romania release of the second tranche full compliance i ......distrigaz sud: gazprom - russia, gaz...

Romania - Second Private Sector Adiustment Loan No. 4675-RO Release o f the Second Tranche - Full Compliance

I. BACKGROUND

The Second Private Sector Adjustment Loan (PSAL 11) was designed to build on and complement the financial and enterprise sector reforms already undertaken by the Government, supported by the World Bank and the first Private Sector Adjustment Loan (PSAL I). The loan pursued five key development objectives:

the exit o f public banks from government ownership through privatization and other options acceptable to the Bank, accompanied by measures to strengthen the overall environment for private sector banking and financial sector modernization;

divestiture o f the largest public sector industrial and commercial loss-makers from the government portfolio. This divestiture was accompanied by other measures to complete privatization o f pools o f enterprises and jo int ventures, to ensure the privatization procedures are transparent, fair and properly scrutinized so that the residual effects o f privatization do not serve as an obstacle to future privatization transactions;

reform o f the energy sector to introduce modem management principles and sound regulation to ensure that utility companies (e.g., electricity and gas) are not used as sources o f cross-subsidization and soft credit (through arrears) that forestalls needed restructuring o f enterprises. This reforni wil l be accompanied by the adoption o f the necessary legal and regulatory framework for private sector participation, increasing prices towards cost recovery levels, ensuring consistency and transparency in tariff structures, and increasing collections for sustainable operations, needed reinvestment, and higher quality services delivery;

strengthening o f the business environment by the removal o f the administrative barriers that impede investment and trade, the removal o f the most special hnds for fiscal consolidation and transparency, and a strengthening o f accounting, governance and bankruptcy standards and practices for a more competitive private sector-oriented economy; and

provision o f meaningfid social protection for those displaced by restructuring and privatization and strengthening the effectiveness o f the social safety net in the long term.

11. RECENT ECONOMIC DEVELOPMENTS

Romania i s pursuing a broad reform agenda, including economic, institutional and governance reforms, anchored in the process o f EU accession. As a result, growth has been re-established with GDP growth o f 4.9 percent in 2003, led primarily by investment and exports. Inflation has also declined from 40 percent in 2000 and 22.5 percent in 2002 to 15.3 percent (CPI, period average) in 2003. Good macroeconomic performance contributed to reach a record level o f official reserves o f over US$7 bil l ion in 2003 - an impressive increase o f US$3.5 bil l ion since 2000. However, there has been a marked deterioration o f the current account deficit to 5.9 percent o f GDP in 2003 from 3.4 percent in 2003 fuelled in part by expansion o f bank credit to

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the private sector, which grew by about 45 percent in real terms (largely consumer credit and mortgages) and by the effects o f earlier increases in wages.

FDI increased slightly in 2003, hovering around the last three years' average and financing 46 percent o f the current account gap. The fiscal deficit i s at a relatively manageable level o f 2.3 percent o f GDP, down from 4.0 percent in 2000. Public sector debt at the end o f 2003 was 26.2 percent o f GDP.

Quasi fiscal deficits remain high however, stemming from arrears and non-payment in the SOE sector. Problems are most persistent in the energy sector, particularly district heating. Quasi fiscal deficits and implicit subsidies are also prevalent in the mining and railway sectors where non-payment to pensions and social funds are common.

The banking sector i s on firmer footing and direct lending b y the central bank has been eliminated. In contrast to the past, privatization seems to be picking up momentum as well as restructuring o f the railway and mining sectors. Progress in stabilization and growth contributed to a decline in poverty to 29 percent in 2002.

IMF Program: The IMF successfully completed i t s fifth Stand-By Agreement (SBA) with Romania in October last year and i s preparing a Precautionary SBA which i s likely to be o f 24 months duration. Two missions have been conducted for this new SBA. Agreement was not reached on the program at that time. However, during the Spring meetings an understanding was reached on a fiscal deficit o f 2.1 percent o f GDP (or less if revenue outturn i s larger than currently projected). This was the only outstanding issue, and subject to management approval o f the deficit target, the SBA i s tentatively planned to go to Board June 30,2004. Reflecting i ts concern about the size o f quasi-fiscal deficits, the Fund i s insisting that all investment spending, including the large planned road projects be kept on budget regardless o f the financing mechanism.

The new SBA i s likely to continue the themes o f the previous program with an emphasis on maintaining macro stability, reducing inflation, limiting increases in the public sector wage bill and the minimum wage, and pursuing privatizations. In addition, i t will likely call for initiation o f bankruptcy proceedings against non-payers o f taxes, layoffs in the mining sector, and the closure o f inefficient district heating operations.

A significant portion o f the structural agenda for the Fund has been worked out in close consultation with the Bank and a growing portion o f the correspondence with the authorities on specific issues has been issued jointly b y the Bank and the Fund, (for example, related to privatization o f CEC Savings Bank, reform o f the labor code, and development o f the mining sector reform strategy). In a new development for the Fund's program, governance issues are being directly addressed in the Letter o f Intent. This has been done with consultation with the Bank and echoes closely the content o f the PAL program. Managed well, this intensive collaboration and reinforcing conditionality provides greater impetus for the success o f both Bank and Fund programs and for the overall reform process.

Overall, the Bank considers the macroeconomic situation and policy framework in Romania satisfactory.

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III. PROGRESS AGAINST TRANCHE RELEASE CRITERIA A Bank supervision mission has confirmed that the Government has made satisfactory progress in carrying out the program outlined in the Letter o f Development Policy and all the conditions for second tranche release have been met overall in areas related to the financial sector, energy sector, privatization and social protection. Following i s a summary o f the Government’s actions related to the conditions o f the Loan.

Financial Sector

1. The Borrower has offered for sale Banca Comerciala Romana in accordance with applicable management, ownership, legal and regulatory requirements of the National Bank of Romania, and has taken all necessary steps for completing the sale of the said bank.

Status: Condition has been met.

According to the revised privatization strategy, the selling to EBRD and IFC o f a stake o f 25 percent plus two shares took place. The transactions with the two international financial institutions was completed on October 3,2003. The transactions were debated and approved by the Boards o f the two international financial institutions on October 28 and 30,2003. The signing ceremony o f the two contracts took place on November 4,2003. On February 27 and March 1,2004, the Shareholders’ Agreement and the contract o f selling option were signed. The General Shareholders’ Assembly held April 23,2004 approved the new structure o f the shareholders and the changes in the by-law o f BCR regarding the separation between the administrative and executive functions in the BCR’s management. The second stage o f selling 8 percent o f shares to the staff was also finalized.

2. The Borrower has submitted to the Bank evidence on satisfactory progress in implementation of the restructuring plan of the Savings Bank, as such plan has been agreed with the Bank.


On August 26, 2003, the team o f experts sent by Interprojects GmbH started their activity to support CEC (the Savings Bank) to implement i t s restructuring strategy, according to the concluded twinning management contract. The technical assistance i s aimed at supporting the management o f five main departments within CEC (treasury, accounting, IT, network, cards) in the restructuring process. The contract completion i s scheduled for June 2004. Moreover, the Government decided to proceed with privatization earlier than initially intended.

On April 7,2004, the Cabinet approved an Emergency Governmental Ordinance including prior actions to launch the privatization o f CEC. The privatization commission has been setup and the announcement for hiring the privatization advisor was posted on May 17,2004 in Financial Times and other publications.

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Privatization

3. The Borrower has offered for sale o r has taken irreversible measures, agreed upon with the Bank, for the disposition and sale o f the assets o f ALRO and ALPROM.


ALRO has been privatized (the contract was signed on April 30, 2002 with a consortium that includes Conef, Marco Acquisition and Marco International). ALPROM also has been privatized (the contract was signed on December 19,2002 with the same consortium as above).

4. The Borrower has offered for sale, in privatization pools acceptable to the Bank, eight o f the ten companies selected upon agreement with the Bank; and has worked out, f rom work-out pools acceptable to the Bank, eight o f the ten companies selected upon agreement with the Bank, in accordance with the approved restructuring plans.


All companies in pools were offered for sale/work-out. Out o f the 20 companies in pools, nine companies have been privatized, three companies are under a voluntary liquidation process, two companies are under negotiations, and for six companies offers are expected to be received.

Energy Sector

5. The Borrower has offered Distrigaz Sud and Distrigaz N o r d for sale through an open international competitive tender fo r strategic buyers and announced the sale and the sale process to the public.


The contract with the Privatization Advisor Credit Suisse First Boston was signed on March 4, 2003. The privatization strategy was completed and submitted to the Government for i t s approval on October 24, 2003. I t was approved and published in the Official Gazette on November 14, 2003. On December 3, 2003 the Bank issued no objection to the draft announcement and on December 5, 2003 the announcement was published in Financial Times, Adevaml, Ziaml financiar, Romania Libera, Bursa and Nine 0’ Clock.

By January 23,2004 the following companies submitted preliminary and unbinding offers.

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Distrigaz Nord: Wintershall - Germany, Gazprom - Russia, Gaz de France - France, E.ON/ Ruhrgas-Germany and Enel - Italy; Distrigaz Sud: Gazprom - Russia, Gaz de France - France, E.ON/ Ruhrgas-Germany and Enel - Italy.

All investors were qualified for the next stage. The final offers are expected to be submitted by July 16,2004.

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6. The Borrower has offered fo r sale at least fifty-one percent (51 percent) o f the total capital o f Petrom, and has made progress with the sale process, in accordance with a privatization plan agreed upon between the Borrower and the Bank.


The privatization advisor (consortium including Credit Suisse First Boston and ING Barings) finalized the privatization strategy, which has been approved by the Governmental Decision no.924/ 2003. The sale announcement was published on August 26, 2003. B y September 19, 2003, 15 expressions o f interest were received, out o f which only 11 were short listed and only eight submitted preliminary and unbinding offers. The privatization committee reviewed these offers together with the privatization advisor. The negotiations on the preliminary and unbinding offers were completed by end-February 2004.

The final offers were received on April 15,2004 from OMV-Austria, MOL-Hungary, Occidental Petroleum-USA. The winning bidder was announced on May 21, 2004 and the Government started concluding negotiations with OMV. The contract i s expected to be signed by end-July 2004.

7. The Borrower has: (a) approved a privatization strategy fo r the two electricity distribution companies, satisfactory to the Bank, and offered fo r sale the controlling shares in said companies; and (b) adopted a privatization strategy for the electricity generation sector, acceptable to the B a n k


(a) The pre-qualification o f the potential investors expressing interest was completed at the end o f March 2003. Four companies were prequalified and invited to bid. By the beginning o f July 2003, only ENEL-Italy announced their intention to submit the preliminary and unbinding offers for both companies which were received and have been negotiated. The final and binding offers were received in March 2004. The contract i s expected to be signed by end-June 2004. Two other distribution companies have been offered for sale. The privatization o f these two and the remaining four will be supported under the PAL program.

(b) In 2003 the Government approved a Road Map for the Energy Sector. In addition to the restructuring o f Termoelectrica, th is addresses the privatization o f two o f i t s four subsidiaries. The process was launched and i s supported by the PAL program.

A similar restructuring and partial privatization will be carried out for Hidroelectrica (the main hydropower generator). The timing o f the privatization will be linked to the development o f the electricity market, for which the Bank i s providing support under the ongoing Electricity Market Project.

8. The Borrower had submitted satisfactory evidence to the Bank that the cumulative year-to-date rate o f collection for payments to Distrigaz Sud and Distrigaz N o r d has reached ninety-seven and a half percent (97.5 percent) o f the total billings, and that the

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accounts payable to the gas producers and gas transmission companies, resulting f r o m gas delivery, wi l l be pa id within sixty (60) days, commencing on January 1,2002.


Collections are subject to monthly monitoring. By end-April 2004, the cumulative year-to-date rate (January - April 2004) o f collection for payments to Distrigaz Sud and Distrigaz Nord was about 105 percent o f the total billings. To eliminate seasonal variations, collection performance i s also assessed on a 12-month rolling basis. The collection rate on a 12-month rolling basis (May 2003 - April 2004) was about 100 percent o f 12-month billings. The company-by-company breakdown o f year-to-date (and 12-month) collection rates as o f end-April 2004 was as follows:

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Distrigaz Sud - 104.8 percent (12-month rate 101.9 percent) Distrigaz Nord - 105.4 percent (12-month rate 98.1 percent)

The accounts payable to the gas producers and gas transmission companies, resulting from gas delivery, was paid within 55 days o f sales, commencing on January 1,2002.

9. The Borrower has submitted satisfactory evidence to the Bank that: (a) the cumulative monthly rate o f collection for payments to Electrica has reached at least ninety-seven and a ha l f percent (97.5 percent) o f the total billings for the per iod commencing f r o m January 1, 2002; (b) the monthly rate o f collection fo r payments to Termoelectrica has reached one hundred percent (100 percent) o f the total electricity billings for each month commencing f rom October 1,2001; and (c) the cumulative monthly ra te o f collection for payments to Termoelectrica fo r district heating supplies has reached a t least ninety-seven and a ha l f percent (97.5 percent) o f the total billings for the period commencing f r o m January 1, 2002.

la) Status: Condition has been met.

Jb) Status: Condition has been substantially met.

lc) Status: Condition has been substantially met.

Collections are subject to monthly monitoring. The primary performance measure i s a 12-month rolling average to smoothen the impact o f seasonal variations. The achievements at end-April 2004 were:

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Electrica - 99.0 percent (99.6 percent in April 2004) Termoelectrica for electricity - 97.0 percent (144.6 percent in April 2004) Termoelectrica for district heat - 95.3 percent (185.9 percent in April 2004)

(a) Electrica collections - collections f rom electricity consumers. In 2003 Electrica achieved 98.0 percent collection level, meeting the agreed 97.5 percent target. From May 2003 until April 2004, the collection rate was slightly higher at 99.0 percent. While these are highly satisfactory collection rates, challenges remain in collections from some state-owned enterprises (SOEs) and

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government agencies. The Government has acknowledged it i s ultimately responsible for these non-payments, and in May 2004 approved an Ordinance under which it undertakes to make payments from the budget in cases where uti l i t ies are obliged to continue to supply defaulting state-owned enterprises and other government agencies. I t i s expected that th is explicit commitment will help ensure that non-payment in the electricity sector remains under control. Bill collection from non-government consumers i s satisfactory and will remain the responsibility o f the utilities without budgetary back-stopping.

During the gas and electricity distribution privatization processes, the Government tried to pass on SOE and other govemment agency arrears to the new private owner. Prospective investors, however, regard the arrears to be uncollectible, and agreements were negotiated under which such arrears are replaced by long-term govemment bonds. These arrangements reflect the Government’s acknowledgement that i t i s responsible for these arrears. The same approach i s expected to be followed in the future electricity discom privatizations - including the privatization o f the other six discoms included in the P A L program.

(b) Termoelectrica’s collections - for bulk electricity supply. The agreed target o f 100 percent collection has proven to be optimistic. Termoelectrica’s collections at 97 percent closely reflect those of Electrica’s. Termoelectrica collected 93.1 percent o f i t s bill from Electrica and another 4 percent through a system o f offsets. Instead o f the Government paying Electrica for governmental electricity consumption, Electrica paying Termoelectrica, and Termoelectrica paying taxes, the Government and Termoelectrica offset these liabilities (i.e., govemment payments for electricity consumption and Termoelectrica’s tax payments to the Govemment were offset). In view o f Electrica’s collection accomplishments and Termoelectrica’ s achievement o f collections at 97 percent, the condition i s considered substantially met.

(c) Termoelectrica’s collections - for bulk heat supply. The agreed target o f 97.5 percent collections has proven to be optimistic given the poor financial and operational condition o f most o f Termoelectrica’s bulk heat clients - district heating utilities selling heat to final consumers, mostly households. Termoelectrica has however been able to improve i t s collections substantially to 95.3 percent through a combination o f measures: (i) intensified pressure on the clients, and (ii) by transferring a number o f i t s smaller district heating facilities to the local authorities which are then also directly in charge o f their heat production, in addition i t s distribution.

After having restructured electricity and gas sectors, the Government i s now launching a program to restructure the district heating sector. Romania has an extensive district heating system, which even after some consolidation covers 179 cities. Many o f the systems are under great operational and financial stress, but the continued provision o f heating i s an essential service. While tariffs have been adjusted, they have not kept up with increasing costs. The Government at both the central and local levels has responded by increasing subsidies, both to heat producers and to heat consumers. As a result, the annual subsidy burden now exceeds US$350 mil l ion and has become a major fiscal issue.

The Government has prepared with Bank and EU support a strategy for the restructuring o f the district heating sector that aims to address the sector’s most chronic operational and financial issues. The strategy covers pricing, subsidies, and restructuring and rehabilitation o f heat production, heat distribution and heat consumption, including heat metering and heat control measures. Diff icult decisions including politically sensitive pricing and subsidy issues wil l then

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have to be addressed during the implementation o f the strategy. Government approval o f the strategy was a condition o f the first installment o f the P A L program. The proposed PAL2 (FY06) and PAL3 (FY07) will support the implementation o f the strategy. I t i s also proposed that, in parallel with the P A L program, the Bank provide investment financing for the implementation o f key actions o f the strategy.

The restructuring o f the district heating sector wil l be a major challenge in Romania. Thus, the satisfactory and sustainable resolution o f Tennoelectrica’s district heat collections issues will not be possible until the program has made considerable progress. In view o f the Government’s commitment to such restructuring and i t s interim actions which have brought collections to 95.3 percent (a highly commendable level given the condition o f the clients), the condition i s considered substantially met.

Social Protection System

10. The Borrower has (a) submitted satisfactory evidence that sufficient portion within the Borrower’s budget i s allocated to finance the Minimum Guaranteed Income Program: and (b) enacted a L a w on the National Social Assistance System and enabling legislation, satisfactory to the B a n k


For each o f the last three years, the budget allocation for the MIG program amounted to 0.4 percent o f the GDP, as agreed with the Bank and the IMF. Through the Law approving the 2003 budget, it provided Lei 6,867.7 billion, out o f which Lei 5,495.4 bil l ion was from the state budget and Lei 1,372.3 bil l ion from the local budgets.

In addition, the Parliament has enacted the Law 705/2001 on the National Social Assistance System and Ordinance 68/2003 on Social Assistance Services, satisfactory to the Bank.

11. The Borrower has enacted legislation, acceptable to the Bank, to strengthen the financial viability and to rationalize the structure and financing mechanism for unemployment benefits.


The Law 76/2002 regarding the unemployment insurance and employment incentives has been enacted and promotes a system o f measures stimulating employment and ensuring the financial viability o f the unemployment insurance budget. In this way, the Government Decision 377/2002 approved the procedures regarding the access to the employment incentives, financing means and instructions for their implementation. Through the Law 76/2002 the unique level o f the unemployment indemnity was established to 75 percent o f the country gross minimum wage in the case o f unemployed persons, and respectively to 50 percent in the case o f graduates not being able to be employed. Thus, the discrepancies in the system o f setting up the unemployment indemnity were eliminated and the indemnities were correlated with the level o f the minimum wage. As a result, the Unemployment Fund has rzl~l a budget surplus for the last three years.

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12. The Borrower has: (a) enhanced and consolidated the public pension pillar reform, through amending necessary legislation in manner satisfactory to the Bank; and (b) submitted to the Parliament a draft legislation on the Mandatory Private Pension Pillar, satisfactory to the Bank.


[a) Status: Condition has been met.

Through the Law 333/2002 the Parliament approved some amendments to the Law 19/2002 on the continuation o f the reform and consolidation o f the public pensions pillar, setting up transparent and financially viable indexation rules.

Jb) Status: Condition has been met.

The draft Law on the Mandatory Second Pillar was drafted and posted on the website on November 14, 2003 for public debates. I t was submitted to the Government for a f i rs t lecture on May 6, 2004 and was discussed on May 20, 2004. The draft Law was also discussed on June 3, 2004 at a Cabinet meeting, and approved in principle. I t i s expected to be published and submitted to the Parliament in June 2004.

IV. CONCLUSIONS In view o f the overall performance and progress with the implementation o f the program supported by the Loan, and in compliance with the specific conditions o f release as described in Section 2.02 (d) and Schedule 3 of the Loan Agreement, the Bank has informed the Borrower o f the availability o f the second tranche in the equivalent o f EUR 169,900,000.

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romania release of the second tranche full compliance i ......distrigaz sud: gazprom - russia, gaz...

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