Document of The World Bank

FOR OFFICIAL USE ONLY

Report No. 86436-GE

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND INTERNATIONAL DEVELOPMENT ASSOCIATION

PROGRAM DOCUMENT

FOR

TWO PROPOSED IDA CREDITS

IN THE AMOUNTS OF SDR 7.8 MILLION AND SDR 6.85 MILLION (US$12.1 MILLION AND US$10.6 MILLION EQUIVALENT)

AND

A PROPOSED LOAN

IN THE AMOUNT OF US$70 MILLION

TO

GEORGIA

FOR THE

THIRD COMPETITIVENESS AND GROWTH DEVELOPMENT POLICY OPERATION

May 28, 2014

Poverty Reduction and Economic Management Unit South Caucasus Country Unit Europe and Central Asia Region

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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GEORGIA –GOVERNMENT FISCAL YEAR January 1 – December 31

CURRENCY EQUIVALENTS (Exchange Rate Effective as of May 28, 2014)

Currency Unit = Georgian Lari (GEL) US$1.00 = 1.7718 GEL

ABBREVIATIONS AND ACRONYMS

CEM Country Economic Memorandum CIS Commonwealth of Independent States CPS Country Partnership Strategy

CSO Civil Society Organizations DCFTA Deep and Comprehensive Free Trade

Area DPO Development Policy Operation DSA Debt Sustainability Analysis EBRD European Bank for Reconstruction and

Development ECA Europe and Central Asia EU European Union FDI Foreign Direct Investment GDP Gross Domestic Product GEMM Georgia Electricity Market Model IBRD International Bank for Reconstruction and

Development IDA International Development Association IDPs Internally Displaced People IFC International Finance Corporation IFAC International Federation of Accountants IMF International Monetary Fund IPSAS International Public Sector Accounting

Standards LEPL Legal Entities of Public Law MIP Medical Insurance Program MOES Ministry of Education and Science MOF Ministry of Finance

MOLHSA Ministry of Labor, Health and Social Affairs

NBG National Bank of Georgia NPLs Non-Performing Loans OECD Organisation for Economic Co-operation

and Development PEFA Public Expenditure and Financial

Accountability PFM Public Financial Management PIRLS Progress in International Reading

Literacy Study PSFMR Public Sector Financial Management

Reform Project SBA Stand-By Agreement SCF Stand-By Credit Facility SDS Social Economic Development Strategy SDSS Special Data Dissemination Standards SIMS Social Information Management Systems SDR Special Drawing Rights TBT Technical Barriers to Trade TSA Targeted Social Assistance TIMSS Trends in International Mathematics and

Science Study UHC Universal Health Care USAID United States Agency for International

Development WTO World Trade Organization

Vice President: Laura Tuck Country Director: Henry G. Kerali

Acting Sector Director: Roumeen Islam Sector Manager: Ivailo V. Izvorski

Task Team Leader: Mona Prasad

GEORGIA

THIRD COMPETITIVENESS AND GROWTH DEVELOPMENT POLICY OPERATION

TABLE OF CONTENTS

LOAN/CREDIT AND PROGRAM SUMMARY ...................................................................................................... i

1. INTRODUCTION AND COUNTRY CONTEXT (INCLUDING POVERTY DEVELOPMENTS) ........... 1

2. MACROECONOMIC POLICY FRAMEWORK ............................................................................................. 3 A. RECENT ECONOMIC DEVELOPMENTS ............................................................................................................ 3 B. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY ........................................................................... 4 C. IMF RELATIONS ........................................................................................................................................... 7

3. THE GOVERNMENT’S PROGRAM ................................................................................................................ 8

4. THE PROPOSED OPERATION ........................................................................................................................ 8 A. LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION ............................................................... 8 B. PRIOR ACTIONS, RESULTS AND ANALYTICAL UNDERPINNINGS .................................................................... 9 C. LINK TO CPS AND OTHER BANK OPERATIONS ........................................................................................... 20 D. CONSULTATIONS, COLLABORATION WITH DEVELOPMENT PARTNERS ........................................................ 21

5. OTHER DESIGN AND APPRAISAL ISSUES ............................................................................................... 21 A. POVERTY AND SOCIAL IMPACT ................................................................................................................... 21 B. ENVIRONMENTAL ASPECTS......................................................................................................................... 24 C. PFM, DISBURSEMENT AND AUDITING ASPECTS ......................................................................................... 25 D. MONITORING AND EVALUATION ................................................................................................................. 26

6. SUMMARY OF RISKS AND MITIGATION ................................................................................................. 27

ANNEXES

Annex 1: Policy and Results Matrix ............................................................................................................................ 29 Annex 2: Letter of Development Policy ...................................................................................................................... 33

TABLES

Table 1: Macroeconomic Trends and Projections ......................................................................................................... 5 Table 2: Fiscal Indicators............................................................................................................................................... 6 Table 3: Debt Sustainability Analysis ........................................................................................................................... 7 Table 4: Changes to the Prior Actions in this Operation ............................................................................................. 10 Table 5: DPO Prior Actions and Analytical Underpinnings ........................................................................................ 19 Table 6: Summary of Poverty, Social, and Gender Impacts ........................................................................................ 23

FIGURES

Figure 1: Job Creation in Georgia ................................................................................................................................. 2 Figure 2: Links between Georgia 2020 and the DPO Pillars and Policy Actions .......................................................... 9

The proposed Competitiveness and Growth Development Policy Operation for Georgia was prepared by a team consisting of Mona Prasad (Task team leader), Mariam Dolidze, Congyan Tan, Sarah Babirye, Tamuna Namicheishvili, Adriana Damianova, Ahmed Eiweida, Darejan Kapanadze, Nino Kutateladze, Nino Moroshkina, Joseph Melitauri, Salvador Rivera, Angela Prigozhina, Nistha Sinha, Galina Alagardova, Sandro Nozadze, Ghada Youness, Dandan Chen, and Malcolm Childress. The team is grateful for overall guidance provided by Henry Kerali, Roumeen Islam, Ivailo Izvorski, and Rashmi Shankar. The team gratefully acknowledges the excellent collaboration of the Georgian authorities, development partners, as well as the support and guidance of peer reviewers Philip English and Barbara Cunha.

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LOAN/CREDIT AND PROGRAM SUMMARY

GEORGIA

THIRD COMPETITIVENESS AND GROWTH DEVELOPMENT POLICY OPERATION

Borrower Georgia Implementation Agency Ministry of Finance Financing Data IDA credit of US$12.1 million on blend IDA terms with a maturity of 25 years including a 5-year

grace period and an interest rate of 1.25 percent per annum. IDA credit of US$10.6 million on hard IDA terms with a maturity of 25 years including a 5-year grace period and an interest rate of 1.40 percent per annum. IBRD flexible loan of US$70 million with a variable spread, 25 years maturity, and 10 years grace period. Commitment linked repayment schedule and level repayment of principal.

Operation Type Third in a programmatic series of three Development Policy Operations. Pillars of the Operation and Program Development Objective

Pillar I: Strengthen legislation to promote market access to the EU and improve customs efficiency, power sector reliability and the quality of general education.

Pillar II: Improve the coverage and transparency of the budget.

Pillar III: Improve the accessibility to and quality of healthcare services and efficiency of targeted social programs.

Result Indicators Deep and Comprehensive Free Trade Agreement with the EU Number of animal vaccinations done by the National Food Agency

Baseline: Negotiations planned to commence in 2012. Target: The number of European and international standards registered/adopted as Georgian standards will increase by 10 percent by 2014 from 4,700 in 2011. Baseline: 1.2 million animal vaccinations in 2012 Target: 3.5 million animal vaccinations in 2014

Customs violation detections for a given number of checks based on the risk based management system

Baseline: 175 cases in November/December 2011. Target: 100 percent increase in cases detected by November/December 2014.

Percent of primary education teachers who are aware of formative assessment techniques to improve student learning

Baseline: 33 percent (2011). Target: 40 percent (2014).

Score on PEFA indicator (PI-25) Baseline: D+ in November 2008. Target: C+ in 2014.

Percent of hospitals, outpatient facilities, and laboratories submitting detailed reports on compliance with upgraded standards

Baseline: None (2011). Target: 65 percent (2014).

Percent of population covered by publicly funded health programs

Baseline: 19 percent (2011). Target: 90 percent (2014).

Time taken to issue first benefits after assessing beneficiary eligibility

Baseline: 10 days for state pension in 2011. Target: 3 days for state pension in 2014.

Overall Risk Rating Moderate. The main risks arise from external vulnerability, fiscal pressures, and weak implementation capacity in some line ministries.

Operation ID P146890

1

IDA AND IBRD PROGRAM DOCUMENT FOR A PROPOSED THIRD DEVELOPMENT POLICY OPERATION

TO GEORGIA

1. INTRODUCTION AND COUNTRY CONTEXT (INCLUDING POVERTY DEVELOPMENTS)

1. The third competitiveness and growth development policy operation in Georgia will help the government in its efforts to strengthen competitiveness and improve social and fiscal outcomes with the ultimate objective of eliminating extreme poverty and boosting shared prosperity. These objectives will be achieved through reforms in the areas of trade and trade facilitation, the power sector, education, public financial management and effectiveness of social spending. The proposed policy actions were agreed to with the previous government in Georgia and are fully supported by the new government. The actions are anchored in the Country Partnership Strategies (CPS) for 2010-13 and 2014-17 and are consistent with the government’s new development strategy. This is the last operation in the programmatic series of three operations spanning 2012-14, in the amount of US$92.7 million.

2. The parliamentary elections of October 2012 and the presidential elections one year later ushered in a new government led by the Georgia Dream coalition. The one year period between the two elections was marked by policy uncertainty and slow implementation of public programs that resulted in diminished consumer and investor confidence and lower growth. After the presidential elections, Irakli Gharibashvili was appointed the new Prime Minister, and under the new constitution that shifted power from the Presidency has full executive authority over domestic and foreign policy.

3. The main development challenge faced by the country is persistent unemployment as a result of low net job creation and a lack of skills markets need. With economic transformation in Georgia, some of the older industries died, shedding their labor force. New industries grew during the same period, but have not been able to absorb the workforce as effectively because net job creation has been low (Figure 1). New growth sectors, especially in tourism and other service sectors, have not been able to generate formal employment as effectively as a robust agri-business or manufacturing sector would have. In addition, progress in improving the ease of closing a business, getting electricity and access to finance remains limited. Businesses complain that job seekers do not have adequate skills, in large part because the existing educational curriculum is not in line with the demands of the private sector.1 The lack of required skills forces highly educated workers to take up less skilled jobs or remain unemployed. In line with these developments, although Georgia experienced a period of high economic growth during 2004-08, unemployment persisted at 13 percent. Unemployment rose during the 2008-09 global economic and financial crisis and reached 17 percent in 2010 before falling to 15 percent in 2012, after two years of recovery. The majority of the work force – more than 55 percent – is employed in agriculture (mostly self-employed in family subsistence farming), but the sector contributes to only 8.2 percent of GDP. Low productivity levels in agriculture have contributed significantly to high rural poverty. The urban poor are largely employed in elementary occupations such as laborers in construction work (mainly men) and

1 World Bank, Skills Mismatch and Unemployment in Georgia: The Challenge of Creating Productive Jobs, 2012.

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services and sales occupations including personal care work (mainly women). The gender difference in unemployment rates was negligible in the 2000s before the crisis. It increased thereafter and in 2011, male unemployment was 16.7 percent while female unemployment was 13.1 percent. Unemployment among higher education graduates, particularly women, is extremely high reflecting the inadequacies of the current education system. Nearly 44 percent of unemployed women and 35 percent of unemployed men in Georgia are higher education graduates.2 Tackling this unemployment problem will need reforms both in the business environment and in the quality and relevance of the education system.

4. Unemployment and low earnings for the self-employed in subsistence agriculture have been the key factors limiting progress in reducing poverty. In 2011, the incidence of poverty was 15.6 percent for the self-employed and 24.2 percent for the unemployed compared with 10.8 percent among households engaged in wage employment. This demonstrates the link between employment status and incidence of poverty. It also shows that the composition of jobs is a key

determinant of poverty reduction with subsistence farming making limited contributions towards welfare enhancement. Clearly, eliminating poverty and boosting shared prosperity in Georgia will require growth with considerable employment generation and the composition of jobs will be equally crucial.

5. There has, however, been a significant progress in poverty reduction and shared prosperity in recent years, but driven by other factors. The poverty rate, according to the national poverty line, fell from 21 percent in 2010 to 14.8 percent in 2012 and the mean consumption of the bottom 40 grew at 5.3 percent annually, exceeding the growth enjoyed by the population overall.3,4 This was mainly attributable to government transfers, food disinflation and increased earnings. Inequality in Georgia is higher than in the ECA region on average with a Gini coefficient of 40.7 in 2011. In Georgia, episodes of poverty reduction and increase do not closely align with periods of GDP growth underscoring the fact that growth has not been inclusive. This dichotomy can be explained by the low net job creation during growth episodes and the employment limitations imposed by the relatively lower educational attainment of the poor. This is further corroborated by the fact that the consumption of the bottom 40 percent of the population increased by only 0.3 percent annually during 2006-12, whereas the national average consumption expenditure rose by 1.2 percent a year.

2 World Development Indicators. 3 Poverty at the Europe and Central Asia (ECA) regional poverty line of US$2.50 per person per day was 45 percent in Georgia in 2011 and has not changed much over the past decade. 4 Consumption growth among the bottom 40 percent was 5.4 percent during 2010-12 compared with 3.6 percent for the population as a whole.

Figure 1: Job Creation in Georgia

(In percent)

Source: GeoStat.

10.9 11.2

6.88.4

-11.7-9.1

-11.4

-8.2

-0.8

2.1

-4.6

0.2

2007 2008 2009 2010

Job Creation Job Destruction Net Job Creation

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6. The proposed operation supports the government in helping create jobs via advancing further structural reforms and protecting those who do not gain from these reforms. Georgia experienced rapid growth since 2004 with the exception of 2008-10 when it was hit by the global economic crisis. The country also made several improvements in its business environment and enjoys a high ranking in the World Bank’s doing business indicators. However, the sources of productivity growth, which aided economic expansion during the last decade, appear to have run their course and future productivity improvements will need to come from other areas. These include improvements in market access, the logistics infrastructure, and skills, as well as growth in firm-level productivity supported by specific reforms in the business environment. A supportive macro-fiscal environment will remain a necessary condition. This Development Policy Operation (DPO) supports government reforms in some of these areas.

7. Reform efforts supported by this operation have been grouped in three pillars. Pillar I supports legislation to increase market access to the EU and improve customs efficiency, power sector reliability, and the quality of general education. Pillar II supports improvements in the coverage and transparency of the budget. Pillar III supports improvements in the accessibility and quality of healthcare services and efficiency of targeted social programs.

2. MACROECONOMIC POLICY FRAMEWORK

A. RECENT ECONOMIC DEVELOPMENTS

8. After a fiscal stimulus driven post-crisis recovery during 2010-12, economic growth weakened again in 2013, but this time driven by different factors. GDP growth fell from 6.2 percent in 2012 to 3.2 percent in 2013, largely driven by weak and uneven execution of the budget and relatively lower private investments attributed to political uncertainty, which weakened business and consumer confidence. The new government that came to power as a result of the October 2012 parliamentary elections announced changes in the labor code, tax code, competition legislation, land management and policies towards foreign investments. This uncertainty spurred a wait-and-see behavior among businesses and consumers. At the same time, in a bid to trim public expenditures, the government suspended some infrastructure projects. As a result, the fiscal deficit reduced to 2.5 percent of GDP in 2013.

9. Lower government expenditures and the sluggish domestic demand subdued imports while exports increased significantly, leading to a much improved current account balance in 2013. Georgia’s current account deficit was 5.9 percent of GDP in 2013, a sharp reduction from 11.7 percent a year earlier and from 22.8 percent in 2008. Imports remained at about 58 percent of GDP while exports grew from 38 percent of GDP in 2012 to 45 percent in 2013. This was mainly fueled by a four-fold increase in exports to Russia after removal of the trade embargo, as well as significant growth in exports to other Commonwealth of Independent States (CIS) countries. The main products which drove exports included re-exported cars, wine and copper ore. Tourism was the main contributor to trade in services while remittances grew by 10 percent in 2013. Large FDI inflows constitute the major source of financing of the current account.

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10. The National Bank of Georgia loosened its monetary policy in response to low inflation caused by weak domestic demand. With headline inflation significantly below the target of 6 percent, the National Bank of Georgia (NBG) cut its policy rate by 1.5 percentage points to 3.75 percent during 2013. The economy experienced disinflation in 2013, with a 0.5 percent decline in the average price level. The de facto stabilized arrangement against the dollar over the past couple of years has contributed to low inflation. In addition, a reduction in administered prices on energy and utilities, and a decline in the cost of health services also reduced overall prices. The exchange rate is broadly in line with fundamentals (0.3 percent overvalued as per the macro balance approach). Driven by lower inflation, the real effective exchange rate depreciated by 1.5 percent during 2013.5 Monetary policy is geared towards inflation targeting although in the context of a highly dollarized economy and weak capital markets, there is limited transmission of interest rate changes.

11. Credit growth strengthened during 2013 and the financial sector showed signs of recovery. The reduction in policy rates helped reduce the lending rates of the commercial banks, increasing credit growth to 26 percent in 2013 from 10.5 percent in 2012. The introduction of an agricultural lending interest rate subsidy program though the Agricultural Development Fund helped stimulate lending to agricultural producers while the other main borrowers were from the trading sector and hotels and restaurants. The ratio of non-performing loans (NPLs) to total loans declined from 9.6 percent at the beginning of 2013 to 7.5 percent by the end of the year. This is a significant improvement from an NPL ratio of 17.9 percent at the end of 2009. The banks’ return on assets rose to 2.6 percent in December 2013 compared with 1 percent a year earlier. The banks are adequately capitalized with a capital adequacy ratio of more than 17 percent at the end of 2013, with no significant vulnerabilities in the banking system. However, the large share of loans in foreign currency (about 60 percent of the total) gives rise to foreign exchange risk.

B. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY

12. Economic growth is projected at an average of 5.5 percent a year over the medium-term based on greater policy certainty, improved market access, and strong structural reform implementation. Medium-term growth prospects depend on a number of factors, including improved economic ties with the EU, improved relations with Russia (which will benefit trade and tourism), and the robust reform program outlined in the government’s development strategy, which will support growth in private investment (Table 1). Growth prospects depend on Georgia’s ability to leverage the DCFTA and Association Agreement with the EU, which will improve market access and encourage FDI. A trade sustainability impact analysis commissioned by the EU suggests a potential increase in GDP growth of 4.3 percent in the long-run.6 This will call for labor and capital reallocations to more productive sectors, involving capacity building on regulatory approximation particularly in trade facilitation, technical barriers to trade and intellectual property rights, and upgrading of and investment in human capital. While public investment will be maintained over the medium-term, private investment is expected to strengthen. Thanks to a better business environment and improved confidence, gross investment is likely to increase to an average of 27 percent of GDP a year 5 NBG estimate. 6 See Trade Sustainability Impact Assessment in Support of Negotiations of a DCFTA between the EU and Georgia and the Republic of Moldova, October 2012.

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during 2014-17. Even so, this will be lower than the 2004-07 average of 32 percent of GDP a year.

Table 1: Macroeconomic Trends and Projections

2010 2011 2012 2013 2014p 2015p 2016p 2017p

Actuals Projections

(Percent change, unless otherwise indicated)

National Accounts

GDP nominal (in billions of GEL) 20.7 24.3 26.2 26.8 29.4 32.9 37.0 41.5

Real GDP growth 6.3 7.2 6.2 3.2 5.0 5.5 6.0 6.0

Consumer price index 7.1 8.5 -0.9 -0.5 4.0 4.5 5.0 5.0

GDP per capita (in U.S. dollars) 2,614 3,220 3,515 3,597 3,716 4,031 4,397 4,844

Gross investment (in percent of GDP) 21.6 26.2 28.9 24.8 26.2 27.4 27.8 28.0

Gross national saving (in percent of GDP) 11.3 13.4 17.3 18.9 18.0 19.7 20.2 20.5

(In percent of GDP, unless otherwise indicated)

General Government Operations

Revenues and grants 28.3 28.2 28.9 27.6 26.9 27.4 27.4 27.4

Tax revenues 23.5 25.2 25.1 24.8 24.2 24.8 24.8 24.9

Expenditure and net lending 34.8 31.7 31.7 30.1 30.7 30.5 30.1 29.7

Current expenditure 26.4 23.0 24.8 24.9 24.8 24.5 24.0 23.6

Capital expenditure and net lending 8.4 8.8 6.8 5.2 5.9 6.0 6.1 6.1

Overall fiscal balance -6.5 -3.5 -2.8 -2.5 -3.8 -3.0 -2.7 -2.3

External Sector

Current account balance -10.3 -12.7 -11.7 -5.9 -8.1 -7.8 -7.6 -7.5

Exports of goods and services 34.9 36.5 38.1 44.7 45.3 46.4 47.1 47.9

Imports of goods and services 52.7 55.5 57.8 57.7 59.2 59.4 59.8 60.0

FDI (net) 5.8 6.2 3.9 5.6 6.2 6.3 6.3 6.3

Foreign exchange reserves

(Months imports of goods and services) 4.4 4.2 3.8 3.7 3.6 3.8 3.8 3.9

(In millions of dollars) 2,264 2,818 2,873 2,823 2,914 3,362 3,739 4,183

Total public debt 38.7 33.6 32.3 32.2 34.5 33.4 33.0 32.7

Source: Georgian authorities; and Bank and IMF staff estimates and projections. 13. Fiscal consolidation is a policy priority for the government even with a wider deficit in 2014. The fiscal deficit is expected to widen to 3.8 percent of GDP in 2014 with a pick-up in social expenditures and relatively lower revenues due to the lagged impact of the growth slowdown in 2013. An increase in capital expenditures and tax refunds will also contribute to higher spending. Various measures are under consideration to narrow the deficit over the medium-term. These include increased expenditure efficiencies in social benefits, reforms in public investment management, the establishment of bonus limitations for public employees and limits on other non-essential expenditures. The share of capital expenditures will level off, with social spending – which grew significantly in 2013 and will rise to more than 9 percent of GDP in the medium term – rising to tilt the balance in favor of current expenditures. The introduction of universal health care in 2013 and higher benefit levels under pensions and targeted social assistance contributed to an increase in social benefits by 23 percent in 2013 compared with 2012. With the full-year impact of the cost of universal healthcare, expenditure on social

6

benefits will increase further in 2014. An aging population and the need to improve health outcomes and coverage of the poor in social assistance programs are likely to keep social expenditures high over the medium-term. To achieve the desired outcomes, strengthening the effectiveness of social spending and supporting the government on developing the institutions and capacity to support program implementation will be crucial.

Table 2: Fiscal Indicators

2010 2011 2012 2013 2014p 2015p 2016p 2017p

Actuals Projections

(In percent of GDP) Overall fiscal balance -6.5 -3.5 -2.8 -2.5 -3.8 -3.0 -2.7 -2.3

Revenues and grants 28.3 28.2 28.9 27.6 26.9 27.4 27.4 27.4

Taxes 23.5 25.2 25.1 24.8 24.2 24.8 24.8 24.9

Non-tax revenues 4.8 3.0 3.7 2.8 2.7 2.6 2.5 2.5

Total expenditure and net lending 34.8 31.7 31.7 30.1 30.7 30.5 30.1 29.7

Current expenditure 26.4 23.0 24.8 24.9 24.8 24.5 24.0 23.6

Wages and salaries 5.4 4.7 4.6 5.2 4.7 4.8 4.9 5.1

Goods and services 5.4 5.0 5.1 3.8 5.8 5.9 6.0 6.2

Interest payments 1.0 1.2 1.1 0.9 1.2 1.2 1.2 1.1

Subsidies and grants 1.9 1.8 2.1 2.0 1.9 1.7 1.6 1.5

Social expenses 7.8 6.8 6.7 8.6 9.6 9.6 9.3 9.1

Other expenses 4.5 3.7 3.8 4.5 1.7 1.3 1.0 0.7

Capital expenditure and net lending 8.4 8.8 6.8 5.2 5.9 6.0 6.1 6.1

Source: Georgian authorities; and Bank and Fund staff estimates and projections. 14. The renewed focus on competitiveness and fiscal consolidation will support external sustainability. Higher economic activity and public spending in 2014 will cause the current account deficit to increase before improved competitiveness – driven by the government’s structural reforms, especially in the context of the DCFTA – and a narrowing fiscal deficit start narrowing the external deficit again. Net FDI is likely to amount to 6.3 percent of GDP on average while the national saving rate increases to 20.5 percent of GDP by 2017.

15. Regional uncertainties could dampen Georgia’s export performance and reduce remittances. CIS countries accounted for nearly 56 percent of Georgia’s goods exports in 2013 with Azerbaijan at 24 percent, Armenia 11 percent, Russia 6.5 percent and Ukraine 6.6 percent. In addition, Turkey accounted for another 6 percent of Georgia’s exports. Although a lower export growth has been assumed for 2014, economic difficulties in some of Georgia’s trading partners could further reduce exports through lower demand and loss of price competitiveness (since the Russian ruble and Turkish lira are depreciating). The majority of tourist arrivals in Georgia in 2013 were from Turkey (30 percent of the total), Armenia (24 percent), Azerbaijan (20 percent), Russia (14 percent) and Ukraine (2 percent). Hence, there is a downside risk for lower tourism receipts as well, which accounted for 58 percent of Georgia’s service exports in 2013. Nearly 55 percent of private money transfers to Georgia in 2013 originated in Russia, most of which were remittances. However, remittances are small in Georgia and accounted for only 5 percent of GDP in 2013. The adverse impact on exports could be cushioned to some extent with increased exports to EU countries (assuming that EU does not get impacted by these developments) after the DCFTA is in place.

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In addition, for oil and gas imports, Georgia is largely dependent on Azerbaijan which makes it less vulnerable to regional uncertainties.

16. Georgia’s public debt remains sustainable. Total public sector debt fell from 38.7 percent of GDP in 2010 to 32.2 percent in 2013 due to continued fiscal consolidation efforts. About 80 percent of public debt in 2013 was external and was dominated by bilateral and multilateral debt. Gross external debt, including inter-company loans, continues to be high and is expected to remain at more than 80 percent of GDP over the medium-term. The 2013 Debt Sustainability Analysis (DSA) by the IMF confirms that debt indicators are within prudential thresholds.

Table 3: Debt Sustainability Analysis

2010 2011 2012 2013 2014p 2015p 2016p 2017p

Actuals Projections

(In percent of GDP) Total public sector debt 38.7 33.6 32.3 32.2 34.5 33.4 33.0 32.7

External public sector debt 33.6 29.1 27.5 25.8 26.7 25.8 25.2 24.8 Domestic public sector debt 5.1 4.5 4.8 6.4 7.8 7.6 7.8 7.9

Gross external debt (including inter-company loans)

83.9 77.8 82.0 80.2 83.7 83.4 83.2 82.7

Source: Georgian authorities; and Bank and Fund staff estimates and projections.

17. Georgia’s overall macroeconomic policy framework is adequate for this operation. With greater political stability, overall business confidence is expected to improve and will help strengthen growth prospects. The government remains committed to fiscal consolidation, which will have a beneficial impact on the fiscal and current account deficit and on public debt levels. In addition, the National Bank of Georgia’s reserves position remains comfortable.

C. IMF RELATIONS

18. The IMF Stand-By Arrangement (SBA) and the Stand-By Credit Facility (SCF) ended in April 2014 and a new arrangement is under discussion. The SBA and SCF were approved in April 2012 for SDR 250 million (US$386 million). The authorities have treated the program as precautionary and have not drawn from the facilities. The IMF program emphasizes fiscal consolidation and sound macroeconomic policy, with a focus on growth-enhancing structural reforms. The proposed DPO complements the Fund program. The Bank closely coordinates with the Fund on macroeconomic developments, debt sustainability analysis, fiscal consolidation, and public financial management. With the conclusion of the SBA and the SCF, a new arrangement with the Fund is under discussion.

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3. THE GOVERNMENT’S PROGRAM

19. The main objective of the Socioeconomic Development Strategy of Georgia, “Georgia 2020,” is to achieve faster, inclusive, and sustainable growth averaging 7 percent per annum. This assumes that structural reforms will support rapid growth in investment, employment, and firm productivity and also ensure the realization of potential benefits associated with the DCFTA in terms of higher exports and FDI. The SDS plans to help the private sector develop into the engine of growth and, at the same time, emphasizes the redefined role for the state to facilitate inclusion through better delivery of public services, addressing market failures and cross-cutting constraints. The SDS intends to establish an evidence based policy framework, supported by monitoring and evaluation mechanisms, to ensure that policy interventions are relevant, have impact, and enable course correction.

20. The strategy is based on four pillars: maintaining macroeconomic stability, strengthening competitiveness of the private sector, developing human capital and enhancing access to finance. The following priorities are highlighted:

• Pillar 1: Establishing the pre-conditions for growth in terms of a stable macroeconomic environment, effective public sector management, and fiscal efficiency and responsibility.

• Pillar 2: Strengthening human capital - health, education, and social safety nets.

• Pillar 3: Improving private sector competitiveness by building on past successes and further enhancing the investment climate, especially for SMEs, and focusing on firm productivity.

• Pillar 4: Increasing access to finance.

21. The core sectors covered in the proposed DPO are well aligned with the targeted sectors in Georgia 2020. The sectors included in this operation are prioritized in the government’s program and include energy, exports, education, and health. The new government has refocused its reforms towards the social sectors, particularly social assistance, education and health. It has also indicated its commitment to the growth strategy focused on investments in the tradable sectors and has expressed full ownership of the policy actions under this DPO.

4. THE PROPOSED OPERATION

A. LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION

22. The DPO objectives under the three pillars are anchored in the government’s development strategy. The three DPO pillars map to three of the four priority areas outlined in Georgia 2020 (Figure 2). In addition, the objectives of this operation are also fully consistent with the ongoing and the new CPS which focuses on areas in which the bank has a comparative advantage. These include convening power, rigorous analytical work, and the ability to leverage on assistance from development partners.

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23. The policy actions supported by this DPO targets the government’s most urgent development challenges. Export promotion and an increase in FDI are essential for productivity growth and are being targeted through the DCFTA with the European Union (EU). An efficient and reliable supply of energy to domestic businesses and consumers is necessary to improve the business environment. A sound education system and increased access to health care will help develop human capital. Improved public financial management will promote better policy making and fiscal discipline and will contribute to macroeconomic stability. Finally, improved effectiveness of social spending will help increase assistance to the poor.

Figure 2: Links between Georgia 2020 and the DPO Pillars and Policy Actions

24. The current DPO builds on previous development policy operations. The previous series of DPOs concentrated on crisis mitigation and structural reforms to ensure post-crisis growth. The reforms were anchored in public finances (new budget code), increased social safety nets, and improvements in the business environment (tax compliance and trading across borders). The current DPO series lays the foundation for increased competitiveness and inclusive growth by furthering reforms in these three areas. Lessons learned from previous operations have been instrumental in the current series. As a result, the design of the reform program was led by the government, the areas chosen were those where the bank had a strong track record of engagement and the reform actions were based on a realistic assessment of the country’s implementation capacity.

B. PRIOR ACTIONS, RESULTS AND ANALYTICAL UNDERPINNINGS

25. In response to the change in government in 2012 and the evolving policy environment, 4 of the 10 prior actions in this operation were modified. Despite these modifications, the strength of the overall package was maintained (Table 4).

Macroeconomic stability

efficient public spending

effective public administration

Competitiveness of private sector

Human capital development

Access to finance

Pillar I

Promote market access, enhancing exports and

foreign investment

Customs efficiency

Enhance climate for in the power sector

Improved national curriculum and better human resource policies.

Pillar II

Efficiency of treasury management

Coverage and transparency of financial

reporting

Pillar III

Accessibility and quality of healthcare services

Efficiency of targeted programs

Georgia 2020 DPO

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Table 4: Changes to the Prior Actions in this Operation

Trigger as per DPO2 Revised Prior Action in DPO3 Reason

Monitoring framework established and assessment of new national curriculum to be prepared.

The Minister of Education and Science has issued Order No. 180 dated May 2, 2013, Order No. 960 dated December 3, 2013 and Order No. 220 dated March 4, 2014 for establishing a framework for the monitoring of the implementation of the new national curriculum for primary, basic and secondary education.

The full assessment of curriculum implementation at the primary, basic and secondary level will go beyond the timeframe of this operation since it includes teacher interviews and classroom observations in several schools throughout the country. The government has put in place the framework and also initiated the process and shared the assessment report for primary schools in Tbilisi.

Continued attention to teaching profession through designing a more comprehensive teacher performance appraisal system and enhancing opportunities for career development.

The Minister of Education and Science has issued Order No. 39/N dated March 28, 2014 adopting professional standards for teachers which gives professional characteristics, knowledge and skill requirements pertaining to the teaching environment, teaching/learning process, and professional development for each category of teachers.

The MOES has developed a performance appraisal system for teachers. The adoption of this appraisal system is however contingent on a set of legislative amendments in the education sector. These amendments are in the initial stages of consultation with stakeholders. Parliamentary approval for these amendments is expected in 2014 but it is unlikely to be completed within the timeframe of this operation.

The Ministry of Finance of Georgia includes budgets of local self-governments and five largest LEPLs in the e-budget.

The 2013 budget performance of all central government LEPLs is available through the e-budget and the Minister of Finance of Georgia issued Order No. 77 dated March 14, 2014 and Order No. 442 dated December 31, 2013 requiring all central government LEPLs to submit budget performance numbers for 2014 either through the e-budget or through hard copies and only through the e-budget from 2015 onwards.

The decentralization reform which is currently underway has created some uncertainty on the number and size of municipalities. Hence, the government needs more time to work on the integration of budgets of municipalities with the e-budget. Therefore, this prior action has been limited to LEPLs but instead of the 5 largest LEPLs, it includes all central government LEPLs.

Nation-wide rollout of SIMS.

The Ministry of Labor, Health and Social Affairs has adopted the pension module of the Social Information Management System throughout the country.

The Social Information Management System (SIMS) consists of three components: (i) pensions, (ii) child protection, and (iii) targeted social assistance (TSA). The government is in the process of changing the rules for adoption and foster care and this will have an impact on the second component on child protection. Hence, this component will be finalized once these rules are in place. On the third component, the government is in the process of changing the methodology for the calculation of TSA by reducing the weight of subjective measures. This process is expected to be finalized in 2014 and the TSA component of SIMS will be completed thereafter.

Pillar I: Strengthen legislation to promote market access to the EU and improve customs efficiency, power sector reliability and the quality of general education.

26. While Georgia’s exports have grown in absolute terms, vulnerabilities remain. The share of exports in GDP was only about 38 percent in 2012 in Georgia, compared with over 90 percent in Estonia and the Slovak Republic, 78 percent in Lithuania, and 59 percent in Latvia. While there has been growth in exports in absolute terms, an analysis of the composition and dynamics of the export basket reveals significant weaknesses: (i) loss of market share in key markets and products; (ii) stagnant and low product sophistication and quality for its level of development; (iii) lack of product diversification with scrap metal, re-export of used cars, wine and processed food, water and tourism dominating; and (iv) low survival of export firms. The government is working in these areas and significant benefits could accrue from the DCFTA.

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There is also potential for renewable energy exports from Georgia which could be strengthened through strengthening of transmission capacity and implementation of environmental and social safeguards. This operation supports the government in some of these areas.

Prior Action 1: The Government of Georgia has issued Decree No. 288 dated April 14, 2014 for setting up the competition agency for the implementation of the Law on Competition No. 6148-IS dated May 8, 2012. The Government of Georgia has issued: (i) Decree No. 120 dated May 17, 2013 mandating indication of country of origin and date of production for eggs, (ii) Decree No. 198 dated July 30, 2013 defining the rules of bio-production, (iii) Law No. 1915 dated December 27, 2013 making the violation of food labeling an offense, and made budget provisions for an additional 180 staff in the National Food Agency in the 2014 budget for the implementation of the Law on Food Safety No. 6155-IS dated May 8, 2012.

27. Export-led productivity growth was a key element of the previous government’s growth strategy and is a priority area for the current government. However, Georgia’s exports remained under 40 percent of GDP during 2004-12 and were dominated by resource based products like metals and minerals (66 percent of total exports in 2010-11) while higher value-added and employment generating products have had a marginal share. Export of services have grown at a faster rate, although this has been dominated by transport and tourism receipts, unlike other ECA countries that have also managed to tap into the markets for information technology and other business services. In addition, export markets have been concentrated in the CIS countries (especially Azerbaijan and Ukraine) and Turkey.7 The country has found it difficult to enter new markets in Europe because the survival probability of Georgia’s exports is low. This is primarily because the quality and sophistication of its products has not evolved much.

28. Securing market access through trade agreements will therefore help Georgia increase its export sophistication and quality and attract more foreign direct investments. Towards this, the government is in the process of implementing reforms to meet the requirements of the DCFTA with the EU. Such an agreement will enable Georgia to make improvements in several trade-enabling areas like sanitary and phytosanitary standards, intellectual property rights protection, competition, technical regulations on industrial products and customs and trade facilitation. Georgia is receiving technical assistance from the EU in these areas. Negotiations between Georgia and the EU on the DCFTA were concluded in July 2013. The European Parliament passed a resolution on the EU Neighborhood Policy on October 23, 2013. On Georgia, the resolution supported the initialization of the Association Agreement which includes the DCFTA and the initialization happened at the Eastern Partnership summit in Vilnius in late November 2013. This is expected to be followed by the signing of the agreement by June 2014.

29. The first package of legal reforms which would enable this free trade agreement was approved by the Georgian Parliament in May 2012. It included the framework law on competition, a code on free movement and safety of products (also referred to as the technical barriers to trade (TBT) code) and the law on food safety. The implementation of the law on

7 In 2006 Russia imposed a trade embargo on Georgia’s main exports (wine, citrus and mineral water). This embargo has however been lifted in July 2013 and exports to Russia have increased since.

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safety and free movement of products was supported by the second DPO in this series. However, the new government decided to make amendments to the law on competition and the law on food safety and therefore, their implementation support was moved to DPO3. The World Bank was fully involved in the amendments made to the law on competition and majority of their comments were incorporated. The EU played a similar role in ensuring the robustness of the amended law on food safety. Both the laws have been strengthened and are in line with international standards.

30. The current operation supports the government’s efforts to implement the law on competition and the law on food safety. The amendments to the law on competition were approved by the Parliament on March 21, 2014. Thereafter the government issued the implementation decree to set up the competition agency. The law on food safety also underwent amendments which were approved by the parliament on April 17, 2014. In the meantime, the government made significant progress on implementation of some of the key provisions of this law, including those on the rules for bio-production, mandatory labeling of the date of production and country of origin for eggs and for making violations in food labeling an offense. In addition, the government made budgetary provisions for an additional 180 staff in the National Food Agency which will be the primary unit responsible for implementation of the law on food safety.

Result: The expected result of these policy actions is to increase the number of European and international standards registered/adopted as Georgian standards by 10 percent by the end of 2014. In addition, the number of animal vaccinations by the National Food Agency is to increase from 1.2 million in 2012 to 3.5 million in 2014. In 2013, approximately 2.6 million animal vaccinations took place.

Prior Action 2: The Revenue Service under the Ministry of Finance has adopted the Trade Facilitation System to integrate customs processes and simplify transactions for handling containers in sea ports.

31. Despite significant improvements in customs administration, high transportation and transit service costs continue to be a weakness. This drives up the overall cost of importing and exporting goods, and is also an impediment to Georgia becoming a transit hub. Some progress has been made in this area though more needs to be done. One of the steps already taken by the government to reduce these costs is the issuance of certificates of origin and permits related to exports, imports and transit at border crossings points or customs clearance zones. A streamlining of customs procedures for transit traffic was also implemented through the introduction of the automated selectivity system which helped strengthen the risk-based management system for customs.

32. A better flow of information between customs and traders will help reduce costs further. This has been facilitated through the adoption of the Trade Facilitation System (software) for containers in sea ports which will improve coordination among traders, shipping and freight forwarding companies and customs. DPO3 supported the adoption of this software by the Revenue Service to integrate processes and simplify transactions. Based on pilot runs, the Trade Facilitation System for handling containers in sea ports was modified and is now ready. Stage-wise adoption of the system started on March 8, 2014 and the system was fully adopted by the Revenue Service by March 31, 2014. Some of the savings for the government will be in the

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form of reduced staff, storage and administration costs, while the benefits to traders will be in the form of reduced time required for completing customs documentation, reduced handling and storage costs, and greater transparency and access to information.

Result: The expected result of these policy actions is to increase the customs violation detections based on the risk based management system by 100 percent by December 2014. This reform was supported by the second operation in this DPO series and the customs violation detection increased by 113 percent in December 2012 from December 2011.

Prior Action 3: The Georgian National Energy and Water Supply Regulatory Commission (Electricity Regulatory Authority) has issued Decree No. 10 dated April 17, 2014 adopting the new transmission grid code. The Law on Electricity and Natural Gas No. 816 dated June 27, 1997 was amended through Parliament Resolution No. 1902-RS dated December 27, 2013 and the Minister of Energy has amended the Market Rules through Order No. 6 dated January 31, 2014 to enable the adoption of the grid code by the Electricity Regulatory Authority.

33. The strategic objectives of the government in the power sector include provision of reliable domestic energy supply and greater participation in regional hydropower trade. Georgia has large hydropower resources which it can exploit to achieve both the objectives. It also has a strategic location between oil rich Azerbaijan and a large electricity market in Turkey. The government has already amended the Electricity Market Rules to prioritize the access of new hydropower and renewable energy projects to the transmission grid. The government has also signed the Cross-Border Electricity Trading Agreement with Turkey, which is an initial step towards regional power trade. In collaboration with the United States Agency for International Development (USAID), the government is drafting the law on renewables while technical assistance is also being provided on other aspects of the legislative framework like the law on electricity and gas.

34. To ensure power system reliability, the Electricity Regulatory Authority approved the new transmission grid code. The technical document detailing the grid code was fully harmonized with EU requirements. The development of the grid code is part of the government’s commitment to a broader set of sector reforms within the Georgia Electricity Market Model (GEMM) 2015. The grid code was approved by the electricity regulatory authority on April 17, 2014.

Prior Action 4: The Minister of Education and Science has issued Order No. 180 dated May 2, 2013, Order No. 960 dated December 3, 2013 and Order No. 220 dated March 4, 2014 for establishing a framework for the monitoring of the implementation of the new national curriculum for primary, basic and secondary education.

35. The government’s new socio-economic development strategy emphasizes high quality of education to improve human capital. Strategic priorities include increasing labor market relevance of educational programs to meet workforce requirements, increasing access to preschool education, improving quality of general education, emphasizing vocational training, and enhancing the attractiveness of the teaching profession. The Government of Georgia has

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already made several improvements in the education system, especially in the areas of finance and governance of educational institutions. This led to the elimination of corruption in the university entrance examinations and increased transparency through the introduction of a per student financing system in general education and student grants in higher education. To enhance quality, the government developed a new national curriculum framework and launched teacher certification examinations. In addition, investments were made to reconstruct and rehabilitate schools and equip them with computers and modern laboratory facilities. As a result of all these efforts, learning outcomes in Georgia showed a modest improvement as measured by the 2011 performance of fourth grade students in PIRLS and TIMSS. However, performance of Georgian students in international assessments remained below the Organization for Economic Co-operation and Development (OECD) and regional averages.

36. The quality and relevance of general education needs to be strengthened further to support competitiveness and growth. The government has taken a few steps in this direction. For monitoring education quality, Georgia implements national sample-based assessments and participates in international student assessments. Also, the new curriculum for Grades 1 to VI was implemented in September 2011 and for Grades VII to XII in September 2012. Curriculum based trainings were provided to teachers and implementation support mechanisms were put in place including a hotline for curriculum questions at the Ministry of Education and Science.

37. There is now a need to monitor curriculum implementation to further strengthen its quality. Towards this, the Ministry of Education and Science (MOES) approved the program for implementation and monitoring of the national curriculum for primary and secondary education by Decree No. 180 (dated May 2, 2013) Decree No. 960 (dated December 3, 2013) and Decree No. 220 (dated March 4, 2014). Under the provisions of these decrees, the Curriculum Department at the Ministry of Education and Science developed a monitoring framework to assess the quality of the new curriculum implementation at the school level. The monitoring process will focus on primary, basic and secondary education, and will include classroom observations, teacher interviews, and study of classroom assessment documents in different grades in all the subjects. The first phase of the assessment started in end September 2013 for primary public schools in Tbilisi and the report was finalized in February 2014. The report indicated improvements in the learning environment and structure of the teaching and learning process. The teachers have indicated the lack of modern teaching infrastructure, science labs and supplementary teaching materials as one of the key implementation constraints. They also indicated difficulties in teaching social and communication related skills.

Prior Action 5: The Minister of Education and Science has issued Order No. 39/N dated March 28, 2014 adopting professional standards for teachers which gives professional characteristics, knowledge and skill requirements pertaining to the teaching environment, teaching/learning process, and professional development for each category of teachers.

38. Low remuneration and inadequate opportunities for career development has led to poor teacher quality. This is essentially a fallout from the low education budget that amounted to 2.6 percent of GDP in 2013 compared with an ECA average of 4 percent. Within the small budget, most of the resources are used to pay salaries limiting spending for other enhancements in the education sector. Despite recent pay revisions, the most recent in January 2013, average

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wages in the education sector are only 33 percent of those in the public administration, negatively impacting the quality of teachers, 85 percent of which are females.

39. The government has taken some steps to improve the quality of teachers through certification examinations and a new compensation scheme. In July 2011, the government expanded the teacher certification program to include all subjects. By end-2013, about 20 percent of the teachers were certified. However, this certification process only measures teachers’ knowledge but not classroom teaching techniques. In addition, most teacher training programs were geared to ensure success in the certification examinations. As per the new compensation scheme, teacher salaries are now based on education and qualification, teaching experience, and hours taught per week. There are additional payments for school masters and directors, certified teachers and for higher work-load.

40. This operation supports further improvements in teacher quality through the adoption of professional standards which outline professional requirements for different categories of teachers. The new standards will be organized around four main areas for each of the four categories of teachers: (i) professional skills, (ii) teaching environment, (iii) managing the teaching process and (iv) professional development. These standards clearly define minimum requirements for starting teachers and the requirements to advance to the next category or level in the hierarchy. This is a significant departure from the earlier standards which focused more on the factual knowledge of subject matter and was less oriented towards developing and measuring pedagogical and methodological skills to improve teacher and student performance. These standards will also help raise awareness among teachers regarding formative assessment techniques to improve student learning.

Prior Action 6: The Minister of Education and Science has issued Order nos. 162, 163, and 164 dated February 6, 2014 for the implementation of the new quality assessment system for the evaluation of school principals which certified 981 candidates.

41. The government has implemented the quality assessment system for school principals in accordance with the new standards and criteria for school principals. The assessment system includes a test followed by an interview administered by the Ministry of Education and Science. The assessment process for the first cohort of school principals under the new system started in July 2013 and was concluded in February 2014, approving 981 candidates who were certified from a total of 3107 applicants. These certificates are valid for the next 7 years.

Result: The expected result of these policy actions is to increase the percent of primary education teachers who are aware of formative assessment techniques to improve student learning from 33 percent in 2011 to 40 percent by 2014.

Pillar II: Improve the coverage and transparency of the budget.

42. Improvements in public financial management are crucial in Georgia to ensure expenditure effectiveness and aid the process of fiscal consolidation. Progress has been made in the areas of program based budgeting and adoption of budgetary and financial management

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systems. Program based budgeting was used for the 2012 and 2013 State Budgets which were adopted by the Parliament and the integrated budget management system is largely functional. However, significant challenges remain on accounting standards, coverage of financial reporting and the e-budget system. Technical assistance in these areas was provided under the Public Sector Financial Management Reform Project (PSFMR) which was funded by the Bank and other development partners and ended in March 2012. The current operation supports further improvements in these areas.

Prior Action 7: The Ministry of Finance of Georgia has consolidated financial reports of all central government budgetary organizations prepared in accordance with the modified cash-basis International Public Sector Accounting Standards.

43. The adoption of the modified cash basis International Public Sector Accounting Standards will help strengthen the accounting standards used to report the government’s fiscal accounts. The process of adoption of the modified cash basis IPSAS started in 2009 with the issuance of a ministerial decree endorsing the IPSAS implementation plan. This was followed by the establishment of the Board of Standards of Accounting for the Public Sector of Georgia in 2010 and IPSAS training in 2011. All the training material and the IPSAS have been translated into Georgian and have been cleared by the International Federation of Accountants (IFAC). In addition, the IPSAS has been uploaded on the dedicated treasury website. The modified cash-basis IPSAS was initially piloted in eight budgetary organizations and in June 2013, the government produced a cash statement and report aligned with the international standards.

44. The current operation supports the adoption of modified cash-basis IPSAS, in accordance with IPSAS2, in all the central government budgetary organizations. All line ministries submitted their financial statements by May 1, 2013. These statements were brought together and a consolidated financial statement was prepared on the modified cash-basis IPSAS by the end of June 2013. The balance sheet which was prepared along with the consolidated financial statement included the domestic and external liabilities of the government, including on-lent external loans. However, on the asset side the picture was incomplete, though consistent with IPSAS2. The financial statement is publicly available through the website of the Ministry of Finance. The government’s treasury department has requested assistance from the World Bank to identify the main asset classes which have been classified into three categories: (i) unidentified assets like land, forests and infrastructure, (ii) assets which need to be evaluated since no cost estimate is available, and (iii) assets whose valuation needs to be redone because the existing estimates are outdated. This is expected to be a fairly long-term exercise since the majority of assets are unidentified.

Prior Action 8: The 2013 budget performance of all central government LEPLs is available through the e-budget and the Minister of Finance of Georgia issued Order No. 77 dated March 14, 2014 and Order No. 442 dated December 31, 2013 requiring all central government LEPLs to submit budget performance numbers for 2014 either through the e-budget or through hard copies and only through the e-budget from 2015 onwards.

45. The coverage of the budget is being expanded to include Legal Entities of Public Law while transparency is being enhanced through wider coverage in the e-budget system.

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Legal Entities of Public Law (LEPLs) are entities created under various ministries to provide specific public services for which they can charge service fees which they are allowed to retain for their needs and for this part of the revenues their operations are not integrated with the budget. Such revenues accounted for 10 percent of the 2012 State Budget. Since 2012, the financial flows of 141 LEPLs were included in the state budget execution reports as a separate chapter. Efforts are now underway to further integrate LEPLs with the budget and enhance transparency by integrating the financial transactions of LEPLs with the electronic budget system. This will facilitate improved monitoring of LEPL expenditures.

46. The current operation supports the inclusion of budget performance of all central government LEPLs in the e-budget. The 2013 budget performance reports of all central government LEPLs is available through the e-budget. The concerned staff in LEPLs has now been trained to make submissions in accordance with the requirements of the e-budget. During 2014, the LEPLs will have the option to submit budget performance numbers either through the e-budget or through hard copies. However, from 2015 onwards, all submissions will happen only through the e-budget.

Result: The expected result of these policy actions is to improve Georgia’s score on the Public Expenditure and Financial Accountability (PEFA) indicator (PI-25) to C+ by 2014. This indicator measures the quality and timeliness of annual financial statements. Georgia has achieved its end of the program target in the 2012 PEFA assessment. The improved score reflects the requirements of PEFA guidelines pertaining to the annual preparation of a consolidated government statement, external audit of the financial statements within 15 months of the end of the fiscal year and presentation of the statements in a consistent format with some disclosure of accounting standards.

Pillar III: Improve the accessibility to and quality of healthcare services and efficiency of targeted social programs.

47. The new government prioritized universal healthcare, increased age-based and special pensions, and enhanced cash assistance to families in need. This was done because Georgia has one of the highest rates out-of-pocket expenditures on healthcare and these expenses are impoverishing for the relatively poorer households. In addition, there is also a need to improve coverage and access of the very poor to social benefits and services. To support the new and enhanced initiatives, the Ministry of Labor, Health and Social Affairs (MOLHSA) increased expenditures by 24 percent in 2013 compared with the previous year. The current operation supports improvements in the efficiency of social expenditures and quality of healthcare services.

Prior Action 9: The Minister of Labor, Health and Social Affairs issued Order No. 01-25/n dated June 19, 2013 for implementation of upgraded standards for facilities providing primary health care.

48. While progress has been made on UHC and wider inclusion of people in the state health programs, significant challenges remain in the quality of healthcare. In September 2012, pensioners, children (below six years), persons with disabilities and students were included

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in the state health programs. UHC was introduced in March 2013 and initially covered only out-patient and emergency healthcare services. Thereafter, in July 2013, UHC was expanded to include a broader package of services such as elective surgery, oncology, and delivery. However, challenges remain and further strengthening of the quality of healthcare is needed, especially in primary healthcare, laboratory services and overall organization of services at different levels. The first operation in this series supported upgraded standards for hospitals through the issuance of permits.

49. The current operation supports the government’s efforts to further improve health standards in all facilities providing primary health care. In June 2013, the government implemented quality standards for all facilities providing primary healthcare. These standards pertain to those for infrastructure, equipment and provision of relevant services. In addition, the government also mandated the inclusion of dental care to the list of services available in primary health care facilities providing high-risk interventions. The process of upgrading standards for hospitals continued with the introduction of new standards related to control of infectious diseases and patient safety in hospitals. The State Regulation Agency for Medical Activities is responsible for ensuring adherence to health standards by hospitals and facilities providing primary health care. Adherence is ensured through random checks and self-reporting by hospitals and primary health care facilities.

Result: The expected result of these policy actions is to increase the percentage of hospitals, outpatient facilities and laboratories submitting detailed reports on compliance with upgraded standards from zero in 2011 to 65 percent by the end of 2014. In addition, the percent of population covered by publicly funded health programs is expected to increase to 90 percent by 2014 from 19 percent in 2011. As of April 2014, nearly 85 percent of the population was covered by publicly funded health programs.

Prior Action 10: The Ministry of Labor, Health and Social Affairs has adopted the pension module of the Social Information Management System throughout the country.

50. There is a need to improve the access and targeting of social assistance. The targeting effectiveness of social programs (targeted social assistance, TSA, and medical insurance plan, MIP) in Georgia is better compared with peers. However, there is a need to improve benefits administration further so as to ensure that the non-poor do not receive assistance as this will release resources to help the poor. As of June 2013, 45 percent of households were registered as socially unprotected families but only one quarter of them received social assistance cash benefit. In addition, nearly half of the poorest households still do not receive TSA. Also, the time taken between submission of applications and receipt of benefits is long and imposes costs on the poor. This operation supports improvements in some of these areas though there are other issues which will need to be addressed to improve efficiency and coverage of social assistance programs.

51. The Social Information Management System will help improve targeting effectiveness of social assistance and enable beneficiaries to access benefits faster. The social information management system (SIMS) will ensure that adequate fiduciary standards are maintained and institutional capacity is not overstretched. It will also be able to exchange information with other government information, such as revenues and property databases and

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hence will help quicken verification of data provided by applicants on their socio-economic status. The SIMS consists of 3 pillars with various sub-components: (i) pensions, (ii) child protection and guardianship, and (iii) targeted social assistance. The government has trained the relevant staff and implemented the pension module throughout the country. The other two modules will be completed in due course of time.

Result: The expected result of these policy actions is to reduce the time taken for issuing benefits after assessing eligibility for state pensions from 10 days in 2011 to 3 days in 2014. The government took 5 days to issue benefits under state pensions in December 2013.

52. The policy actions in the 2012-14 DPO series in Georgia are underpinned by substantive analytical work. Details are presented in the table below.

Table 5: DPO Prior Actions and Analytical Underpinnings

Prior Actions Analytical Underpinnings Progress

Pillar I Pillar I (Prior actions 1-6) Georgia CEM (2011) called for trade

facilitation, investment in infrastructure, efforts to help build better skills, and increased reliability of power supply.

Prior action 1: The Government of Georgia has issued the relevant decrees to support implementation of the law on competition and the law on food safety.

Sources of Growth Study (2012) suggested improvements in market access for exporters.

Fulfilled.

Prior action 2: The Revenues Service has adopted the Trade Facilitation System to integrate processes and simplify transactions for handling containers in sea ports.

Georgia Diagnostics and Needs Assessment of the Revenue Administration (2010) suggested continued strengthening of customs efficiency to reduce the time taken to process transactions to reduce overall costs of trading. Sources of Growth Study (2012) recommended strengthening the logistics chain and improving customs efficiency.

Fulfilled.

Prior action 3: The Electricity Regulatory Authority has approved the transmission grid code to improve power system reliability.

Regional Report on Electricity Markets (2012) recommended strengthening market institutions in the power sector to support regional trade and facilitate future investments.

Fulfilled.

Prior action 4: The Ministry of Education and Science has adopted a framework for monitoring the implementation of the new national curriculum for primary, basic and secondary education.

South Caucasus Skills Study (2012) recommended modernization of the education system to address skills mismatch and to better prepare the work force for positioning in the job market. Georgia Demographic Change: Implications for Social programs and Poverty (2012) recommended strengthening of skills formation, especially in formative years.

Fulfilled.

Prior action 5: The Ministry of Education and Science has adopted professional standards for teachers which gives professional characteristics, knowledge and skill requirements for different categories of teachers.

Fulfilled.

Prior action 6: The Ministry of Education and Science has implemented the new quality

Fulfilled.

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Prior Actions Analytical Underpinnings Progress

assessment system for the evaluation of school principals which certified 981 candidates.

Pillar II Prior action 7: The Ministry of Finance of Georgia has consolidated financial reports of all central government budgetary organizations prepared in accordance with the modified cash-basis International Public Sector Accounting Standards.

Public Expenditure Review (2012) suggested an improvement in the quality of public spending in the context of fiscal consolidation. Georgia PEFA Assessment (2008) recommended improvements in the availability of systematic information on service delivery units including LEPLs. It also suggested that reporting should be carried out either through the accounting system or by routine data collection.

Fulfilled.

Prior action 8: The Ministry of Finance of Georgia has included the budgets of all central government LEPLs in the e-budget.

Fulfilled.

Pillar III Prior action 9: The Ministry of Labor, Health, and Social Affairs has implemented upgraded standards for facilities providing primary care.

Georgia Demographic Change: Implications for Social programs and Poverty (2012) recommended improvements in the coverage of social safety nets and the need to ensure wider access to health care services. Public Expenditure Review (2012) recommended higher coverage under the medical insurance plan and improvements in the quality of health care provided.

Fulfilled.

Prior action 10: The Ministry of Labor, Health and Social Affairs has adopted the pension module of the Social Information Management System throughout the country.

Fulfilled.

C. LINK TO CPS AND OTHER BANK OPERATIONS

53. The current DPO series is an essential part of the CPS for 2010-2013 and also provides the link to the new CPS for 2014-17. The 2010-13 CPS was built on two pillars: (i) meeting post-conflict and vulnerability needs; and (ii) strengthening competitiveness for post-crisis recovery and growth. As the economy recovered from the 2008-09 crisis, the government moved to a more medium-term agenda and refocused its efforts on competitiveness. As a result, the CPS Progress Report (2011) proposed a greater emphasis on the second pillar. The CPS 2010-13 remains fully consistent with the government’s reform program in Basic Data and Directions (2014-17). Though the 2012-14 DPO series forms less than a fourth of the overall Bank portfolio in Georgia, its criticality is underpinned by the fact that it helps leverage budget assistance from other development partners like the EU. This operation is also fully consistent with the new CPS which focuses on: (i) strengthening public service delivery to promote inclusive growth, and (ii) enabling private sector-led job creation through improved competitiveness. The second and third pillar of this DPO supports the first area of focus of the new CPS while the first pillar of this operation supports the second area of focus of the new CPS.

54. The proposed DPO builds on previous Bank operations and complements existing operations by supporting improvements in key sectors. The policy dialogue underlying the proposed operation was greatly facilitated by the previous DPO series, the 2005-08 Poverty Reduction Support Credits and the Public Sector Financial Management Reform Support project.

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The current portfolio of Bank investment projects in Georgia is split between transport (68 percent) and urban development (32 percent). IFC’s investments are largely in the areas of airport infrastructure, hydro power, real estate, banks, agriculture, and micro-finance. It is also providing advisory services on taxation, customs and investment legislation.

D. CONSULTATIONS, COLLABORATION WITH DEVELOPMENT PARTNERS

55. The government has undertaken broad-based consultations with all relevant stakeholders on many of the prior actions supported by this operation. On the framework law on competition, several rounds of consultations were held with the business community and the government also consulted with the donors and other stakeholders. Similar consultations were held on the prior actions in the education sector wherein all relevant stakeholders were a part of the finalization of professional standards for teachers and the establishment of the framework for monitoring curriculum implementation. On the trade facilitation system, the government not only consulted with the stakeholders but also provided training on the new system. In addition, the Bank team has met with civil society organizations (CSOs) and has continued this engagement through sectoral work, especially in the areas of education, environmental sustainability and social protection. The World Bank also organized a series of consultations (November 2013 – March 2014) to seek views on its Country Partnership Strategy (CPS) for Georgia for 2014-17. The consultations were held with representatives of civil society, think-tanks, private sector, donor organizations and government officials at all levels. The proposed DPO and its follow-up series were included in the draft CPS and audiences were invited to discuss this operation as well as other proposed operations in the CPS program.

56. The Bank has active collaboration with USAID and the EU on their programs. USAID is providing technical assistance on trade facilitation which complements reforms under the current DPO series. The EU is providing both financing and technical assistance on trade and trade facilitation related measures in the context of the DCFTA and on public financial management, with particular emphasis on program budgeting. The Bank has coordinated closely with USAID and the EBRD in supporting the government’s power sector strategy. In addition, the Asian Development Bank has also lent to the Government of Georgia to improve regional power transmission.

5. OTHER DESIGN AND APPRAISAL ISSUES

A. POVERTY AND SOCIAL IMPACT

57. Georgia’s unemployment remained stubbornly high at 15 percent in 2012 and new hiring in the formal business sector declined further in 2013. An educational curriculum which is out of sync with private sector needs also adds to the problem. The pre-crisis growth-episode in Georgia was led by the private sector. After the crisis, the government stepped in with increased transfers and public investments. While the former did not create jobs, the latter led to a construction led growth which benefited the poor proportionately more, adding to their earnings. With a growth slowdown in 2013, the number of business sector employees declined by 3 percent. The decline in employment in the construction sector was more drastic at 25 percent and will have significant implications for the poor. The disparity between rural and urban unemployment rates continued, with urban unemployment at 26.2 percent in 2012 and

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rural unemployment at 7 percent. The big difference can be explained by the fact that most of the rural population is self-employed in agriculture and therefore do not count as ‘unemployed’. This labor market status has underpinned the poverty and inequality dynamics in the country.

58. The probability of being poor or among the bottom 40 percent is strongly associated with labor market status, gender and limited access to economic opportunities. The poor and those in the bottom 40 percent are more likely to live: (i) in larger households with greater number of dependents, and headed by someone with less than secondary education and/or a woman; (ii) in households suffering larger unemployment and inactivity rates, and headed by a self-employed individual; and (iii) in rural areas. Furthermore, Georgia has one of the highest incidences of Internally Displaced People (IDPs) in the world (estimated at 5.6 percent of the population). IDPs are dependent on subsistence agriculture and on social assistance, with limited recourse to adequate housing, sustainable livelihoods and jobs. Rates of employment and economic self-reliance are low among IDPs and they account for a disproportionate amount of the poor.8 More than 17 percent of IDPs are unable to afford nutrition or suffer from systematic starvation while only 48 percent claim average or above average nutrition levels.

59. The overall poverty, social, and gender impacts of the policy measures supported by the DPO are largely expected to be positive. The policy measures supported under Pillar I are expected to have positive distributional impacts. In the case of the first prior action (related to implementation of DCFTA), simulations suggest that in the medium term, improvements in the living standards will occur for everyone, with relatively larger impact at the upper end of the distribution.9 Improved coverage and targeting of social programs in general, and actions under Pillar III specifically, will be needed to efficiently respond to any adverse social and distributional impacts of reforms. In addition, the rollout of the pension pillar under SIMS can enhance poverty reduction since pensions cover a large share of the population and have a strong poverty reducing impact. Table 6 summarizes the expected poverty, social, and gender impacts. While some measures have no direct gender impacts, reforms to the teacher performance appraisal system will positively affect women given that more than 80 percent of teachers are female. Enhanced standards of health services delivery also have the potential to benefit women via improved reproductive care services. In addition to gender equality, education reforms are expected to be beneficial from the point of view of shared prosperity. In 2012, 85 percent of those in the bottom 40 had secondary education or less. This same group also faces higher unemployment rates and greater rates of rural self-employment. Good quality education in public schools can therefore potentially have a large impact on shared prosperity. The prior actions in Pillar II improve the overall functioning of the public sector and are expected to be distributionally neutral.

8 World Bank, 2013, “Supporting the Livelihoods of Displaced Persons in Georgia.” 9 ECORYS-CASE, 2012, Trade Sustainability Impact Assessment in support of negotiations of a DCFTA between the EU and Georgia and the Republic of Moldova, Final Report.

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Table 6: Summary of Poverty, Social, and Gender Impacts DPO 3 Program Expected Distributional, Social, and Gender Impacts

of Reform

Pillar I Prior action 1: The Government of Georgia has issued the relevant decrees to support implementation of the law on competition and the law on food safety.

Positive impact on net incomes of all with relatively smaller impacts on the lower end of the distribution. Although overall prices will decline under the DCFTA, an initial increase in food prices is predicted. This increase in food prices is expected to adversely affect those at the bottom end of the distribution for whom net food purchase accounts for a significant share of household expenditures. The overall impact of the DCFTA will be a combination of the price effect described above and the predicted rise in wage earnings for all income groups coming either from greater employment or higher relative wages. The impact of the DCFTA is thus expected to boost average net incomes for all with the gain being smaller for those at the lower end of the distribution due to the price effect.

Prior action 2: The Revenues Service has adopted the Trade Facilitation System to integrate processes and simplify transactions for handling containers in sea ports.

Distributionally neutral.

Prior action 3: The Electricity Regulatory Authority has approved the transmission grid code to improve power system reliability.

Distributionally neutral as access to electricity is nearly universal.

Prior action 4: The Ministry of Education and Science has adopted a framework for monitoring the assessment of the implementation of the new national curriculum for primary, basic and secondary education.

Positive distributional impacts via potential improvements in educational outcomes of children.

Prior action 5: The Ministry of Education and Science has adopted professional standards for teachers which gives professional characteristics, knowledge and skill requirements for different categories of teachers.

Positive distributional impacts via potential improvements in educational outcomes.

Prior action 6: The Ministry of Education and Science has implemented the new quality assessment system for the evaluation of school principals which certified 981 candidates.

Positive distributional impacts if there are gains in student test scores. Positive impacts on gender equality in the labor market are also expected because teaching is a popular occupation for educated women in Georgia but teacher salaries are low. To the extent that this low wage for teachers arises from perception of low productivity workers joining this occupation, introduction of quality standards is expected to raise wages for existing teachers.

Pillar II Prior action 7: The Ministry of Finance of Georgia has consolidated financial reports of all central government budgetary organizations prepared in accordance with the modified cash-basis International Public Sector Accounting Standards.

Distributionally neutral.

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DPO 3 Program Expected Distributional, Social, and Gender Impacts of Reform

Prior action 8: The Ministry of Finance of Georgia has included the budgets of all central government LEPLs in the e-budget.

Distributionally neutral.

Pillar III Prior action 9: The Ministry of Labor, Health, and Social Affairs has implemented upgraded standards for facilities providing primary care.

Positive distributional and gender impacts. Potential benefit to all users, in particular, women accessing reproductive health care. While most women have a usual place for preventive and curative care, they seek care from very different sources. The less well-off women are more likely to use raion or city hospitals while better off women use women’s consultation clinics and primary health centers. In addition, quality of care also varies. Implementing and monitoring of health standards has the potential to remove these socioeconomic differences in quality of critical preventive care.

Prior action 10: The Ministry of Labor, Health and Social Affairs has adopted the pension module of the Social Information Management System throughout the country.

Possible enhancement to the poverty reducing impact of pensions. Not only do pension transfers cover a large share of the population across the income distribution, but they also have strong poverty reducing impact. In 2011 an estimated 56 percent of the Georgian population and 60 percent of the less well-off lived in a household that received old-age pensions. Thus improved efficiency of pension transfers will further contribute to alleviating poverty.

B. ENVIRONMENTAL ASPECTS

60. Most of the policy reforms under this operation are neutral to the environment with the exception of the prior action supporting the implementation of the law on food safety. Operationalizing the legislative components of the DCFTA would entail adoption of the food safety law and enhancement of sanitary and phytosanitary standards in the field of agro-production. This is likely to lead to the application of cleaner and more responsible technologies of primary production and food processing. Export orientation would mean higher quality standards of produce, which is attainable through better pesticide management, well controlled application of agrochemicals and careful selection of animal feed. Environmental impacts of such improvements are likely to be positive as they are expected to lead to decrease in environmental pollution from poor quality and/or extensively used inputs. However, more stringent requirements in the quality of post-harvest treatment, storage of agricultural products, safety of sawing material, and health and sanitary conditions in animal farms may lead to increased application of disinfectants and antibiotics that may be potentially harmful for the environment. Therefore, the by-laws and regulations supporting the food safety law should carry provisions for mitigating the above-mentioned risk.

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C. PFM, DISBURSEMENT AND AUDITING ASPECTS

61. The public financial management risks in Georgia are acceptable for this operation. The 2012 PEFA showed significant improvements in the country’s budgetary and financial management systems compared with the 2008 PEFA. The basic set of systems for strategic budget planning, budget formulation and execution has been put in place. The integrated public financial management system is in an advanced stage of implementation with functional modules in several key areas. Significant progress has been made in the area of program budgeting with assistance from the EU. The previous DPO series supported program budgeting and improvements in the public investment program. The current DPO series is supporting the government’s efforts at moving to modified cash basis IPSAS and increased coverage and transparency of the budget with an emphasis on the e-budget. The 2012 consolidated financial statements prepared by the Treasury are in line with modified cash basis IPSAS has been published on the Treasury’s website. All extra-budgetary funds have been closed state financial transactions have been unified under a single treasury account. Government budgets are published on the Ministry of Finance’s (MOF) website.

62. The Competition and State Procurement Agency continues to improve transparency in public procurement processes by adopting international standards. The Law on State Procurement was enacted in 2009 and provides a good legal framework for second generation reforms, including introduction of e-procurement. The unified e-procurement system was launched in 2010 and a user manual was developed to ensure effective functioning. All documents needed in the process of public procurement are uploaded into the system electronically which makes them accessible to all interested parties. The current system has reduced the volume of paperwork and has increased transparency. As a result, in February 2012, the Bank agreed to use the government’s e-procurement system for procurement of goods under Bank financed projects which are valued at less than US$100,000. The Bank is working with the Competition and State Procurement Agency to further modify the e-procurement system so that it can be used for more complex procurement methods.

63. As per the August 2013 Article IV review of the IMF, the NBG’s foreign exchange management system and safeguards are adequate. The September 2011 safeguard assessment showed that NBG complies with International Financial Reporting Standards and is externally audited by an international firm. The de facto exchange rate arrangement in Georgia has been reclassified as a stabilized arrangement against the US dollar since April 2013. However, the de jure exchange rate arrangement is floating. The NBG remains committed to improving the functioning of the foreign exchange market and enhancing exchange rate flexibility. The March 2013 amendment to the 2010 agreement between the NBG and Treasury Service of the Ministry of Finance ensures that foreign exchange transactions between the government and the NBG are priced at the market exchange rate of the day when the foreign exchange order is submitted to the NBG.

64. Borrower and credit amount: The Borrower will be Georgia. Upon effectiveness of the Financing Agreement, which is subject to ratification by Parliament, the proposed IBRD loan of US$70 million and the two IDA credits of US$12.1 million and US$10.6 million will be made to Georgia, represented by the Ministry of Finance. The IBRD loan will have a maturity of 25 years including a 10-year grace period.

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65. Disbursement: The proposed DPO will be disbursed in US dollars into the Treasury department’s foreign currency account maintained at the NBG. The disbursed proceeds of this development policy operation will form part of the country’s official foreign reserves. The recipient, The Government of Georgia, shall ensure that upon deposit of the loan proceeds into the said account, an equivalent amount in GEL at the official exchange rate will be deposited within 30 days of disbursement in the Treasury Single Account in the NBG and accounted for in the Recipient’s budget management system. The proceeds of the operation deposited at the Treasury Single Account with NBG will be available to finance budget expenditures. The foreign exchange proceeds of the proposed third DPO will be sold by the NBG or held in reserves, in accordance with the objectives of monetary policy. The Ministry of Finance will be responsible for the operation’s administration, for preparing the withdrawal application, and for maintaining the Treasury Foreign Currency Account at the NBG. The Ministry, with the assistance of the NBG, will maintain records of all transactions under DPO3 in accordance with sound accounting practices.

66. Confirmation and eligible expenditure: The Ministry of Finance will provide to the Bank a confirmation that the amount of the operation has been credited to an account that is available to finance budget expenditures (the format of the confirmation letter should be acceptable to the Bank). This confirmation letter is required within 30 days of receipt of the amount. If, after the proceeds are deposited in the NBG account, the proceeds of the operation are used for ineligible purposes as defined in the Loan Agreement and the Financing Agreement, the Bank will require the Government of Georgia to promptly, upon notice from the Bank, refund an amount equal to the amount of said payment to the Bank. Amounts refunded to the Bank upon such request shall be cancelled.

67. Reporting, auditing and closing date: Given the improvements in Georgia’s public financial management system and IMF’s positive assessment of the NBG, no additional fiduciary arrangements including audit will be required for the proposed DPO. Audits of the earlier Poverty Reduction and Support Operations were also unqualified and revealed no issues of concern. There were also no audit requirements under the previous DPO series. The closing date of the proposed credit will be March 31, 2015.

D. MONITORING AND EVALUATION

68. The Ministry of Finance leads the effort in coordinating the overall implementation of the DPO program. The Deputy Minister of Finance is the main counterpart for this operation and he coordinates with all the line ministries which are involved in the DPO series. The line ministries submit progress reports on the prior actions and result indicators to the Ministry of Finance as and when requested. Given the long history of budget lending operations in Georgia, some institutional capacity and memory has been built up on data requirements for monitoring. While there are some variations between line ministries, in general, they have the capacity to provide good and timely data when needed.

69. Regular reviews are carried out by the Bank team to monitor progress on the reforms during supervision missions. Data for monitoring is generally available through special requests made to the respective ministries and is reliable. Macroeconomic data is available through the statistical agency. Georgia subscribed to the IMF’s Special Data Dissemination Standards (SDSS) in 2010 and is a compliant country. As a result, timely and

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good quality data is readily available through the National Bank of Georgia, Ministry of Finance, and the National Statistics Office.

6. SUMMARY OF RISKS AND MITIGATION

70. The main risks to the operation and mitigating measures are summarized below.

(i) Political and governance risks

• The risk exists that the policy uncertainty that characterized much of 2013 returns and weakens program sustainability. This risk is mitigated by the stabilization in the political context since the Presidential elections in October 2013 and the demonstrated commitment by the new government to the reforms under the ongoing DPO series. Despite changes in key political posts, the ruling coalition has strengthened its position both in the Parliament and at the local self-government level. The Bank team is in constant dialog with the authorities to ensure that the reform measures supported by this operation are sustained.

(ii) Macroeconomic risks

• High unemployment, fiscal pressures and external vulnerability are the main risks to the economy. Low net job creation even during high-growth periods led to high and sustained unemployment levels in the country which in turn have a negative impact on poverty and shared prosperity. Fiscal risks could emanate from further increasing the scope of public health services and ineffective use of the increased budget allocation to social benefits. This could impact program performance in terms of the population effectively covered by publicly funded health and social sector programs. Mitigating factors include continuous dialog with and technical assistance from the World Bank in the health and social assistance sector. The government’s commitment to efficient public financial management and fiscal consolidation over the medium-term while maintaining capital expenditures, and adherence to Georgia 2020, which focuses on increasing competitiveness, human capital development and access to finance, will help address medium- to long-term growth and employment concerns. This in turn will ensure that Georgia reaps the benefits from the DCFTA. On the external front, the country continues to be vulnerable given its high current account deficit and large external debt, heightening foreign exchange risks. In addition, disturbances in some of its key export markets could affect external performance. Manifestations of external disturbances could take the form of lower FDI, exports, remittances and other capital inflows and could impact overall macroeconomic stability, a pre-condition for program performance. Mitigating factors include a flexible exchange rate policy, comfortable foreign exchange reserves, market access and good relationships with donors who could ramp up their programs if needed.

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(iii) Operational design, implementation and sustainability

• Weak implementation capacity, especially in the line ministries, could undermine the benefits of the reforms. Implementation of this DPO series spans several ministries and capacity is limited in some of them. This has been mitigated through technical assistance provided by the World Bank and other development partners. Donor supported programs are providing assistance in key policy areas covered by this DPO series like the power sector (World Bank, USAID, and EBRD), social protection (World Bank), education (World Bank) and trade facilitation (EU).

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Annex 1: Policy and Results Matrix

Prior Actions and Actions Fulfilled Results

Actions fulfilled under DPO 1 Actions fulfilled under DPO 2 Prior Actions for DPO 3

Pillar I: Strengthen legislation to promote market access to the EU and improve customs efficiency, power sector reliability and the quality of general education.

• Georgia has enacted laws adopting trade-related reforms which include the framework Laws No. 6155-Is on food/feed safety, veterinary and plant protection; No. 6148-Is on free trade and competition; and No. 6157-Is on general product safety and liability dated May 8, 2012, needed to meet the requirements of the DCFTA with the European Union.

• The Government of Georgia has issued: (a) Governmental Decrees No. 317 and 318 dated July 31, 2012, and No. 488 dated December 28, 2012; (b) Orders of the Minister of Economy and Sustainable Development No. 1-1/1527 dated July 23, 2012; and No. 1-1/1740 dated September 10, 2012; (c) Order of the Director General of the Georgian National Agency for Standards and Metrology No. 2 dated January 10, 2013, for the implementation of the law on Safety and Free Movement of Products.

• The Government of Georgia has issued Decree No. 288 dated April 14, 2014 for setting up the competition agency for the implementation of the Law on Competition No. 6148-IS dated May 8, 2012. The Government of Georgia has issued: (i) Decree No. 120 dated May 17, 2013 mandating indication of country of origin and date of production for eggs, (ii) Decree No. 198 dated July 30, 2013 defining the rules of bio-production, (iii) Law No. 1915 dated December 27, 2013 making the violation of food labeling an offense, and made budget provisions for an additional 180 staff in the National Food Agency in the 2014 budget for the implementation of the Law on Food Safety No. 6155-IS dated May 8, 2012.

Deep and Comprehensive Free Trade Agreement with the EU

• Baseline: Commencement of negotiations in 2012.

• Target: Increase in the number of European/ international standards adopted as Georgian standards by 10 percent by 2014 from 4,700 in 2011.

Number of animal vaccinations done by the National Food Agency

• Baseline: 1.2 million in 2012. • Target: 3.5 million in 2014

• The Government of Georgia issued Decree No. 357 on September 23, 2011, Decree No.426 on December 31, 2010, Decree No.366 on September 23, 2011, Decree No. 354 on September, 23 2011, Decree No. 738 on November 17, 2011, Decree No.445 on December 1, 2011, Decree No. 116 on March 11, 2011, Decree No. 120 on March 11, 2011, Decree No. 425 on December 31, 2010, and Decree No. 428 on December 31, 2010, authorizing the revenue service to issue certificates of

• The Ministry of Finance has strengthened the risks-based management of customs control by introducing the automated selectivity for transit traffic.

• The Revenue Service under the Ministry of Finance has adopted the Trade Facilitation System to integrate customs processes and simplify transactions for handling containers in sea ports.

Customs violation detections for a given number of checks based on the risk based management system.

• Baseline: 175 cases in the month of November/December 2011.

• Target: 100 percent increase in cases detected in the month of November/December 2014.

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Prior Actions and Actions Fulfilled Results

Actions fulfilled under DPO 1 Actions fulfilled under DPO 2 Prior Actions for DPO 3

origin and import, export and transit related permits at the border crossings.

• Ministry of Energy has amended Order No. 77 on Electricity (Capacity) Market Rules dated August 30, 2006 by virtue of Order No. 99 dated May 30, 2013 to prioritize new hydropower projects and renewable power production access to the grid with remaining congested transfer.

• The Georgian National Energy and Water Supply Regulatory Commission (Electricity Regulatory Authority) has issued Decree No. 10 dated April 17, 2014 adopting the new transmission grid code. The Law on Electricity and Natural Gas No. 816 dated June 27, 1997 was amended through Parliament Resolution No. 1902-RS dated December 27, 2013 and the Minister of Energy has amended the Market Rules through Order No. 6 dated January 31, 2014 to enable the adoption of the grid code by the Electricity Regulatory Authority.

• Ministry of Education and Science of Georgia has: (a) issued Decree No. 36/n dated March 11, 2011, approving a new national curriculum for Grades I through XII, effective September 15, 2011; (b) implemented the new national curriculum for Grades I through VI including the distribution of supporting materials.

• The Ministry of Education and Science of Georgia has issued Decree No. 16/n dated February 18, 2011 amending Decree No. 1101 dated December 4, 2009 expanding teachers voluntary certification examinations to include teachers for all grades and in all subjects effective July 2, 2011.

• The Government of Georgia's Ministry of Education and Science has: (a) approved a new national curriculum for Grades I through XII; and (b) implemented the new national curriculum for Grades VII through XII including the distribution of supporting materials to schools.

• The Government of Georgia's Ministry of Education and Science has amended Order No. 576 dated October 21, 2005 and issued Order No. 04/N dated January 29, 2013 approving new Teacher Salary Scale and Instructions recognizing teacher experience and performance.

• The Minister of Education and Science has issued Order No. 180 dated May 2, 2013, Order No. 960 dated December 3, 2013 and Order No. 220 dated March 4, 2014 for establishing a framework for the monitoring of the implementation of the new national curriculum for primary, basic and secondary education.

• The Minister of Education and Science has issued Order No. 39/N dated March 28, 2014 adopting professional standards for teachers which gives professional characteristics, knowledge and skill requirements pertaining to the teaching environment, teaching/learning process, and professional development for each category of teachers.

• The Minister of Education and Science has issued Order nos. 162, 163, and 164 dated February 6, 2014 for the implementation of the new

Percent of primary education teachers who are aware of formative assessment techniques to improve student learning.

• Baseline: 33 percent in 2011. • Target: 40 percent in 2014.

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Prior Actions and Actions Fulfilled Results

Actions fulfilled under DPO 1 Actions fulfilled under DPO 2 Prior Actions for DPO 3

quality assessment system for the evaluation of school principals which certified 981 candidates.

Pillar II: Improve the coverage and transparency of the budget. • The Ministry of Finance of

Georgia prepared financial reports of 8 pilot agencies in accordance with modified cash-basis accounting methods as part of the transition to adopting IPSAS.

• The Government of Georgia's Ministry of Finance has issued Order No. 97 dated April 8, 2013 adopting the rules for the preparation of financial statements by the State Budget Organizations using the modified cash-basis methods in accordance with international public sector accounting standards (IPSAS).

• The Ministry of Finance of Georgia has consolidated financial reports of all central government budgetary organizations prepared in accordance with the modified cash-basis International Public Sector Accounting Standards.

Score on PEFA indicator (PI-25) which measures the quality and timeliness of annual financial statements.

• Baseline: D+ in November 2008. • Target: improve to C+ by 2014.

• The Government of Georgia has issued Decree No. 111 dated March 23, 2012 requiring the inclusion of information pertaining to the financial flows of Legal Entities of Public Law (LEPLs) in the annual budget execution report.

• The Government of Georgia has harmonized the electronic budget management system (E-budget) with the electronic treasury system (E-treasury).

• The 2013 budget performance of all central government LEPLs is available through the e-budget and the Minister of Finance of Georgia issued Order No. 77 dated March 14, 2014 and Order No. 442 dated December 31, 2013 requiring all central government LEPLs to submit budget performance numbers for 2014 either through the e-budget or through hard copies and only through the e-budget from 2015 onwards.

Pillar III: Improve the accessibility to and quality of healthcare services and efficiency of targeted social programs.

• The Ministry of Labor, Health, and Social Affairs of Georgia has implemented the upgraded standards in all hospitals by issuing permits as of January 1, 2012 in accordance with Decree No. 385 dated December 17, 2010 to improve safety and quality of healthcare services. • The Government of Georgia has issued Decree No 165 dated May 7, 2012 expanding medical insurance plan to children below the age of six (6) and pensioners.

• The Government of Georgia issued governmental Decree No. 36 dated February 21, 2013 introducing universal health coverage for the primary and emergency care.

• The Minister of Labor, Health and Social Affairs issued Order No. 01-25/n dated June 19, 2013 for implementation of upgraded standards for facilities providing primary health care.

Percent of hospitals, outpatient facilities, and laboratories submitting detailed reports on compliance with upgraded standards.

• Baseline: None in 2011. • Target: 65 percent by 2014.

Percent of population covered by publicly funded health programs

• Baseline: 19 percent (2011). • Target: 90 percent (2014).

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Prior Actions and Actions Fulfilled Results

Actions fulfilled under DPO 1 Actions fulfilled under DPO 2 Prior Actions for DPO 3

• The Government of Georgia's Ministry of Labor, Health and Social Assistance has adopted three pilot modules in the district of Tbilisi, Rustavi and Mtskheta regions for social information management systems on: (a) state pension; (b) state compensation; and (c) state social packages.

• The Ministry of Labor, Health and Social Affairs has adopted the pension module of the Social Information Management System throughout the country.

Time taken to issue first benefits after assessing beneficiary eligibility

• Baseline: 10 days for the assignment of state pension in 2011.

• Target: 3 days for the assignment of state pension by 2014.

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Annex 2: Letter of Development Policy

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