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									                                      Document of
                                     The World Bank


                             FOR OFFICIAL USE ONLY



                                                                       Report No. 24113-MD



                      MEMORANDUM OF THE PRESIDENT

                                        OF THE

              INTERNATIONAL DEVELOPMENT ASSOCIATION

                                       AND THE

                 INTERNATIONAL FINANCE CORPORATION

                                        TO THE

                             EXECUTIVE DIRECTORS

                                          ON A

         COUNTRY ASSISTANCE STRATEGY PROGRESS REPORT

                                           FOR

                          THE REPUBLIC OF MOLDOVA



                                      May 20, 2002




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.
The last Country Assistance Strategy for Moldova was discussed by the Executive Directors
                           in May 1999 (Report No. 18896-MD)




                             CURRENCY EQUIVALENT
                             (Exchange rate as of April 4, 2002)

                                    Currency Unit = Leu
                                      US$1 = Lei 13.5
                                     Leu 1 = US$0.074

                      GOVERNMENT’ S FISCAL YEAR
                                 January 1 to December 31

                     ABBREVIATIONS & ACRONYMS

   AAA                             Analytical and Advisory Activities
   CAS                   -         Country Assistance Strategy
   CFAA                            Country Financial Accountability Assessment
   CIS                   -         Commonwealth of Independent States
   CPAR                            Country Procurement Assessment Program
   CPM                             Communist Party of Moldova
   EU                              European Union
   GDP                   -         Gross Domestic Product
   GNP                             Gross National Product
   IDA                             International Development Association
   IFC                             International Finance Corporation
   IFI                   -         International Financial Institutions
   IMF                             International Monetary Fund
   MDG                             Millenium Development Goal
   PIU                   -         Project Implementation Unit
   PRSP                            Poverty Reduction Strategy Paper
   SAC                   -         Structural Adjustment Credit
   STI                             Sexually Transmitted Infections
   WTO                   -         World Trade Organization




                   IDA                                             IFC
Vice President           Johannes F. Linn     Vice President          Assaad J. Jabre
Country Director         Roger W. Grawe       Director                Khosrow Zamani
Task Team Leader         Suman Mehra          Task Team Leader        Gjergj Konda
                                                                                                     FOR OFFICIAL USE ONLY




                                              THE REPUBLIC OF MOLDOVA

                                         COUNTRY ASSISTANCE STRATEGY

                                                      TABLE OF CONTENTS

EXECUTIVE SUMMARY ............................................................................................................................ i
I. INTRODUCTION ....................................................................................................................................... 1
II. RECENT DEVELOPMENTS ................................................................................................................ 1
     A. POLITICAL SETTING.....................................................................................................1
     B. ECONOMIC PERFORMANCE ........................................................................................1
     C. SOCIAL DEVELOPMENT ..............................................................................................2
III. PROGRESS ON 1999 CAS OBJECTIVES ..................................................................................... 4
IV. MAIN DEVELOPMENT CHALLENGES AND GOVERNMENT PROGRAM .................................... 6
    A. POVERTY REDUCTION AND THE PRSP......................................................................6
    B. STRENGTHENING GOVERNANCE ..............................................................................7
    C. ECONOMIC OUTLOOK..................................................................................................8
V. PROPOSED IDA AND IFC INTERIM OPERATING PLAN .................................................... 9
    A. EXPERIENCE UNDER THE 1999 CAS ...........................................................................9
    B. OBJECTIVES FOR FY02-03 ..........................................................................................11
    C. IDA/IFC PROGRAM ......................................................................................................12
    D. PARTNERSHIPS ...........................................................................................................13
VI. RISK MANAGEMENT ........................................................................................................................ 14




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.
TABLES

Table 1:    MDGs and Moldova
Table 2:    Key Economic Indicators
Table 3:    1999 CAS Portfolio Performance Triggers and Outcomes

BOXES

Box 1:      Activities Supporting Good Governance
Box 2:      Planned and Actual IDA Lending for Moldova (FY99-FY01)
Box 3:      Planned IDA Lending for Moldova (FY02-03)

ANNEXES

Annex A1:   Key Economic and Program Indicators – Changes from Last CAS
Annex A2:   Moldova at a Glance
Annex B2:   Selected Indicators of IDA Portfolio Performance
Annex B3:   IDA Program Summary
Annex B3:   IFC and MIGA Program
Annex B4:   Summary of Non-lending Services
Annex B5:   Social Indicators
Annex B6:   Key Economic Indicators
Annex B7:   Key Exposure Indicators
Annex B8:   Status of IDA Operations
Annex B8:   Status of IFC’s Held and Disbursed Portfolio
Annex B9:   Country Assistance Strategy and Performance Matrix


Map         IBRD 24285R3
                   MEMORANDUM OF THE PRESIDENT OF THE
                 INTERNATIONAL DEVELOPMENT ASSOCIATION
                AND THE INTERNATIONAL FINANCE CORPORATION
                      TO THE EXECUTIVE DIRECTORS ON A
                       COUNTRY ASSISTANCE STRATEGY
                       FOR THE REPUBLIC OF MOLDOVA

                                  EXECUTIVE SUMMARY

i.      The Government considers poverty reduction to be the major challenge for Moldova and
plans to formulate the Poverty Reduction Strategy Paper (PRSP) in FY03 based on a fully
participatory process. In the interim, the authorities have updated the Interim Poverty Reduction
Strategy Paper (I-PRSP). To ensure consistency with the PRSP, a full Country Assistance
Strategy (CAS) will be prepared after the PRSP is completed. Meanwhile, this Progress Report
reviews developments since the Executive Directors discussed the last CAS for Moldova in May
1999, summarizes the experience in implementing its strategy, and presents the interim operating
plan and lending and analytical priorities for FY02-03.

ii.     Moldova has undergone three Government changes since the last CAS with significant
interruptions in the reform process due to the political flux. The political picture has changed
considerably over this period with the Communist Party of Moldova (CPM) winning a decisive
victory in early elections in February 2001 as the electorate registered its disaffection with
previous governments. With Moldova having shifted to a Parliamentary democracy in July 2000,
the CPM assumed control of the Presidency and the Government. This is the first instance in
Moldova’s ten year history in which one political group has overall responsibility for initiating,
enacting and implementing legislation and related development policies and programs.
Moldova’s leadership is committed to identifying and implementing a program to sustain growth
and reduce poverty and endorses the reform program as a means to achieve these objectives. The
Government is working closely with its international partners, especially the Bank and the IMF,
to implement the Government’s economic and social development agenda.

iii.     After a decade of deteriorating economic performance, the government has successfully
stabilized the economy, launched structural reforms to stimulate growth, and begun the process of
establishing an effective social protection system. Real GDP growth was 2 percent in 2000,
rising to 6 percent in 2001. While the Government has made notable progress in the
macroeconomic and structural reform process since the last CAS, a significant agenda remains.

iv.     Despite the recent reform progress, Moldova is now the poorest nation in Europe having
started out at independence as a middle-income country. At US$390 in 2001, GNP per capita is
only one-third of the pre-transition level. With economic recovery only in its second year,
poverty is still very high. Approximately 55 percent of all Moldovans – close to 2.4 million
people - live below an absolute poverty line of US$2.15 per day (in purchasing power parity
terms). Simultaneously, Moldova has become one of the region’s most heavily indebted
countries with an external debt stock (excluding energy arrears) of about 83 percent of GDP.
With external debt service obligations totaling over 60 percent of central government revenues in
2002, and over 40 percent in 2003, before falling to lower levels in subsequent years, Moldova
faces severe liquidity problems in the near-term.

v.       The 1999 CAS for Moldova focused on three inter-related objectives: macroeconomic
stability and growth, private sector development, and public sector reform. Since 1999, Moldova
has made significant progress in establishing and maintaining a sustainable fiscal and monetary
framework. In line with the Government’s program, a substantial part of the planned
privatizations were completed (notably in power distribution) and almost all arable land
distributed to private owners. But enterprise privatization slowed down in 2001, partly because
MOLDOVA                                        - ii -                        CAS Progress Report

of the elections. As a result, planned privatizations of a number of key companies, including
telecommunications, wineries and power generation, have been delayed. Progress on private
sector development has been discontinuous, with most of the achievements concentrated early in
the CAS period although the current Government has taken welcome steps to simplify licensing
and registration. Public sector reforms have lagged well behind expectations, although public
expenditure management has improved significantly.

vi.     Because of “stop-go” implementation due to frequent Government changes, actual
lending in FY99-01 amounted to US$76 million – an annual average of US$25 million - as
compared to US$125 million – an annual average of US$42 million anticipated in the CAS as the
most likely outcome. Portfolio performance improved, however, with performance indicators
consistently higher than CAS targets.

vii.    The objectives of the 1999 CAS – macroeconomic stability and growth, private sector
development and public sector reform – continue to frame the key development challenges for
Moldova under the broad goal of poverty reduction. Sustaining the successful stabilization
efforts of recent years will require continued prudent fiscal policies consistent with low inflation
and increased and better-targeted social expenditures. The implementation of an effective debt
management strategy is also crucial. Mobilizing private capital and know-how will require
completing the privatization of important enterprises like Moldtelecom, the wineries, and the
continued restructuring and privatization of the energy sector. Market-oriented agricultural
policies need to be maintained and an investor friendly business environment developed. Public
administration reform, and an improved public/private interface, including legal and judicial
reform, are essential elements of a strategy to reduce corruption and strengthen governance.

viii.  During FY02-03, total IDA lending of up to US$102 million – an annual average of about
US$50 million - would constitute the base case. Of this total, up to US$40 million would be in
adjustment lending and up to US$62 million in investment lending. This level of assistance
would be predicated on satisfactory performance under an IMF-supported program, the
formulation and implementation of the PRSP, satisfactory implementation of the reform program
supported by Structural Adjustment Credit (SAC) III, and continued satisfactory portfolio
performance.

ix.     Risks to IDA’s activities in Moldova include further delays in reforms due to the
Government’s inability to build consensus and implement the necessary measures, Moldova’s
vulnerability to external shocks, and the limited capacity of Moldova’s administrative machinery.
These risks are mitigated by a number of factors. Moldova has already established a track record
of fiscal consolidation, reduced reliance on domestic debt, prudent central bank policies, and
reforms to encourage the shift of external trade to new markets. In addition, to minimize the risk
of delays in reform implementation, SAC III has been designed as a three tranche operation with
front-loading of reform measures and back-loading of funding. Also, the planned implementation
of the public sector reform program with Bank assistance will help strengthen institutional
capacity.

                    Proposed Agenda for Discussion by the Executive Directors
          The Directors may wish to discuss whether the proposed strategy of increasing the
           focus on governance issues as the privatization agenda is being completed is
           appropriate.

          The Directors may also wish to discuss whether the composition of the proposed
           lending program, which emphasizes poverty and public sector reform issues, is
           appropriate given Moldova’s development needs.
                  MEMORANDUM OF THE PRESIDENT OF THE
                INTERNATIONAL DEVELOPMENT ASSOCIATION
               AND THE INTERNATIONAL FINANCE CORPORATION
                     TO THE EXECUTIVE DIRECTORS ON A
              COUNTRY ASSISTANCE STRATEGY PROGRESS REPORT
                      FOR THE REPUBLIC OF MOLDOVA

                                        I. INTRODUCTION

1.      Moldova’s last full CAS for FY99-01, was discussed by the Board of Directors in May
1999. IDA and IFC had initially planned to prepare a full CAS for Board discussion in FY02, but
decided to wait until Moldova’s full PRSP is ready early in FY03 to ensure that the two
documents are fully consistent. In the interim, this Progress Report provides an overview of
performance since the 1999 CAS, parameters for IDA’s and IFC’s interim operating plan, a
context for proposed adjustment lending to Moldova, and lending and analytical priorities to
support the proposed interim operating plan for FY02-03.

                                  II. RECENT DEVELOPMENTS

A. POLITICAL SETTING

2.      The period 1991-2000 witnessed multiple government changes with a fractured polity,
and faltering efforts to implement structural change. In February 2001, following early elections
necessitated by Parliament’s inability to elect a President, a disaffected electorate, which had
endured years of corruption, political instability, and a marked decline in incomes gave the CPM
an absolute majority in Parliament. The CPM won more than 50 percent of the votes and 71 out
of 101 seats in Parliament. The new Parliament elected the CPM leader, Vladimir Voronin, as
President and he appointed Vasile Tarlev, a non-party businessman as Prime Minister. Economic
Ministers were retained from the previous largely technocratic Government. CPM members hold
key ministries, including agriculture, privatization, and the social sectors.

3.       The pace of reforms has been slow due to the difficulties of building consensus across a
diverse electorate and the Government’s initial belief that Moldova could join the Russian
Belarussian union and gain valuable concessions. In the event, anticipated concessions from
Russia, such as reduction in energy prices and debt restructuring did not materialize (except for
some reduction in gas prices). As a result, the President’s initial populist program has evolved
gradually into a program based on market-oriented principles underpinned by anti-corruption
measures. Despite political difficulties stemming from CPM policy initiatives which run counter
to Moldova’s transformation to a market economy, the Government has successfully maintained
most important policy and institutional measures from previous reform efforts and has resisted
initiatives which would have reversed past progress toward a functioning market system.
Moldova’s leadership remains committed to working closely with international financial
institutions, including the Bank and the IMF, and to continuing the reform process.

B. ECONOMIC PERFORMANCE

4.      Moldova’s economic performance since 1999 is a commendable contrast to its record
throughout most of the 1990s. Starting with an impressive fiscal adjustment process in 1999
largely through deep cuts in inefficient public expenditures, the authorities stabilized the
economy following the severe shock of the 1998 Russia crisis. At the same time, the authorities
intensified structural reforms to stimulate growth, and began to modernize the social protection
system. Since then, the Government has maintained hard budget constraints; established a sound
regulatory framework and an independent regulatory agency in the energy sector, sold three out
of five power distribution companies which serve two-thirds of the consumer base; reformed the
pension system and cleared pension arrears; virtually completed land distribution and farm
MOLDOVA                                             -2-                                 CAS Progress Report

privatization; and improved corporate governance through privatization. Both agriculture and
industry are recovering, with growth in areas where Moldova has a comparative advantage such
as textiles, light industry, wine-making, and communications. Services and construction are also
growing. Moldova’s membership to the World Trade Organization (WTO) and the Stability Pact
for South Eastern Europe in 2001 should also open new opportunities for trade and foreign
investments.

5.      The macroeconomic results are also encouraging. Real GDP growth has increased from 2
percent in 2000 to 6 percent in 2001. Inflation has dropped from over 18.5 percent at end 2000 to
6.4 percent by end 2001. The Government has successfully reduced the cash fiscal deficit from
10.5 percent in 1997 to less than 1 percent in 2001. The exchange rate is stable.

6.      While macroeconomic and structural reforms are now starting to have an impact with
notable progress since the 1999 CAS, a significant economic management agenda remains. In
particular, high levels of external debt and debt service due during this year and the next pose an
exceedingly difficult management problem. As a result of excessive external borrowing in the
mid-1990s, Moldova is now among the region’s heavily indebted countries with an external debt
stock (excluding energy arrears) of about 83 percent of GDP in 2001. Public and publicly
guaranteed debt exceeds 70 percent of GDP, with a Net Present Value of about 60 percent of
GDP reflecting only moderately concessional terms. External debt service obligations on public
and publicly guaranteed debt total almost 50 percent of Central Government revenues in 2002,
and about 40 percent in 2003, before they fall to lower levels. To manage the large debt and debt
service burden, the Government plans to: (a) continue a tight fiscal stance to maintain a primary
fiscal surplus of 1.5 percent of GDP; (b) earmark privatization proceeds to amortize external
public debt and eliminate government wage arrears; (c) refrain from new borrowing on non-
concessional terms; (d) use market-based methods where possible to reduce debt; (e) improve the
management of external domestic public debt; and (e) work with creditors to restructure debt.

C. SOCIAL DEVELOPMENT

7.      Having started out at independence as a middle-income country, Moldova is now the
poorest nation in Europe. At US$400 in 2001, GNP per capita is only one-third of pre-
transition levels1. With economic recovery only in its second year, poverty is still very high.
Approximately 55 percent of Moldovans – almost 2.4 million people - live on less than
US$2.15 per day (in 1996 purchasing power parity). The prevalence of poverty increased by
about 20 percentage points between 1997 and 2000, but appears to have leveled off since
then. Income inequality is also high as are the disparities between Chisinau and the rest of
the country. Poverty in rural Moldova is worse than in urban areas, with the rural population
comprising over two-thirds of the poor. There is a high correlation between land ownership
and income. The 1999 Poverty Assessment suggested that the landless agricultural workers
are among the poorest of the poor. Subsequently, there appears to have been a slight
reduction in the relative poverty risk for hired agricultural workers since 1997. The
unemployed, in both rural and urban areas also have high poverty risks, but workers
constitute the majority of the poor reflecting their large share in the population,.

8.      After a deterioration in the health status of Moldovans in the early years of the transition,
Moldova has made steady progress since the mid-1990s in reversing the decline in life
expectancy and in restoring the health status to higher levels than before the economic crisis. The
most notable reversals have been in life expectancy which increased from 65.9 years in 1995 to
67.4 years in 2000. Infant and maternal mortality rates have also declined steadily, although at
18.4/1,000 live births, infant mortality is still high – about four times the European Union (EU)

1
 While accounting practices and price distortions in the former Soviet Union undoubtedly overstated Moldova’s
pre-independence income, clearly national income and living standards have fallen drastically.
MOLDOVA                                         -3-                              CAS Progress Report

average. The incidence of tuberculosis rose to 89 cases per 100,000 in 2001, almost double the
level in 1990. Moldova is one of four countries in the region with the highest incidence of HIV
infection. On average, overall health outcomes in Moldova are at least 50 percent worse than in
the EU. Most of Moldova’s health indicators also lag behind those for other Commonwealth of
Independent States (CIS) countries and countries with similar per capita incomes.

9.      There are similar signs of distress reflected in education indicators. Except at the primary
and secondary levels, enrollment rates have declined. There are serious concerns about access to
quality education, with the poorest children, especially girls in rural areas, and youth worst
affected. The disparities are greatest for secondary and higher education. Anecdotal evidence
suggests that absenteeism in basic education among poor children is high as they look for work
primarily in subsistence or wage agriculture. Physical facilities are deteriorating, and other inputs
such as basic teaching and learning materials, and laboratory facilities are in short supply. The
departure of younger teachers and the inability to attract and retain replacements has led to an
increased reliance on older and retired teachers.

10.      Although public expenditures on education and health are increasing slightly in real
terms following sharp declines between 1995 and 2000, intra-sectoral expenditures need urgent
rebalancing to improve their equity, efficiency and effectiveness. Previous reductions in
expenditure were accompanied by increases in formal and informal charges without adequate
protection for the poorest segments of the population. The Government needs to fund key inputs
in basic education and build upon the successful quality improvements under the Bank-financed
General Education Project. At the same time, because of the decline in the birth rate to below
replacement levels, and the consequent reduction in future enrollments, physical infrastructure
and staffing will need significant rationalization. The quality and energy efficiency of the
existing facilities also need to be improved as do the skills of the teaching force. Health
expenditures are heavily biased towards high cost tertiary care at the expense of primary care
services. Health facility consolidation is underway with Bank assistance for a Health Investment
Fund Project, and the closure of most provincial hospitals has already freed up resources to
expand the primary care network.
11.     The 1999 Poverty Assessment noted that the targeting of Moldova’s social protection
system is poor. Although there were some improvements in 2000 in the targeting of direct
subsidies to meet utility and energy costs, the Government recognizes that further improvements
are needed. Under pension reforms implemented in 1998, significant progress was made in
rationalizing the pay-as-you-go system. The reforms have produced significant results: pension
arrears have been eliminated, cash collections have been increased, and the social insurance
budget has recorded a small surplus. However, the Government is concerned about the still very
low general public pensions received by the majority of pensioners as well as the large
discrepancies in the pension levels between the different categories in the system.

12.      As summarized in Table 1, almost all the Millenium Development Goals (MDGs) are
relevant for Moldova. The MDGs which warrant close attention are as follows: (i) halve the
proportion of people living in poverty and eradicate hunger, as more than 50 percent of the
Moldova population live below the poverty line; (ii) achieve universal primary education, as
about 10% of compulsory school age children are not participating in the basic education system;
(iii) reduce child mortality by two thirds, which would require the under-five mortality rate to
come down to about 7 per 1,000 live births by 2015; (iv) improve maternal health, which would
require reducing the mortality ratio to less than 10 per 100,000 live births; (v) combat HIV/AIDS
and TB by reversing the spread of these diseases; (vi) ensure environmental sustainability; and
(vii) develop a global partnership for development.


                                  Table 1: MDGs and Moldova
MOLDOVA                                                           -4-                                           CAS Progress Report

                                                                         1990           1995          1999         2000
Eradicate extreme poverty and hunger                                   2015 target = halve 1990 $1 a day poverty and malnutrition rates
Population below $1 a day (%)                                                ..           11.3             ..              ..
Achieve universal primary education                                                  2015 target = net enrollment to 100
Net primary enrollment ratio (% of relevant age group)                       ..            ..              ..              ..
Reduce child mortality                                                    2015 target = reduce 1990 under 5 mortality by two-thirds
Under 5 mortality rate (per 1,000)                                         25.2           27.4           22.2             22.0
Infant mortality rate (per 1,000 live births)                              19.0           21.2           18.2             18.4
Improve maternal health                                                 2015 target = reduce 1990 maternal mortality by three-fourths
Maternal mortality ratio (modeled estimate, per 100,000 live births)         ..           65.0             ..              ..
Combat HIV/AIDS, malaria and other diseases                                  2015 target = halt, and begin to reverse, AIDS, etc.
Prevalence of HIV, female (% ages 15-24)                                     ..            ..            0.1               ..
Contraceptive prevalence rate (% of women ages 15-49)                        ..           73.7             ..              ..
Incidence of tuberculosis (per 100,000 people)                               ..            ..           130.0              ..
Ensure environmental sustainability                                                   2015 target = various (see notes)
Forest area (% of total land area)                                          9.7            ..              ..              9.9
Nationally protected areas (% of total land area)                            ..           1.2            1.4               ..
CO2 emissions (metric tons per capita)                                      4.8           2.6            2.2               ..
Develop a Global Partnership for Development                                          2015 target = various (see notes)


13.     Further cross sectoral efforts are needed to achieve the MDGs, as well as to measure their
achievement. The quality and availability of data related to the MDGs varies across sectors.
While reliable health data is available, additional information is needed on poverty and education.
The Government is already actively involved in preparing a Poverty Reduction Strategy Paper,
which will build up the capacity to monitor poverty and provide stakeholders with a roadmap to
work toward reducing poverty. Public sector reforms have been contributing to improving the
health status, and are also expected to help reduce poverty and increase education enrollment and
quality. Under the ongoing IDA-financed health project, strategies to control TB, HIV/AIDS and
STI were updated, and pilot projects are being carried out. The Government has requested IDA
assistance to control these epidemics, and has obtained a grant of US$1.7 million from the AIDS,
Tuberculosis and Malaria Global Fund for this purpose.

                                         III. PROGRESS ON 1999 CAS OBJECTIVES

14.     The 1999 CAS focused on three inter-related objectives: macroeconomic stability and
growth, private sector development, and public sector reform. The strategy gave priority to
achieving a stable macroeconomic framework linked to key structural reforms to create the basis
for growth in an open market economy. The CAS envisaged support for reforms in agriculture,
enterprise and energy to stimulate a supply response and promote private sector-led growth.
Public sector reform was judged to be essential for developing an enabling environment for
private investment, by downsizing and reshaping the role of the state while reorienting public
expenditures to reduce poverty. Annex B9 summarizes in matrix form the progress made toward
these objectives.

15.      Overall, significant progress has been made in establishing and maintaining a sustainable
fiscal and monetary framework. The Government has eliminated barter and other in-kind
transactions, and significantly reduced netting-out operations and accumulation of arrears.
Higher revenues largely through improved collection of taxes and social security contributions,
and expenditure rationalization have resulted in a primary surplus in the range of 1-2 percent of
GDP. As mentioned in para. 5 above, inflation has fallen sharply and the exchange rate has
stabilized. Moldova has had much less access to foreign financing than anticipated in the process
of achieving these results. After almost a decade of decline, prudent macroeconomic policies and
significant progress in structural reforms have resulted in GDP growth of 2 percent in 2000 and
an impressive 6 percent in 2001.
MOLDOVA                                        -5-                             CAS Progress Report

16.      Moldova’s vulnerability to external shocks has diminished mainly as a result of financial
stabilization, and decreased reliance on financing through T-bills and foreign debt. To a lesser
extent, trade recovery and restructuring have also helped reduce vulnerability. As one of the first
CIS countries to accede to the WTO in 2001, Moldova has consolidated its commitment to an
open trade regime.

17.     Progress on the second objective, private sector development, has been discontinuous,
with most of the achievements concentrated early in the CAS period. The privatization of large
manufacturing enterprises, three out of five state-owned power distribution companies, and the
gas supply company, were in line with the Government’s program. Privatization slowed
considerably in 2001, in part due to the elections. Key enterprises in the manufacturing (large
wineries, tobacco) and infrastructure sectors (the remaining two power distribution companies,
power generation companies and Moldtelecom) have not yet been privatized. The injection of
private capital, including from IFC, for the privatized power distribution companies will help
improve the operational and financial viability of the power sector. Meanwhile, the new market-
oriented legal and regulatory framework in the energy sector is functioning effectively although it
faces periodic challenges from vested interests.

18.     With financial assistance from IFC in FY00-01, the Government has increased the
availability of medium-term funding for viable private companies. In order to help develop the
small and medium enterprise (SME) sector, IFC has provided technical assistance and credit lines
to local banks, strengthening their lending skills and risk management capabilities for SME
financing. With funding from a Dutch Trust Fund, IFC is helping two private local banks to
improve their banking operations and managerial skills. IFC has helped establish a
microenterprise credit institution providing local currency loans to micro- and small enterprises.
The aim is to convert this institution to a commercial bank once it expands its range of services.
In the energy sector, IFC has lent US$25 million to three recently privatized distribution
companies that have been sold to a strategic investor. IFC has also invested US$16.6 million in a
nation-wide global system for mobile communications (GSM) to help meet the urgent need to
modernize telecommunications.

19.     Land privatization is virtually complete and farm restructuring covers over 80 percent of
agricultural land, including once off debt write-offs where necessary. With IDA assistance, the
Government is introducing a land registration system to establish a land and real estate market,
and land transactions, primarily leasing, are beginning to take place. In the context of the
proposed SAC III, the Government has signed a Memorandum of Understanding for Agriculture
with the Bank laying out an agreed framework of market-oriented agricultural policies to which
the Government will adhere. While the Government has long had a tendency to revert to
interventionist solutions whenever problems arise, such interventions have ususally been
abandoned or significantly modified on the basis of detailed technical dialogue. The essential
elements of the judicial infrastructure needed to foster the private sector have also started to
develop.

20.     Public sector reforms – the third objective of the 1999 CAS – have lagged behind
expectations, although significant steps have been taken to improve public expenditure
management. A previous Government took an important step forward by adopting a
comprehensive public sector reform strategy. While the overall strategy is still subject to
reconfirmation by the current Government, the authorities have approved the transition to a
medium term expenditure framework. Debt management and expenditure planning capacity has
improved with rationalization of nominal compensations, social funds, and health infrastructure.
A fully financed energy subsidy scheme for vulnerable groups has been implemented. The
Government has made some progress in improving targeting, but further improvements are
needed. There has been little progress in reorienting the role of the state following initial
progress in decentralizing key service delivery, including district heating and water supplies. The
MOLDOVA                                               -6-                                CAS Progress Report

current Government reversed administrative-territorial reforms which were implemented in 1999.
However, the Constitutional Court has ruled that these reversals are unconstitutional. Key among
these are the proposed changes in the election law whereby mayors would be elected by local
councils rather than by popular vote as is currently the case. The Government has accepted the
decision of the Constitutional Court2. Parliament has recently completed the long-pending task of
rewriting Moldova’s civil code, inter-alia, to ensure its compatibility with market institutions and
processes.

21.     The Government’s reform program also includes the modernization of the justice system.
The intent is to improve the performance of the courts by consolidating the court structure,
streamlining the processes, and strengthening the enforcement of court decisions. In addition, the
Government has also attempted to improve the quality and availability of notary services.
However, the strategies employed, which rely too heavily on top-down controls and too little on
incentive reforms are not likely to be effective.

           IV. MAIN DEVELOPMENT CHALLENGES AND GOVERNMENT PROGRAM

A. POVERTY REDUCTION AND THE PRSP

22.     The Government and other major stakeholders consider poverty reduction to be the major
development challenge facing Moldova.            Meeting the poverty challenge will require
mainstreaming poverty issues across all policies and investments as well as concerted efforts to
design and implement well-targeted and effective poverty reduction programs. It will also
require upgrading existing data collection and analysis and better coordination among agencies to
design and monitor appropriate anti-poverty policies and programs. Poverty reduction in
Moldova is fully consistent with a growth and structural reform agenda geared to raising incomes
and living standards, upgrading social protection, and empowering communities under the rule of
law.

23.     The Government has welcomed the PRSP process as the primary mechanism for orienting
and coordinating Government and development partner activities. After initial delays,
mechanisms for engaging the relevant government agencies, CSOs, and international partners in
the PRSP process are now in place and a full PRSP is scheduled for March 2003. The recent
finalization of the updated I-PRSP and the Preparation Status Report for the full PRSP reaffirms
the Government’s commitment to complete Moldova’s transformation to a market economy and
to implement an effective poverty reduction strategy. A joint assessment by IMF and Bank staff
notes that the status report accurately reflects Government commitment to poverty reduction and
the PRSP process. The Government will, however, face a major challenge in engaging civil
society in a dialogue on development issues given the relative inexperience and lack of a tradition
on both sides for such activities in Moldova.

24.     The Government’s development agenda attaches priority to completing the divestiture of
enterprises which are still state-owned (including wineries, tobacco and Moldtelecom) to promote
private investment and generate employment. In parallel, the Government plans to invest in the
agriculture sector to accelerate post-privatization growth and to realize the sector’s considerable
potential for raise incomes and reduce poverty. At the same time, the planned completion of
power sector restructuring is necessary to commercialize operations and ensure reliable power
supplies. Priorities to help meet the population’s basic needs include heating and clean drinking
water. The Government plans to start the process by improving the availability, quality and
efficiency of heating in public buildings such as schools, hospitals and residential buildings for
the disabled and other vulnerable groups. To reduce the incidence of water-borne diseases, the


2
    The CPM Parliamentary majority exceeds the two-thirds necessary to amend the Constitution.
MOLDOVA                                         -7-                             CAS Progress Report

Government will provide access to safe and affordable drinking water supplies and sanitation
services, in particular for poorer communities.

25.     While the authorities do not yet have a consistent approach with integrated responses to
the full range of development problems Moldova faces, they recognize the need for a broad
framework. As stated in para. 22 above, they intend to develop the PRSP for that purpose,
building on the I-PRSP. In the interim, a number of documents form the building blocks for a
Government framework. They include: the three-year Poverty Reduction and Growth Facility
(PRGF) program agreed with the IMF; the Agricultural Policy Memorandum signed with the
Bank; the draft letter of Development Policy associated with the proposed Structural Adjustment
Credit (SAC) III; a comprehensive Public Sector Reform Framework Document and draft Letters
of Sector Policy in the health, agriculture and energy sectors.

B. STRENGTHENING GOVERNANCE

26.     With the economy stabilized and structural reforms, in particular privatization, underway,
the Government needs to turn its attention to strengthening governance. The previous
Government reaffirmed its commitment to improving governance by adopting a comprehensive
public sector reform strategy in November 2000, which however remains subject to
reconfirmation by the current Government. The strategy comprises three elements: (i) public
administration reform; (ii) public expenditure management; and (iii) public/private interface.
Reforms in the justice system are also crucial to strengthen governance and should be an integral
element of public sector reform. IDA activities to help strengthen governance are summarized in
Box 1.

Public Administration Reform
27.     The Bank anticipates that the Government will reconfirm that civil service reform is at the
center of its agenda to improve governance. The politicization of the civil service, and salary
levels which are significantly below private sector levels, are key contributors to a weak and
corrupt public administration. Frequent government changes and turnover of public officials
exacerbate the problem. While Moldova’s state administration is not large relative to other
countries, its revenue generating capacity is low. In response to the Government’s request, IDA
will support the formulation and implementation of a strategy to de-politicize the civil service. In
addition, the Government intends to carry out a reorganization based on a functional review of
the central government and a study to inform the establishment of a permanent Government
secretariat. In parallel, legislation will be enacted to create a legal basis for a merit-based,
professional and de-politicized civil service.

Public Expenditure Management
28.      The Government has made significant progress in streamlining and improving public
expenditure management, especially in the areas of budget execution, cash management, and debt
management. A budget system law consistent with international standards , and a single treasury
system is operational at the state and local levels. The assets and liabilities management and cash
management functions in the Ministry of Finance and the Treasury have been upgraded. To
improve resource allocation and accountability, the Government is moving to a medium term
expenditure framework; it also plans to implement a fiscal decentralization strategy and increase
fiscal autonomy.

29.    The Government attaches priority to improving public financial management and
accountability, and plans to strengthen the audit and accounting functions. In response to the
Government’s request, IDA has launched a Country Financial Accountability Assessment
(CFAA) and will undertake a Country Procurement Assessment Program (CPAR) both to be
completed in FY03.
MOLDOVA                                          -8-                                CAS Progress Report

Public/Private Interface

30.     Recognizing the need to reduce corruption and improve the public/private interface to
attract foreign and domestic private investors, the Government has obtained Parliamentary
approval for a substantial body of legislation including Insolvency, Control of Money
Laundering, Licenses, etc. The authorities are also reforming the Customs Administration, and as
mentioned in para. 19, are finalizing a market-oriented Civil Code to provide the framework for
business legislation and commercial transactions. The Law governing the Court of Accounts is to
be changed to modernize its operations and better define its areas of responsibility, including
limiting excessive exercise of authority. Building on this progress, the Government needs to
adopt a more strategic and systematic approach to developing the rule of law in order to achieve
its growth and poverty alleviation objectives. The process of strengthening the rule of law should
include the introduction of appropriate incentives for individuals and firms to behave in a socially
responsible manner and assured access to judicial and legal services. The reform of the judiciary
needs to be closely coordinated with the reform process for other public sector institutions to
ensure the consistent application of the principles of good governance.

                         Box 1: Activities Supporting Good Governance
   Area of Governance      IDA Credits and IDF Grants           Analytical and Advisory Activities

  Anti-Corruption        Trade and Transport Facilitation in   CFAA (FY03)
  Strategy               South East Europe Project (FY03)      CPAR (FY03)
  Legal Reform                                                 TA on Electricity Law (FY02)
                                                               TA on Land Code (FY02)
                                                               TA on Telecommunications Law
                                                               (FY02)
                                                               Legal and Judicial Assessment (FY03)
                                                               TA on the Law on Notaries (FY02)
                                                               TA on draft Insolvency Law (FY02)
  Public                 Social Protection Management          TA for Public Sector Reform
  Administration         Project (FY99)                        Framework Document (FY01)
  Reform                 Health Investment Fund Project        TA for Medium-Term Expenditure
                         (FY01)                                Framework (FY02)
                         Public Sector Reform Project (FY03)   Pay Survey (FY01)
                         IDF Grant for Strengthening           Center of Government Decision Making
                         Moldova’s Statistics (FY99)           Study (FY01)
  Transparency           SAC II (FY99)                         Public Economic Management Review
                         SAC III (FY02)                        (FY02)
                         IDF Grant for Environmental           Dissemination of Agricultural Sector
                         Compliance & Enforcement              Strategy (FY02)
                         Capability (FY01)
  Participation          Social Investment Fund Project        Participatory Poverty Assessment
                         (FY99)                                (FY01)
                         Pilot Water Supply and Sanitation     I-PRSP (FY01, FY02)
                         Project (FY03)                        PRSP (FY03)
                         IDF Grant for SIF Regional Network
                         (FY00)

C. ECONOMIC OUTLOOK

31.     The deepening of sound financial policies and structural reforms would enable Moldova
to sustain growth, reduce poverty and lower debt. Real GDP is projected to grow at about 5
percent per annum over the medium-term (Table 2). With a continuation of prudent monetary
policy, inflation is projected to stabilize at about 6 percent over the medium-term and the
exchange rate is expected to remain competitive. Continued fiscal consolidation and lower
interest payments after 2002 are expected to gradually lower the overall fiscal deficit.
Improvements in the business environment should contribute to higher foreign and domestic
MOLDOVA                                             -9-                             CAS Progress Report

investment in agro-processing, including the wine industry, light industries, and internet services
(the web economy) resulting in a rebound in exports (after a slow down in 2002 because of lower
growth in Russia and Western Europe). Growth in investment and exports from 2003 onwards
would stabilize GDP growth at around 5 percent per annum. The current account deficit is
projected to improve moderately from 9.4 percent of GDP in 2001 to 6.4 percent in 2004 as
Moldova diversifies its export products and markets, and continues energy sector reforms to
lower dependence on energy imports. In line with improvements in export competitiveness,
Moldova should both regain traditional export markets and tap new markets in western Europe.

32.      There are signifcant risks associated with this economic outlook. As mentioned in para.
6, Moldova’s high levels of debt and debt service present an extremely difficult problem. In
2002, Moldova faces a severe liquidity crunch due to the scheduled repayment of the remaining
US$43 million Eurobond in due in June, 2002. The Government’s current strategy relies on
mobilizing additional resources from privatization proceeds and assistance from development
partners, in addition to informal debt restructuring. Moldova also remains vulnerable to external
shocks such as the Russian crisis of 1998 and periodic droughts. While such risks cannot be
entirely mitigated, Moldova’s progress toward macroeconomic stability and stronger market
institutions can have a marked impact in increasing its economic resilience.

                                   Table 2: Key Economic Indicators

                                                            Actual          Est             Projected
                                                          1999    2000      2001    2002      2003      2004
 INCOME, OUTPUT, and INFLATION
 GNP per Capita (US$, Atlas method)                        410       390     400     450       480       520
 Real GDP Growth (%, calculated from 1995 prices)          -3.4      2.1      6.1     4.8       5.0       5.0
 Consumer Price Index (% change)                           39.3    31.3       9.8     6.6       8.4       6.0
 PUBLIC SECTOR BUDGET
 Overall Balance (cash basis)                              -6.1      -3.0    -0.6    -3.2      -2.4      -1.1
 EXTERNAL BALANCE
 Current Account Balance (% GDP)                           -4.0      -9.4    -9.4    -8.9      -6.8      -6.4
 FDI/GDP                                                    3.3      9.9      8.5     6.1       9.4       7.7
 TDS/XGS                                                   30.0    18.1      17.6    21.5      22.1      21.5
 TDO/GDP                                                   87.5    96.7      82.9    79.0      76.2      72.8
 Gross Official Reserves (in months of imports of G&S)      2.6      2.5      2.3     2.1       2.8       3.1
 Exchange Rate (Average)                                   10.5    12.4      12.9    13.5      14.4      14.9
 Imports
                V. PROPOSED IDA AND IFC INTERIM OPERATING PLAN

A. EXPERIENCE UNDER THE 1999 CAS

33.     The 1999 CAS developed three lending scenarios based on performance under the
following criteria: (i) macroeconomic management; (ii) structural reforms; (iii) poverty reduction;
and (iv) portfolio performance. In the event, policy performance was mixed with “stop-go”
implementation due to frequent Government changes and early elections. While the “high case”
triggers were predominantly met, several of the associated target dates were not met. IDA sector
strategies were drawn up for rural, energy, and private sector development, and the operational
pipeline strengthened both in terms of investments and sector linkages to the adjustment program.
However, IDA lending for energy and rural investment was delayed pending implementation of
MOLDOVA                                               - 10 -                                     CAS Progress Report

sector policy reforms. The composition of the lending program remained as anticipated except
for the public sector reform credits which were delayed. As a result, Moldova was not able to use
IDA resources as fully as had been anticipated within the CAS timeframe. Actual lending in
FY99-01 totaled US$76 million – an annual average of US$25 million - as compared to US$125
million (an annual average of US$42 million) anticipated in the CAS as the most likely outcome
(Box 2). Actual lending included SAC II in FY99 to support the Government’s structural reform
program and ease the impact of the Russia crisis, and projects to support community driven
development, improved social protection and health care. SAC II was ultimately and
satisfactorily disbursed by the end of FY00 and a US$5 million supplement was approved in
FY02 to alleviate the devastating impact of a severe ice storm on energy infrastructure.
                Box 2: Planned and Actual IDA Lending for Moldova (FY99-FY01)
                                                                                             Lending
  Lending Scenarios                                                             Planned in the                  Actual
                                                                                  1999 CAS
                                                                                (US$ millions)
                                                                                                       (US$ millions)
  High Case: IMF-supported macroeconomic program on track;                  65.0     FY99            66.0     FY99
  satisfactory implementation of privatization program, agriculture,       130.0     FY00-01
  and energy sectors and public sector reform programs; improved
  portfolio performance
  Base Case: IMF-supported program on track; uneven                         65.0     FY99
  implementation of structural reforms in the enterprise, agriculture,      60.0      FY00-01
  and energy sectors, and public sector reform programs; improved
  portfolio performance
  Low Case: Reform implementation stalled                                  65.0      FY99
                                                                           25.0      FY00-01         10.0         FY00-01


34.     The performance of the IDA-financed project portfolio has improved, demonstrating the
value of investment lending as a significant element of IDA’s overall assistance program. The
high case portfolio performance triggers have been met – the disbursement ratio was consistently
above CAS targets, and currently there are no problem projects (Table 3). Undisbursed balances
have gone down from US$100 million in FY99 to US$42 million as of end April 2002, indicating
accelerated results on the ground. Some generic issues remain to be tackled. This performance
has depended crucially on the availability of Dutch grant resources for project counterpart funds
which in the longer term must be funded from domestic revenue resources. In addition, recurrent
and disruptive investigations by the Court of Accounts which interprets its mandate far beyond
the usual public sector audit function, has systematically released matters under investigation to
the press, and appears subject to insufficient Parliamentary oversight, have severely impaired the
functioning of several project implementation units (PIUs) and other market-oriented institutions.
Finally, the harmonization of PIU staff salaries and terms could remove another source of
administrative friction.

              Table 3: FY99 CAS Portfolio Performance Triggers and Outcomes
                                              FY99                       FY00                     FY01
                Trigger
                                      CAS                       CAS                       CAS
                                     Target     Outcome        Target      Outcome       Target      Outcome
      Disbursement Ratio (%)            18           32         19              21         20            29
      Problem Projects (%)              18           9          15              20         10               0

35.      Lessons learned include the need to: (i) continue to emphasize institutional strengthening;
(ii) ensure that IDA assistance is commensurate with ability to implement; (iii) reach agreement
on sector policies in the context of lending for individual sectors; (iv) promote community driven
development which has proven to be a very effective mechanism; (v) broaden the participation of
MOLDOVA                                        - 11 -                           CAS Progress Report

and strengthen the dialogue with the public on development issues; and (vi) establish the
analytical base for policy measures and foster dialogue and debate with stakeholders to promote
understanding and ownership. For example, the preparation and dissemination of the agricultural
sector strategy has been key in building consensus and providing the underpinnings of the
agricultural reforms to be supported by SAC III. The Debt Sustainability Analysis has been
instrumental in formulating the Government’s debt management strategy. The IDA-financed
Social Investment Fund has successfully demonstrated the sustainability of community driven
development in raising incomes and living standards in poorer communities. This initiative helps
empower poor communities, and directly benefits vulnerable groups such as orphans, disabled
and other disadvantaged children. A grant from the Japanese Social Development Fund will
extend support to Romanian curriculum schools and other education investments in selected
Transnistrian communities in which different sub-groups are willing to work together to support
the investments.

B. OBJECTIVES FOR FY02-03

36.      The objectives of the 1999 CAS – macroeconomic stability and growth, private sector
development and public sector reform – continue to frame the key development challenges for
Moldova under the broad goal of poverty reduction. Within these objectives, the relative
priorities for the period of this CAS Progress Report reflect the progress achieved under the 1999
CAS, as well as new conditions that have arisen under the current government.

37.      Government actions to sustain sound macroeconomic policies would build on the
successful stabilization efforts of recent years. Key among these is maintaining a fiscal stance
which is consistent with low inflation, maintaining social expenditures at current levels in real
terms, while improving their targeting and efficiency by rationalizing excess facilities and
staffing. In parallel, wage and pension arrears as well as inter-agency arrears should be cleared.
It is also crucial that the Government implement an effective debt management strategy that
meets short term obligations in a manner consistent with longer term sustainability and growing
creditworthiness.

38.      The Government’s private sector development program entails completing the CAS
agenda and further strengthening the role of market forces in the economy. Major enterprises,
such as wineries, tobacco and Moldtelecom, which are still owned by the state need to be
privatized. In parallel, the ongoing restructuring and privatization of the energy sector, including
power, gas and district heating, needs to be completed. The Government also needs to ensure that
all agricultural policies and programs fully respect property rights and allow market forces and
incentives to prevail. In addition, the Government needs to promote a market and investor
friendly business environment with special attention to SME development. Protecting property
rights and contract enforcement requires access to trusted conflict resolution mechanisms and
affordable legal services which are currently in short supply. A comprehensive reform of the
legal and judicial framework is, therefore, also essential.

39.      Public sector reform priorities remain as articulated in the 1999 CAS. They need to be
addressed recognizing the critical role of the rule of law and institutions to apply it effectively.
Building on the initial steps during the last CAS period, the Government has requested IDA
assistance to help tackle the sizable governance agenda to complement policy reforms and
facilitate Moldova’s modernization process. Key measures include public administration reform
and a merit-based civil service with concomitant salary reforms. Public expenditure reforms,
including strategic planning, expenditure rationalization, especially in the social sectors,
expenditure monitoring and a robust audit function are also important objectives.
MOLDOVA                                        - 12 -                          CAS Progress Report

C. IDA/IFC PROGRAM

40.     The proposed interim operating plan covers the period FY02-03 pending the
completion of the full PRSP in FY03 and subsequent full CAS. The program includes
support for agricultural and energy investments which were delayed under the 1999 CAS.
The program also includes support for new investments consistent with the increased poverty
orientation under the PRSP process and with broader global or regional priorities flowing
from the Bank’s global/regional agenda, such as water supply, environment under the Global
Environment Facility and regional trade and transport facilitation for Stability Pact members.
Adjustment lending under the proposed SAC III would support continued structural reforms
thereby completing the private sector development agenda of the 1999 CAS.

41.     The IFC will continue its focus on helping develop financial markets and SMEs. In
addition, IFC’s private sector development priorities include agriculture and agri-processing,
tourism, and the groundwork for eventual support to privatization of infrastructure sectors.
To improve SME access to long-term financing, IFC is also looking for opportunities to
establish leasing operations. On the basis of studies on the hotel and wine industries, IFC is
now reviewing the the potential for expanding hotel capacity and modernizing Moldova’s
economically important wine sector, including restructuring and renovation of plantations
and installation of modern production and bottling equipment. IFC also anticipates
investment opportunities in food processing, packaging and distribution.

42.      In terms of economic and structural policies, Moldova is now operating in a base case
scenario reflecting a combination of continued reform with discontinuities in implementation due
to political uncertainties. Triggers for the base case include: the maintenance of a satisfactory
macro-economic framework, satisfactory formulation and implementation of the PRSP,
satisfactory implementation of the structural reforms supported by SAC III, progress on public
sector reform, and continued satisfactory portfolio performance. The base case anticipates that
the pace of implementation could be affected by political divisions and the need for consensus
building, as well as capacity constraints in Government administration.

43.    This CAS Progress Report does not include a high case scenario. At this juncture, it is
important that Moldova establish a track record of consistent uninterrupted reform
implementation under the base case. A low case scenario would result from an explicit break in
policy dialogue with the international financial institutions (the IMF on the macroeconomic
framework, and the Bank on structural reforms) with low likelihood of getting back on track
without a fundamental change in the economic or political regime.

44.      Total lending of up to US$108 million in the base case would consist of up to US$40
million in adjustment lending, and up to US$68 million in investment lending. Adjustment
lending has proven the most effective means to deliver support for reforms in Moldova allowing
for effective treatment of cross-cutting reforms and cross-sectoral linkages which characterize the
transition process in the country. In addition, adjustment operations have played an important
role in the political economy of Moldova by helping to “bridge” transitions between
Governments while ensuring continuity in the broad policy framework. Adjustment lending is
also essential for Moldova’s financial sustainability over the short term. The country faces a
financing gap of about US$99 million in 2002 (excluding disbursements under the PRGF
Arrangement with the IMF and IDA adjustment lending) due to the structure of debt service
payments which drop off markedly after 2002.
MOLDOVA                                          - 13 -                              CAS Progress Report

                      Box 3: Planned IDA Lending for Moldova (FY02-03)
                                                                           Lending Program
 Lending Scenarios
                                                                             US$ millions
 Base Case:                                                   FY02:
  Satisfactory macro-economic framework maintained (as       SAC Supplement                        5.0
     evidenced by an IMF-supported program being on track)    SAC III                              30.0
  PRSP satisfactorily formulated and implemented             Rural Investment and Services        10.5
  Structural reforms supported by SAC III satisfactorily     FY03:
     implemented                                              Energy II                            35.0
  Progress in implementation of public sector reforms        Public Sector Reform                 10.0
  Portfolio performance remains satisfactory                 Pilot Water Supply and Sanitation    10.0
                                                              Trade and Transport Facilitation      7.0
 Low Case:                                                    FY02:
  Explicit break in policy dialogue with the IMF on macro-   SAC Supplement                        5.0
    economic framework and the Bank on structural reforms     Rural Investment and Services        10.5
  Low likelihood of getting back on track without a          FY03:
    fundamental change in the economic or political regime    Pilot Water Supply and Sanitation    10.0
                                                              Trade and Transport Facilitation      7.0

45.     In addition to the proposed SAC III accompanying this CAS Progress Report, a first
Public Sector Reform Credit is planned for FY03 to initiate support for the Government in this
area. Meanwhile, to modernize agriculture and raise rural incomes and living standards, a
proposed IDA Credit would finance a Rural Investment and Services Project (FY02). Post-
privatization, the project would provide support services and affordable financing to private
farmers and rural businesses. With IDA assistance, the Government has established a robust
regulatory framework for the energy sector and increased private participation in the sector. An
IDA Credit for Energy II (FY03) would help modernize the transmission network and
commercialize sector operations.

46.    Through the Trade and Transport Facilitation in South Eastern Europe Project (FY03),
Moldova would become one of eight Stability Pact member countries modernizing customs,
border controls, and cross border-cooperation. The project would also reduce opportunities for
smuggling and corruption. A pilot Water Supply and Sanitation Project (FY03) would test
approaches to maximize the poverty reduction impact and enhance prospects for community-
driven development initiatives in villages and small towns. It would also improve sector
governance and start the process of commercializing utilities. In the event that the policy
environment necessitates a shift to the low case, lending would be limited to a maximum of
US$30 million primarily in the social sectors (in addition to the US$5 million SAC supplement
approved in November 2001.

47.     Analytical and advisory activities (AAA) will continue to play an important role in
informing Government decision-making. The ongoing Public Economic Management Review
will help fine-tune public sector reform measures, including public administration, the civil
service, fiscal decentralization, public expenditure management and budget systems and
processes. A Legal and Judicial Assessment is helping lay the basis for decisions on policy
measures to improve governance. An ongoing Transport Policy Note will inform Government
decisions in the transport sector in the context of the Stability Pact. In addition to the CFAA and
CPAR mentioned earlier, upcoming activities in FY03 include a trade study, a growth study, an
updated poverty assessment, and assistance to help formulate the PRSP.

D. PARTNERSHIPS

48.    Bank assistance during the CAS period was complemented by support from the IMF and
a number of bilateral development partners. IMF-support for the Government’s reform program
continues to be closely coordinated with Bank support for structural reforms. The Netherlands
has provided crucial budgetary support during the reform process, and complemented Bank
MOLDOVA                                       - 14 -                          CAS Progress Report

assistance for private sector development, and projects in the health and agriculture sectors. The
Japanese PHRD Fund has provided a number of grants to prepare adjustment operations as well
as investment projects in a several areas including agriculture, energy, and health, social
protection and private sector development. EU assistance and the TACIS Program have played
an important role in supporting the structural adjustment process. USAID has provided key
support in land distribution and in establishing property rights thereby helping to develop land
markets, energy sector improvements, and customs modernization. UK DFID is an important
partner on debt and poverty alleviation issues, including the SIF and social assistance. SIDA and
GTZ are also supporting structural reforms and the development of key areas such as agriculture,
community driven development under the SIF and child protection. UN agencies are providing
key support to help reduce poverty, TB, and AIDS, and improve health and education services.
NGOs like the Soros Foundation are playing an important role for example in combating
trafficking in women and strengthening civil society.

                           VI. RISK MANAGEMENT

49.      The Bank Group’s program in Moldova faces higher than average risks. The foremost
risk is a disruption in the program and a setback to reforms resulting from lack of Government
commitment and/or capacity to follow through. The design of IDA adjustment lending mitigates
this risk through multi-tranching and emphasis on up-front actions. Furthermore, investment
lending in key sectors such as agriculture is linked to up-front agreement on sector policy
frameworks. Beyond conditionality, broad consultation and dissemination of policy analyses will
help build consensus among diverse stakeholders in parallel with the PRSP preparation process.
IDA AAA and assistance from other partners specifically supports increasing capacity to
formulate policy and implement reforms.

50.    Moldova’s economy remains vulnerable to negative external shocks, especially periodic
droughts, regional financial contagion, and fluctuations in demand for Moldovan exports Land
reform and sound agricultural policies have resulted in more stable agricultural production.
Despite drought conditions in 2000 for example, Moldova’s agricultural production was good.
Moldova’s impressive fiscal consolidation and lower reliance on the domestic debt market, and
prudent central bank policies with increased reserve levels effectively reduce the country’s
exposure to regional financial shocks. Finally, ongoing macroeconomic and structural reforms
encourage the shift of external trade to new markets.

51.    Weak systems for the implementation of the rule of law present additional risks.
Strengthened coordination with other development partners, and the implementation of the
Government’s public sector reform program will over time upgrade Moldova’s administrative
machinery to levels commensurate with the development challenge. Integrated efforts to develop
economic opportunities for the poor, protect rights, and promote the appreciation of the rule of
law would increase the demand and prospects for effective institutional reform.


                                      James D. Wolfensohn
                                           President



By:

Shengman Zhang                                                                    Peter Woicke

Washington, DC
[DATE]

								
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