Statement by Jan Piercy at the Board meeting of March 18, 1997

CONFIDENTIAL International Bank for Reconstruction and Development 87612 International Development Association International Finance Corporation Multilateral Investment Guarantee Agency FOR OFFICIAL USE ONLY EDS97-79 March18,1997 Board Meeting of March 18, 1997 Statement by Jan Piercy China: Country Assistance Strategy 1. We come to this CAS at a time of leadership change in China and I welcome the Board's discussion of the country assistance strategy. As China is the Bank's largest borrower, the strategy we discuss today will define the Bank's relationship with China until the turn of the century. We need to be focused and selective for the Bank Group's assistance to target areas where the Bank can make a difference. The Bank has a major opportunity to assist the Government in addressing the challenges China faces in a catalytic and innovative manner. In two visits to China in the last year, I have had the chance to meet our very effective Resident Mission team and to witness the Bank's broad engagement in the field. 2. China has made great progress in its economic reform program and should be commended for its efforts to develop a market-oriented economy. This process, however, is incomplete, as the Ninth Five Year Plan clearly recognizes. One cannot fail to note that many of the problems facing China are a result of the incomplete and partial nature of these reforms. In the financial sector, state-owned enterprises, public sector management, and the enabling environment for the private sector, much remains to be done to foster a sustainable economy. The challenges of reducing poverty, funding social sector programs, protecting and cleaning up the environment, and dealing with the growing inequity between rural and urban areas, particularly coastal and marine provinces, must also be tackled.· 3. China's very large reserves and huge inflows of private capital afford a unique opportunity for the Bank to narrow its focus to activities in which it has a distinct comparative advantage, particularly in the poorer, rural regions which have been slow to benefit from overall national growth. Poverty reduction should be paramount. As the IDA 11 report clearly states, this includes "providing further support to the agriculture and informal sectors, which are the principal sources of income for the poor; expanding poor people's--and especially poor women's--access to land, credit and information; establishing basic labor standards and working conditions; and reforming legislation and policies that disadvantage the poor." In this regard, we commend China for the attention it has placed on educating girls. 4. I, therefore, have reservations about the CAS which we discuss today. Given the major challenges the CAS effectively outlines, we find it difficult to discern a clear strategy and set of priorities for the This document has a restricted distribution and may be used by recipients only in the perfonnance of their official duties. It should not be distributed without the consent of the Executive Director concerned. ,.  ,, 2 Bank Group. Additionally, in our opinion, this CAS is not up to the standard we now expect from the Bank-- it has no alternative lending levels, no triggers for the Bank's program, and a list of priorities which simply parallels the government's own five theme agenda. While this may appropriately reflect China's own priorities, these arenas are too broad to focus the Bank's work selectively. I think this is inadequate for a country which will consume almost twenty percent of the Bank's lending in coming years. 5. While I welcome Box 4 and the Bank's support for poverty reduction, I regret that this is such a small portion of our work in China. It is unclear to me how the Bank can meet this primary mission in China. The underfunding problem for social sector services, most notably education and healthcare for the rural poor, is flagged, but without any numbers. This becomes all the more acute as IDA resources will no longer be available after IDA 11 and the Bank has been unsuccessful in urging China to borrow on IBRD tenns for social sector projects as have other countries in the region. What evidence is there that provinces and municipalities will borrow on IBRD terms for social sector projects as is cited in paragraph 41? At the same time, we are told that China can afford to recapitalize its banking system if needed, and note that the new budget includes a 12.7 percent increase in military expenditures. Such expenditures fly in the face of China's still serious poverty problems and could contribute to expanded pressure on the military budgets of other regional borrowers. 6. Indeed, the Bank cites its limited financial role, now dwarfed by private capital flows, as the reason it is unable to promote and obtain further policy advances. We question the logic that Bank involvement in financing power projects and highways, particularly in coastal provinces, serves as a demonstration effect to promote economic policy changes which will open the market to greater private sector participation and directly promote poverty reduction. This is particularly true of the interior provinces, which the Bank's own research indicates are being overlooked. 7. The Bank's program in China is biased to heavy infrastructure, with almost half the lending program in the power and transport sector. We cannot help but wonder if this is an efficient allocation of resources, when China can attract large flows of private capital and the private sector stands ready to invest in_ infrastructure, if only the appropriate legal and regulatory framework were in place. 8. In fact, I was bard-pressed to find reference to "private sector development" or "privatization,'~ policies which the Bank vigorously promotes elsewhere. While China may be reluctant to move forward in these areas, the Bank's hesitation to strongly advocate these policy changes serves no one's interest and sends the wrong signal to China and other Bank borrowers. This said, I do recognize the challenges of privatizing SOEs when social services are closely linked to these organizations. We, therefore, welcome the Bank's efforts in pension reform and delinking social services. 9. For example, the poor management of state-owned enterprises is widely recognized in China and is highlighted in the CAS. SOEs are now a drain on the economy. They are also inextricably linked to the financial sector woes, as state-owned banks and financial institutions have had to provide the bulk of their financing to SOEs. While the CAS recognizes this as a problem, the Bank's strategy is unclear.  3 10. Past efforts to support restructuring have largely failed, and we can no longer support assistance to SOEs for modernization improvements and-expansions, even under the guise of environmental improvements. Promoting, through policy dialogue and reform and the development of economic and regulatory frameworks, a legal and economic basis for new institutions such as TVEs, proprietorships and privately owned enterprises could go a long way to address these and other problems. 11. In a related area, other than small technical assistance, I can find no clear strategy, with benchmarks and performance based triggers, for supporting trade and investment reform, which is also necessary to catalyze greater private sector interest. 12. Other Bank initiatives are hardly mentioned. Enhanced participation by affected people seems to play only a minor role in China. While the Chinese portfolio is enviable for its implementation record, I wonder if increased participation would not provide for better designed and more effective projects in areas other than infrastructure. I note here that the seven problem projects in the China portfolio are all in rural and social development, strategic areas that this Board has reaffirmed as priorities in the past year. 13. The government of China clearly recognizes its major environmental problems and we welcome the Bank's ongoing research in this area. I wonder however, if the $300 odd million allocated to environment, much of it in the industrial pollution area which supports state-owned enterprises, outweighs the negative impacts of over one billion dollars of new highways and power plants each year. As a side note, I hope that the Bank is ready to support China's goal of phasing in lead-free gasoline by the year 2000 -- a significant environmental and health improvement. 14. President Jiang Zemin has made a commitment "to take an iron hand in its fight against corruption." We welcome this move and believe that the Bank should actively support this effort. As experience shows, one of the most effective ways to reduce corruption is to reduce the state's role in the economy through economic liberalization, privatization and deregulation. 15. As a global institution, the Bank has broad experience in the policy reforms and investments needed as a country transitions to a market-oriented economy. We provide this advice to our other borrowing countries and require explicit policy reforms linked to investment programs. We should expect nothing less of our largest borrower. 16. I urge management to reconsider the Bank's strategy in China. In the past few weeks we have spent much time discussing the shape and direction of the new Bank -- a Bank which increasingly focuses on poverty reduction and social development; a Bank with a renewed focus on rural development and a reaffirmed commitment to environmentally sustainable development; a Bank which promotes partnership with the private sector and actively encourages an environment which fosters private sector development; a Bank which focuses on participation of all affected groups in a country; and, a Bank which demands selectivity and performance from itself and its borrowers in tackling development challenges head-on. This CAS does not reflect these values in its gradualist approach to policy reform and an investment program which is skewed towards heavy infrastructure. I  4 17. This CAS is a blueprint for the Bank's activity into the 21st century with its largest borrower. As such, I think it clearly illustrates the tensions implicit in the Strategic Compact. While we promote borrower ownership, and I have no doubt about China's ownership of this CAS, the Bank also has developed a number of policy convictions which are clear in the compact, but little evident in this CAS. The Bank needs greater consistency to have credibility in its efforts, internally as well as externally.