Document of The World Bank

Report No: ICR 62713

IMPLEMENTATION COMPLETION AND RESULTS REPORT

(IBRD-G 2040)

ON

PRIVATE AND FINANCIAL SECTOR POLICY BASED GUARANTEE

IN THE AMOUNT OF

UP TO EUR 300 MILLION

(NOT TO EXCEED THE EQUIVALENT OF US$400 MILLION)

TO THE

REPUBLIC OF SERBIA

June 20, 2011

Private and Financial Sectors Development Unit (ECSPF) South East Europe Country Unit (ECCU4) Europe and Central Asia (ECA)

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(Exchange Rate Effective June 16, 2011)

Currency Unit =Serbian Dinar (RSD) RSD 1.00 = US$ 0.01

US$ 1.00 = RSD 67.417

FISCAL YEAR 1 January – 31 December

ABBREVIATIONS AND ACRONYMS

CAR Capital Adequacy Ratio CPS Country Partnership Strategy

DDOR DDOR Insurance Company DIA Deposit Insurance Agency DIF Deposit Insurance Fund DPL Development Policy Loan

EBRD European Bank for Reconstruction and Development EU European Union FDI Foreign Direct Investments

FSAP Financial Sector Assessment Program FSSP financial sector support program GoS Government of Serbia ICR Implementation Completion and Results Report IDF Institutional Development Fund ISR Implementation Status and Results Report JSC Joint Stock Company

LLCs Limited Liability Companies LOLR Lender of Last Resort M&E Monitoring and Evaluation

MOERD Ministry of Economy and Regional Development MoF Ministry of Finance MoJ Ministry of Justice MoU Memorandum of Understanding NBS National Bank of Serbia NPL Non-performing loans PA Privatization Agency

PBG Policy Based Guarantee PDMA Public Debt Management Authority PDO Program Development Objectives

PFDPLs Programmatic Private and Financial Sector Development Policy Loans PFSAC Private and Financial Sector Adjustment Credit

PFSPBG Private and Financial Sector Policy Based Guarantee

Vice President: Philippe H. Le Houreou

Country Director: Jane Armitage

Sector Manager: Lalit Raina

Task Team Leader: Aurora Ferrari

ICR Team Leader: Gordana Popovikj Friedman

REPUBLIC OF SERBIA PRIVATE AND FINANCIAL SECTOR POLICY BASED GUARANTEE

CONTENTS

Data Sheet A. Basic Information B. Key Dates C. Ratings Summary D. Sector and Theme Codes E. Bank Staff F. Results Framework Analysis G. Ratings of Program Performance in ISRs H. Restructuring

Table of Contents

1. Program Context, Development Objectives and Design .................................................1 2. Key Factors Affecting Implementation and Outcomes ...................................................5 3. Assessment of Outcomes ...............................................................................................9 4. Assessment of Risk to Development Outcome.............................................................20 5. Assessment of Bank and Borrower Performance..........................................................21 6. Lessons Learned ..........................................................................................................23 Annex 1 Bank Lending and Implementation Support/Supervision Processes....................25 Annex 2. Beneficiary Survey Results...............................................................................26 Annex 3. Stakeholder Workshop Report and Results .......................................................27 Annex 4. Summary of Borrower’s ICR and/or Comments on Draft ICR...........................28 Annex 5. Comments of Cofinanciers and Other Partners/Stakeholders.............................29 Annex 6. List of Supporting Documents ..........................................................................30

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A. Basic Information

Country Serbia Program Name Private and Financial Sector Policy Based Guarantee

Program ID P102651 L/C/TF Number(s) IBRD-G 2040

ICR Date 06/20/2011 ICR Type Core ICR

Lending Instrument Guarantee Borrower REPUBLIC OF SERBIA

Original Total Commitment

Up to USD 400.0M Disbursed Amount N/A

Implementing Agencies: The Ministry of Finance

Cofinanciers and Other External Partners

B. Key Dates Second Programmatic Private Financial Sector Development - P096711

Process Date Process Original Date Revised / Actual Date(s)

Concept Review: 09/07/2010 Effectiveness: 04/15/2011 04/15/2011

Appraisal: 12/28/2010 Restructuring(s):

Approval: 02/10/2009 Mid-term Review:

Closing: 04/13/2017 04/13/2017

C. Ratings Summary C.1 Performance Rating by ICR

Overall Program Rating

Outcomes Highly Satisfactory

Risk to Development Outcome Moderate

Bank Performance Highly Satisfactory

Borrower Performance Highly Satisfactory

C.2 Detailed Ratings of Bank and Borrower Performance (by ICR) Overall Program Rating

Bank Ratings Borrower Ratings Quality at Entry Highly Satisfactory Government: Highly Satisfactory

Quality of Supervision: Highly Satisfactory Implementing Agency/Agencies:

Satisfactory

Overall Bank Performance

Highly Satisfactory Overall Borrower Performance

Highly Satisfactory

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C.3 Quality at Entry and Implementation Performance Indicators

Implementation Performance

Indicators QAG Assessments (if any)

Rating:

Potential Problem Program at any time (Yes/No):

No Quality at Entry (QEA)

None

Problem Program at any time (Yes/No):

No Quality of Supervision (QSA)

None

DO rating before Closing/Inactive status

None

D. Sector and Theme Codes Second Programmatic Private Financial Sector Development - P096711

Original Actual

Sector Code (as % of total Bank financing)

Banking 50 50

Central government administration 33 33

General industry and trade sector 17 17

Theme Code (as % of total Bank financing)

State enterprise/bank restructuring and privatization 67 67

Regulation and competition policy 17 17

Corporate governance 16 16

E. Bank Staff Second Programmatic Private Financial Sector Development - P096711

Positions At ICR At Approval Vice President: Philippe H. Le Houerou Philippe H. Le Houerou Country Director: Jane Armitage Jane Armitage Sector Manager: Lalit Raina Lalit Raina Task Team Leader: Aurora Ferrari Aurora Ferrari ICR Team Leader: Gordana Popovikj Friedman ICR Primary Author: Gordana Popovikj Friedman

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F. Results Framework Analysis Program Development Objectives (from Program Document) The objective of the PFSPBG is to support reforms in three policy areas: (i) enhancing business environment to encourage private sector investment; (ii) strengthening financial discipline with continued reform of the non private enterprise sector with a particular focus on bankruptcy; and (iii) building a stable and more efficient financial sector through continued restructuring of state holdings in banking, enhancing crisis preparedness, supporting insurance sector development, and promoting development of capital markets. Revised Program Development Objectives (as approved by original approving authority) N/A (a) PDO Indicator(s)

Indicator Baseline Value

Original Target Values (from

approval documents)

Formally Revised Target Values

Actual Value Achieved at

Completion or Target Years

Indicator 1 :

Improved legal framework for corporate governance in place. Over the medium term, such a framework will support: (a) increased independence of the internal supervision body in Joint Stock Companies (JSCs); (b) increased shareholders rights; (c) stronger role of non-executive and independent members of the board; and (d) increased transparency of reporting.

Value (quantitative or Qualitative)

Revised Law on Business Entities submitted to Parliament

Revised Law on Business Entities submitted to Parliament

Date achieved N/A 12/31/2010 12/31/2010 Comments (incl. % achievement)

This outcome indicator was achieved 100%. Further, the revised Law on Business Entities was adopted by Parliament on 05/25/2011. It is in compliance with EU directives.

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Indicator 2 :

New set of regulations in place reflecting: (a) the elimination of not less than 190 unnecessary regulations, and (b) the amendment of 25 regulations and 20 laws by the end of 2011. Implemented recommendations are to lead to annual cost savings for businesses of at least EUR 120 million by end 2011.

Value (quantitative or Qualitative)

None

Elimination of at least 190 regulations; amendment of 25 regulations and 20 laws.

Regulatory Impact Assessment in place, resulting in elimination of 192 regulations and 304 adopted recommendations for amendment of 30 regulations, 30 laws. Estimated savings of EU 142 million by end ’11.

Date achieved 12/31/2010 12/31/2010 Comments (incl. % achievement)

Achievement of over 100%.

Indicator 3 : Establishment of a comprehensive record of state support measures, including subsidies and grants contributing to better expenditure management and more transparency.

Value (quantitative or Qualitative)

Registry of Regional Development Measures and Incentives, satisfactory to the Bank, established within the SBRA and is operational

Registry of Regional Development Measures and Incentives, satisfactory to the Bank, established within the SBRA and is operational.

Date achieved 12/31/2010 12/31/2010 Comments (incl. % achievement)

100 Achievement,

Indicator 4 : CAR of the banking system is maintained at the level of at least 12% and the required recapitalizations are conducted using transparent criteria allowing the use of public funds only where there is no private sector alternative.

Value (quantitative or Qualitative)

At least 12% CAR and transparent recapitalization.

CAR 20.1% in the banking sector and three banks were recapitalized using transparent methods.

Date achieved 12/31/2010 12/31/2010 Comments (incl. % achievement)

Achievement 100%.

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Indicator 5:

Bank resolution framework improved through the introduction of: (i) bridge bank resolution on a closed bank basis for systemic banks; and (ii) financial assistance in the form of grants, loans or guarantees based on a least cost test performed by the DIA, and emergency funding arrangements for DIA.

Value (quantitative or Qualitative)

Amendments to the Laws on Banks, Bankruptcy and Liquidation of Banks and Insurance Companies, and Deposit Insurance and Deposit Insurance Agency enacted. Law on Budget for 2011 includes a provision for government guarantee to DIA.

Amendments to the Laws on Banks, Bankruptcy and Liquidation of Banks and Insurance Companies, and Deposit Insurance and Deposit Insurance Agency enacted. Law on Budget for 2011 includes a provision for government guarantee to DIA.

Date achieved 12/31/2010 12/31/2010 Comments (incl. % achievement)

Indicator 6: Consolidation of the RoS holdings in banking sector: banks with majority RoS ownership reduced from 4 to 2 by 2010.

Value (quantitative or Qualitative)

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Banks with majority RoS ownership reduced from 4 to 2.

Banks with majority RoS ownership reduced from 4 to 2.

Date achieved 12/31/2010 12/31/2010 Comments (incl. % achievement)

Credy Banka was sold to a foreign group, Postanska and Privredna Pancevo were merged, and Srpska Banka will remain as is. This outcome indicator was fully achieved.

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(b) Intermediate Outcome Indicator(s)

Indicator Baseline Value

Original Target Values (from

approval documents)

Formally Revised

Target Values

Actual Value Achieved at

Completion or Target Years

Indicator 1 : A bank diagnostic and triage exercise is completed for the entire banking sector in Serbia and all banks.

Value (quantitative or Qualitative)

Bank diagnostic and triage exercise was completed.

Date achieved 12/31/2010 Comments (incl. % achievement)

100% achievement. The bank diagnostic and triage exercise is now regularly conducted every six months.

G. Ratings of Program Performance in ISRs

No. Date ISR Archived DO IP

Actual Disbursements (USD millions)

H. Restructuring

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1. Program Context, Development Objectives and Design The Programmatic Private and Financial Sector Policy Loans (PFDPLs) to the Republic of Serbia were a series of two operations during the period 2009-2010, totaling EUR 105.7 million (US$150 equivalent) of World Bank funding. The PFDPL series was designed to support the Government of Serbia (GoS) structural reform program through improvements in the business environment, continued reform in the enterprise sector and public utilities and building a more efficient and stable financial sector. The PFDPL series was originally envisaged to include three operations, however, the plan for a Third PFDPL was changed to allow for the use of a Policy Based Guarantee in the amount of EUR 300 million, upon request from the Government of Serbia. The selected lender is Société Générale. The use of an IBRD guarantee has helped the GoS gain access to international markets at lower costs and longer maturities. The Private and Financial Sector Policy Based Guarantee (PFSPBG) has allowed Serbia to issue a relatively sizable commercial debt in a challenging environment and help GoS expand its existing investor base. The design of the underlying financing and of the guarantee coverage has been driven by the GoS need to match its debt (portfolio risk) management and reduce funding costs. The terms of the commercial loan offered by Société Générale represent a significant improvement in interest rate charged for borrowing in hard currency, considerably extend the maturity, and further the process of Serbia’s full integration into the international financial market. Furthermore, the GoS’ status as a global borrower has been solidified, which may lead to better terms for borrowing banks and companies in Serbia. As a policy based guarantee is not a DPL option under current Bank policies, the PFDPL series had to be terminated after PFDPL 2, and PFDPL 3 has been transformed in a stand-alone Policy Based Guarantee operation, with an almost identical policy matrix1 the originally envisaged PFDPL 3.

1.1 Context at Appraisal Serbia began its transition to a market economy late and under difficult circumstances. The 1990s was a lost decade for Serbia. Its economy was devastated by regional conflicts, international sanctions, and trade shocks following the break-up of the former Yugoslavia in 1991. These effects were compounded by delayed transition and poor economic management. By 2000 recorded GDP had fallen to below one-half of its 1989 level, while other central and eastern European countries had made significant progress on the transition path. In January 2001, the new Government launched an ambitious reform program for a rapid transition to a more market oriented economy, normalization of relations with foreign creditors, and integration with regional, European Union (EU) and world markets. Fiscal

1 In consultations with the Borrower, some of the non-core benchmarks of the original matrix of PFDPL3, pertinent to the energy sector reforms, were omitted and more emphasis was places on the financial and enterprise sectors reforms.

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balance was achieved in 2004, as structural reforms began to have impact and expenditure commitments were reduced, and a surplus of 0.8 percent of GDP was achieved in 2005. The Serbian economy grew rapidly during the first decade of the century and until 2008, fuelled by capital inflows, exports and domestic demand, and supported by the economic reforms mentioned above. GDP growth averaged 5.4 percent per year during 2001-08, with exports growing at an average annual rate of around 30 percent, albeit from a low base. Output rose in real terms by nearly 50 percent between 2000 and 2008, as the corporate sector started to post profits and the banking sector restructured. About 80 percent of growth was attributed to non-tradable sectors (financial, telecoms, retail). Strong economic growth was, however, accompanied by a widening external current account deficit, rapid credit growth, increasing private sector debt and non-performing loans in the period immediately preceding the financial crisis. Imports grew faster than exports and the trade deficit reached 22.8 percent of GDP in 2008. The external current account deficit increased from 8.7 percent in 2005 to 18.3 percent in 2008, driven by a widening private sector savings-investment imbalance (about 90 percent of the deficit in 2008). The contraction of global demand and spending largely impacted the real sector and the competitive position of private sector companies. The economy also faced the remnants of the previous systems in the forms of cumbersome, business-unfriendly regulations with legislation not compatible with the EU, slow public administration and large number of “socially-owned” enterprises in the portfolio of the Privatization Agency (PA). The business regulatory environment, a key factor for sustainable and stable private sector growth and job creation, needed improvement to facilitate firm entry and growth and approximation to the business regulations of the EU. The Government started a comprehensive reform program in business entry, adoption of key elements of business legislation, enhancement of access to finance and introduction of Regulatory Impact Assessment (RIA) in the legislative process. The new Government in 2008-2009 demonstrated commitment to deepen the reforms and further enhance the business climate in the country, by streamlining the business registration procedures, improving the legal framework for corporate governance, commencing the implementation of a comprehensive regulatory review called “regulatory guillotine”, institutionalizing RIA and strengthening its role, and strengthening the framework for enforcement of contracts. For the remaining socially owned enterprises (SOEs), the GoS developed a program to continue with restructuring, privatization and/or bankruptcy of remaining of SOEs, thus strengthening financial discipline. In the financial sector, substantial reforms were undertaken to deal with the state ownership in the banking and insurance sectors, develop the capital markets, improve the legal framework for supervision and introduce measures to insure stability in the sector during and following the financial crisis. The banking sector faced the global financial crisis in a healthy situation, with high liquidity and capital buffers due to conservative policies by National Bank of Serbia (NBS). However, the magnitude of the international crisis revealed some challenges. A fast withdrawal of over 15 percent of deposits took place amid false media reports and rumors in late 2008. The GoS adopted then a set of measures for crisis preparedness. The measures aimed at maintaining

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consumer confidence and stability in the banking sector and included the launching of a financial sector support program (FSSP) under the auspices of the “Vienna initiative” (with 10 foreign banks and their home supervisors) and with support from the IMF. In addition, a comprehensive program for restructuring and consolidation of state-owned banks, strengthening of the insurance supervision and development of capital markets legal framework (Securities Law and the Law on Business Entities). The economy picked up in 2010, despite the fact that it was severely hit by the global crisis. Strong exports and the adoption of timely and appropriate measures were key in re-establishing macroeconomic stability. As far as government borrowing is concerned, Serbia’s experience is limited in terms of instrument and sources. An assessment of the latter had to be conducted to establish Serbia’s eligibility for a policy based guarantee. In particular, GoS has never accessed international markets independently. Serbia did borrow once, but as Serbia and Montenegro, in 2005, with the issuance of US$1 billion 20-year Eurobond designed to exchange old London Club debt. However, this bond is currently thinly traded in markets, and it yields roughly 7 percent, with somewhat limited volatility. Otherwise, GoS has tapped only the local capital market and the domestic banking sector, the latter primarily through club loans. Borrowing heavily from local market sources, banks in particular, has increased the risk of collusion among financial actors. Moreover, reliance on local markets may lead to some crowding out of the corporate and household sectors in the context of more deleveraging by subsidiaries of international banks operating in Serbia. To improve its debt management capacity, the GoS approved a medium-term debt management strategy and created a debt management agency. The strategy, which covered the years 2009-2011, was included in the Budget Memorandum. The main objective of the original strategy was to increase the share of government debt denominated in local currency. This objective was to be reached in two stages. In a first phase, dinar-denominated securities would be issued only for short-term liquidity financing, while long-term securities in dinars would be considered in the medium-term once the dinar-euro interest rate spread had declined. The establishment of the Public Debt Management Authority (PDMA) in 2009 strengthened the institutional framework for government debt management. The PDMA is now fully staffed with 23 officials. Its priorities are enhancement of the debt management system, preparation of a procedures manual, and issuance of more dinar-denominated securities in the local market. Subsequent debt strategies were more comprehensive. Increased dinar exposure in the medium-term was complemented by aims to diversify Euro sources in the shorter-term. The updated strategy for 2010-2012 continued to focus on increasing local currency exposure in the medium term. In addition, the 2011-2013 strategy aims to access new sources of financing in global markets, specifically Euro-denominated debt, in an effort to reduce the interest paid and lengthen the maturity of the debt.

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1.2 Original Program Development Objectives (PDO) and Key Indicators (as approved)

Program Development Objective:

The objective of the Private and Financial Sector Policy Based Guarantee (PFSPBG) is to support reforms in three policy areas: 1) enhancing business environment to encourage private sector investment; 2) strengthening financial discipline with continued reform of the non private enterprise sector with a particular focus on bankruptcy; and 3) building a stable and more efficient financial sector through continued restructuring of state holdings in banking, enhancing crisis preparedness, supporting insurance sector development, and promoting development of capital markets. Key Indicators:

• Improved legal framework for corporate governance in place, to support in the medium term: (a) increased independence of the internal supervision body in Joint Stock Companies (JSCs); (b) increased shareholders rights; (c) stronger role of non-executive and independent members of the board; and (d) increased transparency of reporting.

• New set of regulations in place reflecting: (a) the elimination of not less than 190 unnecessary regulations, and (b) the amendment of 25 regulations and 20 laws by the end of 2011. Implemented recommendations are to lead to annual cost savings for businesses of at least EUR 120 million by end 2011.

• Establishment of a comprehensive record of state support measures, including subsidies and grants contributing to better expenditure management and more transparency.

• Capital Adequacy Ratio (CAR) of the banking system maintained at the level of at least 12 percent.

• Bank resolution framework improved through the introduction of: (i) bridge bank resolution on a closed bank basis for systemic banks; and (ii) financial assistance in the form of grants, loans or guarantees based on a least cost test performed by the DIA, and emergency funding arrangements for the Deposit Insurance Agency (DIA).

• Consolidation of the Republic of Serbia (RoS) holdings in banking sector: banks with majority RoS ownership reduced from 4 to 2 by 2010.

1.3 Revised PDO and Key Indicators, and Reasons/Justification

There were no revisions of the PDOs.

1.4 Original Policy Areas Supported by the Program (as approved): The objective of the Private and Financial Sector Policy Based Guarantee was to support reforms in three policy areas: Pillar I: Enhancing business environment

• Further simplification of business entry through implementation of a single agency approach to business registration;

• Improving the legal framework for strengthening corporate governance and facilitating business operations;

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• Streamlining regulations of business operations and reducing business compliance costs;

• Improving legal and institutional framework for competition; • Improving effectiveness of enforcement of court decisions and authentic documents.

Pillar II: Strengthening financial discipline

• Facilitating bankruptcy of Socially-Owned Enterprises (SOE); • Improving financial discipline in the socially and state-owned sector.

Pillar III: Building a stable and more efficient financial sector

• Enhancing crisis preparedness and bank resolution; • Restructuring and divestment of state-owned banks; • Strengthening the insurance sector; and • Supporting capital market development.

1.5 Revised Policy Areas

In relation to the PFDPL series, the policy areas supported under the PFSPBG were streamlined and focused on the business environment and financial sector reforms, while the energy sector was excluded from the policy matrix.

1.6 Other significant changes The PFSPBG emerged from a previous Programmatic Private and Financial Sector Policy Development Loan (PFDPL) series which was initially envisaged to consist of a series of three regular development policy loans to support the structural reform agenda of the Government of Serbia. However, as the international crisis hit Serbia, it was necessary to adjust the scope and refocus the design of the operations to include measures aimed at maintaining stability in the banking sector. Furthermore, on request from the GoS, the PFDPL series was terminated after the completion of the Second PFDPL operation, whereas the planned Third PFDPL in the series was transformed into a [stand-alone] Private and Financial Sector Policy Based Guarantee (PFSPBG) in the amount of up to 300 million EUR (not exceeding an equivalent of 400 million USD). The cancelation of the third PFDPL was deemed consistent with the overall support to the original objectives of the PFDPL. The PFSPBG followed up on the implementation of the reforms supported by the PFDPL1 and PFDPL2. Use of the policy based guarantee allowed Serbia to benefit from access to the international markets at lower costs and longer maturities, driven by the need to match the country’s debt portfolio management and reduced funding costs.

2. Key Factors Affecting Implementation and Outcomes

2.1 Program Performance This operation is a Policy Based Guarantee from the IBRD. The guarantee covers the principal amount of a commercial bank borrowing of up to EUR 300 million, not exceeding the equivalent of US$400 million, with a 6-year bullet maturity on a non-accelerable basis. The loan proceeds were made available to the Borrower upon the effectiveness of the Loan Agreement with Société Générale, by ratification of the Law on Borrowing of the Republic of

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Serbia from Société Générale with a Guarantee from the World Bank, by the Parliament of Serbia on February 28, 2011 and published in the Official Gazette No.13-11. There were no changes to the terms of the loan from Société Générale from what described in the program document. The guarantee involves no immediate transfer of funds from the Bank but sufficient funds would need to be provisioned from the Bank assets to meet a call on the guarantee if required. When called under conditions provided for under the Agreement, the payment from the Bank will be made as a single payment to the lender or agent of the lender. The indemnity agreement between Serbia and the World Bank provides that the former will repay the latter on demand or as the Bank otherwise directs, if the guarantee is called. Table 1: Prior Actions for PFSPBF PRIVATE AND FINANCIAL POLICY BASED GUARANTEE Prior actions from Program Document Status 1) The Borrower’s Government has approved the draft Law on Business Entities, satisfactory to the Bank, and submitted it to its Parliament for adoption

Completed

2) The Borrower has completed a comprehensive review of regulations of business activities, and the Borrower’s Government has approved the recommendations of that review

Completed

3) The Registry of Regional Development Measures and Incentives, satisfactory to the Bank, has been established within the Serbian Business Registers Agency (SBRA) and is operational

Completed

(4) The National Bank of Serbia has completed a diagnostic assessment of all banks operating in Serbia in accordance with the methodology adopted under the Second Programmatic Private and Financial Development Policy Loan provided by the Bank, and enforced bank recapitalization to a capital adequacy ratio of at least 12%.

Completed

5) The Borrower’s Parliament has: a) enacted amendments satisfactory to the Bank to the Law on Banks, Law on Bankruptcy and Liquidation of Banks and Insurance Companies, Law on Deposit Insurance and the Law on the Deposit Insurance Agency; and b) enacted the Law on Budget for the year 2011 which contains a provision satisfactory to the Bank on the State Guarantee to the Deposit Insurance Agency.

Completed

6) Banks with Borrower majority ownership have been merged, privatized or restructured in accordance with the strategy adopted under the Second Programmatic Private and Financial Development Policy Loan provided by the Bank

Completed

2.2 Major Factors Affecting Implementation: Government Priorities and Commitment: The GoS put private sector development at the center of its strategy to promote growth and income convergence of European level. To increase the private sector contribution to growth, the GoS implemented a series of policy measures to increase productivity and investment, upgrading the physical infrastructure and its quality, improving the business environment, privatizing non-private enterprises, and promoting financial sector policies and FDI promotion. In fact, the core of GoS’s growth agenda was composed of improvements in the business environment, financial

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discipline/divestment of non-private enterprises and financial sector development. Although, by the second PFDPL, emphasis was placed on the financial sector in order to reduce macroeconomic/financial risks and prepare the country to better cope with a global financial crisis. The Government proved its commitment to reforms in the following areas supported by the PFDPL 1 and 2 and continued under PFSPBG:

• further enhance the business climate in the country, by streamlining the business registration procedures, improving the legal framework for corporate governance, implementing a comprehensive regulatory review called “regulatory guillotine”, and strengthening the framework for enforcement of contracts;

• in relation to the remaining socially owned enterprises (SOEs), the GoS facilitated the restructuring, privatization and/or bankruptcy of remaining of SOEs, by, continuing with the privatization/resolution of SoEs and enacting the new Law on Bankruptcy;

• further, in response to the global financial crisis, the Government adopted a set of measures aimed at strengthening crisis preparedness by maintaining consumer confidence and stability in the banking sector and by launching a financial sector support program (FSSP) under the auspices of the “Vienna initiative” (with 10 foreign banks and their home supervisors) and with support from the IMF. In addition, a comprehensive program for restructuring and consolidation of state-owned banks, strengthening of the insurance supervision, and gradually extended the maturity of T-bills thus improving debt management function.

EU Accession: A major factor affecting implementation was Serbia’s desire to accede to the EU. Around such desire, major forces seemed to have coalesced. EU accession has come to be perceived as the key driver of Serbia’s economic reforms, and to some extent as a source of stability in a region with a history of political instability. The objective of EU accession was particularly influential in the number of Laws which were developed with the PFDPL support as well as of other laws and by-laws, which complied with EU requirements. In April 2008 the Government Serbia signed a Stabilisation and Association Agreement (SAA) and in December 2009, submitted its application for EU membership. In February 2010, the Interim Agreement on Trade and Trade-related issues between Serbia and the EU (part of the SAA) entered into force. The importance of EU accession in the commitment of Serbia to the key reforms supported by the PFDPL (and other WB operations) could not be underestimated. History of successful cooperation in policy reforms with the World Bank: The reforms supported by the PFDPL series and the PFSPBG built upon (and continued) previous budget support policy operations financed by the World Bank which the GoS implemented with a good degree of success since the early 2000s. The operations included the Programmatic Private and Financial Development Policy Credit (PPFDPC-1) and a successful series of two consecutive Private and Financial Sector Adjustment Credits. The PFSAC-I focused on initial reform measures in five areas: (i) banking sector reform, (ii) reform of socially owned enterprises; (iii) bank asset and enterprise workouts; and (iv) financial sector regulatory and supervisory framework. The PFDPL is, to a large extent, a continuation of the PFSAC. The Serbian institutions designing and implementing the reforms developed a fluid and constructive cooperation with the World Bank teams.

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Global financial crisis: The global financial crisis severely affected Serbia and impacted also the focus of the PFDPL program. First, the pace of SOE privatization slowed down considerably due to lack of interested FDI. Moreover a number of already signed privatization contracts had to be cancelled due to lack of investments by the buyers. As a result the PFDPL program with respect to SOEs focused more on the introduction of a new, more efficient bankruptcy framework for all companies, including SOEs. Secondly the program supported by the PFDPL had also to be modified to take into account the impact of the global crisis on the banking sector. This meant that the financial sector pillar had to include a new focus on bank diagnostics, crisis preparedness and bank resolution. Collaboration and coordination with the IMF and other donors: Reforms in Serbia were supported by the World Bank and other key international development partners in a collaborated and coordinated approach. The Bank maintained close working relations with the IMF and other donors (such as EAR, SIDA, USAID, DFID) assisting the GoS for the purposes of harmonizing policy reforms, seeking synergies among the respective operations and avoiding overlaps. The international support has been substantial and required intensive coordination.

2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization At the Government level, the Ministry of Finance was responsible for the overall implementation of the proposed operation and for reporting process and coordinating actions among other concerned ministries and agencies. At the same time, monitoring and evaluation is supported by various data sources collected by the stakeholders in the implementation of the program, namely: (i) the Ministry of Finance, (ii) the Ministry of Economy and Regional Development (MOERD), (iii) the Ministry of Justice, (iv) the PA, (v) the NBS, (vi) the DIA, and (vii) the SBRA. The Bank has been monitoring actions and reviewing progress of the implementation of the operation, as well as the subsequent actions of the GoS program by using [the short term] reform benchmarks and the overall program outcomes outlined in the Policy Matrix. Baseline and medium term outcomes are stated in the Matrix. The baselines and outcomes are objective, concrete and measurable indicators of economic, financial and institutional performance. As specified in paragraph 31 of BP 14.25 (Guarantees), supervision will be carried out in accordance with procedures applicable to Development Policy Lending (OP /BP 8.60). Implementation Status and Results Reports (ISRs) will be completed annually until Guarantee expiration. These ISRs will assess compliance of the GoS with contractual undertakings under the financing agreement and whether circumstances exist that would lead to a call on the guarantee. ISRs will also assess, in more detail as new information comes to light, the financial impact of the PFSPBG in terms of increased market access, leverage etc. 2.4 Expected Next Phase/Follow-up Operation The GoS remains committed to completing the substantial reform program implemented thus far in private and financial sector areas. While, the GoS has made considerable progress in the business environment, privatization/restructuring/bankruptcy of non-private enterprises, and in financial sector development, the reform agenda has not yet been completed. In the short term, the GoS is committed to advancing the businesses environment reforms into further improving issuing of construction permits and completing the implementation of the

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recommendations of the comprehensive regulatory review. As far as privatization and restructuring is concerned, the GoS plans to proceed with the incorporation of Railways and Post, two large state owned enterprises, and with the privatization of Telekom. Finally regarding the financial sector, the GoS plans to divest its minority stakes in banks and eventually privatize the last state owned insurance company, Dunav. On the regulatory front, the NBS is planning implementation of Basel 2 by the end of 2011. The current four-year Country Partnership Strategy (CPS) covers the period FY08-FY11, so that Serbia and the World Bank will soon reassess priorities and cooperation for the next CPS period. However, it is certain that support to the EU agenda and enhancing competitiveness will be at the core of the Strategy.

3. Assessment of Outcomes

3.1 Relevance of Objectives, Design and Implementation The proposed PFSPBG is consistent with the CPS and the FY09 CPS Progress Report of Serbia. The CPS supports three GoS priorities: (i) private sector led growth to ensure income convergence with European levels; (ii) increased opportunities and participation in growth; and (iii) management of emerging environmental and disaster risks. The reform program in the PFSPBG focuses on (i) and (ii) priorities. The CPS and CPS Progress Report envisaged support in the private and financial sector through a series of three Private and Financial Development Policy Loans (PFDPL). The envisaged reforms are also in line with the GoS’ aspiration to join the European Union (EU). PFSPBG continues the successful reforms supported under the Private Financial Development Policy Loan (PFDPL) I and II: the reforms proposed under the originally planned PFDPL III form the basis for the PFSPBG. In the context of preparation of the third operation under the PFDPL series, the GoS has requested to avail of an IBRD PBG rather than a loan. As a PBG is not a DPL option under OP 8.60 (Development Policy Lending) and a "Programmatic PBG" option does not exist under OP 14.25 (Guarantees), the PFDPL series has been terminated after PFDPL 2, and PFDPL 3 has been transformed to a stand-alone PBG operation, with an almost identical policy matrix to that envisaged in PFDPL 3.

3.2 Achievement of Program Development Objectives The OVERALL PFSPBG PROGRAM OBJECTIVES were to:

• Increase international market access of GoS. • Improve the business environment. • Strengthen financial discipline in the non-private enterprise sector, and • Build a stable and more efficient financial sector.

Key reforms supported by the PFSPBG:

• Establishment of a single window for registration of employees in the Pension and Health Insurance Funds.

• Development of a new Law on Business Entities and the new Law on Enforcement and Security.

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• Development of regulations for the implementation of the new Law for Protection of Competition and regulations for the implementation of the Law on Bankruptcy.

• Establishment of a Registry of Regional Development Measures and Incentives within SBRA.

• Comprehensive review of regulations of business activities and adoption of recommendations resulting from that review.

• Continuing with resolution of SOEs. • Enactment of amendments to the Law on Banks, Law on Bankruptcy and Liquidation

of Banks and Insurance Companies, Law on Insurance and the Law on the Deposit Insurance Agency.

• Diagnostic assessment of all the banks in the system and enforced bank recapitalization.

• Banks with majority state ownership merged, privatized or restructures. • Strengthened deposit insurance function.

All core and non-core benchmarks under PFSPBG were implemented and the expected outcomes of the program have been substantially accomplished. In total, 16 outcomes have been identified, out of which

• 14 expected outcomes were achieved, or 87.5 percent of the total number of outcomes.

• 1 was Not Achieved, or 6 percent. • 1 was Partially Achieved, or 6 percent. • 2 cannot be measured because the government has not had any funding needs;

therefore it has not sought to raise funding from international financial markets.

Table 2: Status of Achievement of Outcomes

Subject Outcomes Comments The IBRD Guarantee will facilitate access to international markets The IBRD guarantee will assist the GoS to access longer tenor loans at lower interest rates

The GoS will raise funding independently from international market: Status: N.A.

The GoS will raise Euro loan funding with a maturity of more than three year at an interest rate below euribor plus 500bps. Status: N.A.

GoS has not sought new funding from international market, as it did not have funding needs. However, GoS has announced the issuance of the first ever Eurobond in fall 2011.

Pillar I: Enhancing Business Environment

Policy Area Outcomes Status of Outcome

Comments

1.1. Further simplification of business entry through implementation of a single agency approach.

Reduction of the business compliance costs estimated at up to EUR 15 million by end 2011.

Achieved

1.2. Improving legal framework for strengthening corporate governance and facilitating business operations.

Improved legal framework for corporate governance in place. Over the medium term, such a framework will support: (a) increased independence of the internal supervision body in JSCs; (b) increased shareholders rights; (c) stronger role of nonexecutive and independent members of the board; and (d) increased transparency of reporting.

Achieved

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1.3. Streamlining regulations of business activities and reducing business compliance costs.

New set of regulations in place reflecting: (a) the elimination of not less than 190 unnecessary regulations, and (b) the amendment of 25 regulations and 20 laws by the end of 2011. Implemented recommendations are to lead to annual cost savings for businesses of at least EUR 120 million by end 2011.

Achieved

1.4. Improving legal and institutional framework for competition.

Improved competition framework in place which, over the medium term, will strengthen the authority of the Commission for Protection of Competition in: (a) determining abuse of dominant position and existence of cartels, and (b) imposing enforcement measures.

Achieved

1.5. Improving effectiveness of enforcement of court decisions and authentic documents.

Improved enforcement framework in place which supports, over the medium term: (a) streamlined proceedings; and (b) introduction of professional enforcement officers.

Partially Achieved

A new Law on Enforcement and Security was enacted, however regulations have not yet been developed.

Pillar II: Strengthening Financial Discipline

Improved bankruptcy framework, which, over the medium term, will lead to: (a) an increase of initiation of bankruptcy cases of qualified entities, (b) higher recovery rates and lower costs, and (c) shorter resolution time.

Achieved

Number of entities with accounts which have been blocked for over 3 years reduced by 6,600 by end 2010.

Achieved 2.1 Facilitating Bankruptcy of Socially- Owned Enterprises

The portfolio of companies in the PA restructuring, auctions and tenders is reduced as bankruptcy procedures are undertaken, sending an additional positive signal to markets.

Achieved

2.2. Improving financial discipline in the socially and state owned sector.

Establishment of a comprehensive record of state support measures, including subsidies and grants contributing to better expenditure management and more transparency.

Achieved

Pillar III: Building a Stable and More Efficient Financial Sector

CAR of the banking system is maintained at the level of at least 12 percent.

Achieved

Bank resolution framework improved through the introduction of: (i) bridge bank resolution on a closed bank basis for systemic banks; and (ii) financial assistance in the form of grants, loans or guarantees based on a least cost test performed by the DIA, and emergency funding arrangements for DIA.

Achieved

3.1. Strengthening crisis preparedness and bank resolution.

Through introduction of payout software and payout procedures and implementation of MOU with the NBS, the deposit insurance scheme can make fast payouts.

Achieved

3.2. Restructuring and divestment of state-owned banks

Consolidation of the RoS holdings in banking sector: banks with majority RoS ownership reduced from 4 to 2 by 2010.

Achieved

Dunav’s social ownership structure is replaced by state ownership hence paving the way for subsequent privatization.

Not achieved

Process started. Amendments to the Law on Insurance are pending Parliamentary approval

3.3. Strengthening the insurance sector

Life and non-life insurance business lines are separated by end of 2011.

Partially Achieved

Status to be monitored by end-2011.

3.4. Supporting capital market development

Increased mobilization of capital by providing more options to investors and longer term funding for the GoS in local currency.

Achieved

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The status of achievement of the outcomes is as follows: Subject: Increased market access:

Outcomes: 1. The GoS will raise funding independently from international market. Status: Not

Achieved.2. The GoS will raise Euro loan funding with a maturity of more than three year at

an interest rate below euribor plus 500bps. Status: Not Achieved.

Upon borrowing from Société Générale with guarantee from the World Bank which was completed two months ago, the Government of Serbia has not attempted new access to the international capital market in 2011 as there was no need for such access. However, preparations are under way for issuance of the first Eurobond of up to EUR 700 million in the fall of 2011, and the procurement of lead arranger is currently in process. The experience with the PFSPBG is perceived as significant enhancement of the government capacity to close this transaction successfully. Pillar I: Enhance Business Environment Policy area 1.1. Further simplification of business entry through implementation of a single agency approach. Outcome: Reduction of the business compliance costs estimated at up to EUR 15 million by end 2011. Status: Achieved.

The GoS transformed the Serbian Business Registers Agency (SBRA) into a one-stop-shop for business registration. The one-stop-shop system for registering a company has been in place since May 2009. The number of steps to register a business was reduced from 11 to 8. It now takes up to 5 instead of 23 days to register a business. According to the EU Progress Report 2010 for Serbia, the number of registered companies stood at 113,000 in May 2010, up from 106,000 in April 2009. Approximately 225,000 entrepreneurs were registered with the Serbian Business Registry Agency, i.e. around 5,000 more than a year earlier. The Agency has also further extended the number of registers, including the Registry for Financial Statements. A single form is now used to register new workers to the Pension Fund or the Health Fund which represents a considerable reduction in business compliance costs resulting in annual savings of approximately EUR 15 million, calculated according to the standard cost model. Policy area 1.2: Improving legal framework for strengthening corporate governance and facilitating business operations. Outcome: Improved legal framework for corporate governance in place. Over the medium term, such a framework will support: (a) increased independence of the internal supervision body in JSCs; (b) increased shareholders rights; (c) stronger role of nonexecutive and independent members of the board; and (d) increased transparency of reporting. Status: Achieved.

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To strengthen corporate governance and facilitate business operation, a new Law on Business Entities was approved by the Parliament. The new law, in compliance with new EU directives, includes provisions to: (i) harmonize presently conflicting provisions of the Law on Business Entities and the Law on Securities Market; (ii) regulate entrepreneurs (at the same time the existing Law on Private Entrepreneurs will be abolished); (iii) regulate existing business associations (i.e. Association of Banks), which have been omitted in the existing Law on Business Entities; (iv) regulate the establishment, operations and closure of branch offices of foreign legal entities, and (v) define the duties and responsibilities of management and improve corporate governance by allowing the option of choosing between one- or two-tier corporate governance system for Limited Liability Companies (LLCs) and JSCs. Reforms under (ii) alone should lead to a reduction in administrative costs for businesses estimated in approximately EUR 6 million per year.

Policy Area 1.3: Streamlining regulations of business activities and reducing business compliance costs. Outcome: New set of regulations in place reflecting: (a) the elimination of not less than 190 unnecessary regulations, and (b) the amendment of 25 regulations and 20 laws by the end of 2011. Implemented recommendations are to lead to annual cost savings for businesses of at least EUR 120 million by end 2011. Status: Achieved and exceeded. The GoS introduced a Regulatory Impact Analysis (RIA) requirement in the legislative process in 2004 to improve the quality of new regulations. The implementation of the RIA will ensure that new regulations (i.e. the legislative flow) are based on a clear rationale and adequate analysis of costs and benefits. To reduce compliance costs of existing business regulations (legislative stock), a comprehensive regulatory review was completed in accordance with the Government Strategy adopted under the PFDPL1. The regulatory review was initiated in early 2009 and consisted of four phases: inventory, analysis, recommendations, and implementation. As a result of the inventory, 2,000 laws and regulations were identified as impacting economic activity. The Council for Regulatory Reform also formed ten working groups chaired by a representative of the private sector to further analyze the 2,000 laws and regulations and recommend simplification actions. Based on the review, 192 unnecessary regulations were abolished and 304 recommendations for amendment to 30 laws and 30 regulations were adopted. About 195 recommendations have already been implemented which is estimated to lead to annual cost savings for businesses of approximately EUR 50.8 million, while the full implementation of all adopted recommendations by end 2011 is expected to lead to an estimated annual cost savings of around EUR 142 million. Examples of the cost savings associated to some of the recommendations are presented below:

• Introduction of single window approach for registering workers - EUR 15 million. • Simplification of existing procedures such as extending the deadline for businesses to

place their daily cash revenue into their bank accounts from one to seven days - EUR 39.5 million.

• Requiring the Tax Authority to ensure electronic submission of required tax filing documents - EUR 8.5 million.

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• Eliminating the requirement for preparing and stamping the travel requests for using the company vehicles each time the vehicle is used - EUR 21 million.

• Eliminating the requirement for posting the company name on the company vehicles - EUR 2.6 million.

Policy Area 1.4: Improving legal and institutional framework for competition. Outcome: Improved competition framework in place which, over the medium term, will strengthen the authority of the Commission for Protection of Competition in: (a) determining abuse of dominant position and existence of cartels, and (b) imposing enforcement measures. Status: Achieved. This was a legal-institutional outcome. In the summer of 2009, the GoS enacted a new Law on Protection of Competition which overcame the deficiencies of the previous Law of 2005. In addition, GoS adopted eight new regulations required to implement the new Law on Protection of Competition. These regulations had been originally included in PFDPL 3. The new Law on Protection of Competition addressed all major business concerns, removed the disincentives to foreign direct investment, strengthened the independence of the Commission for Protection of Competition and is fully in line with EU standards. In addition, eight new regulations required to implement the new Law on Protection of Competition have been adopted. These include: (i) Regulation on criteria defining relevant market; (ii) Regulation on content of request for individual exemption; (iii) Regulation on categories and special conditions for block-exemptions; (iv) Regulation on the form and content of the official identification; (v) Regulation on content and the manner for notification of concentration; (vi) Statute of the Commission for Protection of Competition; (vii) Regulation on criteria for measurement of the amounts of fines, the manner and payment timeframe under the measure for protection of competition and procedural penalties and on conditions for definition of other measures; and (viii) Regulation on conditions of relief from pecuniary fines under measures for protection of competition (Leniency Program).

Policy Area 1.5: Improving effectiveness of enforcement of court decisions and authentic documents. Outcome: Improved enforcement framework in place which supports, over the medium term: (a) streamlined proceedings; and (b) introduction of professional enforcement officers. Not achieved. Enforcement mechanisms remain a stumbling block for business operations. According to the Doing Business 2011 indicators on enforcing contracts, Serbia ranks 94th in the world, with 635 days necessary for enforcement. Therefore, there is no indication of improvement. However, to speed up enforcement processes, a new Law on Enforcement and Security was recently adopted by the Parliament of Serbia. The implementation of the new Law will enhance the enforcement of court decisions as well as enforcement based on authentic documents, such as contracts and invoices. To this end, the Law introduced the concept of professional enforcement officers (i.e. private bailiffs) licensed and supervised by the MoJ. On the basis of the new legislation, it is expected that Serbia will improve its ranking in enforcing contracts in Doing Business 2012 (to be issued in the fall of 2011). However,

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regulations for implementation of the new Law and introduction of professional enforcement officers are underway. Pillar II: Strengthening Financial Discipline Policy area 2.1: Facilitating Bankruptcy of Socially-Owned Enterprises

Outcome: Improved bankruptcy framework, which over the medium term, will lead to: (a) an increase of initiation of bankruptcy cases, (b) higher recovery rates and lower costs, and (c) shorter resolution time. Status: Achieved. To increase recovery in bankruptcy in general and especially in the context of non-private enterprises, a new Law on Bankruptcy was introduced in 2009. The new Law increased process efficiency, established automatic triggers for bankruptcy, and created new rules for pre-packaged reorganization. In addition, the new Law also improved the current bankruptcy framework, particularly in regards to the addition of the set-off provisions, the improvements to the reorganization process, and the avoidance of pre-bankruptcy transactions. Furthermore, it clarified issues with respect to licensing, appointment, removal, and disciplining of bankruptcy administrators. The Doing Business 2011 report credited government efforts in this area, and Serbia was ranked 86th globally in ‘Closing a Business’ indicator or 15 spots higher than the previous year.

Following the enactment of the new Law on Bankruptcy, bankruptcy administration is being enhanced. This effort includes already adopted amendments to the Law on Agency for Licensing of Bankruptcy Administrators, as well as revisions to the National Standards for Administering the Bankrupt Estate and the Code of Ethics. Moreover, to track case activities, an electronic reporting system has been established. Finally, eleven implementation regulations for the new Law on Bankruptcy have been approved. These include regulations on the code of ethics, implementation of reorganization, pre-packaged reorganization, registry of bankruptcy estate, awards and fees of bankruptcy administrators. Outcome: Number of entities with accounts which have blocked for over 3 years reduced by 6,600 by end 2010. Status: Achieved. The Law on Bankruptcy requires automatic bankruptcy proceedings for enterprises with accounts blocked for over three years. Based on this new procedure, the NBS sends the candidate list to the commercial courts, which formally declare bankruptcy. The (non-core) benchmark for this outcome (procedures filed for at least 10,000 with accounts which have been blocked for over three years) was exceedingly met. The introduction of automatic bankruptcy triggers has resulted in initiation of bankruptcy for over 13,000 entities with accounts blocked for over three years. As a result, the bankruptcy process for approximately 9,500 entities has been completed and they were erased from the business register.

Outcome: The portfolio of companies in the PA restructuring, actions and tenders is reduced as bankruptcy procedures are undertaken sending an additional positive signal to markets. Status: Achieved. The non-core benchmark for this outcome (bankruptcy procedures initiated for at least 160 qualifying companies from the PA portfolio between January 1, 2010 and November 30, 2010

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was exceedingly met. As of early November 2010, there were 955 socially owned companies in the PA portfolio (see Table 3). Of these 673 enterprises were in bankruptcy/forced liquidation. In 2010, 162 companies from the PA portfolio were put in bankruptcy and further 81 companies were in auction, tender and restructuring procedure in the PA. Progress with the latter category is well underway and should be completed by July 2011. Privatization for the remaining 201 was temporarily stopped for various reasons, such as unresolved ownership status with former Yugoslav republics. The state owned enterprises reflected in the Table 8 represent previously privatized socially-owned companies for which the privatization contracts were cancelled.

Table 3: PA Portfolio - Status as of November 2010 Status Number of socially

owned enterprises Number of state owned

enterprises Bankruptcy/ Forced Liquidation 673 0 Auction 25 47 Tender 6 19 Restructuring 50 84 Privatization suspended 201 50 Under Preparation 0 21 Total 955 221 Grand Total 1,176

Source: Privatization Agency

Policy areas 2.2: Improving financial discipline in the socially and state owned sector. Outcome: Establishment of a comprehensive record of state support measures, including subsidies and grants contributing to better expenditure management and more transparency. Status: Achieved. This outcome was achieved by completion of a core-benchmark (The Registry of Regional Development Measures and Incentives, satisfactory to the Bank, has been established within the SBRA and is operational). The goal of establishment of the Registry of Regional Development Measures and Incentives under the SBRA was to better monitor state aid. The Registry will record all measures and incentives funds by the GoS and international organizations to a variety of entities including companies. Further, the Registry will record the following type of information: type, purpose and form of incentive, providers and users, financial information, and territorial focus. The government institutions obliged to report to the Registry include: the MOERD, the Ministry for National Investment Plan, the Ministry of Infrastructure, the Ministry of Agriculture, Forestry, and Waterworks, the Ministry of Finance, the Development Fund, the National Employment Service, the Serbian Investment and Export Promotion Agency, the National Agency for Regional Development, the Agency for Insurance and Financing of Exports and the EU Integration Office.

Pillar III: Building a stable and more efficient financial sector. Policy area 3.1: Strengthening crisis preparedness and bank resolution. Outcome: CAR of the banking system is maintained at the level of at least 12%. Status: Achieved.

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The Serbian banking sector is well-capitalised, with average capital adequacy ratio of 20.4 percent as of March 2011. At the end of 2010, only 6 out of total of 33 banks had a capital adequacy ratio under 15 percent. To ensure that the system was well capitalized to withstand the shock of the crisis, a bank diagnostic and triage exercise was implemented. In December 2009,the NBS completed the stress testing for the entire banking sector (i.e., 34 banks), under the methodology adopted under the Second Programmatic Private and Financial Policy Development Loan to ensure that the banks area adequately capitalized (i.e. CAR of at least 12%). In the recent period, Metals Banka was recapitalized by the Province of Vojvodina, while Komercijalna Banka, a state owned bank with EBRD minority ownership, raised more equity from existing and new shareholders, including the IFC. Further, Credy Bank was recapitalized by Nova KBM from Slovenia. The NBS repeats the stress testing exercise every six months. Outcome: Bank resolution framework improved through the introduction of: (i) bridge resolution on a closed bank basis for systemic banks; and (ii) financial assistance in the form of grants, loans or guarantees based on a least cost test performed by the DIA, and emergency funding arrangements for DIA. Status: Achieved. The PFSPBG supports a complete overhaul of the bank resolution framework to increase efficiency and reduce the cost of resolving banks. Amendments to the Laws on Banks, Bankruptcy and Liquidation of Banks and Insurance Companies, and Deposit Insurance and Deposit Insurance Agency have been enacted. Under the new framework, purchase and assumption and bridge bank on a closed bank basis have been added, as well as financial assistance for these tools on a least cost basis. Finally, to ensure that the DIA has access to emergency funding for bank resolution/payout, the implicit government guarantee included in the existing Deposit Insurance Fund and the Law on DIA has been made explicit with the approval of 2011 budget law. RSD 110 million (approximately EUR 1 million) have been allocated to cover the commitment fee for a EUR 100 million stand-by credit line from commercial banks to the DIA for contingency purposes. By doing so, the implicit GoS’s guarantee to the DIA will be made explicit.

Outcome: Through introduction of payout software and payout procedures and implementation of MOU with the NBS, the deposit insurance scheme can make fast payouts. Status: Achieved.

The deposit insurance fund has been strengthened. The fund increased in size to around EUR 140 million at Q3 2010 as a result of an initial capitalization by the GoS and raising of premium. In line with best practices, the DIF current size is adequate to cover the failure of a mid-size bank. The capacity of the fund to deal with large payouts has been strengthened by developing payout procedures, introducing payout software, adopting a Memorandum of Understanding (MoU) on information sharing between the DIA and the NBS. Amendments to the legal framework to specifically provide for extraordinary funding and equate the depositors of banks in liquidation with those of banks in bankruptcy have also been approved. Policy area 3.2: Restructuring and divestment of state-owned banks. Outcome: Consolidation of the RoS holdings in the banking sector: banks with majority RoS ownership reduced from 4 to 2 by 2010. Status: Achieved.

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The GoS has continued the divestment program for state owned banks. To consolidate the state-owned banking sector and reduce likely capital injections, the GoS adopted a strategy in May 2009 (under the Second Programmatic Private and Financial Policy Development Loan) which called for the reduction of majority state owned banks from four to two over the next two years. Of the four majority state owned banks, Credy Banka was sold to a foreign group, Postanska and Privredna Pancevo were merged, and Srpska Banka will remain as is. As a result the number of majority state owned banks has decreased from 4 to 2. Policy area 3.3: Strengthening insurance sector. Outcome: Dunav’s social ownership structure is replaced by state ownership hence paving the way for subsequent privatization. Status: Not achieved. The achievement of this outcome is expected in the medium term. However, the GoS has committed to future privatization of Dunav. To this end, GoS has approved and submitted to the Parliament legal amendments to the Law on Insurance that define the process of transformation of socially owned capital in the insurance sector into state owned. Furthermore, the amendments mandate the commencement of privatization of at least 20 percent of state owned capital in insurance companies by the end of 2013.

Outcome: Life and non-life business lines are separated by end of 2011. Status: Partially achieved. The non-core benchmark (Amendments to the Law on Insurance requiring the separation of life and non non-life insurance by the end of 2011 are enacted by the Parliament) has been met. To reduce the potential for systemic risk in the sector, insurance companies are required to separate the life and non-life insurance businesses. Amendments to the Law on Insurance have been enacted requiring the separation of life and non-life business by the end of 2011. Outcome: Increased mobilization of capital by providing more options to investors and longer term funding for the GoS in local currency. Status: Achieved.

To increase domestic savings mobilization, the GoS is committed to developing capital markets. The establishment of a yield curve is essential in this respect. The GoS has therefore gradually extended the maturity of the GoS T-bills from 3 months to up to 24 months.

================================================================== 3.3 Justification of Overall Outcome Rating Rating: Highly Satisfactory The objectives of this operation have been highly relevant to the strategic priorities of the country. Priority actions were well selected and contributed to the operation’s outcomes. All prior actions of the Private and Financial Sector Policy Based Guarantee were completed and over 87.5 percent of the outcomes have been achieved on the short-term. This operation supported Serbia to implement a structural reform program in the business environment and financial sector and mitigate the effects of the global economic crisis, while at the same time

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allowing Serbia to benefit from access to the international financial markets at lower costs and longer maturities. The use of the IBRD guarantee as an instrument helped the Government of Serbia to improve its debt management capacity by expanding its creditor base. In addition, the Serbian Public Debt Management Authority was given an opportunity to become familiar with the legal requirements of international tenders and global banks. The results of the PFSPBG, summarized above, suggest that the expected outcomes have been substantially achieved within 6 months of signing of the guarantee. The two outcomes of increased market access as well as the outcome related to the privatization of Dunav are very likely to be achieved in the medium to long term. The law mandating Dunav privatization has been submitted to Parliament, while Serbia is planning to access international capital market with the first ever Eurobond in the fall of 2011.

3.4 Overarching Themes, Other Outcomes and Impacts (a) Poverty Impacts, Gender Aspects, and Social Development There were no measured poverty impacts specifically related to this operation. Policies supported by pillar 1 (enhancing business environment) - and pillar 3 (strengthening the financial sector) of the PFSPBG are likely to help create jobs. Reform measures under Pillar 1 are all targeted at decreasing business compliance costs, creating better conditions for private local and foreign investments, and ultimately leading to job creation. The reforms supported under Pillar 3 increased the safety of savings by increasing deposit insurance coverage and enhancing payout speed. Furthermore, measures supporting banking sector capitalization ensure that the system is stable and has enough resources to continue intermediating.

Enterprise restructuring measures under Pillar 2 could have a potentially negative impact on workers and hence on poverty levels. In practice it is highly unlikely that such impact will materialize. Under Pillar 2, the GoS has committed to complete the privatization of socially owned enterprises and to put into bankruptcy companies (private and socially owned) with blocked accounts. Potentially three sets of workers could be affected: (i) workers of companies with blocked accounts for which bankruptcy initiated, and (ii) workers of socially owned companies that will be placed in bankruptcy/forced liquidation. In practice, over the past year (the year over which the policy actions supported by this operation took place) the GoS has focused on filing for bankruptcy socially owned companies that could not be sold and on putting companies with blocked account into bankruptcy. The employment impacts of these measures are limited. For example, it is estimated that the 160 socially owned enterprises for which bankruptcy was initiated in 2010 employed 1861 employees. As many workers have not been receiving salaries for years, losing a job might not necessarily result in an income shock for their households 29. Moreover, as claims for unpaid salaries rank either first or third in the list of creditors’ priority, employees are likely to receive part if not all of the due salaries in the bankruptcy process. Concerns for a negative poverty impact have also been limited by the fact that restructuring of large companies has been put on hold during the crisis, with the GoS subsidies contributing to keep the firms afloat.

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Formal measures to mitigate the employment shock on redundant workers are also in place, such as the Transition Fund, and active labor market programs. The World Bank is supporting the strengthening of active labor market programs by building monitoring and evaluation capacity in this area, and by supporting the impact evaluation of one of the largest programs in support of self-employment. (b) Institutional Change/Strengthening The PFSPBG introduced some changes in the institutional framework and strengthened a number of existing institutions. Given the long-term nature of institution building, the full institutional benefits of the PFSPBG reforms are expected in the medium to longer-term. Among the key institutions strengthened by the PFSPBG, the following could be highlighted:

• Serbian Business Registers Agency (SBRA) - one-stop shop for business and employment registration and registration of financial, leasing and pledge rights on movable assets and rights. SBRA hosts more than 20 types of business registries including the Registry of Regional Development Measures and Incentives which was established under the auspices of PFSPBG.

• The Office for Regulatory Reform and Regulatory Impact Analysis - ensuring sustainability of regulatory reforms by advancing the regulatory impact assessment and regulatory guillotine, which were formerly managed by temporary government bodies.

• Deposit Insurance Agency – in addition to strengthening its payout procedures, the DIA has acquired new resolution functions for banks once the operating license has been withdrawn.

• Public Debt Management Authority – For the first time the debt management agency run an international tender in the context of very cumbersome public debt laws.

The institutions in Serbia developed a large body of new legislations in compliance with directives of the European Union which has improved the business environment and functioning of the financial system. Moreover, redundant regulations have been abolished and contradictory regulations have been amended in the context of the review of regulations of business activities. (c) Other Unintended Outcomes and Impacts

The global economic crisis negatively impacted the process of privatization of the socially owned enterprises. Therefore, the program with respect to SOEs was shifted to the introduction of more efficient regimes for bankruptcy and contract enforcement. Moreover, to support the banking sector at a time of stress, new emphasis on crisis preparedness was added.

3.5 Summary of Findings of Beneficiary Survey and/or Stakeholder Workshops N/A

4. Assessment of Risk to Development Outcome Ratings: Moderate

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Reforms already introduced, as well as those that must be introduced in the near future, have been widely accepted in Serbia. In fact, there is a strong commitment to reforms as a path to access the European Union. Such commitment seems to percolate the whole political and societal spectrum. Risks to the sustainability of reforms are therefore modest, particularly now that some economic growth is taking place. The donor community continues to support this process. The degree of coordination among donors is substantive and contributes to reduce risks. Several ongoing projects complement the PFSPBG and contribute to its sustainability. These include an Institutional Development Fund (IDF) grant for capacity building of newly established Office for Regulatory Reform and RIA of the Government of Serbia, IDF grant for public enterprises corporatization. New IMF program is being negotiated and expected to bein place shortly. The main risks which have been identified relate to the macroeconomic situation in Serbia. Macroeconomic risks remain substantial. Serbia went into the financial crisis with a high (balance of payments) current account deficit, aggravated by rapid foreign currency credit growth and large cross-border borrowing of domestic enterprises. Specific risks include:

• The global economic outlook remains uncertain. Furthermore, potential fallout from weaknesses and risks in eurozone economies could have a significant impact on Serbia; Greece in particular has been the second largest investor in Serbia since the beginning of the transition. A New IMF program is being negotiated.

• Serbia faces considerable balance of payments financing needs over the next few years. Risks are mitigated by Serbia’s pursuit of a robust agenda of policy reform, and by the size of the multilateral support package.

• Vulnerabilities of the banking sector remain in the context of substantially reduced profitability and stable but high NPLs (17.1 percent2). Key mitigating factor is the very high capitalization and liquidity of the system. As of March 2011, the aggregate CAR was 20.4 percent and the banking system’s liquid assets covered 36.9 percent of short term liabilities. An increase in the rate of NPLs could pose a risk to the solvency of the system.

Mitigation of overall risks is ensured by GoS’s long term commitment to reforms. Serbia has a good record of continuous reforms and commitment to EU accession. Such a record creates solid environment for cooperation and confidence with the donor community and allows stakeholders to focus more intensively on results.

5. Assessment of Bank and Borrower Performance (a) Bank Performance in Ensuring Quality at Entry

Rating: Highly Satisfactory

The design of the guarantee instrument underlying the PFSPBG benefited from lessons learnt from previous PBGs implemented by The World Bank in Argentina (1999) and Colombia

2Status as of end March 2011, quoted by NBS.

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(2001). Further, the program supported by the PFSPBG builds on lessons learned from other transition experiences and other financial crisis. Tailored lessons from the latter (and in particular on bank resolution) were incorporated in the Financial Sector Assessment Program (FSAP) that was completed shortly before the PFSPBG was designed. This preparatory work was instrumental in ensuring that the success of the implementation of the program in such short timeframe. Considering the large body of knowledge used by the team to design the PFSPBF and advise the government on the relevant policy reforms, the quality of entry of the Bank is assessed as Highly Satisfactory. Finally donor coordination was ensured throughout. The result was a program design that was consistent with the national development strategy and focused on EU accession priorities, best practices in crisis preparedness and on business environment reforms. (b) Quality of Supervision

Ratings: Highly Satisfactory The Bank devised an effective approach to work with counterparts in their respective pillars of the reform program. The Bank cooperated effectively with the Ministry of Finance, which was the coordinator of activities on the Borrower’s side, maintained close cooperation with the Ministry of Economy and Regional Development and with the National Bank of Serbia. The Bank assisted through a number of challenging reforms with persistence and delivering high level support in all policy areas. By all indications, the counterparts in the Government of Serbia were very satisfied with the technical support and systematic approach to reforms provided by the Bank Team. Moreover, the task team monitored the country’s overall economic performance and the timely adoption and effective implementation of the agreed program conditions. They also validated the Borrower’s monitoring and evaluation findings on the progress and results of program implementation. Further, the task team consulted and coordinated with the IMF in carrying out its supervision work. The impact of the guarantee as an instrument and the level of achievement of the objectives are direct results of the very strong cooperation with GoS and of the strong supervision by the Bank team. Therefore, the quality of supervision has been assessed as Highly Satisfactory. (c) Justification of Rating for Overall Bank Performance The overall performance is rated Highly Satisfactory since the Bank performance in both Ensuring Quality at Entry and in Quality of Supervision were rated Highly Satisfactory.

5.2 Borrower Performance (a) Government Performance

Ratings: Highly Satisfactory

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The Government developed the institutional and regulatory framework to improve the public sector governance, the business regulatory environment and ensure financial sector stability. Cooperation with the Bank Team was very strong. They completed all prior actions and non-core benchmarks, readily shared information with the Bank team and continue to implement reforms. For example, the Parliament adopted two key laws, namely the Law on Enforcement and Law on Business Entities after the issuance of the guarantee. The Government showed strong commitment to the consultation process (i.e. consultation with stakeholders on important legislative amendments, now a mandatory requirement, broad involvement of business community in the regulatory review process). (b) Implementing Agency or Agencies Performance

Ratings: Satisfactory In general the implementing agencies performed well. Most agencies followed through on the program reforms and handled well the challenge of preparing substantial amounts of new legislation. The Ministry of Economy and Regional Development performed well in leading work on privatization and bankruptcy, preparation and implementation of the review of regulations of business activities, reviewing a substantial amount of legislation, and establishing new practices such as the regulatory impact assessment. Both the PFSPBG and the EU accession agenda played a critical role in driving the pace of the reforms. In implementing agreed upon measures, the professionalism and dedication of the Government Team proved to be determinant factors. (c) Justification of Rating for Overall Borrower Performance

Ratings: Highly Satisfactory The performance of the Government was highly satisfactory and the performance of the implementing agencies was satisfactory. The overall rating has been weighted as Highly Satisfactory.

6. Lessons Learned The following important lessons were learned during the implementation of this operation: x It is important to maintain sufficient flexibility, particularly in the case of

programmatic policy development loans, to adapt and respond to client needs and economic realities in the country. As the PFDPL operation was implemented and Bank team was preparing the Third PFDPL operation in the series, the Government of Serbia requested support with a guarantee, rather than a loan, to access international markets and refinance its debt obligations. In light of Serbia’s strong track record in macro, structural and social policies, sustainable external financing plan and coherent borrowing strategy, a policy based guarantee was prepared within 5 months from the time GoS requested it.

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x Good coordination with other partners and providing necessary technical assistance on a timely basis. Cooperation among international agencies (i.e. World Bank, IMF, SIDA) and with other donors, in particular the EU, is essential since extensive technical assistance has been provided and needs to be coordinated and aligned with the country’s priorities and strategic goals.. This cooperation was underscored by the central role played by the Government of Serbia through the Ministry of Finance. Further, the reforms in the financial sector pillar of the program, in which the Bank has had a comparative advantage, were designed in cooperation with the IMF. The financial sector reforms have been also directly supported by the State Secretariat for Economic Affairs (SECO) of the Swiss Confederation technical assistance to DIA and by investments in undercapitalized banks by the EBRD and the IFC.

Borrower/Implementing Agencies/Partners (a) Borrower/Implementing agencies: N/A

(b) Cofinanciers: N/A

(c) Other partners and stakeholders: N/A (e.g. NGOs/private sector/civil society)

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Annex 1 Bank Lending and Implementation Support/Supervision Processes

(a) Task Team members P102651 - Private and Financial Sector Policy Based Guarantee

Names Title Unit Responsibility/ Specialty

Lending Aurora Ferrari Country Program Coordinator ECSPF Task Team Leader Andrej Popovic Private Sector Development SpecialistECSPF Irina Astrakhan Country Program Coordinator AFCZA Aida Japarova Program Assistant ECSPF Eugene Gurenko Lead Financial Sector Specialist GCMNB

Lewis Hawke Senior Financial Management Specialist ECSO3

Nikola Ille Senior Environmental Specialist ECSSD Alexandru Cojocaru Consultant ECSPE Marina Wes Lead Economist ECSPE Dusko Vasiljevic Economist ECSPE Caterina Ruggeri Laderchi Senior Economist ECSPE Nikolai A. Soubbotin Senior Counsel LEGEM Nicholay Chistyakov Senior Finance Officer LOAFC Gianfranco Bertozzi Senior Financial Officer BDM Tomas Inge Magnusson Consultant BDM

Hiroshi Tsubota Lead Financial Officer/Debt Capital Markets & CBP BDM

Neil Pravin Ashar Counsel LEGCF Thomas A. Duvall Consultant LEGCF Xavier Cledan Mandri-Perrott Senior Infrastructure Specialist FEUFS Jasna Vukoje Program Assistant ECCYU Supervision Aurora Ferrari Country Program Coordinator ECSPF Task Team Leader

Andrej Popovic Private Sector Development SpecialistECSPF Private Sector Dev. Specialist

Gordana Popovikj Friedman Private Sector Development SpecialistECSPF ICR Team Leader Jasna Vukoje Program Assistant ECCYU Team Assistant

(b) Staff Time and Cost P102651 - Private and Financial Sector Policy Based Guarantee

Staff Time and Cost (Bank Budget Only) Stage

No. of staff weeks USD Thousands (including travel and consultant costs)

Lending/Supervision FY11 104.8 Total: 104.8

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Annex 2. Beneficiary Survey Results N/A

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Annex 3. Stakeholder Workshop Report and Results N/A

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Annex 4. Summary of Borrower’s ICR and/or Comments on Draft ICR

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Annex 5. Comments of Cofinanciers and Other Partners/Stakeholders N/A

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Annex 6. List of Supporting Documents

� Implementation Completion and Results Report (ICR) on Programmatic Private and Financial Development Policy Loans (ICR00001882)

� Program Document, Private and Financial Sector Policy Based Guarantee (PFPBG), January 2011.

� Program Document, Programmatic Private and Financial Sector Development Policy Loan Two (PFDPL2), October 2009.

� Program Document, Second Programmatic Private and Financial Sector Development Policy Loan (PFDPL), February 2009.

� Implementation Status Report (ISR), PFDPL2, March 2010. � Serbia Country Partnership Strategy for FY08-FY11. � Aide Memoire, Private and Financial Sector Policy Based Guarantee (PFSPBG), Appraisal

Mission, December 2010. � Aide Memoire, PFDPL Pre-Appraisal Mission – Deferred Drawdown Option, December 2007 � Aide Memoire, Insurance Sector Technical Assistance Mission, March 2009 � Aide Memoire, Capital Markets Technical Assistance Mission, April 2009 � Aide Memoire, PFDPL2, May 2009 � Aide Memoire, PFDPL2 Appraisal Mission, July 2009 � Evidence of Second Programmatic Private and Financial Development Policy Loan Core

Conditions Realization of PFDPL, Memo from Ministry of Finance of Serbia, July 2009 � IBRD Results Brief, Private and Financial Sector Policy Based Guarantee Briefing � Serbia - Enterprise Surveys, available at:

http://www.enterprisesurveys.org/ExploreEconomies/?economyid=206&year=2009 � BEEPS At-A-Glance 2008 Serbia available at: � http://siteresources.worldbank.org/INTECAREGTOPANTCOR/Resources/704589-

1267561320871/Serbia_2010.pdf � Doing Business, Serbia, available at: � http://doingbusiness.org/data/exploreeconomies/serbia � Serbia 2010 Progress Report, European Commission, available at:

http://ec.europa.eu/enlargement/pdf/key_documents/2010/package/sr_rapport_2010_en.pdf � EBRD Transition Report 2010: Recovery and Reform: Serbia Country Assessment, available

at http://www.ebrd.com/pages/research/publications/flagships/transition/serbia.shtml � Zakon za zaduzivanje kod Societe Generale uz garanciju Svetske Banke, (Law on Borrowing

from Societe Generale with a Guarantee from the World Bank), Official Gazette 478/11 � Interviews and consultations:

9 Aurora Ferrari, Task Team Leader, PFSPBG 9 Ms. Irina Astrakhan, Task Team Leader, PFDPL1-2 9 Mr. Andrej Popovic, Private Sector Development Specialist, PFDPL Team Member,

ECSPF, WB Belgrade office 9 Ministry of Finance of the Republic of Serbia 9 Council for Regulatory Reform, Belgrade 9 Serbian Business Registers Agency, Belgrade 9 National Bank of Serbia 9 Privatization Agency of Serbia, Bankruptcy Unit

� Websites: 9 Ministry of Economy and Regional Development: www.merr.gov.rs 9 Ministry of Finance: www.mfin.gov.rs 9 National Bank of Serbia: www.nbs.rs 9 Privatization Agency: www.priv.rs 9 Council for Regulatory Reforms: www.srp.gov.rs 9 Parliament of Serbia http://www.parlament.gov.rs/

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