Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 11542-RO

STAFF APPRAISAL REPORT

ROMANIA

INDUSTRIAL DEVELOPMENT PROJECT

APRIL 26, 1994

MICroGHAPHiICS

Report No: 11b42 RCType: SAR

Country Operations DivisionCountry Department IEurope and Central Asia Regional Office

This document has a restricted distribution and may be used by reipiens only In the perfonnace oftheir official duties. Its contents may not othenwise be disclosed wihout World Bank authoradon.

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CURRENCY EQUIVALENTS

Currency Unit Romania Leu (L)

US$1.00 - lei 450.00 on January 1, 1993US$1.00 = lei 735.00 on July 1, 1993US$1.00 = lei 1276 on December 31, 1993US$1.00 - lei 1680 on April 15, 1994

ABBREVIATIONS AND ACRONYMS

BA Bank for AgricultureCBF Chemical BankCC Commercial CompaniesCCB Cooperative Credit BankCEC Savings BankCO Certificates of OwnershipDFB Dacia-Felix BankEFF Export Finance FundEIB European Investment BankEXIM Export Import Bank of RomaniaFX Foreign ExchangeGDP Gross Domestic ProductIDP Industrial Development ProjectIRR Internal Rate of ReturnLC Letter of CreditLIBOR London Inter-Bank Offered RateMIND Bank for Small Industry and Private InitiativeMOE Ministry of EnvironmentMOI Ministry of IndustryMOF Ministry of FinanceNAP National Agency for PrivatizationNBR National Bank of RomaniaPFI Participating Financial InstitutionPHARE EC-Phare TA Program for Eastern EuropePO Purchase OrderPOF Private Ownership FundPSD Private Sector DevelopmentRA Regie AutonomesRBFT Romanian Bank for Foreign TradeRC Restructuring CommitteeRCB Romanian Commercial BankRDB Romanian Bank for DevelopmentSAL Structural Adjustment LoanSCL Single Currency LoanSGF Societe GeneralSME Small and Medium Scale EnterprisesSOE Statement of ExpendituresSOF State Ownership FundTA Technical AssistanceTCB Ion Tiriac Commercial BankTD/MOF Treasury Department of the Ministry of FinanceUCECOM Central Union of Cooperatives

ROMANIA - FISCAL YEAR

January 1 - December 31

FOR OFFICIAL USE ONLY

ROMANIA

INDUSTRIAL DEVELOPMENT PROJECT

STAFF APPRAISAL REPORT

Table of ContentsPage No.

LOAN AND PROJECT SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . .

I. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . ... . .

A. Background .1... . . . . . . . . . . . . . . . . . . . . . . . .

II. INDUSTRIAL RESTRUCTURING AND PRIVATIZATION PROGRAM . . . . . . . . . . . . 2

A. The Industrial Sector.. 2(a) Industrial Structure. 2(b) Economic Environment and Impact of Recent Policy Reforms . . 3

B. Enterprise Reform . . . . . . . . . . . . . . . . . . . . . . . . . 4C. Privatization.. 5

(a) Privatization Program. 6(b) Institutional Framework. 6(c) Privatization to Date. 7(d) Measures to Speed-up Privatization . . . . . . . . . . . . . 8

D. Restructuring . . . . . . . . . . . . . . . . . . . . . . . . . . . 9(a) Government's Industrial Strategy . . . . . . . . . . . . . . 9(b) Institutional Framework and Recent Developments . . . . . . . 11

E. Private Sector Development ...... . ............ . 12(a) Small Scale Private Sector (SME) . . . . . . . . . . . . . . 12

III. FINANCIAL SECTOR . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

A. Current Structure of the Financial Sector . . . . . . . . . . . . . 14B. Financial Sector Reform ...... . . .. . . .. . . .. . . . . 15C. Financial Markets ....... .. .. .. .. .. .. .. .. . . 16

IV. PROJECT RATIONALE ......... .. ............. ... . 19

A. The Bank Group Strategy for Assistance . . . . . . . . . . . . . . 19B. Rationale for Bank Involvement ..... . . . . . . . . . . . . . 20

V. THE PROJECT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

A. Objectives and Scope of the Proposed Project . . . . . . . . . . . 22B. Financing Component ........... .... .... .... . 23C. Technical Assistance Component ...... . .. . .. . .. . . . 25D. Project Cost and Financing Plan . . . . . . . . . . . . . . . . . . 26E. Environmental Impact . . . . . . . . . . . . . . . . . . . . . . . 27

This document has a resticted distnbution and may be- usd by redpiens ondy Inthe pebmnsY of tberoffidcaldutes.Itscontentsmaynototherwisebedisclosedwitd WoddBankaMtoraiat

VI. PROJECT IMPLEMENTATION AND ONLENDING ARRANGEMENTS . . . . . . . . . . . . 27

A. Loan Terms and Conditions ... . . . . . . . . . . . . . . . . . . 27B. Lending Arrangements .... . . . . . . . . . . . . . . . . . . . 29C. Loan Administration . . . . . . . . . . . . . . . . . . . . . . . . 33

VII. BENEFITS AND RISKS . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

A. Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35B. Risks .36

VIII. AGREEMENTS REACHED AND RECOMMENDATIONS .37

List of Tables

Table 3.1 Non-Government Credit Volume in Real Terms . . . . . . . . . . . 17

Table 4.1 Policy-Related Measures and Objectives Accomplished DuringProject Preparation . . . . . . . . . . . . . . . . . . . . . . . 21

Table 5.1 Technical Assistance for Privatization and Restructuring . . . . . 25Table 5.2 Estimated Total Project Cost .... . . . . . . . . . . . . . . . 26Table 5.3 Proposed Financing Plan . . . . . . . . . . . . . . . . . . . . . . 26

Table 6.1 Participating Financial Institutiorns with Romanian Capital . . . . 31Table 6.2 Conditions of Effectiveness . . . . . . . . . . . . . . . . . . . . 32

List of Annexes

Annex 1 Technical Assistance Component Specification . . . . . . . . . . . 38Annex 2 The Banking Sector . . . . . . . . . . . . . . . . . . . . . . . . 42Annex 3 Participating Banks .. 51Annex 4 Foreign Trade and Export Credit Demand . . . . . . . . . . . . . . 66Annex 5 Criteria and Procedure for PFI Qualification and

Accreditation .. 71Annex 6 Foreign Exchange Market and Foreign Exchange Credit Market . . . . 77Annex 7 Estimated Disbursement Schedule of the Proposed Loan . . . . . . . 83Annex 8 Supervision Plan .. 84Annex 9 List of Documents in Project File . . . . . . . . . . . . . . . . . 87

This report was prepared by Ms. S. Brajovic-Bratanovic (EClCO), Mr. P. Van der Veen(IENIM), and Mr. A Goldschmidt (Consultant). Peer review was conducted byMessrs. M. Hinds (EMTDR), J. Nellis (PSD) and Ms. I. Zurayk (EC2CO). The followingindividuals have also contributed to project preparation: R. Heath, R. Chalk,H. Bhattacharya, E. Mangan (IENIM); S. Sattar (MNEPH), R. Roberts, L. Ponzio,C. Calcopietro (Consultants).

ROMAN-IA

INDUSTRIAL DEVELOPMENT PROJECT

LOAN AND PROJECT SUMMARY

Borrower: Romania

Loan Amount: US$175 million

Beneficiaries: Private enterprises and exporters, Ministry ofIndustry (MOI), National Bank of Romania (NBR),participating financial intermediaries.

Loan Terms: Single currency loan (SCL) in US dollars for twentyyears, including five years grace period, at Bank'sstandard variable rate for SCLs denominated in USdollars.

Onlending Terms: The Government will onlend funds to theparticipating financial intermediaries (PFI) inUS dollars at the prevailing six-months LIBOR plusa margin of 30 basis points to be charged by theMinistry of Finance (MOF). The PFI subsidiaryloans will be extended on a first-come first-servedbasis, back-to-back to PFI subloans to finalbeneficiaries and vith the same maturities. ThePFIs subloans to the beneficiaries will bedenominated in US dollars at LIBOR plus the MOFmargin and a market-based PFI spread. The subloansfor investment finance will be provided at variablemarket-based interest rates with 3-17 yearmaturities and 1-5 years grace; the subloans forexport finance will be provided at fixed market-based interest rates and up to one year maturities.For both credit components, the final sub-borrowerswill bear the exchange risk. The PFIs will bearthe full credit risk of their subloans.

Proiect Descrigtion: The Project will finance (a) investment of privateenterprises to improve international competitive-ness and/or expand exports; (b) exDorts byproviding partial to full coverage of exporters'pre-shipment finance needs for imported inputs; and(c) technical assistance to help in designing andimplementing policies and strategies forprivatization and restructuring, and forstrengthening institutional capacity of theindividual PFIs.

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Benefits and Risks: The expected benefits include: (a) improvedconditions for effective supply response;(b) increased export potential, efficiency andprofitability of private industrial enterprises;(c) improved capacity of the financial sector toprovide export and restructuring related finance;(d) increased competition and integration ofRomanian financial markets; and (e) further advancein building policy and institutional framework tospeed up ownership transformation and restructuringand to stimulate the private sector growth. Themechanisms developed and the technical assistanceput in place should yield significant demonstrationeffects.

Institutional weaknesses and skill deficiencies ofbanks, enterprise managements and governmentagencies is the main risk. It is addressed throughTA covering all aspects where skill deficienciesmay jeopardize successful implementation, andthrough increased Project supervision. There isalso a risk concerning PFI intermediation capacity-- macroeconomic volatility and uncertain prospectsmay adversely affect the PFIs' willingness toengage in invc-tment lending or decrease their riskexposure capacity. This is addressed through theproposed Project conditionalities, by increasingthe capacity of banks to take and sustain riskthrough mandatory loan classification andprovisioning and by increasing the level of generalloan loss reserves; through TA to improve the PFI'scapacity to assess and manage risk; by keeping openaccess to eligible PFIs; and by maintainingflexibility in the allocation of funds to theexport and investment finance components. The PFIcredit risk and the foreign exchange risk of finalbeneficiaries have also been decreased by extendinga single currency loan. The macroeconomicinstability is a major risk, which is addressed bythe SAL and through ongoing policy dialogue withthe IMF and the Bank. In addition, the Bank willreview project implementation one year after loaneffectiveness with an option not to extend furthercommitments in case of adverse developments.

Estimated Cost:(US$ Million)

Local Foreign Total

Investment Credit 55.0 102.0 157.0Export Credit 104.0 70.0 174.0Technical Assistance 0.0 3.0 3.0

TOTAL 159.0 175.0 334.0

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Financinf Plan:

(US$ Million)local Foreien Total

IBRD 0.0 175.0 175.0Sub-borrowers 40.0 0.0 40.0Financial Intermediaries 119.0 0.O 119.0

TOTAL 159.0 175.0 334.0

Estimated Disbursement:

(US$ Million)95 FY97 FY98

Annual 53.0 61.0 35.0 21.0 5.0Cumulative 53.0 114.0 149.0 170.0 175.0

ROMANIA

INDUSTRIAL DEVELOPMENT PROJECT

I. INTRODUCTION

A. Background

1.01 In the period since the 1989 revolution, the Government of Romaniahas formulated and started implementation of far-reaching reform programs tostabilize the macroeconomic situation and to move towards an efficient marketeconomy. A new legal and institutional framework has been established, and thepolicy framework has been substantially liberalized. Commercialization andcorporatization of the state enterprise sector has been completed, and enterprisemanagement has been freed from direct government intervention in production andinvestment decisions. Recognizing the difficulty of achieving an adequate supplyresponse and efficiency gains in enterprises owned and operated by the publicsector, the Government plans to divest 6,300 state-owned enterprises. Thirtypercent of the state's equity in commercial enterprises has already been divestedthrough allocation to five Private Ownership Fund^ and mass distribution of theirshares. By end-1993, about 490 small and medium-size companies have beenprivatized and another 500 are in active preparation. A program is beingdeveloped to provide a variety of options for the full privatization of a largenumber of enterprises, while at the same time motivating and assisting theremaining viable enterprises to adjust effectively to the new market-orientedenvironment during the transition to eventual privatization.

1.02 The ownership reform of the state sector is supplemented by a broadprogram to support growth of indigenous private sector enterprises. About546,000 new private firms were registered by end-1993, of which about 30 percentwere in manufacturing and trade, and about 78 percent have already opened forbusiness. About 29,000 joint ventures have been formed by end-1993, of whichabout 100 involve large state enterprises. In the 1991-1993 period, the privatesector has productively absorbed over one million employees and its participationin GDP has grown from less than one percent in 1989 to about ten percent in 1991and an estimated 30 percent in 1993.

1.03 There are, however, some areas where progress has been rather slow.The enterprises' response to systemic and policy changes has been largelyreactive, such as stopping production and laying off labor; actual restructuringhas barely started. The volume of foreign investments has been low, oftenbecause of expected difficulties to obtain finance for post-privatizationrestructuring. The growth of private firms has also been inhibited by crowdingout from access to capital, raw materials, and infrastructure. Both theCovernment and most enterprise managers, however, have come to realize the needfor an energetic proactive approach to restructuring and/or privatizing theirenterprises and to attracting foreign partners.

1.04 The proposed Industrial Development Project will assist theGovernment to speed up the process of transition by creating conditions forfaster and more efficient supply response and by supporting the establishment ofenabling policies and institutions. While the restructuring needs of Romanianenterprises, especially in industry, are considerably greater than what can be

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addressed through a single operation, it is anticipated that the proposed Projectwill have a broad impact on the overall transition process through: (a) promotingdevelopment of the private sector enterprises by providing financial support toprivate enterprise restructuring and investment programs and to exploiting theexport potential of Romanian industry; (b) assistance in the desigr. of theinstitutional and policy framework for privatization and restructuring, and increating an enabling environment to increase private sector share of the economy;and (c) supporting the banking sector reform by improving prudential regulationsand bank supervision, strengthening individual banks and encouragingrestructuring and privatization of state-owned banks. By generating growth andemployment in the private sector, the proposed Project would facilitate reformsin the state sector by mitigating the cost of those reforms.

1.05 To support the proposed Project, the Government is requesting a Bankloan of US$175 million. The proposed Loan would include: (a) a financingcomponent of US$172.0 million, including US$102 million for restructuringinvestments in private industrial enterprises and US$70.0 million for exportfinancing to help realize Romania's export potential; and (b) a technicalassistance comRonent of US$3.0 million to support institution building andtraining of staff in key government agencies and in the banking sector.

II. INDUSTRIAL RESTRUCTURING AND PRIVATIZATION PROGRAM

A. The Industrial Sector

(a) Industrial Structure

2.01 By standards of most market economies, Romania has a la.ge industrialsector, which in 1989 accounted for 58 percent of net material product and 38percent cf total employment. In the traditional pattern of socialistindustrialization, Romania has promoted producer goods industries. In 1989,these accounted for 56 percent of the total industrial output, while the shareof consumer goods subsectors (i.e., textiles, garments, food processing,electronics and consumer durables) declined during the 1980s to only 24.5 percentof the output.

2.02 Among the producer goods industries, machine building had a dominantposition, accounting for about 28 percent of gross output in 1989 and about 36percent of the net material product by industry. This specialization wasstrongly influenced by Romania's position in the CMEA markets. The secondlargest subsector was chemicals, including oil refining and petrochemicals. Itaccounted for about 21 percent of the total industrial output in 1989. Thissubsector oiiginally derived its importance from the domestic endowment in oiland natural gas resources. These resources have been badly depleted by the1980s, however, and must now be supplemented by oil and natural gas imports.Metallurgy, the third largest subsector, kept its share at about 9.8 percent ofindustrial output throughout the 1980s.

2.03 High energy intensity and obsolete and worn-out capital stock arecommon characteristics of Romanian manufacturing technology. Priority given tonew investments rather than modernization of the existing capital stock duringthe 1980s, combined witk the decline in equipment imports from OECD countries andthe stagnation of imports from the CMEA, resulted in the growing obsolescence ofRomanian industry. Whi? obscure depreciation rules make realistic estimatesrather difficult, it appears that by 1990 about half of the fixed capital ofRomanian industry had already been fully depreciated. The particular situationvaries by sector.

(b) Economic Environment and Impact of Recent Policy Reforms

2.04 At the start of the reform in 1990, large sections of Romanianindustry were inefficient at international market prices. Historically, theinefficiencies persisted due to the price distortions in e. ptive domesticmarkets, an indiscriminate flow of funds from the Government, a certain degreeof cross-subsidization between domestic and international markets and anorientation toward CMEA markets. The industrial performance in the past has beenalso constrained by the lack of micro level incentives fcr improving enterpriseperformance and the constrained mobility of resources.

2.05 The regulatory, institutional and business environment of theenterprise sector has significantly changed since the reform started. The policyreform started in 1991. Measures aiming toward correcting relative prices,imposing hard-budget constraints, limiting access to credit and increasingcompetition, have put the enterprise sector under enormous stress. With higherprices of inputs and limited scope for increasing output, due to the drasticallyfalling demand in domestic and in the CMEA markets and increasing internationalcompetition, many enterprises have faced sharp declines in their sales.Industrial output fell by about 18 percent in 1990 and 20 percent in 1991 (a two-year drop of about 36 percent); in 1992, industrial production was about 22percent lower than in 1991 (or about 52 percent of its 1989 level). The outputdecline leveled off in 1993; the total industrial production volume registeredan increase of about one percent. There were, however, marked adjustments in theoutput of specific subsectors. For example, food and beverages, wood, pulp andpaper, and textiles sector produced 10-15 percent less than in the same periodin 1992; various branches of chemical industry (e.g., artificial fibers, plastic,rubber) increased output 2-5 percent, as have varioui branches of machinebuilding; electrical machines and metallurgy increased output by 8 percent; mostsuccessful were the furniture, consumer electronics, and road transport vehiclesbranch, with 20-29 percent output increases.

2.06 The foreign trade performance was negatively affected by the declineof CMEA markets and by the confusion accompanying systemic collapse. Inaddition, in 1991 and 1992, Romania lost two prominent trading partners (Iraq andYugoslavia) due to the UN embargo. In 1990, the convertible currency exportsfell to about 56 percent of their 1989 level, and declined by another 4 percentin 1991. In 1992, the export decline was successfully arrested mostly due to thesignificantly improved policy environment, including trade liberalization, openentry policies, rationalization and lowering of tariffs, improved management ofthe foreign exchange regime and leave the full retention policy. The convertible

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currency exports grew by about 22 percent compared to their 1991 volume andremained at about the same level in 1993. The industrial sector still accountsfor the bulk of exports, with a share of about 85 percent in 1993, a decreasefrom about 95 percent in 1989. More detailed analysis of export performance isprovided in Annex 4. The participation of the private sector in exportactivities has substantially increased; in 1993, the private sector accounted forabout 27 percent of total exports.

2.07 The restructuring programs in Romania have been left almost entirelyto the initiative of enterprise management. The most prominent element of theenterprise adjustment so far has been labor retrenchment. This has been morepronounced in labor-intensive sectors, where the cost of labor represents ahigher percentage of the variable cost of production and the skill level islower. In capital-intensive industries, the labor retrenchment is smaller, sincethe loss of skilled labor could become an unsurmountable problem if theenterprises' prospects improved. In the aggregate, in 1991, the retrenchment oflabor led to an 11 percent decline in the total industrial employment as comparedto 1989. The trend continued in 1992, with the total industrial employmentfalling to about 76 percent of its 1989 level. The manufacturing sectorwitnessed the most significant employment decline; in 1992, the employment stoodat about 85 percent of its 1991 level and 77 percent of its 1990 level.Nonetheless, the slow pace of retrenchment relative to output contraction inindustry gcnerated an 11 percent reduction in the average labor productivity in1991, and further 17 percent decline in 1992. In 1993, however, this trendreversed, showing an increase in labor productivity of about 7 percent.

B. EnterRrise Reform

2.08 About 6,300 enterprises in public ownership dominate the Romaniancorporate sector. In 1989, they accounted for about 92 percent of the totaleconomic establishments; the industrial sector comprised 2,102 publicenterprises. By the end of 1990, essential elements of the new regulatoryframework were in place to start the enterprise reform: Law No. 54, on FreeInitiative and Small Business Establishment, legalized small-scale privateinitiative; Law No. 96 on Foreign Capital Investments opened Romania to foreigninvestors; and Law No. 31 on Corporations provided a regulatory framework for theestablishment and management of commercial companies. Law 31 established a two-tier governance structure comprised of an Administration Council, elected by thegeneral shareholders meeting to exercise ownership interest in a commercialcompany, and a Management Board, appointed by the Administration Council foroperational management of a company. For companies in state ownership, the roleof a general shareholders meeting is played by the Council of StateRepresentatives.

2.09 Law No.15 on Restructuring of State Economic Unit has initiated afull-scale commercialization and corporatization of the Romanian state-ownedenterprises, except for a number of designated strategic sectors (e.g., military,power, mining, oil and gas exploration and exploitation, telecommunications).Enterprises have been converted into state-owned autonomous companies (RA, regieautonomes) and commercial companies (CC, joint-stock limited liability).Allowing for full managerial autonomy, the Government's objectives were to impose

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hard budget constraints and managerial accountability on both categories and toprivatize the commercial companies. The National Agency for Privatization hasbeen established to lead the conversion and the subsequent privatization process.

2.10 By mid-1991, the commercialization of the corporate sector wascompleted. Of the total number of about 6,700 companies, about 600 regieautonomes1 and about 6,300 commercial companies were established. Of about 2,140enterprises under the manufacturing arm of the MOI, about 20 were classified asRAs and the rest are now operating as commercial companies. Through theconversion of enterprises into CCs, property rights were intended to beconcentrated in a corporate board (i.e., the Administration Council) appointedby the owners: initially the parent ministries, then the State and tne PrivateOwnership Funds and eventually the new private shareholders. The introductionof the corporate governance framework, under Law No. 31, was accomplished ratherquickly, but decision-making continued to be hampered by unclear ownership rightsand responsibilities.

2.11 A numbsr of ownership and management issues critical forimplementation were addressed during Project preparation, as otherwise they couldhave slowed privatization, negatively affected access to Bank credit lines, andcomplicated decisions related to enterprise borrowing and subprojectimplementation. Specifically, the Government has: (a) streamlined the structureand clarified the responsibilities of the Council of State Representatives, whichacts as a general shareholders meeting for CCs in state ownership, and of theAdministration Council, with an objective to enhance the decision-making processconcerning enterprise privatization and restructuring;2 and (b) introducedmanagement contracts for enterprises in (majority) state ownership aiming toclearly establish managerial accountability and performance-based managementincentives.3

C. Privatizationl

2.12 The Government considers privatization to be the most effective wayto improve enterprise efficiency by providing better incentives to capital,management and labor. The privatization policy has been gradually developedthrough extensive discussions with the Bank and through consulting assistanceprovided by the EC-PHARE. The Privatization Law was promulgated in mid-1991 withthe principal objective of transferring all Romanian CCs to private hands withinseven years. Besides speed, the other major concerns of the Government have beenthe transparency and fairness of the process, and the amelioration of its socialcosts.

I/ Subsequent review mandated by the SAL reduced this number to about 430 at end-1993.

2/ Respective amendments to Law 31 were a condition for negotiations.

0/ Submission of Law on Management contracts to the Parliament was a condition for Board presentation.

*6-

(a) Privatization Program

2.13 The privatization program concerns about 6,300 enterprises with about4 million employees. It stipulates the distribution of 30 percent of statepatrimony to Romanian citizens in the form of Certificates of Ownership (CO) infive Private Ownership Funds (POF). Each citizen holds COs of all five funds,and the COs may be exchanged for shares of commercial companies in the processof privatization. The POFs, with portfolios of about equal values, hold 30percent of the shares of virtually all Romanian CCs and are expected to managetheir portfolios so as to advance the privatization process, and to raise thevalue of the outstanding COs. The 70 percent balance of the CCs shares have beenallocated to the State Ownership Fund (SOF). The SOF mandate is to sell itsportfolio of shares or liquidate enterprises or their components in annualprograms, each comprising at least 10 percent of the initial SOF portfolio, untilthe CCs are completely privatized (in maximum seven years).

2.14 In addition, the Privatizarion Law has initiated early privatizationof about 30 medium to large enterprises and a process of small asset sales. Forthe early enterprise privatization, the objective of the program has been to gainhands-on experience in various modes of privatization, including privateplacements, public floating of shares and employee or management buy-outs. Forthe sale of assets, where the enterprises themselves decide to offer an asset forsale and enjoy the sale proceeds, the objectives have been to: provide animmediate means to start restructuring enterprise balance sheets; allow moreefficient use of assets by the private sector; and gain experience in competitivebidding processes.

(b) Institutional Framework

2.15 The institutional framework for large-scale privatization in Romaniaassigns the major roles to the SOF and the five POFs. These institutions areplaced under the auspices of the Perliament. The SOF by-laws were enacted inJune 1992.4 They define the SOF as the public agency responsible forprivatization, for restructuring including liquidations, and for providingcorporate guidance to all Romanian companies. The SOF is expected to divest itsownership share of enterprises within a period of seven years; its firstprivatization program was presented to the Parliament in January 1993.5 Sinceits establishment in October 1992, the SOF has focused on attaining institutionalcapacity to privatize small and medium-size companies; its capacity to addressrestructuring and liquidation will be addressed only in 1994. Given themultitude of responsibilities and the size of its portfolio, the SOF mustcontinue to devote a massive effort to building its capacity, and itsinstitutional culture and skills. Success of this effort will be one of thecritical factors in the transition.

4/ Finalization of the SOF by-laws, establishment of its Board and initial sw.affing were conditions forappraisal of the proposed Project.

If Formulation of 1993 Privatization Program, its submission to the Parliament and subsequent approval was acondition of project effectiveness.

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2.16 The POF by-laws were adopted by the Parliament in July 1992. ThePOFs are defined as comr.mercial companies, which are a hybrid between a holdingcompany and a mutual fund. They have a number of objectives: to improve thevalue of their portfolios and of underlying COs; to provide for orderly exchangeof COs for CCs shares; and to speed up the privatization process by sharing withthe SOF the responsibility for privatization. The POFs' headquarters are placedin five different towns to bring direct exposure to experiences of market economyto local environments. Since the POFs are smaller and more dynamic agents thanthe SOF, the portfolio allocation and the resulting portfolio management policieswill substantially influence the speed and success of privatization and thecourse of restructuring in Romania. The proposed Project assisted in finalizingthe design of the POFs.6

2.17 The next step in the privatization program is the development ofmethodologies, procedures and programs for large-scale privatization, includingdetailed quantitative targets and implementation plans for the variousprivatization schemes. The manner by which the state exercises its ownershiprights is of utmost importance for privatization, as well as in critical casesof enterprises being restructured. Therefore, the formulation of a comprehensivepackage of instruments to exercise ownership rights and provide corporateguidance to CCs is also on the agenda. Constraints which may inhibit the paceof implementation would also have to be addressed, such as the occasionalconflicting roles of the various agencies involved in the process; the inadequacyof the financial sector; and the lack of managerial and/or institutional capacityin many CCs to turn them around and make them profitable and attractive toprivate investors.

(c) Privatization to Date

2.18 Considerable privatization has already taken place in Romania. Theprincipal path to private ownership, in terms of private capital commitment, hasbeen through joint ventures with a foreign partner. Since the enactment of theLaw on Foreign Investments in 1990, over 29,000 joint ventures, with committedcapital of about US$760 million, have been formed. Similar to experienceselsewhere in Eastern Europe, foreign investments have initially involved a largenumber of ventures with small capital commitments; in 1992, the investors'philosophy changed, and new joint ventures involved larger companies (about 103joint ventures so far) and higher capital commitments. Another major path toprivatization has been through leasing assets to a private company or throughmanagement contracts (an estimated 50,000 contracts). Both mentioned routes toprivatization have largely been initiated and managed by the enterprisesthemselves. Finally, there has been a spectacular growth of indigenous privatesector enterprises (further elaborated in Section E).

2.19 The early grivatization program was completed in early 1993. About2,900 assets, mostly shops, warehouses, smaller production facilities and, to alesser extent, underutilized production equipment, have been sold from the

li Finalization of POF by-laws, POP portfolio allocations and registration of POTs, and establishment oftheir Boards were a condition for appraisal of the proposed Project.

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initial list of about 7,800 assets. About 22 small and medium companies havebeen privatized. Shares of two of these companies were successfully floated onthe market by the domestic banks; employee and management buyouts have been usedin about 18 cases; and about five cases involved private placements with foreigninvestors.

2.20 The enactment of the small enterprises privatization methodology(para. 2.22), a fast-track standard procedure, has substantially advancedprivatization of small companies. By March 1994, about 400 had been sold mostlythrough management and employee buyouts. The SOF, with the responsibility toprepare enterprise evaluation and lead negotiations, estimates that it would takeanother two years to privatize all enterprises in the "small" category, the majorobstacle being the lack of institutional capacity to prepare evaluations andnegotiate deals. The SOF is currently able to privatize about 60-80 enterprisesper month. Of the medium size companies, about 100 have been targeted forprivatization, and 39 have been privatized; of the large companies, three havebeen privatized.

(d) Measures to Speed-up Privatization

2.21 In order to meet the ambitious privatization targets, specificmeasures are needed to speed up the process by proceeding on parallel tracks andby employing new innovative approaches, including mass privatization. Therecently elaborated privatization program for 1994 recognizes this need and, asdetailed below, the Government is committed to taking steps to introduce othermeasures to speed up the privatization process.

2.22 The aggregate CC portfolio has been classified in three categories,according to the size of the CCs. Privatization is now proceeding on paralleltracks; for each category, specific measures have been or will be introduced tospeed up privatization. Small companies are to be privatized through a simplecompetitive bidding procedure, similar to the one used for the sale of assets.It is managed by a committee, including SOF/POF and NAP representatives.7 Of thetotal of about 6,300 CCs to be privatized by the SOF, about 3,100 have beenclassified in the "small" category. Likely investors targeted for this group ofCCs include enterprise managers and employees; private entrepreneurs whosecompanies have successfully grown or who are integrating backwards from the tradebusiness; and small foreign investors.

2.23 For the medium-size companies, a group of about 2,500 CCs, theresponsibility to manage privatization is assigned to the POFs. The POFportfolio distribution allows POPs to specialize by industrial sectors or bygeographical regions. In mid-1993, to encourage the privatization of the medium-size CCs, the SOF issued instructions empowering management of CCs in afinancially viable condition and operating in competitive markets (i.e., thereare more than three domestic producers) to seek private investors (targetingforeign companies). The SOF also issued methodological norms for the preparation

7/ The procedure was enacted in January 1993, originally being a condition for effectiveness of the proposedProject, and is in implementation since May 1993.

of the privatization prospectus. Once an investor has been found, the managementis asked to contact the SOF and to formally initiate the privatization process.To accelerate the privatization of medium-size CCs, a number of new innovativemass privatization schemes are being designed and will be introduced throughselected pilot exercises, evaluated and then fully implemented on a large scale.

2.24 These include: a) Rrivatization funds, in the form of privately-managed investment companies which would bid for a majority of shares of CCs oftheir choice. A number of investment companies is currently under preparationand one (Capital SA) has already been established. The founders of investmentcompanies are typically Romanian banks (e.g., Tiriac and RBFT in the case ofCapital SA) or other non-bank financial institutions, and one or more foreignfinancial institutions (e.g., EBRD and Wasserstein Perella in the case of CapitalSA); b) privatization through the use of success-fee-based privatizationmanagement contracts. The SOF plans to retain reputable foreign consultants tofind foreign investors for a batch of companies in a sector and would reimburseconsultants with a percentage of the sales price once the privatization deal iscompleted. The sector-based privatization will be initiated for textiles,garments, detergents, wood-based industries, and a number of other sectors;c) real estate investment funds are being discussed; and d) an additional massprivatization scheme or an improvement of the existing scheme allowing COs to beused to purchase the SOF shares is being actively considered.

2.25 The large companies, including about 700 CCs, are to be privatizedon a case-by-case basis. The SOF will take the responsibility of preparing thecompany, in terms of downsizing and shaping up the operations, and activelyseeking foreign investors. For certain very large companies, typically incapital-intensive sectors, foreign investors are few and can easily be identifiedfrom a small number of international conglomerates. The privatization of suchsectors (e.g., steel, non-ferrous metallurgy, fertilizers, refineries, cement)would be approached on a sectoral basis and through specific sector restructuringand privatization strategies.

D. Restructuring

(a) Government's Industrial Strategy

2.26 The Government's approach to industrial restructuring distinguishesbetween two types of enterprises and subsectors: a) enterprises in capital-intensive sectors, where the restructuring should be introduced in the contextof sector rationalization strategy and where the size of enterprises and theirimportance in local and national economy justify a more direct governmentinvolvement; b) enterprises in sectors which already operate in commercial marketconditions and where the restructuring could be left to market forces and toenterprise management initiative. The first type of government-engineeredrestructuring notably includes sectors with the largest number of lossmakers(i.e., metallurgy, chemicals and machine building) and subsectors characterizedby gross overcapacity comprising a number of production units with virtuallyidentical technology and undifferentiated products (such as fertilizers andrefineries).

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2.27 The short-term program specifically targets large lossmakers thatneed urgent intervention and support to cut the operating losses that willeventually be either liquidated, merged with others, or downsized to the pointwhere resulting units may become viable. In almost all cases, it involvesenterprises where liquidation or restructuring will have significant socio-political implications. About 100 large enterprises, mostly from metallurgy,chemicals and machine building sectors, have already been identified, includingsome of the 30 enterprises with the largest interenterprise arrears followed bythe SAL, enterprises with the largest arrears with the banking system and withthe largest overdue tax liabilities. In June 1993, the Government startedimplementation of an emergency program by selecting 30 enterprises in criticalfinancial condition, isolating them from other economic agents and placing themunder surveillance of a restructuring committee.

2.28 The medium-term adjustment program, beyond 1996, has a "constructiverestructuring" dimension. It is intended for industrial branches and individualenterprises that are considered viable and with growth potential, even if theyare not presently profitable. The targeted industrial subsectors include: lightmachine building, food industry, small-tonnage chemical industry, and traditionalexport-oriented light industries. In order to support the restructuring process,the Government plans to finance investment projects, guarantee commercialcredits, reschedule debts, bring in private financing together with statefunding, and provide moderate protection for the subsectors deemed to be in thenational interest.

2.29 Both the short- and the medium-term industrial adjustment programgive high priority to the closure of economically non-viable enterprises.However, the method of selecting such enterprises is still unclear and theiraccess to finance seems to leave too much room for discretion. It is crucialthat large state-financed restructuring be confined to a few vital RAs and to alimited number of CCs that are expected to remain in state ownership in the nearfuture and that cannot be closed down, and to demonopolization that needs to beimplemented prior to privatization.

2.30 The Government's exact role and the rationale for its involvement inthe industrial restructuring process has still not been well defined. Accordingto the Privatization Law, the SOF, being the majority shareholder of CCs, isresponsible for their restructuring, while the responsibility for restructuringof RAs remains with branch ministries. The branch ministries are alsoresponsible for industrial sector strategies. The MOI has launched extensivesector studies covering 85 subsectors, of which 52 have been completed. On thebasis of these studies, the MOI plans to devise a comprehensive industrialpolicy, including restructuring and privatization, that will be forwarded to theSOF to serve as a guideline for enterprise restructuring strategies. TheGovernment is currently refocusing the responsibilities of the MOI, includingsupport to establishment of an enabling environment for the private sector. Theproposed Project would support this effort in a number of ways: (a) by helpingthe MOI to define its new role and how it would be exercised; (b) by assistingthe MOI to develop sector restructuring strategies; and (c) by providingtechnical assistance to the MOI to develop the necessary institutional capacity(Annex 1).

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2.31 In view, however, of the heavy competing demands on fiscal andexternal resources, the Government's direct role in enterprise restructuring canonly be modest. It should be restricted to helping with labor retrenchment, anddisposal of all peripheral activities and assets. Most restructuring is bestleft to new private owners. The provision of money for new investment can onlybe highly exceptional, and even then can most prudently be organized between thebanks and their clients in enterprise workouts. To facilitate thisrestructuring, the Government should clearly signal to the enterprises that theymust focus on reducing costs and that they should plan the rationalization oftheir activities without expecting state financial assistance.

2.32 Parallel to the Government-managed programs, there will be arestructuring process initiated and managed by enterprises themselves, which willbe financed by enterprises' own funds and by the banking sector. This willinclude viable enterprises, which already operate in competitive markets, andenterprises subject to post-privatization restructuring. Restructuring of thelatter will be supported by the investment component of the proposed Project.

(b) Institutional Framework and Recent Developments

2.33 According to Law 58, the SOF bears the responsibility for corporategovernance and restructuring of CCs. Since its establishment, the SOF has beenprimarily concerned with building institutional capacity for privatization andwith privatizing small companies. To get ahead with the restructuring of the 30isolated enterprises, the Government has created a provisional RescructuringCommittee (RC). International experts were retained, with Bank's help, to assessfinancial recovery programs prepared by managements of isolated companies and torecommend a course of action. In December 1993, the Restructuring Committeeproposed and the Government endorsed an action plan to downsize 21, to liquidatesix, and to privatize three enterprises.

2.34 The first isolation exercise having proved to be a promising approachin addressing the issue of enterprise restructuring and of enforcing financialdiscipline, the Government is planning to extend it to a second and larger groupof troubled enterprises, including some RAs. In January 1994, the Governmentestablished another list of 30 enterprises (5 RAs and 25 CCs) which, onaggregate, represent 50 percent of the losses and 45 percent of the inter-enterprise arrears of the state-enterprise sector. In order to eventually returnto profitability and to settle their arrears, these enterprises must undergo adrastic exercise in loss-reduction and downsizing. Some debt-relief measures andrecapitalization may be inescapable. Eventually, some of them will be eitherliquidated, merged with others, spun off as separate units, or privatized. Inalmost all these cases, the restructuring will have significant socio-politicalimplications.

2.35 A more permanent institutional arrangement has also been implementedin 1994. An independent SOF subsidiary, called the Directorate for SelectiveRestructuring, with a separate balance sheet, has been created to managerestructuring, including liquidation of large loss-making enterprises. It tookover the implementation of the RC decisions and would eventually consider all 80to 120 firms deemed critical to the stabilization process. The RC has been

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dismantled, but the Government has institutionalized its functions in the formof a department called the Restructuring Agency, under the Council forCoordination, Strategy and Economic Reform. The most important immediatechallenges are: a) to efficiently implement restructuring decisions regardingthe first 30 problem enterprises; b) to clearly define rules that would helpselect the next group of enterprises that should be put in isolation; and c) toensure that the new SOF subsidiary does not create an open-ended subsidy systemwith little or no incentive. to effectively force either exit or privatization.A strong signal must continuously be sent to loss-making and other enterprisesthat they must adjust or face liquidation.

2.36 Industrial Technology Infrastructure. Over the long run, theGovernment intends to develop a comprehensive industrial technologyinfrastructure to help enterprise managements to improve their business andtechnical practices. A study, financed by the proposed Project (Annex 1), wouldreview the existing 140 institutes, which were a basis of the industrialtechnology infrastructure ir the old regime, aiming to conceptualize and developa practical implementation program for a new market and service-orientedframework. Consideration would be given to streamlining and strengthening partof the existing structures, including changing the ownership of the institutesto transform them into private, specialized, services-oriented facilities.

E. Private Sector Development

(a) Small Scale Private Sector (SME)

2.37 A large number of private sector enterprises have been establishedsince the revolution. By end-1993, about 546,000 firms were registered, of which29 percent as family establishments under Law No. 54, and the rest aspartnerships and joint-stock companies under Law No. 31. About 78 percent ofthese companies have opened for business. A breakdown of registered SMEs by areaof economic activity indicates that about 30 percent are active in manufacturingand trade and the rest in the agriculture and services sector. There isrelatively equal participation by family associations and commercial companiesin manufacturing and trade; in the services sector, commercial companies dominatestrongly, accounting for over 76 percent of SMEs.

2.38 Romania looks to the emerging private sector to provide a majorimpetus for economic expansion, employment, innovation and growth during thetransition. Indigenous small and medium enterprises would likely be the onlyagents capable of absorbing the excess labor certain to be cast off fromrestructured or liquidated state enterprises. Despite the lack of properinstitutional framework, difficulties with access to finance and "red-tape" inmany other areas, the SME growth has been remarkable. In the 1991-1993 period,the SME sector (excluding agriculture) productively absorbed over one millionpeople. By 1993, over 5,000 of these new private companies employed between 21and 50 employees, and about 800 had more than 50 employees. Their output grewfrom less than one percent of GDP in 1989 to about ten percent in 1991, and anestimated 30 percent in 1993. The markets for larger production-oriented SMEsare mostly domestic; only about nine percent of their output is exported. Theymostly operate in the final goods markets.

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2.39 As part of an effort to develop a viable and coherent PSD strategy,the Department for Private Small and Medium Enterprises of the National Agencyfor Privatization (DPSME/NAP) conducted a national survey on the impact of thesocial and economic environment on private sector development in Romania. Thesample was composed of 1,500 small and medium enterprises. In a separate effortfunded by the EC-PHARE, a consultant surveyed 200 newly-established SMEs. Thesurvey findings raise concerns, as they indicate that the current environmentdoes not allow the SME sector to utilize its full potential. The Government isaware of these problems and intends to create a more favorable environment anda supportive institutional framework for SME development, including actions to:

(a) create a supportive institutional framework, including governmentagencies and non-governmental entities run by entrepreneurs,operating at the national and the regional levels;

(b) improve coordination, eliminate overlaps, improve targeting andreLevance of programs and activities for SME support and increasethe quality of SME-related services;

(c) provide SME-related services, including direct advice and trainingof entrepreneurs on legal provisions, accounting and bookkeeping,financial management, loan applications and other banking matters,marketing, business planning, production management, financialplanning, etc;

(d) improve SME access to financing; and

(e) address the most urgent problems related to SME operations and toremove red tape.

2.40 Progress has alread, been made on some of the programs agreed on inthe course of the proposed Project preparation. At the regional level, theGovernment is playing a catalytic role to encourage formation of variousassociations of entrepreneurs. A study concerning options to provide the SMEcredit guarantees has been completed, and an SME Credit Guarantee Fund has beenestablished.8 The SME Credit Guarantee Fund is owned by the Government, by thebanks which intend to use its services and by a number of private investors, andwill be operated on a commercial basis. From the twelve-point action program,the barriers to private sector access to the social safety net and other socialservices have been removed; a program for promotion of entrepreneurship throughmass media has been finalized and its implementation started; two pilotincubation centers have been established; and agreements with a number ofuniversities were signed allowing entrepreneurs access to their facilities andtraining.

8/ This was a condition for negotiations of the proposed Project.

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III. FINANCIAL SECTOR

A. Curgent Structure of the Financial Sector

3.01 Until December 1989, the Romanian financial system operated under thecentral planning mechanism. Financial flows were controlled administratively,leaving little role for central or commercial banking functions. The NationalBank of Romania (NBR) issued notes but had little responsibility for the money,credit, or interest rate policy. Savings were mobilized through the Savings Bank(CEC), which lent out a small portion of its resources in the form of housingloans and passed the remainder to the NBR. The Romanian Bank for Foreign Trade(RBFT), the Investment Bank (now the Romanian Bank for Development, RDB) and theBank for Agriculture and Food Industry (now Bank Agricola, BA), respectively,were responsible for lending to the trade sector, the state enterprise sector andagriculture. All risks were absorbed by the Government. Consequently, thebanks' capitalization was extremely low. Funds were mostly borrowed from the NBRand supplemented by deposits from clients in their respective sectors. The NBRalso had quasi-commercial banking functions, taking deposits of state enterprisesand making short-term loans, mostly for working capital.

3.02 Reform of the banking system has been initiated early in the processof transition to a market economy. Entry to the banking sector was liberalizedas soon as the new Government took office. A two-tier banking system wasestablished by late 1990, and formally legislated in April 1991 with the passageof the Law on Banking Activity and the Law Concerning the Status of the NationalBank of Romania. The Banking Law endows commercial banks with universal bankingpowers, and the NBR is given a high degree of formal independence.

3.03 By the end of 1990 a number of private banks was established,including the Bank for Small Industry and Private Initiative (MIND), theCooperative Credit Bank (CCB) and the Ion Tiriac Bank for Commerce (TCB). Limitsof the types of customers and financial services that could be provided byforeign banks were lifted, and entry for new foreign or mixed ownership banks wasliberalized. This group currently includes the Chemical Bank (CBF), the SocieteGenerale (SGF), the Frankfurt-Bucharest and the MISR Bank. There were also newentries by banks in state ownership, including the Romanian Commercial Bank(RCB), which was formed in late 1990 by carving out the commercial portfolio fromthe balance sheet of the NBR; and the Export-Import Bank of Romania (EXIM), whichwas established in 1991 to strengthen financial services to the foreign trade-oriented industrial and services sectors. By late 1991, the private bank, DaciaFelix (DFB, based in Cluj), the Banca Creditului Romanesc S.A. (Credit Bank) andthe Bank Post, S.A. were created. The Romanian commercial banking sector nowcomprises six state-owned banks, six private banks (with Romanian capital andjoint ventures) and the Bucharest branches of four foreign banks. Another sevenprivate banks have passed registration and are preparing to open for business.More detailed analysis of the Romanian banking sector is provided in Annex 2.

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B. Financial Sector Reform

3.04 Substantial strengthening of the financial sector is required for itto be able to support the process of transition, especially privatization andindustrial restructuring. The banking system is characterized by high marketconcentration, weak funding base, rigid and unsophisticated structure of fundingand lending instruments, and high nominal growth (Annex 2). Open access and theuniversal banking principle have yielded a multitude of new private banks and theemergence of competition. Bank capitalization has been substantially improved.At end-1991, the capitalization of the commercial banking sector was about 2percent. By end-1992, the capitalization improved to about 8 percent and in 1993only two banks were below the international capital adequacy standard.

3.05 The NBR is increasingly using indirect instruments to manage monetaryand credit policies, and interest rates have been fully liberalized.9 It hasenacted prudential regulations concerning new bank licensing; ownership of banksand qualification of its management; branching; credit risk exposure to a singleclient and affiliated groups; and currency risk exposure rules. The SupervisionDepartment has been reorganized and strengthened and has already started on-sitesupervision. Donor TA and direct assistance by the NB of Holland has been andwill continue to be readily available to the NBR.

3.06 The current business environment is still not fully conducive to thedevelopment of healthy financial intermediaries. The macroeconomic environmentis volatile, and a level playing field for all economic agents has not been fullyimplemented. This creates problems in appraising and pricing credit, interestrate and currency risks. The current level of (tax deductible) general loan lossreserves mandated at 0.5 percent of banks' asset portfolio, taxes banks' capacityto sustain risk. Income is reported on accrual basis which inflates banks'profitability and profits are taxed on nominal rather than inflation-adjustedbases. Specific measures are urgently needed to increase banks' capacity to takeand sustain risk, and to make sure that reported financial position reflectsbanks' business reality. This includes: (a) introduction of rules for risk-based capital adequacy; (b) rules on asset classification and provisioning; and(c) increase in (tax deductible) general loan loss reserves to a levelcommensurate to financial risk inherent in the current business environment.10

3.07 The proposed Project would also contribute to strengthening of thebanking system by improving business practices for appraisal of projects andclients and by providing technical assistance to strengthen individual banks'appraisal capacities; by introducing new instruments and financial servicesrelated to export finance; and by stimulating competition and assisting the smallprivate banks to penetrate corporate credit markets. Assistance would also beprovided to the NBR to facilitate the implementation of prudential regulations,

9/ The interest rates liberalization is not fully effective in Romanian financial markets, especially in thedeposit market. This is due to the inherited structural rigidities (see Annex 2).

10/ Conditions for loan effectiveness of the proposed Project.

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to improve banks' capacities to manage their risks and asset/liabilityportfolios; and to improve banks' internal controls and audits (Annex 1).

C. Financial Markets

3.08 Financial intermediation in Romania is performed almost exclusivelyby the banking system. Credit markets have traditionally been characterized bystrong segmentation. This segmentation was both logical (e.g., different creditconditions and access rules) and institutional (i.e., access was provided onlythrough assigned banks). Due to the market segmentation, economic agents havefaced different conditions of access and different marginal pricing, dependingon their identity, economic activity, ownership, size, etc. The new Banking Law(i.e., free entry and branching, universal banking) and the change of rulesallowing economic agents to select their bank addressed some of the main issuesof the credit markets in Romania. The investment credit markets are, however,still dominated by the two state-owned banks (RDB and BA), which hold about 80percent shares in the respective markets for industry and agriculture lending,and by the RCB, which dominates the short-term end of the corporate creditmarkets. The RBFT and the new private banks are successfully challenging theirdominance. Moreover, these new banks are also playing an extremely positive rolein contributing to the integration of the traditionally segmented credit marketsin Romania.

3.09 While interest rate deregulation measures and the abolishment ofdirect credit controls have provided more scope for the working of market forcesin banking and finance, other measures are also needed aimed at: (a) unifyingthe market; (b) strengthening the competitive structure of the banking system;(c) improving the competitiveness of financial institutions; and (d) improvingthe capacity of the banks to analyze risk and to price loans accordingly. Theproposed Project, by opening access to all qualified banks and providingtechnical assistance to strengthen their capacities, aims to address operationalaspects of the noted issues.

3.10 Since the revolution, the total credit has substantially contractedin real terms (Table 3.1). At end-1993, the volume of credit in real terms wasonly about 34 percent of that in 1989. The maturity structure has also changed.While the long-term end of the credit market accounted for 28 percent of thetotal market in 1989, its share declined to about 8 percent in 1993 and thevolume to about 10 percent of that in 1989. Another important structural changeis a much larger number of market participants. On the supply side, the numberof banks has roughly doubled, although the newcomers still accounted for about12 percent of the total domestic credit market at end-1993. There was also asubstantial increase on the demand side. Due to the enterprise commercializationand the new private sector entrants, the number of credit transactions hasincreased by more than ten times.

3.11 Investment Credit Market. Bank credit has traditionally had only alimited role in the industrial investment finance. In the state enterprisesector, about 55 to 60 percent of investment has been financed directly by thebudget, another 25 to 30 percent by the retained earnings and depreciation funds,and only 9 to 12 percent by the banks. For investments in modernization,

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rehabilitation or expansion, up to 80 percent has been financed from depreciationand retained earnings. Credit control has traditionally been maintained throughcredit ceilings determined by the type of credit and industrial activity. Thefinancial sector reform has formally replaced this mechanism with discretionarycontractual relations based on bank assessments of projects' viability andclients' creditworthiness. The industrial credit market currently accounts forabout 20-25 percent of total credit in Romania, a significant fall from the over45-50 share traditionally held in the last two decades. The market is dominatedby public enterprises.

Table 3.1: Non-Government Credit Volume in Real Terms

Domestic Credit | Foreign Exchange lTotal Credit Credit 1/

Notn-goverrnmentbil. Lei ;/ Short-Term Long-Term

l___________LX' a/ A/ A/ v/ a/1989 810 100 100 70 100 28 100 2

1990 683 80 74 64 94 33 42 3

1991 1,375 58 28 77 34 19 24 4

1992 1,915 40 43 75 20 _ 14 56 11

1993 4,555 34 38 77 10 8 67 15

Source: NBRAnnual Inflation: 1990 - 105; 1991 - 279; 1992 - 200; 1993 - 280Deflator Coefficients in Relation to 1989: 1990 W 1.05; 1991 - 2.93; 1992 - 5.86; 1993 16.411/ Volume in real terms in percentages of 1989 volumea' Term structure in percentages of total credit3/ Converted at official NBR reference rates: 1989 - 12; 1990 - 35; 1991 - 186; 1992 - 430; 1993 - 1250

3.12 Term-credit has severely contracted since the revolution. In 1991,its volume in real terms was a mere 34 percent of that in 1989; by end-1992, themarket further contracted in real terms to about 20 percent and by end-1993 toabout 10 percent of its 1989 volume. The foreign exchange non-government creditmarket in Romania initially took an even larger dip. In 1990, it contracted to68 percent and, in 1991, to a mere 8 percent of its 1989 volume. In 1992,however, this market started to recover, due to the funds provided byinternational development banks and to suppliers credit. By end-1993, the volumeincreased to about 67 percent of that in 1989, and its share in the total creditmarket in Romania increased to 15 percent. In terms of demand/supplycharacteristics and instruments, this market is very different from the one thatexisted before and immediately after the revolution.

3.13 The transformation of banks into joint-stock companies brought moreconservative lending practices. Due to high inflation, the maturities ofavailable credits have shortened to well below two years, access to foreignexchange is difficult and credit for capital investments involving imports is

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practically not available (Annex 6). The small and medium-size enterprises,including export-oriented enterprises and the new private enterprises which havegrown to employ over 20 people, are most negatively affected by the lack of term-finance. This is particularly problematic because the supply response from thesetypes of enterprises holds a potential for reversing Romania's current economicdecline.

3.14 Based on the MOI surveys, the investment demand of viable export-oriented enterprises which operate in a competitive market environment totalsabout US$0.5 billion annually. It originates in export sectors such as textiles,garments and leather, wood, pulp and paper, building materials, light engineeringand chemicals industries. Companies seek credit to improve internationalcompetitiveness and profitability, to consolidate theit export positions, or tofacilitate privatization or joint ventures with foreign private investors. TheNAP estimates that the SME investment demand currently amounts to about US$150million annually. Neither estimate includes incremental permanent workingcapital demand, which would increase the estimates by US$200 million and US$50million, respectively.

3.15 The volume of the proposed Project's investment credit component wasdetermined based on intermediation capacity of t financially viable part of theRomanian banking sector, excluding the state-owned banks that were notfinancially viable and the branches of foreign banks. The assumption that thereal growth of aggregate balance sheet size for such banks will be kept at about20 percent annually, gives an estimated US$200 million incremental intermediationcapacity."1 The existence of a pipeline of viable projects was confirmed byscreening a number of investment proposals from various sectors, includingtextiles/leather, machine building, metallurgy, electronics and machine tools.The reviewed investment proposals amount to approximately US$55 million, of whichabout half are with IRRs of over 20 percent; these were presented by viableenterprises with a proven record as successful exporters.

3.16 Working Capital Finance. Access to working capital finance is of keyimportance for a successful supply response in Romania. As part of the tightcontrol mechanism, enterprises in the central planning system were typicallyseverely undercapitalized as compared to similar enterprises in a market economy.The conversion process to commercial companies in Romania did not take care ofthis problem, as the enterprises were not properly capitalized before they wereconverted. Furthermore, a large number of enterprises were participating inbarter arrangements with the CMEA, which lowered their working capital needs.Once the CMEA disintegrated, working capital needed to be increased. Anotherreason has been a significant devaluation of national currency, which requireda corresponding increase in working capital for enterprises which use importedinputs and spare parts. Increases in wages and prices of domestic inputs,combined with the general lengthening of collection periods, have also requiredan increase in working capital.

11/ However, this operation will remain within limits set by the Government's credit policy and is notincremental in this respect.

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3.17 Exacerbating increased working capital needs of the corporate sectoris the lack of capacity of the financial sector to deliver, in terms of volume,timing and instruments. This has been reinforced by the NBR policy of creditrestraint introduced as a part of the stabilization program. For initiallyviable enterprises, the limited access to working capital often has been a reasonfor the decline in capacity utilization and/or the loss of markets. For example,a few enterprises in the textiles and garments sector, which are successfulexporters, operate at about 50 percent of capacity. Their effective capacityutilization has been determined not by their opportunity to sell, but by theiraccess to working capital. The access to finance somewhat improved by 1993, andthe volume of short-term finance recovered, in real terms, to about 38 percentof that in 1989. This was mostly due to the large spreads in the range of 20 to30 percentage points which the banks considered adequate to accommcdate theircredit risk concerns.

3.18 The lack of working capital finance combined with uncertainties inthe terms of access to foreign exchange market and the ability to timely buy theforeign exchange has been especially detrimental to exporters. Unless anexporter has his own source of foreign exchange, he would normally obtain aforeign suppliers' credit, or a credit in domestic currency and then exchange leifor convertible currency in the foreign exchange (FX) market. (Foreign exchangecredit markets and foreign exchange markets are analyzed in Annex 6). The FXmarket supply was typically 8-15 percent of the demand in the 1991-1992 periodand about 2-5 percent of the demand in 1993, making access to foreign exchangeby particular exporters haphazard and dependent on the FX position of theexporter's bank on any particular day. Potential exporters who need foreignexchange typically wait one to three months to satisfy their demand, hence theyare not able to transact if an export order entails strict delivery schedules.

3.19 The proposed Project's demand estimates for export finance werederived based on the assumption that the export credit line under the Projectshould be able to finance major categories of positive value-added Romanianexports, taking 1993 as a base year. This yields a demand estimate of aboutUS$630 million for export finance (Details are provided in Annex 4). Thisestimate was cross-checked by a detailed survey, by sectors and enterprises, ofexport potential unrealized due to the lack of adequate foreign exchangefinancing. The survey was conducted by the MOI in October 1992. Within sectors,enterprises were screened based on profitability and export experience. For theelectronics, chemical/petrochemical, machine building and textile sectors, apotential incremental export volume in 1993 was estimated at US$1.36 billion,requiring an estimated US$443 million in foreign exchange financing.

IV. PROJECT RATIONALE

A. The Bank Group Strategy for Assistance

4.01 The reform strategy in Romania has been rather steady. TheGovernment remains committed to moving decisively and coherently across a broadfront to sustain the reform effort. The reform priorities include:(a) macroeconomic stabilization as a prerequisite for the success of the reformprogram; (b) accelerating the transformation of ownership; (c) rationalization

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of productive sectors to make them efficient and ilternationally competitive; and(d) providing social protection to the affected segments of the population.

4.02 In intensive dialogues over the past three years, the Government andthe Bank have found considerable agreement on the priorities for adjustment anddevelopment. The Bank's medium-term country strategy comprises several strategicthemes as reference points for guiding the overall program in support ofRomania's reform effort. The Bank aims to: (a) facilitate and support Romania'sstructural reform and its transformation to a market economy; (b) contribute tofinancing its balance-of-payments requirements, and help establish itscreditworthiness; (c) support sectoral adjustment and development efforts; and(d) help mobilize resources from both official and private sources. -

4.03 The centerpiece of the Bank's current operations in Romania has beenthe SAL, which was approved in July 1992. The SAL program, along with the Fundstand-by arrangement, provided a macroeconomic framework for the transition. Itsupports stabilization efforts, including fiscal reform, price and tradeliberalization; introduces measures to further policy reforms of the enterprisesector and to strengthen financial discipline; and aims to improve theaffordability and effectiveness of the social safety net. Continued support toenterprise reform is critical for the success of the transition. The Bankintends to deliver this support through the proposed Project and the futureadjustment operations.

4.04 The proposed Project is fully consistent with the Bank's assistancestrategy for Romania and supports all its major elements. In the November 1991to September 1992 period, the proposed Project was the main vehicle to assist theGovernment to conceptualize and develop a regulatory, institutional andprocedural framework for privatization. Table 4.1 summarizes policy-relatedmeasures and the associated objectives which have been accomplished duringProject preparation. The intention was to ensure that the overall environmentis conducive to privatization and to the successful growth of the private sector.

4.05 Other related Bank projects include the Private Farmer and EnterpriseSupport Project and the Employment and Social Services Project. The former aimsto stimulate transformation and development of the private agricultural sectorin Romania, including its distribution and food processing aspects, while thelatter aims to improve services associated with the social safety net, helpingto ease the exit of non-viable firms and accommodate workers' retrenchment.

B. Rationale for Bank Involvement

4.06 In the period since the revolution, the Government has successfullyestablished the legal and institutional framework necessary for a market economy.The role of the state in both macro and microeconomic management has changed.On the macro-level, the new policies have emphasized liberalization (e.g., price,foreign trade, interest rates, entry and exit policies), decentralization andcompetition (e.g., in banking, industry, agriculture), and market and privatesector orientation. At the micro level, the Government has already disengagedfrom involvement in operational management of enterprises; it has commercializedvirtually all enterprises in trade and manufacturing sector and started to

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enforce their financial discipline; and plans to fully divest its holdings in thenext seven years. Financial policies and entry to the banking sector and marketshave been liberalized, resulting in emergence of the new private institutions andin changes of financial market structure and availability and quality offinancial services.

Table 4.1: Policy-Related Measures and ObjectivesAccomplished During Project Preparation

Macro Objective Measure sProjet Objective Completed

Privatization

• Complete development of legal * Finalize SOF by-laws and initiate * Allocate decision making * Aug. 92 1/and institutional framework staffing of the SOF responsibilities

* Finalize POF by-laws and complete * Sep. 92 1/allocation of POF portfolios

I Submit POF documents for * Oct. 92 1/registration

* Speed up privatization * Start distribution of Certificates of * Increase number of * Sep. 92 2/Ownership potential clients

* Finalize draft procedure for * Dec. 92 /privatization of small companies

* Decree on privatization of small * Jan. 93 4/companies

* Adoption of 1993 privatization * Mar. 93 4/program

Enterprise Reform

* Improve corporate guidance * Amendment to Law 31, para 212 * Improve corporate guidance * Nov. 92 2/on Corporate Boards and decision-making

* Submission to Parliament of Draft * Improve bank appraisal * Nov. 92 3/law on Operations of Public capacityAccountants

* Submission to Parliament of * Improve management * Feb. 93 _/Performance Based ManagementContracts Law

* Create enabling environment for * Agreed SME loan guaranteeprivate sector development program o Improve access to finance * Nov. 92 g/

for SMEs

L, Onginally condition of Appramsal.?/ Onginally condition of Negotdions.2/ Onginally condfiton of Board Presention.1/ Onginally conditon of Effcteness.

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4.07 The Government has also recognized that export development andintegration of the Romanian economy into the international financial and goodsmarkets is a key to successful transition and to achieving a sustainable growthpath. To this end, the Government has opened access to the trade sector;liberalized foreign trade; unified and simplified the tariff regime; practicallyremoved exchange controls on current account transactions; and started to managethe exchange rate through market-based mechanisms. However, a supply responseto the new incentives and opportunities has been slower than expected, mostly dueto the lack of managerial and technical skills in ministries, enterprises andbanks and to difficulties in access to finance.

4.08 At the macro level, the Bank has been involved in the transitionprocess in Romania from the very beginning. At the micro level, it has twop.:sible choices. One is to wait until the restructuring and privatization ofthe real sectors is completed and then provide investment resources. Thetransition, however, may take years to accomplish and the process may fail or besignificantly slowed because of the lack of skills and financial resources.Another is to actively promote growth of the private sector and to support theprocess of transition through policies and institution-building work and byproviding well calibrated financial assistance, through banks already operatingon sound financial and commercial principles, to competitive private enterprises.The proposed Project elects the latter approach. It aims to address criticalneeds which impair the supply response of the export sector and which can besatisfied within the present system at minimum risks.

V. THE PROJECT

A. Obiectives and ScoDe of the Proposed Project

5.01 In line with the country assistance strategy, the principalobjectives of the proposed Project are to: (a) promote growth of the privatesector and create conditions for an effective supply response from viable privateindustrial enterprises; (b) advance structural transformation of the enterprisesector in Romania, and specifically privatization and restructuring; and (c)facilitate transformation of Romanian credit markets and introduction of safe andsound banking practices. These objectives would be achieved by: (a) improvingaccess to foreign exchange credit for investment and export finance to viableprivate enterprises; (b) assisting in the design of the necessary policies andby strengthening the institutional framework for privatization and restructuring;and (c) strengthening the capacity of participating banks to efficiently allocateresources and to improve financial services tc the corporate sector.

5.02 The proposed Project would be supported by a US$175 million Bankloan. The Loan would be used to provide:

(a) Finance for creditworthy enterprises capable of assuming foreignexchange risk, in two components:

(i) Investment Finance for private enterprises to improveinternational competitiveness and/or to expand exports; and

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(ii) Exnort Finance to provide partial to full coverage ofexporters' preshipment finance needs for imported inputs; and

(b) Technical Assistance to help in policy formulation and to strengtheninstitutional capacity in the areas of privatization andrestructuring, and for capacity-building in the banking sector.

5.03 The finance component, in the total amount of US$172.0 million ofBank funds, will be divided into US$102 million for investment lending andUS$70.0 million for export finance. The investment component will receiveadditional cofinancing by the European Investment Bank, amounting toECU30 million. Proposed technical assistance of US$3.0 million would be providedin the context of an integrated overall program, financed by the Governmentbudget and other multilateral (e.g., EC-PHARE, EBRD) and bilateral (e.g., USAID,UK-Know-How-Fund) institutions.

B. Financing Component

5.04 The Investment Finance Comnonent would provide investment loans toprivate enterprises, in the context of broader restructuring programs. Due tothe severe lack of foreign exchange financing in Romania, the investment financeis targeted to most viable enterprises in the industrial sector aiming to improvetheir international competitiveness, export capacity and profitability ofexports. The availability of investment finance is also expected to addressconcerns of foreign investors. It has been noted that many of them might bewilling to commit equity capital, but are discouraged by the lack of finance forpost-privatization restructuring.

5.05 The access to investment finance would be open to viable privateenterprises,12 which are capable of bearing the foreign exchange risk. A subloanapplication would have to be presented in the context of the enterpriserestructuring program and business strategy. More specifically, eligibility ofenterprises and projects would be determined based upon:

(a) economic and financial viability of a project, with financial andeconomic rates of return of minimum 15 percent;

(b) satisfactory financial condition of a prospective borrower andcapacity to bear the foreign exchange risk. The latter will beassessed by reviewing: (i) recent history of export performance;(ii) future prospects including analysis of targeted markets andestimated growth of exports and foreign exchange income; and(iii) analysis of enterprise's international competitiveness;

12/ The term private refers to enterprises incorporated under Law 31, including wholly privately-ownedenterprises established by private entrepreneurs and enterprises originally in public ownership which havebeen privatized under Law 58. If not majority privately-owned, enterprises will be required to present aprogram for full privatization and the State Ownership Fund (SOP) should initiate actions expected to leadto private ownership within one year after the subloan has been extended. The actions should commit the SOPto divest its ownership if an investor can be found, such as placing the enterprise on a list of enterprisesoffered for sale by the SOF.

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(c) presentation of a satisfactory business plan and restructuringprogram clearly indicating: (i) measures which have been alreadytaken; (ii) intended areas of further improvements of enterpriseperformance and efficiency; (iii) financing plan for elements notcovered under the subloan with adequate assurances from otherfinancing agencies; and (iv) if an enterprise is not whollyprivately owned, intentions for completing privatization; and

(d) clearance by the Ministry of Environment concerning environmentalaspects.

5.06 The subloans will be denominated in US dollars to match theprospective export revenues of subborrowers. The interest rates would bevariable, based on US dollar prevailing six-months LIBOR plus a market-basedspread. The proceeds of the sub-loans would be used to cover the foreigncurrency cost associated with capital investments, including permanent workingcapital needs, to improve quality, packaging or to address other productdeficiencies; to improve production cost structure; to address productionbottlenecks; or, when having a reasonable prospect to increase exports, toincrease capacity to produce exportable products.

5.07 The Export Finance ComRonent would address current problems ofinadequate access to export-related working capital finance, which especiallyhurts private enterprises and less experienced exporters. These are due tobalance-of-payment difficulties and imperfections in the foreign exchaxtge and theforeign exchange credit markets (Both markets discussed in Annex 6). It will beprovided through a revolving fund to cover pre-shipment financing needs for theimported inputs of Romanian exporters. With an expected average maturity of 120days, the US$70.0 million financed by the Bank would revolve about three timesper year, yielding a US$210.0 million financing capacity.

5.08 The access to export finance will be open only to direct exporters.Eligibility will be determined based on:

(a) possession of an irrevocable letter of credit (LC) in convertiblecurrency issued by a creditworthy financial institution or aconfirmed purchase order issued in his favor by a respectableforeign buyer;

(b) exRort experience in products similar to the transaction for whichexport finance is being sought; and

(c) positive value-added for the export product based on internationalreference prices.

5.09 The credit to participating financial institutions (PFIs) torefinance the subloans will be extended on a first-come first-served basis andback-to-back with the PFI subloans to exporters. The PFI subloans will bedenominated in US dollars with an average maturity of up to one year and at fixedinterest rates, with reference to US dollar LIBOR plus a market-based spread.To further alleviate the banks' risk concerns, especially regarding new

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inexperienced exporters from the private sector, a special export guaranteesprogram has been introduced by the EXIM Bank and is available to the sub-borrowers.

5.10 In the longer term, the export finance may become unnecessary due tothe easing of foreign exchange constraints. The Bank and the Government willjointly monitor the use of funds allocated to this component against developmentsin the financial sector and assess the continuing need for export finance on anannual basis.

C. Technical Assistance Component

5.11 The main objective of the TA component is to provide consultingassistance and training for the design and implementation of an effective policyand institutional framework for privatization and industrial restructuring, andto strengthen the capacity of PFIs. The cost estimates of the proposed technicalassistance program are summarized in Table 5.1.

Table 5.1Technical Assistance for Privatiation and Restructuring

l ________________________ (US Thousand) l

l________________________ Project Funds Other Related Funds1' Total

Ministry of Industry 1,700 10,700 12,400

National Bank of Romania 1,300 5,000 6,300

TOTAL 3,000 15,700 I 18,700

1/ Includes TA tunds for progfams and activres direcly retated to this Project by intemationai donors (EC-PHARE) and throughbiiatea assistance (US-AD, UK-Know-How, e GoenmenXt of Holland. Sweden. Switzenand. etc.).

5.12 The details of the technical assistance program are contained inAnnex 10. The Bank funds would be used as follows:

(a) Ministry of Industry (MOI), for: (i) sector studies and consultingassistance for the development of sector restructuring andprivatization strategies; (ii) environmental consulting services forMOI; and (iii) a study on industrial technology infrastructure;

(b) National Bank of Romania, consulting help to assist in:(i) implementation of a new Chart of Accounts for banks;(ii) formulation of guidelines and training in risk management andasset/liability management policies for commercial banks; and (iii)establishment and strengthening of internal controls and auditing incommercial banks; and

(c) Participating Financial Institutions (through the NBR) for:(i) strengthening PFI credit and risk management policies;(ii) strengthening PFI appraisal capacity; and (iii) improving PFIloan administration.

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D. Project Cost and Financing Plan

5.13 An estimate of the total cost associated of proposed Project is shownon Table 5.2.

Table 5.2Estimated Total Project Cost

(US$ Milron)

7 ~Arnount|

Local Foreign Total

Investment Component 55.0'' 102.2 157.0lExport Component 104.OyE 70.0 174.0

TAComponentt ~~~0.0 3.0 3.0l

Total 159.0 175.0 334.0

1/ Enterprises Funds and PFI Funds_/ From Table 5.1

5.14 The Bank financing would cover US$175 million equivalent, or abouthalf of the total cost of the proposed Project. For the investment finance,local financing would come from enterprises and the PFIs, or, to a lesser extent,financing may be available from the State or Private Ownership Funds. For theexport finance, local financing may be raised from the banking sector or fundedby enterprises themselves. The financing plan developed with these assumptionsis presented in Table 5.3.

Table 5.3Proposed Financing Plan

(US$ Million)

Amount

Local Foreign Total

IBRD 175.0 175.0Enterprises 40.0 - 40.0PFIs 119.0 . 119.0

Total 159.0 | 175.0 334.0

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E. Environmental Impact

5.15 The proposed Project has been classified in Category B.Environmental aspects would be addressed in the MOI and at the enterprise level.A capacity to address environmental issues would be established in the MOI, inorder to be able to provide full cooperation on initiatives and programs of theMinistry of Environment (MOE). The MOI has already established a Department ofthe Environment; a consultant financed by the proposed Project would be assignedto the Department to help in building institutional capacity for environmentalimpact assessment, and to introduce specific measures to address identifiedenvironmental issues.

5.16 With the Bank's help, the Government has already developed acomprehensive strategy for environmental protection and conservation. TheEnvironmental Law, setting up standards comparable to those in EEC, has beenenacted. As required by that Law, an environmental impact analysis would haveto be prepared for each investment project; the analysis would be reviewed by theMOI and cleared by the competent office of the Ministry of Environment.Investment projects, which seek term finance from the Bank credit line, would berequired to present to PFIs the clearance of the Ministry of Environmentconcerning the environmental impact of the proposed investment. The PFIs willmonitor compliance with environmental regulations in the course of normalsubproject supervision.

VI. PROJECT IMPLEMENTATION AND ONLENDING ARRANGEMENTS

A. Loan Terms and Conditions

6.01 The proposed Loan of US$175 million will be made to the Governmentthrough the Ministry of Finance (MOF) for a period of 20 years, including fiveyears of grace. It will be a single currency loan (SCL) denominated inUS dollars at the Bank's standard variable interest rate for the US dollarSCLs. 13 The Government will administer directly the technical assistancecomponent, but will onlend funds for export and investment finance to PFIs, whichwill channel these resources to eligible borrowers. Lending arrangementsinclude: (i) Loan Agreement between the Bank and the Government; (ii) SubsidiaryFinancing Agreements between the MOF and the PFIs; and (iii) Subloan Agreementsbetween the MOF and the PFIs, back-to-back to Subloan Agreements between the PFIsand final borrowers. The PFIs would be requested to sign a Subsidiary FinancingAgreement as a condition of participation in the proposed Project.14 The

13/ The participating banks are eligi0le for SCLs since they have a need for a US dollar loan to matchrevenues from lending to their clients, who are expected to earn export revenues in US dollars. The SCLterms will reduce the currency and interest rate risk that the HOF or the PFIs would have faced withcurrency pool loan terms. The LIBOR basis of the SCL interest rate is appropriate for the export financecomponent, but may introduce interest rate risk in the investment finance component for sub-borrowers, whoserevenues are not correlated to LIBOR movements.

14/ Signature by at least two PFIs is a condition of effectiveness of the proposed Project.

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Subsidiary Financing Agreement will include: (a) an acceptance of financingconditions by a PFI; (b) a commitment to follow agreed appraisal procedures andeligibility criteria; (c) an agreement to establish or strengthen a technicalappraisal unit; (d) an agreement to establish a Credit Committee; (e) anagreement to undertake external audits and to implement the auditor'srecommendations; and (f) an agreement to provide periodic reports on theportfolio financed from Bank funds. The Subloan Agreements will refer toparticular subprojects and must be in a form and content satisfactory to theBank.

6.02 The MOF subloans to PFIs ("subsidiary loans") will be extended on afirst-come first-served basis and back-to-back to the PFI subloans .to finalbeneficiaries, with identical amounts, maturities and repayment schedules. Thesubsidiary loans to PFIs will be made in US dollars at the prevailing LIBOR basedIBRD rate, plus MOF spread of 30 basis points. The MOF spread will cover thereal MOF cost, including administration cost, commitment fees, applicableinterest charges and other incidental expenses. The PFIs would onlend the fundsto eligible enterprises for eligible export transactions and investment projects.The PFIs will assume the related credit risk. The subloans will be made in USdollars, at interest rates priced on the basis of six-month LIBOR plus the MOFmargin and a market-based PFF spread. The subloans for export finance will beextended at fixed rates; the term subloan will be extended at variable interestrates. The beneficiaries will assume the foreign exchange risk and the interestrate risk for the term lending. Subsidiary and subloans terms and spreads willbe reviewed by the Bank from time to time.

6.03 Investment Finance. Maturities of subloans for investment financewill range from three to 17 years, with grace periods from one to five years.Grace periods and repayment schedules will be flexible to suit requirements ofindividual projects and enterprises. The maximum subloan size will be US$8million. Exceptions may be authorized on a case-by-case basis based onsignificantly increased foreign exchange earning potential of particular projectand/or borrower. This maximum will be reviewed and may be adjusted from time totime.

6.04 Repayments by the PFIs to the MOF will match the repayment schedulesof the borrowing enterprises. Should the final sub-borrower prepay all or partof the subloan prior to maturity, the PFI should immediately prepay itssubsidiary loan to the MOF. In case of arrears in principal or interestrepayment on any due date from a borrower, the PFI will nevertheless be liablefor payment to the MOF. The MOF will establish a rollover fund with resourcesgenerated by repayments of all subloans under the proposed Project. Resourcesfrom the rollover fund will be available to finance additional subprojects or toservice the Bank Loan.

6.05 Export Finance. Subloans will be extended for up to US$5 millionwith maturities of up to one year. Specific subloan amounts and maturities willbe determined based on particular export transactions and specific informationabout the average time frame of a production cycle from receiving the confirmedexport order until payment. Exceptions on a case-by-case basis may be authorizedby the Bank. The maximum subloan amount will be reviewed and may be adjusted

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from time to time. An exporter will be obliged to assign the export proceeds toa PFI, and will receive only net proceeds. The PFI will be expected to repay,i.e., replenish the export finance revolving fund, even if the export paymentdoes not materialize.

6.06 The following forms of financing will be available: (a) exportcredit to finance purchase of imported inputs; and additionally, from therevolving export finance fund; (b) discounting of an irrevocable LC of anexporter who has already financed an export transaction from his own sources,providing that the reimbursement request is made within 180 days and that theprocurement procedures applicable under this proposed Project have been followed.The financing may be used to cover expenses for imported inputs. The !IOF willestablish a revolving fund to hold the repayments under the export financecomponents. The revolving fund will continue to provide, during the loan graceperiod, transactions based on export finance under the same terms and conditions.

6.07 Free Limit. Initially, a free limit for both types of finance willnot be established. The Bank will continue to review the subloans proposed byeach PFI until a PFI's appraisal capacity is deemed satisfactory. At this time,a free limit for the particular PFI will be established. This free limit willbe PFI specific and may be adjusted from time to time.

6.08 Technical Assistance. The Government plans to onlend funds fortechnical assistance to executing government agencies. This will be accomplishedthrough interagency arrangements satisfactory to the Bank.

B. Lending Arrangements

6.09 The Apex Arrangements. The financing for both components would beprovided through an apex arrangement to allow open access of new PFIs. The apexfunctions would include: (i) qualification and accreditation of the PFIs; (ii)administration of the disbursements and collection (repayments) of funds advancedto PFIs; and (iii) monitoring of PFIs to ensure their continued qualifications.Initially, the Bank would retain the responsibility for qualification andaccreditation of the PFIs and for periodic evaluation of their eligibility. Thisfunction would be discharged in close cooperation with the NBR. In particular,in accordance with agreed criteria (Annex 5), the NBR would screen financialinstitutions which have applied to participate in intermediation of the Bankfunds and to propose to the Bank financial institutions which are deemed capableto qualify. As a part of the normal supervision process, the NBR will continueto monitor the soundness of PFIs, including their capacity to appraisesubprojects, and inform the Bank of any deterioration of their financial andoperating conditions; and to ensure that the PFI subject their financialstatements to external auditing on a regular basis.

6.10 The Treasury Department in the MOF (TD/MOF) would have the primaryresponsibility for operational functions, including: (i) providing subsidiaryloans to PFIs; (ii) for the investment finance, collection of funds from PFIs,for the export finance, maintenance of the revolving fund facility; (iii)repayment to the Bank; and (iv) reporting and monitoring the use of project

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funds.'5 A unit having specific responsibility to administer the Bank Loan fundswill be established in the TD/MOF.16 The unit will be staffed with experienced,adequately trained individuals. The monitoring and reporting would also requirea good accounting and management information system in order to trackdisbursements and collections of funds and to provide the necessary reports inaccordance with Bank procedures (e.g., procurement, reporting).

6.11 Participating Banks. The institutional objectives of the financingcomponent are to: (a) encourage competition and provide enterprises withalternatives regarding access to finance; (b) strengthen financial infrastructureand the delivery system for export and investment finance; (c) reinforce thedevelopment of new financing methods and instruments employed by the bankingsector; and (d) promote introductinn cf ..aFe and sound banking practices. It is,therefore, desirable that several banks participate in intermediating both theexport and the investment finance subcomponents. The private banks have beenencouraged to participate as PFIs, in order to strengthen their competitivenessand to spread the risk which would otherwise be confined to the public sector.

6.12 All banks operating in Romania are eligible to participate providedthat they meet the qualification criteria (Annex 5). The qualification criteriainclude:

(a) satisfactory financial position and capital adequacy meetinginternational standards;

(b) good standing with the NBR and satisfactory financial policies andoperating procedures, especially concerning loan classification andprovisioning and project appraisal;

(c) satisfactory operational performance, especially concerning past-due and non-performing loans and collection ratios regarding totalloan portfolio and Bank's loan portfolio; and

(d) satisfactory technical capacity to identify, appraise and superviseutilization of the Bank funds and, for the export finance, to handleinternational trade transactions and the related documentation.

6.13 The PFIs' responsibilities include: (a) promotion and building ofthe project piDeline; (b) subproject and borrower appraisal; (c) subloanadministration; (d) subproject performance supervision; and (e) periodicreporting to the TD/MOF and the Bank. The PFIs would be required to establisha technical unit, specialized in long-term project lending, properly staffed withat least one industrial engineer, one financial analyst, and one economist, andcapable of meeting Bank standards on project appraisal and supervisionl". The

15/ Note that the apex will not be involved in credit decisions and/or in rationing credit among the PFIs.

16/ Establishment of this unit was a condition for Board presentation of the proposed Project.

17/ For export lending, the unit staff should include a financial analyst and an export finance specialist.

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unit will perform the appraisal and supervise all subprojects financed by a PFI.Appraisals should be cleared by the respective PFI Credit Committee. The PFIsare also expected to introduce appropriate internal audits and controls.

6.14 Ten banks have applied for participation so far, of which eight wereprequalified by the NBR (Annex 3, Table A3.1). At the outset, a minimum of twoeligible PFIs would be sufficient to start project implementation. The Bankappraisal was based on two types of criteria: (i) level of capitalization andcapital adequacy, using international standards as qualification criteria; and(ii) qualitative criteria showing that a bank has a satisfactory capacity tointermediate Bank funds. The qualitative criteria included managerial structureand quality of management, management information systems, appraisal prqceduresand risk management (e.g., loan loss provisioning), internal control and auditingsystems, accumulated experience in banking operation, plans for external auditingby qualified (foreign) auditors, corporate strategies and staff development andtraining programs. For qualitative criteria, the minimum acceptable standards,rather than standards for banks operating in developed market economies, wereused. Annex 3 provides full details on the banks' financial position andappraisal, and Table A3.2 summarizes the appraisal results of the proposed eightbanks.

Table 6.1: Participating Financial Institutions with Romanian Capital(in billion lei, as of February 1994)

Qualfied Pending Qualification l

TRSF" ROB TCB OF8 EXIM RC8

Ownership Mixed in pvatz. Private Pite State State

Capital 108 59 17 45 36 129

Total Assets 2Z445 812 278 447 74 2,681

Loan 844 411 123 247 22 1,395

cust.Deposlts 162 256 43 92 0 450

%LoanCoverage 32 77 49 55 100 42

% CredtMaikePeretatton 16 8a 2 5 26

Soure: N8R

6.15 Five banks have successfully passed the Bank's appraisal (Table 6.1.Detailed assessments are provided in Annex 3). The Foreign Trade Bank (RBFT),the Societe Generale (SGF), the Chemical Bank (CBF), the Romanian DevelopmentBank (RDB) and the Tiriac Commercial Bank (TCB), were found fully eligible forparticipation. These banks cover about 22 percent of the Romanian total creditmarket, and about 85 percent of the foreign exchange credit market. Anotherthree banks have substantially met the qualification criteria, but need to takespecific actions before they are accredited.

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6.16 All banks are expected to further strengthen their appraisal andproject follow-up capacity and their internal controls and auditing procedures.Technical assistance for this purpose will be provided even before the proposedLoan becomes effective. For the export finance, technical assistance will befinanced by the Swiss Government and for the term-finance and loan administrationby the EC-PHARE.

6.17 Specific measures will also be taken to increase banks' capacity totake and sustain financial risk, and to make sure that the reported financialposition reflect the banks' business reality. These measures, which areconditions of loan effectiveness, are summarized in Table 6.2.

Table 6.2: Conditions of Effectiveness

Macro Objective Condition Project Objective

Banking Sector Reform

. Complete prudential regulations . Issue NBR regulations on rsk- . Facilitate supervisionbased captal adequacy

. Increase banks capacity to . Issue NBR regulations on assetsustain risk classification and provisioning

. Improve capital adequacy . Increase level of general loan loss . Improve risk-takingreserves capacity and capital

I adequacy

6.18 Technical Assistance. The technical assistance component will bemanaged by the beneficiaries. Most beneficiaries of the proposed Project havealready established Technical Assistance Coordination Units within theirrespective External Relations Departments. 18 These units have been operationaltypically for about two years and have managed technical assistance by the Bank'sTA/Critical Imports Loan, by the EC-PHARE and the other donors. Before Boardpresentation, the Bank would: (i) perform a final review of the organization andstaffing of the units; and (ii) organize procurement seminars for staffresponsible to manage technical assistance under the proposed Project.

6.19 The technical assistance to PFIs will help to improve their technicalcapacity. The TA would be managed by the NBR and will be available to allRomanian banks with priority given to the PFIs. For the TA to improve appraisaland loan administration capacity, consultants would be placed with the RomanianBanking Association, including specialists for financial analysis and loanadministration, economic analysis, industrial process engineering, export financeand procurement specialist. In addition, the PFI lending operations would be

18/ Satisfactory orsanization and staffing of the units is a condition for Board presentation of theproposed Project.

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closely supervised during the early stages. For the TA to improve portfolio riskassessment and asset liability management and internal controls, the TA will beplaced with the Supervision Department of the NBR.

6.20 In addition, the market assessment and the quality of appraisalswould be enhanced by a set of detailed sector studies financed by or through theBank, and covering practically all sectors from which a viable demand isexpected. Two of these studies have been completed (textiles, garments andleather, financed by the Swiss Trust Fund; wood based industries, pulp and paper,financed by the Swedish Trust Fund); another three will be completed by loaneffectiveness (fertilizer, cement and artificial fiber sectors, financed by theBank's TA/Critical Imports Loan); and two will be financed by the proposedProject. Fifty nine other studies financed by EC-PHARE have also been completed.

C. Loan Administration

6.21 Procurement. Procurement will be performed by final beneficiaries.For items which cost less than US$100,000 equivalent, procurement will follownormal commercial practices satisfactory to the Bank. Procurement of items whichcost US$100,000 equivalent or more will follow the Bank Procurement Guidelinesestablished for financial intermediary operations. For the investment finance,items which cost US$100,000 to US$1 million equivalent would be procured throughinternational shopping on the basis of at least three competitive quotationsobtained from suppliers in two eligible countries; for items which cost more thanUS$1 million equivalent, the limited international bidding procedure would befollowed. For the exDort finance, items which cost US$100,000 to US$3 millionequivalent would be procured through international shopping on the basis of atleast three competitive quotations obtained from suppliers in two eligiblecountries; for items which cost more than US$3 million equivalent, the limitedinternational bidding procedure would be followed.

6.22 The PFIs will be required to maintain records of the procurement madeunder the proposed Project, with summaries of offers received and awards madeunder each subloan. These records would be used by external auditors in auditingthe PFIs' statement of expenditures. The first contract cleared by a PFI and allcontracts above US$1 million equivalent for the term finance and US$3 million forexport finance will be subject to prior review by the Bank; review of othercontracts will be on a sampling basis. The Bank will organize a procurementseminar for the PFIs. In addition, foreign consulting assistance in procurementmatters would be made available to the PFIs. From time to time, procurementseminars will also be organized for the borrowing enterprises.

6.23 For consultants to be retained under the proposed Project, theimplementing agencies would follow the Bank Guidelines for the Use ofConsultants. A nature of consulting services and costs of individual TA itemsare specified in Annex 1.

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6.24 Disbursement. For the investment component, disbursements willcover up to 100% of: (i) foreign exchange expenditures (CIF) for directlyimported goods or ex-factory costs of locally produced goods, as well as up to80 percent for other items procured locally; (ii) foreign exchange expendituresfor engineering, consultant services for the preparation of enterprise businessplans and restructuring or privatization programs, and computerization; and (iii)foreign expenditures for technology transfer, licenses and other payments forspecialized technology and associated equipment of proprietary nature. For theexport finance component, disbursements will cover up to 100 percent of the CIFcost of imported production inputs. For the technical assistance component,disbursements will cover up to 100% of: (i) foreign exchange expenditures (CIF)for directly imported goods; (ii) foreign and local expenditures for consultantservices; and (iii) foreign exchange expenditures for training. Proceeds of theproposed Loan may not be disbursed for payments of taxes and duties levied by theGovernment.

6.25 Due a the great number of small disbursements expected under theproposed Project, disbursements under US$1 million per item would be made againsta certified statement of expenditures (SOE), for which appropriate documentationwould be retained by the PFIs and the implementing agencies. Disbursements aboveUS$1 million per item would be made on the basis of full documentation. TheBank's reimbursement would be limited to expenditures made by final borrowers notmore than 180 days prior to the Bank's receipt of the request for reimbursement.A disbursement seminar will be organized by the Bank to familiarize the PFIs andthe implementing agencies with the disbursement procedures.

6.26 Special Account. Since the proposed Project would involve thefinancing of many small items, a special account would be created in a mutuallyagreed bank to facilitate disbursement. Most expenditures under the proposedProject (which are approved by the PFIs and the TA implementing agencies,respectively, and subsequently authorized by the Bank) would be met out of thefunds in the special account. When appropriate, special commitments or directpayment to foreign suppliers may also be used. The Bank would disburse aninitial amount of US$17.5 million (representing about four months ofdisbursements) into the special account upon effectiveness of the Loan and wouldperiodically replenish the account on the basis of reimbursement requests.

6.27 Revolving Export Finance Fund. For the export credit component, theMOF would create an account in a bank, on terms and conditions acceptable to theBank, to hold the repayments of subsidiary loans by PFIs. Funds in the revolvingfund would be used to finance other export credit applications for the samepurposes and under the same terms and conditions as the original funds under theexport credit subcomponent.

6.28 Disbursement Schedule. The estimated disbursement schedule for theproposed Project is contained in Annex 7. The expected disbursement of theproposed Loan is based on ECA/MENA experience with similar operations, adjustedfor the expecteL impact of the export finance subcomponent. The technicalassistance component is estimated to be fully committed in 12 months, anddisbursed in 24 months. The export finance component is expected to be fullycommitted and disbursed in 18 months, beyond which the financing would continue

- 35 -

through the revolving fund mechanism. The investment component is expected tobe fully committed in 39 months and disbursed in 51 months.

6.29 The initial commitment cut-off date is on January 1, 1996. At thattime, the Bank will review exchange and interest rate policies, foreign tradepolicies and Project's implementation record. The performance criteria for asatisfactory implementation record are: (a) at least US$26 million of projectfunds committed; (b) at least US$20 million of project funds disbursed;(c) projects and export transactions amounting to at least US$20 million in thelending pipeline; and (d) at least two financial institutions still qualified andparticipating in the project. If, on the basis of this review, the Bankdetermines that the Project implementation record is satisfactory and that themacroeconomic environment remains conducive to the attainment of the Project'sobjectives, the final subloan commitment date will be extended to December 31,1997. Otherwise, the Bank may choose, in cooperation with the Government, toredesign or close the proposed Project. The closing date for the loan isDecember 31, 1998.

6.30 Reports and Audits. The PFIs would submit semi-annual reports oncommitments, disbursements, collections and arrears under the proposed Projectto the Bank. In addition, the PFIs would maintain proper accounts for subloans,including supporting procurement and disbursement documents, which would beaudited annually by external auditors acceptable to the Bank. Since mostsubloans would be disbursed on the basis of SOEs, the regular annual audit of thePFI would have to include a special opinion on the adequacy of SOE procedures.Audit reports have to be submitted to the Bank no later than six months after theclose of a PFI financial year. These audits should include a certification thatthe PFI is in compliance with the financial covenants agreed under the proposedProject.

6.31 Under the technical assistance components, the implementing agencieswould prepare and submit semi-annual progress reports to the Bank. Accountsspecific to the project would be maintained separately and would be auditedannually by external auditors acceptable to the Bank. Audit reports should besubmitted to the Bank no later than six months after the close of the agency'sfinancial year. In addition, the Government and TD/14OF will prepare a ProjectCompletion Report for the entire project six months after the completion ofdisbursements, covering all related activities during project implementation anddescribing the project's costs and benefits.

VII. BENEFITS AND RISKS

A. Benefits

7.01 The proposed Project is an investment operation that would supportimplementation of reforms for private sector development, restructuring andprivatization of state enterprises, and in the banking sector. The proposedProject will yield major benefits to Romania by: (a) promoting growth of viableprivate enterprises; (b) creating conditions for effective supply response;(c) increasing exports and improving competitiveness of Romanian exporters;

- 36 -

(d) improving the capacity of the financial sector to provide export financeservices and to appraise, finance and supervise investment projects; and(e) assisting the Government to formulate and implement policies for furtheringprivatization and restructuring.

7.02 The proposed Project would support competitive private enterprises.It would directly assist in building healthy and efficient private financialinstitutions, which would increase competition and contribute to financial marketintegration. By helping PFIs to develop expertise in project lending, it wouldpromote more efficient investments. The mechanisms developed and the technicalassistance put in place would facilitate continuing transformation of thecorporate sector. In addition, it should lead to improvements in enterprisemanagement.

7.03 The proposed Project will have a positive environmental impactethrough the rehabilitation and restructuring of enterprises, including moreenvironmentally sound technologies and operations. The subloan covenants willrequire that any facilities to be provided under the Project meet newenvironmental standards. The proposed Project is thus introducing a conceptwhich may lead to similar concerns by the PFIs in their future lendingoperations. In addition, the proposed Project aims to build institutionalcapacity of the Ministry of Industry to deal with environmental issues.

B. Risks

7.04 The main risk of the proposed Project is a shortfall resulting fromgeneral institutional weakness, including skill deficiencies of banks andenterprise managements. This risk has been addressed by including technicalassistance for all participants in the Project covering the most importantaspects where skill deficiencies might jeopardize the Project's success. Closesupervision, beyond a level normally allocated for Bank projects, will also beperformed to contain this risk (Annex 8).

7.05 Volatility and uncertain prospects can adversely affect PFIswillingness to diversify and/or to engage in long-term lending; a generalincrease in non-performing assets would decrease the PFIs' capacity to take thecredit risk associated with the proposed Project. This risk is addressed throughincreasing the capacity of PFIs to take and sustain financial risk, byintroducing mandatory asset classification and provisioning and by increasingmandatory general loan loss reserves; through the technical assistance to PFIsto better manage risks, off- and on-balance sheet, and by improving theircapacities to assess the credit risk associated with particular borrowers andprojects; through the TA to banks and through preparation of sector studies whichcould be utilized in the project appraisal; by keeping the access open toeligible PFIs; and by maintaining flexibility in terms of reallocation ofinvestment component funds to export finance, and vice-versa. The credit riskof the PFIs and the foreign exchange risk of the final beneficiaries has beendecreased by extending a single currency loan rather than the Bank's standardpooled loan.

7.06 Macroeconomic instability and deterioration of enterprise businessenvironment is a major risk. It may adversely affect investments and exports and

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contribute to rapid deterioration of enterprise viability and the PFIs' financialconditions and profitability. This risk is addressed by the Bank's SAL, andthrough on-going macroeconomic policy dialogue with the IMF and the Bank. Inaddition, the macroeconomic environment and the progress-in-transition programsand in project implementation will be thoroughly reviewed one year after loaneffectiveness, with an option to cut off further commitments in case of seriouslyadverse developments or to redesign the proposed Project.

VIII. AGREEMENTS REACHED AND RECOMMENDATIONS

8.01 During the negotiations, final agreements with the Ministry ofFinance have been reached on the following: (a) interest rate and on-lendingterms to PFIs (para. 6,02); (b) content and form of Subsidiary Credit Agreementswith PFIs (para. 6.01); (c) apex arrangements to be implemented by the MOF andthe NBR (para. 6.09); (d) content of the TA program and agreements for channelingthe TA funds (paras. 5.12 and 6.18); (e) establishment of special accounts onterms and conditions satisfactory to the Bank (para. 6.26); (f) a revolving fundfor export finance (para. 6.27); and (g) content of audit reports and that theyare prepared and furnished to the Bank in a timely manner (para. 6.30).

8.02 Regarding conditionalities, the following agreements have beenreached:

(a) Conditions of Effectiveness. (a) Subsidiary CreditAgreements signed by at least two PFIs; (b) NBR regulationsto increase general loan loss reserves issued; (c) NBRregulations on asset classification and provisioning issued;and (d) NBR regulations on risk-based capital adequacy issued;

(b) Condition of Disbursement. For the export finance component,the MOF would establish a revolving fund for export finance,satisfactory to the Bank, to revolve export credits during theloan grace period; and

(c) Condition Concerning Loan Commitment Period. The initialcommitment cut-off date will be on January 1, 1996. At thattime, the Bank will perform a review (para. 6.29) and, ifsatisfied, extend the loan commitment date to December 31,1997.

8.03 The proposed Project constitutes a suitable basis for a singlecurrency loan to the Government of Romania in the amount of US$175 million at aBank's standard variable interest rate for single currency loans for a period of20 years, including five-year grace period, under terms and conditions outlinedin Chapter VI.

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R0O4ANIA

INDUSTRIAL DEVELOPMENT PROJECT

Technical AssistanceComponent Specifi.ation

1. Skill deficiencies and the lack of institutional capacity are amongthe main reasons for the slow start of Romania's transition, for the sluggishprogress of major transition programs, and for the persisting inefficiencies inresource mobilization and allocation. The main objectives of the TA componentare: (i) to provide assistance for the design and implementation of an effectivepolicy and institutional framework for privatization and industrialrestructuring; (ii) to develop capacity in the banking sector to effectivelymanage its assets and liabilities and to appraise, price and manage financialrisks; and (iii) to improve export and investment lending and loan portfoliomanagement practices of participating banks. Table A1.1 summarizes TA to beprovided under the proposed Project. Following is a brief description ofspecific TA components. Detailed Terms of Reference are kept in the projectfiles.

Table A1l1: Technical Assistance Siumary

caCtPOy RECIPIENT COST (US$ SERVICE IXPECTED___________ TOUSAND) PROVIDERI/ START/END

(i) flestructurinR* Sectorel Studies MDI/CC 700

Electrical Machinery MDI/CC 300 FirD 9/94-4/95Electronics + Consumer goods MOI/CC 400 Firm 9/94-4/95

Environmental Assistance "Di 150 Indiv. 1/95-1/96Industrial Technology Infrastructure Study M01 250 Firm 9/94-4/95Industrial Policies and Sector Strategies M01 6So Indiv. /Firm 9/94-9/95

(ii) TA for the Banking Sector Banus 500Implementation of Unified Chart of Accounts 150 Indiv. Firm 7/94-3/95Assistence for Asset/Liability and risk Mgmt. 200 Indiv. 9/94-9/95Assistance for Internal Control Systems 150 Indiv. /Firm 1/95-S/95

(iii) TA to PartiCiDating Financinc Institutions FrI 800 Firm 5/94-9/95Export Finance 150Project Appraisal 350Loan Administration 150Procurement/Disbursement 150

CC - Commercial CompaniesMOt - Ministry of Industry1/ FirA - Consulting company by shortlisting.

Indiv, - Individual consultants; for amounts higher than 50,000. more than one individual in to beretained. Consultants will be selected based on CVs of three qualified consultants.

PFI - Participating Financial Institutions

- 39 - mm JLPage 2 of 4

2. TA for ProJect Preparation. The TA during project preparationincluded restructuring studies for sectors from which major financing demands areexpected. The studies have multiple purposes: (i) to help the MOI designenterprise assistance programs to address issues common to most enterprises inparticular sectors; (ii) to help the KOI develop restructuring strategies; (iii)to help SOF/POFs identify enterprises which could be privatized immediately; and(iv) to provide the PFIs with sectoral context upon which to base projectappraisals. Two such studies have been completed during preparation of theproposed Project: the Wood Based Industries Study (including pulp and paper,wood processing and furniture manufacturing) has been financed by the SwedishTrust Fund and the Textiles, Garments and Leather Sector Study has been financedby the Swiss Trust Fund.

A. Restructuring

3. The TA program for restructuring, to be administered by the NOI,amounts to US$1.7 million. Following is a brief description of the specific TAcomponents.

4. Sector Studies. In order to be able to design targeted programs. foreffective restructuring and rapid privatization, the Government plans to initiatereviews of all major industrial branches. The studies program was developedjointly with the MOI in December 1991 including about 80 industrial subsectors.In addition to the two studies mentioned above, about 51 subsector or branchstudies financed by the EC-PHARE have been completed. Remaining studies to befinanced under the IDP are for sectors for which donor funding could not be foundincluding electrical machinery, electronics and consumer goods.

5. The overall objective of the sector studies is to provide detailedand up-to-date information on the institutional structure, competitive advantage,weaknesses, and prospects of particular sectors within the context of a marketeconomy and world competition. With four major audiences, a sector study should:(1) assist the Ministry of Industrv to develop a sector restructuring strategyand identify assistance programs to support this strategy; (ii) assist governmentagencieg to develop strategies for accelerated privatization in the sector, andidentify policy actions that may be required to help enterprises to prepare forprivatization; (iii) assist individual firms to better assess their currentoperations, and identify viable development opportunities; and (iv) provideinformation to domestic and foreign private investors and banks to determinepotential investment opportunities.

6. More specifically, the studies will cover three broad areas: (i) theexisting structure of the industry, including products, capacities, number ofcompanies, organization, historical profitability, investments, imports andexports, value added, etc., including international comparisons whereappropriate; (ii) markets and marketing, and a review of local market potentialand of export market potential, including an assessment of global trends; (iii)strategic direction, including identification of the industrial segments/productsthat are currently competitive and strategies that will be required to maintainand strengthen competitiveness; identification of the constraints that prevent

- 40 - ANNEX 1Page 3 of 4

certain segments from attaining international competitiveness and appropriateactions to deal with these constraints; and recommended strategies for sectorrestructuring including, as necessary, downsizing of production capacities.

7. Consulting assistance to the MOI to develop environmental assessmentaud recovery management capabilities. The Ministry of Environment is currentlyresponsible for the development of environment policies, standards and monitoringprocedures and assessment guidelines. The role of the Ministry of Industry isto assist the enterprises in preparing environmental assessments and to achievecompliance with national standards and environmental policies. The consultantis expected to help the MOI develop the capacity to provide assistance toenterprises in preparing environmental assessments, including a set of manualsto be used by enterprises for environmental assessments, and to prepare specificpilots which will demonstrate efficient methods to address environmental problemsin enterprises in specific sectors.

8. The Industrial Technologv Infrastructure Study will assess theexisting situation and needs and propose the conceptual framework to developindustrial technology infrastructure in Romania, including its regulatory andinstitutional framework and development plan. This will specifically addressregulations concerning standards, patents, technology purchase and licensing andother eleuents of regulatory and institutional framework concerning intellectualproperty rights, quality control framework, and the related institutions; addressthe future role of the 140 existing institutes in supporting the industrialsector; propose the framework for strengthening the capacity for applied researchand industrial technology consulting; address financing aspects; and proposemeasures to strengthen, refocus or downsize a number of institutes.

9. Technical Assistance to the Ministry of Industry would include thefollowing TA items: (i) advisors to the MOI to assist in the development ofindustrial policies and specific sector restructuring strategies; and(ii) computers and office automation equipment and training.

B. TA to Banks

10. TA under the proposed Project would be needed to help the NBR and thebanks in Romania to operationalize and implement the new systemic framework,especially prudential regulations, with the objective to improve safety andsoundness of Romanian banks. More specifically, assistance will be provided to:

(a) assist in implementation of the unified Chart of Accounts forbanks, including development of the requisite accounting andconversion manuals, staff training and assisting the banks inconverting their current system to the new chart of accounts;

(b) assist in the development of guidelines and operationalpolicies and the requisite implementation manuals concerningmethods for assessment of and limits on the exposure tovarious types of financial risks on- and off-balance sheet,

- 41 - ANNEX 1Page 4 of 4

pricing of various risk elements and management of risk(including methods for loan classification and levels ofprovisioning) and staff training; asset/liability managementfor commercial banks including specific techniques to managemismatches of asset/liabilities portfolio, advises onportfolio structure and instruments with various risk featuresthat could/should be introduced in Romania, etc.; and

(c) assistance in the conceptualization, development of respectivemanuals and technilues and implementation of a system ofinternal audits and controls in commercial banks and therequisite staff training.

11. This assistance will be provided for a period of nine months.Consultants will be situated in the NBR and will provide assistance to all bankslicensed and operating in Romania.

C. TA to Participating Financial Institutions

12. Technical assistance to PFIs for the duration of about 12months is also deemed necessary to strengthen their capacity to appraise creditsfor export and investment finance, to administer the credit lines and to developloan supervision capacity. Specifically, TA will be available to assist a PFIto start operations, to help internali--e operating procedures and to developmonitoring and reporting systems, to prvvide on-the-job training for staff, andto assist in initial appraisal and lo- supervision for subloans extended underthe proposed Project.

13. This assistance would be managed by a steering committeeincluding a representative of the NBR and of all PFIs. It would be providedunder the auspices of the Banking Association and will be physically located inthe NBR. Priority will be given to participating banks, but access to TA willbe open to other banks. Experienced foreign consultants with the followingprofiles would be financed: (i) financial analysis and loan administration; (ii)economic analysis; (iii) industrial process engineering; (iv) export finance; and(v) procurement specialization.

- 42- ANNEX2Page 1 of 9

RQMANIA

INDUSTRIAL DEVELOPMENT PROJECT

The Banking Sector

1. Reform of the banking system was initiated early in the process oftransformation to a market economy. Entry to the banking sector was liberalizedin mid-1990. The two-tier banking system was established by late 1990, andformally legislated in April 1991 with a passage of the Law on Banking Activityand the Law Concerning the Status of the National Bank of Romania (NBR). TheBanking Law endows commercial banks with universal banking powers, and the NBRis given a high degree of formal independence.

2. The dominant institutions in the sector are banks inherited from thecentral planning system: the Bank for Agriculture (BA), the Romanian DevelopmentBank (RDB), the Savings Bank (CEC), and the Romanian Bank for Foreign Trade(RBFT). While still in state ownership, these banks are incorporated as joint-stock commercial companies and enjoy a universal banking license. By the end of1990, a number of private banks was established, including the Bank for SmallIndustry and Private Initiative (MIND), the Cooperative Credit Bank (CCB) and theIon Tiriac Bank for Commerce (TCB). The new regulatory framework provided forliberalized entry of new foreign or mixed-ownership banks, and removed limits onthe types of customers and financial services that could be offered by foreignbanks. This group currently includes the Chemical Bank (CBF), the SocieteGenerale (SGF), the Frankfurt-Bucharest and the MISR Bank. There were also newentries by banks in state ownership, including the Romanian Commercial Bank(RCB), which was formed in late 1990 by carving out the commercial portfolio fromthe balance sheet of the NBR; the Export-Import Bank of Romania (EXIM), which wasestablished in 1991 to strengthen financial services to the foreign trade-oriented industrial and services sectors; and the Bank Post, S.A. By late 1991the private bank Dacia Felix (DFB, based in Cluj) and the Banca CredituluiRomanesc S.A. (Credit Bank) were created. The Romanian commercial banking sectornow comprises six state-owned banks, six private banks (with Romanian capital andjoint ventures) and the, Bucharest branches of four foreign banks. Another sevenprivate banks are in the first phase of the registration process,1 and one hasapplied for registration.

I/ Since mid-1992. banking licenses are issued in two steps. The first step allows the banJk toreSister std start preparing itself to open for busineses. After an NBR review and satisfactoryfindings conicorning readiness of the prospective bank, an operating license allowing the bank toopen for business is issued. Sevn banks reoeived the first-stage licence in the October 1992 toOctober 1993 period including: Bancs Rt aneasca, Banca Cteditul Comnercial Roman (CREDCOI), Banc&de Credit Consurcial si Industrial., Banca de Credit si Detvaltare (RQ4EXTSRA), BancaIntercoufesionaLa Raena, Santa Roman a Patronotulut Privet (PATRWBARK) and Buchaxest Bank.

- 43 - ANNEX 2Page 2 of 9

3. The structure of the commercial banks' balance sheets is shown inTable A2.1. The main characteristics of the Romanian banking sector are:

Table A2.1: Structure of the Commercial Banks Balance Sheets

PercentaMe of Total Assets Percentage Chargesl/Dec 1993/ Dec 1992/

Assets Dec 91 Dcc Pec93 DSc1992 Dec 1991

Foreign Assets 4.6 7.7 12.9 +343.9 2/ +184 /Cash 0.8 12 0.7 +154.7 +183Non-Govt. Credit 60.1 492 47.8 +255.7 +39Govt. Credit 5.4 5.1 3.9 +201.0 +60Interbank Asets 21A 252 22.5 +2223 +106Other Assetl/ 7.7 11.0 12.1 +298.3 + 151

Liabilities

Foreign Liabilities 6.0 5.5 7.0 +296.6 +55Clients Deposits 39.7 36.0 33.8 +240.1 +63Loans from NBR 17.0 9.0 153 +435.6 - 10Interbank Loans 12.6 24.6 11.8 +191.9 +42Equity 3.0 7.8 4.8 +190.3 +337

ii Other asseu include non-peformg assets covetd by Dedsion 447/1991 and LAw 7/1992.2/ Inaease also reflects depredation of leL In 1991, the vohime actually declned by 2% in US dollars tams; in 1992, it

increased by 17 % in US dollar terms; in 1993, thfe volume increased by about 6% in US dollar tenns.l/ Changes in nominal values Annual inflation in 1991 was 279%, in 1992 - 200%, and in 1993 - 280%.

VerX higb market concentration. At end-1990, over 93 percent of thebanking sector non-government credit was concentrated in fourgovernment-owned banks (BA, RDB, RCB and RPFT), and about 40 percentof the total deposits in the Savings Bank. By end-1993, the shareof the largest four banks in the credit market stood at 87 percent;on the deposit side, their total share (including the Savings Bank)stood at 50 percent.

Weak funding base and dependence on NBR refinancing and interbankliabilities. In 1990, the NBR and interbank financing accounted forabout 45 percent of the total domestic liabilities (of which about80 percent is NBR refinancing); own deposits (excluding the CEC)accounted for 18 percent of the total domestic liabilities; and theratio of own funding to the total non-government lending was about27 percent. The situation has substantially improved in the 1991-1992 period. By end-1992, the interbank financing accounted foronly 26 percent of the total domestic liabilities (of which about 48percent is NBR refinancing); own deposits accounted for 28 percentof the total domestic liabilities and the ratio of own funding to

- 44 -Page 3 of 9

the non-government lending improved to about 55 percent. There wasalso a modest improvement in 1993; by end-1993, own depositsaccounted for about 30 percent of domestic liabilities, and loancoverage increased to about 58 percent.

Unsophisticated structure of instruments and poor quality of theloan portfolio of state-owned banks, including heavy concentrationby sectors and enterprises. Some of the commercial banks startedtheir operations with exposures to a single borrower higher thantheir equity capital. The heavy portfolio concentration in specificsectors (e.g., BA in agriculture, RDB in manufacturing) coupled withthe dominant position of these banks in their respective creditmarkets, has also created an effective sector-bound segmentation ofcredit markets in Romania.

High_ jnstitutional growth. About 25 new licenses have been issuedsince the entry was liberalized and 17 new banks have opened forbusiness. However, the highest growth in absolute terms waswitnessed with the largest state-owned banks. In the 1990-1992period the RCB staff increased from 3,000 to 9,200 employees and thenumber of branches from 110 to 221; the RDB increased employmentfrom 2,000 to 3,600 and the number of branches from 49 to 170.

Strong contraction in real terms. The growth of the commercialbanks' balance sheet was high in nominal terms; in real terms,however, the size of the balance sheet substantially contracted inthe 1990-1993 period. Total assets of commercial banks rose by 114percent in 1991, by another 75 percent in 1992, and by 256 percentin 1993; in real terms, however, the total assets at end-1992 wereabout 85 percent, and at end-1993 about 72 percent of that at end-1990. Non-government credit volume in nominal terms doubled in1991, grew another 40 percent in 1992, and 256 percent in 1993; inreal terms, the end-1992 volume was 64 percent and at the end-1993volume about 54 percent of its end-1990 level. Medium- and long-term credit volume increased by 71 percent in nominal terms in the1990-1993 period; in real terms, at end-1993, it was about 13percent of that at end-1990.

Financial Position and Profitability. In the course of 1992, theprofitability of Romanian banks has substantially increased, mostlydue to the very large spreads (e.g., at end-1992, deposit ratesstood in the 13.5-65 percent range, and lending rates in the 33-96percent range), lower tax levels, and growth of the off-balancesheet services and the related commissions. The portfolio risk ofall private banks and a number of smaller state-owned banks hasgenerally decreased, including maturity mismatches of assets andliabilities and interest rate risk exposure, foreign exchange riskexposure, and credit risk exposure. The latter is due to acombination of factors including conservative credit policies, more

- 45 - ANNEX_gPage 4 of 9

careful clients and project appraisals and sign ,icantly shorteraverage maturities. General improvement of the financial positionsof a certain class of corporate clients has also played a role.

The financial condition of the largest state-owned banks, however,has remained precarious. With a weak funding base, they almostcompletely rely on the CEC and the NBR refinancing, and continue toengage in adverse selection.

Increasing Private Sector ParticiRation and Improved Capitalization.As of end-1991, private capital in the banking sector accounted forabout 6.4 percent of the total capital. The newly created EXIM Bankbrought to the system about three time more than the total privatecapital committed in the 1990-1991 period. In 1992, the privatecapital increased to about 22 percent and, in 1993, to 28 percent ofthe total capital.

At end-1990, equity capital in the Romanian banking sector was abouttwo percent of the total liabilities. Low capitalization was mostlyconfined to state-owned commercial banks. In 1991, thecapitalization of the banking system increased to about threepercent, due to the occasional recapitalization of the state-ownedbanks and to the new capital brought by the new entrants. By end-1992, the capitalization of the banking system increase- to abouteight percent due to the strong contraction of the banks' aggregatebalance sheet in real terms. At end-1993, capitalization hasdeclined to about six percent; while the new capital committed in1993 greatly surpassed the volume committed in 1992, an aggressivegrowth of the banking sector asset portfolio has brought the overalldeterioration of capital adequacy. However, the private and thesmaller state-owned banks have kept their risk based capitaladequacy ratios at eight percent or more, and the deterioration hasbeen mostly the result of the significant worsening of the financialposition of the two largest state-owned banks which account forabout 40 percent of the total capital in the banking system.

Policy Environment

4. A monetary control framework based on the two-tier banking system wasestablished quite early in the 1990 banking reform. The NBR has graduallyintroduced reserve requirements, limits on re-financing credit and re-financingrates as instruments for monetary control. Given that the financial markets wereunderdeveloped and that neither banks nor enterprises were fully responding tomarket signals, there were limits to the effectiveness of these indirectinstruments. Minimum reserve requirements were introduced in January 1992, butthe instrument has not been used as a tool for controlling liquidity on an on-going basis. The NBR capacity for monetary programming has been and is stilllimited, partly due to the lack of capacity in the NBR and partly due to the lack

- 46 - ANNE 2Page 5 of 9

of precision and the difficulties with consolidation of branch accounts of largebanks.

S. In the course of 1991, the NBR continued use of global creditceilings. The global ceilings were translated into guidelines for individualbanks, thus inhibiting emerging competition in the credit markets. Moreover,direct credit controls could have been a major stimulant to the increase ininter-enterprise lending, both voluntary and involuntary. During 1992, the NBRstarted to rely more on its refinancing operations to control the evolution ofthe monetary base by using three types of refinancing facilities: lines ofcredit, including regular credits (two week maturity at NBR reference rate),special credits (medium to long term with interest rates below the referencerate), and auction credits (short term with a rate determined by bidding and eachbank having a pre-assigned bidding amount). By end-1992, the share of specialcredit lines in the total NBR refinancing operations rose to 79 percent and byend-April 1993 to 96 percent, thereby rendering the auction mechanism inoperativeand the NBR getting close to loosing its capacity to effectively influence themonetary aggregates. In October 1993, the NBR initiated a major restructuringand repricing of its refinancing facilities aiming to regain monetary control andto influence adjustment of interest rate levels to posicive real terms. By end-1993, against the background of increasing refinancing rates which becamecomparable to the level of inflation, the NBR refinancing facilities includedabout 35 percent in regular credit lines, 20 percent as preferential credits, 34percent as auctioned credit, and 11 percent as overdraft facilities.

6. The interest rate liberalization was ir.troduced in 1991, but withmixed effects. Interest rates on deposits remained depressed, partly due to theSavings Bank business policies and its extremely high concentration in thedeposit markets. Another significant factor was low-interest government depositswith commercial banks, which were due to the large operating surpluses of extrabudgetary funds; at end-1992, these amounted to about L240 billion or about 17percent of commercial banks' total liabilities. At end-1991, the average depositrates stood in the 6-14 percent range; at end-1992, the cost of depositsincreased to the 13.5-65 percent range with government deposits covering the lowend of the spectrum.

7. The increase in refinancing rates of the NBR, from an average nominalinterest rate of about 49 percent in July to about 120 percent in December 1993,has been followed by the substantial increase of deposit ratds in the bankingsystem. By January 1994, the level of deposit interest rates was in the 60-110percent range. The lending rates have followed a similar path, from the 50-85percent range in July to the 75-130 percent range at end-1993. In 1994, theinterest rates on loans have, for the first time in recent Romanian economichistory, reached positive real levels.

Recent Banking Sector DeveloRments

8. The mid-1993 to end-March 1994 period was characterized bydeterioration of the banks' financial positions triggered by the withdrawal of

- 47- ANEL.Page 6 of 9

government deposits in July 1993, followed by a substantial increase in the costof NBR refinancing and the cost of funding in general. The withdrawal ofgovernment deposits (at 10 percent annual interest rate) was initially fullycompensated by tha increased volume of NBR refinancing (from about Lei 235billion average in June to Lei 767 million by August 1993) delivered throughregular ("current") credit lines at the NBR reference rate of 70 percent(compounded rate of about 97 percent); the NBR auction and overdraft facilitieshave practically rtot been used until September 1993. In October, however, theNBR moved Lo restructure the composition and to reprice its refinancingfacilities. Regular credit lines were partly replaced by auctions (frompractically zero volume in August to Let 396 billion in October and Lei 642billion in December 1993) with the respective nominal rates increase from about84 percent to over 150 percent in the October-December 1993 period, and overdraftfacilities (from practically zero to Lei 352 billion in October and Lei 187million in December 1993) with respective nominal rates increase from about 106percent to 250 percent. In real terms (i.e., compounded rate), the rates inJanuary 1994 were as high as 540 percent for auction refinancing and 870 percentfor overdrafts. The average cost of the NBR refinance (including very low costpreferential credit lines) increased from about nominal 49 percent (APR 56percent) in June 1993 to 137 percent (APR 362 percent) in January 1994.

9. Consequently, competition has promptly developed in the depositmarkets. The nominal rates on sight deposits increased from about 30 percent inJune 1993 to 45 percent in January 1994 (and as high as 85 percent for certainbanks with generally low deposit base) and from the 30-50 percent to 60-110percent range, respectively, for term deposits. Most affected were, of course,banks who did not manage to develop their own funding base in the 1990-1993period (notably BA and RCB) and private banks whose asset portfolio size grewwell ahead of their own funding (notably Dacia Felix). The positive effects ofthese developments were the declining dominance of CEC in the deposit marketsand an increase of domestic deposits (by about 72 percent in the July 1993 toFebruary 1994 period), but the increase in the stock of deposits still remainedbelow the level of inflation. In response to the higher funding cost, lendingrates have also increased to 110-130 percent nominal rates (i.e., compound ratesin the 180-240 percent range). This has brought an increased systemic risk,reflected in an increased level of losses; in the July 1993-February 1994 period,overdue credits increased by 2.3 times for domestic currency borrowing and about4 times for foreign currency credits.

10. The dynamics of portfolio adjustments of Romanian banks wasdetermined by inh.ent rigidities in the asset portfolio's structure by the levelof viable domestic demand and by the size and ownership structure of particularbanks. The three largest state-owned banks (RCB, RBFT and BA) continued theiroperations with little or no adjustment; this was essentially supported byallowing privileged access to the NBR regular credit lines (the three accountedfor 99 percent of the total volume) priced at nominal 70 percent rates; exclusiveaccess to preferential credit at 10-70 percent nominal rate (100 percent of thetotal volume); and access to NBR auctions (typically 100 percent of the totalvolume, with an exception of the Dacia Felix, who occasionally participated,

- 48 - ANNEX-2Page 7 of 9

accounting for 5-8 percent of total auctioned an.ount). In effect, by end-1993the reliance of the banking system on the NBR refinancing facilities againincreased to over 50 percent of the total liabilities; by February 1994, thevolume of the NBR refinancing was roughly twice as big as the total household andcommercial sector deposits.

II. Against the background of increasing funding cost and uncertainfunding perspectives, the adjustment of the private banking sector and the RDBwas much more dynamic. Banks have kept the nominal volume of lending at aboutthe July 1993 level (i.e., contraction for more than 50 percent in real terms)mostly due to the lack of viable demand at the level of nominal lending ratesbeyond 130 percent. Profit margins were also squeezed compared to their 1992 tomid-1993 levels, and banks were attempting to increase profits by increasing thefrequency of loan service payments. Uncertainty has also been reflected in thesignificant shortening of maturities, from about three months average in mid-1993, to less than two month average in March 1994. In the 1992 to mid-1993period, the average maturity of domestic credits was about 3 months whichcorresponded to an average business cycle. Now, maturities of two months or lessdo not cover an average business cycle, and working capital finance ispractically not available in Romania. Banks have, however, quickly realized thegravity of this situation and are in the process of addressing it through capitalincrease (50-200 percent increase has been announced by the DFB, Tiriac, RDB,Bank Post, Bank Coop and RDB). The new capital will typically be paid in foreignexchange and involves foreign investors. By significantly increasing equity, abank promptly decreases its funding needs; the higher capital base will alsoallow somewhat longer maturities, and the bank would be better able to keepinterest rates at levels attractive to its clients.

Banking Environment

12. State-owned enterprises (often monopolies) are not accustomed and/orcompelled to respond to market signals, and they either pass on the cost offinancing or do not pay. Repeated debt forgiveness may have created a moralhazard problem, in that the beneficiaries of these schemes (i.e., the delinquententerprises and the three largest state-owned commercial banks) may now expectthe Government to continue this practice in the future. On the other hand, bankshave not been in a position to increase their capacity to take and sustain riskother than through capital increase. The case in point is profit taxation, wherethe profit taxes are levied on nominal profits, rather than on profits adjustedfor inflation, which leads to continuous erosion of capital. At the same time,mandatory loan loss reserves are low, and banks are not encouraged to provision,in that provisions and loss reserves are not considered to be a part of thebanks' operating costs beyond the tax-deductible general provisions of 0.5percdnt of the total loan portfolio. The proposed Project will address thisissue through conditionalities for loan effectiveness: the NBR will introducemandatory asset classification and provisioning according to internationallyaccepted standards, and general loan loss reserves will be increased to twopercent.

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13. The credit appraisal, however, is likely to remain difficult. Inaddition to the still limited capacity of financial institutions to identify andcorrectly price the credit risk, there are also systemic problems. Romania lacksstable institutions and the track record of political cohesion necessary todesign and consistently implement the macroeconomic policy and institutionalreforms. The rules of the game have not yet been fully established, and a levelplaying field for all economic agents has not been fully implemented. Thiscreates problems in appraising and pricing credit risk, especially concerningnon-negotiable financial instruments with longer maturities.

Prudential Regulations and Supervision

14. The NBR is aware of the serious implications of the currentlydifficult business environment for the safety and soundness of the bankingsector. The Supervision Department of the NBR has been established immediatelyafter the new regulatory framework was enacted. The Department comprises threedivisions and now employs about 25 staff. Since mid-1992, a comprehensive setof prudential regulations has been enacted, including:

- new two-step licensing regulations with increased minimum requiredcapital;

- loan exposure limits and portfolio exposure limits includingexposure to a single borrower and affiliated groups, regional andsector concentration limits, foreign currency exposure limits, andcontingent liabilities exposure rules;

- ownership and management/board qualifications;

prohibited business and regulations concerning diversification; and

- insider lending and connected lending.

The issuance of prudential regulations concerning the definition of capital,capital adequacy and loan classification and provisioning, which are comparableto international standards, are conditions of effectiveness of the proposed Loan.

15. Most importantly, the NBR has started to exercise its supervisoryauthority, including off- and on-site supervision. In 1993, the NBR revoked theforeign exchange operations license of one bank; fined another bank for breachof regulations; and suspended a general manager of a third bank because ofmismanagement of the bank's risks. The banking system appears to be reacting ina positive way. The NBR reports notable improvements in attentiveness of banksto supervisory initiatives from the NBR.

16. However, there are other areas that still need to be addressed.First, there is currently no mechanism to protect deoositors of the private ormixed banks. For the state-owned banks, the protection is provided onlyimplicitly, except in the case of the state-owned Savings Bank (CEC). In the

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event of liquidation, individual depositors are to be reimbursed to the extentpossible, given the state of the bank's assets. Second is grovth management.The Romanian banking sector is growing very rapidly, in terms of number oftransactions, number of clients and branching. The negative aspect of the highgrowth environment is the danger of over-extension. At least three institutionsare known to have seriously jeopardized their financial positions due to theirfailure to diligently manage growth. Third, according to the currentregulations, there are few limits to business diversification, and banks canengage in certain types of capital market activities.2 So far, banks' activitieshave included the intermediation in the placement of securities in the processof privatization and the equity investments. Banks' engagement in the securitiesand equities business implies potentially large contingent exposures whicb mustbe subject to regulation and prudential supervision. However, this has so farreceived little attention by the NBR.

I/ This is an approach followed by san EEC cout.rie (e.g. zaa='). but with corrs.poadis prudanti*Lregulations and supervision.

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INDUSTRIAL DEVELOPMENT PROJECT

Participating Banks

1. The proposed Project has generated a very strong interest forparticipation by Romanian banks. The qualification summary is provided in TableA3.1. Ten banks have applied for participation, of which siX were able to meetqualification criteria, two were asked to take additional measures to be able toqualify and two were rejected. New applicants will be invited before theproposed Loan becomes effective and the application process will remain openuntil the funds are coomitted.

Table A3.1: Qualification Sumary

FingBank Ownesip Apisa 1/ ApaisaL 2f Commenets

RBFr State 3J Yes YesRCB State Yes No To be reppriedllnac Bank Private Yes Yes Qualified in August 1993RBD State Yes Yes Qualified in July 1993Dacia Felix Mied Yes Yes To be reappraisedCredit Bank Mixed NoBank Post State NoEXIM State / Yes No To be re-sedChemical Bank Forign Yes YesSociete Generale Forein Yes Yes

/Results of the NB apprasa/ Participadon in the proposed Project

3/ Intheprocessofprvatizaonorsootoobepuivatled

2. The appraisal was based on the level of capitalization and capitaladequacy, using international standards as qualification criteria, and onqualitative criteria. The following qualitative aspects were studied:

- quality of management, managerial structure and human resources;

- risk management - identification of risks, credit appraisal andmonitoring procedures, loan loss provisions, funding structure;

- information systems - data bases, computerization level and qualityof management information systems;

- internal control and auditing systems;

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business strategy and future growth/diversification plans;

plans for external auditing (by international auditing firms) in thenear future); and

- in the case of the two private banks, their accumulated experiencein banking business and operations.

Annex 5 provides a detailed description of the qualification process andcriteria.

Table A3.2: Summary of Banks Appraisals

ROMANIANBANK FOR ROMUNIAN RCHARIAN ION TrRIAC DACIAFOREIGN COFMERCIAL BANK COtMMERCIAL FELIX CHEMICAL SOCIETE

CRILERIA TRADE _a FCR DEYL EX IBANX _ ANK LUN , BADM GElnMIU

Capital adequacy Yes No (4) Yes Yes Yes yes Yes (2) Yes (2)sufficient?

Fin. performance Yes No Yes Yes (1) Yes Yes Yes Yessatxsfactory duringlast two years?

-Financial policies Yes Yes Yes Yes Yes Yes Yes Yesmeet min. standards?j/

-Satisfactory loan Yes Yes (7) Yes No Yes developing (3) (3)classification andprovisioning?6/

-Standard credit Yes Yes Yes developing Yes Yes Yes Yesappraisal policies?

-Skills sufficient Yes Yes Yes Yes Yes Yes Yes Yesfor export finance?

-Good standing with Yes Yes Yes Yes Yes (9) Yes (9) Yes Yes

-External audits Yes Yes Yes Yes (8) Yes Yes (6) N/A N/A

Note: (1) Less than two years of activity.(2) Branch of a foreign bank, with risk fully assumed by the headquarters.(3) Loan classification and provisioning as required by the headquarter supervisory authorities.(4) Final decision pending full review and classification of asset portfolio.(5) Standards reflecting commercial practices of the Romanian environment.(6) To be introduced by the NBR by end-1993. Currently not mandated by prudential regulations.(7) No systematic loan classification.(8) First external audit to be done at end 1993.(9) Except lending to connected parties which is being addressed.

3. For the financial performance, the appraisal has also includedassessment of volatility of the financial condition of a bank, its risk profileand flexibility inherent in the structure of its balance sheet. For thequalitative criteria, minimum acceptable standards, rather than standards forbanks operating in developed market economies, have been used. The quality of

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management has been given major importance at appraisal. Specific concernsincluded management appreciation of risks in the current business environment andof financial market conditions, existence of a coherent growth anddiversification program, and management understanding of bank's majordeficiencies and existence of plans to address them. Staff skills and relevantexperience were also appraised. However, because of the developmental role ofthe proposed Project, willingness to develop such skills, if currently less thansatisfactory, was also acceptable for participation. Staff training and massivetechnical assistance would be provided under the proposed Project to build theskill capacity to the fully satisfactory level. A summary of bank appraisals isprovided in Table A3.2.

Romanian Bank for Foreign Trade (RBFT)

4. The RBFT was established during central planning as a specializedbank with a monopoly over the conduct of all foreign exchange transactions anda responsibility for managing Romania's balance of payments. It was incorporatedunder the new Banking Law in December 1990 as a joint-stock company wholly ownedby the state. By end-1993 about 1.3 percent of equity was sold to employees, andPrivate Ownership Funds owned 29.6 percent of equity. Senior management hasproposed that the RBFT be privatized in 1994, through the floating of shares forRomanian investors and by direct placement of up to 50 percent of shares withforeign institutions. The EBRD has subsequently announced its intention to buyup to 20 percent of the total RBFT shares by dilution of ownership.

5. At end-1993, the RBFT capital amounted to LIOO billion, up from aboutL35 billion at end-1992 and L20 billion at end-1991. In the course of 1992, toprevent erosion, the RBFT capital was converted and is now recorded in foreignexchange; it is invested abroad yielding about 8-9 percent return. The capitalincrease was to improve its capital adequacy and to prepare the bank to implementits diversification and growth-oriented strategy. The strategy includes plansfor aggressive marketing in order to diversify its customers base, which is nowdominated by enterprises from the trade and services sectors; a program todiversify from financing import and export transactions into lending andprovision of other business-related customer services (e.g., overdraft accounts,equity finance); and plans to improve regional coverage and access to itsservices. Application for participation in the proposed Project is seen as oneof the steps in line with the RBFT business strategy.

6. The RBFT has been regularly audited by external auditors. Financialstatements as of end-1991 and end-1992 received clean audit opinions. At end-1992, the RBFT assets totalled L862 billion; by end-1993 the total assets wereabout L2 trillion (an increase by 2.3 times). The main assets were loans topublic enterprises (L617 billion of which, 75 percent foreign exchange loans) anddeposits with the NBR (L757 billion) and with other banks (L38 billion). Theshort-term credit constituted about 70 percent of the loan portfolio. The own-funding base, comprising sight and term deposits, provided full coverage of theloan portfolio, both for domestic and for foreign exchange credits. Aggressivegrowth of the loan portfolio, which increased by 88 percent in 1992, and by 2.3times in 1993 has also brought some problems. The past-due loans amounted to

- 54 - ANNEX 3Page 4 of 15

about 4 percent of the RBFT assets in 1991 and the ratio increased to 8 percentin 1992 and 10 percent in 1993. The RBFT capital amounted to L100 billion atend-1993, and the capital adequacy ratio (based on the Basel formula) was closeto 8 percent, down from about 18 percent at end-1992. The ratio was calculatedwith an assumption that 90 percent of the nominal value of loss and doubtfulloans portfolio at end-1992, amounting to L40 billion, has been underwritten bythe government.1 In addition, a reduced risk weight was attached to RBFTcontingent liabilities, of which a significant part has been covered by cashcollateral.2 With regard to the loan loss provisions, the RBFT external auditsclarify that the provisions are based on the NBR regulatory requirements andmanagement evaluation of portfolio risks. The RBFT profitability 'has beenreasonably good. The net profit amounted to L7.7 billion providing for about 9percent return on capital in 1992, and L14 billion and about 14 percent,respectively, in 1993.

7. The RBFT risk management has been substantially strengthened inrecent years. As of now, and according to its declared policy, the RBFT does nottake the maturity and interest rate risk; it does, however, take limitedguarantee-related foreign currency risk. Thus, the main risk which exists in thebank's asset portfolio is the credit risk. However, the bank has recentlydiversified into equity investments. This was intended to help restructuring ofsome of the bank's larger borrowers, thus improving their financial position anddecreasing their probability of default.3

8. The RBFT has introduced procedures for credit appraisal. These arespecified in a detailed manual, which also defines the various credit approvaland risk exposure limits. The adequacy of these procedures and their relevanceto the changing structure of the Romanian economy needs to be periodicallyreviewed by the NBR, as well as by the RBFT's external auditors. The bank hasrecently established a loan review function, as the on-going monitoring of thequality of loan portfolio reduces the probability of loan losses.4 All customerswith loans above L50 million are reviewed each month and problems are reportedto management.

I/ The bad loan portfolio includes a L23 billion credit to the OLTCIT plant which produced Citreon carsunder license. and export credit in the form of deferred payments to several Middle Eastern and Africancountries. The OLCIT Loan was advanced before 1989. The ten percent weight factor is based on Decision 447of 1991 and Law 7 of 1992.

2/ Contingent liabilities covered by government guarantees were assigned the risk factor zero.However. in the course of 1993 RBFT calLed about L84 million of unconditional government guarantees whichthe Government has not honored so far.

I/ The RBFT Board of Directors recently imposed ceilings on such activities. Risks attached to suchactivities will be explicitly taken into account when determining the required level of capitalization ofRBFT.

j/ The establishment of a Loan Review function was a condition for qualification.

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9. The bank employs 1300 employees, of which 40 percent have academicdegrees, and about 30 percent are under the age of 30. The bank conducts regularand comprehensive training programs for its employees (about 200 hours oftraining per employee per year) with the help of specialists and foreignfinancial institutions. All banks' commercial activities are computerized.Major actions are underway to further improve internal controls and managementinformation systems.

10. The RBFT was found eligible for participation in the proposedProject. However, there are certain reservations with regard to the readinessof bank's staff to cope with the challenges of rapid growth of its loan portfolioand its branch network. These reservations relate to the unstable macro-conditions, the lack of relevant experience and less-than-satisfactory internalcontrol and management information systems. However, the RBFT management isproviding strong leadership and is fully conscious of the potential pitfalls offast diversification and growth, and of the current skill deficiencies.

Societe Generale (SGF)

11. The SCF has maintained a representative office in Bucharest from themid-50s and opened a branch in 1980. It was initially restricted to operatingin foreign currency and started to transact with Romanian entities only after the1989 revolution. In 1992, the SGF has diversified into local currencyoperations. Its interest in participation stems from the changed businessstrategy of the headquarters, with a strong interest to expand operations and tobecome a major player in Eastern Europe. Senior management of the Bucharestbranch see participation in the proposed Project as an opportunity for the branchto further penetrate local financial markets and to expand its customer base.

12. As of end-1993, the branch's total assets amounted to L59 billion,up from about 15.6 billion in 1992. The main activity of the branch is to takedeposits, which are kept with its Head Office in Paris or with other brancheswithin the banking group. These activities account for 86 percent of both bank'stotal liabilities and total assets. Since end-1992, the SGF started to engagein domestic credit activities. By end-1993, the total loan portfolio amountedto L644 million or about 1 percent of the total assets. About 98 percent ofthese credits were sbort-term trade finance. The SGF has a "nominal" capital ofLU.3 billion. Its net profit for 1992 amounted to FF2.1 million.

13. The branch is controlled by the Head Office in Paris, which reviewsits accounts on a monthly basis. The SCF authority to approve credit is limitedto FF3.5 million, and it is obliged to follow Societe Generale's appraisalprocedures. Larger loans have to be approved by the Head Office, which assumesfull responsibility for the operations of the branch. The branch does not takeforeign exchange or interest rate risk. The country risk limits set by the HeadOffice for Romania are high enough as not to impose an effective ceiling on thebranch's local currency credits. However, the SGF is conservative with itsdomestic credit operations. This is due to the lack of financial information andof solid business records of potential borrowers.

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14. All risks undertaken by the branch are born by the Head Office. Theappraisal of eligibility of the local branch to take part in the proposed Projectwas thus based on the financial strength and soundness of the Societe Generale.Since it is known to be a major international financial institution, the localbranch was found to be eligible.

Chemical Bank (CBF)

15. The CBF is a branch of a major US bank, with operations in Bucharestsince 1974. The office has been previously operated under the nameManufacturers Hanover Trust. Its business has traditionally been confined toforeign individuals and companies operating in Romania and was restricted toforeign exchange operations. After the 1989 revolution, the CBF started totransact with Romanian individuals and enterprises and has developed a clienteleof about 100 companies, mostly in private ownership. The CBF has recentlyapplied to the NBR to start operations in domestic currency.

16. As of end-1993, the CBF's total assets amounted to L106 billion. Themain activity is to attract foreign currency deposits (L71 billion) and placethem with its headquarters or other branches around the world (L105 billion).A substantial amount of its activity is off-balance sheet in the form of stand-byL/C (US$0.5 million), confirmed L/C (US$33 million), and financial guarantees toexporters (US$11.5 million). In 1992, the bank accrued net profit of US$4.6million.

17. The CBF currently does not have authorization to diversify intocredit operations. It is tightly controlled by the Head Office, which receivesall records on a daily basis, approves all transactions involving any kind ofrisk, and is fully responsible for operations of the branch. The CBF interestin participation stems from its management's concerns that the bank would not beable to compete, and could even loose its Romanian customers, unless it is ableto provide a more comprehensive set of financial services. To that end, thebranch has applied to headquarters to reconsider its business strategy in Romaniaand to assign the branch broader authorization to expand its business activities.The management hopes to get such authorization before the proposed loan becomeseffective.

18. Given the existing risk exposure arrangements - i.e., all risks ofRomanian operations are to be attributed to the parent's capital - the decisionon eligibility of the local branch was based on the financial strength andsoundness of the parent bank, and the CBF was found eligible for participation.

ExRort-Import Bank of Romania (EXIM)

19. The EXIM was founded in March 1991 as a joint-stock company whollyowned by the state with an initial capital of L30 billion. The Government plansto privatize the bank in the near future, but a minimum 51 percent share wouldbe kept in state ownership. The EXIM is a complex institution, expected tooperate both on behalf of the state and on its own account. It is engaged inboth lending and insurance business.

- 5 7 - ANNEX 3Page 7 of 15

20. On behalf of the state, the EXIM plans to provide financing ofexports and imports of goods in domestic and foreign currency, and to guaranteeimport credits, medium and long-term export credits against political andcommercial risks, and short term export credits against political risks. Theseoperations are carried out within the limits established by the Romanian Inter-Ministerial Committee for Guarantees and Credits for Foreign Trade, and on termsestablished by the Government. On its own behalf, the EXIM activities includelending for exports and im.ports; insurance and reinsurance of export creditsagainst commercial risks; equity participation in banks and insurance companiesin Romania and abroad; banking and financial consultancy; assessments ofcommercial and political risks; and correspondent banking. Participation underthe proposed Project belongs to the EXIM's own activities.

21. After about a year of very intensive training, commercial activitieson the Government's behalf started in April and on its own behalf in August 1992.The opening balance sheet consisted of L19 billion paid-in capital, which wasincreased to L25 billion by end-1992 and to L35 billion by end-1993. The capitaladequacy ratio is currently well above 50. The EXIM is engaged in two types ofoperations on its own behalf, including export financing and export insurance.It has originally maintained a consolidated balance sheet of its operations. Atappraisal, the EXIM was advised to separate its banking and insurance businessas a condition for participation. Since end-1992, the EXIM maintains separatefinancial statements for insurance and banking activities. For example, out ofthe bank's total capital, L5 billion are 'designated" to cover potential lossesfrom its insurance activity. However, since this allocation is not legallybinding, it still not certain that a loss in the insurance business will notimpose a further strain on the part of the capital that is supposed to backcredit and other banking risks.

22. Most of the EXIM's operations so far have been performed on behalfof the Government. The EXIM management is rather conservative concerningoperations on EXIM's own behalf, in recognition of the lack of experience andlimited capital. A long gestation period enabled EXIM to be rather systematicabout organizing its business. Staff has received massive training throughbilateral assistance from the EEC and technical assistance to develop policiesand business procedures. All major areas of activity are covered by proceduresand manuals adopted from major OECD financial institutions; for example, creditappraisal and monitoring process, country risk analysis, internal controls.Treasury procedures and internal auditing and controls that are being developedare expected to provide for better asset/liability and risk management. Themanagement information system is rudimentary, but a more comprehensivecomputerized system is being developed. This and the accumulated experience fromoperating as a government agent will allow the EXIM to get into full-scaleoperations on its own behalf.

23. The EXIM currently employs 200 staff, organized in credit, insuranceand risk management operations. They are a mix of experienced staff, who joinedthe EXIM from middle-level management positions in older Romanian banks, andyoung staff recruited from the university. The EXIM management has engineeredan aggressive business development program. It is planning to open 6 to 8 new

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branches (with an investment of L6-8 billion), and to eventually be able tofinance an export volume of about US$5 billion.

24. Since the first EXIM operations started only recently, there is noaccumulated experience. By end-1992 period, the total volume of EXIM's creditactivity amounted to L4.3 billion. By end-1993, the EXIM's credit portfolioincreased to L27 billion, all funded from its capital, and mostly extended atpreferential rates to selected importers and exporters. The quality ofappraisals and EXIM's performance is therefore hard to evaluate. The finaldecision on EXIM participation (i.e., its accreditation) will be made after thecurrent activities in developing systems, procedures, and management informationare finalized. A foreign external auditing firm is currently auditing the bankbooks and advising on the organization of an internal audit division. In orderto be able to qualify, the management has also been asked to formally delineatethe EXIM's banking and insurance business. Preferably, the EXIM should beorganized as a holding company with two subsidiaries engaged in banking andinsurance business. The bank must also gain sufficient experience in export andproject-related lending.

Ion Tiriac Commercial Bank (TCB)

25. The TCB was set up in 1990 with an initial subscribed capital of L500million, of which 50 percent in US dollars and the rest in domestic currency.By Romanian standards, the TCB has a broad shareholding base. Ion Tiriac and hisgroup of foreign investors have subscribed 51 percent of equity; the rest wassubscribed by individual Romanian and foreign investors and by some foreignbanks. In the 1990-1992 period, the TCB capital continued to grow (partly dueto revaluation of the foreign exchange portion). In December 1991, the sharecapital (equity) was L4.3 billion; by December 1992, the equity increased toabout L7 billion and the total capital to about L17.5 billion. In 1993, theequity was further increased to L36 billion (five times). While remaining aprivate bank, the TCB ownership has changed in the process. The majorshareholders are Ion Tiriac and his group (35 percent), and the European Bank forReconstruction and Development (EBRD-20 percent). The third largest shareholderis a joint venture headed by the local SIVA company (18 percent). The rest isheld by various companies (12 percent) and the Romanian public at large. For1994, further capital increase has been announced. For the time being, the TCBcapitalization level meets international capital adequacy criteria. Based onunaudited financial statements submitted to the NBR, the risk based capital ratiowas 17.2 percent at end-1991, 50 percent at end-1992, and at end-1993 about 20percent. The planned capital increase is to prepare the TCB for further growthand diversification of its activities.

26. At end 1993, the total value of the TCB's assets was L283 billion,up from about L15 billion at end-1991, and about L54 billion at end-1992. Of thetotal assets, L97 billion were the foreign liquid assets (i.e., casb, depositsand marketable securities). The total lending portfolio amounted to about L102billion (36 percent of the total assets), of which 75 percent has been extendedin foreign exchange. The TCB customers are almost exclusively private. A partof its asset portfolio is kept in the interbank market (10 percent), mostly in

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the form of short-term loans; the share is, however, significantly smaller thanin 1991 and 1992, when the funds in the interbank market typically accounted for50-70 percent of the TCB's asset portfolio. Management explained that thechanged asset portfolio structure characterized by a rapid increase of the loanportfolio (about four times in 1992 and five times in 1993) results fromliberalization of interest rates, allowing the TCB to charge spreads commensurateto what the bank perceives as appropriate in relation to the credit risk; and thebuild up of relationships with a number of reasonably creditworthy clients in the1990-1993 period, allowing the TCB to extend on-balance sheet financing afterinitial positive experiences with first-time clients. The TCBE's loan portfoliois entirely funded from its own deposit base. In 1993, the TCB started toinvest, rather aggressively, in stocks of private companies; equity investmentsincreased from about L2 billion at end-1992 to L56 billion at end-1993.

27. The TCB's business experience has been positive so far. As a newbank, it had a limited scope of operation and risk exposure. It has originallyfocused on off-balance sheet operations related to the foreign trade business,and has avoided taking the interest rate and the foreign exchange risk. Thecredit risk was also limited: the major part of the asset portfolio hastypically been in foreign liquid assets and in the interbank market. However,the TCB has started to change its business policy by increasing the size of itsloan portfolio and, recently, by getting into investment banking operations.Concurrently, the bank has started to develop risk management policies, internalcontrols and management information systems. It has adopted standard creditappraisal procedures and the institutionalized credit review structure includesthe Loan Committee and the Risk Committee. Since it began its operations, theTCB has had only a handful of loans in default.

28. The TCB board has 9 members, 3 of which are also bank executives.It employs 350 staff, of which 22 are credit officers. Managerial and seniorstaff positions have been typically filled with experienced managerial andtechnical staff from older Romanian banks (e.g., RDB, RBFT) and by Romanians withbanking experience returning from abroad. Less experienced staff have receivedon-the-job training. There are no systematic plans for comprehensive upgradingof skills to be able to support business growth and diversification. One of thereasons cited for TCB interest in the proposed Project was the availability ofTA and of other types of help expected to be made available to participatingbanks.

29. The TCB has a very high growth potential. The management foreseesextensive growth in terms of volume and size of its operations and their regionalcoverage, as well as business diversification. The real problem is that thecapacity of the TCB to prudently manage its growth is not fully in place, bothin terms of skills and in terms of infrastructure needed to support staff andmanagement decisions (e.g., risk management, management information systems).The TCB capacity to absorb fast growth successfully is especially problematic interms of the planned increase in the number of branches and in terms of businessdiversification (for example, merchant banking and credit card business).

- 60 -Page 10 of 15

30. At appraisal, the decision concerning the TCB accreditation has beenpostponed until the externally audited financial statement for 1992 becomeavailable. As a condition for qualification, the TCB has also been asked to:(a) adopt a policy that the amount of total credit granted to affiliated parties(shareholders and companies associated with them) would not exceed 20 percent ofbank's capital, and reach settlement concerning exposure to affiliated parties(e.g., through capital increase); (b) introduce internal audits and controls,including formulation of an intensive annual audit program; and (c) improvecoordination of growth and diversification plans with build-up of skills andinstitutional capacity.

31. In May 1993, the Bank was informed that the TCB succeeded in gettinga clean audit opinion on its externally audited financial statements. It was re-appraised in early July 1993. The re-appraisal confirmed the TCB's solidfinancial condition with a capital adequacy ratio of over 50 percent. In themeantime, the management has satisfactorily addressed all issues raised atappraisal, except for the somewhat higher volume of connected lending. The TCBwas qualified for participation by Bank's management decision in September 1993.

Dacia Felix Bank (DFB)

32. The DFB is one of the newer bazks in Romania. It opened for businessin March 1991. It is the only bank in Romania with headquarters out of Bucharest(the DFB headquarters are in Cluj). In December 1991, the DFB equity capitalamounted to about L600 million; by end-1992 the capital reached L4.6 billion andby end-1993 about L15 billion. There are also plans to increase the equitycapital by about 3-5 times by end-1994. The ownership of the DCB is welldiversified. Among the bank's owners are 2800 private individuals, 2200 privatecompanies and 318 government-owned companies. Private individuals and privatecompanies account for well over 51 percent of capital. The largest DCBshareholder holds about 12 percent of its equity; there are two companies (oneprivate and the other state- owned) which hold about 8 percent (each) of the DFBcapital. However, the announced capital increase in 1994 will involve areputable Swiss bank, which will become a majority shareholder.

33. As of end-1993, the DFB's assets amounted to L288 billion, up fromabout L27 billion at end-1992. The loan portfolio accounted for about 72 percentof the total assets (L208 billion of which L34 billion in foreign currency); itincreased by about 10 times in 1993, and the foreign currency loan portfolioincreased by 35 times. The portfolio is well diversified, although with highregional concentration, and mostly extended to private enterprises. Between end-1991 and end-1993, the DFB's capital adequacy ratio fell from 27 percent to 6.3percent, and the capital increase become necessary to bring the capital adequacyto a level required by international standards. The deterioration of capitaladequacy was due to the rapid expansion of its credit operations. The managementclaims that the DCB arrears on principal or interest were never higher than 1percent of the total loan portfolio. The DFB funding base is weak. About L67billion (32 percent coverage of the loan portfolio) stems from own deposits, andthe remainder is borrowed in the interbank market.

- 61 - ANNEX 3rage 11 of 15

34. The DFB has experienced very fast growth since its establishment.The bank employed 45 people in March 1991, 310 in October 1992 and close to 2000by end-1993. From about 24 branches at end-1992, the DFB doubled the number byend-1993, and intends to open 16 new branches in the near future. Most employeeshave been recruited from the older government-owned banks. The largestdepartment of DFB is a credit department. The DFB Board of Directors consistsof 19 members. Most of the board members are private shareholders. There arealso representatives of government companies which own shares of the bank, andfour board members are bank officials.

35. Compared to other Romanian banks, the DFB's growth has beenreasonably well managed. Early on, it established a relatively advanced computersystem. All branches have PCs. The Head Office computer provides a dailybalance sheet to the management, including branch balances. The bank iscurrently engaged in developing an even more comprehensive management informationsystem.

36. The DFB has introduced appraisal procedures and risk managementpolicies. It does not take the interest rate and the foreign exchange risk. Abranch can grant a credit of up to L10 million. A credit committee at theheadquarters may grant a loan for up to 10 percent of the DFB capital, and theboard can increase the maximum loan amount up to 20 percent of capital. Theboard must explicitly approve all foreign exchange loans exceeding US$0.5million. Each credit application includes balance sheets and income statementsof the borrower for the last 3 years. For the medium-term credit, feasibilitystudy is conducted by the DFB itself. As of now, the DFB has not made anyspecific loan loss provision above the general provisions required by the NBR.Every month, the whole credit portfolio is reviewed by credit officers and theoverdues and borrowers in deteriorating financial conditions are brought to theboard's attention. The bank, however, does not practice systematic borrower andloan classification. Given a very aggressive growth rate, the loan reviewfunction and the internal control systems need to be improved.

37. At appraisal in 1992, the DFB was found eligible to take part in theproposed Project, once its capital reaches US$10 million, and providing that itscapital adequacy ratio continues to meet the international standard of 8 percent.This has been subsequently accomplished in April 1993. However, review of theDFB loan portfolio in July 1993 revealed an incidence of lending to connectedparties amounting to about 80 percent of its capital. In addition, there wereserious concerns regarding too fast growth of the DFB loan portfolio andespecially regarding the extremely weak funding base, which could easily backfireif financial environment in Romania deteriorates in any respect. The managementwas informed that the bank will be qualified only after the connected lending hasbeen brought in line with NBR prudential regulations, the DFB external auditreport for 1993 is presented to the Bank, and the portfolio risk profile isadequately addressed.

- 62 - ANNEX 3Page 12 of 15

Romanian Development Bank (RDB.

38. The Romanian Development Bank (RDB) originated in the centralplanning system and has been known as the Investment Bank of Romania. Itsresponsibility was to advance investment loans -o the industrial and constructionsector and to provide working capital finance to construction enterprises.Reform of the financial sector and introduction of the two-tier banking systemin late 1990 led to the establishment of RDB on December 1, 1990, as a commercialcompany with universal banking license and wholly owned by the Government. Thebank took over 41 former branches of the Investment Bank and its asset andliabilities portfolio. The RDB is a state-owned bank (30 percent owned by thefive POMs); however, the Government has recently announced that it will beprivatized in the course of 1994 and has started to prepare the bank forprivatization.

39. In the end-1990 to end-1993 period, the RDB experienced high growthin nominal terms: its total capital increased from L9.5 billion at end-1991, toL30.7 billion at end-1992, and to L50 billion at end-1993; its total assets grewfrom L106.6 billion at end-1990, to L202.3 billion at end-1991, to L 282.8billion at end-1992, and to L680.6 billion at end-1993. This was accompanied byan equally aggressive growth of the RDB's branch network, from 41 branchesinherited from the Investment Bank to 140 branches at end-1992. However, in realterms, the RDB's balance sheet contracted by about 6 percent in 1991, byapproximately 30 percent in 1992 and by another 30 percent in 1993.

40. From about L106 billion at end-1990, the RDB's loan portfolio grewto L221 billion at end-1991, of which L144 billion (.119 billion after lossadjustments) in customer loans and L77 billion in compensation credits; the bankwrote-off about L25 billion to cover loan losses (equivalent to about 17 percentof its loan portfolio). As a result, the customer loan portfolio contracted in1991 by a total of 42 percent in real terms. At end-1992, the loan portfolioamounted to L193 billion, of which about L180 billion were customer loans and theremainder were compensation credits. With losses equivalent to about 15 percentof the loan portfolio (L27.8 billion), the real volume of the RDB loan portfoliowas L152 billion. This was a contraction of further .6 percent in real termscompared to its size at end-1991, and of 64 percent in real terms compared to itssize at end-1990. At end-1993, RDB's loan portfolio amounted to L374 billion,a further contraction of over 20 percent in real terms. This contraction of theRDB balance sheet and loan portfolio enabled the bank to consolidate itsfinancial position and to change the risk profile of its balance sheet. Theconsolidation has been accompanied by a radical change of RDB clients, who nowinclude a significant number of private enterprises. Against the background ofsimilar contraction of Romanian enterprise credit market, the RDB managod tomaintain its credit market share at about 8 percent level throughout 1992 and1993.

41. The significant contraction of the RDB's asset portfolio coupled withincrease in the RDB's share capital have brought a significant improvement ofcapital adequacy. The accumulated losses in the capital account were reducedfrom L20.8 billion in 1991 to L9.6 billion in 1992, and the bank received a

- 63 - ANNEX 3Page 13 of 15

capital injection of L 14 billion in the course of 1992. Consequently, the RDBmoved to a positive net worth position of about L13 billion at end-1992. Theratio of capital to risk-weighted assets improved from negative 7 percent at end-1991, to 7.9 percent at end-1992, and to over 10 percent at end-1993, thusmeeting the international capital adequacy standards. Favorable conditions incredit markets, with spreads as high as 30 percentage points, have also boostedRDB's profitability. Net interest income increased from L3.9 billion at end-1991 to L24.5 billion at end-1992. The total after tax income improved from aloss of L22 billion in to a profit of L14.9 billion.

42. Another positive development has been a much improved' fundingstructure. The RDB's customer deposits doubled from L88.3 billion in 1991 (43percent coverage of the loan portfolio) to L 153 billion in 1992 (93 percentcoverage), and L274 billion (73 percent coverage) in 1993. The RDB became a netlender in the interbank market. Consequently, the RDB has gained better controlover its cost of funds. Coupled with successful resolution of the portfoliomaturity mismatches, this has brought a significant degree of flexibility toadjust its balance sheet size and structure to changing conditions in theRomanian economic environment.

43. The RDB has also made an excellent progress in building itsinstitutional capacity. Most important auditor's recommendations weresuccessfully implemented in the course of 1992 including restructuring of thebranch network, closer preoccupation with risk control and portfolio managementand improvements in credit appraisal and supervision capacity. The bank haspursued an ambitious institution-building program in 1993, includingcomputerization and introduction of a computerized management information system,further strengthening of risk management policies and procedures, and a massivetraining program for management and staff.

44. The RDB was originally appraised in October 1992,.and was rejectedbecause it did not meet capital adequacy and other qualification criteria.Management was informed about major issues which need to be addressed for thebank to qualify for participation. It was re-appraised in July .993. Thecapital adequacy and the financial position were found satisfactory and allrecommendation to management were successfully implemented. Consequently, theRDB has been qualified for participation in the proposed Project.

Commercial Bank of Romania (RCB)

45. In the 1945-1989 period, the National Bank of Romania (NBR), undercentral planning system, provided working capital and other non-investmentfinancial services to Romanian enterprises. The financial sector reform, whichwas initiated in early 1990, included establishment of a two-tier banking system.The RCB was formed in December 1990 by carving out commercial operations from theoriginal NBR portfolio. It immediately became the largest Romanian bank.

46. At end-1990, the RDB accounted for about half of the total assets andabout 60 percent of the total credit portfolio of the Romanian banking sector.Its dominance, with over 80 percent share, was especially strong in the short-

- 64 - ANNEX 3Page 14 of 15

term end of the credit market. In the 1991 to mid-1993 period, the RCB remainedthe largest Romanian bank. However, its degree of market dominance has beensuccessfully challenged; its share declined to 35 percent in 1991 and to 24percent of the total banking sector assets in 1992 and 1993; the total share innon-government credit market contracted to 47 percent and 30 percent,respectively.

Table A3.3: Summary of RCB Balance Sheet(in L billion)

1990 1991 1992 1993Dec. Dec Dee. June

Assets 285 775 935 2.549Loans 269 648 (2) 583 (3) 1,249 (4)

(of which bad) (40) (70) (105) (5)customer Deposit 191 234 450Sbare Capital 7 (1) 12 30 42Total Capital 7.4 21 88 109no. of Branches/Offices 110 180 200 221No. of Employess 3000 6500 9200 10500

Notes: (1) Authorized capital of L 12 blUion of which L 7 billion paid-in capital(2) Includes L 334 billion in compensation credits under Law 80(3) Of which L 29 billion are compensation credits under Law 80(4) Of which L 19 billion are compensation credits under Law 80(5) Of which L 36 billion to be absorbed by the Government under Law 7

47. Against the background of persistent decline of the RCB's share inthe domestic credit market, the RCB's balance sheet grew in nominal andcontracted in real terms. Key parameters are summarized in Table A3.3. Animportant reason for the significant contraction was that 96 percent of the RCB'sloan portfolio consists of loans to state owned enterprises, with a heavyconcentration in machine-building, chemicals and metallurgy. These were thesectors most severely affected by the loss of markets and systemic changes in the1991-1993 period, with obvious consequences concerning the quality of RCB'sassets.

48. At end-1991, the RCB took a major hit by putting aside L70 billionin provisions for bad and doubtful loans, and ended a year with a loss of L78billion. However, 1992 was a good year thanks to the large interest margins:the RCB's net interest income increased from L16 billion in 1991 to L136 billionin 1992 (i.e. 8.5 times); fees and commission income increased from L1.7 billionto L9 billion, respectively. This has enabled the RCB to put aside additionalL48 billion in loss provisions and hyperinflation reserves and to make a netafter tax profit of L88 billion. With the L18 billion state capital infusion,the RCBs capital position consequently improved from L48 billion negative networth at end-1991, to L42 billion positive net at end-1992. At the same time,

- 65 -Page 15 of 15

the RCB's ratio of capital to risk weighted assets improved from negative 36percent at end-1992 to 7.7 percent at end-1992, or close to internationalstandard for risk based capital adequacy.

49. Funding strategy is the RCB's weak point. It's own funding baserelative to the size of the portfolio continued to deteriorate from about 27percent of total liabilities at end-1991 to 25 percent at end-1992 and 18 percentat end-1993. The proposed Loan coverage has worsened from 81 percent in 1991 to71 percent in 1992 and to 36 percent in 1993. This has made the RCB especiallyvulnerable to changes of the cost of funds and conditions of access to theinterbank market and the NBR refinancing facilities.

50. On the more positive side, the RCB has made significant progress ininstitution building. This includes automation of the RCB's branch nettiork;significant improvement in quality of management reporting; improvement in creditappraisal and loan administration procedures; establishment of strategic planningand of loan supervision function including a work-out unit; strengthening ofbank's international activities; major staff training programs; etc.

51. The RCB was first appraised in November 1992. Based on financialstatements at end-1991 and mid-1992, it was rejected due to the inadequatefinancial condition and the failure to meet capital adequacy criteria. It was re-appraised in June 1993. At this time, the RCB was able to meet the capitaladequacy criteria established for participation in the proposed Project.However, the qualification was postponed until such time when the followingactions have been taken: (a) full loan portfolio review and loan classification(allowing for meaningful portfolio with assessment) has been completed; (b)specific risk management policies and an action plan to address high portfolioconcentration in machine-building, metallurgy and chemical sector have beendeveloped; and (c) a program to expand its funding base and gain better controlover the cost of funds has been designed.

-66 - ANNEX 4Page 1 of 5

INDUS¶RIAL DE2EL0PMENT PROJECT

Foreigh Trade and Expnort Credit Demand

Trade Balance

1. As in the other reforming socialist economies, Romania's trade andpayments system operated in a barter-trade regime with the CMEA countries andthrough normal commercial contracts with the rest of the world. The tradevolumes between the two zones were roughly equal in the 1980s. The trade accountbalance with the convertible currencies markets was positive throughout the1980s; in 1988 it reached a peak of US$3.6 billion.

2. Compared to the other CMEA and to most developing countries, Romaniahas been a major exporter; exports accounted for 31 percent of GDP in the 1980.1981 period. The policy of self-reliance and increasingly compressed importseventually brought deterioration of export performance to about 19 percent of GDPin the 1988-1989 period. Systemic changes after the revolution and the CMEAcollapse brought a further reduction of foreign trade in recent years. In 1990-1991, the total exports fell to less than 10 percent of GDP. The trade accountbalance has been consistently negative since the revolution, with the worstdeficit of US$3.4 billion experienced in 1990, the first year after therevolution.

3. In both absolute and relative terms, the decline of Romania's exportperformance after the revolution has been even worse than the decline of its GDPand industrial output. The total exports declined from US$11.4 billion in 1988(of which US$6.5 billion to convertible currency markets), to US$5.8 billion in1990 (of which US$3.4 billion to convertible currency markets), to US$4.28billion in 1992, and US$4.5 billion in 1993 (Table A4.1). With an encouragingannual growth of about 29 percent in 1992 and 8 percent in 1993, the convertiblecurrency exports have not yet reached their 1989 level and the total exports areabout one-third of the export volume in the last full year of central planning.

4. The decline of exports in the face of systemic collapse and the CMEAdisintegration has occurred in all former CHEA countries. However, Romania'speers in Eastern Europe (e.g., Hungary, Poland, Bulgaria) have experiencedreasonably fast recovery of the convertible currency exports, which had notmaterialized in the Romanian case. This was mostly due to the unsustainablecomposition of Romanian traditional exports and to a number of other structuralor systemic reasons.

- 67- ANNEX 4Page 2 of 5

Table A4.1: Romanian Trade Balance(in US$ million)

-Tota- -ehnvtble Curendcs- -Tranferatle Ruble&-tno-rps lUoWs BEaince Imoons faalance Imnors Ex DJnBasa

1987 8,313 10,491 2,178 3,428 $864 2,436 4,349 4,206 .143

1988 7,642 11,392 3,750 2,903 6,511 3,608 4,271 4,450 179

1989 8,437 10,487 2,0z0 3,406 S,9S6 2,5S9 4,602 4,144 .458

1990 9,114 5,770 -3X364 S,107 3,364 -1,743 3,678 2,170 .1-,08

1991 5,345 4,125 -1220 45e2 3,236 .1,266 455 592 137

1992 5,433 4,286 -1,147 5,290 4,197 -1,093 143 89 -54

1993 S,675 4,527 -1,148 5,675 4.527 .1,148 - -

Sourc: National Bank of Romania.

Issues in Exi:ort Reco2very

5. Fuels and oil-based chemical exports have traditionally accounted forabout 60 percent of Romania's convertible currency exports; these exports weremostly based on arbitrage between the oil prices within the CMEA block and theprices of oil-related products in international markets. Such arbitrageopportunities have disappeared since the CMEA disintegration. On the CHLk side,about 60 percent of exports during the 1980s were registered in the machinery andequipment category. The markets for capital goods were especially hard hit sincethe transition to a market economy started in the former CMEA countries.

6. Another systemic reason for declining export performance is thedilapidated capital stock of Romanian enterprises. The policy decision in theearly 80s to repay Romania's external debt and the consequent halt in capitalequipment imports, resulted in a situation where 75-100 percent of the Romaniancapital stock is older than ten years even in the most prominent export sectors.Maintenance or restoration of their competitive positions requires significantinvestments in rehabilitation and modernization of enterprises' capital stock,in concert with other types of restructuring.

7. Other systemic reasons for the continuing decline of exports are tobe found in the past industrial policies resulting in specific structuralfeatures of the Romanian manufacturing sector. As a legacy of the self-reliancepolicy, the producers in Romania maintain a highly diversified productionspectrus and are all virtual monopolists at the single product level. In otherwords, a producer typically has monopolistic suppliers of his production inputs,and he is himself a monopolistic supplier to his customers. Problems affectingenterprises in a system with such structural characteristics are contagious, inthat they very quickly spread down supply chains. Enterprises are not able toescape, unless they are well capitalized, have adequate access to finance and

- 68 - ANNEX 4Page 3 of 5

imported inputs, and have reasonably developed marketing and procurementcapacity, none of which has been the case in Romania.

8. A highly volatile economic environment, with frequently changingrules of the game (e.g., price and foreign exchange management policies switchingfrom fairly liberal to increasingly government c.r.trclld) Ies elso contributedto export decline. The case in point is the decline in exports following theNovember 1991 "full surrender of export proceeds" policy, and the fast recoveryleading to a first monthly foreign trade surplus in August 1992, after the fullretention policy was re-introduced. This generally difficult situation has beenfurther aggravated by the lack of capacity of the banking sector to deliverappropriate financing in terms of volume, timing and instruments. Finally, thearrears problems have hurt Romanian exporters almost as badly as otherenterprises.

9. On the positive side, there are sectors and enterprises which,despite all odds, have managed to do reasonably well. This has been the case ingarments and knitwear, furniture and small engineering products industries. Acommon factor for these sectors is that the prices were liberalized early, andthe enterprises have had long-term commercial arrangements with a company in someOECD country.

Short-Term Remedies

10. The Government is aware that the rapid recovery of exports holds akey to economic recovery and to successful transition. On the policy front, anumber of measures have been implemented aiming to improve the policy environmentfor exporters. Access to foreign exchange has been liberalized, and mechanismsallowing market based management of exchange rates were introduced. (Fulldetails are provided in Annex 6). The tariff regime was unified and simplified.Import quotas and licensing for protection purposes are practically non-existent.Exports and imports can, with few exceptions, be undertaken without explicitgovernment approval. This has provided for a relatively unbiased trade-incentives regime which promotes export and import activities based on efficiencyand competitiveness.

11. Besides the mentioned policy and structural factors, which will takea longer time to address, exports are constrained by the difficulties inobtaining adequate pre-shipment finance. Since the import content of Romanianexports can be as high as 50 percent, the ability of exporters to obtain pre-shipment finance on time and at competitive rates is critical to the rapidimprovement of export performance.

12. Government agencies (i.e., MOI, HOF, Ministry of Trade, NationalStatistical Office) do not presently collect detailed information concerningimport dependency ratios of Romanian exports. Indicators of import dependencieswere developed through a detailed survey of foreign trade enterprises, most ofwhich are virtual monopolies concerning foreign trade in their respective sectors(Table A4.2)

- 69 - ANEX 4Page 4 of 5

Table A4.2: Import Dependency of Romanian Exports

Name of Foreigp Trade Organization Sectoral Direct Average Import ContentProducts as a % of Export Value

ARPIMEX Shoes, Leatherwear up to 50l

CONFEX Garments 30 to 40%

CONST RANSIMEX Construction Services and Equipment up to 509'l

| LECTRONUM Electronic Equipment, Cable, Telecomm. up to 15%Equipment

|FlUCT EXPORT Agricultural Products 30%

IELXIM Furniture, Cast Products, Carpets. Toys up to 30%

MASINO EXPORT IMPORT Machine Tools, Woodworking, and Textile up to 15%Machinery

MEHANO EXPORT IMPORT Construction Equipment, Railway Roling up to 20%Stock, Diesel Engines, Air Compressoss

ROMANO EXPORT Teiles, Fabtic, Knitwear, etc. up to 20%

ROMELECRO JElectrical Equipment and Appliances 15%

ROMSlT Glassware, and Ceramies up to 20o

TEHNO FOREST EXPORT Furniture, Wood Products, Prefab. Houses IS%

TEHNO IMPORT EXPORT Ball Beatrings, Technical Goods up to 40%

UNWMERSALTRADING Tractors, Farm Macbinezy, Trucks, Buses 10-20%

vrrRoaiM Building Materials, Woodworking and up to SO%*,1 _________________________ Building Machinery

Soumce: Foreign Trade Companies.

13. The availability of pre-shipment export finance in foreign currencyis currently limited to the foreign supplier credit lines. Access to finance iscomplex azd expensive relative to financing terms of Romania's internationalcompetitors. (Elaborated in detail in Annex 6). Due to the inability to convertdomestic currency into foreign exchange in a timely manner, the domestic creditmarkets are also inconvenient. The exporters are practically forced to financethe export production almost entirely from their own funds. This limits therealization of their full export potential. The proposed line of credit inforeign currency under the proposed Project, appropriately priced at competitiverates, can help remove the credit constraint to exports and enhance the pricecompetitiveness of Romanian exporters.

- 70 - A~~~~NNEX 4Page 5 of 5

Export Credit Demand

14. Export credit demand estimates were derived in two ways. First, anassumption was made that a credit line under the proposed Project should be ableto finance all major categories of positive value-added Romanian exports.Estimates are summarized in Table A4.3. Given an average of about 100-120 daysper export cycle, the annual foreign exchange financing demand would total aboutUS$631 million, which translates to about US$180 to 210 million for a revolvingexport credit line.

Table A4.3: Convertible Currency Exports of Selected IndustrialSectors and Their Financing Estimates

(in US$ million)

Average Estimated1991 1992 1993 % Import Financing

Content Demand

Plastic, Rubber Articles 52.0 85.4 76.4 10 7.6

Leather Products 16.9 24.8 27.9 15 4.2

Wood-Based Industries 112.2 154.6 159.5 15 24.0

Tetiles, Garments 3253 4543 7003 20 140.0

Footware 66.8 72.7 145.2 50 72.5

Base Metals and Artidces 608.8 733.9 926.4 15 3.9

Machinery and Electronics 3859 464.7 386.4 20 77.2

Transport Equipment 300.5 444.0 372.4 25 93.0

Industrial Goods 363.8 365.7 368.0 20 73.6

631.0

Source: Ministryof Industry.

15. Alternative estimate of pre-shipment export credit demand was madethrough a detailed survey of exporters with a proven track record, conducted bythe Ministry of Industry in late 1992. The exporters were asked to identify veryspecific export opportunities which they would not be ab.e to fulfill due to thelack of pre-shipment finance. The opportunities referred to potential 1993export contracts for which the companies have received invitation to bid, or tospecific detailed information received from their old clients or their tradingcompar4ies. This survey yielded a total of US$1.36 billion in potentialincremental export volume, requiring an estimated US$443 million in foreignexchange financing.

- 71 - 6AE 5Page I of 6

INDUSTRIAL DEVLOPUi4NT -PROJECT

Criteria and Procedure for PFI Cualification and AccXtditation

1. ApplicatioL for ParticiRatio. An application for participation ofa financial institution in the intermediation of IDP-financed credit lines shallbe filed with the Department of Bank Supervision, National Bank of Romania.

2. Papers Reguired. The applicatior. for participation sboild beaccompanied by: (a) a full set of documents and tables as listed in Attachment2 of this document; (b) an outline of operational policies and guidelines asspecified in Attachment 3; (c) a brief corporate strategy outline as explainedin Attachment 4; and (d) a statement, signed by the Chief Executive Officer, thatthe financial institution agrees to be subject to the Bank's appraisal process.

3. Screening. Upon submission of the application supported by the abovelisted documentation, the National Bank of Romania (NBR) will review theapplication. According to the qualification criteria listed in Attachment 1, theNBR would decide whether a bank qualifies for full appraisal or not. If theopinion is positive, both the World Bank and the applicant bank should benotified. A bank, which, according to the opinion of the NBR, does not meet thequalification criteria will be informed in writing, including specific reasonsfor refusal of their application and advice regarding necessary improvementsbefore it could re-apply. A copy of this letter would be forwarded to the WorldBank.

4. AoRraisal. At an opportune time, the World Bank would appraise abank for which a positive opinion by the NBR has been received. If the appraisalwere satisfactory, the bank would be advised to submit papers necessary foraccreditation. Otherwise, the bank would be informed in writing as to why it isnot able to qualify.

5. Accreditation. The accreditation would be effected upon presentationof the following documentation:

(a) Board Resolution - A copy of the resolution of the Board ofDirectors of a PFI authorizing the PFI to sign with the Ministry ofFinance a Subsidiary Credit Agreement concerning loans financed byIDP against subloans that it intends to extend to eligible borrowersand subprojects, and designating twc authorized signatories (atleast one signatory shall have the rank of vice president or officerof equivalent rank to sign on behalf of the PFI all paperspertaining to the loans;

(b) Letter of Understanding, accepting for IDP-financed projects andtransactions to: (i) adhere to the Operating Policy guidelines for

- 72 - ANNEX SPage 2 of 6

IDP-financed credit lines; (ii) establish a unit or an identifiablegroup to be responsible for approval and supervision of IDP-financedsubprojects and a Loan Review Committee; and (iii) provide trainingfor the unit or group staff as advised by the World Bank; and

(c) Agreement for IDP-financed projects and transactions to: (i) adhereto procurement and disbursement procedures of the World Bank; (ii)maintain loan accounts and documentation; and (iii) submit annuallyexternally audited financial statements concerning the IDP relatedportfolio for as long as the bank continues to participate in IDP-financed credit lines.

6. Susnension/Termination of 4ccreditation. In case a subsequentevaluation of the eligibility of a PFI shows that it has not maintainedcompliance with the qualification and accreditation criteria and/or with theOperating Policies Guidelines, it will be suspended from further participation.Once the reasons for suspension have been satisfactorily resolved, the bank wouldbe able to re-apply for participation.

- 73 - AM SPage 3 of 6

ATTAQCME 1 TO ANNX .2

QUalifleation Criteria

1. A financial institution that seeks to participate in IDP-financedcredit lines should be in a sound financial condition and have a satisfactoryperformance reflective of the healthy loan and investment portfolio, and shouldadhere to sound operating policies and procedures. Specifically, a financialinstitution must comply with the following qualification criteria:

(a) The ratio of total capital to risk assets should not be lower than8 percent, of which 4 percent primary capital.

(b) It must have demonstrated satisfactory performance, includingprofitable operations, for at least a year immediately preceding thedate of application for accreditation.

(c) It must have satisfactory financial policies and operatingprocedures, including loan classification and provisioning on theasset-by-asset basis.

(d) The PFI shall comply with the ceilings and limitations on loans todirectors, officers, stockholders, and related interests, includingthe 20 percent single borrower limit in accordance with existingregulations. A bank would be obliged to report to the National Bankof Romania all assets where the exposure to a single borrowerexceeds 10 percent of bank capital.

(e) The total past due loans must not exceed 10 percent of the totalloan portfolio of assets acquired after January 1, 1991. Afinancial institution whose level of arrears exceeds the 10 percentceiling may still apply for participation, providing that theunimpaired capital and reserves are sufficient to meet the minimumcapital requirements. Appraisal of such a financial institutionshould finally determine whether or not it will be allowed toparticipate.

(f) It must ha-ve satisfactory credit appraisal policies and anorganization, management and staff with the requisite expertise toidentify, appraise and supervise the utilization of the loans; and,for export finance, to handle international trade transactions andthe related documentation.

(g) It must be in good standing with the National Bank of Romania, andbe in satisfactory compliance with all pertinent laws, rules andregulations to the satisfaction of all regulatory authorities.

(h) It must have a business strategy acceptable to the World Bank.

- 74 - ANNPage 4 of 6

ATTACHMENT 2 TO ANNEX 5

Documents and Data to be Provided with Annlication for Participation

I. Documents

1. Financial statements for three years immediately preceding the date ofapplication, including Balance Sheet, Income Statement and Sources andUses of Funds Statement;

2. Articles of Establishment and By-Laws;

3. Number of branches/subsidiaries, their relationship with head office,their authorizations;

4. List (including very short biography) of Board members and SeniorManagement;

5. Manuals on different policies and procedures specifically including:income accrual, loan classification, provisioning, project appraisal,project supervision and risk exposure;

6. Three samples of project/credit analysis;

7. Business plan including assumptions of financial market demand;

8. List and exposure to 20 largest clients;

9. Technical assistance or staff capacity building program currently inprogress or planned;

II. List of Tables

1. Table 1: Organizational Chart including number of professional staff

2. Table 2: Highlights of Past Operations (Product Lines)

3. Table 4: Portfolio Risk (exposure and arrears)

4. Table 5: Funding Position

5. Table 6: Actual and Projected Income Statements

6. Table 7: Actual and Projected Balance Sheets

7. Table 8: Actual and Projected Cash Flow Statements

- 75 - AME 5Page 5 of 6

Outline of Policy Statements

1. mission Statement

2. Policies to Maintain Institutional Strength and Soundness

2.1 Portfolio quality2.2 Appraisal standards2.3 Exposure limits: single enterprise, industry/subsector, business

groups, affiliates2.4 Relationship vis-a-vis directors, officers, shareholders and related

interests

3. Asset-Liability Management Guidelines

3.1 Liquidity management3.2 Currency matching3.3 Maturity matching3.4 Matching of variable vs. fixed rate assets and liabilities

4. Rate of Return Criterion

5. Borrower Restrictions

5.1 Minimum current ratio5.2 Maximum debt/equity ratio5.3 Minimum debt service coverage ratio

6. Financial Prudence Ratios/Guidelines

6.1 Capital adequacy6.2 Adequacy of provisions6.3 Minimum debt service coverage ratio6.4 Minimum collection ratio

7. Procurement Policy

8. Environmental Considerations

-76- A_ EPage 6 of 6

ATTACHMENT 4 TO ANNEX 5

Outline of Corporate Strategy

1. Relations with Corporate Sector, Financial Sector and Government

2. Strategies to Strengthen the Balance Sheet

2.1 Portfolio quality2.2 Capital adequacy2.3 Balance sheet vs. off-balance-sheet growth2.4 Diversification of asset mix and liability base

3. Business Strategies

3.1 Product line development/diversification, including time-boundtargets

3.2 Relative importance of various asset/liability product lines3.3 Marketing strategies3.4 Target market shares

4. Funding Strategies

4.1 Products offered or planned to increase the own funding base4.2 Measures to manage the funding risk

5. Operational Strategies

5.1 Improvements in internal control5.2 MIS development5.3 Automation5.4 Planning and budgeting5.5 Financial management systems5.6 Project finance: appraisal and supervision standards and procedures

6. Operations, Profitability and Balance Sheet Projections

6.1 Profitability of product lines, relative growth and importance overtime

6.2 Relative contribution to profit by product lines6.3 Relative magnitude and composition of assets and liabllities on the

balance sheet

a:\annez5 (April 25. 1994)

-77 - ANNEX 6Page 1 of 6

ROMANIA

INDUSTRIAL DEVELOPMENT PROJECT

Foreign Exchange Market and Foreign Exchange Credit Market

A. The Foreign Exchange Markets

(a) Exchange Rate Management Policies

1. The liberalization of the foreign exchange markets and operations inRomania was initiated in November 1990, as a part of the first package ofpolicies initiating the transition to a market economy. The liberalizationmeasures included 50 percent foreign exchange retention of export proceeds;liberalization of current account payments and trans-border capital transfers,including cash payments, bank transfers and foreign debt service; andintroduction of foreign exchange asf,ounts for physical and legal persons infinancial institutions authorized to oterate in Romania. In February 1991, theGovernment established a foreign exchauge market allowing access to banks legallyoperating in Romania and to government agencies and the NBR. The original ruleswere somewhat modified in June 1991, by placing limits on the amounts andpurposes of current account payments and trans-border capital transfers. Theforeign exchange market was further liberalized in July 1991, allowing theestablishment of foreign exchange bureaus and, in effect, opening direct accessto the foreign exchange market to physical persons.

2. In practice, the active exchange rate management policy wasimplemented only half-way. The government state-owned enterprises (i.e., RAs)and certain other enterprises operating in sectors deemed of strategicimportance, continued to operate in a fixed exchange rate regime. Since Novemberof 1990, for about a year, the exchange rate was kept at US$1 - 60 leu. The restof the economy was operating in a "free floating' exchange rate regime. If anenterprise was not an exporter, foreign exchange needs were to be satisfied inthe foreign exchange market. In the period November 1990 to November 1991, theexchange rate on the free market segment increased from US$1 - 60 lei to US$1 -250 lei. Thus, there was an exchange rate difference of over 4 times betweenthose who had access to the fixed rate segment of the market and those who didnot, with accompanying relative price distortions.

3. The policy shifted again in November 1991 due to the need to unifythe exchange rate and to get hold of sufficient foreign exchange to bring thecountry through the winter period, since the anticipated disbursements from theC-24 did not materialize. The four sets of regulations enacted inNovember/December of 1991 included: exchange rate unification and a newmechanism for government management of the exchange rate; rules for andpriorities in foreign exchange allocation; limitations on current payments andtrans-border capital transactions; and strict control of foreign exchangeaccounts of physical and legal persons. The new rules resulted in a significantdecline of Romanian exports.

- 78 - ANNEX-6Page 2 of 6

4. In May 1992, as a part of a policy package associated with the secondIMF stand-by, the foreign exchange related policies and markets were againliberalized, including introduction of 100 percent retention of export proceeds.The main elements of the foreign exchange related regime include: (i) re-establishment of the foreign exchange market in the form of interbank market forbuying/selling operations effected by legal persons, and a market consisting ofa network of foreign exchange bureaus for buying/selling of foreign currencyeffected by physical persons. The interbank market operates in two forms, as adaily auction market and through direct interbank settlements (originally allowedfor amounts of less than US$50,000 per transaction). Legal persons participatein the interbank market through their "principal" bank. Buyers in that marketare requested to present documents attesting to the current account nature nftheir operations and are allowed to buy an amount of up to the payment due value;if they already owe some foreign exchange funds, they may only buy thedifference; (ii) capital transfers are allowed only for specifi'- purposes andneed to be authorized by the NBR and, in some cases, by the MOF. The applicantsmust prove the source of financing and that they do not have other outstandingliabilities; (iii) legal and physical persons are allowed to keep foreignexchange accounts. The regulations stipulate the legal sources of foreignexchange for deposits; and (iv) the exchange rate for leu is based on the averageprice determined in daily auctions in the interbank market. The NBR has beenallowed to participate and conduct operations in the market to protect thenational currency and to manage international reserves.

(b) Recent Developments

5. 'While establishing the foreign exchange market, the course of theexchange rate policies was dictated primarily by a wish to avoid a vicious spiralof inflation-depreciation, that could be established if the exchange rate wasfreed in the absence of complementary supporting macroeconomic policies. TheGovernment also wanted to ensure secure access to foreign exchange for importsof energy and raw materials. Large fiscal deficits (especially in 1992), highlynegative interest rates through most of the period, and episodic priceliberalizations contributed to pressures on the exchange rate. In concert withthe policies of gradualism in other areas, the authorities opted for a policy ofgradual liberalization of the exchange regime intended to lead to eventualconvertibility, by manipulating the rules of market access and limiting the dailychanges cf the exchange rate. In the event, the leu has undergone substantialnominal devaluation with episodic phases of real appreciation and depreciation.By end-l991, the leu was trading at 1276 lei to one US dollar, from the rate of20 lei to tne US dollar in October 1990, a depreciation, in real terms of about35 percent; compared to the fourth quarter of 1992, however, the rate experienceda real appreciation of about 40 percent.

6. In summary, substantial distortions have emanated from management ofthe exchange rate. Recognition that these policies were harming Romania'sprospects for sustained income growth become more apparent in late 1993. Inearly 1994, the Government finally decided, under the umbrella of the IMF Stand-by agreement, to fully liberalize access to foreign exchange market and allowfree float of the exchange rate.

- 79 - ANNEX 6Page 3 of 6

(c) Foreign Exchange (FX) Market Operations

7. The exchange rate has been managed through the FX market, and it hasnot been allowed to move more than 5 percent from the reference exchange rate ofthe praceding day. Since August 1992, the banks have been obliged to bring tothe FX market auctions all orders above US$2,000 equivalent. This has Increasedthe volume of market transactions but the level of executions, however, hasremained rather low. The market mechanism in the mid-1992 to end-1993 period hasbeen the following. The auction participants submit to the NBR their sale orpurchase orders in closed envelopes, quoting the amount and the respectiveexchange rate. The sale offers are then organized in the ascending order,starting from the lowest exchange rate; and the purchase offers are organizedin the descending order, starting with the highest bid. Both are executed in therange in which the sale/purchase orders match, the rest remains unfulfilled. Thedaily average of executed orders determines the equilibrium foreign exchange.

8. In September 1992, the rules of the auction market were furtherchanged in that the sale/purchase orders were to be first organized and executedonly among clients of the same bank. After the operations within a bank havebeen settled, the remaining selling orders were to be executed. The rationalefor the new rules was to motivate the banks to be more aggressive in convincingtheir exporter-clients to sell their foreign exchange. In the September-November1992 period, the typical daily volume of the FX auction market stood at aboutUS$3-5 million equivalent on the supply side, and US$15-20 million equivalent onthe demand side. The percentage of fulfilled orders for the market as a wholewas in the 7-25 percent range. The situation has substantially worsened duringthe winter months when the level of executions typically stood at 5 percent orless of the foreign exchange demand. Against the background of the Government'sfirm resolution not to allow fast depreciation of the exchange rate, this wasmostly because the purchase orders associated with imports of energy products,food, medications and similar necessities preempted orders of other marketparticipants.

9. The spring 1993 brought little improvement. The GovernmentIsexchange rate policy with managed movements within the 5 percentage range hasbrought an increasing disparity of supply and demand in the foreign exchangemarket. Rather than allowing a free float until an equilibrium is established,the disequilibrium has been addressed by de-facto tightening the rules of accessto the foreign exchange market. However, there has been no real improvement.In summer 1993, the average level of purchase orders execution was still in the2-5 percent range. The total amount of foreign exchange offered in the marketin June 1993 was US$61 million, of which US$48 million (79 percent) was sold atprices within the administered range; on the other hand, the registered foreignexchange demand amounted to US$ 1.7 billion, of which US$48 million (2.8 percent)was successfully transacted.

10. Government interventions in determining the exchange rate were notable, however, to prevent continuing depreciations. Moreover, parallel marketsflourished, at premiums often much above the official rates. At the end of 1993,it was estimated that only about 15 percent of exchange transactions was passing

- 80 - ANNEX 6Page 4 of 6

through the official auction market. About two-thirds of the flow that wassuccessfully transacted was using an unofficial "grey" market, consisting largelyof interenterprise transactions, at a premium generally between 25-35 percent ofthe auction rate. The persistent wide divergence between the official andparallel rates entailed substantial implicit subsidies to those importers whowere able to obtain foreign exchange in the auction. In addition, pricing ofenergy and agricultural products referenced the official rate as the benchmarkfor domestic price setting, entailing considerable implicit subsidies to energyusers. Meanwhile, the many changes in the foreign exchange regime undercutRomania's drive for sustained export growth and reduced confidence in the leu.

11. Radical changes, including liberalization of market access and takingsteps towards allowing for free float of the exchange rate introduced in January1994, have had a positive effect on the market. Against the background ofsubstantial depreciation of leu (from 1250 lei to one US dollar at end-1993 to1600 lei to one US dollar at end-March 1994), the "grey" market rate fell withinthe range of 5-10 percent of the nominal (i.e., official) exchange rate, and thepercentage of the foreign exchange purchase order execution increased to the 70-80 percent range.

B. Foreign Exchange Credit Market

(a) Sources of Foreign Exchange Credit

12. Excluding the international financial institutions, the typicalsources of foreign exchange credit in Romania include:

13. (i) Credit extended by foreign supgliers directly to Romanianimporters. The total volume of such credits is not precisely known, as thecredit is not reported in banking statistics. However, it is reported in thebalance-of-payment statistics. Foreign suppliers provide credit to Romanianimporters from their own sources, i.e., in the form of inter-enterprise credit.These are short-term credits; maturities rarely exceed five years and aretypically 18-30 months. To cover their credit risk, suppliers may purchasecredit insurance in their home countries.

14. (ii) Credit by foreign sumnlier's bank to Romanian importers. Thisarrangement typically includes the RBFT as a provider of an irrevocable paymentguarantee for Romanian importers. The RBFT typically asks for irrevocablecounter-guarantee by the Romanian importer's local bank. A Romanian importer istypically asked to deposit cash collateral of 120 percent of the guaranteeamount, expressed in lei, at the prevailing exchange rate. Rather than seekingguarantees from Romanian banks, a foreign supplier's bank may seek a guaranteefrom government-owned foreign credit insurance agency in the supplier's domicile(e.g., EXIMBANK in US, COFACE in France, HERMES in Germany, SACE in Italy, ERGin Switzerland, etc.). The availability and cost of such guarantees vary and thefees may or may not be market-based.. If the cost of a guarantee is at below-market rates, then the total amount is typically authorized by governments (orsometimes Parliaments) of respective countries. In some cases, guaranteec areavailable only for specific sectors or purchases.

- 81 - ANNEXPage 5 of 6

15. (iii) Credit lines opened by various Foreign ExDort Credit Agenciesto stimulate exports from their countries to Romania. The credit lines arenormally intermediated by the RBFT, due to its long-standing businessrelationships and a good reputation abroad. Utilization of these credit linesmay require an RBFT guarantee, and the RBFT may ask for a counter guarantee fromthe Romanian importer's local bank.

16. These credits are typically extended with maturities of up to fiveyears, with six months to one year grace periods. Credits are delivered toRoman.an banks at fixed interest rates; the RBFT reports that the ratesnegotiated in early 1994 were 5.63 percent for US dollar credit lines; 6.21percent for DM credit lines; 5.37 to 6.125 percent for SF credit lines; and 7.97percent for FF credit lines. Interest rates on credits to final borrowers areestablished by taking this basis and adding a margin which covers theintermediation cost and risk of a Romanian bank, plus a profit margin.

(b) Foreign Exchange Credit Market Volume

17. The total size of the foreign exchange credit market in Romania issmall, relative to the domestic credit market size and also relative to the sizeof Romanian economy (Table A6.3). In the 1989-1991 period, the market hassubstantially contracted in absolute terms. The contraction was parallel to thatof the domestic credit market. In 1992, against the continued contraction of thedomestic credit market, the foreign exchange credit market started to recover.Its size increased by 44 percent in dollar terms, and its share in the totalcredit volume increased from 3.3 to 11 percent. The growth of the foreignexchange credit market continued in 1993; its share in the total credit increasedto 20 percent and the market volume increased by about 45 percent in dollar termsand by almost four times in the domestic currency terms.

Table A6.3: Non-Government Foreign Exchange Credit Market

Volume FX Credit as X(milile1) (Il1U.SS Total NG Credit

1989 20,309 846 4.01990 23,100 385 3.81991 57,915 322 4.41992 213,554 464 11.01993 841.764 673.41 20.0

Source: NBR.Note: Note that the foreign guarantee progr do not appear in the statistics.

18. The foreign exchange credit market growth did not realize its fullpotential. In 1993, of about US$900 million foreign export credit lines andguarantee programs available, only about 70 percent has been committed. Less

- 82 - ANNX 6Page 6 of 6

than half of this amount has actually been utilized. There Is a number ofpossible reasons for the low utilization:

- The total cost of financing, including credit and associated guaranteesand counter guarantees, is very high;

- The cost of goods, which could be financed througb these programs, is notprice competitive when compared to prices in international markets;

- Romanian importer may not be willing to switch from his normal supplychannels if he cannot be assured of long-term relationships (includingavailability of financing) with a foreign supplier implied by the use ofparticular foreign credit/guarantee facilities;

- Procurement management problem concerning higher value-added Romanianexporters, who may need to import a number of items requiringestablishment of specific credit arrangements and the use of a number ofcredit lines/guarantees for a number of suppliers from differentcountries;

- Various limitations introduced by foreign creditors and/or guaranteeproviders (e.g., limited to specific sectors or suppliers) or by Romaniangovernment policies (e.g., import license requirements on certainproducts, or prohibitions to pay prices higher than international prices).

- The RBFT acts as a hub of foreign governments' guarantee and export creditprograms in Romania. The RBFT intermediation capacity and/or businessdecisions concerning the off-balance sheet foreign exchange rlsk exposureact as an effective limit to utilization of these credit lines orguarantee programs.

- 83 - A7Page 1 of 1

ROMAIAZI

lNDUSTRIAL DEVELOPMENT PROJECT

Estimted Disbursement Schedule of the Pronosed Loan

Egtimated ScheduleCumulative

Calendar Year Fiscal Year Amount Amount Z of Totaland Semester and Semester -(US$ Million)--

1994 II FY95 I 15.0 15.0 8.61995 I II 38.0 53.0 30.3

1995 II FY96 I 42.0 95.0 54.31996 I II 19.0 114.0 65.1

1996 1 FY97 I 20.0 134.0 76.61997 I II 15.0 149.0 85.0

1997 rI FY98 I 12.0 161.0 92.01998 1 II 9.0 170.0 97.0

1998 II FY99 I 5.0 175.0 100.0

Note Amouts rfe to en of period. D hih l_e of diburement durng the fit 18 monts Is due to: (i) thewpom finu componetm (US70 Mion equM lent), whudi is aexcted to dbure USSIS, USS30 and USS2milion. tecv* i the dtr se amneters after the loan becomtes eective; and (I the tedmicasulsmncotnent, whd &s a twoyr pplm and minmed to disbumewith a seedule USS1-14mnion die Om four aesete req"a*We. For the n of cradit (USS102 miion) the andarddisuremnt >prfil hor Romanis has ben used as bausL To refet the xpeaed dynenc of the Projectquaner 1820 in the sandrd dibunement table for Romama whid aornt for 6 pero" of the total crediwwo added to quaner1s516.

-84 - ANNEXa8Page 1 of 3

ROMANIA

INDUSTRIAL DEVELOPMENT PROJECT

Supnrvision Plan

Approximate Dates Activity Expected Skill Staff Input(Month/Year) Requirements (Staff Weeks)

…-. -.- -- --- . - - . - --- . . . . . -_ -.. -- . . -- . . . - . . ...-- -- - . . . . -_ _

1/95 Supervision Mission 10

- Review accreditation of Banking SpecialistPFIs Financial Specialist

- Review EFF arrangements Disbursement Specialistin TD/MOF Procurement Specialist

- Review PFI export and Engineerinvestment appraisalarrangements

- Review TA for MOI

6/95 Supervision Mission 12

= Review credit pipelines 2 engineers= Review appraisal Financial Specialist

procedures Economist* Review TA to PFIs Procurement/- Review progress of Disbursement SpecialLst- consultancy studies- Verify phase-out of

subsidized credits- Conduct procurement/

disbursement seminar- Review TA/TORs and

short 1Lst for Banks

- 85 - ANNEX 8Page 2 of 3

Approximate Dates Activity Expected Skill Staff Input(Month/Year) Requirements (Staff Weeks)

12/95 Supervision Mission 10

- Review export finance Banking Specialistappraisal, procurement, Financial Specialistdisbursement Engineer

- Confirm PFI eligibility Economist- Review TA for MOI/MOF/NBR/

SOF- Review investment lending

pipeline, appraisal quality,procurements/disbursements

6/96 Sugervision Mission 10

= Review macroeconomic Banking SpecialistDevelopments Economist

- Review business Engineerenvironment

- Assess ProjectImplementation Results

- Review continuous PFIeligibility

- Review benefits/risksrelated to a choice ofsingle currency loan

Supervision Mission

12/96 - Review TA for MOI/NBR Financial Specialist 66/97 - Review investment Engineer 66/98 component Economist 6

- Review export component- Review EFF procedures- Review procurements/

disbursements

- 86 - ANNEX 8Page 3 of 3

Approximate Dates Activity Expected Skill Staff Input(Month/Year) Requirements (Staff Weeks)

Supervision Kission12/97

- Rev4.ew investment Financial Specialist 6component Engineer

- Review export component Banking Specialist- Review Procurements/

Disbursements- Review continuous PFI

eligibility (Assesscontinuous need for EFF)

12/98 Supervision Mission 6

- Review Special Accounts Financial Specialist- Review Procurements/ Economist

Disbursements- Review outstanding issues- Agree on Project closing

date

6/99 Project Completion Report 8

Preparation of project Engineercompletion report at Financial SpecialistHeadquarters Economist

Total Missions Total Staff Weeks

FY94 2 22FY95 2 20FY96 2 12FY97 2 12FY98 1 6PCR

80

- 87 - ANNEX 9Page 1 of 1

ROQkWIA

INDUSTRIAL DEVELOPMENT PROJECT

List of Documents in Project e

1. Mission Aide-Memoires and Back to Office Reports dated December 1991;February, May, July and November 1992; August 1993; April 1994.

2. Wood-Based Industry Study, Jaako Poyry, Sweden, September 1993.

3. Romania Textile and Leather Industry Study, Rovetex, Switzlerland,April 1994.

4. Romania - Machine Building and Steel Sector Assessment, Back to OfficeReport, April 8, 1992.

5. Romania - Non-Ferrous Metal/Mining Sector Assessment, June ?O, 1992.

6. Romania - Fertilizer Sector Assessment, June 1992.

7. Romania - Petrochemical Sector Assessment, October 1992.

8. Romania - Review of the Industrial Sector and Enterprise Reform: MainReport; 6 Annexes; Attachments.

9. Statistics Concerning Export Financing Demand, October 1992.

10. Intermediate Report on SMEs, June 1992 and February 1994.

11. Blueprint of Government Strategy to Promote PSD and SME Sector, CNSVeneto, December 1991.

12. Lazard trere - Strategy for Implementation of the Privatization Law (inFrench), April 1992.

13. Consultants Report - Summary of Bank Appraisal Results, December 1992and July 1993.

14. Survey of the Impact of Social and Economic Environment on PrivateSector Development in Romania, NAP, May 1992.

15. Technical Assistance for organization and implementation of the SOF andfive POFs, Roland Berger, February 1993.

16. Terms of Reference for Technical Assistance under the IndustrialDevelopment Project.

MAP SECTION

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