China - Country assistance strategy

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 14454 CHA MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR THE PEOPLE'S REPUBLIC OF CIfiNA May 4, 1995 Country Department 2 East Asia and Pacific Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  DATE OF LAST CAS August 3, 1993 CURRENCY EQUIVALENTS (as of February 1995) Currency Unit = Yuan (Y) $1.00 = Y 8.50 Y 1.00 = $0.12 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS CIR - Country Implementation Review ESW - Economic and Sector Work FDI - Foreign Direct Investment FIAS - Foreign Investment Advisory Service GDP - Gross Domestic Product HRD - Human Resource Development LRMC - Long-run Marginal Cost NEPA - National Environmental Protection Agency PBC - People's Bank of China RMC - Resident Mission in China SDB - State Development Bank SOE - State-owned Enterprise TA - Technical Assistance TVE - Township and Village Enterprise VAT - Value-added Tax WTO - World Trade Organization FISCAL YEAR January 1 - December 31  FOR OFFICIAL USE ONLY MEMORANDUNM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA 1. THE ECONOMY A. RECENT ECONOMIC DEVELOPMiENTS 1. In 1994, the Chinese economy experienced slower growth, accelerating inflation, a dramatic turnaround in the trade balance and substantial inflows of foreign direct investment. During the course of the year, the Chinese authorities successfully implemented exchange system and fiscal reforms and took important steps toward improving monetary management. Their attention now needs to turn to reducing the size of the quasi-fiscal deficit that, in turn, requires vigorous efforts to reform state-owned enterprises (SOEs) and the financial sector. I/ 2. Strong Growth and Export Performance. For the third year in a row, China's growth was in double digits. The record growth in 1992 (13.6 percent) and 1993 (13.4 percent) was followed by an expansion in GDP of 11.8 percent in 1994. Nevertheless, the Chinese authorities had success in slowing the growth of aggregate demand in 1994. In particular, consumption growth declined to 5 percent (14.4 percent in 1993) and fixed investment grew by 15.8 percent in real terms, down from 25.3 percent in 1993. Industrial growth decelerated, declining from above 20 percent in the previous two years to 17.4 percent in 1994. Agriculture grew at 3.5 percent in 1994, somewhat slower than in 1993 and below the 4.5 percent a year average of the past 10 years. Natural disasters in various regions were partly to blame with grain output (445 million tons), in particular, falling 12 million tons below the record harvest of 1993. 3. On the other hand, reflecting the dramatic turnaround in the trade balance, net exports accounted for 25 percent of growth in 1994 (-25 percent in 1993). The external current account moved from a deficit of $12 billion (2.8 percent of GDP) in 1993 to a surplus of $2 billion (0.4 percent of GDP) in 1994. This was due to the sharp expansion of exports (30 percent) and a moderate increase in imports (10 percent). Contributing to the trade outturn were strong external demand, moderating domestic demand, and exchange system reforms, which included the initial depreciation of the currency and easing of access to foreign exchange (para. 8).2/ As in years past, foreign joint-venture enterprises accounted for a major part of the increase in overall exports; these enterprises now account for over half the country's manufacturing exports. 4. Continued Inflationary Pressures. Inflation accelerated in 1994 to over 20 percent- double the target rate set by the authorities for the year. The 12-month increase in the retail price index 1/ See 'China: Country Economic Memorandum," Report No. 13399-CHA, October 26, 1994 for detailed aralysis. 2/ The real effective exchange rate appreciated during the course of 1994, eroding almost completely the initial impact of the nominal devaluation. 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.  -2 - peaked at 25 percent in October and had declined to 23 percent by December.3/ Despite some moderation in investment growth and decline in consumption demand, persistently high rates of inflation continue to pose risks to economic stability. CIUNA: SELECTED ECONOMC INDICATORS (1993-94) (Growth rate in percent; unless otherwise indicated) 1993 1994 June DecJ une Dec. Economic Activity Real GNP /a 14.1 13.4 11.6 11.8 Fixed asset investment by state-owned units, nominal /a 70.7 57.8 37.5 34.2 Overall retail price index /b 13.9 17.6 19.6 23.2 Monetary Sector /b Broad money 26.6 23.7 29.7 34.4 Household deposits 22.5 27.9 42.8 41.5 Fiscal Sector /a /d Total budgetary revenue 1.5 23.1 22.6 19.2 Total budgetary expenditure 12.6 21.2 27.0 25.4 External Sector Merchandise exports (f.o.b.) /a /e 4.3 8.8 30.2 31.9 Merchandise imports (c.i.f.) /a /e 23.0 28.9 21.1 11.2 State foreign exchange reserves (S billion) /c 18.9 21.2 31.9 51.6 Exchange rate (average Y/S), official 5.76 5.80 8.66 8.45 /a Year-on-year change. /b Growth relative to the same period in previous year. /c End of period. /d Based on Chinese definitions, which differ from those used by the IMF's GFS. /e Customs basis. Source: Chinese authorities and staff calculations. 5. In July 1993, the government introduced an economic stabilization package, widely reported as the "16-point program," in a concerted effort to lower inflation and avoid another repeat of the stop-go cycles experienced by the Chinese economy since 1978. The program was partially successful in moderating growth in aggregate demand, even though the rate of fixed investment, at 37 percent of GDP, remains high.4/ Despite overall restraint in credit policy, monetary aggregates grew rapidly in 1994 (34 percent increase in broad money). In contrast to previous inflationary bouts, however, the People's Bank of China (PBC) lending to financial institutions was not an important factor. Instead, China's large balance of payments surplus drove the monetary expansion. Positive net exports, together with large net capital inflows, more than doubled PBC's international reserves to $52 billion.S/ Unable to sterilize these inflows through open-market operations and reluctant to allow a large appreciation of the currency, PBC instead tightened credit to financial institutions. But this credit tightening was insufficient to compensate for the magnitude of the increase in foreign reserves. 3/ The retail price index increased by 21.7 percent year-on-year. 4/ Despite the recent upward adjustnents made by the Chinese Statistical Bureau to the output of the services sector, Bank staff analysis suggests that nominal GDP remains underestimated by some 20 percent, owing to inadequate coverage of grain and rural services output and the impact of administered prices. (See Bank report 'China-GNP Per Capita,' Report No. 13580-CHA, dated December 15, 1994). With this adjustment, investment levels in China would be lower-30 percent of GDP-in line with levels in other East Asian economies. 5/ By end-March 1995, international resrves had risen to some S58 billion.  - 3 - 6. The growth in money supply accommodated increases in adrninistered prices. Much of the 1994 increase in retail prices can be explained by cost-push pressures caused by overdue reforms in administered prices, especially for food grains.i/ Upward price adjustments affected food grain (40 percent), crude oil (52 percent), natural gas (114 percent), gasoline (14 percent), diesel fuel (38 percent) and cotton (59 percent). The exchange system reform and the expansion of the value-added tax (VAT) at the beginning of the year also contributed to the increase in the 1994 price level. 7. As in years past, structural problems continued to generate inflationary pressure in 1994. This pressure is unlikely to moderate unless and until reforms in the SOE and financial sectors are tackled in earnest. As in the past, there was periodic easing of credit in response to the needs of SOEs; guidelines for wage restraint were ignored as some SOEs adopted the 50 percent civil service wage increase; and excessive SOE investments continued to reflect the absence of a hard budget constraint and the impact of strongly negative interest rates in real terms. 8. Progress with Structural Reforms. During 1994, China made substantial progress in the implementation of structural reforms, the basic agenda for which was outlined in November 1993 at the Third Plenum meeting of the Fourteenth Communist Party Congress. Extensive exchange system reforms were implemented in early 1994. The dual exchange rate system, effective since 1986, was unified on January 1, 1994 at the rate of Y 8.7 per $1, implying a nominal devaluation of the official rate of about 50 percent (from Y 5.8/$1) in domestic currency terms. However, since only 20 percent of trade was being conducted at the official rate by January 1994, the effective nominal devaluation was much smaller. Following further reforms in the exchange system, the single exchange rate is now the product of foreign exchange buying and selling decisions by designated financial institutions through a national network with electronic bidding systems. The current foreign exchange system can be characterized as a managed float. 9. In early 1994, the government announced afiscal reform package that overhauled the tax system and fundamentally restructured intergovernmental fiscal relations. The reform was aimed at simplifying the tax structure, increasing the buoyancy of tax revenues and reducing reliance on distortionary taxes. Also, intergovernmental fiscal relations were redesigned to increase the share of the center in tax revenues and enable greater fiscal equalization across provinces. The reforms also included the creation of a new national tax service to collect central and shared taxes, which will operate alongside local tax services in charge of local tax collection. Implementation of fiscal reforms is off to a good start. Tax revenues were higher than budgeted in 1994, but government revenues as a percentage of GDP continued to decline. With a strong increase in budgetary expenditures spurred by the increase in civil service wages, the budget deficit is estimated to be about 2 percent of GDP, the same as in 1993. 10. Financial reforms in 1994 included measures to strengthen the central bank, through constraining the ability of PBC branches to create credit, separating its affiliated entities, and strengthening and standardizing its supervision capacity. Also, direct government borrowing from PBC was terminated and efforts are being made to launch open-market operations. A new Central Banking Law, aimed at enhancing PBC's operational autonomy to conduct monetary policy, was enacted in March 1995. The government also announced major changes in 1994 to support the "commercialization" of banks by separating policy from commercial lending. Policy lending has been transferred to three newly- created development banks: the State Development Bank (SDB), the Export-Import Bank, and the Agricultural Development Bank. 6/ Calculations show that 72 percent of the rise in the retail price index over the twelve months preceding October 1994 was due to the food price index.  - 4 - 11. In early 1994, the government announced the "10,000-1,000-100-10" SOE reform experiment. This calls for: 10,000 large- and medium-scale SOEs to adopt new accounting methods; 1,000 large SOEs to adopt new state asset management regulations; 100 large and medium SOEs to become corporatized; and 10 (now 18) cities to undergo "comprehensive reform." The 18 cities targeted for comprehensive municipal reform and the 100 enterprises to participate in the corporatization component of the program have been selected; with the adoption of the new State Asset Management Regulations, the valuation of 1,000 large enterprises is under way; and the implementation of the new accounting standards (published July 1993) in 10,000 large SOEs is largely complete. Although there were no new major policy initiatives from the center in 1994, experiments with enterprise reform continued at the municipal and provincial levels. These included experiments with shareholding arrangements and pension pooling, staff lay-offs, and a limited number of bankruptcies. B. THE EXTERNAL ENVIRONMENT 12. The successful implementation of the "open-door" policy over the past 15 years has led to China's rapid integration into the international trade and finance system; China is now the tenth largest trading nation in the world and the largest recipient of capital flows among developing countries. The benefits to China have been enormous. China's remarkable growth is due in large part to efficiency improvements brought about by increased exposure to international markets. The benefits to the international community are equally significant. Thanks to rapidly rising incomes, China's domestic market is expected to absorb large import and investment flows in the future. With the increasing flexibility of the economy and improvements in economic management, China is well positioned to take advantage of the opportunities offered by greater integration into the world economy and to respond quickly to sudden changes in the international economic environment. 13. Trade Prospects. China's entry into the international trading arena has been impressive. In the past 15 years, while world exports increased at about eight percent annually, Chinese exports grew at some 15 percent, resulting in a 2.5-fold increase in the share of China in world exports (nearly 2 percent in 1992). In the process, China achieved significant transformation of its export structure, which now benefits from substantial product and market diversification. China is not yet a member of the World Trade Organization (WTO) as the protocol for China's entry continues to be negotiated. Membership in the WTO is important not only for China but for the international trading community as a whole. It would protect China's trade against arbitrary action, and provide to the international community a contractual commitment toward the eventual establishment in China of a trading system consistent with international norms. Stable access to markets and sustained export competitiveness are expected to enable China to continue its past export performance (9-10 percent growth a year) in the future, thereby increasing further its share in world trade. Such an environment would also allow China to continue to rely on international trade to spur domestic productivity improvements. 14. Capital Inflows. Perhaps the most striking feature of China's external capital account has been the sharp rise in foreign direct investment (FDI) inflows, principally to the manufacturing and real estate sectors. Gross FDI inflows grew from virtually nothing in 1980 to $33 billion in 1994, and now account for almost half of all FDI flows to developing countries. Commitments of FDI have slowed considerably, however, declining from $110 billion in 1993 to $63 billion in 1994. In the wake of Mexico's troubles and given the large sums of FDI flowing into China (20 percent of investment and 35 percent of exports), two points are worthy of note. First, China's external payments situation is healthy. There are no significant exchange rate distortions; the current account was in surplus in 1994 and deficits in the past have rarely exceeded 3 percent of GDP; and the country's external debt structure is sound (see para. 15). Second, the composition of capital inflows into China suggests relative stability,  - 5 - with FDI accounting for more than half of the total while only 9 percent is in the form of short-term or portfolio equity flows.7/ C. CREDITWORTIBNESS 15. China's total external debt increased to $98 billion in 1994 from $84 billion at the end of 1993, but external indebtedness indicators improved. At end-1994, total external debt was equivalent to 83 percent of exports of goods and services (92 percent in 1993) or 19 percent of GNP, comfortably below the averages for East Asia and the Pacific. Short-term debt amounted to $15.4 billion at end-1994, or 16 percent of the total-less than in 1993. Around half of China's total external debt is owed to private creditors and commercial banks; this share is considerably lower than in 1980, when it was closer to 90 percent. The share of external debt at variable rates has been declining steadily from 44 percent in 1990 to 39 percent in 1994, thus lowering China's vulnerability to interest rate fluctuations in international financial markets. 16. Overall, China's external debt and debt-service position remained sound. The debt-service ratio, which stood at a low 11.1 percent in 1993, declined further to 9.7 percent in 1994. Looking ahead, China's external payments position is expected to remain robust. To sustain a growth rate of 9 percent, China's import requirements will remain substantial. Also, servicing the country's rising stock of FDI through repatriation of profits and dividends will make a growing claim on export earnings as more foreign-invested projects come onstream. The current account balance is therefore projected to move from a small surplus of 0.4 percent of GDP in 1994 to a deficit of 1.6 percent of GDP by the end of the century. On the assumption that net FDI inflows will be about $22 billion in 1995 and decline thereafter, China's external borrowing needs will be modest in 1995 but then rise steadily in subsequent years. Average annual gross disbursements of medium- and long-term debt in 1995-2000 is estimated to be $17 billion, slightly lower than levels achieved in the recent past. The bulk of these flows will be from international capital markets, with about 30 percent from official bilateral and multilateral sources. Net disbursements, however, are projected to remain modest-an annual average of about $7 billion until 2000. With this level of net borrowing, China's already low debt-service ratio is expected to decline further to 7.7 percent by 2000 (servicing costs of all external liabilities, including FDI, however, are projected to reach 15 percent of exports), and international reserves would still be maintained at the comfortable average of about 4-5 months of imports. 2. KEY CHALLENGES AND THE GOVERNMENT'S STRATEGY A. CHINA'S DEVELOPMENT OBJECTIVES AND POLICIES 17. Despite China's considerable achievements on the economic and social fronts since 1978, the Government faces significant challenges over the medium term. One set of challenges has to do with sustainable growth within a stable macroeconomic environment, and another with poverty reduction, human resource development (HRD), and improving the distribution of income, both across the urban- rural divide and among the different strata of Chinese society. 7/ Even these numbers exaggerate the risks to China. Portfolio inflows in China have taken the form of stocks, rather than the short-term (and moreover index-linked and dollar-denominated) treasury paper that accounted for the bulk of Mexico's inflows. China's domestic bond market is closed to foreign investors. China also has a uniquely egregated equities market with sepsrate share categories for foreign investors, who cannot participate in the domestic share market. Thus, a loss of confidence would not lead to a direct outflow of portfolio equity funds and impose downward presure on the Renminbi as foreign equity holders could only sell their tock to other foreign equity holders (in US dollars).  - 6 - 18. The challenge of sustainable growth with stability requires: * developing better indirect instruments of macroeconomic management that can help to dampen the stop-go cycles experienced during the reform period; * furthering the market orientation of China's SOEs and financial institutions that are still largely insulated from competitive pressures; * easing long-standing constraints to growth by alleviating infrastructural bottlenecks, particularly in the energy, transport, water, and communications sectors; and * curbing the spread of environmental problems amidst rapid urbanization and the flurry of development activities. 19. The other set of challenges has to do with poverty and the balancing of growth's benefits within the country, both in rural areas where the largest poor populations reside and urban areas where an increasing number of poor is emerging. These challenges require: e formulating new, effective responses to the plight of the 80-100 million Chinese absolute poor; - providing more, and better, social services in these poorer regions, where especially women's health and girls' education are often neglected; and * promoting greater equity between the rapidly growing coastal provinces and the less dynamic inland provinces (particularly in the southwest and northwest), by removing incentives that attract people to coastal areas, improving access to rural social services (education, health), and developing an effective system of intergovernmental fiscal transfers. 20. Government's Strategy. A series of comprehensive decisions (also known as "Fifty Articles") during the chronicled Third Plenum of the Fourteenth Congress of the CPC (November 1993) represents the most recent and comprehensive response of the Government to key challenges facing China. It is also China's first real attempt at formulating a clear, coherent and comprehensive blueprint for making the transition to a market-based economy with Chinese characteristics. It represents a significantly different approach to reform than the former "feeling for stones to cross the river." The most recent country economic memorandum on China (see footnote 1) discusses the content of the Third Plenum reform program. 21. In responding to the macroeconomic challenges, the Third Plenum reform program adopted major policy changes in thefiscal area and in thefinancial sector (paras. 9-10). While fiscal reform is essential to safeguard the maintenance of crucial government services, at the heart of the transition to a socialist market economy is the progressive introduction of market forces in the allocation of capital. In this regard, the Government has mapped out further policy reforms in the financial sector that include: replacing the credit plan with indirect monetary instruments, ultimately including market-responsive interest rates and nondiscriminatory access to foreign exchange; curtailing directed credit to quasi-fiscal activities; developing the capital markets; and developing banking and nonbanking supervision, prudential regulation, and payments systems.  - 7 - 22. The Government is aiming at improving SOE efficiency by means of reforms through both organizational arrangements for public enterprises (changes in ownership and management systems) and in the policy environment in which they operate. With regard to the former, three aspects are considered: the legal framework within which they operate; the systems and regulations governing relations between government and the enterprises; and ownership reform issues, with respect to both government ownership and ownership diversification. The SOE policy environment covers four major areas of importance: the financial sector (especially enabling the banks to behave more like real banks in their relations with the SOEs); trade reform, to subject enterprises to greater foreign competition; social reforms, to relieve enterprises of the burden of benefits administration; and competition policy, especially in terms of factor mobility and exit policy. 23. Removal of infrastructural bottlenecks will require appropriate instruments and incentives for channeling a larger share of domestic savings into the infrastructure sector. The newly established State Development Bank will assume a leading role in infrastructure projects involving central government participation. However, local governments will continue to assume important responsibilities in view of emerging bottlenecks in China's cities, which are home to a population of about 400 million and growing between 4 to 5 percent per year. Bolstering local government finances will be key to meeting this challenge. Further price reforms and appropriate user fees will also increase the retained earnings of infrastructure companies, which can be mobilized to meet the growing investment needs. For example, revenue from increased rail tariffs already is estimated to cover over 50 percent of planned sectoral investments, and the average consumer electricity tariffs are estimated to cover over 90 percent of their long-run marginal cost (LRMC). In view of the large investment requirements, the Chinese authorities intend to complement domestic resource mobilization by expanding the scope for FDI in the infrastructure sector (particularly power and transport-rail, roads, and ports-as well as telecommunications). In addition to further price reforms, a transparent framework for private participation will be essential to making infrastructure investment more attractive. 24. To curb the spread of environmental problems induced by rapid development, the Government will continue to rely on the network of local and provincial environmental protection bureaus, which, under the leadership of the National Environmental Protection Agency (NEPA), enforce environmental laws, regulations, and standards. Environmental degradation is a major problem in urban areas. While many cities are responding through industrial renovation, better regulations, and investment in abatement, the problems are spreading to the newly developing areas around city cores. The Government is now exploring the use of environmental taxes on polluting inputs to complement the economic incentives from effluent fees and fines already in place. China's National Environmental Action Plan and Agenda 21 program provide direction for these and other environmental improvement efforts. Environmental pressure has also grown in rural China, due to agricultural and industrial expansion. Government interventions, both policy-based and through physical investments, include those in soil, water, forestry, and the expansion of protected areas. 25. The Government's response to poverty eradication is an ambitious "8-7 Plan," which aims to eliminate extreme poverty by 2000 by raising per capita income in poor counties at least to Y 500 per year (in constant 1990 prices) through a targeted intervention program. The program aims at nearly 600 counties, and expects to raise agricultural output of the 80-100 million poor located in high mountain areas, deserts, steeply sloped areas, reservoir areas in the central and western sections, and highly disease-prone areas, and thereby to raise them at least to the subsistence level by the year 2000. This would be done principally by increasing the allocation of farmland; providing each household a minimum lot (one mu-about a sixth of an acre) for forest, orchard, or cash crop usage; setting up a side business, such as livestock breeding, for each household; and providing an enclosed meadow or pasture to each. Opportunities would be provided also to each family to have a member transfer into a township and  - 8 - village enterprise (TVE) or a more developed area. They would also be given access to improved infrastructure and education and health services. 26. The Government recognizes that much of its success in lifting more than 170 million from the ranks of some 270 million absolute poor since the beginning of reform in 1978 can be attributed to broad participation in fast rural economic growth, underpinned by extraordinary growth in agriculture. By 1985, however, the momentum of rural growth slowed, especially in the remote upland areas where many of the remaining absolute poor were concentrated. To deepen the impact of rural reforms, especially in areas where the absolute poor are most prevalent, the Government plans to boost its support to agricultural production and raise the level of investment in agriculture. These measures aim further to reduce absolute poverty, and also to prevent possible erosion of past gains. However, the transition and significant reduction of absolute poverty, from large numbers of poor spread widely across the countryside in the late 1970s to pockets of poverty in remote, resource-poor areas by the mid-1980s, have prompted the Government to redirect its poverty strategy through the "8-7 Plan" by targeting interventions more accurately; this will be accomplished by increasing development and social services assistance in the remaining poorest counties and "graduating" some of the well-off counties and provinces from the poverty reduction program. To account for locational factors, greater assistance will be extended to such poor areas, as well as those areas with large concentrations of minority nationalities. To promote labor mobility, lack of which has constrained the poor, especially in remote and hilly areas, from seeking employment elsewhere, the Third Plenum promotes the reform of residence registration regulations to allow greater mobility of rural populations to work in factories or do business in small cities and towns, to develop rural tertiary industries, and to encourage the transfer of rural surplus labor to new endeavors. B. A CHANGING CHINESE VIEW OF THE BANK GROUP 27. During the early 1980s, the Bank Group was viewed as an institution that could help promote China's reintegration with the global economy following years of isolation. China's interest then was to tap the Bank's technical expertise and experience in development, along with access to relatively inexpensive financial resources. The Government sought the Bank Group's assistance in many sectors and across a broad geographic area so that as many project entities as possible would benefit from sectoral technical expertise, as well as project evaluation and preparation methods (e.g., economic and financial analysis of projects; competitive bidding and procurement procedures; project design and implementation techniques). 28. As an example, the Bank's initial lending for education focused on all levels of education (primary through university), covered numerous provinces (in some projects, as many as 20), and included large scholarship programs. Such education lending also included significant imports of laboratory equipment, computer hardware and software, and books and periodicals that aimed primarily to transfer knowledge. Bank-supported projects also made important qualitative contributions to Chinese higher education by supporting the introduction of a reformed undergraduate economics and finance curriculum. 29. By the end of the 1980s, China had, to a large extent, exposed successfully its already well- trained and disciplined manpower to the technology and knowledge available outside its borders. Its engineers had successfully tapped into leading-edge technology and expertise in their respective sectors. Chinese economists, including those returning from universities in the West, could now identify easily the economic issues faced by their country, and propose policy reforms to deal with them.  -9- 30. These changes began to alter the nature of inputs for which China looked to the Bank. If the Bank's macroeconomic and sector work failed to go beyond the identification of key issues and broad policy advice, it was of limited use to the Chinese authorities. For example, it was no longer sufficient to recommend that housing and social security responsibilities should be removed from SOEs; that PBC should have greater say in setting and implementing monetary policy; or that commercial banks should be "restructured." The Government now expected the Bank, through its studies and projects, to contribute to ways in which policy changes should be implemented, often drawing on its experience to provide lessons from other countries as to what would work, what would not work, and why. As China has gained confidence in dealing with key sectoral issues, she has become more selective in identifying fewer sectors (e.g., energy and transport), and subsectors (e.g., basic education in poor and minority areas) for Bank involvement. In the social sectors especially, the focus now could shift from technology transfer to poverty alleviation in resource-poor and minority areas that benefitted little from the "trickle down" effects of the decade's rapid economic growth. 31. Despite the gradual hardening of Bank lending to China in recent years 8/ and its growing economic success, China continues to look to the Bank Group for significant development support for the following reasons. First, the Chinese authorities are concerned about the destination of private flows and recognize that relatively little is going into more risky but socially desirable, longer- term investment projects. Second, China continues to value the Bank Group's experience in economic development and project analysis, as well as the quality of the Bank's analytical work. Third, the lack of maturity in China's fiscal, monetary, and financial systems, and the absence of an intergovermnental transfer system do not yet facilitate the allocation of resources to such high return areas as infrastructure, HRD, and environmental protection. 3. THE BANK GROUP'S OBJECTIVES AND ASSISTANCE STRATEGY 32. The Bank Group's objectives and assistance strategy are to help China meet its two major challenges: (a) achieving macroeconomic stability while maintaining rapid (and more efficient) growth, and (b) sustaining this growth by shifting resources toward priority areas, including poverty reduction, HRD, infrastructure, and environmental protection, that are currently underfunded. The ultimate objective is to assist the Government in developing the institutions and instruments necessary to sustain rapid growth and broad-based development using a mix of economic and sector work (ESW), technical assistance (TA), lending, investments and guarantees from the Bank, IFC and MIGA. 33. To help the Government meet its first challenge, the Bank Group will assist efforts to restructure the incentive framework, implement market-oriented reforms, and increase reliance on indirect instruments for macroeconomic management. Special emphasis will be given to reforming the SOEs by commercializing their operations, ending their dependence on subsidized credit from the banking system, and transferring their social service functions to more appropriate agencies. Closely linked will be reforms in the financial sector to encourage more efficient financial intermediation, better resource allocation, and higher returns to savers. Reforms in these two sectors lie at the core of the Government's future policy agenda, and are designed not only to increase the efficiency with which investment resources are used in the economy, but also to facilitate the management of aggregate demand. 8/ China's blend ranio (defined as IDA to total IDA/IBRD lending) between FY91-95 has declined from 0.62 to 0.22.  - 10- 34. To help the Government meet its second challenge, the Bank will assist efforts to improve the fiscal situation and to develop institutions, processes, and skills necessary to reallocate government resources toward high-priority public expenditures. As noted in paragraph 9, the steady decline in tax revenues as a share of GDP has weakened the central government's fiscal capacity to increase much- needed public expenditures in infrastructure, health, education, environmental protection and poverty alleviation. The Bank will use analysis and TA to help improve tax policy and administration, and to introduce an intergovernmental transfer system. But restoring the fiscal health of Government and the development and implementation of such an intergovernmental transfer system are expected to take several years. In the interim, the broad need in China for channeling investment toward infrastructure development, poverty alleviation, and environmental protection makes each of these areas a natural focus for Bank assistance. A. AREAS OF Focus 35. This broad strategy translates itself into four major areas of focus for Bank Group operations: support for implementation of macroeconomic and structural reforms (which includes reform of the SOEs and the financial sector), removal of infrastructure bottlenecks, alleviation of poverty, and environmental protection. Attachment 1 (following page 23) summarizes the Bank's strategy, key objectives, assistance program and milestones. The rest of this section sets out these four areas of focus in greater detail. 36. Macroeconomic and Structural Reforms. Support for implementing China's macroeconomic and structural reforms stands at the very center of the Bank's assistance strategy in China. The continuation of market-oriented reforms and the development of indirect instruments for macroeconomic management are critical to China's drive to enhance investment efficiency and macroeconomic stability. The Bank will continue to provide the Government with advice on all aspects of macroeconomic policy through its ESW program. The topics for these studies will be chosen in close consultation with the Chinese authorities, as in the past. Increasingly, the Bank has been providing the Government with short, focused policy notes that examine key issues of current importance. Every other year, the Bank's Country Economic Memorandum will be used to take a fresh look at macroeconomic policy issues, and provide a coherent overview of the emerging policy priorities confronting the Government. 37. Reform of SOEs is crucial for improving efficiency in most sectors of the economy, facilitating reforms in the financial sector (see para. 10), and reducing the consolidated public sector deficit, thereby easing inflationary pressures. The SOEs account for about half of industrial output, absorb the bulk of bank credit and employ 76 million urban workers, who depend on them for housing and social benefits. Nearly all Bank lending operations touch upon issues related to enterprise efficiency. 38. The Bank Group's assistance to SOE reform in China applies a common framework, guided by four key principles: * Create autonomous corporate enterprises, with clear lines of governance, fully transparent and modern financial accounts, and clearly defined management prerogatives and responsibilities; * Separate the provision of social services (including housing, social security, education and health) from enterprises;  - 11 - * Subject enterprises to market discipline, by eliminating subsidies and promoting competition, or to appropriate regulation, for natural monopolies in infrastructure; and * Promote greater flexibility in ownership to facilitate enterprise restructuring through acquisition of new technologies, management expertise, and financing sources. 39. Within this policy framework, the Bank Group will continue to operate at two levels. First, we will assist through our ESW and TA work. In collaboration with key Government agencies, the Bank is mounting an extensive study of the SOE sector that will investigate issues in corporate governance, separation of social services, labor mobility, and rationalization of the policy and incentive environment within which SOEs operate. In addition, the Government and the Bank are sponsoring a major conference in China in June 1995, where Bank officials and international experts will have the opportunity to comment on reform options presented by senior Chinese policymakers. A parallel study on social security reform arrangements will examine alternative institutional and financial options for introducing unemployment insurance and providing retirees with pensions. Follow-up actions will include TA and further studies on specific policy issues as necessary. 40. Second, the Bank Group will continue to finance pilot projects in various provinces to demonstrate key principles of SOE reform. The Enterprise Housing and Social Security Reform Project (FY95) will test innovative approaches to social service provision in five municipalities. A proposed Labor Market Development Project will introduce reforms in labor contracting arrangements and support programs for training and financial assistance for retrenched SOE workers. In industry, the Chongqing Industrial Reform Project (FY96), as with the recently-approved Shenyang Industrial Reform Project (FY95), will work with municipalities to change the institutional framework and principles for enterprise governance; and to establish a unified state asset management bureau responsible for oversight, enabling ownership diversification and asset divestiture, competition for access to capital, and growth of the nonstate sector. Infrastructure projects, notably railways and power, will mobilize new sources of finance and promote SOE reforms through corporatization and asset divestiture. In agriculture, the proposed State Farm Commercialization, the Animal Feed, and the Seed Commercialization Projects will promote enterprise restructuring by transferring technical and managerial know-how to enterprises, which would also benefit from increased management and financial autonomy. The IFC, through joint ventures with SOEs, including the Yantai Cement and the Dalian Glass Projects, will facilitate the entrance of major, world-class industrial partners into China to achieve greater economies of scale, and introduce new technologies and approaches to enterprise management. 41. Linked closely to enterprise reforms is the range of financial sector reforns being implemented by the Government. While China has made substantial progress since the breakup of its monobanking system in the mid-1980s, it is still some way from having a vibrant, competitive financial system that can allocate financial resources efficiently to contribute to macroeconomic stability. A weak central bank, underregulation, lack of competition, a skewed and rigid structure of interest rates, and the obligation of banks to supply policy loans constrain performance of the financial sector. However, recent Government policy reforms in the financial sector augur well. The Fourteenth Party Congress mapped out Government policies with respect to the financial sector, focusing upon the creation of an autonomous Central Bank, strengthening of the regulatory framework, simplification of the interest rate structure, the transformation of the specialized banks into commercial banks, and the separation of directed credit responsibilities to the three policy banks (see para. 10). 42. The Bank proposes to employ primarily ESW and TA resources to examine the appropriate sequence of policy actions in the financial sector necessary to strengthen the financial health of the banking system and to improve the efficiency of financial intermediation. Apart from a banking sector  - 12 - reform paper completed recently, the Bank is also preparing a study of China's capital markets and a paper on interest rate policies for the use of the Chinese authorities. In addition, a Financial Sector Technical Assistance Project (FY93) is currently assisting PBC transform itself into an effective central bank. Two other projects are being considered to assist specialized banks make the transition to true commercial banks. But the design of these projects and the decision to go ahead with them will depend, in part, on progress made in improving the overall policy environment in the financial sector. 43. Fiscal reforms are essential for improving macroeconomic management by increasing the efficiency and the social impact of public expenditures, and facilitating reform of the enterprise sector by transferring primary responsibility for provision of the social safety net to the Government. The Bank aims to improve the management of fiscal resources in three ways: (a) the Fiscal Technical Assistance Project (FY95) is expected to help the Government implement the recent fiscal reforms and to prepare future reforms, including the implementation of a new national tax administration, developing a central- provincial grants scheme, and enhancing the budgetary processes; (b) the Public Investment Study would provide policy advice to improve China's public investment process; and (c) the proposed Urban Finance Study would assist the Government to enhance its capacity for improved financial management at the subnational level. Continuing reforms of the legal system are needed not only to complete the framework of economic and commercial laws for a market economy, but also to develop and reinforce the mechanisms for implementation, including administrative agencies, judicial and other dispute resolution fora, and the legal profession. Bank assistance will be provided through the Economic Law Reform Project (FY95) and other lending and ESW initiatives. 44. Over the next two or three years, indicators of China's progress could include the following milestones (see Attachment 1): improvement of the fiscal and monetary frameworks, leading to lower inflation; annual growth of 8-9 percent; conversion of the specialized banks into commercial banks (para. 10); effective startups of policy banks; a simplification of the interest rate structure and more frequent interest rate adjustments; and the introduction of a new system for intergovernmental transfer of fiscal resources. To assess China's progress in SOE reform, we intend to use the following milestones: results of our analytical work are successfully disseminated and incorporated into projects designed to pilot enterprise reform; successful implementation and replication of pilot projects in other provinces and municipalities; broader diversification of enterprise ownership, including private firms; and greater flexibility in industrial organization, including entry, exit (via bankruptcy), and merger. 45. Infrastructure Bottlenecks. The second area of focus is to help alleviate infrastructure constraints. China's infrastructure sectors continue to suffer from bottlenecks, with heavy investments required for the foreseeable future. The orders of magnitude cited by various sources range from about $40 billion per year to around $60 billion per year over the next three to four years. In response to the request by the Chinese authorities and, until greater inflows from the private sector can be attracted, approximately 50 percent of the Bank Group's lending commitments for FY95-97 will support infrastructure development. In this effort, we will promote reforms through projects designed to raise overall efficiency and stimulate private capital flows, involving six important areas for reform: * Commercialization and corporatization of operating companies and enterprises; * Realignment of regulatory and legal frameworks; * Introduction of competition and transparency; * Ensuring adequacy of the tariff policy; * Transfer of new technology and modern operational and environmental techniques; and * Development of new sources and methods of financing.  - 13 - The Bank Group's strategy in infrastructure will be to focus primarily on power, transport, and water resource management. We envisage direct lending in the infrastructure sector to include six power projects (hydro, thermal and transmission), one railway project, five highway projects and one waterway project over the next three years. We anticipate utilizing new approaches to catalyze increased private investment in this sector including, for example, the selective use of the mainstreamed guarantee instrument. The use of partial guarantees, to supplement efforts to mobilize additional capital through cofinancing, might help to increase investments in infrastructure (para. 69). Sector work will be dovetailed to lending program requirements. 46. More specifically, in highways, the key problem facing China is its past neglect of the sector, which has resulted in a highway network that ranks among the smallest in the world relative to China's population and geographic size, and the consequent need for modernization and growth. The Bank's program in this sector will aim to assist in the development, management and financing of the highway system. This emphasis would include the introduction of important new technologies, but the Bank's primary justification for continued involvement in highways would be to help China avert some of the better-known problems of rapid motorization, including inappropriate pricing and subsidies, neglect of safety and environmental side effects, and urban congestion. In addition, the Bank will assist China with the design of traffic management schemes, which protect bicycles so as to ensure that they continue to be used even as the number of motor vehicles increases. The principal challenge in railways is for the Ministry of Railways (MOR) to create a modern railway system that is more responsive to the changing needs of its customers within a market economy. The Bank will assist MOR to create an organizational structure that will permit the provision of improved and competitive services in each area of business, such as intercity passenger services, bulk commodity and container freight services. In addition, the Bank will assist MOR with the introduction of new technology and the financing of expansion in rail capacity. The remaining challenge in the transport sector in China is to assist with the introduction of modern transport logistics systems and multimodal transport facilities that are essential to the growth of China's exports. 47. In energy, reforms of the 1980s loosened the centralized management of the power sector, mobilized and diversified financial resources, and improved cost recovery. However, the partial reforms brought about new challenges: power supply has increased dramatically but still fails to cope with the surging demand, and the ad hoc approach to reform has yet to establish a coherent, transparent framework for sustained development of the sector. China requires an average yearly capacity addition of between 15 and 20 GW (to the year 2000), which is equivalent to the total installed capacity in Indonesia or Belgium. To meet these challenges, the Government introduced a reform agenda in the early 1990s to ensure that enterprises are run as efficient businesses and to reduce barriers to entry through the six areas of reform noted above (para. 45). Bank assistance will continue to emphasize direct support to regional and provincial power companies in their transition to autonomous, business-oriented entities. Direct lending operations will involve a gradual shift away from the more advanced coastal provinces toward the less-developed inland provinces. Project-related TA for the sector, associated with lending operations, is expected to focus, inter alia, on institutional capacity-building for electricity conservation activities and development of the regulatory framework for the sector. In addition, the Bank Group is working with the Chinese authorities on ways to expand private financing of power infrastructure. 48. The unprecedented growth in China's cities is creating a host of complex issues, with the pace and direction of that growth having major implications for economic efficiency and environmental sustainability. The health of the urban population is threatened by pollution resulting from unsatisfactory water, sanitation, drainage and solid waste services, and inadequate urban industrial and household waste management. Urban traffic congestion is becoming an important constraint to urban productivity, and vehicular air pollution is posing a serious health threat in China's cities. The ability of local governments  - 14 - to respond to these challenges is limited, with ongoing reforms in the fiscal, financial, enterprise and labor systems altering the framework under which cities are managed. An important component of the Bank's assistance strategy is the improvement of the urban environment through projects that enhance environmental planning and management capabilities. Associated with the need to improve the urban environment is a strategic focus on urban transport, where the Bank's strategy is to demonstrate innovative solutions to the urban transport problem through comprehensive, city-based projects. We are also beginning to engage the Government in structural issues associated with rapid urbanization and changes in the role of local governments. Our strategy emphasizes the links between urban management, municipal finance, and China's reform agenda. Areas of our dialogue include: the consequences for municipal governments as they shed direct enterprise management function; establishment of sustainable resource bases and management systems; how to equip small towns and nonincorporated areas with adequate administrative and fiscal systems; and how best to modify the intergovernmental fiscal transfer system and, within each city, the investment allocation mechanism to ensure that basic services benefit the poor. Sector work on municipal finance and on rural-urban migration will provide a basis for this dialogue. 49. We will evaluate China's progress in this area against the following milestones: enactment of a revised Railways Law, a National Electricity Law, and a Telecommunications Law, which would further commercialization and corporatization of operating entities and competition among them; replication of the policy content of Bank projects in new projects that are sponsored by other provinces; emergence of privately financed infrastructure projects outside the southern provinces; adjustment of average power tariffs to LRMC countrywide, but particularly in the interior provinces; presentation of the results of important sector work at conferences and seminars; establishment of a model river basin corporation in Hunan, and self-financing water districts in Hunan and Hubei; and commercial pricing of bulk water in Shanxi. 50. Poverty Reduction. Support for China's seven-year plan to eradicate poverty and promote HRD makes up our third area of focus. The relatively poor resource base at the center, combined with the absence of an effective intergovernmental transfer system, continues to impede the Government's efforts to reach the poor effectively. The recently introduced tax reforms and efforts to establish an intergovernmental fiscal transfer system are intended to increase the center's financial strength and its ability to transfer resources to the less developed provinces more effectively, but this will take the rest of the decade to realize. Thus, availability of IDA- 1I resources, earmarked exclusively for poverty- related projects, would help to sustain the Bank's poverty initiatives in China. 51. We will assist China in further defining the implementation aspects of the "8-7 Plan," which is the National Poverty Reduction Plan (para. 25), and complement the Government's expenditure with well-focused Bank financing. Our approach to helping China to reduce poverty is well-represented by the proposed Southwest Poverty Reduction Project, which adopts a focused multisectoral rural development approach to help as many as three million upland smallholders in 35 of the poorest counties in three resource-poor provinces in southwestern China. Through pilots like this, the Bank's strategy is to assist the Government with the implementation of bold, innovative, and workable strategies to alleviate the harsh conditions facing the 80-100 million absolute poor. Other poverty-oriented projects in the pipeline include: Basic Education in Poor and Minority Areas, Rural Health Services in Poor Areas, Disease Prevention, Hexi Corridor, and Shanxi Poverty. We have already undertaken a comprehensive poverty study, with a focus on rural poverty. The results have been incorporated into our current work on China. Our strategy will emphasize analytical work on issues concerning emerging urban poverty and growing income and regional disparities. We will sharpen the poverty focus of our lending to agriculture, health, and education projects by targeting more of the project proceeds to the poor counties included in the Government's "8-7 Plan." We will also design IBRD-IDA blend projects in the poverty and HRD  - 15 - areas, where the nature of the project so warrants (e.g., rural infrastructure, commercial activity, labor market development, retraining of workers), to introduce efficiencies in resource utilization and effectiveness of services. 52. Poverty-related issues are particularly severe in the rural areas. These issues include: (a) relative stagnation of income growth in all rural areas; (b) large-scale water shortages in the north and west; (c) inadequate entrepreneurial development and Government investment in the rural areas of the interior provinces; (d) lack of integrated logistical and marketing systems for agricultural commodities (such as grain, fertilizer, vegetables, and animal products) required to link producers to urban and foreign markets; (e) inadequate feed processing capacity and technology to accelerate the shift toward the production of high-valued animal products; and (f) unsustainable exploitation of marginal lands. The Bank's program will continue to be selective in agriculture. Our strategy will be to assist the central and local governments through prospective operations and sector work to develop in-situ income-generation programs in lagging provinces; continue development of sustainable techniques to upgrade marginal agricultural lands; incorporate major water storage, transfer, irrigation, drainage, and flood control schemes into future projects; and seek to assist in the eventual transfer of bulk water from the Yangtze Basin to the Yellow River Basin. TVEs at the provincial level will be supported through several operations, including one national-level operation. Implementation assistance to the Grain Distribution and Marketing Project (FY93) is the most important contribution we can make to bulk logistical development in China's agricultural sector. And, finally, a proposed operation will lay a solid technical foundation for the development of livestock production into the 21st century. 53. To follow the Government's progress in this area, we plan to use the following milestones: the "core poor" constitute a significantly higher proportion of our project beneficiaries in Bank-assisted projects; the results of the analytical work in urban poverty and income and regional disparities are disseminated widely by the Government to focus government agencies' (both central and local) attention on poverty impact, and phased into the design of poverty projects of the future; and three or four IBRD- IDA blend projects are developed in the poverty and HRD area. 54. In the field of HRD, the challenges are changing and becoming more complex in the face of rapid economic transition, increasing costs of providing social services and safety nets, rising unemployment, huge labor redeployment needs, an aging population and mounting public expenditures. Rather than to try and tackle the entire range of issues in this field, the Bank-with the agreement of the Chinese authorities-has selected a few issues to focus upon. This approach, which focuses upon rural health and basic education services in poor provinces and labor redeployment, reflects selectivity in the face of the vastness of this field, as well as China's own successes in meeting education and health needs, and recognizes the importance of labor market reforms. 55. In the health sector, Bank assistance will focus on assisting the Government: to meet the basic health needs among the rural population-particularly those living in absolute poverty; to reinvigorate initiatives on disease prevention, by retaining the gains made against infectious and endemic diseases and by implementing innovative programs against noncommunicable and chronic disease; and to design alternative methods of financing health care that balance private and public financing to assure cost-effective delivery of health services to all. In the education sector, the focus will be: to educate the poor, minorities, and girls; to improve the effectiveness of teaching services; and to design and implement reforms in the education sector in line with the "Guidelines for Development and Reform of China's Educational System" issued by the Chinese authorities. In the area of labor redeployment, China's objective will be to facilitate the redeployment of nearly 120 million people from the farm sector and about 20 million people from the SOEs into enterprises in small townships and villages and the rapidly growing service sector. The Bank's assistance will focus on helping the Government design and  - 16 - implement labor market development policies; establish labor market information and intermediation entities; and improve the training and retraining of workers in skills required by the growing market economy. 56. Environmental Protection. And the fourth area of focus in our assistance strategy is to help China safeguard the environment. Prior to the 1980s, China's strategy of rapid industrial growth and agricultural intensification paid little heed to environmental damage. Even though these problems are now recognized and implementation of environmental action plans has begun, development pressures on water, air, and land resources continue to intensify. Critical challenges now include: providing safe urban and rural drinking water; managing hazardous and toxic wastes; reducing waste output by increasing industrial efficiency in energy and other input use; protecting marginal lands through promotion of sustainable agricultural practices; and preserving forest reserves and other harbors of biodiversity. Our assistance strategy supports NEPA in developing and implementing national environmental policy, complementing that through ESW-based policy dialogue on industrial pollution control and energy and water resource pricing. The lending program will focus on sustainable land use in rural areas and industrial pollution in urban areas. In the rural sector, the Bank will continue to support the sustainable development and management of forest resources, improved land use on degraded and marginal soils, and development of new watershed management and protection models, particularly through close supervision of three large natural resource projects that were approved in FY94. In the urban sector, the lending program will focus primarily on urban environmental problems. We will work with municipal and provincial authorities to develop more effective enforcement of environmental regulations, manage demand for water and other resources, and finance needed investment aimed at improving water and air quality. We envisage supporting two or three such lending operations annually. Second-phase GEF activities have been identified and Montreal Protocol programs on ozone-depleting substances will continue. China's sectoral progress will be monitored through: improved level and structure of user charges for environmental services in non-Bank projects; wide dissemination of ESW findings; completion of the national motor vehicle pollution control action plan; and reducing the rate of deterioration in water and air pollution. Attachment I summarizes the objectives of the Bank's the assistance program, the strategy, and the progress milestones. B. PROPOSED FY95-97 LENDING AND ECONOMIC AND SECTOR WORK 57. ESW Program. The Bank's proposed ESW for FY95-97 mirrors the changing needs of China's reforms and is designed to complement the reform strategy adopted in November 1993. We share the Government's concerns over the disruptive potential of inflation, and our interest also is to emphasize the establishment of the institutional framework and policy instruments that will allow more effective management of the economy. As the restructuring of the SOEs and the financial sector are necessary preconditions for the successful completion of fiscal and financial reforms, our ESW program will attach considerable importance to these issues. Of the 13 studies that the Bank is preparing during FY95, six focus on these two issues directly. 58. The changing dimensions of China's requirements have led the Bank to reorganize the manner in which it designs its ESW. Whereas, in the earlier years of reforms, the Bank dedicated much of its resources to the theoretical underpinnings of reform, the broad outlines for reform are now established, and what China requires is more advice on implementation of reforms. For this purpose, the Bank will produce shorter analytical reports that can be more widely disseminated within China. The Bank will also continue to rely on the useful role played by conferences, workshops, speeches and the media in maintaining our economic and sector dialogue with the Chinese authorities. In both of these areas, the Bank's Resident Mission will play a leading role, especially in helping the Government by preparing short pieces in response to specific requests for advice.  - 17 - 59. Finally, the Bank expects to initiate a fresh review of poverty in China (following the comprehensive poverty report issued in June 1992-Report No. 10409-CHA) in the context of the "8-7 Program" and more recent developments. Our proposed work program for FY95-97 is shown in the box below. CHINA: PROPOSED MAIN AREAS OF ESW FOR FY95-97 /a FY95 FY96 FY97 1. Implementation of Macro Country Economic Memorandum Country Economic Memorandum Country Economic Memorandum and Structural Reforms Capital Markets Development (Update) Rural Social Security Interest Rate Liberalization Urban Fiscal Management State Asset Management and Public Investment Food Distribution Divestiture Banking Sector Reform| Modern Enterprise Reform Social Security System Reform 2. Alleviation of Infrastructure Transport Logistics Urban Transport Bottlenecks Transport Strategy Foreign Direct Investment 3. Poverty/Human Resource Higher Education Reform Regional Disparities/Income Poverty Survey Update Development Health Care Financing Distribution Rural-Urban Migration Social Development 4. Environmental Protection Urban Environment Management Industrial Pollution Greenhouse Gas Study (with UNDP and Government) /s Includes formal ESW and substantive informal outputs, but omits policy notes that will be an important part of future ESW outputs. 60. Lending Program. An indicative lending program for FY95-97, which has been formulated cooperatively with the Chinese authorities, would implement the strategy presented in this CAS to promote broad-based economic development and reduce poverty within an environmentally sustainable framework (Annex A2). As we have seen (para. 45), this translates into a continuing role for large infrastructure projects to alleviate bottlenecks. Additionally, emphasis on efforts to alleviate poverty will continue to be important in agricultural and social sectors, as well as the environmental sector as discussed earlier (paras. 52-56). 61. We envisage a Base lending case for China of $2.5-3.0 billion a year in FY95-97, about the same as the lending extended in FY92-94. As this CAS period runs into the first year of IDA-11, the breakdown of lending between IBRD and IDA depends on the outcome of the Eleventh IDA Replenishment.2/ We anticipate the sectoral distribution of lending during this period to be reasonably balanced, as in the past, with increasing emphasis on infrastructure and poverty alleviation. By volume, close to a half of the three-year lending program would finance operations in energy and transport, a quarter would support the social sectors and the environment, and a sixth would finance agriculture. At this level of lending China's share in the IBRD portfolio will rise steadily. We will monitor closely the evolving IBRD portfolio to ensure that exposure to China conforms to the Bank's guidelines. 2/ We have included a notional IDA amount for FY97 for programming purposes. This does not presume in any way to predict the outcome of the ongoing IDA-1 I replenishment discussions or any decision by the IDA Deputies concerning China's access to IDA resources after FY96.  - 18 - 62. The foregoing lending case recognizes China's actual and potential capacity for accessing other sources of external financing. China's external position has been strong in recent years, with substantial inflows of FDI, especially into export-oriented manufacturing. With large capital inflows and the current account deficit projected to remain moderate, capital transfer is not the primary objective or the determining principle of the level of Bank Group lending, which at current and proposed levels accounts for a relatively small share of China's total resource requirements. However, the Chinese authorities are concerned about the volatility of private capital flows and have requested explicitly that the Bank Group maintain lending at $3 billion per year; the Bank is seen as a reliable, core financing source. They have indicated the importance they attach to a stable, reliable flow of funds from the Bank Group to support the reform program in the four main areas discussed in Section 3.A. 63. A Downside Scenario. The Bank Group's program refrains from linking variations in the country program size to specific triggers. This is because the likelihood of major slippages in the reform program is low; a single event would be unlikely to necessitate a strong reaction from the Bank. The Government is committed to gradual market-oriented reforms. The record of the Government over the past 15 years and broad consensus at the highest political levels on the direction and pace of future reforms puts the Bank's program on a much more secure footing than is the case in most countries. Nevertheless, we will monitor the pace of reform closely, keeping an especially keen eye on the rate of inflation, expansion in the money supply and bank credit, the share of nonperforming assets in the banking system, and the pace of SOE reforms. Through our policy dialogue and our ESW, we will work with the Chinese authorities to ensure that reforms are on track and macroeconomic stability is maintained. 64. That said, developments that might affect negatively the Bank's lending program would stem principally from growing macroeconomic instability and/or the slackening of structural reforms. We believe that the probability of such an outcome is low, but there is a possibility that the momentum of reform might falter with a change of leadership, in turn leading to declining confidence of international investors and a cessation or even a reversal of capital flows. 65. Reversals, or prolonged delays, in SOE reforms, financial reforms and price reforms, coupled with worsening domestic and external balances, inevitably would reduce the effectiveness and economic benefits of Bank-financed projects. In such a situation, the Bank would reduce its lending, perhaps by as much as half. The strategy in this scenario would be to protect lending for poverty reduction, HRD, agriculture, and environmentally-related projects in FY96-98. 10/ That would mean eliminating lending to specific areas in the following order: industry and the financial sector, power, operations supporting reform of SOEs, and other infrastructure operations, especially the innovative ones designed to facilitate entry of the private sector. 66. We have also considered the likely impact on China of external financial market disturbances that are unrelated to domestic policy reversals. The conclusion is that there is little current cause for concern because both financial and real indicators point to great strength in China's external accounts. Notwithstanding this positive assessment, we will continue to monitor carefully developments in these indicators. 67. Mobilizing Private Financing. Despite large foreign private capital flows into China in recent years, most private commercial debt has been of relatively short maturity, and most equity investment has gone to projects with relatively short payback periods. Both domestic and foreign private 10/ As the FY95 lending program is essentially complete, we do not plan to introduce any changes to projects that are scheduled to go to the Board in this fiscal year.  - 19 - investors have been reluctant to invest in long-gestation infrastructure projects. Perceived risks have deterred the private sector from investing in longer-term financial instruments. Four important areas causing uncertainties are: * absence of clear, time-tested policy, legal, and regulatory frameworks, to cover, among other issues, convertibility and transferability; * inadequate transparency and competition; * different perceptions of risks and expected returns between investors and the government; and * limited local availability of domestic term finance and underdeveloped capital markets that are not always accessible. 68. The Bank Group will continue to assist China in developing the policy framework needed to mobilize private financing for infrastructure, through its ESW, lending, investment, and guarantee programs. During the past year, the Bank has conducted policy dialogues with both the core and sector ministries, through a comprehensive policy note, including a version that presented opportunities in the power sector, and through participation in seminars and other fora. The Foreign Investment Advisory Service (FIAS) sponsored an important Beijing roundtable conference, jointly with the State Planning Commission, in November 1994 to improve the policy environment to attract FDI. IFC is discussing with Government the possibility of participating in demonstration projects in power generation and transport that embody the main characteristics of sound limited-recourse financing. Such projects will add to the confidence of foreign investors interested in China's infrastructure opportunities. The Bank's project lending in infrastructure (see paras. 45-49) systematically attempts to reduce the uncertainties facing private investors. 69. The Bank Group also provides guarantees through MIGA and the recently introduced IBRD guarantee program to support private financing of infrastructure projects. The overarching principle underlying the use of the Bank Group's guarantee facilities is that they should complement other financing available to China, for example, development loans and export credits. Bank Group support for private infrastructure projects will emphasize IFC's equity and loan instruments, as well as MIGA's insurance against political risks. Because neither IFC nor MIGA requires the Chinese Government's counterguarantee, they would tend naturally to be a first point of inquiry with the Bank Group. The MIGA offers long-term coverage for specific political risks, viz., currency transfer, expropriation, war and civil disturbance, and breach of contract, with a focus on risk coverage of equity investments, shareholder loans, or loans by commercial banks (so long as equity in the project is also insured by MIGA). Its activity level in China, however, will be constrained by currently limited headroom for China coverage, and difficulties in providing full transfer coverage in China (para. 70). In association with the Bank's lending program, IBRD guarantees potentially can play a significant, complementary financing role for large infrastructure projects that require resources beyond the financial capacity of IFC or MIGA. 70. Until late 1994, MIGA had not provided currency transfer coverage in China because the local currency is not legally and practically convertible. But MIGA's currency transfer coverage consists of two different parts: (a) inconvertibility, i.e., the inability of an investor/lender to convert local currency into foreign currency; and (b) transfer, i.e., the inability of an investor/lender to send foreign currency out of the country. MIGA now offers transfer coverage in China, and the first guarantee  - 20 - contract covering currency transfer in China was issued in December 1994. MIGA considers the lack of legal convertibility of the local currency to be a serious impediment to foreign investment in China. 71. With respect to the other areas of uncertainty, we propose to assist in the enhancement of transparency and competition through Bank project loans and the increased use of Standard Bidding Documents by project entities and better understanding of government organizational structures and processes. In addition, the policy conferences organized by FIAS will continue to respond to these areas of investor concern. The satisfactory division of risks and rewards between investors and the government would be facilitated by the Bank Group through policy advice associated with ESW and IBRD guarantees. We propose to respond to the lack of domestic term finance and capital markets through Bank and IFC lending and investment, ESW and FIAS' advisory service, mobilization of greater cofmancing for infrastructure projects, both public and private (para. 83), and selective use of the IBRD partial credit guarantee. This instrument can supplement scarce term finance, facilitate private financing of publicly- owned infrastructure by extending the maturities of loans beyond what is otherwise available from private lenders, and demonstrate how Chinese enterprises can gain access to capital markets. At the same time, we will be careful not to use this instrument as a substitute for other traditional cofinancing instruments- in particular, suppliers', buyers' and export credits-that can serve, for example, as significant sources for equipment financing. 72. In utilizing all of its instruments to help mobilize private financing of infrastructure, the Bank Group will tailor the mix of instruments to conform to Chinese priorities for: (a) recourse to the international financial and capital markets, and (b) support from the Bank Group. For example, despite its undeniable potential to facilitate the startup of new joint ventures that would provide infrastructure services, the Bank's partial risk guarantee is likely to have no immediate application in China as the Government currently is unwilling to extend counterguarantees in favor of SOEs or foreign-participated joint ventures. The Bank's partial credit guarantee is operational, however; two pilot guarantees have already been approved 11/ and a third is scheduled for Board presentation early in FY96. 73. Portfolio Implementation. Combined IBRD/IDA commitments to China were just over $3 billion in both FY93 and FY94, making China the Bank's largest borrower (in terms of new commitments). The cumulative project portfolio is balanced, with 29 percent of the total for Agriculture, 22 percent for Transport, 18 percent for Energy and 11 percent for Industry. The balance (20 percent) supported social sectors, the environment, and cross-sectoral programs of TA. 74. Historically, the implementation of Bank projects in China has been very successful, as evidenced by supervision ratings that have been consistently above Bank and regional averages. A well- developed local administrative capability, powerful sense of borrower ownership, and thorough project preparation hold problem projects to a minimum and ensure a quick Government response to and turnaround of those problems that do emerge. During 1989-93, ratings dipped slightly, the expected result of a maturing portfolio now numbering approximately 100 active projects; nonetheless, ratings remain well above both regional and Bank averages. 75. Since January 1986, four Country Implementation Reviews (CIRs) have been held in China. The fourth, held in February 1993, resulted in agreement on an action plan to enhance performance in the following areas: 11/ The partial credit guarantees accompanied loans for the Yangzhou Power Project (FY94) and the Zhejiang Power Project (FY95).  - 21 - * the quality of projects at entry; * the role of the Government in implementation and supervision; * resettlement planning, funding and monitoring; * the implementation of TA and institutional development components; and * procurement and contract administration. Improvement in all five areas has been achieved through action plans that emphasized: introduction of more realistic Chinese procedures for estimating project costs and planning budgetary allocations; training of project staff in portfolio management and ex-post project evaluation; development of Chinese resettlement guidelines responsive to both Government and Bank requirements, and training of local staff in resettlement implementation, monitoring and evaluation; project designs and organizational arrangements that promote more effective use of TA, and compilation of a local experts database to facilitate use of local consultants; and updating of the Bank's Model Bidding Documents in Chinese and continued training of project staff in Bank procurement and disbursement procedures. 76. Recognizing the increasing role the provinces play in the successful implementation of Bank projects, CIR-4 also recommended that Provincial Implementation Reviews be held in key provinces alternatively with CIRs. In April 1994, a province-specific portfolio review was held in Jinan for Shandong Province and a countrywide industry portfolio review was held in Nanjing, Jiangsu Province. The Shandong exercise gave other provinces and the central government the opportunity to review the successful Shandong portfolio and identify lessons from the province's achievements. Risk management and the debt repayment burden caused by the January 1994 exchange rate unification were the major topics of concern. Following the exercise, the Ministry of Finance and the Bank agreed to prepare a paper on these issues and to hold a workshop on management of foreign exchange risk. 77. At Nanjing, a frank discussion on the industrial portfolio took place. The decision to place more emphasis on market-driven restructuring programs in Bank lending to SOEs (paras. 37-40) was one result of this session. The evident value, both to China and the Bank, of sectorally focused portfolio reviews means that they will become part of our regular work program, linking achievement of development objectives in the portfolio to the sectoral strategies set forth in the CAS. The next sector review-for agriculture-is planned for the second quarter of FY96; the next full CIR will be held in Beijing in April 1996. 78. The Resident Mission's role in project implementation is continuing to evolve. In addition to providing general operational support to Headquarters task managers and visiting missions, the Resident Mission (RMC) has assumed responsibility for the coordination of the revision of Model Bidding Documents and prescreening of disbursement applications. The RMC is also doing some selected procurement prescreening and has led Project Launch workshops, procurement seminars, and business opportunities seminars. The assumption of these new responsibilities is expected to improve implementation, accelerate disbursement and procurement, and reduce supervision costs. C. IFC AND MIGA 79. The International Finance Corporation's assistance strategy for China focuses on the following five principal objectives: (a) to serve as a catalyst to increase private and foreign investment, (b) to mobilize funding from commercial sources through limited-recourse financing, (c) to promote a more favorable climate for the nonstate sector through project structuring and advisory activities, (d) to accelerate development of the financial sector and capital markets (including stock markets) through establishment of nonstate financial institutions and (e) to focus geographically and by sector, given the huge needs of China as measured against IFC's overall resources.  - 22 - 80. The Corporation's operations in China consist of project financing and investment-related advisory work. Most of IFC's investments have been joint ventures between foreign investors and Chinese enterprises in the general manufacturing sector. Work in the capital markets area includes the establishment of three venture capital funds, and TA to the China Securities Regulatory Commission. To date, IFC has invested in 13 projects, with a total investment of nearly $200 million. The bulk of these investments have taken place in the past few years. 81. The implementation of market-oriented policy and regulatory reforms will require ongoing and close coordination between the Bank and IFC, in addition to cooperation with FIAS and MIGA in their respective areas of concern. In the coming year, priority areas for coordination will include strategies for financing private infrastructure, foreign participation in joint ventures, securities regulation, financial sector and capital markets reforms, and the foreign exchange system. Where appropriate, IFC will draw upon its operational experience with project financing and capital markets development to assist in the formulation of the Bank Group approach. Further detail of these coordination efforts is provided in the IFC China strategy paper prepared for the IFC Board. 82. MIGA has offered coverage against the risks of Expropriation and War and Civil Disturbance since China became a member in 1988. It has issued eight contracts to date covering these two risks for an aggregate liability of about $58 million. Over a dozen projects are currently under review, and an additional 87 preliminary applications are pending. Should all the projects in the pipeline materialize, it would leave very little headroom for future China guarantees until MIGA's country capacity is adjusted. Another problem for MIGA's activities in China has been difficulties in obtaining from the Chinese authorities host government approvals, which are a prerequisite for proceeding with any project MIGA is considering insuring. D. COOPERATION WITH OTllER MULTILATERAL AND BILATERAL INSTITUTIONS 83. China has not drawn on IMF resources since a standby agreement in 1986. The Bank maintains close liaison with the Fund on macroeconomic matters, including through cooperation in the staffing of key missions. The Fund is also supporting the preparation and implementation of the Bank- assisted Fiscal Sector TA project. The Asian Development Bank (AsDB) is the other leading source of multilateral development assistance, and the two institutions maintain ongoing liaison on policy objectives and operational priorities. Close contact is also maintained, in the TA area, with the United Nations Development Program (UNDP); the Bank is either executing or cooperation agency for four UNDP subprojects currently under implementation. In addition, the Bank holds regular consultations with the principal bilateral agencies active in China (including Japanese agencies, which together provide the largest bilateral program, and those of a number of other OECD nations): bilateral sources have helped to finance TA subcomponents in 23 Bank-supported projects in China. Chinese administrative mechanisms in the past have generally discouraged cofinancing on a larger scale. Responsibility for administering aid is dispersed among different Government agencies, making coordination among donors difficult. The table below illustrates the present cofinancing arrangements in China for major donors. Developing an effective, well-coordinated cofinancing system of World Bank projects in China will take some time. The Chinese need to consider measures to promote cofinancing more seriously in view of a leveling off of Bank lending to China, combined with large external financing needs in many projects. In particular, the Government's intention to encourage greater private investment in the infrastructure sectors may open new possibilities. We are investigating ways to channel funds into infrastructure projects and for projects in poverty and human resources, to offset declining IDA resources.  - 23 - ClINESE GOVERNMENT AGENCIES ADMINISTERING FOREIGN ASSISTANCE (By Major Source and Administering Agency) Administering Agency Source MOF MOFTEC PBC BOC MOA IBRD X IDA X IMF - - X UNDP - X - WFP - - - - X AsDB - - X Eximbank (Japan) - - X X OECF (Japan) - X Other bilateral - X Notes: MOF =Ministry of Finance; MOFTEC =Ministry of Foreign Trade and Economic Cooperation; PBC=People's Bank of China; BOC=Bank of China; MOA=Ministry of Agriculture; UNDP=United Nations Development Program; WFP=World Food Program; and AsDB=Asian Development Bank. E. ISSUES FOR BOARD CONSIDERATION 84. Progress in the transformation of the Chinese economy from a command to market economy has been remarkable, not only in its pace but also in its contribution to the welfare of the Chinese people. Yet, significant challenges remain. To sustain the high growth rates of the past and lift the remaining 80-100 million out of absolute poverty, China will need to push forward with the remaining, difficult reforms while maintaining a stable macroeconomic environment. 85. We have identified financial, fiscal, and SOE reforms as key areas to concentrate the Bank Group's efforts to help China further its reforms within a stable macroeconomic environment. Moreover, the infrastructure, HRD, and environment sectors will receive special emphasis and provide the bridge to furthering the reforms. The Executive Directors may wish to discuss the appropriateness of the refbrm and sectoral priorities proposed. Richard H. Frank President ad interin   SUMMARY OF BANK'S KEY OBJECTIVES, STRATEGY, ASSISTANCE PROGRAM AND MILESTONES ASSISTANCE PROGRAM 1995-1997 OBJECTIVES ACTION/STRATEGY PROGRESS MILESTONES ESW/TA LENDING 1. Assist in the Implementation * Focus analytical work on rinancial sector reforms ESW * Financial Sector * Improvement of fiscal and monetary framework of Macroeconomic and (including capital market development), labor * Capital Markets Development leading to lower Inflation, annual growth between Structural Refonss (through market reforms, and fiscal and monetary reforns Development * Technology Development 8-9 percent. fiscal, monetary and SOE (especially the allocation of public resources * Public Investment and * Housing and Social Security * Conversion of specialized banks into commercial policy reforms) across sectors and levels of government) Finance * Chongqing Industrial banks. Use TA projects to develop institutions, transfer * Interest Rate ProjectfWuhan * "Poticy" and commercial lending separated with international experience in key poUcy areas, and Liberalization * Labor Market Development sart-up of policy banks create capacity for policy analysis and * CEM (Macro- * Seed Sector * Simplification of interest rate structure and more implementation in key ministries and management) Commerciatization frequent adjustments of interest rates commissions. * Modern Enterprise * State Farm * Introduction of new system for Inter-governmental * Continue to use the CEM to monitor progress In Reform Commercialization transfers of fiscal resources macroeconomic reforms, assess current economic * Social Security System * Animal Feed Project * Results of analytical work successfully developments, and convey key policy messages to Reform * Railways VIII Project disseminated and incorporated Into projects senior policy makers. * State Asset Management designed to pliot enterprise reforns| * Use the analytical capacity of RMC to provide and Divestiture * Pilot projects are successfully implemented and quick-response poliy advice when requested by * Policy Conference: SOE replicated in other provinces Government. Reform * Broader diverstfication of ownership fonns among * Concentrate analytical work on labor enterprises, including private firms redundancy, separating social services from TA * Greater flexibility in Industrial organization, SOEs, and enterprise autonomy areas where the * Fiscal TA including entry, exit (via bankruptcy), and merger Government needs and asks for help * Financial TA * Develop pilot projects in a few provinces to * Legal TA demonstrate how key elements of SOE reform can be implemented: Shedding housing and social security responsibilitiesl -Redeploying redundant laborl -industrtsa restructuringl -CorporatHzatHon/Commercialization of enterprbesf 2. Assist in the Alleviation of * Bank program focused primarily on the power, ESW * 6 Power Projects, including * Enactment of Railways, Nationai Electricity, and Infrastructure Bottlenecks transport, and water resource management * Transport Logistics hydro, thermal and Telecommunications laws sectom * Transport Strategy transmision * Policy content of Bank projects replicated in new * Sector work is dovetalied to lending program * Foreign Direct * 1 Railway, 5 Highway, and projects sponsored by other provinces needs. Investment 1 Waterway Projects * Expansion of privately financed infrastructure * Project designs encourage improvements in * Urban Transport * Wanjiazhal Water Transfer projects outside southern provinces efficiency and private capital flows through: * Cross-Basin Water Project * Average power tariffs approach LRMC country- - Transfer of new technology and modern Transfer * Yangtze Basin Water wvide but especially In the interior provinces operational and management procedures Resource Project * Results of key sector work are presented in - Commerctslization and corporatzation of * Guangzhou Urban conferences/sembnars operating companies/enterprises Transport * Estabishment of model river basin corporation in - ReaDgnment of regulatory and legal framework Hana, and sel-financing water districts in Hunan - Introduce competition and tramFparency" and Hubel - Adequate tariff polcy * Commercial pricing of bulk wvater in Shanxi - Development of new sources of financing * Selective use of partial/performance guarantees to _ "jump-start" FDI flows.  SUMMARY OF BANK'S KEY OBJECTIVES, STRATEGY, ASSISTANCE PROGRAM AND MILESTONES ASSISTANCE PROGRAM 1995-1997 OBJECTIVES ACTION/STRATEGY PROGRESS MILESTONES ESW/TA LENDING 3. Support 7-Year Plan to * Focus new analytical work on emerging urban ESW * Basic Education in Poor and * The "core poor" constitute a significantly higher Eradicate Poverty/Human poverty and growing Income and regional * Regional Disparities/ minority areas 11 & III proportion of our project beneficlaries in Bank Resources Development disparity Income Distribution * Rurd Health Services projects. * Sharpen the poverty focus of agriculture, health * Rurd Urban Migration * Disease Prevention * The results of the analytical ork in urban poverty and education projects by shifting more of the * Higher Education Reform * South West Poverty and income and regional disparities are project proceeds from the poor to the "core poor" * Health Care Financing * Heai Corridor disseminated widely by the Governunent to focus * Design IBRD-IDA blend projects in the human Reform * Shanxi Poverty Government agencies' attention on poverty resource development areas where the nature of * Second Vocational impact, and phased into the design of poverty the project warrants It (e.g., infrastructure, Technical Education projects of the future commercial activity), and which would introduce * Iodine Deficiency Disorder * Three or four IBRD-IDA blend projects are eMffciencies in resource utilization and Control developed in the poverty and human resource effectiveness of services. development area. 4. Protect Environment * Concentrate efforts primnarily on urban ESW * Zhejiang Environment * Improved level and structure of user charges for environment problems * Urban Environmental * Hubei Urban Environment environmental services in non-Bank projects * Design "stand alone" pilot environment projects in Management * Yunnan Environment * Wide dissemination of ESW findings selected provinces that promote: * Industrial Potlution * Liaoning Environment * Completion of national vehicle potlution control - Sound economic and fimancial pohcles for * Greenhouse Gas Study * Guangxl Environment action plan environmental management and sustainable (with UNDP and * Shanghai Sewerage IT * Reduced deterioration rate in water and air development Governnent) * Technology Development polution - Development of the necessary Institutional and * Watershed Development regulatory framework ProJeds * Through ESW and TA assist the NEPA's capacity * Shenyang and Chongqing to: Industrial Projecs - Implement recommendations in the National I GEF Projects Environment Action Plan O Projects - Disseminate: lessons learned from the * ODS Projecs implementation of Bank's environment projects (including GEF) and analysis made in ESW. o3  ANNEX Al Page 1 of 1 CHINA-Selected Indicators of Bank Portfolio Performance and Management Indicator FY92 FY93 FY94 FY95 (current) Portfolio Performance Number of Projects under implementation 89 93 103 98 Average Implementation Period (years) ^ 3.8 3.5 3.8 N.A. Percent of Problem Projects rated U or HU b (for past years, rated 3 or 4) Development Objectives c 1.4 2.7 2.2 N.A. Implementation progress (or overall 3.4 5.4 9.7 N.A. status for past years)d Canceled during FY 0 0 0 1 Disbursement ratio (%)f 26.4 24.9 24.9 24.5 g Disbursement lag (%)h -8.7 7.6 4.1 5.5s Memorandum item: % completed projects 0 0 0 NA rated unsatisfactory' Portfolio Management Supervision resources (total staff weeks) 1,015 1,218 1,239 NA Average supervision (staff weeks/project) 11.4 13.1 12.0 NA Supervision resources by location (in %) % headquarters 98.3 97.2 97 NA % resident mission 1.7 2.8 3 NA Supervision resources by rating category (staffweeks/project) Projects rated HS or S 11.3 12.9 11.3 NA Projects rated U or HU 26.2 14.8 19.2 NA Memorandum item: date of last/next CPPR Apr-94 FY 96 a. Average age of projects in the BanKs country portfolio. b. Rating scale: HS" denotes "Highly Satisfactory," "S" denotes "Satisfactory," "U" denotes "Unsatisfactory," and "HU" denotes "Highly Unsatisfactory." c. Extent to which the project will meet its development objectives. d. Assessment of overall performance of the project based on the ratings given to individual aspects of project implementation (e.g., management, availability of funds, compliance with legal covenants) and to development objectives e. The Shanghai Industrial Development Project was canceled. f. Ratio of disbursements during the year to the undisbursed balance of the BanKs portfolio at the beginning of the year. g. FY 95 disbursements prorated. h. For all projects comprising the BanKs country portfolio, the percentage difference between actual cumulative disbursements and the cumulative disbursement estimates as given in the "original SAR/PR Forecasr or, if the loan amounts have been modified, in the "Revised Forecast." The country portfolio disbursement lag is, effectively the weighted average of disbursement lags for projects comprising the Bank's country portfolio, where the weights used are the respective project shares in the total cumulative disbursement estimates. A negative disbursement lag indicates actual disbursements exceed estimated disbursements. i. For projects rated in the FY only: from the OED database (as of 12131/93.)  ANNEX A2 Page 1 of 2 CHINA--Bank Group Fact Sheet, FY92-98 IBRD/IDA Lending Program, FY92-98 Category Past Current a Planneda b FY92 FY93 FY94 FY95 FY96 FY97 FY98 Commitments (US$m) 2,526 3,172 3,070 3,049 2,590 2,840 2,730 Sectors (%) Agriculture 11.4 30.0 41.5 15.7 17 15 25 Industry/Finance 3.3 4.7 0 11.8 12 10 10 Energy/Power 37.1 12.6 19.7 22.9 31 30 25 Telecommunications 0 0 8.1 0 0 0 0 Transportation 21.8 29.3 16.9 24.3 15 20 20 Environment 9.5 9.5 5.2 3.8 5 10 0 Urban Development 2.4 3.5 4.9 12.0 0 10 5 Water supply and sanitation 4.4 3.8 0 0 10 0 5 Education 5.1 3.2 0 3 5 5 5 Population, Health & Nutrition 5.1 0.0 3.6 4.0 5 0 5 Technical Assistance 0 3.5 0 2.1 0 0 0 TOTAL 100 100 100 100 100 100 100 Lending instrument (%) Adjustment loans 0 0 0 0 0 0 0 Specific investment loans and others 100 100 100 100 100 100 100 TOTAL 100 100 100 100 100 100 100 Disbursements ($USm) 1,371 1,575 1,926 1,099 c Repayments (US$m) 160 221 282 173 c Interest (US$m) 263 305 356 210 c a Planned, as of 2/28/95. b Planned lending reflects the base case scenario's IDA lending after FY96 is subject to availability of IDA-I1 resources. c As of 12/31/94  ANNEX A2 Page 2 of 2 CHIINA-IFC and MIGA Program, FY93-95 Past Category FY93 FY94 Fy9Sa IFC approvals (US$m) 35.7 27.5 61.0 Sector (%) Agribusiness 0 0 0 Capital Markets 0 100 0 Chemicals/fertilizers 0 0 0 Infrastructure 0 0 0 Manufacturing 100 0 100 Oil/mining 0 0 0 TOTAL 100 100 100 Investment instrument (%) Loans 91.7 0 100 Equity 8.3 100 0 Quasi-equityj 0 0 0 TOTAL 100 100 100 MIGA guarantees (US$m) 0.5 11.6 45.6 MIGA commitments (US$m) 0 0 0 'As of December 31, 1994  ANNEX A3 Page 1 of 1 CHINA--Summary of Economic and Sector Work (No.of formal outputs) Category FY94 FY95 FY96 FY97 Agriculture 1 1 Industry 1 2 Finance 1 1 Energy Power 1 Telecommunications Transportation 2 2 Urban development 2 Human resources 1 Education 1 Population, health and nutrition 1 Social sector 2 Public sector management 1 Environment 1 1 Trade policy reform Other non-sector-specific 1 1 Other economic work 1 1 Poverty assessment Private sector assessment Country economic memorand 1 1 1 1 Other (specify) Total economic and sector work 8 9 7 6  ANNEX A4 Page 1 of 2 Poverty and Social Development Indicators China Most Same regionfnconme group Nest Latest singleyear recent higher Unit of estimate East Low- income Indicator measure 1970-75 198085 1987-92 Asia income group Priority Poverty Indicators POVERTY Upper poverty line local curr. .. 180 324 Headcount index %ofpop. 26 11 12 19 Lower poverty line local curr. 161 287 Headcount index % of pop. 20 9 9 GNP per capita USS 380 470 760 390 SHORT TERM rNCOME INDICATORS Unskilled urban wages local curr. .. Unskilled rural wages Rural terms of trade Consumer price index 1987=100 62 86 150 Lower income Food .. 85 146 Urban Rural SOCIAL INDICATORS Public expenditure on basic social services % of GDP .. Gross enrollment ratios Primary %schoolagepop. 126 124 123 121 103 Male 135 132 127 126 113 Female 115 114 118 117 96 Mortality Infant mortality per thou. live births 48.0 37.0 31.0 39.0 73.0 45.0 Under 5 mortality .. .. 37.8 49.0 108.0 59.0 Immunization Measles % age group .. 74.0 95.0 88.4 72.7 DPT .. 78.0 95.0 89.5 80.6 Child malnutrition (under-5) .. .. 21.3 24.7 38.3 Life cxpectancy Total years 64 68 69 68 62 68 Female advantage 1.5 2.9 3.2 3.6 2.4 6.4 Total fertility rate births per woman 3.4 2.3 2.0 2.4 3.4 3.1 Matemal monality rate per I00,000 live births .. 44 115 114 Supplementary Poverty Indicators Experditures on social securitv % of total gov't exp. .. .. .. Social security coverage % econ. active pop. .. .. .. Access to safe water: total % of pop. .. .. 78.0 72.0 68.4 Urban 81.0 87.0 83.4 78.9 Rural . 66.0 60.2 60.3 Access to health care Population growth rate GNP per capita growth rate Development diamond b 6+~ (annual average. percent) 0 (annual average, percent) Lifel epmectdan | 4 4 j 5 *~~~~~~~~~~1 Life cxpectancy 4j.5 GNP Gross * :o ~~~~~~~~~~~~~~~~per primary capita enrollment -2 ~ ~ ~ ~ ~ ~ ~ ~ I-l0oAcest af ae 1970-75 1980-85 1987-92 1970-75 1980-85 1987-92 Accesstosafewater ' China China - Low-income Low-income a. See the technical notes, p.389. b The development diamond, based on four kev indicators, shows the average level of development in the country compared with its income group. See the introduction.  ANNEX A4 Page 2 of 2 China Most Same regionlincome group NW Latest single year recent higher Unit of estimate East Low- income Indicator measure 1970-75 1980485 1987-92 Asia income group Resources and Expenditures hIUMAN RESOtJRCES Population (mre=1992) thousands 916,395 1,051,013 1,162.165 1.688.909 3,194,535 942,547 Age depcndency ratio ratio 0.78 0.54 0.50 0.55 0.67 0-66 Urban % of pop. 17.3 23.7 26.8 29.4 26.7 57.0 Population growth rate annual % 1.8 1.4 1.2 1.4 1.8 1.4 Urban 2.4 4.4 2.6 2.9 3.4 4.8 Labor force (15-64) thousands 481,759 617,906 698.525 928,465 1,478,954 Agriculture % of labor torce 76 74 .. Industry 12 14 .. 4. 3. .. Female 42 43 43 41 33 36 Females per 100 males Urban number . 88 Rural .. 95 NATURAL RESOUlRCES Area thou. sq. km 9,561.00 9,561.00 9,561.00 16,367.18 38.401.06 40,697 37 Density pop. persq. km 95.9 109.9 120.1 101.8 81.7 22.8 Agricultural land ol land area 43.1 50.3 53.4 44.5 50.9 Change in agricultural land annual % 1.2 1.4 0.0 0.1 0.0 Agricultural land under irrigation % 10.5 9.4 9.6 14.5 18.2 Forests and woodland thou. sq. km 1,389 1,279 1,247 Deforestation (net) annual % fNCOME Houschold income Share ot top 20% ot households %of income .. 39 42 42 42 Share ol'bottom 40% otfhouseholds .. 18 17 18 19 Share ot bottom 20% o1 households .. 7 6 7 8 EXPENDITtJRE Food % of GDP .. 43.1 .. Staples ,. .. . Meat, fish, milk, cheese, eggs .. .. .. Cereal imports thou. metric tonnes 3,718 5,852 11,661 33,591 46,537 74,924 Food aid in cercals .. 262 172 581 9,008 4,054 Food production pcr capita 1987= 100 90 119 140 133 123 Fertilizcr consumption kg/ha 16.1 35.3 58.7 75.1 61.9 Shareot agriculture in(DP %ofGDP . 33.7 27.2 21.5 29.6 Hlousing %ofGDP 5.5 Averacc household sizc persons pcr household . 4.8 UJrban 3.8 Fixed invesimcnt: housine