Ukraine - Rehabilitation Loan Project

 Rehabilitation Loan Report No: ; Type: Report/Evaluation Memorandum ; Country: Ukraine; Region: Europe And Central Asia; Sector: Macro/Non-Trade; Major Sector: Economic Policy; ProjectID: P009108 The Ukraine Rehabilitation Loan, supported by Loan 3831-UA for US$500 million equivalent, was approved in FY95 and closed on schedule in FY96. The first half of the loan was made available upon effectiveness in April 1996 and the second half was released a month later, on May 15, 1996. The loan was fully disbursed. Cofinancing for the project was provided by the Canadian Government for US$10 million and the Export-Import Bank of Japan for US$150 million. The Implementation Completion Report (ICR) was prepared by the Europe and Central Asia Regional Office. The Borrower's comments are included in the appendices to the ICR. The main objective of the loan was to support the Government’s economic reform program to stabilize the economy and create the conditions for a resumption of economic growth. Specifically, the loan aimed to support: (a) the development of competitive markets; (b) improved financial discipline and hard budgetary constraints for enterprises, farms, and banks; (c ) the targeting of benefits to the most needy. Key reforms supported by the project included price and trade liberalization, development of the private sector, abolition of the system of state orders, privatization of small, medium and large enterprises, and agricultural land; restructuring of the electricity sector; and improved targeting of benefits to protect vulnerable groups. Other objectives were: (i) to finance critical imports; (ii) to strengthen the social safety net; (iii) to improve the foreign exchange market; and (iv) to provide a framework for financial assistance from other donors. Progress in attaining the loan's objectives was mixed. The loan provided timely financial help to Ukraine during a financial crisis, thus helping to carry reforms forward. By the end of 1995 there was a successful macroeconomic stabilization program which, compared to 1994, almost halved the budget deficit, reduced the rate of inflation to 1-2 percent a month, replenished international reserves, stabilized the currency, liberalized the prices of major goods and services, and opened foreign exchange and trade regimes to market forces. But various administrative price controls and export restrictions are still in place. Moreover, new export quotas and export duties have been placed on some commodities. Privatization was a notable disappointment. At the end of 1995 the majority of small, medium, and large enterprises were still government-owned. Little progress was made in imposing financial discipline on enterprises. In response to monetary tightening, and reduced government subsidies, interenterprise arrears grew 240 percent in 1994 and another 128 percent in the first half of 1995. Although on a smaller scale, subsidies were renewed to ailing industries, especially the coal sector. Commercial banks were encouraged by the Government to make loans to state enterprises. No comprehensive reforms were introduced to strengthen the social safety net. A severe lack of analytical and institutional capacity, as well as inadequate statistical data on the recipients of social assistance, hindered the targeting and administration of social protection programs. Several factors help to explain the shortfalls of this ambitious operation. There was a political struggle between decisionmakers that weakened support for the reforrns. The need for certain liberalization measures recommended by the Bank was not fully understood by some government officials, who questioned the allocative ability of the private markets and feared that the privatization process would be open to corruption. Poor weather and shortfalls in external financing also contributed to weaken stabilization and liberalization measures.  The ICR rates project outcome as satisfactory, institutional development as modest and sustainability as uncertain. Given the formidable economic crisis at the time the loan was approved, OED concurs with these assessments except for project outcome. While good progress was made in stabilizing the economy through the project, the lack of transparency in the enterprises’ payback records, the clearly disappointing results of enterprise privatization, the failure to impose hard budget constraints on enterprises, and the inability of the Government to improve the targeting of social assistance programs lead OED to rate project outcome as "marginally satisfactory." The ICR is of satisfactory quality and provides useful insights into the linkages between macroeconomic stabilization and the structural reforms. Of particular analytical importance for the Bank's similar lending operations in the future is the ICR’s clear portrayal of enterprise reform as the reverse side of the macroeconomic stabilization. The ICR also provides useful lessons, such as the risks of overoptimistic Bank assessments of economic and institutional progress, the need to involve in the policy dialogue those government officials who are more skeptical about the reforms, and the need for intensive monitoring and supervision, particularly from a well-staffed resident mission. However, there are important data omissions to substantiate the ICR's assessment of the loan's contribution toward its objectives. An audit is planned.