan including grants from the EU and budget financing. The program estimated investment and operating costs at about â&#x201A;Ź6.9 billion, including Euro 2.8 billion for rehabilitation. The Environment Sector Operational Program and a Regional Operational Program, both endorsed by the EU in 2007 indicate serious financing gaps which would require a targeted action to raise funds from all possible sources, including the International Financial Institutions (IFIs) and commercial banks in four major categories: 12. A major challenge ahead is to improve the operational efficiency of water companies and implement a financial management program that would allow them to make economic decisions on operations and investment. The companies will need to decrease administrative water losses, increase bill collection rates, and implement a comprehensive network leak detection program. The Bank is providing substantial investment support in line with Bulgariaâ&#x20AC;&#x2122;s National Strategy on Environment (2005-2014). The Municipal Infrastructure Development project (Euro101 million) is ready for negotiations. The development objective of the project is to provide uninterrupted supply of water to the communities in the project area and more specifically to: (a) improve the reliability and quality of water provision to the communities in selected settlements in the project area, and (b) assist municipalities to improve investmentplanning capacity.

D. Solid Waste Management 13. Closing down wild dumps that are in non-compliance is lagging. Under the prevailing legislation municipalities are obliged to close wild dumps by July 2009. To avoid sanctions, waste generated in regions without a functioning sanitary landfill will need to be disposed at existing sites that are in compliance with EU environmental standards. However, this will escalate transport costs, and require municipalities to accept waste from other regions. Even though regionalization of waste management has started, it remains unclear how the regional associations will operate, what is their role in regional waste management planning, and how to overcome the notorious Not-In-My-Backyard (NIMBY) perception. So far, no arrangements have been put in place at existing sites, and without support and buy-in from local communities this is not deemed to be possible. 14. Meeting EU targets on reduction of landfilled waste will be difficult. Households have little if any incentive for waste reduction and sorting at source, despite an active recycling market. Although separated collection has been initiated with encouraging results, it represents only a small proportion of landfilled waste. The main reason is that fees for regular waste collection are too low and there are no financial incentives for the user to separate or reduce household waste. Even though by law municipalities have been given room to adjust fees, they are reluctant to do so due to public resistance. 15. Many of the planned and existing landfills are financially unviable. Capital investment costs of landfills that comply with high environmental standards are high, as are their operating costs. Environmentally sound regional landfills require a minimum size to generate economies of scale to become financially viable. However the availability of EU grants has favored a system of smaller landfills in close proximity, choosing lower transport costs over higher investment cost per ton. Although this was a rational short term response to existing incentives, it will affect long-term financial sustainability. Moreover, average waste collection and gate fees are very low compared to other countries in the region and cannot cover full costs.

Environment 16. To ensure sustainability of investments the municipalities have to gradually adjust waste fees within a given range set by the law. Consensus building is critical to avoid politics standing on the way of cost recovery tariff adjustments. At the same time, reduction of landfilled waste cannot be achieved without the right financial incentives to promote sorting and recycling. Landfill taxes, disposal charges, or other levies imposed at a higher level of government can be effective ways to reduce the amount of waste for landfilling, and increase the share for reuse or other forms of sustainable treatment. In addition, revenues from such a fee can provide a stable source of income for strengthening and maintaining an effective system of supervision and enforcement.

E. Management of Industrial Pollution 17. Most of the existing industrial installations require substantial upgrade in order to meet the EU legislative requirements. Administration of implementation of IPPC Directive will require significant capacity and knowledge building beyond the public sector institutions. Industry – both producers and users - will bear the cost of technical improvements to meet the EU standards, for which sound policies for enforcement of the requirements of the internal market are needed. Implementation of IPPC will be costly and politically sensitive from a domestic economy point of view and therefore incentives for combination of various abatement options with adoption of clean technologies need to be promoted. 18. The energy industry remains the biggest polluter where the estimated cost for control and prevention for existing power plants is Euro 362million. Solutions other than end of pipe solutions need to be considered as well as green investment schemes. An update of the Energy-Environment Strategy could be initiated to reflect the challenges of meeting international obligations to reduce Green House Gases (GHG) emission and contribute to mitigating Climate Change and prepare a National Strategy and Action Plan for climate change (with the leading role of MOEW). In order to address pollution from burning coal, coal briquettes for heating, a shift of energy policies towards use of cleaner coal, switching to cleaner fuels, and increasing the share of renewable energy sources and strict emission regulation should be policy priority. A rough estimate of the investment cost to deal with emissions from burning coal could range between Euro 543-752 million and operation and maintenance cost of Euro 95-132 million.

III. POLICY RECOMMENDATIONS In the Short Term • Develop a national network of protected areas including new protected areas , restore biocorridors and preserve existing ones to link Natura 2000 and protected areas. • Improve strategic planning of large water management investments. • Improve the operational efficiency of water companies—decrease administrative water losses, increase bill collection rates; implement a comprehensive network leak detection program and implement a financial management programs that would allow water utilities to make economic decisions on operations and investments. • Prepare and implement Plans for Preservation and Management of priority species from the wild flora and fauna. • Address overlaps and weaknesses of agencies responsible for environmental planning, coordination, and regulation. Local authorities and stakeholders should play a larger role in supporting the sustainable development of the Black Sea Coast. • Establish inter-ministerial council to improve coordination between MOEW, the ministries of transport, agriculture, and the National Tourist Agency on coastal zone issues.

Environment • Stop the urban sprawl that destroys coastal environment and could put at risk the tourist business. • Close down wild dumps and reduce landfilled waste while ensuring buy-in from the local community. • Provide incentives for waste reduction and sorting at source—by raising fees for waste collection and gate fees (which are very low) and introducing new fees/taxes. Landfill taxes, disposal charges, or other levies can be effective ways to reduce the total amount of waste and increase the share of recycled waste. Revenues from increased fees can provide a stable source of income for strengthening and maintaining an effective system of supervision and enforcement.

In the Medium Term • Consider the creation of an environmental police force. • Prepare a National Strategy and Action Plan for preserving and restoring wetlands; including management plans for key wetlands (e.g. Danube flood plain, coastal and Maritza river wetlands, Ramsar and Natura 2000 sites, and bird sanctuaries). • Prevent poaching by working through NGOs with the local population in wetlands to raise their awareness and advise them on alternative sources of income. • Develop a system for monitoring habitats and species and provide adequate financing of activities for species and habitats preservation. • Address pollution from burning coal and coal briquettes for heating. Energy policies must shift towards using cleaner coal, switching to cleaner fuels, increasing the share of renewable energy sources, and enforcing strict emission regulation.

Education

EDUCATION I. CONTEXT 1. Bulgaria has recently introduced sweeping reforms of its secondary education system to promote more autonomy and accountability of schools for better learning outcomes and improved efficiency of public spending. Per-student-financing and delegated budgets have led to a wave of school closures that had become essential in the wake of a dramatic decline in student numbers. Their closure has resulted in larger schools, with more opportunities to pool education resources (e.g. to provide students with better facilities), create larger class sizes and, in the future, attract and retain higher quality teachers. As opposed to the previous centralized system, school-based management with a considerable degree of decision-making power of the school principal has set the stage for schools to better adjust to local needs and opportunities for a better education. External student assessments are now routinely conducted, which have substantially improved the evidence base for education policy-making. However, concerns remain as to the accountability of schools to the local community. While principals are accountable to the municipal authorities for the use of financial resources, parents have little formal ways of holding principals accountable for learning outcomes. 2. The reform was launched in the face of dramatic challenges in terms of unsatisfactory learning outcomes, early school leaving and considerable inequities in the education system. Bulgariaâ&#x20AC;&#x2122;s participation in international student assessments on the eve of the reform has laid out the extent of the challenge. For example, PISA revealed that more than 50 percent of Bulgarian 15-year-olds can barely read, while too many young Bulgarians are leaving the education system early and without the skills needed in the knowledge-based labor market. This will have dramatic effects on productivity of labor in Bulgaria in view of the unfavorable demographics. Achieving the same standard of income with the advanced economies in the EU and supporting a growing number of retired people will fall on the shoulders of fewer Bulgarians. Creating more productive workers for the future implies investing in heightening the quality of the education that every child receives today. Bulgaria simply cannot afford to have as many socio-economically children drop out of school as is currently the case. 3. The ongoing economic crisis places strains on the available public resources which would imply spending public resources more wisely. This means furthering reforms that optimize the use of public resources for education to ensure resources for investments in education quality and better learning outcomes for all children, improved access, and accountability for results. This policy note highlights the main challenges facing the education sector in Bulgaria and presents a range of concrete policy instruments to address those challenges.

II. KEY CHALLENGES A. Improving Quality and Relevance of Bulgariaâ&#x20AC;&#x2122;s Education System 4. Many Bulgarian secondary school students leave education insufficiently prepared for the knowledge economy. While too few young Bulgarians are staying on in education, especially at higher levels, many who do stay in education do not acquire the necessary skills and competencies to compete in a high innovation economy and meet skill needs from employers â&#x20AC;&#x201C; marketable, often vocational, qualifications which would guarantee a job. But this also holds for generic, transferable skills increasingly needed in an era of fast technological change where learning to learn competencies become crucial. More than 50 percent of Bulgarian 15 year olds

Education scored very low on the PISA 2006 reading test – a significantly higher share than elsewhere in the EU – new and old Member States alike – and other developed economies. Other international tests, like TIMSS, also showed worsening of quality of education over time. 5. Bulgaria has an unusually wide dispersion in student performance. There is a high achievement gap between the top and bottom 20 percent of the student population and, as importantly, a large between-schools variation in student performance. In other words, there are many high quality schools but also many failing schools. Although socioeconomic variables are obviously accounting for this dispersion, there are of course school and classroom factors which also contribute to its explanation. A study on the determinants of learning carried out by the World Bank in 2008 shows that those school factors are not related to either the qualifications of teachers or to teacher career satisfaction but rather to school administration and actual operation. 6. Bulgaria’s vocational education and training (VET) system remains un-reformed with few formal communication channels to the labor market. The quality and labor market relevance varies substantially across the vocational schools. Some of them are among the elite schools in the country, while others are of much lower caliber academically and in terms of the quality of their facilities. The VET system in Bulgaria streams students before the end of the compulsory education (as early as 7th grade) into vocational schools and designated occupational areas. International experience indicates that students streamed narrowly early in their education are harder to reorient than their contemporaries in general secondary education when they become unemployed, because of their weak educational background. They also often have difficulty accessing tertiary education, and lifelong learning opportunities. In other EU and OECD countries, the streaming into VET typically takes place only at the end of compulsory general education, roughly at age 16. Many OECD countries have been also exploring the development of flexible educational pathways in upper secondary education, which allows the integration of relevant generic vocational skills in all secondary schools to respond to the needs of a diverse student population, and changes in the nature of work. 7. The system for student assessments that has been recently launched needs to be sustained to track performance at individual school level. Bulgaria has been building up systems of data collection, including on external student assessments. The challenge now is to ensure that the systems are effectively used to provide timely feedback on the education system overall, but also on how individual schools are doing and guide school improvement plans. The new, decentralized Bulgarian education system with school-by-school student assessment allows easier identification of poorly performing schools and, therefore, could tackle their problems in a targeted manner. This would also enable schools to become more accountable for their results, not just to Regional Inspectorates and to municipal authorities but to parents, employers and other stakeholders in civil society. 8. Performance incentives for teachers and a renewed offer of professional development opportunities are key for improving quality of primary and secondary education. Over the last two years, important efforts have been made to attract, train, retain and reward effective teachers. Furthermore, a parallel initiative has been successfully implemented with regard to school directors. It is urgent now to finish this agenda, first by consolidating the role of the Institute of Directors and the career development system of school directors; and second by monitoring the initial outcomes of the differentiated payment scheme introduced a year ago by the Ministry of Education. The closure of the National Pedagogical Center, anticipated by a Ministerial Decree in June 2009, clearly leaves a vacuum in the teacher policy framework of Bulgaria that needs to be addressed immediately.

Education 9. Moving to a competency-based approach in curriculum and learning. Curriculum reforms across the world are introducing elements of a competency-based curriculum with emphasis on problem solving and teamwork, creative use of knowledge and information, and building the basis for continuous life-long learning. This requires a redefinition of curriculum content, tasks and standards, more geared towards “situated” learning and less focused on disciplinary knowledge and absorbing “raw” information. Bulgaria has rolled out a new curriculum for basic education which needs to be systematically evaluated. In particular, the proposed reform of the 8th grade needs to be seriously reconsidered as it may have unexpected negative effects on the quality and relevance of education and on student retention rates in upper secondary education.

B. Improving Access and Equity 10. Too many young Bulgarians drop out of school early without enrolling in training or joining the labor market. Close to 25% of the 15-24 year old were neither in employment, education nor training in 2005 (Figure 1). Early school leaving has been particular pronounced among the Roma minority, with a considerable drop-out risk already at the primary level, often owing to inadequate learning environments in schools and at home. 23 Bulgaria is hardly the only EU member state with a NEET problem, but there are also positive examples: in the Netherlands 35% of the youth were both in the labor market and education at the same time. Lacking part-time employment opportunities and low youth participation in the labor market in Bulgaria appear to go hand in hand. In addition, the drop-out rates after the 7th grade of 70% are staggering suggesting that the existing exams could be reconsidered to provide incentives for more inclusive education. Bulgaria might explore options for introducing incentive measures to keep youth in school for longer such as: (i) cash incentives for youth from low income families to stay in school beyond post compulsory age, such as the Education Maintenance Allowance (EMA) Program in the UK, or (ii) the extension of mandatory schooling until the completion of upper secondary education or until the age of 18, as recently introduced in the Netherlands. Figure 1: Youth participation in education and employment e ducation and e mployme nt status of 15-24 ye ar olds, 2005 40 30

Denmark

Netherlands

Finland

Sweden

United Kingdom

Ireland

Germany

Austria

Slovenia

Poland

EU 27 av

Belgium

Spain

Latvia

France

Malta

Estonia

Greece

Portugal

Lithuania

Slovakia

Italy

Cyprus

Czech Republic

-20

Hungary

-10

Romania

Bulgaria

Luxembourg

percent

-30 ne ithe r in e ducation nor e mployme nt

both in e ducation and e mployme nt

Source: Eurostat

11. Pre-primary school leaves behind a large number of more marginalized kids and does not promote equally school readiness. There is strong international evidence that investments in early childhood education and development interventions, including health and educational programs, have a substantial impact on subsequent education outcomes in primary

World Bank (2008): Bulgaria: Living Conditions before and after EU Accession.

Education and secondary schooling and yield greater returns than later investments 24. While such programs play an important role in raising human capital across the population, they are particularly important for children from marginalized backgrounds. Bulgaria has already introduced one year of free and mandatory pre-school and raised its pre-primary enrollment rate from 66 to 74 percent between 2000 and 2008. However, while the mandatory year remains not fully implemented, in particular among the more marginalized children such as Roma, preschool enrollment in the advanced EU countries is above 90 percent. Further promoting the early childhood education and development agenda will involve developing new child welfare services aimed at children aged 0-3 focused on community outreach and parental training as well as expansion of the supply of crĂ¨ches/nursery and kindergarten places for the 3-6 year olds.

C. Raising Autonomy and Accountability 12. Increased accountability for learning outcomes and results in schools is key to the success of reform. Policy makers in the Ministry of Education and Science (MES) need new instruments to hold school principals and mayors accountable for the added value of schools, particularly for student learning outcomes. The challenge is to build up the role of mayors and school principals as active partners in identifying and implementing innovative solutions to improve the quality of education for all Bulgarians. D. Developing a Modern Tertiary Education System 13. The participation rate in tertiary education lags behind other EU new member states and the gap is widening. While in Table 1: Gross Enrollment Rates (ISCED 5 2000 participation in tertiary education in and 6) Bulgaria was on par with the average for the 2000 2007 other new member states, participation has Bulgaria 44.4 49.5 increased only marginally there after and by Slovakia 28.7 50.8 2007 Bulgariaâ&#x20AC;&#x2122;s tertiary enrollment was the Czech Republic 29.4 54.8 lowest among the EU. There are two main Romania 24.0 58.3 reasons for this: (i) completion rates from Estonia 55.6 65.0 secondary schools are relatively low, Average, exc. Bulgaria 43.0 66.4 particularly among the Roma minorities, Poland 49.7 66.9 and (ii) the alternative tertiary sector Hungary 36.7 69.1 (polytechnics, etc) hardly exist in Bulgaria. Latvia 56.3 71.3 In Bulgaria, only 3.1% of all tertiary level Lithuania 50.3 75.6 students are enrolled in alternative tertiary 55.7 85.5 institutions. In countries such as Australia, Slovenia Canada and the UK, the percentage is about Source: UNESCO 40. (Table 1). 14. The university side of the tertiary sector is characterized by a large number of institutions (53), many of them small and specialized. Student-teacher ratios are low, faculty is ageing, and there are excessive student-teacher contact hours, leaving little time for research. Further, distribution of students by academic disciplines differs from the rest of EU and may not match the needs of a modern economy -- for example, Bulgaria probably overproduces graduates in social science, business and law, and under-produces graduates in services, science, math and ICT. Public tertiary education spending at 0.9% of GDP is comparable to the EU25 average of 1.1% of GDP and in Bulgaria per student spending relative to per capita income is the highest. It

Cunha, F., Heckman, J., Lochner, L. & Masterov, D. (2005), Interpreting the evidence on life cycle skill formation (North Holland, Amsterdam).

Education is not the resources that are the constraint. Rather, the root cause of the problems in the university sector is inadequate management.

III. POLICY RECOMMENDATIONS 15. The summary of suggested policy options is based on World Bank’s analytical and advisory service provided to Bulgarian authorities in the context of a successful Development Policy Lending program and other non-lending activities. A more detailed policy note on the sector is being currently prepared.

In the Short Term

• Develop further the student assessment system to increase accountability of individual schools to municipal authorities, parents, and employers. • Adopt active measures to attract, retain and reward effective teachers and school directors. This would require offering new professional development opportunities and monitoring the initial outcomes of the differentiated payment scheme introduced a year ago. Moreover, the closure of the National Pedagogical Center had left a vacuum in terms of developing strategies and implementing policies to enhance the quality of teachers. • Redefine the current curriculum content, tasks and standards to move to a competencybased approach in curriculum and learning. The new curriculum for basic education adopted recently needs to be systematically evaluated. • Eliminate the 7th grade examination to improve access and relevance of secondary education. • Consolidate the New Matura Examination as the prevailing instrument for university admission. • Enhance and diversify options for financial support for university students through student loans (recently introduced as a public guarantee on private lending but, until now, with no interest in participating in the scheme from private banks) and scholarship programs for financially constrained students. • Adopt a renewed strategy for vocational education and training (VET) 25 to provide students with skills required in the knowledge economy and offer alternatives to non-academic individuals. The strategy could include delaying the currently early selection into profiled and non-profiled schools (after 7th grade) and delaying the streaming of students into vocational education until after the completion of compulsory general education. This would also involve developing curricula for vocational secondary schools that balance vocational and general skills (in particular mathematics, science and language skills) and introducing pathways from vocational secondary schools to universities. • Address gaps in the implementation of recent reforms for per student financing to increase responsibility of local administrations and schools, and promote accountability. This could be done by continuing to provide hands-on training at local level by the staff of the ministries of finance and education; setting learning targets for schools and local authorities and rewarding results; introducing local school councils representing parents, local communities and municipalities, and empowered to review schools’ programs and financing, and hold school principals for learning outcomes.

In the Medium to Long Term • Prevent school drop-out through focused attention on dramatically underperforming schools, early school counseling and professional orientation for students at risk. The ongoing 25

World Bank (2007). "Accelerating Bulgaria's Convergence: The Challenge of Raising Productivity", Washington D.C.

Education anti-drop-out program of MES also seeks to increase the offer of extra-curricular activities, and its impact needs to be monitored and evaluated systematically. It will be critical to address quality and drop-out risks in schools where the majority of the student population is Roma, including by furthering efforts to tackle segregation and promote educational integration. • Introduce combined training and work programs for youth beyond compulsory school age. Such programs would seek to keep youth in education and training programs until the age of 18, and could emulate OECD experience. Consider incentives to keep youth in schools beyond compulsory age. 26 They may include cash incentives for youth from low-income households, extension of mandatory education to completion of upper-secondary, the increase of the eligibility threshold for the Guaranteed Minimum Income (GMI) contingent on youth 15-18 old studying beyond compulsory schooling, etc. Such measures, however, hinge on improvements in school outcomes, especially for children from marginalized households. • Implement the new VET strategy. • Establish Regional Integrated VET Resource Centers (RegiVET) to provide new avenues for students in compulsory education to access educational opportunities at the secondary level and continue at the tertiary level in new and promising occupational areas. . • Establish National Qualification Authority that would have three tasks: (i) the establishment and maintenance of National Qualifications Framework for all educational awards in Bulgaria; (ii) the establishment, promotion, and maintenance of the standards for education and training awards in all institutions (secondary, alternative tertiary, universities); (iii) the promotion and facilitation of access, transfer, and progression through the education and training system • Expand life-long learning. This would require easier alternative entry into higher education for adults, incentives for employers to extend education and training facilities, and for employees to participate, and recognition of qualifications obtained through informal and nonformal education, as well as through work. • Strengthen external support services to schools, especially counseling and guidance services for students. Schools serving disadvantaged areas or/and student groups need particular attention. • Strengthen early childhood education and development (ECED) initiatives. 27 The Government may promote ECED by developing new child welfare services aimed at children age 0-3, focused on community outreach and parental training, and by expanding the supply of crèches/nursery and kindergartens for the 3-6 years old. • Shift funding from financing an enrolled student (the current “per student financing”) to financing a student graduating (e.g. as is done in the tertiary institutions in Denmark). • Promote greater competition among tertiary education institutions to enhance the relevance of their programs to labor market requirements. This would require, in particular, changes in university governance, to enhance accountability for results.

OECD (2008) Jobs for Youth: United Kingdom, OECD: Paris Cunha, F., Heckman, J., Lochner, L. & Masterov, D. (2005), Interpreting the evidence on life cycle skill formation (North Holland, Amsterdam). 27

Health Care

HEALTH CARE I. Context 1. Bulgaria has undertaken several significant health sector reforms during the past decade, but a large unfinished policy agenda remains to improve health status of population and enhance efficiency of public spending on health. Bulgariaâ&#x20AC;&#x2122;s health standards are below those of most EU members. The life expectancy at birth in Bulgaria is 6.5 years below the EU average, almost two years below the EU10 28, reflecting the higher incidence of cardiovascular disease, cancer, and other lifethreatening diseases. Two thirds of beneficiaries in Bulgaria are dissatisfied with public health services, a considerably higher proportion than in the rest of the EU where only one third of beneficiaries express dissatisfaction with the service, as well as higher than the EU10 average dissatisfaction of 49%. (Table 1). 2. Public expenditure on health in Bulgaria at 4.2% of GDP in 2008 appears to be lower than in most of the EU10 countries although comparable and even higher than in the median for upper middle income countries. At the same time, at 38% of total expenditure, out-of-pocket payments in Bulgaria are 50% higher than the EU10 average. The high proportion of out-of-pocket expenditure is associated with inequities in access, inefficiencies of public spending on health, and the varying quality of health care. Public expenditure has been increasingly financed by the National Health Insurance Fund (NHIF), which financed 60% of total public expenditure in 2008 (about BGN 1,700 million) compared to less than 4% in 2001. Enhancing the efficiency and effectiveness of public sector spending on health continues to be a key policy priority for Bulgaria. This would require dealing with the rapidly growing hospital sector and adjusting the pharmaceutical policy to contain rise in spending and ensure the sustainability of the system. 3. The following discussion of policy issues and recommendations is focused on only a few key aspects. A more complete overview of the sector and a policy agenda will be proposed in a sector policy document which will be prepared by the World Bank later in 2009 in consultation with the Bulgarian Authorities.

Table 1: Selected health indicators: Bulgaria and the EU (latest available year) Government health spending as % of GDP Out-of-pocket payments as % of total health expenditure % satisfied with availability of quality health care Life expectancy at birth

Bulgaria 4.2

EU-10 4.6

EU-27 6.7

72.6

74.5

79.1

Sources: WHO Health for All database, NHIF, Gallup. Data for Bulgaria are from the Ministry of Finance and refer to 2008.

EU10 refers to the 10 new member states since 2004, excluding Cyprus and Malta.

Health Care

II. Key Challenges A. Rapidly Growing Hospital Sector 4. The hospital sector consumes a disproportionate share of resources, posing significant challenges to system sustainability while quality of services remains to be improved. The number of hospitals has increased from fewer than 300 to over 400 within five years, and many of the new ones are specialized institutions treating expensive cases. The NHIF is obliged to contract with all new providers, with minimal delay, which further encourages new entrants. Between 2002 and 2007 the total number of hospitalizations increased by 33%, while the average cost per case rose by 44% in real terms. Total inpatient expenditure has doubled over this period. The introduction of annual hospital budget ceilings in 2007 has helped stabilize the trend, and the new NHIF IT system offers a valuable tool for monitoring medical claims and enforcing its business rules. However, further measures will be needed to rationalize the system. Hospital restructuring master plan has been developed but has not been adopted yet. The key instruments of licensing and accreditation that can be used to ensure quality of care are currently underutilized while investment needs of the sector 29 are high (estimated to range between EUR 858-1,644 million over the next 10-15 years).

B. Primary Health Care 5. The rapid growth in the hospital sector is in part due to the under-performance of the primary care level. This is a result of several factors. Total spending for primary care is about 8% of the NHIF budget, half the comparable share in Western Europe. The payment method of primary care doctors does not provide adequate incentives for improved service provision, and referral rates to specialized out-patient and hospital care are high. Most primary care doctors were not originally trained as general practitioners (GP), and a requirement to obtain this training has been repeatedly postponed (the target date is now 2015). As a result, beneficiary surveys indicate lack of trust in family doctors, including low uptake of preventive exams and frequent bypassing of primary care in favor of direct contact with higher levels of care. Inequities are important: although the total number of GPs is more or less sufficient (77 per 100,000 inhabitants compared with the EU average of 98), 17.8% of the positions in regions with unfavorable conditions remain unfilled; similarly, the number of specialized outpatient centers per 100,000 inhabitants varies from 2.26 to 16.40.

C. Pharmaceutical Policy 6. The pharmaceutical policy is financially unsustainable and inequitable. Bulgaria has recently passed new by-laws regulating pharmaceutical policy, and on June 1st, 2009 it launched a new positive drug list for reimbursement. These measures represent a potential step forward, but important risks remain. The new drug list includes many new and expensive drugs (e.g., for hepatitis and multiple sclerosis), and the previous practice of using waiting lists to ration drug access in response to fixed budgets is no longer being implemented. As a result the new drug list puts at risk the NHIF drug budget in the second half of 2009. The margin for savings is limited by the already low level of reimbursement for drug expenditures compared to other countries, which results in significant out-of-pocket payments, and prevents adequate access to priority drugs for the poor.

D. The Role of MOH and NHIF

Source Development Of A Hospital Master-Plan, Restructuring Strategy And Related Advisory Services, Consultants report produced by Credes Groupe Burgeap under the World Bank Health Sector Reform Project

Health Care 7. The institutional framework for sector management needs substantial improvement. The huge increase in inpatient activities and related spending points to the need to strengthen regulation and control at the Ministry of Health and coordination with the NHIF. In recent years, and as required by legislation, the NHIF negotiated a National Framework Contract (including fee schedules) with a single entity -- the Bulgarian Medical Association (BMA). These negotiations are not properly linked with the budget process and exclude other key stakeholders. The role of NHIF and the possible transition to a multiple insurer model have been under discussion for some time in Bulgaria. Each of the broad policy objectives of the sector – improved hospital efficiency and quality, strengthened primary care, and sustainable pharmaceutical policy– could be addressed through different approaches. Successful examples of single payer models (as embodied by NHIF) and well-designed multiple payer systems, as well as less successful examples of both can be found elsewhere in Europe. Regardless of which model is adopted, success will depend on “getting the details right”. The multiple insurer models can be particularly complex (including mechanisms to reduce incentives for risk selection), and international evidence suggests they may lead to higher health expenditures.

III. POLICY RECOMMENDATIONS 8. The economic downturn offers an opportunity to send a clear signal that reforms to promote hospital efficiency are being initiated, and stakeholders should begin to adjust to a more competitive, streamlined and performance-based system. To protect public healthcare spending during the downturn and mitigate the impact on the poor, intra-sectoral restructuring will need to take place.

In the Short Term

• Adopt a Hospital Rationalization Master Plan. Enabling the purchaser of health care (e.g., NHIF) to selectively contract with hospitals would oblige hospitals to compete for public funding, and prove that the health services they offer are good value for (public) money. The transition from paying hospitals on the basis of clinical care pathways (CCPs) to diagnosis-related groups (DRGs) would also be beneficial. • Develop a comprehensive policy for long-term care (LTC) as a key component of hospital reform in Bulgaria. • Avoid cuts in the primary care budget. • Contain the increase in the pharmaceuticals budget in 2009 and next year. Re-introducing waiting lists for certain high-cost drugs might be warranted as lowering the already low reimbursement rate might not be feasible. • Hold CCP prices for services constant in 2010 and reducing CCP prices for services whose volume increased rapidly in recent years. These measures need to be evaluated in light of the budget environment. • Use NHIF reserves to help absorb the impact of eventual budget adjustments as a last-resort coping mechanism within the sector.

In the Medium Term

• Restructure hospitals in line with the Master Plan. • Establish an independent entity in charge of licensing and accreditation of hospitals to improve quality of care and support the rationalization of the hospital sector, • Develop performance indicators for hospital care that are regularly monitored and reported, including measures that reflect consumer satisfaction with the care they receive. • Develop a strategy for financing the large investment needs in the sector to compliment the identified financing from European Structural Funds for social infrastructure of EUR280 million • Introduce stronger pay-for-performance measures at the primary care level. Preliminary steps that have been taken in this direction should be closely monitored and evaluated to determine their impact.

Health Care • Change regulative standards to expand the list of conditions under the responsibility of primary care physicians which can help keep a greater number of patients away from specialized levels of care. • Use the new NHIF IT system to monitor referral and prescription patterns by individual physicians and take corrective action when necessary. • Introduce various contracting models for drug procurement to ensure flexibility and obtain greater value for money within the public budget. • Revise the negotiations of NHIF with providers to better link it with the budget framework and include other stakeholders in addition to the Bulgarian Medical Association. • Define clearly the benefit package covered by NHIF. Achieving greater clarity in this regard could set the stage for a more prominent role for multiple insurers to provide a supplementary benefit package above and beyond the basic publicly-funded coverage.

Pensions

PENSIONS REFORM I. CONTEXT 1. The pension system has undergone significant and well designed reforms since 2000. It increased retirement ages, curtailed early retirement programs, diversified the system into 3 pillar structure and introduced simple and fair benefit formula. Even though the disability program has experienced spillovers at the beginning of the reform, more recent administrative efforts of the NSSI have proven reasonably effective. 2. However, attempts to restore financial self-sustainability of the pension scheme were not as successful as envisaged. Ad hoc pension increases have weakened the link between contributions and benefits and have contributed to unsustainable increase in pension spending. The increase in the retirement age was countered by the large increase in disability pensions from 2000 through 2004-2005, generous pension indexation, and ad hoc bonuses. The drastic reduction in contribution rates has led to structural deficits financed from the State budget general revenue. These deficits are compounded by the uncommon Bulgarian policy of full tax exemption of the first and second pillars, and partial exemption of the third pillar (where contributions are partly exempt, investment income is fully exempt, and benefits are taxed). Finally, the economic and financial crisis is starting to put significant pressures on the government budget which has recently subsidized around 40 percent of pension spending. In the future the recent tail winds of rapidly increasing coverage, high wage growth and the presence of still active baby boom generation are not likely to continue, so fiscal pressures on the scheme will only increase.

Figure 1 Only about 60 percent of pension spending is covered by contribution revenue Financial performance of Pension Insurance and Overall NSSI Budget as percent of GDP 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 2000

2001 2002 2003 Pens i on i ns urance exp.

2004

2005 2006 2007 Pens i on i ns urance revenue

2008

Source: NSSI

3. Fiscal discipline and further reform of the pension system are needed. In the short-term the authorities need to avoid ad-hoc pension increases and further cuts in contribution rates. In the mediumto long-term, additional reforms would be needed to ensure fiscal sustainability of the pension system.

II. KEY CHALLENGES A. Contribution Rates 4. The reduction of contribution rates in 2006 was introduced with an expectation that this reform could be revenue neutral, as a lower tax wedge on labor would induce expansion of coverage which would compensate for lower contribution rates. Based on preliminary World Bank projections that incorporate most recent pension increases and cuts in contribution rates “pure” pension system deficit that excludes formal Government contributions is expected to stay at 4 – 4.5% of GDP for the next 5 decades of which 10% Government contribution rate is only expected to cover 2% of GDP.

Pensions 5. Figure 1 clearly demonstrates that this did not happen. Increases in employment since 2006 did not result in commensurate increases in contribution revenue that would offset much of the loss of revenues from lower rates. Instead, the revenues decreased dramatically. Moreover, this drastic move has put Bulgarian contribution rates at the lower end of the regional spectrum with Bulgaria having the worst demographic situation. The last proposal to further cut contribution rates over the next four years will only increase this divergence. Any such cuts in pension contribution rates, if opted as measure of reducing compliance burden on firms, will need to be accompanied by reforms that ensure the fiscal sustainability of the pension systemâ&#x20AC;&#x201D;increasing retirement age, limiting early retirement, and changing the indexation rules. 6. The newly introduced government support to the pension system does not solve fiscal sustainability problems and might create distortions. Since January 1, 2009 Government is providing 12% matching contribution, thus reducing pension contribution paid by employer and employee by 4 percentage points compared to 2008 to 18% in 2009. This â&#x20AC;&#x153;explicitâ&#x20AC;? government support would be enough to cover only half of the deficits projected for the next few decades. In addition, while Government contributions are not especially distortive now that the pension scheme covers most of the old population along the whole income spectrum, significant coverage contraction among elderly poor is expected which would greatly increase such distortions in the future. This is because during the last two decades unemployment and informal labor market have left a sizable proportion of the population, mostly poor, with very sporadic contribution histories, which for them will translate into very small pensions and often into no pension at all. At the time when these people reach retirement age shifting significant Government resources to the program that excludes a big proportion of lifetime poor will tend to redistribute from unsubsidized poor to subsidized wealthier population. Therefore, it is important that a longer term plan is developed to put the pension system on the self-sustainable basis, financed solely by contributions.

B . R etir ement E ligibility C onditions 7. Recent increases in statutory retirement ages will contribute to easing financial pressures for the pension system, but further increases may be necessary. Transition to a new statutory retirement age resting point was completed in year 2009, although retirement ages of 60 and 63 are still low by OECD standards where statutory retirement ages of 65 for both men and women have become the norm and where individual countries are gradually raising it to 67. The gender difference in retirement ages is especially hard to justify as life expectancy of women at age 60 stands at 20.32 years and is more than 4 years longer than that of men at the same age. 8. Moreover, still a significant number of people draw either disability or early retirement pension before reaching statutory retirement age. Some 57 percent of men and 36 percent of women are already in receipt of some pension (for old age and disability) by the time they reach retirement age. The proportion of early retirees, excluding disabled, currently stands at 40 percent for men and 18 percent for women. These numbers are expected to naturally come down as the list of contributors eligible to retire early has been cut to 25 percent of the previous size in 2000. However, people who have accrued early retirement rights before 2000 will continue to exit labor force prematurely still for many years to come. In addition, some groups will continue to be eligible for early retirement. For example, teachers can retire 3 years earlier with a reduction of pension equal to 0.2 percent per month of advanced retirement which covers only about half of the costs of early retirement that NSSI incurs in these instances.

C . Disability R ates 9. Transition to higher retirement age that occurred in 2000-2009 period has coincided with a significant spillover from old age to disability program. While NSSI seems to have stabilized the growth of disability benefits, the pressure on the disability program is expected to grow as early retirement provisions continue to be phased out, and unemployment spikes due to the economic crisis.

Pensions 10. While administrative capacity to control the costs of the disability program seems to have increased, the incentive structure to claim disability would benefit from a review. In the majority of social insurance schemes worldwide disability pensions are lower than regular old age pensions. This is also true in Bulgaria, where average old age pension stood at BGN 177.23 and disability pension stood at BGN 140.69 in 2007. However, disabled are also eligible for the social disability pension supplement of around BGN 30, practically equalizing both kinds of pensions and increasing the incentive to pursue disability certification in borderline cases. D. I ndexation of Pensions 11. Decisions regarding existing pension levels in Bulgaria are often of an ad hoc nature. For example, by law pensions are supposedly indexed according to the “Swiss rule” which was carefully designed to control pension expenditures. The rule calls for the growth rate of pensions to be an arithmetic average of inflation and wage growth. While this type of indexation allows for some increase in real incomes of pensioners, their incomes grow slower than wages which is, from time to time, deemed “unfair” and adjusted/corrected in an ad-hoc manner. The result of such adjustments is that pensions have actually increased faster than wages during this decade. Unscheduled and growing end-of-year “bonuses” amounting to 1-6% of the annual pension spending were granted in 2005-2008, financed from the state budget. These practices contribute to unsustainability and undermine incentives to contribute by weakening the link between contributions and benefits.

III. POLICY RECOMMENDATIONS 12. A renewed reform agenda could address the longer term sustainability concerns discussed in the previous section, and to a lesser extent mitigate the short-term deterioration of the system brought about by the economic crisis. A more detailed pension policy note will be prepared by the World Bank later in 2009 in consultation with the Bulgarian Authorities.

In the Short Term

• Refrain from further ad-hoc pension increases • Consider cuts in contribution rates only if accompanied by reforms to improve the long-term sustainability of the pension system. • Consider exit strategy for formalized Government contribution to the scheme. • Further strengthen disability certification processes to respond to likely increase in disability claims due to the economic downturn.

In the Medium Term

• Consider eliminating gender differences in retirement age and start aligning retirement age to EU levels. • Review rules for early retirement (eligibility, 2-for-1 length of service credits and penalties) and phase out faster old rights to discourage early retirement. • Review the rules and incentives for disability retirement so that disability pensions are in practice lower than regular old age pensions. • Improve long-term financial planning in the Ministry of Finance and analysis of the reasons for slow improvements in compliance rates. • Unless appropriate mitigation can be implemented, an increase in contribution rates should not be ruled out.

Social Safety Net

SOCIAL SAFETY NET I. CONTEXT 1. Bulgariaâ&#x20AC;&#x2122;s non-contributory social safety net schemes include: (i) support for low-income and vulnerable households through the Guaranteed Minimum Income (GMI) and the Heating Allowance ; (ii) the Monthly Benefit for Families with Children as well as birth grants, paid maternity leave for uninsured mothers and other support schemes under the Law on Family Support for Children; (iii) benefits for people with disabilities through the Monthly Supplement for Social Integration, complementing disability pensions; and (iv) institution and community-based social services. The GMI and heating allowances are means-tested poverty mitigation programs targeted at the most vulnerable households. The monthly benefit for families with children combines categorical and means-tested targeting, with a higher threshold for selecting beneficiary families. The monthly supplement for social integration provides a monthly supplement for people with disabilities, with the view of supporting their social integration. 2. Expenditure for social safety net programs is a relatively small share of the overall spending for social protection. Bulgaria spent in 2008 about 1.3% of GDP on social welfare programs (on the four non-contributory safety net schemes mentioned above and other types of social assistance) which is in line with spending trends in other new EU member states. Budgetary allocations for the four main social assistance and child allowance programs in 2007 amounted to only 7% of total spending on social protection (Table 1). While overall social protection spending amounted to more than 35% of total public spending, the four targeted social assistance and child allowance programs accounted for only 2.5% of total public spending.

Table 1: Public Spending on Social Protection Programs, 2007 Social insurance and assistance categories Pensions The four targeted social assistance and child protection programs Other social insurance, social assistance and social care Social insurance, social assistance, and social care (total)

BGN million

as percent of total public spending

as percent of total social insurance, social assistance, and social care spending

as percent of GDP

4,691

22.9

64.8

8.3

504.6

2.5

7.0

0.9

2,039

10.0

28.2

3.6

7,235

35.3

100.0

12.8

Source: Staff estimations based on data from the Ministry of Finance, Social Assistance Agency of the Ministry of Labor and Social Policy, and the National Statistics Institute (NSI).

3. The economic crisis increases the need for social safety net protection for the poorest Bulgarian households. The economy is expected to contract significantly in 2009 following a decade of economic growth, which will affect household welfare through rising unemployment, increasing informal economy, and cutbacks in wages. The global crisis will also affect remittances from Bulgarians working abroad, which provide almost 7% of the householdsâ&#x20AC;&#x2122; consumption. The economic downturn is expected to continue in 2010 and the recovery after that will be slow. Overall poverty 30 is projected to increase by up to 25% by end-2010 (i.e., an estimated 182,000 people falling below the poverty threshold), while the number of extreme poor could increase by 14% and exceed 400,000. The increase in extreme poverty is

Please provide definition, and of extreme poverty.

Social Safety Net particularly sensitive to remittances, which provide 30% of the consumption and 35% of the income of families that depend on them. 31 4. The following discussion will review the effectiveness of the main social safety net transfer programs, and suggest some policy options aimed at mitigating the impact of the crisis on Bulgariaâ&#x20AC;&#x2122;s poorest households, and addressing medium-term objectives as well. The note draws on the 2007 MultiTopic Household Survey and on the World Bankâ&#x20AC;&#x2122;s experience in the region.

II. KEY CHALLENGES A. Effectiveness of Social Safety Net Schemes 5. The targeting accuracy of GMI and heating allowance is high; these schemes are the only schemes entirely oriented towards poverty mitigation. GMI and heating allowances transfer 84% and 67% of benefit spending, respectively, to the poorest 20% of households. This is a very solid performance by international standards. As expected, the Child Allowance - which is not an explicitly targeted antipoverty benefit - transfers 70% of benefits to the non-poor. The targeting of GMI and heating allowance and their effectiveness in transferring resources to those who are most in need may be due to the low levels of benefits (suggesting there may be self-targeting of those who really need the benefit, and consistent with the low coverage discussed below) rather than to sound targeting methods per se. 6. However, benefit adequacy is low; social assistance benefits only account for a relatively small, though important, part of household income. As illustrated below, less than 16% of the poorest households quintile receive GMI and heating allowance. These schemes do better on the coverage of very poor households, with 33-36% receiving benefits. However, this means that about two-thirds of the very poor households do not have access to the benefits provided by these two programs. The number of beneficiaries of GMI has sharply declined in recent years, from around 140,000 in early 2005 to below 40,000 in early 2009. This reflects in part improved employment opportunities which have pulled people off social assistance, and is corroborated by the substantial decline in poverty incidence between 2003 and 2007 due to fast economic growth32. However, it also reflects the decision to apply more stringent eligibility criteria before performing the means test. As of July 1, 2006, the maximum duration of eligibility for GMI for able-bodied working age beneficiaries was limited to a maximum of 18 months. While they are eligible to enroll in remunerated employment and training programs upon losing GMI benefit eligibility, affected beneficiaries cannot re-apply for the benefit until after 12 months of break in benefit receipt. The stringent criteria were introduced on the premise that beneficiaries who lose welfare benefits would have a strong incentive to seek a job. The policy measure has been strictly enforced since January 2008, resulting in a substantial drop in beneficiaries from around 60,000 to below 50,000 in just two months, and the duration of GMI benefits was further reduced to 12 months as of July 2008. The European Committee of Social Rights recently assessed that the eligibility tightening of social assistance is in violation of Bulgariaâ&#x20AC;&#x2122;s obligation under the European Social Chapter. 7. Coverage of child allowance, in particular of the very poor, is substantially higher than GMI and heating allowance, but misses 45% of the poor households. 45% of poor households (i.e., households living under the poverty threshold of BGN 185 per month per adult equivalent in 2007) with children under 18 do not receive child allowance benefits, in spite of an eligibility threshold for child allowance in 2008 of BGN 300 per month. The low coverage may be due to access barriers (e.g., uninformed potential beneficiaries or too complex application rules), or benefit levels that are too low to make it worthwhile for beneficiaries to apply, especially in rural areas where access to Social Assistance Offices is difficult. 31 32

World Bank (2009), Bulgaria: Poverty Implications of the Global Financial Crisis (Report No. 47792-BG). World Bank (2008), Bulgaria: Living Conditions before and after EU Accession

Social Safety Net B. Spending on the Social Safety Net 8. The GMI budget has seen Table 2: GMI budget and expenditure considerable savings in recent years, BGN '000 2006 2007 2008 2009 suggesting there is a fiscal space for budgeted 85,850 85,850 85,850 85,850 expanded coverage of the GMI even within executed 83,480 65,759 38,217 the existing envelope. These savings reflect Source: Social Assistance Agency different developments, including the tightened eligibility criteria for GMI, including the time limit to 12 months, the fact that eligibility thresholds were not raised commensurate with rising incomes, falling unemployment and the introduction of greater fraud control. Table 2 shows that budgeted amounts for the GMI were kept unchanged in nominal terms between 2006 and 2009 despite the fact that actual spending has been on a decline and changes to policy for GMI eligibility were introduced that had a significant impact on the number of beneficiaries.

C. The Social Safety Net and Employment Activation 9. Bulgariaâ&#x20AC;&#x2122;s employment activation approach is unbalanced and not in line with mainstream activation policy across the EU. First, the low adequacy of GMI implies that benefits may not act as an important disincentive to look for employment. Barriers to employment lie elsewhere, for example in low skills and mobility of jobseekers, and limited employment opportunities. Second, Bulgaria opted for rigid time limits on eligibility, recently declared in violation of Bulgariaâ&#x20AC;&#x2122;s obligations under the European Social Charter, rather than pursuing a discretionary approach on benefit sanctions to enforce cooperation of the job seeker and an agreed gateway towards sustainable employment, as many EU Member States, including Germany and the United Kingdom, have done. This is considered essential for the activation of highly disadvantaged individuals; this is relevant for the Roma, given that the majority of GMI beneficiaries are Roma and often with very limited skills and no prior formal employment history. Third, more restrictive GMI entitlements were not complemented with sufficient institutional change in the employment office which also remain institutionally entirely separate from the social assistance administration. Institutional change to render employment offices more effective is admittedly challenging and requires a culture of partnership with non-governmental and community-based organizations which is incipient in Bulgaria. 10. There are barriers to moving people off welfare and limitations to the effectiveness of the more stringent GMI rules. A survey conducted by the National Statistical Institute in April 2008 showed that only around 15% found formal employment while 70% of the surveyed beneficiaries reported to have remained unemployed 3 months after GMI support stopped despite high labor demand, and almost 15% worked in the informal sector, as self-employed, or in temporary employment.. About 27% of the people who lost welfare benefits stated that they had not looked for jobs after losing GMI support, quoting reasons such as lack of qualification (almost 60% of the GMI beneficiaries had primary education or less), low pay offered, family reasons (child care), long distance of the offered job to the place of residence. The survey also pointed to insufficient support from employment offices: many former beneficiaries reported that they were not counseled on job opportunities and were not promptly offered participation in programs for subsidized employment or training, despite early identification of beneficiaries and the preparation of individual action plans. 11. While many of the former GMI beneficiaries enrolled onto remunerated training and subsidized employment, there seems to be attrition from any form of employment office programs. Administrative data from the employment agency hints at substantial decline in number of beneficiaries of employment office programs. Anecdotal evidence from local employment offices in Sofia suggests that attrition may concern in particular mothers of children above the age of 3 who stay at home to care for children. Removing the GMI benefit from the mother may have disproportionate effects on children,

Social Safety Net as, according to international experience, the mother’s contribution to household income is more likely to be spent on children.

III. POLICY RECOMMENDATIONS In the Short Term

• Expand coverage of the GMI by simplifying eligibility conditions including the requirement to having been registered unemployed for nine months prior to applying for the benefit, as well as the interdiction to travel abroad. • Review GMI eligibility criteria (in particular the 12-months limit on benefits) in the light of the worsening employment prospects for low-skilled GMI beneficiaries, and taking into account the impact on poor households, many of which with children, with a view to maintaining the GMI primary objective of a last resort social safety net. • In the context of the economic crisis, consider the introduction of a separate temporary GMI top-up benefit without raising the eligibility threshold permanently. This could address transient poverty risks for poor and vulnerable households who are already receiving GMI but who are deprived of informal and casual coping mechanisms during the crisis. • Continue to offer public works programs through the employment office. • Strengthen monitoring of GMI to scale-up the most effective tools and experiences.

In the Medium Term

• Revisit the employment activation framework to build partnerships between employment offices and social assistance administrations with NGOs and community-based organizations, and enable employment offices to address better the needs of disadvantaged job seekers. • Deepen institutional interaction between social assistance administrations and employment offices or integrating them • Continue to strengthen registries and monitoring systems, including tracking applications for programs, both accepted and rejected, and identifying the reasons for rejection. • Reduce administrative costs for GMI, for example by conducting the means-test less often (not every month) and simplifying the applied equivalency scales.

REFERENCES Betcherman et al (2007). A Review of Interventions to Support Young Workers: Findings of the Youth Employment Inventory. World Bank Social Protection Discussion Paper No. 715, World Bank, Washington, D.C. Draft report of Working Group under the Ministry of State Administration and Administrative Reform, 2009. Analysis of State Fees, Administered at the Central Level and Proposals for Undertaking of Measures. Government of Bulgaria. November 2008. Draft Bulgarian Energy Strategy by 2020. Ministry of Finance. Report of the consolidated state budget as of 31 December 2008. OECD (2008): Employment Outlook 2008, Chapter 1. Off to a Good Start? Youth Labor Market Transitions in OECD Countries. OECD, Paris. OECD (2008). Jobs for Youth: United Kingdom. OECD, Paris. Quintini and Martin (2006). Starting Well and Losing Their Way? The Position of Youth in the Labor Market in OECD Countries. OECD Social, Employment and Migration Working Papers No. 39, OECD: Paris. The Lisbon Review 2008: Measuring Europe’s Progress in Reform. Red to Gray: The “Third Transition” of Aging Populations in Eastern Europe and the Former Soviet Union, World Bank: Washington, D.C., 2007. World Bank & IFC (2007). Doing Business 2008. Washington, D.C. World Bank (2008). Bulgaria: Investment Climate Assessment. Washington, D.C. World Bank & IFC (2008). Doing Business 2009. Washington, D.C. World Bank (2009). Bulgaria: Reforming the Regime of State Fees. Document of the World Bank. July 2009. World Bank, 2008. Bulgaria: Investment Climate Assessment Enterprise Survey. World Economic Forum. Executive Opinion Survey 2007, 2008. World Bank (2008). Bulgaria: Raising employment and human capital for growth and convergence. World Bank (2007). Accelerating Bulgaria's Convergence: The Challenge of Raising Productivity", World Bank, Washington D.C. World Bank (2009). Bulgaria: Poverty Implications of the Global Financial Crisis. (Report No. 47792-BG). World Bank (2008). Bulgaria: Living Conditions before and after EU Accession.

REPORTS – BULGARIA IN FOCUS http://www.worldbank.bg/WBSITE/EXTERNAL/COUNTRIES/ECAEXT/BULGARIAEXTN/0 ,,contentMDK:22011258~pagePK:1497618~piPK:217854~theSitePK:305439,00.htmlBULGAR IA: Forest Policy Note (May 2009) http://www.worldbank.bg/WBSITE/EXTERNAL/COUNTRIES/ECAEXT/BULGARIAEXTN/0,,contentMDK:22236125~pagePK:1497618~piP K:217854~theSitePK:305439,00.html

BULGARIA: Diagnostic Review of Consumer Protection and Financial Capability (May 2009) http://www.worldbank.bg/WBSITE/EXTERNAL/COUNTRIES/ECAEXT/BULGARIAEXTN/0,,contentMDK:22236041~pagePK:1497618~piP K:217854~theSitePK:305439,00.html

Bulgaria: Investment Climate Assessment (Dec. 2008) http://www.worldbank.bg/WBSITE/EXTERNAL/COUNTRIES/ECAEXT/BULGARIAEXTN/0,,contentMDK:22011258~pagePK:1497618~piP K:217854~theSitePK:305439,00.html

B ulgar ia: C or por ate G over nance A ssessment (Dec. 2008)

http://siteresources.worldbank.org/BULGARIAEXTN/Resources/305438-1224088560466/Bulgaria2ROSCfinalreport.pdf

Bulgaria: Accounting and Auditing ROSC (Dec. 2008) http://siteresources.worldbank.org/BULGARIAEXTN/Resources/305438-1224088560466/33061PReportAAengl.pdf

Bulgaria: Resourcing the Judiciary for Performance & Accountability - Judicial Public Expenditure and Institutional Review (Oct. 2008) http://www.worldbank.bg/WBSITE/EXTERNAL/COUNTRIES/ECAEXT/BULGARIAEXTN/0,,contentMDK:21961468~pagePK:141137~piP K:141127~theSitePK:305439,00.html

C atastr ophe R isk I nsur ance F easibility Study (J une 2008) http://siteresources.worldbank.org/INTBULGARIA/Resources/RiskinsuranceBG.pdf

Accelerating Bulgaria’s Convergence: the Challenge of Raising Productivity (Sept. 2007) http://www.worldbank.bg/WBSITE/EXTERNAL/COUNTRIES/ECAEXT/BULGARIAEXTN/0,,contentMDK:21494784~pagePK:1497618~piP K:217854~theSitePK:305439,00.html

Bulgaria: Raising employment and human capital for growth and convergence - Policy Note (Nov. 2008) http://siteresources.worldbank.org/BULGARIAEXTN/Resources/PolicyNoteEmploymentandHumanCapitalFINALcleannov17.pdf

Bulgaria’s Policy for Regulatory Reform in the European Union: Converging with Europe’s Best Regulatory Environments (Oct. 2007) http://siteresources.worldbank.org/BULGARIAEXTN/Resources/305438-1224088560466/RIA_ENG.pdf

R efor ming administr ative pr ocedur es in the tour ism, food and r oad tr anspor tation sector s in B ulgar ia (Oct. 2007) http://siteresources.worldbank.org/BULGARIAEXTN/Resources/305438-1224088560466/SPR_ENG.pdf

REGIONAL AND GLOBAL REPORTS Doing B usiness 2009 (Sept. 2008) http://www.worldbank.bg/WBSITE/EXTERNAL/COUNTRIES/ECAEXT/BULGARIAEXTN/0,,contentMDK:21940453~pagePK:141137~piP K:141127~theSitePK:305439,00.html

F r om R ed to G r ay - T he “ T hir d T r ansition” of A ging Populations in E aster n E ur ope and the for mer Soviet Union (2007)

http://web.worldbank.org/WBSITE/EXTERNAL/COUNTRIES/ECAEXT/0,,contentMDK:21378474~pagePK:146736~piPK:146830~theSitePK: 258599,00.html

E U10 R egular E conomic R epor t (Oct. 2008)

http://web.worldbank.org/WBSITE/EXTERNAL/COUNTRIES/ECAEXT/0,,contentMDK:20268176~pagePK:146736~piPK:146830~theSitePK: 258599,00.html

World Development Report 2009 http://econ.worldbank.org/WBSITE/EXTERNAL/EXTDEC/EXTRESEARCH/EXTWDRS/EXTWDR2009/0,,menuPK:4231145~pagePK:64167 702~piPK:64167676~theSitePK:4231059,00.html