Romania - The challenge of transition (Vol. 2 of 2) : Volume two

Report No. 9497-RO Romania The Chailenge of Transition (In Two Volumes) Volume II December 3, 1991 Country Departnient I Europe and Soviet Union Region FOR OFFICIAL USE ONLY .,~~~~~~~~~~~~~~~~P A~~~~~ Document of the World Bank 0 This document has' a restricted distribution and may be used by recipients only in the performance 6f their official duties. Its contents may not otherwise be disclosed without World Ban~kauthorization.Report No.8906-ANG  CURRENCY EQUIVALENTS Unit of Currency: Leu (Plural: Lei) Exchange Rate: Lei per U.S. Dollar Period Averiage End of Period Lei/Trans. Period Commercial Non-Comnmercial Commercial Non-Commercial Ruble 1975 20.000 12.000 20.000 12.000 n.a. 1980 18.000 12.000 18.000 12.000 n.a. 1985 17.141 12.241 15.730 11.230 15.5 1986 16.153 11.337 15.280 10.500 15.5 1987 14.557 9.759 13.740 8.420 15.5 1988 14.277 8.747 14.370 8.840 15.S 1989 14.922 8.992 14.490 8.910 15.5 1990 22.432 ... 34.710 ... 17.0 1991 March n.a. ... 36.97 ... ... April n.a. ... 60.67 ... Source: IFS: 1983, 1984 and 1991; Romaniar authorities. Note: The commercial rate applies to all foreign trade and capital transactions in convertible currencies, and a non-commercial rate applied largely to tourism. The Transferable Ruble rate was abolished in February 1991.  FOR OFFICIAL USE ONLY GLOSSARY OF ABBREVIATIONS BAFI Bank of Agriculture and Food Industry BA Bank Agricola BIS Bank for International Settlements CEC Savings Bank CBR Crude Birth Rate CMEA Council for Mutual Economic Assistance EEC European Economic Community FIAS Foreign Information Advisory Service FTO Foreign Trade Organization GAAP Generally Accepted Accounting Principles GDR German Democratic Republic GOR Government of Romnania GW Giga-Watt 'IA Hectares IBEC Intemational Bank for Economic Cooperation ICOR Incremental Capital Output Ratio MAFI Ministry of Agriculture and Food Industry MNE Ministry of the National Economy MOE Ministry of the Environment MOP Ministry of Finance MOLSS Ministry of Labor and Social Services MOT Ministry of Tranport MPWT Ministry of Public Works and Transport MW Mega-Watts NAP National Agency for Privatization NBR National Bank of Romania NEM New Economic Measures POF Private Ownership Fund QR Quantitative Restrictions RA R6gie Autonome RBD RomauL an Development Bank RBFT Romanian Bank for Foreipn Trade RCB Romanian Commercial Bank SME Small- and Medium-Scale Enterprises SOE State-owned Entesprise SOF State Ownership Fund TOE Ton Oil Equivalent TR Transferble Ruble VAT Value Added Tax This document has d 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.  VOLUME 11 TABLE OF CONTENTS Page No. CHAPTER 1: 'HE ROMANIAN FINANCIAL SYSTEM ...................... 1 I. Overiew of the Financial System .. 1 A. The Pre-Reform Structare .1 B. Recent Changes ........................................ 2 II. Monetary and Credit Policy in Flux ............................... 3 A. Monetary Overhang ...................................... 3 B. Instruments of Policy ..................................... 7 lII. Bank Supervisions ........................................ 10 IV. The Commercial Banks ..................................... 12 A. Overview ........................................... 12 B. Description of the Banks .................................. 13 V. Training Needs .......................................... 19 Appendiv 1 Summary Baiance Sheets Figures of Principal Romanian Banks ..... ........ 21 Appenr -t 2 Risk-Weighted Assets and Minimum Capital Requirements of the Romanian Banks .. 22 CHAPTER 2: THE ENERGY SECTOR ............33 I. Sector Overview .......................................... 33 II. Production and Trade ...................................... 34 Ill. Energy Uses ............................................ 38 IV. Main Issues ............ ............................. 39 V. Requirements for Rehabilitation and Sustained Viability .................. 41 CHAPTE'1 3: STRUCTURE AND PERFORMANCE IN ROMANIAN AGRICULTURE. 47 I. Background ............................................ 47 H. Recent Performance ........................ 48 A. Performance in Primary Production ........................... 48 B. Domestic Consumption and Nutrition .......................... 57 III. Marketing, Foreign Trade, and Pricing ............................ 58 IV. The Input Supply Situation ................................... 69 V. Agriculturl Infrastructure and the Technical Services ...... .. ........... 75 VI. Agricultural Employment .................................... 86 VI. The Agro-Processing Industries ................................ 87 VIH. The Rural Financial Market ................................... 89 IX. Sectoral Adjustment Policies ..91  iv PaseeNo. CHAPTER 4: REVIEW OF THE NDUSTRIAL SECTOR AND ENTERPRISE REFORM ......... ...................... 103 I. Industrial Stricture and Performance ............ ................ 103 A. Background ......................................... 103 B. Industrial Structure ........... ......................... 104 C. Output ............................................ 106 D. Export Performance . ................................... 109 E. Investment . ........................................ 112 F. Technology . ........................................ 115 0. Employment ........................................ 119 H. Financial Position .119 I. Productivity and Competitiveness .124 It. Sectoral Reviews ..126 A. Ferrous Metallurgy Sector .127 B. Machine Building Sector .129 C. Chemical Sector .132 D. Electronics, Electrotechnics, and Fine Mechanics (EE) Sector .136 E. Textiles, Garments, Footwear, and Leather (TGFL) Sector .138 Ill. Industrial Organization and Legal Framework ..141 A. Ownership Structu .141 B. Industrial Organization .142 C. Size Distribution .143 D. Oversight Structure for State Enterprises .144 E. Incentive Systems .145 F. Regulatory Framework for Enterprise Reform .146 0. Privatization .151 IV. Framework for Industrial Sector Adjustment ..151 A. Ownership Reform and Privatization .152 B. Ownership Functions and Enterprise Management .155 C. Restructuring .157 D. Special Programs .161 E. Increasing Capacity for Supply Response ...... 169 Appendix Privatization in the Enterprise Sector ..177 CHAPTER 5: ROMANIA'S I'RASTRUCTURE .193 I. The Transport Sector ..193 A. Overview .193 B. Sector-Wide Issues and Recommendations .194 C. Roads .198 D. Railways .199 B. Ports ..... .................................. 201 F. Bucharest Urban Transport .201 0. Government Priorities .203  v Page No. 11. Telecommunications Survey and Reconnaissance .................... 203 A. Summary .......................................... 203 B. Background and Organization ......... ..................... 205 C. The Existing Network and Services ....... ................... 209 D. Service Tariffs and Revenues ......... ..................... 211 E. Quality of Service ...................................... 214 F. Mission Analysis . ..................................... 215 G. The Scope of the Required Development ....................... 218 H. Mission Recommendations .......... ...................... 222 III. Water Resources and Pollution Management .......... ............. 224 A. Summary and Conclusions .......... ...................... 224 B. Description and Assessment ............................... 226 C. Recommendations for a Prograrn of Reform ..................... 229 D. Preparing and Managing the Reform Program .................... 231 IV. Water Supply and Sewerage ............. .. .................. 232 A. Summary and Conclusions ........... ..................... 232 B. Description and Assessment; Issues and Constraints .... ............ 234 C. Recommendations for a Program of Sector Reform ..... ............ 239 D. Preparing for and Managing the Sector Reform Process .... .......... 243  vii LIST OF TABLES Page No. Table 1.1 Romania - Selected Interest Rates .............................. 8 Table 2.1 Energy Production and Trade, 1980-90 ......................... 36 Table 2.2 Romania - Primary Energy Sources and Users ..................... 37 Table 2.3 Romania - Energy Imports and Exports ......................... 38 Table 2.4 Romania - Energy use by Industrial Subsectors ..................... 39 Table 2.5 Energy Sector Investment, 1991-95 Projected by the Government ....................... 45 Table 2.6 Energy Price Structure, November 1990 ......................... 46 Table 3.1 Romania - Trends in Crop & Livestock Output Value in the 1980s .51 Table 3.2 Romania - Trends in Agricultural Land Use and Crop Pfrduction ..................................... 53 Table 3.3 Romanian Animal Census, Sept, 1990 ......... ................. 54 Table 3.4 Official Producer Prices for Agricultural Commodities ..... ........... 65 Table 3.5 Domestic and Border Price Comparisons ....... ................. 67 Table 3.6 Employment in Agriculture .................................. 86 Table 4.1 Share of Industry in the Romanian Economy, 1980-90 ..... .......... 103 Table 4.2 Structure of Industrial Output ............. ................. 105 Table 4.3 Net Material Product and Value Added by Industry, 1980-90 ............................................ 107 Table 4.4 Industrial Capacity Utilization, 1988-90 ........................ 108 Table 4.5 Industrial Production and Labor Productivity 1989-90 .109 Table 4.6 Structure of Exports and Imports by Production Categories in 1989 .110 Table 4.7 Pattern of Exports and Imports by Currency Area, 1981-89 ........................................ 111 Table 4.8 Investments in Romania, 1980-90 ............................ 113 Table 4.9 Sources of Investment Finance for Major Industrial Subsectors in 1989 ............................... 114 Table 4.10 Investment Projects in Manufacturing, 1991 ...................... 115 Table 4.11 Share in Energy Consumption versus Gross Industrial Output and Value Added for Selected Industrial Subsectors, 1989 ...................................... 117 Table 4.12 Employment in Industry, 1980-90 ............................ 119 Table 4.13 Effective Taxation Rate and Contribution to Govenment Tax Revenues for Selected Industrial Subsectors, 1989 ............... 120 Table 4.14 Effective Tax Rates in Selected Industnal Enterprises ............ .............................. 121 Table 4.15 'ustrative Prices for Industrial Inputs and Products, 1990 ..................................... 125 Table 4.16 Industrial Enterprises Size Structure, 1985 and 1989 ................ 143 Table 4.17 Romania - Classification of State-Owned Enterpris,s ................ 150 Table 5.1 Roma.Zil - Distribution of Investments in Water Supply and Se.verage, 1985-89 .................................. 236  viii LIST OF CHARTS Chart 1.1 Broad Money in Selected Countries, 1988 .........................S Chart 1.2 Romanian Money Holdings ............................. 6  CHAPTER 1 THE ROMANIAN FINANCIAL SYSTEM 1. OVERVIEW OF THE FINANCIAL SYSTEM A. The Preo-eform Structure 1.1 U' -+if December 1989, the Romanian financial system existed to implement the central plan; flows of funds were controlled administratively, leaving little role for central banking or commercial banling fUnctions, as these are understood in market economies. The National Bank of Romania (NBR) was charged with note issue, but had little -esponsibility for money, credit, or interest rate policy. Risks were absorbed by the Governtent, banks consequently maintained little or no capital, and no body existed to supervise financial institutions. Banks provided little in the way of services to their clients and had scant authority to allocate credit.!' 1.2 Savings were mobilized through the Savings Bank (CEC), which lent out a small portion of its resources in the form of housing loans and then passed the remainder to the NBR. The Romanian Bank for Foreign Trade (RBFT), the Investment Bank (now the Romanian Bank for Development, RBD), and the Bank for Agriculture and Food Industry (now Bank Agricola, BA), respectively, were responsible for lending to the trade sector, the state enterprise sector, and agriculture, mostly with the funds borrowed from the NBR and supplemented by the deposits from the clients in their respective sectors. In addition to serving as the bank of issue, the NBR also had quasi-commercial banking functions, both taking deposits of state enterprises and cooperatives and making short-term direct loans, mainly to the former, and mostly for working capital. The system was supplemented by a few small cooperative banks, an insurance company (ADAS, subsequently split intr, two insurance companies and one auto-servicing firm), and four foreign banks? with sharply limited activities (basically for foreigners). This specialized environment contrasted markedly with that of pre-WWII Romania, when there were about 2000 financial institutions, about 450 of which were commercial banks. 1.3 In this system, banks were not especially important in financing investment. In the state enterprise sector, about 55 to 60 percent of investment was financed directly by the budget, another 25 to 30 percent by retained earnings and depreciation funds, and only 9 to 12 percent by the banks. Some of the banks, particularly the RBFT (as a result of its overseas operations), became acquainted with western banking practices and appear to I/ In the early 1970s, with the decentralization of the planning process and the creation of the cenrala, a regional layer of administration charged with formulating and executing parts of the planning process, there is some evidence that the banks' role increased somewhat. Still, they were essentially passive forces in the credit allocation process. ZI Manufacturers Hanover, Socidt6 G6n6rale, Misr Romanian Bank (a joint venture between Misr Bank of Egypt and RBEFT), and Frankfurt-Bucharest Bank A.G. (joint venture of RBFT with Deutsche GenossenschafRsbank and Berliner Handels-und-Frankfurt Bank).  2 llnvG a knowledge of their clients on the lending side. Nevertheless, for the past 40 years Romanian bank management has not been forced to assess risk or to compete for clients. Thus as in other emerging socialist economies, commercial (and central) banking skills are in short supply. 1 .4 During the pre-reform period, enterprises and agricultural cooperatives regularly made losses and fell behind on their loans. Prices were administratively restrained and firms were required to transfer most of their net -'amnings back to the State. Government surpluses accumulated, particularly as fiscal policy was tightened in conjunction with the repayment of Romania's foreign debt. These surpluses were employed periodically to cover the banking system's losses. By the end of 1988, all recognized bank losses were written-off, using fun4ing from tho budget or from the accumulated surplus. Subsequently, all but about Lei 150 billion (presently acknowledged losses) were written-off by rnid-1990, with a corresponding reduction in government deposits. The latter declined orom Lei 310 billion (39 percent of estimated GDP) in March 1989 to Lei 6.6 billion on September 30, 1990 (about I percent of GDP). In sharp contrast to the situation in F'land, the banks have no foreign currency exposure, although the RBFT had a Lei exposure to domestic firm; that financed exports in the Middle East and Africa. in early July 1991, the Government removed 90 percent of all remaining pre-existing losses (Lei 135 billion), requiring the state banks, now operating as independent commercial companies, to absorb the remaining 10 percent (Lei 15 hillion). B. Recent Changes l.5 The new Government, which took office in June 1990, dedicated itself to moving to a market economy and, in the financial sector, to moving to a two-tier banking system and to encouraging the formation of private banks. The Romanian Commercial Bank (RCB) began operations on December 1, 1990 with all of the commercial business of the NBR. Several private banks have been approved since last fall. The Bank for Small Industry and Private Initiative began operating on October 1, 1990, with a capital of Lei 1.5 billion. About one third of the shares are owned by various handicraft cooperatives and, although the chief goal of the bank will be to make profits for its owners, a secondary goal appears to be to support the private handicraft sector. Other private banks that began operating recently are the Cooperative Credit Bank and Bank Tiriac. Additionally, a bank may be formed from part of the national postal network, the offices of which often take savings deposits as agents for the CEC (i.e., these deposits are on the books of CEC) and assist in making transfers and payments. Such a bank could immediately be an important competitor for CEC and thereby sti-mulate improved service and innovation on the deposit side. 1.6 April 1, 1991 saw the passage of the Law On Banking Activity and the Law Concerning the Status of the National Bank of Romania, which together .onfirmed the shift to a two-tier banking system. In general terms the former law endows commercial banks with "universal" banking powers, while the latter gives the National Bank of Romania a high degree of de jure independence--in fact, higher than in many European countries. One potential drawback is that the law permits excessive exposure of banks to enterprises and also allows nonfinancial firms to control banks, as noted in the main body of the report; regulations issued by the NBR should be usl to  3 limit both of these prob'ems. The laws also allow tor the possible provision of eithe. public or private deposit insurance. However, even if private, the law stipulates that the NBR will supervise the fund. Thus it is likely that in the event of a run on the fund, the NBR would be the lender of last resort. To the extent that insurance is provided, the limits should be kept quite low (e.g., perhaps up to Lei 150,000 per account) to minimize both contingent liabilities on the National Bank and the Bud, rd to limnit excessive risk taking on the part of banks. This is especially important in view of the nascent supervisory capabilities of the NBR. 1.7 With the passage of the two banking laws, the National Bank now shuuld be allowed to exercise its legal independence (which could be quite high by international standards) in determining monetary policy and in supervising banks, while the Government should not attempt to influence unduly banks' credit decisions unless it is willing to commit budget funds directly. The next steps will be to implement the changes and to ensure both that monetary and bank lending policies impose financial discipline on firms and, ultimately, that capital is allocated on market principles. II. MONETARY AND CREDIT POLICY IN FLUX A. Monetary Overhang 1.8 Both wartime and planned economies tend to develop a monetary overhang, defined as an accumulation of actual money balances above their desired level (eqwlivalently, a fall in actual relative to desired income velocity of money). In socialist economies, the accumulation is involuntary, as consumer goods typically are rationed by central planners. Whatever its causes, an overhang can circumscribe the ability of the authorities to conduct an anti- inflationary monetary policy: even if money creation is restrained in a flow sense, the outstanding stock can 'be suddenly drawn down, leading to a spurt of prices. 1.9 Chart 1 shows M2/GDP ratios for selected economies in 1988. Romania's overhang by these standards is evident but still below that of Bulgaria. In June 1990, M2 was Lei 572 billion, or about 72 percent of the prev;ous year's GDP. It is difficult to estimate what part of this stock might be quickly spent. However, in countries with a comparable per capita income, M2/GDP ratios might be about half that figure, with a range of 25 to 40 percent. Also, as seen in Chart 2, the monetary holdings of the household sector as a proportion of money incomes increaed steadily from 1970, which was thought to be a "golden year' in Romania, with relatively little overbang. The jump in 1990 (data through September) reflected primarily both an estimated 20 perctnt fall in money incomes as well as a 13 percent rise in money holdings, perhaps related to the increased likelihood that goods would actually soon be availabie.l' ast year's ratio of money holdings to incomes was somewhat more than 1/ See Gerard Caprio and Patrick Honohan, 'The Persistence of Excess Liquidity," World Bank mimeo, 1990, for arguments on the link between excess liquidity in the household sector and the probability of economic reform.  4 double that of 1970; since somo fimancial deepening would be expected on the basis of intervening real income growth, these data are not inconsistent with the suggestions from cross-country evidonce on the overhang. 1.10 Several well-knowni options exist for dealing with money overhangsY In brief these options are: * a jump in the price level; X a jump in real output; * an increase in money demand, ceteris paribus; * a blocking of part of monetary holdings; and