China - Highway Project

Document of The World Bank FOR oMcOA USE ONLY oc/ ) Z2 9- C%/4 Ck /S 4Y- c// Report Ne. P-4038-CHA REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND THE INTERNATIONAL DEVELtPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN MIOUNT EQUIVALENT TO US$42.6 MILLION AND A PROPOSED CREDIT OF SDR 30.3 MILLION TO THE PEOPLE'S REPUBLIC OF CHINA FOR A HIGHWAY PROJECT April 23, 1985 This document ba a restricted distributon id -y be used tly recpients only in the performance of their officil duties. Its contents may not osherwise be disclosed without World Bank autborization.  CURRENCY EQUIVALENTS Calendar 1984 April 1985 Currency Unit = Renminbi (RMB) (RMB) US$1.0 = Y (Yuan) 2.32 Y 2.84 Y 1.0 = US$0.43 US$0.35 FISCAL YEAR January 1 - December 31 WEIGHTS AND MEASURES 1 meter (m) = 3.28 feet (ft) 1 kiLometer (km) = 0.62 mile tmi) 1 square meter (sq m) = 10.76 square feet (sq ft) 1 square kilometer (km2) = 0.4 square miles (sq mi) 1 hectare (ha) = 0.01 km2 = 2.47 acres (ac) 1 kilogram (' ..g) = 2.2046 pounds (lbs) 1 metric ton (m ton) = 2,204 pounds (lbs) PRINCIPAL ABBREVIATIONS AND ACRONYMS USED AADT - Average Annual Daily Traffic CAD - Computer Aided Design CHB - County Highway Bureau CNTIC - China National Technical Import Corporation CTC - Central Trucking Company CTD - County Transport Department ERR - Economic Rate of Return GNP - Gross National Product HB - Highway Bureau HPDI - Highway Planning and Design Institute HSRI - Highway Scientific Research Institute ICB - International Competitive Bidding LCB - Local Competitive Bidding MOC - Ministry of Communications MOE - Ministry of Education MOF - Ministry of Finance PHB - Provincial Highway Bureau PTC - Provincial Trucking Company PTD - Provincial Transport Department SAA - State Auditing Agency VOC - Vehicle Operating Costs  FOR OMCIAL USE ONLY CHINA HIGHWAY PROJECT Loan, Credit and Project Summary Borrower: People's Republic of China Amount: US$72.6 million equivalent ccmprising US$42.6 million equivalent IBRD and SDR 30.3 million (US$30 million equivalent) IDA. Terms: Loan: 20 years including 5 years of grace; standard variable interest rate. Credit: Standard. Project Description: As the Bank Group's first involvement in China's highway subsector, the proposed project would address a number of needs by assisting Government in: (a) improving the quality of future con- struction works by modernizing highway design, and by updating and improving construction and material specifications; (b) increasing the cost-effectiveness of highway investments by improving economic evaluation techniques for the evaluation and selection of road investmpnts, and by supporting Government's new policy of moving to competitive bidding for public works; (c) supporting a highway research program, with particular emphasis on improving and strengthening the existing paved national road network, improving road capacity in congested areas and improving road safety; and (d) strengthening the capabilities of staff working in the highways sub- sector by carrying out a training program. In addition, the project would support the Government's program for completing the national road network by constructing or improving about 230 km out of a total of 4,000 km of missing links in the network. It would also support a national program of improving economic activity in rural areas through the construction or improvement of about 1,400 km of rural roads. There is some risk of delays in project implementation since this is the first time that competitive bidding will be used for highway construction in China, and these delays couLd increase costs. This risk vould be reduced by appropriate supervision in the early project stages. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Project Costs: Local Foreign Total ------ (US$ million)--- - Road construction 77.7 51.5 129.2 Design and research improvement 0.1 2.5 2.6 Road maintenance improvement - 1.8 1.8 Training program 2.1 2.1 Consultant services - 0.6 0.6 Base Cost 77.8 58.5 136.3 Physical contingencies 7.8 5.9 13.7 Price contingencies 11.2 8.2 19.4 Total Project Cost /a 96.8 72.6 169.4 Right-of-way cost 7.2 - 7.2 Total Financing Required 104.0 72.6 176.6 Financing Plan: IBRD and IDA - 72.6 72.6 Government 104.0 - 104.0 Total Financing 104.0 72.6 176.6 Estimated Disbursement: Bank/Group FY 1986 1987 1988 1989 1990 1991 ------------ (US$ million) - Annual 9 25 30 5 2 1.6 CumuLative 9 34 64 69 71 72.6 Economic Rate of Return: 20Z Staff Appraisal Report: No. 5408-CiA dated April 19, 1985 /a Including taxes and duties of US$16.8 million equivalent.  REPORT AND RECOMMENDATION OF TFE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTR'JCTION AND DEVELOPHENT AND THE INTERNATIONAL DEVELOPMENT ASSOCIATION ro THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN AND CREDIT TO THE PEOPLE'S REPUBLIC OF CHINA FOR A HIGHWAY PROJECT l. I submit the following report and recommendation on a proposed loan and credit to the People's Republic of China to help finance a Highway Project. The loan, for $42.6 miLlion, would have a term of 20 years, including 5 years of grace, at the standard variable interest rate. The credit, for the amount of SDR 30.3 ($30 million equivalent), would be on standard IDA terms. PART I - THE ECONOMY 2. A country economic memorandum, entitled "China: Recent Economic Trends and Policy Developments" (No. 4072-CHA), was distributed to the Executive Directors on March 31, 1983. An economic mission that visited China early in 1984 is currently preparing a report on long-term development issues and options, which is expected to be submitted to the Executive Directors by May 1985. Basic data on the economy are given in Annex 1. Background 3. To address problems of economic inefficiency and structural imbalances, the Government initiated a program of reform and adjustment in 1979. Reform implementation proceeded most rapidly in agriculture and culminated with the introduction of the "production responsibility system" (in various forms), which gave households and small groups autonomy in production and investment decisions and allowed them to keep most income earned after contracted payments to the state and collective. By the early 1980s, the vast majority of production teams in China had implemented such a system. Reform of the urban economy started out much more slowly, but nevertheless signi- ficant systemic changes occurred, including bonuses for individual workers; profit retention by state-owned industrial enterprises (at first on an experimental basis); fiscal decentralization measures, which allowed provinces to share in the benefits of increased revenues and gave them more freedom in budgeting; and some decentralization of foreign trade authority. Adjustment policies resulted in an increase in the share of consumption in GDP; a rise in the share of light industry in total industrial output, substantial improve- ments in living standards, rapid growth of foreign trade (particularly manufactured exports), and relatively modest (in relation to past trends) GDP growth. 4. A number of problems emerged in the process of reform and adjust- ment, including large budget deficits in 1979 and 1980, a deterioration of the external position and a significant current account deficit in 1980, infla- tionary pressures and some overt price increases, and excessive investment demand resulting from decentralization of investment decision making and  - 2 - financing. In response to these difficulties the Government imposed a stabil- ization program in early 1981, which relied mainly on administrative con- trols. It resulted in a slowdown in growth, a reduction in price inflation (to around 2% p.a.), a sharp cutback in budget-financed investment, a Lower budget deficit (12 of GDP in 1981); and a current account surplus of $1.5 billion in 1981 and $5.6 billion in 1982. Economic Performance, 1981-84 5. Economic growth picked up in 1982 with che resumption of rapid growth of heavy industry and the rebound in investment. Overall performance has continued to be strong since then, and real GDP growth averaged over 8% p.a. from 1981 to :984. Shortages of energy, many producer goods, and con- struction materials were exacerbated by the rapid growth of demand. yet price increases were limited by further strengthening of administrative price controls (particularly in 1983). Government budget revenue grew very slowlv in 1982 (1.3%) but much more rapidly in 1983 (7.9%) and 1984 (as much as 10%), due to a new tax on enterprise retained funds and extrabudgetary incomes of Governmenc organizations. This permitted an increase in budget expenditures on investment of 17Z in 1983 and a further rise in 1984, while maintaining a relatively small budget deficit (less than 2% of GDP in 1983). Growth of subsidies was largely steamed by stopping increases in most of the agricul- tural procurement prices. 6. Gross industrial output value grew at over 10% p.a. between 1981 and 1984, with heavy industry growing somewhat faster than light industry (12% vs. 9%), a reversal of the 1978-81 pattern. The energy constraint on industrial growth was eased by rising coal output (8% p.a. in 1981-84) and maintaining annual crude oil output at over 100 million tons, along with improvements in the efficiency of energy utilization (primary commercial energy consumption grew only 60% as fast as GDP in 1981-83). Agriculture has continued its very strong performance, with gross agricultural output value rising at 9% p.a. in 1981-84 and grain output at 7% p.a. (reaching over 400 million tons in 1984). Cash crops and animal husbandry have also grown very rapidly, stimulated by rising demand and attractive prices. 7. There have been impressive increases in personal incomes throughout the period 1978-83. Average per-capita income in rural areas rose by about 12% p.a. in real terms and urban incomes by about 5% p.a. Rural income growth was mainly due to production increases, efficiency improvements, and growth of employment in nonagricultural activities, as well as substantial agricultural procurement price increases (through 1981). Urban income growth, on the other hand, can be attributed primariLy to wage and benefit increases, which have exceeded growth of labor productivity. 8. Control of the aggregate level of investment and its composition has continued to be a serious problem. Enterprise and local government investment continued to increase sharply in 1982, far exceeding plan guidelines. In 1983, more stringent measures brought this part of investment under control (though it still exceeded plan targets). But investment outside the rural sector remains rather inefficient, and improvements in efficiency have been hindered by administrative controls. Construction costs have risen continuously (10% p.a. in 1978-83).  - 3 - 9. China has maintained a strong external position. The dollar value of both exports and imports stagnated in 1981-83, but this masked considerable increases in the volume of foreign trade. Since 1983, imports have grown more rapidly than exports, and in the first 11 months of 1984, exports rose by 18% and imports by 25%. Manufactured export growth was sLower in 1981-84 than in 1978-81, but it started from a much higher base and occurred in the face of worsening world market conditions. Foreign debt and debt service ratios remained at very low levels ($6.4 billion and 5.5X respectively in 1983); China's foreign currency reserves (excLuding gold) rose to $17 billion (over 7 months' imports) by mid 1984 end have stabilized at that level since then. The value of the Chinese renminbi declined by about 36% against the SDR between the end of 1981 and late 1984 (60% against the US dollar). Recent Reforms 10. Rural reforms have continued to progress more rapidly than reforms elsewhere in the economy. A salient trend has been the spread of nonagri- cultural activities such as processing, transport, and commerce. "Specialized households" (which concentrate on one type of pursuit - often cash crops, animal husbandry, or nonagricultural activities) and pooling of capital by small groups of households in various types of ventures are becoming more common forms of economic organization in China's rural areas. Wholesale markets for some agricultural products have emerged. To encourage investment in land improvement and development, farming contracts between collectives and peasant households (which typically had been fixed for no more than 3-5 years) can now be extended to as long as 15-20 years. In early 1985, it was announced that planned procurement quotas for agricultural commodities will be abolished; more methods of financing investment in rural nonagricultural activities will be permitted (including tax exemptions, local government bonds, higher interest rates to attract more saving, etc.); and the growth of the agricultural processing industry in coastal areas will be promoted. 11. The momentum of urban reforms has revived, with significant progress on a number of fronts. Since early 1984, a main focus has been further broadening and clearer delineation of the decisionmaking authority of urban enterprises. Profit retention now extends almost universally to state-owned industrial enterprises and in nonindustrial sectors like transport, commerce, construction, and other services. Urban collectives and individual enter- prises as well as a variety of joint ventures between them and state enter- prises have grown rapidly (the number employed in urban individual enterprises rose from 150,000 in 1978 to 2.31 million in 1983). 12. In financial reforms, the most important new development was the implementation of a profit tax system to replace profit remittances to the Government budget by state enterprises. Though most enterprises have switched to this system, the benefits have been limited because of the application of a different effective tax rate for each enterprise, to offset the impact of distorted relative prices and other factors. Similar problems have resulted in the abandonment of an attempt to impose a fee or charge on the fixed capital provided to state enterprises by the Government, and they have  - 4 - hindered the shift from grant to loan financing of new fixed investment, despite strong Government support. Financial discipLine at the enterprise level remains weak, in spite of efforts to strengthen accounting and auditing systems and more strictly enforce existing financial regulations. 13. In the crucial area of price reform, a major price adjustment for textiles and textile raw materials occurred in early 1983; it helped balance supply and demand, to a large extent equalized profit rates for synthetic and cotton textiles (which are close substitutes in production and consumption), and drastically reduced subsidies for cotton procurement, with only a small net effect on the Government budget. Prices of many "minor" consumer goods (which individually do not have a significant impact on living standards) and the majority of agricultural commodity prices have been decontrolled and are now set by negotiations between producers and commercial units. "Floacing prices" (up to 20% above or below official prices) are now allowed for many industrial producer goods (either for all output or for output above the mandatory plan target). Price adjustments for key energy products and raw materials (which in many cases are severely underpriced) and for subsidized basic consumer goods like grain and edible oil have proven more difficult to implement, hindered by the potential impact of price changes on urban living standards and on the finances of energy-using enterprises. Nevertheless, some price rises have occurred (e.g. for coal and petroleum), and moreover the share of free market transactions (at largely uncontrolled prices) has increased in recent years. 14. Reforms in the employment and wage system have made limited progress. The bulk of urban labor is still allocated administratively, and transfers of workers or professionals among enterprises are heavily impeded. Numerous attempts are being made to link individual performance more closely with rewards, including piece-rates, "floating wages," and various types of contractual "responsibility systems." These have achieved some success, but problems of egalitarian distribution of bonuses remain, and many enterprises give out bonuses in kind or disguise them as allowances in order to evade regulations. 15. China's foreign exchange rate system has been unified with the abolition of the "internal settlement rate" (Y 2.8 to $1) at the beginning of 1985. Direct foreign investment (which was first allowed in the late 1970s but developed slowly due to the lack of a legal framework) is being actively encouraged and joint venture agreements have increased sharply. In addition to four "special economic zones" open to foreign investment and subject to more flexible policies, 14 coastal cities were recently opened up in the same way. 16. Significant steps have been taken to develop new tools of indirect macroeconomic management. The central banking functions of the People's Bank of China were separated from its commercial banking functions (which were given to the newly-established Industrial and Commercial Bank of China) at the beginning of 1984. The central bank relies on redeposit requirements and a discount window to influence the operations of specialized banks, and even- tually may use discount rates and interest rates in general as a flexible tool of macroeconomic management. Adjustments in indirect taxes may be used to  affect profitability and supply, in the absence of or as a supplement to price reform. Scope for horizontal flows of investment funds is also being widened, with enterprises investing in each other and in joint ventures and in some cases purchases of stocks by individuals occurring. Though restrictions on secondary trading remain, Government bonds purchased by individuals now can be sold to banks or used as collateral for loans. Long-term Issues and Prospects 17. The Central Committee of the Chinese Communist Party issued a major document on urban reforms in October 1984, which reaffirmed and consolidated recent reforms and gives some general guidelines for the direction of future reform. It emphasizes the need for breakthroughs in the following areas: (a) enlivening and better motivating urban enterprises; (b) clearly separating Government and enterprise functions (and limiting direct intervention by Covernmenc organizations in enterprises' day-to-day operations); (c) reforming the price system; (d) improving incentives in the wage and bonus system; (e) establishing a planning system that is in harmony with greater reliance on the market mechanism and developing indirect macroeconomic management; (f) up- grading managerial personnel to meet the new demands on them in a reformed economy; (g) removing obstacles to a unified national market and promoting cooperation and technology transfer among regions; and (h) expanding utiliza- tion of foreign capital and advanced technology. Among the main themes of the document are the role of competition in promoting a more dynamic, flexible economic system; the recognition that a certain degree of income inequality is necessary to provide better incentives for economic development; the need for clear responsibilities and appropriate incentives at all levels in the economy; and the recognition that thoroughgoing price reform must involve liberalizing the mode of price determination, not just adjusting administratively set prices. Managers of large state-owned enterprises, however, will still be appointed by the Government organizations; a few key products will still be subject to mandatory planning and distribution by the Government; state ownership and control over certain institutions like banks and railways will not be relinquished; and establishment, relocation, changing product lines, mergers, and shutdown of enterprises will still be subject to Government approval. 18. The Central Committee declaration represents a political commitment to economic reform, which will help foster an environment in which fundamental reforms can be gradually implemented in a coordinated way. But specific policy measures will take a considerable length of time to design and then to implement. Many of the reforms required will be very difficult, particularly since reforms in different areas are closely interrelated, and thus appro- priate sequencing and coordination become essential. For example, price reform in the absence of improvements in enterprise financial discipline will have limited benefits, yet the more profit-oriented behavior that would result from tighter financial discipline would exacerbate the adverse impact of distorted prices. Similarly, reform of the labor allocation system will be incomplete without eliminating many of the "social responsibilities" of enter- prises (which now provide housing, medical care, and pensions for their workers and in many cases education and jobs for workers' children) and replacing them with Government supported social service programs.  - 6 - 19. China's objective of quadrupling the gross output value of industry and agriculture between 1980 and 2000 (which means GDP growth of well over 6Z p.a.) will require significant improvements in efficiency as well as continued high saving and investment rates. There will be major structural changes in the economy over the next two decades, including a reduction ir the share of agriculture, a rise in the share of industry and possibly in that of services (which at present is unusually low), and substantial urbanization (in smaller towns if not in large cities). There will also be a shift within agriculture, away from grain and basic crops and into cash crops and animal husbandry. 20. Certain physical/technical constraints will hinder the attempt to achieve China's targets for the year 2000 and its longer-term goal of catching up with the developed countries. Despite rapid growth and substantial improvements in efficiency in recent vears, agriculture mav again become a constraint on overall growth, since land in China is severely limited. In energy, shortages of fuel (primarily coal) and eLectricity may continue to constrain growth as they do now. Transport and commercial infrastructure will become increasing drags on the economy without large new investments (as weLl as improvements in efficiency). In mobilizing resources in all these areas, China could profitably make use of foreign borrowing. Finally, the rising share of the elderly in China's population (related to the slowdown in popu- lation growth) means that more resources will have to be devoted to main- taining their consumption levels, especially in the decades after 2000. 21. Poor motivation and inefficient utilization of labor in the state sector of the economy are a major problem which can be solved only by coor- dinated reforms in labor allocation, the wage system, enterprise management, and social services, among other things. Reforms in the system of education and training to develop China's "human capital" potential also are crucial. Backward technology and inefficient utilization of existing technology must be dealt with by a combination of reforms, appropriately directed investment, and transfer of advanced foreign technology. Irrational location of factories, suboptimal scale of many plants, and poor utilization of physical capital in general are related problems. 22. If reforms successfully transform the economic system, with a beneficial impact on growth and efficiency, a new set of issues will come to the fore. Management of a reformed economy with indirect fiscal, monetary, and other instruments is one of the most important ones. rn this context, maintaining an adequate saving rate (if the Government no Longer accounts for the bulk of aggregate saving) and avoiding inflation (as well as deep cyclical downturns) will be major goals. Assuring an adequate minimum standard of living for the population and an appropriate level of social services will become a major chalLenge as enterprise and rural communal responsibilities in these areas are reduced. The problem of poor, backward rural areas in various parts of the country wiLl continue to require attention. Redistribution of financial resources through the fiscal system, easing restrictions on migra- tion out of the poorest areas, and lower nonagricultural wages to make invest- ment in them more attractive are among the options for alleviating poverty in these areas.  - 7 - 23. The Government is now in the process of finalizing its Seventh Five Year Plan (covering the period 1986-90). The combination of potentialLy fundamental reforms and the urgent need for large investments in many parcs of the economy to build the foundation for further growth makes this task a difficult one. In order to mobilize the investment resources needed for rapid, sustained economic growth and development, China will need to rely in part on foreign borrowing. This is recognized by the Government, which plans to gradually draw down its substantial foreign exchange reserves and hopes to attract foreign capital through a variety of channels. China also has a claim to concessionary lending because it is still one of the poorer countries of the world. But its access to concessionary capital to finance its development and modernization program is limited; apart from Bank Group funds, a significant amount of concessionary capital is likeLy to come only from Japan and a few other bilateral donors and will probably average no more than $500- 600 million p.a. during the rest of the 1980s. PART II: BANK GROUP OPERATIONS 24. For China to sustain rapid growth over the coming decades, with increases in efficiency and innovation while maintaining equity in distribu- tion, will require continuing and fundamental reforms. These challenges are compounded by China's large investment requirements and the difficulties associated with its efforts to open up to the rest of the world. In light of this, there are several broad objectives for the Bank to pursue in its reLationship with China. First, the Bank can offer China its development experience and institutional knowledge as well as the opportunity for interaction with the Bank's other member countries. Second, the Bank can assist China in removing major constraints on development and in improving investment planning and policy coordination in the priority sectors - particu- larly energy, transport, other infrastructure, human development and industry. Third, the Bank can assist the Government in its efforts to remove the remaining pockets of poverty. 25. The Bank Group's strategy to meet these objectives is formulated in line with China's broad development priorities and related issues outlined in Part I of this report. However, Bank Group lending can provide only a small portion of overall resource needs. As a key element of the strategy, therefore, the Bank's lending operations will aim to create a substantial demonstration effect applicable to China's overall development efforts. For example, projects involving new techniques for land development or for provi- sion of social services have been designed so that they can be repeated by local authorities within their existing resources. Some of the agriculture projects and the rural health projects are examples of this approach. The introduction of international competitive bidding through Bank projects (first to finance goods, and later civil works) is now being adopted by the Government for most local purchases and many domestic construction projects. 26. Bank assistance can help improve the efficiency of investment, through introduction and dissemination of improved analytical techniques for investment and project planning and through institution building. Preparation of the project appraisal manuals for the China Investment Bank and the  Agricultural Bank of China, consultant assistance and the EDI sponsored programs, as well as specific sector work in Lransport, industry, health, education and other sectors have improved the quality and content of project proposals. Assistance to Chinese enterprises and agencies through staff training, consultant assistance, creation or reorganization of institutions, and improvement of costing and financial management has been included in a number of projects ranging from the ports and railway projects to the several education and petroLeum projects. Specific sector work in enterprise manage- ment, urban development, health and industry has also pruvided assistance for improvement of investment efficiency. 27. Human resource constraints are a particularly serious problem for China's development. There are severe scarcities of higher level trained manpower. Substantial economic and sector work and technical assistance and training components in most of the Bank projects are providing support. In terms of poverty aLleviation, the rural health project, proposed urban and water supply projects and sector work on labor mobility and regional development options address poverty, health and equity issues. 28. Transfer of technology in the broad sense is of fundamental impor- tance in China's eEforts to improve efficiency of the economy. Outmoded, inefficient and costly industrial technologies are serious impediments to development and are wasting valuable energy resources. Here, the Bank can play the role of an intermediary. In transportation, energy, industry, agriculture and even education, the Bank can finance transfer of technology through equipment imports, provision of foreign consulting assistance, arrangement of training and promotion of licensing and other agreements such as are now being discussed in the railways and other projects. Long-term investment for new t2chnology will require increased foreign borrowing in the future and the Bank can assist China through cofinancing. Progress is being made in introducing co-financing under the first and second power projects, coal, urban, water, and some agriculture projects, and the Bank will continue these efforts. 29. For most of these elements of country strategy, however, progress will be gradual and will require sustained Bank invoLvement over a series of projects in various sectors. Economic and Sector Work 30. Economic and sector work in China was initially designed in part as a learning experience to provide the Bank with a basis of knowledge on the development and functioning of the Chinese economy. It also introduced the Government to alternative ways of economic analysis and views about its achievements. 31. In the last four years, the above approach has been well received and has allowed economic and sector work to be particularly relevant to the problems of adjustment and reform which have been in the forefront for the Government. Followup to the first economic report emphasized technical assistance and sector work for investment analysis and selection techniques and enhanced sector planning. The content of the lending program has been  - 9 - directly influenced as a result. The rural credit project, the China Investment Bank projects, and future regional industry projects are among examples of the links between economic and sector work and the lending program. 32. More fundamental research into the problems of enterprise management is now nearing -ompletion in collaboration with Chinese economic research institutions. r: has yielded insights into the thinking and reaction of enterprise manal,ers to system reform and led to better understanding of how policy changes can improve planning, performance and management of enterprises. In addition, there is a variety of project-related sector work underway through studies included in the projects. These are expected to produce the basis for detai'ed discussion of development opcions and policies in the various sectors. 33. Current economic work focuses on future options and issues to the year 2000 and a comprehensive report will be ready Later this fiscal year. In light of the experience of other countries in making the transition from low to middle income levels, the report will pay special attention to inter- sectoral linkages and cross-sectoral and economy-wide issues. 34. Future economic and sector work will be based on the conclusions of the economic report and will look in more detail at some of the issues raised. It will continue to improve our knowledge of the economy - its struc- ture, the issues and constraints in key sectors, and the functioning of the economic management system. Collaboration on issues of institutional and policy change with Chinese research institutions will continue. Review of the investment program in key sectors when the Seventh Five Year Plan (1986-90) is finalized will help develop the next generation of projects for the lending program. Lending Operations 35. Since China's change of representation in the Bank Group in May 1980, 24 projects involving lending of $2,391 million to China have been approved. Annex II contains a summary statement on these loans and credits as of March 31, 1985. For this fiscal year we expect to present a total of twelve projects to the Board. These include: the already approved projects for Second Agricultural Research, Second Power, Second University Development, Changun (Luan) Coal Mining, Seeds, and Rural Water Supply; the proposed Highway Project; and other projects in railways, fertilizer production, forestry, Pishihang-Chaohu area development and gas engineering. 36. For FY86 and beyond, the China lending program should continue to grow from current levels. Areas of emphasis would include development of energy resources, transport infrastructure, skilled manpower and improved technology. We wili also investigate the feasibility of a regional approach in a number of sectors to take better account of intersectoral linkages. 37. -In the transport sector, railway, port and road capacity must be substantially increased. So far, one project each in ports and railways has concentrated on increasing capacity, upgrading technology for lower cost  - 10 - operations, and estabLishing better costing systems. Expanding domestic capacity to manufacture improved transport equipment will continue to be a theme in the sector and this should provide scope for substantial foreign private sector involvement. Improved management and information systems and analytical techniques for better cost control wiLl be encourage-, under the projects, which, once proven, will be suitable for wider use throughout Lransport enterprises. Intermodal coordination and planning and assessment of alternative investment choices will have increasing prominence in both lending and sector work. 38. In che energy sector, lending has included six projects, which have emphasized increased energy output and technology transfer through financing of equipment, technical studies, craining and consultant assistance. The Lubuge Hydropower Project has resulted in the Government's extensive use of competitive bidding for power projects. Fuel alternatives for electric power, generating plant Location and interconnection of power grids will be the subject of future work. For development of China's petroleum and coal resources, Bank Group assistance is emphasizing acquisition of appropriate technologies, least cost planning of investment and related transport investment programs. 39. In agriculture, six projects have emphasized support services through improved research and education, production increases through new land development, reclamation, use of improved technologies and management, and strengthening of the agriculture credit system and seeds development. Future projects in forestry and agriculture credit will continue to strengthen sup- port services and rural institutions. Land and area development projects will endeavor to provide modeLs of integrated regional development. Specialized activity projects such as fisheries, livestock and agro-processing may also be developed to support on-going structural transformation in agriculture. 40. In the industrial sector, two projects have focused on establishing and strengthening the China Investment Bank. Improved investment selection criteria, incentives for more efficient management, technoLogy transfer, and energy conservation are priorities for future projects. Lending will have a two-pronged approach - further strengthening of the China Investment Bank (and perhaps other financial interm2diaries) and financing large regional production-oriented projects such as for fertilizer, machine tools, and cement, to expand output and demonstrate the merits of improved subsector analysis and planning. 41. Further expansion of higher education and improvement of teaching, curricula and graduate quality will be needed to the end of the century. The human resource constraints have already been addressed by five education projects and a component of the Rural Health/Medical Education Project. The value of international competitive bidding for equipment purchases and of international advisory panels for educational policy and curriculum reform has been demonstrated in the first projects. Improved university management is being encouraged through establishment of quantitative targets for growth, student-teacher ratios, classroom utilization, laboratory experiments per- formed, and other reforms (including development of evaluation and monitoring procedures and greater decentralization). Future projects in health, urban  - 11 - development and water supply will assist the Government in addressing diffi- cult poverty-linked questions of affordability, cost recovery, and minimum standards with focus on particularly impoverished regions. 42. Implementation. Project implementation is generally proceeding well. There have been some initial delays in procurement because of the Government's unfamiliarity with the concept of bidding, but these are now being addressed through a central procurement agency. Most project agencies, as well as the Ministry of Finance and the State Planning Commission, have established and staffed offices to handle Bank Group projects. To support further expansion of the lending program, accelerate project preparation, improve project implementation, and facilitate further economic and sector work, the Bank Group is planning to open a resident office in China early in FY86. III. THE TRANSPORT SECTOR A. The Transport System 43. Like other centrally planned economies, China's economy is very 'transport intensive." In the same land area, U.S. freight traffic is only four and a half times the freight traffic of China with a GNP nine times as large. This intensity of transport is explained partly by: (a) China's economic structure, with the service sector accounting for a very low share of GNP; (b) the historical emphasis on heavy industry, requiring the movement of ores, steel, and other bulk products; and {c) the high level of energy con- sumption per unit of output in China's industry (energy use per unit of GDP is two and a half times that of other low-income developing countries). 44. Investments. Over the period 1949-79, some Y 110 billion, or 17% of all new investment coming under the heading "State Capital Construction," went to transport. In comparison to other countries, the annual investment in China's transport sector has been relatively low, and as a result transport has become a bottleneck to economic development. In the past, the railways received nearly 70% of all investment in transport and communications, but starting in the late 1970s the share of investment in railways declined to about 50%, implying a redistribution of investment to other transport facilities. However, the highways subsector has not yet benefitted from this redistribution. Investment on highways has steadily decreased from 25% during 1963-65 to only 12X by the end of 1975; since then, it has stabilized at around 15% of total transport investment. In the coming decades, much larger investment will be needed in transport if bottlenecks to economic development are to be avoided. 45. Traffic Trends. Since 1952, China's domestic traffic has grown significantly. Freight traffic reached 1,007 billion ton-km in 1983, almost a fourteen-fold increase. At an average growth rate of 9S p.a., the increase in freight traffic occurred at a higher rate than growth of domestic product during the same period. Passenger traffic multiplied by 12.5 times, reaching 310 billion passenger-km in 1983. Since 1978, growth in passenger traffic has averaged 12% p.a., more than twice the overall rate of economic growth. As in  - 12 - other countries, growth in transportation demand is expected to continue to exceed the ove:all growth rate. 46. Railways. The railway system more than doubled in size between 1949 and 1983, when it totalled some 52,000 route-km, of which about 9,182 km were double or multiple tracked and some 2,650 km were electrified. Further double tracking and electrification are in progress. Rail freight traffic has grown from about 39.4 billion ton-km in 1950 to 665 billion ton-km in 1983, at an average rate of 92 p.a. Since 1978, freight traffic has grown less rapidly, averaging about 4.5% p.a. Passenger traffic by rail has grown from about 21.2 billion passenger-km in 1950 to 178.0 billion passenger-km in 1983, at an average annual rate of 6.7Z. Passenger traffic has risen sharply since 1978, increasing 62Z in five years and placing heavy demand on equipment and line capacity. Railway operations show a high Level of efficiency in track and equipment utilization. 47. In spite of a great increase in capacity and traffic volume, the share of railways in freight and passenger traffic measured in ton-km and passenger-km decreased from 79% and 73%, respectively, in 1960 to 7OX and 59% in 1982. The traffic lost by the railways has been absorbed by highways whose share increased from 2% to 11% for freight traffic and 18% to 36% for passenger traffic over the same period. However, the railway is expected to predominate for quite some time, especially for freight traffic. The Bank Group's first involvement in China's railway sector was the Railway Project (Loan 2394-CHA) in 1984 which financed priority infrastructure investment on two lines as weLL as equipment, technical assistance and training to improve electric locomotive production. A second railway project is being prepared. 48. Highways. Traffic on China's highways has increased steadily, par- ticularly with recent developments in rural areas which generated a high demand for short-distance passenger travel. Although China's road network is now the sixth largest in the world, it is still relatively underdeveloped. Government is planning to expand and improve the network in connection with efforts to develop light industry and agriculture. The proposed project would support this plan. 49. Ports. In the period 1976-80, port traffic increased at a rapid average grovth rate of 11.3% p.a., reflecting China's opening to foreign trade. Domestic coastal shipping and inland water transport also increased substantially. Despite vigorous efforts to achieve higher productivity, ports became congested. A major effort to modernize ports started in the early 1970s and continues, with particular emphasis on container and bulk terminals, the latter mainly for coal. The Bank Group's first involvement in the China transport sector was the Three Ports Project (Loan 2207-CHA) in 1982 which includes a coal berth at Huangpu and container berths at Huangpu, Shanghai and Tianjin. A second ports project is being prepared.  - 13 - 50. Transport Policy for the 1980s. In recent years, China's transport development policy has focused not only on expanding individual modes but also on establishing links between modes, incorporating new technology and strengthening institutions. With these aims in mind, the Government dialogue with the Bank Group has centered on: (a) constraints on capacity of both freight and passsenger traffic; (b) the role of various modes and, in particular, the modal allocation of short-distance traffic; (c) management of the transport system, including policy, planning, coordination, and pricing; (d) choice of technologies for both infrastructure and vehicles; (e) energy conservation; and (f) staff training and development. B. The Highway Subsector 51. Management and Staff. The Ministry of Communications (MOC), through its Highway Bureau (HB), is responsible for formulating regulations, specifying construction standards, and providing technical support to the Provincial Highway Bureaus (PHBs). The HB does not itself construct major infrastructure. The PHBs carry out road planning, construction, maintenance and administration in their areas in line with general policy guidelines, using their provincial budgets. PHBs also supervise the work of the County Highway Bureaus (CHBs). 52. Staff Training. Staff of the HOC and the Provincial Transport Departments (PTDs) are in general professionally competent, but for many years have not been exposed to new technology and therefore often use outmoded work methods and equipment. Although technical manpower planning and assessment of related training needs for the highway subsector have only recently been resumed, preliminary estimates indicate that a substantial number of engineers, assistant engineers and technicians would be required each year by MOC to meet proposed targets of the Seventh Five-Year Plan. There is an argent need to strengthen and expand formal education and training programs to upgrade skills and increase the number of technical staff. A training com- ponent is therefore included in the proposed project to assist MOC in modern- izing and raising staff professional standards in the highway subsector. 53. Traffic Growth and Characteristics. Growth of motor traffic on the trunk highways has led to problems of road capacity and pavement strength. Projecting annual growth rates of 15% for motor traffic and 14.5% for the vehicle fleet, traffic volume will double in less than five years. In the vicinity of some major cities, the annual growth of traffic is now as high as 18-19% and congestion is already a serious problem. Apart from the traffic growth, one of the prime causes of this congestion is the traffic mix which includes slow-moving bicycles, tractors, and animal-drawn vehicles that impede traffic flows. Assuming that the present traffic composition continues, many segments of the existing trunk road network will be saturated within the next five years. 54. The Network. In 1983, the network comprised about 915,000 km, of which only 173,000 kmn or about 20% were paved. Most of these pavements are of poor quality, as they have exceeded their design life and are deteriorating rapidly with increased motor traffic. As a result, maintenance is becoming more difficult and costly. Current road density of about 94 km per 1,000 km2  - 14 - or 9.1 km per 10,000 population is also low, even though the network in 1983 was already 11 times larger than that in 1949. For purposes of design and technical specifications, the highway network is classified as Expressway, Class 1, 2, 3 and 4, according to the amount of traffic to be carried. No expressways have yet been built and only some 2% of the total v-ad length has been built to Class 1 and 2 standards, i.e., for average annual daily traffic (AADT) of more than 5,000 vehicLes and 2,000-5,000 vehicles, respectively. The network is generally of low standard. 55. For administrative purposes, roads are classified as trunk, county, rural (communal), and special purpose. Trunk roads consist of national and provincial roads and are the responsibility of the PTDs. National roads serve as links between provincial capital cities, other important cities, autonomous regions, ports and major transport terminals. Provincial roads serve the provinces and cities, and have mainly been built to standards lower than Class 2. County roads, the responsibility of the County Transport Departments (CTDs), are usually lower than Class 3 (AADT below 2,000 vehicles). Commune roads, which are built and maintained by local authorities, cannot meet even Class 4 road standards (AADT below 200 vehicles), and some road sections are impassable after severe rain. The special purpose roads, built exclusively for mining, forestry or other purposes, are constructed and maintained by the main user. 56. The administrative classification of the network has become more systematic since 1978, indicating improvement in planning and management. The classification process revealed that some 4,000 km of national road sections are either missing or substandard and not motorable and as such are considered to be missing road links. Upgrading the national road network, including construction of missing road links, is among the MOC's top priorities. 57. The Vehicle Fleet. Most of China's vehicle fleet is domestically produced. Several features of the fleet are striking. First, trucks out- number cars by about nine to one. Second, there are almost no light trucks of less than 2 tons capacity and no large trucks of more than 8 ton capacity. Third, vehicles have outmoded designs and very low fuel efficiency, with most trucks being gasoline rather than diesel powered. 58. In 1983 China produced some 140,000 trucks and is ranked tenth largest among civilian truck producers worldwide, yet this is still not sufficient for the huge and growing domestic demand. The entire stock of trucks is about 1.6 million units. Assuming a very optimistic 10-year depreciation period per vehicle, the present production would be barely enough to replace those depreciated. With a 9% annual increase in freight transport, a shortage of vehicles is inevitable, and the need for trucks with capacities of over 8 tons and less than 2 tons is expected to be acute. It will therefore be necessary for Government to increase the number of vehicles produced and to improve their quality and efficiency so as to reduce vehicle operating costs. 59. The Trucking Industry. Competition between public trucks operated by HOC and own-account trucks (i.e., those owned by factories, communes or any cooperative organization) is increasing. The share of own-account trucks in  - 15 - the total fleet grew very rapidly from 30% in 1949 to 86% in 1979. However, MOC trucks still handle more than 25% of freight traffic. MOC's trucking industry comprises the Central Trucking Company (CTC) and the Provincial Trucking Companies (PTCs). CTC specializes in modern, large-volume transport, including a container crucking service. It handles longer distance inter- provincial traffic, while the PTCs handle the shorter hauls and intermodal transfers. 60. Both MOC and own-account trucks share problems of misallocation and mismanagement of truck and fuel resources which result in a simultaneous shortage of some trucks while a large number of trucks are not fully used. This is a more serious problem for own-account trucks, judging from their very low average load factor of about 35% compared to the 65% average load factor for MOC trucks. 61. Vehicle Operating Costs, Trucking lariffs and Profit. The CTC reports a 30! profit/revenue ratio in che past few years, buc many PTCs operate at a loss. Part of the problem is that a narrow range of uniform tariffs has been established countrywide, without sufficiently allowing for the topography and other conditions affecting local operating costs. Each year, the Trucking Division of MOC issues a set of planned vehicle operating cost (VOC) targets and official tariff rates which serve as guidelines for trucking companies. The official tariff rates in 1983 were about 17% higher than the planned VOC targets and in theory would ensure a 17% profit to trucking companies; however, actual VOCs are in many cases higher. A greater problem for the trucking companies is the practice of keeping many old, inefficient trucks in their fleets which need to be maintained and overhauled at considerable expense. Fuel, vehicle repair, and overhauls for these trucks comprise over 40% of total VOCs. 62. Planning, Budgeting, and Financing. MOC and the State Planning Commission are responsible for overall planning of the country's road network, but are directly involved only in major projects. Approved projects are passed on to lower level authorities for execution. Recent highway planning has shown three main weaknesses: (a) there has been little or no planning of roads in relation to other transport modes; (b) selection of road investments has not been based on economic criteria; and (c) HB design standards have not been followed by the provincial implementing agencies which adjust quality and design specifications to reflect the availability of local funds. With Bank assistance in planning, the use of economic criteria for road investments is becoming an accepted practice and has been applied in selecting investments under the proposed project. The Bank has also assisted the MOC to revise and improve the efficiency of design standards; a stipulation that MOC would enforce the new standards is part of the proposed project. The more general problem of lowering design standards to suit funds available would be addressed within the general context of pricing in the transport sector and specifically through road user charges in the subsector. Intermodal planning remains a problem and will be the subject of further assistance. 63. There are two major sources of road financing: the Capital Con- struction Investment Budget from the central government and the road mainte- nance tax collected by the provincial governments. Funding from the Capital  - 16 - Construction Investment Budget is in the form of a grant or loan depending on whether the project is considered a national investment. Et is used only for new investment projects, not for road maintenance. The amount of capital investment funds allocated for highways in 1981 amounted to Y 82.3 million. Total revenues from road maintenance taxes amounted to Y 4.0 billion in 1983, 80% of which goes co maintenance and 20% for administration: this allocation represents an expenditure of an average of about Y 3.500 per km which can be considered high. The road maintenance fee is imposed on both MOC and social trucks, but using different rate systems. The road maintenance fee for MOC trucks is a fixed proportion (10-i5%) of total revenues, but for social trucks, it is a lump-sum fee charged on the vehicle loading capacity (Y 70-100/capacity-tonimonth). With the different systems. MOC trucks tend to pay a lower fee than do social trucks of comparable size. The road maintenance fee rate *s especially costly for the many trucks which are under- used. The justification for the two types of road maintenance fee is unclear, particularly since a uniform pricing system exists in most other areas. The present fee-charging system should therefore be reviewed to determine its economic effects. 64. Engineering, Construction and Maintenance. The engineering of road and bridge projects is done by the Planning and Design Institutes at MOC's central, provincial and county levels. Major road and bridge projects are done by the HOC Planning and Design Institute. MOC's Highway Scientific Research Institute (HSRI) provides support and advice on materials, etc., as needed. The design standards and guidelines for engineering design are set by MOC. Expatriate consultants are used only for specialized studies and then in joint venture with MOC's Highway Planning and Design Institute (HPDI). Since the workload of the HPDI is expanding in line with the increased traffic on the highway network, the Institute would be strengthened under the project. 65. Construction of roads and bridges was formerly done as a force account operation by construction bureaus attached to MOC headquarters or to the Provincial and County Transport Departments. However, in May 1984, Government authorized the introduction of competitive bidding for civil works projects and the establishment of construction companies from the existing public construction bureaus to carry out works on national and provincial roads. MOC has proposed the use of competitive bidding for the first time in China for highways to be financed under the proposed project, and to facili- tate this change, Bank staff and an expert on bid documentation are helping prepare the documents required for the proposed project. 66. National and provincial roads are generally well maintained by the PTDs. However, maintenance of paved roads is becoming more costly, ranging between Y 3,000 and Y 5,000 per km, due to their poor quality and the rapid traffic growth. Maintenance of county roads at the local level is adequate in scope and well organized, but due to the labor-intensive methods used, roads are surfaced with large size, hand-crushed stones providing poor riding surfaces. 67. Statistics on road traffic accidents are neither comprehensive nor reliable bdt the situation is far from satisfactory. The low standards of most roads combined with the mix of slow and fast moving traffic create  - 17 - hazardous conditions. Under- the proposed project, the HSRI would carry out a road safety study. 68. Highway Development: Objectives and Strategies. In the past 30 years, Government policy and strategy for the highway subsector sacrificed road quality for road length. Consequently, China is faced with a network of substantial roads that is unable to accommodate rapidly increasing traffic. In line with overaLl sector policy for the 80's (para. 50), the MOC's broad objectives for the highway subsector are (a) to improve the quality of existing roads and highway management; and (b) to expand the network with efficient aid cost-effective planning, design and construction. The Bank Group's strategy for the subsector is to support Government's twin objectives for highways by assisting the process of network expansion while helping to direct development policy toward greater quality improvement. This support would be within the framework of longer-term objectives concerned with increasing efficiency and cost-effectiveness in meeting the increased transport demand in the subsector. These objectives would address specific policy, institutional and technological areas such as: improved economic evaluation techniques for the selection of road investments; improved intermodal planning; transport tariff and road user taxation systems; increased efficiency in the road transport industry; improved efficiency in construction by supporting Government's policy of competitive bidding and development of the local contracting industry; staff training; modernization of highway design and updating and improving construction and material specifications; and supporting highway research. The Bank Group has agreed with Government that a number of these objectives would be dealt with under the proposed project. IV. THE PROJECT 69. In June 1983, the Government requested Bank Group assistance in financing a program of road construction and improvement as well as the strengthening of its overall capability to deal with the highway subsector. The proposed project was prepared by the Ministry of Communications (MOC) and the Highway Bureaus of the Provincial and County Transport Departments and appraised by a Bank Group mission in October/November 1984. A Staff Appraisal Report (No. 5408-CHA, dated April 19, 1985) is being distributed separately. Supplementary data are available in Annex III. Negotiations were held in Washington on April 1-5, 1985 with a Government delegation led by Mr. Wang Liansheng, Deputy Director, External Finance Department, Ministry of Finance. 70. Objectives and Scope. The proposed project would support Govern- ment's objectives for the subsector by assisting in: (a) modernizing highway design, and updating and improving construction and material specifications; (b) improving economic evaluation techniques for the evaluation and selection of road investments and supporting competitive bidding for public works; (c) supporting a highway research program, with particular emphasis on improving the condition of the paved road network, relieving road congestion and improving road safety; and (d) strengthening staff capability through training.  - 18 - 71. The project would include: (a) construction or improvement of about 230 km of national roads to provide interprovincial road links which would allow increased and more efficient economic activity in and between the provinces; (b) construction or improvement of about 1,400 km of rural roads to heLp promote economic deveLopment in rural areas, where agriculture, the country's primary economic activity, still employs 72% of the country's work force; (c) provision of computer-aided design and engineering equipment and site investigation and related laboratory equipment for the HPDI in order to modernize future highway designs; (d) provision of laboratory testing and other research-related equipment for the HSRI in support of their research program; (e) training of staff from the MOC's Highway Bureau, the PHBs, the HPDI and the HSRI; (f) consultant services and technical assistance to help the MOC, the PHBs and the Highway Institutes in the supervision and quality control of road construction, and for the three studies to be done under HSRI's research program and for seminars and workshops as needed; and (g) purchase of basic road maintenance equipment for selected provinces. 72. Road Construction/Improvement. The 230 km of national roads to be constructed or improved under the project comprise seven road sections located in six provinces. Estimated present traffic on the roads is relatively heavy and ranges from 264 AADT to 3,064 AADT. One road has been designed to Class 1 standard, two roads to Class 2 and the remainder to Class 3. The roads were selected by the Provincial Transport Departments (PTDs) as the missing links in the nationaL network in most urgent need of construction or improvement. Detailed feasibility studies and detailed engineering were prepared by the PTDs with guidance from MOCs Highways Bureau; contract documents for interna- tional and local competitive bidding are being prepared with the guidance of Bank Group staff and the help of an expatriate consultant financed under Technical Cooperation Credit (Credit 1412-CHA). 73. The 1,400 km of rural roads to be constructed or improved under the project consist of 59 road sections in six provinces. The roads have been designed to Class 3 and Class 4 standards, which are appropriate. The roads have been selected by the County Transport Departments which have also prepared the feasibility studies and detailed designs with the guidance of the PTDs and MOC's Highway Bureau. Assurances were obtained from Government that design standards and construction of the road sections would be as agreed with the Bank Group (Section .3.01(a) of and Part A.1 of Schedule 4 to the draft Development Credit Agreement).  - 19 - 74. Assistance to the Highway Planning and Design Institute. The Institute assists in planning and supervising the designs of highways throughout China, but its performance is hindered by outmoded equipment and a lack of trained staff. To help the Institute carry out this increasingly heavy work program more efficiently and more cost-effectively, staff wouLd be trained under the project, and the Institute' s equipment would be upgraded and modernized. Computer-aided design equipment as well as equipment for site investigations and materials testing would be financed under the project. In addition, an engineering data bank, including a national roads condition inventory, would be established, and computerized management information systems introduced. 75. Assistance to the Highway Scientific Research Institute. Soils and materials testing equipment as well as staff training would be financed under the project to enable the Institute to carry out its research program and ful- fill its task of being the major scientific and technological research base in China on highway transportation. Equipment and expatriate assistance wouLd also be provided to allow the Institute to carry out three studies of (a) strengthening, rehabilitation and maintenance of the existing paved road network (para. 66); (b) road congestion near cities (para. 53); and (c) road safety (para. 67). Assurances were obtained from the Government that project studies wouLd be carried out under terms of reference acceptable to the Bank Group beginning by July 1, 1986 to be completed by December 31, 1987, and that the Government and the Bank Group would exchange views on the findings of the studies (Section 3.01(a) of, and Part A.2 of Schedule 4 to, the draft Development Credit Agreement). 76. Staff Training. The proposed three-year training program (1986- 1988) aims at upgrading and modernizing the skills of the technical staff in the various fields concerned with the highway subsector. To improve the proficiency of MOC and the PTDs, including staff from HPDI and HSRI, selected personnel would be sent abroad for academic and practical training to be provided under some 50 overseas fellowships in various aspects of highway operations. In addition, MOC's Highway Institutes and the capacity of the Provincial Transportation Technical Schools would be strengthened by: purchasing equipment and books, training abroad of professors/instructors, and upgrading curricula. Assurances were obtained that the training would be carried out according to a program agreed with the Bank Group (Section 3.01(a) of, and Part A.3 of Schedule 4 to the draft Development Credit Agreement). 77. Consultant Services. A total of about 50 man-months of expatriate consultant expertise would be needed under the proposed project. Local expertise available in the Institutes in the sector would be used to the extent possible. Expatriate help would be sought only for those areas of advanced technology where local expertise is lacking. Supervision of the national road construction or improvement works will be done mainly by local staff supported by a number of key expatriates; about 20 man-months of foreign expertise would be needed to help set up and implement the organizational systems and procedures for effective quality control on site. About 15 man- months of expatriate expertise would be needed for the studies to be done by the HSRI and about another 15 man-months to help with seminars and workshops  - 20 - on specialized topics related to the highway sector. During negotiations, agreement was reached with Government on Terms of Reference for the consulting services. Consultants would be employed under terms and conditions acceptable to the Bank Group and in accordance with Bank Group Guidelines. 78. Road Maintenance Equipment. Maintenance of the existing rural roads is difficult because the roads are mostly surfaced with uncompacted large size hand-crushed stone, which gives a very rough riding surface. The level of service of these roads could be greatly improved with the appLication of fine- crushed material compacted to a dense layer. Under the project, some maintenance equipment, such as motor graders, mobile crushers and smooth-wheel rollers, would be provided to the CTDs for che maintenance of these roads and the rural roads to be constructed or improved under the project. 79. Project Cost and Financing. The total project cost, including contingencies, is estimated at about $169.4 million equivalent, with a foreign exchange component of $72.6 million or about 43%. The base cost estimates are in March 1, 1985 prices. Physical contingencies are caLculated at 10% of base cost estimates. For the calculation of price contingencies, it is assumed that exchange rate adjustments will, on average, be made to maintain "purchasing power parity" during the project impLementation period. On this basis, price escalation for both foreign and local costs: (a) when expressed in U.S. dollars, is based on expected international annual inflation rates of 5% in 1985, 7.5% in 1986, and 8% in 1987-1989; (b) when expressed in Yuan, is based on expected domestic inflation of 3% p.a. in 1985-1989. Taxes and duties on construction are estimated at $11.8 million equivalent. Civil works costs are based on work quantities calculated from detailed designs; equipment costs are based on manufacturer price quotations. 80. The Bank loan of $42.6 million and IDA credit o SDR 30.3 (US$30 million equivalent) would finance about 43% of total project costs or about 100% of the foreign exchange costs. The Government would provide about $104.0 million to meet the remaining capital costs of the project. 81. Implementation. MOC will have overall responsibility for project implementation. The national roads will be constructed and improved under unit priced contracts under the supervision of the Provincial Transport Departments (PTDs), which are part of the provincial governments but under HOC leadership. Construction Bureaus presently attached to the HOC or PTDs which have satisfactory experience on road works and adequate resources are being set up as financially and legally independent construction companies to bid on the national road contracts. These companies will form the basis of the new contracting industry in China. PTDs will supervise the contracts through a project management unit to be established in each province; each unit will be comprised of a project manager, engineer, supervisor and other staff as needed. Construction of national roads is expected to start in late 1985 or early 1986 and be completed in three years. Construction or improvement of rural roads would be carried out under force account for reasons of efficiency. The CTDs have welL organized and experienced construction units with adequate resources and ready access to local materials and local labor, enabling them to start work without delay. Because the works are generally small in scope and are located in remote mountainous areas, international  - 21 contractors are unlikeLy to be interested, nor would the preparation of detailed engineering and bid documents to ICB standards be cost-effective for such low standard roads. Similarly, for domestic contracting, there are at present virtually no local contractors for such work in these areas, and the construction companies newly-formed for purposes of national provincial road construction and upgrading would face substantial mobilization costs, given the lack of familiarity with these areas and their remoteness. The construction units would be directly supervised by the County Transport Departments, but under the overalL control of the PTD project management units. Construction of rural roads would start by late 1985 or early 1986 and be compLeted in two years. Road works included in the project represent the total road programs of the various provincial and county governments involved during the project period. Under the project, specialized expertise would be made available to both the provincial and county authorities to help them set up suitable organizations with appropriate systems and procedures to control the quality of work. Project road construction is within the capacity of the implementing agencies. 82. MOC and the project provinces will enter into a Project Implementation Agreement setting out their respective responsibilities in project implementation. While the Bank Group would not be a party to this agreement, signing of the Project Implementation Agreement on terms and conditions satisfactory to the Bank Group would be a condition of loan/credit effectiveness, and noncompliance with its provisions would be grounds for default under the loan/credit. (Sections 3.03(a), 5.01 and 6.01(a) of, and Part B of Schedule 4 to, the draft Development Credit Agreement, and Sections 3.01(a), 4.01 and 5.01(b) of the draft Loan Agreement). 83. Procurement. Construction of national roads would be carried out under international and local competitive bidding (ICB and LCB). The China National TechnicaL Import Corporation (CNTIC), in conjunction with MOC, would organize the ICB. MOC and the provinces will organize the LCB. Local bidders would be required to be financially and legally autonomous. Two major national road contracts ($44.4 million) would be carried out through contracts awarded on the basis of ICB by prequalified firms in accordance with Bank Group Guidelines. The other national roads ($22.0 million), which are unlikely to attract international contractors because of their location and size, would be awarded on the basis of LCB. To support the Government's move toward competitive bidding for civil works, Bank Group staff and an expatriate specialist in contract documentation are helping MOC prepare the bid documents neaded for ICB and LCB for the national road contracts; the expatriate assistance is being financed under Technical Cooperation Credit (Credit L412-CHA). Construction or improvement of rural roads ($94.1 milLion) would be carried out under force account. The PTDs would sign priced agreements with the county governments for this work. During negotiations, agreement was reached with Government on a priced Bill of Quantities for each rural road subproject in order to establish a firm and agreed cost. 84. Road maintenance equipment ($2.3 million) would be procured by ICB, but as the equipment to be procured for the HPDI and HSRI and ($1.4 million and $1.7 million, respectively) and for the training component is highly specialized, limited international bidding from at least three suppliers would  - 22 - be used. However, items or group of items estimated to cost Less than the equivalent of US$50,000 per contract, up to an aggregate amount not to exceed the equivalent of US$300,000, may be procured on the basis of comparison of price quotations solicited from a list of at Least three suppliers eligible under the Guidelines and in accordance with procedures acceptable to the Bank Group. CNTIC or another authorized government agency would be responsible for all equipment procurement. A summary of project procurement arrangements is given below. Procurement Method Total Project Element ICB LCB Other Cost C--------- (S million) ------------- Civil Works National Roads 44.4 22.0 - 66.4 (20.5) (10.2) - (30.7) Rural Roads - - 94.1 94.1 (33.1) (33.1) Equipment 2.3 - 3.2 5.5 (2.3) (3.1) (5.4) Training and Consultants - - 3.4 3.4 _____ (3.4) (3.4) Total 46.7 22.0 100.7 169.4 (22.8) (10.2) (39.6) (72.6) Note: Figures in parentheses are the respective amounts financed by the Bank Group. 85. Under ICB, qualifying domestic contractors and manufacturers would be permitted to participate and would be eligible for a margin of preference of 7-1/2% for civil works and 15% for goods, or the prevailing customs duties, whichever is lower, in the evaluation of bids. Since this would be the first time that contracts would be awarded on the basis of competitive bidding in the highway subsector in China, all contracts for civil works and equipment would be subject to prior review and agreement by the Bank Group. 86. Disbursements. Disbursement of the loan/credit would be as follows: 46% of the total cost of national road construction; 35% of the total cost of rural road construction; 1OOX of foreign expenditures for directly imported equipment, 100% of local expenditures (ex-factory) and 75% of local expenditures for other items locally procured; 100% of the costs of foraiga consulting services and local experts; and 100% of the costs of over-  - 23 - seas training of staff. To facilitate disbursement, a Special Account would be opened in US dollars in a Bank acceptable to the Bank Group with an initial deposit of the US dollar equivalent of SDR 10.0 million, which represents the estimated expenditures for a four-month period. Applications for replenishment of the Special Account would be submitted quarterly or whenever the Special Account is drawn down to 50% of its initial deposit, whichever comes first. 87. Loan/credit disbursements would be made as follow.s: against priced contracts for national road civil works and equipment; priced agreements for the force account civil works on ruraL roads; actual costs for training over- seas; and against statements of expenditure for the training component and for goods or services costing less than US$50,000. The project would be completed by June 30, 1990. Loan Closing is expected by June 30, 1991. Project disbursements are expected to be completed slightly earlier than the regional profile shows. Since China's economy is growing steadily, revenue accrual is expected to remain strong during the project period and therefore delays due to budgetary constraints are not anticipated. 88. Auditing, Reporting and Monitoring. The State Auditing Agency (SAA) has been established to carry out detailed audits of government agency accounts. Assurances were obtained from Government during negotiaticns that the accounts of project-related expenditures would be audited by independent auditors acceptable to the Bank Group, and that audit reports would be sent to che Bank Group for review within six months of the close of the fiscal year (Section 4.01(b) of the draft Development Credit Agreement). The Bank Group currently accepts SAA audits for this purpose. Project progress reports would be submitted to the Bank Group quarterly by MOC, and a Project Completion Report would be prepared by Government and submitted to the Bank Group not later than six months after the Loan/Credit Closing Date. 89. Environmental Effects. The road improvements should cause no significant environmental problems. By following existing alignments to the extent technically and economically feasible, the acquisition of scarce agricultural land will be minimized. The improved alignment and reduction of existing hazardous dust and mud by paving would improve road safety. 90. Justification, Benefits and Risks. China's new economic policy is creating a rapidly growing demand for both long- and short-distance road transport. The rapidly increasing output of textile, chemical, electronic and food processing industries, which are all well suited to road transport, has been accompanied by a growing demand for transport between cities and often across provincial boundaries. In rural areas, agricultural production as well as the increasing production of household and rural enterprises must be trans- ported, often very rapidly, to nearby towns aS,t other neighboring areas. Further, various enterprises have come to realize the financial advantages of highway transport, which enables them to deliver industrial goods and perish- able products rapidly and promptly to cities. The development of tourism throughout China and the very rapid increase in highway passenger traffic have also indicated the need for substantial development of highway infrastructure  - 24 - to serve the various and steadily increasing needs of China's economy. The proposed project would address these needs. 91. Since the national road sections included in the project are missing links in the network, traffic would be diverred from more circuitous routes. The 1984 traffic levels on the existing roads range from 264 AADT to 3,064 AADT. Tratfic volumes are estimated to grow by 9X p.a. from 1984 to 1988, when the roads would be opened. Allowance for generated traffic was made by increasing the growth rate to 12% p.a. for two years following opening of the roads and then a gradually decreasing growth rate over the pr.)ject life. The main benefit expected from the construction of national roads is substantial savings in vehicle operating costs (VOCs) resulting primarily from distance savings and to a lesser extent from reduced VOCs due to improved surface conditions. Other benefits such as time savings and reduced accidents and congestion on the existing alternate routes are smailer and have onLy been quantified when significant on roads with the highest traffic volumes. 92. The benefits of rural roads to be constructed or improved under the project comprise transport cost savings as well as value added to production which the roads would make possible by reducing transport costs. The benefits would accrue to residents of the areas served, which are now accessible only by trails, with all transport by porters. The transport cost per ton km would fall from Y 3 - Y 4 at present to Y 0.2 with the roads. The largest benefit would be in terms of value added through the exploitation of resources which are uneconomical at the prevailing transport cost and impractical in terms of the hard labor involved. Since the proposed roads to be constructed are in the more hilly areas of the various provinces included in the project, the resources are mainly from coal mining, construction materials, marble, timber and bamboo production; and only to a lesser extent from increased agricultural production of cash crops. 93. Based on the combined costs and benefits of all project roads and some minor maintenance equipment to be provided under the project, the overall ERR of the project is 20%. 94. The main project risk is the possibility of delays in implementation and benefits due to the introduction of ICB and LCB. To minimize this risk, appropriate Bank Group assistance and supervision will be provided in the early project stages. It is unlikely that traffic growth will be lower than estimated since road transport in China is at an early stage of development and the potential for growth is very larLte. Traffic growth may well be higher than estimated. The risk is therefora very, low that the rate of return would fall below the above estimate. Sensitivity analysis shows that if construc- tion costs increased by 20%, the ERR would fall to 17%.  - 25 - PART V - LEGAL INSTRUMENTS AND AUTHORITY 95. The draft Development Credit Agreement between the People's Republic of China and the Association, the draft Loan Agreement between the People's Republic of China and the Bank, the recommendation of the Committee provided for in Article V, Section l(d) of the Articles of Agreement of the Association, and the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement of the Bank are being distributed separately to the Executive Directors. 96. Special conditions of the project are listed in Section III of Annex III. Additional conditions of effectiveness would be that (i) China's State Council shall have approved the Development Credit and Loan Agreements; and (ii) the project implementation agreement between the Government and the project provinces shall have been executed under terms and conditions acceptable to the Bank Group. 97. I am satisfied that the proposed loan and credit would comply with the Articles of Agreement of the Bank and Association. PART VI - Recommendation 98. I recommend that the Executive Directors approve the proposed loan and credit. A.W. Clausen President Attachments April 23, 1985 Washington, DC 4  -26- ANNEX I Page L of 6 Culu&. UP 31. 0o - SOCIAL [t DA 3 cvuN. , s, up. or U-- NC RcOUPS (VWCXTED AYIEAGIS) /a NONT (MST NECU ESTUGTA) lb 19o i97Qk 5t ASIA PACIFIC A5z*4 rric TTaL 951.0 9341.0 9581.0 ACRICILTAURL 3257.8 2311.0 2145.9 LM CAPITA CUS) 40.0 Ic 10.0 310.0 273.8 1091.2 - mv!EI.M CAPITA (tULOGUI OF OL IOOvALZT) 191.0 230.0 420 272.0 567.3 IIuLunOu Am YWAL 3UECS * ,OPOLAT mNA-TRA. (?MoAM) "7100.0 543700.0 1003175.0 * um PO10U1111 (Z 0F TOTAL) 13.4 Id .. 10. 21.7 4.; Po ToI&0 OJECnT PoLATION 11 n1u 2000 (N.L) 11%8.3 SnT.0MT NPOPULATMI (IKLL) 1441.0 IOPUIATIU NWMIhI 1.7 II SQ. MI. 71.9 U.5 103.5 18". 281.9 MR SQ. M. AGRI. uD 211.1 217.9 234.3 245.S 1735.1 PO1U.TION am STICEWE (1) 0-14 us5 3.9 37.7 30.9 35.3 39.0 15-8 IRS 34.3 21.2 63.3 5". 57.4 85 AND 439 M. 3.1 5.5 4.3 3.3 POIWLATION CILO RATE (t) TOL 1.3 2.1 1.5 1.9 2.3 caw .. .. .. 4.1 4.3 CRUDE 3X13 RATE (M TUG0S) 39.2 /a 34.0 13.5 27.7 30.1 c3 D0AXS UTZ (M 1TOM) 23.5 7a 10.1 8.8 10.1 9.5 GYWSS W300 0TION SA7T 2.5 re 2.3 1.2 1.1 2.0 PLAJ PLANNINc ACRTS. AIN 30S) .. OSC25 (Z 0o N l WmEs) .. .. 89.4 if .. 52.7 FM Amm m iid XW OF FO0D 01OD. LU CLPITA (1589-71-100) ,, 100.0 124.0 112.5 123.0 In CAPIiA SUPPT OF CALORIES (1 or 3WIRM1 NTS) 93.0 .0 107.0 97.7 114.4 PROTINS (CAS PU DAT) 56.0 53.0 88.0 36.3 57.0 OF UI_ AHD L ANMD POISE 1.0 18.0 17.0 kA 14.9 14.1 CDID (ACEG 1-4) DEA t 'ATE 26.0 14.0 7.0 9.3 7.2 LIFEXPECT. AT r312 (TEARS) 41.0 lb 12.2 84.5 h0.0 0.4 IWAUT ORT-. EAT! (PE T300S) i* s. o 109.0 67.0 83.8 t.3 ACCSS TO SAP! VAEI (510?) TOTAL .. .. 32.9 37.0 tUNAS .. .. 70.9 54.8 383MAL . 3o-0 22-1 24.4 AeCS TO 131?A DISPOSAL (S Or POPoMTIOE) TOTAL .. .. .. 13.1 41.3 1311 .. .. .. 72.J 47.4 _1 .. .. 4.4 33.3 POrVLATInO >LU PJUCTAI 3390.0 11 3830.0 11 18100 it 3484.2 7749.4 POP. LU OIWSIJ PtSOn 4050.0- 2570.0 1790.0 4793.1 2460.4 POP. LU EOSPITAL DBD TOTAL 1040.0 780.0 490.0 1084.5 104.2 Gal" 210.0 .. 160.0 291.0 851.2 IDEAL 10140.0 .. 1020.0 5"3.4 259.4- SS13S LU NOSPAL ID ._ .. .. -- 27.0 * sor S I OOSCDeLD TOtAL _ .. 5.2 031*3 .. .. a.2 . 303