Ukraine - Rehabilitation Loan Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 16334 IMPLEMENTATION COMPLETION REPORT UKRAINE REHABILITATION LOAN 3831-UA February 27, 1997 Country Operations Division II Country Department IV Europe and Central Asia Region 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 disclosed without World Bank authorization.  CURRENCY EOUIVALENTS (as of February 28, 1997) Currency Unit Hrivnya US$1 Hrivnya 1.765 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS IBRD - International Bank for Reconstruction and Development IDA - International Development Association PIU - Project Implementation Unit SOE - Statement of Expenditures MOF - Ministry of Finance AGSECAL - Agriculture Sector Adjustment Loan CG - Consultative Group EDAL - Enterprise Development Adjustment Loan FSU - Former Soviet Union GDP - Gross Domestic Product ICR - Implementation Completion Report IMF - International Monetary Fund NBU - National Bank of Ukraine STF - Systemic Transformation Facility VER - Voluntary Export Restraint UKRAINE'S FISCAL YEAR January I - December 31 Vice President: Johannes Linn, ECAVP Director: Basil Kavalsky, EC4DR Division Chief: Wafik Grais, EC4C2 Responsible Staff: Chandrashekar Pant, Consultant, Ritu Anand, Senior Economist, EC4C2  FOR OFFICIAL USE ONLY IMPLEMENTATION COMPLETION REPORT UKRAINE REHABILITATION LOAN 3831-UA Contents Preface .......................................................................i Evaluation Summary ...................................................................... ii Part I. Project Implementation Assessment .......................................................................1 Part II. Statistical Tables ...................................................................... 12 TABLE 1: SUMMARY OF ASSESSMENTS ...............................................................................13 -14 TAbLE 2: RELATED BANK LOANS/CREDITS .............................................................................. 15 TABLE 3: PROJECT TIMETABLE .............................................................................. 16 TABLE 4: LOAN/CREDIT DISBURSEMENTS: CUMULATIVE ESTIMATED AND ACTUAL ....................................... 17 TABLE 5: KEY INDICATORS FOR PROJECT IMPLEMENTATION ...................................................................... 18-21 TABLE 6: KEY INDICATORS FOR PROJECT OPERATION .............................................................................. 22 TABLE 7: STUDIES INCLUDED IN PROJECT .............................................................................. 23 TABLE 8A: PROJECT COSTS .............................................................................. 24 TABLE 8B: PROJECT FINANCING .............................................................................. 25 TABLE 9: ECONOMIC COSTS AND BENEFITS .............................................................................. 26 TABLE 10: STATUS OF LEGAL COVENANTS .............................................................................. 27 TABLE I 1: COMPLIANCE WITH OPERATIONAL MANUAL STATEMENTS ............................................................. 28 TABLE 12: BANK RESOURCES: STAFF INPUTS .............................................................................. 29 TABLE 13: BANK RESOURCES: MISSIONS .............................................................................. 30 Appendixes: A. Borrower contribution to the ICR ...................................................................... 31-33 B. Map Vice President: Johannes Linn, ECAVP Director: Basil Kavalsky, EC4DR Division Chief: Wafik Grais, EC4C2 Responsible Staff: Chandrashekar Pant, Consultant, Ritu Anand, Senior Economist, EC4C2 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 disclosed without World Bank authorization.   IMPLEMENTATION COMPLETION REPORT UKRAINE REHABILITATION LOAN 3831-UA Preface This is the Implementation Completion Report (ICR) for the Rehabilitation Loan in Ukraine, for which Loan No. 3831-UA in the amount of US$500 million equivalent was approved on December 22, 1994 and made effective on December 27, 1994. The loan closed on June 30, 1996, the original closing date. The first part of the disbursements, which was made available upon effectiveness was fully disbursed by April, 1996. The second part ($250 million) was released on May 15, 1996. The loan was fully disbursed on May 31, 1996. Co-financing for the project was provided by the Canadian Government for US$10 million and the Export-Import Bank of Japan for US$150 million. The ICR was prepared by Chandrashekar Pant, Consultant for the Country Operations Division II of the Europe and Central Asia Region, and reviewed by Wafik Grais, Division Chief, EC4C2, and Ms. Judy O'Connor, Principal Operations Officer, EC4DR. The borrower provided comments that are included as appendixes to the ICR. The ICR was prepared as a desk task in the second half of 1996. It is based on material in the project file. The borrower contributed to the preparation of the ICR by preparing its own evaluation of the project's execution.   IMPLEMENTATION COMPLETION REPORT UKRAINE REHABILITATION LOAN 3831-UA Evaluation Summary Introduction 1. The Rehabilitation Loan was preceded by the Institutional Building Loan ($27 million) approved by the Board in June 1993. Following years of macro-economic instability and economic mis- management, in mid-1994 newly elected President Kuchma indicated his firm commitment to macroeconomic stability and systemic reforms. The Rehabilitation Loan supported his efforts. Since then, the Bank has approved 10 projects, including the Hydropower Rehabilitation and System Control Project ($114 million) approved in April 1995, the Agricultural Seed Development Project ($32 million) approved in May 1995, a Pilot Project in the Coal Sector ($15.8 million) and a Housing Project ($17 million) approved in May 1996, the Enterprise Development Adjustment Loan (EDAL, $310 million) approved in June 1996, a small Social Protection Support Project ($2.6 million), approved in September 1996, an Electricity Market Development Loan ($317 million) and an Agriculture Sector Adjustment Loan (AGSECAL, $300 million) approved in October 1996, an Export Development Loan ($70 million) approved in November 1996, and a Coal Sector Adjustment Loan ($300 million) approved in December 1996. The Bank's economic and sector work has included a Country Economic Memorandum (1993), and sector reviews in Agriculture, Transport, Energy, Environment, Finance, Housing, and the social sectors. A poverty assessment was completed in June 1996. Project Objectives 2. The main goals were to significantly lower the rate of inflation, to stop the decline in economic activity and to create a market-oriented, private sector-led economy. Funds from the Loan were also meant to alleviate the severe shortage of energy in the winter of 1994-95 and to strengthen the social safety net. The Bank's loan also provided a framework for financial assistance from other donor agencies. The goals were appropriate, but too ambitious. Implementation Experience and Results 3. The results of the project were mixed. On the positive side, the loan financed critically needed energy imports, alleviating the harsh winter conditions. The budget had more resources to strengthen the social safety net. The Rehabilitation Loan also provided a framework for mobilizing the international financial community in support of Ukraine's efforts. Through the CG process which the Bank chaired, the Loan prompted the international community to pledge $ 5.5 billion in economic assistance, debt rescheduling, and arrears consolidation to meet Ukraine's 1995 balance of payments financing requirements. By its timely support to Ukraine's reform efforts, and the additional resources mobilized through the CG process, the Rehabilitation Loan strengthened the position of the reformers within the government, and enhanced their ability to carry them forward. Two years down the road, this may be one of its biggest achievements.  - iii - 4. The project was less successful in other respects. First, macro-economic performance was erratic. Though the rate of inflation came down from an average of 16 percent per month in 1994 to about 5 percent in December 1995, this was much more than the targeted rate of 1-2 percent per month. Economic activity fell 13 percent in 1995, considerably more than the 5 percent projected by the Bank. And Ukraine could not prevent a further accumulation of external payment arrears. Partial success was achieved in liberalizing the economy and reducing the role of the state. Compared to the past, the domestic pricing and foreign trade regimes are considerably liberal today, though the state continues to intervene more than it should. After many false starts, privatization was finally initiated but the pace was very slow for most of 1995 (paras. 12-21). 5. Deep divisions continued to exist within the government and outside (notably in Parliament) on the need for reforms and their pace, which constrained their implementation. Reforms were also slowed down by institutional constraints and unfamiliarity with the way markets function. Poor weather and less than expected external financing also contributed to slower than projected economic recovery (paras.22- 25). 6. While the Rehabilitation Loan addressed key issues and policies, there were some aspects in the design that were not fully thought through. For example, closing down a few large enterprises and requiring restructuring plans to be drawn up were insufficient to improve financial discipline. More attention should have been devoted to addressing the issue of arrears in the energy sector. 7. Objectives and indicative targets of the reform program supported by the Loan were often too optimistic. To some extent, targets were deliberately ambitious to exhort greater effort. But it also reflected an inadequate appreciation of the continuing opposition to reforms. Institutional constraints which slowed down implementation were not adequately recognized. 8. The reform process remains uncomfortably fragile, and can be reversed. To prevent this, the government must attempt, even more determinedly than before, to continue the course of reforms it has initiated. Rapid privatization of industry and agriculture, and strict enforcement of financial discipline and accountability in state enterprises are essential. And payment issues in the energy sector need to be addressed urgently as they could quickly undermine Ukraine's external creditworthiness. The international community must continue to actively support these efforts of the government. Summary of Findings, Future Operations, and Key Lessons Learned 9. The results were more than satisfactory when compared to the economic situation existing at the time the loan was approved. The rate of inflation was lowered, and the rate of decline in GDP was slowed down. The economy was considerably liberalized and privatization was initiated. However, by and large, the outcomes fell short of expectations, and the reform process remains fragile and by no means irreversible. 10. Follow-up operations carry forward the reforms initiated under the Rehabilitation Loan. In June 1996, the EDAL was approved which accelerates privatization of small and large enterprises, and supports the growth of the capital market and post-privatization restructuring of enterprises. An  - Iv - Agriculture Sector Adjustment Loan was approved in October 1996 that seeks to accelerate land reforms and private sector development. The Electricity Market Development Loan aims to hasten the development of a competitive wholesale market for electricity. And the Coal Sector Adjustment Loan facilitates efficient restructuring in the coal sector. Other operations planned for the near future include a Pre-Export Guarantee Facility, Urban Transport Project, and a Legal Reform Loan. Follow up adjustment operations are proposed to support reforms in the public sector and in the financial sector. 11. The main lessons from the project are as follows: (i) There is a strong tendency in the Bank to be over-optimistic about the outcomes of adjustment operations, both in terms of macroeconomic objectives (reduction in inflation, growth of GDP and exports) as well as structural changes (extent of privatization, demonopolization). (ii) The opposition to market reforms is deeply entrenched. The Bank needs to decide whether there is sufficient commitment within the country to warrant its continued involvement in reform efforts and then to stay engaged despite slippage and temporary reversals, which are inevitable. In practical terms, this requires identifying some key signposts that indicate the government's commitment to reforms (such as macroeconomic stability and privatization) and to continue to support the government as long as these signs point in the right direction. (iii) To the extent possible, the Bank should seek to involve in policy discussions those in government who are skeptical about the reforms, especially when they pertain to agriculture and the social sectors. This may be time-consuming and difficult, but ultimately beneficial. (iv) Institutional capacity is limited, and very little can be done in the short time frame of an adjustment loan to change this. The Rehabilitation Loan had to be comprehensive in coverage because major distortions were everywhere and addressing one of them without the other would have failed. But subsequent operations should as far as possible be more narrowly focused. In this context the emphasis on sector adjustment loans is appropriate. The Bank should continue to assist the government in developing its capacity to design and manage reforms, recognizing there is no quick and easy fix. (v) The most difficult reforms to implement, and the most important, are those that seek to enforce financial discipline in enterprises and farms, and make them more responsive to market forces. Apart from privatization in industry and agriculture, phasing out of budget transfers and credit subsidies to specific sectors and enterprises, prevention of accumulation of payment and tax arrears, and measures to facilitate new entrants and the closure of unviable firms are especially important. Adjustment in the energy sector is especially urgent as payment arrears threaten Ukraine's external creditworthiness. (vi) There is often a tendency to do something more about enterprises that will not immediately be privatized. Typically, this takes the form of closing down a few large unviable enterprises and requiring restructuring plans to be developed for selected enterprises. However, there is little evidence suggesting these measures have contributed to any lasting solution. Unless there is a very clear concept behind these kinds of interventions, and a long term commitment from the Bank to remain closely involved in these efforts, they should be avoided. (vii) Policy conditionality should be designed to be as 'close' as possible to the specific objective that is to be achieved. Thus for example, conditions such as "presentation of draft law to Parliament .." should be avoided because (a) legislation may not be really required (as in the case of  v - procedures for land registration in Ukraine) and (b) there is a big gap between presentation of law and its approval by Parliament, let alone the implementation of the policy. (viii) Given the uncertain political support for reforms, the limited institutional capacity and the uncertainties of predicting the nature and size of supply response, it would be prudent to maintain realistic expectations and to be flexible in our response to slippages in policy and projected outcomes. The phased disbursement design of the Ukraine Rehabilitation Loan was a useful innovation in this regard. (ix) Intensive monitoring and supervision by the Government and the Bank is essential during the early years of reform when slippages may occur not just because there is active opposition but merely because of misunderstanding about what needed to be done or insufficient manpower. An adequately staffed Bank Resident Mission can play an invaluable role in this respect. (x) A suitably empowered authority in the Government to coordinate and oversee progress in reforms is vital not only for the internalization of the reform program, but also to prevent implementation of sectoral policies that go against the spirit of the economy-wide reforms.  IMPLEMENTATION COMPLETION REPORT UKRAINE REHABILITATION LOAN 3831-UA Part I. Project Implementation Assessment A. PROJECT OBJECTIVES 1. Economic conditions in Ukraine were worsening when the government initiated economic reforms which were supported by the Rehabilitation Loan. The rate of inflation had touched hyperinflationary levels by the last quarter of 1993. Real GDP was estimated to have declined by 27 percent in the first half of 1994, following a cumulative decline of 38 percent during 1990-93. Real wages had fallen by more than 60 percent in 1993 and had not recovered. And with the accumulation of huge payment arrears with Russia and Turkmenistan, Ukraine was finding it increasingly difficult to pay for critically needed energy imports. 2. In late 1994, under the leadership of the newly elected President Mr. Kuchma, Ukraine embarked on a comprehensive program of macroeconomic stabilization and market-oriented economic reforms. The main objectives were to reduce the rate of inflation, to stop the decline in economic activity and to create a market- oriented, private sector- led economy. The World Bank's Rehabilitation Loan (for $500 million) supported these objectives. Funds from the Loan were also meant to alleviate the severe shortage of energy in the winter months, and to help pay for strengthening the social safety net. Together with the IMF's Systemic Transformation Facility (STF), the Bank's loan sought to provide a framework for financial assistance from other donors. 3. Given the sorry state of Ukraine's economy, there was no question about the objectives. Nor was there much doubt about what needed to be done. Loose financial policies had played havoc with macro-economic balances, and there was general agreement that a tightening of financial policies was necessary to reduce the rate of inflation and improve the balance of payments. State interventions were pervasive and were stifling entrepreneurship, forcing an increasing share of the economy underground and capital abroad. Freeing the shackles from the private sector and progressively increasing the role of markets was necessary in order to stem the economic decline and improve productivity. Thus the loan supported the de-regulation of prices and the foreign exchange and trade regimes; privatization and demonopolization in agriculture and industry; and measures to strengthen the social safety net. In the short term, the loan financed the most critical and obvious needs; energy imports were badly required to alleviate the harsh winter conditions, and budgetary support for strengthening the safety net was essential not only on humanitarian grounds but also to maintain public support for structural reforms. 4. While the objectives and the direction of reforms were clear, there is no doubt that they were ambitious, maybe unrealistically so. Partly, this reflects a basic dilemma faced by the Bank in other countries of the region as well. On the one hand, the depth of the economic crisis and the magnitude and pervasiveness of the distortions in the economy necessitates a wide-ranging program of macro-economic stabilization and structural reforms. Piece-meal measures are not likely to work. On the other hand, the inadequate institutional capacity makes it very difficult to implement market reforms across a wide front.  -2 - The Bank has typically favored going for the comprehensive approach, knowing well that some of the targets may not be achieved and that further adjustments in the objectives and program may be required as capacity or other constraints are faced. This was also the approach in this project (See section C). The reforms were ambitious in another important respect. It was clear that the consensus in favor of reforms was at best fragile. While the main counterparts in government were committed to the reform program, a large section of government and population did not understand it, nor were in favor. The risk this posed to implementation was recognized, but it was felt that opposition could only be overcome gradually by the demonstrable results of the reforms (lowering of inflation, stopping the decline in economic activity). B. ACHIEVEMENT OF PROGRAM OBJECTIVES 5. The results of the reform program thus far and the loan are mixed. On the positive side, the proceeds of the loan helped finance critically needed energy imports and alleviated the harsh winter conditions. In addition to the funds directly made available by the Bank through this loan, the Japanese Government cofinanced the loan for $150 million and the Canadian Government provided an additional $10 million. The support lent to the reform program by the Bank and the IMF was also instrumental in attracting other external donors to Ukraine's cause. Overall, through the CG process which the Bank chaired, the international community pledged $5.5 billion in economic assistance, debt rescheduling, and arrears consolidation to meet Ukraine's 1995 balance of payments financing requirements. 6. The reform program was less successful in other respects. First, macro-economic performance was erratic through 1995 and early 1996. Though the rate of inflation came down considerably compared to the pre-reform days, (from an average of 16 percent per month in 1994 to about 5 percent in December 1995), this was much more than the targeted rate of 1-2 percent per month. Moreover, progress was uneven. Inflation remained stubbornly high in late 1994-early 1995, then slowed down to monthly rates of about 5 percent by the middle of 1995, before rising to almost 14 percent in September 1995. Monthly inflation fell to about 5 percent in November and December before rising to more than 9 percent in January 1996. While some of these increases were attributable to increases in administered prices, nevertheless the underlying rate of inflation exceeded program targets. It is only since the spring of 1996 that the rate has been down consistently to around 2 percent monthly. 7. Economic activity also fell more than projected in 1995. Real GDP is estimated to have fallen by 13 percent in 1995 compared to the Bank's estimate of 5 percentl This may have been due to a number of factors, including partial and inconsistent implementation of reforms (see Section C and Appendix 1), less than anticipated foreign financing, and exogenous factors (such as the drought affecting agricultural output in 1995). Thus while industrial production was hurt by the break-down of the state order system, the slow pace of privatization, weak financial discipline and continuing restrictions on trade hampered a market-based positive supply response. Price volatility and other uncertainties in the policy environment also contributed to dampening producer and investor confidence throughout 1995. 8. The strong growth of exports to Western countries in 1995 (20 percent in volume) was a remarkable achievement. However, the balance of payments remained severely strained and Ukraine The real decline in economic activity may have been less than what these numbers indicate due to the growth of the underground economy.  - 3 - continued to accumulate external payment arrears (mainly on account of gas payments to Russia and Turkmenistan) in 1995. These arrears reflected weak payment discipline by the government, households and enterprises within Ukraine, and insufficient real adjustment in the energy sector in particular. 9. An important objective of the reform program supported by the Loan was to increase the role of markets and the private sector and reduce the interventionist role of the state in resource mobilization and allocation. In this respect, important gains were made, though once again progress was much slower than expected (for a summary evaluation see section below; for more details about specific commitments, see Appendix 1). Compared to the past, the domestic pricing and foreign trade regimes are considerably more liberal, though the state continues to intervene more than it should. After many false starts, privatization was finally initiated but the pace was slow for most of 1995. It has picked up since. 10. The Loan was a rapid response from the Bank to Ukraine's financial crisis. By providing timely financial assistance, and mobilizing the international community to support Ukraine's reform program, it helped shore-up the credibility of the few reformers in government at the time, and strengthened their capacity to carry the reforms forward. Their task would certainly have been more difficult had this support not been forthcoming as quickly as it did. This is arguably the Loan's most important achievement. 11. Another achievement was that the Loan opened up a sweeping agenda for reforms, including in particular in crucial sectors, such as energy and agriculture. Important issues were identified and first steps in reforms were taken. Subsequent operations (such as the EDAL, sector operations in power and coal, and the AGSECAL) seek to deepen these reforms and carry them forward. C. IMPLEMENTATION RECORD 12. As mentioned above, the record of implementation of macro-economic policies and structural reforms was mixed. Notable successes were achieved, and a definitive break was made from past policies towards establishing a market-based economy. However, reforms have been slower and shallower than expected. 13. Macroeconomic stabilization: A critical component of the stabilization effort was the containment of the budget deficit. Despite the revenue losses stemming from major tax reforms, as well as the general weakening of economic activity, the overall fiscal adjustment during 1995 was good. The cash deficit for 1995 was around 4 percent of GDP, less than half of the 8.6 percent recorded in 1994, but more than the 3.3 percent targeted at the beginning of the year. The slippage was largely due to over- runs in expenditures, reflecting larger than planned wage increases to government employees, subsidies to the coal mining sector, and the payment of arrears on gas imports. The larger budget deficit and the less than expected financing from external sources resulted in a larger than targeted volume of banking system credit to the budget. 14. Monetary policy was tuned to reduce the inflation rate to 1-2 percent per month by the end of 1995 and to replenish international reserves. However, broad money expanded more rapidly than programmed, mostly due to larger than expected capital inflows in the second and third quarters of 1995. The National Bank of Ukraine's (NBU) intervention to prevent an appreciation of the currency resulted in an over-run in its international reserves. The absence of measures to sterilize this increase in reserves  -4 - led to the over-expansion of base money, fueling inflationary pressures. There was also an over-run in banking system credit to non-government sector, which was partly due to efforts by the NBU through the banking system to assist specific enterprises. Thus, to summarize, while there was a significant tightening of both fiscal and monetary policy in 1995 compared to the pre-reform period, there were significant slippages in both fiscal and monetary targets. Some of these slippages were the direct result of attempts to bail out specific enterprises or specific sectors (e.g., coal industry) and contributed to lax financial discipline. These slippages not only jeopardized some of the macro-economic objectives, but by contributing to loose financial discipline they also undermined structural reforms and weakened the supply response of the real economy. In early 1996, the government undertook corrective measures and tightened financial policies. The rate of inflation has come down markedly since, to 0.1 percent in June 1996. Emboldened by this achievement, in September 1996 a new currency, the hrivnya was introduced. 15. Structural Reforms: The loan supported wide ranging reforms aimed at liberalizing the economy and promoting the private sector. Domestic trade and prices were to be liberalized, the foreign exchange and trade regimes were to be opened up to market forces, and privatization of agriculture and industry was to be accelerated. In these efforts too, the record was mixed. While major changes have been made, in many cases these fell far short of expectations. 16. Most prices were liberalized and limits on trade and profit margins lifted. Administered prices for utilities and communal services were significantly increased to recover costs. The multiple exchange rate system was abolished. Export quotas were eliminated, except for exports subject to VER and other international agreements and for exports of grain. Imports remained free from quantitative restrictions, and the average import tariff remained low. These were major achievements for an economy mired in pervasive controls for decades, and in the midst of continuing economic decline. 17. However, various controls continue to operate. Indeed, in some cases, new interventions have replaced controls that existed previously. Prior notification of price changes continued to be required from more than 16 categories of artificial monopolies, and local governments can regulate prices of additional "monopolies"2 Limits on profit and marketing margins for bread products remained in place for most of 1995. While export quotas were eliminated for most commodities, other interventions were maintained to control exports, such as the pre-export registration requirement and the system of "indicative" prices. Quotas were re-introduced in early 1995 on exports of ferrous and non-ferrous scrap, and grain producers suffered from quotas on their exports for most of 1995. In May 1996, export duties on certain commodities were introduced. Exports under barter trade continued to be heavily taxed. These policy irregularities not only hurt economic recovery directly; they also undermined the confidence of producers and investors in the government's commitment to market reforms. 18. The most notable disappointment was in privatization, where the pace was much slower than envisaged under the loan. Only about a third of small enterprises had been privatized by the end of 1995 compared to the expectation of 90 percent. Slippage was significant in the case of medium and large enterprises also: compared to the goal of privatizing about 8000 enterprises by end of 1995 (out of a total of 18,000), a majority of shares were sold to the private sector in only 1015 of these enterprises. By March 1996, the number had risen to 1233. In agriculture, the amendments to the Land Code and the draft Land Law that would have facilitated the development of a land market have yet to be passed by Parliament, more than a year later than expected. 2 This was reduced to 9 categories in mid-1996.  19. There was also little progress in enforcing stricter financial discipline in enterprises. The budget renewed its subsidies to ailing industries, particularly to the coal sector. Commercial banks were also encouraged by the government to extend credits to the enterprise sector. And the government decided that the budget would continue to assume responsibility for. the gas debts accumulated by enterprises. Inter-enterprise arrears, including payment arrears, continued to grow strongly in real terms during the year.3' 20. No comprehensive reforms were introduced to strengthen the social safety net, including old age pensions. The statistical and informational foundation for poverty analyses remains inadequate and the ability to formulate social programs is limited. 21. To summarize, important gains were made during 1995-early 1996 in achieving macro-economic stabilization and in moving Ukraine toward a market-based economy. Most notably, the rate of inflation was brought down and Ukraine was able to mobilize significant external financial assistance (including rescheduling of its debts) from external creditors. The economy was considerably liberalized and first steps were taken in privatization. However, implementation fell short of expectations, and in some cases, measures were taken that conflicted with the market-orientation of reforms. Moreover, the impact of these reforms, and their sustainability, are threatened by the slow progress in implementing reforms at the enterprise and farm level. Privatization was much slower than projected in agriculture and industry, and financial discipline in enterprises remains weak. The social safety net is fragile. D. MAJOR FACTORS AFFECTING PROJECT IMPLEMENTATION 22. An overwhelming factor that affected economic decision-making in all spheres was the continuing political struggle between those that favored reforms that those that opposed it. Deep divisions continued to exist within the government and outside. For example, within the government, there was strong opposition from the Ministry of Trade to the liberalization of exports, and sectoral ministries remained skeptical about reforms in agriculture and privatization in general. Opposition to reforms was also reflected in the continuing Parliamentary resistance to privatization and tax reforms4 and in constant pressure on the government to provide financial assistance to specific branches of the economy even if this jeopardized macroeconomic stability. The protracted confrontation between the President and Parliament regarding the division of powers between the executive and legislative branches further delayed the implementation of key measures. Even when reforms were not completely blocked, the constant opposition from large sections of the Parliament and vested interests (e.g., the agriculturists, coal miners) made the government unduly cautious and vulnerable to pressure. This fundamental problem also explains the constant irregularities in policy-making during the year. In this context, it is all the more remarkable that some significant reforms were implemented, though it could be argued that this was possible largely due to external support (or pressure as some would call it), 3 Inter-enterprise arrears grew 240 percent in 1994 and another 128 percent in the first half of 1995. 4 For example, in October 1995 Parliament approved a law that required agro-industrial enterprises to be privatized according to complicated, protracted procedures including a 12-month closed subscription period. The law also effectively guaranteed 51 percent of the shares of agro-industrial enterprises free of charge to agricultural suppliers, including state and collective farms. With agroindustrial enterprises accounting for more than half of the enterprises targeted for privatization in the first year of the project, the law would have been very damaging to the privatization efforts were it not vetoed by the President in December 1995. With respect to agricultural land, after much delay, amendments to the Land code were accepted by the appropriate Parliamentary Commission, but they have not yet been passed by Parliament.  -6 - including from the IMF and the Bank. Hopefully, the new Constitution, giving more powers to the President, will allow the government to implement reforms more aggressively. 23. Opposition to reforms was not always due to pressure from vested interests. Often it reflected legitimate concerns, and inadequate appreciation of the way markets work. Thus various restrictions on exports and on barter trade were imposed in part to prevent capital flight. Here the concern was legitimate, the policy instrument inappropriate. Similarly quotas on grain exports partly reflected a lack of confidence in the ability of the private sector and market to allocate grain to shortage areas. Opposition to privatization partly reflected concerns that the process may be open to corruption. Practical problems also delayed implementation of some reforms. 24. A combination of these reasons affected the implementation of the privatization program which was far slower than envisaged during most of 1995. First, there was serious political opposition to privatization, both for medium and large enterprises at the central level, and for small privatization in some local governments. Second, public awareness and interest in privatization grew only slowly, which delayed the sale of shares. Third, there were design flaws that were rectified during the course of privatization. For example, the minimum reservation price intended to prevent accusations of selling enterprises too cheaply often turned out to be too high. Managers and workers did not have sufficient incentive to offer their enterprises for privatization. And finally there were institutional limitations such as insufficient number of auctions centers. Some of these issues have since been addressed during the course of 1996. 25. Finally, there were factors that were beyond the government's control. Poor weather resulted in lower than projected levels of agricultural output in 1995. Output levels may also have been reduced by the lower than expected level of disbursements from external donors (with the exception of the Bank and the IMF). This shortfall in external financing also increased the reliance of the government on domestic borrowing and jeopardized the stabilization and liberalization objectives. E. PROJECT SUSTAINABILITY 26. There is little doubt that significant reforms were implemented during 1995-96 that moved Ukraine toward a market-based economy. There should be no doubt however that the entire reform process is still uncomfortably fragile, and can be reversed. The tightening of financial policies is putting the pressure on some important sectors (such as coal miners, the agrarian lobby) that has strong and vocal representation in Parliament, and opposition to reforms remains robust. On the other hand, there is as yet no visible or organized groundswell of support for reforms, and the safety net remains fragile.5 Unless there are tangible and visible benefits and sufficient number of clear winners, the risks of reversal are significant. 27. To prevent this, three things are important. First, the government must attempt, even more determinedly than before, to continue the course of reforms it has initiated. In particular, it needs to move more quickly to complete the privatization of industry and agriculture, and to enforce financial One reason for this could be that the very fact that existing controls were largely ineffective (as indicated by the growing underground economy) meant that the immediate gains from liberalization were less manifest. Real benefits would only be evident when investment begins to recover and efficiency gains accrue. Both require a good track record of macroeconomic stabilization and private sector supporting policies.  discipline and commercial concerns in those enterprises that remain in state control. The energy sector is of special importance. No amount of market liberalization can generate a positive supply response unless producers and investors have an incentive to react appropriately to market forces. At the same time, the social safety net has to be strengthened to mitigate the effects of restructuring on the really poor. There can be no resumption of sustainable economic growth unless these reforms are accelerated. 28. Second, the international community must continue to actively support the government's efforts, at least until a strong domestic constituency in favor of reform emerges. This support must comprise not only a large commitment of financial resources, but also technical assistance in providing short term advice and in building long term institutional capacities in various areas of policy-design and implementation. Careful and frequent monitoring of progress in all areas will also be necessary in order to identify reversals and slippage and new approaches to solving emerging problems in implementation. Any setback to market reforms there is likely to have an adverse impact on Ukraine's transformation as well. F. BANK PERFORMANCE 29. In a sense, preparations for the Rehabilitation Loan began soon after Ukraine became independent. At that time, it was clear that significant policy-reforms would be required if Ukraine was to overcome the crises caused by the break-up of the Soviet Union. Precious time was lost as the government seemed unable to take the necessary steps to reverse the economic decline and it was only after Mr. Kuchma's election as President in mid-1994 that the government finally indicated its resolve to deal with the deepening economic crisis. Throughout this period, the Bank and the IMF continued to engage in policy dialogue with the government both at the macro-economic level as well as in key sectors such as agriculture, energy, the enterprise sector, banking and the social sectors. Consequently, when the government indicated its resolve to tackle the crisis boldly, the Bank was well prepared to respond. A comprehensive policy package was developed and the loan was approved within 3 months from the time discussions were initiated. This quick response from the Bank, and the mobilization of other external resources that followed the implementation of reforms the loan supported, not only helped pay for critically needed energy supplies during the winter months, but also strengthened the hands of reformers with the government and encouraged them to stay the course. In addition, the Bank's timely response considerably enhanced its credibility within Ukraine. 30. The broad contours of the policy package seemed appropriate, even if there were weaknesses in some components. Its strength was that it tried to link the macro- or economy-wide aspects of reforms to the micro- or sectoral reforms in an organic way. The idea was that without sectoral reforms, macro- economic stabilization policies would not be sustainable. Nor would any supply response be forthcoming unless structural reforms affected producers directly. Agriculture and energy were especially important. Thus, trade policy reforms emphasized the need to eliminate the quota on grain exports. Privatization of large enterprises included explicit targets for grain silos and warehouses necessary for the development of markets in agriculture. The program to liberalize domestic trade focused on reducing the scope of state trading in agricultural commodities, and in introducing competitive practices. And agricultural land privatization was a key consideration in the loan. Similarly, the loan focused on several of the most important issues in the energy sector, including pricing, arrears, and the development of a competitive wholesale market for electricity. Some of these issues had a direct bearing on macroeconomic stabilization, apart from their financial and efficiency impact on the sector itself. Reforms in these sectors, combined with measures to promote privatization and hard budget  -8 - constraints in state enterprises, provided a good balance to the pure stabilization and liberalization policies in the loan. 31. While the package may have been appropriate, it was flawed in some respects. First, the targets and expectations were often too optimistic, both in relation to the past record as well as what was known about the government's implementation capacity. Despite skepticism, a judgment was made that in view of the time already lost by Ukraine it was necessary to aim high, and that as implementation and other constraints emerged, targets would be suitably revised. This was factored in the design of the loan.6 32. While this flexibility was necessary, sometimes the large gap between targets and outcomes was embarrassing and undermined the Bank's credibility. For example, under the Rehabilitation Loan all export restrictions, except a specified few, were to be eliminated. Yet restrictions still remain. The same is true for privatization in industry and agriculture. 33. Second, some of the proposed policy measures in the area of enterprise financial discipline were not fully thought through. At one level, financial discipline was to be strengthened by maintaining tight control on budgetary transfers and subsidized credits from the banking system. At another level, rapid privatization was expected to take care of the problem. Yet there remained an anxiety that something more direct had to be done, without quite knowing what. To satisfy the need for "something", it was decided that financial discipline would be enforced by: (i) picking a few large enterprises for closure, presumably to indicate the government's firmness; and (ii) identifying some large enterprises for which restructuring proposals would be developed and subsequently implemented. This "solution" was by no means unique to Ukraine; it had been tried elsewhere and there is no evidence that it had worked. It did not work in Ukraine either. 34. The energy sector is especially vulnerable to payment indiscipline, which has serious ramifications for Ukraine's external creditworthiness. The Rehabilitation Loan required the government to establish a mechanism to ensure prompt payment to energy suppliers from budgetary organizations and enterprises. However, no mechanism was developed, and the government continues to take periodic recourse to ad-hoc decrees to force payments from defaulters. Given the important macro- and micro- impact of these problems, more thought is warranted to address this issue. 35. Supervision of the loan was adequate. A comprehensive review in March 1995 identified shortfalls in implementation, and after some corrective measures were taken, the second disbursement was released in mid-May 1995. In addition to another supervision mission in June 1995, continuous monitoring was done in the context of IMF missions and during the preparation of the Bank's EDAL and the proposed AGSECAL. The Resident Missions of the Bank and the IMF were also very useful in keeping a close eye on the status of implementation of the loan. Important slippages were identified and continuous pressure has been maintained to stay the course. However, it would be fair to say that it was 6 The Rehabilitation Loan to Ukraine was designed somewhat differently from the first Rehabilitation Loans in other countries of the region. On the one hand, the government urgently needed foreign financing to purchase its energy imports during late 1994 and early 1995. Yet, for practical reasons significant policy measures could not be implemented until the spring of 1995. To help the government pay for energy imports, and still maintain pressure on the government to implement important policy reforms, the Rehabilitation Loan was disbursed in two parts. US$250 million were disbursed when the loan was approved (December 27, 1995) and the rest was disbursed in May 1996 after the Bank had satisfied itself that adequate progress continued to be made in implementing reforms. Unlike other adjustment loans, judgments on performance were not tied to specific conditions.  - 9 - largely the anticipation of new loans, or the threat of suspended disbursements, that led to corrective measures or a new round of reforms. 36. In retrospect it could be argued that the disbursements from the loan should have been stretched out, at least till the third quarter of 1995, to maintain the pressure for reforms. This option was seriously considered, but rejected on the grounds that (a) it would not address Ukraine's immediate financing needs and (b) subsequent fast disbursing operations would continue to provide ample leverage to the Bank. The main issue is to what extent the Bank is prepared to go to enforce compliance with policy commitments. G. BORROWER PERFORMANCE 37. Ukraine was a late starter in economic reforms. But it moved fast once Mr. Kuchma was elected President. Within a couple of months, a stabilization program had been agreed upon with the IMF, followed soon after with the comprehensive program of structural reforms supported by the Rehabilitation Loan. A small but dedicated team of reformers spearheaded the Ukrainian effort, which was remarkable given the opposition of so many both within the government and outside. Tough measures were adopted, and the direction was set for the future. These efforts bore fruit and Ukraine received substantial external financial support. 38. However, there was and still is a sense that the reforms are not yet sufficiently internalized. Ukraine's financial position was critical and it badly needed external financing which was unlikely to materialize unless it had the support of the IMF and the Bank. Under this compulsion, policy commitments were made that were not sufficiently understood nor agreed upon by key members of the government. This was true in several areas, but particularly true in foreign trade, agriculture, and social sectors. In privatization too, there was serious disagreement within the government and it was by no means clear that agreement with the Bank had settled these issues. It was not surprising that serious problems arose when the measures had to be implemented. Either reforms were delayed, or in some cases steps were taken that violated the spirit of earlier reforms. Only the promise of new loans or the threat of stopping disbursements triggered a fresh round of reforms. While the situation may be improving, domestic support for reforms remains fragile, and continuing external financial and other support is necessary if the reform process is to be carried forward. 39. The institutional and technical capacity to implement reforms remains weak but is improving. There is no doubt that at least some of the delays in critical reforms could have been reduced if implementation capacity was better. This is as true of macroeconomics management as it is of sectoral reforms. There is also a need to improve policy coordination, not only to orchestrate the sequencing of reforms in different areas, but also to avoid the issuance of government regulations and decrees that are inconsistent with the reform program. During 1995, this kind of coordination was only done prior to Bank or Fund supervision missions; it needs to be institutionalized and adequately empowered. H. ASSESSMENT OF OUTCOMES 40. The outcomes were more than satisfactory when compared to the economic situation existing at the time the loan was approved. Inflation is down to low monthly rates, and the rate of decline in GDP has been slowed down. Ukraine was also able to attract more than expected external capital flows and  - 10- the pace at which external arrears was mounting has been reduced. The economy has been considerably liberalized and the pace of privatization has picked up. 41. The outcomes are less satisfactory in two respects. First, by and large, results fell short of expectations. In some cases there were policy reversals. Second, and more important, the reform process remains fragile. Unless there is a long term but hard headed commitment from the Bank and IMF to continue to support reforms, it is still too early to rule out risks of reversal. I. Future Operations 42. Recognizing the need for continuing balance of payment support to Ukraine and the importance of deepening reforms in the real sectors of the economy, in particular in industry, agriculture and energy, the Bank moved quickly to design specific operations in these areas. Follow-up operations carried forward the reforms initiated under the Rehabilitation Loan. In June 1996, the EDAL was approved which accelerates privatization of small and large enterprises, and supports the growth of the capital market and post-privatization restructuring of enterprises. An Agriculture Sector Adjustment Loan was approved in October 1996 that seeks to accelerate land reforms and private sector development. The Electricity Market Development Loan aims to hasten the development of a competitive wholesale market for electricity. And the Coal Sector Adjustment Loan facilitates efficient restructuring in the coal sector. Other operations planned for the near future include a Pre-Export Guarantee Facility, an Urban Transport Project, and a Legal Reform Loan. Follow-up adjustment operations are proposed to support reforms in the public sector and in the financial sector. The Bank will continue to chair the Consultative Group meetings. J. KEY LESSONS LEARNED 43. The main lessons from the project are as follows: (i) There is a strong tendency in the Bank to be over-optimistic about the outcomes of adjustment operations, both in terms of macroeconomic objectives (reduction in inflation, growth of GDP and exports) as well as structural changes (extent of privatization, demonopolization). (ii) The opposition to market reforms is deeply entrenched. The Bank needs to decide whether there is sufficient commitment within the country to warrant its continued involvement in reform efforts and then to stay engaged despite slippage and temporary reversals, which are inevitable. In practical terms, this requires identifying some key signposts that indicate the government's commitment to reforms (such as macroeconomic stability and privatization) and to continue to support the government as long as these signs point in the right direction. (iii) To the extent possible, the Bank should seek to involve in policy discussions those in government who are skeptical about reforms, especially when they pertain to agriculture and the social sectors. This may be time consuming and difficult, but ultimately beneficial. (iv) Institutional capacity is limited, and very little can be done in the short time frame of an adjustment operation to change this. The Rehabilitation Loan had to be comprehensive in coverage because major distortions were everywhere and addressing one of them without the other would have  - Il - failed. But subsequent operations should as far as possible be more narrowly focused. In this context, the shift towards sector adjustment operations is appropriate. The Bank should continue to assist the government in developing its capacity to design and manage reforms, recognizing there is no quick and easy fix. (v) As in other parts of the region, the most difficult reforms to implement are those that seek to enforce financial discipline in enterprises and farms, and make them more responsive to market forces. Yet these are the most critical areas, especially when markets have been significantly liberalized. Apart from privatization in industry and agriculture, some of the other measures in this area include the continued brake on budget transfers and credit subsidies to specific sectors and enterprises, prevention of accumulation of payment and tax arrears, and measures to facilitate new entrants and the closure of unviable firms. (vi) There is often a tendency to do something more about enterprises that will not immediately be privatized. Typically, this takes the form of closing down a few large unviable enterprises, and requiring restructuring plans to be developed for some other enterprises. Quite apart from the fact that it is often hard to assess what are viable activities and what are not given all the different distortions and accounting issues, there is little evidence that these measures have contributed to any lasting solution. Yet they persist in the Bank's 'conditionality' repertoire, to the aggravation of the government prior to implementation and to Bank's staff thereafter. Unless there is a very clear concept behind these kinds of solutions, and a long term commitment from the Bank to remain closely involved at all stages of the effort, these interventions should be avoided. (vii) Policy conditionality should be designed to be as 'close' as possible to the specific objective that is to be achieved. Thus for example, conditions such as "presentation of draft law to Parliament .." should be avoided because (a) legislation may not be really required (as in the case of procedures for land registration in Ukraine) and (b) there is a big gap between presentation of law and its approval by Parliament, let alone the implementation of the policy. (viii) Given the uncertain political support for reforms, the limited institutional capacity and the uncertainties of predicting the nature and size of supply response, it would be prudent to maintain realistic expectations and to be flexible in response to slippages in policy and projected outcomes. The phased disbursement design of the Ukraine Rehabilitation Loan was a useful innovation in this regard. (ix) Intensive monitoring and supervision by the Government and the Bank is essential during the early years of reform when slippages may occur not just because there is active opposition but merely because of misunderstanding about what needed to be done or insufficient manpower. An adequately staffed Resident Mission can play an invaluable role in this respect. (x) A suitably empowered authority within the Government to coordinate and oversee progress in reforms is vital not only for the indigenous development of the reform program, but also to prevent implementation of sectoral policies that go against the spirit of the economy-wide reforms.  - 12 - Part II. Statistical Tables Table 1: Summary of Assessment Table 2: Related Bank Loans/Credits Table 3: Project Timetable Table 4: Loan/Credit Disbursements: Cumulative Estimated and Actual Table 5: Key Indicators for Project Implementation Table 6: Key Indicators for Project Operation Table 7: Studies Included in Project Table 8A: Project Costs Table 8B: Project Financing Table 9: Economic Costs and Benefits Table 10: Status of Legal Covenants Table 11: Compliance with Operational Manual Statements Table 12: Bank Resources: Staff Inputs Table 13: Bank Resources: Missions  13 Table 1: Summary of Assessments A. Achievement of Objectives Substantial Partial Naligib Not applicable Macro Policies C0 Sector Policies C C C Financial Objectives a [ C C Institutional Development [ (0C Physical Objectives C C C E Poverty Reduction a C [ 0 Gender Issues lEl [El Other Social Objectives C C C [l Environmental Objectives C C 0 Public Sector Management C [El El C Private Sector Development C I. C Cl Other (specify) E C C C (Continued)  14 B. Project Sustainability Likely Unlikely Uncrtain C. Bank Performance satisfacto Satisfactory Deficient Identification [i E 1 Preparation Assistance l a l Appraisal El E Supervision i:i D. Borrower Perfonnance satsfa= Satisfactorv Deficient Preparation n I3 o Implementation a E 3o Covenant Compliance ] El Operation (if applicable) E l E HigIh& kLl E. Assessment of Outcome satisfaty Satisfactor Unsatis by unsatisfactory ) ) (/) El l E  15 Table 2: IBRD Loans Loan/Credit Title Purpose Year of Approval Status Preceding Operations 1. Institution Building Loan Institution Building FY93 Under implementation Following Operations 1. Hydropower Rehab Energy rehabilitation FY95 Under implementation 2. Agricultural Seed Develop Specific investment loan FY95 Under implementation 3. Housing Foster growth of the FY96 Signed 12/19/96 housing market Not yet effective 4. Coal Pilot Restructuring of the coal FY96 Under implementation industry 5. Enterprise Develop Adjust Support acceleration of FY96 Under implementation enterprise privatization 6. Social Protection Support Support the move toward FY97 Signed 12/19/96 targeting of social assistance Not yet efffective 7. Electricity Market Develop Support the development FY97 Under implementation of a competitive electricity market 8. Agriculture Sector Adjust Support acceleration of FY97 Under implementation land reforms and private sector development 9. Export Development Specific investment loan FY97 Approved 11/21/96 Not yet signed 10. Coal Sector Adjust Facilitates efficient FY97 Under implementation restructuring in the coal sector  16 Table 3: Project Timetable Steps in Project Cycle Date planned Date actual/latest estimate Identification (Executive Project Summary) Preparation N/A 9/94 Appraisal N/A N/A Post appraisal N/A N/A Negotiations 9/93 11/94 Letter of development policy/MERP 9/93 11/94 Board presentation 12/94 12/94 Signing 12/94 12/94 Effectiveness 12/94 12/94 First tranche release N/A N/A Midterm review N/A N/A Second (and third) tranche release N/A N/A Project completion 6/96 6/96 Loan closing 6/96 6/96  17 Table 4: Loan Disbursements: Cumulative Estimated and Actual (US$ thousands) FY95 FY96 Appraisal estimate 362.4 137.6 Actual 364.16 135.84 Actual as % of estimate 101% 99% Date of final disbursement N/A 5/31/96  0- Table 5: Key Indicators for Project Implementation UKRAINE REHABILITATION LOAN STATUS OF MEASURES UNDERTAKEN IMPLEMENTATION RECORD I. MACROECONOMIC STABILIZATION 1. Agreement with IMF on standby arrangement. A standby arrangement was agreed upon in April 1995. Initial results of the program were encouraging; inflation 2. Satisfactory implementation of macroeconomic stabilization policies. fell to monthly rates of around 5% in April-August 1995, from 28% in December 1994. However, the second half of 1995 witnessed delays and slippages, and the targets of the Standby Arrangement were not achieved. Corrective measures were adopted in early 1996 and a rephasing of the Standby Arrangement was agreed upon between the Government and the IMF. Performance criteria and indicative targets are currently being met. Inflation has dropped to 0.1 % in June 1996. 1. Sharply reduce numbers of artificial monopolies subject to price "Artificial monopolies" subject to price regulation were not reduced, merely rearranged into 16 broadly defined regulation (by January 1, 1995). categories. In addition, oblasts have the authority to regulate additional items of "monopolies". There exists a large Price Inspection Unit to enforce price controls. 2. At retail level, maintain price controls only for public utilities, public transportation, fuel for households, and rents. 3. Eliminate limits on profit margins for crude oil and oil products (as of Eliminated as of December 1994. January 1, 1995). 4. Periodically adjust natural gas prices for industrial, agricultural and As of December 1994, industrial and agricultural users pay the full cost of imported gas. governmental organizations to cover import, domestic contribution. 5. Liberalize wholesale electricity prices by end of 1995 when competitive market is established. 6. Establish competitive wholesale market for electricity by end of 1995.  7. Liberalize coal prices, except for household use by January 1, 1995. Price raised to world equivalent levels in January 1995, but not liberalized by end of 1995. 8. Increase electricity prices for households to achieve 40% cost recovery Electricity charges for households was increased in March 1995 to achieve 8O0/. of cost recovery. However, certain by January It, 1995 and 60% by June 1995. groups of households remain entitled to substantial discounts. As of mid-1995, the average household electricity price recovers about 50% of cost. 9. Increase prices of other household public utilities and rents substantially Prices of transportation, coal and gas to households were raised in February 1995 to achieve cost recovery of at in January and June 1995. least 400/o. Housing rents and charges for communal services were raised to achieve 30%i/o cost recovery on June 1, 1995 (from 20% in February 1995). 10. Liberalize bread prices by January 1, 1995. Eliminate profit margin Not done. Bread prices were raised in October 1994 but subsequent increases were less than the rate of inflation. ceilings on bread and bread products, baby food and flour as of January 1, Bread and most bread products remained subject to maximum profit and marketing margins. 1995. 1. Abolish existing trade system of state orders, including grains, by System of state orders was abolished. However, procurement of grain was significantly larger than necessary for January 1, 1995. Limit state procurement to goods necessary for budgeting budgetary organizations. Significant part of government procurement still not done on basis of competitive organizations and adopt open bids and tenders for this process. mechanisms (e.g., more than half of procurement of agricultural commodities is not done through commodity exchange or other competitive tender mechanisms. I. Progressively open inter-bank market for foreign exchange to all The participation of licensed banks has increased and rules goveming membership in the inter-bank market allow licensed banks. for new participants. 2. Eliminate all export quotas and licenses by January 1, 1995 except the All export quotas for (1) goods subject to VER and other international agreements, and (2) grain were eliminated in goods subject to VER and other international contingent agreements. early 1995. All export quotas except for (1) goods subject to VER and other international agreements and (2) grain were eliminated in early 1995. Export registration requirements were also abolished except for exports under international agreement and to prevent anti-dumping action. However, a system of "indicative export prices" was introduced to control exports. Quotas on the export of grain were eliminated in February 1996. 3. Lower maximum import tariffs to 30% by January 1, 1995 and further by Imports with tariffs above 30%/o estimated to be 0.7% of total imports in 1994. No further reductions in tariffs in end of 1996. If tariffs were raised above the maximum rate temporarily, the 1995. cumulative share of goods with such tariffs in total imports in 1993 could not exceed 1%. 4. Unify excise duties on imported and domestically priced goods by March 1995. 5. No QRs to be imposed on imports. Imports remain free of QRs. I-  1 Complete privatization of 900/o of small enterprises by end of 1995. Only 290/ of 45000 small enterprises privatized by end of third quarter of 1995. 2. Distribute paper certificates in 5 oblasts by December 15, 1994. Implemented. Paper certificates were made available in all oblasts in February 1995, though as of mid-1995, only 12% of the certificates had actually been collected by citizens. By mid-April 1996, over 2/3 of the population had either collected their certificates or opened privatization accounts with the Savings Bank. 3. Complete stock auctions (including tirucking and warehousing) in 5 oblasts for at least 200 medium to large enterprises using simplified procedures by March 15, 1995. 4. Privatize some grain silos. 5. Extend stock auctions to the entire country by April 1995. 6. Auction at least 1000 medium and large enterprises between January- Since the first pilot auctions in February 1995, about 400 medium and large enterprises were privatized using June 15, 1995. vouchers by end of 1995. 7. Complete sale of shares by public auction of at least 8000 medium and In 1995, majority of shares sold in the private sector in only 1015 of the 8000 enterprises. By March 1996, this large enterprises by end of 1995. number had increased to 1233. 8. Present to Parliament appropriate amendments to the Land Code by Not done. Expected to be done prior to release of second tranche of AGSECAL, expected before December 31, January 1, 1995. 1997. 9. Present to Parliament a draft law on registration of land and other real Not done. Expected to be done prior to release of second tranche of AGSECAL, expected before December 31, estate specifying procedures for registering land and real estate by January 1997. 1, 1995. 1. Implement restructuring plans in 20 large enterprises, including partial or full privatization, partial or full closure, divestment of assets, etc. 2. Close down some large non-viable state enterprises. Ministerial orders were issued for the closure of 24 coal mines in 1995. As of mid-1995, coal production had already been stopped in 8 mines, and labor force reduced by 6000. 1. Eliminate credit ceilings on banks and shift to market oriented measures Individual credit ceilings on banks were eliminated and refnance credit of the NBU is allocated by credit auctions of monetary policy by early 1995. at market interest rates. However, new programs of directed credit, aimed at selected enterprises were implemented in 1995 and refinance credits were targeted to specific enterprises.  2. Complete study defining, evaluating and costing alternative restructuring plans for former state bonds by March 15, 1995. 3. Develop concrete restructuring proposals by mid-June 1995 for implementation later in the year. 1. Complete policy papers on social assistance and on pensions and unemployment compensation by mid-March 1995. 2. Begin implementation of comprehensive reforms by end of 1995. 3. Initiate integrated household survey to most needy families, and A scheme of income based targeted subsidy was implemented effective May 1, 1995. This scheme provided implement improved targeting scheme based on survey results. income support to households in which the housing and energy bill exceeded 15% of its total income. 4. Protect pension of low income pensioners. 5. Initiate measures to strengthen the pension system over the longer term, e.g., by raising retirement age and by discouraging pensions for active workers. 6. Based on study, implement comprehensive reforms in unemployed compensation scheme. 7. Review expenditures of social insurance. 8. Initiate means to eliminate propuska.  22 Table 6: Key Indicators for Project Operation Estimated Actual 1. Key operating indicators in SAR ) 11. Modified indicators (if applicable) ) - NOT APPLICABLE - 111. Modified indicators for future J operation (if applicable) )  23 Table 7: Studies Included in Project Study Purpose as defined Status Impact of study at appraisal/redefined - NOT APPLICABLE -  24 Table BA: Project Costs Appraisal estimate Actual/latest estimates (US$ million) (US$ million) Item Local Foreign Total Local Foreign Total costs costs costs costs 1. Import 0.0 660.0 660.0 0.0 660.0 660.0 Total 660.0 660.0 0.0 660.0 660.0  25 Table 8B: Project Financing Appraisal estimate Actual/latest estimates (US$ million) (US$ million) Source Local Foreign Total Local Foreign Total costs costs costs costs 1. IBRD/IDA 0.0 500.0 500.0 0.0 500.0 500.0 2. Cofinancing institutions 0.0 160.0 160.0 0.0 160.0 160.0 3. Other external sources 0.0 0.0 0.0 0.0 00.0 00.0 4. Domestic contribution 0.0 0.0 0.0 0.0 00.0 00.0 * Canada $1Om JEXIM $150m  26 Table 9: Economic Costs and Benefits - not applicable -  27 Table 10: Status of Legal Covenants Original Revised Agreement Section Covenant Status Fulfillment Fulfillment Description of Covenant Comments Type Date Date LA 3.01 (a) 9 C --- --- Consultation and exchange of views LA 3.01(b)(c) 9 Progress report to be submitted to the Bank LA 3.02 9 C --- --- Procurement schedule LA 3.03 3 C --- --- Local currency transactions to be made at Market Exchange Rate LA 3.04 5 C --- --- Maintain Project Manager and staff LA 3.05 5 C --- --- Maintain staffed inter-agency committee responsible for monitoring and coordinating Program implementation. LA 3.06(a)(c) 1 C --- --- Maintain records and accounts. Covnenat type: Present Status 1 = Accounts/audits 8 = Indigenous people C = covenant complied with 2 = Financial performance/revenue 9 = Monitoring CD = complied with after delay generation from beneficiaries 10 = Project implementation not covered by CP = complied with partially 3 - Flow and utilization of project funds categories 1 - 9 NC = not complied with 4 - Counterpart funding 11 = Remedies 5 = Management aspects of the project or 1 2 = Sectoral or cross-sectoral budgetary or executing agency other resource allocation 6 = Environmental covenants 13 = Other 7 - Involuntary resettlement  28 Table 11: Compliance with Operational Manual Statements Statement Number and Title Describe and comment on lack of compliance - NOT APPLICABLE - I  29 Table 12: Bank Resources: Staff Inputs (5'000) Planned Revised Actual Stage of project cycle Weeks USSs Weeks US$s Weeks US$s Preparation to appraisal 10.0 35.6 42.4 164.2 76.8 239.7 Appraisal 0.0 0.0 12.3 23.6 12.3 23.1 Negotiations through 0.0 0.0 20.2 39.9 20.2 29.8 Board approval Supervision 20.0 57.6 47.6 185.2 50.3 214.6 Completion 10.0 34.0 2.8 15.0 2.8 15.0  30 Table 13: Bank Resouces: Missions Performance Rating 2 No. of Days in Implementation Development Types of 3 Status of project cycle Month/Year Persons Field Specialization Status Objectives Problems Preparation 08/94 7 14 E,F,A,O Appraisal through 06/93 13 25 E,F,A,O Board approval Supervision 12/93 3 10 E,O 04/95 7 8 E,O 08/95 7 8 0 Completion 1 - Specialization 2 - Performance Rating 3 - Types of Problems A = Agriculturalist 1 = Minor problems F = Financial E = Economist 2 = Moderate problems T = Technical F = Financial Analyst 3 = Major problems M = Managerial ' Other includes country officer, operations analyst, sector specialist, procurement and disbursement specialists. Many of the specialists visited the country in combination with other missions.  31 NATIONAL AGENCY OF UKRAINE FOR RECONSTRUCTION AND DEVELOPMENT Mr. Sergiy Kulyk Alternate Executive Director Conclusion on Rehabilitation Loan Implementation (Loan No. 383 1-UA Rehabilitation Loan of the World Bank was aimed to support restructuring, macroeconomic stabilization of economy, renewal of economic growth and development. It was not possible to achieve the above mentioned goals at the expense of own financing. This is why implementation of the Rehabilitation Loan was very important and timely. The project has considerably facilitated implementation of most of positive changes. Ukraine economic program focuses on the following mutually interdependent elements. Firstly, macroeconomic stabilization is based upon financial and monetary restrictions, supported by the corresponding taxation policy. Secondly, measures aimed at promoting competition at the commodity and services markets envisage actions along several strategic lines, such as for example liberalization of prices on the internal market as well as foreign trade regime and currency exchange, discontinuation of the state orders system and liberalization of internal trade. Thirdly, it is envisaged that commencing of privatization process, application of liquidation procedures and regulations on bankruptcy and revision of methods of enterprise management will lead to introduction of stricter budget restrictions for enterprises. Corresponding financial policy (including discontinuation of target crediting, introduction of realistic positive interest rates and implementation of measures to strengthen payment discipline) and also reformation of financial sector will facilitate introduction of changes envisaged by the program at the level of separate enterprises. With the purpose to ensure stable reduction of inflation rate, Ukraine introduced stringent financial and monetary policy in order to prevent transformation of price rise, connected with liberalization of prices on the internal market and unification of exchange rates into inflation as well as to achieve desired goal:  32 balanced budget. Public expenditures have been considerably reduced, including subsidies for bread and coal, housing and municipal services as well as agricultural sector subsidies. The general aim in the sphere of pricing policy was considerable limitation of the state interference ( at the level of central Cabinet of Ministers as well as at the level of local power bodies) into the process of prices formation and regulation. This is conducive not only to more effective distribution of resources, energy carriers in particular, which are in constant shortage and which are exported from abroad and also consolidation of the state budget. The Cabinet of Ministers has cut most ways to of the state interference into price formation process, including direct control over prices, income restrictions, fixed upper limit on retail trade surcharge at the state and local levels and also informing local bodies of power and getting their approval to change prices for particular goods and services. At the industrial level the state control over prices remained only for those goods and services, where monopoly position of the manufacturer has natural character (power, gas, central heating, water supply and sewage, public transport and premises rent) as well as for the few remaining artificial monopolies, the number of which is reducing. The Cabinet of Ministers of Ukraine made decisive steps towards acceleration of the private sector development and its integration into normal economic processes and have removed main obstacles on this way. Firstly, procedures of registration of new businesses was simplified and the term of its consideration by the local bodies of power was reduced. Access was opened to all spheres of economic activity, including transport services and distribution of goods. Secondly, with accelerated tempo of privatization, an access to means of production was facilitated, because stricter budget limitations for state enterprises make the latter either to sell or to lease real estate and other property. State enterprises are allowed to sell their property of the value below 2000 minimal wages by open competitive sale. Thirdly, the Cabinet of Ministers developed new taxation system in order to reduce the burden of taxes on economic activity and completely do away with discrimination of the private sector where such discrimination exists. In order to promote export and open Ukraine economy for international trade and competition the Cabinet of Ministers implemented decisive steps in the sphere of reforming foreign trade regime. On October 5, 1994 operations were resumed at interbank currency exchanges. Official rate for forced turning in of currency was eliminated in October 26, exchange rate was unified and at present it is determined at interbank auctions. All licensed banks are eligible to participate in currency tenders, exchange rate is determined and their applications are processed without interference of administrative bodies. Distribution of hard currency through Tender Committee  33 was abolished. Current accounts in KBV high level of convertibility was resumed with full convertibility for all trade and accompanying operations. The Cabinet of Ministers has also implemented measures to liberalize foreign trade. All export quotas and licenses were abolished excluding only those which are subject to voluntary export restrictions. With unification of exchange rate and abolition of export quotas there disappeared the need in price indices, which were used for control and regulation of export. Price indices are issued only to ensure supply of information to exporters; customs service received instructions to stop their usage for regulation of export. As far as import is concerned, the state does not implement quantitative limitations excluding licenses, which at present are applied to norms of health care and safety measures. The system of tariffs for import was modified towards introduction of low and unified rates. It was achieved by means of reducing maximum tariff rate by 20 per cent. Ukraine will try to avoid frequent revision of the system of tariffs. During the process of preparation and implementation of the Project the Cabinet of Ministers of Ukraine efficiently collaborated with the World Bank by maintaining constant relations and working with World Bank missions. Generally, joint work with the World Bank has considerably facilitated and improved relations between Ukraine and other financial donors. Sincerely, Deputy Chairperson of the National Agency T. Solianyk   IBRD 27828R 20' \ 250 30, < ,o' ; 35