China - Enterprise Reform Project

Document of The World Bank Report No: 36577 IMPLEMENTATION COMPLETION REPORT (IDA-32710) ON A CREDIT IN THE AMOUNT OF SDR 3.7 MILLION (US$ 5.0 MILLION EQUIVALENT) TO THE PEOPLE'S REPUBLIC OF CHINA FOR A ENTERPRISE REFORM PROJECT June 29, 2006 China and Mongolia Country Department Poverty Reduction and Economic Management Department East Asia and Pacific Region  CURRENCY EQUIVALENTS (Exchange Rate Effective June 2006) Currency Unit = Renminbi (Yuan) Renminbi 1.00 = US$ 0.1251 US$ 1.00 = Renminbi 7.9965 FISCAL YEAR January 1 December 31 ABBREVIATIONS AND ACRONYMS ADB Asian Development Bank ASEM Asia-Europe Meeting BOF Bureau of Finance CAS Country Assistance Strategy CQ Consultant Qualification DCA Development Credit Agreement DIFD Department of International Finance and Development (United Kingdom) ERP Enterprise Reform Project ETC Economic and Trade Commission LIL Learning and Innovation Loan LME Large and Medium Enterprise MIS Management Information System MOF Ministry of Finance PAD Project Appraisal Document PHRD Policy and Human Resources Development PMO Project Management Office PRTC Property Rights Transaction Center (Shenyang) PSD Private Sector Development PSR Project Status Report QAG Quality Assurance Group SARS Severe Acute Respiratory Syndrome SETC State Economic and Trade Commission SME Small and Medium Enterprise SMG Shenyang Management Group SOE State-Owned Enterprise TOR Terms of Reference XUAR Xinjiang Uyghur Autonomous Region WBI World Bank Institute Vice President: Jeffrey Gutman, Acting Country Director David R. Dollar Sector Manager Khalid Mirza Task Team Leader/Task Manager: L. Richard Meyers  CHINA ENTERPRISE REFORM PROJECT CONTENTS Page No. 1. Project Data 1 2. Principal Performance Ratings 1 3. Assessment of Development Objective and Design, and of Quality at Entry 2 4. Achievement of Objective and Outputs 9 5. Major Factors Affecting Implementation and Outcome 16 6. Sustainability 17 7. Bank and Borrower Performance 18 8. Lessons Learned 19 9. Partner Comments 19 10. Additional Information Annex 1. Key Performance Indicators/Log Frame Matrix 20 Annex 2. Project Costs and Financing 21 Annex 3. Economic Costs and Benefits 23 Annex 4. Bank Inputs 24 Annex 5. Ratings for Achievement of Objectives/Outputs of Components 25 Annex 6. Ratings of Bank and Borrower Performance 26 Annex 7. List of Supporting Documents  Project ID: P060270 Project Name: ENTERPRISE REFORM PROJECT Team Leader: L. Richard Meyers TL Unit: EASHD ICR Type: Core ICR Report Date: June 29, 2006 1. Project Data Name: ENTERPRISE REFORM PROJECT L/C/TF Number: IDA-32710 Country/Department: CHINA Region: East Asia and Pacific Region Sector/subsector: General public administration sector (41%); General industry and trade sector (32%); Other social services (18%); Micro- and SME finance (9%) Theme: Improving labor markets (P); Small and medium enterprise support (P); State enterprise/bank restructuring and privatization (P); Corporate governance (S) KEY DATES Original Revised/Actual PCD: 03/11/1999 Effective: 07/21/2000 07/21/2000 Appraisal: 05/06/1999 MTR: 09/01/2000 Approval: 06/28/1999 Closing: 06/30/2002 12/31/2005 Borrower/Implementing Agency: ROC/State Economic and Trade Commission (SETC); ROC/Municipalities of Changsha; ROC/Shenyang; ROC/Wuhan and Wuhu; ROC/Ministry of Health Other Partners: STAFF Current At Appraisal Vice President: Jeffrey S. Gutman Jean-Michel Severino Country Director: David R. Dollar Yukon Huang Sector Manager/Director: Homi Kharas Hoon Mok Chung Team Leader at ICR: L. Richard Meyers Klaus Lorch ICR Primary Author: Thang-Long Ton 2. Principal Performance Ratings (HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible) Outcome: U Sustainability: UN Institutional Development Impact: N Bank Performance: U Borrower Performance: U QAG (if available) ICR Quality at Entry: U Project at Risk at Any Time: Yes Note on the Ratings: 1. The above ratings apply only to the four original components of the project which cover enterprise reform activities in the four, then two, participating municipalities. These were closed for all practical purposes on  June 30, 2002. The Bank Performance was rated as "marginally satisfactory." But since the ICR rating system allows no such rating, Bank's performance was recorded as "S" above. 2. The rating for the first additional component on snow emergency recovery operation can be found in its own ICR, Implementation Completion Note on the Xinjang Uyghur (Altai) Snow Disaster Recovery Component and Xinjiang Uyghur (Tacheng) Snow Disaster Recovery Component, Report No. 27454, November 2003. 3. The rating for the second additional component on SARS and Infectious Disease Program is satisfactory, concerning the activities funded from the proceeds of this project which are now completed. The overall review of this program can be found in the documents of the Basic Health Services Project (Task P003566 ) as this program is still on-going at the writing of this document. 3. Assessment of Development Objective and Design, and of Quality at Entry 3.1 Original Objective: 3.1.1. Background. State-owned enterprises (SOEs) were a key element in the Chinese economy in the 1990s. In 1997, China had about 300,000 SOEs involved in commercial activity, employing about 11 percent of the country's total workforce and accounting for nearly half of fixed assets and about one quarter of GDP. While reliable SOE financial data were scarce, it appeared that the share of loss-makers had increased and the sector's total net profit decreased, with rising debt-equity ratios, unsold inventories and over-capacity in many industries. Industrial SOEs tended to be saddled with extensive burdens in terms of financial debt, over-capacity, excess employment, and social facilities. As a result, the health of the banking sector was affected by a high share of non-performing loans to SOEs and by the potential risk and opportunity costs associated with the disproportionate credit allocation to SOEs. While enterprise reforms during this period sought to strengthen SOE governance through a variety of initiatives, the impact on SOE performance fell short of the expectations on the whole. At the same time, the performance of collective and cooperative enterprises seemed to have slowed as well, characterized by limited management skills, unclear ownership arrangements, no access to the Shanghai, Shenzhen or overseas stock markets, and difficulties in obtaining credit from banks. Non-collective private or individual ventures had been emerging rapidly from a low base level, accounting for a rapidly growing share of employment generation although they, too, have been facing many constraints. 3.1.2. In 1997-98, the government embarked on a course of accelerated and deepened enterprise reform with a wide range of initiatives. Local authorities were transferring many of their small and medium-sized SOEs to private ownership. The private sector was formally recognized as a key engine of employment generation while a constitutional change acknowledged the important role of private enterprises. Local governments were admonished to cut back the plethora of charges whose collection burdened SMEs. Some private enterprises were given the right to engage directly in export and import activities. Bank lending to SMEs was being encouraged through the establishment of local-level credit guarantee institutions and somewhat more flexibility in lending rates. While the privatization of larger enterprises was not formally encouraged, it was quite common to see partial changes in ownership through stock market listings and employee shares, transfer of assets and operations into joint ventures, and efforts to attract strategic investors into distressed firms. At the same time, efforts to strengthen SOE governance through other means were being reinforced. (1) The government sought to harden - 2 -  SOE's budget constraints by requiring banks to strengthen their credit analysis skills, intensifying their prudential supervision, and discouraging local government guarantees. The government also addressed industrial SOE's extensive burdens in terms of financial debt, over-capacity, excess employment and social facilities. (1) For example, these included building a corps of special inspectors for large SOEs, transferring SOEs from the military, police and party organs to the central and local governments, linking managers' incentives more to the firm's financial performance, and more strictly enforcing managers' accountability through replacements and legal action. Management training received high priority, with a 3-months executive development program now practically mandatory for top managers of large SOEs and with special courses for managers of loss-making SOEs. More broadly, the government seeks to enhance corporate governance by strengthening accounting standards, audit quality, public disclosure requirements, and penalties for misreporting. 3.1.3. The implementation speed of several such reforms was however circumscribed by the slowdown of economic growth and the ensuing difficulties in labor absorption. The decline of macro-economic growth was due to a contractionary domestic policy in 1996-97 and a drop in exports to Asian markets. In late 1998, with the regional financial crisis abating, the government gave a new impetus to reform by calling for the resolution of non-performing bank loans through asset management companies. Since the bulk of bad loans of these banks were SOE debts, this triggered a focus on corporate financial restructuring. A new Securities Law was introduced and effective in mid-1999 to help overhaul the securities industry, its prudential supervision, financial disclosure, the approval process for market listings, and other key elements. These reforms would enhance the role of minority shareholders in corporate governance, impose more market discipline on listed firms, and in the longer run facilitate the access of sound firms to capital markets. 3.1.4. While enterprise reform polices are expected to deepen and accelerate with the above initiatives, implementation of reform measures on the local level faced a number of constraints: (i) little experience, limited skills and capacity, and narrow knowledge of international experience and good practice standards among district and municipal authorities, and their difficulty in assessing the results of experiments and adapting international practices to local circumstances; (ii) underdeveloped business support services at the local levels, and limited experience among enterprises and local authorities in drawing on financial and other advisory services required for corporate restructuring; (iii) shortcomings in accounting, audit and disclosure which called for special efforts to verify and assess financial data, necessary for many enterprise reform activities; (iv) several restructuring actions, such as debt write-off, bankruptcy, stock market listings and, to some extent, lay-offs tended to be governed by administrative quota allocation rather than market-based incentives; and (v) increasing role of non-state enterprises at the sub-national level required adjustments in policy instruments, support programs, and institutional responsibilities in the industrial and other sectors. 3.1.5. The Enterprise Reform Project (hereafter ERP) was designed to help assess the potential and problems of enterprise reform measures in the local context, identify and adapt promising approaches further to local circumstances, test them through implementation on a pilot basis, and share the lessons widely for replication. These lessons, as well as the enhancement of implementation capacity in the participating municipalities, would facilitate follow-up support by the Bank and other agencies. Carried out in partnership with other donor agencies and private - 3 -  institutions, this project was part of a broader Assistance Program for Enterprise Reform Program in China. The Program provided policy advice and technical assistance on additional aspects of enterprise reform. It was consistent with the Bank Group's strategy and objectives in the 1995 and 1997 Country Assistance Strategies (CAS) which were grouped in five major themes, one of which was to ensure macroeconomic stability and maintain structural reform momentum. The SOE reform was highlighted in this context as one of the critical structural reforms, together with financial sector and public finance reform. 3.1.6. Objectives. The objective of the ERP was to learn from and apply innovative methods for the reform of China's SOE sector. It was expected to contribute to one of the CAS objectives on SOE reform by assisting four pilot municipalities to develop and to model the implementation of SOE restructuring and transformation in the industrial sector, together with related experimental support for management training, labor re-training, and the development of private small and medium enterprises (SMEs). It aimed to help deepen enterprise reform in China while contributing to the CAS objective in maintaining the momentum of structural reforms. The development objectives of this Learning and Innovation Project was to identify and adapt potential improvements in enterprise reform methods to local circumstances, test their feasibility through pilot implementation, and make these lessons widely known among local and central policy-makers, leading to the replication of promising reform methods beyond the Project itself. These enterprise reform measures will address: (i) corporate restructuring and transformation of large and medium state enterprises; (ii) management development; (iii) re-training and re-employment of laid-off state enterprise employees; and (iv) development of private small and medium enterprises. 3.2 Revised Objective: 3.2.1. The ERP and its original components were closed on June 30, 2002. However, the project's objectives and its the Development Credit Agreement (DCA) were revised twice, and the project closing date extended by the Bank's management, to accommodate the authorities' requests that the remaining undisbursed balance be allocated for assistance in two emergency situations in China: (i) the snow disaster emergency in Xinjiang region in 2000/01 and (ii) the outbreak of the Severe Acute Respiratory Syndrome (or SARS) in Southern China in 2003. 3.2.2. The first amendment of the ERP provided emergency support to China through a snow disaster emergency operation when the Xinjiang region had a series of disastrous snowstorms. The objective was to assist the Borrower in restoring social and economic infrastructure critical to the livelihood of herders devastated by the unusually severe snowstorm in the hard hit areas of Altai Prefecture and Tacheng Prefecture of Xinjiang Uyghur Autonomous Region (XUAR), and in enhancing and strengthening the disaster response capacity of the affected herders. It reflected the Bank's policy for emergency assistance, including restoration of assets and production levels in the disrupted economy through financing of investment and productive activities