Romania - Structural Adjustment Loan Project

ZA/v I/ 1y / - So Document of The World Bank FOR OMCIL USE ONLY H4LCROF'ICHE COPY Report No. P- 5776-RO Type: (PR) HOOPENGARD! X32554 / H5 245 / ECICC) REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED STRUCTURAL ADJUSTMENT LOAN IN AN AMOUNT EQUIVALENT TO US$400 MILLION TO ROMANIA MAY 6, 1992 This document has a restricted distribution and may be used by recipients only in the performance of their nrtini dntioc Its contents mav not otherwise be disclosed without World Bank authorization.  CURRENCY BOUIVALENTS Currency Unit - Lou (pl. ral Lei) US$1 - Lei 198 Leu 1 - US$ 0.0051 Lei ger US Dollar Official Interbank 1989 December 15 1990 November 25 1991 Aprl. 60 200 1991 November 180 1992 May 198 ABBREVIATIONS AND ACRONYMS CC Commercial Company (enterprise to be privatized) CEC State Savings Bank CEM Country Economic Memorandum CMEA Council for Mutual Economic Assistance EBRD European Bank for Reconstruction and Development EC European Community FDI Foreign Direct Investment GOR Government of Romania IMF International Monetary Fund LDP Letter of Development Policy MoEF Ministry of Economy and Finance NAP National Agency for Privatization NBR National Bank of Romania PETROM RA for petroleum POF Private Ownership Fund NVO Private Voluntary Organization QRs Quantitative Trade Restrictions RA Regle Autonome (enterprise not to be privatized) RAH RA for coal RAL RA for lignite RAFIROM Holding company for -:efineries RCB Romanian Commercial Bank RENEL RA for Electricity ROMGAZ RA for Natural Gas SA IMF Standby Arrangement SAL Structural Adjustmernt Loan SE State-owned Enterprise SOE Statement of Expenditure SOF State Ownership Fund TA Technical assistance USAID United States Agency for International Development ROMANIA -Fiscal Year January 1 - December 31  FOR OFFICIUL USE ONLY STRUCTURAL ADJUSTMENT LOAN Table of Contents Loan and Program Summary 1. Introduction 1 II. The Challenges of Transition 2 A. Structural Adjustment and the Development Agenda 2 B. The Reform Program and Recent Economic Developments 4 C. The Government's Strategy, the Bank's Role, and the SAL 9 III. Macro-Economic Policies: Prices, the Exchange Rate, and Stabilization 10 A. Exchange Rate and Price Liberalization 11 B. Monetary Policy 13 C. Fiscal Adjustment 14 D. An Incomes Policy 16 E. Investment Programming 16 IV. Reforming and Restructuring the Enterprise Sector 17 A. Trade and Competition Policies 18 B. Enterprise Financial Discipline 19 C. Privatization and Private Sector Development 23 V. Social Safety Net 26 VI. Medium-Term Outlook, External Financing Needs, and Creditworthiness 27 VII. The Proposed Loan 35 VIII. Recommendation 37 Text Box: Enterprise Reform Program 20 Text Tables: Table 1: Macroeconomic Indicators (1988-1991) 7 Table 2: Macroeconomic Projections 32 Table 3: Medium-Term Financing Plan 33 Table 4: Debt Indicators 34 Annexes -- see next page This report is based on an appraisal mission that visited Romania in March, 1992, and that included T. Hoopengardner (Task Manager and Principal Country Officer), F. Dhanji (Senior Economist), R. Anand (Senior Economist), W. Abdelati (Economist) and M. Sumlinski (Consultant). W. McCleary (Lead Economist) and E. Maciejewski (DMF Resident Representative) also participated in the mission. Also contributing to the appraisal of this loan were missions led by L. Fox (social sectors), R. Pepper (energy), and S. Brajovic-Bratanovic (industry). EClCO (F. Levy, Division Chief) and EC1 (M. Viehen, DireA.tor) are the Division and Department responsible for this loan. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disckSed without World Bank authoriation.  AumS Annex I : Macroeconomlc Indlcators to be Honitored under SAL 38 Annex II : Matrix of SAL-supported Adjustment Measures & Conditlonality 39 Annex III : Social Indicators of Development, 1991-92 43 Armex IV : Letter of Development Policy 45 Annex V : Supplementary Project Data Sheet 62 Annex VI : Status of Bank Group Operations 63 no: IBRD No. 23664  ROMANIA STRUCTURAL ADJUSTME =AN (SAL) OAN AND PROGRAM SUMMARY Borrower: Romania Amount: US$400 million equivalent lexms: Repayment in seventeen years, including five-year grace period, at the Bank's standard variable interest rate. Des urigtIon The Government of Romania is committed to basic economic & Qhjgctsiv: reform. Its goals are: (i) maintaining a stable macro-economic environment; (ii) making productive sectors efficient and internationally competitive; (iii) privatizing land, housing and enterprises; and (iv) protecting the affected segments of the population. The objectives of the proposed Structural Adjustment Loan (SAL) are to support: the stabilization efforts of the Government while maintaining the momentum of price liberalization and the progressive opening of the economy; enterprise reform, especially enterprise financial discipline and privatization; and an affordable and effective social safety net. This operation has been prepared in parallel with _ second IMF Standby that is being considered by the Fund Board on May 29, 1992. lisks: The primary risk to the proposed SAL is that social tension created by the program could find expression through the politial system, and that this could impede the reform program. So far, the Romanian reform program has proceeded well despite the short-term difficulties. Romanian governments since the revolution have been committed to reform and we expect this commitment to continue after the forthcoming election. Romania's Parliament will ratify the SAL prior to loan effectiveness. Disbursements: The loan would be in two tranches, the first, equivalent to $250 million available upon effectiveness and the second, equivalent to $150 million after compliance with second tran^he conditions expected approximately six months later. Retroactive financing of up to $80 million, equivalent to twenty percent of the loan, for expenditures incurred after February 24, 1992, is proposed. The Japanese Export-Import Bank is considering cofinancing with the amount not exceeding $100 million equivalent. Rate of Return: Not applicable ADpraisal Report: Not applicable Schgdule of Bauk Fiscal Year USS Millen Disbursements: FY92 100 FY93 300 IBRD No. 23664  REPORT AND RECOMNENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED STRUCTURAL ADJUSTMENT LOAN TO ROMANIA I. Introduction1 1. Romania is one of the largest of the former centrally-planned economies in the Central and East European Region with a land area of 237 thousand square kilometers and a population of 23 million. Per capita income in 1990 was about $1620 (World Bank Atlas). The country has a wide range of natural resources, including a fertile agricultural base, substantial deposits of coal and lignite, oil and natural gas, and scattered mineral deposits. Long a major food producer, Romania was a large exporter of agricultural products until the early eighties. 2. The Communist Party seized power in 1948 and quickly installed central planning while nationalizing most privately-held property. In the early fifties it instituted a strategy of self-sufficient industrialization. Building on domestic hydrocarbon resources, the country invested heavily in refining and downstream chemical plants, and established a very large machine- building industry. Despite a lack of attention to consumer goods industries and the service sector, and a development pattern highly intensive in the use of energy and raw materials, the strategy was reasonably successful in attaining rates of growth averaging between 6-8 percent per annum until the late seventies. 3. In the aftermath of the second oil shock (1979), Romania had difficulty servicing its external debt. The sudden withdrawal of short-term foreign credits prompted a decision to prepay all foreign debt, a process completed in 1989. The resulting import compression had deeply negative economic and social consequences for the nation. The importation of modern machinery and equipment was almost completely halted, leaving an obsolete and depreciated capital stock. Little room was allowed for imports of raw materials, and growth slowed substantially. At the end of the decade, production and per capita incomes were no higher than at the beginning. While investment remained high during the eighties, by far the greater part was channelled towards existing, inefficient industries; in the latter half of the decade, investment was progressively diverted to huge and unproductive "showcase" projects. The availability of food and other consumer goods declined sharply; electricity and heat were diverted away from households to supply energy for the industrial export drive; pronatalist health policies, denying all forms of contraception to the population, led to tragic rates of maternal and infant mortality; historic city centers were razed; a program to relocate villagers to new towns was begun. The end of the decade witnessed an increasingly demoralized and weary population, profoundly isolated--both politically and socially--from the rest of the world. I The Country Economic Memorandum, *gania, th Callen of Taniti (9497-RO dated December 3, 1991), covers background and recent economic developments in detail.  2 4. Following the bloody overthrow of the Ceausescu regime in December 1989, elections were held in May 1990. These were won by a coalition of parties affiliated under the banner of the National Salvation Front, with Ion Iliescu as President and Petre Roman appointed as Prime Minister. The new government adopted a sweeping program to turn Romania into a market economy. International support for Romania rapidly dissipated after protesting students in Bucharest were attacked by miners, reportedly with conservative political support, in June 1990. Nevertheless, the government continued with the reform program and, by September, 1991, had established the basic legal and regulatory framework for a market economy. The miners returned to Bucharest again in September 1991, this time ostensibly to protest price liberalization and the accompanying austerity program. Although the miners do not enjoy widespread popular support, they nevertheless succeeded in forcing the resignation of Roman's government. 5. The new government was a multi-party coalition led by Theodor Stolojan, one of the most respected economists and reformers in the country. Stolojan has, with the support of Parliament, redoubled Romania's reform efforts. A new Constitution, ratified by popular referendum in December, 1991, guarantees property rights and confirms "Romania is a market economy". Elections for Parliament and the Presidency, planned for late June or early July, 1992, are likely to lead to another reform-minded coalition, albeit with parliamentary power more widely dispersed among the various parties than at present. II. The Challenags of Transition A. Structural Adjustment and the Development Agenda 6. In intensive dialogue over the past two years, the Romanian government and the Bank have found considerable agreement on the priorities for adjustment and development. The proposed SAL is a critical instrument to forward the process of policy definition and implementation, and to help provide a framework for the desired structural changes. In discussing Romania's program and potential SAL components, several strategic themes have been reiterated as reference points for guiding the overall program of adjustment. 7. Like other countries in the region, Romania's economy under communism was run on strict command lines. Prices paid little allocative or signalling role. Materials and supplies were allocated to enterprises on the basis of pre-established production targets. The fiscal and financial systems were passive redistributors of resources. Private property rights were largely extinct. The first element of the adjustment agenda has thus been the development of market institutions, including the reintroduction of the price mechanism, the reinstitution of private property rights, the design of a new legal framework, and the transformation of public policy and administration to address fundamentally different needs and challenges. 8. At the beginning of this process, Romania had no recent history of decentralized price-setting or of enterprise autonomy in decision making-- unlike Hungary and Poland, where partial reforms had been implemented ten to  3 twenty years earlier. The autarkic and self-reliant character of the Ceausescu regime had denied Romanian managers exposure to market economies, to modern technologies and to modern commercial and financial practices; civil servants, bankers and academics lacked even an elementary acquaintance with market economics and institutions. As a result, the leap towards market economics has had little to build upon. 9. Another major challonge of adjustment is the downsizing, restructuring, tecbnological upgrading and reorientation of Romania's industrial sector, while managing the socio-geographic consequences of rapid change. Industry accounts for about half of production in Romania, and about 70 percent of industrial output is devoted to the manufacture of producer goods. This vector of industrial supply is quite inconsistent with the composition of domestic demand, ard is not explained by any evident comparative advantage in international trade. In addition, most individual enterprises suffer from production inefficiencies: they operate in highly concentrated settings, are greatly overstaffed, produce a sreat variety of products on short runs, use old and often obsolescent equipment and technologies, and in many instances produce output that is uncompetitive internationally. Past location decisions have emphasized geographical dispers-on of enterprises, leaving mizy individual towns hostage to the fortunes of one or two large enterprises. Abrupt structural change will consequently create severe regional distress. 10. Adjustment of the economy towards more efficient energy consumption and more reliable and efficient supply is central to both near and medium-term development. Much of Romania's industrialization was premised on the availability of abundant domestic primary energy sources of coal, oil and natural gas. Known reserves of oil and natural gas have, however, been in rapid decline, and production has been falling since the mid-seventies. Imports of energy are growing rapidly and now account for over one-third of the overall import bill; in late 1991, the unavailability of foreign exchange to finance energy imports was an important factor in the decline in domestic production. At the same time, the pattern of development has been largely wasteful of energy; sub-sectoral energy intensities 3-8 times higher than comparable industries in OECD countries are routinely reported. Moreover, the domestic electricity generating system has seriously deteriorated due to lack of adequate maintenance and use of poor grade materials in important components. The total installed capacity of 22 GW is capable of only 9 GW of output. 11. While building the institutions of the market, restructuring industry and reducing energy intensity represent a core agenda of adjustment, there are additional areas of policy emphasis which could yield rapid benefits. In the interwar years, Romania was the largest food producer and largest agricultural exporter in the region. The collectivization of land and discriminatory pricing policies to extract surpluses to feed the investment drive in industry dulled agricultural incentives, reduced productivity growth, and resulted in stagnant or declining output for some years. A properly devised agricultural strategy and institutional support could stimulate a reasonably rapid supply response.  4 12. Prior to the last decade, Romania was making significant inroads into competitive Western markets with exports of agricultural commodities, machinery, wood products, textiles and other consumer goods. A share of this success can be at*ributed to uneconomically low prices or soft financing terms, but the potential for exports at market prices appears to be high in these sectors, as well as ir tourism. over the eighties, however, trade patterns shifted away from Romania's underlying comparative advantage. The economy largely exported qualitatively inferior machinery and equipment and consumer goods to the (former) Soviet Union, in exchange for oil, gas and raw materials. Convertible currency trade has been overwhelmingly dominated by the import of fuels and metals and the export of refined products. (In 1988-89, total exports were about 19 percent of GDP, divided equally between the CMEA and convertible currency trade.2) The restoration of export dynamism must be an important objective of adjustment policies to satisfy the demand for imports of raw materials and energy and to facilitate the technical upgrading and modernization of the capital stock. 13. Romania does have the advantage of a very small foreign debt and could, in principle, use its borrowing capacity to help finance the transformation of the productive base of the economy. Thus far, however, the financial markets have not found the country attractive. This lack of private financial support "y 'Be zttributable to a credibility gap between the GOR's stated intentions and what financial markets think the GOR can actually deliver, but it may also be simply that other countries in the region are more familiar. Because external finance is limited, it is especially important that it be used wisely. In particular, it will be important that such borrowing be largely used for investment rather than consumption. In this regard, the development of an investment program, at least for the public sector, is of particular importance for the restoration of growth and long-term development. B. The Reform Program and Recent Economic Develoments Systemic Reforms 14. The government which took office following the May 1990 elections announced the unequivocal intention to transform the economy into a market economy. It was generally understood in Romania that this would entail massive systemic change. Specific programs have been developed at an intense pace, most often by individuals with little experience and with recourse to foreign advice largely limited to the Bank and Fund. The results have been considerable and impressive: (i) Leaal Framework. A formidable volume of legislation (over a hundred bills) covering most of the essential legal institutions of a market economy has been enacted. The new Constitution guarantees property 2 For comparison, in 1980-81, exports to all destinations were about 31 percent of GDP and imports about 33 percent of GDP.  5 rights. The most important remaining missing pieces of the legal framework are a Bankruptcy Law (paragraph 59) and a Competition Law (paragraph 57). (ii) Prices and Trade, A three-stage price liberalization (paragraph 29) has freed most prices in the economy, except for some basic food products, household basic needs such as rents and heat, and energy prices to households. Such exceptions, however, are an important fraction of household budgets and are the subject of specific SAL conditionality (paragraph 45). The exchange rate was unified in November 1991, and the leu made convertible for all current account transactions. A new import tariff code, with modest nominal pr-tection rates (the majority between zero and 15 percent) became effective on January 1, 1992. There are no quantitative restrictions on imports, although a reduced number of QRs still apply to exports. (iii) Financial Sector Reform. A banking reform has established a two- tier banking system. The central bank operates under one of the most independent charters in the region; indirect instruments of monetary control are being rapidly developed; and a number of foreign banks have begun operations. (iv) The Role of Government. In the aftermath of the revolution, command structures were rapidly broken; the number of ministries was reduced by half; enterprises were given full autonomy over decision-making. The general government's share of national income has been reduced from about 50 percent to about 30 percent of GDP -- in particular, the government has removed itself from making investment and financing decisions for enterprises. The tax system is undergoing a fundamental reform: a VAT is being designed, as is a system of generalized personal income taxation. A decentralization of expenditure responsibilities to local governments has been enacted. (v) Ptivatizatign. Enterprises have been reclassified into "regies autonomesa and "commercial companies" with the intent that the latter be privatized. The great majority of enterprises have been commercialized (transformed into joint-stock, limited liability companies); a program of distributing 30 percent of stock free to the population through a set of mutual funds is about to be implemented; the first privatizations of small shops and restaurants occurred in December, 1991, and ambitious timetables exist for further privatization of small units of enterprises and also medium- and large-scale enterprises. Governance arrangements for enterprises are being installed through the establishment of State Enterprise Councils (roughly equivalent to boards of directors). About 50 percent of the housing stock has been sold to the population. A liberal Foreign Investment Law has been passed, and many legal constraints to the development of the private sector have been removed. (vi) LandR4efoxr. The country has embarked upon a major land reform, and 65 percent of agricultural land already has passed into private  6 ownership (although cadastral surveys to enable land titling are still in progress). (vii) Social Safety Net. Building upon previous programs, a safety net comprising uneWployment compensation, family assistance and pensions has been installed. These systems, though imperfect (paragraph 76 and following), have established the bases for cushioning the immediate impact of unemployment on family incomes. 15. The social costs and consequences of the transition are bdginning to be felt, and strains are evident. Enterprises and their managers have been slow to respond to the new market environment. The understandable weaknesses of public administration have resulted in delays in deiinition and delivery of the programs needed to give support to the reform. The transition, in short, is not without difficulties. These specific problems and the proposed SAL responses are discussed in greater detail below. Stabilizatign 16. In 1990, in the first six months after the revolution, macro management was loose as a result of inevitable confusion accompanying systemic collapse. Large wage increases were awarded in an effort to lift the harsh climate of consumer repression. The consequent rapid rise in consumption, followed by the demise of the CMEA and the Gulf War (Iraq was a major trading partner and debtor), resulted in a serious deterioration in the balance of payments. The current account balance swung from several years of surplus to a deficit of 9 percent of GDP, almost entirely financed by a drawdown in reserves (see Table 1 on page 7). Thus, in addition to initiating the reforms enumerated above, Romania adopted a stabilization program in early 1991 which was supported by a Standby Arrangement with the WNF. 17. A dual-exchange rate system was introduced, under which energy and raw materials were imported at a low "official' rate, financed by a 50 percent surrender requirement on export receipts. A very tight nominal credit ceiling was imposed, along with an incomes policy offering partial indexation of wages. In addition, a stringent fiscal target was set, with a revised deficit not to exceed 2.4 percent of GDP. Through September, 1991, the Romanian authorities met the credit targets in the IMF program and the fiscal deficit for the year was only 2 percent of GDP. However, there was a considerable shortfall in expected financing from international sources, leading to a revision in expected reserve levels. As 1991 progressed, it became evident that the dual exchange rate system was becoming a source of major economic distortions; accordingly the rate was unified in November 1991.  7 Table 1. Macroeconomic Indicators 1988 1989 1990 1991 p) ............. ........................... ............... .......................... ................. Growth rates GDP production -0.5 -5.6 -8.4 -13.0 Industry -2.9 -6.6 -19.2 -20.6 Agriculture 9.1 -6.0 12.5 -1.6 GDP Expenditure -1.9 0.0 6.1 -18.6 Investment -2.1 *1.6 -38.3 -30.a Consumqption 2.1 -0.4 10.2 -1:.v Trade & Balance of Payments Export (bit 5) Cony. currencies 6.5 6.0 3.4 3.5 Transf. rubles 4.5 4.1 2.2 0.6 Total 11.4 10.5 5.8 4.1 leport (bit S) Conv. currencies 2.9 3.4 5.1 4.8 Transf. rubles 4.3 4.6 3.7 0.5 Total 7.6 8.4 9.1 5.3 Current account balance (bit I" a) 3.9 2.5 -3.3 -1.1 Curr. acc. balance as X of GDP a) 6.5 4.7 -8.6 -3.4 Reserves excl. gold (bit $) 0.8 1.9 0.4 0.4 Reserves in months of import b) 3.2 6.5 0.9 1.0 Fiscal - Cons. General Governrent (bit le1) Deficit S0.5 66.9 -3.5 -T.5 Revenues 384.6 408.0 358.3 804.4 Expenditures 334.1 341.1 361.8 811.9 as X of GOP Deficit 5.9 8.4 -0.4 -0.4 Revenues 44.9 51.1 42.5 39.0 Expenditures 39.0 42.7 42.9 39.3 Money & credit Credit (bit t1.) 813.1 810.4 615.2 1326.7 N2 (bit t1e) 424.3 441.7 514.5 1023.4 Velocity (GDPIM2) 2.0 1.8 1.6 2.0 Prices & wages Inflation - CPI :etc. over Dec.) 2.9 0.6 37.7 222.8 Inflation - GDP defiator 1.9 -1.2 15.5 181.4 Real wage -0.2 2.4 4.6 -24.9 c) Uneoiloyment (th) na na 60.0 337.4 Uneeployment rate na na 1.0 2.9 Nemo items Exchange rate 14.3 14.9 22.4 64.6 GOP fn current prices (bit lei) 8S7.0 798.0 844.0 2065.1 GDP in cons. '80 prices (bit lei) 738.9 696.1 637.5 5S4.3 ... . .... .. . .. . ...................................................._ . _ p) - preliminary a) Ffgures for 1991 are based on Balance of Payments figures different from data reported by custom which is used for calculations in Tables 2 & 3. b) in months of convertible currency inports. c) December 1991 over October 1990.  8 18. Nevertheless, the stabilization effort was undermined by the appearance of large enterprise arrears. By end-1991, these arrears amounted to some 20 percent of GDP on a net basis. Several reasons have been posited for the appearance of arrears. In the first place, the rapid, successive price liberalizations led to an extended period of disjointed and chaotic price setting with unjustified price increases reportedly being instituted by monopoly suppliers of intermediate goods. In these circumstances, some enterprises were simply unwilling to pay suppliers. Secondly, the tight credit program failed to provide for the huge increase in requirements for working capital consequent upon the large change in the price level. This led to highly constrained enterprise liquidity positions. Thirdly, there were no clear arrangements for interest on arrears. In a period of rising interest rates, some enterprises may well have viewed arrears as their least-cost source of funds. Some creditors made attempts to index their claims to inflation, but this does not seem to have been a general practice. Fourthly, some enterprises were in fundamental difficulty, and the price liberalizations simply unmasked their inability to cover even variable costs. Their difficulties in turn cascaded and spread through the system, undercutting the liquidity of profitable firms as well. 19. Late in 1991, Parliament passed the Law on Settlement of Outstanding Payments (Law 80) instructing the National Bank of Romania to address the arrears problem and clear the "blockage" of payments. This was accomplished by a generalized extension of credit through the banking system. Enterprises were required to use these credits to pay their suppliers in successive rounds of settlement. The exercise, referred to as 'global compensation," was largely completed by end-February. A credit expansion of about lei 400 billion was required, and the National Bank then took measures, including the imposition of reserve requirements, to offset this expansion. NBR has also provided for interest on arrears at market rates, eliminating what may have been an incentive for late payment. Economic IMlact 20. The costs of stabilization and reform have already been high. Industrial output fell by about 20 percent in 1990 and ah,.in in 1991 (a two- year drop of about 36 percent); investment fell by over 60 percent; and overall GDP has fallen by nearly 20 percent (see Table 1). A number of factories have been closed, and, in the large integrated enterprises, numerous production lines have been shut down. Although Romania was not as closely integrated into the CHUA as other countries in the region, the collapse of the trading bloc exacted substantial costs: exports and imports have roughly halved in value since 19893, and the economy faces serious difficulties in 3 As seen in Table 1, convertible currency exports have plummeted. This may be attributed to three primary factors: first, a substantial portion of Romanian trade with the Soviet Union and the other CMEA countries was already denominated in hard currency prior to 1989, so the collapse of this trade reduced both hard currency and transferable ruble earnings; second, Romania lost as customers Iraq and several other West Asian countries affected by the Gulf War; and third, Romania stopped its previous policy of exporting at all  9 financing its energy, raw material and food requirements. The successive price liberalizations have resulted in a quadrupling of the price level; real wages fell by about 25 percent between November 1990, when the price liberalization began and December 1991 (Table 1). At the same time, official unemployment rose from negligible numbers to some 588,000 by mid-April 1992 (about 4.6 percent of the labor force) and is expected to continue rising rapidly in the near future. C. The GoveXnment's Strategy. the Bank's Role. and the SAL 21. The GOR's reform strategy has been surprisingly steady, although there has been a discernible maturing of expectations over the past year. The principal policy-makers are now fully aware of the costs of transition and of the harsh external environment they face. While debates between "fast-track" reform and "gradualism" do surface, there is no constituency for returning to the past. 22. At the same time, the Romanian authorities have drawn the lesson from experience that the transition cannot just be left to its own devices. Simply redefining the system of prices, decision-making and laws, and then withdrawing government from an active role, is, in their view, insufficient to generate positive and acceptable economic outcomes. The near closing down of the economy in November 1991 for lack of energ7, the forceful government interventions required to assure food supplies, and the rise of the interenterprise arrears problem are pointed to as examples that introducing orderly market conditions among inflexible, inexperienced and undeveloped microeconomic decision units will take time. In addition to the perceived need for stronger management of the transition, there is now the recognition that enforcing the real restructuring of the microeconomic and sectoral bases of the economy is the fundamental challenge facing the reform program. 23. The government remains committed to moving decisively and coherently across a broad front to sustain the reform effort. The mejor objectives include: (i) ensuring a stable macro-economic environment as a prerequisite for success in the reform program; (ii) transforming the productive sectors to make them efficient and internationally competitive; (iii) accelerating the transformation of ownership structures; and (iv) providing some protection to the affected segments of the population. 24. In support of Romania's reform effort, the Bank's medium-term country strategy is to: a. Facilitate and support the structural reform efforts and the transformation to a market economy; b. Contribute substantially (with the IMF, EC, EBRD) to financing balance-of-payments requirements, and help establish Romania's creditworthiness through supporting programs of adjustment and reform; costs -- i.e., domestic demand began competing with foreign demand.  10 c. Support sectoral development efforts; and d. Help mobilize resources from both official and private sources. 25. The proposed SAL is the most important resource transfer instrument in the lending program. The SAL has also been the most critical element of the policy dialogue, involving the Prime Minister and his Cabinet and senior officials in the NBR in long and detailed discussions of reform policy. Its conditionality would set the basis for the lending operations to follow. Moreover, the loan may become an important cofinancing vehicle; the Japanese Export-Import Bank is considering cofinancing with the World Bank with the amount not exceeding $100 million equivalent. 26. The proposed SAL has three objectives": * To support stabilization efforts, while maintaining the momentum of price liberalization and the progressive opening of the economy (Section III below); * To further structural reforms and to expand private ownership in the enterprise sector (Section V); and * To ensure that an affordable and effective social safety net is in place (Section IV). III. Macro-Economic Policies; Prices, the Exchange Rate and Stabilization 27. The Government's macroeconomic program for 1992 is designed to (a) contain the decline in real output; (b) reduce the rate of inflation sharply from a monthly rate of 19.5 percent in January 1992 to less than 1.5 percent at the end of 1992; and (c) bring about an increase in international reserves of $500 million (one month of projected 1992 imports) by the end of the year. Supporting these objectives will be a consistent set of fiscal, monetary, and interest rate policies; a tight incomes policy; and a flexible exchange rate policy in support of a more open economy. In addition, a program of structural reforms--including further price liberalization, further loosening of controls on exports and imports, privatization, improvements in public enterprise performance, and additional financial and fiscal reforms--is aimed at improving economic efficiency. In support of its 1992 stabilization program, the Government has reached agreement on a one-year Standby Arrangement from the IMF, in an amount equivalent to SDR 314.04 million. It also expects to receive financial support under the Compensatory and Contingency Financing Facility (CCFF) totalling SDR 76.5 million. & a Bar nresetatin and Baecond tracerlase conditin he0khas akDtedand Formal conditions for Board presentation and second tranche release are summarized in the context of the entire SAL-supported adjustment program in Annex II on page 39.  11 agreed idficators nd tartsfor 1992 (macro indicators to be monitored are listed on page 38). 28. At the same time, the GOR recognizes that macroeconomic stability will again be threatened if enterprise arrears are allowed to accumulate. Clearly, tight monetary and fiscal policy are prerequisite to restoring price stability, and an incomes policy and other policies can help, but it is apparent that both the effective conduct of macro-policy and effective restructuring of the industrial sector require a considerable improvement in enterprise financial discipline as well. This section discusses price liberalization, monetary and fiscal policy, and other macroeconomic stabilization policies. Enterprise arrears and enterprise financial discipline are treated in Section IV on reforming the enterprise sector. A. ExchanWM Rate and Price Liberalization 29. Beginning in November 1990,5 price liberalization in Romania has proceeded in several steps. By July 1991, most price ceilings were abolished except for certain minerals and ener.g products, some agricultural inputs, and, in the social interest, certain consumer goods. As a result, most prices can be freely negotiated between economic agents, except in cases where there are three or fewer producers or when prices are temporarily subsldized by the budget. In these exceptional cases the prices are negotiated by the economic agents under the surveillance of specialized government bodies. The list of explicitly subsidized items was reduced to five consumer food items -- bread, sugar, edible oil, milk and butter (a few cheap meat products were subsequently added); and a number of wage goods including house rents, urban transport and household energy. These commodities are an important part of the household consumption basket, and their prices, too, are being liberalized over a two-year period (paragraph 45). Producer subsidies remain for some minerals and for the railways. 30. In November 1991, the growing distortion in the dual exchange rate system led to a unification and sizeable devaluation o. the exchange rate (from 60 lei to 180 lei to the dollar); the new exchange regime adopted was that of a *managed* float with rates established in an interbank market. Exporters were required to surrender 100 percent of foreign exchange proceeds to NBR at the interbank market rate of exchange, and importers bid for foreLgn exchange in the interbank market. Starting in April, 1992, the exchange regime was further liberalized. The surrender requirement has been reduced to 30 percent, and licensed foreign exchange offices are permitted to participate directly in the interbank market. 31. The government opted to pass the full impact of the devaluation on tradeable goods prices through to the domestic economy, the only exceptions being the selected subsidized consumer items listed in the previous paragraph. The immediate impact was an initial burst in inflation reflecting the realignments of relative prices, in the face of downward nominal price rigidity. At the same time, in an effort to avoid the disorderly conditions 5 A full treatment is found in the CEK, pages 35-38 and 83-88.  12 of the previous liberalization episodes, the government issued Decision 776 attempting to establish a less disruptive environment of price formation, so as to provide a period of relative calm where enterprises could assess the implications of the new pricing structures on their costs and competitiveness. The decree sets limits on some prices and all margins, and requires price registration. Intended price increases must be announced 90 days in advance. 32. Although the intentions behind the Decision were understandable, the powers granted to the Ministry of Economy and Finance to "prevent abuses" in price formation went beyond the philosophy and principles of establishing a liberal, non-regulated environment of decentralized price setting. In the meantime, the exchange rate came under renewed pressure, as "street" rates, and rates quoted in licensed, decentralized exchange offices rose to 75-100 percent higher than the interbank rate. (Much of the reason for this can be attributed to inconsistent interest rate policies which are now being corrected; see paragraph 36 and following below). The government has thus taken measures to further liberalize the exchange rate regime. The GOR intends that state involvement in price setting will be limited to (a) the remaining subsidized consumer goods until the end of 1993, by which time the subsidies are to be phased out, and (b) clearly documented cases of market failure, such as natural monopolies (see LDP paragraph 31). Ag,LJge c conditiong ofsecond tranche re1lease. the 00KwiL eliminate Ulmts on Rdrice n 3 E &y*s= The governmeiSt intends to rely on alternative means of achieving the goals of Decision 776 such as: (i) the passage and forceful implementation of a Competition Law to remove barriers to entry (paragraph 57); (ii) the collection and widespread dissemination of information on international prices to strengthen the negotiating power of buyers; and (iii) the use of 'moral suasion" and, when necessary in special cases, arbitration when price rises appear excessive and unwarranted. 33. Enrgy Pricing. The GOR is determined to allow energy prices (except for households, which is about 11 percent of total demand) to reflect international equivalents. - a condition of oraesent=ati. thes 00 raisd unces or cude il.lecticiy,col n llfnte to worxld mrket IU2sL With the exception of household energy, price increases have ranged from about 300 percent to about 1000 percent within one year. ge U, ~~~~~~~~~~~~~~(See LDP paragraph 32). Electricity, heat, natural gas, LPG and heating oil prices to households have been maintained at subsidized levels, although these subsidies will be eliminated in steps along with other consumer subsidies (see paragraph 45). 34. In view of high energy intensities of production, certain sectors -- metallurgy, chemicals, and construction materials (which jointly consume 40 percent of energy produced in the economy) -- are likely to find their profits squeezed and bankruptcies imminent. Nonetheless, the decision to move most  13 energy prices to international equivalents is to be welcomed, given the high priority of reducing energy intensity. 35. Obviously, higher energy prices will have little impact on real behavior unless enterprises are compelled actually to pay them. Through 1991, many enterprises stopped paying RENEL, the RA for electricity production and distribution; indeed, arrears to RENEL were an important component in the overall arrears problem. At the end of January 1992, RENEL informed 40 state industrial firms that their electricity would be cut off if they didn't pay overdue bills ranging in size from lei 300,000 to lei 15 million (approximately $1,500 to $80,000). Half of the firms complied immediately, and more rushed to pay as power began to be phased down. It remains to be seen whether RENEL's crackdown will have a demonstration effect on other firms that have continued to supply customers in arrears. B. Monetary Policy 36. The 1991 stabilization program allowed for a growth of total domestic credit of 15 percent in 1991 in nominal terms, with a targeted inflation rate of about 160 percent (December 1991 over December 1990). With the emergence of the arrears problem, the credit target could not be held and domestic credit grew by about 100 percent in 1991. Over the same period, prices rose by 233 percent, following a 38 percent price hike in the final quarter of 1990 (meaning that the cumulative inflation since prices were liberalized in November 1990 has been 322 percent). This increase, coupled with negative real interest rates, appears to have eliminated the monetary overhang (the M2/GDP ratio fell from an estimated 72 percent in September 1990, to 50 percent in 1991). 37. Monetary policy will serve as one of the two main nominal anchors in the 1992 stabilization program. Together with fiscal and wage policies, it has the responsibility of containing inflationary pressures arising from continuing price adjustment and liberalization, exchange rate changes, and exogenous external shocks. Accordingly, the program has an 88 percent target for expansion in broad money (M2), which is based on conservative projections for prices and the demand for money. The target for the increase in domestic credit is 67 percent. The target for inflation for the program period is 115 percent, so the money supply will decline substantially in real terms. 38. Interest rates were technically liberalized on April 1, 1991, in the sense that banks were freed to set rates, and until January 1, 1992, there had been no intervention by the authorities to influence the level of rates. However, interest rates hardly moved during this period of high inflation. For historical reasons, the State Savings Bank (CEC) is by far the dominant taker of deposits, which it then on-lends to the other banks. This made NBR's higher rediscount rate largely irrelevant. During all of 1991, the deposit rates offered by CEC were highly negative in real terms -- at 6.25 percent nominal per annum, in the face of an annual inflation of over 200 percent. Banks "borrowing" deposits from the CEC at about 10 percent nominal have also set low lending rates. All banks are able to accept deposits and issue certificates of deposit, but they did not find it necessary as long as they could borrow from the CEC. A docile banking public permitted the interest  14 rate rigidity to persist, although by the end of 1991 the CEC was beginning to lose deposits and pressure was evident on the exchange rate. 39. The NBR imposed a deposit floor on the CEC on January 1, 192, tripling interest rates (sight deposits: 18 percent; one-year time deposits: 24 percent). Given monthly inflation rates since the beginning of the year, however, rates remained negative in real terms, and the Government has now adopted a policy of maintaining interest rates on deposits and credit that are positive in real terms with respect to anticipated inflation. To ensure that the central bank's interest rate policies do have an impact on the real economy, the government is requiring that major public savings institutions pay market-related rates on their negotiable instruments. 40. Structural rigidities in the financial sector and interlinkages between banks and their clients have inhibited the effective implementation of monetary policy and created possible conflicts of interest for decision-makers in the financial sector. Accordingly, the NBR intends to use its regulatory powers to ameliorate these problems over time (see LDP paragraph 16 and following). C. Fiscal Adjustment 41. Government budget revenues fell from about 50 percent of GDP in 1989 to 39 percent of GDP in 1991 (Table 1). Although to some extent the decline reflects the fall in economic activity, it has also been the result of a sharp lifting of the tax burden on enterprises, as Romania transforms its tax system co the needs of a market economy. During this period, the government has laid the foundations of a modern tax system, putting in place a profit tax (replacing obligatory profit remittances), a progressive individual (wage) income tax (replacing the former payroll tax), and fundamentally modifying the turnover tax. The fiscal authorities are continuing to effect improvements in these taxes. Preparations are underway to introduce a simplified VAT at the beginning of 1993, and a global personal income tax in 1994. 42. The general government budget deficit in 1991 is estimated to have been about 2 percent of GDP. This fiscal performance was attained during a year when real GDP fell by 13 percent and industrial production by 21 percent, and two stages of price liberalization occurred which, along with the unification of the exchange rate, transferred some of the formerly implicit consumer subsidies onto the budget. The burden of containing the deficit fell chiefly on investment expenditures. Investment financing from the budget dropped to 4.4 percent of GDP in 1991 (from 17 percent of GDP in 1989 and 8 percent in 1990), as responsibility for investment was shifted from government to state 6 From January 1, 1992, the profit tax has been simplifeied by reducing to two the number of rates and liberalizing the depreciation norms. The authorities intend to move to a single, lower rate of profit tax when the VAT is introduced. The turnover tax was also further modified as of December 1, 1991, reducing the number of rates to only 5 and simplifying the calculation and payment of tax.  15 enterprises. To a large extent, the decline in government investment expenditures was warranted to stop unproductive showcase projects as well as to limit the access of RAs to the budget. However, needed investments in health, education and infrastructure have also suffered; budgetary investments in these sectors account for less than 2 percent of GDP now, vith the rest of budget investment expenditures going to defence and the Cernovoda nuclear power plant. 43. In 1992, the government is aiming for a 2 percent of GDP general government deficit. At present, estimated budgetary subsidies to producers are 2 percent of GDP7. The overall deficit target assumes that there will be no additional claims on budgetary resources to finance losses of enterprises, and that the process of restructuring and liquidation will remain extrabudgetary. In this regard, the proposed monitoring of arrears and measures to enforce greater enterprise discipline under the SAL assume particular importance in order to avoid the recurrence of a cycle of arrears buildup and bail-out of firms in difficulty. 44. At the same time, considerable demands will be made on the budget to meet the social costs of the transition. A large part of budget expenditures is already directed toward some form of social assistance. About half of consolidated general government budget expenditures in 1992 is for the social safety net; pensions and family allowance cash transfers (excluding the wage tax credit for children) are estimated at about 9 percent of GDP; consumer subsidies about 6 percent of GDP; and unemployment compensation is projected at about 2 percent of GDP. In addition, there is a modest system of locally administered social assistance primarily targeted at the elderly, the disabled and the handicapped. Of these, new schemes for social protection during the transition period include unemployment benefits and consumer subsidies. The GOR has earmarked financial resources to a special fund to finance unemployment benefits. The amount budgeted seems sufficient to fund the substantial increase in unemployment compensation that is expected in 1992 (paragraph 77). 45. Subsidies to households are for food (bread, milk, sugar, cooking-oil, butter, and some meat products), for household electricity, heat, natural gas, LPG, and heating oil, for rents, for public transportation and for some other wage goods. The government is aware of the large budgetary cost and unnecessarily wide coverage of these subsidies and intends phasing them out and replacing them by a means-tested social assistance program by the end of 1993 (paragraph 78). tarre dthe consumer subsidies by end-1993. The government reduced subsidies to consumers by 25 per cent on Kay 1, 1992 and intends to reduce them by a further 25 per cent on September 1, 1992, and finally eliminate them by the tnd of 1993 (see LDP paragraph 10). This phased subsidy reduction is already incorporated in 7 Although all RAs are permitted by law to receive producer subsidies, the government has in fact restricted them to 5 mines and the Railway Company. It is the intention of the GOR to eliminate even these over the medium-term; recently two mines were closed down.  16 the 1992 budget. As a ,segnd tranche condition. the SgR wll achiee satisfactory DRoLre.s with the subsidy reduction & rogram, D. An Incomes Policy 46. The incomes policy introduced in January 1991 was based on limits to individual wage increases. This system was difficult to monitor and it obstructed the development of labor markets. On January 1, 1992, the GOR adopted a system that discourages inflationary increases in the total wage bills of enterprises. Previous limits on individual wages were cancelled. The system applies to all commercial companies with majority state ownership and RAs. These firms may set individual wages and salaries, but increases in the total wage bill above a given limit wi,l be taxed. The initial ceiling was established as of October, 1991, and it is to be adjusted each quarter. It is intended that the adjustments allowed will not keep pace with increases in prices. In order to ameliorate an anti-employment bias in the system, higher ceilings are available to expanding firms. E. Inv_estment Prggramming 47. As noted earlier, investment in the budget has dropped dramatically. While this may be appropriate in the short t;erm in order to achieve stabilization objectives and to stop expenditure on economically unsound projects, the prolonged postponement of investment would harm the economy's long-term prospects for recovery and growth. At the same time, there is a very large overhang of unfinished public investment projects (over 50 percent of 1990 GDP), which is urgently in need of review. A a ojnditogn of Boalld re,sentation. th GOR ,has (a) dertak"en a guick review of gublic investment oroiects to identify tbose that should be stoo2dn imediately: and (b) de2s2gnted a unit within fovernmet to take resoon,sibilt,v for public ,investment LrogxamminL. To satisfy second tranche release conditions the GIOR intends to (a) com21et2 the inesmen review. discU&s its results with the Bank. and suseoen gXJrolectsdth inadeguate iustification: and (bQ tf theinvestment unit Ladeguate.y, estab2ish its work 2X2&a=m. and elaborate the decision criteria it will us,e t,o evaltge roec,ts. the GOR will comletae,a detailed revieX by the aed of 1992 ia 2reoaation forL the 1923 budset. (See LDP paragraph 13). 48. The largest ongoing investment project in Romania is the Cernavoda nuclear power plant. Five units were originally planned; substantial work has already been completed on Unit One. Even though Unit One may not have been economic when the work started, it is probably justified on a "sunk cost" basis to go ahead. Units Two through Five, however, are still at early stages of development. As a coditlon of loard Presentation. the qQR arreed to discontinue fundine for Units TIo Sthru ieof the Cernavoa nulear ooe 2lanL DedinL coM1etion of ,a sNaisfAtaGo studv of their eggnmic t2zuLEFA (see LDP paragraph 15). 8 The TA/Critical Imports Loan includes funds for an Investment Advisor, for training in cost-benefit analysis, and for short-term assistance in major reviews.  17 IV. Reforming and Restructuring the Enterprise Sector 49. The SAL will support the continuing restructuring of the enterprise sector through price liberalization and decentralized price setting (paragraph 30 and following); the introduction of greater domestic competition (paragraph 57); further changes in tax codes and regulations to provide a less distorted and more stable business environment; and more rapid progress in privatization (paragraph 68 and following). Equally important will be assistance and support to the government in developing criteria and implementation mechanisms for enterprise liquidations and restructurings. As discussed above, macro- economic signalling is ineffective when hard budgets do not exist, and overall financial stability is threatened when insolvent firms entangle "good" firms in their financial failures. It must be recognized, however, that liquidations and restructurings are among the most difficult elements of reform. Despite the many accomplishments of the reform program to date, achievements in this area have lagged. 50. The GOR's efforts can only take hold if enterprises adjust to the new market environment. These adjustments have proved to be difficult in all reforming countries. To begin with, managers are inexperienced, with entrenched behavior patterns that take some time to alter. They are now confronted by systemic, operational, financial and technological challenges that they are ill-equipped to handle. Second, the responses called for by the new market environment are inevitably painful -- in most instances requiring shedding of labor, and in many cases involving closure of product lines or entire factories. Not surprisingly, there are attempts to delay or avoid taking necessary actions. Third, the ownership interest of the state is not well defined. Managers have a certain latitude to run their enterprises in a manner that serves their own interest rather than the public interest or the long-term interests of the enterprises. 51. In these circumstances a variety of strategies and actions are needed. First, there should be no retreat from the introduction of a liberal market environment; the greatest stimulus to change will precisely be the necessity of adaptation. Second, the enforcement of financial discipline is paramount. Third, the state must exercise its continuing ownership functions through pressing for appropriate restructuring and, if necessary, liquidation of enterprises. At the same time, however, the private sector's share of production should rapidly expand. Finally, the costs of adjustment have to be tackled through the development of an effective safety net. 52. This section deals with particular aspects of these reforms to be supported by the SAL: (a) Trade and competition policies; (b) Enterprise financial discipline; and (c) Privatization and new private sector development The social safety net is covered in Section V.  18 A. Trade and Competition Policies 53. Trade liberalization. The external sector can become an important contributor to aggregate demand and a source of needed inputs. Foreign competition for the domestic market, and the requirements of foreign customers, can enforce efficiency and quality control. The trade regime is therefore an important element of the enterprise environment. Trade liberalization in Romania has proceeded rapidly. The monopolies of the 75 foreign trade organizations were abolished as early as February 1990, and private enterprises are permitted to participate freely in trading activities. The number of economic agents carrying out foreign trade activities increased considerably, to about 19,700 commercial companies of which: 13,100 (67 percent) private companies; 5,100 (25 percent) joint ventures and 1,500 (8 percent) production commercial companies and regies autonomes. These new units tend to be focusing on consumer goods, however, and interindustry trade tends to remain concentrated. 54. Extorts. Temporary administrative controls on exports introduced in 1991 have been substantially reduced already. Except for a few cases, the original justifications for export restrictions have been progressively eroded; and, in consequence, the lists of banned items and the amounts of quantitative restrictions have been periodically revised. a condiion o BoArd gresentAtioM. the gOR reue henme f foogdssublet o xor bn and cuotas by more than 501 elative o d-1991. At the beginning of 1992, the number of items subject to quantitative restrictions on exports was reduced from 112 to 33, and the number of items temporarily prohibited from export fell from 81 to around 35. Only two of these items, furniture and sheet metal, accounted for one-third of the value of exports subject to QRs in 1991. The government recognizes the importance of removing obstacles to export growth and, A A seon hcil lir exDot bans and auota eiceot on sbsided os or thse reauort restraint becaus of codtin ini rifcutis 55. Imorts. Despite the worsening balance of payments situation, the authorities have avoided the use of quantitative restrictions on imports throughout 1991. No import quotas or bans exist (except for armaments, drugs and precious metals). Since 1990, all imports are subject to import licenses that the GOR argues are automatic and maintained essentially for statistical purposes. The Bank has argued against having any licenses, however automatic, and it is the intention of the GOR to eliminate licenses in 1992 as the new information system based on custom declarations provides an improved statistical source. Although there are no quantitative restrictions on the import side, import competition has been limited by foreign exchange availability and its allocation through the inter-bank market. The GOR intends to fully liberalize exchange rate transactions; the exchange rate system will remain a managed float. 56. With the removal of non-tariff barriers, the revised tariff structure has become the main instrument of trade policy. Recent revisions reduced the dispersion in tariff rates, which were adopted under Resolution 673 in September 1991 under the harmonized system nomenclature, generating a trade weighted average nominal rate of protection of around 12X. The new tariff  19 code was submitted to GATT for negotiation of Romania's new protocol. In the meantime, the government reduced the rates on most items substantially for 1992 only. The average weighted tariff rate for 1992 dropped to about 5 percent. 57. a3g L1ntLt., Little action has taken place with respect to competition and antitrust thus far. An office in the Ministry of Economy and Finance has been given responsibility in this area, but there is no competition or antimonopoly law or enforcement power for relevant provisions of existing legislation. The Bank instigated an OECD seminar on competition and antitrust during the first week in September 1991, and the GOR is now drafting a Competition Law with advice from the OECD. The draft law provides for the creation of a Competition Council to enforce its provisions, and the GOR intends by end-1992 to draw up an action program for demonopolization or deconcentration of specific activities (see LDP paragraph 47). B. Enterprise Financial Discipline 58. The GOR made a good effort in 1991 to compel enterprise adjustment by imposing a hard budget constraint on them. Production subsidies were eliminated except for mines and the railways, monetary policy was very tight through most of the year, and banks were given greater power and incentive to say no" to bad loans. This discipline on the part of the GOR, NBR and banks was undone by enterprise indiscipline with respect to each other (paragraph 18, 36). Tight fiscal and monetary policy will continue, and the GOR will enforce enterprise financial discipline with legislation, an "early warning" monitoring system to identify problems quickly, and institutions and procedures to handle those problems aggressively. The GOR is also developing a medium-term restructuring strategy and it has commissioned restructuring studies of specific sectors and individual enterprises. 59. Legislation. The Law on Settlement of Outstanding Payments (Law 80) (paragraph 19) required the OR to submit to Parliament a draft follow-up law providing for the retirement of the global compensation credits created by the arrears clean-up and also for the prevention of the recurrence of the arrears problem. The GOR has now promulgated Decisions 82 and 162 with the force of law, covering global compensation and enterprise financial discipline, and it has submitted to Parliament a draft Follow-Up Law to Law 80. This satisfies arrar adttthe bd ofn arrers. The enterprise financial discipline decision requires firms to meet their  20 Enterprise ef.orm Package :. EnterDrise Environment A.- Prices Enterprises now face meaningful price signals. The exchange rate was devalued and unified *n November, 1991; a nearly complete pass-through of wortd market prices is being effected. Most notably, energy prices paid by enterprises reftect the world market, except for natural gas. The i.atural gas price has been raised by about 300 percent, but it remains only about 55 percent of the price of imports from the CIS. The SAL would require 10 percent quarterly increases in real terms. Interest. rates were more than doubled on January 1, 1992, but remain negative in real terms. The &C intends that future interest rates will reflect expected inftation. ; . Legal Framework The legal framework for the transition to a market economy is largely in place. (See also ..Co"petitIon and Enterprise Liquidation below.) C.;t gCmetton The 6OR intends to present to Parliament shortly a draft Competition Law. -s.- .. D.Trade Quantitative restrictions on imports have largely been removed and a new import tariff schadu We with low rates took-effect January 1, 1992. Tariffs for 1992 are so low, in fact, that the World.Bank has recommended an increase. Export bans and quotas are being drastically reduced. * t. Hard budaet constraint . . Enterprise Financial Disciptine t-. .. . In order to distourage the buildup of new arrears, the GOR has (1) issued decisions with. force of law nd presented to Parliament draft legislation establishing the rights of creditors -`:nd providing recourse in the event of nonpayment; (2) established a monthly monitoring system to E .catch .e.nterprtse problems early; and (3) implemented a process for restructuring or liquidation for nterprises in-danger. of accumulating8unacceptable arrears. B. .Enterorise Li-u1dation and Restructuring : 1. Anew Bankruptcy Law-has been submitted to Parliament. 2. The Law on Settlement of Outstanding Payments (Law 80) passed by Parliament in Oceeber, 1991 # provides six months for.enterorises to pay their arrears. If these obligations Are" t.paid When scheduled, creditors may:subject the'debtors to. bankruptcy or restructuring. Law 80 Is reinforcedaby subsequent-decisiors and legisistion (see II.A.1. above).. .3. Smtl nearly" privatizations would permit sale.of enterprise subunits for the value of ;.hy4y s.icil assets;: liquidation could follow. ..4. ..The GOR. is deVetoping. a-restructuring strategy including-determination of the role of te t.ate, .the role of Baiks anid the financinr sources. ::: : The SAl.would require subsector restructuring studies for chemicets, machine building d metallurgy*.-Four specif.ic ptoblem enterprises would be singled out for special studies also. ; :..Inarticipation of priv tation,.most-enterprises have been restructured as romercial. It :.joint.stock companies slated for privatization snd inelifibte for subsidies. State: riterprise Councils have been created to exercise the State's Qwnership function pending.,. priv$Sa.t.1izat.l.on..: .. T Pri'vatizatitonLar promulgated inAugust, .1991, provides for-early -pilotw p.,.r..l!v,a$tiations. of medlu ( and large.Commercial Companies, and for earty "smallt privatizations of i>>: iWt4dits ofo nterpris$es. Thirty:CCs haVe been selected for early "pilot" privatizations and ove*r 3000 Its for earl.y ."iall"privatizations. The first privatizations have already occurred.  21 obligations in the order of the due dates, regardless of who the creditor is. Firms can be declared insolvent when payments are 30 days overdue. After an additional 30-day review period, debtors can be subject to forced repayrant, including through bankruptcy proceedings. In addition, asl afis tranch condition. a neu BankruoScv Law has been Dresented to Parliament Pending its passage the existing commercial code can be used to enforce bankruptcies. See LDP paragraph 52. These laws and decisions break new ground in Romania, and shortcomings in them will undoubtedly become apparent over time. The COR intends to continue to develop further laws and regulations over time as needed to enforce financial discipline. 60. Monitoring f ystem. As a Board 2rsentation ,c,rdition, the GOR,has put in 2samcie,a x earlyrwa,rnino" monito2rag syXstgM acce,table to the Ban,kto trigfer direct goveMuntal Action whe,nit,is warranted (see LDP paragraph 55). The monitoring system relies primarily upon enhancements of existing reporting systems to compile monthly information on enterprise financial performance, especially: arrears to the banks, other enterprises or the government; operating losses; and rapid buildup of inventories or goods in process. The main reporting system for enterprises is operated by the Accounting Department and Computing Center of the HoEF. In addition to this core reporting system, the Department of Financial Control is preparing a report on the use of compensation credits and the reported causes for the arrears. Prospective difficulties will also be reported by the recently installed State Enterprise Councils. 61. As part of the general reporting system that began in 1991, enterprises provide the MoEF with operating accounts on a monthly basis, balance sheets on a quarterly basis, and more detailed accounts on an annual basis. The system, designed with the technical assistance of French experts, covers the statistical requirements of NoEF Departments (Tax Administration, Budget, Accounting, Control, and Public Debt) as well as the line ministries, the National Commission for Statistics and the National Agency for Privatization. The reporting system is comprehensive, including about 6,000 state enterprises, both RAs and CCs. This data is used in periodic reports on the financial indicators of state enterprises according to branch, ministry and source. 62. lonitoring of the repayment of Law 80 guaranteed credits (see also paragraph 19) will be primarily the responsibility of the commercial banks, which are to report to the MoEF through the NBR. In addition, the MoEF system will be modified to provide monthly information for the next six months on the compensation credits. The reporting system provides detailed information on total loans from the banking system, in addition to the Law 80 credits. Arrears on loans from the banking system will be reported and will be identified by age in three categories: over 30 days overdue, over 90 days and over one year. The buildup of new arrears will be reported on a monthly basis for: domestic suppliers (interenterprise arrears), foreign suppliers, other credits (includes salary arrears and payments out of payroll accounts) and foreign services (e.g. freight charges). Overdue payments to domestic suppliers will be reported according to age, similar to arrears to banks.  22 63. State Action. In the majority of arrears cases, creditors will be expected to pursue the remedies available under the law, including the bringing of bankruptcy actions against debtors. In addition, the largest, most important arrears problems will be considered by the Cabinet or by a sub- Cabinet group it selects on a case-by-case basis. The Cabinet will have a variety of tools available for resolving the problems of the defaulting enterprises, including accelerated privatization, full or partial liquidation, directed labor shedding, management changes, and financial restructuring. Substantial indications that such actions are being taken will satisfy the scond tracecniinta te01ineette ytmt etr n restructurint and undertake liquidiations in firms that are economically non- 64. Second tranche release would depend on judgments that (a) financial discipline is being effectively enforced on the enterprises; and (b) appropriate actions and procedures are being invoked and followed in the cases where financial discipline slips. Overall financial discipline will be evaluated on the basis of one principal ratio: the ratio of arrears of state- owned enterprises to state-owned enterprise turnover (which would be monitored monthly as a SAL macroeconomic indicator); treatex tha. 7.51 (second tranche condition). The relevant variables are available, with only a six-week lag, from the enterprise monitoring system. With respect to actions on specific enterprises, the Bank will need a clear demonstration that )aw Cabiet aoun s ma be esieated to nfore enero ise finacia _nterorises to b _nkrtmtcv/liauidation. Particular attention in this assessment will be given to the largest, most important problem cases. Specifically, the Bank and GOR will agree on a group of examples to be monitored during the life of the SAL program. The group will include the enterprises with the largest operating losses, the largest global compensation credits, and the largest current arrears. 65. Restructuring stratey9. As the year progresses, and as firms face hard budget constraints, an increasing number of enterprises can be expected to experience difficulties. Many of these enterprises should be candidates for liquidation. However, some enterprises will be suffering from temporary 9 The government role in enterprise restructuring comprises: (a) operational restructuring, i.e. the way enterprises are organized and managed (partial liquidations, divestitures, changes in management and management structure, and labor force reductions); (b) financial restructuring, meaning especially cleaning up balance sheets; and (c) technical restructuring, meaning upgrading capacity, usually through new investments. In this report, and in discussions with the Romanian government, we explicitly exclude consideration of new investments. *Restructuring is used in the narrow sense of operational and financial restructuring.  23 and not fatal problems, where a judicious blend of temporary support, accompanied by sound restructuring, could place the affected unit on a competitive footing. While the government considers privatization as the first best solution for dealing with enterprises, it realistically recognizes that privatization of many enterprises will take time and, in any event, some enterprises will need to be restructured before they are in a condition to be privatized. 66. The Bank and the GOR have, over many months, discussed the principles that should guide the development of a restructuring strategy. Agreement has been reached on the following: (i) Restructuring should essentially be designed and implemented at the enterprise level. (ii) Enterprises should enter the restructuring process either (a) voluntarily, (b) as part of bankruptcy proceedings (if appropriate) or (c) if the government, in exercising its ownership functions, so decides. giii) In certain sectors and sub-sectors, it is possible that most or all enterprises might face difficulties. Such industries could include metallurgy, machine-building, refineries and segments of the chemical industry. In these cases, individual enterprise restructuring should be considered in the context of broader sectoral realignment, toward which the government should first conduct comprehensive subsector studies to establish appropriate strategies for downsizing, before individual enterprise restructuring is embarked upon. (iv) The enterprise development fund that has been established by the government should not be used to subsidize the losses of enterprises; it should rather be used to help develop restructuring plans. (v) Enterprises which develop restructuring plans should present these for financing to the banks. If the banks decline to finance the plans, the enterprises should be liquidated. Under no circumstances should restructuring finance be used to bail out firms which cannot ultimatW.y hope to survive. 67. Restructuring studies. The Ministry of Industry in Romania has already, with PHARE and IBRD assistance, nominated the chemical, metallurgy and machine-building sectors for immediate, detailed analyses with a view to developing sub-sectoral rationalization programs. It has also, again with IBRD assistance, agreed to select a number of major enterprises for immediate development of liquidation/restructuring plans. C. Privatization and Private Sector DeveloRment 68. Changes in the ownership structure of the economy are a fundamental component of the Romanian reform program. The passage of an agricultural land law has resulted in the transfer so far of about 65 percent of formerly state-  24 controlled land into private ownership. About 50 percent of the housing stock has already been sold to private owners. Finally, a sweeping Privatization Law was passed in July 1991, mandating the distribution of 30 percent of the assets of commercial companies free to the population. The law establishes five mutual funds (known as Private Ownership Funds or POFM) to serve as conduits for this distribution. The remaining 70 percent of assets are to be held initially by a State Ownership Fund (SOF), and the law establishes that 50 percent of the SOF's holdings must be transferred to private hands within three years. The SOF is to disappear entirely in seven years. A National Agency for Privatization (NAP) has been managing the process of developing the strategy and shepherding the necessary legislation through Parliament. It is now developing the statutes governing the operation of the mutual funds and the SOF. These institutions are to be established by July 1, 1992. 69. Law 54 legalized small private enterprises in 1990, and over 200,000 firms have been licensed. Several tens of thousands of these firms are now in business, perhaps 80 percent in distribution and retail sales where capital requirements are low. The law, passed soon after Romania's revolution, contained unnecessary constraints on small enterprises. However, these constraints are easily circumvented by private businesses because of provisions in more recent legislation, and they are having no apparent effect on the way business is conducted. Practical constraints need to be addressed through an active program of promoting and facilitating new ventures. Private sector development i well-supported in Romania, with PHARE, EBRD, USAID and many PVOs active. 70. The proposed SAL would support the implementation of the privatization strategy by: first, broadening the coverage of the enterprises available for privatization; and second, supporting a fast-track route of early privatizations. Other planned operations would provide follow-up support to the SOP and POFs. 71. Coverag. Early in the reform program, the government classified all enterprises as either autonomous public sector enterprises (regies autonomes-- RAs) or commercial companies (CCs). In concept, RAs, by and large, include companies that would normally be regarded as public utilities; while commercial companies are enterprises that in market economies would usually be found in the private sector. RAs are eligible for public subsidies and are not intended to be privatized. During the conversion process, several hundred RAs were created at the national and local levels as compared to about 6000 CCs. The criteria used to classify enterprises as RAs appear to have been excessively broad. As a BAoad gXresentati_on gonditio. the gOR h,as desg&ated An office to1 be 2eDOnS. As a m r ,second tranc,e condLtonLg the GOR will detemrmie obiective cteria acceDtable tgo the Bank fgr RA desin8na.ion. and initiat-e a xroce,ss for conErting RAs not meeting these criteria into CCs. (See LDP paragraph 63). 72. Early Privatizations. The Privatization Law provides for privatizations in advance of the operation of the SOP and POFs. These early privatizations include both small and large enterprises. Sales of sub-units of larger enterprises, called 'small privatizations-, are envisaged to comprise entities such as shops, restaurants and workshops. Al acondiJtion of Board  25 presentation. the GR has chasiUed a list 2f overml.000 , h candi,da tes ;fo earlyriv,a,tizatiton and of,f,eedforsale over 250 entities. The GOR intends to privatize several hundred of these candidates each month until they have all been privatized; as a seondi tranche condition. the bulk of these small Drivatizations must be comolete. (See also LDP paragraph 14.) 73. As a Board res,entation conditoan. thirLy m.egdm and larte-sca1e nternriggs have alsog been identLfied for early "gilt" Drivttizatigns, and ten firms have been DRepae,d fgr sale via auctio neuotiated sale. or mnagement or emDloe,e bauy-out, The thirty firms were chosen from a number of sectors and were selected on the basis of above-average performance measured by a variety of indicators. The NAP is receiving considerable international assistance (e.g. from Britain and the US) in preparing these firms for privatization. The GOR intends to complete the first ten "pilot" privatizations in the next few months and, in satisfacti,onof a second tranche condition, tog greare another ten firms for medium- and larue-scale "ilot" rivLaytizatigns, (See LDP paragraph 59). 74. The Workings of the SOP and the POFs. The Privatization Law created the SOF as the holder, on behalf of the state, of 70 percent of the shares of commercial companies. The SOF is to act as the owner of these enterprises. It will receive dividends on its portfolio holdings. It can initiate restructuring or liquidation proceedings, and it is also required to reduce its portfolio over time. To this end, it must develop annual plans for privatization and submit them to the government. The five POFs were created to serve as intermediaries for the holdings of the 30 percent of shares to be received by eligible citizens. It is intended that the five POFs will initially be about the same size by value, and that at the outset they will not own shares in the same firms. After the initial allo^ation of the shares of CCs, the five POFs will issue certificates of ownership to the population; every eligible citizen will receive a certificate from each POF. POFs have been given the power to sell enterprises on behalf of POF shareholders and the SOF. 75. A great deal of work remains to be done to establish these institutions. To begin with, the statutes defining the functions, roles and manner of operation have to be drafted. There is potential here for a great deal of confusion and overlapping mandates. For this reason the NAP has sought international assistance to help define the terms under which these institutions will operate. Next, the SOF and the POFs need to be staffed and readied for operations. The shares of the commercial companies have to be distributed among the SOP and the several POFs. Certificates of ownership have to be distributed to the population indicating their ownership of the POPs. Arrangements for the tradeability of POF shares must also be made. The GOR intends that the SOF and POFs will be operational by mid-1992 (see IDP paragraphs 60 and 61).  26 V. Social Safety Net 76. Romania began the reform program with a reasonably well developed system of family benefits and pensions, and a program of social assistance directed to the needy. -Building on these long-established systems, an unemployment compensation scheme was introduced in February, 1991. In concert, all of these schemes will help cushion adjustment costs for individuals and families. However, each scheme has its own particular shortcomings.10 The goal of SAL- supported actions with respect to the social safety net is to better target expenditures without increasing the burden on the budget. The SAL will support improved consistency of immediate financing needs with overall financial stability in the short run, while bringing attention to the longer- term issues that need to be addressed. 77. Support to the uneragplgyd. In early 1991, Parliament legislated an unemployment benefit scteme providing income support, job information services, and retraining benefits. While the initiation of the program was a positive development, the law has a number of deficiencies. First, the scheme includes two groups that add substantially to the cost of the scheme, but that have a weak rationale for inclusion: school leavers and the other new entrants to the labor force. As a ondion of Board presenation the GOR has oMnensation for schoollaes(trii ih19 rdae)adetat to --he labor forc(see LDP paragraph 65). Second, the eligibility ceiling on outside income from agriculture is too low, and could exclude many deserving laid-off workers whose families received a small plot of land in the land reform. Third, "technical unemployment" benefits have been granted by the GOR to over 400,000 workers in firms allegedly affected by energy or other input shortages. Such benefits were justified as an emergency measure in 1991, but the supply of energy to industry, while not unlimited, is now more dependable, and commercial companies should take revponsibility for managing the supply of inputs and their own labor force. Accordingly, this unemployment category has now been eliminated. 78. Social assistance. A system of social assistance is the ultimate safety net for persons who have insufficient income to meet their basic human needs -- for example, persons who are ineligible for unemployment benefits, or whose eligibility has expired. During the next twelve months, the priorities in this area are to (i) establish a minimum level of household income (poverty line) as a benchmark for setting minimum benefits, and (ii) expand eligibility for locally-administered social assistance (mainly the free meals program) and cash assistance for those whose incomes fall below the threshold. The GOR intends to expand targeted social assistance to benefit those passing an agreed means test (see LDP paragraph 70). The program includes an expansion of existing programs for special groups (e.g., the handicapped), vouchers for in-kind assistance (e.g., food coupons, housing allowances), and cash assistance to bring families' incomes up to the poverty line. The government 10 For a full analysis see Romania -- AccelerAting the Transition: Human Resource Strategies for the 1990s, 9577-RO dated October 21, 1991.  27 intends that this program will be coordinated with the removal of price stsbsidies for basic household services such as heating and public transport (paragraph 45). 79. Family benefits. The COR currently provides support to families with children through (a) a 20 percent reduction in wage taxes for any worker who has ever had children; and (b) a cash benefit payable to those who work in the state sector or are unemployed. These family benefits should be revised to eliminate wasteful spending and free up funds for targeted assistance to the poor. It is not efficient to retain both the cash allowance and the wage tax credit for families, and a choice should be made between the two approaches. With either approach, only families with children under a certain age (16, for example) should be made eligible for the benefit, which should be equal for all children. Reform should also include eliminating the birth grant and pensions for mothers of large families. As a second tranche condition. the fovrnmnt illaot asysem atifacor toR the ank for nrovidi unvrsal IIAr frfmliswt aulfie hlrn defin ualifvin@ chilren s areedwit th Bak Dand inmimn ytmt ii h family benefi transfer navments to 2 Dercent of GDP by end-1992 (see LDP paragraph 69). 80. Pension sstem. The elderly constitute a group particularly vulnerable to rapid economic change, and the pension system is an important element in their protection. The current pension system provides very low benefits at a relatively young retirement age. It is actuarially unsound, administratively complex, and is becoming unaffordable. The existence of separate pension funds for different occupations serves as a barrier to labor mobility. Some of the funds are unfinanceable in the medium term, and the low retirement age discourages labor force participation. These characteristics make pension reform a concern for efficient labor market development, for medium-term macro stability, and for the development of an effective social safety net. A comprehensive reform of the pension system is planned following detailed study of what is required (see LDP paragraph 66 and following). 81. Sigk layea. In the past, the state bore the full cost of workers' salaries when they were out sick. a d ofBa ba. ORhas no eeoe rea t ubaue nldn transfern h This will give enterprises an incentive to discourage unjustified absences. (See LDP paragraph 71). VI. Medium-Ter Outlook_ External Financing Needs. and Creditworthiness 82. Romania is undertaking a far-reaching internal reform program at the same time that a major external mArket -- the CMEA -- has collapsed, and with disappointing international support. While the adjustment that is occurring, and the comprehensive nature of the Romanian reform effort, provide a basis for restored growth and creditworthiness, domestic policy reform alone will not be sufficient to support a sustained recovery. Support from the international financial iwntitutions -- particularly the World Bank and the IMF -- will be needed to provide the resources to supplement the domestic adjustment and investment efforts. The value of the accompanying technical  28 assistance, analysis, and advice is multiplied in the context of Romania's years of isolation and sparse experience with the functioning of a market economy. 83. By end-1991, Romania's GDP had fallen, relative to 1989, by about 20 percent in real terms, following a 6 percent decline in 1988-89. The annual flow of fixed investment fell by a cumulative 60 percent in real terms. Exports, weakened by the collapse of the CMEA and loss of the Iraqi and other West Asian markets, fell by about 60 percent, while imports fell by about 35 percent (Table 2). After several years of surpluses, Romania ran current account balance of payments deficits of 8.6 percent of GDP in 1990 and 3.5 (5.6 percent based on customs data) percent of GDP in 1991. Successive price liberalizations, by end-1991, effected a change in the domestic price level to about three times the level at end-l990. The unification of the exchange rate in the final quarter of 1991 resulted in an interbank market exchange rate of lei 180/$ compared with 15 in 1989, before the reform and stabilization programs were set in train; the rate subsequently climbed to about lei 200/$ and the rate at legal retail exchange offices was lei 330-360/$. 84. In the medium term, the policy reforms that the authorities have introduced are expected to result in increased productivity and the restoration of growth. The impulses to growth are expected to come essentially from two mutually interacting sources; (a) efficiency gains; and (b) a supply response to changes in incentives. The greatest efficiency gains are expected from the industrial sector as a result of improved resource allocation and increased efficiencies in plant operations. The closure of nonviable enterprises (particularly those producing negative value-added), and the shutting down of unprofitable product lines, are necessary steps in the reorganization of production. Over the medium term, resources can be expected to be reallocated away from heavy industry towards the production of light manufactures and consumer goods. The two major sources of operational efficiencies emanate from reduced use of energy and the shedding of redundant labor. The supporting policy environment has been put into place, through appropriate energy pricing, hardening of enterprise budget constraints and the provision of unemployment compensation, to stimulate substantial improvements in competitiveness in the coming years. In the medium term wider access to foreign investment and international experience, know-how, and technologies will be the key to reducing unit-costs and increasing productivity and competitiveness; in this, access to international finance will be of great importance. While efficiency gains can yield substantial growth dividends, there are further areas in which a more direct supply response can be expected. Agriculture in Romania should, given an appropriate policy environment, grow rapidly and the service sector, traditionally neglected, has considerable potential for expansion into personal and business lines, especially tourism. Growth in these areas, and in new manufacturing enterprises, is likely to be particularly stimulated by new private sector entrants, and by privatization efforts., It For a full discussion of the potential sources of growth in the Romanian economy, see Chapter V of the CEN.  29 85. A projected trajectory for growth, adjustment and the build-up of external liabilities is provided in Tables 2 and 3. The very tentative nature of these projections must be underlined. Only preliminary figures for 1991 are reported by this time of the year. The purpose here is to illustrate a plausible and consistent path of adjustment. 86. The scenario presented below is based on a number of plausible assumptions about the stance of policy. The scenario presumes continued adherence to a stabilization program, including tight fiscal and monetary policies and a strict incomes policy. This would lead to a reduction in inflation to an annualized rate of 40 percent at end 1992, and reduced rates thereafter. It also presumes that the government will pursue the rapid privatization of small-scale enterprises; the development of an efficient banking sector; the closing down of nonviable enterprises, accompanied by the implementation of programs for sectoral and enterprise restructuring; and the delivery of unemployment and other social benefits. Finally, an effective program to reduce the energy intensity of production is also assumed. As discussed earlier, most of the legal and policy framework for these conditions is already in place, and the government intends to implement this program. In the event that these assumptions are not entirely borne out, the consequences would be lower growth and higher inflation. Some compression of growth in consumption and investment could occur without necessarily raising the external deficit. 87. In the scenario presented here, industrial output would continue to fall in 1992 up to 1994, as the sector continued the shakeout of uncompetitive activities. Production would grow slowly thereafter -- at between 2-4 percent a year, as the opposing forces of a shrinking heavy industry sector and a growing light industry and consumer good sector operated. Agriculture holds substantial promise, and the sector is expected to grow by about 3-4 percent a year after 1993 (higher growth could be anticipated to occur as early as 1993, except that the major land reform in progress is inhibiting short-term growth and there is uncertainty about external markets). The services sector, virtually neglected under socialist planning, is expected to grow more rapidly after 1994, with growth rising to about 4-5 percent p.a. in 1996-2000. (See Table 2.) By 2000, the shares of GDP would be agriculture, 21 percent; manufacturing industry, 40 percent; and services, including construction and trade, 39 percent. For comparison, the shares in 1989 were agriculture, 11 percent; manufacturing industry, 60 percent; and services, 29 percent. 88. The demand impulses for growth are expected to be more muted. Internally, fixed investment declined in 1991, to about 16 percent of GDP, in the wake of the ongoing stabilization program. Thereafter, fixed investment would remain at 16-17 percent of GDP, allowing for the rehabilitation of existing capital stock -- particularly in energy-saving investments, expansion of light industries, and maintenance and rehabilitation of infrastructure. The level of consumption, after a 14 percent decline in 1991, is expected to remain unchanged in 1992 with minimum growth of 0.3 percent in 1993, before  30 recovering to a per capita trend growth of about 3-4 percent per annum in the rest of the decade.2 In short, considerable economic restructuring and adjustment is concentrated in the next five years, after which the basis is established for higher, sustained, long-term improvements in standards of living. 89. Externally, the economy's convertible currency terms of trade would remain roughly the same through the decade.13 Great uncertainty, of course, attends the development of the ex-CMEA markets. In this scenario, no growth is axpected from these markets and, indeed, by end-1991, Romania's trade is expected to have already become very largely oriented to convertible currency markets. Exports, starting from a considerably diminished base, are projected to grow by 5-6 percent per annum in real terms through the decade. This export growth assumes an active exchange rate policy, following the exchange rate unification and devaluation in November 1991, and strong export promotion and market development efforts. Exports would include traditional exports to convertible currency markets, in particular of agricultural goods and of tourism. Imports, constrained initially in 1991-93 by insufficient external financing, after slow recovery in 1993 are expected to grow at 3-4 percent per annum through the decade. 90. The financing gap associated with this scenario would average $0.2 billion per annum in the five years 1992-97 -- assuming major financing contribution by the EC, the DMF and the IBRD; after 1997 they would average $1.0 billion per year. Interest on debt accumulated to finance these deficits would engender current account deficits averaging $1.2 billion in 1992-97 (6 percent of GDP), again along a declining trend; current account deficits thereafter would amount to an average $1 billion per annum, or about 3 percent of GDP. 91. Financin; and Debt Burden. Table 3 summarizes a financing plan attached to this scenario. Between 1992 and 1995, by far the greatest burden would be borne by multilateral and bilateral lenders, who are anticipated to provide some 69 percent of the $4.8 billion financing required. The presumption here 1 For most of the eighties total consumption in Romania, as measured in the National Income and Product accounts, was about 65 percent of GDP, investment was about 30 percent, and net exports registered a surplus of about 5 percent of GDP. This pattern is very different from other middle income countries where total consumption typically is about 78-81 percent of GDP, gross investment is about 20-22 percent of GDP and external deficits are of the order of 1-4 percent of GDP. In 1990 large wage increases were given in Romania, and consumption ratcheted upwards; in 1991 consumption declined, but the fall in national income meant a rise in the ratio of consumption to GDP (see Table 2). These ratios now approximate the experience of other countries at similar levels of income. 13 Very little is known about prospective changes in CMEA terms of trade. In these projections, it is assumed that the external prices faced by the economy are international convertible currency prices, i.e., full adjustment to international prices is achieved in the first half of 1992.  31 is that Romania's return to the private capital markets as a creditworthy borrower will be slow to develop. The largest lenders from 1992-95 would be (a) the SC and bilaterals with $1.7 billion (of which $0.8 billion is expected in 1992); (b) the I1F with $1.7 billion; and (c) the IBRD, with $1.1 billion. The remaining financing is expected to come from the EBRD, direct foreign investment, with modest remaining gaps to be filled by suppliers' credits. 92. Several points may be made in connection with the level and presumed distribution of financing. First, these requirements are considerably below the requirements that were estimated in similar exercises in late 1990 and in mid-1991. Current account deficits of closer to $2.0 billion a year for several years were then being projected as a measure of the balance of payments need. The estimates here are more conservative, in part because a better sense of the impact of the demise of the CMEA is now available; in part, because the size of resource deficits has been, to an extent, constrained by the judgement that finance will not be easily available to Romania; and, in part, because the decline in domestic activity was far deeper and far more rapid in 1991 than originally imagined. Second, the overall financing gaps are projected to average $250 million per year to 1996 -- sums which can most likely be filled by short-term import financing. These relatively small gaps are, of course, made possible by assuming a very prominent multilateral and bilateral presence. Should this financing not materialize, the gaps to be financed would widen. Put differently, the importance of the IMF and the IBRD to Romania's continuing adjustment and to the success of the reform program cannot be overemphasized. 93. The overall debt burden should pose no particular issue. As seen in Table 4, there would be a fairly rapid buildup of debt to about $7.5 billion by 1995, after which the debt grows to $14 billion by the year 2000. Debt to GDP and debt to export ratios would stay around 37 and 100 percent, respectively, and the debt service ratio would peak in 1998 at just over 17 percent, declining to 16.5 percent in 2001. 94. However, preferred creditors will account for a large share of Romania's debt, and IBRD will account for a large share of preferred creditors. This raises the possibility that there may be an IBRD exposure problem even though the overall debt situation seems manageable. In fact, the total debt service ratio is so low that debt service due the IBRD is only 2.9 percent of exports by 2000. 95. Nevertheless, reducing IBRD's share of debt is an important element of country strategy. In order to help assure broad burden-sharing among official sources of assistance, IBRD will participate actively in a Consultative Group meeting to be chaired by the SC in the near future and is also encouraging cofinancing of IBRD lending operations. IBRD is also cultivating contacts with commercial lenders, with a view to accelerating their return to Romania.  32 Table 2: Romania. Key Macroaeconomic indicators .-----Actual-..... ----------- -Projectedj------------------------ 1990 1991 1992 1993 1994 1995 1996 2001 ............... ................................ ,*...................................................................................................... ...... Real Growth Rates (five year , , , ........................ average) Gross Desmtic Product -6.2 -13.0 -5.2 -1.8 1.0 2.9 3.5 4.7 Agriculture 12.5 -1.6 -5.0 1.0 2.5 4.0 4.0 3.7 Industry -19.2 -20.6 -7.9 -3.0 '0.7 2.0 3.0 4.6 Services * 6.4 -8.2 -2.0 -2.0 2.0 3.4 3.7 5.4 Exports of 6RFS -46.8 -18.3 5.4 S.0 5.5 5.8 5.8 6.4 Imports of GNFS -10.6 -25.1 -4.6 1.5 2.3 2.9 2.9 4.8 Total ConsmAptfan 9.8 -13.7 0.0 0.3 1.1 1.9 2.5 4.3 Totat investment -2.5 -24.4 -23.9 -10.9 -2.3 4.4 4.4 4.7 A-- ctual------ ----------------Projected------------------------- 1990 1991 1992 1993 1994 1995 1996 2001 As a X of GOP .............................. Total Consauwtion ?2.8 76.4 80.4 82.1 82.3 81.5 80.7 79.6 uotal Investment 34.3 29.7 23.8 21.6 20.9 21.2 21.4 21.6 Saving-Investment GaP 1) -9.1 -6.1 -4.2 -1.7 -3.2 -2.7 -2.1 -1.5 Current Account 2) -8.6 -5.6 -6.9 -5.9 -5.1 -4.8 -4.4 -3.6 totae exports of 6RfS 17.2 16.2 18.0 19.2 20.1 20.7 21.1 22.8 Totat Ioports of GNfS 26.3 22.6 22.8 23.6 23.9 23.9 23.7 23.8 In millions of USD ... ...................... ................ Resource balance *3.4 -1.9 -1.2 -1.1 -1.0 -0.9 -0.8 -0.? Current account -3.3 -1.8 -1.2 -1.2 -1.2 -1.1 -1.1 -1.2 International Reserves In months of iports of CNFS 0.5 0.7 1.5 1.9 2.3 2.6 2.7 3.2 .................................................................................................... * Includes construction and transportation. 1) Rest 2) Noidnal  33 Table 3. Nedum-Term Financing Plan (billions USD) 1992 1993 1994 1995 1996 2001 Exports of GNUS 5.3 S.8 6.4 7.2 8.0 14.5 Imports of GNFS 6.5 6.9 7.5 8.1 8.8 15.2 Resouree Delanee -1.2 -1.1 -1.1 -0.9 -0.8 -0.7 Current Account -1.2 -1.2 -1.2 -1.2 -1.2 -1.2 Interest paid 0.2 0.3 0.4 0.5 0.6 1.1 ................................ Princ.pal Rep. an NLT & INF 0.2 0.3 0.3 0.7 0.8 1.4 Multi lateral 0.0 0.0 0.0 0.1 0.1 0.5 of which IhRD 0.0 0.0 0.0 0.0 0.1 0.3 EC/Silateral 0.0 0.0 0.0 0.1 0.1 0.1 E8RD 0.0 0.0 0.0 0.0 0.0 0.1 Private & commercial 0.0 0.0 0.1 0.1 0.1 0.9 Financing Gap 0.0 0.0 0.0 0.0 0.0 0.6 IMF Repurchases 0.2 0.2 0.2 0.5 0.5 0.0 Change in reserves n.e.i. 0.5 0.3 0.3 0.3 0.2 0.4 (- a decrease) Errors & Omissions 0.0 0.0 0.0 0.0 0.0 0.0 Total financing needs 2.0 1.7 1.8 2.1 2.1 3.0 ................................ Gross Disb. on NLT & INF 2.2 1.5 1.6 1.6 1.5 2.3 Multilateral 1.4 0.8 0.6 0.5 0.6 0.8 of which 33RD 0.4 0.5 0.1 0.1 0.2 0.4 EC/Bilateral 0.8 0.3 0.4 0.2 0.2 0.2 EBRD 0.1 0.2 0.1 0.2 0.2 0.2 Private & commercial 0.3 0.3 0.6 0.7 0.9 1.5 Finaning gap 0.0 0.0 0.2 0.2 0.4 1.4 IMF Purchases 0.5 0.4 0.4 0.4 0.0 0.0 Change in short term (net) -0.4 -0.1 -0.1 0.2 0.2 0.2 Direct Foreign Investnent 0.2 0.2 0.2 0.3 0.4 0.5 Total Financng Sources 2.0 1.6 1.7 2.1 2.1 3.0 ................................  34 tebte 4. Debt Indleot.or 1992 1993 1994