WORLD BANK GROUP Kosovo Public Expenditure Review March, 2023 WORLD BANK GROUP Kosovo Public Expenditure Review June 2023 This report was prepared under the guidance of Xiaoqing Yu (Country Director, Western Balkans), Lalita Moorty (Regional Director, Equitable Growth, Finance and Institutions), Massimilliano Paolucci (Country Manager, Kosovo), Jasmin Chakeri (Practice Manager, Macroeconomics, Trade and Investment), Tania Dmytraczenko (Practice Manager, Health, Nutrition, and Population) and led by Tihomir (Tish) Stucka (Senior Economist, Macroeconomics, Trade and Investment) and co-led by Besart Myderizzi (Economist, Macroeconomics, Trade and Investment), co-led by Ha Thi Hong Nguyen (Senior Economist, , Health, Nutrition, and Population) and including Isolina Rossi (Economist, Macroeconomics, Trade and Investment); Zoran Anusic, Senior Social Protection Specialist), Sarah Coll-Black (Senior Economist, Social Protection), Mrike Aliu (Human Development Specialist, HECHN), Daniel Prinz (Young Professional, Health, Nutrition, and Population), and Tihomir Strizirep (Consultant). The team is grateful to Rhedon Begolli (Senior Energy Specialist, Energy) for his inputs and advice, Mjellma Rrecaj (Senior Program Assistant) for administrative support. to peer reviewers Aghassi Mkrtchyan (Senior Economist), Ajay Tandon (Lead Economist) and Marvin Ploetz (Senior Economist). The team would also like to thank the representatives of the Budget Office and Debt Office, the Ministry of Finance, Labor, and Transfers, as well as the Ministry of Health and the Board of the Health Insurance Fund for comments on the draft health chapter, as well as participants to the Round Table on Advancing Health Reforms toward Universal Health Coverage on March 20, 2023 in Pristina, Kosovo. The PER is a product of the staff of the World Bank Group. The findings, interpretations, and conclusions expressed in this report do not necessarily reflect the views of the Executive Directors of the World Bank (or the governments they represent), or the Government of the Republic of Kosovo. 4  Kosovo Public Expenditure Review 5 Executive Summary and its implementation requires significant financing. Kosovo will need to mobilize public and private resources and modernize its public management capacities to address these structural constraints. The question then becomes – how this can be done most effectively. A New Public Expenditure Review for Kosovo 4. Public and publicly guaranteed (PPG) debt remains low and can accommodate 1. Kosovo has gained a creditable reputation for prudent macro-fiscal management; additional financing for structural reforms and an investment push, but if not managed yet necessary structural reforms and related fiscal pressures lie ahead. The country’s adequately could jump to over 35 percent of GDP over the medium term. At 21 percent track record includes consistently high output growth rates, prudent fiscal deficits supported of GDP in 2022, and from a static perspective, Kosovo performs well compared to peers in by fiscal rules, and one of the lowest public debt levels among peers. The Government was terms of the size of public indebtedness. However, from a dynamic perspective, the speed of able to successfully weather the COVID-19 crisis and mitigate the impact of the ongoing public debt accumulation since the last Public Expenditure Review in 2014 and up to 2020 is inflationary crisis caused by the Russian invasion of Ukraine thanks to its healthy fiscal rather high, reaching a cumulative 10 percentage points. This increase in public debt occurred accounts and stable financial sectors. At the same time, however, the overlapping external primarily due to accelerated domestic debt accumulation, while in parallel the country shocks have highlighted the inherent volatility that mirrors Kosovo’s structural limitations— was under three IMF programs after independence, which provided an anchor for fiscal especially in health, energy, and education—and accentuates gaps in both human and physical policy. More recently, increased IFI and donor financing supported pandemic management capital. Addressing such structural shortcoming will come with fiscal costs. Unmet spending measures. Since 2021, public debt declined in terms of GDP, yet at the same time there is an needs in two critical sectors – health and energy – call for improved financing accompanied additional 7 percent of GDP in ratified, undisbursed external financing agreements due to by structural and institutional reforms to maximize service delivery. Furthermore, there are lingering public investment capacity bottlenecks. Going forward, if unmet spending in energy spending pressures and inefficiencies in social protection (including pensions) that need to and health is addressed without enhancing revenue mobilization, and structural reforms be contained through reforms. If spending in these areas is increased without enhancing do not keep in check spending on social protection (including pensions), then the country revenue mobilization, Kosovo may face growing fiscal pressures which would, in turn, is likely to face growing fiscal pressures which would translate into a sharper upward debt translate into a sharper upward debt trajectory. Thus, going forward, the key challenge is to trajectory, which could, over the medium term, rise above 35 percent of GDP. This is, however, not only preserve macro-fiscal stability, but to do so while using fiscal policy as an effective a crude assessment based on realistic parameter assumptions that requires further nuancing. tool for increasing development returns and unlocking higher potential growth. Therefore, the sharp rise in PPG debt warrants a more detailed analysis of a wide range of factors that would enhance the robustness of the PPG trajectory assessment. 2. Creating fiscal space to make the necessary investments will require careful decision-making to maximize returns and minimize risks. Kosovo is a unilaterally 5. The objective of this Public Expenditure Review (PER) is to help the government Euroized economy, and recent shocks have demonstrated the importance of maintaining identify means for improving the structure and quality of public services, enhance adequate buffers for the government to deploy fiscal space to protect vulnerable households the equity of government spending, and take a holistic view of policies that will affect and firms when needed. However, Kosovo will need to spend more and spend better in its financing needs over time. To do so, the PER has analyzed fiscal issues that have not been human capital investments if the country is to close the living standards gap with European explicitly detailed in, or are in the process of being incorporated into, the medium-term peers. Furthermore, the transition away from a “brown” towards a substantially “greener” expenditure framework and the economic reform program. The most notable issues include economy and power generation infrastructure will require major new public investments the urgently needed energy investments, the ramifications of the new law on public salaries and significant mobilization of private sector investments with public support. The effective on the budget, the sustainability of the untargeted social protection system, and possible deployment of Kosovo’s available fiscal space in support of a growth acceleration and a green pathways of the cost of pensions in light of expected changes to eligibility criteria, and the transition has the potential to be transformative in the years ahead, if the right policies are health spending and health financing conundrum. The PER also looks back at past World put in place. Bank PER recommendations and their implementation record, in the attempt to shine a light on measures that remain valid and could still be implemented. 3. Several structural issues of importance to public finances stand out as Kosovo looks to the future. Despite the strong post-pandemic rebound in economic activity, one in four Kosovars is still estimated to live on less than USD 6.851 per day. In absence Key policy priorities of poverty targeting mechanisms, social protection is dominated by benefits provided to specific categories of citizens, without reference to their income status. Poverty is heavily impacted by public health service delivery, which necessitates sizable private out of pocket 6. Over the past decade, spending on policies with a short-term impact, including payments, especially in absence of an out-patient drug program and limited healthcare the recent crisis management measures, has often crowded out spending on long- services. Higher spending on health would promote access to Universal Health Care, but term structural reforms. Before the pandemic, public spending growth was largely driven health financing reforms in Kosovo have been stagnating over the last decades and need by: (i) categorical social benefits and pensions; (ii) public salaries; (iv) agricultural subsidies renewed impetus. Labor market conditions and formalization improved recently, although and (v) transport infrastructure investment. Measures mitigating the impact of Covid-19 labor market outcomes remain the weakest in the Western Balkans, especially for women. and the recent inflationary crisis have added to these pressures. New social protection Limited access to early childhood education exacerbates women’s low participation in programs have been introduced, while the necessary poverty targeting infrastructure is the labor market. Furthermore, volatile electricity import costs and domestic electricity yet to be developed. Expenditure prioritization, to ensure sustained growth, provide for production bottlenecks created an energy crisis affecting households, businesses and, employment and poverty reduction, and improve the living conditions of Kosovo’s citizens, ultimately, public finances. The government approved a new and ambitious Energy Strategy, still has significant room for improvement. 1 2011 purchasing power parity; latest data available refers to 2017 6  Kosovo Public Expenditure Review 7 Social assistance scheme and pensions – focusing support on those Public sector wages – ensuring a stable foundation for service delivery who need it most 12. After a period of significant increases, wage spending stabilized between 2015 7. The social assistance scheme (SAS) could be made more flexible to adapt to the and 2022, yet Kosovo spends more than comparative peers on public wages. Until evolving poverty landscape. The amounts spent on social assistance targeted toward the 2022, the compensation system remained deeply fragmented and ineffective, and in need poor and assistance for citizens with special needs are modest. In fact, spending on the of standardization through unified legislation on public salaries. A new law on public sector SAS has been crowded out over the past decade, with the percentage of social protection salaries was adopted at end-2022 and implemented in March 2023. Prudent implementation spending allocated to the SAS falling from over 20 percent total social protection spending of the new law is key for ensuring effective public compensation management. in 2009 to 8 percent of the total in 2019. 13. The most important policy decision following the new wage law and coefficients 8. In the short term, government could focus on reforming the targeting mechanism is to re-systematize public employment.3 The distribution of public employment in line and establishing procedures to expand the SAS when shocks occur. The government could with the new wage law coefficients can only be realistic after the re-systematization process consider improving the SAS for more efficient poverty targeting and introduce incentives for is finalized. It is also crucial to ensure that grade inflation is avoided to ensure costs are work by disregarding some income from employment in order to become eligible for benefits. contained. 9. Over the medium term, SAS policies could include the introduction of a social registry 14. Furthermore, careful balancing needs to be ensured between employment (information system) to better identify eligible households across programs and which growth, changes in the value of the coefficient, and the rollout of allowances and households are receiving support from which programs. Finally, to enhance social equity the compensation. The number of vacant positions as compared to the 2023 budget is government may want to increase social assistance to households in need through reallocating significant. Effective management of public hiring and realistic budgeting of employment spending from less efficient programs that do not target the poor, such as some pension programs, positions at the central level is crucial to enhance safeguards for a prudent implementation to programs more effective in serving the poor. In this context, timely implementation of the of the new public wage law. recently ratified Social Assistance System Reform project with the World Bank is key. 15. Past collective contracts could be assessed to evaluate the size of contingent 10. Kosovo’s pension system remains fragmented, and its fiscal cost has been liabilities. The Government should conduct a detailed assessment of contingent liabilities steadily increasing. The number of basic pension and ex-contributory beneficiaries2 is stemming from past collective contracts and provision adequately to address possible costs expected to increase to 240 thousand by 2030. Since independence, two main reasons are that could materialize. A credible projection of payments on court-ordered damages would seen to account for the steady rise in the fiscal cost of pensions: i. expanded generosity of be prudent to ensure adequate planning of wage spending and safeguard the maintenance existing non-contributory pensions; and ii. introduction of new non-contributory pension of the wage rule. benefits for specific categories of citizens. The introduction of unfunded schemes and war- related benefits before the pandemic and outside a comprehensive pension reform strategy has adversely impacted the systems’ sustainability, adequacy, and equity. Pension system Energy – financing the green transition simulations suggest that fiscal costs and adequacy of inflation-indexed non-contributory 16. Kosovo’s energy sector is under significant pressure due to limited and benefits could decline rapidly. As a result, possible new ad-hoc interventions and the unreliable generation capacity in a context of increasing demand. Despite recent introduction of new schemes may crowd out public funds and congest the development of efforts to scale-up energy investments in renewable energy sources, the sector continues to the core pension system fundamentals. rely predominantly on inefficient and highly polluting fossil-fuel energy generation. Recent 11. Kosovo’s pension system challenges urgently require a reform strategy with efforts to promote energy efficiency are a step in the right direction, and there is significant broad political consensus. A comprehensive reform of the current pension system could room for scaling up efficiency support. Managing growing demand needs with imports is be considered to bring the system to a predictable long-run sustainable social and fiscal an acute short-and medium-term challenge, especially under elevated international energy path. From a fiscal perspective, an integral reform could mitigate costly ad-hoc programs prices due to Russia’s invasion of Ukraine. Import demand spikes particularly during the and policy interventions and build a systematic approach towards pension policy. As part winter heating season, when import prices are the highest. Import electricity prices in of this reform, a review could take place of the current contribution rates to the second relevant reference markets remain significantly higher than domestic production prices pillar with a view to enabling the payout of lifetime annuities. For basic pensions, the and regulated tariffs for final consumers. Hence, external energy shocks represent a source inflexible CPI indexation rule could be revisited. For categorical benefits (merit and legacy of both macroeconomic and fiscal risk. pensions) of beneficiaries below the age of 65 or citizens inheriting these benefits, formal 17. Kosovo’s long-term fiscal sustainability and output growth depend on securing labor disincentives could be removed while politically feasible solutions for replacement an affordable, reliable, and sustainable energy system. The Government needs to balance of these schemes with more targeted compensatory grants could be considered. Delinking the energy policy mix with the objective of prioritizing energy security, diversifying away categorical benefit levels from the minimum wage, currently pending Assembly approval, is from lignite and supporting the poor and most vulnerable. In addition, adequate financial seen as a step in the right direction. In the meantime, the Government could continue with planning for the implementation of the Energy Strategy 2022-2031 is key to ensure fiscal its recent administrative efforts to avoid double dipping between different schemes and sustainability and mobilize private and donor financing in a timely manner. ensure effective implementation of residency criteria. 2 From 2008, responding to demands from former contributors to the Yugoslav pensions system, higher transfers were for contributors with 15 years of contribution to the former pensions system, which was also differentiated by education level in 2016. At end 2022, the Constitutional Court ruled against the 15-year 3 Systematization refers to regulating organizational parts and systematizing public employees’ positions and minimum contribution qualification requirement, hence increasing eligibility for higher pensions. accompanying salaries across central government and public agencies. 8  Kosovo Public Expenditure Review 9 18. Therefore, the Government needs to develop a detailed financing plan for 23. Health financing in Kosovo has not been fully developed yet. Resource mobilization implementing the Energy Strategy (2022-2031) and incorporating it in the medium- and consequently health spending is among the lowest when compared to peers. Insufficient term fiscal strategy. Kosovo’s Energy Strategy expects the energy sector to be a key driver public spending causes input constraints, poor access, and low quality of care. Risk pooling of economic growth and employment opportunities. Although private sector activity is could be further enhanced, while the practice of strategic purchasing is currently lacking envisioned, the extent of its participation remains to be fully defined. The Government in Kosovo. Healthcare services are paid for with a predetermined budget defined annually needs a detailed financing plan for its strategy. The plan should clearly reflect information based on rigid input line items such as salaries, goods and services, and utilities. There on expected sources of financing, and a breakdown of anticipated private and public are no clearly stated decisions on the three key elements of strategic purchasing – benefit investments and the types of operations that will be leveraged to support implementation. In package, contracting, and provider payment. Other conditions for strategic purchasing are cases where private investment is expected to be the main source of financing, the financing also not present. plan needs to reflect potential offtake guarantees that could be a source of fiscal risks. 24. Strategic purchasing and provider-payer split could be implemented 19. Once the energy sector stabilizes and energy investment picks up, tariffs should independent of social health insurance premium collection. With the establishment of become reflective of costs. In the context of the existing energy crisis, the revision of the the Health Insurance Fund, Kosovo has practically introduced a purchaser although it has tariff structure for households introduced in February 2022 can serve as a tool to incentivize not been performing strategic purchasing. energy efficiency and pass on the cost of energy to users consuming above 800kWh a month. However, as the energy sector normalizes the Government could consider allowing 25. Introducing a targeting mechanism for exemption in social programs would a pass-through of prices to tariffs, including for commercial consumers, to ensure these ensure fairness and fiscal sustainability. Implementing a new poverty-targeting reflect actual market costs and incentivize demand adjustments. The March 2023 universal instrument that considers observable income through a means test and informal/ increase in tariffs4 was a necessary step in this direction. In the medium term, proceeding unobservable income through a proxy means test could improve poverty targeting, better with the liberalization of the market for medium-voltage consumers should be considered. reflect the high rates of informality in the Kosovo labor market and serve as a foundation Ensuring that tariffs reflect costs is also critical for encouraging private sector investment. for targeting health insurance exemption of the poor. Such a poverty-targeting mechanism At the same time, transparent, fully budgeted, and timebound support should be provided would improve effectiveness of social protection system, as well as targeting of exempted to energy vulnerable and low-income households. categories from health service co-payment and future insurance contributions. 20. The government could also consider strengthening market-based mechanisms 26. Instituting an effective national risk pool would allow for sharing of health to support RES. The Government envisages a significant role for the private sector in and financial risks among the rich and the poor, the sick and not sick, and across the implementation of the energy strategy and the development of the energy sector. It, municipalities. An “effective mechanism” relies mostly on prepayment, delinking health therefore, requires due consideration that investors benefit from a predictable, fair market status with payment at the point of services. With the small size of the population, it is environment as well as well-structured market-based mechanisms in support of RES recommended that risk is pooled at the national level. As a start, public financing for investments. health should be consolidated to avoid fragmentation. Following the typical model in other countries, most of the funds (the “risk pool”) could be housed with the Health Insurance Fund, while the Ministry of Health would become a smaller financing agent. Budget Health – investing in human capital funds going through the Ministry would be used mostly for public health programs and major capital investment, while funds going through the Health Insurance Fund would be 21. Achieving improved health outcomes through fiscal spending would enhance for individual services, for which the Fund would purchase in its new role as a strategic human capital in Kosovo. Kosovo lags peers in terms of both amounts allocated for purchaser. healthcare and on the effectiveness of public spending to improve health outcomes, reflected in lagging health outcomes compared to peers. 27. The prospect of raising additional funds through health insurance premium depends on a number of aspects and warrants careful considerations. Before Kosovo 22. Appropriate health financing arrangements can promote progress towards embarks on mandating contributions as currently described in the Health Insurance Law, it universal health coverage (UHC). Universal Health Coverage means that all people is important to obtain clarity on the potential impact on the labor market, the funding gap have access to the health services they need, when and where they need them, without which is based on actuarial costing of the benefit package, enforcement capacity, population causing financial hardship. Health financing arrangements are important in achieving demand for social health insurance, and potential equity risk of the flat rate premium. UHC because they define how revenue is generated to pay for health services, how risks Evidence from global experience shows that mobilizing contributions from payroll taxes and costs are pooled across people, and how goods and services are purchased. Although alone will not bring countries closer to UHC. Invariably, segments of the population will public services are envisaged in Kosovo to be free or subject to small user fees, in practice need to be subsidized from general revenues. Despite recent improvements, the informal services and drugs are usually not fully available. As a result, patients incur significant out- sector in Kosovo remains sizable. In this context, the general budget will ultimately remain of-pocket (OOP) expenditures which exacerbate existing income inequalities. Under such the most important revenue source for health. circumstances, sick people often carry the burden of funding their treatment. This financial burden can be particularly severe for the poor, or for people with chronic conditions, who need medications on a regular basis. 4 http://www.ero-ks.org/zrre/en/press-release-14 10  Kosovo Public Expenditure Review 11 Chapter I. I.1. Fiscal I.2. I.3. Assessment I.4. I.5. I.6. 1.7. I.8. This introductory chapter presents the objectives, conceptual framework and methodology of the Kosovo Public Expenditure Review 2023. 12 I.1.  Introduction for the unbilled energy consumption in four municipalities. More importantly, outdated, and unreliable coal-based power generation capacity, coupled with lagging energy transition to renewables and limited integration with regional energy markets, remains a 1. In the short time since gaining independence, Kosovo has established a creditable key source of macroeconomic and fiscal vulnerability. Hence, this long-neglected area may reputation for macro-fiscal management; yet the economy’s persisting structural require significant financing from the Government to address the energy infrastructure gap, bottlenecks weigh on public finances. The country’s track record includes consistently including in the context of the recently approved and ambitious Energy Strategy. high output growth rates, prudent fiscal deficits supported by fiscal rules, and one of the 5. Several structural issues stand out as Kosovo looks to the future. Despite lowest public debt levels among peers. Yet, short term pressures from overlapping crises improvements, the physical infrastructure gap remains wide given Kosovo’s legacy of war have brought to the forefront entrenched structural challenges in public finances. Kosovo and transition. Recent short-term pressures, such as the need to subsidize electricity imports, recovered rapidly from the COVID-19 pandemic, but the economic volatility and fallout the approval of the Law on Public Wages, increased on-lending to POEs, and the expansion of caused by the war in Ukraine resulted in a surge in inflation, putting poverty reduction at social transfers in response to the inflationary crisis, constrains the fiscal space available for risk, aggravating macro-fiscal challenges, and accentuating the urgency of fiscal reforms scaling up long term investments, including on energy generation. At the same time, there and the need for a push in public investment. are other sizable medium to long-term investment needs, including district heating and 2. Kosovo has significant physical and human capital investment needs, and the energy efficiency, the rail network, water storage and irrigation, wastewater management, fiscal space to make necessary investments, but this will require careful decision- as well as education (particularly for early childhood). As a landlocked economy, Kosovo’s making to maximize returns and minimize risks. Recent shocks have demonstrated the access to markets in Western Europe is constrained and relies on the transport networks importance of maintaining adequate buffers so that government can deploy fiscal space of Albania, North Macedonia, Serbia, and Montenegro. The opening of two major highways to protect vulnerable households and firms when needed. However, Kosovo will need to providing easier access to the port of Durres and the port of Thessaloniki has alleviated spend more and spend better in its human capital investments if the country is to close some pressure, but these assets are already depreciating and need adequate maintenance. the living standards gap with European peers. Further, the transition of an economy and 6. Public spending on human capital development has become even more critical to power infrastructure that is currently “brown” to one which is substantially “greener” will reaping the potential of a young population in full. Three-fourths of Kosovo’s population require major new public investments. The effective deployment of Kosovo’s available fiscal are younger than 35, and this could be its greatest resource to unlock potential growth, but space in support of a growth acceleration and a green transition, has the potential to be also a risk if economic and social opportunities lag. Social protection, an important factor transformative in the years ahead, if the right policies are put in place. to improve human capital development, has expanded significantly yet remains inefficient 3. This Public Expenditure Review (PER) takes place against the backdrop of in terms of targeting the most vulnerable groups. The rise in social protection also includes overlapping multiple external crises. The adverse human impact of the COVID-19 the expansion of non-contributory pensions since the 2014 PER. On the other hand, public pandemic in Kosovo was high, pausing the poverty reduction trend in 2020 and disrupting spending on healthcare in Kosovo is relatively lower than in peers, and the country also lags human capital accumulation. In this context, universal healthcare and health financing on health outcomes. In 2017, for example, more than 11 percent of Kosovar households in Kosovo has come to the forefront of policy discussions. A fast and buoyant recovery in spent more than 15 percent of their non-food consumption expenditure on health. Thus, 2021, with Kosovo as one of best performers among peers, raised hopes that the structural lack of financial protection against health shocks is a major risk for the poor. agenda would return to the forefront of policymaking. However, the war in Ukraine, with its 7. Health financing reforms in Kosovo have been stagnating over the last decades. reverberations, adds another major shock to countries in the Western Balkans like Kosovo, While various governments have vowed to develop social health insurance (SHI), so far stifling the post-pandemic growth momentum and exacerbating development challenges. this has not been implemented. One of the possible reasons is that health financing, and These compounding external crises have led to global supply chain disruptions and health insurance in particular, are complex topics that do not immediately resonate with increased price pressures, further threatening food security and access to energy, especially health sector players and can have wide-ranging macro implications. The exclusive focus on in highly import dependent countries like Kosovo. In parallel, the climate crisis continues SHI may distract the attention from the fact that a health financing instrument should only to intensify, with drought and flood shocks expected to become more frequent and severe serve as a means to an end. Structural issues in the overall health financing arrangements due to climate change, aggravating further the physical water stress and water insecurity hinder achieving the objectives of any health system – access, quality, equity, efficiency, and in Kosovo. financial protection – generally accepted as universal health coverage (UHC) outcomes. 4. The Government, households, and businesses were confronted with an energy 8. Spending on education has more than doubled over the last decade, yet human emergency driven by volatile electricity import costs, domestic electricity production capital gains are limited. Kosovo spends 4.6 percent of GDP and 16 percent of total bottlenecks, and high prices of other traditionally used heating fuels. In March 2022, government spending on education, similar to comparators. But only 23 percent of pre- the Government committed close to EUR100 million in electricity import subsidies, and school children are on track in terms of expected literacy and numeracy skills. Education over EUR30 million in energy efficiency subsidies. The energy regulator approved a spending, particularly at the local level, predominantly emphasizes wage compensation, tariff increase and re-introduced a block tariff scheme for households in February 2022, whereas capital spending and maintenance with the lagging school network optimization incorporating government import subsidies in the scheme. However, until March 2023, remains a major challenge. With the lowest regional participation rate of women in the when the regulator introduced a uniform tariff increase, prices for commercial consumers labor market, increasing access to early childhood education (ECD) is a pressing short-term remained unchanged and implicitly subsidized, given that the liberalization of medium- and long-term need. The Government has prioritized investment in new ECD facilities, but voltage commercial consumers is still not rolled out. Against the pending implementation the spending needs are high and can only be met with higher efficiency within the sector of an agreement between Kosovo and Serbia, the Government also paid 0.7 percent of GDP and across other spending areas. 14 Fiscal Assessment Kosovo Public Expenditure Review 15 9. This third PER since independence is aimed at identifying means for improving Box 1. cont. the structure and quality of public services and enhancing equity of public spending. The 2023 PER encompasses an overview macro-fiscal chapter and one thematic chapter on Kosovo’s Economic Kosovo’s MTEF 2023-2025 sets priorities with a three-year perspective in financing healthcare. The macro-fiscal chapter will set the scene by contextualizing the public Reform Program accordance with the strategic objectives of the Government, as reflected expenditure analysis by presenting a succinct overview of the macroeconomic and fiscal in the National Development Strategy (NDS) and the Economic Reform (ERP) for and the landscape and a PER retrospective light, in which the status of past PER recommendations Program (ERP) 2023-2025. In the medium-term, the Government’s Medium-Term is reviewed, recommendations that remain relevant established, and their potential impact priorities reflected in the MTEF are as follows: 1) supporting sustainable Expenditure assessed. The macro-fiscal chapter will, in addition, entail insights into social protection, economic development; 2) promoting equity in human capital Framework (MTEF) including pensions; the public wage bill implications following the adoption of the new law development; 2) strengthening security and the rule of law; 4) enhancing 2023-2025 on public salaries and new coefficients; and energy subsidies and investments, topics that the quality of governance. have not been sufficiently detailed in the government’s Medium Term Fiscal Framework (MTEF) 2023 – 2025, also given the later approval of the Energy Strategy. The objective of According to the MTEF, budget expenditures are expected to stabilize the health chapter is to facilitate a common understanding of the health financing situation and return to historical growth levels, in compliance with the Law on in Kosovo, which can serve as a basis for reaching a consensus on the way forward. The Public Financial Management. Over the period 2023-2025, expenditures chosen topics for this PER are aligned with issues outlined in Kosovo’s Economic Reform are expected to increase by an average of 3.4 percent and are projected Program, specifically key challenges 2 and 3 (Box 1). The unifying theme of the report will to maintain a share of around 29.8 percent of GDP on average. In terms be the debt sustainability analysis through which the impact of various policy scenarios will of risks, the MTEF identifies a number of different external and domestic be examined. Finally, the PER output is timed to aid the Government in the preparation of risk factors. Among these are the continuation of the war in Ukraine, the the 2024 budget and has been closely coordinated with the IMF’s ongoing dialogue with the outbreak of new COVID-19 variants, the energy crisis, risks associated with Government. contingent liabilities and POEs and under-execution of capital investment. The MTEF does not, however, spell out the implications of several large unknowns such as the implications of the recently passed Law on public Box 1. wages, energy generation investments, and more elaborate plans on social assistance programs, including pensions. This PER will shed more light on Kosovo’s Economic Kosovo’s ERP 2023-2024 was submitted on January 2022, before the these issues. Reform Program outbreak of the war in Ukraine. As a result, the macro-fiscal scenarios (ERP) for and the presented in the document may be partially obsolete. However, the Medium-Term medium-term reform challenges and priorities remain relevant. In terms Expenditure of the policy framework, the ERP identifies the following main challenges Framework (MTEF) and reforms areas to enhance to competitiveness and inclusive growth: 2023-2025 Key challenge 1: Promoting sustainable employment by improving quality education and connecting it to labour market needs I.2.  Assessment of past PER recommendations • Reform measure #1: Adapting Vocational Education and Training implementation progress to the needs of the labour market • Reform measure #2: Increasing and ensuring quality in higher education by strengthening the KAA and profiling higher education 10. To set the scene for the budget analysis and associated policy recommendations, institutions this retrospective will provide insights into the policy implementation record with • Reform measure #3: Increasing employment, reducing inactivity, respect to recommendations from the 2010 and 2014 PERs. The recommendations in the formalization, developing professional skills, improving and previous two PERs covered a wide range of topics, and this retrospective will focus on the expanding public employment services and vocational training most important aspects of the World Bank’s suggested policy reforms. The main suggestions in line with labour market demands, with special emphasis on proposed by the World Bank covered general policy areas such as the levels of fiscal deficits, vulnerable groups. revenue, and spending measures, but also sectoral issues including in energy, transport, health, and education. The implementation record of previous policy recommendations from the 2010 Key Challenge 2: Reorganizing the health sector to provide adequate and and 2014 PERs is mixed. accessible health services for all citizens 11. Recommendations to strengthen macro-fiscal management have been largely • Reform measure #4: Improving health services implemented. Since 2014, the government has largely adhered to fiscal rules and maintained sustainable public debt levels. Specifically, the governments adhered to the fiscal deficit ceiling, Key Challenge 3: Creating conditions for sustainable energy supply the state debt ceiling, and the implicit minimum floor on budget reserves when utilizing • Reform measure #5: Developing Energy Efficiency and Renewable privatization proceeds. Since the last PER, the Parliament adopted in January 2016 a new Energy Sources policies in view of the green transition amendment to the Law on Public Financial Management and Accountability introducing a • Reform measure #6: Reforming the energy market ceiling on public wage growth and an exemption to the deficit ceiling for public investments financed through International Financial Institutions. In April 2017, the Parliament also approved amendments to the Kosovo Liberation Army War Veterans Law that limits total spending for war veteran pensions at 0.7  percent of GDP. This ceiling is, however, still not 16 Fiscal Assessment Kosovo Public Expenditure Review 17 legally binding and is pending the reclassification of war veterans as per the 2017 amendments. Box 2. Overall, from 2014 to 2022, the Government fully adhered to all legally binding fiscal rules, except for compliance with the deficit ceiling in 2020. Driven by the COVID-19 pandemic, the Key tariff policy From January 2017, the Energy Regulator has started the gradual Government relaxed the deficit ceiling rule until end-2022. Nevertheless, both the actual deficit changes from the process of electricity energy market liberalization. Large industrial end- in 2021 and 2022 are in full compliance with the rule. The budget for 2023 is planned under 2014 PER consumers using 220kV and 110kv transmission were fully liberalized the now fully binding deficit rule. While benefit levels have remained frozen and have dropped in 2017. After the surge in energy prices on the European market in late in real terms, the enactment of the legal ceiling on war veteran benefits remains a challenge. 2021, Kosovo’s sole ferro-nickel producer NewCo Ferronikeli, and one of Finally, the new law on public wages has significant scope to stay within the limits of the public the largest exporters in the country, has closed production due to higher wage growth rule. Specifically, given the latest annual nominal GDP growth rate of 17 percent power prices. The process of deregulation for industrial consumers of in 2021, which the rule refers to, the Government has maintained the credibility of this aspect 35kV and 10kV started in 2019, but the process was interrupted in 2020 of the fiscal rule in 2023, but at the expense of fiscal space and heightened budget rigidity. due to the pandemic crisis. From April 2017, the energy regulator also 12. Public procurement, tax administration and energy efficiency measures are removed the winter and summer tariffs, maintaining only the night and also examples of policy areas where the World Bank’s recommendations were largely day differentiation, and increasing the average tariffs for the whole year. implemented. However, at the same time, the regulator also removed the block tariff, which gave rise to an increase in energy consumption during the winter. • E-procurement is fully operational; however, the procurement process continues to face In February 2022, against the rapid rise in import costs, the regulator re- significant bottlenecks, including efficiency and efficacy of the Procurement Review introduced block tariffs and increased tariffs for household consumption Body and complexity of procurement procedures that hinder budget execution. The above 800 kWh per month. Tariffs fully reflect the cost of feed-in tariffs Government has recently initiated a legal review process to address these challenges. provided until 2021 to renewable resource energy producers. In March The costly maintenance of roads continues to be underbudgeted, which is an aspect 2023, the Energy Regulator announced a 15 percent increase in tariffs of procurement planning that requires further implementation. Many procurement for both households and commercial consumers, to be based on the bottlenecks are often a reflection of underlying limited capacity in project preparation. tariff structure introduced in 2022. • In the area of tax administration, tax debt collection has been centralized, the quality and quantity of tax inspectors has been somewhat enhanced, risk assessment modules have been improved, and efforts were made to combat tax evasion. • Finally, donor-supported energy efficiency projects are being implemented, including in municipal public buildings, and the energy efficiency fund is fully established. The 14. Health reform measures suggested by the Bank have not been implemented. These government has recently intensified energy efficiency support in the private sector proposals included the sustainable operationalization of the public health insurance scheme through subsidizing purchases of heating equipment with higher levels of efficiency (as per 2014 health insurance law) to raise additional resources for the under-funded health such as stoves with biomass, biomass boilers and other equipment. sector. The recommendations suggested the introduction of a public health insurance scheme with the following conditions: (i) the contribution rate should be set at 5 rather than 7 percent; 13. Recommendations on accelerating energy production investments and (ii) only poor groups should be exempt from premium payments and co-payments; (iii) health adjusting energy tariffs have been implemented only partially (Box 2). Despite very insurance should be implemented in a fiscally neutral fashion to safeguard the sustainability of large capital expenditures during the period 2010 to 2019 ranging between an average the budget and guarantee that other sectors do not suffer an undue burden; (iv) build adequate of 7.5  percent of GDP (2014-19) and 11.2  percent of GDP (2010-13), the majority was capacity to administer a health insurance system and ensure a smooth transition from the Health spent on transport infrastructure, limiting space for energy investments, as suggested by Financing Agency to Health Insurance Fund. The health insurance scheme has not yet been the World Bank. This comes against fully depreciated coal-powered plants’ assets and no operationalized and the long list of contribution exemptions in the current legislation would carbon taxation, keeping production costs low despite significant investment needs and jeopardize the sustainability of the scheme were it to be implemented as per current legislation negative externalities from coal-based production. This production cost is in turn reflected in force. Furthermore, the out-of-pocket health expenditures continue to be an important factor in relatively low tariffs, which disincentivize efficiency and green transition. Through feed- in pushing people into poverty. In addition, the creation of the Health Information System (HIS), in tariff support, new wind and, to a lesser degree, solar capacities were developed since the a precondition for launching the insurance scheme, has not been completed. The section on last PER; with the latest Selac wind farm of 102.6 MW operationalized in 2021. The share of health financing in this PER discusses this issue in more detail. The proposal to refocus spending energy from renewable sources increased in with the the quarter target, when accounting on primary health care while restricting further capital investments to prioritize maintenance also the use of biofuel. Yet, energy investments – especially in clean energy sources - need of existing facilities and curtail non-performance-based wage increases for medical staff has not to be intensified to further enhance energy supply, and carbon externalities have yet to taken place, and health spending remains the lowest in the region, in GDP terms. be gradually reflected in tariffs. Furthermore, the government approved at end-2022 an 15. Social protection is another area which has recorded little progress. The World Bank energy strategy that foresees the rehabilitation of current active coal powerplants and an proposal argued for introducing a system that better identifies the poor and vulnerable to enable ambitious target of 1400 mW of renewable resources by 2030 to gradually enable the use an expanded coverage of the last-resort social assistance scheme. In parallel, such a system would of part coal-fired capacity only as back-up capacity. minimize leakage to wealthier groups and ensure that the social assistance scheme provides necessary support for households to climb out of poverty, for example, by providing training and by allowing benefits to “phase out” when a beneficiary finds employment rather than losing benefits instantly. Since 2020, new programs were introduced, which however remained largely untargeted, reducing the efficiency of social protection in the country. A new Social Assistance System Reform Project with the Word Bank that aims to achieve these reform objectives was 18 Fiscal Assessment Kosovo Public Expenditure Review 19 ratified with significant delay in 2023. The suggestion to reallocate resources away from the proposed expansion of veterans’ benefits and toward the poor and vulnerable, including to I.3. Macro-fiscal landscape challenges shield them from the impact of increased energy prices is outstanding. Specifically, the fiscal rule on war veterans spending, introduced through an IMF program, is not yet applied, as the war 17. From a longer-term perspective, Kosovo’s macroeconomic stability has been veteran’s re-classification process by combat experience has not been initiated. Since the last maintained over the past decade largely facilitated by four economic anchors: unilateral PER concluded in 2014, a significant number of new untargeted programs were implemented euroization, fiscal rules and prudent headline fiscal management, EU membership (see section on fiscal trends). prospects, and resilient diaspora flows to the economy. As a unilaterally euroized 16. Finally, the implementation of recommendations regarding the transport sector – economy, the authorities’ ability to react to changes in external conditions are limited. When notably the implementation of road user charges – remains a work in progress. In the capital inflows or terms of trade deteriorate, as they did during the overlapping crises, the area of railways, the transport and network management has been divided into two separate main policy lever is fiscal policy. This also means that policy makers have a difficult task of entities. The 149 km Route 10 railway rehabilitation investment – amounting to EUR165 million balancing the large developmental needs - both in terms of infrastructure and human capital – has commenced with EU investment grants, and EBRD and EIB lending, but implementation - whilst managing macroeconomic shocks and maintaining fiscal sustainability. Nevertheless, has been slow. The 2023 budget also foresees financing for preparing investment on a railway Kosovo has so far upheld a prudent fiscal stance characterized by elaborate fiscal rules and linkage with Albania, and the Peje-Pristine railway rehabilitation. Finalization of key road prudent debt management. Despite the pandemic shock and the contraction in 2020, public infrastructure projects is long overdue: including the Prishtina-Mitrovica (started in 2012 and finances were quickly consolidated over 2021 and 2022. The resulting low public debt level financed by OFID, IDB, and SDF) and the Prishtina-Podujeve roads, as well as the Prishtina- of just over 20 percent of GDP provides some fiscal space, although large financing needs and Gjilani highway. In 2021, the Government also canceled the Kieve-Zahaq (Peje-Prishtine) absence of external market access limits the ability to borrow against the background of higher highway construction planned with EBRD and EIB lending, opting for a rehabilitation option. budget rigidity. Ample access to concessional IFI financing is an opportunity to close the vast The Prishtina bypass project is still under development. To increase resources available for infrastructure gap, but implementation bottlenecks have limited their impact to date. Much the long-term maintenance of roads, the Bank proposed to introduce road user charges and needed structural reforms are notionally supported by EU membership prospects to further adjust vehicle registration fees. Road user charges do not exist for Route 6 and 7 and the Gjilan unleash growth. In the meantime, strong ties to workers and families abroad serve as an engine Motorway. With an in-expensive introductory scheme (EUR1 per segment for cars and Euro 2/ of economic growth through financing in the form of exports of travel services, remittances for segment for buses and trucks) and with two toll stations per highway (entrance and once city private consumption, and foreign direct investment – mostly in real estate, but also services and junction, i.e. Suhareke or Ferizaj), back of the envelope calculations show that at least EUR18 manufacturing. million could be raised to finance maintenance. Moreover, this would also improve effectiveness 18. Kosovo transitioned to upper middle-income status thanks to a strong growth of public spending given that the cost of maintenance is carried by highway users rather than performance since independence, yet several constraints limit Kosovo’s ability to sustain the general population. higher and inclusive growth. Between 2010-2021, cumulative growth outcomes exceeded those in Moldova, Armenia, two rapidly growing smaller economies, and Kosovo’s neighbors, such as North Macedonia and Albania (Figure 1). Specifically, since the last 2014 PER, real GDP grew cumulatively 33 percent (2015-2021), after growing 38 percent during the period 2010 to 2014. The country experienced its first recession since independence in 2020, during the Covid-19 pandemic, when real output contracted 5.3 percent driven by a drop in investment. The recovery, however, was swift and robust thanks to strong fiscal support, among others: economic activity rebounded 10.7 percent in 2021, with the real GDP level exceeding the level recorded in 2019. For longer time trends, average real output growth slowed to 4.2 percent (2015 to 2021) compared to 6.7 percent during the period 2010 to 20145 due to stronger growth in net imports and the contraction in 2020. Yet, Kosovo continues to run a significant merchandise trade deficit of above 40 percent of GDP, alleviated somewhat by the positive balance in service trade; primarily driven by diaspora, but also with notable recent increases in ICT services. The prevailing merchandise trade deficit not only shows the high import dependence of Kosovo’s economy, which exposes it to international price volatility, but also highlights the limited level of exports and competitiveness. Meanwhile, political constraints, such as lack of membership in the UN and NATO toward which Kosovo aspires to, pending EU visa liberalization, and trade barriers from some non-recognizing countries, weigh on both export and FDI potential. 19. Kosovo’s real per capita GDP level remains significantly below aspirational peers, although a sizable catch up has taken place over the years. In 2021, Kosovo’s real per capita GDP (in PPP terms) remains around 80 percent of Albania, Armenia, and Moldova, 70 percent of North Macedonia, and 56 percent of Montenegro’s levels. In relation to aspirational peers, Kosovo’s per capita income ranges between one-fourth and one-third compared to countries such as the Baltics, Croatia, Slovenia, and the EU more broadly. That said, over the past decade, 5 Based on the compounded annual growth rate (CAGR) 20 Fiscal Assessment Kosovo Public Expenditure Review 21 Kosovo has managed to catch up significantly with most of the structural and aspirational peers: of the increase in investment was a pickup in private investment, including construction, which in the case of Albania, North Macedonia, and Montenegro the difference in per capita income has has a high import content and drove import demand. A key sign of recent structural change, declined 10 to 14 percentage points, roughly 1.5 percentage points per year (Figure 2). Similarly, however, is the growth and diversification in merchandise exports, which almost doubled in the country caught up with Croatia, Slovenia, and the EU by around 6 percentage points. Moldova value from 2019 to 2021, despite the cessation of nickel exports at end 2021 as a result of the and the Baltics recorded an equally good, if not better, per capita GDP growth trajectory compared energy crisis. to Kosovo, and thus no reduction in the per capita income difference has taken place over the past decade. This, however, can be explained in part with a stronger decline in population in these 21. After a decade of stable prices, soaring inflation is adding pressure to firms and countries (the denominator) than in Kosovo. households balance sheets (Figure 4). The inflation rate averaged 0.8 percent between 2014 and 2020, whereas in 2021 it jumped to 3.4 percent. Therefore, Kosovo was already experiencing heightened inflationary pressures before Russia’s invasion of Ukraine. The increase in energy prices at end-2021 has already led one of Kosovo’s top exporters, its only Fig 1. Cumulative growth Fig 2. Kosovo’s real per capita GDP iron-nickel producer, to suspend operations. By the end of 2022, annual inflation reached a performance (PPP) and catch-up historic high of 11.6 percent (y/y), fueled by further increases in the price of food (16 percent), energy (13 percent), and transport (17 percent). Construction inputs increased almost one- 150 90 fifth (y/y) over 2022, with construction activities representing over half of private sector changes in GDP (baselne y 2010) investment in Kosovo. The sharp rise in food inflation had a more pronounced impact on 80 households that spend a larger share of their incomes on food. This shock also highlighted 140 70 concerns over food security and dependency considering the significant deficit in food trade. Against this backdrop, the Government introduced additional agricultural subsidies and, as in 60 2020 and 2021, was compelled to implement social measures and employment incentives to 130 50 mitigate the impact of inflation on citizens’ incomes. 40 120 30 Fig 3. Components of domestic Fig 4. Inflation developments 110 20 demand 10 6 25 growth rate in % inflation in % 100 0 20 ARM/MDV -10 ALB North Macedonia Montenegro Baltics Croatia EU 5 90 4 15 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 3 10 KOS 2010 5 Source: ALB Source: 2 2021 WDI and staff calculations MKD WDI and staff calculations EU catch-up 0 MDV / ARM av. 1 -5 0 2020 2022 2010 2012 2013 2014 2015 2016 2018 2019 2021 2011 2017 20. The structure of the robust real GDP growth trajectory has undergone some 2010-2014 2015-2021 changes since 2014. The overall slowdown in growth since the last PER (i.e., 2015-2021) was, on average, driven by slower growth in domestic demand and stronger growth in net imports. Moreover, underlying factors driving domestic demand have shifted since 2014. During 2010- private consumption consumer price 2014, private consumption grew on average 5.5 percent per annum, while investment grew Source: investment Source: import price 3.7 percent. This is in part explained by the significant base effect on private consumption post- Kosovo Statistical Agency Kosovo Statistical Agency independence, including with support from fast financial deepening and consumer lending, as and staff calculations and staff calculations well as strong growth in service exports driven by increased diaspora visits. The roles reversed in 2015-2021, as investment growth picked up and recorded an average annual rate of 5.5 percent, whilst private consumption decelerated to 3.8 percent (Figure 3).6 The main driver 22. Despite recent improvements, the labor market continues to reflect chronically low participation rates. Tensions over public wages were also high in 2022, marked by strikes in education, which took place in September 2022. The education trade union organized a strike of 6 Based on CAGR 22 Fiscal Assessment Kosovo Public Expenditure Review 23 teachers that led to a one-month delay in opening schools affecting close to 320 thousand pupils. The real net wage in the public sector has risen in 2020 by 9 percent compared to 2019 and then Fig 7. Non-debt creating financing of Fig 8. Total external debt declined in 2021 close to 5 percent due to high inflation. Nevertheless, real net wages are still CAD 3.7 percent higher than in 2019. Public sector wages lag those in publicly owned enterprises 16 200 % of GDP % of GDP (POEs) and consistently represent roughly 80 percent of their salary level (Figure 5). Private sector wages are the lowest with only 55 percent the level of those in POEs, but unofficial payouts 14 180 taking place in the grey economy and other forms of compensation bonuses make this difference 160 blurry. Low labor force participation and employment, especially among women, is one of the key 12 140 binding constraints to growth and poverty reduction in Kosovo (Figure 6). In line with buoyant 10 120 recovery, the employment rate grew from 30.1 percent in 2019 to 31.1 percent of the population in 2021, representing an increase of almost 20 thousand jobs. Although annual information on 8 100 labor markets remains limited to 2021, administrative data for 2022 show an acceleration in 6 80 formal employment and a declining trend in registered unemployment. Survey data for the first 60 quarter of 2022 also confirm this trend. Nevertheless, while women’s employment rates are low 4 40 across the Western Balkan region, there are significant variations between countries, ranging 2 20 from only 16.5 percent of working age women in Kosovo to 55 percent in Albania.7 Finally, Kosovo enjoys the lowest Gini index in the region, which matches people’s perception of income gaps in 0 0 Baltics ARM MKD MNE KOS ALB SVN MDV HRV the country (WB 2017). -2 23. A mildly narrowing current account deficit since 2014 was largely financed by non- ALB ARM MDV MKD MNE Baltic HRV KOS debt creating flows (Figure 7). Since 2014, the current account deficit (CAD) narrowed, on average, 1.3 percentage points to 7.3 percent of GDP compared to the period 2010-2014. This CAD structural peers was driven by a mild compression in the merchandise trade deficit, higher remittances, and a Source: Source: net FDI aspirational peers shift toward higher net services exports. The CAD was financed primarily by FDI inflows, a non- Kosovo Statistical Agency Kosovo Statistical Agency average debt creating flow, which limited the buildup in total external debt to 37 percent of GDP in 2021, and staff calculations and staff calculations roughly one-third of the structural8 and aspirational peers (Figure 8). Nevertheless, considering that much of FDI inflows are related to diaspora investment in real estate, the productivity of such foreign investment is limited compared to investments in goods or services production capacity. 24. The trend of a narrowing CAD has reversed with the onset of Russia’s invasion of Ukraine and surging import prices. The CAD deteriorated to close to 11 percent of GDP, against a trade deficit of 46.5 percent of GDP. Kosovo has no oil refineries and is a large Fig 5. Real net wages and their Fig 6. Labor force participation importer of fuel, with over 640 million liters of diesel and petroleum imported in 2021. cumulative growth Domestic storage capacity and inventories are low, and the impact of international price 700 50 hikes is immediate. In March 2022, the government froze wholesale and retail trade margins Real wage level (in euro) Cumulative growth rate, in % 600 47 45 on fuel, in an attempt to slow mounting inflationary pressures. Nevertheless, retail prices 500 40 of diesel increased unabated by more than 30 percent from February to early June 2022, 400 34 35 and more than 65 percent compared to the average level of prices in June 2021. Kosovo is 300 30 also a net importer of electricity due to a spike in demand during the winter season, with 200 25 13 percent of its annual electricity consumption covered by imports in 2021. Electricity 100 21 20 imports are higher than expected due to the frequent malfunction of outdated coal-fired 0 15 power plants, which completely rely on local coal deposits. Public Publicly Private Sector Owned Sector 25. In response to difficulties in the power sector, the Government extended Enterprises in March 2022 the state of energy emergency for an additional three months and committed close to EUR100 million in electricity subsidies. Meanwhile, the energy regulator approved a tariff increase and re-introduced a block tariff scheme in February Real net salary level 2021 2022, the decision was first annulled by the Appeals Court in May, and then re-introduced Source: Cumulative growth rate Source: by the Supreme Court ruling, creating in the interim budgetary uncertainties. In parallel, the Kosovo Statistical Agency of real net salary Western Balkans Regional authorities announced measures to subsidize energy efficiency equipment worth roughly and staff calculations 2012-2021 economic report EUR 11 million. Specifically, the subsidies are related to biomass boilers such as wood, pellets, briquettes that will be subsidized up to 70 percent of the investment value, but also heat pumps that reduce 30 percent of energy consumption, efficient air conditioners and individual stoves with biomass, wood, for families with a social scheme. In addition to direct subsidies, the Government subsidized energy savings compared to 2021 through 7 World Bank Group and Vienna Institute for International Economic Studies 2020 energy bills, at double the level of the saved amount (likely to reach as much as EUR 20 8 Montenegro is an outlier 24 Fiscal Assessment Kosovo Public Expenditure Review 25 million if 10 percent of total energy consumption is saved for four months). On the other hand, in August 2022, the Government also paid out EUR 40 million to the Kosovo energy Fig 9. Kosovo’s revenues, Fig 10. Primary deficit and stock of transmission company KOSTT, to cover for the currently unbilled consumption of energy expenditures, and fiscal public debt, % GDP in four Kosovo municipalities where the majority of the population is ethnically Serbian.9 deficit, % GDP 26. Large net imports of agricultural products represent another external risk 34 23 8 Primary deficit, % GDP Public debt, % GDP % of GDP factor and exposes the country to international price volatility. A third of wheat 21 7 consumption is imported, primarily from Serbia, while many other essential agricultural 32 19 products are also fully imported. Export restrictions from Serbia were relaxed but added 6 to supply chain uncertainties. Import dependence could be exacerbated as domestic 17 5 agricultural production is affected by increases in the price of fertilizers imported primarily 30 15 from Russia and Austria. In response to these developments, the authorities introduced 4 a package of additional agricultural subsidies, including subsidies for fuel and fertilizers, 13 28 3 amounting to roughly EUR 50 million (or 0.6 percent of GDP). 11 9 2 27. Over the medium term (2014-2021), fiscal accounts in Kosovo recorded an 26 average overall deficit of 2.8 percent of GDP. During 2010 to 2014, the country ran an 7 1 overall fiscal deficit of 2.2 percent of GDP, outperforming almost all structural peers. This 5 0 fiscally prudent performance has hardly changed during the period 2014 to 2021, when the 24 2020 2012 2013 2014 2015 2016 2017 2018 2019 2021 2020 2010 2012 2013 2014 2015 2016 2018 2019 2021 2011 2017 deficit averaged 2.8 percent of GDP with the pandemic year included and averaged 2 percent without this outlier (Figure 9). Moldova is the only country among the structural peers with a smaller average overall fiscal deficit. However, Kosovo’s underlying fiscal stance looks very different as reflected by its primary deficit (Figure 10). It amounted to 2.4 percent of GDP over the 8-year period and coincides with North Macedonia and Montenegro at around Fiscal deficit Public debt Source: Revenues Source: Primary deficit 2.5 percent of GDP (Figure 11). At the same time, Albania, Armenia, and Moldova had a Kosovo Ministry Kosovo Ministry primary deficit of around 1.5 percent of GDP, close to an entire percentage point difference Expenditures of Finance of Finance per annum. In other words, structural peers had a much higher overall fiscal deficit, which emanated from a larger interest payment bill, which on average totaled over 2 percent of GDP in Albania, Armenia, and Montenegro. In North Macedonia and Moldova interest payments amounted to 1.2 and 0.8 percent of GDP, respectively, which is still a multiple of Kosovo’s 0.4 percent of GDP. Fig 11. Overall and primary fiscal Fig 12. Increase in public debt 2014 28. Lower interest payments account for the lower deficit levels compared to peers deficit across structural peers, to 2021, % GDP and public debt levels are low; but the speed of public debt accumulation from the % GDP last PER is significant. Kosovo started with domestic debt operations only in 2012, so it is a latecomer to international and domestic borrowing. Kosovo also inherited a relatively 5 change in deficit, % of GDP smaller debt stock from the breakup of former Yugoslavia, as opposed to other former Yugoslav republics. Specifically, one-third of the 5 percent of GDP public debt legacy from 4 former Yugoslavia was repaid by the US, which left the authorities with a public stock of debt of roughly 3.5 percent of GDP. Hence, from a static perspective of the level of public 3 debt, Kosovo is doing well compared to structural and aspirational peers (Figure 12). However, from a dynamic perspective, the speed of public debt accumulation since the last 2 PER in 2014 is rather high as Kosovo has gained 10-percentage points. This increase in public debt occurred primarily due to accelerated domestic debt accumulation, and on two accounts: first, three IMF programs after independence, which provided an anchor for fiscal 1 policy, and second, increased IFI and donor financing in support of pandemic management measures. Kosovo has an additional 7 percent of GDP in ratified, undisbursed external 0 MDV KOS MNE MKD ARM ALB financing agreements due to limited public investment execution capacity. overall fiscal deficit Source: primary fiscal deficit Source: Kosovo BOOST and GFS Western Balkan Regional for other countries Economic Report 9 Besart: please add here the relevance of these four municipalities being ethnic Serb. 26 Fiscal Assessment Kosovo Public Expenditure Review 27 29. Kosovo’s good track record on fiscal policy before the pandemic allowed the use 32. Government revenues in Kosovo continue to remain amongst the lowest in of countercyclical fiscal policy to mitigate the economic and social consequences of Western Balkans and in Europe. Worldwide, Kosovo’s revenue-to-GDP ratio corresponds the pandemic in 2020 and in 2021. Specifically, the pandemic placed significant pressure to its income level as measured in GNI per capita terms (Figure 13).11 Yet, this comparison on the fiscal position in 2020, as public revenues fell by almost 9 percent (y/y) against an also includes resource-rich developing countries, which have generally lower government increase in current expenditures by a record 18.6 percent. As a result, the budget deficit revenue-to-GDP ratios (for example Indonesia with 14 percent, or Sub-Saharan countries reached 7.6 percent of GDP in 2020, up from 2.9 percent in 2019, despite a 20 percent drop with 15 percent to 20 percent of GDP). If compared to European countries, Kosovo lags in public investment. In 2020, Kosovo financed its deficit by issuing new domestic debt (2.5 significantly in revenue collection relative to income (Figure 14). Compared to structural percent of GDP), mobilizing external concessional debt (3.3 percent of GDP), and drawing peers, Kosovo’s revenue-to-GDP ratio is higher than Armenia’s and similar to Albania’s down liquidation receipts (1.1 percent of GDP) and government deposits. in 2019. In 2022, however, Kosovo caught up with Moldova’s revenue-to-GDP ratio of 30 percent, and was close to North Macedonia’s with 31 percent, but significantly lagging 30. Over 2021, the fiscal balance significantly improved thanks to buoyant revenues Montenegro which has a revenue ratio of over 40 percent of GDP (Figure 15). The gap and public investment underspending. Tax revenues increased 29 percent by end-2021 widens to about 13 percent of GDP when compared to aspirational peers’ average revenue compared to 2020, driven by a rebound in economic activity and imports, higher inflation, level in countries like Croatia, Slovenia, Slovakia, and the Baltics (Figure 16). Kosovo’s low and formalization. Overall, a sizeable economic stimulus packages were introduced in revenue base is explained by comparatively lower tax rates, absence of mandatory social 2020 (4.4 percent of GDP) and 2021 (5.1 percent of GDP), which included measures for contributions, as well as the regionally wide prevalence of informality. Numerous tax employment support, including those targeted for women, increased access to finance exemptions also limit the tax base, and a partial analysis suggests, according to MoFLT, that and liquidity for businesses and households, direct support to firms and farms, additional tax expenditures account for close to 2 percent GPD in 2021, with the value likely to be cash benefits for old-age pensioners and social assistance recipients, new universal child higher once a comprehensive analysis in undertaken. allowances and maternity benefits for both employed and unemployed women. Capital spending remained subdued both in 2020 and 2021 averaging 5.4  percent of GDP. Public debt is estimated at 22.4  percent of GDP at end-2021. The lower-than-expected budget deficit enabled the government to reduce planned domestic borrowing and build cash Fig 13. Global total fiscal revenue by Fig 14. European total fiscal revenue buffers. Government deposits at the central bank reached 3.9 percent of GDP at end-2021, income level, 2019 by income level, 2019 compared to 3.3 percent in 2020. As a result, total public and publicly guaranteed (PPG) debt remains at close to 21 percent of GDP. The composition of PPG debt entails 65 percent of 60 60 Revenue-to-GDP, % Revenue-to-GDP, % domestic debt, and is held predominantly by the Kosovo Pension Savings Trust, commercial banks, and the Central Bank of Kosovo. The reminder (35  percent) represents financing 50 50 from IFIs and bilateral creditors. Hence, both the fiscal deficit and debt-to-GDP ratio are among the lowest among structural and aspirational peers. Kosovo 40 40 30 30 I.4. Government Budget 20 20 I.4.1.  Budget revenues Kosovo 10 y = 8.1549x-46.707 10 y = 5.408x-15.893 31. The declining trend in budget revenues since 2014 was reversed more recently R² = 0.4597 R² = 0.1426 with a boost from formalization and higher inflation. From 2010 to 2014, revenue 0 0 collection averaged roughly 27  percent of GDP, but then declined by an average of one 7.5 8 8.5 9 9.5 10 10.5 11 11.5 9 9.5 10 10.5 11 11.5 percentage point between 2015 and 2020 (Figures 15 and 16, and Box 3). In 2021, revenues exceeded 27 percent of GDP and – with a sizable inflationary and formalization boost, ln GNI per capita ln GNI per capita while revenues recorded around 30 percent of GDP in 2022. Despite the implementation of the Stabilization and Association Agreement (SAA)10 from 2016 and other free trade agreements with significant fiscal impact, tax revenues remained largely stable at around 23 percent of GDP from 2010 to 2021; notably jumping above 25 percent of GDP in 2021. Source: Source: The slowdown in revenue collection is accounted for by smaller non-tax revenues, which WDI and staff WDI and staff fell from 5.4 percent in 2010 to 3 percent of GDP in 2021, primarily due to lower receipts calculations calculations from POE dividends. Between 2009 and 2015, the Government received EUR 465 million mainly from telecom company dividends. 11 GNI – Gross National Income is defined as gross domestic product, plus net receipts from abroad of compensation of employees, property income and net taxes less subsidies on production. Compensation of employees’ receivable from abroad are those that are earned by residents who essentially live inside the 10 According to Kosovo Customs, the cumulative forgone revenue from the SAA and the Free Trade Agreement economic territory but work abroad (this happens in border areas on a regular basis), or for people who live (FTE) with Turkey in in 2021 was estimated at 1.15 percent of GDP (or Euro 97 million for the SAA and 20.7 and work abroad for short periods (seasonal workers) and whose center of economic interest remains in for the FTE with Turkey). their home country. 28 Fiscal Assessment Kosovo Public Expenditure Review 29 Fig 15. Revenue-to-GDP in 2019, Fig 16. Revenue-to-GDP, Box 3. structural peers aspirational peers Key tax policy Since the last PER, an increase in headline VAT rate represents the key 45 50 changes change in tax policy and significant regressive dimensions of the taxation % GDP system remain. In 2016, the Government increased the headline VAT rate 40 from 16 to 18 percent and introduced a reduced VAT rate of 8 percent for 45 essential goods – mainly edibles. The VAT threshold was also lowered from 50 thousand to 30 thousand Euros per annum. Except for North Macedonia, 35 the headline VAT rate is lower than in all structural or aspirational peers. 40 Excise rates, particularly on tobacco, increased marginally too from 2014 to 30 2021. Kosovo is the only country in Western Balkans that applies a uniform 10 percent customs duty on all imported goods. 25 35 Tax rates on personal and corporate income are relatively low and flat. 20 Kosovo is the only country in the region where income from dividends is not taxed at all and income from capital gains, especially real estate transactions, 30 is practically untaxed due to administrative constraints. Immovable property 15 tax revenue collection, with a standard statutory rate of 0.15 percent of value, 10 constitutes less than 0.5 percent of GDP and less than 2 percent of tax revenue; 25 implementation of land tax is still at an early stage. The flat Corporate Income 5 Tax rate of 10 percent, with 5-year loss carryover provision, is only higher than in Montenegro and in line with regional average. The Personal Income 20 Tax rate is progressive, but the top rate of 10 percent is significantly lower 0 2020 2009 2014 2015 2016 2017 2018 2019 2010 2012 2013 20 11 than that of structural and aspirational peers. Sole proprietors providing ALB ARM MDV MKD MNE KOS services, including doctors or lawyers, declaring less than 30 thousand Euros in turnover can still choose to pay a presumptive tax of 9 percent on their turnover (or 3 percent in case of small trade activities). SLO Source: Source: HRV GFS and KOS BOOST, GFS and KOS BOOST, SVK staff calculations staff calculations Baltics KOS 34. Indirect taxes levied on imports still constitute the bulk of tax and total revenue collection, reflecting the structural features of Kosovo’s economy (Figure 17). A total of 77 percent of total tax revenues is collected through VAT and excise duties. With an 33. Aspirational peers benefited from faster average revenue growth and collect average of 11.6 percent of GDP from 2010 to 2021, VAT is the most important source of tax significantly higher revenues from social contributions. Revenue collection dynamics revenues, and accounts for about half of the total tax collections during the period 2010 correspond to the situation in Albania and Slovenia, whereas in structural peers such as to 2021. Of the total VAT collected, less than one-third is collected domestically, reflecting: Moldova and Montenegro or aspirational peers such as Croatia, Slovakia, and the Baltics, Kosovo’s exceptionally high trade deficit, but also the need to provide advance payment revenues increased faster. The bulk of the difference between Kosovo and aspirational peers of VAT on imports without a fully streamlined reimbursement process. Nevertheless, the is accounted for by social security contributions, the collection of which ranges between 12 importance of domestic VAT collection has risen steadily over the years, from 2.3 percent of and 17 percent12 of GDP in Croatia, Lithuania, Slovenia, and Slovakia, whereas in Estonia and GDP in 2010 to 3.7 percent of GDP in 2021. The remaining two-thirds of VAT revenues are Latvia the level of social security contribution collection is somewhat lower and amounts derived from imports (i.e., VAT at the border), which until recently exhibited a falling trend, to 6 to 10 percent of GDP. declining steadily from 9.2 percent of GDP in 2011 to 8.1 percent of GDP in 2020. However, a sharp increase in international prices explains the sudden spike in VAT collected at the border to 9.6 percent of GDP in 2021 (expected to reach 11 percent of GDP in 2022). Direct taxes remain below 4 percent of GDP (Figure 18). 12 For the reference period between 2014 and 2020 30 Fiscal Assessment Kosovo Public Expenditure Review 31 Table 1. Excise duties, % GDP and share in total Fig 17. Indirect taxes, % GDP Fig 18. Direct taxes, % GDP Excise duties 2020 2021 2020 2021 25 4.0 % GDP % GDP % GDP % in total excises 3.5 TOTAL 5.9 6.4 100 100 20 3.0 Collected at the border: 5.8 6.3 98 99 2.5 Petrol 0.4 0.4 6 6 15 2.0 Diesel 3 3.2 52 50 Heating Oil 0 0 0 0 10 1.5 Motor and Hydraulics Oils 0 0 1 0 1.0 LPG 0 0 1 1 5 Cigarettes 2 2.3 33 36 0.5 Beer 0.1 0.1 1 1 0 0.0 Other Alcoholic Drinks 0 0 0 1 2020 2020 2010 2012 2013 2014 2015 2016 2017 2018 2019 2021 2010 2012 2013 2014 2015 2016 2017 2018 2019 2021 2011 2011 New PT Vehicles 0 0 0 0 Used PT Vehicles 0.1 0.2 2 3 Excise Personal Income Tax Other 0.1 0 1 0 Source: Custom Duties Source: Corporate Income GFS, staff Border VAT GFS, staff TaxDuties Internally Administered Excises/1: 0.1 0.1 2 1 calculations calculations In Country VAT /1 mostly for alcoholic drinks domestically produced Source: Kosovo Ministry of Finance, staff calculations 35. Excise duties represent the second most important source of indirect taxation, 36. Over the past decade, tax buoyancy is estimated to have averaged significantly and in fact of total tax revenues. Excises account for just below one-third of indirect taxes, over unity.13 Assessing Kosovo’s tax buoyancy allows to ascertain if the government is keeping and just above one-fourth of total tax revenues. Almost all excise duties are collected at the tax mobilization in line with economic activity and estimating individual tax buoyancies helps border (Table 1). Therefore, excises together with VAT collected at the border amounted identify the weak and strong aspects of the revenue system (Dudine and Jalles, 2017). Three to 16 percent of GDP, or 64 percent of total tax revenues in 2021. This incidentally also methods were used to estimate tax buoyancy, and in all cases real GDP was used as the tax base corresponds to the average tax collection at the border since 2010. Excise duties on diesel (Haughton, 2018).14 Measures of tax buoyancy tend to vary a lot from year to year, and in the case account for half of all excises collected, or 3.2 percent of GDP in 2021. Together with excises of Kosovo those estimates vary across years between 3.62 and 0.74 (Figure 19). On average, real on petrol totaling 0.4 percent of GDP, fuel excises contribute close to 60 percent to total tax revenues are buoyant and increased 1.6-1.8 percent for every 1 percent increase in real GDP excises collected. In the long run, this source of revenue will need to be reconsidered as in during the period 2012 to 2021. Taxes on income, profit and capital gains are more responsive June 2022 the EU Parliament backed the European Commission’s proposal of zero emissions to changes in GDP compared to taxes on goods and services (Figure 20). This is in line with the from new cars and vans by 2035. As a result, from 2035 all new cars sold should be zero- findings for advanced and emerging markets (Dudine and Jalles, 2017). Tax elasticities are not emission. If Kosovo joins the EU within the next 10-15 years, these rules will apply. While calculated as such an approach would mean removing the quantitative impact of all law changes second-hand petrol/combustion engine cars after 2035 can still be purchased, there is during the assessed period.15 likely to be a significant price disincentive in terms of cost of fuel, maintenance, purchasing and insurance. Excises on cigarettes account for about one-third of total excise revenues, or 2.3 percent of GDP in 2021. These excises represent one of the options together with other health taxes such as excises on alcohol and sugar beverages to elevate excise revenues in 13 Haughton (2018) Estimating tax buoyancy, elasticity, and stability, African Economic Policy Paper the longer run, while in parallel pursuing important public health objectives, with sizeable Discussion Paper Number, July 1998; Dudine and Jalles (2017) How Buoyant is the Tax System? New Evidence from a Large Heterogeneous Panel, IMF Working Paper, WP/17/4. budget implications in terms of health-related costs (NCDs, etc.). 14 The three methods were as follows: (a) calculate buoyancy for each year, and then take the average. This approach is susceptible to outliers; (b) calculate the growth of tax revenue, and of the base (GDP), between the end years and use these to calculate buoyancy. The approach is sensitive to the end years chosen; and (c) use OLS regression on tax revenue and GDP. 15 Tax elasticity differ from tax buoyancy calculations. Tax elasticity is calculated as it would have been if 32 Fiscal Assessment Kosovo Public Expenditure Review 33 Fig 19. Tax buoyancy (Δ taxes, real/ Fig 20. Individual taxes, average Box 4. ΔGDP, real), in % buoyancy (2012-2021) IMF policy Personal income tax and social security contributions: Broadening 3.5 recommendations the personal income tax (PIT) base is a key policy objective, and the Tax buoyancy from the General PIT should play a more prominent role in revenue generation. The top Diagnostics of the PIT rate should be raised to 20 percent for high incomes to increase 3.0 Tax System (2021) progressivity. A withholding tax should be levied on dividend income at 5 percent and rates applying to interest, rents, capital gains, income from intangibles should be raised to 15 percent. 2.5 Corporate income tax (CIT): In the medium-term, a rate increase to 2.0 15 percent should be considered, alongside dividend taxation, as well as some base broadening and improved cost-based investment incentives to attract real foreign investment. 1.5 Value added tax (VAT): Modernizing the VAT will assist macroeconomic growth, reduce the trade deficit, and provide an estimated additional 1.0 2.79 percent of GDP in revenues. Most of the current VAT exemptions and zero rates should be eliminated. 0.5 Excise taxes: The excise regime is well designed and contributes significantly to revenue creation. That only specific rates are applied is a 0.0 strength of the regime that should be retained, but there are no corrective Taxes Taxes on Taxes on taxes on coal or electricity generation. The excise rates applied to fuels income, profits, goods & should be raised, together with introducing excises on coal and/or & capital gains services electricity generation, or alternatively phasing in a carbon tax. The rates on alcohol, tobacco and sugar beverages should also be raised. Method a) Source: IMF (2021) - General Diagnostics of the Tax System in Kosovo Source: Source: Method b) Ministry of Finance, staff Ministry of Finance, staff Method c) calculations calculations I.4.2.  Budget expenditures 37. In 2021, the IMF produced a General Diagnostics of the Tax System in Kosovo, which provides an in-depth assessment of the country’s taxation system and tax 38. Kosovo’s rules-based fiscal policymaking framework effectively limits excessive policy recommendations (Box 4). The report proposes policy measures to address key departures of the spending portfolio from available resources. From 2014 to 2022,16 weaknesses in Kosovo’s main tax categories. The objectives of the proposed measures are Kosovo has fully complied with a legal cap of 2 percent of GDP on its budget deficit, with to: i) mobilize revenues; ii) eliminate distortions and close loopholes in the tax system; the notable exception of the year 2020 when fiscal rules were relaxed amidst Covid-19. The iii) simplify rules to ease compliance and administration and eliminate exemptions Government also planned the 2021 and 2022 budget with a level of deficit that exceeds and preferential treatments; and iv) make the system more efficient in delivering a the legal cap, in line with Assembly authorization. However, the actual deficit resulted fair distribution of the tax burden. Overall, measures recommended could raise about at less than 2 percent of GDP in both years due to revenue overperformance and budget 1.8 percent of GDP more in PIT, 1.2 percent of GDP more in business taxes, 2.7 percent underspending. The deficit fiscal rule becomes fully binding again in 2023, and the approved of GDP more in VAT, and about 3.5-4 percent of GDP more in excises or a carbon tax. In 2023 budget is fully compliant. There are two important exceptions, however, to the legal total, potential estimated additional tax revenues are around 5.75 percent of GDP, with an deficit ceiling: a) the government can use a windfall of privatization receipts to overspend additional 3.5 percent of GDP in excise duties. on capital projects beyond the ceiling, provided it has adequate budget reserves (4.5 percent of GDP); and b) it can also overspend on capital expenditure to utilize concessional financing from credible International Financial institutions (IFIs). Privatization resources have significantly depleted17 and capacity to implement IFI project financing remains 16 The amendments to the Law on Public Financial Management and Accountability introducing the legal ceiling on the budget deficit were approved in August 2013 and implemented from 2014. there had not been any change in the tax laws, including the tax rates or bases. Thus the tax elasticity is a 17 Between 2012 and 2021, the Government utilized Euro 424.5 million to finance budget spending. Over hypothetical construct. It tries to reconstruct what would have happened if there had been no changes in Euro 390 million were withdrawn as temporary funds (without cleared claims), hence represent contingent the tax rules - i.e. what tax revenue would have been if last year’s laws continued to apply this year. liabilities. 34 Fiscal Assessment Kosovo Public Expenditure Review 35 still limited. Against this strictly defined framework, room for implementation of new same period. In comparison to aspirational peers, the spending gap is commensurate to policies without compromising the credibility of revenue planning is limited and calls for the fiscal revenue gap and averages roughly 13 percent of GDP. While Croatia, Slovenia and increased effort to enhance efficiency and effectiveness of public spending towards higher Slovakia have total spending outcomes exceeding 40 percent of GDP, the Baltic countries development returns. have recorded spending outcomes between 35 and 39 percent of GDP. The difference in spending levels is also partially explained by the fact that Kosovo’s pillar II pension outlays, 39. Since the last PER in 2014, spending on policies with a short-term impact often due to the defined-contribution nature of the system, are not consolidated as part of crowded out needs for higher spending on long-term structural reforms. Between government budget spending. 2015 and 2019, spending growth was largely driven from politically powerful constituents reflected through higher: (i) categorical benefits and pensions; (iii) public salaries; (iv) 42. Since 2020, short-term measures to mitigate the impact of these crises have agricultural subsidies and (v) transport infrastructure. Since 2020, the need to mitigate the dominated the fiscal policymaking space. Over 2020 and 2021, the Government of impact of Covid-19 and the recent inflationary crisis have added to these pressures, and Kosovo had to spend almost 4 percent of GDP on average per annum for different measures new social protection programs have been introduced in the absence of a poverty targeting to manage and mitigate the impact of COVID-19, the majority of which consisted of cash infrastructure, and without time to rationalize legacy untargeted benefits. In fact, these transfers. Measures in 2020 included private sector, local government, and publicly owned spending pressures are squeezing space for much needed investments in health, education, enterprise (POE) support, social protection20 measures, and sectoral support measures. energy, and other capital projects, which could boost growth and reduce poverty. The Lack of a poverty targeting mechanisms diminished the effectiveness of these measures 2021 Kosovo Country Economic Memorandum (CEM) provides two important conclusions towards mitigating the impact on the most vulnerable. Private sector measures included, for consideration: significant increases in agricultural subsidies have failed to tackle the among others, a 3-month deferral on all major tax categories, private sector wage and social underlying weak productivity of farmers and wage-focused increases in education spending contribution subsidies, including on informal employment conditional on formalization, have not alleviated Kosovo’s poor pre-university education outcomes. The new National agricultural subsidies as well as subsidies of up to 50 percent of SME rent expense. Meanwhile, Economic Reform Program (NERP) 2022-202418 identifies three key developments sectoral support included wage allowance for frontline workers across institutions, and outcomes fiscal spending needs to target: 1) sustainable employment through quality and additional allocations for goods and services in the health and education sectors, which market-relevant education, 2) adequate and accessible health services for all citizens, and lasted during 2020 and 2021. Liquidity support was also provided by allowing a tax- 3) fostering sustainable energy supply and use (Box 2). free withdrawal of 10 percent of defined-contribution pension savings. The government committed to reimburse withdrawals for contributors with less than 10 thousand in savings 40. Since 2014, extrabudgetary spending in Kosovo remained low, but there have (a state liability of about EUR100 million) from 2023 onward. Government measures to been increasing recent precedents in direct Government lending to POEs. Given the combat the COVID crisis spilled over into 2021, including the time-bound reduction of VAT relatively young age of the country, Kosovo has managed to break away from planned for hospitality services, select wage subsidies, and implicit energy tariff subsidies through economy legacy problems of significant financing for parastatals and other extrabudgetary the reduction of royalties. organizations. The public broadcaster and several smaller cultural entities are the notable exception. Kosovo also stands out in the region for its prudent leveraging of PPPs and 43. As a result, social protection continued expanding from 2020, entailing a mix government guarantees. However, after the significant Government loans provided to the of temporary and permanent measures. Social protection measures included primarily Kosovo Energy Corporation between 2008 and 2012 (totaling EUR192.5 million), the a doubling of payments under the Social Assistance Scheme (for six months in 2020, three practice was resumed for other POEs – including mining – in 2022 (EUR32.6 million). The months in 2021, and two months in 2022). At the same time, additional pension payments 2023 budget also plans for additional EUR40 million in POE lending under discrete financing for beneficiaries receiving below EUR100 per month started in 2020 and were extended conditions. This practice undermines the credibility of the rules based fiscal framework. throughout 2021. Grants for marginalized groups were implemented over three years, as Provision of guaranteed Purchasing Power Arrangements (PPAs) in the energy sector well as unemployment severance payments (in 2020 and 2021). Universal child allowances should also be adequately reflected under the recording and analysis of the Government’s were fully rolled out from between 2021 and 2022, covering all children under the age contingent liabilities of 16, and maternity benefits for unemployed mothers were introduced. A benefit floor of EUR100 was introduced for pensions and social assistance in early 2022. Overall, in 2022, 41. At close to 30  percent of GDP in 2019 and 2021, total general government the Government spent an estimated 4  percent of GDP on inflation mitigating measures expenditures in Kosovo are one of the lowest in the Western Balkan region and in as well as electricity import and efficiency subsidies [excluding payments for energy Europe.19 Despite recent improvements, Kosovo’s general government expenditures are on consumption in four municipalities]. Social measures included, in addition to two rounds average smaller than in both structural and aspirational peers. This reflects the smaller of cash transfers to social assistance beneficiaries, transfers to state pension beneficiaries, fiscal space governed by the relatively lower revenue-to-GDP ratio, exhausted privatization public servants, and students. receipts, limited access to international debt markets, and low track record in fully utilizing IFI project financing. Kosovo’s total spending-to-GDP ratio is about 5  percentage points below the average in structural peers, which totals roughly 35 percent of GDP. This average is, however, driven by Montenegro’s large total expenditures that averaged close to 48 percent of GDP during the period 2015 to 2021. Albania too has a 1.2 percentage point larger total spending bill per year when compared to Kosovo, whereas Moldova and North Macedonia average a total spending bill of 32 and close to 35 percent of GDP per annum. The only country with a smaller spending bill is Armenia with 28 percent of GDP for the 20 Unlike in other countries, social protection in Kosovo is financed by government revenues. Given Kosovo’s war legacy and labor market structure, most retirees today have limited contributions to the relatively young (created in 2001) defined-contribution pension system. In other words, social protection = social 18 https://mf.rks-gov.net/desk/inc/media/23D2D3B1-81C1-41FE-B6C0-2D5C739A6F69.pdf assistance (non-contributory) and social assistance (contributory) + social services. Effectively, in Kosovo 19 In 2019 total expenditures were 29.7 percent of GDP while in 2021 they were 29.3 percent of GDP. social protection ≈ social assistance because it is almost all government funded. 36 Fiscal Assessment Kosovo Public Expenditure Review 37 Budget rigidity is not pronounced compared to peers Fig 21. Kosovo’s budget rigidity, % of Fig 22. Rigidity: comparison of 44. Budget rigidity is a concept closely associated with the fiscal space debate. The total spending Kosovo’s peers, 2019 spread of the international crisis driven first by the pandemic and followed by the war in Ukraine has put additional pressure on fiscal-policy space worldwide. An important aspect 60 90 % of total spending % of total spending in this context is the extent of fiscal flexibility of public budgets in an environment of limited access to international markets and an underdeveloped domestic credit market. The latter 80 description corresponds to a group of countries, which Kosovo is part of. 50 70 45. The emergence of fiscal rigidities reflects public policy choices and the means of their financing. In this context, establishing the degree of budget flexibility is important 40 60 for the public debate. Nevertheless, understanding the type of rigidity inherent in a given budget, its origin, and reasons behind it seem equally important as the degree of budget 50 flexibility itself. 30 46. The traditional approach to budget rigidity assumes that the totality of certain 40 expenditures is beyond the policy maker’s control as they reflect long-term legal obligations enshrined in the country’s legislation.21 This approach aggregates, for 20 30 example, compensation of employees, social security benefits, transfers to subnational governments, transfers to sub-national governments, and debt service as a percentage of 20 total spending. Other, non-traditional approaches propose estimating a structural and non- 10 structural component of the budget, with the former determined by long run economic 10 fundamentals. The non-structural component is determined by short-run, transitory factors related either to the business or political cycle. The non-traditional approach is 0 0 2020 2010 2012 2013 2015 2016 2018 2019 2017 2014 2021 2011 inappropriate for Kosovo considering the short time period since independence, and thus ALB ARM MKD MDV KOS associated difficulties in quantitatively assessing the structural components. 47. Kosovo’s budget rigidity has significantly increased since 2010 (Figure 21). The rigidity assessment includes public wages, interest payments, and social transfers consisting Wages and Compensation Wages of pensions and social assistance. Based on this basic metric, Kosovo’s budget rigidity Source: Interest Payments Source: Interest Kosovo BOOST, GFS 2022, BOOST 20022 has risen from 40 percent to roughly 55 percent of total spending. The more pronounced 2022 Pensions for Kosovo Soc benefits spending rigidity in the budget is almost solely attributable to the rise in pension payments, Social Assistance which are based on a plethora of different programs. The largest jump in rigidity occurred in 2014 totaling roughly 8 percentage points. If other transfers are added to the basic metric, which includes subsidies to POE and non-POEs as well as subsidies to farmers, then the rigidity increases from 47 percent in 2010 to 67 percent in 2021. However, between 7.5 Spending by functional categories reveals lagging health spending compared to and 10 percentage points seem to represent temporary programs or reversable programs comparator countries that does not require major legislative steps, which would reduce the rigidity just below 60 percent. 49. Spending by Social Protection, Education, Health, Economic Affairs, General Services, and Public Order and Safety account for roughly 91 percent of executed 48. Yet, compared to peers, Kosovo fares well in terms of budget rigidity (Figure 22). spending during the period 2014 to 2021. Looking at the functional composition over In 2019, the budget rigidity in Kosovo is broadly comparable to North Macedonia levels, time, two trends stand out: first, the share of general services and economic affairs in whereas Albania, Moldova and Armenia exhibit much higher levels of rigidity, in excess of total spending has dropped since 2010 from 23 and 27 percent respectively, to 12 and 16 75 percent for the former two, and more around in case of the latter. The reason for Kosovo’s percent, a decline of more than 10 percentage points over a decade; and second, a more smaller rigidity is twofold: first, interest payments on public debt are much smaller than in than doubling of social protection, from 13 to 27 percent of total spending during the same peers; and second, social benefits, despite the recent rise, are still below those in peers as a period driven largely by an increase in old age pensions’ spending and a tripling of spending percent of total general government spending. on families and children in absolute terms. Meanwhile, spending on public order and safety initially declined sizably between 2010 and 2015, from 8 to 5 percent of total spending, and then almost doubled to around 9.5 percent of total spending during the period 2016 to 2021 driven by an increase in police force expenditures (mainly higher wages and overtime compensation and capital spending on vehicles) but also higher spending on the judiciary from 2018 onward. 21  Echeverry, Bonilla, and Moya 2006; Cetrángolo and Jiménez 2009; Vegh et al. 2017. 38 Fiscal Assessment Kosovo Public Expenditure Review 39 50. Kosovo’s spending record on human capital against comparators is mixed. Box 5. Education is aligned with aspirational peers (but dominated by staff compensation), health spending levels correspond to the lower end of structural peers, while social protection Fig B1. Life expectancy at different Fig B2. Child mortality at expenditures are the lowest, on average, among all peers in GDP terms, given the absence levels of health expenditure different levels of of a social security system. Comparatively, several aspects stand out during the period health 2015 to 2019. First, in Kosovo and its peers, total social protection (SP) spending is higher than health and education spending. Kosovo nevertheless represents an exception because its SP expenditures (6.3 percent of GDP on average)22 are roughly half the size compared to aspirational peers and Moldova, around two-thirds of Albania’s SP bill, and somewhat smaller than Armenia’s spending. Second, Kosovo’s education bill (4.6 percent of GDP on average) exceeds significantly spending on health (2.9  percent of GDP) and corresponds more to relative amounts spent in aspirational peers. Finally, in contrast to spending on education, Kosovo lags aspirational peers in health expenditures during the period 2015 to 2019, and spends an equivalent amount as Albania, on average, but 1.3 percent less per annum compared to Moldova. 51. The pandemic accelerated health spending. Since 2010, health spending increased from 9 percent to 12 percent of total spending, with an acceleration in 2020-21 due to the pandemic. Health spending has risen an estimated 23 percent since the last PER (2014) in per capita terms, from EUR75 to EUR92 in 2021, yet it remains low as spending increased in comparators too. Kosovo’s spending growth rate largely corresponds to per capita health spending increases in structural peers such as Albania, North Macedonia, and Montenegro. As a result, the level of health spending in peers remains two to five times higher. Meanwhile, in Moldova health spending has almost doubled during the same period. Box 5. Source: Source: WDI, WB staff calculations WDI, WB staff calculations Technical efficiency The extent of health spending places Kosovo on the technical of health spending efficiency frontier, albeit at very low levels in the European and Central Asian region. Technical efficiency implies that public spending Kosovo appears technically efficient in terms of life expectancy, but delivers the highest marginal benefit for a given level of resources. there is room for improvement in the area of child mortality (Figures For example, increasing value for money in public procurement, B1 and B2). Kosovo’s efficiency score of 99 and 93 percent (2018 and strengthening bidding processes, mandating cost-benefit analyses, 2019, respectively) seems to suggest that it lies on the frontier with or tightening controls on fraud and corruption could increase the respect to life expectancy given its per capita health spending. In terms technical efficiency of public spending. A data-envelopment analysis of child mortality, if the health system operated at maximum efficiency, (DEA) of the relative efficiency of various national healthcare and Kosovo could, according to this metric, reduce child mortality by educational systems is often used to assess a country’s experience in roughly 20 percent, without the need for additional resources. With the international context. Figures B1 and B2 depict an output-oriented technical efficiency estimates expressed in relative terms to a given DEA model in the European context to maximize improvements in level of spending, it is possible for a country to be fully efficient while key health sector outcomes (e.g., life expectancy at birth and infant remaining below the outcome levels of countries with greater health mortality) without altering per capita health spending. The scatter expenditures. As Kosovo’s GDP per capita health spending increases, matrix of the input and output variables shows that across countries, the technical efficiency gains will have to accelerate significantly, if the higher levels of per capita healthcare spending are associated with country is not to fall behind peers. longer life expectancy at birth and lower infant mortality rates. 22 As shown in budget 40 Fiscal Assessment Kosovo Public Expenditure Review 41 Planning credibility and budget execution is adversely affected by consistent budget under-execution driven by capital spending Fig 23. Deviation of executed from Fig 24. Average deviation by budgeted amounts, 2014 to functional area for period 52. Budget execution since 2010 trails budgeted amounts in every year (Figure 2021, (%) 2014 to 2021, (%) 23). On average, execution was 6.4 percent below budget or 93.6 percent of the approved budget, with 2019 representing an exceptional year in which execution was below budgeted amounts by 9.1 percent, or in other words totaled 91 percent of the approved budget. We focus first on functional areas that account for just over 90 percent of fiscal spending such as general services, economic affairs, social protection, public order and safety, health and education. Overall, economic affairs, social protection, and health (except in one year) have underspent their budgets consistently since 2010. Interestingly, health did not overspend neither in 2020 during the pandemic nor in 2021 but rather underspent by roughly 4 percent. Education spending exceeded the budget in six out of eight years since 2014 (the last PER), by an average of 12 percent. Spending in general services exceeded the budgeted amount by an astonishing 45 percent during the period 2010-2015 (mainly on account public wage changes). After that, overspending from 2016 to 2019 was reduced to an average of 6 percent, whereas during 2020 and 2021 budgeting changed and the execution was 12 and 2 percent below budget in general services. 53. Over-execution in education occurs primarily in pre-primary and primary education, mainly due to over-execution of wages and salaries (likely to have occurred due to payments based on court cases). Under-execution in capital spending usually offset in part the over-execution in wages. Over-execution also occurs repeatedly in secondary education. The persistent under-execution in tertiary education typically offsets somewhat the overspending taking place in pre-primary and primary areas. Interestingly, the secondary education budget has been persistently half the size of its execution over the years until 2020, when the budget caught up with the execution. The same applies to the Source: Source: budgeting of wages and salaries in pre-primary and primary education, which resulted in a BOOST Kosovo, 2022 and BOOST Kosovo, 2022 and balanced outcome in 2020. Economic affairs, health and social protection are areas that are WB staff calculations WB staff calculations continuously overbudgeted. Social protection and economic affairs in particular have seen so far, on average, an under-execution of 16 and 12 percent per annum, respectively (Figure 24). 54. Capital spending across functional spending positions largely accounts for the Expenditures by economic categories reveals an acceleration in current spending driven under-execution of the budgets. Since 2014, capital spending execution totaled 85 percent by social protection spending of the budget, almost evenly spread across functional spending categories.23 The exceptions are general services, with an execution of 117  percent of the budgeted amount, and 55. Over the last decade, capital spending in Kosovo has by far exceeded that in its environmental protection with an overrun of 22 percent on average since 2014.24 Defense structural peers, in GDP terms. Total expenditure in Kosovo appears below the average and public order and safety represent areas with the most realistic budgeting as execution levels recorded in the European context (Figure 25) and is at the lower end when compared is around 93-98 percent, on average.25 The lowest execution rates are seen in housing to Kosovo’s structural peers (Figure 26). That said, the Kosovo’s expenditure composition and community amenities and social protection, with an average of 55 and 59 percent (or differed significantly from comparators, at least initially. Throughout the past decade, median of just above 60 percent). Kosovo stood out among both structural and aspirational peers in terms of the size of its capital spending (Figure 27). On average, Kosovo spent close to 8 percent of GDP on capital expenditures over the past decade, with peaks of over 10 percent of GDP between 2011 and 2013, and around 7 percent of GDP from 2017 to 2019. This is almost eight times larger than average capital spending in aspirational peers, in which capital spending ranged from 0.5 percent of GDP in Croatia to 1.9 percent of GDP in Estonia from 2010 to 2019. In structural peers, such as Albania and Moldova, capital spending remained fairly stable over the same period at around 6 and 4 percent of GDP, respectively (Figure 28). 56. However, large capital expenditures were heavily skewed toward road infrastructure. Since 2010, on average, more than half of all public capital expenditures were spent on road infrastructure (Figure 29). In 2012 and 2017, a record-high of close 23  Measured as a simple average and median to 60 percent of total capital expenditures (or 6.8 and 4.4 percent of GDP, respectively) 24  The median for general services amounts to 112 percent and for environmental protection 139 percent. were invested in roads. The road infrastructure was almost entirely financed from domestic 25  Based on the median 42 Fiscal Assessment Kosovo Public Expenditure Review 43 budget resources, with IFI financed capital project spending remaining lackluster. Once Routes 6 and 7 were finalized, capital spending on roads declined steadily to 2 percent of Fig 25. European expenditures by Fig 26. Total expenditures (average GDP in the three years after 2017. Meanwhile, capital investment in health and education income level, 2019 2015 – 2021), in % GDP accounted together for only 6.4 percent of total capital expenditures in 2010 and rose to 60 expenditure-to-GDP, % 11 percent in 2015 and 18 percent in 2020, in part as a result of COVID-related health investments. Investment in energy was largely off-budget. 55 50 57. Public investment on energy was primarily channeled through private sector mobilization or on-lending operations focused on electricity transmission. Direct 45 public investment – including on energy efficiency – remained low. Investments in 40 renewable energy (140 MW in two projects) were carried out through the feed-in tariff 35 support schemes with 12 year Purchasing Power Agreements (PPAs). Investment in the 30 transmission system has been significant (including the 400-kW energy highway with 25 Albania) and largely realized through Government on-lending operations with IFIs. The substantive investment in transmission stands in sharp contrast to energy production. 20 Kosovo y = 5.1102x-12.23 After a significant Government loan to the energy corporation focused on mining capacities, 15 R² = 0.1384 investment in energy – including efficiency - declined to a trickle, from 0.4 percent of GDP 10 in 2010 to 0.1 percent of GDP in 2020. However, a new Energy Strategy adopted in 2022 9.2 9.7 10.2 10.7 11.2 has significantly increased investment commitments from the Government and will have ln GNI per capita important implications on public expenditure planning, debt, and fiscal risk management. These implications are discussed in more detail later is this chapter under a separate sub- section on the fiscal implications of the energy sector in Kosovo. Source: Source: 58. Current spending in Kosovo caught up with many structural peers by 2019 and WDI, Wb staff GFS and Kosovo BOOST, continues to be on the rise (Figure 30). In 2011, Kosovo’s current spending amounted to calculations WB staff calculations close to 19 percent of GDP, about 4.5 percentage points lower than in Albania and Armenia, and more than 10 percentage points less than in Moldova, as the choice of a public investment push dominated the budget. Eight years later, in 2019, Kosovo closed the current spending- to-GDP gap with respect to Albania and Armenia and halved the difference with respect to Moldova. In 2021 and 2022, current spending-to-GDP increased further to an average of 25 percent. Fig 27. Current vs capital Fig 28. Capital spending in Kosovo expenditures in Kosovo, and peers, % GDP 59. Current spending increased consistently on account of wage increases and % total implementation of new social programs. Social transfers have been increasing by about EUR100 million roughly every two years since 2013. Put differently, Kosovo experienced 120 12 consistent rapid increases in current spending, with spurts in 2014/15 and 2018/19, when over two-year periods spending jumped on average by about 0.8 percent of GDP per 100 10 annum. The first surge (2014/15) was driven by an electorally driven increase in public wages (hiking current spending by 0.9 percentage points of GDP in 2014) and pensions 80 8 and categorical benefits (increasing 0.6 percent of GDP in 2014 and 2015). Specifically, the first spurt entailed a 25  percent increase in public wages (except for political staff) 60 6 and a 25 percent increase in pensions with a 50 percent increase for early Trepça miners. During this period, higher war veterans’ pensions drove transfer spending, with the 40 4 additional transition/reclassification of veterans as war disability benefiaries adding to the cost pressure. Also, ex-contributory pensions increased through a new classification by 20 2 level of education as a proxy for years of contribution. In addition, collective and sectoral agreements encompassed the payment of experience allowance and additional bonuses. 0 0 The second surge (2018/19) entailed again a jump in current transfers (pensions in 2018 2020 2010 2012 2013 2015 2016 2018 2019 2014 2017 2011 2020 2010 2012 2013 2015 2016 2018 2019 2014 2017 2021 2011 and subsidies in 2019), which was coupled with an acceleration in spending on goods and services (0.4 percent of GDP) that were neglected for a decade. Finally, in 2019 the 90’s teachers supplemental pension program was introduced, while in 2021 child allowances were introduced and the government prescribed minimum pension or social assistance Albania Current spending that could not be below EUR 100 per month. Source: Source: Armenia, Rep. of Capital spending Kosovo BOOST Kosovo BOOST Kosovo, Rep. of Moldova, Rep. of 44 Fiscal Assessment Kosovo Public Expenditure Review 45 60. At four-fifths of total current spending, the single largest spending item in the budget Fig 29. Current vs capital Fig 30. Current expenditures peers, over the past decade remains the wage and compensation bill (Figure 31). In terms of total expenditures in Kosovo, % GDP expenditures, wage and compensation spending accounts for close to one-third since 2010. % total Between 93 and 95 percent of wages goes to the following functional areas: education (around 38 percent on average), followed by public order and safety (roughly 19 percent), health (around 34 18 percent), and general services (close to an average of 15 percent). Real wages rose on average 32 7.5 percent from 2010 to 2021, with some variation across functional areas. For example, public order and safety saw the strongest increase in the mass of the paid wages from 2010 to 2021 of 30 close to 20 percent, followed by economic affairs by roughly 11 percent, and health and defense 28 by around 10 percent. The education sector, meanwhile, experienced an average real growth rate of 6.2 percent over the same period. These average real growth rates are marked by significant 26 variation over the past decade. For the period 2020/2021, marked by COVID-19, real wages and compensation in the health sector grew 9.5 percent, in line with the extra labor effort required 24 by the pandemic, whereas education and public order and safety saw an increase of around 4 22 percent, while general services experienced a decline of 2.3 percent. 20 61. At end 2022, the Government approved a Law on Public Wages. The non-regulated compensation system was highly fragmented, including through lack of a unified compensation 18 methodology, but also because of a plethora of allowances provided through Government 2020 2010 2012 2013 2015 2016 2018 2019 2014 2017 2011 decisions or specific laws. Kosovo has also adopted in 2016 a fiscal rule that limits changes to the total wage bill with the level of nominal GDP growth in the country. The challenge will be to implement the new law on wages while maintaining the credibility of the public wage fiscal Albania rule in a context of: a) ongoing systematization of public positions in line with new legislation on Source: Source: Armenia, Rep. of public officials and b) management of significant vacant positions compared to the budget. We Kosovo BOOST GFS and Kosovo BOOST Kosovo, Rep. of analyze the impact of the new law on public wages later through a sub-section on public wages Moldova, Rep. of and salaries. 62. Meanwhile, interest payments remain at manageable levels, their sharp rise serves as a reminder that debt servicing can soon take away much needed fiscal space (Figure 32). Interestingly, the line item that grew the most in real terms was interest payments, which Fig 31. Main components of current Fig 32. % Interest payments in 2019, rose 35.4 percent from 2014 to 2021, closely followed by pensions (31 percent) and social spending, in % GDP assistance (28 percent).26 For the time being, however, low levels of interest payments provide significant fiscal space to Kosovo’s authorities (Figure 28). This is driven by low levels of public debt in Kosovo with interest payments in most cases significantly below those in structural and aspirational peers. Put differently, Kosovo’s interest bill of 0.3 percent of GDP, provides fiscal space on the order of 1.3 percent of GDP when compared to structural peers, which average 1.6 percent of GDP, and around 0.8 percent of GDP when compared to aspirational peers. The latter, however, is a more diverse group with Croatia and Slovenia recording an interest bill of 2.6 and 1.7 percent of GDP, whereas Estonia’s interest payments barely reach 0.1 percent of GDP. 63. Social transfers are a key driver of current spending growth. Kosovo has a mix of programs that have social objectives, but only one program that explicitly targets protection against poverty. Social spending consists of four main categories of programs: a) two programs of benefits for citizens aged over 64 which serve as non-contributory pensions, b) various programs of compensatory nature for specific categories of citizens, mostly war related, c) disability assistance benefits, and d) social assistance programs (including energy subsidies).27 In December 2022, almost 312 thousand citizens received transfers from these schemes: 192 thousand citizens aged over 64 received age-defined benefits, 23 thousand household heads were supported through social assistance (on behalf of 90 thousand family members), 24 thousand citizens received disability related assistance, while 71 thousand citizens benefited from other categorical benefits. This excludes of temporary programs adopted in response to the pandemic Source: Source: and inflation. Kosovo BOOST GFS and Kosovo BOOST 26 These growth rates represent compound annual growth rates of spending outcomes that were adjusted for inflation rates in each year. 27 This includes Social Assistance Scheme and other benefits directed to the same household 46 Fiscal Assessment Kosovo Public Expenditure Review 47 Spotlight: 64. Social protection spending, a subset of social transfers, in Kosovo has risen significantly over the past decade. Unlike in other countries, social protection in Kosovo is Social Transfers financed by government revenues. Given Kosovo’s war legacy and labor market structure, most retirees today have limited contributions to the relatively young (created in 2001) defined- contribution pension system. As a result, large expenditures on non-contributory programs attempt to replace the absence of a social insurance scheme. Spending on social protection in Kosovo rose from 4.3 percent of GDP in 2010 to 8.3 percent of GDP in 2021, with a notable acceleration in 2020 and 2021.28 This rise in government spending over the past decade has been driven by the introduction of new programs, such as the war veterans’ pension and, to a lesser extent, disability pensions, such as the introduction of the compensation scheme for the blind and their caregivers (Table 2). 65. A recent jump in social transfers in 2020 and 2021 was driven by measures aimed to protect the population from the negative impacts of the COVID-19 pandemic and inflation. Additional or higher payments were provided to exiting beneficiaries; but new programs were also introduced. Some of these new schemes were timebound, such as Measure 1529 which provided three monthly payments to households with no formal income and who did not benefit from other social schemes. Others, such as the newly introduced child allowance and maternity benefit,30 are conceived as being permanent (Table 2). 66. Yet, total social spending remains lower than in comparator countries given the absence of an explicit social insurance scheme. Despite the increase, total social protection spending was lower than average levels of spending among Western Balkan countries in 2021 and the regional average of 9.5 percent for Europe and Central Asia (ECA).31 I.5. Spotlight: Social Transfers Table 2. Overview of introduced social spending and wage increases since 2015 67. The bulk of spending on social transfers is largely untargeted to reach the 2020 2022 2019 2016 2018 2015 2021 2017 Description poorest. Spending on age benefits (non-contributory pensions), specifically the basic and ex-contributory pension, and the newer war veterans’ benefits (Table 2), has historically accounted for a significant proportion of social protection spending (Figures 34 and 35). A 25% across-the-board civil servant’s wage increase                 In contrast, the amounts spent on social assistance targeted toward the poor (the Social A 25% across-the-board increase in pensions                 Assistance Scheme)32 and assistance for citizens with special needs are modest. In fact, spending on the SAS has been crowded out over the past decade, with the percentage of Collective agreement signed (experience and other allowances in p.s.)                 social protection spending allocated to the SAS falling from over 20 percent in 2009 to 8 War veteran pension payments start               percent in 2019. The modest rise in SAS payments in 2020 and 2021 reflects an increase in the amount paid to beneficiaries rather than a broadening of coverage. In this context, the Ex-contributory pensions increase and differentiated by education level               overall coverage of social protection trails that of other countries in the Region. Based on the War-inflicted disability class. re-opened             2017 household survey data (HBS), an estimated 45 percent of the population is covered by social protection programs,33 which is below the average of 61 percent among ECA Political staff and judiciary wage increases           countries.34 While the distribution of beneficiaries of social protection programs in Kosovo is somewhat pro-poor, the distribution of benefits itself is not, with almost 30 percent of 90’s education workers supplementary pensions         benefits being allocated to the richest quintile of the population as compared with just less Universal child allowances     than 18 percent to the poorest.35 This is important because poverty-targeted programs tend to pay less per household. Health spending as a percentage of GDP is also much lower Maternity benefits for unemployed mothers                 compared to rest of the region, while out of pocket expenditures are an important factor Source:Source: WB staff that contributes to poverty in Kosovo. 28 This refers to only government spending on social protection for the reasons that are elaborated in this paragraph. 29 Measure 15 is classified under “Other social assistance programs” in Figure 2. 30 This is a labor market program 32 In 2020, the SAS was complemented by Measure 15, which aimed to expand coverage of poverty-targeted 31 Based on World Bank SPEED, most recent data available; figures include the Social Assistance Scheme, social assistance to additional households. This Measure was, however, timebound and has ended. energy subsidies and assistance to families with children with disabilities, assistance to foster families and 33 2017 HBS. all government-funded pension schemes (basic and ex-contributory, special, war veterans and war-related, 34 SPEED database. and disability pensions). 35 Information based on the total social protection benefits reported by households in the HBS 48 Fiscal Assessment Kosovo Public Expenditure Review 49 69. War veterans’ and war-related pensions made up 21 percent of government Fig 33. Expenditure on social Fig 34. Government spending on spending in 2021 (Figure 1) are not targeted to the poorest members of this category protection programs in social protection in Kosovo, of citizens. From 2009 to 2020, the number of war-related beneficiaries increased from the region and other select 2008-2021 (% GDP) 12,000 to 52,000 individuals36, raising concerns about the fiscal sustainability of pensions. countries, 2017-21 (% of GDP) While some war-related pensions may be warranted given the consequences of the war for individuals, they tend to be more generous than the SAS payments, even though their objective 16 3.0% 9.0% % of GDP is not to alleviate poverty. For example, the scheme for War Veterans of the Kosovo Liberation 14 8.0% Army (KLA) pays a monthly amount of EUR 170, which, until 2022, was equivalent to the 2.5% minimum wage and much higher than that paid under other social assistance programs.37 12 7.0% Surviving spouses (and children up to age 26) of martyrs, civilian and former Kosovo KLA war 2.0% 6.0% 10 invalids, KLA members and civilians who disappeared in the war and war veterans are also 5.0% eligible for benefits. Such payments raise concerns about possible disincentives for official 8 1.5% 4.0% employment, as veteran’s benefits are conditioned on employment,38 hence fostering informal 6 1.0% 3.0% work. At the same time, well-off and less well-off veterans receive the same benefits, without a differentiation according to a social census.39 4 2.0% 0.5% 70. Nevertheless, Kosovo has the lowest expenditure on pensions in Europe and the 2 1.0% Western Balkans (Figure 37). When war-related pensions are added, the expenditures only 0 0.0% 0.0% slightly exceed the EU countries with lowest pension costs - Lithuania and Ireland. Nonetheless, ALB BIH MNE MKD BGR SVK ROU KSV 2009 2020 2008 2010 2012 2013 2015 2016 2018 2019 2021 2014 2017 2011 2019 2018 2019 2020 2017 2017 2017 2021 pension costs catching up with EU countries while Kosovo’s population is younger and replacement rates lower than in EU countries, raises concerns. As indicated earlier, pension costs have been on a strong upward trend as a consequence of external factors such as aging, as well as internal like ad hoc interventions in the pension system. Labor market programs (%) Personal Income Tax Fig 35. Pension expenditure as % of GDP Source: Social assistance (%) Source: Corporate Income World Bank SPEED Ministry of Labor and TaxDuties Social insurance (%) 16 Database (2022) Social Welfare (2020) and % of GDP, 2018 Social care services (%) Paun Jarallah et al. (2019). 12 Kosovo (2020) 8 4 0 68. Non-contributory state pensions and war-related programs are a defining feature Federation BIH EU (27 countries) Montenegro France Greece Cyprus Netherlands Portugal Kosovo total Ireland Iceland Poland Switzerland Finland Lithuania Malta Latvia Estonia Bulgaria Romania Czechia Slovakia Slovenia Croatia United Kingdom Sweden Belgium Spain Austria Albania N. Macedonia Rep. Srpska Serbia Hungary Norway Germany Italy Turkey Luxembourg Denmark Kosovo non-war of social protection envelope in Kosovo. Old-age pensions make up the majority of social protection payments to the population. Basic and ex-contributory pensions made up 59 percent of government spending on cash transfers in 2021, with special pensions making up an additional 2 percent of GDP (Figure 36). Unlike in most countries, the basic pension has universal coverage, covering both poor and non-poor elderly alike (above age 64). Pillar II pensions are based on a fully funded Defined Contribution scheme but are only limited to a segment of the population that started contributing from 2001The basic pension was increased to EUR 100 in 2022, whereas the number of beneficiaries of the basic pension increased from 120,000 in 2016 to almost Source: Eurostat; and pension agencies in Western Balkans countries 150,000 in 2022. In parallel, beneficiaries of the ex-contributory pension rose from just over 40,000 to almost 50,000. A universal basic pension (Pillar 1) is tax financed and – given Kosovo’s independence path – has not inherited any funds or continuity from the former Yugoslav system. In fact, the universal basic pension is not conditioned on prior work experience and is as such an age-based assistance scheme. From 2008, responding to demands from former contributors 36 A total of eleven schemes are included, as defined by Law No. 04/L-054 on the Status and the Rights of the to the Yugoslav pensions system, higher paying transfer were for contributors with 15 years of Martyrs, Invalids, Veterans, Members of Kosovo Liberation Army, Sexual Violence Victims of the War, Civilian contribution to the former pensions system, which was also differentiated by education level in Victims and Their Families; Law No. 04/L-172 on Amending Law No. 04/L-054. Source: Ministry of Finance, 2016. At end 2022, the Constitutional Court ruled against the 15-year minimum contribution Labor and Transfers 37 The current Law on Minimum Wage proposes to delink the monthly amount paid through this scheme from qualification requirement, hence increasing eligibility for higher paying pensions. Given Kosovo’s the minimum wage. sensitive legacy, a significant number of non-targeted categorical transfers are also sometimes 38 Veterans are eligible for veteran’s benefits only if officially unemployed. This is applicable until the 2016 called pensions and include benefits for war veterans, martyr families, civil and combat war- amendments are implemented regulating the veterans’ re-categorization. Under the amendment veterans inflicted disabilities, 90’s education sector employees, former Trepça miners, former Kosovo will still receive half of the benefits even if they are officially employed. 39 Though the Household Budget Survey does not capture the totality of war-related pension beneficiaries, the Security Corpse members, and early retirees of Kosovo Security Forces. To date, only former 2017 survey shows most households that reported receiving these benefits were not poor. political prisoners were compensated through lump sum payments. 50 Fiscal Assessment Kosovo Public Expenditure Review 51 71. Social transfers in Kosovo are neither effective nor equitable and the social I.5.1.  Social Assistance Scheme (SAS) in need of pro-poor adjustment assistance scheme does not include the required flexibility to adapt to the evolving poverty landscape. Although spending on social transfers is high compared to other Western 73. Poverty-targeted social assistance in Kosovo increased as a share of social Balkan countries, around 90 percent of social transfers is allocated toward old-age (non- protection spending in 2020 and 2021 after decreasing nearly threefold between contributory) basic pensions, war veterans and other war-related pensions, and disability 2009 and 2019. Spending on the SAS fell by 8.4 percent in real terms and from 0.69 to 0.45 pensions (Figure 37). In contrast, transfers targeted towards the poor -Social Assistance percent of GDP between 2009 and 2019; the number of SAS beneficiaries declined from Scheme (SAS) - made up only 0.7 percent of GDP. With the introduction of the child benefit in over 40,000 to about 24,000 households between 2005 and 2019. Over the last decade, 2021, spending on other social assistance programs only amounted to 2 percent of government increases in spending on more generous categorical programs, as discussed above, have spending on social transfers. Below, the SAS is described first followed by the pension system. crowded out spending on the SAS. This overall trend reversed slightly during 2020 and 2021 when the Government harnessed the SAS to protect poor people from the negative impacts of the COVID-19 pandemic. As a result, spending on the SAS nearly doubled in 2021 as compared to 2019, reaching 0.7 percent of GDP in both 2020 and 2021. This increase Fig 36. Composition of spending on cash was, however, largely driven by the provision of higher payments to existing beneficiaries transfers in Kosovo, 2021 (% of GDP) rather than an expansion in coverage, without due consideration of the poverty impact, welfare needs and fiscal impacts. This is reflected in the fact that the number of beneficiary 100% families increased only slightly in 2020 and 2021, reaching around 25,000 households. 90% 74. While spending on the SAS is higher than among neighboring countries, most 80% countries have several poverty-targeted programs allowing broader coverage of the 70% poor. Spending on the SAS alone is high in comparison to the spending in other Western 60% Balkan countries on their last-resort income support program (LRIS). However, Kosovo’s LRIS is the only program aiming to reach the poor. For example, coverage among the poorest 50% quintile in Kosovo was 26.2 percent, which is far below the average of 54.3 percent among 40% countries in ECA. This points to the important role that the SAS plays in mitigating poverty 30% in Kosovo. 20% 75. The SAS’s incidence does not correspond to the country’s poverty profile. Based 10% on the most recently available data, only about 7 percent of the total population benefits from 0% the SAS, whereas the official national poverty rate is closer to 20 percent. Only about one in 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 four people in the bottom quintile receive the SAS (Figure 38, panel a). Recent diagnostics of SAS design and implementation reveal explicit disincentives and administrative restrictions to labor market participation, especially for women; the paragraphs that follow describe some of these key features.40 Basic old-age pensions Ex-contributory pensions Source: Ministry of Labor and Social Welfare (2020) and Paun Social Assistance Scheme War-related schemes 76. The SAS beneficiary eligibility, verification and recertification process are Jarallah et al. (2019). War veteran pensions (excl. veteran pensions) overly narrow and inflexible. Currently, households must fall into one of two eligibility Other social assistance Disability pensions programs categories: Category I, which requires that all adults be ‘dependent’ (not able to work), or Note: Data on labor market spending only available for the years Labor market Special pensions Category II, in which one adult has to be registered as unemployed and caring for a child 2017 2018, 2020 and 2021. under five years of age or an orphan under 15 years of age. Households falling into these categories then must pass a means test and a verification of assets and living conditions. The verification of assets and living conditions is conducted through home visits, potentially introducing the discretion of social workers. Approved households must recertify every 72. In 2021, the Government introduced a new program to provide direct support to 12 months for Category I and every 6 months for Category II.41 Such restrictive conditions children; but this program is also not based on poverty targeting. Prior to 2021, Kosovo exclude the working poor and may create incentives to work informally and/or to obtain did not have a dedicated child or education grant within its social protection system; rather, an disability status to maintain eligibility for the scheme. additional grant of EUR 5 per month per child was provided to SAS beneficiaries, in addition 77. SAS eligibility criteria are not data driven. For example, the SAS Category II criterion to the benefits for children with disabilities, a monthly cash support of EUR 100. In 2021, the that the youngest child be younger than five years results in the exclusion of poor families Government introduced a child benefit, which was initially allocated to all children under the age with school-age children. The use of this criterion for eligibility is unique to Kosovo and has of 2 years and subsequently increased to all children under 16 years, to be paid to their mother not been supported by research. Its choice seems counterintuitive as there is no reason to into her bank account. The program pays EUR 20 per month to children under two years of age and EUR 10 per month to children three to 16 years of age. As of 2021, 127,432 children were benefiting from this initiative, although this is anticipated to increase further given the phased 40 World Bank. Kosovo Social Assistance Scheme Study Assessment and Reform Options. Washington DC: implementation of the program and the demographics of the country. Previous estimates suggest World Bank, 2019 that a child benefit of EUR 10 per month to all children under 16 years in Kosovo could amount to 41 Additionally, the MFLT cross-checks the formal income reported by beneficiary households to the Tax EUR 60 million per year. At the same time, given that in Kosovo poorer households tend to have Authority on a monthly basis and, if above the threshold for eligibly, households have exited from the more children, this program is somewhat pro-poor; but yet not based on poverty targeting. program. 52 Fiscal Assessment Kosovo Public Expenditure Review 53 believe that these households will escape poverty once their children turn five years of age. On the contrary, poverty incidence among households increases with number of children in Fig 38. Spending on last resort income support in the household, regardless of age. The benefit amount also applies very stringent economies select countries, 2016-2021 (% of GDP) of scale, meaning that larger families are not sufficiently compensated for their needs. Furthermore, under Category I, once a child turns 19 years of age, the family loses eligibility 0.005 0.025 even if he/she is still in education; in other countries, students ages 19-24 are often exempt 0.0045 from work requirements in order to receive social benefits. 0.004 0.02 78. The SAS’s poverty headcount reduction impact has been modest. In 2017, three- 0.0035 quarters of SAS benefits reached the bottom quintile of the distribution for consumption, 0.003 0.015 placing its targeting performance among the best in the Western Balkans (Figure 38, panel 0.0025 b) and in Europe and Central Asia. Yet, importantly, relatively accurate targeting is due to low coverage and restrictive categorical criteria rather than to adequate beneficiary 0.002 0.01 identification. As see in Figure , the SAS’s impact on poverty is more modest than in some 0.0015 other countries in the Western Balkans which have lower rates of spending on their last 0.001 0.005 resort income support programs. 0.0005 0 0 WB BIH MNE MKD SRB ALB KSV Fig 37. Coverage and benefit incidence of social 2006 2016 2017 2019 2020 2020 2019 assistance in select countries, bottom quintile, 2015-2018 Source: a. Coverage of bottom quintile, percent b. Benefit incidence, percent World Bank staff estimates based on national statistical data (2021). 35% 90% Note: 30% 80% WB6 is a simple average of the six Western Balkan countries. 70% 25% 60% 20% 50% 79. The SAS benefit is a flat rate that increases with family size but slowly and, as 15% 40% a result, covers a lower share of the consumption needs of larger families compared 30% with smaller ones. The benefit amount currently provides EUR 70 for a one-member family, 10% EUR 90 to a two-member household, with an additional EUR 10 provided for additional 20% 5% family members. Indexation of the benefit is ad hoc and discretionary despite existing 10% legal rules. Although there has not been any formal inflation indexation of the SAS benefit, 0% 0% discretionary increases of the benefit amount have more than offset benefit erosion and led MNE ALB MKD KSV SRB BIH MKD BIH SRB KSV MNE ALB to an increase in the real value of SAS. Additionally, since early 2020, the SAS benefit amount 2015 2018 2016 2017 2018 2015 2016 2015 2018 2017 2015 2018 has been increased on a permanent basis, with temporary top ups provided repeatedly, such as a doubling of the benefit in early 2020, a 30 percent increase in 2021, and another doubling in late 2022, as the Government uses this Scheme to protect poor people from Source: shocks. As of 2022, the Government introduced a floor of EUR100 for SAS beneficiaries. World Bank SPEED database (2016-2018). 80. The adequacy of social assistance in Kosovo is above most countries in Europe Note: and Central Asia. During 2017, on average, the benefit amount represented 39 percent of Non-contributory basic pensions and war-related pensions not included. Figures for Kosovo represent the SAS program. Bottom the total consumption of beneficiaries in the first quintile for consumption.42 Despite recent quintile refers to the bottom quintile for consumption per capita. Benefit incidence refers to the percentage of total benefits accruing to the bottom quintile. increases, the average SAS benefit amount remains that of the basic pension (EUR 100 per month). Additionally, households enrolled under Category I must have their eligibility reassessed every 12 months, whereas Category II households must be reassessed every six months,43 thereby undermining the security of this support to beneficiaries, while also 42 In this year, the average beneficiary household received over EUR 1,000 or about EUR 83 per month (according to the HBS 2017). 43 Additionally, the MFLT cross-checks the formal income reported by beneficiary households to the Tax Authority on a monthly basis and, if above the threshold for eligibly, households have exited from the program. 54 Fiscal Assessment Kosovo Public Expenditure Review 55 increasing administrative burden on caseworkers. The SAS is also a gateway for other in- kind benefits and associated rights for its recipients, including energy subsidies. Fig 39. Fiscal Cost of Pension Benefits (as % of GDP) 81. The Government has committed to reform the SAS by removing categorical eligibility criteria and institutionalize an energy vulnerable consumers program. 8 At the heart of this initiative is the commitment to remove categorical eligibility criteria and transition to a means and proxy-means tested eligibility process which would enable 7 effective identification of most vulnerable citizens. At the same time, the Government has 6 committed to create an energy vulnerable consumers program which would improve coverage of this program beyond LRIS and selected pension scheme. Finally, enhancing 5 universal healthcare coverage, particularly in terms of reducing out-of-pocket spending on pharmaceuticals, could also significantly enhance social protection in Kosovo. 4 3 I.5.2.  Pensions 2 82. Kosovo’s pensions system is fragmented. As discussed above, the Government 1 has introduced unfunded/non-contributory schemes and war-related benefits around the foundation of the pension system. The consequences of the chosen eligibility criteria and 0 benefit levels of these unfunded schemes are adversely impacting the systems’ sustainability, 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 adequacy, and equity. The benefits of the ex-contributory system, of the security forces, and war veterans have been set higher than other categories and have covered a broad range of risks. For others, the pension system is unlikely to protect against the risks of poverty, Source: disability, and loss of breadwinner. Pension system simulations suggest that the fiscal costs Kosovo MLSW and MoF. and adequacy of inflation-indexed non-contributory benefits could decline rapidly. As a result, possible new ad-hoc interventions and the introduction of new schemes may crowd out public funds and congest the development of the core pension segment. Therefore, an integral and comprehensive reform of the current pension system segments and its operations could put the system on a long-run sustainable social and fiscal path. 84. Status quo simulations of the pension system suggest that the combination of basic pension and second pillar (KPST) currently are unlikely to prevent the risk of 83. Historically, the fiscal cost of pensions has been steadily increasing for two old-age poverty due to design and parameter characteristics. The core segment of the reasons: i. expanded generosity of existing non-contributory pensions; and ii. pension system and its long run structure is a combination of two elements. First, a fully introduction of new non-contributory pension benefits. Fiscal costs have been rising funded, defined contribution individual-account based second pillar, with the main objective for age-related and war-related pensions (Figure 40). While the basic pension budget to replace the income in proportion to contributions paid (KPST). Second, a universal basic grew by a half of percentage point, the ex-contributory pension costs accelerated with pension aimed primarily to prevent the risk of old-age poverty. Status quo simulations of its revised formula to include the level of education in 2016, and a 15 percent increase in the pension system seem to indicate that the combination of a basic pension and the second 2019. Specifically, the cost of ex-contributory pensions reached 1.8 percent of GDP in 2020. pillar currently may not be able to prevent old age poverty due to its design and parameters. Similarly, a new wage-related supplement to basic pension for teachers, introduced in 2019, added a decimal point to the total costs. At the same time, the revision of the war-related 85. As the population ages, the ratio of pensioners relative to contributors is expected pensions and their ad-hoc increases have contributed to a gradual increase in pension to deteriorate rapidly. The current unfunded public pension system is financed from expenditures to 1.7  percent of GDP in 2020. The rapid growth of pension expenditures general revenues, rather than pension contributions, so the concept of “system dependency” has been a consequence of what appears to be a fragmented pension policy, dispersed (ratio of beneficiaries to contributors) does not apply. Instead, the dependency is expressed opportunities for proposing new pension initiatives, and a possible absence of cost-control with respect to the employed population. In this context, the system dependency would mechanisms accompanying new pension proposals. surge as the population ages. Currently, the basic pension is provided to one half of current beneficiaries, while the special, merit and legacy pensions cover the rest. Over time, special pensions could phase out and, if no changes are introduced to pension parameters, the basic pension would capture the bulk of beneficiaries, with the dependency ratio reaching 50  percent of the working age population by 2075 (Figure 41). These results are based on the population forecasts which are embedded in the 2011 census. If the new census, scheduled for 2023, reflects a lower profile for the working age population (i.e. because of faster than previously anticipated migration), then the ratio could deteriorate further. 56 Fiscal Assessment Kosovo Public Expenditure Review 57 88. Without reforms, the status quo scenario is unlikely and could be seen as a Fig 40. System dependency ratio Fig 41. Public pension expenditure source of fiscal risk. As the experience of the past decade has shown, the current pensions in Kosovo (beneficiaries to in Kosovo, 2020-2080, system has continuously been augmented with ad-hoc new programs and design changes. working age population)- Baseline Moreover, the recent Constitutional Court decision on ex-contributory pension eligibility Baseline criteria, if not addressed as part of a systemic reform, may worsen the fragmentation and inequity of the system. As the population ages, the political agency of different age 60% 8% groups will also change. Therefore, a sustained status quo situation may carry fiscal risks, 7% as without reform the pension system may represent a fiscal and budget credibility risk. 50% Hence, quantifying alternative ad-hoc policy paths is fraught with caveats, yet scenarios of 6% higher fiscal cost and deeper inequities cannot be eliminated. Recent demographic trends 40% and the risk of accelerated migration from being in the neighborhood of an aging Europe, 5% appears to add to arguments in favor of some urgency of reform. 30% 4% 89. Covid-19 withdrawals from personal KPST accounts created a precedent and 20% 3% significant fiscal liability for the state, generating distributional, social, and legal 2% risks. While some second pension pillar countries around the world allowed for withdrawals 10% from the pension accounts, none of the countries chose to reimburse it from the budget. The 1% withdrawal from the second pillar without reimbursement or compensation reduces future 0% 0% pensions. While easing the impacts of the current crisis, it is shifting the burden into the old age. A responsible mitigating policy in case of allowing the second pillar withdrawals would 2080 2080 2050 2050 2068 2068 2020 2020 2056 2056 2026 2062 2026 2062 2038 2038 2032 2032 2044 2044 2074 2074 have been to compensate the withdrawn amounts by contributing more the following years. A full, and unconditional reimbursement from the budget for those with savings of up to EUR10,000, and a tax-free withdrawal for the rest, represents a direct gift to those that withdrew. In other words, this policy could be seen as an untargeted transfer to the Pension beneficieries/ Pension expenditures/ Source: working age population, % Source: GDP, baseline, % better off beneficiaries at the expense of the taxpayers. The potential unconditional and World Bank Pension Basic pension/working age World Bank Pension full reimbursement liability stands at around EUR 100 million. The Assembly’s refusal Model for Kosovo, 2021 KLA veteran and family/ Model for Kosovo, 2021 to authorize a second round of withdrawals is a step in the right direction, ensuring the working age Ex-contributory/working age sustainability of the second pillar system and reducing the risk of old age poverty for Kosovar citizens. 86. Without reforms, the adequacy of most pension benefits is likely to decline.44 The adequacy of all pension benefits indexed to CPI of all benefits adequacy indexed with I.5.3.  Policy recommendations CPI inflation will decline over the next decades to socially unsustainable levels. Specifically, 90. In the short term, government SAS policies could focus on targeting and the basic pension adequacy ratio would gradually fall from the current 19 percent to as coverage. First, the Government could consider reforming the SAS targeting mechanism for low as 5 percent of the average wage by 2080. Meanwhile, pensions directly or indirectly more efficient poverty targeting and introduce incentives for work by disregarding some indexed to wages, such as armed forces, KPC, war veterans and martyrs would not lose in income from employment in order to become eligible for benefits. Second, the Government adequacy. Therefore, inequities between benefits such as ex-contributory and basic pension could consider establishing protocols and procedures to expand the SAS to additional poor would remain. Moreover, the differences between war-related wage-indexed pensions and households when shocks occur. non-war flat benefits are set to widen and aggravate the inequity within Kosovo pension system. 91. Over the medium term, SAS policies could further include the introduction of a social registry (information system) to better identify eligible households across 87. Pension expenditures are likely to decline in parallel with adequacy, although programs and which households are receiving support from which programs. Furthermore, from a political economy perspective this is an improbable scenario. Assuming an increased analytical effort could help understand the needs of members of a household, pension adequacy gradually falls to only 5 percent, pension expenditures could drop from so that they can be referred to appropriate programs, and supported by integrated data their current level of 6.7 percent of GDP to 3 percent by 2080 (Figure 42). From a social systems. Finally, to enhance social equity the government may want to increase social perspective, such an outcome may not be desirable, despite the arithmetic fiscal appeal of a assistance to households in need through reallocating spending from less efficient programs reduced burden for the budget. The rigid CPI indexation rule could be revisited to halt the that do not target the poor, such as some pension programs, to programs more effective in decline in adequacy, which in turn could result in ad-hoc interventions in benefit levels and serving the poor. formulas. Against this background, a revision of the benefit rules could be an opportunity for a pension system overhaul, the elimination of perceived inequities, and the creation of 92. In addition, Kosovo’s pension system challenges are complex and require a system that would responsibly, socially as well as fiscally, serve many future generations. an integral reform strategy with broad political consensus for hard but necessary decisions. Simulations confirm that a comprehensive reform of the current pension system segments and its operations is needed to bring the system to a predictable long-run sustainable social and fiscal path. From a fiscal perspective, only a clear and integral reform can close the ad-hoc pension policy decisions loop, hence building safeguards against 44  Pension adequacy is the share of the pension benefit in the average wage 58 Fiscal Assessment Kosovo Public Expenditure Review 59 Spotlight: fiscal and debt sustainability risk. As part of this reform, a review is needed of the current contribution rates to the second pillar with a view to enabling the payout of lifetime annuities. Public Wage Bill For basic pensions, the rigid CPI indexation rule could be revisited. For categorical benefits (merit and legacy pensions) of beneficiaries below the age of 65 or citizens inheriting these benefits, formal labor disincentives should be removed while politically feasibly solutions for replacement of these schemes with more targeted compensatory grants could be considered. Delinking categorical benefit levels from the minimum wage, currently pending Assembly approval, is a step in the right direction. In the meantime, the Government should continue with its recent administrative efforts to avoid double dipping between different schemes and ensure effective implementation of residency criteria. Until a clear pension reform is finalized and adopted, fragmented stand-alone pension initiatives,45 including for early retirement schemes, should be on hold and all future initiatives required to be accompanied by long-run fiscal and social assessments. 93. The recent Constitutional Court decision extending ex-contributory pension eligibility to individuals with less than 15 years of former-YU service needs to be addressed as part of an integral pension reform strategy. Conservative preliminary estimates assuming an implementation by different benefit levels per years of service suggest that this could add fiscal costs of up to 0.4 percent of GDP on average per year in the next decade, while the total present value of the additional liability to the state may potentially reach 20 percent of GDP.46 Adopting these policies without further analysis and outside of an integral pension reform strategy would be fiscally risky and constrain further work on pension reform. 94. At a technical level, the Government of Kosovo should continue to strengthen pension analysis capacities. In 2021, the Government revised the legislative base to introduce new requirements for subjecting social (10 years) and pension (50 years) policy initiatives to long term financial analysis, as well as transparently disclose both the analysis of proposed policies and existing schemes under the new standards. The Government should ensure full compliance with these legal obligations and ensure adequate staffing, skills, and institutional development to fully operationalize these requirements. The new census is a significant milestone for informing pension analysis, and an adequate update of long-term population forecasts is critical to improve the quality of pension analysis. I.6.  Spotlight: Public Wage Bill I.6.1.  Overview of trends 95. Kosovo historically spent about one-third of its total expenditures on public employee compensation (Figure 43). Between 2008 and 2019, the wage bill averaged 43 percent of total current spending. In terms of total spending, wages and salaries peaked close to 34 percent in 2015, from 24 percent in 2008. Since then, this share has been gradually declining, resulting just below 30 percent between 2019 and 2021. In 2022, the share of wage spending dropped further, below the historical average, to 26 percent, on account of: a) lower public wage spending as pandemic-related costs were phased out; and b) higher subsidies and transfers against the inflationary crisis elevated total government spending, the denominator. In GDP terms, the Government spent an average of 8.4 percent on wages and salaries between 2008 and 2022 (Figure 45). The wage bill cost increased from 6.4 percent of GDP in 2008 to 9.1 percent in 2014, thereafter hovering around an annual average of 8.8 percent of GDP. In 2020, given pandemic induced output contraction and additional staffing needs, wage spending reached almost 10 percent of GDP. It then took a downward path mirroring the post-pandemic rebound and the inflation driven increase 45 Initiatives such as introducing the separate early retirement system for police officers or widening the in nominal output over 2021 and 2022. Spending on wages and salaries dropped to 8.4 eligibility for ex-contributory pension benefit to those with less than 15 years of contribution. 46 The estimate of 0.4 percent and 20 percent liability are estimates based on the 2020 draft proposal to award percent of GDP in 2021 and is estimated to have further dropped by 1.1 percentage points the benefits as a proportional supplement to basic pension for those with ex Yu service below 1 years. of GDP in 2022. 60 Fiscal Assessment Kosovo Public Expenditure Review 61 96. Public employment growth slowed since the last PER in 2014 but remained an important driver of public wage spending. As part of internationally supported state Fig 42. Share of wage spending in total Fig 43. Local and central level public building efforts, Kosovo employed over 90 percent of its public service before declaring spending empolyment in Kosovo (in independence in 2008. Public employment, excluding employment in publicly owned thousands) enterprises, stood at close to 75 thousand in 2008 and rose roughly another 9 percent until 202247. Overall, from 2008 to 2014, the number of public employees increased by a total 50 46 of 6 percent. Between 2015 and 2022, public employment grew at a rate of 4 percent. The 44 bulk of the increase in employment since 2008 resulted from hiring at the central level 45 (Figure 44). This employment growth stems primarily from the consolidation of public 42 order, defense, and justice institutions, followed by increases in education and health sector 40 40 staff. Education and health accounted for 45 percent of public employment in 2022 (81 thousand in FTE, and close to 83 thousand accounting for part-time positions). Meanwhile, 35 38 the local government employs just over half of total public employees, broadly maintained a 30 36 constant level of employment. Against this backdrop, public employment growth remained a moderate but nonetheless an important cost driver of spending on wages and salaries in 34 Kosovo. 25 32 97. A legal ceiling on public wage growth was enacted in 2016. The introduction of 20 30 a legal ceiling on public wage growth in 2016, effective from 2019, anchored public wage 2009 2008 2020 2010 2012 2013 2014 2015 2016 2017 2018 2019 2022 2021 2011 2008 2009 2010 2012 2013 2014 2015 2016 2018 2019 2020 2022 2017 2021 2 011 spending to a more gradual and predictable growth trajectory (Figure 46). In the context of a 2015 Stand-by Arrangement program with the IMF, Kosovo introduced in 2016 a fiscal rule, which caps total wage spending growth to the latest available annual nominal GDP growth rate. Delays in the publication of national accounts imply that the rule uses Spending on wages Central FTE, eop nominal growth with a two-year lag as a cap on wage spending growth. The use of nominal Source: and salaries as % total Source: Local FTE, eop growth as an anchor could allow for procyclical wage increases. There is also some lack of MoFLT Treasury Spending on wages MoFLT Treasury clarity on the application of the rule in terms of budgeted versus actual amounts spent on and salaries as % wages. Despite these shortcomings, the introduction of the rule has contributed to positive current spend. behavioral changes in policymaking that have enhanced prudent public compensation. 98. Kosovo spends more than structural peers on public employee compensation (Figure 47). For the period 2010-2021, Kosovo’s spending on wages and salaries exceeded Moldova and North Macedonia by 1.1 percent and 1.7 percent of GDP, respectively. At the Fig 44. Spending on wages and salaries Fig 45. Annual changes to wage and same time, Kosovo spent 3.8 percentage points more than Albania and more than double than relative to GDP salary spending Armenia spends on public wages. However, this comparison needs to be interpreted with an important caveat in mind. Kosovo has a highly consolidated institutional setup. Except for 10 25 the Public Broadcaster and a few cultural institutions, Kosovo has no extrabudgetary funds or parastatals, which can be found in other countries. 20 8 99. Kosovo’s wage bill is well below levels recorded in aspirational peers (Figure 15 48). Between 2008 and 2021, aspirational peers such as Slovenia, Croatia, and the Baltic 6 countries spent on average an additional 2.1 percent of GDP on wages and salaries. The gap is 10 even higher in 2021, at 3.2 percent of GDP, or 4.2 percent of GDP when compared only to the 4 5 regional aspirational peers, Croatia, and Slovenia. While this comparison reveals differences in salary levels between Kosovo and aspirational peers, it also mirrors differences in the level of social security contributions and personal income tax rates. In Kosovo, employer 2 0 pension contributions - the only mandatory contribution scheme - account for 9.1 percent of total wage spending, or 0.8 percent of GDP, in 2021. In contrast, in Estonia, for example, -5 0 employer contributions accounted for 28 percent of total wage spending and 3 percent of 2009 2009 2008 2008 2010 2012 2013 2014 2015 2016 2018 2019 2020 2022 2010 2012 2013 2014 2015 2016 2018 2019 2020 2022 2017 2017 2021 2021 2011 2011 GDP in 2021 (or 2.7 and 0.5 percent of GDP in Latvia and Lithuania, respectively). Wages and salaries, %GDP Source: Central Level Wages, %GDP Source: MoFLT Treasury MoFLT Treasury Local Level Wages,%GDP 47 In full time equivalency (FTE) levels. In 2022, the difference between FTE and total employment stood at close to 1,500 employees, primarily due to part-time positions in education and other sectors. 62 Fiscal Assessment Kosovo Public Expenditure Review 63 payment for court ordered damages under wages and salaries amounted to EUR20 million, Fig 46. Wage spending as % of Fig 47. Wage spending as % of GDP, or 3 percent of total spending on wages and salaries. By September 2022, the Government GDP, Kosovo and structural Kosovo and aspirational paid an additional EUR14 million for such damages, which are primarily related to benefits comparators comparators stemming from collective contracts. 102. Before the pandemic in 2020, the public compensation system incorporated over 61 categories of allowances and compensations, which accounted for an 8.7 estimated 20 percent of total wage spending.48 Kosovo’s public payroll system and its 8.4 8.4 12.7 12.6 11.9 11.9 financial management information system communicate only at an aggregate level. This 7.6 11.6 7.5 7.0 10.7 6.9 means that information on specific allowances is not disaggregated under the Government’s 10.5 10.3 10.3 6.6 9.9 chart of accounts. As a result, allowances and compensations are reported under base 8.7 8.4 salaries within financial statements. However, based the above incentivization is based 4.9 4.4 on identification of specific decisions and estimated from a sample of monthly payroll information. The experience allowance alone is estimated at 8 percent of base salaries for 3.0 2.9 16.5 years of average work experience for public employees. Other allowances included general allowances of EUR30/month for all employees classified as civil servants, or sectoral allowances for IT staff, Kosovo police, Tax Administration, risk allowances (for police officers, firefighters, etc.), qualification allowances in education, or very specific allowances designated for staff of a specific institution (i.e. the Mines and Minerals Commission, Special Kosovo Moldova Mongolia North Albania Armenia Slovenia Croatia Latvia Lithuania Estonia Kosovo State Prosecutor, or allowances for General Secretaries in Ministries). In 2019, experience Macedonia allowances, meal compensation, and other fixed allowances are estimated to have represented around 15  percent of total wage spending (and 1/5 of total wage spending when adding overtime compensation and honorariums). Spending on wages 2021 Source: and salaries as % total Source: Average 2010-2021 103. During the pandemic, the government introduced additional frontline sector World Bank MPO World Bank MPO Spending on wages allowances and compensation. In 2020 and 2021, the Government – under the pandemic database and IMF GFSY and salaries as % database and IMF GFSY current spend. management and recovery support packages - paid an additional EUR55.6 million to compensate for the efforts needed in managing the impact of the pandemic. This represented 5 and 3.4 percent of total wage spending in 2020 and 2021, respectively. In 2022, based on data until September 2022, spending on such allowances is estimated to have declined to 100. In the absence of a holistic public wage law, compensation levels across different EUR11 million, or 1.6 percent of total wage spending. government functions were fragmented, inequitable, and even unpredictable. The Law on Civil Service, in force from 2010 to 2019, encompassed a fraction of public 104. The number of vacant positions in the public sector remains high, pose a source employment, excluding education, health, public order and the judiciary, and many other of uncertainty on public wage growth. In 2021, the number of budgeted positions stood at sectors. As a result, these categories of public employees were largely defined through 86 thousand, while actual public employment stood at 81.5 thousand (or 83 thousand when specific laws. Sectoral legislation – such as, for example, legislation on internal audit or the including part-time positions). This implies that close to 6 percent of budgeted positions judiciary - often defined rules targeting specific additional compensation levels. Therefore, are vacant, and that public employment can significantly increase in the future. The gap is while salary levels were overall defined through government decisions, specific categorical almost exclusively attributed to the central level, with most unfilled positions within the allowances outside the coverage of the Law on Civil Service proliferated. Finally, the absence justice and prosecution institutions, tertiary education and health institutions, and the of an overarching, all-encompassing public wage law, created another important gap: the Ministry of Defense. The 2023 budget incorporates an increase in the number of planned introduction of compensation benefits through collective contracts. employment positions from 86 thousand in the 2021 to 88 thousand in 2023. However, employment overbudgeting is a historical feature of the budgeting process in Kosovo. Apart 101. Collective contracts, based on unclear legal foundations, added to the from the historical trend, recent delays in filling up vacant positions are in part attributed fragmentation of the compensation system, and generated significant costs and to the pandemic and to difficulties of implementing the law on public officials adopted in contingent liabilities, especially at the local government level. Sectoral collective 2019. contracts, such as the education or health sector collective contracts, or the general collective contract signed in 2014 (in an electorally motivated context), introduced numerous 105. Together with the first law on public salaries, the Kosovo Assembly adopted in benefits for public sector employees, including the experience allowance (at 0.5 percent 2019 a law on public officials, which remained largely unimplemented. This legislation of base salary per year of experience), meal compensation, work anniversary bonuses, and was anticipated to pave the way for the full standardization and systematization of public retirement bonuses. The experience allowance was, in general, implemented across the employment. At the same, the legislation foresees the centralization and standardization government, effectively imposing a 0.5 percent minimum increase in wage spending. Yet, of public hiring through a digital platform under the management of the Ministry of Public given the grant-based financing of local governments, the introduction of other benefits Administration. However, several important provisions from this legislation were also – especially for meal compensation, anniversary bonuses, and retirement bonuses – was never fully institutionalized. As a result, local governments were exposed to litigation action causing an accumulation of contingent liabilities. In 2021 alone, after reporting of such costs was adequately classified in line with the General Auditors recommendations, 48 This estimate is based on identification of specific decisions and calculated from a sample of monthly payroll information 64 Fiscal Assessment Kosovo Public Expenditure Review 65 annulled by a Constitutional Court decision in 2019. As a result, the systematization of 109. The rise in net base salaries is likely to be softer in 2023 and 2024 than public sector positions was halted, and the Government decided to submit a new draft law anticipated, given the prudent decision on wage coefficients. With an assumed to the Assembly. distribution of public employment as per coefficients of the new law, net base salaries (net of contributions, taxes, allowances, and compensations) are projected to increase by roughly 6.6 percent in 2023 and 6.3 percent in 2024 (Table 1 in Annex III.1). The assumed I.6.2.  New law on public sector salaries employment distribution per coefficient is based on similar compensation levels before the approval of the law and incorporates net savings of approximately EUR15 million from 106. In December 2022, the Kosovo Assembly adopted a new law on public salaries. categories set to see a decline in their base salary. The latter includes primarily higher The approval of this legislation provides a unique opportunity to establish a long-term income earning categories of public employees. This same calculation constitutes the basis anchor for public wage management in light of the weaknesses of the compensation for the assumption on the transitional allowance described below. system in absence of such a holistic law on salaries. For more than a decade, Kosovo has been attempting a deep-rooted public administration reform, which would standardize and 110. While public discourse was primarily centered around the level of the unify public employment and compensation. The reform was also anchored in EU accession salary coefficient, the difference in aggregate spending on allowances will be a key support instruments. With preparations intensified in 2018, the Assembly adopted determinant for the prudent implementation of the new law. With almost 1/5 of wage Kosovo’s first law on public wages in 2019 that envisaged significant increases in wages spending attributed to allowances and compensation, the ability of the law to regulate and compensation. The original 2020 budget incorporated considerable contingencies for spending on allowances is critical for generating the necessary savings that are needed to its implementation. However, this legislation was annulled by the Constitutional Court, and accommodate the increases in base salaries, especially at the early stages of implementation. as a result public wages did not increase as anticipated. The significant contingencies for Against this background, the law introduces the following key changes: the implementation of this legislation, however, represented important fiscal buffers that enabled the Government’s rapid reaction to the Covid-19 pandemic. In the meantime, the • Experience allowance -- integrates the experience allowance previously stemming from development of a new public wage law was delayed by the pandemic and the political cycles the collective contract as part of the primary legislation; however, the law has halved until 2021. These delays prevented higher wage spending but resulted in increased public the amount of the allowance for the first 15 years of experience from 0.5 percent of the pressure driven by pent up expectations on what the new public wage law would deliver base salary per year to 0.25 percent per year. With an estimated average experience of in terms of wage increases. The approval of the new public wage law, therefore, followed 16.5 years in the public service, this translates into a reduction of this allowance from intensive public pressure, including from trade unions, for not only higher wages but also 8.25 percent of base salaries to 4.25 percent, hence generating savings despite the other types of compensation before the law’s enactment. Whilst the law on public wages increase in base salaries (Article 6). was enacted in December 2022, the government has set the value of the salary coefficient • Honorariums -- introduces a general cap of 20 percent of base salaries for honorariums for public sector wages coefficients in February 2023. for additional functions within the public sector (Article 8). 107. In parallel to the law on public salaries, the Assembly also enacted a new law • Transition allowance -- introduces a two-year transition allowance (first year at on public officials. The new law on public officials regulates the entire systematization of 100 percent, second year at 50 percent) for employees affected by a reduction in base job positions in the public sector, including their hierarchy and equivalence across different salary. The definition excludes the calculation of allowances as part of the eligibility sectors. The law also sets forth the centralized recruitment process, to be completed through for the transition allowance. (Article 41). a digital system. The new law also introduces mandates for all levels of management in • Cap on other categories -- in addition to the experience and transition allowance, the the public sector (an amendment which the EU has criticized). Keeping in mind the short law defines 10 categories of allowances public employees can benefit from (Article 22). period for these two laws to become operational, the simultaneous approval of these two For each of these categories, a specific cap is introduced with respect to base salaries, pieces of legislation comes with risks. The systematization of public employment should either at program level or individual level (Article 23-34). Details on the applied caps have preceded the preparation of the law on public salaries with a fully predictable cost. are presented in the annex to this document (Table 2 in Annex III.1.) Therefore, the law on public salaries has started being implemented with a provisional • Compensation -- regulates 10 categories of compensation and set caps for each systematization, which may change once the law on public officials is fully implemented, category based on base salaries (Article 35). which is expected to occur by the end of 2023. This adds a significant element of uncertainty • Meals -- meal compensation is eliminated from the list of available compensations. and hampers budget credibility. 111. Baseline projections suggest that the Government can accommodate spending 108. In contrast to the 2019 public salaries law, the new law stipulates that public on allowances and compensation in line with the new law and comply with the fiscal salary coefficients are determined through the annual budgeting process. Considering rule on public wages. In view of the two-year lag reference of the fiscal rule on public the uncertainty stemming from the absence of a completed systematization of public wages, the relevant cap for public wage growth in 2023 is nominal GDP growth in 2021 (i.e., employment, this is a positive feature of the new law. It ensures the necessary flexibility to 17.5 percent); for 2024, the reference cap is the nominal growth of GDP in 2022, estimated at manage the total wage bill in line with the legal limits imposed by the fiscal rule on public close to 10 percent. The Government can, therefore, spend up to EUR52 million in 2023 and wage growth. However, the lack of a defined coefficient in primary legislation, means that about EUR90 million in 2024 for allowances and compensation, excluding the experience the budget impact assessment of the law on salaries provides little assurances on the final allowance and the transitory allowance. Legal restrictions imposed on every category of cost of the legislation. In February 2023, the Government approved a decision to set the allowances with the new law should ensure that the associated spending is likely to result level of the public wage coefficient at EUR105 in 2023 and EUR110 in 2024. During the at lower levels. That all said, the working assumptions of constant employment and stable same month, the Parliament adopted an amendment to the budget of 2023 to enact the new spending on court-ordered damages are an important caveat. Baseline projections seem to coefficient for 2023. suggest that if the Government is to use fully the budget space provided by the fiscal rule, then it could exceed budgeted amounts by over EUR60 million in 2024. Assuming a salary 66 Fiscal Assessment Kosovo Public Expenditure Review 67 Spotlight: coefficient of EUR115, the Government is likely to continue maintaining compliance in 2025 as well. 112. Under some downside scenario conditions, the wage bill rule could be violated Energy in 2025, particularly if public employment increases rapidly. If the Government fills budgeted vacant positions by 2025, and introduces health insurance premia in 2025, the wage bill rule could not be upheld. Under this scenario, the Government reaches its 2023 budgeted level of employment of 88,000 employees by 2025. In addition, the Government starts to collect health insurance premia in 2025 and adjusts wages to cover both employer and employee contributions at 7 percent of gross wages. Under this scenario, nominal GDP growth in 2023 (as a reference to 2025 wage growth cap) drops by 2.3 percentage points following a further easing of inflation pressures. With these assumptions, the Government would need to cover a gap of EUR83 and EUR194 million in 2024 and 2025, respectively, in comparison to 2023 budget projections. At the same time, this would exceed the wage-rule consistent allocation for 2025 by EUR55 million. I.6.3.  Policy Recommendations 113. Complete systematization of public employment. The backbone of a more credible assessment of the cost of implementation of the new law on wages is the adequate systematization of public employment in line with the new legislation on public officials. The distribution of public employment in line with the new wage law coefficients can only be realistic after the systematization process is finalized. It is also crucial to ensure that I.7.  Spotlight: Energy grade inflation is avoided to ensure costs are contained. I.7.1.  Energy sector challenges 114. Carefully balance between employment growth, changes in the value of the coefficient, and the rollout of allowances and compensation. Notwithstanding the 119. Kosovo’s energy sector is under significant pressure due to limited and limitations of the assessment, a key message from the scenario analysis above is that the unreliable generation capacity against increasing demand. Despite recent efforts Government will need to carefully balance between employment growth, changes in the to scale-up energy investments in renewable energy sources (RES), the sector continues value of the coefficient, and the rollout of allowances and compensation envisaged by the to rely predominantly on inefficient and highly polluting fossil-fuel energy generation.49 law. Effective management of public hiring and realistic budgeting of employment positions This long-standing structural deficiency has been further aggravated in the current at the central level is crucial to enhance safeguards for a prudent implementation of the energy crisis landscape. Managing growing demand needs with imports has turned into new public wage law. an acute short-and medium-term challenge, considering the elevated international energy prices due to Russia’s invasion of Ukraine. In 2021 and 2022, net imports represented 13 115. Conduct detailed assessment of contingent liabilities stemming from past percent of consumption needs. Under relatively stable import prices, as until 2020, net collective contracts. The Government should conduct a detailed assessment of contingent imports remained manageable, as only one-third of households use electricity for heating.50 liabilities stemming from past collective contracts and provision adequately to address Yet, import demand spikes particularly during the winter heating season, when import possible costs that could materialize. A credible projection of payments on court-ordered prices are the highest. Import electricity prices in relevant reference markets over 2022 damages would be prudent to ensure adequate planning of wage spending and safeguard remained significantly higher than domestic production prices and regulated tariffs for the maintenance of the wage rule. final consumers. After averaging at EUR 113/MWh in 2021, import prices peaked in August 2022 at EUR495/MWh, as a direct consequence of the energy crisis triggered by the war 116. Integrate allowances and compensation in Government chart of accounts. The in Ukraine, and have averaged EUR322/MWh during the second half of 2022.51 Hence, the standardized categories of allowances and compensations foreseen with the law should challenge is that Kosovo’s import needs occur when prices are high, and its energy exports be integrated in the Government chart of accounts to establish a direct link between the take place when prices are low. The price differential between domestically produced and payroll system, the Kosovo financial management information system (KFMIS), and the imported energy is high, and at times of overlapping external shocks – such as the one budget development system (BDMS). Caps on allowances should be digitally integrated in triggered by the war in Ukraine – it becomes a source of both macroeconomic and fiscal risk. the payroll system and BDMS to build safeguards on the implementation of allowances, while the caps on spending for compensation should be digitally monitored. 117. Undertake audit of records on work experience. The Government should conduct an internal audit of records on experience to ensure credible implementation of the experience allowance. 118. Carefully plan introduction of health insurance premiums, if applicable. Plans to introduce the collection of health insurance premium collections should be also carefully 49  See Annex for more details thought through in the context of public wage spending management. 50  We’ll ask Rhedon for the reference 51  https://hupx.hu/en/market-data/dam/historical-data 68 Fiscal Assessment Kosovo Public Expenditure Review 69 120. The recently approved Energy Strategy for 2022-2031 foresees a significant amounting to EUR57.5 million for these costs. As a result, over 2021 and 2022, the direct scale-up in energy investments and exposes the budget to a combination of new payments and implicit transfers (due to dividend cancelation) from the Government to contingent liabilities, on-lending, and higher direct budget spending needs. The KOSTT for 2021-2022 totaled EUR85.1 million (1.1 percent of GDP). strategy foresees that by 2031 (i) 35 percent of total electricity consumption will be covered by RES, with total installed RES capacity reaching 1600 MW; (ii) a reduction of GHG 125. In 2022, subsidies to support energy efficiency were introduced as part of the emissions in the power sector by 32 percent (iii) improving energy efficiency and achieving crisis response measures. In 2022, the government introduced two emergency related a reduction in final energy consumption and (iv) advancing regional market integration. The efficiency programs to incentivize energy savings and reduce energy demand. First, a strategy, furthermore, aims at supporting energy affordability for vulnerable consumers, EUR9 million subsidy program was implemented to support energy efficiency through with a target of revising the price support scheme for vulnerable consumers by 2024, and replacement and purchase of new efficient biomass boilers, heat pumps, and individual introducing at least two new energy-related schemes for vulnerable consumers. stoves. The second measure for energy efficiency targets households and firms’ energy bill costs compared to 2021 consumption levels: if consumers save 10 percent compared to 121. The implementation of the Energy Strategy will require substantial financing. the same month of the previous year, they are subsidized at 20 percent of their bill. Based The Strategy’s estimated cost of the energy transition plan is almost EUR4 billion on 2021 collection and assuming energy efficiency incentives lead to a reduction of 5-10 (41.5 percent in projected 2023 GDP). According to the draft Action Plan of the Energy percent of electricity, the cost of the program for the Government could range between Strategy, the budget required to implement the Energy Strategy over a three-year period EUR18-37 million. is EUR742 million (7.7 percent of projected 2023 GDP). Under the Draft Action Plan, the cost would be covered by a mix of public and private resources. The costs of the strategy 126. In addition to direct transfers, implicit subsidies were provided through the remain to be adequately incorporated under the Government’s Medium Term Expenditure tariff structure during 2022. In February 2022, the Government of Kosovo revised the Framework. A number of donor- and IFI-supported projects have already been defined that structure of the electricity tariff for households introducing a new block-tariff scheme. are part of the strategy. Under the new scheme users consuming over 800 KW of energy per month pay more for their electricity consumption, whereas tariffs for users consuming less than 800 KW remain unchanged. The new tariff structure affected approximately 22 percent of users, while I.7.2.  Energy subsidies in times of an energy crisis electricity prices for the remaining 78 percent of households will remain unchanged.52 Poverty analysis shows that the current tariff structure is regressive, with households at the 122. Electricity imports subsidies increased to prevent the spillover of soaring bottom of the welfare distribution spending disproportionally more for energy expenditures. import prices on tariffs. In February 2022, the Energy Regulator increased tariffs for Affordability of electricity is considered a critical issue when spending on energy surpasses households consuming monthly more than 800 Kwh. Tariffs for commercial users remained a certain threshold. When households spend more than 10 percent of their overall budget unchanged. Until 2022, most of the import price increases have not been passed on through on electricity (or energy), they are considered ‘electricity poor’ or ‘energy poor’. In Kosovo, tariffs. At an average of EUR66/MWh, current electricity tariffs for households and firms approximately 16 percent of households are estimated to be ‘electricity poor’ using this were among the lowest in the Western Balkan region and are not at cost-recovery levels definition.53 (Figure 49). In March 2023, the Energy Regulator increased uniformly electricity tariffs by 15 percent, bringing the cost closer to recovery levels. 127. Contingency funds in the 2023 budget total EUR197 million (2.1  percent of projected 2023 GDP)). They consist of an explicit energy contingency of EUR75 million 123. To reduce the impact of soaring import prices, the government raised subsidies (0.8  percent of projected 2023 GDP) and an additional contingency of EUR37.4 million to cover the price differential. In 2022, the rapid increase in electricity prices and demand under subsidies and transfers as part of a EUR122 million (1.3 percent of projected 2023 for electricity led to a significant increase in import costs (Figure 50), amounting to EUR218 GDP) unspecified contingency under the Ministry of Finance, Labor, and Transfers. Given million by December 2022. In 2022, the value of electricity imports was equivalent to 2.7 that international energy prices in reference markets have eased from their August 2022 percent of GDP, or 3.9 of total imports (an increase of 1.4pp compared to 2021). In 2021, peak but remain elevated (averaging at EUR 152/MWh for January and February 2023), the Government provided import subsidies of EUR20 million (0.3 percent of GDP) to cover this flexibility is necessary to preserve fiscal space in case of further external shocks. Import the cost of electricity imports through the Kosovo Energy Corporation (KEK). In 2022, the levels in 2021 and 2022 averaged above 3000 GWh, with almost one-third of this energy authorities spent three times as much (EUR74 million) to subsidize the price of electricity imported during the first quarter of the year. Notwithstanding the oversimplification related and reduce the impact of rising import prices on tariffs. With prices expected to remain to seasonal price adjustments, with a budget of EUR75 million, the Government can provide above historical averages, and imports hovering at above 3,000 GWh over the last two years, an average annual subsidy of approximately EUR 25/MWh, which is broadly in line with last the pressure on Kosovo’s import bill will likely stay elevated. At end 2022, the Government year’s level. However, an increase in average import prices or energy demand compared to allocated an additional EUR20 million to KEK with the aim of subsidizing energy imports last year would likely necessitate higher allocations assuming no changes to tariffs. This into 2023, bringing the total amount of transfers to EUR94 million for 2022, hence totaling once again underscores the need for measures to focus on energy efficiency and to allow altogether EUR114 million for the period 2021-2022 (or 1.4 percent in 2021 GDP). for tariff gradual adjustments for import prices. The March 2023 traiff increase significantly mitigates fiscal risks related to volatile import prices. 124. As import prices and demand increased, the cost of covering unbilled energy in Kosovo’s northern municipalities skyrocketed. Between 2010 and 2020 the total cost of 128. Before the onset of the energy crisis, fiscal support for the energy sector was electricity consumed in the four northern municipalities averaged EUR8.5 million annually on a declining trend, and consisted of direct lending, interest payment write-offs, and has significantly increased during 2021 and 2022. In 2021, the total cost amounted and government on-lending for transmission investment. The financial support was to EUR41.8 million, of which EUR7.6 million were covered from public transfers and the remaining from KOSTT’s budget (ERO, 2021). In the same year, the Government transferred EUR20 million as an in-year cancelation of a EUR20 million dividend to the Government declared by KOSTT. In 2022, the Government provided KOSTT with two rounds of transfers 52  https://www.kesco-energy.com/eng/news/explanations-about-the-new-approved-tariffs-b-236/ 53  World Bank estimates based on 2017 Household Budget Survey 70 Fiscal Assessment Kosovo Public Expenditure Review 71 primarily represented by direct Government loans to KEK from 2005 to 2012 totaling EUR202 million, a related interest-payment write-off in 2015, and significant on-lending Fig 50. Total amount of direct Fig 51. Total amount of direct from IFIs for transmission investments. Furthermore, a total of EUR47 million was spent on subsidies provided to coal/ subsidies by cathegory in the energy subsidies from 2016 to 2020, with subsidies dropping from EUR15 million (due to lignite electricty producers (in period 2018-2019 (In EUR interest write-off) to EUR5.6 million a year for the same period. Hence, Kosovo spent more EUR mln) mln) on direct subsidies than Bosnia and Herzegovina, North Macedonia, and Montenegro, in GDP terms. Between 2018 and 2019, Kosovo spent EUR12.7 million, or 0.2 percent of 2019 GDP in direct subsidies to electricity producers. This compares to EUR 42.9 million (or 0.12 percent of 2019 GDP) in Bosnia and Herzegovina, 0.02 percent of GDP in Montenegro, and 0.55 percent in North Macedonia (Figures 51 and 52). The largest component of subsidies is represented by direct budget transfers but can also take the form of deferred or reduced budget revenues or write-offs of arrears to the budget. More specifically, in the case of Kosovo, the Energy Community calculates the implicit subsidy resulting primarily from a non-market-based interest rate on KEK loans as a subsidy as well as the 2015 interest rate write-off. When looking at subsidies provided to SOEs for investment needs, Kosovo spent less than regional peers. Fig 48. Electricity prices in 2022 (first Fig 49. Value of electricty imports, semester) Euro per Kwh 2021-2022 Source: Source: Energy Community 2020 Energy Community 2020 I.7.3.  Electricity subsidies to the most vulnerable are limited 129. Support for the poor and vulnerable through energy subsidies remains limited. At EUR4.4 million in 2022 (0.1 percent of GDP), direct energy subsidies for consumers are delivered to beneficiaries of the social assistance scheme (SAS) and selected pension programs. Between 2017 and 2022, subsidies provided directly to consumers averaged EUR4.5 million, representing 0.5 percent of overall spending on subsidies and transfers in 2021, and is budgeted to remain constant until 2024. The scope of support for energy consumption has been driven primarily by fiscal consideration rather than actual needs, as reflected by the fact that budget allocations for this scheme have remain unchanged irrespective of the evolution of number of beneficiaries, poverty rates and energy needs. Moreover, as observed during the energy crisis, given the subsidy is provided as a “top- Source: Source: Eurostat Customs and Central Bank up” to SAS beneficiaries the design of the system does not offer the flexibility to expand of Kosovo benefits to other households. During the crisis, subsidies delivered through the SAS scheme to protect consumers from raising prices have remained stable. 130. The direct subsidy scheme for consumers benefiting from SAS provides beneficiaries with an explicit subsidy averaging EUR123.8 per household. As shown in Table 3, the direct subsidy scheme is extended to three types of beneficiaries: SAS beneficiary households (covering 59.6 percent of the subsidy budget), recipients of four war-related 72 Fiscal Assessment Kosovo Public Expenditure Review 73 benefits/pensions (28.4 percent) and people with selected disabilities (9.8  percent).54 I.7.4.  The new Energy Strategy The number of direct beneficiaries (families) of the electricity subsidy decreased by approximately 37 percent between 2017 (35,102 families) and 2022 (21,897 families). A sizable investment push requires a detailed financing plan The existing electricity subsidy scheme is not sufficient to protect electricity vulnerable 131. The ambitious new Energy Strategy will have a high investment cost with households. Simulations confirm key limitations of the scheme’s ability to protect the most strong implications for the fiscal framework in the decades ahead. The strategy targets vulnerable given its low coverage, poor targeting, and inadequate generosity. According a complete phasing out of coal by 2050. To achieve this, it foresees a complete transition from to simulation using the 2017 Household Budget Survey (HBS), less than a quarter of the coal to renewables, including in the mix a strong energy efficiency and sustainable heating households in the poorest quintile receive the electricity subsidy (Figures 53 and 54). 55 component to manage demand growth. In the meantime, it envisages the refurbishment Table 3. Direct electricity subsidy for SAS beneficiaries, 2022 of the Kosovo B and some of the Kosovo A capacities, with the latter envisaged to shift in use only as strategic reserve from 2028. The strategy defines 2025 and 2031 as an interim milestone, and the following targets are of particular importance from a fiscal perspective: Direct beneficiaries Average size of subsidy Yearly fiscal cost (families) per family • Refurbish Kosovo B1 and one unit of Kosovo A by 2025 and Kosovo B2 by 2026, and close one of the three Kosovo A unit (with the option of closing 2) once all other units Yearly Monthly are refurbished. Total Share (%) EUR Share (%) (Euro) (Euro) •  Increase RES capacity, including prosumers, from 290 MW to 490 MW in 2025 and 1600 MW by 2031 (with minimum 100 MW from prosumers). SAS Recipients 21,897 61.6 2,710,982 59.6 123.8 10.31 • Increase network capacity to handle variable RES generation from 147 MW in 2021 to War-related pensioners 9,984 28.1 1,293,595 28.4 129.6 10.79 500 MW in 2024 and 2000 MW by 2031. • Install 170 MW of battery storage capacity by 2031. Benefits for disability 3,614 10.1 449,118 9.8 124.5 10.37 • Increase RES capacity in district heating to from 15 MWth to at least 65 MWth by 2025 Total 35,495 100 4,453,695 100 125.9 10.4 • By 2031, generate close to 16 percent consumption savings compared to the baseline consumption scenario. Source: Authorities administrative data for 2022 • Double by 2031 the cogeneration capacity of Termokos (Prishtina District Heating), from 140 MWth in 2021. • Establish a vulnerable consumers program by 2024. Fig 52. Total amount of direct Fig 53. Total amount of direct • Complete preparations of carbon pricing system by 2025 and integrate with EU ETS subsidies provided to coal/ subsidies by cathegory in the by 2031. lignite electricty producers (in period 2018-2019 (In EUR EUR mln) mln) 132. The Government estimates the costs of the new energy strategy by 2031 between EUR2.8 and 4 billion. However, the strategy does not provide a detailed investment plan for the strategy, particularly with estimates between public and private investment. Moreover, the strategy is not accompanied by a financing plan for public sector investments. At the same time, no discussion is provided on the likely impact of investments on future electricity tariffs. 133. For the planned refurbishment of existing coal generation capacities in line with higher environmental standards, the energy strategy estimates public investment of EUR390 million (4  percent of projected 2023 GDP). Together with planned EU grant financing for the installation of particle filters, planned at EUR70 million, the total estimated investment stands at EUR460 million (4.7 percent of GDP in projected 2023). The average estimated implicit refurbishment cost for the four units (2 Kosovo B units and 2 Kosovo A units) stands at around 0.5 million/MW, based on present available capacity of these units. The strategy does not specify what form of public investment is envisaged: a direct government subsidy or on-lending to KEK. Two Kosovo B units and one Kosovo A unit are planned to be refurbished by 2026 (83% of capacity), hence creating a financing need for EUR 323 million, and an investment of close to EUR 400 million Source: Source: (4.2 percent of projected 2023 GDP) together with Kosovo B filters. If refurbishment and Energy Community 2020 Energy Community 2020 installation of filters is completed between 2024 and 2026, this translates into a direct average cost of EUR 133 million/year for this period (i.e., between 1.1 and 1.3 percent of projected GDP). KEK property, plant, and equipment (PPE) investment stood at 36.9 million and 32.5 million in 2020 and 2021, respectively. KEK’s free cash from operations (FCO) in 2021 stood at EUR 110.7 million in 2021 and is likely to have increased in 2022. Even if FCO 54  Specifically, paraplegic and tetraplegic and blind persons. 55  World Bank, Policy Note 2019. Latest available HBS data is for 2017. 74 Fiscal Assessment Kosovo Public Expenditure Review 75 increases on average by 50 percent by 2024, it is unlikely to be able to absorb a full increase I.7.5.  Policy recommendations of 108 million/per year in investment (excluding EU grant financing). As such, from a fiscal risk perspective, a scenario where half of the investment cost (EUR 160 million) is covered 137. Kosovo’s long-term fiscal sustainability and growth depend on securing an by the Government through direct subsidies, sovereign guarantees, or on-lending cannot be affordable, reliable, and sustainable energy system. The uncertainty associated with precluded. This analysis excludes any risks of cost overruns. the energy outlook in the short and medium term, two main objectives stand out. First, the Government needs to balance the energy policy mix with the objective of prioritizing 134. It is unclear whether the energy strategy entails the cost of additional energy security, diversifying away from lignite and supporting the poor and most vulnerable. imports required to meet consumption needs whilst KEK powerplants are under Second, adequate financial planning for the implementation of the Energy strategy for 2022- refurbishment. If one unit of Kosovo B is refurbished per year, and the Kosovo A unit 2031 is key to ensure fiscal sustainability. More specifically, the Government may want to is refurbished in the last year, it implies that it will create a gap in supply equivalent to think about the following: equivalent to their available capacity. With 6067 GWh supplied from KEK to the transmission network in 2021, one Kosovo B unit provided on average 28 percent of the supply, and one 138. Developing a financing plan for the Energy Strategy (2022-2031) would Kosovo A unit 14.5 percent of the supply. Hence, assuming 2021 production levels, and an help in the planning process. Kosovo’s Energy Strategy expects the energy sector to estimate of average import prices at EUR 75/ MWh, shutting down one Kosovo B unit for be a key driver of economic growth and employment opportunities. Although private one year (a conservative assumption) could cost EUR127 million, while shutting down one sector activity is envisioned, the extent of its participation remains highly uncertain. The Kosovo A unit would cost - under the same assumptions – EUR 66 million. A refurbishment Government needs a detailed financing plan for its strategy. The plan should clearly reflect within three years by 2026 entails possible additional costs of EUR 320 million on imports information on expected sources of financing, and a breakdown of anticipated private and (or 3.3 percent of projected 2023 GDP), which are also likely to burden the budget either public investments. In cases where private investment is expected to be the main source of as a direct transfer cost or other financing operation (on-lending or guarantee). Even with financing, the financing plan needs to reflect potential offtake guarantees that could be a an assumption of EUR 50/MWh on import prices, or shorter refurbishment times, this cost source of fiscal risks. component would remain significant, at a cumulative of EUR 214.6 million within 2023- 2026. 139. Once the energy sector stabilizes, the Government may want to ensure that tariffs are reflective of costs. For the purpose of addressing the energy crisis, the revision 135. The strategy estimates the investment cost for installing the targeted additional of the tariff structure for households introduced in February 2022 can be used as a tool 1,321 MW of RES capacity at EUR1.3 billion (13.5 percent of projected 2023 GDP). The to incentivize energy efficiency and pass on the cost of energy to users consuming above strategy does not explicitly define the planned shares between wind, solar, and other RES 800kWh a month. However, as the energy sector normalizes the Government should investments. As it stands, the implicit build cost per MW of installed RES is estimated at just consider stabilizing the tariff system, allowing a pass-through of prices to tariffs to ensure below EUR1 million per MW. The strategy targets, as an intermediate result, the increase of these reflect actual market costs and incentivize demand adjustments. Ensuring that RES capacity of 210 MW by 2025, followed by another 1,111 MW between 2026 and 2031. tariffs reflect costs is critical for encouraging private sector investment. At the same time, The Government’s EERP Project, supported by the World Bank, estimated the technical transparent, fully budgeted, and timebound support should be provided to vulnerable and potential for solar energy at 3,600 MW and for wind at 1,200 MW;56 hence the targets can low-income households. be considered realistic from a technical capacity perspective. The costs are broadly in line with EERP simulation inputs (1.2 million/MW for solar and 0.8 million/MW for small scale 140. To attract the private sector, strengthening market-based mechanisms to PV). However, the dynamics of investment planning seem overly ambitious, averaging 70 support RES could be considered. The Government has planned a significant role for the MW per year until 2025, and 185 MW/year between 2026 and 2031. private sector in the implementation of the energy strategy and the development of the energy sector. For this reason it will be crucial that investors benefit from a predictable, 136. Given the Government’s commitment to introduce competitive support fair market environment as well as well-structured market-based mechanisms in support mechanisms for RES, most of the build cost is expected to be borne by the private of RES investments. This will be critical to attract much needed private resources for the sector. Yet, the strategy also envisages public investment in RES, likely at the early stages sector and guaranteeing a predictable and fair market environment. of the strategy as the RES auctions market develops. If the Government finances half of the investment by 2025 (110 MW), and only 1/5 of the planned investment by 2031, most likely 141. Ensure on-lending to POEs is carried out in line with the new Law on Public through on-lending, the total cost to the government in terms of financing is estimated at Debt Management and with sound debt sustainability considerations: in line with the around EUR110 million by 2024, and another EUR220 by 2031.The Government is already provision of the new Law on Public Debt, the Government can only on-lend (as opposed discussing with the EU and KfW a 100 MW solar project to be developed by KEK, likely with to direct lending) to POEs. That means that the Government cannot determine the rate a significant grant component. However, if private investment is mobilized through implicitly through which POEs obtain loans. In this context, the Government can either issue bonds guaranteed PPAs, this could have spillovers to the Government balance sheet as PPAs where the specific on-lending objective is transparently disclosed, or the Government can represent contingent liabilities for the budget. Adequate capacity needs to be built within carry out the same procedure through lending from financial institutions. the Government to manage and properly provision for such contingent liabilities. Given that 142. Build capacity to manage and transparently disclose energy related contingent the RES auction design is still not defined, another important element is the cost of land liabilities. Given the expected increase in PPA usage to mobilize private sector investment, for implementing RES projects; and whether the land offered will be public or private. For ensure safeguards are in place to manage related fiscal risks. example, for small scale PVs, assuming 2 ha/MW as a technical requirement, a total of 1,300 ha would be needed to install 650 MW of solar capacity (half of the 2031 RES target). 56 Energy Efficiency and Renewable Energy Project: Support for Grid Integrated Renewable Energy Generation (WB7035-06/19) Least cost RE mix - Final Report 76 Fiscal Assessment Kosovo Public Expenditure Review 77 Spotlight: Alternative 144. Public debt risk indicators improved since 2014 (Table 4). Both refinancing (or rollover) and interest rate (or re-fixing) risk improved over the past nine years. Specifically, public debt average time to maturity was prolonged from 3.5 to 5.5 years, while public debt maturing within a year has declined from 5.5 percent to 3.6 percent of GDP in 2021. Meanwhile, fixed- rate public debt has increased from 87 percent to 95 percent, with debt re-fixing in one year scenario more than halving from 47 percent to 21 percent. The latter also implies that not only has the share of fixed debt increased, but the share of short-term domestic debt has declined since 2014 to the extent that 3-, 6- and 12-month government securities were not issued in 2020 and 2022, and a very small amount was issued in 2021. Finally, the exchange rate risk has further declined since 2014, and is minimal with 97 percent of the public debt issued in euros, the domestic currency. Table 4. Public debt risk indicators Indicator 2014 2018 2021 2022 2025 External public debt (Euro, mil) 326 416 577 641 1473 Domestic public debt (Euro, 257 677 1106 1112 1616 mil) Debt level State guarantees (Euro, mil) 10 44 31 30 27 Total public and publicly 593 1137 1714 1783 3116 guaranteed debt (Euro, mil) Total public and publicly 11 17 21 21 29 guaranteed debt (% GDP) Debt cost Weighted Average interest rate 2.1 2.1 2.0 2.2 Total public debt interest 0.2 0.3 0.4 0.5 0.5 payment, % GDP Public debt maturing within 1 39 27 16 20 - year (% of total debt) I.8.  Spotlight: Alternative public debt scenario Refinancing Public debt maturing within 1 5.5 4.3 3.6 - - 143. Notwithstanding the doubling of the level of public debt since 2014, in GDP risk year (% GDP) terms, the cost of debt remains low (Table 3). Total public and publicly guaranteed Average Time to Maturity debt tripled to EUR1.7 billion, and roughly doubled in GDP terms, from 11 percent of GDP 3.5 3.4 5.7 5.5 - (ATM) in 2014 (the time of the last PER) to 21 percent of GDP in 2022. The cost of debt rose in tandem with the level of debt, from 0.2 to 0.5 percent of GDP. This low level of interest Public debt with fixed interest 87 85 95 95 91.3 payments is explained by the large share of below-market financing received from IDA, rate (% of total) which accounts for 34 percent of total outstanding external public debt. Interest payments Interest Public debt with variable are also dampened by financing from IBRD and the IMF that account for an additional 13 15 5 5 8.7 rate risk interest rate (% of total) one-fourth of the outstanding external debt stock. In contrast, commercial banks such as UniCredit and RBI Austria, with associated commercial lending rates, have a share of less Debt refixing in 1 year (% of 47 39 21 - than 5 percent of total outstanding external debt stock. Domestic borrowing, meanwhile, total) gained in prominence since 2014, increasing from EUR257 million in 2014 to EUR1.1 Exchange Public debt in foreign currency billion in 2022. In 2022, the revenue windfall was used to reduce issuance of domestic debt, 13 13 5 3 0 rate risk (% of total) hence bringing down public debt relative to GDP. The high liquidity of the domestic market ensured an implicit interest rate of about 2.2 percent in 2022,57 helping keep the cost of debt Public debt in local currency 87 87 95 97 100 low. Lastly, state guarantees have continuously declined since 2018, reaching 0.3 percent of (i.e. Euro) GDP in 2022. Source: State Debt Program 2017-2019, 2019-2021, 2020-2022, 2021-2023, 2022-2024, 2023-2025, Annual data on total debt, Jan-Dec 2022 (January 2023) Note: 2022 to 2025 represent Government projections under their baseline 57  Calculated as interest payments in 2022 divided by domestic debt stock at end-2021. 78 Fiscal Assessment Kosovo Public Expenditure Review 79 145. To assess the impact of the latest policy developments, one needs to re- 146. The PER baseline includes estimates of the impact of the new law on public evaluate the public and publicly guaranteed (PPG) debt projection from the State salaries and new coefficients, and results in a flat public debt trajectory at around Debt Program and Economic Reform Program 2023-25 (Figures 55 and 56). Two 20 percent of GDP (Figure 45). The baseline projected for the next five years assumes a countervailing forces are at play and argue in favor of a re-evaluation of the PPG debt path nominal increase in government compensation of employees in 2023 of about 17 percent depicted in green in Figures 43 and 44. First, both figures demonstrate the inherent bias in compared to 2022, but its impact is softened by the strong growth in nominal GDP. Put planned budgets that overestimate capital expenditures, which in turn results in spending differently, the rise in the wage bill is expected to contribute to a widening fiscal deficit under-executions and, thus, in less pronounced increases in public debt trajectories.58 In to 1.4 percent of GDP in 2023, which is almost one percentage point higher than the year other words, the public debt projections for 2021 and 2022 have consistently exceeded before. the actual outcomes, which is shown by the difference between the black line and the red and blue lines (Figures 43 and 44). Second, possible higher spending in social protection 147. The debt sustainability simulation presented below is grounded in a realistic and health as well as a surge in capital expenditures based on the energy strategy have not set of assumptions that encompasses three key policy scenarios that have not been been included in the Government baseline at the time of the PPG projection. In sum, both included in the Government’s Medium Term Fiscal Framework (MTEF) 2023 – 2025. forces work in opposite directions: the first exerts downward pressure, whereas the second Specifically, the alternative scenario assumes the simultaneous materialization of three key applies upward pressure on the PPG debt path. policy changes compared to the baseline: (i) the timely implementation of the new energy strategy without accommodating its cost through savings; (ii) the relaxation of eligibility criteria for higher-paying pensions (based on the ruling of the Constitutional Court) and indexation of pension benefits to inflation; and (iii) decision to increase health spending Fig 54. Public debt projections 2018 Fig 55. Public debt projections 2017 levels relative to GDP in line with the regional average by 2030 (without corresponding to 2025, various state debt to 2025, various ERPs changes in taxation that would elevate government revenues). Assumptions for each of the programs three policy changes are described in more detail below and in the Annex. • Implementation of the new energy strategy: the implementation cost of the new strategy by 2030 is estimated at roughly EUR3.2 billion, or 34 percent of 2023 GDP. It is assumed that about half of the cost will spillover to public and publicly guaranteed debt, either as direct budget expenditures (6 percent of 2023 GDP), or as on-lending and state guarantees (9 percent of 2023 GDP). The remainder of the investment totaling roughly 19 percent of 2023 GDP is in this scenario expected to be covered through either donor grants or private capital without government guarantees. The latter would be channeled mostly toward new renewable energy capacities and the electricity distribution network upgrade. The implementation of the strategy could add to the financing need an average of 2.8  percent of GDP from 2024 to 2026, and an average of 1.2 percent  of GDP from 2027 to 2030. The cost during the first stage of implementation is primarily generated by the planned refurbishing of the existing electricity generation capacities by 2026. Key cost drivers related to the implementation of the strategy include on-lending to the public energy producer to support refurbishment of existing capacities, electricity import subsidies to substitute supply while existing powerplants are under refurbishment, transmission network upgrade investments, transfers as well as public investment to achieve new energy efficiency targets, and transfers to implement a new program on energy vulnerable consumers. • Higher pension costs: at end-2022, the Kosovo Constitutional Court (CC) issued a ruling that is likely to have an impact on the number of retirees in Kosovo that will receive the higher paying pension of average EUR210, rather than the universal Source: Source: pension of EUR 100 that every Kosovo citizen above 65 is entitled to. The total number State debt program ERP 2019-21, 2020-22, of retirees in Kosovo is projected to increase from just below 200 thousand in 2023 2017-19, 2019-21, 2020- 2021-24, 2022-25 to 240 thousand in 2030. Compared to the baseline, the alternative scenario assumes 22, 2021-23, 2022-24, that 30-40 percent of retirees59 will shift to the higher paying ex-contributory pension 2023-25 from the universal pension, because of the ruling. Such a transition would result in additional spending on pensions averaging 0.7  percent of GDP between 2023 and 2030. This is a conservative estimate that does not account for further reform, i.e. differentiating payment by year of contribution. In addition, the indexation of pension 59 This amount is based on the idea that employment in Yugoslavia was around 30-40 percent of the total working age. Therefore, if the eligibility criterion is altogether removed an estimated 50-60 percent would 58  The exception here is the pandemic year (2020) receive the universal pension. 80 Fiscal Assessment Kosovo Public Expenditure Review 81 benefits to CPI would produce an additional cost of 0.3 percent of GDP on average for 2023-2030. Therefore, the alternative scenario assumes higher pension spending on Fig 56. Public and publicly guaranteed Fig 57. Fiscal deficit projections, the order of 1 percent of GDP, on average, for the period 2023 to 2030. debt, baseline and alternative baseline and alternative • Increased health spending: In 2022, Kosovo’s public spending on health is estimated scenario (% GDP) scenario (% GDP) at 2.7 percent of GDP. Structural and aspirational peers spent on average 4.5 percent of GDP on health. The assumption here is that the Government decides to gradually increase spending levels of health that would allow for a convergence to comparator averages by 2026. Without any revenue-side measures, this translates into an additional financing need of 1.4 percent of GDP, on average, from 2023 to 2030. 148. The alternative, downside scenario places PPG debt on a sharp upward trajectory that pushes the level of PPG debt to above 35 percent of GDP within the next five years (Figure 57). There are two elements to the precipitous rise in PPG debt: first, higher government spending on energy infrastructure, pensions, and health (Table 5) more than triples the fiscal deficit from 2025 to 2028 (Figure 58); and second, contingent liabilities in the shape of on-lending and state guarantees add below the line between 0.7 and 1.7  percent of GDP per annum to the PPG debt levels. The downside scenario is somewhat simplistic in nature yet is realistic enough to provide food for thought and action. Conceptually, a number of events can either dampen or elevate further the debt trajectory over the projection period. In other words, the downside scenario is static rather than dynamic. For example, the energy investment push can result in real GDP growth rates exceeding the currently assumed average of 4.5 percent during the period 2024 to 2028, if there is no acceleration in imports, which would cause a full or partial trade-off. Experience has shown that there is often an upward bias when estimating spillover effect from higher Source: Source: WB staff projections WB staff projections investment on real output growth. For this reason, LIC DSAs, for example, have a separate realism check for the relationship between investment and growth. An event that could dampen the debt trajectory is a slower increase in health spending from the additionally assumed 1.2 percent from 2023 to 2025 and 1.5 percent of GDP from 2026 to 2028 per annum, or higher tariffs for energy or other sources of additional taxes be it general or for Table 5. Additional government spending simulated in the downside the health sector as this would provide budget financing and reduce the need for debt- scenario (in EUR million unless otherwise indicated) financing. Events that could elevate further the trajectory include, to mention just a few, an increase in public employment through filling of unstaffed positions, a larger share of 2023 2024 2025 2026 2027 2028 2029 2030 public uptake in energy investment which is debt financed, additional contingent liabilities 1. Additional pension materializing through Public-Private Partnership (PPP) arrangements, or simply an inflation 54.2 79.7 104.7 128.8 140.8 154.2 168.6 183.3 spending rate that is below the current projection as it would reduce the denominator (nominal GDP) through the GDP deflator. 2. Energy investment - 0.0 114.5 119.8 89.3 89.3 56.3 56.3 56.3 direct expenditure 3. Additional health 98.8 136.6 149.1 189.0 202.2 212.4 223.0 234.1 financing 4. Additional expenditure/deficit 153.0 330.8 373.5 407.0 432.3 422.9 447.8 473.7 (1+2+3) 5. Energy investment - sublending or sovereign 0.0 178.1 196.1 127.3 122.4 89.1 89.1 89.1 gurantee: 6. Additional financing 153.0 508.9 569.6 534.3 554.7 511.9 536.9 562.8 need (4+5) 7. Additional financing 1.6 4.8 5.0 4.4 4.2 3.7 3.7 3.7 need, % GDP memo: Nominal GDP 9,598 10,508 11,471 12,274 13,133 13,790 14,479 15,203 82 Fiscal Assessment Kosovo Public Expenditure Review 83 Chapter II. I.1. Health I.2. I.3. Policy I.4. I.5. Assessment I.6. 1.7. I.8. This introductory chapter presents the objectives, conceptual framework and methodology of the Kosovo Public Expenditure Review 2023. 84 II.1.  Advancing health financing reforms to contribute to include piloting the management of the outpatient drug benefit package by the health insurance fund, introducing contracting and case-based payment for treatment outside the universal health coverage goals public sector, and gradually expanding performance-based capitation payments for primary health care. 149. Health financing reforms in Kosovo have been stagnating over the last decades. While various governments have vowed to develop social health insurance (SHI), so far this has not been implemented. One of the possible reasons is that health financing, and health II.2.  The link between health financing and UHC insurance in particular, are complex topics that do not immediately resonate with health sector players. The exclusive focus on SHI may distract the attention from the fact that a health 153. Appropriate health financing arrangements can promote progress towards financing instrument should only serve as a means to an end. Structural issues in the overall UHC. UHC means that all people have access to the health services they need, when and health financing arrangements hinder achieving the objectives of any health system – access, where they need them, without causing financial hardship. Health financing arrangements quality, equity, efficiency, and financial protection – generally accepted as universal health are important in achieving UHC because they define how revenue is generated to pay for coverage (UHC) outcomes. To date, there is a lack of understanding of how current health health services, how risks and costs are pooled across people, and how goods and services financing practice has facilitated or hampered the country’s progress toward effective UHC. are purchased. It is important to note that improving health financing in itself will not 150. Instead of presenting a “standard” public expenditure review for health, achieve UHC. Health financing is one of several building blocks of a health system, along the objective of this chapter is to facilitate a common understanding of the health with service delivery and governance. Social determinants of health are also important financing situation in Kosovo, which can serve as a basis for reaching a consensus contributors to good health outcomes.61 on the way forward. The topic is motivated with a basic framework of health financing 154. Health financing has three key functions: (1) resource mobilization, (2) functions and how they contribute to UHC goals. Global good practices and examples from pooling, and (3) purchasing.62 Resource mobilization incorporates the decisions to peer countries are presented in Annex 1 to help draw comparisons with the situation in generate funds from different sources and allocate necessary resources to develop and run a Kosovo.60 The chapter describes the status of health financing and its implications for UHC. A health system. Sources of funds can include individuals/households, firms, the government, long-term vision for health financing is presented and recommendations for possible short and sometimes external sources like development assistance. Some contributions are and medium term (3-5 years) policy priorities are provided based on the current situation health-specific, while others contribute to general government revenues, which can be and desirable trajectory. The exclusive focus on health financing is deliberate although other used to finance health. Pooling involves decisions about how financial contributions and important health system functions – such as service delivery and governance – will need to risks are spread across individuals. It can range from out-of-pocket (OOP) payments, where move in parallel for health financing reforms to achieve their intended outcomes. individuals/households pay directly for the services they obtain at the point of service, to 151. The chapter demonstrates that Kosovo’s health financing system has important funding services through a pre-payment system financed by general government revenues shortcomings which hinder its progress toward UHC. Driven by low government spending, or health insurance. The third key function is purchasing, which includes decisions on what Kosovo’s total health spending is lower than that of most peer countries. At the same time, services and interventions to buy (“what to buy”) from which providers (“from whom to private spending on health is high and increasing which suggests that households are not buy”), and the design of provider payment mechanisms and incentives (“how to buy”). well-protected against health shocks as they often must pay out-of-pocket, particularly for 155. To achieve UHC, public financing should be the main source of funding for pharmaceuticals. Health services are often of low quality, leading to underutilization and health. The two main revenue-raising modalities used for public financing are general poor health outcomes. The lack of strategic purchasing means that there are few incentives taxation and health insurance contributions. In addition countries increasingly also tap for providers to improve performance, leading to significant inefficiencies in the system. into innovative taxes, such as health taxes on tobacco and alcohol, to mobilize additional Although public health financing relies exclusively on general taxation - a mechanism best resources that could be used for health. While health insurance contributions are raised designed to provide risk pooling across population groups - in reality the health benefits mainly in the form of mandatory earmarked payroll taxes, revenues from general taxation are too small and the financial burden of health care falls disproportionately on the sick and health taxes may or may not be earmarked for health. Examples of earmarking general and the poor. At the same time, lack of a proper poverty targeting mechanism leaves many taxation for health include Brazil, where a formula is included in the Constitution to poor people uncovered while benefiting significant number of non-poor with co-payment mandate a certain share of general revenues that must be allocated to the service purchaser. exemption in the public health institutions, putting the financial viability of the system at Another example is Kyrgyzstan, where the government is committed to spend at least 13 risk. percent of its general expenditure on health under an agreement with donors of the Sector 152. To address the shortcomings identified, the chapter proposes recommendations Wide Approach. . Earmarking has several possible disadvantages, including introducing on the overall strategic directions for health financing functions and highlights unnecessary rigidities in the budget process, additional economic distortions, procyclicality several priorities for short-term measures. The Kosovo government should introduce and fragmentation. However, earmarking can help protect revenues for health and increase strategic purchasing and separate the payers and providers of health services to improve public support for paying taxes, as well as introduce an element of accountability, among the efficiency and quality of services. To improve equity, instituting an effective national other advantages.63 Financing health systems from OOP spending is both inefficient and risk pool will be needed and options to mobilize additional resources should be considered carefully. Short-term measures which could bring about concerete results for the population 61 For more details on other building blocks of the health system in Kosovo, see: Nguyen et al. “Kosovo Health System: An Assessment of Core Functions and Performance” (2023). 60 In line with the overall PER, to the extent that data are available, peer countries include structural peers 62 J Kutzin (2001) A descriptive framework for country-level analysis of health care financing arrangements. (Albania, Armenia, Moldova, North Macedonia, and Kyrgyz Republic, Montenegro, North Macedonia, Bosnia Health Policy. 2001 Jun;56(3):171-204. and Herzegovina, Albania, and Serbia), and aspirational peers (Estonia, Lithuania, Latvia, Croatia, and 63 Cashin, C, S Sparkes, D Bloom (2017), ‘Earmarking for Health: From Theory to Practice,’ Health Financing Slovenia). Working Paper No. 5, World Health Organization, Geneva, Switzerland. 86 Health Policy Assessment Kosovo Public Expenditure Review 87 inequitable, exposing individuals and households to financial hardship when seeking care, 159. Some child health indicators have improved recently, yet they are still far including risk of higher and deeper impoverishment, as well as risk of foregone care.64 behind most peer countries. Perinatal mortality, which reflects prenatal, childbirth and neonatal care has decreased from 17.34 per 1,000 live births in 2012 to 9 per 1,000 in 2020. 156. Kosovo’s peer countries have adopted different combinations of funding Nevertheless, the infant mortality rate is still high in Kosovo. The number of deaths per sources and flow of funds arrangements from sources to key financing agents. In terms 1,000 live births among children under one year of age in Kosovo is around that of Albania, of revenue generation, countries do not rely exclusively on general taxation or mandatory but more than double than that of Croatia. According to the 2019-2020 Kosovo Multiple insurance contributions. Drawing on both financing sources allows the government to cover Indicator Cluster Survey (MICS), the probability of a child dying between birth and their segments of the population that would have been excluded in a system entirely financed fifth birthday is 15 per every 1000 births. The most frequent causes of infant mortality from employment-based contributions. Typically, countries with a smaller formal sector have been lower respiratory tract infections, acute infective diarrhea, perinatal causes, rely more on general taxation, whereas countries with a larger formal sector rely more on congenital malformations, and unclassified conditions, again pointing to weaknesses in the insurance contributions. For example, between 87-90 percent of domestic public expenditure service delivery system. on health in Kygyzstan in 2015-2017 came from the general budget, and mandatory health insurance contributions accounted for merely 10-13 percent.65 In Croatia, Romania, and 160. The incidence of infectious diseases other than COVID-19 appears to be stable Slovenia, the share of mandatory health insurance contributions in total health financing and is not a major contributor to the disease burden of the population. However, ranges between 65-70 percent.66 At the same time, regardless of sources of funds, countries the incidence of tuberculosis is much higher than in peer countries. The incidence of can decide to channel most of health revenues through the insurance agency or other form tuberculosis in 2017 was 43 per 100,000 population, more than double the rate in the of service purchaser. For example, in Kyrgyzstan, the Mandatory Health Insurance Fund neighboring Albania and nearly four times higher than in Serbia. Nevertheless, it has been manages roughly 80 percent of the total public spending on health. on a slow decline in recent years. 157. Purchasing must be “strategic” to facilitate progress towards UHC and refer to 161. In summary, Kosovo’s disease burden is characterized by an unfinished agenda “the what”, “from whom” and “how” decisions. An explicit benefit package is preferable of communicable and basic child health issues, coupled with rising NCDs. This pattern as it can help transparently prioritize services and guarantee access to those services. For is typical for countries in the early stage of demographic and epidemiological transition. contracting and paying providers, countries are moving toward output-based payment Examples of countries that have successfully gone through this period will be useful combined with incentives for quality and efficiency. Public financing can also be used to for Kosovo in developing proactive measures to curb the growth of NCDs and preempt contract private providers to expand access and enable quality control by the purchaser. healthcare cost escalation.68 Further details on financing functions are presented in Annex III.4. 162. Kosovo’s health financing system is predominantly based on the Semashko model whereby the central government assumes the role of both provider and financier of healthcare services.69 This includes a centrally planned provision of health II.3.  Health and health financing in Kosovo care within state-financed and state-owned health facilities. Health is financed from general tax revenues. Additionally, as under the Semashko model, the government recognizes all II.3.1.  Overview healthcare providers as public service employees. The private sector is licensed by the 158. Compared to most countries in the region, Kosovo has a relatively young Ministry of Health (MoH) but is otherwise completely independent. The MoH is responsible population which means that the incidence of and mortality from non-communicable for the development, implementation, monitoring, evaluation, and coordination of policies diseases (NCDs) remain relatively low but are increasing. Children under 15 currently in the health sector while the budget envelope for health is largely defined by the budget account for almost a quarter of inhabitants, and only nine percent of the population is aged allocations and appropriations passed by the Assembly based on proposals from the 65 or above, compared to 15 percent in neighboring Albania and over 20 percent in most Ministry of Finance (MoF). other peer countries. The young population puts Kosovo in a favorable position concerning 163. The legal framework for health financing has not been fully developed. The Law health and healthcare cost, which will change once the population gets older. For example, on Health and Law on Emergency Medical Services defined the framework for regulation cancer incidence in Kosovo in 2019 was 149 per 100,000 population, roughly one quarter and governance of health services in Kosovo. These laws mainly cover service delivery. In of the rate reported for Croatia in the same year, and the cancer mortality rate (non-age 2014, Kosovo enacted a Health Insurance Law (HIL), which would give all citizens the right standardized) was also 4 times lower. The difference is less remarkable when Kosovo is and obligation to carry mandatory SHI. To date, most provisions of the law have not been compared to Albania.67 Despite having a relatively low incidence, NCDs represent major implemented and Kosovo is working on having an updated HIL enacted before taking any causes of death and their burden is increasing. Between 2012 and 2019, the number of further steps to roll out SHI. Nevertheless, in connection with the previously enacted law, diagnosed cases of breast cancer increased from 200 to 500 per 100,000 and the number of the country established a Health Insurance Fund (HIF) in 2016, which has been staffed diagnosed cases of cancers of the female reproductive system increased from below 100 to with a small number of personnel. Until now, the HIF is only responsible for the payment of nearly 300. The trend can be partly attributed to improvement in diagnosis and reporting, treatment outside the public sector, mainly abroad, under the so-called “Medical Treatment which remain inadequate. The increasing trend in NCDs may be fueled by widespread risk outside the Public Health Institutions (MTOPHI) program.” factors such as smoking, low physical activity, and unhealthy nutrition. 64 Ajay Tandon, Christoph Kurowski, David B. Evans (2022) “General Taxation and Social Health Insurance” 68 For more details on health outcomes and disease burden, see: Nguyen et al. “Kosovo Health System: An 65 The World Bank (2019) Program Appraisal Document. Primary Health Care Quality Improvement Program. Assessment of Core Functions and Performance” (forthcoming 2023). Report number: PAD3083 69 The Semashko model of health care (named after the first Minister of Health in the former Soviet Unions 66 Authors compilation. – Nikolai Semashko), dominated by publicly owned medical facilities, salaried health workers, and an 67 A caveat is warranted about the possibility of underreporting in Kosovo due to unreliable health statistics. exceptionally high degree of governmental administration.  88 Health Policy Assessment Kosovo Public Expenditure Review 89 164. The public service delivery system consists of University Clinical Center of 166. The Government of Kosovo has consistently reiterated the development of Kosovo (UCCK, tertiary level), seven general hospitals in the regions (secondary SHI as a priority in various policy documents yet progress so far is insufficient. The level), and family medicine centers (FMCs) in 38 municipalities (PHC level). Each Health Sector Strategy 2017-2021 envisioned ensuring sustainable health financing as one municipality has a network of FMCs comprising one main family medicine center (MFMC) of the strategic objectives. According to this document, by the end of 2018, the HIL would and several affiliated centers (with family doctors and nurses) or medical posts (with only be adopted, as well as the legal framework needed to start premium collection; a list of nurses). The general hospitals and UCCK form a system of Kosovo Hospital and University basic outpatient services with costing would be drafted; and the outpatient drug benefit Clinical Services (KHUCS) which is a centralized management structure of hospital services package would be finalized together with implementation modalities. By the time of writing for the whole country. this document (February 2023), none of these objectives have been met. The Government Program of 2021 – 2025 again identified rolling out SHI as one of the priorities for the 165. Financing decisions for each major actor of the system rest with the Assembly health system, which would be preceded by the adoption of the revised HIL and secondary based on budget proposals prepared by the MoF. As shown in Figure 59, funds are legislation for premium exemption, co-payments, outpatient drugs, pharmacy contracting, transferred to the MoH for services under its control (mostly public health and outpatient and MTOPHI. Adoption of a law to amend the previous HIL was included in the legislative drugs), to the KHUCS for secondary and tertiary services, and to local governments for PHC program of the MoH for 2022 but was not achieved. The National Development Strategy 2030, services. The HIF receives funding to cover its own operation and process reimbursement which recently passed through public consultations, foresees that the share of population for MTOPHI. covered by health insurance will reach 100 percent and current health expenditure as a share of GDP will reach 10 percent in 2030, presumably enabled by the expansion of SHI. Fig 58. Current flow of public funds II.3.2.  Resource mobilization and health spending 167. Total health spending in Kosovo is lower than in most structural and aspirational peers in absolute value and as a share of GDP. In 2019, total health expenditure (THE) Budget financing (MOF) was estimated at US$ 226 per capita in nominal terms (Figure 60). That said, in terms of GDP differences were less pronounced, with Kosovo exhibiting similar health spending as in Albania and exceeding spending in the Kyrgyz Republic (Figure 61). It is important to note that there is no specific socially optimal normative level or share of public financing for health across countries. Thus while the level and share of Kosovo’s health spending relative to peers are described here, this should not be taken as suggesting a spending target. Health Insurance Fund Ministry of Health KHUCS Municipalities Wages and Salaries Wages and Salaries for Wages and Salaries Earmarked health Fig 59. Total health spending per Fig 60. Total health spending as a for HIF staff public servants at MOH for hospital staff grant for PHC capita (current US$), 2019 share of GDP (%), 2019 Slovenia 2219 Armenia 11.3% Estonia 1599 BaH 9.0% Goods, services, and Goods, services, Wages and Salaries Lithuania 1370 Serbia 8.7% Public health transfers (MTOPHI) and transfers for PHC staff Latvia 1167 Slovenia 8.5% Croatia 1040 Montenegro 8.3% Montenegro 735 N. Macedonia 7.3% Serbia 641 Lithuania 7.0% Outpatient drugs Goods, services, BaH 554 Croatia 7.0% for PHC and transfers Estonia Armenia 524 6.7% N. Macedonia 437 Latvia 6.6% Moldova 284 Moldova 6.4% Capital Investments for Albania (2018) 275 Albania (2018) 5.2% tertiary and secondary Kosovo 226 Kosovo 5.1% healthcare Kyrgyz Rep. 62 Kyrgyz Rep. 4.5% 0 500 1000 1500 2000 2500 0% 5% 10% 15% Source: WB staff Source: Source: WDI, 2022 (peer countries) and authors’ calculations based WDI, 2022 (peer countries) and authors’ calculations based on MoH and Household Budget Survey data (Kosovo) on MoH and Household Budget Survey data (Kosovo) 90 Health Policy Assessment Kosovo Public Expenditure Review 91 168. The low total spending is driven largely by government health expenditure that accounts for between 60-65 percent of THE. Government spending on health fluctuated Fig 61. Government health expenditures as around 3 percent of GDP between 2015-2019. This is the lowest value among comparator percent of total government expenditures countries, with the exception of Albania (Table 5). Health spending increased to nearly in 2019 4 percent of GDP in 2020, when extra resources were made available to the health sector for COVID-19 related activities. However, this declined to 3.5 percent of GDP in 2021.70 Bosnia and Herzegovina 15.4 Comparable data are not available for peer countries although all countries experienced a Slovenia 14.2 rise in health spending during the peak year of COVID-19. A record high level budget of EUR North Macedonia 13.6 296 million was recently adopted by the Parliament for 2023, which foresees a significantly larger envelop for health personnel in anticipation of the effectiveness of the revised wage Lithuania 13.2 law. Low government spending on health as a share of GDP is a combination of overall lower Estonia 12.9 revenue mobilization and lower prioritization of health within government expenditures. Croatia 12.1 In 2019, Kosovo spent 10.6% of general expenditures on health, lower than the median of Moldova 12.1 12.05% and average of 11.45% among peer countries (Table 6 and Figure 62). Serbia 12 Table 6. Government health expenditure, % GDP Montenegro 11.3 Kosovo 10.6 2015 2016 2017 2018 2019 Latvia 10.4 Albania (2018) 9.8 Bulgaria 4.16 4.14 4.17 4.34 Kyrgyz Republic 7.1 Croatia 5.61 5.64 5.60 5.66 6.40 Armenia 5.7 0 2 4 6 8 10 12 14 16 18 Latvia 3.33 3.47 3.44 3.72 4.20 Lithuania 4.36 4.42 4.28 4.40 5.10 Romania 3.86 3.91 4.05 4.43 Source: World Bank and Kosovo Ministry of Finance Bosnia and Herzegovina 6.62 6.55 6.30 6.24 6.20 Albania N/A N/A N/A 3.0 169. Private health expenditure has been increasing in nominal terms, from an EUR Kosovo 3.10 2.95 2.88 3.05 3.2 116.4 million in 2015 to EUR 135 million in 2019 (Table 7). Between 84-88 percent of private health expenditure was estimated to come from OOP payments, incurred by households for medicines or at the point of service in both the public and private sectors. OOP payments were estimated based on the Household Budget Surveys (HBSs) of 2014 Source: Eurostat and author calculations (Kosovo) and 2017, assuming the same rate of increase between 2017 and 2019 as between 2014 and 2017. The second source of private health expenditure comes from private health insurance, which covers diagnostics and treatment in the private sector. Revenue from private insurance increased from EUR 13.4 million in 2015 to EUR 19.6 million in 2019. Between 2015 and 2019, OOP payments were estimated to have increased by 12 percent in nominal terms, with the corresponding rate of increase for private health insurance amounting to 46 percent, further underscoring the adverse impact of the public system missed implementation of rolling out SHI. 70  Authors’ calculation using data from Kosovo Statistics Office (https://askdata.rks-gov.net/) 92 Health Policy Assessment Kosovo Public Expenditure Review 93 Table 7. Estimates of private health expenditure in million EUR (current value) Fig 62. Health expenditures by budget organizations (EUR million)   2015 2016 2017 2018 2019 300 M Total private exp (million EUR) 116.4 122.3 126.0 130.3 135.1 250 M Of which:           200 M OOP payments 103.0 106.0 109.0 112.3 115.5 150 M Private health insurance 13.4 16.3 17.0 18.0 19.6 100 M OOP as share of private exp (%) 88 87 87 86 85 50 M Rate of increase 2015-2019           M OOP payments (%) 12 2015 2016 2017 2018 2019 2020 2021 Private health insurance 46 Ministry of Health KHUCS Private exp as % of THE 41 41 41 39 38 Source: National Health Accounts Report, 2021 Municipalities (PHC) HIF OOP exp as % of THE 36 36 36 34 32 Source: Voncina (year) 170. In 2020 and 2021, due to the COVID pandemic, health expenditures were 23 and 33 percent higher, respectively, than in 2019. In 2020, expenditures through the Fig 63. Health expenditures by budget MoH were nearly doubled, and rose further in 2021. There was also a smaller increase organizations (EUR million) in expenditures through KHUCS and the HIF in 2021 (Figure 63). The increase in health expenditures through MoH and KHUCS was driven by spending on goods and services MoH KHUCS Municipalities (Figure 64), which more than doubled at the level of MoH, increasing from 10.2 million 70 M 160 M 90 M euros in 2019 to EUR27.1 million in 2020 and more than tripled to EUR34.2 million by end- 2021. At the KHUCS, goods and services spending increased from EUR41 million in 2019 60 M 140 M 80 M to 52.8 in 2020. Municipalities increased their goods and services spending in PHC from 120 M 70 M EUR7.9 million in 2019 to EUR22.4 million in 2020, followed by a drop to EUR12.9 million 50 M 60 M in 2021. The MoH also made substantial capital investments during this period: non- 100 M 40 M 50 M financial asset spending increased from EUR6.4 million in 2019 to EUR14.2 million in 2020 80 M and EUR12.0 million in 2021 (Figure 64). A large share of municipalities’ PHC spending 30 M 40 M goes to wages and allowances by design since the PHC grant formula is primarily intended 60 M 30 M to pay for these. The total budget for PHCs also includes essential medicines spending and 20 M 40 M 20 M capital investments. 10 M 20 M 10 M M M M 2015 2016 2017 2018 2019 2020 2021 2015 2016 2017 2018 2019 2020 2021 2015 2016 2017 2018 2019 2020 2021 Wages and Allowances Goods and Services Utilities Source: National Health Accounts Report, 2021 Subsidies and Transfers Non-financial assets 94 Health Policy Assessment Kosovo Public Expenditure Review 95 II.3.3.  Risk pooling Box 6. 171. Although public services are envisaged in Kosovo to be free or subject to small What is strategic Purchasing becomes strategic or active when purchasers of user fees, in practice services and drugs are usually not available. As a result, patients purchasing? health services deliberately select the goods and services to buy pay OOP at the point of service. Under such circumstances, sick people carry the burden of and the providers to buy from. Strategic purchasing arrangements funding their treatment. This financial burden can be particularly severe for the poor, or for create financial incentives for providers to contribute to health system people with chronic conditions, who need medications on a regular basis. Currently, there is objectives. They can help prioritize cost-effective health services no mechanism to share financial risks between the sick and the healthy as well as between the (e.g. primary care over unnecessary hospitalization), incentivize poor and the better-off. Furthermore, there is no objective mechanism to identify the poor, prevention and health promotion, and reduce wasteful spending especially taking into account informal income. With the planned collection of mandatory on unnecessary services. Appropriate arrangements can also be insurance contributions, continued financing from the general budget will remain crucial to made to pay providers more to work in underserved areas or serve provide subsidies for the population cohort lacking the capacity to pay premiums. vulnerable populations, while reducing incentives to collect informal 172. The limited size of the PHC grant and its rigid formula do not allow for risk fees from patients. Payments can also be made contingent on meeting sharing across municipalities with different socio-economic conditions and disease accreditation standards and following clinical treatment guidelines. burden. The formula is based on input norms rather than actual performance, which The following steps are typically included in the development of in turn reflect the population size documented in the 2011 Census, with a small top up strategic purchasing: for “on-going programs.” The indicators for the on-going programs in the Medium-Term Expenditure Framework (MTEF) 2023-2025 include the expected number of home visits 1. Establishment of an institution to pay for health services using for pregnant women and children and for palliative care, again reflecting norms rather than a sufficient pool of funds – this is typically the Health Insurance actual performance. As a result, grant funds are inadequate to meet local health financing Fund. needs. Specifically, in 2019, only 8 out of 38 municipalities reported that the health grant was 2. Creation of an institutional architecture for purchasing sufficient. Thus, municipalities spent on average 13.5 percent more for PHC than the amount (licensing, certification, registration, accreditation, Health allocated in their health grant.71 This has potential equity implications as the smaller and Technology Assessment, patient safety, etc.) and mechanisms poorer municipalities have limited fiscal space to top up PHC funding. In addition, census for accountability. data does not consider differential migration patterns over the last 10 years, penalizing 3. Revision of the public financial management system to support remote areas with more constrained mobility. strategic purchasing. 4. Granting of appropriate autonomy to providers over many II.3.4.  Strategic purchasing spending decisions. 5. Development of IT infrastructure for the payer and providers 173. The practice of strategic purchasing is currently lacking in Kosovo. Healthcare to exchange data on health service delivery, patient outcomes, services are paid for with a predetermined budget defined annually based on rigid input costs, etc. line items such as salaries, goods and services, and utilities. There are no clearly stated 6. The regulation of the relationship between the payer and decisions on the three key elements of strategic purchasing – benefit package, contracting, providers via contracts, defining the obligations of both and provider payment. Other conditions for strategic purchasing are also not present. parties, including performance targets and quality, and clear instructions for claims submission, processing, monitoring, and reporting. 7. Creation of output-based payment methods based on claims. 8. Definition of payment rates that reflect real costs and include risk adjusters for cost differences across geographic locations, levels of care, age, gender, and other dimensions. 9. Specification of lists of covered services (benefit package) and covered medicines (an essential medicines list or formulary). 10. Definition of standard treatment guidelines with standards for the quality of care and guidelines for referrals, including any gate-keeping policies. Source: Cashin, C, Nakhimovsky S, Laird K, Strizrep T, Cico A, Radakrishnan S, Lauer A, Connor C, O’Dougherty S, White J, Hammer K. September 2018. Strategic Health Purchasing Progress: A Framework for Policymakers and Practitioners. Bethesda, MD: Health Finance & Governance Project, Abt Associates Inc. 71 World Bank (2020). Policy Note on Financing Education and Health at the Local Level in Kosovo. Kosovo Local Administration Policy Diaglogue Platform. July 2020 96 Health Policy Assessment Kosovo Public Expenditure Review 97 174. An explicitly defined service benefit package is nonexistent. The benefit package 179. The lack of contracting with private providers by the government represents regulates the scope of services the population is entitled to when seeking care in the public a missed opportunity to expand access for the population and control quality of sector, while services in the private sector are subject to full user fees. The Law on Health care in the private sector. Private health sector capacity grew sharply in recent years. defines the free entitlement to healthcare services and highlights the types of services Between 2015 and 2020, the number of private institutions increased by 49 percent, from each level of care should offer. However, the definition is too broad, and since services are 1062 to 1582, with the largest increase experienced in outpatient specialist clinics.74 In not explicitly defined, it is not clear to what extent: (i) the population is aware of the free 2019, private hospital beds accounted for 13 percent of all hospital beds in Kosovo. The services as well as the services subject to user fees; and (ii) the benefits are guaranteed. In fast development of the private sector, both in financing through private insurance and in practice, staff shortages and the lack of equipment, medicines, and medical supplies, results provision of services, has created a parallel market catering to the better off, and if not often in absent health service availability. managed well, could threaten the success of the national risk pool when SHI is rolled out. 175. The outpatient drug benefit is almost nonexistent. Although there is a list of 180. One of the preconditions for strategic purchasing is a well-functioning essential medicines that MoH procures and distributes to PHC, the variety and quantity information system and Kosovo is still at an early stage in this regard. With the of drugs is limited. Field interviews conducted for this study revealed that the quantity introduction of contracting and new provider payment methods, classifications of diagnoses of drugs provided by the MoH only meets one tenth of the actual needs. Often, patients and procedures will become of utmost importance. Health care providers currently do not have to come back to the facilities for drugs because they are not available on the day of produce data on diagnoses and procedures connected with patient visits. For diagnoses, the their consultation, or they go to private pharmacies to avoid waiting. It is reported that the International Classification of Diseases, Tenth Revision (ICD-10) has been adopted by the preponderance of drugs, except insulin, are paid for by patients. Institute of Public Health but is not widely used, whereas a procedure classification has not been adopted. The main source of information is Health Statistics, managed by the Kosovo 176. Currently, subsidies are poorly targeted in Kosovo. A key element of any benefit Agency of Statistics. The statistics are at the aggregate level and are not updated in real time. package is the identification of population groups eligible to receive subsidies. Exemptions Furthermore, the quality of health statistics leaves much room for improvement as even the currently incorporate a combination of categorical and poverty (means testing) targeting. most basic statistic - cause of death - is not available for some 20 percent of all registered The result of this approach is seemingly excessive population of patients that are exempted deaths. Under the World Bank financed Kosovo Health Project (KHP), Health Insurance from user fee payments. Specifically, an estimated 70-80 percent of patients are not obliged Fund’s Information System (HIFIS) and an electronic prescription application have been to pay user fees when seeking care in the public sector.72 At the same time, strict eligibility developed. However, HIFIS will not be operationalized until SHI becomes functional, criteria for identifying the poor result in a significant gap in coverage – about 7  percent of whereas the e-prescription application is awaiting the rolling out of the Outpatient Drug the population benefits from social assistance, while the national poverty rate is close to Benefit Package. 25 percent. When SHI is rolled out, the same group currently being exempted from user fees will likely be exempted from premium payments. Addressing the targeting ineffectiveness 181. While many countries have moved beyond line-item budgets and adopted more of health subsidies will be crucial for the fairness and financial sustainability of insurance. sophisticated provider payment methods for incentivizing quality and efficiency, line-item budgets remain the only method of payment for hospital care in Kosovo. 177. Contracting for services with public providers does not exist, and the type and All wages, drugs, and supplies are purchased through the government budget. For PHC, the volume of services to be expected from each provider is not stipulated. This greatly health grant allocation to municipalities is capitation-based and is based on input norms, limits the ability to ensure provider’s accountability. In principle, PHC providers should with only a small number of inputs being included in the formula. Neither the capitation play a gate keeping role and address the majority of health issues at their level. In practice, formula nor the line-item budgeting for hospitals provide any incentives for improving it is reported that PHC tends to refer patients out quite easily.73 Similarly, hospitals are free efficiency or quality of care. to determine the structure of hospitalizations (volumes of care and case mix), which risks limiting access for patients with serious and costly-to-treat conditions. Finally, performance and quality indicators are not defined and hence not monitored. 178. For purchasing to be effective, health facilities need to have a certain degree of autonomy. In Kosovo, public facilities have little to no autonomy in budget spending due to the rigid line-item budget norms and their low resource envelope. At the PHC level, as much as 87 percent of all spending is used to pay fixed costs, most of which are salaries that are centrally managed, leaving little room for management decision on spending. Healthcare workers negotiate their agreements (with specific rights and financial rewards) in a collective bargaining process with the central government, even though their employer is the local government. With the management of PHC decentralized, these facilities are reported to be sometimes influenced by municipalities in staff selection decisions. At the hospital level, KHUCS decides the annual budget and planning on behalf of general hospitals. User fees collected by the general hospitals are not treated as additional funding for the hospitals but go back to KHUCS’ central budget. 72 JICA (2022) Data Collection Survey on Health Sector to Build Resilient Health Systems toward Universal Health Coverage in the Republic of Kosovo. Final Report. February 2022 73 World Health Organization (2019) Primary health care in Kosovo: rapid assessment. 74  Kosovo Agency of Statistics 2022 98 Health Policy Assessment Kosovo Public Expenditure Review 99 Box 7. II.4.1.  Insufficient public spending causes input constraints, poor access, and low quality of care HIF reimbursement Kosovo has an Administrative Instruction that allows patients to of treatment outside get treatment outside the public health institutions and be paid by 183. With only 3  percent of GDP devoted to health, Kosovo’s health system faces public health the HIF under the MTOPHI program (Administrative Instruction a number of significant challenges, including inadequate funds to pay health care institutions No. 03/2017).. This includes mainly treatment outside Kosovo but personnel, maintain health facilities, or purchase sufficient medicines and medical supplies. also in local private facilities in some instances. Since 2018-2019, the Kosovo compares unfavorably with peers both in terms of inputs into service delivery and funds for treatment outside the public health institutions has been actual utilization of public services. For inpatient care, in particular, with 2.3 beds per 1,000 transferred to the HIF instead of MoH. The goal of this program is population, Kosovo’s network of public hospitals has far fewer beds than all comparator to provide financial support to citizens and residents of Kosovo for countries (Figure 65). Similarly, the number of hospital doctors per 100,000 population health services which cannot be provided in public health institutions. is lowest among peers except for Albania (Figure 66). The low number of beds does not Patients have the right to apply for the program through the Division necessarily mean that Kosovo needs more hospital beds since the occupancy rate of the for MTOPHI, after completing the full documentation (including the existing beds is also low and care should be moved more towards PHC rather than hospitals. reference from the Counselling Commission). Medical records, Report An additional limitation is that the data for Kosovo comes from an outdated census and pre- of the Counselling Commission composed of three doctors from KHUCS, Covid statistics. and two proforma invoices should be submitted together with the administrative documents. Final decision is made by the MTOPHI. If approved, treatment is paid by the HIF. Fig 64. Hospital beds per 1,000 Fig 65. Hospital physicians per The HIF’s management of payment under MTOPHI is best population in 2018 or latest 100,000 population characterized as passive purchasing or pure processing of year available payment. The process lacks proper and standardized procedures to specify the types of services the Counselling Commission can refer a Lithuania 6.4 Lithuania 276 patient for treatment outside public health institutions. In addition, Moldova (2014) 5.7 Estonia 215 the MTOPHI program makes decisions on a case-by-case basis without involving the HIF in any decision-making role nor in understanding the Serbia (2017) 5.6 Croatia 181 budget limitations. The HIF is currently serving only as a payment agent, Croatia (2017) 5.5 instead of developing standardized approval and monitoring processes. Latvia 175 It does not engage in any contract negotiation with hospitals abroad. Latvia 5.5 Serbia 159 This approach has generated significant financial risk for the MTOPHI Estonia 4.6 Slovenia 145 funds: for example, in 2021, the Fund spent EUR1.4 million on MTOPHI Slovenia 4.4 more than the budgeted amount of EUR8 million. In addition, the Fund Armenia 130 is facing contingent liability from commitment letters issued to foreign Kyrgyz Rep. (2014) 4.4 Montenegro 117 providers which has not yet materialized as debt. As of December 31 N. Macedonia (2017) 4.3 2022, the liability was reported to be more than EUR 26 million. Armenia (2015) Moldova 104 4.2 Montenegro (2017) N. Macedonia 95 3.9 BaH (2014) 3.5 BaH (2012) 88 Albania (2013) 2.9 Kosovo (2019) 83 Kosovo 2.3 Albania 58 II.4.  Shortcomings in UHC goals associated with health financing arrangements 0 2 4 6 8 0 50 100 150 200 250 300 182. The lack of significant reforms in health financing over the last decades represent a missed opportunity for Kosovo to address various shortcomings vis-à- vis UHC goals of achieving access, quality, efficiency, equity, and financial protection. In Source: Source: fact, as seen above, key financing functions are organized in a way that disincentivizes WDI (peer countries) and HFA, 2013 (peer countries) authors’ calculations based 2012 (BiH) and 2019 improvements. Some constraints are highlighted below, with a caveat that observed on KAS data (Kosovo) (Kosovo, authors’ calculations outcomes are multidimensional and financing alone is only partly related to the outcomes. based on KAS data) 100 Health Policy Assessment Kosovo Public Expenditure Review 101 184. Service utilization is low for both outpatient and inpatient care. Kosovo records fewer outpatient contacts per person than peers, except Albania and the Kyrgyz Republic Fig 68. Reasons for dissatisfaction with visit to (Figure 67). In 2019, the number of discharges per 100 population in Kosovo ranged from 38 public health institution (%), 2017 percent of those recorded in Lithuania to 83 percent of those recorded in North Macedonia (Figure 68). No drugs available 33.4 Other quality of care concerns 20.9 Long waiting hours 13.9 Other services not available 9 Fig 66. Outpatient contacts per capita, Fig 67. Hospital discharges per 100 No diagnostic/lab facilities 8.8 2019 or latest year available population in 2019 or latest No specialists 7.6 year available Too expensive 4.1 Poor knowledge of treating doctor/nurse 1.7 Lithuania (2014) 8.7 Lithuania (2014) 24.08 Other 0.6 Serbia (2014) 7.8 Latvia (2014) 18.59 Montenegro (2014) 7.1 Slovenia (2014) 18.37 N. Macedonia (2013) 7.0 Estonia (2014) 17.51 Source: Slovenia (2014) WB staff calculation using 2017 HBS 6.6 Croatia (2014) 17.45 Moldova 6.4 Moldova 17.35 Estonia (2014) 6.3 Armenia 14.67 Croatia (2014) 6.3 186. The quality of hospital services is challenged by a host of constraints, most notably BaH 14.58 lack of qualified staff and equipment. This has resulted in a long waiting list and the need to Latvia (2014) 5.9 Kyrgyz Republic 13.75 refer patients to private practice or abroad due to the public hospitals’ inability to provide certain BaH 5.2 services. In January and February of 2022 alone, 7,645 patients were reported to be waiting Armenia Serbia 13.47 for any type of surgical, diagnostic, or other hospital treatment in the UCCK in Prishtina.76 This 4.1 N. Macedonia (2013) 11.21 represents close to 10 percent relative to the total discharges from UCCK in 2019. Most patients Kosovo 3.0 were waiting for radiology, vascular surgery, and ophthalmology services. The most common Kyrgyz Republic 2.5 Kosovo 9.27 reasons for patients to be on waiting list include lack of staff and lack of equipment (Figure 70). Albania (2013) 2.5 Albania (2013) 8.62 0 2 4 6 8 10 0 5 10 15 20 25 30 Fig 69. Reasons for being on the waiting list, in number of patients Source: Source: 8000 7337 HFA (peer countries) and HFA (peer countries) and 7000 authors’ calculations based authors’ calculations based 6000 5380 4973 on KAS data (Kosovo) on KAS data (Kosovo) 5000 4000 3697 3000 2227 2000 1904 1000 443 185. Despite PHC being free and geographically accessible, points to poor quality of 0 Lack of Lack of Lack of human Lack of physical Lack of Lack of Others* care as an important reason for low use of services. In fact, over 33 percent of respondents staff equipment expertise space supplies operating days in the 2017 HBS cited unavailability of drugs as their reason for dissatisfaction with public (operating room) health institutions (Figure 69). Primary care capacity in terms of team composition, competencies and available equipment does not match the health needs and expectations of the population, which leads to decline in reputation and, therefore, bypassing of PHC services.75 Source: MoH Rapid Hospital Service Assessment Survey (2022) 75  World Health Organization (2019) Primary health care in Kosovo: rapid assessment 76  The Ministry of Health (2022) Results of the Rapid Hospital Service Assessment Survey. March 2022 102 Health Policy Assessment Kosovo Public Expenditure Review 103 II.4.2.  Absence of strategic purchasing contributes to inefficiency that can save women’s and babies’ lives when complications occur during pregnancy or birth. However, C-section use for non-medically indicated reasons is a cause for concern 187. Incentives are missing to improve performance. Without an active role of a because the procedure is associated with considerable short-term and long-term effects strategic purchaser and a proper contracting mechanism, providers do not face any pressure and healthcare costs. C-section use has increased over the past 30 years in excess of the to improve performance. Within limited data available, inefficiency is evident by the weak 10–15 percent of births, a level generally considered optimal.79 role of PHC and the suboptimal use of hospital resources. 188. Costly hospital resources are used for outpatient care and for treating many II.4.3.  Lack of effective pooling and a guaranteed benefit package conditions that should be addressed at PHC. Hospital admission rates for hypertension and diabetes - conditions which should be treated in PHC with no hospitalizations - by far 191. With 32-35 percent of THE being borne by the households through OOP outstrip those recorded in OECD countries. This indicates that many hospitalizations may payments, Kosovo is at a significantly higher level than is generally accepted to be unnecessary. In 2016, hospitalization rates per 100,000 inhabitants amounted to 776 be reasonable for financial protection (no more than 20 percent). A majority of OOP for hypertension and 396 for diabetes, compared to the OECD averages in 2015 of 131 and payments is spent on pharmaceutical products, ranging between 70 percent in 2015 and 174, respectively.77 In 2019, 27 percent of all outpatient visits took place in the hospitals, 57 percent in 2017, the latest year for which data are available (Figure 72). Most notably, and 40 percent of all hospital outpatient visits occurred in UCCK – the only tertiary hospital in 2017, 15 percent of household’s health expenditure incurred in the public health in the country. institutions, despite the very low level of user fees. Nearly one forth (24 percent) of OOP expenditures is incurred in the private sector. 189. Bed occupancy rate in the hospital is low, particularly in general hospitals (Figure 71). Between 2015-2019, the average bed occupancy rate in general hospitals totaled 52-53 percent. Hence, half of the bed capacity is put to use, while the hospitals still maintain the running cost for the whole structure, stretching further the limited resources Fig 71. Composition of household OOP spending for utility, maintenance, equipment, and supplies. on health (%) 70.1% Fig 70. Bed occupancy rates of UCCK and general hospitals 57.0% 80% 70% 24.1% 20.0% 60% 15.2% 4.4% 5.2% 50% 1.4% 0.4% 2.2% Pharmaceuticals Public Health Private Health Health Services Other 40% Services Services Abroad 2015 2016 2017 2018 2019 2015 2017 Occupancy rate UCC Source: Source: WB staff calculations using HBS Author calculations based on KAS data Occupancy rate General hospitals 192. Out-of-pocket expenditures are exacerbating existing income inequalities. 190. The issue of efficiency and appropriateness of health services provided is When considering OOP health payments, the poverty headcount increases from 15.5 also evident in the high rate of caesarian sections (c-sections), which has risen from percent to 17.1 percent and extreme poverty headcount increases from 4.6 percent to 5.4 28 percent in 2016 to 33 percent in 2020.78 There is no apparent explanation for this percent (Table 8). In 2017, more than 11 percent of Kosovar households spent more than increase, especially as there are not explicit financial incentives to carry out C-sections. 15 percent of their non-food consumption expenditure on health. C-sections are the most common surgery in many countries around the world, a procedure 77  WHO EURO. Primary care rapid assessment 2018 78  Kosovo Agency for Statistics, 2022 79  https://www.thelancet.com/series/caesarean-section 104 Health Policy Assessment Kosovo Public Expenditure Review 105 Table 8. Measures of Poverty Based on Consumption Gross and Net of as diagnosis-related groups (DRGs) in combination with quality performance measures Spending on Health Care should be considered. It is important to note that while the use of DRGs can improve efficiency, it cannot in itself solve all issues in the system and should be part of a systematic   Gross of health payments Net of health payments approach to reform. Poverty line = Total poverty line Box 8. Poverty headcount 15.5% 17.1% Poverty line = Extreme poverty line Examples of the The introduction of strategic purchasing is usually gradual, and the introduction of pace of introduction varies by country. In Croatia, for example, hospital Poverty headcount 4.6% 5.4% strategic purchasing: financing reform occurred incrementally, with each step building on Source: World Bank staff calculations using 2017 HBS Croatia and the previous one: Germany • 1996: Global budget • 1998: Capped fee-for-service (FFS) II.5.  Advancing health financing reforms toward UHC goals – • 2002: Capped FFS + case-based payment overall directions and next steps: policy recommendations • 2009: DRG-based payment • 2015: DRG-based payment + pay-for-performance 193. Kosovo is at a critical crossroad in terms of health financing. Pressures for long delayed health financing reforms seem to be mounting and any major direction adopted The Croatian Health Insurance Fund (HZZO) began first with transition now will have lasting impacts on the future of the health system. A clear and common long- from line-item budgets to global budgets and then to capped FFS. term vision is needed for each of the key health financing functions – resource mobilization, This is a global budget with FFS invoicing up to a ceiling or cap. pooling, and strategic purchasing. Based on these choices a concrete roadmap with The purchaser then transitioned to DRGs incrementally, beginning milestones for short- and medium-term measures needs to be developed. The technical and with pilot testing before scaling up DRGs nationally. Eventually, Key political complexities of health financing reforms, combined with limited implementation Performance Indicators and Quality Indicators were added to the capacity, and lack of multiple preconditions as outlined above, dictates that the roadmap payment model. starts with relatively simple steps to gradually develop the system before a full-blown roll out of reforms in all health financing functions. The main goals behind hospital payment reforms were cost reduction and rationalization of resources, as well as improvement of certain 194. This section provides recommendations on general directions for strategic performance indicators such as shortening average length of stay purchasing and pooling functions, the setup of which has strong implications for thereby achieving higher patient turnover and reduced waiting times value for money of public financing. In addition, key considerations are elaborated to for certain procedures. inform government’s decision in moving forward with resource mobilization reforms. Finally, some concrete measures that could serve as priority actions in the next 3-5 years One of the greatest challenges to the reform was costing of services are described in detail below. although HZZO introduced patient-level electronic invoicing in 1999. A second major challenge was related to the incentives that DRG payment systems create for providers to upcode, in order to be reimbursed at a Introducing strategic purchasing and provider-payer split higher rate. To monitor possible upcoding and other gaming, the HZZO 195. Strategic purchasing and provider-payer split can be implemented independent used fraud detection software. The algorithm automatically detects of premium collection for SHI. With the establishment of the HIF, Kosovo has practically anomalies to help target suspicious claims that need to be verified introduced a purchaser although it has not been performing strategic purchasing. For the with chart audits. Fund to truly play such a role, the following essential elements need to be in place. In Germany, introduction of the DRG-based payment system was 196. Being the strategic purchaser of health services, the HIF will contract gradual with a stepwise withdrawal of the former mixed payment directly with public and private providers at all levels of care through purchasing system. It can be divided in four phases. In the preparation phase arrangements. The contracting should be based on pre-determined criteria to realize value (2000-2002) a cost-accounting system to calculate cost weights was for money, accountability, and equity among others. For PHC, the current grant formula developed and cost weights were calculated from a sample of voluntary which does not incentivize quality improvement, relies on the 2011 census and does not participating hospitals (around 100 in 2002). The first version of the meet PHC needs, could be replaced with a risk-adjusted capitation method, whereby age, sex, G-DRGs (German – DRGs) system had 664 DRGs. During this phase, and population density can be used as risk adjusters to begin with. To mitigate risks related the WHO’s International Classification of Procedures in Medicine was to capitation, certain performance indicators should be developed. Capitation payment converted into the German Operations and Procedures Codification can also be blended with fee-for-service to incentivize targeted priority services, such as Index and the ICD codes into the ICD-10-German Modification (ICD- preventive care, screening, and management of noncommunicable diseases. For hospitals, 10-GM). in the transition phase, global budgets, case-based payment for prioritized services could be introduced. In the long term, introduction of the prospective payment mechanisms such 106 Health Policy Assessment Kosovo Public Expenditure Review 107 Box 8. cont. Introducing a targeting mechanism for exemption in social programs to ensure fairness and fiscal sustainability Examples of the • 1996: Per diem charges + case and procedure fees 199. Implementing a new poverty-targeting instrument that considers observable introduction of • 2000-2003: Preparation phase for the G-DRG introduction income through a means test and informal/unobservable income through a proxy strategic purchasing: • 2003-2004: Budget neutral phase of the G-DRG implementation means test could improve poverty targeting, better reflect the high rates of informality in the Croatia and • 2005-2009: Convergence to the state-wide base rate Kosovo labour market and serve as a foundation for targeting health insurance exemption of Germany • 2010 to date: Convergence from the state-wide base rate to a the poor. Such a poverty-targeting mechanism would improve effectiveness of social protection nation-wide base rate system, as well as targeting of exempted categories from health service co-payment and future insurance contributions. The new mechanism will require, inter alia, the definition of detailed Since 2005 the contracting parties have been authorized to negotiate operational procedures, capacity building of the Centres for Social Work, and the development additional reimbursement by means of case-based or per diem and deployment of adequate software. This is critical for ensuring that the reform benefit the remuneration for highly specialized services and supplementary poor and vulnerable population. fees for expensive drugs, medical devices and procedures, additional payment for certain day cases of curative care (i.e. for geriatric care Instituting an effective national risk pool and renal insufficiency), and grants/budgets for teaching activities, emergency services, accommodation costs of accompanying persons, 200. Effective risk pooling allows for true sharing of health and financial risks among the securing the necessary provision of services or excessively limited rich and the poor, the sick and not sick, and across municipalities. An “effective mechanism” demands for care, care for foreign patients, activities related to quality relies mostly on prepayment, delinking health status with payment at the point of services. With improvement, or integrated care contracts. the small size of the population, it is recommended that risk is pooled at the national level. As the start, public financing for health should be consolidated to avoid fragmentation. Following the typical model in other countries, most of the funds (the “risk pool”) could be housed with the HIF, while the MoH will become a smaller financing agent. Budget funds going through the MoH will be used mostly for public health programs and major capital investment, which would 197. A list of services covering PHC, emergency, outpatient specialized care, and not exclude the capital investment currently in the KHUCS and municipality budget. Funds going hospitalization – in the public and private sectors - will need to be developed and through the HIF are for individual services, for which the HIF will purchase in its new role as a properly costed. The design of the benefit package should include disease burden, cost strategic purchaser. With the HIF assuming the role of the national risk pool/single purchaser of effectiveness, and priorities given to certain marginalized population groups. Although individual health services, the flow of funds could look like the Figure 73 below. there are well-established methodologies for defining and revising a benefit package, this is an complex process for which capacity needs to be developed. As a start, Kosovo could consult the benefit packages from similar health systems. Some simple tools for the benefit package design are also available from international sources, such as the CHOosing Fig 72. Current flow of public funds Interventions that are Cost-Effective (CHOICE) developed by the WHO80 and Disease Control Priorities (DCP3) program developed by the World Bank and partners.81 The definition of Budget financing (MOF) the benefit package needs to be done in conjunction with a proper costing exercise. Not only the cost of providing services needs to be estimated, but actuarial costing is also required to consider the price elasticity of demand in the scenario where the package will be offered to Ministry of Health Health Insurance Fund the population with no or very low co-payment. 198. To start using new payment methods will bring some new challenges. For New provider payment methods Wages and Salaries IPH, public PHC PHC Admin cost for HIF example, misuse and fraud could be exacerbated under the DRGs system as shown in servants at MOH centers services the case of Croatia and Germany above. To limit misuse and fraud to the lowest possible level, a software module Fraud Detection needs to be developed and integrated with the Contracting Fund for strategic electronic invoice system as all data will be stored in that system. This system aims to Goods and services & transfers: purchasing of services Hospital Public Health Services, Trainings, Admin Hospitals services find intentional and accidental errors in provider reporting and invoicing. An algorithm in the public and costs, licensing, etc. private sectors automatically finds anomalies and records invoices that need to be further checked. In addition, the development of a Business Intelligence module will provide timely and in- Capital Investments for primary, Fund for strategic purchasing of depth analytics to inform decision-making of the strategic purchaser. secondary, and tertiary healthcare services outside the country Pharmacies Outpatient drugs Source: authors 80 http://www.who.int/choice/en 81 http://dcp-3.org 108 Health Policy Assessment Kosovo Public Expenditure Review 109 201. In this scenario, the only source of public funds will come from the budget because the lower end in terms of current evasion (4.2 percent). Furthermore, although good data insurance premium collection has not started. This scenario only describes the revision on the distribution of smoking across income groups is not available for Kosovo, analyses of the flow of funds currently available to the health sector, with the goal of reducing from other countries suggest that lower-income groups may experience the largest health fragmentation and increasing the purchasing power of the single purchaser. The biggest improvements but also might pay for the tax disproportionately. differences between the current flow of funds (Figure 59) and this model (Figure 73) is that, following international best practices, a single risk pool would be created by: 205. The prospect of raising additional funds through health insurance premium depends on a number of aspects and warrants careful considerations. Before Kosovo • Eliminating the separate budget lines going from the budget to KHUCS and to embarks on mandating contributions as currently described in the HIL, it is important to municipalities. Instead, funding for hospitals and PHCs (for individual services) obtain clarity on the following issues: will be pooled at the central level and managed by the HIF. This will allow the HIF to adjust spending to hospital versus PHC services flexibly. This will also allow the • What could be the impact on labor market? The current HIL specifies the rate to be HIF to perform strategic purchasing, using contracting and performance management 7 percent of gross salary for the formal sector (to be split between employer and mechanisms to hold providers accountable for service provision – a task that the employee) or 7 percent of taxable income for self-employed people who pay tax on Treasury is ill equipped for: real income – the two largest contributory groups. For the formal sector, the group for which enrollment enforcement is the most feasible, insurance contribution acts • Enabling a national level pooling for PHC instead of the current municipal level as additional payroll tax, effectively increasing the cost of formal employment which risk pooling because the HIF will contract with all PHC facilities on similar terms, could in turn increase informality. The extent this will happen in Kosovo is unclear, with adjustments as needed to account for socio-economic conditions and disease although literature from other countries in general finds that the impact of higher profile of the location. taxes on formality could be small.85 • What should be the contribution rate? It is not known whether the 7 percent is Considerations for mobilizing additional resources for health sufficient to cover benefits because a benefit package has neither been defined nor costed. The first step in determining the contribution rate should be to develop and 202. The low health spending in Kosovo suggests a scope to mobilize additional conduct actuarial costing of the benefit package. Based on the total cost, funding gap sources for health. While general taxation should remain the main source of core financing that could be filled by premium collection can be identified. Keeping in mind that the for health, fiscal space for health can be increased through different channels, some are purpose of collecting mandatory insurance contributions is to raise additional revenue more applicable to Kosovo than others – through improving general macro-fiscal conditions, for health, it is crucial that additionality is respected and revenue from insurance will prioritizing health vis-à-vis spending on other sectors, obtaining more foreign assistance not crowd out spending on health from the general budget. or donation from diaspora, tapping into “innovative health taxes” such as taxes on the consumption of unhealthy items or on pollution, raising health sector specific revenue such • What is the practical feasibility of raising substantial revenue through insurance as health insurance premium contributions, and improving efficiency to enlarge the sources contributions? As is the case with other countries, mandatory contributions are available for health within the same spending envelope.82 Recent work on fiscal space best enforced within the formal sector, whereas Kosovo’s economy remains highly for health in Kosovo suggests that other than properly implementing SHI and collecting informal. Although there are no official statistics, the share of the informal sector in premiums as specified in the law on health insurance, economic growth will be the main the overall workforce is estimated to range from over a quarter to over 40 percent.86 source of fiscal space in Kosovo. This is line with findings in other middle-income countries, Furthermore, evasion is expected to be high.87 According to a World Bank study, the where the scope to raise more revenue and to reprioritize health is more limited than in rate of non-compliance in personal income tax was estimated at 33 percent in a many low-income countries. 2018 study. The ability to enforce premium contribution in the informal sector also largely depends on population willingness to pay for health insurance, which will be 203. Increasing excise taxes on the consumption of alcohol, tobacco, and potentially impacted by the expected benefits derived from having insurance. An online survey sugar-sweetened beverages, earmarked or non-earmarked for health, can be an of 1,068 citizens revealed that only 25 percent of the respondents were willing to pay attractive option due to their potential positive impact on population health. For at least 3.5 percent of their monthly salary to insurance and nobody was willing to example, increasing excise taxes on cigarettes to the EU benchmark level could generate pay 7 percent which is a true cost of insurance.88 Note that the survey sample may be EUR 74-91 million over the 2026-2033 period while also reducing smoking prevalence by skewed toward the more educated that have access to an online platform, hence the 3.1 percentage points (8.6 percent) from 36.4 to 33.3 percent.83 Increasing excise taxes on willingness to pay among the general population may even be smaller. alcohol and potentially sugar-sweetened beverages also has significant revenue potential. 204. There are important considerations in increasing taxes on tobacco in Kosovo. On the practical level, this can lead to an increase in contraband tobacco imports. 85 Rocha et al. (2018) find that in Brazil a decrease in taxes on formalizing firms only had a very small and Vladisavljevic et al. (2022)84 find that 20.4 percent of current smokers in Western Balkans transitory positive impact on formalization. The estimated low formalization elasticity meant that the countries evade taxes on tobacco products, though this share is higher for hand-rolled government lost tax revenues on encouraging formalization by lowering taxes. Bíró et al. (2022) find that in Hungary increased enforcement in the formal sector led to 10.5% of workers likely receiving envelope tobacco (86.7 percent) and lower for manufactured cigarettes (8.6 percent). Kosovo is at wages (semi-formal workers) doubling their reported earnings while only 2% of these semi-informal workers left formal employment. The overall fiscal effects were positive. Ulyssea (2020) is a recent review of the evidence on the causes and consequences of informality in developing countries. Their summary of the evidence suggests that the impact of taxation on formalization is relatively muted. 82 Tandon, A., Cashin, C. Assessing public expenditure on health from a fiscal space perspective. World Bank 86 Alexandru Cojocaru. 2017. “Kosovo Jobs Diagnostic.” World Bank, Washington, DC. License: Creative Health, Nutrition and Population Discussion Paper, 2010 Commons Attribution CC BY 3.0 IGO 83 Cite FSA or health tax paper 87 Schneider et al. (2008) Kosovo Health Financing Reform Study. Report No. 43183-XK. The World Bank 84 Vladisavljevic M, Zubović J, Jovanovic O, et al Tobacco tax evasion in Western Balkan countries: tax evasion 88 Jaha, Jona, “Universal Healthcare Coverage and the Future of Healthcare in Kosovo” (2019). Thesis. prevalence and evasion determinantsTobacco Control 2022;31:s80-s87 Rochester Institute of Technology. Accessed from https://scholarworks.rit.edu/theses/10219 110 Health Policy Assessment Kosovo Public Expenditure Review 111 • How to mitigate the potential equity risk of premium contributions? Unlike income preparation steps that are suitable to Kosovo’s capacity before embarking on a full-blown tax which puts higher income people in a higher tax bracket, the current flat rate of rolling out of premium collection and before channeling most of public funds through the 7 percent payroll contribution imposes a differentially higher burden on people with HIF. low salaries. Furthermore, the practical challenges in enforcing premium contribution among the self-employed and the large size of the non-contributory group mean that 207. It is recommended that health financing reforms could be implemented in one segment of the population (the formal sector) will end up bearing the bulk of the phases, with the first phase focusing on relatively simple steps to familiarize the tax burden associated with insurance. Some countries address this issue by shifting system with the practice of strategic purchasing and pooling. The first phase will more to taxes on consumption and wealth rather than on wage-based income alone. build on activities that have been supported by the World Bank and other international For example, France has widened the revenue base for SHI to include earmarked partners. By focusing on concrete measures that have a relatively good chance of success, income tax (levied on all sources of income and not just payroll), taxes on tobacco and the proposed phasing will make the benefits of the reform more apparent to end users and alcohol, the pharmaceutical industry, and voluntary health insurance. The shift to a increase buy-in prior to implementing premium collection. Over the next 3-5 years, some broader definition of taxable income aims to address inequities in revenue generation specific activities could include: as richer individuals tend to have higher wealth-related income.89 • How to cover those who do not contribute to SHI? Moving from the current system that Piloting the management of the Outpatient Drug Benefit Package (ODBP) by the HIF finances health from general government revenues to one that raises SHI premiums, 208. Currently, outpatient drugs are procured by the MoH, stored in the central could entail moving away from universality of entitlements to entitlements based warehouse, and distributed to PHC through a public supply chain system. The on contributions. Thus, a key question is how individuals who do not contribute to distribution channel managed by the MoH stops at the MFMCs, and it is the responsibility of SHI would access health services. The health insurance law directly exempts from the MFMCs to ensure drugs are available in smaller health centers and health posts within contributions individuals who are poor according to the official poverty test. It also their network. The drugs are included in the Essential List of Medicine (ELM). There are allows for the possibility of other exemptions. Nevertheless, it is possible that some several drawbacks in the current system. First, in many municipalities, some medicines such individuals who are not exempted from the payment of contributions would fail to pay, as insulins are currently dispensed only at the MFMCs, which is a problem for patients living in which case arrangements need to be made for their being able to access services, in rural areas, who have to come to the MFMC to get drugs. Due to shortages, sometimes possible after the payment of contributions or the costs of care. facilities do not have medicines in stock, so patients have to come back to obtain them. • Evidence from global experience shows that mobilizing contributions from Although private pharmacies have a wide network, they are not contracted to distribute payroll taxes alone will not bring countries closer to UHC. Invariably, segments outpatient drugs financed from the government budget. Second, the ELM is outdated and of the population will need to be subsidized from general revenues. Furthermore, the process of updating it is not based on good practice. Finally, there is no mechanism to as countries experience the changing nature of the workforce, with increased self- assess population needs which would then inform policies, i.e. the essential list. The stock employment and increased dependency ratio due to ageing population, the share of request is mostly based on historical experience. insurance funds that are financed from employment taxes is expected to decrease. Hungary, for example, has moved to enhance the sustainability of health financing in 209. The ODBP pilot will introduce a new way of dispensing medicines by having light of ageing by relying more on transfers from general taxation for its SHI system.90 the HIF contract with private pharmacies in addition to public pharmacies of the Estonia and Montenegro went as far as abandoning mandatory contributions from FMCs. Some advantages of this system include: the ODB drugs will be easily accessible for payroll altogether. most of the population because the private pharmacy network is well-developed around the country; the cost to maintain the central warehouse and public supply chain system will be reduced and eventually be removed; and the needs of the population will be better Concrete short- and medium-term measures to develop capacity for strategic purchasing met. Implementing the pilot will help HIF to develop the capacity to fully implement and risk pooling e-prescription, manage contract with pharmacies, perform centralized procurement and 206. Significant steps are required in order to achieve the vision outlined above. framework procurement, exercise price control of pharmaceutical products and doctors’ Among others, these include adopting legislations to enable the change in the fund flow prescribing behaviors, and work with the MoH to develop an evidence-based benefit mechanism in the health sector. These also entail changes in the roles and relationships package starting with medicines – all key functions that a typical health insurance fund in among key stakeholders. For example, the MoH will no longer be directly involved in peer countries are performing. purchasing drugs and services, but will set rules and standards; individual hospitals will 210. The pilot of the ODBP should be implemented in parallel with the start of the have the status that allows them to contract directly with HIF and holds them accountable long overdue measures to control pharmaceutical pricing. Prices of medicines in Kosovo for their performance rather than being dependent on KHUCS; they will also have more are currently not regulated, and a reform that would set maximum allowed prices through autonomy in deciding their own staffing; municipalities will not manage the PHC centers international price comparisons, widen the scope of publicly financed outpatient drugs and in their jurisdiction and will not receive the grant for PHC from the Treasury, rather PHC improve their procurement and distribution has been delayed on several occasions. This centers will be contracted directly by the HIF; and health personnel must be able to receive reform foresees setting maximum allowed prices of all prescription medicines, regardless additional payment for their good performance rather than the standard wage. It is clear of whether they are paid for by the state, by benchmarking prices in North Macedonia, that such reforms entail major political risks and technical challenges. If not handled well, Albania, Montenegro, and Croatia. A law on pricing of medicinal products was developed the popularity of reforms will be at risk. For these reasons, it is important to take careful but has not been approved. 211. Some important preconditions for piloting and rolling out the ODBP are already in place, largely supported by the KHP. The drug package itself has been developed as 89 Commonwealth Fund 2020, cited in Tandon, Kurowski, and Evans (2022?) 90 Szabolcs et al 2019, cited in Tandon, Kurowski, and Evans (2022) well as two software modules – the e-prescription system housed in the MoH and the claims 112 Health Policy Assessment Kosovo Public Expenditure Review 113 management system housed in the HIF. These two systems still do not exchange information so it would be necessary to develop an application programming interface (API) to establish References communication with each other and another API for communication with the software used by the pharmacies (public and private).. Annual Financial Report on the Budget of the Republic of Kosovo, various years. Introduction of contracting and case-based payment for treatment outside the public Cashin, C, S Sparkes, D Bloom (2017), ‘Earmarking for Health: From Theory to Practice,’ sector Health Financing Working Paper No. 5, World Health Organization, Geneva, Switzerland. 212. In order to make treatment abroad financially sustainable, it is recommended JICA (2022) Data Collection Survey on Health Sector to Build Resilient Health Systems that the HIF engages in a contractual relationship with providers and develops a toward Universal Health Coverage in the Republic of Kosovo. Final Report. February 2022 simple case-based payment as a form of payment. Case-based payment is a popular Nguyen, H, M Aliu, L Voncina, D Prinz (2023), ‘Kosovo Health System: An Assessment of Core method to control hospital inpatient expenditures across countries. It can be based on a Functions and Performance,’ Mimeo, World Bank, Washington, DC. single flat rate per case or in a more complex form - DRGs. Currently, HIF reimbursement for leukemia, the most common condition for treatment abroad, is subject to a wide range - Tandon, A, C Kurowski, D Evans (2023), ‘General Taxation and Social Health Insurance,’ between EUR 90,000 and EUR 900,000. In a case-based payment model, the cost (price) of Mimeo, World Bank, Washington, DC. the treatment of leukemia would be predefined. This price would be offered to healthcare providers abroad which would then be contacted by the HIF for a certain volume of services Voncina, Luka (2021) Kosovo Health Insurance Fund Financing Plan 2022-2026. Technical (patients). Through this activity, the HIF would also build its capacity for managing hospital Note. contract and introducing a full-fledged DRG payment system for hospital services in the World Bank (2020). Policy Note on Financing Education and Health at the Local Level in future. Kosovo. Kosovo Local Administration Policy Diaglogue Platform. July 2020. Gradually expanding performance-based capitation payment (PBCP) building on the World Health Organization (2019) Primary health care in Kosovo: rapid assessment. experience of the KHP 213. Under KHP, MFMCs received additional transfers from the budget to finance quality improvement activities in the municipalities. The transfer was defined as “performance-based” in a sense that a fixed and small amount is awarded for each patient registered using a simple information system, practically incentivizing facilities to use the patient registration application developed for PHC. In this system, the MoH signed MOU with each municipality which specified expectations and eligible use of funds. Additional funding was appreciated by the municipalities as instrumental for improving quality of care and responding to the emergency COVID-19 situation. However, there was no rigorous mechanism to assess the effects of such funds on real performance and the performance- based payment ended with the closing of KHP. The on-going capitation grant formula does not incentivize quality improvement, is based on old census data, and does not fulfil the PHC’s needs. 214. Building on this recent experience, Kosovo could reinstitute PBCP with certain modifications to develop a system for capitation payment that is in line with international best practice. Specifically: • “Performance” will be defined in terms of actual service delivery, such as population screening, home visit, and preventive health checkup. In the beginning, it is important to select simple indicators that are easy to capture and verify. Modification of the information system could be needed to capture such indicators • The MFMCs will sign a contract with the HIF instead of an MOU with the MoH, practically making HIF the purchaser of these services • In addition to performance-based payment, the capitation amount should also adjust for some basic demographic information of the catchment population, such as age and sex • In the beginning, the funds will be small and independent of the current PHC grant to avoid risks to providers. Such funds could come from the annual adjustment set by the MOF. Gradually, a larger portion of PHC funding could be channeled through the HIF until the Fund is capable of handling full payment for PHC, and legislation will change accordingly to allow for the modification of PHC fund flow. 114 Health Policy Assessment Kosovo Public Expenditure Review 115 WORLD BANK GROUP