Document of

The World Bank

FOR OFFICIAL USE ONLY

ReportNo. P 7139 MD

REPORT AND RECOMMENDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

AND THE INTERNATIONAL DEVELOPMENT ASSOCIATION

TO THE

EXECUTIVE DIRECTORS

ON A

PROPOSED LOAN

IN AN AMOUNT EQUAL TO US$ 55 MILLION

AND ON A

PROPOSED CREDIT

IN AN AMOUNT EQUIVALENT TO SDR 33 MILLION

TO

THE REPUBLIC OF MOLDOVA

FOR THE

SECOND STRUCTURAL ADJUSTMENT LOAN AND CREDIT

August 18, 1997

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

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

REPUBLIC OF MOLDOVASECOND STRUCTURAL ADJUSTMENT CREDIT AND LOAN

CURRENCY EQUIVALENTS(as of July 30, 1997)

Currency Unit = LeiUS$ I = Lei 4.6

WEIGHTS AND MEASURESMetric System

ABBREVIATIONS AND ACRONYMSARA - Agricultural Restructuring Agency

ARIA - Agency for Restructuring and Enterprise AssistanceCAS - Country Assistance StrategyCIS - Commonwealth of Independent States

DMP - Debt Management PlanEBRD - European Bank for Reconstruction and Development

EFF - Extended Fund FacilityESW - Economic and Sector WorkFSU - Former Soviet Union

FY - Fiscal YearGDP - Gross Domestic ProductGTZ - German Technical Assistance AgencyIDA - International Development Association

IBRD - International Bank for Reconstruction and DevelopmentIFC - International Financial CorporationIMF - International Monetary Fund

INCON - Joint Stock Company - Agricultural Produce (Moldova)JSC - Joint Stock Company

LDP - Letter of Development PolicyLIBOR - London Inter-Bank Offer Rate

LPG - Liquid Petroleum GasMIGA - Multilateral Investment Guarantee Agency

PP - Privatization Plan

PSD - Private Sector DevelopmentRAO Gazprom - Joint Stock Company - Natural Gas (Russia)

SAL - Structural Adjustment Loan (Credit/Loan)SDR - Special Drawing RightsSOE - State-Owned EnterprisesSSC - Strategic Studies CenterSTF - Systemic Transformation Facility

TACIS - Technical Assistance for the CIS (European Union)UNDP - United Nations Development Programme

USAID - United States Agency for International DevelopmentVAT - Value Added Tax

MOLDOVA - FISCAL YEAR

January I - December 31

Vice President: Johannes F. Linn (ECAVP)Country Director: Roger W. Grawe (ECC07)

Unit Director: Pradeep K. Mitra (ECSPE)Task Team Leaders: Arup Banerji, Hafez Ghanem (ECSPE)

FOR OFFICIAL USE ONLY

REPUBLIC OF MOLDOVASECOND STRUCTURAL ADJUSTMENT CREDIT AND LOAN

Credit/Loan Summary

Borrower: Republic of Moldova

Amount: US$ 100 million equivalent, consisting of credit ofSDR 32.6 million (equivalent to US$ 45 million), and loan ofUS$ 55 million.

Terms: The credit will be payable in thirty-five years, including tenyears of grace, on standard IDA terms.The loan will be payable in twenty years, including five years ofgrace, at the standard interest rate for LIBOR-based US dollarsingle currency loans.

Commitment Fee/ Variable rate between 0.00% - 0.50% (set annually by theService Charge: Executive Directors of IDA) on undisbursed credit balance,

beginning 60 days after signing, less any waiver.0.75% on undisbursed loan balances, beginning 60 days aftersigning, less any waiver.

Objectives and Description: The proposed three-tranche credit and loan would support theGovernment's reforms, necessary to create conditions for aresumption of growth and an improvement in living standards inMoldova.

To achieve this goal, critical reforms need to be undertaken in:(i) improving financial discipline; (ii) privatizing the energysector; (iii) accelerating land reform and land privatization; (iv)reforming the pension system; and (v) completing enterpriseprivatization, especially for small-scale.

Benefits: The credit and loan would provide the Moldovan Governmentwith short-term budgetary support essential for maintaining thelevel of basic public services at a time of fiscal transition. It willalso provide necessary foreign exchange to purchase importscritical for Moldova's economic activity. The availability oflow cost, non-inflationary budgetary financing will helpconsolidate Moldova's economic stabilization and maintain itsshort-term creditworthiness. At the same time, the reformprogram supported by the credit and loan will address keybottlenecks and enhance the prospects of long-term growth andimproved living standards.

Risks: The operation has three major risks. The greatest risk ispolitical. With Parliamentary elections due within the next year,it is possible that the reform process may be slowed or stalled.

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

i.

Second, the Government may be hampered by weak institutionalcapacity for effective implementation, especially in the areas offarm restructuring and energy sector privatization. Finally, thereis the risk that the much needed economic expansion, the aim ofthe reform program, will be delayed and thus push Moldova intoa less sustainable economic path. This may be due to slowreform implementation, or an exogenous shock to production orincome that lowers growth.

The operation seeks to minimize the overall risk by ensuring thata major part of the reform agenda is front-loaded, and will beimplemented before Board presentation. To mitigate the politicalrisks, the Government and Bank have been carrying out a widedialogue with diverse elements of civil society, so as to buildbroad-based support for the reform program. To alleviate therisks to the program caused by weak implementation capacity,the Bank is working with two non-Governmental agenciesspecifically created to implement reform programs in agricultureand enterprise restructuring, and helping the Government tomobilize external technical assistance for implementation. Theprogram includes social mitigation efforts, in its fiscal, pensionreform, and energy sector reform components.

Schedule of Disbursement - SDR 25.4 million (equivalent to US$ 35 million) immediatelyafter credit effectiveness (expected in September 1997);- SDR 7.2 million (equivalent to US$ 10 million) andUS$ 25 million upon satisfaction of second tranche releaseconditions (expected about June 1998);- US$ 30 million upon satisfaction of third tranche releaseconditions (expected about March 1999).

Poverty Category Not applicable

Project ID Number MD-PE-44 147

Map IBRD No. 24285R3

REPORT AND RECOMMENDATION OF THE PRESIDENTOF IBRD AND IDA

TO THE EXECUTIVE DIRECTORSON A PROPOSED

SECOND STRUCTURAL ADJUSTMENT LOAN AND CREDITTO THE REPUBLIC OF MOLDOVA

TABLE OF CONTENTS

PART 1. THE ECONOMY ............................................... IA. Moldova's Transition Challenge .................................................... IB. Political Consensus on Economic Reforms ................ .................................... 2C. Reducing Arrears is a Clear Priority .................................................... 3D. Extending the Privatization Program is Necessary for Growth ............................................ 4E. Towards Achieving Moldova 's Economic Goals .................................................... 4

PART 11. MOLDOVA'S ADJUSTMENT PROGRAM ................................................ 6A. Program Objectives .................................................... 6B. Promoting Macroeconomic Stability .................................................... 7C. Creating a Fair and Affordable Pensions System ............................ ........................ 9D. De-Monopolizing and Privatizing the Energy Sector .................................................... 10E. Creating a Competitive, Private Agricultural Sector .................................................... 12F. Completing Enterprise Privatization .................................................... 14

PART 111. THE PROPOSED LOAN .................... R. 1 6A. The Proposed Loan is Central to the Country Assistance Strategy ..................................... 16B. Benefits and Risks .................................................. 17C. Bank Operations .................................................. 20D. Financial Arrangements .................................................. 20E. Collaboration With IMF And Other Donors ................. ................................. 21

PART IV. RECOMMENDATION OF THE PRESIDENT ............................................... 22

ii

ANNEXES

Annex I Table 1: Main Economic IndicatorsTable 2: Balance of PaymentsTable 3: Debt IndicatorsTable 4: Moldova at a Glance

Annex 2 Status of Bank Group Operations and Status of IFC Operations

Annex 3 Timetable of key processing events and Staffing

Annex 4 Letter of Development Policy

Annex 5 Matrix of Policy Conditionality

BOXES

Box l Government Expenditure Arrears 8Box 2 Farm Restructuring 13Box 3 Project Risks and Mitigation Measures 17Box 4 Measures Already Taken Under the Program 19

REPORT AND RECOMMENDATION OF THE PRESIDENTOF IBRD AND IDA

TO THE EXECUTIVE DIRECTORSON A PROPOSED

SECOND STRUCTURAL ADJUSTMENT LOAN AND CREDITTO THE REPUBLIC OF MOLDOVA

1. I submit for your approval the following report and recommendation on aproposed Structural Adjustment Credit to the Republic of Moldova in the amount ofSDR 32.6 million (amount equivalent to US$ 45 million), and a proposed StructuralAdjustment Loan to the Republic of Moldova in the amount of US$ 55 million, toprovide support for the Government's economic reform program. The credit and loan(collectively SAL 1) will be disbursed in a total of three tranches.

2. The credit would be on IDA terms, with a maturity of 35 years including a graceperiod of 10 years, and would be disbursed in two tranches: SDR 25.36 million(equivalent to US$ 35 million) immediately after effectiveness, and SDR 7.24 million(equivalent to US$ 10 million) to be disbursed upon satisfaction of second tranche releaseconditions (expected about June 1998).

3. The loan would be made for 20 years, including a grace period of 5 years, at thestandard interest rate for LIBOR-based US Dollar single currency loans with an expecteddisbursement period of 0-3 years, and would be disbursed in two tranches:US$ 25 million to be disbursed upon satisfaction of second tranche release conditions(expected about June 1998), and US$ 30 million to be disbursed upon satisfaction of thirdtranche release conditions (expected about March 1999).

4. The Republic of Moldova joined the IBRD on August 12, 1992, MIGA on June 9,1993, and IDA on June 14, 1994.

PART I. THE ECONOMY

A. Moldova's Transition Challenge

5. Moldova's independence in 1991 brought with it considerable economicdisruptions. There was a significant breakdown of traditional trade linkages and paymentsystems and a traumatic exposure to world prices. The combination of a large terms-of-trade shock (30 percent of GDP in 1992 prices), a decline in the demand for its exports,and severe weather (droughts, hurricanes and floods) nearly crippled the country'seconomy. Inflation soared, cresting at about 2,200 percent in 1992. By 1994, almostthree-fourths of industry was at a standstill, agriculture was declining and GDP was justover 40 percent of its 1990 level.

2

6. Independence was also followed by a period of political instability. In the armedconflict between the Moldovan regions on the east (Transnistria) and west banks of theNistru, discord over economic policies was aggravated by ethnic tensions. A cease-firewas declared in 1992. Since then, there has been slow progress towards a mutuallyacceptable resolution to the problem, with the resumption of trade and transport, andsome production, between the two regions. In May 1997, the Moldovan President signeda memorandum with Transnistrian representatives on settling the conflict, but the detailsof the eventual accord are yet to be worked out.

7. Since 1993, Moldova has rapidly stabilized its economy, and has started structuralreforms. Moldova's most visible economic policy success has been financialstabilization, supported by the IMF (through an STF, two stand-by arrangements and anEFF). A new currency was introduced in 1993, and monetary and fiscal policy tightened.Inflation fell to an annual rate of around 15 percent in 1996, one of the lowest rates in theFSU. The Government's initial round of structural reforms, supported by aRehabilitation Loan (approved in 1993) and a first Structural Adjustment Loan (approvedin 1994) focused on three areas: (i) privatizing, restructuring, and demonopolizingenterprises; (ii) strengthening the legal and regulatory framework in the financial sector;and (iii) liberalizing prices and trade.

8. The reforms have moved Moldova's economy towards improved efficiency andresponsiveness, but the agenda is yet incomplete. The situation became particularlydifficult in 1996, when economic and political factors converged to slow the pace ofreforms. Adverse weather conditions contributed to a drop in GDP by 10 percent. At thesame time, a volatile election season resulted in some slippage in the reform program.The new Government in Moldova is now working to combine progress in financialstabilization with a second generation of structural reforms aimed at revitalizing theeconomy through imposing payments discipline and promoting private sector led growth.

B. Political Consensus on Economic Reforms

9. Building consensus on economic reforms in Moldova has not been easy.Presidential elections were held in late 1996. The new President, Mr. Petru Lucinschi,immediately announced his determination to continue, and even accelerate, the reformprogram. One of his first actions was to issue a decree on urgent measures which stressedaction in two key areas: (i) improving financial discipline, particularly payment ofbudgetary arrears to workers and pensioners, and (ii) accelerating privatization (especiallysmall-scale privatization), land reform, and the development of urban and rural landmarkets. Unfortunately, valuable time was lost in bargaining with Parliament: first, overthe composition of the new government; and second, over Parliamentary adoption of keyelements of the reform program. Legislation on the tradability of agricultural land waspassed only in July 1997, after the President intervened decisively and pointed out that

3

failure of the Parliament to support the reforms would logically lead to resignation of theGovernment and early Parliamentary elections.

10. The period of political change is not over. Parliamentary elections are due in theSpring of 1998, and the various political parties are already maneuvering for position. Itis possible that Parliament will postpone adoption of politically difficult reforms in therun up to the elections. The Parliament has already postponed further consideration of theGovernment's proposed increase in the pension age until October, recommending thatthis be discussed as part of the overall reform in the pension system expected to beimplemented in 1998. It is possible that the present Government will change after theelections, and that the next Government will be less committed to reform. The Presidentand Prime Minister have responded to political uncertainty by front-loading the reformprogram and taking the case for reform directly to the public. Much of the key legislationneeded for the program has already been adopted by Parliament, with three importantexceptions: the law on pensions, the legal framework for demonopolization of the energysector, and the detailed plans for privatization of the energy utilities, as well as, possibly,further amendments to the land tradability law to promote the land market. Work overthe coming months will focus on the implementation of reforms that have already beenwidely discussed in the country and formally adopted by Parliament, and on developingthe consensus required to put the remaining measures in place.

C. Reducing Arrears is a Clear Priority

11. There is a consensus on the need to improve payments discipline. It is nowgenerally agreed that that the failure to impose hard budget constraints is jeopardizing thegains of stabilization and blocking further progress in economic restructuring. Theenergy sector is increasingly being singled out as a key problem.

12. Moldova's success at stabilizing the economy could be compromised by thefailure to carry out structural fiscal reforms. As in other FSU countries, tax revenues tothe State Budget have been falling, and reached a low of 18.3 percent of GDP in 1996.Difficult decisions on restructuring and reducing expenditure commitments werepostponed. At the same time, the cash deficit was reduced in order to combat inflation.Arrears from the Government have been the result. By end-1996, budgetary arrears ofthe consolidated Government (State and local, including the Social Fund) were estimatedat 964 million lei, or 11.8 percent of GDP. The Government owed 213 million lei toenergy enterprises, 112 million lei in wages to budgetary employees, and 121 million leito the Social Fund. This further reduced the Social Fund's already limited ability to paypensioners-it, in turn, owed 315 million lei in pensions. Failure to pay the elderly theirpensions in a timely fashion resulted in a great deal of suffering and had serious socialconsequences. The situation has improved over the first half of 1997, with theGovernment acting aggressively to reduce the stock of pension arrears by two thirds.

4

13. Financial discipline throughout the economy is weak. This is a particularlyserious problem in the energy sector where collection rates are very low-at the end ofApril 1997, the receivables of Moldenergo (the power utility) accounted forUS$ 98 million, or some 4.7 percent of GDP. The debt to the energy enterprisescompromises their ability to repay foreign creditors for energy imports. The stock ofMoldovagas's arrears to RAO Gazprom of Russia was US$ 212 million, including almostUS$ 45 million in penalties by the end of March, 1997. The energy sector's debts toUkraine (for electricity and coal) totals over US$ 50 million. The continued growth inthese arrears, if unchecked, will compromise Moldova's creditworthiness.

D. Extending the Privatization Program is Necessary for Growth

14. While payments discipline is needed to consolidate stabilization, maintaincreditworthiness and restructure the economy, growth will necessitate ownership change.Accelerating the pace of privatization in agriculture (which, together with agro-processing, represents 60 percent of GDP) is particularly important. Less than a fifth ofMoldovan agricultural land is privately managed. The former collective and State farms(now registered as joint-stock companies) continue to manage some 80 percent ofagricultural land. They are performing very poorly, with agriculture output dropping by11 percent in 1996. The majority of former collective and State-owned farms are inarrears to their workers and to the Social Fund. As a result, there is pressure for changefrom within the agricultural sector. The Government has begun the process by launchingtwo pilot farm restructuring projects in the Orhei and Nisporeni regions, with financialand technical assistance from USAID and TACIS. The Nisporeni program has now beenexpanded to 70 farms nationwide.

15. In the urban sectors, mass privatization has been successful, but small-scaleprivatization is being hampered by municipalities which prefer to lease premises ratherthan sell. Privatization of urban land is proceeding very slowly, and the land underprivatized enterprises is only beginning to be sold to the new owners. These problemsjeopardize the development of small businesses, with particularly negative consequencesfor the services sector, which represents only 27 percent of GDP. The experience ofCentral European countries indicates that expanding services is key to economic growthin transition economies-for example, the services sector is about 54 percent of GDP inPoland and 60 percent in Hungary. The Government is determined to move ahead withthe privatization of urban land and small-scale enterprises.

E. Towards Achieving Moldova's Economic Goals

16. Moldova's medium-term economic prospects will depend greatly upon theimplementation of structural reforms, and, to some extent, on the presence or absence ofexternal shocks (related to the weather and its impact on the harvest). Growth will come

5

from increased private sector activity in agriculture, agro-processing and the servicessector. This requires domestic and foreign investment. To promote investment, Moldovaneeds macroeconomic stability, a liberalized economy, and further privatization. Theimplementation of policies in these areas, supported by the proposed SAL II, shouldproduce sustainable growth with a projected median of about 5 percent per year (seeAnnex 1).

17. Continued stabilization requires efforts to increase revenue and reduceexpenditure commitments. The Government's objective is to reduce the fiscal deficit ona commitments basis from 9.7 percent of GDP in 1996 to below 4 percent by 1998. Thisis a major adjustment that would allow for a reduction in arrears of around one percent ofGDP. It would also be consistent with a rigorous monetary stance and declining inflation.Inflation is projected to drop under the program to about 12 percent in 1997 and sevenpercent in 1998.

18. Macro-economic stability, together with increased liberalization and acceleratedprivatization would encourage private entrepreneurs to invest. The rate of fixedinvestment, which is currently under 9 percent of GDP, is targeted to rise to 14 percentover the next decade-which is comparable with countries in Central Europe.' Initially,growth is expected to be concentrated in services, such as retail trade and transportation,where the legacy of central planning has left a great deal of unfulfilled demand and wherethe required investment is typically small. The service sector could grow by as much as10 percent a year, so that its share in GDP would gradually rise. This expansion inservices will require that the private sector be able to purchase real assets (land andoffice space). Land reform and farm restructuring-together with free markets forinputs and outputs, and adequate support services for private farmers-will be critical forthe expansion of agriculture. After a short adjustment period, agriculture growth couldreach a median rate of about five percent over the medium-term, with annual fluctuationsrelated to weather conditions. Industry, especially export-oriented agro-processing,should pick up in tandem and grow at roughly the same rate as agriculture. This wouldbe fueled in the medium term by increased inflows of direct foreign investment, which isprojected to rise from US$ 59 million in 1996 to the range of US$ 100 million by 2002.

19. Full implementation of structural reforms would also bring about a largeimprovement in the social situation. A key objective of the program is to ensure thatgovernment workers receive their wages on time, and pensioners, many of whom areamong the most vulnerable groups, can count on steady monthly payments. Theunemployed will benefit from expanding job opportunities, mainly in the service sector.

Much of Moldova's official investment and saving is due to inventories (stocks), which were recorded tohave increased by 20 percent of GDP in 1995. It is likely that this inventory is overvalued (and someof them are "waste" stocks that may not eventually be sold. Much of the remainder will be drawndown as demand recovers (see Annex 1, Table 1). It is useful, therefore, to look at savings andinvestment figures corrected for rough estimates about the size of waste stocks.

6

As the labor market tightens, real wages will begin rising, and are projected to reach their1991 level in five to seven years.

20. External stability will depend crucially upon reforms of the energy sector. Theprogram aims to stop the uncontrolled build-up of energy debt as much-needed structuralreforms are introduced. Energy imports, US$ 316 million in 1996, are projected todecline steadily to about US$ 302 million in 2000, slowing the growth in imports.Macro-economic projections indicate the need for significant externalfinancing over themedium term. The current account deficit is projected to come down steadily, but isestimated to remain as high as 6.8 percent of GDP by the year 2000, partly due to theprojected rise in investment. The stock of external debt is projected to reach a peak ofover 52 percent of GDP in 1999, before declining to around 40 percent by 2006, and thedebt service ratio is projected to exceed 22 percent of exports by the turn of the century,before declining to below 18 percent thereafter. These creditworthiness indicators areacceptable, but do indicate serious risks, especially if growth of GDP and exports doesnot recover in the short term.

PART II. MOLDOVA'S ADJUSTMENT PROGRAM

A. Program Objectives

21. The Government's program aims at laying the foundations for a resumption ofgrowth through reforms at the macro and micro-economic levels. Past macro-economicframeworks focused on monetary stabilization, and succeeded in bringing inflation down.However, by combining loose fiscal policies (commitments deficits of nearly 10 percentof GDP) and tight money (cash deficits of some 3 percent of GDP) the Government wastaking scarce resources away from the private sector through the build-up of budgetaryexpenditure arrears. The present program marks a tightening of fiscal policy and areduction of budgetary arrears, with the goal of releasing resources for the private sector.At the same time, the program deals with key supply bottlenecks. Land reform and farmrestructuring should reverse the decline in agriculture, Moldova's largest economicsector. Small-scale privatization and the creation of an urban real estate market shouldhelp bring about an expansion of the service sector and increase employment.Restructuring and privatizing the energy sector should enhance the quality of energysupply and reduce costs, making Moldovan enterprises more competitive.

22. Policy reforms are complemented by other actions under the program aimed athelping bring about a supply response. In agriculture, the Government is putting inplace-with Bank and other donors' support-a project to build a system of ruralfinancing, and to provide technical and marketing support to the newly-privatized farms.A Private Sector Development Project-also supported by the Bank and other donors-supports enterprise restructuring and provides management training and a line of credit.

7

The Government's public investment program, and donors' project financing, support theobjectives of the reform program.

23. The reform program has two key components: (i) resolving the arrears problemand enforcing financial discipline; and (ii) laying the foundation for stable growth byexpanding the privatization program. The Government's strategy to deal with arrears isbased upon action in three areas. First, fiscal policy aims to ensure that obligations towage earners, the Social Fund and the energy sector are adequately funded within arealistic revenue envelope. Second, the energy sector is being restructured to ensure thatno more arrears will be accumulated. This restructuring is based on de-monopolizationand privatization, to enforce financial discipline, lower production costs and improveservice quality. Third, the system of social protection and pensions is being overhauledto ensure adequate, but affordable, protection for the elderly and the vulnerable.

24. The Government's strategy to lay the basis for sustained growth focuses on farmrestructuring, privatization of agricultural and urban land, small-scale privatization, andensuring good quality energy services. The objective is to privatize at least 25 percent ofMoldovan farms and to complete small-scale privatization over the next two years. Theprogram aims to complete enterprise privatization, focusing on privatization to strategicinvestors, cash privatization, and privatizing key infrastructure sectors-energy andtelecommunications. Industry and agriculture are suffering from poor energy servicesand unpredictable supply. Therefore, the program encompasses reforms in the energysector to improve service quality-which will have a positive effect on growth, inaddition to improving financial discipline and creditworthiness.

B. Promoting Macroeconomic Stability

25. Macroeconomic stability has been jeopardized by the mounting arrears from thebudget, which has led to increasing economic and social problems. The budget's debt tothe energy enterprises has contributed to the enterprises' inability to repay foreigncreditors for energy imports, and the debt to wage earners and to pensioners hasthreatened their income security and engendered protests and social unrest. Reducingbudgetary arrears has emerged as one of the top priorities of the Government. TheGovernment has decided to focus its efforts on controlling the commitments deficit, notjust the cash deficit as in the past.

26. Parliament has passed a 1997 budget which implies a dramatic decline in thecommitments deficit-from 9.7 percent of GDP in 1996 to less than 4 percent in 1997.The cash deficit is likely to be higher, at about 5 percent, to allow for a reduction inarrears. At the same time, expenditure estimates are now more realistic than in the past,and ensure adequate financing for wages, pensions and energy consumption by budgetaryinstitutions. Fiscal adjustment is being achieved through a combination of revenueincreases and expenditure reductions. Revenue measures include a doubling of gasolineand diesel excises, increased excises on wine and cigarettes, and a strengthening of tax

8

enforcement through a strengthening and reorganization of the customs department andthe tax police. The Parliament also adopted the general framework of a reformed TaxCode, and rationalized the income tax system. Expenditure measures concentrate onfreezes in public sector wages and nominal pensions, and reduced subsidies to enterprisesand consumers. The budget also includes a mechanism to withhold revenues from localauthorities that fail to be current on Social Fund, energy, wage and other prioritypayments. To eliminate unplanned shocks to the budget, it also sets a ceiling on newGovernment guarantees.

27. Those policies are starting to yield results. During the first half of 1997, thecommitments deficit dropped to an estimated 4.5 percent of GDP. Revenue collectionsimproved. Excluding Social Fund contributions, tax revenues were up by about 8'/2percent over the first quarter of 1996. Current wages and pensions are being paid in atimely manner (Box 1).

I,I i J L2]bL L ^

end-December 1996 end-May 1997Million lei % GDP Million lei % est. GDP

GOVERNMENT EXPENDITURE ARREARS(excluding intra-govt. arrears) 964 11.8 908 9.1

Budgetary Arrears (gross) 690 8.4 862a 8.6o/w To budgetary employees 112 1.4 II1 1.1

To energy sector 213 2.6 180 1.8For capital investment 98 1.2 93 0.9

Social Fund Arrears (gross) 395 4.8 181 1.8o/w Topensioners 315 3.8 111 1.1

a/ includes Lei 82 million of external arrears that were paid on June 6, 1997.

28. The Government expects that, at a minimum, its reform measures will prevent anincrease in arrears-a second and third tranche condition of SAL II. The data in Box 1,and subsequent indications, show that it has so far been successful in reducing pensionarrears, and in stabilizing wage and energy arrears. However, arrears to other supplierscontinue to grow. The process of controlling arrears will be facilitated by the deepeningof fiscal reforms under the 1998 budget, implementing the new Tax Code and makingprogress in rationalizing expenditures, especially in the health and education sectors.The Government will be assisted in this process by the newly established StrategicStudies Center, an autonomous organization responsible for macroeconomic analysis,policy formulation, and monitoring implementation of the reform program

9

C. Creating a Fair and Affordable Pensions System

29. Fiscal adjustment will allow the Government to meet important social obligations.In 1996, some pensioners-as well as other social benefit recipients-did not receive anypayments from the Social Fund for nine consecutive months. The Governnent isdetermined that this situation will not recur in the future. In the short run, this will beaccomplished by more realistic Social Fund budgets that rationalize expenditures andensure that revenue shortfalls are covered through transfers from the State Budget. TheGovernment is also committed to implementing more far-reaching structural reforms toensure that the system is viable and equitable over the medium-term.

30. The 1997 Social Fund budget approved by Parliament in March will help ensurethat the Fund's current obligations will be met. This budget has four important features:(i) it refrains from any increases in nominal pensions-the Government is now operatingon the principle of no pension increases until all arrears are repaid; (ii) it reducescontributions from 35 percent of the wage bill to 30 percent, so as to lower their negativeimpact on the labor market and improve compliance; (iii) it cuts administrativeexpenditures; and (iv) it provides for substantial transfers from the State Budget (about2.5 percent of GDP) to cover the deficit. The Government is aware that transferring largeamounts of resources from the Budget to the Social Fund is not sustainable over themedium term. It has identified measures to save 25 million lei in Social Fundexpenditures in 1998 and proposed to Parliament an increase in the pension age of sixmonths per year over 10 years. In June, the Government adopted a strategy to improvethe public pension system, which is outlined in a strategy paper on reforms of the publicpension system prepared by the Ministry of Labor and Social Protection.

31. The proposed reforms in the strategy paper have three goals. First, adequate incomesupport in old age for the whole population, from both State and supplemental pensions.Second, affordability for all generations, by relying on realistic levels of contributionfrom all age groups. Third, fairness-through equal treatment for all, pensions mostlyrelated to contributions, and transparency. Pensions granted after 1998 will thus be basedon a new formula. People will have to work longer before retiring, but in return theywill get a better pension. For most people the main pension will be the contribution-determined service pension, with all contributions counting the same regardless of sector.A "social pension" will be used as the Government's security valve. It will be either:(i) in addition to the service pension, but very low so that the main pension is the servicepension; or (ii) a minimum guaranteed pension, if the service pension is too small.Enactment by Parliament of a law based on these principles is a condition for the secondtranche of SAL II, and the 1998 Social Fund budget will reflect these principles.

32. Individuals and employee groups will have the opportunity to complement theirState pensions with fully funded, privately managed pensions. The Government will putin place the regulatory and institutional framework for the operation of private pensionfunds. It has established a working group, including representatives of Parliament, theGovernment, banking and insurance supervision units, insurance companies, banks and

10

large employers, to prepare a revised version of the draft Law on "Non-State PensionFunds". A key concern is to provide sufficient security for private pension schemes.Enactment by Parliament of legislation on private pensions is a second tranche condition.To regulate the non-State pension funds, a regulatory body will be established by theGovernment in 1998.

D. De-Monopolizing and Privatizing the Energy Sector

33. Lack of reform in the energy sector has been a serious impediment to bothstabilization and growth. Financial indiscipline has contributed to mounting externalarrears, while the lack of assured and high-quality supplies of power has helped hold backindustrial growth. The Government's program takes action in three areas: (i) restoring theenergy sector's financial equilibrium, and stopping the build-up of energy-related externaldebt, through debt management and price adjustment, (ii) ensuring domestic financialdiscipline, hard budget constraints, and better quality of energy services for consumersthrough creating an appropriate regulatory system and demonopolizing and privatizingthe electricity, gas and petroleum industries; and (iii) ensuring that these reforms do notdeprive poor households of a minimum supply of energy through measures to mitigatethe impact of energy price increases on vulnerable groups.

34. A Debt Management Plan (DMP) adopted by the Government outlines a set ofactions to restore the financial viability of key enterprises operating in the sector:Moldenergo (electricity); Moldovagas (gas supply); Termocom and Termocomenergo(district heat). These actions include price adjustments, improvements in paymentcollections, write-off of uncollectable receivables, mutual payment cancellations, and therepayment of debt with interest over a period of five years. In order to implement the DMP,the Government increased energy prices twice-in March and June 1997. Householdtariffs for gas were increased by 15 percent in March and then by 40 percent in June; forelectricity by 33 and 44 percent; and for heating by 31 and 100 percent. Now, prices fullycover costs, including debt repayment. Moreover, the structure of prices has improved,with the difference between the prices charged to households and other consumers forelectricity and gas eliminated. The price differential for district heat will be eliminated in1998. The Government is determined to completely eliminate cross subsidies, which willinvolve raising the electricity and gas prices for households above those charged high-volume consumers in order to reflect the higher cost of service. Despite the price increases,the Government will ensure that, for electricity and gas, end-user collections will risesteadily into 1998. To further ease constraints on the energy companies' financialviability, the Government will, in 1998, reduce subsidies to privileged groups (now paidfor by the energy companies), and fund any remaining subsidies from the State Budget.These measures will help resolve the financial difficulties faced by the energy sector.

35. In order to avoid the development of a gap between energy prices and costs in thefuture, the Government is putting in place a transparent and predictable regulatory system

11

that will be independent of short term political interests. It has already established aregulatory agency, and issued a resolution that spells out its main responsibilities,determines its structure, and provides financing until it becomes self-supporting through asystem of license fees. The responsibilities of this agency, and its successor regulatorybody, are restricted to the regulation of prices, the promotion of competition, and the controlof the quality of service provided to consumers. It will fulfill these responsibilities bylicensing each type of activity and enforcing compliance with the rules and conditionsstipulated in the licenses. By the fall of 1997, the regulator will develop generic/modellicenses and will issue specific licenses to all the entities in the natural gas and electricitysubsectors that are eligible for licenses. For district heating, the Government will transferthe regulatory responsibility to the municipalities in 1998.

36. Privatization will begin once the regulatory framework is fully in place. In July1997, the Government adopted a detailed plan for de-monopolization and principles ofprivatization of the electricity industry. The plan calls for restructuring the industry inorder to develop competition among generators, to de-monopolize wholesale electricitytrading (which are second tranche conditions) and, following a period of about three years,to de-monopolize retail trading and provide a choice among suppliers for large consumers.The Government expects that, by end- 1998, a majority of the shares of electricity generationand low-voltage distribution companies will be sold to private investors who have theability to bring the capital and know-how needed for the modernization of the sector(offering the shares in these companies for sale is a third tranche condition!.

37. Privatization of the gas industry and the oil trading subsector is expected toproceed rapidly. The Government has already sold 50 percent of the shares ofGazsnabtransit (the company that owns the high-pressure transmission system). Lowpressure pipelines are owned by 25 regional gas distribution and supply companies that arealso engaged in the marketing of LPG. These companies have already been corporatized,and about 20 percent of their shares have been sold to their employees. It is expected that,by March 1997 (a second tranche condition), no less than 51 percent of the shares of thesecompanies will be offered for sale to private investors. The Government has also adopted aplan to de-monopolize the distribution and marketing of oil products, by selling parts of thedepots and transport assets of Tirex Petrol (an oil trading company) to private investors. Ftthen plans to sell the majority of the shares of Tirex Petrol.

38. The Government has taken steps to offset the impact of the price increases on thepoor and the more vulnerable groups in society. The 1997 budget includes 3 5 million lei tocompensate vulnerable groups for energy tariff increases. The Social Fund will provideadditional compensation to people who are unemployed or fall in one of the specialcategories (e.g. families with more than 3 children) for the energy price increase, for whichits budget includes 49 million lei. In 1998, these compensations are expected to be targetedto the most vulnerable.

12

E. Creating a Competitive, Private Agricultural Sector

39. Efforts to enhance financial discipline are being complemented by policies topromote rapid economic growth. In primarily agrarian Moldova, the agricultural sector isa key engine for growth. The agrarian reforms implemented by the Government aim torevitalize private initiative in the sector. This is being done by: (i) accelerating theprocess of farm restructuring and land privatization in order to complete the transitionfrom collective and State farms to arrangements where farmers are free to farm in anysystem they choose; (ii) creating an efficient market for land by removing regulatoryimpediments; (iii) liberalizing rural and agricultural markets; and (iv) enhancingefficiency by reducing tax and subsidy distortions.

40. Land reform in Moldova began with the Government increasing the number ofhousehold plots and giving out land shares (for land used by large-scale farms) to almosta quarter of the population. Until 1996, actual restructuring of large-scale farms wasslow-out of about 950 large-scale farms, only 80 farms were fully restructured intoentirely private operations, partly because a February 1995 amendment to the Land Codeblocked individual exit from large-scale farms. However, the process accelerated in 1996for two reasons. First, a Constitutional Court decision restored the possibility ofindividual exit. Second, pressure created by the increased economic difficulties ofunrestructured large-scale farms resulted in a new push for restructuring. Localrestructuring initiatives now receive increased support from the Government. Ongoingpilot projects for farm restructuring supported by international donors have succeeded indeveloping new private farm structures.

41. The Government is accelerating the process of large-scale farm restructuring,and plans to complete the restructuring of about 250 large-scale farms over the next 18months (satisfactory progress in restructuring is a second and third tranche condition).The restructuring will be based on full privatization of land (physically identified landplots for each beneficiary with individual titles), and the new land owners will freelydecide on the way they wish to continue farming (Box 2). Land will remain in individualprivate ownership in the various forms of newly emerging farming organizations, andthese forms provide opportunities for further restructuring and modifications in land use.In order to facilitate this process the Government has already (i) revised and improved theexit and registration procedures for establishment of private farms (simplified procedures,set clear and reasonable time limits, ensured a reasonable appeal process etc.);(ii) reviewed ongoing farm restructuring pilot projects and prepared practical guidelinesfor the dissemination of these experiences, as well as a program to extend these projectsto the national level; and (iii) commenced the functioning of the AgriculturalRestructuring Agency, a non-governmental institution created to implement and supportthe nationwide program of farm restructuring.

13

Box 2: Farm Restructuring

For a former kolkhoz (agricultural cooperative) or sovkhoz (State farming enterprise) to be"restructured" in Moldova, the following have to hold:

* the assembly of the members of the farm decide to enter into a restructuring process;

* identified plots of lands are transferred to individuals, in accordance with theindividuals' rural land entitlements under Moldovan law;

* movable and fixed assets of the farm are distributed to the individual farm members inaccordance with their asset share entitlements;

* successor farming units are created, and the members have freedom of choice to adopt orjoin any of the various forms of farm organization.

42. The Government is establishing legal and institutional conditions for afunctioning land market, necessary for the success of land reform. The foundation waslaid by a September 1996 decision of the Constitutional Court, which eliminated themoratorium on land sales. Since then, several key measures have been taken to promoteland transactions. In July 1997, the initial legal framework for the land market wascreated by enacting a new Law on Normative Price of Land, which also restricted the useof normative prices and eliminated lease control for privately-owned land. The new Lawcontains provisions that may still act to hamper the full and free operation of the landmarket. These include a moratorium on resales of land and a broad range of pre-emptivepurchasing rights. To ensure that the land privatization process proceeds as envisaged, theGovernment will closely monitor progress. As a second tranche condition, it will thentake needed measures to remove any impediments to the functioning of the land market(including, if necessary, adoption by Parliament of necessary amendments to the newLaw). The transfer tax on land sales was lowered by Parliament from five to two percentof the normative price. At the same time, the establishment of a national cadastre systemincluding land registration and titling has begun, with the National Agency for Geodesy,Cartography, and Cadastre being established to coordinate this process. The Governmentexpects to complete the titling and registration of about 15 percent of land parcels overthe next 18 months.

43. Concomitantly, the Government is following up on the market liberalizationmeasures that were started under the program supported by SAL I. To open up the grainmarket, it has introduced a system of auctions for the marketing of concessional foodgrain deliveries, applied the new public procurement system to State purchases (includinggrain), and ensured that grain exports do not require any prior permissions. It has alsoadopted a plan to complete the privatization of the two largest public enterprises in thesector-Fertilitate and Cereale-that would remove residual monopolistic features fromagricultural markets. Most of the remaining Government-owned shares for Fertilitate andCereale will be offered for sale by mid-1998 and end- 1998, respectively (second and thirdtranche conditions).

14

44. The Government will also carry out a study of the system of direct and indirecttaxation and subsidization of agriculture. The study will include recommendations torender the agricultural tax and subsidy system more comprehensive, enforceable andmarket-friendly. It is also expected to recommend that a cap is put on annual subsidiesand that support programs focus on efficiency enhancements. Completion of the study isa second tranche condition and implementation of its recommendations is a third tranchecondition.

F. Completing Enterprise Privatization

45. While land reform is key for agricultural development, broad-based economicgrowth necessitates growth in industry and in services. The creation of an enablingenvironment for such growth in Moldova requires accelerating privatization in urbanareas. The process has already begun, with the successful mass privatization program.As a result of the mass privatization and the development of small private businesses, theprivate sector has increased its share in production of goods and services. Today, about60 percent of industry, 70 percent of trade and services, and 44 percent of constructionand transport is under private ownership. At the same time, 85 percent of public housinghas been privatized.

46. The Government intends to privatize most productive assets which remain in Statehands. The Government has a three-pronged strategy for enterprise privatization: (i)completing the mass privatization program to divest the State of any remaining shares inenterprises that were due to be privatized; (ii) privatizing urban real estate and creating aland market to encourage the growth of small and medium enterprises; and (iii) shiftingfrom voucher privatization to cash privatization to help encourage domestic and foreigninvestment, promote rapid restructuring of privatized companies, and generategovernment revenues.

47. Moldova' s mass privatization program achieved its objectives, with theparticipation of around 3.1 million Moldovan citizens (90 percent of "patrimonial bond",or voucher, holders). Most citizens invested their "patrimonial bonds" in 1,142 mediumand large joint stock companies (JSCs) and 1,093 small-scale enterprises (shops, coffeehouses, etc.). The State, however, still holds shares in over 1,000 companies that wereundersubscribed when their shares were offered. The Government is now selling theseshares, and intends to complete the offer of at least 50 percent of the shares by mid- 1998.

48. The sale of leased premises and land under privatized enterprises is needed toencourage small private businesses, and to expand the real estate market. Privatization ofland under privatized enterprises will support a faster restructuring of the enterprises,making them more attractive for local and foreign investors, and providing them with acollateral for bank lending. To date, about 2,000 leased premises have been identified aspotential candidates for privatization. The sale of these leased premises has started-theMinistry of Privatization has received 74 applications for buying leased premises and has

15

approved and processed 48. A barrier to the acceleration of this process has been theunrealistically high normative prices for land. In May 1997, the normative prices for theprivatization of land under privatized enterprises were reduced by Parliament. TheGovernment proposes to allow buyers to pay for the land in installments for up to fiveyears.

49. The results of cash privatization have been below expectations. Out of 190small-sized enterprises approved to be privatized for cash, only 45 were sold in 1995, and17 in 1996. To expand cash privatization, the Government has started implementing amore flexible pricing policy, and is reducing the starting price after the first auction if thesmall-sized enterprise is not sold. It is also holding a new type of auctions. On March14, 1997, the first "Dutch auction" was held for the sale of small scale objects. In orderto encourage the participation of Moldovan citizens in cash privatization, the Governmenthas created a mechanism for selling a small number of shares to individuals, who may notbe able to afford to buy large quantities.

50. The Government plans to privatize shares in hundreds of JSCs and other StateOwned Enterprises (SOEs) that were left out of previous privatization programs. This isa difficult task even for a country with a developed capital market where the JSCs andSOEs have a business record. Each JSC or SOE will require a feasibility study in order tochoose an appropriate privatization strategy, based on its size, profile and marketcondition. The privatization program supported by SAL II includes a large menu ofprivatization methods such as auctions, selling shares through the Stock Exchange,public offerings, trade sales, debt-equity swaps, and capitalization of the privatizedenterprises. The Government is pursuing a program of institutional strengthening andtechnical assistance for the Ministry of Privatization.

51. The Privatization Program for 1997-1998 (97/98 PP) was approved byParliament in July 1997. The 97/98 PP contains most of the productive assets still ownedby the State, including:

* Real estate: leased premises of small-sized enterprises, and the land under oradjacent to privatized enterprises;

* Small-scale enterprises: both those approved earlier for cash privatization butremaining unsold, and those left out of previous privatization programs;

a Medium and large enterprises: those left out of the previous privatizationprograms, and JSCs that have already been restructured;

* Most State shares injoint stock companies;a Companies in the infrastructure sectors: including energy and

telecommunications companies (the Government has retained an internationalinvestment bank, with EBRD support, to help privatize Moldtelecom throughsale to strategic investors).

52. Implementation of the 1997-98 Privatization Program is a condition for therelease of the second and third tranches.

16

PART III. THE PROPOSED LOAN

A. The Proposed Loan is Central to the Country Assistance Strategy

53. The CAS of April 1996 presents a three-pronged assistance program aimed atsupporting private sector development, strengthening public institutions and financialdiscipline, and improving social services and safety nets. In the CAS, agreement on aprogram for SAL 11 and its implementation are the triggers for the base case FY 96-98lending program-1I projects totaling US $290 million. The justification is that themeasures supported by SAL 11-payments discipline and completion of privatization andland reform-are necessary conditions for sustainable growth and creditworthiness.Without the SAL II reforms, the Bank's program would move to a low case.

54. SAL 11-supported policy reforms are also necessary for the success of Bankinvestment operations. Hardening the budget constraint facing enterprises andcompleting ownership change are needed for the success of Bank-supported PrivateSector Development projects (PSD I and II). Land privatization and rationalizing thetaxation/subsidization of agriculture would help achieve the objectives of the AgricultureI and II, Cadastre and Irrigation projects. Improving payments discipline and reducinggovernment arrears-to energy enterprises as well as to teachers, doctors andpensioners-are critical for the success of the Energy and Education projects.

55. In turn, investment lending is designed to support the adjustment programInstitution building and detailed conditions that are required for the success of the reformsunder SAL II are supported by investment operations in the key sectors: PSD, agriculture,energy and the social sectors. The investment operations will accelerate the supplyresponse to the policy changes, and expand political support for the reforms.

56. The proposed loan and credit amount is double the US $50 million proposed inthe CAS, because it supports a broader and deeper program than initially expected. Theneed for a stronger program is driven by the unexpected worsening in the macro-economic situation in the second half of 1996-GDP fell by nearly 15 percent in thesecond semester and arrears doubled. The program has been strengthened in three keyareas: reversing the build-up of budgetary and Social Fund arrears, privatizing the energysector (which was not considered to be an option a year ago), and land reform and farmrestructuring (where the Government wants to go deeper and faster than was expected atthe time of CAS preparation). The depth of the reform program supported by SAL IIimplies an increase in its short term costs-eliminating budgetary and Social Fund arrearsalone will cost the Government almost US$ 200 million. It also means thatimplementation of the reform program and disbursement of SAL II will require moretime. Mainly because of the time needed to privatize the energy sector, carry out landreform, and develop the social consensus for pension reform, the proposed loan and creditare now expected to disburse over 18-24 months in three tranches. The CAS envisionedSAL II as a two tranche operation that would disburse over 9-12 months.

17

B. Benefits and Risks

57. Benefits: SAL II would provide the financial underpinning for the MoldovanGovernment's cross-sectoral reform program. It will have three fundamental benefits.First, the reform program supported by SAL II will address key bottlenecks, and enhancethe prospects of long-term growth and improved living standards by setting in place acomprehensive program of reforms that will span the 1998 Parliamentary elections.Second, it will provide short-term budgetary support essential for maintaining the level ofbasic public services at a time of fiscal adjustment. The availability of low cost, non-inflationary budgetary financing will help consolidate Moldova's economic stabilization.Third, it will provide necessary foreign exchange to purchase imports critical forMoldova's economic activity while maintaining creditworthiness.

Risks Mitigation Measures. Delays in policy implementation due to . Front-loading the core policy reforms as

upcoming Parliamentary elections pre-Board conditions. A new Government with weaker . Extensive dialogue with broad elements

ownership of the reform program could be of civil society, and a public educationin place after the Parliamentary elections program, to build consensus for the

reform program. Weak implementation capacity of * Essential elements of the TA program are

Government already in place, and donor coordinationmeetings are regularly organized

* Slow rebound in economic growth, due to . Front-loading the core policy reforms asdelayed implementation of reforms or pre-Board conditions and focus onexogenous shocks implementation

. Social mitigation programs in place aspart of program

58. Risks: The operation has three important risks (Box 3). The greatest risk ispolitical. With Parliamentary elections due in early 1998 (paragraph 10), it is possiblethat the reform process may be slowed or stalled. In case there is a new government, itmight be less reform-minded than the present one, lack ownership of the SAL II programdeveloped by its predecessor, and not implement it fully. There may also be delays inpolicy implementation during the months preceding the elections. The operation seeks tominimize the overall risk by ensuring that a major part of the reform agenda is front-loaded (Box 4). Most of the core reforms under the program have already been taken.The Government, with support from the Bank, has been carrying out an extensivedialogue with many elements of civil society. A public education campaign, includingregular roundtable discussions led by the Resident Mission, has helped explain the reformprogram and build broad-based support for it.

18

59. The Government's reform program is very ambitious, and will require a great dealof institutional capacity for effective implementation. This is especially true for farmrestructuring and energy sector privatization. The Government wants to move veryquickly in these two areas and has set ambitious targets and deadlines. However, weakinstitutions and lack of experience could hamper implementation, and in turn delayrelease of the second and third tranches of SAL II. In order to minimize this risk, theGovernment has created a special Agricultural Restructuring Agency (ARA) and ensuredthe availability of sufficient technical assistance to carry out the program. In the area ofenergy sector privatization, technical assistance is being provided to the Agency forEnterprise Restructuring (ARIA) and a program for strengthening the Ministry ofPrivatization is being put in place. The Bank is helping the Ministry of Privatization withtechnical assistance proposals to support implementation of the 1997/98 PP. To helpensure arrears reduction, the Bank is cooperating closely with the IMF in monitoring thefiscal program of the Government.

60. The reform program supported by the proposed SAL II is designed to lay thefoundations for a resumption of economic growth. But there is the risk that there will bea delay in the return to growth, pushing Moldova onto a less sustainable economic path.This could happen if reform implementation is slow, or if there is an exogenous shockaffecting production (for example bad weather) or income (for example a deterioration inthe terms of trade). If the resumption of growth is delayed by two to three years, evenwith structural reforms in place, the current account balance could worsen significantly,lifting debt indicators to unsustainable levels (for instance, debt-to-GDP ratios of over 70percent, and debt service ratios of around 25 percent, by the year 2000). Continuedeconomic decline could weaken the reformers in Government and erode support for theprogram. The program is designed to mitigate this risk by front-loading key reformconditions and concentrating on implementation. The program includes social mitigationefforts to cushion the worst-off in society, by ensuring that arrears to the population arepaid promptly, pension reform ensures prompt payment of pensions, and the poor areshielded from the effects of increased energy prices.

19

Box 4: Moldova SAL 11: Actions Already Taken Under the ProgramMacroeconomic Stability. Adopted a realistic 1997 budget, and satisfactorily implemented it.* Improved revenue collections, ensured no increase in total arrears from 1997 general budget, and adhered to the guarantees ceiling.. Parliament adopted the general framework and the chapter on income taxes of the new Tax Code.* The Ministry of Finance mandated improved financial reporting by Govemment agencies, and the 1997 budget law included a mechanism forimproving financial discipline of local govemments.* Started operations of the Strategic Studies CenterPension Reform:* Enacted a viable 1997 Social Fund budget. Covered the 1997 Social Fund deficit by a transfer from the State Budget, to ensure 1997liabilities are timely.. Froze nominal pensions, reduced payroll taxes, and lowered administrative expenditures.* Continued timely payments to pensioners, and pension arrears reduced by about 60 percent.. Produced a draft strategy paper for reform of the public pension and social protection systems. Adopted Govemment resolution endorsingthe condusions of the strategy paper and outining the directions of reforms of the public pension system* Established a permanent working group, for the preparation of a new law on non-state pension funds.Enerav Sector Reform:* Prepared a Debt-Management Plan (DMP) and restructured the stock of payables and receivables of electricity, gas and heating companies.* Increased, effective March and June 1997, the prices and tariffs of electdricity, heat and gas, to attain full cost recovery.. Started implementing the surcharge applicable to electricity consumption above the norms set by Govemment Resoluton 807 of December1995.. Adopted a plan to de-monopolizethe distributionand marketing of oil productsby selling parts of the depots and transportassetsof Tirex Petrol toprivate investors.. Issued resolution to formally adopt Debt Management Plan (DMP) and adopted a schedule to fully eliminate cross subsidies in the energysector.. Adopted detailed de-monopolization plan and the principles for privatizaton of the gas and electricity industries.. Established a national regulatory body for the energy sector as a non-govemmental organization.Agricultural Reforms:. Improved exit and registration procedures and performance standards for establishment of private farms.. Adopted process for providing fiscal and statistical identification numbers for farms registered at the local level, and simplified the farmregistration process.* Reviewed farm restructuring pilot projects, disseminated the experiences and prepared a program to extend these projects to the nationallevel.. Initiated functioning of the Agricultural Restructuring Agency for farm privatization and restructuring.. Moratorium on land sales removed by decision of Constitutional Court.. Established the National Agency for Geodesy, Cartography and Cadastre to implement national cadastre system.. Liberalized prices and marketing regimes.* Made progress in demonopolizing input supply and grain handling.. Completed first phase of privatization of agro-processing.. Amended the Law on the Normative Price of Land, for agricultural land, removed lease control for privately owned land and provided thelegal framework for land sales.. Removed requirement that Rayon Executive Committees approve land allocatons for persons exiting ex-collective and state farms.. Initiated review of the systems of direct and indirect taxes/subsidies in agriculture.. Developed procedures to apply new public procurement system to grain purchases, and ensured grain exports do not require priorpermissions.Privatization:* Prvatized 85 percent of public housing* A comprehensive privatization program for 1997/98 adopted by Govemment, and enacted by Parliament* Induded in the privatization program regulatons to allow Moldovans to participate in cash privatization by buying a small number of shares.. Held 'Dutch auctions', to ensure more flexible prices if firm is not sold at asking price.. Approved a resolution setting the mechanisms for the sale of shares still held by the State but approved to be privatized for patrimonialbonds.* Lowered the normative price of land under enterprises as agreed with the Bank.. Offered for sale 200 leased premises of small scale firms* Eliminated baniers to cash privatization of small-scale firms.* Prepared a technical assistance program, satisfactory to the Bank, to support the implementaton of the 1997/98 PP* Conducted a review of the functioning of the Share Registry and transferred privatized companies to that registry.

20

C. Bank Operations

61. The Bank's assistance program in Moldova has combined policy-based lendingwith investment operations, technical assistance and ESW. Policy lending has providedquick disbursing balance of payments funds in support of macroeconomic stabilization,price and trade liberalization, and the initial phase of structural reform, notablyprivatization, financial sector reform, and enterprise restructuring. Quick disbursingloans have included the US$ 26 million Drought Recovery project and the follow-upUS$ 60 million Rehabilitation Loan, both approved in 1993, as well as the US$ 60million Structural Adjustment Loan approved in late 1994.

62. Investment lending began in 1995 with the US$ 30 million Pre-export GuaranteeFacility, which offers political risk insurance designed to attract working capital loansfrom abroad. The investment lending program accelerated in 1996 with the approval of aUS$ 35 million loan for the Private Sector Development project, a US$ 10 million loanfor the First Agriculture project, and a US$ 10 million loan for the Energy project. Thefirst IFC investment in Moldova (US$ 10 million in INCON, a major agroprocessor) wasapproved in December 1996. Expansion of investment lending has continued in 1997,with a US$ 16.8 million loan for the General Education project, approved in April, a SDR6.6 million IDA credit for the PSD II project, approved in June, and the US$ 23 millionCadastre project, scheduled for Board presentation in late 1997. Priority sectors forfuture investment lending include agriculture, PSD and the social sectors. Although US$81 million in investment lending has been committed to date, disbursements have beendelayed by a number of factors, including the slowdown in structural reform in 1996,unfamiliarity with World Bank procedures, and a chronic shortage of counterpart funds.

63. The lending program has been complemented by a portfolio of grant fundedtechnical assistance projects, ranging from the preparation of public procurementlegislation to the development of modem enterprise accounting standards and the designof health care reforms. The country assistance program includes an active non-lendingservices program which mixes short policy notes on issues of immediate importance within-depth macroeconomic and sector studies. A core component of the ESW program isthe Poverty Assessment scheduled for completion in December, 1997.

D. Financial Arrangements

64. Loan Amount and Borrower: The proposed Structural Adjustment Credit(SDR 32.6 million) and Structural Adjustment Loan (US$ 55 million) would be made tothe Republic of Moldova, represented by the Ministry of Finance. Disbursements underthe proposed Credit and Loan will be made to two accounts ("Deposit Accounts"), oneeach for the Credit and Loan, of the Ministry of Finance established at the National Bankof Moldova for this purpose.

21

65. The Credit will be on IDA terms, with a maturity of 35 years including a graceperiod of 10 years, and would be disbursed in two tranches: SDR 25.36 million(equivalent to US$ 35 million) immediately after effectiveness, and SDR 7.24 million(equivalent to US$ 10 million) to be disbursed upon satisfaction of second tranche releaseconditions (expected about June 1998).

66. The Loan would be made for 20 years, including a grace period of 5 years, at thestandard interest rate for LIBOR-based US Dollar single currency, and would bedisbursed in two tranches: US$ 25 million to be disbursed upon satisfaction of secondtranche release conditions (expected about June 1998), and US$ 30 million to bedisbursed upon satisfaction of third tranche release conditions (expected about March1999).

67. Disbursements. The loan and credit will be released in three tranches, againstsatisfactory implementation of the adjustment program, include compliance withstipulated second and third tranche release conditions and maintenance of a satisfactorymacroeconomic framework. Upon notification by the Bank of loan effectiveness and ofsecond and third tranche release, the proceeds of the first, second and third tranchesrespectively of the Credit and Loan will be deposited by the Bank into the respectiveDeposit Accounts at the request of the Borrower. If after deposit into these account theproceeds of this Credit or Loan are used for ineligible purposes (i.e., to finance importsfrom non-member countries, or goods and services on the Bank's standard negative list),the Bank will require the Borrower to either; (a) return that amount to the account for usefor eligible purposes; or (b) refund the amount directly to the Bank (in which case theBank will cancel an equivalent undisbursed amount of the Credit or Loan). In accordancewith the Operational Directive on the Simplification of Disbursement Rules underStructural Adjustment and Sectoral Adjustment Loans (February 8, 1996), disbursementswill not be linked to specific purchases and, hence, there will be no procurementrequirements.

68. Reporting, Accounting and Auditing. The National Bank of Moldova wouldmaintain records of all transactions under the loan/credit in accordance with soundaccounting practices. Although routine audits of the Deposit Accounts will not berequired, the Bank reserves the right to require audits at any, time.

69. Closing Date. The closing dates of the proposed Credit and Loan will beDecember 31, 2000.

E. Collaboration With IMF And Other Donors

70. Cooperation with the IMF on Moldova is very close. A SDR 135 million threeyear EFF was approved in May 1996. Although disbursements under the EFF weresuspended in late 1996, a successful program review and implementation of agreed prior

22

actions put disbursements back on track in July 1997. The SAL II team collaborated withthe Fund on the analysis of the 1997 State Budget and Social Fund. Members of the teamparticipated in the February IMF review mission. Cooperation with other major donors isalso excellent. The Governments of the Netherlands and Japan cofinanced previous Bankadjustment operations. The Netherlands Government, USAID, TACIS, and GTZ arecofinancing the PSD project. The Netherlands Government and USAID are providingtechnical assistance for the energy sector restructuring program. The NetherlandsGovernment and TACIS are providing financial support to the Agriculture RestructuringAgency, and USAID is supporting the farm restructuring program. The TACIS programincludes technical assistance for pension reform. The Bank and EBRD have workedclosely together on PSD and the financing of the public investment program. The twoinstitutions have also cooperated on the implementation of structural reform, notablyprivatization. The Bank is cooperating with UNDP on the development of a povertyalleviation strategy and the establishment of the Strategic Studies Center.

PART IV. RECOMMENDATION OF THE PRESIDENT

71. 1 amn satisfied that the proposed credit and loan would comply with the Articles ofAgreement of the Association and the Bank, respectively, and I recommend that theExecutive Directors approve it.

James D. Wolfensohn

President

by Caio K. Koch-Weser

Washington, DC

August 18, 1997

Attachments

Annex I

Table 1: Moldova: Main Economic Indicators Table I of 4

1995 1996 1997 1998 199 2000 2001 2002 2003 2004 2005 2006

Real Growth Rate

GDP 3.0%/o -10.0% 1.2% 3.0% 4.5% 5.0% 4.9% 4.8% 4.7% 4.6% 4.6% 4.5%Consumption 0.0%/o 4.8% 5.6% 6.1% 5.3% 4.9% 3.1% 2.4% 2.8% 3.1% 3.5%

Inflation (average) 35.5% 20.8% 14.4% 9.0% 5.6% 5.1% 5.1% 5.0% 5.0% 5.0% 5.0% 5.0%Inflation (end of period) 29.5% 17.6% 11.7% 7.3% 5.4% 5.1% 5.0% 5.0% 5.0% 5.0% 5.0% 5.00/4

Exports (GNFS) 8.2% 7.7% 7.5% 8.3% S.3% 7.6% 6.7% 5.9% 5.3% 5.0% 5.0%Imports (GNFS) 18.1% 6.2% 5.3% 4.7% 4.7% 4.8% 4.8% 5.0% 5.0% 5.0% 5.0%o/w: Energy 7.8% 0.6% -1.1% -2.8% -1.0% 0.2% 1.6% 2.5% 2.5% 2.5% 2.5%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

As % GDP

Exports 50.9% 51.9% 49.2% 47.6% 47.2% 47.2% 48.3% 49.0% 49.5% 49.6% 49.7% 49.8%Imports 59.8% 66.1% 61.2% 57.4% 54.4% 52.1% 51.2% 50.6% 50.1% 49.6% 49.2% 48.9%6eResource Balance -8.9% -14.2% -12.0% -9.% -7.3% 4.8% -2.9% -1.5% -0.6% 0.0% 0.5% 0.9%Current Account -8.6% -13.1% -11.1% -10.4% 8.6% -6.8% -5.6% -4.6% -4.0% -3.7% -3.3% -3.0%

Gross Domestic Saving 20.90/o 14.1% 12.4% 10.6% 9.0°/0 8&5% 8.3% 9.7% 11.9% 13.8% 15.5% 16.7%Gross Domestic Saving less Waste Stocks 2/ 5.9% 0.3% 1.1% 3.3% 4.8% 6.5% 8.0% 9.7% 11.9% 13.8% 15.5% 16.7%Gross Domestic Investment 29.8% 28.3% 24.3% 20.4% 16.3% 13.3% 11.2% 11.2% 12.5% 13.8% 15.0% IS.%Gross Domestic Investment (excluding waste stocks) 3/ 14.8% 13.5% 11.5% 10.4% 10.0% 9.9% 9.7% 11.0% 12.5% 13.8% 15.0% 15.8%Fixed Investment 9.8% 8.6% 7.2% 7.0%/a 7.3% 8.0%4 8.9% 10.1% 11.4% 12.6% 13.8% 14.6%

o/w: Public 1.8% 1.9% 1.4% 1.5% 1.7% 2.0% 2.3% 2.7% 2.9% 3.2% 3.3% 3.4%

Government Revenue 25.1% 27.2% 26.4% 26.0%/6 25.5% 24.5% 24.3% 24.1% 24.0% 23.8% 23.6% 23.5%o/w: Tax Revenue 20.1% 18.3% 18.6% 19.4% 20.5% 19.8% 19.8% 19.8% 19.8% 19.8% 19.8% 19.8%

Govemment Expenditure 30.8% 33.5% 31.3% 30.9% 30.5% 27.8% 27.6% 27.3% 26.9% 26.4% 25.9% 25.6%Fiscal Deficit (cash basis) -5.7% -6.3% -4.9% -5.0% -5.0% -3.3% -3.3% -3.1% -2.9% -2.6% -2.3% -2.1%Fiscal Deficit (committment basis) -7.6% -9.7% -3.9% -2.8% -2.8% -3.3% -3.3% -3.1% -2.9% -2.6% -2.3% -2.1%Arrears Accumulation 1.9% 3.4% -1.0% -2.2% -2.2% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Memo:Change of Stocks 20.0% 19.7% 17.1% 13.4% 8.9% 5.2% 2.3% 1.2% 1.2% 1.2% 1.2% 1.2%

Change in Viable Stocks 5.0% 4.6% 3.8% 3.2% 2.3% 1.1% 1.2% 1.4% 1.4% 1.4% 1.4% 0.0%Change in Waste Stocks 15.0% 13.9% 11.3% 7.4% 4.2% 2.0% 0.3% 0.0% 0.0% 0.0% 0.0% 0.0%

Arrears Accumulation (neg. = repayment) 145.0 282.3 -96.1 -232.0 -256.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0

1/ Govemment Savings - Fiscal Balance + Public InvestmentGovemment Balance + Private Balance - Change in Stocks= External Balance2/ GDP in Moldova is estimated by end-use only. Over-valucation of stocks implies inflated saving given measured consumption.3/ Ratio assumes no adjustment for waste stocks to official GDP.

Table 2: Moldova: Balance of Payments Table2 f4(millions of US dollars)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

MerchandiseExports(FOB) 740.7 822.0 879.9 949.7 1037.7 1149.2 1264.8 13796 1491.9 1603.1 1718.4 1842.1Nonfactor Services 124.3 123.0 148.0 166.7 183.5 200.3 216.5 233.0 249.5 266.6 284.2 302.9Exports of GNFS 865.0 945.0 1027.9 1116.4 1221.2 1349.4 1481.3 1612.6 1741.4 1869.7 2002.6 2145.0

Merchandise Imports (FOB) 794.0 1044.5 1075.5 1138.7 1197.1 1267.5 1343.9 1428.3 1521.9 1620.4 1726.3 1838.9Nonfactor Services 222.0 159.0 202.8 207.2 211.9 219.6 227.0 234.5 242.1 249.9 257.9 266.1

1016.0 1187.7 1279.8 1361.0 1446.8 1548.3 1645.5 1747.3 1848.0 1952.1 2061.7 2177.6Imports ofGNFS 1016.0 1203.5 1278.4 1345.9 1408.9 1487.2 1570.9 1662.8 1764.0 1870.3 1984.2 2105.0

o/w: Capital 97.4 105.4 114.4 124.4 135.9 147.1 157.1 167.7 178.9 191.1 204.2 217.7

Resource Balance -151.0 -258.5 -250.4 -229.5 -187.8 -137.8 -89.6 -50.2 -22.6 -0.6 18.4 40.0

Net Factor Income -20.5 -31.9 -61.1 -90.8 -108.7 -129.0 -152.8 -171.2 -188.0 -206.9 -221.9 -238.7Factor Payments 41.4 58.4 90.9 122.3 143.1 164.7 190.3 210.4 229.0 249.8 266.4 285.7

o/w: Interest 31.2 40.9 65.8 88.6 99.7 110.4 124.1 131.5 136.7 143.8 146.4 151.6o/w: Profit Remittances 10.2 17.5 25.2 33.7 43.4 54.4 66.2 78.9 92.3 106.0 120.0 134.2

Factor Receipts 20.9 26.5 29.9 31.5 34.4 35.8 37.4 39.2 41.0 42.9 44.5 47.1

Current Transfers 35.0 60.0 59.0 56.0 52.0 50.0 48.0 46.0 44.0 42.0 40.0 38.0Workers Remittances 18.0 18.9 19.8 20.8 21.9 23.0 24.1 25.3 26.6 27.9 29.3 30.8

Current Account Balance -146.0 -238.5 -232.6 -243.5 -222.6 -193.8 -170.3 -150.1 -140.0 -137.6 -134.1 -129.8

Foreign Investment 73.0 59.0 65.0 75.0 85.0 90.0 95.0 100.0 100.0 100.0 100.0 100.0Portfolio Investment 0.0 18.0 20.0 22.0 25.0 28.0 32.0 34.0 37.0 40.0 42.0 44.0

Net Long-Term Loans 123.0 88.6 137.5 229.8 173.1 137.2 109.4 92.9 85.0 61.6 68.1 42.4Disbursements (exclIMF) 162.0 125.6 206.5 299.3 275.9 268.4 263.9 275.7 303.1 273.8 259.2 264.3

o/w: GAP 0.0 0.0 10.0 129.7 166.8 180.4 163.6 163.1 179.1 142.1 123.0 124.5Amortization 39.0 37.0 69.0 69.5 102.7 131.2 154.5 182.8 218.1 212.2 191.0 221.9

Other Capital Flows 1/ 27.0 106.4 88.0 5.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Change in Net Intl. Res. (-increase) -77.0 -33.5 17.2 -53.3 -60.5 -61.4 -66.1 -76.8 -82.0 -64.1 -76.0 -56.6IMF Credit 65.0 25.0 44.0 -4.1 -38.2 -34.8 -37.0 -46.9 -50.1 -39.0 -32.4 -19.2

Memo:GDP (mil US 5) 1698.44 1820.92 2089.53 2345.92 2588.76 2856.83 3068.74 3288.44 3521.34 3768.04 4030.09 4308.31Average Exchange Rate (LCU/US$) 4.5 4.6 4.6 4.6 4.6 4.6 4.7 4.8 5.0 5.1 5.2 5.4RealExchangeRate 2/ 100.0 81.8 73.4 68.8 66.9 65.4 65.4 65.4 65.4 65.4 65.4 65.4Terms ofTrade 3/ 100.0 100.7 101.8 102.8 103.8 105.1 106.3 107.4 108.4 109.5 110.6 111.7Reserves in Months of Imports 2.9 3.0 3.0 3.2 3.2 3.2 3.2 3.2 3.2 3.2 3.2 3.2

1/ Includes energy arrears, short-term loans and errors and ommissions.2/ Decrease = Appreciation3/ Increase = Improvement

Annex ITable 3 of 4

Table 3: Moldova: Debt Indicators

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Total DOD (US$M) 691.0 829.8 1038.1 1227.8 1361.7 1466.1 1536.6 1581.6 1615.5 1639.1 1651.8 1708.0Debt Service (USSM) 69.0 85.9 156.8 228.2 273.6 276.3 315.6 361.2 404.9 395.0 369.8 392.7

Total Debt/GDP 40.7% 45.6% 49.7% 52.3% 52.6% 51.3% 50.1% 48.1% 45.9% 43.5% 41.0% 39.6%Debt Service GDP 4.1% 4.7% 7.5% 9.7% 10.6% 9.7% 10.3% 11.0% 11.5% 10.5% 9.2% 9.1%Interest/GDP 1.8% 2.2% 3.1% 3.8% 3.9% 3.9% 4.0% 4.0% 3.9% 3.8% 3.6% 3.5%Debt Service/Total Exports 7.6% 8.7% 14.5% 19.5% 21.4% 19.6% 20.5% 21.5% 22.4% 20.4% 17.8% 17.7%DOD/Export 76.4% 83.8% 96.3% 105.1% 106.6% 104.1% 99.6% 94.3% 89.3% 84.5% 79.6% 76.8%

IBRD Debt (US$M) 152.0 154.0 162.7 240.1 269.2 313.4 371.7 442.8 517.9 594.3 638.4 719.2IBRD Debt Service Due (US$M) 8.0 11.0 11.1 15.7 25.2 29.9 34.8 39.1 49.0 59.5 100.0 111,7IBRD Debt/GDP 8.9% 8.5% 7.8% 10.2% 10.4% 11.0% 12.1% 13.5% 14.7% 15.8% 15.8% 16.7%1BRD Debt/Total DOD 22.0% 18.6% 15.7% 19.6% 19.8% 21.4% 24.2% 28.0% 32.1% 36.3% 38.6% 42.1%IBRD Debt Service / GDP 0.5% 0.6% 0.5% 0.7% 1.0% 1.0% 1.1% 1.2% 1.4% 1.6% 2.5% 2.6%IBRD DebtService/TotalExports 0.9% 1.1% 1.0% 1.3% 2.0% 2.1% 2.3% 2.3% 2.7% 3.1% 4.8% 5.0%IBRDDebtService/TotalDebtService 11.6% 12.8% 7.1% 6.9% 9.2% 10.8% 11.0% 10.8% 12.1% 15.1% 27.0% 28.5%

Preferred Creditors Debt (US$M) 447.0 537.0 685.7 842.2 892.7 903.3 917.7 930.0 939.9 963.0 979.6 1056.0Preferred Creditors Debt Service Due (US$M) 57.0 37.3 61.9 121.8 140.0 131.3 140.7 157.9 171.3 171.5 157.8 156.6Preferred Creditors Debt/GDP 26.3% 29.5% 32.8% 35.9% 34.5% 31.6% 29.9% 28.3% 26.7% 25.6% 24.3% 24.5%Preferred Creditors Debt/Total DOD 64.7% 64.7% 66.1% 68.6% 65.6% 61.6% 59.7% 58.8% 58.2% 58.8% 59.3% 61.8%Preferred Creditors Debt Service/ GDP 3.4% 2.1% 3.0% 5.2% 5.4% 4.6% 4.6% 4.8% 4.9% 4.6% 3.9% 3.6%Preferred Creditors Debt Service / Total Exports 6.3% 3.8% 5.7% 10.4% 11.0% 9.3% 9.1% 9.4% 9.5% 8.8% 7.6% 7.0%Preferred Creditors Debt Service/Total Debt Service 82.6% 43.4% 39.5% 53.4% 51.2% 47.5% 44.6% 43.7% 42.3% 43.4% 42.7% 39.9%

Preferred Creditors include World Bank, IMF, and EBRD.

Annex I

Table 4: Moldova at a glanceEurope &

POVERTY and SOCIAL Central Low-

Moldova Asia income I Development diamond^

Population mid-1996 (millions) 4.3 479 3,229GNP per capita 1996 (US$) 600 2,180 500 Life expectancy

GNP 1996 (billions US$) 2.6 1,043 1,601

Average annual growth, 1990-96

Population (%) -0.1 0.3 1.7 i GNP GrossLabor force (%) 0.2 0.5 1.7 primary

Most recent estimate (latest year available since 1989) capita enrollment

Poverty: headcount index (% of population)Urban population (% of total populalion) 52 65 29

Life expectancy at birth (years) 69 68 63Infant mortality (per 1, 000 lve burths) 22 26 69 Access to safe water

Child malnutrition (% of children under 5) -Access to safe water (% of populafion) .. .. 53

Illiteracy (% of populafion age 15+) 4 34

Gross pnmary enrollment (% of school-age population) 94 97 105 'Moldova

Male 95 97 112 Low-income group

Female 94 97 98

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1976 1985 1995 1996Economic ratios

GDP (billions USS) .. .. 1.7 1.8

Gross domestic investment/GDP .. .. 29.8 28.3 Openness of economyExports of goods and services/GDP .. .. 50.9 51.9Gross domestic savings/GDP .. .. 20.9 14.1

Gross national savings/GDP .. .. 21.3 15.2

Current account balance/GDP .. .. -8.6 -13.1Interest payments/GDP .. .. 1.8 2.2 Savings - Investment

Total debt/GDP .. .. 40.7 45.6

Total debt service/exports .. .. 7.6 8.7Present value of debt/GDPPresent value of debt/exports .. .. 71.9 Indebtedness

197546 1986-96 1996 1996 1997465

(average annual growth) - MoldovaGDP 4.4 -5.5 -3.0 -10.0 4.1GNPpercapita .. -11.3 -3.8 -10.1 4.0 Low4ncome group

Exports of goods and services .. .. 3.6 8.2 7.3

STRUCTURE of the ECONOMY

1975 1985 1996 1996t976 of G9B6 196i Growth rates of output and investment (%)

(% of GDP) I

Agriculture .. .. 50.6 49.9 1 I5Industry .. .. 23.2 23.1 40

Manufacturing .. ,. 11.6 11.5 I 2Services .. .. 26.3 27.0 20

-450Private consumption .. .. 58.9 65.5 j -GoGeneral govemment consumption .. .. 20.2 20.3Imports of goods and services .. .. 59.8 66.1

197545 1986-96 1996 1996 I(average annual growth) Growth rates of exports and imports (%)

Agriculture .. ,. 4.0 -10.9 20Industry .. .. -6.5 -10.2 1 10

Manufacturing .. .. -6.0 -10.2 i °Services .. , -11.1 -7.2 -i5 2 I 92 93 994 5 s 6

.20Private consumption .. ., -0.8 2.5 -30

General govemment consumption .. .. -18.2 -7.3 .40 IGross domestic investment .. .. -17.2 -11.1 ,50

Imports of goods and services .. .. 5.9 18.1 Exports ImportsGross national product .. .. -3.8 -10.1

Note: 1996 data are preliminary estimates. Figures in italics are for years other than those specified.

* The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond willbe incomplete.

Annex 14of4

Moldova

PRICES and GOVERNMENT FINANCE1975 1986 1995 1996

Domestic prices Inflation (X)(% change) | 2,000Consumer prices .. .. 36.1 26.0 ! 1.soo

Implicit GDP deflator .. .. 29.9 23.5 1,000

Government finance it

(-6 of GDP) . 0 'Current revenue ., 25.1 27.2 91 92 93 94 95 96

Current budget balance .. -4.0 -4.4 - GDP def. -CO-CPIOverall surplus/deficit ., ,, -5.7 -6.3

TRADE1975 1985 1995 1996 E

(millions US$) Export and import levels (mill. USS)Total exports (fob) .. .. 741 822 1,200

Commodity 1 - Live Animals & Animal Product .. .. 67 84 1000Commodity 2 - Vegatable Products .. .. 76 425 l

Manufactures .. .. 96 101 00!

Total imports (cf) 773 1,045 600.Food ... 32 49 400.Fuel and energy .. .. 352 316 200 D .

Capital goods .97 05 0

Export price index (1987=100) .. .. .. 101 so 91 92 93 94 95 9s

Import price index (1987=100) .. .. .. 100 i Exports milmportsTerms of trade (1987= 100) ... . 101 !

BALANCE of PAYMENTS1975 1985 1995 1996

(millions US$) Current account balance to GDP ratio (%)

Exports of goods and services . .. 865 945 aImports of goods and services .. .. 1,016 1,204 90 91 92 93 94 95 i9Resource balance .. -151 -259

Net inrome .. -21 -32 , 4;

Net current transfers .. 26 52 5l

Current account balance,before official capital transfers .. .. -146 -239 tj i

Financing items (net) .. 223 272 -2Changes in net reserves .. -77 -33 -14

Memo: i_IReserves including gold (mill. US$) .. .. 257 315

Conversion rate (locaV1US$) .. . 4.5 4.6

EXTERNAL DEBT and RESOURCE FLOWS1975 1985 1995 1996

(millions US$) Composition of total debt, 1995 (mill. US$)Total debt outstanding and disbursed .. .. 691 830

IBRD .. .. 152 164 FG

IDA ,, 0 1 156 A152

Total debt service 69 69IBRD 8 8IDA 0 1. E

Composition of net resource flows j23(Official grants .. .. 0 0Official creditors .. .. 108 57

Private creditors .. o 15Foreign direct investment .. .. 73 59 84 231Portfolio equity .. .. 0 0

World Bank programCommitments .. .. 60 60 A - IBRD E - BilateralDisbursements 6.. 7 67 B - IDA D - Other multilateral F - Private

Principal repayments ,, 0 0 C - IMF G - Short-termNet flows .. 67 67 !Interest payments .. 8 11Net transfers 5.. 9 56

Development Economics 8/12/97

Note: Estimates for economies of the former Soviet Union are subject to more than the usual range of uncertainty.

Annex 2Generated: August 14. 1997

Status of Bank Group Operations in MoldovaIBRD Loans and IDA Credits in the Operations Portfolio

Differenceoriginal Amount in US$ Millions Between actual

Loan or Fiscal and expectedProject ID Credit Year Borrower Purpose IBRD IDA Cancellations Undisbursed Disbursements a/

No.

Number of Closed Loans/credits: 3

MD-PE-38641 L38510 1995 REPUBLIC OF MOLDOVA PRE-EXPORT GUAR. FAC 30.00 0.00 0.00 30.00 0.00MD-PE-8555 L40200 1996 REPUBLIC OF MOLDOVA ENERGY 10.00 0.00 0.00 10.00 1.00MD-PE-8556 L40110 1996 REPUBLIC OF MOLDOVA AGRICULTURE I 10.00 0.O0 0.00 9.75 2.50MD-PE-8561 L39771 1996 REPUBLIC OF MOLDOVA PRIV. SECT. DEV. I 10.00 0.00 0.00 8.22 0.00MD-PE-8561 L39770 1996 REPUBLIC OF MOLDOVA PRIV. SECT. DEV. I 25.00 0.00 0.00 24.50 6.88MD-PE-8558 L41510 1997 REPUBLIC OF MOLDOVA GENERAL EDUCATION 16.80 0.00 0.00 16.80 0.00

Total 101.80 0.00 0.00 99.27

Active Loans Closed Loans TotalTotal Disbursed (IBRD and IDA): .75 145.82 146.57

of which has been repaid: 0.00 0.00 0.00Total now held by IBRD and IDA: 101.80 145.82 247.62Amount sold : 0.00 0.00 0.00

Of which repaid : 0.00 0.00 0.00Total Undisbursed : 99.27 0.00 99.27

a. Intended disbursements to date minus actual disbursements to date as projected at appraisal.b. Rating of 1-4: see OD 13.05. Annex D2. Preparation of Implementation Summary (Form 590). Following the FY94 Annual Review of Portfolio performance

(ARPP), a letter based system will be used (HS = highly Satisfactory, S = satisfactory, U = unsatisfactory, HU = highly unsatisfactory): see proposedImprovements in Project and Portfolio Performance Rating Methodology (SecM94-901), August 23, 1994.

c. Following the FY94 ARPP, "Implementation Progress" will be reported here.

MoldovaSTATEMENT OF IFC's

Committed and Disbursed Portfolio(In US Dollar Millions)

Committed Disbursed. __________________ IFC IFC

FY Approval Company Loan Equity | Quasi Partic Loan Equity Quasi Partic1997 INCON 6.93 2.00 0.00 0.00 3.46 0.00 0.00 0.00

Total Portfolio: 6.93 2.00 0.00 0.00 3.46 0.00 0.00 0.00

Annex 3

REPUBLIC OF MOLDOVA

SECOND STRUCTURAL ADJUSTMENT LOAN AND CREDIT

TIMETABLE OF KEY PROCESSING EVENTS

1. Time taken to prepare: 9 months

2. Prepared by: Government with the assistance ofIBRD staff

3. Preparation missions: October 15-November 1, 1996December 12-15, 1996

4. Pre-Appraisal/Appraisal missions: January 19-February 1, 1997March 18-29, 1997

5. Negotiations: May 12-20, 1997

6. Planned Board presentation: September 9, 1997

7. Planned date of effectiveness: September 10, 1997

8. Expected program completion: December, 2000

STAFFING

Vice President: Johannes F. Linn (ECAVP)Country Director: Roger W. Grawe (ECC07)

Unit Director: Pradeep K. Mitra (ECSPE)Responsible Staff: Arup Banerji, Hafez Ghanem (Task Team Leaders, ECSPE),

Csaba Csaki (ECSRE), Louise Fox (ECSHD), Kristin Gilbertson(ECSIN), Alessandra Iorio (LEGEC), Laszlo Lovei (ECSEG),Elena Nickulina (ECCMD), James Parks (ECCMD), TheodorStolojan (PSDEN)

Contributors: Mats Andersson (ECSIN), Brian Berman (ECSRE), CorinaCertan (ECCMD), Mark Davis (ECSPE), Clive Gray(Consultant), Vladimir Kreacic (ECSPF), Markus Nievergelt(Consultant), Jonathan Walters (ECSEG)

Peer Reviewers: Pedro Alba (IECDR), James Bond (IENTI), Alberto Valdes(AGRDR)

Team Assistants: Una Raymond, Marinette Guevara (ECSPE)

Annex 4Page 1 of 14

August 14, 1997

GOVERNMENT OF THE REPUBLIC OF MOLDOVA

LETTER OF DEVELOPMENT POLICY

1. The difficult initial period of political, social and economic transition followingMoldova's independence was marked by an unfavorable imbalance between export andimport prices, disruption of traditional trade patterns, calamitous weather adverselyaffecting agricultural growth, and runaway inflation. Since 1993. however, theGovernment of Moldova has focused on a program that has rapidly stabilized itseconomy. and has begun the process of structural reforms.

2. Financial stabilization, supported by the IMF. has been a success, with inflationdropping to one of the lowest rates in post-Soviet states. However, the Governmentrecognizes that the stabilization is still very fragile, as budgetary arrears to workers in thebudget sphere, the Social Fund and the energy sector increased sharply in 1996. TheGovernment's initial round of structural reforms, supported by the World Bank's firstStructural Adjustment Loan, focused on privatizing, restructuring, and demonopolizingenterprises; strengthening the legal and regulatory framework in the financial sector; andliberalizing prices and incentives. However, the Government recognizes that the agendaof structural reforms is incomplete and insufficiently effective. This is underscored bythe fact that concrete results have lagged behind-GDP has continued to decline, byabout 3 percent in 1995 and 10 percent in 1996.

3. The Government is determined to continue on the path of reforms, to ensureeconomic expansion and social justice. To ensure that stabilization is consolidated andsustained growth assured, further bold reforms are required. The objective of theactivities of the Government, in cooperation with the World Bank, is to promotestructural adjustment of the national economy and the creation of conditions for stablegrowth, focused on the stimulation of private sector development. The Government hasidentified a set of fundamental policy measures for the period 1997/98. These policiesaim to:

* increase the financial resources of the Government andfurther rationalizetheir use, by taking measures to restore budgetary discipline, stimulateindustry and exports, overhaul the system of social protection, and cutexpenditures on Government administration;

* encourage production, by restructuring enterprises, reviving industry,demonopolizing the energy sector, and encouraging entrepreneurship;

Annex 4Page 2 of 14

* revitalize agriculture, by carrying out agricultural reforms, restructuringcollective and state farms, privatizing agricultural and urban land, and creatinga market for land;

* reform the social sphere, by increasing effectiveness of budget spending onsocial programs, maintaining employment, improving the demographicsituation, and improving the living standards of the population;

* stimulate the inflow of necessary investment resources, and help promoteMoldova's exports, by implementing the Privatization Program for 1997/98,with an emphasis on cash privatization to Moldovans and foreign investors;

* create a new regional administration policy by reforming the regionaladministrative structure of the country, and re-orienting local governmenttoward European standards of local self-administration with respect toownership, budget and management.

4. The Government's vision is. therefore, to bring about rapid growth throughencouraging greater private investment, expansion of trade and stronger links to Europe.The program described in this letter aims to achieve this vision through a tightening offiscal policy and a reduction of budgetary arrears that would release resources for theprivate sector. At the same time, the program deals with key supply bottlenecks. Landreform and farm restructuring should reverse the decline in agriculture. Small scaleprivatization and the creation of an urban real estate market should help bring about anexpansion of the service sector and increase employment. Restructuring and privatizingthe energy sector should enhance the quality of energy supply and reduce costs to makeMoldovan enterprises more competitive. Because growth should be accompanied byenhanced social protection, especially for the elderly and the vulnerable, pension andsocial reform is also a Government priority. The overall basis for carrying out these taskswill be the strengthening of the State, protection of human and property rights, and theadvancement of civil unity and legal order.

A. Reducing Budgetary Arrears

5. The Government recognizes that the steep buildup of budgetary arrears threatensboth the stabilization process and social security. Expenditure arrears from the generalbudget, including the State Government, the Social Fund and local governments,amounted to 963 million lei at the end of 1996 (11 percent of GDP-644 million for theState Government and the Social Fund). By the end of the first quarter of 1997, thearrears had been reduced to 934 million lei (506 million for the State Governmentincluding the Social Fund) with 130 million of the 138 million lei of the StateGovernment's arrears reduction coming from the reduction in pension arrears. Thereduction in pension and wage arrears is continuing, with overall arrears falling to below8 percent of GDP by mid-year. The Government has undertaken to change the focus ofits efforts, by aiming to ensure that its expenditure commitments are in line with revenues.The Government is working closely with the IMF in order to ensure that the stabilizationprogram is consistent with these efforts.

Annex 4Page 3 of 14

6. The Government's 1997 budget makes a start by taking significant steps towardstightening fiscal policy, reducing the commitments deficit from 9.7 percent of GDP in1996 to about 3 percent, and the cash deficit from 6.7 percent of GDP to below 5percent. To control arrears, the Government is committed to ensuring, from now on, thatexpenditure allocations are more realistic than in the past, so that adequate financing forwages, pensions and energy consumption by budgetary institutions is ensured.

7. The current revenue system is inadequate, and suffers from a reduced tax base,inadequate taxation instruments and low enforcement capabilities. The continuinginability to collect sufficient revenue has been a cause of the large commitment deficit.Recognizing this, the Government has undertaken to take measures to increase resourcemobilization and reduce inefficiencies by overhauling the taxation system. Revenue-increasing measures already undertaken include a doubling of gasoline and diesel excises,increased excises on wine and cigarettes and the elimination of many VAT exemptions.

8. By early 1998, the Government will work towards the adoption by Parliament of therevised Tax Code, which focuses on improving the efficiency of the taxation system. TheParliament has already passed the first two components of the Code, dealing with thegeneral framework and the laws on income taxes. In consultation with its tradingpartners in the CIS, the Government is switching the basis for taxing trade from the"origin principle" (where VAT is on exports) to the "destination principle" (wherecountries impose VAT on imports). This is expected to boost VAT revenues, as largevolumes of imports from CIS countries begin to be taxed. The efficacy of these measuresshould be reflected in increasing tax collections over time.

9. There has already been a demonstrated improvement in revenue collections from thelevels achieved in 1996. Revenues increased from 584 million lei (32.4 percent of GNP)in the first quarter of 1996 to 737 million lei (39.6 percent of GNP) in the first quarter of1997. An increased effort to collect tax arrears is also bearing fruit. The Governmentrecognizes that these figures, while encouraging, mask the continuing practice ofaccepting contributions in kind, (especially for Social Fund contributions) which is animplicit subsidy to inefficient enterprises, allowing them to dispose of unsold stocks. TheGovernment intends to eliminate the practice of accepting payments in kind for currentSocial Fund contributions by end-1998.

10. The Government has been compelled during 1997 to resort to the unfortunate practiceof using tax receipts from economic agents (including collections in kind) forexpenditures not programmed into the budget including for purposes such as support toagriculture, and payments to RAO Gazprom (Russia). The Government recognizes thatsuch practices lower financial discipline and tax collections, and contribute to the buildupof arrears. The Government commits not to take any such decisions in the future, andespecially during the SAL period.

11. The Government is also taking steps to address the special danger posed by thegrowing importance of the informal economy and tax evasion. By a decree of thePresident, a department has been created for corruption and economic crime control. TheParliament has approved the Amendments to Law 633, which has strengthened the power

Annex 4Page 4 of 14

of the tax administration, allowing it to seize the assets of those who do not pay taxes.By end-1997, the Government intends to improve enforcement capacity, by the creationof a Tax Police that that will report to the Ministry of Finance. This process of improvingtax administration and collections will be continued. Over the next year, further workwill be done on computerizing the tax service and developing a system of formal audits.

12. The Government is also working towards improving the public expenditure system,which has contributed to fiscal imbalances. It has already taken measures to lowerexpenditures on areas not central to social security and promoting economic growth. Inthe 1997 budget, expenditure cuts were concentrated on subsidies to enterprises andconsumers and state security outlays. Public sector wages were also frozen. As a result,expenditure commitments in 1997 were lower (by about 6 percent of GDP) from 1996levels. On the other hand, there is need to reallocate expenditures within sectors to makethem more efficient. This is especially true for the social sectors-health and education.The Government intends to initiate, with World Bank help, work on expenditure reformin the social sectors. By 1998, the Government hopes to use the results from this study torationalize social sector expenditures.

13. Local authorities have contributed significantly to the arrears buildup, with anespecially large buildup in local government arrears in the first quarter of 1997 (by 120million lei). The Government agrees to fully implement a sequestering mechanism toimprove the financial discipline of local authorities, which it already has the authority toimplement under the 1997 budget law. The Government intends to retain thisarrangement, which is outlined in Box 1, over the coming years.

14. Financial discipline of the local authorities will also be aided by the reform of theregional administrative structure of the country, envisaged by the Government in 1998.This reform will be based on reducing the number of the administrative bodies (to about12) by consolidating the existing rayons, and taking into account the resolution of theTransnistria and Gagauzia problems. The overall local administration reform will aim toimprove the new regional authorities' principle of self-administration, raise theresponsibility of local administrations for more efficient use of their productive andfinancial inputs, and resolve social and environmental problems of the regional territories.

15. The Government is taking action to reduce unforeseen shocks to the budget, whichhave been a causal factor in increasing expenditures above planned levels. In particular,these shocks have come from the issuance of Government guarantees for domestic andinternational loans to enterprises. The Government recognizes that it has, in the past,made inadequate provision in the budget for the risk of these guarantees being called. OnJanuary 1, 1997, outstanding stock of internal guarantees was 90.5 million lei, while the1997 budget has provided for a risk fund for called guarantees of just 30 million lei.Therefore, for guarantees on loans to enterprises, the Government agrees to limit itsissuance of external guarantees on loans to US$ 35 million for the year, to have no netincrease in the stock of internal guarantees on loans to enterprises, and issue no newguarantees on loans to enterprises that have defaulted on loans in the past 18 months.The Government also commits itself, to a significant reduction in both external and

Annex 4Page 5 of 14

internal guarantees, and agrees to discuss with the Bank appropriate levels of guaranteesfor the 1998 budget.

BOX 1: Mechanism to Monitor and Control Local Government Arrears

a The budget will appropriate resources on a disaggregated basis: For every local authority,expenditures will be budgeted according to economic line items (including wages, SocialFund payments, payments for energy, food and medicine). The planned budget for eachinstitution will be realistic, fully covering core areas of expenditures. This mechanism willthen permit monitoring of actual expenditures by the Ministry of Finance to prevent arrearsbuildup, and prevent the practice of deliberate under-budgeting of key items.

* Payments will be prioritized, and arrears regularly monitored. For each administrative unit,five items of expenditures will have to be paid on a priority basis: wages, Social Fundcontribution, energy, food and medicine. The budgeted amounts for these five items will notbe allowed to be exceeded. For energy and input purchases, there will be contracts to controlspending. These contracts would be binding quarterly agreements with the suppliers toprovide exactly as much of the product as is allowed by the budget. On a monthly basis, theMinistry of Finance will monitor the spending of rayons.

* The Ministry of Finance will use a sequestering mechanism: If arrears are detected, theequivalent amount will be deducted by the Ministry of Finance from the subsequent month'srevenue allocation. For local governments, the sequestered revenue would be a portion of thecentrally collected revenues owed to them. The sequestered funds would be placed in aspecial fund, and the Ministry of Finance will use them to repay arrears. This sequestering offunds will continue until arrears by the responsible unit are cleared. The Ministry willsequester funds from the rayon; the administrator of the rayon would then have theresponsibility of imposing financial discipline on its own sub-units.

* There will be incentives to promote structural adjustment of expenditures: Administrativeunits will be allowed to use any savings from planned amounts of expenditures fordiscretionary spending. This measure thus provides reform-minded rayons with incentives tounilaterally streamline expenditures.

B. Creating a Fair and Affordable Social Protection System

16. In the last two years, the financial condition of the Social Fund, out of which almostall types of social benefits are paid, has deteriorated. Collections, especially those in cash,have been falling, as the Government and enterprises have built up arrears to the Fund.Concurrently, the number of pensioners has been increasing-in addition to old-agepensioners, new classes of privileged pensioners have added to the financial burden of theFund. As a result, some pensioners-as well as other social benefit recipients-did notreceive payment from the Social Fund for several months in 1996. Moreover, anextensive array of privileges (free or discounted prices for utilities and services) awardedto various categories of individuals who are deemed vulnerable are often not paid for bythe budget, but by the enterprises that provide the services.

17. The Government attaches a high priority to timely payment of social benefits, inparticular pensions, and has taken a series of measures to improve the financial conditionof the Social Fund. This is with a view to preventing any future buildup in pensionarrears and liquidating previously accumulated arrears. The 1997 budget adopted byParliament contains prowth in expenditures, holding pensions constant at 1996 nominal

Annex 4Page 6 of 14

levels and provides for a transfer of 297.5 million lei from the state budget to the SocialFund to cover the current deficit and to provide for moderate arrears liquidation. SocialFund payment arrears have already been reduced by about 130 million lei, and currentpayments are being made with a lag of one-and-a-half months.

18. The Government is aware that transferring large amounts of resources from thebudget to the Pension Fund will not be sustainable over the medium term. With a view tofurther rationalizing pension expenditures and putting the Social Fund budget on asustainable basis over the short term, the Government is committed to taking measures,such as reducing benefits for working pensioners and lowering privileges, that will ensurea saving of at least 25 million lei in 1998.

19. The savings measures are the first step in a larger pension reform program beinginitiated by the Government and set forth in the resolution on the draft strategy for reformof the pension system, adopted on June 2, 1997. The pension reform will result increation of a three-tier pension system consisting of a minimum guaranteed pension, anearnings related component and a supplemental, optional non-state pension.

20. The reform will encompass the following measures: (i) containment of expendituresto enable current payments of pensions and other benefits through increase in the pensionage, reduction in privileged pensions and control of disability pensions; (ii) gradualintroduction of a new pension formula that provides higher pensions for those workerswho will be affected by the increase in pension age and that strengthens the link betweenduration and magnitude of contributions and benefit levels while assuring minimumbenefit levels to the poorest; (iii) introduction of legislation providing the framework forestablishment and supervision of non-state pension funds to provide supplementalpensions; and (iv) administrative and institutional reforms needed to administer the newsystem including investments in development of individual contribution records andimprovement in social tax collection.

21. The Government has established working groups to prepare a draft state pension lawand a draft non-state pension fund law reflecting these objectives, for submission toParliament by the end of 1997. In June 1997, the Government adopted and submitted toParliament a decision to increase the pension age by five years (to 65 for men and 60 forwomen) over a period of 10 years. The Government will undertake to ensureParliamentary approval of all aspects of the pension reform by mid-1998.

22. The Government's program calls for reform of the system of compensations andsocial benefits. In conjunction with the poverty assessment now under preparation withthe Bank, the Government intends to consolidate and rationalize the existing system ofsocial benefits with a view towards improving overall efficiency of expenditures andimproving targeting through focus on vulnerable groups. These reforms will beimplemented by the Government following the adoption by Parliament of the Law onState Benefits.

Annex 4Page 7 of 14

C. Restructuring, De-Monopolizing and Privatizing the Energy Sector

23. The Government recognizes that reform in the energy sector is essential to Moldova'sfuture. Lack of reform in this area has contributed to the buildup of external arrears andconstrained enterprise growth. A key problem has been the continuation of explicit andimplicit subsidies to enterprises and the population in the form of inadequate tariffs and thedelivery of energy to non-paying customers. As a result, energy utilities-Moldenergo,Moldovagaz, Termocom, and Termocomenergo-have built up substantial debts to eachother, the Government and their suppliers. By April 1997, arrears of Moldovagaz to RaoGazprom reached US$ 212 million.

24. The current situation is an impediment to enterprise growth. Today, the pricing systeminvolves a large cross-subsidy from enterprises (high-volume customers, who are lessexpensive to service) to households. At the same time, enterprises that pay are not assuredof continuous delivery of energy.

25. The Government is pursuing a comprehensive reform of the energy sector. The reformplan comprises three groups of actions:

* debt management, price adjustment and mitigation of the effect on thevulnerable;

* the creation of an appropriate regulatory system; and

* privatizationof the electricity, gas and fuel industries.

26. The Government adopted, on July 1, 1997, Decision #547 "On the Debt ManagementPlain which outlines a set of actions to restore the financial viability of the major energyutilities. These actions include price adjustments, improvements in payment collections, thewrite-off of uncollectable receivables, mutual payment cancellations and the repayment ofdebt (payables and credit) with interest over a period of 5 years.

27. In order to implement the DMP, the Government is adjusting energy prices. In March1997, tariffs for electricity were raised by 33 percent, for gas by 15 percent, and for districtheat by 31 percent for households. On June 1, 1997, tariffs were raised further to covercosts fully, including both operating costs and debt repayment.

28. The Government's policy is to improve the structure of energy tariffs. The eliminationin June 1997 of the difference between the prices charged to households and otherconsumers for electricity and gas will be followed by the corresponding elimination of thedifferential for district heat, in the first half of 1998. The Government is determined tocompletely eliminate cross subsidies for electricity and gas during the first half of 1998,which will involve raising their prices for households above those charged to high-volumeconsumers in order to reflect the higher cost of service.

29. The Government recognizes that, in spite of improvements in the tariff structure, thefinancial position of the energy enterprises will not improve unless accompanied by risingcollections. In 1996, the collections for Moldenergo averaged 91.4 percent of costs (68percent of costs in the first quarter of 1997). For Moldovagaz, 1996 collections were 77percent of cost (just 40 percent in the first quarter of 1997). Moreover, only a small fraction

Annex 4Page 8 ofl4

of these collections were in cash. In the first quarter of 1997, only 33 percent of collectionswere in cash for Moldenergo, and 6 percent for Moldovagaz. Accordingly, theGovernment undertakes to ensure that end-user collections by the fourth quarter of 1997will be at least 100 percent for both Moldenergo and Moldovagaz. It will also ensurethat, by the fourth quarter of 1997, collections in cash for electricity are at least 50percent of the total, for gas at least 30 percent of the total, and, for the first six months of1998, are at least 50 percent of the total for both sectors.

30. The energy companies also provide explicit subsidies to privileged groups by providingservices at a discounted rate, including a 50 percent gas price discount provided tohouseholds that use gas for heating, at a cost of about 15 million lei. The Governmentacknowledges that these subsidies are provided for the State's social objectives, and thusshould not be financed by the energy enterprises themselves. By the first half of 1998, theGovernment undertakes to eliminate the gas subsidy, or fund it through the State budget.Price discounts for privileged consumers will be limited to the norms specified inGovernment Resolution 807 of December 11, 1995. The energy enterprises will becompensated from the State budget for the cost of these transfers.

31. The Government has taken steps to offset the impact of the impact of these energyprice increases on the poor and the more vulnerable groups in society both through theState budget and the Social Fund. The 1997 budget includes 35 million lei to pay fordiscounts to privileged groups (10 million lei for gas, 11 million lei for electricity and 14million lei for district heating). At the same time, the Social Fund's 1997 budget includes49 million lei for compensating people who are unemployed or fall in one of the specialcategories (e.g. unemployed, pensioners, privileged consumers and families with more thanthree children) for the energy price increase. The current targeting of privileges is toobroad. The Government undertakes, by the first half of 1998, to reduce the coverage ofthese compensations to the most vulnerable groups as identified by the revised socialassistance strategy (paragraph 22).

32. The Government recognizes that, in spite of its actions to rationalize the pricingstructure for energy, gaps between energy prices and costs may occur in the future due toshort-term imperatives. To avoid this problem, the Government is putting in place atransparent and predictable regulatory system. It has established a Regulatory Agency, andissued a resolution that spells out its main responsibilities, determines its structure, andprovides financing until it becomes self-supporting through a system of license fees. TheGovernment is committed to change the status of the Agency into an independent,permanent, regulatory body once the legal framework is in place to support this action.

33. The responsibilities of the energy Regulatory Agency focus on three areas:

* the regulation of prices,

* the promotion of competition, and

* the control of the quality of service provided to consumers.

34. The Agency will fulfill its responsibilities by licensing each type of activity andenforcing compliance with the rules and conditions stipulated in the licenses. By the fourth

Annex 4Page 9 of 14

quarter of 1997, the Agency will develop 18 generic/model licenses. These will be sevengeneric licenses in the power industry (for generation, dispatch, high-voltage transport, low-voltage distribution, import and wholesale and retail trading); seven generic licenses in thegas industry (for production, storage, high-pressure transport, low-pressure distribution,import and wholesale and retail trading), and four generic licenses in the district heatingindustry (for heat-only production, co-generation of heat, heat transmission, and heatdistribution and retail). By December 1997, the Agency will issue specific licenses to allthe entities in the natural gas, electricity and district heating subsectors that are eligible forlicenses. By June 1998, the Government will transfer the responsibility for regulating thedistrict heating subsector to the municipalities, and change the role of the Agency (or itssuccessor) in this sector to one of an advisory character.

35. The Government recognizes the need to restructure, demonopolize and privatize theelectricity and gas industries. This would generate competition among electricitygenerators, offer (after about three years) large consumers a choice among retailers, andattract private capital and know-how needed for the modernization of the energy systems.Privatization will begin once the regulatory framework is fully in place. Also, measureswill be undertaken for technical renovation, small electric power station promotion as wellas non-traditional energy resources (sun, wind) usage.

36. On July 8, 1997, the Government adopted the Decision #628 "On Restructuring theEnergy Sector", which includes a detailed de-monopolization plan and the principles ofprivatization for the electricity industry. In the fourth quarter of 1997, the Government willestablish separate joint-stock companies to own and operate the Moldovskaya, Chisinau Iand II and Balti power plants, and (not more than) five joint stock companies to own andoperate the low-voltage distribution network. A single company will be created to own andoperate the high-voltage transmission system and dispatch center. By mid-1998, not lessthan 51 percent of the total shares of electricity generation and low-voltage distributioncompanies will be offered for sale to strategic investors who have the ability to bring thecapital and know-how needed for the modernizationof the sector.

37. The Government expects the privatization of the gas industry and the oil tradingsubsector to occur rapidly. The Government has already sold 50 percent of the shares ofGazsnabtransit-the company that owns the high-pressure transmission system. Lowpressure pipelines are owned by regional gas distribution/supply companies that are alsoengaged in the market of LPG. These companies have been corporatized and about 20percent of their shares have been sold to employees. The Government intends to privatizethese companies by the end of 1997. It is considering various privatization methods,including a negotiated sale to RAO Gazprom through a debt-for-equity swap. TheGovernment has adopted a plan to de-monopolize the distribution and marketing of oilproducts and other fuels by selling parts of the depots and transport assets of Tirex Petrol toprivate investors. It then plans to sell the majority of the shares of Tirex Petrol.

38. The Government recognizes the possibility that some shares of the energy enterprisesoffered for sale will remain unsold. In that case, the Government will take othermeasures in order to facilitate their sale.

Annex 4Page 10 of 14

D. Creating a Competitive and Private Agricultural Sector

39. The agricultural sector should be the engine for future growth, and the Governmentplaces a very high priority on agriculture sector reforms. A liberal price and marketregime for agriculture has been introduced. Progress has been achieved in the de-monopolization of input supply and grain handling. The first phase of privatization ofagro-processing has been completed. Farm restructuring and land reform are on-going,with the completion of two pilot projects in the Nisporeni and Orhei rayons, and thesubsequent expansion of the former project to 70 farms nationwide. The Government'sintention is to accelerate the process over the next two years by:

* creating a market for land, and restructuring the ex-collective and State farms,

* demonopolizing and privatizing the grain sector, and

* promoting the emergence of a competitive input supply sector and agriculturalproduct marketing services.

40. In the first phase of land reform, the Government increased the number of householdplots and gave land shares (for land used by large-scale farms) to about a million people.Until 1995, however, actual restructuring of large-scale farms was slow-only 80 ofabout 950 large-scale farms were restructured into entirely private operations. However,the restructuring process accelerated in 1996, following a Constitutional Court decisionthat restored the possibility of individual exit from large-scale farms.

41. The Government recognizes that to ensure a fully functioning land market, the use ofnormative land prices must be restricted. The Parliament has reduced the tax on landtransfer from five percent to two percent, and further cuts may be envisioned if thisproves inadequate to stimulate the land market. On July 25. 1997, the Parliament enactedlegislation which provides an initial framework for the land market and removes leasecontrols on private land.

42. The Government is promoting further acceleration of large-scale farm restructuring.It is envisaged that the restructuring of at least 250 large-scale farms will be completedover the next 18 months. The restructuring will be based on full privatization of land,i.e., physically identified land plots for each beneficiary with individual titles. The newland owners freely decide on the way they wish to continue farming. Land will remain inindividual private ownership in the various forms of newly emerging farmingorganizations, and these forms provide opportunities for further restructuring andmodifications in land use. In order to facilitate this process, the Government has:

* revised and improved the exit and registration procedures for establishment ofprivate farms (simplified procedures, clear and reasonable time limits,reasonable appeal process etc.);

* reviewed ongoing farm restructuring pilot projects and prepared practicalguidelines for the dissemination of these experiences as well as a program toextend these projects to the national level;

Annex 4Page 11 of 14

* started the functioning of the Agricultural Restructuring Agency, a non-governmental institution created to implement and support the nationwideprogram of farm restructuring.

43. The appropriate role of the Government and of ARA in farm restructuring is now toprovide a facilitating environment for voluntary farm restructuring; to actively promotefarm restructuring through extensive public education efforts; to provide the farms withmanuals and assistance in their restructuring efforts; and to facilitate the resolution of thefarm debts to both the State and commercial entities.

44. The Government is establishing a uniform cadastre system, and other legal andinstitutional conditions. It is thereby setting up a system of clear and enforceableownership rights necessary for a functioning land market, a pre-condition for the successof land reform. The establishment of a national cadastre system, including registration ofrights and issuance of extracts of the registration system on request, will be based on aLaw on National Cadastre, which the Government submitted to Parliament on June 8,1997. The Law will lay out the principles of land registration, most notably: (i) the jointregistration of land and buildings on one real property title; (ii) the decentralization ofregistration to the city or rayon level, under the authority of the National Agency forGeodesy, Cartography, and Cadastre (NAGCC); (iii) a parcel-based system ofregistration; (iv) parcel boundary identification for identification of ownership; (v) first-time registration of properties free of charge; and (vi) the establishment of a warrantyfund to guarantee for correctness of title information during transactions. As an interimmeasure, the Government will confide responsibility for all cadastre and land titlingactivities, including those stipulated in the new law on land tradability, to the NAGCC.

45. Titling and Registration will take place at a different pace in urban and in rural areas.The Government expects to complete registration of rights of about 50 percent of urbanproperties during the next five years. In order to facilitate farm restructuring, rural titleswill be issued, initially, with only limited surveying determining plot boundaries, andtherefore without Coverage through a Government Title Warranty Fund soon to beestablished. These titles would be issued with emphasis on quick delivery, by primariasand not rayonal registration offices, supporting the farm privatization process, butallowing subsequent harmonization and integration of registration information in thenational cadastral information system. On the basis of such simplified procedures, theGovernment expects to complete titling of a minimum of about 15 percent of rural landparcels in Moldova by mid-1999. At the same time, the Government commits toregistration of property rights for all farmers who have left their former kolkhoz.

46. The Government is concerned about enhancing credit discipline in the agriculturalsector. In the past, debt forgiveness was common when the sector suffered droughts andfloods. With the decision to rely exclusively on the commercial banks for agriculturefinance, this will no longer be an option. The Government recognizes the serious natureof the expanding farm debt, now estimated at 2.8 billion lei . Under Resolution 163(February 24, 1997) the Ministries of Finance, Agriculture and Economy are required toprovide recommendations for the settlement of these farm debts, on a case-by-case basis.To the extent feasible, the Government would like to avoid individual farmers being

Annex 4Page 12 of 14

burdened with past debt of the former collective farms. Therefore, in many cases, thephysical and financial assets of the farm, including share-holdings obtained under themass privatization process will be used to settle debt, prior to restructuring. For themedium term, the Government wishes to work with the Bank and other donors, thecommercial banks and the insurance companies, to explore the possibilities of loan riskinsurance and crop insurance.

47. The Government is followinz up on the market liberalization measures introducedunder the SAL I program. Agricultural exports will be a key part of Moldova's economicrecovery. Today, there is no Government regulation prohibiting the export of grain.Other bureaucratic obstacles to grain exports-including approval from the Ministry ofAgriculture's External Relations Department-have also been removed. In order toensure transparency, the Government will abstain from introducing any new exportrestrictions on grain during the 1997 and 1998 agricultural seasons.

48. The Government has obtained concessional delivery of grain from several donorcountries, notably through the PL480 program of the United States. When this grain wassold at domestic prices (that were about 60 percent of world prices), there was a largesubsidy from the Government to consumers. The distribution of the grain through theparastatal "Cereale" was not transparent. To improve the situation, the Government hasintroduced a system of auctions for the marketing of concessional food grain deliveries,and applied the new public procurement system to state purchases, including grain.

49. The Government took steps in 1995 to restructure and initiate privatization of theformer State monopolies Cereale and Fertilitate. The Government has reviewed plans topursue the privatization of Cereale and Fertilitate, and has decided to complete theprivatization of Fertilitate by end-1997 and of most of the units of Cereale by mid-1998.Cereale and Fertilitate will be fully privatized by mid-1998, except for the facilitiesrequired to hold the State's emergency grain reserve. If the remaining shares are notfully subscribed in the initial offering, the Government will take necessary action to sellthe shares.

50. The Government has commissioned a study of the system of direct and indirecttaxation and subsidization of agriculture with financial support from the Bank. The studywill formulate recommendations to render the agricultural tax/subsidy system morecomprehensive, enforceable and market-friendly; to introduce a cap on annual subsidies;and to ensure that support programs focus on efficiency enhancements. The results andrecommendations of the study will be adopted, including (to the extent possible) byincorporation into the 1998 budget.

E. Completing Enterprise Privatization

51. The Government considers that the mass-privatization in Moldova has achieved itsmain goals. A considerable part of state property has been privatized, and a new privatesector has been created. Most Moldovan citizens invested their patrimonial bonds (PB)in 1,142 medium-sized and large joint stock companies (JSC) and 1,093 small-scaleenterprises (shops, coffee houses, etc.). Approximately 3.1 million Moldovan citizens

Annex 4Page 13 of 14

(90 percent of PB holders) participated in the mass privatization. About 85 percent ofpublic housing was privatized.

52. The Government recognizes that the task of privatization is not over. The State stillowns a large amount of productive assets. The Government intends to implement a largescale program of privatization for cash. This new privatization strategy will helpencourage domestic and foreign investment; bring about a rapid restructuring of theprivatized companies; and generate revenues.

53. The Privatization Program for 1997-1998 (97/98 PP) was approved by the Parliamenton June 26, 1997. The 97/98 PP contains most of the remaining state-owned productiveassets, including:

* premises of all small sized enterprises which were leased;

* the land under privatized enterprises;

* small-scale enterprises which were already approved for cash privatization,but remained unsold;

- most state shares in joint stock companies;

- most small, medium and large enterprises which were left out of the previousprivatization programs; and

* infrastructure enterprises, including energy and telecom companies.

54. The Government understands that leased vremises must be sold in order to encouragesmall private businesses and develop the real estate market. The Government hasidentified about 2,000 leased premises as potential candidates for privatization. The saleof these leased premises has started. The Ministry of Privatization has received 150applications for buying leased premises and has approved and processed 75. Under theGovernment's program, 200 of these leased premises were offered for sale by May 1997.By December 1997, a further 300 premises will be offered for sale, and 500 more will beoffered for sale by mid-1998.

55. The Government recognizes that the sale of land under privatized enterprises willsupport faster restructuring, making these enterprises more attractive for local and foreigninvestors, and providing them with collateral for bank lending. To accelerate thisprocess, the high normative prices for land have been reduced by Parliament, and theGovernment has started implementing Regulation No. 562, dated October 23, 1996, onthe sale of land under privatized enterprises. By June 1998, the target is to sell land under25 percent of privatized firms, with a further 25 percent to be sold by the first quarter of1999. If needed, the Government will take further measures to accelerate landprivatization.

56. The results of cash privatization have been below expectations. Of 224 smallenterprises approved for cash privatization under the previous program only 97 were sold.To expand cash privatization. the Government has started to reduce the starting price afterthe first auction if the enterprise is not sold. Further, "Dutch auctions" have been

Annex 4Page 14 of 14

introduced for the sale of small scale objects. The Government is committed to extendingthis method of auction.

57. The Government is committed to encourage the participation of Moldovan citizens incash privatization. It has included in the Privatization Program regulations to allowMoldovans to participate in cash privatization by buying a small number of shares.

58. For medium and large joint stock companies, the Government will issue internationaltenders for the cash privatization of five companies by December 1997, and a further 17companies by mid-1998. In addition, it will offer for sale the State's remaining shares in25 percent of the joint-stock companies that were originally to be privatized forpatrimonial bonds by December 1997, offering a further 25 percent by mid-1998.Finally, it will take all measures necessary to privatize seven medium and largeenterprises that were included in the restructuring program supported by SAL I.

59. Each joint stock company or SOE included in the 97/98 PP will require a feasibilitystudy in order to choose an appropriate privatization strategy (based on its size, profileand market condition). The 97/98 PP includes a large menu of privatization methodssuch as auctions; selling of shares through the Stock Exchange; public offering; tradesales; debt-equity swaps; capitalization of the privatized enterprises and bankruptcy andliquidation. The Government is continuing its program of institutional strengthening andtechnical assistance for the Ministry of Privatization.

60. The Government will continue its efforts to develop its reform plan for the longerterm. As a part of this process, in January 1998, it will examine the draft Mid-TermStrategy of Sustainable Development of Republic of Moldova, prepared by the Center forStrategic Studies and Reforms which is supported by the World Bank and UNDP.

Ion Ciubuc

Prime Minister

Annex 5Page I of 7

MOLDOVA: SECOND STRUCTURAL ADJUSTMENT LOAN

Matrix of Policy Conditionalitv(Note: Core conditionalities are in bold)

- - OBJECTIVES ACTIONSA. MACROECONOMIC SUSTAINABILITYEnsure the social and economic Taken Prior to April 1997 Taken prior to September 1997 Prior to Prior tosustainability of fiscal adjustment Second Tranche Third Tranche

1. Eliminate budgetary arrears . Adopted a realistic 1997 * Satisfactory implementation . Maintain agreed . Maintain agreed macro-(especially to wage earners, the budget. The budget eliminates of 1997 budget. macroeconomic framework, economic framework,Social Fund, and the energy sector), VAT exemptions, increases excise . Improved revenue including no increase in including reduction inby improving revenue performance, taxes, improves enforcement, and collections, ensured no increase general budgetary arrears general budgetary arrearsrationalizing expenditures, and freezes or decreases most in total arrears from 1997 general from the level of such arrears as agreed with the Bank.reducing unplanned shocks to the expenditure items, while providing budget, and adhered to the as at December 31, 1996. . Continued progress inbudget. adequate funding for wages, guarantees ceiling. macroeconomic stabilization,

payroll taxes and energy. It also . Progress in expenditureset a ceiling on new Government rationalization, especially inguarantees. social sectors.* Parliament adopted the . Adoption by Parliamentgeneral framework and the chapter of the remaining articles ofon income taxes of the new Tax the draft revised tax codeCode. agreed with the Bank

(including chapters on VATand land tax).

2. Strengthen budgetary . The Ministry of Finance has * Satisfactory . Satisfactorymanagement mandated improved financial implementation of the implementation of the

reporting by Government agencies, mechanism for improving mechanism for improvingand the 1997 budget law included a financial discipline of local financial discipline of localmechanism for improving financial governments. governments.discipline of local governments.

3. Enhance domestic capacity for . Started operations of the . SSC to monitor * SSC to monitormacro-economic analysis and policy Strategic Studies Center (SSC) implementation of SAL II implementation of SAL IIformulation program. program.

Annex 5Page 2 of 7

B. PENSIONS AND SOCIALPROTECTION REFORMS Taken Priorto April 1997 Taken prior to September 1997 Prior to PriortoReforn the system of pensions and Second Tranche Third Tranchesocial assistance to one that is viableand equitable1. Make the Social Fund fiscally . Passage of a viable 1997 . Prepared 1998 Social Fund * Implementation of savings . Implementation ofviable Social Fund budget by Parliament. budget incorporating measures measures savings measures.

* Freezing of nominal pensions, projected to save 25 million lei inreduction in payroll taxes, and expenditures in 1998.lowered administrativeexpenditures.

2. Provide regular payments to 0* Covered the 1997 Social Fund . Continued timely payments * Continuation of timely * Continuation of timelypensioners and recipients of social deficit by a transfer from the State to pensioners. payments to pensioners. payments to pensioners.assistance budget, to ensure that 1997 . Payments for January

liabilities are met in time. through May 1997 made on time,and pension arrears reduced byabout 60 percent. :

3. Reform the pension system to an . Produced a draft strategy . Adopted Government * Enactment of a law, and . Continued progress inequitable and fair three-pillar system paper for reform of the public resolution endorsing the adoption of implementing implementating measures

pension and social protection conclusions of the strategy paper regulations, in each case under the new laws onsystems. and outlining the directions of satisfactory to the Bank, on public pensions, social. Established a permanent reforms of the public pension public pensions and social protection systems, andworking group with representatives system. protection systems. non-state pension funds.from Government and outside * Enactment of a law and . Establishment of aGovernment, for the preparation of adoption of implementing regulatory body for non-a new law on non-state pension regulations, in each case state pension funds.funds. satisfactory to the Bank, on

non-state pension fund.

Annex 5Page 3 of 7

OBJECTIVES ACTIONSC. ENERGY REFORMSRestore the sector's financial viability Taken Prior to April 1997 Taken prior to September 1997 Prior to Prior toand improve quality of energy Second Tranche Third Trancheservices.

1. Restore the energy sector's . Prepared a Debt- . Increased energy tariffs and * Maintain energy prices and . Maintain energy pricesfinancial equilibrium, and stop the Management Plan (DMP) and prices further, to attain full cost tariffs at such levels so as to and tariffs so as to ensurebuild-up of energy-related external restructured the stock of payables recovery. ensure full cost recovery in full cost recovery indebt and receivables of Moldovagas, * Issued resolution to formally accordance with the DMP. accordance with the DMP.

Moldenergo, Termocom and adopt Debt Management Plan * End-user collections for * Full elimination of crossTermocomenergo. (DMP) and adopted a schedule to first six months of 1997 will be subsidies for gas and. Increased, effective March fully eliminate cross subsidies in at least 80% for Moldenergo electricity and introduction of1997, the prices and tariffs of the energy sector. and 50% for Moldovagas. By uniform tariff for allelectricity, heat and gas. the end of 1997, the targets will categories of consumers of

be 100% for both. heat.. No decrease incollection rates below thosein 1997.. Reduction in subsidiesto privileged groups, andsubsidies funded from Statebudget.

Annex 5Page 4 of 7

C. ENERGY REFORMS Taken Prior to April 1997 Taken prior to September 1997 Prior to Prior to(CONTINUED) Second Tranche Third Tranche

2. Impose domestic financial * Started implementing the . Adopted detailed de- * Enactment by Parliament of . Transfer thediscipline and hard budget surcharge applicable to electricity monopolization plan and the detailed individual privatization responsibility for regulatingconstraints, and improve quality of consumption above the norms set principles for privatization of the projects for the gas and electricity the district heating sub-sectorenergy services for consumers, by Government Resolution 807 of gas and electricity industries. industries, satisfactory to the to the municipalities.through demonopolization and December 1995. . Established a National Bank. * Offer for sale to privateprivatization of the energy sector . Adopted a plan to de- Agency to regulate the energy . Establish joint stock investors at least 51

monopolizethe distributionand sector. companies to own and operate percent of the total sharesmarketing of oil products by selling the Borrower's power in each of the joint-stockparts of the depots and transport generation plants, low voltage companies that own andassets of Tirex Petrol to private distribution system, high operate the Borrower'sinvestors. voltage transmission system electric generation and low

and dispatch center. voltage distribution* Offer for sale to private facilities.investors no less than 51percent of the total shares ineach of the joint stockcompanies that own andoperate low-pressure gaspipelines.* Transform regulatory Agencyinto non-state regulatory body.* Regulatory body to haveissued specific licenses to alleligible entities in the natural gasand electricity sub-sectors.. Offer for sale no less than 51percent of the total shares inTirex Petrol to private investors.

3. Ensure a minimum supply of * Adopted measures to . Ensure sufficientenergy for poor households mitigate the impact of energy price targeting of measures to

increases on poor and vulnerable make energy affordable to thegroups poor and vulnerable groups .

Annex 5Page 5 of 7

OBJECTIVES ACTIONSD.AGRICULTURAL REFORMS

Lay the foundations for land reform, Taken Prior to April 1997 Taken prior to September 1997 Prior to Prior toagricultural growth and rural Second Tranche Third Tranchedevelopment1. Accelerate the process of farm . Improved exit and registration . Adopted the process for . Achievement of progress . Achievement ofrestructuring and land privatization, procedures and performance providing the fiscal and statistical satisfactory to the Bank in the progress satisfactory toand ensure that it is done in an open, standards for establishment of identification numbers for the restructuring of former the Bank in thefair and transparent manner. private farms. farms registered as legal entities collective and state farms in restructuring of formerFarmers will have the right to exit, or . Reviewed farm restructuring at the local level, and simplified accordance with criteria collective and state farmsto continue farming in any system pilot projects, disseminated the the farm registration process. agreed between the Borrower in accordance with criteriathey choose. experiences and prepared a and the Bank. The target is agreed with the Bank. The

program to extend these projects 125 farms. target is an additional 125to the national level. farms.. Initiated functioning of theAgricultural Restructuring Agencyfor farm privatization andrestructuring.

2. Create an efficient market for land, * Moratorium on land sales . Adopted the Law on the * Completion of a review of * Progress satisfactory toby reducing normative prices and removed by decision of Normative Price of Land and Land functioning of the land market. the Bank in land titling undereliminating regulatory impediments. Constitutional Court. Tradability, to remove lease . Implementation of a unified parcel-based

* Established the national Agency control for privately owned land measures satisfactory to the system, with a target of atfor Geodesy, Cartography and and provide the legal framework Bank to remove any least 10 percent of privateCadastre to implement national for land sales. impediments to the beneficiaries.cadastre system. . Removed requirement that functioning of the land

Raion Executive Committees market including, ifapprove land allocations for necessary, adoption bypersons exiting ex-collective and Parliament of amendments tostate farms. the Law on the Normative

Price of Land and LandTradability. This may includethe further lowering of thetransfer tax on land.* Progress satisfactory to theBank in land titling under aunified parcel-based system,with a target of at least 5

.___________________________________ _______________________________ __________________________ percent of privapercent of private beneficiaries.

Annex 5Page 6 of 7

D. AGRICULTURAL REFORMS (CONTINUED) Taken Prior to April 1997 Taken prior to September 1997 Prior to Prior toSecond Tranche Third Tranche

3. Liberalize rural and agricultural . Liberalized prices and * Initiated a review of the * Submission to the Bank * Achievement ofmarkets, and enhance efficiency by marketing regimes. systems of direct and indirect of a study satisfactory to the progress satisfactory toreducing tax/subsidy distortions. * Progress in demonopolizing taxes/subsidies in agriculture. Bank of the systems of direct the Bank in implementing

input supply and grain handling. . Developed procedures to and indirect taxation and the agreed* Completion of first phase of apply new public procurement subsidies in the agricultural recommendations of theprivatization of agro-processing. system to grain purchases, and sector including study of the systems of

ensure grain exports do not recommendations for the direct and indirectrequire prior permissions. reduction of subsidies and taxation and subsidies in

tax reforms. the agricultural sector.. Measures satisfactory to * Measures satisfactorythe Bank shall have been to the Bank shall havetaken towards the been taken towards theprivatization of all units of the privatization of units ofagricultural, former parastatal the agricultural, formerentity, Fertilitate. parastatal entity, Cereale

I as agreed with the Bank.

Annex 5Page 7 of 7

OBJECTIVES . ACTIONSE. PRIVATIZATIONAccelerate small scale privatization Taken Prior to April 1997 Taken prior to September 1997 Prior to Prior toand development of small business Second Tranche Third Tranche

1. Privatize urban real estate and . Privatized 85 percent of public . Lowered the normative price of . Achievement of progress . Achievement ofcreate a market for it housing land under enterprises as agreed satisfactory to the Bank in the progress satisfactory to the

with the Bank. sale of land under privatized Bank in the sale of land* Offered for sale 200 leased enterprises. The target is to sell under privatizedpremises of small scale firms land under 25% of privatized enterprises. The target is(shops, coffee houses etc.). enterprises to sell land under an

* Sell additional leased premises additional 25% ofof small scale firms. The target is privatized enterprises.300 additional enterprises. * Sale of additional leased

premises of small-scalefirms. The target is 500

.__________________ _ _additional enterprises.2. Start privatizing medium and large . A comprehensive . Enacted the 1997/98 * Achievement of progress . Achievement ofscale enterprises for cash, and to privatization program for 1997/98 privatization program. satisfactory to the Bank in progress satisfactory tostrategic investors, to encourage adopted by Government. . Eliminated barriers to cash implementing the 1997/98 the Bank indomestic and foreign investment and . Included in the privatization privatization of small-scale firms. privatization program. implementing thebring about a rapid restructuring of program regulations to allow . Prepared a technical . Offer for sale the state's shares 1997/98 privatizationthe privatized companies. Ensure Moldovans to participate in cash assistance program, satisfactory to in 7 medium and large former program.that privatization is carried out in a privatization by buying a small the Bank, to support the SOEs, restructured under pilotfair and transparent manner number of shares. implementation of the 1997/98 restructuring program.

. Held "Dutch auctions", to privatization program.ensure more flexible prices if firm * Conducted a review of theis not sold at asking price. functioning of the Share Registry

and transfer privatized companiesto that registry.

3. Complete the mass privatization . Approved a resolution setting _ Offer for sale the state's . Offer for sale the state'sprogram the mechanisms for the sale of remaining shares in 25% of JSCs remaining shares in an

shares still held by the State but that were to be privatized for additional 25% of JSCsapproved to be privatized for patrimonial bonds. that were to be privatized

_______________________X__________ patrimonial bonds. for patrimonial bonds.I~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

IBRD 24285R3

28-

5<Dnev \ t o Nemirov lM O L D O V ATo Nem,oi,oM L DAoilev- U K R A I N E

r\ I~~~~~~~~~~oo'skiyfBriceni ;g , \ Towi-itsr °0 SELECTED CITIES

NATIONAL CAPITAL

RIVERS

48B8 R C X \ 48° | l | RAILROADS

Floresfi' 4 <0 >ROADS

r( \ Rbnita i' - j INTERNATIONALa t < Rezinov BOUNDARIES

V %< \! / ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~300

t L \ VOrhei Th\ >. rhe boundoi-esr

X \<~~~~~~~~~~~~~~~~~~~~~~arasi Dl rhp. Wrld B.. G o .. pF n

tffl Jngheni fk \ K ) \ stotu5 of ony t-ritony,tX~~~~~~~~~T! Gr orioppl" 0r .. yprzr - f--f-t

NRIN

> T \U 7/59 \| To~~~~~~~~~~~~~~~~~~~~~~~.Kyiv

tg n c e s~~~~~~~~~~~~~~~~~~~~~~neti Bend4

%/< 1 f tt / \ 19 t)~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~T a Odeso

0 25 50lCiiliXt

R O M A N I A Tio Odn

MILES~~~~~~~~~~~

\ ~~~~~~~~~~~~~To Biriad o Cmratt I rb>XA /> | ) ~~~~~~~~~~~~~~~~~~~~~~~~~To Artsie TO Tat.ruoy

-460 ' U K R A I N E 461

iA Jurdiulesli4| ' BLAC K

KILOMETERS I4/T uhw f+Z

0~ ~ ~ 2 0 C, ond consoto.

MILES 1997

APRIL 1997

IMAGING

Report No.: P 7139 iviDType: PR