world bank document...director: yukon huang, ec3 division chief: kadir t. yurukoglu, ec3c1 staff:...

Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 15812

IMPLEMENTATION COMPLETION REPORT

REPUBLIC OF KAZAKSTAN

REHABILITATION LOAN(LOAN 3649-KZ)

June 26, 1996

Country Operations I (EC3C1)Country Department III (EC3)Europe and Central Asia Regional Office(ECA)

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

Currency Unit: Tenge [national currency adopted November 199311 Tenge = 100 Tyins

Tenge per USSPeriod Period Average End of Period

1993 --- 61994 36 541995 61 64

June 21, 1996 67 --

WEIGHTS AND MEASURESMetric System

GOVERNMENT FISCAL YEARJanuary 1 - December 31

ABBREVIATIONS AND ACRONYMS

CMEA Council for Mutual Economic AssistanceFSU Former Soviet UnionFXC Foreign Exchange Market ComponentG + NFS Goods plus Non-Factor ServicesGOK Government of KazakstanICR Implementation Completion ReportIPF Investment Privatization FundMPP Mass Privatization ProgramMSRP Memorandum on Structural Reform PoliciesMUV Index of Unit Value of Manufactured ExportsNBK National Bank of the Republic of KazakstanPIC Pre-Identified Imports ComponentPIU Project Implementation UnitSAL Structural Adjustment LoanSSP Small Scale PrivatizationSTF Structural Transformation FacilityUSD United States Dollar

FOR OFFICIAL USE ONLY

Contents

Preface ............................ i

Evaluation Summary ............................ ii

Project Implementation Assessment .... .............................. 1

A. Project Origin and Objectives .......................... 1B. Achievement of Objectives ......................... 2C. Implementation Record and Major Factors Affecting the Project ................ 7D. Project Sustainability ........................................... 7E. Bank Performance ........................................... 8F. Borrower Performance ........................................... 8G. Assessment of Outcome ......................................... 9H. Future Operations ........................................... 10I. Key Lessons Learned .......................................... 10

Statistical Tables ................................................ 13

AnnexesMission's Aide Memoire ........................................ A. 1Borrower's Contribution to the ICR ................................. A.3

Map IBRD 28007

Vice President: Johannes F. Linn, ECADirector: Yukon Huang, EC3Division Chief: Kadir T. Yurukoglu, EC3C1Staff: John Holsen, EC3C1

This docunent has a restricted distribution and may be used by recipients only in the performance of theirofricial duties. Its contents may not otherwise be disclosed wiUhout World Bank authorization.


REPUBLIC OF KAZAKSTAN

REHABILIATION LOAN(Loan 3649-KZ)

PREFACE

This is the Implomentation Completion Report (ICR) for the Rehabilitation Loan to Kazakstan,for which loan 3649-KZ in the amount of US$180 million equivalent was approved on September 17,1993, and made effective on December 22, 1993.

This loan was closed on July 31, 1995, compared to the original closing date of December 31,1994. As this was a Rehabilitation Loan, rather than a Structural Adjustment Loan, the disbursementswere not tranched. Final disbursement took place on August 22, 1995, at which time a balance ofUS$5,698 was canceled.

The ICR was prepared in the Country Operations I (Azerbaijan, Kazakstan, Kyrgyz Republic,Tajikistan, Turkmenistan, and Uzbekistan) Division of Country Department III of the Europe & CentralAsia Regional Office. It was prepared by John A. Holson, and was reviewed by Kadir T. Yurukoglu,EC3C1 Division Chief; by Marc Blanc, Project Adviser, Country Department III; and by ConstantineMichalopoulos, Senior Adviser, Country Department III. The borrower provided comments that areincluded as an annex to this ICR.

As supervision of the Rehabilitation Loan was merged with preparation of the successor StructuralAdjustment Loan (SAL I), which was approved in FY95, preparation of this ICR was begun duringmissions related to this SAL. It was completed during a mission in May 1996. The report is based uponmaterial In the project file and discussions held with Borrower staff involved in project implementation.T'he Borrower contributed to the preparation of the ICR by reviewing the draft ICR and by preparing itsown evaluation of the project's preparation and implementation.

ii

IMPLEMENTATION COMPLETION wEPORT

REPUBLIC OF KAZAKSTANREHABILITATION LOAN

(Loan 3649-KZ)

Evaluation SummaryIntroduction

1. The Rehabilitation Loan was designed to support the Government's program of macroeconomicand structural reforms that was intended to facilitate Kazakstan's transition from being part of a largecommand economy to being an independent market economy increasingly integrated into the worldeconomy. This program was initiated at a difficult time, when Kazakstan was severely handicapped bythe disruption of its traditional trading relations with the CMEA and FSU, and was trying to recover fromthe elimination of transfers from the Soviet Union (which in the earlier period had amounted to close to10 percent of GDP). The economic situation in Kazakstan was further complicated by the breakdownof the Ruble Zone and the introduction of the Kazak tenge in November 1993. In addition, although thegeneral direction was understood, the details of the path that would lead from a command economy toa market economy were by no means clear.

Project Objectives

2. At the macroeconomic level, the primary objective of the Rehabilitation Loan was to support theprogram to stabilize the economy, including bringing inflation under control and renewing growth. Atthe structural level, the objective was to support the implementation of policy and institutional reformsthat were intended to promote both an early supply response and the development of a competitive marketeconomy. The Government's "Memorandum on Structural Reform Policies' outlined specific measuresto be taken in five areas. They were: (1) price, subsidy and trade policies, (2) privatization and reformof state enterprises, (3) developing a competitive private sector, (4) financial sector reform, and (5) socialprotection.

Implementation Experience and Results

3. Macroeconomic Trends. The macroeconomic program adopted in mid-1993 proved to beexceedingly optimistic with respect to the targets for both real output and the control of inflation. Theinitial targets greatly underestimated the difficulties involved in the transition from a command to amarket economy. The program assumed a decline in real GDP of 7.5 percent in 1993, followed by arecovery of 1 percent in 1994. Instead, real GDP fell by 15.7 percent in 1993 and by another 25 percentin 1994. The program had assumed that inflation would be held to 926 percent in 1993, while in 1994the rate would fall to 104 percent. Instead, prices went up by 1237 percent in 1993 and inflationaccelerated to 2071 percent in 1994. The response of Kazakstan's economic policy makers to thesedevelopments was a renewed effort at stabilization in 1995. As a result of tight fiscal and monetarypolicies, the increase in retail prices between 1994 and 1995 was limited to 176 percent. Within 1995(i.e., between December 1994 and December 1995), the increase in retail prices was held to only 60percent. There was less success, however, with stabilizing the real economy. Real output dropped byan additional 8.9 percent in 1995, bringing the reported level to only 44 percent of its 1991 level.However, because the growing shadow economy has escaped the official GDP estimates, this figure

iii

probably somewhat understates the level of output in 1995. It seems reasonable to conclude that outputin 1995 was roughly half of the level of 1990. The 5-year decline in real output now seems to be ending.Data for the first quarter of 1996 indicate that real GDP was one percent above the same period of theprevious year.

4. Structural Reform. During 1994 good progress was made in implementing structural reformsrelated to price and trade liberalization, small scale privatization, and financial sector reforms. However,achievements were limited in the areas of privatization and restructuring larger enterprises, in developingcompetitive markets, and in reforming the system of social protection. In 1995, however, the pace ofstructural reform accelerated in those areas where it had been weaker during the previous year.

(a) Price, subsidy and trade policies: By October 1994, when bread prices were liberalized,the authorities had virtually completed the elimination of direct administrative pricing andrelated consumer subsidies. A foreign exchange market was functioning and mostrestrictions on imports had been removed. By April 1994 the number of products underexport quotas had been reduced from 34 to 7.

(b) Small scale privatization (SSP) got off to a relatively rapid start in 1994. About 2,900establishments had been sold by the end of the year. By the end of 1995 a total of over1 1,000 had been sold. By this time the privatization of small scale retail trade, publiccatering and service establishments had been substantially completed. The massprivatization program (MPP), covering medium-sized firms, became operational in April1994 - by which time 97 percent of the citizens had received their privatization couponsand 25 percent of these coupons had been invested in Investment Privatization Funds(IPFs). Under the MPP there were 22 auctions, at which shares of a total of 1700enterprises were offered for sale. By February 1996 the authorities had offered forprivatization share packages in almost all the enterprises eligible for mass privatization.

(c) Despite the formal ending of most forms of direct government management and control,competitive markets are developing only slowly. Between June 1993 and June 1994,many holding companies were created which, in fact, took over many of the functionsand powers of the old industrial branch ministries. There were 81 such holdingcompanies. They functioned as cartels, engaging in cross-subsidization, marketsegmentation, and vertical integration. Finding themselves in a very new and uncertainenvironment, it is perhaps not surprising that managers sought comfort in holdingcompanies that provided an environment which had many similarities with the previoussystem. And, since there was no more than an embryonic market, it is hardly surprisingthat managers sought assurance regarding both sources of supply for their inputs andmarkets for their outputs through vertical integration. But the problems created were alsosoon recognized. The need to break up monopolistic holding companies, and to createmore competitive markets, has been recognized and progress is now being made. AnApril 1995 decree identified 77 of the 81 holdings for reorganization. Two are to bereorganized as state-owned enterprises, but most are being dismantled.

(d) Although it remains an area of continuing concern, the Kazakstan authorities have madegood progress in strengthening the commercial banking system. At the beginning of thereform program the central bank tightened its enforcement of prudential rules, closing14 banks in 1993 and 22 banks in 1994. Credit auctions were expanded, with access

iv

limited to banks in good prudential standing. Some state banks were restructured andpartially privatized. Since April 1995 banks have been required to classify loans;changes in the tax code are expected to result in proper provisions for doubtful loans.Banking sector reforms are continuing (and are being supported by a Financial SectorAdjustment Loan).

(e) Strengthening of social services and the social protection system has been constrained bythe tight budgetary situation. However, in September 1995 the level of unemploymentbenefits was significantly improved in recognition of the importance this would have inconnection with future enterprise restructuring and down-sizing. So far the costs havebeen financed by cutting back on some other activities which had been previouslyundertaken by the Employment Fund. A major reform of the old-age and survivorspension system was approved by Parliament in June 1996. In the case of health care, anew three-tier system has been adopted which includes a guaranteed benefit funded bybudget resources, an additional entitlement financed by an earmarked payroll tax (whichgoes to a compulsory medical insurance fund), and a third tier of services which are tobe bought voluntarily.

Summary of Findings. Future Operations. and Key Lessons Learned

5. The success of the Rehabilitation Loan in supporting structural reforms must be classified as"substantial" and be considered encouraging. Even though there were some delays, and there are somethings that have not yet been done, the authorities have made impressive progress in implementing thereforms outlined in the August 13, 1993, "Memorandum on Structural Reform Policies". The Bankrecognizes that most reforms cannot be "done with a pen", but require building new institutions as wellas dismantling old ones. And successful reform will, in many cases, also require a change in the mindset and attitudes of enterprise managers and government officials. These processes -- involving bothinstitutional and cultural changes -- will require a number of years. But the progress being made isencouraging and merits continued Bank support.

6. Understanding that the transition process will take time, and recognizing the determination theKazak political leadership and policy makers have shown, the Bank has continued its support foreconomic reform in Kazakstan. The Rehabilitation Loan was followed with the First StructuralAdjustment Loan, and with loans for Finance and Enterprise Development and for Social Protection. AFinancial Sector Adjustment Loan was approved on June 25, 1996. Bank staff have started preparationof a Second Structural Adjustment Loan (SAL ll), which is scheduled to be ready for Board considerationin March 1997.

7. Rather than anything new and startling, the Bank's experience with the Rehabilitation Loan toKazakstan has served to confirm the lessons which have been learned earlier with other adjustmentoperations and also lessons which are being learned as the Bank seeks to support the transition processin the former command economies. The two most important lessons from this operations are:(1) The transition from a command to a competitive and growing market economy is more complex andwill take longer, than many assumed initially. This is especially true in the case of countries such asKazakstan which in the past have had very little contact with Western market economies. (2)Fundamental to the success of any adjustment operation is the borrower's commitment to the program.A core team of national officials with whom Bank staff can work, and whose reform efforts can besupported by Bank lending, is essential if the Bank's assistance is going to be effective.

IMPLEMENTATION COMPLETION REPORTREPUBLIC OF KAZAKSTAN

REHABILITATION LOAN(LOAN 3649-KZ)

Project Implementation Assessment

A. Project Origin and Objectives

1. The Rehabilitation Loan was designed to support the Government's program of macroeconomicand structural reforms that was intended to facilitate the transition from being part of a large commandeconomy to an independent market economy increasingly integrated into the world economy. Thisprogram was initiated at a difficult time, when Kazakstan was severely handicapped by the disruption ofits traditional trading relations with the CMEA and FSU, and was trying to recover from the eliminationof transfers from the Soviet Union (which in the earlier period had amounted to close to 10 percent ofKazakstan's GDP). In addition, although the general direction was understood, the details of the paththat would lead from a command economy to a market economy were by no means clear.

2. At the same time as the Rehabilitation Loan was being prepared, IMF staff were working on aprogram which would permit a drawing under the Systemic Transformation Facility. An STF drawingwas approved by the Fund Board on July 23, 1993. This economic program provided a short-termmacroeconomic framework for the Bank's Rehabilitation Loan. In turn, the Bank's loan provided quicklydisbursing balance of payments support which made a necessary contribution to the macroeconomicprogram.

3. The Rehabilitation Loan is one in a series of operations which are intended to support Kazakstan'stransition from a command to a market economy. A few weeks before the September 17, 1993, Boardmeeting at which the Rehabilitation Loan was approved, the Executive Directors had approved aTechnical Assistance Loan for Kazakstan. Under the latter loan the Bank has provided technical supportfor privatization and enterprise reform, for financial sector reform, and for social sector reform. Otherclosely related loans, all approved in FY95, were the Financial and Enterprise Development Loan, theSocial Protection Loan, and the first Structural Adjustment Loan. A Financial Sector Adjustment Loanwas approved on June 15, 1996. Preparatory work has begun for the Second Structural Adjustment Loan(SAL Il); it is expected that SAL II will be ready for Board consideration in March 1997. TheRehabilitation Loan is the first of these operations to be fully disbursed and closed. But, in the followingdiscussion of economic reform in Kazakstan, this Implementation Completion Report deals with a processwhich is on-going, which has been supported by a number of Bank operations, and which the Bank iscontinuing to support.

4. At the macroeconomic level, the primary objective of the Rehabilitation Loan was to support theprogram to stabilize the economy, including bringing inflation under control and renewing growth. Theloan provided quickly disbursing foreign exchange during a period when this support was badly needed.The need for quickly disbursing external financing was particularly great in 1994, when the currentaccount deficit reached 5.9 percent of GDP and there was a need to build up foreign exchange reservesafter the Ruble Area broke apart and Kazakstan established its own national currency. At the structurallevel, the objective was to support the implementation of policy and institutional reforms that wereintended to promote both an early supply response and the development of a competitive market

2

economy. The Government's "Memorandum on Structural Reform Policies" outlined specific measuresto be taken in five areas. They were:

1. Price, subsidy and trade policies.2. Privatization and reform of state enterprises.3. Developing a competitive private sector.4. Financial sector reform.5. Social protection.

B. Achievement of Objectives

5. Macroeconomic Objectives. The macroeconomic program adopted in mid-1993 proved to beexceedingly ambitious with respect to the targets for both real output and the control of inflation. Theprogram assumed a decline in real GDP of 7.5 percent in 1993, followed by a recovery of 1 percent in1994. Instead, real GDP fell by 15.7 percent in 1993 and by another 25 percent in 1994. (See Table 1.)The program had assumed that inflation would be held to 926 percent in 1993, while in 1994 the ratewould fall to 104 percent. Instead, prices went up by 1237 percent in 1993 and inflation accelerated to2071 percent in 1994. (These inflation rates are based on the index of retail prices and represent thepercent increase over the prior year.)

6. It is clear that the initial targets were optimistic and greatly underestimated the difficultiesinvolved in the transition from a command to a market economy. In addition, the economic situation inKazakstan was further complicated by the breakdown of the Ruble Zone and the introduction of the Kazaktenge in November 1993. This added to the already serious problems of interrepublican payments. Theinternal economy also suffered from growing payments problems -- between enterprises, to banks, andfor taxes owed the government. In the spring of 1994, an attempt was made to "clear" these growingpayments arrears. After a "netting out" process involving the claims and obligations of enterprises, banksand the government, credit was expanded to pay the obligations of those enterprises that at the end of thenetting out process were in a liability position. This clearance of arrears process added significantly tomonetary expansion and inflationary pressures during 1994.

7. The response of Kazakstan's economic policy makers to the problems of 1994 was a renewedeffort at stabilization. As a result of tight fiscal and monetary policies, the increase in retail pricesbetween 1994 and 1995 was limited to 176 percent. Within 1995 (i.e., between December 1994 andDecember 1995), the increase in retail prices was held to only 60 percent. There was less success,however, with stabilizing the real economy. Real output dropped by an additional 8.9 percent in 1995,bringing the reported level to only 44 percent of its 1991 level. However, because the growing shadoweconomy has escaped the official GDP estimates, this figure probably somewhat understates the level ofoutput in 1995. But it seems reasonable to conclude that output in 1995 was roughly half of the levelof 1990. Data for the first quarter of 1996 indicate that real GDP is no longer declining, but in fact wasone percent above the same period of the previous year.

8. The major trends in the Kazak economy between 1993 and 1995 are summarized on theaccompanying Table 1. One indicator of the Government's fiscal effort is the decline in the real levelof government expenditures -- which in 1995 were, in real terms, only 42 percent of their 1993 level.In part because of the very tight liquidity situation, however, the decline in revenues was somewhatgreater. Although the tenge appreciated by 171 percent between 1993 and 1995, exports have beenrecovering and the increase in imports has been limited by both tight credit and the trend in the real level

Republic of Kazakstan: Implementation Completion Report 3

of economic activity. The reduction and subsequent elimination of export taxes and other restrictions(quotas and licenses) has made possible the recovery of traditional exports despite the appreciation of thereal exchange rate. As a share of GDP, the current account deficit has declined dramatically (due to the

Table 1: Kazakstan: Selected Economic Indicators. 1990-1995

1990 1991 1992 1993 19s4 1996

Trend in Real GDPIndex 1990=100 100.0 88.2 78.7 64.7 48.5 44.1% change from prior year -11.8% -13.0% -15.7% -26.1% -8.9

GDP Deflator 1% change between years) -- 90% 1780% 1174% 2210% 156%Retail prices 1% change between years) -- 91% 1381% 1237% 2071% 176%

General Government Finances (% of GDP)Receipts -- -- -- 40.1% 24.1% 22.5%Expenditures -- 40.8% 30.7% 25.2%Deficit -- -- -- -0.7% -6.6% -2.7%

General Govt Finances (Index Real 1993 100)Receipts -- -- -- 100 45.0 38.3Expenditures -- -- -- 100 56.4 42.1

Balance of Payments (million US$)Exports (G+NFS) -- -- -- 3449 3308 6253

Imports (G+NFS) -- -- -- 4244 4110 5380Resource Balance -- -- -- -795 -802 -127Current Account Balance -- -- -- -759 -757 -218

Capital Inflow (net) -- -- -- 1125 se9 329lof which direct foreign investment) -- -- -- 473 820 e6o

Increase in Net Foreign Assets [+I - -- -- -- 368 211 111Current Balance as Percent of GDP -- -- -- 7.9% 5.9% 1.2%

Gross NBK Foreign Reserves (stock)Million US$ [including gold] -- -- -- 640 1236 1660In months imports (G+NFS) -- -- -- 1.8 3.2 3.2

Exchange Rate (annual average)Tenge per US -- -- -- 2.8 36.1 61.4

Index Real X-Rate (1993 - 100) -- .. .. 100 179 271

From Monetary SurveyGrowth in Broad Money (%, Dec-Dec) -- -- -- 690% 717% 98%Ratio, Government Credit to GDP -- -- -- -0.8% 1.7% 2.4%Ratio, Rest of Economy Credit to GDP -- -- -- 32.7% 13.6% 8.1%Ratio, Broad Money to GDP -- -- *- 14.1% 6.7% 7.6%

Sources: Goskometat, Ministry of Economy, National Bank of Kazaketan. and IMF staff estimates. The figures forgeneral government finances include the social protection funds and the Road Fund. Ratio indicators for money andcredit were calculated using the average of start-year and end-year stocks divided by annual GDP. The index of the realexchange rate has been calculated using the GDP deflator for Kazakstan and the MUV for world prices.

4

appreciation of the tenge as well as the reduced deficit in dollars). Starting from zero at the end of 1992,Kazalcstan has built up its gross foreign reserves (including domestically produced gold) to $1.66 billionat the end of 1995, equivalent to over three months imports.

9. Reflecting the fiscal and monetary discipline enforced in 1995, the growth in the money supplyduring the year was held to 98 percent - compared to increases of about 700 percent during the twopreceding years. Inflation had lead to sharp increases in the velocity of money prior to 1993. In theSoviet Union the money supply had traditionally been about 50 percent of GDP, but the monetaryoverhang that developed in the late 1980s increased this figure to about 70 percent. The drop to 14percent in 1993 thus already represented a massive increase in the velocity of money. Velocity doubledagain between 1993 and 1994, but then slowed slightly in 1995. The tightness of credit policy isreflected in the ratio of credit to GDP. Credit to the "rest of the economy" fell from 33 percent of GDPin 1993 to14 percent in 1994 and then to only 8 percent in 1995. The level of banking system credit to the "restof the economy" declined even in nominal terms during 1995. Tight credit and high real interest rateshave contributed to the continuing problems of payments arrears, and arrears have in some ways becomea substitute for money and banking system credit. The establishment of financial discipline, an increasingsupply of credit for working capital and investment, and the moderation of real interest rates are allneeded if the real economy is going to recover and function efficiently.

10. Structural Reform Objectives. When compared with the objectives set out in the "Memorandumon Structural Reform Policies", good progress was made during 1994 in implementing structural reformsrelated to price and trade liberalization, small scale privatization, and financial sector reforms. Duringthis year achievements were comparatively limited in the areas of privatization and restructuring of largerenterprises, in developing competitive markets, and in reforming the system of social protection.However, in 1995 the pace of structural reform accelerated in those areas where it had been slowerduring the previous year. Paragraphs 11-20 describe the progress that has been made in the structuralreforms discussed in the government's "Memorandum on Structural Reform Policies" (MSRP). AnnexTable 5, on "Key Indicators for Project Implementation", summarizes the performance with respect tothe specific measures in the "Plan of Action" which accompanied the MSRP.

11. By October 1994, when bread prices were liberalized, the authorities had virtually completed theelimination of direct administrative pricing and related consumer subsidies. A foreign exchange marketwas functioning and most restrictions on imports had been removed. By April 1994 the number ofproducts under export quotas had been reduced from 34 to 7. In the case of those products still subjectto quotas, 30 percent of the quotas were auctioned (while the remainder continued to be assigned to statetrading companies). Regarding price, subsidy and trade policies, all of specific measures proposed for1994 were in fact implemented during that year.

12. Small scale privatization (SSP) got off to a relatively rapid start in 1994. About 2,900establishments had been sold by the end of the year. By the end of 1995 a total of over 11,000 had beensold. By this time the privatization of small scale retail trade, public catering and service establishmentshad been substantially completed. The mass privatization program (MPP), covering medium-sized firms,did not become operational until April 1994 -- by which time 97 percent of the citizens had received theirprivatization coupons and 25 percent of these coupons had been invested in Investment PrivatizationFunds (IPFs). Under the MPP there were 22 auctions, at which shares of a total of 1700 enterprises wereoffered for sale. By February 1996 the authorities had offered for privatization share packages in almostall the enterprises eligible for mass privatization. The final coupon auction was held of January 30, 1996,


by which time all of the coupons collected by the IPFs had been redeemed. The specific SSP and MPPobjectives outlined in the MSRP have now been accomplished, but in most cases this was done in 1995rather than in 1994.

13. In addition to the SSP and the MPP, 180 of the largest enterprises (each having more than 5,000employees) have been identified for case-by-case privatization. This part of the privatization programhas moved relatively slowly. In most cases, the government has adopted an approach of contractingmanagement to the private sector rather than immediate privatization. As of early 1996, only 5 of theseenterprises had been sold. Another 44 were under management contracts with private sector groups(including 12 foreign management groups). In 1996, the Government is initiating "Stage Three" of itsprivatization program. This will include sales of state-owned shares in enterprises that at present are onlypartially privatized as well as continued implementation of the case-by-case program for larger state-owned enterprises.

14. Enterprise restructuring, including down-sizing and liquidation of enterprises that are not provingto be financially viable, has gone slowly. With output at about half of the 1990 level, and with liquidityextremely tight, they has been an understandable reluctance to take present financial difficulties as a clearindication of non-viability in the longer term. Analysis of profitability has been complicated by the factthat price signals have by no means been clear; in addition to the major changes in the real exchange rate,relative prices have moved as administrative controls and subsidies were eliminated and also in responseto changes in the degree of monopolistic price setting. In addition, the limited benefits available to thosewho became unemployed created a general reluctance to discharge workers. Moreover, the likelyeffectiveness of government action in enterprise restructuring is questioned by many, especially given thelimited concern with micro level economic efficiency that existed under the command economy and thepolitical reluctance of public authorities to down-size and liquidate. However, the August 1993 'Planof Action" accompanying the Rehabilitation Loan called for the authorities to "develop an approach toadjustment assistance ... [which would] condition financial assistance to large enterprises on thepreparation and implementation of satisfactory restructuring plans". But it was not until March 1995 thatthe Rehabilitation Trust was created to implement this objective for a limited number of the larger loss-making enterprises. For most firms it is anticipated that the needed restructuring will take place as aresult of the combination of privatization and credit restrictions by commercial banks.

15. Despite the formal ending of most forms of direct government management and control,competitive markets are developing only slowly. There was an unanticipated set back during the periodloan implementation was beginning when numerous holding companies were created which, in fact, tookover many of the functions and powers of the old industrial branch ministries. There were 81 suchholding companies. They functioned as cartels, engaging in cross-subsidization, market segmentation,and vertical integration. Finding themselves in a very new and uncertain environment, it is perhaps notsurprising that managers sought comfort in holding companies that provided an environment which hadmany similarities with the previous system. And, since there was no more than an embryonic market,it is hardly surprising that managers sought assurance regarding both sources of supply for their inputsand markets for their outputs through vertical integration. But the problems created were also soonrecognized. For example, in 1994 a few holding companies controlled practically the entire agriculturalmarketing chain, from farm gate through food processing to the retail outlets. This, in combination withthe liberalization of farm input prices, lead to a shift in the terms of trade against farmers, and addedgreatly to the serious problems being faced by the agricultural sector.

6

16. The need to break up monopolistic holding companies, and to create more competitive markets,was soon recognized and progress is now being made. An April 1995 decree identified 77 of the 81holdings for reorganization. Two are to be reorganized as state-owned enterprises, but most are beingdismantled. In agriculture and food processing, grain elevators are being auctioned, as are flour and feedmills and macaroni factories.

17. In addition to privatization (including demonopolization prior to privatization), other measuresare helping to create more efficient and competitive markets. A commodities exchange is nowfunctioning. Arrangements, however, for a securities exchange are not yet completed. Early in 1995the first part of the Civil Code, focusing on property and contractual rights, was adopted. This has beenfollowed by legislation to strengthen the framework for secured lending and land registration. Althoughthe legal framework for bankruptcy now exists, so far few creditors appear to have availed themselvesof these procedures. Nonetheless, in November 1995 the country's largest steel mill was declaredbankrupt and the Government has initiated insolvency procedures against a number of other insolvententerprises.

18. Although it remains an area of continuing concern, the Kazakstan authorities have made goodprogress in strengthening the commercial banking system. The specific objectives outlined for 1994 inthe MSRP were all accomplished within that year. At the beginning of the reform program the centralbank tightened its enforcement of prudential rules, closing 14 banks in 1993 and 22 banks in 1994.Credit auctions were expanded, with access limited to banks in good prudential standing. Some statebanks were restructured and partially privatized. However, the some of the problems in the bankingsystem soon became apparent, and the central bank had to intervene when both the savings bank(Sberbank) and the construction bank (Kredsozbank) experienced financial distress. Since April 1995banks have been required to classify loans; changes in the tax code are expected to result in properprovisions for doubtful loans. Banking sector reforms are continuing (and are being supported by aFinancial Sector Adjustment Loan). However, there can hardly be a financially sound banking systemuntil real interest rates have come down to more realistic levels and the enterprises that are the clientsof the commercial banks are themselves in better financial condition.

19. Strengthening of social services and the social protection system has been constrained by the tightbudgetary situation. However, in September 1995 the level of unemployment benefits was significantlyimproved in recognition of the importance this would have in connection with future enterpriserestructuring and down-sizing. So far the costs have been financed by cutting back on some otheractivities which had been previously undertaken by the Employment Fund. A major reform of the old-age and survivors pension system (including a politically controversial three-year increase in theretirement age) was approved by Parliament in June 1996. In the case of health care, a new three-tiersystem has been adopted which includes a guaranteed benefit funded by budget resources, an additionalentitlement financed by an earmarked payroll tax (which goes to a compulsory medical insurance fund),and a third tier of services which are to be bought voluntarily.

20. One important concern has been the maintenance of adequate services as commercialized andprivatized enterprises divest themselves of the pre-school and health facilities which they had traditionallysupported. Although such divestiture has been going on in an ad hoc fashion, in May 1996 a programwas adopted to rationalize this process. Pilot programs, supported by the Bank's Social ProtectionProject, are already underway in two oblasts. The housing sector is an area where a clear strategy hasnot yet been developed, and there is much concern about the social consequences of passing all housingand utility costs on to the occupants. Although the flats in multi-family buildings are presumed to be


privatized, in practice the enterprises and municipal authorities that previously provided this housing oftenare the only entities that exist to provide (usually inadequately) for the maintenance of these building.There remains the need to establish structures to manage multi-family buildings with privatized flats andalso to require the new owners to cover the full costs of operation and maintenance of (with a suitablesafety net for the poorer residents).

21. Summary, The success of the Rehabilitation Loan in supporting structural reforms must beclassified as "substantial" and be considered encouraging. Even though there were some delays, theauthorities have made impressive progress in implementing the reforms outlined in the August 13, 1993,"Memorandum on Structural Reform Policies". The Bank recognizes that most reforms cannot be "donewith a pen", but require building new institutions as well as dismantling old ones. And successful reformwill, in many cases, also require a change in the mind set and attitudes of enterprise managers andgovernment officials. These processes - involving both institutional and cultural changes - will requirea number of years. But the progress being made is encouraging and merits continued Bank support.

22. The desired impact of the loan on the balance of payments, on the budget, and on the availabilityof some pre-identified imports, were accomplished simply by the disbursement of the loan. The sale ofthe foreign exchange component in the auction market made foreign exchange available to importers andalso generated counterpart funds which helped finance the budget. The agricultural sector was the mainbeneficiary of the pre-identified imports component, with $39 million out of a total of $43 million beingused for that sector. While at the time of appraisal it had been anticipated that $94 million would be usedfor the foreign exchange component, and $86 million would be used for the pre-identified imports, in thecourse of implementation $43 million was reallocated from the latter to the former. This contributed tothe objective of the more rapid utilization of the resources being provided by the Bank.

C. Implementation Record and Major Factors Affecting the Project

23. Looked at in terms of achievement of the economic reform objectives, the implementation recordis discussed above. Looked at in terms of the speed and smoothness of implementation following Boardapproval, the few difficulties that did arise are discussed below under "Bank Performance" and "BorrowerPerformance". The problems that did arise were resolved without great delay. They were, for the mostpart, simply the consequence of the inexperience of the Borrower in dealing with the Bank -- andprobably also the inexperience of the Bank in dealing with the Borrower.

24. One must also note the difficult and changing environment in which economic policies were beingdesigned and implemented. In the summer of 1993, at the time the STF agreement with the IMF wasbeing approved and the Rehabilitation Loan was being negotiated, it was still generally assumed thatKazakstan would continue to be a member of the Ruble Zone. But events quickly demonstrated that thiswas not a practical course of action. On November 15, 1993, Kazakstan left the ruble zone andintroduced its own national currency. It is hardly surprising that, in the final months of 1993 and theearly months of 1994, the economic authorities were heavily occupied with the immediate problemsrelated to their newly achieved monetary independence. It is much to the credit of the authorities thatthey continued their efforts at longer-term structural reforms during this difficult step in the transition.

D. Project Sustainability

25. Under the heading of "sustainability" the basic concern is the sustainability of Kazakstan'seconomic reform program as a whole. It is too early to give a final and definite answer to this question.

8

There have been both "winners" and "losers" as a result of the stabilization and reform efforts. Someof the initial "winners" may now have a vested interest in delaying further reforms, since the developmentof more open and competitive markets would undermine their present positions. Given the decline ineconomic output and the growth in economic insecurity, there no doubt are many losers who are unhappyand worried. But at the moment they are not a vocal group. And the authorities have demonstrated astrong commitment to continuing reform.

26. The sustainability of the economic reform process will in large measure depend upon its successin more effectively meeting the needs of the whole population. More particularly, the sustainability ofthe efforts at structural reform will depend in large part upon whether the authorities are now successfulin stabilizing output and then bringing about the renewal of economic growth. Recent economic data,which indicate that real GDP during the first quarter of 1996 was one percent above the level of the sameperiod of the previous year, offer hope that this is the case. If output and incomes are recovering, it willbe much easier to complete the enterprise restructuring, and to mobilize the budget resources needed forsocial and economic infrastructure and for a more adequate social safety net. This will require a carefullybalanced program so as not to lose the hard won gains of bringing inflation under relative control. Andit must be kept in mind that some major adjustments in relative prices are not yet completed (particularlyfor housing and public utility services to households), and that these adjustments in relative prices willprobably require some increases in the average level of prices.

E. Bank Performance

27. The Bank's overall performance in connection with the Rehabilitation Loan was fully"satisfactory' and consistent with the Bank's desire to provide experienced staff who could makesubstantial contributions to the policy dialogue and the design of an effective project. During thepreparation stage Bank staff cooperated with the Fund as well as with the Kazakstan authorities in helpingwork out the economic reform program. Although there was a substantial time lag between the beginningof project preparation in June 1992 and the post-appraisal in July 1993, the project moved quickly afterthe 1MF Board approved a Structural Transformation Facility agreement on July 23, 1993.

28. During the implementation stage the Bank demonstrated the flexibility that was needed to permittimely disbursement of the loan. By mid-May 1994, less than four months after the loan had becomeeffective, all of the $94 million in the foreign exchange component had been exhausted. However, onlyabout $31 million out of the $86 million for pre-identified imports had been committed. In thesecircumstances $43 million was reallocated from the pre-identified imports component to the foreignexchange component (which reduced the pre-identified imports component from 48 percent to 24 percentof the total).

F. Borrower Performance

29. The Borrower's overall performance in connection with the Rehabilitation Loan was certainly"satisfactory". As indicated above (section B), the structural reform program outlined in the"Memorandum on Structural Reform Policies" has generally been implemented, although in some casesmore slowly than originally planned. During the preparation of the project, there was excellentcooperation between the authorities and Bank staff. Given the newness of the whole process of transitionfrom a command to a market economy, no one -- in the Government, in the Bank, or elsewhere -- hadanswers to all the difficult questions that arose. There was a generally good policy dialogue between the


authorities and Bank staff, and the latter were able to be helpful in the design of the program of structuralreforms which is outlined in the resulting policy memorandum.

30. There were, however, some initial problems in project implementation. At the start the ProjectImplementation Unit (PIU) had been inadequately staffed, and there was substantial turnover in the initialmonths. These problems were overcome with the recruitment of new national staff and the extension ofthe duties undertaken by the Crown Agent advisors. There were also delays in providing the PIU withthe necessary administrative support. After these initial difficulties had been overcome, the PIUfunctioned effectively. Given the lack of experience on the part of the national officials, the role of thePIU's expatriate advisers was absolutely crucial to the timely implementation of the project.

31. Two problems arose with the Pre-identified Imports Component (PIC) of the Rehabilitation Loan,one relating to counterpart deposits and the other relating to procurement. The sectoral ministries initiallysought to avoid depositing counterpart for imports financed under the Rehabilitation Loan, thus in effectgetting an unauthorized increase in their budgetary appropriation. This problem was resolved when therevised budget was approved by Parliament in May 1994 and the financing of pre-identified imports waseffectively brought into the budget framework. Even before the loan had become effective, it was clearthat there would be problems in reconciling the Bank's procurement rules with Kazakstan's regulationson the importation of agricultural chemicals. Under the latter only registered products could be imported,and for most products only a single brand name was registered for the particular product. Testingrequirements made the registration process a lengthy one; consequently, in order not to delay the importof agricultural chemicals needed for the spring planting season, the Bank agreed to sole sourceprocurement in a limited number of cases. However, given the fact that Kazakstan was a new borrower,the proportion of PIC procurement that was subject to international competitive bidding was relativelyhigh.

32. This introductory experience with international competitive bidding was both useful andsuccessful. The prices obtained were better than had been anticipated by the end users, thus allowingsomewhat larger quantities to be imported with the same financing. Before this experience withprocurement of critical imports under the Rehabilitation Loan, some national officials thought thatfollowing the Bank's standard procurement procedures would only complicate matters and would notresult in better prices than had previously been obtained by the state trading organizations. Subsequently,however, the concerned officials acknowledged the substantial benefits that had resulted from internationalcompetitive bidding.

G. Assessment of Outcome

33. When looked at in terms of the implementation of specific structural reforms on the timetable setforth in the Government's "Memorandum on Structural Reform Policies", the outcome of the projectshould be considered "satisfactory". While there were delays and problems in some areas, when onerecognizes the complexity of the process, it must be concluded that good progress has been made towardsthe broad structural reform objectives. The disbursements from the Rehabilitation Loan providedadditional resources at a very difficult time, as well as signaling the support of the internationalcommunity for the country's reform efforts. The targets fixed in 1993 for stabilizing output and priceshave proved to be too optimistic and 1994 was a difficult year. In 1995 significant progress was madein bringing inflation under control, but real output continued to decline. Recent figures on real outputare more encouraging, since GDP for the first quarter of 1996 is estimated at one percent above the levelof the same period of the previous year.

10

34. The Rehabilitation Loan is the first Bank loan to Kazakstan that has been "closed". Except forthe Technical Assistance Loan that was signed and became effective on the same dates as theRehabilitation Loan, it is the first Bank loan to Kazakstan. The preparation and implementation of theloan provided valuable experience for both the Bank and the Borrower which are yielding benefits in thesubsequent working relationships. A particularly important "outcome" was the development of aneffective policy dialogue, through which Bank staff could share their experience with what had worked(and what had failed) in other countries, and as a result of which the Bank staff could better understandthe "local" factors that strongly influenced what would be both desirable and feasible in Kazakstan.

H. Future Operations

35. The Bank recognizes that the transition from a command economy to a competitive marketeconomy, and the integration of the Kazakstan economy into the world economy, are processes that willnecessarily take some time. In comparison with Central Europe, the countries of Central Asia arehistorically as well as geographically far more removed from the Western market economies. It is goingto take time to develop the institutions and the attitudes that are needed in a modern market economy.At the public sector level, the problem is not that of abolishing the role of the state, but rather one ofchanging the role of the state. In addition to the recognized concerns with macroeconomic management,provision of adequate economic and social infrastructure, and basic social protection, it is necessary forthe state to create a regulatory and incentive framework which motivates enterprise managers toefficiently produce and market the goods and services wanted by the community. This means gettingbeyond the initial period in which the most profitable activities often have been collecting "rents" frommonopoly power and the ability to influence the decisions of public officials.

36. Understanding that the transition process with take time, and recognizing the determination theKazak political leadership and policy makers have shown, the Bank has continued its support foreconomic reform in Kazakstan. The Rehabilitation Loan was followed with the First StructuralAdjustment Loan, and with loans for Finance and Enterprise Development and for Social Protection. AFinancial Sector Adjustment Loan was approved on June 25, 1996. Bank staff have started preparationof a Second Structural Adjustment Loan (SAL II), which is scheduled to be ready for Board considerationin March 1997.

37. It is anticipated that SAL II will be the Bank's last general adjustment loan for Kazakstan. Futurelending will be focused more on specific sectors and to an increasing extent upon specific investmentprojects. Institution building and strengthening sector policies will, however, play a major role in theselending operations. In addition to basic infrastructure and social services provided by the public sector,continued support for enterprise restructuring, for capital markets development, and for post-privatizationassistance to privatized enterprises are all areas in which Bank support could prove useful.

I. Key Lessons Learned

38. Rather than anything new and startling, the Bank's experience with the Rehabilitation Loan toKazakstan has served to confirm the lessons which have been learned earlier with other adjustmentoperations and also lessons which are being learned as the Bank seeks to support the transition processin the former command economies. Ranging from the more general to the particular, the key lessonsfrom the Rehabilitation Loan are:


(a) The transition from a command to a competitive and growing market economy is morecomplex and will take longer, than many assumed initially. This is especially true in thecase of countries such as Kazakstan which in the past have had very little contact withWestern market economies.

(b) Fundamental to the success of any adjustment operation is the borrower's commitmentto the program. A core team of national officials with whom Bank staff can work, andwhose reform efforts can be supported by Bank lending, is essential if the Bank'sassistance is going to be effective.

(c) The Bank's contribution is in project design, and sharing the lessons of experience, asmuch as in providing financial resources. However, recognizing that "transitioneconomics" is more of an art than a science, Bank staff must avoid "text book" solutionsand be able to adapt their recommendations to the particular situation.

(d) Expatriate advisers have a strong and essential role in the Project Implementation Unit,at least until the borrower has gained more experience in working with the Bank. Aswell as being advisers, the expatriate staff must be prepared to take on both training andoperating responsibilities.

(e) Attention must be given to seeing that the PIU has adequate physical facilities andoperating budget, as well as appropriate national and expatriate staff. The Bank shouldbe satisfied that, between the government budget and Bank-financed technical assistance,all the essential requirements are fulfilled.

(f) The Pre-Identified Imports Component (PIC) of the Rehabilitation Loan complicatedimplementation, but probably had no substantive effect on the composition of imports;from the standpoint of the government agency using PIC resources, the constraint onimports was the agency's budget appropriation rather than foreign exchange. Theprincipal benefit of having a PIC component (rather than using all of the resources forthe FXC) was the exposure of government officials to the Bank's procurement proceduresand to the advantages of international competitive bidding.


Statistical Tables

Table 1: Summary of AssessmentsTable 2: Related Bank Loans/CreditsTable 3: Project TimetableTable 4: Loan Disbursements: Cumulative Estimated and ActualTable 5: Key Indicators for Project ImplementationTable 6: * Key Indicators for Project OperationTable 7: * Studies Included in ProjectTable 8A: Project CostsTable 8B: Project FinancingTable 9: * Economic Costs and BenefitsTable 10: Status of Legal CovenantsTable 11: * Compliance with Operational Manual StatementsTable 12: Bank Resources: Staff InputsTable 13: Bank Resources: Missions

* Standard Tables 6, 7 and 9 are not included because they are notapplicable to this Rehabilitation Loan. Table 11 is not included becausethere have been no instances of non-compliance with Operational ManualStatements.

Table 1: Sumnary of Assessments

A. Achievement of obiectives Substantial Partial N.gigibe Not ADolk

Macro policies t] F 2 -2Sector policies ] [ IZ

Financial objectives W E 2 nInstitutional development 5] ] [2

Physical objectives [ El [

Poverty reduction 2 [ E [

Gender issues [ L 2 [ ]

Other social objectives [2 2 [2

Environmental objectives [2 [ 3 Public sector management E] [2

Private sector development [ [2 [

Other (specify) [2 [2 32

B. Prolect sustainability Likely Unilkely Uncerbin

C. Bank Performance Suiiafnetory Satisfactov .D,flbt

Identification [2 2

Preparation assistance [ 32

Appraisal [ [2

Supervision [ [ 2

HighlyD. Borrower Performance Satifactory SauUafs Defkbnt

Preparation [2 [Implementation [ [2

Covenant compliance [2 2

Hlghly HbhivE. Asmsement of outcome Sdigdatoryy Unatiuf L lr Ur

[2 [2 [2

Table 2: Related Bank Loans

Loan Purpose Year of approval Status

At same time as Rehabilitation Loan:

Technical Assistance Loan Privatzation and enterprise FY94 Underreform; financial sector; social implementationsector; insttutional support.

Following operations:

Structural Adjustment Loan I Continue support for FY95 Underreform programs implementation

Finance & Enterprise Development Enterprise restructuring; FY95 Underpayments system and other Implementationbanking system improvement.

Social Protection Safety net for workers FY95 Undereffected by restructuring; Implementationdivestiture of social assets.

Financial Sector Adjustment Reform and strengthen FY96 Approved by Boardfinancial sector on June 25, 1996

Structural Adjustment Loan II Continue support for expected FY97 Planned Board datereform programs in March 1997

Table 3: Project Timetable

Steps in Project Cycle Date Planned Actual Date

Identification (IEPS) --- April 1992Preparation June 1992Appraisal October 1992Post-Appraisal --- July 1993

Negotiations August 1993Letter of development policy --- August 1993Board presentation --- September 1993Signing --- October 1993

Effectveness October 1993 December 1993Project complebon December 1994 July 1995Loan closing December 1994 July 1995

Table 4: Loan Disbursements: Cumulative Estimated and Actual(US$ thousands)

FY94 FY95 FY96

Appraisal estimate 150,000 30,000 - -

Actual 116,890 62,920 190Actual as % of estimate 77.90% 210.00% - -

Date of final disbursement August 4, 1995 [for US$190,056]

Table 5: Key Indicators for Project Implementation

A. Price, Subsidy and Trade Policies

The "Plan of Action" accompanying the "Memorandum on Structural Reform Policies' (MSRP) called for (1)reductions in subsidies in the 1994 budget, (2) elimination of price controls on fodder, (3) raising petroleumproduct prices to border prices, (4) termination of central bank credits at preferential rates and inclusion of anycontinuing interest rate subsidies in the budget, (5) reduction of number of commodities under export quotas, (6)a uniform import tariff of 15 percent on non-CIS imports, and (7) state procuarement to fulfill bilateral tradeagreements at freely negotiated or market prices. With the exception of the uniform import tariff on non-CISimports, these policies have been implemented. In the case of the tariff on non-CIS imports, Kazakstan hasjoined a customs union with Russia and Belarus and has, with some exceptions, adopted the common externaltariff of this group of countries.

B. Privatization and Reform of State Enterprises

The "Plan of Action" called for (1) offering all enterprises engaged in retail and wholesale trade, and relatedtrucking and distribution activities, for sale by the end of 1994, (2) distribution of coupons for mass privatizationby the end of 1993, (3) mass privatization of enterprises accounting for 70% of the total assets of non-agriculturalmedium and large enterprises by March 1995, (4) preparation of legislation on governance of enterprisesexpected to remain in public sector, (5) case by case privatization of 10 large enterprises by March 1994 and asecond 10 by March 1995, (6) design of an approach to adjustment assistance linked to preparation ofsatisfactory restructuring plans, and (7) inclusion of all forms of direct Government financial assistance toindividual enterprises in the budget. The targets for privatization were not met in 1994, but were generally metin 1995. (Available data on medium and large enterprises relate to number of enterprises rather than to theproportion of total asset value.) An exception is the case-by-case privatization; for the largest enterprises thegovernment has changed its policy from immediate privatization to one of giving management contracts toprivate interests (which are given an option to purchase stock in the firm at a future time). With the exceptionof what is being done through the Rehabilitation Trust for a limited number of firms, the implementation ofenterprise restructuring has been left to the new private owners who are operating in an environment oftight credit.

C. Developing a Competitive Market

In addition to the measures included under "Price, Subsidy and Trade Policies", the "Plan of Action' called for(1) strengthening anti-monopoly legislation and administration, (2) a review of obstacles facing entrepreneurs,(3) reforms in tax law and administration, and (4) preparation of a new law on foreign investment. While thesemeasures have been implemented, the creation of a great many "holding companies" that acted in many wayslike the old industrial branch ministries worked in the opposite direction; more recent steps are leading to thedismantling of these holding companies and thus to the creation of more competitive industrial and commercialstructures. Although the initial specific objectives in this area have been fulfilled, the development of competitivemarkets will require substantial further institutional development.

D. Financial Sector Reform

The "Plan of Action" called for (1) increasing the proportion of NBK credit passing through the auction market,(2) strengthening the licensing requirements and regulatory framework for commercial banks, (3) completion ofan audit of the NBK and diagnostic studies of ten major banks, and (4) completion of studies on term lendingfacilities and on restructuring the commercial banking system. These objectives were accomplished. [TheFinancial Sector Adjustment Loan approved in June 1996 is supporting continuing financial sector reforms.]

E. Social Protection

The "Plan of Acton" called for (1) analyses and recommendations regarding reform of the social protectionsystem and (2) preparation of recommendations on the social services provided by enterprises which would bemore appropriately provided by local authorities. These recommendations were to be ready, respectively, bythe end of 1993 and March 1994. Although the preparation of recommendations was delayed beyond the originaltarget dates, they have since been completed and implementation is beginning. Reforms in the EmploymentFund were introduced in September 1995 and reforms in the pension system were approved by Parliament in June1996. A national policy regarding divestiture of enterprise social assets related to educaton and health wasannounced in May 1996, with implementation beginning in the second half of this year.

Table GA: Project Costs(USS mlions)

Aporaisal Estimate ActualLocal Foreign Total Local Foreign Total

Foreign exchange component - - 94.0 94.0 - - 137.0 137.0

Pre-identified imports - - 86.0 86.0 - - 43.0 43.0of which:Energy -- 30.0 30.0 -- -- --

Agriculture - - 39.0 39.0 39.0 39.0Food industry -- 8.0 8.0 -- -- --

Transportabtion - - 4.0 4.0 3.9 3.9Health -- 5.0 5.0 -- 0.1 0.1

Total -- 180.0 180.0 -- 180.0 180.0

Table 8B: Project Financing(USS millions)ADoraisal Estimate Actual

Local Foreign Total Local Foreign Total

1. IBRD -- 180.0 180.0 -- 180.0 180.02. Cofinancing -- -- -- -- -- --3. Other external sources - - - - -- -- -- - -

4. Domestic contribution - - -- - - - - - - - -

Total -- 180.0 180.0 -- 180.0 180.0

Note: Kazakstan received parallel financing from Japan equivalent to US$75 million, from Austria equivalent to US$5 million,and from Sweden equivalent to US$3 million.

Table 10: Status of Legal Covenants

Section and Covenant: Compliance Status:

Borrower to open and maintain, in dollars, a Special Account on terms and In compliance. Account openedconditions satisfactory to the Bank. on March 3,1994.

Borrower to furnish Bank, no later than six months aftr end of each fiscal In compliance. Reports for yearsyear, audited reports on the records and accounts of the project. ending December 31 submittd

prior to following June 30.

Borrower to furnish Bank copy of agreement between Ministry of Finance and In compliance. Protocol datedNational Bank of Kazakstan (NBK) defining role of latter with respect to February 14, 1994, has beenforeign exchange component of loan. provided .

Pap 18Table 12: Bank Resources: Staff Inputs

(costs in USS thousands)Planned Revised Actual

Stop of Project Cycle weeks USS week USS week USS

Preparation n.a. n.a. n.a. n.a. n.a. 106.2

Appraisal n.a. n.a. n.a. n.a. n.a. 41.7

Negoatons to Board n.a. n.a. n.a. n.a. n.m. 23.7

Supervision n.a. n.a. n.a. n.a. n.a. 119.1

Compbtion 10.0 42.3 7 35.2 3 17.1

TOTAL n.a. n.a. n.a. n.a. n.a. 307.8

Table 13: Bank Resources; Missions

Performance Ratino rb1Number Days in Type Imple- Develop. Types of

Stage of Project Cycle Date Persons Field Staff [a] mentation Objectives Problems [c]

Identification Apr 92 2 21 E, F -- -- --

Preparation Feb93 4 14 E,E,E,F -- -- --

Apprai l Jul93 4 10 E. E, L,P -- -- --

Sup rvision Nov 93 3 5 E, P, P 2 2 MMar 94 1 13 C 2 2 MMay 94 1 12 E 2 2 M

[a) C=Country Officer; E=Economist; F=Financial Sector Specialist; L=Lawyer; P=Procurement Specialist[b] I =Minor Problems; 2=Moderate Problems; 3=Major Problems[c] M=Project Management

ANNEX - Page A. 1


REPUBLIC OF KAZAKSTANREHABILITATION LOAN (3649-KZ)

COMPLETION MISSION'S AIDE MEMOIRE

1. A World Bank mission, consisting of John A. Holsen, visited Almaty from May 20 to June 5,1996, in order (i) to finalize the preparation of the Implementation Completion Report for theRehabilitation Loan approved by the Bank in September 1993, and (ii) to begin discussions on a possibleSecond Structural Adjustment Loan. During his visit Mr. Holsen met with Deputy Prime MinisterSobolev and with officials from the Ministry of Finance, the Ministry of Economics, National Bank ofKazakstan, and Eximbank. The mission liaised closely with Mr. David Pearce, World Bank ResidentRepresentative in Kazakstan, who also participated in some of the mission's meetings. The missionwishes to thank all officials met for their cooperation.

2. Implementation Completion Report (ICR) for the Rehabilitation Loan. This report will providethe Bank's Management and Executive Directors an evaluation of the effectiveness of the RehabilitationLoan. Except for the Technical Assistance Loan, which had been approved a few weeks earlier, this wasthe first Bank loan to Kazakstan (and it is the first Bank loan to be "closed" and thus to require anImplementation Completion Report). In addition to the Bank staff's evaluation, the ICR will include anevaluation from the Government's point of view; this portion of the ICR is being prepared in the Ministryof Finance by the Committee for the Utilization of Foreign Capital.

3. A draft of the Bank staff evaluation has been given to the Committee for the Utilization ofForeign Capital. The Committee has been invited to comment on that draft before it is circulated withinthe Bank. It has been agreed that any comments will be sent in time for them to be received at Bankheadquarters on or before June 14. It was also agreed that the evaluation from the Government's pointof view, which is being prepared by the Committee, would be sent to Bank headquarters so it will bereceived no later than June 14. The Government's evaluation will be included in the ICR without editingby Bank staff.

4. It may be noted that, in its "Assessment of Outcome' section, the staff draft of the ICR concludesas follows: "When looked at in terms of the implementation of specific structural reforms on thetimetable set forth in the Government's 'Memorandum on Structural Reform Policies', the outcome ofthe project should be considered 'satisfactory'. While there were delays and problems in some areas,when one recognizes the complexity of the process, it must be concluded that good progress is beingmade towards the broad structural reform objectives."

5. Initial Discussions on a Second Structural Adjustment Loan (SAL II). Given the progress withstructural reforms, the Bank is now able to consider a Second Structural Adjustment Loan to Kazakstan.During the present visit the mission discussed the general policy areas in which specific 'plans of action"might be prepared. The implementation of these plans would then be supported by SAL II. As a resultof these discussions, several areas have been identified which are logical and highly desirablecontinuations of the structural and economic management reforms already under way. These areas are:(1) enterprise reform and the third stage of the privatization program; (2) divestiture of enterprise socialassets; housing and communal services; (3) administrative and budgetary reforms; (4) budgeting for

ANNEX - Page A.2

infrastructure and other public sector capital expenditures; (5) the management of domestic and externalborrowing; and (6) the organization, management and regulation of public utilities. These policy areasare described in more detail in the attachment to this memorandum. Should the Kazak officials concernedhave further thoughts regarding any of these policy-areas, or wish to suggest other areas in which policyreforms might be supported by SAL II, they are asked to discuss them with the Bank's ResidentRepresentative.

6. The next step in the process of preparing SAL II will be to discuss the suggested policy areas atBank headquarters, and to consider whether the preparation of satisfactory plans of action in these areas,or perhaps in several but not necessarily all of these areas, would provide an adequate basis for SAL II(assuming, of course, continued reasonably satisfactory progress in other aspects of the reform program).The Bank would plan on sending a pre-appraisal mission in September to discuss the specifics of whatmight be included in the plans of action. If there are no unexpected delays, appraisal could take placein late November, negotiations could be completed in January 1997 and SAL II could be presented to theExecutive Directors in March 1997.

Almaty, Kazakstan4 June 1996

ANNEX - Page A.3


REPUBLIC OF KAZAKSTAN - REHABILITATION LOAN (3649-KZ)

BORROWER'S CONTRIBUTION TO THE ICR

1. Introduction. A Rehabilitation Loan in an amount of 180 million USD was allocated by theWorld Bank in support of the Macroeconomic Stabilization and Structural Reform program of theRepublic of Kazakstan, described in the "Memorandum of Structural Reform Policies' (MSRP). TheMSRP was signed by the First Deputy Prime Minister of the Republic of Kazakstan. An "Action Planfor Implementation of Structural Reforms" was attached to the MSRP, and in the course ofimplementation of this plan the Government has undertaken the responsibility to guide a process of marketoriented reforms in five sectors: price, trade and subsidies policies; privatization and reform of the stateenterprises, development of the competitive private sector, financial sector reform, and people's socialprotection.

2. The objectives of the Rehabilitation Loan are:

(a) to support the Government of the Republic of Kazakstan to implement the reformprogram outlined in the MSRP; and

(b) to ease the shortage of foreign exchange needed to finance imports of critical inputs, rawmaterials and spare parts in key sectors of the economy, to support the foreign exchangemarket and to allow the private sector access to the foreign exchange market.

Evaluation of Project Objectives

3. Implementation of the Economic Reform Program. In general the Loan objectives have beenachieved due to the Government's determination to be in line with the reforms policy and open dialoguewith the World Bank. The anti-crisis program was elaborated in the Republic, and implementation ofthis program resulted in considerable improvement in the macroeconomic situation. Thus, in 1995, theaverage monthly growth of the tenge-per-US$ exchange rate was 1.5 percent, while in the first half of1994 the exchange rare had increased about six fold. Inflation in 1995 was 154 percent compared to1253 percent in 1994.

4. A considerable deceleration in the decline of gross domestic product (GDP) and industrialproduction was achieved. In nine months of 1995 the value of GDP in current prices was 722 billiontenge. The structure of GDP in current prices can be shown as follows:

manufacture of goods 42%performance of services 47%taxes (indirect taxes less subsidies) 11 %

5. The State budget status has improved and the budget deficit became manageable.

6. The Republic faces now a period of transition, which has the following main features:privatization of the state ownership, creation of the market institutions and formation of the relevant

ANNEX - Page A.4

legislation. These components of the transition to a market economy are closely linked and depend oneach other. The appropriate legislative basis can not be established overnight using the standards acceptedin the developed countries. Therefore its establishment and development was performed on anevolutionary basis: from simple to complex -- with the maximum consideration for the internal featuresof the economy of Kazakstan.

7. In 1995 small scale and mass privatizations were mainly completed; agricultural privatization,dismantling of monopolistic industry is being carried out. From the start of the privatization process15,700 enterprises were privatized.

8. Auction procedures are used for privatization of the middle and large enterprises. From Januaryuntil November (eleven months) of- 1995, 211 joint stock companies were established. Receipts fromprivatization during eleven months of 1995 increased 1.8 times compared to the relevant period of theprevious year.

9. Reform of the present tax system was implemented. It was aimed, from one side, to increase theactivity of businessmen and manufacturers to provide economic growth, strengthen the financial system,and expand the tax base; and from the other side, to provide a reasonable level of state budgetexpenditures, not allowing growth of the budget deficit and stimulation of the inflationary process. Anew Tax Code was adopted.

10. Procedures for the sanitation and bankruptcy of insolvent enterprises were established.

11. Since the beginning of the transition period, resources were attracted into the economy ofKazakstan in the form of:

economic assistance from official sources 2 billion US$export credits 2 billion US$direct foreign investment 2.88 billion US$

(according to Goskomstat data)

12. At the present time, when features of stabilization and structural adjustments are irreversible, thestrategy of the World Bank and other international financial organizations and donor countries is directedto support strengthening and improvement of the sector reforms through investment loans.

13. Imnort ComponAnt Implementation. The Rehabilitation Loan was utilized to finance imports inamount of 180 million USD and initially consisted of:

(a) a foreign exchange market (FXC) component in the amount of 94 million USD to provideaccess for importers to the foreign exchange auction market to finance imports inaccordance with sound commercial practices; and

(b) a pre-identified critical imports component (PIC) in amount of 86 million USD allocatedfor support and rehabilitation of the critical production sectors.

14. Foreign exchange component: The foreign exchange component has increased the amount offoreign currency at the market providing access of the commercial companies to import activity basedon the market practices and not on administrative decisions. As compared to the initial allocation, 43

ANNEX - Page A.5

million USD were transferred from the PIC to the FXC in order to provide support for the newlyintroduced national currency. Thus the FXC amounted to 137 million USD.

15. Financing of the expansion of the auction market and non-inflationary financing of the budget wasprovided through FXC. Signing of the agreement between the Ministry of Finance of the Republic ofKazakstan and the National Bank of the Republic of Kazakstan (NBK) provided for the automatic saleof these proceeds at the official rate of the NBK, and allowed reimbursement up to the net monthly salesof foreign exchange by the NBK on the auction market. The amounts reimbursed were paid to theaccount of the Ministry of Finance at the NBK and became available for further interventions on theauction market. Goods imported under the FXC were those not included in the negative list of the Bank,and were not financed through other loans.

16. Pre-Identified Import Component (PIC): Initially 86 million USD were allocated to PIC. Latein the course of project implementation 43 million USD, initially allocated for the energy sector, foodprocessing industry, and Ministry of Health of the Republic of Kazakstan (for drugs, vaccines, and rawmaterials for manufacture of medicines) were reallocated to the FXC since the Ministry of Finance wasin doubt concerning deposit of counterpart by these sectors of the economy, and due to difficulties in thebalance of payments and the introduction of the new currency. The final value of the PIC amounted to43 million USD.

17. In spite of the difficulty in appraisal of the influence of the Loan on imports, it provided resourcesto support industry in the difficult period of transition and to ease the reform process. For example, 70percent of the population in Kazakstan depends on public transport; change for worse in transportationservices would affect all aspects of life of the urban population. Under the PlC, 3.54 million USD wasallocated to finance 10 percent of one year's need for spare parts for the existing stock of the existingstock of "Ikarus" buses. This permitted a decrease in the number of buses removed from service due tothe absence of spare parts, and also to prolong duration of their service after repairs.

18. Procurement of pesticides, herbicides, and veterinary medicines was financed out of the loanproceeds for a total amount of 38.83 million USD, which had a significant importance for support of thefood production, and decrease in the loss of agriculture production due to diseases and pests.

Performance of the Bank

19. The Bank had a key role in elaboration of the Government's reform program, taking part in thedesign of this project. The Bank assisted the Government in implementation of the reforms by theallocation of financial aid.

20. The Bank helped in the adoption of the Privatization Program in April 1993, the implementationof which was started in July 1993.

21. With Bank assistance, a Law on Commercial Banks was prepared. It was adopted in April 1993at the last Parliament session.

22. A draft of the new Law on Foreign Investment was prepared with the help of the Bank.

23. Upon Bank advice regular prices on oil products were increased twice, and this has shifted onto consumers the burden of price increases for oil imported from Russia.

ANNEX - Page A.6

24. In the process of loan implementation, the Bank provided prompt assistance withrecommendations and advice. Bank supervision missions have been making analyses of the reformimplementations, and the results of these analyses were submitted to the Government in the form ofmemoranda.

Perfornunce of the Borrower

25. By the middle of 1993 an essential progress in elaborating and beginning implementation of asound reform program was achieved in Kazakstan. Rapid privatization was a key element in thisprogram. Liberalization of prices for most of the goods and services was a turning point in the reforms.

26. Successful implementation of the reforms was possible due to the Government's determinationto stick to its initial objectives and maintain a considerable dialogue with the Bank.

27. A strict procedure for repayment of funds by procurement organizations was elaborated. TheMinistry of Finance followed this procedure in order to avoid hidden subsidies. In particular, by requestof the Ministry of Finance, proceeds allocated under the PIC for procurement of goods for the energysector and food industry were transferred to the FXC after appraisal by the Ministry of Finance of thepossibility of funds reimbursement in these sectors.

28. In spite of the fact that initially Kazakstan was not aware of Bank procedures and regulations, theGovernment has relied upon the Bank's assistance and has worked in close cooperation with the Bankspecialists and with the procurement, finance and disbursement advisors financed out of the TechnicalAssistance Loan proceeds.

29. With the help of the Finance and Disbursement Advisor, records and accounts were maintainedwhich adequately reflected the expenditure of the loan proceeds in accordance with consistentlym.aintained sound accounting practices, and this was reflected in the audit reports submitted to the Bank.

30. Details of the Borrower's performance in the course of implementation, describing problems anddifficulties encountered by the Borrower and lessons for the future, are shown in the following part ofthis report, which provides information on operational aspects of implementation.

Actual Situation at Project Launch Workshop (October 1993)

31. As this was the first World Bank loan to Kazakstan, and the PIU was not yet adequately staffedto commence implementation, the arrival of the procurement consultants to commence an advisorycontract was most timely. Little implementation work had been started and the advisors were able toassess the situation, and to commence work with the beneficiaries in an effort to achieve the maximumamount of progress in the shortest possible time. Much time and effort was required to establish "goodworking practices' with the PIU when none of the staff had any realistic Western commercial experience.

Process and Progress of Implementation

32. As a result of the lack of staff within the PIU, and as time was of the essence, it was consideredessential for the advisors to initially act independently of the PIU staff, in order to prepare the necessarydocumentation for international bidding and to finalize the Lists of Goods to be imported under theCritical Import List, with each of the beneficiary organizations, and to obtain the no-objection of the Bank

ANNEX - Page A.7

to the finalized requirements of each end-user. This was no easy task, with difficulties being experiencedwithin the Ministry of Agriculture, and in the Ministry of Health, in the defining of their requirements,and then understanding the procedures (that internally were undergoing change) with regard toregistration, and to the acceptability of supplies from certain sources. None of the beneficiaries hadexperience with Bank procedures, nor in most cases of any exposure to normal Western commercialpractices. It was thus necessary in the best overall interests of the GOK to minimize the amount ofpractical training of PIU and other Ministry staff, and to concentrate on the objective of securing thespecified goods, through international competitive tendering, in the shortest possible time.

33. There was considerable dialogue between the Loan Task Manager and the Government'sProcurement Advisors, and with the support of the Bank staff, progress was achieved, with some of theend-users.

34. During the course of implementation, and to suit the rapidly changing economic situation withinthe country, the GOK had revised their thoughts as to the size and composition of the scope of the criticalimports component, and decisions were taken to amend components by requesting Bank approval totransfer funding from the PIC to the FXC component in order to provide support for the newlyintroduced national currency. As a result, the components for food industry, for Uzen oil fields, and forthe drugs and equipment portions of the health sector allocation, were re-allocated. Thus the componentsthat did proceed were the procurement of pesticides and veterinary medicines for the Ministry ofAgriculture, the spare parts for Ikarus buses under the transport sector, and the spare parts for medicalequipment for the health sector.

Milestones Achieved

35. In January 1994 tender documents were issued for the procurement of pesticides with a potentialvalue of 30 million USD. As a result of the evaluation and recommendations, 21 contracts were awardedto international firms from nine countries for the supply of approved pesticides for the 1994 growingseason. Deliveries were made from Europe and from Japan, and both road and rail transportation wereused as a means of transporting the goods into the country. As a result of savings achieved over budget,additional quantities of product were able to be procured, through additional competitive tendering.

36. On June 16, 1994, tender documents were issued for the procurement of veterinary medicines.As a result of the evaluations and recommendations, 21 contracts were awarded to international firmsfrom seven countries for the supply of approved veterinary medicines. Road and rail transportation wereused to deliver the goods to Kazakstan.

37. On June 20, 1994, tender documents were issued for the procurement of Ikarus bus spares underthe Ministry of Transport allocation. Following evaluation and recommendations, four contracts wereawarded to international firms.

38. On February 24, 1994, the first tranche of the foreign exchange component was released aftersubmission of 36 million USD of customs receipts had been cleared by the World Bank. On March 31,1994, the second tranche of the foreign exchange component was released after submission of 58 millionUSD of customs receipts had been cleared by the World Bank.

ANNEX - Page A.8

HMndrances to Implementation

39. The lack of staff in the PIU to be able to work with the consultants, and the lack of Englishlanguage skills amongst the PIU staff, were the major hindrances to rapid progress being achieved in theearly months after the Loan became effective.

40. The complexity of the World Bank procurement and disbursement procedures was never fullyunderstood by either the PIU staff or by the representatives of the beneficiaries.

41. The Government's economic strategy was, through necessity, being modified to take cognisanceof the rapidly changing situation in the country. Thus policy matters were given greater priority in Loanimplementation matters amongst the end-users.

42. There was a steady turnover of staff in many of the government institutions including the PIU,and continuity of contact for day to day training, and the normal processing of loan documentation,became a significant issue. Staff allocated to be responsible for the documentation became a significantissue. Staff were allocated to be responsible for the implementation of large sums of money for theirministries or organizations, but were quite unsuited to the task, and in consequence were generally notprepared to take the responsibility for the compiling and processing of documentation.

43. There was a lack of understanding at the highest levels of government, of the level of attentionthat was necessary to be paid to implementation, especially to procedural matters: the roles of the variousentities involved in implementation were never clearly defined and clarified to all of the parties involved.

44. The lack of training opportunities and facilities for key national staff who were to be involvedin the loan implementation was a reason for much of the work on the loan procurement being undertakenby the consultants rather than the PIU or end-user staff who had little or no commercial exposure of anykind, let alone of a kind necessary to assist meaningfully with day-to-day loan implementation matters.

45. The lack of funding to enable the PIU to operate on a day-to-day basis was a significanthinderance, and meant that initially there were no international communications available within theoffice, and thus time delays occurred whilst communications were sent and received through externalsources, and funded by an additional allocation from the Technical Assistance Loan to the advisor'scontract.

46. The lack of "dedicated" staff in both the PIU and the end-user organizations meant thatimplementation work had to compete with other duties as assigned by the respective authorities withinthe GOK.

Overall Review

47. Implementation of the two components of the loan were achieved within two years and the amountof the loan was fully disbursed. Critical imports in the agricultural and transport sectors were made, andthe foreign exchange component was critical in providing support to the newly established nationalcurrency (the tenge) that was introduced in November 1993.

48. Mistakes were made, and delays did occur, but as this was the first loan to be implemented inKazakstan, it was inevitable that problems would be encountered.

ANNEX - Page A.9

Lams for the Future

49. Any PIU must be fully staffed and equipped and be allocated operational expenses either fromwithin the loan, or from the government's own budgetary resources, before the loan is declared effective.

50. The end-users/beneficiaries must be fully aware of their responsibilities and be ready to participatefully in the implementation of their portions/allocations. They must designate sufficient "dedicated" stafffor the work to be undertaken, in conjunction with the PIU staff and their advisors.

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