Romania - Structural Adjustment Loan

Docaunent of The World Bank FOR OMCIL USE ONLY Report No. 14726 INFLEMENTATION COMPLETION REPORT ROMANIA STRUCTURAL ADJUSTHMT LOAIN JUNE 21, 1995 Country Operations Division Country Department I Europe and Central Asia Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Leu (plural Lei) US$1 = 1773.9 Leu I = US$ 0.00056 Lei per US Dollar Official 1989 14.92 1990 22.43 1991 76.39 1992 307.95 1993 760.05 1994 October 1752.95 1994 November 1756.55 1994 December 1773.90 WEIGHTS AND MEASURES Metric System FISCAL YEAR OF BORROWER January I - December 31 ABBREVIATIONS AND ACRONYMS Cc Commercial Company CCFF Compensatory Contingency Fund Facility CMEA Council for Mutual Economic Assistance EBRD European Bank for Reconstruction and Development EU European Union FESAL Financial and Enterprise Sector Adjustment Loan G-24 Group of 24 GDP Gross Domestic Product GOR Government of Romania IBRD Intemational Bank for Reconstruction and Development ICB International Competitive Bidding ICR Implementation Completion Report IDA International Development Agency IDP Industrial Development Project IMF International Monetary Fund JEXIM Japan Export and Import Bank MoF Ministry of Finance NBR National Bank of Romania RA Regie Autonome SAL Structural Adjustment Loan SAR Staff Appraisal Report SBA IMF Standby Arrangement SOE State-owned Enterprise SOF State Ownership Fund STF Systemic Transformation Facility TACI Technical Assistance and Critical Imports Loan  FOR OFFICIAL USE ONLY IMPLEMENTATION COMPLETION REPORT ROMANIA STRUCTURAL ADJUSTMENT LOAN [Loan no. 3481-RO] CONTENTS Preface ........................................................... i Evaluation Summary . ................................................. ii PART I. Project Implementation Assessment ...... ....... ..1................... A. Introduction ................................................ 1 B. Macroeconomic and Reform Background to the SAL ...................... 1 C. Achievement of Project Objectives ................................. 3 D. Implementation Record: Compliance and Constraints ..................... 6 E. Bank Performance ........................................... 7 F. Borrower Performance ......................................... 7 G. Sustainability . ............................................. 7 H. Assessment of Outcome and Key Lessons Learned ....................... 9 PART II. Statistical Tables .....................11........................ 1 Table 1: Summary of Assessments .................................. 12 Table 2: Related Bank Loans/Credits ................................. 13 Table 3: Project Timetable ....................................... 13 Table 4: Loan/Credit Disbursements: Cumulative Estimated and Actual ... ....... 14 Table 5: Key Indicators for Project Implementation ........................ 14 Table 6: Project Financing ....................................... 14 Table 7: Status of Legal Covenants .................................. 15 Table 8: Bank Resources: Staff Inputs ............................... 17 Table 9: Bank Resources: Missions ................................. 18 Appendices: A. Mission's aide-memoire B. Borrower contribution to the ICR C. Map This documcnt has a restricted distribution and may be used by recipients only in the performance of their |official duties. Its contents may not otherwise be disclosed without World Bank authorization.l   IMPLEMENTATION COMPLETION REPORT ROMANIA STRUCTURAL ADJUSTMENT LOAN [Loan no. 3481-RO] Preface This is the Implementation Completion Report (ICR) for the Structural Adjustment Loan in Romania, for which Loan 3481-RO in the amount of US$400 million equivalent was approved on June 2, 1992 and made effective on July 20, 1992. The loan was closed on December 31, 1994 compared with the original closing date of December 31, 1993. The first tranche, released upon effectiveness, was fully disbursed by March 31, 1994. The second tranche was released on April 27, 1994 and was fully disbursed by December 31, 1994. Cofinancing for the project was provided by Japan Export-Import Bank for US$100 million and a Dutch Grant of 15 million guilders. The ICR was prepared by Farid Dhanji, (Senior Economist, ECICO) and reviewed by Christiaan Poortman (Division Chief, ECICO) and George Zaidan (Project Adviser, EC1DR). The Borrower provided comments that are included as an appendix to the ICR. Preparation of this ICR was begun during the Bank's final supervision/completion mission, in December 1994. It is based on material in the project file. The Borrower contributed to preparation of the ICR by preparing its own evaluation of the project's execution and initial preparation, and commenting on the draft ICR.   - ii - IMPLEMENTATION COMPLETION REPORT ROMANIA STRUCTURAL ADJUSTMENT LOAN [Loan no. 3481-RO] Evaluation Summary Introduction i. In December 1989, the communist regime of Nicolae Ceausescu was overthrown, and Romania began the process of transforming its political and economic institutions. ii. Three Governments have been in place since 1990, each committed to a program of structural reforms aimed at turning one of the most centrally controlled and managed economies in the region into a market economy. The three Governments have shared an approach of gradualism in reform and have sought to protect the population from the harsher social costs of the transition. The Structural Adjustment Loan (SAL) was prepared under the first two Governments, negotiated with the second and largely implemented by the third. iii.. Early in 1990, Romania resumed its relationship with the World Bank and other international financial organizations. The Bank prepared a comprehensive economic report' that helped establish the reform agenda and the bases for adjustment lending. In response to the new Government's request for immediate assistance, the Bank mounted a Technical Assistance and Critical Imports loan to assist the authorities build the institutional capacity for a market economy, and thus complement SAL actions. A loan to the Health sector was approved in 1991. The SAL was approved in June 1992 and was conceived as part of the program of international support to the country's economic reform program, which also included co-financing by the Export-Import Bank of Japan, an IMF Stand-by and drawings from the Compensatory Contingency Fund Facility, and a G-24 bilateral program. After second tranche release, the Netherlands provided grant co-financing. iv. The situation facing the Government and the Bank at the inception of the SAL was complex and difficult. International reserves had been depleted, a large fiscal deficit was developing, output was falling sharply and inflation was accelerating. The country was facing an incomplete and faltering price liberalization, a potentially explosive consumer subsidy bill, and large inter-enterprise arrears that threatened to further undermine financial stability. The SAL was designed to support an ambitious and comprehensive adjustment program that addressed the causes of instability, and establish programs that would deepen systemic change in the transition to a market economy. In the event, the SAL became the centerpiece of the Bank's dialogue with Romania on issues of stabilization and systemic reform for a period of almost three years. Project Objectives and Achievements v. Broadly conceived, the SAL had two main objectives: (i) to support stabilization efforts, while maintaining the momentum of price liberalization and the progressive opening of the economy; and (ii) to further structural reforms and to expand private ownership. I Romania: The Challenge of Transition (Volumes I & II), Report No. 9497-RO, December 3, 1991.  - iii - vi. To promote achievement of project objectives, an ambitious program of actions was agreed upon between the Bank and the Government: stabiization measures complemented IMF SBA actions on monetary and fiscal policy by focussing on the elimination of consumer subsidies; price and trade liberalization was to be accomplished by substantially deregulating price setting in the economy, and by drastically reducing the number of export restrictions; in addition specific actions on raising energy prices were sought; specific privatization targets were set; enterprise financial discipline was to be secured by a series of actions resulting in a measurable reduction in the volume of inter- enterprise arrears; improving public sector management focussed on reducing the number of regies autonomes (RAs) and in establishing a public investment unit; finally, the SAL supported the establishment of a unified family benefits scheme. vii. Over the broad range of involvement the SAL can be judged a success, although progress was uneven and implementation slower than expected. At the time the loan was closed, Romania was closer to achieving macroeconomic stability than at any period in the previous four years; inflation had been reduced from an annual rate of nearly 300 percent in 1993 to almost 60 percent in 1994 and the budget deficit was about 2 percent of GDP; consumer subsidies were entirely eliminated. Substantial progress was made in liberalizing price setting and in aligning energy prices to world market prices. Further actions remain to be taken, however, in reducing the Government's role in price setting, and in maintaining energy prices at levels agreed to under SAL formulae. The number of export restrictions were reduced by about 90 percent. The privatization targets of the SAL were met, although a year later than expected, with about 3000 small shops and businesses privatized as well as about 600 medium- and large- scale enterprises. Although the Government has since developed a mass privatization program, a lengthy design and legislative course has slowed the momentum of privatization. Measures taken by the Government to reinforce and maintain enterprise financial discipline resulted in a significant reduction in the aggregate enterprise "arrears to turnover" ratio from 40 percent to about 12-14 percent. Although this technically did not meet the SAL criterion of 7.5 percent, progress was considered sufficient to allow release of the second tranche. Achieving enterprise discipline remains, nonetheless, a continuing issue for securing stabilization gains and achieving efficiency. A public investment unit was created as agreed under the SAL, and served effectively to filter entries to the capital budget. The areas of activity of the RAs was clarified and the number of RAs subsequently reduced by 50 percent. And finally, a new unified family benefits was instituted by abolishing a tax credit for employees with children and making the child allowance universal and equal for all children. viii. The SAL was ambitious and complex, with a large number of agreements to be fulfilled. In retrospect, it appears clearer that while the SAL did meet its objectives, a simpler design might have been considered. Even so, the core elements of stabilization, price liberalization, privatization and financial discipline would, almost certainly, have been part of any adjustment operation, as actions on each issue complemented and reinforced actions in other areas. These, indeed, were precisely the areas in which implementation difficulties were experienced, and would likely have been experienced, even in a less complex operation. Implementation Experience ix. Implementation of the SAL was satisfactory, although delays were experienced. The loan became effective in July 1992 and the first tranche was released upon effectiveness, and disbursed by March 1994 (with almost the entire tranche disbursed by October 1993). After an extension of the closing date by a year, due largely to the change in Government, the second tranche was released in April, 1994--an interval of 21 months (see para xii below)--and was fully disbursed by December 31, 1994. x. The most important factor affecting implementation of the SAL was the fact that the loan was negotiated with one Government and implemented by another.  - iv - xi. The new Government that took power in November 1992 was elected on a platform to continue reform measures. While initially surprised by the breadth and scope of commitments under the SAL, the Government moved rapidly to establish "ownership." Understandably, however, through much of the ensuing period, the Government was in continuous negotiation with the Bank over these commitments, and needed time to understand and accept those commitments; eventually, policies and programs were put in place. xii. Implementation of the core SAL actions was not smooth. Macroeconomic conditions deteriorated sharply in 1993, as the Government attempted to dampen domestic inflation by controlling the nominal exchange rate while maintaining highly negative real interest rates. Credibility eroded as the exchange rate became increasingly overvalued, a flight from domestic currency accelerated and inflation soared to 300 percent. In late 1993. measures were taken to restore consistency in the application of policy instruments, and the outcome was a much improved performance in 1994. The same worries about domestic inflation also led to protracted discussion of price liberalization measures; while a substantial deregulation occurred in mid-1993, the Bank assessed this as insufficient for tranche release, and a side-letter was provided by the Government signalling its intention to withdraw further from price regulation by early 1994. The agreement to reduce the volume of inter-enterprise arrears to a measured ratio to enterprise turnover, was initially designed as one indicator of increasing financial discipline. It was much criticized by the Government and, indeed, the Bank's Board had urged staff not to apply the criterion mechanistically. (The Romania SAL was the first to tackle this issue.) While the Bank worked closely with the Government to establish the policies and programs that would harden budget constraints, inevitable lags as policies took effect meant that supporting evidence of adjustment such as plant and product line closures, redundancies and the like, took time to develop. Bank supervision through the life of the loan was continuous and intense, and was much aided by the Bank Resident Mission. xiii. The performance of the Borrower was satisfactory, especially given the changes in Government - since 1990, twice interrupted by political demonstrations, the lack of experience with market economics, and insufficient technical and institutional capacities to design and implement reform programs. Procurement and disbursements went relatively fast once the loan tranches were released, although unfamiliarity with Bank procurement procedures, and occasional lack of interest in supplying trade documents by newly formed trade companies sometimes caused difficulties. Summary of Fmdings, Future Operations and Key Lessons Learned xiv. The SAL was the center of the Bank's dialogue with the three successive Governments; helped frame the reform agenda for the implementing Government; and attained a high donor visibility, with progress serving as a barometer of progress in structural reforms. Most of the specific objectives of the SAL were achieved. Moreover, the loan provided the building blocks for further adjustment lending, and allowed investment lending to proceed. At the same time, the SAL was the most important resource transfer instrument in the Bank's lending program and contributed to re- establishing Romania's creditworthiness.  - v - xv. The reorientation of vision supported by the SAL towards the development of market institutions and a market economy has strong political support in Romania and sustainability appears secure in this regard. Nonetheless, debates remain active in Romania as to the demarcation of the line between state and market, between control and greater liberalization, and as to the acceptable pace of reform. Since the loan closed, delays have been experienced in carrying through with price deregulation and tariff increases; most importantly, after the initial achievements in privatization, there has been a considerable slowing in momentum, although, as noted, a mass privatization program has recently been legislated. The policies and programs of the SAL should, then, be regarded as an important first step in the transition, which need to be consolidated and deepened. While rapid privatization commands attention, other areas require continuing focus. In particular, macroeconomic stabilization could be threatened by continuing enterprise losses, and concomitant bank losses. The Government has a difficult agenda ahead in tackling the problems of chronic loss makers. Repressed inflation through delayed tariff increases, and incomplete price liberalization, carries substantial economic costs, and failure to take action will only purchase a temporary postponement of difficulties. xvi. A number of lessons emerged from the experience with the Romania SAL: (i) political commitment and the early establishment of "ownership" by the implementing Government, were key to the specific successes in achieving the SAL's major objectives; (ii) early macroeconomic stabilization is vital, and is possible even in severely distorted environments if consistency in the use of instruments is applied. The benefits brought by stabilization to all aspects of the reform process, and to growth, have been substantial and salutary; (iii) allowing large loss makers to enter bankruptcy and close down, often with large regional employment implications, has proven very difficult. This issue does not have an easy answer. It is likely to remain close to the center of the adjustment and reform agenda for some time to come; and (iv) institution building in all functions and endeavors of the market economy was a key part of the SAL. While there has been improvement in the technical and administrative capacities in the public administration in the last three years, much remains to be done. xvii. A number of SAL actions are being supported by activities outside the SAL. Macroeconomic stabilization efforts are being supported by an IMF SBA/STF that has been programmed to run to the end of 1995. Other SAL actions are supported by ongoing or planned Bank operations. The energy pricing actions are reaffirmed in a Petroleum Subsector Rehabilitation Loan and a planned Power Rehabilitation Project. Support for investment programming functions are routinely included in investment operations in order to strengthen institutions. The social safety net is further developed and sustained in an Employment and Social Protection Project. The reform of the enterprise environment is being supported through the development of a Financial and Enterprise Sector Adjustment Loan. This second adjustment operation is specifically designed as a follow up to the SAL and will contain measures that seek to accelerate privatization, provide further impetus to the hardening of budget constraints, and strengthen the financial system.  IMPLEMENTATION COMPLETION REPORT ROMANIA STRUCTURAL ADJUSTMENT LOAN [Loan no. 3481-RO] PART I. PROJECT IMPLEMENTATION ASSESSMENT A. Introduction 1. In December 1989, after a violent overthrow of the old regime (unique to the revolutions of Central and Eastern Europe) Romania began the process of transformation to a market economy. Among the most centrally controlled and managed of all economies in the region, Romania was little prepared for the shocks of transition and reform. The economy was heavily industrialized, intensive in the use of energy and materials, and with a concentration in inefficient heavy industries. The decision to repay all foreign debt, taken in 1982, bequeathed an economy characterized by obsolescent technologies and severely run down for lack of imports. To effect the capital transfer, consumption was severely compressed through the eighties. In the latter half of the decade, investments were directed at huge showcase projects. External contacts, moreover, were sharply curtailed, leaving Romanian society isolated from the rest of the world. 2. The Government that was elected in May 1990 suffered from a crisis of legitimacy that affected Romania's immediate post-revolution political settlement. Beset by popular disaffection manifested in near permanent student demonstrations, it was overthrown in September 1991 by miners rioting in Bucharest over declines in their real wages. It was replaced by a transition Government that lasted a year, until elections in September 1992 saw the election of a Government that has lasted through the present. This last Government initially possessed a precarious tenure as it did not enjoy a Parliamentary majority and has governed through coalitions. SAL preparations were begun under the first Government; the loan was negotiated with the second, and was largely implemented by the third. The three Governments have shared two common approaches to economic management; first, a preference for gradualism in reform in an effort to avoid sharp economic shocks that could affect the delicate political equilibrium; and second, a concern that the population be protected from the social costs of transition. B. Macroeconomic and Reform Background to the SAL 3. In 1990, in the immediate aftermath of the revolution, Romania embarked upon expansionary demand policies to meet pent-up demand for consumer imports. In combination with the collapse of the CMEA, and a sharp reduction in convertible currency exports, the trade balance swung from a surplus of $2 billion in 1989, to a deficit of $3 billion in 1990. By the end of the year foreign reserves were fully depleted. Accompanied by a loss of internal economic coordination as central planning was dismantled without replacement by markets, and disruptions caused by the spontaneous breakup of collective farms, output declined by about 20 percent. Prices were controlled for most of the period, however, and little inflation was experienced. 4. 1he Government's reform agenda. The Government that took power in May 1990 adopted a comprehensive reform program that encompassed the three broad pillars of stabilization, systemic and structural reform, and social protection. A two-tier banking system with an independent central bank was quickly established and the powers of line ministries curtailed and functions redefined. The MoF shed the role of financing enterprise investment programs, and began the process of developing a  market-oriented tax system. Enterprises were divided into RAs or public utility type agencies which were expected to remain in public ownership, and commercial companies (CCs) that were to be privatized. An innovative privatization program, was legislated through which 30 percent of the equity of commercial enterprises was distributed to citizens through private ownership funds with the remaining 70 percent held by a Social Ownership Fund, to be privatized within seven years. A comprehensive land reform, stimulated initially by spontaneous privatization of cooperative land, resulted in 80 percent of agricultural land being privately owned. An unemployment fund was created and a process of pension reform begun. 5. In October 1990, Romania initiated the first of a sequence of a gradual price liberalizations. Gradualism was intended to prevent "excessive" rises in food and raw materials prices, discipline monopoly power, and dampen inflation while minimizing economic disruptions. A stabilization program was adopted (supported by the IMF), in which tight monetary and fiscal policies were accompanied by an initial devaluation and the adoption of a dual exchange rate system. Gradualism in price liberalization, however, created considerable uncertainty in price formation, and fed inflationary expectations that were signaled and amplified in a growing divergence between the official and parallel exchange rates. Further "liberalization" episodes in 1991 only added to the uncertainty and inflation mounted much more rapidly than programmed, to 161 percent. Moreover, enterprises, unused to contract formation rules and often with imprecise governance arrangements, began to accumulate substantial arrears to suppliers that posed a serious threat to economic functioning and financial stability. At the end of 1991, inter-enterprise arrears amounted to almost 80 percent of enterprise turnover. In view of the deteriorating macroeconomic situation tranche releases from the IMF SBA/CCFF facilities were held in abeyance. 6. The Government that assumed power in September 1991 unified and devalued the exchange rate. In the face of considerable political tensions and civil unrest it issued a price decree that slowed price liberalization. The arrears were tackled through a "global compensation scheme" orchestrated by the central bank in which an injection of credit into the financial system allowed enterprises to net out their claims on each other. While this did not, in the event, result in a substantial expansion of overall credit, some banks nonetheless were left holding loans to enterprises that would otherwise have been unable to pay their debts. 7. World Bank Role. The World Bank has played an important role in Romania's transition. The Bank country strategy has been to help promote stabilization and structural reform; to help finance balance of payments requirements; and to help re-establish Romania's creditworthiness through supporting programs of adjustment and reform. 8. A 1990 economic mission provided policy makers with a comprehensive survey of the state of the economy and recommendations on the content of a reform program. The SAL was developed from the findings of this mission. A social sectors mission similarly surveyed the social sectors. In response to a Government request for immediate financial assistance, the Bank mounted a Technical Assistance and Critical Imports Loan (approved in June 1991) followed by a loan to the Health Sector (approved in October 1991). 9. The Bank's SAL (approved in June 1992) was one of a number of international initiatives to support Romania's reform program, including a second IMF Stand-by Agreement (SBA for SDR 314 million) and a Compensatory Contingency Financing Facility (CCFF for SDR 76.8 million). The Export-Import bank of Japan (JEXIM) provided $100 million in co-financing, and was joined (after second tranche release) by a Netherlands grant of 15 million guilders. Bilateral assistance was also provided under G-24 auspices. 10. Following the SAL the Bank has mounted a number of lending operations, including to agriculture, industry, energy, transport and the social sectors. Under preparation for some time has  been a Financial and Enterprise Sector Adjustment Loan, that has been designed as a follow-up to the SAL. The Bank has been an important provider of advice and technical assistance in almost all areas of reform and sectoral development. As Romania has found it difficult to mobilize external support, the Bank organized two Consultative Group meetings, in 1993 and 1994 respectively. 11. Objectives of the Structural Adjustment Program. The situation facing policy makers and the Bank at the inception of the SAL was certainly complex (see above). It was recognized that the paramount requirement was to reduce inflation and stabilize the economy. In this regard, the country was facing an incomplete and faltering price liberalization, a potentially explosive consumer subsidy bill, and the threat of a re-emergence of enterprise arrears that could undermine financial stability. 12. Broadly conceived, the SAL had two main objectives: first, to support stabilization efforts, while maintaining the momentum of price liberalization and the progressive opening of the economy; and second, to further structural reforms and to expand private ownership. An ancillary objective was to provide balance of payments support to an exchange constrained economy. Recognizing the importance of a social safety net, the Bank assured itself during loan preparation that the requisite financial and institutional facilities for unemployment and social assistance were in place; safety net agreements were not then explicitly incorporated into the loan. 13. At the core of the SAL was the view that hard budget constraints should be imposed upon enterprises. It was accepted by the Government and the Bank that further enterprise evasion of financial discipline could vitiate attempts at stabilization and impede growth over the medium term. In addition to (i) complementing IMF supported stabilization efforts, by seeking the elimination of consumer subsidies, the strategy then called for: (ii) accelerated introduction of a liberal market environment, through greater price and trade liberalization and greater internal competition; (iii) the enforcement of financial discipline through Government actions against non-compliant firms to be measured by an arrears target; in addition, the SAL supported the submission of a Bankruptcy Law to Parliament, and the development of restructuring strategies for certain industrial sectors (chemicals, machine building and metallurgy) systemically affected by the transition; and (iv) rapid privatization, as measured by specific targets. In addition, the SAL supported (v) the strengthening of public sector management by reducing the number of RAs and through establishing a public investment unit. Finally, (vi) the SAL sought the establishment of a unified family benefits system. 14. The Romania SAL was ambitious and complex. The design, nonetheless, was appropriate in the circumstances. The core areas of focus--stabilization, price liberalization, financial discipline, and privatization-were all intimately related, and represented the critical reform issues facing the economy. The SAL, moreover, focussed on real reforms, rather than contenting itself with simply establishing a legal and institutional framework that would permit such reforms. Failure to tackle these areas concurrently would have established an incomplete agenda and weakened performance and impact. C. Achievement of Project Objectives 15. The SAL was successful in achieving its objectives, although unevenly across the many areas of involvement. Progress was slower than anticipated, and there has been some weakening of momentum in key areas since the release of the second tranche. 16. Macroeconomic Stabilization. This component of the SAL, with strong leadership from the IMF, has been among the most successful. At the time the loan closed on December 31, 1994, Romania was closer to achieving macroeconomic stability than at any period in the previous four years.  - 4 - 17. The path to greater stability has been difficult, and encompassed a complex interplay between fiscal adjustment, price liberalization, credit and interest rate management, and exchange rate policies. In the course of 1993, the new Government accomplished a salutary fiscal adjustment by reducing the deficit to zero, from 7 percent in 1992, largely through a near complete elimination of consumer subsidies (a SAL condition). A major liberalization of price setting took place in May 1993, although controls remained on a number of important products. The rate of exchange remained controlled and the rate allowed to appreciate, while the level of interest rates for both deposits and lending, for most of the year, were highly negative. These policies eroded credibility: a flight from domestic currency accelerated, widening divergences between the official and parallel market rates were experienced, and inflation soared to 300 percent. The second IMF SBA/CCFF operation was then unable to be completed. 18. In late 1993 the Government, alarmed by the failure of inflation to recede, took steps leading to the free determination of the exchange rate in an interbank auction, as well as raising interest rates to positive levels in real terms. With the adoption of these measures a new IMF Stand-by (accompanied by a drawing from the Systemic Transformation Facility) was put in place in April 1994. 19. Macroeconomic performance improved substantially in 1994. By the end of the year inflation had been reduced to almost 60 percent. The budget deficit was about 2 percent of GDP. The current account deficit in the balance of payments was I percent compared with the previous high of almost 9 percent of GDP in 1990; exports, in particular, were performing well after having to absorb the shock of the disappearance of the CMEA. Unemployment had risen to almost 11 percent of the labor force, some 6 percentage points higher than in the year the SAL was signed; real wages were some 60 percent of pre-reform levels. The output decline was halted in 1993 with GDP growing by 1.3 percent, with a further increase of 3.4 percent in 1994. 20. Systemic and Structural. A number of important accomplishments of the SAL were recorded in the area of systemic reform. a. Prices and Trade (i) By mid 1993, price setting in the economy was largely liberalized and consumer subsidies eliminated; a 30 percent margin restriction on markups was removed for most products, and a 90-day notification period for price changes was reduced to 30 days. As in market economies, utility prices remained subject to control. Controls were retained on low-quality bread, and on milk. The Government continued to establish procurement prices for major agricultural commodities, but introduced "premium" payments to farmers to approximate state prices with prices obtainable in the free market. While deregulation was substantial it fell short of full SAL compliance, as price setting for a number of products continued to be controlled. A side-letter by the Government undertook further liberalization by March 1994. This regime of improving price liberalization continued until late 1994 when, however, the Government re-introduced regulations on price formation on a small number of food items. (ii) The SAL established a number of agreements concerning energy prices in an attempt to align these more closely with economic cost. These agreements were attained in the course of 1993 and maintained through the first half of 1994. There has been a substantial lag, however, in raising domestic energy prices since the release of the SAL second tranche.  (iii) The SAL sought the elimination of most export restrictions, in particular a number of export bans. These were reduced by about 90 percent during the life of the loan, and non-binding export quotas opened for the two large remaining items, wheat and maize. b. Privatization (i) The privatization targets of the SAL were met, although a year later than expected. The loan called for the privatization of some 3,000 shops, service businesses, restaurants, workshops and the like (the so-called "small privatization"), as well as for the privatization of about 20 selected state-owned firms. By closing date, the Government had privatized over 3,000 small firms and almost 600 medium and large CCs. c. Financial Discipline (i) Progress was made in hardening the budget constraints for enterprises. Implementation, however, proved difficult. The Government designed a system for monitoring enterprise financial results on a monthly basis, allowing for a better control of arrears. A set of 30 enterprises accounting for the largest amount of arrears, losses and compensation credits, was initially selected for special monitoring. However, the Government experienced difficulties in taking action on these initial 30 enterprises, mainly due to the high political cost of restructuring, liquidating or privatizing them. A Restructuring Committee was then created and, by end-1993, a "financial isolation" exercise established. The Government selected another set of 30 enterprises to be placed under special surveillance and an Action Plan for restructuring, downsizing, labor shedding and liquidation or/and privatization was developed. The Parliament adopted a law allowing for easier declaration by creditors of debtor insolvency, while the Government declared a number of firms insolvent. These actions coupled with the introduction of interest on arrears had a strong demonstration effect. The SAL prescribed a reduction in the aggregate enterprise arrears to turnover ratio from 40 percent to 7.5 percent. In the event, the ratio was reduced to about 12-14 percent and performance was judged sufficient to proceed with second tranche release. d. Public Sector Strengthening (i) A public investment unit was created and staffed as agreed under the SAL. A number of investments of dubious economic merit were suspended as a result of the work of this unit. Moreover, only investments included in the Public Investment Program were provided budgetary support. (ii) The Government clarified the areas of activity appropriate for the RAs (essentially conditions of natural monopoly), and reduced their number by almost 50 percent. Further rationalization is warranted. e. Family Benefits (i) Under the SAL-supported actions, a new unified family benefits system was established in October 1993, abolishing the previous inefficient duplicative family benefits program.  -6- D. Implementation Record: Compliance and Constraints 21. Implementation of the SAL was satisfactory, although delays were experienced and there was an uneven pace of adoption of measures. The loan became effective in July 1992 and the first tranche was released upon effectiveness; all but US$ 1.8 million of the initial tranche of US$ 250 million was disbursed by October 1993, and the tranche was fully disbursed by March 1994. After an extension of the closing date by a year, largely due to the change in Government, the second tranche was released in April, 1994-an interval of 21 months--and was fully disbursed by December 1994. 22. The most important factor affecting implementation of the SAL was the fact that the loan was negotiated with one Government and implemented by another. 23. The new Government that took power in November 1992 was elected on a platform to continue reform measures. The Government did not, however, enjoy a Parliamentary majority. Although initially surprised by the breadth and scope of commitments under the SAL, the Government moved rapidly to establish "ownership." Nonetheless, through much of the ensuing period, the Government was in continuous negotiation with the Bank over these commitments, and needed time to understand and accept those commitments; eventually policies and programs were put in place. 24. Three of four central components of the SAL--macroeconomic stabilization, price liberalization and enterprise financial discipline--proved difficult to implement. As noted earlier, macroeconomic stabilization was delayed by a full year as the Government tried to dampen domestic inflationary pressures by allowing the exchange rate to become seriously overvalued; this policy mistake was abetted by holding interest rates negative in real terms, and continuing attempts to directly influence key domestic prices. Fragmentation in decision making was probably the source of the failure to apply consistent policies. Similar difficulties were experienced in price liberalization, where ever present anxieties about monopolistic pricing, excessive speculation, and impacts of price increases on already declining living standards generated resistance to rapid price deregulation. 25. Imposing financial discipline proved especially difficult. The Government moved commendably early to establish an "early warning" monitoring system. However, the law establishing ownership funds had explicitly placed control over state-owned enterprises in a "State Ownership Fund" (SOF), that answered to Parliament and not to the Government and that, further, had been given charge of enterprise restructuring activities. Moreover, the enterprises themselves, having been commercialized and granted autonomy in operations, were resistant to what they perceived as a reimposition of central monitoring. Much internal discussion and negotiation was then required before an agreed set of policies could be implemented. The inevitable lags as these policies took effect meant that supporting evidence of enterprise adjustment such as plant and product line closures, redundancies, improvements in financial performance and the like, took time to develop. 26. In the period before the release of the second tranche two features of the SAL came in for especial criticism. First, the Government suggested that the condition of "maintaining a satisfactory macroeconomic policy framework" was vague and imprecisely defined in advance by the Bank. This led the Borrower to be unsure which specific actions or outcomes would prove adequate. Explicit macroeconomic "performance criteria" were, in fact, deliberately eschewed at the time of Board presentation, on the grounds that these could only be poorly defensible guesses in circumstances of such deep structural and systemic change. It still remains unclear that the ex ante provision of quantitative outcome indicators should have been provided or, had they been provided, performance would have proved sufficiently satisfactory to advance second tranche release, especially in the absence of agreement with the IMF.  27. A second criticism was that the arrears to turnover ratio, that carried the burden of judging whether financial discipline was being achieved, was mechanistic and could not capture qualitative dimensions of progress. On this latter criticism the Bank agreed; indeed the Board had instructed staff at time of approval not to apply the criterion too rigidly. It took a number of visits by Bank supervision missions to develop the modalities by which financial discipline would be introduced. Part of the difficulties lay in agreeing to the measures that should be undertaken; in part, difficulties were experienced in establishing the legal and institutional framework and the technical competencies to bring the necessary discipline to bear. Once it became apparent, however, that the adopted measures were in fact achieving their intended effect, the Bank saw no objection to the release of second tranche even though the precise arrears criterion had not been met. E. Bank Performance 28. Bank performance was satisfactory. The Bank entered into close and constant interaction with counterparts in all stages of the SAL, with especially intense supervision. All three Governments welcomed the financial and technical support provided to Romania's reform program. At the design and negotiation stages, successive missions interacted closely with the Prime Minister and relevant members of the Cabinet. This visible high profile at the preparation stage was instrumental in allowing consensus on design to be achieved. It was recognized that the arrears problem presented a new challenge for adjustment policy, one not met before in Bank policy lending. The approach in the Romania SAL was comprehensively discussed by staff and by senior Bank management before being agreed to by the Romanian authorities. 29. Relations with the IMF were close at all stages in the SAL cycle with staff from the Bank often overlapping with Fund missions and vice versa. The dialogue was especially close in late 1993, when the IMF and the Government agreed on a new Standby, thus opening the way for release of second tranche once the Fund's prior conditions had been met. F. Borrower Perfornance 30. Borrower performance was satisfactory, especially given the difficulties of obtaining domestic political consensus, and that vital technical capacities had to be built during implementation. The policy dialogue involved the Prime Minister and his Cabinet as well as senior officials from the MoF, line Ministries, Government agencies and the NBR. The MoF was the implementing agency. At the time implementation commenced the Government established an Interministerial Committee of all institutions involved. This greatly facilitated the dialogue--both internally as well as with the Bank. 31. Disbursement/Procurement Issues. Procurement and disbursements proceeded relatively quickly once the loan tranches were released. The loan proceeds financed all imports excepting a usual negative list of ineligible items such as arms, nuclear reactors and parts, and luxury products. Procurement proceeded satisfactorily even though many Romanian foreign trade companies found it difficult to comply with Bank procedures; difficulties were occasionally encountered as there were no incentives for the trade companies to provide import documents. G. Sustainability 32. In the broadest sense, the SAL supported a number of actions of central consequence to a transformation from one economic system to another. The reorientation of vision towards market institutions has strong political support in Romania and this is very unlikely to change. Moreover, the actions supported by the SAL--stabilization, price and trade liberalization, financial discipline, privatization have become better appreciated--both as goals, as well as the instruments required to achieve them. As may be expected, however, debates remain active in Romania as to where the line should be drawn between market and state, between intervention and laissez faire, between control  - 8 - and deregulation, and also as to the pace at which reforms are politically sustainable. Occasional retreats have been experienced with respect to SAL accomplishments, and the momentum of privatization in particular, has visibly slowed. While the SAL's achievements are many, it is clearly only the first step in a long process. 33. Consolidation and deepening is required in a number of areas for the economy to be placed on a path of sustainable long term growth. Macrostabilization, despite the accomplishments, remains of concern as financial discipline is not firmly rooted in the behavior of all economic agents; if enterprise losses are ultimately monetized, renewed instability is a likely outcome. In this regard the Government has a difficult agenda in tackling the problems of chronic loss makers and devising programs for liquidation. Price liberalization has advanced but further deregulation is required if the appropriate relative prices are to guide decision making. Moreover, a propensity to delay tariff increases for public utility services, albeit often rooted in concern for living standards, has become increasingly evident and should be replaced by clear rules of automaticity. The focal point of future reforms must be privatization. A Mass Privatization Program has recently been legislated, and contains the potential for rapid divestiture, and a shift of controlling interests to the private sector. To secure the full potential benefits of the law will require imagination, and most of all, political will. 34. A number of SAL actions are being supported by activities outside the SAL. Macroeconomic stabilization efforts are being supported by an IMF SBA/STF that has been programmed to run to the end of 1995. Other SAL actions are supported by ongoing or planned Bank operations. The energy pricing actions are reaffirmed in a Petroleum Subsector Rehabilitation Loan and a planned Power Rehabilitation Project. Support for investment programming functions are routinely included in investment operations in order to strengthen institutions. The social safety net is further developed and sustained in an Employment and Social Protection Project. The reform of the enterprise environment is being supported through the development of a Financial and Enterprise Sector Adjustment Loan. This second adjustment operation is specifically designed as a follow up to the SAL and will contain measures that seek to accelerate privatization, support more specific policies and programs to enforce financial discipline, and strengthen the financial system. H. Assessment of Outcome and Key Lessons Learned 35. The SAL was at the center of the Bank's dialogue with successive Governments for a period of three years, with other international institutions and financiers, and often the press, looking on to receive the Bank's verdicts on the progress of structural reforms. As a result, the loan acquired a prominence and visibility unusual even for loans of this type. While good relations were maintained with the implementing Government during the period, there were occasional times-especially in the period during which the second tranche release was delayed--when strains were experienced. Moreover, other Bank lending was delayed because of the delay in tranche release. Despite these difficulties, the SAL can be judged a success. It proved to be a principal instrument in framing the immediate reform agenda for a new Government while providing multiple areas of policy dialogue for the Government and the Bank. Most of the specific objectives of the SAL were achieved. Moreover, the loan provided the building blocks for further adjustment lending, and allowed investment lending to proceed. Finally, the SAL secured an important resource transfer, including through co-financing, at a time when Romania was finding it very difficult to borrow abroad. (i) Political commitment and the early assumption of ownership by the implementing Government has been key to success. This commitment was maintained despite difficulties in obtaining domestic political consensus, and even when there were differences of opinion about actual policies as well as speed of implementation. The sustainability of the changes brought about the SAL require continuing commitment, even in the absence of policy agreements embodied in a new adjustment operation.  - 9 - (ii) The change in Government necessitated a substantial investment by the Bank in consultation and supervision. Flexibility in implementation became important in these circumstances, while holding fast to the core vision of the SAL. (iii) The SAL was ambitious, comprehensive and complex. This proved cumbersome to the implementing Government, and increased supervision burdens. In retrospect, while greater simplicity might have been sought, it is unlikely that any SAL prepared at the time could have avoided addressing the complementarities that existed betwoon the major areas of focus-stabilization, price liberalization, financial discipline, and privatization. The implementation difficulties experienced in some of these areas would then have surfaced in a less complex loan. (iv) The central importance of early macroeconomic stabilization emerges as a key lesson of the SAL. In retrospect, inflation was used as a solvent for formidable political and social demands in the wake of a collapsing economy and major systemic change. While the political difficulties intrinsic to Romania's transition may have been underestimated, nonetheless, the delayed stabilization amplified uncertainty and postponed recovery. The vital importance of consistency in applying the instruments of macroeconomic policy also emerged as a lesson of the Romanian experience. Gradualism in price liberalization, accompanied by a controlled exchange rate overvaluation, and highly negative real interest rates eroded credibility in economic management and placed the economy on the brink of hyperinflation. (v) The SAL supported privatization and achieved its specific agreements in this regard. Nonetheless, privatization slowed after the initial "targets" were met. Had this been foreseeable, SAL design should have placed greater emphasis on achieving a more rapid pace of privatization. (vi) Allowing large loss making-enterprises to go bankrupt has proven extremely difficult. TMe SAL attempted to put in place an environment that secures financial discipline, and was successful in reducing the levels of involuntary inter-enterprise credit. Nonetheless, large loss makers have managed to stay bankruptcy proceedings. In parallel, demands for subsidies and new investment monies by the beleaguered enterprises has been strong, even as the Government budget is pressured by weak revenue sources and high social expenditures. Some bank portfolios have experienced continuing strain because of the difficulties of their clients. These problems do not have an easy, one-dimensional solution. They are likely to remain close to the center of the adjustment and reform agenda for some time to come. The Bank's lending program has been developed to help address the difficulties. (vii) Institution building in all functions and endeavors of the market economy was a key objective of the SAL. While there has been some improvement in human resources and technical and implementation capacities in the public administration in the last three years, much remains to be done.  - 10- PART H. STATISTICAL TABLES Table 1: Summary of Assesments Table 2: Related Bank Loans/Credits Table 3: Project Timetable Table 4: LoanlCredit Disbursements: Cumulative Estimated and Actual Table 5: Key Indicators for Project Implementation Table 6: Project Financing Table 7: Status of Legal Covenants Table 8: Bank Resources: Staff Inputs Table 9: Bank Resources: Missions  - 11 - Table 1: Summary of Ausesments A. Achievement of objectives Substantial Partial Negligible Not Applicable Macro policies EXl El El