Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-6969 UA REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED COAL SECTOR ADJUSTMENT LOAN IN AN AMOUNT OF US$ 300 MILLION TO UKRAINE November 15, 1996 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS (as of July 18, 1996) Currency Unit = Karbovanets US$1 = 178,400 1 Karbovanets = US$0.0000056 From September 2, 1996 1 Hryvnia = 100,000 Karbovanets WEIGHTS AND MEASURES Metric System FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS EU TACIS - European Union Technical Assistance for the Commonwealth of Independent States FSU - Former Soviet Union GDP - Gross Domestic Product IBRD - International Bank for Reconstruction and Development IMF - International Monetary Fund LCSP - Letter of Coal Sector Policy MCI - The Ministry of the Coal Industry NBU - National Bank of Ukraine SBA - Stand-by arrangement SECAL - Sector Adjustment Loan STF - Systemic Transformation Facility SPF - State Property Fund UDKR - Ukrainian State Company for Restructuring Coal Industry Enterprises USAID - United States Agency for International Development FOR OFFICIAL USE ONLY UKRAINE Coal Sector Adjustment Project Loan and Program Summary Borrower: Ukraine Executing Agencies: Ministry of the Coal Industry and Ministry of Finance Amount: US$ 300 million Terms: Maturity of seventeen years, including five years of grace at the standard LIBOR-based variable interest rate for US$ single currency loans. Loan Objectives: The proposed Coal Sector Adjustment Loan (Coal SECAL) will provide a significant portion of Ukraine's balance of payments and budget deficit financing needs in late 1996 and in 1997, including part of the fiscal costs of restructuring the coal sector. Without the loan, the upfront costs of sector restructuring, including its social mitigation, would almost certainly not be financed. The Bank's provision of the proposed loan, and its associated conditionality, would enhance the credibility of the Government's sector reform program. In the absence of the loan, budgetary support to the sector would be limited, large arrears would accumulate, and little or no restructuring would take place. The lack of restructuring would prevent the attainment of productivity improvements in the sector, deepen the poverty of those currently dependent on the sector for their livelihood, and risk undermining macroeconomic stability through funding of growing losses in the sector. Loan Description: The proposed SECAL will be quick-disbursing and will provide budget and balance of payments support, linked to the conditionality specified for tranche release. Disbursements of the proposed loan will not be linked to any specific purchases, but will be subject to a standard negative list of ineligible goods and countries of origin. Benefits: The loan will allow the implementation of the first stage of a reform program for the coal sector which will reduce the need for fiscal subsidies through productivity enhancement and through addressing urgent social issues. It will also facilitate the reemployment of currently wasted resources in more productive uses elsewhere in the economy, and will do so in a manner which minimizes the social costs of adjustment. Implementation of this first stage of reform will make a substantial 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 wiLhout World Bank authorization. ii contribution towards the medium-term goal of creating a more efficient coal sector, attractive to private capital and no longer dependent on fiscal or quasi-fiscal support. Without the loan, (i) the coal sector will represent a permanent threat to macroeconomic stability; (ii) high-cost mines will continue to be a burden on the more efficient mines if the cross-subsidy system is reinstated; (iii) payments arrears will continue to accumulate creating hardship for the workforce and undermining adjustment in the rest of the economy; and (iv) the accumulation of coal sector receivables will continue to soften the budget constraint on the important power and steel sectors thereby delaying those sectors' restructuring. Effective reform of the coal sector will also send a strong signal to the rest of the economy of the Government's resolve to harden budget constraints for state-owned enterprises to promote restructuring and a competitive market orientation, which in turn will promote economic growth and underpin macroeconomic stabilization. Risks: The principal risk is loss of policy commitment by the Government in the face of resistance by coal industry lobbies with vested interests and by labor unions representing those who bear the social costs. This risk of policy reversal will be mitigated to some extent by (i) social protection and employment creation measures to minimize the social costs of adjustment; (ii) an effective public information and participation program to raise awareness both of social protection measures and of the costs of continued coal sector subsidies borne by the rest of the population; (iii) firm implementation of coal sector reform such that productivity and profitability gains are apparent early in the adjustment process; (iv) timely financial assistance from the Bank; and (v) the resumption of economic growth in Ukraine. However, the risk remains significant. The factors which create a risk of policy reversal also create a risk of negative publicity for the Bank. However, this will be mitigated by (i) the extent of Government ownership of the restructuring program; and (ii) public information concerning the social mitigation aspects of the restructuring program. There is a risk of inadequate institutional capacity to implement the program. This will be mitigated by technical assistance and by intensive supervision of the proposed Coal SECAL. Disbursement: The SECAL will be released in two tranches of equal size: the first on effectiveness (expected end-December 1996) and the second on fulfillment of second tranche release conditions (expected in mid-1997). Commitment Fee: 0.75 percent on undisbursed loan balances, beginning 60 days after signing, less any waiver. iii Poverty Category: Poverty-focussed, limited to social safety net for redundant coal industry workers, their families and affected communities. Rate of Return: Not applicable Map: IBRD 27634 Project ID Number: UA-PA-40564 Vice President: Johannes F. Linn, ECA Director: Basil Kavalsky, EC4 Division Chief: Dominique Lallement, EC4IN Task Manager: Jonathan Walters, EC4IN UKRAINE COAL SECTOR ADJUSTMENT LOAN CONTENTS Part I. COUNTRY BACKGROUND ............ ..1............. A. Recent Economic Developments and the Government's Economic Reform Priorities ........ ..1......... Part II. THE UKRAINIAN COAL SECTOR ................ 2 A. Background .................................... 2 B. Past Development Policies ........................... 3 C. Institutional Arrangements and Employment ................ 4 D. Coal Prices, Cross Subsidies and Direct Subsidies .... ........ 5 Part III. THE GOVERNMENT'S REFORM PROGRAM FOR THE COAL SECTOR 7 A. Introduction ... . ................................. 7 B. Market Liberalization .............................. 7 C. Restructuring and Privatization ........................ 8 D. Investment in Viable Mines ................. I ........ 9 E. Closure of Unviable Mines and Mitigation of Social and Environmental Costs ........... .. ............. 10 F. Redirection and Reduction of Subsidies ................... 12 Part IV. THE PROPOSED SECTOR ADJUSTMENT LOAN ....... ...... 16 A. Rationale for Bank Involvement ....................... 16 B. Program Implementation and Loan Conditions .... .......... 16 C. The Proposed Loan ............................... 21 D. Benefits and Risks ................................ 22 Part V. RECOMMENDATION ............................... 23 TABLES Table 1 Coal Sector Employment Table 2 A Snapshot of the Coal Industry as Reform is Implemented Table 3 The "With-reform" Scenario Table 4 The "Without-reform" Scenario ANNEXES 1. Letter of Coal Sector Policy 2. Investments for Coal Production 3. Technical Note on Budgetary Projections 4. Production Subsidies and Performance Contracts 5. Social Impact Monitoring SCHEDULES A. Timetable of Key Project Processing Events B. Status of Bank Group Operations C. Country at a Glance MAP IBRD 27634 - Ukraine Coal Industry Restructuring REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED COAL SECTOR ADJUSTMENT LOAN TO UKRAINE 1. I submit for your approval the following report and recommendation on a proposed Coal Sector Adjustment Loan (Coal SECAL) to Ukraine for US$300 million to provide financial support for the Government's Coal Sector Restructuring Program. The Loan would be at the standard LIBOR-based variable interest rate for US$ single currency loans, with a maturity of seventeen years, including five years of grace. PART I. Country Background A. Recent Economic Developments and the Government's Economic Reform Priorities 2. Ukraine faces an enormous challenge in transforming its economy from a centrally planned system to a market-oriented one. Policy failures during the first three years of Ukraine's independence, combined with major external shocks have compounded the problem. By 1994, officially recorded output had fallen by 50 percent since 1990 and inflation, while coming down from hyperinflationary levels, was still in triple digits. The current account deficit widened and the external situation became increasingly tenuous with a large accumulation of payment arrears (mainly on gas imports from the former Soviet Union). Living standards deteriorated sharply and poverty increased. 3. In October 1994, a clear break was made from past policies as Ukraine began to lay the foundations for macroeconomic stabilization and structural reforms with the objectives of reducing inflation and promoting sustainable economic recovery and better living conditions for the population. In support of the Government's program, the IMF approved a first purchase under the Systemic Transformation Facility (STF) in October 1994 and the World Bank approved a Rehabilitation Loan in December 1994. In April 1995, a 12-month stand-by arrangement (SBA) and a second purchase under the STF was approved by the IMF Board. The IMF-supported stabilization program entailed tight fiscal and monetary policies with the aim of lowering inflation to about 1 percent monthly by year-end. The Bank's Rehabilitation Loan supported a wide-ranging series of measures aimed at reducing government intervention in the economy, developing competitive markets and introducing elements of a social safety net. 4. Much has been accomplished over the last 18 months. The exchange rate has been unified and a substantial degree of current account convertibility established; the trade regime has been liberalized; domestic prices have been largely decontrolled, consumer subsidies reduced and energy prices increased to world levels for non-household users (and substantially raised for household users); tax reform has 2 been initiated with the introduction of a modern profit tax; the state order system has been abolished; a mass privatization program has been launched; agricultural land reform is being initiated; and a radical restructuring of the energy sector is underway. 5. The performance in 1995 indicates a substantial reduction in macroeconomic imbalances. The fiscal deficit (on a cash basis) was reduced to 5.3 percent of GDP (from 8.2 percent in 1994) even in the face of a decline in revenues of 4.4 percent of GDP. Notwithstanding the large cut in expenditures, the current account deficit remained at $1.5 billion, equivalent to 4.4 percent of GDP. Given the dependence on monetary financing of the deficit, inflation only fell to 180 percent (down from 400 percent in 1994). Exports increased -- for the first time since Independence -- by 6.4 percent in volume. This increase in exports was based on a large (19 percent) increase to non-FSU countries in spite of an appreciation of the real exchange rate by 60 percent. The output contraction (officially recorded) slowed down somewhat to 12 percent. 6. There are, however, a number of factors that point to the fragility of these early successes and indicate the considerable challenges ahead in securing macroeconomic stability and restoring growth. First, the fiscal situation appears better than it is; the cash deficit was contained by running up arrears and postponing expenditures. On a commitments basis the deficit was higher; including arrears it is estimated by the IMF to have been between 7 to 9.5 percent of GDP. Second, progress was uneven during the year, underscoring the difficult political and social situation: notably, in mid-1995, the Government gave in to state enterprise pressures and extended budgetary and credit support, including to the coal sector. The persistence and even increase in wage and energy arrears shows that public enterprises have not yet adjusted and credible hard budget constraints are still lacking. In effect, soft budget constraints, with fiscal and quasi-fiscal support, are being used to maintain output and employment levels in the absence of a well-targeted and adequately-funded social safety net. PART II. The Ukrainian Coal Sector A. Background 7. In 1994, Ukraine's coal industry employed 925 thousand people, or 4.3 percent of the labor force of the country. The coal industry supplied 76 million tonnes of washed coal (94 million tonnes unwashed), with a market value of about US$ 2.3 billion (while GDP was US$ 22.8 billion), meeting 24 percent of total primary energy demand in Ukraine. Coal miners received one of the highest salaries among industrial employees (which bore no close relationship to productivity differences), were the best organized, and wielded considerable political influence. The presidential and parliamentary elections of 1994, for example, were scheduled one year ahead of time in response to demands made by striking coal miners. 8. The Ukrainian coal industry is now in a deep crisis. Between 1990 and 1995, production decreased by 50 percent. Coal used to be one of the major Ukrainian export commodities, but coal exports were minimal by 1995 (2.4 million tonnes compared to 20 million tonnes in 1990). Imported coal captured 20 percent of the Ukrainian market as a result of high domestic coal prices, problems with timely delivery and coal quality, and the aggressive marketing of Russian and Polish coals. The productivity of Ukrainian coal miners is extremely low by international comparison, and now it is low even by historical Ukrainian standards: employees engaged in the core production activities produced on average only 105 t of saleable washed coal per capita in 1995, a drop of 34 percent since 1990. For 3 comparison, hard coal mines produce about 200 t of coal per employee per year in Russia, 400 t in Poland, 2,000 t in the United Kingdom, and 4,000 t in North America. Employment in the Ukrainian coal industry is falling fast as unpaid wages drive workers out of the sector - by May 1996 the industry employed 684,000 workers (a 26 percent decline from 1994). 9. Despite high domestic coal prices, the coal industry is unable to cover its costs. Payment arrears accumulated by many of its traditional customers have contributed further to the financial crisis, leading to the inability of many mining enterprises to pay salaries and key suppliers (in particular the power sector). However, the ability and the willingness of the state to subsidize coal production had dropped to an all-time low by 1995, due to a general decline of budgetary revenues in the shrinking economy, and the recognition by policy makers that further large-scale production subsidies endangered the macroeconomic stabilization effort. B. Past Development Policies 10. Ukraine's total coal reserves amount to 52 billion tons of which 23 billion tons are proven and probable (excluding possible) reserves. Cumulative coal production has been more than five billion tons. Ukraine has huge coal reserves, but a large portion of those reserves appear to be uneconomic. The geological reasons for the high costs and the low productivity are great depth, high temperature, frequent gas outbursts, and thin coal seams. Therefore, planners of the former Soviet Union decided to invest in Siberia and Kazakhstan where coal is found in thick seams near the surface and a higher return on the investment could be expected. More generally, mining shifted from underground to surface operations everywhere in the world. This trend was reinforced by the rapidly increasing availability of oil and gas after World War II. Deep coal mining in Western Europe reacted since the late 1950s by closing uneconomic, non-competitive mines, and increasingly concentrating the declining production on the best mines only. 11. Following independence, the Ukrainian coal industry hoped that the decline in coal production would be reversed with generous support from the state. In 1992-94, long term planning focussed on finding ways to increase coal output in order to reduce Ukraine's dependence on imported fuels. The reduction of production costs did not receive a high priority, and no decision to concentrate coal production on the best mines was made. Instead, funds were systematically channeled from the better mines to the worse mines to sustain the operation of the latter. As a result, the poorer mines now possess a complicated network of cross-cuts and inclines which have been continuously extended causing rapidly increasing operating costs, while the better mines could not make full use of their potential due to a lack of funds for rationalization and modernization investments. 12. In early 1994, the Cabinet of Ministers approved a "Program for the Development of the Coal Mining Industry of Ukraine and its Social Sphere up to the Year 2005". The "Program" was based on the expectation that coal demand would stabilize in 1994 and then rapidly increase. Accordingly, the "Program" included the construction of 21 new mines, capacity increases in 14 existing mines, and reconstruction of 46 mines, to be funded by the state. The closure of 48 mines in the 1995-2005 period was also planned, mostly in response to the expected exhaustion of their minable coal reserves. While the "Program" included the corporatization of enterprises and the replacement of centrally-controlled wholesale prices with contractual prices agreed between buyers and sellers, the target date for the implementation of these actions was left unspecified. 4 13. In 1995, the new government (appointed in late 1994) recognized that the devastating state of the industry called for acceleration of the corporatization and price liberalization process, and the rapid closing of the most uneconomic mines. Thirty nine mines were selected for closure, including 24 mines that were to be closed in the first group in 1995-1998. The Government promised to help to alleviate the social problems connected with the closing of mines, and urged the coal industry to focus on the rationalization of the better mines through organizational/managerial changes and targeted investments. It became clear to the Government that without a fundamental change of established attitudes and practices, further deepening of the current crisis of the coal industry was unavoidable. C. Institutional Arrangements and Employment 14. Government Oversight. The Ministry of the Coal Industry (MCI), the key government agency for the coal sector, was established in late 1994, taking over the responsibilities of the former State Coal Committee. MCI is responsible for the development of government policy in the coal sector, appointment and supervision of enterprise managers, approval of coal production and marketing plans, establishment of coal prices, advising the government on the allocation of subsidies (and directed credit), and decisions regarding the closure and development of mines. The Ministry of Economy plays an important role in the development of annual and long term production and investment programs and financing arrangements. The role of the Ministry of Finance is focussed on the approval of subsidies in connection with the annual budget cycles. 15. Industrial Structure. There are 383 enterprises in the coal industry. Out of these, 295 enterprises are organized into 40 associations, and 88 are free-standing (or independent). Twenty three associations are engaged in coal production, three in coal washing, and the rest are active in geological research, shaft design, mine construction, mine automation and mechanization, and equipment repair. The coal washing associations operate 45 washing plants, while 17 washing plants belong to coal production associations and two to independent mines. The independent enterprises include coal mines, and non-core production activities such as peat production plants, machine building plants, engineering and research institutes, construction companies, and transportation and marketing enterprises (associations also own non-core production activities). Only 12 mines are independent, all of which are in the Donbass. The independent mines are generally larger than the other mines (their average annual output is 60 percent higher), more modern and more efficient (the average unit production cost of independent mines is 25 percent lower than the unit cost of the rest of the mines). Concerning the legal status of the enterprises, only 28 are joint stock companies mostly engaged in machine building and construction - the remainder are non-corporatized state enterprises. 16. Coal industry enterprises own and operate kindergartens, summer camps for children, houses of culture, sanatoria, rest houses, sport facilities, and more than 20 million m2 of housing plus related heating networks and boilers. In 1995, the cost (net of revenues) of operating the social assets was Krb. 31 trillion, equal to about 7 percent of the market value of coal produced. Only a small share of these costs was covered by contribution from the beneficiaries. Seventy percent of expenditures were on housing and twenty percent on kindergartens. 5 17. Employment. In May 1996, the coal industry employed 684,000 people. The composition is shown below: Table 1: Coal Sector Employment coal extraction at mines 410,000 workers 357,000 o/w underground 267,000 olw surface 90,000 managers/admin. 54,000 other coal extraction' 54,000 other coal production2 18,000 Total Coal Production 482,000 Non-core Production 92,000 Social Assets 110,000 18. Marketing. In the past, the coal marketing enterprise, Uglesbyt, played a particularly important role. It had an exclusive right to purchase coal from mines and washing plants and sell coal to customers. However, at end-1995, domestic coal marketing was demonopolized. Mines now have complete freedom to sell coal in the domestic market, and the distribution assets of Uglesbyt have been divested to individual mines and associations. By June 1996, Uglesbyt (renamed Uglresource) handled only about 10 percent of total coal sales (although it retained its export monopoly). D. Coal Prices, Cross Subsidies and Direct Subsidies 19. Coal Prices and Cross Subsidies. In 1992-94, coal prices were kept significantly below domestic production (and import) costs. However, on March 1, 1995, following the transfer of responsibility for setting coal prices from the Ministry of Economy to MCI, average coal prices were raised to US$ 33/t, a level that was intended to cover the average cost of domestic production. Actual coal prices paid by the end-users depend on type, calorific value, ash content, moisture content, sulphur content and size, and were determined in a price list issued by MCI. Prices paid by Uglesbyt to the producers (associations and independent mines) were the so-called "accounting prices", which were determined by modifying wholesale prices on a mine-by-mine basis with a factor that took into account the production costs of each mine (while keeping the average "accounting price" equal to the average wholesale price). This arrangement allowed the cross-subsidization of high-cost associations and mines by low-cost ones, and became a major source of financing for loss-making mines as direct subsidies from the Government budget were cut. I/ Maintenance and mine development workers who are not attached to specific mines, and coal association administrative staff. 2/ Support workers for miners. 6 20. The cross-subsidies that the high cost mines have received from the low cost ones (an estimated US$ 400 million in 1995) reduced the incentives to increase efficiency, and, for the better mines, denied the opportunity to reinvest profits to maintain or further improve performance. By mid-1995, this system of transfers between mining associations, independent mines, and Uglesbyt was under severe strain. This was due to the increasing level of receivables on sales arranged through the regional units of Uglesbyt, and also by the increasing reluctance of the more profitable mines and the regional Uglesbyt offices to transfer the payments to the high cost mines. This exacerbated the cashflow position of the highest cost mines, bringing them closer to the point of collapse. 21. Direct Subsidies. The coal industry has received substantial subsidies under a number of headings (e.g., compensation for low prices, support of centralized investments, geological survey) and channels (e.g., budgetary grant, credit from the budget, credit from the National Bank and from commercial banks guaranteed by the budget). These subsidies have significantly contributed to the overall budget deficit. The support for the coal industry was equivalent to 8.3 percent of total budgetary expenditures (about 4 percent of GDP) in 1993, and 5.6 percent of budget expenditures (3 percent of GDP) in 1994. In 1995, Krb. 36 trillion of production/investment subsidies were spent on the coal industry, equivalent to only 1.6 percent of total budget expenditures (about 0.8 percent of GDP). 22. This declining trend of subsidies (as a percentage of GDP) clearly indicated a change in the direction of fiscal policy, despite considerable political pressure to reverse the trend. However, the sustainability of this rate of decline was highly questionable given that direct subsidies were replaced to a considerable extent by cross-subsidies and by arrears accumulation, in the absence of a fundamental restructuring of the coal industry. Indeed, during the course of 1995 the gradual breakdown of the cross- subsidy system described above and increased import competition, led to substantial arrears accumulation, the imposition of a coal import tax3 in July, and a resurgence of direct subsidies in the second half of the year (the Krb. 36 trillion - equivalent to US$ 240 million - spent on the sector represented an overrun of almost 30 percent on the amount originally budgeted for the coal sector). 23. Payables and Receivables. Accumulated payables of the coal sector rose to US$ 1.05 billion equivalent by August 1995 (from US$ 338 million in the first quarter of the year), representing about 6 percent of total inter-enterprise arrears in Ukraine. By the same date, receivables reached US$ 760 million (from US$ 210 million in the first quarter). Under severe political pressure in the latter half of 1995, the Government undertook various budgetary outlays and loan guarantees to pump liquidity into the coal sector to stabilize the position, particularly in view of the growing wage arrears. However, the financial situation of the coal industry continued to deteriorate and by June 1996 the net negative position had reached approximately US$ 1.1 billion (payables of US$ 2.2 billion and receivables of US$ 1.1 billion). The majority of these payables are owed to the workforce or to public sector creditors; a substantial portion of debts to the latter can be interpreted as a quasi-fiscal subsidy. 24. Financing the Coal Industry's Losses. In short, the US$ 240 million of direct subsidies in 1995 were supplemented by an estimated billion dollars in cross-subsidies and net arrears accumulation. The 1996 budget recognized the overambitious nature of the decline in fiscal support in 1995, and included Krb. 151 trillion for the coal sector (equivalent to 2 percent of GDP, 4 percent of total Government expenditures, or approximately US$ 750 million). Almost all of the Krb. 42 trillion (equivalent to about 3/ The tax is fixed in ECUs/tonne and is differentiated by type of coal; it is equivalent to about 10 percent of the value of the coal. 7 US$ 230 million) disbursed in the first five months of 1996 went to pay wage arrears. Nevertheless, in early June 1996, a very substantial wage arrears problem remained - Krb. 36.4 trillion (plus Krb. 46.2 trillion of unpaid pension and other social protection contributions). The effective abolition of cross- subsidies during the first quarter of 1996, and the continued appreciation of the real exchange rate, were clearly creating pressure for direct subsidies. Total coal industry losses for 1996 are projected at US$ 606 million.4 PART III. The Government's Reform Program for the Coal Sector A. Introduction 25. The Government has embarked on a fundamental reform of the coal sector, which is expected to take at least 8-10 years to complete - this represents a major challenge given international experience on the feasible pace of coal restructuring. The reform program aims to (i) salvage the economically viable portion of the coal industry through an increase in productive efficiency and competitiveness; (ii) diminish the fiscal burden imposed by the coal sector; and (iii) provide a social safety net for the mineworkers and their communities affected by sector adjustment. 26. Intensive dialogue on this reform program took place between the Government and the Bank in the context of preparation of the Ukraine Coal Industry Restructuring Report (Report No. 15056-UA, March 4, 1996); the policy recommendations of the report were discussed and agreed with senior Government officials in January 1996. In February 1996 a Presidential Decree was adopted which outlines the main measures to be undertaken in the Government's coal sector reform program.5 The program covers market liberalization, corporatization of potentially viable mines, closure of loss-making mines, social cost mitigation, social asset divestiture, mine privatization, and privatization of non-core activities. The program is discussed in detail below. 27. The Government's program was discussed at a widely-publicized conference on the Ukrainian Coal Industry held in Kiev, April 11-12, 1996, in which central and local government officials, labor unions, mine management and international organizations participated. The program is also being discussed between management and labor at the local level in a series of consultative meetings. B. Market Liberalization 28. The use of the accounting price mechanism to effect cross-subsidies from low-cost to high-cost mines was abolished in early 1996. At the same time, mines became free to market coal in competition with each other without the intermediation of Uglesbyt. The price list issued by MCI, specifying prices at which sales contracts can be concluded, was abolished when the mine corporatization process was completed in late 1996 (although non-corporatized mines in receipt of production subsidies are required 4/ For operational simplicity, profits/losses are defined throughout this report as net accrued operating income before interest and depreciation. Allowances for depreciation and the use of borrowed funds are both so low in the Ukrainian coal sector that this definition does not represent a significant distortion. 5/1 Decree 116/96 of February 7, 1996. This decree was followed on March 4, 1996 by Order 73 of the Minister of the Coal Industry, which outlined the implementation arrangements. 8 to report their prices to the Ministry of Economy). At the same time, all corporatized mines have been granted the right to export coal (known as "special exporter" status)6; a requirement that all coal export contracts be reviewed by the Ministry of Foreign Economic Relations and Trade will remain in place until early 1997, at which time coal exports will be fully liberalized. In order to maintain competition for domestic producers, there will be no increase in coal import taxes nor imposition of quantitative restrictions on coal imports.' C. Restructuring and Privatization 29. All 276 mines have been divided into four categories. Category 1 mines are currently profitable and will receive no subsidies (76 mines). This will create the preconditions for privatization in the medium term (see para. 36 on the constraints on near-term privatization). Mines currently making losses will either be closed immediately or will be subsidized on a temporary basis. These have been classified into: (a) Category 2 mines (of which there are 105) which have the lowest losses and which will be allowed one year to regain viability and possibly graduate to Category 1; (b) Category 3 mines (75) which are scheduled for closure in the medium term unless they can undertake sufficient improvements in profitability to demonstrate viability - in the meantime closure plans are under preparation for all Category 3 mines; and (c) Category 4 mines (20) which are scheduled for immediate closure. 30. The Category 1 and 2 mines will be corporatized and placed under 15 state-owned holding companies (which will also include coal washing plants and marketing enterprises).8 Category 3 mines will be supervised by newly-created divisions of the Ministry of the Coal Industry (MCI) at the oblast level. Category 4 mines will cease production and be transferred to the closure agency, UDKR. 31. The allocation of the temporary production subsidies for each Category 2 and 3 mine within the budgetary ceiling (determined for each oblast in accordance with the overall ceiling for production subsidies agreed between MCI and the Ministry of Finance) will be decided by MCI, after submission of proposals from the oblast-level divisions of MCI. Subsidy allocations will be based in particular on (i) expected annual operating cost as a function of current costs and changes in input prices, geological conditions, labor productivity, etc.; and (ii) expected annual revenue as a function of coal production and the market value of coal. Category 2 and 3 mines will be prohibited from investment and recruitment (except for transfers from other Category 2 and 3 mines under the same oblast-level division of MCP, and Category 2 mines will be permitted to recruit faceworkers and average increases in wage rates will 6/ The right to export coal currently requires admission to the status of "special exporter" under Ukrainian trade legislation, which is granted on a case-by-case basis. 7/ The existing coal import duty of approximately 10 percent provides only a low level of protection. In addition, in view of the projected real appreciation of the exchange rate, effective protection of Ukrainian coal is expected to decline. 8/ Holding companies will include both Category 1 and 2 mines (at least in most cases). The consequent risk of cross-subsidies from Category 1 to Category 2 mines within a given holding company is mitigated by the allocation of direct budget subsidies to Category 2 mines and by the one-year limit on the life of Category 2. 9/ In view of this exception, those workers least able or willing to leave the coal industry consequent on mine downsizing or closure can be temporarily absorbed by other mines; this measure is designed to reduce the social costs of employment reduction and hence decrease political resistance to labor restructuring. 9 not exceed the minimum level consistent with the Coal Industry Tariff Agreement (the industry-wide wage agreement). 32. In order to minimize the need for subsidies and to enhance productivity, employment contracts for managers of Category 2 and 3 mines will provide for performance-related remuneration (from January 1, 1997). The incentive payments will be based on the difference between (i) actual subsidies and budgeted subsidies; and (ii) payables at the beginning and the end of the year (see Annex 4 for elaboration of the performance contract mechanism). 33. As an alternative option for Category 3 mines, the Government has established a mechanism for leasing mines to mine management, employees or other private parties. The Government recognizes that employment reductions and the settlement of wage arrears may be necessary to attract lessees. At commencement of the lease, accumulated payables and receivables will be disposed of through a debt restructuring process (the Government will assume the social liabilities). A leased mine would not be eligible for fiscal support after commencement of the lease. MCI is seeking technical assistance to design and implement the debt restructuring and leasing processes (from USAID and the UK Know-How Fund respectively). 34. Movement between categories will be possible, but only if mines which transfer conform to the requirements of the new category. A mine moving from Category 1 to Category 3 will thus be eligible for subsidies but will not be allowed to recruit new workers, undertake investment, or pay salary increases above the minimum. A mine moving from Category 2 or 3 to Category 1 will no longer be eligible for subsidies but will be allowed to invest, and will have autonomy over wage and recruitment policy. Category 2 will cease to exist one year after the original division of mines into categories and no movement into Category 2 will be permitted during that year; mines still in Category 2 at the end of the year will be distributed between Category 1 and Category 3 depending on whether they are profitable or not. 35. In order to enhance coal sector efficiency and reduce costs, all non-core productive activities (with the exception of coal washing facilities) will be divested and privatized or will be liquidated by end-1997. Social assets of the coal industry will be transferred to local government administration or will be privatized by mid-1998 (see para. 43). D. Investment in Viable Mines 36. The Government wishes to promote investment in potentially viable mines in view of the outmoded technology, low productivity and very poor health and safety record of even those mines which have good geological and economic prospects. In view of the level of uncertainty over sustainability of the new policy framework, the poor industrial relations experienced by the coal industry, the poor financial position of major customers (particularly the power'" and steel sectors), and the weakness of the Ukrainian banking sector, significant availability of private capital for the coal industry is unlikely in the near term. However, the nature of the coal mining process is such that investment in replacement mining capacity is periodically required in each mine if that mine is not to cease production. In addition, investment in the viable mines may prove necessary for political acceptability of the overall restructuring 10/ The Ukraine Electricity Market Development Project focusses on improving financial discipline in the power sector. 10 process. The Government has therefore decided to provide direct support for investment in Category 1 mines until private capital is forthcoming.'" 37. Any investment support from the Government will be provided in the form of loans at the National Bank of Ukraine (NBU) discount rate (and within the public investment program). Mines will be required to provide at least 20 percent of investment costs from non-budgetary sources. Such investment will be focussed on enhancement of capacity utilization in existing mines; this will serve to minimize both the distortionary effects of government intervention and its fiscal cost. The Government budget for the coal sector (see para. 45 & ff.) will place a cap on such investment support. E. Closure of Unviable Mines and Mitigation of Social and Environmental Costs 38. Mine Closure. The Government intends to close 20 mines per year for the next few years, although the pace may accelerate if that proves socially acceptable and financially feasible. Estimates of the number of unviable mines to be closed over the medium term currently include more than half the industry.'2 Mine closure plans include social and environmental mitigation measures. Physical closure (i.e. shaft-filling and land reclamation) and social mitigation will be managed by the mine closure agency, UDKR. The liabilities and assets of closing mines will be transferred to a receiver for disposal.'3 39. Environmental Management. The Government will ensure that mines are closed in an environmentally sound manner. The Coal Pilot Project (approved by the Board, May 16, 1996) which focusses on three mine closures will yield lessons (by early 1997) for enviromnental management practices as regards shaft-filling, control of emissions (of methane, sulphur oxide, particulate matters etc.), fire hazards, water quality control, safety of storage sites and abandoned buildings, erosion from tailing piles, subsidence and land reclamation (these issues are discussed in detail in the Coal Pilot Project Staff Appraisal Report). Monitoring and evaluation under the Pilot Project is being carried out by independent experts under the supervision of UDKR to assess compliance with the environmental management plan for each mine. The lessons drawn from the experience under the Coal Pilot Project will be applied to the sector-wide mine closure program, and the plan for closure of each mine will include environmental analysis. UDKR is receiving technical assistance to develop its environmental monitoring and evaluation capacity to carry out these functions on a sector-wide basis. 40. Social Mitigation. The phasing of mine closures is intended to spread the social costs over time and to minimize the risk of political upheaval undermining the overall sector restructuring program. In general, the mines with the highest financial losses will be closed earliest. However, in certain cases those mines are highly concentrated geographically; in such cases, sequencing of closures will be necessary on social grounds. The Government places a very high priority on the mitigation of the social costs of mine closure that are borne by mineworkers and their communities. 11/ Some investment in safety enhancement may be needed in Category 2 and 3 mines, which will be funded through the production subsidy. 12/ It is assumed that all category 3 and 4 mines and half of category 2 mines will be closed - a total of about 160 mines. 13/ Technical assistance in the design of the debt restructuring process (including the terms of reference of the receiver) is being provided by USAID. 11 41. The Government has assumed the liability for the statutory minimum severance pay (three months wages) for layoffs of workers in the context of either mine closure or labor force downsizing. Annex 3 provides details of projected employment reduction. In addition, the Government has taken over the liability for disability payments (as well as the provision of free coal to disabled ex-mineworkers) for mines to be leased or closed. In the case of mine closure, the Government will also take over any liability for settlement of wage arrears. These measures will provide an immediate social safety net for mineworkers leaving the industry. The inability of mines to meet all these liabilities is a major obstacle to labor force restructuring and a cause of poverty amongst redundant miners. In addition, the gradual improvement in the financial health of the mining sector will eliminate the wage arrears problem for those remaining in the coal industry. The cost of free coal distribution to coal industry pensioners, currently borne by the coal mines, will also be assumed by the Government from the beginning of 1997. 42. In addition to the Government's takeover of these social liabilities, special social mitigation programs funded by the Government budget (see para.45 & ff.) are being established in all coal mining oblasts to provide a social safety net and promote employment creation for ex-mineworkers and for their communities; these programs will provide medium-term social mitigation for mineworkers leaving the industry. Implementation of these programs will draw on the experience gained in Donetsk oblast under the Coal Pilot Project, which includes labor-intensive public works, job search and pre-redundancy counseling, reemployment support, microcredit for small businesses, and free coal for ex-mineworkers and their families. 43. Mines currently own substantial social assets (principally of housing and kindergartens but also health and recreational facilities). These assets tend to be very inadequately maintained, which imposes a significant social cost on mining communities. They will be fully transferred to municipal administration or be privatized by mid-1998. In cases where cost recovery for services transferred to the municipalities is less than 100 percent, the municipalities will receive targeted budgetary transfers to cover the shortfall until mid-1998.'4 In the case of mine housing transferred to municipalities, a central government budget allocation will be made to the municipalities to contribute to the cost of deferred maintenance and capital repairs in view of the extreme dilapidation of much of this housing."5 44. Social Impact Monitoring. Mechanisms for social impact monitoring and extensive public participation are being reinforced to ensure that consultation with affected parties is maximized and that social protection programs are indeed reaching the intended beneficiaries.'6 The social impact indicators which are being monitored include (i) receipt of severance pay, back wages, disability payments, unemployment benefits, pensions, and free coal by beneficiaries; (ii) availability of training, job search and pre-redundancy counselling, and employment services; (iii) availability of an adequate level of health 14/ The Government intends by January 1, 1997 to introduce full recovery of the operations and maintenance costs of housing (which constitutes about 70 percent of the assets to be transferred). For other social assets (principally kindergartens) the operating losses (about US$ 19 million per year) will be funded by a targeted central government transfer through mid-1998 and from the general income (including general transfers from the central government) of the municipalities thereafter (although a substantial portion of the social assets will eventually be privatized by the municipalities). 15/ See Patrick Bodnar, 'Coal SECAL Social Assets Component", June 1996 for detailed cost estimates. 16/ The Coal Pilot Project is financing a program of stakeholder participation in the coal industry restructuring process. 12 and education services, housing maintenance, heating and utilities; (iv) individual worker notification of mine closure and employment status, availability of public information on sector restructuring and social protection; (v) effectiveness of public works, reemployment support, and microcredit programs; (vi) adequacy of UDKR's implementation capacity. Monitoring of the social impact of restructuring is also expected to yield information on barriers to labor mobility and employment creation. Annex 5 provides further detail on social impact monitoring. F. Redirection and Reduction of Subsidies 45. The ultimate objective of the Government's coal sector reform program is a competitive and efficient industry no longer reliant on budgetary support. Given the depth of the industry's problems, the phasing out of budgetary support will take several years - current projections suggest that production subsidies will cease in 2002 (see Table 3). Moreover, the process of restructuring itself creates a substantial need for budgetary support. Market liberalization and the resulting elimination of cross- subsidies require direct subsidization to those mines which previously received cross-subsidies (although the fiscal cost of these measures will be partly offset by increased profit tax revenue from those mines which carried the burden of cross-subsidies); physical, social and enviromnental costs of mine closure and labor force downsizing will need to be funded by the state if the restructuring program is to be sustainable; social asset transfer will require budgetary transfers from central to local government (although this will be mitigated by increased cost recovery); and budget support for investment to enhance capacity utilization in viable mines may be necessary for the political feasibility of the restructuring process. 46. The Government budget for the coal sector in late 1996 and in 1997 will refocus fiscal support on the restructuring process, within a multi-year framework for the phasing out of fiscal support (in particular, of production subsidies).17 In parallel, the Government will ensure that quasi-fiscal subsidies do not substitute for the loss of direct subsidies through the further accumulation of payables; this is to be achieved through a combination of bankruptcy proceedings"3, the performance contract mechanism and improved financial discipline amongst coal industry customers and suppliers (in particular the power sector). This medium-term decline in fiscal and quasi-fiscal support will be a critical element in promoting restructuring of the viable core and closure of the non-viable portion of the coal industry. 47. The evolution of key variables in the coal industry as reform is implemented is given in Table 2 below. These projections constitute the performance indicators of the sector reform program. The medium-term budgetary framework with and without sector reform are given in Tables 3 and 4 below (the key assumptions behind these projections are outlined in Annex 3). The with-reform scenario shows substantially lower budgetary flows than without reform. This is primarily because the social and physical costs of mine closure will be outweighed by the savings in production subsidies to the closing mines and to the remaining mines, whose budget constraints will be hardened by the sector reforms. 17/ The IMF is considering incorporating a provision in the proposed Extended Fund Facility such that the overall fiscal deficit target in 1997 will be higher if coal restructuring expenditures are undertaken and SECAL financing is provided. 18/ It is expected that the design and implementation (with USAID-financed technical assistance) of debt restructuring procedures for mines to be leased or closed will serve as a pilot for such procedures to be applied to debts of the rest of the coal industry. 13 However, in the absence of reforms it is probable that the Government would not actually be prepared to provide the very large budgetary flows necessary to cover the projected financing needs - the shortfall would then be financed by arrears accumulation by the coal industry. Table 2: A Snapshot of the Coal Industry as Reform is Implemented (Coal SECAL Performance Indicators) 199C 1997 2004 Number of mines"9 276 222 129 Output (unwashed coal) (million tonnes) 75 80 92 Profit/(loss) ($ millions): all mines -745 -243 253 subsidized mines -851 -468 $ cost/tonne (excl. interest and depreciation): all mines 35.5 30.1 29.3 subsidized mines 50.9 41.7 l $ price/tonne 25.6 27.0 32.1 Budget support as % of GDP 2.021 1.6 0.06 o/w production subsidy 1.6 0.9 - Budget support as % of total government expenditure 4.4 3.6 0.16 Employment in coal extraction (mid- 463,000 402,000 162,000 year)2I Output/employee 162 199 568 19/ These figures represent the numbers of mines in production at the beginning of 1996, the end of 1997, and the end of 2004 respectively. 20/ These figures exclude those employed in the non-core production activities and in social assets (these are to be divested from the coal industry). 14 Table 3: The 'With-reform" Scenario _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __.... ... ... .s s..... Year, ,, : '96: '97: , -'96 '99" '00E '0 ' Et 02- '030 d '"04 ' Production Subsidy2' 638 468 270 214 89 0 0 0 0 Net Investment Loans 31 32 107 106 111 -7 -74 -95 -95 Special Social 10 37 49 51 85 61 7 7 7 Mitigation Programs l Physical Cost of Mine 27 100 72 83 73 35 0 0 0 Closure Severance Pay 7 16 14 17 34 3 3 3 3 Wage Arrears for Closing & 12 26 12 0 0 0 0 0 0 Leased Mines Disability Payments for Mines to 15 42 50 68 91 107 114 121 127 be Closed or Leased Free Coal for Coal Industry 0 32 33 33 34 35 36 37 38 Pensioners Social Asset Transfer 75 42 13 0 0 0 0 0 0 TOTAL 815 794 620 572 517 233 86 73 80 Year'9 -'9'j7- '96 '99 ,-,-'00 D "'02 '03 '04: _._ Production Subsidy 118 89 51 41 17 0 0 0 0 Net Investment Loans 6 6 20 20 21 -1 -14 -18 -18 Special Social Mitigation Programs 2 7 9 10 16 12 1 1 1 Physical Cost of Mine Closure 5 19 14 16 14 7 0 0 0 Severance Pay 1 3 3 3 7 1 1 1 1 Wage Arrears for Closing & 2 5 2 0 0 0 0 0 0 Leased Mines Disability Payments for Mines to 3 8 10 13 17 20 22 23 24 be Closed or Leased Free Coal for Coal Industry 0 6 6 6 6 7 7 7 7 Pensioners Social Asset Transfer 14 8 2 0 0 0 0 0 0 TOTAL 151 151 118 109 98 44 16 14 15 21/ The 1996 production subsidy figure represents the amount budgeted. It is projected to fall short of the amount actually needed in the with-reform scenario by US$ 213 million or Krb. 39 trillion (0.5 percent of GDP), which will lead to a corresponding increase in the net payables position of the coal industry. 15 Table 4: The "Without-reform" Scenario .... ........ ..US$ Million _ _ 1- -:- -" -'"::'- -' -:' -': '' " ' ' ' . ' --= -- '96 ;97 - -98 '99 ' '01 '02 '0 '04 Production Subsidy 784 1130 1319 1487 1650 1792 1918 2109 2210 Investment Grant 31 32 120 137 150 67 0 0 0 Special Social Mitigation Programs 0 0 0 0 0 0 0 0 0 Physical Cost of Mine Closure 0 0 0 0 0 0 0 0 0 Severance Pay 0 0 0 0 0 0 0 0 0 Wage Arrears for Closing & Leased Mines 0 0 0 0 0 0 0 0 0 Disability Payments for Mines 0 0 0 0 0 0 0 0 0 to be Closed or Leased Free Coal for Coal Industry Pensioners 0 0 0 0 0 0 0 0 0 Social Asset Transfer 0 0 0 0 0 0 0 0 0 TOTAL 815 1162 1439 1624 1800 1859 1918 2109 2210 ___________________ ~~Trillion Karbovinets Yea- -'9 '9"''' '''''-' ' "'9 '00 '01 '2 '09 "'' *' "- ' '"- '04 Production Subsidy 145 215 251 283 313 341 364 401 420 Investment Grant 6 6 23 26 29 13 0 0 0 Special Social Mitigation 0 0 0 0 0 0 0 0 0 Programs IL I I_I_I _ I_I_I_1 _ 1 ost of Mine Closure 0 0 0 0 0 0 0 0 0 Severance Pay 0 0 0 0 0 0 0 0 0 Wage Arrears for Closing & 0 0 0 0 0 0 0 0 0 Leased Mines I Disability Payments for Mines 0 0 0 0 0 0 0 0 0 to be Closed or Leased Free Coal for Coal Industry 0 0 0 0 0 0 0 0 0 Pensioners Social Asset Transfer 0 0 0 0 0 0 0 0 0 TOTAL 151 j 221 274 309 j 342 354 j 364 401 i 420 22/ The 1996 total represents the amount budgeted. It is projected to fall short of the amount actually needed to fund the production subsidy in the without-reform scenario by US$ 179 million or Krb. 33 trillion, which will lead to a corresponding increase in the net payables position of the coal industry. 16 Part IV. The Proposed Sector Adjustment Loan A. Rationale for Bank Involvement 48. The proposed Coal Sector Adjustment Loan (Coal SECAL) will provide a significant portion of Ukraine's balance of payments and budget deficit financing needs in late 1996 and in 1997, including part of the fiscal costs of restructuring the coal sector. Without the loan, the upfront costs of sector restructuring, including its social mitigation, would almost certainly not be financed. The Bank's provision of the proposed loan, and its associated conditionality, would enhance the credibility of the Government's sector reform program. In the absence of the loan, budgetary support to the sector would be limited, large arrears would accumulate, and little or no restructuring would take place. The lack of restructuring would prevent the attainment of productivity improvements in the sector, deepen the poverty of those currently dependent on the sector for their livelihood, and risk undermining macroeconomic stability through funding of growing losses in the sector. The proposed Coal SECAL complements the IMF's support for the Government's macroeconomic stabilization program through the ongoing Standby Arrangement and the proposed Extended Fund Facility (the latter will be designed to reflect the key fiscal and structural measures of the Government's coal sector reform program in its conditionality). 49. The proposed loan is consistent with the Country Assistance Strategy (discussed by the Board on June 27, 1996) in its focus on public sector restructuring and mitigating the social costs of adjustment. It will also facilitate private sector development through the rapid privatization of non-core activities and some social assets, and through creating the preconditions for the eventual privatization of core activities and the remaining social assets. Furthermore, rapid private sector development as promoted by the Government's overall structural reform program supported by other Bank interventions (e.g. the Enterprise Development Adjustment loan approved on June 27, 1996, Agricultural Sector Adjustment Loan (approved on October 17, 1996), will be critical to the success of restructuring in the coal sector, particularly through their impact on the creation of alternative employment opportunities. 50. The proposed Coal SECAL has been prepared in parallel with a Coal Pilot Project (approved on May 16, 1996) which will finance the physical and social costs associated with closing three coal mines. However, as the full restructuring of the sector will take at least 8-10 years, additional external financing will be needed. Further Bank lending in support of coal sector adjustment would be considered if the first phase of restructuring, to be implemented under the proposed SECAL, is successful; success would be measured by timely implementation of the measures in the sector reform program and by attainment of the performance indicators (see Table 2). A follow-on Coal Restructuring Project is provisionally planned for FY97 to cover a larger number of mine closures, building on those aspects of the Pilot Project which prove to be effective; in addition, further support through the Bank's adjustment lending program may prove desirable to consolidate and deepen the restructuring process. The proposed SECAL is also complementary to the Bank's interventions in the Ukrainian power sector, particularly the Electricity Market Development Project (approved on October 10, 1996), through the focus in both operations on financial discipline and market liberalization. B. Program Implementation and Loan Conditions 51. The Government's program of measures to reform the coal industry through the end of 1997 is reflected in a Letter of Coal Sector Policy (LCSP) (attached in Annex 1). Implementation and monitoring of the LCSP will be the primary responsibility of the Ministry of the Coal Industry (MCI), in collaboration with relevant central and branch ministries (in particular, the Ministries of Economy, 17 Finance, Labor and Social Protection), the State Property Fund, and local authorities. MCI has already established teams for this purpose. 52. The UK Know-How Fund is providing assistance to the Ministry of the Coal Industry and UDKR (the mine closure agency) to implement and monitor the reform program. USAID is to provide advice and training to MCI and the coal industry on debt restructuring. In addition, the Bank's Coal Pilot Project includes assistance to develop a public information strategy, social protection and assessment programs, environmental mitigation plans, and regional/local economic development programs. EU TACIS will provide additional assistance in mitigating the social impact of coal restructuring. This is intended to facilitate the generalization of lessons from the Coal Pilot Project across all closing mines in the Donbass region. The newly-corporatized companies will need assistance in the areas of investment policy, marketing, financial management, and accounting; USAID, EU TACIS and the UK Know-How Fund intend to provide such assistance for part of the coal industry. Further assistance in these areas will be sought from other donors. 53. The proposed SECAL will be released in two equal tranches: the first on effectiveness and the second on fulfillment of the specific tranche release conditions outlined below, if general progress in implementation of the sector reform program (as outlined in the LCSP) and in macroeconomic stabilization are also satisfactory. 54. The following measures were implemented prior to Board presentation of the proposed loan: Sector Restructuring (i) division (by Ministerial Order) of all mines into four categories: 1. profitable mines; 2. potentially profitable mines which are allowed one year to demonstrate their viability; 3. non-viable mines for which closure plans are under preparation and which will be eventually transferred to UDKR; 4. non-viable mines for immediate transfer to UDKR. (ii) initiation by Ministerial Order of performance contract system for category 2 and 3 mines and of leasing arrangements for category 3 mines; (iii) corporatization of all mines in categories 1 and 2, and establishment of 15 holding companies to own those mines; (iv) placing (by Ministerial Order) of all category 3 mines under direct supervision of the Ministry of the Coal Industry; 18 Market Liberalization (v) granting all corporatized coal mines special exporter status (by decision of the Cabinet of Ministers); (vi) abolition of price control (in particular, the price list system has been eliminated by Ministerial Order) except for category 3 mines which will be required to declare their prices to the Ministry of Economy; Budget Support (vii) establishment (by Ministerial Order) of a subsidy allocation mechanism that restricts subsidies to those mines in categories 2 and 3 that satisfy the following criteria: (a) prohibition of recruitment (except from other Category 2 or 3 mines in the same oblast and recruitment of faceworkers by Category 2 mines will not be restricted); (b) limitation of average increases in wage rates to the increase in the minimum wage rate specified in the Coal Industry Tariff Agreement; and (c) prohibition of investment;' (viii) establishment by Ministerial Order of a mechanism that provides budget support for investment only under the following conditions: (a) only Category 1 mines will be eligible for budgetary support for investment; (b) all support to be in the form of loans at the NBU discount rate; (c) all investments to have a minimum of 15 percent expected internal rate of return, confirmed by independent expert review, and to be accepted within the Government's public investment program; (d) at least 20 percent of investment cost to be funded from non-budgetary sources; 23/ The investment prohibition for mines which receive subsidies does not apply to expenses for: - normal mine development work required to prepare replacement faces and works required to assure health and safety of mineworkers; - replacement of parts and sub-assemblies of equipment essential for production; and - acquisition of a sufficient stock of parts and materials to ensure reliable and safe production in the short-run. 19 (e) no budget support for investment in new mines; 24 (ix) agreement between the Goverment and the Bank on the Government budget for the coal sector for 1997,5 including allocations for production subsidies, investment loans,26 physical costs of mine closure (including environmental mitigation), settlement of social liabilities, special social mitigation programs, and funding of social asset divestiture;' Social Mitigation (x) agreement with the Bank on mine closure procedures (including public announcement of mine closure) and satisfactory progress in the implementation of the closure plans, including commencement of the social and environmental mitigation measures, with respect to at least 20 mines which have ceased production and have been transferred to UDKR;28 (xi) Government take over of severance pay liability from mines undergoing labor restructuring; (xii) effectiveness of the Coal Pilot Project, and budgetary transfers to UDKR and the municipalities necessary for Coal Pilot Project functioning have been made; (xiii) satisfactory performance under the Coal Pilot Project with respect to the receipt of statutory cash benefits and free coal distribution by ex-mineworkers9; (xiv) putting in place monitoring mechanisms to assess social mitigation and social asset transfer; 24/ Where construction of new mines in the Government's investment program had already commenced by August 1, 1996 a review of those investments will be completed by end 1996 using the rate of return criterion described in Annex 2. Budget support for investment expenditures made after such review will be converted to a loan basis once the mine is operating. 25/ The assumptions used in the calculation of the 1997 budget for the coal industry are presented in Annex 3. 26/ The proposed investment allocation mechanism is described in Annex 2. 27/ The with-reform scenario (Table 3) reflects the agreed 1997 budget. 28/ In addition, the Government will ensure that the payment of statutory benefits, distribution of free coal and the establishment of satisfactory arrangements for continued access to social assets for laid-off, retired or disabled workers from these mines takes place within 60 days of loan effectiveness. This is reflected as a covenant in the loan agreement. 29/ Statutory cash benefits include back wages, severance pay, unemployment benefits, disability pay and pensions. Free coal is to be distributed to mineworkers leaving the coal industry involuntarily, mineworkers laid-off due to disability, families of workers killed in mine accidents, and coal industry pensioners. 20 Economy-wide Reform (xv) satisfactory macroeconomic performance. 55. The following measures will have been implemented prior to release of the second tranche: Sector Restructuring (i) signature of performance contracts (based on a model satisfactory to the Bank) for all category 2 and 3 mines (other than those which are leased); (ii) satisfactory progress on corporatization/privatization of non-core activities; Market Liberalization (iii) abolition of all restrictions on coal exports, except if an anti-dumping investigation has been initiated against Ukrainian coal exports;' Budget Support (iv) any investment support from the budget to have been consistent with the Ministerial Order establishing the conditions for such support (namely only Category I mines, loans at the NBU discount rate, minimum 15 percent rate of return, investment to be within PIP, at least 20 percent of investment costs to be from non-budgetary sources, and no investment in new mines). (v) Government expenditures in the coal sector to have been consistent with the agreed 1997 budget (both in aggregate and in composition); (vi) payables of mines in Categories 1, 2 and 3 not to exceed the level prevailing for August 1, 1996; Social and Environmental Mitiyation (vii) satisfactory progress in implementing social and environmental mitigation measures related to the 40 or more mines which will have ceased production and have been transferred to UDKR.3' This will require (a) implementation in a manner satisfactory to 30/ Under Ukrainian trade legislation, if a commodity is subject to an anti-dumping investigation initiated by an importing country subsequent export contracts must be reviewed by the Ministry of Foreign Economic Relations and Trade. Coal exports have not to date been subject to such an investigation. 311 Details of the mechanisms for monitoring and evaluation of social protection are provided in Annex 5. Environmental mitigation components of the Coal Pilot Project are expected to be evaluated by early 1997 (see para. 39 above). The environmental mitigation action plan to be adopted by second tranche release will include the development of sector-wide monitoring and evaluation systems under the supervision of UDKR. 21 the Bank of an action plan for social and environmental mitigation;32 (b) receipt of statutory cash benefits and free coal distribution by ex-mineworkers; (c) continued access to social assets by laid-off mineworkers; and (d) satisfactory progress on the physical closure of those mines. The evaluation of social protection will incorporate information from the social impact indicators outlined in the Government's Letter of Coal Sector Policy33; (viii) divestiture of the social assets of at least 100 mines and receipt by municipalities of funds budgeted for social asset transfer; Economy-wide Reform (ix) satisfactory macroeconomic performance. C. The Proposed Loan 56. Loan amount and borrower. The proposed Coal SECAL of US$ 300 million would be made to Ukraine represented by the Ministry of Finance. Disbursements under the proposed SECAL will be made to the National Bank of Ukraine (NBU), and an account (the "Deposit Account") of the Ministry of Finance established at the NBU for this purpose will be credited with the domestic currency equivalent at the official exchange rate of the day (which is defined in Ukraine as the rate determined by the latest currency auction). The Government will thereby receive non-inflationary budget support. The foreign exchange proceeds of the proposed SECAL will be sold by the NBU or will be held in reserves, in accordance with the objectives of monetary policy. The loan will be payable over seventeen years, including five years of grace, at the variable LIBOR-based interest rate for US$ single currency loans. 57. Loan management. Loan administration will be the responsibility of a loan manager employed by the Ministry of Finance, in view of the budgetary support nature of the loan (see para. 51 on MCI's management of the program of sector reforms). The loan manager will be responsible for preparing the withdrawal applications, maintaining the Deposit Account and arranging for its timely audit (if requested by the Bank), and monitoring overall loan implementation. The loan manager will also be responsible for coordinating the preparation of the Borrower's contribution to the Implementation Completion Report and for writing those sections relating to loan administration, while the MCI will write those sections concerning implementation of the LCSP. 32/ Such an action plan is to be formulated by February 28, 1997, drawing on the preliminary lessons from implementation of the Coal Pilot Project. This is reflected as a covenant in the loan agreement. 33/ The social impact indicators which are being monitored include (i) receipt of severance pay, back wages, disability payments, unemployment benefits, pensions, and free coal by beneficiaries; (ii) availability of training, job search and pre-redundancy counselling, and employment services; (iii) availability of an adequate level of health and education services, housing maintenance, heating and utilities; (iv) individual worker notification of mine closure and employment status, availability of public information on sector restructuring and social protection; (v) effectiveness of public works, reemployment support, and microcredit programs; (vi) adequacy of UDKR's implementation capacity. 22 58. Disbursements. Upon notification by the Bank of loan effectiveness and of second tranche release, the proceeds of the first and second tranche respectively of the loan will be deposited by the Bank in the Deposit Account at the request of the Borrower. If after deposit in this account the proceeds of the loan are used for ineligible purposes (e.g. to finance items imported from non-member countries, or goods and services on the Bank's standard negative list), the Bank will require the Borrower to either (a) return that amount to the account for use for eligible purposes, or (b) refund the amount directly to the Bank (in which case the Bank will cancel an equivalent undisbursed amount of the loan). In accordance with the Operational Directive on the Simplification of Disbursement Rules under Structural Adjustment and Sectoral Adjustment Loans (February 8, 1996) disbursements will not be linked to specific purchases, and hence there will be no procurement requirements. 59. Repor*ing, Accounting, and Auditing. Although routine audit of the Deposit Account will not be required, the Bank reserves the right to require audits at any time. 60. Closing date. The closing date of the proposed loan will be December 31, 1997. 61. Environmental category. The loan is in category B for the purposes of OD 4.01. The Letter of Coal Sector Policy (and second tranche conditionality) includes the extension of environmental management practices applied under the Coal Pilot Project to all mine closures. 62. Poverty Category. The proposed SECAL underpins Government policies to mitigate the social impact of coal sector restructuring through timely settlement of social liabilities, funding of social asset transfer and special social mitigation programs in coal mining oblasts. The proposed SECAL is therefore a poverty-focussed operation. D. Benefits and Risks 63. Benefits. The loan will allow the implementation of the first stage of a reform program for the coal sector which will reduce the need for fiscal subsidies through productivity enhancement and through addressing urgent social issues. It will also facilitate the reemployment of currently wasted resources in more productive uses elsewhere in the economy, and will do so in a manner which minimizes the social costs of adjustment. Implementation of this first stage of reform will make a substantial contribution towards the medium-term goal of creating a more efficient coal sector, attractive to private capital and no longer dependent on fiscal or quasi-fiscal support. 64. Without the loan, (i) the coal sector will represent a permanent threat to macroeconomic stability; (ii) high-cost mines will continue to be a burden on the more efficient mines if the cross-subsidy system is reinstated; (iii) payment arrears will continue to accumulate creating hardship for the workforce and undermining adjustment in the rest of the economy; and (iv) the accumulation of coal sector receivables will continue to soften the budget constraint on the important power and steel sectors thereby delaying those sectors' restructuring. Effective reform of the coal sector will also send a strong signal to the rest of the economy of the Government's resolve to harden budget constraints for state-owned enterprises to promote restructuring and a competitive market orientation, which in turn will promote economic growth and underpin macroeconomic stabilization. 65. Risks. The principal risk is loss of policy commitment by the Government in the face of resistance by coal industry lobbies with vested interests and by labor unions representing those who bear 23 the social costs. This risk is particularly pronounced because (i) the costs of adjustment are highly concentrated amongst those who depend on the coal industry while the benefits are diffused through the Ukrainian population at large; and (ii) the extent of the adjustment required is such that the restructuring process will be prolonged. 66. The consequence of a loss of commitment would be a diversion of budgetary subsidies from restructuring of the industry to the maintenance of output and employment, upward pressure on the budget overall, and continued loss of potential GDP. Alternatively, there could be pressure for import protection (particularly if the real exchange rate continues to appreciate) which would retard the restructuring process in even the more viable mines. 67. This risk of policy reversal will be mitigated to some extent by (i) social protection and employment creation measures to minimize the social costs of adjustment; (ii) an effective public information and participation program to raise awareness both of social protection measures and of the costs of continued coal sector subsidies borne by the rest of the population; (iii) firm implementation of coal sector reform such that productivity and profitability gains are apparent early in the adjustment process (thereby fostering support in the viable core of the industry for the restructuring process); (iv) timely financial assistance from the Bank; and (v) the resumption of economic growth in Ukraine, through the implementation of stabilization and overall structural reform, supported by the Bank and the Fund. However, the risk remains significant. 68. The factors which create a risk of policy reversal also create a risk of negative publicity for the Bank. However, this will be mitigated by (i) the extent of Government ownership of the restructuring program; and (ii) public information concerning the social mitigation aspects of the restructuring program (the Coal Pilot Project is financing the formulation of a public information strategy for MCI and UDKR). 69. There is a risk of inadequate institutional capacity to implement the program. This will be mitigated by technical assistance financed by the UK Know How Fund, USAID, EU TACIS and the proposed Bank Coal Pilot Project (as well as the possible follow-on Coal Restructuring Project), and by intensive supervision of the proposed Coal SECAL. PART V: Recommendation 70. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and I recommend that the Executive Directors approve it. James D. Wolfensohn President by Caio K. Koch-Weser Attachments: Washington, D.C. November 15, 1996 Annex 1 Transmittal Letter KABIHET MIHICTPIB YKPAIHH I6 ;epec- IF 6p. Y,.62-2547/Y rIaHy )KefMCy cy.ByiB4eHCOHy rIpe3RzeHTy MixcHapoaHoro 6aHKy peKOHCTPYKUii Ta pO3BH4TKY IIlaHOBHIH riaHe Byjib4eHcoH! 3asqBa, sKa HazaETbCA, npo cTpaTeriuo y ByriTiTHiM iIpoMHcJIo- BOCTi, BHI3HatIaE nporpaMy peC)OpM B YKpaiHi. HaMipamI nporpaMI 40ijI, 51K ripBegeHi B 3asBi, e 3ztiflCHeHHA cTpyKrypHol riepe6y,aoBs ByrIJlBHO1 IIpOMHCJIOBOCTi i IIOM'AIKieHHA ii COUiJaIhHHX HaCJW,KdB. Mu 3BepTaEMOC51 Llo MixHapoxlHoro 6aHKy 3 IIpOXaHH51M IIpO HaD;aHH5I 3af4MY Ha cTpyKrypHy niepe6yzLoBy B pO3Mipi 300 MiTnA4oHiB aonapiB CLIA zmIA riiz;puimEi uief uiporpaM. 3 noBaroio rpeM'ep-MiHiCTp YKpauHr aBIO JIa3apeHKo lpapsO02 9/13/96 UIK 4 Annex 1 Page 1 of 5 GOVERNMENT OF UKRAINE Letter of Coal Sector Policy 1. Since late 1994, the Government of Ukraine has been undertaking a comprehensive stabilization and structural reform program. This program aims to overcome the economic crisis, reduce inflation, and restore economic growth. This will be achieved through a combination of fiscal prudence and monetary restraint, combined with measures to promote economic efficiency. These measures are aimed at enhancing the role of competitive markets in the Ukrainian economy by trade and price liberalization, privatization, private sector development, and restructuring of the public sector, while improving the effectiveness of the social safety net for the most vulnerable groups in the adjustment process. 2. The achievement of stabilization and general structural reform will be necessary for the success of coal sector reform. Low inflation, liberalization and an increased role for the private sector will all be essential for the restoration of economic growth and employment creation. Overall fiscal restraint will free up budgetary resources for more effective targeting of social protection and for financing coal sector restructuring costs. 3. In turn, the reform program underway in the coal sector is supportive of the objectives of the overall stabilization and structural reform program. The coal sector reform will reduce the long-term need for subsidies through productivity enhancement and through addressing urgent social issues. It will also facilitate the reemployment of currently underutilized labor and capital in more productive uses elsewhere in the economy, and will do so in a manner which minimizes the social costs of adjustment. Implementation of this first stage of reform will make a substantial contribution towards the medium-term goal of creating a smaller, more efficient coal sector, attractive to private capital and no longer dependent on state support. The economically viable part of the coal industry will thereby be preserved. 4. The main directions of the Government coal sector reform program are outlined in Decree of the President of Ukraine of February 7, 1996, No. 116 "On Coal Industry Restructuring". The objectives of the coal sector reform program will be pursued through market liberalization and the promotion of competition, restructuring and privatization, a market-focused investment policy, closure of unviable mines (including environmental mitigation), mitigation of the social costs of restructuring, and the redirection and reduction of subsidies. A. Market Liberalization and the Promotion of Competition 5. The Government believes that efficiency in the coal sector can be substantially increased only through a process of market liberalization and enhanced competition. The regional offices of the coal trading organization, Uglesbyt have been divested into separate entities, and the remaining part of the company (recently renamed Ukruglresource) no longer enjoys any monopoly rights in coal marketing; all corporatized coal enterprises are free to market coal to any customer at prices which are freely negotiated between buyer and seller. 6. The use of accounting prices to cross-subsidize high-cost mines at the expense of low-cost mines has been abolished, which will significantly enhance incentives for cost reductions. Similarly, the Government is committed to maintaining protection from imports at only modest levels in order not to undermine the drive to improve efficiency in the Ukrainian coal sector; coal import taxes will not be Annex 1 Page 2 of 5 raised from their current level nor will quantitative restrictions be imposed on coal imports. At the same time, the objective of penetrating export markets will be pursued by the abolition of all restrictions on coal exports. B. Restructuring and Privatization 7. All 276 mines have been divided into four categories. Mines which are currently profitable have been placed in Category 1 and will receive no subsidies. This will create the preconditions for privatization in the medium term. Category 1 includes 76 mines. The 200 mines currently making losses will either be closed immediately or will be subsidized on a temporary basis. These mines have been divided into: (a) Category 2 mines which are potentially profitable and which will be allowed one year to regain viability and graduate to Category 1 (105 mines); (b) Category 3 mines which are scheduled for closure in the medium term unless they can undertake sufficient improvements in profitability to demonstrate viability (75 mines); and (c) Category 4 mines which are scheduled for immediate closure (20 mines). 8. The Category 1 and 2 mines will be corporatized and placed under 15 state-owned holding companies (which will also include coal washing plants and marketing enterprises and other core activities). Category 3 mines will be supervised by newly-created divisions of the Ministry of the Coal Industry (MCI) at the oblast level. Category 4 mines will cease production and be transferred to the closure agency, UDKR. 9. The allocation of the temporary production subsidies for specific Category 2 and 3 mines within the budgetary ceiling determined for each oblast will be decided by MCI. Subsidy allocations will be based in particular on (i) current production costs; (ii) market value of coal; and (iii) changes in geology, mine infrastructure, and labor productivity. Mines receiving subsidies will be prohibited from investment and recruitment (except for (a) transfers from other Category 2 and 3 mines under the same oblast-level division of MCI and (b) faceworkers recruited by Category 2 mines), and average increases in wage rates will not exceed the minimum level consistent with the Coal Industry Tariff Agreement. 10. In order to minimize the need for subsidies and to enhance productivity, employment contracts for managers of Category 2 and 3 mines will provide for performance-related remuneration. The Government is committed to having at least 50 percent of the performance contracts signed by January 1, 1997. The incentive payments will be based on the difference between (i) actual subsidies and budgeted subsidies; and (ii) payables at the beginning and the end of the year. 11. As an alternative option for Category 3 mines, a mechanism has been established for leasing mines to employees, mine management, or other private parties. The Government recognizes that employment reductions and the settlement of wage arrears may be necessary to attract lessees. At commencement of the lease, accumulated payables and receivables will be disposed of through a debt restructuring process (the Government will assume the social liabilities). A leased mine would not be eligible for fiscal support after commencement of the lease. MCI will seek technical assistance to design and implement the debt restructuring and leasing processes. 12. Movement between categories will be possible, but only if mines which transfer conform to the requirements of the new category. A mine moving from Category 1 to Category 3 will thus be eligible for subsidies but will not be allowed to recruit new workers, undertake investment, or pay salary increases above the minimum. A mine moving from Category 2 or 3 to Category 1 will no longer be Annex 1 Page 3 of 5 eligible for subsidies but will be allowed to invest, and will have autonomy over wage and recruitment policy. Category 2 will cease to exist one year after the original division of mines into categories and no movement into Category 2 will be permitted during that year; mines still in Category 2 at the end of the year will be distributed between Category 1 and Category 3 depending on whether they are profitable or not. 13. In order to enhance coal sector efficiency and reduce costs, all non-core activities (machine building, transport, construction etc.) will be divested and privatized by end-1997. Social assets of the coal industry will be progressively transferred to local government administration or will be privatized (see below). C. Market-focused Investment Policy 14. The Government wishes to promote investment in viable mines that have good geological and economic prospects in order to increase their productivity and improve their health and safety records. The Government's coal sector investment policy is to maximize private sector participation and minimize budgetary outlays, in order to ensure that investment choices are based on profitability and that Government funds are not exposed to excessive risk. However, substantial private capital inflows to the coal sector are not expected in the near term; therefore Government investment policy focuses on stemming the decline in productivity in profitable mines while creating conditions attractive to private capital. Any investment support from the Government will be provided within the Government's overall public investment program and will be in the form of loans to mines from the Government budget at the National Bank of Ukraine discount rate. Such investment will be primarily focussed on enhancement of capacity utilization in existing mines. Budget support will not be available for commencing new mine construction; where construction of new mines in the Government's investment program had already commenced by August 1, 1996 a review of those investments will be completed by end 1996. Budget support for investment expenditures made after such review will be converted to a loan basis once the mine is operating (on the same interest rate and repayment terms as for other mines). D. Closure of Unviable Mines 15. In order to reduce the heavy burden that uneconomic mines place on both viable mines and on the Ukrainian taxpayer, the Government plans to close these mines at a minimum rate of 20 per year. Mine closure will be managed by UDKR. An integral part of this mine closure element of the program is implementation of a plan for mitigation of the social and environmental consequences of mine closure in accordance with the guiding principles outlined in paragraph 17 and Section E of this Letter. Mines will be closed only after the necessary capacity to provide social and environmental mitigation is in place. Before a mine is closed, a closure plan, which will include appropriate social and environmental mitigation measures to be implemented with respect to that mine, will be adopted. The liabilities and assets of closing mines will be placed into the hands of a liquidation commission (appointed by MCI) for disposal. 16. The phasing of mine closures is intended to spread the social costs over time. In general, the mines with the highest financial losses will be closed earliest. However, in certain cases those mines are highly concentrated geographically; in such cases, sequencing of closures will be necessary on social grounds. The Government places a very high priority on the mitigation of the social costs of mine closure that are borne by mineworkers and their communities. Annex I Page 4 of 5 17. The Government will ensure that mines are closed in an environmentally sound manner, and that the implementation capacity of UDKR is adequately developed for that purpose. The Coal Pilot Project currently underway for three mine closures will yield lessons for environmental management practices as regards shaft-filling, control of emissions, fire hazards, water quality control, safety of storage sites and abandoned buildings, erosion from tailing piles, subsidence and land reclamation. These lessons will be applied to the sector-wide mine closure program, and the plan for closure of each mine will include environmental analysis. E. Mitigation of the Social Costs of Restructuring 18. The Government has assumed the liability for the statutory minimum severance pay for layoffs of workers in the context of either mine closure or labor force downsizing. In addition, the Government has taken over the liability for disability payments for mines to be leased or closed. In the case of mine closure, the Government will also take over any liability for settlement of wage arrears. These measures will provide an immediate social safety net for mineworkers leaving the industry. The cost of free coal distribution to coal industry pensioners will also be assumed by the Government. 19. In addition to the Government's takeover of these social liabilities, special social mitigation programs funded by the Government budget are being established in all coal mining oblasts to enhance the social safety net and promote employment creation for ex-mineworkers and for their communities. As these programs evolve, they will draw in particular on the experience gained in Donetsk oblast under the Coal Pilot Project, which includes labor-intensive public works, job search and pre-redundancy counseling, reemployment support, microcredit for small businesses, and free coal for ex-mineworkers. 20. Mines currently own substantial social assets (principally in the form of housing and kindergartens but also including health and recreational facilities). They will be fully transferred to municipal administration or be privatized by mid-1998. In cases where cost recovery for services transferred to the municipalities is less than 100 percent, the municipalities will receive budgetary transfers to cover the shortfall until full cost recovery is reached. In the case of mine housing transferred to municipalities, a central government budget allocation will be provided in view of the extreme dilapidation of much of this housing. 21. Mechanisms for social impact monitoring and extensive public participation are being reinforced to ensure that consultation with affected parties is maximized and that social protection programs are indeed reaching the intended beneficiaries. The social impact indicators which are being monitored include (i) receipt of severance pay, back wages, disability payments, unemployment benefits, pensions, and free coal by beneficiaries; (ii) availability of training, job search and pre-redundancy counselling, and employment services; (iii) availability of an adequate level of health and education services, housing maintenance, heating and utilities; (iv) individual worker notification of mine closure and employment status, availability of public information on sector restructuring and social protection; (v) effectiveness of public works, reemployment support, and microcredit programs; (vi) adequacy of UDKR's implementation capacity. F. Redirection and Reduction of Subsidies 22. The system of cross-subsidies which reallocated revenues from low-cost mines to subsidize high- cost mines has been abolished; this abolition is intended to promote productivity increases in both low- Annex 1 PageS5of 5 cost and high-cost mines. Some of the former recipients of the cross-subsidies, namely the Category 2 and 3 mines, will now need to receive production subsidies from the Government budget, pending closure or the attainment of profitability (and consequent graduation to Category 1). However, it is essential to both fiscal stability and to the enhancement of efficiency in the coal sector that these subsidies are phased out rapidly; this will occur through cost-cutting measures including mine closure, employment reduction, and efficiency improvements induced by the performance contract mechanism. The budget will also temporarily fund a modest level of investment (on a loan basis) in Category 1 mines primarily to enhance capacity utilization. 23. There will also be substantial restructuring costs to be borne by the budget over the medium term. These will include: (i) special social mitigation programs; (ii) physical cost of mine closure (including environmental mitigation); (iii) settlement of social liabilities (severance pay, disability payments, free coal and wage arrears for closing mines and mines to be leased, and free coal distributions to coal industry pensioners); and (iv) compensation to municipalities for social asset transfer. 24. In order to reinforce financial discipline, the Government will take measures to ensure that there is no increase in real terms in the total payables and receivables of mines in categories 1, 2 and 3 from the levels prevailing for those mines at August 1, 1996. This will be achieved through a combination of bankruptcy proceedings, the performance contract mechanism and improved financial discipline amongst coal industry customers and suppliers (in particular the power sector). UKRAINE COAL SECAL POLICY MATRIX ISSUE MEASURES ALREADY TAKEN MEASURES TO BE TAKEN BEFORE SECOND l _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ T R A N C H E Macroeconomic Satisfactory implementation of the stabilization program. Continued implementation of the stabilization program. Stabilization Market Liberalization Coal trading demonopolized Abolition of all restrictions on coal exports (except for prevention of dumping). Cross-subsidies eliminated Granting all corporatized coal mines special exporter status. Abolition of price control (except for category 3 mines which will be required to declare their prices to the Ministry of Economy). Restructuring and Division of all mines into four categories: Signature of performance contracts for (based on a model Privatization satisfactory to the Bank) all category 2 and 3 mines (other than 1. profitable mines; those which are leased). 2. potentially profitable mines which are Satisfactory progress on corporatization/privatization of non- allowed one year to demonstrate their core activities. viability; 3. non-viable mines for which closure plans are under preparation and which will be eventually transferred to UDKR; 4. non-viable mines for immediate transfer to UDKR. UKRAINE COAL SECAL POLICY MATRIX Establishment of a subsidy allocation mechanism that restricts subsidies to those mines in categories 2 and 3 that satisfy the following criteria: (a) prohibition of recruitment (except from other category 2 or 3 mines in the same oblast and recruitment of faceworkers by Category 2 mincs will not be restricted); (b) limitation of average increases in wage rates to the increase in the minimum wage rate specified in the Coal Industry Tariff Agreement; (c) prohibition of budget support for investment. Initiation by Ministerial Order of performance contract system for category 2 and 3 mines and of leasing arrangements for category 3 mines. Corporatization of all mines in categories I and 2, and establishment of 15 holding companies to own those mines. Placing all category 3 mines under direct supervision of the Ministry of the Coal Industry. Closure of Unviable Mines Coal production ceased in 24 mines and 20 of those mines were transferred See "Mitigation of Social and Environmental Costs" below. to UDKR. Agreement with the Bank on mine closure procedures (including public announcement of mine closure). See "Mitigation of Social and Environmental Costs" below. UKRAINE COAL SECAL POLICY MATRIX Investment in Viable Mines Establishment by Ministerial Order of a mechanism that provides budget Any investment support from the budget to have been consistent support for investment only under the following conditions: with the Ministerial Order establishing the conditions for such support (namely only Category I mines, loans at positive real (a) only Category I mines will be eligible for budgetary interest rates, minimum 15 percent rate of return, investment to support for investment; be within PIP, at least 20 percent of investment costs to be from non-budgetary sources, and no investment in new mines). (b) all support to be in the form of loans at the NBU discount rate; (c) all investments to have a minimum of 15 percent expected internal rate of return, confirmed by independent expert review, and to be accepted within the Government's public investment program; (d) at least 20 percent of investment cost to be funded from non-budgetary sources; (e) no investment in new mines. Mitigation of Social and Coal Pilot Project approved by Board. Satisfactory progress in implementing social and environmental Environmental Costs mitigation measures related to the 40 or more mines which will Liability for disability payments in closing mines transferred to Social have ceased production and have been transferred to UDKR. Insurance Fund. This will require (a) implementation in a manner satisfactory to the Bank of an action plan for social and environmental Satisfactory progress in the implementation of the closure plans, including mitigation; (b) receipt of statutory cash benefits and free coal commencement of the social and environmental mitigation measures, with distribution by ex-mineworkers; (c) continued access to social respect to 20 mines which have ceased production and have been transferred assets by laid-off mineworkers; and (d) satisfactory progress on to UDKR; physical closure of those mines. Government take over of severance pay liability from mines undergoing labor restructuring. Divestiture of the social assets of 100 mines and receipt by municipalities of funds budgeted for social asset transfer Declaration of effectiveness of the Coal Pilot Project, and budgetary transfers to UDKR and the municipalities necessary for Coal Pilot Project functioning have been made. Satisfactory performance under the Coal Pilot Project with respect to the payment of statutory cash benefits and free coal distribution to ex- mineworkers and their families. Putting in place monitoring mechanisms to assess social mitigation and social asset transfer. UKRAINE COAL SECAL POLICY MATRIX Redirection and Reduction of Agreement between the Govemment and the Bank on the Government Govemment expenditures in the coal sector to have been Subsidies budget for the coal sector for 1997, including allocations for production consistent with the agreed 1997 budget (both in aggregate and subsidies, investment loans, physical costs of mine closure (including in composition). environmental mitigation), settlement of social liabilities, special social mitigation programs, and funding of social asset divestiture. Payables of mines in Categories 1, 2 and 3 not to exceed the level prevailing for those mines at August 1, 1996. Annex2 Page 1 of 2 Investments for Coal Production The Government has decided to allocate in the budget a credit program to finance investments for coal production in mines which do not receive production subsidies. The total amount allocated for such credits will be determined as follows. From the total budget support to the coal sector, which is limited. by macro-economic considerations, the following allocations to the coal sector will be deducted with priority: (a) funds for closing depleted and uneconomic mines, including their social and environmental mitigation; (b) payment of social liabilities and operation of social assets; and (c) temporary operating subsidies for Category 2 mines. The remainder of the total budget allocation to the coal sector is available for state credit financing of investments in mines which do not receive production subsidies if there are sufficient economically justified projects. The Credit Program The objectives of the program are to increase efficiency and reliability and to decrease costs of coal production. The program has the following main characteristics: The program will finance the improvement of utilization of existing production capacity and safety; No financing will be made available under the program for the construction of new mines;' Only mines which do not receive production subsidies will be eligible for credits under the program. Credit Terms A credit to an eligible mine for an approved investment proposal would be made available under the following terms: The maximum credit amount will not exceed 80 percent of the costs of the investment project. The remainder of the project costs shall be financed from the mine's own funds, private investors, local commercial banks, foreign lending institutions etc. without Ukrainian Government financing or guarantees. Funds from the Credit Program will be only disbursed after other funds to finance the project have been secured; Starting with the first disbursement, the mine shall pay interest, calculated monthly at the National Bank of Ukraine interest rate; The mine shall repay the credit, after a three-year grace period, in equal semi-annual rates over a period not to exceed 10 years; 1 Where construction of new mines in the Government's investment program had already commenced by August 1, 1996 a review of those investments will be completed by end 1996 using the rate of return criterion described below. Budget support for investment expenditures made after such review will be converted to a loan basis once the mine is operating (on the interest rate and repayment terms below). Annex2 1!3= 2 of 2 If the mine is part of a parent organization (association, holding company, mining company), then such organization shall guarantee the payment of interest and principal; In the event of a default of a mine or parent organization on servicing the debt, all disbursements from the Credit Program to such mine or organization will be suspended. Credit Application and Approval Project proposals and credit applications must be submitted by interested mines to the Ministry of Coal Industry. The following criteria will be applied for selecting proposals: The internal rate of return of the project. The minimum qualifying return shall be not less than 15 percent. In selecting projects, priority will be given to the highest internal rate of return; The quality of the mine's business plan to be submitted with the project proposal. The business plan must contain, inter alia, marketing arrangements for the mine's total coal output and managerial/organizational changes to improve the mine's financial results; The mine's financial and operational track record; The Ministry of Coal Industry will pre-select submitted project proposals on the basis of these criteria. The following procedures will be followed to obtain credit approval for a pre-selected proposal: Independent experts, including banks and other organizations with lending experience in the coal industry, will appraise the proposal. The independent experts may request clarifications and recommend modifications; Each proposal endorsed by the independent experts and MCI will be submitted for approval to the Ministries of Economy and Finance; The Ministries will assess: (a) the validity of the individual project justification; and (b) the consistency of the project with the Government's overall public investment program; Detailed procedures regarding credit application, processing and approval, as well as monitoring and reporting requirements, will be laid down in a manual prepared by MCI and approved by the Ministries of Economy and Finance. Annex 3 Pare 1 of S Technical Note on Budgetary Projections This note has been written as part of the preparation of the Ukraine Coal Sector Adjustment Loan (Coal SECAL). It is intended to outline projections of budgetary support for the coal sector through the year 2004 and the key assumptions behind those projections. The timing of measures assumed in these projections is based on Decree 116/96 outlining the main directions of the Govermnent's sector reform program and on the SECAL conditionality. Table 1: The "With-reform" Scenario ...i.E---- E-.E-- : -:-:-L - :y :i- :.: h.-...:--. ...... .... ....,# 1YM- 4 '8. : , 0, : . . . 0--1,-00-- i. . .. Production Subsidy' 638 468 270 214 89 0 0 0 0 Net Investment Loans 31 32 107 106 III -7 -74 -95 -95 Special Social 10 37 49 51 85 61 7 7 7 Mitigation Progranms _ Physical Cost of Mine 27 100 72 83 73 35 0 0 0 Closure Serance Pay 7 16 14 17 34 3 3 3 3 Wage Arrears for Closing & Leaed Mines 12 26 12 0 0 0 0 0 0 Disability Payments for Mines to be Closed 15 42 50 68 91 107 114 121 127 or Leased Free Coal for Coal Industry PenBioners 0 32 33 33 34 35 36 37 38 Social AsetTransfer 75 42 13 0 0 0 0 0 0 TOTAL 815 794 620 572 517 233 86 73 80 E. Y w ,-; ..' ...'..'..... .-..'t,: - -S ,- i, -,0X t-iA Production Subsidy 118 89 51 41 17 0 0 0 0 Net Investment Loans 6 6 20 20 21 -1 -14 -18 -18 Special Social Mitigation Progranms 2 7 9 10 16 12 1 1 1 Physical Cost of Mine Closure 5 19 14 T 16 14 7 0 0 0 1 Severance Pay 1 3 3 3 7 1 1 1 1| Wage Arears for Closing & 2 5 2 0 0 0 0 0 0 Leased Mines Disability Payments for Mines to be Closed 3 8 10 13 17 20 22 23 24 or Leased Free Coal for Coal Industry Pensioners 0 6 6 6 6 7 7 7 7 Social AwetTransfer 14 8 21 0 0 0 0 0 0 TOTAL 151 151 118 109 98 44 16 14 1S I/ The 1996 production subsidy figure represents the amount budgeted. It is projected to fall short of the amount actually needed in the with-reform scenario by US$ 213 million or Krb. 39 trillion (0.5 percent of GDP), which will lead to a corresponding increase in the net payables position of the coal industry. Annex 3 Page 2 of 5 Microeconomic Assumptions 1. Production subsidy. The production subsidy projection is based on detailed financial analysis of the =c^a industry using mine-by-mine data. The mines are divided into four categories. Mines which are profitable have been placed in Category 1 and will receive no subsidies. Category 1 includes 76 mines. Mines currently making losses will either be closed immediately or will be subsidized on a temporary basis. These mines have been divided into: (a) Category 2 mines which have the lowest losses and which will be allowed one year to undertake sufficient improvements to graduate to Category 1 (105 mines). It is estimated that Category 2 mines will be redistributed equally between Categories I and 3 at the end of the year; (b) Category 3 mines which are scheduled for closure at the rate of 17-26 mines per year unless they can undertake sufficient improvements in profitability to demonstrate viability (75 mines); and (c) Category 4 mines which are scheduled for immediate closure ( 20 mines). 2. More specifically, real wages are assumed to increase by 4 percent per annum in Category 1 mines, and to remain constant for other categories. Non-labor input costs are assumed to be 70 percent fixed and 30 percent variable. Since variable costs represent mainly internationally traded goods (such as electricity), this part of the non-labor input costs is assumed to increase by only half of the consumer price index increase in Ukraine in view of the projected real appreciation of the exchange rate (see macroeconomic assumptions table). Other non labor input prices are assumed to increase at the same rate as the consumer price index. In 1997, it is assumed that there will be a one-time decrease of about 21 percent in non-labor input costs in connection with the separation of non-core activities and the merger of production associations into a reduced number of holding companies. Assumptions for output, prices, and employment reductions are given below. 1996 11997 1998 1999 2000 2001 2002 2003 2004 output (million tonnes) 75 80 82 79 78 80 83 88 92 price per tonne 26 27 28 28 29 30 31 31 32 employment reduction (%) 15 17 13 14 26 6 6 6 6 3. Net investment loans. Only Category 1 mines will be eligible for loans from the budget for investment expenditures which enhance capacity utilization subject to certain criteria (primarily a minimum internal rate of return of 15 percent). Because of the large investment backlog, it is assumed that all Category 1 mines will apply for investment loans in 1996 and 1997, for an average credit amount of US$ 6.5 million per mine (in line with the debt servicing capability of the mines and with MCI's estimates of investment needs). It is further assumed that the 53 mines which graduate from Category 2 to Category 1, and Category 1 mines which didn't receive loans in 1996 or 1997 will apply for loans from 1998 to 2000 (also for an average credit amount of US$ 6.5 million). It is assumed that the approval rate will increase over time (from 22 percent in 1996-1997 to 61 percent in 1998-2000). Investment lending commitments from the budget cease in 2000. Loans will finance a maximum of 80 percent of investment costs in each case. All credits are assumed to be disbursed during a three-year grace period and repaid over the following ten years (with a 10 percent default rate). The interest rate is assumed to be 7 percent per annum on the dollar value of the credit. 4. Special social mitigation programs. Workers leaving the mines will be eligible for special social mitigation programs. In the context of the Coal Pilot Project such programs have been costed and are being tested. It is assumed for budgetary purposes that the cost per worker of the pilot programs can be generalized for all workers leaving the mines involuntarily. This represents US$ 1200 per worker disbursed over a two-year period. It is assumed that involuntary departures in 1996 begin to benefit from the special social mitigation programs in the last quarter of 1996. Projections of involuntary departures (from closing and downsizing mines) are given below. Annex 3 Page 3 of 5 1" 19C l97 MS99 1 l99 20002 2001 1-2002 j2003 2004 |involuntary 17279 35861 29043 31367 59232 3139 2948 2770 260 |departure 5. Physical cost of mine closure. It is assumed that mines will be closed at a rate of 17-26 per year. Th cost of physical closure (i.e. including environmental protection costs but excluding social mitigation costs) per mine i assumed to be US$ 3.0 million disbursed over 1.5 years (of which about US$ 400,000 are for environmental mitigation) Costs for pumping additional water from mines in the vicinity of closing mines are assumed to be borne by the operatin, budget of the affected mines (this is estimated at US$ 1.4 million per mine closure) rather than being included in th closure costs. 6. Severance pay. It is assumed that all workers leaving the coal industry involuntarily will have severanc pay funded from the budget according to their legal entitlement (namely three months wages - currently about US$ 131 per month). 7. Wage arrears for closing and leased mines. It is assumed that the budget will pay wage arrears for al workers who are dismissed as a result of mine closures. It is also assumed that the budget will take over th responsibility for wage arrears in the case of mines to be leased, in order to make the mine sufficiently attractive fo lessees. It is further assumed that ten mines will be leased in 1997 and five per year thereafter through 2000. 8. Disability payments. It is assumed that the budget will take over the responsibility for disability payment (as well as free coal to disabled ex-mineworkers) in the cases of mines to be closed or leased. 9. Free coal for coal industry pensioners. The budget is to take over the cost of distributing coal free o charge to pensioners (from the coal mines) who do not have access to district heating. On average, this entitlement i: 3.4 tons per person per year (costed at US$ 35 per ton in 1996 prices) for 260,000 retired pensioners. 10. Social asset transfer. Social assets are to be fully transferred to municipalities by mid 1998. Municipalitie4 will receive exceptional central budget transfers in 1996 (the necessary amount has already been allocated), 1997 and thi first half of 1998 targeted to cover (i) operating losses until such time as 100 percent cost recovery is achieved (assume( to be end-1996 for housing and beyond 1998 for kindergartens); (ii) deferred maintenance for housing equivalent to 3( percent of operating costs; and (iii) the cost of capital repairs. Beyond mid 1998 municipalities will fund theii expenditures on these social assets out of general revenue (or will privatize the assets). 2/ The jump in involuntary departures in 2000 reflects the fact that the last subsidized mines will close in 2001; therefore the policy of allowing transfers from closing mines to other subsidized mines (which are not to be closed for some time) will cease in 2000. Annex 3 Page 4 of5 Macroeconomic Assumptions 195 196 1997 19_ 1_9 2000 2001 2002 2003 2004 inflation (c.p.i.) 379 48 20 12 10 9 8 7 6 5 economy-wide real wage (index) 100 107 114 123 131 140 150 160 172 184 real exchange rate (% change: + means appreciation) 40 5 17 9 7 6 5 4 3 2 Nominal exchange rate (Kbv. thousand\US $) 147 185 190 190 190 190 190 190 190 190 total budget expenditures (Kbv. trillions) 2451 3451 4232 4865 5572 6244 6982 7747 8426 9144 nominal GDP (Kbv. quadrillions) 5.1 7.5 9.4 11.4 13.4 15.5 17.7 19.9 22.1 24.4 The "Without-reform" Scenario 11. The without-reform scenario differs from the with-reform scenario in the following respects: (i) coal production declines by 14 percent over the period 1996-2004; (ii) real wages increase at 4 percent per annum in all categories; (iii) employment decreases by 10 percent per annum; (iv) category 2 mines receive subsidies indefinitely; (v) no mines are closed or leased; (vi) neither non-core activities nor social assets are divested; (vii) associations are not transformed into holding companies; (viii) there is no Government budget responsibility for special social mitigation programs, physical costs of mine closure, severance pay, wage arrears, disability pay, free coal, or social asset transfer; (ix) investment support from the budget is on a grant basis. Annex 3 Page 5 of 5 The without reform projections are given below: Table 2: The "Without-reform" Scenario _____ _____ _____ IJUSt million Y ear t9600000000 tl00000000009700000000:0000000-,40 9Rfi '9 'tS'000000 F:00OIE;it '02t"0: '03' - '04'.t..t. jt 004 0XiA Production Subsidy 784 1130 1319 1487 1650 1792 1918 2109 2210 InvestmentGrant 31 32 120 137 150 67 0 0 0 Special Social Mitigation Programs 0 0 0 0 0 0 0 0 0 Physical Cost of Mine Closure 0 0 0 0 0 0 0 0 0 Severance Pay 0 0 0 0 0 0 0 0 0 Wage Arrears for Closing & Leased Mines 0 0 0 0 0 0 0 0 0 Disability Payments for Mines to be 0 0 0 0 0 0 0 0 0 Closed or Leased Free Coal for Coal Industry Pensioners 0 0 0 0 0 0 0 0 0 Social Asset Transfer 0 0 0 0 0 0 0 0 0 TOTAL3 815 1162 1439 1624 1800 1859 1918 2109 2210 Year '96 '9 9 9 0 0 0 0 04 Production Subsidy 145 215 251 283 313 341 364 401 420 Investment Grant 6 6 23 26 29 13 0 0 0 Special Social Mitigation Programs 0 0 0 0 0 0 0 0 0 Physical Cost of Mine Closure 0 0 0 0 0 0 0 0 0 Severance Pay 0 0 0 0 0 0 0 0 0 Wage Arrears for Closing & Leased 0 0 0 0 0 0 0 0 0 Mines Disability Payments for Mines to be 0 0 0 0 0 0 0 0 0 Closed or Leased Free Coal for Coal Industry 0 0 0 0 0 0 0 0 0 Pensioners Social Asset Transfer 0 0 0 0 0 0 0 0 0 TOTAL3 151 221 274 309 342 354 364 401 420 3/ The 1996 total represents the amount budgeted. It is projected to fall short of the amount actually needed to fund the production subsidy in the without-reform scenario by US$ 179 million or Krb. 33 trillion, which will lead to a corresponding increase in the net payables position of the coal industry. Annex 4 Page 1 of 1 Production Subsidies and Performance Contracts 1. Mines in Category 2 and 3 will be eligible for production subsidies. As a condition of providing the subsidy, the mines will be prohibited from investment' and recruitment2, and average increases in wage rates in these mines will not exceed the minimum level consistent with the Coal Industry Tariff Agreement. Within the budgetary ceiling, (determined for each oblast in accordance with the overall ceiling for production subsidies agreed between MCI and the Ministry of Finance) the allocation of subsidies to each mine will be decided by the Ministry of the Coal Industry (MCI), after submissions of proposals from the oblast-level divisions of MCI. The size of the proposed subsidy for each mine would depend on (i) expected annual operating cost as a function of current costs and changes in input prices, geological conditions, labor productivity, etc.; and (ii) expected annual revenue as a function of coal production and the market value of coal. 2. The proposed system of performance contracts between MCI and mine directors is not without precedent. All general directors of production associations and directors of mines are employed under contracts with MCI. These employment contracts include many elements of a typical performance contract, e.g., salary bonuses are tied to the achievement of certain performance indicators such as production targets (tons and quality), the reduction of accidents, etc. 'The main differences between the old and the proposed new system would be the following: (i) All mine managers receiving production subsidies would have a performance contract directly with MCI3, as the production associations would disappear, and mines eligible for production subsidies would be placed under newly-created oblast-level administrative divisions of MCI. (iii) The performance contracts would focus on financial indicators rather than physical ones. Specifically, the performance of each mine director would be judged against his/her ability to ensure that the mine operates within the agreed financial parameters, i.e., all losses should be covered by the production subsidy without an increase in the stock of payables. Salary bonuses/penalties would be tied to differences between the planned and the actually received subsidy adjusted for changes in the stock of payables between the beginning and the end of the year. The details of the bonuses/penalties and the provisions for auditing are to be elaborated with technical assistance financed by the UK Know-How Fund. 1/ Normal mine development work to prepare replacement faces, the replacement of parts and sub- assemblies of equipment essential for production, works required to assure the health and safety of mineworkers, and the acquisition of sufficient stock of parts and materials to ensure reliable and safe production in the short run will be permitted. 2/ Transfer of personnel from other Category 2 and 3 mines under the same oblast-level division of the Ministry of Coal Industry will be permitted as will recruitment of faceworkers by Category 2 mines. 3/ For Category 2 mines, this rule would be slightly modified in the first year (after the first year, Category 2 mines would be transferred to Category I or 3). These mines would belong to 15 holding companies (initially 100 percent state owned), therefore the performance contract would involve three parties: MCI, the general director of the holding company, and the mine director. Annex 5 Page 1 of 2 Social Impact Monitoring 1. Social mitigation for sector restructuring on a scale as vast as coal sector restructuring in Ukraine is uncharted territory. Experience does not provide tried and true social mitigation programs that may be relied upon to produce predictable results. The Government of Ukraine is experimenting with a variety of approaches, and it is unclear which ones will prove effective and efficient and which ones will not. Because the Government is experimenting in uncharted territory, with outcomes unpredictable, it is essential to monitor carefully how well various elements of social mitigation work. During the SECAL-supported coal sector restructuring program, the World Bank is supporting social mitigation monitoring in two stages. 2. In the first stage, three different but complementary methodologies will be used to monitor social mitigation in the three pilot mining communities covered by the Bank-supported Coal Pilot Project and two "control" communities, one where the mine is closing and one where the mine is not expected to close. The methodologies include: Household surveys. Household surveys of the three communities in the Pilot Project plus two other communities in the first round were undertaken in September 1996. Subsequent surveys will follow at intervals of between 3 and 6 months. Approximately 300 households will be sampled in each community. The surveys will focus on social conditions generally, household economic circumstances, social services, social benefits, wages and employment. This work is being undertaken by the Eastern Ukrainian Foundation for Social Monitoring, based in Kharkiv. Ethnographic studies. A team of anthropologists from Kharkiv State University will conduct a longitudinal study of workers (and their families) who are laid off in each of the Coal Pilot Project communities and two control communities. The study will be based on in-depth qualitative interviews, taken at 3 month intervals starting in September 1996. The study will focus on information flows, social mitigation measures, and coping strategies. Data collection. assessment. Monthly data will be collected from local labor offices, social protection offices, pension offices, municipal public works offices, and health and educational facilities in the three Coal Pilot Project communities and two control communities, and from UDKR, in order to monitor the quality of the services and benefits these entities are supposed to provide. The data collected from these sources will be confirmed in short interviews with randomly selected beneficiaries and program administrators. A set of indicators has been developed that closely reflects planned project interventions. Indicator data will be channeled each month to project managers for rapid project feedback. The results of this monitoring will be cross-correlated with the results of the household surveys and anthropological studies in order to identify the strengths and weaknesses of the whole social mitigation effort. In the early stages of project implementation, both UDKR and independent researchers will undertake this monitoring activity. Depending on the outcome, UDKR may succeed in building its own institutional capacity to take over the monitoring task in the future. 3. These three complementary approaches will make it possible to draw conclusions about how welt mine workers who lose their jobs due to sector restructuring (and their families) are being served by the statutory elements of the social mitigation package, by social services transferred from mines to municipalities, and by the employment creation programs financed by the Coal Pilot Project. 4. In the second stage (during the first quarter of 1997), based on the experience with monitoring social mitigation measures in the three pilot mining communities and two control Annex 5 Page 2 of 2 communities, all or some of the approaches described in paragraph 2 above will be expanded sector- wide. At the time release of the second tranche of the SECAL is considered, information about social mitigation in the whole sector should be available. UKRAINE SCHEDULE B COAL SECAL ADJUSTMENT LOAN UKRAINE Status Of Bank Group Operations In UKRAINE PFDBR25 - Summary Statement Of Loans and IDA Credits (LOA data as of 10/31/96 - MIS data as of 11/13/96) By Country Country: UKRAINE Amount in USS miLlion (less cancellations) Loan or Fiscal Undis- Closing Credit No. Year Borrower Purpose Bank IDA bursed Date Loans 1 Loans(s) closed 500.00 L36140-UA 1993 UKRAINE INSTITUTION BUILDING 27.00 22.18 12/31/97(R) L38650-UA 1995 UKRAINE HYDROPOWER REHAB. 114.00 112.31 12/31/00 L38910-UA 1995 UKRAINE AGRIC. SEED DEVELOPM 32.00 32.00 09/30/00 ** L39850-UA 1996 UKRAINE HOUSING 17.00 17.00 06/30/99 L40160-UA 1996 UKRAINE COAL PILOT 15.81 15.56 12/31/99 L40570-UA(S) 1996 UKRAINE ENTER. DEV. ADJUST. 310.00 209.80 12/31/99 ** L40970-UA 1997 UKRAINE SOCIAL PROTECT. SUPP 2.60 2.60 06/30/98 ** L40980-UA 1997 UKRAINE ELECTRICITY MARKET 245.40 245.40 12/31/99 ** L40981-UA 1997 UKRAINE ELECTRICITY MARKET 71.60 71.60 12/31/99 ** L41030-UA(S) 1997 UKRAINE AGRICULTURE SECAL 300.00 300.00 12/31/97 TOTAL number Loans = 10 1,135.41 1,028.45 TOTAL*** 1,635.41 of which repaid TOTAL held by Bank & IDA 1,635.41 Amount sold of which repaid TOTAL undisbursed 1,028.45 Notes: * Not yet effective ** Not yet signed *** Total Approved, Repayments, and Outstanding balance represent both active and inactive Loans and Credits. (R) indicates formally revised Closing Date. (S) indicates SAL/SECAL DRL's and RIL's Loans and Credits. The Net Approved and Bank Repayments are historical value, all others are market value. The Signing, Effective, and Closing dates are based upon the Loan Department offical data and are not taken from the Task Budget file. UKRAINE SCHEDULE C Page I of 2 COAL SECAL ADJUSTMENT LOAN Ukraine at a glance Europe & Lower- POVERTY and SOCIAL Central middle- Ukraine Asia Income Development diamond' Population mid-1995 (millions) 51.6 488 1,154 GNP per capita 1995 (USP,l ' 1,630 2,240 1,700 Life expectancy GNP 1995 (billions US$) 85.0 1,093 1.962 Average annual growth, 1990-9S T Population (.) -0.1 0.4 1.4 I GNP A Labor force (%) -0.1 06 1.8 per Gross Most recent estimate (latest year available since 1989) capita enrollment Poverty headcount index (% of population) 32 V Urban population (% of total population)t 70 66 56 Life expectancy at birth (years) 69 68 67 Infant mortality (per 1,000 live brthsa) 15 23 36 Access to sae water Child malnutrition (% ofchildrer under 5) Access to safe water (% of populatIon) 97: 78 Illiteracy (% of population age *5+; 2 Gross primary enrollment (% ofschool-age populaion) 87 97 104 Ukraine Mtale . -. -: - 87 97 105 - Lower-middle-income group Female 87 97 101 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1976 1986 1994 1995 - Economic ratios' GDP (bilions 11S$) -. 99.6 86.2 Gross domestic investmentUGDP 27.3 8.8 8.9 Exports of goods and non-factor serviceslGDP 64.5 45.6 Openness of economy Gross domestic savings/GDP 28.4 3.0 5.6 Gross national savings/GDP .. 2.7 4.7 Current account balance/GOP ... . -6.1 -4.2 Interest payments/GDP .. .. 0.1 0.6 Savings Investment Total debt/GDP .. .. 6.5 9 8 Total debt service/exports 2.1 6.1 Present value of debt/GDP 5.0 Plresent value of debtlexports . - 34.8 Indebtedness 1975-84 1985-95 1994 1998 1996-04 (average annuat growth) Ukraine GOP 3,5 -66 -23.5 -118 5 -- S. GNP per capita 3.1: -6.8 -21.6: -13.7 -03 Lower-middle-income group Exports of goods and nfa .. .. -11.0 6.7 8.1 STRUCTURE of the ECONOMY 1975 1985 1994 1 996 (% of GOP) Growth rates of output and investment (%1 Agriculture .. 19.3 17.4 17.8 so Industry .. 45.6 45.4 42.3 30/ Manufacturing .. 38.0 40.5 38 7 Services .. 35.2 37.2 39.9 -30 Private consumption .. 53.7 77.2 77.2 280 General government consumption .. 17.9 19.8 17.2 G0 --GDP Imports of goods and non-factor services .. .. 70.3 48.9 197S-84 198S-9S 1994 1996 (average annual growth) Growth rates of exports and Imports (
Groupe de la Banque mondiale · President's Report
Ukraine - Coal Sector Adjustment Loan Project
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