Moldova - Transport sector review (Vol. 3 of 3) : Policy note & executive summary

Report No. 13891-MI) Moldova Transport Sect-or Review Policy Note and EXe(cutiVe' SumLmlnary November 16, 1995 C'oMliitr\ lcX'partwwinr IV Furopu and Ccra .il Asia Rcgit,n Document of the World Bank  CURRENCY UNITS and EQUIVALENTS Lei Lei USSI = 4.3 Lei (as of November, 1994) DM Deutsche Mark US$1 = DM 1.5435 (as of September 9, 1994) ECU European Currency Unit US$1 - ECU 0.8109 (as of September 9, 1994) USD US Dollar USc US cent WEIGHTS, MEASURES and OTHER UNITS bin billion inh inhabitant kilo, kg kilogram km kilometer M, mln million pass passenger sq km, km- square kilometer T ton (metric. 1,000 kg) th thousand vd vehicles per day CONVERSION FACTORS 1 mile 1.609 meters I kg = 2.205 lbs I UIS gallon = 3.785 liters I sq km = 0.386 square miles CHEMICAL COMPOUNDS C,Hy, HC Hydrocarbons CO Carbon Monoxide CO2 Carbon Dioxide NOX Nitrogen Oxides SO2 Sulfur Dioxide  GLOSSARY OF ACRONYMS AND ABBREVIATIONS ATC Air Traffic Control CAA Civil Aviation Administration CIF Cost-Insurance-Freight CIS Commnonwealth of Independent States EBRD European Bank for Reconstruction and Development EDI Electronic Data Interchanges EU European Union FIATA Federation Internationale des Associations des Transitaires et Assimiles FOB Free-On-Board FSU Former Soviet Union GATT General Agreement on Tariffs and Trade GDI Gross Domestic Investment GDP Gross Domestic Product IATA International Air Transport Association ICAO International Civil Aviation Organization IMF International Monetary Fund E|C Letter of Credit MDSMTO Moldovan Department for Standards, Metrology and Technical Oversight MOT Mlinistry of Transport NBM National Bank of Moldova OECD Organization for Economic Cooperation and Development PIP Public Investment Plan SAL Structural Adjustment Loan SGS FSU Railway Association SOE State Organizations and Enterprises SZD FSU's Soviet Union Railways TACIS Technical Assistance for Commonwealth of Independent States TEA Technical and Economic Assessment TIR International Road Transport VAT Value-Added Tax   MOLDOVA POLICY NOTE TRANSPORT SECTOR REVIEW A. INTRODUCTION Purpose 1. This policy note highlights the recommendations in the Moldova Transport Sector Review, and provides a basis for discussions between the World Bank and the Government regarding future World Bank investments and sector policy work in transport. This policy note links the performance of the transport sector to the program of economic reforms supported by the Structural Adjustment Loan (SAL) approved in December 8, 1994; shows the importance of transport to trade and the balance of payments deficit; demonstrates the losses likely to be sustained by the sector in the absence of reforms; and addresses the priorities for improving the efficiency of the sector and the possibility of World Bank assistance in realizing these priorities. Background 2. The capacity of the transport sector of Moldova exceeds current demand, as it was developed in support of a pattern of economic development which no longer corresponds to market realities. The sector has endured major changes in relative prices of its inputs, such as fuel and capital goods, and a major contraction in demand as FSU trade decreased following independence. The shocks experienced, which would have presented serious adjustment difficulties in any case, were made worse by the rigidity of the management style. Transport has been somewhat slower to adjust than other sectors, and Moldova faces the risk of losing valuable infrastructure and services built over a significant period, unless the sector takes measures to address its financial difficulties. 3. The severity of the financial constraint is such that it limits the extent to which services can be improved, and additional investments introduced. The Government has undertaken an economic adjustment program which is being supported by the IMF, and by the World Bank through a recently approved SAL operation. The transport sector, in turn, needs to respond to the new economic environment by initiating energetic reform measures of its own in harmony with the adjustment program of the Government to avoid further degradation. Structural Adjustment 4. The Moldovan program of economic reforms aims at: * Change in Ownership of Means of Production * Hardening of the Budget Constraint  ii Policy Note and Executive Summary * Creating a Competitive Environment * Provision of Targeted Social Protection The implementation of the program of privatization, liberalization, and fiscal and monetary policies has begun. Such macro-economic adjustment defines a new context for each economic sector. In the case of transport, specific reforms are needed to harmonize its future development with the economic adjustments under way . Current Economic Situation 5. Moldova, like all the countries of the former Soviet bloc, fell victim to external shocks beyond its control due to the disintegration of the Soviet Union. Furthermore, Moldova was affected by internal strife, beset by draught and lately by floods, and lacked a national consensus on the need for economic reform until early 1994 when a new Parliament was elected. Still, this consensus is fragile. Moldova's economy has contracted since 1990, and in 1994, its output is reported to have fallen by 20%, for a cumulated negative growth in output of about 65% since 1990. However, positive growth of as much as 2% is expected in 1995 with growth rates of more than 5% expected from 1997 onwards. B. RATIONALE FOR REFORMING THE SECTOR 6. The Moldovan transport sector (representing 6% of GDP) needs to reflect the changes in economic policy and reform itself to adequately support economic recovery. The present transportation system, however, has been slow in adapting to change, as evidenced by the delays in privatizing road transport as intended by the 1993/1994 privatization program. To support its export led growth, Moldova should choose the least-cost transport services, whether those services are provided by domestic or foreign carriers. The following paragraphs describe the rationale for reforming the sector and highlight: (a) the sector's vital role in facilitating Moldovan trade; (b) its magnitude -- the largest service item -- in the balance of payments, with a negative balance of about $60 million in 1994; (c) its potential to generate some savings on this services account; and (d) future demand. Importance of Transport in International Trade 7. Because international trade is important, amounting to 74% of GDP, transport is important as its facilitator. Moldova is a net importer of transport services, i.e., it buys more transport services abroad than it sells. It is also in the best interest of Moldova to access its markets by means of the most cost- effective transport services. In so doing, its exports would cost less at their final destination, demand for them would tend to increase, and foreign exchange savings would result.  Policy Note and Executive Sunimar iii Transport and the Balance of Payments 8. In 1993, transport represented 84% of all service transactions or $53 million. In 1994 net imports of transport services from convertible and non convertible countries are expected to exceed 50% of all net service balances. With privatization and opening of the economy, there would exist possibilities of import substitution, i.e., displacement of some foreign transport suppliers by local ones, to the extent that Moldovan transport could compete successfully by taking full advantage of lower labor costs. In addition, the total transport bill would decrease as international transporters would have lower costs and would face a competitive situation, forcing them to pass some of the savings to their clients. This would once again, support and increase the competitiveness of Moldovan traded goods by reducing export costs. The possible savings and potential for increased exports are significant. 9. Comparing Moldova's freight factor' with those of European countries, suggests the existence of inefficiencies which could probably be reduced or eliminated as discussed in paras. 40-45 below. If Moldova's freight factor was reduced from the current 5.8 % ad valorem, to a level closer to that achieved by the EU (1.5%), substantial cost reductions would result. By applying such cost reductions to the US$1 billion merchandise trade in 1993, excess costs to the economy of about US$40 million could be avoided annually. This is about a third of the total balance of payments deficit for Moldova in 1994. Losses to the Economy: Trade Inefficiencies 10. Several sources of excess costs to trade and transport have been identified in Moldova. They are associated with: road, rail and multi-modal transport; banking and documentation services; trade controls; customs procedures; and requirements for product certification. Each instance of an excess cost amounts to a barrier to trade and economic recovery. World Bank estimates indicate that total direct excess costs of all trade and transport barriers amount to about 6.2% of total trade (exports + imports) or about $60 million. Over one-third of these costs relate to trade-control, procedural and financial barriers. Their eradication would be achieved without significant costs through trade liberalization. The liberalization of trade includes the removal of the need for permits and licenses, and of constraints preventing freight-forwarders to enter the market. The remainder, of about US$40 million per year, would be offset by implementing corrective actions estimated at a one time cost of about US$10.5 million. The additional annual earnings from increased exports could be as high as US$60 million (See below, Trade and Transport Facilitation, paras. 40-45). Future Traffic Demand 11. Given the intrinsic link between overall economic performance and transport, output in the transport sector started to fall at an alarming rate in 1990, and the sector recorded a cumulated decline in traffic volumes of about 75% for the 1990-1994 period. Total freight volume in 1991 was about 307 million tons; in 1994, the figure is expected to be about 87 million tons. 12. The Government's reform program makes a significant break from the past. The negative growth of the economy and thus the decline in traffic volumes could be reversed in 1995, and positive growth 1/ The freight factor is the freight cost as a percentage of shipment (merchandise) value.  iv Policy Note and Executive Summary would begin to be made in 1996 (see Figures 1.1 and 1.2). Under this program, traffic volumes could reach 109 million tons by the year 2000. This amounts to 36% of 1991 volumes. Traffic Forecasts, Freight min ton ' Does not include Transnistrian traffic for 1992 and 1993 350 . -. ;n -1 0 Air 300 P=_ Road' 250 Railways 200- River 150 1 l994Traffic loolFi00 r-V 7100 jxji 10[ 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Figure 1.1 Traffic Forecasts, Passenger mn pass. * Does not include Transnistrian Traffic for 1992 and 1993 500 450 . Air 400 T - Road- 300 l ip [t"V; 0 # 0 0 0 Railways 300~~~~~~~~~~~y .i.:.; ~ ~ ~~~~~~~~ ~River 250 200 .0Fj(. l><j; i W>.^AsS ,: | 1994Traffic 150 100LLfj| Rl 50 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Figure 1.2 13. Given that traffic volumes are not expected to recover to Moldova's full capacity within this decade, it is recommended that the expansion of the road network, and all other capital investments in the sub-sectors, be delayed until traffic volumes make them necessary and financially viable.  Policy Note and Executive Summary v C. POLICY ISSUES AND STRATEGY 14. The first major policy reform area concerns the sector's institutions. It includes the role of the Government and the establishment of an enabling environment for private-sector development within transport. The policy issues are: a) the Government is both policy maker and operator which discourages private sector participation; b) transport enterprises have responsibilities for social services not directly associated to transport services, crowding out rehabilitation and renewal of assets; c) restrictive regulations increase costs and further discourage competition; and d) transport enterprises have been privatized slowly and do not perform as commercial entities. 15. The second major area for sector reform concerns trade and transport facilitation. The policy issues are related to: a) some trade controls remain since the last reduction in the list of goods requiring export licenses (April 1994); b) slow and inefficient customs and border crossing procedures; c) unnecessary steps in documentary procedures affecting trade operations; and d) restrictive and complicated financial procedures. 16. The major sub-sector issues relate to significant problems such as: a) the erosion of the asset base and mounting rehabilitation needs; b) accelerating de-capitalization from maintenance backlogs; c) lack of technological updating; d) impossibility to upgrade equipment; and e) shortage of spare parts. Proposed Transport Sector Strategy 17. Under economic adjustment, the three central objectives for the transport sector of Moldova are to: (a) lower unit costs; (b) lower fiscal costs; and (c) obtain efficient levels of resource use. The elements of the proposed strategy to meet these objectives are: * institutional and financial restructuring including: a new Government role in the sector, and development of private-sector participation (Section D); * trade and transport facilitation measures (Section E); and * cost recovery and market determined pricing of transport services (Section F). The implications of sector adjustment are quite significant as illustrated in Figure II below. Under the macroeconomic adjustment program and its effective budget constraint, the sector without a corresponding adjustment strategy of its own, would experience losses and de-capitalization totalling 268 million lei per year from 1997 onwards. By contrast with sector adjustment, a net surplus of about 100 million lei would be taking place by 1999. It is worth noting that this surplus would occur after renewals and moderate investments in the sector have been reestablished. The elements of the transport sector strategy are presented in some detail in the following sections.  vi Policy Note and Executive Summary Transport Sector Public Surplus, 1991 - 2002 Gross Surplus, under restructuring Gross Surplus, without restructuring- min 1994 Lei 100 50 -50 -200' 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Including accurate provisions for depreciation and same investments as under restructuring Figure II D. INSTITUTIONAL RESTRUCTURING The Role of the Government 18. The role of the Government under economic adjustment will be to implement the legal and institutional reforms necessary to: deregulate, liberalize and privatize the sector; revise and adjust policies to sustain the process; allow full cost recovery; guarantee internal mobilization of resources; and provide incentives to the private sector, while reducing the Government own's direct participation in sector operations. 19. As a result of remaining price controls and regulations, cost recovery is insufficient throughout the sector and specific government action is needed. The solution to the cost-recovery problem lies in the transfer of pricing responsibilities to individual enterprises, by introducing competition and market determined pricing (see paras. 46-50). State Owned Enterprises (SOEs) do not mobilize sufficient resources, which has led to the current backlogs of maintenance, financial arrears, and lack of technical innovation. Even under the severe contraction of output experienced by Moldova, financial health of sector enterprises can be restored in a few years by means of restructuring programs. This would reverse the de-capitalization and accumulation of arrears which are so pervasive today. The implementation of such restructuring programs needs the strongest possible Government support (see paras. 21 to 39). 20, A priority measure is the consolidation of regulatory and policy-making functions over all transport sub-sectors within the Ministry of Transport (MOT). For efficiency and cost-saving reasons, it is recommended that operational responsibilities be transferred to independent, commercially-based entities, and in the case of road transport, to the private sector. In this regard, it is also recommended that construction companies currently under MOT be privatized under the 1995/1996 program (see below).  Policy Note and Executive Summary vii Privatization, Restructuring, and Conunercialization 21. The Government has committed to undertake an accelerated privatization program under the SAL for 1995-1996. In the case of transport this is in a first stage focused on road and bridge construction enterprises and trucking companies. Privatization could take place by either liquidating the assets of insolvent SOEs or selling them to private interests. In the second case, the enterprises need to be restructured to reach financial equilibrium and be attractive to potential buyers. In addition,, SOEs remaining under Government ownership would also need restructuring, i.e., liquidation and revaluation of assets, cost reduction programs, updating of accounting practices and ensuring cost recovery. The commercialization of SOEs refers to their operation once restructured, under competitive conditions and under commercial principles without Government interference in the management of their operations. 22. Restructuring and commercialization of operations would happen consistently throughout the sector, either because of privatization, or in the case of SOEs, as a result of restructuring programs leading to commercial operations. Commercial operations under cost effective conditions will be obtained as a consequence of competition from international and local suppliers of transport services across sub-sectors under market determined prices (see paras. 46-50). It would also facilitate future expansions of the Government's privatization program. Table I at the end of this section summarizes the financial adjustment and restructuring plans discussed for the sector. Road/Bridge Construction Enterprises 23. Although some of the construction enterprises have been able to secure contracts abroad, there is a drain of Government resources to pay salaries of inactive construction enterprises. A possible solution to reducing unnecessary MOT overhead costs, and improving the quality of road works, is the privatization of road construction enterprises.2 24. Based on the experience of other countries, competition will lead to an improvement in the quality of work and a reduction in unit costs. Under the current structure, there are no incentives to perform the road works properly since each company has an exclusive franchise to operate in a given region. This lack of competition results in uneven surfaces, which leads to premature aging of roads, high unit costs, and exacerbates the problem of maintenance backlogs. In the initial stages of privatization, the formation of joint ventures with foreign companies or the establishment of equipment leasing arrangements to private contractors from road construction equipment pools may be considered. Their privatization, accompanied by cost recovery from road users (see paras. 46-50 below), would lead to their steady work and the improvement of the quality of maintenance in the road system. This would also reduce trucking costs. 2/ Privatization is defined here as the transfer of ownership from the state to private hands either by auctioning assets or by selling the stockholding of the state enterprises to individuals or to other private enterprises. Corporatization is the formation of a joint-stock company (corporation).  viii Policy Note and Executive Summary Trucking Services 25. Currently. MOT shoulders unnecessary expenses resulting from idle trucks and their associated personnel: the utilization coefficient of the trucking fleet is currently under 30%. Besides privatization of existing enterprises, the most expedient solution to this problem would be to auction off the surplus assets/trucks to small, independent operators. This would have the additional benefit of increased competition in the trucking industry. 26. As the emerging markets neighboring Moldova further develop, the demand for cost-efficient and environmentally friendly trucking services will grow. However, the trucking fleet in Moldova is composed of trucks of old design and poor quality, and thus its operating costs are high and reliability low. Few trucks meet emission standards in Western Europe, preventing their use in trade outside the FSU. The Moldovan trucking industry will be unable to compete in the future market without significant investment into new technologies and assets. Without price liberalization (paras. 46-50 below), it will not be able to attract private investment. Railways 27. Rail freight traffic has dropped by 60% between 1991 and 1993 with a further drop of 9% in 1994. Although rail will continue to serve trade with the FSU and transport heavy cargo such as coal, oil products, and construction materials, the drop in rail freight traffic is likely to continue given that trucking, a faster transport mode, has become the preferred domestic freight transport mode and is likely to make inroads in international transport as well. The loss of market share will be compounded as the trucking industry is privatized and becomes more efficient. If similar experiences in the West are any indication, this process is impossible to avoid, and it will be important for the railways to orient their services to their future demand. The current losses in revenue resulting from over capacity in the sub- sector could be compensated by reducing costs (see Table I), and leasing or selling any railway assets that are not currently engaged in transport activities, including land, buildings, and equipment. 28. The potential insolvency of the railway enterprise is a problem of immediate concern. To remain solvent, the railway enterprise must begin operating on a commercial basis. The first step in this direction is the removal of cross-subsidies by non-transport activities, since it contradicts cost recovery objectives (see pars. 46-50). The second step towards commercialization is to separate the accounts of passenger and freight services: each should operate on the basis of cost-recovery, especially for passenger transport where only 60% of costs are recovered. The third step towards commercialization is to hand over all non- railway activity to the appropriate agencies (e.g., the recreational facilities should go to labor unions or be privatized, medical services to the Ministry of Health or contracted to a private medical service delivery enterprise, etc.) and auction off all non-railway assets. Fourth, evaluate railway staff needs, and rationalize where necessary, i.e., staff should be retained only if their labor is needed. 29. However desirable privatization may be for the railway sub-sector, the railway enterprise is far from ready for it at present. Thus, it is a priority for the railway enterprise to begin the process of restructuring with a view to its eventual privatization. Only privatized enterprises are able to attract foreign capital investment, which the railways would require to upgrade its technology, e.g., development of multi-modal transport.  Policy Note and Executive Summary ix Multi-modal Transport 30. The development of multi-modal transport is necessary to assist the growth of trade (see para. 42). Although the transport enterprises are in no financial position to undertake such investments at this time, they could start preparing for this eventual technological upgrading. This will require eliminating: a) cumbersome customs and other border formalities; b) outdated commercial and transport documentation procedures; and c) deficient insurance arrangements. The development of multi-modal transport would benefit from the liberalization of the freight forwarding business (paras. 40-45), and the availability of leased equipment. The Airline Industry 31. A major effort to restructure the national civil aviation conglomerate is underway. It aims to break it up into independent entities according to function: (a) an airline company; (b) airport operations company; (c) a civil aviation authority (CAA) acting as the regulatory agency; (d) an air traffic control (ATC) unit, under the authority of CAA, to manage both lower and upper airspace and coordinate all traffic, including approaches and take-offs; and (e) aerial groups working on agriculture and air taxi services separate from the commercial airline company. Points (c) and (d) have been already accomplished. Separation of (a), (b) and (e) are under study by a national commission since November 1994. It is recommended that each of these independent entities be responsible for its own commercial viability, i.e.,cost recovery and resource mobilization. In addition, it is recommended that each of these entities be privatized, with the exception of the regulatory agency. Alternatively, ATC and the airport could also be considered as public functions operating on a commercial basis. To increase efficiency, Air Moldova would cease all non-airline activities. 32. It is a priority that the airline company be allowed to operate as a commercial entity with the authority to adjust ticket prices to cover costs and terminate unprofitable routes in a competitive environment. In the medium term, the airline, as well as the independent airport authority, should formulate a long-term business plan and train its upper management in marketing and business practices employed by successful airline/airport operations companies elsewhere in the world. Competition in civil aviation would be introduced by allowing the operation of international carriers. 33. Given the excess airport capacity in Moldova, investments in additional capacity would need to be postponed until warranted by additional traffic. Priority measures are to upgrade existing air navigation and ATC equipment at Chisinau to International Civil Aviation Organization (ICAO) standards, and to refurbish the terminal building. 34. The restructuring of the civil aviation sub-sector would require the immediate passage of an Aviation Law implementing the above measures. Public (Urban/Suburban) Transportation 35. Given the heavy reliance of the population of Moldova on the public transportation system, (over 50% of all motorized trips, compared to 20% in Western Europe and 3% in the United States), the system needs to be adequately maintained to ensure the continued supply of services into the future. The continuation of the practice of allowing financial shortfalls in all modes of the public transportation system  x Policy Note and Executive Sunmnary is no longer possible, and in the case of urban transport, could lead to a total breakdown due to a lack of resources. The World Bank recommends the privatization of road passenger transport as soon as feasible. 36. The current fare structure is one of the main causes of financial shortfalls in the public transport sub-sector. It includes a broad fare-exemption policy whereby 70% of the population qualifies for exemptions (37 categories in all). Cost recovery could be improved by narrowing this broad policy and providing direct income assistance to targeted groups under the social protection elements of the Government's adjustment program. Currently, revenues cover only 20% of total expenses. A priority measure is for the municipal authorities to use their full authority to restructure urban transport and to set fares according to cost recovery, with the goal of full cost recovery by the year 1997. Under full cost recovery for restructured operations, fares for trolley-buses would be $.05 and for buses $0.13. 37. This expense of about $3 to $6 per month per worker, does not seem to pose an affordability problem when combined with targeted income assistance. The transport element in a household budget is typically under 10%, and local surveys have reported that only 35% of household incomes in Chisinau come from official (other than private) sources and are thus higher than otherwise reported. According to the Municipality of Chisinau, the population also feels that the fares are too low; painfully aware of the fact that in the absence of realistic fares, reduction in services, longer waiting times and crowded vehicles, and an ever worsening perspective, would be the only alternative. In the view of the Ministry of Finance, hardship situations would be addressed as direct income supplements to the target population. 38. The restructuring would be facilitated by the transfer, from MOT to the operational authority of municipalities, of all its remaining urban bus services. Alternatively, these buses could be privatized or auctioned off. It is also recommended that the "mixing" of services at the enterprise level, i.e., trucking, taxi and bus services provided by a single enterprise, a significant source of inefficiency, be eliminated. This mixed structure easily lends itself to cross-subsidization, e.g., between trucking services and inter- urban bus service, a practice which leads to distortions and operational inefficiencies in the sub-sector. 39. Suburban bus services, despite an 80% decrease in ridership since 1990, is still an important mode of public transportation in Moldova (71 million bus riders in 1993); however, the fleets have not been adequately maintained and a shortage of spare parts has resulted in a drop in fleet utilization from greater than 60% a few years ago to 30% today. Over 30% of the fleet is operating beyond its economic life and tariffs are still controlled by MOT. However, if the financial position of the bus authorities does not improve, the purchase of replacement buses will not be possible as it has been the case in 1993 and 1994. In contrast to urban/suburban buses, the international bus services, which operate on a commercial basis and enjoy freedom from tariff controls, are profitable. The market is already open to international operators from Bulgaria, Romania and Turkey.  Table I TRANSPORT SECTOR FINANCIAL ADJUSTMENT and RESTRUCTURING PLANS ACTIONS Urban Transport Railways Air Moldova Chisinau Airport Trucking, Taxis and City of Chisinau Inter-Utrban Bus Atsse Restructuring P Revalue Assets from current 4 I min Lei to Si) nolr Lei from cuTcnt 116 min Lei to 720 mmn Let from current 20 mIn Let to 40 min Let separate aiport from airline m 1995 R Depreciation fully depreciate in t0 years fully depreciate locos in 5 yrs, fully depreciate in 10 years cars in 8 yis, and tracks in I S yrs v A Tariff Adjustment and Rationalitatlon T Curient lardlf (or Charges) Incrcase 3 over 5 years passenger 0 2 in 1995 and reach 1994 levels - 2 75 by 1999 2 over 5 years for passengerand freight raise landinguchage from $6 50 Lo $10 per ton by 1998 fre,git * 1 5 Iby 1995 and reach 1994 levels 0 2 25 by 1999 and establish a $1 1 airport fee per passenger Z Final Average Tariffs bus 0 19 Lei/pass, trolley 0 58 Let,pass 0 106 Lei/pass kmn and 0 114 Lei/ton km 2 45 Lei/pass km and 0 99 Lei/ton km A Other Measures all passengers pay full fare by 1996 eliminate current tariffdiscriminations clminate tanTffdiscrimination between offcr services an an equal basis to all carriers T in freight and passenger transport Moldovan and foreign citizens 0 Sttff R.edu-tin and Salary Increases Staff Reducton from curTent 3,320 to 2,000 over 4 years from current 20,896 to 12,000 over 4 years from current 2.435 to 700 by 1995 bring from current 600 to 300 o (includes separation of Lthe airport from the airline) during sepaation from the airline F Salary Iscrs * 3 over 5 yeam 3 over 5 years 3 over 5 yc.- e 3 over 5 years Severance Payment up to 3 years of salary up to 3 years of salary up to 3 years of salary up to 3 yers of salary T H Cast Keductinn Prugram Ditesoture of all non-transpurt actavies mainly mnmicipal housing including townships, and medical and education facilities includes airline township and Black Sea resorts stAn Pnsf-aaauon of some bus routes as well as expedition operations, industnal productionr agncultural and sanitary aviation and SECTOR vehicle and spare part manufaturing maintenance of rolling stock other non-transport-related activities  xii Policy Note and Executive Summary E. TRADE AND TRANSPORT FACILITATION 40. As seen in paras. 9 and 10, excess costs in trade and transportation are important and result from: a) road transport inefficiencies; b) old technology in rail transport and the lack of multi-modal transport technology; c) trade control barriers; d) inefficient customs procedures; e) slow documentary procedures and complicated financial procedures; and f) telecommunications inadequacies. The expected balance of payments improvement from removing direct excess costs and the accompanying increased export volume could reach up to US$120 million per year. This does not include revenues from transit traffic. Given that the removal of trade control would provide a third of the benefits to be gained without significant investments, it deserves the highest priority. 41. Road Transport Barriers to Trade. Excess costs result from the following, and are estimated at US$ 35 million, most of which result from fleet impediments. * Fleet Composition Impediments. Since the current trucking fleet in Moldova is uneconomical (low capacity, fuel inefficient), and does not meet EU emission standards, these trucks will increasingly be limited to domestic and FSU use. Thus, for trade with the EU, Moldova will need to allow entry of European trucking companies to facilitate trade and supplement its own fleet with modern heavy trucks. Infrastructure and Equipment Barriers. The design standards of East-West roads, their state of disrepair, and the lack of repair facilities for international trucking prevent in some cases the use of modern trucks and trailer combinations. Among the recommendations to remove these barriers are: the introduction of management information systems to monitor traffic and network conditions, the rationalization of transport equipment (leasing), and/or allowing freedom of entry to private suppliers. * Restrictions due to Regulation and Deferred Privatization. Government policies regulating entry and transport prices, as well as banking regulations affecting access to banking, are suppressing private-sector development, while putting an efficient and competitive trucking industry beyond the reach of Moldova. * Roadside Controls and Informal Transactions. Informal payments to get through check points are prevalent and represent a cost which is borne by the freight in each case. Upgrading Multi-modal Transport 42. Upgrading rail and road technology to allow multi-modal transport, i.e., containerization, would lead to cost savings estimated at US$ 5 million per year, and liberalizing the freight forwarding business would lead to further cost savings.  Policy Note and Executive Summary xiii Trade Control Measures 43. To improve the efficiency of trade, the recommended measures are as follows: elimination of remaining export/import licensing requirements as envisioned under the SAL agreements; rationalization of the administrative procedures involved in obtaining papers for export; and easing of certification requirements for imports all of which add unnecessary transaction costs. Customs Procedures and Border Crossings 44. Customs procedures and border crossings represent excess costs of about US$5 million per year at today's levels of trade and would increase with an expansion of trade. * Customs Procedures. To increase the efficiency of customs procedures, the following measures are recommended: generalization of pre-shipment inspection; reduction of lengthy customs declaration and documentation preparation by using separate customs tellers for export and import operations, and by increasing the number of trained customs inspectors assigned to industrial warehouses; simplification of customs classification rules, va.uation methods, and local content requirements; facilitation of title dispensations in simple cases; development of sufficient bonded facilities for transit traffic; and elimination of administrative formalities such as those of temporary admission and security deposit requirements as well as most instances of product certification. * Border Crossings. A priority goal is to obtain border crossing times of 10 minutes per vehicle, a typical processing time at border crossings in Europe. Investments in computer technology could be made for each border crossing as these investments have high returns (payback period expressed in months). Physical investments at the Leusheni and other border crossings could be considered after the implementation of simplification measures and technology upgrading discussed above. Documentary and Financial Procedures 45. Foreign trade and its associated businesses, such as insurance companies, are young and inexperienced in Moldova. (Some of them went bankrupt when loans they insured turned out to be non- performing .) Documentary and financial barriers result in increased costs of 1 to 1.5% ad valorem. * Insurance Documents. Insurance documents do not comply with international standards and are not accepted by foreign banks. The companies, however, are rapidly improving. It is highly recommended that documents be standardized conforming to international practices and the market be opened to allow entry of foreign insurance companies. * Letter of Credit (LIC). The L/C procedure is an expensive service and a complicated process not accessible to small entrepreneurs in Moldova. The opening of the market to international banks will accelerate the upgrading of financial services. Another possibility is to introduce electronic data interchange (EDI) technology in order to reduce complexity of paperwork and elininate risk of discrepancies.  xiv Policy Note and Executive Summary Foreign-Exchange Access. Restrictions on capital account transactions have resulted in a limited list of enterprises allowed to have off-shore banking accounts. Until external financial services are better developed, this affects the ability of small and medium sized enterprises to operate in foreign currency which constrains trade and adds to transaction costs. F. COST RECOVERY AND MARKET DETERMINED PRICING 46. Throughout the sector, costs of providing transport services are not recovered. Applicable road user charges are insufficient to cover road maintenance expenditures. The maintenance backlog is estimated at $330 million and very little work is being performed today. Railways do not cover costs and balance their books with "non-transport" income. If proper depreciation charges were applied, a deficit would show. The airline, in addition to discriminatory prices, i.e., some passengers do not pay for the full cost of services by design, does not depreciate its assets, does not have sufficient income to buy spares, and is forced to cannibalize planes to keep a few of them in operation. Road and rail passenger transport do not cover their costs either. This has resulted .n a lack of renewals and an aging plant. In the case of both urban and suburban bus transport, lack of cost recovery has also resulted in a reduction of the available fleet. In Chisinau, for instance, eight (8) out of forty four (44) existing bus lines do not operate due to an insufficient number of buses. 47. Lack of cost recovery is the main cause of the sub-sectoral issues discussed above, i.e., the erosion of the asset base of the sector, mounting maintenance backlogs and lack of renewals, widespread obsolescence, and shortages of spare parts. 48. Recognizing the need to recover costs does not give implicit approval to all cost structures as they exist today. Numerous expenditures not associated with the provision of transport services are in fact competing for resources and crowding out renewals and technical innovation. The determination of the viable enterprise structure and its costs is one of the results of the privatization, restructuring and commercialization of transport enterprises. Today these enterprises are not credit-worthy and do not have debt capacity which could allow them to address their problems. 49. Under the gradual economic recovery envisioned, restructured transport enterprises, be it state owned or private, operating under cost recovery principles would be able to pay their arrears, substantially increase salaries, cover severance payments to redundant workers, restore capacity, and most importantly, develop the financial capacity to implement significant investment programs. In so doing, the productivity of both capital and labor would begin to increase consistently for the railways, airline and urban transport. 50. Recovering costs, and reducing them by means of restructuring, does not guarantee minimum transport costs. This can only result from competition among suppliers of transport services. The need to ensure competition and have market determined prices leads to the liberalization of entry and prices for domestic transport. Given Moldova's position as a net importer of transport services, the opening of its markets to international transporters and freight-forwarders is unavoidable. In this fashion, the lower costs of the more efficient suppliers, and the cost reductions from the removal of barriers to trade discussed above, would be passed back to users in the form of lower transport costs.  Policy Note and Executive Summary xv G. INVESTMENT PRIORITIES AND FINANCING OPTIONS 51. The needs of the transport sector of Moldova include technical assistance to implement policies for sectoral adjustment and project finance. The priorities are those set out in the proposed transport strategy. 51. In the case of road infrastructure, they are the introduction of road user charges, privatization of construction enterprises and implementation of a program for the rehabilitation and maintenance of the main national and international roads (Clearance of the $330 million backlog of road maintenance is not feasible with current levels of traffic.) Privatization of road transport with reduction or elimination of import duties for road transport equipment, and opening of transport markets to international operators would complete the priorities list for the road sub-sector. In addition, restructuring of urban transport as discussed above would take place simultaneously. 52. The railways foremost priority is its institutional and financial restructuring. This is necessary to generate its capacity to invest and perform its economic role in a competitive environment. Otherwise it would weaken and eventually disappear quite independently of its role in support of FSU trade. A program of priority renewals and repairs would need to be updated in the light of: (a) the progress made in the restructuring exercise; and (b) the actual development of railway traffic. The impossibility of recovering costs for some new infrastructure investments and equipment purchases under consideration by the railways, would make advisable their postponement. 53. Air transport needs, as a first priority, to open its market to competition, and define its legal framework establishing the separation of the policy making and regulatory functions, from airport, air traffic control, and airline operations. This needs to be followed as a matter of urgency by the restructuring of the airline, ATC and the airport operations. The survival of the sub-sector and the safety of its operations over the next three years or so are dependant on these actions. As a result, arrears can be expected to be eliminated, normal maintenance of aircraft resumed and an equipment renewal program started as early as 1997. 54. The feasibility of an oil port on the Danube is under study financed by TACIS. The project was not included in the consultants Public Investment Program (PIP) report as it was intended to be a private sector operation. Previous indications received from the Government implied that SOEs would contribute equity and the Government would commit itself under a guarantee agreement. If this is still the case, the arrangement proposed and the project's feasibility need to be carefully reviewed to ensure that limits to expenditures and indebtedness established under the Government's adjustment program are adhered to. In addition, the role of the port vis a vis the continued existence of the railways, as well as the restructuring of the energy sector and the distribution of oil products needs to be established. The experience with shipments of Iranian oil imports to be discharged at either Ukrainian or Romanian ports as recently announced, would be of particular interest in this regard. Sectoral Adjtstment/Institutional Reform 55. The World Bank and other donors could consider providing grant funds for the implementation of some of the policy and institutional adjustments discussed above. Its support could cover: a) training; b) technical experts; and c) equipment and logistical support.  xvi Policy Note and Executive Summary Investment Priorities 56. Within each sub-sector the most urgent priorities identified give the following possible interventions: * Rehabilitation of the Core Road Network. The first investment operation in road infrastructure under consideration by EBRD, would rehabilitate important sections of the international road network and identify required technical assistance. * Restructuring the Railways. A corporate strategy would be formulated, accounting systems would be updated, and the fare structure would be revised for cost recovery and generation of debt capacity to carry out investments. Asset management and cost reduction strategies would also be formulated, including divestiture where applicable. This project would also include technical and management training. * Restructuning Urban Transport Services. Technical assistance would support the restructuring and privatization of the urban transport sub-sector. In addition, it would generate investment capacity necessary to renew buses and procure spare parts for the bus fleet on a continuing basis. Implementation of a fare structure to ensure cost recovery would make this possible. * Implementation of Trade and Transport Facilitation Measures. Finance is necessary to implement the corrective measures identified in paragraphs 40 through 45 and not covered under the SAL agreements. -- JUpgrading of Air Traffic Control and Refurbishing of Terminal. Carefully selected expenditures are needed to remove the current isolation of Moldova from the international business conmmunity and improve access. 57. Financing Options. Investments should concentrate on rehabilitating existing infrastructure, subject to cost-benefit analyses, rather than on new construction. Investments supported by the World Bank would be open to co-financing by other multi- and bilateral organizations. 58. The World Bank will provide assistance in reforming the sector's policy framework. It may also consider one lending operation to provide investment finance for the priority areas above, in support of the macroeconomic reform program established by the Government of Moldova. 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