Document of The World Bank Public Disclosure Authorized

Report No: 25550-RU Public Disclosure Authorized

PROJECT APPRAISAL DOCUMENT

ONA

PROPOSED LOAN

IN THE AMOUNT OF US$161.10 MILLION

TO THE

RUSSIAN FEDERATION

Public Disclosure Authorized FOR A

ST. PETERSBURG ECONOMIC DEVELOPMENT PROJECT

April 15, 2003

Infrastructure and Energy Sector Unit Russia Country Unit

Public Disclosure Authorized Europe and Central Asia Region CURRENCY EQUIVALENTS (Exchange Rate Effective April 15, 2003) Currency Unit = Ruble (RUB) RUB 1 = US$0.03 US$1 = RUB 31.18

FISCAL YEAR January I - December 31

ABBREVIATIONS AND ACRONYMS CAS - Country Assistance Strategy CFAA - Country Financial Accountability Assessment CIF - Cultural Investment Facility DFID - Department for Intemational Development (UK) EBRD - European Bank for Reconstruction and Development ECA - Eastern Europe and Central Asia Region ECSIE - ECA Infrastructure and Energy Services Department EIB - European Investment Bank EMP - Environmental Management Plan FMR - Financial Management Report GDP - Gross Domestic Product GRP - Gross Regional Product GTZ - German Technical Assistance FIAS - Foreign Investment Advisory Services FISP - St. Petersburg Foundation for Investments GOSKOMSTAT - Federal Committee for Statistics GOSSTROI - Federal Committee for Construction and Communal Services ICR - Implementation Completion Report IFI - International Financial Institution KEPP - St Petersburg Committee of Economic Development. Industrial Policy, and Trade KGA - St. Petersburg Committee of Urban Planning and Architecture KF - St. Petersburg Committee of Finances KUGI - St. Petersburg Committee of Property Management KZRtZ - St. Petersburg Comnmittee of Land Resources and Land Development MNR - Federal Ministry of Natural Resources NDEP - Northem Dimension Environment Partnership NIB - Nordic Investment Bank NGO - Non-Governmental Organization PIU - Project Implementing Agency SAL - Structural Adjustment Loan SME - Small and Medium Enterprise SUE - State Unitary Enterprise SPB-EDL - St. Petersburg Economic Development Loan TACIS - Technical Assistance to CIS Countries (EU) USAID - US Agency for International Development

Vice President: Johannes F. Linn, ECAVP Country Director: Julian F. Schweitzer, ECCUI Sector Director: Hossein Razavi, ECSIE Sector Manager: Sumter Lee Travers, ECSIE Task Team Leaders: Richard L. Clifford, ECCUI Jean-Jacques Soulacroup, ECSE RUSSIAN FEDERATION ST. PETERSBURG ECONOMIC DEVELOPMENT PROJECT

CONTENTS

A. Project Development Objective Page

1. Project development objective 3 2. Key performance indicators 4

B. Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 6 2. Main sector issues and Government strategy 7 3. Sector issues to be addressed by the project and strategic choices 16

C. Project Description Summary

1. Project components 19 2. Key policy and institutional reforms supported by the project 23 3. Benefits and target population 23 4. Institutional and implementation arrangements 24

D. Project Rationale

1. Project altematives considered and reasons for rejection 25 2. Major related projects financed by the Bank and/or other development agencies 26 3. Lessons learned and reflected in the project design 29 4. Indications of borrower commnitment and ownership 31 5. Value added of Bank support in this project 31

E. Summary Project Analysis

1. Economic 31 2. Financial 32 3. Technical 33 4. Institutional 34 5. Environmental 36 6. Social 37 7. Safeguard Policies 40 F. Sustainability and Risks

1. Sustainability 40 2. Critical risks 41 3. Possible controversial aspects 42

G. Main Loan Conditions

1. Effectiveness Condition 43 2. Other 43

H. Readiness for Implementation 44

I. Compliance with Bank Policies 44

Annexes

Annex 1: Project Design Summary 45 Annex 2: Detailed Project Description 48 (A) Adjustment Component 48 (B) Matrix of Core Policy Actions 60 (C) Investment Component 65 Annex 3: Estimated Project Costs 72 Annex 4: Economic Analysis 73 Annex 5: Financial Summary 75 Annex 6: (A) Procurement Arrangements 76 (B) Financial Management and Disbursement Arrangements 84 Annex 7: Project Processing Schedule 91 Annex 8: Documents in the Project File 92 Annex 9: Statement of Loans and Credits 93 Annex 10: Country at a Glance 96 Annex 11: Country Context and Macro-Economic Situation 98

MAP(S) IBRD 27188R RUSSIAN FEDERATION ST. PETERSBURG ECONOMIC DEVELOPMENT PROJECT Project Appraisal Document Europe and Central Asia Region ECCUI Date: April 15, 2003 Team Leader: Richard L. Clifford Sector Manager: Sumter Lee Travers Sector(s): General industry and trade sector (30%), Other Country Director: Julian F.Schweitzer social services (30%), Housing finance and real estate Project ID: P069063 markets (20%), Sub-national govemment administration Lending Instrument: Structural Adjustment (20%) Loan /Hybrid Theme(s): Municipal governance and institution building (P), Municipal finance (P), Legal institutions for a market economy (P)

P6iect:FifiaifciiWDtifDt~.T. 4 *;2-~ rPr oe Fnn -. C. n . 8. Dt_...... *',-,~~ -**-;,owx.-,,'r,, [X] Loan [ ] Credit [] Grant [ Guarantee [ Other: For LoanslCredits/Others: Loan Currency: United States Dollar Amount (US$m): 161.10 Borrower Rationale for Choice of Loan Terms Available on File: RX Yes Proposed Terms (IBRD): Variable-Spread Loan (VSL) Grace period (years): 5 Years to maturity: 17 Commitment fee: 0.75% Front end fee (FEF) on Bank loan: 1.00% Payment for FEF: Capitalize from Loan Proceeds Financing. Source ore BORROWER 51.84 26.86 78.70 IBRD 140.33 20.77 161.10 Total: 192.17 47.63 239.80 Borrower: GOV. OF RUSSIAN FEDERATION Responsible agency: MINISTRY OF FINANCE Address: 9 Ilyinka ul., Moscow 103097, RUSSIA Contact Person: Mr. Alexander Pavlov Tel: (7-095) 913-4406 Fax: (7-095) 9134531 Email: Other Agency(ies): Ministry of Culture Address: 7 Kitaygorodsky Proyezd, Moscow 103097, RUSSIA Contact Person: Mr. Mikhail Svidkoy, Minister Tel: (7-095) 925-0608 Fax: (7-095) 925-9158 Email:

City of St. Petersburg Address: Smolny Palace, St. Petersburg 193060, RUSSIA Contact Person: Mr. Vladimir A. Yakovlev, Governor Mr. A. Vakhmistrov, Vice-Governor for Construction Tel: (7-812) 319-9030 Fax: (7-812) 310-0002 Email: Estimated Disbursements ( Bank FY/US$m):

>j *+tio4.si2005 7 " ' ;2005 , -- ~-Q07 200 2w209. Annual 56.04 76.88 36.29 30.45 22.93 17.22 Cumulative 56.04 132.92 169.21 199.66 222.59 239.81 Project implementation period: 6 years (2 years on adjustment component) Expected effectiveness date: 09/30/2003 Expected closing date: 08/31/2009

-2- A. Project Development Objective

1. Project development objective: (see Annex 1)

Background: The break-up of the Soviet Union in 1991 and the transition from ceritral planning to market economy in Russia was difficult. Continuing infusion of financial resources into unprofitable State enterprises and economic management indiscipline created high rates of inflation and increasingly unsustainable fiscal imbalances. This led to the crisis of August 1998 when Russia defaulted on its domestic and foreign debt obligations. Since 1999, however, the macro-economic turnaround has been significant. Real GDP increased by about 3 percent in 1999, about 8 percent in 2000, 5 percent in 2001, and reached about 4 percent in 2002. Inflation declined from about 86 percent in 1999 to about 19 percent in 2001, and dropped to 15 percent in 2002. However, this recovery was driven, in addition to the steep depreciation of the Ruble, essentially by the rise in prices for exports of natural resources and, in particular, oil and gas. Excessive dependence on natural resource exports leaves the economy vulnerable to external shocks and greater diversification of economic activities will be indispensable for sustaining growth in the medium and longer term. Of critical importance will be the expansion of a more broad-based private sector and an increase in the role of small and medium enterprises whose contribution to GDP still remains below the levels of other more advanced ECA countries, (see Annex 11 for a detailed presentation of the macroeconomic context and recent economic developments).

The Federal Government has put in place an impressive program of reforms (Medium Term Program of Social and Economic Developmentfor 2002-04, 'The Medium Term Program') to reduce poverty levels, achieve economic modernization, develop financial intermediation, improve fiscal efficiency, and reduce regional economic disparities. Improving the climate for private sector development is one of the key objectives of the Federal Government's Medium Term Program and the implementation of a comprehensive set of deregulation measures aimed at removing administrative barriers to entry and reducing costs of doing business in Russia is under way.

Achievements and failures of the Federal Government are echoed in Russia's 89 Regions (Subjects of the Federation), which control a substantial share of the economy. Aggregate fiscal revenue of the sub-national sector is currently roughly equal to that of the Federal Government and the volume of sub-national public sector investment about three times that of the latter. However, regional economic growth over the past decade has been uneven giving way to growing inequality in terms of per capita income, investments, and social indicators. Persisting weakness in the financial sector has inhibited the emergence of an effectively operating system of financial intermediation that could provide the basis for stronger business development.

Although a series of reforms is under way, deficiencies in the system of intergovernmental fiscal relations and sub-national finance structures are still severe. An important contributing factor is that, despite the Federal Government's continuing efforts to increase its control over the Regions, the existing system of decentralization of political and administrative powers in Russia leaves regional authorities considerable (either de jure or de facto) freedom to set the pace and scope of implementation of Federal Government-mandated reforms. Successfully extending structural reform to sub-national level and reinvigorating flagging regional and local economies is a major challenge for the Federal Government and is vital to securing the sustainability of future economic development and social cohesion of Russia.

As outlined in the Federal Government's Medium Term Program, sustainable growth will require: (a) developing and implementing policy and regulatory frameworks that foster private sector development as the main engine of economic growth; (b) improving fiscal management in order to allow local

- 3 - authorities to ensure adequate delivery of public services; and (c) improving the efficiency of funding and management of public economic and social infrastructure. A number of regions are striving to improve their fiscal management and increase their attractiveness for domestic and foreign investors. Among them, St Petersburg, Russia's former imperial capital and a paramount center of culture, arts and education, has been a leader in the drive for reform. Efforts to overcome the adversities of transition and create the basis for the city's development in the new political and economic context were begun by the Govermnent of the City of St. Petersburg (the "City") as early as 1997 with the adoption of a Strategic Plan outlining the options for the future development of the city. Designating economic diversification as one of its key targets, the Strategic Plan identified support for new businesses, privatization of City-owned state enterprises, improved land use, and tourism development as the main pillars for the future economic growth of the city and emphasized that the exploitation of the unique opportunities provided by its geographical position and the riches of its historical heritage should be a keystone for the success of the development strategy.

Project Development Objectives: The St. Petersburg Economic Development Loan (SPB-EDL) will support the City in its efforts to accelerate the implementation of key elements of the Strategic Plan, which was designed to enhance the city's prospects for sustainable economnic growth in the medium- and longer term, and allow it to more fulLy exploit its position as Russia's "Window to the West". To this end, SPB-EDL will contribute to: (a) improving the business climate in St. Petersburg by facilitating the creation of new private sector enterprises, increasing private ownership and transactions of land and real estate, and improving land use planning; (b) strengthening the City's financial management and ensuring the long-term stability of its fiscal revenue base; and (c) enabling St. Petersburg to preserve its unique position as one of Russia's top centers of culture and the arts through the rehabilitation of key cultural heritage and tourism assets. An additional indirect, yet strategically important goal pursued by the Bank through preparing SPB-EDL, is to develop and test a model of Bank operation in support of structural reform at sub-national level that, in the future, could be replicated elsewhere in Russia or other ECA countries.

SPB-EDL builds up on the experience of the recently completed St. Petersburg City Center Rehabilitation Project (Ln. 41440-RU) and complements the assistance provided to Russia by the Bank through the Fiscal Federalism & Regional Fiscal Reform Loan (Ln. 46470 -RU), the Foreign Investment Advisory Services (FIAS) surveys, and other operations in the areas of business development, land and real estate markets development, and sub-national fiscal management (see Section D.2: Major Related Projects). SPB-EDL is designed as a hybrid loan for the reasons explained below, (see Section D. 1: Project Alternatives). The adjustment component of the loan will address the first two of the above objectives while the investment component will support the third objective.

2. Key performance indicators: (see Annex 1)

The first two sets of indicators (a, b) below refer to the adjustment component and specify the tranche release conditions (triggers) of which a detailed description (including monitorable targets and performance indicators) is found in the SPB-EDL Policy Matrix (see Annex 2.B). The third set of indicators (c) refers to the investment component:

(a) improve the business climate in St. Petersburg, stimulate the expansion of private sector participation in the local economy, and promote development of land and real estate markets:

- 4 - * enactment of the reform of the City's business licensing regime; * simplification of regulations for creation of private small- and medium enterprises (SMEs); * divestiture of City-owned or City-controlled commercial business entities; * introduction and mandatory use of standard procurement procedures and documents for all,City procurement; * adoption of a Law Regulating Urban Development Activities in St. Petersburg (hereafter the Law on Urban Development); * enactment of zoning and plot subdivision regulations and implementation of zoning plans for at least eight selected city districts; * revision of price schedule for land privatization; * divestiture of City-owned commercial real estate through competitive auction;

(b) strengthen the City's financial management and ensure the long-term stability of its fiscal revenue base: * adherence to agreed City debt service ratios; * maintenance of shares of capital and social sectors expenditure in City budget at agreed levels; * adoption of guidelines for selection of investment projects and formation of a three-year capital investment program; * completion of inventory of City-owned real estate and corresponding updating of tax rolls; * decrease in rent reduction coefficients for City-owned land and commercial real estate; * increased transparency of off-budget rent and tax concessions; * reduction of City subsidies and other forms of financial assistance to business entities and moratorium on any new tax concessions and subsidies; * annual publication of independently audited accounts of key utility service providers; * establishment of control mechanism for accounts payable of City-controlled State Unitary Enterprises (SUEs).

(c) enable St. Petersburg to preserve its position as a center of culture and the arts: * rehabilitation of buildings of eight Federal cultural institutions completed by the end of the project; * Cultural Investment Facility (CIF) resources fully committed by end of fourth year of project implementation and completion of all CIF operations by end of project; * completion of management improvement studies for at least two major cultural institutions by end of project;

Satisfactory macroeconomic performance is a basic requirement and will be measured, in consultation with the International Monetary Fund, based on the fiscal and monetary stance, inflation, the balance of payments, and the extent to which the macroeconomic environment could affect the objectives of the project. Monitoring of the achievement of performance targets will be ensured as part of regular project supervision by the Bank. Contrary to other SAL-type operations, SPB-EDL, owing to its hybrid nature, will allow the monitoring to be carried out over the total duration of six years of the project, (i.e. four years beyond the completion of the adjustment component), and therefore provide, for the first time, an opportunity to closely follow the actual effects of policy changes in the medium-term. Additionally, the SPB-EDL monitoring will be complemented by the Bank's regular periodic CEFIR surveys of the business climate in selected Regions of Russia, including St. Petersburg.

- 5- Quantifiable outcome indicators measuring annual progress towards achievement of project development objectives in St. Petersburg will include: o increased number of SMEs registered; o the number and percentage of City-owned or controlled enterprises divested; o number of private transactions for land and real estate sales and purchases; o expansion of zoning to cover the entire City; o number of land parcels in private ownership; o improved creditworthiness; o growth in tourism.

B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Document number: 24127-RU Date of latest CAS discussion: June 6, 2002 SPB-EDL is included in the CAS discussed in June 2002.

The main goals of the Bank Group's strategy in Russia in the period 2002-2004 outlined in the June 2002 CAS are to capitalize on the current favorable environment, help mitigate the underlying risks to the sustainability of growth, and extend the opportunities arising from the Government's Medium Term Program more widely across Russia's population, objectives that are closely aligned with corporate priorities and the Millennium Development Goals. The success of the Government's program of reform will largely depend on the implementation capacity of, and incentives offered to, sub-national governments. Bank support will be targeted accordingly and focus on the following priority areas: o Improving the business environment and enhancing competition by: (a) creating the conditions for diversification of the economy in order to reduce over-reliance on the natural resource sectors, upgrading infrastructure and restructuring natural monopolies; (b) promoting a level playing field among businesses by improving the protection of property rights and fostering competition by limiting administrative barriers, special privileges, and preferential treatment; (c) increasing effective financial intermediation and opportunities for entry and growth of new enterprises; and (d) developing and delivering modern and flexible education and training services, developing the knowledge economy, and ensuring that Russia's science and technology assets are effectively used. o Strengthening public sector management by: (a) enhancing accountability mechanisms and information flows within and across different levels of government to assure consistent implementation of reforms and to reduce the incentives for corruption; (b) improving fiscal management at the national and sub-national levels; and (c) improving the efficiency and quality of public service delivery, particularly in areas such as the provision of basic infrastructure and communal services that are critical for improving the investment climate and supporting long-term growth. o Mitigating social and environmental risks by: (a) reducing poverty and mitigating the negative consequences of income security, including the identification of vulnerability to particular risks by age and gender; (b) improving the quality of selected health and education services and, in particular, addressing the threat of communicable diseases; (c) improving the design, targeting, administrative capacity and financing of social protection programs; and (d) addressing environmental hazards and improving environmental management.

- 6 - SPB-EDL will directly address issues linked to the first two CAS priorities. Improving the policy and regulatory framework governing private business development in St. Petersburg' and creating the conditions for the emergence of an efficiently operating land and real estate market will stimulate private sector development and facilitate the expansion of SMEs. Strengthening the City's fiscal management will give private investors greater confidence in St Petersburg as a prime location for doing business in Russia. Preserving and increasing the attractiveness of cultural assets will contribute to foster the diversification of the local economy and reduce its vulnerability. By focusing on improving the city's prospects for economic development, SPB-EDL will, above all, help create new opportunities for employment and contribute to a reduction of social inequalities among the city's inhabitants.

SPB-EDL will also provide an excellent opportunity to build up and expand on the Bank's partnership with EBRD and other international donors involved in St. Petersburg.: Preparation of the City finance management component of SPB-EDL has been carried out in regular consultation with EBRD and has benefited from the groundwork done under its 1996 Municipal Support Project. EBRD as well as the Nordic Investment Bank (NIB) are currently actively involved in the financing of investments in local utilities and transport infrastructure whose successful implementation will, in turn, benefit from the reforms supported by SPB-EDL.

2. Main sector issues and Government strategy:

2.1 Background: With a total population of currently about 4.7 million, St. Petersburg is the second largest urban agglomeration in Russia. Administratively, it is, together with Moscow, the only city in Russia that has the status of a Region ('Subject of the Federation'). The city, which in 2003 will celebrate the 300th anniversary of its foundation by Tsar Peter the Great in 1703, was the capital of the Russian Empire until 1917. Designated by UNESCO as a World Heritage Site in 1990, it is home to some of the world's most important art treasures, and displays one of Europe's largest concentrations of eighteenth and nineteenth century civil and religious architecture. The city was, and still is, an important manufacturing center, and as Russia's largest port in the West, a strategic gateway for exports to, and imports from, the markets of the European Union and the Western hemisphere.

Like other regions and cities in Russia, St. Petersburg had to weather the fundamental structural changes brought about by the disintegration of the Soviet Union and the transition of the last decade. Because of the features of its economy inherited from the Soviet period, the August 1998 crisis hit the city disproportionately hard. In 1999, St. Petersburg's real GRP contracted at a rate of 5.4 percent while real GDP fell by 4.9 percent for Russia as whole. As a result of the crisis the city's industrial sector (which was to a large extent defense oriented) experienced a structural shift from heavy industry (machine-building and metallurgy) towards food processing and other light industries producing consumer goods.

In 2001, the city's industrial output was dominated by food processing (37 percent), followed by machine building and metal processing (35 percent). Equally important, the share of services in GRP increased from about 50 percent prior to 1998 to 59 percent in 2001. Continuing decline of heavy industry, compensated by concurrent increases in consumer-goods industry and accelerating growth of service activities are expected to be the hallmark of the St. Petersburg economy over the foreseeable future.

In St. Petersburg, as elsewhere in Russia, the transition resulted in decreasing incomes and increasing inequality. The level of poverty in the city is comparable to the prevailing poverty rates for the urban population of Russia during the period 1998-2000 with the incidence of poverty being highest among the households with: (a) several children, (b) a single parent; and (c) unemployed adult members. As in the

- 7 - rest of Russia, there is also a class of "new poor"- working individuals who cannot reach a basic standard of living due to low wages and/or irregularities in the payment of salaries. According to the Federal Committee for Statistics (GOSKOMSTAT), in 2000 the fraction of the city's population with disposable resources per capita less than the official subsistence minimum (or poverty line) was 39.8 percent in St. Petersburg, which is roughly similar to the overall urban poverty rate of 39.4 percent, slightly lower than the all-Russia poverty rate of 42.6 percent, but significantly higher than the 24.6 percent poverty incidence in the city of Moscow during the same period.

2.2 Main Development Issues: Efforts to improve the climate for investment and economic development were initiated by the City already several years ago. The 1997 Strategic Plan, which was prepared in close consultation with all concerned economic and social stakeholders, provided a detailed blue-print for the programs of institutional and policy reforms and related measures that were considered indispensable for promoting private sector business development. While some of the broad array of activities identified by the Strategic Plan have been completed or are in progress, a series of key reforms that are essential to stimulate private sector investment are still on hold or under discussion. Absent the implementation of such reforms, St. Petersburg remains fettered in its attempts to more fully exploit its potential for economic diversification, benefit from its proximity to the markets of the European Union and the Western hemisphere, foster new employment opportunities and reduce poverty levels among its population. Among the various pillars for future economic growth, tourism both domestic and international, remains a largely under-exploited sector despite the city's unique potential to be one of Europe's most sought after centers for culture and the arts.

Economic development of a city like St. Petersburg is a complex process that requires the involvement of a range of actors with often divergent agendas. It is also subject to a wide array of constraints many of which are outside the control of the City. However, while the role and weight of these City-external factors cannot be underestimated, there are a number of important issues that are within the competence of the City. Most critical among them are the following: o Poor business climate: Despite considerable efforts made by St. Petersburg to improve its image abroad, the city still has a reputation of being a rather inhospitable home to private business. There are at least three major reasons for this perception:

- Analytical work undertaken by the City and the Bank and detailed in the 2001 FIAS Report on Administrative Barriers (see Section D.2: Related Projects) points to the burdensome regulatory and licensing environment as one of the most critical obstacles to attracting new businesses. Although the St. Petersburg Licensing Chamber has recently adopted some measures to promote standardization of licensing procedures, no systematic attempt has been made to date to bring the City's registration and licensing regime for businesses in line with the Federal Government's program of deregulation measures.

- The lack of a level playing field creates additional difficulties for expansion of private sector businesses. At this point, the City still owns, or has a controlling interest in, many commercial business entities that would perform more efficiently and competitively if privatized. It also provides a variety of tax breaks, subsidies, and other forms of financial support to selected businesses, including in the tourism sector.

- Although significant improvements have been made over the past several years to increase transparency and competitiveness in public procurement, in reality participation in City tenders still remains restricted. The lack of standardized tender documents and bid evaluation procedures

- 8- is at the root of frequent complaints about collusion among competing enterprises, and significantly reduces the overall effectiveness of the bidding process. As highlighted in the 2001 FIAS Report, corruption at all levels is perceived as an important factor for business development. Although St. Petersburg is sometimes censored in the media for its non-transparent business environment, the situation in the city is hardly unique since corruption is a pervasive phenomenon that affects the public and the private sector in all of Russia.

Lack of easy access to land and commercial real estate is another important factor that contributes to the city's poor business climate and discourages prospective private sector investors. To date, the City has made only moderate progress in developing the legal and regulatory framework for efficient land and real estate markets. It has begun an inventory of City-owned real estate and completed a significant portion of.the urban land cadastre, developed a title registration system, and privatized a small number of land and real estate properties including various commercial premises. It has also taken steps towards building a policy consensus on an improved approach to urban planning that should culminate in the adoption of a new law on urban development. These steps notwithstanding, at this point, the City and the Federal Government together still own approximately 92% of the land - of which about 30% - 40% is estimated to belong to Federal entities - as well as most of the .nonresidential real estate within the boundaries of the city. The main issues with which the -emergence of efficiently operating land and real estate markets is confronted are the following:

- Because the City controls the allocation of available land to private investors for development, it has not created comprehensive and transparent rules and procedures for issuance of land use and development permits. As a result, the City continues to determine land use and development parameters mostly on a case by case basis for each plot or building. The lack of transparent and comprehensive rules and procedures for land use decisions and the issuance of development permits is at the root of widespread complaints about inefficiency, unpredictability, bureaucratic arbitrariness, and alleged corruption. Time-consuming and costly, the land allocation and permitting process therefore creates a serious obstacle for the development of new businesses, especially for SMEs.

- As elsewhere in Russia, ownership of land has legally been treated by the City differently from that of built up real estate. Building owners generally do not own the land on which buildings are located, but are given a long-term lease by the City. From a tenure security point of view a long-term lease can be the equivalent of land ownership, but from a practical point of view, as implemented in Russia today, it carries significant disincentives for some prospective investors. Inter alia, city land leases, usually lacking asset value and subject to greater legal uncertainties, to date have been unacceptable to the banks as collateral; secure long-term lease rights are presently granted only after the developer has completed the entire investment, exposing him to considerable risk; and land allocation under lease arrangements from the City is not only a cumbersome and lengthy process, it may also subject the investor to extensive City interference in investment decisions. Further privatization of City-owned land could avoid the legal and administrative pitfalls of the land leasing system, increase turnover in the private market, and encourage conversion of center-city land to more appropriate and valuable uses. The 2001 Federal Land Code gives building owners the right to demand transfer of title to the land on which a building is located at a price not to exceed appraised market value or 30 times the applicable land tax, and also prohibits further sale of buildings without sale of the underlying land. While the City has made the required adjustments to the schedule of land prices, further incentives to privatization are needed. Such further incentives include in particular, the elimination of land rent concessions that encourage large industrial land users in the center city

-9- to rent rather than own, and to occupy valuable center city land for low value uses, as well as greater transparency and predictability in the city laws and regulations governing land development, (see Report on Land and Real Estate Market Issues in Project File).

- The City has tried to use its land and real estate as a tool of economnic and industrial development and to provide to that effect off-budget subsidies in the form of rent concessions (i.e. rent rate reductions) to selected beneficiaries. Such rent concessions are extended to about 50% of the City-owned commercial premises in the four central districts and, through a so-called "large area coefficient', to various industrial land users. Industries holding over 2,500 hectares of land in and around the city center receive land rent concessions that reduce scheduled land rents by as much as 75%. - As seen elsewhere, such a subsidization policy, while politically expedient on occasion, is uneconomnical and fails to achieve its urban development objectives since it encourages less than optimal use of land and space and leads to inadequate urban densification. This policy encourages present low-value users to use more real estate than needed, speculate in the land value or to sublet excess space in the informal market, maintaining an artificial scarcity of land and building space available for economically desirable city center uses. Combined with the distorting effects of administrative pricing of land and rental rates it effectively prevents the development of competitive land and real estate markets and comes at a high cost for the City in terns of foregone revenue (see paragraph below).

Cigyfinancial management: Existence of stable and predictable fiscal environment is of paramount importance for the expansion of private sector activities and enhancement of St. Petersburg's attractiveness for private investors both domestic and foreign. Over the past few years, the City has made steady progress in improving the management of its finances and as a proof of its good performance to date, it becarne eligible in 2002 for a USD4.0 million grant from the Federal Government under the Bank Fiscal Federalism & Regional Fiscal Reform Loan. However, much remains to be done to overcome persistent weaknesses and secure the long-term sustainability of its current satisfactory status. Key issues that must be addressed are the following:

- Debt service must be carefully managed. Since 1998, the City has successfully improved its fiscal management and reduced key fiscal burden ratios (see Table 1, below). As of 1999 the City has been able to run close to balanced budgets on a cash accounting basis. However, on a commitment basis (that is when the outstanding arrears are included) the budget has shown a persistent deficit of between 1.7 percent and 6.7 percent of GRP. In 2001, reductions in interest payments on debt generated a primary surplus of 1.6 percent of GRP. Revenues, partly derived from higher economic growth, also increased. At the end of 2001, the 'public debt to revenue' ratio had decreased to 25 percent from about 55 percent in the 1998-99 period while the 'debt service to revenue' ratio had fallen to 3.4 percent from around 8 percent in previous years, (see 2002 Creditworthiness and Fiduciary Assessments available in the Project File.) Table 1: Selected Budget Performance Indicators 1998- 2003

1998 1999 2000 2001 2002 estimate ______12______0 03 , Total Revenues/GRP 19 16. 161 20 19.1 192 Total Expenditurs/GRP 18.X 16.5 15 19. 19.1 196 Budget Balance/GRP (%, cash) 0.1 -0 1 0. 0.5 0. -0.4 Budget Balance/GRP (%, commitments) -1. -6 -3. -2.t -2.3 n/a Prmary Surplus/GRP (%/6) 1. 1., 2. 1. 0 0.1 Budget Surplus/Revenue (%) 0 -0. 4. 4.3 2 _1.9- Public Debt/GRP (%) * 10.4 9.1 5. 5., 5 ( 47 Public Debt/Revenue () 54. 561 33.5 25. 25 1 24.5 Debt Service/Revenue (%) 7. 7. 8.1 3. 3. 2.6 Current Revenue/Current Expenditures (%) 115 141 141 14t 121 131 Memo- Stock of Arears 1,58 10,211 9,6 8,564 7,85 n/a Public Debt (min rubles) 9,371 14,804 12,57 12,65 14,76 18,500 GRP (mln rubles) 89,79 154,721 232,92 245,00 292,90 394,379 *Public Debt includes City guarantees issued, as ofyear-end Source: City Committee of Finance, Bank staffcalculations

The City has been pro-active in managing its debt and responsive to the shocks of higher external debt service stemming from the August 1998 crisis and ensuing devaluation of the Russian ruble. Debt service on five-year USD 300 million Eurobond issued in 1997 was maintained and active debt management allowed the City to keep its solvency. Improved revenue and budget management perfornance has enabled the City to make an early payback of the Eurobond in 2002.

Social sector and capital investment expenditure must be kept at adequate levels. Over the past few years the City has given the budget a stronger developmental orientation and, to that effect, begun to adjust its fiscal policy priorities. Targets for change have included, inter alia, (a) gradual phasing out of subsidies, (b) strengthening of non-interest and social expenditures, and (c) increases in capital investments (see Table 2). However, absent a suitably designed multi-year capital investment program, the risks of derailment remain high and make it difficult to achieve a satisfactory level of financial efficiency in investment expenditure.

Table 2: St Petersburg Budget Expenditure In 1998-2002, Economic Classification (% of total expenditures)

1998 1999 2000 2001 2002 Estimate

Total Expenditures 100 100 100 100 100 100 Current Expenditures 78.8 70.6 73.9 72.8 77.4 73.3 Wages and Salaries 15.6 13.4 17.9 18.0 21.6 22.4 Purchase of goods & services 21.6 21.2 31.6 36.0 n/a n/a Interest payments 7.5 7.0 5.1 3.9 2.9 2.6 Interest on domestic debt 5.0 3.3 2.6 2.3 2.3 2.0 Interest on foreign debt 2.5 3.8 2.5 1.7 0.7 0.6 Subsidies and Transfers 34.1 29.0 19.2 14.8 16.7 16.1 Capital Expenditures 20.1 29.4 22.9 27.2 22.6 26.7 Purchase of equipment 2.9 5.6 3.6 3.0 2.4 2.3 Capital construction 8.4 16.9 13.5 20.8 13.5 15.8 Capital repair 8.8 6.8 5.8 3.4 6.5 8.2 Net lending rminus repayment 1 2 0.0 3.3 0.6 n/a n/a Source- City Committee of Finance, Bank staffcalculations

- 11 - The redefinition of priorities has led to a noticeable shift in the structure of the City's expenditures. Subsidies and transfers decreased from about 34 percent of total expenditures in 1998 to less than 15 percent in 2001, while concurrently the share of social expenditures (health, education and social protection) increased from about 34 percent to about 40 percent in 2001, and that of capital expenditures from 20 percent in 1998 to about 27 percent in 2001, (see Table 3, below).

Table 3. Social Expenditures (in % of total expenditures)

199S 199 2000 2001 2002 Estimate

Total Social expenditure 37.7 37.2 36.6 29.8 44 2 44.7 of which Education I8.8 16.9 IS 9 13 2- 17.5 18.4 Health 11.1 12.0 12.5 8.4 10.7 110 Social Policy 8.6 7.8 8 3 8.2 13 3 12.2

- Fiscal revenue sources must be more fully exploited. According to estimates made by the City Committee for Property Management (KUGI) in 2002, the quarterly budgetary loss stemming from rent concessions on City-owned premises amounted to RUB 567 million rubles, or approximately USD 18 million. Annual losses from land rent concessions to large industrial land users in the center are estimated to exceed USD 20 million per annum. The total annual losses from rent concessions are in excess of USD 80 million, and equal approximately 3% of budget revenues. Revenue losses from such foregone rent income are not reflected in the City's budget, nor does the City provide the St. Petersburg Duma, (the local Parliament) or the public any reports on the beneficiaries or costs of such rent concessions. Neither the provision of financial support by the City to commercial sector enterprises nor its participation in such enterprises are supported by a transparent assessment of the economic and social benefits derived from these measures, the number and type of their direct and indirect beneficiaries, and the cost of the fimancial support to the City's finances in terms of foregone fiscal revenue.

- Financial risks must be reduced and made transparent. The economic turmoil of the late 1990s has resulted in a situation in St. Petersburg, like many other Russian cities, where State-Owned Unitary Enterprises (SUEs) have large commercial debts and budget organizations often have substantial accounts payable or arrears. Since these could ultimately constitute contingent liabilities on the City budget, prudent fiscal management requires that the City develop a comprehensive understanding of its contingent liabilities. In 2002, the City therefore adopted procedures for the registration, with the Committee of Finance, of all St. Petersburg SUEs' borrowings. In 2003, the City will start to monitor commercial debt held by SUEs, as well monitor the accounts payable of budget finance organizations. The city also needs to reduce and eventually eliminate its arrears (accounts payable) to enterprises and suppliers. In 2002, the City prepared a plan for reducing its arrears of RUB 1,329 million (USD 42 million) jointly to Vodokanal, Fuel and Energy Complex (TEK), and Lenergo. The City will pay off RU1B 770 million (USD 24 million) of these arrears to the three enterprises in 2003. The reduction in arrears is made possible in large part to the adjustment funds that will be received from the World Bank loan.

-12 - In 1997, as part of its key institutional reforms, the City started to produce Financial Plans as part of medium-termn budget planning. Financial Plans are developed for four years on a rolling basis for the current budget year, and three outer years and updated periodically by the City Finance Comrittee The main goals of the Financial Plans are to develop better forecasts of aggregate revenues and expenditures by key categories in support of improved budget planning. The plans are based on certain key macro-economic assumptions, which for 2002-05 are given in Table 4, below. The assurmptions for inflation are close to those made by the Federal Ministries of Economic Development, and Finance, respectively, for their medium-term outlook for the economy. Payroll growth rates may reflect some deviance from national targets reflecting the City's own additional effort to raise real public sector wages and reduce the wedge between public sector and private sector wages.

Table 4: St. Petersburg: Key Macro-economic Assumptions for Financial Plan

2001 2002 2003 E 2004 l 2005 Indicator Measurement Unit Operating Projections

______R epo rt ______% mean annual change 22.7 14.3 13.0 11.0 9.5 %change,. Dec. to Dec. 18.1 14.0 11.0 10.0 9.0 Million rubles 245,000 292,900 340,000 393,500 452,300 Gross Regional Product %growth rate (constant 4.0 3.5 3.2 3.8 4.2 Prices) Payroll Growth Rate % annual change 56.7 25.2 17.2 15.9 15.0 (including Social charges)

Each Financial Plan is approved by the City in a resolution and published in the local mass media. The most recent Financial Plan was approved in May 2002 and its key financial indicators are shown in Table 5 below.

Table 5: St. Petersburg Financial Plan Indicators, 2002-05

2002 2003 2004 2005 Overall Budget Surplus 0.4 0 0 0 Primary Budget Surplus 1.1 0.5 0.4 0.4 Revenues/GRP (%) 19.9 19.5 17 8 17.1 Expenditures/GRP C%) 19.5 19.5 17.8 17.1 Current Expenditures/Total Expenditures (%) 80.4 81.2 84.2 82.8 Capital Expenditures/Total Expenditures (%) 19.6 18.8 15.8 17.2 Toal Debt (at current exchange rate, min. rubles) 14,766 12,911 13,106 12,770 Of which Guarantees issued (as of year-end) 5,765 4,094 3,647 3,171 Total Debt/GRP (0/6) 5.0 3.8 3.3 2.8 Sovereign Debt Service/Total Expenditure (%/6) 0.03 0.03 0.02 0.02 Current Expenditures/Revenues (%) 126 123 119 120 Source: CoF; Bank staff calculations

Until recently, the plan was primarily used to ensure compliance with debt obligations through forecasts of debt repayments, and less as a tool for casting fiscal choices within the overall resource constraints. Debt repayments had clear priority in expenditures, followed by wages and utility payments. Capital expenditures were treated as a residual. Moreover, the macroeconomic basis of the plans were not robust. For instance, inflation and revenue forecasts were not reliable, and typically forced the budget to be reconsidered (sometirnes repeatedly) in the middle of the fiscal year. Formal rules about distribution of additional revenue were not developed ex ante.

- 13 - Key elements of the Financial Plan over 2003-05 are: o The overall budget is envisaged to be in balance with a small primary surplus. o Revenues are projected to fall as a share of GRP from 19.9 percent in 2002 to 17.1 percent in 2005. (The precise basis for the lower revenue forecast needs to be examined further). The burden of both direct and indirect taxation is projected to fall as a share of GRP. Within the overall revenues, there is a shift towards federal transfers (reflecting the absorption of extra-budgetary funds into the federal budget) and higher own revenues from income generating activities. o Reflecting the revenue trends, expenditures are projected to decrease as a share of GRP from 19.5 percent of GRP in 2002 to 17.1 percent of GRP in 2005-a fiscal adjustment of 2.4 percent of GDP over 3 years. Both current and capital expenditures are projected to shrink though the latter are compressed almost three times as much as the former. o Within the overall smaller expenditure envelope, expenditure composition is projected to change. Social policy expenditures are projected to increase from 2.0 percent of GRP in 2002 to 2.5 percent of GRP in 2005. Some categories of expenditures are projected to maintain their share (in terms of GRP), most notably, education (3.5 percent of GRP), public health and physical culture (1.9 percent of GRP), and housing and utilities (2.3 percent of GRP). Debt service expenditures are small and declining, particularly for foreign debt service. o Within capital expenditures, there is a relative emphasis away from new construction towards capital repairs. o The Government proposes to maintain a budgetary Reserve Fund equivalent to about 1 percent of total expenditures (or 0.2 percent of GRP). o Public Debt is projected to fall as a share of GRP, from 5.0 percent in 2002 to 2.8 percent in 2005. (These numbers do not include the proposed World Bank loan under SPB-EDP or other Eurobond issues being discussed within Government). o Privatization proceeds are very small at Rb52 million per year and planned to be utilized towards reducing the public debt.

With recent growth and the decreasing debt burden on the City economy, the Financial Plan should be strengthened through a more rigorous examination of fiscal assumptions underlying it. It can also be used as an initial step towards developing a medium-term fiscal framework, which would provide an effective instrument for guiding annual budgetary choices. This would enable: (i) a better examination of underlying budget dynamics, identify trends, and implement responses to rectify problems; (ii) the adoption by policymakers of an overall fiscal strategy over a medium-term during which macroeconomic benefits are more likely to be visible and which would therefore enable greater political acceptance of budgetary trade-offs; and (iii) provide a longer time horizon for participants to discuss policy changes and be assured of budgetary resources.

O Underutilizationof St Petersburg'scultural and arts heritage: St. Petersburg is a UNESCO World Heritage Site, is home to some of the world's most important art treasures and possesses one of Europe's largest concentrations of eighteenth and nineteenth century architecture. In spite of the wealth in art works and the number of cultural events taking place in the city, tourism remains a relatively underdeveloped sector of the city economy and is far from being exploited to its full potential. Most of the 3.6 million visitors recorded in 2002 were from Russia, and the attractiveness of St. Petersburg to foreign visitors remains under-exploited. While precise data are not available, hotel and other related statistics suggest that the number of foreign visitors does not exceed 500,000 - 600,000 annually and has not seen any significant growth in recent years, especially among tourists

- 14 - from Westem Europe. Aside from Russia's relatively cumbersome visa regime (which is outside the control of the City) the main factors inhibiting, for the time being, significant growth of international tourism are the shortage of accommodations of international standard, the shortage, low quality and reliability, of tourism support services including transportation, and the still embryonic presence of business activities linked to the art scene such as galleries, etc. The city's climatic conditions further aggravate the problems by reducing the main tourism season to a few months in the summer, even though there appears to be a considerable potential for off-season tourism that could be tapped more fully.

In addition, virtually all of the St Petersburg's key cultural landmarks are property of the Russian Federation and remain outside the City's responsibility in terms of operations and investments decisions (a situation akin to that of Washington, DC). Many of these monuments are in fragile physical conditions as a result of years of neglect and, in many cases, are ill-equipped to handle increasingly larger number of visitors. Finally, it must not be overlooked that decades of bureaucratic administration have left a legacy of management systems and procedures that provide no incentives for the institutions managing the cultural assets to take full advantage of the potential for revenue generating opportunities that is created by, especially, the flow of foreign visitors.

2.3 City Government strategy. Confronted with the challenges of dealing with structural changes in the economy and persistent poverty, the City prepared in 1996-97, with the support of USAID and the Bank's St. Petersburg City Center Rehabilitation Project, the Strategic Plan for city development. The Plan was prepared in close consultation with, and extensive participation of, the civil society (see section E6: Social Issues). Its key objective was to help the City design the blue-print of a framework for the future development of the city, .define its specific comparative advantages in the context of market-economy Russia, and identify the measures necessary to achieve the long-term development goals. The Plan is built around the following four "strategic objectives", each of which is accompanied by a specific plan of action:

* establishment of a favorable business climate: To become one of the most attractive places for investment in the Russian Federation, the city must create an effective competitive environment, reduce the tax burden, develop the land and real estate markets, reform city planning regulations, improve labor mobility, and stimulate private investment in the real economy.

* integrationinto the world economy: To utilize the uniqueness of its geographic location in Russia, its cultural heritage, and its education base, the city must increase foreign trade and transport using a variety of measures, including improvements to the port and other transport infrastructure, work with the Federal Government to address the issues of transport regulation, tariffs, and customs procedures. It also must promote St. Petersburg as a cultural and tourist destination, and develop science and knowledge-based enterprises.

* improvements in the urban environment: To revive the historic city center - which is vital for improving tourism - the city must make improvements in urban transport, energy supply and water, waste management and green spaces. One of the strategic objectives is to significantly increase the number of foreign visitors and to focus to that effect on the promotion of cultural tourism as the City's main product.

* establishment of a favorable social environment: To improve its social environrnent, the city must focus on increasing social protection, especially for women and children, ensuring quality health care, particularly for infectious diseases, drug addiction, TB and AIDS, and improving educational

- 15 - services. It also must take steps to better preserve and exploit the city's cultural and historic heritage, develop outreach and education programs, and solve the severe problems that plague the housing sector by promoting privatization and restructuring of building maintenance services, and utility tariffs. Last, but not least, serious efforts must be made to improve the quality of the City's public administration.

Following the adoption by the St. Petersburg Legislative Assembly of the Strategic Plan in December 1997, the City began to address a series of the document's recommendations for changes in the City's policy and regulatory framework. Progress has been slow, however, in part due to local politics, in part but equally importantly, owing to the need to reconcile and harmonize local laws and legal acts with Federal legislation. Delays at the Federal level in the adoption and enactment of critical elements such as the Federal Land Code inevitably led to delays at the regional level. A complete evaluation of the implementation results to date of the Strategic Plan carried out in 2002 by the Leontieff Center, one of the leading non-public St. Petersburg research institute, is available in the Project File.

3. Sector issues to be addressed by the project and strategic choices:

3.1 City development issues addressed by the project

SPB-EDL draws on the extensive economic and sector work carried out by the Bank in Russia on issues of business environment, intergovernmental finance and sub-national fiscal issues, (see Section D.2: Major Related Projects). It also continues the work started under the St. Petersburg City Center Rehabilitation Project. It builds up in particular on the experience gained by the City to date in the implementation of the Strategic Plan and addresses some of the most critical issues identified by the Strategic Plan as a precondition for the successful transformation of St Petersburg's economy. The overall thrust of the City's program of reforms is explained in the Development Policy Letter (see Annex 2.A). The specific measures which the City is committed to take under SPB-EDL are detailed in the Policy Matrix (see Annexes 2.B) and include the following:

On Project Objective # 1:

Improve the business climate in St. Petersburg,stimulate the expansion ofprivate sector pardcipation in the local economy andpromote the development of land and realestate markets

o Improve support for small and medium enterprises

To this effect the City will: (a) facilitate the establishment of small and medium enterprises; and (b) complete the reform of the business licensing regime.

- 16- o Reduce the Citv's investments in commercial business entities

To this effect the City will: (a) divest City-owned or City-controlled commercial enterprises including but not limited to SUEs o Reform, and increase transparency of. Citv procurement procedures

To this effect the City will: (a) carry out an independent annual audit of City procurement procedures (b) adopt standard bidding documents and evaluation procedures (c) make mandatory the use of new bidding documents and procedures o Clarify, and increase predictability of. pernitted land use and development permits

To this effect the City will: (a) adopt the Law On Urban Development (b) upon adoption of the Law On Urban Development adopt the legislative and nornative acts necessary to implement system of legal zoning in accordance with requirements of the Russian Federation land code and city planning code (c) implement the legal zoning system in selected city districts over the first two years of SPB-EDL implementation o Increase private participation in land and real estate markets

To this effect the City will: (a) divest through competitive auction up to 550 City-owned premises during the first two years of SPB-EDL implementation; (b) reduce average prices charged for privatization of occupied land from normative prices in effect prior to the adoption of the 2001 Land Code; (c) expand program of trust management for City-owned premises.

On Project Objective # 2:

Strengthen the City'sfiscal management and ensure the long-term stability of itsfiscal revenue base: o Improve the effectiveness of budgetary management.

To this effect the City will: (a) keep debt service within agreed prudential limits and ratios, and consistent with Federal legislation and mutually agreed budgetary targets for 2003 and 2004; (b) maintain share of capital expenditure in total budgetary expenditure as well as shares of expenditure for health and education at agreed levels; (c) reduce arrears (i.e. accounts payable) to utility service provided by agreed amounts; (d) adopt guidelines for the selection of investment projects and the formation of a three-year capital investment program.

- 17 - o Enhance budgetary transparencv and reduce fiscal risks

To this effect the City will: (a) introduce a system for the registration of borrowings of City-controlled SUEs which will enable monitoring of their debt; (b) create database of accounts payable to City-controlled SUEs and monitor compliance with targets for annual reductions of arrears; (c) introduce commitment control. o Complete inventory of City-owned buildings and premises

To this effect the City will: (a) identify unregistered land and real estate property users; (b) ensure proper entry into tax rolls; (c) carry out issuance of appropriate rights. o Increase City revenues

To this effect the City will: (a) eliminate fiscal and financial subsidies to commercial enterprises; (b) provide remaining subsidies or tax concessions on a competitive, non-discriminatory basis and with full public disclosure; (c) declare moratorium on granting new tax concessions and subsidies to business entities and evaluate the cost of tax exemptions in terms of foregone fiscal revenues; (d) reduce rent reduction coefficients for City-owned premises; (e) increase average land rents for enterprises for City-owned land. o Improve the performance and transparency of operations of key utility service providers

To this effect the City will: (a) carry out independent audits of eight key energy and other utility service providers (b) provide free access of independent power generating enterprises to networks of energy suppliers

On Project Objective # 3: Enable St. Petersburgto preserve its position as a center of culture and the arts. A key part of the City's strategy for an economic transformation, is the full exploitation of its comparative advantage as a center of arts and culture. The land and real estate and business environment measures described above will facilitate, among other things, the growth of the number of enterprises associated with the artistic scene. At the same time the investments financed under SPB-EDL will improve the condition of eight of the city's major cultural assets and thereby strengthen the city's position as an international destination for patrons of the arts. SPB-EDL will also provide funds to other cultural institutions in, or in the immediate vicinity of, the city for small-scale rehabilitation works and institutional strengthening activities, improve their accessibility to the public and their management, and increase their capacity to organize and implement out-reach programs.

- 18- 3.2 Strategic choices for the Project Achieving the Project Development Objectives set for SPB-EDL requires a project design that is tailored to the specific needs and-constraints of St. Petersburg. The choice of a hybrid loan as the most suitable option among the Bank's lending instruments is based on the following consideration (see Section D. 1: Project Alternatives Considered): As indicated, the main development objective of SPB-EDL is to foster economic growth in St. Petersburg by supporting the City in implementing a series of key policy and regulatory reforms. St. Petersburg's position is exceptional, however, as its prospects for economic growth are interdependent with the preservation of its cultural heritage assets. Preservation of the city's cultural assets is, therefore, a key pillar for the city's economy while development of private sector business, particularly in the area of tourism related activities, is a precondition for a better use of the cultural assets. Moreover, an economically imperiled city cannot preserve world-class cultural assets or the physical and social environment necessary to attract the world to its cultural assets. Attempting to achieve the development objectives through two separate but simultaneous operations not only would have been impractical from an operational point of view, but also it would have hindered the city to fully realize the benefits stemming from the city's unique character.

Creation of a policy and regulatory framework conducive to private sector development has been recognized early on as one of the critical primary necessities for the city and was one of the main conclusions of the Strategic Plan. In this context, giving preference to a policy based operation over an investment loan for the city component was a logical choice and consistent with the lessons learned from the frequently poor performance of investment operations as vehicles for structural and policy reform (see Section D.3: Lessons Learned).

C. Project Description Summary 1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed cost breakdown):

The project includes two main components: A. Adjustment Component City Budget support (US$100.00 million). This component will provide budget support to the City. The funds will be on-lent by the Borrower, the Federal Government, to the City in local currency against the implementation by the latter of a series of agreed policy reforms under terms and conditions detailed below (see Section C.4: Institutional and Implementation Arrangements). The reforms which are described in detail in a Letter of Development Policy and Policy Matrix (see Annexes 2.A and 2.B.) aim at: (a) improving the business climate in St. Petersburg, stimulating the private sector participation in the loc'al economy, and promoting the development of land and real estate markets; and (b) strengthening the City's fiscal management and ensuring the long-term stability of its fiscal revenue base. The component is designed on the basis of two disbursement tranches. All of the conditions for the release of the first tranche (USD 40 million) except the condition related to the adoption of the Urban Development Law ha've been fulfilled at the time of Board Presentation and no disbursement will be made prior to City compliance with all first tranche conditions. The conditions for the release of the second tranche are expected to be fulfilled, at the latest, 24 months after release of the first tranche.

- 19 - 1B. Investment Component

The component consists of four sub-components (for a detailed description see Annex 2.C): 1. Subcompohent (a): Rehabilitation of cultural assets (US$93.60 million). The sub-component will finance repair and/or rehabilitation works that will help protect historical buildings of eight major cultural institutions from further physical deterioration, increase the exhibition and activities capacity of the institutions, improve the operational safety and efficiency of the facilities for both visitors and personnel, and provide higher safety of artwork on display from physical damages, theft or other hazards. The projects to be financed under the sub-component are the following: o State Hermitage Museum: Urgent repair and rehabilitation works in the East Wing of the General Staff Building. o State Mariinsky Theatre: Rehabilitation works including repair and/or replacement of internal utility networks in the existing building; replacement of stage machinery and rehabilitation of stage area; and upgrading of commercial services areas. o State Russian Museum: Rehabilitation of two inner courtyards in the Mikhailovsky Palace; reconstruction of the Winter Garden in the Marble Palace; and restoration of the St. George Hall and two Corp-de-Gardes (guard pavilions) in the Mikhailovsky Castle. o Peter and Paul Fortress Museum: Repairs of drainage and other utility networks; water infiltration protection of the St. Peter and Paul buildings; and restoration of the existing pathways and walkways. o State Shostakovich Philharmonic Academy: Replacement of lighting, air-conditioning, and sound systems; and repair of other internal utility networks. o State Rimski-Korsakov Conservatory: Rehabilitation of the English Church. O Tsarskoye Selo Palace State Museum: Rehabilitation of the Hermitage Kitchen, the Turkish Baths, and bridges. o Pavlovsk Palace State Museum: Rehabilitation of the Temple of Friendship.

2. Subcomponent (b): Cultural Investment Facility (CIF) (UJS$7.30 million). The sub-component will build on the successful experience of the Cultural Fund which was part of the St. Petersburg City Center Rehabilitation Project. It will provide, on a competitive basis, grant funding to eligible cultural institutions in, and in the vicinity of, St. Petersburg for small-scale investments and institutional strengthening activities of up to USD 200,000 equivalent (unless otherwise agreed with the Bank) that would help the recipients to: (a) increase own-source commercial revenue, (b) improve the accessibility to cultural assets or activities of the public through, inter alia, installation of special facilities for the handicapped, materials for the development of outreach programs, and upgrading of public information systems; and (c) carry out critically needed small investments for the preservation of buildings and assets including security systems, other protective equipment, restorative emergency repair works, and (d) improve their financial management, budget and investment planning. Specific operational arrangements, including eligibility criteria and selection and evaluation procedures for the facility are detailed in the FISP Operations Manual.

-20 - 3. Subcomponent (c): Institutional Strengthening (US$0.60 million). The component will provide technical assistance including staff training, to two major cultural institutions (State Mariinsky Theater, and State Russian Museum) with a view to improve the institutions' capacity to: (a) carry out financial management including budgeting, accounting, and planning (including financing of Operation and Maintenance) in accordance with international standards, and (b) improve marketing and business development.

4. Subcomponent (d): Project Implementation (US$8.89 million). The component will finance: (a) the operating costs of the Project Implementation Unit (FISP) for the duration of the project; (b) the completion of design studies required for the implementation of works for the State Mariinsky Theater and the State Hermitage Museum; and (c) services of technical specialists for specific aspects of project supervision, including technical expertise in rehabilitation of historical buildings.

-21 - Summary of Costs

,omponent 'S _-

1. City Budget Support 100.00 100.00 100.00 0.00 2a. Rehabilitation of cultural assets 47.74 93.60 45.86 49.00 State Hermitage Museum 9.55 16.90 7.35 State Marinsky Theater 24.68 48.40 23.72 State Russian Museum 4.49 8.80 4.31 St. Peter and Paul Fortress 4.02 9.70 5.68 State Shostakovich Philharmonic 1.79 3.50 1.72 State Rimsky-Korsakov 1.53 Conservatory 3.00 1_.47 _ Tsarskoye Selo Palace 1.07 2.10 1.03 Pavlovsk Palace 0.61 1.20 0.59 2b. Cultural Investment Facility 1.47 7.30 5.83 80.00 2c. Institutional strengthening 0.13 0.60 0.47 79.00 2d. Project Implementation 1.57 8.89 7.32 82.00 PIU Operations 0.49 3.49 3.00 86.00 Design and Supervision 1.05 5.00 3.95 79.00 Other Consultant Services 0.03 0.40 0.37 92.00 Total Project Base Cost 50.90 210.39 159.49 75.81 Physical Contingencies 16.76 ______16 .76 Prce Contingencies 11.04 11.04 Front-end fe 0.00 1.61 1.61 100.00 _ Total Financing Required 78.70 239.80 161.10 67.1S

- 22 - ,,, =, ,='Costs :,of;-C';i2 flin-ancing. Bank-'

Total Project Costs 0.00 0.0 0.00 0.0 Front-end fee 0.00 0.0 0.00 0.0 Total Financing Required 0.00 0.0 0.00 0.0

The investments for the State Hermitage Museum and the State Mariinsky Theater will take place within a broader program of improvements fully financed by the budget funds of the Government of the Russian Federation for an amount of US$ 32.70 million. In that extent, the investments will complement (i) a project aimed at upgrading the utility networks and the visual environment of the Palace Square (Hermitage Museum buildings), regulate visitor parking, and increase the safety for pedestrians, (ii) a project aimed at upgrading the utility networks of the Theater square (on the front of the Mariinsky Theater), reduce the illegal parking spaces and improve the access conditions to the theater for users of public transport.

2. Key policy and institutional reforms supported by the project:

The objective of SPB-EDL is to support the adoption, enactment and implementation by the City of a program of key policy reforms that are both at the core of the Federal Government's Medium Term Program and are consistent with the orientation of the CAS. Specifically, SPB-EDL will focus on inducing critical changes in the City's policy and regulatory framework for private business development and land and real estate markets, and management of City finances, as summarized in the description of the City Government Strategy in Section B.3, above and detailed in the Development Policy Letter and Policy Matrix included in Annexes 2.A and 2.B.

3. Benefits and target population:

The main immediate beneficiary of SPB-EDL, through the improved prospects for employment and income generation, is the 4.7 million population of St. Petersburg population as a whole. Through the adjustment component, SPB-EDL will help the City to: (a) establish a policy and regulatory environment that will facilitate the creation of new private enterprises and therefore contribute to fostering new employment opportunities; (b) increase the economic, efficiency of land and real estate markets through the implementation of effective land use regulations, release of underutilized assets into the market and conversion of such assets to higher use which in turn are expected to ease access to and lower the cost of land-and commercial facilities; and (c) improve the prospects for long-term sustainability of the City's fiscal position and ensure permanently stable allocations of budgetary resources to education and health. Fiscal stability and predictability are critical for allowing the City to improve the quality and reliability of infrastructure and services delivery and make it attractive to investors. Through the investment component, SPB-EDL will contribute to: (a) preserving and enhancing the role of St. Petersburg as a major center for culture and the arts, and (b) increasing the city's attractiveness for domestic and international tourism.

-23- 4. Institutional and implementation arrangements:

The Borrower for SPB-EDL will be the Russian Federation. Overall responsibility for implementation oversight will rest with the Ministry of Finance as the primary executing agency. The implementation duration of SPB-EDL as a whole is six years with the implementation of the adjustment component expected to be completed within a period not exceeding two years.

The adjustment component will be implemented in accordance with Bank standard procedures and practices for adjustrnent loans. Loan proceeds will be on-lent by the Federal Government to the beneficiary, the City, on the basis of anxOn-lending and Implementation Agreement concluded between the Federal Government and the City which will define the terms and conditions to be fulfilled by the City as a prerequisite for the two successive tranche releases. Signing of the On-lending -and Implementation Agreement will be a Condition for Effectiveness.

The overall responsibility for the implementation of the adjustment component at the City level will rest with the Governor of St. Petersburg. Operational responsibility for implementation will be with a Working Group specifically created for SPB-EDL and composed of the three Vice-Governors for Construction, Economic Development, and Finance, respectively.

Monitoring of City compliance with conditionality pertaining to the adjustment component will be carried out by the Bank as part of its regular project supervision. Monitoring of the economic and social effects of the measures implemented by the City under the adjustment component will be monitored by the Bank with the assistance of local consultants. The hybrid nature of SPB-EDL will allow such monitoring to be carried out over the total duration of six years of the project (i.e. four years beyond the completion of the adjustment component), and therefore provide, for the first time, an opportunity to closely follow the actual effects of the policy changes in the medium-term. Main economic indicators to measure progress towards achievement of project development objectives are shown in Section A.2, above (Key Performance Indicators). A methodology for monitoring the social effects of the project including survey arrangements and indicators is being developed and will be ready prior to supervision start up.

The investment component will be implemented in accordance with Bank standard procedures and practices for investment operatioqns by, and under the supervision of, entities of the Federal Government. Technically, the two components will be implemented independently and there will be no cross-conditionality between them other than that no disbursement for the investment component can be made prior to the release of the first tranche of the adjustment component.

Responsibility for the of implementation of the investment component will rest with the Ministry of Culture. The Ministry of Culture oversees all Federal cultural institutions even though the latter are administratively largely autonomous in decisions on technical and financial management and business development.

Day-to day management of project preparation and implementation of the investment component will be the responsibility of the St. Petersburg Foundation for Investments (FISP), the project implementation agency created for the implementation of the St. Petersburg City Center Rehabilitation Project. Set up in the legal form of a foundation by the City and the National Center for Housing Reform, FISP operates under the oversight of a Board comprised of representatives of the Federal Government and the City.

-24 - The Cultural Investment Facility (CIF) will be managed by FISP, as under the St. Petersburg City Center Rehabilitation Project. Technical appraisal of funding requests submitted by eligible institutions will by carried out by qualified experts hired by FISP and decisions on grant allocations will be made by ari Inter-Ministerial Grant Evaluation Committee comprised of representatives of the Ministry of Culture, the Ministry of Finance, and the Ministry of Economic Development and Trade.

D. Project Rationale 1. Project alternatives considered and reasons for rejection:

Rationale for a hybrid operation The preparation of two separate investment and adjustment operations had been considered as a possible option but rejected at an early stage of project preparation for two main reasons: First, a hybrid operation was preferred as an altemative because the linkage between policy and investment provided by a hybrid loan is the most effective means of promoting economic growth in the city and addressing remaining key recommendations of the Strategic Plan. Second, a hybrid loan was also preferred because it allowed to better match the specific conditions of St. Petersburg where achieving the objective of economic growth requires dealing simultaneously with issues of policy and regulatory reform by the City and the preservation of cultural heritage assets owned and operated by entities of the Federal Government;

Designnof adiustment component The adjustment component is structured in two tranches. The options of a single-tranche operation and multi-tranche (i.e. more than two) operation were considered but rejected. The reason for the choice of the two-tranche option was that it combines sufficient flexibility in designing the timing of the policy reforms with a realistic approach to dealing with constraints of the political consultative process. In the case of SPB-EDL where a sub-national entity is the main beneficiary, a single-tranche operation was considered risky as it would not have provided the Federal Government any instrument or ability to effectively leverage the actual implementation of the reforms. A multi-tranche operation was considered equally risky as it could provide incentives to procrastination in decision-making.

Adiustment vs. sector investment loan

Loan resources under the adjustment component will be provided to the City as budgetary support. Originally, consideration was given to financing instead a time-slice of the City's capital investment program. The option was not pursued because, as shown below by the experience of the St. Petersburg City Center Rehabilitation Project (see Section D.2: Major Related Projects), it entailed a substantial risk that by supporting the City in financing specific investments and engaging in corresponding contractual obligations the project would lose its capacity to leverage policy reform. An additional complicating factor was that the City still lacks a suitable multi-year capital investment programming system, an issue which is addressed by the policy conditionality of the adjustment component of SPB-EDL (see Annexes 2.A and 2.B).

-25 - Choice of St. Petersburg as proiect location One of the important strategic goals of the proposed SPB-EDL is to develop and test a model for future Bank operations at the sub-national level and, if conclusive, promote its replication in other regions or cities. To this end, a highly visible demonstration effect is needed. The choice that had to be made was to work either with a Region that was suffering from economic decline, was mired in problems of economic and social survival, and had poor prospects for visible immediate returns on policy reforms or with a Region or city that was enjoying a positive albeit modest economic growth and had a reasonable experience in carrying out reforns. The choice of St. Petersburg came naturally since it was one of the few Russian cities or Regions that already possessed a detailed blueprint for the future development through the preparation of the Strategic Plan and, as an additional and important advantage, had acquired a considerable familiarity with Bank operations through the implementation of the St. Petersburg City Center Rehabilitation Project.

2. Major related projects firnanced by the Bank and/or other development agencies (completed, ongoing and planned).

The Bank has been active in St. Petersburg since the mid-1990s. In March 1997, the Bank approved the St. Petersburg City Center Rehabilitation Loan (Ln. 41440-RU) for USD 31.0 million. The project, whose total cost was USD 46.10 million, was closed on April 30, 2002. The objectives of the St. Petersburg City Center Rehabilitation Project were to: (a) further develop and agree with the City and the Government of the Russian Federation on a Strategic Plan and an investment program for the rehabilitation of the historic center city; (b) initiate a program of regulatory reform to assure competitive real estate markets and a competitive business environment in the center city; (c) support a program of public information and participation in the decision-making process for city development and investment; (d) carry out some visible physical improvements that could be replicated on a larger scale in the future; and (e) assist cultural institutions in the city to improve their ability to generate non-budget revenue. To this end, the project financed technical assistance including the completion of the Strategic Plan (preparation of which was started with the assistance of USAID), the rehabilitation of selected sites in the historic city center, and a cultural grant facility that benefited a number of cultural institutions.

The Strategic Plan provided the basis for an ambitious program of reforms included in the project. However, the project was overly optimistic in some of its key assumptions and objectives, failed to make adequate provisions for Russia's political realities, and paid insufficient attention to the time-constraints inherent to any consultative legislative process. While investments and technical assistance components were carried out satisfactorily, only a few of the reforms targeted were actually implemented at the time of project completion. The November 2002 ICR for the project concludes that the project's overall achievements in terms of development objectives' outcome should be rated 'unsatisfactory' and that the operation's design was flawed from the outset as it attempted to achieve major policy reforms by means of an investment operation, even though the operation was successfully completed in terms of investments and provided support for the preparation of the SPB-EDL (see section D3: Lessons Learned). Among the achievements made by the project the most noteworthy are the successful implementation of various pilot projects that laid the ground for further rehabilitation of the city's historical center, the creation of a geographic information system on land and real estate data accessible to the public, the creation and implementation of a Cultural Fund which provided financing for local cultural institutions on a demand-driven basis for small-scale revenue generating investments, as well the development of a policy reform program which served as a base for the preparation of SPB-EDL.

-26- More generally, the Bank has undertaken a variety of cross-sectoral operational and analytical work in Russia for all the themes addressed in the policy conditionality of SPB-EDL over the past few years.

In the area of fostering improvements in the environment for business development, the Bank's involvement has included the following:

* Analytical work on improving the Russian business 'environment included a 1998 high-level workshop and collection of published papers on enterprise reform carried out collaboratively witlh the Government (see, Broadman (ed.) Russian Enterprise Reform: Policies to Further the Transition, World Bank Discussion Paper No. 400, 1999); a 2001 FIAS report on Administrative'Barriers; as well as a 2002 study that examines day-to-day impediments to business transactions in thirteen Russian regions - including St. Petersburg - based on case studies of more than 70 Russian firms and banks, (see Broadman (ed.) Barriers to Business Transactions in Russia's Regions, The World Bank, 2002). The latter study focuses on four key issues: (a) regional impediments to inter-enterprise competition and new business start-ups; (b) regulation of infrastructure service providers, especially in the telecommunications and internet sectors; (c) access to bank credit and other sources of finance; and (d) the efficacy of arbitration courts (arbitrazh) at the regional level in settling business disputes.

* On the lending side, SAL I (Ln. 41800-RU, approved in 1997; US$ 600 million), SAL II (Ln. 42610-RU, approved in 1997; US$ 800 million), and SAL HI (Ln. 43820-RU, approved in 1998, US$ 1.5 billion) all had major components supporting measures to: (a) reduce barriers to entry faced by new private enterprises including, inter alia, improving the licensing law; (b) strengthen inter-enterprise competition and creditors' rights through reform of, inter alia, the bankruptcy law and the joint-stock company law; (c) rationalize the regulatory regime governing utility monopolies; (d) encourage foreign direct investment; and (e) make the privatization of remaining state-owned shares more transparent and competitive.

As regards land management and real estate issues, Bank involvement has included:

* Economic and Sector Work comprised of, inter alia, Harding Commercial Real Estate Market Development in Russia, CFS Discussion Paper No. 109, 1995, Berthaud, Renaud et al.: Housing Reform and Privatization, Sector Report No. 14929, 1995. De Melo and Ofer The Russian City in Transition, Policy Research Paper No. 2165, 1999, Kaganova et al. Monitoring Indicators of land and Real Estate Reforms, World Bank-Urban Institute, 1999, Berthaud Land Use Patterns, St. Petersburg Case Study, ECSEE Study, 1998.

* Lending operations: The Land Reform Implementation Support Project - LARIS (Ln.37560-RU, USD 80 million, approved in 1994) supported the introduction of a uniform land registration system consistent with the development of markets in land and real estate with a primary focus on rural areas. A follow-up Land Registration and Cadastre Project is under preparation with the objective of further improving cadastre and registration systems. The Housing Project (Ln. 38500-RU, USD 400 million, approved in 1995) supported the extension of land and real estate registration systems to urban areas as well as a significant amount of technical assistance to address legal issues related to land and real estate. A Housing Market Support Project is under preparation and is expected to be submitted to the Board in FY05.

Bank involvement in the area of intergovernrmental finance has included the following:

- 27 - o Economic and sector work which has been extensive producing a series of reports and technical papers: Wallich, Russia and the Challenge of Fiscal Federalism, (1994); Le Houerou (1995) Fiscal Management in the Russian Federation (1995); Le Houerou and Rutkowski: Federal Transfers in Russia: "Their Impact on Regional Revenues and Incomes" Comparative Economic Studies (1998); Freinkman et al. Subnational Budgeting in Russia: Preempting a Potential Crisis (1999); and Freinkman and Yossifov (1999) Decentralizationin Regionalfiscal systems in Russia: Trends and Links to Economic Performance(1999). o Lending included the following operations: The First Tax Administration Project (Ln. 38530-RU, USD 16.8 million, approved in 1995 ) focused on tax modernization in Nizhny-Novgorod and Volgograd, thus addressing fiscal issues from the tax side. In 1998 a sizeable block of policy conditionality pertaining to intergovernmental reforms was included in SAL m. The Regional Fiscal Technical Assistance Loan, (Ln. 45280-RU, USD 30 million, approved 1999) provided assistance to the Russian Federation in strengthening federal and regional fiscal legislation and monitoring capacity, and provided assistance to six regions to carry out diagnostic studies and prepare reform programs. The Fiscal Federalism and Regional Fiscal Reform Loan (Ln. 46470-RU, US$120 million, approved in 2001 supports the regions in the development and implementation of fiscal reform programs that will promote financial transparency, budgetary accountability, and strengthened fiscal management policies and practices. The City received a USD4.0 million grant under this loan on the strength of its fiscal reform performance to date.

In addition to the Bank, a number of bilateral agencies and other International Finance Institutions (IFIs) have been active in these areas in Russia. USAID was instrumental in the preparation of the Strategic Plan for St. Petersburg. It also contributed to setting up a City land cadastre and title registration system and preparing legislation on urban land use and urban development control.

EBRD supported the City with a Municipal Support Loan (US$100 million; approved in 1997) and assisted it in launching a US$300.00 million Eurobond issue in 1997. Additionally, EBRD has financed water supply and environmental projects. It is currently considering financing the completion of a flood barrier protecting the city from recurring floods. It has also participated in the financing of a number of private business ventures in the industrial and commercial sectors including tourism related activities.

St. Petersburg is one of the targeted areas for the Northern Dimension Environmental Partnership (NDEP), supported by the Nordic Investment Bank, the European Investment Bank (EIB), the EBRD, and the Governments of Norway, Sweden and Finland.

TACIS, DFID, GTZ have funded various technical assistance programs for the improvement of City accounting and information systems, and City fiscal and financial management, as well as contributions to work on intergovernmental fiscal relations, and taxation.

-28 - |-- ~~- .; | ,| _ 7i-Latest Supeirvision - - _ Sector-- ;= -Issue- Projct - (PSR)yRatings. - .. _-_____-____-_____-.-.______. ___-__-_-__--:__,_.__._-___-(Bank-financed projects only), Implementation Development Bank-financed Progress (IP) Objective (DO) Insufficient availability of financial St. Petersburg Center City S U resources to rehabilitate the historic Rehabilitation Project center of St. Petersburg and help preserve the city's cultural heritage.

Weak regional institutional capacity to Regional Fiscal Technical S S implement intergovernmental fiscal Assistance Project reform; and improve fiscal management at regional level.

Lack of incentives at regional level to Fiscal Federalism & Regional S S implement fiscal reform. Fiscal Reform Project

Other development agencies EBRD St. Petersburg Municipal Support Project; Water Supply Project Environmental Projects Infrastructure Projects.

USAID Strategic Plan for St. Petersburg.

DFID/KHF Municipal Finance Advisory, Municipal Good Governance.

GTZ Public expenditure management.

TACIS Municipal management

Northern Dimension Environmental Infrastructure projects Partnership I_I IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory)

3. Lessons learned and reflected in the project design:

Lessons from the St. PetersburgCity Center Rehabilitation Project Implementation of policy and regulatory reform was a major objective of the project. The project failed to achieve significant results, however, because it was: (a) unrealistic in its objectives and assessments of

-29 - political realities, and (b) designed as an investment project and therefore unable to leverage actual implementation of reforms. Other specific lessons include: o the central role of legal and regulatory reform at both Federal and local government levels for the development of land and real estate markets; o the awareness of the difficulties faced by the introduction of more transparent procedures for land use and development as a result of vested interests of the various City agencies involved; o the high level of interest in the development of suitable urban policies and regulations shown by citizens, the business community and NGOs.

Lessons from adjustment lending in Russia:

The Bank has provided the Russian Federation with a sequence of three SALs. While the outcomes from the SALs have been less than expected, the SAL program was successful in: o introducing and maintaining a strong focus on systemic structural reforms; o promoting dialogue and instilling the merits of reform in the program which ultimately led to the adoption by the Government of its own program in 2000 that is in approach, content and design clearly consistent with the "road map" provided by the SALs; o maintaining steady reform progress with emphasis on reform implementation and preventing major reversals, even during trying economic times; and o preparing the ground for, and beginning to put in place, many important changes in the legal and regulatory environment necessary for effective reform implementation.

Lessons learnedfrom cultural heritageprojects: The scope of the investment component of SPB-EDL departs to a large and significant extent from other earlier cultural heritage projects supported by the Bank worldwide. A first generation of cultural heritage projects focused primarily on physical conservation of sites and structures, but paid insufficient attention as to whether such operations where effectively linked with or part of a comprehensive urban development strategy and provided an opportunity for economic development. The 1999 Bank Framework Paper on 'Culture and Sustainable Development' recommended that cultural heritage operations should only be considered if, inter alia, they would support core development objectives and help leverage private investment generating local employment. The 2001 ECA guidelines for cultural heritage operations 'Cultural Assets in Support of Transition' underlines the need to design cultural heritage operations in the broader context of local economic development and generation of employment opportunities and to ensure that 'Bank-financed activities revolving around cultural assets [..] substantially contribute to socioeconomic development....' as well as 'include a minimum package of institution building components to ensure sustainability'. SPB-EDL fully complies with these requirements as by its very design it conceives the preservation of physical cultural assets a critical component in an operation whose primary objective is to further the economic development of St. Petersburg as a whole and complements physical rehabilitation works with advisory assistance to help key cultural institutions improve financial management and business planning.

- 30- 4. Indications of borrower commitment and ownership:

The commitment of the authorities of the Federal Government and the City to the project is demonstrated by a series of actions:

* The Governor of St Petersburg, Mr. Yakovlev, indicated his full support to the principles of the proposed policy reforms in a letter to the Bank of March 2002 and confirmed, via the minutes signed on December 20, 2002 of the Working Group, his agreement to the matrix discussed during of the December 2002 project appraisal. * The outline of the proposed program of investments for cultural assets was agreed to by the authorities of both Russian Federation and the City as confirmed by a letter dated April 25, 2001 from Mr. V. Khristenko, Deputy Prime Minister to the Bank. * The interest of the Russian Government in the Bank's involvement in the preservation of cultural assets in St. Petersburg was the subject of a letter from the President of the Russian Federation, H.E.Vladimir Putin, to the President of the Bank in Spring of 2000.

* Discussions during project preparation with the management of the cultural institutions involved in the project resulted in an explicit agreement on the objectives and outline of the proposed programs of technical assistance.

5. Value added of Bank support in this project:

SPB-EDL is also a logical continuation of the Bank's efforts to help the Government of the Russian Federation accelerate the implementation of its Medium-Term Program at the regional level with a view to support the gradual diversification of the economy. Because of both its long-standing involvement in issues of business development policies and sub-national finance in Russia and its familiarity with the specific problems of St. Petersburg gained under the St. Petersburg City Center Rehabilitation Project, the Bank is uniquely positioned to effectively assist the City in achieving its objectives of fostering further economic development through improving the conditions for private sector participation in the economy, securing the long-term stability and sustainability of the City finances, and exploiting its comparative advantage as a center of culture and the arts. The Bank is the only IFI that combines an extensive knowledge of Russia's macro-constraints with the operational experience of lending operations. Under SPB-EDL the Bank exclusively addresses issues that are not being addressed by any other IFI and is not involved in sectors where support from other IFIs is available, (see Section D.2: Major Related Projects, above).

E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8) 1. Economic (see Annex 4): (C)Cost benefit NPV=US$ million; ERR = % (see Annex 4) 0 Cost effectiveness * Other (specify)

- 31 - For Adjustment component: Traditional methodologies for economic analysis of projects are not practical in the case of an adjustment type operation. The economic rationale for the adjustment component is that it will provide greater flexibility to the City in the use of the resources and allow it, in particular, to meet any fiscal costs associated with the structural reformns agreed to under SPB-EDL. The City needs to borrow to finance its expenditure programs and costs resulting from the reforms in the face of (a) limited sources of new revenue, (b) potential decline in revenues from federal tax reforms, and (c) relatively higher cost of current domestic borrowing. Key expenditure programs that are currently under-funded and risk further curtailments include public investments in capital repairs, current expenditures in education, health and social protection, and arrears reduction. In this context, the resources provided by SPB-EDL will allow the City to maintain and expand the basis for future economic growth, reduce the risk of intra-year arrears, and, thereby, enhance the credibility of the City budget.

For Investment Component

The objective of the investments funded under the SPB-EDL is to contribute to the preservation of architectural monuments that are part of the world's cultural heritage, assure their protection from further physical deterioration, improve the access and working conditions for visitors, patrons, artists, and employees and increase the safety of artistic treasures on display from theft or physical hazards. The cultural assets of St. Petersburg are unique and the full benefits of their preservation present difficulties for any comprehensive valuation. Economic analysis distinguishes three broad categories of benefits: recreation (consumption) benefit, aesthetic, and existence (including option of use) value. Consumption or recreation benefits can be assessed through revealed preference, as signaled through market prices, or contingent valuation surveys can be used when market prices are not observed. In order to estimate aesthetic and existence value, contingent valuation surveys are usually utilized.

No contingent valuation surveys were conducted, in large part because market prices and willingness-to-pay (WTP) can be observed through the fees charged by the various cultural institutions. For Russian visitors, the fees charged are much below those charged for foreign tourists, reflecting two distinct markets driven by sharp differences in average incomes. In the case of foreign visitors, WTP is reflected in the total sum of admission prices to the key cultural sites, which for the average foreign visitor represents a total price of roughly $80 in admission fees per stay in St. Petersburg. Based on this price, the recreation and consumption value of the city's assets to foreign tourists is roughly $50 million. While Russian visitors and foreign tourists represent two distinct markets, as reflected by the different prices paid by each group for admission into cultural sites, the share of revenues from ticket sales from each group is currently about equal among the key cultural sites (due to the much greater number of Russian visitors). The implication is that the value ascribed to consumption (recreation) value was about equal for both Russians and foreigners.

2. Financial (see Annex 4 and Annex 5): NPV=USS million; FRR = % (see Annex 4)

Adjustment component

A Creditworthiness Review of the City and a Core Fiduciary Assessment were completed in May 2002 and are available in the Project File. Applicability to SPB-EDL of financial management procedures for adjustment loans in Russia was confirmed at Negotiations.

- 32 - Investment component

No financial analysis was carried out for the investment component since SPB-EDL will only benefit nonprofit cultural-institutions and not commercial entities that generate profit. SPB-EDL will not result in any new financial -obligations for the beneficiary institutions, as investments will be financed directly by the Federal Government on a grant basis. While difficult to assess ex-ante, it is safe to assume that the upgrading of utility networks and replacement of worn out and obsolete equipment will lead to significant reductions in operating costs and easily offset any incremental costs that could result from activity development resulting from the project.

Given the uncertainty of costs inherent to rehabilitation works in historical buildings, the Federal Government will make reasonable efforts to ensure financing for any cost increases for physical and financial contingencies over and above the levels taken into account for determining of project costs at appraisal (see Section E.3 below). Federal Government Agreement to this arrangement was confirmed at Negotiations.

Fiscal Impact:

Adjustment component

The fiscal impact of the policy reform implemented under SPB-EDL on the City is expected to be essentially positive. The broadening of the City's tax base through the creation of new businesses and employment, the reduction of various tax and rent concessions, and the elirnination of other forms of City financial support to enterprises will, in the medium- and longer term, significantly increase the City's fiscal revenues.

Investment component

The fiscal impact of the investment component will be negligible as it will be financed as a Federal budget contribution and not result in any financial costs to the beneficiary institutions. Possible increases in recurrent costs at the level of these institutions are expected to be largely offset by the significant gains generated by decreases in utility and other operating costs as a result of repairs and replacement of worn out and energy-inefficient equipment.

3. Technical:

Adjustment component

There are no technical issues involved in the adjustment component.

Investment component

Rehabilitation of existing buildings always carries a risk of unforeseen costs for items that cannot be identified ex-ante whatever the quality of preparatory studies. The risk is greater in the case of cultural and historical architectural monuments since works do not only have to satisfy technical criteria but also must respect the architectural and artistic integrity of the buildings. Given the specifics of Bank loan administration, cost overruns could result in major complications for timely and satisfactory completion

- 33- of works and become a cause for unwarranted political embarrassment. Furthermore, rehabilitation of musical theatres and museums also poses specific special engineering and construction challenges and has a potential for creating a reputational risk for the Bank.

These risks have been reduced by the selection of firms specialized in this type of work for the feasibility and technical design studies, and in the case of the Mariinsky Theater, by the competitive selection of an internationally experienced design firm. During project preparation, the Bank has been assisted by the Chief Architect of the Chateau de Versailles (France), an expert in rehabilitation and renovation of historical buildings of international recognition. This consultant has been in charge of controlling the quality of the design and technical studies for all the rehabilitation projects included in SPB-EDL. Risks will be further mitigated by the involvement of specialized consultants whom the Bank will hire for project supervision as well as the creation of a group of international experts who will advise the Ministry of Culture on specific preservation issues.

Although technical risks cannot be eliminated due to the very nature of the works financed under SPB-EDL, their potential implications for the financial management of the project will be reduced significantly as a result of: (a) retaining on an exceptional basis ex-ante physical contingencies at a relatively high level of 20%; and (b) limiting Bank financing to a fixed maximum amount determined at appraisal with the Federal Government making reasonable efforts for ensuring the financing for any possible additional cost in excess of said amount.

4. llnstitutional:

4.1 Executing agencies:

The primary executing agency for SPB-EDL is the Russian Federation's Ministry of Finance. The executing agency for the adjustment component is the City of St. Petersburg. The executing agency for the investment component is the Ministry of Culture.

4.2 Project management:

The adjustment component of the project will be implemented in accordance with standard Bank procedures and practices for adjustment loans. At City level, the responsibility for implementation of the adjustment component rests with a Working Group which is composed of the three Vice-Governors for Construction, Economic Development, and Finance, respectively, and reports to the City Governor.

Responsibility for managing the day-to-day implementation of the investment component as well as the management of the Cultural Investment Facility (CIF), will be entrusted by the Federal Government to the St. Petersburg Foundation for Investments (FISP) which, as previously under the St. Petersburg City Center Rehabilitation Project, will serve as the local Project Implementation Unit (PIU). The federal government will provide funds for technical reviews and approval of design documentation as required under Russian Law.

Although FISP was created for the management of the St. Petersburg City Center Rehabilitation Project, its responsibilities exceed those of a traditional PIU and include a wide array of activities including commercial ventures. To avoid any situation of potential conflict, care has been taken to set up specific financial management arrangements that will allow it to maintain permanently full accountability for and transparency of transactions and decisions related to SPB-EDL. Additionally, to take into account the

- 34 - specific nature of SPB-EDL, the composition of the Board of FISP will be amended to include the Ministry of Culture. Appointment of members of the FISP Board will be a Condition for Loan Effectiveness. FISP responsibilities and working procedures for the management of SPB-EDL, including procurement, disbursement and financial management arrangements are described in a FISP Operations Manual. Specific procedures and arrangements for environmental screening (Environmental Management Plan) are included in the Operations Manual. Adoption by the FISP Board of an Operations Manual acceptable to the Bank will be a Condition for Loan Effectiveness. CIF will be managed by the FISP. Technical appraisal of finding requests by qualified experts will be required and decision for financing will be made by an Inter-Ministerial Grant Evaluation Committee comprised of representatives of the Ministry of Culture, the Ministry of Finance, the Ministry of Economic Development and Trade. Appointment of members of the Inter-Ministerial Grant Evaluation Committee will be a Condition for Loan Effectiveness. Specific procedures and arrangements, including project eligibility and selection criteria as well as environmental screening procedures are included in the FISP Operations Manual referred to above.

4.3 Procurement issues:

Adjustment component

No procurement is involved under the adjustment component.

Investment component

No major procurement issues are expected under the investment component. Nevertheless, the Country Procurement Assessment Report (FY01) noted that Russia is considered a 'high risk' country. All procurement for goods, works and consultant services will be carried out in accordance with Bank guidelines. The Bank has carried out a Procurement Capacity Review of FISP in December 2002. It concluded that FISP procedures were fully satisfactory, but that FISP staff would benefit from specialized additional training.

A detailed description of procurement arrangements is included in Annex 6.A.

4.4 Financial management issues:

The Project financial management arrangements meet minimum Bank requirements. The OP/BP 10.02 has been met.

Adjustment component

SPB-EDL will follow the procedures which the Bank has previously agreed with the Federal Government under the Fiscal Federalism and Regional Fiscal Reform Loan, for monitoring the funds disbursed under adjustment loans. These procedures, which provide for a "real time tracking" of resources, will require the opening of a separate account in foreign currency in the Central Bank of Russia, reporting to the World Bank after each transaction, and expedited audits of the account.

- 35 - Investment component

A Financial Management Capacity Assessment of FISP was carried out in July 2002. The assessment concluded that the staffing of the financial and accounting departments of FISP was adequate. The assessment found no significant financial management risks. The project will be implemented by the FISP which is familiar to the Bank procedures (the FISP was the implementing agency for the Saint Petersburg Center Rehabilitation Project). The FISP has sound accounting, budgeting and intemal control system in place; its staffing is adequate and appropriate for the Project. For the purpose of the Project, the FISP will keep improving its current financial management arrangements by providing training to its financial management staff and by improving accounting software to produce the required FMRs and other mandatory reports. The FISP will submit FMRs the Bank quarterly followed by audited annual FMRs and IFRS financial statements. The FMRs fornat is defined and acceptable for the Bank As far as FISP implements the Saint Petersburg Center Rehabilitation Project it has appointed the auditor acceptable for the Bank. SA and co-finance account will be opened in state owned bank, acceptable for the World Bank and agreed with RF Ministry of Finance. There are no financial management conditions for effectiveness of the loan. A detailed description of financial arrangements is included in the Annex 6B of this document.

5. Environmental: Environmental Category: F (Financial Intermediary Assessment) 5.1 Summarize the steps undertaken for environmental assessment and EMP preparation (including consultation and disclosure) and the significant issues and their treatment emerging from this analysis.

No environmental issues of significance are anticipated under SPB-EDL.

The adjustment component of SPB-EDL will help improve prospects for new business formation, contribute to more rational and economically efficient land use through improved zoning and increase the availability of land for new developments through the removal of tax concessions and promotion of competitive market mechanisms for land and real estate. As a result, the project can be expected to have, over time, a significant positive environmental effect as it will, inter alia, encourage existing and largely derelict manufacturing plants to move out of the historic city center and give way to gradual environmental clean up and replacement of environmentally detrimental activities by service activities and residential housing.

The investment component will exclusively finance the repair and rehabilitation of existing historic buildings. Effects on the environment resulting from construction activities may include dust, noise, and other construction-related local and temporary nuisances such as temporary increase of heavy vehicle traffic. To mitigate such adverse environmental impacts, contractors will be required to follow environmentally sound construction practices and include environmental safety requirements into the technical specifications and contracts for civil works. Compliance with such instructions will be closely monitored during implementation. Possible environmental issues arising from activities under the investment sub-component 2a and the Cultural Investment Facility (CIF) will be addressed through appropriate instructions, respectively in the EMP and in the FISP Operations Manual environmental assessment guidelines (see Section E.4.2, above). These documents and procedures have been submitted to the Bank for review, found in accord with FI and B principles and have been disseminated for public review in the city of St Petersburg.

-36- 5.2 What are the main features of the EMP and are they adequate?

N/A

5.3 For Category A and B projects, timeline and status of EA: Date of receipt of final draft: N/A

5.4 How have stakeholders been consulted at the stage of (a) environmental screening and (b) draft EA report on the environrnental impacts and proposed environment management plan? Describe mechanisms of consultation that were used and which groups were consulted?

SPB-EDL does not target any specific group of stakeholders and its main beneficiary is the city's 4.7 million population as a whole. Given the design of the project there are no stakeholders that could or would need to be consulted specifically on environmental issues for either the adjustment component or the investment component. The program of policy reforms included in the adjustment component is the direct outcome of the Strategic Plan which was prepared in extensive discussion with the various stakeholders interested and the population of St. Petersburg at large. None of the reforms proposed has direct environmental implications and only positive effects in the medium-and longer term. The works financed under the investment component are carried out under the auspices of the Ministry of Culture of the Russian Federation and the oversight of the Boards of the institutions which, in a number of cases, include or are advised by representatives of the international art scene, public and private international cultural institutions as well as, in the case of the State Hermitage Museum for instance, organizations such as UNESCO.

5.5 What mechanisms have been established to monitor and evaluate the impact of the project on the environment? Do the indicators reflect the objectives and results of the EMP9

In accordance with prevailing Federal Government legislation, environmental management in Russia is a shared responsibility of the Federal Government and the Regions. Environmental reviews and environmental impact assessments are carried out by the Ministry of-Natural Resources (MNR) and its deconcentrated units in Russia's seven administrative regions (okrug) and are governed by a legal and regulatory framework that can be considered satisfactory-according to a Bank review of June 2002. In accordance with the Federal regulations all works financed under the investment component are subject to mandatory review including an Environmental Impact Assessment (which provides for public participation) and a State Environmental Review by MNR staff or if, advisable, MNR appointed independent experts. Compliance with environmental regulations-will be monitored and/or enforced by the North-West okrug MNR branch in St. Petersburg in close cooperation with FISP and relevant City agencies.

6. Social: 6.1 Summarize key social issues relevant to the project objectives, and specify the project's social development outcomes.

SPB-EDL does not target specific social groups nor does it primafacie adversely affect the well-being or livelihood of any such group nor does it include activities that might entail significant social risks.

- 37 - Rather, it is expected to lead to essentially positive outcomes.

The adjustment component will: (a) increase opportunities for greater private participation in the economic life of the city, (b) broaden, and improve access to, the land and real estate markets and, as a result of greater supply, lead to lower average land and real estate prices for new commercial and residential users; and (c) reinforce the incipient reorientation of City budgetary management towards increased spending for social sectors.

Facilitating the creation of new private enterprises especially SMEs will contribute to the creation of new employment and income sources for households. While it is impossible to determine ex-ante the number and socioeconomic level of the beneficiaries of such new employment opportunities, it is safe to assume that the spectrum of qualifications and skills will be broad and that therefore a substantial number of beneficiaries will be found among the 40% of the city population that are currently below the poverty level. On the downside, it is recognized that the divestiture of City-owned or City-controlled enterprises as well as the reduction or elimination of City financial support to certain enterprises could lead to the closing of some unprofitable enterprises and/or the reduction of redundant workforce. While such loss of employrnent is the unavoidable result of the transition to market economy, it can be expected that its impact will, at least to a certain extent, be mitigated by the creation of new employment opportunities as a result of the reforms introduced under SPB-EDL.

Creating the conditions for a better functioning, land and real estate markets should not have adverse social effects for a variety of reasons. First, while the ownership of land has remained concentrated in the hands of the City, ownership of housing has become diversified over the past decade. In 2002, about 45% of all apartments which were formerly City-owned had been privatized. Virtually all new housing construction is destined for the private market. Concurrently, a significant change in the socioeconomic distribution of population has occurred and continues to be occurring in all areas of the city. In a context of shrinking population (from 5.1 million in 1990 to 4.7 million in 2001), the number of housing units has, according to City estimates, increased by at least 20% over the last ten years. Communal apartments, in turn, have decreased by 20%. The result of these changes has been a socioeconomic redistribution of both population and property values that brings St. Petersburg closer to the population and price gradients typical for a market economy. Privatization of land currently owned by the City together with a simplification of land use procedures and zoning regulations should induce an increased supply of idle land for development. Resulting cheaper land costs can be expected to further loosen up the market for residential spaces of all categories. Conversion of industrial land, which in some cases may have been exposed to contamination with pollutants, to residential use is subject to compliance with Federal environmental regulations and monitored by the relevant authorities of the MNR and the City. City-internal migration is a normal phenomenon but it must be noted that such relocation of population is an entirely voluntary process as the City has very strict resettlement policies and procedures that were reviewed by the Bank in connection with the St. Petersburg City Center Rehabilitation Project and found satisfactory.

Removal of fiscal privileges on commercial premises may negatively affect individual beneficiaries of such privileges and cause some of them to either move to other locations with rent levels more in line with their actual financial capacity or close their activities. Such adverse effects on a few beneficiaries are expected to be largely offset, however, by the overall economic benefits that will accrue to the city population as a whole through the elimination of market distortions, the increase in the City's fiscal income, and its improved ability to deliver essential services.

The investment component is socially neutral as it will deal exclusively with the physical plant of the cultural assets benefiting from the project. It will not alter the access conditions to cultural events and

-38 - monuments of all classes of Russian citizens who at this point still benefit from an easy access to artistic events due to a preferential low tariff regime with various social groups enjoying free access. Additionally, most major Federal cultural institutions in St. Petersburg are engaged in extensive educational and out-reach programs for the city population, many of which are funded, increasingly with the help of private business sponsors.

6.2 Participatory Approach: How are key stakeholders participating in the project?

SPB-EDL does not target any specific social group. The main beneficiary of the adjustment component is the St. Petersburg business community and through the improved prospects for employment and income generation, the St. Petersburg population as a whole. The program of policy reforms included in the adjustment component is the direct outcome of the Strategic Plan which was prepared in extensive discussion with the various stakeholders interested and the population of St. Petersburg at large. St. Petersburg is also one of the few cities in Russia that has established a participatory approach to the preparation of the annual City budget. Steps taken to this effect include the publication of a medium-term financial plan, NGO-led public hearings on draft budgets, clear and relevant economical and functional classification of the budget, and availability of access to the budget and other financial information on the City website (www. fincom.spb.ru).

The preservation of historical and cultural monuments in St. Petersburg is part of the population's pride and identity as shown through the city's experience during Wwn. Given the technical and noncontroversial nature of the works financed by the project, it appears unlikely that there are any stakeholders in the city with special and specific interests that would need to be consulted or would be able to provide specific advice. The interests of the world cultural community are preserved through the close association of UNESCO and other international and bilateral cultural institutions with the management of the major cultural institutions in St. Petersburg.

6.3 How does the project involve consultations or collaboration with NGOs or other civil society organizations?

As noted above, the program of policy reforms included in the adjustment component is the direct outcome of the Strategic Plan which was prepared in extensive discussion with the various stakeholders interested and the population of St. Petersburg at large.

6.4 What institutional arrangements have been provided to ensure the project achieves its social development outcomes?

N/A

6.5 How will the project monitor performance in terms of social development outcomes?

Social indicators will be included in the monitoring program for the adjustment component and closely followed as part of the overall monitoring process of SPB-EDL. Participation of experts in rehabilitation of historical and cultural monuments in the Bank supervision of the investment component will be sought to assure work implementation in accordance with intemational standards and best practice.

- 39 - 7. Safeguard Policies: 7.1 Are any of the following safeguard policies triggered by the pr ect? -- - 1 < '- polecy - -d _ TrIggered Environmental Assessment (OP 4.01, BP 4.01, GP 4.01) 1 Yes C) No Natural Habit2ts (OP 4.04, BP 4.04, GP 4.04) U Yes ) No Forestry (OP 4.36, GP 4.36) U Yes * No Pest Management (OP 4.09) U Yes 9 No Cultural Property (OPN 11.03) s Yes U No Indigenous Peoples (OD 4.20) C Yes w No Involuntary Resettlement (OP/BP 4.12) ( Yes w No Safety of D)ams (OP 4.37, BP 437) U Yes w No Projects in International Waters (OP 7.50, BP 7.50, GP 7.50) U Yes w No Projects in Disputed Areas (OP 7.60, BP 7.60, GP 7.60)* U Yes t No

7.2 Describe provisions made by the project to ensure compliance with applicable safeguard policies.

Since all work will be done within existing buildings owned by the Government, SPB-EDL will not require land acquisition and will not result in involuntary resettlement. Given that the project will be carried out with advisory assistance from the Ministry of Culture and its experts, no issues of management of cultural property are expected to arise. As it focuses exclusively on preservation of existing cultural properties, SPB-EDL does not raise any issue in the sense of OP 1 1.03.

The above assurances notwithstanding, there remains a potential reputational risk for the Bank stemming from its involvernent in high visibility work on World Heritage treasures of the kind encountered in St. Petersburg. The risk is mitigated, to a large extent, by the involvement of UNESCO and other international cultural entities such as the Guggenheim and Getty Museums in the management of the State Hermitage Museum, the association of world renown composers and conductors in the activities of the State Mariinsky Theatre, etc.

(b) If application is still to be determined, describe current or planned efforts to make a determination.

N/A

F. Sustainability and IRisks 1. Sustainability:

As a hybrid operation, SPB-EDL presents two distinct dimensions of sustainability. In the case of the adjustment component, the sustainability of the policy reforns depends on: (a) the degree to which the reforms rest on City ownership and are backed by political consensus and legislative action, where necessary; and (b) the skill and thoroughness with which these policies are implemented by the City.

-40 - In the case of the investment component, the rehabilitation of cultural assets the sustainability issue is more diverse. Works financed under SPB-EDL are one-time investments. The current state of deterioration is the result of years of accumulated neglect. The critical issue is to prevent further recurrence of lapses in periodic maintenance of buildings and equipment. To this effect, and to ensure the sustainability of the investments, SPB-EDL will finance programs of technical assistance for at least two of the major institutions (State Mariinsky Theater and State Russian Museum) with a view to help them improve their financial management systems and set up medium- and long-term investment strategies and maintenance programs.

2. Critical Risks (reflecting the failure of critical assumptions found in the fourth column of Annex l):

The principal risk for a successful implementation of the adjustment part of SPB-EDL will come from the possible resistance to changes in the City bureaucracy where officials at various ranks may attempt to maintain the status quo and protect vested interests.

The investments to be financed under the cultural assets component, i.e. engineering and construction in a difficult environment (musical theater, art museum, historic monuments) are faced with the risks inherent to all such works in whatever context. The procurement procedures for the feasibility studies of these works emphasized recent, relevant experience for all the design firms. To further mitigate the risk, the Bank has sought the assistance of highly qualified international experts to review the design proposals for the rehabilitation works for the eight cultural institutions and intends to hire similarly qualified experts to participate in project supervision.

Specific implementation risks are described below.

-41 - _- ::. , 7T:hiRk~i . T_RISk~flft!titiiOflt^-, -- IiFWOW-,i_% From Outputs to Objective Political consensus is not reached on S Compliance with significant up-front design and implementation timetable for conditionality as a condition for Board policy reform. presentation.

Project design and work execution is not S Careful selection and pre-qualification of carried out in accordance with design and construction firms during international standards. procurement process.

Use of specialized consultants by the Bank to advise on the quality of bids and monitor work execution.

Demand for small-scale investments M CIF design has been prepared on the basis of through CIF is weak and will not allow extensive preliminary survey of institutions available resources be fully used. potentially interested in CIF as well as the experience acquired under the St. Petersburg city Center Rehabilitation Project.

Cultural institutions are unwilling to H TA and training programs will be prepared and follow up on recommendations of TA implemented in permanent and close programs. coordination and involvement of institutions. From Components to Outputs Federal Government counterpart funding S Early agreement sought from Federal appropriations for rehabilitation works is Government on details of project financing delayed. arrangements.

Cultural institutions are not able to S FISP will provide necessary assistance and submit adequate proposals for CIF guidance to institutions. small-scale investments.

Design and procurement process delays H Selection of design consultants emphasizes implementation of works. relevant international experience. Overall Risk Rating S Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N(Negligible or Low Risk)

3. Possible Controversial Aspects:

The project presents substantial reputational risks to the Bank. St Petersburg is often branded in the media as a corrupt environment and the Bank's support to the City may be seen as tacit consent to corrupt political or economic management practices. Though not an anti-corruption project, many elements of the policy reforms under the SPB-EDL will support a more transparent business environment. To further mitigate this risk, the City has requested that, during project supervision, the Bank provide advice on a communication strategy and campaign, similar to the consultation process developed during the preparation of the Strategic Plan.

-42 - Bank investment of the magnitude of SPB-EDL in the rehabilitation of cultural assets and, in particular, the State Mariinsky Theater, could expose the Bank to some criticism since it could be argued that the Bank, as a lender of last resort, should direct its resources at numerous cultural heritage assets that are imperiled throughout Russia's poorer Regions and, unlike the city of St. Petersburg, lack any prospect of being able to mobilize public or private funding necessary for their survival or preservation. While the argument cannot be dismissed offhandedly, it must be counter-argued that: (a) the nature and technical complexity of the rehabilitation of cultural institutions such as the State Mariinsky Theater leads to financing requirements of a scale that cannot be met, in the Russian context, through private contributions or ordinary Federal budget contributions without putting the very existence of the institution as going center of art at risk; and (b) institutions such as the State Mariinsky, the State Hermitage Museum or the State Russian Museum play a pivotal role in the economy of St. Petersburg and the economic effects derived from their preservation and continuing existence are incommensurably greater than those an investment in a more remote and tourism-wise less accessible location would yield.

G. Main Loan Conditions 1. Effectiveness Condition

* Signing of On-lending and Implementation Agreement between Federal Govermnent (Ministry of Finance) and City * Conclusion of an FISP Agency Agreement with MOF and Ministry of Culture * Revision of FISP Charter and appointment of FISP Board members * Appointment of the CLF inter-ministerial grant evaluation committee members * Adoption of FISP Operations Manual acceptable to the Bank

2. Other [classify according to covenant types used in the Legal Agreements.]

Disbursement Conditions:

- Release of the first tranche of the Adjustment component of the project upon compliance with first tranche conditions of reform measures detailed in Policy Matrix (see Annex 2.B). - Disbursements under the Investment component of the project are to be made after the release of the first tranche of the Adjustment component of the project. - Continued satisfactory macroeconomic performance.

-43 - H. Readiness for Implementation i 1. a) The engineering design documents for the first year's activities are complete and ready for the start of project implementation. 1. b) Not applicable.

! i 2. The procurement documents for the first year's activities are complete and ready for the start of project implementation. i 3. The Project Implementation Plan has been appraised and found to be realistic and of satisfactory quality. 4. The following items are lacking and are discussed under loan conditions (Section G):

1. Compliance with Bank Policies i 1. This project complies with all applicable Bank policies. i 2. The following exceptions to Bank policies are recomrnended for approval. The project complies with all other applicable Bank policies.

Richard L. C d Sumter Lee Travers Julian F Team Leader I Sector Manager Country Director

-44 - Annex 1: Project Design Summary RUSSIAN FEDERATION: ST. PETERSBURG ECONOMIC DEVELOPMENT PROJECT

z~ ,. .-- \ r .3 ::,-ieyK i eH rmace, ' - iData-'C'ol'lection Strategy ,

>'~:Hierirch~y6f,Obje'ctives- ---e.r. .~In'dicators t,\9_,9--f f,-w4... re- - -.--. . '-: .... CriticalAsurn.tiori, Sector-related CAS Goal: Sector Indicators: Sector/ country reports: (from Goal to Bank Mission) Improving business and Growth of St. Petersburg Annual Government Share of private sector investment climate at City GRP in absolute and per Economic Reports. activities in city economy will level. capita value. increase as a result of EDL Annual City reports. supported policy reforms.

Diversify city economy to Increase in contribution of St. Petersburg preserves its mitigate effects of external service sector activities to role as a major international shocks and reduce poverty. GRP tourism center.

Economic growth contnbutes to poverty reduction.

Project Development Outcome / Impact Project reports: (from Objective to Goal) Objective: Indicators: Policy and regulatory More competitive environment Quarterly PIU Project Progress New firms are created and environment is conducive to due to (i) 10% p.a. (2003 base Reports existing ones are able to the expansion of private sector year) increase in the number restructure and expand. enterprises. of new SMEs registered in St Bank Supervision Reports Petersburg; and (ii) 10% p.a. (2003 base year) increase in City annual economic and the number of applicants financial reports assisted by the city's CEFIR and other surveys on Information Centers. business climate

Larger and more efficient Foundation for a land and real Land and real estate markets private market for land and estate market is established develop such that land use real estate. with with 5% p.a (2002 base becomes based on appropriate year). increases in private price signals. transactions for land and real estate (measured by divestiture of City-owned land and real estate through sale, long term lease and trust management and private transactions).

Improved City fiscal City achieves and maintains Budgets for 2002 and 2003 are management capacity. creditworthy status from an approved. international credit rating agency.

City to preserve its Renovated facilities will Better financial and business comparative advantage in contribute to 8% p.a. (2002 planning of key cultural culture and the arts. base year) growth in toursim institutions leads to increase in in St Petersburg. the latter's revenues

-45- Output from each Output Indicators: Project reports: (from Outputs to Objective) Component: 1. City Budget support Support to SMEs Quarterly PIU Project Political consensus reached on Progress Reports reform design and City has improved its policy City Legislation (Urban implementation. and regulatory enviromnent Development Law) and Bank Supervision Reports for business, and improved its Regulation (Zoning) fiscal management capacity. Divestitures

Elimination of tax and rent concessions

Financial Plans for 2002-4.

2a. Rehabilitation of cultural assets

Buildings of eight key cultural Rehabilitation of buildings Pre-design and Design studies Government and cultural institutions will be preserved pertaining to eight key cultural institutions are in full and developed institutions is completed by Designers Progress reports agreement with proposed the end of the project (year 6). works and implementation schedule.

Design and works are completed in accordance with international standards for cultural monuments of the type included the projects (musical theater, art museum, etc.).

2b. Cultural Investment Facility

The assets of the participating 100% of funds committed by Quarterly PIU project progress Demand for funding of local cultural institutions will end of year 4 reports small-scale investments exists be preserved and developed. and is sufficient to allow for Bank supervision reports competitive quality based allocation process.

2c. Institutional Two major institutions review Annual Financial Statements Institutions develop and adopt strengthening financial management systems. of institutions new financial management systems. Budgets of institutions include adequate provision for Operation and Maintenance.

Project Components I Inputs: (budget for each Project reports: (from Components to Sub-components: component) Outputs)

1. City's Budget Support USD 100.00 million

- 46 - Bank Supervision Mission Reports

CEFIR surveys

2a. Rehabilitation of USD 93.60 million Quarterly PIU Project Government counterpart cultural assets: Progress Reports funding is made available in State Hermitage Museum: USD 16.90 million timely fashion. State Mar insky Theater: USD 48.40 million Bank Supervision Mission State Russian Museum USD 8.80 million Reports Design and procurement St. Peter and Paul Fortress USD 9.70 million process is completed Museum Disbursement Reports expeditiously to allow work State Shostakovich USD 3.50 million implementation according to Philharmonic schedule and original cost State Rimsky-Korsakov USD 3 00 million estimates. Conservatory Tsarskoye Selo Palace USD 2.10 million Museum Pavlovsk Palace Museum USD 1.20 million

2b. Cultural Investment USD 7.30 million Quarterly PIU Project Quality and quantity of Facility (CIF) Progress Reports submitted funding proposals is sufficient to ensure adequate Bank Supervision Mission use of CIF resources. Reports Investment Proposal Disbursement Reports Evaluation Committee is staffed adequately and operates efficiently.

2c. Institutional USD 0.60 million Quarterly PIU Project Two key cultural instititutions Strengthening Progress Reports start making changes in their financial management systems. Bank Supervision Mission Reports Trained staff remain in institutions. Disbursement Reports

2d. Project implementation: USD 8.89 million Quarterly PIU Project PIU staffing is adequate to Progress Reports ensure satisfactory a PIU operating expenses USD 3.49 million coordination and control of b Design and supervision USD 5.00 million Bank Supervision Mission project implementation. c. Other consultant services USD 0.40 million Reports

Disbursement Reports

-47 - Annex 2: Detailed Project Description RUSSIAN FEDERATION: ST. PETERSBURG ECONOMIC DEVELOPMENT PROJECT By Component:

Project Component 1 - US$ million

Annex 2-A: Adjustment Component

DEVELOPMENT POLICY LETTER AND POLICY MATRIX

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February 11, 2003 07-108/114

Mr. James D. Wolfensohn President The International Bank for Reconstruction and Development

Dear Mr. Wolfensohn,

In terms of its size, St-Petersburg is the second city (after Moscow) in the Russian Federation accommodating about 4.6 million residents. In 2000, a gross regional product (GRP) of St.-Petersburg was equal to about $8 billion, which accounted for 3.2 percent of the GDP of the

- 54 - Russian Federatiori. St.-Petersburg is a major industrial center known for its food industry, hi-tech machine-building (including shipbuilding), a high level of development of its transport and communications sectors. Also, the city occupies leading positions in the area of research studies, education and health. St.-Petersburg is the second largest financial center in Russia after Moscow while the St-Petersburg stock exchange occupies a leading position among the bond markets of the subjects of the Russian Federation.

In addition, St-Petersburg is a treasury of the world culture. The city accommodates some most valuable sites of the world cultural and architectural heritage that have been included in the UNESCO list. Tourism is one of the key elements of the municipal economy. According to the official data, 3.7 million visitors camne to St-Petersburg in 2002. After 1991, the city economy experienced significant transformations. The industrial production diminished sharply and a tangible structural shift was made towards the food industry and other sectors geared to producing the consumer goods. Employment in the industry shrank from 33 percent in 1990 down to 20 percent in 2000. At the same time, a share of services in GRP augmented from 50% in early 90s up to 60% in 2000 while a share of those employed in the service sectors (health, education, tourism, and culture) went up from 16% of the total employment in 1991 to 24% in 2000.

While the industrial production would continue to play an important role in the St-Petersburg economy, the economic growth in the future is expected to be primarily secured through the development of the services sector, mainly culture and tourism, transport, financial services.

With a view to identifying the avenues for transformation of the municipal socioeconomic structure and elaborating a program for future development, in 1997 the Government of St-Petersburg adopted a Strategic Plan for St-Petersburg. The Strategic Plan was prepared with the assistance of several donor agencies, including the World Bank, and was widely discussed at the level of the city government involving representatives of the civil society. The plan defines four strategic areas that should underlie various alternatives for city development: creation of the favorable business climate, integration in the world economy; improvement in the urban environment; establishment of the favorable social climate.

We have already started implementation of the Strategic Plan. Regarding the creation of a favorable business climate, the regulation of operation of the natural monopolies was improved and the balanced tariff policy was put in place. The adoption of new federal and municipal laws resulted in a decrease of requirements for licensing of the activities and registration of the new entrants. As regards the level of integration in the world economy, the city strengthens its status of one of the leading transportation centers of Russia as well as its international reputation of a center of cultural tourism. Serous improvements are noted to have taken place in urban environment. The historical center of the city is under reconstruction, which is being carried out not only as part of the 300-year anniversary of St-Petersburg but, to a greater extent, due to our efforts to support arts and develop tourism in St-Petersburg. At this time, several earmarked programs designed to strengthen a social safety net system and ensure labor protection are being implemented.

We hereby request the World Bank to help continue the implementation and follow-up on the ambitious reform program set out in the Strategic Plan. We identified the following areas that would be most challenging and critical in achieving our reform objectives:

- strengthening of the financial management system in the city and assurance of sustainable tax revenues to the city budget;

- 55 - - improvement in the business climate, encouragement of broader involvement of the private sector in the city economy, promotion of land and other real estate market development.

We fully realize that the reform program outlined below in the letter is ambitious in its scope and challenging technically and politically and, therefore, to implement it in full would, in all likelihood, require quite a number of years. At the same time, we believe that this program sets appropriate basic principles and a necessary perspective for a program of specific reforms, which we are planning to carry out under the World Bank Loan in question within the period of 2003-2005.

Financial management. Beginning from 1998, the city managed to come up with the budgets that were almost free of deficit. A distinctive feature of the reforms in the municipal fiscal area is a focus on enhanced fiscal transparency. This includes promulgation of the medium-term financial plan; introduction of the consolidated budget, which is clear and appropriate and has the form of a document that can be accessed by wide public; and also periodic reporting on the status of budget execution.

However, the financial management system in the city still features several weak points that are necessary to eliminate to further improve the results of budget execution and create the conditions for economic growth.

With this purpose in mind, the city adopts the following measures:

1. Improvement in municipal fiscal management. The city will introduce a system to assess fiscal risks for the budget. The city will also introduce a system of registering the loans taken on by the state unitary enterprises (SUEs), which would allow to improve monitoring of their liabilities. The city will monitor the accounts payable of the budgetary entities based on the inventory of such entities recently completed, and a reduction of debts to a zero level by 2004 will be a performance indicator. At the same time, the city will also start monitoring the accounts payable of SUEs.

2. Improvement in the system of managing the development budget. The city will develop methodological guidelines for preparation of the capital budget that would include such issues as selection of investment projects that would receive budgetary support; development of a long-term program for capital investment consistent with medium-terrm objectives of the economic policy and financial plan; fostering interaction between various structures of the city administration that participate in capital investment budgeting (including monitoring and assessment of the investment projects).

Business Climate. Collaborating with the World Bank, other international counterparts and the federal Government, we are working towards better understanding of the private business. In developing the Strategic Plan, there were numerous consultations with the consurmers and private businesses who supported the need to implement a multilateral reform program. The city will adopt the following measures:

1. Improve transparency, efficiency and independence of the municipal infrastructure monopolies (in the electricity, gas and water supply, sewage, transportation and communication sectors). While fundamental transformations may, by and large, take place in concurrence with changes at the federal level, we will, at the city level, set up, through the legislation, a comprehensive regulation system for natural monopolies; establish an independent authority which would be charged with control and regulation

- 56- of the natural monopolies; create mechanisms that would grant all customers equal rights to access services of the natural monopolies; strengthen protection of the consumers by introducing standard service contracts for subjects of the natural monopolies; adopt regulatory acts governing connection of new customers to the networks of natural monopolies; establish rules for providing the city authorities and wide public with the information about operation of the natural monopolies.

2. Reduce barriers for development of the new enterprises, especially small and medium enterprises. This includes adoption of legislative and regulatory acts to bring the city licensing and registration standards in line with the federal legislation; limitation of discretionary powers of the officials dealing with licensing and registration; creation of the mechanisms to strengthen coordination between municipal licensing and registration authorities and other regulation and supervision bodies; limitation and regulation of intervention of inspecting and regulating bodies in the operation of the enterprises.

3. Reduce the city's involvement in commercial enterprises. We will reduce establishment of the new city-owned public enterprises and institutions; reduce the number of St-Petersburg unitary enterprises to those instances where their existence is, on the one hand, more efficient, and, on the other hand, more appropriate in comparison with private companies; privatize St-Petersburg unitary enterprises that are presently operating on competitive or potentially competitive markets; make inventory and provide financial assessment of city-owned enterprises along with the review of the functions they perform; ensure transparency and gradually eliminate a system of fiscal and financial subsidies (credit security, tax concessions) to commercial enterprises.

4. Improve municipal procurement procedures. While the municipal procurement system has been improved over the last several years, which includes its better transparency and enhanced competition, there still remains a potential that has not been fully utilized to involve the private sector in implementation of the municipal orders on a wider basis. The Strategic Plan features recommendations to the city to adopt special laws and regulatory acts that would provide all economic entities with equal access to bidding for the municipal service or supply contracts, as well as to resources available for the city (real estate, land parcels, etc.).

5. Elaborate a public control system for regular assessment of the competitive environment and changes in the conditions of economic operation due to impacts from implemented measures. Now the system of monitoring the economic environment is under construction and is operating irregularly. There is no comparison with the situations in other regions or countries. The city will annually conduct independent monitoring of the conditions for business activities in St-Petersburg to assess the effectiveness of the reforms that have been made by comparing the city reforms with the reforms made in other Russian regions and other countries. Also, mechanisms will be created to inforn potential investors, both domestic and foreign, about the situation with economic climate in St-Petersburg.

As indicated in the Strategic Plan, an essential factor for the creation of favorable business climate is the development of land and real estate markets.

It would be fair to point out in this connection that the city is, in certain respects, limited in its freedom to act as a subject of the federal system. A considerable portion of the city

- 57 - land is still in federal ownership. Taxes on the real estate are still regulated at the federal level. Besides, the activities of many agencies and a lot of requirements to the approval process for investment in the real estate are governed by federal regulatory acts and implemented by federal agencies that are beyond the control of the city administration.

Despite such limitations, the city is working to build up a regulatory legal framework for operation of the efficient real estate markets. A large share of the city land cadastre is in place; an effective title registration system has been developed; a portion of land and real estate has been sold and privatized; a city planning method is being improved; work has been initiated to take stock of municipal real estate and improve its management in order to increase revenues to the municipal budget. We realize that much more should be done. Therefore, we try to improve operation of the land and real estate markets to enhance competitiveness of St-Petersburg, to engage new enterprises more actively and thereby contribute to economic development of the city. Our plans include the following measures:

1. Reduction of tax concessions and preferential rents on commercial real estate. With a view to increasing revenues to the city budget from renting the municipal real estate, the city will revise rental rates for commercial real estate based on the level of current prices on the private market and index these rates.

2. Improvement in city planning to specify allowed land use and provide for easier land development. Adoption and implementation of the Law on Regulation of City Planning Activities in St-Petersburg will facilitate strengthening of property rights, cost reduction, simplification of land development regulations, and enhanced investment attractiveness of the city.

3. Increase in the number of real estate sites transferred to private owners and/or to investors in accordance with the new Land Code of the RF. The city will bring its legal framework in line with the new Land Code of the RF. The city will also make efforts to increase a share of land and real estate passed into private ownership or leased out for a long time period without preliminary subscription with investment conditions.

4. Provision of information - which is larger in volume and higher in quality - about real estate markets, including transactions with municipal real estate, and about inventory of the real estate in public ownership. The city will complete inventory of the land and real estate sites owned by the city or municipal enterprises. The city will also provide publication of the essential infornation (location, purpose, parties to transaction, rental rate or selling price) about all transactions with municipal real estate (sale and rent). To enhance transparency of the privileges in leasing out the real estate and imposing taxes, the city will identify all municipal real estate (land and buildings) leased out at the rates lower than those in the market, as well as all organizations that are benefiting from privileged taxation; estimate revenue losses for the municipal budget and show them in the budget as expenditures for subsidies.

5. Improvement in the city-owned real estate management. For this purpose, the city will adopt a legal framework for trust management, which will ensure transfer of the city-owned real estate for management by private agencies.

- 58- I hope that upon review of the submitted program, the World Bank will find it possible to provide a loan to St-Petersburg. This loan would enable the city to achieve its objectives of institutional and economic development and ensure steady and sustainable growth of its economy necessary for the improvement of living standards of St-Petersburg population.

V.A. Yakovlev St-Petersburg Governor

- 59- Annex 2-B: Matrix of Core Policy Actions

[ Prior to Board 1 _ No. Objective Presentation (First Prior to Second Tranche Performance Indicators Time Bodies in ______Tranche Release) Release Frame Charge A. Improveinent of Business Environment Support Development of Small and Mediuin Enterprises (SMEs) I a lmprove conditions for the Facilitate establishment o Funds for Information Centers Ql, 2003 KEPP stablishment and operations SMEs. are in 2003 budget f pnvate SMEs in St. Petersburg I b Continued implementation of the 25°o increase in assistance 003-2004 KEPP acilitation of the establishment of provide by the Information SMEs Centers in the 12 moths following the disbursement of the first tranche I c Reform of the City's (i) Order # 89-p issued by the Ql, 2003 KEPP Business Licensing Licensing Chamber of the Saint Regime. Petersburg Administration on March 30, 2001 changed; and (b) St. Petersburg Licensing Chamber issues order to ensure no subdividing of licensed ctivities within the List of Licensed Activities. educe the Citv's Investments in Commercial Enterprises 2 Divest City-owned or Implementation of reduction of Enactment by City Govemment Q3.2003 KEPP ity-controlled enterpnses the number of City-owned or of the City Administration's KUGI in the commercial sphere so ity-controlled commercial Order "On Optimizing the s to create greater economi nterpnses in SPB, though Number of St Petersburg State pace for new, pnvate sector ivestiture or other means, Unitary Enterpnses" and other ntrants including but not limited to the all necessary administranve and State Unitary Enterprises (SUEs) regulatory implementing numerated in the City measures such that offers for sale idmnistration's Order "On of a majority of the enumerated timizing the Number of St. SUEs has begun etersburg State Unitary ______Enterpnses". _ Reform Municipal Procurement Procedures 3a Improve the City's system Implementation of Agreement on tenns of reference Q2, 2003 KEPP for awarding public nacted amendments to for independent audit of City's ontracts in order to he Law of St Petershurg procurement procedures to be stimulate competition, "On St Petersburg financed by the City increase transparency and Municipal Order" as well govemment. ccountability and entry of as enacted related ew economic agents into normative acts regulating the market City procurement procedures. 3b Continued implementation of 3a. Adopt standard bidding 2003-2004 documents and evaluation reports

Introduce mandatory use of the above documents and reports.

Carry out independent audit of city procurement conducted under new guidelines for 2002 ______and 2003. Introduce Land Use and Urban Planniig Regulations 4a Reduce costs and time. Adopt Law on Regulating Adoption of law Q2. 2003 IPGA ncrease clanty and Urban Development IKS

- 60 - predictability of land uise Activities in St and development permits Petersburg

4b Adoption and phased Adoption of nonnative act on 2003-2004 KGA implementation of clear and oning regulation precise zoning regulations and plans for additional areas of the Implementation of City Land city, conforming to the Use Commission. requirements of the Russian Federation land code and City Adoption of nonnative act on planning code land plot subdivision.

Implementation of oning plans for the following areas of the City (approximate areas) - Administrative Distnct or Pushkin 600 ha; Suzdalskyje Ozera 394 ha. -Pargolovo 1353 ha. - Kolomjagi 389 ha: - Krestovsky Ostrov 378 ha, - Petrovsky Ostrov 125 ha, - Sinopskaya Embankment 1 16 ha; - Vyborgskaja Embankment 232 ha Increase Private Particl ation in Land and Real Estate Market 5 Reduce the City's role in Signtficantly reduce Adoption of an appropriate 4, 2002 KUGI and and real estate markets average prices charged fo nonnative act for a revised KZRiZ privatization of occupied schedule of land prices for and from nonmative privatization of occupied land. prices in effect in 2001 Minimum average pnce reduction of 25% based on companson of effects of new pnce schedule with schedule of normative pnces for land pnvattzation in effect pnor to adoption of new schedule 6a Commence divestment of Commencement of premises 2002 KUGI additional City-owned auctions in 2002. premises through competitive auction Offering of at least 150 premises ______for sale in 2002 6b Continued divestmcnt of ContinLiation of aictions throug 003 KUGI dditional City-owned premises 2003

Offenrng of an addinonal 400 City-owned premises for sale through time of disbursement of second tranche. B. Sttengthen City Financial Management _Strengthen Financial Managementit 7a Stabilize City finances Aggregate fiscal Expenditure management- (i) 2002-03 KF performance consistent share of capital expenditure in with the prudential limits total expenditures at least 20%; set by City and federal (n) share of education legislation, and the expendittires in total Budget Law for 2002. expenditures at least 18%; (m) hare of education expenditures Financial Plan for devoted to capital expenditures 2003-05 agreed to and at least 8%, (iv) share of health approved. expenditure in total expetiditure at least 10%; (v) prepare plan in 2002 reduce arrears (accounts payable greatet than or equal to

- 61 - 3 months) to Vodokanal, TEK, Lenergo and in 2003 reduce arrears by Rubles 770 million.

7b Aggregate fiscal performance Debt management. (i) pnmary 003-2004 consistent with the prudential balance (revenues less limns set by City and federal non-interest expenditures)/ GRP egislation, and the mutually greater than or equal to zero: (n) agreed budgetary targets for 2003 guaranteed debt/total revenues less than or equal to 10%; (mi) mancial Plan for 2004-06 agreed direct debt/operating revenues to and approved. less than or equal to 50%; (isv) debt service/expenditures less than or equal to 15%; (v) increase in debt service/total expenditures per year less than or equal to 5 percentage points 8a Enhance budgetary Timely implementation of i) adoption of procedures for Regtlar KF ansparency and reduce measures for fiscal registration of SUE borrowings onmtonng fiscal nsks management reform in (commercial debt) share of f progress 2002 SUEs covered = 100% in 2002. gatnst (n) percentage of SUEs with ndicators commercial debt covered by unng monitonng = 100% in 2002. (Im) 2002-04 perentage of city expenditures covered by commitment control - 12% in 2002.

8b Timely implementation of (i) percentage of budget finance egtlar KF measures for fiscal management organizations covered by onitoring reform in 2003 monitonng of accounts payable of progress 50% in 2003, (n) organization gainst of data collection on accounts ndicators payable of all SUEs in 2003. unng ercentage of city expenditures 002-04 covered by commitment control - 19% in 2003

Development and adoption of guidelines for selection of investment projects and formation of a 3-year capital investment program as part of he medium-tenm financial plan. _ Improve Management of City-Owned Real Estate 9 Improve management of Adoption of legal and normative 20% increase in the amount of 003 KUGI City-owned buildings and acts necessary to expand program space subject to trust premises by implementtng of trust management. management over 2002 base line mark-et onented managemnen. of 78,000 square meters ractices. 10 nsure more efficient use of Complete the inventory of (i) Identification of unregistered 003 KUGI ity-owned real assets by tCty-owned buildings and land and property users; (ii) KZRiZ liminating "free use" of city remises entry into tax rolls, (iii) isstuance roperties __I ____ ' _ _ of appropnate nghts. _ It Improve quality and flow of Implement a reporting system Reporting system for land and 2003 KUGI information budget process which reflects revenue losses from premises rent reduction KF rent concessions and rent coefficients implemented in the reduction coefficients including 2004 budget process. concessions and reduction

- 62 - |oefficients for premises and land

Reduce City Subsidies and Frieeze Tax Conicessions to Enterprises 12 Decrease City-provided Implementation of newly enacted A three-fold reduction in the Q3, 2003 KEPP subsidies to businesses and City acts to () elimmiate, under a ratio of budget transfers made to KF mnprove the transparency of time-bound schedule by the end o commercial enterpnses ny remaining subsidies or this program, all City-provided (subsidies, subventions, meeting ax concessions so as to fiscal and financial subsidies to commitments under earlier stimulate competitive commercial enterpnses and (n) Issued guarantees and sureties lestructunng of existing freeze or decrease over the using budget funds) in the first enterprises duration of this program the half-year of 2003 to the amount number of tax concessions (with of such transfers for the same respect to property, profit, income penod in the previouis year. sales or other business taxes) eclaration and observance of a made to commercial enterpnses. moratonum on granting new tax Implementation of the new oncessions (of all types). measures should also result in fill subsidies, and subventions to ublic transparency of any usiness entities. starting from remaining support being made to anuary 1, 2003. control of the commercial enterpnses Any effectiveness of any remaining remaining subsidies, subventions concessions, subsidies and or tax concessions are to be subventions based on provided on a fully competitive cost-benefit analyses and makin basis and without any the results available in a form discnmination of concession fully accessible to the public recipients by the fornm of ownership, scale of operations,

______nationality, or size of investment. lReduce Land and Real Estate Market Distortions 13a Increase City revenues and Reduce rent reduction coefficient Adoption of appropnate 2003 KUGI, achieve more efficient use of for City-owned premises normative act reducing rent Adminis- land and buildings by reduction coefficients for rative liminating preferential City-owned premnises Commit- ents tee 15% Decrease in estimated lost rent revenue year to year over 2002 base line of US$24 million equivalent cunrency units per quarter t

7 5% increase in projected average effective rent per square meter over 2002 base line of US$40 per square meter *

* (controlled for inflation and scheduled rent increases) 13b Increase average effective land Reduce the large area coefficient 003 KUGI rents for City-owned land plots for reduction of land rents for KF enterprises

15% increase in average projected land rent per square meter over 2002 base line of US$7 per square meter. (controlled for inflation and _scheduled rent increases ) Impi-ove Performance and Transparency of Key Utility Service Providers 14a Reform of regulation Provide clear, legal right Adoption and implementation of Q 1,2003 KEPP oveming of access by independent the "Tarff Policy Concept of the KF nergy/infi-astructure genersting enterpnses to City of St. Petersburg" upplies and increase public City's electricity networks transparency of financial of energy suppliers. prations of ity-owned/controlled nergy / infrastructui e

- 63 - Isuppliers in St. Petersburg l 14b First annual publication of Independent auditors hired, Q3, 2003 KEPP ndependently audited financial Audits conducted; 2002 KF accounts-developed in financial accounts published accordance with Intemational Accounting Standards (IAS)-of theCity's key energy/infrastructure service providers in St Petersburg: Lenenergo, TEK Kurotenergo. PES, St. Petersburg Elektroseti, Gorodskoye Gazovoye Khozyaystvo Lengas, Fuel and Energy Complex of St Petersburg. The first financial accounts subject to this condition ______bshallbe those for 2002.

KEPP Committee of Economic Development, Industrial Policy and Trade KGA Commnittee of Urban Planning an Architecture KF Committee of Finance KUGI Committee Property Management KZRiZ Commnttee of Land Resources and Land Developent

- 64 - Annex 2-C: Investment Component

Subcomponent 2a: Rehabilitation of Cultural Assets

The sub-component will finance repair and/or rehabilitation works that will help protect historical buildings of eight major cultural institutions from further physical deterioration, increase their exhibition and activities capacity, improve the operational safety and efficiency of the facilities for both visitors and personnel, and provide higher safety of artworks on display from physical damages, theft or other risks. Final design studies for all sub-projects will be completed by Board Presentation, except for the State Hernitage Museum and the State Mariinsky Theater sub-projects. For the latter two, pre-design studies will be available in May 2003 and completion of final design will be carried out as part of project implementation.

The projects to be financed under the sub-component are the following

1. State Hermitage Museum - East Wing of the General Staff Building (USD 16.90 million base cost)

The General Staff Building was built in 1819-29 by the architect Carlo Rossi to house the headquarters of the lmperial Army as well as offices of the Ministry of Foreign Affairs, Ministry of Finance and other Departments of the Imperial administration. It borders the south side of the Place Square and faces the Winter Palace, now the State Hermitage Museum.

The East Wing of the General Staff building was assigned to the State Hermitage Museum in 1993. The museum started rehabilitating the building in 1998. Since then several rooms with original decorations restored have been opened to the public. However, most of its 37,000 sq. meters of floor space remain unoccupied and in a state of dilapidation despite the museum's critical need for more suitable exhibition space.

The project will allow for the completion of the rehabilitation of the building, including the restoration of the facades of the five inner courtyards. The building will be used to accommodate special exhibitions, services for visitors, and technical services as well as room for the museum's educational and other out-reach activities. The project will complement a program of works financed and carried out separately by the Federal Government with a view to upgrade the visual environment of the Palace Square, regulate visitor parking, and increase the safety for pedestrians.

The project will finance in particular:

* Structural reinforcement of existing building * Repair and reinforcement of walls * Restoration and improvement of the inner courtyards * Replacement and improvement of electrical networks, telecommunication systems, and water supply and sewerage systems * Installation of HVAC climate control systems * Installation of security systems * Improvement of access for disabled visitors * Exterior lighting

- 65- 2. State Mariinsky Theater (USD 48.40 million base cost)

The State Academic Mariinsky Theater, named in honor of Maria Alexandrovna, wife of Tsar Alexander 11, is one of the world's most famous ballet and opera institutions, and together with the State Hermitage Museum, one of St. Petersburg's major tourism attractions. The current theater building was built in 1847-49 by the architect Albert Cavos (who also built the Moscow Bolshoy Theater) after the original theatre was destroyed by fire. Extensive renovation was carried out in 1894-96 by the architect Victor Schroeter.

The quality of both the artistic performances and the historic interior decoration of the theatre hides a depressing and worrisome reality of broken and run-down utility systems and stage production installations, and inferior working conditions for artists, stage workers, and other support staff. Changing stage sets is time-consuming and contributes to excessively lengthening the duration of performances. Lack of long-term general planning for the utilization of the Building leads to overcrowding and negligence over security and safety measures. Safety and security conditions are extremely poor and the lack of an adequate fire protection system, in particular, has the potential for creating incidents of catastrophic dimensions.

The project will allow for the complete renovation of the operational areas of the theatre in conditions that will cause only minimal disruptions of the theater activities. The objective of the renovation works is to upgrade interior utility networks and systems to intemational efficiency and safety standards, increase the operating efficiency of the stage machinery and shorten stage set changes to internationally accepted levels by the exhaustive retrofitting of the systems in place, and improve the overall effectiveness in the use of the existing public spaces to improve the provision of services to customers. The building rehabilitation will be complemented by a series of works financed and carried out separately by the Federal Government for the upgrading of the surrounding Theatre Square including the improvement of the access conditions to the theatre for users of public transport.

The project will finance in particular:

o Exhaustive assessment and re-organization of the functional scheme of the Theater o Repair and reinforcement of weakened foundations and structural reinforcement of the existing structures o Rehabilitation and modernization of the stage o Replacement and improvement of electrical networks, telecommunication systems, and water supply and sewerage systems o Replacement and re-configuration of the HVAC climate control systems o Installation of safety and security systems, in particular for fire protection o Assessment, preservation and/or improvement of the acoustic quality of the Theater o Re-configuration of the orchestra pit to its original state o Historical restoration of the architectural and ornamental elements of the Theater o Improvement of access for disabled patrons o Exterior lighting

- 66 - 3. State Russian Museum (USD 8.80 million base cost)

The State Russian Museum was created in 1895 and opened to the public in 1898. The museum, which owns the world's largest collection of Russian fine arts, is housed in four palaces in the center of the city: the Mikhailovsky Palace and its adjoining Benois Wing, the Stroganoff Palace, the Marble Palace, and the Mikhailovsky Castle (Engineering Castle). The latter two palaces were incorporated into the museum only in the past ten years and, after years of neglect, are in need of urgent repair and restoration.

The Mikhailovsky Palace was built in neo-classical style by the architect Carlo Rossi in 1819-1825 for Grand Duke Mikhail Pavlovich. It was extensively remodeled in 1895-1898 by the architect Vasily Svinin to accommodate a public museum. A program of gradual restoration of the palace has been undertaken since 1991, but is far from completion.

The project will finance in particular:

. Conversion of the two inner court yards into year-round accessible public spaces * Installation of fire protection systems and of elevators to improve, in particular, access conditions for the disabled * Improvements to visitor access and services areas

The Marble Palace, one of St. Petersburg's earliest landmarks of neo-classical architecture, was built in 1768-1785 by the architect Antonio Rinaldi as a present from Catherine the Great to Count Grigory Orlov. Most of the palace's interiors were reconstructed in the 1840s by the architect Alexander Briullov. From the mid-1930s to 1989 the palace housed the Leningrad branch of the Lenin Museum and, during that period, the interior decorations suffered extensive damage. A program of comprehensive restoration has been prepared but has only seen a partial execution.

The project will finance in particular:

. Restoration of the Winter Garden with flower garden, including reconstruction of the marble fountain in its original late 19th century design

The Mikhailovsky (Engineering) Castle was built between 1797 and 1801 by the architects Vasiliy Bazhenov and Vincenzo Brenna. Originally an imperial residence, it was converted into a school for engineers in 1823, (one of its most famous students being Dostoyevsky). A program of comprehensive restoration that was prepared by the museum has seen an only incipient implementation postponing to later critical components such as the repair and restoration and conversion into an exhibition space of the St. George's Hall, one of the palace's central reception rooms.

The project will finance in particular:

* Repair of the ceiling and supporting structures of the St. George's Hall * Restoration of the original decoration

- 67 - The Garde-de-Corps (Guard Pavilions) of the Mikhailovsky (Engineering) Castle, built concurrently by the architect Vincenzo Brenna, consist of two oval-shaped neoclassical constructions located at the original gate of the property. Previously used as offices, the pavilions are in a state of advanced disrepair.

The project will finance in particular:

o Complete outside and inside renovation of the buildings o Installation of a children's art educational center in the East pavilion, o Installation of a multimedia educational and communication center in the West pavilion

4. St. Peter-and-Paul Fortress State Museum of St Petersburg History (USD 9.70 million base cost)

The St. Peter and Paul Fortress is the place where the city of St. Petersburg was founded on May 27, 1703 by Tsar Peter the Great on Zayachy island. In its current shape the fortress was built in the 1720s by the architect Domenico Trezzini and houses some of the oldest constructions in the city (Imperial Mint 1724, Engineers House 1748, St Peter and Paul Cathedral, the burial vault of the Imperial Family, 1733). Aside from military and other uses, the fortress housed until the 1918 revolution one of the empire's most notorious prisons. Converted in 1924 into a museum, the fortress encloses a complex of 36 buildings. Despite its historic and symbolic value the fortress has suffered from serious neglect, lack of maintenance, and exposure to the rigors of the climate. Utility networks and infrastructure inside and outside the ramparts are ineffective or in disrepair. Collapse of storm water drainage and inadequate protection of foundations against the effects of groundwater infiltration poses a serious threat to several superstructures of the Museum.

The project will finance in paticular:

o Rehabilitation and repair of utility networks (electricity, water supply, sewerage, district heating, etc.) o Repair of storm water drainage networks o Water infiltration protection and shoring up of the buildings' foundations o Restoration of the existing pathways and walkways

5. State Shostakovich Philharmonic (USD 3.50 million base cost)

The State Shostakovich Academic Philharmonia occupies a neo-classical building that was originally built by the architects Carlo Rossi and Paul Jacot in 1834-1839 as the Nobles' Assembly. While the building itself is in relatively fair condition, a substantial effort is needed to upgrade its intemal utility systems and equipment to a level commensurate with the institution's intemational reputation.

The project will finance in particular:

- 68- . Restoration of original decorations in various rooms * Installation of access systems for disabled to the concert hall * Repair and replacement of interior utility systems, especially, air conditioning and ventilation systems * Replacement of electric lightning and acoustical equipment

6. State Rimsky-Korsakov Conservatory - English Church (USD 3.00 million base cost)

The former English Church on the Neva English Quay, built in 1814 in neo-classical style, was one of the last works of the architect Giacomom Quarenghi in 1814. It was recently awarded to the, State Rimsky-Korsakov Conservatory, Russia's oldest music school founded in 1862 and located opposite the Mariinsky Theater on the Theater Square. Once restored, the church will allow the conservatory to significantly expand its activities and performances and maintain its teaching functions during a future renovation of its main building.

The project will finance in particular:

* Strengthening and reconstruction of the structure of the building * Removing of non historical additions to the courtyard facades to restore their original aspects * Replacement and improvement of all utilities networks, * Installation of safety and security systems, in particular, for fire protection * Assessment, preservation and/or improvement of the acoustic quality of the main hall * Improvement of access for disabled visitors

7. Tsarskove Selo State Museum. (USD 2.10 million base cost)

Located about 25 kms outside St. Petersburg, Tsarskoye, Selo, was the principal imperial country residence from 1752 to 1918. Designed by the architect Bartolomeo Rastrelli in 1752 for Tsarina Elizabeth II it was rernodeled and expanded under successive tsars during two centuries, and especially during the reign of Catherine the Great. Altogether the palace and its park occupy an area of about 300 has dotted with over 200 palaces, pavilions and works of art. Virtually totally destroyed during WWII, the palace and the park have since been rebuilt to their original appearance, though restoration is not still not complete. The Hermitage kitchen pavilion on the northem border of the Hermitage grove, built in 1776 by the architect Vasily Neyelov, served both as a kitchen, and a gateway to the park. The building is decorated only on the outside, the interiors being purely functional. Currently closed, the museum plans to reopen the kitchen pavilion as a cafeteria and coffee shop for visitors.

The project will finance in particular:

. Restoration of the facades * Upgrading of inner spaces

The Turkish Bath pavilion was built in 1853 by the architect Ippolito Monighetti near the Great Pond of the Catherine Park as a typical example of the prevailing fashion of oriental style decoration. After WWII, some perfunctory repairs of the walls and floors were carried out in 1953. Due to lack of maintenance the structural integrity of the building is at risk and has led to its closure.

- 69 - The project will finance in particular:

o Exhaustive repairs and restoration of the building to restore its historical aspects and decorations.

The project will also finance the restoration of seven historical bridges in severely degraded physical conditions, which link different areas of the Park.

8. Pavlovsk State Museum (USD 1.20 million base cost)

Construction of the palace and the park of Pavlovsk was started in 1777 as a gift from Catherine the Great to her son, Grand Duke Paul. The Pavlovsk park which occupies an area of about 600 has was designed by the architect Charles Cameron in the 'English Garden' style with a seemingly natural landscape dotted with pavilions, bridges, sculptures, ruins and other art objects. The Temple of Friendship, the first building in Russia to use elements of Doric style, was designed by Cameron in 1780 by the architect. Although perfunctorily repaired in the 1970s, the pavilion has been closed to the public since 1990 due to safety risks. The building lacks adequate protection against infiltration of rain and ground water and needs extensive repair and restoration.

The project will finance in.particular:

o Exterior and interior restoration and repair works of the Temple and strengthening of its foundations.

Subcomponent 2b: Cultural Investment Facility (USD 7.30 million)

The Cultural Investment Facility (CIF) aims at building on the successful experience of the Cultural Fund included in the St. Petersburg City Center Rehabilitation Project. It will provide grant funding to eligible cultural institutions in, and in the vicinity of, St. Petersburg for small-scale investments and institutional strengthening activities of up to USD 200,000 equivalent (unless otherwise agreed with the Bank) that will help the recipients to: (a) increase own-source commercial revenue; (b) improve the accessibility to cultural assets or activities of the public through, inter alia, installation of special facilities for the handicapped, development of outreach programs, and upgrading of public information systems; (c) carry out critically needed small investments for the preservation of buildings and assets including security systems, other protective equipment, and emergency restorative repair works; and (d) improve their financial management, budget and investment planning.

Due to CIF's nature as an open grant program, it is not possible to determine ex-ante the type of projects for which financing will be sought by eligible recipients. The CIF will finance activities in the following areas in particular: o Education and out-reach programs: financing of the equipment, publication of books, video and audio files and other documentation o Technical assistance and/or training for the staff of the institutions in the fields of financial management, bugdeting and investment planning o Small-scale renovation and restoration of cultural assets o Small-scale projects for cultural and commercial activities beneficial for the local cultural institutions (construction, installation and equipment for information centers, museum stores, education centers)

- 70 - * Small scale retrofitting of safety and security systems, as well as access for the disabled in the premises of the buildings.

Subcomponent 2c: Institutional Strengthening (USD 0.60 million)

(a) Financial mana8ement (USD 200,000)

Cultural institutions such as the State Mariinsky Theater, the State Hermitage Museum, the State Russian Museum and others included in SPB-EDL benefit from a growing number of visitors and are expanding their activities in Russia and, increasingly, abroad. Although it gives them access to other sources of revenues than Federal Budget transfers, the increased popularity also creates new constraints for operating and administrative expenses. In a context of persistent uncertainty of Federal Budget transfers, specifically for major investments and repairs, a cautious management of resources becomes, therefore, a necessity.

The project will finance technical assistance for the development of financial management systems for two major institutions, the State Mariinsky Theater and the State Russian Museum. The assistance will provide effective managerial, planning and monitoring tools for day-to-day use by the institutions' managers for tasks such as financial reporting, budget management, investment planning, financing of Operation and Maintenance, etc. The financial management systems will be based on the current accounting system used locally but will also allow the institutions to present their financial situation under international standards. The assistance is expected to result in increasing significantly the capacity of the institutions: (i) to improve and optimize the management of their revenues, (ii) to plan their activities and monitor their costs, and (iii) to broaden their prospects for international partnership and donors by improving accounting transparency.

(b) Business Plan development (USD 400,000)

As a complement to the financial management assistance, assistance would be provided to the two above-mentioned institutions to set up the framework for development of business activities: design of a coherent business plan, merchandising, edition of publications, contract management for leases; in order to ensure their long-term ability to increase their own sources of revenue. The strategy would not only focus on a commercial approach, but also aim at broadening the public's access to cultural assets through suitable publications and other means of communication.

Subcomponent 2d: Project implementation (USD 8.89 million)

The component will finance:

* The operating costs of the Project Implementation Unit (FISP) for the duration of the project (six years), including training for FISP staff; (total cost: USD 3.49 million); * The completion of design studies required for the implementation of the works for the State Mariinsky Theater and the State Hermitage Museum, to be completed by November 2003; and the architectural supervision of the construction works (total estimated cost: USD 5.00 million); and * Services of technical specialists for specific aspects of project supervision; (total estimated cost: USD 0.40 million).

- 71 - Annex 3: Estimated Project Costs RUSSIAN FEDERATION: ST. PETERSBURG ECONOMIC DEVELOPMENT PROJECT

- * , -*-Local t Foreign ' Total.-

.- Pj. PctCost BDy Compone*7 ' - - US $mfilion US $million - US $million 1. Adjustment Component: 100.00 0.00 100.00 - City Budget Support 2. Investment Component 0.00 2a. Rehabilitation of Cultural Assets 62.00 31.60 93.60 2b. Cultural Investment Facility 7.30 0.00 7.30 3 2c. Institutional strengthening 0.20 0.40 0.60 2d. Project implementation 4.69 4.20 8.89 Total Baseline Cost 174.19 36.20 210.39 Physical Contingencies 10.54 6.22 16.76 Price Contingencies 7.44 3.60 11.04 Total Project Costs 192.17 46.02 238.19 Front-end fee 1.61 1.61 Total Financing Required 192.17 47.63 239.80

*'4.' ' .'. , Local n Foreign,-<-. Total` ,,--- - .Pr-ioject-Cost-By Category - - , US $rmillioion - US $millipn Adjustment loan (for City Budget Support) 100.00 0.00 100.00 Works 78.74 40.98 119.72 Consultant Services 1.54 5.04 6.58 Cultural Investment Facility 8.05 0.00 8.05 PIU Operating costs 3.84 0.00 3.84 Total Project Costs 192.17 46.02 238.19 Front-end fee 1.61 1.61 Total Financing Required 192.17 47.63 239.80

Idcntifiable taxes and duties are O(US$m) and the total project cost, net of taxes, is 239.8 (US$m). Therefore. the project cost shanng ratio is 67 18% of total project cost net of taxes.

- 72- Annex 4: Economic Analysis RUSSIAN FEDERATION: ST. PETERSBURG ECONOMIC DEVELOPMENT PROJECT

The investments funded under the SPB-EDL will contribute to halting the continuing deterioration of the physical state of major cultural institutions, improve their operating conditions, and increase the safety of visitors and patrons, artists, art works, and staff. A great many of St. Petersburg's architectural treasures are in poor physical condition as a result of inadequate maintenance-both now and especially in the past-and due to a lack of funds for rehabilitation works in recent years. Unless current trends are reversed, deterioration of the cultural assets is likely to accelerate, leading to irreversible damage and losses of some of the world's cultural heritage assets. If the cultural assets were to deteriorate to the point of decay, the number of visitors will also be adversely affected. Large-scale investments are needed in the cultural assets, not only to preserve the value these assets serve for both local and global communities, but also to ensure the long-term sustainability of tourism.

Preservation of cultural assets can be valued in traditional economic terms, using analysis based on well-established techniques. In general, the benefits of cultural sites can be divided into three broad categories; namely, recreational (consumption) benefits, aesthetic, and existence (includes option of future use for non-visitors) value. However, placing a value on each category for any cultural site is always difficult, since cultural assets have characteristics that make some aspect hard to value or are simply just considered invaluable. For example, some might consider the aesthetic and existence value of sites like the Hermitage Museum as infinite, as is signaled by virtue of the fact that it is a UNESCO World Heritage Site. Similar arguments could be invoked for many other sites in St. Petersburg. Consumption or recreation benefits can be assessed through observed prices for the commodity or service or close substitutes (i.e. through revealed preference). Alternatively, contingent valuation surveys can be used when market prices are not observed, or when no close substitutes exist. In order to estimate aesthetic and existence value, contingent valuation surveys are usually utilized.

In the case of St. Petersburg, the cost of contingent valuation surveys is also not justified, since willingness-to-pay (WTP) can be assessed through entrance fees charged by the institutions. This provides market prices for consumption of the services provided by the cultural assets, thereby providing observed WTP by patrons of the sites. It should be noted, though, that only in the case of foreign tourists do the entrance fees equal market prices, and hence true WTP. For Russian citizens, the prices charged by the cultural institutions are much lower compared to foreign tourists. An analysis of travel costs would also reveal higher WTP by foreigners and more price-inelastic demand functions. The higher WTP by foreigners reflects differences in demand that result in large part from discrepancies in income levels, suggesting two distinct markets for the city's cultural assets; one local and one foreign. In the case of Split, Croatia, surveys showed that residents of the core of the city were had a higher WTP than foreign visitors, but residents outside the core area had a much lower WTP compared to foreigners. An analysis of the revenue structure of the cultural institutions shows that while foreign tourists constitute a much smaller share of visitors than do Russian citizens, they typically account for about half of revenues from ticket sales. This implies that regardless of current shares of patronage, the value ascribed to entry (consumption) rights by foreign tourists and Russian visitors is roughly equal, due to the much greater number of latter.

A foreign tourist is estimated to pay a total of roughly USD 80 on average for admissions into the key cultural assets, such as the Mariinsky Theater, The Hermitage Museum, and the State Russian Museum during his stay in the city. Using this price of $80 for the total sum of admission costs

- 73 - shows that the value of the city's assets to foreign tourists visiting St. Petersburg is roughly $50 million. It is assumed that the improvements in physical state of the cultural assets, along with growth the city's economy, will allow steady growth in foreign tourists, thereby allowing this value to increase over time.

It is possible to estimate partial values for aesthetic and existence benefits for St. Petersburg. These can be calculated using assumptions based on experience in other cultural heritage projects, rather than survey data, as extensive contingent valuation and social assessment surveys were not carried out in order to assess the value of the cultural assets to both users and non-users. In the case of the Fes Medina in Morocco, visitors to Morocco who did not visit the Fes Medina, had expressed-through surveys-a WTP of about 43% those of visitors to the Fes Medina itself. Using this methodology would place the value of St. Petersburg's cultural assets to tourist's visiting Russia, but not St. Petersburg, at an additional benefit of over $100 million. This value would reflect an additional existence value, which would also partly reflect an option value, to tourists who may visit St. Petersburg in the future.

While simply estimating the value from foreign tourists, or the avoidance of decreases in visitors, under-estimates the full benefits of preserving and maintaining the cultural assets in good operating conditions, it does provide a good proxy for the value of the Bank's investments. It also fits in with the project's objective of maintaining St. Petersburg as a key attractor of foreign tourists into Russia. While the longer-term objective is to facilitate larger numbers of visitors to the institutions, the growth in visitors, especially foreign, is driven by forces linked to the city's economic well being, rather than the immediate physical state of the assets.

-74- Annex 5: Financial Summary RUSSIAN FEDERATION: ST. PETERSBURG ECONOMIC DEVELOPMENT PROJECT Years Ending December 31

| Year1 I Year 2 | Year 3 r Year 4 | Year 5 l Year 6 | Year 7 Total Financing Required Project Costs Investment Costs 53.7 76.2 35.6 29.8 22.3 16.8 0.0 Recurrent Costs 0.8 0.7 0.7 0.7 0.7 0.4 0.0 Total Project Costs 54.5 76.9 36.3 30.5 23.0 17.2 0.0 Front-end fee 1.6 0.0 0.0 0.0 0.0 0.0 0.0 ,Total Financing 56.1 76.9 36.3 30.5 23.0 17.2 0.0 Financing IBRDIIDA 49.0 67.9 14.9 12.7 9.7 7.0 0.0 Govemment 7.1 9.0 21.4 17.8 13.3 10.2 0.0 Central 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Provincial 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Co-financiers 0.0 0.0 0.0 0.0 0.0 0.0 0.0 User Fees/Beneficiarles 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Total Project Financing 56.1 76.9 36.3 30.5 23.0 17.2 0.0 Project costs presented above include physical and price contingencies. These contingencies amount to about USD 27.80 million Investment costs include cost of City budget adjustment loan (USD 100.00 million) Main assumptions:

- 75 - Annex 6(A): Procurement Arrangements RUSSIAN FEDERATION: ST. PETERSBURG ECOI1OftIC DEVELOPMIENT PROJECT

Procurement

Note: The Adjustment Component of the project, by its nature, does not involve any procurement. The following section applies therefore only to the Investment Component of the project.

A. Procurement Methods (See Table A)

1. ProcurementArrangements. Procurement of works and goods financed by the World Bank will follow the World Bank's "Guidelines for Procurement under IBRD Loans and IDA Credits" dated January 1995, and revised January and August 1996, September 1997 and January 1999. Procurement of services will follow the World Bank's "Guidelines for Selection and Employment of Consultants by World Bank Borrowers" dated January 1997 and revised September 1997, January 1999 and May 2002. The World Bank's latest editions of standard bidding documents and contracts will be used. All procurement will be handled centrally by the Project Implementation Unit - the St. Petersburg Foundation for Investment Projects (FISP).

A Procurement Capacity Assessment of FISP was conducted in December 2002. It is recommended that:

a) FISP procurement specialists acquire better knowledge of procurement of complex works contracts. If necessary, he/she should be sent to procurement training in the ITC ILO Turin or similar courses. b) A one- or two-day procurement training session should be held for the staff of the FISP during the project launch workshop. c) An updated Operations Manual should be prepared before Board presentation. d) The PrIU should consider the possibility of using more adequate computer hardware and software to better manage the project and to comply with the WB reporting requirements. e) During the initial stage of project implementation, intensive supervision from the World Bank will be important to ensure proper management and provide guidance.

2. Civil Works (US$ 119.72 million). Civil works will cover repair and rehabilitation of cultural assets that will help protect historical buildings of eight major cultural institutions from further physical deterioration, increase the exhibition and activities capacity of the institutions, improve the operational safety and efficiency of the facilities for both visitors and personnel, and provide higher safety of artworks on display from physical damages, theft or other risks. The projects to be financed under the sub-component are the following:

o State Hermitage Museum: Urgent repair and rehabilitation works in the East Wing of the General Staff Building.

o State Mariinsky Theatre: Rehabilitation works including repair and/or replacement of intemal utility networks in the existing building; replacement of stage machinery and rehabilitation of stage area; and upgrading and reorganization of the theater departments.

- 76- o State Russian Museum: Rehabilitation of two inner courtyards in the Mikhailovsky Palace; reconstruction of the Winter Garden in the Marble Palace; and restoration of the St. George Hall and two Corps-de-Gardes in the Mikhailovsky Castle. o Peter and Paul Fortress Museum: Repairs of drainage and sewerage networks; water isolation of buildings; and restoration of pathways. o State Shostakovich Philharmonic Academy: Replacement of lighting, air conditioning, and sound systems; and repair of other internal utility networks. o State Rimski-Korsakov Conservatory: Rehabilitation of the English Church. O Tsarskoye Selo Palace State Museum: Rehabilitation of the Hermitage Kitchen, Turkish Baths, and bridges. o Pavlovsk Palace State Museum: Rehabilitation of the Temple of Friendship.

Major contracts for procurement of civil works will be concluded using ICB procedures. For such contracts pre-qualification of contractors will be required. Works estimated to cost less than US$4,000,000 equivalent per contract up to an aggregate amount of US$ 18.00 million will be procured through NCB. The Bank's standard documents for national competitive bidding will be used.

3. Consultants' Services (US$ 6.58 million). Consulting assignments will provide technical assistance to two major cultural institutions (the State Mariinsky Theatre and the State Russian Museum) with the view to improve their capacity to carry out financial management, marketing and and business development. Consultants financed under the Project, including auditors providing yearly audit under the whole project, will be selected through a quality and cost-based selection (QCBS), and by using the Bank's Standard Request for Proposals.

For the preparation of the project, two architecture firms were selected under the QCBS procedure for the pre-design studies of the rehabilitation of the State Mariinsky Theater and the State Hermitage Museum with financing from the Russia Portfolio Development Loan - PDL (Ln 3844-RU). The RFPs provided for the possibility to award the final design studies under a second contract to the same firms in case of satisfactory performance by the consultants under the first contract. Therefore, the final design studies contracts may be awarded to the same consultants (US$ 5.5 million, including US$ 3.3 million for the Mariinsky Theater and US$ 2.2 for the Hermitage museum).

Several individual consultants will be hired to cover specific aspects of contracts' supervision, (US$ 0.42 million).

4. Cultural Investment Facility (US$ 8.05 million). This component will provide grant funding to eligible cultural institutions for small-scale investments and institutional strengthening activities up to US$ 200,000 (unless otherwise agreed with the Bank) that would help the recipients to: (a) increase own-source commercial revenue; (b) improve the accessibility to cultural assets or activities of the public through, inter alia, installation of special facilities for the handicapped, development of outreach programs, and upgrading of public information systems; (c) carry out critically needed small investments for the preservation of buildings and assets including security systems, other protective equipment, and emergency restorative repair works; and (d) improve their financial management, budget and investment planning. The Inter-ministerial Grant Evaluation Committee, using criteria and procedure acceptable to the Bank, will select such

- 77 - institutions competitively. Actual requirements are not known at this point in time. It is agreed that expenditures under this category will include small contracts for procurement of goods or works; no consultants will be engaged under this component.

Works under this category, estimated to cost US$100,000 and more per contract but less than US$4,000,000 will be subject to National Competitive Bidding (NCB) requirements. Contracts for works estimated less than US$ 100,000 each, will be subject to the procedure applicable to minor works contract, based on quotations obtained from three qualified domestic contractors in response to a written invitation. The invitation will include a detailed description of the work, including basic specifications, the required completion date, a basic form of agreement and relevant drawings, where applicable, and contracts will be awarded to the contractor who offers the lowest price quotation for the required work, and who has the experience and resources to successfully complete the contract.

Technical equipment and other goods will be procured under the CIF subcomponent. Goods costing US$100,000 and more per contract will be subject to Intemational Competitive Bidding (ICB) requirements. Contracts for goods estimated to cost less than US$ 100,000 will be awarded on the basis of the Bank's Intemational Shopping (IS) procedure, where price comparison will be conducted among responsive quotations obtained from at least three qualified suppliers from at least two eligible countries. Off-the-shelf goods, estimated to cost up to US$50,000 per contract may be procured through National Shopping (NS), based on comparison of responsive quotations obtained from at least three domestic suppliers.

Comparatively small and simple consultants' assignments which should help the CIF Beneficiaries to improve their financial management, budget and investment planning will be implemented through contracts with individual experts or with consulting firmns. In the latter case the firn will be selected using the QCBS procedures.

5. Incremental Operating Costs (US$ 3.84 million). The Bank will finance usual operating costs of the FISP. Evidence of actual expenses will be retained by the FISP and will be reviewed by Bank staff randomly during supervision missions. These expenditures will vary according to annual budget that will be prepared by the FISP and submitted to the Bank for the agreement before any expenditures are incurred.

a. PriorReview Thresholds (Table B). The World Bank will conduct a prior review of the following procurement documentation:

i) Works: All ICB, all NCB contracts, as well as first two MW contracts will be submitted for prior review. ii) Goods: First two contracts under IS and first two contracts under NS will be subject to prior review. iii) Consultants' Services: All contracts with firms above US$100,000, the sole source contracts and all contracts above US$50,000 with individual consultants will be subject to prior review. iv) The contracts that would not be subject to prior review would be subject to ex-post review.

- 78 - 6. Procurement Plan for the entire duration of the project (see Table C below).

Procurement methods (Table A)

Procurement Method_ Total Expenditure Category ICB NCB Other' N.B.F. Cost 1. Works 103.43 16.29 0.00 119.72 (38.98) (6.88) (0.00) (45.86) 6.58 6.58 2. Consulting Services (4.77) (4.77) 3. Cultural Investment 1.71 6.34 8.05 Facility (1.25) (4.61) (5.86) 4. City budget support 100.00 100.00 (Adjustment Component) (100.00) (100.00) 5. Incremental Operational 3.84 3.84 Costs (3.00) (3.00) 1.61 1.61 6. Front-end fee 1.61 1.61 ______(1.61) (1.61) Total 103.43 18.00 118.37 239.80 (38.98) (8.13) (113.99) (161.10)

- 79 - Table Al: Consultant Selection Arrangements (optional) (US$ million equivalent)

Selection Method - Consultant Services Expendfture Category, QCoBS QBS SFB LCS CQ Other N.BF.: Total Cost' A. Firms 6.16 0.00 0.00 0.00 0.00 0.00 0.00 6.16 (4.43) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (4.43) B. Individuals 0.00 0.00 0.00 0.00 0.00 0.42 0.00 0.42 (0.00) (0.00) (0.00) (0.00) (0.00) (0.34) (0.00) (0.34) Total 6.16 0.00 0.00 0.00 0.00 0.42 0.00 6.58 (4.43) (0.00) (0.00) (0.00) (0.00) (0.34) (0.00) (4.77) Including contingencies Note: QCBS = Quality- and Cost-Based Selection QBS = Quality-based Selection SFB Selection under a Fixed Budget LCS Least-Cost Selection CQ = Selection Based on Consultants' Qualifications Other = Selection of individual consultants (per Section V of Consultants Guidelines), Commercial Practices, etc. N.B.F. = Not Bank-financed Figures in parentheses are the amounts to be financed by the Bank Loan.

-80 - Prior review thresholds (Table B)

Table B: Thresholds for Procurement Methods and Prior Review'

g <-- '; ContractValue-'. - . - ContractsSdibjectfto: ; _ ; -, ' . 7 q r .-- Threshold Procurernnt - - Prior-Review.- Expenfditure.Category, ; (US$ 1houtsar'ds) ,Methold'' - U ,r illions j 1. Works >4,000,000 ICB All ICB contracts; <4,000.000 NCB All NCB contracts; <100,000 MW First two MW contracts 121.50 2. Goods >100,000 ICB All ICB contracts; (under Culture Investment <100,000 IS First two contracts; Facility) <50,000 NS First two contracts 0.25 3. ServicesConsulting QCBS All contracts above US$100,000; IND All contracts above US$50,000; SSS All contracts 6.15 4. Miscellaneous 5. Miscellaneous L 6. Miscellaneous

Total value of contracts subject to prior review: US$127.9 million Overall Procurement Risk Assessment: High Frequency of procurement supervision missions proposed: One every 6 months (includes special procurement supervision for post-review/audits)

-81 - Table C. Procurement Plan

Deseription Type Est. Procure- No. of Issue Bid/Prop. Conitract Contract amount nient packages BD/RFP Receipt signed conmpleted (USS000) Method

Sprt . .'' .j -' ..

NPO!iT2(R Cp nipquenr;iisesWt1ib ji,tla iT,...... -i_. i f r~- 5 r .- . ,.. . ,-.;-' h...... ______,

- -r-1-- ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ t < 3

- 82 - Description Type Est. Procure- No. of Issue Bid/Prop. Contract Contract amount ment packages BDIRFP Receipt signed completed (USSOOO) Mlethod 12 Restoraion of seven bridges of W 300 NCB I JLn-2003 Aug-2003 Oct-2003 Sep-2005 the T-arskoye Selo Palace State lMuseurn

1:13; ! : e t 2bhfCuiItiii -• UWF ;:8,OSO: NCB,MW, , S . isttb ,, Irhfijk. t jW - 'DCurtCg; ?

s',-.Ž.~$~ ~~-.j I. . ____I .ta~f4. IA, :Alf.& t ___ X uhbnip~ui~t2~( ti~udap*I~~.. ~A ! .. I ' - . .r2 '

14 Developmeint of financial CS 220 Q C B S I Jan -2004 Apr -2004 Mkla-2004 Sep -2004 management 15 Techmical assistance In marketinig CS 440 QCBS I Jan-2004 Apr-2004 :Nlav-2004 Scp-2004 and business desclopment _

Sii.ircomponchi-2d_Im .. -.-...... Wdj 6O} " 11 r '49t 76 J. YEij,,. F

16 Second phase otfdcsign conutact CS 2.20)0 QCBS I Jun-2003 Iol-2003 Apr-2007 for thc Statc Hcrmitaucc M\lusCum 17 Seconild phJe of desum contraLt CS 3.300 QCBS I Jul-200t3 JuL-2003 Sep-2009 lor the State N'lariin,,k Theatie 13 Technical a,pects of contracts CS 420 1I Se%eral During Diiing During, During man.-emeni Project Project Project Project Implemen- Implemeni- Impleimien- Implemen- tltion tatio tatione UltlOIo

I L) PIL Operational c\pcni,cs 3.84(0 During DurigQ [DUIII,-, Durinig Protect Protect Project Plojeet Ihp leicie- Implenien- Implemeni- Iniplenien- tation I tation tatO11UIOiiI

.-lI /Ot410!/tIS I)t11`tIl'7LI id tII e ahoWh C blee 1111/IIlmC COWt/lgellC ley

Thice-hold, genei ally differ b\ country and projcCt Conmtilt "Asse-Nsment of Agcncs\' Capacity to Imiieplcilt PioLuremenit" and contact the Regional Piocurenient Al\ iser fot gulidance

- 83- Annex 6(B) Financial Management and Disbursement Arrangements RUSSIAN FEDERATION: ST. PETERSBURG ECONOMIC DEVELOPMENT PROJECT

Financial Management 1. Summary of the Financial Management Assessment

A - Adjustment component

At City level, the responsibility for implementation of the adjustment component rests with a Working Group which is composed of the three Vice-Governors for Construction, Economic Development, and Finance, respectively, and reports to the City Governor. The adjustment component of the project will be implemented in accordance with standard Bank procedures and practices (including Disbursements) for adjustment loans. SPB-EDL will follow the procedures which the Bank has previously agreed with the Federal Government under the Fiscal Federalism and Regional Fiscal Reform Loan, for monitoring the funds disbursed under adjustment loans. These procedures, which provide for a "real time tracking" of resources, will require the following: o A separate account in a foreign currencywill be opened in the Central Bank of Russia and managed by the Ministry of Finance. The first tranche of the Adjustment component will be deposited in this account for a total amount of USD 40 million, upon fulfilment of the condition detailed in the Matrix of Core Policy Actions (First tranche release). The second tranche of the Adjustment component will be deposited in this account for a total amount of USD 60 million, upon fulfilment of the condition detailed in the Matrix of Core Policy Actions (Priorto Second tranche release). o Monthly report for the use of the loan prepared by the City of St Petersburg and approved by the Working Group. A progress report prepared by the Ministry of Finance will be sent to the Bank, prior to the release of the second tranche of the Adjustment Component. * Yearly audits of the account will be conducted by independant private auditors acceptable to IBRD on standard terms of reference. Audit contracts will be procured in accordance to the World Bank's procurement guidelines and financed by the loan proceeds.

B - Investment component The financial management capacity assessment was performed by the World Bank's Financial Management Specialist before Negotiations. Below is the summary report of the assessment.

I. Executive summary The PIU (FISP) financial management arrangements meet minimum World Bank requirements.

Strengths and Weaknesses

The significant strengths that provide a basis of reliance on the project financial management system include: (i) the experience of the PIU and its financial management staff of implementing similar Bank-financed projects and satisfying Bank financial management requirements; (ii) the unqualified audit reports and positive management letters issued by the PIU and project auditors during the last three years; and (iii) sound internal control system within the PIU.

- 84 - The risky areas in terms of financial management are: (i) proper valuation of the repair work and other assets and liabilities, and (ii) absence of integrated information financial management system. Risk (i) will be mitigated by quarterly expert valuation of the construction and repair work followed by disclosure of the results in corresponding quarter FMR. Risk (ii) will be mitigated by implementing of integrated information financial management system soon after the Project starts.

II. Implementation arrangements

(i) Staffing

FISP financial department staffing is described in the FISP Operation Manual. At the time of the assessment all financial positions were occupied, and there were no current need for hiring additional staff.

The financial department consists of two divisions with two staff each. The division responsible for preparation of reporting for the Bank is called financial management department. It consists of two people: a Financial Manager and an Economist. The division responsible for the statutory reporting is the accounting department. It consists of two persons, the Chief Accountant and the Accountant. The education and work experience of the PIU staff seem to be adequate with the TORs for the positions. Generally, the same staff worked for FISP during the implementation of the previous project.

(ii) Cultural Investment Facility

Component 2b "Cultural Investment Facility" provides for the creation and implementation of a Cultural Investment Facility. The PIU will be responsible for managing the fund. The PIU will collect requests for financing (grants) from any local cultural institutions, review them and submit for approval to an Inter-Ministerial Grant Evaluation Committee. The Committee will evaluate the requests and approve payments for any of them. The PIU will proceed with implementation of the projects in accordance with the World Bank procedures. Therefore, the role of the PIU includes only collection of information and payments according to the decisions of the Committee.

The accounting system of the FISP will record only the transfer of funds from the project accounts to the grant beneficiary's bank account. All accounting transactions related to the use of these funds will have to be recorded by a simple accounting system established by each of the grant beneficiaries. In order to standardize these accounting system and allow proper control of the beneficiary's accounts by FISP, the PIU will prepare a simple accounting Manual/ Guidelines that will describes this simple accounting system that the beneficiaries need to establish. This document will be translated in Russian in order to be easily adopted by the beneficiaries as a reference guide. In order to control that each of the grant beneficiaries' accounting systems are properly handled, FISP will have to carry out regular controls of these grant accounting systems.

III. Budgeting and accounting

(i) Sources of Funds

There will be only two sources of funds for the Project: the Government of the Russian Federation and IBRD. The IBRD funds will be transferred by traditional direct payments and SA payments. Letters of Credit and IBRD guarantees will also be used. There will be no FMR-based disbursement.

- 85 - The co-financing funds will be disbursed through standard procedure established by the Russian Government and the Russian Budget Code. The co-financing money will be budgeted yearly and included into the annual country budget, which is to be approved by the Duma. Once approved these funds can be withdrawn by the PIU through Ministry of Culture by standard requests to a co-financing account located in a commercial bank. This account will be fully managed by the PIU. The expenditures made out of any funds will be made through standard IBRD procurement procedures. The PIU Financial Director will be responsible for proper payments out of IBRD and co-financing funds.

(ii) Budgeting

Within the overall Project budget disclosure in this PAD, the PIU will prepare separate annual budgets for each year of the Project implementation. These budgets will be derived from the Procurement Plans for each year. Both annual budget and Procurement Plan should obtain prior "No Objection" from IBRD. The annual budgets are subject to reconciliation and approval by the Ministry of Culture. The annual budgets will be included into the Russian Federation annual budget, which is subject of approval by Duma. Based on the approved budgets, the PIU will develop quarterly budgets. The comparison of actual results with the budgeted figures will be done quarterly and disclosed in the FMRs.

(iii) Accounting

The FMR Guidelines - Financial Monitoring Reports: Guidelines to Staff issued by the Financial Management Operating Services, and Procurement Sector Board (November 30, 2001), Page 6, suggests that in case the project is implemented by a profit-oriented entity, the project financial statements should be prepared using the accrual method, however the PIU is a not-for-profit organization and therefore can use cash method of accounting.

Nevertheless, at the same time the PIU is allowed by its statutes to perform income generating activities from commercial operations and other statutorily defined activities. The volume of these operations will vary from year to year. Therefore reporting of PIU as an Entity in accordance with IFRS will also be produced on annual basis to control economical validity of the PIU. IFRS accounting policy is developed and meets minimum IBRD requirements.

The PIU will also be responsible for the statutory reporting in accordance with national accounting standards in RUR. The PIU will also submit reporting documents of predefined format to GOSSTROI and the Ministry of Finance on a monthly basis.

(iv) FinancialManagement Information System

The PIU information system includes the Innotec software package linked by MS Excel with the Platinum software package. Innotec is used for statutory and project accounting, whereas Platinum is used for preparation of the reporting for the Bank. The data transfer from Innotec to Platinum is built on MS Excel spreadsheets. This system is not perfect because this additional integration link leads to increased risk of error and increased level of manual reconciliation. Nevertheless the whole system is able to produce the required reporting and therefore does not require immediate change. The PIU plans to implement one integrated information system for all areas of accounting and reporting soon after the Project starts.

-86 - (v) IBRD loan disbursement

Bank funds will be disbursed under the Bank's transaction-based procedures including SOEs, Special Account (SA), Letters of Credit and direct payments; FMR will only be used for monitoring purposes. Supporting documentation for SOEs, including completion reports and certificates, will be retained by the Borrower and made available to the Bank during project supervision missions. Disbursements for expenditures above the SOE thresholds will be made against presentation of full documentation related to those expenditures. There is no plan to move to periodic disbursements.

Afler the crisis, the Bank and the Government of the Russian Federation have agreed that all project SAs will be held in two state-owned commercial banks. The FISP SA will be opened in Vnesheconombank. Withdrawal applications for the replenishments of the SA will be sent to the Bank at monthly or least every three months.

2. Audit Arrangements

A. Reportingfrom PIU

The PIU will report to the Bank using FMRs in USD. The FMR includes breakdown per components and expenditure types with comparison with budgeted figures. The draft format of FMR is developed and is acceptable to the IBRD. The FMR will be prepared on a cash basis. The PIU will prepare the periodic FMRs for each full calendar quarter, and submit them to the Bank within 45 days after the end of the reporting period. The reliability of such FMRs will be audited during the annual audit, and a separate paragraph will be included in the project audit opinion.

B. IBRDfinancial management supervision

During project implementation, the Bank will supervise the project's financial management arrangements in two main ways: (i) review of the financial part of project's FMRs as well as the project's annual audited financial statements and auditor's management letter; and (ii) during the Bank's supervision missions, review of the project's financial management and disbursement arrangements (including a review of a sample of SOEs together with the disbursement specialist and movements on the Special Account) to ensure compliance with the Bank's minimum requirements. The Bank-accredited Moscow-based Financial Management Specialist will visit the project at least once a year. The frequency of the supervision missions will depend on the PIU's financial management performance and will be calculated using ECA FM Risk Model.

C. ExternalAudit

Previous PIU audit arrangements were acceptable to the IBRD. Audits were always performed based on TORs reviewed by the Bank's financial management specialists. The audit opinions on the project accounts were unqualified for the whole period of the PIU operations.

The audit of the project will be conducted by independent private auditors acceptable to the IBRD, on standard ECA terms of reference, and procured by the PIU in accordance with the World Bank procurement guidelines, conditioned to the prior "No Objection" by the IBRD Procurement department. Separate terms of reference will be prepared for the Adjustment component of the project, and this audit might be conducted by the same auditing firms as the Investment component.

- 87 - The annual audited project financial statements (FMRs) together with the PIU IFRS reporting will be provided to the Bank within six months of the end of each fiscal year and also at the closing of the project. The first and final audits can cover up to 18 months. The contract for the audit awarded during the first year of project implementation and thereafter may be extended from year-to-year with the same auditor, subject to satisfactory performance. The cost of the project audits (Adjustment and Investment components) will be financed from the proceeds of the loan, category 3 "Consultants".

The following chart identifies the audit reports that will be required to be submitted by the project implementation agency together with the due date for submission.

Audit Report Due Date FISP Entity IFRS audit Within six months of the end of each reporting period; the first and the final audit can cover a period of up to 18 months. FMR annual. Separate opinion on the reliability o Within six months of the end of each reporting the FMRs submitted to the Bank and covering the period; the first and the final audit can cover a fiscal year period up to 18 months. Audit of Adjustment component Within six months of the end of each reporting period; the first and the final audit can cover a period up to 18 months

The PIU statutory reporting and operating activities are expected to be audited by the Chamber of Accounts, KRU (regional audit body) and the Tax authorities.

D). Country Issues

The financial management capacity within the Russian Federation is currently the subject of a Country Financial Accountability Assessment, which was completed in FY2001 but has not yet been finalized. The CFFA focused on the public sector, while the private sector was assessed by other studies. Pending the graduation of the govermment's financial management and procurement capacity and infrastructure to a level of performance that would allow the World Bank to rely on those systems, the CFAA recommended that fiduciary functions (disbursement, procurement, accounting and reporting, and operational reviews) continue to be outsourced to specialized agencies. Such agencies (possibly the successors of today's Foundations) present the advantage of utilizing skilled consultants and reliable, suitable, and stand-alone computerized information systems. Primarily because of other implementation considerations, any weaknesses that may exist in the financial management capacity in Russia have been mitigated for this project, by the use of an existing Project Implementation Unit (PIU) for project implementation. An agency agreement is going to be signed by the Borrower and the FISP (PIU), assigning FISP the role and responsibility for the financial management.

Based on the Bank's current audit policy, the CFAA recommends maintaining the current arrangements for the annual audit of Bank-assisted projects, which involve audit by private sector audit firms competitively appointed among those pre-selected by the Bank, in consultation with the MOF (11 firms at present). In addition, the work performed by the Accounts Chamber should also be reviewed by the Bank on a regular basis and taken into consideration in project preparation and supervision. The Accounts Chamber routinely performs documentary reviews of Bank projects because they involve international borrowing and the use of budget funds in the form of counterpart financing. These reviews are geared mostly towards assessing the efficiency and cost-effectiveness of project expenditure and the prevention and/or detection of possible waste of resources and abuses. This recommendation is taken into account for the current project. The Project will be regularly audited by a private firm, acceptable to the

-88- Bank. All audit reports, prepared by the Accounts Chamber in respect of this project, will also be reviewed by the auditors and the Bank. All valuable recommnendations would be taken into account.

3. Disbursement Arrangements

Allocation of loan proceeds (Table C)

The proceeds of the Loan will be disbursed in accordance with the Guidelines in the "Disbursement Handbook". The Project has been designed to be carried out over a period of six years and is expected to be completed by February 28, 2009. A period of six months will be allowed to complete disbursements with the Loan Closing Date of August 31, 2009. Disbursement categories and percentages to be financed under each category are presented in Table C, as follows:

Table C: Allocation of Loan Proceeds

-A j?' Expe*ditutr C di)te '.:A,-- untri in'USS$iilliono , -Fin ancing7 Percentage:'- City Budget Support 100.00 100.00 Works 45.86 49.00 Cultural Investment Facility 5.83 80.00 Consulting Services 4.79 72.80 Incremental Operating Costs 3.01 86.25 Total Project Costs 159.49 Front-end fee 1.61 100.00 Total 161.10 Note. All percentage calculations above are based on prices including contingencies.

Disbursement Procedures.

A Special Account will be opened in a commercial Bank acceptable to the Bank, and Managed by the FISP. The Initial Deposit (Authorized Allocation) will be equivalent to US$ 6.0 million. However, the Authorized Allocation will be limited to an amount equivalent to US$ 3.0 million until the aggregate amount of withdrawals from the Loan Account, plus the total amount of all outstanding special commitments equals or exceeds US$ 15.00 million. Payments made from the Special Account will cover eligible expenses under the project. Applications for replenishment of the Special Account will be submitted monthly (or earlier as desired) or at least quarterly. The replenishment applications will be supported by the necessary documentation, the SA bank statement, and a reconciliation of the bank statement. The SA will be audited annually by independent auditors, acceptable to the Bank.

Statement of Expenditure (SOE) procedures will be used for the following expenditures: (a) goods; (b) all works under contracts costing less than US$100,000 equivalent each;(b) services of consulting firms under contracts costing less than US$100,000 equivalent each; (d) services of individual consultants under contracts costing less than US$50,000 equivalent each; (e) operating costs and training, under such terms and conditions as the Bank shall specify by its notice to the Borrower.

- 89 - Graphic: Project Flow of Funds

Ilvoices FISP 4i Acceptance Ats ier

nI _ -I- - -__S> aI |FISP Management p - RUR =t - == /' II II~~~~~~~~~~~~~~~~~~~~~~1.-----

I_T,.fer - RURI' 7p. L / _j _ RUR 1-_ RllRPnRntsU

II _4__ / \ A USDcanwrson USDD tpaymnt a Co -finacing Account / \ |Specal Account 11 I RUR /Rfr\| USD 4 4I T4 repknishtmntofl

Mlnistiy of Cultulre ThM1e W'orld Bank 7 Trantsfet t1f I I _a r linkis fitvn sforeplenW,nmnt the Treasuniuv\ to acconnt In Mfinistzy of Finance coninnercial c ft oot bantk k

Ministry of Culture RF Treasuy Account in RF Treasury

_ D Request for payn= _--D -- Transfer of funds Controlled by the FISP

-90 - Annex 7: Project Processing Schedule RUSSIAN FEDERATION: ST. PETERSBURG ECONOMIC DEVELOPMENT PROJECT

Project Schd6§k nl.n.ied...:Actual Time taken to prepare the project (months) 20 26 First Bank mission (identification) 12/01/2000 12/04/2000 Appraisal mission departure 07/01/2002 03/19/2003 Negotiations 02/24/2003 04/18/2003 Planned Date of Effectiveness 09/01/2003 09/01/2003

Prepared by:

* For the Adjustment component of the Project: City of St Petersburg Working Group * For the Investment Component: Government of the Russian Federation and FISP

Preparation assistance:

Bank staff who worked on the project included: :Name, - - .rS-e I!t-It- Richard L. Clifford, ECCU I Deputy Country Director / Task Team Leader Jean-Jacques Soulacroup, ECSLE Urban Management Specialist / Project Manager for the Investment Component Asad Alam, ECSPE Lead Economist Maria Amelina, ECSSD Social Development Specialist Harry Broadman, ECSPE Lead Economist Stephen Butler, Consultant Consultant, Real Estate and Land Specialist Frederic Didier, Consultant Architect, Cultural Heritage Specialist Yelena Dobrolyubova, ECCU I Operations Analyst Jean-Yves Dubois, Consultant Quantity Surveyor Peter Ellis, ECSIE Economist Delphine Hamilton, ECSIE Program Assistant Alexander Mizgunov, ECSPS Financial Management Specialist Jonathan Pavluk, LEGEC Senior Counsel Radwan Shaban, ECSPE Lead Economist Karl Skansing, ECSPS Senior Procurement Specialist Alexander Roukavichnikov, ECSPS Procurement Specialist Stephan Titov, ECSPE Economist

-91 - Annex 8: Documents in the Project File* RUSSIAN FEDERATION: ST. PETERSBURG ECONOMIC DEVELOPMENT PROJECT

A. Project Implementation Plan

1. Project Implementation Plan 2. FISP Operational Manual

B. Bank Staff Assessments

1. Public Expenditure and Institutional Review (Creditworthiness and Fiduciary Assessment), May 2002 2. Financial Management Assessment Report, August 2002 3. Strategic Plan Assessment, August 2002 (conducted by consultants to the Project Team) 4. Land and Real Estate Assessment, January 2003

C. Other

1. Strategic Plan for St. Petersburg, 1998 2. RFP packages and signed contracts for design and pre-design of the cultural assets

*Including electronic files

- 92 - Annex 9: Statement of Loans and Credits RUSSIAN FEDERATION: ST. PETERSBURG ECONOMIC DEVELOPMENT PROJECT 26-Mar-2003 Difference between expected and actual Original Amount in USS Millions disbursements Project ID FY Purpose IBRD IDA GEF Cancel. Undisb Orig FmmRevd P046497 2003 HEALTH REF IMP 30 00 000 0 00 0 00 30 00 0 00 0 00 P066155 2003 TAXADM 2 100.00 000 000 000 10000 000 000 P064508 2002 TREASURY DEVT 231 00 0 00 0 00 0 00 228 19 *0 41 0 00 P050489 2002 FISC FED B REG FISC REF 120 00 0 00 0 00 0 00 80 80 27 47 0 00 P050474 2001 EDUC REFORM 50 00 0 00 0 00 0 00 48 34 15 94 0 00 P008832 2001 MUNWATER&WW 12250 000 000 000 11928 4986 000 P046061 2001 MOSC URB TRANS 6000 000 000 000 51 14 2641 000 P038551 2001 MUN HEATING 85 00 0 00 0 00 0 00 81 91 13 07 17 94 P064238 2001 NRESTRUCT 8000 000 000 000 7848 1665 000 P058587 2000 REG FISC TA 30 00 0 00 000 0 00 21 66 17 16 545 P053830 2000 SUST FORESTRY PILOT 60 00 0 00 0 00 0 00 5910 24 60 0 00 P050487 1999 STATESTATSSYST 3000 000 000 000 2215 1349 282 P046496 1998 SOCPROTIMPL 2860 000 000 061 671 731 000 P044200 1997 BUREAU OF ECON POL 22 60 00 000 0 00 3 07 3 07 1 37 P050891 1997 ELECSECTRREF 4000 000 000 000 3561 3561 3561 P008825 1997 EDUCINNOV 7100 0 00 0 00 3 00 33 21 2507 0 00 P00814 1997 HEALTH REFORMPILOT 6600 000 000 000 3487 3211 000 P045622 1996 COAL lAP 25 00 0 00 0.00 0 00 5 76 5 76 5 76 P008800 1996 ODSCONSMPPHASEOUT(GEF) 000 0 00 80 00 000 566 1181 1187 P008801 1996 BIODIVCONSV(GEF) 000 000 2010 000 044 232 -413 P008831 1996 LEGAL REFORM 5800 000 0 00 0 50 22 32 22 82 2282 P035761 1996 COMMUNITYSOCINF 20000 000 000 5650 606 6256 1906 P035764 1996 BRIOGEREHAB 35000 000 000 19533 755 20289 4489 P036973 1996 ENT HOUSING DIVST 30000 000 000 16574 6714 23288 12984 P042622 1996 CAP MRKT DEV 8900 000 000 33 75 2866 6241 24 11 P008821 1995 ENVMGMT 11000 000 000 000 4522 4522 4522 P008823 1995 PORTFOLIODEVT 4000 000 000 1049 216 1265 570 P008827 1995 HOUSING 40000 000 000 18573 730 19302 4230 P008828 1994 FININSTS 20000 000 000 5950 6361 123.11 5120 P008839 1994 ENTERPRISE SUPPORT 20000 000 000 5000 8608 13608 4507 P034579 1994 LAND REF IMPL SUPPORT 80 00 0 00 0 00 0 00 17 30 17 30 4 68

Total 327870 000 8010 76114 139977 143823 51157

- 93 - RUSSIAN FEDERATION STATEMENT OF IFC's Held and Disbursed Portfolio Jun 30 - 2002 In Millions US Dollars

Committed Disbursed IFC IFC FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic 1996/98 Alpha Cement 0.00 0.00 0.00 0.00 0.00 0.00 0 00 0.00 1997/99 Aminex 0.00 0.12 0.00 0.00 0.00 0.12 0.00 0 00 2001 BVF 0.00 14.91 0.00 0.00 0.00 5.55 0 00 0.00 2002 Baltiski Leastng 2.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1998 Borsteklo 0.00 15.00 0.00 0.00 0.00 15.00 0.00 0.00 1999 Campina 6.20 0.00 0.00 0.00 6 20 0.00 0.00 0.00 2002 Center-Invest 2.00 0.00 0.00 0.00 0.00 o.oo 0 00 0 00 1999 DLV 0.00 0.60 0.00 0.00 0.00 0.60 0.00 0.00 2002 Delta Credit 20.00 0.00 0.00 0.00 10.00 0.00 0.00 0.00 2002 Delta Leasing 10.00 0.00 0.00 0.00 0.00 0.00 0 00 0.00 1998 DreVo 0.00 0.90 0.00 0.00 0.00 0.89 0.00 0.00 2002 Egar Technology 0.00 1.50 0.00 0.00 0.00 0.00 0.00 0.00 1995 First NIS Fund 0.00 1.80 0.00 0.00 0.00 1.80 0.00 0.00 1994 Framlington Fund 0.00 7.80 0.00 0.00 0.00 7.80 0.00 0.00 2002 ICB 10.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2000 Ikea MOS 15.00 0.00 0.00 0.00 15.00 0.00 0.00 0.00 2002 KMB Bank 7.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1998 Mosenergo 16.86 0.00 0.00 0.00 16.86 0.00 0.00 0.00 2002 NBD 2.50 0.00 0.00 0 00 2.50 0.00 0.00 0.00 2001 NMC 2.10 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2001 OMGC 10.00 0.00 0 00 0.00 10.00 0.00 0.00 0.00 1996 Pioneer First 0.00 4.00 0.00 0.00 0.00 4.00 0.00 0.00 2001 Probusiness Bank 0.00 0.0O 5.00 0.00 0.00 0.00 5.00 0.00 1994 RTDC 0.00 7.50 0.00 . 0.00 0.00 7.50 0.00 0.00 1998/01 Ramstore 30.00 0.00 0.00 0.00 30.00 0.00 0.00 0.00 2001 Ruscam 13.00 0.00 0 00 0.00 6.50 0.00 0.00 0.00 Russ Stndard Bnk 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2002 Russ Tech Fnd 0.00 1.00 0.00 0.00 0.00 1.00 0.00 0.00 1995 Russia Registry 0.00 1.50 0.00 0.00 0.00 1.50 0.00 0.00 1994 SCF Restructured 0.00 1.10 0.00 0.00 0.00 1.10 0.00 0.00 0 Sonic Duo 24.00 0.00 6.00 10.00 12.71 0.00 6 00 5.29 2002 Swedwood Tichvin 6.45 0.00 0.00 0.00 6.45 0.00 0.00 0.00 2002 Toribank 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0 00 1998 UNEXIM Bank 5.28 0.00 0.00 0.00 5.28 0.00 0.00 0.00 1996 Volga-Dnepr 16.90 0.00 0.00 13.00 0.00 0.00 0 00 0 00 2001 ZAO Storaenso 7.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1998/02 Total Portfolio: 206.29 57.73 11.00 23.00 121.50 46.86 11.00 5.29

Approvals Pending Comrnitment FY Approval Company Loan Equity Quasi Partic 1999 DLV 3.00 0.00 0.00 0.00 2001 Bema Gold 0.00 0.00 1.00 0.00 2001 Pakenso - RI 0.00 0 00 0.20 0.00 2001 Ford Russia 55.00 0 00 0.00 55.00 2002 Borsteklo IV 25.00 0.00 0.00 0.00

- 94- 2002 Welor 12.00 2.00 0.00 0.00 2002 Ramstore III 30.00 10.00 0.00 30.00 2002 KMB Bank 0.00 0.00 3.00 0.00 2002 IBS 0.00 0.00 12.00 0.00 2002 AFC 5.00 0.00 0.50 10.00 2002 Pfleiderer 12.41 0.00 0.00 0 00 Total Pending Comnutment: 142.41 12.00 16 70 95.00

- 95 - Annex 10: Country at a Glance RUSSIAN FEDERATION: ST. PETERSBURG ECONOMI'C DEVELOPMFENT PROJECT Europe & Lower- POVERTY and SOCIAL Russian Cneitrnl middle- Federaton Asia Iiicom Development dlamond' 2001 Population, mid-year (millons) 144.7 475 2,164 Lfe expectancy GNI per-capita (Atlas rnetfoo US$) 1,750 1.960 1 j240 GNI (Atlas method, USS billions) 253.4 930 2,677 Average annual growth, 1995-01 Population (% 404 0.1 1.0 Labor force (%) 0.1 0. 1.2 GNI - Gross per priary Most recant estimate (latest year avilable, 199501) capita enrollment PovertY (%of popularion belownatlonalpovertylIne) 28 Urban population (%of total population) 73 63 46 Life expectancy at birth (years) 65 69 69 Infant mortality (per 1,000 Ive bIrths) 16 20 33 Child malnutriton (%of chldren under 5) 3 .. 11 Access to an improved water source Access to anlmprved water source (%ofpoulation) 99 90 80 Illiteracy (%ofpopulation age 15+) 0 3 15 brossprimarvenrollment (%of'school-agepopulaqon) 117 102 107 -RussianFederation Male 117 103 107 Lower-.mddle-ncome group Female 116 101 107 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1981 1991 2000 2001 EconomIk ratbos GDP (US$ billions) .. 5421 259.6 310.0 Gross domestic Investment/GDP . 36.3 16.6 22.1 Exports of goods and services/GDP .. 13.3 44.5 38.3 Trade Gross domestic savings/GDP . 36.6 37.0 34.7 Gross national savings'GDP . 36.3 32.9 31.7

Current account balance/GDP .. 16.3 9.7 Domestic s\n Interest payments/GDP . . 1.1 2.6 Investment Total debttGDP .. 12.5 62.4 49.8 svn Total debt service/exports .. .. 9.9 14.5 Present value of debt/GDP . 57.0 Present value of debt/exports . .. 127.5 Indebtedness 1981-91 199141 2000 2001 200145 (average annual growth) GDP -2.9 9.0 5.0 4.0 Russlan Federaton GDP per capita .. -2.7 9.6 5.6 4.5 Lower-middle4ncorne group Exports of goods and services . 2.3 9.1 0.5 2.7 STRUCTURE of the ECONOMY 1981 1991 2000 2001 Growth of Inveomnt and GDP ( (%of GDP) 40 Agriculture . 14.3 6.4 6.9 Industry . 47.6 39.0 37.6 20 Manufacturing . . 0 Services 38.1 54.6 55.6 -20 99 00 Ot

Private consumption . 46.9 46.2 50.9 40 General govemment consumption 16 5 16.8 14 3 GOt G 0P Imports of goods and servlces . 13.0 24.1 23 6

1981-91 199141 2000 2001 Growthofexportaandlmports(%) (average annual growth) Agriculture . 4.5 5.0 10.8 '0 Industry . 4.8 11.8 6.0 20 Manufacturing ...... Services -0.3 6.7 4.3 o o 7 0

Pnvate consumption 0.3 16.7 8.0 20 General govemment consumpton -1 0 1.6 -1.0 40 Gross domestc Investment . -14.6 18.6 17.0 - Exorts limports Imports of goods and services -2 5 20.2 20.5

Note 2001 data are prelirNnary esanmates *The diamonds show four key indicators in the country (in bold) compared vith its Income-group average if data are nossing. the diamnwd wil be ,ncwnlete.

-96- Russian Federation

PRICES and GOVERNMENT FINANCE 1981 1991 2000 2001 Inflation (%) Domestic prices 2 (%change) _ Consumer prices 92.6 20 8 21.5 150 Implicit GDP deflator 128.6 40.5 17 9 *oo Government finance so (%of GDP, includes current grants) 0 Current revenue 37 2 34.4 go 97 99 99 oo 0o Current budget balance 7 7 5.6 -G DP deflator *CPi Overall surplus/deftclt 2.9 3.1

TRADE

(USS millions) 1981 1991 2000 2001 Export and Import levels (USS mill) Total exports (fob) 105.565 101,603 125,000 Crude oil 25,319 24 288 Natural gas 16,644 17.760 Manufactures 10.000 11.200 75.000 Total Imports (c)d 47,191 56,748 so,00 Food . .. 7,400 9.000 Fuel and energy . 899 1.000 25,000 Capital goods 10,6W 14.000 ss go 97 Oa 99 oo oi Export price Index (1995=100) 105 100 Import price index (1995=100) 83 79 c Exports * Imports Termns of trade (1995=100) 126 126

BALANCE of PAYMENTS

(USS mIt ions) 1981 1991 2900 2001 Cument account balance to GOP (%) Exports of goods and services 115.540 112,506 20 Imports of goods and services 62,467 73,168 Resource balance 53.072 39,338 15-

Net Income -10.789 -9,793 o - Net current transfers 90 381

Current account balance 42,374 29,926 5 - Financing Items (net) -23,959 -15,623 o Changes in net reserves -18,415 -14,303 _ s 90 97 s 99 00 01 Memo: Reserves includIng gold (US$ millions) .. 2,813 27,972 36,622 Conversion rate (DEC. loca#USS) 2.58E-3 28.1 29 2

EXTERNAL DEBT and RESOURCE FLOWS 1981 1991 2000 2001 (US$ millions) ComposItion of 2001 debt (USS mill.) Total debt outstanding and disbursed 67.590 162,023 154,411 IBRD 6.844 6.746 A 6,746 IDA - 0 0 G 20,972 C 7,400 Total debt service 11.510 16.490 D. 223 IBRD 679 739 IDA 0 0 ComposIton of net resource flows Official grants .. ., , . \ -7.10 Official creditors -688 -1,245 Private creditors -2.658 -2,259 F 61.970 Foreign direct investment -463 -122 Portfolio equity -100 610 World Bank program Commitments 30 275 A -IBRD E -Bilateral Disbursements 540 377 B- IDA D Other rmltilateral F -Private Principal repayments 267 355 C -IMF G -Short-terrn Not flows 274 22 Interest payments 412 384 Net transfers -139 -362 uevetopment tconomics

-97- Additional Annex 11: Country Context and Macro-Economic Situation

RUSSIAN FEDERATION: ST. PETERSBURG ECONOMIC DEVELOPMENT PROJECT

1. In the early nineties Russia faced challenges of the break-up of the Soviet Union in 1991 and the necessity of the transition from the central planning to market economy. Since 1992, the Government has implemented a series of economic reforms, the most important of which were price liberalization and mass privatization. Starting in 1997 some elements of stabilization became visible. In 1997 annual inflation fell to around 11 percent, the current account balance remained in surplus at about 0.5 percent of GDP, and GDP growth was positive (0.3 percent) for the first time since the beginning of the transition.

2. However, budget performance remained a vulnerable item of the macroeconomic agenda and the primary risk to sustainability of the stabilization. At the federal level, strong efforts to reduce the budget deficit in the early 1990s ran out of steam in 1997. Tight monetary policy and a stable exchange rate (used as a nominal anchor in the course of stabilization) were not supplemented by fiscal adjustment, and federal budget deficits in the second half of the nineties remained between 7 to 10 percent of GDP. The Government started to rely heavily on both domestic and external borrowing to fill the budget gap and turned to increasing accumulation of arrears and massive use of barter and non-cash offsets. Estimates suggest that the magnitude of these types of implicit subsidies reached up to 10 percent of GDP. The combination of tight monetary policy, loose fiscal policy, fixed exchange rate regime, and excessive public borrowing inevitably led to macroeconomic crisis. (See Brian Pinto, Vladimir Drebenstov and Alexander Morozov. 2000. DismantlingRussia 's Nonpayments System Creating Conditionsfor Growth. World Bank Technical Paper)

3. In August 1998, Russia experienced major crisis when the govemment defaulted on most of its domestic and some foreign debt obligations and was forced to abandon the pegged exchange rate regime. The crisis led to sharp real depreciation of the ruble, major banking sector crisis, a subsequent drop in GDP of 4.9 percent, and an increase in inflation to 84 percent.

4. Since 1999, however, the macro-economic tumaround has been significant. Starting from the second half of 1999, three major factors have led to an increase in real GDP and industrial production: i) significant real depreciation after the 1998 crisis (with a subsequent import substitution effect, higher demand from export-oriented industries and resulting higher money demand); ii) compressed real domestic energy prices combined with a positive external shock in terms of oil and gas price boom; and iii) elimination of the Government market borrowing overhang and therefore reduced crowding out of the private sector. Real GDP increased by 3.2 percent in 1999, by 9 percent in 2000, by 5 percent in 2001, and by 4.3 percent in 2002, bringing cumulative growth over 1999-2002 period to more than 25 percent. In 2000-2002 growth was primarily driven by increase in private consumption demand, facilitated to some extent by a windfall revenue from high oil and gas prices, while the role of investment and net exports was gradually declining.

-98- 5. On the fiscal side, a significant increase in federal revenues, from 13.5 percent of GDP in 1999 to 17.1 percent in 2002, has led to a strong fiscal position. The primary surplus in 1999-2002 varied from 2.2 to 5.4 percent of GDP and an overall budget surplus was positive (from 1.2 to 1.8 percent of GDP) in 2000-2002 for the first time in a decade of transition. Furthermore, all revenues raised by the federal budget since early 1999 have been in cash.

6. The ratio of public debt to GDP, which rose from 49 percent in 1997 to 142 percent in 1998 as a result of devaluation, fell in 1999 to 105 percent of GDP as a result of inflation erosion of domestic debt, repayment of debt (especially to the IMF), strong growth, and real appreciation of the ruble. In 2000, this ratio decreased even further to 65 percent of GDP, due to continuing strong growth of the economy, real appreciation of the ruble, and a write-off of US$10.6 billion as a result of the London Club restructuring agreement. In 2002 public debt to GDP ratio was estimated to be at 40.5 percent.

7. Inflation was constantly on a decline each year from 36.5 percent in 1999 to 15.1 percent in 2002. The current account maintained a significant surplus and the Central Bank has built up considerable foreign exchange reserves- from US$12 billion in August 1998 to about US$48 billion by end 2002. As a result real effective exchange rate appreciated by 37 percent in 2000-2002.

8. In addition, higher demand for liquidity and better macroeconomic policy have resulted in a significant reduction of non-cash offsets in payments to the budgets and transactions between enterprises. Gazprom and RAO UES have been allowed to disconnect consumers for nonpayments. In short order, RAO UES started collecting 100 percent of payments and, as a result, the company was able to pay its debts to the budgets and to Gazprom. Gazprom paid 100 percent of its taxes owed to the federal budget starting from the second half of 2000, and RAO UES followed a similar path. It appears that the share of barter transactions declined from 30 percent in 1999 to 15.3 percent in November 2002. Subnational budgets' non-cash execution was also eliminated from 2001 (from about 50 percent in 1998 and 12 percent in 2000).

9. The recent strong growth has helped to reduce unemployment, increase real wages, and as a result reduce the share of population living below the subsistence level (defined by the government) from 35 percent by the middle of 1999 to 27.4 percent in the third quarter of 2002.

10. However, an overall competitiveness of the economy in 2000-2002 suffered as growth of real wages (69 percent) and real appreciation of the ruble (37 percent) significantly outpaced productivity growth (14.6 percent). This recovery was driven essentially by the rise in prices for exports of natural resources and, in particular, oil and gas. Excessive dependence on natural resource exports leaves the economy highly vulnerable to external shocks and greater diversification of economic activities will be indispensable for sustaining growth in the medium and longer term. Of critical importance will be the expansion of a more broad-based private sector and an increase in the role of small and medium enterprises, whose contribution to GDP still remains well below the levels of other more advanced ECA countries.

- 99 - 0 0 MAP SECTION

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2 NOneIZ R Pskov 13 Ivonovo 23 Vlodomor 25 Belgorod 31 DoNhCstOr, 4l KoI,lmyo- 49 KINov 3 Kanehr 9 Len ngroNd 14 KoIuNo 24 Yoro,IeoI 54 Chelyeb,rok 62 Gany AlTol 71 ChgIa 26 KuCsk 22 Ingush Kholmg 81 KorocUolka 4 ooms IS STPoemrbnoN C 8 Toygah S0 Mar,y El 55 Kurgon y 15 KoaI,o,ao 27 L,pemsk 23 KobordEno-Bolkor 63 Keme,oovo 72 Agon Baoyot R2 KoTyok S Murmoansk 11 KaI,anqnard 42 Peanz 5I Mordovn 56 Orenburg 16 Moscow 28 Tomnboa 6.1 NNCosibCrs 73 erkuIsE 83 Xhoborovsk 34 Krosnodor 43 Sonmoro 52 Nalznm,y 6 Vologda 17 MoEOo Csy Novgorod 57 Perme 65 Gmsk' 74 UoT-OFdpo 29 Voronezh 25 Adygeyo 44 Sorolan BRoyl 84 leion,I AG 18 Orel 58 Kor,a-Permnrak 66 Tormsk 75 Krosnoyorsk 36 HorTElOsEeTo 45 ETomErTON 85 MagodJn 19 Ryo2nom 59 UduTITOT 67 Tyn,eo 37 Roslaa 46 Volgogrod 76 Evenk 86 Chumols 20 Somolensk 60 Svrios 68 RhonTy Maes, 77 Khokos, 38 STnov,opal 47 Uiyonovsk 87 Pr,morsk 21I Tver 39 Karoahaeaa-ChTerkess 69 Ton,ioIaNOEneE 78 Ne,me,T 88 Sokhohno 79 Tuvo 89 Socolt (ToIsm)

DECETTET 1995