Ukraine - Coal Sector Adjustment Loan Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No: 22236 IMPLEMENTATION COMPLETION REPORT (41180) ON A LOAN IN THE AMOUNT OF US$ 300 MILLION TO THE GOVERNMENT OF UKRAINE FOR A COAL SECTOR ADJUSTMENT LOAN June 25, 2001 Energy Sector Unit Europe and Central Asia 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 (Exchange Rate Effective April 2001) Cunrency Unit = Hryvnia (UAH) 1UAH = US$ 0.18 US$ 1 = 5.5 UAH FISCAL YEAR July I - June 30 ABBREVIATIONS AND ACRONYMS ICR Implementation Completion Report IMF International Monetary Fund MCI Ministry of Coal Industry MOF Ministry of Finance QAG Quality Assurance Group UAH Ukrainian Hryvnia UDKR Ukrainian State Company for Coal Sector Restructuring Vice President: Johannes F. Linn Country Director: Luca Barbone Sector Manager: A. David Craig Task Team Leader: Heinz Hendriks  FOR OFFICIAL USE ONLY UIKRAIE COAL SECTOR ADJUSTMENT LOAN CONTENTS Page No. 1. Project Data 1 2. Principal Performance Ratings I 3. Assessment of Development Objective and Design, and of Quality at Entry 1 4. Achievement of Objective and Outputs 3 5. Major Factors Affecting Implementation and Outcome 5 6. Sustainability 6 7. Bank and Borrower Performance 6 8. Lessons Learned 7 9. Partner Comments 8 10. Additional Information 8 Annex 1. Key Perfornance Indicators/Log Frarne Matrix 9 Annex 2. Project Costs and Financing 10 Annex 3. Economic Costs and Benefits 11 Annex 4. Bank Inputs 12 Annex 5. Ratings for Achievement of Objectives/Outputs of Components 14 Annex 6. Ratings of Bank and Borrower Performance 15 Annex 7. List of Supporting Documents 16 Annex 8. Borrower's Contribution 17 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.   Project ID: P040564 Project Name: COAL SECAL Team Leader: Heinz Hendriks TL Unit: EMTIM ICR Type: Core ICR Report Date. June 26, 2001 1. Project Data Name: COAL SECAL L/C/TF Number: 41180 CountryIDepartment: UKRAINE Region: Europe and Central Asia Region Sector/subsector. NN - Mining & Other Extractive KEY DATES Original Revised/Actual PCD: 06/03/1996 Effective: 12/27/1996 12/27/1996 Appraisal: 07/19/1996 MTR: Approval: 12/11/1996 Closing: 12/31/1997 06/30/2000 Borrower/lImplementing Agency: GOVERNMENT OF UKRAINE/MINISTRY OF COAL INDUSTRY Other Partners: MINISTRY OF FINANCE STAFF Current At Appraisal Vice President: Johannes Linn Johannes Linn Country Manager: Luca Barbone Basil Kavalsky Sector Manager: A. David Craig Dominique Lallement Team Leader at ICR: Heinz Hendriks Jonathan Walters ICR Primary Author: Heinz Hendriks 2. Principal Performance Ratings (HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible) Outcome: S Sustainability: UN Institutional Development Impact: SU Bank Performance: S Borrower Pe7formance. S QAG (if available) ICR Quality at Entry: U Project at Risk at Any Time: Yes 3. Assessment of Development Objective and Design, and of Quality at Entry 3.1 Original Objective: (a) To support balance of payment and budget financing needs in late 1996 and in 1997, including part of the fiscal costs of restructuring the coal sector; (b) to help transfonn the coal sector into a self-sustained sector; and (c) to improve the productivity of the coal sector.  These objectives reflected the priorities of the coal sector at that time, as identified by the Government and supported by the Bank's Country Assistance Strategy. Objective (a) was aimned at short-term support, while Objectives (b) and (c) were aimed at progress towards long-term goals that still are very valid today. The underlying actions, as defined in the tranche release conditions, were very demanding. Not all of them were responsive to the sector's circumstances and development priorities. 3.2 Revised Objective: The Development Objective (a) was revised to extend the period for balance of payment support to December 31, 2000. This revision reflects the delays incurred in meeting conditions of release of the original second tranche of US$ 150 million which, at the Government's request and at the Regional Operations Committee approval, was restructured into four smaller tranches (three tranches of US$40 million each and a final tranche of US$30 million) to enable the Government to continue the most crucial task of its coal sector restructuring program, i.e., the closure of uneconomic mines and the mitigation of the social and environmental impact. 3.3 Original Components: The reform program supported by the loan included: * division of all mines into four categories; * a performance contract system for category 2 and 3 mines (MCI); * corporatization of category I and 2 mines; * supervision of category 3 mines by Ministry of Coal Industry; * abolition of all restrictions on coal exports; * abolition of price control; * restrictions on subsidies of category 2 and 3 mines to transitional support for operating costs, no investrnent and constraints on recruitment; * restrictions on state support for category I mines to investment loans (subject to conditions), no operating costs subsidies; * net payables for mines in categories 1-3 not to increase from the 1996 level of UAH3,890 million; * an agreed coal sector budget for 1997; * closure of 40 mines in a socially and environmentally satisfactory manner; and * divestiture of the social assets of 100 mines Not all original components were required to meet the objectives and some components were beyond the control of the implementing agency. Moreover, for the country and the sector, no relevant lessons from prior projects were available at that time. 3.4 Revised Components: The number of mines to be closed was raised to 44 mines, while all unfulfilled conditions for operating mines were waived. During implementation of the program, closure of uneconomic mines was identified to be the single most important action that was fully under control of the implementing agency and had the most positive impact on the operating mines 3.5 Quality at Entry: The ICR rates the SECAL as 'Unsatisfactory' for Quality at Entry because the Loan was restructured later and the conditions for release of the original second tranche proved to be over-demanding, even though norn-achievement of part of those conditions was the result of an unforeseen escalation of barter trade. However, notwithstanding the U rating for Quality at Entry, a sensible and pragmatic response was taken - 2 -  by switching the later phase of the SECAL fully to mine closures. Also, the feasibility of the central task of the reform program, i.e., the closure of uneconomic mines and the mitigation of the social and environmental impact, was confirmed under this adjustment operation. The Coal Pilot Project had provided evidence of the feasibility of mine closures at the time of appraisal of the SECAL and valuable additional lessons from the implementation of the Coal Pilot Project were taken into consideration for the later restructuring of the SECAL. Finally, a Rapid Supervision Assessment, carried out by QAG on July 23, 1999, found that the project design was sound, the project was ready for implementation at approval and the borrower was committed to the project. The use of the SECAL vehicle is considered appropriate because it allowed timely support to the Government at the critical starting phase of its coal sector restructuring. A specific investment operation would have taken much more time to prepare, with the associated risk of slowing down the mine closures. Even after restructuring of the loan, the SECAL vehicle remained appropriate because the conditionality allowed to move forward with mine closures in a difficult environment. The experience gained with implementation of both, the Coal SECAL and the Coal Pilot Project, has been valuable for designing the follow-on project, the Coal Sector Social Mitigation Project, as a specific investment operation. 4. Achievement of Objective and Outputs 4.1 Outcome/achievement of objective: Achievement of objectives and outputs was satisfactory. In particular, the following progress was made towards achievement of the three objectives: (a) To support balance ofpayment and budget financing needs, including part of the fiscal costs of restructuring the coal sector: During the period December 1996 to October 2000, the loan provided $300 million balance of payment support. The Government provided budgetary funds for the restructuring of the coal sector at a rate sufficient to meet the implementation progress criteria agreed with the Bank from time to time for the release of individual loan tranches. This development objective has therefore been achieved, albeit over a longer time period than originally foreseen. (b) To help transform the coal sector into a self-sustained sector: While operating mines are still far from being self-sustained, significant progress was made for the sector as a whole towards achieving sustainability through the closure of more than 70 mines (by the time of the last tranche release), a number significantly larger than agreed under the program. This development objective has therefore been achieved. (c) To improve the productivity of the coal sector: Despite the closure of 49 mines during the period 1995 to 1999, coal production fell by only 3%. Over the same period, both total employment and employment of industrial production workers fell by 24%, corresponding to an increase in the labor productivity of the sector of 27 %. This development objective has therefore been achieved. 4.2 Outputs by components: The outputs of the revised components are fully satisfactory. The closure of more than 70 uneconomic mines is a very significant output that exceeds expectations and more than compensates for the non-achievement of some of the original components. In the following, the significance of outputs from all original components are described. * Division of all mines into four categories: The Ministry of Coal grouped the mines into four categories as agreed. However, the significance of this categorization was largely reduced through non-enforcement of restrictions for operating subsidies and investments. - 3-  * Performance contract system for category 2 and 3 mines: A performance contract system was introduced in 1997. By the second quarter of 1997, some 57% of the managers of the 210 mine administration units had signed performance contracts, with this percentage rising to 93% by the end of the year. Performance contracts were also signed with 34 directors of holding companies. Enforcement appears to have been effective: during 1998, there were 19 dismissals of mine administration unit managers and 8 dismissals of holding company directors for contract violations. * Corporatization of category I and 2 mines: All category I and 2 mines were corporatized at the level of administration units, and are managed by the Ministry through 19 holding companies and 9 production associations. The intention was for the viable mines to be allocated to the holding companies and the unviable mines to the production associations. However, little progress has been made in merging and closing holding companies and production associations to streamline the management of the sector and create viable mining companies or mine groupings. * Supervision of category 3 mines by Ministry of Coal Industry: Category 3 mines are being supervised by the Ministry of Coal, as are most category 1 and 2 mines. The intended separation of category 3 mines from category I and 2 mines was only partly implemented. * Abolition of all restrictions on coal exports: All restrictions on coal exports have been removed. However, because of other distortions, the removal had limited impact. * Abolition ofprice control: Price control has been abolished. However, the full potential impact could not be achieved due to rampant barter trade and non-payment for coal. * Restrictions for subsidies to category 2 and 3 mines: The agreed restrictions (on recruitment and wage increases) as a condition for receiving operating subsidies have been enforced for category 2 and 3 mines through the system of performance contracts with the managers of the mine administration units. Although there have been contract violations, severe violations have been dealt with by the dismissal of mine managers (see above). The constraint on recruitment contributed to the decline of 24% in the number of industrial production workers noted earlier. The restriction on investment in these mines was only partly observed, and some investment support was made available to both category 2 and category 3 mines. The amounts were, however, small because of the overall budgetary restrictions. * Restrictions for investments in category I mines: The system of investment support being provided as repayable loans at the National Bank of Ukraine discount rate (as set out in the Letter of Coal Sector Policy) was generally not implemented, and most investment support continued to be provided on a grant basis. Furthermore, with only a small number of exceptions, the 76 category 1 mines continued to receive operating cost subsidies. - Coal sector budget for 1997: The coal sector budget funds for 1997 were provided by the Government in the agreed total amount; however the use of funds deviated from the program insofar as less funding was provided for restructuring and more for operating subsidies and investments. Also, the explicit condition of not increasing the payables of mines beyond the level of August 1996 could not be achieved. * Closure of 40 mines in a socially and environmentally satisfactory manner: This output has been achieved and exceeded. * Divestiture of the social assets of 100 mines: Limited progress has been made on the transfer of social assets to municipalities. Only 6% of the kindergartens, 8% of the cultural facilities and 19% of the housing had been transferred as at January 1, 2000. Most of these transfers have been taking place at closing mines, and apart from the mines of the Coal Pilot Project, have been concentrated in four production associations. A key issue has been the refusal of regional administrations to take responsibility for the operation and maintenance of the social assets without adequate budgetary support. 4.3 Net Present Value/Economic rate of return: Not applicable. -4 -  4.4 Financial rate of return: Not applicable. 4.5 Institutional development impact: While the SECAL had little impact on improving the institutional framework for operating mines, it had a significant positive impact in strengthening the institutional capacity for mine closures. The mine closure agency UDKR became a unique institution which, largely thanks to the SECAL, executed its tasks competently and successfully despite political attacks and budget shortages. 5. Major Factors Affecting Implementation and Outcome 5.1 Factors outside the control ofgovernment or implementing agency: During the implementation period of the program, international coal prices continued to decline. While the impact on implementation and outcome of the SECAL may be very limited (mainly because of non-payment for coal, see next paragraph), it contributed to the fact that not even the best mines are competitive in the export markets and that more mines than originally expected need to be closed in the longer run. 5.2 Factors generally subject to government control: Non-payment and barter trade are systemic throughout the state sector in the Ukrainian economy and go far beyond the problems of the coal sector. For the Coal SECAL, non-payment for coal has been the single most important factor with negative impact on implementation and outcome, in particular relating to the better part of the coal mining industry. In 1998, only about 30% of coal was paid for in cash. The majority of the coal is traded in barter, mostly in multi-party deals involving electricity generators and distributors. A substantial portion of the coal (an estimated 8%) is not paid for at all. The cash receipts from coal sales are significantly below the needs for paying miners' wages. Except for one or two mines, this is true even for the best mines with the lowest production costs. For political and social reasons, the Government continues to grant production subsidies, with first priority applied to wage payments for practically all mines, thus leading to violation of the agreement not to pay subsidies to category I and 2 mines. Despite the subsidies, no mine is in a comfortable financial situation. Wage arrears, on average 6 months, range between 2 and 10 months. They have been and continue to be the cause of frequent strikes. Non-wage debt of the mines increased dramatically because of the non-payment for coal and despite the subsidies. Indeed, in 1997, the increase in net payables represented an additional hidden subsidy to the sector of approximately half that provided as open budget subsidies. By January 1, 1999, the total net payables of the coal industry had increased to about UAH5, 106 million, or 30% higher than the level of payables agreed under the SECAL. This is another violation of the agreements, caused substantially by non-payment for coal and aggravated by apparently high dealer profits and corruption in the opaque and economically inefficient barter trade. Established regulations and procedures increased the time and costs of mine closures. There are too many regulations and similar legal instruments (orders and decisions) at various levels of the Government (President's Office, Cabinet of Ministers, Line Ministries). These legal instruments are often general and ambiguous, in some cases even contradictory. Some outdated regulations of the Soviet era, including mine safety rules, have been a hindrance to fast and efficient mine closures. In public, the Government has been largely silent on coal sector reform. Even when faced with false and damaging media reports, the Government did normally not come forward with coherent public information on coal sector restructuring and explanations of the rationale. Lack of a coherent reform policy and public information may have favored political opposition to coal sector reform. - 5 -  5.3 Factors generally subject to implementing agency control: MCI, as the main implementing agency, did not provide adequate budget transfers to UDKR for fast and efficient mine closures. Under the pressure of a tight budget, MCI had to manage a compromise between two financially conflicting tasks: keeping the discontent of miners in operating mines under control, and achieving progress in restructuring, i.e., the closing of uneconomic mines. In order to exit from this situation and build the basis for a future sustainable coal sector, the budget for restructuring must be given absolute priority. A key role in preparation and supervision of mine closures has been allocated to the design institutes. While the technical knowledge and capacity of these institutes is appreciated, they also exercised bureaucratic power with a negative impact on time and costs of mine closures. Although MCI has full control over the design institutes, it chose not to redefine the design institutes' role. 5.4 Costs andfinancing: As an adjustment operation, the Coal SECAL does not maintain a cost estimate and a financing plan. The Government, through MOF, disbursed an acceptable overall budget for the coal sector. However, within in this overall budget, the executing agency MCI did not give the necessary absolute priority to the funding of mine closures (see comment under Section 5.3). 6. Sustainability 6.1 Rationale for sustainability rating: The Unlikely rating has been given on the basis that the policies as pursued under the original SECAL design will probably also in the near future not be fully implemented. Even the mine closures that were successfully implemented under the restructured SECAL are, in the short run, unlikely to be continued at the rate established under the SECAL, given indications from the latest (June 2001) changes in the Government. However, it is considered inevitable that mine closures will continue in the longer run. While the sector as a whole is still far from being sustainable, the irreversibility of the mine closures effected under the SECAL is a significant step achieved towards sustainability of the sector. 6.2 Transition arrangement to regular operations: For the sector, it is too early to think of transition arrangements to regular operation. Several more mine closure programs of the size of the program supported under the SECAL would have to be implemented before the continuing mines could operate in an adequate market environment. To achieve this final goal as soon as possible, the key action is now to improve the closure procedures and apply the lessons learned from the SECAL for the next round of mine closures. 7. Bank and Borrower Performance Bank 7. 1 Lending: Bank lending performance is regarded as satisfactory, despite the acceptance of conditions for the original second tranche release that proved to be unrealistic. The loan was processed on a timely schedule in order to address the Governnent's balance of payment needs and to seize an opportunity for a bold step forward in the Government's restructuring of the coal sector. The Bank's preparation of the project entailed agreement on the coal sector budget for 1997, which was an important step to achieve consensus among different branches of the Government. The first tranche was disbursed promptly. When it had become evident that some conditions tied to the budget and the operation of continuing mines proved to be unrealistic and could not be met, the Bank entered timely into discussions with the Borrower to restructure the loan. While there have been delays in effectiveness of the amendment and the disbursement of individual - 6 -  new tranches, this was not under the Banks control (effectiveness was delayed due to late ratification by Parliament, and some tranches were delayed because of unsatisfactory status of the macro-economic framework). 7.2 Supervision: Supervision of the loan was intensive and highly improved by the active involvement of the Kiev Resident Mission in following-up with different Government branches on critical steps for fulfillnent of tranche release conditions. In mid-1999, the project has been subject of a Rapid Supervision Assessment by the Quality Assurance Group. The assessment of the supervision was a clear 'Satisfactory'. 7.3 Overall Bankperformance: The overall performance of the Bank is assessed as satisfactory. Borrower 7.4 Preparation: The Borrower's performance in preparing the project is regarded as satisfactory, despite the projection of unrealistic sector performance criteria at the time of appraisal and the adoption of a mine classification system that proved not to be implementable. The Borrower brought into operation its newly created closure agency UDKR with remarkable speed and efficiency. An adequate initial number of mines was transferred to UDKR for closure without major problems. 7.5 Government implementation performance: For the most part, Government implementation performance was satisfactory. Concerning the non-payment for coal, it may have been difficult for the Government to control this phenomenon specifically in the coal sector, but a more rigorous dealing with the consequences might have been possible and useful. Concerning the over-regulation and bureaucracy, the Government and UDKR, in some instances, have demonstrated remarkable flexibility to go ahead with the mine closures. However, in other cases decisions took inordinately long. Also, the Government did not adequately react to false and damaging media reports concerning coal sector restructuring. 7.6 Implementing Agency: Although not stipulated in the Loan Agreement, the implementation of the program was executed by three agencies: UDKR, MCI and MOF. While UIDKR performed remarkably well under the constraints and political attacks it had to deal with, MCI's and MOFs implementation performance was satisfactory only for the most part. Although MCI did not provide UDKR with the agreed budget and did not change the role of the design institutes, it did transfer the mines to UDKR as agreed and it always kept control over UDKR's performance. While MOF became actively involved under the pressure of a tranche release, it could have intervened faster and more vigorously to advance the implementation of the Municipal Credit Line. 7.7 Overall Borrower performance: The overall performance of the Borrower is assessed as satisfactory. 8. Lessons Learned Special agency for mine closures. The creation of UDKR has been a key to the success of the Coal SECAL. There have been closures by mining companies but they were not finished and normally these mines ended up with UDKR to complete the task. The SECAL implementation also has shown that an agency like UDKR needs to be protected. There have been attempts by the coal industry and by local administrations to abolish or weaken UDKR. Furthermore, the agency should have its own fully secured - 7 -  I,udget. In oestmnett versus adjustment operation. If restructuring depends critically on adequate financing, an investment operation is preferable over an adjustment operation. Realistic goai seWttng. The selection of financial performance criteria for the restructuring of an old industiial sector should be avoided. Instead, simple physical criteria that can be achieved and easily monitored should he preferred. 9. Partner Comments (a,' Borrower/implementing agency. Detailed comments from the Borrower can be found in Annex 8. (b) Cofinanciers: Not applicable. (c) Other parrners (NGOs/private sector): Not applicable. 10. Additional Information A detailed list of additional available documentation on the project can be found in Annex 7. - 8 -  Annex 1. Key Performance Indicators/Log Frame Matrix Not applicable. -9-  Annex 2. Project Costs and Financing Not applicable. - 10-  Annex 3. Economic Costs and Benefits Not applicable. - 1 1 -  Annex 4. Bank Inputs (a) Missions: Stage of Project Cycle No. of Persons and Specialty Performance Rating (e.g. 2 Economists, I FMS, etc.) Ilmplementation Development Month/Year Count Specialty Progress Objective Identification/Preparation March 1996 3 Task Manager, Economist, Englineer June 1996 6 Task Manager, Economist, Engineer, Institutional Specialist, Restructuring Specialist, Labor Specialist Supervision January 1997 5 Task Manager, Economist, S S Engineer, Restructuring Specialist, Operations Officer April 1997 6 Task Manager, Economist, U S Engineer, Restructuring Specialist, Labor Specialist, Operations Officer September 1997 5 Task Manager, Economist, U U Engineer, Restructuring Specialist, Operations Officer December 1997 3 Task Manager, Economist, U U Operations Assistant May 1998 6 Task Manager, Restructuring U U Specialist, Institutional Specialist, Micro-Financing Specialist, Labor Specialist, Operations Officer July 1998 5 Task Manager, Restructuring U S Specialist, Institutional Specialist, Labor Specialist, Operations Officer October 1998 4 Task Manager, Institutional U S Specialist, Labor Specialist, Operations Officer January 1999 5 Task Manager, Restructuring U S Specialist, Institutional Specialist, Labor Specialist, Operations Officer April 1999 5 Task Manager, Restructuring S S Specialist, Institutional Specialist, Labor Specialist, Operations Officer June 1999 4 Task Manager, Institutional S S Specialist, Labor Specialist, Operations Officer - 12 -  December 1999 3 Task Manager, Labor Specialist, S S Operations Officer ICR February 2001 2 Task Manager, Operations Officer (b) Staff Stage of Project Cycle Actual/Latest Estimate No. Staff weeks US$ ('000) Identification/Preparation 33.9 147.7 Supervision 150.6 441.3 ICR 6.0 25.0 Total 232.0 722.7 - 13-  Annex 5. Ratings for Achievement of Objectives/Outputs of Components (H=High, SU=Substantial, M=Modest, N=Negligible, NA=Not Applicable) Rating EI Macro policies O H O SU O M O N O NA ? Sector Policies OH * SU OM O N O NA O Physical O H *SUOM O N O NA O Financial O H O SU * M O N O NA Z Institutional Development 0 H * SU O M 0 N 0 NA OEnvironmental O H OSU*M O N O NA Social El Poverty Reduction O H OSUOM O N O NA O Gender OH OSUOM ON ONA Oi Other (Please specify) OH OSUOM ON O NA El Private sector development 0 H O SU O M 0 N 0 NA Z Public sector management 0 H O SU *M 0 N 0 NA Oi Other (Please specify) O H OSUOM O N O NA -14-  Annex 6. Ratings of Bank and Borrower Performance (HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HU=Highly Unsatisfactory) 6.1 Bankperformance Rating