ASEM Trust Fund Review Meeting Washington D.C., April 19, 2002

Country Strategy Notes

China: ASEM Country Strategy Note April 2002

1. To date China has benefited from $ 8.3 million in ASEM Trust Fund (TF) resources for 12 country-focused technical assistance projects. It has also been included in several multi-country studies. These activities are helping China deal with some of its most pressing challenges, which, if not adequately addressed, have the potential to cause a far more severe crisis than that experienced in East Asia some years ago. ASEM TF grant resources have funded international experts in areas of vital concern to China, which is now restructuring bankrupt state-owned enterprises (SOEs), establishing a legal, policy and institutional environment conducive to private sector development, reforming what has been a technically bankrupt financial sector, developing a national social security system to facilitate labor mobility and allow SOEs to shed burdensome social responsibilities, and protecting the poor and vulnerable from the effects of economic restructuring. China’s size and the scale of these problems means that no one donor is able to respond adequately to its needs. The country’s development partners are therefore collaborating on key issues, as dictated by their comparative advantages. The partnership of ASEM is a fine example of how the such collaboration can work, and work successfully. Recent Developments Relating to ASEM TF 2. Growth in 2001. China’s economic performance in 2001 remained strong, with growth officially estimated at 7.3 percent. This reflects the fact that domestic demand rather than the international economy—which fell into recession during the year—is the main driver of the country’s aggregate economic performance. The Government’s ongoing fiscal stimulus program aided domestic consumption and investment growth, although the effects of foreign capital flows on investment were also significant. Indeed, foreign direct investment in China reached $45 billion last year, making China the largest recipient of FDI inflows in East Asia.

34087

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

2

3. Progress but an unfinished agenda on banking and corporate sector reform. A slowdown in China’s economy towards the end of the year brought into sharp relief a number of structural and policy issues. Investment demand in the latter part of 2001 was slowed by a credit crunch, as banking system reforms resulted in bank efforts to strengthen their portfolios and make higher provisions for losses. This is desirable in a transition economy, and significant strides are being made in banking reform. The main targets of reforms are strengthening supervisory and regulatory functions of the People’s Bank of China’s (PBOC, the Central Bank), commercializing the four major state banks, and bringing the banks' management, credit and accounting systems closer to international standards. Action taken by the PBOC have included establishing a special asset management company within each state bank to handle non-performing loans; merging their provincial branches and provincial capital city branches; and division of the financial businesses provided by banks, insurance, brokerage, and credit cooperatives. Many state-owned banks are preparing to list on local and overseas stock exchanges. However, China must still take many steps to prepare its financial intermediaries to operate in the more competitive environment created by China’s recent accession to WTO on December 11, 2001.

4. Although great effort is being put into reshaping the industrial sector, its losses expanded during the year. While all industrial enterprises reported a growth of 8.1 percent in profit for the 2001, this was lower than in 2000. Key state enterprises have been particularly affected, and in the first two months of 2002 their profits fell by over 37 percent (y/y). In addition to changes in accounting methodology, the decline in oil prices and a fall in output account for the shrinking SOE profits. The government is therefore showing greater support for private sector development, and in March 2002 the State Development Planning Commission issued a document entitled, “Some Opinions on Promoting and Guiding Private Investment.” This spelled out policies encouraging private investment in all areas open to foreign investors, ending discrimination by state banks against private investors, and allowing some tax holidays for private firms in their start-up stage. Since the private sector is the fastest growing part of the economy but has been constrained by limited access to financing and an unsupportive business environment, this policy paper is considered important for private sector growth.

5. Increasing income inequality and social instability. China’s rapid economic growth has not prevented rural-urban inequalities and inter-provincial income gaps as the coastal provinces grow at a much faster rate than inland areas, especially the west. Between 1998 and 1999, the growth rate (3.8%) of rural per capita net income in all regions was barely a third of that between 1995 and 1996 (13.2%). And some of the poorest provinces had little rural income growth or even declining incomes. Poverty reduction during that period slowed and inter-provincial income gaps widened. Recent data suggest that rural poverty may have fallen over the past two years, and especially in 2001, as improvements in the rural terms of trade and higher rural incomes were accompanied by stronger growth in rural consumption. Nevertheless, this does not mean an end to rural distress, which is widespread, nor does it mean that rural-urban inequality is narrowing. If anything, the gap has widened, as urban income growth has outstripped that of the rural areas and, with the exception of last year, urban consumption growth has

3

also been more rapid. Thus, more than 200 million rural people in China still live on less than $1 per day. Urban areas, though generally much better off, are nevertheless seeing a rise in poverty due to slowing economic growth and economic restructuring. The Government, with support from its development partners, is identifying ways of accelerating pro-poor growth and human capital development in the lagging western region, where most of the poorest Chinese live. 6. The increased unemployment that has accompanied enterprise restructuring and provoked social tension has spurred government efforts to develop a financially sustainable national social protection system to provide services formerly delivered by enterprises. July 2001 saw the launch of the Liaoning Social Security Pilot Program, which is testing an approach for transferring management responsibility for social insurance from enterprises to municipalities and provinces. After a pilot period, the approach developed will be expanded to other provinces. Impacts of and Lessons from ASEM TF I 7. The ASEM Trust Fund for China is assisting the country to deal with the vulnerabilities described above. The six TA grants made available under ASEM TFI for market-oriented corporate and financial sector reform totaled US$5.1 million and focused on bad debt resolution for banks (US$1.4 million), development of deposit insurance for banks (US$0.4 million), strengthening smaller banks (US$1.5 million), debt restructuring and loan workouts of state enterprises (US$0.6 million), building government capacity in debt management (US$0.7 million), and addressing critical social aspects of corporate restructuring (US$0.5 million). These activities brought in external expertise and technical support to assist policy makers in some of the key issues facing them. 8. During implementation of these grant- funded activities, several lessons were learned which has benefited the design of subsequent projects.

• The task for strengthening one of China’s smaller banks highlighted the benefits of a narrow focus on issues. However, two other lessons were learnt; a) the importance of having the top management’s involvement: staff involved in the implementation often needed to report directly to top management since introducing changes usually affect the whole organizational structure and lead to significant conflicts with and resistance from existing departments; and b) secondly, consultants’ effectiveness in implementing a TA activity can be constrained by the absence of a train- the-trainer concept.

• The need for a narrow scope was also recognized in the early stages of the activity

to assist China develop effective strategies and methods to restructure SOEs by using debt workout as a mechanism. The client scaled down the original proposal that called for investigation of seven topics to only three specific topics. This facilitated in-depth analysis of weaknesses in the legal, regulatory and policy framework and identification of needed changes in policies and practices. With planned dissemination of findings and possibly the publication of a research paper

4

based on the data and information collected during grant implementation, there is a good prospect that key policy makers will accept and implement some of the recommendations.

• The ASEM TF -funded work on the social aspects of corporate restructuring

indicated the need for firm commitment by the implementing cities, especially when difficult changes are involved. The municipalities of Wuhu and Shenyang had that commitment and successfully completed their programs. However, the cities of Changsha and Wuhan decided to withdraw from the program.

9. Some practical lessons were also learned. First, a three-year implementation period, not the two years initially proposed, will often be needed to roll out major change initiatives. Second, World Bank grant execution by Beijing Office staff normally proved effective in keeping the projects on track in difficult times. 10. Grants provided for the health and education sectors, totaling almost US$1.2 million, similarly also played a valuable role in advancing important strategic policy analysis during a period of transition. The ongoing ASEM Trust Fund grant of US$300,000 for monitoring and strengthening the financing of education, for example, supported (i) the design and implementation of reforms to move basic education financing in poor rural areas away from a system of locally collected and allocated education surcharges to a new, regularized system of county- level rural taxation; and (ii) development of an intergovernmental transfer system to allow movement of substantial amounts of funds from central government revenues to poor provinces. The aim is to minimize the adverse consequences on the poor of education sector adjustments being made in response to the financial and economic constraints facing many segments of Chinese society. With approval of an additional US$250,000 in TF funding, the applicability and feasibility of the studies’ findings are being tested in two of the poorest provinces in China, Guangxi and Ningxia. ASEM TF II Priorities 11. Under the second phase of ASEM TF support, priorities will continue to be financial sector reforms, social insurance development, and reorientation of human development activities to reduce the impact of economic adjustment on the poor. For the corporate sector, the emphasis is on creating an enabling environment for ownership transformation and enterprise restructuring and reform. To date, grants have been approved for (i) social security reform in China, to protect those in need and to facilitate corporate restructuring (US$777,000); (ii) poverty mapping in Indonesia, Thailand, and China, to improve targeting of government assistance to the poor (US$985,000 for three countries); (iii) MOF design of improved cash management capacity as a foundation for improved functioning of the government securities market (US$310,000), (iv) technical support to the State Council Office for Restructuring of the Economic System (SCORES) in shaping and building consensus around a comprehensive reform strategy (US$400,000) and (v) technical support to the Chinese Securities Regulatory

5

Commission (CSRC) to promote adoption of professional risk management policies and practices in the securities market (US$600,000). 12. Proposals being discussed for future ASEM TF Support include the following:

• Role of Enterprise Groups - Based on experience of conglomerates in Western

Europe and elsewhere, how much of a role can enterprise groups play in enhancing post-WTO competitiveness and enterprise reform? ($500,000)

• Pension Funds and Corporate Equity - What are the comparative experiences of public and private pension funds in Western and Eastern Europe, North and South America, and elsewhere in holding and managing corporate shares, and what lessons can be derived for China? ($500,000)

• Assistance to Asset Management Companies (AMCs) - While the Cinda AMC is benefiting from a current ASEM TF grant in improving management of converted corporate equity, similar assistance could be provided to the other three AMCs ($1.2 million)

• Assistance to China Securities Regulation Commission – The CSRC is expected to need support in various areas, including reviewing/commenting on new company and securities law and regulations ($400,000)

• Business Environment in Lagging Western Regions - What are the regulatory and procedural impediments to investments and business operations, and what are regional strengths, weaknesses, and opportunities? ($500,000)

Steering Committee for ASEM Programming 13. As recommend by those attending a recent ASEM TF evaluation meeting in Bangkok, establishment of a Beijing-based ASEM Steering Committee is being planned with the aim of ensuring strong beneficiary ownership of ASEM TF grants to China as well as adequate consultation with beneficiaries in programming ASEM resources. As proposed, the Steering Committee would include representatives of MOF, the World Bank and the EU's Beijing office. World Bank representation on the Committee would be headed by the Deputy Head of Mission, with advice provided by Bank staff in Beijing dealing with corporate, financial and social protection issues. It is envisioned that Committee meetings would be scheduled every six months or when deemed appropriate by Committee members. Endorsement of this proposal by China’s Ministry of Finance and the EU’s Beijing office has been sought.

6

Indonesia: ASEM Country Strategy Note April 2002

1. The ASEM Trust Fund has played a major and visible role in shaping the crisis response in Indonesia. Under ASEM TF I twenty-one different grants were made, including three multi-country grants, for a total of US$8.5 million. Allocations under the initial tranche of ASEM TF II comprise three grants totaling $657,000, plus a regional grant for $985,000 for which Indonesia is taking a part. ASEM TF funds were one of the only sources of support for developing crisis-response activities, particularly for social sectors As the crisis evolves towards recovery, ASEM TF-funded initiatives are providing essential buildings blocks for Indonesia’s future. Recent Developments Relating to ASEM TF 2. The establishment of the new government in August 2001 created a sentiment of cautious optimism in Indonesia. Although progress was quickly made with the IMF program, other reforms continued at a slow pace for several months, frustrating observers. However, towards the end of 2001 and early 2002 some significant steps were taken, notably steps to firmly launch the privatization program and increase oil prices. Progress is now continuing at a steady pace. The IMF program remains on track with work underway for the fifth review, and preparations are being made for the Paris Club meeting, anticipated in April. While confidence has risen that the necessary political and economic stability has been achieved to allow for progress, it is clear that the short and medium-term economic challenges facing the government continue to be daunting. 3. Bank and corporate restructuring and fiscal sustainability remain high on the list of priorities. In the medium-term, the government must continue efforts to shift the focus of its poverty reduction efforts from crisis-response social safety nets to a broad-based strategy for attacking poverty and vulnerability in Indonesia. Additionally, to consolidate democracy and to set the conditions for sustainable growth, changes are needed in the way Indonesia is governed. 4. Following the initial phases of banking sector stabilization and recapitalization, the financial sector reform program supported by the IMF, World Bank, and ADB is now focused on the process of consolidation and restructuring to revitalize the credit process, build sound governance, and return bank ownership to the private sector. Post-crisis Indonesia still has 149 banks, 75 percent of whose assets are state-controlled, up from 43 percent before the crisis. The deteriorating economic and political environment in the first half of 2001 caused bank restructuring and reform to slow. The largest nationalized or BTO (bank taken over) bank was recently sold and the sale of another such bank, Niaga, is currently on offer.. The poor financial performance of banks and other factors, perpetuated in part by high interest rates, has left the banking system as a whole undercapitalized, raising the issue of additional bank closings and a possible second recapitalization. Recent parliamentary approval of the sale of a 51 percent share of Bank

7

Central Asia gives encouragement that the two branches of government are now finally working together to accelerate the bank restructuring program. Also on the bright side, NPLs (non-performing loans) in the banks declined to 17.4 percent in June 2001, though little is known about the quality of the restructuring.

5. Despite crisis recovery, various dimensions of poverty still affect half of all Indonesians. The 1997 economic crisis increased poverty significantly. Preliminary analysis suggests that as of February 2000 poverty may have declined slightly from its peak in February 1999 of 27 percent. Because real wages stagnated (in industry) or declined (in agriculture) and inflation rose between late 2000 and early 2001, it is unlikely that further progress has been made on returning to pre-crisis poverty levels. Moreover, Indonesia’s far-reaching decentralization, while offering long-run prospects for public services more responsive to the needs and desires of the poor, has in the short run created uncertainties and disruptions. 6. The Government has committed to developing a broad-based poverty reduction strategy and has recently established an inter-ministerial coordinating and management mechanism—the Poverty Alleviation Committee—chaired by the coordinating minister for people’s welfare, with the coordinating minister for economy as the deputy chair and with a secretariat including staff from the vice president’s office. The committee has been established to address the multi-dimensional nature of poverty in Indonesia, and will be aided by a technical support team. Plans are underway for the Government to work on an interim poverty reduction strategy paper. The next step will be for it to engage in consultation on the poverty strategy with civil society, the regions, and donors. 7. Governance is Indonesia’s key medium-term development challenge. Weak governance has, if not caused, then at least aggravated the economic crisis out of which Indonesia is just emerging. The crisis brought to the surface the lack of accountability, transparency, and rule of law in Indonesia, compounded by weak institutions unresponsive to the population at large and to the poor in particular. Indonesia scores consistently low in surveys on rule of law, corruption, and business environment. Illegal gains from corruption have mainly benefited the rich and were a major factor in the downfall of the Suharto regime. Bad governance has affected the poor across the board, including lack of basic law and order, lack of mechanisms to influence budgetary choices, poor quality services, and lack of transparency and accountability in the use of funds. 8. The Government’s medium-term policy directions emphasize the importance of improved governance and of addressing social inequity and poverty as part of a sustainable and just economic recovery. President Megawati’s speech on the 2002 budget reiterated this point when she emphasized the need to “create good governance and public order and security.” The State Policy Guidelines, adopted in 1999, underline the supremacy of law and the protection of fundamental human rights. The Government’s Propenas five-year plan (GOI FY2001-05) builds on these guidelines and is organized using five major priority areas: (i) building a democratic political system while maintaining national unity; (ii) realizing the supremacy of law and clean governance; (iii)

8

accelerating economic recovery and building a sustainable and just development platform; (iv) improving the development of people’s welfare and cultural resilience; and (v) improving regional development. Impacts of and Lessons from ASEM TF I 9. ASEM TF support has been critical for shaping the Government’s and the Bank’s response to the social impacts of the crisis. Protecting the poor from the worst effects of the crisis has been a main goal of the program. Initial grants were used to set up accelerated information gathering and analysis so that the scope and nature of the social crisis impacts could be defined. ASEM TF also supported development of the highly successful US$400 million Scholarships and School Grants Program to keep vulnerable school-age children in school. A multi-donor effort, this countrywide program has been one of the success stories of Indonesia’s response to the crisis. ASEM TF funds supported establishment of the Community Recovery Program, an NGO-led safety net for the most vulnerable that channeled assistance to grassroots organizations across the country. ASEM TF support was also provided for improving social safety net monitoring in Indonesia through a combination of “spot checking” measures, information campaigns, better grievance mechanisms, community and NGO monitoring, and an information clearing house. 10. Implementation experience showed that Indonesia’s ASEM TF programs substantially exceeded initial expectations. ASEM TF-funded studies provided fast, reliable data on the poverty impacts of the crisis, showing that impacts were much more heterogeneous than expected. Based on these findings, donors moved away from generalized safety nets to programs that focused on vulnerable groups. Because of their quick response, ASEM TF grants then became the chief means for independent monitoring of targeting efficiency, including use of community-based monitoring. ASEM TF support also had a major impact on policies and programs for the poor beyond safety nets and diagnostic studies. ASEM TF studies documented significant drops in spending for health and education, which provided the basis for revising public expenditures to protect core poverty services. 11. In the education sector, ASEM TF-supported surveys and analysis on school enrollments, dropouts, and school finances led to a clear assessment of the real impact of the crisis on education and to better targeting of scholarships and school grants. An independent complaints and response mechanism reduced misuse of public funds in the sector. Beyond the crisis, ASEM TF supported development of a medium-term strategy for the education system. Task forces have been working to develop a roadmap for education in Indonesia, as it begins to tackle issues of quality improvement, deal with decentralization, and teach democratic values. 12. In support of the banking restructuring program, ASEM TF provided funding to IBRA for a program of financial sector advisory services, primarily to help establish an independent review committee of international and Indonesian experts and to enhance

9

TA coordination for IBRA and Bank Indonesia. ASEM TF also contributed significantly to the strengthening of local institutions and to decentralization efforts. Support included programs to improve local government public expenditure and financial management systems and to monitor implementation of regional deregulation efforts under the economic adjustment program. ASEM TF financed a program to improve fiscal policy analysis by the Ministry of Finance. 13. A number of lessons emerged from the previous rounds of ASEM TF activities. First, given the institutional turmoil that has prevailed in Indonesia, Bank execution of ASEM TF programs allowed for much more rapid preparation and start-up times than had been the norm. Weak local capacity, on the other hand, resulted in poor implementation of a disproportionate share of government-executed activities. Continued case-by-case decisions on the most effective implementation arrangements are therefore recommended (the recipient countries were quite vocal on this issue – they seem to think that they never were given a chance to even execute on their own – please either change this sentence or agree with BAPPNAS that this arrangement is OK – Freddy questioned me last year in front of all the donors/recipients why the Indonesia execution share is so low. ). Second, the cost of Bank supervision of ASEM TF grants has been substantially higher than expected. Special efforts are required to design activities that are affordable in terms of administrative budget availability. And, third, flexible reallocation procedures are needed to allow ASEM TF projects to adapt quickly to Indonesia's highly fluid environment. (The evaluators questioned the delay in implementing the ASEM activities, cost overruns, weak ownership of activities, and weak monitoring and evaluation. Is there anything that you can say to improve the perception? ) ASEM TF II Priorities 14. The Country Assistance Strategy FY01-03 for Indonesia, the overarching goal of the World Bank Group in Indonesia, is to support efforts to reduce poverty and vulnerability by fostering a more democratic and decentralized environment. Accordingly, the Bank Group’s strategy is focusing on the following three broad priority areas: • Sustaining economic recovery and promoting broad-based

growth. In the short run, this requires macroeconomic stability and accelerated bank and corporate restructuring. In the medium term, it will involve policies and public expenditures aimed at poverty reduction, efficient private sector growth, and human capital and infrastructure development to improve competitiveness.

• Building national institutions for accountable government. This

includes legal and judicial reforms, civil service reforms, better public financial management and procurement, effective decentralization, and close attention to sustainable management of the rapidly depleting natural resource base of the country.

10

• Delivering better public services to the poor. This priority involves assistance to help define government roles and responsibilities as functions are decentralized; support for improved public service delivery by sub-national governments with demonstrated pro-poor, pro-growth reform procedures; and promotion of community development and selective assistance to post-conflict areas.

15. Our strategy for ASEM in Indonesia remains as previously noted. As the recovery is taking hold, the priorities for ASEM Trust Fund II are shifting to focus on Indonesia’s medium-term development challenges. Since the crisis both hit Indonesia more deeply than it did other countries and was accompanied there by a political upheaval that slowed implementation of comprehensive reforms, many of the suggestions involve following-through on activities already launched and underway. Bank and corporate restructuring have a long way to go, and, with half of all Indonesians vulnerable to episodes of extreme poverty, sustainable poverty reduction will continue to be a major issue. ASEM TF priorities, therefore, will remain at the center of Indonesia’s development agenda. 16. To date, the Indonesia program has drawn on ASEM TF II support for both social and financial and corporate sector reforms. • Social reform. A grant of $207,500 was made to support pro-poor

policy development by the Government, drawing on consultations with civil society and other stakeholders. This grant will support the development of a broad based, participatory poverty reduction strategy. Additionally, Indonesia is one of three countries included in a grant, totaling $985,000, funding improvements in poverty mapping in the region.

• Financial and corporate sector reform. A grant for $250,000

was approved for building debt management capacity in the Government and a second, for $200,000, was made for improving fiscal policy analysis. Two additional grants, for financial sector reforms and for building investor confidence by promoting good corporate governance, have been approved and final steps on signing are underway with the Government.

17. Other possible areas of emphasis under ASEM TF II include the following. • Bank and corporate restructuring. In terms of bank

restructuring, the Bank will retain its leadership role for work on the state banks and IBRA. In addition to those already funded, possible activities for the next ASEM TF phase include strengthening monitoring of the

11

performance and restructuring of the state-owned banks and preparation for privatization and the continuation of current ASEM TF-supported IBRA projects. Priority work will also be undertaken on the design and implementation of a medium-term financial sector strategy, including non-bank financial institutions, the capital market, housing finance, and micro-finance. For corporate restructuring the focus will continue to be on creating and supporting the enabling framework for effective resolution, including the support of the corporate restructuring activities of IBRA’s two asset management units and the Jakarta Initiative Task Force (JITF) and for improving the commercial court and bankruptcy process.

• Development and implementation of a broad-based poverty

reduction strategy. The new government is developing a poverty strategy and is already being supported through ASEM TF II. It is anticipated that work on agricultural policy and food security will also be part of this broad-based poverty strategy approach, which may require additional grant support. For the education sector, the agenda for possible ASEM TF support will move towards quality issues: curriculum reform, teacher training, and cost-effective education. Health programs must focus on ensuring that basic services to the poor are provided and on helping the private provision of health services to recover and thrive.

• Governance and anti-corruption efforts. As part of crisis

recovery, ASEM TF support is warranted for laying the foundations for revitalized, sustainable institutions. (The Bank has increased work on governance and anti-corruption issues in close collaboration with partners specifically by helping establish the Partnership for Governance Reform in Indonesia, which brings together the Government, civil society, the private sector, and donors to facilitate a national dialogue on governance.) Of special importance will be work in civil service reform and programs for evaluating and improving the quality of public service delivery in a decentralized environment. Corruption and public transparency are of particular concern in Indonesia, and future ASEM TF programs could help efforts to improve public procurement and financial management and audit systems. A pressing need exists to tap international expertise in areas such as reforming the judiciary, developing effective sanctions, using community controls, and developing civil society accountabilities.

• Analytical work at the sub-national level. With

decentralization, the duty of ensuring public services will shift increasingly to local governments. In order to ensure that Indonesia’s poverty reduction approaches are effective, it is first necessary to develop a better understanding of local institutions, local capacity, public expenditure programs, the fiduciary environment, and the quality of public service delivery to the poor. This will be undertaken by cross-sectoral teams that engage with sub-national governments, civil society groups, the

12

private sector, and local communities. Recognizing that central government capacity will also need to be strengthened simultaneously to meet its remaining responsibilities in a post-decentralization era, ASEM TF II is providing support for improving fiscal policy analysis and for building capacity to manage the country’s large public debt according to sound international practices.

Indonesia ASEM Committee 18. Discussions are underway with Government of Indonesia to determine the structure of the in-country ASEM Committee which will be responsible for developing the ASEM strategy, reviewing and prioritizing proposals and monitoring implementation of ongoing ASEM activities. It is anticipated that this committee will also draw on existing Government/donor working groups to align support.

13

Korea: ASEM Country Strategy Note April 2002

1. As the Republic of Korea (ROK) puts the Asian financial crisis behind it has committed to continue structural reforms and to change the Korean economy and society. It has also declared a commitment to share its experiences in turning its economy around from the worst of the Asian financial crisis with its neighbors. The government has articulated a long-term vision to transform Korea into an advanced knowledge-based nation. Support from ASEM TF II will help Korea continue its structural transformation and to share this experience with its neighbors. Recent Developments Relating to ASEM TF 2. Korea has achieved one of the fastest rates of economic development of any country in the world. Between 1966 and 1996, its per capita income grew by an average of 6.8% per annum, and it became an OECD Member in 1996. Towards the end of 1997, however, Korea experienced its worst economic crisis since the Korean War. Nonetheless, Korea made a remarkable recovery from the crisis and its economy grew at 10.7% in 1999, 8.8% in 2000 and around 3% in 2001. 3. In the coming years, Korea faces a difficult and competitive global environment. Its wages have risen and it is experiencing increasing competition from lower-wage countries in East Asia. Although its manufactured exports have been expanding rapidly, it is being squeezed between the developed OECD countries at the higher end, and China and other East Asian developing countries at the lower end. As a result of these developments and the increasing importance of knowledge, Korea is confronted with the unprecedented challenge of transforming itself into a knowledge-based economy. 4. Increases in scientific understanding and very rapid advances in information and communication technologies (ICTs) mean that knowledge and information have become key to competitiveness. The rapid development of ICTs and the Internet is exposing inefficiencies in the functioning of markets, firms and institutions, putting downward pressure on prices and accelerating the need to restructure and adapt to changing conditions. ICTs are also improving the efficiency of interaction among government agencies and the delivery of government services, as well as facilitating consultation with the public. This is bringing a new potential for the re-organization of administrative and political institutions and for dramatic reductions in the cost of delivering services. 5. Looking ahead, a few challenges stand out in Korea’s development policy agenda:

• Maintaining stability in a globalizing environment: Korea’s increased integration into the global economy has raised the premium on policies that enhance resilience to shocks. Prudent macroeconomic policies are necessary

14

of course, but not enough; the financial sector and corporate finances—key sources of vulnerability in the 1997 crisis—must also be placed on a sound footing.

• Spurring productivity growth: Korea’s growth in the future will need to rely increasingly on productivity improvements, in contrast to the past when factor accumulation was the main driver. This implies a growth path that will require stronger competition and market discipline in the economy.

• Adapting to an increasingly competitive global market: Increased competition in manufacturing from other emerging market economies, importantly from China, will necessitate (i) a move up the value-added production ladder for Korea in manufacturing (higher quality, more ICT and knowledge- intensive products) and (ii) complementary development of the service industry. This calls for a more flexible and adaptable economy, less concentrated and with a more vibrant small and medium size enterprise sector.

• Modernizing the social protection system: The system for social assistance and insurance will need to be strengthened: to provide a stronger safety net to the poor and vulnerable against shocks and the impact of economic restructuring; and to provide for, in a sustainable manner, an ageing population that will increasingly turn from traditional to more formal systems of old-age insurance.

6. Given these challenges, the structural and institutional reform program being implemented by the Korean government focuses, correctly, on four key areas:

• corporate sector reform, to reduce high corporate indebtedness, improve

corporate governance, and strengthen competition. • Financial sector restructuring, including a swift resolution of problem

financial institutions and assets in the wake of the crisis and longer-term improvements in the regulatory and institutional framework to underpin the development of a sound financial system in the future.

• Public sector reform, to reduce government intervention in the economy and improve the quality of governance.

• Labor market reform, to increase flexibility in the employment and mobility of workers, complemented by a strengthening of the social protection system.

World Bank assistance strategy 7. The ROK and the World Bank relationship has moved to a mature partnership. There is no more any new lending to ROK. In this new phase of partnership the World Bank is providing knowledge in selected frontier issues of development ( building a knowledge economy and financial and corporate restructuring ) and ROK is contributing in many ways to the World Bank’s resources and services to lesser developed countries in the region. In this partnership the ROK benefits from the global expertise of the Bank and the Bank members benefit from the valuable lessons that can be applied from ROK experience in other countries in the region and beyond. To achieve these objectives, the

15

Government of Korea and the Bank signed a “Knowledge Partnership” MOU last year under which the Bank provides technical assistance in the form of economic and sector work and Korea makes available Korean specialists, at their expense, to disseminate knowledge to other countries. Support via ASEM TF II would be a valuable addition to the limited resources of the World Bank and ROK to implement the “Knowledge Partnership” MOU, especially in enhancing knowledge sharing among ASEM members and will create important benefits for the global development community.

Impacts of and Lessons from ASEM TF I 8. Korea benefited from 9 ASEM TF I projects, amounting to $4.9 million. 4 projects were geared toward financial and corporate sector reforms whereas 5 projects focused on reforming the social safety systems and human resources development. While the earlier projects had a slow start because of the country’s unfamiliarity with Bank trust fund procedures, particularly in procurement and execution arrangements, the activities gained momentum from late 1999 onwards. Most of the activities have contributed significantly to the country’s reform agenda over the past 4 years. 5 projects are now completed. 4 projects are wrapping up the activities now. 9.. For the financial sector restructur ing, two ASEM TF grants supported the government’s effort to strengthen the capacity of the Financial Supervisory Commission (FSC), develop the operational capacity of Korea Asset Management Corporation (KAMCO) and strengthening the government’s debt management capacity. Extensive training programs were provided using Asian as well as European experts for FSC and KAMCO. The grant for the debt management capacity led to the establishment of the Korea Center for International Finance. 10. Two grants for corporate sector restructuring were implemented; namely, Supporting Korean Institute of Certified Public Accountants and Development of a Framework for Private Sector Participation in Infrastructure. While the first project is still underway the second project is completed with the Korea Private Infrastructure Investment Center gaining international exposures and the development of the “Model Transaction for Private Sector Participation in Infrastructure in Korea. 11. Grants for social sector also provided timely technical assistance inputs to the country which implemented a range of policies to strengthen its social safety nets and mitigate welfare loss during the crisis. The grant for Reforming Social Protection for Workers in Korea, specifically, addressed the issue of workers’ welfare loss caused by corporate restructuring. The assessments on the labor market response to the labor law changes, the public employment services, the efficiency of the public compensation fund, and the cost-effectiveness of public works and loan schemes all served as building blocks for the government to review its labor policies and regulations. The international conference drew lessons from other countries including Europe and provided Korean authorities with a broader set of policy options in their labor market reform agenda.

16

12. While the ASEM TFI activities have contributed significantly to the reforms of financial sector and social security systems and the country has recovered rapidly from the crisis, challenges do remain and implementation of the reform agenda is yet to be completed. One of the key lessons from ASEM TFI projects is the time required to distill the reform measures and building capacity in a rapidly changing environment. In order for the country to tackle the three overarching challenges and to share its experiences with ASEM Asian partners, it needs to be engaged in ASEM TF processes, tapping a limited resources from ASEM TF2. ASEM TF II Priorities 13. Priority areas for ASEM TF II support include: (a) technical assistance to the relevant ROK institutions in corporate restructuring and improving the corporate governance. The TA will mainly be sourced from Europe; and (b) provide supplemental ( to their own resources) funding to support to relevant institutions in ROK to prepare and disseminate materials ( including materials suitable for the distance learning via the Global Distance Learning Network) on their experiences in dealing with the social and financial dimensions of the Asian financial crisis. This will include their experiences in using the funds provided to them under the ASEM TFI.; 14. It is clear that in the context of the ASEM TFII, including South Korea as eligible for funding requires a strong justification especially when they are also a potential contributor. We believe that the case rests on two main arguments

(1) helping with the unfinished agenda for the financial and corporate restructuring and thus help reduce the future vulnerabilities. ROK would welcome TA from European sources in this effort; and (2) the demonstration effect on many developing countries from documenting and disseminating the ROK success story to other ASEM members, and beyond. As a matter of principle , we propose to ask the ROK authorities to share in the financing of the ASEM TFII projects .

Steering Committee for ASEM TF II Programming 15. The In-Country Steering Committee for Korea is expected to be led by the Ministry of Finance and Economy (MOFE) with the Ministry of Planning and Budget and other relevant Ministries involvement. The Senior Advisor to the Vice President, East Asia and Pacific Region, who is also the Acting Country Director for ROK, will represent the World Bank.

17

Philippines: ASEM Country Strategy Note April 2002

1. The ASEM Trust Fund (TF) has played a critical role in supporting government activities to mitigate the adverse effects of the Asian financial crisis. Under ASEM TFI, eight country-specific grants were approved for a total of US$7.2 million. Five of these have already been completed, and three are still under implementation. A ninth grant was approved during the first round of ASEM TFII. In addition, nine regional grants benefiting the Philippines were approved. ASEM TF has provided technical assistance activities to strengthen the financial and banking sector, back completion of a poverty indicators survey, support activities to lower the incidence of out-of-school youth, and assist with governance and anti-corruption reforms. Recent Developments Relating to ASEM TF 2. Economic growth in 2001 exceeded expectations with GDP growing by 3.4 percent, despite the global slowdown that led to a 16 percent downturn in export earnings. Other accomplishments include falling inflation, interest rates at historic lows, currency stabilization, passage of long-awaited structural reforms, and essentially meeting the 2001 budget deficit target. These achievements provide a sound foundation for further reforms and establishing a pattern of poverty reducing growth. However, the reality is that there has been no reduction in poverty over the past four years. 3. Favorable economic statistics have been accompanied by weaknesses in the financial position of both the Government and the banking system. Tax revenue as a share of GNP continued to decline in 2001, and at 12.7 percent last year, is down 3.5 points of GNP from pre-Asian crisis levels. Furthermore, the non-performing loan ratio for banks continues to rise (the current level is approximately 18 percent). 4. Poverty reduction is at the forefront of the Government’s updated Medium-Term Philippine Development Plan, 2002-05 (MTPDP). Its target growth of over 5 percent per year is attainable only if the key building blocks for sustained growth—an environment conducive to increased investment and productivity within both private and public sectors—is firmly in place. Stronger growth must be complemented by increased participation in development by the poor to attain the desired rapid reduction in poverty. 5. Government has stressed that improved governance is critical to poverty alleviation. In particular, (i) raising fiscal revenues is seen as essential for government to achieve fiscal consolidation while simultaneously increasing funding of investments in poverty reducing activities; (ii) fiscal risks pertaining to contingent liabilities need to be managed and provisioned; (iii) financial sector strengthening and deepening is important for renewed private sector development; and (iv) investor confidence needs to be rebuilt with continued improvements in corporate governance. Impacts of and Lessons from ASEM TFI 6. ASEM TFI has played an important role in initiating and supporting the implementation of policy reforms, as illustrated below. More importantly, ASEM TFI

18

has played a catalytic role by enabling innovative processes. It is fair to say that in the absence of this Fund, such activities might not have been undertaken when they were most needed (for instance, the use of technology assisted poverty surveys immediately after the crisis, and governance reforms). The challenge now is to sustain the momentum on implementation of reforms that have already been started and to support the government in initiating new reform measures. 7. The Financial Sector. All ASEM TFI financed activities in this sector were completed in 2001 and have made significant contributions in assisting the government in its effort to strengthen the financial sector. They contributed to (i) strengthening audit capacity within the Commission on Audit; (ii) assisting the Government in designing and implementing financial sector reforms; (iii) financing a diagnostic audit of one of the largest commercial banks in the Philippines that was being groomed for privatization by the Government; (iv) supporting a study on strengthening the legal protection for banking supervisors, recommendations of which fed into the New Central Bank Act of 2000; and (v) establishing a computer-based early warning system to improve the Central Bank’s off-site supervision. 8. The Social Sector. In order for the Government to be able to respond promptly to mitigate the adverse social impact of the crisis with the right interventions, it was necessary to put in place a monitoring system that could provide timely and accurate poverty-related data. The Enhanced Poverty Monitoring Project addressed this concern by providing technical assistance to the National Statistics Office (NSO) to implement the Annual Poverty Indicators Survey (APIS). APIS was designed as a tool for regular monitoring of not only the poverty incidence, but also of other social sector indicators during and immediately after the crisis. All activities under this grant have now been completed and the main achievements can be summarized as follows:

• APIS significantly expanded the scope of the survey instrument beyond the collection of income and expenditure data. It also collected information on education and health status, family planning, employment, housing and sanitation, access to services, and several questions on the impact of the crisis. It thus yielded important information on the household level welfare on a nationally representative basis that was hitherto unavailable.

• An innovative technique was used to collect the nationwide survey data – use of hand-held computers. This brought the NSO to a new level of information technology which has been quite unprecedented elsewhere in the world.

• The APIS findings have been widely disseminated and as a result been used by several researchers to learn more about the welfare impact of the crisis as well as the profile of the poor and determinants of household living standards. For instance, they were used in the World Bank Poverty Assessment (2001). The widespread dissemination of key findings has also enr iched the discussion between the Government and civil society on poverty-related issues.

• A nationwide survey on users’ perceptions of the provision of pro-poor Government services was partly financed by this grant. It was administered by a private non-profit organization in the Philippines and the data was analyzed and the report has now been widely disseminated in the country. The

19

survey findings highlighted issues from the perspective of the beneficiaries in accessing and utilizing public services in sectors such as basic education, health, drinking water, low-income housing and subsidized food. An innovative feature of this survey was that it combined the qualitative questions on public services with a quantitative consumption module taken from the APIS. The survey is now being institutionalized within selected Government departments.

9. A pilot project for the Development of Out-of-School Youth is ongoing and has started to demonstrate some positive effects. About 82 percent of this grant has been disbursed. The incidence of out-of-school youth was exacerbated by the crisis, and this project aims to develop and test mechanisms that will enable children from seven to fourteen years old to be schooled or to remain in school. It also supports piloting an employment and entrepreneurship program for youths aged fifteen to twenty-four. As of January 2002, total target beneficiaries of these efforts stand at 4,859, of whom 977 are receiving sponsorship in formal school, 1,541 are supported in basic education through alternative learning systems, and 2,341 are receiving technical education. 10. Governance. An ongoing grant on Improving Governance and Reducing Corruption is supporting reforms in this area by financing knowledge sharing activities and awareness programs, enhancing the capacity for reforms, and fostering partnerships with civil society. About 52 percent of the grant amount has been disbursed so far. First, this grant has supported establishment of Procurement Watch, Inc. (PWI), a civil society-based organization formed to help reduce graft and corruption in public procurement. PWI has been actively involved in crafting and advocating for the Government Procurement Reform Bill, drafting the Executive Order (EO) No. 40 which consolidates procurement rules and procedures for national government and its agencies, and training procurement officials and other agency personnel on the new procurement procedures. Secondly, with reference to anti-corruption activities, the grant financed a workshop on tax administration strategy in October 2001, organized by the Bureau of Internal Revenue. The goal of the workshop was to push for and strategize tax administration reform to increase tax compliance. Third, to strengthen corporate governance, the grant funded the work of Institute of Corporate Directors in development and delivery of a training course for the directors of government financial institutions and government owned and controlled corporations. It also supported a workshop to review the report on standards and codes (ROSC) in corporate governance. Fourth, the Congressional Planning and Budget Office organized a 2½-day Legislative Oversight Planning Workshop for the Congress Secretariat in December 2001. This workshop arrived at a common definition of legislative oversight, formulated a strategic framework to fast track oversight system, and drafted a basic outline for institutionalizing the Philippine legislative oversight system. Finally, courses on investigative journalism were also conducted, a result of the conviction that a strong, responsible, and credible media is a good deterrent to corruption.

20

11. Several lessons can be drawn from the experience of implementing the ASEM TFI in the Philippines. On the positive side, the catalytic effect of timely, targeted grant funds cannot be underestimated. This was also acknowledged by the government during a trust fund review workshop between government implementing and oversight agencies and the World Bank in November 2001. Secondly, as noted earlier, the grants have facilitated innovative techniques and pilot activities, which are expected to have far reaching effects (for example, a second APIS conducted in 2000 once again used hand-held computers). Thirdly, with the help of this funding it has been possible to involve civil-society in activities such as Procurement Watch to strengthen governance. Finally, it has allowed the formation of alliances between the private sector, government, and donors. The formation of the tri-partite Out-of-School Children and Youth (OSCY) committee supported by one of the grants is a good example of such a partnership. 12. However, other lessons have also emerged. First, successful implementation of these grants hinges on strong government ownership and commitment. For bank-executed regional grants, ownership and engagement by countries concerned is needed. The availability of grant resources alone is not always enough if the government is not fully committed and involved in all phases of implementation. Involving the government, especially the Department of Finance (DOF) and the implementing agency, during the proposal design stage is especially important to get an indication of how committed they are to proposed reforms. For instance, two grants (Social Protection and Social Housing, and Strengthening Social Protection) had to be closed before full implementation due to lack of Government commitment to reforms envisioned under those grants. However, in our view, this should be expected at times since it is a sign that the funds are being used for those activities which have a high priority for the Government, which are realistic, and are expected to have some tangible effects. Second, more attention could have been paid to monitoring and evaluation mechanisms. During the trust fund review workshop with the Government in November 2001, one of the suggestions by the participants was that a unit/committee be established within the Government (preferably DOF) to monitor and evaluate the implementation and impact of grant- funded projects. This will increase accountability and also assist in resolving any implementation issues as they emerge, and this in turn will allow for faster implementation of grant activities. ASEM TFII Priorities 13. The forthcoming CAS for the Philippines was designed in consultation with the Government of the Philippines and interested stakeholders, and it is closely aligned with the four themes of the MTPDP: (i) macroeconomic stability and equitable growth based on free enterprise; (ii) agriculture and fisheries modernization with social equity aimed at raising rural incomes in a sustainable manner; (iii) comprehensive human development and addressing regional disparities; and (iii) good governance and the rule of law. The ASEM TFII focal areas of financial sector and social sector reforms fit well with the MTPDP and CAS themes.

21

14. Improving Governance. President Macapagal-Arroyo has made good governance one of the pillars of her administration. The World Bank will continue to provide technical assistance in this area as requested by the government. Future support in this sphere can focus on the following areas, which have also been identified by the Government as key development challenges:

• Support public sector reforms, in general, and agencies such as the Bureau of Internal Revenue, the Civil Service Commission, and the Judiciary.

• Help specific public sector agencies to implement anti-corruption programs; provide catalytic resources to support citizen monitoring of public services; and support capacity building and technical assistance to enforcement agencies responsible for enforcing the anti-corruption laws and regulations.

15. Financial Sector Reforms . ASEM TFII can aid in ongoing pension system reforms. The Government has signaled renewed commitment to pension and financial sector reform. Through past grants, the Government established and funded the work of the Presidential Retirement Income Commission (PRIC). Further assistance in this area should allow the Government to complete this work and move forward with actions to ensure the sustainability of pension schemes. The reform of the pension system will also foster the reform and development of the financial markets by introducing new products and services and increasing public confidence in the system. 16. Protecting the Poor. Reducing the vulnerability of the poor by designing better targeted social protection programs and comprehensive human development is one of the key objectives of the Government’s MTPDP and the Bank’s CAS. In this area, ASEM TFII can be used to finance the following activities:

• Developing quick response monitoring systems that generate information on conditions among the poor, even at the barangay level, to help in more effectively designing decentralized pro-poor programs.

• Establishing a rural social indicator database to monitor the effectiveness of pro-poor rural development programs. This is important for the Philippines, since a majority of the poor still reside in rural areas.

• Promoting community-based approaches for development, which seem to have greater impact on the ground.

• Evaluating the response of the public institutions and NGOs responsible for protecting the poor during a crisis and making recommendations for improvement.

• Supporting the APIS if resource limitations render the Government unable to undertake it, so that this tool can continue to be used to identify the country's changing poverty dynamics.

Modalities of Programming ASEM TFII with Clients 17. Modalities of delivering ASEM TFII were discussed with the staff of International Finance Group (IFG) within the DOF in March 2002. Following the recommendation of the ASEM Review Workshop in Bangkok in March 2002, it was

22

tentatively agreed that a steering committee consisting of representatives from the DOF, European Commission, and the World Bank Office Manila will be formed in the near future. The primary responsibilities of this committee would be to contribute to future ASEM country strategies, to monitor the implementation of ASEM TFII activities, and to resolve any issues that emerge. Final working arrangements are expected to be agreed upon during April-May 2002. For this current strategy, draft of the above priorities was shared with IFG for comments.

23

Thailand: ASEM Country Strategy Note April 2002

1. The ASEM Trust Fund has provided support to critical programs adopted by Thailand after the financial crisis to restructure the financial and corporate sectors and to develop effective social protection policies and poverty alleviation efforts. Recent Developments Relating to ASEM TF 2. Thailand embarked on a comprehensive macroeconomic and structural reform program in response to the 1997 financial crisis. The reform program, which focused on the corporate, financial, and social sectors, is produc ing positive results and recent data show that the Thai economy is recuperating. It is expected that continuous efforts will boost growth to about 2.5% to 3% in 2002. Second, the reduction in external debt has cleaned the national balance sheet and positions the country well for recovery. Third, the external terms of trade, which deteriorated sharply last year, appear to have bottomed out, and are likely to improve in the future. 3. Thailand’s growth rate of about 4 to 4.5 percent per annum during the 1999-2000 period was sufficient to break the trend of higher poverty rates triggered by the Asian crisis. Based on an analysis of the recently released Socio-Economic Survey 2000, the National Economic and Social Development Board (NESDB) reports that the incidence of poverty has dropped from 15.9 percent of the population in 1999 to 14.2 percent in 2000. This has implied that the number of individuals who live in households whose income falls short of the poverty line has declined during that period by close to one million, from about 9.8 million to 8.9 million (until the onset of the crisis, in 1997, high growth had created many employment opportunities and poverty had fallen from 32.6 percent of the population to 11.4 percent in 1996). 4. Much has been done to stabilize the financial and corporate sectors since the crisis. Overall market sentiment has improved and Government stimulus are deepening and aspects of consumption are reviving. However, there is continued risk to banks and firms from the overhang of distressed loans. While, Non-Performing Loans (NPLs) have dropped from a high of 47% to about 12%, distressed loans remain high. The flow of re-entry NPLs (due to the poor quality of debt restructuring) has exceeded new NPLs (due to the economic downturn). Debt restructuring has been the largest contributor to the reduction of NPLs in the financial system, but the rate of restructuring has been declining. 5. However, the momentum of recovery is likely to be impeded by the capacity of the Thai economy to address some of the structural risks. These risks are primarily medium-term in nature, and include fiscal risk (as a result of rising public debt), financial and corporate risk (as a result of weak balance sheets of the firms would prevent them from expanding the basis for investments), and social protection risk (as the consolidation do the recovery is not fully consolidated and social program depend heavily on government funded programs). These risks, if not managed well, could prevent Thailand

24

from achieving the full potential of a solid recovery and its full employment growth potential of around 5-6 percent over the medium-term. Strengthening social protection is a high priority, a key lesson from the 1997 crisis. Impact of and Lessons from ASEM TF I 6. The ASEM TF I has played an important role in providing critical advisory services for key activities in three focal areas (and it would continue to do so under the ASEM TF II): social policy reforms, financial and corporate reforms, and public governance programs. 7. ASEM TF I provided nine grants for a total amount of US$ 5.8 million supporting nine programs. More than 60% (about US$ 3.6 million) of the funding was absorbed by programs those focal areas (the balance supported programs in education, corporate sector governance and improvement of environment). These programs included: (i) Financial Sector Advisory Services, which supported much-needed reform of financial sector structure and policy, supervision of specialized financial institutions, and the establishment of the Public Debt Management Office within the Ministry of Finance; (ii) Revival of the Corporate Sector, which supported improvement in the monitoring of distressed corporate firms as they moved through the process of debt restructuring and enhanced the professional capacity of Thai banks and finance companies to undertake corporate restructuring; (iii) Poverty Alleviation and Social Protection Strategy, which has supported a diverse range of analysis, training, and publications, including a critical set of contracts defining the poverty reduction challenge in Thailand, the Social Monitor on Poverty, and elaboration of a strategy on poverty reduction. As of January 30, 2002, five of these grants have been completed, with total disbursements amounting to about US$4.7 million. 8. Implementation of ASEM TF I has uncovered several lessons in Thailand. First, by complementing a wider program of donor support, it has enabled a range of programs aimed at ameliorating the effects of the 1997 economic crisis and building resilience and institutional capacity to prevent future similar events. Funds can be highly catalytic, even if the amounts are relatively small, if they are targeted on a priority area and are implemented quickly and with flexibility, such as the programs implemented in the corporate and financial sector. Second, national agencies necessarily have different capacities in implementation. Where possible, we recommend working with agencies that have demonstrated an ability to implement external assistance. If this is not possible, extra time for implementation and extra administrative costs must be built into the activity. Therefore, the implementation period may need to be reviewed. This fact deals particularly with the limited absorption capacity of the institutions involved, which results in the need of phasing out the implementation of the of the various programs. Finally, ASEM TF I has helped promote partnerships with other donors and with different government and non-government stakeholders. ASEM TF I complemented the funding and thus the implementation of programs supported by other donors such as grants from the Japanese and Australian Government in programs such as those supporting the strengthening the financial sector supervisory framework.

25

ASEM TF II Priorities 9. As reported in the previous Country Strategy Note, within the overall development strategy adopted by the government, the Thai authorities with Bank support has identified four major development priorities: enhancing competitiveness, strengthening social policy, improving governance, and protecting the environment. The World Bank country assistance strategy is building on these four priorities. All four priorities—described below—relate directly to the ASEM TF I and ASEM TF II priority areas of financial and corporate sector reform and social policy reform.

• Enhancing Competitiveness. The government will focus on accelerating bank and corporate sector restructuring, maintaining appropriate macroeconomic policies, developing the legal and judicial systems, strengthening science and technology, supporting skills development and education, improving the business environment, and modernizing the infrastructure regulatory framework. Within this overall support program, ASEM TF II has approved a grant (Dispute Resolution Office: Out of Court Mediation Capacity Building Project) for US$456,000 which supports strengthening of institutional capacity to administer out-of-court mediation for financial disputes and non-performing loan cases, and to promote public understanding and awareness of the out-of-court mediation process.

• Strengthening Social Policy. Thailand in strengthening social

protection, social development, and social services for the poor. Progress in this area will require better analysis of service management and will involve establishing or supporting programs that narrow gaps in service coverage, equity, and efficiency and address gender inequities. This will require improving occupational safety and health, improving employment services and labor market information, and enhancing the administration of social assistance programs. The involvement of civil society and communities will help ensure the effectiveness of these programs. The Capacity Building and Strategy for Poverty Reduction Program, which aims to build capacity within key government agencies to formulate and implement effective poverty reduction policies, has secured funding for about US$582,000 from ASEM TF II. Additional programs scheduled to be submitted for funding aim at assisting policy makers in strengthening institutional capacity and in developing effective social protection policies and programs that help meet the needs of the most vulnerable segments of the population.

26

• Improving Governance. This includes programs aimed at enhancing public sector performance and at providing further assistance in civil service, revenue, and budgetary reform; promotion of transparency and accountability; and decentralization to local administrations.

• Protecting the Environment. This includes programs aimed at

boosting the quality of environmental resources, thus greatly improving the quality of life of all Thais, especially the poor. Assistance will focus on institution building, natural resource management, enforcement, and deepening of local participation.

10. The envisaged World Bank assistance in these areas would be delivered through a combination of lending and analytical and advisory activities (including Country Development Partnerships, under which the Government and a group of donors agree to support a specific set of capacity building and policy reform activities). The current shift toward more non- lending activities is expected to deepen over the next years. Consequently, grant resources, such as the grant financing available under the ASEM TF II would support capacity building and technical assistance. Grant financing from the ASEM TF II is one of few possible sources of external support for Thailand’s efforts to deepen the reform program and improve capacity for implementation. In the absence of appropriate funding, these efforts will be risking serious setbacks. In-country Steering Committee. 11. A meeting was organized in Thailand by the European Commission on March 11/12 to discuss a draft Evaluation Report of ASEM TF I with the participation of most donors and recipients. It was agreed that decentralization of project selection and the establishment of an in-country Steering Committee were required with a view towards enhancing participation, ownership of project design and selection, and consultation with recipients. The Steering Committee is expected to work on country strategy notes, prioritize proposals, and monitor the activities and will be comprised of representatives from the recipient country, ASEM TF donors, and the World Bank. The Thai authorities are in the process of designing the working arrangements and specific composition of the Thai Steering Committee.

27

Vietnam: ASEM Country Strategy Note April 2002

1. ASEM Trust Fund resources have become an important source of technical assistance for Vietnam, addressing the key areas of corporate restructuring (state enterprise reform), banking reform, social safety nets, and decentralization. Vietnam has benefited from seven grants under ASEM I, ranging from US$100,000 to US$1.8 million, for a total of US$5.8 million. In addition, three country specific and one regional grant under ASEM II are currently pending the Government’s countersignature. It is envisaged that the total amount available for Vietnam under ASEM II will be in the same order as under ASEM I. The grants have been designed so as to maximize the prospects for impact in the key ASEM TF focus areas of banking, corporate restructuring, decentralization, and social protection and to complement other ongoing technical assistance work. Recent Developments Relating to ASEM TF 2. This note provides an updated context for the ASEM TF technical assistance by demonstrating its close links to the Bank’s Country Assistance Strategy, which has been prepared in close partnership with the Government of Vietnam, and by highlighting the important development challenges ahead. The note also provides some illustrations of how the trust fund has supported challenging policy changes in Vietnam, notes some of the lessons learned so far in effectively utilizing these resources, and explores the implications for ASEM II. 3. Since the start of the Asian crisis, the Government of Vietnam has been undertaking some important preparatory work for serious reforms in banking and state enterprise management and to create a more supportive environment for private sector activity. The ASEM TF grants are an important element in this diagnostic and design work. 4. Vietnam export growth recovered remarkably fast after the Asian crisis. As a result Vietnam managed to reach GDP growth rates in the range between 5% and 6% in the years following the crisis. In 2001 Vietnam’s economy grew by around 5% in real terms which is slightly slower than in 2000. The target of doubling GDP by 2010, as put forward in Vietnam’s 10-year Socio-Economic Development Strategy, means that Vietnam on average needs to grow by approximately 7% a year in the coming decade. To reach this target, the country must continue and deepen planned reforms relating to the state enterprise sector and banking sectors as well as changing attitudinal problems towards the private sector. 5. In the past two years, some important new measures have been taken and, as noted above, good preparatory work has paved the way for much deeper action in the future. In June 1999, a new Enterprise Law was passed by the National Assembly and became law on January 1, 2000. This offers a framework for a much more level playing field than in the past. In response, during the year 2000, the private sector registered

28

more than 14,000 new enterprises followed by an additional 21,000 new registrations in 2001. In addition, the process of State-owned enterprise (SOE) reform was stepped up in 2000, with equitization proceeding at an altogether more rapid pace than in the past. The implementation of equitization slowed somewhat in 2001, but recent Government initiatives such as the issuance of decree 63 on transforming SOEs into one-member limited liability companies indicates that the pace of reforms is on its way to a rebound. This process of equitization has been partly made possible by the extensive technical assistance provided through the ASEM TF. 6. In January 2001, the IMF and the World Bank reached agreement in principle with the Government of Vietnam on a package of macro and structural reforms that will be supported by a financial package (consisting of a Poverty Reduction Strategy Credit from IDA, a Poverty Reduction and Growth Facility drawing from the IMF, and bilateral co-financing). The PRGF program was approved by the IMF Board on April 6, 2001 and by the World Bank Board on June 5, 2001. The ASEM TF grants have helped to lay the groundwork for reaching this important point in our discussions with the Government. Grants will continue to be important in helping to implement this reform program. 7. In September 2001, the Government took a step forward towards second-generation reforms by adopting a master plan for public administration reform. Reforms in this area will complement economic reforms and will help establish a framework for a market-based economy in Vietnam that functions both effectively and efficiently. Reforms in this area have until now taken place without an overall framework for the direction in which the public sector should move. In addition, Vietnam is expected to adopt a strategy for legal and judicial reforms in 2002. These commitment to legal reforms, improved governance and increased transparency coupled with the economic reforms are important steps in the right direction towards a market based in economy in Vietnam. 8. These reform measures are part of Vietnam’s comprehensive poverty reduction and growth strategy (CPRGS) expected to be approved by the Government in April 2002. This strategy will identify actions needed to further reduce the level of poverty in Vietnam. Impacts of and Lessons from ASEM I 9. The Bank is in the process of preparing its next Country Assistance Strategy (CAS) for Vietnam. The CAS will be based on Vietnam’s CPRGS which identifies three main themes that are all relevant to the priority focal areas of the ASEM Trust Fund, namely: economic growth and transition towards a market economy, equitable and socially inclusive development and improved governance. 10. Transition to the market economy will, as already mentioned, be central to the CAS, and reforming SOEs is at the heart of this challenge. Vietnam’s SOE reform program covers general measures that would increase competition for all enterprises—by easing private entry and by liberalizing trade—as well as enterprise-specific measures

29

aimed at diversifying ownership, reducing losses, and improving the efficiency of SOEs. Equitization and divestiture of individual SOEs will diversify ownership; liquidations will reduce losses of non-viable SOEs; and restructuring and downsizing will improve the efficiency of the SOEs that remain in state hands. 11. Vietnam’s banking reform program is another critical aspect on the path towards a market economy. It covers four areas: restructuring of non-state (joint-stock) banks, restructuring of state-owned commercial banks (SOCBs), improving the prudential regulatory and supervisory framework, and leveling the “playing-field” for all banks. The restructuring of non-state joint-stock banks (JSBs) has picked up momentum after a delayed start. Several JSBs have been closed, merged, or rehabilitated with private shareholders providing additional capital. For three large State-owned commercial banks (Incombank, Vietnam Bank for Agriculture and Rural Development, and the Bank for Investment and Development) detailed restructuring plans were adopted recently. In addition the State Bank of Vietnam has issued a decision that would govern the phased and conditional recapitalization of the State-owned commercial banks. 12. The challenge of promoting social equity remains a central plank of the Government of Vietnam's policy framework. Poverty is declining rapidly in Vietnam, but it still remains a major issue. National surveys show that poverty is a largely rural phenomenon and that it is at much higher and deeper levels among ethnic minorities. Investments in basic infrastructure and social services as well as in generating sustainable rural employment are essential to achieve continued poverty reduction. The SOE reform agenda, however, also raises key social equity issues that must be addressed if these critical economic policy reforms are to be sustainable. 13. Looking ahead, it is clear that the challenge for Vietnam and for the Bank’s operations in the country is shifting from appropriate policy formulation to appropriate policy implementation, with the goal of achieving sustainable results. Strong political will is essential for this program, but it also requires strong technical and institutional capacity, which warrants strong support by external donors. 14. The seven ASEMI projects have progressed gradually. The trust funded activities all support priority Government activities, while being directly in line with the ASEM Trust Fund’s own focal areas. ASEMI technical assistance grants have helped bring much needed external expertise and has also exposed the Vietnamese policy makers to other countries’ reform experiences. In addition, the grants’ has financed studies and other analyses of issues specific to Vietnam to ensure that reform measures are tailored to Vietnam’s needs. The trust fund interventions have catalyzed analytical work and fueled policy change in important ways, as illustrated by the examples discussed below. (Again, we are wrapping up ASEMI activities. Please discuss the results of ASEMI activities). 15. State-Enterprise Reform. ASEM TF grants of more than US$2 million (together with Danish, Australian, British, and Japanese grants of US$12 million) are supporting the formulation and initial implementation of the SOE reform program in Vietnam. This support is provided to the National Steering Committee for Enterprise Reform and

30

Development (NSCERD) and the SOE Reform Department of the Office of the Government, which are charged with developing overall policy, as well as with coordinating and monitoring implementation. Some support has also been provided to line ministries, such as the Ministry of Industry, the Ministry of Construction, the Ministry of Agriculture and Rural Development and the Ministry of Transport, as well as peoples’ committees charged with implementing SOE reform. 16. The trust funds support each recipient agency in designing strategies to implement their SOE reform plans; for example, testing alternative legally feasible methods of divestiture; improving the equitization process; identifying different ways of dealing with excess labor; advising on the NSCERD policy framework and operational modalities; assisting in launching the public information campaign regarding SOE reform (which has proved to be most difficult component); and building capacity through on-site training. The work on selected aspects of enterprise reform is benefiting from international best practice transmitted through advisory assistance and training. The European experience in developing programs for excess workers of downsized industries and in safeguarding social services in the cases of enterprise privatization or closure could provide a range of experience including international best practice to the Vietnamese counterparts. Moreover, European experts have extensive experience advising Eastern European transition countries on such issues. Therefore, all international consultants and trainers funded by the grant come from EU countries, mostly France. 17. The activities aim directly at raising competitiveness of the enterprise sector of Vietnam experiencing stagnation due to systemic and organizational problems. The Government counterparts demonstrate full ownership of the project. Hands-on restructuring work at the enterprise level brought about a rich blend of issues in the SOE reform area which the consultants analyze and formulate recommendation as to their resolution. 18. One ASEM fund deals specifically with SOE restructuring of enterprises under the Ministry of Transport (MoT). For this particular fund two separate workshops were conducted in Hanoi, one in mid-May 2001 and another in late-June 2001. The first workshop covered the results from the consultant’s preliminary review of financial data provided for each of the Ministry’s SOEs, focusing on aggregate financial performance and trends in financial performance by Corporation/company group. This workshop also introduced issues associated with the classification of SOEs, and discussed a preliminary framework for SOE classification. The second workshop focused on reform options for the Ministry’s SOEs, and developed further a reform classification and prioritization schema that could be applied by the MoT. The project report for this grant has now been finalized. 19. Banking Reform. The State Bank of Vietnam (SBV) and the government of Vietnam are undertaking a significant reform of the financial sector and the implementation of a detailed bank specific restructuring plan is the next critical step in the bank reform program. Three grants under ASEMI have supported these reforms by undertaking activities that can largely be spilt into the following areas:

31

Restructuring State-owned Commercial Banks

- Advisory services for pre-audit work - Advisory services to implement restructuring plans

Restructuring Joint-stock Banks (JSBs)

- Assessment of 5 JSBs - Review of risk management procedures and techniques - Help in establishing a management information system - Risk Management training

Creating the institutional framework for asset resolution and disposition

- Establishing national Asset Management Companies (AMCs) - Training and workshops on AMCs. - Study tours to USA, Canada and Poland.

Accounting, Credit Reporting and Supervision and Corporate Governance for Financial Institutions

- Review and development of key functions for a Credit Bureau - Workshop on Credit Bureau - Bank corporate governance training - Review of the Banking sector legal and regulatory framework

20. Social Equity and Inclusion. Two types of activity were funded by ASEMI grants aimed at improving social equity and inclusion. The first related to the development of “social safety nets” for workers that would be declared redundant by SOE reform. The ASEM TF grant of US$100,000 permitted detailed analytical and empirical work for developing a “voluntary” redundancy package tailor-made to Vietnam’s conditions. Using data from the Vietnam Living Standard Survey (VLSS), the size of the redundancy package was based on the calculated loss of lifetime-earnings arising from loss of an SOE job. This package was expected to ensure that it would be accepted voluntarily, thereby reducing the extent of resistance to redundancy. Two workshops have been held (in May 1999 and June 2000) to disseminate the findings and to generate consensus on the package and on the design of the “social safety net” for SOE workers. The ASEM TF grant for this work has been highly appreciated by the Government of Vietnam. It has enabled a process that brings together many different stakeholders—central Government agencies, provincial governments, SOEs, labor unions, and others—to develop a shared understanding of how best to approach this very sensitive issue in Vietnam. This TF activity is now completed. 21. The second grant was aimed at the rural poor. This grant of US$497,000 has been made to the Vietnam Ministry of Planning and Investment (MPI) to support preparation of a targeted poverty reduction project. The grant funded technical assistance and essential equipment for MPI to enable it to prepare a project that will provide small grants to about six hundred of Vietnam’s poorest communes. (IDA has provided a credit,

32

called the Community-based Rural Infrastructure Project, of US$ 103 million to Vietnam to support this small grants program). The grants are to be used to fill gaps in essential public infrastructure, create employment in remote areas, and help establish a demand-driven approach to project planning and implementation. Essential public infrastructure includes basic community access (roads and bridges), primary schools, health centers, drinking water and sanitation systems, and electrification. The communes that will benefit from this assistance are in remote areas with populations dominated by ethnic minorities. Without such targeted assistance, these poor communities would wait a long time for their essential infrastructure needs to be met. 22. Between August 1999 and June 2001, the grant supported preparation of the IDA credit with 16 consultancies, six workshops (five of them in the field), and two study tours to comparable projects assisted by the Bank elsewhere in the region (Indonesia and the Philippines). The six key products of the consultancies were: a social assessment (chosen as a best practice by the Bank’s social development family); a training needs assessment (that has become the blueprint for a multi-million dollar training program); a project field manual (that provides detailed and practical guidance on project implementation); a project implementation plan; the project’s management information system (MIS); and the Government’s own project feasibility study (approved at the level of the Prime Minister). 23. The first round of projects are now closed or approaching its closing date. Some of the key lessons they provided are described below.

• The process of activating the grants and executing the procurement process has taken a long time. Many of the recipient agencies had not executed World Bank projects before, resulting in a steep “learning curve” to be overcome in implementing ASEM TF grants. • Once underway, the ASEM TF grants are proving very effective in helping Vietnam to access the much-needed external expertise in funding analytical and empirical work that help to tailor reform measures to Vietnam’s specific conditions and to disseminate findings from studies to a wider set of stakeholders in the country.

ASEM II Priorities 24. In light of this experience, the strategic focus for the ASEM TF portfolio (for ongoing and future projects) should seek to follow-up on and deepen work launched in the areas of corporate or state-enterprise restructuring, banking reform, and implementation of Vietnam’s CPRGS. This will ensure that the ASEM Trust Fund resources used in Vietnam have the maximum impact at the lowest cost for three reasons. First, banking and state-enterprise restructuring and reform will be central to Vietnam’s growth and poverty-reduction objectives for the next three to five years. If the Government adopts the reform program that has been developed to-date with technical assistance support from ASEM TF and other donors, the implementation of that program

33

will require a lot more technical assistance. Second, since the recipient agencies in the affected areas—that is, the Bank Restructuring Committee, the state-owned commercial banks, the National Steering Committee for Enterprise Restructuring and Development, the line ministries, and the people’s committees—have gained experience in implementing World Bank administered grants, ASEM TF support may be used at relatively lower cost than if new agencies were to be brought in for later phase projects. Third, implementation of the CPRGS is essential for Vietnam in lifting more people out of poverty and help them to gain an income level where they are less vulnerable towards unforeseen events such as illness, natural disasters or crop failures.

Modalities for programming ASEM II with clients

25. The modalities for programming ASEM II activities with the Government of Vietnam are still under discussion. Initially, the Government has expressed their interest for these discussions to take place within already established Government-donor partnership groups. The discussion on modalities will be continued in the aftermath of the ASEM review meeting on April 19. Which specific ASEM II activities to undertake in Vietnam will be discussed in these meetings under the agreed coordination structure.