world bank documentdocuments.worldbank.org/curated/en/329761468235759887/pdf/multi0... · 1998....

Document ofThe World Bank

FOR OFFICIAL USE ONLYReport No. 19550

IMPLEMENTATION COMPLETION REPORT

BULGARIA

Rehabilitation Loan (4078-0-BUL)Critical Imports Rehabilitation Loan (4157-0-BUL)

Financial and Enterprise Sector Adjustment Loan I (4239-0-BUL)

June 28, 1999

Private and Financial Sector Development UnitEurope and Central Asia Region

This document has restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed without WorldBank authorization.

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CURRENCY EQUIVALENTS(as of May 25, 1999)

Currency Unit = Lev (plural Leva)Lev 1 = US$0.0005US$1 Leva 1,846

AVERAGE EXCHANGE RATES

1994 1995 1996 1997 199853.7 67.2 177.9 1,674.1 1,754.7

WEIGHTS AND MEASURESMetric System

ABBREVIATIONS AND ACRONYMS

ASAL - Agricultural Sector Adjustment LoanBDZ - National Railway CompanyBNB - Bulgaria National BankBTC - Bulgarian Telecommunications CompanyCAS - Country Assistance StrategyCBA - Currency Board ArrangementCIRL - Critical Imports and Rehabilitation Loan

EU - European UnionFESAL - Financial and Enterprise Sector Adjustment Loan

IBRD - International Bank for Reconstruction and DevelopmentIFI - International Financial Institution

IMF - International Monetary FundLDP - Letter of Development PolicyMPP - Mass Privatization ProgramPSB - Public Sector Bank

RL - Rehabilitation LoanSAL - Structural Adjustment LoanSBA - Stand-by ArrangementSOE - State-Owned Enterprise

SPAL - Social Protection Adjustment LoanSSB - State Savings Bank

USAID - United States Agency for International Development

BULGARIA FISCAL YEAR

January 1 - December 31

Vice President: Johannes F. Linn, ECAVPCountry Director: Andrew N. Vorkink, ECCO5

Sector Director: Lajos Bokros, ECSPFProgram Team Leader: Albert Martinez, ECSPF


BULGARIA FOR OFFICIAL USE ONLY

Rehabilitation Loan (Loan no. 4078-0-BUL)Critical Imports Rehabilitation Loan (Loan no. 4157-0-BUL)

Financial and Enterprise Sector Adjustment Loan (Loan no. 4239-0-BUL)

ContentsPREFACE ............................................................ i

EVALUATION SUMMARY ............................................................ ii

PART 1. PROGRAM IMPLEMENTATION ASSESSMENT ............................................................ I

A. BACKGROUND AND PROGRAM OBJECTIVES ................................................................... 1B. ACHIEVEMENT OF OBJECTIVES ................................................................... 3C. MAJOR FACTORS AFFECTING THE DESIGN OF THE LOANs ........................................................... 5D. SUSTA INABILITY ................................................................... 6E. BANK PERFORMANCE ................................................................... 7F. BORROWER PERFORMANCE ................................................................... 7G. ASSESSMENT OF OUTCOME ................................................................... 8H. FUTURE OPERATIONS ................................................................... 9I. KEY LESSONS LEARNED ................................................................... 9

PART II. STATISTICAL TABLES ........................................................... 10

TABLE 1-A: SUMMARY OF ASSESSMENTS - RL .. 1................................................. 11TABLE 1-B: SUMMARY OF ASSESSMENTS - CIRL .................................................................. 12TABLE 1-C: SUMMARY OF ASSESSMENTS - FESAL I .............................................. 14TABLE 2: RELATED BANK LOANS/CREDITS .................................................................. 15TABLE 3: LENDING TIMETABLE .................................................................. 17TABLE 4: LOAN/CREDIT DISBURSEMENTS: ACTUAL .................................................................. 17TABLE 5-A: KEY INDICATORS FOR PROGRAM IMPLEMENTATION - RL . . 18TABLE 5-B: KEY INDICATORS FOR PROGRAM IMPLEMENTATION - CIRL . . 23TABLE 5-C: KEY INDICATORS FOR PROGRAM IMPLEMENTATION - FESAL . . 31TABLE 6: KEY INDICATORS FOR LENDING OPERATION .................................................................. 38TABLE 7: STUDIES INCLUDED IN LOAN PREPARATION .................................................................. 38TABLE 8A: PROGRAM COSTS .................................................................. 38TABLE 8B: PROGRAM FINANCING .................................................................. 38TABLE 9: ECONOMIC COSTS AND BENEFITS .................................................................. 39TABLE 10: STATUS OF LEGAL COVENANTS .................................................................. 39TABLE 11: COMPLIANCE WITH OPERATIONAL MANUAL STATEMENTS ..................................... 40TABLE 12: BANK RESOURCES: STAFF INPUTS .................................................................. 40TABLE 13: BANK RESOURCES: MISSIONS .................................................................. 41

APPENDIXES:

A. BORROWER CONTRIBUTION TO THE ICR ............................................................. 42B. MAP ............................................................. IBRD No. 26532R

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

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BULGARIA


Financial and Enterprise Sector Adjustment Loan (42390-BUL)

Preface

This is the combined Implementation Completion Report (ICR) for: (i) the RehabilitationLoan (RL), for which Loan 4078-0-BUL in the amount of US$30 million was approved onAugust 1, 1996 and made effective on October 11, 1996; (ii) the Critical Imports RehabilitationLoan (CIRL), for which Loan 4157-0-BUL in the amount of US$40 million was approved onMay 8, 1997 and made effective on August 12, 1997; and (iii) Financial and Enterprise SectorAdjustment Loan (FESAL I), for which Loan 4239-0-BUL in the amount of US$100 million wasapproved on October 30, 1997 and made effective on February 10, 1998.

The RL was closed on July 31, 1997, the CIRL on June 30, 1998, and FESAL I on April30, 1998. All three loans were one-tranche operations, released upon effectiveness. The RL wasfully disbursed on November 1, 1996, the CIRL on August 14, 1997, and FESAL I on March 3,1998. Cofinancing for FESAL I was provided by the Export - Import Bank of Japan (JEXIM)for an amount in Yen equivalent to US$50 million. The agreement with JEXIM was signed onDecember 18, 1998 and made effective on February 12, 1999.

The ICR was prepared by Albert Martinez (ECSPF) and Marinela Dado (ECSPF), andreviewed by Andrew Vorkink, Country Director (ECC05). Significant inputs were provided byLada Stoyanova (ECSPF), Lena Roussenova (ECSPE), and Nevena Alexieva (ECCBG). NuzhatAhmad (ECSPF) produced and processed the report. The Borrower provided comments that areincluded as Appendix 1 to the ICR.

Preparation of this ICR is based on materials in the project files, interviews with theproject task managers, and inputs from the team preparing FESAL II. The Borrower contributedan independent evaluation of the three projects, as contained in Appendix 1.

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BULGARIA

Rehabilitation Loan (40780-BUL}Critical Imports Rehabilitation Loan (4157-0-BUL)

Financial and Enterprise Sector Adjustment Loan I (4239-0-BUL)

Evaluation Summary

Introduction

i. The Rehabilitation Loan (RL) of US$30 million and the Critical Imports RehabilitationLoan (CIRL) of US$40 million were quick disbursing operations to support the initial phases ofthe stabilization and reform program of the Government. The RL was approved on August 1,1996 and made effective on October 11, 1996, and the CIRL was approved on May 8, 1997 andmade effective on August 12, 1997. The Financial and Enterprise Sector Adjustment Loan(FESAL I) of US$100 million to support Bulgaria's enterprise and banking sector reforms wasapproved on October 30, 1997 and made effective on February 10, 1998.

Loan Objectives

ii. The banking and foreign exchange crises that emerged in late 1995 forced Bulgaria tocome to terms with designing and implementing serious reforms. After years of tentativeattempts at reform, an emergency program of measures was launched in mid-1996 to stabilizethe economy, arrest the decline in confidence, and accelerate the process of enterprise andbanking sector reforms. At an early stage, the Bank, the IMF and other development partnersprovided technical assistance to help the Government develop and implement the program. TheGovernment's measures included the closure of banks and the introduction of an explicit partialdeposit guarantee scheme. As part of a concerted effort by the international financial institutions(IFIs) and other development partners, the Bank approved the RL to provide rapid financialsupport. The RL was envisaged to finance the immediate costs of the program, the mostimportant of which was the fiscal burden of assisting workers being displaced in the enterpriserestructuring and liquidation programs.

iii. The decisiveness with which the emergency measures were introduced was not sustained.Implementation of more fundamental reforms, especially in the enterprise sector, was incompleteand, as a consequence, failed to secure adequate and timely financing for the program. This ledto reduced confidence in the Government's policies, which led to a sharp downturn in economicactivity. By late 1996, Bulgaria was in the midst of a full-blown economic crisis.

iv. The social consequences of the crisis were dismal. Real wages fell by 30 percent in 1996in the face of skyrocketing inflation. The collapse of incomes was compounded by shortages ofbread, medicine, energy, and agricultural inputs, as well as by sky-rocketing prices of basicnecessities. The difficulties faced by Bulgarian households were instrumental in bringing downthe Government, with the resignation of the Cabinet and the dissolution of Parliament. An

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interim Government was formed in February 1997. The latter was granted broad powers by theoutgoing Parliament to manage economic policy and to negotiate with the IFIs.

v. The interim Government moved rapidly to ease the population's hardships and to preparefor serious reformn. It alleviated the severe shortage of bread through emergency imports ofwheat and the liberalization of the wholesale price for domestic wheat, and strove to improveconditions in other critical areas, such as energy and agricultural inputs. Most importantly, thecaretaker Government set the stage for earnest reforms by putting in place a new economicprogram designed in close cooperation with the IMF and the Bank. To provide quick financing,the Bank approved the CIRL to help finance socially important critical imports and therebyachieve greater acceptance of the Government's economic program.

vi. The severity of the crisis bro-aght about radical changes. Early general elections in April1997 led to the formation of a reform-minded Government with an absolute majority inParliament. Shortly after the elections, the new Government affirmed its commitment to acomprehensive program of macroeconomic stabilization and restructuring of the economy toaccelerate the process of transition to a market economy. The centerpiece of the stabilizationprogram was the introduction of the IMF-endorsed Currency Board Arrangement (CBA) in July1997. In parallel with stabilization policies supported by the IMF Stand-by Arrangement (SBA)agreed in April 1997, the Government restarted and accelerated reforms in the banking andenterprise sectors. The Bank approved FESAL I on October 30, 1997 to provide fast-disbursingfunds to support the program.

Implementation Experience and Results

vii. Rehabilitation Loan. The objectives of the reforms supported by the RL were partiallyachieved. While attempts were made to stem the financial and foreign exchange crises, themeasures taken (such as the closure of banks and actions in enterprise reform) did not reach thecritical level needed to restore confidence in the economy or credibility in the Government.There were significant delays in the introduction of enterprise restructuring measures, and earlierreform commitments did not translate into timely actions. The closure of non-viable enterpriseswas held up by legal and bureaucratic procedures. Cash privatization was slow and lackedtransparency. The economic crisis deepened and led to the resignation of the Government.However, the RL helped reduce the social impact of enterprise restructuring by providing fiscalsupport for severance payments, and provided the groundwork for future reforms.

viii. Critical Imports Rehabilitation Loan and Financial and Enterprise Sector AdjustmentLoan. In contrast, the reforms supported by the CIRL and the FESAL successfully achievedtheir objectives. The interim Government that took office in February 1997 introduced a seriesof important measures to arrest the crisis and set the stage for structural reforms. The first effortswere concentrated on securing the wheat supplies of the country through emergency imports. Toimprove the market availability of domestic supplies, the Government liberalized wholesaledomestic prices. Adjustment of administered prices of petroleum, utilities, and agriculturalinputs followed to correct the distortions created by hyperinflation. Above all, the interimGovernment succeeded in designing a far-reaching economic program assisted and endorsed bythe IFIs. The program of reforms included: (i) the establishment of a CBA to anchorexpectations and reinforce financial discipline in the budget, enterprises, and banks; and (ii)

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deepening of reforms in the banking and enterprise sectors, in particular an ambitiousprivatization program.

ix. Structural Reforms. Until late 1996, privatization was extremely slow - mired in a poorlycoordinated process that attracted little interest from foreign strategic investors compounded bythe lack of political will. However, a number of large transactions were completed during 1997,increasing privatization proceeds to the budget. In addition, the line ministries began a steadyflow of divestiture of smaller SOEs. To accelerate the pace of the privatization of large SOEs,the Government appointed international and local privatization agents in 1997 and early 1998,but most of the transactions were not expected to be completed until mid-1999, when thecontracts with the privatization agents are due to expire. The Government also developed aprogram of divestiture of small and medium enterprises aimed at achieving a cumulative targetof 95% of small and medium enterprise assets by the end of the 1999.

x. As part of the Government's efforts to improve financial discipline in the SOE sector, theGovernment placed 64 enterprises under bankruptcy and liquidation procedures and another 71enterprises in an Isolation Program. Enterprises under the Isolation Program accounted for about50 percent of SOE sector losses in 1995. The program limited the access of 30 state-ownedutilities and transport enterprises (Group A) and 41 large state-owned commercial enterprises(Group B) to bank credit, thereby forcing a fundamental restructuring of their operations with aview to achieving financial solvency of Group A enterprises, and privatization or liquidation ofGroup B enterprises. However, the application of the law on bankruptcy and insolvency,although improved since the mid-1 990s, has been slow because of institutional weaknesses.

xi. The stabilization and other reform measures implemented in 1996 and 1997 resulted insignificant improvements in the structure and financial condition of the banking system. Banksreported an improvement in their liquidity position which may be attributed to several factors,including improved awareness of risks and intensification of banking supervision. Banks havebeen also been focusing on improving their loan portfolios, rather than expanding lending.Between 1996 and 1998, nonperforming loans of the banking system fell from 47 percent to 13percent of total loans, and risk-weighted capital to assets ratio increased from five percent to 35percent.

xii. The privatization program for banks got off to a slow start in 1997, but has since picked uppace. Of the seven public sector banks that remained in mid-1997, two banks have beenprivatized and the process for privatizing three others is underway. For one bank (Biochim),there are no specific plans for immediate privatization but the Bank Consolidation Company(BCC), as the owner of Biochim, secured a management contract with a foreign consulting firmfor 12 to 18 months during which diagnostic studies of Biochim will be undertaken and aprivatization plan developed. The "Law on the Transformation of the State Savings Bank" wasapproved in early 1999 and authorized the State Savings Bank (SSB) to engage in commercialtransactions under the banking law, which enables the Bulgarian National Bank (BNB) to imposerestrictions on SSB's banking activities.

xiii. The basic legal and regulatory framework for banking is almost complete in terms ofcoverage. Prudential banking regulations were restructured since the approval of FESAL I.Regulations on bank licensing and large exposures were amended. A new Accountancy Law and

a Bank Accounting Chart were promulgated in January 1998, and the 1997 accounts of all bankswere required to be audited by international auditors based on IAS. Banking supervision hasbeen overhauled with the strengthening of the Banking Supervision Department (BSD) in theBNB, bestowed with greater powers under the direction of a deputy governor.

xiv. While progress in structural reforms has been much more decisive since the currentGovernment took office in mid-1997, the pace was slower than originally planned due to overlyambitious targets combined with weak implementation capacity. Nonetheless, the currentGovernment has not wavered in its resolve to complete the program of reforms and has beenaddressing obstacles to the acceleration of implementation efforts.

Summary of Findings, Future Operations, and Key Lessons Learned

xv. The RL's main objective was to support the initial phases of the Government'sstabilization and structural reform program by helping finance the costs of enterpriserestructuring and liquidation, and by strengthening the social safety net. A total of 22,000employees received severance compensation in 1996, and the social protection programs wereimproved. However, weak implementation of the stabilization and structural reform programsdid not arrest the deepening economic and financial crisis in 1996.

xvi. The CIRL aimed to support the new program of reforms under an interim Government thattook office in early 1997. The implementation of the initial phases of a new program of reformswas generally successful. Macroeconomic stability was restored with the reduction of the budgetdeficit, lowering of inflation, and stabilization of the exchange rate. Along with themacroeconomic success, structural reforms proceeded with the acceleration of privatization andliquidation of SOEs, closure of failed banks, reform of the legal and regulatory framework forbanking, and strengthening of banking supervision capacity.

xvii. The objectives of FESAL I were to accelerate privatization, support banking reform, andimpose financial discipline on SOEs. Privatization agents were appointed to accelerate the saleof large SOEs, a privatization program for the public sector banks (PSBs) was designed andimplemented, and an Isolation Program was introduced to imposed hard budget constraints onthe largest loss-making SOEs. While the original timetable for the achievement of performancetargets was, in retrospect, too ambitious given the weaknesses in institutional capacity, theGovernment has nonetheless continued to move towards completing the reforms.

xviii. The reforms supported by all three loans were important building blocks for futureoperations. The social protection programs supported by both the RL and CIRL enabled theimplementation of the privatization program designed under FESAL I. The structural reformssupported by FESAL I laid the stage for future FESALs (II and III) and Agricultural SectorAdjustment Loans (ASAL I and II).

xix. The experience in the design and implementation of the reforms supported by the RL,CIRL, and FESAL I yielded the following important lessons:

* Credibility is critical to the success of any reform program. While the there were notableand substantive actions undertaken by the Government in 1996 to reverse the economic

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decline and arrest the financial crisis, the efforts were hesitant and incomplete, resulting inlack of confidence in the sustainability of Government's policies. This led to a deepening ofthe crisis and eventually to the fall of the Government. On the other hand, the interim andsucceeding Governments moved quickly and decisively in designing and implementing aneconomic stabilization and structural reform program. The setting up of the Currency BoardArrangement was an important instrument in establishing the credibility of Governmentpolicies.

* Effective coordination among the IFIs and other development partners contribute tothe successful implementation of reform programs. The Bank and the IMF wereimportant players in the design of the reform program that addressed the crisis in 1996-97.To support implementation of the reforms, Bulgaria received substantial technical assistancefrom other development partners including EU-Phare and USAID. The privatization of largeSOEs, the sale of the PSBs, and the implementation of the Isolation Program were supportedby the development partners. The Bank played a major role in coordinating the activities ofthe development partners.

* One tranche quick disbursing operations are appropriate where: (i) an agreed multi-year program is in place to be supported by a series of lending operations; and (ii) thereis considerable uncertainty in the environment and significant institutional weaknesseswhich require a constant recalibration of the program design, implementation details,and performance targets. The conditions under which all three loans were prepared werehighly uncertain with high risks of policy reversals or incomplete implementation. Onetranche operations were appropriate under these conditions to provide financing as well asincentives to move the reform program forward. In all three loans, a second tranche wouldhave been problematic. In the case of the RL, the incomplete implementation of the reformprogram would have made second tranche conditionalities impossible to meet. In the case ofthe CIRL and FESAL I, the timetables for achieving certain performance targets as describedin the Letters of Development Policy (LDPs) were too ambitious given institutionalweaknesses and the lack of experience in privatization of large SOEs and PSBs. This wouldhave made a second tranche for FESAL I problematic due to the need to make adjustments tothe timetables for performance targets as well as to the program design itself, such asintroducing amendments to the Privatization law and strengthening the bankruptcy andliquidation framework. But in all cases, future operations were programmed to build on thegains made as a result of past operations.

I Continuity of task management and effective internal Bank coordination are essentialto the efficiency and responsiveness of Bank operations. FESAL I was managed by fivetask managers, three of them during the time when the crisis in Bulgaria became full-blown.This resulted in confusion with the Government having to deal with different people. TheBank reorganization in 1997 resolved many of the past coordination problems that existedamong various Bank units.

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BULGARIA


Financial and Enterprise Sector Adjustment Loan (4239-0-BUL)

Part I. Program Implementation Assessment

1. The Rehabilitation Loan (RL) of US$30 million and the Critical Imports RehabilitationLoan (CIRL) of US$40 million were quick disbursing operations to support the initial phases ofthe stabilization and reform program of the Government. The RL was approved on August 1,1996 and made effective on October 11, 1996, and the CIRL was approved on May 8, 1997 andmade effective on August 12, 1997. The Financial and Enterprise Sector Adjustment Loan(FESAL I) of US$100 million to support Bulgaria's enterprise and banking sector reforms wasapproved on October 30, 1997 and made effective on February 10, 1998.

A. Background and Program Objectives

2. Rehabilitation Loan. The banking and foreign exchange crises that emerged in late 1995forced the Government in office at that time to begin the process of designing and implementingserious reforms. After years of indecisive attempts at reform, an emergency program ofmeasures was launched in mid-1996 to stabilize the economy, arrest the decline in confidence,and accelerate the process of enterprise and banking sector reforms. At an early stage, the Bank,the IMF and other development partners provided technical assistance to help the Governnentdevelop and implement the program. The Government's efforts at dealing with the immediatebanking crisis included the closure of banks and the introduction of an explicit partial depositguarantee scheme. It also began a bank restructuring program consisting of: (i) limitedrecapitalization of banks; (ii) restricted unsecured financing by the Bulgarian National Bank(BNB); (iii) work-out arrangements to improve capital adequacy; and (iv) improved supervisionand accounting practices. Enterprise reforms included: (i) closure of some of the largest lossmaking enterprises; (ii) restructuring of potentially viable strategic enterprises; (iii) accelerationof privatization; and (iv) assistance for redeployment of redundant workers to alternativeproductive employment.

3. The Bank, the IMF and other development partners endeavored to help Bulgaria deal withthe crisis in 1996. For its part, the Bank approved the RL to provide rapid financial support. Theloan helped finance the immediate costs of the reforms, the most important of which was thefiscal burden of assisting workers being displaced in the enterprise restructuring and liquidationprograms.

4. The decisiveness with which the emergency measures were introduced proved short-lived.Implementation of more fundamental reforms, especially in the enterprise sector, was hesitantand incomplete and, as a consequence, failed to secure adequate and timely financing for theprogram. While the IMF approved a new Stand-by Arrangement (SBA) in July 1996, policyslippages prevented the completion of the first review of the program; hence, no further fundswere released beyond those provided at the time of IMF Board approval. This further reduced

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confidence in the Government's policies and introduced considerable uncertainty, eventuallyleading to a sharp downturn in economic activity. By late 1996, Bulgaria was in the midst of afull-blown economic crisis as a result of a vicious cycle of galloping inflation, exchange ratedepreciation, increases in the budget deficit, growing payments on the domestic debt, increasedcentral bank financing, and consequently higher inflation rates. Real GDP declined by 10percent in 1996.

5. The social consequences of the crisis were even more dismal. Real wages fell by 30percent in 1996 in the face of skyrocketing inflation. The collapse of incomes was compoundedby shortages of bread, medicine, energy, and agricultural inputs, and by rising prices of basicnecessities. The difficulties faced by Bulgarian households were instrumental in bringing downthe Government at that time, with the resignation of the Cabinet and dissolution of Parliament;In the wake of month-long street protests, an interim Government was formed in February 1997and was granted broad powers by the outgoing Parliament to manage economic policy and tonegotiate with the international financial institutions (IFIs).

6. Critical Imports Rehabilitation Loan and Financial and Enterprise Sector AdjustmentLoan. The interim Government moved rapidly to ease the population's hardships and to preparefor serious reform. It alleviated the severe shortage of bread through emergency imports ofwheat and the liberalization of the wholesale price for domestic wheat, and strove to improveconditions in other critical areas such as energy and agricultural inputs. Most importantly, thecaretaker Government set the stage for earnest reforms by putting in place a new economicprogram designed in close cooperation with the IMF and the Bank. The core principles of theprogram were macroeconomic stabilization, speedy and transparent privatization, liberalizationof prices and trade, quick reduction of SOE losses, restructured State finances and a downsizedpublic sector, improved incentives for business and investment, rapid restitution of farm land,improved targeting of the social safety net, and reduced corruption.

7. To provide quick financial support to the program, the Bank approved the CIRL to helpfinance socially important critical imports. The imports were envisaged to prevent the furtherdeterioration of the conditions faced by Bulgarian households. The loan was deemed necessaryto ease the immediate pressures confronting Bulgarian society and help achieve greateracceptance of the Government's economic program.

8. The severity of the crisis brought about radical changes. Early general elections in April1997 led to the formation of a reform-minded Government with an absolute majority inParliament. Shortly after the elections, the new Government affirmed its commitment to acomprehensive program of macroeconomic stabilization and restructuring of the economy toaccelerate the process of transition to a market economy. The centerpiece of the stabilizationprogram was the introduction of the IMF-endorsed Currency Board Arrangement (CBA) in July1997.' As a result, by the end of 1997, monthly inflation fell to one percent, the exchange ratebecame relatively stable, foreign exchange reserves recovered sharply to US$2.5 billion, realwages recovered by 25 percent since the beginning of 1997, and the economy began to showsigns of recovery of GDP.

I The CBA included the full convertibility of the lev, 100 percent backing of base money with foreign reserves, the eliminationof central bank financing of the budget and other debtors (except for a special liquidity fund for last resort lending to banks facingsystemic risks), and the lifting of controls on interest rates.

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9. The macroeconomic program paved the way for structural reforms. In parallel withstabilization policies supported by the IMF Stand-by Arrangement (SBA) agreed in April 1997,the Government restarted and accelerated reforms in the banking and enterprise sectors. Thereforms built on previous measures implemented by the caretaker Government. The Bankapproved FESAL I on October 30, 1997 to provide fast-disbursing funds to support the programof structural reforms, in particular: (i) the acceleration of privatization or liquidation of state-owned enterprises; (ii) the imposition of loss reduction and financial discipline measures onstate-owned enterprises; and (iii) the privatization of public sector banks and the development ofa sound market-based banking system.

B. Achievement of Objectives

10. Rehabilitation Loan. The objectives of the reforms supported by the RL were partiallyachieved. While attempts were made to stem the financial and foreign exchange crisis, themeasures taken, such as the closure of banks and actions in enterprise reform, did not reach thecritical level needed to restore confidence in the economy or credibility in the Government.There were significant delays in the introduction of enterprise restructuring, and reformcommitments did not translate into timely actions. The closure of non-viable enterprises washeld up by legal and bureaucratic procedures. Cash privatization was slow and lackedtransparency. The economic crisis deepened and led to the resignation of the Government at thattime. However, the RL helped cushion the social impact of enterprise restructuring by providingfiscal support for severance payments.

11. Critical Imports Rehabilitation Loan and Financial and Enterprise Sector AdjustmentLoan. In contrast, the program supported by the CIRL and the FESAL I successfully achievedits objectives. The interim Government that took office in February 1997 introduced a series ofimportant measures to arrest the crisis and set the stage for structural reforms. The first effortswere concentrated on securing the wheat supplies of the country through emergency imports.Moreover, the Government liberalized wholesale domestic prices to improve the marketavailability of domestic supply. Adjustment of administered prices of petroleum, utilities, andagricultural inputs followed to correct the distortions created by hyperinflation. Above all, theinterim Government succeeded in designing a far-reaching economic program assisted andendorsed by IFIs. The program was supported by all political parties in the country to ensure adegree of continuity after the new Govermnent took office. The program included: (i) theestablishment of a CBA to anchor expectations and reinforce financial discipline in the budget,enterprises, and banks; and (ii) the deepening of reforms in the banking and enterprise sectors, inparticular an ambitious privatization program covering public sector banks and state-ownedenterprises.

12. Structural Reforms. The gains made on the macroeconomic front since the adoption of theCBA have been accompanied by advances in broadly based structural reforms. The periodleading up to the economic crisis of late 1996 and early 1997 was characterized by aninconsistent approach to reforms in the enterprise sector resulting from the lack of politicalcommitment. Meager progress in economic restructuring was a key reason for the decline ofoutput in 1996. Until late 1996, privatization was extremely slow - mired in a poorlycoordinated process that attracted little interest from foreign strategic investors and compoundedby the lack of political will. The worsening fiscal situation in 1996 led authorities to increasetheir efforts toward privatizing large enterprises for cash. In 1997, the Government put in place amore systematic approach to privatization which consisted of: (i) sales of large enterprises to

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strategic investors with the assistance of privatization agents; (ii) sale of groups of largeenterprises under pool privatization; and (iii) privatization of smaller enterprises throughauctions, negotiated sales, stock exchange sales, and Mass Privatization Programs involvingvoucher distribution.

13. A number of large transactions was completed during 1997, increasing privatizationproceeds to the budget, and line ministries began a steady flow of divestitures of smaller SOEs.To pick up the pace of privatization of large SOEs, the Government appointed privatizationagents for: (i) some of the largest SOEs accounting for about 10 percent of long tenn assets witha view to their sale to strategic investors by mid-1999; and (ii) another group of SOEs classifiedinto eight pools representing 10 percent of long term assets for sale to strategic investors by early2000. Most of the transactions are expected to be completed in 1999. The program also aims tocomplete by end-1999 the privatization of smaller enterprises which account for about 15 percentof SOE long term assets. The second wave of mass privatization was launched in late 1998 todispose of residual shares owned by the State as well as offer majority shares in a fewenterprises. With the exception of delays in the privatization of a few SOEs which are stillexpected to sold or liquidated within 1999, the Government is roughly on target as of early June1999.

14. As part of the Government's efforts to improve financial discipline in the SOE sector, theGovernment placed 64 enterprises under bankruptcy and liquidation procedures and another 71enterprises in an Isolation Program. Enterprises under the Isolation Program accounted for about50 percent of SOE sector losses in 1995. The program limited the access of 30 state-ownedutilities and transport enterprises (Group A) and 41 large state-owned commercial enterprises(Group B) to bank credit, thereby forcing a fundamental restructuring of their operations with aview to achieving financial solvency of Group A enterprises, and privatization or liquidation ofGroup B enterprises. In Group A, the program led to: (a) the closure by end-1998 of the EnergyResource Fund, which provided financial subsidies to loss-making enterprises in the energysector; (b) a gradual raising of district heating prices in order to phase out subsidies to districtheating companies; (c) the implementation of a restructuring plan for the State RailwayCompany (BDZ); (d) the preparation of a restructuring plan for the Sofia Transport Company;and (e) the launching of a program to close loss-making coal mines. Of the enterprises in GroupB, 30 have exited the program through privatization or liquidation and the remainder are to beprivatized or liquidated by mid-1999.

15. In addition to the Isolation Program, 64 enterprises were placed under voluntary and courtsupervised liquidation procedures. This resulted in the privatization of 29 of the 64 enterprises.For the remaining 35 companies, bankruptcy and liquidation proceedings are underway and willbe completed through the sale of shares or assets. Notwithstanding such progress, theapplication of the law on bankruptcy and insolvency, although improved since the mid-1990s,has been slow because of institutional weaknesses.

16. The stabilization and reform measures implemented in 1996 and 1997 have resulted insignificant improvements in the structure and financial condition of the banking system. Banksreported an improvement in their liquidity position which may be attributed to several factors,including improved awareness of risks and intensification of banking supervision. Banks havebeen focusing on improving their loan portfolios, rather than expanding lending. Between 1996and 1998, nonperforming loans of the banking system fell from 47 percent to 13 percent of totalloans, and risk-weighted capital to assets ratio increased from five percent to 35 percent.

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17. The privatization program for banks was slower than originally envisioned in 1997.Nevertheless, a Bank mission in 1998 assessed the revised timetables as reasonable and thestrategy more robust. Of the seven public sector banks that remained in mid-1997, two bankshave been privatized and the process for privatizing three others is underway. For one bank(Biochim), there are no specific plans for immediate privatization but the Bank ConsolidationCompany (BCC), which is the owner of all public sector banks with the exception of the StateSavings Bank, secured a management contract with a foreign consulting firm for 12 to 18 monthsduring which diagnostic studies of Biochim will be undertaken and a privatization plandeveloped. The "Law on the Transformation of the State Savings Bank" was approved in early1999 and authorized the State Savings Bank (SSB) to engage in all commercial transactionsunder the banking law, which empowers the Bulgarian National Bank (BNB) to imposerestrictions on the activities of SSB.

18. The basic legal and regulatory framework for banking is almost complete in terms ofcoverage. Prudential banking regulations were restructured since the approval of the FESAL I.Regulations on bank licensing and large exposures were amended. A new Accountancy Law anda Bank Accounting Chart were promulgated in January 1998, and the 1997 accounts of all bankswere required to be audited by international auditors based on IAS. Banking supervision hasbeen overhauled with the strengthening of the Banking Supervision Department (BSD) in theBNB, bestowed with greater powers under the direction of a deputy governor.

C. Major Factors Affecting the Design and Success of the RL, CIRL, and FESAL I

19. The preparation of the RL, CIRL, and FESAL I was done in the context of a history inBulgaria of lack of sustainability and poor implementation of reform prograrns. Bulgaria'stransition history has been characterized by periodic and temporarily successful stabilization thatwas undone each time by the failure to follow through with structural reforms. The country'sproblems were due in part to its less favorable starting position. It was saddled with anexceptionally high external debt burden and significant distortions in the economy compared tomost other countries of Central and Eastern Europe. In addition to the usual costs of transition,these burdens proved too much for earlier Governments which lacked the political will tointroduce and sustain fundamental reforms. The resulting economic malaise exacerbated thepolitical instability, shortening the average life span of Governments. As a result,macroeconomic and structural adjustments were never implemented in a coherent and sustainedmanner. The design of Bank loans would have to recognize the risks of lending in such anenvironment.

20. The banking and foreign exchange crises in late 1995 and early 1996 were met with the alltoo familiar tentativeness. The authorities began in mid-I 996 with a strong stabilization effort aswell as programs for privatization, liquidation, labor redeployment, and strengthening of bankingsupervision. The Bank supported these reforms with the RL, with the possibility of futureadjustment lending depending on the progress in implementation. However, implementation wasincomplete. No further funds were released under the IMF SBA of July 1996 beyond thosedisbursed at IMF Board approval. The Bank could not move forward with the planned lendingsince the full set of policies required for the success of the program was not introduced. Thefailure to secure financial support from IFIs and the wavering pattern of reforms further erodedthe public's confidence in the ability of the Government to manage the economy.

- 6 -

21. The social toll of the crisis altered the political landscape. For the first time since thebeginning of transition in 1990, Bulgaria elected in 1997 a reform-minded Government with an

-absolute majority in Parliament. The election results reflected the fact that the public was finallyconvinced of the need for a market-oriented economic program. This opened a new window ofopportunity for radical reforms in Bulgaria. The complete change in regime centered on theCBA which bestowed credibility on the stabilization policies and the commitment to earnestreform. The Critical Imports Rehabilitation Loan provided rapid financial assistance to supportthe renewed reforms. The Financial and Enterprise Sector Adjustment Loan followed whenGovernment complied with the conditionalities for Board approval. Progress in structuralreforms has been much more decisive since the current Government took office in mid- 1997, butthe pace was slower than originally planned due to overly ambitious targets combined with weakimplementation capacity. The current Government is firm in its resolve to complete the prograrimof reforms and has been addressing obstacles to the acceleration of implementation.

D. Sustainability

22. The rationale for the design of each of the three loans was to support incremental steps inthe implementation of macroeconomic and structural reforms. Each operation supportedGovernment performance in the context of a multi-year reform program. Hence, each loan had aletter of development policy (LDP) and a comprehensive matrix of future actions to beundertaken by the Government following Board approval even though these actions were notconditionalities for the respective loans. However, these actions would form the starting pointfor future loans, thereby ensuring sustainability. The Country Assistance Strategy (CAS) ofApril 9, 1996 had a three phase approach for Bank support: (i) technical assistance to help theGovernment design a stabilization and structural reformn program; (ii) rapid but limited financialassistance upon adoption of an acceptable program; and (iii) adjustment operations to support theinitial stage of implementation of key reforms. The RL and CIRL were part of the second phaseand FESAL I represented the third phase. Further implementation and completion of the reformprogram is envisioned to be supported by programmed FESAL II and FESAL III.

23. Nevertheless, there were risks to the sustainability of structural reforms. Bulgaria had toadhere to prompt and continued implementation of structural reforms to consolidate the gainsfrom stabilization measures anchored in the CBA. Any lapses in implementing the measures inany of the reform areas would counteract earlier efforts at tackling the economy's underlyingstructural problems and therefore compromise the macroeconomic gains. To address these risks,the phased approach enabled the Bank to reward performance, maintain a dialogue with theGovernment, and provide incentives for sustained progress towards completing the program.

24. Bulgaria's development partners provided funding for technical assistance to helpimplement several major reforms complementing Bank operations by reducing the risk of poorimplementation. The EU and USAID provided much of the funding for the privatization of largeSOEs and PSBs, the Isolation Program, and the upgrading of bank supervision capacity. TheIMF provided extensive technical support to the BNB.

E. Bank Performance

25. The Bank's resolve to continue its support to Bulgaria's transformation despite a history ofpolicy reversals was well justified. The country had successfully implemented its liberalizationand stabilization program in 1990/91 with IMF support and introduced rudimentary measures in

- 7 -

the enterprise and financial sector. Because the Government at that time appeared committed todeepening the reforms, the Bank decided in 1992 to work closely with the authorities to developa far-reaching financial and enterprise sector adjustment program to be supported by a FESAL.But because of the slow progress and the stop and go nature of policy implementation thatprevailed until early 1997, the Bank's assistance strategy focused on encouraging and assistingthe authorities in preparing the reform program. At an early stage in the preparation of theFESAL, the Bank designed a comprehensive technical assistance (TA) program in the reformareas, which represented the first phase of the three phase assistance strategy described earlier.In addition to providing TA to implement the program, the Bank team mobilized other donors,such as EU-Phare and USAID. The RL and the CIRL encouraged the adoption of key elementsof the reform program at a time when the country was engulfed in a severe crisis.

26. The preparation of the FESAL beginning in 1992 turned out to be long and arduous.Successive Bank teams preparing the FESAL had to struggle with diverging intentions and lackof coordination within the various Governments. At an early stage, various Bank missionsconveyed concerns to Bank management about the high risks of such an operation as the signalsregarding Government intentions and willingness to launch a dynamic reform process wereuncertain. Difficulties in project preparation were aggravated by a lack of continuity in Bankstaff. The current Government's seriousness and resolve in implementing an ambitious reformprogram allowed the Bank to come to closure on the design of the FESAL and provide timelysupport.

F. Borrower Performance

27. Preparation. Borrower performance during the preparation of the economic programssupported by the RL, CIRL, and FESAL I was mixed. The Bank and the Bulgarian authoritiesworked closely in the design of a structural reform program following the 1991 SAL. Yet theinability of the various Governments leading up to the caretaker administration in February 1997to implement reforms delayed the preparation of the program to be supported under the FESAL.On the other hand, the Government's full cooperation, as evidenced by the speedy preparation ofthe RL (12 days) and the CIRL (3 weeks), coupled with successful negotiations by fax in bothcases, reflected quick decision-making on the Government's part. Nevertheless, preparation ofFESAL I up until the political crisis of early 1997 was hampered by a general lack ofunderstanding and coordination on the Government's side. The initial absence of a centralinstitution to coordinate activities in the reform areas, the involvement of too many governmentbodies in restructuring and privatization, the weak administrative capabilities and thereorganizations of ministries created confusion and frequent delays. The erratic process ofpreparing FESAL I mirrored the country's inability until mid-1997 to achieve a breakthrough inlaunching a dynamic reform process principally because of the absence of consensus, inparticular in the Government and in Parliament.

28. Implementation. The turnaround in the political and social consensus in support of areform-minded Govermnent elected in April 1997 reversed the country's poor track record inpolicy implementation. Its stop and go efforts at reform after an initial surge in 1991 left thecountry far behind other transition economies. As Bulgaria was heading towards an economiccrisis, an attempt at stabilization and reform was made in the summer of 1996. Thus, theGovernnent complied with the actions needed for Board presentation of RL. However, theGovernment did not comply with some commitments on enterprise reform made in the policymatrix for future actions, and the adjustment program unraveled in a few months as the crisis

- 8 -

deepened. As the country gained momentum towards reform in 1997, up-front conditions underthe CIRL and FESAL I were likewise met. However, the timetable for the implementation ofmany of the future actions under both the CIRL and FESAL I was in retrospect too ambitiousgiven institutional weaknesses and lack of experience in privatization of large SOEs and PSBs.Nonetheless, the Governmnent endeavored to accelerate structural reforms by addressingconstraints as these constraints become known. For example, the Privatization Law has beenamended several times to eliminate obstacles to the privatization process.

G. Assessment of Outcome

29. The RL's main objective was to support the initial phases of the Government'sstabilization and structural reform program by helping finance the costs of enterpriserestructuring and liquidation, and strengthening the social safety net. A total of 22,000employees received severance compensation in 1996, and the social protection programs wereimproved. However, the weak implementation of the stabilization and structural reformprograms did not arrest the deepening economic and financial crisis in 1996.

30. The CIRL aimed to support the new program of reforms under an interim Government thattook office in early 1997. The implementation of the initial phases of a new program of reformswas generally successful. Macroeconomic stability was restored with the reduction of the budgetdeficit, lowering of inflation, and stabilization of the exchange rate. Along with themacroeconomic success, structural reforms proceeded with the acceleration of privatization andliquidation of SOEs, closure of failed banks, reform of the legal and regulatory framework forbanking, and strengthening of banking supervision capacity.

31. The objectives of FESAL I were to accelerate privatization, support banking reform, andimpose financial discipline on SOEs. Privatization agents were appointed to accelerate the saleof large SOEs, a privatization program for the public sector banks (PSBs) was designed andimplemented, and an Isolation Program was introduced to imposed hard budget constraints onthe largest loss-making SOEs. While the original timetable for the achievement of performancetargets was, in retrospect, too ambitious given the weaknesses in institutional capacity, theGovernment has nonetheless continued to move towards completing the reforms.

H. Future Operations

32. The reforms supported by all three loans were important building blocks for futureoperations. The social protection programs supported by both the RL and CIRL enabled theimplementation of the privatization program designed under FESAL I. The structural reformssupported by FESAL I set the stage for future FESALs (II and III) and Agricultural SectorAdjustment Loans (ASAL I and II).

I. Key Lessons Learned

33. Credibility is critical to the success of any reform program. While the there werenotable and substantive actions undertaken by the Government in 1996 to reverse the economicdecline and arrest the financial crisis, the efforts were hesitant and incomplete, resulting in lackof confidence in the sustainability of Government's policies. This led to a deepening of the crisisand eventually to the fall of the Government. On the other hand, the interim and succeedingGovernments moved quickly and decisively in designing and implementing an economic

- 9 -

stabilization and structural reform program. The setting up of the Currency Board Arrangementwas an important instrument in establishing the credibility of Government policies.

34. Effective coordination among the IFIs and other development partners contribute tothe successful implementation of reform programs. The Bank and the Fund were importantplayers in the design of the reform program that addressed the crisis in 1996-97. To supportimplementation of the reforms, Bulgaria received substantial technical assistance from otherdevelopment partners including EU-Phare and USAID. The privatization of large SOEs, the saleof the PSBs, and the implementation of the Isolation Program were supported by thedevelopment partners. The Bank played a major role in coordinating the activities of thedevelopment partners.

35. One tranche quick disbursing operations are appropriate where: (i) an agreed multi-year program is in place to be supported by a series of lending operations; and (ii) there isconsiderable uncertainty in the environment and significant institutional weaknesses whichrequire a constant recalibration of the program design, implementation details, andperformance targets. The conditions under which all three loans were prepared were highlyuncertain with high risks of policy reversals or incomplete implementation. One trancheoperations were appropriate under these conditions to provide financing as well as incentives tomove the reform program forward. In all three loans, a second tranche would have beenproblematic. In the case of the RL, the incomplete implementation of the reform program wouldhave made second tranche conditionalities impossible to meet. In the case of the CIRL andFESAL I, the timetables for achieving certain performance targets as described in the Letters ofDevelopment Policy (LDPs) were too ambitious given institutional weaknesses and the lack ofexperience in privatization of large SOEs and PSBs. This would have made a second tranche forFESAL I problematic due to the need to make adjustments to the timetables for performancetargets as well as to the program design itself, such as introducing amendments to thePrivatization Law and strengthening the bankruptcy and liquidation framework. But in all cases,future operations were programmed to build on the gains made as a result of past operations.

36. Continuity of task management and effective internal Bank coordination are essentialto the efficiency and responsiveness of Bank operations. FESAL I was managed by five taskmanagers, three of them during the time when the crisis in Bulgaria became full-blown. Thisresulted in confusion with the Government having to deal with different people. The Bankreorganization in 1997 resolved many of the past coordination problems that existed amongvarious Bank units.

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Part II. Statistical Tables

Table 1-A,B,C: Summary of AssessmentTable 2: Related Bank Loans/CreditsTable 3: Lending TimetableTable 4: Loan/Credit Disbursements: Cumulative Estimated and ActualTable 5-A,B,C: Key Indicators for Program ImplementationTable 6: Key Indicators for Lending OperationTable 7: Studies Included in Loan PreparationTable 8A: Program CostsTable 8B: Program FinancingTable 9: Economic Costs and BenefitsTable 10: Status of Legal CovenantsTable I1: Compliance with Operational Manual StatementsTable 12: Bank Resources: Staff InputsTable 13: Bank Resources: Missions

Table 1-A: Summary of Assessments

Rehabilitation LoanA. Achievement of Objectives Substantial Partial Neliible Not afpicable

Macro Policies P M 5Sector Policies a 5 [

Financial Objectives 0 3 5 5Institutional Development E I IZI 0

Physical Objectives 5 5 5Poverty Reduction 5 5 Gender Issues aI E a

Other Social Objectives 53 0 5Environmental Objectives j] 5 s O

Public Sector Management 5 0 0

Private Sector Development Ex 0l

Other (specify) 5 5 5 5

B. Project Sustamability Likely Unlikely Uncertain(vi) (vi) (vi)

HiglC. Bank Performance Satisfactory Satisfactory Deficient

Identification 0 [ 0

Preparation Assistance 5 [ 5Appraisal 5 5Supervision 5 [x 0

- 12 -

Table 1-A: Summary of Assessments RL ContinuedHighly

D. Borrower Performance Satisfactory Satisfactory Deficient(/) (V') (/)

Preparation P7 El

Implementation 7 E I

Covenant Compliance I El

Operation (if applicable) E El

Highly HighlyE. Assessment of Outcome Satisfactory Satisfactory Unsatisfactory unsatisfactory

El El l

Note: The low ratings in the achievement of objectives, sustainability, and assessment of outcome derivemainlyfrom the poor implementation of the reforms, leading to the deepening of the economic andfinancialcrisis and the fall of the Government at that time. However, the Bank was cognizant of these risks, but wentahead with the RL to encourage the Government to implement reforms. The RL supported many importantmeasures that were undertaken by the Government, including the closure of many insolvent enterprises, theestablishment of the Mass Privatization Program, and the closure of bankrupt banks. One of the importantmeasures supported by the loan was the establishment of an appropriate severance pay mechanism, which atthat time was a major obstacle to enterprise closures. The succeeding interim and elected Governments wereable to build on the reforms begun by the RL, reducing the time required to design and implement the currentprogram. If viewed from the point of view of the RL being part of a series of loans (with the CIRL andFESAL I) supporting the design of the current program, the ratings of the RL would be more positive.

Table 1-B: Summary of Assessments

Critical Imports Rehabilitation LoanA. Achievement of Objectives Substantial Partial Negligible Not applicable

(V)~~~~(.

Macro Policies El L E

Sector Policies a7 LI

Financial Objectives LI L ElInstitutional Development 0C

Physical Objectives a E E J

Poverty Reduction E E 0l

Gender Issues U Iii

- 13 -

Table 1-B: Summary of Assessments CIRL ContinuedOther Social Objectives [ a 5Environmental Objectives ] 0] 5Public Sector Management 0] C] [Private Sector Development 0 1 00

Other (specify) E 5 ] ]

B. Project Sustainability Likely Unlikely Uncertain(1) (1) (1)

HighlyC. Bank Performance Satisfactory Satisfactory Deficient

(/) (V) (V)

Identification El [ 0

Preparation Assistance [21 I Appraisal [ []

Supervision l x ]

D. Borrower Performance Satisfactory Satisfactory Deficient(/) (/) (v/)

Preparation [ E]

Implementation 0 Fi 0

Covenant Compliance 5 5 nOperation (if applicable) 5 Fc

Highy HighyE. Assessment of Outcome Satisfactory Satisfactory Unsatisfactory unsatisfactory

V) s ) (/)

O] m1 0 a

- 14 -

Table 1-C: Summary of Assessments

FESAL IA. Achievement of Objectives Substantial Partial Negligible Not applicable

Macro Policies 0

Sector Policies a I I]Financial Objectives [ E I I

Institutional Development [ E E EPhysical Objectives ElPoverty Reduction al E ElGender Issues -l 3

Other Social Objectives El C0

Environmental Objectives E 0l []Public Sector Management El El ElPrivate Sector Development 0l 0l

Other (specify) E (I a []

B. Project Sustainability Likely Unlikely Uncertain(/) (V) (V)

C. Bank Performance Satisfactory Satisfactory Deficient

Identification []7Preparation Assistance ] 3 0

Appraisal E El

Supervision [ El

- 15 -

Table 1-C: Summary of Assessments FESAL I ContinuedHighly

D. Borrower Performance Satisfactory Satisfactory Deficient(V) (V) (1)

Preparation [2] [1 I

Implementation I [iI I

Covenant Compliance E u I

Operation (if applicable) U U

Highly HglE. Assessment of Outcome Satisfactory Satisfactory Unsatisfactory unsatisfactory

Table 2: Related Bank Loans/Credits

Loan/credit title Purpose Year of Statusapproval

Preceding Operations

1. Technical Assistance To support the Government in its implementation of its FY 1991 ExtendedProject for Economic reform program consisting of technical assistance to June 30,Reform Loan No. 3384 through the financing of resident advisors and short- 1999(US$17 million) term consultants, studies, training and minor amounts

of equipment in the areas of private sectordevelopment, enterprise restructuring, development ofaccounting and auditing standards, bank restructuring,strengthening of the social safety net, energy sectorstrategy, institutional development to support activitiesin trade reform, debt management, macroeconomicmanagement, statistics and the services of animplementation advisor.

2. Structural Adjustment To support the Government's economic reform FY1992 CompletedLoan No. 3397 program aimed at reducing macroeconomic(US$ 250 million) imbalances and laying the foundations for sustained

growth and restoration of creditworthiness. Structuraladjustment measures included: (i) increasedcompetition and establishment of market-basedrelative prices through trade policy reform,demonopolization and liberalization of prices; (ii)private sector development, through reform of theregulatory/incentive framework, creation of a modernbanking system, and privatization of state owned

-16-

assets; (iii) restructuring of SOEs and energy sectorand reform of energy pricing; and, (iv) establishmentof an adequate social safety net.

Following Operations

1. Social Protection To support the social protection reform program FY 1999 On-goingAdjustment Loan No. aimed at mitigating the adverse effects of transition4409 (DEM145.7 million) on the poor and vulnerable and at initiating the set-up

of an effective and sustainable system of incomesupport and poverty relief that meets the requirementsof a market economy. Areas of support includedsocial insurance, unemployment programs and socialassistance.

2. Agricultural Sector To provide balance of payments support (US$75 FY 1999 On-goingAdjustment Loan No. million equivalent) conditioned upon Bulgaria's4499-0 extensive program of policy reform aimed at(US$ 75 million) developing a competitive, market based agricultural

sector.

3. Proposed Financial and To continue to support the Government's Financial FY 2000 UnderEnterprise Sector and Enterprise Structural Adjustment Program preparationAdjustment Loan II (FESAP), comprising of: (i). divestiture of SOEs

under the current privatization program by mid-2000through a transparent and competitive privatizationprocess or liquidation procedure; (ii) banking reformincluding the privatization of public sector banks, theestablishment of a sound legal and regulatoryframework for banking, and the upgrading of bankingsupervision capacity; (iii) energy sector restructuring,including passage of an energy law that would enableprivatization of certain segments of the sector,establishment of a regulatory commission, andestablishment of rules for an electricity market.

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Table 3: Lending Timetable

Actual Dates

Steps in Lending Cycle Rehabilitation Critical Imports FESAL ILoan Rehabilitation

Preparation 06/15/96 02/28/96

Appraisal 07/05/96 04/10/97 06/23/97

Negotiations 07/08/96 04/21/07 09/25/97

Letter ofDevelopment/SectorPolicy (if applicable)

Board Presentation 08/01/96 05/8/97 10/30/97

Signing 08/02/96 07/10/97 11/14/97

Effectiveness 10/11/96 08/12/97 02/10/98

First Tranche Release 11/30/96 08/31/97 03/31/98(if applicable)

Midterm review (ifapplicable)

Second (and Third)Tranche Release (ifapplicable)

Completion

Loan Closing 07/31/97 06/30/98 04/30/98

Table 4: Loan/Credit Disbursements: Cumulative Estimated and Actual

(US$ millions)

Rehabilitation Critical Imports FESAL ILoan RehabilitationFY97 FY98 FY98

Appraisal Estimate 30 40 100Actual 30 40 100Actual as % ofEstimate 100% 100% 100%Date of FinalDisbursement 11/30/96 08/12/97 03/31/98

- 18-Table 5-A: Key Indicators for Program Implementation

Action MatrixRehabilitation Loan

OBJECTIVES MEASURES TAKEN FUTURE POLICY ACTIONS STATUS1. Macroeconomic Program A program of measures to stabilize Maintain a sustainable fiscal and Sustainable fiscal and external positions maintained

the economy, arrest the decline in external positions. through 1997 and 1998.Re-establish confidence and confidence and accelerate themacroeconomic stability and process of reforms was introduced inpromote economic growth and May 1996, after consultation with theprivate sector development. World Bank and the IMF.

a) Fiscal Policy

- Reduce budget deficit from - Increased value added tax rate - Enhance efficiency of tax system - Budget deficit increased from 6.3% of GDP in 19955.7% of GDP in 1995 to 3. 1 % from 18% to 22%. Doubled and tax and customs to 12.7% in 1996 before reducing to 2.5% in 1997.in 1997 and limit the excise taxes on wine and beer, and administrations by equalizing - Revenue collection fell in 1996 and in Ql-1997.borrowing requirements of the increased taxes on hard liquor and corporate income tax rates on allconsolidated government tobacco by 50%. enterprises; reducing dividendbudget. - Reduced non-interest real taxes; and restricting tax

expenditures in 1996 to 26.5% of preferences.GDP by limiting subsidies to - Limit non-interest expenditures in - Non-interest expenditures were limited to 24.9 % ofSOEs while allowing for 1997 to less than 28% of GDP, by GDP in 1996 and to 25.7 % of GDP in 1997;increased social spending further reducing subsidies and subsidies were further reduced from 11. I % of GDPespecially those associated with transfers while increasing social in 1995 to 0.8 % in 1996 and 0.7 % in 1997; sociallabor retrenchment policies expenditures, wages and expenditures were also reduced from 10.8 % in

maintenance and operations. 1995 and 9.1 % in 1996 to 8.5 % of GDP in 1997.

b) Pricing Policies- Adjust prices and tariffs in - Doubled electricity tariffs to the - Increase further and maintain - Further increases and adjustments of administered

order to limit subsidies to equivalent of US3.3 cents/Kwh electricity tariffs at US3.5 prices to international levels continuously carriedstrategic enterprises and and increased fuel prices to reflect cents/Kwh. Continue to adjust out.maintain their financial international prices and exchange fuel prices on a monthly basis inviability. rate movements. line with international prices and

most recent exchange ratemovement.

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OBJECTIVES MEASURES TAKEN FUTURE POLICY ACTIONS STATUSc) Monetary and Foreign

Exchange Policies

Restore confidence in the - Raised basic Central Bank - Limit growth of broad money to - In late September 1996 the BNB trieddomestic currency and lower interest rate to 108% (180% levels consistent with declining unsuccessfully to limit money supply growth andthe rate of inflation. annualized). inflation targets in the context of restore confidence in the Lev and the banking

- Restricted foreign exchange market determined floating sector by raising the base interest rate to 300 %intervention and allowed exchange rate. Use more (simple annual), putting nine ailing banks underexchange rate to depreciate by extensively open market conservatorship and providing support for viableclose to 100% in the last two operations for monetary banks. Open market operations were extensivelymonths. management. conducted but turned out insufficient to bring

- Sharply lowered availability of money supply under control because of lack ofrefinancing to weak banks foreign financing, decline in real demand for

money, induced by bank runs and lack ofconfidence in the Lev, and high inflationaryexpectations fueled by a huge budget fnancinggap filled by the BNB.

- Fixed exchange rate regime introduced in mid-1997under a currency board arrangement (CBA),inflation reduced and confidence in the Lev andbanks restored; open market operationsdiscontinued prior to the CBA introduction; moneysupply growth brought in line with growth ofdemand for money; a limited lender of last resortfacility introduced by the CBA that has not beenused so far.

- 20 -

OBJECTIVES MEASURES TAKEN FUTURE POLICY ACTIONS STATUS

H1 State-Owned EnterpriseReforms and Privatization

Strengthen financial discipline inSOEs and accelerate the processofprivatization

a) Liquidation Process

- Eliminate 25% of the losses of - Filed court bankruptcy petitions - Complete bankruptcy petitions and - Twenty-nine of the 64 enterprises have beenstate-owned enterprises by for 40 of the 64 enterprises the liquidation of the enterprises, privatized, the remainder are still under courtliquidating (either through identified for closures. Trustees pursue privatization of remaining supervised bankruptcy and liquidation procedures.closure or privatization) 64 of appointed in each of the 64 assets, and assist workers in Reform of bankruptcy and liquidation framework is

the worst performing SOEs. enterprises. process of retrenchment. being undertaken as part of FESAL II reforms.Laid-off workers under the liquidation programwere entitled to severance pay equivalent to up tosix times their average wage (COM Resolution No.131 of 1996). Under COM Resolution No. 100 ofApril 1998 workers in enterprises in liquidation laidoff after March 1, 1998 were entitled to a lump-sumpayment of Lev I million.

- 21 -

OBJECTIVES MEASURES TAKEN FUTURE POLICY ACTIONS STATUSb) Isolation Process

Isolate and restructure 70 - Identified key SOEs that will be - Have new legislation governing - The Isolation Program was legally established bylarge and potentially viable isolated through a government isolation restructuring process the "Law on Financial Rehabilitation of State-state-owned enterprises in process supervised reorganization. approved. Owned Enterprises", adopted on August 9, 1996,order to improve their - Drafted new legislation for the published in State Gazette #68/1996.profitability through process akin to bankruptcy - Finalize and implement individual - To this end, rehabilitation plans were prepared forsignificant downsizing, procedures. plans to downsize, eliminate non- all companies by mid 1997. Some of the plans wereenforcement of financial - Sharply reduced credit to core businesses and reduce red. not of sufficiently high standard and have not beendiscipline, and management identified enterprises. fully implemented.accountability with a view of - Raised electricity tariffs and fuel - Continue to adjust prices to - Electricity prices were adjusted several times. Ineventual privatization or prices to improve financial maintain financial viability. 1998, the GOB reached an agreement with the IMFrestoration of financial viability. on regular adjustments till the year 2001. Thisviability. - Established period for isolation to agreement has been complied with so far. Latest

be no more than 24 hours. adjustment took place on 01/01/99. Next one isplanned for 07/01/99. District heating prices do notensure financial viability, and are being adjusted asper agreed with the IMF time schedule. Regularrailway tariff increases have been implemented.

- Liquidate identified SOEs that are - The Law on Financial Rehabilitation of State-not turned around or privatized Owned Enterprises was amended on December 29,within two years. 1998 to extend the isolation program till June 30,

1999. As per agreement with IMF, an exit strategyfor each enterprise was developed, and the GOB isfirmly committed to liquidate enterprises that havenot been privatized by then.

c) Privatization

- Accelerate the process of - Distributed vouchers to 2.8 - Expand the privatization program - About 65% of total state-owned LT assets asprivatization through an million citizens. to include SOEs accounting for measured at end 1995 are covered by the currentexpanded voucher "mass - Scheduled first auction for 50% of all SOE assets. Privatization Program.privatization" program. October 1996. - Enhance the mass privatization - By April 15, 1999 two majority stakes were offeredInclude 1000 companies with - Established new Stock and program by including majority for privatization under the "second" masstotal capital of Lev 90 billion Securities Exchange Commission. private stake position in large privatization wave.in first wave of auctions. - Prospectuses approved for 60 enterprises.

privatization funds that can own - Facilitate cash privatization by - Deferred payment schemes are available only toup to 34% of shares in any one extending a deferred payment management-employee buyers.company. scheme to all investors, selling

enterprise to managers and workerson concessional terms.

- 22 -

OBJECTIVES MEASURES TAKEN FUTURE POLICY ACTIONS STATUSd) Labor Market Program - Issued the decree governing the Notify and pay severance to - As of 15 April 1999, 67,717 workers affected by- Alleviate social costs retrenchment program. projected 65,000 workers affected restructuring have been notified and received

associated with labor - Established national and rapid by the government program. severance pay.retrenchment under enterprise response teams in National - Use the unemployment and - Legislative changes with the enactment of theliquidation and isolation Employment Service agency to retraining fund and support from Unemployment Protection Act (1998), betterprograms by providing support deal with layoffs and provide other donors to provide labor funding and management of the unemployment andto retrain and redirect laid-off retraining program. market information, employment retraining fund. No verifiable data exists as to theworkers and extend severance - Established the program to and counseling, retraining, and small extent to which the workers affected by thepayments to those affected by affect severance payments and enterprise development skills to government program used the services of the localdownsizing. magnitude of payments. workers dislocated by the reform unemployment offices.

program.III. Banking Sector Reform

Reestablish the soundness of the - Closed two banks. - Adhere to programs outlined in - Memoranda of Understanding signed with allbanking system through a - Placed three banks in Memorandum of Understanding, recapitalized banks and with seven private banksprogram of closures, conservatorship. including prohibition of any new with negative capital adequacy positions in 1996;restructuring and improved asset - Approved law and established lending by banks with negative five banks placed in conservatorship in May 1996,position, and to strengthen the new policies governing deposit networth. followed by another nine banks in September 1996;role of supervision and improve guarantees. licenses of banks in conservatorship revoked inaccounting practices. 1997.

- Introduced limited program of - Adhere to program requiring banks - Higher capital adequacy requirements introducedbank recapitalization. to achieve specified capital for 1997 (8 %), 1998 (10%) and 1999 (12%) and

- Restricted Central Bank adequacy positions under new met in 1997 and 1998.refinancing credits. accounting standards.

- Signed Memorandum of - Prohibit any bank without 4%Understanding with 18 banks to capital adequacy standard to paybe recapitalized or with negative dividends.net worth. Memoranda outline - Increase staff and training of - Intensive banking supervision department stafftargets for bank operations supervisory agencies. training carried out in 1997 and 1998.including goals for loan recoveryand cost cutting measures.

- 23 -Table 5-B: Key Indicators for Project Implementation

Action MatrixCritical Imports Rehabilitation Loan

POLICY AREA MEASURES TAKEN FUTURE POLICY ACTIONS STATUSL Macroeconomic Program A program of measures to Maintain sustainable fiscal and Sustainable fiscal and external positions

Re-establish macroeconomic stabilize the economy, arrest external positions maintained through 1997 and 1998.stability and restore economic the decline in confidence andgrowth. accelerate the process of

reforms was agreed with theIMF in March 1997.

a) Fiscal policy- Reduce budget deficit from - Accelerate cash privatization. - Budget deficit in 1997 reduced to 2.5 % of GDP

11% of GDP in 1996 to 3.8% in down from 12.7 % in 1996 and 6.3% in 1995.1997 and eliminate the need for - Some progress in cash privatization achieved;central bank credit. - Strengthen revenue collection by - Improvement of revenue collection achieved in

establishing a large-taxpayers unit, 1997; a large tax-payers' unit established in Q2-raising VAT threshold, and Q4 1997; VAT raised from 18% to 22% in 1996;increasing penalties and interest on government penalties, fines, fees, patent andoverdue tax liabilities. charges expressed in the legislation in nominal

terms increased in 1997 to reflect inflationarydevelopments; strengthened collection ofoutstanding tax liabilities in 1997.

- Control non-interest expenditure by - Non-interest expenditures were limited to 24.9 %rationalizing programs and reducing of GDP in 1996 and to 25.7 % of GDP in 1997;public employment by 10 percent of subsidies were further reduced from 11.1 % ofwork force. GDP in 1995 to 0.8 % in 1996 and 0.7 % in 1997;

social expenditures were also reduced from10.8%in 1995and9.1 %in 1996to8.5%ofGDP in 1997. Public sector employment reducedby 58,000 workers in 1997.

b) Monetary & Exchange RatePolicies

- Restore confidence in the - Linked the determination of - Establish a currency board - Currency board arrangement (CBA) establisheddomestic currency and lower basic Central Bank interest arrangement. in mid-1997the rate of inflation. rate to the market yields of

TBills.- Eliminated unsecured

refnancing to weak banks.- Observed strict limits on the

creation of net domestic assets.

- 24 -


II. Enterprise ReformAccelerate privatization andstrengthen financial disciplinein SOEs. _

a) Privatization- Accelerate drastically the - Privatized 5 percent of the - Privatize SOEs accounting for at - By mid-1999, about 35% of total state-owned LT

privatization of SOEs to transfer state owned assets through least 40 percent of total SOE long assets were privatized.ownership, governance and cash-based programs and term assets (as of December 1995) bymanagement responsibilities to another 18 percent through end 1997.private operators. This is the voucher based programs.overriding priority of the - Offer for sale BTC. - Offers for the sale of BTC were collected by mid-program. - International privatization March, 1999. Negotiations with prospective

agent appointed for the buyer(s) are underway.privatization of BTC.

b) Liquidation- Reduce upfront 28 percent of - Closed 30 and privatized 11 - Close or privatize by mid-1997 - Enterprises accounting for at least 32% of losses

the SOE sector losses in 1995. out of the original list of 64 enterprises that contributed at least in 1995 have been effectively closed orSOEs. 28% of SOE losses in 1995. privatized. No information is available on the

losses of enterprises beyond the list of 64- Effective sale by end- 1997 of at least - Completed.

50% of the long term assets of theclosed enterprises.

c) Isolation - Isolated the enterprises from - Approve and implement Financial - Rehabilitation plans were approved for all- Reduce upfront 50 percent of the banking system. Recovery Plans. companies by mid 1997. Some of the plans were

the SOE sector losses in 1995. - Prepared Financial Recovery not of sufficiently high standard and have notPlans. been fully implemented. Some of the plans are

- Increased administered prices being updated or redrafted.of water, coal, heating for - Privatize or liquidate all enterprises - The isolation program was extended till June 30,industries, electricity, natural which are not utilities or mines. 1999. As per agreement with IMF, an exitgas, liquid fuels, and strategy for each enterprise has been developed,telecommunications to cover and the GOB is firmly committed to liquidatecosts. enterprises that have not been privatized by then.

- Increased prices of household - Maintain revenues of the utilities - Relative financial stability has been maintainedheating and transportation and (including budgeted subsidies) to through price and tariff adjustments (electricity,budgeted subsidies, cover at a minimum their operating district heating, railways) and budget subsidies.

and financial expenses.

- 25 -


d) Financial Discipline- Restore financial discipline and - Require utilities to suspend service to - Utilities have adopted procedures for suspending

ensure that utilities are enterprises in arrears. service to enterprises in arrears. These

effectively collecting their procedures are to be further discussed in the

accounts receivable. context of FESAL II.

III. Banking Sector ReformsRe-establish the soundness ofthe banking system through aprogram ofprivatization andstrengthening the role ofregulation and supervision.

a) Legal and regulatory framework- Strengthen the legal and - Amend the Law on Banks and Credit - The new Law on Banks and the Law on the BNB

regulatory framework to Activity; Enact a Law on Bank passed in mid 1997; the Law on Banks and Credit

facilitate privatization and Insolvency. Activities amended in May 1996 to make the

promote sound banking - Amend the Commercial Code, the establishment of conservatorship and bankruptcy

practices. Tax Law and related laws/regulations procedures possible; it was accompanied by the

to facilitate foreign investment in the establishment of a depositor protection scheme.banking sector. - Higher capital adequacy requirements introduced

- Raise the requirement of capital for 1997 (8 %), 1998 (10%) and 1999 (12%) andadequacy to 12% and revise other met in 1997 and 1998.banking regulations to reflect - Banking regulations have been amended to reflectinternational standards. international standards.

- Introduce international bank - IAS are currently under implementation;accounting standards (IAS) and - A new Deposit Insurance Law acceptable to thedisclosure standards, and start Bank/IMF enacted in 1998.implementation.

- Enact a new Deposit Insurance Lawacceptable to the Bank/IMF.

b) Banking supervision- Enhance BNB's authority and - Signed Memorandum of - Contract four residential international - Residential international banking supervisors

effectiveness in enforcing the Understanding with 18 banks banking supervisors and form joint contracted and joint on-site inspection teams

legal and regulatory framework. which outlined targets for loan on-site inspection teams. formed in 1997-1998.recovery and cost cutting - Adopt a banking supervision program - Banking supervision program acceptable to the

measures. acceptable to the Bank/IMF and Bank/IMF adopted and currently under

- Placed 15 banks in initiate its implementation. implementation.conservatorship and filed forbankruptcy against thesebanks.

- 26 -


c) Privatization of public sectorbanks (PSBs)

- improve the governance of the - Adopted a privatization - Announce in the international media - The Government's intention to privatize all PSBs

PSBs by changing their strategy for BCC. the Government's intention to or to enter into management contracts with

ownership and/or control. - Appointed privatization privatize all PSBs or to enter into reputable banks announced in 1997-1998; anadviser to BCC. management contracts with reputable intensive search for strategic investors initiated.

- Started due diligence review. banks. Initiate an intensive searchfor strategic investors.

- Conclude by end-1997 four - Two PSBs privatized in 1997 and 1998; threetransactions, of which at least two are more PSBs are currently in a process ofprivatizations. privatization.

IVAgricultural SectorLiberalizationCreate a competitive market-based and export-orientedagriculture andfood industry. - Increased the sale price of - Eliminate the system of controls on - Price controls and price mark-ups cancelled as of

wheat by state entities to $160 profit margins of agricultural and July 1, 1997 by a Decree of CoM No 269 from

per ton, and maintain the price food products by end-May. 1997.at least 85% of international - Eliminate by end-May import quota - No duty free import quotas for cereals and cereal

price CIF Sofia. and duties on cereals and cereal products are envisaged in the Customs Tariff forproducts. 1999.

- 27 -


- Started using competitive - Eliminate all export bans by mid- - Export bans and export taxes were abolished mid-bidding procedures for the 1997 (no export tax to be 1997; the remaining export taxes on sunfloweremergency Government introduced). and sunflower products were cancelled by CoMpurchases of wheat this spring - Liberalize the sale prices of cereals Decree No 169, July 31, 1998

and other cereal products by mid- - Prices were liberalized by CoM Decree No 187 of1997. August 13, 1998. As of July 1, 1999 a new Law

- Remove non-tariff barriers against for Consumer Protection enters into force whichimport and export of fertilizers by cancels the old Law on Pricesmid-1997. - Only the imports of chemicals is subject to

licensing.- Abolish any direct or indirect - Abolished

subsidies to prices of wheat, wheatflour, bread and other cereal productsby mid-1997.

- Eliminate import and export - No registration and licensing are currently appliedadministrative constraints. according to CoM Decree No 271/98 on trade

policy measures, related to exports and imports- Use open and transparent auctions for - A transparent and open procedure is applied -

the sale of Government-procured announcements in newspapers are published.supplies of cereals.

- Submit a new law to Parliament in - Several measures were applied to facilitate landJuly to facilitate privatization of restitution process, all limitations on land leasestate-owned land, revamp the were lifted (in terms of areas and duration ofregulations for leasing, titling, and lease), decisions of the Land Commissions willoccupation rights, and revise the ban have the legal power of notary deeds, foreignon foreign land ownership. legal entities registered in Bulgaria can own land.

- Offer for sale all state mills and the - All mills are in the process of privatization, 49 of26 state trading companies by end- total 59 mills have been privatized covering 76 %1997. of their assets, on average 55 % of the assets in

agriculture are private by end March 1999.

- 28 -


V Social Protection ReformIncrease effectiveness, efficiency,

transparency and sustainabilityof social protection programs.

a) Social Assistance- Improve targeting of programs - Revised benefit coefficients to - Establish a consolidated two-tier - Two-tier MIGP established, based on new Social

to provide adequate protection increase assistance to children MIGP (utility voucher and cash Assistance Act (1998), including energy supportto vulnerable groups at in poor households supported benefit). program and consolidated benefit - both in cash.affordable cost. by the minimum income All benefits, payments and eligibility, is based on

guarantee program (MIGP). an annually calculated Base Minimum Income- Set up temporary utility (BMI).

voucher program for poor - Set up matching fund scheme for - As of FY 1999 MIGP payments, except energyhouseholds and benefit levels MIGP. support program, based on 50/50 cost sharingraised since 3/97. between municipal and central government

budgets.- Improve targeting of child - A draft Family Support Law was submitted to

allowances, medical support Parliament, that includes universal child benefitsprograms and maternity assistance. and means tested birth grants and other one time

- Eliminate payment of untargeted benefits. Both testing and benefits are based onsocial assistance through insurance BMI.funds.

- Provide sufficient quality of - Augmented temporary - Involve NGOs in services and - The Social Assistance Act (1998) provides forsocial care services. resources for social care recentralize financing for inter- licensing NGO social services. In 1999 Regional

institutions via EU municipal institutions. Social Assassinate centers were created tosupplement. supervise quality of services provided at

municipal level and ensure adequate informationflows to the central government.

b) Severance Pay- Protect workers laid-off under - Introduced severance benefit - Extend program to cover budgetary - Budgetary sector employees receive severance

structural reform program. scheme for laid-off SOE sector employees. benefits as per the Law on Unemploymentworkers. Security and Employment Incentives, adopted on

December 16, 1997.

- 29 -

OBJECTIVES MEASURES TAKEN FUTURE POLICY ACTIONS STATUSc) Pensions- Increase fiscal transparency, - Separated pension fund from - Establish one-month reserve fund for - One-month reserve funds has been established

sustainability and targeting of budget. PAYG pension scheme. and is being maintained.the pension system. - Made legal provision for - Comply with legal provision for - Legal provisions have been complied with.

transparent budget subsidy for budget subsidy to cover non-non-insurance expenses. insurance expenses.

- Adopted program for - Cease financing of recreational - Financing of recreational facilities wasimproved payroll tax facilities. discontinued through the establishments of aadministration and tracking of commercial affiliate of NSSI. An action plan hasindividual records. been prepared and in being followed for the

- Changed benefit formula to privatization of the affiliate's assets.require extended contribution - Enact new PAYG pension law to: - A comprehensive Pension Insurance Code isperiod for full pension. (a) eliminate most early-retirement under advanced preparation. Early drafts of the

- Introduced employee categories legislation indicate compliance with the Bankcontribution. (b) phase in later pensionable age requirements, as defined in the Social

(c) introduce actuarially sound benefit Protectional Adjustment Loan. Regulationsformula eliminating most early retirement categories were

(d) establish targets for gradual adopted in October 1998, with an implementationreduction of pension payroll taxes date 01/01/2000. The target date for introduction

of the new pension system is 01/01/2000.- Prepare legislation for voluntary, - A draft Law on Supplementary Voluntary

private pension and funded Pension Insurance has passed first reading inoccupational schemes. Parliament and is awaiting second reading.

d) Unemployment - Reduced unemployment fund - Further reduce payroll tax rate from - Unemployment payroll tax is reduced to 4%payroll tax from 7% to 5% 5% to 3%. (1998).2

- Extend contribution period for - The contribution period for benefit eligibility has- Made adequate budgetary benefit eligibility. been extended from 6 months of employment

allocation to clear arrears of within the last 12 calendar months, to 9 months ofGovernment to domestic - Change the benefit formula to reduce employment within the last 15 calendar months.pharmaceutical suppliers work disincentives. - Benefits formula has been changed to (1) take(approximately $20 million into account only the years worked. The formerequivalent) and to ensure - Eliminate ineffective active labor formula included an index for age as well.adequate purchase of supplies programs and strengthen job - Detailed analysis of the effectiveness of activein 1997 (at least $22 million information services. labor marker policies is almost complete.equivalent). Completion of the analysis and agreement on

action plan is a SPAL second tranche condition.

2 In 1997 the unemployment payroll tax was reduced to 4.5% in accordance with SPAL Board presentation condition. As of I July the Govemment proposes to reduce it to 4.0 %.

- 30 -OBJECTIVES MEASURES TAKEN FUTURE POLICY ACTIONS STATUS

e) Supply of medicines - Take all necessary administrative - Necessary steps were taken to ensure regular- Ensure adequate supplies in steps to ensure that medical supplies supply of medicines in 1997 within budgetary

1997 of medicines to hospitals are in fact provided to hospitals and constraints. In 1998 amendments to theand clinics. clinics. Pharmaceuticals Act were passed by Parliament

and will become effective for outpatient care inI _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _I__ _ _ _ _ _ _ I__ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ I__ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ Ja n u a ry 2 0 0 0 .

- 31 -

Table 5-C: Key Indicators for Program ImplementationAction Matrix

Financial and Enterprise Sector Adjustment LoanObjectives of Policy Measures Measures Already taken Indicative Plan for the Next Six Status

MonthsI. Macroeconomic Framework

The main objectives of the Agreed macroeconomic framework in Maintain agreed macroeconomic The Government was able to maintain the agreedGovernment's macroeconomic place. framework. macroeconomic frameworkprogram are to achievestabilization and restore economicgrowth.

II. Enterprise Sector

Acceleration of Privatization SOEs, accounting for 17.8 percent of Privatize SOEs accounting for at By March 30, 1998, only an additional 5% of SOE assetsDrastic acceleration of the total SOE long-term assets (as of least an additional 23 percent of were privatized. By mid-1999, about 35% (cumulative)privatization of state-owned December 1995), have been privatized.3 total SOE long-term assets (as of of total state-owned LT assets were privatized. However,enterprises (SOEs). December 1995). with the expiration of the privatization contracts with

privatization agents in 1999, large SOEs representing 20percent of assets would be divested by end-1999. TheSME privatization is expected to be almost complete byend-1999, representing an additional 15 percent of SOEassets.

International privatization agents have Appoint international privatization By March 30, 1998, international privatization agents forbeen appointed to privatize three large agents for the 27 selected SOEs. 31 selected SOEs were appointed. As of April 30, 1999,SOEs already selected or to assist in there were privatization agents for about 90 SOEs.selling individual assets in cases whereshares cannot be sold. A further groupof 27 SOEs has been selected forprivatization by such agents, including11 SOEs from the isolation program.

An international privatization agent has Implement the strategy for the sale Bids for 51% of BTC shares were received in Marchbeen appointed for the privatization of of BTC shares, designed by the 1999. Negotiations with the prospective buyer areBTC, and a decision of the Council of privatization agent. underway.Ministers has been issued abolishing the

3 To be counted as privatized, at least 67 percent of the shares of an enterprise must have been transferred to private owners.

- 32 -Objectives of Policy Measures Measures Already taken Indicative Plan for the Next Six Status

Months25 percent limit on the sale of BTC Offer for sale or for restitution all Portions of the residual shares were sold during theshares. residual shares from the first wave Centralized Public Auctions of January 25 - February 5,

of the Mass Privatization Program. and March 3 - March 19, 1999.

Liquidation

Reduction of the 1995 level of 59 of the 64 SOEs slated for liquidation Take legislative and regulatory Amendments to the Bankruptcy Law, approved in JuneSOE losses by 28 percent. under Government Decision 480/96, measures to streamline and 1998, set the limit of two months for courts to decide on

plus a further group of 86 loss-making accelerate the process of the bankruptcy petition and three months for the supremeSOEs, have been either privatized or bankruptcy and liquidation, while court to rule on appeals concerning such decisions.closed. (These enterprises employed protecting the rights of the Enterprises accounting for at least 32% of losses in 199526,000 workers and accounted for 28 creditors. have been effectively closed or privatized.percent of the SOE sector losses in1995.)

Isolation Program (41' Group Benterprises)

Reduction of the 1995 level of The Financial Recovery Plans (FRPs) of Ensure that all SOEs selected The Isolation Program was legally established by theSOE losses by 50 percent. all 41 Group B enterprises have been under Government Decision "Law on Financial Rehabilitation of State-Owned

approved and are under implementation, 480/96 are in the process of exiting Enterprises", adopted on August 9, 1996. As of Marchand decisions have been taken on the isolation program, either 30, 1998, seven SOEs were privatized and one liquidated.whether these enterprises will be through liquidation or As of April 30, 1999, 17 SOEs have been privatized andliquidated or privatized. privatization. 13 are in liquidation/bankruptcy procedure.

The 1996 Law on Financial Rehabilitation of State-Owned Enterprises was amended on December 29, 1998to extend the isolation program till June 30, 1999. As peragreement with IMF, an exit strategy for the remaining11 enterprise was developed, and the GOB is firmlycommitted to liquidate enterprises that have not beenprivatized by then.

Isolation Program (30 Group Aenterprises)

Decisions have been taken and To implement the cost reduction Rehabilitation plans were approved for all companies byRevenues of the utilities and the implemented for all Group A enterprises measures proposed in the FRPs and mid 1997. Some of the plans were not of sufficientlymines (including budgeted on: (i) the level and adjustment meet the cost recovery targets. high standard and have not been fully implemented.subsidies) to cover, at a minimum, mechanisms for tariffs; (ii) the level of Some of the plans are being updated or redrafted now. Attheir operating and financial subsidies; and (iii) cost cutting the end of 1998, 28 of 30 enterprises reported loWses.expenses. measures.


Months

ElectricityThe average tariff has been increased to To adjust all tariffs, as necessary to Electricity prices were adjusted several times. In 1998,about US$0.035/kWh in October 1997 ensure continued compliance with the GOB reached an agreement with the IMF on regularand will be maintained at a cost covering FESAL conditions. adjustments till the year 2001. This agreement has beenlevel by the application of a fuel complied with. Latest adjustment took place onadjustment formula agreed with the 01/01/99. Next one is planned for 07/01/99. ElectricityWorld Bank under the Power Project. and rail tariffs were adequate but district heating tariffs

remained well below the level required for cost recoveryin 1997.

RailwaysPassenger tariffs have been set, and will Regular railway tariff increases have been implemented.be adjusted, as required, to achieverecovery of at least 50 percent ofoperating and fnancial expenses beforesubsidies. Freight tariffs have been set,and will be adjusted as required, toachieve full cost recovery withoutsubsidies.

TelecommunicationsTariffs have been set to achieve full costrecovery, and will be adjusted andrebalanced as required, to maintain anadequate level of investment and self-financing ratio.

District HeatingIndustrial tariffs have been set, and will District heating prices do not ensure financial viability,be adjusted, as required, to achieve full and are being adjusted as agreed with the IMF.cost recovery plus an adequate margin tofinance investments and working capitalrequirements without subsidies.Household tariffs have been set, and willbe adjusted as required, to achieve costrecovery after subsidies.

- 34 -

Objectives of Policy Measures Measures Already taken Indicative Plan for the Next Six StatusMonths

Isolation Program (30 Group A Natural Gasenterprises) (continued) Pending liberalization of the gas trade, Further liberalize the trade and Being discussed in the context of FESAL II

the price of gas has been set, and will prices of gas, petroleum products,remain regulated, on the basis of the CIF and mining products. No entryprice of gas delivered to Bulgaria, plus a barriers to firms.margin to cover transit costs andoverheads of Bulgargas.

Coal and ligniteDomestic prices of coal and lignite havebeen raised close to world levels, andimports are freely allowed with a lowtariff of up to 5 percent.

Financial DisciplineRestore fnancial discipline and The Council of Ministers has issued a Enforce the measures to restore Utilities have adopted procedures for suspending service

ensure that utilities are effectively Decision requiring the utilities to fnancial discipline. Ensure that to enterprises in arrears. These procedures are to be

collecting their accounts suspend service to, or to require advance the aggregate payment arrears in further discussed in light of the FESAL II agreements.

receivable. payment from, enterprises with arrears the enterprise sector have notfor more than 30 days. A monitoring increased by more than 10 percentsystem has been established that reports above their level of June 30, 1997.on the status of arrears on a weekly basisto allow the Govermment to take actionin a timely fashion in the most importantcases.

- 35 -


III. Banking Sector

Adjustments to the LegalFrameworkCreate a legal framework for the A new "Law on Banks" has been passed, Enact a new Deposit Insurance A new Deposit Insurance Law acceptable to thebanking sector that is suitable for mainly to facilitate the resolution of Law, and establish a sound Deposit Bank/IMF was passed in April 1998 and becamethe introduction of the Currency insolvent banks, improve bank licensing Insurance Scheme. effective in January 1999. The law guarantees both BGBoard Arrangement (CBA) and the procedures, strengthen accounting and Lev and foreign currency deposits at 95% for deposits updevelopment of a safe and sound external auditing provisions, introduce to BG Lev 2 million, and at 80% for those above BG Levbanking sector. provisions on bankers' fiduciary duty 2 million but no more than BG Lev 5 million. A Deposit

and conflicts of interest, rationalize Insurance Fund was set up in early 1999.penalties for regulatory non-compliance,and limit the coverage of the Law to Decide on whether a new SSB Law A Draft law on the Transformation of the SSB into a solebanks. will be enacted and/or the existing proprietor joint stock company became effective in April

Law will be revoked, with SSB 1998. It provides for subjecting SSB to the Law onthen subjected to the Law On Banks and for its transformation into a commercial bank.Banks. Clarify the future role of The SSB is currently in a process of restructuring andSSB, including the option of a transformation into a commercial bank. In August 1998"narrow" bank, agreement was reached between the BNB and the SSB on

restrictions on the SSB's activities until it has thecapacity to conduct all normal commercial bankoperations. A transition period was introduced thatwould last until May 2000; during that transition periodall Lev deposits at the SSB will have a full governmentguarantee; by end of 1998 the SSB had to comply with allprudential regulations.

A new "Law on the Bulgarian National Amend the Collateral Law and The Law on Registered Pledges has been passed,Bank" has been passed to adjust BNB to establish a registry of collateral. amendments to it have been suggested and are expectedthe needs of the CBA and to increase its to be approved by Parliament soon. The collateralindependence and accountability. In registry is being modernized.particular, the new Law ensures theindependent authority of the DeputyGovernor responsible for bankingsupervision.

- 36 -


Strengthening of BankingSupervision Banking Supervision has been improved Ensure that at least five joint on- Intensive banking supervision department staff training

by strengthening the independent site inspection teams are operating; carried out in 1997 and 1998.Develop a safe and sound banking authority of BNB's Supervision effective off-site surveillance aresystem through enhancing BNB's Department. The new Law on Banks functioning; and an acceptable Joint on-site inspection teams have been formed asauthority and effectiveness in authorizes BNB to revoke licenses of training program is ongoing. needed and feasible, and training is being carried out byenforcing the legal and regulatory banks that violate the Law or the BNB international on-site experts.framework. regulations, and obliges it to revoke

licenses under clearly definedconditions. If a license is revoked, aconservator must be appointed, andBNB must file for liquidation of thebank or for bankruptcy proceedings.The revocation of a bank license cannotbe appealed.

BNB has recruited a resident Ensure that full implementation of Programming and implementation of banking supervisioninternational banking regulation/ the banking supervision program is needs to be further strengthened. Banking supervisionsupervision expert with assistance from underway. program acceptable to the Bank/IMF adopted andthe IMF and is recruiting two resident currently under implementation.international experts for off-sitesurveillance (EU-Phare) and tworesident international experts plus short-term experts (USAID) for on-siteexaminations.

BNB has adopted a Strategic Plan for Ensure that all banks are either in Higher capital adequacy requirements introduced forOn-site Examinations which requires: compliance with revised banking 1997 (8 %/6), 1998 (10%) and 1999 (12%) and met in 1997(i) the formation of joint on-site regulations, or that effective and 1998. The Banking Supervision Departmentinspection teams that will include the regulatory enforcement measures monitors banks' compliance with revised bankingforeign examiners; (ii) improvement of have been taken, including regulations; in January 1998 the license of a private bankthe procedures for on-site inspections, withdrawal of bank licenses and was revoked; recapitalization of banks has been carriedoff-site analysis and early warning; (iii) filing for bankruptcy; that Bank out in the context of privatization.intensive training for bank supervisors; licenses have been revoked for alland (iv) preparation of an annual banks under conservatorship; andcompliance report covering all banks. that recapitalization of banks will

be carried out only in the context ofThe 1996 accounts of all PSBs have a change in governance resultingbeen audited by international auditing from privatization or afirms and provided to the Bank for management contract.review.


Months

Privatization of Public SectorBanks (PSBs)

The Government has announced The Government's intention to privatize all PSBs or toEnsure stabilization and growth of repeatedly its intention to privatize the enter into management contracts with reputable banksthe banking system through six PSBs (all PSBs other than SSB), or announced in 1997-1998; an intensive search for strategicimproving the governance of, and to enter into management contracts with investors initiated.the public's confidence in, the reputable private banks, and an intensivePSBs by changing their ownership search for strategic investors has beenand/or management. initiated.

Resident international bank Conclude two transactions by end- Two PSBs privatized in 1997 and 1998; three more PSBsprivatization/restructuring consultants 1997 and initiate the preparatory are currently in a process of privatization.have been contracted for BCC, with measures for the privatization ofreputable investment banks to be the remaining four PSBs.contracted, as necessary, to assist in theprivatization of selected PSBs.

The shares of a PSB (United Bank ofBulgaria) have been sold to EBRD(35%, plus a 35% call option), Bulbank(35%) and Oppenheimer & Co. (30%),and an agreement with the new ownersprovides for an additional substantialcapital injection.

A Resolution Plan has been adopted for A management contract for Biochim Bank has beenan insolvent bank (Biochim Bank), signed. It provides for the strengthening of the bank'swhich provides for the strengthening of management, restrictions on lending, enhancedthe bank's management, restrictions on supervision and preparation for privatization.new lending, enhanced supervision,recapitalization, and initiation of biddingprocedures for the bank's privatization orthe conclusion of a managementcontract. The first steps of The Plan isunder implementation.

- 38 -

Table 6: Key Indicators for Program Operation

Not Applicable

Table 7: Studies Included in Loan Preparation

Not Applicable

Table 8A: Program Costs

Appraisal estimate Actual/latest estimates(US$ million) (US$ million)

Item Local Foreign Total Local Foreign Totalcosts costs costs costs

Rehabilitation LoanIBRD 30 30 30 30

Critical Imports RehabilitationLoan

IBRD 40 40 40 40FESAL I

IBRD 100 100 100 100*Import Export Bank of Japan 50 50

Total

Table 8B: Program Financing

Appraisal estimate Actual/latest estimates(IJS$ million) (US$ million)

Item Local Foreign Total Local Foreign Totalcosts costs costs costs

Rehabilitation LoanIBRD 30 30 30 30

Critical Imports RehabilitationLoan

IBRD 40 40 40 40FESAL I

IBRD 100 100 100 100*Import Export Bank of Japan 50 50

Total

* To date, no disbursements have been made.

- 39 -Table 9: Economic Costs and Benefits

Not Applicable

Table 10: Status of Legal Covenants

Rehabilitation Loan

Agreement Section Covenant Present Description of CovenantType Status

Loan Agreement 3.01 9 C Borrower and the Bank to exchange views on the progress(a, b, c) achieved in carrying out the program and on any proposed action

taken after loan disbursement that could reverse the program'sobjectives.

Loan Agreement 3.02 1 C Borrower to have the Deposit Account audited in accordance(a, b, c) with appropriate auditing principles to the Bank; to fumish to the

Bank reports of the audit by said auditors within 6 months afterthe Bank's request for such audit; and to furnish information onthe Deposit Account and Audit to the Bank upon such request.

Critical Imports Rehabilitation Loan

Covenant Present Description of CovenantAgreement Section Type Status



Loan Agreement 3.02 1 C Borrower to have the Deposit Account audited in accordance(a, b, c) with appropriate auditing principles to the Bank; to furnish to the

Bank reports of the audit by said auditors within 6 months afterthe Bank's request for such audit; and to fumish information onthe Deposit Account and Audit to the Bank upon such request.

Financial and Enterprise Sector Adjustment Loan

Covenant Present Description of CovenantAgreement Section Type Status



Loan Agreement 3.02 1 C Borrower to have the Deposit Account audited in accordance(a, b, c) with appropriate auditing principles to the Bank; to furnish to the

Bank reports of the audit by said auditors within 6 months afterthe Bank's request for such audit; and to furnish information onthe Deposit Account and Audit to the Bank upon such request.

Covenant types: Present Status:

1. = Accounts/audits 8. = Indigenous people C = covenant complied with2. = Financial performance/revenue 9. = Monitoring, review, and reporting CD = complied with after delay

generation from beneficiaries 10. = Project implementation not covered by CP = complied with partially3. = Flow and utilization of project funds categories 1-9 NC = not complied with4. = Counterpart funding 11. = Sectoral or cross-sectoral budgetary or5. = Management aspects of the project or other resource allocation

executing agency 12. = Sectoral or cross-sectoral policy/6. = Environmental covenants regulatory/institutional action7. = Involuntary resettlement 13. = Other

- 40 -Table 11: Compliance with Operational Manual Statements

Not Applicable

Table 12: Bank Resources: Staff Inputs

BulgariaRehabilitation Loan

Actual

Stage of project cycle Weeks US$

Preparation to Appraisal

Appraisal 7.2 15.7

Negotiations through Board approval 2.0 13.7

Supervision 5.4 35.8

Completion

Total 14.6 65.2

Critical Imports Rehabilitation LoanActual


Preparation to Appraisal 20.2 77.5

Appraisal 1.3 3.5



Completion

Total 33.3 230.9

Financial and Enterprise Sector Adjustment LoanActual


Previous Fiscal Years N/A* N/A*

FY 1997-1999

Preparation to Appraisal 131.8 348.6

Appraisal 13.3 44.2



Completion 1.7 6.4

Total 185.2* 530.1*

*Note: Previous fiscal years staff weeks and financial information is not retrievable.

- 41 -

Table 13: Bank Resources: Missions

BulgariaRehabilitation Loan

Performance RatingL Types ofStage of project cycle Month/ No. of Days in Specialization' Implem. Developm. Problems3

Year Persons Field status objectivesThrough Appraisal None

Appraisal through Board Noneapproval

Supervision None

Completion None

I - Key to Specialized staff skills: 2 - Key to Performance Ratings: 3 - Key to Types of Problems:etc. etc. etc.

Critical Imports Rehabilitation LoanPerformance Ratin t Types of

Stage of project cycle Month/ No. of Days in Specialization' Implem. Developm. Problems3

Year Persons Field status objectivesThrough Appraisal 7

Appraisal through Board 1approval

Supervision 2

Completion

I - Key to Specialized staff skills: 2 - Key to Performrance Ratings: 3 - Key to Types of Problems:etc. etc. etc.

Financial and Enterprise Sector Adjustment LoanPerformance Rating Types of

Stage of project cycle Month/ No. of Days in Specialization' Implem. Developm. Problems3

Year Persons Field status objectivesThrough Appraisal 4/92-7/94 8

Appraisal through Board 10/96 1approval

Supervision 3-4/98 2

Completion

I - Key to Specialized staff skills: 2 - Key to Performance Ratings: 3 - Key to Types of Problems:etc. etc. etc.

- 42 -Appendix 1Page 1 of I

COUNCIL- OF MINISTERS

COMMISSION FOR WC,7- WITH THE INTERNATIONAL FINANCIAL

ON THE IMPiI9 - 1- .7 )N COMPLETION REPORT ON THEREHABILITATION OAN CR:Y- CAL :'i .ORTS REHABILITATION LOAN

AND FINANCIAL A7. 17 . ._L SECTOR ADJUSTMENT LOAN I

* The Implementation Completion on the three loans has been reviewed by theMinistry of Labor and Social; Polcy (MLSP), the Ministry of Finance, the Ministry ofHealth, and tne Council for Stractural ¾.. ,-orn

* The Ministry of Health, Ministry of Finance and the Council on Structural Refornhave no remarks and agree with the assessments made in the ImplementationCompletion Report of the World Bank.

* The Ministry of Labor and Social Policy (MLSP) made the following comments onthe Rehabilitation Loan (4078-0-BUL):

1. Based on National Employment Service (NES) data, for the period July 1996 -April 1999 68 757 people were registered as unemployed. They were released as aresult of the Structural Reforn and compensated with funds from the Loan,according to the following scneme:

1996- 21 764 peopie1997- 26 648 people1998- 12 091 people1999 - 8 254 people

Total: 68 757 people

2. In the process of utilization of the loan, the MLSP and NES have made their bestefforts to meet the loan's objectives in the agreed timeframes. A very goodorganization for management and coordination of funds was established, all thepayments were made in time and 3 575 additional workers received compensationsfor unemployment. Therefiore MLSP considers the Table I assessment "negligible"under "Achievement oi objectives ", rows "Macro Policies", "Sector Policies ", and"Institutional Development", and fhe assessment of "deficient" in under"Implementation " do not refer to the work of MLSP and NES.

June 17, 1999

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