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# High Level Steering Group (HLSG)
# REBUILDING KOSOVO MOVES AHEAD; 
   LONG-TERM CHALLENGES REMAIN
   High Level Steering Group Meets to Review Progress - Washington, September 28, 1999
# Statement of the High Level Steering Group (HLSG) Meeting
   Washington, September 29, 1999
# K O S O V O - Report on Pillar IV’s Activities
   Joly Dixon, Head of Economic Reconstruction, United Nations Mission in Kosovo
   Washington, 28 September 1999
# High Level Steering Group Agrees on
   Priorities for an Action Plan to rebuild Kosovo and its Neighbors
   BRUSSELS, July 13, 1999

 
High Level Steering Group (HLSG)

Washington, September 28, 1999

The High Level Steering Group was created as a result of the Cologne Summit [http://www.seerecon.org/KeySpeeches/KSS-1999062501.htm] of the Heads of State and Government to guide the donor coordination process for the economic reconstruction, stabilization, reform and development of the South East Europe.

Participants¹ at this second meeting of the High Level Steering Group examined the progress of Kosovo's reconstruction and economic recovery program; shared information on economic prospects and macro-financial needs of the countries in the South-East Europe Region, including plans and timing for future donor conferences; reviewed the preparation of regional economic and financial initiatives, particularly the EIB on basic infrastructure investment [http://www.seerecon.org/News/eib.htm] and the EBRD for private sector development; and reviewed interaction with the Stability Pact structures.

Press Release
http://www.seerecon.org/PressReleases/press019-29-9-99.htm    see below !

Chairmen's Conclusions
http://www.seerecon.org/News/HLSGChCon.htm    see below !

United Nations Interim Administration Mission in Kosovo (UNMIK)
EU Pillar -- Economic Reconstruction and Development (Pillar IV)
Report on Pillar IV's Activities (pdf)
http://www.seerecon.org/News/unmik4.pdf    see below !

See First High Level Steering Group Meeting
http://www.seerecon.org/News/news1999071301.htm    see below !
 

¹ The High Level Steering Group for South East Europe (HLSG) was jointly chaired by Messrs. James D. Wolfensohn, President of the World Bank, and Pedro Solbes Mira, European Commissioner for Economic and Monetary Affairs. Membership also includes the Finance Ministers of Canada, France, Germany, Italy, Japan, Russia, the United Kingdom, the United States, and Finland (representing the Presidency of the European Union), as well as Managing Director of the International Monetary Fund (IMF), the President of the European Investment Bank (EIB), and the President of the European Bank for Reconstruction and Development (EBRD), the Special Coordinator of the Stability Pact for South-Eastern Europe, and the Deputy Secretary General of the United Nations. In addition, the Finance Minister of the Netherlands and the representative of UN Mission in Kosovo (UNMIK) attended the meeting.

 
REBUILDING KOSOVO MOVES AHEAD;
LONG-TERM CHALLENGES REMAIN

High Level Steering Group Meets to Review Progress
Washington, September 28, 1999

The process of rebuilding Kosovo is making progress, but international policy makers attending the second High-Level Steering Group for Southeast Europe, convening in Washington, DC at the IMF/World Bank Annual Meetings, heard that substantial challenges still lie ahead as the UN Mission in Kosovo (UNMIK) works out how to resolve short-term humanitarian issues as well as longer-term reconstruction needs.
     Under the joint chairmanship of European Commissioner for Economic and Monetary Affairs, Pedro Solbes Mira, and World Bank President, James D. Wolfensohn, the High Level Steering Group today welcomed the progress being made by UNMIK in laying the foundation for a sound market economy and in preparing a budget for Kosovo for the rest of 1999 and 2000. However, the Group also called on international donors to disburse the money they had previously pledged for both budgetary support, and humanitarian aid in time for the onset of the Balkan winter.
     In addition, mindful of the need to protect both domestic revenues as well as external donor support from corruption or misappropriation, the Group also welcomed the setting up of strict financial and auditing controls to ensure that all transactions involving the Kosovo budget are transparent and fully accountable.
     The Group, which was set up to guide the donor coordination process for the economic reconstruction, stabilization, reform, and development of the Southeast Europe Region after the recent Cologne Summit, encouraged UNMIK to create the right business conditions to attract private investment and, more broadly, accelerate the process of transforming Kosovo into a modern market economy. "It is essential that the next Kosovo Donors Conference is fully successful, in particular, in helping to fund a real operational budget for Kosovo," EU-Commissioner Solbes said.

Prospects and Needs of Southeast Europe

The Group reviewed the economic consequences of the recent hostilities in Kosovo, which caused major setbacks for the economies of Albania, Bosnia and Herzegovina, Bulgaria, Croatia, the former Yugoslav Republic of Macedonia, and Romania. Although the rapid return home of Kosovar refugees after the end of the hostilities brought considerable financial relief for those countries which had offered them shelter, many of these regional economies still face continuing disruption in investment, tourism, trade, and transit routes around the Federal Republic of Yugoslavia (FRY). As a result, in many countries, economic reform and transition programs have come under considerable pressure.
     At the first High Level Steering Group meeting in Brussels in July 1999, participants had expressed concern about the 1999 balance of payment situation in the six most affected countries in Southeast Europe. However, at the meeting today, the Group said it was pleased to see that their budgetary needs have been largely filled as a result of adjustment efforts by most countries and extra international donors assistance.
     In 2000, the IMF projects a substantial residual balance of payments gap for the six countries, arising from the need to fund renewed reform and adjustment efforts, as well as mitigating the remaining impact of the Kosovo crisis.

Interaction with the Stability Pact

The Group welcomed the successful launching of the Stability Pact at the Summit Meeting in Sarajevo at the end of July, and the various announcements made with respect to special economic and financial assistance to the region.
     "I am particularly pleased that we have been able to accomplish all of this in true partnership," said World Bank Group President James D. Wolfensohn. "We face extremely complex challenges in our work on the Balkans and there is no chance for success without such partnerships."
     The Group noted that close coordination between the activities undertaken by the Stability Pact and its Working Tables, in particular the Table on Economic Reconstruction, Development and Cooperation, and the initiatives of the High Level Steering Group is essential.
     For their part, the World Bank and the European Commission will continue to organize donor coordination meetings to mobilize appropriate financing. However, continued economic reform and domestic adjustment by the countries in the Region will be essential to lay the foundation for an efficient transformation to a market economy.

 
Statement of the High Level Steering Group (HLSG) Meeting

Washington, September 29, 1999

The High Level Steering Group for South East Europe (HLSG), whose membership includes the Finance Ministers of Canada, France, Germany, Italy, Japan, Russia, the United Kingdom, the United States, and Finland (representing the Presidency of the European Union), as well as Managing Director of the International Monetary Fund (IMF), the President of the European Investment Bank (EIB), and the President of the European Bank for Reconstruction and Development (EBRD), the Special Coordinator of the Stability Pact for South-Eastern Europe, and the Deputy Secretary General of the United Nations met under the joint chairmanship of Messrs. James D. Wolfensohn, President of the World Bank, and Mr. Pedro Sobles Mira, European Commissioner for Economic and Monetary Affairs. In addition, a number of Development Ministers, as well as the Finance Minister of the Netherlands and the representative of UN Mission in Kosovo (UNMIK), attended the meeting.

This was the second meeting of the HLSG which was directed by the Heads of State and the Government at the Cologne Summit to guide the donor coordination process for the economic reconstruction, stabilization, reform, and development of the South-East Europe Region. At this meeting, we recalled the conclusions of our first meeting on July 123, 1999, setting out the mandate and broad objectives of out work, including the economic dimensions of UN Security Council Resolution 1244 on Kosovo, and assistance to the people of the Federal Republic of Yugoslavia. We also:

• Examined the progress of Kosovo's reconstruction and economic recovery program;
• Shared information on economic prospects and macro-financial needs of the countries in the South-East Europe Region, including plans and timing for future donor conferences;
• Reviewed the preparation of economic and financial initiatives benefiting the South-East Europe Region as a whole; and
• Reviewed interaction with the Stability Pact structures.

We agreed on the need for authorities in the region and donors to promote transparency and good governance to ensure that adequate safeguards are in place so that official assistance is used for its intended purposes.

Kosovo

We welcomed the progress being made in rebuilding the economy of Kosovo, fulfilling the economic dimensions of UN Security Council Resolution 1244 which calls for substantial autonomy and meaningful self-administration. The representatives of the United Nations provided a status report on the progress that is being made by UNMIK in establishing a civil administration and in creating an institutional basis for successful economic reconstruction and recovery, with the assistance of the World Bank, IMF and major donors. We recognize that substantial challenges still lie ahead as UNMIK works to implement its plans to address urgent issues as well as longer term reconstruction needs. We and our experts noted the considerable progress that is being made by UNMIK in laying the foundations for a sound market economy and in preparing a budget for Kosovo for the remainder of 1999 and for 2000, including an initially small amount of domestic revenue generation. We welcome the progress being made with the establishment of strict budget/fiscal controls to ensure that domestic revenues as well as external support is used only for appropriate purposes. We underlined the importance of UNMIK taking all necessary steps to introduce full accountability and transparency in the Kosovo budget at all levels. We encourage UNMIK to pursue its efforts to ensure that domestically generated revenues fully cover recurrent costs as quickly as possible. We agreed that the provision of external budgetary support, fairly shared among donors, is essential to help cover the residual financing needs identified under the budget prepared for Kosovo by UNMIK in close collaboration with the IMF and World Bank. We urge donors to disburse quickly the pledges already made for support to meet these funding needs.

We welcomed the successful outcome of the first Kosovo Donors' Conference in July at which over US$2 billion of assistance was pledged. We are pleased that emergency assistance to cover in particular humanitarian activities for the period until the end of the year has been committed by donors. We urge donors to disburse quickly their pledges made for winterization. Damage assessments have been finalized and a full-scale Priority Reconstruction and Recovery Program is under preparation by the European Commission and the World Bank in cooperation with UNMIK. This Program, and its associated financial needs, will be presented to the donor community at the second Kosovo Donors' Conference to be held in mid-November in Brussels. The Program should guide donors in pledging and making specific commitments to specific sectors and projects. We encouraged UNMIK to move ahead in putting into place a healthy and predictable environment for private investment and, more broadly, an accelerated process of transition to transform Kosovo into a market economy. We invite our business communities to look at investment opportunities in Kosovo. We instruct the Working Level Steering Group (WLSG) to consult intensively with UNMIK economic authorities during this crucial formative period.

Prospects and Needs of the Region

We reviewed, again, the short-term negative economic and financial consequences of the recent events in Kosovo for Albania, Bosnia and Herzegovina, Bulgaria, Croatia, the former Yugoslav Republic of Macedonia, and Romania. The Kosovo crisis caused a major setback to the region's economies, and its impact is still being felt. Although the rapid return of refugees to Kosovo has meant a reduction of costs for the host countries, other disruptions -- in trade, transit, tourism, and investment -- are continuing. As a result, in many countries, economic reform and transition programs have come under considerable pressure.

At our last meeting in July 1999, we noted that significant financing gaps remained in the 1999 balance of payments of the six most affected countries in the Region despite the resolution of the Kosovo conflict. As of today, these financing gaps have been largely filled as a result of significant adjustment efforts by most countries and additional official financing made available by donors. As for the year 2000, the IMF projects a substantial residual balance of payments gap for the six countries, resulting from the need to support renewed reform and adjustment efforts, as well as the remaining impact of the Kosovo crisis. The World Bank and the European Commission will continue to organize donor coordination meetings to mobilize appropriate financing. However, continued economic reform and domestic adjustment by the countries in the Region will be essential to lay the foundation for an efficient transformation to a market economy.

Regional Initiatives

We welcomed the preparatory work under way to develop economic and financial initiatives for the South-East Europe Region. We took note of the main conclusions of the work undertaken by the various members of the HLSG, in particular the EIB on basic infrastructure investment and the EBRD on private sector development. We would expect the Working Table on Economic Reconstruction, Development and Cooperation of the Stability Pact to complement this work drawing on the regional initiatives being developed by the governments, academia and independent think-tanks of the countries in the region, in particular those involving more than one country and those designed to increase directly inter- and intra-regional trade and investment. It is our intention to review this work with a view to selecting priority initiatives that could merit concerted financial support from the private sector, major donors, and international financial institutions. This review will take place before a Regional Conference is held. Such a conference will be organized by the European Commission and the World Bank in liaison with the Stability Pact mechanisms as soon as it can be appropriately prepared.

In terms of regional initiatives, we distinguish between (i) regional projects and/or programs that will enhance cooperation and partnership between the countries of the region; and (ii) reforms and/or agreements that will bring about closer economic and financial integration within the region and also more widely. The first group of initiatives includes, in particular, initiatives that promote private sector investment, improvements in the legal and regulatory environment, and infrastructure interconnections. Final selection of such projects and/or programs should be based on rigorous analysis of economic benefits and costs, on sound commercial principles and on the involvement of the private sector where possible and appropriate. The second group of regional initiatives is likely to be developed in the context of developing a closer link between the countries of the region and the European Union.

Interaction with the Stability Pact

We noted the successful launching of the Stability Pact at the Summit Meeting in Sarajevo at the end of July, and the various announcements made with respect to special economic and financial assistance to the region. We believe that the promise of peace and stability will help create an atmosphere in which business activity could thrive and investment would be guided by principles of economic efficiency. As mentioned earlier, regional programs of economic collaboration and integration will be promoted under the umbrella of the Stability Pact.

The Special Coordinator of the Stability Pact provided us with a full account of the recent meeting of the Regional Round Table and ongoing preparations for both the set-up and the work programs of the Working Tables. Close coordination between the activities undertaken by the Stability Pact and its Working Tables, in particular the Table on Economic Reconstruction, Development and Cooperation, and the initiatives of the HLSG is essential. The HLSG members are of the view that this Working Table will play an important role in a range of regional economic issues such as trade, infrastructure interconnections and initiatives to improve the investment climate in the region. Financial coordination and pledging initiatives should, however, be overseen by the HLSG and WLSG structures.

Next Meeting

The next meeting of the HLSG will take place in early 2000 in Brussels.

http://www.seerecon.org/News/unmik4.pdf

 
UNMIK headquarters, Pristina, Kosovo
Postal Address: P.O. Box 515 or 596, 91000 Skopje, FYROM
Tel.: +381 (38) 500 223 ext. 4101 or +381 (63) 446 229 Fax : +1 (212) 963 8113

EUROPEAN UNION  -  UNITED NATIONS

UNMIK
UNITED NATIONS INTERIM ADMINISTRATION MISSION IN KOSOVO
EU Pillar – Economic Reconstruction and Development

K O S O V O
Report on Pillar IV’s Activities

Joly Dixon
Head of Economic Reconstruction
United Nations Mission in Kosovo

Washington, 28 September 1999
 

Pillar IV’s Activities in Kosovo
 

Introduction

UNMIK and Pillar IV, with very considerable assistance from the IMF, World Bank and a number of bilateral donors, have made significant advances since I reported in July. We have been grappling with the institutional vacuum in Kosovo and have sought to fulfil our responsibility to the people of Kosovo, by laying the foundations for an economy that corresponds to their needs and aspirations, and by progressively involving them in our decision making. And finally, we are seeking to meet our responsibility to donors, to make sure that the resources they provide are used as effectively as possible. However in Kosovo, as in Alice’s Wonderland, it is necessary to run faster and faster to stay in the same place.

The first part of this report outlines the progress that has been made with Pillar IV’s three short-term priorities: keeping the economy going; building a basic macro-economic framework; and establishing a policy dialogue with the local population. The second part of the report outlines our current thinking on some major issues for the medium-term framework, where for the moment we are concentrating on: housing and the construction industry; agriculture and food processing; and strategies for the development of the enterprise sector.

I. Three Short-term Priorities

• Keeping the economy going
• Building the macroeconomic framework
• Policy dialogue with the local population

Keeping the economy going

Together with KFOR and the humanitarian community, Pillar IV has been active in trying to ensure that essential economic services keep working and that preparations are made to get through the coming winter. Hence for example we have been a leading partner in getting KFOR, the major donors and former and current Kosovar Albanian and Serb managers from the power sector to adopt a strategy which should mean that Kosovo has enough power to supply electricity and heating for the winter.

The strategy includes the following:

- Restoring production at the two coal mines to meet the needs of the two power plants: “Kosovo A” and “B”.
- Keeping the two generating units of Kosovo A running all winter, while the two generating units of Kosovo B will go through major repairs at staggered times.
- Repairing the three major transmission lines.
- Restoring distribution to communities across Kosovo.
- Repairing the district heating plant in Pristina. (However financing is still needed for fuel).
- Setting up arrangements for charging customers by December.

A consortium of companies has been given a contract to manage Kosovo’s power sector through March 2000. It will work closely with the Kosovars at the power station, and will ultimately turn it over to Kosovar management. The management team will be accountable to a supervisory board, chaired by UNMIK and including major donors.

It is hoped that these types of arrangements both for dealing with the property rights issues and the donor co-ordination issues can serve as a model for work in other similar areas.

We have also been working with KFOR and the Donor Community in the areas of water supply, emergency rehabilitation of road and rail, facilities and the opening of the Pristina airport to wider non-military use.

Building the Macro-economic Framework

Kosovo has no organised economic framework. There is no Central Bank or Finance Ministry. All payments are in cash and there is no banking system. Public sector workers are not paid, the taxation system is unclear and services like electricity are not paid for. Under these circumstances it was clear that Pillar IV should concentrate initially on creating some of the basic institutions of the economy.

Currency, Payments and Banking

Since July we have legalised the currency situation; made some substantial progress with payments issues; and defined a strategy for the banking sector.

Currency

A regulation on the use of currency in Kosovo was passed on 2 September 1999. This regulation was necessary because there is a manifest preference by residents of Kosovo to contract and transact in foreign currency, and especially in Deutsche mark (DM). In order to provide a firm legal basis for this reality, the Regulation:

• Legalises the use of foreign currency in contracts and payments and removes all former FRY-restrictions on the possession or use of any foreign currency.
• Provides for UNMIK to keep its budgets and accounts in Deutsche Mark. Obligatory payments to the authorities, such as customs duties, taxes and fines, will also be defined and paid for in this currency. Anyone wishing to make an obligatory payment in Yugoslavian Dinar (YUD) will be allowed to do so, but an administrative fee will be levied to cover administrative and handling costs.

The YUD retains its legal status and will continue to be used, to the extent that the businesses and people in Kosovo so desire. Also there is no question of creating or issuing a separate currency for Kosovo. Such a move is not being considered, nor is it necessary for the proper operation of the Kosovo economy.

Payments System

As Kosovo is for the moment a purely cash based economy, being able to handle cash safely is essential to the economy in general and to both the expenditure and the revenue sides of the budget. Pillar IV has recently been making considerable efforts in this direction. It has been a large task because not much of the previous system could be used. That system was based on the Yugoslav payments bureau in Kosovo (SDKK), which had a monopoly on domestic payments in Yugoslav dinar. The SDKK is incompatible with a market economy. However its vaults in both Prishtina and the districts and some of its staff will be used to develop a cash management system for UNMIK.

The first step is to physically and formally take control of the Payments Bureau and turn it into a Cash Payments Office (CPO) which will be under UNMIK’s responsibility but partially staffed by locals. The CPO will be in charge of storing the receipts from taxes collected at the border, and for handling the payments that have to be made from the Kosovo budget, including those to public sector employees. Details of progress with this operation are given in Annex 1.

At a later stage, when the CPO is working well for UNMIK business, it can be opened up to other depositors, starting with municipalities and other government entities and then moving to private enterprises.

The CPO will not be a bank. It will be a cash warehouse and transfer service. Thus it will not make investments and will need to raise the revenue needed for its operations from service fees. The CPO will become part of the Banking and Payments Authority of Kosovo.

Banking

There are no solvent banks in Kosovo and there is a complete regulatory and supervising void. It is therefore necessary to start from scratch. The intention is to:

- Set up a new regulatory authority – the Banking and Payments Authority of Kosovo;
- Enact a new banking law.

The Banking Authority will be a small organisation headed by a Board comprised of UNMIK officials, resident representatives of international organisations and locals. UNMIK/International agency personnel will have a majority. The organisation will be independent and non-political. Its main purpose will be to supervise the banking sector. It will have the sole responsibility for issuing bank licences and will quickly develop a licence application package (financial data, bio-data, capital resources, etc). It will also be responsible for continuing supervision of banks and evaluation of their performance and on-going ability to meet the regulatory criteria.

The new banking law will be based on the existing models. It will define banking activities and prohibit deposit taking by entities without a licence. It will also set capital standards and initial requirements, as well as both transactional and organisational prudential requirements on issues like large risks. Finally it will define the mechanisms for corrective actions and eventually receivership and liquidation.

At the start the senior management positions in the Banking Authority will be filled by well-qualified international staff, who will be “shadowed” by a Kosovo local. As the core of the necessary international staff have already arrived, thanks to USAID, and as it is the intention to have these basic pieces of legislation in place very quickly, it should be possible to have a legally operating banking sector in Kosovo by November.

This effort is also designed to deter the creation of pyramid schemes and other types of fraudulent activity growing out of the informal banking practices extant in Kosovo today.

The Budget

Annex 2 presents the Kosovo Current Budget for end 1999 and 2000, which builds on the previous presentation in July.

The most dramatic progress that has been made since July is that the revenue side of the budget has become a reality to the extent that some taxes are actually being collected at the border and are flowing into the Kosovo budget. The “Regulation on the Establishment of the Customs and other Related Services in Kosovo” came into effect on 1 September 1999, and since then some six million-DM have been collected.

Our activities with regard to the budget have been concentrating on:

i) Establishing Budgetary Procedures

ii) Considering possibilities for a broader tax base

iii) Improving estimates for the 1999 budget and outlining the 2000 budget.

Budgetary Procedures

It is important that UNMIK move quickly from the stage of simply reacting to problems to a stage of setting priorities and dealing systematically with their budgetary implications. To do this we intend to set up a Central Fiscal Authority (CFA).

The CFA will have a structure like a finance ministry. It would have departments for budget preparation, treasury, tax administration and collection and auditing functions. The CFA will be under UNMIK control, managed by foreign experts but with a substantial Kosovar professional staff. This will have the advantage that once UNMIK hands over, there is a self-standing entity that can continue to function normally. Initially, the CFA will have a dozen international staff to run it and to hire and train local staff and future management. The first of this international staff has arrived, thanks to USAID, and is now preparing the setting up of the CFA. However, significant progress has already been made within UNMIK to establish basic budgetary procedures. Both central administration units in Prishtina and the district administrations were involved actively in formulating the expenditure estimates. In conjunction with the next payment of urges/stipends at end September, comprehensive payroll records are being developed and procedures for more efficient payment, though the SDK, are to be adopted as a precursor to the CPO. This will also be integrated on the Treasury function of the CFA, whose development has begun in recent days.

A Broader Tax Base

As discussed above, the tax base at the moment consists of customs duties, excise taxes and a pre-sales tax, all collected at the border. The applicability of the taxes and the total amount levied varies according to types of goods, with the effective rate ranging from 0% to 75%, with the upper range applying to the normal excisable goods: alcohol, tobacco and oil products. We are proposing to broaden the tax base by introducing:

- A tax of 10 percent on the gross receipts of larger hotels and restaurants, to be introduced by 1 January 2000.
- A final withholding tax on wages, which should be introduced from 1 January 2000.
- A presumptive tax for small businesses, starting from March 2000.
- As a temporary measure, this tax should also apply to larger unincorporated businesses and the professions; the longer-term objective should be to re-introduce, when administrative constraints allow, a more developed personal income tax for this purpose.
- A corporate profit tax, with effect from January 2000.
- A tax administration code, applying consistently to all relevant taxes.

As discussed in the Budget paper in the Annex, it is also desirable to phase out the existing arrangement whereby goods of Macedonian origin are subject to an administrative fee of 1 percent rather than the customs duty of 10 percent.

The Budget Numbers for 1999 and 2000

Annex 2 gives the main budget numbers. We start on the revenue side and table 1 in the Annex gives some estimates for:

i) Possible revenue for the rest of 1989. The estimate is lower than the one presented in July because collection started a little later than hoped and collection rates are less than hoped.

ii) Three scenarios for the year 2000, which differ according to the percentage of excisable goods that we are able to to tax. If only 30 % is taxed, revenue would be 167 million-DM. If 40 % is taxed, revenue would be 231 million DM. There is also a very first estimate of the revenue that might be generated from the new taxes.

iii) Revenue in 2001 and 2002. It was thought essential to make some attempt at this more medium-term outlook. As donor financing in this area will cease, expenditures must be set in the light of prospects for domestic financing if the budget is to be sustainable,

On the expenditure side of the budget (see table 2 of the Annex), the estimates have been derived using much the same methodology as was used in the July exercise. This continues to be a current expenditure budget. (There is no investment expenditure and even little or no maintenance expenditure.) The large expenditure items are therefore wages, income transfers and some overhead costs. The costs of the newly founded Kosovo Protection Corps have not yet been included.

The total wage bill depends upon employment levels, and wage rates. The assumption is that Kosovo should have a lean public service. Total public sector employment would be around 52,000 compared with the over 120,000 that were previously employed. At end September agreements will be made to 43,000 workers.

Wage rates are set by building on the existing system of wage relativities; and then setting the basic wage rate.

Income transfer payments are mostly old age pensions and social security. There is an existing pensions system, but there are many problems in taking over the previous entitlements. It seems more appropriate to redesign a new means-tested system targeted at the old, invalid and seriously disadvantaged. We have not yet good ideas on the details of the system but have budgeted for 70 DM per month for around 100,000 recipients.

Overhead costs have been determined simply by estimating them to be given percentage of wage costs. The following has been used:

- in education, overheads are put at 20 % of the wage bill but purchases of books and furniture are separate;
- in health, overheads are put at 50 % of the wage bill and there is a substantial item for pharmaceuticals on top of this;
- in civil administration and public services, overheads are put at 30 % of wage costs

The results of all this are that total expenditure is estimated to be about 120 million DM for the rest of 1999 and about 350 million in 2000, if the average wage is 225 DM per month. Each extra 25 DM per month on the average wage costs the budget about 20 million DM.

It should be recalled that the tentative medium-term revenue was about 350 million. Hence an average wage rate of around 225 to 250 DM should be sustainable.

Policy Dialogue

UNMIK will not succeed if it simply replaces one outside force with another in Kosovo. The first experiences were not good. Regulation 1 – the so-called mother of regulations -was not well received by the local population.

Learning from this experience, the Mission has tried to discuss its policy ideas and rationales much more with the Kosovars in an attempt to build consensus and their support. An “Economic Policy Board” has been set up.

- It is co-chaired by Pillar IV and M. Ajri Begu – the man who calls himself Governor of the Bank of Kosovo.
- It includes another eight Kosovar members, including Isa Mustafa and Adem Grabovci, each of whom calls himself finance minister.
- It has the power of proposal as well as acting as an advisory body.
- It reports to the Kosovo Transition Council.
- Some technical working groups we have set up under the EPB. They are already performing a useful advisory role. The Working Group on Enterprise and Property, for instance, has debated the role and the prerogatives of the Chamber of Economy of Kosovo. This is an important institution, which in the past acted more to constrain than to improve the activity of the enterprises. The working group has set some of the basic principles under which a market-oriented institution should work. A small technical assistance project financed by the EU TAFKO will help to draft a new by law and to identify possible ways in which the Chamber can be used to promote business and enterprise culture.

The experience with the EPB has been good. Both the currency law and the customs law were extensively discussed the process was well received.
 

II. The Medium-term Framework

The next stage, on which we have already begun, is to establish a medium-term sector based framework for economic revival and reconstruction. This framework has to recognise the weaknesses of the economy, in particular that it has been starved of investment over a decade; that it has lost international markets; and that a lot of valuable equipment and productive assets have disappeared or been destroyed.

The framework should also take into account that over the last decade while public enterprises were generally declining, private enterprise and the parallel economy was growing. It is estimated that there was a 50 % decline in GDP from 1989 to 1995 caused primarily by a dramatic drop in output levels in the publicly owned industrial sector. In contrast output levels in the private owned sector have remained constant, with the result that privately owned enterprises contributed close to 50 % of total GDP by 1996 and about 80 % of GDP by 1998. Finally the framework has to take into account that as well as there being no banks and payments system, there is no regulatory framework.

In these circumstances the strategy will have to concentrate on private sector development and as much on institution building and development of human capital as on investment in physical capital. It seems appropriate to concentrate initially on the following major sectors:

• Housing and construction
• Agriculture and food-processing
• Enterprise development

Very soon it will also be necessary to develop strategies for:

• Infrastructure and public utilities
• Institutions and Training
• Education and Health

Housing and construction

The construction sector, like the rest of the economy, has been in steep decline over the last decade. However it still represents, along with agriculture, the sector where productive revival is likely to take place most quickly.

Construction of urban multi-unit dwellings was largely in the hands of a small number of state owned construction firms which have been devastated, with Kosovar Albanians being made redundant and much of the construction equipment being removed. Rural housing is largely privately owned and rural construction done by own labour or small private enterprises.

The officially recorded output of completed housing units dropped in the 1990s at approximately 25 % of the levels in the 1980s with records indicating only 168 flats and 1231 private houses being completed in 1995. Despite this it is also estimated that 80 % of all recent private investment in Kosovo has been in private housing.

Damage to dwellings and public buildings began on a significant scale by October 1998 and then escalated dramatically after the beginning of the bombing in March. It is estimated that damage or destruction has affected 120,000 houses out of the total housing stock of about 250,000 units.

The immediate priority has been to ensure that there is adequate shelter for the winter, and much progress has been made. Now it is essential to move towards a medium-term programme for rural housing rebuilding, urban housing improvements and development of the construction industry.

Rural housing

The proposal is to have a large-scale housing rehabilitation programme, which would start in early spring 2000. Around 60,000 households could be targeted to receive assistance in the form of materials for “primary rehabilitation” of an average 75 m2 of floor space, while 20,000 of these corresponding to the most vulnerable households would also be eligible for top-up assistance towards payment for skilled labour.

Urban housing

Many returning refugees are gravitating towards Pristina and other large urban centres. While this migration may be attributed in part to the greater extent of destruction of dwellings in rural areas, the attraction of the urban centres is also based on expectations of income earning opportunities and improved access to public and other services in urban areas. Furthermore there may have been considerable over investment in rural private housing over the last few years, because of the lack of alternative investment opportunities. The implications of the urbanisation scenario are that (i) not all damaged houses in rural areas may need to be rehabilitated given the absence of permanent owner occupiers and (ii) new housing, in addition to rehabilitation of existing units, will be required in urban areas.

Construction Industry

The industry recovery programme for Kosovo will need to give prominence to urgent capacity building investments across the spectrum of construction sector. As well as encouraging the formation of teams of crafts people and small family run building firms, it is appropriate to stimulate the creation of medium and larger contractors, including consideration of privatising and restructuring social-public construction firms and construction material manufacturers. There should also be the provision of technical assistance in the form of management support and equipment to those private/state construction firms assessed to have potential.

Agriculture and Food-processing

Prior to the war the rural population accounted for about 65 percent of the total population and agriculture and food processing was a very significant element of GDP. With the war and prior months of violent tensions in 1998, agricultural production, as well as related processing industries have almost come to a standstill.

The majority of livestock (cattle: 50 percent, small ruminants: 65 percent, poultry: 85 percent) which contributed around half of the value of agriculture production is reported to have been lost or killed. A significant share of agriculture mechanisation (tractors: 55 percent, combine harvesters: 75 percent) are lost or need repair; and many farm buildings (stables, sheds and storage space) have been destroyed. Agro-processing infrastructure, in particular privately owned small and medium size enterprises, have also experienced damage either through direct destruction or looting of assets. The high demand for wood (both for fuel and construction purposes) in the aftermath of the war is putting increasing pressure on the longer-term sustainability of forests in the province. Mines, present or perceived to be present in rural areas, are currently limiting access to agriculture land.

However there is a vibrant tradition of family-based agriculture. There were also parallel structures marked by an impressive capacity for private initiatives, and these are already re-emerging. These are good bases on which to build a revived rural sector.

The aim of a medium term rural programme is to provide employment and income to a large share of the population in Kosovo and to enhance food security in the province. The challenge consists in jump-starting agricultural activities in the immediate future and addressing, from the onset, a range of institutional and structural issues, which will require a longer-term perspective. A programme could be grouped around three themes: (a) reconstruction aimed at jump-starting agriculture and the rural economy; (b) support to private sector development in rural areas; and (c) support to institution capacity building. Activities need to be launched and implemented from the onset across all three themes and hence do not imply sequencing; rather, the emphasis is anticipated to shift over time.

i) The jump-start would come from a major programme to re-supply the agricultural community with livestock, mainly cattle, agricultural machinery; and essential inputs like seed and fertiliser. The scheme would be mainly voucher based so as to provide the maximum possible choice to farmers and encourage increased local involvement in the delivery of goods. It has to be examined whether there can be some inter-changability between the housing and the agricultural voucher-schemes.

ii) Support to the private sector in rural areas will involve mainly the privatisation of socially-owned agro-processing enterprises very early in the reconstruction process, using simple tendering procedures aiming at local or regional investors, combined with post-privatisation financial support to ensure operations of privatised assets. This will require some building of specific agricultural credit and micro credit schemes. It will also be necessary to ensure adequate production incentives to farmers by adopting a policy aimed at phasing out donor provided food aid to the province over the coming 18 months. There will continue to be food insecure segments of the population well after the summer harvest of 2000, which will require protection through public works schemes or the re-establishment and funding of a social safety net (pension, welfare). Similarly, phasing out of donor (including NGOS) supplied farm inputs (seeds, fertilisers, agro-chemicals) in the course of the year 2000 will become important if crowding out of private initiative in this field is to be avoided.

iii) It will also be essential to support institution building. One element of such institution building consists in establishing an agricultural administration. This should respond to the needs of the sector, while limiting public involvement to a few core functions like: agriculture statistics; sanitary and key veterinary diagnostic services; quarantine facilities; a simple agricultural information service. Other key institutional issues for the agriculture sector that need to be addressed in the medium-term are the review, formulation and adoption of new legislation on: (a) property rights, transactions, and registration to allow for the development of a land and real estate market; (b) co-operatives and associations to allow for the voluntary development of producer co-operatives and professional associations; and (c) maintenance of price and trade policies which ensure efficient markets and the free flow of internal and external trade.
 

Restart of the Enterprise Sector

The enterprise sector consists of three basic components. First a number of publicly owned companies formally engaged in all sectors of the economy but predominantly located in the industrial sector. There are currently around 200 of these enterprises, of which 66 could be classified as major enterprises. They are generally in very poor condition, but are perceived by the population to be major potential sources of wealth and employment. Second there is a much larger population, both in terms of numbers of enterprises and of their collective output, of privately owned enterprises. These tend to be in trade and services. Third there is a substantial parallel segment. While it is not clear, it appears that this segment consists of grey market activities in trade and services on a small to medium scale. The challenge therefore is to be seen to be making progress with the publicity-owned sector for political and social reasons, while freeing up the potential of the private and parallel sectors for growth.

It is intended to pursue three simultaneous strategies. First, increase the private sector’s content by transferring the potentially viable public enterprises to private ownership. Second, promote the growth and development of the privately owned enterprises already within the official economy and encourage new start-ups. Third, embrace the parallel economy and bring it within the official economy through a combination of inducement and requirement.

As one might expect, each of these strategies will operate along different timelines. The most promising sectors in the short term are likely to be privately owned trade and services, which have already demonstrated a remarkable rebound. Closely following these sub-sectors should be privately owned agricultural production (assuming the effective assistance of donors), and newly-privatised agro-processing and construction. Allowing the existing private sector to lead the way, shortly followed by the newly privatised sub-sectors is likely to have a high short-term pay-off. This would create the breathing space necessary to work on structural solutions for other sectors of industry and mining, which will need considerable time to adjust to the dramatically changed circumstances around Kosovo in the year 2000 and beyond.

In order to effect its three-fold strategy, UNMIK and the donor community need to work in three broad areas:

• Create a legal and regulatory framework conducive to the development of private enterprise, effectively setting the proper climate within which the private sector can flourish.
• Set policies with regard to lending of capital.
• Devise an overall programme for privatisation of viable enterprises and liquidation of the remainder – therefore addressing the content issue.

It will also be necessary to develop a comprehensive consensus building campaign and, once the policies are set, a substantial public education programme. The public education effort should be aimed at the general public in order to bring their expectations levels in line with the current reality and to convey the salient points of the new structure of the economy.

Regulatory Framework

The framework should include the following elements:

• An effective and simple business registration system;
• An appropriate property rights legal framework, including collateral and bankruptcy legislation;
• Basic business law and contractual rights legal framework supportive of private business formation and operation;
• A practical legal mechanism for resolving property disputes;
• A competition law framework which severely limits the scope for public intervention in industries which are not natural monopolies;
• A comprehensive accounting legal and regulatory framework which promotes the application of International Accounting Standards for financial and tax accounting purposes.

As it will take time to complete this framework, and even longer to create the institutional capacity to implement it, it will be crucial to prioritise work according to a critical path analysis which focuses on removing the biggest obstacles first.

Credit for Private Enterprises

The absence of a banking system that can provide credit for viable productive activity is probably the most serious constraint to private sector growth in Kosovo. As a consequence, the private sector is limited to activities that require minimal investment, mainly in the services and retail sectors. Filling this void with a credit programme based on sound economic and financial principles is therefore very important indeed. Currently, a number of donor organisations are trying to support the private sector by providing grants to small business without any form of financial intermediation. Anecdotal evidence suggests that these grant programmes are not co-ordinated, leading to the same enterprises receiving support from various donors. Clearly, this creates serious distortions. It will be necessary to set up a donor co-ordination forum for enterprise support, and agree that donor efforts will be concentrated on setting up sound SME credit programmes, phasing out the grant programmes as soon as there is an alternative in place, which could be in March 2000.

Basic principles, which would form the basis for an SME Credit Programme for Kosovo should be the following:

• SME lending activities must be conducted within the newly established banking supervisory regime;
• Credit should be extended through the Programme for private enterprises only, based on sound credit analysis;
• Credit should be extended to enterprises in the parallel sector only upon their conversion to the official economy (i.e. that they register as enterprises and fully comply with the legal regime)
• Borrowing terms extended to enterprises should not distort competition with commercial credit;
• The Programme should be conducted in such a manner that supports the medium term institution building needs for the banking sector;
• Donor financed SME credit should be viewed only as a transitional mechanism until a healthy banking system will be developed;
• Donor co-ordination must be maximised and perhaps overseen by UNMIK itself. Kosovo does not need several SME Credit Non-bank financial institutions and/or the distortions that numerous programmes can create;
• Apply similar principles to the extension of micro-credit and agricultural credit.

Other support for Private Enterprises

There are several other useful interventions to be considered in support of SME development, most of which have been implemented in other transition economies:

• Business advisory services can introduce the business community to skills like the development of a sound business plan and credit application and accounting and auditing. A programme providing these services could be quite useful, as long as the use of the programme would be optional, and certainly not a pre-requisite for access to SME credit;
• Venture capital funds can increase the amount of resources available for equity investment into Kosovar businesses. These programmes could be very useful in channelling diaspora capital to legitimate investment in Kosovo.

A Privatisation Programme for Small and Medium sized Public Companies

Consideration should be given to a scheme to privatise a number of publicly owned companies, especially in the food processing and construction materials industries.

Such a transformation programme should be designed to maximise the chance of achieving the main objective: to contribute to growth by spring 2000. This means that the design should maximise the scope for attracting investment and improving management, and should allow for rapid implementation. The following options could be considered:

• Transferring ownership wholly to the workers. This option will not allow the enterprises to attract significant investment, nor is it likely to improve management. It should therefore be rejected, as it already is by most leading thinkers on enterprise issues in Kosovar society;
• Attracting (foreign) strategic investors. In the current legal framework in Kosovo, this option is unlikely to succeed in the short term. In addition, the type of enterprise at issue – relatively small enterprises producing for local markets – is unlikely to be of interest for foreign investors;
• Ownership transfer through auction. This method is easy and quick to implement. If combined with pre-qualification of bidders on criteria aimed at establishing their genuine ability to invest in and manage the enterprise in question, it will also achieve the other objectives set out above. As the objective of this programme would not be to raise revenues but to transfer assets into private hands and maximise the injection of capital into the enterprise, it would be preferable to select the winning investor based on the amount (s)he is prepared to invest. Although one would expect the vast majority of investors in these enterprises to be domestic, there would be no reason for excluding foreigners from participating in these auctions.

A Plan for Large Public Enterprises

There is an emerging consensus among leading thinkers in Kosovar society about the fact that it would be important for UNMIK Pillar IV to set up an ownership and privatisation working group under the auspices of the Economic Policy Board. This group could provide important input into the work on public ownership described directly above and start focusing relatively quickly on the design of a programme for privatisation of large enterprises. Current thinking in Kosovo is that such a programme should be implemented only after elections, however, there would be a very high premium on trying to reach a consensus that a pilot programme could take place in the year 2000.

Public debate and a public education programme. In addition, it is of paramount importance to start a public debate and a public education programme on large enterprise privatisation as early as possible. Time is of the greatest essence in dealing with the unrealistic expectations that both the workers and the general population have about the viability of large enterprises in Kosovo. The main purpose of this debate and education programme would to get the message across that Kosovo’s economic future does not lie in recreating the Kosovo of 1989, but in building a different Kosovo based on current and future economic realities and opportunities.

A pilot programme for large enterprise privatisation. The purpose of a pilot programme for large enterprise privatisation would be to strengthen the consensus on the overall approach by setting a positive example. This would have the additional benefit of bringing some of Kosovo’s best large enterprises into private hands as early as possible, so that they can start contributing to growth. Since these enterprises will need foreign strategic investment, the basic method for this programme would be privatisation through tenders to strategic investors, with similar provisions for workers’ rights as discussed in the section on agroprocessing and construction material enterprises above. To maximise the chance for success, the financial advisers who would assist in the implementation of this pilot programme would receive an incentive-based reward. They would also be allowed to pick a certain number (perhaps 10) enterprises from the entire list of large enterprises based on their own judgement on the chance of a successful sale for each enterprise.

If the pilot programme is successful, it might be possible to follow with another “batch” of enterprises under a similar programme, possibly allowing for adjustments in the programme based on the experience with the pilot programme. One would anticipate, however, that the momentum for attracting strategic investors would soon fade, as many enterprises will simply not be attractive enough. It will be important to switch gears as soon as this happens, since it is a waste of resources to attempt to privatise assets that have little value. At that point, the programme should switch gears to a solution that is not aimed at attracting investment, but on disposing of the remaining assets as quickly and efficiently as possible.
 

Conclusions

In summary, we have focused on developing both a short term and medium term strategy. In the short term our efforts to keep the economy going have been successful to date. In the power sector these have been greatly facilitated by the speed and flexibility with which the EC Task Force and several bilateral donors have contributed to a financing package totalling some 50 million Euro. We have resolved the currency issue, begun building a cash management system (see Annex 1), and specified the design for a well supervised bank regulatory system, which can be put in place now that the qualified international staff is arriving. It should be possible to have legal banks, licensed to operate in Kosovo in November. We have significantly reworked and expanded a budget for Kosovo (see Annex 2), and have also made considerable progress with establishing transparent and effective budgetary procedures. Newly arriving international staff will also help us quickly to set up a Central Fiscal Agency.

From a qualitative viewpoint one of the most significant initiatives has been the formation of our Economic Policy Board, co-chaired by myself and a leading Kosovar economist. This has enabled us to better communicate with leading Kosovo thinkers on economic matters and should increase our ability to form consensus and reach out to the general public.

In the medium term, again with the significant assistance at the Fund and Bank, we have made substantial progress in formulation detailed strategies of economic recovery and restructuring. Initially we intended to focus on housing and construction, agriculture and food processing, and enterprise development. In each area we believe we have a sufficiently specific understanding of the current status and almost complete proposals for programmes, to be presented at the Donor Conference in October. For that conference there will also be strategies for infrastructure and public utilities, institution development, as well as education and health.
 

Annex 1

Use of Payments Bureau Facilities by UNMIK

In the past week we have enhanced physical security at the Pristina branch of the payments bureau (hereafter referred to as SDK) and restored access to vault facilities in the other branch offices (Mitrovica and Peje). There is now a basis for making greater use of SDK facilities and services in budgetary receipts and payments (and, as experience is gained in this area, for other transfer operations).

This note lays out a general strategy for use of the SDK in budgetary operations, focusing on four areas: safekeeping of customs revenues; collection of customs revenues on behalf of the customs administration; and effecting payments of stipends, wages, and pensions. It reflects discussions with Pillar II, CAM-K, KFOR, and SDK staff.
 

1. Safekeeping of customs revenue

To enhance security at the Pristina branch of the SDK, we have had the locks and combinations for the vaults and all entrances to the vault area changed by the Fichet-Bauche security firm of France. We have been given control of the main vault of the Pristina branch of the payments bureau. These changes provide a basis for safeguarding of customs revenues at this facility from now on.

We plan that accumulated customs revenues will be moved immediately from UNMIK facilities to the Pristina SDK vault, and that customs revenues collected at the customs border posts henceforth will be transferred directly to this vault. This will also help position UNMIK to begin integrating SDK facilities and services into other budgetary operations.

With the opening of second and third customs border posts at Vernice and Globocica,, it would make sense to put a similar storage arrangement in place at the SDK branch office in Prizren. Because there is only one vault at the Prizren office, however, any action by UNMIK to take control of the vault would preclude the SDK from continuing its normal operations. Under these circumstances, use of the Prizren vault as a major facility for the safekeeping of customs revenues from Vernice would appear to require the assignment of UNMIK personnel on a full-time basis to the Prizren branch of the SDK, either to control or to monitor access to the vault. As a result, the current plan is to transfer funds directly from Vernice to Pristina, with an intention to investigate the possibility for use of the Prizren SDK branch at a later stage.
 

2. Collecting customs revenues on behalf of the customs administration

The original CAM-K action plan envisaged that most customs revenues would be collected at inland facilities, such as the main SDK branches, rather than at the border posts. It should now be feasible to do this.

Initially it was envisaged that such a system would be based on payment of customs tariffs, sales taxes, and excises at SDK offices at least 48 hours in advance of the arrival of the goods at the border. Importers would be registered, and would make advance payments under their unique registration number. At the end of each day, a record of advance payments would be stored on a computer diskette and carried manually to the border posts. When the goods arrived at the border, the customs officers would refer to this record to verify that the payments had been made. Importers preferring to make payments at the border post could still do so, but would be charged a penalty of 5 percent.

The most recent thinking from CAM-K is to have registered importers maintain advance import duty deposit balances at the SDK significantly larger than the next expected shipments, with obligations being deducted from this account as trucks pass the border. Customs officers would confirm the deposit balance and deduction over a satellite phone link.
 

3. Payment of stipends, wages and pensions

Use of SDK staff and facilities to help make payments could greatly increase the speed and efficiency of these operations, since the cashier windows at SDK offices are set up for disbursement of cash to the public. As a first step, we have agreed with Pillar 2 staff on procedures to replace the current “envelope” approach.

Under the current proposal, UNMIK would prepare master lists of recipients of payments, broken down by the SDK office nearest to their place of residence. The appropriate lists would be forwarded, at minimum, to each of the seven SDK main branches (Pristina, Peje, Gjakove, Prizren, Ferizaj, Gjilan, and Mitrovica), along with a stock of DM banknotes sufficient to make the payments in its area. SDK cashiers would disburse funds to recipients upon submission of appropriate evidence of identity.
 

4. Transfers of funds

Under the procedures described above, all revenues and external assistance for local payments by UNMIK will be taken from depositories in Pristina and transported to SDK branches elsewhere in Kosovo. For the present KFOR will continue to do this, but it is sorely stretched and the expansion of stipend operations to cover simultaneous payments to 43,000 recipients at end-September will increase the burden.

For this reason, it is clear that at some point we will want to consider both maintaining working balances at the SDK main branches and spreading out the timing of payments.
 

Annex 2

The Kosovo Current Budget for end-1999 and 2000

1. THE REVENUE FRAMEWORK

The donor community has indicated its readiness in principle, very exceptionally and temporarily, to fund a large part of the current expenditure of Kosovo’s public administration. This means that in the immediate future spending is constrained both by customs revenue collection and by how much donors can be convinced to contribute.¹ However, it is clear that this situation will not last; donors will want to have a reasonable prospect that the Kosovo budget for current expenditure will become largely ² financed from domestic sources. Therefore, the first anchor point for this budget is an estimate of what could be the level of domestic tax revenue in the medium term. This serves as an indication of what spending could be today. In that way, Kosovo’s public spending level would not have to be adjusted once foreign funding of current expenditure is phased out.

Table 1 - Revenue Projections, 1999-2002
In million DM                   1999 2000 2000 2000 2001 2002
                              Sep-Dec (A)  (B)  (C)
Existing Taxes
1. Customs                        9    28   47   53   55   63
2. Excises                       15    44   51   58   59   67
3. Sales tax on imports          24    71   86   96   99  114
Sub total                        48   143  184  207  213  245
Taxes proposed
4. Hotel/restaurant tax           0     5    5    5    8    8
5. Wage tax ^1/                     0    10   10   10   23   30
6. Tax on unincorporated business 0     5    5    5   14   14
7. Corporate profit tax           0     5    5    5    9    9
8. Other ^2/                         0     0    0    0   20   40
Sub total                         0    25   25   25   73  100
TOTAL                            48   167  209  231  285  345

Memo items:
Percent of excised goods taxed   30%  30%  35%  40%  37%  40%
Customs duty, Macedonian imports  1%   1%  10%  10%  10%  10%
Total recorded imports (DM mn)   133  400  475  529  549  633
Non-budget employment           25,000 25,000 25,000 25,000 37,500 50,000
Average net wage                 225  225  225  225  225  225

^1/ Introduced April 1, 2000; excludes budget sector workers.
^2/ Revenue from taxes not yet identified.
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¹ It should be recalled that Kosovo is not in a position to borrow, either domestically or abroad. Thus it cannot run a budget deficit in the conventional sense.
² Largely, but not fully. In view of its level of development it is reasonable to assume that Kosovo will be able to benefit from foreign financial assistance into the medium term at least.
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Table 1 provides an estimate of tax revenue through 2002. For the year 2000, it provides three different scenarios. The basic assumptions are as follows.

1. The base of Kosovo revenues is provided by the taxes which began to be levied on 3 September: customs and excise duties and sales tax levied at the border.

2. Besides the rate of these taxes (e.g. 10% for the customs duty) there are a few crucial variables that determine revenue. These are identified as memo items in the table. First, the level of smuggling, or its inverse, the percentage of excised goods such as cigarettes, alcoholic drinks or petroleum products that are actually taxed. The assumption in this budget is that during the remainder of 1999 30% of imports on which excises should be levied will actually be taxed – i.e. 70% will be smuggled. This will gradually improve over time as the customs service becomes more efficient, but we remain fairly modest in assuming that even in 2002 60% will still be smuggled. These are average rates; for instance, it is assumed that the customs service will be less succesful in taxing cigarettes (easy to smuggle) than oil products.

3. Excise duty revenues are driven by estimates of smoking and drinking habits, numbers of cars and assumptions on annual mileage and fuel consumption, etc.

4. The import duty on goods of Macedonian origin is currently 1%, by virtue of an existing trade agreement. It is reasonable to fear that this will lead to considerable fraud with declarations of origin; moreover, there is already pressure to extend similar treatment to Albania, entailing further revenue losses. A suspension of this favourable treatment of imports from Macedonia would generate more customs revenue. Incidentally, the budget assumes that excises and sales taxes are still levied on imports from Macedonia, irrespective of whether there is a derogation from the standard customs tariff.

5. Another crucial variable is the total level of recorded imports. This determines the base on which the border taxes are levied. The revenue projections are quite sensitive to this variable, but in view of the absence of macroeconomic or trade data it is extremely hard to determine the right level. The import figures in Table 1 have been derived by combining information on previous import levels and known import levels of neighbouring countries, adjusting for levels of development – again based on judgement rather than data.

The second part of Table 1 provides a very tentative indication of revenues from taxes that do not currently exist, but which could be introduced in the near future. This builds on recommendations from an IMF team that visited Kosovo during the second half of August. Obviously, no decisions have yet been taken on whether to introduce these taxes, let alone on their precise definition. However, they are considered feasible, even with a rudimentary tax administration, which still has to be set up.

Clearly, therefore, the revenue estimates are extremely tentative and the margin of error is high. Nevertheless, they were constructed rigorously, building up from as much detail as is available, and with the help of a number of economists with substantial relevant experience. The result is not as solid as would be desirable, but it is the best that is possible at the moment.

The total revenue in Table 1 provides the first pivotal indication for the Kosovo budget: within another 2-3 years, revenue could be of the order of 300-350 million DM per year. This sets the order of magnitude that it is reasonable to assume for expenditure, even in the short term – assuming that the initial gap between domestically generated revenue and expenditure will be covered by donor funding.
 

2. EXPENDITURE

The expenditure estimates in the current draft version of the Kosovo budget have been derived in a manner that is fundamentally similar to what was done for the Donors Conference in July. Starting from estimates of staffing levels in key public services, and adding estimates for wage rates, a wage bill is determined. Then there is an estimate of what will be required in terms of social security payments, again starting from numbers of beneficiaries and rates per person or family. Although there are some fairly substantial non-wage elements in this budget as well, such as schoolbooks and pharmaceutical products, it remains a budget for current expenditure; there is essentially no provision for investment or major rehabilitation. These latter requirements will need to be addressed in a subsequent phase of the budget process, once detailed sectoral studies of investment needs become available.

The lion’s share of public expenditure will be on wages and income transfers. This means that policy decisions will be necessary on three variables that together determine the outcome: numbers of public sector employees, wage relativities (how much more a doctor earns than a nurse), and the absolute wage level. Mutatis mutandis the same applies to social transfers.

As regards each of these three parameters, the guiding principles behind this budget have been the following: ³

1. On employment levels, the starting point has been to have a lean public sector in Kosovo. The public sector should be able to perform its core functions but it is not an employment scheme. At the same time we have carefully examined previous staffing levels, both as a guide to what is reasonable for the future and what Kosovar society might expect of us. Reconciling leanness with continuity from the past did not turn out to be a great problem. For instance, the number of teachers that was previously active in the education sector can be considered to be reasonable and adequate.

2. As regards wage relativities, it is important to understand how the public sector wage mechanism functioned in the past. Put simply, there used to be a basic wage defined for the whole public sector, and any particular job would be assigned a certain multiple of that base rate. Say, the base was 100 dinars. A doctor would earn 7 times that, a nurse 3 times, and a cleaner 2 times. For most of the public sector we have been able to identify the relativities that were used previously. There are good grounds to stay with these relativities for the time being: it absolves us from inventing new ones, it will be easily recognisable for
____________________
³ More detailed assumptions are given or implicit in the detailed budget tables per sector and should be reviewed by and discussed with Pillar II experts.
________________

the workers, and it will in many cases be considered the fair thing to do. Therefore, this budget has assumed that we broadly retain pre-existing relativities. There is one major exception to this: we consider some of the traditional relativities in the health sector to be fundamentally flawed. They provide perverse incentives for doctors to work in hospitals, and to become specialists, rather than to work in primary health care. As a result there is considerable overstaffing in hospitals and understaffing in primary care. This budget rectifies this by providing for a premium to doctors in primary care.

3. Since there appears no need to deviate fundamentally from pre-existing public employment levels, or to modify wage relativities, this leaves the basic wage rate as the pivotal parameter. By increasing or lowering this basic rate, the entire public sector wage bill (and thus the bulk of expenditure) can be moved up or down to bring total expenditure close to the anchor defined in the revenue section above: medium-term fiscal revenue. The result of this operation then needs to be subjected to two reality checks: is the resulting wage level likely to be acceptable to public sector employees, and is it more or less in line with what could be expected as an average wage in a country of this level of economic development.

While salary costs are the largest single component in the expenditure budget, and thus the average public sector wage rate is the most crucial variable, there are two other main components that merit consideration: social assistance and pensions, and overhead costs.
 

Social assistance and pensions

There is a well-organised and articulate pensions lobby in Kosovo, consisting of a pensioners’ organisation, the pension fund and to some extent the post office (which used to be instrumental in the pension payment process). This lobby has been making forceful demands for the resumption of pension payments, including arrears, and claiming that it would be able to implement these payments if UNMIK provides them with the money. Close examination by Pillar IV and the World Bank has shown that there are serious problems with this. First, the people in question (some 95,000 are on the books) are in fact those covered by the Kosovo branch of a FRY occupational pensions and invalidity insurance scheme; it is unknown how many of them are still in Kosovo but there are good grounds to assume that many of them are not, which makes implementation of payments very difficult. Second, this group may well not be the most needy category of elderly Kosovars. Third, using the pension fund’s lists may in fact consolidate a discrimination against Albanian Kosovars expelled from the public sector during the past decade. Fourth, resuming pension payments, even without retroactivity, would mean that the Interim Administration recognises a liability towards this group of people, which would bind the successor Administration once UNMIK hands over. Fifth, a resumption of pension payments may help induce a large-scale return of beneficiaries into Kosovo, which has ramifications that need to be considered. Sixth, the cost would be very substantial: assuming that all beneficiaries would be reached, the monthly cost is about 7 million-DM per month or 84 million per annum.

Nevertheless, it is clear that there are substantial groups in Kosovar society that require some form of social assistance, and the budget should provide for this. Rather than starting from pension insurance entitlements, it is probably better to give priority to those most in need, through a system that includes means-testing. This could include children orphaned during the recent hostilities, or families that have lost their wage earner. One possible way to identify the most destitute could be to use the very extensive network of the Mother Teresa charity, which claims to have a complete view of all households in the province, visiting each one every two weeks and maintaining a good central database.

This budget does not pretend to have found a solution for this problem, which would require urgent further examination to produce workable solutions. The budget does include a “placeholder” amount for social assistance and pensions of 84 million DM, which would allow the disbursement of 70 DM per month to 100,000 families (or some other combination of amounts adding up to 7 million DM per month).

Overhead costs

During the recent refinement work on sectoral expenditure, the World Bank experts in co-operation with Civil Administration experts has come to the conclusion that a simple way to account for non-wage costs is to assume the following:

• In education, overheads are put at 20% of the wage bill; purchase of books and an initial investment in furniture are separate from this.
• In health, overheads are put at 50%, excluding a substantial item for pharmaceuticals.
• In civil administration and public services, overheads are put at 30%.

The fact that overheads are calculated as a percentage of the wage bill means that overhead costs vary with the average public sector salary level; this is reasonable since a substantial part of overheads will have a wage component paid to outside contractors, and public sector wages will have an influence on the Kosovo-wide wage level.

Budget estimates for public expenditure

The overall results of our expenditure estimates are presented in Table 2. Annex Table 1 gives detail on public sector employment and wage relativities, and Annex Table 2 provides a more detailed version of the expenditure estimates.

The section on Revenues above gave a range of 300-350 million DM for medium-term fiscal revenue; it would be imprudent to foresee public expenditure much in excess of this range. The budget presented here runs to just over 350 million DM, which is therefore at the top end of the range. This assumes an average public sector wage level of 225 DM per month, net.⁴
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⁴ For simplicity, this budget does not assume payment of either income tax or social security contributions on public sector wages – adding this in would just augment both the revenue and the expenditure side of the budget by the same amount.
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Table 2 - Current Public Expenditure Summary
In millions of DM
                                  1999     2000
                                 Sep-Dec

Education                         44.0     93.4
Health                            24.9     74.8
Civil Administration              13.4     40.3
Public services                    3.3      9.9
Transfers and subsidies           32.7     98.2
Maintainance                       0.0     30.0
Contingent expenditure             3.3      4.5
Total current public expenditure 121.6    351.1
p.m. Salaries                     46.6    139.7
Social assistance and pensions    28.0     84.0
Other                             47.1    127.4

Budget based on average public sector wage of DM 225 per month

To demonstrate the sensitivity of the expenditure side of the budget to different assumptions on the wage level, Table 3 gives some comparisons of the aggregate numbers. Roughly, a difference of 25 DM per month for the average wage makes a difference of 20 million DM to annual public spending.

Table 3 – Current Public Expenditure sensitivity to wage assumption
Figures apply to year 2000

Average Public Sector Wage        200       225        250
(DM per month, net)
Total Current Expenditure        331.4     351.1      371.0
In million DM, full year
 

3. CONCLUSIONS

Combining the revenue and expenditure sides of the budget for the remainder of 1999 and 2000 produces the picture given in Table 4.

Table 4 - Kosovo Budget Summary, 1999-2000
Figures in million DM              1999     2000
                                  Sep-Dec

Domestic fiscal revenue              48      209
Current expenditure                 122      351
Shortfall to be funded by donors    -74     -142

Wage assumption    225 DM
Revenue for 2000:  scenario B from Table 1
 

The highly tenuous nature of these numbers should be emphasised again. The main assumptions that underlie them have been set out above. The two most important considerations that constrain the budget are:

(i) it would be unwise to set spending at levels that are very different from what Kosovo could sustain without foreign funding for its current public sector spending in the medium term, and

(ii) the ex-ante deficit should remain in a range that will be acceptable to donors, and falling over time.

The first of these two constraints is adhered to in this budget, but only marginally, since we assume very rapid progress in domestic revenue collection. One implication of this is that it would be very difficult, from a fiscal point of view, to opt for higher average pay in the public sector than the 225 DM implicit in this budget.

Whether we have stayed within the second constraint is hard to assess. Fortuitously, the shortfall for 1999 is no higher than tentatively announced at the Donors’ Conference in July, and although the 2000 shortfall is double the one for 1999, it is a full-year figure and thus shows a decline over time. Considerable efforts will still be required to mobilise the necessary funds. A transparent budget will be an important aid in this campaign.

 
High Level Steering Group Agrees on Priorities for an Action Plan to rebuild Kosovo and its Neighbors

BRUSSELS, July 13, 1999 -- Four weeks after the end of fighting in Kosovo, at the inaugural meeting of the High Level Steering Group, participants¹⁾ endorsed priorities for an action plan to rebuild Kosovo and repair the economies of neighboring countries, and set the course of action to be followed for reconstruction. The Group also confirmed the first Kosovo donors meeting to be held on July 28 in Brussels. At the conference, donors will be given an interim damage assessment report on Kosovo in addition to a progress report on the establishment of UNMIK - the United Nations Mission in Kosovo.

In addition to discussing its mandate and working methods, the Group focused not only on Kosovo but also the South-East Europe region as whole. The need to provide balance of payments support to these countries in 1999 was stressed, in order to help them alleviate the short-term negative economic consequences of the crisis. The region will continue to suffer from the effects of disruptions in trade, transit and tourism for the foreseeable future.

Concerning assistance to the Federal Republic of Yugoslavia, ministers agreed that until fundamental democratic reforms are in place, no assistance other than humanitarian aid, addressing urgent and essential human needs, will be provided.

¹⁾  Participants include Finance Ministers of Canada, the EU (represented by Finland), France, Germany, Italy, Japan, the United Kingdom, and the United States, and leading representatives from the European Bank for Reconstruction and Development, the European Investment Bank, the International Monetary Fund, the Stability Pact for Southeast Europe, the United Nations, and the World Bank.

Press Release and Statement from the Meeting
http://www.seerecon.org/PressReleases/press009-13-7-99.htm

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