Kosovo Country Partnership Framework FY17-21 Public Consultations October 21, 2016
Contents Country Context and Development Challenges Designing the New CPF SCD Priorities Government Agenda Lessons Learned from Previous Engagement 2
COUNTRY CONTEXT AND DEVELOPMENT CHALLENGES 3
Kosovo: Fragile post-conflict state aspiring to EU Kosovo declared independence in February 2008, after being UN protectorate since 1999. Incomplete diplomatic recognition remains a key obstacle. Kosovo is recognized as independent by 109 out of 193 UN member countries, and 23 out of 28 EU member states. Other causes of fragility: weak rule of law; lack of interethnic cohesion; traditionally close network of personal ties and loyalties dominate business relations; high youth unemployment and risks of radicalization; poor governance and accountability; challenges with including minorities and integrating returnees and IDPs; and lagging regions. Kosovo is potential candidate for EU membership. In recent years, the country has accelerated its EU integration process, including through: (i) signing the Stabilization and Association Agreement (SAA) with the EU in October 2015 which came into effect on April 1, 2016; and (ii) deepening coordination with the EC on economic policies and governance issues. 4
Growth in Kosovo has been positive and above Western Balkans average Real GDP Growth, 2008-2016 7.00 6.00 Kosovo SEE6 5.00 4.00 3.00 2.00 1.00 0.00-1.00 2008 2009 2010 2011 2012 2013 2014 2015 2016 (Est.) -2.00 Source: World Bank staff calculations based on data from national statistical offices. 5
Growth is driven mainly by consumption fueled by remittances and ODA Kosovo decomposition of real GDP growth, 2011-2016 Kosovo remittances and ODA, percent GDP, 2009-2012 8.0% 6.0% 10.5 4.0% 2.0% 0.0% -2.0% 4.4% 3.9% 3.4% 3.6% 2.8% 1.2% 2011 2012 2013 2014 2015 2016 (Est.) 17.2 2.9 9.4 3 11.2 1.9 4.1 2.3 2.2 7.6 8.4-4.0% -6.0% Consumption Investments Net exports Real GDP growth Net ODA percent of GDP (2009-12) Personal Remittances percent of GDP (2009-12) 6
Limited role of exports that remain unsophisticated and poorly diversified Export, percent of GDP 2009-13 32.9 49.6 39.1 29.6 34.3 18.4 Kosovo Albania BiH FYR Macedonia Montenegro Serbia Export Composition by Product Groups 2005 (inner circle) vs 2014 (outer circle) Mineral products 6% 15% Agriproduce 13% 13% 4% 16% Light mnfg 9% Chemicals 6% Export Composition by Country 2005 (inner circle) vs 2014 (outer circle) Western Balkans 39% 51% China & india 22% 44% Machinery 4% Other 39% 10% Base metals 52% Other European Italy 15% 7
40 FDI Performance is weak and new FDI jobs were in non-tradable sectors FDI, net inflows (% GDP) FDI, net inflows per capita (US$) 8,000 6,000 30 4,000 2,000 20 0 KSV BIH MKD ALB SVN SRB HRV MNE 2004-2009 2010-2015 10 4,000 Jobs Created by FDI Projects in Kosovo 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 3,000 2,000-10 KSV ALB BIH HRV MKD MNE SRB SVN Source: WB WDI 1,000 0 8 Source: FDI Markets
Infrastructure Bottlenecks are among the Top Constraints for Private Sector Growth.. Investment Climate Reform Agenda Is Yet To Be Completed. 60 50 Infrastructure challenges Percent of firms identifying electricity as a major constraint 200 160 120 Doing Business Rank, 2016 136 124 163 40 29 80 40 66 47 32 28 57 67 71 48 20 23 22 18 0 0 10 9 5 7 6 4 4 5 2 KSV MCD ALB BiH SRB MNE ECA Source: BEEPS 2013 and EBRD 9
. and Financial Intermediation Remains Low and Access to Finance Problematic 70 60 50 40 30 20 10 0 34 35 17 15 Domestic credit to private sector, % of GDP 2005 2015 28 44 23 51 54 55 42 41 KSV ALB SRB MKD BIH SVN HRV 52 65 100 75 50 25 Sources of financing of investment by private firms, % Internal Resources Banks Supplier Credit Stock Market Other 71 81 62 81 55 56 0 Kosovo Albania BiH Macedonia Montenegro Serbia 80 60 40 20 0 43 45 Percent of firms identifying A2F a major constraint for growth % 62 20 19 8 Small (5-19) Medium (20-99) Large (100+) 29 22 14 12 14 17 Source: WB WDI 6 7 5 8 Kosovo Macedonia BiH Serbia Albania Montenegro 4 10 300 200 100 0 299 Value of collateral needed for a loan % of the loan amount 276 255 243 Source: BEEPS 2013 190 150 Kosovo Macedonia Albania Montenegro BiH Serbia Source: BEEPS 2013 Source: BEEPS 2013
Kosovo has the potential to achieve exceptional growth performance if it utilizes its demographic dividend Population Pyramid: Kosovo vs BiH comparison Bosnia and Herzegovina 11
but it continues to face high structural unemployment, low labor force participation rates, and... 35.0 Kosovo unemployment rate, percent of LF, 2015 Activity rates as percent of population over 15 years of age, 2015 80 30.0 25.0 long term other 70 60 20.0 50 15.0 40 10.0 30 5.0 0.0 KSV BiH MKD SRB MNE ALB 20 10 Largest gender gap in Western Balkans Sources: World Bank staff calculations based on national statistical offices. Note: The regional total excludes Kosovo. 0 ALB BiH KSV MKD MNE SRB SEE6 EU28 Sources: National statistical offices and Eurostat 2015 data. Note: Kosovo data is for population aged 15-64. 12
Share of total HH income... a large reliance on non-wage income in households 100% 90% Kosovo: Income shares by source and consumption decile 2015 80% 70% 60% 50% 40% 30% 20% 10% Other Net income from own business Domestic remittances Foreign remittances Pensions Social welfare receipts Rent, dividends and interest Per diem work Wages and salaries 0% 1 2 3 4 5 6 7 8 9 10 Decile Source: HBS, Kosovo Agency of Statistics 13
Kosovo in a self-perpetuating cycle Remittances/ Aid Fuelling domestic demand Migration Large Under- employment in Agriculture and low labor force participation Narrow production base and low productivity Lack of Job Creation Inadequate human capital base Large Appeal for Public Sector Employment/ Increase in Reservation Wages Limiting business expansion/investment opportunities in tradeables Tradeables: Large imports of goods/small exports performance Non Tradables: sector expansion or price pressures Limited competitiveness /productivity 14
leading to declining productivity Wages and Productivity in Kosovo 300 250 200 150 100 50 2003Q4 2004Q4 2005Q4 2006Q4 2007Q4 2008Q4 2009Q4 2010Q4 2011Q4 2012Q4 2013Q4 2014Q4 Average Wage Public Average Wage private Average Wage GDP per worker(constant LCU) Source: Ministry of Finance data. Note 100= 2003Q4 15
Despite progress in poverty reduction, Kosovo remains one of the poorest country in Europe 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Real GDP per capita, percentage of EU average income per capita Poverty headcount in Kosovo, 2000-2013 45 40 60 Percent of population 35 50 30 40 25 20 15 30 20 10 Old series New series 0 2000 2002/03 2003/04 2004/05 2005/06 2009 2010 2011 2012 2013 ALB BIH KSV MKD MNE SRB SEE Sources: World Bank staff calculations based on national statistical offices. Note: The regional total excludes Kosovo. Source: World Bank staff analysis of Kosovo Household Budget Surveys 16
Need to rebalance growth towards higher productivity and greater competitiveness Declining marginal benefits: shrinking ODA by reduced security concerns; slowing pace of public investment by past reconstruction efforts; dynamism of the non-tradable sector aconstrained by the small internal market. Mounting social pressure: protracted low job creation, demographic pressures, and emigration. EU accession: structural transformation and heightened productivity to cope with competitive market forces and provide opportunities for income catch up. Reforms to support rebalancing of growth towards higher productivity and greater competitiveness: While preserving fiscal discipline, reprioritize public expenditures and reorient taxation Improve energy security via affordable and comprehensive energy strategy Enhance the infrastructure networks and environment for business expansion in tradable sectors to reap the benefits of European integration. Strengthen inclusion by building human capital and providing equal opportunities to tap into unemployed/underemployed resources. Improve stewardship of Kosovo s environment and natural resources. 17
Key Priorities Maintaining macroeconomic stability while reprioritizing public expenditure Reducing infrastructure bottlenecks and creating a more attractive business environment for private investment and expansion of tradable sectors Better stewardship and greater productivity of natural resources Greater inclusion by building human capital and providing equal opportunities Rebalancing growth towards higher productivity and greater competitiveness Refocusing Kosovo s growth agenda requires retaining several features of its economy as a foundation, while increasingly tapping into production factors natural and human resources that are either chronically underused or not used at all. This will help expand opportunities for the poor to sustainably improve their welfare, reduce poverty, and promote shared prosperity. To broaden the economy s narrow production base, boost job creation, and reduce the heavy dependence on imports, Kosovo s current growth strategy needs to be amended across the board through 18 new governance, macroeconomic, structural, and social policies.
Detailed Priorities Maintaining macroeconomic stability while reprioritizing public expenditure Align the budget more closely with development needs and improve the allocation and efficiency of public spending: As the economy becomes euroized and given the benefits of structural reform and the changes in income policies, the scope for macroeconomic policy is limited by the availability of fiscal buffers and external financial support. Proper balance between stabilization and development objectives needs to be achieved. Kosovo is sensitive to political business cycles and prone to election-related episodes of fiscal largesse. There has also been a tendency to overinvest in physical infrastructure, particularly roads. It is expected that, soon, the combination of these factors will either cause the deficit to surge or crowd out priority development-focused spending. Serious trade-offs will be needed, particularly if new power generation facilities require public resources. Regardless of the magnitude of public spending in the energy sector, reprioritizing expenditures across sectors would contribute more to addressing the poverty and unemployment challenges and would provide more value for money. Shift to direct taxation and strengthen tax administration: Meeting all fiscal needs will be more difficult if, as expected, border revenues, which make up over 70 percent of total revenues, decline as EU integration and free trade agreements advance. A gradual shift to domestic revenue and direct taxation is necessary and feasible. Tax policy also needs to reflect the degree of compliance, the size of the shadow economy (which is estimated at 27 35 percent of gross domestic product), and the capacity of the tax administration to adopt appropriate international best practice. 19
Detailed Priorities Reducing infrastructure bottlenecks and create a more attractive business environment Capitalize on comparative advantages: Kosovo already has comparative advantages in several goods (garments, textiles, and food) and services (travel and communications). Manufacturing has the potential not only to spur income and exports, but also to generate employment among skilled and unskilled workers. Given their direct impact on other sectors and on human capital formation, modern services, which are already a major source of income, have the potential to transform Kosovo s economy. However, manufacturing and modern services have been held back by large regulatory and infrastructure gaps. Ensure good governance and reinforce the rule of law: Good governance is an element of the soft infrastructure that is necessary for a well-functioning, competitive, and innovative market economy that has discarded the socialist legacy. The inadequate development and performance of governance institutions, particularly the shortcomings of the judicial system, are a major obstacle to business success. Because they raise the costs and risks associated with doing business, they encourage the offering, giving, receiving, and soliciting of bribes. Addressing gaps in soft infrastructure would also help strengthen social cohesion. Enhance the business environment. The establishment of an effective legal, regulatory, and administrative framework to govern trade and investment would help enhance the capacity of businesses to withstand competitive pressures and connect with global value chains, thereby generating jobs and spurring competition, innovation, and productivity increases. A number of policies that support trade and investment need more work, including in strengthening property rights; reforming and streamlining licensing; reforming inspections; implementing customs and trade regulations; streamlining standardization, accreditation, and certification systems; enhancing foreign direct investment and export promotion; clarifying competencies on competition; and tightening the arrangements for corporate governance, financial reporting, and auditing. Secure property rights: develop the land market, and coordinate the use of national geographical data. Ensure reliable and affordable energy: Energy insecurity has heavy costs for businesses and is the largest obstacle to attracting high-quality FDI to Kosovo. Relying on external suppliers is not realistic from either a supply security or a cost perspective. Short-term energy deficit problems can be addressed partly by regional interconnectivity. In the long run, though, even taking into account the costs of managing environmental and social externalities, the best value-for-money option is an energy strategy that incorporates renewable energy, energy efficiency measures, and a new power plant. Increase connectivity. In a small and landlocked economy, connectivity is critical to successful integration with regional and global markets. Kosovo has invested heavily in new physical capital, but the investment in new highways risk squeezing out other public investments. Also strategic for Kosovo s competitiveness is addressing infrastructure bottlenecks in broadband digital communications, which can pave the way for income growth and job creation. 20
Detailed Priorities Better stewardship and greater productivity of natural resources Counter the effects of decades of neglect and war: Given the country s abundance of natural resources and its fertile land, greater productivity and sustainability in agriculture and mining where Kosovo benefits from comparative advantages are critical to exports and to import substitution because they can generate resources for development. Modernizing agriculture and mining, building up institutions and policies, and setting technical standards and regulations will be critical to addressing environmental and health risks and to aligning with EU norms. Consideration should also be given to the impact of trade agreements. Increase productivity in agriculture. Agriculture accounts for about 12 percent of GDP and 25 35 percent of total employment. In Kosovo, it is also a safety net. About 60 percent of the population own land for cultivation, and 30 percent own livestock. About 60 percent of the poor live in rural areas and, to a large degree, depend directly or indirectly on agriculture for their livelihoods. However, there are structural and interrelated challenges to agriculture s competitive and growth potential, including insufficient scale, financing, integration, and market links. Alignment with EU and international standards and technical regulations needs to be ensured. The sector will need to adapt to the drought and flood threats of climate change, which will affect Kosovo s limited water resources. Manage natural resources sustainably. Kosovo has large reserves of lignite, lead, zinc, silver, nickel, cobalt, copper, iron, and bauxite, and high-quality construction minerals such as andesite, basalt, diabase, gabbro, granite, limestone, and marble. Mining, which was a mainstay of the economy of the former Yugoslavia, has the potential to generate exports, growth, and resources for development. It is estimated that Kosovo s mineral endowment is sufficient to offset the start-up costs necessary for major upgrades. The principal challenge to relaunching Kosovo s mining industry is attracting private investment, considering that sectoral governance is weak and Kosovo s status is unresolved. Reforms to improve the rule of law and minimize discretionary decision making are necessary; but so, too, is addressing a legacy of unresolved labor, social, and environmental issues that affect workers and communities. Remedying environmental legacies related to mining will be vital to relieving health impacts, bringing degraded land back into productive use, and reducing public opposition to production. 21
Detailed Priorities Greater inclusion by building human capital and providing equal opportunities More jobs and more productive workers are vital to building the critical human capital that is necessary to ensure that low-income households participate in and benefit from economic growth. Kosovo has a young population and a potentially large demographic dividend, which makes the jobs agenda all the more critical. Improving the quality and relevance of education at all levels and ensuring equitable access to educational opportunities at early ages is a first step that needs to be complemented by more opportunities to acquire the skills that private employers are seeking. The development of these skills opens up wage employment opportunities, but it may also stimulate greater selfemployment and entrepreneurship in such areas as agribusiness, information and communication technology (ICT) enabled jobs, and other emerging sectors. Given Kosovo s extremely low labor force participation, improved opportunities are needed for women and minorities. For greater social inclusion and cohesion, policies are needed to enhance the opportunities of all wealth groups, ethnicities, and regions to access health care, education, and social protection equitably. A large share of the population is vulnerable to income shocks and falling back into poverty, and the social safety net has major gaps. Building up institutions, improving targeting, and making public spending more efficient in health care, education, employment services, and last-resort social assistance would promote equal opportunity and short-term protection. Given Kosovo s history, better targeting and coverage in social protection is paramount, and budgetary support should be directed to the poor rather than special interest groups. Shortcomings in the inclusion and participation of women at all levels of society are a major concern. Health outcomes could be enhanced by shifting the focus from hospitals to primary care, water, and sanitation to meet basic needs. 22
Detailed Priorities Maintaining macroeconomic stability Reducing infrastructure bottlenecks and create a more attractive business environment Better stewardship and greater productivity of natural resources Building human capital and providing equal opportunities Improve the allocation and efficiency of public expenditure Improve governance, rule of law and business climate Increase productivity in agriculture Increase employment and labor productivity through education Strengthening tax policy and administration Reduce energy bottlenecks Ensure sustainable management of natural resources Increase quality and equality of opportunity through labor policies Deepen and widen financial intermediation Reduce transport bottlenecks Increase quality and equality of opportunity through social protection Reduce ICT bottlenecks Increase the quality and equality of opportunity through health 23
THANK YOU! 24