46896 V2 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized

Document of The World Bank

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

AND INTERNATIONAL FINANCE CORPORATION

AND MULTILATERAL INVESTMENT GUARANTEE AGENCY

COUNTRY PARTNERSHIP STRATEGY

FOR

THE PEOPLE'S REPUBLIC OF CHINA

FOR THE PERIOD 2006-2010

May 23, 2006

China Country Management Unit East Asia and Pacific Region

International Finance Corporation

Multilateral Investment Guarantee Agency Currency Equivalents

US$1.00 = RMB 8.037 (as of March 2006) The last China Country Assistance Strategy was discussed on December 19, 2002.

Abbreviations and Acronyms AAA Analytical and Advisory Activities IEG Independent Evaluation Group ADB Asian Development Bank IFC International Finance Corporation AIDS Acquired Irrunune Deficiency Syn- IMF International Monetary Fund drome M&E Monitoring and Evaluation ASEAN Association of Southeast Asian Na- MD Gs Millennium Development Goals tions MIC Middle Income Country CAE Country Assistance Evaluation MIGA Multilateral Investment Guarantee CAS Country Assistance Strategy Agency CDB China Development Bank MOFCOM Ministry of Commerce CDD Community-Driven Development MoF Ministry of Finance CDM Clean Development Mechanism MoFA Ministry of Foreign Affairs CEM Country Economic Memorandum MSE Micro and Small Enterprises CG Consultative Group NCMS New Cooperative Medical Scheme CPC Communist Party of China NDRC National Development Reform CPS Country Partnership Strategy Commission CR Completion Report NGO Non-Governmental Organization CSR Corporate Social Responsibility NPL Non-Performing Loan CSRC China Securities Regulatory Com- ODA Official Development Assistance mission ODS Ozone Depleting Substance DAC Development Assistance Commit- OECD Organization for Economic tee Cooperation and Development DFID United Kingdom Department for PBoC People's Bank of China International Development PCBs Polychlorinated Biphenyls DOTS Directly Observed Treatment Strat- PEP Private Enterprise Partnership egy (for treating tuberculosis) POPs Persistant Organic Pollutants Environmental Impact Assessment EIA PPP Purchasing Power Parity European Union E.U. PSU Public Service Unit FDI Foreign Direct Investment QAG Quality Assurance Group Foreign Investment Advisory Ser- FIAS RCC Rural Credit Cooperative vice RMB Renminbi (Chinese currency) FY Fiscal Year SAFE State Adrnin. of Foreign Exchange FYP Five Year Program SARS Severe Acute Respiratory Syndrome GDP Gross Domestic Product SCB State-owned Commercial Bank GEF Global Environment Facility SME Small- and Medium-sized Enter- Greenhouse Gas GHG prise Goe Government of China SOE State-Owned Enterprise HFC Trifluoromethane TA Technical Assistance HIV Human Irrununodeficiency Virus TVE Township and Village Enterprise IBRD International Bank for Reconstruc- UN United Nations tion and Development U.S. United States ICT Information and Communications WBI World Bank Institute Technology WRM Water Resources Management IDA International Development Asso- ciation WTO World Trade Organization

IBRD IFC MIGA Vice President: Jeffrey Gutman Declan Du.ff Yukiko Omura, Hxec. Country Director: David Dollar Karin Finkelston Philippe Valahu Task Team Leader: Johannes Zutt Stoyan Tenev Cecilia Sager

• • ii Table of Contents

Executive summary...... v

Country context ...... 1 Social and economic context ...... 1 Poverty profile ...... 4

China's development challenges ...... 7

Bank Group track record ...... 11

Bank Group strategy ...... 15 Pillar 1: Integrating China into the world economy ...... 18 Pillar 2: Reducing poverty, inequality, social exclusion ...... 20 Pillar 3: Managing resource scarcity and environmental challenges ...... 23 Pillar 4: Financing sustained and efficient growth ...... 28 Pillar 5: Improving public and market institutions ...... 30

Delivering the Bank Group program ...... 33 The portfolio ...... 35 The Bank Group's knowledge program ...... 37 Partner roles and donor coordination...... 38 Portfolio management ...... 39 Managing risks ...... 43

Annexes Annex 1: China CPS results matrix...... 47 Annex 2: CAS completion report ...... 55 Annex 3: Private sector strategy ...... 109 Annex 4: Millennium development goals ...... 121 Annex 5: Consultations on country partnership strategy ...... 123 Annex 6: Standard CPS annexes ...... 131 Annex 7: Country Financing Parameters ...... 145

iii • •

Executive summary

hina has grown rapidly since 1978, when it began to reform. Over the past 27 years, it has shifted from a centrally-planned to a market economy, maintained GDP growth of about 9% per annum, and lifted 400 million people out of pov­ Certy . With a population of 1.3 billion, China recently became the world's fourth largest economy and third largest trading nation. Even so, China remains a developing country, with GDP per capita about $1,740 and more than 135 million people living on less than $1 a day. It also faces daunting challenges in maintaining rapid growth; managing the resource demands and environmental consequences of growth; and addressing the result­ ing inequalities in income and opportunity, which could otherwise undermine the consen­ sus needed to undertake growth-oriented policy reforms. To succeed in meeting these challenges, China will need to shift its growth strategy from one that relies heavily on industry and investment to one that encourages development of the services industry and reduces barriers to labor mobility. Growth that is more balanced between industry and services as well as between capital accumulation (on one side) and urban employment and productivity growth (on the other) will result in higher employment growth, a more economic and sustainable use of energy and primary commodities, and less environmental degradation. The Government of China (GoC) will encourage this shift in implementing its 11th Five Year Program (FYP), which is a "people-centered" strategy aim­ ing to achieve a "harmonious society" that balances economic growth with distributional and ecological concerns. The Bank Group continues to play an important development role in China. Through a combination of AAA and knowledge embedded in its limited lending, the Bank has sup­ ported innovations that, scaled-up, have provided benefits far exceeding the direct benefits of the original projects. These spillover benefits include, for example, key policy or institu­ tional reforms, upgraded technologies, and stronger human resource capacity in local gov­ ernments. Innovations typically draw on the Bank Group's international experience and emerge from a long-term GoC-Bank Group partnership founded on trust, shared commit­ ment, and pragmatic cooperation aiming to bring a sustainable solution tailored to a press­ ing development problem. Given China's financial circumstances and its appropriate development program, the Bank Group aims to be a client-driven knowledge institution that uses lending and other operations to pilot reforms and support institutional development. This Country Partnership Strategy (CPS) focuses on five thematic areas of engagement that build on the Bank Group's international expertise while maximizing the creation and dissemination of knowledge of China's development processes inside and outside China. In particular, the Bank Group aims to help:

• Integrate China into the world economy, by deepening its participation in multilateral economic institutions, reducing internal and external barriers to trade and investment, and contributing to its overseas development efforts (pillar 1); COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

• Reduce poverty, inequality and social exclusion, through promoting balanced urban­ ization, sustaining rural livelihoods, and expanding access to basic social and infra­ structure services, particularly in the rural areas (pillar 2); • Manage resource scarcity and environmental challenges, through reducing air pollu­ tion, conserving water resources and optimizing energy use (partly through pricing reforms), improving land administration and management, and observing international environmental conventions (pillar 3); • Deepen financial intermediation, by expanding access to financial services (especially among SMEs), developing the capital markets, managing systemic risks, and maintain­ ing financial stability (pillar 4); and • Improving public and market institutions, by improving firm competitiveness, reform­ ing public sector units, and rationalizing intergovernmental fiscal relations (pillar 5).

The Bank Group will support GoC activities in these areas through a variety of instru­ ments. IBRD AAA and lending will apply international expertise to helping the GoC to complete the transition to a market economy, improve the welfare of the poor and near­ poor, and develop and implement sustainable resource-management practices. In an in­ creasingly important role, IFC investments will support China's structural transition by helping the GoC to strengthen financial institutions and shift assets into the private sector while also helping the private sector to adopt international practices. In parallel, MIGA guarantees will support infrastructure development through FDI, in areas where investors perceive signifi­ cant non-commercial risk and with a focus on lagging regions. In general, Bank Group interventions will aim to complete standard-setting model projects or transactions that pro­ mote innovation, create demonstration effects, and achieve best practices. Bank Group AAA will remain a large part of the program, supporting in particular pillars 1, 4, and 5, where opportunities for lending and investment are limited. IBRD lending­ which will also aim explicitly at learning-will support pillars 2 and 3 and, to a modest extent, 4. IFC investments and TA will focus on pillars 4 and 5, with selective contributions to pillars 1, 2, and 3 as well. MIGA guarantees and TA will support pillars 1, 2, 3, and 5, while WBI learning and capacity-building activities will support pillars 1, 3 and 5. Over the CPS period, it is expected that the Bank Group's overall exposure to China will remain stable or grow slowly. IBRD lending is expected to range over $1.0 billion to 1.5 billion a year; IFC investments to grow from about $400 million to about $700 million a year; and MIGA guarantees to remain at about $50 million in coverage a year. The key risks to the Bank Group's development effectiveness in China are stagnation in the reform process, financial sector difficulties, an external shock, a health epidemic such as the avian flu, or social instability leading to an economic slowdown. Each risk is being carefully monitored, and the GoC is taking measures to address each of them.

••vi Country context

ver the last 25 years, the Bank Group's relationship with China has evolved from The Bank one where the Bank Group shared its international experience with a newly Group's emerging China to one where China, as it begins to take a larger role in the 0 international community, is increasingly sharing its experiences and its thinking on relations hip global development issues with the Bank Group and the rest of the world. In recognition of with China China's double role as a Bank client and a development partner, the Bank Group's new is evolving strategy for China is a Country Partnership Strategy (CPS) that covers the period 2006 to 2010 and is co-terminous with the 11th Five Year Program (FYP) of the GoC. A mid-term review of the CPS will be conducted in July 2008.

Social and economic context

Towards developing an all-inclusive "xiaokang" society

China's FYPs set out the objectives, guiding principles and main tasks for China's economic and social development for a five-year period. Under the 10th FYP, which covered the period 2001 to 2005 (including the period of the last CAS), the GoC continued to pursue its aim of establishing a harmonious and moderately prosperous ("xiaokang') society. Rapid growth since the beginning of the reform period in 1978 enabled the GoC to reach its original target of raising GDP per capita to $800 by 2000, but the GoC at that time also recognized that the resulting xiaokang society was "at a low level", "not all-inclusive", and "very uneven". Hence, in November 2002, it put forward a vision of an "all­ inclusive xiaokang society" by 2020. That aim was subse­ quently identified, inter alia, with three quantitative Producer goods targets: achieving GDP per capita of $3,000, increasing Market prices 0 46 87.3 urbanization to 50%, and decreasing the ratio of agricul­ State-guided 0 18 2.7 tural employment to total employment to 30% (from 50% State-fixed 100 36 10.0 in 2000). Retail sales China's progress under the 10th Five Year Market prices 3 69 96.1 Program State-guided 0 10 1.3 State-fixed 97 21 2.6 Steady progress towards these goals was made under the Farm commodities 10th FYP. The GoC achieved its principal objective of Market prices 6 58 96.5 maintaining rapid economic development over 2000 to State-guided 2 20 1.6 2005, as China's GDP increased by about 57% (an aver­ State-fixed 93 22 1.9 age increase of 9.5% per annum) and GoC revenues by Source: NDRC and Price Yearbooks l•• COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

about 136%. Agricultural production, and in particular grain production, improved, while the output of manufactured products rose substantially. Many major construction projects were completed and others were initiated in areas such as energy, transportation, commu­ nications, and water conservancy. The GoC also continued to implement reforms in the areas of rural development, state-owned enterprises (SOEs), and the financial, fiscal, tax and investment systems, with a view to improving macroeconomic management and strength­ ening the role of market forces in allocating resources (see Table 1 on market-based pric­ ing). With its accession to the World Trade Organization (WTO) in 2001, China continued to open up to the outside world. Imports from other Asian countries have grown rapidly as Progress China becomes an export destination of choice, especially of parts for assembly. The 2004 was made free trade agreements between China and ASEAN reinforce this trend. Over 2001 to 2005, China's import and export volume tripled, making China the third largest trading nation in in the 10th the world (and also making the country more vulnerable to trade shocks), while foreign Five Year direct investment (FDI) increased by $274 billion cumulatively (with about $60 billion added Program in each of 2004 and 2005). China also strengthened its external position. Its trade surplus exceeded $100 billion in 2005, driven partly by rising FDI, and rising current account sur­ pluses together with strong capital inflows brought net international reserves to $819 billion by the end of 2005 (second only to Japan). In adjusting to China's growing international role, the central bank in July 2005 announced that it would no longer peg the renminbi to the U.S . dollar but move to a managed floating exchange rate regime based on market conditions with reference to a basket of currencies; the renminbi thereafter appreciated slightly against the dollar. As the pace of industrialization, urbanization, market development and internationaliza­ tion increased and China's overall production capacity reached new highs, people's living standards also reached new highs. Over 2000 to 2005, urban per capita disposable income rose by 58% and rural per capita net income by 290f<> (both in real terms). About 42 million new jobs were created in the urban areas, and consumer spending on housing, communi- cations, automobiles and services grew significantly, lead­ ing to highly visible changes both in rural and urban Figure 1: Growth rates(%, 1990-2003) areas. China also managed to avoid serious economic disruptions from the Asian financial crisis, the SARS out­ 14 break, and several major natural disasters. At the same time, China's development encountered 12 several problems during the 10th FYP period. One key 10 problem has been heavy dependence on investment to 8 maintain growth (see Figure 1), reflecting financial sector

6 inefficiency as well as a local government preference for investment over consumption.1 Other problems include 4 weak capacity for independent innovation, excessive con­ 2 sumption of energy and resources, worsening environ­

0 mental pollution, serious unemployment, widening gaps Household Government Capital Export in development between urban and rural areas and be- consumption consumption formation volume

1 In 2004, the Goe tried to moderate investment growth (which was raising concerns about over­ heating and the re-ignition of inflation) by deregulating interest rates and imposing a series of measures to limit investment in over-heated sectors, but investment growth has remained high. Hence, changing China's unbalanced economic structure and pattern of growth remains a key challenge. COUNTRY CONTEXT tween regions, growing disparities between certain income groups, and inadequate devel­ opment of social programs. The 11th FYP aims to start solving these problems.

China's 11th Five Year Program

The GoC's 11th FYP, which has been under preparation since July 2003, covers the period 2006 to 2010. The draft of the 11th FYP, approved by the National People's Congress in March 2006, deepened the GoC's commitment to achieving an all-inclusive xiaokang soci­ ety and began to articulate a detailed roadmap towards achieving it. Based on data from China's first economic census, the program will implement a "scientific approach to devel­ The 11th opment" to build a "harmonious society", with more jobs, better services, improved social Five Year security, and higher living standards for China's citizens. In continuity with the 10th FYP, the 11th FYP aims to sustain the rapid and steady development of China's "socialist market Program economy", while in addition achieving the "five balances" (between rural and urban devel­ will aim to opment, interior and coastal development, economic and social development, people and achieve a nature, and domestic and international development) and making economic and social moderately development more people-oriented, comprehensive, balanced and sustainable. The 11th FYP includes two key quantitative targets. First, it aims to achieve annual GDP prosperous growth of 7.5%, with the goal of doubling 2000 GDP per capita by 2010. Second, it aims to society reduce energy consumption per unit of GDP by 20%, and the total discharge of major pollutants by 10%, by 2010, with a view to relieving mounting pressure on resources and the environment. The program also includes a number of strategic priorities and major tasks, including:

• Rebalancing China's pattern of growth, by accelerating development of the service sector; improving the performance and competitiveness of large industry through utiliz­ ing technological innovation; and building a resource-efficient and environmentally­ friendly society through undertaking key energy-saving projects and developing a "circular" (recycling) economy; • Deepening reforms and opening further to the outside world; • Constructing a "new socialist countryside" that will modernize agriculture, build rural institutions, improve rural infrastructure and service delivery, and raise farmers' incomes; • Promoting more balanced development among the different regions, by en­ couraging cooperation and mutual assistance among them; zoning the territory into four different development categories; and promoting urbanization to take advantage of the leading role of city clusters in driving development and poverty reduction; and • Increasing the capacity for independent innovation as well as for assimilating advanced foreign technologies, refining them, and integrating them into commercial applications.

The 11th FYP recognizes that achieving these tasks will place increased demands on government. Hence, the program is also committed to combatting corruption; improving transparency; establishing a sound accountability system; reducing discretion in matters subject to administrative review; reforming government administration to separate regula­ tory functions from enterprise management; and rationalizing the state's role in service delivery by determining when the state should merely regulate the private production of a particular good or service, when it should fund its provision, and when it should undertake direct provision. COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

China's 11th FYP is ambitious, even considering China's remarkable track record of economic growth and poverty reduction since the beginning of the reform period. At the same time, it directly addresses most of the central development challenges facing China today (namely, the imbalances that have arisen in part as a result of China's development Poverty success) and also sets out appropriate goals for reducing poverty and achieving further reduction social and economic development. Hence it provides an appropriate framework and pro­ continues, gram for the Bank's new CPS to support. but about 135 million Poverty profile still live on less than $1 With robust growth, both the incidence of poverty and the number of poor have declined since 2001, and at an impressive rate (Table 2). Official estimates now put the number of a day poor at 26 million, but this group is best described as 'extremely poor' by global standards. Using the Bank's $1/ day consumption poverty line, poverty fell by about one-third over 2001 to 2004, yet there are still about 135 million poor in China (the second largest national concentration after India and more than 10% of the global poor). Using the GoC's official poverty line, which is about $0.70 per day, poverty fell a more modest 10% over the same pe­

Official poverty line 3.2% 2.8% riod, indicating that the extreme poor ($0. 70/day) 29.3m 26.1m are benefiting less from China's rapid $1 /day consumption 15.4% 10.4% growth. A recent World Bank poverty poverty line 196.1m 134.9m assessment found that: Source: Bank estimates based on NBS household data

Box 1: Factors contributing to rural income inequality in China

Recent Bank work shows that rural income inequality is mainly affected by differences across households in the number of income earners relative to dependents, which might limit migration possibilities; differences across households in human capital as well as regional differences in the returns to human capital; and geography and remoteness, which limits local non-farm employment.

£ (/) Distance from township (1.6%) Cl (I) c Q) ·- ~ Productivity of land (3.7%) • E~ "i:: ~ No. of household members who are migrant workers (4.8%) -c ::J~ 0 c Land per worker (6.3%) • (.) ·- f!? ~ o= Regional differences in returns to human capital (8.1%) -(.) (I)::J .!!! O" No. of household members with local nonfarm employment (8.2%) .. ~~ .0 ·­ Human capital of household workers (14.2%) (I) Q) i:: E Q) 0 (/) (.) Region(14 .4%) - <3 .!: Household structure: dependency ratio (38.2%) I I I 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Contribution (%) of factor to observable sources of inequality COUNTRY CONTEXT

Box Z: Is China's poverty line too low?

The answer appears to be Yes. Of 63 countries with data, only eight use poverty lines below the $1 a day consumption line. China is one, and it has the lowest ratio of official poverty rate to the $1 a day rate. China's official poverty line was only 24% of rural mean income in 2003 (it was 68% in 1980), and studies suggest that the line is equivalent to the food spending needed to attain the recommended intake of 2,100 calories a day, imply­ ing that all food and non-food basic needs cannot be met

Ratio of poverty rate under official poverty line to poverty rate under dollar-a-day poverty line 5 Countries with national poverty Q) lines below $/day '§ ~ 4 ~~ China Tanzania Q) >- Nigeria India i) i 3 0. > Uganda Ghana -ro a.0 Zimbabwe Mali «3 >- ii= ro 2 o~ ~~ 0 VT &£1 I I 0 6 11 16 21 26 31 36 41 46 51 56 61

• Poverty is a rural phenomenon: 93% of the poor are in rural areas, 6% are migrants working in urban areas for six months or more a year, 1% are urban. • About one in two poor people live in the western provinces. • Households in remote mountainous areas, in minority areas, or with an adult unable to work have a higher incidence of poverty (although 98% of poor house­ holds have two or more people able to work). • Poverty incidence declines steadily with years of schooling (nearly 40% of the poor have less than 7 years, over 90% have less than 10 years). • Recent progress in non-income dimensions of poverty has been less than ex­ pected, given China's per capita rate of growth.

The distribution of poverty

Using poverty as a lens, China can be viewed as three distinct regions (see Table 3). The coastal region, where 38% of the people live, benefited from its geographical location and an ear­ lier introduction of reforms to achieve Population (m) 493 430 371 rapid growth and poverty reduction. GDP per capita (US$) 2,395 1143 919 Share of national GDP(%) 59 24 17 By contrast, the central and wester~ Share of national FDI (%) 85 11 4 regions have lagged behind. If these FOi as GDP % 4.6 1.4 0.6 two regions were an economy on Source: China Statistical Yearbook, 2005. COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

their own, they would constitute a lower-income country with a population of about 800 million and an FDI-to-GDP ratio that is about half that of sub-Saharan Africa. China's development challenges

ince initiating reforms in 1978, China has performed extremely well, emerging re­ Maintaining cently as the world's fourth largest economy and third largest trading nation. Even rapid so, China remains a developing country, with GDP per capita of $1 ,740 and about growth will S135 million people living on less than $1 a day. To continue to reduce poverty, China needs to maintain rapid growth, manage its resource demands and environmental conse­ require a quences, and address the rising inequalities that are a by-product of growth. change in the growth Maintaining rapid growth strategy

With sound macroeconomic management, China in 2006 should see low inflation, growth of 9.0%, and a decline in the current account surplus (after a record surplus in 2005). China will probably sustain this growth rate through the CPS period, and it has the potential to sustain high growth rates beyond it, but this will require a transformation in its growth strategy. Over 1993 to 2004, the GoC implemented a growth strategy that favored industry and investment over services and employment. Low resource prices, weak enforcement of envi­ ronmental regulations, and subsidized financing from a compliant banking sector all favored industry, which grew sharply from 1990 to 2004. About 60% of growth over the period resulted from growth in capital stock, while total factor productivity growth contributed a third and employment growth only 6%. At the same time, most industrial growth was in the form of labor productivity growth rather than employment growth, with the result that the absorption of surplus rural labor was largely left to the slower-growing service sector. This in turn produced lower growth in urban employment and agricultural productivity than ex­ pected, as well as growing rural-urban income inequality. China cannot afford to continue with this growth strategy, as it will limit the shift of labor from agriculture to urban employ­ ment, further widen the productivity gap between agriculture and the rest of the economy, and encourage pollution as well as greater inefficiency in the use of natural resources. Recognizing this, the CPC's Central Committee in October 2005 discussed shifting from a growth pattern that favors capital-intensive industry to one that is less resource-intensive, more 'knowledge- driven' (i .e. more Table 4. Sources and aspects of growth (1993-2004, avg . annual increase,%) efficient), and more On current policies With rebalancing equ ally shared 1978-93 1~ 2004-14 2014-24 2004-14 2014-24 among the popula­ tion. This will in­ GDP growth 9.7 9.5 8.0 8.0 8.0 8.0 volve reducing Total employment growth 3.5 1.1 0.4 0.0 0.8 0.4 Labor productivity growth 7.0 7.8 7.6 8 7.2 7.6 subsidies to indus­ lnvestmenUGDP ratio 30.2 36.8 43.4 55.3 34.5 36.4 try and investment, Agricultural employment (end period) 56.4 46.9 41.1 33.4 31.3 12.5 boosting domestic Source: "China's Pattern of Growth", Kuijs and Wang, 2005 ?•• COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

consumption, encouraging the services industry, and enhancing labor mobility so that growth is more balanced between industry and services as well as between capital accumulation and urban employment and total factor productivity growth. With less capital accumulation in industry and more investment in services, which is more labor-intensive, urban employment would grow faster, leading to a larger transfer of labor out of agriculture, higher agricultural productivity and incomes, and lower rural-urban income inequality (see Table 4 on page 7). To enable domestic consumption to drive demand in the economy, China will need to pursue reforms such as:

• Developing pension and health insurance systems that enable households to rely less on built-up savings, and • Raising government spending on health and education and shifting the composition of spending away from investment.

To maintain growth with lower investment, economic productivity needs to increase through such measures as:

• Continued migration of rural labor to the urban areas, facilitated by: • Giving rural migrants access to urban social services and safety nets; and • Strengthening urban social and infrastructure services, as well as municipal fiscal and financing capacity to provide these services without reliance on excessive land conversion and quasi-fiscal borrowing; • Increased market efficiency, which will in turn be achieved by: • Transforming SOEs and promoting SME and private enterprise growth; • Deepening economic integration into domestic and international markets; and • Continuing reform of the financial markets; • Improved technological capability in firms, achieved by: • Supporting the 'national innovation system' with appropriate incentives; • Encouraging FDI and trade that promote technology transfers; and • Creating incentives for enterprise assimilation of ICT.

If the GoC manages these policy challenges well, China can continue to be a source of Managing growth and productivity increases for the world. the resource Ensuring the sustainability of growth demands of growth is To manage the resource demands and environmental consequences of rapid growth, the China,s GoC recognizes that China needs to conserve water resources, restrain energy consumption, biggest and minimize environmental degradation. China already represents a 4% share of the world economy, and it has become a major source of demand for raw materials in the global challenge markets (in 2004 it accounted for about half of global growth in metals demand and a third of global growth in oil demand, though it still accounts for only 8% of the oil market). Currently, China's GDP is highly energy-intensive: it uses 50-100% more energy per unit of GDP than OECD countries for some industrial processes, and 20-100% more energy for residential heating and cooling than OECD countries with comparable climates. At the same time, water is scarce relative to China's needs, and the efficiency of water usage remains low, in part because water policy is inappropriate (urban water prices are relatively low, discouraging water conservation; even lower rural prices encourage farmers to produce CHINA'S DEVELOPMENT CHALLENGES low-value water-intensive crops such as animal feed rather than high-value food crops; and water pollution standards are poorly enforced). Finally, reliance on coal (chiefly of low quality) together with the spread of motorization (vehicles now number 29 million, with four million more added each year) is intensifying air pollution; 20 of the world's 30 most polluted cities are in China. Rebalancing growth to sectors that require less energy and resources, by using the tax system and regulatory framework to adjust energy and resource use in line with scarcity and social costs, will help. In addition:

• Reducing the energy intensity of GDP will require: • Pricing oil, gas, and electricity so that it takes into account environmental degrada- tion costs and their impacts on welfare; • Adopting higher standards of energy efficiency; • Developing high-density cities with good public transportation; and • Diversifying the sources of energy away from low-quality coal, including by invest­ ing in new technologies (such as fuel-cell, clean coal, and renewables). • Conserving water resources will require: • Pricing water to reflect more accurately the scarcity value of water and the environ­ mental degradation linked to water use and water pollution; • Piloting rural water markets through establishing institutional mechanisms and agree­ ing an initial distribution of rural water rights; and • Taking steps to minimize water pollution by processing urban wastewater for reuse and improving urban solid waste management. Managing By taking action now, while China's urbanization and motorization are in early stages, the GoC will help to limit future demand and also improve the competitiveness of Chinese rising firms producing innovative energy- and water-saving technologies. inequalities depends on improving Managing rising inequalities social China's third challenge is to manage the rising inequalities in income and opportunity that services have come partly as the by-product of its transformation from an agricultural to an industrial economy. These inequalities (see Figure 2), if allowed to persist, could undermine the consensus needed to undertake policy reforms supporting growth and poverty reduction. To counteract this tendency, the GoC aims to rebalance growth to sectors that require less capital and generate more Figure 2: Gini index for per capita income jobs while also strengthening access to key services, through: (1981-2004)

Improving access to good quality social services in • poorer areas; 50 Without adjustments 45.3 Ensuring that social safety nets have broad coverage for spatial cost of • • living differences and provide adequate and effective support to the 41.1 40 ------. ------• needy; ...... ,,,, , , ... .If Reforming intergovernmental fiscal relations to enable .• .• ...... • ~ .. sub-national governments to match fiscal responsibili­ 30 • , ~-~-~ !. ------. ------ties with revenue assignments; and • ._ ,...... _ Adjusted for spatial Improving the management of funds at all levels of cost of living • differences government to ensure that funds are used for intended 20 I 1980 1985 1990 1995 2000 2005 purposes. ------COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Cross-cutting challenges

Further challenges for China include improving governance, addressing gender disparities, and preparing for an upcoming demographic transition.

Governance and corruption Corruption is a problem in China. The GoC is addressing the systemic issues that contribute to corruption through rationalizing SOEs, reforming public sector management (including by shifting service delivery responsibilities to the private sector when appropriate), and strengthening regulatory institutions and the judiciary. Corruption opportunities have al­ ready been reduced by simplifying business licensing, using a 'negative' list to approve investments, and registering (instead of approving) small investments; in addition, stricter guidelines have been set for civil servant behavior and accountability. Under the 11th FYP, the GoC will launch a campaign to combat bribery in business, focusing on irregular trans­ actions in construction, land transfers, property transactions, the purchase and sale of drugs, and government procurement. It will also continue to remedy improper practices that harm public interests and focus more attention on outstanding problems such as arbitrary educa­ tional charges and excessively high medical costs.

Gender Overall, China has a good record on gender issues. Nonetheless, disparities persist between urban and rural areas and inequity is growing in infant mortality as well as in the sex-birth ratio (the proportion of male to female live births was 114 in the 2000 census and now exceeds 130 in five provinces). Gender disparities also persist in illiteracy (e.g., failure to attend primary school) and access to higher education as well as in migrant labor patterns, worker layoff practices, and wage rates.

Demographic transition China is experiencing a profound demographic transition. Its total fertility rate, 1.8, is below the 2.1 needed to maintain population levels, while life expectancy has reached 69.6 for men and 73.3 for women-levels seen in MICs like Brazil or Turkey. In addition, the popu­ lation is rapidly aging: by 2030 the share of the population above retirement age will reach 32% (see Table 5). These changes will have social consequences. Cancer, cardiovascular disease and other diseases of aging will become more common causes of illness and death, requiring health spending to shift to the elderly. Rapid aging will also add to the burden of the public pension system, which is not financially sustainable given current parameters. Low fertility will re­ Table 5: Changing demographics sult in significant 20J5 2010 2020 2030 declines in the number of school­ Total population (millions) 1,308 1366 1,449 1,483 Male 674 700 744 762 age children, with Female 634 666 705 721 the result that the Population share (%) 100 100 100 100 GoC will need to 0-14 years old 20.2 20.0 20.3 17.7 consolidate schools 15 years old to retirement age 60.4 58.3 52 .3 50.1 and adjust educa­ Retirement age or older 19.5 21.7 27.4 32.2 tion planning. Old age dependency ratio 32.2 37. 2 52.5 64 .3

Source: Yvonne Sin, World Bank, 2004

• 11 10 The Bank Group track record

The Bank Group continues to have impact beyond direct project benefits

The CAS Completion Report (Annex 2) found that the Bank Group still plays an important development role in China. Through AAA and knowledge embedded in the Bank's limited lending to China (less than 0.2% of total investment), the Bank has supported innovations that, scaled-up, have far exceeded the direct benefits of the original projects, including The Bank initiating policy reform, introducing institutional reform and innovation, upgrading tech­ Group has nologies, and building human resource capacity. Major developments to which the Bank had impact Group was an important contributor include: but it can • A better understanding of growth and equity issues (through the CEM); also do • A stronger GoC focus on poverty and high-quality poverty analysis, particularly re­ better garding the impact of China's December 2001 accession to the WTO; • Financial sector reforms, including interest rate reform, urban credit cooperative re­ form, and the introduction of private strategic investors to banks; • Deeper financial intermediation, through IFC's issuance of the first renminbi-denorni­ nated bond to be issued by a foreign institution; • Greater emphasis on the private sector and its enabling environment; • Greater GoC awareness of resource scarcity and environmental challenges, at all levels of government, as well as approaches to managing them; • GoC improvements in development planning, including through analytical work sup­ porting the preparation of the 11th FYP; • Greater focus on institutional and regulatory issues (e.g. utility cost recovery); • Greater openness and transparency in GoC project management, including procure­ ment, auditing, environmental assessment, and resettlement plans; • Drafting of the Rural Land Contracting Law; and • Positioning the Bank Group as a knowledge institution, with greater outreach and a stronger focus on ideas, innovation, and learning.

Project and portfolio performance remain strong

• According to IEG, 87% of closed Bank projects evaluated during the CAS period had satisfactory or better outcomes (compared to a Bank average of 79%), 94% likely sustainability (compared to a Bank average of 78%), and 81% substantial institutional development impact (compared to a Bank average of 54%). COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

• The current Bank portfolio has no problem projects; the number of projects at risk in recent years was well below Bank averages; and the IFC portfolio has the lowest loss­ reserve ratio in the region.

During the CPS consultations, GoC officials expressed concerns over some,µroject imple­ mentation issues. These are being addressed. Preparation times are falling, procurement clearances are within Bank norms (in FY05 tum-around time averaged 3.05 days, but clear­ ances for contracts with values above thresholds need improvement), and loan charges were reduced when the Board reduced the front end fee for FY06 to 0.25%. Also under consideration are streamlining safeguards procedures (while recognizing that jurisdictional variability in implementing GoC standards makes harmonization difficult); reducing coun­ terpart funding requirements (MoF and NDRC are considering lower counterpart funding for social and poverty reduction projects on a case-by-case basis); increasing continuity in Bank staff working on a particular project; and delegating more responsibility to Bank staff located in Beijing.

But there is still room for improvement

GoC officials, other stakeholders, and Country Team members noted some constraints that the Bank Group was not fully able to overcome during the CAS period and that remain challenges today, including:

• Failure in some cases to scale-up successful projects through integrating them into GoC programs (due to, inter alia, limited emphasis on innovation in the selection of some projects, lack of a GoC counterpart with unified authority and policy responsibil­ ity, or the absence of rigorous M&E of project impacts); • Failure of the Country Team in some cases adequately to match resources (including staff skills) with country priorities, with the result that there have been some missed opportunities and some inability to engage fully on critical issues where the Bank has been active (e.g. municipal finance, urban transport modes, cross-sectoral environ­ ment issues); • The post-IDA difficulties that poorer jurisdictions have to repay IBRD loans supporting poverty and social sector projects; • Poor integration of AAA, lending, and trust-funded activities (in the latter case because trust fund resource availability does not always match country priorities, client de­ mand, and Bank Group capacities); and • Difficulties in transferring knowledge through the TA components in projects.

Going forward, the Bank Group should build on success factors ...

• The Bank's role in bringing ideas, innovation, and knowledge remains its most valued contribution. While resource transfers are important to sub-national governments, the Bank Group's comparative advantage lies in its role as an international knowledge leader and disseminator of good practices. THE BANK GROUP TRACK RECORD

• Innovations typically emerge from a long-term GoC-Bank Group partnership founded on trust, shared commitment, and pragmatic cooperation. Sustained engagement on key topics is especially important given China's gradualist approach to reform. • The Bank Group's 'dual-track' approach-building trust through lending and support­ ing policy dialogue through sector work-has been a key success factor. As the CAE noted, combining persuasion through analytical work and demonstration through pi­ lot projects has enabled the Bank to "punch above its weight" in China .

... and make use of key lessons learned during the past CAS period

• The Bank Group's new strategy for China should provide a sharper focus on interme­ diate strategic priorities that provide a "compass" for Bank Group programming and dialogue. • The Bank Group can do more to exploit synergies between investment lending and analytical work, while recognizing that demonstration projects supported through lending introduce and localize international knowledge and experience and support sustained levels of GoC-Bank partnership that are not often achieved through AAA alone. • For investment projects, higher priority should be placed on demonstration aspects in project selection, M&E, and the dissemination of lessons learned. • Both China and the Bank Group stand to gain from new approaches that enable increased Bank Group engagement in the social sectors, poverty reduction, and insti­ tutional reforms.

The Bank Group strategy

he Bank Group aims to help China shift over time from a growth pattern that The Bank favors capital-intensive industry to one that is less resource-intensive, more effi­ will support cient, and more equitably shared. This will involve rebalancing growth to sectors China's Tthat require less capital, energy, and resources and generate more urban employ­ ment. Key steps will include increasing market efficiency, improving firm competitiveness, efforts to facilitating the movement of labor out of agriculture and to the cities, and enhancing change its domestic demand. While the Bank Grau p is only one of many external partners of the growth GoC, its activities contribute in various ways to achieving these steps, as indicated in Figure 3 below: strategy

Figure 3: World Bank Strategy for China: Results Chain

China achieves rapid sustainable economic growth that benefits all citizens

Growth pattern shifts from one that favors export-oriented industry and investment to one that also encourages services, employment, productivity, and consumption t t t t Increased market efficiency Improved firm competitiveness Higher domestic Labor movement (eliminating subsidies to industry, (removing barriers to competition consumption out of agriculture encouraging growth of services) and incentivizing innovation) driving demand

Prices of energy, Financing Urban social and Pension, health water and land allocated to Technological infrastructure insurance allow reflect actual highest retum transfer through services less reliance on total costs activities trade and FOi strengthened savings

Pillar4 Pillar 1 Environmental, Goe spending energy use significantly Greater use of Hukou system standards shifted ICT reformed strengthened to health and and enforced education Pillar3 Pillar2 Pillar 5 Pillar 2 Pillar2 ------

Bank assistance under this CPS is organized around five thematic pillars, reflecting a refinement of the 2003--05 CAS pillars and incorporating the ongoing portfolio. Pillar 1, integrating China into the world economy, will be supported mostly through AAA and IFC and MIGA activities, including TA. Pillar 2-reducing poverty, inequality, and social exclu­ sion-and Pillar 3--managing resource scarcity and environmental challenges-will be sup­ ported through AAA, IBRD lending, and IFC and MIGA activities. Pillar 4, financing sustained

lS • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

and efficient growth, will be supported mostly by AAA and IFC activities, with limited IBRD lending, while Pillar 5, improving public and market institutions, will be supported by AAA as well as IFC and MIGA activities. WBI will support learning and capacity-building under pillars 1, 3 and 5. Over the CPS period, IBRD lending will reach up to $1.5 billion per annum, while IFC investments are expected to grow from $400 million to about $700 million per year and MIGA guarantees to remain at about $50 million in coverage per year.

What results do we aim to achieve over the CPS period?

The CPS results matrix (Annex 1) outlines the results that the Bank Group hopes to achieve over the CPS period. Outputs are intended to reflect actions or processes that are substan­ tially in the control of Bank staff; outcomes require additional inputs (including but not limited to GoC action) and are beyond the direct control of Bank staff, though Bank work is intended to contribute to their realization. Of the CPS outcomes, the Country Team places the greatest priority on the following ten:

• Enhanced Chinese engagement in global and regional economic institutions; • Better approaches to improving rural public services; • An extended rural health insurance scheme (NCMS), with fair financing; • Reductions in the discriminatory aspects of urban social policy; • Improved metropolitan area management, especially for service delivery; • Improved land and water resource management, including improved water pricing; • A reduction in energy intensity by 20% by 2010; • Expanded commercially-sustainable formal bank lending to SMEs; • Simplification of cumbersome or anti-competitive business regulations; and • A new intergovernment fiscal transfer law that improves equalization impacts.

In addition, the Bank Group aspires to improve its poverty work with greater access to household data, blend IBRD resources with central government transfers to enable contin­ ued lending to poorer regions, explore the possibilities of using local currency as well as sub-national financing without a sovereign guarantee to support innovation, accelerate the The initial growth of investment activities in lagging provinces, and help develop private sector solu­ tions to environmental problems. basis for Bank Group The Bank Group's vision of its work in China activities in The Bank Group's vision is to be a client-driven knowledge institution that uses investment China must and other operations to pilot reforms, support institutional development, and promote best beGoC practice in the private sector. This CPS aims to focus on a few areas of engagement that demand build on the Bank Group's global knowledge base while maximizing the creation and dissemination of knowledge of China's development processes in- and outside China. In implementing the CPS, the Bank aims to:

• Undertake annual lending and AAA consultations with the GoC to assess CPS imple- mentation progress and refine areas of Bank Group engagement; • Pilot integrated reform programs in a few regions, provinces or municipalities; • Expand knowledge partnerships with key partners inside China; • Increasingly emphasize M&E in its lending and AAA activities to determine what works and to disseminate this knowledge inside and outside China; and THE BANK GROUP STRATEGY

• Leverage scarce Bank resources with bilateral grant resources as well as China's own budgetary resources to maximize impact across China.

The Bank Group has the greatest impact in areas where experienced staff work with GoC counterparts on selected client priorities persistently and sequentially, often over many years. Thus, changes in the Group's strategy over the CPS period will be incremental. The five themes around which the CPS is organized reflect the key challenges that China is confronting and must handle well to continue its "peaceful development". Bank Group interventions will respond to priorities within the themes and be selected on the basis of client demand, the Bank's comparative advantage, expected outcomes (especially innova­ tion), scalability, and cross-sectoral synergies.

Box 3: Why is China a client of the World Bank Group?

The Bank Group provides ideas, innovati01is, and knowledge that China values The GoC values the Bank Group's work in China for the ideas, innovations and knowl­ edge that it brings. It sees the multilateral Bank Group as a neutral, disinterested partner that can be trusted to act in China's best interests, and is strongly interested in learning from the Group's international experience. Bank Group activities build on a long-term partnership based on trust, shared commitment, and pragmatic cooperation that aim to develop and implement sustainable solutions tailored to pressing development prob­ lems. Though modest in scale, Bank Group activities often achieve large impacts, helping to scale-up policy and institutional reform, technological innovation, and improved project management. Under the FY03-05 CAS, for example, the Bank Group contributed to the GoC's stronger focus on high-quality poverty analysis; financial sector reform, including interest rate reform and IFC issuance of a renminbi-denominated "Panda" bond; and greater GoC awareness of resource scarcity and environmental challenges as well as approaches to managing them.

IBRD borrowing While the GoC can access international capital markets at a similar or lower interest rate than IBRD charges, it remains interested in new IBRD borrowing because it values the non-financial services that IBRD provides as part of its loan package and that are not readily available from the private sector. In addition, IBRD typically makes an open­ ended commitment to remain involved in the problem until it is satisfactorily resolved, at a cost that is limited to the IBRD charges on the associated financing. Even if the GoC sees value in IBRD borrowing, why should IBRD continue to lend? First, China remains eligible for IBRD lending, and there is no reason to treat China differently from other eligible members of the Bank. Second, IBRD lending to China brings clear benefits to the Bank and its other members. In financial terms, IBRD lending to China contributes to the Bank's income and so helps to finance its concessional lend­ ing. Although IBRD lending involves small amounts relevant to China, its development impact can be large, due to the spillover benefits of demonstration projects (in poverty reduction, financial sector reform, and natural resource management) which benefit not only China, but also East Asia and the world. Finally, Bank learning from its experience in China can be shared with other Bank members that face challenges similar to China's and are inspired by China's success.

(continued on next page) 17 •• COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Box 3 (continued)

IFC investments To sustain long-term growth, many Chinese enterprises need help to upgrade their cor­ porate governance, environmental and social practices. Chinese private companies work with IFC because they value IFC's services in these areas-services that are most effective when delivered in conjunction with IFC financing. To help Chinese private companies adopt international norms, IFC interventions include significant TA, delivered alone or in combination with financing, mainly through its Private Enterprise Partnership for China (PEP China). As a trusted partner of the GoC and the private sector, IFC also plays a unique role in piloting initiatives that lead to further economic opening and liberaliza­ tion, as demonstrated in the banking sector and bond markets. Interventions focus on completing standard-setting model transactions for private sector investments, with a view to promoting innovation, creating demonstration effects, and improving interna­ tional competitiveness.

MIGA guarantees MIGA complements existing insurance capacity (mostly bilateral political risk providers supporting underlying bilateral trade relationships) and helps attract FDI by covering non-commercial risk associated with projects responding to China's developmental pri­ orities, particularly in infrastructure. It also helps Chinese companies, including SMEs, to invest overseas and facilitates new investment to underdeveloped regions through its guarantees and TA. In addition, MIGA provides mediation support to clients when invest­ ment disputes occur.

WBI activities WBI complements the rest of the Bank Group through its learning and capacity-building programs, which make international best practices, experience and knowledge available to Chinese audiences as well as Chinese successes, experiences and knowledge available to other developing countries (e.g. through the May 2004 Shanghai Conference on Pov­ erty Alleviation).

Pillar 1: Integrating China into the world economy

In 1978, China accounted for less than 1% of the world economy and its foreign trade was worth $20 billion; today, it accounts for 4% and its foreign trade is worth $1 ,155 billion, the Economic third largest national total in the world. This growth has occurred in the context of a broader globalization strategic GoC goal to facilitate China's "peaceful development"---embracing economic glo­ balization while opening up domestic markets and tapping into international ones. Given its benefits emerging position, China stands to benefit from a more open rule-based global economic China system as well as from the exchange of global development ideas, knowledge and experi­ ence. Yet it must also manage the challenges resulting from its success, including the con­ cerns of some nations over its growing global influence and demand for natural resources. In this context, the Bank Group will support China's efforts to reduce barriers to trade and investment and deepen its participation in multilateral institutions, global development ini­ tiatives, and cross-border learning.

• • is THE BANK GROUP STRATEGY

Increasing Chinese participation in multilateral economic institutions

China's increasing integration has been a key driver of its economic success, but it has also increased China's impact on global trade, capital, and commodity markets as well as its interdependence with the global economic system. Sound management of the global economy will require China to have a good understanding of other large economies and other countries to have a good understanding of China's economy. In addition, China's economic management authorities recognize the importance of China's participation in multilateral economic institutions, underpinned by strong research and strengthened ana­ lytical capacity in the government entities that support them. The Bank Group will help to expand understanding and capacities in these areas through:

• Generating accurate information on China's economic and social development and impacts on the world economy, including through preparing a new CEM on managing a resource-scarce economy which will, inter alia, focus on China's indus­ trial policy; land, water and energy policies; pricing; taxation; and recycling; • Generating analytical work on trade issues, to inform China's participation in the WTO, the Doha Round and subsequent rounds of trade talks, and other multilateral and regional trade initiatives; and • Collaborating more closely with Chinese research partners, to gain from their local knowledge, build their analytical capacity, and support China's participation in international institutions.

Reducing barriers to trade and investment

China has a strong interest in strengthening the multilateral trading system. Its greatest economic gains have resulted from its access to global markets; intra-regional opportuni­ ties have been significantly less important. Given that China's market share is rising and that its exports are sensitive labor-intensive products vulnerable to contingent protection and trade disputes, a rules-based system serves to promote growth in trade that benefits both China and its trading partners. Helping to establish such a system while simulta­ neously addressing the remaining barriers to inward and outward trade and investment will enable China to reap the full benefits of increased global integration. To do this well, China needs to complete a rigorous analysis of the costs, benefits, and trade-offs associ­ ated with the various policy options open to it. The Bank Group will help China in this area through:

• Examining the rationale and roadmap for liberalizing the capital account; • Assessing and clarifying options for selectively lowering trade and investment barriers, including their probable impacts on poverty; • Implementing trade facilitation measures, particularly in disadvantaged provinces; • Supporting China's "go-global" efforts with the Bank Group's own South-South research, advisory support, and project development; and • Helping Chinese companies seeking to invest sustainably in other emerging markets and supporting investments by Southern multinationals in China (IFC and MIGA). COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Participating in global development initiatives and cross-border learning

In parallel with its increasing integration into the global economy, China is also playing an increasing role in development activities as it seeks to disseminate its own successes, learn from the innovative practices of other countries, and contribute to global development initiatives. Growing development assistance to Africa, contributions to relief efforts follow­ ing the 2004 tsunami and the 2005 India-Pakistan earthquake, and a substantial pledge at the January 2006 avian flu conference testify to China's growing development role at the global level. As China increases its official development assistance (ODA) over time, it is in the interest of China and the world for China to enter into and influence international structures governing ODA, such as the OECD's Development Assistance Committee and various multilateral donor agencies. Priority areas where the Bank Group can assist China's involvement in overseas development assistance include:

• Increasing China's participation in learning exchanges and disseminating its de­ velopment experiences to other developing countries; • Facilitating China's involvement in global and regional initiatives, such as de­ veloping the Greater Mekong Subregion and managing the threat posed by the avian flu; and • Working with Exim Bank to define cofinancing policies for its overseas concessional loans.

Pillar 2: Reducing poverty, inequality, social exclusion

China dramatically reduced poverty after 1980, but pockets of extreme poverty remain and income inequality has risen to levels that are high by international norms. While some increase in inequality is to be expected with reforms that introduce market-based rewards­ Fighting as some people make more rapid and successful transitions than others-it can be a source poverty of social instability and lead to inequality in access to health care and education, and consequently declines in well-being for the excluded. If inequality stems from poor health remains a care, limited education, or other factors creating unequal opportunities to participate in priority growth, it can also reduce efficiency and limit growth to less than economic potential. To help address these tendencies, Bank Group activities will support GoC efforts to protect the livelihoods of the rural and urban poor that have a limited capacity to participate in China's growth while also building the capacities and opportunities for those that can participate.

Eliminating absolute poverty

China's remaining poor are increasingly concentrated among those with limited ability to participate in China's growth-the elderly, disabled, geographically remote, and small eth­ nic minorities. For these people, the GoC's rural poverty program needs to be better tar­ geted, so that more resources actually reach them. Poor villages have been designated and funds earmarked, but relatively limited funding directly reaches poor households, as most funding is absorbed at village- or county-level poverty projects. In addition, social assistance programs for the poor need to be expanded. Since 93% of the poor are rural, expanding rural health insurance and social protection programs is key. While the entire health service THE BANK GROUP STRATEGY

Table 6: Availability of health care ( 1980-2004) •I Resour~per1,000people 1900 1990 ·~ , , .. ?CXJO 2C!l:4~1;.;,,._-:,"1' Hospital beds Urban 4.70 4.18 3.49 1.64 Rural 0.95 0.81 0.80 0.76 Health personnel Urban 8.03 6.59 5.1 7 4.93 Rural 1.79 1.38 1.44 0.98* Source: China Statistical Yearbooks, 2005;* = 2003 delivery system needs reform, the rural poor suffer the most (see Table 6). Public health spending is largely focused on hospital subsidies and the urban health insurance scheme (which has annual revenues of about RMB900 per beneficiary). Moreover, the shift since 1980 towards private practice at the village and township levels, combined with the infor­ mational advantage of providers over patients, can lead providers to administer unnecessary but profitable care that results in financial calamity to their patients. The New Cooperative Medical Scheme (NCMS) for rural areas will help, but since proposed funding for the scheme is only RMB40 per person per annum (compared to average rural health spending of RMB274) , the scheme will either go bankrupt or leave households exposed to considerable financial risk. China's pension system also needs reform-premiums are high, risk pooling is inadequate, and governance structures are underdeveloped-and again the rural poor suffer the most, as most of the rural population is not covered by any formal pension program at all. In this context, the Bank Group can help protect the livelihoods of the remaining poor in rural and urban areas by:

• Piloting a community-driven approach to targeting poverty interventions on poor households, including in minority villages; • Identifying options for containing health service delivery costs (e.g. by shifting from fee-for-service towards a prospective or capitation payment system); • Identifying options for increasing funding to NCMS, so it covers basic care and some high-cost inpatient risks, with subsidies for the poorest users (e.g. through expansion of the Medical Assistance scheme); • Identifying possible parameters for a rural social safety net and pension sys­ tem and building policy evaluation and program implementation capacity; • Catalyzing private sector investment in lagging regions (IFC and MIGA); and • Supporting the International Poverty Reduction Center in China (IPRCC).

Building the capacities of the poor

Poverty reduction will also occur through building the capacities of the poor and creating more opportunities for them to participate in China's growth. Better education and training will be key, as they will help raise productivity and transform China from a lower to an upper middle-income country. While quality improvements are needed across all levels of education, the emphasis now should be on providing greater access to education to disad­ vantaged groups (the poor, minorities, migrants, transitioning workers, and people in re­ mote areas), including at secondary and tertiary levels (see Table 7 for national gross enrollment rates). The Bank Group will help in these areas by:

21 •• COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

• Developing policy and implementation mechanisms for financing China's free 9-year compulsory education program and for providing poor students with finan­ cial aid for higher education; • Piloting ways to deliver skills training integrated with employment opportuni­ ties and including adequate monitoring and evaluation of outcomes; and • Building capacity for outgrower (small farmer) development and product trace­ ability in agribusiness and forestry projects (IFC).

Expanding economic opportunities for the rural poor

For people living in rural areas and small towns, it is also important to expand economic opportunities. Given China's water scarcity and limited arable land, increasing agricultural incomes will depend on improving agricultural productivity and diversifying into more profitable but also more water- and land-efficient crops. Work also needs to be done to improve the rural business climate and increase opportunities for off-farm employment. Investments aiming to create an effective intercity transportation and communications sys­ tem are key to combining local markets into a national market, encouraging rural produc­ tion for the market, and spreading the benefits of city-led growth. While the GoC has invested heavily in infrastructure since 1980, all modes of surface transportation (1.87 mil­ lion km of roads, 75,000 km of railway, and 122,000 km of waterway) remain well below need, while only one in two people has a telephone and one in ten has internet access. The Bank Group can help GoC expand economic opportunities for the rural poor by:

• Demonstrating the value of scaled-up commercialized agriculture, higher-value crops and animal products, and the use of farmers associations, while also en­ couraging research and private sector investment in agriculture; • Upgrading transport infrastructure, particularly rural roads but also expressways, railroads and waterways linking inland provinces to the dynamic coast, so that trans­ portation benefits accrue to the poor, while also improving network management and traffic safety; • Expanding rural connectivity and information systems, improving the environ­ ment for information and communications technology (ICY), and leveraging ICT to enhance service delivery and SME competitiveness; and • Supporting microf'mance and rural credit cooperatives (see Pillar 4).

Facilitating the migration of surplus rural labor to the urban areas

China's urban population has expanded at historically unprecedented rates, from about 172 million people in 1978 to 543 million by 2004 (see Table 8), with an increase of 105 million

Table 7: Key education statistics China UpperMIC OECO ------·------~------·------Indicator : 1995 · . 2IID 2004 average average

Primary gross enrollment rate (%) 107.0 105.0 107.0 106.0 101.0 Secondary gross enrollment rate (%) 78.0 89.0 94.0 85.0 107.0 Tertiary gross enrollment rate (%) 7.0 13.0 19.0 38.0 69.0 GoC spending on education (% GDP) 2.6 2.8 3.3 4.6 5.7

Source: China Education Statistical and Science and Technology Yearbooks, 2004 THE BANK GROUP STRATEGY

in the last five years alone. At the same time, industry has Table 8: China' s urbanization continued to move to the cities to reap the benefits of ag­ J Population (m) glomeration, which include economies of scale and scope, l,Y.eaL, Total Urban % linkage effects, gains from industrial diversity, access to deep 1978 963 172 18 pools of labor with varied skills, and innovation resulting 1985 1,059 251 24 from the clustering of firms and researchers. With surplus 1990 1,1 43 302 26 rural labor estimated still to exceed 100 million, the GoC 1995 1,211 352 29 recognizes that, for many rural people, the long-term means 2000 1,267 459 36 to reducing poverty will involve moving to the cities. While 2004 1,300 543 42 urban job creation is expected to remain strong, particularly 2010 1,366 628 47 in the warmer densely-populated cities on the coast and 2020 1,449 797 55 along the Yangtze river (see Table 9), absorbing migrants Source: Yvonne Sin, World Bank, 2004 into the urban areas will bring challenges in expanding hous­ ing, health care, and education, while avoiding diseconomies of scale. How China shapes its urbanization will determine much of the productivity and resource intensity of its economy. Besides supporting investments in human capital, the Bank Group can help by:

• Piloting programs that provide skills training as well as information and sup­ port in job searching to migrants; • Identifying options for reforming aspects of urban social policy that limit the access of rural migrants to benefits in the urban areas; • Improving the quality of urban management and infrastructure as well as the efficiency of urban markets to attract and retain businesses and jobs; and • Supporting private enterprise growth in cities as the main source of sustain­ able job creation (IFC).

Pillar 3: Managing resource scarcity and environmental challenges

The GoC is increasingly concerned about resource use patterns that are unsustainable, involving inefficiencies that further deplete supply, erode resource quality, and generate pollution. While resource development and improved technologies may bring some relief, better resource management is essential to sustainable development. Because China is at the beginning of its urbanization and motorization, it is still building the infrastructure that will determine the future level and spatial distribution of its resource use: prudent choices today would help to manage demand and minimize waste in the future. To help China to manage its resources, Bank Group activities under this theme will help to mainstream environmental concerns into the development process; create a resource-saving society through better regulation, pricing and taxation of natural resources; and meet China's commitments under international environmen- tal conventions. Table 9: Shares in the economy(%, 2003) ·- Province GDP Export FOi Building a resource-efficient society Shanghai 5.3 10.5 10.2 Jiangsu 10.6 13.6 19.7 As China's heavy industries continue to grow and urban Guangdong 11.6 35.1 14.6 consumers-increasing in number and wealth-expand their Total 27.6 59.1 44.6 use of appliances and motor vehicles, China will face grow- Source: China Statistical Yearbook, 2004 COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Table 1o· W ater use by sector ing demands for water and energy (see Table 10 for growth 1900 2004 in water use). These demands will be increasingly difficult bm 3 % bm 3 % to meet. China has limited supplies of water (about 1/ 4 the global average per capita) and of oil and gas. For growth to Total 444.0 558 remain robust, China needs to manage these limited re­ Production 416.0 94 .0 482 86 .0 Agricultural 370.0 83 .0 359 64.0 sources well. This will involve both improving the efficiency Industrial 46.0 10.0 123 22.0 of supplying water and energy and reducing the intensity of Domestic 28.0 6.0 65 10.0 their use through aggressively pursuing changes in technol­ Urban 6.8 1.5 28* 5.2* ogy, industry composition, resource pricing, and conserva­ Rural 21.3 4.8 29* 5.3* tion incentives to restrain consumption (see Table 11 for Source: World Bank, 2006. Note: • 2000 data energy intensity in selected industries). It will also involve developing a "circular" (recycling) economy and improving the management of natural resources such as land, grasslands, forests, and water resources, including by involving affected communities. Such measures will help to reduce the impact of China's growth on its environment. Although China is still a less developed country with a small environmental footprint per capita, its overall environmental impacts are already large. China's reliance on coal to meet 70% of its energy needs has made it the world's second largest emitter of C0 ; in addition, 2 Good two out of three cities in China fail to meet acceptable air quality standards, contributing to illness and premature death. The Bank Group can help China to save water and energy choices resources, restrain consumption, and minimize environmental impacts by: today help to manage • Promoting more efficient water and energy supply systems, including by: • Encouraging the development and use of clean and renewable energy tech­ resource nologies Cbiogas, wind, and photovoltaic energy (with GEF funding)); demands • Demonstrating more efficient ways of supplying and using coal, including and clean coal technologies, since much future supply will come from plants fueled by minimize China's coal reserves even if the GoC dramatically expands renewable energy and meets its ambitious targets for hydro and nuclear power; waste in the • Strengthening the commercial management of energy supply companies future by helping them to divest non-core assets and the GoC to reduce monopolistic practices and clarify regulatory frameworks (esp. for oil and gas); • Creating more competitive electrical power markets, starting with generation and gradually extending into wholesale and retail; • Creating more efficient water markets, inter alia by piloting bulk water mar­ kets and expanding volumetric water pricing; • Expanding urban wastewater collection and treatment facilities while up­ grading utility management and performance, so that affected cities expand the reuse of water (currently only 30% of water is reused in China, compared to 75% in other industrialized countries); and • Expanding the role of the private sector in supplying energy and water.

Table 1 1: Energy use per unit of output: China vs. 1nternat1onal best practice Nitrogen Electric Coal-fired Heavy Coal-fired Steel Cement Fertilizer Paper Motors Boilers Trucks Power

Best practice 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 China good practice 1.21 1.45 1.31 2.20 1.11 1.15 2.25 1.19

Source: NDRC, Mid- to Long-Term Energy Conservation Plan, 2004

• • 24 THE BANK GROUP STRATEGY

• Identifying policy options for reducing consumption, including by: • Promoting the liberalization of water, oil, gas, and electricity markets as well as the gradual establishment of pricing mechanisms that reflect mar­ ket supply and demand and the scarcity of resources (over 50% of energy efficiency gains in the 1980s-90s resulted from price rises that encouraged indus­ tries and consumers to buy resource-efficient products); • Identifying stricter resource-use standards for cars, buildings, appliances, and industrial processes, and improving enforcement, to moderate growth in demand and create incentives for firms to upgrade capabilities; • Identifying ways to reduce water use in agriculture, e.g., by shifting towards less water-intensive crops and improving the productivity of irrigation; • Promoting urbanization and transportation options, including public trans­ portation, that reduce the movement of goods and services and shift it to the most efficient modes, to reduce pollution and fuel consumption; and • Identifying private financing for renewable, energy efficiency projects. • Mitigating the environmental impacts of human activities, including by: • Piloting strategic environmental assessments in selected cities and provinces, to integrate environmental concerns into development activities; • Piloting improved approaches to natural resource management, by involv­ ing communities and promoting socially-responsible private investment, to contain resource degradation and resulting negative externalities; and • Promoting good corporate practices in environmental management.

Improving land administration and management Reducing China, unlike any other country, distinguishes firmly between rural and urban land use rights, markets, and administration. Urban land, owned by the state, enjoys a more com­ energy plete set of use rights than rural land, owned by collectives. Local governments have exclu­ intensity is sive power to acquire mral land for public or private development purposes. Moreover, atop land acquisition by law results in compensation payment based on agricultural output value priority rather than actual real estate value, which is often much greater. Thus collective landowners usually do not benefit from the higher value of land when it enters urban markets or is allocated for development use. Administratively, local governments decide on land to be acquired and compensation to be paid with relatively little oversight. This frequently results in imprudent local government reliance on revenue from land conversion to supplement their budgets as well as inefficient urban growth patterns (as cheap land fuels expansion rather than higher density). The GoC is taking steps to address these issues. The national land law is under revision, land acquisition procedures and administrative oversight are to be strengthened, and innovative measures (e.g., annuities, insurance schemes, and local social security systems) are being tested to protect the interests of farmers whose land is acquired. The Bank is helping to address these challenging issues by:

• Outlining options for clarifying landholder rights, land acquisition and com­ pensation practices, and supporting alternative approaches to the requisition of rural land for urban public and private users; • Helping to enhance the role of land as a stable revenue source (e.g., by introduc­ ing a property tax), thus lessening incentives for farmland conversion; • Helping to strengthen public accountability by establishing administrative over­ sight procedures and by improving information disclosure practices. COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Box 4: How China can manage vehicle fuel use and improve the environment

By using proven technologies and policies, the GoC can dramatically lower future fuel use and green-house gas emissions without compromising its automative industrial de­ velopment objectives (in China there are just 9 cars per 1,000 people; in the U.S. 700). The figure below shows alternative futures: The Road Ahead scenario assumes current fuel prices and motorization growth rates, with car numbers reaching 145 million, utilization remaining at about 12,500 km per year, and conventional gas as the fuel choice for all but 1-2% of vehicles by 2020. The Oil Saved scenario assumes 10% fewer cars in 2020 than the Fuel use and greenhouse gas emissions: "Road Ahead", fuel prices at Euro­ alternative possible futures (2005 = 100) pean levels, car utilization of about 1000 10,200 km per year, and high use of 900 hybrid electric, compressed natural 800 gas, and small electric vehicles (50%, 700 200/o, and 10% respectively by 2020). 600 The City Saved scenario adds 500 high-density city development, bet­ 400 ter public transportation, and high 300 parking and road charges on ve­ 200 hicles used in cities, further reduc­ 100 ing vehicle use to 8,800 km per year. 0 (Source. China Motorization Trends, 2005 2020 ~~2020 2020 ~ Ng and Schipper, 2005). Actual Road Ahead Oil Saved Cities Saved

• Fuel GHG

Observing international environmental conventions

While the GoC has compelling domestic reasons to address its resource scarcity and envi­ ronmental challenges, it has also made commitments under international environmental conventions (on climate change, ozone-depleting substances (ODS), persistant organic pol­ lutants (POPs), biodiversity, and international seas). The Bank Group can help China to meet its environmental commitments by:

• Demonstrating the use of coal-bed methane and carbon finance transactions, and scaling them up; • Eliminating ODS and piloting phaseout projects for mirex, chlordane, and poly- chlorinated biphenyls (PCBs); • Formulating a strategy to protect biodiversity; • Showing how pollution in coastal areas can be effectively reduced; and • Promoting sustainable cultural and eco-tourism by developing model sites and increasing the number of heritage sites with environmental protection measures in place. THE BANK GROUP STRATEGY

Box 5: Addressing climate change

With a rapidly growing coal-dependent economy, China has a critical role to play in global efforts to address climate change. China is already the second largest emitter of C0 in the world (although per capita emissions are still just 1/4 of the average devel­ 2 oped country level), and it could surpass the U.S., the current leader, by 2030. The main cause is coal consumption, which causes 80% of China's green-house gas (GHG) emis­ sions as well as widespread air pollution and acid rain. With its long coastline and vast expanses of arid and semi-arid land, China is also vulnerable to the adverse impacts of climate change, which could intensify water shortages in northern China, increase the incidence of extreme temperature events and consequent flooding and droughts, and reduce the yields of major crops. The sheer size and speed of China's economic growth suggest that China cannot follow traditional growth patterns and must adopt proactive energy policies to avoid potentially large risks of elevated health and environmental damage and energy supply disruptions which could undermine China's long-term goal of becoming a prosperous and harmonious society. China has a good understanding of the challenge of addressing climate change. The Goe has made commendable efforts to reform the energy sector and support the adop­ tion of energy-efficient and renewable energy technologies. For the 11th FYP, China has pledged to improve energy efficiency by 20% and meet 10% of its energy needs from renewables by 2020. Yet many of the GoC's interventions in the energy sector have been reactive and incremental, due to concerns about supply disruptions and high financial costs. With the goal of quadrupling the economy between 2000 and 2020, China still has many opportunities to address climate change through vigorously adopting low-carbon energy options for new investment over the next 15 years, during which two-thirds of the 2020 economy will be built. As the world's largest developing economy, with substantial and growing market power, China could become a world leader in using advanced thermal and large-scale renewable energy technologies; setting energy efficiency stan­ dards for buildings, manufacturing, and automobiles; and creating an efficient urban and public transportation network. Because China will continue to rely on coal in the near term, the GoC also needs to promote low-impact coal mining and utilization technologies and accelerate afforestation and reforestation programs to support carbon sequestration. A proactive policy response of this kind would generate large national benefits by im­ proving ambient air quality, reducing acid deposition, and mitigating climate change damage to human health and the environment. The Bank Group, in close partnership with the GoC, is engaged in a range of areas directly relevant to climate change. Reducing China's reliance on coal has been a major theme of the Group's policy dialogue and has been supported by Bank, IFC and GEF lending and AAA on improving energy efficiency, increasing the use of natural gas, and scaling-up the renewable energy market. The Bank has also helped to formulate the recently-passed China Renewable Energy Law, assess opportunities for participation in the Clean Development Mechanism (CDM) market, design the policy and institutional framework for CDM market development, and establish and capitalize the Clean Devel­ opment Fund. In January 2006, the Bank and the GoC identified several areas for deep­ ening their partnership on climate change under the CPS, including strengthening policy making and institutional capacity; strengthening the enabling environment for CDM projects; supporting research, transfer and application of low-carbon technologies; and facilitating knowledge transfer and research on climate change impacts and adaptation technologies. Deepening this partnership is a key objective of this CPS.

27 • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Pillar 4: Financing sustained and efficient growth

While China has a good investment climate relative to other developing countries, this is not true for its financial system, which provides poor services to the dynamic private sector that is the main engine of growth and job creation. SOEs account for only a fifth of industrial GDP but absorb two-thirds of credit, and it is surprising that China needs to invest 45% of GDP to grow at its current rate. If the financial sector did a better job of allocating invest­ ment to high return activities, China could grow at the same rate with less investment, while also experiencing lower levels of NPL.s.

Expanding access to finance

Meeting the demand for financial services efficiently, including in rural areas, involves ensur­ ing the long-run financial stability of service providers in a fair and competitive market. In 2004, the GoC removed the upper limit on loan interest rates, enabling financial markets for the first time accurately to price financial risks. Reform efforts now aim to expand access to commercially sustainable financial services so that, over time, non-commercial lending is eliminated except where socially justified. This will require promoting competition within the banking sector, both from healthier domestic banks and new domestic and foreign en­ trants, through leveraging capital raising and privatization to improve bank governance and Competition resolving unviable banks that stay in business by underpricing risks or overbidding for depos­ should help its, thus competing unfairly with sounder banks. It will also require commercializing SCBs to expand through divesting non-core assets, restructuring bad debt, and introducing new ownership and governance arrangements. Recent progress has included attracting foreign strategic in­ access to vestors that bring new capital and management practices, including through public stock financial offerings (see Table 12). Increased private participation, if done well, could reduce the po­ services tential for further state-financed recapitalizations and improve the incentives for bank staff to serve client needs (today, most firms in China have difficulty obtaining bank loans due to high costs, complex procedures, restrictive collateral requirements, and demanding terms and conditions; lack of a credit rating system aggravates these problems). In this area, the GoC could lever its ownership interest in the SCBs and central government SOEs that are troubled debtors to develop a framework for restructuring the debtors, thus helping to elimi­ nate pressure for non-commercial lending by SCBs. The Bank Group will continue its large research program focused on these issues, and in addition is helping to expand access to financial services with TA, lending and IFC investments, by:

• Piloting commercially sustainable formal bank lending to MSEs; • Piloting reforms in rural credit cooperatives through model transactions; • Identifying ways to expand rural access to f"'tnancial services; • Improving the internal governance and external regulation of financial insti- tutions (banks, collective investments, insurers, and pension funds); • Providing TA for IFC partner financial institutions in the lagging provinces; • Supporting development of private financial institutions; • Catalyzing development of the private equity and venture capital industry; • Supporting development of the distressed assets market so assets can quickly be returned to productive use and enterprises regain access to finance. THE BANK GROUP STRATEGY

Developing capital markets Table 12· Foreign partic1pat1on 1n banking sector Type of participation 2002 Oct 2004 China also needs sound capital mar­ kets to diversify the financial system Representative offices 211 233 Commercial operations 180 204 and enable the economy better to Licensed for RMB business 45 105 withstand shocks. As the principal is­ Total assets ($b) 478 659 suer of debt securities, the GoC can Source: Bank for Intern ational Settlements and CBRC ensure efficiency in the government bond market by becoming a price- taker in the primary market, thus improving secondary market liquidity and helping to promote overall market development. As a sponsor, approver, and financier of infrastruc­ ture investments, it can help ensure that infrastructure in more developed cities and prov­ inces or that can generate revenues is increasingly financed on a non-concessionary basis in new project and enterprise finance markets. As an owner of financial intermediaries actively engaged in the markets, it can take further steps to improve the internal governance of these intermediaries. The Bank Group can help by:

• Articulating a regulatory framework for basic equity security, fixed-income (debt) security and derivatives markets; • Leveraging Bank investments to promote market development and strengthen f'tnancial institutions and mechanisms (e.g. through securitized transportation projects or the district financing vehicle in the Shanghai APL); • Strengthening non-banking private f'tnancial institutions; • Supporting development of the local currency bond market; and • Promoting securitization markets and piloting a secondary mortgage market to promote the availability of and control the risks in housing finance.

Managing systemic risks and maintaining financial stability

Work will also continue to strengthen the capacity of the PBoC to identify, assess, and mitigate systemic risks emanating from the financial system (see Table 14 for deposit liabili­ ties of financial institutions). This will involve helping to raise the bank's financial stability functions to international standards; improving the quality of the analysis and presentation of its Financial Stability Reports; and strengthening the capacity of its Conglomerates Divi­ sion. In addition, efforts will be made to improve the transmission of monetary policy and explore China's policy options with respect to such subjects as deposit insurance, financial sector taxation, pension systems man- agement, and (through FIAS) creditor rights protection. The Bank Group can Table 13 · Control of companies on Shanghai provide assistance by: stock exchange (2002) Control Number % • Helping to draft a Futures State-owned enterpri se 569 78 Law; Collective 22 3 • Supporting institutional devel- Private enterpri se 110 15 opment for secured transac- Social organization 8 tions, credit reporting, and Foreign enterprise 9 1 leasing, and systemic change Unclear 11 2 in rural credit cooperatives TOTAL 729 100 Source: China Outlook, Oxford Analytica, 2005 COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Table 14 Deposit liabilities of financial and non-banking private fi­ .inst1tut1ons (RMB tr) . ..• nancial institutions through 1 Deposits ,. :, .,., .,.· ~' ,..,, ,,,~ •.;r,.?1t2;,." Mid-2005 .,,~~,,'?liil:l!I model transactions; ~~·o.,.DttS#f/it.t'~~ ,,,,.,~~k.vA•'~*'"'"~~-ill&,~~u.J: .... ~¥irt~,...rii/,it ~~- • Strengthening bank capacities Enterprise deposits 9.6 in risk management and PBoC Urban and rural savings 13.9 capacity to assess and mitigate All other deposits 4.8 TOTAL 28.3 systemic risks emanating from the financial system. Source: PBoC

Pillar 5: Improving public and market institutions

China's recent growth has been based on high investment and labor mobilization, but over time sustaining growth will depend on increasing firm-level competitiveness. To be com­ petitive in the long run, Chinese firms need to develop sophisticated products, know their customers, exploit opportunities for forward integration, and strengthen interfirm coopera­ tion. Many Chinese firms have already learned to behave in these ways, and global Chinese brands, such as Haier and Lenovo, are now emerging. The GoC can accelerate this process by improving corporate governance and creating a more competitive business environment. This will help firms to hold down costs, target attractive consumers, and develop differenti­ ated products that have a unique value, are globally competitive, and can support higher prices and higher wages. In addition to helping the private sector succeed, the GoC needs to continue with its own administrative reforms to complete the transition to a market economy. In particular, work should continue on redefining the state's role in service delivery, which is still mainly the responsibility of public service units (PSUs), by deciding where the state should be involved in service delivery; in what manner; and at what level(s) of government. It should also strengthen budget formulation, execution, and reporting-against an improved M&E framework-and achieve better alignment between revenue assignments and fiscal respon­ sibilities at sub-national levels of government, with a view to improving the equity and efficiency of public funding. The Bank is active in each of these areas.

Improving firm competitiveness

The GoC recognizes that institutionalizing innovation to help firms develop new technolo­ gies a11d raise productivity is key to China's continued growth. In 2002, it created a 'national inno~ation system' that aims to link reforms with technological development, but incentives are still not right and few innovations are being commercialized. Creating better incentives will involve improving corporate governance. Many restructured SOEs still have inefficient management practices, are operating at a loss, or depend on protection of a local govern­ ment to survive. In addition, many newer firms fail to evolve from their start-up structures, with the result that the failure rate is high (the average private firm closes seven years after incorporation). Moreover, many barriers continue to characterize the business environment in parts of China. These include the maintenance of 'restricted' sectors; burdensome licens­ ing, inspections, inland customs, and land-use approval procedures; incomplete or non­ public regulatory systems; unauthorized and discretionary fees and fines; unequal tax, financing, land use, and trading policies for SOEs (which domirlate upstream' industries) and private firms (which are active downstream); elevated transportation and logistics costs (often due to entry barriers); and impediments to nationwide distribution networks. The net THE BANK GROUP STRATEGY result is that China is not enjoying the productivity gains that could be realized from an integrated and competitive national market. The Bank Group can help to correct this situa­ tion by: TheGoC • Modeling SOE transformations that set transparency and efficiency standards; should do • Encouraging corporations to adopt international practices in corporate gover­ nance, disclosure, protection of public shareholders, and social responsibility (through everything IFC model transactions and support for Development Marketplace); it can to • Alleviating private sector management skills shortages with IFC's SME tool-kit, help the Global Business School Network, and Business Edge management training; private • Catalyzing reforms of business regulations that are unduly burdensome or that are needed to protect competition by prohibiting monopolization, restraints on sector, trade (including local rules, subsidies, import levies), and other practices that unrea­ without sonably limit competition; impeding • Strengthening the ability of investment promotion agencies to help lagging provinces attract greater FDI, with IFC's field-based facility extending its coverage competition beyond the original scope of Sichuan and Western China; and • Helping to improve innovation (e.g. by identifying appropriate incentives; support­ ing private ICT firms and the venture capital industry (IFC); and helping firms to harness technology transfers out of FDI more effectively (IFC and MIGA)).

Reforming public service units

China has more than one million PSUs, employing about 30 million people. Most PSUs were created as public service providers, and non-state provision of services remains limited. In the short term, therefore, improving service delivery in China requires improving PSU per­ formance. Past reforms have had positive results, but also created undesirable consequences: for example, PSUs have received greater fiscal autonomy and now raise almost half of their funding through fees, but autonomy has not necessarily brought improved performance or accountability; additional revenues are increasingly captured by personnel spending; and fees can be a barrier to access for the poor. In the longer term, it also requires redefining the state's role in service delivery. Generally speaking, the state should not be involved in directly providing private goods or services, which can best be left to the private sector, except to correct failures in equity and efficiency. But when service delivery involves public goods or there is a market failure requiring intervention, the GoC needs to decide whether it will regulate non-state production of the good or service, fund its provision, or undertake direct provision-and it needs to decide a division of labor between the various levels of government. The desirable scope and manner of intervention in service delivery cannot be determined in theory; it requires a careful review of market failure in the delivery of each service involved and the availability of public and private resources to address that failure. The Bank Group can help by:

• Identifying opportunities for divesting PSUs of the commercial production of private goods and services that can best be left to the market; • Helping to develop a broader variety of organizational forms for service pro­ viders, including 'delegated' PSUs (which are direct subordinates of a core govern­ ment department with no independent legal status or accounting system); 'devolved' PSUs (which have independent status); non-profit organizations, public sector SOEs, private SMEs, and large listed companies outside the public sector;

31 • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

• Piloting PSU reforms, including support to private investment, in different sec­ tors (e.g. health and education) and localities with a view to determining the appropriate mix of public and private delivery and improving accountability (e.g. through establishing and enforcing performance contracts, strengthening finan­ cial accountability, reforming the personnel and compensation system, and empower­ ing users).

Rationalizing intergovernmental fiscal relations

Improved PSU service delivery will also depend on improving China's intergovernmental fiscal system, which continues to be a barrier to equity in resource allocations, especially in lagging regions. By international norms, local government financing of services is high in China: for example, local authorities finance 55-60% of public health spending and 70% of education spending. Moreover, because the intergovernmental fiscal transfer system does not at present correct for the large geographical disparities in revenue-generating capacity and in addition the expenditure responsibilities of lower levels of government are not matched with revenue assignments or fiscal transfers, there is a highly unequal pattern of government spending on service delivery both across and within provinces. Rural areas suffer the most. Although rural China today receives more in public transfers than it pays in taxes (a recent reversal of millenia of history), many services are still seriously underfunded in the rural areas. Without more equalizing transfers, inequalities in access to services are likely to increase. Happily, the GoC now raises over 20% of GDP in revenues, so it has the fiscal capacity to rebalance the fiscal system: the key challenge is identifying and imple­ menting the appropriate institutional reforms. The Bank Group can help by:

• Identifying institutional reforms that will result in a more equitable and trans­ parent fiscal system, including steps to increase the clarity, equity and efficiency of functions and expenditure assignments across levels of government; expand the tax­ sharing system to the sub-provincial level; develop new sources of local revenues (such as a property tax, local personal income tax, or higher resource tax); and con­ solidate transfer programs with a view to improving their equalization impact; • Supporting a pilot comprehensive reform of sub-provincial finances; and • Strengthening mechanisms to monitor service delivery, including by identifying ways to make transfers conditional upon meeting agreed minimum standards of ser­ vice delivery in relevant sectors (e.g. compulsory 9-year education).

Improving budget performance

Budget management in China could be further strengthened by better aligning budget resources with government priorities, particularly at local levels (where an incremental budgeting process does not allow retrenchment from areas that are no longer priorities). The Bank Group can help by:

• Supporting revision of the Budget Law and expansion of the national treasury system to sub-provincial levels to increase transparency and accountability of pub­ lic finances, and • Articulating means to make broader use of performance indicators in M&E for budget units and piloting public service delivery surveys. Delivering the Bank Group program

he Bank Group's approach-how Bank Group instruments, including the ongoing portfolio, support the development agenda outlined in this CPS-reflects the find­ ings of the CASCR, Client Surveys, CPS consultations, and other assessments of the TBank's performance in China. The Bank Group will continue to ensure that assis­ tance to China is client-driven through regular dialogue with the GoC, annual AAA and lending consultations, and increased provision of quick-response policy notes. To further The Bank increase effectiveness, the Bank Group in this CPS aims to: Group's program • Articulate a more sharply defined set of results to guide Bank assistance. The will results matrix (Annex 1) outlines the targets and indicators to monitor Bank Group performance in implementing the CPS. Reflecting the Bank Group's business in China, continue to most outcomes consist of policy and institutional reforms that the Bank Group will emphasize support through a combination of demonstration projects or transactions and comple­ innovation mentary analytical work. Outcomes incorporate and build heavily on the ongoing port­ and ideas folio and long-term GoC-Bank Group partnerships. To enhance accountability, outputs as much as possible reflect actions or processes that are substantially in the control of Bank staff, while outcomes typically require additional inputs (including but not limited to GoC action), and so are beyond the direct control of Bank staff. It is important to recognize that the attribution of outcomes is a formidable problem for the Bank Group: even when the Group's advice is consistent with GoC policy and institutional outcomes, the causality is indirect and diffuse (e.g. passing through mid-level officials and other stakeholders), with China's own efforts and the advice and support of many other part­ ners, botl1 domestic and external, typically contributing more strongly to the outcomes. • Emphasize scaling-up successful innovations and ideas through: • Focusing on the demonstration aspects of the Bank Group's work in project selection (potentially enhanced by greater Bank-GoC upstream dialogue on the pipeline), implementation, and especially M&E (with more project resources de­ voted to assessing, distilling, and disseminating project lessons); • linking lending, non-lending and trust-funded interventions more effec­ tively. This will involve organizing lending and non-lending on a thematic basis, strategically integrating trust funds, encouraging greater cross-sectoral discussion within the Bank Group of progress toward CPS milestones, and ensuring that the lessons of demonstration projects and transactions are fully reflected in analytical work and dialogue on policy and institutional reforms; and • Continuing to explore innovative delivery mechanisms, such as focusing a package of interventions on a particular province or region, or taking a sector-wide approach in areas such as road transportation.

33 • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

• Encourage greater integration of IBRD, IFC, MIGA and WBI work around the results identified in the CPS, capitalizing on the comparative strengths of each insti­ tution, with IBRD focusing on strengthening the efficiency, sustainability, and equity with which public goods are provided and IFC and MIGA focusing on the private sector dimensions. In particular, IBRD will assist the GoC to complete the transition to a market economy, improve the welfare of the poor and vulnerable, and promote sus­ tainable resource-management practices while seeking to strengthen the GoC's institu­ tional capabilities to encourage a level playing field and competition in the private sector. IFC will respond to the structural changes accompanying China's transition through standard-setting model transactions for private sector investments, particularly in the financial and environmental sectors, and partnering with companies seeking to adopt international standards in corporate governance, environmental and social prac­ tices. In parallel, MIGA's guarantee activities will target infrastructure development through FDI, and support other areas where investors perceive significant non-commer­ cial risk, including support for FDI in lagging regions (also supported by TA) . Finally, WBI will further align its knowledge and learning services to complement IBRD, IFC and MIGA activities. • Facilitating continuing Bank Group engagement in poverty reduction and so­ cial sectors by actively working with GoC partners to operationalize new funding arrangements-including the blending of IBRD and central government transfers-that enable continued innovative IBRD lending in these sectors. Experience over the previ­ ous CAS period has shown that IBRD lending, when deployed strategically, brings a depth of international knowledge, experience and partnership that increases the effec­ tiveness of Bank contributions-and associated GoC financing-in ways difficult to achieve through analytical work alone. • Seeking to further simplify and streamline Bank project processes, including reducing project preparation times and the cost of doing businesses by further integrat­ ing Bank procedures with GoC procedures.

Business volume

Over the CPS period, IBRD lending is expected to range over $1.0-1.5 billion a year;1 IFC investments to grow from $400 million to about $700 million a year; and MIGA guarantees to remain at about $50 million in coverage a year. Lending is likely to involve the prepara­ Overall tion of 10 to 12 projects per annum, all on IBRD terms, supplemented in selected poverty, business social sector, and energy projects with GEF or other grant resources. Because China can access international capital markets,2 the GoC has indicated that lending will continue to volume will involve complex projects that have some policy or institution-building component with be stable potential for learning and scale-up and that also draw on IBRD technical expertise for which

1 After peaking at $3 billion per annum in the mid-1990s, lending fell to under $600 million in FY02, due to China's graduation from IDA. The currently proposed lending envelope of up to $1.5 billion per annum is sustainable in the medium term as it would keep IBRD exposure below the Single Borrower Limit of US$ 14.5 billion, assuming modest ( +/-10%) fluctuations in disbursements and exchange rates. Given the sensitivity of exposure projections to these assumptions, IBRD continues to monitor exposure developments closely. Additionally, the exposure management arrangements as agreed in February 2003 (see: "An Approach for Managing Lending and Exposure in Countries Close to the Concentration Limit: Specific Arrangements in the Case of China, R2003-0003 ", January 13, 2003) allow China to increase its exposure above the Single Borrower Limit conditional on the activation of a Bond Purchase Agreement,

• • 34 DELIVERING THE BANK GROUP PROGRAM there is no perfect private-sector substitute. A pipeline totaling $5.8 billion in new lending was agreed with MoF and NDRC during the most recent annual Bank-GoC lending program discussion (April 2006); as in the past, this program is subject to revision in light of evolving circumstances and will be formally reviewed with the GoC on an annual basis. To respect the $1.5 billion annual lending ceiling, funding will not be committed for all projects listed in Annex B3, IBRD, over FY06-08.

The portfolio

Bank lending: As of March 2006, the Bank held about $5 billion in undisbursed loans to China, of which $4.96 billion was on IBRD terms and $60 million on IDA terms (for projects approved before July 1999). The lending program has a number of unique characteristics, which partly explain unusual intercountry comparisons in areas such as sector concentra­ tion, portfolio performance, and lending preparation costs.

Rural development 31 35 29 28 18 13 838 Social sectors/TA 19 9 25 10 7 3 204 Energy 12 18 11 20 9 10 657 Urban environment 16 11 13 12 37 40 2,559 Transportation 16 20 19 27 29 34 2,151 o/w urban transport 3 2 3 3 7 6 400 Industry 6 7 3 3 0 0

Source: World Bank Business Warehouse

• Loan repayment obligations typically cascade down to a project's ultimate ben­ eficiaries, increasing ownership and portfolio performance but also limiting IBRD lend­ TheIBRD ing opportunities in support of direct poverty interventions (including basic social services), as beneficiaries have limited repayment capacities. portfolio • Most lending is specific investment lending (Shanghai Urban APL is the first and in China only programmatic loan, and China has had only one adjustment loan (a rural sector has some adjustment loan in FYSS)). unique features which would protect IBRD against the financial risks from any gross exposure above the Single Borrower Limit. Finally, if there were an unexpected deterioration in China's macro-financial or economic condi­ tions (e.g. a sharp escalation of the financial problems in the banking or SOE sector), the Bank would reassess the appropriateness of its ongoing lending program, both in terms of lending volume and the policy actions to be implemented, and take corrective action. 2 China is rated investment grade (as of April 2004, Moody's rated China AZ, Fitch A-, and S&P BBB+). In October 2004, the GoC issued two sovereign bonds, including a US dollar issue and a euro issue, with a value at settlement of about $1.78 billion at prevailing exchange rates. In 2005, spreads above LIBOR dropped to 50 basis points.

3s • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

• Infrastructure heavily dominates the lending portfolio (over FY00-05, about 40% of lending by volume was in urban water supply, wastewater treatment, and sanitation; 34% in highways, railways, and inland waterways, of which 6% was in urban transport; and 10% in electrical energy and renewables, see Table 15 on page 35), and most projects involve IBRD financing of $100 million or more. • Given the preponderance of infrastructure, about 80% of projects fall into cat­ egory A for environmental assessment (compared to 8% Bank-wide). The portfolio's large average loan size, concentration in category A projects, and loss of access to PHRD grants almost wholly explain the program's high average project preparation cost. Nonetheless, in terms of Bank budget spent per $1 million loaned, category A projects in China are prepared at about 50% the cost of category A projects in the rest of the Bank. • Despite losing access to concessional financing from IDA, about 13% of the FY00-05 portfolio by volume continued to support rural development, especially watershed, forest, and grassland management, and another 3% to support direct poverty and social programs. This represents a sharp drop in commitments (from a combined 44% by volume) compared to FY90-94, but the drop would have been greater still if DFID had not agreed to blend some of its grant resources with IBRD funds to reduce loan repay­ ment obligations.

IFC investments: IFC's committed portfolio in China, as of January 2006, stands at $1.125 billion. Manufacturing accounts for the bulk of IFC's total exposure (at 390/o) followed by financial markets (26%) and infrastructure (14%). Almost half of IFC's commitments are in the form of loans; equity accounts for 39%, while 12% is in the form of quasi-loan and quasi­ equity. The share of equity in China is higher than in IFC as a whole. This is consistent with IFC's value proposition in China to be the preferred partner for companies seeking to adopt international standards in the areas of corporate governance and environmental and social practices. Most of IFC's clients are domestic companies that need a lot of assistance to improve corporate practices. Thus, TA as a self standing service or indirectly through the PEP China is an integral part of IFC's portfolio supervision.

Table 16: Compos1t1on of IFC investments (by project number and volume ($m)) ~J' . FY85-00 · ·. . . FY91-95 FY96-00 FY01-05 ~~t ., •, L~~0fr . ._ . ,. . ~ ,,}'!i:~ · X-2!,u~~: , • f'.J9. ,, Yo.lyrr;i~ . No. y_o1u_n:~ . ., No. Volume Manufacturing and services 4 56 4 80 7 115 15 491 Agribusiness and forestry 1 10 4 19 6 126 Financial services 2 11 18 485 Funds 3 3 38 5 65 Chemicals 25 4 55 3 40 Infrastructure 5 36 9 211 Health and education 3 28 Information technology 4 24 Total 5 59 9 153 22 236 63 1,470

Source: World Bank Business Warehouse

MIGA guarantees: MIGA's portfolio in China consists of six contracts for a maximum liabil- ity of about $130 million, which is much lower than MIGA's country limit. Four contracts, DELIVERING THE BANK GROUP PROGRAM with a gross exposure of $123.2 million, were issued under the last CAS. About 89% of the portfolio is in the infrastructure sector (mainly with sub-sovereign commitments).

Piloting new approaches to IBRD lending

In cooperating with MoF and NDRC as well as interested provinces and municipalities, the Bank Group's China program will continue to seek opportunities to develop new approaches that respond to China's unique set of circumstances.

• IBRD will work with MoF and NDRC upstream to identify lending opportunities that support policy and institutional innovation. The nature of the expected inno­ vation in selected projects will be more explicitly detailed and a more rigorous M&E framework will be built around the expected innovation to ensure that lessons learned are fully captured and disseminated. • In selected cases, IBRD will work with provinces and municipalities to migrate away from discrete ring-fenced investment loans towards programmatic lend­ ing taking a program-wide approach (e.g. for developing Fujian's rural roads network), though lending amounts will be small initially. • The Bank will work with Chinese development partners to develop innovative approaches to financial intermediation (e.g. working with Shanghai to develop a new financing modality for metropolitan infrastructure or working with CDB to provide credit to micro- and small-scale enterprises). • IBRD and IFC will jointly explore opportunities directly to assist sub-national entities (local governments, public utilities, and the development banks that fund them) without sovereign guarantees and preferably in local currency. • IFC will seek ways to expand its capacity to reach domestic enterprises through local currency products. • IBRD will seek to soften repayment terms for poorer jurisdictions to enable the use of IBRD funds for poverty reduction and social projects in poorer provinces, includ­ ing possibly through pooling MoF budgetary funds with IBRD loans.

The Bank Group's knowledge program (AAA)

In January 2005, the Bank and the GoC announced that they would collaborate on more than 100 research programs over the next five years. The overall analytical program will draw on local expertise and be demand-driven. It will be grouped around the five thematic clusters of this CPS (themes which also have high priority in the GoC's 11th FYP) and balanced between activities that inform specific policy decisions and activities that address strategic development issues where the GoC believes that the Bank can make a contribu­ tion. The program will be delivered through persuasion-from policy notes, detailed opera­ tional studies, face-to-face and distance learning courses, and study tours-and also through demonstration-from lending operations and model transactions. To maximize impact, the Bank Group will:

• Strive to ensure that the strategic relevance, quality, coherence, and integration of Bank Group products is as high as possible, through regular program discussions with the GoC and within the Country Team; COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Table 17: FY06-08 AAA program • Respond quickly and flexibly to GoC requests for ana­ .\;. ."',.:"~-~~ lytical work on topical issues; China' s integration into world economy • Pay more explicit attention to innovation, and embed CEM (managing resource-scarcity) robust M&E frameworks in formal AAA and demon­ Trade and poverty stration projects; Strategic uses of FOi • Collaborate more closely with Chinese researchers and Poverty , inequality , social exclusion experts as well as other (domestic and international) Poverty assessment advisors to the GoC in an effort to influence the over­ Participation in poverty reduction all development policy dialogue in China; Rural health system reform • Improve dissemination-particularly Chinese-language Rural social protection reform dissemination-through preparing brief research notes Labor market development for wide circulation, posting AAA on the Bank's Chi­ JCT in rural areas nese website, and continuing outreach through re­ Balancing regional development search entities and occasional GoC seminars; Metropolitan area management • Encourage experienced staff to make long-term com­

Resource scarcity and environment mitments to working with GoC counterparts on client Water scarcity priorities; The 'circular' (recycling) economy • Sustain AAA partnerships with DFID, the IMF, ADB, Green' national accounting and OECD (on fiscal reforms, PSU reforms, regional Climate change development, etc); and Land policy reform • Deliver IFC's TA program (about $48 million over the CPS period) primarily through PEP China (based in Financial sector Sichuan), with a focus on the business environment Access to financial services (50%), financial market development (-25%), and de­ Commercial rural financing Infrastructure finance veloping standards and public-private partnership Financial stability models. Policy banking Capital markets WBI learning and capacity-building activities are ex­ pected to remain at current levels. This implies greater Public and mar1

Partner roles and donor coordination

China still receives development assistance from a variety of official sources (see Table 19 on page 40), focused on poverty reduction, health care, water supply and waste-water treatment, urban and transportation infrastructure, and environmental sustainability.

• With GoC encouragement, the Bank's donor coordination activities have fo­ cused primarily on developing strategic partnerships with multilateral and bilat­ eral donors and development partners (DFID, the IMF, ADB, and OECD). DELIVERING THE BANK GROUP PROGRAM

• Multilateral and bilateral donors have committed about $889 million to Bank Partnerships activities through a range of trust-funded activities, enabling Bank assistance to remain very China to expand significantly in the areas of poverty reduction, human development, rural development, and environment protection. important • The Multilateral Fund for the Implementation of the Montreal Protocol, the Ozone Trust Fund, and the Global Environment Facility ( GEF) constitute the largest multiple-donor sources of trust funds. In particular, the Bank administers almost $560 million in commitments for two self-standing Table 18: Global Environment Facility Program projects phasing out ozone-depleting substances ~ : :;., 1 4 .;,·- f1i"~,. US$m as well as about $247 million in GEF commit­ '"'· - ' ::oa. "fi.J ·- ments (see Table 18). Another $100 million in en­ Biodiversity Sustainable Forestry Development 16 ergy and environment GEF cofinancing is under Lake Dianchi Freshwater Biodiversity 1 preparation. Climate change • An innovative 'blending' partnership be­ Heat Reform and Building Energy Efficiency 18 tween the GoC, DFID and the Bank has al­ Renewable Energy Scale-Up 1 40.2 lowed the Bank to remain active in poverty and Energy Conservation 1 22 social sector projects. Begun in FY02, DFID has Energy Conservation 2 26 committed grants totaling about $100 million to Renewable Energy Development 27 be blended with IBRD loans totaling about $300 Beijing Environment 2 25 million to reduce the effective interest rate for Utility-Based Energy Efficiency Finance (IFC) 16 International waters three Bank projects (Tuberculosis Control, Ba­ Hai River Basin Water Resource Management 17 sic Education in Western Areas, and Poor Rural Guangdong Pearl River Delta Urban Dev. 10 Communities) to about 2%, enabling the Bank Other to remain active in these areas following the Gansu and Xinjiang Pastoral Development 10.5 cessation of IDA lending. PCB Disposal and Management 18.3 • Donor trust funds also support non-lending tech­ Total 247 nical assistance and project preparation costs.

Portfolio management

Social and environmental safeguards

The current context for applying safeguards policies presents opportunities and risks. Chi­ Portfolio nese practices with respect to environmental impact assessments (EIAs) are improving, both management in terms of analytical quality and institutional willingness to enforce compliance with na­ tional regulations. There is also growing public awareness and appreciation of the environ­ continues ment and its relationship to quality of life and sustainable development. Nonetheless, EIA to receive practice and willingness to implement agreed environmental management and mitigation high levels plans varies throughout China. There are still gaps in quality from one province to another of attention and from one environmental institute to another, and the consistency of enforcement and compliance are highly variable. Land acquisition and resettlement in China is becoming increasingly important as land pressures mount in several parts of the country. While there are relatively few gaps between GoC policy and the Bank's safeguards policies, there are gaps between GoC expectations and the practices of local governments, which are responsible for land acquisition, compen­ sation and resettlement programs. Performance in Bank-assisted projects is mostly satisfac- COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Table 19: Donor activities in China t . J • ·! ', • Strategy , Recent ~£?.~:mor, ... , ~nd,9P.~f~ti

ADB Promotes pro-poor growth by About $1.5 billion in About 90% of . Urban Poverty enabling greater access of poor to annual lending during 2006-2008 Study 2002 benefits of economic prosperity, 2006-2008; $12 million project lending to . Poverty Profile opportunity. Four priorities are (i) in technical assistance central & western (2003) promoting equitable and inclusive grants annually regions. Non- Private Sector growth; (ii) making market work lending focus on Assessment better; (iii) improving environment; policy, legal and (2003) and (iv) foster regional cooperation. governance . Development Key sectors: transport; water supply/ reform of Private wastewater; agriculture, natural Enterprise resources; energy; environment (2003)

Australia Strategy (2006-10) aims to support $30 million grants No specific China's own balanced development provincial focus. policies by building capacity and Focus on national providing TA, building institutional level engagement linkages between Australia and China on policy, to support China's development and planning and work collaboratively in the region. management Focus on governance, health (chiefly HIV/AIDs) and environment (chiefly water resource management)

Canada CIDA's 2005-2010 Country C$30 million annually Environmental . Country Development Programming programming Development Framework focuses on: (i) human focus on west. Programming rights, democratic development, and Framework good governance and (ii) 2005-2010 environmental sustainability

Denmark Environment and energy, climate € 14 million (2005-08) Northeastern and change (COM), including wind energy (significant soft loans southwestern development program and TA not included) regions activities for COM

European Country Strategy Paper 2002- 2006 € 250 million grants No specific focus Union key areas: social and economic (2002- 2006) reform; environment and sustainable development; good governance and the rule of law

Ford Gender equity, poverty, participation Around $15 million/ No specific focus. . Most analytical Foundation and community-based empowerment. year in grants on Clusters of work products of Sectors include: development finance average in western China. grants are and economic security; education; published by governance and public policy; the sustainable development; sexuality organizations and reproductive health; law and themselves rights; NGO development

France Energy efficiency, environment, urban Grants: € 9.7million/ Embassy: eastern . Wuhan and development, transportation, health, year (Embassy); € 5m and central Chongqing governance and judicial system, (AFD & FFEM/2004- provinces; AFD: municipalities education 08). Soft Loans:€152m western monographic (2005).Tied soft loans: provinces; French studies €150m (2005) GEF: northeast provinces

(continued on next page) ••40 DELIVERING THE BANK GROUP PROGRAM

Table 19: Donor act1v1t1es 1n China (continued) Ji Strategy Recent . _Don?r i,_ ~nd Operations ·- ·'" ~ . .: . . , ~i~~r:cing ; ...... i:ocl\~. are'.?~ c,, ,'~ ... _a .nalytical wor,k _ Germany Sustainable economic development Grants: €33.5m; Concentration on . Portfolio analysis and legal cooperation, environment Loans: €83.5m (2005) central, western by German policy, protection and sustainable use and northeastern Development of natural resources (including provinces; also Institute energy and urban development); national level Environmental health (HIV/AIDS); railbound projects in Beijing Protection and Use transport; water (wastewater, water of Resources management, drinking water) and . Water, Wastewater solid waste and Solid Waste

Italy Strategy focuses on health, cultural Grants: $42 m; Loans: 85% western and heritage, environment, education, $138 m (2002-2008) central provinces vocational training and institutional building

Japan Economic Cooperation Program for Determined on annual JBIC loans focus . Rural Pension China (2001) addresses global issues basis. In FY 2004, on inland areas Insurance System (environment, HIV, TB, etc); JBIC loans totaled Improvement study supporting reform, and open policy; ¥85.9 billion, grant (ongoing) promoting multilateral cooperation assistance totaled ¥4 .1 . Decentralized and mutual understanding between billion, and technical Management of China, Japan; poverty alleviation; cooperation totaled Poverty Alleviation private sector development. JBIC's ¥5.9 billion Fund (2005) priorities are environmental . Study on protection, human resource Effectiveness of development, poverty reduction JBIC Environment Projects (2006)

Nether1ands Environment, private sector €19 million grants Main focus on development, rule of law, (2005) northwest, preservation of Tibetan culture western and central regions

New Poverty alleviation $1m per year Western . Evaluation report Zealand provinces on development and cooperation (2005)

Norway Environment $16m per year, $3 m of Western and which is in form of northeastern direct grants provinces; also polluted and/or poor areas of central provinces

Sweden Strategy (2006-10) promotes reform $8 million grants on an Cooperation on . Results Analysis process in areas of environmentally annual basis (options central ministry Swedish Technical sustainable development, human for concessionary pilots in Yunnan, Cooperation 2001- rights and legal development and credits) Guizhou, Sichuan 2004 (2005) social security and gender equality and Inner Mongolia

UNDP 2006-2010 UN Development Total resources: $280 Focus on national . UN Common Assistance Framework (UNDAF) and million for 2006-2010 policy advice and Country Country Programme Document dialogue; capacity Assessment (2004)

(contin ued on next page) 41 •• COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE 'S REPUBLIC OF CHINA

Table 19 Donor act1v1t1es 1n China (continued) Strategy . __ · Recent Donor and Operations . , ,.,, Financing . , Focus areas analytical work < .~i"'"'iiit.Y'.._._,~j..it: .L• •

(CPD) assists Government to realize building and • UN contribution to Xiaokang vision of all-round human knowledge 11th five year plan development The programme sharing • China Human components are: achieving MDGs and Development reducing human poverty, environment Report 2005: and energy for sustainable human Development with development, responding to HIV/AIDS Equity and other communicable diseases.

United Strategy (2006-2011) focuses on £35 million annual Poorer Western • China Country Kingdom meeting MDGs for basic education, grants provinces Assistance Plan health (HIV/AIDs, TB, health system (2006) reform) and access to water and Studies of China's sanitation, plus developing a partnership impact on global with China on international development development (2005) issues Urban Poverty (2004) • Studies on health system reform (2005) • China & Global Forest Products Market (2006)

tory and counterpart agencies are usually diligent in their application of agreed resettlement action plans, yet it is likely that land acquisition and resettlement will become an increas­ ingly prominent issue for China generally as well as for the Bank. Moving forward, the Bank will continue to seek ways to streamline safeguards proce­ dures which apply to Bank projects and identify possibilities for more reliance on country systems, in appropriate situations and where there is advantage for both the Bank and our Chinese counterparts. Following TA from the Bank, SEPA recently issued technical guide­ lines making public consultation and information disclosure mandatory in the environmen­ tal assessment process. Areas for further improvement in the safeguards process include the quality and timing of analytical work, analysis of alternatives, and more meaningful public consultation and information disclosure. The Bank will seek opportunities to build capacity in these areas through lending operations, safeguards training and professional development.

Procurement, disbursement and financial management

Procurement has been decentralized to the Beijing office, except for contracts with values exceeding certain thresholds (still cleared in Washington), and procurement requests are now handled in three business days on average. Under new legislation promulgated over the last five years, procurement of works is now usually completed through competitive bidding in an economic, efficient, and fairly transparent manner; most tenders attract a large number of bidders; and the lowest responsive bid is often substantially below the cost estimate. With China's entry into the WTO and growing private sector capacity, procure- DELIVERING THE BANK GROUP PROGRAM ment of goods is increasingly completed in conformity with international commercial prac­ tices (though China has not yet signed the voluntary WTO Agreement on Government Procurement). By contrast, procurement of consultants remains weak: most consulting firms are government design or research institutes; the Bank's clients typically wish to work with groups with which they already have a working relationship; and quality does not appear to drive decisions. Further reforms are needed in this area to achieve international norms. Financial management (FM) assessments are now also conducted and cleared in Beijing, though the regional FM manager continues to review overall China portfolio FM risks and quality arrangements. With the exception of special commitments for which the supporting documents are sent directly from suppliers to Washington, all project withdrawal applica­ tions are now processed in Beijing (typically within the targeted five days). To build local capacity, training courses and workshops are provided regularly to auditors to improve the quality of project audits and to MoF and implementing agencies (including during project launch and selected supervision missions) to upgrade FM and disbursement procedures in the implementing agencies. An IDF grant was recently approved to support strengthening the capacity and effectiveness of provincial, municipal and county auditors in China, and with Bank support a database of qualified technical trainers is being established to contrib­ ute to capacity-building in the China National Auditing Office (CNAO). In addition, the Bank-supported Accounting Reform and Development project helped to establish three residential training facilities (in Beijing, Shanghai, and Xiamen) to improve China's account­ ing and auditing technical competency. Finally, with continued support from Bank grants, some MoF staff have been sent overseas to learn the experiences of other countries on public budget management.

Portfolio reviews

IBRD lending: Given the size and complexity of the China portfolio, as well as its strong performance, the Country Team (CI) has not undertaken portfolio-wide performance re­ views. Instead, the team identifies emerging issues that present a risk and undertakes an issue-specific review as needed. In the past, these reviews have focused on streamlining project preparation, procurement, or disbursement procedures, or identifying opportunities to adopt a country systems approach to selected safeguards. A review is currently planned for the implementation of TA components of IBRD projects. Thematic supervision and assessment, including of safeguards and making use of IEG, QAG and CT retrospectives, has also proved to be effective in achieving improved portfolio management. The decen­ tralization of senior Bank staff to the Beijing Office has considerably strengthened the ca­ pacity of the CT to manage these matters in-country.

IFC investments: Given the rapid growth of IFC's China program in the last three years, most of the portfolio is young and has yet to be evaluated for development impact. Opera­ tions Evaluation Group (OEG) evaluations done in the last three years of older projects in the portfolio show a satisfactory development outcome in 71 % of the cases. In the last two years IFC has been shifting portfolio resources and responsibilities to the field. Currently there are eight staff in the Beijing office working on portfolio supervision. This has allowed better risk management and better client service. IFC's China portfolio is performing well with the lowest loss-reserve ratio among the larger countries in the region.

MIGA guarantees: MIGA follows projects insured in China on a quarterly basis, which coincides with MIGA's process for provisioning for claims. Over the 2003-05 CAS period, COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

MIGA did not pay any claims for projects insured in China although it did have one project in the mediation process, implying an intense dialogue with the GoC to help sort out potential investment disputes. In addition to its guarantee activities for projects in China, . MIGA also worked closely with the GoC to help solve investment disputes between foreign investors and local partners in the water and power sectors.

Risks are Managing risks moderate and being The key risks to the Bank Group's development effectiveness in China are:

monitored • Stagnation in the reform process. Although China's economic reforms have signifi­ cantly increased the role of market forces and private initiative, much remains to be done. Failure to continue the reform process could lead to economic stagnation and rapid build-up of quasi-fiscal liabilities because of the ongoing need to subsidize loss­ making SOEs. • Weakness in the financial sector. The GoC has undertaken important reforms in recent years to strengthen financial enterprises. Progress has been made in corporatizing SCBs, restructuring debt, and shareholding reforms, including the introduction of strategic in­ vestors into three of the four largest SCBs, yet there remain concerns about credit risk management, bank governance and internal controls. Weak performance of some SCBs creates the potential for financial sector difficulties and is a source of contingent fiscal liabilities that need carefully to be managed. The GoC is committed to taking further action to accelerate financial reform, improve corporate governance, and establish effec­ tive performance incentives as well as a risk control and capital constraint mechanism so as to transform SCBs into dynamic market players that are able independently to bear market risks. To promote the development of a sound business model for SCBs, listing of eligible SCBs in domestic and overseas capital markets is also being encouraged. • Unsustainable debt levels: Long-term fiscal risks exist in China, mainly due to the GoC's contingent liabilities, arising from banks' NPLs, unfunded pension obligations, unrecorded local government debt, and external borrowings by SOEs. Data limitations preclude precise estimates of these quasi-fiscal liabilities, but they are believed to be significant. • An external shock. China's growing exposure to global trade is making the economy increasingly vulnerable to trade shocks, with particular vulnerability to a global reces­ sion, trade disputes with key export markets, or other disruptions (such as a terrorist attack) that affect global trade. • Social dissatisfaction leading to an economic slowdown. Although the first stage of economic reform mainly benefited agriculture and the rural sectors, in recent years urban areas have been much more successful in creating wealth, jobs, and opportuni­ ties. Increasing social and economic disparities-between coastal qnd interior regions, between rural and urban populations-may result in social dissatisfaction that results in slower economic growth. • A cross-border emergency such as SARS or the avian flu. SARS caused 800 deaths and reduced Asian GDP growth by 0.5 percentage points in 2003. While it is estimated that the effects of a mild avian flu pandemic would be small (less than 0.5% of GDP), a 'medium' pandemic could have sizable supply-side impacts (fatalities, worker absentee­ ism, and an overwhelmed health care system) as well as demand-side impacts to which export-oriented economies would be especially vulnerable. ••44 DELIVERING THE BANK GROUP PROGRAM

These risks are closely being monitored. Forces in favor of slowing or even reversing the reform process are currently weak. In the financial sector, banks have reoriented lend­ ing to reduce exposure to overheated sectors and also taken steps to assess risk on the basis of commercial (rather than policy) considerations. Reforms in the pension system and sub­ national government borrowing are being accelerated, helping to contain fiscal risks, while structural reforms supporting growth in non-state activity, progressively greater market dis­ cipline, and increased openness to foreign direct and portfolio investment, are helping to preserve economic stability. Recent measures to slow bank lending, money supply and investment are helping to reduce the risk of overheating, though vigilance remains neces­ sary. Debt sustainability is not a medium-term issue, because direct government debt is small (24% of GDP at end-2004). The budget deficit in 2005 was 1.6% of GDP, down from 3.6% in 2000, and according to the IMF this deficit is expected to remain constant in nominal terms, implying a decline in the primary deficit of about 0.25% of GDP per annum. In addition the GoC has over $800 billion in international reserves as well as substantial SOE assets and growing tax revenues to meet fiscal obligations arising from realized contingency liabilities. The GoC is aggressively taking measures to address income disparities and build a harmonious society, including increasing investment in rural development and facilitating migration of rural population to the cities. Finally, the risk of an avian flu pandemic is well known globally and, following the Beijing Conference in January 2006, at-risk countries are actively improving veterinary services and health systems to respond as needed.

Conclusion

China by many measures has been the most successful developing country over the past 27 years. Most importantly, sustained and rapid growth has enabled it to lift about 400 million people above the $1 dollar per day poverty line (at PPP). But past success is not a guarantee of future success: many countries have done well for a period only to stagnate later. For China to continue to grow and to reduce poverty, it will need to continue its transition to a market economy, integrate more fully into the global economy, further develop its financial services (including pensions and insurance), improve the management of natural resources (especially land, water and energy), protect the environment, and strengthen public and market institutions. Continued progress in these areas is important to China, but given China's growing impact on the global economy, it is also important to the world. In many of these areas, no one knows exactly what sort of policy and institutional reforms will work best in China. Research on potential or experimental reforms remains a crucial input into the GoC's policy debates and decisions. While the GoC has many partners in implementing its development program, the World Bank Group-by embedding global knowledge and ex­ perience in its research, technical assistance, lending projects and model transactions-is better positioned than most to introduce innovative solutions to China's development prob­ lems and to carefully evaluate the results so that China can learn what reforms are successful and should be scaled-up. The World Bank Group is pleased to support China's develop­ ment and will work hard with the GoC to help bring lasting prosperity to all Chinese citizens, including the most poor.

Paul Wolfowitz President

INTEGRA TING CHINA INT OTHEWORLD ECONOMY

Increased Chinese Imperfect understanding of China Enhanced Chinese Strengthened partner-agency research and AAA : CEM , WTO accession/ involvement in in rest of the world (and vice engagement in global and analytical capacity supporting China's Doha round studies, China and international versa) regional economic institutions participation in global and regional economic global economy, trade economic institutions institutions, including WTO development, trade finance; Boao Forum

Increased Chinese Rising domestic and international China meets WTO Continued analysis of implications of Doha AAA : trade impact analysis; trade and overseas resistance to further integration commitments and participates and other trade negotiations on economy, Doha round support investment due to perceived effect on poor fully in Doha Round including services, agricultural subsidies (MOFCOM); investment and the environment; limited climate analysis; experience with overseas China implements free trade investment agreement with ASEAN countries

Higher volume and better TA to help GoC understand and consider IFC and MIGA assistance quality of overseas' subscribing to OECD principles for overseas SAFE capital flows monitoring; investment investment AAA on inward and outward FOi , investment climate analysis

Increased Chinese Limited experience with ODA Higher and better quality Better correspondence between China's ODA SAFE capital flows monitoring ; participation in China ODA and other ODA providers; Exim Bank co­ work with MoFA on ODA official development finances with IBRD; GoC contributes to assistance (ODA) multilateral development agencies

)> REDUCING POVERTY , INEQUALITY , AND SOCIAL EXCLUSION z z m Absolute poverty Limitations of current area-based Greater community Community-level programming and AAA : COD , poverty in rural x eliminated poverty reduction policy; limited participation in poverty implementation capacity-building piloted in areas. Financing : poverty analysis of vulnerability (persistent reduction programs selected villages n I poor, migrants, the elderly) and z limited development of social Strengthened social insurance Options articulated for national rural pension AAA : rural pensions )> programs to serve their needs programs (pension systems, policy n urban and rural health "Vl ;o insurance); reformed and m Options clarified for expanding rural health AAA, financing : rural health Vl expanded safety nets c programs (dibao) insurance (NCMS) and Medical Assistance, ~ with fairer NCMS financing Vl ~ .....i • (continued on next page) n Annex 1: China CPS Results Matrix (continued) 0 • c •.i:. Long-term China development goals Medium-term CPS goals Bank Group performance z 00 ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ -i ;%l Goals Constraints Outcomes Outputs lnteNentions -< ")> REDUCING POVERTY , INEQUALITY , AND SOCIAL EXCLUSION ;%l -i z Options identified for national rural safety net AAA : rural social protection m ;%l policy framework Vl and rural health :r: Higher capacity of Inadequate capacity and financing Education financing supports Financing plan options prepared for free AAA, financing : education "Vl the poor to for social service delivery; more equitable access and compulsory 9-year education finance and efficiency; IFC -i ;%l participate in China's inappropriate provider incentives higher educational attainment investments growing economy and institutional arrangements in m~ () health care; lack of health Health care financing structure Options identified for higher education TA: student assistance in -< insurance encourages increased and financial aid higher education ,, 0 more appropriate use of ;%l health services, esp. among Options identified for care-based payment -i :r: rural poor system m "m Options clarified for shifting from supply to 0 demand subsidies "r rr:! Options identified for financing and AAA : rural health, PSU reform . Vl ;%l organizational reform of public health Financing : rural health; WBI m on health economics "c r"" Improved Limited diversification; limited Improved agricultural Better crop, animal varieties introduced Financing (incl IFC) : livestock, n employment and access to market information; productivity and incomes in agriculture technology, supply 0 income opportunities constraints on investment in project areas, with scale-up New farmers cooperatives law drafted chain , agro-processing, rural ,, n for the poor in rural production and supply chain potential infrastructure. AAA : farmers :r: areas, including assets Public-private partnership approaches to associations, food safety, rural z towns and small agricultural technology piloted ICT digital divide )> cities Reduced transport, utilities, Projects piloted in rural and small-town Financing : railways, and communications costs for transportation and communications waterways, roads , small cities, the poor in selected areas infrastructure, modeling new approaches rural ICT. AAA : ICT policy and regulation, digital divide

Further migration of Limited integration of migrants to More equitable access to Options identified for reforming urban social AAA : labor market; urban surplus agricultural urban areas due to (i) social services in selected policies to reduce discrimination against social security; education for labor to the urban discriminatory aspects of urban urban areas migrants and improve access to information migrant kids. Financing : urban areas social policy, (ii) skills deficit, and and services transport; housing market; (iii) limited absorptive capacity of migrant skills cities Better employment Labor-market led skills training programs AAA : labor market; vocational opportunities for migrants, and successfully piloted and scaled-up education. Financing : migrant protection of their rights, in skills; vocational education selected areas

(continued on next page) Annex 1 China CPS Results Matrix 1cont1nued ) ~ , Long-term China development goals .. ~ ·>)~11e,dium-terrr1CPSgoals :~ ~ - · : : , · Ban~GrolJpperformance ·~ 12~~ ~.0!].S,t!;,~~~

REDUCING POVERTY , INEQUALITY , AND SOCIAL EXCLUSION

Strengthened urban planning Integrated development strategy/plan AAA : household urban and management in selected prepared for selected jurisdiction(s) services, firm competitiveness jurisdictions surveys; metropolitan management. Financing : municipal projects; metro projects; NE skills

MANAGING RESOURCE SCARCITY AND ENVIRONMENT AL CHALLENGES

Institutional fragmentation, Opportunities identified for Examples piloted of integrated metropolitan AAA : round-tables on metro, lack of coordination limits metropolitan areas to benefit area planning, financing, or managing through other urban management effective infrastructure from planning, financing, and transaction or new institutional arrangements challenges (infrast. PPPs, service delivery on managing investments on a service provision regulation, metropolitan scale metropolitan/regional scale infrast. finance) ; metro dimension addressed in urban infrastructure portfolio

Creating a resource- Water and energy production and More efficient energy supply Clean energy and renewable energy Financing : clean energy and efficient society that supply systems inefficient systems demonstrated technologies piloted and scaled-up renewable projects, power takes into account generation/ transmission, the costs of More efficient ways of supplying and using pumped storage projects, environmental coal demonstrated including GEF, IFC degradation and investments. AAA : PPIAF pollution - Commercial management in selected energy study. particularly for water companies strengthened and energy (oil, gas, z~ and electricity)-to More efficient water supply Water savings concept piloted and scaled-up AAA : water scarcity. z m meet GoC goal for systems piloted; water Financing : water x 2010toreduce productivity increased in Bulk water markets piloted management, irrigation energy intensity by selected jurisdictions (") 20% over 2005 I Model urban water supply and wastewater AAA : water/sanitation z treatment facilities built assessment; recycling. ~ Financing : wastewater (") -0 Vl Overconsumption and inefficient Viable policies and Roadmap identified for liberalizing water and AAA : water valuation , China ;;>J m water and energy resource technologies identified to help energy markets, so prices reflect total 2020. Financing : rural water Vl allocations resulting from resource reduce water and energy marginal cost managemenUirrigation; c ~ pricing that does not reflect real consumption per unit of GDP transmission projects; IFC Vl cost on the margin (incl. Appropriate resource-use standards investments ..i:. s:: \.0 environmental externalities) articulated, with TA for improved enforcement ~ ;;>J • (continued on next page) x n Annex 1: China CPS Results Matrix (continued) 0 • c •U1 .: Long-term China development goals Medium-term CPS goals Bank Group performance z 0 -i ~- ~als Constraints . -0-u-tc_o_m_e_s______O_u_t_p_ut_s ______ln_terventions : ;;tJ -< )>" MANAGING RESOURCESCARCllY AND ENVIRONMENT AL CHALLENGES ;;tJ -i z Approaches identified to reducing water use J"'1 ;;tJ in agriculture vi I Transport, urbanization options identified to Financing : urban transport, vi" reduce transport-generated pollution, fuel use railway, inland waterways -i ;;tJ Improved natural Poor natural resource and Environmental concerns Strategic environmental assessments piloted AAA : CEM; circular economy; 2:i J"'1 resource environment management leading mainstreamed into for selected sectors and regions green accounting. Financing Cl management, to to excessive degradation of development plans and energy, forestry (incl. IFC), .,,-< reduce degradation renewable resources and activities, resource Improved approaches to land, forest, rural , urban projects 0 and depletion depletion of non-renewable management systems groundwater, water basin, and river ;;tJ -i resources management piloted in selected projects I J"'1

Improved waste management Roadmap identified for increasing waste AAA : water and sanitation J"'1" 0 in selected jurisdictions removal fees assessment; ecofarming; "r recycling . Financing : waste­ ~ Model urban solid and liquid waste removal water treatment, solid waste vi ;;tJ systems implemented (incl. IFC investments, MIGA J"'1 guarantees) c" co Policies, mechanisms to address agriculture r non-point pollution piloted and scaled-up n 0 Improved land Poor land policies cause Model land administration and Integrated land administration and Financing : land administration .,, n administration and inefficiencies with socially management systems management system piloted systems. AAA : land policy I management undesirable outcomes developed reform , IDF on land acquisition z Options identified for revising property law to regulations )> recognize land contracting rights, rural land as collateral

New land acquisition policy articulated

International China's rapid development is China continues to make Options identified for stabilizing GHG AAA : climate change. environmental associated with increased progress in meeting its emissions Financing : HFC23, COM , commitments emissions of greenhouse gases commitments under clean energy, POPs phaseout met and other pollutants, as well as international environmental Model projects undertaken for phasing out program, protected areas, growing pressures on remaining conventions selected POPs (PCBs, chlordane, mirex) forestry. TA: biodiversity natural habitats, coastal partnerships ecosystems and remaining cultural Options for biodiversity protection strategy heritage, which are of global articulated interest Model projects implemented for reducing Financing : large ecosystem land-based pollution in coastal areas pollution reduction invest. fund

(continued on next page) Annex 1: China CPS Results Matrix (continued) · Long term China development goals . ·· •· ,;_· ~ • 1 Medi~m-teITT!cp"s9da1§ ~,':·h ~,\s~t~.'1.. :,,,·:;J~.,, ,:.,. ":1c~:~~~··i sank~Gf~Dp'pi;rforma.n6~·1.,'.··I

MANAGING RESOURCE SCARCITY AND ENVIRONMENT AL CHALLENGES

Model heritage and tourism Listed heritage sites pi loted, with Model cultural heritage projects developed environmental protection in place projects (Gansu, Guizhou); trust funds

FINANCING SUSTAINED AND EFFICIENT GROWTH

Increased access to, Legal, regulatory and supervisory Access to selected financial Barriers to commercial small-scale finance Financing : MSE finance; IFC and improved impediments to commercially services (rural credit, small­ identified bank and RCC investments/TA allocative efficiency sustainable micro, small and scale credit, housing finance) of, financial services medium enterprise finance, rural expanded in selected Market-oriented rural finance scheme piloted Financing : Mortgage Corp .; finance, and housing finance jurisdictions AAA : national housing strategy; PSRB financing to rural small businesses IFC support of housing finance, piloted incl. secondary mortgage institutions; TA: PSRB and others

Secondary mortgage markets expanded in pilot jurisdictions

Pilot microfinance financing-only institutions

Pilot credit information systems established TA: PBoC; IFC (PEP China) (incl. for consumer credit) support for credit information bureaus

Deepened financial Underdeveloped markets for long­ Enabling environment for Options for prudent investor protection Various TA programs with markets term risk finance; underdeveloped capital markets and insurance scheme articulated, with view to adoption by CSRC, CIRC, PBoC; AAA : >z capitalized securities, insurance industry improved 2010 infrastructure finance. IFC z m industries; no financial derivative investment/TA in NBFls, x market; lack of enabling regime for Legal framework and appropriate regulatory distressed assets markets

fixed income market; legal, institutions developed in areas such as (e.g.) (') regulatory barriers restrict stock securities law, secured financing law, futures I z circulation of non-listed companies law, leasing law, securitization law > (') More developed infrastructure Municipal and enterprise bond markets IBRD/IFC projects develop Vl finance developed in selected jurisdictions or lines of municipal/enterprise " ;;o business infrastructure bond markets m Vl & securitization; IFC bond c issues c:; Vl

V1 (continued on next page) • () Annex 1: China CPS Results Matrix (continued} 0 • c •V1 Long-term China development goals Medium-term CPS goals Bank Group performance · N z ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ -i ;;tJ Goals Constraints Outcomes Outputs ... . Interventions ~ :, : -< -0 )> FINANCING SUSTAINED ANDEFFICIENTGROWTH ;;tJ -i z Strengthened corporate Steps taken to strengthen corporate AAA : investor protection, rn ;;tJ governance, including governance framework in line with OECD disclosure and enforcement Vl improving transparency and principles I -0 accountability Vl -i ;;tJ Improved mitigation Risks emanating from financial PBoC capacity to identify, Options identified for reforming ownership, AAA : depositer protection; ?:i of systemic risks in system and sectors financed by assess and mitigate governance structures of SCBs (incl. sale of rn bailout policies; SCB () the financial sector bank debt; external pressures (e.g. systemic risks strategic stakes) ownership/governance; -< capital flows) strengthened exchange rate risk and ,, 0 Options for bank failure resolution policies financial vulnerability. TA: ;;tJ and associated institutional capacity identified financial stability functions; -i I periodic Stability Report rn -0 PBoC financial stability functions improved to rn 0 international standards -0 'or; Vl STRENGTHENING PUBLIC AND MARKET INSTITUTIONS ;;tJ rn -0 c Strengthened firm State dominates ownership of China implements 1999 Goe Model SOE privatization transactions AAA : insolvency reform, state ClJ and regional many large enterprises; SOEs decision to 'let go' of small completed asset management reform , ()' competitiveness crowd out private sector (e.g. and medium-sized SOEs social protection IFC 0 overcapacity, access to finance); Enterprise bankruptcy law options articulated investments -n non-viable SOEs difficult to 'exit' () I z Selected publicly-listed SOEs Approaches identified for helping SOEs to AAA : corporate governance, )> and large private corporations establish boards with independent outside CSR; IFC investments and TA adopt international best directors to help companies improve practice in corporate standards in corporate governance and corporate Assistance provided to selected listed governance and in social and social responsibility companies to implement CSR code environmental practices; TA: corporate directors

Investment climate includes many Simplified business entry and Options identified for simplifying business AAA : firm surveys give ratings, restrictions regulation, particularly in the entry (including licensing, access to land) promote awareness of western and northeastern competitiveness, and support provinces Options identified for simplifying, revising reforms to improve investment selected business regulations to prohibit climate monopolization, restraints on trade, and practices that unreasonably limit competition

Means to improving firm-level innovation identified

(continued on next page) Annex 1: China CPS Results Matrix (continued)

• • - "'1ic " • • ~ ii ~~~., - '" ' • ' - • c ')rt ·, • ,.. :1. Long-term China development goals · ·,: , ' • M~qiu!!l:t~_rm<;:P~goals),~,;·'.:~,,,.. ·: ,, , . • , , , -:. , .· Ba.IJ~~Group performanc:;E? '<., :!~: ~

STRENGTHENING PUBLIC AND MARKET INSTITUTIONS

West and northeast lag dynamic Increased FOi inflows in west Investment promotion agencies strengthened MIGNFIAS assistance to coast economically and northeast regions in lagging provinces investment promotion agencies; IFC frontier Approaches identified to realizing higher FOi investments, SME fund for inflows in west and northeastern provinces equity investments in high (as % of total FOi) growth private companies in the west; support to provincial development plans

Improved service Goe involved in services beyond Improved accountability in Categorization of PSUs initiated, according to AAA : PSU reform; investment delivery normal government role; PSUs model PSUs type/level of GoC involvement climate surveys; public service underfunded, over-staffed, focused delivery surveys. Financing : on profits Policy actions to privatize PSUs articulated poverty, local e-government; IFC investments in private Reform options articulated for allowing not­ health, education for-profit private entities to be public service providers

More equalizing Expenditure assignments are not Better alignment between Expenditure assignments clarified across Financing : rural and urban intergovernmental matched by local revenue fiscal responsibilities and levels of government projects. AAA : NE subnational fiscal transfer system autonomy or an effectively­ revenue assignments at sub­ finance; TA support for sub­ targeted transfer system, thus national levels, including New local revenue sources (e.g., property, provincial pilot on placing disproportionate burden on improved equity and efficiency local personal income tax) identified; selected intergovernmental fiscal counties, townships for financing in public funding piloting system; learning on fiscal social services management, public sector Options for new transfer law identified, performance (WBI); rural l>z consolidating transfer programs with improved health z equalization impact xm

Improved Limited link between plan and Improved link between Appropriate revisions to the budget law AAA : IOF on M&E framework () budget budget; inadequate monitoring planning, budget, service articulated for 11th FYP; Northeast J: performance systems on government spending delivery demonstrated in subnational finance, rural z l> selected areas; greater budget public finance Measures identified for expanding national () transparency treasury to subnational level Vl" ;

IJ1 UJ •

Annex 2 China 2003-05 CAS Completion Report (CASCR)

Date of CAS: January 22, 2003 Progress Reports: None required Period Covered: January 2003 to June 2005 CASCR drafted by: Christopher Finch, Senior Country Officer

Table of Contents

Introduction ...... 56 Country developments ...... 56 Results assessment ...... 57

I. CHINA AND TIIE WORLD ECONOMY ...... 60 Promoting China's integration into the global economy in the WTO era ...... 60

II. POVER1Y, INEQUAUTY, SOCIAL INCLUSION ...... 61 Increasing employment and productivity off and on the farm ...... 61 Strengthening transport links within and to lagging regions ...... 64 Developing human resources ...... 66 Strengthening social protection ...... 67 Improving targeted poverty reduction programs ...... 69

m. MANAGING RESOURCE SCARCI1Y ...... 70 Strengthening effectiveness of environmental institutions ...... 70 Improving air quality ...... 71 Managing water resources ...... 72 Managing land and natural resources ...... 75 Protecting global environmental commons ...... 75

IV. REFORMING TIIE FINANCIAL SECTOR ...... 77

V. STRENGTIIENING PUBLIC AND MARKET INS1TllJTIONS ...... 79 Strengthening institutions for macroeconomic management ...... 79 Improving public sector management and delivery of services ...... 81 Promoting private sector development and enterprise reforms ...... 85

Overall performance, monitoring and evaluation ...... 87 Bank Group instruments ...... 87 Country dialogue and donor coordination ...... · ...... 91 Client feedback ...... 92 Portfolio management ...... 94

Conclusions and lessons ...... 96 Attachments ...... 101

ss • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Introduction

This CASCR evaluates the effectiveness of the Bank Group's assistance to China under the 2003-05 CAS. It is based primarily on a self-assessment, conducted by the Country Team CCD, with the purpose of identifying key lessons to inform preparation of a new World Bank Group CPS for the period 2006 to 2010. The 2003 CAS aimed to support China's twin transitions from a rural agricultural to an urban industrial society and from a centrally-planned to a more globally-integrated market­ based economy. The CAS was aligned to objectives of China's 10th FYP, which covered the period 2001 to 2005 and included key goals of: (i) sustained growth of 7% a year, (ii) sustainable development through higher productivity in agriculture and in industrial SOEs, creation of 40 million jobs, and safeguarding the natural resource base; (iii) economic re­ structuring, rural reform, and opening to the world through better macroeconomic manage­ ment, fiscal reform, and financial sustainability; building competitive globally-integrated markets; accelerating agricultural diversification and rural reforms to raise incomes; and improving science and technology input into production; (iv) coordinating economic and social development by paying greater attention to quality of life, investing in human capital, protecting natural capital, improving social protection, promoting the rule of law, and broad­ ening democratic participation; and (v) the development of economically and socially lag­ ging western and central provinces. Bank assistance targeted three broad related objectives: improving the business envi­ ronment and helping to accelerate China's transition to a market economy; addressing the needs of poorer and disadvantaged people and lagging regions; and facilitating an environ­ mentally-sustainable development process. Each objective was broken down into five sub­ objectives. Although the 2003 CAS was not officially a "results-based" CAS, a detailed 21-page program matrix (Annex BlO) provided the most articulated description of these objectives as well as of the GoC's strategy and planned actions, planned and ongoing Bank interven­ tions, and major interventions of other donors in support of each sub-objective. In total, the matrix described 118 GoC priorities, and 135 progress benchmarks and multiple Bank Group instruments.

Country Developments during the CAS Period

China continued to make significant progress toward many of the development goals of its 10th FYP during the CAS period. China became the world's fourth largest economy and the third largest trading nation as its role in world trade and in the regional production chain continued to expand rapidly. GDP growth averaged 10% per annum over 2003 to 2005, extending one of the highest sustained rates of growth in the world, while inflation aver­ aged 1.4%, with the economy rebounding strongly from a sharp contraction in the second quarter of 2003 largely due to SARS. China's export volume increased 26% in both 2003 and 2004, much faster than GDP, and it now accounts for 4% of world output (in nominal terms) and about 6% of global trade. Official GoC poverty data indicate that China also sustained its achievements in poverty reduction, efforts that have lifted more than 400 million people out of poverty and accounted for nearly three-quarters of poverty reduction in the developing world over the past 25 years. China is on-track to meet many of the Millennium Develop­ ment Goals (MDGs), including eradicating extreme poverty and hunger, extending primary education enrolment, and developing a global partnership for development.

• • s6 ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

Since the beginning of the reform period in 1978, the GoC has maintained continuity in China's basic economic policies while increasing emphasis on people-centered develop­ ment that balances growth objectives with social needs, environmental sustainability, and efforts to reduce inequalities between and within regions. Under the 10th FYP, the GoC continued to liberalize and open China's economy (e.g., it reduced tariffs, liberalized inter­ est rates and deepened financial intermediation, shifted to a managed floating exchange rate regime, privatized SOEs and expanded the private sector, and also reduced internal barriers to factor mobility) while also implementing a range of reforms to reduce inequality and improve environmental sustainability. The 11th FYP, submitted to the National People's Congress in March 2006, deepens the GoC's commitment to achieving an "all-inclusive xiaokang" society. In particular, it aims to implement a "scientific approach to development" to build a "harmonious society" that sustains the rapid and steady development of China's "socialist market economy", achieves the "five balances" and makes economic and social development more people-oriented, comprehensive, balanced and sustainable. Significant development challenges remain in China. Growth has continued to depend heavily on investment, and job creation has been limited as industrial growth has been based primarily on labor productivity growth rather than employment growth. Inequality remains high, with central and western regions continuing to lag behind the coastal region. Poverty is increasingly concentrated in rural areas, as the limited absorption of surplus farm labor resulting from China's capital intensive growth has limited increases in rural productiv­ ity. Progress in non-income dimensions of poverty has lagged behind the rate of growth of per capita income, with clear disparities in human development indicators between rural and urban areas. Service quality and access is significantly lower in rural than in coastal areas, and despite increased government transfers to poorer jurisdictions, imbalances re­ main in the intergovernmental fiscal system. Improvements in the efficiency of natural re­ source use have not kept pace with increasing resource demands, and growing scarcities of key resources-particularly energy and water-along with associated environmental im­ pacts, pose possible impediments to the sustainability and equity of future growth.

Results Assessment

In assessing the Bank Group's contributions to China's development progress over the CAS period, the CASCR builds on multiple assessments, including IEG's 2004 Country Assistance Evaluation, QAG's 2005 review of AAA, internal reviews of Bank project effectiveness, and client consultations (including regular dialogue with GoC counterparts, CPS consultations, a Client Survey, and feedback obtained through the China website). In general, these re­ views found that the Bank continues to make a substantial contribution to China's develop­ ment (OED found that the Bank in China continues to "punch above its weight"). This CASCR largely concurs with those findings. Nonetheless, the task of assessing Bank perfor­ mance in a country as large and complex as China over the brief CAS period faces several challenges, which limit the precision with which the Bank's contributions can be described. In particular:

• Because the Bank Group's impact in China depends on its influence on policy and institutional reform (rather than on the direct provision of goods and ser­ vices), impacts are difficult to identify precisely. Although the China portfolio is one of the Bank's largest, it is small in relation to China's economy (less than 0.2% of total investment over the CAS period). Hence, the Bank's impact is felt through the COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

demonstration effects of lending projects, and the influence of analytical work on policy reforms. When the Bank is successful, it contributes to development impacts that reach far beyond the direct outputs of the AAA and projects that it supports, but, given the presence of other change agents in China, it is rarely the case that the Bank is the only contributor at the start of the causal chain that leads to a given result. In most cases, other (domestic and external) agents have also contributed, and these multiple inputs have led to a unique approach that no change agent fully presented as such at the outset of the reform process. Determining the effectiveness of the Bank's work in China is necessarily an exercise in judgment. • Because the Bank Group's impact in China is cumulative, with results emerging in sectors where the Bank has developed a long-term relationship and provided multiple inputs over many years, it is particularly difficult to articulate with any confi­ dence the results of the Bank's work completed over the most recent CAS pe­ riod. Many of the Bank Group's interventions during the CAS period will set the stage for results (in terms of policy and institutional reforms, scaled-up technologies or ca­ pacities, and so on) that will unfold in the future. This is particularly so for the many CAS interventions that were initiated (as planned) late in the CAS period. In fact, many of the Bank impacts that can be confidently discussed at this point involve Bank perfor­ mance that precedes the 2003-05 CAS period. • Quantitative indicators that are often used in other (e.g. IDA) countries to assess Bank performance are limited in availability and usefulness in the case of China. For many development indicators, data covering some or all of the CAS period is not yet available, meaning that recent trends in development outcomes are difficult to establish. In addition, Bank impacts-which aim to involve policy or institutional reform-do not readily translate into specific quantitative achievements.

As an initial stage in preparing this CASCR, the country team reviewed all 135 progress benchmarks from the 2003 CAS and provided a written assessment of progress made toward each benchmark, describing Bank contributions as well as key lessons learned. This re­ sulted in a very detailed document with limited usefulness in providing an overall assess­ ment of the Bank's performance. In particular, the document tended to offer a distorted picture of the Bank Group's overall performance over the 2003-05 CAS period: (i) Though the benchmarks in the matrix were numerous, the matrix did not make any attempt to prioritize or establish a clear hierarchy between them, treating all results (misleading) as having the same importance. (ii) The matrix for the most part did not provide measurable baseline and target indicators, and many benchmarks were stated generally as improve­ ments in development outcomes, with the result that quantitative measurement of perfor­ mance was elusive. Finally, (iii) many benchmarks represented higher-order goals to which Bank Group assistance was aligned but over which the Bank's interventions alone would, even in the best of circumstances, have only an indirect influence, with the result that Bank performance could be assessed only in terms of Bank contributions to particular outcomes­ recognizing that other agencies also contributed and that the impact of different contribu­ tions is extremely difficult, if not impossible, to disentangle. As a result of these shortcomings, the CASCR does not reproduce the CAS's original program matrix with an additional column stating the "status at completion" for each CAS benchmark. Instead, while, the 2003 program matrix forms the intial point of departure, this CASCR aims to organize the details by articulating clearly the key results that the CAS expected to be achieved, the contributions that the Bank made, and the lessons learned. Moreover, given that the Bank Group's impact arises indirectly from its influence on policy

• • ss ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

Figure 4: The CAS pillars (2003-05) mapped to the CPS pillars (2006-10)

Pillar 1 Pillar 1

Improving business environment and Integrating China into the world economy accelerating transition to market economy • Participating in multilateral institutions • Strengthening macroeconomic management .---t---. · Reducing barriers to trade and investment • Participating in global development initiatives

Integrating China into global economy

Pillar4 Refonning the financial sector • Establishing an overall sector policy structure • Restructuring the banking system Financing sustained and efficient growth • Improving governance and regulatory structures • Expanding access to finance • Establishing capital markets --- • Developing capital markets • Managing systemic risks, maintaining stability

Promoting PSD and enterprise reforms • Improving environment for private sector activity • Corporate restructuring, ownership diversification Pillar 5 • Strengthening corporate governance

Improving public and market institutions Promoting private participation in infrastructure • Improving firm competitiveness • Reforming public service units • Rationalizing intergovernmental fiscal relations Improving public sector management • Strengthening the judiciary • Improving environment for good governance

Strengthening management of cities Pillar2

Strengthening performance of public utilities Reducing poverty and inequality • Promoting balanced urbanization Pillar2 • Sustaining rural livelihoods Expanding access to social services Health care Addressing the needs of poorer people and Education disadvantaged regions Social protection • Increasing employment and productivity • Expanding access to infrastructure services • Strengthening transport links Transportation • Developing human resources Information and communications technology • Strengthening social protection • Improving poverty reduction programs

Pillar 3 Pillar 3

Facilitating an environmentally sustainable Managing resource scarcity and development process environmental challenges • Strengthening environmental institutions ....______. • Conserving water resources • Improving air quality • Optimizing energy use • Managing water resources • Reducing air pollution • Managing land and natural resources • Improving land administration, management • Protecting global environmental commons • Observing environmental conventions

For 2003-2005 GAS, pillar components are fisted in order For CPS, pillar components are listed in order of of appearance in Annex 810 (countiy program matrix) appearance in main document and program matrix COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

and institutional reforms, the CASCR presents a largely qualitative review of Bank Group assistance over the past three years. In the following text, each section provides an overview of major Bank contributions, factors that contributed to or limited success, and key lessons for consideration as the new CPS is developed. To increase the utility of the CASCR, the 2003 CAS objectives have been rearranged according to the thematic structure of the new CPS. The diagram-Figure 4--Dn the preceding page depicts the 2003 CAS sub-objectives mapped to the new CPS themes, with activities from objective 1 in the 2003 CAS divided into three parts corresponding to new CPS pillars 1, 4, and 5: integrating China into the global economy, reforming the financial sector, and strengthening institutions.

China and the World Economy

Promoting China's integration into the global economy

The category "Integrating China and the global economy" appears as one of the sub-pillars of pillar I of the 2003 CAS. In this area, the Bank aimed to support China's integration into the world economy by helping the GoC to cope with the rapid changes expected following China's 2001 WTO accession.

Implement commitments under and build capacity for conforming with WfO: The Bank aimed to help the GoC implement specific WTO commitments through advising on the design and implementation of trade-related laws and regulations. Benchmarks were largely achieved, primarily through an ongoing Economic Law Reform project, as the Bank (and WBI) helped responsible agencies, including the State Council, to ensure the compat­ ibility of numerous business laws with WTO requirements and to build the capacity of GoC officials to implement WTO-related reforms. Partly as a result, China has generally met its WTO obligations, and accession itself provided strong impetus to growth. IFC's manufactur­ ing and financial sector investments, coupled with IFC/MIGA support (to MoF, the Exim Bank, and Sinosure) for outward investments and China's "go-global" program, also helped companies build capacity to prepare for increased global integration.

Reforms to maximize benefits and smooth impacts of increased integration: To help the GoC to design complementary policies, the Bank also sought to provide strategic analysis of the economic impact of WTO-related reforms, in particular, through completing a major study and multiple background studies highlighting the small adverse effect ofWTO accession on rural poverty and the impo1tance of complementary countervailing policy measures, especially in rural infrastructure and education (which the GoC has undertaken at a rapid rate). Bank-supported studies also strongly articulated the importance of liberalizing labor markets and reducing barriers to internal trade in order to achieve poverty reduction following WTO accession. While CAS benchmarks on actions to liberalize labor markets and reduce internal trade barriers did not include specific targets, the GoC has taken several important steps to address the concerns expressed in Bank reports: in particular, the hukou system is being relaxed, rural out-migration is now actively encouraged, and specific locali­ ties are taking steps to improve local investment climates.

Promote knowledge economy: The Bank aimed to help promote China's knowledge economy through improving R&D and information flows and bridging the digital divide.

• • 60 ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

The GoC has made great progress in developing China's information infrastructure (e.g. the number of fixed and mobile phones has reached 600 million ( 40% of the population)), and the Bank provided important inputs, including support to a high-level policy dialogue on digital divide issues (facilitated by a WBI study on lifelong learning), a joint research pro­ gram to develop the national JCT strategy, and GDLN expansion across China. IFC invest­ ments (of $25 million) in young, small, high-tech companies and support for venture-capital funds also contributed. Through the Shanghai Poverty Conference and follow-on activities (See Improving Targeted Poverty Reduction Programs on page 69), the Bank Group also helped to disseminate China's successful development experiences to other developing countries.

Lessons learned on promoting China's global integration

• Integrating China into the world economy requires action beyond WTO accession­ including greater Chinese participation in other multilateral economic institutions as well as in overseas investment and development assistance. • Reforms to liberalize labor markets and reduce internal trade barriers are still needed to ensure a wider and more equitable distribution of the benefits of globalization. • Bank support for pilot JCT projects modeling new approaches in rural areas and small towns would complement and add value to its JCT policy advice.

Poverty, Inequality, Social Inclusion

Pillar II of the 2003 CAS aimed to address the needs of poorer people and disadvantaged regions. Under this pillar, in line with the growing GoC emphasis on balanced development, the Bank Group sought to continue to shift its support from well-off coastal areas to disad­ vantaged inland provinces, with a focus on employment generation on and off the farm, infrastructure provision, human development, and social protection. In addition, the Bank sought to expand support to the development of cities and towns and to the provision of jobs for the large pool of rural surplus labor.

Increasing employment and productivity off and on the farm:

The Bank sought to assist the GoC with investments to demonstrate improved approaches to high-value, diversified agricultural development, natural resource management, water­ shed rehabilitation, and agricultural research addressing China's specific needs. In parallel, the Bank planned continued support in addressing relevant tax and fiscal policies, public and private financial services, and land tenure issues, as well as Bank-IFC activities to promote private investment in lagging regions.

Spur off-farm job creation: The Bank Group aimed to support absorption of rural surplus labor in off-farm employment by promoting the development of regions, SMEs, and munici­ pal investment climates as well as policy reforms to create more flexible markets for land, labor, and capital (Bank Group engagement in each of these areas is covered under other CAS sub-objectives below). In addition to interventions targeting specific localities and policy reforms, the Group provided cross-cutting interventions that examined overall development constraints and options to spur growth in lagging regions, including studies and technical COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

assistance on private sector development in lagging regions, national market integration and factor mobility (see below), city development strategies, and support for preparation of the 11th FYP. IFC supported off-farm job creation through investments ($166 million) in agribusiness and forestry-which created jobs for tens of thousands of farmers-and techni­ cal assistance to build farmer capacity to meet demand.

Strengthen management of cities: The Bank also sought to strengthen urban manage­ ment and policy, as part of a cross-cutting CAS theme on urban development and environ­ ment with a direct focus on supporting the provision of jobs to surplus rural labor. (These activities are included under the Poverty pillar of the new CPS, but were included under Pillar I-on the business environment-in the 2003 CAS.) Primarily through support under urban and transport programs, the Bank contributed to better management and financial mechanisms at metropolitan and regional levels that facilitate urban development and job creation:

• Through Bank inputs into policy dialogue and the 11th FYP, the Bank advocated the establishment of a national policy framework to facilitate factor mobility, urban eco­ nomic restructuring, and measures to improve the rural-urban interface. • Urban projects supported innovative management and financial mechanisms at metro­ politan and regional levels, including infrastructure finance initiatives in urban environ­ ment (under the Shanghai APL) through a district financing vehicle, preparation of an enterprise bond issue, and private sector participation. Fitting with China's needs, the Bank has increasingly focused on rapidly growing satellite cities and towns, and on building ties between local jurisdictions addressing urban environment challenges. • Bank studies and dialogue on small town and municipal development, including an extensive City Development Strategy program in five major cities (with DFID and Cities Alliance financing), guided the GoC's continued attention to facilitating the absorption of rural surplus labor in urban areas and improving urban economies through economic restructuring, diversification, and enhanced city networking. The Bank provided ana­ lytical support for housing maintenance policies, and a pioneering grant-funded urban poverty alleviation initiative was implemented in Liaoning province.

Enhance agricultural productivity: Under this sub-objective, the Bank aimed to support China's goals to promote diversified agricultural development and increased production of higher-value agricultural products (including via investments in research and extension), develop land markets, and promote watershed rehabilitation as well as better water man­ agement in irrigation.

• Diversified agricultural development. In target areas, Bank projects helped raise the share of higher-value crops in total agricultural output and reduce the area planted to standard grain crops, while recognizing that the GoC remains committed to maintaining sufficient grain planting to achieve national food security. Substantial achievements were also made in reforming the role of non-state entities in marketing agricultural commodities, with the Bank helping to promote farmers associations. Delays in the preparation of several supporting Bank projects, including Jiangxi, Gansu and Xinjiang Pastoral Development, and Heilongjiang Dairy, which are only beginning to be imple­ mented, also delayed some of the demonstration impacts that the Bank has sought. In addition, Bank support to restructuring and revitalizing investments in research and extension was initiated only in late FY05 (through the Agriculture Technology project).

• • 62 ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

The CAS also included a benchmark on reforming rural administrative fees and taxes­ an area where the GoC has made progress-but the Bank was not directly engaged. • Land markets. While CAS benchmarks have not yet been met, progress is continuing and has been satisfactory, with the Bank providing key inputs. A comprehensive pro­ gram of Bank AAA is helping to articulate a roadmap for land policy reform, and the 2003 Rural Land Contracting Law, whose formulation was supported under an IDF grant, explicitly permits and protects voluntary transfers of rural land use by farmers during the 30-year land use right term. Further reform is needed to enable land to be used as collateral for credit (a long-standing objective of Bank assistance) or direct trade of agricultural land titles. • Watershed rehabilitation, irrigation, soil and water resource management. Build­ ing on initiatives piloted under the Bank's widely-acclaimed Loess Plateau projects, improved soil and land management techniques (land terracing, conversion of agricul­ tural land on steep hillsides back to forest and steppe) continued to be scaled-up in GoC programs. In promoting water management reforms, the Bank's Tarim Basin, IAIL- 2, and Water Conservation projects demonstrated the potential for Water User Associa­ tions to empower rural farmers by improving the equity of irrigation and bolstering farmer incomes. Bank projects have also helped to establish the important principle that water quotas should apply to irrigation use and to assess such use through water mea­ surement and evapo-transpiration. These objectives were fully achieved, although more work is needed to mainstream reforms into the GoC's own programs.

Lessons learned on off·farm employment, city management, and agriculture

• With increasing demand for basic urban services, particularly in smaller and me­ dium-sized cities within larger metropolitan and city-regional areas, enhanced ap­ proaches to metropolitan management will become increasingly needed, including mechanisms for governing interactions between and among municipal and county/ district governments (in particular related to planning and provision of infrastructure services). • On-lending for income-generating activities to farm households has proved prob­ lematic, so the focus of Bank support is shifting toward a greater emphasis on the institutional aspects of agricultural productivity (e.g., strengthening local institutions such as farmer and water associations, better targeting of agricultural extension ser­ vices toward public goods). • Promoting legal parity between state ownership and collective ownership of land is key to ensuring farmer's rights and quality-enhancing land investments. More work needs to be done in developing land use markets, in particular, to use land as collateral.

Promote environmentally sustainable development in the western region: The CAS included separate sub-objectives aiming to strengthen GoC capacity to address environmen­ tal issues and to assist with the development of energy resources in western regions. The Bank suppo1ted these objectives through a model Strategic Environmental Assessment of China's Great Western Development Strategy and the preparation of Guidelines for Assess­ ment of the linkages between Environment and Poverty Alleviation, based on case studies in Sichuan and Yunnan. This sub-objective was largely achieved, as sustainable agriculture and watershed management methods piloted by the Bank (e.g., the Loess Plateau) continue

63 • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

to be scaled up in western regions. While relatively small in financial terms, Bank Group investments in hydropower (IBRD) and in metallurgical coke production (IFC) demon­ strated technologies to reduce air emissions in western provinces while also promoting higher environmental, health and safety standards.

Strengthening transport links within and to lagging regions

Under the CAS, the Bank aimed to support the GoC's efforts to expand transportation infrastructure within and to the poorer provinces through interventions in the highway, railway and waterway sectors, primarily consisting of investments designed to address criti­ cal bottlenecks and to demonstrate more efficient financially and environmentally sustain­ able construction and management practices. The GoC's physical targets (included in the CAS as a progress benchmark) were largely met, with the Bank making small but catalytic contributions which successfully built local capacity, facilitated transport flows, reduced transport costs, and improved living conditions along the constructed and rehabilitated highways, as measured at the completion of the projects finalized during the CAS period. There has also been success in reforming transport logistics and scaling-up practices dem­ onstrated under Bank interventions, though more could be done.

• Physical targets. Since the mid-1990s, China has expanded its highway and railway networks at an unprecedented rate, correcting for previous under-investment (a prob­ lem signalled by the Bank in the mid-1990s). The core of the GoC's highway investment program has been the National Trunk Highway System (NTHS), a 35,000 km network of highway corridors with a projected cost of $150 billion; over 1999-2004, highway kilo­ meters increased from about 12,000 to 34,000. The railway network has also expanded rapidly, from 56,000 km in 1996 to 70,000 in early 2005. The Bank played a catalytic role in both areas, through supporting on average two new highway projects as well as one or more railway, urban transport or inland waterway projects each year, mostly in the central and southern regions. Despite the GoC's transportation advances, infrastructure remains well below demand. The density of the road and rail networks remains low relative to geographic area or population in comparison with other countries at the same stage of development, particularly in railways, where a large part of the network remains clogged and potential customers have to wait or be turned away. • Economic impacts. Though it is difficult to discern the ultimate socioeconomic im­ pacts of the Bank's program, the transport projects completed during the CAS period have shown high economic rates of return-ranging from 15% to 29o/(}-and a substan­ tial reduction in interurban and urban transport costs. These effects were attained by the combination of investments in major thoroughfares with complementary investments in rural roads or urban transport. The Bank's insistence on a more balanced approach within and across modes has led to noticeable impacts in the poorer areas of the provinces where projects were implemented, with assessments showing positive project contributions, in target areas, to non-farm employment, rural incomes, enterprises such as tourism, and association with increased infrastructure access. • Institutional development. Bank support has helped raise technological and man­ agement standards in the jurisdictions where it has worked, including for road safety and planning and management mechanisms, but larger spill-over effects have been limited. Bank TA addressed, inter alia, logistical services, transport safety, and transport technology and management, and helped raise the policy discussion and standards in the jurisdictions where it was applied. For instance, road safety approaches in the ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

design of highways, the treatment of black spots, and control of truck overloading have become more commonplace in China-although such activities have yet to be mainstreamed. By contrast, project implementation and management mechanisms dem­ onstrated under Bank projects-including transparent procurement and measures to improve social and environmental sustainability-have been widely disseminated and scaled-up. • In urban transport, good models of comprehensive urban transport planning have been established in a number of cities, but national mechanisms and capacities for scaling-up these experiences are limited, and municipalities often emphasize investment in ring roads without adequate assessment of transport demand. Bank efforts at the project level to support improved traffic management, road safety, and reduced vehicle emis­ sions have proven to be time-consuming and staff intensive.

Less progress has been made in supporting intermodal transport logistics or the promo­ tion of greater container penetration. While there have been successes, such as IFC's invest­ ment in modernizing the Yangtze River fleet to meet growing demand for container vessels, Bank Group support has been more limited in these areas, either because the private sector was ready to assume the necessary responsibilities (e.g., long-distance trucking operations) or because key GoC entities (e.g., customs administration and Ministry of Commerce) have not requested Bank assistance.

Lessons learned in transportation

• The GoC's strong role in the selection of projects and their components has yielded strong client ownership and rapid implementation, but has also challenged the Bank to find ways to advise on sector-wide matters. The interest of GoC counterparts to move rapidly with physical investments can also in1pact a project's ability to build stronger planning, management, and operational capacities. • In road projects, the desire to finance components that can generate revenues to be used to repay loan costs-e.g. toll roads-has often tilted the balance towards fi­ nancing higher-class highways, although increasingly, greater GoC attention to ad­ dressing income inequalities has translated into a greater willingness to include rural roads in Bank-supported projects. Further capacity needs to be built for managing the selection of rural road investments and their procurement and maintenance. • Coordination among transport modes to ensure efficient investment and pricing re­ mains a key challenge. Since there is no single entity responsible for all transporta­ tion investments, coordination falls to a relatively small team of specialists within NDRC. This organizational structure risks producing road plans that do not strike the best balance among classes of roads (e.g. that underemphasize lower-class roads servicing poorer communities), providing limited guidance to cities regarding devel­ oping nationally consistent and sustainable transport networks, and selecting and implementing intermodal transportation options that increase rather than reduce the fu el-use and pollution impacts of the transportation sector. Recently the Bank has focused attention on helping NDRC and its provincial counterparts in project selec­ tion, but more work is needed in this area to ensure that decision-making takes a sector-wide perspective. • Key challenges include improving coordination among transport modes to ensure efficient and sustainable investment programs, implementation of a fuel tax, and strengthening mechanisms to scale-up successful demonstrations in cities. COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Developing Human Resources

One of the key challenges that the CT faced, operationally, over the 2003--05 CAS period was to identify a modality for continued IBRD lending in the social sectors, following China's graduation from IDA and the difficulties entailed by borrowing on IBRD terms for social sector projects in poorer jurisdictions with limited repayment capacities. Given that lending is the primary means through which the Bank pilots and demonstrates new ap­ proaches to China's development challenges, the reduction of lending in the social sectors threatened to reduce the Bank's engagement and level of strategic dialogue in these areas. In the end, continued involvement under the 2003 CAS was made possible by DFID, which agreed on a pilot basis to cofinance a number of Bank projects in the social sectors by blending DFID grant funds with IBRD resources to reduce the effective interest rate of the IBRD loan.

Improve coverage and quality of education: In the 2003 CAS, the Bank supported China's goals to: (i) expand access to quality basic education; (ii) decentralize education planning and budgeting; and (iii) reorient higher and vocational education through support for qual­ ity enhancements and demand-driven training and skills development. The Bank and the GoC recognized that China needed an education system that would produce higher quality results, use resources more efficiently, and be sufficiently equitable to maintain social cohe­ sion. A two-pronged strategy was agreed for pursuing these aims, involving (i) ensuring better resourcing for the weakest parts of the system to provide increased access to basic education for all and (ii) encouraging the most dynamic parts of the system to grow and continually improve in quality.

• Basic education. During the CAS period, the GoC completed the 4th and launched a new basic education project in collaboration with DFID with a goal of supporting national level reforms and promoting innovation. Together, these projects have pro­ vided $515 million in financing for improving school facilities, teacher training, manage­ ment, and innovations in educational service delivery in poor provinces, and have promoted more child-friendly participatory teaching methods in target schools and bet­ ter financial management in some provincial education bureaus. Increased government transfers for compulsory education in rural areas are in line with the findings of Bank AAA, in part funded by ASEM, which helped to analyze financial transfer programs to support education in poorer regions. • Higher and vocational education. The Bank and China worked closely together to improve the quality and relevance of undergraduate science education, with invest­ ments in curriculum reform, faculty upgrading, teaching skills and lab equipment, and vocational education. The Bank successfully piloted and disseminated curricula re­ forms; helped improve professional development for faculty and administrators as well as student assistance programs; and enhanced competitive funding mechanisms. These interventions helped institutions to pursue greater efficiency, measure outcomes by tracking their performance in the labor market, and align with market demands through developing closer ties with industries. IFC also supported higher and voca­ tional education through investments to develop high quality distance medical educa­ tion across China and to strengthen institutions providing specialized training (e.g., bank training).

• • 66 ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

Although the relative importance of Bank financing in the education sector has dimin­ ished with growing national investment, Bank projects continue to provide important ve­ hicles for building capacity at the sub-national level and for incubating innovation. Even so, Bank engagement in the education sector was difficult during the eAS period, given that poorer jurisdictions found it difficult to borrow on IBRD terms for social sector projects unless the loans were subsidized by grant resources.

Protect health services: In the health sector, the Bank Group aimed to support the Goe to improve health services, with a particular emphasis on service delivery to disadvantaged groups and the rural population. The eAS included multiple progress benchmarks, most of which were very ambitiously national in scope. In providing support, the Bank's ongoing portfolio of health projects (no new health projects were launched during the eAS period) had some important successes. In particular, the Goe made use of a pilot under the Bank's Basic Health Services project to formulate its national Medical Assistance program, which provides financial assistance to the poorest households so that they can access essential health care. Health 9 introduced important innovations for reaching populations at high risk of HIVI AIDS, and the Tuberculosis project (the largest such project in the world, made possible by DFID grant cofinancing) met WfO targets for enhanced tuberculosis detection across a project area covering 700 million people. WBI has also contributed to building capacity in health economics and financing through sustained partnership with a network of higher education institutions, and IFe invested in a hospital to expand access to interna­ tional-standard medical services in Beijing and Shanghai. Even so, relative to the ambitious goals set out in the eAS, the Bank Group's impact on the sector has been modest. Reflecting the Bank's changing role (including limited prospects for future lending in a non-IDA envi­ ronment) as well as increased Goe attention to health care financing and delivery issues in the wake of the SARS epidemic, the Bank during the eAS period repositioned its assistance from a focus on discrete project interventions to one of greater engagement on policy issues in the rural health sector, with a major collaborative AAA effort examining the policy changes necessary to make quality health care accessible and affordable to the rural population. While it is too early to assess the results of this ongoing effort, it sets the stage for the Bank better to support Goe policy reforms in the future.

Strengthening social protection

Under the eAS, the Bank planned to help the Goe to strengthen its national social protec­ tion framework and introduce policy reforms in the areas of pension reform and labor markets. During the eAS period, the Bank continued a long-term program of assistance through three ongoing lending operations, a substantial AAA program, and WBI learning events. This program supported Goe pilot initiatives, helped to shape the policy framework and debate, and contributed to long-term institution building as the Goe continued to make progress on a wide range of reforms in social insurance, urban (dibao) and rural assistance programs for vulnerable households, and reforming labor markets, including relaxation of some barriers to labor mobility.

• On pensions, Bank-Goe analysis deepened policy-makers' understanding of system design flaws and reform options to improve sustainability. Evaluation of national poli­ cies and an approach piloted in Liaoning province provided concrete proposals to reform policy parameters to restore financial viability, improve organizational structure and administrative procedures, and strengthen financial and information management COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

across the system. Bank assistance has directly led to the establishment of an actuarial unit in MoF and localized an analytical tool in the Ministry of Labor and Social Security that has been used to assess pension reform options at central, provincial, and munici­ pal levels across China. • On labor markets, Bank TA helped to identify major barriers to labor market integra­ tion as well as options to strengthen the unemployment insurance program. The Labor Market Development Project helped to improve active labor market programs and de­ velop a labor market information system, now widely adopted across China, that pro­ vides expanded access to information and services to people seeking to acquire new skills and search for new jobs (including workers redeploying as the result of SOE reforms). • On social safety nets, not planned in the CAS, the Bank helped the GoC assess the urban minimum living allowance program established in 1999 as well as a number of pilot rural social assistance programs targeted at vulnerable households. These interven­ tions provided building blocks for ongoing GoC efforts to develop a framework for rural social protection complementing national poverty alleviation programs.

Lessons learned in supporting strengthened social services

• Reflecting the Bank's shifting relationship with China, innovation, experimental pro­ gram design, and global knowledge-sharing are of primary importance in the social sectors. While large-scale financing needs remain, new projects should be designed and implemented with the ain1 of helping to inform evolving policies. To this end, the newest generation of projects are being designed with a comparatively heavier emphasis on experimental design and capacity building. • Sub-national units which currently have responsibility for loan repayment have some­ times been reluctant to finance bold experimental activities or monitoring and evalu­ ation activities which would contribute to the greater public good. They have perhaps tended to place a greater emphasis on stretching the investments in infrastructure and hardware in response to inunediate pressures. Options to address this difficulty might include providing national subsidies for loan repayment, blending IBRD re­ sources with national programs to reduce loan charges, including larger "central government components" in projects, co-financing, or targeting assistance only on the most reform-minded provinces. • Reducing IBRD charges for social sector projects in poorer jurisdictions with lin1ited repayment capacities continues to be necessary to enable IBRD demonstration projects to continue in these areas. The Bank has been encouraged by the GoC's recently­ expressed willingness to blend resources from the GoC's central budget with IBRD resources to hold down loan repayment obligations for poor beneficiaries in selected circumstances. A key challenge for the new CPS will involve working out the de­ tailed arrangements to realize this solution, starting with an appropriate pilot project. • In education, further work is needed to help the most vulnerable-the disabled, migrant children, ethnic minorities and the very poor-achieve 9-year compulsory education. An improved assessment system is needed to monitor learning over time and inform policies to improve quality. Frameworks for financing, private sector investment and quality assurance in secondary and higher education are also re­ quired as the pressure continues for these sub-sectors to grow. ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

Improving Targeted Poverty Reduction Programs

Strengthen effectiveness of anti-poverty programs in lagging areas. Under the 2003 CAS, the Bank sought to advise the GoC on effective implementation and targeting of anti­ poverty strategies, policies, and programs. CAS objectives were fully achieved as the Bank continued to build a close partnership with the State Council's Leading Group Office for Poverty Alleviation and Development (LGPR) and saw significant impact from its poverty­ focused AAA and poverty reduction projects. Ongoing implementation of the GoC's rural poverty program continues to align with collaborative Bank assistance, including recom­ mendations for improved targeting (e.g., shifting from county- to village-based targeting as the GoC designated 148,000 poor villages); strengthened financial monitoring and supervi­ sion; increased local participation in project design, implementation and monitoring; stron­ ger outreach to minority nationalities, the disabled, and other vulnerable groups; and further expansion of the rural poor's access to basic education and health services. Work on a new poverty assessment is underway, and will help to improve understanding of the changing distribution, nature, and causes of remaining poverty in China. In May 2004, the Bank's poverty reduction work in China was showcased during the Shanghai Conference on Scaling-Up Poverty Reduction, organized by WBI. In addition, in October 2004, the GoC chose the Bank Group to be the first recipient of its Poverty Eradi­ cation Award for international agencies. As an outcome of the Shanghai conference, WBI helped to establish and strengthen the International Pove1ty Reduction Center in China (IPRCC), a research and training center that is growing into a repository of knowledge on China's development experience and a regional hub integrated with a network of similar centers. Other GoC agencies have requested WBI assistance to package their development knowledge in a way that is relevant for other countries, particularly in Africa. While there have been many successes as well as very close agreement with the GoC on the poverty reduction policy framework, it is clear that more needs to be done to achieve real change on the ground. Poor villages have been designated and funds earmarked, but relatively limited funding directly reaches poor households, as most funding is absorbed at village- or county-level poverty projects. While the GoC's commitment to a more demand­ driven approach is real, much remains to be done to develop practical measures at the local level to better empower villagers to be more in control of poverty reduction efforts and to reach the most remote and disadvantaged.

Lessons learned in supporting poverty reduction initiatives

• Further work needs to be done to mainstream poverty-reduction objectives into general rural development programs and to build a national poverty-reduction pro­ gram which rolls out needed reforms across the western and central provinces where most of the remaining rural poor reside. • Continuing innovation will be needed as the GoC continues to refine targeting of poverty reduction efforts (e.g., testing household-based rural targeting), to develop multi-faceted and differentiated approaches to reach remaining groups of rural poor (including the poor in remote mountainous areas and minority areas as well as specific categories of poor such as those with limited land, ability to migrate or to work), and to enhance participatory measures and community-driven development approaches. COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Managing Resource Scarcity & Environmental Challenges

The 2003 CAS emphasized assisting the GoC to achieve more environmentally-sustainable development. Shaped by the findings of a major study (China: Air, Land, and Water) car­ ried out by the State Environment Protection Agency (SEPA) and the Bank, the second pillar of the CAS defined five dimensions of Bank Group support for the environment: institu­ tional reform, protecting and managing air, land and water resources, and cooperating with institutions to protect the global commons. Bank interventions were largely successful in supporting policy and institutional reforms and model practices. Even so, concerted GoC efforts and progress in many areas failed to keep pace with China's rapid economic growth, with the result that resource scarcity and environmental challenges continued to grow dur­ ing the CAS period.

Strengthening Effectiveness of Environmental Institutions

As planned in the CAS , the Bank assisted Chinese authorities to strengthen the country's environmental law and regulatory framework as well as institutional capacity to monitor and enforce regulations. The most important achievement during the period was the enact­ ment of the new (2003) Environmental Assessment Law. As part of an ongoing effort to prepare implementing regulations for the new law (with completion planned for 2006), the Bank helped SEPA to prepare guidelines for public participation and information disclosure (implemented for the first time in early 2005), two areas in which Chinese requirements have lagged international best practice. Some Bank urban and transport projects have served as models for state-of-the-art monitoring and enforcement, and WBI provided extensive capacity building to SEPA's directors and environmental protection bureaus (EPBs). Perhaps most significantly, environmental and social reviews under the Bank's safeguards combined with GEF and other funding mechanisms helped to mainstream environmental concerns into local planning in some jurisdictions implementing Bank-supported projects.

Lessons learned in strengthening effectiveness of environmental institutions

• Further effort is needed to integrate environmental objectives at the strategic and planning stages (e.g. through greater use of Strategic Environment Assessments) and in sectoral investment programs. Mainstreaming environmental considerations in projects has been an important tool for addressing environmental issues and build­ ing local capacity. The Bank can potentially play a more significant role through greater upstream involvement in the preparation of sector strategies and planning, when environmental considerations can be taken into account in a more effective manner. • After closure of the Environmental TA project, the Bank didn't have a framework for continuous policy dialogue and assistance to environmental policy and institutional development. Trust funds became the primary mechanism supporting analytical work and TA, imposing constraints on continuity, predictable financing, and scope of work. ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

Improving Air Quality

Building on its long-term partnership with China in the energy sector, the Bank was largely successful in providing assistance for energy sector reforms, restructuring, and technology transfer promoting greater use of renewable energy and cleaner fuels, energy efficiency, and expanded air pollution control technologies. While the Bank made important contribu­ tions, mostly through its small energy program with parallel support from GEF, China struggled to sustain earlier progress toward improved air quality as rapid increases in coal consumption and industrial production-associated with a rapidly growing economy-in­ creased air pollution.

Assisting conversion to renewable energy and clean fuels. The Bank supported GoC efforts to promote the expanded use of natural gas, clean coal, renewable energy sources, and improved energy efficiency through an ongoing program of research and targeted investments:

• Studies supported by t11e Bank and GEF paved the way for the 2005 Renewable Energy Law which, inter alia, sets out the connection, pricing and cost recovery arrangements for grid-connected renewable electricity. • Catalyzed in part by the Bank's Renewable Energy Development project, the CAS pe­ riod saw a significant increase in interest and uptake of photovoltaic (solar) power, for off-grid electrification, with the project helping to finance 175,000 systems. Technology transfer and market development activities have approximately halved prices of photo­ voltaic systems and Chinese companies are now internationally competitive, with a burgeoning export market. • Bank AAA along with IFC investments and TA (targeting the largest private-sector natu­ ral gas distributor) contributed to the development of the gas market and further expan­ sion of gas distribution infrastructure that is now increasing gas penetration. • Bank assistance helped to successfully demonstrate models of sustainable project fi­ nancing, commercialization, private sector participation, and the use of carbon financ­ ing in supporting medium/small-sized hydropower plants in five poor counties.

Providing efficient energy delivery. China increasingly emphasized energy conservation during the CAS period, including the promulgation in 2004 of China's new Medium and Long-term Energy Conservation Plan. The Bank served as a core partner for GoC efforts to design and implement energy efficiency programs in two main areas.

• The Bank helped to develop an energy performance contracting industry through help­ ing to develop new investment and financial intermediation mechanisms to encourage the adoption of financially-viable energy conservation investments. By 2005, some 60 energy performance contracting companies in China held energy efficiency investments of $100 million. • The Bank helped the GoC to develop and implement urban heating system reforms as well as building energy efficiency standards. AAA and a $18 million GEF operation supported a new central government program to pilot heat billing and pricing reforms in several northern cities. • IFC investments have also demonstrated that environmentally compliant, well-managed private power plants can be financially viable in the Chinese market.

11•• COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Lessons learned in improving air quality

• The long-term Bank-China partnership in the energy sector has been an important factor in Bank contributions and provides the platform for continued assistance. Sustained engagement will be needed to support scaling-up progress in energy effi­ ciency, technology transfer, and implementing the Renewable Energy Law, with a strong emphasis on capacity-building. • While improving energy efficiency is important to reducing the resource intensity of the sector and overall economy, addressing serious air quality issues requires an integrated approach with cross-sectoral coordination. During the CAS period, the Bank lacked appropriate instruments to support such a comprehensive approach. • Future Bank assistance to combat air pollution will need to take into account the shifting nature of China's air quality challenges. Residential and vehicular sources of air pollution are expanding rapidly, and represent areas where China may wish to obtain Bank assistance in the future. Air pollution reduction efforts now more than ever need to focus on how to reduce ambient concentrations in the most cost­ effective ways.

• Moving beyond largely successful efforts to incorporate energy-efficient technologies and more rigorous emission standards in new power plants, the Bank is poised to help assess and pilot optimal ways to clean up existing plants (the focus of the Shandong Flue Gas Desulfurization Project planned for FY07).

Managing Water Resources

Improve water management and conservation in agriculture and rural areas. The CAS aimed to support improved rural water management through investments in water saving, support for improved water pricing, irrigation system modernization, flood control, and integrated river basin management. Goals for water conservation were largely met within Bank-financed activities, but there is scope for further mainstreaming successful demonstrations into the GoC's own programs. Reforms in the sector have been directed at introducing the concept of real water savings and applying an integrated set of water-saving measures in irrigated agriculture. Guided by the Country Water Resources Assistance Strat­ egy, CAS goals were largely met as the Bank helped China to find solutions to traditional water resource management (WRM) problems using non-traditional approaches. Significant GoC achievements to which the Bank contributed included:

• Establishing the first river-basin-level institutional arrangements for an intra-provincial river basin (Tarim) through a dynamic and participatory process that involved farmers, agricultural support services and water services providers; • Establishing a water quota system, including a quota for the environment; • Increasing attention on the conservation and management aspects of WRM, particularly on the arid north China plain; • Expanding the number and viability of Water User Associations; • Developing a tripartite approach to real water savings involving the use of cutting-edge international technology and engineering, agriculture and management measures. The introduction of a volumetric basis for irrigation water charges as an integral part of the formation of Water User Associations was a significant step (one that has now been incorporated in all Bank support for Water User Associations). ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

Lessons learned in rural/agricultural water conservation and management

• Although much remains to be done, awareness of the need to address water use efficiency and conservation has grown significantly in China over the past three years. Key factors in the success of Bank assistance have been institutional commit­ ment and GoC willingness to adapt cutting-edge technology to address China's chal­ lenges. • The CAS period demonstrated the clear linkages between sustainable water resource management and poverty reduction, the need for institutional reforms at the river basin level to include an integrated strategy of both top-down and bottom-up mea­ sures, and the usefulness of remote sensing in monitoring water waste and defining water rights. • Experiences during the CAS period also reinforce the importance of participatory approaches that align farmer incentives, efficient use of water in irrigated agriculture, and overall agricultural productivity; of charging for irrigation water on a volumetric basis; and of developing an effective system of defining rights to water. • The Bank, in partnership with the Ministry of Water Resources (MoWR), should focus future Bank investments and activities on formulation of WRM and water management components as an integral part of infrastructure projects; translation of water conservation and sustainability goals into workable programs, policies and strategies through analytical assistance and investments; and selection and financing of high-priority infrastructure and WRM investments, including projects that focus on water re-use for domestic and industrial purposes. • Investment projects have been used as vehicles to help the GoC promote the difficult institutional changes needed to deal with critical WRM issues. However, the Bank in strategic partnership with MoWR needs to become more involved in upstream dia­ logue focused on planning and implementing investments and also in defining the necessary legal, institutional, and policy reforms needed.

Improve urban water quality and management. The CAS supported China's goals to expand municipal sewage treatment and solid waste management, clean up the most pol­ luted waterways, and establish working models of wastewater re-use primarily through financing model investments. Wastewater collection and treatment was the largest component of the eight new urban environment projects approved during the CAS period, and MIGA guarantees during the period focused on wastewater treatment and water supply projects. Urban environment projects have contributed to increased capacity in target cities and utilities to deliver waste­ water and other services in a more financially- and environmentally-sustainable manner. Bank projects have enabled the cities to install facilites with appropriate treatment technol­ ogy and the needed size, thus optimizing investment costs of wastewater treatment (an independent study conducted by Liaoning province found that Bank projects had cost savings of 30-40% compared to similar GoC investments). Other major contributions in­ clude: the use of cost recovery pricing for water demand management; promotion of inter­ municipal planning of wastewater services to achieve larger economies of scale; ensuring sewage collection capacity complements wastewater treatement plants (capacity utilization in Bank-financed wastewater treatment plants is higher than in non-Bank-financed plants in other cities); and expanding collection and treatment services to peri-urban areas outside of core cities. Urban projects have helped the GoC to operationalize decrees on corporatization, COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

introduce commercial principles and cost recovery in wastewater management, and build the capacity of sector institutions, particularly in provinces and metropolitan areas where there has been sustained Bank engagement (Shandong, Beijing, Tianjin, and Shanghai). Components of these projects have also successfully encouraged local industries to invest in pollution control through small loans and so comply with environmental regulations. Re­ cent Bank AAA has also laid the initial groundwork for improving solid waste management. CAS objectives related to wastewater treatment were largely met in target localities, with the Bank playing a limited but important role in helping the GoC to meet ambitious targets for expanded wastewater treatment (according to GoC statistics, the daily municipal sewage treatment rate rose to 43.6% by end-2004, compared to a target of 45% by end-2005). However, it is difficult to measure the extent to which model practices have been scaled-up. Progress in meeting CAS benchmarks for cleaning up the three rivers and three lakes has been slower, because of delays in complementary action beyond Bank project investments. Despite the progress outlined above, as well as continued strong GoC commitment, water pollution continues to be a serious problem in China. As a by-product of China's rapid growth, wastewater discharge continues to increase; collection systems fail to keep pace with growth in treatment capacity and continue to lag needs; and so some treatment plants operate below their design capacity. The water quality situation in China's 20,000 towns and townships below the city level is a major challenge (and an increasing focus of Bank invest­ ments and AAA) . Consideration should be given to monitoring not only the amount of wastewater treated but also the amount collected to ensure that incentives in the sector support appropriate action. More can also be done to support compliance with regulations on pre-treatment of industrial waste, particularly for financially-strapped SOEs employing a large local workforce and for the municipal environmental protection bureaus that are responsible for enforcement. In this context, the central government is appropriately en­ couraging under-loaded municipal wastewater treatment plants to increase their revenues and their locality's wastewater collection and treatment amounts by receiving additional pre-treated industrial wastewater, particularly in peri-urban areas with mixed industrial and residential development.

Lessons learned in urban wastewater treatment and solid waste management

• Further work is needed to support the dissemination and scaling-up of successful practices demonstrated under Bank projects, in part through the water and wastewa­ ter sector study currently underway and through exposure of Chinese officials and sector agencies to international good practice (inter alia through the IWA Confer­ ence in Beijing in 2006). • Management of sludge generated at water and wastewater treatment plants, indus­ trial effluents, and solid waste are increasingly pressing challenges. Assisting in the tighter monitoring of sludge disposal, encouragement of alternative sludge treatment options, increasing industrial pollution treatment in key sectors, and strengthening solid waste management are areas where Bank engagement can be usefully ex­ panded. • Improved water quality will also require new approaches to control non-point pollu­ tion sources.

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Managing Land and Natural Resources

Bank-supported projects successfully piloted new approaches for natural forest protection, erosion control, and watershed rehabilitation, but were less successful in efforts to increase commercial timber and economic tree plantations. The Loess Plateau and the Gansu and Xinjiang Pastoral Development projects demonstrated watershed rehabilitation, erosion con­ trol and measures to prevent desertification, which in turn helped to steer local and national funding toward these activities. Complementing a GoC logging ban, the Sustainable For­ estry Development project provided models for protecting natural forests and sustainable management in a number of nature reserves (and mobilized resources and know-how from GEF and the E.U.). Over 700,000 ha of forests were planted under Bank projects. Because of the size and large-scale of some national programs, the contribution of Bank-funded activi­ ties to increase commercial timber and economic tree plantations were modest.

Lessons learned in managing land and natural resources

• Community participation and buy-in are important factors to increase the sustainability of nature reserves. • New tree plantations have potential to reduce pressure on natural forests in China as well as in the Asia region, but sustainable forest policies are needed to encourage the participation of financial institutions in commercial forestry. • Clear policies and adequate funding are necessary to improve natural resources conditions and management. Outstanding issues include the need for improved monitoring and evaluation, linkage between environmental and economic aspects of resource conservation, and implementation of sustainable forest policies to promote commercial forest plantations.

Protecting the Global Environmental Commons

The Bank supported China's participation in global environmental initiatives in areas tar­ geted under the CAS: the phase-out of ozone depleting substances (ODS), where China fully met interim targets; conservation of biodiversity; participation in the Clean Develop­ ment Mechanism (CDM) and mitigation of greenhouse gas emissions; and phase-out of persistent organic pollutants (POPs). In addition to providing IBRD resources, the Bank assisted China in obtaining significant grant funds through GEF to address these globally significant environmental issues (since GEF was launched in 1991, the Bank has approved fifteen GEF co-financed projects in China, involving $230 million in GEF grant resources, the largest GEF funding to a single country in the Bank) as well as through mobilizing dedicated grant resources for ODS phase-out and carbon finance.

• Reduction of ODS. China's ODS reduction program, the largest in the world, has fully met its interim targets, suggesting that enterprise-level activities, coupled with national policies that address both production and consumption issues, combine for an effective approach. For the next few years, there will be a need for more effective enforcement of ODS policies, development of suitable alternatives to ODS, and cost-effective ODS destruction and conversion technologies. COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

• Improved conservation of biodiversity. In support of China's rapid creation of na­ ture reserves, which now account for 15% of total land area, the Bank provided assis­ tance through several GEF projects to strengthen local protected areas management. In parallel, to address systemic problems, the Bank is working with SEPA, UNDP, the E.U. and other partners to develop a comprehensive Biodiversity Partnership Framework. • Mitigation of greenhouse gas emissions. The Bank's largest GEF Climate Change Program facilitated passage of the Renewable Energy Law and encouraged use of renewables and energy efficiency investments (described under the Air Quality section, above). • Participation in Clean Development Mechanism (CDM). China's emission of green­ house gases has continued to increase as a function of its rapid economic growth and continued reliance on coal and oil as major sources of energy. In addition to Bank contributions in the energy sector, the Bank helped China to assess the opportunities and benefits of participation in CDM, provided technical assistance to support the regu­ latory and institutional framework for CDM, and supported pilot CDM projects that have helped lay the foundation for a carbon emissions trading market. The Bank's contribu­ tion to climate change mitigation is likely to increase with its involvement in the prepa­ ration of a National Climate Change Program, HFC-23 project, Carbon Finance Assist program, and the development of the CDM market. • Phase-out of persistent organic pollutants. Bank-supported analytical work, capac­ ity building, and preparation of demonstration projects with GEF support in selected provinces also supported China's 2004 ratification of the Stockholm Convention for the phaseout of persistent organic pollutants (POPs). To ensure effectiveness, more effort will be needed to strengthen the involvement of stakeholders, especially at the province level, increase public awareness of related health and environmental risks, and extend the program to sectors and substances not covered by the planned demonstration projects.

Lessons learned in protecting the global environmental commons

• Adjusting the prices for natural resources and environmental services in line with opportunity costs will be needed to encourage more efficient resource use and the development of alternatives. • In order to reach planned targets for environmental protection, resource savings, and sustainable management, strong inter-governmental collaboration is needed at both the central and local levels. Overlapping or unclear institutional mandates for inte­ grating resource management and environmental protection into the development process, coupled with weak environmental management and enforcement, are un­ derlining some resource scarcity and environmental challenges. • Building on poverty-environment linkages, the development of China's poorer rural regions needs to address poverty simultaneously with degraded natural resources, such as soil erosion and deforestation. • Although the enforcement of current environmental regulations has improved, their tightening and continuous progress on the monitoring and enforcement side is needed. Strengthening the effectiveness of Environmental Protection Bureaus and coordination among sectors, particularly at the county and township levels, will be particularly important.

• • 76 ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

Reforming the Financial Sector

As part of the broader objective to improve the business environment under pillar 1 of the CAS, the Bank sought to support China's efforts to transform its financial system to meet the needs of the country's market-oriented economy. IFC investments and over $1 million per year of Bank Group analytical support-provided through a wide range of strategic and policy advice, studies, workshops, and TA-supported these reforms. This contributed to GoC accomplishments in the reform of state-owned commercial banks (SCBs), financial sector policy reform (especially regarding interest rate liberalization, a major accomplish­ ment that removes a key impediment to the financial sector), and the improved regulation of securities firms (including promulgation of a net capital rule, a cornerstone of the regula­ tory framework). Assistance also strengthened Bank Group relationships with Chinese coun­ terparts, building the foundation for deeper future collaboration, including a planned project on medium and small enterprise finance. More work is required to reach the important long-run benchmarks of capital market development and expanded access to financial ser­ vices for small rural businesses and lower-income housing.

Support establishment of an overall financial sector regulatory policy framework. The Bank aimed to help the GoC to reach a consensus on its long-term financial sector objectives and its appropriate future role in the sector. During the CAS period, the State Council, MoF, NDRC, PBoC, and the regulatory authorities for banking, securities and insur­ ance generally took policy decisions that promote a progressive transition to a diverse and competitive financial system that can meet the needs of firms, households and governments in a growing market economy. The liberalization of lending interest rates and the reform of the government bond market were key milestones long advocated and supported by the Bank. .

Promote commercialization of the financial services industry. Under the CAS, the Bank Group also planned to support various aspects of banking system reform, including assistance with recapitalization and restructuring of the four largest SCBs. During the CAS period, two SCBs-the Bank of China and the China Construction Bank-were recapital­ ized, including by transferring NPLs to asset management corporations; they were also incorporated and formal boards of directors were appointed. A similar process is underway for a third (and the largest) SCB, the Industrial and Commercial Bank. All four of the large SCBs sought foreign strategic investors in preparation for a global public listing of their shares during the CAS period, and three of them were turned into joint stock companies in 2005; commercialization of the fourth-the Agricultural Bank of China-is expected, albeit with more difficulty. During the CAS period, non-state capital also flowed into other finan­ cial institutions at a reasonable pace though full privatization of a significant portion of these other institutions is unlikely in the near term. Pioneering IFC investments and TA helped non-state commercial banks improve corporate governance and risk management and, in some cases, attract foreign strategic partners. In addition, the GoC created an ownership agency (Huijin Central Investment), which is pursuing a commercialized approach to SCB governance. While all of these developments are essentially attributable to the strong lead­ ership of the PBoC and CBRC, the Bank provided a range of SCB-related policy and opera­ tional recommendations advocating and supporting them. Bank advocacy has also concerned reducing political interference in making management appointments or other major deci­ sions in the banks (this is now emerging as a key issue) as well as addressing non-commer­ cial pricing and low real returns in the banking industry (factors which will continue to COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

constrain the more rapid entry of private capital), but progress has been less evident in these areas. In addition, while interest rate liberalization has created the space for better pricing, abundant liquidity will continue to lead to high lending competition (and perhaps under-pricing) in the near term. Throughout the CAS period, the Bank has been a persistent advocate of the principle that commercially-sustainable lending is feasible in China's more difficult and underserved markets, such as micro and small enterprises (MSEs) and rural areas. This principle is in­ creasingly accepted within the GoC, and reasonable progress is being made, except in rural markets which are poorer and present more difficult access challenges. In recognition of its work in these areas, the Bank has been invited to pilot a commercially-sustainable MSE finance program, currently under preparation, and it has also assessed the potential role of the Postal Savings and Remittance Bureau (PSRB) in lending to rural markets and provided advice to PSRB, PBoC and the CBRC in this matter. Despite this progress, the Bank has been less successful in ensuring that public resources directed toward rural finance reform and institution-building are adequate for scaling-up financial services in rural areas. Other areas of Bank influence have concerned the development of the secondary hous­ ing finance markets, initially through the issuance of mortgage backed securities (MBS); the creation of a banking regulatory authority (CBRC); and the creation of credit information registries. Regarding MBS, the Bank has supported policy assessments, the design of an appropriate regulatory framework, and various decisions on institutional arrangements; fur­ ther support is anticipated, both with respect to MBS, and also to develop mortgage liquidity facilities and reform and develop mortgage insurance. Following analytical work that led to the creation of CBRC, the Bank has been engaged in a sustained institution-building pro­ gram, and its AAA is expected to be directed to all three regulatory agencies (CBRC, the China Insurance Regulatory Commission and the China Securities Regulatory Commission (CSRC)) over the near term.

Continue to restructure banks and other financial institutions while minimizing fiscal and social implications and maintaining stability. During the CAS period, the PBoC, CBRC and CSRC successfully resolved a number of distressed banks, trust companies, and securities firms . The Bank provided a range of advice, including with respect to bank failure resolution policies and practices, and more broadly, the means to minimize costs and moral hazards in resolving distressed institutions. It also supported adoption of a new net capital rule for securities firms, which further enables CSRC to weed-out weak firms. In addition, the State Council endorsed a pilot restructuring of the rural credit cooperative (RCC) system, for which the Bank assessed the plan and offered strategic and policy advice. Restructuring efforts encountered difficulties, which were in many cases anticipated in the Bank's assessment, and the program is being refined to address them. IFC supported the development of the distressed asset market, including financing that demonstrated alterna­ tive approaches for resolution of NPLs and distressed real estate assets.

Establish sound capital markets. Many reforms of the government bond market were implemented with Bank advice, though little progress was made on the reform and devel­ opment of the corporate and sub-national government bond markets. A new plan for re­ solving the overhang of state and legal person shares on the Shanghai and Shenzhen stock exchanges has been announced, but its effectiveness remains to be seen. Despite the Bank's advocacy and TA, regulatory fragmentation remains a particular problem in capital markets, especially with respect to bond market reforms, and building the capacity of the CSRC remains a challenge. IFC supported the development of the non-state insurance sector Cw.ith

• • 78 ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

Lessons learned in supporting the financial sector

• Important constraints to deeper and faster progress include: the weak finances of many sub-national governments, which nonetheless need to invest in infrastructure and seek to undertake other investments; the still important role of SOEs in the economy and their need for finance; the high number of government agencies with jurisdiction over elements of the financial system and the consequently fragmented regulatory framework; the burdensome approval or consent process that applies to nearly all reform and development initiatives; and finally the sheer magnitude and duration of the institutional and human resource investments required to move to a commercialized financial system.

investments in life insurance, re-insurance, and insurance products serving the consumer lending and SME insurance needs of rural credit cooperatives). In a landmark event, IFC issued the first Renminbi ("Panda") bond by a non-Chinese issuer.

Strengthening Public and Market Institutions

The first pillar of the 2003 CAS articulated an integrated set of activities related to improving the business environment, with sub-objectives on macroeconomic management, private sector development and enterprise reform, and governance and public sector management. Infrastructure reforms, originally covered under both private sector development (private sector participation) and governance (public utility performance) sub-objectives, are con­ solidated below to reduce duplication and overlap. In contrast to CAS pillars II and III, the bulk of the Bank's assistance for theme I was provided through analytical and advisory services rather than through investment lending.

Strengthening Institutions for Macroeconomic Management

Promote macroeconomic stability. The CAS set general directions for macroeconomic support and planned for a combination of rapid response notes on issues of immediate concern together with in-depth analytical work, recognizing the need to maintain flexibility to respond to changing client needs. The Bank supported macroeconomic policies through regular economic updates, a variety of policy notes (covering, inter alia, macroeconomic policy stance, fiscal policies, state enterprise reforms, and interest rate liberalization), and formal reports such as the country economic memorandum. These activities have generally been successful in putting key policy issues on the agenda as well as in promoting dialogue on options based on cross-country knowledge and experience. The program matrix set progress benchmarks in three main areas:·

• Macroeconomic management. As set out in the CAS, the Bank provided advice on interest rate liberalization, external trade and market regimes, and fiscal sustainability issues, as well as on investment climate and labor market policies (see related sections). China maintained a good overall macroeconomic performance during the CAS period, with strong growth and low inflation as well as efforts to rein in overheated investment sectors. Key developments to which the Bank contributed included further liberaliza- COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

tion of interest rates (a move long advocated by the Bank), launch of a short-term capital flows monitoring system in the State Administration of Foreign Exchange (SAFE) that will allow a gradual opening of the capital account, and economic census support (which contributed to China's recent improvement of its GDP figures). The Bank also provided advice-through policy notes and government-organized forums--on fiscal and monetary stances to cope with external contingencies (e.g., global slowdown, SARS) during the CAS period. Bank TA in the field of statistics, fuel tax, labor market reforms, macroeconomic modeling and capital flows monitoring also helped policy makers make informed choices on the basis of more rigorous technical background analyses while training a cadre of specialists to carry the work forward. Bank work on the investment climate, SOEs and SCBs, as well as on FDI policies has contributed towards understand­ ing key impediments that remain in bringing about a stronger investment climate. • Fiscal management capacity. Aligned with CAS benchmarks and building on prior analytical work and technical assistance, the Bank advised on improving identification and analysis of risks to China's state debt and also provided TA to MoF to enhance its capacity to record and monitor public debt. This work is continuing with a view to­ wards eventually integrating the external and domestic public debt databases and using it for making debt management strategy and policy decisions. The Fiscal TA funded the first phase of the treasury management system, which is currently being expanded, and an IDF grant supported design of a tracking system for poverty funding from the center to the counties. At an aggregate level, China's fiscal management has been consistent with the maintenance of macroeconomic stability and high GDP growth rates during the CAS period. At the central level, fiscal reforms have been undertaken, some in accordance with the recommendations of the Bank's Provincial Public Expenditure Review (2002). However, quasi-fiscal activities of local governments remain substan­ tially unrecorded and the Treasury Single Account (TSA) does not cover most of the public service units. Extra-budgetary funds, especially at the sub-national/municipal levels, are still large. • Intergovernmental f°uiance. The CAS set a general benchmark ("Further adjustments in revenue and expenditure assignment and transfers between levels of government") and strategy (advise on inter-government finance issues) for Bank activities in intergov­ ernmental finance. Building on the Bank's 2002 Provincial Public Expenditure Review and other earlier analytical work, the Bank sought further to contribute to understand­ ing key constraints in the fiscal system as well as to advocate greater equalization in the intergovernmental finance system. The Bank provided a package of policy papers, at the request of the GoC in 2003, on cross-cutting fiscal processes and structural eco­ nomic reforms. The ongoing Rural Public Finance study and the Liaoning subnational finance study have further contributed to an understanding of the fiscal situation at the sub-provincial level, and WBI has developed a multi-year program of training for pro­ vincial officials in intergovernmental fiscal relations and local finance in local universi­ ties together with MoF. However, despite sustained Bank engagement (and Bank technical work characterized by central authorities as salient inputs in an intensely political process), progress toward addressing imbalances has been limited., While most expenditure assignments are not any clearer than before, revenue assignments have changed-the enterprise income tax as well as the personal income tax are now shared taxes. In addition, the central government has started to increase the equalization grant to poor provinces by using part of the revenues of the enterprise income tax to fund the equalization grants pool, and some of the new earmarked grants (among others for civil service salary increase and for ethnic minorities) are more targeted at poorer

• • BO ANNEX 2: CHINA 2003-05 CAS COMPLETION .REPORT (CASCR)

Lessons learned on macroeconomic management support

• As China globalizes further and integrates its highly fragmented national market, the need to better understand the micro-dimensions of intergovernmental relations and associated institutional arrangements has become imperative. • Data sources within China remain weak and fragmented, which make the assess­ ment of macroeconomic risks difficult to gauge on a robust and continuous basis. Work towards increasing this data availability for research and analysis is underway. • Teaming up with the IMF and OECD has been instrumental in producing high­ quality advice. • Entrenched interests in the current system impede systemic improvements in inter­ governmental fiscal system and greater equalization. Working at the provincial level to develop a comprehensive approach to sub-national fiscal issues may be a way forward.

provinces. However, impact at the sub-provincial level is less clear, as provinces have significant discretion in sub-provincial distribution. Moreover, the hundreds of ear­ marked grants that have been created in recent years limit the transparency of the system, and may undermine incentives for local governments to seek efficiency and growth. In addition, local governments continue to lack a significant tax base with rate authority.

Improving Public Sector Management and Delivery of Services

Objectives for Bank assistance were grouped under three sub-themes: (i) improving the regulatory environment for good governance, (ii) strengthening the management of cities (discussed under theme 2 above); and (iii) strengthening the performance of public utilities in delivering infrastructure.

Improve regulatory and incentive environment. Under this sub-objective, the Bank sought to support improvements in procurement, auditing, public service delivery, and the legal profession. Despite relatively limited levels of Bank assistance, CAS objectives to assist with public sector procurement, accounting and financial reporting, and improved capacity in the legal system were largely met. The Bank contributed to strengthening China's pro­ curement law, procedures and capacity- including establishment of a procurement training program in five universities - fiscal management, reporting and auditing systems, and public service standards. Under the Economic Law Reform project, the Bank contributed to devel­ oping and implementing a unified lawyers and judges examination system, curriculum re­ form at the national judges college, court administration reforms under review by the Supreme People's Court, and establishment of a public internet-based legal information system (www.chinalaw.gov.cn). The Bank also helped to pilot efforts to solicit citizen feedback on service delivery in a number of cities. Sustained Bank support for GoC efforts to reform public service units (PSUs)-including a series of reports, a joint conference with the GoC and OECD, and a major report on the PSU reform strategy-helped to raise awareness of the need for reform and provided important inputs into the GoC's reform plan. Originally conceived as an input on the development of China's small services sector, the PSU work has played a catalytic role toward clarifying the budget links of public services units and laying the groundwork for increased private sector entry into the services sector.

81 • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Lessons learned in improving the regulatory and incentive environment

• Bank assistance for procurement and accounting reform increasingly focuses on implementation of the reforms that have been adopted. To better sequence and integrate Treasury reforms, the Goe is seeking Bank assistance in developing a Stra­ tegic Reform Framework that adapts international best practice and supports Goe efforts to develop an Integrated Government Financial Management System. For the future, the Bank could further contribute to completion of the legal framework (in which there are still some gaps) and implementation (through inter alia ongoing work to improve the judiciary and access to justice). The Bank can also further assist the Goe in identifying factors that may contribute to corruption and identifying struc­ tural reforms for addressing them.

Improve infrastructure services and performance of public utilities. The eAS in­ cluded multiple benchmarks relating to reforms designed to improve the efficiency and sustainability of infrastructure service delivery. The Bank made important contributions, but the scale of the Bank's contributions varied considerably across sectors. Building on its long­ term engagement, the Bank largely achieved its objectives and continued to make signifi­ cant contributions to sector-wide reform in the energy sector and in railroads through a combination of sustained policy advice and demonstration projects. Progress was more limited elsewhere. Bank support for roads, transport services, and urban utilities contributed significantly to related reforms at the local and provincial levels, but the Bank's ability to contribute to scaling-up successful reform experiences was complicated by decentralized authorities in these sectors and less substantial engagement in sector-wide analytical work.

Urban utilities. The Bank sought to support improvement of the framework for public­ private investment as well as the management and pricing of water supply and sanitation services. Supported by central government policy, municipalities have made progress in setting up autonomous utility companies, recovering service delivery costs, and experiment­ ing with private sector participation (PSP) in urban services. The Bank's urban water supply and wastewater projects, which comprised 22 projects in 67 cities during the eAS period, supported these priorities through a strong emphasis on utility performance, corporatization of public utilities, improved cost recovery, and enhanced technical and management skills. Progress was made toward greater cost recovery (with the introduction of a new progres­ sive water tariff scheme in Beijing and wastewater tariff adjustments in several other major cities supported by Bank loans) and private sector participation. Bank contributions were largely limited to specific municipalities where Bank projects were implemented, but the Bank also assisted the GoC in preparing for further public utility reforms by conducting the North China Water Quality Management Study.

Energy utilities. The Bank Group sought to help with implementation of power sector reforms to create new and separate companies, continue unbundling power generation from distribution, and develop competitive power markets. Building on more than a decade of engagement in the energy sector, the Group supported China's efforts to break monopo­ lies and expand competition in the sector. Key achievements were realized during the CAS period: ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

Lessons learned in supporting urban utilities

• The limited autonomy and capacity of many new utility companies, particularly in wastewater, results in their continuing to operate as municipal service companies. The rapid expansion of private sector participation (PSP) in the absence of an ad­ equate regulatory framework and independent regulation capacity is also a cause for concern. • Going forward, sustainable urban utility reform will need improved legal and regu­ latory frameworks; MoF and NDRC have welcomed planned Bank analytical work in this area. • Expanded use of performance indicators will be needed if efforts to promote cost recovery and PSP are to bring desired improvements in cost savings and efficiency. • Bank-supported projects need better to anticipate the higher level of required invest­ ment for wastewater compared with water supply and the longer time required to transform staff of a municipal service into an enterprise. Improved capacity building in Bank projects will require longer time horizons, greater counterpart ownership, and improved quality in design and delivery of TA.

• The GoC's shift from provincial to regional markets in the power sector - with the establishment of two regional markets in northeast and east China, including principles for the development of transmission pricing, better generation pricing, and more ratio­ nal consumer tariffs-is an important step towards increasing inter-provincial trade and improving the use of power resources. • Regulation of the power and gas sectors continued to be strengthened. In particular, a State Electricity Regulatory Commission (SERC) was established and strengthened (in­ cluding regional branches), and it is now playing a key role in developing regional power markets. • Power and gas companies continue to be the most advanced among China's SOEs in terms of corporatization and commercialization (China's three largest oil and gas com­ panies were partially listed on international financial markets), and the Bank has also been active in this area, primarily through strengthening of the reform and regulatory framework. • IFC investments in Shandong's power sector supported creation of a replicable model for privatization and efficiency improvements at the municipal level.

Lessons learned in energy

• Bank success in this sector resulted from client interest, long-term engagement, the Bank's role as an intermediary in disseminating knowledge and international best practice, strong synergy between AAA and lending projects, and strategic sector work with timely and focused policy notes responding to client needs. • Having helped China to shape the principles of energy sector reform, Bank assis­ tance will need to evolve to focus on implementing the reforms that have been adopted, with greater emphasis on capacity building. wro listing provides an op­ portunity to engage on the need to develop a regulatory framework for the oil and gas sector, and further dialogue on the coal sector is possible. COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Transport. Bank contributions to national-level reforms in the transport sector were made primarily in the railroad sector, where significant progress was made in restructuring and reform through the Bank-supported National Railway project, which, inter alia, included studies of legal and regulatory framework options for railway modernization, railway labor productivity, compensation and restructuring. In its continuing reform program, MoR has decentralized into 18 regional profit centers; spun off many non-core activities (e.g. rolling stock manufacturing, telecommunications) as legally independent companies or at least as financially separate subsidiaries; and transferred social services (schools, health centers) to local governments. Nonetheless, there is potential for improvement. Policy and regulatory functions could be separated from enterprises running the trains, thus helping to attract private financing, and current rail pricing (including the construction surcharge) could be reformed with a view to improving rail financing. In addition, as argued in Bank analytical work, private financing of wagons could be a promising entry point for private participation in railway operations, provided that MoR agreed to allow privately-owned freight cars on its network. Further work could also be done on analyzing and ultimately implementing policy and structural options related to institutional separation (including competition policy and the easing of price controls, options to attract new sources of finance and private sector participation). In the road and transport services sector, Bank-funded projects successfully met project objectives and the Bank provided significant analytical work on consolidating toll roads, with modest impacts at the national level. Projects helped to improve funding for mainte­ nance, road management capacity, rural road upgrading and road safety programs. Scaling­ up of provincial results was limited in part because implementation of the fuel tax has been postponed and Bank involvement on road safety issues at the national level has been limited. In addition to mobilizing sustainable financial resources for road maintenance, further work remains to be done to improve the policy and regulatory environment for transport. Private sector participation in China's highway system is advanced in terms of development models and private capital flows, with the private sector contributing nearly 10% of China's total commitment to new construction since the inception of economic reform in the early 1980s, but the degree of risk transfer from the public sector is less than desirable and the legal and regulatory framework for private participation in infrastructure presents obstacles to increased flows of funds. Bank analytical work also highlighted the benefits of consolidating toll road companies into larger networks and setting toll rates to balance financial and economic objectives.

Lessons learned in transport

• There are good prospects for encouraging private participation in the provision of transport servic~s--especially trucking and bus services-provided that the legal and regulatory framework is clarified regarding entry into the industry (to avoid local protectionism) and tariff-setting (to allow enough flexibility to reward innovation). Private participation in the financing of highways and railway infrastructure is less promising but can serve as a lever for institutional reform, especially for railway services. ANNEX 2 : CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

Promoting Private Sector Development and Enterprise Reforms

The CAS focused Bank support for the private sector on the twin priorities of improving the legal and regulatory environment for businesses and continued corporate restructuring of SOEs. The GoC made significant progress in both areas, though considerable constraints remain, with the Bank making important contributions through analysis, dialogue, and TA. CAS objectives under this sub-theme were largely met.

Improving the Environment for Private Sector Activity: During the CAS period, the Bank Group worked at national and local levels to rationalize the commercial law and regulatory framework and to promote investment climate reforms. The Bank-supported Economic Law Reform project (ELRP) provided TA for drafting and building capacity to implement numerous business laws-including contract, bankruptcy, company, partner­ ship, SME, trust, antimonopoly, trade, commerce, intellectual property, and others-as well as for related legal professional training institutions. The Bank also contributed a compre­ hensive study on e-commerce: an electronic signature law was recently passed, but devel­ opment of e-commerce is still constrained by gaps in privacy protection and capacity issues. Over the period, Bank Group assistance focused increasingly at the provincial and local level as Bank support for rationalizing the commercial law framework successfully drew to a close. Bank Group efforts intensified to streamline local requirements for business and strengthen the capacity of investment promotion intermediaries, with a special emphasis on lagging regions. Bank-led investment climate surveys (covering 5,000 firms in 37 cities, primarily in lagging regions) raised consciousness and spurred competition among local officials to improve the local investment climate, complemented by WBI training, and some cities are now actively working to improve the efficiency of the court system and reduce barriers to new business entry. Sustained follow-up engagement with local officials, in the form of detailed analyses by FIAS and IBRD and MIGA TA, is highly promising. Firm level surveys conducted by IFC's Private Enterprise Partnership (PEP, formerly CPDF) in Sichuan increased local attention to improving the business environment and helped local authori­ ties to relax administrative and licensing requirements. Related PEP China and MIGA assis­ tance to strengthen provincial investment promotion agencies in Sichuan and to conduct investment benchmarking studies have helped local officials to promote their locations to potential investors. At the national level, MIGA and FIAS helped the Ministry of Commerce to formulate a national investment promotion strategy.

Corporate Restructuring, Ownership Diversification and Industrial Reorganization: The GoC made substantial progress in corporate restructuring, including reforms in areas where the Bank provided earlier recommendations. The GoC was successful in developing a comprehensive policy for mergers and acquisitions, applying a harder budget constraint, separating SOEs from government control, and disposing of assets acquired by asset man­ agement companies (AMCs)--but it achieved more modest success in transferring social services out of SOEs, a particular problem in the northeast. Related Bank studies were conveyed to key stakeholders, and the recent consolidation of shareholder rights and re­ sponsibilities in a designated state shareholder (the State-Owned Assets Supervision and Administration Commission, SASAC) increased focus on management performance, finan­ cial management and risk management, and increased consideration of dividend policy by DRC and SASAC are entirely consistent with the Bank's earlier recommendations. While bankruptcy reform has been delayed, a combination of trust-funded TA and targeted com­ munications to policy-makers achieved full consideration of global best practices.

ss • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Strengthening Corporate Governance: IFC and World Bank analyses since 2002, as well as IFC investments and involvement in investee boards, have supported good corporate governance practices, including appointment of independent directors, development of institutional investors, conversion of non-tradable state shares into tradable ones, protec­ tions for minority public shareholders, controls on related party transactions, and better disclosure. Bank support for the development of accounting standards has also contributed. IFC's PEP China provided direct assistance to private firms in improving their governance structure and practice. Key post-2002 developments that augur well for corporate gover­ nance include a requirement for more independent directors on listed company boards, independent director and public shareholder approval of related party transactions, intro­ duction of Qualified Foreign Institutional Investors (QFIIs) into the domestic shares market, some pilot debt/equity swaps in 2004 to disentangle publicly-listed subsidiaries from state­ controlled parents, and the May 2005 launch of a program to convert non-tradable into tradable shares. New accounting standards apply to publicly-listed companies and foreign-

Lessons learned in promoting private sector development and corporate reform

• The CAS period highlighted important shifts in demand and reinforced the need for shifts in the focus of the Bank's private sector development assistance. While con­ tinuing to engage on mature topics, such as corporate governance and SOE reform, the Bank Group's private sector effort should shift toward fresher issues-such as corporate social responsibility; the private sector's role in environmental protection; barriers to entry for rural, micro, and small businesses; and development of supply chain linkages between lagging regions and markets in coastal China and overseas­ as well as toward interventions designed to meet the demands of local officials for assistance in improving local-level investment climates. • The CAS period also demonstrated the need for the Bank Group to embrace a combination of sustained inter-disciplinary involvement by IBRD, IFC, FIAS, and MIGA at the local level, reports and engagement with central government technical experts and policy makers, and public dissemination in order to achieve some im­ pact. • Given the incentives for local officials to attract investment (differing levels of FDI are a major contributor to economic disparities between coastal and inland regions), investment climate surveys and support have proven useful for building relation­ ships with counterparts. However, reforms take time, and experience suggests that the best approach is to benchmark China and China's cities against local and global peers, highlight local success stories, provide objective information on global best practices, and build the capacity of investment promotion agencies. A case study examining investment promotion experiences in coastal China might make sense for western and central regions. The Bank could also potentially assist in strengthening additional elements of the e-commerce framework. • The Bank does not anticipate committing major additional resources to SOE privatiz­ ation and restructuring in the future: substantial analyses and recommendations have already been provided, and the key constraint now is not lack of knowledge but rather the need to finance worker severance, transfer SOE social services, and re­ solve SOE NPI.s. Additional Bank engagement on SOE reform is likely to remain limited, and Bank Group analysis and advice on social safety nets and inter-govern­ ment financing may be the most effective way to provide further support for SOE reform.

• • 86 ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR) invested enterprises, but application should be extended to other SOEs as well to improve their financial transparency. SASAC has indicated support for greater reliance on board governance for SOEs, even for those that are 100% state-owned, but appointments to SOE boards have been slowed by a lack of qualified candidates. To the extent that appointments of independent directors and development of corporate boards are impeded by a lack of qualified candidates, the Bank Group could explore the possibility of providing support for directors training. In addition, the Bank Group will continue to participate in public discus­ sion of corporate governance issues as circumstances warrant.

Overall Performance, Monitoring, Evaluation

The CAS emphasized the importance of the Bank's advisory services, anticipated more active IFC and MIGA roles, and noted the need for selectivity and specialization while recognizing that the size and diversity of China's economy would draw the Bank into a wide range of issues and activities. It also encouraged Bank partnerships with other donors, the private sector and civil society.

Bank Group Instruments

Lending: The CAS projected IBRD lending in the range of $3.6 billion to $3.9 billion over FY03-05. Actual IBRD lending reached about $3.35 billion, delivered through 25 investment projects and one emergency project responding to the Severe Acute Respiratory Syndrome (SARS) crisis.1 In addition, the China CT delivered three stand-alone GEF projects totaling $61 million and one PCF project of $10 million during the CAS period. The China portfolio has some unique characteristics: (i) loan repayment obligations cascade down to a project's ultimate beneficiaries, increasing ownership but also limiting IBRD financing oppo1tunities in the poorest jurisdictions, where repayment capacities are limited; (ii) partly as a result, most lending is investment lending; (iii) infrastructure heavily dominates; and finally (iv), given this preponder­ Figure 5: Geographic Focus of Lending ance of infrastructure, about 80% of projects fall into safe­ (Number of projects) guards category A (compared to about 8% for the rest of the Bank). 80% ...... --··· •• 77% Project performance: China's active portfolio of 80 ...... projects is the largest in the Bank and also one of the 60% 58% •• • • • •• ·····•· best-performing. Over FY02-05, the disbursement ratio 42% ranged about 23-24% and the percentage of problem 40% projects remained low (less than 6% by amount, and zero 23% as of January 2006). While the average implementation 20% period of about eight years exceeds the Bank average (about 5.4 years), this is satisfactorily explained by a num­ ber of factors, including: the predominance of complex FY93-95 FY96-98 FY99--01 FY02--05 and innovative infrastructure projects; the presence of - Coastal ·•· Inland

1 The SARS emergency response was financed out of cost-savings realized under six completed IDA projects; these projects were extended accordingly, with the result that the China portfolio for a period included a high percentage (13%) of overage projects. COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Figure 6: Number of Projects FY95-99 multi-province projects involving multiple levels of gov­ ernment (e.g., the TB project covers 1,600 counties); the complete absence of fast-disbursing loans; the redeploy­ ment of substantial realized cost-savings;2 and delays and project extensions related to the SARS epidemic in 2004. Rural/Env 29% ,..-- Of 50 projects evaluated over the last five years, OED Urban/Env 13% rated 10% as less than satisfactory (8% by amount). China ------projects consistently rate higher than Bank averages on sustainability and institutional development. Compared with regional targets, IBRD delivered 25 of 29 planned projects: two projects were delayed be­ yond the CAS period, but will be delivered; another was delivered as planned but financed through a trust fund rather than IBRD resources; and another was dropped at GoC request. Because poor jurisdictions have difficulty repaying IBRD loans which do not generate a revenue stream, lending in China is skewed towards income-gen­ Figure 7: Number of Projects FY00-05 erating infrastructure (of delivered projects, 72% in num­ ber, and 80% of commitments, were in urban and Social!TA 7% transport infrastructure) and away from the social sec­ tors. Even so, the Bank Group has gradually shifted lend­ Urban/Env 37% ing from the richer coastal areas to the poorer central and Rural/Env 18% western areas (77% of Bank projects in FY02--05 targeted ------inland provinces). In the CAS period, per capita Bank lending was no longer positively correlated with provin­ cial income per capita for the first time in the Bank's lending history. Following a trend noted in the CAS, the sectoral composition of new lending has been increas­ ingly weighted toward infrastructure projects in transport and urban/environment sectors.

Analytical and advisory activities (AAA): Organized around a set of sub-themes, the CAS included a AAA strategy which aimed to be demand-driven, balance support for longer­ term strategic development issues with support for specific policy interventions, employ a greater variety of delivery mechanisms, and increase the use of local experts and institu­ tions. These goals were largely achieved. During the CAS period, the Bank delivered a wide range of AAA services requested by the GoC, and China AAA work contributed a total of $19.6 million (24% of all Bank resources spent in China, though below the Bank-wide average of 34%) during the FY02--04 period. A recent review of the Bank's AAA program in China by QAG found that the China AAA program was highly satisfactory for strategic relevance and satisfactory for quality, dialogue and dissemination, coherence and integra­ tion, likely impact, and Bank inputs and processes. The review also found that there is room for improvement in (Chinese-language) dissemination, cross-sectoral integration, and inter­ nal record-keeping. In general, the panel concluded that the Bank clearly remains a credible partner through the quality of its AAA work and that it has the greatest impact in areas where

2 IBRD is required to use GoC unit cost estimates, which frequently overestimate costs; as a result, cost-savings are a frequent occurrence. ANNEX 2 : CHINA 2003-05 CAS COMPLETION REPORT (CASCR) experienced staff worked persistently, continuously (often for many years), and sequen­ tially with GoC counterparts on client priorities, including such matters as power sector regulation, enterprise reform, fiscal issues, financial system reform, corporate governance, and assistance to poorer regions. Continuing demand across the government for Bank AAA, including follow-up requests, further supports this conclusion. It is also noteworthy that the Bank has stepped up analytical assistance-through policy notes, conferences, seminars, workshops, training programs-that respond quickly and flexibly to GoC requests on topi­ cal issues that could not be foreseen in advance (e.g., support for macroeconomic manage­ ment and financial sector). As the QAG review notes, it has become more difficult for the Bank to influence policy and institutional change in China. Over time, China has gained its own experience with the market economy, narrowing the knowledge gap between the Bank and the GoC. Individu­ als within China have become increasingly able to offer advice, the policy-making process has become more open, and the GoC has become more able to attract and screen outside advice on its own, with the result that the Bank is now competing with multiple advisors on many issues. The QAG review also found that while the Bank has disseminated AAA to a broader audience than it reached historically, including through the use of the Beijing office website, more needs to be done to inform a larger share of Chinese people about the Bank's activities. CT members also noted several challenges for the Bank's AAA, including: the costs of collaborative research, the need for improved monitoring of AAA, and the percep­ tion that too much time is spent on AAA production, while not enough is devoted to the implementation of AAA findings.

International Finance Corporation (IFC): Changes in IFC's China program have paral­ leled the development of the private sector in the economy. With the emergence and deep­ ening of China's domestic private sector, IFC has broadened its support for local financial institutions, indigenous industrial and infrastructure en- terprises, and SMEs. IFC's annual investments grew rap­ idly during the CAS period, from $84 million in 20023 to Figure 8: IFC Commitments FY03-FY05 almost $400 million in FY2005, as did its overall China portfolio, which grew from about $540 million at the end 500 of 2002 to more than $1.1 billion in January 2006. Growth 400 was particularly strong in the financial sector, where IFC's portfolio increased from $118 million in FY03 to almost 300 $300 million as of January 2006, and in the infrastructure sector, where IFC investments rose from $45 million to 200 $161 million over the same period. About 40% of IFC's China portfolio is in general manufacturing and services, 100 over 25% in the finance and insurance sector, followed by infrastructure with 14%. Most IFC investments during the 0 FY03 FY04 FY05 CAS period have been with indigenous private enterprises. In line with IFC's role to support the adoption of interna- tional standards in corporate governance, environmental and social practices, and efficiency of operations, equity accounts for a higher proportion of IFC's investment in China-48% for the CAS period-than the average for IFC as a whole, because: (a) a significant portion of IFC's investments, particularly in the financial sector, has

3 The size of the program in FY2003 was affected by the SARS COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

supported (partial) privatizations, which involved IFC taking equity stakes; (b) indigenous enterprises, which are IFC's main partners in China, face limitations on borrowing in foreign currency; and (c) Chinese companies, particularly the privatized financial institutions, need equity to meet regulatory requirements and support growth. Particularly noteworthy during the CAS period were IFC's interventions in the financial sector, where IFC supported best practice models among smaller banks and contributed through investments and TA to the reform of the banking sector; catalyzed private sector entry into sectors previously held by SOEs (insurance, funds management, investment banks), and created new institutions to deepen the financial sector (bond markets, markets for distressed assets). Several non-state commercial banks supported by IFC were able to attract reputable foreign strategic partners, IFC investments supported the development of the non-state insurance sector and IFC supported the first auction of non-performing loans (NPLs) and the first investment fund specializing in distressed assets. In a landmark event for capital market development, IFC together with ADB in October 2005 issued a first renminbi bond by a non-Chinese issuer, a benchmark expected to stimulate the development of the bond mar­ ket in China. IFC also deepened its TA in support of China's business environment, with a focus on encouraging development of SMEs through capacity building, developing alternative sources for SME financing, and supporting private sector development in the interior via IFC's PEP China. IFC supported greater SME access to finance through targeted TA for a range of partner financial institutions (PFis), macro-policy work (including joint work with FIAS to develop a Secured Transactions Framework, collaboration with other Bank Group units to help the PBoC to implement a modern credit reporting system, and assistance to the Na­ tional People's Congress to prepare a new leasing law based on international best practice). IFC also stepped up efforts to support private investment in clean energy in China through partnership and investments to expand natural gas distribution and clean coal technologies.

Multilateral Investment Guarantee Agency (MIGA): MIGA's work advanced consider­ ably over the CAS period, with a more integrated approach to the provision of guarantees and TA evolving over the past three years. MIGA's gross exposure in China has grown, and stood at $130 million as of December 31 , 2005, representing 2.4% of its outstanding expo­ sure. The current portfolio is highly concentrated in the infrastructure sector, which ac­ counts for 89% of exposure. While anticipated demand for MIGA guarantees in the oil and gas sectors did not materialize, there has been a recent resurgence in interest for MIGA guarantee coverage for water and power projects, which involve sub-sovereign risk. This has proven to be an important and growing niche for MIGA in China, as MIGA is prepared to cover municipal risk and local government risk, which many other insurers do only on a case-by-case basis. MIGA is also providing strong mediation support to clients, with a no­ table track record during the CAS period in working with MoF to resolve potential disputes. As planned in the CAS, MIGA continued to strengthen its relationship with Sinosure, China's export credit agency, with cooperation in joint marketing, cross-training, and initia­ tives to promote outward investment in support of China's go-global strategy. MIGA has provided TA at both the national level, where MIGA assistance to the Ministry of Commerce contributed to the drafting and promulgation of the National Guidelines for Investment Promotion in 2005, and at the provincial level, where MIGA worked, for example, with the PEP China (CPDF) in Sichuan in assisting provincial investment promotion intermediaries to define and target their programs. ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

World Bank Institute (WBI): During the CAS period, the China program was WBI's largest. In response to increasing requests, WBI learning programs averaged about 70 events per year, directly reaching some 7,000 participants and covering many sectors and themes. The larger programs focused on environmental sustainability, the investment climate, public administration, the health sector, and social protection. The interest in WBI's programs remained high among both government and private sector agencies. Requests grew for learning events related to increasingly advanced and customized thematic activities, particu­ larly for knowledge and experience sharing with international resource people representing best practices in their field, with seminars and workshops often ending with a discussion on how international lessons learned can be applied in China. This was also manifested during the Global Conference on Scaling-Up Poverty Reduction in Shanghai in 2004. The programs with the best impact were those where well qualified staff worked with the same counterparts and on the same issues for a longer period of time, where activities formed part of a strategic partnership with an influential agency (such as MoF, NDRC, and SEPA) and where distance learning was used to scale-up activities and reach audiences in remote or otherwise hard-to-reach areas. The creation of knowledge networks (e.g. health) proved to be a successful mechanism both for implementing and sustaining the learning efforts after WBI support ended. The WBI program also proved to be a practical forum for bringing up otherwise difficult issues for discussion in a particular sector context, i.e. public participation in environmental assessments, or mechanisms for beneficiaries' feedback and participatory budgeting at the local level. Other lessons learned include the need to prevent fragmentation of the program. With high demand for learning and international knowledge, the available resources are easily spread too thinly across too many sectors. Also, WBI's activities carried the most impact when they were properly aligned with the work of the rest of the World Bank group. Given this track record, WBI intends that future program planning should emphasize consolidation and alignment.

Country dialogue and donor coordination

Responsiveness to clients and outreach: Reflecting China's financial circumstances and its appropriate development program, government demand continued strongly to guide Bank Group engagement, with the Bank responding where it could add value. Overall, the Bank Group maintained a strong partnership with the GoC, IBRD exposure issues were successfully managed, and the Bank continued to expand the role of the Beijing office. Dialogue deepened through a combination of regular meetings with GoC counterparts, annual discussions on the AAA and three-year IBRD lending program, repeated visits of high-level Bank delegations to China, and annual training events in the Bank's offices in DC for GoC counterparts. China counterparts have often noted the importance of the heightened role of the Bank's country office in the dialogue and effectiveness of the assistance program. The presence in Beijing of the (decentralized) Country Director, growing numbers of highly­ skilled national staff, and some 20 international staff (some with long experience in China) has made it possible for Bank staff to inculcate China's unique circumstances and collabo­ rate with Chinese counterparts over extended periods. Often the Bank's more innovative work requires gestation and discussion for GoC counterparts to understand and absorb the full implications, and frequent interaction between Bank and GoC technical staff helps to facilitate this process. In addition, the presence of national staff with GoC experience who maintain good relations and understand how the GoC operates has helped to broaden the Bank's network of contacts in China (where language remains a barrier), 'translate' the work

91 • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

of international Bank experts into the Chinese context, and also bring increasing numbers of GoC officials and Chinese academics into partnership on major AAA. The Bank/WBI made a major effort to support China's interest to share its development experiences with other developing countries, primarily through the successful Shanghai Conference on Scaling-Up Poverty Reduction, which showcased poverty reduction experiences from around the world. The Bank also expanded outreach through Bank staff-led seminars at MoF and Tsinghua University, a strengthened Chinese-language website with most major Bank Group research published in Chinese (which has garnered steadily increasing readership, from 20,000 users in July 2003 to 116,000 in December 2005), establishment of development knowledge cen­ ters at GDLN facilities in western provinces, and an internship program for Chinese univer­ sity students. The Bank also supported local NGOs through its continuing small grants program, commissioning of the first-ever study of China's tax rules for not-for-profit organi­ zations (NPOs), translation of NGO/ NPO laws of other countries, and initiation of a youth engagement program.

Donor coordination and trust fund financing: As planned in the CAS, the Bank contin­ ued to deepen its collaboration with other development partners. Reflecting GoC requests, the Bank's donor coordination activities have focused primarily on developing strategic partnerships with multi-lateral and bilateral donors. Through these partnerships, 68 trust funds were secured during the CAS period (totaling commitments of $186 million), bringing total donor commitments in the active trust fund portfolio to over $889 million as of June 2005. The Multilateral Fund for Implementation of the Montreal Protocol/Ozone (OTF), the Institutional Development Fund (IDF), and the Global Environmental Facility were the top three contributors to this increase. The trust fund portfolio supports project co-financing (about three-quarters of total commitments) as well as non-lending technical assistance and project preparation costs. The Multilateral Fund for the Implementation of the Montreal Protocol/Ozone (OTF) and the Global Environment Facility (GEF) are the largest sources of trust funds. GEF, which made new grants and commitments totalling $113 million during the 2003 to mid-2005 period, provided a key source of support for Bank-Goe efforts to promote renewable energy and energy efficiency, control land degradation, address water scarcity and pollution, and conserve biodiversity. DFID (UK) continued to be the largest contributor to single-purpose trust funds. Under a partnership begun in FY02, DFID provided grant financing that, blended with IBRD loans, softened the effective interest rate for Bank projects in human development (Basic Education in Western Areas) and poverty reduction (Poor Rural Communities Development). Collaboration with DFID expanded during the CAS pe­ riod from blending arrangements to a more comprehensive program including AAA and a TA project. In total, DFID has committed $145 million in funds for co-financing, debt ser­ vice, and TA in support of Bank projects and analytical work, and DFID funds account for 67% of the $18 million of the trust fund portfolio that is Bank-executed. In preparation of the CASCR, staff recommended further evaluation of trust fund management processes in order to reduce fragmentation and better integrate TFs with Bank Group strategic objectives, and reduce transaction costs for both Bank staff and local counterparts.

Client feedback

At consultations held in preparation of the new Country Partnership Strategy, developed in parallel with the CASCR, participants including GoC officials from MoF, NDRC, 23 other central ministries and agencies, 26 provinces, and eight municipalities provided extensive feedback on Bank Group achievements, lessons learned, and areas for improvement. Also ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR) in preparation of the CPS, the Bank conducted a Client Survey between July and September 2005, involving over 200 stakeholders of the World Bank Group in China, including govern­ ment officials from central ministries and local government, academia, the private sector, NGOs, donor agencies, and the media. Feedback included the following:

• Participants said that the Bank-GoC partnership is strong and highly valued, that they regard the Bank as an important development partner, and that they welcome contin­ ued and expanded Bank Group assistance to China. • The Bank has made many important contributions, beyond filling local financing gaps, since it began engaging in the early 1980s, including upgrading technologies, introduc­ ing institutional reform and innovation, building human resource capacity, and support­ ing policy reform (including through support to the preparation of China's 11th Five Year Program). • The Bank Group's role in introducing international experience and expertise and as a provider of knowledge and innovation that catalyze reform is particularly valued. Re­ spondents to the Client Survey indicated that the Bank's knowledge was its greatest value, followed by its financial resources and transfer of new project concepts. • The Bank's role in poverty reduction, the social sectors, and lagging regions are particu­ larly important, and new mechanisms are needed to enable expanded IBRD lending in these sectors.

Nonetheless, the GoC (and, in some cases other stakeholders) has criticized the Bank for its complex operational policies, relatively high costs, and failure to adequately adapt global knowledge to local conditions. Respondents to the Client Survey said that the Bank's greatest weaknesses were being too bureaucratic in its operational policies and procedures and failing to adapt global knowledge to local conditions. CPS consultation participants made similar observations. In particular, the Bank was criticized for:

• The high cost ofdoing business, because of rigorous Bank safeguards provisions; ambi­ tious project objectives (e.g. railway reform); and the imposition of rigid rules (e.g., requiring that a fixed percentage of a project be devoted to TA or rural roads). • High IBRD loan charges, which, because the Chinese system requires these charges to be passed through to the ultimate beneficiaries, limit opportunities to lend to poorer jurisdictions, particularly for non-revenue-generating pro-poor interventions. • Slow project preparation times, although GoC officials and Bank staff have noted recent improvements (e.g., in the Ningbo and Shaanxi projects) as well as the need for joint GoC-Bank efforts, as delays occur on both sides. • Not keeping pace with China's changing development situation nor adequately adapting assistance to the increasing complexity and local realities of emerging development challenges. Client Survey respondents said that failing to adapt global knowledge to local conditions and imposing technical solutions without regard to local realities were key constraints. • Inadequate cross-sectoral teamwork, and a lack of continuity in Bank staff working on a particular project. The GoC has also urged the Bank to delegate further responsibility to Bank staff located in Beijing and make greater use of local consultants.

The Bank Group is working with the GoC to address all of these issues. COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Portfolio management

Costs for CAS implementation: Coefficients for project preparation in China are higher than the Bank average. The average preparation cost for the 20 investment projects pre­ pared for China over FY02-05 was about $550,000, compared to $360,000 for projects in the rest of East Asia and $330,000 for the Bank as a whole. Two characteristics of the China portfolio-namely, larger average loan size and concentration in category A projects (80% of China projects are in safeguards category A, compared to 8% for the Bank and 7% for EAP excluding China)--explain most of the difference between average costs in China and Bank-wide.4 In terms of Bank budget spent per $1 million loaned, the China team is actually quite efficient, as category A projects in China are prepared at about 50% the cost of cat­ egory A projects in the rest of the Bank, mainly because the China team avoids preparing category A projects with small loan amounts (less than $90 million). Further, China's re­ duced access to PHRD funding for project preparation, available only for social/poverty projects, also increased the proportion of project preparation funded by Bank budget. Given the correct comparators, project preparation costs in the China program are reasonable, though budgetary allocations do not reflect the full cost (the region has typically allocated $400,000 for project preparation). Project supervision costs have been maintained at the EAP coefficient (currently $75,000 per annum, of which $65,000 is allocated to the relevant sector unit and the remaining $10,000 off-the-top to operational support). This amount appears to be adequate in China, principally because substantial supervision is managed by national staff out of the Beijing office and most sectors are able to realize travel-related economies by combining missions. Given the high (though efficient) cost of project preparation, and the application of a lower regional norm in allocating preparation budgets, the China CMU typically has diffi­ culty raising AAA allocations to Bank-wide norms. Over FY02-04, the CMU allocated 18% of Bank budget for country services to AAA-significantly less than comparator countries such as Vietnam (22%), Indonesia (26%), India (27%), Brazil (28%), and Russia (33%). The addi­ tion of TF resources does not change the overall picture, mainly because the China program can now access PHRD resources only for inland non-infrastructure projects--China remains the lowest at 24%, with the other countries at or exceeding 31%. To correct this imbalance, the CMU is seeking to reduce project preparation costs (e.g. through delegating further responsibility and authority to national staff; monitoring mission composition and size; ac­ celerating project preparation and dealing promptly and completely with issues, in consul­ tation with NDRC and MoF), but further efficiencies are likely to be modest.

Safeguards: The FY03-05 CAS identifies "more effective safeguards policy application" as essential to improved portfolio efficiency, and promotes policy dialogue and capacity-build­ ing efforts as means to greater harmonization between Bank policies and China's regulatory framework and implementation procedures. In the CAS period, environmental and social safeguards generally have been implemented satisfactorily in the China project portfolio. Moreover, the Bank's policy dialogue has been effective in promoting improvements to environmental assessment, as described elsewhere. Similar ongoing efforts are expected to contribute to improvements in involuntary resettlement regulation and practice. A major AAA activity on overall land policy includes support for revision of China's National Land

4 Bank-wide, preparation costs tend to rise with loan size (doubling the loan size increases prepar­ ation cost by about one-third) and with increased safeguards assessment (category B projects are about 24% cheaper and category C projects 44% cheaper than category A projects). ••94 ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

Law, including land acquisition, valuation and compensation aspects. Capacity-building activities include a new IDF grant to support Ministry of Land and Resources efforts to devise national land acquisition implementation guidelines and to improve oversight of land acquisition practices. The Bank, in collaboration with ADB and Chinese agencies, also supported publication of a China social assessment manual. During the CAS period, the Bank initiated efforts to simplify its own safeguards-related procedures (in order to improve implementation efficiency and reduce burdens imposed on borrowers) and to promote greater reliance on country safeguards systems when consistent with Bank safeguards policy principles and standards. In terms of simplification, the China program made limited progress in identifying ways to streamline internal review procedures and to reduce costly and time-consuming translation processes. GoC counterparts, along with Bank project task teams, frequently remark that safeguards procedures remain unnec­ essarily burdensome. Further steps to improve processing efficiency without diminishing the quality of safeguards-related preparation or implementation also are under review. In addition to transaction cost concerns, the GoC has complained that the Bank's safe­ guards procedures are sometimes incompatible with China's domestic systems. The main differences between the Bank's and China's procedures are: on the social side, the Bank's resettlement policies are more generous than China's (e.g., the Bank's policy objective is income restoration rather than compensation for lost assets, and Bank policy requires that unlicensed businesses and persons lacking residency permits be eligible for assistance); and on the environmental side, the Bank requires an assessment of alternatives, whereas China does not. Within provinces or municipalities where no major compliance gaps exist or where compliance gaps can be overcome, there may be opportunities for expanding the use of country systems with respect to safeguards policies. With regard to environmental assessment and involuntary resettlement, however, it is likely that some policy differences will remain in most jurisdictions. Meanwhile, the application of domestic regulations is frequently weak, such that environmental assessment and resettlement practices in some instances can be less than satisfactory. For these reasons, the Bank will retain direct respon­ sibility for safeguard compliance within its portfolio for the foreseeable future.

Procurement: CAS objectives for procurement were largely achieved during the CAS pe­ riod. The Bank supported the extension of a sustainable procurement training program, with regular training courses and programs delivered in several universities. As set out in the CAS, the Bank worked with the GoC and other donors to disseminate China's 2003 Procure­ ment Law and 2000 Tendering and Bidding Law. The Bank accomplished planned assis­ tance to the GoC to update model bidding documents in 2003, although resource constraints have slowed the issuance of the updated versions to staff. The GoC introduced an electronic review process for bidding documents and evaluation reports to increase the transparency and efficiency of the procurement process and established a database of experts to assist in the technical review process. Finally, as proposed in the CAS, regular workshops have been organized with the GoC to reach out to contractors, suppliers and consultants. While con­ tracting for public works and goods in China has improved, with high levels of competition, procurement in the consulting industry lags behind, with reluctance to promote domestic private consulting firms and a tendency to award consulting contracts based more on affili­ ations rather than quality.

Financial management (FM): The Bank planned a number of steps to improve financial management under the 2003 CAS, including systemic initiatives to support strengthening of China's FM systems, TA to build capacity of public accountability oversight institutions, joint COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Bank-GoC supervision missions, and further decentralization of Bank-related FM and dis­ bursement to the Beijing office. Progress toward planned systemic initiatives-including a planned fiduciary risk mitigation and capacity building strategy and assistance to strengthen disbursement reporting and the quality of audit reports-was limited. However, the Bank provided substantial assistance to build the capacity of China counterparts involved with financial management, including provision of training courses and workshops to project auditors, overseas training opportunities for some MoF staff on public budget management, and support for the establishment of three residential training centers to improve China's accounting and auditing technical competency under a Bank-assisted accounting reform project. Financial management was fully decentralized to the Beijing office, and all financial management assessments are now conducted and cleared locally in the Beijing office. The Bank has also started to conduct joint missions with MoF on new projects, but joint super­ vision missions for existing projects to date have not included the China National Audit Office (CNAO).

Conclusions and lessons

As noted in the introduction, assessing the Bank's performance and impact in China under the CAS is complicated by the very short CAS period, the sheer size of China relative to the Bank's resources, and the highly leveraged nature of Bank assistance. The Bank's impact arises through demonstrating innovative models for addressing specific development prob­ lems that are subsequently scaled-up (using GoC or private sector resources) or through influencing policy and institutional reform measures in its extensive formal and informal AAA. Under these circumstances, this CASCR attempts to capture the Bank's contribution to key GoC achievements during the CAS period-even if the Bank contributions predate the CAS period-as well as the Bank's shorter-term performance in delivering planned CAS inputs, recognizing that the results of many interventions will only be clear in the medium­ term.

• By most measures, including portfolio monitoring, internal reviews, and client feedback, the Bank's assistance to China was satisfactory or better.

• Project implementation has been very good in most sectors, and the China portfolio continues to perform well. Of closed projects evaluated during the CAS period, IEG found that 87% had satisfactory or better outcomes (compared to a Bank average of 79%), 94% had likely sustainability (compared to a Bank average of78%), and 81% had substantial institutional development impact (compared to a Bank average of 54%). • In the ongoing portfolio, the number of problem projects was far below Bank averages (only 1.9% of the China portfolio in FY03---05 compared to 13.8% Bank­ wide), as were the number of projects at risk. • The majority of Bank projects and analytical work planned in the CAS has been successfully implemented or initiated, though there have been delays, particularly in delivering analytical products. Delays were project-specific, resulting from fac­ tors including complexity of blending arrangements and project design, local coun­ terpart ownership and repayment capacity, lack of borrowing space as result of $1-1.5 billion lending cap, and the SARS epidemic.

• • 96 ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

• GoC clients routinely express the value that they attach to Bank Group assistance, noting that Bank projects help to fill local financing gaps and bring a variety of spillover benefits including: initiating policy reform, introducing institutional reform and innovation, upgrading technologies, and building human resource capacity. • A QAG review also found that Bank AAA was highly relevant to China's develop­ ment needs, of satisfactory quality, and adequately disseminated. • Bank Group assistance continued to address key China development challenges and contribute to important Chinese achievements. Through a combination of AAA and knowledge embedded in the Bank's limited lending to China (less than 0.2% of total investment), reform initiatives demonstrated with Bank assistance continued to be scaled-up during the CAS period, with benefits far exceeding the direct benefits of the original projects. Major China developments to which the Bank was an important contributor during the CAS period included: • A better understanding of growth and equity issues (through the CEM) • A stronger GoC focus on poverty • High-quality poverty analysis assessing the impact of China's December 2001 acces­ sion to the WTO • Financial sector reforms, including the October 2004 decision to liberalize interest rates • Capital market development, including through IFC's issuance of the first renminbi­ denominated bond to be issued by a foreign institution • Greater emphasis on the private sector and its enabling environment • Greater GoC awareness of resource scarcity and environmental challenges, at all levels of government, as well as approaches to managing them • GoC improvements in development planning, including through analytical work supporting the preparation of the 11th FYP • Greater focus on institutional and regulatory issues (e.g. utility cost recovery) • Greater openness and transparency in GoC project management, including pro­ curement, environmental assessment, and resettlement plans • Drafting of the Rural Land Contracting Law • Positioning the World Bank as a knowledge bank, with greater outreach and a stronger focus on ideas, innovation, and learning

Nevertheless, there is still room for improvement. The Bank has not always succeeded in influencing desired policy and institutional changes, and GoC officials continue to urge the Bank Group to reposition its assistance to better meet China's needs. Constraints and areas for improvement noted during formulation of the CAS CR included:

• The Bank Group needs to keep pace with China's rapidly changing develop­ ment needs. Increasingly, the GoC requests the Bank to address complex multi-sectoral development challenges with international best practices tailored to meet China-specific challenges. To address China's changing needs, GoC officials encourage the Bank to increase its focus on macro-level challenges (e.g., to assist with regional and provincial development planning), improve the quality and impact of the TA components of its projects, ensure continuity in Bank staff with China experience, and make greater use of Chinese consultants. Country team members also noted that weak integration of AAA, lending, and trust-funded activities limited the Bank's ability to provide sustained cross­ sectoral engagement. The GoC's desire to spread the Bank Group's influence broadly, combined with the absence of an integrated approach targeting a few selected loca- COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

tions, has also contributed to a degree of geographic and sectoral dispersion of the ongoing portfolio. • Projects did not always achieve desired demonstration effects or scale-up. Lim­ iting factors included: insufficient emphasis on innovation or demonstration in project selection (some provincial officials said that the strong emphasis on repayment capacity in project selection limited project focus on innovation); fragmentation of provincial, county, and urban authorities (a constraint noted by provincial officials at the 2005 CPS consultations, who requested Bank support for regionally integrated infrastructure); and the relative absence of rigorous monitoring and evaluation of project impacts. • Though the Bank has a comparative advantage in providing assistance to the social sectors, the combination ofIBRD terms and GoC loan repayment require­ ments has made it difficult to expand Bank lending for the social sectors and poverty reduction, and has constrained the Bank's ability to deploy available re­ sources in these areas at the same time that GoC emphasis on balanced development has increased. Country team members noted that the level of partnership, dialogue, and local knowledge that result from demonstration projects could not be fully replaced by analytical work alone. • Continued effort is needed to simplify and streamline Bank procedures, includ­ ing project preparation, procurement, and safeguards (see Client Feedback above).

Going forward, the Bank can build on success factors ...

• The Bank's role in bringing ideas, innovation, and knowledge remains its most valued contribution. While resource transfers are important to the sub-national govern­ ments that are the Bank's primary clients, the Group's comparative advantage lies in its role as an international knowledge leader and disseminator of good practices. • Innovations typically emerge from a long-term GoC-Bank partnership founded on trust, shared commitment, and pragmatic cooperation. Sustained engagement on priority topics is especially important given China's gradualist approach to reform. Fur­ ther emphasis is needed to maintain a strong strategic dialogue with GoC counterparts, given increasing local expertise and the availability of other advisors. • The Bank's 'dual-track' approach-building trust through lending and support­ ing policy dialogue through sector work-has been a key success factor. As the CAE noted, combining persuasion through analytical work and demonstration through pilot projects has enabled the Bank to "punch above its weight". Where it occurred, synergy between analytical work, TA, and lending enhanced the Bank's contributions, such as in Bank support to power sector reform, participatory approaches to poverty reduction, and integrated watershed management. While AAA served to identify priori­ ties for investment projects, Bank involvement in investment lending (and long-term TA) contributed to Bank staff knowledge of local conditions, relationships with local counterparts, and entree that, in turn, brought greater depth and impact to related analytical work. • The GoC's strong ownership and development focus have been key contribut­ ing factors to the effectiveness of Bank inputs. The Bank's relationship with China is in many respects a model partnership, with the GoC firmly in the driver's seat in setting the development agenda, defining the scope of Bank assistance, and determin­ ing how Bank inputs are ultimately used. This has ensured country ownership of the Bank's assistance. ANNEX 2: CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

... and further incorporate lessons learned. To have greater impact, the Bank Group can:

• Articulate a more sharply defined set of intermediate results to guide its assis­ tance and dialogue. Although the 2003 CAS set broad strategic directions and a de­ tailed (21-page) experimental results matrix, it did not clearly articulate intermediate results that the Bank was seeking to influence nor was it used operationally. The utility of the new CPS can be increased if the Bank Group, in close consultation with GoC counterparts: • Defines a set of priority intermediate outcomes around which ongoing and new Bank assistance will be aligned. These results, which will need to be stated largely in terms of GoC policy and institutional reforms rather than as changes in national or provincial development indicators or service-delivery targets, can pro­ vide the focus for a more integrated package of ongoing and new Bank assistance. Articulation of results will also require realistic expectations of the Bank Group's influence, recognizing that causal linkages between Bank Group inputs, GoC ac­ tions, and their outcomes are tenuous and that outcomes must ultimately be attrib­ uted to a combination of GoC actions and exogenous factors over which no actor has control. • Operationalizes the new Country Partnership Strategy by using the results matrix as a basis for strategic dialogue with the GoC and for periodic cross-sectoral reviews to integrate Bank Group interventions and monitor their impacts. • Focus on scaling-up successful innovations and ideas by: • Emphasizing the demonstration aspects of Bank work in project and transac­ tion selection (potentially enhanced by greater Bank-GoC upstream dialogue on the pipeline), implementation, and especially M&E (with more project resources devoted to assessing, distilling, and disseminating project lessons) • Balancing lending with analytical work (e.g., through greater emphasis on AAA to address sector-specific issues in sectors, such as infrastructure, where the Bank has invested heavily) as well as by encouraging cross-fertilization between AAA and lending (e.g., through linking AAA more explicitly with lessons learned from lend­ ing projects) • Continuing to explore innovative delivery mechanisms, such as focusing a package of interventions on a particular province or region, or taking a program­ wide approach in areas such as road transportation • Better integrate Bank Group assistance to help China to address increasingly complex multi-sectoral development challenges. Responding to China's requests, and achieving CPS results, will require strengthened mechanisms to encourage coop­ eration between Bank Group partners, sectors, and task leaders, including by: • Organizing lending, AAA, and trust-funded interventions on a thematic ba­ sis, strategically integrating trust funds, encouraging greater cross-sectoral discus­ sion within the Bank Group of progress toward CPS milestones, and ensuring that the lessons of demonstration projects are fully reflected in analytical work and policy dialogue • Where relevant, encouraging greater integration of IBRD, IFC, MIGA, and WBI activities around the results identified in the CPS, capitalizing on the comparative strengths of each institution, with IBRD focusing on strengthening the efficiency, sustainability, and equity with which public goods are provided and IFC and MIGA focusing on the private sector dimensions COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

• Facilitate greater Bank Group engagement in poverty reduction and social sec­ tors by actively working with Goe partners to operationalize new funding arrange­ ments-including the blending of IBRD and central government transfers-that enable continued innovative IBRD lending in these sectors. Experience over the previous eAS period has shown that IBRD lending, when deployed strategically, brings a depth of local knowledge, practical experience and partnership that increases the effectiveness of Bank contributions-and associated Goe financing-in ways difficult to achieve through analytical work alone. • Seek to further simplify and streamline Bank project processes, including reduc­ ing project preparation times and the costs of doing businesses by further integrating Bank procedures with country systems.

• • 100 ANNEX 2 : CHINA 2003-05 CAS COMPLETION REPORT (CASCR)

CASCR Attachment 1: Planned lending program and actual deliveries (FY03-05) ::. I. · CAS .Pla~~~Jan_u~ ~.. ~ 3 . _2;;~t~0Y;·~~-!,,_.~·.. · ·X . ·., _. Comple~onRepo~(j~_6e3?.~9Q?) _ : · !i! Pr:. ·. · P.roject · b ' • • ;,"" ·';'!i~· ~: ·"'l·")~lll'•~ .. ~,,~~~;;:•~ IBRD($m) .,. ·lj Status.,,,, . _, · : . ,_ .- . -~ ". • ::~· •• , .,-.•,!i\,?;< IBRD($m).'"'..p l!;,;..,,1.~ '"'~,/'t-"iti; • ·:..k;', :1·.;y... 4~~~>lh;~-I~·.y,~~~\"1i"~~;; r '.,!..i· ~~~~1"1:;1;J,: ...~·~"'::i;;ti'l'. ~,..--;;_• ·":""'· ·~'J.'v"f:Jf{,'"' :h _:£t::>t-.~""'iJJ1t."_,;;. ~ ~ -~ ,.•'I",,,-~~ FY03 Program planned at time of CAS: Xinjiang Highway 3 150 Delivered September 2002 150 Hubei Highway 250 Delivered September 2002 250 Yi-Xing Pumped Storage 145 Delivered March 2003 145 Tianjin Urban Development II 150 Delivered May 2003 150 Shanghai Urban Environment APL (Stage I) 200 Delivered June 2003 200 Liaoning Urban Development 110 Postponed to FY06; under preparation Jiangxi Integrated Agricultural Development 100 Postponed to FY04; delivered November 2003 Gansu and Xinjiang Pastoral Development 66 Postponed to FY04; delivered September 2003 Basic Education in Western Areas 100 Postponed to FY04; delivered September 2003 Regular program subtotal: 1271

Standby program: Anhui Highway 2 250 Delivered June 2003 250 Aquaculture 10 Dropped at the request of Goe Standby program subtotal: 200

FY03 delivered program total: 1145 Other. GEF-Lake Dianchi Biodiversity Restoration 1 Delivered March 2003 1 GEF-Energy Conservation 2 26 Delivered June 2003 26 Other program total: 'Z1 Other program total: 'Z1

FY04 Projects carried over from FY03: Gansu and Xinjiang Pastoral Development 66 Delivered September 2003 66 (GEF $10.5m) Basic Education in Western Areas 100 Delivered September 2003 100 Jiangxi Integrated Agriculture Modernization 100 Delivered November 2003 100 (from FY04)

Program planned at time of CAS: Zhejiang Urban Development 140 Delivered January 2004 133 Inland Waterways 4 95 Delivered March 2004 91 Wuhan Urban Transport 200 Delivered March 2004 200 National Railways 2 200 Delivered June 2004 200 Hunan City/Regional Development 150 Postponed to FY05; delivered September 2004 Lake Tai Water Quality 110 Postponed to FY05; delivered August 2004 Poor Rural Communities Development 100 Postponed to FY05; delivered June 2005 Agricultural Technology 100 Postponed to FY05; delivered April 2005 Inner Mongolia Highway 2 100 Postponed to FY05; delivered February 2005 Economic Reform Implementation 30 Postponed to FY06; under preparation Distance Learning/Knowledge Dissemination 4 Dropped, but supported by trust-fund activities

Regular program subtotal: 1229

Standby program: Guangdong-Pearl River Delta Environment 150 Delivered June 2004 128 Shaanxi Highway 3 200 Postponed to FY06 Standby program subtotal: 300

Additional delivered projects: Hubei Highway 2; delivered June 2004, 200 advanced from FY05 FY04 delivered program total: 1218

Other Program: GEF-Hai Basin Integrated Water Management 17 Delivered April 2004 17 Other program total: 17 Other program total: 17

(continued on next page)

101 • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

CASCR Attachment 1: Planned lending program and actual deliveries (FY03-05) CAS Plans (January 22, 2003) Completion Report (June 30, 2005)

FY Project b IBRD($m) Status IBRD($m)

Fmi Projects carried over from FY04: Tai Basin Urban Environment 110 Delivered August 2004 61 Hunan Urban Development 150 Delivered September 2004 172 Inner Mongolia Highway 2 100 Delivered February 2005 100 Agricultural Technology Transfer 100 Delivered April 2005 100 Poor Rural Communities Development 100 Delivered June 2005 100

Regular program: Hubei Highway 2 200 Delivered June 2004; advanced to FY04 Liuzhou (Guangxi) Environment 100 Delivered May 2005 100 Shanghai Urban Environment APL 2 200 Postponed to FY06; delivered July 2005 Chongqing Small Cities 150 Delivered June 2005 180 Henan Medium-Sized Cities 150 Postponed to FY06; under preparation Upper Yangtze Watershed Rehabilitation 100 Postponed to FY06; renamed Changjiang/PRO Heilongjiang Dairy Development 100 Postponed to FY06; delivered January 2006 Fuzhou Urban Transport 100 Postponed to FY06; delivered December 2005 Henan Highway 4 175 Dropped at the request of GoC Regular program subtotal: 1275

Standbys Ningbo Water Management 100 Delivered March 2005 130 Rural Village/Cities Water Supply & Sanitation 50 Postponed to FY07; under preparation Taiyuan Integrated Urban Development 150 Postponed to FY08 Irrigated Agriculture Intensification 3 200 Postponed to FY06; delivered October 2005 Rural Health 75 Postponed to FY07; under preparation Standby program subtotal: 575

Additional Delivered Projects: Renewable Energy Scale Up (GEF $40m), 87 delivered June 2005 FY05 delivered program total: 1cm

Other Projects GEF-Heat Reform and Building Energy Efficiency 18 Delivered 18 PCF-Jincheng Coal Bed Methane Project 10 Delivered 10 Other program total: :;fl Other program total: :!3

Total (FY03-05 planned regular program): ms Total (FY03-05 delivered program): :m4

• • 102 CASCR Attachment 2: Planned AAA and actual AAA deliveries (FY03-05) AAA theme Core written output Status TA Status Research Status Unplanned delivery

CAS theme: Business Environment and Market Economy

FY03: FY03: FY03: Economic CEM: Sharing Opportunities Completed WBl-WTO Issues Completed WTO Accession, Completed monitoring and Wealth at the Time of for China Policy Reform Globalization (D) and Poverty Reduction Monitoring Briefs (D) Completed Improved Indicators Completed for Social Spending WTO Accession Impacts Completed: Growth, Poverty, Trade, Investment (A)

FY04: FY04: FY04: Public Expenditure Dropped; low Enhancing GoC Dropped; Early Warning Review/CFAA (D) GOC interest, Audit Capacity lack of System for ADB report on budget Identifying and same topic Analyzing Macro-

Fiscal Risks (D) )> z Monitoring Briefs (D) Completed Eight policy notes z rn prepared at Goe x request (note C) N FY05: FY05: n I Development Policy Integrated into 11 '" Support to 11 '" FYP z Review (D) FYP, NE )> N Development 0 0 Strategy w I Monitoring Briefs (D) 0 Completed NE Development V1 Workshop n )> FY03: FY03: VI n 0 Economic PSU Reform (A) Completed SDPC Policy Modeling Completed s:: management in FYOS r" rn CPAR Follow-Up (A) Completed Building Government -l Debt Management Completed 0 Capacity z ;,;, Procurement Post-Review (A) Completed GDLN Devt. for Completed rn "0 Knowledge Management ;,;, -l WBl-lntergov. Relations Completed 0 n and Local Gov. Manage- )> w V'I ment of Finance n • ~ • (continued on next page) (") CASCR Attachment 2: Planned AAA and actual AAA deliveries (FY03-05) (continued) 0 • c • AAA theme Core written output Status TA Status Research Status Unplanned delivery z -1 ;;o FY04: FY04: FY04: -< '"O l> Evaluation, Management of Completed Statistical Capacity Completed Cross-border Capital ;;o -1 Domestic Debt Risks (A) Building Flows Workshop z m Subnational Fiscal Issues Ongoing, scope Decentralization Completed ;;o Vl in Western Provinces (A) extended to (Regional Project) :r: nation-wide '"O Vl -1 FY05: ;;o Knowledge Management Dropped ~ m () Piloting Fiscal Reforms -< in Western Provinces .,, 0 FY03: FY03: ;;o -1 :r: Financial Domestic Finance for Integrated into Finance for Small Firms Completed m Sector Infrastructure policy note (A) Corporate '"O m Development Bond Market 0 '"O Study (D) r m State Commercial Bank Completed APEC Forum TA Completed v; ;;o Restructuring policy note (A) m '"O Development of Institutional Completed WBl-Non-bank Financial Completed c ClJ Investors policy note (A) Institutions r (") WBl/DL-lnfra. Finance Completed .,,0 Deposit Insurance Completed (") System :r: z Debt Resolution for Completed l> Banks IFC Capacity Building Completed in Securities Industry FY04: FY04: FY04: Strategic Framework for Completed Government Securities Completed Improving Risk Management Financial Conglomerates (A) Market Reform in Securities Firms Capital Market Development Corporate Governance of Rural Commercial Banks FY05: Legal, Regulatory and Supervisory Framework for Lending to MSEs Addressing Systemic Risks and Financial Stability (continued on next page) CASCR Attachment 2 Planned AAA and actual AAA deliveries (FY03-05) (continued) AAA theme Core written output Status TA Status Research Status Unplanned delivery

FY03: FY03: FY03:

Markets and Corporate Governance Completed Power Generation: Completed Industrial Integrated enterprises of Enterprise Groups (A) Divestiture, Regulation Competitiveness, in City and Pricing the Investment Competiti- Climate and veness Development of SMEs Gas Development (A) Completed Oil and Gas Sector Completed Regulation Energy Sector Policy Completed State Enterprise Debt Completed Notes (A) Restructuring and Loan Workouts Judicial/Legal Reform (A) Completed WBl/DL-Corporate Completed Governance/Strategy IFC/WB: Transformation of Completed WBl-Accession to WTO Completed Small and Medium Sized Issues

SOEs (A) )> z Improving Investment Completed IFC Corporate Completed z m Climate (WB, IFC, FIAS) Governance -Training >< for Directors N n CAS theme: Disadvantaged people and lagging regions I z FY03: FY03: FY03: }> N Revitalizing Trade, Transport Services Completed Post-WTO Reform of Completed Lagging Poor Areas: Completed 0 0 Lagging and Logistics (A) Ministry of Agriculture Breaking Poverty w I Economies Traps 0 V1 PSD Strategy in Lagging Completed WBl-Rural Poverty Completed Uninsured Risk and n )> Regions (A) Reduction in Western Poverty Dropped V1 China n 0 WBl/DL-Ecological Completed Causes for Completed s: Agriculture and Changes in r "m Development Income Distribution -l 0 WBl/DL-Agri. Prod ., Completed Poverty Monitoring Completed z ;>:> Rural Growth and Env. and Evaluation m WBl-Livestock Completed Land Tenure: Completed in "0 ;>:> Management and Impact on Farm FY04 -l Pastoral Dev. Investment n 0 )> 1.11 V1 WBl-Rural Dev. Training Completed n • (continued on next page) ~ n CASCR Attachment 2: Planned AAA and actual AAA deliveries (FY03-05) (continued) 0 • c • AAA theme Core written output Status TA Status Research Status Unplanned delivery z 0 -i Ol ;;o DevelopmenUlmprove­ Completed -< ment of Land Tenure ")> ;;o Reforms -iz m Rural Dev.: Poverty Completed ;;o Reduction, Env. Protection Vl I Lagging Regions Completed Vl" Development Plan -i ;;o Strengthening Manage- Completed ~ m ment of Pov. Reduction () Funds ,,-< FY04: FY04: 0 ;;o Skills Development for Ongoing Scale-up Poverty -i I Competitiveness (A) Reduction - Shanghai m Conference "m Strengthening Farmers Ongoing 0 "r- Associations, Sichuan (A) ~ Vl Removing Inter-Provincial Completed; ;;o Trade Barriers to Achieve renamed m Market Integration (A) Fragmentation c" of National Product r-°" and Factor Markets n 0 FY03: FY03: ,, n Human and Improving Financing for Completed Capacity Building for Dropped; low I Social Effective Delivery of Urban Medical Insurance Goe interest z )> Development Basic Social Services (A) Reform M&E for Better Social Service Completed Mainstreaming Gender Combined in Poverty Delivery Outcomes Assessment (PA) Improving Health Care Completed Access of Rural Poor Social Assessment Manual Completed WBl-Poverty Identification, Completed Policies, and Evaluation WBl-Health Sector Completed Financing and Reform WBl-SPS on Rural Health Completed Training of Local Health Completed Bureau Directors

(continued on next page) CASCR Attachment 2: Planned AAA and actual AAA deliveries (FY03-05) (continued) AAA theme Core written output Status TA Status Research Status Unplanned delivery

FY04: FY04: FY04 : Gender Assessment (D) Ongoing, merged Poverty Mapping Completed Labor Market Study with PA Empowering Poor Completed Reform of Social Women in Western Areas Protection Mechanism Managing Health Sector Completed Human Development Adjustment to Achieve a Well-off Society FY05: Poverty Assessment (PA) Ongoing; expected in FY06

CAS theme: Sustainable development FY03: FY03: FY03: FY04: Environmental Policy Note on Completed New Cost Model Expanded; Industrial Pollution Expanded; Addressing the Management Environmental in FY04 for Environment completed Control completed Environmental Effects )> Administration (A) in FYOS in FYOS of WTO Accession z z Environmental Completed CCICED Forestry Completed m Protection-Post and Grasslands x WTO(A) Task Force ..N n Reducing Persistent Ongoing, I Organic Pollutants to be completed z FY06 )> N WBl-Environmental Completed 0 0 Economics and Policy w I 0 WBl/DL-Urban Air Completed V1 Quality Management n )> WBl-Urban Project Completed V'I n Analysis/Management 0 Sustainable Completed :s:: r- Development of in FY04 "m Livestock and -l 0 Grasslands in the z Northwest Provinces ;>:J m FY04: FY04: FYOS: 0" ;>:J Strategic Environment Completed Energy Efficiency Completed Valuation of -l Assessment (D) in FYOS in Buildings Environmental Health -n 0 Risks )> V'I " (continued on next page) n • ~ n 0 • c • z 0 -i 00 :;o -< Clean Development Completed Environmental -0 Mechanism Management of SMEs, >:;o Industrial Zones -iz rn Industrial Pollution Replaced by Water :;o Prevention Pollution Prevention Vl I WBl-Environmental Completed -0 Vl Directors Training -i :;o WBl-Environmental Completed ~ Compliance/Enforcement rn C) FY03: FY03: FY03: .,.,-< 0 Infrastructure Urban Restructuring Completed WBl/DL-Sustainable Completed WBl-Regulatory Completed :;o and Urban Policy Note (A) in FY04 Urban Development Reform In China's -i I Development and Management Infrastructure rn Sectors -0 rn Housing Maintenance/ Completed WBl/DL-Transparency Completed 0 -0 r Operations Policy Note (A) in FY04 in Infrastructure rn Concession vi :;o Urban Transport Policy Completed rn -0 Note (A) in FY05 c ex> r Consolidating Completed n Commercialized Toll in FY04 0 Roads Policy Note (A) .,., n Road Traffic Safety Completed I Agenda Note (A) in FY04 z > FY04: City Development Completed Strategy Annex 3 Private Sector Development Strategy

Recent trends in Private Sector Development

One of the important outcomes of market-oriented reforms in China over the past 25 years is the emergence of the private sector as the leading sector of the economy in terms of its contribution to GDP and employment. The growth of the private sector and privatization has transformed the structure of the Chinese economy. Private sector growth remains rapid, with fixed asset investments by private enterprises expanding at about 50% per annum. Over 2000 to 2004, the number of Chinese private enterprises rose from about 1.76 million to 3.65 million, and today the workforce employed in the domestic private sector is esti­ mated to exceed 50 million, of whom more than half are migrant workers that have left the rural areas in search of better livelihoods in the urban areas. Privatization, which accelerated in the mid-1990s, has also been a significant source of private sector growth. Over 1995 to 2005, more than 50% of all industrial SOEs were privatized, and 26% merged or liquidated; as a result, the number of industrial SOEs has declined from about 115,000 in 1996 to about 25 ,000 today, with about 60,000 privatized. The de nova private sector has also contributed to restructuring of the state-owned sector. According to a survey by the All China Federation of Industry and Commerce (ACFIC), about a quarter of the employees in China's private enterprises are workers who have been made redundant by the closure of failed SOEs. The ACFIC survey also found that about 6% of private enterprises had merged with or acquired an SOE, while a further 10% were preparing to do so. The development of the private sector is uneven across regions. While the coastal areas boast the most developed and sophisticated private sector, private sector development is lagging in the western and northeast regions. There have been some important changes in the legal regime for pri­ Table 20· Composition of GDP by ownership type(%) vate sector activities in the last two . " 1998 2003 . years. In March 2004 the constitution ~~< ~ ~~'' ,•.:.. : ~ 't ,;;;~ .Ji!fa.1~ -''. , ·~ \ ...,., ,~>;:.. '11 was revised to include the protection State-controlled fi rms 41 34 of private property, and in February Collectives (incl. red hat firms) 22 13 2005 the State Council offered sub- Registered domestic private fi rms 12 22 stantive legal parameters for the Registered foreign firms 8 15 Registered private firms 20 37 growth of China's domestic private Agriculture (almost all private) 18 15 sector by issuing Certain Opinions on Non-state 59 66 Supporting and Guiding the Develop- ment of the Private Economy (the Opinion). Table 20 presents estimates of the composition of China's GDP by ownership types for 1998 to 2003, during which the share of the official private sector in GDP increased from 20% to 37%, becoming the largest sector of the Chinese economy.

109• • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Critical Issues for Private Sector Development

Based on consultations with private sector representatives and GoC officials, surveys of private entrepreneurs (by IFC, IBRD, Chinese organizations and third parties), public media analysis, and policy documents, a number of issues emerge as critical for the development of the private sector in China at this stage. Some of these issues are legacy challenges related to the ongoing transition from a centrally planned to a market economy-these include, for example, access to market, access to finance, and the role of the state in the economy (shifting from a direct participant to a regulator). A second set of issues relate to the growing expectations of Chinese society vis-a-vis the private sector as the latter becomes the leading sector of the economy-these include a demand for better standards in the area of product quality, corporate governance, social and environmental practices, and contributions to resolving social issues related, for instance, to environmental concerns and social inequality. A third set of issues relates to China's integration into the world economy.

Improving the business environment and strengthening regulatory capacity: Im­ pediments to business that still exist in parts of China include burdensome business licens­ ing procedures and land-use approval requirements; the maintenance of "restricted" sectors, for which the GoC requires a review of foreign investment proposals; high and often discre­ tionary administrative fees; excessive inspections; elevated transport and logistics costs (of­ ten due to entry barriers); cumbersome customs clearance in in-land cities; inconsistencies between labor laws and implementation; weak and sometimes biased commercial dispute resolution mechanisms; and slow adjudication systems. Progress has been made in unifying the regulatory regime for enterprises by various ownership types, but in many important areas such as access to markets, access to finance, tax treatment and other preferential policies, private enterprises are still at a marked disad­ vantage when compared to foreign invested and state-owned enterprises (SOEs). Recent policy documents, such as the Opinion, emphasize that the levying of unauthorized fees by government agencies is prohibited and that private enterprises can refuse to pay charity contributions, or for services provided by government agencies that they have not requested. The Opinion requires both central and local governments to improve their performance, publish supervision regulations and properly regulate their supervision functions. New demands on the GoC's regulatory capacity stem from the continuing liberalization of the economy. The opening of new sectors of the economy to foreign competition re­ quires the GoC to assume the role of a regulator enforcing a level playing field among various players. In addition, liberalization of interest rates and the exchange rate regime as well as the gradual opening of the capital account require the development of a regulatory capacity that is commensurate with the needs of properly functioning financial markets.

Access to markets: While the room for private economic activity has been continuously expanding, private enterprises still face many barriers. The presence of the private sector is still uneven across the industry spectrum (see Figure 9, next page). In general, large state enterprises dominate upstream industries, while private enterprises tend to populate down­ stream industries. In addition, industries are characterized by low industry concentration ratios. The GoC is now seeking to remove the obstacles private enterprises have faced. The recent Opinion confirms that all sectors of the economy that are not restricted by law are open to domestic private enterprises. Currently, there are few explicit restrictions on private sector entry, although private enterprises often face internal administrative or economic

• • 110 ANNEX 3: PRIVATE SECTOR DEVELOPMENT STRATEGY

barriers that effectively preclude or restrict them from enter­ Figure 9: Industry concentration and state share ing certain industries. GoC policy is that Chinese private of gross output (%) enterprises should receive the same treatment as SOEs with respect to investment verification, financing, financial and Textiles tax policies, land use, foreign trade, and economic and tech­ Garments nology cooperation. It also states that all sectors that are Furniture open to foreign investors are also open to domestic private Printing _.___ _ enterprises. Plastics There are already encouraging signs that the domestic Food private sector is obtaining greater market access. For ex­ I Pharmaceuticals ~-- ample, the State Administration for Industry and Commerce Electronics issued a notice on March 21, 2005, facilitating enterprise Equipment jll---• registration and administration services for private enter­ Steel ------• prises. On April 13, 2005, meanwhile, the State Council is­ sued several decisions on Entry into the Cultural Sector of Non-publicly Owned Capital to provide clear rules regard­ ing market access for private enterprises. In the refined pe­ Tobacco •------• Oil and gas J!i!!!!!!!!ll!!!!!!ll!!!l!!!!l!!!!!ll!!!!!!ll!!!l!!!!l!!!!!ll!!!!!!ll!!!i!!!!l!!!!!ll!!!!!!ll!!!l!!!!l!!!!!ll!~ troleum sector, private enterprises have been given market 0 20 40 60 80 100 access to match that of foreign investors. There have also • Industry concentration • State share in gross output been developments in China's civil aviation business. On L __ - March 5, 2005, China's first private airline company, Okay Airways Company, made its maiden flight. In May 2005, two private companies-Yi Yang Group and Hui Run Investments-outbid China's second largest carrier, Air China, for a 65% ownership stake in Shenzhen Airlines.

Access to finance and financial sector development: According to survey results, most small and medium-sized private enterprises complain that they have difficulty in obtaining bank loans because of the complex procedures involved, the requirements for collateral, the unaffordable costs, and the stringent terms and conditions imposed by banks. The lack of a credit rating system for private enterprises in China aggravates this situation. Chinese firms have much less access to formal finance than do firms in any other Asian country surveyed thus far. Approximately 29% of working capital for large Chinese firms comes from bank loans, less than firms in Indonesia, Malaysia, the Philippines, Thailand, or Korea. The situation is even worse for SMEs. On average, only 12% of SME working capital comes from bank loans; by comparison, 21% of SME capital in Malaysia comes from loans, 24% in Indonesia, 28% in the Philippines, and 26% in Thailand and Korea. The lack of formal finance among small firms becomes starkly worse as firm size decreases. The domestic private sector's capacity to raise debt was restricted further in 2004, when the GoC implemented a series of macroeconomic austerity measures to prevent overheating in certain industries. Banks were discouraged from making loans and the one-year lending interest rate was increased by 0.3%. There exist few other viable means through which private businesses in China are able to raise capital. For example, the stringent require­ ments, costs and delays involved in raising finance from domestic or overseas capital mar­ kets mean that such financing is out of reach of most private enterprises. As a result, such businesses often resort to 'grey market' financing. The recent GoC Opinion address the difficulties Chinese private enterprises face in obtaining financing. City, provincial and municipal governments with sufficient resources are required to allocate funds for the development of the domestic private sector, while banks are required to increase the ratio of commercial loans made to such enterprises.

111 • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Importantly, the policy also states that domestic private enterprises should be treated equally with regard to stock market listings, an area where SOEs have traditionally been favored. In addition, stock exchanges for small and medium-sized enterprises (SMEs) are to be developed and qualified private enterprises encouraged to list overseas and issue bonds. Weaknesses in the financial sector represent the major threat to the sustainability of China's economic growth. The financial system in China is too reliant on banks, and non­ banking financial institutions are underdeveloped. State ownership reigns supreme. Reform in the financial sector has generally lagged the overall pace of market reforms in China, though there has been a marked increase in attention to financial sector reform in recent years. In particular, the GoC has injected more than $250 billion to recapitalize the major banks. The urban credit cooperative system has been reformed. A new regulatory frame­ work for the banking sector and the capital market has been established. Second-tier banks have started to attract foreign strategic investors and recently three of the big four banks (accounting for almost half of all financial assets) have attracted strategic investors and are planning to list on international exchanges. While foreign strategic investors will be allowed to hold 20-25%, another 20-25% would be internationally floated. Moreover, the regulators are considering lifting the foreign investment limit. It is possible that, within two or three years, several of the big SCBs will be 40-50o/o-owned by foreign investors. This would change the underlying banking structure, especially in regard to corporate governance, management, and, most importantly, change of ownership, which would gradually break the linkage between the banks and the GoC, especially the local branches of the big SCBs and their respective local governments.

Upgrading corporate practices: To succeed in the long term, the domestic private sector will have to improve the quality of its management and corporate governance. Many me­ dium- to large-sized Chinese private enterprises have failed to evolve from their start-up structures or have adopted management structures that are similar to those of SOEs. In general, managers of private enterprises tend not to emphasize legal compliance, social responsibility or corporate governance issues. It is the GoC's policy to encourage Chinese private enterprises to grow "stronger and bigger". Furthermore, private enterprises are en­ couraged to develop into multinational companies. Fairness and distribution issues related to privatization have been attracting the most public attention recently. The GoC and the general public are concerned that corruption and an erosion of state assets have accompanied privatization and restructuring. In response to rising social demand for fairness and transparency, the GoC has issued a number of regulations that deal in a sensible way with the major conflict of interest situations related to SOE privatization and restructuring, although some of the measures tend to apply different standards of transparency and regulatory oversight to non-state investors. Thus in the cur­ rent environment, there is strong demand for model privatization transactions that set stan­ dards for transparency and efficiency.

New societal demands: Since the reform period started, China's growth has been accom­ panied by growing imbalances between rural and urban incomes, between coastal develop­ ment and development in the other regions (the center, west and northeast), between economic and social development, and between human development and its impacts on natural resources and the environment. Increasingly, the private sector is being expected to contribute to addressing these imbalances.

• • 112 ANNEX 3: PRIVATE SECTOR DEVELOPMENT STRATEGY

Environmental sustainability and energy efficiency In 2004, China accounted for about half of global growth in metals demand arid a third of global growth in oil demand. More­ over, rapid economic growth in China has produced significant environmental damage. Managing China's growing resource demands and their environmental consequences is perhaps the greatest challenge that China faces today. The private sector is expected to contribute to addressing this challenge by helping to develop a circular economy through improving overall efficiency, upgrading environmental practices, and investing in new envi­ ronmentally friendly technologies.

Private participation in infrastructure. From 2002 China added about 20 million people to its urban population each year, creating huge demand for infrastructure services such as water supply, wastewater treatment, solid waste disposal, gas and electricity. The private sector, often in partnership with public entities, is expected to play a bigger role in provid­ ing these services.

Narrowing regional differences. The growing income gap between the coastal areas and the rest of China is creating social tensions. Private sector development in the west and northeast is lagging development on the coast. The interior and the northeast have also attracted a disproportionately small portion of China's FDI. The GoC and the private sector need to work together to develop a conducive business environment that will stimulate private sector investments in these lagging regions.

Integration in the world economy. As China has opened its economy to outside invest­ ment and influence, its growth has had a profound impact on global trade and investment. While China has become one of the largest recipients of FDI globally, it is also increasingly viewed as one of the most important sources of FDI. The GoC's 'go-global' campaign indicates its support for this trend, but outward investors are hampered by administrative obstacles, information gaps, and their relative inexperience with overseas markets.

World Bank Group private sector development strategy

Within the framework of the CPS, the World Bank Group's private sector strategy will support private sector development in China with an emphasis on alleviating the constraints discussed above. Private sector development is an area which requires close integration of IBRD, IFC, and MIGA activities around a common set of priorities, capitalizing on the comparative strengths of each institution (see next page). As China continues to develop, it is expected that the Bank's Group's exposure to China will remain stable or grow slowly with its relative composition gradually shifting away from IBRD loans towards IFC invest­ ments and MIGA guarantees. Based on the preceding analysis and feedback from consultations with the GoC and the private sector, the following areas of involvement have been identified:

• Improving the business environment and strengthening regulatory capacity • Expanding access to markets • Upgrading corporate practices • Expanding access to finance and financial sector development • Enhancing environmental sustainability and energy efficiency • Promoting private participation in infrastructure • Addressing regional imbalances

113 • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Planned activities in these areas are integral to the five pillars of the CPS. The first two support pillar 5 of the CPS, improving public and market institutions. 'Upgrading corporate practices' maps into several of the CPS pillars, including pillar 1-integrating China into the world economy; pillar 4-financing sustained and efficient growth; and pillar 5. 'Access to finance and financial sector development' is an integral part of pillar 4. 'Environmental

The World Bank Group and private sector development

IBRD, IFC and MIGA will work together, capitalizing on their comparative strengths, to create a favorable business environment for the private sector. While IBRD will focus on strengthening the institutional capacity of state entities that deal with the private sector, IFC and MIGA will focus on developing model private sector transactions with strong demonstration effects regarding corporate practices in the areas of corporate governance, environmental and social standards; they will also aim to broaden the impact of FDI In particular, IBRD will use its international knowledge and experience to help the GoC to complete the transition to a market economy, and develop and implement regu­ latory practices and reform options in key areas of the business environment. IFC will respond to the structural changes accompanying China's transition, includ­ ing the shift of assets into the private sector, consolidation in key business sectors, the development of stronger financial institutions, and the adoption of international stan­ dards in corporate governance, environmental and social activities. Its interventions will focus on completing standard-setting model transactions for private sector investments, with a view to promoting innovation, creating demonstration effects, and improving international competitiveness. As in the past, the size and breadth of the IFC program will be a function of the level of development of the private sector in the economy. When the private sector was small and informal, and the industrial and financial sectors were dominated by SOEs and joint ventures with foreign private investors, IFC's program consisted largely of industrial projects sponsored by foreign investors. The subsequent emergence of the domestic private sector has given IFC new opportunities to broaden its program to include support for local financial institutions, indigenous industrial and infrastructure enterprises, and SMEs. Now, the emergence of large indigenous private enterprises is further expanding IFC's opportunities to support China's private sector development to include SOE privatization and South-to-South investment by Chinese companies. In line with these trends, most of IFC's investments going forward are ex­ pected to be with indigenous private enterprises. Moreover, IFC will provide more than money to private indigenous enterprises. These enterprises will also be seeking to im­ prove their management and corporate governance practices, attract and work with strategic partners, and upgrade their environmental and social standards. To assist Chi­ nese private enterprises in these areas, IFC interventions will include significant TA, delivered in combination with financing or as self-standing products, mainly through IFC's PEP China. MIGA's guarantee activities will be directed towards infrastructure development through FDI in the water and energy sectors, where MIGA has been active and where investors perceive significant non-commercial risk, especially when sub-national entities are involved. MIGA will also work with IFC and China's public and private sectors to draw FDI to underdeveloped regions of the country, and to encourage outward invest­ ment by Chinese companies, through providing PRI and building the capacity of Chinese financial institutions and investment intermediaries that support such projects. MIGA's Small Investment Program (SIP) will play an active role in helping private enterprises attract foreign investment and go abroad and invest overseas. ANNEX 3: PRIVATE SECTOR DEVELOPMENT STRATEGY sustainability and energy efficiency' is part of pillar 3--managing resource scarcity and environmental challenges, while 'private provision of infrastructure and addressing regional imbalances' supports Pillar 2 of the CPS--reducing poverty, inequality, and social exclusion.

Improving the business environment and strengthening regulatory capacity. The Bank Group will continue its analytical work in such areas as the investment climate, enterprise and public sector governance. Bank Group work in these areas will seek to help the GoC to complete the transition to a market economy, through redefining the role of govern­ ment vis-a-vis the private sector; changing the corporate and incentive structure in GoC agen­ cies and SOEs; and beginning to address failures in the national system for commercial dispute resolution, which remains an impediment to inter-provincial trade and investment. The focus of investment climate work will be on the central and western provinces and municipalities. Bank-FIAS enterprise surveys already completed in 23 large cities will be extended to another 100, providing objective ratings of enterprise competitiveness and governance, promoting government awareness of government impacts on the investment climate, and catalyzing internally-generated reforms to lower barriers and raise competitive­ ness. Generally speaking, the surveys will focus on identifying and addressing the many impediments to business that still exist in parts of China. Complementing this work, IFC together with MIGA and FIAS will help provinces in northeast, central and western China to attract higher levels of FDI (currently most FDI is directed to China's dynamic coastal economy) by improving the investment climate and strengthening investment promotion capacity. MIGA will work with the Bank and IFC to extend its enterprise benchmarking activity beyond Sichuan province to new regions of the country to improve access to infor­ mation on sector-specific factor costs and conditions that is critical to investor decision­ making. IFC through PEP China will focus its business environment work on: (i) value-chain studies to identify key constraints and develop assistance programs for select sub-sectors (starting with logistics, tourism, and pork); and (ii) legal and regulatory reform in Sichuan and other Western provinces, in particular following up on previous diagnostic work under­ taken by PEP China and other parts of the WBG. The Bank Group will also help to strengthen the GoC's regulatory capacity to respond to market liberalization and integration with the global economy. In support of China's efforts to balance domestic and international development, the Bank will help the GoC to participate more fully in multilateral economic institutions, support and share expe­ riences with other developing countries, and reduce barriers to inward and outward trade and investment. The Group will continue its support to SAFE to improve the monitoring of capital flows; to the central bank to analyze and improve the monetary transmission mecha­ nism; to the economic management authorities to develop better business-cycle monitoring mechanisms; and to the National Statistics Bureau to develop better macroeconomic statis­ tics. Bank Group AAA will also help China to clarify options for selectively lowering trade and investment barriers. This work will examine the rationale and possible roadmap for liberalizing the capital account, adopting an anti-trust law, and implementing trade facilita­ tion measures, particularly with a South-South focus.

Access to markets. With the continued liberalization of the Chinese economy, private enterprises see new opportunities to enter into sectors previously reserved for the state. Recent policy changes encourage Chinese private enterprises to enter industries currently monopolized by SOEs, such as the power, telecommunications, railway, petroleum, mineral exploration and mineral exploitation industries. The opening-up of these industries, to­ gether with the GoC's encouragement of Chinese private participation in SOE reform, dem-

l lS • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

onstrates a GoC intention to abolish discrimination against the domestic private sector. While the entry of private enterprises into these sectors is getting easier, difficulties remain, including high entry barriers (the aviation industry, for example, requires huge initial capital investment); the vested interests of local governments or government agencies in retaining monopolies; and a sometimes hostile and suspicious attitude towards private enterprises (a legacy of the centrally-planned economy). The Bank Group helps private enterprises to enter new sectors of the economy. IBRD will pursue this objective through providing TA to improve regulations and entry conditions in sectors such as infrastructure. IFC will support investment by private compa­ nies in sectors such as infrastructure; oil, gas and mining; and other heavy industry, as well as domestic private sector investment in new and high-tech industries, modem service industries, modem agricultural industry, and industries that require employment of a large workforce, such as processing trade, community services, processing of agricultural prod­ ucts and other labor intensive industries. Health and education are also sectors where pri­ vate participation is expanding, and the Bank Group will support innovation in private, vocational, and tertiary education through IFC (and possibly IBRD) investments. In addition, MIGA guarantees can help private enterprises to attract foreign investments in these new industries where political risks may exist. IFC and MIGA will continue to work together with GoC partners (MOF, MOFCOM, Sinosure, China Exim Bank, and others) to support Chinese companies in their efforts to expand to overseas markets.

Upgrading corporate practices. IBRD and IFC will support improvements in corporate governance practices through investments (IFC) and by helping to create the knowledge and institutional capacity for: (i) strengthening listing requirements on the Shanghai and Shenzhen stock exchanges; (ii) and assisting large enterprises in adopting and implement­ ing codes of corporate social responsibility. Through its investments and associated AAA, IFC will help investee companies and regulators to set appropriate standards for corporate governance. In addition, the Bank Group will help the GoC to improve the internal gover­ nance and external regulation of financial institutions (banks, collective investments, insur­ ance companies and pension funds), as misuse of the funds aggregated in these entities could lead to serious disruptions in the financial sector. IFC will promote sustainability by helping clients become role models that demon­ strate the business case for good environmental, social, and governance practices. At the same time, efforts will be made through PEP China to widen the impact by raising aware­ ness, building capacity, and creating incentives in the business community at large through:

• Linkages: Outgrower development and traceability in agri-business and forestry projects; community development around large industrial, infrastructure, and extrac­ tive projects. • Corporate governance: Assistance to improve corporate governance practices of IFCs' portfolio companies, carry out assessments of new clients, and identify business leads through training of candidates for listing. The program will also generally build awareness and skills through the development of a Corporate Governance Toolkit and Resource Center. • Environment and social Supporting energy efficiency investments; developing op­ portunities for private participation in environmental industries; building capacity of local E&S consultants; organizing workshops on best practices in key industries; help­ ing the Sichuan Environmental Protection Bureau improve SME compliance.

• • 116 ANNEX 3: PRIVATE SECTOR DEVELOPMENT STRATEGY

A major focus of IFC's work (through PEP China) will be to alleviate the shortage of management skills for the emerging private sector in China, in particular in less-developed regions. This draws on three existing IFC product lines:

• Business Edge management training: Following the successful introduction in Chengdu in 2003, coverage will be extended to secondary cities in Sichuan and other Western provinces. In parallel, focus will shift to providing customized, in-company training to achieve commercial viability, and to linking into broader IFC activities like training SME borrowers of client banks. • Global Business School Network: Assist in the roll-out of GBSN for initially two pilot schools in the interior region. • SME Toolkit: Assist with localization and dissemination of the Toolkit, with one or several partner banks and/ or business service providers.

Access to finance and financial sector development: Given the critical importance of financial sector reform and development for the sustainability of China's growth, support to financial sector reform will be an important area of focus for the World Bank Group. IBRD's intervention will be mainly through AAA work, while IFC's instruments will combine invest­ ments in private financial institutions with TA to improve corporate governance and risk management practices. The IFC's objectives in the financial sector are to create best practice models among smaller private banks, catalyze private sector entry into sectors previously held by SOEs (insurance, funds management, investment banks), and create new institutions to deepen the financial sector (housing finance, bond markets, credit bureaus, securitization, markets for distressed assets). In pursuing these objectives, IFC has made several innovative and pioneering investments in city commercial banks, national banks, insurance companies, and other non-bank financial institutions. As a result, IFC is playing a prominent role in the development of China's non-state banking sector. Going forward, IFC is entering the second phase of its China financial market strategy. The approach is to engage more intensively with investee banks to help them develop best practices. This is a resource-intensive activity requiring significant portfolio resources and TA content. IFC's strategy is to consolidate investments in the banking sector by supporting existing clients through both TA and participation in rights issues on a selective basis. To execute the strategy, IFC has increased financial market portfolio resources in the field. IFC has also improved TA interventions by stepping up the Technical Assistance Program to client institutions. So far, $2.5 million in TA has been delivered to portfolio companies and seven projects for $1.6 million are under implementation. IFC has also focused on clarifying the role of foreign strategic investors in improving the practices in Chinese investee banks. Action plans for IFC's portfolio banks have been developed with clear targets on expected progress in the areas of risk management and corporate gover­ nance. State bank reform remains a key focus of IBRD's AAA, which aims to help the GoC to differentiate clearly between commercial and development banks, clarify the mandates of development banks and ensure operational consistency with them, and commercialize the SCBs through introducing new ownership and governance arrangements, divesting non­ core assets, and restructuring troubled debt. A major focus of Bank Group activities in the financial markets will be to help create new non-banking financial institutions to provide alternative sources of financing and re­ duce the dependence on the banking system. IBRD will help expand access to selected

117 • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

financial services by supporting a project piloting commercially-sustainable lending to SMEs by formal financial institutions as well as a project launching a secondary mortgage market to promote the availability of and control the risks in housing finance, while IFC will help to restructure the rural finance system through pilot transactions involving the rural credit cooperatives. The Bank will also seek to help the Postal Savings and Remittances Bureau to pilot lending to rural small businesses and households. In parallel, the Bank Group is helping the GoC to develop sound capital markets, especially basic equity security, fixed-income (debt) security and derivatives markets. In particular, the Bank is assisting in the revision of the Securities Law, the drafting of a Futures Law, and the articulation of an appropriate legal framework (including regulatory institu­ tions) for securitization. Through AAA work the Bank Group will help China develop its bond market. In a landmark event for China's capital market development, IFC in October 2005 issued a first renminbi bond by a non-Chinese issuer. This has helped establish a benchmark and will stimulate the development of the bond market in China. IFC has also invested in a credit rating agency, investment banks, and insurance companies and will continue to explore opportunities to provide funding and TA to development of capital market institutions in China. PEP China will continue AAA to help strengthen the enabling legal, regulatory and supervisory environment to promote access and efficient intermediation with the focus on lagging regions. The objective is to alleviate the severe shortage of capital for private com­ panies, especially SMEs, through four components:

• TA to partner financial institutions: Comprehensive assistance for partner financial institutions in Sichuan and other western provinces; training IFC client banks in core topics like risk management and SME lending; and general coordination of IFC TA to financial institutions in China. • Bank training: Structured training program for the city commercial banking sector, in partnership with the China Banking Regulatory Commission. The program will cover core banking topics and will be delivered through the bankers' association and local training providers, strengthening their capacity. • Non-bank financial intermediaries: Development of viable microfinance initiatives, assistance to IFC investments in leasing, and development of other financial instru­ ments (trade finance, securitization, etc.) • Financial sector policies: Extension of the current work on the secured transactions framework, credit reporting, and leasing law.

Environmental sustainability and energy efficiency: In the energy sector, the Bank Group will continue to support GoC efforts to optimize China's energy use. Bank assistance is expected to involve strengthening the commercial management of energy companies, e.g. by helping the companies to divest non-core assets and the GoC to reduce monopolistic practices and clarify the regulatory frameworks. The Bank will also help the GoC to raise energy efficiency standards where appropriate as well as to develop and introduce pricing structures that more adequately reflect the opportunity costs of resource, environmental and ecological externalities (particularly for petroleum, natural gas, and electricity). In addition, the Bank will continue to manage a large, highly-visible and highly-successful GEF-funded program supporting the development and scaling-up of clean energy and renewable energy technologies, including clean coal technologies, flue gas desulfurization, as well as wind and photovoltaic energy markets. ANNEX 3: PRIVATE SECTOR DEVELOPMENT STRATEGY

Complementing this work, IFC AAA and investments will help to expand the use of renewable energy, develop technologies for clean energy thus reducing China's reliance on coal and support the development of a carbon credit market to reduce carbon emissions. IFC investment in forestry will help to develop models for containing land degradation and the negative externalities that result. Bank Group activities will help to demonstrate the potential use of coal-based methane and carbon finance transactions; pilot phaseout projects for PCBs, chlordane and mirex. Extensive AAA will cover such topics as forestry, carbon finance, recycling, 'green' national accounting, and climate change. In addition, the Bank Group will help the GoC to promote sustainable cultural and eco-tourism by supporting the development of demonstration sites and increasing the number of listed heritage sites with environmental protection measures in place.

Private participation in infrastructure: Working increasingly with secondary cities, which have trouble attracting interest from foreign investors, IBRD financing and MIGA-guaran­ teed FDI will finance urban wastewater treatment plants as well as the associated collection systems, while providing advice and TA on utility corporatization, wastewater tariff levels and administration to ensure that the relevant institutions can operate on a sustainable basis. IFC investment activities will support (i) emerging domestic private companies in power generation; (ii) private investment in water projects; (iii) private participation in gas distribu­ tion and (iv) (potentially) other infrastructure such as airlines/ airports. IFC will continue to explore public private partnership opportunities in infrastructure through the municipal fund and in cooperation with IBRD and MIGA.

Addressing regional imbalances: A FIAS study of the environment for FDI, focused initially on Sichuan and Liaoning, as well as IFC/MIGA/Bank support for local investment authorities in Sichuan and Heilongjiang will aim to develop initiatives for strengthening the business environment in China's lagging regions. MIGA and FIAS will continue their efforts with the Ministry of Commerce to develop a workable implementation plan for a national investment promotion strategy that will help to better distribute new investment, both for­ eign and domestic to the lagging regions~ The Bank Group will place a greater emphasis on institutional aspects of agricultural productivity, such as strengthening supply chains and piloting public-private partnerships in the provision of agricultural support services, in light of the GoC's interest in transferring support services as much as possible from the state to the private sector. Support will include AAA and TA, including investment climate assessment work conducted by IBRD, IFC, and MIGA; IBRD lending in support of integrated rural development, including farming and livestock husbandry; and IFC support for private sector investment in agro-processing. IFC's work on linkages in agribusiness and resource-based investments is also expected to enhance benefits to local communities.

Program and resource implications

Given the growing demand for its services IFC is planning a significant expansion of its program. New commitments are expected to reach $700 million per annum over the CAS period, with IFC expanding its geographic coverage and increasing its resources in the field so as to maximize development impact. This is made imperative by the complexity of regulations as well as language and distance barriers. IFC's Beijing office expanded signifi­ cantly in the last two years, and additional staff will be hired during the CPS period to focus

119 • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

on infrastructure, agribusiness, and environmental/energy related projects and initiatives. There has also been a recent resurgence in interest for MIGA coverage, particularly for projects that involve sub-sovereign risk and in areas and regions that are government priori­ ties, e.g. in infrastructure, water in particular.

• • 120 Annex 4 Millennium Development Goals

China is on track nationally to achieve many of the MDGs for 2015, but national figures mask large and growing development gaps between the relatively-rich coastal zones and poorer central and western regions.

Goal 1: Eradicate extreme poverty and hunger. National poverty reduction goals have been met. China leads East Asia, though the rate of reduction varies between rural areas (4.8%) and urban areas (15.6%). Goal 2: Universal primary education. China is ahead of target; junior secondary en­ rollment has also increased (from 67% in 1990 to 93.6% in 2004). Goal 3: Promote gender equality and empower women. China is slightly off-track on the girl/boy ratio for primary and secondary school, but several provinces with large minority populations have fallen behind and there are concerns over the situation of rural women and increasing margin of newborn boys over girls. Goal 4: Reduce child mortality. China has made progress, but the 2% rate of reduction achieved in 1990s (using UN data) is lower than 4.3% rate required to achieve the target by 2015, and gaps between rich and poor provinces appear to be widen­ ing. Goal 5: Improve maternal health. China has made good progress, as maternal mortal­ ity dropped from 89 per 100,000 live births in 1990 to 50 in 2001 , but the 4.8% rate of reduction is lower than the 5.4% rate required to achieve the target by 2015. There are also large contrasts between coastal and western provinces, where women, especially in remote areas, have limited access to emergency obstetric care. Goal 6: Combat lilVI AIDS, malaria, and other diseases. China has made good progress toward containing malaria, but it lags its neighbors in reducing tuberculosis preva­ lence (scaling-up and improving the detection rate of an effective DOTS program remains challenging). China is also taking steps to reduce HIV prevalence, which is low by international standards but spreading rapidly since 1990s. Goal 7: Ensure environmental sustainability. The GoC is committed to reversing the degradation of land, water, air, and globally significant biodiversity. It is working hard to achieve challenging targets for access to safe drinking water and rural sanitation. Goal 8: Develop a global partnership for development. The GoC has expressed strong commitment and undertaken decisive action to integrate into the global eco­ nomic system.

121 • •

Annex 5 Consultations on Country Partnership Strategy

Preparation of the new CPS was informed by two sets of formal consultations, a Client Survey, and ongoing dialogue between the Bank and Chinese government counterparts. From July 11 to 22, 2005, Bank Group staff consulted with GoC officials from the MoF, NDRC, PBoC, 23 other central ministries and agencies, 26 provinces and 8 municipalities concerning the next CPS for China. From January 9 to13, 2006, a follow-up mission held consultations with GoC officials from MoF, NDRC, other central ministries and agencies and four provinces as well as with representatives of donors, academia, the private sector, and NGOs and CSOs. In addition, the Bank conducted a Client Survey between July and Sep­ tember 2005, involving over 200 stakeholders of the WBG in China. The new CPS also benefited from ongoing dialogue between Chinese officials and Bank representatives through reciprocal visits of high-level officials, meetings between the Bank and GoC counterparts to discuss the lending and AAA programs, as well as ongoing partnerships on specific lending projects and analytical work. During both consultations, participants repeatedly noted that the GoC-Bank Group partnership remains strong, welcomed the shift from an 'assistance' to a 'partnership' strat­ egy, and said that the draft CPS is well aligned with the priorities of the 11th FYP. Most comments consisted in suggestions for placing greater emphasis on specific areas of assis­ tance or results within the framework of CPS objectives.

July 2005 Consultation

During the first round of consultations, GoC participants commented on the overall impact of past Bank assistance as well as strategic priorities for the upcoming 11th FYP and future Bank assistance; they also discussed issues affecting the Bank's ongoing program and of­ fered suggestions for improvement. In their remarks, GoC officials noted that the GoC's overall objectives for the 11th FYP include promoting scientific development and building a harmonious society, with a strong emphasis on achieving the five balances, and they said that the GoC's emerging development priorities for the next five years are well captured in the CPS's thematic clusters. Within the proposed CPS themes, GoC officials articulated various areas of emphasis, including: presenting a balanced view of China in the world, supporting South-South learn­ ing, and promoting Chinese investment abroad; coordinating fiscal and monetary policy, boosting domestic consumption, reforming SOEs and revitalizing industry (especially in the northeast), and developing the services sector; reducing poverty and income disparities (particularly in the west and among ethnic minorities) through improving public health and education, raising rural incomes, facilitating migration out of rural areas (especially through vocational training), and managing growing urbanization; addressing resource constraints, especially through achieving water savings, improving wastewater treatment and solid waste

123 • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

disposal, and developing dean and renewable energy; and protecting the environment, including China's biodiversity. Several central ministries and agencies noted that the Bank would face a large challenge in addressing some of these issues (e.g. transportation man­ agement, water resource management, and environmental protection), due to the disper­ sion of government responsibility in these areas. GoC participants agreed that the Bank has made many contributions to China's devel­ opment since engaging in the early 1980s. Broadly speaking, these include:

• Filling a (local) financing gap, enabling provinces and municipalities to address key infrastructure bottlenecks and implement their overall development plans, and also improving investment structures (e.g. by leveraging private or grant funds); • Upgrading technologies, particularly in areas such as road transportation, waterway navigation, power generation, water supply, wastewater treatment, irrigation, inte­ grated rural development, and environmental and social safeguards; • Introducing institutional reform and innovation, including, e.g., market-based pricing, distance learning, river basin management, water user associations, profes­ sional corporate governance, modern financing models, and participatory approaches to poverty reduction; • Building human resource capacity, e.g. in procurement, disbursement, project man­ agement and supervision; and • Supporting policy reform, e.g., in the power sector and in poverty reduction pro­ grams, both through financing and through an extensive body of high-quality AAA, including recently the investment climate surveys and various reports supporting prepa­ ration of the 11th FYP.

In general, GoC counterparts valued the Bank's assistance in introducing international experience and expertise into their work. They provided many examples where this had been successful and noted that the need for such assistance remained strong even for jurisdictions where the need for financial assistance is now weak (e.g. in Shanghai). Some participants also observed that a few Bank projects (e.g. projects assisting unrestructured industries or providing direct financial support to rural households) had failed to achieve their objectives; Bank staff agreed. In discussing their experiences in collaborating with the WBG, GoC participants ob­ served that Bank processes, particularly related to lending, could be improved through undertaking several measures, including:

• Reducing project preparation times (Bank staff and Goe officials noted recent improvements, e.g. in Ningbo and Shaanxi, and also that progress requires joint GoC­ WBG efforts, as delays also occur on the GoC side); • Reducing loans charges, which can be burdensome (Bank staff observed that China's per capita GDP is now much higher than the threshold for IDA eligibility, that IBRD spreads are already low, and that the front end fee was being reduced to 0.25% in FY06); • Simplifying safeguards procedures, e.g. by adopting GoC procedures (Bank staff noted that simplification is being sought, e.g. by adopting a 'gap approach' for com­ pleting environmental impact assessments (EIAs) and resettlement action plans (RAPs) and also by reducing translation requirements, but that variability in GoC resettlement standards jurisdiction-by-jurisdiction as well as lower GoC EIA standards for assessing project alternatives, consultations, and disclosure makes harmonization difficult);

• • 124 ANNEX 5: CONSULTATIONS ON COUNTRY PARTNERSHIP STRATEGY

• Accelerating procurement clearances (Bank staff noted that the average elapsed time for Beijing-based staff to review procurement through national competitive bid­ ding (NCB) is less than three days, but that procurement through international com­ petitive bidding (ICB) involves Washington-based staff and so usually takes a longer time); • Reducing counterpart funding requirements (Bank staff noted that a recent change in Bank policy allows zero counterpart funding in certain cases, and that MoF and NDRC in light of that policy had agreed to consider lower counterpart funding for social sector and poverty reduction projects in poor provinces on a case-by-case basis); and • Ensuring continuity in Bank staff working on a particular project, delegating more responsibility to Bank staff located in Beijing, and making greater use of Chinese consultants (the Bank is committed to making greater efforts in these areas).

Almost all GoC speakers requested expanded WBG assistance over the next five years, not only in IBRD, IFC and MIGA investments, but also and particularly in innovation and knowledge transfer. In this context, they urged that WBG activities play a demonstration role in implementing forward-looking ideas and practices that align with but extend beyond GoC initiatives. Several participants noted that the Bank can do better in disseminating the results of its AAA and the lessons learned in its projects, to ensure that China captures all of the potential benefits of this work. Some participants urged the Bank to increase its focus on macro-level challenges rather than micro-project implementation. Many provinces and mu­ nicipalities and several central ministries requested WBG assistance in articulating their de­ velopment plans and strategies (as was done recently in Beijing and Hebei), both to engage decision-makers in taking a long-term view and as a framework for selecting Bank projects. While most agreed with the WBG strategy to place greater emphasis on lagging regions, including the revitalization of industry in the northeast, western and central provinces stressed the importance of coastal linkages, and more developed coastal provinces and municipalities noted their ability to play a demonstration role in China's continuing development. Throughout the consultations, GoC participants stressed several strategic shifts which they hope to see implemented during the five-year CPS period. Given that the private sector will be the major driver of future growth, they urged that the Bank seek to leverage its financing to attract more private sector financing and free up public resources for other purposes. They welcomed the growing consensus within MoF and the affected line minis­ tries that it is sensible to keep IBRD engaged in public health, education, and poverty reduc­ tion projects, especially in poorer provinces that are already facing repayment difficulties (e.g. Gansu, Yunnan), by blending public funds with IBRD resources to reduce the effective interest rate charged to project beneficiaries. Many western and central provinces expressed a desire to see an appropriate mechanism articulated and implemented as rapidly as possible in support, e.g., of a demonstration vocational education project. Several more-developed provinces and municipalities also expressed an interest in new Bank lending instruments, such as programmatic loans and sector-wide approaches (SWAps), which they believe would give them greater autonomy in project implementation (in this context, it was noted several times that domestic financial institutions such as CDB already lend on this more flexible basis). Bank staff replied that such approaches, which the Bank uses widely in other coun­ tries, are being piloted in China in the ongoing Shanghai Adjustable Program Loan and the proposed Fujian road transportation SWAp, and that, if successful, MoF and NDRC might approve more widespread use. GoC participants also expressed interest in working with the Bank to develop and test an integrated multisectoral approach to addressing some of China's most common and pressing development problems in a few geographical areas.

125 • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

January 2006 Consultation

During the second round of consultations, representatives of the GoC, donors, academia, NGOs and CSOs provided oral and written comments in response to drafts of the CPS and results matrix that had been provided to participants in advance. In general, participants said that the draft CPS adequately reflected comments provided in the July consultation and reaffirmed that the draft CPS objectives and proposed results are aligned with the priorities of the 11th FYP. Participants generally agreed with the analysis of China's development challenges in the draft CPS introduction and context, while recommending a number of revisions to specific CPS data, language, and planned WBG interventions (which have been incorporated, where agreed, into the CPS document). Participants also requested that the WBG further emphasize certain areas of interest. In particular:

Private sector consultation participants urged the WBG, and in particular IFC, to em­ phasize private sector development more strongly and to expand assistance to the private sector through a combination of direct loan and equity investments as well as through TA to improve the investment climate and access to financial services. They noted that the GoC has increasingly opened markets for domestic private investment (the State Council's issu­ ance of Article 36 in 2005 was cited as an important development) and that the contribution of China's private sector to the economy, to exports, and to foreign investment is growing rapidly. They also asked that the CPS acknowledge the substantial criticism that private entrepreneurs still confront in China, emphasize the role of the private sector in addressing development challenges such as rural employment, and provide greater support to policy changes that would create a level playing field for the private sector. Participants recom­ mended that the CPS should emphasize:

• Scaling up IFC's lending and TA related to the private sector (such as expanding IFC's Project Development Facility to more locations across China), deepening in­ volvement in locally-based research tied to the policy process, and focusing more on sectors rather than on particular companies. Participants supported IFC's plan to in­ crease its investments from $400 million to $700 million per year, while noting that the quality of IFC's assistance, which helps to raise standards in the companies in which it invests as well as to improve the investment climate, is as important as the quantity of IFC lending; • IFC and WBG positioning as pioneers that leverage additional financing, introduce new technologies and management methodologies, and promote better understand­ ing among Chinese companies of how to work with foreign investors; and • Further research to support policy reforms (e.g., removing price controls in the health sector) together with model investments and TA that support key sectors and demonstrate and build capacity for improved management approaches, systems, and financing mechanisms (participants noted, inter alia, the development of the bond market and cited IFC-ADB issuance of the first "Panda bond" as a good step).

NGO participants generally supported the CPS themes and directions while urging the Bank to increase focus on priority areas and to further build cooperation with NGOs. Partici­ pants urged greater WBG emphasis on:

• Poverty reduction including: (i) capacity building and housing for the disabled; (ii) attention to poverty challenges faced by ethnic minorities (including the preservation

• • 126 ANNEX 5: CONSULTATIONS ON COUNTRY PARTNERSHIP STRATEGY

of cultural heritage), (iii) gender equity (with increased focus on underlying causes of gender inequality through, e.g., scaled-up approaches to labor mobility); (iv) control­ ling the spread of HIV/AIDS; and (v) sustainable use of natural resources (through green accounting, greater public participation in formulation of natural resource projects, including sustainable models that promote conservation and alternative approaches and respect ethnic minorities); • Improved governance, including changes in government role and functions, public sector unit (PSU) reform, and institutionalization of social and environmental impact assessments prior to adoption of policy reforms; and • Deepened WBG support to NGOs involved in poverty reduction through facilitat­ ing greater GoC understanding of and support for NGOs (e.g., through expanded procurement of NGO services), direct WBG cooperation such as the China Develop­ ment Marketplace, and promotion of a greater role for NGOs in the provision of public goods.

Representatives of academic and research organizations also stated that the CPS is broadly in line with China's needs and situation and that the WBG was correctly positioning itself in China's development. They urged the Bank to increase its emphasis on innovation to adequately reflect the changing nature of China's development challenges (e.g., the changing character of poverty, increasing concern with trade disputes); strengthen relations with senior GoC officials; and make better use of non-government Chinese researchers and scholars. They suggested that the CPS emphasize:

• Public sector budget and related performance management systems, with greater WBG emphasis on strengthening local government implementation of central govern­ ment policy reforms (e.g., reducing emphasis on capital investments and promoting balanced urbanization through providing housing and services to migrants); • Inequalities in public service provision (e.g., through helping government in pro­ vision of safe water, education, ICT, rural health insurance coverage, rural infrastruc­ ture and services to promote agricultural productivity); and • Financial sector reform (including banking sector reforms to address non-perform­ ing loans, develop the bond market, and build the capacity of local financial institu­ tions to expand access to credit).

As a follow-up to July 2005 CPS consultations, provincial representatives from Guangdong, Henao, Jilin, and Ningxia provided feedback on the draft CPS and matrix. Representatives said that provincial comments from earlier consultations had been well captured in the draft CPS. Participants recommended greater CPS emphasis on:

• Regional and provincial development planning, with articulation of how the WBG will assist selected regions and provinces to conduct comprehensive analyses of social and economic development options and undertake development planning; and • Differing regional and provincial priorities, noting how various CPS themes and sub-themes had particular relevance to their provinces and regions (e.g., for the west­ ern provinces, natural resource and environment; for the northeast provinces, private sector and economic revitalization; for the central provinces, agricultural industrializa­ tion and the role of towns in absorbing surplus labor; and for the coastal provinces, vocational education, energy, debt management and support for remaining poor com­ munities).

127• • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Representatives of line ministries and government agencies, building on their partici­ pation in the July 2005 consultations, also said that the CPS is well aligned with the new FYP while suggesting a number of revisions, including:

• Articulation of a more comprehensive approach to addressing water scarcity, regional development, and labor migration issues; • An expanded description of specific poverty reduction challenges faced by ethnic minorities (public health, including access, HIVI AIDS, and drug trafficking; linkages between poverty and environment degradation; and the protection of tradi­ tional cultures); • A deeper discussion of the environment, including incorporation of FYP targets for energy efficiency; more emphasis on linkages between the rural economy and environmental protection; and capacity-building for environmental management, es­ pecially early warning and response systems for environmental disasters; • Additional discussions on tax reform assistance; payment and incentive mechanisms for teachers; and increasing differentiation of public service (and specifically PSU) delivery challenges; and • The articulation of new models and approaches to improve partnership (e.g., sustained research over a long period of time, linkage of poverty reduction with com­ munity development and environment initiatives).

At a wrap-up meeting, MoF representatives said that they were pleased with the format, layout, and general directions of the draft CPS as well as the consultation process through which it had been developed. They reiterated the GoC's commitment to further strengthening relations with the WBG, following President Wolfowitz' October 2005 visit, and stressed the importance of the CPS as a roadmap for Bank engagement over the next five years. They said that the CPS is very much in line with the priorities of the new 11th FYP and China's internal and external circumstances, is based on sound scientific and technical analysis, and that the five CPS themes are very relevant to China's development needs. In addition, MoF recommended four areas as policy priorities for future WBG assistance:

• Supporting regionally coordinated development by helping regions craft differ­ entiated strategies, reflecting their unique features and development stages, and bring­ ing cross-country experience in regional development; • Supporting rural development, noting that development of rural areas has become a major GoC priority, not only to help rural areas catch up but also to promote their long-term stability, and that the WBG was well-positioned to help formulate a new comprehensive approach (rather than a ring-fenced project-based approach) to im­ proving agriculture and rural development; • Supporting innovation and ideas, particularly with a view to helping local govern­ ments and enterprises to improve their "self-innovation" abilities and build systems and institutions that encourage innovation as a means to enhancing reform and com­ petitiveness; and • Strengthening the accountability and performance evaluation of government officials, with an emphasis on preventative rather than ex-post measures.

• • 128 ANNEX 5: CONSULTATIONS ON COUNTRY PARTNERSHIP STRATEGY

ZOOS Client Survey

In mid 2005, 531 stakeholders of the World Bank in China were invited to provide their opinions on the Bank's assistance to the country by participating in a client survey. The 227 who responded ( 43% of those invited) were drawn from among employees of ministries, ministerial departments, or implementation agencies; local governments; bilateral or multi­ lateral agencies; private sector organizations; NGOs and CSOs; the media, and members of academia and research institutes. Findings from the survey are particularly interesting when compared to the results of the 2002 survey, as priorities and views of the Bank have changed in a number of key areas.

• In 2002, education, social protection, corruption, government effectiveness and jobs were of critical importance. In 2005, education remains on top of the minds of stake­ holders, while social protection, jobs and corruption seem to have diminished as de­ velopment priorities and challenges for China. Instead, inequality, environmental deg­ radation (and limited natural resources) have climbed into the top ranks-though the latter is partly due to a very strong consensus among bilateral and multi-lateral respon­ dents. • In 2005, the Bank was most valued first for its knowledge and second for its financial resources (while the central government has ample resources, local governments that work with the Bank generally face resource gaps). By contrast, in 2002, a plurality of stakeholders said that the 'transfer of new project concepts' was the Bank's most important contribution to China, followed closely by knowledge, with financial re­ sources less of a concern. • While the 2005 survey shows that there has been improvement in the speed at which the Bank disburses funds, a large plurality reported that the number and complexity of the procedures involved in obtaining World Bank financing was the greatest obstacle to the Bank playing a significant role in China's development over the medium term. • The 2005 survey suggests that the quality of the Bank's expertise regarding the chal­ lenges that China faces may need to improve. • The survey findings suggest that stakeholders are comfortable with Bank involvement in a range of areas of concern, including governance, education, social protection, and environmental protection, but they also indicate a reduction in ratings on governance and environmental protection since the 2002 survey. While the rating for the Bank's work in education did not decrease significantly, it was one of the lower ratings for the Bank- a serious concern considering how high a priority education is currently in China. • While ratings are still extremely high related to the Bank's relevance and whether its programs are realistic and sustainable, these numbers have also decreased signifi­ cantly since the 2002 survey. It is unclear why these perceptions have changed. Some areas to explore (detailed above) include: the Bank's expertise, the complexity of its financing, its work in priority areas such as governance and education. Perhaps this result may reflect the less positive views of relationships, e.g., whether stakeholders like to work with Bank staff, whether the Bank treats stakeholders with respect, whether the Bank and GoC work as equal partners, and whether the Bank maintains consistent messages. • A large majority of survey participants uses the internet to gather knowledge and information about the Bank (in preference to a PIC), indicating that the internet pre­ sents a huge opportunity for the Bank to reach stakeholders in China and that the

129 8 8 COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Bank's website needs to continue to be useful and easy to navigate. Survey findings also indicate clearly that more translation will sustain reading audiences in China.

Because there is frequently a correlation between familiarity and positive views of the Bank, it is important to note that while the overall familiarity rating remained about the same when results from the two years are contrasted, within particular stakeholder groups there were interesting changes. The media, academia and the private sector are more familiar with the Bank than in 2002; this may reflect work that the Bank has done to reach out to these stakeholder groups. By contrast, though, employees of ministries were less familiar than in 2002.

• • 130 ANNEX 6: STANDARD CPS ANNEXES

Figure 1: Development diamond* 2004 Population, mid-year (millions) 1,296.5 1,855 2,655 Life expectancy GNI per capita (Atlas method, US$) 1,500 1,080 1,480 GNI (Atlas method, US$ billions) 1,938 2,011 3,934

Averageannualgrowth, 1998--04 Gross GNI Population(%) 0.7 1.0 0.9 primary per capita enrollmeflt Labor force(%) 1.1 1.1 1.2 $ Most recent estimate (latest year available, 1998--04) Acx:ess to improved water source Poverty (% of population below national poverty line) 5 Urban population (% of total population) 42 40 50 China - Lower-middle-income groop Life expectancy at birth (years) 71 69 69 Infant mortality (per 1,000 live births) 28 32 32 Child malnutrition (% of children under 5) 10 15 11 Access to an improved water source (% of population) 77 76 81 Illiteracy(% of population age 15+) 12 10 10 Figure 2: Economic ratios* Gross primary enrollment(% of school-age population) 115 111 112 Male 115 112 113 Trade Female 115 111 111

KEY ECONOMICRA TIOS and LONG-TERM TRENDS 1004 1004 2003 2004

GDP (US$ billions) 256.1 559.2 1,641 .0 1,931 .7 Gro ss domestic investmenUGDP 34 .4 40.0 38 .0 39 .3 Exports of goods and services/GDP 11 .3 24.6 29.6 34 .0 Gro ss do mestic savings/GDP 34 .5 44.4 50.3 52 .8 Indebtedness Gro ss natio nal savings/GDP 35 .3 44.5 50.9 53.8 Current account balance/GDP 0.7 1.9 2.8 3.6 China - Lower-middle-income group Interest payments/GDP 0.2 0.7 0.3 0.2 Total debUGDP 4.7 18.0 12.7 12.9 Total debt service/exports 7.3 7.7 7.2 3.5 Present value of debUGDP 13.3 Present value of debUexports 36.4 Figure 3. Growth of investment and GDP(%) 1984-94 1994-04 2003 2004 2004-08 20 (average annual grow1h) GDP 9.5 8.8 10.0 10.1 8.8 15 GDP per capita 8.0 7.9 9.3 9.4 8.1 Exports o f goods and services 8.1 17.3 26.8 28.4 14.0 10

STRUCTUREoftheECONOMY 1004 1004 2003 2004

(%of GDP) 99 00 01 02 Agriculture 32.0 19.7 12.6 13.1 -- GDI -+- GDP Industry 43.3 46.6 46.0 46.2 M anufacturing 35.5 33 .6 32 .8 33.1 Services 24 .7 33 .8 41 .5 40.7 Private consumption 51.4 45.8 49.0 47.9 General government consumption 14.2 12.4 10.9 10.2 Figure 4· Growth of exports and Imports of goods and services 11.4 22.7 27.4 31 .4 imports(%)

1984-94 1994-04 2003 2004 40 ! (average annual growth) 30 Agriculture 4.0 3.3 2.5 6.3 Industry 12.3 10.0 12.7 11.1 20 M anufacturing 11.7 10.1 14.9 13.2 Services 10.0 9.7 9.5 10.0 ' 10 Private consumption 8.1 7.9 6.5 7.5 General government consumption 9.4 8.6 4.8 6.8 Gross domestic investment 9.1 8.4 18.8 14.1 gg 00 01 02 03 04 Imports of goods and services 9.9 15.5 24 .8 22.5 -- Exports -+- Imports ------

• The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will be incomplete. (continued on next page)

131 • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

Figure 5: Inflation(%) Domestic prices (% change) 10 Consumer prices 8.3 24 .1 1.2 3.9 Implicit GDP deflator 4.9 19.9 2.1 6.5

Govemmentfinance (% of GDP, includes current grants) Current revenue 22.9 11 .9 18.7 19.4 Current budget balance 1.0 1.3 1.9 Overall surplus/deficit -0.8 -1 .2 - 2.8 -1 .7

TRADE 19B4 1994 2003 mi 99 00 01 02 03 04 --GDP Deflator --CPI (US$ millions) Total exports {fob) 26,139 121,006 438,228 593,369 Food 3,232 10,015 17,533 18,870 Fuel 6,027 4,069 11 ,110 14,476 Figure 6: Export and Import levels Manufactures 14,205 101 ,298 403,560 552,818 (US$mill.) Total imports (cif) 27,410 115,614 412,760 561 ,423 Food 2,331 3,137 5,959 9,156 Fuel and energy 139 4,035 29,214 48,003 800.000 Capital goods 7,245 51,467 192,869 252,624 600,000 Export price index (2000=100) 50 103 96 102 Import price index (2000=100) 74 96 102 112 400,000 Terms of trade (2000=100) 68 107 95 91 200,000 BALANCE of P AYMENTS 19B4 1994 2003 mi

(US$ millions) 98 99 00 01 02 03 04 Exports of goods and services 29,039 137,378 485,003 655,827 • Exports • Imports Imports of goods and services 29,183 127,210 448,924 606,543 Resource balance -144 10,168 36 ,079 49,284 Net income 1,534 -1 ,036 -7,838 -3,523 Net current transfers 442 1,337 17,634 22,898 Figure 7: Current account balance to GOP(%) Current account balance 1,832 10,469 45,875 68,659 Financing items (net) -2,363 20,058 71 , 148 137,705 Changes in net reserves 531 -30,527 -117,023 -206,364 Memo : Reserves including gold (US$ millions) 57 ,770 416,208 622,945 Conversion rate (DEC, local/US$) 2.8 8.6 8.3 8.3 ' 2 EXTERNAL DEBT and I 1 RESOURCE FLOWS 1984 1994 2003 mi

(US$ millions) Total debt outstanding and disbursed 12 ,082 100,457 193,567 177,709 IBRD 73 5,933 10,657 11 ,035 IDA 181 6,097 10,314 10,670

Total debt service 2,285 11 ,135 37 ,073 24 ,498 Figure 8. Composition of 2004 debt IBRD 6 679 2,690 1,124 (US$mill.) IDA 4 50 219 262 Composition of net resource flows Official grants 112 337 Official creditors 831 3,117 -3,092 -2,485 fj22,967 Private creditors 240 6,691 -1 ,778 -13,373 Foreign direct investment 1,419 33,787 55 ,507 60,906 (net inflows) Portfolio equity (net inflows) 0 3,915 7,729 10,923 World Bank program Commitments 959 4,035 1,250 1,250 Disbursements 197 2,060 1,616 1,246 F: 55,ill__, Principal repayments 0 323 2,459 999 Net flows 197 1,737 -843 247 A • IBRD B · IDA C · IMF D • Other mu~lateral Interest payments 9 406 450 387 E • Bilateral F • Private G . Short-lerm Net transfers 187 1,331 -1 ,293 -140

• • 132 ANNEX 6: STANDARD CPS ANNEXES

Figure 9 Savings

00

z 40

urban(% urban pop) 2002 69 71 80 ~Metal 15%~ Data from national sources Total wastewater discharged 2003 35.7 46% 54% Figure 14 C02 emissions (tons per capita) (metric tons per capita) COD discharged (kg per capita) 2003 10.4 38% 62% Ammonia Nitrogen discharged 2003 1.0 31 % 69% (kg per capita) Wastewater treated 2003 25.8 (% of municipal wastewater) Industrial solid waste generated (tons per capita) 2003 0.8

Environmental expenditure 2003 1.39% o +-~~~~~~~~~~ (as % of GDP) 1980 1970 1980 1990 2000 Tenth five year plan for environmental protectioni prepared in 2001 - China - Lower Middle Income • • • East Asia andPacific l

133 • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

CPS AnnexB2 Selected Indicators* of Bank Portfolio Performance and Management As of January 1, 2006

~ l_n,d.~tor . . 2003 2004 2005 2006

Portfolio Assessment Number of Projects Under Implementation• 93 87 85 75 Average Implementation Period (years)b 5.0 4.9 5.0 4.5 Percent of Problem Projects by Number"· 0 0.0 3.4 2.4 0.0 Percent of Problem Projects by Amount•· 0 0.0 2.7 3.6 0.0 Percent of Projects at Risk by Number"·• 0.0 3.4 2.4 0.0 Percent of Projects at Risk by Amount•·• 0.0 2.7 3.6 0.0 Disbursement Ratio(%)• 25.5 22.7 21.6 11 .1

Portfolio Management CPPR during the year (yes/no) Supervision Resources (total US$) Average Supervision (US$/project)

Memorandum Item Since FY 80 Last Five FYs

Proj Eval by OED by Number 186 53 Proj Eval by OED by Amt (US$ millions) 25,390.0 8,634.2 % of OED Projects Rated U or HU by Number 9.2 9.4 % of OED Projects Rated U or HU by Amt 8.4 7.8

• As shown in the Annual Report on Portfolio Performance (except for current FY). • Average age of projects in the Bank's country portfolio.

c Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP) . • As defined under the Portfolio Improvement Program. • Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the beginning of the year: Investment projects only. • All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio, which includes all active projects as well as projects which exited during the fiscal year.

• • 134 ANNEX 6: STANDARD CPS ANNEXES

CPS Annex 83. IBRD (as of April 2006)

P~bject Amt Strategic lmpl. Pillar N8me . ($m) Descliption rewards risks ~ S'I".' t < • ~ ; - ~ "-.;:, FY06 Program 2,3,4 Shanghai Urban APL 2* 180 Metro water supply, waste disposal; innovative financing H M 2,3 Inland Waterways 5* 100 Han waterway upgrade; Xiangfan hydropower H L 2,3 Integrated Agriculture Irrigation 3* 200 Increased water, agriculture productivity in low yield areas H M 2,3 Fuzhou Urban Transport• 100 Road and public transport access to Nantai island M M 2,3 Renewable Energy Scale-up 2* 87 Renewable (wind and hydroelectric) power supply H M 2 Heilongjiang Dairy* 100 Improved dairy productivity, sustainable herd management M M all Economic Reform Implementation• 20 TA to Goe agencies H M 2,3 Henan Towns Water 150 Water supply, wastewater treatment in 45 towns H M 2,3 Liaoning Urban Infrastructure 1 (transport) 218 Urban transport improvements in second-tier cities H M 2,3 Jiangxi Highway 3 200 117km Ruijin-Ganzhou mountain highway, local roads M L 2,3 Changjiang/Pearl River Watershed Rehab. 100 Land and water resource management in river basins H M Total 1,455

FY07 Program 2,3 National Railway 3 200 Guizhou, Yunnan railway upgrades M L 2,3 Sichuan Urban Development 2 180 Infrastructure expansion in second-tier cities H H 3 Guangxi Integrated Forestry 100 Improved forest resource management M M 2,3 Fujian Transport SWAp 320 Longyan highway, rural roads; program approach H M 2,3 Shaanxi Highway 3 300 103km Ankang-Tiejiangya mountain highway M L 2,3 Western Rural Water 25 Improved rural water supply, hygiene, in 2 poor provinces H M 2,3 Shandong Urban Environment 2 150 Water supply, wastewater treatment in second-tier cities H L 2,3 Guangdong Pearl River Delta (Foshan) 100 Water supply, waste treatment/disposal, pollution control H M 4 Micro and Small Enterprises 100 Commercially-sustained formal bank lending to SMEs H M Total 1475

Standby 2,3 Liaoning Cities Urban Infrastructure 2 200 Water supply, wastewater treatment in second-tier cities H M 3 Shandong Flue Gas Desulfurization 60 S02 emissions reduction in city heat, thermal power sector H M 2,3 Eco-Farming 120 Renewable energy, improved agriculture productivity H M Total 380

FY08 Program 2 Rural Health 50 Rural health insurance expansion; better spending H H 3 Huai River Basin 150 River basin flood and waterlogging control, management H M 2 Gansu Cultural Heritage 40 Heritage asset protection, sustainable tourism development H M 2,3 Xi 'an Urban Transport 150 City (incl. public) transport upgrade, management H L 2 Jilin Food Safety 100 Improved capacity to produce safe cost-competitive food M M 2,3 Guiyang Urban-Rural Highway 100 Upgrade Youzhajie-Xiaobi road and 500km rural roads H M 3 National Railway 4 300 Wuhan-Beijing electrified railway upgrade M L 2,3 Anhui Provincial Highway Network 200 Upgrad Anhui highways and connected rural roads M L 2,3 Guizhou Cultural Heritage 60 Heritage asset protection, sustainable tourism development H M 2,3 Yunnan Urban Environment 150 Water pollution control in Kunming, Dali, Lijiang, Wenshen H M 3 Hubei Han River Environment 100 Han river basin water resource planning, management H M 3 Shanxi Coal-bed Methane Development 90 Pilot use of coal bed methane as cleaner coal substitute H M Total 1490

Standby 2,3 Taiyuan Urban Transport 150 City transport, wastewater treatment, upgrades H L 2 Migrant Skills and Employment 50 Labor migration facilitation H H 3,4 Energy Efficiency and Development 200 Onlending for firm-level energy conservation projects H H Total 400

Program for FY09 and beyond 2,3 Shanxi Saline Land Improvement 90 Reduced land salinity and enhanced dairy production M M 2,3 Henan Yellow River Eco-Livestock Prod. 80 Enhanced livestock production M M 2,3 Ningxia Highway 250 Upgrade Ningxia-Gansu expressway, management M L 2,3,4 Shanghai APL 3 200 Water supply, solid waste disposal H M 3 Anhui Bengbu Flood Control 100 Flood, water pollution control; heritage management H M 3 Jiangsu Regional Development 150 Water supply, wastewater infra. in second-tier cities H M 3 Western Chongqing Watershed Man. 100 Water resource management H M

(continued on next page)

135 • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

3 Guangdong Pearl River Delta (Shenzhen) 200 Wastewater treatment, water pollution control H M 3 Liaoning Urban Infrastructure 3 (energy) 200 Heating and gas improvements in second-tier cities H M 2,3 Forestry Development 100 Sustainable timber production M M 2,3 Poverty 5 100 County-level poverty reduction in 4 provinces H M 3 Qinghai Xining Urban Flood Control 100 Build flood control, discharge channels; wetlands H M 2,3 Hubei Yiba Highway 150 Build 174km expressway M L 2,3 Jiangxi Inland Waterways 100 Build Ganjiang Shihutang navigation and electricity hub H L 3 Inner Mongolia Renewable Energy 30 Develop 37mw of biomass power resources H M 2 Vocational Education 60 Focus provinces of Guangdong, Shandong, Liaoning H H Total 2,010 Notes:* denotes projects approved by the Board. Projects for FY07 and beyond subject to confirmation in annual lending program discussions; Energy Efficiency as well as last seven projects on list subject to GoC State Council approval.

CPS Annex 83 (IFC and MIGA) IFC and MIGA Program, FY 2003-2006

1 ·"··'·· ;,:, / 20()5 ; 0• • .:,•• 1'. 20)3 ,. ,. ~~.~jiffi.~~"?ld.~"'-..,m 'l'i!:'!!iiiJiiiJ.~'.li:K1"i4F't11$!c ?N ""lj-~,..-.,'i!A'vJi,,/IJ~;,;Ji;;,'*',,'~~' '"""~~i'o'~" -IFC approvals (US$m) 102.60 428.31 355.10 540.0*

Sector(%) Agriculture and For 2 Chemicals 9 3 Collective lnvestme 12 6 Education Services 0 3 Finance & Insurance 43 30 30 Food & Beverages 15 9 Health Care 5 Industrial & Consum 17 6 2 Information 3 9 Nonmetallic Mineral 2 50 Plastics & Rubber 9 10 Primary Metals 12 Professional, Scien Pulp & Paper 17 14 Textiles, Apparel & 5 Transportation and 6 Utilities 10 15 11 29 Wholesale and Retai 2 2 Total 100 100 99 101

Investment instrument(%) Loans 26 52 40 84 Equity 62 45 33 6 Quasi-Equity 12 2 16 9 Other Total 100 100 89 99

MIGA guarantees (US$m) 0.0 77.1 6.1 40.0 *IFC 2006 approvals estimated

• • 136 National accounts (as% of GDP) Gross domestic product• 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 101 .0 102.0 Agriculture 14.1 13.5 12.6 13.1 12.5 11 .9 11.4 11 .1 10.8 10.6 Industry 45.2 44.8 46.0 46.2 47.3 47.0 46.9 46.9 46.7 46.5 Services 40.7 41 .7 41 .5 40.7 40.3 41.1 41 .7 42.0 42.4 42.9 Total Consumption 60.0 58.0 55.0 53.0 52.0 52.0 52.0 52.0 53.0 54.0 Gross domestic fixed investment 33.6 34.8 37.8 39.0 39.0 39.9 39.3 38.7 38.2 38.1 Government investment 3.2 3.4 3.8 3.4 2.2 2.1 2.0 2.0 2.0 2.0 Private investment 30.4 31.4 34.0 35.6 36.8 37.8 37.3 36.7 36.2 36.1 Exports (GNFS)b 22.6 25.1 29.6 34.0 36.3 36.8 35.8 36.0 36.5 37.4 Imports (GNFS) 20 .5 22.6 27.4 31.4 31.9 32.9 32.6 35.2 37.3 39.8 Gross domestic savings 40 .0 42.0 45.0 47.0 48.0 48.0 48.0 48.0 48.0 48.0 Gross national savingsc 39.2 41 .9 45.6 48.0 49.2 49.7 49.6 49.8 48.8 48.4

Memorandum items Gross domestic product 1324816 1453824 1640969 1937963 2258741 2669135 3033877 3371578 3673181 4001763 (US$ million at current prices) GNI per capita (US$, Atlas method) 1000 1100 1270 1500 1730 1940 2240 2510 2930 3080 Real annual growth rates (%, 1990 prices) Gross domestic product at 8.3 9.1 10.0 10.1 9.9 9.2 8.5 7.5 7.0 7.0 market prices Gross Domestic Income 8.3 9.5 8.6 8.2 9.8 9.0 6.5 7.3 5.9 7.1 Real annual per capita growth rates (%, 1990 prices) Gross domestic product at market prices 7.5 8.4 9.3 9.4 9.0 8.8 7.8 6.8 6.3 6.3 Total consumption 7.2 7.4 6.1 6.5 6.8 7.0 7.3 7.7 7.7 7.7 Private consumption 6.3 7.4 6.5 7.5 7.3 7.6 7.8 8.0 8.0 8.0 )> z Balance of Payments (US$ millions) z Exports (GNFS)b 299409 365395 485003 655827 833698 981050 1084817 1213311 1341074 1495410 mx Merchandise FOB 266075 325651 438270 593393 762015 897231 988929 1103614 1230061 1353757 en Imports (GNFS)b 877925 1185199 271325 328013 448924 606543 731359 989623 1371696 1593540 Vl Merchandise FOB 232058 281484 393618 534410 633843 733818 813184 940991 1107122 1289448 );! Resource balance 28084 37383 36079 49284 102339 103125 95194 28112 -30622 -98131 z 0 Net current transfers 8492 12984 17634 22898 22131 20000 20000 20000 15000 15000 )> Current account balance 17401 35422 45875 68659 129138 148836 143137 86732 -4090 -81364 :;>:! 0 Net private foreign direct investment 37356 46790 47229 53131 50000 50000 50000 50000 51500 52000 II Long-term loans (net) -7868 -8331 - 52065 5316 6000 5000 2500 2500 2500 2500 Vl" Other capital (net, incl. 558 1627 75984 79257 19244 22000 15500 7500 -17500 -22500 )> errors & ommissions) z w z ...... Change in reservesd -47447 - 75507 - 117023 -206364 - 204381 -225836 -211137 -146732 -32410 49364 mx m • Vl • (continued on next page) n 0 • c • z w ~ 00 ;;o -< ")> ;;o z~ m ;;o V\ :r:

CPS Annex 86: Key Economic Indicators (continued) V\" ~ ;;o Memorandum items ~ Resource balance (% of GDP) 2.1 2.6 2.2 2.5 4.5 3.9 3.1 0.8 -0.8 -2.5 m C') Real annual growth rates -< ( YR90 prices) -n 0 Merchandise exports (FOB) 9.3 29.7 28.6 28.6 25.9 15.0 10.0 9.3 9.2 7.8 ;;o Merchandise imports (CIF) 10.8 27.8 27 .5 23.3 15.1 12.7 6.0 12.9 14.0 12.9 ~ :r: Public finance (as % of GDP m at market prices)• "m Current revenues 15.1 15.9 16.2 16.6 17.5 17.5 18.0 18.5 18.9 19.0 0 Current expenditures 14.3 15.1 15.0 15.0 15.6 15.8 16.0 16.5 17.2 17.5 .-" m Current account surplus (+) V\ or deficit (-) 0.8 0.8 1.2 1.7 1.9 1.7 2.0 2.0 1.7 1.5 ;;o Capital expenditure 3.6 3.7 3.6 3.3 3.1 2.9 3.1 3.0 2.9 2.8 m c" Foreign financing 0.0 0.0 0.0 0.4 0.2 0.2 0.2 0.1 0.1 0.0 .­c;o (") Monetary indicators 0 M2/GDP 144.4 153.7 162.9 158.4 162.2 166.1 172.6 182.4 194.5 207.5 -n Growth of M2 (%) 17.6 16.9 19.6 14.5 16.8 15.0 15.0 15.0 16.0 17.0 n :r: z Price indices( YR90=100) )> Merchandise export price index 107.4 101.3 106.0 111. 7 113.9 116.6 116.9 119.3 121 .8 124.4 Merchandise import price index 97.1 92.1 101.0 111.4 113.8 116.9 122.2 125.3 129.3 133.4 Merchandise terms of trade index 110.6 110.0 105.0 100.2 100.1 99.8 95.6 95.3 94 .2 93.2 Real exchange rate (US$/LCU)1 123.4 121.4 114.3 112.3 Real interest rates Consumer price index(% change) 0.7 -0.8 1.2 3.9 1.8 1.8 1.6 2.6 1.4 1.7 GDP deflater(% change) 2.1 0.6 2.6 6.9 5.9 3.1 2.0 1.3 0.8 0.8

a. GDP at market prices b. "GNFS" denotes "goods and nonfactor services." c. Includes net unrequited transfers excluding official capital grants. d. Includes use of IMF resources. e. Consolidated central government. f. "LCU" denotes "local currency units." An increase in US$/LCU denotes appreciation. CPS Annex 87· Key Exposure Indicators Actual Estimate Projected , lndicc:itor _ . _ ~- .... __ . 200J . . 2001 ~ • 200? '"" ~ . 2005 . _ 2003 2007 . 2008 . . 2009 2010 ~-... ---.,.,..~..... _..,,...... ,....-~--- ...... _ .....,.._~...... __ ___ ...,...... -_,,,_ ...... -~-- -·---· ______... __,...... ,_ ~-~ ------...... ,.~-----.,_------w- - -·~~- -~------'· - -- .... -~------.... - -- - ... --- Total debt outstanding and 145729 184830 186372 208666 248934 281045 146544 132508 121422 114327 109564 disbursed (TOO) (US$m)• Net disbursements (US$m)• -3148 -1861 -5657 -4637 7986 1907 -15461 -14036 -11085 -7093 -4763 Total debt service (TDS) (US$m) 27092 24538 31086 37179 23657 25825 16738 Debt and debt service indicators (%) TDO/XGS0 48.9 58.3 48.3 40.3 36.8 32.6 13.9 11.3 9.1 7.9 6.8 TOO/GDP 12.2 14.0 12.8 12.7 12.8 12.4 5.5 4.4 3.6 3.1 2.7 TDS/XGS 9.1 7.7 8.1 7.2 3.5 3.0 1.6 Concessional/TOO 20.7 16.0 16.1 IBRD exposure indicators(%) IBRD OS/public OS 8.7 12.1 22.9 19.7 12.6 10.0 10.0 Preferred creditor OS/public 19.6 23.3 32.8 39.0 28.7 17.2 18.1 IBRD DS/XGS 0.4 0.5 0.8 0.5 0.2 0.2 0.1 0.1 0.1 IBRD TOO (US$m)" 11217 11660 11374 10781 11103 11210 11420 11674 11960 12326 12683 IDA TOO (US$m)" 8771 8654 9423 10314 10670 10046 9840 9514 9256 8975 8668 IFC (US$m) Loans 256 244 287 196 326 466 688 900 1100 1350 1500 Equity and quasi-equity/c 109 140 251 314 452 534 610 660 720 790 850 MIGA MIGA guarantees (US$m) 113 87 80 149 91 135

a. Includes public and publicly guaranteed debt, private nonguaranteed, use of IMF credits and net short-term capital. b. "XGS" denotes exports of goods and services, including workers' remittances. c. Preferred creditors are defined as IBRD, IDA, regional multilateral development banks, IMF, and Bank for International Settlements. d. Includes present value of guarantees. e. Includes equity and quasi-equity types of both loan and equity instruments.

)> z z mx O'l

V"l ~ z Cl )> :xi Cl () "V"l )> w z lO z mx m • V"l COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

2002 ASIMCO 0 10 0 0 0 10 0 0 2003 Anjia 0 0.57 0 0 0 0.57 0 0 2005 BCCB 0 59.2 0 0 0 59.03 0 0 2003 BCIB 0 0 11 .88 0 0 0 0 0 2006 BUFH 8.03 0 0 0 8.03 0 0 0 2005 Babei 0 5 0 0 0 5 0 0 Babei Necktie 11 0 0 6 8.94 0 0 4.88 1999 Bank of Shanghai 0 21 .76 0 0 0 21 .76 0 0 2000 Bank of Shanghai 0 3.84 0 0 0 3.84 0 0 2002 Bank of Shanghai 0 24.67 0 0 0 24.67 0 0 2005 BioChina 0 3 0 0 0 0.15 0 0 2002 CDH China Fund 0 2.22 0 0 0 0 0 0 2005 CDH China II 0 18 0 0 0 3.29 0 0 2003 CSMC 0 7.25 0 0 0 7.25 0 0

2005 CT Holdings 0 0 40 0 0 0 0 0 2004 CUNA Mutual 0 11.47 0 0 0 0.94 0 0 2005 Changyu Group 0 18.09 0 0 0 18.07 0 0 1998 Chengdu Huarong 4.48 3.2 0 4.69 4.48 3.2 0 4.69 2004 China Green Ener 20 0 0 0 11 .5 0 0 0 2004 China II 28 0 0 0 0 0 0 0 2004 China Re Life 0 0.27 0 0 0 0.27 0 0 1994 China Walden Mg! 0 0.01 0 0 0 0.01 0 0 2006 Chinasoft 0 0 15 0 0 0 0 0 2004 Colony China 0 16.07 0 0 0 4.68 0 0 2004 Colony China GP 0 0.84 0 0 0 0.22 0 0 2006 Conch 80.42 0 0 0 80.42 0 0 0 2002 Darong 10 1.5 0 8 6.67 1.5 0 5.33 2006 Deqingyuan 0 2.82 0 0 0 0 0 0 1994 Dynamic Fund 0 5.56 0 0 0 3.9 0 0 2005 Fang Xin SHMT 7.2 0 0 4.8 7.2 0 0 1.42 2005 Fang Xin Limited 0 4.67 0 0 0 4.67 0 0 2005 Fang Xin SHDX 1.8 0 0 1.2 0.6 0 0 0.12 2005 Fang Xin SZFX 1.2 0 0 0.8 1.2 0 0 0.24 2004 Fenglin 19 0 6 14 12.45 0 6 11.62 2005 Five Star 0 0 7 0 0 0 0 0 2006 GDIH 50.17 0 0 0 50.17 0 0 0 2003 Great lnfotech 0 1.73 0 0 0 1.03 0 0 2005 HiSoftTech 0 4 0 0 0 3 0 0 2004 IB 0 52.18 0 0 0 52.18 0 0 2004 Jiangxi Chenming 50 12.9 0 40 40 12.9 0 20 2001 Maanshan Carbon 6.75 2 0 0 6.75 2 0 0 2005 Maanshan Carbon 11 0 0 5 1 0 0 2005 Minsheng 15.75 0 0 0 0 0 0 0 2001 Minsheng Bank 0 23.5 0 0 0 23.5 0 0 2005 Minsheng Bank 0 2.8 0 0 0 2.79 0 0 200 NCCB 0 26.58 0 0 0 26.46 0 0 1996 Nanjing Kumho 0 3.81 0 0 0 3.81 0 0 2004 Nanjing Kumho 34 2.23 0 0 34 2.23 0 0 2001 New China Life 0 5.83 0 0 0 5.83 0 0 2005 New Hope 0 0 45 0 0 0 0 0 1995 Newbridge Inv. 0 0.22 0 0 0 0.22 0 0 2005 North Andre 15 0 0 0 0 0 0 0 1997 Orient Finance 0 0 2.86 3.57 0 0 2.86 3.57 2003 PSAM 0 1.98 0 0 0 0 0 0 RAK China 13 0 0 0 10 0 0 0 2006 SAC 3 1.6 0 0 0 0 0 0

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• • 140 ANNEX 6: STANDARD CPS ANNEXES

2003 SAIC 12 0 0 0 12 0 0 0 2000 SEAF SSIF 0 3.86 0 0 0 2.17 0 0 2004 SHCT 40 0 0 30 30.86 0 0 23.14 2004 SIBFI 0 0.07 0 0 0 0.07 0 0 1998 Shanghai Krupp 22.75 0 0 47.24 22.75 0 0 47.24 2006 Shanshui Group 0 5.5 0 0 0 5.5 0 0 1999 Shanxi 12.61 0 0 0 12.61 0 0 0 2002 Sino Gold 0 2.4 0 0 0 2.4 0 0 2005 Stora Enso 50 0 0 25 0 0 0 0 2006 TBK 4 0 0 0 0 0 0 0 2006 VeriSilicon 0 1 0 0 0 1 0 0 Wanjie High-Tech 12.19 0 0 0 12.19 0 0 0 2004 Wu mart 0 3.24 0 0 0 3.24 0 0 2003 XACB 0 20.34 0 0 0 3.25 0 0 2004 Xinao Gas 25 10 0 0 25 10 0 0 2003 Zhengye-ADC 15 0 0 7 11.59 0 0 5.41 2002 Zhong Chen 0 5 0 0 0 5 0 0

Total Portfolio: 583.35 413.78 127.74 192.3 414.41 342.6 8.86 127.66

2002 IEC 0 0 5 0 2002 SML 0 1 0 0 2004 NCFL 0 0 17.88 0 2004 SIBFI 0.26 0 0 0 2004 CCB-MS NPL 0 3 0 0 2002 Zhong Chen 0 0 0 32 2004 China Green 0 0 10 0 2005 MS Shipping 0 5 0 0 2002 Sino Mining 5 0 0 5 2003 Peak Pacific 2 0 10 0 0 2006 Shanshui Group 0 0 2.2 0

Total Pending Commitment: 5.26 19 35.08 37

141 • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

CPS Annex BB· MIGA's Portfolio As of December 31 , 2005, US$m As of end offiscal year FY01 FY02 FY03 FY04 FY05

Sectoral Distribution Finance 0.0 0.0 0.0 0.0 0.0 Infrastructure 70.4 50.9 46.3 123.4 77.1 Mining 0.0 0.0 0.0 0.0 0.0 Oil and Gas 0.0 0.0 0.0 0.0 0.0 Agribusiness/Manufacturing/ 42.8 36.3 33.2 25.3 13.5 Services/Tourism 113.2 87 .2 79 .5 148.7 90.6

MIGA's Risk Profile Transfer Restriction 79.2 54.9 50.3 56 .4 15.9

Expropriation 113.1 87.2 148.7 148.7 90.6 War and Civil Disturbance 91 .4 65.6 64.1 64.1 20.6 Breach of Contract 0.0 0.0 0.0 0.0 0.0

MIGA's Gross Exposure in China 113.1 87 .2 79.5 148.7 90 .6 % Share of MIGA's Gross Exposure 2.2% 1.7% 1.6% 2.9% 1.8% MIGA Net Exposure in China 80 .0 57 .9 51.5 109.4 77.5 % Share of MIGA's Net Exposure 2.5% 1.8% 1.6% 3.4% 2.5% Guarantees Issued (US$m) 0 0 0 77.1 6.1

• • 142 ANNEX 6: STANDARD CPS ANNEXES

CPS AnnexB8 Operations Portfolio (I BRO/IDA and Grants) As of January 5, 2006 ~c!Osei:Jir'·~··· - ii'!J.> "'~""' "~~ IBRD/IDA* Total Disbursed (Active) 4,521.45 of which has been repaid 204.12 Total Disbursed (Closed) 27,430.02 of which has been repaid 11 ,644.15 Total Disbursed (Active + Closed) 31 ,951.47 of which has been repaid 11 ,848.27 Total Undisbursed (Active) 4,889.00 Total Undisbursed (Closed) 53.78 Total Undisbursed (Active + Closed) 4,942.79

PSRrating Onginal Amount(US$m) Disbursed a

~~~~~ ~~~~~~~~~~~~ -~~~~- Project ID ProJectName 00 P FY IBRD IDA Grant Gane. Und1sb. Ong. Rev'd

P051856 Accounting Reform and Development s s 1999 27.4 5.61 11.4 11 .3 P069862 Agricultural Technology Transfer s s 2005 100 94.5 2.7 Poo35g4 Gansu Hexi Corridor MS s 1996 60 90 47.9 49_g 13.7 P075035 Hai Basin Integrated Water s s 2004 17 14.2 1.8 P051888 Ghuangjong Irrigation s s 1999 80 20 10.8 11 .1 P046564 Gansu and Inner Mongolia Poverty s s 1ggg 60 100 13.3 4.6 18.3 -11.6 P071094 Poor Rural Communities s s 2005 100 99.7 15.5 Development P00353g Sustainable Coastal Resources Dev. s s 1gg8 100 2.06 35.3 37.3 13.6 P03g838 ODS 4 Phase-out s s 1gg8 440.4 0.1 225.8 44.3 -13.4 P003409 ODS 3 Phase-out s s 1995 120.1 22.2 5.2 0.5 P076714 Anhui Highway 2 s s 2003 250 163.5 24.0 P067337 Energy Conservation 2 s s 2003 26 8.6 7.9 P003619 Inland Waterways 2 s s 1gg8 123 37 6.0 43.0 6.0 P075602 National Railways 2, Zhe-Gan Line s s 2004 200 1 112.3 -31 .7 -32.7 P0561gg Inland Waterways 3 s s 2001 100 43.9 16.4 P058847 Xinjiang Highway 3 s s 2003 150 57.2 22.2 P077137 Inland Waterways 4 s s 2004 91 0.46 88.1 10.0 9.5 P049665 Anning Valley Agriculture Dev. s s 1999 90 30 2.7 3.8 -6.2 P003566 Health 8, Basic Health s s 1998 85 16.0 15.1 P04210g Beijing Environment 2 s s 2000 34g 244.1 223.1 P073002 Basic Education in Western Areas s MS 2004 100 75.3 45.4 P081161 Chongqing Small Cities # # 2005 180 180.0 P049436 Chongqing Urban Environment s s 2000 200 3.7 121 .8 105.7 P085333 Inland Waterways 5 s s 2006 100 gg_8 2.8 P051705 Fujian Highway 2 s s 1ggg 200 33 .1 33.1 4_g P07051g Fuzhou Nantai Island Peri-Urban Dev. # # 2006 100 100.0 P084003 GEF Guangdong PRO Urban Environment MS s 2004 10 10.0 1.1 P064g24 GEF Beijing Environment 2 s s 2000 25 22.3 21 .1 14.8 P077615 GEF Gansu and Xinjiang Pastoral Dev. MS MS 2004 10.5 g_1 3.2 P072721 GEF Heat Reform and Energy Efficiency s s 2005 18 16.2 --0.8 P038121 GEF Renewable Energy Development s s 1999 27 17.2 25.0 10.5 P067625 GEF Renewable Energy Scale-Up Program s s 2005 40.6 40.2 P06002g GEF Sustainable Forestry Dev. s s 2002 16 g_o 4.0 P075728 Guangdong PRO Urban Environment s s 2004 128 0.6 113.4 -1 .1 P036414 Guangxi Urban Environment s s 1gg8 72 20 13.5 41 .0 53_g 7.5 P065035 Gansu and Xinjiang Pastora Development MS MS 2004 66.27 50.7 13_g1 P058843 Guangxi Highway s s 2000 200 1g_7 22.0 34.7 P003614 Guangzhou City Transport s s 1gg8 200 20 82.8 102.8 25.g po35g53 Health g s s 1ggg 10 50 0.4 22.2 21 .5 10.0 po45g10 Hebei Urban Environment s s 2000 150 61 .3 40.3 P058844 Henan Provincial Highway 3 s s 2000 150 25.6 23.6

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143 • • COUNTRY PARTNERSHIP STRATEGY FOR THE PEOPLE'S REPUBLIC OF CHINA

P047345 Huai River Pollution s s 2001 105.5 57.3 57.3 P075730 Hunan Urban Development s MS 2005 172 170.1 11 .1 P068049 Hubei Hydropower Dev. in Poor Areas s s 2002 105 36.6 14.6 P081749 Hubei Shiman Highway s s 2004 200 145.0 36.0 P070441 Hubei Xiaogan Xiangfan Highway s s 2003 250 51.8 -8.2 P084742 IAIL 3 s s 2006 200 200.0 10.1 P068752 Inner Mongolia Highway and Trade s s 2005 100 95.5 3.0 P070459 Inner Mongolia Highway s s 2002 100 46.6 10.6 P058845 Jiangxi Highway 2 s s 2001 200 54.8 29.2 55.0 P065463 Jiangxi Integrated Agriculture MS MS 2004 100 93.4 24.4 P051859 Liao River Basin HS HS 2001 100 38.0 30.2 P081346 Liuzhou Environment Management s s 2005 100 99.5 2.1 P003637 National Rural Water 3 s s 1997 70 0.2 3.4 3.0 P086505 Ningbo Water and Environment s s 2005 130 123.9 P041268 National Highway 4, Hubei-Hunan s s 1999 350 32.3 32.3 P058846 National Railway s s 2002 160 23.4 20.9 P046829 Renewable Energy Development s s 1999 13 2.6 2.6 2.6 P057352 Rural Water 4 s s 1999 16 30 6.6 6.4 -1 .2 P067828 Renewable Energy Scale-up Program s s 2005 87 86.6 12.9 P070191 Shanghai Urban APL 1 s s 2003 200 165.3 37.5 P043933 Sichuan Urban Environment s s 1999 100 2 61.3 55.3 50.9 P075732 Shanghai Urban APL 2 # # 2006 180 180.0 5.0 P056596 Shijiazhuang Urban Transport P064729 Sustainable Forestry Development P057933 Tai Basin Urban Development s s 2005 61 50.1 3.7 P040599 Tianjin Urban Development 2 s s 2003 150 134.8 21 .2 P056424 Tongbai Pumped Storage s s 2000 320 100 46.9 123.1 P045788 Tri-Provincial Highway s s 1998 230 10.1 10.1 P071147 Tuberculosis Control s s 2002 104 59.5 23.3 P045915 Urumqi Urban Transport s s 2001 100 34.5 34.5 P056516 Water Conservation HS HS 2001 74 9.7 5.4 P069852 Wuhan Urban Transport s s 2004 200 175.7 153.6 P064730 Yangtze Dike Strengthening s s 2000 210 88.3 88.3 88.3 P068058 Yixing Pumped Storage Project s s 2003 145 126.3 25.0 P066955 Zhejiang Urban Environment s s 2004 133 118.4 2.6 P051736 East China Jiangsu Power s s 1998 250 86 19.6 105.6 18.6 P003606 Energy Conservation s s 1998 63 15.1 13.2 P044485 Shanghai Waigaoqiao s s 1997 400 47.5 47.5 47.5 P042299 Technical Cooperation Credit 4 s s 1999 10 35 25.1 23.5 Overall Result 9349.1 537.6 750.5 354.61 5284.0 2245.6 262.8

• • 144 Annex 7 Country Financing Parameters

1. The country financing parameters for China were agreed with the Government of China in February 2005 and notified to the Board on March 4, 2005. They have not been revised since that date.

Cost sharing. Limit on the proportion of Up to 100 percent Bank financing of 100 percent may take place in individual project costs that the Bank may a few selective cases (e.g., for social sector finance projects in the poor provinces or small TA projects financed by donor's grants). For infrastructure projects, significant counterpart funding by provincial I m1:1nicipal governments is expected to continue and the Bank financing proportion would be modest in most cases. For social-sector, rural development, and poverty alleviation projects, the Bank financing proportion might be slightly higher than the current level of about 60 percent.

Recurrent cost financing . Any limits that No country-level limit In China, the Bank will apply this policy flexibly would apply to the overall amount of in well-justified cases. In determining Bank recurrent expenditures that the Bank may financing of recurrent costs in individual projects, finance the Bank will take into account sustainability issues at the sector and project levels. It is expected that the overall proportion of recurrent cost financing is expected to remain at modest levels.

Local cost financing. Are.the Yes Since these two requirements are met in the requirements for Bank financing of local case of China, the Bank may finance local costs expenditures met, namely that: (i) financing in the proportions needed in individual projects requirements for the country's development to efficiently achieve the objectives of the project program would exceed the public sector's concerned. own resources (e.g., from taxation and other revenues) and expected domestic borrowing; and (ii) the financing of foreign expenditures alone would not enable the Bank to assist in the financing of individual projects

Taxes and duties. Are there any taxes and None for national taxes. National taxes are considered reasonable. At the duties that the Bank would not finance? Bank financing of local fees project-level, the Bank would consider whether and levies will be taxes and duties constitute an excessively high determined on a case-by­ share of projects costs. Further, given the highly case basis at the project decentralized fiscal administration and the level. existence of significant extra-budgetary financing (EBF) sources at the sub-national levels, some caution regarding financing of local fees and levies is warranted. Financing of such local fees and levies would be assessed at the project­ level on a case-by-case basis

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~ CHINA ,,J

e PROVINCE CAPITALS ® NATIONAL CAPITAL ~ ~ RIVERS . I -- PROVINCE BOUNDARIES - • - INTERNATIONAL BOUNDARIES ·. , ~ ~Q r ,~ ,: ~ ,' '-.(,. '.~LIPPI 'S 11 Photo Credits:

Cover Photos, from top to bottom: Liu Qian/Kunming Institute of Zoology; Aurelio Menendez/ World Bank; Mats Andersson/ World Bank; Management Office for the Renewable Energy Development Project; Liang Qiang/Xinhua News Agency, Gansu; ARS Progetti; Liang Qiang/Xinhua News Agency, Gansu

Cover Design by Wang Yuheng