Document of The World Bank

FOR OFFICIAL USE ONLY Public Disclosure Authorized Report No. P-7322-BUL

REPORT AND RECOMMENDATION

OF THE PRESIDENT OF THE Public Disclosure Authorized INTERNATIONAL BANK FOR RECONSTRUCTION ANI) DEVELOPMENT

TO THE EXECUTIVE DIRECTORS

ONA

PROPOSED ENVIRONMENT AND PRIVATIZATION SUPPORT ADJUSTMENT LOAN Public Disclosure Authorized

IN THE AMOUNT OF EURO 49.5 MILLION

TO THE

REPUBLIC OF BULGARIA

January 24, 2000

Public Disclosure Authorized This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS (Exchange Rate Effective January 19, 1999)

Currency Unit = BGN (effective July 5, 1999) BGNI =US$0.516 US$1 = Leva 1.937

BULGARIA FISCAL YEAR January I - December 31 WEIGHT AND MEASURES Metric System

ABBREVIATIONS AND ACRONYMS

BNB Bulgarian National Bank BOP Balance of Payments CAS Country Assistance Strategy CBA Currency Board Arrangement CEE Central and Eastern Europe COM Council of Ministers DISAE Development of Implementation Strategies for Approximation and Environment EBRD European Bank for Reconstruction and Development EA Environmental Assessment EIA Environmental Impact Assessment EPSAL Environment and Privatization Support Adjustment Loan EPSP Environment and Privatization Support Program ERPP Environmental Remediation Pilot Project EU European Union FESAL Financial and Enterprise Sector Adjustment Loan FT Financial Intermediary GDP Gross Domestic Product IBRD International Bank for Reconstruction and Development IMF International Monetary Fund IPPC Integrated Pollution Prevention and Control MDK MDK Copper Smelter MOEW Ministry of Environment and Waters MOF Ministry of Finance MOI Ministry of Industry OC Oversight Committee PA Privatization Agency PHARE European Union Development Program PATAs Privatization Advisers and Transaction Agents SARA EU Privatization Assistance Program SOE State-Owned-Enterprises

Vice President: Johannes F. Linn, (ECAVP) Country Director: Andrew N. Vorkink (ECC05) Director: Kevin M. Cleaver (ECSSD) Program Team Leader: Adriana Damianova (ECSSD) FOR OFFICIAL USE ONLY Republic of Bulgaria Environment and Privatization Support Adjustment Loan

CONTENTS

I. INTRODUCTION.1

II. BACKGROUND A. Macroeconomic Performance and Progress in Privatization...... I B. Environmental Policy and Regulation...... 4 C. Privatization and Environmental Policy ...... 5

III. ENVIRONMENT AND PRIVATIZATION SUPPORT PROGRAM (EPSP) A. Objectives ...... 7 B. Policy and Regulatory Reform ...... 7 Amendments to the Privatization Law ...... 7 Procedures for Addressing State Liability ...... 8 Subterranean Resources Act...... 8 Water Act ...... 8 C. Framework for Integrating Environmental Liabilities into Privatization...... 9 Environmental Impact Assessments (EIAs) ...... 9 Risk Assessment Methodology ...... 9 Remediation Plans ...... 10 Execution Agreements ...... 10 D. Framework for Improving Ongoing Environmental Performance...... 10 Integrated Pollution Prevention and Control ...... 10 Environmental Compliance Plans...... 11

IV. THE PROPOSEDLOAN A. Description and Objectives...... 12 B. Links with CAS Objectives ...... 13 C. Value added by the Bank's Involvement ...... 13 D. Lessons from Previous Operations ...... 13 E. Benefits...... 14 F. Costs ...... 15 G. Loan Conditions ...... 15 H. Alternatives Considered ...... 18 1. Technical Assistance ...... 19 J. Implementation and Institutional Responsibilities ...... 19 K. Loan Financial Management, Disbursement and Accounting ...... 21 L. Reporting ...... 22 M. Environmental Category ...... 23 N. Sustainability and Risks ...... 23 0. Collaboration within the Bank, IMF and other Donors...... 25 P. Progress to Date and Timetable...... 25

V. RECOMMENDATION ...... 25 This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwisebe disclosed without World Bank authorization. Annexes

Annex 1. Letter from the Government of the Republic of Bulgaria on its Policy regarding Environmental Liabilities in Privatization Annex 2. EPSL Policy Matrix Annex 3. Program Implementation Responsibilities Annex 4. Timetable of Key Processing Events Annex 5. Key Economic Indicators Annex 6. Bulgaria Key Exposure Indicators Annex 7. Status of Bank Group Operations in Bulgaria Annex 8. Bulgaria at a Glance Map IBRD 30729 Republic of Bulgaria Environment and Privatization Support Adjustment Loan Loan and Program Summary

Borrower: Republic of Bulgaria

Executing Agencies: Ministry of Environment and Waters; Ministry of Finance

Beneficiaries: Workers and population around industrial and commercial sites with significant past and ongoing environmental pollution.

Loan Amount: Euro 49.5 million

Terms: IBRD terms with 20 years maturity including 5 years grace period, at the Bank's standard interest rate for LIBOR-based single currency loans in Euro.

Commitment fee: 0.75 percent of undisbursed loan balances, beginning 60 days after signing, less any waiver.

Objectives: The objective of the loan is to assist the Government of Bulgaria in achieving environmental improvements, supporting the privatization of highly polluting enterprises, and harmonizing with EU environmental requirements.

Description: The loan will support the comprehensive reform of Bulgaria's environmental policies, the establishment of a satisfactory framework for incorporating environmental issues into the privatization, and measures to accelerate the implementation of EU Directive on Integrated Pollution Prevention and Control.

Benefits: The main benefits of the loan would be its support to the Government of Bulgaria's policy and regulatory reform aimed at (i) improving environmental conditions; (ii) protecting human health and sensitive ecosystems; (iii) improving environmental performance in highly polluting industrial sectors.

Risks: There are four groups of risks: (i) The implementation of the EPSAL depends on a successful privatization program of large enterprises. The achievements of privatization outcomes under the Government's reform program ii

supported by the Bank's Second Financial and Enterprise Sector Loan mitigates this risk. (ii) The Government of Bulgaria's commitment to introduce agreed mechanisms to include environmental issues into privatization might be weakened by pressure to complete individual privatization deals quickly. This risk is mitigated by the timely preparation of environmental assessments, which provide the necessary environmental information for both the Government and potential investors to include in the negotiations of the sale. (iii) Failure of the Government to enforce the implementation of environmental Remediation and Compliance Plans. In order to mitigate this risk technical assistance will be provided through the EU PHARE Program to strengthen privatization oversight capacity. (iv) Failure to implement Remediation Plans due to disputes between the private sector and the Government. This risk will be mitigated by the introduction of conflict resolution measures in the Execution Agreements and agreements on institutional responsibilities for dealing expeditiously with disputes.

Environment: The proposed loan has been placed in Category FI.

Financing plan: IBRD Euro 49.5 million

Disbursements: FY'00 Euro 15,345,000 (including front end fee) FY'01 Euro 14,840,000 FY'02 Euro 19,315,000 Cumulative Euro 49,500,000 Project I.D. Number: BG-PE-P057927

Rate of Return:: N.A. Report and Recommendation of the President

Of the International Bank for Reconstruction and Development

To the Executive Directors

On a Proposed Environment and Privatization Support

Adjustment Loan

To the Republic of Bulgaria l. INTRODUCTION 1.01 I submit the followingreport and recommendationon a proposed Environment and PrivatizationSupport Adjustment Loan (EPSAL)to the Republic of Bulgaria in the amount of Euro 49.5 million. The loan will comprisethree single currencytranches in Euro, and will be payable in twenty years, includingfive years of grace, at the Bank's standardinterest rate for LIBOR-basedsingle currency loans in Euro. 1.02 The EPSAL will provide foreignexchange for balance of paymentssupport. The loan is conditionedon implementationof a comprehensiveprogram of policy reform aimed at improvingthe environmentalregulatory system, incorporatingenvironmental considerationsinto the privatizationprogram, and acceleratingthe adoptionof European Union (EU) environmental requirements and practices to improve environmental conditionsand ongoingenvironmental performance of privatizedenterprises. 1.03 This Loan supportsthe Govermnent'smedium-term environmental policy set out in its Letter of Sector Policy, included in Annex 1 of this report. It complements extensivereforn effortsunder the ExtendedArrangement with the IMF and the structural reforms supportedby the Bank under the proposed Second Financial and Enterprise SectorAdjustment Loan (FESALII). II. BACKGROUND

A. MACROECONOMIC PERFORMANCE AND PROGRESS IN PRIVATIZATION 2.01 Macroeconomicconditions have improvedremarkably since the crisisof 1996-97, with the most important accomplishmentbeing macroeconomicstabilization. Sound policies have led to a decline in inflation, single digit interest rates, and a return of confidencein the currency and the banking system. In 1998, Bulgaria's economic developments remained quite favorable despite the Asian and Russian crises. 2

Macroeconomic stabilization has been successfully maintained largely due to the Currency Board Arrangement and a tight fiscal stance. The overall Government balance swung from a 2.5 percent deficit in 1997 to a one percent surplus in 1998. Inflation, at one percent at the end of 1998, remained below expectations. As the stabilization program took hold, economic activity began recovering in 1998. One positive impact of the stabilization program has been the increase in real wages and salaries, which has enabled a recovery in the purchasing power of the population from its very depressed levels. This created some growth in the domestic demand, and consequently, growth rebounded. Real GDP growth reached a rate of 3.5 percent in 1998.

2.02 The economic recovery slowed in the latter part of 1998 as a result of a combination of factors, notably the turmoil in international markets, weak external demand, and the restructuring taking place in the country's industrial sector. Nonetheless, the recovery of GDP growth in 1998 resulted in a decline in the unemployment rate from 14 percent in 1997 to 12 percent at the end of 1998. Despite the recovery in economic growth in 1998, the slow pace of restructuring in the industrial sector has led to some stagnation in exports. With exports stagnating, the country's trade balance deteriorated, and the current account swung into a deficit of 2.1 percent of GDP in 1998. These results indicate that considerably more needs to be done to facilitate a restructuring of the economy in order to achieve sustained economic growth.

2.03 The early 1999 economic developments signaled a weakening of the economy even before the Kosovo crisis. Industrial sales went down by about 13 percent in the first half of 1999. Business confidence in industry also recorded some deterioration, and inventories began to grow suggesting a further weakening in demand. The intense restructuring of the economy led to an increase in unemployment. In addition, export performance continued to weaken during the first half of 1999, contributing to a widening of the current account deficit. Traditional exports of chemicals, fertilizers and metals kept falling mainly due to lower world market prices and the restructuring in these sectors, while textiles, apparel and footwear offset some of the fall in other exports.

2.04 The economy's weakening performance has been exacerbated by the Kosovo crisis. The closure of the border with FR Yugoslavia in late March 1999 resulted in direct and transit trade losses. A large part of Bulgaria's exports was rerouted at much higher cost, while transit trade remained blocked even after the end of the military operations. There was also some limited negative effect on tourism. The conflict initially affected investor confidence and a number of large privatization deals were put on hold. However, after the war, investor confidence revived quite rapidly, and foreign direct investment is now expected to be higher than initially projected for 1999.

2.05 In late 1999, growth outlook improved significantly following some rebound in external demand, and signs of improving domestic conditions. In the third quarter of 1999 GDP grew by 4.5 percent driven by stronger private consumption and increased investment. Slowly, the exports started to pick up, and the increase in imports was mostly due to increase in imports of capital goods. The continuing restructuring of economy brought about a further increase in private sector share in GDP, which generated 58 percent of GDP. However, the downsizing of the public sector was associated with a sharp increase in the unemployment rate, which stood at 15.6 percent in 3

November 1999, or about 14 percent average for 1999. Nevertheless, if the Government continues to aggressively pursue the structural reform program, higher growth rates of at least four percent could be achieved in the medium termn due to the projected improvements in the external environment, and increased domestic investments-both private and public. These expectations are based on the assumption that private sector activity will continue to expand while public investment will grow in line with the public investment program of the Government.

2.06 The adverse effects of the international environment and the related current account deterioration necessitated a tighter fiscal stance. The Government has achieved considerable progress in improving revenue performance and tightening expenditure management, thereby keeping the overall deficit for the first nine months of 1999 to manageable limits. Preliminary data indicate that the revenue and expenditure performance over the first nine months of 1999 will ensure the achievement of the 1999 deficit target of 1.5 percent of GDP if restraint on discretionary expenditures and wage increases is maintained for the remainder of the year.

2.07 After a slow start, the privatization program accelerated in early 1999. As of December 31, 1999, about 78 percent of long term assets of SOEs in sectors other than energy, transport, and infrastructure have been privatized or placed under liquidation or insolvency proceedings. The privatization of large SOEs involves the sale of controlling stakes to strategic investors, while the sale of small SOEs focuses on speed and transparency. The sale of 31 of the largest and most important SOEs utilizes the services of international privatization agents under the Privatization Advisors and Transactions Agents (PATA) program financed by donors and the Bank. An additional 52 large SOEs are grouped into eight pools with each pool assigned to a privatization agent. The Privatization Agency handles directly the sale of the most of the remainder of the large SOEs, while the line ministries are responsible for the privatization of some 3,000 small SOEs. The Government's policy is to liquidate those SOEs in sectors other than energy, transport, and infrastructure, which are not privatized after a reasonable period. By March 31, 2000, the divestiture of SOEs in sectors other than energy, transport, and infrastructure is projected to be completed.

2.08 There are several SOEs - such as the National Electricity Company, the District Heating Companies, the water utilities and the Bulgarian State Railways - where the privatization process is complex or where sector restructuring and the establishment of a legal and regulatory framework are preconditions for privatization and private sector participation. The Government has taken steps to establish the foundation for the privatization and private sector participation in the energy sector by passing the Law on Energy and Energy Efficiency and creating the State Commission for Energy Regulation. The National Electricity Company will spin off several enterprises covering the distribution, generation, and transmission functions, with the distribution enterprises to be privatized beginning 2000. Long terms plans with privatization components have been prepared for the District Heating Companies, the energy related coal mining SOEs, and the Bulgarian State Railways.

2.09 The Second Financial and Enterprise Sector Adjustment Loan (FESAL II) provides support to the Government's structural reforms, including the divestiture of SOEs, 4 development of the banking system, and the restructuring of the energy sector. The CAS also provides for a planned FESAL III, which will support the completion of the reforms in the enterprise and financial sectors, including the privatization of or private sector participation in SOEs in the energy, transport, and infrastructure sectors. It will also focus on the establishment of the enabling environment for post-privatization restructuring and private sector growth.

B. ENVIRONMENTAL POLICY AND REGULATION

2.10 As Bulgaria pursues its economic objectives, it needs to integrate the environrnental concerns into the development agenda. The socialist system left the country with serious environmental problems and a relatively weak and ineffective institutional and regulatory system. Unsustainable environmental management practices resulted in environmental "hot spots", typically around large industrial plants, where people have been exposed to unacceptably high levels of pollution, and the accumulation of hazardous substances which have contaminated drinking water resources and threatened ecosystems with irreversible damage.

2.11 In 1991, Bulgaria adopted an Environmental Protection Act, which provided a new foundation for environmental policy. It revised the system of standards; introduced the principles of pollution prevention and the integration of environmental protection with other areas of national policy; legalized the "polluter pays principle"; provided access to the public on ecological information; and mandated environmental assessment (EA) procedures and requirements for all projects with potentially significant impact on the environment.

2.12 EA procedures were further specified by a Regulation No.4 of 1995 on Environmental Impact Assessments, and gradually refined and adjusted to adopt Western practices, especially concerning requirements for public information and consultation. The legislation also established a more efficient division of responsibilities between the institutions engaged in environmental protection (e.g., MOEW, Regional Environmental Inspectorates, and municipal authorities). The law provides for a list of projects and activities, which require an EA, but also specifies that other projects and activities can be subjected to an EA.

2.13 The framework environment law was followed by several media-specific acts. The Ambient Clean Air Act of 1996, for example, laid down the principles of protecting the health of humans, animals and plants from harmful impact of pollution, and preventing the hazards and harm due to changes in air quality from different activities. The Act and the subsequent Regulation No. 2 of 1998, set out air quality indicators and standards for several key pollutants; limits for emissions; and the rights and obligations of state and municipal authorities, legal entities and individuals on control, management and maintenance of air quality.

2.14 Based on the "polluter pays principle" adopted in the Environmental Protection Act, a 1993 Regulation of the Council of Ministers imposed sanctions for pollution above permissible standards. Sanctions are monthly, and the duration and exact amount are determined individually by order of the Minister of Environment. 5

2.15 Although the above-described measures represent a significant improvement in the environmental policy framework, experience with their implementation is still limited. Additionally, subsidiary legislation under the general framework environmental law has been slow to develop. Several laws have not been revised for the last 30 years, and have become outdated. The Water Law of 1969, for example, has several very significant weaknesses, which impede effective implementation and enforcement, and the adequate use and protection of waters as a natural resource.

2.16 In recent years, significant progress has been made in dealing with specific sources of pollution, and in building institutional capacity to address environmental priorities in Bulgaria. The Bank assisted the Government to conduct an Environmental Strategy Study (FY93) and an Update and Follow-up (FY95). Additionally, the EU PHARE Program has been providing technical assistance to the Ministry of Environment and Waters (MOEW) to strengthen its policy and regulatory capacity, and to improve the skills of domestic consultants and experts in carrying out environmental assessments.

2.17 In 1993, Bulgaria signed an Association Agreement with the EU, establishing a framework for economic and political cooperation in a number of areas including environment. Under the Agreement, which came to force in 1995, the Government is committed to harmonize its laws, regulations, standards, norms, and methodologies with those of the EU. The approximation in the environment sector is the responsibility of the MOEW, which has received support from the PHARE DISAE (Development of Implementation Strategies for Approximation in Environment) facility to prepare an approximation program. The program focuses, inter alia, on the cross-sectoral aspects of environmental management, legal issues such as river basin management, transboundary pollution, the permit regime, and the management of environmental funds.

2.18 As part of preparation for EU approximation, the Government is strongly committed to bring legislation in compliance with the EU environmental acquis, and to establish a modem environmental management system. This will involve a medium-term program to develop a body of legislation, sub-legislative acts, and streamlining of institutional arrangements. One of the most substantial tasks of adopting an EU environmental management framework will be to implement the provisions of the EU Integrated Pollution Prevention and Control (IPPC) Directive, which involves a shift from media-based regulation - focusing, for example, on specific emissions to air or water - to an integrated approach which takes account of the overall impact of an industrial plant on the environrnent.

C. PRIVATIZATION AND ENVIRONMENTAL POLICY

2.19 Despite progress in improving environmental protection policies, legislation, and institutional strengthening, actual achievements in terms of improved environmental performance in highly polluting industries are still modest. Apart from the general economic benefits of privatization, the experience of more rapidly reforming economies has shown that privatization leads to substantial improvements in environmental performance by changing production and managerial objectives, reducing waste of natural resources, and increasing the effectiveness of environmental fines and charges. 6

2.20 Based on international experience, the Government has decided to make environmental performance an integral element of its privatization program requiring polluting industries to improve their environmental performance, adopt internationally recognized environmental management practices, and comply with appropriate environmental regulations.

2.21 It is also recognized that the implementation of sound policy reforms aimed at economic recovery and growth, including privatization, will have to be accompanied by environmental policies and targeted environmental programs in order to achieve the maximum welfare benefits from economic reforms. Experience in many countries, including those in Central and Eastern Europe, has shown that uncertainties about liabilities for past environmental damage and about standards for future environmental performance increase the risk for investors, hinder the privatization process, reduce privatization revenues, and leave serious environmental problems unresolved. There are two separate but linked issues, which must be solved:

* The environmental legacy of the past (pollution stock issue) is a major concern especially for sectors where environmental liabilities are large compared to the value of enterprises. Although the Bulgarian State is legally liable for past environmental damages, uncertainties about the magnitude of the environmental problems and required measures to address them can deter reputable investors, and impede privatization. Sectors especially affected include mining, metallurgy, chemicals and oil refming and petrochemicals. Therefore, there is a need for a clear legal framework backed up by mechanisms for (a) assessing the magnitude of past liabilities, (b) developing plans for appropriate remediation and management of the liabilities, (c) agreeing on the respective responsibilities of the government (as seller) and the new owners for implementing and financing these plans, and (d) dealing with unforeseen liabilities whose extent and nature only emerge after the privatization is completed.

* Few industrial plants are currently able to comply with existing Bulgarian environmental regulations (pollution flow issue) with respect to their emissions, let alone any future regulations that will be adopted as Bulgaria moves to implement EU environmental directives. It is clear that the responsibility for compliance with environmental regulations must lie with the new owners. However, a reasonable time and clear indications for future environmental requirements should be given to investors to make the necessary adjustments and investments to improve their environmental performance. The nature of the emission standards that will apply and the time allowed for compliance with these standards may have a significant impact on the valuation of enterprise and future investment plans. While the Government bears the costs, reflected in reduced privatization revenue, if the time allowed to comply with more stringent environmental regulations is shortened, integrating these requirements into the investment and restructuring plans of the new owners ensures cost- effectiveness in meeting environmental standards. 7

2.22 At the beginning of the privatization process, the Government did not pay special attention to environmental issues. The lack of information about the extent of past environmental liabilities and measures needed to address them has caused delays in the privatization of a number of highly polluting enterprises (e.g., OZK Lead-Zinc Smelter Kurdjali, KCM Plovdiv). In other cases, the lack of attention to environmental issues has resulted in ongoing disputes and unresolved problems. As the Government embarked on an ambitious large-scale privatization program, concerns were raised about the possibility that large and poorly defined environmental liabilities would deter reputable investors.

2.23 The Bank is assisting the Government with an Environmental Remediation Pilot Project (ERPP) which is designed to address environmental liabilities at the MDK Copper Smelter, one of the most polluting enterprises in Bulgaria, as part of its sale to a strategic investor. The ERPP introduced a mechanism for addressing both ongoing environmental obligations and past liabilities in a comprehensive way for the first time: as part of the sale of the company, agreements were made for Environmental Compliance (to improve the performance of ongoing operations) and for the Remediation of Past Environmental Damages (to reduce the risks associated with contamination caused by past operations). While measures to be taken to achieve compliance are entirely the responsibility of the new owner, the Bank assisted the Government in financing the remediation of past damages, which is legally the responsibility of the state.

2.24 The privatization of MDK was the first case in which environmental issues were seen as critically important by both the buyer and by the Government. All of the parties involved have learnt much from the experience, and it has also become clear that the Government can generate the greatest benefit from privatization if it focuses on the development of the environmental policy framework, procedures, regulations, and institutional capacity that systematically apply during and after privatization.

III. ENVIRONMENT AND PRIVATIZATION SUPPORT PROGRAM (EPSP)

A. OBJECTIVES 3.01 The Government's approach and medium-term plan for environmental policy reform are described in its Letter of Sector Policy (Letter.from the Government on its Policy regarding Environmental Liabilities in Privatization, Annex 1). The key objective of the EPSP is to achieve environmental improvements and to support the privatization of highly polluting enterprises by reforming enviromnental legislation, establishing a consistent framework for integrating environmental issues into privatization, and accelerating harmonization with EU environmental requirements and practices. The program would focus on the following key areas:

B. POLICY AND REGULATORY REFORM

Amendments to the Privatization Law

3.02 Bulgaria has introduced several legal regulations concerning environmental liabilities in the context of privatization. The Environmental Protection Act of 1991 stated that foreign or domestic investors were not liable for environmental damage 8 resulting from past action or non-action. However, experience has shown that several investors look for stronger assurances that the state will undertake liabilities for past pollution. Therefore, further amendments to the Environmental Protection Law and to the Privatization Law (Law on Restructuring and Privatization of State and Municipal Enterprises and its amendments) became necessary to confirm that the State retains legal responsibility for environmental pollution resulting from past action or non-action.

Procedures for addressing State liability 3.03 Amendments to the Environmental Protection Law and the Privatization Law about State liability were made in 1998, and supplemented by Council of Ministers Resolution No. 115 of 1998, and Regulation No. 4 of 1998, to clarify basic principles (e.g. the protection of health and ecosystems from unacceptable risks), procedures for determining damages (e.g. methodologies for assessing the magnitude of damage, risks, and remedial action including areas surrounding industrial plants), and financial mechanisms in relation to state liabilities (e.g., financial sources for compensating contaminated land owners or re-cultivating agricultural land). Currently, the Agricultural Land Use and Ownership Act calls for state compensation from the National Fund for Protection and Amelioration of Agricultural Land for the restoration of damaged land when it is returned to its owners. However, since the Government has eliminated this fund as part of its reform program, it is now in the process of identifying alternative financing sources for polluted agricultural land.

Subterranean Resources Act 3.04 Previous legislation of subterranean resources did not properly regulate the way past contamination was addressed at disposal sites and tailing ponds. A new Subterranean Resources Act has been recently approved by the Parliament, which integrates environmental protection and conservation of the "bowels of the earth". The law addresses ownership rights for extraction of subsurface resources, sets up administrative routines and a permit process for exploration and mining or extraction including mandatory assessment of the impact of these activities on environment pursuant to the Environmental Protection Act. Subsidiary legislation will determine responsibilities, and will improve arrangements for addressing both off-site liabilities - for example, the contamination of agricultural land by emissions of heavy metals or chemicals - and liabilities emerging after the sale of enterprises. The latter is particularly important for enterprises with many operating sites spread over a region or the whole country - such as Petrol with depots and filling stations throughout Bulgaria, or the Gorubso mining enterprise which has nearly 40 mining sites spread over the mountains in the South-East Bulgaria. The proposed regulatory changes would also include provisions to deal with the liabilities of enterprises or parts of enterprises that are closed down rather than being privatized. Water Act 3.05 The Water Act of 1969 had significant weaknesses, which limited the adequate protection of waters as a natural resource. The Law set an artificial division between water quantity and water quality, and the different institutions for their control without clearly defining and delimiting their responsibilities. The Law did not formulate any common criteria or requirements for water-use permits which could be withdrawn, 9 modified, or suspended if the user did not comply with their requirements or if more important state, social needs had to be satisfied. Additionally, the Act did not provide a mechanism for determining temporary emission norms to be agreed in the Compliance Plans. A new Water Act was approved by Parliament in 1999; establishing a comprehensive legal framework for environmentally and economically sustainable use of water resources based on river basin management principle. The Law will facilitate the new owners of privatized enterprises to implement Environmental Compliance Plans.

C. FRAMEWORK FOR INTEGRATING ENVIRONMENTAL LIABILITIES INTO PRIVATIZATION Environmental Impact Assessments (EIAs) 3.06 In addition to the EIA requirements for new projects, a program for the preparation of EIAs for enterprises in operation were introduced in Bulgaria in 1996. The program marked the beginning of environmental auditing in industrial enterprises. The required scope and content of audit reports follow the requirements of EU legislation on this subject (Regulation 1836/1993 on voluntary participation of industrial enterprises in the Environmental Management and Audit Scheme (EMAS) and EU Directive 96/61 for IPPC). In the context of privatization, obligations to carry out environmental and financial assessment of past environmental damage was set in a Regulation of the PA introduced in 1993. 3.07 Resolution No. 115/1998 of the Council of Ministers introduced an additional requirement for SOEs in the process of privatization to carry out an EIA, including an assessment of environmental damage caused before privatization. In accordance with the provisions of Bulgarian environmental legislation, the EIA is subject to public consultation and discussion, before the Expert Council of the MOEW approves it. Large industrial enterprises under privatization were required to prepare EIAs. Additionally the EU SARA Program has provided technical assistance to carry out additional environmental assessments. Risk assessment methodology 3.08 In order to clarify the scope of the assessment of past environmental liabilities as part of the EIA for enterprises under privatization, the MOEW adopted a methodology described in Guidance for the Scope and Contents of Reports on the Assessment of Past Environmental Pollution. The methodology adapted international practice and experience with environmental risk assessment to Bulgarian conditions. 3.09 According to the methodology, the scope of environmental assessments depends on the magnitude of environmental risks following a three-stage assessment procedure. The first stage covers a description of the enterprise operations, environmental performance, and relevant standards. The second applies a simplified procedure for risk assessment to classify liabilities associated with the enterprise into cases which present no significant hazard to the population and those which require additional investigation. The third stage involves studies that are more detailed and additional data collection to better characterize the nature and extent of risks, and develop a remediation plan including an assessment of costs involved. 10

Remediation Plans 3.10 In cases when the environmental assessments identify significant risks and the need for remediation measures to be undertaken to protect human health and ecosystems, Framework Remediation Plans for Past Environmental Damages (Remediation Plans) should be prepared according to the third stage of the above described methodology. The Remediation Plans and their cost estimates are to be prepared relying on cost- effectiveness principles, considering various alternatives such as containment and monitoring as well as clean up measures. The activities identified under the EIAs and Remediation plans are subject to public consultations which provide for identifying of negative impacts, and monitoring and evaluation of the effect of activities. The remediation plans involve measures for containment or clean up of past environmental damages the social implications of which are expected to be positive. To facilitate the sale of enterprises, the EU SARA Program has provided technical assistance to the Government to assist in the preparation of Remediation Plans in a number of enterprises where preliminary EIAs indicated significant risks. Execution Agreements 3.11 The regulatory improvements introduce provisions for contractual arrangements for implementation of on-site remediation measures. Remediation Plans will be implemented by the new owners of enterprises after privatization according to Execution Agreements, which represent legally binding arrangements between the State and the new owner for execution of remediation measures on behalf of the state which remains legally and financially responsible for past environmental liabilities. 3.12. Execution Agreements will be an integral part of the Sales Purchase Agreements between the Government and the investors. They include, inter alia, a-Remediation Plan, key stages of work, a disbursement plan, performance indicators against which agreed lump sum payments will be disbursed to the investor, an agreed cap for the total remediation cost, a financing and an insurance mechanism for environmental commitments, and a mechanism for implementation oversight and arbitration.

D. FRAMEWORK FOR IMPROVING ONGOING ENVIRONMENTAL PERFORMANCE

Integrated Pollution Prevention and Control 3.13 The Government is committed to convergence with EU legislation as a fundamental element of its overall goal of joining the EU. The accelerated adoption of EU environmental directives - in particular EU Council Directive 96/61/EC of 24 September 1996 on IPPC - would be the basis for establishing Environmental Compliance Plans for privatized enterprises. 3.14 The IPPC Directive established a framework for industrial pollution management. The overall goal of the Directive is to achieve a high level of protection of the environment by means of measures designed to prevent or reduce emissions to air, water, and soil. According to the IPPC Directive, Member States are expected to issue permits which set emission limits and contain measures following a set of principles including (i) best available techniques (BAT) to prevent pollution; (ii) no significant pollution; (iii) avoidance of waste production by means of waste recovery; (iv) energy efficiency; (v) 11 prevention of accidents and limiting of their consequences; (vi) remediation of sites to acceptable levels after cessation of activities in order to avoid risks.

3.15 According to the IPPC Directive, operators of existing plants have to obtain a permit within eight years of the Directive's implementation, and Member States have to establish a schedule for this process. All permits have to contain conditions to ensure compliance with the basic principles outlined above, and to prevent breaches of EU environmental quality standard. Integrated permits have to contain emission limits and have to lay down requirements to prevent the transfer of pollution from one medium to another. Other requirements concerning soil and groundwater protection and waste management must be specified if necessary. 3.16 The IPPC Directive is being gradually adopted and implemented by Member States. Bulgaria would not be expected to comply with this Directive until it becomes a member of the EU. However, negotiations on Compliance Plans in the context of privatization provide an opportunity and framework for introducing, adopting, and implementing - as far as possible - the provisions of the Directive for newly privatized enterprises, subject to allowing appropriate periods for compliance. This way, the Government will also provide greater certainty to the new owners about the basis for and nature of the environmental standards that will apply to their future operations. The standards and the provisions for integrated environmental permits according to the guidelines of the IPPC Directive would be clearly agreed in the Compliance Plans, which would also form a part of the privatization contract. 3.17 As part of the EPSP, the MOEW elaborated a timetable for implementing the provisions of the EU IPPC Directive. Under the plan, a pilot phase will be introduced when pilot integrated permits will be issued substantially according to IPPC guidelines to selected enterprises (such as OZK Lead-Zinc Smelter, Kurdjali; KCM Plovdiv Lead- Zinc, Kremikovtzi Steel Complex, and Neftochim Petrochemical and Refining Complex) in the metallurgical and chemical sectors. Enterprises for which Compliance Plans will be negotiated during the privatization process are the most likely candidates for participation in the pilot phase of integrated permits. Since these enterprises are typically the largest polluters, this approach will ensure that the integrated permit regime will reduce pollution in industries which pose the highest environmental risks. In the medium-term, the coverage will be extended to at least 80% of large enterprises in these sectors. 3.18 In order to reform environmental legislation, the MOEW is currently collaborating with the Danish Ministry of Environment and the Danish Environmental Protection Agency to support the approximation of Bulgarian legislation with EU requirements on industrial pollution, including the IPPC Directive.

Environmental Compliance Plans

3.19 An Environmental Impact Assessment including an assessment of current environmental performance and past contamination will be prepared for each enterprise under privatization. The EIA will propose a plan to bring the enterprise into compliance with relevant emission standards. The Compliance Plans imply a program of environmental investments for cleaner technologies and waste reduction measures that would gradually bring plants' environmental performance in compliance with the norms 12

and standards. Typically Compliance Plans deal with requirements for environmental performance, set up limits for ambient concentration of pollutants in water, soil, and air, and contain measures for reduction of emissions and concentration of pollutants in the ambient environment. Such measures are expected to have positive environmental and social effects. The implementation of Compliance Plans will be entirely the responsibility of the enterprises.

3.20 However, enterprises under privatization are typically out of compliance with environmental regulations, and it is not realistic to expect new owners to comply with requirements immediately following privatization. The Compliance plans will determine specific temporary norms and standards that will apply to enterprises during the transition period until regular standards could be achieved. Since compliance often requires adjustment in production processes, technologies and additional investments, Compliance Plans should outline a time bound program of investments to upgrade environmental performance and to reduce emissions to meet Bulgaria and/or EU emission requirements. The length of the transitional period and the requirements of the temporary norms will depend upon the investment program envisaged for the enterprises.

3.21 In the context of privatization, the necessary process changes and investments to improve environmental performance can be integrated into the new owners' overall investment program. This way, investments can be optimized, cleaner technologies and waste reduction measures introduced, and investor risks about future uncertainties reduced. Compliance Plans will be agreed upon as part of the Sales Purchase Agreements for the enterprises.

IV. THE PROPOSED LOAN

A. DESCRIPTION-AND OBJECTIVES

4.01 The proposed loan, in the amount of Euro 49.5 million, will be a LIBOR-based single currency loan with a maturity of 20 years, including a five years grace period at the standard interest rate for LIBOR based loans in Euro. The Loan is designed as a multi- tranche adjustment operation. It will provide budgetary support to the Government for (i) improving environmental policies incorporating environmental issues into privatization; (ii) harmonizing Bulgarian environmental legislation and permit process with EU requirements, and (iii) addressing past environmental damages in privatized enterprises. The EPSAL will complement the Bank's support to the Government to reform the state- owned enterprise sector under the proposed present and future adjustment lending support extended by the Bank for structural reforms. The Loan compensates for the budgetary costs (see under costs) and shortfalls associated with the implementation of the EPSP.

4.02 The Government presented to the Bank a Letter on its Policy regarding Environmental Liabilities in Privatization, which was found to be satisfactory, attached as Annex 1. An agreement on the Policy and Action Matrix, which is attached as Annex 2, was confirmed during negotiations held on December 7 and 8, 1999. 13

B. LINKS WITH CAS OBJECTIVES

4.03 The Country Assistance Strategy (Report No. 17655-BUL dated April 9, 1998) focused on supporting Government efforts to underpin the progress in macroeconomic stabilization with durable structural reforms. In particular, the CAS supported the Government to accelerate reforms in the enterprise and financial sectors. In parallel, the CAS included environmental initiatives that would support the objective of protecting and improving the environment and human health, and prudent and rational utilization of natural resources. The Loan will directly support these CAS objectives. The loan will also facilitate structural reforms and private sector development. The mechanism designed under the operation will enable the Government to deal systematically with environmental remediation and compliance issues for enterprises under privatization.

C. VALUE ADDED BY THE BANK'S INVOLVEMENT

4.04 The main benefit of the Bank's involvement comes from the transfer of international best practice in (i) ensuring that a satisfactory regulatory and policy framework is created to oversee and enforce the implementation of remediation and compliance plans; (ii) addressing environmental liability issues during the privatization process; (iii) evaluating environmental threats and identifying cost-effective measures to address serious past environmental damages; and (iv) setting reasonable environmental compliance targets and schedules. The Bank's involvement provides comfort to investors about the proper handling of environmental liability issues, reducing their overall investment risk. The Bank is contributing to capacity building and the establishment of an institutional framework that facilitates cross-sector coordination. 4.05 The Loan will provide a portion of the budgetary expenditures associated with the implementation of EPSP during 2000-2003. Without the loan, major environmental damage, which poses significant threat to human health and ecosystems, could not be addressed. Additionally, in the case of those enterprises which have future economic potential but whose environmental liabilities are larger than the value of their current assets, privatization would be seriously constrained without the Loan. 4.06 In the longer term, the measures under the EPSP will yield substantial benefits from better environmental quality and from the demonstrated commitment to EU membership, but the short term costs are significant for a country that is going through a very difficult period of economic and fiscal adjustment.

D. LESSONS FROM PREVIOUS OPERATIONS

4.07 The proposed operation builds on lessons from other countries in Central and Eastern Europe, as well as elsewhere (e.g., in Latin America) in addressing environmental issues during privatization; as well as the pilot project (ERPP) currently under implementation in Bulgaria. Several lessons emerge from these operations including the importance of: * Providing detailed information about the environmental liabilities of enterprises under privatization and introducing clear environmental requirements into privatization bidding documents. 14

* The involvement of MOEW, other environmental experts, and stakeholders early on in the privatization process. * Including binding environmental agreements as part of the Sales Purchase Agreements. * Strong post-privatization oversight. 4.08 The following measures have been taken to reflect the above lessons in the preparation and design of the EPSAL: * Environmental audits and assessments have been carried out by independent consultants for enterprises under privatization. * The results of environmental assessments, together with indications of environmental requirements, have been incorporated into the Information Memoranda released to potential investors. * Additional assessments have been undertaken when needed, to more accurately assess the remediation cost. * Increased coordination between the MOEW, PA and privatization consultants (PATAs). * The establishment of performance criteria, key stages of work and associated lump sum reimbursements have been recommended as a basis for Execution Agreements.

E. BENEFITS

4.09 Environmental. The main environmental benefits of the Loan would be: (i) an improved environmental management and regulatory system; (ii) protection of human health and sensitive ecosystems from excessive pollution; (iii) mitigation of risks posed by past environmental damages; (iv) improvement of environmental performance in highly polluting industrial sectors; and (v) costs savings by linking environmental compliance with industrial restructuring. The beneficiaries of the loan would be workers, farmers, and the population living in and around the environmental "hot spots" and highly polluted industrial areas. Indirectly, the Bulgarian people would benefit as the loan facilitates the privatization of large enterprises, contributing to better economic performance, higher budgetary revenues, and economic growth. 4.10 Social. The social effects of the proposed EPSP are expected to be positive. Along with the environmental and health benefits for the population, the EPSP will provide employment opportunities and additional new jobs in the private sector. In the medium and long run, it is expected that the execution of the investment programs under the Compliance Plans will prolong the demand for new jobs, which will partially offset the adverse social impact of the downsizing of privatized enterprises.

4.11 To achieve the objectives of the EPSP, the Government will implement the Remediation and Compliance Plans in consultation with the primary stakeholders to create public awareness, and to build support for the proposed activities, and will allow for community monitoring and evaluation during implementation. To extend the 15 community ownership of the remediation and compliance measures the Government will seek local input on social and environmental issues during implementation of the EPSP. If adverse environmental and social impacts are identified during public consultations under the EIA, or during the monitoring activities carried out under the implementation of the remediation and compliance measures, the Government would take measures or ensure that measures to mitigate any such impacts have been taken.

F. COSTS

4.12 The Government will incur budgetary costs in order to implement the EPSP and policy reform both in the form of additional expenditures - associated with remediation of and compensation for past environmental damages - and via losses of privatization revenues brought about by the accelerated implementation of stricter environmental regulations. 4.13 The costs associated with past environmental damages fall into several categories including (i) remediation in privatized enterprises (for which the Government often cannot expect privatization revenues that cover the cost of remediation); (ii) environmental remediation in enterprises under liquidation; (iii) remediation of contaminated agricultural land, or compensation to land owners of such land; and (iv) costs of addressing unforeseen liabilities and potential future third party claims. 4.14 The environmental assessments carried out in selected industrial enterprises from the metallurgical and chemical sectors indicate potential costs of addressing past environmental damages of the following order: Kremikovtzi Steel Complex: $15 million; Neftochim Petrochemical and Refining Complex: $30 million; Assarel-Medet Non- ferrous Mining and Metallurgy Complex: $7 million; OZK Lead-Zinc Smelter Kurdjali: $5 million; Agropolichim: $10 million; Leko-ko Radomir Steel Complex $10 million. However, final cost of remediation depends on detailed assessments and plans on future operations, and investment commitments by new owners. An additional cost of $20-30 million is estimated for off-site and unforeseen liabilities and contaminated sites of liquidated enterprises. 4.15 The costs of environmental compliance for enterprises listed above is estimated to exceed $200 million of which approximately $50 million is associated with the accelerated adoption of IPPC emission standards and regulations.

G. LOAN CONDITIONS

4.16 Loan conditions for tranche one have been fulfilled. Upon loan effectiveness, the Bank would withdraw from the Loan Account a fee amounting to Euro 495,000, while the remaining funds of tranche one amounting to Euro 14,850,000 would be released to Borrower. The Loan will be disbursed in three tranches according to the following conditions: 16 a. Conditions for the first tranche

* Satisfactory macroeconomic performance, including continued compliance under the Extended Arrangement with the IMF and with the structural reforms supported by the Bank. * Amendments to the Environmental Protection Law and the Law on Restructuring and Privatization of State and Municipal Enterprises and its amendments, to explicitly retain the State's liability for past environmental damages. * Parliamentary approval of the Water Act satisfactory to the Bank. * Parliamentary approval of the Subterranean Resources Act satisfactory to the Bank. * Adoption by the Council of Ministers of a Regulation on the principles, conditions, and procedures for settling the State's liabilities for historical pollution. * Adoption of an Order of the MOEW of the Guidelines for the Scope and Content of the Past Contamination Damages. * Preparation of Environmental Impact Assessments for the following privatized enterprises: Neftochim Petrochemical and Refining Complex, Kremikovtzi Steel Complex, and Assarel Medet as the basis of agreeing on Framework Remediation and Compliance Plans annexed to the Sales Purchase Agreements. * Preparation of a timetable acceptable to the Bank, for implementing pilot integrated environmental permits according to the EU Council Directive 96/61 on Integrated Pollution Prevention and Control (IPPC). * Signature of Sales Purchase Agreements for Neftochim Petrochemical and Refining Complex, Kremikovtzi Steel Complex, and Assarel Medet, under which at least 67 percent of the equity interest in the enterprise is transferred to a private owner and the purchaser has paid the required down payment, and the following requirements are fulfilled: > Environmental clauses acceptable to the Bank are included in the Sales Purchase Agreements. > Compliance Plans approved by the MOEW, and acceptable to the Bank are annexed to the Sales Purchase Agreements. > Framework Remediation Plans with cost caps approved by the MOEW, and acceptable to the Bank are annexed to the Sale Purchase Agreement. > Execution Agreements, signed by .the MOEW, MOF and PA and satisfactory to the Bank are annexed to the Sales Purchase Agreements. > The total cost of environmental remediation of these enterprises exceeds US$ 25 million. * Establishment of an inter-agency coordinating mechanism with the participation of the MOF, MOEW, PA, and MOI, or its successor, to oversee the 17

implementation of the EPSP, and designation of an official of MOF to carry out the duties of loan manager. b. Conditions for the second tranche * Satisfactory macroeconomic performance, including continued compliance under the Extended Arrangement with IMF and with the structural reforms supported by the Bank. * Pilot integrated environmental permits issued according to the EU IPPC Directive to at least 5 large enterprises (each with at least 1,000 employees') in the metallurgical and chemical sectors. * Preparation of Environmental Impact Assessments for the privatized enterprises as the basis of agreeing on Remediation and Compliance Plans annexed to the Sales Purchase Agreements. * Satisfactory progress, according to performance indicators agreed with the Bank, in the implementation of Framework Remediation Plans, Compliance Plans and the time-bound implementation plans set out in the Execution Agreements relating to Neftochim Petrochemical and Refining Complex, Kremikovtzi Steel Complex, and Assarel Medet. * Signature of Sales Purchase Agreements for at least three additional large industrial enterprises, under which at least 67 percent of the equity interest in the enterprise is transferred to a private owner and the purchaser has paid the required down payment, and the following requirements are fulfilled: > Environmental clauses, acceptable to the Bank, are included in the Sales Purchase Agreements. > Compliance Plans approved by the MOEW, and acceptable to the Bank are annexed to the Sale Purchase Agreements. > Framework Remediation Plans with cost caps approved by the MOEW, and acceptable to the Bank are annexed to the Sale Purchase Agreements. > Execution Agreements, signed by the MOEW, MOF and PA satisfactory to the Bank, are annexed to the Sales Purchase Agreements. > The agreed cumulative total cost of Remediation Plans for these enterprises and those privatized as a condition of the first tranche exceeds US$ 50 million. * Continued maintenance of the inter-agency coordinating mechanism established as a condition for tranche one to oversee the implementation of the EPSP.

For the purposes of the Loan, a large enterprise would mean an enterprise with at least 1000 employees as at the date of signing of the Sales Purchase Agreement. In some cases where measures for staff reduction were taken as part of the enterprise restructuring, and it preceded the actual privatization, a deviation from the 1000 employee definition might be acceptable to the Bank, where as the date of measuring employees could be up to six months before, or in exceptional circumstances a longer period. This has to be agreed with the Bank on a case by case basis. 18

* Taken measures satisfactory to the Bank, or ensured that such measures have been taken, to mitigate any significant adverse social impact of the EPSP identified during the public consultation process under the EIA or during monitoring activities carried out under the EIA. c. Conditions for the third tranche

* Satisfactory macroeconomic performance, including continued compliance under the Extended Arrangement with the IMF and with the structural reforms supported by the Bank.

* Issuance of pilot integrated environmental permits to at least 80% of all large industrial enterprises (each with approximately 1,000 employees') in the metallurgical and chemical sectors, and thereafter ensured compliance of all such enterprises with the terms of the pilot permits. * Satisfactory progress, according to performance indicators agreed with the Bank, in the implementation of the Framework Remediation Plans, Compliance Plans, and the time-bound implementation plans set out in the Execution Agreements for enterprises privatized as conditions of the first and second tranches. * Continued maintenance of the inter-agency coordinating mechanism established as a condition for tranche one to oversee the implementation of the EPSP.

* Made payments from the remediation accounts for activities under the Framework Remediation Plans above in an aggregate amount acceptable to the Bank2 .

* Taken measures satisfactory to the Bank, or ensured that such measures have been taken, to mitigate any significant adverse social impact of the EPSP identified during the public consultation process under the EIA or during monitoring activities carried out under the EIA.

H. Alternatives considered

4.17 The initial project concept involved an investment lending operation focusing on the implementation of environmental remediation plans. The experience with the Environmental Remediation Pilot Project has shown, however, that the Bank's main value added is linked to the (i) introduction of appropriate policy and regulatory framework and mechanism to address systematically the environmental issues during privatization; (ii) transfer of international best practice in assessing environmental risks and identifying cost-effective ways of addressing them; and (iii) establishment of proper

2 During negotiations the Borrower and the Bank agreed that in order for the third tranche to be disbursed payments from the remediation accounts should equal to approximately 70% of the Loan amounts already disbursed under the first and second tranche. 19 mechanisms for the implementation of environmental measures. The Bank's involvement in the detailed implementation of environmental remediation plans, however, is not necessary and practical. By focusing on policy reforms and the regulatory framework, the Bank's support would apply to the whole program of privatization rather than to a small number of individual deals only. 4.18 The Government could have chosen not to investigate the scope of environmental liabilities of privatizing companies in detail, and transferred the responsibility and an estimated cost of remediation to the strategic investors. However, in this case (i) the net present value of privatization revenues would likely be significantly lower due to higher risk and open-ended responsibilities imposed on investors; and (ii) future disputes would be likely to prevent solutions to serious environmentalproblems and would require public resources.

I. TECHNICAL ASSISTANCE

4.19 In connection with the EPSP, the EU SARA Program has provided technical assistance to the Government to carry out environmental and cost assessments and to prepare Framework Remediation Plans in a number of enterprises including Kremikovtzi, Neftochim and Assarel Medet. The EU SARA Program has agreed to provide additional technical assistance for cost assessment and Framework Remediation Plans for Agropolychim, Agrobiochim, Chimco, LEKO-KO-Radomir, KCM Plovdiv, OZK Kardjali, Eliseina mine, Elazite mine, Osogovo mine and Gorubso complex.

4.20 The EU PHARE Program is providing technical assistance to the MOEW to strengthen its capacity in environmental assessment, auditing, and enforcement. In addition, the MOEW has received support from the Danish Ministry of Energy and Environment in the "Harmonization of the Bulgarian Environmental Legislation with the EU Requirements for Industrial Pollution Control". The second stage of this program is aimed at the implementation of the requirements of the EU Directive 96/61 on IPPC. Under the Danish assistance program, assistance will be provided to: * Train staff in MOEW, regional environmental inspectorates, and enterprises in application of integrated environmental permits. * Prepare legislation for integrated pollution control, and integrated environmental permits, regulations for the implementation of the Ambient Clean Air Act and Air Pollution Act and their harmonization with respective EU directives. * Prepare samples of applications and integrated permits according to the EU IPPC Directive.

J. IMPLEMENTATION AND INSTITUTIONAL RESPONSIBILITIES

4.21 Several agencies would be involved in the implementation of the Environment and Privatization Support Program supported by the Loan. Annex 3 provides a detailed description of the institutional responsibilities of the agencies concerned. 20

Ministry of Environment and Waters (MOEW)

4.22 The MOEW will take the lead in the (i) introduction and implementation of environmental policy reform measures; (ii) implementation of pilot integrated environmental permits for selected enterprises from the metallurgical and chemical industries; (iii) review, negotiation, approval of EIAs, including Framework Remediation Plans and Compliance Plans, and Execution Agreements acceptable to the Bank; (iv) oversight and enforcement of the implementation of Framework Remediation Plans, Compliance Plans, and Execution Agreements; (v) inter-agency technical coordination as chair of the Oversight Technical Committee, and as member of the inter-agency coordinating body; and (vi) monitoring and reporting on the fulfillment of Bank loan tranche conditions concerning the MOEW's responsibilities. 4.23 The MOEW will be responsible for submitting to the World Bank for review the EIAs, including Framework Remediation Plans and Compliance Plans and for making revisions as appropriate, based on comments received from the Bank. The MOEW would be responsible for approval of the Framework Remediation Plans and Compliance Plans acceptable to the Bank. The MOEW together with the MOF, would sign legally binding Execution Agreements with the new owners of privatized enterprises, and would oversee the technical implementation of the Execution Agreements. During implementation of Remediation Plans, the MOEW would be responsible for initiating conflict resolution and arbitration mechanisms in cases when disputes arise. It would ensure efficient participation of its Regional Inspectorates in analyzing the effects of the policy improvements and impact of the implementation, and monitoring the remediation and compliance measures. The Ministry would have to take measures to improve the ability of Regional Inspectorates to efficiently perform environmental monitoring. The Ministry would keep records for each enterprise under the EPSP of the timely fulfillment of the conditions of Remediation and Compliance Plans.

Privatization Agency (PA)

4.24 The PA will be responsible for (i) including the results of environmental audits and assessments, as well as references to environmental requirements in the Information Memoranda of bidding documents, and in the negotiation process; (ii) including environmental clauses, acceptable to the Bank, into the Sales Purchase Agreements; (iii) signing together with the MOEW and MOF the Execution Agreements with the new owners of privatized enterprises; and (iv) ensuring that Framework Remediation and Compliance Plans and Execution Agreements, acceptable to the Bank, are attached as integral parts of the Sales Purchase Agreements. 4.25 The PA will ensure that copies of the appropriate parts of the Sales Purchase Agreements, as well as the Framework Remediation and Compliance Plans and Execution Agreements would be submitted to the Bank for enterprises considered under tranche one and tranche two of the loan. The PA, through the Oversight Technical Committee and the inter-agency coordinating body, will facilitate the implementation of Execution Agreements, and the resolution of potential disputes arising during the implementation of the Framework Remediation and Compliance Plans. 21

Ministry of Finance (MOF) 4.26 The MOF will be responsible for Loan management and more specifically for (i) signing, together with the MOEW, and PA the Execution Agreements with the new owners of enterprises in the agreed sectors for the implementation of Framework Remediation Plans; (ii) ensuring that each year during the implementation of the EPSP, the projected amounts needed for the implementation of Framework Remediation Plans based on the Execution Agreements will be appropriated in the budget; (iii) record keeping of disbursements from Deposit Account in BNB; (iv) record keeping of disbursements into and from Remediation accounts; (v) arranging for annual audits of the Deposit Account and Remediation Accounts; (vi) coordinating with the MOEW to ensure the availability of adequate funds according disbursement schedules set out in the Execution Agreements; (vii) providing to the Bank disbursement reports of the Deposit and Remediation Accounts; and (viii) providing progress reports to the Bank on fulfillment of tranche conditions. MOF has nominated an employee to carry out the duties of Loan Manager. Inter-Agency Coordination 4.27 Implementation of the EPSP will require the collaboration of affected Government agencies and public consultations. An inter-agency consultative group consisting of officials and experts from the MOF, MOEW, PA, and the Ministry of Economy successor of the MOI have been established by an order of the Minister of Finance. The technical review and approval of execution of each stage of the remediation programs would be the responsibility of the Technical Oversight Committee chaired by MOEW.

K. LOAN FINANCIAL MANAGEMENT, DISBURSEMENT, AND AUDITING

4.28 The proposed EPSAL of Euro 49.5 million will be made to the Republic of Bulgaria. Upon notification of Loan effectiveness and approval of the fulfillment of tranche one conditions, the Bank, at the request of the Ministry of Finance, will deposit the proceeds of tranche one into a Deposit Account in the BNB. Prior to that, the Bank will withdraw from the Loan Account a front-end fee amounting to Euro 495,000. The remaining funds amounting to Euro 34,155,000 would be released to the Borrower in two tranches upon fulfillment of loan conditions over a period of three years. 4.29 Prior to furnishing to the Bank a request for withdrawal of loan funds, the MOF will open and maintain in BNB a Deposit Account to exclusively hold the loan proceeds in accordance with terms and conditions satisfactory to the Bank. Over the life of the EPSP, the MOF will allocate annually funds from the central budget sufficient to cover the expenditures for the execution of the approved Framework Remediation Plans, and in accordance with the provisions of the Execution Agreements3 . The MOF will open and maintain Remediation Accounts, according terms and conditions satisfactory to the Bank, in which funds from the central budget will be transferred. The MOF will maintain a balance in the Remediation Accounts sufficient to cover forecast spending for at least one

3 During negotiations the Borrower and Bank agreed that upon disbursement of the third Loan tranche, expenditures committed under the Execution Agreements by the Bulgarian Government in respect of the enterprise privatized under the EPSP would exceed the total Loan amount. 22 year, following the start of each fiscal year. Upon receiving a request for payments from eligible enterprises, MOF will make payments from the Remediation Accounts in accordance with the signed Execution Agreements.

4.30 Loan management will be the responsibility of a Loan Manager employed by the MOF. The Government will maintain accounts and records, or ensure that such items are maintained, showing that loan disbursements were in accordance with provision of the Loan Agreement and the supplemental letter to the Loan Agreement. Such accounts and records will be maintained in a form acceptable to the Bank. The MOF will arrange for the audit of the Deposit Account and Remediation Accounts in accordance with auditing standards acceptable to the Bank and by auditors acceptable to the Bank. An external auditor of BNB will conduct an annual review of the Deposit Account and the Remediation Accounts under terms of reference of the review acceptable to the Bank. The MOF will make the report on the audit of such records available to the Bank. The Loan Manager will be responsible for preparing the withdrawal applications, maintaining the Deposit Account and Remediation Accounts. He/she will be responsible to maintain accounts and records in a form acceptable to the Bank, showing that disbursements were in accordance with the provisions of the Loan Agreement. The Loan Manager will also be responsible for coordinating the preparation of the Borrower's contribution to progress reports and to the Implementation Completion Report by writing those sections relating to loan administration, while the MOEW will write those sections concerning the technical implementation of EPSP.

4.31 In accordance with the Bank Operational Directive of February 8, 1996 on the Simplification of Disbursement Rules under Structural Adjustment and Sectoral Adjustment Loans, funds disbursed under the proposed Loan will be released against satisfactory implementation of the program set forth in the Loan. This includes compliance with stipulated second and third Loan tranche conditions, and progress shown in carrying out the program set forth in the Letter from the Government on its Policy Regarding Environmental Liabilities in Privatization (Annex 1). Disbursement will not be linked to any specific purchases. Thus, evidence will not be needed to support disbursement, nor will procurement requirements be necessary. L. REPORTING

4.32 Reporting requirement will ensure that the Bank is able to monitor the developments in certain areas of concern. Progress in implementing the EPSAL will be monitored through semi-annual reviews conducted by the Bank. The Government will submit to the Bank semi-annually progress reports on the execution of the EPSP. The monitoring and reporting of implementation and overall compliance with loan conditions will be the responsibility of the MOF based on reporting by the MOEW on the execution of Framework Remediation and Compliance Plans. The following indicators will be applied to monitor performance: * Number and cost of implementing Framework Remediation Plans and Compliance Plans agreed between new owners of the privatized enterprises and the Government according to principles and procedures acceptable to the Bank. 23

* Satisfactory execution of Framework Remediation Plans according to stages of works agreed in time-bound Execution Agreements and agreed environmental performance indicators. * Compliance with water and air emissions requirements specified for each enterprise in the Compliance Plans. * Agreed measurable improvements in environmental quality indicators of plants agreed under the Framework Remediation and Compliance Plans. * The number of enterprises for which integrated pilot environmental permits are issued according to EU 1996 Directive on IPPC.

M. ENVIRONMENTAL CATEGORY

4.33 The proposed EPSAL is expected to have a significant positive impact on the environment. The objective of the Loan is to help achieve environmental improvements. The loan supports the establishment of a framework for improving environmental conditions and performance of privatized enterprises. Some of these improvements will require investments for remediation of past contamination and for changes in production technologies. According to the regulatory improvements adopted by the Government related to privatization, the Government is responsible for reviewing and approving environmental assessments of the proposed investments, both as financier of the remediation plans and in its regulatory capacity. Monitoring of environmental compliance is a responsibility of the MOEW and its regional structures. The proposed Loan has been examined by ECSSD and placed in Environmental Category Fl. 4.34 Framework Remediation and Compliance Plans will be prepared, reviewed, discussed publicly, and approved according to the Bulgarian EIA requirements. These have been broadly harmonized with the international procedures and practices. The Bulgarian EA procedures have also been thoroughly reviewed by the Bank and found consistent with the Bank's EA requirements and safeguard polices. All Framework Remediation and Compliance Plans included in the EPSP and implementation progress reports will be subject to Bank review. An adequate loan supervision budget will ensure efficient monitoring of implementation of the environmental reform measures and the framework for incorporating environmental issues into the privatization process.

N. SUSTAINABILITY AND RISKS

4.35 The Government strongly supports the EPSP. However, there are four groups of risks associated with implementation: 1. Failure to complete the privatization program. The implementation of the EPSAL is dependent on the successful implementation of the structural reforms namely successful privatization of large enterprises from the metallurgical and chemical industries. Privatization delays of large, highly polluting enterprises would weaken the EPSP. The targets established under the Extended Arrangement with the IMF and under the Bank's FESAL II imply that the Government has strong incentives to push the privatization program forward as rapidly as possible, which minimizes the risk of privatization delays. At the same 24

time, the support provided under this operation will enhance the prospects for successful privatization of large industrial enterprises. 2. Failure to apply the agreed mechanisms to address environmental issues in the privatization contract. The Government's commitment to introduce the agreed mechanisms may be weakened by pressure to complete individual privatization deals quickly, especially in cases where the investor has little interest in addressing environmental problems at the time of privatization. Transactions which do not comply with the agreed procedures, will not qualify for meeting the conditions for the release of the Loan tranches. Substantial efforts have been made to ensure that environmental assessments, which provide the necessary environmental information, are available to the responsible Government agencies and potential investors, as early as possible during the privatization process. Experience to date suggests that access to such information encourages bidders (and their financiers) to seek a full agreement on environmental issues as part of the overall sale agreement. 3. Failure to enforce the implementation of Compliance and Remediation Plans. The implementation of Framework Remediation and Compliance Plans will be the responsibility of the private sector. The Government may fail to enforce their implementation due to insufficient institutional capability to work with private sector. Provisions to partially mitigate this risk were made through establishing clear contractual arrangements between the Government and new owners of privatized enterprises in the Execution Agreements. In order to mitigate this risk EU-PHARE will provide technical assistance to the post-privatization unit in the PA to strengthen the monitoring of investment commitments of new owners and take measures in the event of non-compliance. The Bank and the Government have worked closely in the design of the EPSP implementation arrangements, and monitoring, and oversight requirements to ensure that necessary arrangements have been put in place before the start of the program. The MOEW will improve the ability of the Regional Environmental Inspectorates to efficiently monitor the impact of remediation and compliance requirements. 4. Failure to implement Compliance and Remediation Plans due to disputes between the private sector and the Government. Changes in the agreed Framework Remediation and Compliance Plans may delay implementation if lengthy disputes arise between the new owners, and the Government is unable to agree on modifications to the plans as a result of disagreements over technical, cost, and/or environmental compliance issues. The risk of such delays is partly mitigated by the technical assistance provided through the EU SARA Program for preparation of environment and cost assessments in the course of privatization, and also by agreeing on the institutional responsibilities within the Government for dealing expeditiously with disputes. As a fallback, the Execution Agreement covering the implementation of the compliance and remediation plans, annexed to the privatization contract, will contain provisions for binding arbitration in accordance with the UNCITRAL Arbitration Rules. The terms of the Execution Agreement and all other associated documents must be satisfactory to the Bank for a transaction to qualify with respect to meeting the tranche release conditions. 25

0. COLLABORATION WITHIN THE BANK AND WITH THE IMF AND EU. 4.36 The preparation of the loan was supported by the financial assistance provided by EU SARA Program to carry out baseline environmental audits and additional environmental assessments for several large enterprises. Additional pre-privatization technical assistance for the preparation of additional environmental assessments and to provide access to independent expertise and advice has been agreed and is under implementation. The preparation of the EPSAL has been in consultation with the Bank FESAL and IMF teams.

P. PROGRESS TO DATE AND TIMETABLE

4.37 Loan negotiations were successfully completed in December 1999. Conditions for tranche one have been fulfilled. It is anticipated that conditions for tranche two and tranche three will be met over a three-year period.

V. RECOMMENDATION 5.01 I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the loan.

James D. Wolfensohn President by Sven Sandstrom

Washington D.C. January 24, 2000

Annex I Page I of 10

LETTER FROM THE GOVERNMENT OF REPUBLIC OF BULGARIA ON ITS POLICY REGARDING ENVIRONMENTALLIABILITIES IN PRIVATIZATION

December 27, 1999

Mr. James Wolfensohn President The World Bank

Dear Mr. Wolfensohn:

1. This letter refers to the World Bank's proposed assistance to the Government of the Republic of Bulgaria to support policy reforms addressing environmental liabilities in the process of privatization of state owned enterprises. The purpose of this letter is to set out the broad objectives of the Government's policies with respect to environmental liabilities and obligations, the harmonization of Bulgarian environmental requirements with those of the European Union (EU), and the institutional and regulatory framework for the implementation of these policies.

Macro-Economic Background 2. Our Government successfully stabilized the economy and substantially advanced long-delayed structural reforms with the support of IMF and the World Bank. We recognize that the immediate challenge is to sustain the success in the stabilization with durable structural reform combined with restored confidence in public institutions. We aim to build on the gains for establishing of an economy with a competitive private sector. This will ensure significant improvements in the living standards of the Bulgarian citizens and will prepare Bulgaria for the accession to the EU, one of the main goals established in our Program 2001. We strongly believe that the assistance of the international community -- in terms of financial resources, technical assistance, and access to foreign markets -- can harness our efforts toward this goal.

3. The Kosovo conflict had a negative impact on Bulgaria's economic and external balance developments. The closure of the border with FR Yugoslavia in late March 1999 resulted in direct and transit trade losses. The conflict affected investor confidence and a number of large privatization deals were put on hold. However, after the war investor confidence revived quite rapidly and foreign direct investment is now expected to be higher than initially projected for 1999. Nonetheless, the Kosovo conflict increased the overall balance-of-payments financing needs of Bulgaria for 1999 by about one percent of GDP, which is less than what was initially estimated, but still implies a substantial increase in the balance-of-payments gap. We estimate that the negative impact on growth was about 1.5 percent. Annex I Page 2 of 10 4. To achieve these objectives, as part of the reform program, the Government has focused its efforts on accelerating the large-scale privatization program. As of October 31, 1999, about 75percent of the long-term assets from the current privatization program has been privatized or placed under bankruptcy or liquidation. We expect that the privatization of the medium to large SOEs will be completed by March 31, 2000. We are currently restructuring the energy sector to enable privatization of various segments of the sector.

Environmental Policy Framework 5. As we pursue our economic objectives, we cannot ignore the negative environmental consequences of past development policies. The socialist system left Bulgaria with serious environmental problems and a relatively weak and ineffective institutional and regulatory system. Unsustainable industrial management practices of the state owned enterprises resulted in the infamous "hot spots" where people have been exposed to unacceptably high levels of pollution, and the accumulation of hazardous substances, which contaminated drinking water resources and threatened ecosystems with irreversible damage.

6. During the past years, significant progress has been made in dealing with specific sources of pollution and building institutional capacity to address environmental priorities in Bulgaria. The Bank assisted the Government to carry out an Environmental Strategy Study (FY93) and an Update and Follow-up (FY95). Additionally, the EU Phare Program has been providing technical assistance to the Ministry of Environment and Waters (MOEW) to strengthen its policy and regulatory capacity, and assist domestic consultants and experts in developing skills to carry out environmental assessments.

7. Bulgaria has adopted an Environmental Protection Act, which revised the system of standards, legalized the "polluter pays principle", and provided the public access to environmental information. Bulgaria has established new environmental assessment (EA) procedures and requirements for all projects with potentially significant impact on the environment. These procedures have been gradually refined and adjusted to adopt Western practices, esDecially concerning requirements for public information and consultation. The new legislation provides for more efficient division of respon.sihilitie between the institutions engaged in environmental protection.

8. Bulgaria signed an EU Association Agreement in 1993, which was ratified by parliament in 1995, thus committing the Government of Bulgaria to aligning its legislation with that of the EU. The approximation in the environmental sector is the responsibility of the Ministry of Environment and Waters. The Ministry received support from PHARE DISAE (Development of Implementation Strategies for Approximation in Environment) facility to prepare an approximation program. The program includes, inter alia, cross sectoral aspects of environmental management, legal issues such as river basin management, transboundary pollution, establishment of an Executive Agency for Environment, economic regulators including integrated permits and the management of environmental funds. The program includes the development of legislation, sub- legislative acts, such as regulations, emission standards etc. At this stage, the Government recognizes that the existing laws and regulations are pertinent to the Annex I Page 3 of 10 objectives of the EU environmental acquis and to the modem environmental management system.

9. Despite the significant steps towards improved environmental protection policies and the institutional capacity built to address environmental priorities, and the achievements in dealing with specific sources of pollution, the results to bring us close to the EU environmental requirements, are still modest

Links Between Macroeconomic Reform and Environmental Policy

10. Bulgarian economy was deeply affected by the economic crisis in 1996-97. The economic contraction hit investments hardest. The financial resources available to the enterprises sector from internal and external sources have declined drastically. Consequently, necessary measures to improve environmental performance in the industrial sector have not been made.

11. The Government now pays serious attention to the existence of environmental problems, and it considers privatization as an opportunity to encourage and force polluting industries to improve their environmental performance, adopt internationally recognized environmental management practices, and comply with appropriate environmental regulations. We believe that restructuring of the industrial sector following privatization can benefit both the economy and the environment by changing production and managerial objectives.

12. We recognize that the implementation of sound policy reforms aimed at economic recovery and growth, including privatization, will have to be accompanied by environmental policies and targeted environrnental protection programs in order to achieve the maximum welfare benefits from economic reforms. The challenge for the Government within the context of the economic restructuring is twofold: first, to provide a regulatory framework, procedures, and clear guidelines for dealing with the legacy of past pollution; second, to integrate environmental considerations in the reform process, thus upgrading environmental policy from sectoral to macroeconomic development policy. This process requires highly diversified participation and support from different political and economic entities.

13. There are two separate, but closely linked issues, which must be solved:

The environmental legacy of the past is a major concern especially for sectors where environmental liabilities are large. These include mining and metallurgy, chemicals and petrochemicals and oil refining. There is a need for a clear legal framework supported by mechanisms which would (a) assess the magnitude of past liabilities, (b) develop plans for appropriate remediation and management of the liabilities, (c) agree on the respective responsibilities of the government (as seller) and the new owners for implementing and financing these plans, and (d) deal with hidden liabilities whose extent and nature only emerge after privatization is completed. Annex I Page 4 of 10 . Few industrial plants are currently able to comply with existing Bulgarian environmental regulations with respect to their emissions, let alone any future regulations that will be adopted as Bulgaria moves to implement EU environmental directives. It is clear that the responsibility for future compliance with environmental regulations must lie with the new owners. However, the nature of the emission standards that will apply and the time allowed for compliance with these standards may have a large impact on the valuation and future investment plans of the enterprise.

14. Based on the above considerations and the lessons learned from the Bank-assisted Environmental Remediation Pilot Project, which established a model for addressing past environmental damages and ongoing pollution, we have recognized that there is a need for a comprehensive policy approach and active involvement of various institutions concerned. That is why our Government decided to embark on the Environment and Privatization Support Program outlined below.

15. In order to provide a stable macroeconomic environrnent in which the proposed environmental policies could succeed, the Government is committed to pursue the agreed policies and reform measures under the proposed FESAL II programs and the Extended Agreement with the IMF conducive to the long term development of the country. In this context, the proposed policies and actions under the EPSP are complementary to the privatization goals set up in the reform program.

Environment and Privatization Support Program (EPSP) 16. The key objectives of the EPSP are to achieve environmental improvements and to support the privatization of highly polluting enterprises by adopting and implementing policy and regulatory reforms, accelerating the implementation of EU environmental directives, and establishing a satisfactory framework for incorporating environmental issues into the privatization process. The program would focus on the following areas:

Environmental regulatory reform

17 The key objectives of the environmental regulatory reform are to (i) streamrline and improve environmental regulations; (ii) facilitate the harmonization of Bulgarian legislation with those of the European Union (EU); and (iii) establish a consistent framework for addressing past environmental liabilities.

18. To achieve these goals the Government has recently undertaken the following steps to improve the existing legal and regulatory framework:

(a) Adopted changes in the Environment Protection Act and the Law on Restructuring and Privatization of State and Municipal Enterprises and its amendments, confirming that the State retains responsibility for environmental pollution resulting from part action or non-action. (b) Adopted Council of Ministers Resolution No. 115/1998, which introduces Annex I Page 5 of 10 requirements for all state owned enterprises in privatization to commission Environmental Impact Assessments including an assessment of remediation costs of historical pollution prior to privatization. c) Issued new EIA Regulation No.4/1998 setting out Environmental Impact Assessment requirements and procedures in compliance with the Methodological Guidelines for Scope and Substance of Past Environmental Pollution Reports in Privatization promulgated by Order of the Ministry of Environment and Waters.

Proposedfurther reform measures: * Protection of water and subterranean resources. In order to address off-site liabilities and specific disposal sites having problems with contaminated land and ground water, a new law on Subterranean Resources and a Water Act will be approved by Parliament to prevent further environmental degradation of natural resources. * Temporary emission requirements for effluent waters to facilitate environmental compliance by privatized companies. Passage and enforcement of a new Water Act will provide a mechanism for determination of individual emission limits and other related emission restrictions. It will enable the Ministry of Environment and Waters to determine realistic compliance requirements for privatized enterprises and to agree on a plan for the adjustment of production processes, technology, and investment requirements. * Conditions and procedures for establishing State liability for past environrnental damage and for estimating the costs of on-site environmental damages. Recent changes in the Privatization law do not provide for clear procedures and conditions for the State to fulfill its responsibilities for past environmental damages. This issue will be regulated by a Council of Ministers' Regulation. The Regulation will set up the principles for assessment of remediation measures and associated costs. Integrated Pollution Prevention and Control 19. In 1996, the GOB introduced an environmental auditing program with the objective of improving the compliance of enterprise operations with environmental legislation. The scope and content of Audit Reports follow the requirements of the European legislation on voluntary participation of industrial enterprises in the Environmental Management and Audit Scheme (EMAS) and Directive 96/61 on Integrated Pollution Prevention and Control (IPPC). The IPPC directive establishes a framework for industrial pollution control in the EU and is gradually being adopted and implemented by member countries.

20. Bulgaria is not expected to comply with the IPPC directive until it becomes a member of the EU. However, by adopting and implementing - as much as possible -- the provisions of the EU Council Directive 96/91 for newly privatized enterprises, and by allowing appropriate periods for compliance, the Government will provide greater certainty to the new owners about the environmental standards and environmental compliance requirements applicable to their operations. AnnexI Page 6 of 10 21. It is the intention of our government to accelerate the adoption of the EU environmental directives as one element of our fundamental goal for harmonization of environmental legislation with that of EU. Specifically, the standards and the provisions for implementing IPPC directive will serve as a basis for establishing Environmental Compliance Plans for privatized companies, that would also form a part of the privatization contracts.

Medium-Term Measures 22. The Government is committed to a series of actions in the medium term, which will foster the legal approximation process, which are:

* Adoption of a timetable for introducing changes in the exsiting legislation to allow implementation of the provisions of the EU Council Directive 96/61 on the integrated pollution prevention and control (IPPC) by November 1999.

* Adoption of a timetable for implementation of the provisions of the EU Council Directive 96/61 on the integrated pollution prevention and control (IPPC) by November 1999.

- Issuing of pilot integrated environmental permits according to the IPPC Directive 96/61 for at least 5 large enterprises in the metallurgical and petroleum sectors by November/December 2000.

* Extension of the coverage of the system of pilot integrated environmental permits by implementing pilot permits according the IPPC Directive 96/61 for at least 80% of all large industrial enterprises (with 1000 employees and above) in the metallurgical, chemical sectors by December 2001.

Framework of integrating environmental issues into privatization

23. In addition to the above policy measures, our Government is committed to adopting and adhering to an agreed set of procedures and conditions which are needed to systeniatically incorporate environmental issues initothe privatization process. These will increase the effectiveness of enforcing environmental laws and regulations pertaining to privatization, and it will ensure the achievement of the EPSAL's objectives.

Agreed procedures Environmental Impact Assessments (EIAs). EIAs, including an assessment of current environmental performance and past contamination, will be prepared for each enterprise under privatization according to Bulgarian regulations. The assessment of past environmental liabilities to be included in the EIA will follow the Methodological Guidelines for the Scope and Content of Past Environmental Pollution Reports in the Privatization Process. According to the methodology, the scope of environmental assessment will depend on the magnitude of environmental risks. Adverse social impacts, if any, will be addressed during the EIA public consultation process, through official complaints from affected people, as well as for monitoring the effect of the activities identified under the EIAs, Remediation and Annex I Page 7 of 10 Compliance Plans. * Remediation Plans. The environmental assessments will identify remedial measures to protect human health and ecosystems and to upgrade environmental performance of enterprises to meet Bulgaria and/or EU emission requirements. Remediation Plans will specify measures, cost estimates of investments and time schedule for completing remedial work needed to address environmental damage from companies' activities prior to privatization.. . Compliance Plans. The EIA will also examine the current environmental performance of the enterprise or plant and will propose a plan to bring the operation into compliance with relevant emission standards. The EIA conclusions will imply a program of environmental investments for cleaner technologies and waste reduction measures to bring into compliance the environmental performance of privatized enterprises with Bulgarian and /or EU emission requirements. Compliance Plans will determine specific temporary norms that will apply to enterprises during the transition period until regular standards could be achieved. Compliance plans will outline time bound program of environmental investments, which will be agreed as part of the Sale Purchase Agreement. * Negotiations. In accordance with the provisions of the Bulgarian environmental legislation, the full EIA is subject to public consultation and discussion before it is approved by the Expert Council of the MOEW/Regional Inspectorate. In practice, these final stages of the EIA process will be completed after negotiations with the selected bidder to ensure that the terms and requirements of the Framework Remediation Plan and future environmental Compliance Plans are agreed with the new owner before they are approved by the MOEW.

3 Sale Purchase Agreements. The sale purchase agreement should include (i) legal references to the environmental obligations of the buyer; (ii) provisions for arbitration in case the Government and buyer have future disagreements about the buyer's environmental obligations; and (iii) environmental annexes including binding Framework Remediation Plan (FRP) and Compliance Plan with explicit provisions for financing, imnplementation,performance indicators, time limits and arbitrary n-echanism,and Execution Agreements.

. Environmental Annexes. In case the environmental annexes cannot be agreed upon at the time of the sale, the sale agreement will refer to the environmental annexes to be added within an agreed period no later than 6 months from the sale at which time they become binding parts of the sale agreement. The sale agreement will set an upper limit to the cost of Remediation Plan (cost cap) based on environmental audits and cost assessments of the remediation measures.

Execution Agreements. The buyer according to the Execution Agreement will be responsible for the execution of the remedial works. The Execution Agreements will include Framework Remediation Plans with schedules; benchmarks (stages of remedial work to be undertaken) and performance indicators against which agreed lump sum payments will be reimbursed by the Government to the buyer. The Annex I Page 8 of 10 implementation of FRP will be confirmed by the establishment of an insurance/performance bond mechanism issued in agreed amounts and corresponding with the cost of remedial measures.

24. To achieve the objectives of the Environmental and Privatization Support Program, the Government of Bulgaria will implement the Remediation and Compliance Plans in consultation with the primary stakeholders to create public awareness, build support for the proposed activities and will allow for community monitoring and evaluation during implementation. To extend the community ownership of the EPSP we will seek local input on social and environmental issues during implementation of the program, and will ensure that community monitoring procedures and structures are in place during project implementation. Further to that, the GOB will make its best efforts to identify and address potential social issues arising from the implementation of the EPSP activities in a manner consistent with the best social practices. If adverse environmental and social impact are identified during the public consultation process under the EIA, or during the monitoring activities carried out under the EIA and under the implementation of the remediation and compliance measures the Government will take measures or will ensure that measures have been taken to mitigate any such impacts.

25. To ensure that the social concerns are taken into account in the privatization of state owned enterprises the Government has initiated a severance payment scheme to provide support to workers laid-off as a result of the structural reform measures. The EPSP program will provide diverse employment opportunities, additional new jobs and business development in the private sector. In the medium and long run, it is expected that the execution of the environmental investment programs under the Compliance plans will prolong the demand for new jobs, which will partially offset negative social effect of the downsizing of privatized enterprises.

Institutional Responsibilitiesfor the Execution of EPSAL 26. Several agencies have been involved in the preparation of the loan and will continue to exercise specific responsibilities under the Environment and Privatization Support Program (EPSP).

Ministry of Environment and Waters 27. MOEW will take the lead in the (i) introduction and implementation of environmental policy reform measures; (ii) implementation of pilot integrated permits for selected enterprises from the metallurgical and chemical industries; (iii) review, negotiation, and approval of EIAs, including Remediation and Compliance Plans, and Execution Agreements acceptable to the Bank; (iv) oversight and enforcement of the implementation of Remediation and Compliance Plans and Execution Agreements; (v) inter-agency technical coordination as chair of the Oversight Technical Committee, and as member of the inter-agency coordinating body; and (vi) monitoring and reporting on the fulfillment of Bank loan tranche conditions concerning the MOEW's responsibilities.

28. The MOEW will be responsible for submitting to the World Bank for review the EIAs, including Framework Remediation, and Compliance Plans, of the privatized enterprises, and for making revisions, as appropriate, based on comments from the Bank. Annex I Page 9 of 10 MOEW will be responsible for the approval of the Framework and detailed Remediation Plans and Compliance Plans acceptable to the Bank. The MOEW, together with the MOF and PA will sign legally binding Execution Agreements with the new owners of privatized enterprises, acceptable to the Bank and will oversee the technical implementation of the Execution Agreements. The MOEW will ensure that the Bank has an opportunity to review and comment on the Execution Agreements before they are finalized. During implementation of the FRP, the MOEW will be responsible for initiating conflict resolution and arbitration mechanisms in cases when disputes arise. It will ensure the efficient participation of its Regional Inspectorates in analyzing the effects of the policy improvements and impact for implementation monitoring of the remediation measures and Compliance plans. MOEW will take measures to improve the ability of the Regional Inspectorates to efficiently perform environmental monitoring. The MOEW will keep records for each enterprise under the EPSP of the timely fulfillment of the conditions of Compliance and Remediation Plans.

Privatization Agency

29. The PA will be responsible for (i) including the results of environmental audits and assessments, as well as references to environmental requirements in the Information Memoranda of bidding documents, and in the negotiation process; (ii) including environmental clauses acceptable to the Bank, into the sale purchase agreement; (iii) ensuring that the Framework Remediation and Compliance Plans and Execution Agreements, acceptable to the Bank, are attached as integral parts of the Sales Purchase Agreements.

30. The PA will ensure that copies of the appropriate parts of Sale Purchase Agreements, as well as the Framework Remediation and Compliance Plans and Execution Agreements will be submitted to the Bank by January 20, 2000 for Neftochim, Kremikovtsi and Assarel-Medet. The PA will also ensure that, and at the time of the sale, or no later than six months thereafter, such documents will be submitted to the Bank for the privatized enterprises considered under tranche two of the loan. The PA, through the Oversight Committee and the inter-agency coordinating body, will facilitate the implementation of Execution Agreements, and the resolution of potential disputes arising during the implementation of Remediation and Compliance Plans.

Ministry of Finance 31. The MOF will be responsible for Loan management and more specifically for: (i) signing, together with the MOEW and PA the Execution Agreements with the buyers of enterprises in the agreed sectors for the implementation of Environmental Remediation Plans; (ii) ensuring that each year during the implementation of the EPSP, the projected amounts needed for the implementation of Remediation Plans based on Execution Agreements will be appropriated in the budget; (iii) record keeping of disbursements from the Deposit Account in BNB; (iv) record keeping of disbursement into the Remediation Accounts; (v) arranging for annual audits of the Deposit Account, and Remediation Accounts; (vi) coordinating with the MOEW to ensure the availability of adequate funds according to disbursement schedules set in the Execution Agreements; (vii) provide to the Bank disbursement reports of the Deposit Account and Remediation Accounts; (viii) provide progress reports to the Bank on fulfillment of tranche conditions. Annex I Page 10 of IO EPSAL management and reporting will be a responsibility of the MOF. MOF has nominated an employee to carry out the duty of Loan manager.

Institutional Coordination 32. The Govemment recognizes the need for better institutional coordination in order to accomplish the environmental objectives of the Environment and Privatization Support Program (EPSP), supported by the Bank. This will require effective and efficient collaboration of affected Government agencies. Therefore, an inter-agency consultative mechansim consisting of the MOF, MOEW, PA and MOI will be established by Order of the MOF By January 15, 2000 under the leadership of the MOF consisting of representatives at the Deputy Minister/Deputy Executive Director levels supported by technical experts to facilitate the integration of environmental issues into privatization according to the agreed mechanisms.

33. The technical,review and approval of execution of each stage of the remediation programs of enterprises will be responsibility of an Oversight Technical Committee, chaired by the Ministry of Environment and Waters and established by a Decision of the Council of Ministers by January 15, 2000. It is also understood that the ability of the PA to monitor the post-privatization process is critical for the success of the EPSP. To this end, the PA will strengthen the capacity of its post-privatization monitoring and control unit to strengthen the monitoring of investor's commitments and take measures against non-compliance.

34. We are pleased with the support the Bank has been extending to our Government for the implementation of the structural reform and environmental management improvements. We are confident that the implementation of the Government's policies related to environmental liabilities in the privatization process will greatly benefit the development of a viable private sector; will reduce health risks of the population; and will improve enterprise environmental performance. We look forward to pursuing our environmental goals and objectives across all sectors of the economy with vigor and expect that your assistance will greatly enhance our capabilities to achieve these ends.

Pelter Z(h6e Evdokia Maneva Deputy rime Minister and Minister of Environment and Waters Minister of Economy Annex 2 Page 1 of 4

REPUBLIC OF BULGARIA ENVIRONMENTAND PRIVATIZATIONSUPPORT ADJUSTMENT LOAN POLICY MATRIX: OBJECTIVESAND TRANCHE CONDITIONS

Components/objectives Measures taken before the first Measures to be taken before the Measures to be taken before Components/objectives tranche release second tranche release the third tranche release

A. Policy and Regulatory Reform 1. Support to the country's Satisfactory macroeconomic performance, Satisfactory macroeconomic Satisfactory macroeconomic restructuring and privatization includingcontinued compliance under the performance included continued performance included continued program. Extended Arrangements with the IMF and compliance under the Extended compliance under the Extended with the structural reforms supported by the Arrangements with the IMF and with Arrangements with the IMF and Bank. the structural reforms supported by the with the structural reforms Bank. supported by the Bank.

2. Develop legal basis for addressing Amend the Law on Restructuring and environmental liabilities. Privatization of State and Municipal Enterprises and its amendments, and the Environmental Protection Law to explicitly retain the State's liability for past environmental damages. 3. Reform environmental legislation to Parliamentary approval of the Water Act allow for the application of temporary satisfactory to the Bank. emission norms. 4. Provide a legal framework for Parliamentary approval of the Subterranean addressing off-site and hidden Resources Act satisfactory to the Bank liabilities; land use issues related to contaminated land, and a compensation mechanism for landowners.

Adoption by the Council of Ministers of a Regulation on the principles, conditions and procedures for settling the State liabilities for historical pollution. Annex 2 Page 2 of 4 Components/objectives Measures taken before the first Measures to be taken before the Measures to be taken before tranche release second tranche release the third tranche release

B. Integrate Environment Issues into Privatization Transactions

1. Develop regulations about Adopt an Order of the Minister of procedures and methodologiesto carry Environment and Waters of Guidelines for out ElAs, assess environmental risks, the Scope and Content of Past and integrate findings into privatization Contamination Damages. transactions. Prepare and approve Framework Remediation Plans and Compliance Plans for Kremikovtsi,Neftochim, and Assarel Medet, annexed to the Sales Purchase Agreements. Annex 2 Page 3 of 4

Components/objectives Measures taken before the first Measures to be taken before Measures to be taken before tranche release the second tranche release the third tranche release

Signature of Sales Purchase Agreements Satisfactory progress according Satisfactory progress according including legally binding Framework performance indicators agreed with the performance indicators agreed with Remediation Plans, Compliance Plans and Bank in the implementation of the Bank in the implementation of Execution Agreements for Neftochim, Framework Remediation Plans, Framework Remediation Plans, Kremikovtsi and Assarel Medet, under Compliance Plans, and Execution Compliance Plans and Execution which at least 67 per cent of the equity Agreements of the enterprises Agreements for enterprises considered for the first tranche. privatized as conditions of the first interest in the enterprise is transferred to a andadscnsecond tranches. rnhs private owner, for which the total cost of Signature of Sales Purchase remediation exceeds $25 million'. Agreements including legally binding Framework Remediation Plans, Compliance Plans and Execution Agreements for at least 3 additional large (over 1000 employees each) enterprises, under which at least 67 per cent of the equity interest in the enterprise is transferred to a private owner, and for which the agreed cumulative cost of remediation for these enterprises and those privatized as a condition for tranche one exceeds $50 million.'

(i) Environmentalclauses acceptable to the Bank includedin the Sales PurchaseAgreement; (ii) RemediationPlan with cost caps approvedby MOEWsatisfactory to the Bank,annexed to the Sales Purchase Agreement;(iii) ExecutionAgreement signed with MOEW. PA and MOFsatisfactory to the Bankand annexedto the Sales PurchaseAgrcement. Annex 2 Page 4 of 4

Components/objectives Measures taken before the first Measures to be taken before Measures to be taken before tranche release the second tranche release the third tranche release C. Framework for Improved EnvironmentalCompliance 1. Acceleratethe harmonization with Develop and approve a timetable and Pilot integrated environmental Pilot integrated permits according to EU Directive on IPPC and develop and targets for implementingpilot integrated permits issued accordaning to the EU the EU Council Directive 96/61 on implement a pilot program for permits substantially according to the EU Council Directive 96/61 on IPPC to at IPPC to at least 80% of all large accelerated adoption of the EU Council Directive 96/61 on IPPC. least 5 large enterprises (each with at industrial enterprises (each with at Directive for the metallurgical and least 1,000 employees) in the least 1000 employees) in the chemicals sectors (ISIC 351-354, 371- metallurgical and chemical sectors. metallurgical and chemical sectors, 372). and ensure compliance with the terms of the pilot permits. 2. Introduce compliance agreements Agreement on legally binding Compliance Satisfactory progress (based on Satisfactory progress (based on with privatized enterprises to ensure Plans annexed to the Sales Purchase performance indicators agreed with performance indicators agreed with their compliance with Bulgarian/EU Agreements for the enterprises privatized as the Bank) in the implementation of the Bank) in the implementation of environmental requirements. a condition for the first tranche. Framework Remediation and Framework Remediation and Compliance Plans and Execution Compliance Plans and Execution Agreements considered in the first Agreements considered for the first tranche. two tranches. Agreement on legally binding Contracted amounts for remediation Compliance Plans annexed to the and made payments from the Sales Purchase Agreements for 3 Remediation Accounts for enterprises additional large enterprises. privatized as a condition for tranche one and tranche two of an aggregated amount acceptable to the Bank. 3. Increase institutionalcapacity for Establish an inter-agency coordinating body Maintain the inter-agency Maintain the inter-agency post-privatizationoversight and with the participation of MOF, MOEW, PA coordinating body with membership coordinating body with membership enforcement of compliance. and MOI to oversee the implementation of satisfactory to the Bank to oversee the satisfactory to the Bank to oversee the EPSP. implementation of the EPSP. the implementation of the EPSP. Taken measures satisfactory to the Taken measures satisfactory to the Bank, or ensured that such measures Bank, or ensured that such measures have been taken to mitigate any have been taken to mitigate adverse adverse social impact of the EPSP social impact of the EPSP identified identified during EIA public during EIA public consultation consultation process or during EIA process or during EIA monitoring monitoring activities. activities Annex 3 Page 1 of 4 Ministry of Environment and Waters (MOEW) Environment and Privatization Support Adjustment Loan (EPSAL)

Loan Coordinator's Responsibilities

1. IPPC implementation * Submit to the Bank, timetable for the implementation of EU IPPC Directive 96/61, including a list of large enterprises in the metallurgical and chemical sectors which will be considered in the pilot phase of the IPPC Directive implementation. * Report to the Bank semi-annually on the progress in issuing pilot integrated permits. * Monitor and keep records on environmental compliance of each enterprise included in the pilot phase of the EU IPPC Directive implementation 2. Environmental Compliance and Remediation . EIAs 0 Ensure timely preparation and review of EIAs for all enterprises included under the EPSP. > Submit Framework Remediation Plans to the Bank for review and comments. > Submit to the Bank relevant EIA documentation for review and approval including records of public consultations. > Coordinate with the SARA unit, PA, and PATAs the preparation and review of additional environmental and cost assessments and Framework Remediation Plans. > Coordinate with the PA and MOF the timely negotiation and agreement on Compliance Plans and Framework Remediation Plans including cost caps. * Execution Agreements > Coordinate with the PA and MOF for timely negotiation and signing of Execution Agreements. > Submit to the Bank for review and comments draft Execution Agreements. > Oversee the implementation of remediation measures according to implementation schedule of the Execution Agreements. * Implementation > Keep records of technical implementation and environmental compliance of each enterprise included in the EPSP and in accordance with perforrnance indicators established in the Remediation Plans and Compliance Plans. > Review phase completion reports submitted by the investors when agreed stages of work are completed, verify technical compliance with agreed environmental and technical standards and performance indicators, and provide technical verification of phase completion reports to the MOF. > Coordinate with the Loan Manager in MOF to update disbursement schedules and plans. Annex 3 Page 2 of 4 > Initiate resolution to problems and arbitration, as necessary. Reporting > Provide bi-annual progress reports on the environmental perforrnance of enterprises implementing Framework Remediation Plans and Compliance Plans and according to a set of performance indicators agreed with the Bank > Submit bi-annual progress reports on the implementation of the Execution Agreements to the inter-government coordinating body and to the Bank. > Complete parts of the Implementation Completion Report related to technical implementation. Annex 3 Page 3 of 4

Ministry of Finance (MOF) Environment and Privatization Support Adjustment Loan (EPSAL) Loan Manager's Responsibilities

Responsibilities

1. General * Oversee the timely fulfillment of loan conditions. * Report to the Bank on fulfillment of loan tranche conditions. * Loan administration according the provisions of the Loan Agreement. 2. Implementation and disbursement * Coordinate signing of Execution Agreements. * Coordinate with MOEW, PA and MOI the organization of regular meetings of the inter-agency coordinating group. - Process the MOF's request to open a Deposit Account in BNB and Remediation Accounts in accordance with the agreed financial management provisions. - Request the Bank to deposit loan funds in the Deposit Account upon notification of fulfillment of loan conditions. * Ensure that MOF maintain adequate funds in the Deposit Account and in the Remediation Accounts in accordance with the provisions of the Loan Agreement and the supplemental letter No. 2 to the Loan Agreement. * Keep records of all financial transactions of the Deposit Account and Remediation Accounts in accordance with the provisions of the Loan Agreement and the supplemental letter to the Loan Agreement. * Arrange for payments from Remediation Accounts against completed remedial works according to the procedures outlined in the Execution Agreements. * Arrange for annual audits of Deposit Account and Remediation Accounts. * Coordinate with MOEW to ensure availability of funds from the central budget according implementation schedules and provisions of the Execution Agreements. * Provide to the Bank bi-annual progress reports of disbursements from the Deposit Account and Remediation Accounts. * Coordinate the Borrower's contribution to the Loan Implementation Completion Report and write sections that relate to loan administration. Annex 3 Page 4 of 4

Privatization Agency (PA) Environment and Privatization Support Adjustment Loan (EPSAL) Loan Coordinator's Responsibilities

1. Preparation of sales v Coordinate with Privatization Advisors and Transaction Agents (PATAs), where applicable, to ensure that: - Preparation of environmental assessments and Remediation Plans is coordinated with the MOEW. - Negotiations with prospective buyers include agreements on environmental issues. * Coordinate with the MOEW to ensure that Framework Remediation Plans are prepared and reviewed according to the privatization time schedule, and submitted to the Bank for review. 2. Sales Purchase Agreements

* Ensure that environmental references, acceptable to the Bank, are included in the Sales Purchase Agreements.

* Sign Execution Agreements together with MOEW and MOF.

* Ensure that Compliance and Framework Remediation Plans, and Execution Agreements approved by the MOEW and acceptable to the Bank, are negotiated and concluded with the Buyers, and annexed to the Sales Purchase Agreements.

3. Post-privatization monitoring * Over a period of 3 to 4 years monitor investor's commitments to implement environmental improvements in the privatized enterprises included in the EPSP. Annex 4 Page I of I

Timetable of Key Loan Processing Events

l. Time Taken to Prepare the Loan 18 Months

2. Identification Mission July 1998

3. Appraisal Mission May 22,1999

4. Negotiations December 7/8,1999

5. Board Presentation February 24, 2000

6. Planned date of Effectiveness March 2000 Annex 5 Bulpria - Seected Key Economic Indicators- 1996-1999

Actual Estiate Projeted Indicator 1996 1997 1998 1999 Gross Domestic Product GDP (USS million) 9831 10146 12255 12286 Real GDP growth (%) -10.1 -7.0 3.5 1.5 Investment (% of GDP) 8.4 11.4 14.7 15.5- Public 1.4 1.9 2.7 3.4 Private 7.0 9.5 12.0 12.1 Consumption (% of GDP) 88.5 83.1 86.3 89.5

Public Sector Balances 1/ Expenditures (% of GDP) 45.3 34.2 35.8 39.5 Revenues (% of GDP) 32.6 31.7 36.8 38.0 Deficit (-) (% of GDP) -12.7 -2.5 1.0 -1.5 Extemal Financing (% of GDP) -2.4 -1.3 -1.0 -0.7

Balance of Payments

Financing Requirements (IJSS million) -27 1789 1793 1681 o/w Current Account Deficit 2/ -522 -818 -86 283 o/w Debt Service 1248 932 1296 1203 o/w Increase in Foreign Exchange Reserves -753 1675 583 195

Financing Sources (US$ million) -27 1789 1793 1681 olw Unrequited Current OfficialTransfers 103 129 71 50 o/w Donor Financing 3/ 270 639 870 711 o/w FDI and Other Private Flows 8 640 221 545 o/w Arrears Clearance and Debt Relief 105 103 -18 50 o/w Others, inc. Errors & Omissions -513 278 650 325

Financing Gap (US$ million) 0

External debt Total External Debt (in % of GDP) 102.3 97.2 80.8 79.0 Debt Service (in % of total exports) 19.4 14.4 22.1 23.4

1/ General Government Budget, inci. SFRD. 2/ Excluding iriterest payments and official transfers. 3/ Including Use of Fund credit, other budgetary/balance support. Source: Official data, M staff and Bank staff preliminaryestimates. Annex6

Bulgaria- Key Exposure lndicaton

Actual Estimate Projected Indicator 1994 1995 1996 1997 1998 1999

Total debt outstandingand 9805 10306 1008 9859 9907 9709 disbursed(TDO) (USSm)'

Netdisbursements(USSm)' 211 -334 -384 267 232 302

Totaldebt service (TDS) 686 1144 1248 932 1296 1203 (USSm)a

Debt and debt serviceindicators (%/0) TDO/XGSb 185.8 148.8 156.3 152.0 169.0 196.7 TDO/GDP 100.2 78.6 102.3 97.2 80.8 79.0 TDS/XGS 13.0 16.5 19.4 14.4 22.1 23.4 Concessional/TDO 1.6 1.8 1.8 1.6 1.6 1.8

IBRD exposureindicators (%) IBRD DS/publicDS 2.3 2.7 3.6 5.4 5.4 5.9 Preferred creditorDS/public 23.3 34.2 29.9 43.2 47.0 30.1 DS (%)C IBRD DS/XGS 0.3 0.4 0.7 0.7 1.0 1.1 IBRD TDO (JSSm)d 415 444 453 501 697 859 Of whichpresent value of guarantees(US$m) Shareof IBRD portfolio(%) ...... IDA TDO (IJS$m)d 0 0 0 0 0 0

IFC (USSm) Loans Equityand quasi-equity /c

MIGA MIGA guarantees(US$m)

a. Includespublic and publiclyguaranteed debt, privatenongu-arnteed, use of IMF credits an term credit. b. "XGS" denotesexports of goods and services,including workers' remittances. c. Preferred creditorsare defined as IBRD, IDA, the regionalmultilateral development banks and the Bank for InternationalSettlements. d. Includespresent value of guarantees. Annex 7 Page I of I

Status of Bank Group Operationsin Bulgaria OperationsPortfolio As of December31, 1999

Difference Between expected Last PSR Original Amount in US$ Millions and actual Supervision Fiscal disbursements a/ Rating b/ Project ID Year Borrower Purpose IBRD IDA Cancel. Undisb. Orig Frm Rev'd Dev Obj Imp Prog

Number of Closed Projects: 9

Active Projects BG-PE-8316 1993 BULGARIA ENERGY 93.00 0.00 0.00 31.80 34.00 0.00 S S BG-PE-8319 1994 BULGARIA WATER COMPANIES RESTRUCTURING 98.00 0.00 41.00 36.60 59.10 24.30 S S BG-PE-8318 1996 BULGARIA HEALTH SECTOR RESTRUCTURING 26.00 0.00 0.00 16.50 18.20 0.00 S S BG-PE-8315 1996 BDZ RAILWAY REHABILITATION 95.00 0.00 0.00 22.80 26.62 0.00D S BG-PE-8323 1997 BULGARIA SOCIAL INSURANCE 24.30 0.00 0.00 13.30 9.50 0.00 S HS ADMINISTRATION BG-PE-33965 1998 BULGARIA ENVIRONMENTAL REMEDIATION PILOT 16.00 0.00 0.00 15.80 8.50 0.00 S S BG-PE-57925 1999 BULGARIA AGRICULTURAL SECTOR ADJUSTMENT 75.76 0.00 0.00 0.00 0.00 0.00 S S LOAN I BG-PE-55156 1999 BULGARIA REGIONAL INITIATIVE FUND 5.00 0.00 0.00 2.30 1.70 0.00 HS S BG-PE-51151 1999 BULGARIA SOCIAL PROTECTION ADJUSTMENT 80.00 0.00 0.00 38.90 36.6 0.00 S S BG-PE-8317 2000 BULGARIA FINANCIAL AND ENTERPRISE SECTOR 96.00 0.00 0.00 0.00 0.00 0.00 HS S ADJUSTMENT LOAN

Total 609.06 0.00 41.00 178.00 194.22 24.30

a. Intended disbursements to date minus actual disbursements to date as projected at appraisal. b. Following the FY94 Annual Review of Portfolio performance (ARPP), a letter based system was introduced (HS = highly Satisfactory, S = satisfactory, U unsatisfactory, HU = highly unsatisfactory): see proposed Improvements in Project and Portfolio Performance Rating Methodology (SecM94-901), August 23, 1994.

Note: Disbursement data is updated at the end of the first week of the month. Data as of December 31,1999

Generated by the Operations InformationSystem (OIS) Annex 7 Page 2 of 2 Status of Bank Group Operationsin Bulgaria Status of IFC's Committed and Disbursed Portfolio As of 31-December-99 (In US Dollar Millions)

Committed Disbursed IFC IFC FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic 1994 Euromerchant FND 0.00 5.00 0.00 0.00 0.00 4.50 0.00 0.00 1996 Interlease Inc. 3.21 .30 0.00 0.00 1.71 .30 0.00 0.00 1997 Sofia Hilton 10.80 0.00 2.00 9.50 3.27 0.00 2.00 0.00 1998 Devnya Cement 29.98 0.00 0.00 0.00 23.22 0.00 0.00 0.00 1999 BAC Bank 0.00 0.00 5.00 0.00 0.00 0.00 0.65 0.00 1999 Isiklar Holding 13.90 1.50 0.00 0.00 13.90 1.50 0.00 0.00 2000 Kronospan Group 12.62 0.00 0.00 9.08 8.22 0.00 0.00 5.91

Total Portfolio: 70.51 6.80 7.00 18.58 50.31 6.30 2.65 5.91

Approvals Pending Commitment Loan Equity Quasi Partic 1999 BPBANK 10.00 12.40 0.00 0.00

Total Pending Commitment: 10.00 12.40 0.00 0.00

Generatedby the OperationsInformation System (OIS) Annex 8 Page I of 2

Bulgaria at a glance Eurous & Lower- POVERTY and SOCIAL Central middle- m Buloaria Asia income Developmentdlamond 1998 Pooulation. mid-vear (millions) 8.3 476 2 285 Life expectancy GNP Dercaoita (Atlas method. USSI 1.230 2,320 1.230 GNP tAtlas method. USS billions) 10.2 1106 2.818 Averaoe annual orowth. 1992-98 Pooulation (%i -0.6 0 2 1 2 Labor force (%l -0.9 05 1.3 GNP Gross

Most recent estImate ilatest vear available. 1992-981 capita < / enrnlrmfnt Povertv I% of ooDulafionbelow national foveflv line) 33 Urban Dooulation(% of totaloooulation) 69 67 42 Life exoectancv at birth tvears) 71 69 69 Infant mortalitv (oer 1.000 live births) 16 25 36 Child malnutrition (% of children under 51 Access to safe water Access to safe water (% of oooulalion) 100 84 Illiteracv(% of ooDulationaae 15+) 19 Gross Drimarvenrollment (% of school-aae ooDulation) 99 92 111 Bulgaria Male 100 116 Lower-middle-incomegroup Female 98 113

KEY ECONOMICRATIOS and LONG-TERM TRENDS 1977 1987 1997 1998 Economic ratios GDP (USS billions) .. 28.4 10.1 12.3 Gross domestic investment/G)P 32.9 11.4 14.7 Exoorts of aoods and services/GOP 40.8 61.9 45.2 I Trade Gross domesticsavinas/GDP 31.1 16.9 13.7 Gross national savinos/GDP 30.2 15.7 12.9 Current account balance/GDP -2.5 4.2 -2.1 Domestic Interest oavments/GDP 1.4 5.1 4.2 Savings Investment Total debVGDP 29.1 99.5 82.2 Total debt servicelexoorts 17.2 16.5 20.3 Present value of debtlGDP - Present value of debt/excorts Indebtedness 1977-87 1988-98 1997 1998 (averaoe annual orowth) GOP 3.6 -4.0 -7.0 3.5 Bulgana GNP Dercaoita 3.5 -3.0 -5.5 4.8 Lower-middle-incomegroup Exoorts of aoods and services 6.2 -12.2 3.1 -15.6

STRUCTJIRE nf fhe ECONOMY 1977 1987 1997 1998 Growth rates of output and investment (%) (% of GOP) ; Aoriculture 11.4 23.8 18.7 Industrv - 59.5 25.3 25.5 .20 - Manufacturina 18.6 17.0 - Services 25.9 40.6 46.2 i20

Private conaumotion 61.5 70.3 71.2 -40 General aovemmentconsumDtion 7.4 12.8 15.1 GDI -GDP ImDortsof ooods and services 42.6 56.4 46.3

1977-87 1988-98 1997 1998 Growthrates of exports and imports 1%) (averaae annual arowth) Aariculture -2.5 -2.6 32.9 1.4 30- Industrv 6.4 -6.4 -11.3 4.3 25 Manufacturin :10/ Services 3.8 -5.5 -19.3 0 5

Private consumotion 3.3 -4.3 -17.2 8.2 93 General covernment consumotion 8.6 -4.3 -1 4 4 0 20 Gross domestic investment 3.2 -8.8 33.1 10.3 - - Imoorts of aoods and services 6.1 -16.3 -2.7 -2.8 -Exports ,'-mports Gross national aroduct 3.7 -3.8 -6.2 4.4

Note: 1998 data are preliminary estimates. The diamonds show four kev indicators in the countrv fin bold) comoaredwith its income-arouoaveraae. If data are missina the diamond will be incomolete Annex 8 Page2of 2

Bulkaria V

PRICES and GOVERNMENT FINANCE 1977 1987 1997 1998 Infaton (%) Domestic price-s (%change) Consumer prices 1,082.3 22.3 ,D00 Implicit GDP deflator 0.1 948.7 22.2 am - 400 Government finance 200 -- -. (% of GDP. includes current grants) 0 Cunrent revenue 60.2 32.7 35.7 93 94 95 go 97 so Current budget balance 1.7 2.5 GDPdeflator cCP- Overall surplusldeficit 2.1 2.5

TRADE (US$ millions) 1977 1987 1997 1998 Export and import levels (USSmillions)

Total exports (fob) 10,287 4,940 4,293 E,000 Other metal 1,801 5.00 ;. Other agriculture 1,479 .. . 40 - Manufactures -. Total imports (cif) 11.. 29811,298 4,932 4,995 Food 409 2.000-_' Fuel and energy 1,565 '°°°. Capital goods 5,128 831 504 0 - 92 93 94 95 95 97 98 Exoort orice index (1995=100) 95 97 87 s < Imoortoriceindex(1995=100. 65 87 85 *Exports Himports Terms of trade (1995=100) 148 112 102

BALANCE of PAYMENTS

fUSS millionsl 1977 1987 1997 1998 Current account balance to GDPratio (%) Exports.of goods and services .. 11,444 6,277 5,548 6- Imports ofgoods and services .. 11,959 5,730 5,716 4 Resource balance -515 547 -168 2 , Net income - -314 -357 -314 2 Net current transfers 108 237 236 4- Currentaccount balance -721 427 -253 -e

Financing items (net) 389 1,248 836 -12 Changes in net reserves 332 -1,675 -583 92 93 94 95 96 97 98 . - Memo: Reserves includino oold fUSSmillions) .. .. 2.474 3.057 Conversion rate (DEC.localUSS) . 1.3 1,696.0 1.760,3

EXTERNAL DEBT and RESOURCE FLOWS 1977 1987 1997 1998 fUSSmillions) Composition of total debt, 1998(US$ millions) Total debt outstandingand disbursed 38 8,266 10,095 10,072 IBRD 0 0 501 4 G740A:477 IDA 0 0 0 0 c 1 120 Total debt service 2 1,989 1,045 1,137 IBRD 0 0 47 58 212 IDA 0 0 0 0 IDA i _ ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~E.1,117 -- Composition of net resource flows Offiidal grants 0 0 129 59 Official creditors 0 651 251 310 i Private creditors 1 779 -129 -8 Foreign direct investment 507 401 Portfolio equity 133 -219 F: 6,406 World Bank program Commitments 0 0 140 101 A - IBRD E -Bilateral Disbursements 0 0 101 196 8 - IDA 0 - Othermultilateral F - Private Principal repayments o 0 16 20 C. - IKF r. - Net flows 0 0 85 176 Interest payments 0 0 31 36 Net transfers 0 0 54 139

DevelopmentEconomics 9116/99

-~~ ~~~~~~~~~~~~~~~~~~~~ ,.- '.'-''''"./ .4~~ ~ ~~~~~~~~~~~~~~~~~~~~~~~ ,, ,,,., Concordance Table Republic of Bulgaria Environment and Privatization Support Adjustment Loan

Agreements Reached and Recommendations in the PR Corresponding Section of Legal Documents K.4.29 Prior to furnishing to the bank a request for withdrawal of loan Article II, Section 2.02 (b) funds, the MOF will open and maintain in BNB a Deposit Account to exclusively hold loan proceeds in accordance with terns and conditions satisfactory to the Bank. G 4.16 (b) The Loan will be disbursed in three tranches according to Article II, Section 2.02 (d) (i) the following conditions: Conditions for the second tranche. * Satisfactory macroeconomic performance, including continued compliance under the Extended Arrangements with the IMF and with the structural reforms supported by the Bank. * Pilot integrated environmental permits issued according to the EU IPPC Directive to at least 5 large enterprises in the metallurgical and chemical sectors. * Preparation of Environmental Impact Assessments for the privatized enterprises as the basis of agreeing on Framework Remediation and Compliance Plans annexed to the Sales Purchase Agreements. * Satisfactory progress, according to performance indicators agreed with the Bank, in the irnplementation of Framework Remediation Plans, Compliance Plans and the time-bound implementation plans set out in the Execution Agreements relating to Neftochim Petrochemical and Refining Complex, Kremikovtzi Steel Complex, and Assarel Medet. * Signature of Sales Purchase Agreement for at least three additional large industrial enterprises, under which at least 67 percent of the equity interest in the enterprise is transferred to a private owner and the purchaser has paid the required down payment, and the following requirements are fulfilled: -Compliance Plans approved by the MOEW, acceptable to the Bank are annexed to the Sales Purchase Agreements. -Framework Remediation Plans with cost caps approved by the MOEW, acceptable to the Bank are annexed to the Sales Purchase Agreements. -Execution Agreements, signed by the MOEW, MOF and PA satisfactory to the Bank are annexed to the Sales Purchase Agreements. -The agreed cumulative total cost of Remediation Plans for these enterprises and those privatized as a condition of the first tranche exceeds US$ 50 million. * Continued maintenance of the inter-agency coordinating mechanism established as a condition for tranche one to oversee the implementation of the EPSP. * Taken measures satisfactory to the Bank, or ensured that such measures have been taken, to mitigate any significant adverse social impact of the EPSP identified during the public consultation process under the EIA or during monitoring activities carried out under the EIA. G 4.16 (c) The Loan will be disbursed in three tranches according to Article II, Section 2.02 (d) (ii) the following conditions: Conditions for the third tranche. * Satisfactory macroeconomic performance, including continued compliance under the Extended Arrangements with the IMF and with the structural reforms supported by the Bank.

* Issuance of pilot integrated environmental permits to at least 80% of all large industrial enterprises in the metallurgical and chemical sectors, and thereafter ensured compliance of all such enterprises with the terms of the pilot permnits. * Satisfactory progress, according to performance indicators agreed with the Bank, in the implementation of the Framework Remediation Plans, Compliance Plans, and the time-bound implementation plans set out in the Execution Agreements for enterprises privatized as conditions of the first and second tranches. * Continued maintenance of the inter-agency coordinating mechanism established as a condition for tranche one to oversee the implementation of the EPSP.

* Made payments from the Remediation Accounts for activities under the Framework Remediation Plans above in an aggregate amount acceptable to the Bank

* Taken measures satisfactory to the Bank, or ensured that such measures have been taken, to mitigate any significant adverse social impact of the EPSP identified during the public consultation process under the EIA or during monitoring activities carried out during under the EIA

K 4.28. Upon notification of Loan effectiveness and approval of the Article II, Section 2.04 fulfillment of tranche one conditions, the Bank at the request of the MOF will deposit the proceeds of tranche one into a deposit Account in the BNB. Prior to that, the Bank will withdraw from the Loan Account a front-end fee amounting to Euro 495,000. L. 4.32. Reporting requirement will ensure that the Bank is able to Article III, Section 3.01 (a) (b) (c) monitor the developments in certain areas of concern. Progress in implementing the EPSP will be monitored through semi-annual reviews. The Government will submit to the Bank semi-annual progress reports on the execution of the EPSP. Performance will be monitored according to an agreed set of monitoring indicators. Article IlI, Section 3.02 (a) (b) (c) K. 4.30. The Government will maintain accounts and records, or 3 ensure that such items are maintain, showing that loan disbursements will be in accordance with the provisions of the Loan Agreement and the supplemental letter to the Loan Agreement. Such accounts and records will be maintained in a form acceptable to the Bank. The MOF will arrange for the audit of the Deposit Account and Remediation Accounts in accordance with the auditing standards acceptable to the Bank and by auditors acceptable to the Bank. The MOF will make the report on such audit of such records available to the Bank.

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