Document of The World Bank

Report No: 27814

IMPLEMENTATION COMPLETION REPORT(SCL-37880)

ON A

LOAN

IN THE AMOUNT OF US$175 MILLION

TO THE PEOPLE'S REPUBLIC OF

CHINA

FOR THE

SHENYANG INDUSTRIAL REFORMPROJECT

March 25, 2004

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

CURRENCY EQUIVALENTS

(Exchange Rate Effective December 19, 2003)

Currency Unit = Chinese Yuan (Y) Y 1 = US$ 0.12

US$ 1 = Y8.2769

FISCAL YEARJanuary 1 December 31

ABBREVIATIONS AND ACRONYMS

BOCOM Bank of CommunicationsCAE Country Assistance EvaluationCAS Country Assistance StrategyCNC Computer Numeric-ControlledCOF CofinancingCSRC China Securities Regulation CommissionCTF Consultant Trust FundECA Europe and Central AsiaEPB Shenyang's Environmental Protection BureauESW Economic and Sector WorkETC Environmental Training CenterFDI Foreign Direct InvestmentFIE Foreign-invested EnterpriseFMS Financial Management SpecialistFRR Financial Rate of ReturnGOC Government of ChinaGOVT. GovernmentHR Human ResourceHWTF Hazardous Waste Treatment FacilityICB International Competitive BiddingICBC Industrial and Commercial Bank of ChinaICR Implementation Completion ReportLPE Large Private EnterpriseLUR Land Use RightM&A Merger and AcquisitionMCE Municipal-controlled EnterpriseMOF Ministry of FinanceMTR Mid-term ReviewNBF Non-Bank FinancedNCB National Competitive BiddingNPC National People's CongressOECD Organization for Economic Cooperation and DevelopmentPCD Project Concept DocumentPFI Participating Financial InstitutionPSD Private Sector DevelopmentQAG Quality Assurance Group

SAMB State Asset Management BureauSAOC State Asset Operating CompanySAR Staff Appraisal ReportSASAC State-Owned Assets Supervision and Administration CommissionSCL Single Currency LoanSEMIS Shenyang Environmental Management Information SystemSESB Shenyang Employment Service BureauSIRP Shenyang Industrial Reform ProjectSIWWMS Shenyang Industry Waste Water Monitoring SystemSME Small and Medium EnterpriseSMG Shenyang Municipal GovernmentSMTCL Shenyang Machine Tool Company LimitedSOCB State-owned Commercial BankSOE State-owned EnterprisesSPMO Shenyang Project Management OfficeSPRTC Shenyang Property Rights Transaction CenterTF Trust FundTL Task LeaderUSD United States DollarWBG World Bank GroupWWMS Waste Water Monitoring System

Vice President: Jemal-ud-din KassumCountry Director Yukon HuangSector Manager Khalid Mirza

Task Team Leader/Task Manager: William Mako

CHINASHENYANG INDUSTRIAL REFORM

CONTENTS

Page No.1. Project Data 12. Principal Performance Ratings 13. Assessment of Development Objective and Design, and of Quality at Entry 24. Achievement of Objective and Outputs 65. Major Factors Affecting Implementation and Outcome 116. Sustainability 137. Bank and Borrower Performance 148. Lessons Learned 159. Partner Comments 1610. Additional Information 16Annex 1. Key Performance Indicators/Log Frame Matrix 17Annex 2. Project Costs and Financing 18Annex 3. Economic Costs and Benefits 20Annex 4. Bank Inputs 21Annex 5. Ratings for Achievement of Objectives/Outputs of Components 23Annex 6. Ratings of Bank and Borrower Performance 24Annex 7. List of Supporting Documents 25Annex 8. Partner Comments 26

Project ID: P003585 Project Name: SHENYANG IND. REFORMTeam Leader: William Peter Mako TL Unit: EASFPICR Type: Core ICR Report Date: March 25, 2004

1. Project DataName: SHENYANG IND. REFORM L/C/TF Number: SCL-37880

Country/Department: CHINA Region: East Asia and Pacific Region

Sector/subsector: Other industry (69%); General industry and trade sector (24%); Sub-national government administration (3%); Water supply (2%); Solid waste management (2%)

Theme: Export development and competitiveness (P); State enterprise/bank restructuring and privatization (P); Pollution management and environmental health (S); Other financial and private sector development (S); Social risk reduction (S)

KEY DATES Original Revised/ActualPCD: 05/02/1992 Effective: 02/15/1995 04/11/1995

Appraisal: 11/12/1993 MTR: 05/31/1997 04/11/1997Approval: 09/06/1994 Closing: 06/30/2001 06/30/2003

Borrower/Implementing Agency: GOC/SMG & SMTCL & ICBC & BOCOMOther Partners:

STAFF Current At AppraisalVice President: Jemal-ud-din Kassum Gautam KajiCountry Director: Yukon Huang Nicholas HopeSector Manager: Khalid Mirza Richard NewfarmerTeam Leader at ICR: William Mako Austin HuICR Primary Author: William Mako

2. Principal Performance Ratings

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible)

Outcome: U

Sustainability: UN

Institutional Development Impact: M

Bank Performance: S

Borrower Performance: S

QAG (if available) ICRQuality at Entry: S

Project at Risk at Any Time:

3. Assessment of Development Objective and Design, and of Quality at Entry

3.1 Original Objective:Context. The objectives and design of the Shenyang Industrial Reform Project (SIRP) need to be assessed in the context of the unique circumstances of China's industry in the early 1990s. Industrial sectors were highly fragmented, with many small and uneconomic manufacturers. Industrial enterprises were heavily over-staffed and burdened with requirements to maintain social service facilities unrelated to their core business. Technologically-obsolescent state-owned enterprises (SOEs) produced inferior goods increasingly inappropriate for a rapidly developing market; damaged the environment through air/water emissions and hazardous solid wastes; and lacked basic marketing, financial management, and other business management skills. There was no practical distinction between government administration and SOE administration. SOEs basically operated as sub-units for various industrial bureaus in the local government. In many cases, SOEs had not even adopted a corporate form. The State's SOE ownership rights were completely fragmented among many government and party organizations. The focus of industrial organization was on supporting social stability through production and full employment, rather than traditional private sector goals of competitiveness and return on capital. These problems were particularly rife in Shenyang, which was the center of old-style industrial development in northeastern China.

Objectives. SIRP was intended to support China's transition to a market economy. (1) A key objective was to help reform and reorganize Shenyang's industry, especially the engineering industry, by creating a modern corporate-led industrial sector with substantial private participation that could increasingly allocate resources on the basis of competitive market forces. (2) The Project was intended to create a new model of business organization, with a focus on separating productive economic activities from government bureaucracy and organizing these economic activities into corporate entities. (3) The Project was also intended to support the expansion of private sector activities. (4) Finally, SIRP was intended to support the enforcement of environmental standards to redress the substantial environmental degradation of the past and ensure that industrial activity would henceforth be environmentally sustainable.

Thus, SIRP sought to achieve both systemic reforms (e.g., government/enterprise relations, environmental protection) and the restructuring of an important enterprise, the Shenyang Machine Tool Company Ltd. (SMTCL). The Project's strategy of restructuring a particular enterprise to provide a model for the restructuring of other industrial enterprises, while ambitious, was consistent both with China's emphasis on experimentation in managing its transition to a more market-based economy and with similar efforts in other transition economies in Central/Eastern Europe.

The 1993 Country Assistance Strategy (CAS) included an emphasis on SOE reform, private sector development, and environment. SOE reform efforts were to focus on (i) corporatization of SOEs -- through clarification of management autonomy and responsibility, separation of SOEs from the government bureaucracy, and exercise of ownership functions through transparent shareholder mechanisms; (ii) ownership diversification; and (iii) stronger accounting standards and business support services. Private sector development (PSD) efforts sought a level playing field for domestic private business (in access to capital, labor, markets, support services) and an efficient and transparent legal framework and procedures for foreign direct investment (FDI). Environmental programs were to support the continued strengthening of institutional capacity for environmental protection at the central, regional, provincial, and lower levels. These goals were further elaborated in the May 1995 CAS, which stated that "special emphasis will be given to reforming the SOEs by commercializing their operations, ending their dependence on subsidized credit from the banking system, and transferring their social service functions to more appropriate agencies." Bank Group assistance for SOE reform was to be guided by four principles: creation of

- 2 -

autonomous corporate enterprises; separation of social services from enterprises; exposure of enterprises to market discipline; and greater flexibility in enterprise ownership to facilitate enterprise restructuring. In environmental protection, the CAS stated that the Bank would "work with municipal and provincial authorities to develop more effective enforcement of environmental regulations."

The Project was highly consistent with the 1993 CAS's emphases on SOE reform and environmental protection. Training for officials was intended to support the separation of enterprise operations from government administration, while SMTCL's restructuring and reform was intended to serve as a model for other SOEs. In environmental protection, the Project focused on training, technology transfer, and infrastructure sub-components to increase the ability of the local authorities to enforce environmental regulations. In the area of private sector development, the Project focused on greater access to capital for private businesses through a Project-financed line of credit.

SIRP was a long project (original term of 7 years; extended to 9 years). The debate on SOE reform and PSD has moved on since SIRP was approved in September 1994. In 1994, the emphasis was on separating economic and bureaucratic functions and promoting greater autonomy for enterprises. Today, the emphasis in China's "state asset management reform" is more on unifying SOE ownership rights and responsibilities in a designated shareholder -- a State-Owned Assets Supervision and Administration Commission (SASAC) -- that can exercise normal corporate governance over remaining SOEs. In the broader area of private sector development in a transition economy, emphasis within the World Bank Group (WBG) has expanded from the simple creation of private enterprises (e.g., through privatization programs) and access to credit. WBG assessments of the investment climate for PSD now regularly cover a broader range of issues -- e.g., barriers to entry, labor market flexibility, taxes, infrastructure, skills, enforceability of contracts, and access to markets. Lastly, discussions of SOE reform must now pay greater attention to safety nets for laid-off workers, impacts on the financial sector, and cost-sharing between central and local governments.

SIRP was a complex project, involving reforms at a variety of municipal government agencies, restructuring and reform at a large and distressed SOE, on-lending through two state-owned commercial banks (SOCBs), and major environmental investments. Project activity was concentrated in Shenyang. The Bank had previously done three industrial projects and an environmental project in Liaoning province. While the counterparts thus had experience with administering Bank projects, SIRP's emphasis on systemic reform was a departure from past projects.

3.2 Revised Objective:Project objectives were not revised.

3.3 Original Components:Component 1: Reform Program Support (US$4,000,000)

This component was to support the Shenyang Municipal Government's (SMG) reform effort by providing training, consulting services, and equipment in six areas. (i) Training for SMG officials was intended to deepen their understanding of market functions and the role of government in a market economy. The program was to include more than 60 percent of officials in 26 bureaus responsible for economic and social development (i.e., 1,600 out of 2,700 officials). (ii) Establishment of a labor market information system was to improve the SMG's employment service operations and facilitate the development of the local labor market. (iii) Training for industrial safety inspectors was intended to strengthen the Labor Bureau's ability to enforce national occupational health and safety standards. (iv) To facilitate property transactions, a property rights market component sought to develop legislation, simplify procedures, develop marketing

- 3 -

capacity, train staff, and equip and link a Property Rights Transaction Center with other Chinese cities. (v) Support to the State Asset Management Bureau (SAMB) for the municipality was intended to enhance the distinction between government administration and SOE administration through SAMB capacity-building; and (vi) Support for the Shenyang College of Finance and Economics was intended to upgrade its economics faculty.

Component 2: Line of Credit (US$40,000,000)

The Shenyang branches of the Industrial and Commercial Bank of China (ICBC) and the Bank of Communications (BOCOM) were designated as participating financial institutions (PFIs) to on-lend SIRP proceeds to finance the modernization and restructuring of industrial enterprises other than SMTCL. Of the original amount, up to $30 million could be used for SOEs while $10 million was to be used for private enterprises. The PFIs were to bear the full credit risks for sub-lending and were responsible for appraisal and supervision of sub-projects. Each sub-project was to meet the following eligibility criteria: (i) any SOE sub-borrower should be organized as a shareholding company (either public or private), while a private sub-borrower could be of any form; (ii) the sub-borrower should have good business prospects and sound finances; (iii) the sub-project should have a minimum economic rate of return of 12 percent and a minimum financial rate of return of 12 percent; (iv) the sub-borrower's up-front contribution should amount to at least 20 percent of total cost of the sub-project; (v) the sub-project must meet Shenyang's environmental standards; and (vi) loans to a single borrower could not exceed $4 million.

Component 3: Shenyang Machine Tools Company Ltd. (US$121,000,000)

SMTCL was created in 1993 through the merger of three separate SOEs engaged in the manufacture of traditional machine tools (lathes, universal adaptors) and one SOE that manufactured control systems. A 1992/1993 feasibility study recommended the rehabilitation and modernization of existing facilities; rationalization of manufacturing processes; enhancement of product quality to international standards, including a shift in production to computer numeric-controlled (CNC) machine tools using imported components; and establishment of an effective management process. Three existing foundries (all small, obsolescent, and polluting) were to be replaced with a single, modern, environmentally-acceptable foundry. Key components were to be outsourced. Non-core social assets (i.e., housing, clinic, schools, service facilities) were to be hived off from SMTCL. The SMTCL workforce was to be downsized 30 percent, from 23,000 staff to 16,000 staff, by 1998. To support these plans, loan proceeds were to finance the procurement of equipment to produce sophisticated computer numeric-controlled (CNC) machine tools and to upgrade product quality (about $100 million); technology transfer from Germany, Japan, and the United States (about $14 million); technical assistance and consulting to enhance internal design and corporate planning, marketing, accounting, and financial management capabilities (about $5 million); and civil works (about $2 million).

Component 4: Environmental Protection (US$10,000,000)

This component was intended to support the SMG's policy of improving the enforcement of existing environmental regulations through three sub-components. (i) A 1992 survey indicated that Shenyang industry was generating 307,000 tons of hazardous waste per year. While 93 percent of this amount could be recycled or most-economically treated/disposed by the large enterprises producing the waste, the remaining 23,000 tons/year from a large number of small hazardous waste generators could be most economically and securely handled through a central Hazardous Waste Treatment Facility (HWTF). The HWTF was intended to handle 26,000 tons/year. (ii) To upgrade water quality monitoring (from infrequent manual sampling), a Waste Water Monitoring System (WWMS) consisting of 25 automatic monitoring

- 4 -

stations at 19 enterprises was to provide continuous monitoring and daily reporting to Shenyang's Environmental Protection Bureau (EPB). (iii) To strengthen the institutional capacity of EPBs at the city and district levels, the Project provided for development of an Environmental Training Center (ETC); a Shenyang Environmental Management Information System (SEMIS) to collect, process, and display environmental data for officials; and a hazardous waste laboratory co-located with HWTF but under the EPB's control.

Given the government's gradualist and experimental approach to enterprise reform and the Bank's experience in China at the time, it appears that SIRP's components were reasonably related to Project objectives. Technical assistance under the Reform Program component related directly to the need and the government's intention to separate enterprise management, government administration, and social protection functions. The Line of Credit component addressed the expectation that an increasing number of private enterprises would find it difficult to obtain financing from state-owned commercial banks (SOCBs). The SMTCL component was intended to address the technical, organizational, and business management needs of a particular enterprise. In retrospect, however, it seems optimistic to have assumed that SMTCL's restructuring could have served as a model for restructuring the rest of Shenyang's industry. The Environmental Protection component directly addressed readily discernible environmental problems. Local counterparts proved capable of administrative, financial, and procurement management of the Project. The local counterparts also proved capable of organizational initiatives within their areas of authority and competence, for example, the segregation of social assets from SOEs, initial implementation of worker safety net programs, and development of exchanges for labor market and property market information.

While the Bank had undertaken industrial lending in China as early as 1982 (Industrial Credit I), these lending operations focused on technology upgrades. It appears that SIRP was the first industrial project with a major reform component. But enterprise reform was, and remains, a complex undertaking involving both local and central government initiatives and programs. It was perhaps underappreciated at the time, in China as well in the ECA countries, that enterprise reform would require a wide-ranging host of complementary progress in such areas as corporate governance, social safety nets, creditor rights, and financial sector supervision.

3.4 Revised Components:

Component Cost RatingREFORM PROGRAM SUPPORT $3,600,000.00 SLINE OF CREDIT $60,000,000.00 USHENYANG MACHINE TOOLS CO. LTD $101,000,000.00 UENVIRONMENT PROTECTION $10,400,000.00 S

In June 2000, in response to an April 2000 request from the Government, the Project was restructured. The World Bank's Executive Directors approved the proposed reallocation of 18 percent of total loan proceeds. This reallocation reflected changed circumstances and progress to-date, and was an effort to provide more effective support to the original developmental objectives.

The SMTCL component was reduced from $121 million to $101 million, with $20 million transferred to the Line of Credit component. In addition, within the remaining SMTCL amount, $10 million was reallocated to support labor reductions at SMTCL and some additional funds were reallocated for technical assistance and technology transfer. SIRP's use of Bank loan proceeds to finance labor redundancy was a first for the Bank, made possible by a March 1996 change in Bank policy. While SMTCL had reduced its workforce from 23,000 in 1993 to 14,000 in 2000, additional reductions of 6,500 down to a workforce of

- 5 -

7,500 or less were considered necessary to improve SMTCL's competitiveness. Under the worker redundancy programs extant in China at the time, "xiagang" (off-post, i.e., laid-off) workers were assigned to re-employment centers set up by their SOEs where they received a living allowance, coverage of social security benefits, some training, and job information for up to three years. Costs were supposed to be shared among the SOE, the social security fund of the local government, and the general government budget. The reallocation of $10 million within this component was to finance SMTCL's contribution for the support of xiagang workers.

The Line of Credit component was raised from $40 million to $60 million. The additional $20 million was to be loaned exclusively to private enterprises. All future sub-loans were to follow the Project's original terms and conditions -- e.g., maximum sub-loan of $4 million and maturity of up to 12 years, including 3 years of grace.

The Reform Program Support component was reduced from $4 million to $2.55 million. The main reason was the reduced allocation for the SMG official training sub-component, which reflected greater use of counterpart funds and lower than anticipated demand as a result of the many other options for civil servant training that developed after Project appraisal. Other fine-tuning included the reallocation of some additional funds for the labor market and the property rights transactions sub-components.

3.5 Quality at Entry:Quality at Entry is rated satisfactory, based on (i) the consistency of Project objectives with the CAS; (ii) the government's priorities, albeit still somewhat tentative; and (iii) support for environmental standards -- both the development of environmental impact statements, as appropriate, and Project support for better enforcement of environmental regulations. A machine tools sector study, an enterprise reform strategy paper, and a draft industrial lending strategy paper provided the analytical underpinnings for SIRP. Indeed, the Project got off to a good start. By 1997, Project counterparts had fully implemented agreed SMG reforms in such areas as managerial autonomy for enterprises, transformation of municipal-controlled enterprises (MCEs) into shareholding companies, transfer of state asset management responsibility from line bureaus to a dedicated asset management bureau, transition of SOE employees to contract (vs. permanent) status, and development of labor and property rights markets.

4. Achievement of Objective and Outputs

4.1 Outcome/achievement of objective:Reorganization of Shenyang' s industrial sector into a modern corporate-led industrial sector with substantial private participation that could increasingly allocate resources on the basis of modern market forces -- Progress toward this objective is unsatisfactory. Despite a substantial increase in private participation, one cannot say that Shenyang's industrial sector has enough private participation, that resource allocation is sufficiently market-based, or that this Project's SMTCL Component and Line of Credit Component have provided a positive demonstration effect and appropriate support.

Private participants in Shenyang's industrial sector include foreign-invested enterprises (FIEs), new ldomestic start-ups, and former SOEs that have become private through "ownership transformation." As of 2002, Shenyang had 509 large private enterprises (LPEs).*/ As detailed below, however, the development of private industry in Shenyang lags behind China's coastal cities and the western city of Chengdu. Distress is common among SOEs. While separate figures are not available for Shenyang's SOEs, 63 lpercent of Liaoning Province's SOEs were unprofitable in 2001; unhealthy assets (e.g., un-saleable inventory, un-collectible receivables) almost equaled equity; and the overall SOE portfolio was nearly insolvent.

- 6 -

As for market-based resource allocation, the prevalence of distress among SOEs suggests the practice lof directed lending and/or inadequate financial sector capacity for credit analysis, monitoring, and resolution of distress. Local labor markets do appear to have become more flexible. But access to land (actually land use rights, or LURs) still appears to be dominated by the local government, as indicated by reasons given for SMTCL's failure after two years to sell its Qihong/Beiyi LURs.As indicated below, SMTCL's repayments on its component have been in arrears, while about half the lLine of Credit sub-borrowers were also in arrears as of mid-2003. The emphasis has been on obtaining capital, rather than on using it effectively, establishing proper controls, and honoring debt service obligations -- all of which are essential for a market-based allocation of capital.

(* LPE is an enterprise with revenues above RMB 5 million and private ownership above 50 percent.)

Separation of productive activities from government bureaucracy and organization of these economic activities into corporate entities -- The separation of economic and bureaucratic organization and activity is satisfactory. As detailed below, municipal controlled enterprises (MCEs) have been corporatized and about 300 have been established as shareholding companies; management autonomy has devolved; and the SMG has established an organizational structure for management of state assets. The evolution of state assets management in Shenyang has been broadly consistent with nationwide trends.

Expansion of private sector activities -- While there has been an expansion, the extent of private sector activity is less than satisfactory. In contrast to 1994, when private participation in Shenyang's industrial sector was negligible, Shenyang had 509 large private enterprises (LPEs) as of 2002. In terms of LPEs per 100,000 of population, Shenyang (at 7.4) was ahead of Changchun (6.0) and Haerbin (3.5); but Shenyang is well behind the coastal cities of Ningbo (66.6), Qingdao (25.4) and Nanjing (24.9) and slightly behind the western city of Chengdu (9.8). The ratio of industrial value-added by LPEs in Shenyang falls short of the ratio for Changchun, for several coastal cities (Ningbo, Qingdao, Hangzhou, Jinan), and for Chengdu -- but is ahead of Nanjing, Dalian, and Wuhan. The assets/liability ratio for LPEs in Shenyang is significantly higher than those in other northeast, coastal, and interior cities. This suggests that LPEs in Shenyang suffer from profitability problems and/or excessive debt.*/

(* From "A Comparison of Private Enterprise Development in Shenyang with Other Cities," based on information from the Shenyang Information Network and 2002 municipal circulars from selected cities.)

Enforcement of environmental regulations -- The development of facilities, development of monitoring and information systems, and training has had a satisfactory effect. It appears that environmental regulations are being enforced. For example, pollution collection charges by the Shenyang Environmental Protection Bureau (SEPB) amounted to RMB 120 million in 2002 and more than RMB 40 million during the first 5 months of 2003 (RMB 96 million annualized). As detailed below, the use of cleaner industrial technologies, economic reforms, and a drop-off in some industrial activities have also contributed to a cleaner environment.

4.2 Outputs by components:Reform Program Support ($3.6 million per revised loan; $2.3 million actual) -- Relative to expectations in the SAR and reforms throughout China over the past five years, this component is satisfactory. Originally, this component included nine sub-components: training, labor market, industrial safety, property rights, state-owned assets, finance/economics training, securities, social security, and project management. Two sub-components were cancelled -- planned securities training was centralized by the China Securities Regulation Commission (CSRC), while social security reform was reorganized into the Liaoning pilot program.

- 7 -

The mid-term review reported in April 1997 that the SMG had substantially implemented the reform program agreed with the World Bank. It cited reforms in SMG reorganization, the granting of autonomous rights to municipal-controlled enterprises (MCEs), the establishment of shareholding companies, bankruptcy procedures and liquidations, mergers and acquisitions, industrial safety inspection, and labor market information.

Discussions with the SMG in December 2003 suggest that these reforms have been sustained. While the reform of state assets management is an ongoing process, Shenyang has largely separated enterprise activity from bureaucratic administrative activity. SMG's Finance Bureau (in lieu of a state assets management bureau) oversees 8 state asset operating companies (SAOCs) which, in turn, oversee about 1100 MCEs. The Finance Bureau reports that all these MCEs have been corporatized as "legal persons" and that 300 are organized as shareholding companies. SOEs (or MCEs) seem reasonably autonomous -- sometimes too autonomous, as the below discussion suggests. While SOE bankruptcies follow the government-mandated administrative "capital structure optimization program" procedure, there have been more than 100 small bankruptcies. The Shenyang Property Rights Transaction Center (SPRTC) supported asset transfers amounting to RMB 690 million by 130 SOEs in 2002, while SPRTC's November 2003 "inventory" consists of RMB 3.1 billion in assets from 208 SOEs. While Project-financed investments in information technology for the Shenyang Employment Service Bureau (SESB) have been overtaken by subsequent improvements in information technology, both SESB's operations and Liaoning's approach to the development of social safety nets seem successful in promoting greater labor market flexibility.

Line of Credit ($60 million per revised loan; $44.7 million actual) -- While the utilization of this line of credit has been acceptable, high defaults by sub-borrowers compel an unsatisfactory rating.

Two participating financial institutions (PFIs) -- the Industrial and Commercial Bank of China (ICBC) and the Bank of Communications (BOCOM) -- proceeded with 33 sub-projects totaling $45.3 million. Actual disbursements totalled $44.7 million, including $6.8 million for 6 ICBC sub-projects at state-majority shareholding enterprises, $22.6 million for 17 ICBC sub-projects at private enterprises, and $15.3 million for 10 BOCOM sub-projects at private enterprises. Thus, private enterprise sub-projects accounted for $37.9 million of the $44.7 million in on-lending disbursements. This amount of sub-lending to private enterprises exceeds expectations in the SAR, but only about $5 million of the $20 million re-allocated in June 2000 for BOCOM lending to private enterprises was actually used. The Bank provided its "no objection" for three additional BOCOM sub-projects. For various reasons (non-competitive terms, business problems, inadequate loan amount), however, these sub-projects were dropped.

While just two sub-borrowers were said to be in default on loan repayments to the PFIs at the time of the November 2002 supervision mission, repayment performance was reported to have substantially deteriorated by the final supervision mission in June 2003. According to information provided by the Shenyang Project Management Office (SPMO), while 24 sub-borrowers were due to be making repayments on sub-loans totaling $26.5 million as of May 2003, 13 sub-borrowers and $13.7 million in sub-loans were in default. This 50 percent default rate is significantly worse than reported nationwide averages. While the November 2002 supervision mission had urged that ICBC and BOCOM supervise their sub-loans closely and take pro-active measures in case of sub-borrower distress, this apparently was either not done or done ineffectively.

Shenyang Machine Tool Company Ltd. ($101 million per revised loan; $81.6 million actual) -- While this component supported significant operational restructuring of SMTCL, the questionable sustainability of SMTCL's business model, the company's growing arrears to the SMG, and SMTCL's casual approach

- 8 -

to capital management compel an unsatisfactory rating.

Since its formation in 1993 from the merger of 3 machine tool companies and 1 industrial controls company, SMTCL has substantially rationalized its manufacturing operations and upgraded its technological capabilities. Non-core social assets have been spun-off. The heavily indebted former Number 3 Machine Tool Works was split off and placed into bankruptcy in 1996. As a result of the procurement of modern equipment, technology transfers, and establishment of links with foreign CNC component suppliers, CNC machine tool sales grew to 50 percent of SMTCL's revenues in 2001. SMTCL management claims that the company is well positioned to meet increasing CNC machine tool demand from China's growing auto, aerospace, and heavy equipment sectors. SMTCL reduced its workforce by about 60 percent, from 17,500 in 1993 (actually 23,000 if #3 Machine Tool is included) to 7,300 at present. This resulted in substantial overtime for some SMTCL workers, sometimes in excess of labor law standards. In late 2002, Bank staff warned SMTCL about the need to conform with China's labor law. A 2003 Country Assistance Evaluation (CAE) suggested that Bank staff should have gone further and actively monitored working hours at SMTCL. It was not clear to Bank staff involved in the Project, however, that such monitoring would have been at all practicable.

These accomplishments in operational restructuring notwithstanding, SMTCL has fallen short in terms of performance expectations, competitiveness, and governance. SMTCL's financial statements indicate that sales growth slowed to just 4 percent in 2002, down from 13-15 percent growth in 2000-2001, 22 percent in 1999, and 39 percent in 1998. This is said to reflect increased competition in the CNC machine tools market. Revenues for 2002 of RMB 1.3 billion were less than one-quarter of the base-case sales projection for 2002 (admittedly, highly optimistic) in the Staff Appraisal Report (SAR). SMTCL's earnings growth has always been volatile. In contrast to the 10 percent earnings growth projected by management for 2002, SMTCL's 2002 earnings of RMB 50 million represented a 46 percent decrease from 2001 and the company's lowest earnings since 1997. Management attributed this decrease to the high cost of imported CNC components. Earnings of RMB 50 million for 2002 were just 6 percent of the base-case earnings projection for 2002 (again, overly optimistic) in the SAR. SMTCL's working capital cycle lengthened in 2002 to a total of 220 inventory/receivables-days. Following a public share offering and debt/equity conversion in 1998, SMTCL's long-term debt service coverage declined from 1.7 in 1998 to 0.9 in 2002. As a result, SMTCL petitioned the central government and National People's Congress (NPC) in early 2003 for another debt/equity conversion. SMTCL has improved labor productivity, reducing the number of workers/$100 million (constant) of revenues from 12,655 in 1993 to 7,281 in 2002. But SMTCL's staffing is still far above the 600-800 workers needed at comparable international companies to support $100 million of sales. The final supervision mission questioned SMTCL's ability to continue financing the purchase, integration, and installation of imported CNC components for powerful, slow-paying customers in key sectors and recommended that SMTCL's shareholders seek a buyer (or real strategic partner) for SMTCL.

Citing cash flow uncertainty and requirements for additional capital investment, SMTCL suspended Project loan repayments to SMG in early 2002. SMTCL's arrears to SMG amounted to $32.1 million by March 2003. World Bank suggestions from November 2002 for operational and financial restructuring to re-start debt service provoked little reaction or discernible effect on SMTCL.

While claiming shortages of finance for operations and capital investment and while falling farther behind in debt repayments to SMG, SMTCL has retained some non-core assets and undertaken some additional diversification. By 2002, SMTCL had diversified into unrelated businesses (real estate, securities, mineral water, advertising, and herbal medicine). Following World Bank recommendations to sell non-core assets for debt repayment, SMTCL sold some of these holdings in late 2002, but retained its shares in a securities

- 9 -

company. Management insists that securities is a growth business and that it would not sell its 10 percent interest in a securities company. For more than two years, SMTCL management has discussed the sale of land use rights for two properties, but has made no discernible progress toward actual sale. In fairness, this may be attributable to policies of the local district government. Finally, in late 2002, SMTCL invested RMB 10 million and committed to investing an additional RMB 10-30 million in three new joint ventures (in milling, CNC devices, and sewing machines). There is no indication that these investment decisions have involved proper consideration of creditors' rights or followed rigorous analysis. Indeed, in May 1998 the World Bank's machine tool industry specialist (a consultant) cautioned that joint ventures are often counter-productive and not an effective way of transferring technology.

Environmental Protection ($10.4 million per revised loan; $10.2 million actual) -- By supporting the development of a Hazardous Waste Treatment Facility (HWTF), information management and monitoring systems, and environmental training, this component was successful in improving the capacity of local authorities to enforce environmental regulations. Pollution charge collections by the Shenyang Environmental Protection Bureau (SEPB) amounted to RMB 120 million in 2002 and more than RMB 40 million during the first 5 months of 2003 (RMB 96 million annualized). By highlighting sources and levels of pollution, the Shenyang Environmental Management System (SEMIS) financed by the Project should support the enforcement of environmental regulations and the imposition of pollution charges. By monitoring 10 major industrial wastewater emitters that account for 40 percent of total industrial wastewater, 4 wastewater treatment plants that account for 100 percent of municipal sewage, and 12 other sites, the Shenyang Industry Waste Water Monitoring System (SIWWMS) should support the enforcement of regulations on water quality. Environmental Training Center (ETC) courses had 5600 participants in 2001 and 2002. The HWTF should provide safe storage for hazardous waste that cannot be recycled or economically handled at its source.

HWTF has been operating below-capacity, but utilization seems likely to improve. Completed in 1996 with an eventual capacity of 240,000 tons and annual processing capacity of 20,000 tons/year, the HWTF is still operating below its processing capacity and below its break-even level. During the first 5 months of 2003, HWTF accepted just 1,500 tons (3,600 tons on an annualized basis) -- versus 20,000 tons/year processing capacity and the 5,000 tons/year needed to break even at current prices. In retrospect, the SAR over-estimated requirements by under-estimating the effects from cleaner technologies, economic reforms, and a drop-off in industrial activity. Shenyang now generates less than 1000 tons of hazardous waste per year. It appears, however, that HWTF's business is picking up. As of October 2002, HWTF had signed collection contracts with 43 of the 64 enterprises accounting for 95 percent of hazardous waste in Shenyang. Between October 2002 and June 2003, the HWTF reportedly signed an additional 50 contracts. The State Environmental Protection Bureau has designated Shenyang's HWTF as one of eight regional sites for all of China and the only site in northeast China. For HWTF to be profitable, it will need to accept hazardous waste from a much broader area of China.

4.3 Net Present Value/Economic rate of return:Not used

4.4 Financial rate of return:The SAR estimated that the SMTCL component would have a return of 23.6 percent under the base-case scenario and 19.8 percent under the low-case scenario. Net cash flow with Project investments was compared with those expected without the Project, in which case the only investments would be those committed to by the 8th Five-Year Plan.

The financial rate of return (FRR) for SMTCL turns out to be very disappointing. Because of delays in

- 10 -

project construction and huge working capital requirements (due to a combined inventory-receivables cycle of 200+ days), net cash flows from the Project turned positive only in 2002. Based on SMTCL's financial statements through 2002 and 2003-2010 financial projections provided by SMTCL management in 2002, the FRR for the SMTCL Component is estimated to be 4 percent. Given the history of overly optimistic projections for SMTCL's financial performance, however, even this low FRR should be viewed with caution.

4.5 Institutional development impact:Overall, the Project's institutional development impact was modest. Looking at the most positive aspects, it appears that the Project provided substantial support for long-lasting SMG reforms (e.g., separation of enterprises from government, development of property rights transactions, labor market development) and for the SEPB's ability to enforce environmental regulations. SMTCL gained some significant benefit from consulting, technology transfer, and training for 3600 employees. The greatest benefits appear to have been in the use of new production technologies, re-organization of production, and better human resource (HR) management. It appears, however, that SMTCL's capacity for strategic planning, marketing management, and financial management are less well-developed. Especially given the rate of arrears among line of credit sub-borrowers, it is unclear whether the Project had any institutional development impact on the Shenyang branches of ICBC and BOCOM.

Development impact may have been greatest and most long-lasting at the two smallest components (Reform Program Support and Environmental Protection). The SMTCL Component and Line of Credit Component overwhelmingly emphasized the deployment of capital to procure new technologies and relatively less emphasis on technical assistance and training. Thus, an over-emphasis on hardware and under-emphasis on "software" (e.g., financial analysis and management, marketing skills, strategic planning) in these two components may actually have worked against long-term development impact.

5. Major Factors Affecting Implementation and Outcome

5.1 Factors outside the control of government or implementing agency:Many crucial factors have remained outside the control of the SMG, SMTCL, ICBC, and BOCOM.

The market for selling CNC machine tools in China has become highly competitive -- more competitive lthan expected in 1993 when the Project was appraised. Because of this market competitiveness -- as well as SMTCL's apparent lack of "critical mass" and pricing power -- SMTCL's sales growth (while remaining far below projections in the SAR) has slowed since 1998; earnings have remained volatile; and receivable-days and consequent requirements for working capital financing have remained high. The apparent unpredictability of the development of China's CNC machine tool market highlights the inherent difficulty -- especially for governments -- of attempting to pick sectors or enterprises likely to emerge as market "winners."The concentration of special investment incentives along China's coasts may have tended to divert lforeign investment to the coastal provinces, to the detriment of the northeastern provinces.A stronger earlier commitment by the central government to far-reaching enterprise reforms -- lincluding greater ownership diversification and other forms of privatization ("ownership transformation"), concentration of state ownership rights and responsibilities in an SOE "ownership agency," an emphasis on maximizing returns on State capital, and stronger corporate governance -- might have had two benefits. First, the SMG might have been encouraged to "withdraw" from additional SOEs and thereby to create a more favorable investment climate for private industry. Second, if there had been greater emphasis on maximizing returns on State capital and on effective corporate governance, SMTCL might have been encouraged to complete its restructuring more efficiently and/or to have sought a strategic investor.

- 11 -

A stronger earlier commitment by the central authorities to raising financial sector regulation, lsupervision, and governance to international standards would presumably have encouraged more careful credit analysis, better monitoring, and a more pro-active response to any sub-borrower arrears by ICBC and BOCOM. A stronger commitment by the central government and legislature to insolvency reform and the lprotection of creditors rights might have encouraged development in China of a "credit culture" and discouraged arrears by both SMTCL and line of credit sub-borrowers.Ceilings on interest rates discourage lending to private businesses, especially small and medium lenterprises (SMEs), and have constrained private sector development. Especially for SME lending, financial institutions need the flexibility to set interest rates high enough to compensate themselves for higher risks and transaction costs. Complete flexibility for financial institutions to set interest rates according to market conditions would have done more to encourage private sector development than could ever have been achieved by a project-financed line of credit.

5.2 Factors generally subject to government control:The importance of the central authorities notwithstanding, the SMG has had control over many important factors affecting the investment climate for local private sector development. For example, it is within the SMG's power to implement a system for business registration, licensing, and inspections that encourages new "entry" by private businesses. The SMG can pursue the privatization ("ownership transformation") of municipal-controlled enterprises (MCEs) through an open process that promotes new management, new investment, and post-privatization enterprise restructuring and performance improvements. Subject to budget constraints, the SMG can provide "safety nets" and labor market information that facilitates the re-deployment of redundant labor from SOEs -- hopefully to growing parts of the economy.

5.3 Factors generally subject to implementing agency control:While concerns remain that the local branches of state-owned commercial banks (SOCBs) may be pressured to lend to local SOEs for non-commercial reasons, the management and officers of the Shenyang branches of ICBC and BOCOM*/ are responsible for the assessment, monitoring, and performance of credits to sub-borrowers under the Line of Credit component. If credit assessment and other aspects of institutional capacity are lacking, such financial institutions presumably have or can find the wherewithal to obtain needed skills -- either commercially or through international financial institutions.

The governance of SMTCL is under the control of its board and its shareholders. Approximately 70 percent of SMTCL shares are state-owned. SMTCL is a locally-administered SOE. Traditionally, the rights and responsibilities of State shareholders in China have been highly fragmented among a number of Government and Party entities -- e.g., the local Finance Bureau, local Economic and Trade Commission, and local Party enterprise working group. This is now changing, with the establishment of State-Owned Assets Supervision and Administration Commissions (SASACs) at the central and local levels of government. While the allocation of shareholder rights and responsibilities has been fragmented, the local authorities are ultimately responsible for the success or non-success of SMTCL.

(* While BOCOM is a joint stock company and not strictly a SOCB, 100 percent ownership by state shareholders may nonetheless leave local branches more amenable to local influence.)

5.4 Costs and financing:As mentioned above (section 3.4), there was some reallocation of project costs, especially away from SMTCL procurement and toward the Line of Credit component and financing for labor redundancy at SMTCL. Overall disbursements were 79 percent of the total loan amount. Compared with the restructured loan, actual disbursements for the Reform Support Component were 65 percent of the available amount.

- 12 -

This appears to reflect organizational changes and perhaps some possible reluctance to borrow for training of officials. Actual disbursements for the Environmental Component were 98 percent of the available amount. Actual disbursements for the Line of Credit Component were 75 percent of the increased amount following the June 2000 restructuring of the loan. Limits on interest rates, which can make it un-economical for financial institutions to bear the risks and transaction costs, were probably a major factor in under-utilization of the Line of Credit component. Actual disbursements for the SMTCL Component were 81 percent of the reduced amount available after the June 2000 restructuring of the loan. It appears that SMTCL's arrears to the SMG from at least early 2001 led the SMG Finance Bureau to freeze further disbursements of Project loan proceeds for SMTCL use.

6. Sustainability

6.1 Rationale for sustainability rating:While gains from the Reform Program component and Environmental component seem sustainable, the unsatisfactory rating reflects arrears by SMTCL to the SMG and by Line of Credit sub-borrowers.

The initial separation of government administration from SOE administration and related reforms lwithin the SMG have been sustained. Further SOE reform and restructuring is likely to depend on the development of SASAC ownership agencies and a more business-like approach to the management of State capital. In environment, the Project has strengthened the SEPB's ability to detect and counter hazardous lemissions and to safely store hazardous solid wastes. In addition, the challenge of environmental protection has been made easier by the development of cleaner industrial technologies and a change in industrial activity in Shenyang.Despite SMTCL's efforts at operational restructuring, SMTCL underwent a debt/equity conversion in l1998 and requested a second debt/equity conversion in 2002. It is difficult to characterize enterprise restructuring as sustainable when the enterprise in question requires a debt/equity conversion every four years.As for the Line of Credit Component, 50 percent arrears by sub-borrowers who should now be making lsub-loan repayments is very discouraging. The resolution and avoidance of such defaulting will require systemic reforms far beyond the scope of this Project. Key systemic reforms would include adoption of international best practices in the regulation and supervision of financial institutions; corporatization and enhanced corporate governance for financial institutions;*/ and capacity-building in the areas of credit analysis and corporate workout.

(* As noted earlier, BOCOM has already been corporatized. Thus, all three systemic reforms are likely necessary to bring about significant improvements in credit analysis, monitoring, and workout.)

6.2 Transition arrangement to regular operations:The Bank's Project team has maintained good relations with key Project counterparts, especially within the SMG and with SMTCL. Discussions with Project counterparts, even on difficult issues, have remained open and candid. The Bank' s team has regularly reiterated, as recently as December 2003, its interest in maintaining a dialogue with key Project counterparts. But while the SMG's reforms got off to a promising start during the first few years of the Project, it appears that the impact of the World Bank's advice on enterprise reform subsequently waned and was modest at best by the end of the Project.

Developments subsequent to the closing of the Project may provide a better opportunity for promoting SIRP's developmental objectives in enterprise reform. Industrial revitalization of the Northeast provinces (Liaoning, Jilin, and Heilongjiang) has emerged as a priority for the new central government. Indeed, the Development Research Center of the State Council and the provincial authorities organized a conference on

- 13 -

Northeast industrial revitalization in Shenyang in December 2003. Central government representatives, high-level provincial authorities (e.g., two governors and several vice-governors), and senior World Bank staff were heavily involved in this conference, which received national media coverage. The Liaoning government has requested follow-on assistance from the World Bank in assessing the province's investment climate. As has been found in other investment climate assessments elsewhere in China, market distortions from loss-making SOEs are likely to be an important issue in Liaoning's investment climate. In addition, as noted earlier, the central and local governments are implementing potentially far-reaching reforms in the governance of China's SOEs. These two developments should provide a broader high-level opportunity to support SIRP's development goals for enterprise reform.

7. Bank and Borrower Performance

Bank7.1 Lending:The Bank fielded a large and experienced team for Project appraisal, which included extensive analyses of China's industrial sector, issues, and reforms; Shenyang's economy and industrial sector; the legal and administrative environment for industrial reform; the machine tool sector; the two participating financial institutions (PFIs); and local environmental issues. The Bank had previously undertaken extensive ESW on China's machine tool sector, other industrial sectors, and industrial policies and restructuring. The Project's design, goals, and projections -- while optimistic, especially in retrospect -- were based on extensive analyses and what might reasonably have been assumed at the time of appraisal.

7.2 Supervision:Bank staff provided timely support for SMTCL and SEPB procurement, review of PFI sub-projects, and selection of consultants. Supervision missions were regular and well-staffed with industry, financial, and labor experts. The TL took the initiative of mobilizing consultant trust funds (CTFs) to finance industry-specific expertise needed to support Project supervision and provide high-quality technical advice to Project counterparts, especially to SMTCL's management. Supervision mission aide memoires contain extensive analyses and recommendations related to the machine tool industry, retrenchment of redundant labor, and SMTCL's operational and financial restructuring. Extensive analysis (especially of labor retrenchment issues) by Bank staff preceded a June 2000 restructuring to adapt the Project to changed circumstances and progress to-date in support of the original developmental objectives.

7.3 Overall Bank performance:The Bank's overall performance was satisfactory. Bank staff labored mightily through Project appraisal and supervision to provide high-quality professional advice and oversight. The Bank's efforts are appreciated by the Shenyang authorities. The ultimately unsatisfactory outcome of the Project seems due rather to over-long adherence to two faulty premises from the time of appraisal. The first faulty premise was that a demonstration project to restructure a particular SOE could succeed in a "semi-reformed" environment -- characterized by weak corporate governance, weak creditor rights, weak supervision of financial institutions -- and that this effort would encourage adequate restructuring by other industrial SOEs to enhance their competitiveness. The second faulty premise was that a Line of Credit -- within the context of an interest rate ceiling and weak governance/supervision of financial institutions -- would significantly spur private sector development in Shenyang.

Borrower7.4 Preparation:The Borrower's performance in lending was satisfactory. There was close cooperation at the time of preparation between the SMG and the Bank. The Reform Program component clearly addressed the need then to separate government administration from SOE administration, while the Environmental component

- 14 -

likewise addressed needs for monitoring and treatment. The SMTCL and Line of Credit components responded to perceived needs and standard approaches from at the time of the SAR. Representatives from all of the counterpart agencies were involved in preparation of the Project.

7.5 Government implementation performance:From a policy perspective, the Project has been generally satisfactory. The SMG rapidly moved forward on the Reform Program and Environmental components. The SMG's work on separating SOE administration from government and developing social safety nets, local labor markets, and the property transactions markets responded to needs to transition to a market-based economy.

7.6 Implementing Agency:On the positive side, the Shenyang Project Management Office (SPMO) did a good job in administering the Project. Available ex post reviews showed no procurement issues for TTL follow-up, financial management was fine; and progress reporting provided a helpful starting point for Project supervision. It should also be mentioned that SMTCL made reasonably rapid early progress in rationalizing its organization and production. The previously-discussed arrears by SMTCL and by many Line of Credit sub-borrowers, however, are a significant negative factor.

7.7 Overall Borrower performance:Overall Borrower performance may be judged as satisfactory, but with significant caveats. Project preparation went well and closely involved all key counterparts. The Project initially made rapid progress in all four components. SPMO performed its Project administration function well. By 1998, however, it appeared that SMTCL's financial performance was regularly falling short of SAR projections. SMTCL's arrears to SMG are troubling, however, as is the high percentage of Line of Credit sub-borrowers in default to the two PFIs as of mid-2003. On the other hand, these shortcomings reflect systemic issues in China's "semi-transitioned" economy. These systemic issues include, most notably, still-weak governance of SOEs and SOCBs; insufficient protections for creditors; inadequate supervision of financial institutions; and "fuzzy" thinking about debt and equity financing, due to the State's dual role as SOE owner and SOE creditor. Within this context, it would have been outstandingly exemplary behavior for SMG's Finance Bureau to insist on adequate operational restructuring by SMTCL, for SMTCL to agree to such restructuring, or for the local branches of the two PFIs to be particularly effective at credit analysis and supervision.

8. Lessons Learned

SOE restructuring -- In most if not all cases, governments are not well-positioned to restructure or 1.govern distressed SOEs. Distressed SOEs should be sold to private investors, who should then be free to restructure the enterprise to make it market-competitive. The experience with SMTCL is consistent with experiences from both OECD countries and the transition economies of Central/Eastern Europe, where it has been shown that new capital investments in SOEs by state shareholders are often a waste of capital. Technology upgrades and capital investment should be left to new owners. While this may not have been clear in 1993, it is abundantly clear now following an additional ten years of experience in many transition economies.Private sector development -- A Bank-financed line of credit through financial intermediaries is clearly 2.insufficient to promote private sector development. Governments and the World Bank Group should focus on the complete spectrum of investment climate issues. These include new business registration, licensing, and inspections; tax administration; labor flexibility; barriers to exit; skill and technology endowments; market access; and access to finance which, in turn, depends on a range of factors including available protections for creditor rights and interest rate flexibility. These PSD investment climate issues should be addressed through surveys, in-depth analyses, technical assistance, and

- 15 -

training. Government counterparts should take "ownership" of efforts to understand and improve the investment climate.SOE reform -- SOE reform needs to be addressed "top-down." Key issues include the effectiveness of 3.the State shareholder; organization and procedures for corporate governance of SOEs; open processes for SOE privatization; adequacy of worker "safety nets;" and maintenance of "hard budget" constraints for both SOEs and private businesses. If these issues -- which should be addressed through ESW and technical assistance -- are not adequately addressed, efforts at SOE reform will have less than satisfactory results.Financing for "hardware" vs. "software" -- Any insistence by a government that it needs to borrow only 4.(or mostly) for "hardware" (e.g., equipment, works) instead of "software" (e.g., technical consultants, training) should be viewed with caution. In the case of this Project, greater efforts on the "soft" side (e.g., training for credit analysis and supervision, working capital management, corporate governance) might have led to better developmental outcomes.Lines of credit -- If the Bank finances a line of credit, it is not enough to rely on ex ante criteria for 5.approval of sub-loans. The PFI should also monitor repayment performance by sub-borrowers and respond effectively to the emergence of defaults or distress among sub-borrowers. The Borrower, PFIs, and the Bank should also be alert to the potential need, for example, for additional PFI training in credit analysis/supervision and corporate workout, institutional development of the financial supervisor, and enhancements to the corporate governance of PFIs.Project management -- For long-duration projects, the appraisal process should take care to develop 6.realistic operating/financial projections, assess sensitivities, and identify remedial actions in case of performance shortfalls. In addition, it should be easier for TLs and project counterparts to respond effectively to any unsatisfactory operating/financial performance. Formal requirements for focusing on whether or not to continue with a project or particular project component might be appropriate. Such formal requirements might be time-based (e.g., every 3 years) or event-based (e.g., operating/financial performance below a pre-determined level for 2 years).

9. Partner Comments

(a) Borrower/implementing agency:The Borrower's final evaluation report provides detailed comments on Project components/sub-components, actual vs. planned expenditures, and Project-related activity. The Borrower expresses satisfaction with Project results as well as with performances by implementing agencies and the World Bank. For such long-duration projects, the Borrower cites a need for flexibility in project design and implementation. See Annex 8 for complete comments.

(b) Cofinanciers:Not applicable

(c) Other partners (NGOs/private sector):Not applicable

10. Additional Information

Not used

- 16 -

Annex 1. Key Performance Indicators/Log Frame Matrix

Outcome / Impact Indicators:

Indicator/Matrix

Projected in last PSR1

Actual/Latest Estimate

Reorganize SMG; 100%Grant the 14 autonomous rights to all MCEs 100% Complete transformation of at least 150 eligible MCEs into shareholding companies;

200%

Strengthen SAMB; Amend the implementing regulations of Bankruptcy Law;

50%, reflecting lack of bankruptcy reform

Amend the implementing regulations of Bankruptcy Law;

0%

Enhance mergers and acquisitions by developing an information system and property rights market;

100%

Develop a program for detachment of nonproductive assets and social services from enterprises;

100%

Enforce national industrial safety standards 100% as of end-1997Adjust contributions to Pension Fund and establish a labor market

100% per Liaoning pilot program

information system 50%, reflecting subsequent need for newer information technology

Review the finance sector reform measures. 0 Train 900 SMG officials 100% as of end-1998Number of enterprises to be declared bankrupt by 2001

25%, based on incomplete bankruptcy reform

Number of mergers and acquisitions by 2001 50%, based on initial administrative approach to M&A

Rate/Number of industrial accidents to be reduced;

Not available

Workers redeployed through new information system up to 150,000 per year in 2001.

15%,reflecting subsequent need for newer information technology

Restructure SMTCL and make it a viable and market oriented enterpriseImpact Indicators: Establish specialized nine Business Units by 1998

33%, based on issues with debt sustainability and repayment

Outsource components 100% by 1999 100%, reflecting outsourcing of CNC components

CNC ratio of production value (85% by 2001) 60%, based on 2002 report attributing 50% of revenues to CNC machine tool sales

Reduce work force by 60% 100% Remove social services by 1996; 100% Train 3600 staff by 2001; 100%Realize the transfer of technology by 1998; 67%, per December 1998 aide memoireDisburse Bank loan by SMTCL(100% by 2001).

83%

Sales increase by % per year (see table) 25% i.e., 2002 sales (per SMTCL's income statement) relative to the SAR base-case

Profits increase % per year (see table); 6%, i.e, 2002 earnings (per SMTCL's income statement) relative to the SAR base-case

Output Indicators:

Indicator/Matrix

Projected in last PSR1

Actual/Latest Estimate

1 End of project

- 17 -

Annex 2. Project Costs and Financing

Project Cost by Components (in US$ million equivalent )Component Revised Loan

US$ millionActual

US$ millionPercentage of Revised Loan

Reform Program Support

3.60 2.38 66.11

Environmental Protection

10.40 10.17 97.79

Line of Credit 60.00 44.91 74.85SMTCL 101.00 81.56 80.75

Total 175.00 139.02 79.44Loan as revised in June 2000

Project Costs by Procurement Arrangements (Appraisal Estimate) (US$ million equivalent)

Expenditure Category ICBProcurement

NCB Method

1

Other2 N.B.F. Total Cost

1. Works 0.00 0.00 0.00 22.50 22.50(0.00) (0.00) (0.00) (0.00) (0.00)

2. Goods 88.50 0.00 61.80 47.00 197.30(88.50) (0.00) (61.80) (0.00) (150.30)

3. Services 0.00 0.00 9.00 3.30 12.30(0.00) (0.00) (9.00) (0.00) (9.00)

4. Technology Transfer 0.00 0.00 14.60 1.40 16.00(0.00) (0.00) (14.60) (0.00) (14.60)

5. Software 0.00(0.00)

0.00(0.00)

1.10(1.10)

0.00(0.00)

1.10(1.10)

6. HR 0.00(0.00)

0.00(0.00)

0.00(0.00)

0.00(0.00)

0.00(0.00)

Total 88.50 0.00 86.50 74.20 249.20(88.50) (0.00) (86.50) (0.00) (175.00)

Project Costs by Procurement Arrangements (Actual/Latest Estimate) (US$ million equivalent)

Expenditure Category ICBProcurement

NCB Method

1

Other2 N.B.F. Total Cost

1. Works 0.00 2.10 25.40 27.50(0.00) () (2.10) (0.00) (2.10)

2. Goods 63.40 63.80 19.40 146.60(63.40) () (63.80) (0.00) (127.20)

3. Services 0.00 0.00 5.10 0.80 5.90(0.00) (0.00) (5.10) (0.00) (5.10)

4. Technology Transfer 0.00 0.00 0.00 0.00 0.00(0.00) (0.00) (0.00) (0.00) (0.00)

5. Software

- 18 -

0.00(0.00)

0.00(0.00)

0.00(0.00)

0.00(0.00)

0.00(0.00)

6. HR 0.00(0.00)

0.00(0.00)

4.60(4.60)

0.00(0.00)

4.60(4.60)

Total 63.40 0.00 75.60 45.60 184.60(63.40) (0.00) (75.60) (0.00) (139.00)

1/ Figures in parenthesis are the amounts to be financed by the Bank Loan. All costs include contingencies.2/ Includes civil works and goods to be procured through national shopping, consulting services, services of contracted staff

of the project management office, training, technical assistance services, and incremental operating costs related to (i) managing the project, and (ii) re-lending project funds to local government units.

Project Financing by Component (in US$ million equivalent)

Component Appraisal Estimate Actual/Latest EstimatePercentage of Appraisal

Bank Govt. CoF. Bank Govt. CoF. Bank Govt. CoF.Reform Program Support 4.00 1.97 2.40 0.50 60.0 25.4Shenyang Environmental Protection Bureau

10.00 4.93 10.20 3.90 102.0 79.1

Line of Credit 40.00 110.60 44.90 9.40 112.3 8.5Shenyang Machine Tool Co. Ltd

121.00 63.40 81.50 31.80 67.4 50.2

Loan component amounts revised in June 2000, including shift of $20 million from SMTCL to LOC. Co-financers include Shenyang Municipal Government, including its Environmental Protection Bureau; BOCOM and ICBC; and SMTCL. The SAR's assumption of $6.9 million in total SMG co-financing has been split pro rata between Reform Program and Environmental.

- 19 -

Annex 3. Economic Costs and Benefits

Not used.

- 20 -

Annex 4. Bank Inputs

(a) Missions:Stage of Project Cycle Performance Rating No. of Persons and Specialty

(e.g. 2 Economists, 1 FMS, etc.)Month/Year Count Specialty

ImplementationProgress

DevelopmentObjective

Identification/Preparation12/03/1989 211/16/1991 1 Operations Officer05/18/1992 9 Operations Officer (3); Financial

Analyst (1); Env. Engineer (1); Engineer (2); Economist (1); Project Officer (1)

02/15/1993 13 Operations Officer (3); Industry Spec. (1); Financial Analyst (1); Economist (2); Institutional Spec. (1); Env. Engineer (2); Engineer (2); Env. Specialist (1)

06/27/1993 8 Operations Officer (1); Industry Spec. (1); Engineer (1); Economist (2); Machine Tools Spec. (1); Financial Analyst (1); Env. Spec. (1)

Appraisal/Negotiation01/16/1994 15 Task Manager (1); Industry

Spec. (1) Economist (2); Engineer (2); Research Analyst (1); Financial Policy Analyst (1); Procurement Spec. (2); Operations Officer (1); TA Specialist (1); Financial Institutions Spec. (1); Financial Analyst (1); Env. Specialist (1)

Supervision

11/09/1994 5 Accounting (1); Banking (1); Financial (1); Engineering (1); Disbursement (1)

S HS

07/13/1995 3 Enterprise Reform (1); Financial (1); Technical Assistance (1)

S S

04/23/1996 3 Enterprise Reform (1); Industrial Specialist (1); Procurement Officer (1)

S S

11/19/1997 3 Engineer/Environment(1); Project Officer (1); Machine Tool Expert (1)

S S

05/21/1998 4 Enterprise Reform (1); Financial Analyst/Indus (1); Machine Tools Expert (1); FA/ PSD - China (1)

S S

- 21 -

06/11/1999 5 Enterprise Reform (1); Industrial/Finance (1); Labor (1); Environment (1); Machine Tools (1)

S S

11/04/1999 5 Task Team Leader (1); Human Resources (1); Industrial/Financial (1); Environment (1); Procurement (1)

S S

06/08/2001 2 Team Leader (1); Sr. Economist (1)

S S

02/08/2002 3 Industry and Finance (1); Labor Restructuring (1); Enterprise Reform (1)

S S

11/01/2002 3 Team Leader (1); Industrial/Financial (1); Environment (1)

S S

06/19/2003 3 Team Leader (1); Industrial/Financial (1); Environment (1)

S S

ICR12/26/2003 2 Team Leader (1);

Industrial/Financial (1)S U

(b) Staff:

Stage of Project Cycle Actual/Latest EstimateNo. Staff weeks US$ ('000)

Identification/Preparation Not Available /aAppraisal/Negotiation Not Available 678.3 /aSupervision Not Available 878.6ICR 8.50 42.6Total Not Available 1,599.5

/a Total amount includes Identification through Negotiation.

- 22 -

Annex 5. Ratings for Achievement of Objectives/Outputs of Components(H=High, SU=Substantial, M=Modest, N=Negligible, NA=Not Applicable)

RatingMacro policies H SU M N NASector Policies H SU M N NAPhysical H SU M N NAFinancial H SU M N NAInstitutional Development H SU M N NAEnvironmental H SU M N NA

SocialPoverty Reduction H SU M N NAGender H SU M N NAOther (Please specify) H SU M N NA

Private sector development H SU M N NAPublic sector management H SU M N NAOther (Please specify) H SU M N NA

- 23 -

Annex 6. Ratings of Bank and Borrower Performance

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HU=Highly Unsatisfactory)

6.1 Bank performance Rating

Lending HS S U HUSupervision HS S U HUOverall HS S U HU

6.2 Borrower performance Rating

Preparation HS S U HUGovernment implementation performance HS S U HUImplementation agency performance HS S U HUOverall HS S U HU

- 24 -

Annex 7. List of Supporting Documents

Mid-Term Review (June 1997)lSupervision mission Aide MemoireslShenyang Machine Tool Company Ltd (SMTCL) financial statements for 2002lSMTCL's financial projections to 2010lCalculation of Financial Rate of Return (FRR) for SMTCL ComponentlData on international peers in machine tool businesslA Comparison of Private Enterprise Development in Shenyang With Other Citiesl

Final Evaluation Report from the Shenyang Project Management Officel

- 25 -

Additional Annex 8. Partner Comments

Part I. Survey of the Project

1. BackgroundThe Shenyang Industrial Reform Project is a comprehensive project, whose principal part is the reform of Shenyang machinery industry, including technical assistance (governmental reform), environmental protection, and business financing through ICBC and BOCOM. The program was approved by Executive Directors of the World Bank on September 6,1994 and by State department of China in October 1994. The program was in execution phase from April 11, 1995 after four legal documents were signed on January 11, 1995. The documents included "Loan Agreement", "Shenyang Project Agreement", "SMTCL Program Agreement", "Financial Agency Loading Agreement".

2. TargetShenyang industrial reform is realized by establishing modern leadership industries with self-owned enterprises, so as to establish new operational organization structure and separate the manufacturing economic activities from the governmental ones. Resolve the problem of low environmental level by supporting the execution of environmental standard improvement to ensure environment protection by new industrial activities. Provide technical assistance to support the development strategy of Shenyang governmental reform. Support the restructure of SMTCL Company. Support modernization reform and restructuring of other enterprises.

3. Components and funds useShenyang Industry Reform Project consisted of four components: (1) 4 million USD for Technical Assistance component. (2) 121 million USD for SMTCL Component. (3) 10 million USD for Environmental Protection Component. (4) 40 million USD for Line of Credit Component by ICBC & BOCOM. The total investment is 2.6 billion RMB, including 1.16 billion RMB counterpart fund and 175 million USD loan from the World Bank. The term of the Bank Loan is 20 years, including 5-year grace period. The program was adjusted in the year of 2000: (1) 3.6m USD for TA component. (2) 101m USD for SMTCL Component. (3) 10.4m USD for Environmental protection Component. (4) 60m USD for LOC Component--ICBC (share-holding enterprise) & BOCOM (private enterprise).

Part II. Execution of the Project

1. Technical Assistance ComponentTechnical Assistance Component supported the Shenyang Municipal Government Reform Action Plan. It has been divided into 9 parts, of which Shenyang Securities & Exchange Supervision Committee sub-component and Shenyang Social Security sub-component were cancelled early in implementation. Total amount of the World Bank loan in the component was changed from USD 4 million to USD 3.6 million in June 2000.

1.1 Shenyang Planning Commission Training Center Project

The total amount of loan is USD900,000. The objective is to deepen the capability for Shenyang Municipal officials governing various reforms including any related to planning, investment, finance, pricing, and state-owned assets.This project was canceled by World Bank in July 2000 after accomplishing foreign language and computer training as well as part of occupational training and other fundamental training due to Shenyang Municipal Government focusing on other projects and

- 26 -

organization changing.

1.2 Shenyang Municipal Labor Market Project

The total amount of loan is USD600,000. The purpose of the project is to enhance the existing organizational structure and technical frame of Shenyang Municipal Labor Bureau to form an effective labor market information system and to promote employment service work. The work for construction of information network and training for employees was finished by October 1999.

1.3 Shenyang Municipal Labor & Safety and Testing Project

The objective is to improve the ability for Shenyang Municipal undertaking labor & safety examination and implementing national safety standard.The total value is USD250,000. With the assistance of expatriates, the training for security inspectors was completed and the appliances for security examination were purchased by October 1999.

1.4 Shenyang Property Right Transaction Center Project

The objective is to help Shenyang Municipal Government improve the operating ability for merging and purchasing Property Right Exchange Center so as to develop an information system.. Total amount is USD750,000. Work on the information system, consultancy, and overseas training was completed by May 2000.

1.5 Shenyang Municipal State-Owned Assets Bureau Project

The objective is to help Shenyang Municipal State-Owned Assets Bureau and its State-Owned Operating Company define work scope and responsibilities so as to execute effectively the state-owned assets rights.Till now, the procurement of equipments, seminars and some trainings have been finished. The amount is USD250,000 in which USD41,218.13 was not used based on a decision by the Shenyang Municipal State-Owned Assets Bureau.

1.6 Shenyang Finance & Economy College Project

The purpose of this project is to strengthen teachers’ ability to present such subjects as market economy, international trade, and finance to meet the increasing demands for officials and enterprise managers. The total is USD300,000. The training for qualified candidates was completed by December 1999.

1.7 Shenyang Securities and Exchange Supervision Committee Project

The objective is to train securities and exchange supervisors and to highlight their comprehensive quality and management ability. Total amount is USD150,000. In 1998, Shenyang Securities and Exchange Supervision Committee combined with Liaoning provincial Securities and Exchange Supervision Committee into one regional Securities and Exchange Supervision Committee directly under the national China Securities Regulation Commission (CSRC). With the new organizational structure, the regional training requirements could be inncluded in the CSRC's national training plan instead of using loan of Shenyang Industrial Reform Project. Hence, this sub-component was cancelled in June 1999.

- 27 -

1.8 Shenyang Social Security Project

The purpose of this project is to help Shenyang Municipal Government work out local social security planning in using the experience of other countries for reference and to cultivate some higher qualified social security managers. The total amount is USD300,000. Because there were many changes of the policies and organization of Shenyang social security, this sub-component was canceled in December 1999.

1.9 Shenyang Project Management Office

The objective is to enhance the comprehensive quality and ability of managers for this project with loan of USD100,000. The training was finished in June 1999.

Table of Technical Assistance ProjectIn: USD

No. Project Unit Loan Amount Payment Balance1 Shenyang Planning CommissionTraining Center 900, 000. 00 369, 405. 53 530, 594. 47

2 Shenyang Municipal Labour Market 600, 000. 00 593, 846. 23 6, 153. 77

3 Shenyang Labour& Safety Inspection Institute 250, 000. 00 250, 000. 00 -

4 Shenyang Property Right Exchange Center 750, 000. 00 663, 877. 26 86, 122. 74

5 Shenyang State-owned Assets Bureau 250, 000. 00 208, 781. 83 41, 218. 17

6 Shenyang Finance& Economy College 300, 000. 00 175, 923. 36 124, 076. 64

7 Shenyang Security and ExchangeSupervision Commission 150, 000. 00 10, 920. 00 139, 080. 00

8 Shenyang Social Security Committee 300, 000. 00 17, 434. 72 282, 565. 28

9 Shenyang The World Bank Loan Industrial Office 100, 000. 00 56, 100. 00 43, 900. 00

3, 600, 000. 00 2, 346, 288. 93 1, 253, 711. 07 TOTAL

2. Environmental Protection Component

This component mainly includes four sub-components, Hazardous Waste Treatment Facilities (and Laboratory), Shenyang Environmental Management Information System, Environmental Protection Training Center and Shenyang Industrial Waste Monitoring System.

2.1 Shenyang Hazardous Waste Treatment Facilities

Shenyang industrial dangerous waste disposal and treatment engineering project was formally started after signing the loan agreement in 1995. Initial design and construction drawing design were finished at the end of 1996. Preparation for engineering construction such as an access road and "three put through and one level" were finished at the end of 1997. Main part of the engineering was begun in April 1998. Main part of the engineering was completed and passed the acceptance of provincial and municipal environmental protection bureaus in June 2000. The project was put into preliminary operation in September 2000 and began formal operation in June 2001. At present, all facilities are operated in good condition and meet the design requirement completely. According to the need of environmental management, a 3600 square-meter storehouse for dangerous waste chemical articles was constructed and put into operation in May 2002.

- 28 -

2.2 Shenyang Environmental Information Center

Shenyang environmental information management system was carried out in two stages. The first stage included the construction of environmental information management system. From June 1996 to the end of 2000, the basic construction of environmental information system was carried out with USD 527 thousand. The design and construction of computer room of the system were finished; the system’s equipment was purchased and installed; the development of the system’s software was finished; multimedia display report system was constructed. The second stage focused on upgrading environmental information system and setting up Shenyang Environment Supervision and Control Center. The main component was completed by June 30, 2003 and now this system has been put into operation. The work of the second stage is busily carried out. Within the scope of the whole city, the system uses advanced method of information science and quick network communication technology to establish environment monitoring network system for the key pollution sources and key regions. The system will monitor in real time the atmosphere and the operating condition of pollution source treatment facilities, etc. Telecommunication links and the storage, display, analysis, and alarm of dynamic environmental data gives the system the sensitive ability to grasp environmental condition and provides rapid response ability to pollution matters.

2.3 Shenyang Industry Waste Water Monitoring System

Shenyang Industry Waste Water Monitoring System (SIWSM) is one of environmental protection sub-projects. By June 30, 2003, the project had completed the construction and the purchase as well as the installation of equipment, and this system had been gradually put into use. After the establishment, the SIWMS can precisely monitor 40% industry waste water from important industrial pollution sources and accurately monitor 100% of urban sewage waste water on a real-time basis. The discharging condition and amount of these enterprises and domestic wastewater can be grasped at the same time. Integrated data and analyses can be sent to management center in time, and related information will be available to the public.

2.4 Shenyang Environmental Protection Training Center

The original loan from the World Bank for Shenyang Environmental Protection Training Center was USD 1.377 million and in July 2002 the World Bank approved to allocate USD 0.103 million to the Municipal Environmental Information Center, so the project’s current loan is USD 1.274 million. The civil work of the sub-component was finished in July 1996, and then put into trial operation. Purchase of training equipment etc. were finished and submitted for use on April 30, 1998. Books and audiovisual document room began inquiry and purchase in the beginning of April 1999 and implemented and finished in July. In December 2000, inquiry and purchase about trainees’ heating system was started and in March 2001 rebuilding was finished. The water supply system was rebuilt and brought into use in June 2002.

- 29 -

2.5 The Use of Fund

No. Title Quantum of loanExpenditure of loan (Till June 30 2003)

1Hazardous Waste Treatment Facilities 5,203,900.00 5,160,405.57

2 Training Center 1,274,000.00 1,273,861.66

3Industrial Waste Monitoring System 1,442,100.00 1,425,760.01

4 Laboratory 530,000.00 529,958.965 Training Center 1,950,000.00 1,779,269.26

Total 10,400,000.00 10,169,255.46

3. Line of Credit (LOC) Component

Line of credit component involves two financial intermediaries—ICBC Shenyang Branch lending U.S $30 million to share-holding companies and BOCOM Shenyang Branch lending U.S $10 million to private enterprises (raised to U.S $30 million after June 2000 Loan adjustment). After approval by Financial Intermediaries, 33 sub-projects have been implemented, which have helped restructure enterprises to accommodate modern production standards and market demands.

70% of the pipeline projects are carried out very well. Economic Rate of Return is estimated at 12%; Rate of Loan Recovery (i.e., interest) is 1.2%; Current Rate of enterprise working capital is at least 1.5:1; and enterprise long-term loan/ equity rate is 70:30. Status of fund utilization in LOC under BOCOM In:USD

NO. Project Unit Loan Amount Payment Balance1 Qiang-Feng Group 1,950,000.00 1,763,443.14 186,556.862 Jimu Furniture Co. 1,390,000.00 1,390,000.00 0,003 Sanyo Air Cond. 1,980,000.00 1,980,000.00 04 Liaoning Baoheng 2,400,000.00 2,400,000.00 0,005 Yongda Group Co. 900,000.00 900,000.00 0,006 Liaodong Foundry

fac570,000.00 570,000.00 0,00

7 Yanling Health Prod 280,000.00 274,862.22 5,137.788 Shenyang

Quansheng530,000.00 530,000.00 0,00

9 Shengyang Medi Pharm

1,500,000.00 1,500,000.00 0,00

10 Shenlong Ceram 4,000,000.00 4,000,000.00 0,0015,500,000.00 15,308,305.36 191,694.64TOTAL

- 30 -

Status of fund utilization in LOC under ICBC In:USDNo. Project Unit Loan Amount Payment Payment

1 Shenyang 213 Mach 2,390,144.00 2,390,144.00 02 Shenyang Hydraulics 756,000.00 756,000.00 03 Xinmin Rolling Fac 1,295,663.54 1,295,663.54 04 Shenyang Wangzu Beer 2,880,000.00 2,880,000.00 05 Fangyuan Aluminum Lt 4,000,000.00 3,800,000.00 200,000.006 Fire Truck Works 1,100,000.00 1,100,000.00 07 Huali Plastic Co. 549,077.70 549,077.70 08 Liaoning Sunnymore 610,000.00 610,000.00 09 Shenyang Xinmin Chem 613,512.94 613,512.94 0

10 Shenyang Gugong Phar 1,380,000.00 1,380,000.00 011 Shenyang Yilai Ceram 1,600,000.00 1,600,000.00 012 Shenyang Elec. Plast 397,830.07 397,830.07 013 Shenyang Sanlong Grp 1,500,000.00 1,497,352.42 2,647.5814 Kexun Group Co. Ltd 920,000.00 920,000.00 015 Shenyang Glued Paper 1,800,000.00 1,800,000.00 016 Shenyang Fareast Syl 700,000.00 700,000.00 017 Northeast H.Voltage 480,000.00 480,000.00 018 Shenyang Meida Build 1,550,000.00 1,550,000.00 019 Jinke Elec.Co.Ltd 800,000.00 800,000.00 020 Donggang Decoration 524,000.00 524,000.00 021 Shenyang Summit Co. 1,820,000.00 1,702,147.47 117,852.5322 Shenyang Pesticide 873,000.00 789,012.43 83,987.5723 Shenyang Tongwang Co. 1,283,000.00 1,283,000.00 0

29,822,228.25 29,417,740.57 404,487.68TOTAL

4. Shenyang Machine Tools Company Limited (SMTCL) Component

The SMTCL Component is the principal part of Shenyang Industry Reform Project, the key point and the pillar of the Project.

4.1 This component pioneered the concept of combining the structural reform with technical restructuring, and insisting on a modern enterprise system. On April 27 of 1993,Shenyang Machine Tools Company was established and converted its fund-collection type to the stock market. SMTCL diversified its investment resources while maintained as state holding company. SMTCL separated its non-production units such as employees clinic, schools and kindergartens, etc. and restructured its production into 7 specialized business units and 1 industrial park. Each of the business units has to be self-sustainable and face their own market challenge.

4.2 After setting up specialized business units, all the supplying of iron parts, welding parts, transportation, and casting parts were switched from in-house to contract suppliers.

- 31 -

4.3 The key part of SMTCL component is adjustment of SMTCL's product mix, from traditional low-value machine tools to high-value computer-numeric controlled (CNC) machine tools.

4.4 With the separation of non-production units from SMTCL, SMTCL used the Loan to downsize 6548 redundant employees, of which 3148 employees were laid-off in year 2001 and 3400 were re-settled. These employees have been completely separated from SMTCL completely and properly resettled.

4.5 SMTCL provided 12 training courses for 25 times to all kinds of management staff, in order to improve their capability in business administration, production development, sales skills, production technologies, and communication skills. SMTCL also organized 23 overseas training programs. A total of 3600 employees have been trained.

4.6 12 technical transfer contracts and consulting service have been accomplished.

4.7 In year 2001,Liability/ equity ratio: 1.74Recovery ratio: 157%Liquidity ratio: 1.25Pure profit vs. sales income (net profitability): 7.4%

Pure profit vs. assets (return on assets): 2.6%

4.8 Utilized Loan of U.S $ 81,560,000.97

5. Utilized Loan Status of fund utilization of Shenyang Industrial Reform Project In: USD

No. Project Unit Loan Amount Used Balance1 TA 3,600,000.00 2,346,288.93 1,253,711.07

2 SEPB 10,400,000.00 10,169,255.46 230,744.543 LOC 60,000,000.00 44,726,045.93 15,273,954.074 SMTCL 101,000,000.00 81,560,000.97 19,439,999.03TOTAL

175,000,000.00 138,801,591.29 36,198,408.71

Part III. Performance of the borrowers

1. The injection of capital from Shenyang Industry Reform Project provided strong fund support to long-term development of enterprises and will have positive impact on Shenyang's long-term economic growth.

It is the first time that Shenyang was granted the Bank Loan for an industrial project. Shenyang municipal government have paid great attention to this project, particularly on pipeline projects selection so that the valuable Bank Loan have been invested in those projects that support industrial policies and have great market prospects and development potential. The Bank Loan enabled those enterprises to enlarge production and to enhance their technologies. The fixed assets have increased remarkably since the input of the Bank Loan. Never before had such large amount of investment been

- 32 -

injected into these enterprises since their establishment.

2.The enterprise manufacturing capacity is improved as well as the production level after obtaining the Loan. Before the loan of the World Bank, these enterprises had problems of outdated manufacturing technology and capacity. Due to the large sum of loan from the World Bank, the previously existing problems were resolved.

3. The loan from the World Bank sped up the pace of enterprise reform and the enterprise restructuring. Seven state-owned enterprises and five groups have been reformed and restructured, five years earlier than had been planned.

4. The World Bank Loan sped up the development of private-owned enterprises and made them meet the requirements of the market competition. There is 37.817m USD for private-owned enterprises, which occupies 83.11% of the total investment. Joint ventures and private-owned enterprises enlarged their manufacturing scales by the introduction of of advanced equipments or manufacturing technologies. It improved the competitive ability and made the enterprises to adapt to market requirements.

5. The loan from the World Bank sped up the process of quality improvement and the output capacity.

6. The program also improved the core competitive capacity of SMTCL, which has been the biggest and strongest machinery manufacturing enterprise and Chinese CNC machinery development and manufacturing base.

Part IV. The Performances of the World Bank

The performances of the World Bank plays an active role in the economic development of Shenyang, the same as other-introduced foreign investment. The World Bank always supported Shenyang industrial programs in program establishment and execution phases. Experts were sent to China to give on-site checking and guidance work. The opinions and suggestions were considered seriously by the enterprises. Corresponding adjustments were made according to the actual happenings, so that the program was executed in the right direction. In addition, the investment could be arranged in time to ensure the smooth execution of the program. What gives deep impression is that the World Bank applied the strict approval procedures through every step of the program. It shall be learned and operated.

Part V: Performance Ratings

Shenyang World Bank Loan Industrial Reform Project, is a comprehensive counterpart project that consisted of Shenyang Machine Tools Company Limited (SMTCL) Component, Technical Assistance (TA) Component, Environmental Protection Component and Financial Intermediary Line of Credit (LOC) Component. It is proved that the World Bank Project has been successfully implemented.

Assessment of Technical Assistance Component: Fulfiled

Supported by World Bank Loan, this component is mainly focused on Shenyang Municipal Government reform that aimed at improvement on the administrative capabilities of Municipal Key

- 33 -

Officials who are in charge of economy and social benefit development, such improvement as better understanding of market function at the market-oriented society, profound understanding of the reform of government planning, investment, financing, set price and better administration of State-owned-assets, etc.

Enhanced the organization and technical structure of Shenyang Labour Bureau and Labor Service lCompany, formulated an effective Labor market information system that facilitated the employment services.Improved the practice capabilities of Shenyang Labor Safety Inspection and implementation of lNational Labor Safety Standard.Developed an information network and improved the functions of assets acquisition or lconsolidation for Shenyang property transaction center.Identified the responsibilities and duty scope for Shenyang State-owned Assets Administration lBureau so that it can fully practice its administration right.Strengthened the teaching force and instructed with better courses mixture for Shenyang Colleges lso that it set up some welcomed courses such as Marketing Economy, International Trade, Finance, etc., in order to meet the increasing demanding of Key officials and enterprises management.Trained supervisors for Security Monitoring system in order to improve their comprehensive lcapabilities. Facilitated Shenyang Government officials to learn the experiences of social security system from ladvanced countries and some high-quality administrators of social security officials were traind.Improved comprehensive capabilities of management of World Bank loan projects.l

ASSESSMENT OF ENVIRONMENTAL PROTECTION COMPONENT: FUFILLED

This component aimed to build up monitoring system to monitor the major pollution sources and critical areas so that realize live-monitoring and data collection of environment statue, performance of pollution-control equipment. After the implementation, it is enable the authorities to realize fully control of the industrial waste-water from key enterprises and sewage of residential area, as well as the fast-response to pollution accident.

ASSESSMENT OF LINE OF CREDIT COMPONENT: FUFILLED

1. The World Bank Loan to Shenyang Industrial Reform Project has provided the financial foundation for the mid and long term development of enterprises, as well as positive impact to long-term economy growth of the whole city.2. The enterprises enhanced production capabilities and improved product quality after granted the Bank Loan.3. The Bank Loan accelerated the pace of enterprises restructuring and push the progress of modern-enterprise-system, such as shareholding4. The Bank Loan promoted the growth of private enterprises and improve their competitive capabilities to fact market challenge.5. The Bank Loan improved product quality so as to create more export orders

ASSESSMENT OF SMTCL COMPONENT: FULFILLED

This is most important component of Shenyang Industrial Reform Project, and major segment of the Bank Loan.

- 34 -

1. The project ignited the regimen that integrated the reform, reconstruction with reorganization, and insist on modern enterprise system2. Reorganized production plants, all the in-house auxiliaries such as wielding parts , iron parts, casting parts and transportation are separated from main business scope and were switched to outside contractors. 3. Adjusted product mixture which solved the problem of repeated low-level products, under-developed of Numerical Controlled Machine Tools.4. SMTCL used the World Bank Loan to downsized 6548 redundant employees, of which 3148 employees were laid-off in year 2001 and 3400 were re-settled. These employees are separated from SMTCL completely and were properly resettled.5. SMTCL provided 12 training courses for 25 times to all kinds of management, in order to improve their capability of business administration, production development, sales skills, production technologies and even communication skills. SMTCL also organized 23 overseas training program. Totally 3600 employees have been trained.6. 12 technical transfer contracts and consulting service have been accomplished.7. With the World Bank loan, the SMTCL increased its competitive capabilities of core business and became the largest machine tools manufacturer in China and the most capable development and production bases of NC machine tools in China.

FUNCTION OF SHENYANG PROJECT MANAGEMENT OFFICE

SPMO is responsible to coordinate between all organizations of each component and the World Bank. It is also in charge of the monitoring of service, administration, implementation of the whole project. SPMO has been appraised many times by the Bank, Shenyang Municipal government, all the pipeline organizations for its outstanding performance.

Part VI. Lessons

1. It is suggested that the program design and execution shall be more flexible due to long-period preparation and execution. It is shown as the lag of program establishment to the execution, which will cause the variances between the actual situations to the prediction. Thus the necessary adjustment shall be accepted according to the actual situations or give preparation for the unpredicted changes.

2. Purchasing is a very important step in the program execution. The long-term bidding document writing and contract confirmation would influence the execution of the program.

- 35 -

- 36 -