Document of The World Bank

Report No.:26687

PROJECT PERFORMANCE ASSESSMENT REPORT

ROMANIA

INDUSTRIAL DEVELOPMENT PROJECT (LOAN 3735)

PRIVATE SECTOR ADJUSTMENT LOAN (LOAN 4489)

September 3, 2003

Sector and Thematic Evaluation Operations Evaluation Department

Currency Equivalents (annual averages) Currency Unit = Romanian Leu (plural Lei)

1994 US$1.00 1,655 1995 US$1.00 2,033 1996 US$1.00 3,083 1997 US$1.00 7,168

1998 US$1.00 8,876 1999 US$1.00 15,333 2000 US$1.00 21,709 2001 US$1.00 29,061

Abbreviations and Acronyms

ALPROM Aluminum Products Company of Romania

ALRO Aluminum Company of Romania

APAPS Authority for Privatization and Management of State Ownership

AVAB Agentia de Valorificare a Activelor Bancare

BA Bank Agricola BCR Banca Comerciala Romana BCR Romanian Commercial Bank BE Business Environment CAS Country Assistance Study CPI Consumer Price Index EBRD European Bank for

Reconstruction and Development

EIB European Investment Bank ES Evaluation Summary EU European Union Exim Export Import Bank of

Romania FESAL Financial and Enterprise

Structural Adjustment Loan FIAS Foreign Investment Advisory

Service GOR Government of Romania IAS International Accounting

Standards IBRD International Bank for

Reconstruction and Development

ICR Implementation Completion Report IDP Industrial Development Project IFC International Finance

Corporation IMF International Monetary Fund MOF Ministry of Finance MOPF Ministry of Public Finance NBR National Bank of Romania NGO Non-Governmental

Organization NPL Non-Performing loans OED Operations Evaluation Department PFI Participating Financial

Institution PIBL Private Sector Institution

Building Loan PPAR Project Performance Assessment Report PSAL Private Sector Adjustment

Loan RDB Romanian Bank for Development SAR Staff Appraisal Report SIDEX Romanian Steel Company SMEs Small and Medium-sized

Enterprises SOEs State-owned Enterprises SOF State Ownership Fund TAROM Romanian State Airline TA Technical assistance WTO World Trade Organization

Fiscal Year

Government: January 1 – December 31

Director-General, Operations Evaluation : Mr. Gregory K. Ingram Acting Director, Operations Evaluation Department : Mr. Nils Fostvedt Manager : Mr. Alain Barbu Task Manager : Ms. Kris Hallberg

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OED Mission: Enhancing development effectiveness through excellence and independence in evaluation.

About this Report

The Operations Evaluation Department assesses the programs and activities of the World Bank for two purposes: first, to ensure the integrity of the Bank’s self-evaluation process and to verify that the Bank’s work is producing the expected results, and second, to help develop improved directions, policies, and procedures through the dissemination of lessons drawn from experience. As part of this work, OED annually assesses about 25 percent of the Bank’s lending operations. In selecting operations for assessment, preference is given to those that are innovative, large, or complex; those that are relevant to upcoming studies or country evaluations; those for which Executive Directors or Bank management have requested assessments; and those that are likely to generate important lessons. The projects, topics, and analytical approaches selected for assessment support larger evaluation studies.

A Project Performance Assessment Report (PPAR) is based on a review of the Implementation Completion Report (a self-evaluation by the responsible Bank department) and fieldwork conducted by OED. To prepare PPARs, OED staff examine project files and other documents, interview operational staff, and in most cases visit the borrowing country for onsite discussions with project staff and beneficiaries. The PPAR thereby seeks to validate and augment the information provided in the ICR, as well as examine issues of special interest to broader OED studies.

Each PPAR is subject to a peer review process and OED management approval. Once cleared internally, the PPAR is reviewed by the responsible Bank department and amended as necessary. The completed PPAR is then sent to the borrower for review; the borrowers' comments are attached to the document that is sent to the Bank's Board of Executive Directors. After an assessment report has been sent to the Board, it is disclosed to the public.

About the OED Rating System

The time-tested evaluation methods used by OED are suited to the broad range of the World Bank’s work. The methods offer both rigor and a necessary level of flexibility to adapt to lending instrument, project design, or sectoral approach. OED evaluators all apply the same basic method to arrive at their project ratings. Following is the definition and rating scale used for each evaluation criterion (more information is available on the OED website: http://worldbank.org/oed/eta-mainpage.html).

Relevance of Objectives: The extent to which the project’s objectives are consistent with the country’s current development priorities and with current Bank country and sectoral assistance strategies and corporate goals (expressed in Poverty Reduction Strategy Papers, Country Assistance Strategies, Sector Strategy Papers, Operational Policies). Possible ratings: High, Substantial, Modest, Negligible.

Efficacy: The extent to which the project’s objectives were achieved, or expected to be achieved, taking into account their relative importance. Possible ratings: High, Substantial, Modest, Negligible.

Efficiency: The extent to which the project achieved, or is expected to achieve, a return higher than the opportunity cost of capital and benefits at least cost compared to alternatives. Possible ratings: High, Substantial, Modest, Negligible. This rating is not generally applied to adjustment operations.

Sustainability: The resilience to risk of net benefits flows over time. Possible ratings: Highly Likely, Likely, Unlikely, Highly Unlikely, Not Evaluable.

Institutional Development Impact: The extent to which a project improves the ability of a country or region to make more efficient, equitable and sustainable use of its human, financial, and natural resources through: (a) better definition, stability, transparency, enforceability, and predictability of institutional arrangements and/or (b) better alignment of the mission and capacity of an organization with its mandate, which derives from these institutional arrangements. Institutional Development Impact includes both intended and unintended effects of a project. Possible ratings: High, Substantial, Modest, Negligible.

Outcome: The extent to which the project’s major relevant objectives were achieved, or are expected to be achieved, efficiently. Possible ratings: Highly Satisfactory, Satisfactory, Moderately Satisfactory, Moderately Unsatisfactory, Unsatisfactory, Highly Unsatisfactory.

Bank Performance: The extent to which services provided by the Bank ensured quality at entry and supported implementation through appropriate supervision (including ensuring adequate transition arrangements for regular operation of the project). Possible ratings: Highly Satisfactory, Satisfactory, Unsatisfactory, Highly Unsatisfactory.

Borrower Performance: The extent to which the borrower assumed ownership and responsibility to ensure quality of preparation and implementation, and complied with covenants and agreements, towards the achievement of development objectives and sustainability. Possible ratings: Highly Satisfactory, Satisfactory, Unsatisfactory, Highly Unsatisfactory.

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Contents

Principal Ratings................................................................................................................v

Key Staff Responsible ........................................................................................................v

Preface.............................................................................................................................. vii

Summary........................................................................................................................... ix

1. Introduction..................................................................................................................1

Background..............................................................................................................1

2. Industrial Development Project..................................................................................3

Implementation Experience .........................................................................6 Outcome.....................................................................................................11 Sustainability..............................................................................................14 Institutional Development Impact..............................................................14 Bank Performance......................................................................................15 Borrower Performance...............................................................................16

3. Private Sector Adjustment Loan ..............................................................................17

Implementation Experience .......................................................................19 Outcome.....................................................................................................19 Sustainability..............................................................................................24 Institutional Development Impact..............................................................24 Bank Performance......................................................................................24 Borrower Performance...............................................................................25

4. Lessons Learned.........................................................................................................25

Industrial Development Project .................................................................25 Private Sector Adjustment Loan ................................................................26

Annex A. Basic Data Sheet..............................................................................................28

Annex B. Private Sector Institution Building Loan (PIBL): Project Components...31

Annex C. Outline of Action Plan to Improve the Business Environment ..................33

Annex D. List of Persons Met .........................................................................................36

This report was prepared by Kris Hallberg and Elliot Hurwitz (Consultant), based on a mission to Romania in December, 2002. Helen Phillip provided administrative support.

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Box

Box 1: Policy-related Measures Achieved During Project Preparation............................. 8 Tables

Table 1: Table 1.1: Selected Macroeconomic Indicators................................................... 2 Table 2: : Participating Financial Institutions for Investment Lending ............................. 9 Table 3: Aggregate Balance Sheet of Romanian Banks, 1998-2002................................ 13 Table 4. Credit to the Private Sector, percent of GDP...................................................... 14 Figures

Figure 1: Two PPAR Projects and Related Loan ........................................................... 3 Figure 2: IDP Disbursements—Estimated vs. Actual......................................................... 7 Figure 3. Romania: Credit to the Private Sector, 1996-2002............................................ 14 Figure 4. Fiscal Deficit as a Percent of GDP, 1992-2002................................................. 22

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Principal Ratings Industrial Development Project (Loan 3735)

ICR* ES* PPAR Outcome Satisfactory Unsatisfactory Unsatisfactory Sustainability Likely Unlikely Likely Institutional Development Impact

Modest Negligible Negligible

Bank Performance Satisfactory Unsatisfactory Unsatisfactory Borrower Performance

Satisfactory Unsatisfactory Unsatisfactory

Private Sector Adjustment Loan (Loan 4489)

ICR* ES* PPAR Outcome Satisfactory Satisfactory Satisfactory Sustainability Likely Likely Highly Likely Institutional Development Impact

High Substantial Substantial

Bank Performance Satisfactory Satisfactory Satisfactory Borrower Performance

Satisfactory Satisfactory Satisfactory

* The Implementation Completion Report (ICR) is a self-evaluation by the responsible operational division of the Bank. The Evaluation Summary (ES) is an intermediate Operations Evaluation Department (OED) product that seeks to independently verify the findings of the ICR. Key Staff Responsible Industrial Development Project (Loan 3735) Project Task Manager/Leader Division Chief/

Sector Director Country Director

Appraisal Sonja Brajovic-Bratanovic

Fred Levy Michael Wiehan

Completion Marcelo Bueno Paul Siegelbaum Andrew Vorkink

Private Sector Adjustment Loan (Loan 4489) Project Task Manager/Leader Division Chief/

Sector Director Country Director

Appraisal Khaled Sherif Yasuo Izumi Andrew Vorkink Completion Khaled Sherif Yasuo Izumi Andrew Vorkink

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Preface

This is the Project Performance Assessment Report (PPAR) for the Private Sector Adjustment Loan (PSAL) for US$300 million, and the Industrial Development Project (IDP), in the amount of US$175 million. The PPAR is based on the President’s Report for the PSAL and the Staff Appraisal Report (SAR) for the IDP, legal documents, the project files, related economic and sector work, as well as interviews with Bank staff and Romanian officials, other donors, and the Implementation Completion Reports for the two projects, prepared in October, 2000 for the PSAL and in June, 2001 for the IDP.

The IDP was approved by the Board in the amount of US$175 million in May, 1994 (later reduced to US$120 million), and closed in December, 2001, two years later than planned after disbursing US$96.9 million.

The PSAL was approved by the Board in June, 1999, and disbursed its first tranche of US$150 million upon effectiveness, in August, 1999. The second tranche of an equal amount disbursed after completion of specified reforms shortly before the project closed as planned in June, 2000.

An OED mission visited Romania in December, 2002, to discuss the two projects with Romanian officials, donors, Resident Mission staff, and other stakeholders. Their cooperation and assistance is gratefully acknowledged.

Following standard OED procedures, copies of the draft PPAR were sent to the relevant government officials and agencies for their review and comments, but none were received.

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Summary

The Romania Industrial Development Project (IDP was approved in May, 1994, and closed in December, 2001), and the Private Sector Adjustment Loan (PSAL was approved in June, 1999, and closed in June, 2000).

The main objectives of the Industrial Development Project (IDP) were to promote private sector growth, particularly by advancing enterprise privatization and restructuring; and to facilitate transformation of credit markets and introduce safe and sound banking practices. This was to be done mainly by the use of two credit lines, together with technical assistance. Prior to 1999, progress on structural reforms had been limited, and a Financial and Enterprise Sector Adjustment Loan (1995-98) had achieved only limited success.

The PPAR finds that the design of the IDP was not well-suited to the achievement of its objectives. The project envisioned transforming credit markets by bolstering the capacity of participating financial institutions (PFIs) using a “learning by doing” approach as they utilized the credit lines, along with a relatively small TA program. This approach was insufficient to deal with a sector still dominated by structures and practices from the time of central planning. Quality at Entry was unsatisfactory, considering that the IDP was undertaken in an unstable macroeconomic environment. Disbursement of the project’s two credit lines was much slower than envisioned, and by project close 79 percent of funding intended for investment finance and 18 percent of funds to support exports had been disbursed. More than two-thirds of investment lending under the IDP was made by three state-owned banks, which had large portfolios of non-performing loans. Overall, non-performing loans comprised 46 percent of all lending under the IDP. Credit to the private sector declined during the implementation of the IDP, and Romania remains lower by this measure than most other transition economies.

The objectives of the Private Sector Adjustment Loan (PSAL) were to support reforms in the enterprise, financial, and social sectors, as well as to improve the environment for private business. The PSAL was intended to accelerate privatization—especially of medium and large-sized firms—restructure state-owned banks to facilitate their privatization or liquidation, and mitigate the employment impact of privatization. The PSAL was largely successful at putting into place a framework for privatization of many of the country’s largest loss-making firms, and thereby reducing the fiscal burden of the enterprise sector. Many of the sales occurred within a year after the project closed. The country’s fiscal deficit declined from 5.5 percent of GDP in 1997 to 2.8 percent of GDP in 2002. The project also established a framework for the resolution of problem banks (e.g., sale, restructuring, liquidation), and made major progress in privatizing large state-owned banks. Bank supervision and accounting and auditing standards were also strengthened. In the social sector, the impact of the structural changes was mitigated by the provision of unemployment and severance benefits as well as other assistance to laid-off workers. Progress was made in laying a foundation for an improved business environment. A law on collateral was passed and a registry established that facilitated its use in secured transactions; tax reform, as well as accounting and audit reform, were

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implemented, and an Action Plan to improve the business environment—based on FIAS recommendations—is being implemented.

The PPAR rates the outcome of the IDP, and Bank and Borrower performance, as unsatisfactory. Institutional Development Impact (IDI) is rated as negligible. Sustainability is rated as likely, compared to unlikely in the ES, based mainly on the more favorable macroeconomic performance of the last three years, the accelerated privatization that has occurred subsequent to project completion, and the prospect of EU accession, which serves as a powerful incentive to maintain and extend reform.

The PPAR rates the outcome of the PSAL, and Bank and Borrower Performance, as satisfactory. IDI is rated as substantial. Sustainability is rated as highly likely.

Key findings and lessons for the IDP included: Financial sector operations should

be undertaken only in a conducive macroeconomic environment; for a project whose goal is to advance structural transformation of the enterprise sector, a more suitable instrument might have been an adjustment operation; the size of the line of credit was too large given the risks and uncertainties of the macro and business environment. For the PSAL, lessons included: Timing and government commitment are critical to the success of an ambitious reform program; ready access to technical assistance was key to project achievement.

Gregory K. Ingram Director-General Operations Evaluation

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1. Introduction

BACKGROUND

1.1 Romania was ruled by Communists for more than four decades until the December, 1989, revolution. The governments that followed were cautious in their approach to structural reforms, and consequently by 1999 much of the legacy of central planning remained. Many loss-making enterprises—both in the enterprise and financial sectors—remained in state hands, and their budgetary and quasi-fiscal burden was large (see Table 1.1). Elections in late 1996 brought reformers to the fore, with a mandate to liberalize the economy, privatize state-owned banks and enterprises, and put the country into a position where it could be considered as a candidate for entry into the European Union (EU).

1.2 However, privatization progress remained slow. An earlier Bank project which aimed to spur reforms in these areas, the Financial and Enterprise Sector Adjustment Loan (FESAL) achieved only limited success. While the FESAL achieved success in deregulation of foreign exchange, prices, and trade, it was less successful in privatization of banks and industrial enterprises, which remained largely state-owned. An OED Performance Audit Report rated outcome as moderately unsatisfactory and Bank and Borrower performance as unsatisfactory. 1 Government commitment was lacking, and financial discipline in the enterprise sector was undermined by the accumulation of arrears, provision of loans to weak enterprises and rollover of loans to such firms, and an insufficient environment of the “rule of law” which made it difficult for banks to collect on loans through the legal system.

1.3 During the same period the business environment (BE) was unfriendly to private business. Businessmen reported that the application of laws and regulations was unpredictable, the labor code was inflexible, and obtaining a permit was cumbersome. Private firms sometimes faced competition from businesses that benefited from state-guaranteed borrowing.

1.4 Macroeconomic Environment—Immediately following the revolution, output fell, but recovery started in 1993 and growth continued until 1996 (Table 1.1). However, this growth was accompanied by large fiscal and quasi-fiscal deficits, high and variable inflation, and a large current account deficit. There were subsidies to favored enterprises, and accumulation of arrears by many firms to banks, utilities, and social funds. This reached a peak in the first half of 1996 when the 150 largest State-owned Enterprises (SOEs) posted losses twice as high as the entire year 1995. In 1997, inflation reached over 150 percent, and output from 1997 to 1999 contracted by nearly 13 percent. At one point in 1997, the government’s foreign exchange reserves reached a perilously low level (US$700 million) and it was feared that the country might default on its foreign debt obligations. The country was out of compliance with its International Monetary Fund (IMF) Stand-by Arrangements for much of the period from 1994 to 1998, and was able to

1. OED, Performance Audit Report (PAR), Financial and Enterprise Sector Adjustment Loan, and Social Protection Adjustment Loan, February, 2001. The loan for US$280 million was approved by the Board in January 1996, however, US$100 million remained undisbursed, and the project closed in April 1998, 4 months later than envisioned.

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draw only SDR214.5 million out of SDR622 million, or 34.5 percent, of the amount approved during that time.

1.5 Since 1997, macroeconomic performance has gradually improved, despite a banking sector crisis in 1999. Inflation has gradually fallen to 34.5 percent in 2001, and an estimated 19.8 percent in 2002.2 Real GDP growth turned positive in 2000, growing by 5.3 percent in 2001, and estimated to grow by 4.5 percent in 2002. During the period 1994-2000, when the IDP and PSAL were implemented, the country experienced considerable macroeconomic volatility.

Table 1: Table 1.1: Selected Macroeconomic Indicators Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Annual Real GDP growth % change -5.6 -12.9 -8.8 1.5 3.9 7.2 3.9 -6.1 -4.8 -1.2 1.8 5.3 4.5

GDP index (1990=100, %) 100 87.1 79.4 80.6 83.8 89.8 93.4 87.7 83.5 82.4 84.0 88.4 92.3

Annual (CPI) inflation, ave, % 5.1 170.2 210.4 256.1 136.7 32.5 38.8 154.8 59.1 45.8 45.7 34.5 22.5

Exports (US$, millions) 4.9 6.1 7.9 8.1 8.4 8.3 8.5 10.3 11.4 13.7 FDI , net 1 (mil. USD) ... 40 77 94 341 419 263 1,215 2,031 1,041 1,040 1,157 1,100 Budget deficit, as % of GDP … … -4.6 -0.4 -2.2 -3.4 -4.8 -5.2 -5.5 -3.6 -4.0 -3.3 -2.8

Tax revenues, as % GDP … … 33.5 31.3 28.2 28.8 26.9 26.5 28.2 30.1 29.4 28.3 Current Account, as % of GDP … … -8.0 -4.5 -1.4 -5.0 -7.3 -6.1 -7.0 -4.1 -3.7 -5.8 -4.3

Total employed 2

(000) 10839 10786 10458 10062 10011 9493 9379 9023 8813 8420 8629 …

Exchange rate, year average, ROL/US$ 22.4 76.4 307.9 760.0 1655.1 2033.3 3082.6 7167.9 8875.6 15332.9 21692.7 29060.9

1/ Net Foreign Direct Investment in Romania 2/ Employment : includes, in accordance with NIS methodology used for the labor force balance, all persons who, during the reference year, carried out a socio-economic profitable activity, excepting military staff and similar, political and community staff. Source: Romania Country Department, IMF, International Financial Statistics, August 2000 and IMF Staff Report 2002 . 1.6 The budget deficit, which reached a high of 5.5 percent of GDP in 1998, has declined since then and was 2.8 percent in 2002. In addition to the fiscal deficit shown above, it is important to consider the country’s non-energy quasi-fiscal deficit, as well as the implicit subsidies and quasi-fiscal deficit of the energy sector, which also placed a substantial burden on the state treasury. (It was the aim of the PSAL to privatize many large loss-making firms, and thus lessen the fiscal drain of the enterprise sector; PSAL II—not the subject of this PPAR—addressed the energy sector). One study estimates that the deficit of 86 major loss-making firms was around 1.1 to 1.4 percent of GDP in 2000 and 2001.3 After rapid increases in energy sector losses in 2000, energy prices were raised substantially,4 which resulted in a rapid decline in energy usage and in the sectoral quasi-fiscal deficit (from 4.9 to 2.7 percent of GDP between 200 and 2002).

2. IMF, Staff Report for 2002 Article IV Consultation, December, 2002, p. 7.

3. OECD, “Economic Surveys: Romania,” October, 2002, p. 46.

4. Between mid-2001 and mid-2002, the gas price for households was raised by over 85 percent, the heating price was doubled, and the price of electricity was raised by 42 percent (all in US dollar terms). IMF, December 2002 Staff Report.

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Figure 1: Two PPAR Projects and Related Loan

Two PPAR Projects and Related Loan$-original $-actual

Ind Development 175 97 PSAL 300 300FESAL 280 180

Project included in this PPAR

20001998 19991995 1996 19971994

2. Industrial Development Project

Objectives

2.1 The objectives of the Industrial Development Project (IDP) were to (a) promote growth of the private sector and create conditions for an effective supply response from viable private industrial enterprises; (b) advance structural transformation of the enterprise sector—specifically privatization and restructuring; and (c) facilitate transformation of credit markets and introduction of safe and sound banking practices. These objectives were to have been achieved by: (a) improving access to foreign exchange credit for investment and export finance to viable private enterprises; (b) assisting in the design of the necessary policies and strengthening the institutional framework for privatization and restructuring; (c) strengthening the capacity of participating financial institutions (PFIs) to efficiently allocate resources and improve financial services to the corporate sector.

2.2 Components and Design—It was envisioned that the US$175 million loan would be allocated in the following manner:

Finance component—US$172 million • Investment finance—US$102 million • Export finance—US$70 million

Technical assistance (TA)—US$3 million (later raised to US$7 million)

2.3 The project design provided for the Ministry of Public Finance (MOPF) to lend through an apex organization, initially the MOPF Treasury Department, to PFIs, which would then on-lend the funds to sub-borrowers. However, the MOPF was unable to serve this function as a result of a legal opinion that Parliamentary approval would be needed, and consequently, prior to project effectiveness, Export Import Bank of Romania (Eximbank) was appointed as the apex. (This change added to project delays) Funds were provided to PFIs based on a reference rate based on LIBOR plus a market-based spread (0.5 percent) to cover Exim Bank’s costs.

2.4 Sub-loans were denominated in US dollars under the Bank’s single currency program, with a term of from 3-17 years, with a maximum of US$8 million (investment

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lending), and with lending rates set at the reference rate plus a market-determined margin set by each PFI (generally around 2-3 percent). PFIs assumed credit risk, while sub-borrowers assumed the foreign exchange risk. Loans to final borrowers were to be made on a first-come, first-served basis.

2.5 Funds were also available for export finance, for which the borrower had to meet the following criteria: possession of an irrevocable letter of credit or confirmed purchase order, and relevant export experience. The maximum loan size for an export loan was US$5 million, and the maximum length was one year.

Relevance of the Objectives

2.6 The IDP objectives were of modest relevance because they did not reflect a completely accurate diagnosis of the development barriers confronting the country. The project was based, in part, on the presumption that the lack of availability of term lending was a major constraint to enterprise expansion. This presumption turned out to be unrealistic, because even when funds from the IDP did become available, many firms did not have the expertise or resources to develop the feasibility studies required by lenders (i.e., they did not apply),5 or they did not utilize the funds successfully if they did secure a loan (leading to a large proportion of non-performing loans, or NPLs, as described below).

2.7 In addition, the project design was insufficient to achieve its objectives. The effort to advance structural transformation of the enterprise sector was dependent on the sufficiency of policy-related measures achieved during project preparation, along with financial support to private enterprise restructuring. While these actions were helpful, they fell far short of being sufficient to ensure progress in this very difficult area (see Box 1).6 Similarly, the project envisioned transforming credit markets and introducing safe and sound banking practices by utilizing a relatively small program of technical assistance, and then bolstering PFI capacity to appraise and manage loans using a “learning by doing” approach. The use of this approach for a sector dominated by large state-owned banks that were routinely providing extensive loans to large SOEs, in many cases on a politically-directed basis, also fell short of being sufficient to assure progress.7

2.8 The IDP was inconsistent with the 1994 partial CAS. While it clearly fit within one of the five “main areas of reform emphasis,” privatization and private sector development, it did not meet the CAS requirement that lending in this area “be conditioned on an overall adequate macroeconomic framework,” (see next para).

2.9 Quality at Entry—Quality at entry was unsatisfactory. First, the IDP was undertaken in a unstable macroeconomic environment (Table 1.1).8 Inflation was 137

5. Based on interviews with project and RM staff.

6. One of the lessons drawn in this PPAR is that an adjustment operation would probably have been a more suitable instrument.

7. The difficulties of achieving change in the financial sector are described in the OED Performance Audit Report of the FESAL, February, 2001.

8. This was acknowledged in the ICR: “The project was executed when Romania’s macroeconomic and business environment were very volatile.” ICR for Industrial Development Project, June 28, 2001, p. 11.

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percent in 1994, the year of project approval, over 200 percent in the two years prior to project approval, and over 30 percent and rising in the years following approval. Other macroeconomic indicators were also highly unstable.

2.10 The Operational Directive 8.30 of 1992 was clear on the approach to be used in such circumstances:

“[in unstable macroeconomic situations] economic actors become more concerned with protecting the value of their assets and less interested in identifying productive investments.

In advance of any financial sector operation, therefore, an explicit assessment should be made of the conduciveness of the country’s macroeconomic environment to realizing the operation’s goals. In particular, where inflation currently exceeds or is projected to exceed 30 percent per year, or the rate of inflation exceeds 20 percent and has shown an accelerating trend in the current year, a proposal to go ahead with financial sector lending should include an analysis of expected inflation trends and their effects on financial decisions in the economy generally, and on the likelihood of the operation’s achieving its intended objectives.”

2.11 The project documents do not reflect an assessment of the conduciveness of the macroeconomic environment to the realization of project goals.9 The unstable macroeconomic environment acted to reduce the demand for credits under the project. However, other factors also acted to constrain the demand for credit: delays in project effectiveness, (see para 2.13, below); a poor business environment, which made it difficult for private firms to operate; and the relatively small number of banks that met IDP eligibility criteria.

2.12 A second factor in quality at entry, the capacity of the financial sector to support the IDP, was weak. Many state-owned banks accredited as PFIs consistently made problematic loans, and so the government had to recapitalize weak banks to the extent of 1.5 percent of GDP in 1996, 1.7 percent in 1998, and 2 percent in 1999.10 Further, the capacity of the National Bank of Romania (which had a key role in the accreditation of PFIs—see para 2.24) in bank assessment and supervision was deficient: “…the ability of the National Bank of Romania’s (NBR’s) banking supervision staff to perform the most basic risk-based supervision, and to obtain an accurate picture of the financial condition of banks, is questionable.”11

2.13 Third, the project design presumed that the policy-related measures undertaken during project preparation (see Box 1) would advance privatization and restructuring of enterprises and serve as a catalyst for private sector growth. This presumption also proved unrealistic, as the measures fell well short of what was needed to achieve the 9. Except that macroeconomic instability was recognized as a risk: “….the macroeconomic environment and the progress-in-transition programs and in project implementation will be thoroughly reviewed one year after loan effectiveness, with an option to cut off further commitments in case of seriously adverse developments or to redesign the proposed project.” SAR, para. 7.06 (italics added).

10. OED, Performance Audit Report, Romanian FESAL, February, 2001, p. 2.

11. Romania Financial Sector Review, op. cit., p. 33.

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objective in this area. In the event, support from Government was uneven, the State Ownership Fund retained a majority stake in many large enterprises, and overall progress in privatization and restructuring was disappointing.12 It was not until 1999, with the advent of the PSAL, that major progress was made in these areas. Indeed, if the project goal was to advance structural transformation, a more suitable instrument might have been an adjustment or technical assistance operation.

2.14 Fourth, the project was over-dimensioned, i.e., the credit lines were too large for such a risky and unstable environment. The Bank might have utilized smaller credit lines in an initial effort to gauge the market, and then developed a larger facility if demand was strong and subloans proved to be of good quality.

2.15 A fifth element of quality at entry was the confusing process established for initial accreditation and ongoing review of PFIs (discussed in detail in para 2.24). This process diffused responsibility between the apex, the Bank, and the NBR.

2.16 Finally, the project was not ready for implementation at the time of approval. This is explained more fully in the next paragraph.

Implementation Experience

2.17 IDP start-up was substantially delayed,13 and the project disbursed much more slowly than envisioned. Board consideration was delayed by the time taken to reach agreement on policy-related measures (Box 1). After Board approval, effectiveness was delayed by factors including: the need to make detailed arrangements for Exim Bank as the apex; difficulty in recruiting qualified PFIs and in training their staffs; and reaching closure on other project administrative arrangements. When the project did become effective, disbursements were delayed by the time needed to consummate sub-loan agreements with PFIs. Meanwhile, other multilateral and bilateral financial institutions (EBRD, EIB, bilateral export credit agencies) entered the market, resulting in less demand for loans under the IDP. Figure 2, below, shows the loan’s estimated versus actual disbursements. Over the term of IDP, macroeconomic turbulence and the availability of more attractive outlets for PFI investments also hindered lending to enterprises.

12. OED, FESAL PAR, p. 6-7.

13. It took around two years from the start of project identification until Board approval in May, 1994. IDP became effective in July, 1995, and the first commitment was made in March, 1996.

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Figure 2: IDP Disbursements—Estimated vs. Actual

IDP Disbursements: Estimated vs. Actual

0102030405060708090

1994 1995 1996 1997 1998 1999 2000 2001

US$

, mill

ions

estimated

actual

2.18 By the end of the project 80 percent of the US$102 million originally intended for investment finance was disbursed, and 18 percent of the US$70 million disbursed to support exports. Of the technical assistance funds, US$4.1 million of the US$7 million was spent, or 51 percent. One consequence of the slow disbursement was that the apex organization, Exim Bank, lost money on the IDP from 1994 through 2000—when it began to earn a profit—because it had to pay the commitment fee on the undisbursed balance (0.5 percent per year). It is estimated that Eximbank (and ultimately its owner, the GOR), paid a commitment fee on the IDP of US$1.7 million.

2.19 Eximbank Role—In 1998, the MOPF requested that Eximbank be permitted to make loans directly to enterprises, i.e., act as a PFI. Because of the numerous conflicts of interest that this would bring, a Bank mission discussed this question with the Ministry, and MOPF withdrew the request. However, Eximbank was permitted to lend reflows from loan repayments on its own account, subject to the same criteria as all other lenders. While this resolution permitted Eximbank to recover some of its losses, it shifted Eximbank’s role away from the agency and administrative functions originally intended, and permitted it to assume credit risk for the sub-loans.

2.20 The question of Eximbank’s ultimate role in the banking system is problematic. In the long run the private banking system should be able to provide export and export-related financing, and there is a question whether a public bank should be the position of competing with these private banks. It may be useful to reconsider the role of Eximbank and potentially limiting it to providing insurance, export guarantees, and other products traditionally provided by similar institutions.

8

Box 1: Policy-related Measures Achieved During Project Preparation

2.2thaplaoffecomproUS

2.2maAs parprocommathe

14. Ssucceased

Privatization

• Complete development of legal and institutional framework o Finalize State Ownership Fund by-laws and initiate staffingo Finalize Private Ownership Fund by-laws

• Speed up Privatization

o Start distribution of certificates of ownership o Finalize draft procedure for privatization of small firms o Adoption of 1993 privatization program

Enterprise Reform

• Improve Corporate Governance o Pass amendments on corporate boards o Submit to Parliament draft law on public accountants

• Create Enabling Environment for PSD o Agreed SME Loan Guarantee Program

1 Because of the generally slow progress, the project was restructured in 1998. At t time, an effort was made to recruit additional banks as PFIs, additional emphasis was ced on extending loans to small and medium enterprises,14 local currency lending was red, and loan approval procedures were streamlined. It was at this time that the TA ponent was expanded from US$3 million to US$7 million. In September, 1999, the

ject was further restructured, with the loan amount reduced from US$175 million to $120 million, and the closing date extended two years to December, 2000.

2 Investment Component—Eight PFIs participated in the investment component, king 74 loans (to 55 enterprises) totaling US$80.4 million, or US$1.1 million per loan. shown in Table 2, below, an additional six PFIs were accredited, but did not ticipate. The four banks accredited in 1999 reflect efforts to increase utilization of ject funds—efforts that were modestly successful. Lending under the investment ponent was highly-concentrated: more than two thirds of investment lending was

de by three state-owned banks: Romanian Commercial Bank (BCR), Bankorex, and Romanian Bank for Development (RDB).

mall and medium enterprises had been eligible since project inception, but few had the resources or sophistication to develop

essful loan applications. In the 1998 restructuring, PFIs were encouraged to seek business from SMEs, and lending terms were to facilitate their participation.

9

Table 2: : Participating Financial Institutions for Investment Lending

Ownership (at

time of accreditation)

Accreditation Percent of total IDB lending

Percent non-performing loans (as percent of total IDB lending)

Disposition

Romanian Commercial Bank (BCR)*

Public 2/96 48.4 33.7 o/w 27.3 Bankorex o/w 6.4 BCR

Privatization is a condition of PSAL II

Romanian Development Bank (RDB)

Public 6/95 20.0 12.1 Privatized 3/99

Ion Tiriac bank

Private 6/95 9.5 Unknown, but thought to be negligible

Demir Bank Private 4/99 6.1 “ Turko-Romanian Bank

Private 1/97 5.5 “ Bankrupt 2/02; MOPF to pay obligations

The Romanian Bank

Private 6/99 5.0 “

BankCoop Private 11/95 2.2 “ Suspended as PFI, 7/97; bankrupt 2/00; MOPF paid obligations to IBRD

Bankorex Public 6/95 (included in BCR total)

Closed and absorbed by BCR in 1999, which took over its assets

Bucharest Bank

Private 8/95 Merged into BCR 9/99

Franco-Romanian Bank

Private 8/95 Accredited, but did not participate in project

Societe General

Private 7/95 Accredited, but did not participate in project

BankPost Public 9/96 Accredited, but did not participate in project; suspended, 7/97

RoBank Private 6/99 Accredited, but did not participate in project

Citibank Private 11/99 Accredited, but did not participate in project

*Includes Bankorex assets transferred in 1999. In 2002, two unsuccessful attempts were made to sell BCR, and then in February, 2003, the government announced that 25% would be sold to the EBRD and IFC, and a majority stake would be divested to a strategic investor at a later date. 2.23 Part of the reason for the lack of demand was that the loan proceeds were in US dollars, and many potential borrowers received payment in different currencies, and were unwilling to take the foreign exchange risk. In addition to the business and macro environment described above, other factors limiting demand included firms’ inability to prepare bankable projects; onerous requirements for collateral; a cumbersome loan

10

approval process (especially prior to the 1998 project restructuring); a lack of interest on the part of some PFIs in utilizing IDP funds.15

2.24 Accreditation of PFIs—The process of initial accreditation and ongoing review of PFIs was confusing insofar as some institutional roles and responsibilities were overlapping.16 The SAR states that the process was to have been performed in the following manner:17

• Prospective PFIs submit application to NBR • NBR screens applications according to specified criteria, including capital

adequacy ratio (CAR), profitability, satisfactory loan classification and provisioning, and “satisfactory operational performance, especially concerning past-due and NPLs and collection ratios regarding total loan portfolio and Bank’s portfolio” (see para. 2.27)

• NBR issues opinion, and, if positive, Bank appraises prospective PFI • For PFIs approved by the Bank, Apex issues accreditation • NBR continues to monitor soundness of PFIs, including their capacity to appraise

loans and status of their financial and operating condition • Apex has primary responsibility for operational functions, including

disbursements to and repayments from PFIs, and monitoring PFIs to assure their continued qualification. However, the Bank also retained a role in reviewing the initial qualification of PFIs as well as periodic updates

2.25 While the financial condition of PFIs was reviewed regularly by Bank supervisory missions, and a number of PFIs were disqualified during the project because of poor financial performance, there is no record of a systematic effort to identify and report NPLs—a critical omission (see next para). It would have been important to require systematic reporting of NPLs since that was a key element of PFI financial performance, and was also an indicator of the extent to which enterprises benefited from the project.

2.26 Non-performing loans—The proportion of non-performing loans under the IDP was very high. The mission was able to identify 11 NPLs from the three largest lenders (BCR, Bankorex, and RDB), totaling US$42.4 million, or 45.8 percent of all lending under the investment component.18 Sixty percent of all RDB investment lending was comprised of NPLs, and 69.6 percent of BCR lending (including Bankorex). These 11 NPLs are now in the portfolio of the Asset Recovery Agency, AVAB, which in the years 2000-2002 was able to recover between 23 and 47 percent of the assets transferred to it.

15. A major reason for the lack of PFI interest in utilizing the loan was the availability of more profitable and less risky uses for their funds during much of the project: “Given the high volatility of interest rates….It was rational behavior for the banks to invest increasingly in low risk and highly remunerative government securities and in deposits with the NBR, and to withdraw concomitantly from the risky and uncertain business of financing enterprises in the real sector.” Romania, Financial Sector Review, March 31, 1999, p. 5. (this is already pointed out in footnote 10)

16. For example, the Apex organization, NBR, and the Bank all had some measure of responsibility for monitoring PFIs to assure their continued qualification.

17. SAR p. 29-30 and Annex 5.

18. To put this into perspective, a financial institution that recovered 85 percent of its outstanding loan principal annually would need to collect a real interest rate of 17.65 percent per annum just to restore the lost capital and without considering the additional interest income necessary to cover its operational and financial costs. Fred Levy, “World Bank Assistance for Financial Sector Development in the ECA Transition Economies” (Draft).

11

One additional technical assistance loan of US$0.9 million from Bankorex is also non-performing and has been turned over to AVAB.

2.27 Accreditation Criteria—The criteria used to accredit PFIs seem adequate, on paper. 19 However, in practice, they were not sufficient to ensure that the banks selected were well-managed and could avoid making bad loans. In retrospect, it is difficult to understand how an institution like Bankorex became accredited and was permitted to participate for such a long time: “….the largest state-owned bank in Romania, Bankorex, long the source of unsound financing of non-viable enterprises and dubious private interests.”20

2.28 Export Finance Component— As noted earlier, this $70 million component was the least utilized of the IDP, with just US$12.4 million disbursing in 23 sub-loans, mainly because of the reluctance of firms to assume the foreign exchange risk. Repayment was relatively good for the export component, with only one loan being designated as a NPL (the PFI eventually repaid the loan).

Outcome

2.29 Outcome was unsatisfactory. As noted above, the objectives were only modestly relevant because they did not reflect a completely accurate diagnosis of the country’s development barriers and because the project design was insufficient to achieve its objectives. With regard to the first objective—promote growth of the private sector and create conditions for an effective supply response from viable private industrial enterprises—as discussed earlier, nearly 46 percent of lending under the investment component consisted of non-performing loans. This demonstrates that enterprises were able to make only limited use of funds loaned under the IDP. While time series data showing the proportion of economic activity in the private sector were not available, data are presented below (Figure 3) showing that credit to the private sector declined over most of the period of the IDP, and that Romania remains below many other transition economies in that regard.21 Achievement of this objective was unsatisfactory.

2.30 With regard to the second objective, advancing enterprise privatization and restructuring, as noted above, progress in this area during the period of the IDP was quite limited, and so IDP achievement was unsatisfactory. The 2001 CAS states:

“While many small enterprises were privatized in the early years of the transition, including all shops and service outlets, nearly all large industrial enterprises remain under state ownership. As a result, the state still holds shares in around 6,000 enterprises and accounts for about three-quarters of industrial output. While the private sector accounts for around 60 percent of GDP, most of its activities are in the service sector.”22

19. CAR had to be at least 8 percent, of which 4 percent primary capital; profitability and performance were required to be “satisfactory;” loans to single borrowers were subject to quantitative limits; and the PFI must have satisfactory credit appraisal policies and capacity.

20. ICR for PSAL project, October 12, 2000, p.5.

21. Of course, it is recognized that many factors beyond the IDP affect the issuance of private credit.

22. 2001 CAS, p. 9.

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2.31 Finally, with regard to the third objective of facilitating safe and sound banking practices, some participating banks interviewed by the mission reported benefits from informal training received in the context of the IDP, and also cited the positive experience of appraising sub-loans under the project. However, other institutions which participated in the IDP fared poorly. Bankorex, the largest PFI—which provided 40 percent of all IDP investment lending—was “subject to undue political influence, had misguided management, and suffered serious credit losses.”23 Approximately 60 percent of Bankorex loans under the IDP were NPLs, and the bank was closed in 1999, with its productive assets absorbed by another bank, and NPLs transferred to AVAB. The Romanian Commercial Bank and Romanian Development Bank also had weak portfolios (Table 2). And two smaller PFIs were declared bankrupt.

2.32 One factor in the failure of PFIs to perform better was that TA intended under the IDP for that purpose was not provided (Para 2.36). It had been intended that TA would be provided to “Strengthen the capacity to appraise credit….administer credit lines and develop loan supervision capacity….develop monitoring and reporting systems….and assist in initial appraisal and loan supervision of sub-loans extended under the project.”24 However, project TA funds were used for other purposes and no formal capacity-building assistance under IDP was provided to PFIs. 25

2.33 Also, if IDP implementation had proceeded in parallel with substantial progress in restructuring the banking sector, the project could have played a complementary role in facilitating better banking practices. However, during the term of the IDP, progress in reforming the sector was slow. The FESAL, approved in January 1996, envisioned privatization of two of the country’s four state-owned banks. But by April, 1998, when FESAL was closed, none had been sold (although progress was made the following year).

2.34 Data on the financial condition of individual Romanian banks were not available, and no assessment of the overall sector was done between the 1998 assessment and March, 2003 . Table 3 shows the findings of the March, 2003, mission on the overall condition of the banking sector. As shown, the overall profitability of the sector improved over the time period, and the return on equity and loan to deposit ratios seem to indicate a healthy banking sector. However, given the very high number of NPL among the IDP sub-loans, the improvements cannot be attributed to the IDP. They are likely due mainly to the privatization or removal of insolvent banks, mostly state-owned, a process not directly connected to the IDP.

23. Romanian Financial Sector Review, p. 23.

24. SAR, p. 41.

25. As discussed below, informal training was provided to PFIs by Bank and RM staff.

13

Table 3: Aggregate Balance Sheet of Romanian Banks, 1998-2002 Aggregate Balance Sheet (Billion ROL) 1998 1999 2000 2001 2002 Total Assets 133,276.30 168,994.80 233,254.10 345,220.70 468,384.40Assets as a % of GDP 31.3 29.3 29.9 31.3Own Capital 14,932.80 16,567.50 27,805.80 48,477.50 64,597.90 Net Profit (Loss) 478.1 -1,915.20 3,695.00 10,533.20 12,800.70

Return on Equity -12.0% 16.7% 27.2% 22.4%Loan/Deposit Ratio 43.9% 44.7% 48.2%

Source: Financial Sector Mission, March, 2003 2.35 From the available evidence, it can be seen that the IDP had a negligible effect on introducing better banking practices.

2.36 TA Component—TA was deemed very important for the success of the project, because of the perception that skill deficiencies and lack of institutional capacity (both in the financial sector as well as in enterprise privatization strategies) were among the main reasons for the country’s lack of reform progress. It was envisioned that sectoral studies would facilitate privatization and restructuring, and that TA to financial institutions would bolster their ability to appraise and manage loans, while maintaining a sound financial position.

2.37 In the event, the TA component was not implemented as planned. The GOR was generally unwilling to use borrowed funds for training and capacity development. While some sectoral studies were completed—financed by other donors—TA funds under the IDP were used only to upgrade the MIS (hardware and software) of three PFIs and Eximbank. Training was provided to PFIs by the Bank on an informal basis, as well as by other donors. Seminars were organized by Eximbank, and by the project staff and Resident Mission to bolster PFI knowledge of credit appraisal and of the specific features of the IDP, however, they were only modestly successful in increasing utilization of the loan. Achievement of the TA component was therefore modest.

2.38 The purpose of the IDP was to increase lending to the private sector, an area where Romania trails other transition countries (see Table 4). Figure 3 below shows credit to the private sector during the period of the IDP. Although many factors affect credit availability, if the credit line had substantial development impact, and if the activity had had a catalytic effect as envisioned, then we might have seen private credit rising. However, between project effectiveness in mid-1995 and its closure at end 2001, credit to the private sector declined overall (in contrast to the pattern in other transition countries), but seemed to rise in 2002, after te project closed, which coincided with improved macroeconomic performance and the privatization of several of the country’s largest state-owned banks.

14

Figure 3. Romania: Credit to the Private Sector, 1996-2002

0%

2%

4%

6%

8%

10%

12%

14%

1996 1997 1998 1999 2000 2001 2002(est)

Perc

ent o

f GD

P

Source: Derived from IMF, International Financial Statistics, January 2003, and August 1999. Data were not available for 1994 and 1995. Data are for deposit money banks only.

Table 4. Credit to the Private Sector, percent of GDP 1995 2001Romania 12 8Russia 8 15Estonia 15 28Poland 12 25Source: Derived from IMF, International Financial Statistics, January 2003, and August 1999 (Romania data are for 1996)

Sustainability

2.39 Sustainability is rated as Likely. As discussed above, little progress was made toward achievement of most project objectives. However, some banks did report that the IDP strengthened their capacity to appraise and manage loans to the enterprise sector. In particular, a number of smaller private banks probably emerged from the IDP in a stronger position: Ion Tiriac bank, Demir Bank, Turko-Romanian Bank, and The Romanian Bank. With the more favorable macroeconomic performance of the last 3 years, reductions in the fiscal and quasi-fiscal deficits, accelerated privatization, and the prospect of EU accession, the progress achieved by these banks is likely to be sustained.

Institutional Development Impact

2.40 Institutional Development Impact was negligible. As discussed above in Outcome, little progress was made in achieving the institutional objectives of the IDP, which were: advance structural transformation of the enterprise sector—specifically privatization and restructuring; and facilitate transformation of credit markets and

15

introduction of safe and sound banking practices. With respect to privatization and restructuring, as noted earlier, progress was minimal until the advent of the PSAL.

2.41 With respect to the transformation of credit markets, most of the technical assistance envisioned under the project did not get delivered—except for informal efforts made by project and RM staff—and the record in appraising and managing loans of the PFIs that played the largest roles in the IDP was poor. As noted earlier, a number of small private banks seemed to have benefited from participation in the IDP, but in the context of the overall sector, progress was limited.

Bank Performance

2.42 Bank Performance was unsatisfactory. As noted earlier, Quality at Entry was unsatisfactory, principally due to the following factors:

• IDP was undertaken in an unstable macroeconomic environment, which hindered lending

• The institutional analysis of the capacity of the financial sector to support this operation was weak, and deficiencies in PFIs hindered project performance

• The size of the loan was too large for such an unstable and uncertain environment • The project was not ready for implementation at the time of approval • The presumption that the achievement of policy-related measures would advance

enterprise privatization and restructuring and serve as a catalyst for private sector growth was unrealistic, and fell well short of what was needed in this area.

2.43 Supervision was unsatisfactory. Despite regular reviews of PFI performance, and the suspension or disqualification of some PFIs, it is difficult to understand how the number of NPLs was permitted to reach nearly half of all investment lending.

2.44 Prior to 1998, supervisory reporting was consistently over-optimistic, e.g.,

• “Promote introduction of safe and sound banking practices—Technical assistance to PFIs has been provided, PFIs were trained in the use of project implementation management system and loan appraisal software; the objective is fully accomplished.”26

• “Improve lending practices—rated SATISFACTORY. The quality of submissions of participating banks is very high. Unsatisfactory subproject applications are rejected. Banks have improved appraisal practices in general, and their loan portfolio quality and collection performance continues to improve.”27

26. Supervision report, November 17, 1995

27. Supervision report, November 12, 1996

16

• “The PFIs are elite Romanian banks. Compared to other members of the banking sector, they are characterized by solid institutional and managerial capacity, above average profitability and better than average risk profile, and robust risk-weighted capital adequacy….”28

2.45 As noted earlier, about $3 million of the technical assistance component was cancelled, but no rationale for these actions could be found in the project documentation. Although considerable informal training was provided to PFIs by project and RM staff, it is still difficult to understand how the project Task Managers made the decision to proceed with disbursement of project funds in the absence of this important augmentation of institutional capacity.

2.46 Starting in 1998 a strong effort was made to improve project performance by restructuring the project (para 2.21). This effort was modestly successful insofar as it was able to promote the IDP, recruit several additional PFIs, and maintain lending at between US$15 million and US$20 million per year despite an inauspicious economic environment.

Borrower Performance

2.47 Borrower Performance was unsatisfactory. While the implementing agency (Eximbank) executed its responsibilities efficiently, the Borrower’s implementation performance had the following deficiencies:

• The Borrower did not maintain macroeconomic conditions that were conducive to the achievement of project goals. In fact, policies led to a highly inflationary environment that provided an incentive for banks to avoid lending to the productive sector at all and instead to focus on investing in government securities

• State-owned entities—Bankorex, BCR, and RDB—provided large loans that proved to be ill-advised

• The Borrower did not accelerate privatization and restructuring to the extent envisioned at project inception.

2.48 In addition, there was tension between GOR agencies involved with the project that probably hindered project performance. A 1997 supervision report stated that the MOPF carried out a financial audit that “was not conducted in good faith,” tied up the staffs of Eximbank and of the PFIs, and diverted their attention from lending. Before tensions were defused, Eximbank announced its intention to exit the project, but mediation by the Bank mission avoided that outcome. There was also tension between Eximbank and the MOPF over who was to bear the risk of loans that defaulted. This was eventually resolved in a February 1998, MOU which clarified that MOPF would be responsible.

28. Supervision report, July 24, 1997.

29. TA was to have included sector studies and consulting assistance for privatization strategies, assistance to strengthen PFI credit, risk management, appraisal, and loan administration capacity. SAR, p. 25. (this is not the place to present what the component was supposed to include)

17

3. Private Sector Adjustment Loan

Objectives

3.1 The objectives of the Private Sector Adjustment Loan (PSAL) were to support reforms in the enterprise, financial, and social sectors, as well as to improve the environment for private business. In the enterprise sector, it was intended to accelerate privatization of state-owned enterprises (SOEs), enforce hard budget constraints on remaining SOEs and close specified large loss-makers—including major coal mines (highly concentrated in the Jiu Valley). In the financial sector, the loan was intended to strengthen the banking system, ensure that state banks were properly restructured as a prerequisite for their privatization or liquidation; improve bank regulation, and further develop the government securities market. In the social sector, the aim was to mitigate the employment impact of privatization through employment support programs, job training, social assistance programs, and job information. And in the area of improving the business environment, the project was intended to strengthen the legal environment, improve accounting standards, and implement an action plan to stimulate private sector development.

3.2 The PSAL was accompanied by a US$25 million technical assistance project, the Private Sector Institution Building Loan (PIBL), which provided complementary support across all areas of PSAL activity. (Activities under PIBL are summarized in Annex C)

3.3 The PSAL was an ambitious attempt to effect enterprise and financial sector reforms that could substantially reduce the pressure on the government’s finances. The project tackled many of the country’s largest loss-making companies; it was the intent of the PSAL to put into place a framework for privatization of these firms and begin the process. Their actual sale was expected to (and largely did) occur soon after the closing of PSAL. The project also aimed to privatize or liquidate banks that were themselves a drain on the treasury, and which—by making problematic loans—facilitated the continuing existence of loss-making firms.

3.4 PSAL was structured in two tranches of US$150 million each, with specific conditions to be met before disbursement. There were two major factors that greatly motivated the government to undertake wide-ranging reforms. First, in 1997-98, GDP contracted by more than 11 percent (Table 1.1), and the budget deficit increased for the fifth consecutive year to 5.5 percent of GDP. These factors, along with an unstable current account balance and mounting external repayment obligations, increased pressure on the GOR, which moved in late 1998 to initiate an ambitious reform program. A second major factor was (and is) the prospect of accession to the EU in 2007. PSAL conditions were well-coordinated with the milestones set out by the EU, and the government—and a broad segment of society—support the effort to “join Europe”, reinforced by NATO’s decision in November, 2002, to invite Romania to join the alliance. Once the government signaled that it understood the severity of the macroeconomic situation, and wished to proceed with reforms, the Bank moved quickly to prepare the project (see para 3.11).

18

Relevance of the Objectives

3.5 PSAL objectives were highly relevant to the country’s development needs. Despite numerous reform efforts during the previous 10 years, many large firms with little or no prospect of viability remained in state hands, causing a substantial fiscal drain (para 1.6). While the FESAL had sought to apply financial pressure through banking and financial service reforms to serve as a catalyst for enterprise privatization and restructuring, two broad weaknesses undermined efforts to achieve many FESAL objectives: government support and commitment were lacking; and the imposition of financial discipline in the real sector was undermined by the run-up of arrears, rollover of loans that were not serviced, the provision of new loans to loss-makers, and the inadequate support infrastructure (e.g., efficient court procedures, market-based valuation standards, professional liquidation companies) which made it difficult for banks and other intermediaries to collect on loans. Government commitment to PSAL was high, and the project was aimed squarely at the development problems that had vexed the country for nearly a decade. With regard to the business environment, the PSAL program acknowledged that privatization and liquidation in the Statement of Expenditures (SOE) sector would not be sufficient to develop sustainable growth. Therefore, PSAL also focused on making the environment more conducive to private sector growth by concentrating on secured interest in personal property, tax reform, bankruptcy, accounting and audit, and the overall enabling environment.

3.6 Despite the large quasi-fiscal deficit of the energy sector, PSAL did not address this area. Bank management envisioned that energy would be addressed in a later operation,30 and made the explicit judgment that seeking to include additional reforms in PSAL could have made the project politically infeasible. This PPAR concurs with that judgment and the limited nature of the PSAL objectives.

3.7 The PSAL was consistent with the 1997 CAS, which seemed to have absorbed the lessons from the shortcomings of the FESAL. The CAS envisioned a new operation that would “more closely target the large loss-makers, simplify mainstream methods of privatization, and provide a renewed impetus to privatization of state-owned banks.”

3.8 Quality at Entry—Quality at Entry was satisfactory, the same rating given by QAG. PSAL was well grounded in analytical work, and adequately established the linkage between the problems diagnosed and the reforms supported by the project. The project was fully consistent with the country strategy, and borrower commitment was strong, although narrowly-focused. The project team consulted with a variety of major stakeholders. The project was prepared quickly—in less than 8 months—when the government signalled that it was ready to consider a significant reform program. The project design was sound, squarely addressed the identified development obstacles, and utilized an innovative approach (“pool privatisation”) to the privatization of medium and large enterprises.

3.9 The PSAL was being readied for Board consideration at around the same time as the ICR for the FESAL was written. The main lessons identified were:

30. Energy sector reform is a main focus of PSAL II, approved by the Board in September, 2002.

19

1. FESAL had too many conditions and too many tranches; future adjustment operations should be shorter and simpler

2. Many conditions were process-oriented; future conditions should be based on fewer, but more easily verified, outcomes

3. There was insufficient government ownership; a high-level counterpart group should be established to design and monitor implementation

4. Institutional capabilities were too weak; the availability of TA should be assured 5. The legal and regulatory framework for enterprise and bank privatization was

weak; the legal framework should be strengthened 6. Greater attention should be paid to public awareness of the reform program

3.10 PSAL took into account the most important of these lessons—including 1, 3, 4, and 5—which were key to its success. PSAL did, however, have a large number of conditions, some of which were process-oriented, and it did not implement a public awareness program.

Implementation Experience

3.11 The PSAL team worked intensively with the government to develop the details of the reforms that would form the conditions of the loan. All first tranche condition were met by June, 1999, when the project was approved by the Board, however, a Fund program was not in place at that time. In August 1999, the Fund approved a Stand-by Arrangement of SDR 400 million to support the government's stabilization and reform program, and the first PSAL disbursement of US$150 million was made soon after. The second tranche of an equal amount disbursed in June, 2000, after all remaining conditions were met.

Outcome

3.12 Outcome was satisfactory, with significant progress made in all four areas of PSAL activity:

Financial Sector

3.13 Performance in this area was satisfactory, with all conditions met, although progress in the establishment of a legal and institutional framework for asset resolution was not made as rapidly as had been hoped. The first area dealt with privatization of state banks. In June, 1999, BCR was subjected to an audit and loan portfolio review, which facilitated development of a satisfactory restructuring plan prior to privatization. Privatization advisors were appointed to help implement restructuring and privatization. BCR has not yet been sold; it is the subject of PSAL II conditionality, and in 2002, two unsuccessful attempts were made to sell the bank. Then in February, 2003, the government announced that 25% would be sold to the EBRD and IFC, and a majority stake would be divested to a strategic investor at a later date.

20

3.14 In the second area, dealing with Bank Agricola, the financial and operational assessment of Bank Agricola (BA) led to an NBR takeover of the bank to contain losses, transfer of a majority of non-performing assets to AVAB, the asset resolution agency, and preparation of BA for privatization or liquidation. Bank Agricola has now been privatized. In the third area, Bancorex’ license was withdrawn in July, 1999, and its name removed from the official company registry, and its assets transferred either to AVAB or to BCR. Bancorex has ceased to exist, shutting down the largest source of loss-making activity in the Romanian economy; its closure would have been inconceivable a few years before and was a milestone in the country’s reform progress.

3.15 In the fourth area dealing with strengthening bank supervision and regulatory compliance, activity had started before PSAL. NBR had already established minimum reserve requirements at 15 percent of all deposits, and during PSAL NBR introduced stricter risk-weighted capital adequacy requirements to bolster bank solvency. Along with higher minimum reserve requirements, these measures enabled NBR to identify problem banks earlier.

3.16 In the fifth area, the GOR strengthened supervisory capacity by reorganizing NBR banking supervision activities into one department focused on on-site inspection, off-site surveillance, strategic/policy coordination, and legal matters. Improved compliance with prudential norms is demonstrated by regular reports based on Basle Core Principles, external audits, and monthly reports related to specific provisioning requirements.

3.17 In the sixth area, strengthening accounting and audit standards and practices, the government had already begun this effort prior to PSAL with adoption of a chart of accounts consistent with International Accounting Standards (IAS), introduction in 1998 of a new Banking Law requiring that all banks appoint independent external auditors, and that banks produce quarterly statements. As part of PSAL, NBR also introduced tighter provisioning standards on a monthly pre-tax basis in the currency of exposure. These measures were subsequently strengthened by new NBR regulations for better risk classification. The condition that loss loans overdue more than 360 days be written off was substantially complied with, while all others were fully complied with.

3.18 The seventh area, focused on creation of a legal framework for asset resolution, is the one area where government performance lagged through most of the PSAL. The main issue was that AVAB was slow to appoint needed management, staff and advisors. However, this situation was rectified in April-May 2000, and AVAB now has needed management, staff and advisors in place.

3.19 With regard to development of a Government securities market, the government established a plan for computerized clearing and settlement of Government securities transactions, and it has offered at least four different maturities.

Enterprise Sector

3.20 PSAL achievement in the enterprise sector was satisfactory, as the government met or exceeded loan objectives. The main goal in enterprise reform was to strengthen financial discipline in the state enterprise sector, liquidate non-viable loss-making

21

enterprises (e.g., mines), privatize most remaining state enterprises (including utilities), and cut losses and subsidies in the state enterprise sector by 22 percent. These objectives were all met.

3.21 PSAL set into motion the sale or closure of a number of firms which became landmarks in the country’s reform progress, and had a substantial impact on the country’s fiscal situation. In the area of large-scale case-by-case privatization, 64 large companies were selected for case-by-case privatization, with 14 advised individually and the remaining 50 grouped into five groups of ten firms linked to one advisor.31 These 14 firms were the largest loss-making firms in the country (outside the energy sector). At the time of the mission, 35 of the 64 firms had been sold, with an additional seven in negotiation, and four more still considering offers.

3.22 In the first group of nine firms (case-by-case), four were sold, including the huge SIDEX steel and ALRO aluminum firms.32 Negotiations are well advanced for the sale of another large aluminum firm, ALPROM. One firm was offered for sale, but received no offers; the government plans to reoffer it. Another firm was restructured, with some constituent parts liquidated and negotiations underway for sale of the others.

3.23 Three firms were withdrawn from this privatization process, with the consent of the Bank, and it is intended that two will be sold by their branch ministries. The national airline, TAROM, was “shopped” by its advisor but found an inhospitable market for airline sales. TAROM currently has a contract with Lufthansa under which its operations are being restructured. Additional attempts will be made to sell the remaining 15 firms of the 64 large case-by-case privatizations.

3.24 In the area of privatizations undertaken by the State Ownership Fund (SOF), PSAL benchmarks were generally exceeded.33 SOF privatized 45 large SOEs and 717 Small and Medium-sized Enterprises (SMEs) (vs. target of 15 and 600, respectively), sold residual shares in 255 companies (vs. target of 160), and reduced losses and subsidies by more than 15 percent (vs. target of 12 percent). In the fourth program area focused on loss reduction in the mining sector, benchmarks were also exceeded as loss reductions averaged more than 47 percent (vs. target of 25 percent), and 14 contracts were signed for technical closure and environmental clean-up (vs. target of six).

3.25 In the power and utilities sector, a 35 percent stake in Petrom was offered for sale, however the sale was not successful. The government outlined an action plan for the establishment of an independent regulatory agency for electricity and heat. Similar progress was made in developing an action plan for the liberalization and regulation of the electricity, telecommunications, railways, and oil and gas sectors, all of which will receive EU assistance.

31. Investment banks were provided with a small retainer and a larger success fee. The presumption was that there would be economies of scale with one firm advising 10 clients. While this was apparently the case in most instances, some officials interviewed believed that advisors mostly concentrated their efforts on the most salable firms.

32. The mission was told that SIDEX alone was losing US$600-900 million per year.

33. Firms privatized by SOF were generally sold to local investors, whereas the 64 large firms described in the preceding section were “shopped” internationally (although some were sold to local investors).

22

3.26 Figure 3.1 below shows the fiscal deficit from 1994 to 2002. The decline in the deficit from 1999 onwards coincides with the divestiture of money-losing state-owned banks and enterprises under the PSAL.

Figure 4. Fiscal Deficit as a Percent of GDP, 1992-2002

Fiscal Deficit, as % of GDP

-6

-5

-4

-3

-2

-1

01992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

defic

it, a

s %

of G

DP

Source: Romania Country Department

Business Environment

3.27 Progress in improving the business environment was satisfactory, though perhaps less dramatic than performance in the banking and privatization areas. Priorities in this area were to strengthen the legal framework for secured transactions, reform the law regulating the Court of Accounts, improve the tax code, modernize accounting standards, and launch a study to determine ways to reduce administrative obstacles to private sector growth. These objectives were broadly achieved.

3.28 In the first area, Article 57 of the Banking Law was abrogated—which had prohibited lending by non-bank entities—and was superceded by a Law on Secured Transactions. This was complemented by implementing regulations and an automated registry for personal property, and permitted a broader range of financial transactions, including factoring and leasing, and greatly facilitated use of collateral.34 The mission was told that nearly 200,000 loans had been guaranteed by collateral registered on the system created under PSAL.

3.29 In the second area, tax reform, significant progress was achieved. Farmers’ and pensioners’ incomes were made subject to personal income tax, and the government withdrew profit tax exemptions for exporters from the corporate tax base. (However, existing investment tax holidays remain because these legal commitments will be respected.) Overall, tax legislation is now more consistent with World Trade Organization (WTO) and EU norms, is more acceptable to the Bank and the Fund, and is backed by a program of implementation support (e.g., public awareness, IT, training). 34. The registry permits individuals to check to see if an object may be used as collateral in another transaction, and also greatly facilitates seizure in case of default.

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3.30 In the third area of bankruptcy reform, the government amended the law and established a reform commission, which developed recommendations (later than envisioned) which as of end-2002 still needed to be acted upon.

3.31 In the fourth area of accounting and audit reform, Ministry of Finance (MOF) issued an ordinance to bring accounting standards in line with IAS, and acceptable by-laws were adopted by the Audit Chamber. However, institutional capacity in the audit field is weak, which undermines the quality of management information generated by firms, raising the cost of credit and investment due to higher risks.

3.32 In the fifth area of assessing the business (or investment) environment, Foreign Investment Advisory Service (FIAS) surveyed 526 companies and provided recommendations encompassing regulatory reform, corruption, company and tax registration, foreign exchange, property rights, standardization, employment, land and site development, and customs and international trade. Based on these recommendations, in September, 2001, the government approved an Action Plan which is now being used as a roadmap for measures to improve the business environment (an outline of the Action Plan is in Annex D).35 To implement the Action Plan, the government set up an implementation group with representation from the Chamber of Deputies, the Chamber of Commerce, Non-Governmental Organizations (NGOs), the business community, civil society, importers, and exporters. Businessmen and representatives of business groups report that the business environment is considerably better than it was a few years ago, is gradually improving—for example in the effort required to register a business—but that Romania still needs to accelerate progress and become more business-friendly to meet Western European norms. The involvement of the World Bank in addressing the BE was thought to be a very positive development.

Mitigation of Social Impact

3.33 Achievement in the area of social cost mitigation was satisfactory. The key priority in the social sphere was to protect those most vulnerable to the negative effects of downsizing and enterprise closure by providing unemployment benefits, severance pay and a new law for micro-credits for new business start-ups. These objectives were achieved, and close coordination was maintained with the EU’s RICOP program which complemented PSAL and provided financial and retraining assistance to those laid off.

3.34 In the area of providing sustainable income support to laid off workers, PSAL conditions were broadly met. The framework Law for Collective Dismissals was passed in June, 1999, and the government provided satisfactory evidence that all eligible workers were paid severance and unemployment benefits. In the area of targeting assistance to laid off workers, pre-layoff services are being rendered, participation is increasing, and NGO intermediaries are now permitted to provide micro-credits in affected geographic areas. And a communications strategy was implemented to raise public awareness of the need to actively search for alternative employment.

35. Business groups reported that the process of implementing the Action Plan has given the business community a voice in the formulation of policies that affect it.

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Sustainability

3.35 Sustainability of the reforms achieved under PSAL is highly likely. The new government elected in 2000 seems committed to the reforms; further reform progress is being achieved under PSAL II; the country’s commitment was reinforced by NATO’s decision in November, 2002, to invite Romania to join the alliance, which provided tangible evidence of integration into European institutions; and, most importantly, the prospect of EU accession in 2007 powerfully motivates officials and the public to sustain and extend reforms.

Institutional Development Impact

3.36 IDI was substantial. Substantial progress was made in the legal and institutional framework for bank privatization and restructuring, though less rapidly than had been hoped. And despite two unsuccessful attempts, BCR has not yet been sold. Bank supervision capacity and accounting and audit standards were strengthened, and a legal framework for asset resolution was developed, although implementation of the new framework was slow.

3.37 As described earlier, progress in the enterprise sector was substantial, with satisfactory achievement of privatization targets—especially among the key large and medium-sized firms. Partially as a result, there has been a steady improvement in the fiscal deficit, which by 2002 declined to around half of what it had been in 1997. A new law on collateral was passed and an automated registry established, and progress was also made on improving the business environment, although some of that progress was embryonic, as it remains to be seen how much actual progress will be made as the “Action Plan” is implemented.

Bank Performance

3.38 Bank Performance was satisfactory. Quality at Entry was satisfactory, as discussed earlier in para 3.8. Borrower officials interviewed had a very positive view of the Bank team, praising its professionalism, expertise, and its ability rapidly to marshal resources (using PIBL) in critical areas.

3.39 The Bank coordinated well with other donors. PSAL conditionality was carefully coordinated with the milestones that the EU requires that Romania meet for its potential accession in 2007. Over the past few years, officials increasingly came to view reform progress, and compliance with PSAL conditions, as critical to their vision of “joining Europe,” which greatly facilitated advancement.

3.40 PSAL conditions were reasonably well-coordinated with Fund programs. Nevertheless, during the period of the PSAL, the Fund urged the Bank to include restructuring of the energy sector as part of PSAL. However, as noted earlier, Bank management and staff considered that inclusion of the energy sector might “overload”

25

reform capacity, and thus did not do so (except for actions related to Petrom). This PPAR concurs with the Bank judgment.36

Borrower Performance

3.41 Borrower Performance was satisfactory. The government worked quickly and well with the Bank team in the identification of the PSAL. The government designated that the implementing agency (PMU) be located in the Ministry of Transportation. Although seemingly an unlikely location, the arrangement worked extremely well, as the Minister established an excellent staff and an efficient structure to coordinate implementation of reforms that were the responsibility of a broad range of Government of Romania (GOR) agencies. Two or three key staff from each participating agency were appointed to a committee that functioned under the Ministry of Transportation, and the PMU maintained daily contact with these individuals. The Minister was provided with daily reports on the status of each reform action, and in turn the Minister provided weekly reports to the Prime Minister and to the rest of the government.

3.42 Borrower compliance with PSAL conditions was very good, especially considering the short time frame of the project. The most impressive progress was made in the area of bank privatization, with two of the most problematic banks removed from the public sector, with significant progress in other areas. Although there were delays in establishing the asset resolution agency—AVAB—the unit is now fully functional. Enterprise sector progress was also impressive, with 35 of the 64 large enterprises sold—including some of the largest lossmakers—and some additional number likely to be sold. Progress in improving the business environment was satisfactory, although it remains to be seen how quickly the Action Plan will be implemented and how effective it will be.

3.43 Macroeconomic performance during and subsequent to the PSAL improved significantly from the instability experienced earlier.

4. Lessons Learned

Industrial Development Project

4.1 Financial sector operations should be undertaken only in a conducive macroeconomic environment—The unstable macroeconomic environment hindered the ability of the project to achieve its goals. The high and variable inflation gave economic actors an incentive to focus on protecting the value of their assets and pay less attention to identifying productive investments.

4.2 For a project whose goal is to advance structural transformation of the enterprise sector, a more suitable instrument might have been an adjustment operation—The policy-related measures undertaken during preparation of the IDP were a useful first step, but fell well short of what would have been needed to achieve significant progress. An adjustment operation, with the transfer of resources focused on

36. Also, as a matter of sequencing, increased energy prices were part of Fund conditionality, and it was logical to raise prices first, and subsequently tackle the privatization of electricity distribution companies.

26

policy change, might have been a better choice. If macroeconomic instability precluded an adjustment operation, a Technical Assistance loan might have been utilized.

4.3 A financial sector operation must be based on a realistic assessment of sectoral capacity and a judicious use of appropriate and meaningful eligibility criteria for participating financial institutions—In utilizing PFIs as intermediaries, the IDP depended on them being well managed, with adequate financial strength, and with requisite loan appraisal and management skills. At the time of project inception (and until 1999), the Romanian financial sector was dominated by state-owned banks that often channeled resources to loss-making SOEs and suffered from frequent Government intervention and a lack of basic banking skills. In a high-risk environment, the Bank clearly needs to go beyond minimally-recognized international levels for accreditation criteria and establish standards that assure that the banks selected have a solid track record of making good loans.

4.4 The size of the line of credit was too large given the risks and uncertainties of the macro and business environment—During project identification, many banks and enterprises reported a “need” for term lending. However, the Bank paid insufficient attention to the turbulent economic conditions prevailing, and the lack of motivation of many enterprise managers to restructure their firms even after privatization. On the banking side, the Bank did not appreciate the disincentives to lend caused by the lack of legal protection—including the absence of effective collateral (addressed by PSAL), weak capital bases, and the attractiveness of short-term, high-yield instruments such as government debt.

Private Sector Adjustment Loan

4.5 Timing and government commitment are critical to the success of an ambitious reform program—Several earlier efforts in the area of PSAL reforms had not succeeded. Macroeconomic and financial turmoil brought the government to understand that quick action was necessary if a debacle, potentially including default, was to be avoided. This, along with the prospect of EU accession, provided much of the political impetus for PSAL success.

4.6 Ready access to technical assistance was key to project achievement—The PIBL provided resources by which PSAL staff could readily access international-level expertise in the restructuring, privatization, and liquidation of both banks and enterprises. Outside expertise was also mobilized to support the creation of an asset resolution agency. And finally, expert advisors provided a great deal of input into the Action Plan to improve the investment climate.

4.7 Collaboration among donors contributed to project success—The Bank worked closely with other donors, which resulted in the transmission of a consistent message to the GOR. While there were occasionally differences in approach or timing, these were generally minor, and effective collaboration with the Fund, EU, EBRD, bilateral donors, and FIAS played a role in project success.

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Annex A. Basic Data Sheet INDUSTRIAL DEVELOPMENT PROJECT (LOAN 3735)

Key Project Data (amounts in US$ million) Appraisal

estimate Actual or

current estimate Actual as % of

appraisal estimate Total project costs 334.00 199.40

Project Dates Original Actual Board approval 5/19/94 Effectiveness 9/01/94 7/17/95 Closing date 12/31/00

Staff Inputs (staff weeks) No. Staff Weeks US$ (‘000) Identification/Preappraisal 151.00 392.400 Appraisal/Negotiation 95.42 220,914 Supervision 145.42 338,202 ICR 4.90 23,432 Total 396.74 974,948

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Mission Data Performance rating Date

(month/year) No. of

personsSpecializations

represented ImplementationProgress

Development Objectives

Identification/ Preparation

12/91 6 Public Sector ManagementPrivate Sector Management

I

Identification/ Preparation

2/92 12 Public Sector ManagementPrivate Sector

Development, Privatization

Identification/ Preparation

4/92 10

Appraisal/Negotiation 10/92 5 Public Sector Management,private Sector Development

Privatization, Export Development, Banking

Appraisal/Negotiation 2/93 4 Public Sector Management, Privatization, Single Currency program

Supervision 1 3/94 5 Public Sector Management, Privatization, Banking

Supervision 2 6/94 4 Public Sector Management, Banking

S S

Supervision 3 9/94 2 Public Sector Management,Banking

Supervision 4 12/94 1 Public Sector Management Supervision 5 3/95 1 Public Sector Management Supervision 6 7/95 5 Public Sector Management,

Financial Sector, Management Information

Systems, Privatization

S S

Supervision 7 11/95 4 Public Sector Management, Financial Sector,

Management Information Systems, Banking

U S

Supervision 8 3/96 2 Public Sector Management, Financial Sector

Supervision 9 5/96 3 Public Sector Management, Financial Sector,

Management Information Systems

U U

Supervision 10 10/96 4 Public Sector Management Information Systems,

Privatization

S S

Supervision 11 6/97 2 Financial Sector, Financial Management

U S

Supervision 12 10/97 1 Public Sector Management Supervision 13 2/98 3 Financial Sector Supervision 14 3/98 2 Financial Sector Supervision 15 6/98 3 Financial Sector U U Supervision 16 1/99 4 Financial Sector, Private

Sector S S

Completion 3/1 1 Operations S S

Annex A. Basic Data Sheet PRIVATE SECTOR ADJUSTMENT (LOAN 4489)

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Key Project Data (amounts in US$ million) Appraisal

estimate Actual or

current estimate Actual as % of

appraisal estimate Total project costs 303.7 303.7 100

Project Dates Original Actual Board approval 6/10/1999` 6/10/1999 Effectiveness 08/25/1999 08/25/1999 Closing date 3/31/2000 6/17/2000

Staff Inputs (staff weeks)

Planned Actual Weeks Weeks

Preparation to Appraisal 4.55 -0.33 Appraisal 6.40 6.63 Negotiations through Board approval 0.13 0.00 Supervision 45.07 92.09 Total 56.15 98.39

Mission Data

Date (month/year)

No. of persons

Staff days in field

Staff days in field

Specializations represented

Throuth Appraisal 4/99 7 10 10 Appraisal Appraisal through Board Approval

5/99 7 7 7 Negotiations

Supervision 10/99 7 10 10 Supervision Supervision 4/2000 10 10 10 Supervision Completion 6/2000 7 7 7 Completion

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Annex B. Private Sector Institution Building Loan (PIBL): Project Components

a. Financial Sector Restructuring and Privatization Support Technical assistance to the financial sector: (i) restructuring the Savings Bank in preparation for privatization; (ii) developing the capital markets by strengthening legislation, regulatory capacity and infrastructure, including revised mechanisms for more active use of the market for Government securities; (iii) strengthening the capital markets regulatory agencies; and (iv) strengthening insurance supervision as Romania develops life insurance and a broader array of non-life products. b. Privatization Support for Enterprises The privatization and liquidation of most large state enterprises is the responsibility of APAPS (formerly the State Ownership Fund), which holds the Government's shares in the remaining 1,444 companies. Technical assistance to support GOR in privatizing the ten largest state investments in private firms in which the Government holds 20 percent or more by disposing of at least 50 percent of its ownership stakes in each of these enterprises. The size of the joint venture will be measured in terms of profitability over the last three years (or less if necessary). c. Privatization Support for the Energy Sector Technical assistance to support the divestiture of key enterprises in the oil, gas, and electricity/power sectors, including majority or strategic sales under market conditions. Legal and regulatory framework for private competition in the energy sector (namely network industries), to increase prices and reduce arrears in the oil and gas sectors, and initiate efforts in other energy sectors to ensure that the growing problem of cross-subsidization and arrears is contained and brought under control. Divestiture included the use of investment bankers as privatization advisors to accelerate the process of liberalization and reform. d. Support for Improved Business Environment: Under this component support for an improved business environment to promote development of an environment conducive to investment and business growth: (i) training of judges and court personnel; (ii) procurement of equipment for the commercial divisions of courts; (iii) refurbishing works to be performed with the commercial divisions of courts; (iv) improving the business environment in Jiu Valley at the municipality level, which has been adversely effected by the mining closures. Advisory services and equipment for removing administrative barriers, improving local public administrations services, and marketing of the region; (v) and a public awareness campaign on improvement of the business environment. e. Institutional and Governance Reform Technical assistance to strengthen: (i) public expenditure management; (ii) external audit; (iii) e-government; (iv) public administration; (v) rule of law; and (vi) health administration. This technical assistance helps in the design and initial stages of implementation of the Government's institutional and governance reform agenda. The

32

overarching objectives of that agenda are to create a more responsive, transparent and accountable public sector.

33

Annex C. Outline of Action Plan to Improve the Business Environment

These are the main points of the Action Plan for Removal Of Administrative Barriers from the Business Environment as approved under PSAL1 and as being implemented under PSAL2. This plan was approved by the Government, and currently is under implementation, approaching its completion. The plan was harmonized with EU requirements, and its implementation is being monitored by the Ministry of Development and Prognosis.

1. Poor communication between the Government (G) and Business Environment (BE) Appoint a Working Group (WG) in order to identify the BE problems and the solutions to solve them FIAS to be engaged to find a tool for monitoring; FIAS already has a tool, also used in Central and Eastern Europe; TOR for a public awareness campaign in order to promote timely the Government actions with impact on the business environment; 2. Poor involvement of the business community in the decision-making process with impact on business. Each Ministry/Government Agency is to hold compulsory consultations with the branch employers associations (business associations) prior to government decisions affecting the branch until the “sunshine law “ for administrative documents is adopted by the Parliament Periodically assessment of the degree of success concerning the involvement of business and employers associations in decisions with impact on business environment (use the FIAS monitoring tool) 3. Improve relationship between authorities and entrepreneurs TOR for the design and implementation of a “best practice” code for the custom officers public relations; The obligation of authorized financial control bodies to announce from time the data, the control objectives, the required documents, and maximum duration of the inspections, excepting that cases regulated by special laws ; All public authorities issuing permits and approvals will set clear timetables and develop standard application forms instead of the currently used, non-standardized ‘requests’ 4. The authorization/approval process (authorizations)

34

Simplification of requested authorizations meaning that special authorisations as sanitary, sanitary-veterinary, labour protection, environmental, fire brigade will be required, in addition to statements on sole responsibility, only for selected sensitive fields of activity. Publish the procedures for delivery of necessary approvals for buildings and set up a maximum durations to obtain those approvals; 5. Procedures for VAT refunds Compulsory ex-ante controls for VAT refunding will be replaced with ex-post controls for taxpayers that fulfill some conditions according to the criteria based on a risk analyses in accordance with legal provisions.

The fiscal authority will pursue random ex-ante controls within the 30 days limit for VAT refunding.

The 30 days limit for refunding VAT will be strictly respected. The VAT refunding claims not subject to random controls will be paid within 30 days. The VAT refunding claims subject to controls will still be paid within 30 days from their filling provided no breaking of the law was observed; Fiscal authorities will pay penalties to companies filling VAT claims in case the 30 days limit was exceeded; 6. Lack of rapid and integrated information of the business community on finance and consulting opportunities for their projects Initiate Web site shared by donors with loans, grants and know – how opportunities provided by the above mentioned for the private business; 7. Difficult procedures for achieving the residence visa Granting of the “business” visa, for the rest of the citizens of OECD countries, which currently don’t have this status 8. Direct communication between MDP and the business community on this project Transfer know – how used in this Action Plan to the Romanian governmental institutions. Initiate and maintain a web site in both Romanian and English dedicated to the Action Plan, and facilitate the communication by email with individual entrepreneurs/ associations to collectively shared feed – back and new suggestions. The monitoring instrument (FIAS), the know – how on designing TOR , developing campaign strategies, and public awareness campaigns, the expertise on promoting the

35

business interests will be gradually transferred to the Contact Group within MDP and to other Governmental institutions involved. 9. Difficulties in communication with foreign investors and responsibilities overlap between present institutions. The Government will set up the Romanian Investment Agency (RIA) – as a sole promotion and information body for foreign investments in Romania; RIA will support inward investments and will also provide support for outward investment, and will collaborate with Regional Development Agencies; RIA will be supervised by a Steering and Supervising Council composed by member of involved Ministries and personalities of business environment. 12. Corporate Governance applied to state owned enterprises and public sector companies. The Government will establish core principles of corporate governance applied to state owned enterprises and public companies.

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Annex D. List of Persons Met Ms. Maria Manolescu, Secretary of State

Ministry of Public Finance

Mr. Stefan Petrescu, Director General, External Public Finance Ms. Mioara Inoescu, Advisor for PSAL/PIBL/RICOP Coordination Ms. Nicoleta Bala, Director, PIBL PMU Ms. Anca Amuza-Conabie

Ministry of Public Finance

Mr. Florian Caimac, Legal Advisor Ministry of Justice

Ms. Mariana Diaconescu, President Ms. Sanda Mihailteanu Ms. Anca Lalu

EXIMBANK

Ms. Diana Pistol, Area Manager Banca Comerciala Romana

Mr. Petru Rares, President Banca Romanesca

Ms. Gabriela Tudor, First Vice President RoBank

Mr. Nicolae Nicolau, Director General Maria Design

Mr. Liviu Nicolescu, Executive Director Romstal Leasing

Ms. Virginia Gheorghiu, Vice President Tofan Group (Consultant, business environment)

Mr. Fergus Cass, President Ms. Ruxandra Stan, Executive Director

Council of Foreign Investors

Mr. Mihai Bogza, Deputy Governor National Bank of Romania

Mr. Constantin Olteanu, Director Foreign Funded Projects Ministry of Labor and Social Solidarity

Mr. George Musliu, Secretary of State Ms. Adriana Miron, Director Ms. Carmen Theordorescu, Senior Expert Ms. Mihaela Preda, Head of Office Ms. Elena Necula, Head of Office Mr. Bogdan Ghita, Senior Expert

Authority for Privatization and Management of State Ownership (APAPS)

Ms. Elena Panaite, Expert Ms. Mona Dumitru

AVAB

37

Ms. Anca Boagiu, Deputy Chamber of Deputies Parliament of Romania

Ms. Cornelia Simion, Director Mr. Nicolae Manole

Business Environment Division Ministry of Development and Planning

Mr. Vasile Olievschi, General Director

Ministry of Public Works, Transport, and Housing

Mr. Florin Pogonaru, President Businessmen's Association

Mr. Stephane Cosse, Resident Representative, Bucharest Neven Mates

IMF

Mr. Ziad Alahdad, Country Manager Ms. Doina Visa, Energy Specialist Mr. Sorin Teodoru Mr. Catalin Pauna

WB Office, Bucharest

Marcelo Bueno S. Brajovic-Bratanovic Khalid Sherif James R. Dick Welch Laurie Effron Ronald Hood

WB Headquarters

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Helen Phillip O:\Private Sector Development\Hallberg\Romania Audit\Romania Audit September 3 final to printshop.doc September 30, 2003 9:46 AM