Document of

The World Bank

FOR OFFICIAL USE ONLY

Z-Aa Ro

Report No. 9652-RO

STAFF APPRAISAL REPORT

ROMANIA

TECHNICAL ASSISTANCE/CRITICAL IMPORTS LOAN

JUNE 11, 1991

Country Department IVCountry Operations DivisionEurope, Middle East and North Africa Regional Office

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EOUIVALENTS

Currency Unit = Leu (plural Lei)US$1 60 LeiLeu 1 = US$0.0167

Lei per US DollarOfficial Rate' Interbank Rate2

1990 November 25 n.a1991 April 60 200 approx.

FISCAL YEARJanuary 1 - December 31

Abbreviations and AcronymsCMEA Council of Mutual Economic AssistanceCONTRANSIMEX Trading Company for Road TransportCONVEX Company for Terminal at Port of ConstanzaDC Direct ContractingEC-PHARE European Economic Commission/Economic Assistance

for the Restructuring of Poland and HungaryEIB European Investment BankERR Economic Rate of ReformGATT General Agreement on Tariffs and TradeGOR Government of RomaniaICB International Competitive BiddingIMF International Monetary FundIS International ShoppingMEF Ministry of Economy and FinanceMOLSP Ministry of Labour and Social ProtectionMOT Ministry of TransportNAP National Agency of PrivatizationNBR National Bank of RomaniaNCS National Commission of StatisticsPETROM Regia Autonoma a Petrolului (Petroleum)PIU Project Implementation UnitRAL Regia Autonoma de Lignitului (Lignite)RENEL Regia Autonoma de Electricitate (Electricity)ROMAGRIMEX Trading Company for Agricultural MachineryROMGAZ Regia Autonoma a Gazelor Naturale (Natural Gas)ROMPOST TELECOM Romanian Post and Telecommunications AdministrationSAL Structural Adjustment LoanSMA Agricultural Machinery StationSOCEP Company fcr Terminal at Port of ConstanzaTA Technical AssistanceTOR Terms of Reference

y The official exchange rate applies to the puachase of foreign exchange that is not retained by exporters(one-half of their foreign exchange receipts a.e subject to retention), the sale of foreign exchange forthe iwportation of a limited nimber of goods, and certain governrnt transactions.

v The Interbai* rate applies to other foreign exchange transactions. The Interba* arket for foreignexchr=ge has been established in April 1991.

FOR OMCALM USE ONLY

ROMAN!A

TECHNICAL aSSISTANCE AND CRITICAL IMPORTS PROJECT

STAEF aPPRAISAL REPO9RT3

Table of Contents

Page No.~

LOAN AND QpMRECT SUMMARY . . . . . . . . . . . . . . . . . . . . i-vi

I. JACKGROUBNP

A. The Economy . . . . . . . . . . . . . . . . . . . . . .1B. Bank Strategy . . . . . . . . . . . . . . . . . . . . 5

I. THE- PROJECT

A. Project Objectives . . . . . . . . . . . . . . . . . . 6B. Project Des:ription and Justification . . . . . . . . . 6

C. Rationale For Bank Involvement . . . . . . . . . . . . . a

D. Detailed Project Description . . . . . . . . . . . . . 8

The Technical Assistance Component . . . . . . . . . . 8

- National Economic Management . . . . . . . . . . . 9- Accounting and Atlditing . . . . . . . . . . . . . 10

- Privatization ak.d Industrial Restructuring . . . . 11- Commercial Banks . . . . . . . . . . . . . . . . . 12

- Energy Sector Development . . . . . . . . . . . . 12- Irrigation Sector Development . . . . . . . . . . 13- Employment Services and Social Security . . . . . 14- Mining Sector Development . . . . . . . . . . . . 15- National Commission of Statistics . . . . . . . . 16- Project Implementation Unit . . . . . . . . . . . 16

The Imports Component . . . . . . . . . . . . . . . . . 16

- Imports for the Petroleum anid Gas Sector . . . . . 18- Imports for the Power Sector . . . . . . . . . . . 18- Imports for the Lignite Mining Sector . . . . . . 20- Imports for the Transportation Sector . . . . . . 21- Imports for the Telecommunications Sector . . . . 23- Imports for the Irrigation Sector . . . . . . . . 24- Imports for Agricultural Machinery . . . . . . . . 25- Environmental Aspects . . . . . . . . . . . . . . 26

III. PROJECT COST. FINANCING AND IMPLEMENTATIN . . . . . . . . . 27

A. Project Cost and Financing . . . . . . . . . . . . . . 27

B. Onlending Arrangements . . . . . . . . . . . . . . . . 30

C. Project Implementation . . . . . I . . . . . . . . . . 31D. Procurement . . . . . . . . . . . . . . . . . . . . . . 34

E. Disbursements . . . . . . . . . . . . . . . . . . . . . 35

F. Accounts and Audits . . . . . . . . . . . . . . . . . . 35

IV. BENEFITS AND RISKS . . . . . . . . . . . . . . . . . . . . . 35

V. AGREEMENTS REACHED AND RECOMMENDATION . . I . . . . . . . . 37

t This ort fs bmse on the findife of pre-aprisetl w appraiord missaim whidc vsited Remnim inFxbri'r Aprf1 1991. Th* oi"sarm eomssted of arff artmm (task nfr), Anbem Tmntle(ntifnol economic _Agement), Uwe Richter. Uyon Anerf Chris Chrlstof id T.T. Shetty (enw).Kidhwe 1adkamf, HRar Fuchs (irdustry). larbra Lee (privatization) David Cotin (Ccoservatfon) Franco Lucca. Peter Vindiotd Nahmad Tirwezi (agriculture) Cv lye Sinclter, DxlseSaers (etalyment services), Heinz Iendri& (mining), likote Holcer mnd goslo Chavic(ettlecsnications). The project Ms red urder the srvision of Philipwe NIlytl, DivisionChief, ENV.W, md Euenio Larf, Dlrectoe,E4.

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

Li

Table of Contents (continued) Rg

MNUNZJ ANNEX 1: Institutional and Pricing Issuems Energy Sector 39ANNEX 2: EconomLc BenefLts, Costs, and Risks of the Energy

Components . . . . . . . . . 47ANNEX 3: Petroleum and Gas Component 52ANNEX 4: Power Component . 54ANNEX 5: LignLt Mining Component 59ANNEX 6: Imports for Transport Component . . . . . 66ANNEX 7s Imports for Telacommunications Component 68ANNEX 8: Irrigation Component . . . . . . . . . 71ANNEX 9: Imports for Agricultural Machinery . e81ANNEX 10: Schedule of Disbursements . . . .. 82ANNEX 11: Documents available in Project File . * . 83

IABLES TABLE II s1: PROJECT COST SUHMARY BY COMPONENT . . . 28TABLE III2: PROJECT COST SUMMARY BY CATEGORY OF EXPENDITURES 29TABLE III.3: FINANCING PLAN . . . . .. 29TABLE III.4: PROCUREMNT ARRANGEMENTS . . . . . . . . 34

CHARTS CHART 11.1: IMPORTS COMPONENTS, OUTPUT EFFECTS AND ECONOMICJUSTIFICATION... 17

CHART 111.1: PROJECT IMPLEMENTATION RESPONSIBILITIES . 32

MEZ IBRD No. 22907

iii

TRCNIALASSXSTACIAN2 CRITICAL IMPORS PROJUCT

STAFF APPRAISAL RUPORT

Loan and PtroimS&AL uaVj

igliflZR s Romania'

FUIA MZUIs For technical assistance components Ministry of Economyand Finance, Ministry of Industries, National Agency ofPrivatisation, Ministry of Labor and social Protection,Ministry of Agriculture, Cooperative Bank, Savings Bank,Development Bank, Comercial Bank, Agricultural Bank,Reg a Autonoma A Petrolului (PUTROM), Regia Autonoma deLignitulut (RAL).

For import components Regia Autonoma de Zlectricitate(RENEL), Regia Autonoma a P-trolului (PETROM), RegiaAutonoma a Gazelor Naturale (RONGAZ), Regia Autonoma deLignituliu (RAL), Romanian Post and TelecommunicationsCompany (ROMPOST TeLECOM), Bucharest Metro, Port ofConstanza for terminals operated by CONVEX and SOCeP,CONTRANSINEX (for buses arId trucking companies),ROMAGRINEX (for agricultural machtnery), and Ministry ofAgriculture.

IQUEts US$180 million equivalent

TOM$St Fifteen years, including five years of grace, at theBank's standard variable interest rate.

esumllJnfnt Part of the proceeds of the loan would be onlent toBucharest Metro, CONTRANSINEX, CONVEX, PETROM, RAL,RENEL, ROMGAZ, ROMAGRINEX, ROMPOST TELECOM, and SOCEPfor the import component. Funds for the tochnicalassistance components would be onlent to agencies notfully financed by budgetary transfers, including PETROM,RAL, Commoercil Bank, Savings Bank, Cooperative Bank,Agricultural Bank, and the Development Bank. Maximummaturity periods under the onlending arrangements are 10years with 3 years of grace. Funds onlont aredenominated in US$ terms or in Deutsche Mark and carryan interest rate of LZBOR or VISOR plus a minimum of 1.5percent for the US dol).ar or DM loans, respectively.

ki TMe prwl i_ of 3t., the sociltst Rq"tlc of bInsf a no tqeW _intuntd. A nw mwlt be dicd ed the nw cnnstltutlmn, pre_tty .ulh prqamtfon.

iv

9ZjC M5gtZiyis The project would provides 5i) technical a*olstance tosupport the ongoing economic reform process in theformulatLon and LmpleaentatLon of macroeconomlc andsectoral policy programs; and (ii) forelgn exchange forthe import of ossential spare parts and equlpment to theirrigation, t-lecommunioations, power, lignite,petroleum, gas and transportatlon sectors and foragricultural machinery to *ustaln output performanco,which is threatened due to serlous foreign exchangeconstraints and dLilocations caused by the transitionfrom a planned to a market economy.

PROJECT DESCRIPTION: The project includes a technlcal assistance and animport component. The technLcal assistance (TAIcomponent would support: (i) national macro conomiemAnacement to prepare fiscal, pricing, budgetlng,investment plannlng, and legal reforms; (ii) strategyformulation and pricing reforms in the enerav soctor,the definition of sectoral restructuring programs in theindustrial sector and support for the Drivatization ofindustrial enterprises, services and housing; (iii) theestablishment of an efficient service to administerunemployment bonefits, improve labor market information,provide emsloyment advioory serviceo and retraLiangactivities, and support reforms of the social securitysystem; (iv) support to the National Commiision ofStatLnieta to improve proessiLng and evaluation ofstatistics; (v) strategic studies, training plans, andassessments for computer requirements, for commerciaIbankss and (vi) sector studies in the irrLaatLon andeneroy sectors, and advisory services to establish aninternationally recognized accountlna and auditLnUprofession.

The imoorts comoonent would provide spare parts andequipment financing for: (i) the transoortatLon sector,including the Port of Constanza, the Bucharest NMero,and for road transportation; (ii) spare parts andequipment financing for: two major oowMr plants,Turceni and Rovinari, and to the lignite mines supplyinglignite to these power plants; (iii) 2etroleum and caswells; (lv) the telecommunications system; (v)LrL$atLon system; and (vi) aoricultural machinery.

yE FITS AND RISKgs The project, through its technical assistance program,is expected to support the ongoing economic reformprogram in Romania, which is proceeding boldly, butwhere policy decisions often are taken without fullknowledge of pollcy optlons, due to unfamlilarity withmarket economLes and lack of knowledge of policiespursued ln other countries. The imports component isdeslgned to maintain productlon in selected key sectors,

v

DUNEPITS AND RISKS: targeted for import financlng under the proposod(contLnued) program. Aggregate output effects of the proposed

project are estimated to be subutantlal. Value wr annualproduction of the energy components alone is estlmatedto amount to US$ 421 million.

Possible political instability leading to changes of keypersonnel is a risk to successful implementatlon of thisprogram. Lignite production may not be sufficient tofeed the Turconi and Rovinari power plants equippedunder the import component. The mining componentincluded under this project is designed to minimize thisrisk. Through careful specification of goods to beimported and targeting of imports to selected economicactivities, output effects are expected to be assured inthe short - term. Maintaining production in the longerterm, would depend on continuing economic reforms,particular in the areas of price liberalization and theestablishment of efficient foreign exchange markets toassure access to imported spare parts and equipment inthe future. Longer - term project success thus dependson continuing economic reforms. Future Bank adjustmentand investment lending is expected to play an importantrole in helping to suctain this reform process.

vl

USS Million

NSTIUN=O PROJ3CT COSTS osi LQghl 29ASl

Technical Asistance 23.0 13.0 36.0Imports Component 174.4 526.4

197.4 65A.

UsS Million

PINANCING PLAN: FQr*in Local Total erc-nta^a

IBRD :180.0 - 180.0 68EIBS 17.4 - 17.4 7Government/BeneficLarLes - 665.0 2

lA197.4 IA 0 Ill

USS MLllion

ESTIMATED DISBURSEMENNT 1922 1994 1995(IBRD Fiscal Year)

Annual 120 35 20 5Cumulative 120 155 175 180

SCONOMIC RATE Or RETURNt Not appllcable

a ElI WI1 prwvtde 1U017.4 silt1io for cofflnwicr of tX pumw cspornrnt.

TUCUNICAL ASSX STANCE AND CRITICAL IMtP RT PROJECT

A. Trhe Rcongm=

1.1 Romania is one of the largest of the former centrally-plannedeconomies in the Central and East European Region with a land area of 237,000sruare kilometers, and a population of 23 million. The country has a widerange of natural resources, including a fertile agricultural base, largedepouitu of coal and lignite, oil and natural gas, and scattered mineraldoposits. Long a major food producer, Romania was a large not exporter ofagricultural products until the early eighties.

1.2 The Communist Party came into power in 1948 and quickly installedcentral planning and nationalized most privately-held property. In the earlyfifties, it instituted a strategy of vigorous, self-sufficientindustrialization. Building on the large domestic hydrocarbon resources, thecountry invested heavily in refining and upstream chemical plants, andestablished a large machine-building industry. Despite a lack of attention toconsumer goods industries and the service sector and a highly energy intensivedevelopment pattern, the strategy wai reasonably successful for a time, ratesof growth averaged between 6-8 percent per annum until the late seventies.

1.3 In the aftermath of the second oil shock (1979), Romaniaexperienced a sudden withdrawal if short-term foreign credits. The action hadwrenching political and economic effects resulting, by 1981, in a cessation offoraign borrowing and ultimately culminating in a decision to repay allforeign debt. These decisions had very negative economic and socialconsequences for the nation. Import of modern machinery and equipment wasalmost halted, leaving a legacy of obsolete and depreciated capital. Growthslowed substartially and, at the end of the decade, production and per capitaLncomes were probably no higher than at the beginning. While investmentremained high during the eighties, most of it was channelled towards existing,inefficient industries. Moreover, in the latter half of the decade,investment was progressively diverted to huge and unproductive "showcase"projects at the behest of an increasingly autocratic ruler.

1.4 In December 1989, the Ceaucescu regime, which had ruled Romaniafor more than two decades, came to a sudden and violent end. In May 1990, acoalition of parties, the National Salvation Front, won large majorities inthe country's first post-revolution elections. After the revolution, theGovernment restored civic freedom, shortened the workweek from six to fivedays, released the restrlctions against imports of consumer goods andreJLrectod some energy supplies from industry to households. The Governmenttook important steps to initiate economic reforms: (i) framework legislationfor privatization was enacted, and the transformation of State enterprisesintojoint stock companies was begun; (Li) land reform was initLated; (ill)

2

restrictions on private enterprise were largely removed; (iv) the monopoly cfthe State over foreign trade was eliminated, and the official exchange wasdovalued by a cumulative 60 percent; (v) prices in rural markets were freed,followed by a first ,.age price reform (in November 1990) in which about halfof the previously regulated prices were also freed, and administered pricesfor some important industrial inputs, including crude oil, were raisedapproximately to international levels.

1.5 During the first quarter of 1991, Parliament legislated a new lawon unemployment benefits, a banking law establishing an independent centralbank and commercial banks, and a law on foreign investment. To replace theprevious ad hoc exchange controls, the Government introduced a dual exchangerate system, involving partial foreign exchange retention rights and aninterbank market, as an explicitly temporary mechanism during the transitiontowards establishment of full currency convertibility. A transitional tariffstructure was put in place, with a permanent scheme under preparationconsistent with GATT. A strict stabilization program for 1991 was adoptedwith support from an IMF standby and a compensatory fund facility, bothapproved in April. This program entails firm budgetary discipline (with amaximum budgetary deficit of 1.5 percent of GDP) and tight monetary and creditceilings. A second phase price reform took place on April 1, 1991, coupledwith a 71 percent devaluation of the domestic currency, and fullliberalization of interest rates. An incomes policy was imposed in January1991 to prevent a wage-price spiral in reaction to the administered priceincreases. A system of monthly compensation to workers and pensioners forthese price increases was introduced to soften the impact on householdincomes.

1.6 Further legislation to implement privatization of commercialenterprises is nearly finalized. The privatization of land is progressingrapidly--almost 70 percent of agricultural land is now estimated to beprivately owned as a result of the new Land Law, compared to only 10 percentin 1989. New la.es on competition and liquidation are expected to be enactedduring the present year. Work is proceeding to prepare a major reform oftaxation (a value added tax and an income tax are planned to be introduced in1993) and of the tariff regime. A broad scale decentralization of Governmentfunctions, including expenditure and revenue authority to new localgovernments is also underway. The Government has indicated its intention toundertake ambitious reforms of social policy, including the reforms ofpensions, and the health and education policy, which are essential to improveproductivity, while developing an adequate safety net and ensuring soundpublic finances.

1.7 The rapid breakdown of previous structures of command and controlin the economy during this first year of the new era resulted, predictably, insevere disruptions of domestic supply and trade patterns. Two major externalshocks--a 40 percent increase in oil prices and the accelerating breakdown ofthe CMEA--contributed to sharp reductions in exporhs and in supplies of *nergyand raw materials. During 1990, industrial output iaclined by 20 percent andoverall GDP by 10 percent. The current account shifted from the artificiallyhigh surplus maintainid under the Ceaucescu regime to a deficit of 7 percentof GDP, financed entirt-Y by a drawdown of reserves. Initial wage increases

3

following the revolution permitted a surge in private cornumptLon. With adecllne in budgetary revenues accompanying theme developments, the previousbudgetary surplus war elimlnated during the year but the budget remained inbalance, mainly due to a sharp cut in investment expenditures.

1.8 Eccnomic growth deteriorated further in the first quarter of1991, with industrial output declining 17 percent compared to the same periodof 1993. The decline in industrial p,roduction in the first quarter war mainlyconcentrated in heavy and energy-intensive industries (coal mining andmetallurgy, machine-building, transport equipment, chemicals), whileelectrical equipment, household appliance, food and beverages, showed declinesbelow 10 percent. While exports are more sluggish tthan expected, fiscaldevelopments have been encouraging so far and monetary indicators have beenkept within the limits of the Standby program. Continued output declines areattributed to uncertainty in the enterprise sector concerning the actualauthority of managers, inefficiencies of State enterprises, bottlenecks in thesupply of inputs, both imported and domestic; workei. indiscipline ("thepsychology of revolution"); the incomplete status of price liberalization,which has squeezed certain subsectors and inefficient State enterprisesgenerally; and, the collapse of markets in the former CMEA member countries,particularly the Soviet Union, and in the Gulf region.

1.9 In the first quarter of 1991, trade in convertible currencies waswell below expected levels for both imports and exports. The convertiblecurrency trade deficit for the quarter was US$611 million, to be measuredagainst a total deficit of US$1590 million for the year as anticipated by theIMP program. External financing remains insufficient. The IMF program hadestimated a financing gap of about US$1.0 billion in 1991, based on theanticipated level of production and exports, and after taking into account thelikely resources available from the IMF and the Bank.

1.10 Romania is embarking on the reform path with two distinctadvantages not shared by the other formerly socialist countries in the regionsit meets a substantial share (70 percent) of its energy consumptionrequirement through domestic production, and it entered the transition periodwith virtually no external debt--an advantage won at bitter cost to theeconomy and the population. Like its neighbors, Romania also has a relativelywell-educated work force and low labor costs, which should facilitate itseconomic recovery and its ability to attract foreign investment once economicreform and stabilization programs are firmly established. But, Romania alsohas several strikes against it. Because the, previous regime was centralizedand autarkic to the extreme and practiced the most distorted allocation ofresources in the region, Romania will have a greater task than the othercountries of the area to develop its institutiond, upgrade its capital stock,and adjust to the behavior and attitudes needed to create a modern marketeconomy. Considering its political and economic heritage, Romania has maderemarkable progress in introducing economic reform measures. The presentGovernment seems to have a clear vision of the required policy reforms andappeArs prepared to implement them decisively. To achieve this objective,Romania requiree coneiderable external assistance, both technical andfinancial.

4

D. hank S%rU t-av

1.11 Romani. initlated discussionm with the Bank and the IMF early in1990 after Bank lending had been discontinued in 1982. The firat missionvisited Bucharest in March 1990. Romania clearly indicated its intention todav*lip a new relationship with the Bank and has requested economic advice ona wlde range of matters, including among others the design of a social safetynot, the protection of the environment, and the assessment of publicinvestment pro,rams. It has further requested assistance for importfinancing, adjustment lending, and technical assistance programsc

1.12 Due to repayment of all foroign debt under the Ceaucescu regime,Romania has very favourable creditworthiness indicators. But creditworthinesswill depend on the restoratton of sustainable economic growth. Bankinterventions through adjustment and investment lending will need to help thecreation of a conducive economic environment, which fosters efficient economicgrowth.

1.13 The Bank's lending program for Romania will reflect the country'ssize and '-Is strength of its economic reform efforts. The Bank'si strategy inRomania has several mutually reinforcing themes:

(a) The proposed operation, the first in Romania since 1982, isdesigned to encourage an almost instantaneous supply response byputting back on line productive facilities crippled by lack ofimported spare parts. This would help halt the economic slidethat started in 1989.

(b) An adequate social safety net is a prerequisite to the changesneeded for the transition from autocratic central planning to apluralistic market-based economy. The Bank's efforts in thehuman resource area will be designed to build a social securitysystem and to strengthen human capital. A health servicesproject has been appraised, and future ope, -'ions in employmentand training and in education are being co.. 'Jered.

(c) Romania has little external debt, but its physical iafrastructurewas so greatly neglected during Ceausescu's draconian importcompression that it now constrains economic growth. An importantpart of future Bank strategy will be to improve the existinginfrastructure. A technica& assistance project for theinfrastructure sectors, recently appraised, will prepare lendinginterventions in these sectors.

(d) Assuming that Romania's present receptivity to Bank advicecontinues, policy-based lending will be an important part of theBank lending program. A sustained, robust supply response willdepend on Romania's ability to create a climate beneficial torapid private sector development. The explicit goal of thestructural adjustment loan will be designed to help create such aclimate. Future policy-based loans will concentrate onparticular areas important to a sustained supply response,

5

especially enterprise privatization, financial modernization,energy pricing, and the environment.

(s) Investment operations in productive sectors will reinforce theprivate sector development effort. The first operatic. in theagricultural sector will be a Private Fanmers' Support Project,the target beneficiaries of which will be the private farmers.

(f) Efficient growth will depend to a large extent on efforts torestructure and privatize large and inefficient industrialenterprises, and policy reform and institutLoan building isneeded to lay the basis for efficient financial intermediation.Interventions in the financial and industrial sector are likelyto figure prominently in our lending program.

II. - R

A. Proleot Obiectlves

2.1 The project's objective is to provide urgent assistance to theGovernment of Romania for two essential activitiess

- To provide technical assistance to Government for the formulationof strategies and policies to promote and accelerate thetransition to a market economy.

* To help avoid further decreases in production while Governmentdesigns and starts implementing its program of economic reforms.Continued decline in production is likely to make the reformprocess unsustainable due to social dislocations leading toincreasing pressures for a slowdown of reforms. It is thusnecessary to help maintain or restore output performance in keysectors of the economy.

B. Plect Denacriotin and Jultification

2.2 The project comprises first, a technical assistance componentwhich would:

Help define restructuring policies for Lndustrial ent rriaes andsupport Privatization and private sector development in industry,services and housing.

Support national economic managemnnt through advisory servicesfor reform in the fiscal, pricing, budget, and investmentplanning systems and for legal reforms which are underway.

Help establish an internationally recognized accounting andauditing system.

6

* Help define strategic plans, training plan. and computer hardwarerequirements for commercial banks.

* Provide assistance in nenrao pricing and energy strategyformulation; undertake audits for gas and oil exploration andassessments of the hydrocarbon potential, and provide managementsupport to the lignite mining sector.

* Undertake a comprehensive irrigation sector study.

* Help create efficient employment services through financingcomputer equipment, training staff who administer unemploymentbenefits, and assessing the social security system.

* Provide the National Commission of Statistics with adequatecomputer equipment.

2.3 Second, the project includes an imoorts component for thefinancing of critical imports of spare parts and equipment for key productionunits in essential productive sectors of the economy. Specifically, theproject would provide spare parts and equipment for the power, petroleum, gas,mining, irrigation, telecommunications and transportation sectors, and providespare parts for the agricultural machinery. In addition, management supportwould be provided to the lignite mining sector, to ensure that the spare partsfiranced under the project would lead to the restoration production ofprevious years.

2.4 Justification for the Imports Comonent. Output performance hascontinuously declined in Romania over the last 18 months, due to inadequateforeign exchange allocation for the purchase of spare parts. This has led toa drastic decline in capacity utilization and rapid falls in production.Declining domestic production of spare parts has exacerbated the situation,particularly for the transportation network, and the power, petroleum, andagricultural sectors.

2.5 The proposed imports component is justified by the fact thatRomania has undertaken very substantial economic reforms, which the Bank ispreparing to support through a SAL in the near future. Since the GOR faces anacute shortage of foreign exchange, the proposed operation is an immediateresponse to avoid further deterioration in the economic fabric of the country.The investment program rests on the assumption that the Bank will becameinvolved in Romania with adjustment and sector investment lending operations.These will need to address outstanding sectoral pricing reforms and supportthe establishment of an efficient foreign exchange market, to ensure LatersJl" that beneficiaries included in the operation will contin.e to have accessto foreign exchange beyond the life of the project. Without such a follow up,the benefits of the project would be short-lived.

2.6 Care has been exercised to ensure that the imports component doesnot interfere with the economic reform by artificially strengthening unitswhich should not survive after the reform. Thus, the program would provideforeign exchange financing only to those productive units which are considered

7

a priori economically viable in the competitive environment of a marketeconomy, or which will retain for some time a character of public utility.Sector and economic activities included in the imports component were selectedafter an assessment of existing competitiveness or projected competitivenessafter only minor restructuring or management improvements. Sectors whichrequire major restructuring, and where comparative advantage remainsuncertain, such as the industrial sector and most of the agricultural sector,have been excluded from the project, since they will need detailed sectoralanalyses before any investment in them can be economically justified.

C. Rationale for Bank Involvamnt

2.7 The Bank's economic mission which visited Romania in November1990 has undertaken a detailed analysis of the economic reform programlaunched by the Government. It has found the program courageous andcomprehensive, and it endorses its broad directions. A Stand-by agreement wasapproved by the IMF in April 1991 which initiated the implementation of astabilization program and provided the framework for strict macro-economicdiscipline. The Bank is preparing a Structural Adjustment operation(scheduled for Board presentation in December 1991) which will support thereform program for the major economic sectors, and investment operations arealso under preparation.

2.8 In spite of Romania's negligible external debt, commerciallenders do not yet seem prepared to extend financing, and due to the continuedpolitical uncertainties in the country, other donors, such as the group of 24represented though the EEC, have only recently initiated negotiations with theGovernment of Romania. Their financial assistance has so far been largelylimited to humanitarian aid. Because of the collapse of the CMEA and forother reasons, foreign exchange reserves are very low.

2.9 Given the importance of the reform measures already undertaken,and of the hesitancy of other donors to provide external resources, rapidinvolvement of the Bank in the financing of the urgently needed foreignexchange requirements for critical sectors is vital, to avoid further collapseof the production system, and to assure the sustainability of thestabilization program.

D. Detailed Proiect Description

The Technical Assistance Component IUSS23.0 million)

2.10 The technical assistance program would provide support for:

* National Economic Management* Accounting and Auditing* Privatization and Industrial Restructuring* Commercial Banks* Energy Sector Maintenance* Irrigation Sector Maintenance* Employment Services and Social Security* Mining Sector Maintenance

8

* National Comission of Statistlcs* The Project Impl.montatLon Unlt

The proposed program has been coordinated with EC-PHARE but no formal co-financlng arrangements hava been made, as flnal financlng decisions under theEC-PHAAE program are still pendlng. Some flexlbllity ln the implementation oftechnical assiLtance components would be requlred to coordlnate wlth otherdonors providlng financing for tochnical assLstance.

National Economic Manauement IUS92.6 millions

2.11 Lack of famillarlty with markot economLes and the lack ofanalytlcal tools to analyze, monltor and forecast economic developments areserious impediments to successful implementation of economlc reforms inRomania. The objective of the component is to strengthen the Natlonal ReformCouncil and the MinLstry of Economy and Finance (NEF) to imprGre policyanalyLsi, forecasting and policy formulation. The Reform Council wasestabllihed to assume the leadlng role ln conceptualizing and implementing theeconomic reform program, while the ME? is charged with implementing the moreroutlne features of economlc management. As the tasks of the Reform Counclland the MEF are dlrectly linked, careful coordlnation between the twoinstltutions is required. As the Reform Councll has so far been primarilyinvolved in the preparatlon of laws, an upgrading of economlc sk'lls L neededto conceptualLze economlc and legal reforms. In MEF, TA is needed tostrengthen macroeconomlc analysis, with particular amphasis glven to thedevelopment of some technical skllls, such as model buildlng to improveforecasting, balance of payments analysis, fiscal analysis, trade, andmonetary policies.

2.12 The Reform Councl would receive support to: (i) enhance theconceptualization and strategy formulation of the Council, its ability toundertake key economlc analysi of issues and add an economlc perspective lnits consLderatLon of all reform-related activlties; and (ii) strengthen thelegal capacity of the Council by givlng lt flexibillty and rosources to accessexternal legal assistance in the drafting and review of laws. The TAcomponent would finance one generalist development economist (15 months) andone macroeconomist (12 months). The general economist would help integratethe work of MEF lnto the work of the Council; the macroeconomi-t would help lnthe preparation of short-term pollcy analysis and provide macroeconomic policyadvice to the Deputy Prime Nlnister ln charge of the Council. In addltlon,the component would finance 24 months of short-term consultancy assignments,primarily for the draftlng of special laws, where legal expertise from otherEuropean countries is required, travel funds for attendance at semLnars andtralnlng abroad, and 20 personal computers along with related equipment.

2.13 Support to the Ministry of Economy and Flnance would consLst ofproviding hlgh level Economic Advisor (18 months) to the Deputy Prime Ministerfor Economic AffaLrs, who is also the responsLble mlnlster for MEF. Theeconomic advLsor would assLit the Deputy Prime MinLster in overall pollcyformulation. At the same time, the advisor would supervise the work of otherlong-term consultants provlded to the MEF and the Reform Council and Lntegrateit into a coherent program. Other advlsors proposed to be financed under the

9

loan, are one quantitative methods specialist (12 months), one internationalmonetary/trade economist (12 months), and one advisor (12 months) to work withthe task force on the review of the unfinlhed and proposed publicinvestments. In addition, the TA would provide financing for 24 months ofshort-term consultants for analysis and training in much areas as nationalaccounts, forecasting methods, statistical analysis, fiscal, monetary andlabor analysis. Short-term training abroad in such areas as national incomeaccounting, macroeconomic modelling and statistics, and 50 personal computers,partly equipped with supplementary features, required for economic modelingwould also be provided. Short-term consultants would also be used to assistthe advisor on public investment programming in specialized sectors, wheremajor investment decisions need to be taken.

2.14 The objective of the advisor assisting with public investmentreviews would be to: (i) help institutionalize a system of investmentprogramming; and (ii) help prepare an investment program for investments whichare fully funded by the central government's budget, and for investments forsemi-autonomous agencies. Appropriate investment planning and prioritysetting is of overriding concern in Romania where many of the major capitalintensive investments, begun under the previous regime, remain unfinished, andmajor additional public investments are required to position the economy tocompete in a market economy. Aareement has been reached during negotiationsthat by August 31, 1992, the GOR would present for Bank review and comments,an investment program for investments funded by the Government central budgetand by semi-autonomous agencies. Specifically, the GOR would submit for Bankreviews (i) the proposed public investment program for fiscal year 1993; and(ii) a program of financial allocations and a timetable for completion ofpriority projects selected from the portfolio of unfinished projects. GORwould uubsequently proceed with implementation of the investment program asagreed upon during joint review.

2.15 The component would be implemented by the MEF and supervised bythe economic advisor to the Deputy Prime Minister. To assure that the twolong-term advisors provided to the Council of Reform and the four advisorsprovided to the NEF operate as a team and provide for closer coordinationbetween the Reform Council and the MEF, efforts would be made to recruit thegroup under one contract from a single consulting organization. Thisorganization would then also be responsible for all logistical arrangements.TORs for long-term consultants have been agreed with the GOR; TORs for short-term consultancies are being prepared and would be approved throughout projectimplementation.

Accountino and Auditina IUSSO.4 millions

2.16 Romania does not have as yet the accounting and auditing capacityrequired in market economies to provide reliable information on the financialstatus and performance of enterprises and banks to existing and potentialinvestors and creditors, and to the managements of the enterprises and thebanks to take sound decisions in an increasingly competitive environment. Alaw has recently been passed to establish the introduction of accounting andauditing regulations and standards conforming with international norms. Thelaw will need to be complemented by an appropriate institutional and

10

regulatory framework, and the development of an accounting and auditingprofession operating according to international standards and practices. Theobjective of the component is to provide initial assistance to the MEF in thedevelopment of a modern accounting and auditing system, and to help establishan accounting and auditing profession. The component would finance a residentadvisor to MEF as well as consultancy services for the Accounting and AuditingInstitute, soon to be established, which would be responsible for thecertification and development of accountante and auditors in Romania.Provision is also made for short overseas study tours and training.

Privptization and Industrial Restructuring (USS2.4 million)

2.17 The Romanian industrial sector needs to undertake majorrestructuring efforts. Prospecte for survival of many industries areweakened by changes in relative prices and the breakdown of the CMEA system.Major parts of the industrial sector will need to be privatized or liquidatedand enterprises will need to be restructured in order to establish acompetitive production system. The privatization component has been designedto assist the National Agency for Privatization (NAP) in: (i) designing andformulating a general privatization strategy and legislation; (ii)conceptualizing the institutional structures for exercising ownership; (iii)developing techniques for small-scale privatization; (iv) carrying out on apilot basis a limited number of operations for privatization of stateenterprises; and (v) providing support to the NAP through advisory servicesand study tours.

2.18 Under the Industrial Restructuring Program, support would beprovided to: (i) define sectoral strategies for industrial restructuring andthe definition of the appropriate institutional framework to implementrestructuring programs; and (ii) develop model restructuring programs forseven or eight enterprises, selected from different subsectors, includingferrous and non-ferrous metals, petrochemicals, machine building, electronicsand electromechanics as well as construction materials. only enterprisesexpected to become economically viable would be selected for restructuring.The preparation of these restructuring programs by joint teams of externalconsultants and Romanian experts would serve as demonstration cases. Theywould be disseminated widely to show various analytical and forecastingapproaches. Selection of enterprises for the inclusion of model restructuringwould be based on the certainty in their ownership and governance and thestrong commitment of their managements to the restructuring process.

2.19 The EC-PHARE program is expected to have an important involvementin industrial privatization and restructuring. Financing indications forthis component remain preliminary, and might become subject to reallocation.Preliminary allocation provides for US$1.0 million of advisory services, studytours and some selected equipment to the NAP. US$1.4 million has beenallocated to the Ministry of Industries for the provision of two seniorresident advisors (12 person-months each for one financial analyst and oneeconomist) directly associated with the Minister of Industry. The comnponentwould further provide for study tours, training, and some hardware withrelated software and training. The component would finance 55 person-months

21

of consultancies for the enterprise restructuring teams establishing modelrestructuring program.

Commercial Banks IUSS2.0 million)

2.20 Substantial reforms will be required to transform the bankingsystem in Romania to meet the requirements of a market economy. The NationalBank of Romania (NBR) has now been restructured am a central bank performingtypical central banking functions much as bank supervision and the.mplementation of monetary policy. NBR is receiving substantial assistanceunder bilateral programs from the IMF central banking department and fromconsultants funded by the EC-PHARE Program. The TA component would,therefore, focus on support to the newly-establ!shed commercial banks.Commercial banks are being transformed into profit-oriented companies whichare expected to opsrate independently from the budget and to provide fullbanking services. However, the portfolio situation of the banks is bleak, asa large proportion of loans outstanding are non-performing, because publicenterprises are unable to repay their obligations. Audits and portfolioreviews will need to be undertaken urgently to assess accurately the financialsituation of the banks. Audits and portfolio reviews as of June 30, 1991 orDecember 31, 1991 are expected to be financed under the EC-PHARE Program. TheTA component would provide financing for the preparation of strategic plans,staff training plans and assessments of computer hardware requirements for theCommercial Bank, the Development Bank, the Agricultural Bank, the CooperativeBank, and (possibly) the Savings Bank. Studies to be financed under the EC-PHARE and this TA program are essential for the restructuring of the bankingsystem and would provide the basis for future lending interventions in thefinancial system.

Enerav Sector Develo2ment (USS3.8 million)

2.21 The objective of this component is to: (i) prepare an energycost and oricina studv; (ii) provide advisory services to GOR to preparerecommendations on an appropriate system and level of energy prices and todesign a program of full price liberalization and/or economic regulation; and(iii) finance an enerayv olicv advisor to the Ministry of Industry who wouldassist in analyzing projected energy demand, institutional, policy, andinvestment requirements to meet future energy demand and facilitate externalsources of additional capital and technical assistance. The component wouldalso provide for some computer equipment and related training for selectedstaff involved in policy formulation at the Ministry of Industries, which isresponsible for the energy sector. The component would further finance twoimportant studies for the petroleum and gas sectors: an Oil and Gas ReservesAudit and Assessment of Operations; and an Evaluation of Hydrocarbon Pros2ectsin Romania. Given the importance of appropriate energy pricing for supply anddemand of energy, agreement has been reached during negotiations that aprogram for pricing reforms in the energy sector be presented to the Bank nolater than September 1, 1992. Based on the recommendations of the Energy Costand Pricing Study, the program would present proposals for pricing reforms inelectricity, hydrocarbon, coal/lignite and district heat to ensure that pricescover economic cost. GOR would subsequently implement pricing reforms asagreed upon between the Bank and GOR during joint review.

12

2.22 The objective of the oil and gas audit is to update oil and gasreserve estimates for Romania. The study would identify the optimum depletionplan for oil and gas reserves, and establish the economic priorities forimplementing this plan. The study would formulate an oil and gas productionpolicy and would also introduce advanced technology for reservoir evaluation.The study would make recommendations regarding technological requirements,appropriate computer systems, as well as the reluted institutional trainingneeds. The objective of the evaluation of hydrocarbon prospects in to providea synthesis of hydrocarbon potential of each major sedimentary basin ofRomania. The study is to develop depositional models which would allow betterunderstanding and prediction of the country's petroleum prospects. It wouldinterpret and integrate geological, geophysical, engineering and logging datawith the detailed study of rock properties. The study would also utilizeatellite imagery technology to prepare an updated and modern geological mapof Romania. The study is expected to be of major importance in attractingprivate investors in the hydrocarbon sector.

Irrioation Sector Development (USS2.7 millionl

2.23 Technical assistance would be provided to carry out a majorirrigation sector review. Technical assistance in the agricultural sector islimited to this one study, as grant financing is expected to be providedthrough the EC-PHARE program for a sector study in agroindustries and advisoryservices for agricultural policy formulation. Irrigation is a key subsectorfor agriculture since almost one third of all arable land (more than 3 millionha) is irrigated. The technical and economic viability of many of existingschemes is uncertain. The irrigation sector study (155 person months) wouldbe an important effort in assessing the role of irrigation in the alteredeconomic conditions of a market economy. It would examine the viability ofvarious established schemes, make restructuring proposals taking into accountcompetitive conditions, provide recommendations regarding appropriateirrigation and drainage technology, and investigate the impact ofprivatization on on-farm irrigation. Consultants would further assess therequired level of operation and maintenance expenditures and recommend levelsof water charges. The study is essential for the preparation of acomprehensive structuring and investment program in the irrigation sector.

2.24 The irrigation study would be carried out in three phases (seealso Annex 8 for detailed description). Phase one would undertake a review ofcompleted documents and data and make a selection of typical schemes fordetailed study under the second phase. In order to facilitate an overallassessment of different types of the irrigation study area, some typicalschemes would be selected for more detailed examination. The results of thisfirst phase should be presented in the form of an inception report, withspecial emphasis on the criteria for the selection of the typical schemes andthe issues which would be studied in greater detail in succeeding phases.Consultant services in the second phase should cover: (i) the preparation ofa near-term investment program for immediate preparationu (ii) the detailedexamination of the issues concerning irrigation, drainage, soil erosion, andthe preparation of preliminary designs and cost estimates for the selectedschemos in the three zones. Consultants should also examine the present and

13

future cropping patterns, local and international marketing, and carry outeconomlc evaluation of the selected schemes on the basis of the proposedremodelling/renovation measures. In the third phase, the consultants shouldprepare a ten-year program of development and rehabililtation, based ontechnical and economic priorities. Furthermore, the consultants would preparethe first five-year tranche of thli prlority program.

2.25 Agreement has been reached during negotiations, that the GORwould ensure that no later than September 30, 1992, the first phase of theproject would be completed and an immediate priority investment program bepresented. By August 31, 1993, the second and third phases of the projectwould be completed, including the ten-year prioritized indicative program anda detailed five-year investment program. Promptly upon completion of eachphase of the study, the GOR would exchange views with the Bank on the findingsof the study and arrange joint meetings between the Bank, representatives ofthe GOR and the consultants to review the findings, to formulate therecomendationr on the proposed investments and to agree on the direction andthe contents of the remaining phases of the study.

Emolovment Services and Social Security ComDonent IUSS3.6 million)

2.26 Romania will experience significant levels of unemployment, asthe country makes the transition from a planned to a market economy.Unemployment has already grown rapidly as uncompetitive factories close downand redundant labor is released from overstaffed companies. Redundant workersstill employed are estimated at 500,000 (5 percent of the total labor force).To avoid undue economic hardships and to assure social peace in a countryunfamiliar with open unemployment, administrative capacities need to becreated to register unemployed workers, to pay unemployment benefits, toprovide for labor market information, and to offer possibilities forretraining. Sufficient financial resources have been earmarked under aspecial fund to finance unemployment benefits, but the Ministry of Labor andSocial Protection (MOLSP) has insufficient administrative capacity to handlesuch numbers of unemployed. Furthermore, the social security system willrequLre extensive modifications to adapt to the needs of a market-basedeconomy, including the creation of an independent social insurance fund andthe creation of a pension fund.

2.27 The employment and social security component would consist ofseven subcomponents, which would:

* improve the labor market information system and develop LivingStandard Measurement Surveys (22 person months consultancy, 20person months of fellowships);

* improve employment counseling, job search and labor exchangetechniques (15 person months consultancies, 6 person monthsfellowships);

* improve productivity, promote inward investment and enhance laborforce mobility by retraining the unemployed and improvingqualification of low/semiskilled workers to improve their ability

14

to react to structural unemployment (5 person monthsconsultancies, 4 person months fellowships);

* assist in generating employment by activating local institutions,mechanisms and systems to *upport the creation and expansion ofemployment and private micro-enterprises by the unemployed (10person months consultancies, 4 person months fellowships);

* for the social insurance program, assist in designing anindependent social insurance fund, in specifying staff trainingneeds to manage the fund, in identifying measures to insure theemerging private sector, and identify measures to improve benefitpayments (14 person months consultancies, 3 person months offellowships);

* automate 170 district offices and the national offices throughprovision of equipment (personal computers) and advisory services(20 person months of consultants and 8 person months offellowships) for establishment of a comprehensive automation planof employment services;

* provide financing for a project implementation advisor (9 personmonths), located in the coordination unit of MOLSP and 15 personmonths of fellowships, to assure the appropriate and timelyimplementation of this complex component.

Mining Sector Development (USSO.9 million)

2.28 Declines ir production in the mining sector have beenparticularly serious during the last 18 months, mostly due to a shortening ofthe work week, to unavailability of some essential spare parts and to badmanagement. The component would therefore provide financing for a managementconsulting contract (37 person months) to introduce a better use of theexisting capital stock and employment of labor. The mining component directlycomplements the imported spare part component for the power sector. Theobjective of the component is to assure adequate levels of production tosupply the two major power plants, Turceni and Rovinari, equipped under theimport component of the project (see paras. 2.34 to 2.41). The managementconsultants wouldt (i) assist in organizing the mines more efficiently toassure productivity increases at its major low cost surface mines; and (ii)prepare a proposal for long-term productivity improvements. Agrement hasbeen reached during negotiations that the GOR would present to the Bank forreview and comment, no later -han January 31, 1993, an action program on: (i)how to improve RAL's economic and financial viability; and (ii) how to ensurein future adequate lignite supplies to the Rovinari and Turceni power plantsin line with additional capacities to be restored under the second phaserehabilitation program. The action program should propose measures on how tosignificantly increase production from low-cost surface mines while decreasingproduction from inefficient underground mining. GOR would subsequentlyimplement restructuring measures as agreed upon during joint review.

15

MaKonal Commission of Statistic iUSS3.0 million)

2.29 The objactive of the component is to support the NationalCommission of Statistics (NCS) in the processing and analysiR of statisticsrequired for the monitoring of economic development in a market-based system.Under the previous regime, production data had been falsified systematicallyto hide shortfalls in production in respect to Plan targets. Unusual progresshas been made by the NCS to correct and adjust the statistics system of thecountry. NCS is already issuing a number of regular publications whichmonitor important indicators. Progress made is partly due to managementhaving shown unusual initiative in setting up twinning arrangements with otherstatistics offices in Westarn European countries. There is, therefore, noneed for the financing of advisory services. Instead a mainframe computer isrequired, which would allow NCS to more rapidly process and analyze data.Installation of adequate computing capacity is nseded now, as a NationalCensus is scheduled to begin in January 1992. Processing of Census data wouldconsiderably speed up the availability of Census results. The loan wouldprovide a mainframe computer, software, and related training of NCS staff inthe use of the computer. Supplementary equipment required for the full use ofthe computer are expected to be provided under the EC-PHARE program.

Proiect Implementation Unit IUSSO.2 million)

2.30 To assure that procurement packages, bid evaluation proceduresand contract signing would proceed as scheduled, and that understanding ofprocurement procedures would expand, the program wou±d provide for anexpatriate procurement advisor (12 person months). The advisor would belocated in the Project Implementation Unit (PIU) and would assist allexecuting agencies of the investment and technical assistance components. Theadvisor would also provide assistance in procurement matters for the proposedTechnical Assistance Project for the Infrastructure Sectors. To assureadequate functioning of the PIU, financing for some essential office equipment(copier, facsimile and two personal computers) would also be financed.

The Imports Component

2.31 The imports component would finance critical import requirementsin the following sectors:

* Petroleum and Gas Sector* Power Sector* Lignite Mining Sector* Transportation Sector* Telecommunications Sector* Irrigation Sectore Agricultural Machinery

Details regarding projected output effects and economic justification of theimports component are provided in Chart II.1

Oo~~~~~~mm CDSSmRcaflC JUBZIAR

c..t (as_amommt *1111in Do esriDtie Productiom effects 1 Economic JustificatWic

(a) Petroleum/ 35 Spare parts and equipment for By 1994 incremental production ERR of 102 percent under baseGas 1,290 shut-in wells of 4 million tons of oil and case scenario (see ANME 2 for1.5 BCM gas, valued at US$217 detailed assumptions).million at 1991 cif prices.

(b) Power &O 2. First phase rehabilitation 4,000 GHW incremental annual ERR of 203 percent under baseof two major power plants, production valued at US$204 case scenario (see ARNME 2 forTurceni and Rovinari million, annually detailed assuAptions)tc) Lignite 26.6 Spare parts for lignite mines 10 million tons of lignite, Net benefit/cost ratio of 2.2supplying Turceni and annually (see AN= 5 for detailedRovinari

assumptions)

Cd) Transportation 35 Spare parts/eJuipment for: 20 percent increase of Increase in income of port.(a) Bucharest Metro onloading at Port Constanza, metro and trucks/buses in(b) two terminals at and 25 percent increase in excess of US$35 million,Constanza Port truck and bus fleet. annually, plus secondary(c) trucks and buses effects resulting from _functioning transport network

(e) Tel ec 6.8 Spare parts and pumping Improvement through number and Primary and secondary incomerunications equipment for existing quality of establisbment of effects.telecommuications network line connection(f) Irrigation 15.9 Spare parts/equipment for 35.000 ha agricultural land Positivo net benefit stream for15 identified irrigation system terrain under irrigation with selected representative schsmnsagricultural production valued taking other investcmnts asbetween US$5.6 to US$8.4 sunk cost (see Amnex 8).million, annually

(g) Agricultural 7 Batteries and transmission 6 million tons of wheat, As output effect to beMachinery belts for coabine barvesters soybeans and maize valued at unusually high, netUS$800 million for 1991 harvest benefit/cost ratio would alsobe very high. Ratio notcalculated as uncertainty aboutallocation of harvest to spartparts only.

y Estimatod for life of spare parts or equipment financed.

17

Im2orts for the Petroleum and Gas Sector iUfS35.O million)

2.32 The country's oil and gas reservoirs are found in four geologicbasins in Romania, the most important of which are around Pliesti. With theexception of this area, most of the other fields are small and scattered,producing from thin reservoir sands having very complex geological settingsand located at depths of about 2,000 meters. The most important gasoccurrence is in the Transylvanian Basin. The gas is of high qua%lity, almostpure methane, produced from about 70 fields with multiple sand reservoirs atdepths of around 3,000 meters. Oil and gas production in Romania dates backto the beginning of the 20th century when it was one of the important oilproducing centers of the world. However, the country's oil and gas reservoirshave long since passed their peak primary production cycle. For this reasonand despite the widespread application of secondary recovery techniques, knoimto Romanian experts, domestic production of crude oil and natural gas havebegun to fall sharply since 1976. Crude oil production has fallen from its1976 level of 14.7 million tone to ubout 8 million tons in 1990. By end-1995, domestic production is estimated to decrease by an additional 2 milliontons. Unless some action is taken to reduce the rate by which productionkeeps declining, the only alternative for meeting demand would be tJ-oughincreased imports.

2.33 Gas production, both associated and non-associated, has fallenfrom 37 billion cubic meters (BCM) in 1981 to 28.2 BCM in 1990. During thenext five years, domestic gas production is projected to fall by about 32percent, from 28.2 BCM to 19.2 BCM. Therefore, unless Romania resorts tohigher standard practices and improved production efficiency, withoutjeopardizing optimization of its natural resources, it will have to rely oncontinuously increasing the import of oil and/or gas. The decline inproduction is largely due to unsuccessful exploration efforts, but it is alsocaused by the unavailability of spare parts, drilling material and e'uipment.The proposed loan would provide US$35 million in spare parts financii (seeAMNEX 31. This would permit the reactivation of 1,290 shut-in wells which areinactive due to lack of material and equipment. ( For details oninstitutional framework and pricing system on energy sector see ANN ).

Imports for the Power Sector (USS40.2 millionl

2.34 Until the end of 1990, electricity was provided by a publicutility which was controlled by the Ministry of Energy. Beginning in 1991,the Government decided to reorganize the energy sector by forming RENEL.Electricity service is provided to all cities and large villages, and to about95 percent of the small villages. Thus, although the level of electrificationin Romania is comparable to that of OECD counties, the quality of serviceremains very poor despite the existence of a very extensive electrical networkand an excessive generating overcapacity.

2.35 Presently RENEL's installed generating capacity is about 21,500 MWof which about 5,500 MW is hydroelectric, 8,600 MW is coal fired and theremaining 7,400 MW is oil and/or gas fired. The main transmission systemoperates at 400 kV. This voltage is also used to interconnect Romania withYugoslavia, Hungary, Bulgaria and the USSR while bulk power purchases from ths

18

USSR are accomplished though a 750 kV tie-line. The installed capacity of thetransformer stations is about 73,500 MVA while the installed capacity of thedistribution transformers is about 51,000 MVA.

2.36 The average utilization factor of RENEL'o generating plants ioonly 34 percent of the installed capacity (7,395 MW compared to 21,540 MW) andthe average plant availability is at a low 46 percent with coal-fired powerplants having an availability of only 28 percent. In addition, the coal-fired plants operate at about 62 percent of their design efficiency (averageconsumption stands at 510 grams per kWH generated %=apared to the design 314grams per kWH). The unacceptable operation of the coal-fired power plants ismainly due to their supply with coal/lignite of below boiler specifications,the absence of foreign exchange for the import of reliable spare parts, andthe managerial problems associated with the reform process, labor disputes andother issues.

2.37 As a consequence of the poor state of the capital stock of thepower sub-sector and Romania's inability to import more electrical energy thanthe 10,700 GWh which it imported in 1990 from its neighbors, RENEL has beenforced to resort to load shedding. In addition, the district heatingcompanies of Bucharest (most of them are operating combined heat and powerfacilities) are not able to meet the heat demand of the city due to theinadequate supply of natural gas and other liquid fuels. To counteract theexperienced supply shortage of electrical and heating energy, the Governmentreverted to closing down, for a period of at least three months, numerousindustries. Nevertheless, even this measure was inadequate to restore thetemperature of the district heating system to the minimum level set by theGovernment.

2.38 Faced with a desperate shortage of electrical energy, REVEL hiredforeign consultants to examine the state of its two largest lignite-firedpower plants (Rovinari and Turceni which are supplied with lignite from themines of Rovinari and Motru) and to recommend the most appropriate and leastcost solution for regaining as much as possible of the original operatingcapability of these plants. The conclusion of the pre-feasibility study,discussed with the Bank, was to rehabilitate the plants in question over twophases. During the first phase, the emergency phase, two 330 MW blocks of theRovinari power station and two identical blocks of the Turceni power stationwould be rehabilitated to a point that it would: (i) permit the blocks to beloaded from the currently low level of about 175 NW to about 250 MW (about 76percent of their name plate capacity); (ii) ensure availability of about 70percent from the currently very low level of about 20 percent; and (iii)assure the performance of the electrostatic precipitators. Such arehabilitation, even if it yields a 60 percent availability instead of thetargeted 70 percent, is estimated to allow RENEL to generate an additional4,000 GWH per year which if valued at US$51,000 per GWh (the price currentlycharged by the USSR for the import of electrical energy) represents an amountof US$204 million per year, which is about 290 percent of the total costassociated with the firet phase rehabilitation.

2.39 The objective of the electricity component is to assist RENEL inincreasing, as soon as possible, the production of electrical energy generated

19

from non-tradab-a (poor quality) lignites by assuring the functioning of fourof the largest generating units while reinstating the original performance ofthe existing electrostatic precipitators. The proposed import program wouldassist the Government to save valuable foreign exchange which would otherwisebe spent in importing more expensive oil, gas or electrical energy. Theproject has been designed tot (i) rehabilitate four 330 KW generating blockes(ii) safeguard the protection system of two 400 kV transformer stations and750 kV transformer station which receives imported electricity from the USSR;(iii) restore and maintain the operating safety of the central and regionaldispatching centers; (iv) regain the original performance of fourelectrostatic precipitators; and (v) provide 50 personal computers. Detailson the spare parts and equipment financed under the component are contained inANNEX 4.

2.40 In addition, the project would also finance the purchase of fivemobile laboratories and the instrumentu of four on-site continuous emissionsmeasuring stations which would enable RENEL to collect valuable informationregarding emissions and pollution levels. This information would be used inconducting the envionmental study financed under the EC-PHARE project (seepara. 2.62).

2.41 The estimated total cost of the proposed power project componentis about US$67.1 million, of which US$40.2 million equivalent would be inforeign exchange. Cost estimates do not include customs duties and taxeswhich are not applicable. The breakdown of the power component cost issummarized in ANNEX 4, Table 1. The EIB has indicated a firm interest in thefinancing of US$17.4 million for this component; an EIB mission has recentlycompleted its appraisal and it expects to present this project to their Boardon July 23, 1991.

Imlorts for the Lionite MininrrSector lUSS26.6 million)

2.42 Domestic coal accourts for about 25 percent of primary energyproduction. The main use of Rot.. nian coal is for electricity generation; 85percent is used in power plants, while the remaining 15 percent are used as alow quality cocking coal in the st.oel industry, in households and for other,mainly industrial purposes. In 19.%, Romania produced about 59 million tonsof coal, including 50 million tons of lignite and 9 million tons of hard coal.In 1989, a record production of 61 million tons was achieved. In 1990,production dropped sharply to 42 million tons, mainly due to the politicalevents and reduced working hours. During the first quarter of 1991,production dropped further, partly due to weather, but partly also due toincreasing shortages of materials and spare parts. In April 1991, theproduction rate regained 80-90 percent of the level of the previous year.

2.43 There are more than 80 mines, scattered over six areas throughoutthe country, but with heavy concentration of lignite mines near Tirgu Jiu andof hard coal mines near Petrosani. While 75 percent of the lignite is minedon surface and 25 percent underground, all hard coal is mined underground.The size of mines, utilization of equipment, and personnel productivity arefar below international standards. Despite poor geological conditions andunfavorable operating coste, large investments havo been made to develop new

20

mines for both surface and underground mining. Production of coal fromunderground mines is judged to be uncompetitive, while surface mines areestimated to be competitive provided major capital investments made in thepast are regarded as sunk costs. Competitiveness of surface mines could besubstant'ally improved with bewter management leading to more efficient use offacto.-s of production. Operation of the mines is presently managed by twostate-owned enterprises, the Regia Autonoma a Lignituliu, comprising alllignite operations; and Regia Autonoma a Huilei, comprising all hard coaloperations. The need for restructuring to address the problems of lowmanpower productivity, low utilization of existing facilities and excessiveproduction costs has been recognized by both enterprises. Studies have beencontracted with the local design institute to improve the performance of themines.

2.44 The objective of the lignite mining component is to meet theincremental demand of 8 million tons for the Rovinari and Turceni power plantsrequired after their completed Phase I rehabilitation. The objective of thecomponent is to restore the production capacity of surface mines of RAL frompresently 42 million tons to 52 million tons, which corresponds to 85 percentof the 1989 level. In the event that unexpected problems should delay orreduce the productivity increases from the continuous surface mines, there isa possibility of increasing deliveries from conventional mines through the useof more trucks engaged through contractors.

2.45 Critical imports consist of wearing materials, such as belts forconveyors, tires and batteries for trucks, of critical electrical parts forcontrol of the major mining equipment, and of materials needed for improvingmaintenance carried out by workshops. The coat of the Lignite MiningComponent is estimated at US$27.5 million, of which US$26.6 million is forcritical imports and US$0.9 million for technical assistance (see para.2.28for management assistance to RAL).

ImDorts for the Transportation Sector (USS35.0 million)

2.46 Romania is highly transport intensive due to past concentrationon heavy industries such as steel, cement, oil refining and petrochemicals,the domestic manufacture of most inputs, the location of production and powerfacilities in remote areas for social reasons, and the subsidization oftransportation. For example, Romania transports about 2.73 ton-kilometers offreight per US$ of GDP, almost 50 percent more than Hungary or Poland, andmore than five times as much as Western Europe. The functioning of thetransportation network is thus essential for the performance of the economy.

2.47 While major changes are going to affect inland transport modes,the role of sea-transport is also going to evolve in support of thedevelopment of foreign trade. Railways have been the backbone of Romania'sinternal freight transportation system in recent decades, carrying close to 90percent of internal freight traffic. Road transport was heavily constrainedby regulation and fuel rationing by the previous administration. Truckscarried less than 10 percent of freight prior to 1990, mostly over shortdistances. Road traffic grew about 70 percent between 1989 and 1991 followingthe elimination of fuel rationing and other regulations, despite a 15 percent

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decline in GDP in 1990. Road traffic 1i expected to continue to grow rapidlyduring the next several years. Urban transport in Bucharest benefits from an*xtensive public transport network but suffers from the low quality ofservices. sea-transport account&. for about 65 percent of Romania's exportsand 40 percent of its imports. The deep-sea port of Constanza on the BlackSea handles about 62 million tons of mostly bulk traffic per annum. The portof Constanza needo to become more responsive to market forces and to providecompetitive services commensurate with the changes being made in the economicenvironment both within Romania and elsewhere. Maritime transport willexperience changes in cargo patterns as well as in ship and cargo handlingtechnology. This will result in greater pressure on the port to providereliable and efficient modern equipment.

2.48 Transport operations in Romania are constrained by the lowavailability of rolling stock and handling equipment. The poor quality ofequipment combined with the scarcity of adequate spare parts are the maincauses of the current situation. Romania manufactured most of its own trucks,as well as buses, railway rolling stock, and construction equipment prior tothe revolution. Much of this equipment is out of service due to lack of spareparts, or should be replaced with imported equipment because of frequentbreakdowns, obsolete technology, or high fuel consumption. Representativeequipment availability rates arei MOT trucks 52 percent, NOT buses 68 percent,diesel locomotives 67 percent, Romanian ships 70 percent, Danube barge fleet30 percent, Bucharest tramway, trolley-buses and buses 69 percent. The portof Constanza is paying more than $25,000 per day in penalties, primarily tobulk iron ore and coal carriers, as the port is unable to unload incomingships at an efficient rate because the conveyor system and crane are out ofservice more than 50 percent of the time due to lack of spare parts. Theoperations of the river transport companies and national shipping lines arealso severely hampered by the lack of spare parts. Finally, the metro systemof Bucharest is important for the functioning of mass transportation; itcarries about 800,000 passengers per day. Only 50 percent of metro rollingstock is currently in operation, due primarily to lack of spare parts.

2.49 The imports component would provide spare parts for trucks andbuses, the Constanza Port and the Bucharest Metro. Import financing for bustransportation in Bucharest is expected to be provided by EC-PHARE. Spareparts financing for the railways has been excluded, as the railway systemrequires major restructuring before imported spare parts will lead tosignificant improvements in performance. River and maritime transport arealso excluded because privatization or the establishment of joint ventures arelikely to affect the ownership and management of equipment. The supply oftires and batteries and other spare parts to trucks and buses should allow a25 percent increase of fleet availability. For the Bucharest metro system,the program will provide batteries for auxiliary electrical devices,components and materials needed to repair traction motors, and a small packageof tools and measurement devices needed which are critical for safeoperations. The project would provide the port of Constanza with spare partsfor bulk handling and container equipment as well as modern equipment tofacilitate a quick improvement of productivity and capacity at the containeryard. This is expected to reduce the penalties on bulk transport and to allowthe port of Constanza to increase its capacity to deal with container traffic.

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2.50 Spare parts for the transportation sector would be distributeddirectly to the Metro system in Bucharest and to the two terminals, SOCEB andCONVEX, at the port of Constanza included under the loan. Details of the listof spare parts provided are listed under ANNEX 6. As spare parts for vehiclesare widely traded on black markets and an appropriate scarcity price isdifficult to establish, tires, engine parts, and batteries would bedistributed under an auction system. The auction would be administered by theimport company, CONTRANSIMEX, and supervised by a Committee established underthe auspices of the MOT. Distribution of batteries, engine parts, and tiresthrough an auction system would also assure equal access of the public andthe newly emerging private trucking sector. Technical assistance to set upthe auction system will be provided through the EC-PHARE program, whichintends to send technical expertise to Bucharest to distribute imported tiresfor taxis, financed under the EC-PHARE program. Aareemen& has been reachedduring negotiations, that all tires, engine parts and batteries imported underthe transport component be distributed under an auction system. The minimumlei price accepted under the auction would be the import value of importproducts valued at the interbank market rate. The maximum amount allowed tobe purchased by one buyer would be restricted. Documents announcing theauction and specifying conditions of participation would be presented to theBank for review and approval.

Imports for the Telecommunications Sector IUSS6.8 million)

2.51 As a result of past neglect and changing priorities, Romania'stelecommunications (TC) network is one of the worst in Europe. Penetration is9.9 Direct Exchange Lines (DELs) per 100 population, which is about averagefor East Central Europe, but the functioning of the network is unusually poor:many DELs are party lines, call completion rates are extremely low, blockageand congestion are severe, the number of faults and the time required to clearthem are very high, and flexibility to reconfigure tr.q network in response totraffic load hardly exists. The long-distance and international networks areparticularly congested. As a result of this, and of the underlying weaknessof the network as a whole, TC facilities and services are not responsive toneeds and presents an obstacle to trade and export development. A newinternational exchange is being installed which will somewhat relievecongestion in international service somewhat; but the effect will not be greatbecause this will merely shift the bottleneck to the rest of the obsolete,worn-out and inadequate network.

2.52 In the medium and long term, Romania must undertake a majorinvestment program to rehabilitate, modernize and expand its TC network andservices. However, the immediate situation is so critical that certainemergency actions are required.

* Spare numbering capacity in the numbering plan is less than250,000--which is unevenly distributed. Thus, there is nopossibility of hooking up more than a few new subscribers, evenif/when equipment and money are available. To utilize theavailable numbers and to free up more numbers requires alteringthe catchment areas of exchanges and re-distributing

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interconnecting transmission cables. This Le currentlyimpoesible because of the extreme shortage of cable.

* Many faults cannot be properly cleared or quality improvedbecause cables have deteriorated or have been cut and cannot bereplaced because of cable shortage. For the same reason, re-engineering to route traffic more efficiently is impossible.

* Numerous elements of the network such as: exchanges,transmission systems, satellite earth stations, power generationsystems are idle, partly idle or are working poorly because oflack of spare parts.

* Lack of basic measuring and testing instrument prevents basicnetwork diagnostice and cripples routine maintenance and repairefforts.

2.53 The network is nearing collapse. Imports which would help tomaintain the functioning of the system are: (i) cables (metallic and opticalfibre) to permit replacement of damaged cables and connecting the newinternational exchange to the rest of the network, re-engineering ofcritically blocked routes and re-distribution of catchment areas to free upnew numbers; (ii) key spare parts for critical elements of the network(especially for exchanges, transmission systems, earth stations, and powersystems); (iii) instruments to support network diagnostics, maintenance,repair and re-engineering. The proposed sum (US$6.8 million) for importfinancing is small, but if carefully targeted, the cables and equipment couldhave an immediate impact by helping to keep the network functioning until morethorough measures can be taken. The implementing agoncy, ROMPOST TELECOM, ispositioned to use the imported equipment efficiently. Technical assistancerequirements to the telecommunications system are expected to be addressoedunder the infrastructure technical assistance project, presently underpreparation.

Imoorts for the Irriaation Sector IUSS15.9 million)

2.54 As described in para. 2.23 irrigation in Romania is important, asone of the principal bottlenecks to agricultural production is the erraticrainfall. The most serious deficiencies occur between June and September whensupplementary irrigation can make a great difference in crop yields. The lackof moLsture affects, in particular, the long season summer crops, such asmaize and sugarbeet and for some horticultural crops. Early dry periods inApril/May, can also be detrimental to winter cereals which urgently requirewater for the formation of the grain. Irrigation in Romania consist of 97large irrigation schemes covering an area of about 2.85 million ha. Another0.45 million are irrigated by smaller schemes of local origin. Totalirrigated areas cover about 33 percent of all arable land. Most of the wateris lifted from the rivers with high capacity electric pumps, sometimes withrepumping, and is distributed through open canals. Irrigated areas contributeabout 50% of the value of all agricultural production in Romania.

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2.55 Major constraints in the lrrlgation sector ares (L) the inabilityto irrlgate the total potential area due to mechanlcal dlfficultles, inparticular due to worn out pumps and the lack of spare partsl (LL) obsoletetechnology resulting ln high irrigation conveyance and application louses;(LiL) absence of automatlc electronic controls for regulation of the canalsand pumping statlon., to match supply and demand; and (iv) high cost andlnadequate supply of electrlcal energy to operate the pumps. These and otherissues would be examlned in a comprehenslve irrlgation and drainage study, tobe financed under the Technical Assiotance Component of the proposed loan (seeparas. 2.23-2.25). The import component would address urgent need of spareparts and equipment as a large number of schemes need replacement and sparesto maintain ln operatlon, for which imported or domestic equipment is notavailable. Theoe requlrements were ldentified by the February 1991 missionand were consldered as priority items vital for the operation of theseschemes.

2.56 The component ($15.9 milllon) would provide flnancing forimported equipment and spares for 15 irrigation schemes, which have seriousproblems delivering water due to equipment failures (see Annex 8 for list ofequipment and spares). With equipment and spare parts provided to theselected schemes, the functioning of irrigation would be assured for about35,000 ha, which would otherwise revert to rainfed agriculture. in themedium-term, these pumping stations for which the spare parts and equipmentare being provided, would continue to be technically viable and would notbecome redundant as a result of sucial changes occurring on the land.However, additional investments may be necessary downstream as a result ofprivatization.

2.57 Only schemes estimated to be economically viable were includedfor financing. As pumping of water is by far the most important costcomponent for delivering water, an analysis based on economic prices forpower, shows that only schemes with up to a pumping height of about 110 meterscan be considered to be economically viable. Schemes selected for equipmentand spare parts financing under the proposed project have a maximum pumpingheight of 16.2 meters and are therefore viable. ANNEX 8 presents assumptionsmade for the analysis and liets the schemes selected. Calculations undertakenfor a few representative schemes also show that continued operation iseconomically justified with positive net incremental benefits throughout theproject period taking past investments as sunk cost. The spare parts andequipment would be procured by the Department of Land Reclamation in theMinistry of Agriculture, and would be installed by the existing machinerystations. The analysis also indicates that in the future, new schemes shouldbe carefully evaluated for economic viability before starting construction,because only limited capital costs can be borne by most schemes.

Imports for Agricultural Machinery

2.58 The agricultural sector in Romania is undergoing fundamentalchange. With the promulgation of the Land Law in February 1991 the major partof land formerly managed by agricultural production cooperatives is nowcultivated by private farmers. Most of the agricultural productioncooperatives, which formerly cultivated 80 percent of land, are expected to be

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dissolved. But the 1991 agriculture production is threatened, am asignificant part of the harvest is expected not to be harvested, since morethan half of the agricultural machinery is inoperative due to lack of spareparts. This is particular true for combine harvesters, which are needed in theperiod between June and September. Most harvesters are Romanian made orimported from former CMEA countries, but important spare parts, such astransmission belts and batteries can and need to be imported from Westerncountries, as the domestic production capacity is estimated to only meetbetween 25 and 50 percent of domestic demand and quality cf parts produceddomestically is very poor, requiring frequent replacements.

2.59 The project would provide for batteries and transmission beltsfor about 20,000 harvesting combines presently out of operation (see ANNEX 8)is expected to help harvest about 20 percent of the wheat, soybeans, and maizeharvest for 1991, over an aggregate area of about 1 million