Ukraine - Transport sector review (Vol. 2 of 3) : Technical report

Report No. 18636-UA Republic of Ukraine Transport Sector Review (In Three Volumes) Volume II: Technical Report November 30, 1998 Infrastructure Unit Expertise Services Europe and Central Asia DGI World Bank European Commission u Document of the World Bank  CURRENCY UNITS and EQUIVALENTS US$1 = Hrv 2.0 lHrv = 100 Kopeck US$1 = USc 100 WEIGHTS, MEASURES and OTHER UNITS Bln Billion Inh Inhabitant Kg Kilogram Km Kilometer Mln Million Pass Passenger pkm Passenger kilometer sq km, km2 Square kilometer T Ton (meteric, 1,000 kg) Th Thousand tkm ton kilometer Toe Ton oil equivalent Vpd Vehicles per day CONVERSION FACTORS 1 mile = 1.609 meters I kg = 2.205 lbs i US gallon= 3.785 liters 1 sq km = 0.386 square miles CHEMICAL COMPOUNDS CxHy, HC Hydrocarbons CO Carbon Monoxide CO2 Carbon Dioxide NO, Nitrogen Oxides SO2 Sulfur Dioxide FISCAL YEAR January 1 - December 31 Vice President: Johannes Linn, ECAVP Country Director: Paul Siegelbaum, ECCl I Infrastructure Director Ricardo Halperin, ECSIN Sector Leader Eva Molnar, ECSIN Task Team Leader: Pedro Taborga, ECSIN  GLOSSARY OF ACRONYMS AND ABBREVIATIONS ADW Average Dead Weight ATC Air Traffic Control BOT Build Operate &Transfer CAA Civil Aviation Administration CEFTA Central European Free Trade Agreement CIF Cost-Insurance-Freight CIS Commonwealth of Independent States CMEA Council for Mutual Economic Assistance COTIF Bern Convention of May 9, 1980 EBRD European Bank for Reconstruction and Development ECAC European Civil Aviation Conference EDI Electronic Data Interchanges EDP Electronic Data Processing EFF Extended Fund Facility EIA Environmental Impact Assessment EU European Union FIATA Federation Internationale des Associations des Transitaires et Assimiles (International Federation of Freight Forwarders and Related Services) FOB Free-On-Board FSU Former Soviet Union GAAP Generally Accepted Accounting Principles GATT General Agreement on Tariffs and Trade GDI Gross Domestic Investment GDP Gross Domestic Product GNP Gross National Product IATA International Air Transport Association IAS International Accounting Standards ICAO International Civil Aviation Organization IMF International Monetary Fund IRI International Roughness Index MOT Ministry of Transport - NBU National Bank of Ukraine OECD Organization for Economic Cooperation and Development PA Per Annum PIP Public Investment Plan SAC Structural Adjustment Credit SGS Societe Generale De Surveillance SMGS USSR Rail Waybill SOE State Organizations and Enterprises TACIS Technical Assistance for Commonwealth of Independent States TIR International Road Transport UZ Ukrzaliznytsia (Railway Administration) VAT Value Added Tax WTO World Trade Organization  ACKNOWLEDGEMENTS The Review is based on findings of a World Bank mission, which visited Ukraine in May/June 1998, and a Transport Policy Workshop which followed it on June 29 - July 3, 1998. The members of the mission were P. N. Taborga (mission leader); Robert Bonney (Highway Specialist); Jean-Paul Desgranges (Aviation Specialist); Jan-Coen van Elburg (Environment Specialist); Parbo Juchnewitsch (Railway Reform Specialist); Rene Meeuws (Containerization Specialist); Philippe de Naurois (Senior Financial Analyst); Gerald Ollivier (Financial Analyst); Ovadia Salamna (Transport and Trade Facilitation); Olev Schults (Railway Specialist); Carlos Silva (Institutional Reform Expert); and Eugene Vernigora (Maritime and River Specialist). The Ministry of Transport and the Ukrainian National Agency for Development and Investment were the main counterparts of the mission on the Ukrainian side. The study has relied heavily on official sources of information and statistics as well as interviews and meetings with Government ministries and agencies. It also draws on on-going World Bank and IMF work on the macro-economic conditions of the country, other sector work, studies supported by EU, EU- TACIS and EBRD, cross country comparisons and other sector benchmarks. The mission gratefully acknowledges the suggestions received from Ms. Jann Masterson and Mr. Mark Davis, and the final updating of the report by Ms. Shobha Subramanian. Major sources of qualitative information were also obtained from the commercial services of France, the United Kingdom and the United States (Business Information Services for the NI',), located in Ukraine. The mission wishes to thank the EU - Expertise Service for its support, which financed consultant time, travel and subsistence, and some of the administrative costs of this work. Without this support, the work presented in this report would have not been possible.  UKRAINE TRANSPORT SECTOR REVIEW Table of Contents 3 TRANSPORT SECTOR: ISSUES AND STRATEGY 3 1 Accounting and Financial Management Information Systems 4 TRANSPORT DEMAND AND FUTURE SCENARIOS 4 1 Container Growth Potential 4 2 Detailed Scenaril by Sub-sector 5 TILE NEW ROLE OF TlE GOVERNMENT 5 1 Advisory Unit Functions 6 TRANSPORT AND TRADE FACILITATION 6 1 Customs, Border Crossing and Documentation 6 2 Infrastructure and Service Quality Barriers 6 3 Multimodal Transport Measures 6 4 Corrective Measures and Related Costs for Modal Inefficiencies 6 5 Security and Insurance Issues 7 ROAD INFRASTRUCTURE SECTOR 7 1 Road Infrastructure-Cost Recovery Analysis 7 2 1 Forecasted Statistics 7 2 2 Proforma Sources & Uses of Funds 7 2 3 Main Financial Indicators (Graph) 7 2 1 Forecasted Statistics 7 2 2 Proforma Sources & Uses of Funds 7 2 3 Main Financial Indicators (Graph) 8 RAILWAYS 8 1 UZ Organization Chart 8 2 UZAssets 8 3 UZ Traffic Levels and Importance in the Economy 8 4 Regional Railways' Description 8 5 Financial Performances and Issues 8 1 1 Railway System-Map 8 1 2 Railway Corridor Map 8 1 3 Traffic Analysis (Railways Historical Data) 8 1 4 Graph: Indexed Traffic (Trends Base 100=1990) 8 1 6 Regional Railways Traffic and Financial Highlights 1996 8 1 7 Financial Highlights 8 1 8 1997- Balance Sheet -Railways  8 2 1 Traffic Estimates 8 2 2 Forecasted Statistics 8 2 3 ProForma Income Statements 8 2 4 Proforma Sources & Uses of Funds 8 2 5 ProForma Balance Sheets 8 2 6 ProForma Ratio Analysis 8 2 7 Main Financial Indicators (Graph) 8 2 1 Traffic Estimates 8 2 2 Forecasted Statistics 8 2 3 ProForma Income Statements 8 2 4 Proforma Sources & Uses of Funds 8 2 5 ProForma Balance Sheets 8 2 6 ProForma Ratio Analysis 8 2 7 Main Financial Indicators (Graph) 8 2 8 Gross Operating Result (Graph) 8 2 9 Investment Financing Capacity (Graph) 9 SEA PORTS 9 1 The Main Seaports of Ukraine 9 2 Maritime Environment under FSU 9 1 1 Historical traffic per port- Export 9 1 2 Historical traffic per port- Import 9 1 3 Historical traffic per port- Transit 9 1 4 Historical traffic per port- Total 9 1 5 Traffic Analysis 9 1 6 Indexed Traffic (Trends Base 100=1990) 9 1 7 Total Sea Ports Traffic 1997 (Graph) 9 1 8 Financial Analysis Odessa-Ilyichevsk 1997 9 2 1 Traffic Statistics 9 2 2 Forecasted Statistics 9 2 3 ProForma Income Statements 9 2 4 Profonna Sources & Uses of Funds 9 2 5 ProForma Balance Sheets 9 2 6 ProForma Ratio Analysis 9 2 7 Main Financial Indicators (Graph) 9 2 1 Traffic Estimates 9 2 2 Forecasted Statistics 9 2 3 ProForma Income Statements 9 2 4 Proforma Sources & Uses of Funds 9 2 5 ProForma Balance Sheets 9 2 6 ProForma Ratio Analysis 9 2 7 Main Financial Indicators (Graph) 9 2 8 Gross Operating Result (Graph) 9 2 9 Investment Financing Capacity (Graph)  10 CIVIL AVIATION 10 1 Air Ukraine 10 2 Condition of Main Airports 10 3 Technical Assistance Program 10 1 1 Main Ukrainian Airlines 10 1 2 Main Ukrainian Airlines-Freight Traffic 10 1 3 Main Ukrainian Airlines-Passenger Traffic 10 1 4 Ukrainian Airports-Passenger Traffic 10 1 5 Ukrainian Airports-Traffic Analysis and Graphs 10 1 6 Airports-Financial Comparisons- 1995 10 1 7 Borispol International Airport- Financial Highlights: 1996-1997 10 1 8 Borispol International Airport- Income Statements and Cash Flow: 1996-1997 10 2 2 Forecasted Statistics 10 2 3 ProForma Income Statements 10 2 4 ProForma Sources & Uses of Funds 10 2 5 ProFonna Balance Sheets 10 2 6 ProForma Ration Analysis 10 2 7 Main Financial Indicators (Graph) 10 2 2 Forecasted Statistics 10 2 3 ProFormna Income Statements 10 2 4 ProForma Sources & Uses of Funds 10 2 5 ProForma Balance Sheets 10 2 6 ProForma Ratio Analysis 10 2 7 Main Financial Indicators (Graph) 10 2 8 Gross Operating Result (Graph) 10 2 9 Investment Financing Capacity (Graph) 12 TRANSPORT SECTOR 12 1 1 Traffic Estimates-All Scenarios 12 1 2 Public Surplus in Transport Sector-All Scenarios 12 1 3 Trade Facilitation Expected Gross Economic Benefits- All Scenarios 12 2 1 Traffic Estimates all Modes 12 2 2 Traffic Estimates all Modes- Graphs 12 2 3 Gross operating Results 12 2 1 Traffic Estimates all Modes 12 2 2 Traffic Estimates all Modes-Graphs 12 2 3 Gross operating Results 12 2 1 Traffic Estimates all Modes 12 2 2 Traffic Estimates all Modes- Graphs 12 2 3 Gross Operating Results  UKRAINE TRANSPORT SECTOR REVIEW Table of Contents 1. INTRODUCTION ..................................................1 A. PURPOSE OF THE STUDY ................................................ I B. ORGANIZATION OF THE STUDY ................................................ 2 C. CONTEXT ..... ... ... ... ... .... ... ... ... ... .... ... ... ... ...3 2. TRANSPORT AND ECONOMIC STABILIZATION ................................................. 5 A. STRUCTURE OF THE ECONOMY ................................................. 5 B. MACRO-ECONOMIC PERFORMANCE ................................................ 6 C. FOREIGN TRADE ................................................ 9 D. ROLE OF THE TRANSPORT SECTOR ................................................ I 1 E. UKRAINE'S ECONOMIC REFORM PRIORITIES ................................................ 13 3. THE TRANSPORT SECTOR: ISSUES AND STRATEGY ................................................. 15 A. MAIN ISSUES AFFECTING THE TRANSPORT SECTOR ................................................ 15 B. STRATEGY FOR THE TRANSPORT SECTOR RECOVERY ................................................. 17 4. TRANSPORT DEMAND AND FUTURE SCENARIOS .22 A. THE TRANSPORT SECTOR IN A CHANGING ECONOMIC SITUATION .22 B. GROWTH SCENARIOS .22 C. HISTORIC AND PROJECTED TRAFFic .24 5. THE NEW ROLE OF THE GOVERNMENT ............................................... 28 A. THE GUIDING PRINCIPLES OF THE CHANGE PROCESS ................................................ 28 B. NEW ORGANIZATION OF THE TRANSPORT SECTOR ................................................ 29 C. MAIN MINISTERIAL FUNCTIONS ................................................ 32 6. TRANSPORT AND TRADE FACILITATION ............................................... 35 A. CUSTOMS, BORDER CROSSING AND DOCUMENTATION ................................................ 36 B. MODAL INEFFICIENCIES ............................................... 39 C. SECURITY, RISK AND INTERNATIONAL INSURANCE ............................................... 42 D. CREDIT, TAXATION AND TRADE PROTECTION MEASURES ............................................... 43 E. FURTHER BENEFITS OF TRADE AND TRANSPORT FACILITATION ............................................... 46 7. ROADS AND ROAD TRANSPORT ............................................... 48 A. ROAD INFRASTRUCTURE ............................................... 48 B. ROAD TRANSPORT ............................................... 57 C. URBAN TRANSPORT ............................................... 59 8. RAILWAYS ................................................ 62 A. THE UKRAINIAN RAILWAY SYSTEM ............................................... 62 B. TRAFFIC LEVELS ............................................... 64 C. FINANCIAL PERFORMANCES AND ISSUES ............................................... 66 D. FUTURE FOR THE R AILWAYS ................................................ 68 E. RAILWAY SECTOR ECONOMIC SUSTAINABILITY STRATEGY ................................................ 69 F. FINANCIAL SUSTAINABILITY AND PROJECTIONS ................................................ 72  9. MARITIME AND RIVER TRANSPORT ..................................; .75 A. ORGANIZATIONAL STRucTuRE .75 B. RIVER PORTS AND RIVER SPPING. .76 C. SEAPORTS.79 D. MARITIME SHIPPING.85 E. FINANCIAL PROJECTIONS FOR SEAPORTS .................................. ; 87 10. UKRAINE CIVIL AVIATION .90 A. INSTITUTIONAL ORGANIZATION OF THE SUB-SECTOR .90 B . AIR TRANSPORTATION .91 C. AIRPORTS.93 D. FINANCIAL SUSTAINABILITY AND PROJECTIONS .98 E. AIR TRAFFIC CONTROL (ATC). 00 F. RECOMMENDATIONS . 101 11. TRANSPORT AND ENVIRONMENT. L03 A. TRANSITION AND ENVIRONMENT ] 03 B. MAIN ISSUES.]. 05 C. RECOMMENDATIONS 110 12. RECOMMENDATIONS .114 A. OVERVIEW.114 B. SECTOR ADJUSTMENT.1.115 C. SUB-SECTOR ETORECOMMENDATIONS .120 LIST OF ANNEXES .123  Introduction 1 1. INTRODUCTION BELARUS 200 f ; 0 t i .C:hernihiv 0 o a o100 200 rni POLAND } Chomobyr' ~KIEV /S, ~~Zhytomyr. FIV Khakiv Luhans'k, Uz horo; Chernsi Kirovohrad* Dnipropetrovs'k K" ih* .0~~~~*onets'k UGARYA l(rvy Ri Zpra f l U S ; I A / ; X ftf w JOeOVA9 tS ~~~~Mariupi 4 T 0 00;ROwMANIA: 0L0t 'AO ,000000 t:0000000XMyko :yw B. das- Setha 86ak Yt Sea A. Purpose of the Study 1.1 This study has been carried out with the financial support of EU-Expertise Service as a direct response to the Government's request to develop a program of assistance in support of a comprehensive transport strategy, with emphasis on the following objectives: (a) identifying key policy reform; (b) reviewing and accelerating the privatization program in the sector; and (c) formulating action plans for restructuring railways, managing road infrastructure, reorganizing civil aviation, maritime, river and urban transport. 1.2 In addition to meeting the above objectives, the study identifies the level of financially sustainable expenditures suitable for inclusion in a Government Public Investment Plan (PIP) and eventual discussion with other donors.  Introduction 2 B. Organization of the Study 1.3 The study is presented as follows: a policy note, this technical report in 12 chapters, its annexes and statistical appendices. The chapters of this technical report are as follow: 1.4 Transport and Economic Stabilization. Chapter 2 gives a summary description of Ukraine's economic situation, trade patterns, followed by a discussion on the role of the transport sector and its potential large contribution to economic recovery and growth acceleration. The potential of transport as an internationally traded service, implications of facilitation measures on the balance of payments are also outlined. 1.5 Main Issues and Need for Stabilization, Modernization and Development. Chapter 3 gives an overview of issues that affect the provision of transport services in Ukraine and describes the enabling environment needed to stabilize, modernize and develop transport services. The current situation of the transport sector, its cost recovery performance, lack of resource mobilization and lack of investment plans are highlighted, and the potential for transport and traLde facilitation explored. 1.6 Transport Demand and Future Scenarios. In Chapter 4, the past and future transport demand of Ukraine is analyzed and explored. Particular attention is given to possible growth and trade development scenarios depending on the degree of regional economic cooperation and paLce of reform in Ukraine. 1.7 New Role of the Government. Chapter 5 reviews the role of the Government and presents the main guiding principles of a successful restructuring of the Ministry of Transport and its related agencies. Restructuring the Ministry of Transport is a prerequisite to a successful reform process and is under active consideration by the Ukrainians. 1.8 Transport and Trade Facilitation. Chapter 6 addresses the barriers to transport a]nd trade, the US$2.8 billion excess costs they impose on the economy, and a strategy and corresponding facilitation measures required to alleviate these barriers. 1.9 Road Sub-Sector. Chapter 7 analyzes the current situation with an identification of major issues related to the sector and makes corresponding recommendations to address them. A special emphasis is put on road infrastructure financing to prevent a fast erosion of the existing network and on reducing unit costs to international standards. The presentation is organized as follows: (a) Road Infrastructure; (b) Road Transport Services; and (c) Urban Transport. 1.10 Railways. Chapter 8 presents the many issues faced by the Ukrainian railways. It gives a description of the physical condition of the railways, nature and quality of operations, current traffic and prospects, and main financial issues. It concludes by offering a strategy to reach financial sustainability in the railways. 1.11 Maritime and River Transport. Chapter 9 outlines the issues faced by seaports and river ports and shipping in Ukraine and proposes some alleviating measures. It describes the organizational structure under which operations are performed, the traffic evolution, the condition  Introduction 3 of physical assets, the problem areas and corresponding recommendations, and financial performnance issues. The Chapter is concluded by a strategy to reach financial sustainability. 1.12 Civil Aviation. Chapter 10 reviews the present situation in civil aviation, its institutional issues and organizational characteristics, priorities in fleet renewal, infrastructure and air traffic control and financial difficulties. It also discusses the potential for institutional and financial restructuring. 1.13 Transport and Environment. Chapter 11 covers the current situation, legislation and institutional authorities with jurisdiction over environmental and resettlement questions arising in the transport sector. It identifies the four major issues related to transport: air pollution, modal shift, transport of dangerous goods and the return of Environmental Impact Assessment. The Chapter concludes with recommendations concerning standards and norms and their future applications. 1.14 Recommendations. Chapter 12 gives an overview of the specific sub-sector recommendations. The chapter highlights a number of triggers for Bank or other financiers participation in transport restructuring. Under a scenario of continued economic reform recommendations are presented under the following headings: a) Policy Reform b) Transport and Trade Facilitation c) Sub-sectors C. Context 1.15 Ukraine only made a break with past economic policies in 1994, three years after independence. Since then, important stabilization, privatization and market liberalization steps have been introduced. Structural reforms, including liberalization of prices and trade, and privatization are underway and increases in exports have been recorded. Stabilization policies so far have been successful, inflation has fallen from 400% in 1994 to 45% in 1996, the exchange rate has stabilized, and a monetary reform is in place. The accomplishments to date, however remain vulnerable to slow or no economic growth, and to an unstable political climate, which continuously seems to hesitate between a government controlled economy and privatization. There are some worrisome indications such as estimates indicating that a substantial amount (about 60%) of the domestic trade is through barter. 1.16 The contraction of the economy has affected the transport sector although transport represented 12.3% of the Ukrainian GDP. The volume of transport cargo declined from 6.3 billion tons in 1990 to 1.9 billion tons in 1997. The freight turnover in billion ton/km decreased from 1,039.3 in 1990 to 185.9 in 1997. 1.17 The slow implementation of a broad and far reaching reform agenda has not yet shown noticeable gains in economic activity, although positive growth might have been experienced in 1997, which would be masked by the fact that unrecorded economic activity would represent most of that growth. Macro-economic measures, all important as they are, need to be accompanied by  Introduction 4 reforms within each sector to have the full effect of supply responses in the transition to a market economy. Today, Ukraine's economy is midway in its transition from plan to market. Much htas been done, and much is left to do. 1.18 The issues of the Transport Sector can be summarized as follows: (a)The existing environment prevents the development of competitive and innovative transport services. The existing environment is constrained by (i) legal and regulatory inefficiencies; state interference in Transport operations including on pricing issues; (iii) lack of cost recovery for State infrastructure; and (iv) a financial framework that prevents sound management of public infrastructure. (b) The pace of reform in the sector needs to match and anticipate the evolution of macro economic policies announced; (c)The asset base of the transport sector is eroding, and rehabilitation, maintenance and renewal backlogs are mounting. (d) Traffic, which has contracted sharply, is showing a modal split different from the traditional one, with a greater reliance on road transport in international trade to Europe when recovery is established; and 1.19 The main questions needing to be addressed are: (i) sustainability of transport activities; (ii) scope for commercialization and privatization under competitive conditions; and (iii) reversal of sector de-capitalization currently underway. A self-sustaining transport sector on the basis of adequate solutions to these main questions would make a significant contribution to the government's efforts to further reduce the budget deficit, currently at about 6% of GDP.  Transport and Economic Stabilization 5 2. TRANSPORT AND ECONOMIC STABILIZATION 2.1 Upon independence on December 1, 1991, Ukraine became the second largest European country with a land area of 603,700 square kilometers. Ukraine is located on the north of the Black Sea and bordered by Poland, Slovakia, Hungary, Romania and Moldova to the west, Belarus to the north, and Russia to the north and east. With 50.4 million inhabitants, Ukraine has the fourth largest population in Europe, mostly from Ukrainian (73%) and Russian (22%) origin. The Ukrainian workforce is well educated and highly skilled. Ukraine's GDP per capita was $1,040 in 1997. 2.2 1990-1997 Economic Evolution. The economy of Ukraine contracted sharply after 1991, before stabilizing in 1994. Prior to Independence, Ukraine was after Russia, the most important economic component of the former Soviet Union (FSU). By 1994, officially recorded output had fallen by more than 50 percent since 1990, inflation was still in triple digits and trade deficit widened. Policy response lagged until 1994. Administrative control of the economy remained extensive. Since 1994, changes in Ukrainian policy have enabled the country to stabilize. However this effort remains fragile. 2.3 Foreign Trade. Trade has similarly been affected by the FSU breakup. Gross goods trade flows represent more than 70% of Ukraine's GDP. Trade broadened and shifted away from FSU markets. It mainly consists in exports of metal and imports of oil products. The industrial future of Ukraine is to be found in shifting towards greater international integration. 2.4 Transport Support to the Economy. The pattern of transport in Ukraine was deeply altered by the drop in FSU traffic and transformation of trade. The transport sector generated substantial economic activity and contributed significantly to reducing the current account deficit. However, this support is and will be progressively weakening unless Ukraine tackles the issues that seriously erode its competitiveness in the provision of transport services. The transport sector is not ready to provide the Just-in-Time transport services needed to integrate Ukraine's large industry into global production chains. A. Structure of the Economy 2.5 Before Independence. Ukraine produced about four times the output of the next- ranking republic in the FSU. Its fertile black soil generated more than one-fourth of the FSU agricultural output, and its farms provided substantial quantities of meat, milk, grain, and other vegetables to the other republics. Likewise, its diversified heavy industry supplied equipment and raw materials to industrial and mining sites in the other regions of the FSU.  Transport and Economic Stabilization 6 2.6 1990-1997 Structural Transformation. The economic structure of Ukraine has been reshaped since Independence (Figure 2.1). Each sector of the economy has been affected by the break-up of the FSU, severe shocks from price adjustments to world levels, and structural reforms undertaken throughout the economy. The industry sector moved to 34 percent share of the GDP in 1997, down from an estimated 45 percent in 1992, with a predominance of steel manufacturing. The agriculture sector (which output was approximately divided by 2 between 1990 and 1997) went down to 12 percent, from an estimated 25 percent in 1990. Figure 2.1. Shares of Gross Value Added by Sector (%) 100% 90% 80% - 70% Imm 60% 50% 40% 30% 7 _ _ _____ 20%- 10%- 0%_ _ _ _. ___ _ 1990 1991 1992 1993 1994 1995 1996 1997 Source: Derzhcomstat * Industry CAgriculture D Construction MTransport & Communications U Trade a Other Servicej B. Macro-Economic Performance 2.7 1990-1994 Economic Contraction. The transformation of Ukraine's economy from a centrally planned system to a market-oriented one has proven to be a daunting challenge. Policy shortcomings during the first three years of Ukraine's independence, combined with major external shocks led to macroeconomic instability and contraction of all sectors. Between 1990 and 1993 agricultural production fell 20 percent, industry contracted 45 percent, and construction declined 54 percent. Recorded unemployment remained limited, disguised unemployment became widespread, affecting 3-5 million workers. By 1994, officially recorded output had fallen by more than 50 percent since 1990 and inflation, while coming down from hyperinflationary levels, was still in triple digits. Although the fiscal deficit was reduced by 1994, the current account deficit had widened and the situation had become increasingly tenuous, i.e., the effects of a large accumulation of payment arrears (mainly on gas imports from the FSU), began deteriorating living standards and increasing poverty. By 1994, the public finance deficit exceeded 8 percent of GDP, the current account deficit was around 6 percent of GDP, the stock of external debt (including arrears) reached US$8,219 million, and international reserves covered only 2.3 weeks worth of imports.  Transport and Economic Stabilization 7 RFge22 UhainenlialsbW 0Utplndt&lRe GMPlndex (pOA 1O019D) 90 GDP= US$48 bin 40. 10. 1990 1991 1992 1993 19A 1995 1996 1997 1998 Source: Derzhcomstat j irTiwan QIt n G-pIndtx 2.8 Reform Program and External Support. In October 1994, a clear break was made from past policies as Ukraine began to lay the foundation for macroeconomic stabilization and structural reforms. An IMF-supported stabilization program (through a systemic transformation facility, and three stand-by arrangements) entailed tight fiscal and monetary policies with the aim of lowering inflation to about 1 percent monthly. The World Bank has supported a wide-ranging series of measures aimed at reducing Government intervention in the economy, developing competitive markets and introducing elements for a social safety net through a Rehabilitation Loan followed by adjustment loans in enterprise, agriculture and energy sectors. 2.9 Impact of Reform. Significant progress was accomplished over the following four years. Inflation has been sharply reduced (to 40 percent annually in 1996 and 16 percent in 1997). The exchange rate was unified and a substantial degree of current account convertibility established; a new currency was successfully introduced. The trade regime has been liberalized. Domestic prices have been partially decontrolled, consumer subsidies partially reduced and energy prices increased to world level for non-household users. Purchasing power has been restored somewhat in the recorded economy as suggested by figure 2.3. The exchange rate appreciated between 1994 and 1997 roughly 60-70% according to various indices, and there are indications of an appreciation "overshot" from mid-1996 onwards, with a recent correction towards parity in mid- 1998. Tax reform has been initiated, the state order system has been abolished. A mass privatization program is being implemented; agriculture land reform is being initiated; and a restructuring of the electricity and coal sectors is underway.  Transport and Economic Stabilization 8 Figure 2.3. Evolution of Purchasing Power Macro-Economic Indicators 200 10 II!1S tl 180 9~~~~~~~~~~~~~~~~~~~~~~~~~~0 160, so l | i ~E~ 140 * * 70 120 60 1 -6 100 so 80 a 40 en 640b i i030 201 _ j110 0 ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~0 1993 1994 1995 1996 1997 1998 Source: Derzhcomstat I"Monthily Wages -Monthily Inflation Exchange Rate (Base June 92=100) 2.10 Considerable Remaining Challenges. 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. (a) First, the stabilization effort is fragile. Tight monetary policy has not been accomplished by sufficient structural measures to reduce expenditures. In effect, the fiscal situation appears better than it is; the cash deficit was contained to a substantial extent by running up arrears and postponing expenditures. This is clearly not sustainable and the Government needs to address the immediate precarious fiscal situation in addition to key structural causes of fiscal imbalance. (b) Second, economic activity remains weak. Officially recorded GDP fell by a further [IO percent in 1996 and continued to fall, albeit at a slower rate, during 1997. Much private activity appears to be channeled into the unrecorded economy, which is substantial and growing. Although the informal economy has cushioned the impact of the decline in officially recorded GDP, it has negative sides too; it reduces the tax and foreign exchange base and makes macroeconomic stability that much harder to sustain. (c) Third, the pace of reform has slowed down. There have been setbacks in several areas of the reform program, notably in the slow progress in tax reform, the inability to achieve greater cost recovery in most of the sectors and the slow progress in agricultural sector reform. There has also been a tendency to create or reinforce monopolistic state structures, notably in agriculture, to handle market activities. The anticipation of Parliamentary and Presidential elections throughout 1997 contributed to delays in implementation of politically sensitive reforms.  Transport and Economic Stabilization 9 C. Foreign Trade 2.11 A Large Foreign Trade. Foreign trade is particularly significant to the economy of Ukraine (Figure 2.4). There has been a fall in foreign trade in 1997, mainly due to a fall of trade with Russia, the value of gross goods trade flows was about US$35 billion in 1997 (more than 70% of GDP). Exports amounted to US$15.5 billion in 1997 or 31 percent of the GDP. Imports represented about US$19.6 billion in 1997 and the deficit in goods trade is estimated to be about US$4.1 billion in 1997. Foreign trade in services is traditionally positive mainly because of transport activities, which represent about 82% of service exports. The balance for the service account is estimated to be about US$2.6 billion in 1997 and it helped reduce the foreign trade deficit to US$1.5 billion. Source: NBU Figure 2.4. Ukraine Detailed Trade Balance Historic (1994-1997) 1994 1995 1996 1997 1998 (est.) 15,000 - 10,000 5,0000 a (5,000) _ (10,000) - (15,000) - (20,000) IOExport-Goods MExport-Services UImport-Goods Ulmport-Services lBalance-Goods OBalance-Services 2.12 Trade Origin and Destination Shifts. Ukrainian trade broadened and shifted away from the FSU market (Figure 2.5 & 2.6). Traditionally the market for Ukraine's products was predominantly Russia. Russia used to be the main trade partner of Ukraine. Since 1994, Ukrainian producers have been forced by the stagnation of the domestic market to increase export volumes outside the CIS. The trade balance with countries outside the FSU in 1997 showed a surplus of US$1 billion, while the trade balance with FSU countries showed a US$5 billion deficit for goods. Figure 2.5. Direction of Trade - Figure 2.6. Direction of Trade - Exports Imports 100% - 100% 50% 60% ~~~~~~ ~~~~40% 1994 1995 1996 1997 1994 1995 1996 1997 ERussia *Belarus mOther CIS OChina MEU MUSA 1Other lRussia *Belarus MOther CIS OEU 30ther  Transport and Economic Stabilization 10 Table 2.1.: Ukrainian Main Trade Partners (in million USD, 1997) Countries Tumover Export Import Russia 15,118 6,936 8,182 Germany 2,073 687 1,386 USA 1,377 443 934 Belarus 1,274 864 410 China 1,253 1,125 128 Turkmenistan 1,152 180 972 Source: Ukrainian Shipping, January-June 1998 2.13 Trade Breakdown. Ukraine exports mainly metal and imports mainly oil product (Figures 2.7 and 2.8). 1997 was a record year for metal exports. Exports of ferrous metals and products grew by 30 percent and accounted for 38 percent of the total exports. Chemical exports fell to 10 percent of exports as a result of worldwide fall in price and technological shortfall on the part of the Ukrainian producers. Machine building export volumes remained almost the same in 1997 at 4% of exports. Main imports remained mineral products and primarily energy resources although their share in total imports dropped from 52 to 48 percent in 1997. Figure 2.7. Composition of Trade Figure 2.8. Composition of Trade Exports, 1997 Imports, 1997 Minerals Agriculture Agriculture 4% 12% 5% Chemicals ~~~~~Machinery and EngineeringOte 10% Equipment Products 32% 4% 15% Otherlcals* _ Other Mineral Ferrous Metal 32% Petroleum 45% 2.14 Changing Demands. The industrial future of Ukraine is to be found in shifting towards greater international integration. The large Ukrainian industrial complex needs to find new clients beyond its traditional partners. The progressive integration of Ukrainian industrial companies in some international production chains, both as partner and as subcontractor, could be an effective solution to reach new client. A sustainable industrial strategy would allow reciprocal transfer of technology, while pursuing some high value added industries. However, such a strategy would be only possible to the extent that deliveries can be performed just in time, predictably and reliably, which is not the case today.  Transport and Economic Stabilization 11 D. Role of the Transport Sector 2.15 The Transport Sector Before Independence. Prior to Independence, Ukraine's transport system was wholly integrated with that of the FSU, and the country served as an important transit channel to the rest of the World. In 1990, 40 percent of the maritime traffic of FSU was transiting through the Black Sea and Azov Sea ports. The railway was part of the former All-Union or Soviet Railways (SZD). These included: (a) overuse of transportation because of planned separation and specialization of production units in a few locations; (b) over-reliance on rail transport, especially for short hauls; (c) centralized control of investments affecting all international transport; (d) technical ability, coupled with unfamiliarity of economic or other market-based analyses; and (e) almost exclusive use of transport equipment not always cost effective by world market standards. 2.16 Relevance of Transport Sector. The Transport Sector cushioned the economic contraction. Transport & Communications share of GDP grew from 8.8 percent in 1990 to 13.3 percent in 1997, after a peak at 14.9 percent in 1996. During the same period, employment in the sector remained about the same at 1.5 million employees, or 6.8 percent of the actual labor force. Transport flows since the break up of the FSU reflect the loss of most of the transit traffic from the FSU combined with the effects of the recent evolution of the economy. It is estimated that total public and private tonnage transported in 1997 (about 1,300 million tons, down from about 6,200 million tons in 1990) represented no more than 15 percent of 1990 levels. 2.17 Transport Services in the Balance of Payments. Transport services, inclusive of transit, generated a surplus in the Balance of Payment of US$3.5 billion in 1997 and accounted for 80 percent of exported services (Figure 2.9). Without export of transport services, including gas transit, Ukraine would have had a negative balance for services of US$900 million instead of the current surplus of US$2.7 billion. The balance of payments account is, in the case of Ukraine, the only source of internationally comparable information on international service transactions, including transportation. It presents transport as an internationally traded service, as opposed to state support to the production function or a social service to consumers. Figure 2.9. Balance of Payments- Services Account- 1997 6,000 0 (2,000) (4,000). EXPORT IMPORT BALANCE in US$ million Source: NBU EITotal ServicesO Transport Services]  Transport and Economic Stabilization _ 12 2.18 Public Investment in the Transport Sector. Generally, public investment in Ukraine is minimal, has fallen dramatically in recent years, from 4.6 percent of official GDP in 1994 to 0.5 percent in 1997 (Figure 2.10). The absence of private-sector investment aggravates the effect of the decline in public investment. Transport assets were used without being maintained. Transport investments accounted for the bulk of capital spending in the Transport & Communications sector (90 percent in 1995). At the central government level, most of the investment was allocated to the road network, while local government funding went to road transport with a small share going to investments in urban transport. Figure 2.10.: Trends in Public Investment as Share of GDP, 1994-97 '4 3% a 2% E I-~~~~~~~~~~~~~~~P 1994 1995 1996 1997 |M Central Govemnment 0 Local ent 2.19 Privatization Process. The privatization process in the transport and infrastructure sector has stagnated, impeding the development of the transport sector. Table 2.2 shows the state of privatization in the transport and road sector as of January 1, 1998. Some success was achieved in privatizing the road transport sector but other modes were far less successful in the process. In addition to privatization, the creation of equal conditions and free entrance should be guaranteed for all companies. Table 2.2.: State of Privatization in the Transport Sector as of January 1, 1998 Transport No No state- No % privatized mode companies owned privatized Road 722 139 589 82 transport Railways 1,207 1,195 12 1 Sea/river 67 49 18 27 Air transport 62 56 6 10 Roads 162 84 78 48 Total 2,220 1,523 703 32 Source: Ukraine: Alook to the 2l"tcentury, EBRD, 1998; EBRD Round Table, 1998. 2.20 Transport Assets. Ukraine's transport sector consists of 172,200 km of roads (excluding municipal, agricultural and forestry roads), 23,350 km of broad gauge, electrified, railroad tracks,  Transport and Economic Stabilization 13 163 airports with paved runways, 7 of which having an annual traffic above 100,000 passengers, and 31 ports. The vehicle fleet consists of about 6.2 million passenger cars, 2.6 million trucks and 250,000 buses. Recent efforts and support from external donors in the transport sector include significant technical assistance under the TACIS program, which aims at expanding maintenance for the main road network and improving the efficiency of road maintenance operations. 2.21 Transport Competitiveness. International competition is beginning to affect the performance of Ukrainian Transport. Given its location and the present oversupply of its infrastructure, Ukraine could become a key player in trade and transport in the region at a minimal cost. The transport infrastructure is not likely to be an issue for transport entities in Ukraine during some of the next coming years. Much of Ukraine's transport infrastructure and equipment is dramatically under-utilized by world standards. Existing and forecast domestic demand is so low that it can be met with only part of the existing network. Yet lost, competitiveness is evident as demonstrated by traffic diverting to other corridors. This is primarily due to the difficulties and excess costs operators face daily. These bottlenecks, as described in the following chapters, would be inexpensive to remove, but would require a strong political commitment and active regional cooperation. 2.22 Transport and Sustained Growth. Ukraine's interest can be properly served only by well-designed efforts at regional integration and economic cooperation with neighboring countries. A significant contribution to economic growth could be achieved by progressively eliminating excess-costs traceable to trade and transport distortions. The government should, as a matter of economic development policy, articulate a multi-modal trade and transport strategy, which will enhance the transit capabilities of its territory. Such a trade and transport strategy would seek to assist and accelerate economic growth by serving domestic transport demand and by contributing to more competitive trade flows. 2.23 Potential Corridor Development. Corridors offer significant development opportunities. Economic activities tend to concentrate along existing corridors because of the lower cost in accessing markets and supplies. Support-to-transit activities' has proven successful in European, Latin American or Asian countries. A number of such activities can be settled in Special Economic Zones in areas benefiting of a dense, high capacity transport network. Such development creates jobs and fosters trade, as is apparent from similar undertakings in Southeast China. E. Ukraine's Economic Reform Priorities 2.24 Ukraine's economic reform priorities during the next few years can readily be characterized as "more of the samne" - more enterprises and farms to privatize, more controls to lift, more market-oriented institutions to establish, and more Soviet institutions to close and reform. But two likely developments indicate that the nature of the challenges will in reality be significantly different during the next stages. 1 including decentralized multinational industrial production, assembly, redistribution, logistics, shipping, information and financial services, and other activities.  Transport and Economic Stabilization 14 (a) First, in the labor markets, the maturing of the newly privatized enterprises and their restructuring for survival in a market economy seem certain to increase radically the numbers of workers thrown into open unemployment as well as the demands for new types of higher skilled workers. Open unemployment is tentatively estimated to rise to 4.5 million by 1999 and this will impact particularly hard on regions and cities dominated by one or two giant Soviet style industries. (b) Second, the next few years seem likely to be years of "fiscal realism" with mnost aspects of national and local government expenditure being put under the microscope in the search for much needed savings. This is likely to re-define the boundaries of the state much more radically than has been the case in Ukraine to-date. It will in the process create many new opportunities and challenges for the private sector but also create immecdiate crises in many services formerly provided by the state but which can no longer be afforded.  Transport Sector: Issues and Strategy 15 3. THE TRANSPORT SECTOR: ISSUES AND STRATEGY A. Main Issues Affecting the Transport Sector 3.1 A number of issues are preventing Ukraine from fully benefiting from its infrastructure and location and developing a competitive and efficient market for transport services. These issues are the following: 3.2 Legal and Regulatory Inefficiencies. The existing procedures and documentation affecting commerce, trade and transport are complex, incomplete, not aligned to international practices, lengthy, costly, constantly changing, and insufficiently known by users. It leads to rent seeking behaviors from those with discretionary power. This is illustrated in detail in Chapter 5. Business cost (official and shadowed) and uncertainty are discouraging the establishment of new businesses, the expansion of new businesses, and foreign investment. This precludes the development of transport services the industry and retail businesses look for, i.e. timely, reliable, flexible, secure, and cost effective delivery through and within the Ukraine. Therefore, creation of global production and supply chains that would integrate Ukraine as an element of the global economy can not take place. Excessive regulation and forms of taxation hamper the private sector, and encourage the move towards the unrecorded economy. 3.3 State Interference in Transport Operations. The sector still operates under many of the organizational and policy structures of earlier days as described in chapters 5 to 11. Practically all transport enterprises and infrastructure sub-sectors, including the national road network, the railway system, the ports, the airports, some airlines, the Metro systems, as well as many organizations involved in transport-related maintenance and construction, are still State-owned units reporting to the Ministry of Transport. Most of them do not operate as autonomous, self- financing and commercially viable entities. This strong state presence coupled with limited investment capacity, limits technical innovations in transport. 3.4 Constraining Macroeconomic Framework. The existing macroeconomic framework impedes efficient trade by imposing restrictive practices. Currency exchange and foreign exchange access are strictly controlled, the tax system is complex, heavy and rather confiscatory. Prices and the banking sector are insufficiently developed, to support commerce and trade still partially controlled by the State. Property rights and titling remain unclear despite the efforts started. 3.5 Insufficient Cost Recovery. Existing user charges, tariffs and fares are often insufficient or inappropriate to cover the cost of maintenance and renewal of the core assets required. The financial performance of transport entities is declining. Tariff regulation and exception prevent the deterrnination of market-determined tariffs and cost recovery. 3.6 Inappropriate Financial Management Systems. Transport enterprises in Ukraine are operating at present in an environment, lacking transparency, with very little disclosure of  Transport Sector: Issues and Strategy 16 financial information and virtually no accountability. The use of the former improved soviet accounting system does not give a fair and realistic picture of financial flows and financial situation in an entity. The State can not decide knowingly the amount of subsidies to be allocated to railway cornmuters since the accounting system does not allow for it. Current transport accounting systems are a major obstacle to correcting structural and operational inadequacies. Costs cannot be isolated and analyzed, and past-over investment cannot be rationalized without properly structured operational and financial information. There is virtually no confidence in reported information, when available, and investors have little basis on which to make investment decisions and/or monitor investment performance. 3.7 Slow Pace of Reform. The sector needs to move towards restructuring and privatization of operations and to a much greater use of the market mechanisms than what was previously done. The current economic situation provides a convenient time in which to implement the necessary structural and institutional changes. The period until the economy recovers may be limited, ;and the sector needs to be restructured to be able to handle growing traffic volumes under increasing competitive pressures. Officials are beginning to accept the logic and inevitability of the changes that will be needed. 3.8 Erosion of the Asset Base. The asset base of the transport sector is eroding. Mounting maintenance, rehabilitation, and renewal backlogs as well as technical innovation and equipment upgrading are not being addressed. Little, if any, maintenance is being done. The impression is that the transport system is existing on its capital stock. Throughout the sector, repair facilities and rolling stock are in need of a substantial overhaul. The situation may, within the next five years, deteriorate to the point at which maintenance and rehabilitation are no longer possible. If this occurs, the only option will be costly and complete reconstruction. 3.9 Misallocation of Revenues. A large part of the funds generated by the transport sector are allocated to finance inefficient and non-competitive non-core activities. For example, the railway employs about 200,000 people to produce, on a force account basis, agricultural products, social services, or industrial products like locormotives. Officially, these non core activities are shown as profit making, but since they provide services or goods under non competitive conditions, the real cost of all these activities is unknown. A large part of actual transport- generated surplus is also misallocated to non-core activities. 3.10 New Modal Split. Traffic, which has contracted sharply, will be showing a different modal split than the traditional one. Reliance on road transport for international trade will increase when the economy recovers, following this worldwide trend. Current infrastructures have not been designed to take this factor into account. 3.11 Oversupply of Transport Infrastructure. With an infrastructure designed to handle seven times its current traffic, Ukraine faces a very high level of maintenance compared to its traffic levels. Twenty four airports receive less than 100,000 passengers annually, 80 percent of the road network has fewer than 300 vehicles per day. Without well-established prioritization techniques, the allocation of the scarce resources is subject to the action of pressure groups.  Transport Sector: Issues and Strategy 17 B. Strategy for the Transport Sector Recovery 3.12 The recovery of transport in Ukraine depends on the ability to (a) stabilize the current situation; (b) modernize assets and operations and (c) develop them to serve new transport demand. The three main components of this strategy are the following: a) Create an enabling environment - Transform the role of the Government - Streamline the legal and regulatory framework for trade and transport - Improve accounting procedures and financial management systems - Impose competitive procurement for state purchase - Impose sound investrnent policy - Organize a social framework to deal with rightsizing of staff b) Reach financial sustainability for state infrastructure in a commercial environment - Impose cost recovery mechanisms for state infrastructure - Liberalize prices - Deregulate the transport sector - Commercialize state transport services c) Corporatize transport entities and competitively privatize transportation services - Organize the financial restructuring of state transport entities (asset evaluation, inter enterprises debt clearing, limitation of barter practices) - Transforn state entities into independent Joint Stock companies - Privatize transport services activities. 3.13 The combined and properly scheduled implementation of this deregulation, price liberalization and financial restructuring of main enterprises as well as effective cost recovery measures will make the corporatization and/or privatization of transport services possible. This in turn will attract private investors. Such a strategy would generate new financial capacities and opportunities to implement a sustainable and realistic modernization and development program for the transport sector in Ukraine. Create an Enabling Environment 3.14 An enabling environment gives entrepreneurs the perception of fairness, openness and freedom from intervention, and sets the rules for true and fair competition. It does not include assurances of profitability. The subsidiary role of the state is a necessary condition, but is not sufficient. The successful commercial operation of the sector calls for a financial framework  Transport Sector: Issues and Strategy 18 suitable to sustain transport operations in a market economy and to mobilize financial resources other than public resources. Private investment resources will only take place within this framework. Key aspects of this suitable financial framework, some of which are already in place, are either macro-economic or transport specific. 3.15 Role of the State and the Government Size. A major change is expected to take place in the role of the state throughout the economy and in particular in the transport sector. The state would have to renounce its current role as the only significant owner, decision-maker and operator in most of the transport activities and would assume a different role instead. The state should move away from running operations and services, holding monopoly positions, and participating directly in productive activities. Its new role should concentrate on defining and implementing policies to: (i) ensure deregulated and transparent transport markets for goods and services; 6ii) allow price to respond to market signals; (iii) ensure a free and competitive transport market environment; (iv) divest from state monopolies through adequate privatization strategies; I(v) ensure the creation of an enabling business environment in the transport sector. This implies the need to define a new role for the Government vis-a-vis transport, where ministerial functions are (i) policy making; and (ii) international promotion of a dynamic sector, formulation and enforcement of safety and environmental regulations. Operations, construction and maintenance would then be functions performed by independent commercial entities across the sector, with increasing private-sector involvement. 3.16 Streamline Legal and Regulatory Framework. A major effort is required in regard to improving the trade and transport legal and regulatory framework (Chapter V). Such a framework should be defined in close cooperation with the private sector and with regional partners of Ukraine, including the EU. The streamlining should focus on : (i) assessing the need for state controls; (ii) reforming and harmonizing customs practices on the basis of the Kyoto Convention and WTO Agreements; (iii) adopting standard documentation that can be transferred automatically between computer networks, (iv) ensuring that the definition of liability, contract of carriage, sales contract, financial transaction schemes is harmonized with international commercial standards and trade practices; (v) facilitating international transactions; (vi) ensuring VAT exemption for transit; and (vii) assuring clear property rights and titling under the law. The streamlining should be accompanied with the definition of a regional IT strategy for Trade and Transport that would enable the introduction of regionally compatible systems throughout the transport chain. 3.17 Improve Accounting and Financial Management Information Systems. An adequate accounting and financial management framework for the transport sector has become an essential factor (Annex 3.1). It will support the sector to: (i) achieve good management perfornance; (ii) deliver efficient and financially sustainable transport services; (iii) mobilize resources and sustaLin operations in a market economy; and (iv) introduce private investment resources in the sector. Key aspects of an acceptable accounting and financial management framework for the sector, should be, as a minimum, the following: (i) generalize Generally Accepted Accounting Principles (GAAP) or equivalent; (ii) improve accounting systems and standards; (iii) introduce audit requirements and improve auditing standards; (iv) adopt financial disclosure requirements in compliance with IAS; (v) ensure that decision-makers and managers become independent and accountable under a proper incentive framework. 3.18 Introduce and Impose Competitive Procurement of Works, Goods and Services. In this transition period and before gradual privatization of transport operations occurs, in order to  Transport Sector: Issues and Strategy 19 appropriately reduce operating and investment costs, state owned entities should be required to introduce and generalize competitive bidding procedures for procurement of works, goods and services to be financed by public funding. 3.19 Impose Sound and Adequate Investment Policy. Direct government expenditure or public debt guarantees require a thorough evaluation of all possible uses for these resources against their benefits. It is necessary to determine the social and economic returns for each option, followed by a descending ranking according to the contribution of each to development. The cut- off rate (i.e., the rate of return below which projects will become ineligible for Government support), will be given by the level of resources available. It is the rate of return of the last project, which can be financed prior to exhausting the resources available. Only projects showing a return in excess of the cut-off rate of return will become candidates for direct government investment or benefit from debt guarantees. 3.20 Organize Adequate Social Framework to Deal with Rightsizing of Staff. Moving from a planned economy to a market economy will imply increased use of new technologies in the transport sector, such as increased containerization in the port Sector, which are unavoidable if Ukraine is to remain competitive in international trade and traffic. The transport sector will need to develop a well-conceived social framework and program to deal with the rightsizing of staff and the labor redundancies, natural consequence of the improvements in productivity sought. A key concern will be to avoid social dislocation and unrest, and to deal with the labor issue in a humane and equitable manner, with an emphasis on redeployment of surplus staff to other productive activities. As part of the stabilization program of the transport sector, a comprehensive labor rationalization short, medium and long term plan, including retrenchment package, redeployment and retraining programs is to be developed to mitigate adverse impacts on labor. Reach Financial Sustainability for State Infrastructure in a Commercial Environment 3.21 Impose Cost Recovery of Public Infrastructure. A well-functioning market system requires that transport users finally pay all costs they impose on the economy, including consumption of public infrastructure and other externalities such as, accidents, pollution, and congestion. The risks of loss of valuable infrastructure and mounting rehabilitation needs, accelerating de-capitalization from maintenance and renewal backlogs, obsolete equipment, shortage of spare parts are the significant issues faced by Ukraine and common to most FSU countries. Reliable, sound and adequate cost recovery mechanisms should be introduced to allow, in a competitive environment, through user charges, tariffs and fares, financial coverage of operating, maintaining, replacing and developing efficient transportation services and infrastructure in the sector. 3.22 Liberalize Prices. Pricing for transport services needs to be determined by the market. This implies a removal of administrative controls and adherence to a cost recovery policy. Although the stated policy indicates that the transport industry is to be run on a commercial basis, with freedom to adjust tariffs as necessary, in practice there remain discriminatory pricing, cross subsidies, and absence of cost recovery. Coupled with low productivity made worse by the contraction in economic activity, the net worth of transport enterprises has decreased. International transport prices should begin to approach those of European countries, on an equal basis.  Transport Sector: Issues and Strategy 20 3.23 Deregulate the Transport Sector. To be successful price flexibility needs to be accompanied by "transparency", i.e. equal and fair access to opportunities and information2, and freedom of entry and exit3. The aim of deregulation and liberalization of markets is to achieve these objectives. The areas where deregulation would assist the stabilization, modernization and development of the transport sector are the following: (i) liberalization of prices for goods and services which still needs to be formalized; (ii) opening of foreign trade; (iii) free access to transport activities; (iv) elimination of needless economic controls in the transport sector which is a source of distortions. The only regulations expected to remain or to be developed relate to rules for competition, safety and environmental standards. Deregulation should be accompanied with, the harmonization or compliance of fundamental transport legislation with existing transport legislation and standards of the European Union and other Western countries. 3.24 Commercialize State Transport Services. To ensure that all the business transport activities are run on a commercial basis, there will be a need to: (i) increase efficiency and reliability of operations; (ii) discontinue uneconomic operations and activities; (iii) intensify marketing efforts and client orientation. Corporatize Transport Entities and Privatize Competitively Transportation Services 3.25 Introduce Professional Valuation of State Assets and Define Adequate Amortization Policy. Although several revaluation of assets in the sector were implemented in 1995, 1996 and recently in 1997, it appears that a professional inventory, valuation of infrastructure assets, equipment and inventories and clear title establishment, will have to be performed, particularly, since privatization of productive operations would have to be envisaged. On another hand, government will have to ensure that periodic adjustments and appropriate depreciation and provisions policies are clearly defined and implemented to take into account economic and financial realities facing the sector. 3.26 Facilitate Inter-enterprises Debt Clearing and Limit Barter Accounting Practices. The government needs to help major state owned companies to straighten out inter-companies short term debts and to let poorly performing companies go bankrupt. Simultaneously the common practice of barter should be limited to avoid demonetarization of the economy, increased contribution to the informal sector, tax evasion and increased poor financial performance of the transport entities. 3.27 Privatize Transport Activities. The transport sector needs to be made an explicit element in the privatization strategy of the government. Active state presence in the productive activities tends to inhibit, weaken and in most cases, prevent the private sector from functioning, as it should. To do so, the govermment needs to decide, as a matter of policy, on the role of the 21 It implies the following: simplification of commercial legal codes applicable; contracting and procurement according to well known rules accessible to all parties; public bidding and notices of intent to procure required for all expenditures; and public appeal mechanisms to ensure that applicable rules are respected. 31 This implies that: permits, licenses, selection of routes and determination of levels of service need to be free of Govermuent intervention, other than actions necessary to enforce safety and environmental standards. Authorization to operate within the sector would become a right of those interested in doing so. In return operators in the sector would be obligated to provide relevant operational data and information to the State.  Transport Sector: Issues and Strategy 21 private sector in delivery of transportation services. Privatization implies the transfer of responsibilities from public to private sector. This transfer can take various forms (see Box 3.1), depending on the activities concerned, actual circumstances, the amounts involved, the entities selected and the timeframe for its implementation. When privatization is not applicable, competitive outsourcing should be applied. 3.28 All forms of private-sector participation are relevant for Ukraine, although, considering the financial context, those offering financing and efficiency gains would yield the greatest benefits. The experience of other countries, in transition economies, highlights some valuable lessons to help guide the definition and implementation of such a strategy in Ukraine. The government will have to focus on several large schemes of objectives. First, improvement in governance, commitment at the highest level of the authorities to private-sector involvement and clear transport policies. Second, elaboration of the most adequate privatization strategy, programs and action plans for each of the sub-sector within the transport sector. Third, development of the institutional, legal and regulatory framework enabling sustainable and competitive privatization process. Fourth, development of a well-functioning domestic capital market as Ukraine cannot just rely on foreign financing for the development of its transport infrastructure. Box 3.1.: Various forms of Private-Sector Participation in Infrastructure (PPI). First, private-sector participation to infrastructure can be encouraged through the use of management contract. These contracts represent the least ambitious form of private-sector involvement. Under these arrangements, a private contractor assumes responsibility for operating an enterprise for a fee, normally for a short period but does not contribute in financing investments. The setting of tariffs remains the responsibility of the government. The principal benefit of these contracts resides in increased operating efficiency associated with private operation. Second, the lease, like the management contract, aims at improving the performance of an enterprise and does not involve any investment financed by the operator. It differs from the former type of agreement in that it transfers the commercial risk to the operator and covers a longer period. It requires an agreement on tariffs. Third, under the concession or "Build-operate-transfer (BOT) arrangement, which can take several forms, the private partner finances and constructs new facilities, operates them and transfers them to the govermnent after an agreed period of time. Authority for setting tariffs is transferred to the concession holder, subject to certain rules predefined within the concession agreement. Fourth, the government can grant new entry to private investment in state-controlled sectors to compete with, or complement, an existing state enterprise. Unlike BOT schemes, new assets are not transferred to the state at the end of the contract period. The private investor remains the owner. With this arrangement, financing for investment is provided, but the performance of the remaining state enterprise does not necessarily improve. Fifth, privatization of a state enterprise is the most radical form of private provision of infrastructure. In addition to efficiency gains and financing of investment, these arrangements generate revenues to the government. The transfer of responsibility can be again done through various forms: sale of assets, sale on a turnkey basis with all assets and liabilities, sale of shares in a stock company. All these forms will have to be allowed under the Privatization legal framework defined by the Government.  Transport Demand and Future Scenarios 22 4. TRANSPORT DEMAND AND FUTURE SCENARIOS A. The Transport Sector in a Changing Economic Situation 4.1 In the transition from a centrally planned to a market economy, the transformations that would take place in the transport sector would be substantial. As observed in the road transport sector, the number of operators, clients and decision-makers would increase substantially. Initial beneficiaries of the opening and expansion of the sector would be transport users, operators and specialized commerce, and financial intermediaries. Of these, the operators may call for control of further entry to protect their initial market shares. As markets expand, new entrants join in the belief that they can beat the current cost structures. If so, the new entrants may lure away customers from first generation operators. The defense of the openness of markets would becorne one of the main new functions of the State in a restructured economy. 4.2 A freer transport sector would actually nurture and encourage entrepreneurial activity in other sectors. Small enterprises would be launched and significant amounts of labor absorbed. The main areas of expansion and growth would be trucking and bus transport, freight forwarding, regional aviation and to a lesser extent, railways. Recurrent maintenance and rehabilitation would not be dependent on the central govemnment budget, and would become a new market for a privatized civil works contracting industry. 4.3 The actual pace of economic reform in Ukraine transport sector has been at best unhurried. Under the program of reform underway, a continuation of this trend is not conceivable. Attempts to continue with old structures operating in markets with restricted entry and protected from foreign and domestic competition would be no longer possible. Public services would operate under cost recovery policies and in a competitive environment. As a result, unneeded investments and excess transport costs would be drastically scaled back, and expansion of sector output with consistent productivity gains would take place. B. Growth Scenarios 4.4 The growth scenario of the Ukrainian economy was developed during preparation of the CAS update recently approved by the World Bank. It reflects the adoption of a program of macroeconomic policies conducive to the opening of the economy and sustainable growth. Based on the Government's commitment to reform the transport sector and the possible speed of introduction and implementation of the needed reforms in the sector, three differentiated scenarios have been developed: (a) a prolonged status-quo scenario; (b) a Gradual Reform scenario; and (c) a Complete Reform scenario.  Transport Demand and Future Scenarios 23 4.5 Status-quo scenario. This scenario assumes the current economic and sociopolitical situation in Ukraine remains unchanged in the medium term (3-7 years). The fiscal crisis cannot be avoided, the Government does not succeed in restoring a sustainable fiscal balance and positioning the economy to restore growth. Most of trade and international transport activities would keep the same patterns. The current pace of reform in Ukraine's transport sector would remain slow and politically difficult. Economic recovery prospects, as measured by GDP growth, would be limited (less than 1 percent/year). Most transport sector entities, which already suffer from current lack of cost recovery and institutional reform, privatization or financial restructuring, would see their asset base continue to gradually erode. Slow changes in traffic demand in all modes would occur. Only timid growth in the limited number of private sector trucking and bus companies would take place. 4.6 Gradual Reform scenario. This scenario assumes that the targets of the reform programs supported by the IMF and the World Bank, already approved by the Government of Ukraine, would be fulfilled. Current reform programs would, therefore, be gradually accelerated, Government consumption and ownership reduced and investment levels would further increase as privatization takes hold. GDP growth would then reach between 2 and 3 percent annually. The programn of reform, privatization, institutional reforms and financial restructuring within the transport sector would be implemented gradually. Attempts to continue with old structures under the guise of privatization by means of joint stock companies operating in markets with restricted entry and protected from foreign and domestic competition would no longer be possible and changes would be decided and introduced gradually over the period 1999-2001. Transport enterprises would undergo a restructuring process and reach sustainable operations in an open, competitive transport sector. Public services not privatized would operate under cost recovery policies and in a competitive environment. Under this scenario, transport traffic would progressively increase in practically all modes, to reach GDP growth levels in the medium term. Growth in private road transport would be even sharper. 4.7 Complete Reform scenario. As the previous one, this scenario assumes that the targets of the reform programs supported by the IMF and the World Bank, would be fulfilled. Following the introduction of an accelerated economic reform program and a strong Government's commitment to its timely implementation, GDP growth would restart in 1999, would reach 3.5% by 2001 and average 5% from there onwards, with the possibility of sharper growth towards the year 2003. Such growth performance would be feasible provided that the expected significant change in the pace of economic reform takes place immediately. During this period, transport enterprises would undergo a timely and successful restructuring process and would reach sustainable operations in an open, competitive transport sector. Under these conditions, the fall in traffic would be arrested in 1998 and would be followed by an increase in economic activity and consequent output of the transport sector. Beginning in 2002 growth rates in the sector, consistently larger than 5% would be observed. 4.8 The Complete Reform scenario will be used throughout the report as the anticipated scenario. Figures 4.1 to 4.6 and Table 4.1 provide details about historic and projected transport demand developed under the Gradual Reform scenario. The effects of this scenario have been shown by contrasting modal detailed results for the Gradual Reform scenario against global results for the status-quo and Complete Reform scenarios. All details for all scenarios developed are given in Annex 4.2, Volume III: Detailed Scenario by Sub-sector.  Transport Demand and Future Scenarios 24 4.9 Status of VAT on Transit. If the exemption status on the VAT were not extended, Ukraine could face a 15 to 20 percent drop in transit traffic and export revenues. VAT on Transit operations has a temporary status of exemption until January 1, 1999. A careful in-depth analysis (costs/benefits) and proposals for the ne-xt steps on the VAT status for transit operations, aft'er this date, need to be carried out urgently, as the growth in trade turnover could be definitively hampered by inadequate decisions. This could deeply affect the transport sector, which could lose in an immediate future between 15 to 20 percent (minimum) of its actual traffic to alternative routes. Regaining this traffic, if ever possible, could take several years and considerable effort. Transit transport being an export could be seen as exempt from current agreements on VAT under the IMF program. Measure 9 of the EFF agreement in force refers only to "local transportation" as opposed to service exports (par 2.17). C. Historic and Projected Traffic 4.10 Freight. Between 1990 and 1997 total tonnage transported decreased by 70%. With a total decrease of about 73% between 1990 and 1997, the road transport's share in tons has dropped from 77% to 67 %. Despite an important decrease of about 66%, the railways share has been relatively stable at or about 15%, sea and river transport's has remained below 3%; and air transport's share has been insignificant throughout. Historically, the railways' share has been dominated by international traffic and by four groups of commodities within it: coal and colke, ores, black metals and construction materials. Railway traffic is vulnerable to competition from a liberalized road transport industry. Container transport represents only 0.5 percent of goods transported but has a significant growth potential (Annex 4.1). Figure 4.1. Historic Traffic, Freight, (Million Tons) 6,000. _ 4,000 2,000 1,000 1| 1990 1993 1994 1995 1996 1997 jjAr E1 Sea Ports * River Ports * Railways * Road C3 Pipeline 4.11 Passengers. The total number of passengers has decreased by 55% between 1990 and 1997, to about 6.8 billion passengers. The dominant mode has been road and urban transport with a stable share of more than 90%. Urban and suburban transport has decreased mainly due to a constant reduction in the number of available vehicles because of insufficient cost recovery.  Transport Demand and Future Scenarios 25 Figure 4.2. Historic Traffic, Passenger (Million) 14.000 | | l_ ___ | i i | . ,.| 12,000 l 10'000ll Ili_l 11 I 1 111 4,000 ll 2,000 0~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~0 o~~~~~~~~~~~~~~~~~~~o [ ]Air Sea Ports River Ports Railways * Road M Urban Transport 4.12 Forecasts. In the Complete Reform Scenario, freight traffic growth is expected to approach 2.5% per year from 1999 to 2001 and 4.5% per year from 2002 to 2005. Passenger traffic is expected to increase by 2% per year from 1999 to 2001 and by 4.5% per year from 2002 to 2005. Total tonnage transported is expected to grow 25% to reach 2.5 billion tons by year 2005, and the railways share is expected to remain at about 14% mostly owing to the continuing importance of heavy bulk products and their dependence on rail transport. Road freight transport s share would remain around 67%, with air, sea and river freight transport combined having a less significant share of about 5%. Passenger traffic would grow about 26% to 8.5 billion passengers. Road and urban transport's share in total passenger traffic would be more than 98%, while rail would come down to about 2%, if still existent. Air, sea and river passenger transport would retain a residual of less than 1%. Table 4.1 gives the detail of modal forecasts over the period 1998 2005.  Transport Demand and Future Scenarios 26 Table 4.1 TRANSPORT SECTOR REVIEW (Actual 1990-1997 and Projected 1998-2005) 1990 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 FREIGHT (min tons) Air 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Sea Ports 122 55 52 51 48 58 61 66 72 78 81 85 88 92 River Ports 66 25 20 13 8 2 2 2 2 2 2 2 3 3 Railways 974 532 408 360 343 334 331 326 321 317 324 330 337 344 Road 4,897 2,811 1,869 1,816 1,254 1,300 1,300 1,339 1,379 1,421 1,492 1,566 1,644 1,727 Pipeline 296 251 244 246 246 250 250 258 265 273 287 301 316 332 TOTAL FREIGHT 6,355 3,674 2,593 2,486 1,900 1,943 1,944 1,990 2,039 2,091 2,186 2,285 2,388 2,497 1990 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 PASSENGER (min pa ssengers) Air 30 15 10 4 4 3 3 4 4 4 4 5 5 5 Sea Ports 26 11 10 8 5 5 5 5 5 5 5 6 6 6 River Ports 19 8 7 4 3 0 0 0 0 0 0 0 0 0 Railways 669 502 736 577 538 506 469 384 315 260 227 198 173 152 Road 8,331 4,795 4,040 3,483 3,305 3,300 3,300 3,399 3,501 3,606 3,786 3,976 4,174 4,383 Urban Transport 5,917 3,406 2,869 2,742 2,914 3,000 3,000 3,090 3,183 3,278 3,442 3,614 3,795 3,985 TOTAL PASSENGE1 14,992 8,737 7,672 6,818 6,769 6,815 6,777 6,881 7,008 7,154 7,465 7,798 8,153 8,531 Source: Statistical documents all sources, Transport department, Railway, Sea and River Ports and Mission Estimates  Transport Demand and Future Scenario 27 Figure 4.3. Traffic Actual and Forecasts, Freight Figure 4.4. Traffic Actual and Forecasts, Passenger 6,000 ~~~~~~~~~~~~~~~~~~~~~~~~14,000 5,000 ~~~~~~~~~~~~~~~~~~~~~~~~12,000 inl 10,000 oomil _ lii 4,000 =_ - pa 8,000 to 3,000 s e r i =nSaPrs R i e o t ng - ie = ers 6,000 2,000 4,000 1,000 2,1000 0 ~~~~~~~~~~~~~~~~~~~~~~~~~~~0 1990 1993 119. 11516 199 ? 19i 98 1999 2000 2001 2002 20013 2004 2005 1990 1993 11994 1995 1996 199? 1998 1999 2000 2001 2002 2003 2004 2005 ~Ai'r Sea Ports ~ River Ports M Railways ~Air ~ ~ e ot RvrPrs iRiwy R_Road Pipeline 17 T c ailwRoad _U Urban Transport 1997 Traffic Figure 4.5.Traffic Forecasts, Freight Figure 4.6. Traffic Forecasts, Passenger 8,000 2,500 7,000 2,000 MI DO ooo pas ton Sen 5,000 s 1,500 ger 1,cenario0 1: Comprlete Reform: Gi#acIu~l _Srsef6rfio3SauQo cn i1ColtRfm_ e ro3ttsQ 500 1,000 0 0 1998 1999 2000 2001 2002 2003 2004 2005 1998 1999 2000 2001 2002 2003 2004 2005 ~~Air rmmm ~~~Sea Ports ~ River Ports Fe: ArRiver Ports on Railways AW Road Pipeline ~M=alasllllllllllllRa MMUrban Transport m* Scnario 1:- Complete Reform ~Scenario 3: Status Quo Scenario 1: Complete Reform ww~Scenario 3: Status Quo  The New Role of the Government 28 5. THE NEW ROLE OF THE GOVERNMENT Introduction 5.1 ECA countries have suffered, from the early sixties until the beginning of this decade, a worsening of their ability to transform inputs into outputs. During this decade and quite apErt from local and regional conflicts, countries able to move away from inherited legal structures and policies, have succeeded to different degrees in reversing this deterioration in cost effectiveness. Countries reluctant to welcome and implement change have not been able to restore growth. 5.2 The instrumental changes instrumental in restoring growth and competitiveness seem to point, in all cases, to a reduction of the role of Government with increased reliance on: (i) Commercial operations and the private sector; (ii) Fiscal equilibrium or close to it; and (iii) Development of legal frameworks, which do not dictate or interfere with production and consumption decisions. Otherwise, a vicious circle of lack of competitiveness, adverse trade balances, insufficienlt investments, and inability to serve debt is seen even in energy exporting countries. 5.3 In the transport sector, there seems to be only one choice to improve efficiency, which is to operate commercially across transport modes. The size of Government is likely to remain limited, owing to reduced economic activity and still ill defined tax bases. This in turn implies that regulatory controls and ownership would need to be relinquished. The MOT would evolve from a transport operator to a policy formulation and deregulation entity. As such it would assure the efficient delivery of transport services while monitoring and addressing safety, environmental and social impacts. 5.4 The MOT, is actively considering this transformation with the support of the EU. This Chapter examines the new role of Government as follows: (a) the guiding principles of the process; (b) organization of the MOT; and (c) Ministerial Functions. A. The Guiding Principles of the Change Process 5.5 The guiding principles of the new organizational structure are the following: (a) A Flexible and Light Structure. The nature of changes and evolution foreseen calI for a flexible and small structure capable of being responsive to the many unforesee:n obstacles to the change process. Preliminary proposals from the MOT on the staff  The New Role of the Government 29 level adjustment seems reasonable. The MOT should be able to contract out routinely additional high quality local or international experts as needs arise for specific and well targeted tasks. (b) Driven by Functional Analyses. The identification of functions needed to address a reform agenda is a priority. A detailed analysis of these functions, leading to their allocation to levels and positions, and defining interrelations between positions would be the starting point. This functional analysis may be adjusted on a regular basis to take stock of the evolving situation. The resulting MOT structure should ensure a well balanced distribution of work load between units, an adequate delegation of functions to enable the Minister to perform its overall task with appropriate technical support, and the specialization of staff. (c) Staff Selection. The staff recruited and assigned to the defined functions, should be motivated, technical, and willing to become active agents of change. The possibility to attract private sector transport operators should be considered, and recruitment for each position should be wide open. (d) Remuneration Reform. There is a need to introduce merit-based processes in recruitment, evaluation and promotion, and create an incentive structure to allow the Ministry to attract and retain qualified and competent staff. The retention of high profile individuals is impossible without a proper compensation, adequate compensation schemes and terns of employment need to be elaborated using private sector benchmarks. This would keep down staff rotation with the possibility to build and develop a core of newly selected staff. (e) Training and Staff Development. The expected rhythm of transport evolution makes necessary well targeted training programs in Ukraine and abroad. This training would enable newly recruited staff to take stock of the considerable experience in public sector restructuring worldwide. B. New Organization of the Transport Sector 5.6 The restructuring of the Transport Sector in Ukraine, as recommended in this report, affects significantly the role and functions of the Ministry of Transport with the transfer of operational responsibilities from the State to the private sector, via commercialization, privatization and divestiture of assets. The role in policy making of supra ministerial entities, technical advisors to the Cabinet of Ministers and modal agencies will disappear, as this function is taken over by the MOT itself. This transformation would be progressive over a transition period corresponding to the pace of sector reform that may be feasible. The new organization of the Transport Sector is described below on the basis of: (i) the elements of the restructured sector; (ii) the proposed organization of MOT; and (iii) the functions of the Ministry. The Elements of the New Organization 5.7 The six main elements of the restructured transport sector are as follows and require specific skills:  The New Role of the Government 30 (a) Public Private Partnership. The introduction of a streamlined legal and regulatory framework requires open institutions cooperating with the various parties involved in the creation and development of supply chains. These parties involve, without being limited to, industrial groups, forwarders, customs, various ministries, the banking and insurance sectors, transport operators, distribution centers, neighboring countries and any agency interacting with the trade process. The aim of this cooperation is to remove progressively unnecessary interventions and enable smooth trade operations. (b) Strengthened Economic Analysis. The allocation of investments, the selection of projects, and the determination of full cost recovery of public infrastructure to ensure their financial sustainability, call for strengthened economic analysis on the Government side. The increase in Government's accountability for the use of public resources will similarly lead to a need for public relations management supported by economic analysis. The new structure proposed by the MOT takes this element inito account. (c) Legal Expertise. The restructuring process needs to be accompanied by the development of new, though less invasive, laws and regulations. International integration, privatization, concessions, and increased outsourcing of activities will create a need for strengthened legal capabilities. (d) Financial Expertise. Financial expertise will be required to proceed with asset evaluations and to transfer these assets, services and responsibilities to the private sector. In the meantime, this type of expertise will be necessary to ensure proper depreciation levels and manage transport services still under state control. (e) Procurement and Contract Management Expertise. The contracting out of activities also needs resources allocated to managing the procurement process and related contracts between the Government and providers of goods and services. Proposed Structure 5.8 The Structure proposed (organizational chart is shown as figure 5.1 below) would include a minister, three deputies, three advisory units, initially four sub-sector departments, and regional secretariats. Ministerial functions, would be delegated for implementation to the units, department and regional secretariats. 5.9 The Minister's Office. Its tasks are those related to the exercise of the authority given under the Public Service Law on the Powers of the Executive Branch. It would include the creation of services and their operation, the representation of the country and its Government, the assignment of concessions and grants and definition of their characteristics, including concession period and its penalties; and coordination of sector policies with applicable State policies, and also other high State powers and tasks which may be assigned.  The New Role of the Govemment 31 Figure 5.1. Proposed Organizational Chart for the New MOT MINISTER nF.PIrrY M1NtSTF.R | | DEPUTY MINISTER ' ''~--1- --- | Administrative Unit ll Legal Unit l F Economic Unit Itemational Unit FIRST DEPUTY MINISTER Regional Ministerial Secretariats MARITIME AND LAND TRANSPORT AIR TRANSPORT ROAD RIVER TRANSPORT CONSTRUCTION AND MAINTENANCE 5.10 Ministerial Departments. While the Law on executive powers confers to the Minister of Transport the responsibility for the above functions, their actual implementation will be assigned to the different operating units of this Institution. These are: Air Transport Department (Airlines, Air Traffic Control and Airports), Land Transport (Buses, Trucks and Pipelines), Railway Transport (railway reform), Maritime Department (Ports, Shipping and Shipbuilding and Repairs) and Road Construction and Maintenance Department. 5.11 Three Advisory Units. Three advisory units would support the Minister's office in its daily activities : the Economic Unit, the Legal Unit and the International Unit. Each of these would have well defined responsibilities as described in Annex 5.1. The Economic Unit would notably assess and monitor the economic impact of policies or investments, formulate the budget of the Ministry and define accordingly infrastructure needs. The Legal Unit would prepare the legal framework for the transport sector and monitor its implementation. The International Unit would facilitate the international integration of Ukraine and its regional cooperation. 5.12 Administrative Unit. The administrative unit would have a traditional role in managing personnel, supplies, reception and dispatch of correspondence, management of the MOT budget, managing accounts of loans and contributions from international organization in coordination with the Economic Unit, and ensuring the operation of Ministerial facilities.  The New Role of the Govemment 32 5.13 Ministerial Regional Secretariats. The national role of the MOT explains the need to have representatives in the main regions and provinces. "Ministerial Regional Secretariats" staffed with officials functionally dependent from the Ministry and receiving their administrative powers from the local Government of the respective region would fulfill this duty. The denomination of the chiefs of these units will be "Ministerial Regional Secretary" and their status will be that of a representative of the Minister in the respective region. The staff of these units must be minimal and, basically, technical. Their task would consist in addressing routine problems that can be solved at the local level. C. Main Ministerial Functions 5.14 Program, Formulate and Implement a National Transport Policy and Strategy. The Minister will formulate transport policy and annually propose to the President of the Republic the programs that will be carried out in the transportation sector, indicating the unit responsible for each task, the intermediate goals of each one and the expected time for each stage. Progress reports will be formally issued at the end of each quarter. At the same time, the Ministry of Transport will inform the President of the Republic on the progress made. (The implementation of the policy will require the introduction of relevant regulations and removal of obsolete ones.) 5.15 Authorize Passenger and Freight Services, National and International. Each transportation service requires an authorization, explicit or implicit. In the case of passengers, in particular for international services, a procedure has to be established involving technical study units at the Department levels. The procedure should be fast and well defined following a policy of openness and freedom of initiative. The principles that should prevail are the following: "each person risks his own capital" and "the State must facilitate the growth of the supply of services". In the case of implicit authorizations, especially for national services, a general framework of basic reporting requirements is needed and each transport enterprise will have to inform the public at the beginning (and at the end) of the services that it is carrying out. Record Units within each Department will have to be organized to follow up. The unit should also maintain an updated record of assets and concede to foreign ships or planes the quality of national carriers if leased by Ukrainian companies. 5.16 Prepare and Implement International Transport Agreements. The significance of transit transport in Ukraine indicates the need for its rapid international integration via the ratification of transportation agreements. The reciprocity principle and acceptance of requests Ito create services from other countries where Ukraine could operate should be favored. The first objective for the Ministry is to obtain conditions under which Ukrainians may have appropriate transportation services, irrespective of whether they are provided by either local or foreign operators. In this case, the procedure is similar to those described for the authorization of the national services, but considering the agreements signed with other countries. The International Unit should be in charge of drafting, ratifying, monitoring and implementing such agreements. 5.17 Elaborate and Publish Annually Transport Statistics. In a restructuring process, valid information is essential to convince unions, public opinion and investors of progress made. Technical units of each sub-sector should elaborate relevant statistics. In general, the statistics of the means of transportation are obtained from those entities with which operators need to deal on a regular basis. In subsequent stages, after the development of tax rolls and data bases, these can  The New Role of the Government 33 provide reliable data on transport operations, starting from the "dispatch documents" which need to be enclosed with each transported freight. 5.18 Coordinate Transport Related Issues. The Minister will ensure the proper coordination of transport related issues with other Ministries and the cabinet. It will specifically focus on improving inter-modal coordination. In the interim, while state transport companies still exist, the Minister will report on these companies to the Cabinet of Ministers while keeping control by means of its technical units of the state transportation companies and on the impact of Cabinet-issued regulations on the state patrimony. 5.19 Present Relevant Budgets and Financial Statements to the Ministry of Finances. The official presentation of the budgets of the ministry and state transport Departments, and financial statement for state transport companies is another function that permits the proper allocation of public resources and control of the State companies. MOT and the Ministry of Finance would review each of these to ensure that public resource allocations coincide with the Governmental strategy. The budget presentation should be the occasion to introduce a cost recovery mechanism for maintenance and repair of state-owned infrastructure. 5.20 Carry-out Studies to Improve Transport Policies, Evaluate Transport Projects and Maintain a List of Projects with an Economic and Social Evaluation. The Economic Unit can carry out small studies, technical reports, have opinions or give technical advice. In some cases, these tasks may happen with the support or joint participation of other advisory units and/or the corresponding operating Department. More complex and specialized studies may be requested under contract from external individuals or companies, keeping in mind the requirements of its final audience. In these cases, the Economic Unit will be the counterpart of the external international or local companies and procure and manage the consultant's service contract. 5.21 Establish Economic (De)regulation for Tariffs and Competition. In the transition to market driven tariffs, tariff setting, and progressive tariff freedom for transportation services in Ukraine is a task that involves the whole ministerial organization. It includes the preparation of regulations that ensure a proper competition between modes. The sub-sector Departments will know the specific tariff framework of the services they are responsible for. The Economic Unit will know the price variations of the main raw materials. Based on this knowledge, the Minister will be given a suggestion. Once prices become free in a liberalized environment, the system generates its own self-control and this function reduces to recording observed real prices. At this point, the improvement of safety levels, environmental protection and competition levels in order to generate effective and efficient services at lowest prices become the only concerns. 5.22 Elaborate Legislative and Normative Acts for Adoption by Parliament. The Ministry sets up regulatory rules and procedures covering the agents operating in transport activities. It seeks to assure that the collective performance of these agents would be consistent with the economic, social, development and safety policies that the Government may define for the country and for the sector. This ministerial attitude means a permanent revision of its activity and adaptation to the new situation. 5.23 Set up and Implement Licensing of Transport Services and Inspections. The Ministry ensures the implementation of regulations. A number of licensing requirements and inspection on staff and equipment used in the provision of road, air and maritime transport  The New Role of the Government 34 services are needed to ensure a limited impact on environment and a reasonable level of safety. Corresponding regulation needs to be designed. In the case of reiterated or serious deviation, it may be necessary to consider suspensions and cancellations of the authorizations to the provider of such transportation service based on a study by the corresponding sub-sector Department. 5.24 Implement Policies on Fiscal Subsidies in Transportation Services. The State has some overarching functions related to minimum subsistence levels of the population, sovereignty and geopolitical integrity of the country. Due to this, in some cases, the continuation of some transportation services corresponding to a universal service obligation may be recognized. These services are defined at the highest political levels of the country such as the President of the Republic and subject to parliamentary approval. The Ministry of Transport will be the organization that will implement such actions, through the sub-sector Departments and the Economic Unit (by the budgetary task) and the Administrative Department (by the accountable management of Ministerial resources). 5.25 Public Investment Policy and Investment Planning. The State must retain the function of defining priorities in constructing or maintaining transport infrastructure, improving the design and/or conditions of some existing transport axes based on transport user needs. In Ukraine, the MOT is responsible for transport infrastructure, and as such is in charge of establishing project priorities and optimizing the use of existing assets. The Economic Unit of the MOT is the entity responsible for this task in accordance with modal agencies' requirements. 5.26 Contracting out and Managing Public Funds. The MOT, using its modal departmenits is responsible for the appropriate use and management of public resources whether collected from the general budget or from user charges. It includes the use of appropriate competitive bidding procedures.  Transport and Trade Facilitation 35 6. TRANSPORT AND TRADE FACILITATION 6.1 Ukraine faces excess costs linked to trade and transport on the order of US$2,700 million, or 6 percent of the country GDP, per year. A review of barriers to trade and transport shows that inappropriate legal and regulatory framework, restrictive practices, lack of professional training in modem trade and transportation techniques, as well as general uncertainty prevailing in the business environment, constitute the most substantial sources of excess costs having a bearing on trade development. Infrastructure, except for the road network, which is in a state of disrepair, constitutes only a secondary obstacle to trade and transport. 6.2 Methodology. This chapter reviews barriers to trade and transport on main transport modes and corridors, from the viewpoint of Ukraine and from that of its trading partners. The indication of significant excess costs resulting from macroeconomic comparisons are confirmed by an analysis of barriers and associated excess costs that affect the trade and transport chain in Ukraine. Barriers and excess costs are studied successively for: (i) customs, border crossing and documentation; (ii) modal aspects; (iii) security, risk and insurance; (iv) credit, taxation and trade protection measures; and (v) corridor development. Estimates offered are based on international comparisons, interviews with govermment officials and transport operators, and existing studies. Corrective measures are presented along with each major barrier. Orders of magnitude for the costs of these corrective measures are suggested, although pre-feasibility studies and budgets would be required to refine such estimates. 6.3 Macro Economic Comparisons. Excess costs associated with transportation operations can be estimated at US$1,682 (or about 4.8 percent of total export and import values) or US$2,874 million (or about 8.2 percent of total export and import values), whether non transport services are included or not. According to IMF Balance of Payments (BOP) data for 1997, country exports and imports of goods amounted to US$35,041 million. For the same year, total transport expenditures associated with these transactions amounted to US$4,505 million, adding 12.8 percent to the transactions cost. Inclusive of communication, financial and other services associated with these transactions, the total charges increase to US$6,388 million, adding 18.2 percent to the transactions cost. These percentages are high in comparison with average European figures, which are in the order of 8 percent and 10 percent respectively4. As far as international trade is concerned, excess transport costs reach about 3.8 percent of GDP, while combined transport and services costs amount to 6.5 percent of GDP. These estimates are conservative since they do not fully account for excess transport costs due to inefficiencies affecting imports and transit trade, which are accounted for in the countries of origin of the shipment. 4calculated on the basis of IMF Direction of Trade Statistics Yearbook, focusing on Exports and Imports from Europe (as a whole) to Developing countries (as a whole).  Transport and Trade Facilitation 36 Total Excess Costs of Barriers and Costs of Recommended Corrective Actions 6.4 The source of trade and transport inefficiencies can be directly or indirectly related to risk management in an unstable and short-term oriented environment. Excess-costs associated with each of the large number of barriers identified (Table 6.1) confirm the order of magnitude from macroeconomic comparisons. A number of low cost corrective actions are recommended. They are aimed at setting up self-sustaining processes to offset excess-costs and establish an environment conducive to enhancing trade and the flow of merchandise across the country. T he nature of the corrective measures is such that considerable national effort must be mustered to help put them under way, adopted and implemented. Table 6.1. Excess Cost and Cost of Corrective Measures5 Barriers Estimated Excess-Costs Cost of Corretive Measures6 (in US$ million per year) (US$ million) 1. Customs, Border Crossing and 745 23.5 Documentation 2. Modal Inefficiencies 1005 21.0 3.Insurance and Security 200 0.3 4. Credit, Taxation and Trade 720 5.0 Protection 6. Transit Opportunities (400) 1.5 TOTAL 2670 50.0 A. Customs, Border Crossing and Documentation Direct Excess Costs 6.5 The total cost of border crossing inefficiencies was estimated at US$745 million. Road, maritime and air transport sectors are the modes primarily affected by these difficulties. In the road sector, an estimated US$530 million7 is wasted in waiting time for trucks at border crossing (Box 6.1) due to improper facilities and procedures, to which US$40 million should be added to include cost imputable to customs and documentation. In the port sector, procedures in place are responsible for excess cargo dwell time in ports averaging 10 working days leading to am estimated US$175 million in financial costs. In the air sector, the low level of traffic may be related to stringent customs control. In addition to these direct costs, unpredictable border crossings prevent the provision of reliable and timely transport services from and to Ukraine, and 5The accuracy of these figures falls within an estimated range of 10 percent. This table was not developed for the purpose of cost-benefit analysis. 6 Corrective measures costs refer only to international inputs required to support their development. Costs of govemment officials redirected or engaged in their design and implementation should be accounted for in the budget of each relevant agency. 7Based on a daily value of ECU 1,000 for Westem Truck and ECU200 for CIS trucks.  Transport and Trade Facilitation 37 explains the loss of competitiveness of Ukrainian Transport corridors and reported transit traffic losses. Box 6.1. Border Crossing Delays. In the road sector, unpredictable long queues and waiting time at border crossing prevents the reliable and timely delivery of goods from or to Ukraine. Delays at major Ukrainian border crossings are still high, although the situation with this respect is reported by the State Customs Service to have considerably improved. Due to inadequate access roads, to under-dimensioned customs facilities, and to inadequate procedures, waiting times at major border crossing points vary usually from 8 to 16 hours and reach up to three days, even when all documents are in order, while 20 minutes should be sufficient. Difficulties for long range transport are compounded by additional delays between Eastern European countries that considerably extend total travel time making it prohibitive to transport to or from Ukraine. For example trucking between Kiev and Paris takes 6 days in average, but could be reduced to 2 to 3 days with proper border crossing. Issues 6.6 Inappropriate Procedures. Existing procedures are lengthy to implement, change without prior notice, fragmented among too many ministries and state agencies, incomplete, vague and full of exceptions, leaving room to arbitrary decisions. Examples abound especially in multimodal transport (Box 6.2). Customs examine every consignment as part of anti-smuggling activities covering cigarettes, alcohol, electronic goods, ghost goods, drugs and nuclear material. This has proven very ineffective compared to risk assessment with computerized techniques and with the use of specialized mobile teams. The time consuming procedure to obtain customs approval to load export goods is conducted in advance at inland customs houses and subject to the arbitrary decision of customs to control or not the loading. Reportedly, shippers leaving from Europe need to check the procedure and documentation required prior to each shipment departure, even though retroactivity and insufficient publicity prevails. Dues must be separately paid to every Ministry imposing inspection. Inspectors do not respect seals of containers under TIR despite international conventions. Customs practices in air transport are similarly regarded as a major cause of traffic diversion away from Ukraine. Box 6.2. Excess Costs for Container Transport. Without calculating the total excess cost caused by waiting times for freight transport or the loss of customers as a result of bureaucratic procedures, a minimum of US$60 million direct excess costs related with this process can be identified. The paperwork for international transport of a container or full truckload costs about US$300 - US$400. To this cost, various additional charges linked to state control during the handling of one container can be valued at more than US$125 (customs control: US$50; sanitary control: US$10; radiological control: US$12; etc.). In 1997, about 500,000 international border crossings have taken place by Ukrainian and foreign trucks. An achievable saving of 30% of this paperwork would mean that costs for international road transportation would be reduced by more than US$52 million. Customs regulations in Ukraine oblige a carrier to hire a customs escort from the port for special cargoes with destination Russia. This service costs US$750 - US$ 1,000 per container. According to the port statistics for 1997, 740,000 tons of cargo have been handled by the Ukrainian seaports, which correspond to approximately 60,000 containers. Almost 60% of the containers (35,000) are in transit. If we suppose that this escort service is required for 30% of the transit containers, canceling of this service would imply a total saving in transport costs of US$10 million.  Transport and Trade Facilitation 38 6.7 Import/Export Regulation. Importing into Ukraine is complicated by considerable paperwork requirements. Goods to be re-sold in Ukraine are assessed high value-added import and, if applicable, excise tax. Export and import controls frequently vary. Goods subject to import licensing include: agricultural chemicals, pharmaceutical products (except dental materials and sutures), veterinary medicines, cosmetics, and hygiene products. Licenses are granted through the Ministry of Foreign Economic Relations and Trade. They are issued in coordination with various Administrations. The mandatory escort for excise cargo in transit increases transit cost by 50 percent. 6.8 Limited International Integration. Ukraine is only the contracting party of the Customs Convention on Containers (1972) and the Customs Convention on the International Transport of Goods under cover of TIR Camets of 1975. These conventions have not even been fully implemented and translated into national laws and procedures to make them legally enforceable instruments. 6.9 Difficulties under TIR Regime. Difficulties are frequent in Ukraine with the TIR system operations. They are encountered with respect to the verification of applicants credibility, finding guarantors for high value consignments, enforcement of guarantees, bringing irregularities to attention, setting penalties for non-compliance, conducting these activities away from border crossings. As a result, seals of truck transiting under TIR carnet are frequently opened by customs, breaking irremediably the transit chain. The procedure governing letters of guarantee required for transit shipments from a Ukrainian port to a Russian or other neighboring counttry destination, is unsuitable with insufficient guarantees, lengthy and complex claims on guarantor, and the scope prevailing in the present system for fraudulent activity to go undetected. 6.10 Governance Standards. The economic contraction with drop in living standards over the last few years is conducive to petty corruption, and provides little incentive to reducing the long queues. Some customs officers are reported to request larger quantities of samples than seems reasonable. "Confirmation" documents and requests are improvised. Inaccurate weight- bridges are often used leading to unwarranted fines. Privatization of some customs operations, to be conducted by internationally renowned organizations such as SGS, should be considered. 6.11 Private-Public Interaction. The current system and its frequent changes are imposed to the private sector, without prior consultation. There is no proper partnership between public and private sector, where both parties would mutually benefit from their actions. Officials are not responsible for the delays they cause to ship departure, cargo transfer, and down-time suffered by vehicles, whether these delays are justified or not. The cargo owner is solely liable for these costs. Officials are not able to communicate in foreign languages and demand time-consuming and costly translations. 6.12 Rail Documentation Barrier. The major obstacle to free passage of goods by rail between neighboring counties lies in the documentary and administrative procedures necessary to hand over train control from one system to another. However, customs controls of train shipments are less extensive than for road transport, as the railway companies deal with fewer consignees. 6.13 Freight Forwarding. Freight forwarding as a profession is still in a developmental stage. Most local freight forwarders act only as customs clearing agents, and not as principals taking charge of the shipment from door-to-door. They do act however as facilitators to obtain  Transport and Trade Facilitation 39 trucking service from all-powerful trucking co-operatives, but they do not take responsibility for the shipment on the most risky leg of the itinerary, once it is transferred to a truck from a port, airport or railway. 6.14 Infrastructure Barriers at Border. Existing border crossing points with Poland Hungary and the Slovak Republic are in need of repair to be used to their full potential. In particular, in the case of the border with: (i) Poland, the crossing at Dorohursk, which serves Lublin in Poland has constraining infrastructure in Ukraine; (ii) Hungary, Zahony, on the Fifth Crete Corridor, is a serious bottleneck for traffic to and from the Ukraine due to a bridge in need of structural repair; (iii) Slovak Republic, Vysne Nemecke, on the sixth Crete Corridor, has witnessed a serious traffic decrease in recent years, due to uncertain economic conditions in Ukraine and despite new freight facilities recently built on the Slovak side. Cost of Corrective Measures 6.15 Customs, Documentation, and Legal Aspects. Several corrective measures listed in Annex 6.1 can be developed and implemented by an internal working group within the Customs organization, led by senior Customs officers. Some external assistance can be made available to explain existing international systems. The estimated overall short-term costs to address these corrective measures, including training of senior officers, is US$500,000. The cost of the process of adjusting to the changes cannot be determined, but it will be offset by rapidly accruing benefits. 6.16 Physical Improvement of Borders. An estimated US$22 million will be required to improve physically border crossings knowing that some of these upgrading works are under implementation. The US$22 million are subject to revision in light of a new EU TACIS study. The US$22 million would be distributed as follows: (i) Zahony : US$2 million (short term) to repair the border bridge, and US$5 million (medium term) to establish joint working facilities and construct new truck terminals; (ii) Vysne Nemecke: reestablish joint agreement and construct a joint truck terminal there at US$5 million (medium term); (iii) Border crossings of secondary importance: improvement for US$15 million in the medium term (Siret at the Romanian- Ukrainian border, and several others on the borders of Belarus, Romania, Russia, and Moldova, North South corridor). B. Modal Inefficiencies Direct Excess Costs 6.17 Aside from border crossings and documentation, the quality of infrastructure, the quality of service provided and the organizational set up of the sector create a serious burden to shippers estimated at US$1,005 million annually. 6.18 Excess Distribution Cost. Truckers' low productivity is estimated to cost US$25 million. The impact of road condition on average speed and cost of transport are not included in the above figure. On the basis of an average freight delay of 21 days on the rail transport chain, the financial excess cost was estimated at US$175 million. Excess costs associated with waterway transport were estimated at US$5 million. To these could be added indirect costs due to the  Transport and Trade Facilitation 40 inappropriate modal distribution of ponderous goods between rail and river transport. Excess costs linked to air transport were estimated at US$50 million, inclusive of traffic diverted. The cost of failing logistics in Ukraine amounts to an estimated US$750 million including US$690 million in forgone trade and losses of agricultural products alone. Box 6.3. Logistic obstacles affecting export of agricultural products. Logistic impediments mostly affect transport, trade, sales and distribution of agricultural products. Shipping distances for var;ious agricultural products range from a few kilometers to thousands of kilometers. Agricultural production is carried by local (mostly automobile) transportation and by national networks (rail, water, and, to a lesser extent, air). Long distance carriage of agricultural products (over 500 km) is mostly by rail. After the breakdown of the Soviet Union, traditional agricultural product routes and traflic volumes have been disrupted. Substantial losses of harvested crops and meat and dairy products are observed. Unsouand delivery and storage systems now cause severe deterioration of transported products. The absence of forwarding services and competition among hauliers often result in carrier irresponsibility. Export controls and their uneven application actually prevent marketing efforts. Lack of monetary incentives lead to spoilage, loss of quality and inefficient operation of available means of transportation. Logistical chains and computer systems for managing, controlling and haulage are essentially absent. Cargo pre-shipment cooling, grading and packing are inadequate. Quality control is absent. Appropriate storage and refrigeration facilities at handling points are scarce. Goods delivery is slow. The unsatisfactory condition of the network of rural Motorways reduces the efficiency of agricultural production and results in the loss of products before transportation. Most rural roads are almost impassable, particularly in the spring and autumn when the need for these roads is acute. Railways lack special-purpose rolling stock, in particular grain-carrying cars. The structure of refrigerated cars does not meet the requirements for carrying perishables in separate batches. There is a shortage of single, self-contained refrigerated cars, while refrigerated containers are virtually non-existent. Water transportation has insufficient reloading capacities. This results in downtimes for railway cars and ships with cargoes, and in the loss of goods. Organizational / Institutional Barriers 6.19 To a large extent, the condition of infrastructure, price inefficiency and poor quality of services presented in Annex 6.2 are a direct consequence of the organizational set up of the sector, which did not stimulate the development of commercial strategies or internal competition. 6.20 Insufficient Competition. Management orientation to marketing activities like searching for clients, maintaining their loyalty by offering competitive tariffs and building up partnerships, and encouraging investrnents are starting to emerge. Incentives for active competition are limited, and ports coexist rather than compete. Privatization of port activities, including stevedoring, is not vigorously promoted within the framework of the present legislation. Ports fall under the "Law of Industry", which does not cover shipping lines, customs, local authorities, or land ownership. The changing regional environment with increasing competition from Russian and Romanian ports may accelerate the pressure for quick reform and commercialization. Some positive signs can be noted, such as the opening of Ilyichevsk port to foreign operators (including Maersk, Sealand and CMN) or Odessa where the two main shippinig companies are ZIM (Israel) and CMA (France). 6.21 Regulated Tariffs. In maritime, urban and rail transport, regulations prevent the managing authority to adopt commercially driven tariffs on the ground of higher national interest  Transport and Trade Facilitation 41 or social impact of tariff adjustment. While these arguments are important, the system in place leads to uncontrolled subsidies benefiting segments of the population that are not necessarily the poorest and to a perpetuation of uneconomical activities. Regulated tariffs also affect the normal modal distribution of traffic. Thus subsidized transport of ponderous materials via rail are identified as a major cause for river transport atrophy, although river transport is known to be far more adapted and cost efficient under normal market conditions. 6.22 Restrictive Practices. Barriers to entry abound in Ukraine. The granting of licenses enabling truckers to drive in foreign countries is conducted on a preferential basis and leads to a black market of licenses accompanied by waiting delays. Foreign ships, apart from German and Austrian are not allowed on the Dnieper river, leading to a de facto monopoly by a private Ukrainian company, Ukrechflot to navigate on this major waterway, and which it chooses not to do. Corrective Measures to these Modal Inefficiencies 6.23 Modal Measures. The strategy and measures related to each sub-sector restructuring are developed in their respective chapters. Closely related to modal measures are actions to foster multi-modal transport. Multi-modal Transport Measures (Annex 6.3). The policy framework fostering competition also leads to optimal integration of various modes and the development of multi-modal transport. The Convention on International Multi-modal Transport of Goods (1980), provides good guidelines for the creation of national legislation in this matter. A network of privately operated terminals with open access to all companies is by far preferable to a larger number of dedicated terminals with restricted access and use. Terminal operators offer five types of services: transshipment services; load unit services; vehicle services; network services; cargo services. The feasibility for such independent operated multi-modal terminals deserves further study including the possibility to attract private investors in necessary capital investments. Regional Coordination. An international and regional approach is necessary in respect of the freight terminals. Measures are required to promote: (a) the establishment of an efficient inter-modal network; (b) technical and organizational standardization; (c) qualitative minimum service requirements; (d) choice of location of new terminals. An exchange or joint use (pool or reciprocity contract) of wagons (containers/wagons) by various transport operators in the network should be established. 6.24 Logistic and Management Measures. The program would include the establishment of training for Ukrainian agricultural logistics and transportation workers in Western Europe, as well as in Ukraine to make them familiar and conversant with conditions, procedures and techniques prevailing in market economies. It would be supplemented by long-term on-the-job training of qualified transportation personnel in transportation firms of Western Europe. In parallel, the introduction of the profession of combined shipment agent and free access to freight transport services, e.g.: in the agricultural sector, should be implemented. 6.25 Cost of Corrective Measures for Modal Inefficiencies. The estimated cost of measures would be US$ 21 million, with US$10 million applied in the short term to improve multimodal facilities and the remainder used to finance technical assistance as outlined in Annex 6.3.  Transport and Trade Facilitation 42 C. Security, Risk and International Insurance Assessment of Inefficiency Costs 6.26 Excess costs falling under this category amount to US$200 million and stem from two sources, namely loss and damage frequency, on the one hand, and avoidable excess insurance premiums due to the legal structure of the industry, on the other hand. Assessors have stated thlat losses or damages affect 15 percent of the shipments they are called to inspect. The high occurrence of corruption, losses and pilferage can be estimated as causing between 1 percent to 3 percent increases in insurance rates, leading in the 1 percent hypothesis, to a total of US$160 million. Kiev local representatives of a large international insurance company estimated higher insurance costs resulting from legal constraints bearing on the insurance industry. Their figures were corroborated by freight forwarders, and amount to 1.33 percent of insured export values, leading to an excess cost of US$40 million. (Annex 6.4 discusses the issues involved) 6.27 Corrective Measures. The two major actions required are: (a) liberalizing insurance laws with respect to foreign trade, removing the obligation for them to insure through a Ukrainian company; and (b) further regulating and consolidating Ukrainian insurance companies in order to increase their capital and reserves, raise their credibility and make them competitive with foreign ones, thus limiting the need for re-insurance. 6.28 Creating transport insurance systems is one of the priorities for Ukraine in promoting containerized transport. In a privatized transport sector, the problem of liability is of serious concern for the shipper and the carrier. Especially in the field of inter-modal transport, respective responsibilities and consequent liabilities are often unclear and difficult to assign. The definition of liabilities and harmonization with international standards8 are critical. 6.29 Cost of Corrective Measures. These corrective measures require 25 man-months of technical assistance estimated at US$300,000 for their design and implementation in concert with expatriate experts, insurance company professionals and management consultants. The aim is: to review the insurance industry framework in Ukraine, to restructure freight and transport insurance components, to harmnonize them with European standards, to make them consistent with reform and additions to be brought to the system of international Conventions accepted by Ukraine, and to reduce costs incurring to shippers all along the transport chain. s The draft Handbook for Multimodal Transport for Officials and Practitioners (UNCTAD, Geneva, 1995) may serve as a tool for adhering practices in risk allocation and insurance systems in international intermodal transport.  Transport and Trade Facilitation 43 D. Credit, Taxation and Trade Protection Measures Direct Cost 6.30 The number, the bureaucratic complexity and the stringent character of the credit and currency regulations constitute a severe obstacle to trade transactions, estimated at US$720 million. When these regulations do not discourage business, they increase the time and costs of conducting both export and import transactions. According to the freight forwarders, the excess cost resulting from these obstacles is of the order of 2 percent ad-valorem and applies to exporters and importers as well, irrespective of their trading partners' geographic location. The various restrictions on credit and on opening accounts abroad prevent traders from obtaining low interest loans and leasing contracts available abroad. This results in limiting the possibility of acquiring goods and services, e.g., foreign transportation vehicles more efficient than those available in Ukraine and allowed to be driven throughout Europe. The high level of commercial lending interest rates makes exports sensitive to delays, as delivery delays translate into payment delays. Exporters from Ukraine are most affected, as they are submitted to at least 40 percent annual borrowing rates. Credit and Finance Issues 6.31 Ukrainian banking is unstable and in a transitional period. Foreign investors are confronted with difficulties in transferring funds both domestically and internationally, in converting currency, and in repatriating profits in foreign currency. The Ukrainian banking system consists of the central bank, the National Bank of Ukraine (NBU), and commercial banks of various classifications. Two state-owned banks (Export-Import Bank of Ukraine and Oschadbank, the Savings Bank of Ukraine) along with three former state-owned banks hold more than 90 percent of the assets, branch locations, and personnel engaged in Ukrainian banking. 6.32 Currency Restrictions9. The use of foreign currency for cash payments on the territory of Ukraine was prohibited as of August 1, 1995. Enterprises with foreign investments are permitted to keep 100% of hard currency revenues generated through the export of goods or services which qualify as their "own production". All other Ukrainian legal entities would be required to sell 50% of their hard currency revenues for Ukrainian currency to an Ukrainian commercial bank. Currently, the official exchange rate, auction rate, and "street" rate move closely together. According to the Foreign Investment Law, the exchange rate for converting foreign investments into Ukrainian currency shall be the rate established by the National Bank of Ukraine. Current legislation stipulates that Ukrainian currency is the only legal form of payment on the territory of Ukraine. 9 Currency decrees stipulate that individual licenses have to be obtained from the NBU to carry out operations relating to the following cases: (i) use of hard currency in the territory of Ukraine as a form of security; (ii) a resident of Ukraine opening a bank account abroad; (iii) a resident making an investment abroad; (iv) obtaining or granting of loans in hard currency by a resident of Ukraine; (v) making hard currency payments abroad from Ukraine, except for payments abroad in hard currency, which are carried out by residents in order to fulfill obligations in such currency to non-residents in connection with payment for goods, services, works, and intellectual property rights.  Transport and Trade Facilitation 44 6.33 A Cash Economy. Due to a combination of delays, changes in market conditions, shlifts in regulations and taxation rules, as well as high rates of interest, it is not unusual that consignees go bankrupt or disappear by the time the consignments are delivered. In such cases, the freight forwarder cannot recover his expenses even if he chooses to take ownership of the shipment, vith all the liabilities attached to it. This very real threat makes it necessary for carriers and forwarders to request advance payment, often in cash, a major impediment to trade development and increase in the transaction cost. This business practice partly explains that prices which consumers have to pay for imported goods are comparatively high. It also allows entry only to dealers having cash or access to credit, and thereby reduces export opportunities as well. Given that the shipper has to bear the brunt of theft and delays consequences, the risk of doing business becomes prohibitive. 6.34 Limited Credit Access. Credit to the private sector is scarce, as commercial banks remain risk-averse; the spreads between lending and deposit rates are high and loans are mainly short-term. In late 1996, the NBU's refinancing rate was 40 percent, a considerable decrease from previous levels as inflation continues to decline. Commercial bank rates have also come doNvn. The majority of commercial bank loans are for ninety (90) days or less, with most terms being thirty (30) days or less. This precludes loans from Ukrainian cornmercial banks for virtually any transaction -- a major problem affecting a wide range of business in Ukraine. Ukraine has adhered to a number of international legal instruments pertaining to international payments via checks, bills of exchange, letters of credit, and collection arrangements. The safest method for an expoiter to Ukraine of receiving payment for an export is through an irrevocable letter of credit. A number of banks are members of SWIFT to provide clients with international payment transfer services. 6.35 Taxation Issues. The Ukrainian tax systeml' remains far from coherent, and seriously increases the cost of doing business. Ukrainian and foreign enterprises must pay taxes quarterly. Many foreign companies have complained about the confusing and contradictory nature of the Ukrainian tax system. Tax resolutions, orders, decrees, and laws are adopted from various branches and agencies of the government, with little to no coordination. Conflicting laws, spotty enforcement, and understaffed and poorly trained agencies combine to allow tax evasion and cause businesses to retreat to the shadow economy and discourage new business development and investment. The Law on Value Added Taxes and the Law on Business Profits were passed by Parliament during the first quarter of 1997, providing for a more favorable VAT and corporate tax. 6.36 Taxation as a Trade Barrier. The combination of a value-added tax (20 percent), import taxes (ranging from 5-200 percent) and excise taxes (10-300 percent) presents a major obstacle to trade with Ukraine. The VAT is levied at 20 percent and is generally payable at the time of customs clearance by the importer. A limited number of goods, as well as a number of agricultural enterprises, are exempt from value added taxes. The 1996 tax package limits VAT exemptions and transforms the VAT from essentially a turnover tax into a true value-added tax. The payment of excise duties should be made in Ukrainian currency at the exchange rate effective on the day of payment. New excise duties for alcohol, tobacco, and automobiles are not calculated by their customs value, but rather by volume, units, or weight (engine volume, in the case of automobiles) imported into Ukraine. 10 The overall Ukrainian tax structure is as follows: 15 percent bracket: for agricultural enterprises serving agricultural producers; 30 percent bracket: general corporate tax rate for a wide range of business entities; 45 percent bracket: for intennediate (commerce and trade) operations; and 60 percent bracket: for gambling and lotteries  Transport and Trade Facilitation 45 Credit, Taxation and Trade Protection Measures-Corrective Measures 6.37 Free Trade Agreements. Ukraine needs to ensure its rapid international integration. Negotiations for a Baltic Sea cooperation agreement and the establishment of a customs union with Moldova should be accelerated. Ukraine intends to become a full member of the Central European Free Trade Agreement (CEFTA), which is predicated on Ukraine first becoming a member of the World Trade Organization. Efforts towards accession to these bodies should be supported. 6.38 Payment Procedures. The mechanisms and instruments to effect payments in Ukraine are limited. Several measures listed below would change this situation, all these mechanisms are found in well functioning markets and are part of an enabling environment for business activities: * Remove import licenses, i.e., make foreign exchange available on the same basis for all imports. * Eliminate market access restrictions for financial products not effectively delivered by domestic provider, such as credit insurance. * Ensure that current laws and regulations affecting trade finance, insurance and international payments are consistent with accepted international practices. * Ratify and implement international Conventions, including the Convention on International Financial Leasing and the United Nations Convention on International Bills of Exchange and Promissory Notes (which addresses payment instruments used in international trade). * Ensure that exchange control regulations do not inhibit the use of current financing and payment techniques. * Develop control procedures that address non-bank providers of export finance, such as invoice discounters. - Allow the use of foreign exchange earnings to purchase modern financial products that enhance their competitiveness but are not available locally. D Promote the concept of factoring"I and cross border leasing. * Provide loan facilities for discretionary working capital to small and micro-enterprises. Cost of Corrective Measures 6.39 The cost of these corrective actions is difficult to assess. They all pertain to long term policy making and medium term programming. Some of them are under consideration. They all require training, information, and high level technical assistance. Based on recent TACIS technical assistance costs, these activities can be estimated to amount to US$5 million over the medium term. However, it is safe to assume that substantial local costs will also be involved to cover activities of Ukrainian Government officers. It encompasses the evaluation of buyer credit-worthiness, credit intermediation, collection services including follow-up of past-due receivables, financing through cash advances against accounts receivable  Transport and Trade Facilitation _ 46 E. Further Benefits of Trade and Transport Facilitation 6.40 Transport and trade facilitation measures will decrease direct costs currently faced. In addition, there would be favorable impacts to: (i) the development of transit corridors, and (ii) trade and welfare benefits. Transit Corridor Development 6.41 Opportunity Cost. Opportunity costs due to the absence of a coherent trade oriernted strategy based on transport corridors can be estimated conservatively at US$400 million in terms of additional employment, GDP, or export revenues foregone over time. According to the January 1998 "Macroeconomic Indicators" publication of the Ministry of Economy of Ukraine, net exports of goods and services have decreased by about 4 percent between 1996 and 1997. A privately owned system of duty free warehouses coupled with export processing and trade zones, equipped with highway and rail terminals, travel, shipping and banking services can be planned and implemented and reverse this trend by one half in the short-term. In such a scenario, the opportunity costs discussed in this section would amount to 2 percent of the sum of merchandise exports (now standing at US$15,000 million) and of the foreign trade oriented transport and services (now about US$5,000 million). The US$400 million opportunity cost was not included in the calculation of excess costs since this is an untapped potential and not a direct cost. 6.42 Untapped Potential. Transit Corridors in Ukraine are in existence only on the map. Their implementation is mainly viewed as a rent-producing device on obliged or preferential itineraries. Opportunities to capture business potential associated with transit and trans-shipment traffic could be induced by creating Special Economic Zones and Free Trade Zones. These would capitalize on the corridors existence as transport cost reducing devices at ports, border crossings and inter-modal junctions. 6.43 Corrective Measures. Enactment of a draft Law on Special Free Economic Zones, which would make it possible to create special free economic zones on areas no larger than 500 hectares is recommended. Among the possible areas to receive Free Trade Zone status are the major Ukrainian seaports, such as Odessa, Kerch, Yalta, Sevastopol, and the Transcarpathian region. 6.44 Cost of Corrective Measures. Once the appropriate legislation is enacted, a Master Plan and a Marketing Plan for Special Economic Zones and for Free Trade zones will have to be developed which is estimated to require US$ 1.5 million. Implementation of the Plan would be left to private investors. It would rapidly bring additional transit revenues to the State, produce employment benefits in the construction sector, and in the medium run, yield significant export and transportation related benefits. Trade and Welfare Gains 6.45 In addition to the pure transport and services cost reduction effects on the balance of payments, the decrease in the CIF cost of goods will expand trade. This will occur by decreasing the domestic price of imported products, provided that they are not subject to restrictive quotas  Transport and Trade Facilitation 47 (welfare gains), and increasing Ukraine's exports towards traditional and new markets (trade gains). 6.46 From an imports perspective, welfare gains arise from the benefits that consumers in Ukraine derive from the lower domestic prices after the removal or reduction of the ad-valorem incidence of non-tariff distortions. The net welfare gain is estimated as the increase in import value times the difference between the ad-valorem incidence of the barriers before and after elimination. 6.47 On the export side, trade gains are obtained simply by summing the trade-creation and trade-diversion effects. The trade-creation effect is the increased demand in an importing country for a commodity from an exporting country, resulting from the price decrease associated with the elimination or reduction of distortions. Trade-diversion accounts for the tendency of importers to substitute goods from one source to another in response to a change in the import price of supplies from one source. The elasticity of substitution between alternative suppliers observed in trading economies is about 1.5, assuming that Ukraine, as an exporting country, has no significant supply constraints in the medium term. 6.48 For each ad-valorem percentage cost reduction, a trade gain can be computed as the sum of trade creation and of trade diversion. In all, the expected balance of payments improvement linked to these trade gains would be close to US$2.1 billion per year. It should be noted that this total does not include additional gains from potential transit traffic growth.  Roads and Road Transport 48 7. ROADS AND ROAD TRANSPORT A. Road Infrastructure Current Situation 7.1 Road Corridors. The priority road corridors involving Ukraine, established at the second Pan-European Transport Conference (known as the Crete Corridors) are: (i) the Third Corridor, between Germany and Ukraixe through southern Poland; (ii) the Fifth Corridor, between Italy and Ukraine, through Slovenia and Hungary, with a branch from Bratislava through the Slovak Republic to Ukraine; (iii) and the Sixth Corridor, between Gdansk and Zilina in the Slovak Republic (passing near the Ukrainian border with the Slovak Republic, at Vysne Nemecke, on ithe Slovak side). 7.2 Ukraine's transit border with Poland, Hungary and the Slovak Republic. Ihe present traffic levels are low due to the current uncertain economic situation in Ukraine. Ukraine could, when conditions return to normal, achieve a very rapid growth compared to the current level of trade, which could lead to a much higher actual traffic increase befween these countries. However little traffic increase is expected before 2005. 7.3 Public Roads. The approximately 172,000 km road network (main roads 31,078 km and local roads 141,637 km) which is the responsibility of the Road Corporation (UKRAVTODOR) has continued to deteriorate over much of its length. The same may be said of the urban network of about 86,000 km and an unspecified length of agricultural and farm-to-market roads. Ihe geographical coverage of the road system is generally adequate, the main exceptions concerning the need for by-passes. Table 7.1. Ukraine Road Network Year | Main Roads (km) Local Roads (km) Total Roads Paved IUnpaved Total Paved Unpaved Total km 1989 30989 87 31076 123735 11956 135691 166767 1990 31035 76 31111 126164 10529 136693 167804 1991 31043 74 31117 128075 9787 137862 168979 1992 31086 74 311601 129721 9083 138804 169964 1993 31072 74 311461 130712 8660 139372 170518 1994 31060 74 31134 131665 9516 141181 172315 1995 31019 67 31086: 132226 8945s 141171 172257 1996 31013 65 31078 132891 8596 141487 172565 1997 31013 65 31078 1333411 82961 141637 172715  Roads and Road Transport 49 7.4 Infrastructure Condition. A study12 undertaken in 1997, indicated that approximately 6,900 km of the main road network were in fair to moderate condition (roughness index averaging about 4.3) and it was also estimated that the remaining 24,000-km were in poor condition (roughness index 5 - 6). Although no measurements have been undertaken, the visual inspection suggests that paved local roads have a roughness index between 5 and 8, while for the remaining estimated 45,000-km of unpaved local road, roughness levels ranging between 7.5 and 12 (verging on impassable) are often observed. Urban roads present a similar picture to the main and local paved road systems. There are also about 16,000 bridges of which an estimated 60% are sub- standard and in need of repair and strengthening. With the increasing number of heavy European trucks transiting through the country this is an issue deserving attention, especially on the main corridors. With adequate maintenance these main corridors should provide enough capacity for some time but it should be realized that without improved customs formalities at the border, any upgrading on these corridors would be wasted. 7.5 Road Expenditures. Due to the very limited resources made available for road maintenance, the position continues to deteriorate with much of the network now requiring expensive reconstruction rather than maintenance. In 1997, it was estimated that actual funds allocated to main road maintenance and rehabilitation amounted to 48 percent of needs and to only 21 percent of the needs on local roads with an overall shortfall on state roads of 72 percent. In the case of urban roads, actual funds available were estimated at 20 percent of requirements. In 1997, approximately US$440 million equivalent were allocated for road maintenance, including rehabilitation, and in 1998, US$550 million were budgeted compared with an estimated US$1.5 billion needed annually. The state road authorities are to be commended on their concentration of resources on routine maintenance, but this has only been possible at the expense of important periodic maintenance, which has led to a growing backlog of rehabilitation and reconstruction. Despite the tight budgetary constraints, the budget allocation is made on the basis of pre-established norms in each oblast without the support of economic evaluation or proven warrants. The share of maintenance of the state road network in expenditures increased progressively from 64 percent in 1993 to 75 percent in 1997, leaving 36 percent in 1993 to 25 percent in 1997 of expenditures for new construction or reconstruction. Table 7.2. Ukraine Annual Road Maintenance Budget and Expenditure" (US$ million) Pavement Year Routine Maintenance Periodic Maintenance Rehabilitation Total Actual Required Actual Required Actual Required Actual Required 1992 23.2 28.7 13.2 22.6 50.9 140.5 87.3 191.9 1993 21.2 25.5 9.61 21.6 42.1 153.6 72.9 200.6 1994 47.4 55.2 28.81 62.5 87.5 384.1 163.8 501.8 1995 93.1 105.8 71.11 118.7 185.6 882.9 349.7 1107.4 1996 143.1 150.2 109.8| 169.2 192.4 1151.4 445.4 1470.9 1997 .______ j 148.21 208.5] 1155.8 300.0 1512.5 7.6 Road Financing. The existing mechanism of road financing primarily based on a tax on enterprise turnover shows some signs of erosion (Figure 7.1). Since 1991, the road system has 12 Study of the Reformn of Ukraine Road Sector Financing: Carl Bros Int & TecnEcon, EBRD, 1997 13 Required Expenditure are based on the Study of the Reform of Ukraine Road Sector Financing: Carl Bros Int & TecnEcon, EBRD, 1997  Roads and Road Transport 50 been financed from a Road Fund established under the Law of Ukraine "On the Sources of Financing of Road Maintenance in Ukraine". The Road Fund has six major sources of revenue including budget contributions from the central and supplementary budgets. In 1997, 85 percent of the Road Fund proceeds were collected via a 0.8 to 1.2 percent tax on enterprises turnover, and 7 percent via a fuel excise charge. Road user charges reflecting the use of the network represent less than 12 percent of road financing. In 1997, the budget dropped by 30 percent in dollar terms following a parliamentary decision to use part of the Road Fund proceeds during the first quarter for other budgetary purposes. The collection of the tax on enterprise turnover has become increasingly difficult as a result of the economic situation. In 1996, an estimated 30 percent of enterprises provided labor, material and equipment in lieu of monetary payment for the tax on enterprise turnover. Figure 7.1. Road Financing (US$ million) 80G 1 _- 00Others 40 N~~~~~~~~~~~~~~ Fuel 2E*PWise Turnover tTax ... . .......... ..... .... .. ......... 1993 1994 1995 1996 1997 7.7 Road Traffic Data. Road traffic data in Ukraine are currently scarce and unreliable. Apart from a few special project related studies, few traffic countings are carried out as a result of economic constraints. It is strongly recommended that a statistically valid program of traffic counting is reintroduced - possibly, initially, using an "N-Point" census system of about 60 sites. Traffic at border crossings is recorded but these data, although identifying the size of the potential source of transit taxes, can cast very little light on general road usage. Furthermore, it has proved impossible to obtain up-to-date official data on the size of the vehicle fleet - this being regarded as a state secret. However, the estimated vehicle-kilometers in 1994 and an estimated average of vehicles and vehicle-kilometers for 1997 - 2000 are as follows. Table 7.3. Ukraine Vehicle Population and Vehicle-Kilometers Vehicle Type 1994 1994 1997 - 2000 1997 - 2000 Vehicle-kms Vehicle-kms bin Vehicles bin pa Vehicles mln pa Car na 17.3 6.3 29.0 Minibus na 0.7 0.2 1.2 Bus na 0.7 0.2 1.2 Truck 2 axle na 3.3 1.0 6.9 Truck 3 axle na 1.7 0.5 2.5 Truck and Trailer na 0.6 0.6 1.0 Articulated Truck na 0.2 0.6 1.2 TOTAL na 24.4 9.4 43.0  Roads and Road Transport 5 1 7.8 Traffic Trends. Enquiry among participants in the transport industry and some government officials indicates that the size of the vehicle fleet given in Table 3 is of the right order and an official estimate for 1996 gives a total vehicle fleet of 8.91 million, which would back up this enquiry. However, although road traffic has been reckoned to be only 50 percent of the 1989 levels and this may correspond with the average vehicle kilometer figures for 1994, the estimated average traffic increase for 1997 - 2000 is considered to be too high. The exception to this last point may be on some of the transit routes. For example, traffic counts that have been carried out on the M17 between Kiev and Chop indicate that traffic has increased from about 9,000 vehicles per day in 1995 to between 12,000 and 14,000 in 1998. If border formalities are eased, this growth will likely continue. Although during the first quarter of 1998 traffic on all modes was reported to have grown, there is little evidence that this is the start of a sustained recovery. 7.9 Impact of Road Condition on Transport Cost. The serious deterioration of the system has led to considerable increase in transport costs, which, in turn, may well create an important barrier to economic activity. In the case of agricultural access roads, it is estimated that as much as 40 percent of production may be lost in some years due to the poor level of access. The following Table 7.4, based upon a 1995 study indicates for different types of vehicles the effect of increasing road roughness on vehicle operating costs (VOC). These figures indicate that in 1995 prices, if the average level of roughness is IRI 5 compared with an attainable level of IRI 3 annual road transport costs will be more than US$566 million higher. With continued road standard deterioration, this situation can only have worsened since 1995 and will continue to do so until resources are increased to an adequate level. Table 7.4. Vehicle Operating costs in Relation to Roughness (US$ million) Truck 2 Truck 3 Trck & DRI Roughness Cars Minibus Bus Axle Axle Trailor Articulated Total 3 2895 244 664 2030 947 481 587 7847 4 3007 256 673 2110 981 496 608 8131 5 3121 269 684 2182 1016 512 629 8413 6 3235 282 698 2268 1052 529 651 8716 7 3375 296 712 2348 1089 546 674 9041 8 3516 313 730 2434 1126 563 6971 9379 9 3686 329 749 2520 1162 58tl 7211 9747 7.10 Road Safety. Ukraine appears to have an exceptionally bad record as regards road safety. Not only is the rate of accidents, whichever way it is measured, very high but also, if official statistics are correct, the severity of accidents is alarming. In 1993, 7462 fatalities occurred (equivalent to a jumbo-jet crashing every 12 days) and 43,453 people were severely injured in Ukraine. The fatality rate per accident was about 0.18 or about four times the rate in the United Kingdom. In 1997, there was a reduction to 5,988 fatalities and 41,964 serious injuries and a fatality rate of about 0.16 but during this period there had been a substantial fall in the volume of traffic. In Ukraine, there were about 7.3 fatalities/I 0,000 vehicles compared with 5.3 in Brazil, 2.8 in New Zealand and slightly over 2 in Britain. Not only does this represent an unacceptable level of human suffering but also a large economic cost which could reach US$1 billion annually. One probable reason for the high fatality rate is the shortage of suitable emergency services, especially ambulances and paramedics, leading to potentially lethal delays in victim treatment..  Roads and Road Transport 52 Table 7.5. Road Accidents Accidents 1993 1994 1995 1996 1997 Total 40,759 42,252 43,152 40,088 37,944 Fatal 7,462 7,560 7,530 6,631 5,988 Injured 43,453 45,881 46,943 44,101 41,964 On Main Roads 2,466 2,845 3,062 2,715 2,599 On Local Roads 4,371 4,756 5,113 4,686 4,510 On Other Roads 6,374 5,246 5,786 5,450 5,095 Kiev & Oblast Centres 11,179 12,183 13,347 12,3311 11,999 7.11 Road Construction Industry. The structure of the construction industry is in a stage of transition from entirely state control to much greater private participation. The state road maintenance structure is also being rationalized and it is possible that the number of oblast/regional road maintenance units will be reduced from about 40 to 32. There are now 658 joint stock companies of various size and reputedly capable of carrying out road works anid maintenance. Of these companies, 45 were originally state owned whilst the remainder were attached to other organizations and formed joint stock companies partly in order to protect their positions in a low demand situation. At present, with the low level of investment and economLic activity, it would be unrealistic to expect quick progress in privatization although the authorities accept that privatization will, eventually, be the route to follow. Maintenance and construction costs in the roads sub-sector are higher than would be expected and, although some of this may be due to the over-sizing of some road geometry, increased privatization and competition would lead to lower prices. This applies in both the state and urban road sectors. Apparently no companies from CIS or FSU states operate in Ukraine, although it is proposed to introduce competitive bidding for road works when resources and the size of the road program permit. The introduction of foreign contractors may require changes in legislation. 7.12 Technical Issues. There are some important and immediate technical issues to address in Ukraine. In particular, it may be advisable to (a) review road maintenance methods and technology; and (b) investigate the adequacy of specifications and the supply of materials. Surface Dressing. Approximately 56 percent of the paved state road network is surface dressed and observation indicates that this is frequently in poor condition with stripping of the aggregate and cracking permitting the penetration of water. Enquiry in other parts of FSU as well as in Ukraine shows that surface dressing lasts a relatively short time - 2 to 3 years - before it has to be repeated. On the other hand, in western European countries, and other countries that have severe weather conditions, a surface dressed road, even carrying high traffic flows, will last commonly 7 to 10 years before a new treatment is required. This results from several factors among which the quality (specifications) of the bitumen used, the cleanliness of the aggregate and the level of supervision. If the life of surface dressed roads could be increased to western European levels; major savings in maintenance costs could be achieved, thus permitting a higher level of overall maintenance even within the existing budget. Even if it became necessary to import suitable bitumen at a somewhat higher cost it would probably still be cost effective. Moreover, improvements could be achieved in a relatively short time. Patching. Patching is an essential part of road maintenance and as the roads continue to deterioirate it becomes more important and consumes more resources. It is possible that some improvements  Roads and Road Transport 53 could be made at relatively low costs and would lead to savings. In particular, many patching units (apart from working under very dangerous conditions) have no compaction equipment and largely rely upon traffic compacting the patch. In addition to this method of uncontrolled compaction giving poor results, there is also a loss of bitumen mix: both these factors lead to increased costs. The procurement of simple compaction equipment for each unit or the improvement of cold mix patches would solve much of the problem, and it is recommended that specifications for such equipment should be prepared and its procurement put in hand. Reform of Road Financing 7.13 New Road Financing Law. The Government has planned that a new road financing and road user charging system will be progressively introduced during the period 1998 to 2000. It will generate sustained funds (Table 7.6) for road maintenance, rehabilitation and high priority construction needs albeit not reaching the needs as estimated under the EBRD study (Table 7.7). The draft Law on Road Financing proposes to phase out the tax on enterprise turnover over a five- year period and increase correspondingly road user charges, namely fuel excise charge and vehicle ownership charge to cover the maintenance and rehabilitation of the network. Were such a reform not introduced, there would be a serious decline in the already small roads budget. The proposed system simplifies the revenue collection and directly relates road use to cost recovery. In order to succeed, the new revenues must be rigorously collected and the road user must clearly perceive that the levies and taxes go directly to road improvement and maintenance. Table 7.6. Comparison of Existing and Government Proposed Revenue Collection Systems (US$ million) 1998 1999 1999 - 2000 2001 2002-2004 Central Gov. Subs Turnover Tax 488 277 173 Tax on Operators 11 Motor Fuel Levy 31 143 203 305 Vehicle Ownership 63 66 103 109 Transit Fees Other Tax & Subs. 14 204 1171 117 117 Total 545 267 6021 597 531 Table 7.7. Proposed Revenue Collection Systems under EBRD Study (US$ million) Source of Funding Proposed System 1997 - 2000 2001-2005 50% Recovery 75% Recovery 100% Recovery 100% Recovery Central Gov. Subs o.oo o.oo 0.00 0.00 Turnover Tax 766.70 383.00 0.00 0.00 Tax on Operators 0.00 0.00 0.00 0.0 Motor Fuel Levy 315.70 477.50 633.00 717.30 Vehicle Ownership 450.90 672.80 900.30 940.30 Transit Fees 0.0o0 0.00 0.00 .00 Other Tax & Subs. 0.0o 0.0o0 0.00 0.0