world bank documentdocuments.worldbank.org/curated/en/933231468293468699/pdf/multi... · 1998. when...

Document ofThe World Bank

FOR OFFICIAL USE ONLY

Report No. 19340

IMPLEMENTATION COMPLETION REPORT

ROMANIA

FINANCIAL AND ENTERPRISE SECTOR ADJUSTMENT LOAN

Loan 3975-0, 1, 2-RO

May 24, 1999

Private and Financial Sector Development DepartmentEurope and Central Asia Region

This document has restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bankauthorization.

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CURRENCY EQUIVALENTSas of May 24, 1999

Currency Unit: Leu/LeiILeu = 6.59065E-05 US$;

US$I = 15,496 Lei

YEAR-END EXCHANGE RATES (Lei to US$1)

1993 1994 1995 1996 1997 19981,276 1,767 2,578 4,035 8,023 10,951

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

Sector Director: Lajos Bokros, ECSPFSector Leaders: Gerhard Pohl, Hennie Van Greuning, Yasuo Izumi, ECSPF

Program Team Leaders: Khaled Sherif, Hiran Herat, ECSPFFESAL Task Managers: Martin Slough, Patrick Tardy, ECSPF

FOR OFFICIAL USE ONLYABBREVIATIONS AND ACRONYMS

AR Agency for RestructuringBA Banca AgricolaBP Banc Post

BKHF British Know-How FundBSE Bucharest Stock Exchange

CC Commercial Company

CEC Savings BankCNVM Securities Exchange Commission

EU European UnionFESAL Financial and Enterprise Sector Adjustment Loan

FRF Financial Recovery Fund

FRP Financial Recovery Program

GD Government DecisionGOR Government of Romania

IBRD International Bank for Reconstruction and Development

IDA International Development Association

IMF International Monetary Fund

IPO Initial Public OfferingMEBO Management/Employee Buyout

MOF Ministry of FinanceMOP Ministry of PrivatizationMPP Mass Privatization ProgramNAP National Agency for PrivatizationNBR National Bank of Romania

PIU Project Implementation UnitPOF Private Ownership Fund

PSD Private Sector DevelopmentRA Regie Autonome

RBD Romanian Bank for DevelopmentRCB Romanian Commercial Bank

RDA Romanian Development Agency

SAL Structural Adjustment LoanSBA Stand-By ArrangementSME Small and Medium-sized Enterprise

SOCB State-Owned Commercial Bank

SOE State-Owned EnterpriseSOF State Ownership FundTA Technical Assistance

USAID United States Agency for International Development

ROMANIA'S FISCAL YEAR

January 1 - December 31

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.


ROMANIA

FINANCIAL AND ENTERPRISE SECTOR ADJUSTMENT LOAN(Loan 3975-0, 1, 2-RO)

CONTENTS

PREFACE ............................................... I

EVALUATION SUMMARY .............................................. i-viii

PART 1. PROJECT IMPLEMENTATION ASSESSMENT ...............................................1

A. STATEMENT/EVALUATION OF OBJECTIVES ...................................... 1IB. ACHIEVEMENT OF OBJECTIVES ....................................... 5C. IMPLEMENTATION AND MAJOR FACTORS AFFECTING THE PROJECT.. 14D. PROJECT SUSTAINABILITY ...................................... 15E. BANK PERFORMANCE ...................................... 1 5F. BORROWER PERFORMANCE ...................................... 16G. ASSESSMENT OF OUTCOME ...................................... 16H. FUTURE OPERATIONS ...................................... 171. KEY LESSONS LEARNED ...................................... 17

PART II. STATISTICAL TABLES .............................................. 21

TABLE 1: SUMMARY OF ASSESSMENTS .22TABLE 2: RELATED BANK LOANS/CREDITS .24TABLE 3: PROJECT TIMETABLE .25TABLE 4: LOAN/CREDIT DISBURSEMENTS: CUMULATIVE ESTIMATED &

ACTUAL .26TABLE 5: KEY INDICATORS FOR PROJECT IMPLEMENTATION .27TABLE 6: KEY INDICATORS FOR PROJECT OPERATION .47TABLE 7: STUDIES INCLUDED IN PROJECT .47TABLE 8A: PROJECT COSTS .. .................................... 48TABLE 8B: PROJECT FINANCING ...................................... 48TABLE 9: ECONOMIC COSTS AND BENEFITS ...................................... 48TABLE 10: STATUS OF LEGAL COVENANTS ...................................... 49TABLE I 1: COMPLIANCE WITH OPERATIONAL MANUAL STATEMENTS .53TABLE 12: BANK RESOURCES: STAFF INPUTS ...................................... 53TABLE 13: BANK RESOURCES: MISSIONS ...................................... 53

APPENDICES:

1. MISSION'S AIDE-MEMOIRE2. INITIAL FESAL PROGRAM POLICY MATRIX3. BORROWER CONTRIBUTION TO THE ICR4. COFINANCIER CONTRIBUTION TO THE ICR

(EXPORT-IMPORT BANK OF JAPAN)5. SECOND PORTION RELEASE MEMORANDUM6. GENERAL MAP


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Preface

This is the Implementation Completion Report (ICR) for the Financial and EnterpriseSector Adjustment Loan (FESAL) in Romania, for which loan 3975-0, 1, 2-RO in an amount ofUS$280 million equivalent was approved on January 18, 1996 and made effective on February29, 1996.

The loan was closed on April 30, 1998, although the original closing date was to beDecember 31, 1997. The first portion (US$60 million equivalent) and the floating portion(US$40 million equivalent), released upon effectiveness, were fully disbursed by March 1, 1996.The disbursements of the second portion totaling US$80 million equivalent under Loan 3975-0-RO and Loan 3975-1-RO took place on June 12 and 17, 1997, respectively. The balance ofUS$100 million equivalent, corresponding to the third portion of the loan, was canceled on April30, 1998. Co-financing of the project was provided by the Export-Import Bank of Japan.

The ICR was prepared by Martin Slough, Patrick Tardy, Jimmy lorga, ArabelaNegulescu, and Nuzhat Ahmad (all ECSPF) of the Europe and Central Asia Region and finalizedby Khaled Sherif, Oleg Petrov, Ramin Shojai, and Tatiana Segal (all ECSPF). It was reviewed byAndrew Vorkink, Director ECCO5, and Lajos Bokros, Director ECSPF. The borrower and theco-financier provided comments that are included as appendices to the ICR.

This ICR was prepared between July and September 1998. The report, which is based onmaterial in the project file, was finalized during the Bank's completion mission in March 1999.The borrower contributed to the preparation of the ICR.


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Evaluation Summary

Introduction

1. The Financial and Enterprise Sector Adjustment Loan (FESAL) of US$280 million wasto support the financial and enterprise sector reform program of the Government and of theNational Bank of Romania (NBR). The Loan was appraised in October 1995 and approved bythe Board on January 18, 1996. The loan agreement was signed on January 19, 1996, and the loanwas made effective on February 29, 1996. The first portion and the floating portion of US$60million and US$40 million equivalent, respectively, were disbursed upon effectiveness. Thesecond portion of US$80 million was disbursed in two parts on June 12 and 17, 1997,respectively. The closing date of the loan was extended from December 31, 1997 to April 30,1998. When the FESAL was closed on April 30, 1998, the third portion of US$100 millionequivalent was canceled.

2. The reform program supported by the FESAL was designed to build on and complementthe reforms previously undertaken in 1990 by the Government and the NBR under a World BankStructural Adjustment Loan (SAL). Preparation of the FESAL started in 1992 at a time when theRomanian economy was suffering from major dislocations. Between 1989 and 1993, theeconomy contracted by 32 percent-industrial output declined by 54 percent-as a result of thecollapse of the Council for Mutual Economic Assistance (CMEA), the Gulf crisis, and theturmoil in (ex-)Yugoslavia. Romania's initial attempts at stabilizing the economy in 1991 and1992 were not successful. Inflation remained high. Implementation problems and fiscal andcredit policies, including insufficient financial discipline in state-owned enterprises (SOEs),played a major role in creating macro-imbalances. However, a major fiscal adjustment tookplace in 1993 and 1994, and macro-stabilization was broadly achieved by the end of 1994. At theend of 1994, fiscal deficits were limited to 2 percent of GDP, inflation fell to 25 percent, andgrowth had recovered to 3.9 percent. These adjustments took place during an interim period inwhich the Government recognized the need for macro-stabilization to make structural reformseffectively take hold. The Government had demonstrated a strong and sustained commitment tostabilizing the economy at the time. This effort was supported by the IMF through a stand-byarrangement (SBA) approved in May 1994.

3. Important successes were achieved in structural reform. As a result of the 1991 LandReform Program, 80 percent of land became privately owned. The country's housing stock waslargely privatized. A majority of SOEs were corporatized. Progress was also made in price andtrade liberalization. A Value-Added Tax (VAT) was introduced. The social safety net wasstrengthened. The energy, transport, telecommunication, and social sectors made some progress,albeit uneven, supported by loans from the World Bank.

4. However, major structural issues remained, including: (i) enterprise and bankprivatization'; (ii) the chronic losses of SOEs in metallurgy, mining, energy, petrochemicals,transport, mechanical, and agro-processing industries2 ; (iii) weak financial discipline in the SOEsector3; (iv) the deteriorating quality of banks' portfolios as a result of the accumulation ofpayment arrears and non-performing loans to industry and agriculture; (v) inadequate supervisoryand enforcement capabilities of the NBR; (vi) inadequate bank accounting and auditingstandards; and (vii) the absence of capital markets. These structural issues needed to beaddressed promptly to remove a potential threat to the still fragile macroeconomic stability thathad been achieved.

Project Objectives

5. The first Government program, supported by the FESAL, was designed to address theseoutstanding structural issues through an integrated approach:

The Enterprise Sector.

(a) Accelerating SOE privatization, including a mass privatization program (MPP)that was the cornerstone of the program;

(b) Enforcing hard budget constraints on remaining SOEs. The major loss-makerswere placed in a special surveillance program, where management was requiredto restore financial viability and negotiate debt rescheduling agreements withtheir creditors or they would face liquidation;

(c) Implementing an action plan to stimulate private sector development;

The Financial Sector

(d) Gradually raising the soundness of the banking system by:

(i) Requiring banks to establish adequate loan-loss provisions for their impairedloan portfolios;

(ii) Phasing in the collateralization of NBR refinancing;

(iii) Strengthening the supervisory and enforcement capacity of the NBR;

6,300 commercial companies (CCs) and approximately 400 non-corporatized regies autonomes(RAs), representing approximately 60 percent of output and employment, were state-owned. The fivemajor commercial banks and the savings bank were state-owned.

2 It was estimated that, on a cash flow basis, the SOE sector generated an aggregate negativeoperating cash flow of approximately 6 percent of GDP.

3 Aggregate payment arrears in the economy were estimated at 23 percent of GDP in 1993.

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(iv) Enhancing competition and the role of the private sector in the bankingsystem by privatizing banks;

(e) Limiting the recapitalization of banks by the state;

(f) Introducing a deposit insurance scheme for individual depositors; and

(g) Developing the capital market by opening the Bucharest Stock Exchange (BSE)and creating an over-the-counter market, the RASDAQ.

Implementation Experience and Results

6. After a promising start, the program floundered in mid-1996 as the Government's attentionshifted toward the presidential and legislative elections that took place in October 1996. Inparticular, the privatization of banks and enterprises slowed down, except for the massprivatization program (MPP), which went ahead; utility tariffs were frozen, thereby increasinglosses in the utilities sector and arrears in the enterprise sector; and financial discipline was notenforced. Socially painful or politically sensitive measures were avoided.

7. A new government ostensibly committed to undertaking deep and fast reform came to powerin late 1996 and asked the Bank to revise the program supported by the FESAL to accelerate thepace of reform. The revised and deepened program, agreed upon with the Bank in February1997, was more wide-ranging and more rigorous than the original one. Several components wereadded to the original set. The overall objectives of the program remained the same. Many of themeasures to implement the revised program called for wide-ranging and significant changes inthe legal framework.

8. This revised program was a success in some areas and a failure in others. The Governmentdid not meet its commitment regarding the maintenance of an appropriate macroeconomicframework. By the end of March 1998, the performance criteria agreed upon with the IMF werenot met and the SBA was terminated in April 1998, with two out of five tranches unreleased. Inthe enterprise sector, privatization targets-the cornerstone of the program-and the conditionsfor private sector development were met, though less than 20% of SOF's portfolio had been soldby end-1997. However, the surveillance program failed: SOEs continued to accumulateunacceptably large losses and payment arrears. In the financial sector, significant progress wasmade, and loan conditions were met in areas such as the collateralization of NBR refinancingcredits; mandatory external audits of banks; creation of a deposit insurance scheme; reform of thepayments system; and the successful opening of the BSE and the RASDAQ. However, theprogram failed to privatize two state-owned banks. Furthermore, the two largest banks, Bancorexand Banca Agricola (BA), faced major difficulties during that period and were bailed out by thestate budget, in defiance of one of the conditions of the loan, due to the insufficient progress andenforcement of loan-loss provisioning, prudential regulations, NBR supervision, and the newchart of accounts for banks.

9. Because real progress was made in implementing the revised program during the firstpart of 1997, the Board agreed to grant five waivers of the original conditions (as a tougherprogram had actually been implemented) and approved the disbursement of the US$80 millionsecond portion of the FESAL on June 6, 1997. The memorandum "Release of Second Portion -Waiver of Conditions" is attached in Appendix 5 of this report. However, the reform program

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then floundered in the second half of 1997 and into the first quarter of 1998 due to politicaldifficulties within the governing coalition and a loss of commitment to reform. The FESALclosing date was extended for four months (from December 31, 1997 to April 30, 1998) in a lastattempt to revive the program. However, little progress was made in meeting Third Portionconditions during the extension period. The Government then agreed with the Bank to allow theFESAL to lapse on April 30, 1998. The last portion of US$100 million was not disbursed.

Summary of Findings, Future Operations and Key Lessons Learned

10. Summary offindings. The project had significant development outcomes. Under theFESAL, pricing and trade has mostly been liberalized. Against a target of 3,600 SOEs, morethan 4,000 SOEs were privatized. Utilities are being corporatized and prepared for privatization(e.g., a minority equity share of the telecommunications company was privatized in late1998/early 1999). Obstacles to new enterprise creation were removed, and more than 300,000new enterprises were registered during that period. The program initiated significant downsizingof loss-making enterprises and a reduction in their labor forces, particularly in mines4 . This wasaccompanied by measures to cushion the social impact of such reductions. A mass privatizationprogram (MPP) was designed and implemented, resulting in 15 million Romanians becomingshareholders. The program was instrumental in supporting the creation of a capital market, inclose cooperation with other donors. The legal regulations to strengthen the prudential,supervisory, and enforcement capabilities of the NBR were promulgated. Other importantcomponents of banking infrastructure- payments system, deposit insurance, banks' chart ofaccounts, credit risk information bureau-were created. Major pieces of legislation were passed,including the privatization law, mining law, foreign investment law, law establishing eligibilitycriteria for severance payments, bankruptcy law, revised banking law, revised NBR law, bankprivatization law, bank insolvency law, revised law governing the savings bank, and thesecurities exchange law. All of these developments are expected to have salutary effects onsubsequent reform efforts, although their earlier absence complicated the abi]ity to effectivelyimplement reforms under the FESAL. Belatedly, privatization of state banks began in late1998/early 1999 (BRD and Bancpost).

11. Overall, the objectives of the enterprise restructuring program have not been achieved, inparticular with respect to utility restructuring and the closure of loss-making CCs. This was dueto the powerful resistance of labor unions and other vested interests, which could not beovercome because the political commitment to achieve program objectives was lacking. Thelegal framework and the judicial system also proved inadequate, in particular with regard toexpediting the liquidation of non-viable firms. The Bankruptcy Law proved hopelesslycumbersome and slow to apply. Most of the CCs that were eventually liquidated were closed byorder of the SOF, their owner, under the provisions of the Trade Act. However, the program wassurprisingly successful in the mining sector, where maximum resistance was expected. Thissuccess was facilitated by providing generous redundancy payments to workers who volunteeredto resign from these mines. Restoration of financial discipline in enterprises was not successful.To impose a hard budget constraint on enterprises placed under surveillance, the initial programplaced a cap on the financial support available from the state, the SOF, and the banks. However,the caps were too generous; the enterprises were able to renegotiate their debts with theircreditors without undertaking cost-cutting measures.

4 Around 100,000 miners left during thie second part of 1997.

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12. In spite of the failure to implement the last part of the program, the FESAL has had apositive impact on the structural reform of Romania. Most of the measures taken, especially inprice and trade liberalization, SOE privatization, banks, and capital market regulation areirreversible. This is expected to assist immeasurably with future project implementation,particularly as significant institutional capacity has been built up during the course of the FESAL,and as the need for structural reform to reverse the economic decline becomes more obvious.The Government has now realized that the success of reform is dependent on the progress ofthree major areas: privatization (of banks, enterprises, and utilities); elimination of financialsupport to non-viable loss-making firms; and development of a sound banking system. This cleardelineation was not so clear to the authorities in 1992 when the FESAL was initially designed.However, the persistent decline in the economy is now recognized to be the consequence ofdelays in structural reform. Thus, future operations are expected to have a broader base ofsupport in recognition of the insufficiency of past programs to achieve needed structural reforms.Also, a much more comprehensive legal framework has been enacted, and a major effort atinstitution building has been undertaken under the FESAL. This foundation will facilitateimplementation of subsequent operations.

13. The FESAL also provided an umbrella for a vast array of technical assistance andtraining programs (delivered either by the Bank or by other donors) to build up local institutionalcapabilities and to train national experts. The FESAL program became the policy anchor ofbilateral support, in particular from the European Union (EU) and the United States Agency forInternational Development (USAID). Close and effective cooperation was achieved between theBank and other donors.

14. Future Operations. The FESAL was allowed to lapse on April 30, 1998 because it hadbecome apparent that the remainder of the program as designed would not be implemented in areasonably short span of time. The program needed an overhaul, in particular to reflect the viewsand agenda of the new Government elected in April 1998, and to incorporate some of the lessonslearned. The Government and the Bank have updated the structural reform program and haveagreed upon a new operation. This new operation "Private Sector Adjustment Loan, RO-PE-64853" was negotiated with the Government on April 30th, 1999, and will be presented to theBoard on June 10, 1999. This project will be a two-tranche operation and aims to stimulatereforms in the following areas:

* In the Enterprise Sector: (a) accelerating state-owned enterprise (SOE) privatization across awide spectrum of sectors; (b) enforcing hard budget constraints on remaining SOEs throughthe closure of big loss-makers (i.e. mines); and (c) implementing an action plan to stimulateprivate sector development and streamline the business environment.

* In the Financial Sector: (a) gradually raising the soundness of the Romanian banking system;(b) ensuring that state banks are properly restructured as a pre-requisite for theirprivatization; (c) ensuring that NBR put into place the regulations that will improve theoverall soundness of the banking system at large; and (d) further developing the governmentsecurities market.

* In the Social Sector: reforms in both enterprise and financial sectors will be addressed by.measures designed to strengthen the social safety net through: (a) rationalizing an incomesupport program for displaced workers; (b) ensuring that an adequate budget is in place forsuch a purpose.

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Also, to strengthen the implementation of the reform program, a new Private Sector InstitutionalBuilding Loan is being prepared. A mining project is being prepared to support mine closuresundertaken by the FESAL.

15. The key lessons learned are presented in paragraphs 16 and 17 below.

16. Project Objectives. The objectives of the FESAL program were appropriately set andremain valid. The program properly focused on taking care of financial and economicfundamentals, in particular price and trade liberalization; enterprise and bank privatization; therestoration of fiscal balance by targeting loss-making SOEs; the removal of obstacles to theemergence of new private firms; and the development of adequate regulatory, accounting, andsupervisory instruments to create a sound banking system and a capital market.

17. Project Design. The main flaws were as follows:

(a) The FESAL tried to include too many areas of reform in a single operation. Theinitial FESAL was a massive operation to be disbursed in four portions over aperiod of two years and included 27 conditions for disbursement. The revisedprogram was even more complex, as it sought to achieve the most difficultenforcement of a hard budget constraint on loss-making SOEs, which hadpreviously evaded the restrictions. As a result, an additional 41 conditions fordisbursement were introduced. Recommendation: Future adjustment operationsshould focus on one area of reform5; should be much simpler and shorter (one-year horizon); and should be disbursed in one or two tranches at the most;

(b) Many of the conditions were based on processes (e.g., design andimplementation of plans or mechanisms; production of reports) or on outcomesthat were subjective and difficult to measure (e.g., improved enterprise cash flowor "substantial progress achieved..."). As a result, monitoring theimplementation required considerable allocation of resources, staff time, andtravel. Recommendation: Conditions should be based on a limited number ofsignificant and easily verifiable outcomes and results.

(c) There was insufficient Government ownership, delivery capacity and control ofprogram implementation, especially with the revised program of 1997. Except in1996, when the Minister of Finance personally took the lead in monitoring theimplementation of the program, the Romanian Government has not beenappropriately represented. For instance, the Bank FESAL team never workedalongside a single Romanian counterpart team despite the Bank's efforts topersuade the Government to create such a team. The responsibility of the designand the implementation of the program were divided among too manyministries6, organizations, and agencies7. To permit resumption of the IMF SBA,

5 However, the links between macroeconomic stability, enterprise sector reform, and financialsector reform must be maintained. These links can be maintained by processing several separate operationssimultaneously, but without systematically stopping disbursement of one because of difficulties in meetingconditions in another.6 Prime Minister, Finance, Reformn, Industry, Transport.

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the revised 1997 program was quickly negotiated with a newly elected andinexperienced Government who did not have a sufficient understanding of whatit was committing itself to. As a result, the Bank may have been too prescriptive,the resulting program may have been too ambitious, and the FESAL team mayhave micro-managed the implementation of the program.Recommendation: Set up a high level counterpart group to design and monitorimplementation of such operations. Build up country ownership of the program.Ensure that it can be realistically implemented.

(d) Romanian institutional capabilities were overestimated and proved too weak forthe scope of the task. This became particularly acute in the areas of policydesign; enterprise and bank privatization; monitoring of SOE financialperformance and discipline; SOE governance; bank supervision; and bankrestructuring.Recommendation: Ensure that institutional capabilities are adequately built up,preferably before project preparation, or at least during project implementation.Technical assistance (TA) and training should be provided, either under specificBank loans8 or by other donors. This was done very successfully when theRomanian capital market was created.

(e) The legal and regulatory framework and the Court system were inadequate tosustain implementation of the program. This became particularly obvious in thearea of enterprise and bank privatization; enterprise and bank liquidation; andutility regulation. Implementation of the program was delayed considerably byconstant changes in privatization legislation and regulations; difficulties inliquidating bankrupt firms and banks; excessive interference by the Court ofAccounts; and problems resulting from uncertainties about land ownership andthe extent of the public domain. The Court system was ineffective in applyingthe bankruptcy law and could not be relied upon to facilitate implementation ofthe program.Recommendation: A thorough assessment of the legal, regulatory, and judicialsystem should be performed early during project preparation. Passage ofessential laws and regulations should be a component of the program. Thejudicial infrastructure should be strengthened either through a specific Bank loanor by other donors.

(f) Though the 1997 Cabinet initially appeared strongly committed to a deep andfast reform, there was no campaign to build up support for the structural reformprogram with parliamentarians, civil servants, the press, and the public at large.Without such a campaign, the FESAL may have appeared (alongside the IMFSBA) as a painful exercise forced upon Romania by international organizations.

NBR; State-Ownership Fund (SOF); Private Ownership Funds (POFs); National Agency forPrivatization (NAP); Romanian Development Agency (RDA); Agency for Restructuring (AR); theSecurities Exchange Commission (CNVM under its Romania acronym); Bucharest Stock Exchange (BSE).

8 The FESAL team and the Resident Mission did provide a huge amount of TA. However, this wasnot properly budgeted for and was sometimes delivered in an untimely and uncoordinated manner.

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Recommendation: Efforts should be made to explain the rationale behind acomplex adjustment operation such as the FESAL to the media, politicians, andcivil servants. A systematic public relations campaign should be built into theprogram.

(g) Other, more specific, design issues were identified:

(i) privatization targets are useful indicators. However, they should bebased on the percentage of state-owned assets actually transferred toprivate ownership and control. Effective sale of a specific enterpriseshould not be a condition;

(ii) loss and payment arrears reductions are the most painful and difficultresults to achieve because they may have a severe social impact.However, measures in this area are unavoidable. Targets should not beenterprise-specific (e.g., list of enterprises to be liquidated), nor shouldthey be based on hypothetical and hard to measure loss/arrears reductiontargets. The emphasis should be placed on enforcement of a hard budgetconstraint and divestiture of state-ownership in troubled sectors (throughprivatization or liquidation); and

(iii) presentation of legislation to the Parliament by the Government is notsufficient. It may remain stalled in Parliament and/or the output may notbe satisfactory. L,oan approval should be contingent on the enactment oflaws satisfactory to the Bank (this must be specified at negotiation).

18. Conclusions: Throughout this project, the Bank has supported a critical phase of thetransition reform program. In recognizing the rapidly evolving country situation, the Bank andBorrower worked collaboratively throughout implementation to achieve the developmentobjectives. The project was supervised at regular intervals and the Government was activelyinvolved in discussing the progress made and results achieved. The program might haveachieved better results with a more realistic assessment by the Bank of the feasible pace ofimplementation. The Borrower demonstrated a strong commitment to the objectives of theprogram, but its implementation capacity was unexpectedly weak. This was due to themultiplicity of implementing ministries and agencies; the lack of effective coordination at asufficiently senior level by way of a strong counterpart group; and the inadequacy of the legaland regulatory framework and the judicial system.

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Part I. Project Implementation Assessment

19. The Financial and Enterprise Sector Adjustment Loan (FESAL) of US$280 million wasan adjustment operation to support the financial and enterprise sector reform program of theGovernment and of the National Bank of Romania (NBR). The Loan was appraised in October1995 and approved by the Board on January 18, 1996. The loan agreement was signed onJanuary 19, 1998 and the loan was made effective on February 29, 1996. The first portion andthe floating portion of US$60 million and US$40 million equivalent, respectively, were disbursedupon effectiveness. The second portion of US$80 million was disbursed on June 12 and 17,1997, respectively (approval was on June 6, 1997). The closing date of the loan was extendedonce, from December 31, 1997 to April 30, 1998. The FESAL was closed on April 30, 1998.The third portion of US$100 million equivalent was not disbursed.

A. Statement/Evaluation of Objectives

20. The reform program supported by the FESAL was designed to build upon andcomplement the reforms that the Government and the NBR started in 1990 under a World BankStructural Adjustment Loan (SAL). Preparation of the FESAL started in 1992 at a time when theRomanian economy was suffering from major dislocations. Between 1989 and 1993, theeconomy contracted by 32 percent-industrial output declined by 54 percent-as a result of thecollapse of the CMEA, the Gulf crisis, and the turmoil in Yugoslavia. Romania's initial attemptsat stabilizing the economy in 1991 and 1992 were ineffectual. Inflation remained high.Implementation problems and fiscal and credit policies, including weak financial discipline instate-owned enterprises (SOEs), played a major role in creating macro-imbalances. However, amajor fiscal adjustment took place in 1993 and 1994, and macro-stabilization was broadlyachieved by the end of 1994: fiscal deficits were limited to 2 percent of GDP; inflation fell to 25percent; and growth had recovered to 3.9 percent. The Government had demonstrated a strongand sustained commitment to stabilizing the economy. This effort was supported by the IMFthrough a stand-by arrangement (SBA) approved in May 1994.

21. Important successes had also been achieved in structural reform. As a result of the 1991land reform.program, 80 percent of land became privately owned. Housing stock was largelyprivatized. A majority of SOEs were corporatized. Progress was also made in price and tradeliberalization. A VAT was introduced. The social safety net was strengthened. The energy,transport, telecommunication, and social sectors were supported by Bank loans.

22. However, major structural issues remained, including:

(a) Enterprise and bank privatization: 6,300 commercial companies (CCs) andapproximately 400 non-corporatized regies autonomes (RAs), representing close

to 60 percent of output and employment, were state-owned. The five majorcommercial banks and the savings bank were also state-owned;

(b) The chronic losses of SOEs in metallurgy, mining, energy, petrochemicals,transport, mechanical, and agro-processing industries: It was estimated that, on acash flow basis, the SOE sector generated an aggregate negative operating cashflow of 6 percent of GDP in 1993;

(c) The generally weak financial discipline of the SOE sector: Aggregate paymentarrears in the economy were estimated at 27 percent and 23 percent of GDP in1992 and 1993, respectively;

(d) The deteriorating quality of banks' portfolios as a result of the accumulation ofpayment arrears and non-performing loans to industry and agriculture: Inparticular, Banca Agricola was extensively used as an instrument to channelsubsidized credits -- mostly funded by the NBR -- to agriculture. Other state-owned commercial banks (SOCBs) continued to finance loss-making SOEs,despite a build-up in loan repayment arrears;

(e) inadequate supervisory and enforcement capabilities of the NBR;

(f) inadequate bank accounting and auditing standards; and

(g) the absence of a capital market.

23. These structural issues needed to be addressed promptly to avoid a potential threat to thestill fragile macroeconomic stability. A first Government program, supported by the FESAL, wasdesigned during 1992 to 1995 to address these outstanding structural issues. After much internaldebate, an integrated approach was adopted that would focus on issues affecting both theenterprise sector and the financial sector. During that 3-year period, the program kept changingas the Government struggled to complete implementation of the SAL and to meet the conditionsof an SBA agreed upon with the IMF. Also, several of the proposed measures wereimplemented - in particular in the financial sector - before the appraisal of the loan. This led tocontinuous redrafting of the program. At the same time, considerable TA was provided by theBank team. Although this was useful, it also delayed the preparation of the FESAL. Eventually,the program was finalized during the second half of 1995. The loan was appraised in October1995 and taken to the Board in January 1996, more than three years after its identification. Theprogram supported by the FESAL outlined the following key objectives:

The Enterprise Sector:

(a) Accelerating SOE privatization, including a mass privatization program (MPP)which was the cornerstone of the program;

(b) Enforcing hard budget constraints on remaining SOEs. The major loss-makerswere placed in a special surveillance program, in which their management was

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required to restore financial viability and negotiate debt rescheduling agreementswith their creditors, or else they would face liquidation;

(c) Implementing an action plan to stimulate private sector development;


(a) Gradually raising the soundness of the banking system by:

(i) Requiring banks to establish adequate loan-loss provisions for theirimpaired loan portfolios;

(ii) Phasing in the collateralization of the NBR refinancing;

(iii) Strengthening the supervisory and enforcement capacity of the NBR;

(iv) Enhancing competition and the role of the private sector in the bankingsystem by privatizing banks;

(b) Limiting the recapitalization of banks by the state;

(c) Introducing a deposit insurance scheme for individual depositors; and

(d) Developing the capital market with the opening of the Bucharest Stock Exchange(BSE) and the creation of an over-the-counter market, the RASDAQ.

24. After a promising start, the program floundered around mid-1996 as the Government'sattention shifted toward the presidential and legislative elections, which took place in October1996. In particular, privatization of banks and enterprises slowed down, except for the massprivatization program (MPP), which went ahead successfully; utility tariffs were frozen, therebyincreasing losses in the utilities sector and arrears in the enterprise sector; and financial disciplinewas not enforced. Socially painful or politically sensitive-measures were avoided.

25. The opposition parties won both the presidential and the legislative elections. A newGovernment came to power in December 1996 allegedly committed to undertake deep and fastreforms. In January 1997, the Bank was asked to design an ambitious reform program. Thisrevised and deepened program was finalized in February 1998 and, per the request of theGovernment, its enterprise and financial sector reform components were incorporated into arevised FESAL program. The overall objectives of the program remained the same. However, itwas more wide-ranging and rigorous than the initial program. New to the program were thefollowing:

Microeconomic Framework and Enterprise Sector

(a) A strong push toward completing price and trade liberalization, including theforeign trade regime so that most internal price controls, export bans, and quotascan be removed;

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(b) The removal of limits on the offered and reserve prices for the sale of shares atauction, in an effort to facilitate a speedier sale of shares of small and medium-sized SOEs;

(c) Detailed privatization targets by methods applied (auction, IPO, sale throughinvestment banks) to ensure that the sale of shares of all categories of enterpriseswould accelerate;

(d) New measures to restore financial discipline and reduce losses. The failedsurveillance regime was abolished. New emphasis was placed on forcingdelinquent firms to pay their debts to the budget and to the utilities;

(e) Adjustment of tariffs to ensure that utilities would reduce their losses. At thesame time, these utilities were to present restructuring plans, including reductionsin their labor costs;

(f) A specific focus on loss-making mines (which had been overlooked in the initialprogram), including passage of a new Mining Law to. enable their privatization;increase of the price of mtining products to world levels to reduce their losses; adrastic program of loss-reduction, including closure of non-viable mines;

(g) The corporatization of the RAs, to be transformed into CCs, as a first step towardtheir privatization; and

(h) The liquidation or closure of a group of 42 large loss-making CCs.

In the Financial Sector

(i) The effective privatization of the Romanian Bank for Development (RBD) andof Banc Post;

(j) The liquidation of two bankrupt private banks (Dacia Felix and Credit Bank);

(k) The restructuring of Banca Agricola;

(I) Improvement of banks' accounting systems and tax treatment, which wouldallow banks to stop accruing interest on overdue loans and reverse previouslyaccrued unpaid interest;

(m) Clarification of the status and activities of the CEC and of cooperative banks;and

(n) Measures to strengthen the CNVM; improve financial information disclosure oncapital markets; and facilitate their access by foreign investors, includingportfolio investors.

26. Many of these measures required significant changes in the legal framework.Amendments to the legislation governing tariff and price regulations, enterprise and bankprivatization, severance payments, the Banking Law, the Statute governing the NBR, the Law

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governing the Savings Bank (CEC), the Accounting Law, the Profits Tax Law, the Lawgoverning Credit Cooperatives, the Law governing Securities Markets, the Trade Act, and theForeign Investment Law were required. New laws were also required, in particular a MiningLaw, a Bank Insolvency Law, and a Collateral Law.

B. Achievement of Objectives

The Enterprise Sector

27. The FESAL program was a success in some areas and a failure in others. The followingis a status report of implementation of the program as of March 30, 1999.

28. Microeconomic framework. The performance criteria agreed upon with the IMF werenot met and the SBA lapsed in May 1998, with two out of five tranches unreleased. The firstreview of the program was completed in September 1997. The program subsequently went offtrack and no further disbursements were made. Several performance criteria were missed by awide margin in both September 1997 and March 1998. Under IMF conditionalities, major areasof shortfall were under the structural adjustment component of the program.

29. Price and trade liberalization. This is one of the most successful components of theprogram. A limited number of industrial prices (mostly mining and petroleum products) were toremain regulated until the end of June 1998. The Office of Competition had designed andimplemented a satisfactory mechanism for monthly adjustments of regulated utility tariffs. Allexport bans and quotas have been removed, except for timber.

30. Enterprise privatization. This was the key objective of the program, and it was achievedper a slightly more lenient definition of privatization transactions than originally agreed uponunder the FESAL. The targets were 3,600 SOEs to be privatized, including at least 500 medium-sized and 100 large enterprises. These targets were met, as 4,024 SOEs were privatized, ofwhich 745 were medium-sized and 124 large. (Under the stricter definition of privatizationagreed upon with the Government under the FESAL, only 3,525 CCs would be considered asprivatized, including 125 large, 610 medium, and 2,790 small enterprises.) However, thisrepresents less than 20 percent of the capital stock owned by the State Ownership Fund (SOF),and less than 10 percent of the total capital stock of SOEs (i.e., including the RAs)9. It can beargued that the targets themselves were not ambitious enough; more than eight years after thedemise of the Ceaucescu regime, Romania's industry remains largely dominated by the publicsector.

31. Under the FESAL program, Romania designed and implemented a mass privatizationprogram (MPP). Although the program was unduly complicated, it was successfullyimplemented. As a result, more than 15 million Romanians became shareholders. However,despite spreading share ownership widely among the population, the MPP did not succeed intransferring control of firms to private owners. Voucher investment funds and foreign investorswere not allowed to participate. Only the Private Ownership Funds (POFs) could collectvouchers and bid for shares on behalf of individuals (they collected less than 15 percent of the

9) The total equity of RAs includes parcels of land belonging to the public domain, which will besubtracted from the equity upon their transformation into CCs.

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total). As a result, the SOF retained control of a majority stake in many SOEs, especially largeenterprises. However, a special provision under the program was the creation of an interimcentral share registry that would allow for MPP share registration and endorsement by theGovernment. This registry was successfully created. As a result, the managers of SOEs and ofpartially privatized firms lost control of share registries, which paved the way for the creation ofthe capital market and for future redistribution and concentration of share holdings by allowingunconstrained share trading among individuals.

32. In an attempt to accelerate privatization, the Privatization Law was amended during thefirst quarter of 1997. At the same time, the revised FESAL program added specific privatizationtargets, geared to the different privatization methods. None of these new targets were met. Forexample: (i) At least 50 SOEs were to be offered for sale per week, for a total of 2,053; only1,052 were offered for sale after January 1997, (ii) At least four enterprises were to be offered forsale through IPO; three were offered, of which two were sold. However, another 26 had beenprepared for sale, (iii) At least 100 large and medium-sized SOEs were to be contracted withinternational investment banks for accelerated sale; only 30 were contracted. Negotiations wereunderway for another 36. This dismal result is in part due to flaws in the amended PrivatizationLaw, which did not improve much upon the previous one. In addition, there were excessivedelays in getting this law enacted and in issuing accompanying regulations and norms. Otherattempts at improving the legal framework took place in the last quarter of 1997 and in the firstpart of 1998. In all cases, tinkering with the law resulted in slowing down the privatizationprocess. In essence, there was no significant acceleration of privatization after the change ofGovernment in December 1996.

33. Private sector development. This was a fairly minor component of the program and itwas successfully implemented. Equal and unconstrained access to public sector procurement wasguaranteed by law. A simplified procedure for enterprise creation was established, and a nation-wide network of one-stop centers for enterprise registration was created by the Trade Registry'°.To prepare this component, a study of the registration process was made. It has since beencomplemented by a survey of 404 small businesses to identify the constraints to private sectordevelopment. A new project is being designed to foster growth of small and medium-sizedenterprises (SMEs) as a follow-up to this component of the FESAL.

34. Enterprise restructuring and loss-reduction measures. The initial program failed.Imposing cost-cutting measures and restoring financial discipline among loss-making SOEsproved to be extremely difficult. Under the initial program, 151 loss-making SOEs were placedunder surveillance"'; of those, 30 CCs had previously been placed in a special isolation program.These enterprises were to be subjected to hard budget constraints, with restricted access to bank

10 The Trade Registry is managed by the Romanian Chamber of Commerce and Industry. TheChamber worked very closely with the FESAL team -- and is still working -- to improve the businessenvironment.

On aggregate, they represented around 45 percent of losses and of arrears. Some of the largestloss-makers -- such as the RAs for coal mining, zinc and lead, precious metals, national television andradio, road maintenance, irrigation, and the largest refinery (Petromidia) -- were not included in thesurveillance program, upon request of the Government. The group of 151 SOEs included 77 poultry andpig farms, which were not all large loss-makers, but were added to facilitate monitoring the performance ofthe agro-industrial sector and, in particular, the distribution and usage of subsidized credits.

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credit and Government and SOF support. Their management was expected to design FinancialRecovery Plans (FRPs), indicating how they proposed to reduce losses and payments arrears andto restore positive operating cash flow. All those SOEs placed under surveillance had tonegotiate conciliation agreements with their banks, the state, and other creditors. Those CCsplaced under surveillance could move out of the program upon: (i) privatization; (ii) re-establishment of positive cash flow for at least two consecutive quarters, without any furtherincrease in payment arrears; and (iii) liquidation.

35. The final objective was that all but 10 CCs (out of a total of 151) should have exited thesurveillance program within the time frame of the FESAL. As of April 30, 1998, 31 wereprivatized (21 percent); 33 were in the process of being liquidated (22 percent); 3 were mergedinto other companies; and only 10 had achieved positive operating cash flow by mid- 1997 (7percent). Therefore, only half of the targeted loss-makers met the objectives of the program overa period of 28 months.

36. The failure of the surveillance program was acknowledged by the Government and theBank in early 1997. It was discontinued in February 1997 and replaced by new measures underthe revised FESAL program. The selection of loss-makers was tightened to include 70 SOEsaccounting for 67 percent of aggregate losses of the sector before operating subsidies. Three sub-groups were identified, including: (i) 20 utilities accounting for 31 percent of the losses (category1); (ii) 6 mines, together with the 2 RAs for road and irrigation work, accounting for 28 percentof the losses (category 2); and (iii) 42 CCs accounting for 8 percent of the losses (category 3).Objectives were set for each category.

37. In category I (utilities), tariffs were adjusted to stem the massive losses incurred in theprevious six months'2. This allowed RENEL and ROMGAZ to return to profitability. However,the railways and most water and heating RAs continue to accumulate losses. Since the closure ofthe FESAL, the Government has approved a restructuring plan for RENEL, which wouldtransform it into a state-owned National Electricity Company. It would be split into severalautonomous components, including energy production, transportation, and retail distribution.The restructuring and possible privatization of Petrom (the oil exploration company) and Romgaz(gaz production and distribution) are still being discussed. Therefore, limited success has beenachieved (mostly by increasing tariffs) in reducing the losses of category I utilities. The essentialtask of cutting their costs, reducing their bloated labor force, making them more efficient, andintroducing competition in the sector has just started.

38. In category 2 (including the mines and the two RAs for road and irrigation maintenance),the price of mining products was raised to world levels. Also, it was agreed that these RAswould introduce cost reduction measures to reduce their losses by at least 50 percent in realterms. About 70,000 employees were laid off during the second half of 1997 (40 percent of totalemployees). As a result of both price increases and labor reduction, the losses of the miningsector were reduced by 40 percent in real terms. To facilitate the liquidation of non-viable minesand the privatization of others, all mines in this category have been or are being transformed intoCCs. They have also spun off auxiliary activities into 28 newly established CCs. A new Mining

12 Most tariffs were frozen in anticipation of the elections. Some utilities, such as RENEL, the

electricity company, were selling below cost price and accumulated considerable losses and paymentarrears.

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Law, drafted with assistance from the Bank, has been passed. A pilot mine closure project,financed by a Bank loan, is being implemented to support closure of non-viable mines.Considering the magnitude of the work accomplished in less than a year in a sector known for itsstrong labor militancy, this component of the program may be considered a success.

39. In category 3 (including 42 large loss-making CCs), the program focused on: (i) theliquidation of at least 10 CCs; and (ii) the privatization of the others, to eliminate the largest loss-making CCs. An additional 11 CCs were targeted for closure in August 1997, in agreement withthe IMF. Altogether, the program failed, with only eight enterprises privatized (15 percent) and11 under liquidation (21 percent). The sales of 13 others were subcontracted to investmentbanks.

40. Overall, the objectives of the enterprise restructuring program have not been achieved, inparticular with respect to utility restructuring and the closure of loss-making CCs. This is due tothe very powerful resistance of labor unions and other vested interests that could not be overcomebecause of the lack of political commitment to achieve program objectives. The legal frameworkand the judicial system also proved inadequate, in particular in expediting the liquidation of non-viable firms. The Bankruptcy Law proved hopelessly cumbersome and slow to apply. Most ofthe CCs that were eventually liquidated were closed by order of the SOF, as their owner, underthe provisions of the Trade Act. However, the program has been surprisingly successful in themining sector, where maximum resistance was expected. This was facilitated by providinggenerous redundancy payments to workers who volunteered to resign from these mines.

41. Restoration offinancial discipline. This component clearly failed. To impose a hardbudget constraint on enterprises placed under surveillance, the initial program placed a cap on thefinancial support available from the state, the SOF, and the banks. The caps were too generous;the enterprises were able to renegotiate their debts with their creditors without undertakingsufficient cost-cutting measures. To a certain extent, the "jail" became a "hospital" whereenterprises under surveillance had access to the technical support of the newly created Agencyfor Restructuring (AR) and to limited financial support (within the agreed caps); enterprisesoutside the system did not benefit from thie same facilities. Payment arrears ballooned in realterms, while they were expected to decrease in nominal terms. The problem was compounded bythe decision of the Government, in the second half of 1996, to freeze utility prices. While in theprevious period, RENEL and ROMGAZ had been functioning as quasi-banks for loss-makingSOEs, and accumulating arrears on their accounts receivable, they started accumulating paymentarrears themselves, thus feeding a spiral of economy-wide payment arrears. By the end of 1996,aggregate payment arrears had reached 27 percent of GDP (up from 18 percent at the end of1995).

42. Under the revised FESAL prograim, a fresh attempt was made to tackle this issue. It alsofailed. The revised program targeted payment arrears to the budget and to the two largestutilities, RENEL and ROMGAZ. The budget was expected to be paid first. Penalties were to becharged on arrears to RENEL and ROMGAZ. Reduction of supply or interruption of service wasto be ordered in case of nonpayment. These measures were not implemented with the necessarydetermination. There were several instances where the electricity supply was discontinued todelinquent customers, only to be swiftly restored in the face of labor and political opposition. ByApril 30, 1998, RENEL's overdue receivables had increased in real terms by 59 percent (from

8

the agreed benchmark level of March 31, 1997) while those of ROMGAZ had decreased by 23percent"3.

43. Employment reduction. Romanian SOEs were vastly overstaffed. Therefore, it wasclear that any privatization and restructuring program would likely include some potentiallysevere labor retrenchment. To facilitate such action, a US$40 million floating portion wasincluded in the FESAL, to be disbursed as soon as 40,000 employees would leave the SOEsector. The target was met even before Board presentation of the loan, and this portion wasimmediately disbursed upon effectiveness.

44. Building on this successful experience, the Government negotiated with the Bank a newloan in February 1998 to finance severance payments. A new law was passed by the Parliamentestablishing eligibility criteria for access to these severance payments. The mechanism wassuccessfully implemented in late 1997 and resulted in a reduction of approximately 70,000miners"4. The aftermath of this program may be more problematic; it appears that many workerswho quit did not find suitable alternative employment and may have been expecting theGovernment to find them jobs once their benefits terminated.


45. Bank Privatization. The program envisaged the successful privatization of two state-owned banks, the first (RBD) by second-portion release, and the second (Banc Post) by third-portion release. Considerable preparatory work for the RBD privatization was undertaken in1995 and 1996, but the work was suspended pending the passage by Parliament of the BankPrivatization Law, which only occurred in mid-1997 (after more than two years of discussion andthe submission of innumerable competing drafts). The Government finally selected (in early1997) Banc Post as the second bank to be privatized. Privatization Commissions for both bankswere appointed in the second half of 1997, chaired by the SOF, and comprising representatives ofthe NBR, SOF, and NAP (National Agency For Privatization). Detailed feasibility studies andevaluations of the two banks were completed by foreign advisors in May/June 1998, andGovernment decisions were issued in July 1998 stating how each bank was to be privatized. OnAugust 7, 1998, the SOF finally offered for sale its shares in RBD and Banc Post requesting bidsfrom strategic investors by August 27 and 28, 1998, respectively. In December 1998, RBD wassuccessfully privatized by selling 51 percent of its shares to Societe Generale of France, and inApril 1999 Banc Post was partially privatized. In the case of Banc Post, the second state-ownedbank to be privatized, the initial valuation of the bank by their foreign advisers was USD 220million. Negotiations with strategic investors were protracted, but on Friday April 2, 1999, theState Ownership Fund (SOF) finally signed a contract for the sale of 35 percent of Banc Post'sshares to GE Capital and 1 0 percent to Banco Portugues de Investimento (BPI). The SOFmaintains shares of 25 percent. GE Capital and BPI are reported to have paid USD 42.8 millionfor their combined stake of 35 percent, valuing Banc Post at around USD 122 million. Theshareholders are committed to investing a further USD 50 million in Banc Post's development.In addition, IFC and EBRD have made subordinated loans to Banc Post, which are convertibleinto equity.

1 3 Payment arrears to RENEL as of April 30, 1998 (Lei 3,400 billion) were twice as large as those ofROMGAZ (Lei 1,762).

14 Redundancy payments granted the miners amounted to 18 months' wages.

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46. Preparations for the Banca Agricola privatization should be timed very carefully. Aphased approach for the BA privatization during 1999/2000 would allow sufficient time for thenew management to restore the bank to financial viability and to implement its institutionalstrengthening program, with the assistance of the external advisors appointed in August 1998.This approach implies that Banca Agricola could be ready for privatization by around06/30/2000. Finally, serious consideration should now be given to the early preparation of RCBfor privatization in 1999/2000.

47. The last issue to be addressed concerned the compensation to be paid by the StateOwnership fund (SOF) to the five Financial Investment Companies [SIFs (ex-POF)] for theirminority shareholdings in each bank. This thorny compensation issue was finally resolved inJuly 1998 by a protocol signed by the SOF and the SIFs, whereby the SIFs received shares inASIROM and ASTRA (two large insurance companies) from SOF, in exchange for their originalshareholdings in RBD and Banc Post, however the SIFs kept additional shares that came fromreinvesting dividends during the period of 1992-1998.

46. Bank Restructuring. A key objective of the FESAL program was the strengthening ofthe banking sector by improved banking supervision, recognition of loan losses, and theprogressive recapitalization of the large banks from retained earnings. During the period 1991 -1994, virtually all the large banks experienced an improvement in their solvency, although theircapital position remained overstated due to insufficient loan loss provisions. Under the FESALprogram, specific loan loss provisions (5 percent for watch, 20 percent for substandard, 50percent for doubtful and 100 percent for loss) were made tax-deductible (commencing in 1995for loans classified as doubtful and loss and in 1996 for the other categories) and the level of tax-deductible general provisions was raised from 0.5% to 2% of loan assets, thereby giving banks astrong incentive to recognize the true quality of their loan portfolio. During the period 1996-1998, many banks continued to consolidate their solvency, despite the higher level of provisions.However, several banks got into difficulties, notably three private banks now under courtbankruptcy procedures (Dacia Felix Bank., Credit Bank, and Columna Bank) and two state-ownedbanks that received massive financial assistance from the government (Banca Agricola andBancorex). One of them (Banca Agricola') entered a complex restructuring exerciseprogressively improving its operational and financial management. However, the financialcondition of Bancorex remains a serious concern, as the bank accounts for roughly 25 percent oftotal bank assets and 50 percent of total foreign exchange-denominated loans extended by thebanking sector, and it is a major borrower of funds from the inter-bank market.

47. The disposal of Dacia Felix, Credit Bank, and Columna Bank has been delayed, owing toseveral successful legal challenges under the old Banking Law of 1991, Bankruptcy Law, andother delaying tactics by the management and shareholders of these three banks. Thesemaneuvers have hamstrung the efforts of the NBR to remove licenses and commence theirorderly liquidation. The new Banking Law, passed in 1998, will strengthen the NBR's ability todeal with problem banks in the future as regulator and major creditor. In the cases of Dacia Felixand Credit Bank, the NBR initiated bankrjptcy procedures as creditor and suspended the licensesof the two banks as regulator. For both banks, the Supreme Court ruled against the NBR'sdecision and suspended the removal of licenses pending final decisions on bankruptcy proceduresby the Court of Appeals.

48. In the case of Bancorex, the balance sheet was partially repaired in mid-1997 by theissuance of treasury bonds in exchange for bad loans contracted by the now abolished Romanian

10

Oil Company (ROC) to the tune of around US$500 million equivalent. However, politicalconsiderations delayed the implementation of a comprehensive restructuring plan for the bank.Under the terms of the Emergency Ordinance providing for the bail-out of the refineries (as finalbeneficiaries of the loans taken by ROC) defaulting on the loans, MOF assumed the loss to thepublic debt. Bancorex undertook to act as an agent for the MOF, keeping evidence of the debtsin off-balance-sheet accounts, and reimbursing MOF if and when the refineries made payments.In effect, loans to ROC were covered by promissory notes issued by the refineries and vestedwith executory power. In case of default, Bancorex had to implement a solution that provedpolitically unacceptable, through court-forced liquidation if necessary. The very complicatedstructure of the financial arrangement provided for in the Emergency Ordinance and the above-mentioned security structure of the non-performing loans led the Banking Committee of theSenate to request an opinion from the Court of Accounts on the legality of the bail-out. TheCourt of Accounts gave a negative opinion, considering that the MOF lacked a legal basis for thearrangement, and it is not clear now whether Bancorex will be required to return the money to theMOF, or another solution will be sought. However, the recapitalization exercise described aboveis only one facet of the problems Bancorex has had to deal with; the more complicated, deep-rooted problems remain virtually untouched. A new management team was appointed in April1998, which undertook to prepare and implement a restructuring plan. A tender was issued inJune 1998 to select an investment bank to act as a restructuring advisor for Bancorex(commencing August 1998). Under the Bank's new structural adjustment operation, Bancorexwill be liquidated.

49. Banking Legislation. One of the notable successes of the revised FESAL program wasthe approval by the Romanian Parliament in 1998 of three improved banking laws:

(i) a new Banking Law (#58/1998) to replace the ]Law on Banks and Banking Activity of1991;

(ii) a new Statute of the NBR (#101/1998) to replace the 1991 statute; and

(iii) Law #83/1998 on Bank Insolvency.

This package of new laws was drafted with technical assistance from the IMF and the WorldBank. Among many improvements, these new laws (i) strengthen the overall supervisory powersof the NBR (including its powers to carry out special supervision and administration of troubledbanks); (ii) require banks to be audited by an independent external auditor; and (iii) establish theprinciple that credit contracts and associated collateral are executory titles, and (iv) explicitlyprovide the minimum qualifications for those who manage banks.

50. Financial Sector Policy. The FESAL program required the NBR's refinancing of banksto be improved by introducing full collateralization by treasury bills. The growth in the stock ofgovernment paper held by banks and the gradual scaling down of NBR's refinancing activitiesenabled this objective to be met satisfactorily. Henceforth, all new refinancing by NBR must be100% collateralized by government obligations except in exceptional cases where emergencyliquidity support is provided to banks undergoing financial rehabilitation.

51. The regulatory framework was considerably upgraded; new regulations governing loanclassification and provisioning, minimum solvency ratio, connected lending, licensing, riskexposure limits, and foreign exchange exposure limits were issued by the NBR. These

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regulations will be further improved following the implementation of the newly promulgatedbanking legislation.

52. Banking Sector Infrastructure. 'NBR runs an effective (although paper-based)payments system, which will be further upgraded by automation of large-value payments toinclude real time settlement, development of a communication platform between NBR and thecommercial banks, and, in the medium term, automation of small-value (high volume) payments.A Credit Information Bureau was established by the NBR, of which the component for PaymentIncidents is fully operational; the other component (Bank Risk Positions) is in an advanced stageof development.

53. NBR Prudential Regulations and Supervision. Over the last few years, the NBR hasintroduced a comprehensive set of prudential regulations that are now being modified andimproved in light of the new banking legislation. During the FESAL, the NBR SupervisionDepartment submitted comprehensive reports on its activities to the Bank every six months.While on-site inspection is gradually improving, the Supervision Department has failed to reacteffectively and quickly to the several troubled banks. Part of the explanation is that the previousbanking laws (dating back to 1991) did not give sufficient powers to the NBR, a shortcoming thatshould be remedied by the new banking laws approved by Parliament in 1998. Another reason isthat the Supervision Department continues to suffer from understaffing, high turnover, andinsufficient training. These problems are compounded by the fragmentation of the banksupervision function among various departments of the NBR. The pending reorganization of theNBR on a regional basis should afford a good opportunity to strengthen bank supervision bymobilizing staff more effectively. The staff members outside Bucharest are presently employedby the Control Department, which presently performs duties commonly associated with banksupervision in market economies. Nonetheless, the ability of the NBR's bank supervision staff toperform the most basic risk-based supervision, and to obtain an accurate picture of the financialcondition of banks, is questionable. In particular, the Supervision Department needs to becomemuch more effective when dealing with clistressed banks that require fundamental restructuring.

54. Bank Accounting Reform. On January 1, 1998, the Romanian banking system adopted anew chart of accounts conforming to International Accounting Standards (IAS). This change wasmandated by the detailed Instruction, dated August 1, 1997, issued jointly by the NBR (#344) andthe MOF (#1418). It appeared at that timre that the state of readiness of the banks was mixed.Some were well advanced in modifying their IT systems to cope with the conversion to IAS, butothers were lagging. Similarly, it was not clear if the NBR and the Ministry of Finance (MOF)themselves were fully prepared for the change, as evidenced by the considerable delay in issuingthe detailed instructions for preparing the 12/31/97 accounts. Nonetheless, the conversion wasimplemented without major disruptions. However, the international business community'sperception and evaluation of the Romanian banking system raises the issue of whether theconversion was done properly in all cases.

55 Government Obligations. The original FESAL program included a condition that theGovernment should confirm that it was current in its payment obligations to banks. The reasonfor its inclusion was that in 1993 and 1994, the Government was overdue in its obligations tobanks under Law 7/92 and under several L/Cs to finance energy imports, which had a negativeeffect on several banks' liquidity. By the time the FESAL agreement was signed in December1995, the arrears had been paid and the CGovernment has remained current ever since.

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56. Credit Cooperatives. The current legislation governing credit cooperatives is highlydeficient in many respects. Credit Cooperatives are established under a special law andeffectively lack any supervision. Furthermore, these Credit Cooperatives can be set up withminimal capital and no solvency requirements. These so called "popular banks" are not membersof the cooperative network, and are free of NBR regulations and supervision. This poses a threatto the financial system. Despite the Bank's efforts to modernize the legal and regulatoryframework, progress is unsatisfactory. Lack of consensus among concerned parties and limitedpolitical will has generated considerable delay in reaching an agreement on a new legalframework.

57. Deposit Insurance and the Role of CEC. In 1996, a well-designed deposit insurancescheme, funded by contributions from the banks, was introduced. This scheme has the explicitbacking of the state and guarantees the deposits of individuals up to a modest amount per.individual per bank. It covered all deposits in Romanian commercial banks, but not the SavingsBank (CEC), whose deposits are still 100% guaranteed by the state without limit. The depositinsurance scheme was introduced after the effective failure of Dacia Felix Bank and Credit Bank,where depositors of these two banks were reimbursed separately from budgetary funds inaccordance with two special Laws passed by Parliament.

58. Regarding the Savings Bank (CEC), the World Bank recommended to the Governmentthat they adopt one of following two models:

(i) Convert CEC into a "narrow" bank whose deposit liabilities would remain 100%guaranteed by the state, but whose assets would be limited to holdings of Governmentobligations and a limited number of other low-risk assets; or

(ii) Convert CEC into a full-service savings bank, operating alongside thecommercial banks, subject to full NBR supervision, but removing the state guarantee ofits deposits and requiring the institution to join the deposit insurance scheme.

The Government chose a modified version of option (ii), submitting to Parliament a draft law toconvert CEC into a full-service savings bank but maintaining the state guarantee of its depositsfor the time being. The draft law was approved by the Senate on October 21, 1997.

59. Capital Markets. The original FESAL program included two conditions related to thedevelopment of capital markets in Romania:

(i) the opening of the Bucharest Stock Exchange (BSE), with technical assistancereceived from the Canadian Government; and

(ii) the establishment of an effective market to register and trade shares of companiesprivatized in the Mass Privatization Program (MPP).

These objectives were both met successfully by the establishment of the BSE and the RASDAQ(an electronic quote-driven market modeled after the NASDAQ, with technical assistance fromUSAID). However, although the market organization and institutional arrangements are modernand operated in a professional manner, the capital markets in Romania remain very thin. Thefinancial crises that hit the emerging markets of Southeast Asia and Russia, and the severe

13

economic problems of Romania, which remain largely unsolved, induced many foreigninstitutional investors (mainly Hedge and Regional Funds) to pull out.

C. Implementation and Major Factors Affecting the Project

60. The FESAL program was a success in some areas and a failure in others. TheGovernment did not meet its commitment regarding maintenance of an appropriatemacroeconomic framework. By the end of March 1998, the performance criteria agreed uponwith the IMF were not met, and the SBA was terminated in April 1998, with two out of fivetranches uireleased. In the enterprise sector, the privatization targets -- the cornerstone of theprogram -- and the conditions for private sector development were met. However, thesurveillance program failed: SOEs continued to accumulate unacceptably large losses andpayment arrears. In the financial sector, significant progress was made and loan conditions weremet in areas such as collateralization of NBR refinancing credits; mandatory external audit ofbanks; creation of a deposit insurance scheme; reform of the payments system; and the successfulopening of the BSE and the RASDAQ. However, the program failed to privatize two state-owned banks. Furthermore, the two largest banks, Bancorex and Banca Agricola (BA), facedmajor difficulties during that period and were bailed out by the state budget, in defiance of one ofthe conditions of the loan, due to the insufficient progress and enforcement of loan-lossprovisioning, prudential regulations, NBR supervision, and the new chart of accounts for banks.

61. The new Government, which came to power in late 1996, asked the Bank to revise theprogram supported by the FESAL to accelerate the pace of reform. The revised program, agreedupon with the Bank in February 1997, was more wide-ranging and ambitious than the originalprogram. Several components were added to the original set. Regarding macroeconomicpolicies, further (and decisive) progress was made in price and trade liberalization. In theenterprise sector, privatization did not accelerate significantly, owing to major delays caused bychanges in the legal and normative framework. The special surveillance program wasterminated, and new approaches were implemented to reduce losses and improve financialdiscipline. More attention was given to the RAs (utilities and mines), which were recognized asbeing at the core of losses and arrears in the economy. Progress was achieved in the initialcorporatization of utilities; setting up adequate tariff levels and adjustment mechanisms; closingloss-making mines; liquidating loss-making CCs; and providing social protection for employeesmade redundant. However, the program also failed to address the problem adequately. SOElosses and payment arrears remain a severe burden on the economy. In the financial sector,further progress was made to implement the restructuring plan of Banca Agricola; to passadequate legislation for dealing with insolvent banks; and to improve legislation governing thesupervision of capital markets. However, other components of the program were notimplemented as planned: the privatization of two banks was initiated but not concluded; thedesign of comprehensive collateral legislation started late; no decision was made regardingchanges in the accounting rules for treating overdue interest; and no progress was made to restrictthe activities and sources of funding of credit cooperatives.

62. As real progress was made in implementing the revised program during the first part of1997, the Board agreed to grant five waivers of the original conditions (as a tougher program hadactually been implemented) and approved the disbursement of the US$80 million second portionof the FESAL on June 6, 1997. The memorandum "Release of Second Portion - Waiver ofconditions" is attached in Appendix 5 of this report. However, the reform program then

14

floundered in the second half of 1997 and in the first quarter of 1998, due to political difficultieswithin the governing coalition and a loss of commitment to reform. The FESAL closing date wasextended for four months from December 31, 1997 to April 30, 1998, in a last attempt at revivingthe program. However, little progress was made in meeting the Third Portion conditions duringthe extension period. The Government then agreed with the Bank to allow the FESAL to lapseon April 30, 1998. The last portion of US$100 million was not disbursed.

D. Project Sustainability

63. In spite of the failure to implement the last part of the program, the FESAL has had aconsiderable and positive impact on the structural reform of Romania. Most of the measurestaken, especially on price and trade liberalization, SOE privatization, and banking and capitalmarket regulation, are irreversible. This is expected to assist immeasurably with future projectimplementation, particularly as significant institutional capacity has been built up during thecourse of the FESAL and as recognition of the need for structural reform to reverse the economicdecline grows. The Government has now recognized that the success of reform lies with threemajor issues: privatization (of banks, enterprises and utilities); elimination of nonviable loss-making firms; and development of a sound banking system. Also, a much more comprehensivelegal framework has been enacted, providing a measure of empowerment to authorities forprudential oversight, which was lacking at the outset of the FESAL. A major effort at institutionbuilding has also been undertaken under the FESAL, reinforced by a greater mandate to ensurecompliance with recently introduced regulatory norms. This framework will remain in place andwill facilitate implementation of subsequent operations.

E. Bank Performance

64. The Bank's performance was responsive, flexible, and pragmatic as the needs of the timedictated. Throughout this project, the Bank supported a critical phase of the transition reformprogram. The policy advice surrounding the design and implementation of this program helpedto crystallize Government thinking and the conversion of principles into programs and actions.In recognizing the rapidly evolving country situation, the Bank and Borrower workedcollaboratively throughout implementation to ensure that program development objectives weremet, and that pragmatic solutions to implementation problems were usually found. The projectwas supervised at regular intervals, and the Government was actively involved in discussing theprogress made and results achieved. The program might have achieved better results had theBank's implementation schedule been more realistic. The design of the project was flawed byincluding too many areas of reform in a single operation with numerous conditions that wereprocess- or mechanism-oriented. However, the objectives were appropriately set and remainvalid. The Bank overestimated the management and implementation capacity of the borrower.The FESAL team and the Resident Mission provided considerable technical assistance toovercome institutional weaknesses, but these were not systematically organized and budgeted toadequately strengthen this critical area of deficiency. Too many ministries were involved withouta mechanism for high-level planning, co-ordination, and implementation. The legal andregulatory framework and the judicial system proved to be inadequate to sustain implementationof the program. Early recognition of these problems and remedial actions would have enhancedthe success of the program.

15

F. Borrower Performance

65. The borrower made sustained and committed efforts to implement the program, but wasimpeded in achieving various objectives due to inadequacies in staffing and organization, weakor ineffective laws and regulations, and a multiplicity of responsible ministries uncoordinated bya high level agency. The borrower successfully completed several of the project componentssuch as Price and Trade Liberalization, Enterprise Privatization, Mass Privatization Program,Private Sector Development, Development of Capital Markets, and Employment Reduction. Theborrower missed by a wide margin several performance criteria agreed upon with the IMFrelating to the Macroeconomic Framework. Deficiencies in Privatization laws resulted inslowing down privatization. Reform of Credit Cooperatives was not successful because ofdeficient laws that still need to be remedied. Bank restructuring was delayed by successfulchallenges under the old Banking and Bankruptcy law; however, improved laws were enacted in1998. Enterprise Restructuring was considerably hampered by powerful resistance from laborunions and other vested interests. The exception was the mining sector, where maximumresistance from the labor unions had been expected. Measures to achieve financial discipline inutilities were not implemented with the necessary determination in the face of labor and politicalopposition. Borrower performance would have been significantly better if attention had beenpaid to building support for the structural reform program with politicians, civil servants, thepress, and the public at large. Because of the lack of any public awareness campaign, the FESALmay have appeared (along with the IMF SBA) as a painful exercise forced upon Romania byinternational organizations.

G. Assessment of Outcome

66. The project had significant development outcomes. Under the FESAL, pricing and tradehave mostly been liberalized; more than 4,000 SOEs were privatized; and utilities are beingcorporatized and prepared for privatization (e.g., a minority equity share of thetelecommunications company has already been privatized). Obstacles to new enterprise creationwere removed, and more than 300,000 enterprises were registered during that period. In spite ofachieving mixed results, the program initiated a significant downsizing of loss-makingenterprises and a reduction in their labor force, particularly in mines'5 . This was accompanied bymeasures to cushion the social impact of such measures. The program was instrumental insupporting the creation of a capital market, in close cooperation with other donors. The legalregulations to strengthen the prudential, supervisory, and enforcement capabilities of the NBRwere promulgated. Other important banking instruments were created (payments system; depositinsurance; banks' chart of accounts; credit risk information bureau). Major pieces of legislationwere passed (e.g., privatization law; mining law; foreign investment law; law establishingeligibility criteria for severance payments; bankruptcy law; revised banking law; bankprivatization law; bank insolvency law; law governing the savings bank; and securities exchangelaw). Belatedly, privatization of state banks began in late 1998/early 1999 (BRD and Bancpost).

67. The FESAL provided an umbrella for a vast array of technical assistance and trainingprograms, delivered either by the Bank or by other donors, to build up local institutional

Around 100,000 miners left during the second part of 1997.

16

capabilities and train national experts. The FESAL program became the policy anchor ofbilateral support, in particular from the European Union (EU) and the United States Agency forInternational Development (USAID). Close and effective cooperation was achieved between theBank and other donors.

H. Future Operations

68. The FESAL was allowed to lapse on April 30, 1998, because it had become apparent thatthe remainder of the program as designed would not be implemented in a reasonably short spanof time. The program needed to be overhauled, in particular to reflect the views and program ofthe new Government elected in April 1998, and to incorporate some of the lessons learned. TheGovernment and the Bank have updated the structural reform program and have agreed on a newoperation. This new operation "Private Sector Adjustment Loan, RO-PE-64853" was negotiatedwith the Government on April 30th, 1999, and will be presented to the Board on June 10, 1999.This project will be a two-tranche operation and aims to stimulate reforms in the following areas:

(a) In the Enterprise Sector: (a) accelerating state-owned enterprise (SOE) privatization across awide spectrum of sectors; (b) enforcing hard budget constraints on remaining SOEs throughthe closure of big loss-makers (i.e., mines); and (c) implementing an action plan to stimulateprivate sector development and streamline the business environment.

(b) In the Financial Sector: (a) gradually raising the soundness of the Romanian banking system;(b) ensuring that state banks are properly restructured as a pre-requisite for theirprivatization; (c) ensuring that NBR put into place the regulations that will improve theoverall soundness of the banking system at large; and (d) further developing the governmentsecurities market.

(c) In the Social Sector: reforms in both enterprise and financial sectors will be addressed bymeasures designed to strengthen the social safety net through: a) rationalizing an incomesupport program for displaced workers; b) ensuring that an adequate budget is in place forsuch purposes.


I. Key Lessons Learned

69. Project Objectives. FESAL objectives were appropriately set and remain valid. TheFESAL program properly focused on taking care of financial and economic fundamentals, inparticular price and trade liberalization; enterprise and bank privatization; restoring fiscalbalance by targeting loss-making SOEs; removing obstacles to the emergence of new privatefirms; and developing adequate regulatory, accounting, and supervisory instruments to create asound banking system and a capital market.

70. Project Design. There were several project design flaws:

(a) The FESAL tried to include too many areas of reform in a single operation. Theinitial FESAL was a "Christmas tree" to be disbursed in four portions over a

17

period of two years, including 27 conditions for disbursement. The revisedFESAL was even more complex, as it sought to achieve the most difficultenforcement of a hard budget constraint on loss-making enterprises. As a result,an additional 41 conditions for disbursement were introduced.Recommendation: future adjustment operations should focus on a more limitednumber of areas of reform'6 , and should be much simpler and shorter (one yearhorizon), with a maximun of two tranches."7

(b) Many conditions were based on processes (e.g., design and implementation ofplans or mechanisms; production of reports) or on outcomes that were subjectiveor difficult to measure (e.g., improved enterprise cash flow; "substantial progressachieved..."). As a result, monitoring implementation required considerableallocation of resources, including staff time and travel. Recommendation:conditions should be based on a limited number of significant and easilyverifiable outcomes and r esults.

(c) There was insufficient Government ownership, delivery capacity, and control ofthe implementation of the program, especially of the revised program of 1997.Except for 1996, when the Minister of Finance clearly took the lead inmonitoring implementation of the program, the Romanian Government was notappropriately represented. For instance, the Bank FESAL team never workedalongside a single Romanian counterpart team. The responsibility of the designand the implementation of the program were divided among too manyministries", organizations, and agencies'9 . To permit resumption of the IMFSBA, the revised 1997 program was quickly negotiated with a newly elected andinexperienced Government that had little understanding of the scope ofcommitment and of the required delivery capacity. As a result, the Bank mayhave been too directive, the resulting program may have been too ambitious, andthe FESAL team may have had a tendency to micro-manage the implementationof the program".

Recommendation: set up a high-level counterpart group to design and monitorimplementation of such operations. Build up country ownership of the program.Ensure that it can be realistically implemented.

16 However, the links between macroeconomic stability, enterprise sector reform, and financialsector reform have to be maintained. These links can be maintained by processing several separateoperations simultaneously, but without systematically stopping disbursement of one because of difficultiesin meeting conditions in another.17 Whenever pressure was exercised on payment of one cost item (e.g., bank debts), arrears wouldemerge on another (e.g., taxes, energy or other suppliers). It should be noted that the requirement for noincreases in arrears to energy suppliers, insisted upon by the IMF for resumption of its SBA, was neverrespected.IS Prime Minister, Finance, Reform, Industry, Transport.

19 NBR; State-Ownership Fund (SOF):; Private Ownership Funds (POFs); National Agency forPrivatization (NAP); Romanian Development Agency (RDA); Agency for Restructuring (AR); theSecurities Exchange Commission (CNVM under its Romania acronym); Bucharest Stock Exchange (BSE).20 Moreover, too many Bank staff were involved in the design and implementation, each with theirpreferred views. Recommendation: the responsibility of the Team Leader should be clearly stated.

18

(d) Romanian institutional capabilities were overestimated and proved to be tooweak for the scope of the task. This became particularly clear in the areas ofpolicy design; enterprise and bank privatization; monitoring of SOE financialperformance and discipline; SOE governance; bank supervision; and bankrestructuring.

Recommendation: ensure that institutional capabilities are adequately built up,preferably before project preparation, or at least during project implementation.Technical assistance (TA) and training should be provided, either under specificBank loans2" or by other donors. This was done very successfully when theRomanian capital market was created.

(e) The legal and regulatory framework and the court system were inadequate tosustain implementation of the program. This became particularly acute in thearea of enterprise and bank privatization; enterprise and bank liquidation; andutility regulation. Implementation of the program was considerably delayed dueto constant changes in privatization legislation and regulations; difficulties inliquidating bankrupt firms and banks; excessive interference of the Court ofAccounts; and problems resulting from uncertainties about land ownership andthe extent of the public domain. The court system proved to be ineffective inapplying the Bankruptcy Law and could not be relied upon to facilitateimplementation of the program. Recommendation: a thorough assessment of thelegal, regulatory, and judicial system should be performed early during projectpreparation. Passage of essential laws and regulations should be a component ofthe program. The judicial infrastructure should be strengthened either through aspecific Bank loan or by other donors.

(f) Though the 1997 Cabinet initially appeared strongly committed to a deep andfast reform, not enough attention was paid to building up public support for thestructural reform program with parliamentarians, civil servants, the media, andthe public at large. Without a public awareness campaign, the FESAL may haveappeared (along with the IMF SBA) as a painful exercise forced upon Romaniaby international organizations.

Recommendation: Efforts should be made to explain the rationale behind theFESAL to the media, politicians, and civil servants,. A systematic publicrelations campaign should be built into the program.

(g) Other, more specific design issues are:

(i) Privatization targets are useful indicators. However, they should bebased on the percentage of state-owned assets actually transferred toprivate ownership and control;

(ii) Loss and payment arrears reductions are the most painful and difficultresults to achieve as they may have a severe social impact. However,

21 The FESAL team and the Resident Mission did provide an inordinate amount of TA. However,this was not properly budgeted for and was sometimes delivered in an untimely and uncoordinated manner.

19

measures in this area are unavoidable. Targets should not be enterprise-specific (e.g., list of enterprises to be liquidated), nor should they bebased on hypothetical and hard to measure loss/arrears reduction targets.The emphasis should be placed on enforcement of a hard budgetconstraint, divestiture of state ownership in troubled sectors throughprivatization or liquidation;

(iii) Presentation of legislation to the Parliament by the Government is notsufficient. It may remain stalled in Parliament and/or the output may notbe satisfactory. L,oan approval should be contingent on the enactment oflaws satisfactory to the Bank (this must be specified at negotiation).

20

Part II. Statistical Tables

Table 1: Summary of AssessmentTable 2: Related Bank Loans/CreditsTable 3: Project TimetableTable 4: Loan/Credit Disbursements: Cumulative Estimated and ActualTable 5: Key Indicators for Project ImplementationTable 6: Key Indicators for Project Operation (Not Applicable)Table 7: Studies Included in ProjectTable 8A: Project CostsTable 8B: Project FinancingTable 9: Economic Costs and Benefits (Not Applicable)Table 10: Status of Legal CovenantsTable 11: Compliance with Operational Manual Statements (Not Applicable)Table 12: Bank Resources: Staff InputsTable 13: Bank Resources: Missions

21

Table 1: Summary of Assessments

A. Achievement of Objectives Substantial Partial Negliible Not applicable

Macro Policies [1 II E lSector Policies a] l oEaFinancial Objectives El 0 0l

Institutional Development aE El ElPhysical Objectives n [] E l3Poverty Reduction El Fl [ [

Gender Issues El El IiOther Social Objectives El l [1 aEnvironmental Objectives ol o El

Public Sector Management E El El-Private Sector El I ElDevelopment

Other (specify) F1 U E

B. Project Sustainability Likely Unlikely Uncertain

(/) (v') (s/)

F[E El

22

HighlyC. Bank Performance satisfactory Satisfactory Deficient

(1) (1) (1)

Identification L i Preparation Assistance E F1

Appraisal Li L3 n

Supervision 3 g n

HighlyD. Borrower Performance satisfactory Satisfactory Deficient

($) (V) (v/)

Preparation Li F

Implementation [ ] [g

Covenant Compliance w LI

Operation (if applicable) Li iii

Highly HighlyE. Assessment of Outcome satisfactory Satisfactory Unsatisfactory unsatisfactory

(/) ($) (V) (V)

23 Li Li

23

Table 2: Related Bank Loans

Loan/credit title Purpose Year of approval Status

Preceding operations

1. Structural To support 1992 ClosedAdjustment Loan Government program(SAL) of macro-economic

stabilizatiorn

2. Petroleum Sector To restructure and 1994 ActiveRehabilitation modernize the

petroleum and gassector

3. Industrial Credit line to finance 1994 Active. RestructuredDevelopment Project investment and to target SME lending(IDP) exports

4. Power Sector To restructure and 1995 ActiveRehabilitation modernize the power

sector

5. Railways To restructure and 1996 ActiveRehabilitation modernize the

railways

6. Bucharest Water To restructure and 1996 ActiveSupply modernize water

distribution .inBucharest

7. Agriculture Sector To support the 1997 ActiveAdjustment Loan program of structural(ASAL) adjustment in

agriculture

8. Social Protection To finance severance 1997 ClosedAdjustment payments and labor

redeployment

9. To help privatize 1998 ActiveTelecommunication telecommunications

Following operations

1. Mining Sector Pilot project to 1998 Being implemented.Restructuring finance mine closures.

24

2. Private Sector Support to 1999 Board - June 10Institutional Building development of theLoan (PIBL) SME sector

3. Private Sector To support program 1999 Board - June1OAdjustment Loan of structural(PSAL) adjustment in the

enterprise, utilitiesand mining, andfinancial sectors

Table 3: Project Timetable

Steps in Project Cycle Date Planned Date Actual

Identification (Executive Project Summary) n.a.

Preparation April 1992

Appraisal October 13, 1994

Negotiations September 18 to 25,1995

Letter of Development Policy November 30, 1995

Board Presentation January 18, 1996

Signing January 19, 1996

Effectiveness February 29, 1996

First Portion Release March 1, 1996

Floating Portion Release March 1, 1996

Second Portion Release June 12-17, 1997

Project Completion December 31, 1997 April 30, 1998

Loan Closing December 31, 1997 April 30, 1998

25

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

FY96 FY97 FY98

Appraisal estimate 100 100 100

Actual 100 80.0 0

Actual as % of estimate 0 80.0 0*

Date of final Junedisbursement 12-17

* Balance was canceled on April 30, 1998

26

Table 5: Key Indicators for Program Implementation(Policy Matrix)

OBJECTIVES ACTIONS TAKEN BEFORE ACTIONS TO BE TAKEN ASSESSMENTBOARD PRESENTATION BEFORE SECOND

__________________ __________________ TRANCHEMACROECONOMIC POLICY

* Establish and maintain Maintenance of a Amendments to Law 21/96 to A successful component of the

appropriate economic macroeconomic framework be submitted by the program. A limited number of

framework in support of consistent with the program on Government to the Parliament industrial prices (mostly mining and

consistent trade, pricing, the basis of indicators agreed to limit tariff and price petroleum products) were to remain

monetary, and budgetary upon by the Government, the regulations (primarily from regulated until the end June 1998. The

policy. Bank. Progress achieved by the utilities) to a short list of Office of Competition has designed

Government in carrying out the goods and services, as agreed and implemented a mechanism for

* To liberalize prices and program should also be upon with the Bank. Producer monthly adjustments of regulated

trade of all goods and considered, prices of crude oil and natural utility tariffs; and all export bans and

services currently subject to gas to be explicitly excluded quotas have been removed, except for

competition. from the list. Crude oil price timber.to be negotiable directly by

* The foreign trade regime to the refineries and to their

be extensively liberalized, users with domestic producers

made stable, predictable, and importers.and applied equally to alleconomic agents. All export bans and quotas to

be removed, except for goodsthat export may have anegative environmentalimpact (e.g. timber). List tobe agreed upon with the Bank.

27

ACCELERATION OF PRIVATIZATIONPrivatization is the priority Completion of 1,500 Adoption of changes required This objective has been successfullyof the enterprise reform cumulative privatizations since in the legal and regulatory achieved. The initial targets forprogram. It will be sharply the enactment of Law 58,1991. framework, including GD 887 privatization were exceeded.accelerated to ensure swift and Ordinance 39/95, to allow However, this represents less than 20transfer of enterprise Issue of an ordinance, for the sale of shares at percent of the capital stock owned bycontrol and of full acceptable to the Bank, auction to the highest bidder, the State Ownership Fund (SOF) andownership to the private establishing deferred payment without a minimum price less than 10 percent of the total capitalsector. There will be no facilities for the sale of shares limit and sale conditions, stock of SOEs. Romania's industryenterprise excluded from still held by the SOF after based on a methodology remains largely dominated by thethe program, except for a exchange of coupons for shares agreed upon with the Bank. public sector.small number of regulated under the MPP.activities. After passage of the above, atShares and assets will be Formalization and publication least (50) enterprises offeredsold the highest bidder or of standard contracts, agreed for sale at auction per week.the best offer, with no upon with the Bank, for theminimum price limit. cash sale of shares discounted At least (4) enterprises offered

by more that 30%. for sale at Initial PublicOffering (IPO).

Launching the program ofinstallment sales of 40% of the All enterprises of category 3shares of the CCs in the MPP. (as defined under Law 55/95)

to be offered for sale, and atleast (100) of those, forwhich strategic investors haveexpressed an interest, to becontracted with internationalinvestment advisors foraccelerated sale.

28

Completion of at least 2,750cumulative privatizations,since the enactment of Law58/91, including 400 medium-sized and 50 large enterprises.This number to include wholeenterprises only, asincorporated as of January 1,1992.

PRIVATE SECTOR DEVELOPMENT* Constraints to private sector Effective activation of an Establishment of a simplified A minor component of the program; it

development will be interim share registry allowing procedure for enterprise was successfully implemented. Equal

removed. Specific for MPP share registration and creation as agreed upon with and unconstrained access to public

programs will be designed endorsement by the the Bank. sector procurement was guaranteed by

to foster enterprise and job government of the design of a law. A simplified procedure for

creation. system (acceptable to the Bank) enterprise creation was established and

for the registration and trading a nation-wide network of one-stop

of shares. centers for enterprise registration hasbeen created by the Trade Registry.

As a result of a survey conducted of404 small businesses to identify theconstraints to private sectordevelopment, a new project is beingdesigned to foster growth of small andmedium-sized enterprises (SMEs) as afollow-up of this component of the

__ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ F E S A L .

29

ENTERPRISE RESTRUCTURING AND FINANCIAL DISCIPLINE* The priorities are to Submission to the Bank of Ordinance 13/95 to be Under the initial program, a sample of

drastically reduce losses in acceptable FRPs for the core repealed. 151 loss-making SOEs were placedthe enterprise sector, is a group of 13 CCs. under surveillance, of which 30 CCspriority, to reduce Guidelines to be adopted to had previously been placed in abudgetary subsidies, to govern in detail the licensing, special isolation program.eliminate the quasi-fiscal selection, and pay ofdeficit, and to enforce liquidators under Law 31/95 The final objective was that all but 10financial discipline on the and Law 64/65. They should, CCs out of 151 should have exited thebasis of market principles. at a minimum: surveillance program within the time

Establishment of the legal (i) allow companies as well frame of the FESAL. As of April 30,* Accelerated privatization of framework for the surveillance as individuals to be named as 1998: 31 were privatized (21 percent);

loss-making SOEs will be regime (Ordinance 13/95) liquidators; 33 were -- or are in the process ofthe key to achieving loss- (ii) allow foreign as well as being -- liquidated (22 percent); 3reduction and financial domestic persons to be named were merged into other companies;discipline. as liquidators; and only 10 had achieved a positive

(iii) lay out the principles and operating cash flow by mid-1997 (7ranges for pay structure of percent).liquidators; and(iv) lay out the principles for Only half of the targeted loss-makersdisposing of assets, including met the objective of the program, overopen auctions when possible. a period of 28 months.

Completion of 7 privatizations Failure of the surveillance program* To eliminate losses among and liquidations out of the was acknowledged and discontinued

utilities, their tariffs will be group of CCs placed in in 1997 and replaced by a new set ofraised and maintained, with isolation under GD 301/93. actions to include 70 SOEs, 20monthly adjustment, at an utilities, 6 mines, 2 RAs for roads andadequate level to cover irrigation work, and 42 CCs. These

30

costs. Utilities will were grouped in three categories.discontinue servicing non-paying corporate customers.

I - Utilities (category 1) Limited success was achieved in* To eliminate losses among reducing losses of utilities, mostly by

non-utility SOEs, those List of such utilities to be increasing tariffs. The essential taskdelinquent in their agreed upon with the Bank. of cutting down costs, reducing thepayments will be declared labor force, improving efficiencies andinsolvent. The non-viable Initial adjustment in the tariffs introducing competition in this sectorenterprises, or parts of of these utilities, including has just begun.enterprises, will be closed. natural gas for households, asThe others will be either agreed upon with the Bankclosed under Law 31/95 or (NB: this adjustment to betaken through insolvency made not later than March 1,proceedings, as organized 1997).under Law 64/95. TheCourt system will be Initiation of monthlyreinforced to increase its adjustments according to theeffectiveness in handling exchange rate or the CPI, asthese cases. agreed upon for each product,

one month after the initialadjustment.

From the base date of January1, 1997, no increase inpayment arrears in nominalterms due to any utility incategory 1.Government Decision to be

31

issued requiring each utility incategory 1 to take appropriateaction to collect accountsreceivable overdue by morethat 60 days, includingreduction of supply orinterruption of service.

Penalty interest to be chargedby each utility in category 1on accounts receivableoverdue by more than 30 daysat the NBR weekly auctionrate plus 10%.

As a result of both sales price2 - Large loss-making Regies increases and labor reduction, theAutonomes (category 2) losses of the mining sector were

reduced by 40 percent in real terms.List of these Regies To facilitate the liquidation of non-Autonomes (RAs) to be viable mines and the privatization ofagreed with the Bank. the others, all mines in this category

have been or are transformed intoThe Government to submit to CCs. They have also spun offthe Parliament legal changes auxiliary activities into 28 newlynew laws required to permit established CCs. A new Mining Law,the conversion of mining RAs drafted with assistance from the Bank,into CCs. has been passed. A pilot mine closure

project, financed by a Bank loan, isDraft Mining Law to be under implementation to support

32

submitted by the Govermnent closure of non-viable mines. The roadto the Parliament. maintenance RA has been split into 3

CCs, while the irrigation RA is stillIncrease of the price of being reorganized. Considering themining products to world magnitude of the work accomplishedlevel. in less than a year in a sector known

for its strong labor military, thisA plan of action to be component may be considered apresented by the government success.indicating how losses ofcategory 2 firmns will bereduced by at least 50% inreal terms in 1997. This planto include, inter alia, actionson: (i) prices; (ii) wage rates;(iii) number of employees;and (iv) closure of non-viableunits.

Upon conversion of RAs intoCCs, privatization of theseCCs, as a whole or in part, tobe initiated.

The program aimed at liquidating 213 - Other large loss-makers and privatizing the remaining 42 large(category 3) loss making CCs. This objective was

not achieved as only 8 categories wereList of these enterprises to be privatized and 11 were underagreed with the Bank not to liquidation. The sale of 13 others

33

include enterprises of the were subcontracted to investmentagricultural sector, which will banks.be dealt with under theASAL. Overall, the objectives of the

enterprise restructuring program wereClosure of operations and not achieved. This was due to veryinitiation of liquidation of at powerful resistance of labor unionsleast 5 enterprises in this and of various vested interests thatcategory, accounting for at could not be overcome because of lackleast 5% of losses of the SOE of political commitment. The legalsector in 1996 (or a longer framework and the judicial systemperiod, to be agreed upon with also proved inadequate.the Bank).

Accelerated privatization ofall other CCs in category 3 orparts of these, to have beeninitiated.

BANK PRIVATIZATIONRestructuring and Specific loan-loss provisions Passage by Parliament of a During the period 1991 to 1994,privatization of state-owned by banks to be rendered tax Bank Privatization Law, virtually all the large bankscommercial banks, which, deductible according to an agreed upon with the Bank, experienced an improvement in theirinter alia, will reduce the agreed upon phased-in schedule which does not impose undue solvency, although their capitalshare of the state in the during 1995 and 1996 as restrictions on participation position remained overstated owing tobanking sector. follows: (a) during 1995, for by fit and proper banking insufficient loan loss provisions.

loans in the loss (100% institutions in the capital of

34

* Privatization of two state- provision) and doubtful (50% the state banks to be During the period 1996-98 many

owned banks. provision) categories; and (b) privatized. banks continued to consolidate their

during 1996 and subsequent solvency, despite the higher level of

* A bank will be considered years, for the following Revision of the RBD provisions. Several got into

as privatized when at least categories of impaired credits privatization plan, in difficulties, notably three private

51% of its shares have been (i.e., loss 100% provision), agreement with the Bank, and banks now under court bankruptcy

transferred either to entities doubtful (50% provision), and consistent with the new Bank procedures (Dacia Felix Bank, Credit

which are 90% in private sub-standard (20% provision). Privatization Law when Bank and Columna Bank) and two

ownership, or to private NBR to issue a circular enacted. Implementation state-owned banks which received

individuals. requiring banks to undertake initiated. massive financial assistance from the

full loan-loss provisioning and government (Banca Agricola and

requiring them to retain 50% of Finalization of a privatization Bancorex).the net profit after tax until they action plan for the secondhave reached the minimum bank to be privatized, to be A report on the feasibility study and

level of capital adequacy. agreed upon with the Bank, evaluation conducted was submitted to

and approved by its General the Government, which resulted in aEstablishment of WODs in Assembly of Shareholders and Government Decision issued for Phase

each of the major banks. the NBR. Such privatization II and consortium reappointed to (i)plan to include an offer for sell the banks (BancPost and RBD) to

Finalization of a privatization sale, listing on the BSE, and reputable foreign financial institutions

action plan for RBD agreed sale of at least 10% of its with an interest in taking a strategic

with the Bank and approved by shares by public offering, over stake in these banks and (ii) to prepare

the stakeholders, NBR, and the and above those held by the a public offering of at least 20% of the

Government. Such a SIFs and the bank's bank's interest.

privatization plan to include an employees.offer for sale, listing on theBSE and sale of at least 10% ofits shares by public offering,over and above those held by

35

the POFs and its employees. | lBANK RESTRUCTURING AND DEBT RECOVERY

Finalize closure/liquidation Specific loan-loss provisions by The Government to take all NBR's efforts to remove licenses andor rehabilitation of Dacia banks to be rendered tax necessary steps to ensure that commence orderly liquidation ofFelix Bank and Credit Bank deductible according to an the closure/liquidation of Dacia Felix, Credit Bank and Columnaon a sound financial and agreed upon phase-in schedule Dacia Felix Bank and Credit Bank has been hampered by severalinstitutional footing. during 1995 and 1996 as Bank is undertaken as quickly successful legal challenges

follows: (a) during 1995 for as possible. No additionalloans in the loss (100% refinancing to be granted The new Banking Law passed in 1998provision) and doubtful (50% meanwhile to either bank, and will strengthen the NBR's hand inprovision) categories; and (b) 100% reserve requirement to dealing with problem banks in theduring 1996 and subsequent be applied to any new future as regulator and major creditor.years-for the following deposits taken by the two In the case of Dacia Felix and C reditcategories of impaired credits banks pending finalization of Bank, the NBR initiated bankruptcy(i.e., loss (100% provision), the closure/liquidation or procedures.doubtful (50% provision) and rehabilitation process. Both banks have their current accountssub-standard (20% provision). Bt ak aetercretacut

with the NBR blocked. In the case of

* Restructure Banca Agricola NBR to issue a circular A restructuring plan for the Columna Bank, the SOF initiatedin a timely fashion to deal requiring banks to undertake Banca Agricola, agreed upon bankruptcy procedures, but NBR hasnot only with the stock of full loan-loss provisioning and with the Bank, to be prepared not suspended the license; and thebad debts in its present loan requiring them to retain 50% of by the NBR, Ministry of Court has not yet ruled on the case.portfolio, but also to put the the net profit after tax until they Finance, and the State A tender was issued in June 1998 torestructured bank on a have reached the minimum Ownership Fund. select an investment bank to act assolid institutional and level of capital adequacy. restructuring advisor to Bancorexfinancial footing so that it vcan conduct its future Establishment of WODs in (commencing August, 1998). First. . . ~~~~~~~~~~~~~~~~~~~concrete measures to tackle the Bank'soperations in a sound and each of the major banks. serious difficulties are being taken.prudent manner.

36

Finalization of privatization Submission of government toTo develop a proper legal action plan for RBD agreed the Parliament of either (i) aframework for dealing with upon with the Bank and new Bank Insolvency Law; or A notable success of the revised

insolvent banks; to include approved by the shareholders, (ii) an additional chapter FESAL program was the approval by

restructuring and/or a well- NBR, and the Government. covering bank insolvency in the Romania parliament in 1998 of

defined process of orderly Such a privatization plan to Law #33/1991. three improved banking laws: (i) a

liquidation. include an offer for sale, listing new Banking Law (#58/1998) toon the BSE, and sale of at least substitute the Law on Banks and10% of its shares by public Banking Activity of 1991; (ii) a newoffering, over and above those Statute of the NBR (#101/1998) toheld by the POPs and its replace the 1991 statute; and (iii) Lawemployees. #83/1998 on Bank Insolvency.

* Modify and strengthen the An on-going commitment from This package of new laws was drafted

laws relating to bank the government that there will with technical assistance from the IMF

contracts, collateral, and be no recapitalization of banks and the World Bank.

bankruptcy to ensure that in by the state budget, by the These new laws strengthen the overall

case of non-payment, banks NBR, or from extra-budgetary supervisory powers of the NBR

can execute expeditiously funds except immediately prior (including its powers to carry out

their loan contacts with to privatization or as needed is special supervision and administration

borrowers. a bank is being intervened by of troubled banks); require banks to be

NBR. audited by an independent externalauditor; establish the principle thatcredit contracts and associatedcollateral are executory titles andexplicitly provide the minimumqualifications for those who managebanks.

37

NBR PRUDENTIAL REGULATIONS & SUPERVISION* To ensure that banks NBR to issue a circular for Submission of government to The NBR has introduced a

comply with NBR phasing in the collateralization the Parliament of amendments comprehensive set of prudentialprudential regulations and of its refinancing credits to to Laws #33/1991 and regulations which are now beingto enable NBR to apply banks, as agreed upon with the 34/1991, agreed upon with the modified and further improved insanctions and penalties for World Bank. Bank, which strengthen the light of the new banking legislation.non-compliance. regulatory, enforcement, and

sanctioning powers of theNBR. During the life of FESAL the NBR

Supervision Department submittedImprov theoNBR to have attempted to carry Submission to the Bank of a comprehensive reports on its

* Improve the off-site out annual on-site inspections report from the NBR activities to the Bank every sixsuirveillance and on-site of all banks. Such inspections demonstrating the compliance months. While on-site inspectionsupervision of banks by the to include, where appropriate, a of the banks under NBR's gradually improved, the SupervisionNBR. critical assessment of the supervision with the circulars Department has failed to react

banks; latest semi-annual and prudential regulations on effectively and in a timely fashion toportfolio reviews, and the loan-loss provisioning, capital the several troubled banks.associated loan-loss adequacy, and the distributionprovisioning recommended. of net profits; and describing Supervision Department continues to

the measures taken by NBR suffer from under-staffing, highagainst non-complying banks. turnover, and insufficient training and

experience.The staffing of the SupervisionDepartment of NBR shall beincreased to its fullcomplement of approximately70 staff.

38

NBR to submit to the Bank areport demonstrating that on-site inspections of banks arebeing carried out.

NBR to issue a regulationrequiring mandatoryindependent external audits ofbanks.

* Limit banks' utilization of NBR provided two successive semi-

refinancing credits from Submission to the Bank of a annual reports demonstrating that

NBR without suitable report prepared by the NBR credits to commercial banks were

collateral. demonstrating progress collateralized by Treasury bills insatisfactory to the Bank in accordance with the agreed uponimplementing Regulation 3/95 phase-in schedule.issued by NBR in respect ofcollateralization of NBR'srefinancing credits to banks.

DEPOSIT INSURANCE AND THE ROLE OF CEC

* Reduce CEC's share of Endorsement by the In 1996, a well-designed deposit

deposit-taking among the Government and NBR of a insurance scheme was introduced

population, and provide a detailed proposal for a covering all Romanian commercial

level playing field for deposit insurance scheme loans but not the Savings Bank (CEC),

deposit-taking by all banks. agreed upon with the Bank. whose deposits are still 100%guaranteed by the state without limit.

* To improve the legal Submission by the The deposit insurance scheme was

framework for the Savings government to the Parliamnent introduced after the effective failure of

Bank (CEC) by converting of amendments to Law Dacia Felix Bank and Credit Bank,

it into a joint-stock 66/1996 which would: where depositors of these two banks

39

commercial bank, and by (a) convert CEC into a were reimbursed separately fromrequiring CEC to join the commercial company; budgetary funds in accordance withDeposit Insurance Fund and (b) render CEC explicitly two special Laws passed by theto submit to full NBR subject to the licensing, Parliament. The first expected payoutsupervision and prudential regulations, and from the Deposit Insurance Fund willregulation. supervision of the NBR; be to depositors of the Columna Bank.

(c) integrate CEC with Law33/1991 and all other Regarding the Savings Bank (CEC),legislation concerning the World Bank recommended to thebanks and commercial Government that they adopt one ofcompanies. following two models:

(i) convert CEC into a "narrow" bankwhose deposit liabilities would remain100% guaranteed by the state, butwhose assets would be limited toholdings of Government obligationsand a limited number of other low-riskassets; or

(ii) convert CEC into a full-servicesavings bank, operating alongside thecommercial banks, subject to full NBRsupervision, but removing the stateguarantee of its deposits and requiringthe institution to join the depositinsurance scheme.

A draft law of a modified version of_________ _I_ _option (ii) was submitted to

40

Parliament to convert CEC into a full-service savings bank but maintainingthe state guarantee of its deposits forthe time being. The draft law wasapproved by the Senate on October 21,1997, and approved by the BankingCommission of the Chamber ofDeputies shortly thereafter, but itssubmission to the plenary session ofthe Chamber of Deputies has beendelayed.

Because of the singularly importantrole the Savings Bank (CEC) caneventually play in financing thedevelopment of a true consumersociety in Romania, the Bank noteswith approval: (a) the restructuring,strategic planning, and trainingassistance being provided to the CECby the Deutsche Sparkasse; (b)management's commitment to anexternal audit of the 1997 and 1998accounts by a recognized internationalaccounting firm, due to be selected bytender shortly; and (c) the cautiousapproach to expanding the bank'slending activities espoused by thenewly appointed senior management.

41

However, it is important that, givenCEC's limited experience in grantingcredit, any new lending programstargeted towards individuals andSMEs should be introduced gradually,and only to the extent that the staff inthe lending branches selected for thepilot exercise have been fully trainedin sound and prudent lendingprocedures.

ACCOUNTING STANDARDS FOR BANKS* Implement sound, Issuance of a regulation by the A new chart of accounts conforming

internationally recognized, NBR introducing a uniform to International Accounting Standardsaccounting standards in chart of accounts for banks, in (IAS) was adopted on January 1, 1998.enterprises and banks, accordance with This change was mandated by thesupported by competent internationally accepted detailed Instruction dated August 1,accounting and auditing accounting standards. 1997 issued jointly by the NBR (#344)staff. and the MOF (#1418).

The Government to submit to* Modify the accounting rules the Parliament the necessary The state of readiness of the banks,

for treating overdue amendments to the including the NBR and the Ministry ofinterest. Accounting Law, the Profit Finance (MOF), to cope with the

Tax law, and NBR's conversion to IAS was mixed. Someregulations for the accounting were well advanced in modifying theirsystem to be used by banks, IT systems, but others were lagging.requiring banks to (a) stop This was evidenced by theaccruing interest to the Profit considerable delay that occurred in

42

and Loss Statement on loans issuing the detailed instructions forwhich are overdue 90 days or preparing the 12/31/97 accounts.more (or to make a 100%provision for such interest on An issue with strong relevancy to thea monthly basis); and (b) to international business community'sreverse out (or provision perception and evaluation of the100%) previously accrued Romanian banking system is whetherinterest on such loans. the conversion was in all cases done

properly. Lack of a verificationmechanism would caution that victorynot be declared on this front, or atleast not yet.

GOVERNMENT OBLIGATIONS

* Settlement of overdue The Government to issue a The original FESAL program included

Government obligations to report stating that it is current a condition that the Government

banks. in all its payment obligations should confirm that it was current into the banks, including its payment obligation to banks. Theprincipal and interest due to reason for its inclusion was that inbanks under Law 7/92 and 1993 and 1994, the Government wasOrdinance 1/94. overdue in its obligations to banks

under Law 7/92 and under severalL/Cs to finance energy imports, whichhad a negative effect on several banks'liquidity. By the time the FESALagreement was signed in December1995, the arrears had been paid andthe Government has remained currentever since.

43

l l~~~~~~~~~~~~~~ - l T CREDIT COOPERATIVES

* Restrict the activities and Submission of the The current legislation governingthe funding sources of Govermnent to the credit cooperatives is highly deficientcredit cooperatives; subject Parliament of amendments to in many respects. Credit Cooperativesthem to suitable prudential Law 106/1996 agreed upon are established under a special law andregulations; and place them with the Bank which would: effectively lack any supervision.under the supervision of (a) remove the name "bank" Furthermore, these CreditNBR or another suitable from any credit cooperatives; Cooperatives can be set up withregulatory authority. (b) limit authorized activities minimal capital and no solvency

to members only; (c) limit requirements. These so calledmembership to individuals; "popular banks" are not members of(d) restrict authorized the cooperative network and are freeactivities to acquiring funds of NBR regulations and supervision.from members' contributions This poses a threat to the financialand granting small loans to system. Despite the Bank's efforts tomembers for purposes achieve a modernization of the legalspecified in the amended and regulatory framework, progress isLaw; (e) prohibit credit unsatisfactory. Lack of consensuscooperatives from borrowing among concerned parties and limitedfrom outside sources; (f) limit political will has generatedlending to any individual or considerable delay in reachinghis relatives to 5% of a credit agreement on a new legal framework.cooperative" total assets; and A draft law, satisfactory to the Bank,(g) subject credit cooperatives was prepared with technical assistanceto the supervision of NBR or from the Swiss Government andanother competent authority forwarded to the Romanian authoritieswith the mandate to issue and in May 1998, but so far the law hasenforce prudential regulations. not been amended.

44

CAPITAL MARKETS* Improve supervision of the Opening of the Bucharest Stock Government to submit to The original FESAL program included

capital markets, access by Exchange Parliament for approval two conditions related to the

foreign investors, and the amendments to Law 52/1994, development of capital markets in

disclosure requirements of establishing CNVM's Romania: (i) the opening of the

firms quoted on the supervisory and law Bucharest Stock Exchange (BSE),

Bucharest Stock Exchange enforcement authority over with technical assistance received

(BSE) and the RASDAQ the BSE and the RASDAQ from the Canadian Government; and

market. market, and requiring (ii) the establishment of an effectivepublicly-held companies to market to register and trade shares ofuse licensed shareholders' companies privatized in the Massregistries and to disclose Privatization Program (MPP).periodic financial information.

These objectives were both metGovernment to submit for successfully by the establishment ofParliament for approval an the BSE and the RASDAQ.amendment to Law 31/1990subjecting publicly-held However, although the marketcompanies to the provisions organization and institutionalof Law 52/1994. arrangements are modern and operated

in a professional manner, the capital

Government to submit to markets in Romania remain very thinParliament's approval an due to the financial crises in theamendment to the Foreign emerging markets of Southeast AsiaInvestment Law, repealing the and Russia, the severe economicrequirement of prior approval problems of Romania, and the pull-outof foreign portfolio of many foreign institutional investorsinvestment by the Romanian (mainly Hedge and Regional Funds).Development Agency, and Consequently, both the value of traded

stocks and the volume of transactions

45

appropriate changes to the has fallen sharply recently to theNBR foreign exchange lowest values since the opening of theregulations (including, inter two regulated markets, BSE andalia, measures to control RASDAQ.money laundering), in order toensure foreign investors theprompt repatriation ofprincipal, interest, anddividends in respect of bondsand equities traded in theRomanian capital markets.

46

Table 6: Key Indicators for Project Operation

Not Applicable

Table 7: Studies Included in Project

Study Purpose as defined at Status Impact of studyappraisal/redefined

1. Study of the Registration To identify the constraints to C Based on this study aProcess Private sector development. new project is being

designed to fostergrowth of small andmedium-sizedenterprises (SMEs)

2. Feasibility Study and To develop a comprehensive C Following the studyEvaluation of Bank strategy for the privatization GovernmentPrivatization of the BankPost and RBD Decisions were

banks. issued on how eachbank was to beprivatized.

3. Diagnostic Review of Banca To identify and prioritize C A diagnostic reviewAgricola the most urgent measures for of Banca Agricola

restructuring. was undertaken byBank of IrelandInternationalConsultants (BIIC) inDecember 1997. Theinstitutionaldevelopment plan hasbeen implemented byBA managers withthe long-termassistance of BIISunder a separatecontract, as perAugust 1998.

47

Table 8A: Project Costs

Actual/latest estimates(US$ million)

Item Local Foreign Totalcosts costs

IBRD/IDA 183.1 183.1

Cofinancing Institutions (the 50 50Export-Import Bank of Japan)Domestic Contributions n.a. n.a. n.a.

Total 233.1 233.1

Table 8B: Project Financing

Actual(US$ million)

Item Local Foreign Totalcosts costs

IBRD/IDA 183.1 183.1

Cofinancing Institutions (the 50 50Export-Import Bank of Japan)Domestic Contributions n.a. n.a. n.a.

Total 233.1 233.1

Table 9: Economic Costs and Benefits

Not Applicable

48

Table 10: Status of Legal CovenantsRomania

Financial and Enterprise Sector Adjustment Loan

Covenant PresentType Status

Agreement Section Description of CovenantLoan Agreement Sched. 4, Sect. 12 C Achievement of numeric privatization targets for CCs as agreed with the Bank.

I (1)Loan Agreement Sched. 4, Sect. 12 C Establishment and activation of a system for the registration and trading in shares of

1(2) CCs.Loan Agreement Sched. 4, Sect. 12 C Establishment of a simplified procedure, agreed with the Bank, for the registration of

1(3) new enterprises.

Loan Agreement Sched. 4, Sect. 12 CP The Government of the Borrower to submit a report to the bank, demonstrating in a

1(4) manner acceptable to the Bank that substantial progress has been made inimplementing the financial recovery of the Core Group of CCs, including meeting theaggregate and specific benchmarks agreed with the Bank.

Loan Agreement Sched. 4, Sect. 12 CP Exit of at least fifty (50) CCs from the surveillance program established byI(5) Government Decision 212/95, out of which at least twenty (20) CCs, which have not

been placed in isolation under Government Decision 301/93, have been privatized orliquidated, while the remainder of the fifty (50) CCs have re-established, to thesatisfaction of the Borrower and the Bank, a positive cash flow.

Loan Agreement Sched. 4, Sect. 12 CP Completion of an additional five (5) privatizations or liquidations out of the group of

1(6) CCs placed in isolation under Government Decision 301/93.

Loan Agreement Sched. 4, Sect. 12 CP The Borrower has submitted a report to the Bank, demonstrating with respect to the

1(7) Core Group of RAs substantial progress measured against detailed benchmarks asagreed with the Bank in the implementation of their financial recovery programs.

Loan Agreement Sched.4, Sect. 12 NC Substantial progress in the implementation of the mechanism to forestall future build

1(8) up of arrears in the energy sector, as measured against benchmarks agreed upon withthe Bank.

49

Loan Agreement Sched. 4, Sect. 12 C Observance of the limits on financial support by the Government of the Borrower, the1(9) Financial Recovery Fund and SOF to state-owned enterprises as agreed upon by the

Borrower and the Bank.Loan Agreement Sched.4, Sect. 12 C Submission to the Bank of a report prepared by NBR, demonstrating the compliance

I (10) of the banks under NBR's supervision with its circulars and prudential regulations,relating to loss provisioning, capital adequacy and the distribution of net profits, anddescribing the measures taken by NBR against non-complying banks.

Loan Agreement Sched. 4, Sect. 12 C Implementation of the privatization action plan of the Romanian Bank forI (11) Development, as agreed with the Bank and as adjusted, if necessary, in order to reflect

the mandatory provisions of the new bank privatization law, if enacted.Loan Agreement Sched. 4, Sect. 12 C Finalization of a privatization action plan, satisfactory to the Bank, for a second bank

1 (12) to be privatized, and approval by the general assembly of shareholders, theGovermt.{ent of the Borrower, anu the NBR of such privatization action plan.

Loan Agreement Sched. 4, Sect. 12 C Submission to the Bank of a report prepared by NBR demonstrating progress1 (13) satisfactory to the Bank in the implementation of Regulation No. 3/95, issued by NBR

in respect of collateralization of NBR;s refinancing credits to banks.Loan Agreement Sched. 4, Sect. 12 C NBR has: (i) increased the staff of its banking supervision department to its full

1(14) complement; (ii) provided a report demonstrating that on-site inspections of bankshave been carried out in accordance with the inspection program as agreed upon withthe Bank, and (iii) issued a regulation requiring mandatory audits of banks byindependent external auditors.

Loan Agreement Sched. 4, Sect. 12 C Endorsement by the Government of the Borrower and NBR of a detailed proposal for1(15) a deposit insurance scheme, agreed with the Bank.

Loan Agreement Sched. 4, Sect. 12 C Issuance of a regulation by NBR introducing a uniform chart of accounts for banks in1(16) accordance with internationally accepted accounting standards.

Loan Agreement Sched. 4, Sect. 12 C The Government of the Borrower has prepared a report demonstrating that it is currentI ( 17) with all its payment obligations to banks, including in respect of principal and interest

due to banks in accordance with Law 7/92 and Ordinance 1/94.Loan Agreement Sched. 4, Sect. 12 C Achievement of further numeric privatization targets for CCs as agreed with the Bank.

11(I)Loan Agreement Sched. 4, Sect. 12 CP Exit of all CCs placed under surveillance according to Government Decision 212/95,

II (2) except for those agreed upon by the Government of the Borrower and the Bank, fromthe surveillance program through: (i) privatization; (ii) re-establishment, to the

50

satisfaction of the Government of the Borrower and the Bank, of a positive net-cash_flow; of (iii) liquidation.

Loan Agreement Sched. 4, Sect. 12 CP Completion of a total of at least ten (10) additional privatizations or liquidations out of

11 (3) the group of CCs placed in isolation according to the provisions of GovernmentDecision 301/93.

Loan Agreement Sched. 4, Sect. 12 CP With respect to the core Group of RAs , substantial progress towards phasing out

11 (4) uneconomic activities and improvement of their cash flows.

Loan Agreement Sched. 4, Sect. 12 NC Substantial progress in the implementation of the mechanism to forestall future build

11 (5) up of arrears in the energy sector, as measured against benchmarks agreed upon withthe Bank.

Loan Agreement Sched. 4, Sect. 12 C Observance of the limits on financial support by the Government of the Borrower, the

11 (6) Financial Recovery Fund and SOF to state-owned enterprises, as agreed upon by theBorrower and the Bank.

Loan Agreement Sched. 4, Sect. 12 C Submission to the Bank of a report prepared by NBR demonstrating the compliance of

11 (7) the banks under NBR's supervision with the circular on prudential regulations, relatingto loan loss provisioning, capital adequacy and the distribution of net profits, anddescribing the measures taken by NBR against non-complying banks.

Loan Agreement Sched. 4, Sect. 12 NC Implementation of the privatization action plan referred to in paragraph 12 of section I

11 (8) of this Schedule 4.

Loan Agreement Sched. 4, Sect. 12 C Submission to the Bank of a report demonstrating full implementation of the

11 (9) provisions of Regulation 3/95, issued by NBR in respect of collateralization of NBR'srefinancing credits to banks.

Loan Agreement Sched. 4, Sect. 12 CP Submission to the Bank of a report from NBR demonstrating that: (i) on-site

11 (10) inspections of banks have been carried out in accordance with an inspection programagreed with the Bank; and (ii) banks are in compliance with the regulation issued byNBR in respect of mandatory audits of banks to be carried out by independent externalauditors.

Loan Agreement Sched. 4, Sect. 12 C Establishment of the deposit insurance scheme referred to in paragraph 15 of Section I

II. (11) of the Schedule 4.

Loan Agreement Sched. 4, Sect. 12 C The Government of the Borrower has furnished a report demonstrating that it is

11(12) current in all its payment obligations to banks, including principal and interest due tobanks in accordance with Law 7/92 and Ordinance 1/94.

Loan Agreement Sched.4, Sect. 12 C The Borrower has implemented the employment adjustment program in its enterprises

III. placed under surveillance under Government Decision 212/95, as agreed with theBank.

51

Loan Agreement Art. III.Sect. 09 C Prior to each such exchange of views, the borrower shall furnish to the Bank for its3.01 b review and comment a report on the progress achieved in carrying out the Program, in

such detail as the Bank shall reasonably request.Loan Agreement Art. III, Sect. 09 NC Without limitation upon the provisions of para (a) of this Section, the Borrower shall

3.01 c exchange views with the Bank on any proposed action to be taken after thedisbursement of the Loan which would have the effect of materially reversing theobjectives of the Program, or any action taken under the Program, including anyaction specified in Schedule 3 to this Agreement.

Loan Agreement Art. III, Sect. 01 NC Have the USD Deposit Account, the DEM Deposit Account, and the FRF Deposit3.02 a Account audited in accordance with appropriate auditing principles consistently

applied, by independent auditors acceptable to the Bank.Loan Agreement Art. III, Sect. 01 NC Furnish to the Bank as soon as available, but in any case not later than six (6) months

3.02 b after the date of the Bank's request for such audit, a certified copy of the report ofsuch audit by said auditors, of such scope and in such detail as the Bank shall havereasonably requested.

Loan Agreement Art. III, 01 NC Furnish to the Bank such other information concerning the USD Deposit Account, theSection 3.02 c DEM Deposit Account, and the FRF Deposit Account, and the audit thereof, as the

Bank shall have reasonably requested.Loan Agreement Sect. 2.02 d 12 C That the macroeconomic framework of the Borrower is consistent with the Program as

B i determined on the basis of indicators agreed upon by the Borrower and the Bank.

Covenant types: Present Status:

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

beneficiaries 10. = Project implementation not covered CP = complied with partially3. = Flow and utilization of project funds by categories 1-9 NC not complied with4. = Counterpart funding 11. = Sectoral or cross-sectoral budgetary5. = Management aspects of the project or executing or other resource allocation

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

52

Table 11: Compliance with Operational Manual Statements

Not Applicable

Table 12: Bank Resources: Staff Inputs

Note: Data on planned and revisedfigures are no longer available

Actual

Stage of project cycle Weeks US$ '000

Preparation to 347.6 1042.7AppraisalAppraisal 147.8 770.0Negotiations through 32.6 64.9Board approvalSupervision 241.3 556

Completion 3.8 7.5Total 769.3 2441.1

Table 13: Bank Resources: Missions

Stage of project Month/ No. of Days Specializationcycle Year Persons in

FieldThrough Appraisal 4/92 3 21

6/92 2 129/92 2 1811-12/92 4 122/93 3 146/93 2 1210/93 2 182/94 3 143/94. 4 85-6/94 3 196/94 8 219/94 10 219-10/94 1 39-10/94 3 1511/94 1 201-2/95 2 81-2/95 1 144/95 3 7

53

Appraisal through 5-6/95 2 19Board approval 5-6/95 1 17

5-61/95 1 28Supervision 3/96 2 10 Priv. Sector

1 4 Fin. Sector7/96 3 20 Fin. Sector

2 53 Priv. Sector11/96 1 5 Fin. Sector

1 10 Priv. Sector2/97 1 10 Div. Chief

3 36 Fin. Sector3 52 Priv. Sector1 8 Econ. - Legal

5/97 1 4 Div. Chief2 17 Fin. Sector2 17 Priv. Sector

12/97 2 22 Fin. Sector2 22 Priv. Sector

Completion 5/98 1 12 Fin. SectorTotal 623

54

Appendix 1. Mission's Aide-Memoire

A World Bank mission consisting of Messrs. Khaled Sherif and Ramin Shojai visited Romaniafrom April 22 to May 2, 1999. As part of their terms of reference, they discussed with theGovernment the draft Romania FESAL ICR. The objectives of the mission were to discuss thelessons learned from the FESAL, and to prepare for the upcoming Board presentation of thePSAL. The following aide-memoire details findings between the Bank and Government ofRomania.

Project Objectives and Prospects for Success Under the PSAL

FESAL objectives were appropriately set and remain valid. The FESAL program properlyfocused on taking care of financial and economic fundamentals, in particular price and tradeliberalization; enterprise and bank privatization; restoration of fiscal balance by targeting loss-making SOEs; removal of obstacles to the emergence of new private firms; and the developmentof adequate regulatory, accounting, and supervisory instruments to create a sound bankingsystem and a capital market.

In spite of the failure to implement the last part of the program, the FESAL has had aconsiderable and positive impact on the structural reform of Romania. Most of the measurestaken, especially on price and trade liberalization, SOE privatization, and banking and capitalmarket regulation, are irreversible. This is expected to assist immeasurably with future projectimplementation, particularly as significant institutional capacity has been built up during thecourse of the FESAL, and as recognitioni of the need for structural reform to reverse theeconomic decline grows.

The Government has now recognized that the success of reform lies with addressing three majorissues: privatization (of banks, enterprises and utilities); elimination of nonviable loss-makingfirms; and development of a sound banking system. Also, a much more comprehensive legalframework has been enacted, providing a measure of empowerment to authorities for prudentialoversight that was lacking at the outset of the FESAL. A major effort at institution building hasalso been in place under the FESAL, reinforced by a greater mandate to ensure compliance withrecently introduced regulatory norms. This culture will remain and will facilitate implementationof subsequent operations.

GOR and the Bank both believe that the PSAL will help bring the economy closer to stability andcompetitiveness by finishing the work originally begun under the FESAL. Prospects for successare now considered greater due to the significant passage of legislation and regulations, andtechnical assistance provided under the FESAL in support of institutional capacity building.These and other achievements under the FESAL are expected to contribute to PSAL success.

Project Design Problems and Lessons Learned

There were several project design flaws under the FESAL:

* The FESAL tried to include too many areas of reform in a single operation. The initialFESAL was to be disbursed in four portions over a period of two years, and included 27

conditions for disbursement. The revised FESAL was even more complex; with anadditional 41 conditions for disbursement introduced.Recommendation: Future adjustment operations should focus on a more limited number ofareas of reform22 ; and should be much simpler and shorter (one year horizon); with amaximum of two tranches.23

* Many conditions were based on processes (e.g., design and implementation of plans ormechanisms; production of reports) or on outcomes that were subjective and difficult tomeasure (e.g., improved enterprise caish flow; "substantial progress achieved..."). As a result,monitoring implementation required considerable allocation of resources, including staff timeand travel.Recommendation: Conditions should be based on a limited number of significant and easilyverifiable outcomes and results.

* There was insufficient Government ownership, delivery capacity, and control of theimplementation of the program, especially of the revised program of 1997. Except in 1996,when the Minister of Finance clearly took the lead in monitoring implementation of theprogram, the Romanian Government 'was not appropriately represented.Recommendation: Set up a high level counterpart group to design and monitorimplementation of such operations. Build up country ownership of the program. Ensure thatit can be realistically implemented.

* Romanian institutional capabilities were overestimated and proved to be too weak for thescope of the task. This became particularly clear in the areas of policy design; enterprise andbank privatization; monitoring of SOE financial performance and discipline; SOEgovernance; bank supervision; and bank restructuring.Recommendation: Ensure that institutional capabilities are adequately built up, preferablybefore project preparation, or at least during project implementation. Technical assistance(TA) and training should be provided, either under specific Bank loans24 or by other donors.This was done successfully when the ]Romanian capital market was created.

* The legal and regulatory framework and the court system proved to be inadequate to sustainimplementation of the program. This became particularly acute in the area of enterprise andbank privatization; enterprise and ban]k liquidation; and utility regulation. Implementation ofthe program was considerably delayed by constant changes in privatization legislation andregulations; difficulties in liquidating bankrupt firms and banks; excessive interference of theCourt of Accounts; and problems resulting from uncertainties about land ownership and theextent of the public domain. The court system proved to be ineffective at applying the

22 However, the linkage between macroeconomic stability, enterprise sector reform, and financialsector reform has to be maintained. This can be done by simultaneously processing several separateoperations, but without systematically stopping disbursement of one because of difficulties in meetingconditions in another.23 Whenever pressure was exercised on payment of one cost item (e.g., bank debts), arrears wouldemerge on another (e.g., taxes, energy or other suppliers). It should be noted that the requirement for noincreases in arrears to energy suppliers, insistecl upon by the IMF for resumption of its SBA, was neverrespected.24 The FESAL team and the Resident Mission did provide an inordinate amount of TA. However,this was not properly budgeted for and was sometimes delivered in an untimely and uncoordinated manner.

2

Bankruptcy Law, and could not be relied on to facilitate implementation of the program.Recommendation: Conduct a thorough assessment of the legal, regulatory, and judicialsystem early in project preparation. Passage of essential laws and regulations should be acomponent of the program. The judicial infrastructure should be strengthened either througha specific Bank loan or by other donors.

* Though the 1997 Cabinet initially appeared strongly committed to deep and fast reform, littleattention was given to building up support for the structural reform program withparliamentarians, civil servants, the media, and the public at large. Without a publicawareness campaign, the FESAL may have appeared (along with the IMF SBA) as a painfulexercise forced upon Romania by international organizations.Recommendation: Attention should have been paid to explaining the rationale behind theFESAL to the media, politicians, and civil servants. A systematic public relations campaignshould be built into the program.

* The FESAL provided an umbrella for a vast array of technical assistance and trainingprograms, delivered either by the Bank or by other donors, to build up local institutionalcapabilities and train national experts. The FESAL program became the policy anchor ofbilateral support, in particular from the European Union (EU) and the United States Agencyfor International Development (USAID). Close and effective cooperation was achievedbetween the Bank and other donors.Recommendation: Sustain donor cooperation for effective implementation.

Other, more specific design issues were identified:

• Privatization targets are useful indicators. However, they should be based on the percentageof state-owned assets actually transferred to private ownership and control.

* Loss and payment arrears reductions are the most painful and difficult results to achieve asthey may have a severe social impact. However, measures in this area are unavoidable.Targets should not be enterprise-specific (e.g., list of enterprises to be liquidated), nor shouldthey be based on hypothetical and hard to measure loss/arrears reduction targets. Theemphasis should be placed on enforcement of a hard budget constraint, and divestiture ofstate ownership in troubled sectors through privatization or liquidation.

* Presentation of legislation to the Parliament by the Government is not sufficient. It mayremain stalled in Parliament and/or the output may not be satisfactory. Loan approval shouldbe contingent on the enactment of laws satisfactory to the Bank (this has to be specified atnegotiation).

Lessons Learned and How It Applies to the PSAL Design

The FESAL was allowed to lapse on April 30, 1998, because it had become apparent that theremainder of the program as designed would not be implemented in a reasonably short span oftime. It needed to be overhauled, in particular to reflect the views and program of the newGovernment nominated in April 1998, and to incorporate some of the lessons learned. TheGovernment and the Bank are now in the process of updating the structural reform program,based on Government proposals in the form of the PSAL. The initial objective is to replace theFESAL by one separate adjustment operation that focuses on the enterprise sector, utilities and

3

mining, and the financial sector. This project will be a two-tranche operation and aims tostimulate reforms in the following areas:

(d) In the Enterprise Sector: (a) accelerating state-owned enterprise (SOE) privatization across awide spectrum of sectors; (b) enforcing hard budget constraints on remaining SOEs throughthe closure of big loss makers (i.e., mines); and (c) implementing an action plan to stimulateprivate sector development and streamline the business environment.

(e) In the Financial Sector: (a) gradually raising the soundness of the Romanian banking system;(b) ensuring that state banks are properly restructured as a pre-requisite for theirprivatization; (c) ensuring that NBR put into place the regulations that will improve theoverall soundness of the banking system at large; and (d) further developing the governmentsecurities market.

(f) In the Social Sector, reforms in botlh enterprise and financial sectors will be addressed bymeasures designed to strengthen the social safety net through: (a) rationalizing an incomesupport program for displaced workers; (b) ensuring that an adequate budget is in place forsuch purposes.


4

Appendix 2.INITIAL FESAL PROGRAM POLICY MATRIX

ROMAN: PiomdI AnEd p Sedor Adjsumt Lme (DAL)ftPk d ogm of Poseiy Rdofog

Md,CRQECONOMIC Policy nessures incompliance, Mainteact facco anencc, ofance-Miteac fam^o Mantmuc of is of s rOf UmLnmnC6ofPOLLCY with SAL adjustment economic framework economic framework economic framework economic framework

programs. conitet with thc prosrm constnt with the propam ooanijmt wah the pgrm coasicet w_ the pramEstbsh apppriate macro- as detemimed on the basis of as ddminod on tho basi of as demined 4o the basi of as detannined on the basi ofecoommic fraework in indicators agsesd upon by the indicatom s d upon by the ina Wrd Wo by tdhe =ators agred wa bysuppwt of onsistet trade, Gon and the lnk Goverment ad te Bank Gme g aud the Rak dke Gcvern and dihinduMisL mneaq nd an progrm achse by and propes achieved by and p1o. iohwd by Dun& and pmpo -,",dbudgary policies theGovwermont in the theGovenment In tho thcGovuramat in the by thGov in the

carr*g oWt of the pZgam. caring oVt of the prgam rn g4 ott of to og cari oe of th poga

0

NNey Xma ~4J~ulb ~mAt~pu~Dq~q. .. A~*~* h Doar& ~ I *S0 SS....... .. EWR nr 1 '

RIVMZA10 As of 10130/9S, xxx m^aU Completion of 1,500 Compltionofatlea 2,750 CompletinofatIlcat3,600CCs privatized out of 3,100; cumulative privatizations cumuWive privatizations, cumulative privatzations,

elarated and efctive xxs medium CCs out of 2,S00; sinco the wactment of Law sineF te rancet of LAw sims the anatm of Law

prdzafizon of major nd xx kWge CCs out of 700. 581991. 5S1991, including at eat 531991, including leastpoieon of the sWeowasd 400 madium-sized and 50 S00 medium-sizd and 100

entetpris sector. Sigure of a t&hnical Issue of an Ordinance, large CCS. re CCs.assistance progrm wit EU acceptable to the Bank,

A CC is considered Pbit to assist mi pparing establishigddamdpaymentpfivdiud wbe lat 90% and implacating tho MPP faliie ior the sae of shaesof iu slates buow and the inil registon of st* hbad by the SOP atertrafered AWer to ities sae. exchangeofCOsandcouponswbicb am 90% in pivat If Sharm under thc Mm.ownaabp, or to priveindiv~aah. ormaliksti andpublicafm

of sndsr contacts, agedwih the Bank, for te cashslo of shae discound bymor than 30%.

Launchmbg of tie progam ofbastmhr sau of 40% ofthe sa of the CCs in doe

_ _ _ __ __ MW. _ _ _ _ __PP.

EPbb a f om .basisSr Sipeaofa Maxanuduof EfBctive adtivation of an Esblishmet and activation

s_aating d th dig of UndJ_at wih USMD to interim sha registry of a atan Sr theahsmed noudYetMW dmmasyIt1r1cmgisbatioen aGwg r MP sham sa exsin and tading in

ad lait of aae. r di - M andaradomnmt sla.by th oovrmmat of Ihcdesign of a system,aooepta to tie Bank, brthe gion andUi ft ofshsvcs.

0

:^ ~ 56' * - 4' '- mm .~~IN KW a R BNffi i;iPRIVATE SElCTOR Impamtaio of vcwad Endorsement by tho Bbli_ tm of a si_feDEVELOMM SM devomet w lem, G _vnmt of a 4mifitd p ,odwt n weed with the

wwmfd by NAP, wab _e,ut b ftb to dw o* for tbrc npao ofTo veam co_kut to _Imbdtdw, xdo Bok Inhwuld ton_ow et u.P5D mpo nrd p co_ming ,v t & dtA tbe g- of aee wwk=d dWrwMI _ nmbot x.no io A l - * I ,ca n b*.coAlded

iqt3 of dkle Aot" 0 ofr""KM. E o

.> lse b. CY4V.

~'$* 1 - _ _ '~_

top e by wptot i o ToS re m~gu~a to himumihualldam.., ~ebadhg _eak, _hich ._uld w a ~m~imsP

PSD mad ptovid ouwive remu~ic mvum, traimiag~ the re~ of a

4' 0*.. , , . X <,Z

LOSS-REDUCTION, LAw 76 ables craditon to Submiwion to the Bank of Ie Governmcatto submits Exit of CCs pled undr Reduon of empyment inFINANCIAL JNE cnixaforoc their ight. (Pnaky acceptable FM for the comn report to the bank surveillance from the ettpfiscs placod unrAND GOVBIINANCE OF tit roe on arun of group of 13 CCs. d_anstrag, in a m,mw P sllhc peogm (GD murvllhnce, as agecd wthIERQ ALB O.1S% per dian.) acceptable to the Bank, that 212J95) sept for those the DanCOUPAM dI, 13 CCs have made irdI to hbdcw, on aect

BDakPtcy Law has been substnfal progrs in of oam of do foSoiag.Expedbe anuums to stcm passed. inp_menting their PMPs,

tapris. loes including meeting thc () puivatizioo;30 CC, wc plaeed in a agtregate and specific

As much as possibe spca ucalo prgani (GD bechmuk agreed wih thbo iiH) zetblisnt, to theacokat psiwvdo and 301M3) to prwvt fSther Dank. satisfaction of the

w<e emtic g to sw comtanination of baus; Gsovesnastudof thcBank,

owns. recovery progrm were Estbkliswi t of the leg Exit of at last 50 CCs fkom of a pose net cash Bow;prepared by enteprise framework for the tho suveWan progm and

Cleridtiosandeahroct - 6nganat with technosil surveillance regime etblshd by GD 212/95,of the rigs of credkos asisace financed by the (Ordianc 139). out of wch at lea 20 CC,, (ii) lquidation.agast delinquat debtIor. Bank. which have not boee plaoed

insolatiounderG1301M93, The Goaneat and theProtectionof d'ilosl api On_Aec 13/95 cres an hwve bem Fpivatixd or ak willc pna li of up tocreditors while in a.b Pngdlftsma& hra liquidated, while the 10 aophs wich will_opnixt or in the spcca svela pwuam, ra of the odw So unmn in the .wlllncp.o of _babot. which would allow CCQ hewv r.lied. to progr for up to ODe yaw

pasticg SOls to dder teo malisctin of the do r third poties ruasDevelop an ordedy askt cmg r ds, pG_tma and the Bank, afbrhsacwaiup itmcaasd o _N of co_oilirn podia casb now.reduce inter-enterprise _p_ hc w to bomb aodnarl. witd the c act sand Compition of 7 pivati- Cosipi of addion S Comes of addiional 10.

smpemien of andoss and liquidationsucot pidvalims or Myddstid piacatiom or li 1idmmr liTransparency and a eoit 151 CC plwed of tho Soup of CCs plaed in of te gop of CC. out of db. pg of CCsjuaifsoation in budget udw mmAeo by GD isolation under GD 301M93. paeo_d in isotoneud GO placd inQba'ips ceder GDawast. 212/95. SOBs ink dre1 la 301193. 30193.

F9is PIN wih theodc-4 a to nAm loss andsum. zand to m poe

fi

p.

0w

I.

LOSS-REDUCTION. Boards of Di_caon fully Submission to the Bank of ThnGovaunmcttosubmita Substmntialprogzu bytho6FINNCIAL DSCIPLNE stfd for most RA&. Fust acceptable FRPs for the corn report to the Bank RAs owards phasing outANDGOVMNtACE seis ofm gacmntconat group of 6 RAm. demonstrating, in manneu usecondmi advtivu sdRILGIBS AUTlNOMES pod with mnaniuitd. aocceabc to the Bank. that imping their cash flow.

NW psra c Contacs db 6 RAm have madeReduce loss ad aar of am being designed. Financia subsanl progres inregqi atonoms. Limit and control and monitoring _pamating their FRPs,ukimasdy reduo budgcazy orgaixed by sctor ministris, including mecting thefinncing of thir bum and MOP and Count of Acount. aggrgate and specificsmm. bawbmark - with dth

Mjor RA included in thc BnRsu.vilne pzrOgmn.

0I-

of II

HARD BUDGET Adpion by the Govenunmt Substantial progress in Subsantial psogmes inCONSZ& ON RAE of a mchn m, acbulc imnpkmcation of tbc implema to of tbre

AND : CA to thr Ba, to forabll m anium to lfo A= _m to flu MItuMD

FI&&AL g:Qtuffim fiumtr buid up of a n in buDd up of aurosn in tho build up of arrus in diethe enagy setor. ncludn = sedw, as nacuzd gy sabr, u musuzred

Impose hard budget an ag4ent on benwha apinu bachmk agr_eed againu ben _mark agredconszuint on tbe avaIabliy to be met. upon wit the Dank. upon with th Daukof budgeay or SOPr oure to RAs and CCQ An overall cap on Obeavane of the agred Ob0erman of the ageedp4ced in the swvilanee Government and SOP *WoaoGowrnawsdSOF c ano vuemaadSOFpforan. fimiusl awpoit in 1995 to anal appoit to a- fnan son"t to "0-

swmd asw nder owmd a_ up . owned atgm.the ruvafane Proamgetablished by Ordinan13195 fre mawiu akdedarni GD 21219S, iking

the maoro-eoonoaio84woned prsm, on:

ii) budstary .*u adiwnvm.t tamkft;

(ilb Govmet gua_deam boak 1ein; and

(iv) SOP corporate

0

ct_.~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~.

_ _ . .~~~~~~~~~~~~~~~~~~~~~~~~~~~~~I

I-

~~~~~~~~~~~~~~~~~~~~.*' ** ** *t(. S b : + *.l. . :::<

. . ... ,,, .( 4$ 4 ? 4 | | _ W ...* . ~~ *

4 ~........... Z &Qf&

sa.NXCR.Eal,ICrpRSO Successive rounds of Speeific loan4o-s ptavisionsANI? REMA1S=apsN ta, &camna by bhak to be rndad tax

aha and poxddio ruwa by d*duab aooadig to -Restruoturing and thmajarbanaks. hav*_wuWd agred pbs.4-im rchedulspiAtkl of atawmd is dosiled istitionl dub .1995 an IM as

_ I~~1 banksahab do4opmi prerua. ia5bws (a) dw m995-fori geras, will radwc tbe lhn in do b. (140%sare of *c Sat in th prov )addo Xm(50%bankin r. prvhaoo) c_ ; aWd

(b) during 1996 and

fowing anegouiu ofinapird ardb (oL, ks(100% provmicm), doultl(50% p sia.) ad rob-andd (0% pmvino)I.

NOR to ieY cirulr Submiso to the ank of a Subsni to tdo ank of ain in banks to tdutako epeal km die NMR rpogt hor te NMRba lowlan-h. provbkining danorad SdheeoWanlnms dgnoiatd.ce apimplameand requiing tnm to utah of the banb undr NBRs of tW bnb uar NDRs50% of th mt pro& afit er spvl wkti dhecizoular survisawr do t ieromInstax until they hw reacod 1a peudeah zgup mm os and peudh zph . cathe miobmun l., of capia1 han40m; eoiuinaIng.eap1 bhanhaa in.in&mg1ladequy, ad_qua d t diation adqacy .. d doote ube

of sad pefo, and dma* of mat pos. al 0d=7*gEdabldnat of WODs in tho ma tm by NMR tbe _m s Wm by Nlleach of th majo bnb. agantnommoalingbaks. aVinatnom4=Vbi%be.

nb

Privatizalion of at kast one Bank Privatzation Task Force Finalization of a privatizain Implanentation of the RBDstate-owned bank and (BPVF) established to develop action plan for RBD agreed privatization plan, as adjusedpmparation of a second one and guide implenentation of with the Bank and approved in agreement with the Bank,for privatization. the bank privatizaion rategy. by tht shareholders, NBR nd in order to teflect the

the Government. Such mandatory provisions of theA bank will be consided as privatization plan to iclude nw Bank Prvatiatio Law,privaized when at leat 51% an offer for sale, listing on if and when enacted.of its shar ha bn the BSE and sale of at kttransferred cither to atom 10% of its shates by public Finalization of a privafization Implementation of thewhich are 90% in privat offering, over and above action plan for the second pnvaziza plan of theownenhip, or to private those held by the POPs and bank to be privatized, to be seond k, as adjustd inindividuals its employeae *ed with th Bank, and agement with the anck, in

approvd by its Gel orderto reflect th mdatoryAssembly of Shaeholdes, provisns of the new Bankthe NBR. Such privatization Ptizadion LAW, if andpan to indude an offer for when enacted.sal, ho"g on the BSE andsla of at lat 10% of itsshares by publ orin,over and shove hos held bythe POPs and its cmpboyee.

An oagoipg commtmfron the Gcvmat thatthere will be no.xecapaaia of beak byth sa budget, by to NBR,orfroon xma budgctar AindcxWpt im iy pnur toprivatiztico or as needeupon a bank being inevenedby NBR.

go

0Hi%

FINANC1XL SEN[ Esabblshmict of auction NBR to iue a ciculr for Subisasion to t Bank of a Submnision to the Bank of apOLICX system for NOR refiancing piiuing in the coDlarl- Ipost prepard by NBR repolt prepased by NBR,

cr-dAs. izaton of iss refinancig demonstrating progress demonstrating fullAchieve market-based crdit to bankm, as ageed satisfhtor to the Oank in iq_plmnation of Regultionpostive ea rates of isAt with the World Bank. i dOmeRo lation3/9S 3J9S isued by NlR into psted tvabe of blcl iued by NBR ist repect of respePt of cofliAcallasi ofcunncy in the light of coflaetation of NBR's NBi's refinsning erdes touted inftion and to rfuinah ng craft to banks bank.

zdsum the sUb a offincial mourees forinvestment.

Limit bnks' utilzis ofrefnanng crtedit frmNiR without adequatecoilatersi.

Improve the prudenti NDR has issued prudeal NBR to havc undertaken to The staffing of theregulation and supervision of regulations covering: carry out nnual on-site Supervi Depart_n ofbank by NBR. (a) licensing, (b) loan insecion of al bak. NiR " beinc asedto ka

expasm limits, (c) cumrcy Such inspecdion to inlude, fuAlM e mk _ of arund 70exposures, (d) insider wbe. apprpriae, a riiel staff.lending/conneced lending aswa-ment of the banks(c) captl adequacy, and lest semIAn potfio NBR to sawi to tho Bank a NilR w bmitn to ftb Bank a() lo casifcation and reviws mnd the asocied reea demonstrating tha on- xqpost d_smeiag tdot theprovisioning. Rules reating to loan-loss provisioning sie inpecto of baun asrc rIqnirodon.binspeedonofownership of banks by nn- rooommedadd. being caried out. bak arm tkS pa7bak and equity holdinp ofbank in non-banks ar NBR to iuu a regultion Submio to tie Bank of acovered in the basic roquiring mandatory post prepaed by NSRk&stion. indepndt cnenl audis demonstrating conWiian of

of banks. ban with madatory

'U rg

t~~ . '.w t' Sm VSRES|!

Reduoc CEC's slr of Houwchold avings with CEC Endorsement by the hmnplemettonofthedeposkdqpok4-aking amon d incuded in bank liablti for GoCwmni and NBR of a isumnce swoe.population, and pmvidc a which NBR reserve deailed proposal for aWoel playing fied for rupaizenta apply. dcpos itmuanoe scedeposi-ing by all banls. agred wh the Bank.

Commenrcial banks nowcompeing with CBC forboushold dpo4s.

Inpqove thc speed and NBR R.gu.tion No. 1011994,Sctiany of payment by readiag a paper-bas

introduciSg a modern muidstil eompatios ofPaymms system. kumak paymmi. becam

eopaminl an Apu 3, 199S.A obuing sktin is held daily,usdarthepi of the BaokSetdlmeos Dep_ton of thNDR in Bum At and in 41Ysds. In the *du tam,NDR i;_hds to lanh a

PeLYins system.

To eablish an cffetiw and Ageenet in painc4pl bysintinabsemdaoinx NIR and the Bankerb_an to ta the diak Asasaiutan the marku ofmanagement of b establiahing a credit

6no berm (CI).

0

.. _ .__. . ... .... ... ,, . ........ .. __._ .. _~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~0@

eo

0

I-

I-

_Pok ___

ACCOUNTING AND New cowunting sandards and Isuac of a reguion byAUDITiN an Acoounting Law have been the NBR introducing a

adoped. The new standards uni echwt of acounts forImplement sound, ae baed on EU stanads. buk, in acordance whitternationalty zucoized . internationally accptedacouing dsdards in As fhom January 1, 1994, al aoutig sandards.cauprises ud banks. sp- coaupises =ied to prepscported by coinpoent their accouats in acodaceaccoutig and audtng with now chat ofstandards. accotai.

Mhe LAw o_pZg theproksn of accounts adaudiiws hu bm -p d.

Dibbishmat -.of l nAiooiation of CettifidAccountant and Andites.

CAPrrAL MARKET Ordina 18 sad 24 nd Opening of tho Bucharestsubsequent regulations Stock Exchae

Esablib Cap_ MSZkC4 adptod Secuiry Excaeinclding thc MM dt Act spptoed by Pudinmmt.National Securities NSC estblished.Comission (NSC).

Seulemcat of Overdue In December 1994, thc Ihe Governmnt to sue a hec Govenunt to ioue aGovameat Obgtaoms to GoVUM sent itsoverdue riolt swig tit is curat Rqt statg dt its aemntBanks obligdo to cemmtia1 in an its payns oblptia in Ae its payma obl4ais

banks, s required under Law to the banb, incld to the beoak, itchdg'7192 pdnkipul ad iktiwt due to pt o*d and iurM duo to

beaks under La 7/92 nd ban under Lw 7192 andOrdnunce 1/94. Ordi 194.

m;mWufslhad195 Nowner S, 1995

0

16-

Appendix 3. Cofinancier contribution to the ICR(Export-Import Bank of Japan)

Romania: Financial and Enterprise Sector Adjustment LoanComments on Implementation Completion Report (ICR)

1. In Romania, insufficient financial discipline in state-owned enterprises (SOEs) was oneof major sources of the macroeconomic imbalances. We suppose that such insufficientfinancial discipline in SOEs had made the government of Romania that came to power inlate 1996 and committed itself to structural reforms unable to maintain an appropriatemacroeconomic framework during the period of FESAL program. Taking this intoaccount, the current government should continue efforts in restoring fiscal balance bytargeting at loss-making SOEs.

2. In this regard, we can agree to the idea in the ICR to replace the FESAL by oneseparate adjustment loan focusing on the enterprise sector, utilities and mining, and thefinancial sector. We also support the recommendation that the future adjustmentoperations should be much simpler and shorter, provided that those operations include theelimination of financial support to non-viable loss-making SOEs.

3. The ICR would better describe the adverse impact on the overall program objectivesenvisaged under the FESAL that resulted from the nonobservance of the third trancherelease conditionality.

4. The ICR could also refer to the advantage and disadvantage (if any) of focusing onboth the financial and enterprise sectors in one adjustment operation. In order toencourage the steady implementation of adjustment programs, could it be an alternativeto have separate adjustment loans and reduce the number of conditionalities and theconcerned ministries and agencies?

Appendix 4.SECOND PORTION RELEASE MEMORANDUM

lntemational Bank for Reconstruction and Development

FOR OFFICIAL USE ONLY

R97-1 18

FROM: The Acting Secretary May 27, 1997

ROMANIA - Financial and Enterprise Sector Adjustment Loan(FESAL) (Loan No. 3975-0, 1, 2-RO)

Release of Second Portion - Waiver of Condition

I1. Attached is a President's Memorandum entitled, "Romania - Financial and EnterpriseSector Adjustment Loan (FESAL) (Loan No. 3975-0, 1, 2-RO): Release of Second Portion -Waiver of Condition" dated May 22, 1997.

2. In the absence of objection (to be notified to the Vice President and Secretary or DeputySecretary by close of business June 6, 1997), the reconmnendation contained in paragraph 33 of theMemorandum will be deemed approved and be so recorded in the minutes of a subsequent meetingof the Executive Directors.

Questions on the memorandum may be referred to Mr. Patrick Tardy, (Ext. 32202).

Distribution:

Executive Directors and AlternatesPresident's Executive CommitteeSenior Management, Bank, IFC and MIGA

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.

FROM: The President May 21, 1997

ROMANIA

FINANCIAL AND ENTERPRISE SSECTOR ADJUSTMENT LOAN "(ESAL)LOAN No. 3975-0,1, 2-RO

RELEASE OF THE SECOND PORIION - WAIVER OF CONDMONS

1. This memorandum summanzes progress made under the FESAL Programsupported by a Loan of US$280 million equivalent for Romania. This operition wasapproved by the Board on January 18, 1996. Conditions for second portion release arespecified in Schedule 4, Section I of the Loan Agreement. The following report presentsthe actions taken by the Government to meet the specific conditions for release of thesecond portion and requests that the Executive Directors approve the waiver of certain ofthe conditions.

2. Recent political and economic developments in Romania are described in detail inthe recently distributed Country Assistance Strategy for Romania (Report No. 16559-RO, May 9, 1997), which will be discussed at the Board on June 3. Very briefly, the newGovernment designated in November 1996 was faced on taking office with a majoreconomic crisis, which it has moved quickly to resolve. Macro policy in 1996 had beene-xcessively expansionary, with effective controls on the foreign exchange and moneymarkets, all in violation of the IMF Stand-By Program which had been approved inDecember 1995. Non-compliance with the FESAL program in 1996 contributed to themnacro imbalances. The newly designated Government has moved quickly, however, torestore the macro balances, as well as implement the structural measures (including thosethat are part of the FESAL program) which lie at the heart of the difficulties. TheseFESAL measures are described in detail below.

1. BACKGROUND

Objectives of the Operation

3. Preparation of the FESAL started in 1992, to build on measures undertaken withinthe program supported by the Structural Adjustment Loan and regulatory reformsupported by the Industrial Development Project. The FESAL focused on implementationof concomitant structural reforms in both enterprise and financial sectors. FESAL's majorthrust was in privatization of enterprises and banks. Other main objectives included priceand trade liberalization; enforcement of hard budget constraints on remaining State OwnedEnterprises (SOEs) to restore the profitability and financial discipline of the sector;facilitation of private sector development; creation of an efficient and dynamic capitalmarket; and improving the soundness of the banking system. These objectives have

remained valid over the whole project development cycle. Under the FESAL,considerable changes have been engineered in both the enterprise and financial sectors.

The Original Program

4. The FESAL was approved by the Board of Executive Directors on January 18,1996. During the preparation period, the Bank provided considerable technical assistancein most components of the operatron. Many measures-such as the lazihing of imassprivatization program and the strengthening of the regulatory framework of the bankingsector-were actually implemented during preparation of the operation: The loan wasdeclared effective February 29, 1996, and the first and the floating portions of the loanwere immediately disbursed. By mid-1996, major progress has been accomplished in thearea of enterprise privatization, private sector development, capital market developmentand banking sector reform. However, two important components of the programs hadfallen behind: (i) SOE loss-reduction and financial discipline; and (ii) bank privatizationand supervision. As the country geared up for presidential and legislative elections duringthe second half of 1996, it became clear that the difficult decisions required to tackle thesetwo issues would be delayed.

Bringing the Program Back on Track

5. The Govermment elected in November 1996 has adopted a decidedly strongerapproach to enterprise and financial sector reforms. The new program was announced inFebruary 1997. Although the main policy objectives remained the same as those initiallyagreed with the Bank, it was a more comprehensive and reform-oriented program than theone agreed with the previous Govemment. After intensive work with the Bank in Januaryand February 1997, the new Government announced a set of measures designed to get theprograms back on track, which included: (i) liberaLization of prices and trade in mostproducts and services of the competitive sector; (ii) accelerated privatization of largestate-owned enterprises (SOEs), including Regies Autonomes; (iii) an end to goverrunent-managed restructuring of SOEs prior to privatization; (iv) further measures, notablyextensive legislative reform, to strengthen the banking sector, (v) new measures to fostercapital market development; and (vi) promotion of direct foreign investment.

6. More effective approaches (e.g. enterprise restructuring) have been adopted by theGovernment, in agreement with the Bank, under this new program. However, theobjectives, the expected results, the structure and the loan amount of the FESAL haveremained unchanged.

7. The main changes between the new, stronger, program and the initial one are thefollowing:

(a) Price and Trade Liberalization: The stronger program aims at: (i) effectiveliberalization of most prices and trade regulations for all goods and servicessubject to competition; and (ii) removal of export bans and quotas. Thesewere largely implemented during the first quarter of 1997.

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(b) A;cderaton of j ion: The revised program provides for: (i) theadoption of simplified methods for the sale of shares at auction, withoutany reservation price; and (ii) spetcific targets for the sale of SOEs atauction; through initial private offering; and through the Jervices ofinternational privatization agents.

(c) Enterinse Restrucftuing aW Frin, F c: -The Goverbment andthe Bink ageed that the g-vermnmnt- tnged process to restructure loss--makig SOEs prior to pdivatiaion, which was envisaged under theoriginal policy program, had not and would not yield the'desired results.Enterprises placed under surveillance were exempted from servicing past-due debts, but nevertheless continued (in violation of the accords) toaccumulate losses and arrears. It was agreed that the authorities would.now pursue a more market-oriented process to bring loss-maldng SOEsunder control, by offering only two possible outcomes: privatization ofloss-making SOEs or creditor-driven liquidation of those which cannot beprivatized. Specific actions have been agreed and recorded in the revisedprogram, most already implemented: (i) the government-managedsurveillance regime has been terminated; (ii) new eligibility criteria havebeen established for severance payments; (iii) timely payments of taxes andsocial security contributions to the budget is being aggressively enforced;(iv) the liquidation of nonviable firms is being accelerated; (v) utility tariffshave been adjusted to ensure the utilities' financial equilibrium; (vi)financial discipline is more rigorously enforced; (vii) utilities areimplementing cost reduction measures; (viii) a significant group of loss-making SOEs have been closed in May 1997; and (ix) Regies Autonomeswill be transformed into Commercial Companies to open them toprivatization or bankruptcy (the prerequisite changes in the legalframework have been prepared and await Parliamentary approval).

(d) Bank Privatization: A Law on Bank Privatization has now been passed andsigned by the President. This will enable bank privatization to proceed.

(e) Banking Sector Regulation and Supervision: A number of changes havebeen introduced in the regulatory framework of the financial sector. Theyinclude legislation on the insolvency of banks and changes in the legal andregulatory framework governing the accounting system and the taxation ofbanks.

(f) Recent Issues in the Banking Sector: The failure of two private banks in1996, and the severe deterioration in 1996 of the financial condition of theGovernment-controlled Banca Agricola, have had to be addressed by thenew government. Specific actions have been undertaken, including: (i)liquidation of the two failed private banks; and (ii) preparation of asatisfactory restructuring plan for Banca Agricola. Furthermore, since thelaw on the Saving Bank (CEC) was amended in 1996, creating undue

3

ambiguities, it was agreed that: (iii) the status of--and applicableregulations to-the CEC and the newly created credit cooperatives wereclarified. Finally, an agreement was reached on: (iv) the modernation ofthe legal system to enable creditors to better secure their loans withcollateral.

(g) Q t Market and Forilm by =: To fster the smooth functioningof the capital market, it was agred that the law enforceinent authority ofthe Securities Exchange ComiWssion and information disclosurerequirements would be strengthened. Also, the law on foreign investmentwill be amended to allow foreign portfolio investors unencumbered entryand exit of the Romanian market.

8. The revised FESAL program makes some of the original conditions irrelevant--e.g.continued implementation of the surveillance program'--because their objectives will bemet or exceeded through an alternative strategy. Certain other conditions--specifically inthe banking sector2--which have been delayed by inaction of the previous Government, arenow well under way to be met. At the time of third portion release, the Bank will assessonce again the progress achieved by the Government in carrying out the Program (asdefined under the Loan Agreement). In particular, special attention will be given to thosepassages of the Program which refer to the actions which are the subject of the conditionsfor which a waiver is presently proposed. The revision of the FESAL policy program wasalso closely coordinated with work under way at the time by other Bank teams-in theagricultural sector (ASAL) and in social protection (SPAL)3--and by the IMF4. TheFESAL is an integral part of this package. Support to the Government, at this time, tohelp preserve the integrity of this package, is justified, given the good progress made indesigning and implementing the first phase of the renewed program, and the secondportion release of the FESAL is now warranted.

ii. PROGRESS AGAINST SECOND PORTION RELEASE CRITERIA

9. Second portion release conditions have been satisfied, in accordance with the LoanAgreement between the Borrower and the Bank, with the exception of the conditionsregarding: (i) financial discipline; (ii) privatization of banks; (iii) IAS Chart of Accountsfor banks; and, (iv) the Government report stating it is current in its obligations to banks.

I Loan Agreement: Schedule 4, Section I, Items 5 and 8.

2 Loan Agreement: Schedule 4, Section I, Items 11, 12, 16 and 17.

3 For instance, the redundancy package designed under the SPAL was tailored to estimated laborshedding under the FESAL.

4 The Government of Romania was granted a 13 month Stand-by Arrangement with the IMF, in theamount of SDR301.5 million, on April 22, 1997.

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Other conditions, regarding enterprise restructuring, were only partialy met bu't have nowbeen superseded by the new, stronger program developed with the Bank.

A - Macr oneoic Framework. Enterprise Sector and CaoitW M -'ai

Macroeconomic framework

10. lThe new G6vernment has adopted a balanced macroecohonuc -policy programincluding (i) liberaliziton of the exchange rate (h) contkniroent of the budget deficit; (iii)liberalization of tariffs and prices; and (iv) remnoval of exports bans and quotas. 'Thissatisfies the requirement that a proper macroeconomic framework be'in plac*. In addition,on April 22, 1997, the Board of the IM approved a new '13-month Standby Arrangementwith Romania, in an amount of SDR 301.5 million.

Privatization of SOEs

11. As of May 1, 1997, a cumulative 2,865 SOEs have been privatized in accordancewith the definition agreed at negotiation5 of which 68 are large enterprises, 473 aremedium-sized and 2,324 are small. This satisfies the condition for second portion releaseof 2750 privatizations, including at least 50 large and 400 medium-sized enterprises. Anadditional group of 532 former SOEs are majority-owned by private shareholders,although they do not satisfy the more stringent definition of privatization used for theFESAL.

12. In addition, the Romanian mass privatization program has been successfullycompleted, with a remarkable 93 percent subscription rate. As a result, over 13 millionRomanians have become shareholders in rnore than 5,500 enterprises. Furthermore, thenew Government has agreed with the Bank to alter the privatization strategy and methodsin such a way that the residual shares of the mass privatized enterprises will be swiftly soldat auction, by tender or through the RomaLnian OTC market (called the RASDAQ).Blocks of shares will be offered for sale, without a reservation price nor conditions of sale,to the highest bidder, at a pace of about 200 offerings every month. Already, 1,060enterprises have been offered for sale at auction and 454 have effectively been privatized,under the more cumbersome payments facilities followed previously. Larger enterpriseswill be sold either by IPO through the Bucharest Stock Exchange (BSE). Four offeringsare scheduled to take place in July 1997, to be followed by two more offerings everymonth. Lastly, the privatization of 100 large and medium-sized enterprises is beingsubcontracted to international privatization agents. Forty two contracts have already beensigned and five sales already completed. A team of consultants, managed by the Bank and

For an enterprise to be considered as privati zed under the FESAL, either 90 percent of the stockmust havc been transferred to private owners or at least 5 I percent of the stock must have beenpurchased by a single private sector.

6 Loan Agreement: Schedule 4. Section 1. Itern 1, which reads: Achievement of numeric privatizationtargets for CCs as agreed with the Bank.

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financed by a PHRD Grant, is presently assisting the State Ownership Fund (SOF) in e, hiring and supervising these privatization agents. Therefore, the privatization target of i3,600, including at least 100 large and 500 medium-sized SOEs-which is the conditio'n forthird portion releaseis expected to be met before the eLnfd of the year

Capital Market Development

13. The system for registratioik and trading of dawes has been established and activatedin late 19967. Therefore, this condift for socond goion release is satisfied. Thedevelopment of the Romanian capital market is a remarkable success story. It is recelvingstrong support from bilateral donors (USAID, EU Phare, the British Know How Fund andthe Canadian Development Agency). A Securities Exchange Commission is operating andmost regulations are in place. An independen,ly run share registry and a depository areoperating. The very dynamic OTC market (the RASDAQ) is developing fast: 450enterprises are actively traded every day, while more than 2,500 are already listed. TheBSE has now 26 listed enterprises. By late April, the volume of weekly transactionsreached ROL 35 billion. Weekly transactions in the RASDAQ had reached ROL 50billion. This timely development of a vibrant capital market will greatly facilitate the post-mass privatization trading of shares, to foster concentration of shareholdings and bettergovernance of privatized firms.

Private Sector Development

14. The Romanian Chamber of Commerce and Industry has created a nation-widenetwork of one-stop-shops for enterprise registration. Coupled with administrativesimplification which has been implemented, enterprises can now be registered technicallyin less than a weekS. This satisfies the condition for second portion release. .Furthermore,the Government has submitted to the Parliament amendments to the Corporate Law (Law31/91) in a such way that formalities for registration of firms will be simplified fiurther.

Enterprise Restructuring

15. The new Government program--presented in para.7(c) above--addresses the issueof loss-making SOEs in a much more focused and decisive manner than the program. Thenew program provides for privatization, closure or drastic loss-reduction measures for agroup of 68 important loss-making SOEs which together accounted for 72 percent of thelosses of the entire SOE sector in the first three quarters of 1996. The original program offinancial isolation tried to deal with I51 SOEs, but many of these were small, and togetherthey accounted for only around 40 percent of the losses of the sector in 1995. TheGovernment has also issued a Decision to dissolve the Romanian Oil Company, the recentestablishment of which had created a monopoly in the oil sector. This decision paves the

Loan Agreement: Schedule 4. Section 1. Item 2, which reads: Establishment and activation of asystem for the registration and trading in shares of CCs.

8 Loan Agreement: Schedule 4. Section 1. Item 3, which reads: Establishment of a simplifiedprocedure, agreed with the Bank, for the registration of new enterprises.

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way for the liberalization and privatization of the oil industry. It wil also remove a majorobstacle to foreign investment.

16. Among the Core Group of 13 Commercial Companies (CC,) Wageted forrestructuring under the original progra9, two ,werei,azd ,(A lw ,e and thefive steel enterprises (Sidex, Siderurgicq Republica, SidercC,ost)mnd canicimproved their performance in 1996 up to the point. tW they no loW6r wpOar .iti thegroup of the largest 200 loss-makers. Thus they could have exited from Xo uueiceprogram. This initial target group of CCs-viich no longer includes the larest loss-makers-has been replaced by a larger selection of 41 CCs, representing 12.5 percent ofthe losses of the SOE sector in the first 3 quarters of 1996. Among these CCs, one hasbeen sold, another has been declared bankrupt,; seven are being closed (with liquidatorsalready appointed), and the other 33 have been offeredfor sale, to be advertisedimnminently in two international business joumals.

17. The Core Group of six Regies Autonomesl° (RAs) did not improve their financialperfornance in 1996. Moreover, four other national RAs and a number of local RAs,which were not selected initially, accumulated large losses and became as problematic asthe initial group. The Government realized that, although cost reduction measures arevithout doubt essential for all those enterprises, most of the losses were the result oftariffs (utilities) or output prices (mines) which had been administratively set in 1996 at alevel which could not possibly allow these firms to recover their costs.

18. Under the new program, two groups of RAs have been defined: (i) a group of 19.utilities and (ii) a group of 8 other RAs (of which 6 rmines), which together generated 31and 29 percent of the losses of the SOE sector, respectively. Drastic action has beentaken on both groups. For the first, utility tariffs were raised to a level which ensuresadequate cost recovery. For instance, industrial electricity and railway passenger tariffswere raised by 190 percent and 100 percent respectively, on March 1, 1997. The utilitiesare also implementing cost reduction plans, which are monitored under investmentprojects of the Bank and EBRD in the power, oil and gas, rail transport and water sectors.As a result of the sharp tariff adjustments and of cost cutting measures, losses of theseutilities have been stemmed in the first months of 1997.

19. The six mining RAs in the second group, which employed 170,000 workers,generated 23.5 percent of the losses of the entire SOE sector in 1996. There again,drastic action has been undertaken by the new Government. Twenty-three unprofitable

9 Loan Agreement: Schedule 4. Section I. Item 4, which reads: The Govermment of the Borrower tosubmit a report to the Bank, demonstrating in a manner acceptable to the Bank that substantialprogress has been made in implementing the financial recovery plans of the Core Group of CCs,including meeting the aggregate and specific benchmarks agreed with the Bank.

to Loan Agreement: Schedule 4. Section I. Item 7, which reads: The Borrower has submitted a report tothe Bank, demonstrating with respect to the Core Group of RAs substantial progress measuredagainst detailed benchmarks as agreed with the Bank in the implementation of their financialrecovery programs.

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pits have been closed during the first quarter of 1997. Employment has been reduced by3,518. Prices of mining products have been increased to world levels. As a result, thelosses of this group have been reduced by 36 percent in real terms during the first quarterof 1997. Furthermore, detailed cost-cutting plans have been drafted. They have beenreviewed and dKeemed satisfactory to the Bank. If implenented as planned, they would.reduce the losses of these mines by two third in real tems over the whole of 1997.Employment would also be reduced by around 33,500. i.e. by arouidd 20 percent ofthepresent labor force.

20. U.nder this new program, the Government has addressed vigorously the issue ofSOE losses and has imposed loss reduction measures which have already yielded resultsbeyond those expected of the original surveillance regime. At the same time, slignificantprogress has been.achieved toward mneeting the agreed numeric targets for exit from thesurveillance regime". Out of the original group of 151 SOEs placed under surveillance,11 have been privatized, 19 have been (or are being) liquidated and 5 have generated apositive cash flow over the last two quarters. Out of the group of 22 SOEs placed inisolation in 1993, four have been privatized and one has been liquidated12

21. In consideration of the above, the conditions for second portion release. as perSchedule 4. Section I. Items 4. 6 and 7 of the Loan Agreement. are satisfied. while awaiver is proposed for Item S.

Enterprise financial discipline

22. The amount of payments overdue to RENEL by more than 30 days were not toincrease in nominal terms above the level of September 30, 1995, (i.e. Lei 686.8 billion)'3.This condition had been satisfied during much of 1996. However, the aggravation of thefinancial blockage during the last months of 1996--which was induced in large part by theincreasing losses generated by the utilities--made this objective unsustainable. By March30, 1997, these payment arrears had increased to Lei 781 billion. Furthermore, as a resultof the increase by 190% in industrial electricity prices on March 31, these payment arrearsincreased to Lei 1,200 billion. The same phenomenon has been observed with the gasutility, ROMGAZ. Thus, arrears to these two utilities (representing 2/3 of arrears toutilities) increased by 33 percent in nominal terms in April which, while less than the price

Loan Areement: Schedule 4. Section I. Item 5. which reads: Exit of at least fifty (S0) CCs from thesurveillance program established by Government Decision 212/95, out of which at least twenty (20)CCs, which have not been placed under isolation under Government Decision 301/93, have beenprivatized or liquidated, while the remainder of the fifty (50) CCs have re-established, to thesatisfaction of the Borrower and the Bank, a positive cash flow.

12 Loan Afreement: Schedule 4. Section 1. Item 6. which reads: Completion of an additional five (5)privatization's or liquidations out of the group of CCs placed in isolation under GovernmentDecision 301/93.

13 Loan Agreement: Schedule 4. Section I. Items 8, which reads: Substantial progress in theimplementation of the mechanism to forestall future build up of arrears in the energy sector, asmeasured against benchmarks agreed upon with the Bank.

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increases, was still an increase nominal terms. However, arrears to the othertilitesactually decreased by 21 percent in nominal terms. This situation is theshort teri insIRtof the steep increao in the price of energy, which was necesary to refied Xtw .cost-ofenergy and to ensure full cost cvy of these udlites It will.take some dnforthot sprice increas to be normally aosorbed through the system. RENEL and ROMGAZ haveconsiderably increased their preure on late payers, through suspension 8fAie. fr isexpected that financial discipline will be progressively restored in 1997, e lly sincethe Governmeut is more fbrc6fi ly addressn the Jproblem at the bource,'bilqwdating orprivatizing hin-viable energy-intensive filrn. In consequence, a waiver of tis condition ispropRosed-

Imposition of a hard budget constraint'4

23. By repealing Ordinance 13/95, which created the surveillance regime, the newGovernment has also terminated the Financial Recovery Fund. Furthermore, theEmergency Ordinance amending the Privatization Law 58/91 now forbids the StateOwnership Fund from financing SOE restructuring. Lastly, the subsidies allocated by thebudget to the RAs in 1997 have been cut 'by more than half. As a result, the externalfinancial support to SOEs has been reduced below the limits agreed with the Bank. Thiscondition for second portion release is satisfied.

B - Bankine Sector

Bank Privatization

24. The FESAL program envisages the privatization of two state-owned banks.Initial preparations for the privatization of the Romanian Bank for Development'5 (RBD)were made at the time of the first portion release in December 1995, but irnplementationwas delayed pending the approval by Parliament of a Bank Privatization Law, which wasunder discussion for many months in 1996 and early 1997. The Law was finally passed bythe Parliament and was been promulgatedl by the President in May 1997.

25. The previous preparatory work arLd valuation of RBD undertaken by Credit(Commercial de France and Deloitte and l'ouche are to be updated from end-1995 to April1.997 as soon as the Privatization Commission for RBD is appointed. Implementation isexpected to follow swiftly, given the excellent financial condition of the RBD, theadvanced state of preparedness of its management, and the considerable investor interestin RBD.

14 Loan Agreement: Schedule 4. Section 1. Item 9 which reads: Observance of the limnits on financialsupport by the Government of the Borrower, the Financial Recovery Fund and SOF to state-ownedenterprises as agreed upon by the Borrower and the Bank.

Loan Agreement: Schedule 4. Section I. Item 11, which reads: Implementation of the privatizationaction plan of the Romanian Bank for Development, as agreed with the Bank and as adjusted, ifnecessary, in order to reflect the mandatory provisions of the new bank privatization law, if enacted.

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26. Regarding the second bank to be privatized"6, the authorities have selected BancPost. Preparatory work has already been undertaken, which can be riadily updated or"c aPrivatization Advisor is selected. In consideration of the above. a waiver-ii prodosdinrespect of the two second portion rdease conditions for bank privatizatiQn..

NBR Supervision

27.' In compliance with the conditions listed, as per Schedule 4, Section l, Itei 10,1318 and 14"9 of the Loan Agreemer4, the NBk has submitted the required reports.satis&ictory to the Bank, and has increased the staff in its Supervision Departinent to itsfull complement. All banks in Romania are currently being audited by independentexternal auditors, which is a requirement now included in the amended Law on Banks andBanling Activity which is presently awaiting Parliamentary approval. In consideration ofthe above. these conditions for second portion release are satisfied. Ini addition, thepowers of the NBR to supervise the banking system will be enhanced by i number ofamendments to the banking laws20 which have been approved by the Government forsubmission to Parliament. Passage of the improved laws is expected to occur by the endof June, 1997.

Deposit Insurance

28. The second portion condition relating to Government endorsement of a detaileddeposit insurance scheme2' was met by Parliamentary approval in 1996 of a DepositInsurance Law. The new scheme is already operational (a third portion release condition),and the Deposit Insurance Fund is building up gradually from contributions. This

16 Loan Aereement: Schedule 4. Section 1. Item 12 which reads: Finalization of a privanizat.ion plan,satisfactory to the Bank, for a second bank to be privatized, and approval by the general assembly ofshareholders, the Govemrnent of the Borrower, and the NBR, of such privatization action plan.

17 Schedule4. Section I. Items 10, which reads: Submission to the Bank of a report prepared by NBR,demonstrating the compliance of the banks under NBR's supervision with its circular and prudentialregulations, relating to loss provisioning, capital adequacy and the distribution of net profits, anddescribing the measures taken against non-complying banks

is Schedule 4. Section I. Items 13, which reads: Submission to the Bank of a report prepared by NBRdemonstrating progress satisfactory to the Bank in the implementation of Regulation No. 3195,issued by NBR in respect of collateralization of NBR's refinancing credits to banks.

1 Schedule 4. Section I. Items 14, which reads: NBR has: (i) increased the staff of its bankingsupervision department to its full complement; (ii) provided a report demonstrating that on-siteinspections of banks have been carried out in accordance with the inspection program agreed uponwith the Bank; and (iii) issued a regulation requiring mandatory audits of bankss by independentexternal auditors.

20 The Law on Banks and Banking Activity, the Law on the NBR Statute, and the new Law on BankInsolvency.

21 Schedule 4. Section 1, Items 15, which reads: Endorsement by the Government of the Borrower andNBR of a detailed proposal for a deposit insurance scheme, agreed with the Bank.

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onition for second portion release is satisfied. The Bank has also recommended to theGovernment that the adequacy of the funding be reviewed, with a view to increasing thelevies on the banks and obtaining a specific contribution from the State budget.

Chart of Accounts for Banks

29. Preparations are far advanced to require commercial banks to adopt a new Chartof Accounts'7 based on Iriteinal AccoiAting Standards (lAS) as from January 1,1998. The new LAS Chart of Accounts has already been tested on a pilot basis in arepresentadve sample of four banks (large and small, state-owned and private) with a viewto NBR forsnally issuing the Accounting Regulations for Banks on or before June 30,1997, in order that all banks can operate on 'a arallel basis under the old and new systemsduring the second half of calendar 1997 and switch to the new system only at thebeginning of 1998. In consideration of the above. a waiver is proposed in respect of thissecond portion release condition.

Government Report demonstrating that it is current in its obligations to banks

30. The Ministry of Finance is preparing a report stating that, with the exception of itsobligations to the Banca Agricola, which are the subject of a separate agreement in thecontext of the Banca Agricola restructuring, the Government is either (i) current in all itsobligations to banks; or (ii) has agreed to a schedule for complying promptly with anyoverdue obligationsiS. This report is expected to be delivered to the Bank by June 15,1997. In consideration of the above, a waiver is proposed in respect of this secondportion release condition.

The restructuring of Banca Agricola

31. Although not a second portion release condition of FESAL, the restructuring ofBanca Agricola has become a vital element in the banking reform program, given the sizeof this banks (the largest in Romania, aside from the CEC), and the extreme financialdifficulties of this institution that became evident in 1996 and early 1997. TheGovernrnent has recently agreed to take vigorous action to restore the bank's credibility,solvency and liquidity by: (i) appointing new management immediately, who will sign acomprehensive Governance Contract with the Government, the State Ownership Fund andthe NBR; (ii) swapping Lei 2.7 trillion of Treasury bills and bonds in exchange for thewritten-down bad loan portfolio; (iii) requiring Banca Agricola to execute and realizecollateral estimated to be worth Lei 2 trillion (book value Lei 6.5 trillion); (iv) establishingan Advisory Conmmittee, to which the new management must report quarterly; and (v)hiring internationally experienced advisors to assist the new management in downsizing

17 Schedule 4. Section I. Items 16, which reads: Issuance of a regulation by NBR introducing a uniformchart of accounts for banks in accordance with internationally accepted accounting standards.

i Schedule 4. Section I. Items 17, which reads: The Government of the Borrower has prepared a reportdemonstrating that it is current with all its payment obligations to banks, including in respect ofprincipal and interest due to banks in accordance with Law 7/92 and ordinance 1194.

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and turning round the bank, with a view to preparing Banca Agricola for eventualptivatization. A comprehensive letter has been sent by the Government to the Bibk andEBRD, setting out these steps in detail. These actions are expected to reverse tideclining fortunes of Banca Agricola, a necessary step to restoring confidence in thebanking system.

U.L CONCLUSION AND RECOMMENDATION

32. In summary, the program being supported by the FESAL went off track in1996, as the previous Government in the period before the election did not implementor enforce several of the key measures (in particular with regard to financialdiscipline). Since taking office, however, the newly-elected Government developed(with the assistance of the Bank) a significantly stronger program than the original one,announced the program publicly in February, and then immediately implemented thekey first phase of it.

33. Given the progress achieved to date with respect to implementation of the newprogram and compliance with the conditions indicated above, I am satisfied that thesecond portion release is wanranted. It is proposed that the Executive Directors approvethe waiver of the conditions specified in Schedule 4, Section I, Items 5, 8, 11, 12, 16 and17 of the Loan Agreement. Upon such approval, the Bank will notify the Borrower thatthe second portion of USS80 rnillion equivalent is available.

James D. WolfensohnPresident

by Caio K. Koch-Weser

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Appendix 5. Borrower Contribution to the ICR

The FESAL operation has been related to a program that proved to be much morecomprehensive and ambitious in the conditions of a duration of two years, out of whichthe first year has been an electoral year. It is known that the election year is normally lostfrom the point of view of progress, all forces being concentrated on winning the electionand not on the fulfillment of agreed conditionalities. It also proved impossible for oneGovernment to put in practice the conditionalities negotiated and agreed by anotherGovernment.

As a matter of fact, this situation has also been reached because of the unusual longperiod of time for preparing the program (1 992-Jan 1996), almost 4 years, which meantbig expenditures for Bank, results non reflecting the expenditures level, notwithstandingsignificant progress have been made for the structural reform.

A short comparison with the similar programs in other countries shows the conclusionthat, besides the fact that the FESAL has covered a quite difficult period, theconditionalities in the program were too tough as compared with other countries.

Both the Bank and the borrower have drawn lessons from this program for futureoperations. Specific programs with well defined conditionalities and not includingelection years, have important chances to be successful. Moreover, the World Bankinitiative for long term strategies - 1 Oyears (the CDF) - is a very good opportunity toprepare programs in order to maintain the trend of the reforms irrespective of the differentGovernments that might manage the implementation of such programs.

Appendix 6. General Map

IBRD 2871 0

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bi .= NATIONAL CAPITAL1- ~~~~~EXPRESSWAY

C ~~~~~~~~~~~~~~~~~~~~~~,MAJOR ROADS

T. KiAi- j3.OTHER PORTS

/UG O SLA V A I AE. 4 n _ T A RIVERST. Bodopon0 COUINTY (JUDET) BOUNDARIES

_ O Thiswosroducke A b y L J INTERNATIONAL BOUNDARIES

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world bank documentdocuments.worldbank.org/curated/en/933231468293468699/pdf/multi... · 1998. when...

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