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HARRAL · WINNER · THOMPSON · SHARP · KLEIN R R A F 15 October 2006 October2006 15 P R INAL EPORT ROJECT AILWAY ESTRUCTURING ESTRUCTURING RMENIAN RMENIAN

FINAL REPORT

ARMENIAN RAILWAY RESTRUCTURING PROJECT

15 October 2006 Prepared by

HARRAL WINNER THOMPSON SHARP KLEIN, INC 8606 Timber Hill Lane Potomac, Maryland 20854 [email protected] CONTENTS

CONTENTS...... I 1: EXECUTIVE SUMMARY...... 1 Project Objectives...... 1 Armenian Economy...... 2 Railway Markets...... 2 The Need for Restructuring ...... 3 Restructuring Options...... 4 Legal and Regulatory Structures ...... 4 Social Mitigation Efforts...... 5 Accounting and Management Structures ...... 5 Structure of the Final Report ...... 5 2: BACKGROUND ...... 1 Existing Situation and Structure ...... 3 Productivity Measures ...... 7 AR Capital Needs...... 10 Locomotive Fleet...... 10 Wagon Fleet...... 12 Infrastructure...... 13 The Need for Restructuring ...... 14 3: MARKET ANALYSIS & TRAFFIC FORECASTS...... 1 Summary...... 1 Competitive Setting...... 2 Freight Market Analysis ...... 3 Market Analysis: Domestic Traffic...... 5 Market Analysis: Import Traffic...... 8 Market Analysis: Export Traffic ...... 9 Freight Traffic Forecasts...... 12 Low Forecast...... 13 Most Likely Forecast ...... 13 Most Likely Forecast ...... 14 High Projection, with Abkhazia Reopening ...... 15 Border Re-openings and the Potential for Transit Traffic ...... 17 Traffic Potential of Ayrum-Gyumri-Kars Transit Corridor...... 20 Passenger Traffic...... 22

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page i Armenian Railway Restructuring Project: Final Report Contents

4: RAILWAY RESTRUCTURING ANALYSIS ...... 1 Armenian Railway’s Future Without Restructuring...... 2 Selling AR Rolling Stock...... 6 Armenian Restructuring Options ...... 6 AR Commercial, Operational, and Organizational Restructuring...... 7 Recommended Restructuring Options...... 15 Full Concession ...... 15 Operating Concession/Management Contract for Infrastructure...... 16 Concession Operator and Infrastructure Manager: ...... 18 Financial Analysis...... 18 Full International Concession ...... 19 Financial Analysis...... 22 Operating Concession with Management Contract for Infrastructure ...... 27 Financial Analysis...... 28 Summary...... 33 Sensitivity to Changes in Traffic...... 34 Recommendations...... 35 5: LEGAL AND REGULATORY ISSUES...... 1 Transport Law ...... 1 Considerations in Refining the Legal Framework:...... 2 Regulatory Environment...... 3 Concession Contracts...... 5 Safety, Standards and Licensing...... 7 6: HUMAN RESOURCES & SOCIAL IMPACT ISSUES...... 1 Introduction and Methodology...... 1 Human Resources Working Group ...... 2 Armenian Railway Staff Characteristics...... 2 AR Employee Inventory...... 3 Human Resource Flows...... 4 Natural Attrition ...... 6 Average Number of Employees and Average AR Monthly Salary...... 7 AR Staffing Needs Now and In the Future...... 8 Restructuring Program Impacts...... 10 Staff Reduction Methodologies ...... 11 Phased Staff Reductions ...... 12 Staff Reduction Potential...... 12 Profile of Potential Redundant Staff ...... 13 Social Safety Net For Redundant AR Staff...... 13 Critical Issues List ...... 13 Staff Training and Retraining ...... 14 Critical Railway Skills Development...... 15 Social Mitigation Tool: ...... 15 Improvements to Work Practices:...... 15 Review of the Armenian Government Policy on Public Restructuring ...... 16 Community Issues Related to Restructuring ...... 16 Review of the Legal, Political and other Barriers to Restructuring ...... 16 Armenian Labor Market ...... 16 Proposed Social Mitigation Program ...... 17 Potential Staff Departure Targets...... 17

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Adverse Selection...... 19 Compensation Options and Cost ...... 19 Redeployment Options and Costs...... 20 Recap of Estimated Social Mitigation Program Costs...... 22 Legal Authority ...... 22 Implementation Arrangements...... 22 Responsibility for Staff Reduction and Social Mitigation Program ...... 22 Next Steps: Employment Restructuring Actions ...... 23 7: ACCOUNTING ISSUES...... 1 Methodology of Review...... 1 Current State of AR’s Cost Accounting ...... 2 Cost Structure & Allocation...... 3 VectoRail’s Cartage Model ...... 4 Cost & Revenue Centers...... 5 General Ledger...... 6 Management Reports...... 11 Auditors’ Findings...... 11 Characteristics of a new Accounting System...... 12 New Accounting System Unit Costs and Cost Allocation ...... 13 Cost Centers, Enterprise Accounting, And Function Codes ...... 14 Solutions for New General Ledger & Chart of Accounts...... 16 Solutions for Management Reporting ...... 16 Steps Prior to Restructuring...... 18 Implementation of Changes...... 18 Requirements For A Restructured AR Operation...... 19 8: CONCLUSIONS AND RECOMMENDATIONS ...... 1 Implementation ...... 3 Possible Concessioning Schedule ...... 5 APPENDICES...... 1 Appendix A Customer and Shipper Interviews ...... 1 Appendix B Traffic Forecasts...... 1 Appendix C Financial Statements ...... 1 Appendix D Changes to the Draft Railway Law...... 1 Appendix E Public Sector Restructuring In Armenia...... 1 Appendix F Community Consultations...... 1 Appendix G Social Barriers to Restructuring ...... 1 Appendix H International Railway Restructuring Experience...... 1 Appendix I Proposed Armenian Railway Chart of Accounts ...... 1 Appendix J Accounting System Change Implementation Schedule ...... 1 Appendix K Railway Restructuring in Neighboring Countries ...... 1

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page iii 1: Executive Summary

PROJECT OBJECTIVES

he purpose of this project is to provide consultancy services supporting the restructuring of Armenian Railways with the objectives of developing a restructuring plan that Tincreases private participation in the rail sector, and supports commercialization of the railway in freight marketing, human resources planning and accounting. The main components of the study were defined as:

1. Analysis of how the railway should be structured, including relationship between railway and government, internal structure of the railway (vertical separation or integration, role of rolling stock maintenance entities, etc.), and appropriate forms of private participation. 2. Preparation of a human resources plan, providing for a social safety net for staff that may become redundant in the restructuring. 3. Preparation of an analysis of freight markets and a forecast of traffic. 4. Develop plan to revise accounting to create an infrastructure cost center and passenger and freight profit centers.

This Final Report addresses each of the items above and provides our analysis of: • The current structure and situation of the rail sector in Armenia • Armenian Railway markets and the potential for rail traffic in the future, including an analysis of the impact of potential border openings • How the sector should be restructured • The legal and regulatory framework that will enhance the restructuring effort • The social impacts of railway restructuring and how the associated human resources issues should be addressed in the recommended restructuring • The accounting practices of Armenian Railway and how they should be modified to support improved management practices and the restructuring effort in the future.

The railway has been generous in its cooperation with our team, providing ready access to senior railway managers and government officials. The railway has also provided substantial data and analysis requested. Our work has benefited from some substantial prior studies

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 1 - 1 Armenian Railway Restructuring Project Final Report Executive Summary conducted by the railway and other consulting firms. This project is not the first to be conducted for or by Armenian Railway. We have drawn upon important work that preceded this study including, but not limited to these:

• The TRACECA Joint Ventures Report, TEWET, 1998 • Post-Conflict Study of Railways in Armenia, Azerbaijan, Georgia and Turkey, CANARAIL, 2000 • Telecoms Review, CANARAIL, 2000 • The Armenian Railway Business Plan, HWTSL, 2000 • Armenian Railway, Update of the Five Year Business Plan, Grant Thornton Amyot, 2003

We found these earlier studies to be sound and consistent with international best practices. In addition to our review of prior work, the Armenian Railway and Government of Armenia provided time, data, and the opportunity to inspect facilities, conduct in-depth interviews with key managers, shippers, and government and transport officials.

ARMENIAN ECONOMY Macroeconomic conditions in Armenia have been unstable over the last 20 years, with the economy being quite sensitive to events beyond the control of the Armenian Railway and often of the Armenian Government – earthquakes, separatist activity in Georgia, political unrest in Armenia and conflicts with neighboring countries, changes in energy prices, and significant economic and political change in Georgia and Russia. As a result of these factors, Armenian GDP and other economic indicators have been volatile. In recent years, Armenia has seen positive economic growth, moderate inflation, an improving balance of payments, and a generally improving economic outlook. The Armenian economy has enjoyed significant economic growth over the past few years and, to a modest extent, this growth has been reflected in increasing rail traffic.

RAILWAY MARKETS The Armenian Railway, however, remains a very light density, marginal rail service. Rail and passenger traffic has fallen to but a small fraction of its levels in the 1980s. The Armenian economy has evolved since that time as well and the industries and traffic flows that contributed greatly to Armenian Railway freight flows have long since disappeared. In this report, we reviewed current national, regional and global economic conditions to assess the prospects for rail traffic growth in and through Armenia.

There are significant prospects for growth from the current very low levels. But, most of those prospects depend upon opening borders to Turkey, Azerbaijan, and Iran. While such openings are possible, the timing of such openings is impossible to predict. It seems evident that they will not materialize in the near future. We also considered the evolving relationship in Georgia and the line through Georgia to Russia via Abkhazia. Our analysis indicates that the opening of this line could promote some growth in Armenian imports; export markets for Armenian goods will take longer to develop. Overall, our Most Likely forecast is based on existing current international rail connection through Georgia and its ports as well as continuing growth in the Armenian economy. Some specific industries, notably cement and gold, have good growth prospects but depend on factors outside the control of Armenian Railway managers. The Most

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Likely freight forecast calls for modest but steady growth in rail traffic. But that growth is dependent on improvements in rail services and better customer relationships. The forecasts are summarized in the chart below.

Rail passenger services in Armenia are operated at a significant loss and ridership has not revived with the economy. We reviewed the costs to continue passenger services and found them to be daunting. Most Armenian Railway passenger equipment is old and in need of replacement. Coupled with declining traffic levels and passenger revenue, the cost of replacing railway passenger rolling stock does not appear to be worthwhile, even as a public service. Public passenger transport can be provided more economically by subsidizing road transport services (public or private bus services). A private sector initiative in rail passenger services is unlikely unless it is heavily subsidized by government. Rail passenger transport volumes therefore depend on government subsidy. We analyzed several options, including continuing current passenger transport capacity and determined the subsidy requirements. The recommendation contained in this report is that rail passenger services be eliminated as quickly as possible and substitute road transport services contracted to provide necessary public service. Passenger traffic forecasts considered are also summarized on the chart below. s r e

t e m o

Projected Armenian Railway Traffic l i

6.0 0.50 K r e g n

0.45 e Freight - Likely s s a

5.0 Freight - High P

0.40 n Freight - Low o i l l Pax - Likely i B Pax - Flat 0.35 4.0 Pax - Recommended 0.30 Forecast

3.0 0.25

0.20

2.0 0.15 B i l l i o

n 0.10

G 1.0 r o s

s 0.05 T o n n

e 0.0 0.00 K

i 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 l o m e t e r s

THE NEED FOR RESTRUCTURING The condition of Armenian Railway’s assets and operations was assessed. We found that the Armenian Railway has significant investment needs, including replacement of much of its rolling stock, continuing investment needs to maintain its main line between Yerevan and the Georgian border, significant infrastructure investments to renew its overhead power systems and several very old steel bridges, among many other investment needs. Existing passenger services also require the maintenance and renewal of a number of passenger stations and other facilities. The railway currently maintains no fewer than five workshops and depots for its aging rolling stock fleet. Its operations now require only about 8 or 9 working locomotives to

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 3 Armenian Railway Restructuring Project Final Report Executive Summary provide services—the resulting ratio of rolling stock to depots is unreasonably and unnecessarily low. The Armenian Railway currently maintains and must renew facilities, depots, stations, and other assets in numbers far beyond its long term requirements.

Current conditions can not be sustained in the long term. Someone will have to finance ever more critical investment needs—either the government of Armenia or private sector investors—as the railway does not have the scale or financial strength to afford or finance much new investment. If private sector participation is expected, railway operations will have to be more efficient and effective. More traffic would help greatly, but that, in itself, is also insufficient. In any event, some investments must be financed by the railway; to become a creditable borrower, the railway must improve its efficiency and cost effectiveness, and show that it can generate sufficient earnings to support debt and interest payments. These are areas that must be addressed directly by the restructuring effort—improve commercial efficiency, improve financial effectiveness, and provide sufficient returns to attract private capital.

RESTRUCTURING OPTIONS These issues are reviewed in the report and two restructuring options are developed and analyzed to improve railway performance, attract private sector participation and to help revitalize the rail sector. The restructuring options include a full concessioning of Armenian railway assets and services to a private sector enterprise specializing in operating light density railway lines on a commercial basis. A second option includes concessioning freight operations and contracting for infrastructure maintenance services from that concessionaire. While there are significant differences in the options, both rely almost wholly on private sector funding for freight services. In both cases, what is now a significant and looming cost to government is converted to a new revenue stream for government. A careful financial analysis of both options shows that private sector operation is feasible and that private sector operators are likely to be attracted to the opportunities in Armenia. Such an outcome is not a surprise as these techniques have been used in many countries around the world to restructure, reform, and revitalize rail freight services. The World Bank and others have extensive experience in concessioning railways in South America, Latin America, Africa, Canada, Australia, and New Zealand. Europe and several CIS countries have experienced rising levels of private sector investment in their rail industries and operations. The restructuring techniques recommended in this report have extensive antecedents and precedents and there is a large body of work available to guide Armenian efforts to implement one of the restructuring options. The report recommends a Full Concession model of restructuring with some risk mitigation measures to provide a robust result.

LEGAL AND REGULATORY STRUCTURES Restructuring will require changes in legal and regulatory structures covering rail and surface transport in Armenia. We have reviewed existing regulatory environment and the proposed Law on Railways. The report includes recommendations on specific language in the railway law and recommends a consultative arbitration based approach to regulation for the rail sector. Our review showed that the Armenian Railway is no longer a natural monopoly and commercial activities in the freight sector require very limited regulatory oversight. Specific structures and recommendations are contained in the report and its appendices concerning rail regulation.

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SOCIAL MITIGATION EFFORTS Restructuring is likely to have a significant impact on railway employees – either recommended restructuring option reduces direct railway employment from the current level of about 4,700 employees to about 1,500 or less (depending on the governments decision relative to passenger services). Since more railway functions will be outsourced, total rail sector employment is not so substantially reduced but most railway employees will nonetheless be directly affected by restructuring. We review methods for mitigating social impacts of restructuring in current use in Armenia and develop a set of recommendations that will enhance the restructuring process and mitigate adverse effects on railway employees.

ACCOUNTING AND MANAGEMENT STRUCTURES Finally, we review current railway accounting and management reporting systems to determine whether they can quickly be made more effective. Improved accounting and management reporting will help manage the railway now and make the transition process much more transparent. We find that the system can be easily modified and make specific recommendations on how to implement such changes and on changes in the chart of accounts to enable managers to assess costs, budgets, and railway performance in the near term. These changes should be accompanied by structural changes in the railway organization and by requiring more accountability of managers and employees. These techniques are well proven and should be easily implemented.

STRUCTURE OF THE FINAL REPORT The remainder of the Final Report describes our findings and analysis in more detail. Chapter 2 presents a summary of current railway conditions and reviews the prospects currently faced by the railway. This chapter reviews railway productivity benchmarks against other similar railways and reviews the capital needs of the railway. It concludes that the railway has deferred more than AMD 54 billion in investments and renewals, a backlog that must be eliminated if the railway is to survive. It also shows that, as currently structured, the railway has continuing annual capital needs of at least AMD 4 billion (US$ 8.8 million).

Chapter 3 contains a review of Armenian Railway markets and develops several traffic and revenue forecasts for the railway, including a Most Likely forecast (wherein total revenue averages about AMD 10 billion (US$ 23 million) per year (in constant 2005 currency). This chapter also reviews the potential for rail traffic should various international rail connections be opened and estimates the traffic impacts and likelihood of such openings. In many cases, economic conditions between and among neighboring countries has changed so much that firm forecasts are not possible. In these cases, a qualitative assessment is provided.

Restructuring options are discussed and evaluated in Chapter 4. Based on the assessment in Chapter 2 and forecasts from Chapter 3, the restructuring report assesses the financial implications of not restructuring and of the two best restructuring models developed during this project. The financial assessment finds that a full concession of Armenian Railway might bring as much as US$ 10 million in international tenders from companies experienced in operating railways like AR. The analysis reveals that should the government not restructure the railway, it

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 5 Armenian Railway Restructuring Project Final Report Executive Summary must spend upwards of AMD 135 billion (US$ 300 million) between now and 2020 to keep the railway operating at current capabilities. Rather than this vast cash infusion, the recommended restructuring option will bring new revenue of about AMD 12 billion (US$ 27 million) to the government while also revitalizing the railway.

The proposed restructuring will require some significant changes in legal and regulatory practices in Armenia. These are discussed and described in some detail in Chapter 5. An appendix to this chapter contains a mark-up of specific recommended changes to the proposed Law on Railways. Human resource and social impacts from restructuring are discussed in Chapter 6. This chapter includes a description of the current Armenian Railway labor force including its age and education profile. One of the significant results of this project is the development of a human resources database that contains information on every employee of the railway including department, function and a summary categorization of skills by title.

Accounting issues are reviewed in Chapter 7. In this chapter we review current accounting systems and practices and discuss how the existing accounting systems can be modified to provide more transparency and better management information. Specific recommendations on changes and on a new chart of accounts are developed and a schedule for implementation is presented.

Chapter 8 summarizes our findings and further explains our recommendations, particularly in regard to restructuring option that should be adopted.

An appendix contains summary information and details on a number of different factors. In addition, the final report is accompanied by a CD-ROM containing more detailed data, including the human resources database, operating statistics, prior reports and the financial models used in the financial analysis.

Questions and comments on this report and its contents should be directed to:

John H Winner Harral Winner Thompson Sharp Klein, Inc. 8606 Timber Hill Lane Potomac, Maryland 20854 [email protected] [email protected]

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 6 2: Background

ailways have been active participants in the economic development of the Caucuses Region for over a century. The first rail line in the region was an extension of rail Rservices from Russia to Tbilisi, built in 1872. This line was extended to Baku in 1883 and the line from Tbilisi to Gyumri and Kars (today in Turkey) was started in 1895 and

Georgia

Airum

Sanahin Spitak Vanadzor Ijevan Azerbaijan Gyumri Dilijan

Hrazdan Pemzashen

Akshalins Yerevan Vardenis Armavir Karmir Blur Ararat Massis Armenia Road Railway Turkey Blockage Yerask

Aktau &D Kazakhstan Ukraine Russia VS LDQ No vor ossiysk Ã6 Ab khazia Grozny HD Black Sea Georgia Uzbekistan Potsi Tbilisi Batumi Armenia Baku Yere van Azerbaijan Kars k

a r

a

Iran g Megri

A Turkey Aghband

Iran Tehran Syria Iraq extended to Yerevan in 1902.

Before the dissolution of the Soviet Union, the Armenian Railway (AR) was part of the Trans- Caucuses Railway within the Soviet Ministry of Railways (MPS). Armenia’s railway, along with railways in Georgia and Azerbaijan were operated as a part of this larger network, headquartered in Tbilisi, Georgia. After World War II, the railways in the region were gradually rebuilt to a higher and much heavier standard. Investments in upgraded electrification, heavy rail, and improved signal systems were made over the period up to the late 1980s. All three railways serving the Caucuses are of a similar design, built to a 23/25 tonne axle loading standard, with 3 kV-DC overhead electrification and similar track and infrastructure standards. The properties use similar rolling stock—the same kinds of road and

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 2 - 1 Armenian Railway Restructuring Project: Final Report Background shunting locomotives and freight wagons bought from the same factories, built to the same standards. Following Armenia’s independence in 1991, AR was established as a separate railway. Shortly after independence, the conflict between Armenia and Azerbaijan flared; Azerbaijan and Turkey closed their borders with Armenia. Although a cease-fire was announced in 1994, the borders remain closed to this day. The border closures isolate a 46 km segment of AR in southern Armenia, which is now closed. An additional segment of line east of Dilijan closed because of a landslide so there is no service to the Azeri border, also closed. AR’s only open international connection is at Ayrum with the Georgian Railway. This connection is a strategically important lifeline for imports of oil and food products into Armenia.

In 1988, at the peak of Soviet era rail traffic, AR carried nearly 30 million tonnes of freight, generating nearly 5 billion tonne-kilometers, and 5 million passengers, generating some 400 million passenger-kilometers. At the end of 1988, Armenia was hit with a devastating earthquake. Rail freight traffic peaked in 1989 as relief aid swelled rail freight movements. The Armenian economy was nearly destroyed by the earthquake. At the same time, the Armenian economy continued to be depressed by the economic dislocations stemming from the dissolution of the Soviet Union and the conflict with Azerbaijan, which reached its peak in 1992 and 1993 and resulted in closure of borders to Azerbaijan and Turkey. Rail traffic collapsed along with the economy. By 1993, AR carried only 1.5 million tonnes of freight,

Armenian Railway Traffic Unit Kilometers 6 0.5

0.45

5 0.4

0.35 4

0.3

3 0.25

0.2

2 B

0.15 B i i l l l l i i o o n n

0.1 N P e 1 a t s

s T e o n

n 0.05 g n e e r

K K i i l l

o 0 0 o m 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 m e e t t e e r r s s generating about 0.35 billion gross-tonne-kilometers. Freight traffic remained at about that level until 2002. Military activity, refugee movements, and continuing aid to rebuild after the Spitak earthquake helped passenger traffic grow to some 450 billion passenger kilometers in the early 1990s. After that, passenger traffic declined precipitously.

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Economic growth resumed in 2002 and has been satisfyingly high over the past few years. By 2004, railway traffic had increased to 2.6 million tonnes and about 0.68 billion tonne- kilometers. But passenger traffic continued a long decline, to just over 700,000 passengers and less than 0.03 billion passenger kilometers. While economic growth has given rise to some increased rail traffic, the Armenian economy is growing away from rail-based industries so rail traffic growth no longer is closely related to GDP growth. In addition, interruptions in electricity supply and improvements to the road network in Armenia as well as in Georgia have increased road transport’s ability to compete for freight movements. Because of the shifting nature of the economy, obvious difficulties associated with line and international connection closures, and improving road conditions, shipper interviews indicate that freight traffic has begun shifting from rail to road transport. Major shippers also report that trucking companies are simply easier to do business with than the railway.

While traffic growth may provide some improvement in financial performance, for the railway as a whole, the restructuring program should contemplate a continuation of slower growth from these reduced levels rather than a return to the very high traffic of the late 1980s. There is a potential for Armenian Railway to participate in increased trans-Caucuses rail traffic flows should a way be found to open some borders. Trade with Russia and Europe could also be favorably affected by the reopening of the Abkhazian railway line. Traffic forecasts and the changing composition of AR’s traffic base are discussed in the Railway Traffic Forecast chapter.

EXISTING SITUATION AND STRUCTURE Armenian Railways has undergone tremendous change in the last decade. Since becoming an independent national railway in 1991, Armenian Railway continued to experience major reductions in traffic. It has only just started to adjust its physical plant and operations to its much smaller traffic base. The huge reductions in traffic have resulted in severe financial constraints which the government of Armenia has been unable to ease. As a result, the railway has slashed expenditures for materials and capital goods. The railway’s rolling stock fleet is aging and much of it is reaching retirement age in the next few years. The reduction in traffic obviated the need for rolling stock investments until recently, when the aging fleet and new traffic growth has resulted in the need for new investment.

In 1998, in a move to reform the railway and make it more commercial, AR was reorganized. The reorganization was an element of a World Bank loan for much needed infrastructure investment.1 The railway was reorganized to have the following elements:

• Railway Department. A part of the Armenian Ministry of Transport and Communications, it serves as the owner and oversight agency for the operating companies. • Infrastructure CJSC. A closed joint stock company; it owned and operated the infrastructure of the railway and charged for its use. • Rollingstock CJSC. A closed joint stock company, it owned, maintained and leased the rolling stock fleet and provided locomotive drivers and assistants.

1 The World Bank loan was mostly used to finance infrastructure improvements, in particular on the critical and mountainous line between Gyumri and Ayrum, at the Georgian border.

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• Transportation CJSC. A closed joint stock company, it operated both passenger and freight transportation services. • A number of non-core companies. The CJSC units were expected to pay one another for services rendered. However, mechanisms for billing and payment were not fully developed and the distribution of freight revenue, collected by the Transportation Company, became the subject of considerable discussion within the railway organizations. The other companies had to bill and collect revenue from the transportation unit, not from final railway customers, this lengthened accounts payable times. There was no general agreement between units about real costs or a schedule of tariffs for their services and no unit had a sufficiently sophisticated costing system to support detailed costing.

Based on interviews with railway management, the structure was largely unworkable. More Railway Department

Frt Loading/ Unloading Rolling Stock Transportation Infrastructure JSC JSC JSC Yerevan Civil Construction Loco Depot Passenger Track Sect. Gumri Services Gumri Gyumri Civil Construction Loco Depot Stations Track Sect. Yerevan Yerevan Vanadzor Yerevan Water Loco Depot Stations Track Sect. Suppy Sanahin Gumri Yerevan Railway Suppy Wagon Stations Track Sect. Depot Gumri Vanadzor Sevan

Stations Power Sect. Gyumri Wagon Construction Depot Savan Ijevan Yerevan Stations Power Sect. Vanadzor Massis Hrazdan Wagon Dep. Tunnel/Bridget Nurnos Stations Power Sect, Garmir Blur Gumri Ayrum Ballast Repair Train Stations Power Sect, Ararat Yerevan Gyumri Rail Hospital Stations Sig & Com Armavir Gumri Arzeni Rail Hospital Stations Sig & Com Abovian Yerevan Yerevan Rail Masis (Cap. Polyclinic Repair) time was spent discussing how to allocate insufficient revenue than on managing the railway. The railway had more assets to maintain than it had revenue traffic to use and pay for them. Employment was considered fixed and little was done to reduce costs to fit the collapsing traffic base. Thus, the discussions between the various CJSC’s became more desperate as costs continued, revenue fell, and the asset base deteriorated.

ARMENIAN RAILWAYS ORGANIZATION STRUCTURE 1998-2002

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In late 2002 and early 2003, the Ministry of Transport and Communications reorganized the railway into a more traditional state-owed railway structure, vertically integrated and centrally managed. The reorganized company also has a closed joint stock company structure. Recently, a supervisory board has been appointed to provide oversight to the railway management and to represent the shareholders interests. All stock is owned by the government and the supervisory board is appointed by the government. The current structure is shown in the diagram on the next page. Some non-core units were divested as a part of the reorganization process, but many remain within the overall CJST structure of the railway.

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 2 - 5

Armenian Railway Restructuring Project: Final Report Background

ARMENIAN RAILWAYS ORGANIZATION STRUCTURE FROM 2002

Minister of Transport & Communication

Supervisory Board

Director General

1st Deputy Deputy Deputy Deputy Deputy Director Director Director Director Director Infrastructure Rollingstock Transportation Safety Administratio

Construction Infrastructure Rollingstock Finance & Accounting Economics Supply HR Transport Traffic Safety Admin Department Department Department Control Dept Department Department Department Department Department Department Technical Construct’n Track Locomotive Finance Traffic Security Sigs+Coms Wagon Economics Freight Motor Pool Electrical Technical Revenue Passenger Department International Payroll Expediting Department Goods Legal Department Armenian Railway Branch Structure Passenger Branch Yerevan track section Gyumri C&S section IT Yerevan station Gyumri track section Sevan C&S section Department Gyumri station Vanadzor track section Yerevan locomotive depot Vanadzor station Sevan track section Gyumri locomotive depot Masis station Ijevan track section Sanahin locomotive depot Karmir Blur station Masis mechanized track section Yerevan wagon depot Ararat station Yerevan electricity supply section Gyumri wagon depot Armavir station Gyumri electricity supply section Nurnus wagon reparation Abovian station Hrazdan electricity supply section Restoration and anti-fire trains Sevan station Yerevan C&S section Maintenance Equipment Section

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Productivity Measures As a result of the collapse of Railway freight and passenger volumes and Armenian Railway’s inability to reduce critical railway components consistent with those volumes, the productive efficiency of the rail system has fallen to extremely low levels. The most common measure of productive efficiency is employee productivity, measured in terms of traffic units per employee (the sum of net ton-kilometers for freight and passenger kilometers for passenger traffic). The chart below, focusing principally on regional and former Soviet and Soviet bloc countries,

Employee Productivity (000Trafic Units/Employee) Estonia Russia Latvia China Chile Lithuania Switzerland Netherlands Turkey Slovenia Mongolia Poland Hungary Romania Slovakia Georgia Czech Croatia Macedonia Yugoslavia Armenia 146

0 500 1,000 1,500 2,000 2,500 3,000 indicates that AR ranks very low by this measure. This low productivity results directly from the fact that freight and passenger traffic dropped to 7% of prior volumes while AR employment was only reduced to about 40% of 1989 levels.2 Moreover, AR data is the most current of the railways shown. Given that the last few years have been a period of traffic growth for almost all carriers, the unfavorable comparison is likely somewhat understated.

2 From somewhat under 12,000 employees in 1988-90 (from Republic of Armenia Transport Sector Review, Volume II, Technical Report, May 30, 1997) to about 4,750 employees in 2005 (HWTSK AR employee data base). Much of this reduction, moreover, was in non-core activities.

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Three measures of asset utilization also show Traffic Density (000 of TU per km) the productivity of Armenian Railway assets is China quite low. These measures are significant as Russia they summarize the largest investments USA railways typically require and thus provide Estonia Latvia some measure of the productivity of capital Switzerland employed in the business. Lithuania Infrastructure Utilization: Netherlands A standard measure of infrastructure utilization Mongolia Georgia is traffic units per kilometer of track, a measure Poland of traffic density. Armenian Railway traffic Slovakia density is low primarily because its traffic base Slovenia is quite small. Even so, the low density of AR Czech infrastructure emphasizes the need to reduce Romania Hungary the capital required and, where possible, to Turkey reduce the amount of infrastructure that is Croatia maintained, especially if it is unused. Yugoslavia Chile The data for Armenia are from 2005 while that Armenia 925 Macedonia of other railway systems in this comparison are the latest available, typically from 2002 and 0 10,000 20,000 30,000 40,000 2003. The value of transit traffic can be seen in this measure as most of the lowest density rail systems do not have transit traffic. Some, such as the Czech rail system, have many excess lines that are very lightly used which provide a tram service for small communities.

Rolling Stock Utilization

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AR wagon productivity appears to be somewhat higher than other productivity measures primarily because it uses a number of foreign wagons. Overall, AR wagon productivity is low. AR locomotive productivity is also very low, in part driven by the number of EMU units in its fleet and low utilization of that equipment. Freight locomotive utilization is also low, reflecting AR’s difficult terrain, small trains, and low traffic base. The overall productivity of AR’s rolling stock is quite low relative to many other railways, indicating that equipment investments will be harder to justify and argues for acquiring used equipment when replacements are needed.

Freight Prices Freight Revenue per Ton-Km AR’s current average freight rates are Switzerland significantly higher than many other Macedonia NIS and regional carriers, including the Hungary Turkish and Georgian railways. AR Netherlands domestic traffic has short hauls and Slovakia must compete with rising road transport Czech competition. International traffic, Slovenia dependent on a single gateway with Romania circuitous and slow interchange with Georgia Railway, must also compete Croatia with road transport which currently Armenia 0.0237 offers better service and lower prices for Poland 40 foot container traffic and deal with Lithuania the complexity of multi-carrier, multi- Georgia pricing authority arrangements. USA Turkey WagonEstonia Productivity Loco Productivity (000 of ton-km per Wagon) 000 Traffic Units / (loco + MU) Chile Latvia China China China Russia Russia Chile USA Mongolia Estonia Netherlands Russia Latvia Latvia Mongolia Netherlands USA Mongolia Lithuania 0.00 0.01 0.02 0.03 0.04Lithuania 0.05 0.06 0.07 Slovenia US$ Turkey Estonia Poland Croatia Slovenia Turkey Hungary Switzerland Chile Georgia Slovakia Poland Switzerland Slovakia Romania Hungary Czech Armenia 330 Georgia Czech Croatia Romania Macedonia Yugoslavia Armenia 6,056 Macedonia Yugoslavia

0 1,000 2,000 3,000 4,000 0 25,000 50,000 75,000 100,000 125,000 150,000 Given these problems, we do not believe that AR can offset its high costs and low productivity with significantly increased prices. To attract transit traffic, it is unlikely that AR will be able to

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 2 - 9 Armenian Railway Restructuring Project: Final Report Background substantially exceed tariffs of Georgian or Turkish railways. While some other countries benefit from under-developed highway systems, a high value commodity mix, or other factors that permit higher freight charges, this is not likely to be sustainable for a short-haul carrier such as AR facing competition from road transport and with limited routing options.

Conclusion: Armenian Railway is a small railway with low productivity by each of the preceding four measures. Its traffic volumes are simply too low to justify the staffing levels, fleet size and high capital cost infrastructure that AR has tried to support. While its services may be essential to the development of the Armenian economy, its low traffic volume, short hauls, and lack of transit traffic require that it consume less capital and labor, if it is to be economically viable.

AR may be motivated to retain staffing levels and a fleet and capital structure out of hope for a revival of traffic from the lows of 2000. Total traffic units have now reached about only 12% of their 1898 levels. The traffic forecasts described in the next chapter indicate that under even under optimistic traffic assumptions (e.g., opening of the Abkhazia rail link between Georgia and Russia, and reopening the Turkish border to transit traffic through Armenia), traffic levels cannot be expected to exceed four to nine million tons within the next fifteen years—no more than 15% to perhaps 25% of Soviet era volumes. The structure of the regional economies and their transport networks have changed forever and retaining staffing and capital cost structures more suitable to those past years simply is not a financially viable option.

AR CAPITAL NEEDS Over the past seventeen years Armenian Railway has had little need for new investment—it had excess assets for the traffic that remained. The Armenian Railway was built to handle traffic an order-of-magnitude greater than it has currently. AR has heavy rail, 25 ton axle loadings, it is electrified at 3 kV-DC, and received more rolling stock than it needed in the distribution after the dissolution of the soviet rail system. The sharp decline in traffic obviated the need to invest in new rolling stock or make substantial investments in infrastructure renewal. Moreover, traffic declines had a devastating effect on the profitability of the railway; it did not have the funds available for substantial investment, even if it had been needed.

Now, however, after 17 years of very limited investment, the railway is experiencing some modest freight traffic growth. As discussed in the next Chapter, freight traffic could nearly double over the next 15 years or so; more if some borders are reopened—freight traffic could increase by a factor of four if transit routes to Turkey are opened. This will put new demands on aging Armenian Railway infrastructure and rolling stock and will require investment to replace rolling stock and repair deteriorated infrastructure.

Locomotive Fleet

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The Armenian Railway locomotive fleet, particularly its fleet of main-line electric locomotives is aging and most of the existing fleet will become obsolete over the next five years. Typically, electric main-line locomotives of the type operated by Armenian Railway have a useful life of about 35 years. Over the next five years, many of the railways locomotives will pass that mark and will need to be rebuilt or replaced. Existing locomotives use control technology from the 1940s which limits the tractive effort available and requires high maintenance inputs. The chart below shows the locomotive fleet available over the next 15 years..

In 1995, AR had some 34 electric locomotives in its ownership that were less than 35 years old. By 2000 that number had been reduced to 29; this year only 15 locomotives will remain. By 2011, only five years from now, the useful fleet will be reduced to about 6 locomotives; by 2017 none will remain. The railway uses about 7 or 8 main line electric locomotives on a daily basis now. Given the need for preventive maintenance and current repairs, AR estimates that it needs to have an active fleet of about 16 units to support its current daily requirements. Without additional locomotives (new or rebuilt) there will not be enough locomotives available after about 2010 to sustain current traffic levels, certainly not enough to sustain a doubling or greater increase in freight traffic.

Similarly, the fleet of electric passenger trains, already aging, will be reduced substantially over the next five years. From some 68 units available in 1995, the fleet was reduced to about 47 in 2000 and in 2006 only 18 units aged 35 years or less remain. Some units are currently operating beyond the expected 35 year life since AR reports operating 6 sets of electric trains, each of 4 or 5 cars. By 2011, there will be only eight units left from the existing fleet. While passenger traffic is declining, the available fleet is declining faster. New investment, radical reductions in passenger services, or a substantial rebuilding program will be required to maintain current levels of passenger service.

Locomotive Units Remaining 180 Electric ML Diesel ML 160 Shunting Electric Trn Diesel Pax 140 34

120 29

100 53

80 16 16 15 15 53 14 14 14 60 8 66666

50 50 49 49 48 40 68 48 47 47 47 47 47 47 47 45 45 47 44 44 20

18 18 18 18 18 9988888775 0 1995 2000 2001 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

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Wagon Fleet The Armenian Railway’s freight wagon fleet is experiencing the same level of age-based obsolescence. The chart below shows the age distribution of the wagons remaining on AR’s books as of the end of 2005.

AR 2005 Wagon Fleet by Age 350

Younger than useful life 300

250

s 200 n

o Older than useful life g a

W 150

100

50

0 68 65 64 59 58 57 56 55 54 53 52 51 50 49 48 47 46 45 44 43 42 41 40 39 38 37 36 35 34 33 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 Age of Wagons (Years)

The chart shows a substantial number of freight wagons reported in the fleet that are 32 years old or more—some more than 60 years old. Generally, the useful life3 of freight wagons is considered to be about 32 years for interchange service between CIS rail systems unless a substantial capital rebuilding has been completed.

CIS railways have agreed to a convention to extend the useful life of railway rolling stock. The extension generally requires a capital repair meeting certain investment standards. The investment typically extends useful life by 8 to 10 years. While some CIS railways have used this convention to extend the useful life of certain equipment, generally the investment required and the life added has proven to be a poor economic trade-off and not much equipment has been subject to such life-extension investments. Some of the wagons reaching the end of their useful interchange life could still be in reasonably safe condition and used for freight movements within Armenia without such substantial capital repairs. However, as wagons age, they require significantly more maintenance and experience higher levels of running repairs.

3 Useful life is the CIS accepted life for interchange purposes, generally a maximum of 32 years for common freight wagons, but some types have a useful life of only 25 years. AR’s reported fleet had an average useful life of 28 years, based on the types of wagons in its fleet.

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The chart below shows the number of existing AR wagons that will be within the CIS interchange conventions from 1995 to 2020. The wagon fleet available for interchange service was more than 3,000 units in 1995, will number less than 2,000 in 2006, and stand at about 1,000 by 2011, just five years from now and less than 100 in 15 years. Our estimates indicate that AR required about 1,000 wagons to service its traffic in 2005, including wagons waiting for repair. However, its mix of wagon types is not suited to the current traffic mix and there are currently shortages of some types of wagons (e.g., semi-wagons) by our calculations. Based on the most-likely traffic forecast, the railway will require a fleet of some 1,400 wagons by 2020.

Infrastructure The origins of the Armenian Railway date from the late 1800s. The principal lines were rebuilt to a high standard in the 1950s and generally maintained to that standard till the late 1980s.

Freight Wagon Fleet Remaining 3,500 3,263

3,000

2,672

2,500

1,984 2,000 s 1,835 n o 1,653 g a

W 1,478 1,500 1,306 1,125 976 1,000 830 688 546 454 500 337 289 188 144 99 0 1995 2000 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Damage from the 1988 Spitak earthquake occasioned some significant investment in infrastructure renewals into the early 1990s. Even so, the main line from Ayrum to Yerevan includes a number of bridges built in the late 1890s. While they may have been strengthened in the 1950s, the major structures remain bridges from a different era.

The AR main line traverses difficult terrain with many engineering features which require substantial maintenance inputs for safe operation. The complex geometry of the railway line wears track more rapidly than normal so the life of major components such as rail, sleepers, fastenings and ballast is limited. The large decline in traffic reduced wear rates significantly— weather and geometry have become the major life limiting factors. Even so, much of the line is operated under slow-ordered speeds of 30 kph or less.

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Until the recent US$15 million World Bank loan financing track rehabilitation in the critical mountainous areas north of Ani, the infrastructure has received little renewal capital since the 1990. The restoration work provided capital repairs to the worst 70 kilometers of the 186 kilometers of main-line between Ayrum and Ani. The work reduced the amount of slow ordered track and train speeds have increased to about 60 kph in the restored areas. Significant restoration work remains to be done, including strengthening and replacing critical bridge structures, renewing track that was skipped in the recent project and tackling lines south of Ani.

The Need for Restructuring AR’s estimated deferred and annual renewal capital needs, as it is currently operated, are summarized in the table below.4

Deferred Investments Annual Item Quantity Estimated Unit Cost Total Renewal Locomotives 7 $ 3,000,000 $ 21,000,000 $ 1,500,000 Wagons 500 $ 30,000 $ 15,000,000 $ 100,000 Passenger EMUs (cars) 15 $ 800,000 $ 12,000,000 $ 1,000,000 Bridges 6 $ 2,000,000 $ 12,000,000 $ 500,000 Electrical Traction - $ - $ 8,000,000 $ 1,000,000 Track/Infrastructure (kms) 250 $ 170,000 $ 42,500,000 $ 4,000,000 Signal/Communications - - $ 2,000,000 $ 250,000 Machinery/Depots - - $ 10,000,000 $ 500,000 Total $122,500,000 $8,850,000

We estimate AR deferred investments, under current conditions, total about US$122 million (AMD 55 billion at 2005 costs and exchange rates). Annual renewal of existing assets would require about US$8.9 million (about AMD 4 billion). These estimates do not include investment will be required for traffic growth or for replacement of assets that become life expired in the future. The railway also needs more investment in information systems to manage the property and operations better.

Without investment in rolling stock, particularly locomotives, the railway will have insufficient resources to provide continuing services. This is especially true in regard to passenger services, where the electric train fleet is worn out and is becoming unsafe for service. We estimates that replacement EMU trains would cost about US$4 million (AMD 1.8 billion) each and that six sets of equipment would be required to continue to provide current services—an investment of some US$24 million (about AMD 11 billion).

AR is barely profitable currently, and its recent profitability has been built mostly by limiting investment and renewals. The reliance on prior investment and on an infrastructure in better condition than necessary for dwindling traffic cannot continue because many of the railways’ assets are now about life expired.

4 Based on analysis of prior reports on Armenian Railway, age profile of assets, observation of many facilities, discussions with each infrastructure department, our own estimates for locomotives, EMU, and wagon fleets.

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In summary, Armenian Railway is not very productive, expensive to operate, expensive for its customers and increasingly less competitive, and needs a great deal of capital—a difficult situation to resolve.

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3: Market Analysis & Traffic Forecasts

SUMMARY

his section of the Final Report encompasses HWTSK’s market analysis and traffic forecasts for AR, taking into account comments made on the Interim Report by Armenian T governmental and railway officials and the World Bank. We first address three sets of forecasts that assume that Armenia’s currently closed borders remain closed. Next we consider the potential impact of opening Armenian Railway connections and discuss the most likely near term option: opening the Turkish border crossing for, at a minimum, transit traffic to and from Georgia. We also discuss the potential impacts of other border openings, including the opening of the Abkhazia line between Georgia and Russia, over which Armenian traffic could flow into Russia. We also present a range of passenger projections, but the level of passenger business is essentially tied to Government subsidy policy rather than general economic conditions. Under all scenarios AR passenger business is anticipated to remain a small part of railway services and to at best break even financially, after government subsidy. The major traffic scenarios are as follows:

Low Forecast Scenario: In this scenario, we assume that economic growth in Armenia continues to focus substantially on the service economy and that annual GDP growth in the forecast period will decline from double-digit levels of 2000-2005 to annual rate of 6%, the consensus projection of IMF and other international agencies. We project that, for AR traffic categories that failed to grow in the context of the 2000-2005 recovery period, tonnage will continue to stagnate or grow only marginally during the more modest economic expansion forecast. We also project that a key high-risk domestic traffic category (gold ore) is lost and that increasing intermodal competition hinders railway tonnage growth.

Most Likely Scenario: In this scenario, we postulate the same economic growth in Armenia, but project that high-risk gold ore traffic is retained and recovers to 2004 tonnage volumes. We assume that Armenian Railway is somewhat more successful in competing with trucks, but that the relationship between AR traffic growth and Armenian GDP expansion during the 2000-2005 period, leaving aside two commodity groups with special circumstances (see below), generally continues to prevail.

High Forecast Scenario: Here we assume the general traffic growth in the most likely scenario, but project that domestic gold ore tonnage recovers to twice the 2004 levels, and that the rail line through Abkhazia is

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 3 - 1 Armenian Railway Restructuring Project: Final Report Market Analysis & Traffic Forecast reopened, connecting Georgian Railway to the Russian rail system and allowing Armenian export-import traffic to move all-rail to and from Russia and Europe.

Turkish Border Reopening: As a sensitivity test, we examined the impact of the Armenia-Turkish border reopening for at least transit traffic between Turkey and Georgia with connections to the Caspian Basin. We find here that a diversion of 15% of volumes projected to move over Georgia ports during the projected period (a figure our analysis indicates is feasible) could double AR tonnage volumes. However, this would still leave AR a relatively small carrier.

To perform a financial evaluation of the restructuring options subsequently discussed, the most likely scenario tonnage volumes are assumed and projections are made for ton-kilometers and revenues, based on average haul and average revenue for each commodity group.

COMPETITIVE SETTING As discussed in the Interim Report, AR is a very short haul railway. In 2005, its average length of haul was 225 kilometers. Average import/export hauls were nearly 300 kilometers (or roughly the distance from the Georgia border to Yerevan) and domestic hauls around 190 kilometers, but only some 130 kilometers if large movements from remote gold mines to Ararat are excluded. These distances (and in fact even the approximate 700 kilometers from the Georgia port of Poti to Yerevan) are commonly regarded as highly truck competitive.

Competition to AR is largely limited to road transport (except for long haul passenger transport by air). As a landlocked country, there are no maritime competitors and the only pipeline transport in Armenia is for natural gas. Armenian government statistics on road transport volumes are limited to for-hire carriers, but since the vast bulk of road transport is via wholly owned vehicles of enterprises, including freight forwarders, those data are essentially useless. However, there is strong evidence that road competition is quite pervasive for most commodities, including bulk transport. As noted in the Interim Report and later in this Chapter, a comparison of cement production statistics as compared to rail traffic volumes indicates that the domestic rail share of cement transport can be no more than about 15% and of inputs to cement production only perhaps 20%. The isolation of copper mines in southern Armenia has meant that all of that important traffic moves by road until it can be transloaded (as concentrate in reduced volumes) to rail for export. While Armenia lacks data on container traffic, Georgian data indicates that the rail share of containerized traffic moving through Georgia ports is only about 5-10%, and the portion of that traffic moving into Armenia cannot have a much greater rail share. Trucks are competitive even for longer haul bulk commodities. To illustrate, 2004 Armenia statistics on petroleum fuel and associated imports, less natural gas, indicate a volume of 480,000 tons,5 versus AR rail volumes of 315,000 tons. That would be just a 65% rail share, and it is widely felt that truck volumes are substantially underestimated due to illegal traffic.

AR passenger volume has fallen precipitously since independence, hardly surprising given an average haul of under 40 kilometers. Armenian statistics indicate that AR carries only a fraction of one percent of passenger volume.

5 National Statistical Service of the Republic of Armenia, Foreign Trade of the Republic of Armenia by Commodity Subgroup 2004.

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In summary, therefore, while AR is the sole rail carrier in Armenia it certainly does not have a monopoly. Its role as a passenger carrier is quite marginal and, as a freight carrier, it is faced with serious road competition even for major bulk commodities such as cement.

FREIGHT MARKET ANALYSIS During the 2000-2005 period, AR tonnage traffic volume grew at an annual rate of about 13%, approximately the same rate as that of Armenian GDP. The inference of a close relationship between Armenian GDP and rail traffic, however, is misleading (see the chart below). Over the past five years, AR’s growth was driven principally by:

1. One private firm’s reopening of dormant gold mining and production assets (raising nonferrous ore tonnage from 21,000 tons in 200 to 664,000 tons in 2004 and 481,000 tons in 2005). This is

AR Cargo Traffic by Major Commodity Groups 3000

Non-Metallic Ore, domestic Cement Exports Cement Clinker Exports 2500 Limestone, Domestic Misc Imports All Other

2000 ) 0 0 0 (

s 1500 n o T

1000

500

0 2000 2001 2002 2003 2004 2005 shown in the top item in the chart below. 2. The development of cement and cement clinker exports to Georgia by two cement plants (an increase from about 5,000 tons to 263,000 tons). Domestic limestone traffic (the chief input to these firm’s cement production) also increased. Neither of these developments was driven principally by Armenian GDP growth. While several comments on the traffic forecasts correctly point out that AR has several dozen customers, directly or through freight forwarders, aside from the above three customers6 AR traffic grew at an annual rate of only about 4%, or about one-third the rate of Armenian GDP growth. In fact, excluding the miscellaneous category of imports – which was driven by inputs to the rapid growth in Armenian construction as the economy recovered – AR tonnage annual growth was

6 The three include the gold company and two cement customers. Cement customer traffic, shown in shades of red in the chart, includes shipments of input materials for cement production as well as cement outputs.

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 3 - 3 Armenian Railway Restructuring Project: Final Report Market Analysis & Traffic Forecast only 1.7%, less than a sixth of GDP expansion. In fact, “all other” traffic in 2005, shown in blue in the chart above, was actually below 2002 levels.

Three factors contribute to this relationship: relatively short hauls (especially domestically, but even for imports and exports via Georgia ports); improved roads; and very rapid expansion of privately owned commercial vehicles and private automobiles (both for own use and for hire)7. With Armenian GDP growth projected by IMF to fall from the 13% annual increases achieved in the recent economic recovery to about 6%, a continuation of the recent relationship between AR traffic and economic growth would imply expansion of most categories of AR traffic of at most about 1-2% annually.

As noted above, the three base forecast scenarios are based on current border conditions (Armenian Railway rail connections only through Georgia). Projections of gold ore and cement industry output and input are based largely on interviews with shippers and industry news reports. Projections of other AR domestic and international export-import traffic are based on an assessment of the relationships between AR traffic growth and Armenian GDP in the 2000-2005 period, and the outlook of AR freight forwarder and business customers based on direct interviews. Customers interviewed are listed in Appendix A.

Under the current conditions of closed borders with Azerbaijan and Turkey, there is, of course, no transit traffic and none is projected for the three cases. An estimate of the impact of reopening the Turkish border (the Armenian border crossing we think most likely to be reopened first) is presented separately; an estimate of traffic generated from opening of a connection to Russia through Georgia and Abkhazia is also discussed. For each category of AR business, the market analysis address factors that impact particular commodities and shippers and base the range of forecasts on the contingencies that might create more or less traffic for AR. In most cases, these contingencies are significantly beyond the control of AR management and we assume in each case that AR management will respond to available traffic opportunities in a commercial manner (that is, we do not assume differences in management performance under different scenarios).

A price elasticity analysis based on railway and shipper interviews was not possible during this study and the traffic projections therefore are based on the demand outlook given a continuance of 2005 price levels. A price elasticity analysis was not possible for several reasons, the first was the impossibility of isolating the effect of price from both railway service deficiencies and from input and output factors affecting the products shipped. Virtually all of AR’s customers are quite non-transparent with regard to production costs, sales prices, and internal road transport costs, making the impact of adjustments to transport costs difficult to calculate—elasticities would have to be based on derived demand estimates, beyond the scope of this study. The extensive use of freight forwarders, whose rail and truck charges as intermediaries are also non-transparent, compounds this problem. The second reason relates to the prominence of international traffic in the AR traffic mix. This adds several layers of unpredictability to the first set of issues, including: • The fact that a price change on the AR portion of a haul is greatly diluted by the majority of the through rate being set by Georgian Railways and other rail and non rail parties to the

7 According to the Armenian traffic police, a total of some 53,000 vehicles were imported to the country, mainly from Russia and Western Europe, between 2003 and 2005, bringing Armenian motor vehicles from roughly 250,000 to 300,000, an increase of 20% in just two years.

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transport haul (and an AR change could readily be offset by adjustments of those transporters) • The impact of fluctuating exchange rates for dollar or Swiss frank-denominated international rates • The non-transparency of non-Armenian transport charges, maritime/port fees and miscellaneous wagon handling charges, both official and “unofficial” Some general information is known, such as that rail container movements from Georgia ports are inferior to truck in both price and service. Unfortunately, however, AR is not in charge of its own destiny as far as most pricing is concerned and its knowledge of customer cost sensitivities is limited by both customer secretiveness and the limitations of its own data systems. Without a shipment costing system8 it is difficult to even assess which existing pricing levels provide what level of profitability. Our financial analysis shows that freight traffic generally makes a contribution but constructing a traffic costing model is not within the scope of this study. While a demand elasticity assessment is certainly desirable when reliable data exist, we concluded that the most prudent basis for AR projections would be one based on existing price structures. A more commercially oriented operator will likely be more familiar with its shippers and understand their markets better than AR. It is reasonable to believe that a more commercially oriented railway would make price adjustments, both upwards and downwards, and achieve both greater traffic volume and more revenue, there is insufficient information available to project either additional traffic that might be available from pricing discounts, or higher margins available from price increases on inelastic traffic.

Market Analysis: Domestic Traffic In the last five years, Armenian Railways’ domestic traffic has tripled, from just over 330,000 tons in 2000, during the depths of the post-independence economic slump, to just over one million tons in 2005 actually reaching 1,157,000 tons in 2004. However, the great bulk of this growth, as outlined below, came from the business of one customer hauling one nonferrous metal commodity, gold ore, which in 2003-2004 accounted for over 50% of total AR domestic tonnage. The remaining half of AR domestic traffic has grown significantly, from 313,000 tons in 2000 to 598,000 tons in 2005 (or nearly double). However, the bulk of recovery had occurred by 2002, when traffic other than nonferrous metal reached 573,000 tons. Domestic non-gold ore traffic growth has been quite small since 2002, despite significant growth in the Armenian economy over the past three years. For reasons discussed below, it is unlikely that the performance of the 2000-2005 period can be repeated, and there is a significant risk of actual domestic traffic decline. The factors affecting key commodities hauled by AR domestically are discussed below.

Gold Bearing Ores: By far the largest source of AR domestic traffic growth since 2000 has been nonferrous ore, well over 90% of which is gold bearing ore from one privatized mining operation.9 A large open pit gold mine (near Zod) and a smaller underground mine (near Meghradzor) were operated by the Armenian government until 1997 when operations were suspended due to a lack of capital for

8 The VectoRail rail traffic costing system was installed at AR in 2000 under a World Bank financed grant but, while implemented in the grant project, the costing system was never used. 9 In Armenian Railway statistics, the domestic nonferrous ore category also contains a modest amount of copper/molybdenum ore concentrate, and export nonferrous ore exports is comprised of these copper/molybdenum concentrates, as gold ore is processed internally and not exported.

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 3 - 5 Armenian Railway Restructuring Project: Final Report Market Analysis & Traffic Forecast reinvestment. Ore from these mines had been processed at a central gold processing facility at Ararat, but with the closure of the mines little ore traffic moved between 1997 and 2001. However, in 1998 a private company named Sterlite Gold (a Canadian registered company with Indian ownership interests and management) obtained rights to process tailings left at the Ararat plant from past operations. Sterlite formed the Ararat Gold Recovery Company (AGRC) to invest in upgrades to the processing plant and began processing the tailings left behind from previous processing. While processing the tailings at the Ararat plant, Sterlite conducted a series of feasibility studies on the closed mines and eventually concluded that reopening the mines could be “a marginally profit proposition … viable with proper planning and control.” 10 Consequently, AGRC acquired rights to the mines as well as ownership of the Ararat plant. In 2002 the company began shipping gold ore by rail for processing (approximately 254 kilometers from Zod to Ararat; 125 kilometers from Meghradzor to Ararat). The company has reported that subsequent testing indicated that both the tonnage available and grade of ore from the mines were less than expected but, the rising price of gold offset lower than expected yields sufficiently to keep the project in operation. By 2004, gold ore shipments between the mines and processing plant had increased to over 600,000 tons.

Relations between Sterlite and Armenian Railways (as well as the government) have been contentious. The company has claimed that it was assured of lower transport costs when it acquired the mines and has been dissatisfied with timely delivery of wagons. Sterlite has periodically refused to pay the full tariff rate and AR has withheld service in retaliation. The company has investigated moving the processing plant to Zod, which would eliminate much of the rail service, although it would have to overcome strong environmental opposition to doing so.11 Government has had numerous issues with the company on environmental matters, safety and accuracy of operational and financial reports.

As recently as December 2005, Sterlite denied a series of reports that it was about to pull out of Armenia. An Internet publication, The Russia Journal, reported “The [Ararat] plant has the capacity to process about 1 million tons of ore per annum, but the cost of transportation is prohibitive. … the costs of production outstripped revenues; and in an unaudited statement for the [third quarter 2005], Sterlite posted a loss of $2.5 million. The company blames the loss on falling grades at the Zod mine, falling tonnages of tailings, and lower grades in the tailings.” 12 In May 2006 Sterlite issued a call for expressions of interest to conduct a formal feasibility study of constructing a new processing plant at Zod using environmentally benign technology versus upgrading the Ararat facility.

The Sterlite traffic accounted for the great bulk of the 664,000 tons of nonferrous ore transported by AR in 2004 – a figure that dropped to about 480,000 tons in 2005 due to the disputes with the railway and the mining company’s troubles. In January 2006, the mining company suspended all shipments. In April, company officials informed HWTSK that some shipments had resumed of higher quality ore from the smaller underground mine, but that traffic from the main mine at Zod remained suspended. They indicated that decisions on future production were unresolved at that

10 Sterlite Gold web site (www.sterlitegold.com). 11 Current processing technology uses cyanide and the watershed near the mine drains into Lake Sevan, one of Armenia’s most outstanding natural resource. More benign technology and stringent environmental control measures would be required for approval of plant relocation. 12 The Russia Journal (November 17, 2005) beta.russiajournal.com.

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 3 - 6 Armenian Railway Restructuring Project: Final Report Market Analysis & Traffic Forecast time, awaiting the study cited above and further analyses of the quality of the ore. Hence, the future of this traffic is highly conjectural. On the one hand, the mines and processing plant could remain closed, or the processing facility moved to Zod, eliminating most rail movement of gold ore.13 On the other hand, Sterlite/AGRC or a successor could move up to the one million ton annual capacity of the existing Ararat plant, or even upgrade capacity at some future date. AR rates and services might well have an impact on the outcome, but also might not be determinative – ore quality, the price of gold, and mine expansion costs will be crucial to future decisions and rest on technical evaluations and market conditions beyond the control of railway management. In the traffic forecasts that follow, our low forecast assumes that gold traffic is lost (the situation as of early 2006); the most likely forecast assumes that gold traffic recovers to 2004 levels (about 600,000 tons annually); the high forecast assumes an annual volume of one million tons. We adopt the 600,000 ton figure as most likely based on AGRC’s continuing commitment to the business (despite reported offers to buy out), a judgment that environmental approvals for processing facility relocation to Zod are unlikely, a continuing strong market for gold and the prospect that upgrading the processing facility at Ararat will improve production economics, and AGRC’s recent resumption of modest shipment volumes.

That said, the future of this business a risky one and is essentially independent of other factors that drive the high and low forecast scenarios -- economic growth in Armenia and the region, or improved external rail connections. Consequently, there is a potential traffic volume swing of approximately one million tons in any scenario related to this one customer. The traffic is predominantly over a rail line with little other business14 and may properly be regarded as an independent venture to be evaluated separately on its own terms. The gold recovery company’s advice that a wide range of outcomes is possible based on the outcome of pending evaluations and negotiations must be regarded as definitive. We believe that a new less hostile relationship with the company and improved rail service can secure the most-likely forecast volumes pending the outcome of the other evaluations.

Construction Materials: Apart from the growth in gold ore traffic, essentially all of the expansion in AR domestic traffic has been in construction materials, which rose from about 20,000 tons in the depressed year of 2000 to over 200,000 tons in 2004 before slumping somewhat in 2005. Limestone is the largest element here, along with powdered aggregates (some of which are byproducts of copper concentrate processing). Cement, produced from limestone and other mineral inputs, has been growing rapidly in the export market to Georgia, but has been fairly stable in the domestic market (around 50,000 tons annually), reflecting the use of trucks for short-haul transport of cement to domestic sites15. Thus, the growth in AR limestone traffic, appearing as a domestic movement, supports manufacture of cement both for domestic use (where distribution is mainly by truck) and for export (almost all to Georgia, delivered substantially by rail).

13 Ore might move from the deep mine at Meghradzor to a new processing facility, a distance of some 140 kilometers. 14 Most other traffic on this line is limestone and mineral construction materials. 15 AR domestic volume is only about 15% of the roughly 340,000 tons of cement in 2005 estimated to be consumed in Armenia. In 2005 Armenia produced about 500,000 tons of cement—the rest was exported to Georgia. Limestone and other minerals used as inputs to cement are about double cement production, so the 180,000 tons of domestic construction materials inputs hauled by AR are under 20% of total domestic volumes.

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As both the Armenian and Georgian economies are expanding rapidly, we expect the construction materials segment of AR construction materials business to continue to grow, but not at the very high rate that it has from the very low levels of 2000. That 2005 domestic construction materials moves were below 2004 reflects this slowing down. Despite the 2005 slump, we think a 3% (low case) and 4% (most likely and high forecast) annual rate of growth is realistic for construction materials, reflecting continued growth in the Armenian economy plus derived demand for domestic movements related to expanding construction in Georgia. Due to increasing truck competition, annual growth rates above these levels would be unlikely. In addition, higher growth is inhibited by constraints on the export markets for Armenian cement as discussed below.

Other: Other categories of Armenian Railways freight traffic have fluctuated greatly from year to year, but have scarcely expanded overall, despite the boom in the Armenian economy.16 Short hauls within Armenia and the vast increase in motor vehicles over the last five years have limited growth. In addition, rail access to Armenia’s main copper and molybdenum ore producing areas is cut off due to AR lines passing through the closed Azerbaijan territory of Nakhichevan, placing that traffic on the roads. Consequently, rail transport of copper and molybdenum ore (also classified as nonferrous ore) has been limited, with the products converted to concentrates or blister copper prior to rail transport, sharply reducing potential rail volumes.17 The Armenian economy additionally has placed greater emphasis on high value products and services, limiting rail potential. Nonetheless, we forecast a 1% (low forecast) to 2% (most likely and high forecast) annual growth for domestic AR traffic other than gold ore and construction materials.

Market Analysis: Import Traffic Imports over Armenian Railways grew by about 3% annually between 2000 and 2005, but by only about 1.5% annually since 2002, despite the significant expansion of the Armenian economy and growth in consumer and business purchasing power. Oil and food products make up over two thirds of imports by rail and growth in both categories has been very modest. In fact, 2005 volumes for both grain and oil products are below 2002 levels. As with many countries, Armenia does not encourage dependence on goods and commodities produced outside Armenia and traffic has tended to be limited to essential commodities: fuel, food and critical inputs to construction.

Oil Products: Rail imports of oil products to Armenia have been flat despite the expansion of the economy and increased use of private motor vehicles. This partially has been due to conversion of vehicles to natural gas, delivered to Armenia by pipeline, but also by loss of rail modal share of oil products to truck, both legal and illegal. Both trends may continue, but holding oil consumption flat over the next 15 years and continued reliance on trucks for bulk deliveries could be difficult, hence we forecast a 1% annual growth in AR hauled oil product imports in the low forecast; 2% growth is projected in the most likely and high forecasts. Food Products:

16 An example of extreme fluctuation is the category of industrial raw materials which peaked at 271,000 tons in 2002, fell to 25,000 tons in 2004 and recovered to 197,000 tons in 2005. Such volatile results reflect AR’s thin traffic base of only a few businesses for each commodity. Volume fluctuations may be compounded by inconsistency in reporting. 17 According to the Armenian Copper Programme, 11.1 million tons of ore mined in 2003 produced only 16,600 tons of copper concentrate.

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Rail-hauled food imports, dominated by grain, have fluctuated substantially from year to year, but also have not grown overall. 1-2% annual growth is also projected for this traffic, as with oil products, but even this growth will need to be supported by improved rail service, particularly for containerized food items, where rail currently has a small modal share. As long as rail transit times from Georgia ports are much inferior to trucks and rates, especially for 40 ton containers are as great or greater, traffic growth will be inhibited. Georgia Railway performance is at least as critical to growth of this traffic as Armenian Railways performance.

Other: The only substantial growth in imports over AR has been mostly in fertilizers and materials related to the construction industry (e.g., steel sheets and frames). While this growth appears to be slowing, we project 2% annual growth in the low forecast; 3% in the most likely and high forecasts. While we expect purchasing power in Armenia to grow faster than these rates (again, the IMF projects real GDP growth rates at about 6% through 2008), the mix of imports is likely to increasingly include diverse high value goods that are truck competitive, constraining rail traffic growth.

Market Analysis: Export Traffic Well over half of Armenia Railways exports now are destined to Georgia, the remainder pass through the Georgia ports of Poti and Batumi. Exports to Georgia are notably construction- related, dominated by cement. Exports through the Georgia ports have been principally metal scrap, copper concentrate and blister copper and miscellaneous products in containers.

Cement and Construction Products: These exports are similar to construction products in the Armenia domestic market in that both Armenia and Georgian construction demand are driven by the healthy economic growth of the recovering regional economies. As with AR’s domestic traffic, a 3% (low case) and 4% (most likely and high forecast) annual rate of growth is realistic for cement and construction materials exports to Georgia. Interviews with the Armenian cement industry indicated a commercial belief (consistent with international experience) that the maximum transport range for cement is only about 700 kilometers, limiting the export market essentially to Georgia. Industry spokesmen also indicated a belief that current potential is limited by inadequate and substandard AR rolling stock.

Copper: Exports of copper from Armenia, mostly destined to production facilities in West Germany affiliated with Armenian mining operations, may be expected to grow, along with molybdenum (found in association with copper ore deposits). Government promotion of this industry will support expansion. However, overall volumes are constrained by changing processing stages within Armenia. First, facilities located at or near the mine sites process ores into concentrates, greatly reducing the copper ore tonnage that must be transported (even more dramatically for molybdenum than for copper). Second, the Armenian Copper Programme, a closed joint-stock company incorporated in Armenia, has developed and is expanding a copper smelter in Alaverdi, Armenia. The smelter produces blister copper from copper concentrate, further reducing the volume to be transported and producing a high value product that can be moved in containers and transported competitively by truck. Interviews with copper industry personnel showed them to be very cautious about the future outlook for copper products—copper is very sensitive to international market conditions. In fact, AR 2005 shipments were less than half those in 2004.

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Even so, ACP has made significant investments in production facilities and for this reason we project a 2% (low case) and 3% (most likely and high forecast) annual rate of growth for rail- hauled copper (nonferrous) exports.

Ferrous Metals/Metal Scrap: In the years following independence, the Caucuses countries, including Armenia, exported vast quantities of metal scrap made available by the closure of industrial complexes and excess inventories of aging or derelict equipment. While world demand for metal scrap remains very high, Armenia and other countries in the region are depleting available supplies of scrap and, with growing domestic economies, are absorbing more of these materials domestically. Consequently, a 0% (low case) and 1% (most likely and high forecast) annual rate of growth only is projected for the metal scrap export trade. It is distinctly possible that depleting stocks of scrap metal will eventually lead to a decline in this export trade, but given continuing high level of word demand, we project some growth in rail-hauled export scrap markets.

Container and Miscellaneous Exports: Containerized and miscellaneous exports moving by rail beyond Georgia share important characteristics with copper traffic (and, in fact, a portion of Armenian containerized exports are copper). These characteristics include a higher average value of the products shipped and vigorous competition from trucks. The 2% (low case) and 3% (most likely and high forecast) annual rates of growth projected for copper are also applied to this traffic category. Maintaining this rate of growth is likely to require investment in wagons to reduce loss and damage as well as increased cost for insurance and quality control. Improvements in service to the ports are anticipated in the higher forecast projections.

Specialized Minerals: Armenia produces three categories of minerals that are potentially attractive in export markets, but currently move in minor quantities due to high transport costs. These include perlite, bentonite and dimension (architectural grade) stone for building construction. Perlite is used in the oil industry for filtering, as well as for insulation, soil additives and a host of other applications. Bentonite is used as a drilling lubricant among other applications. Dimension stone is used for facings in building construction. Armenia is known for high quality in each of these products, but transport related obstacles and high costs have rendered them largely non- competitive.18 Growth in these commodities is not separately projected in the low forecast or most likely base case, but adjustments are made in the high forecast, which also envisions Abkhazia reopening. That projection assumes that perlite exports resume at 50,000 tons in 2007 with the successful culmination of pending negotiations for a discount rate with Georgian Railways and the affected shipper.

Abkhazia Reopening: Reopening of the rail line through Abkhazia is believed to offer opportunities for Armenian exports both to Russia and Eastern and Western Europe. These opportunities would arise because the all-rail route would have lower overall transport costs than those now entailed in transferring cargos to vessels or car ferries at Georgia ports and, for goods off-loaded to vessels, then reloading to rail in Russia, Ukraine or Eastern Europe for delivery to destination. Georgia Railway has a monopoly on the connection to Abkhazia, however, and in theory could raise its rates to capture any savings from cost reductions over the Abkhazia route. For the purpose of our

18 For the first two products, Azerbaijan offers a natural market that has been lost due to the regional conflicts.

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 3 - 10 Armenian Railway Restructuring Project: Final Report Market Analysis & Traffic Forecast high forecast we project that Georgia Railway will not exploit its monopoly position, but rather will seek to increase traffic by at least a partial pass-through of cost savings. The Abkhazia line requires rehabilitation prior to reopening. In the high forecast we project that a political settlement occurs in the near future and that the line can be made operational by January 2009.

Growth in Armenia exports arising from reopening rail connections to Russia via Abkhazia will stem from two sources: traffic that is currently moving over the Georgia ports; and traffic that has been priced out of the market due to high transport costs or poor service quality. Based on our discussions with AR management and its shippers, the following developments appear plausible as a high-side estimate of Abkhazia reopening:

• The annual rate of growth for Armenian exports currently moving over Batumi and Poti would triple beginning in 2009. As a substantial amount of Georgia ports traffic moves to the Mediterranean or other points not advantaged by an Abkhazia reopening, this is a high estimate. However, we defer to freight forwarders’ and AR’s conviction that relief from the bottleneck now posed by the cost and capacity limitations of the Black Sea wagon ferry would open significant new export opportunities.

• Specialized minerals now driven out of export markets by high transport costs (e.g., perlite, bentonite and dimension stone) would begin to move over Abkhazia in 2009 in a volume of 60,000 tons and grow at an annual rate of 6%, along with perlite transport exports resumed in 2007.19 The firm presently attempting to rebuild Armenian perlite production recently failed to reach agreement on a volume rate agreement with AR and Georgian Railways, but serious negotiations did occur and Abkhazia reopening should contribute to agreement on a rate-service package that would allow movements to resume. Stone exports (including relatively high value stone tile) that are under development by the business interests operating Ararat Cement offer potential under improved service. Bentonite for use in Russian oil production offers potential, because of the growth in that industry, although inhibited by low product value and alternative sources.

• The rate of growth in imports would increase by 50% due to lower transport costs and improved service, despite government policies to hold down import dependence.

We acknowledge that the above scenario is more indicative of the potential scope of Abkhazia reopening potential than it is a firm forecast. The import of this scenario, however, is that each of the above assumptions are highly optimistic because of the uncertainty concerning the pricing behavior of Georgian and Russian railways, the expense of reopening the Abkhazia line, as well as the uncertain capacity and timing of a reopened route. The enterprises that previously used this route, such as heavy industrial materials feeding into the Soviet military and industrial complex, textiles and leather goods, are almost entirely dismantled in Armenia and are unlikely to be revived. The essential conclusion of this review, illustrated below, is that even if Abkhazia did substantially stimulate Armenia’s remaining export sector, that growth will not likely alter AR’s status as a small rail carrier or fundamentally change the economic characteristics of the railway.

19 Pending negotiations with Georgian Railways and a perlite producer, as well as the relatively high value of the product, may make resumption of perlite movements possible without Abkhazia reopening.

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FREIGHT TRAFFIC FORECASTS Using the above assumptions, the following traffic projections for Armenian Railways were made:

• A Low Forecast, assuming loss of gold ore traffic and slow expansion of other traffic due to road competition. • A Most likely Forecast, with more successful railway competition with roads, but without Abkhazia reopening • A High Projection, with Abkhazia reopening and a substantial expansion of export traffic

Data tables supporting each projection are included in Appendix B. The projections that follow are identical to those in the interim report, as additional review of the relationship between Armenian GDP growth and railway traffic trends and further interviews with AR and with shippers confirmed our confidence in the previous findings. In addition to commodity-specific findings, AR and a number shippers have expressed concern, based on their own outlook regarding overall traffic development, that the traffic base will not support private sector participation or investment. While we do not reach that conclusion, we share a similar perspective or the traffic outlook. In all cases, AR will remain a small rail carrier.

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Low Forecast The low forecast is shown in the chart below. We do not regard this scenario as the most probable, but it illustrates that the railway’s recovery since the terrible traffic years of 2000 and 2001 has been greatly enhanced by growth in domestic nonferrous metal traffic, dominated by a single customer transporting gold ore. Domestic gold ore shipments are shown in white in the chart below. Here the forecast assumes that gold ore transport declines—either due to relocation of the processing plant or closure of what is purported to be a marginal business and a decline in the recent near record price of gold. If that business should be lost and truck competition continues to erode rail market share, Armenian Railway traffic could sink toward two million tons a year and take several years to recover to current volumes. The railway would remain a very small volume carrier, about a tenth the traffic volume of Georgia Railways, and would find it difficult to attract substantial investment.

Armenian Railway Low Traffic Forecast 5,000

4,500

4,000

3,500

s 3,000 n o t

d

n 2,500 a s u o

h 2,000 T

1,500

1,000

500

0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

EX-ferrous metal EX-construction materials EX-nonferrous ore EX-other goods-commodities EX-industrial raw materials EX-cement IM-grain IM-sugar IM-oil products IM-chemical and mineral fertilizer IM-other goods-commodities DO-wheat wheat flour DO-industrial raw materials DO-scrap metal DO- cement DO-other goods-commodities DO-construction materrials DO-nonferrous ore

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Most Likely Forecast The most likely forecast is shown in the chart below. As discussed previously, this forecast projects that the gold ore traffic is retained and resumes its growth, that Armenian Railway has greater success in competing with trucks, and that the Armenian economy continues to grow as assumptions regarding economic growth discussed previously hold throughout the period. The result is railway traffic that grows to nearly 4 million tons by the end of the period. Even so, Armenian Railways remains small by global and regional standards. Given vigorous competition from roads, the shift of the Armenian economy to goods and services that minimize transport costs, and continued reliance on only one open border, it is not likely that Armenian Railways traffic will exceed 4 million tons annually over the next fifteen years.

This most likely forecast is used as the basis for the financial analyses. We believe that while some details of forecast traffic growth may not appear, other traffic growth is equally likely. Note that the forecast assumes continued economic growth throughout the period and improvement in rail services, including investments in rail equipment and infrastructure. While such even growth is unlikely, we believe that overall growth levels depicted in this forecast are achievable and likely.

Armenian Railway Most Likely Traffic Forecast 5,000

4,500

4,000

3,500 s

n 3,000 o t

d n

a 2,500 s u o

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500

0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 EX-ferrous metal EX-constructionYear materials EX-nonferrous ore EX-other goods-commodities EX-industrial raw materials EX-cement IM-grain IM-sugar IM-oil products IM-chemical and mine fertilizer IM-other goods-commodities DO-wheat wheat flour DO-industrial raw materials DO-scrap metal DO- cement DO-others goods-commodities DO-construction materrials DO-nonferrous ore

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High Projection, with Abkhazia Reopening The high forecast assumes reopening the all-rail route through Abkhazia and is shown in the chart below. As noted earlier, the projection assumes more competitive AR services, continued economic growth in the region, and that savings from an Abkhazia reopening are passed on to shippers by Armenian, Georgian, and Russian Railways. The result is a tripling of export levels that could be expected using Georgia ports, and that specialized minerals products that were priced out of the market again become competitive to Russian and European markets. With these very optimistic assumptions, Armenian Railways traffic grows to about 4.7 million tons by the end of the period.

Despite the potential positive effects of an Abkhazia reopening, the impact of the reopening may not be as great as has been forecast here. Frankly put, the volume of Armenian exports by rail that move beyond Georgia is small, only about 250,000 tonnes, and the industrial base in Armenia that supported exports to Russia in Soviet times – textiles, industrial goods, military equipment – has largely disappeared. Specialty minerals such as bentonite and perlite for oil drilling and industry applications meet very particular needs and their markets are likely to revive slowly. In consequence, while potentially helpful, the reopening of Abkhazia rail routes is

Armenian Railway High Traffic Forecast 5,000

4,500

4,000

3,500

s 3,000 n o t

d

n 2,500 a s u

o 2,000 h T

1,500

1,000

500

0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

EX-ferrous metal EX-construction materials EX-nonferrous ore EX-other goods-commodities EX-Specialy minerals EX-industrial raw materials EX-cement IM-grain IM-sugar IM-oil products IM-chemical and mine fertilizer IM-other goods-commodities DO-wheat wheat flour DO-industrial raw materials DO-scrap metal DO- cement DO-others goods-commodities DO-construction materrials DO-nonferrous ore unlikely to massively expand Armenian Railways traffic volumes.

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BORDER RE-OPENINGS AND THE POTENTIAL FOR TRANSIT TRAFFIC Currently Armenian Railways has no transit traffic because all rail border crossings except that with Georgia are closed. Reopening any of the border crossings could have significant impact on Armenian Railways traffic. The greatest impact would arise from increased transit traffic. There are four potential corridors that might be reopened that could result in significant traffic gains for AR; each is discussed below.

Direct connection to Azerbaijan via Akstafa, Azerbaijan to Ijevan, Armenia corridor: This corridor has been out of service for some time due to regional conflicts and landslides which have closed the line north of Dilijan. Some components of the line have been vandalized and the line would require significant reconstruction to reopen for rail traffic. Opening of the Ijevan border would permit Azerbaijan shippers to deliver goods to Armenia and vice versa. However, absent other border openings, little transit traffic would result from reopening this connection.

Should diplomatic relationships allow opening this border, we believe the Armenia-Turkey border would be opened at about the same time. Thus, the Azerbaijan-Georgia-Armenia-Turkey connection would also be available. The Azerbaijan-Georgia-Armenia-Turkey connection would be much less expensive and would likely precede or preclude opening this line. Because of this, we do not believe that reopening this corridor can be commercially justified within the range of the forecast period and conclude that it does not offer Armenian Railways any tangible business

Aktau C Kazakhstan as Ukraine Russia pi Novorossiysk an Abkhazia Grozny S ea Black Sea Georgia Uzbekistan Potsi Tbilisi Batumi Armenia Baku Yerevan Azerbaijan Kars

Turkey

Iran Tehran Syria Iraq expansion opportunities beyond those discussed below relative to the Armenia-Turkey border opening.

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Southern Armenia transit corridor, Mindjevan, Azerbaijan-Iran via Megri: This is an alternative route for Azerbaijan to and from Iran traversing 47 kilometers of southern Armenia with the Iranian border crossing section in Nakhichevan. Azerbaijan and Iran have other working connections via existing Caspian Sea and eastern Azerbaijan rail-highway routes. Iran is constructing a rail link to connect directly with the Azerbaijan Railway, so interest in the crossing on Azerbaijan’s part is likely minimal and the benefits to AR from this opening alone likely would be small. However, coupled with opening of the Iran-Nakhichevan corridor, discussed below, opening of this corridor could provide some benefit from transit traffic additional to that discussed below.

Iran-Nakhichevan-Georgia corridor via Nakhichevan, Megri-Yeraskh-Gyumri-Ayrum) We concur with Grant Thorton’s comments in the prior business plan that border reopenings eventually could convert this route into substantial traffic corridor, making copper/molybdenum mines in south Armenia more competitive, as well as facilitating commerce to and from Iran, Nakhichevan, and Georgia and points beyond. We expect that the Armenia-Turkey border would also open at the same time, permitting traffic flows to Turkey. Before benefits of reopening any of the above routes can be calculated, however, a joint Azerbaijan-Armenia-Iran study of the costs of rehabilitating the route and its market potential will need to be undertaken and a basis for cooperation among the parties established. We think it unlikely that this will occur and the route reopened to traffic before late in the traffic forecast period at best. While the route has long

Aktau C a Kazakhstan Ukraine Russia sp ia Novorossiysk n Abkhazia Grozny S ea Black Sea Georgia Uzbekistan Potsi Tbilisi Batumi Armenia Baku Yerevan Azerbaijan Kars

Turkey

Iran Tehran Syria Iraq term potential, it cannot be reasonably quantified at this time.

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Georgia-Turkey Corridor, Kars, Turkey-Tbilisi, Georgia via Ayrum-Gyumri-Akhuryan: The Georgia-Armenia-Turkey corridor can be the first transit corridor to develop traffic because the involved lines are currently in operation and only short segments would require rehabilitation. Traffic flows over this corridor could physically occur within a matter of weeks. This corridor is really the key corridor for increased transit flows and an important element in creating value from reopening other corridors.

It may possible to open this corridor without direct cooperation between Armenia and Azerbaijan. In fact, the Turkish border could be reopened with a minimum of Turkey-Armenia official interaction. A third party private operator could be chartered to provide transit services between Georgia and Turkey, prior to the resolution of diplomatic issues between the various countries involved. In this case, Armenian shippers would benefit from the opening only in that increased transit traffic would provide a higher and more stable traffic base, better AR financial performance, and, most likely, improve the condition of the infrastructure and interchange relationships at the Georgia border. Eventually, as country relationships improved, additional traffic, including traffic to and from Armenian shippers, could use the corridor. Any further border openings would increase traffic across AR significantly. The potential for this corridor is sufficient that it merits a preliminary quantification and that is provided below.

Aktau C a Kazakhstan Ukraine Russia sp ia Novorossiysk n Abkhazia Grozny S ea Black Sea Georgia Uzbekistan Potsi Tbilisi Batumi Armenia Baku Yerevan Azerbaijan Kars

Turkey

Iran Tehran Syria Iraq

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Traffic Potential of Ayrum-Gyumri-Kars Transit Corridor Recent regional developments suggest that, should the Turkish border connection be reopened, substantially larger volumes of transit traffic would likely to move more quickly over the Ayrum-Gyumri-Kars route than previously thought. There are several reasons for this, based on extensive interviews in Armenia and in Georgia:

• The volume of westbound crude oil and petroleum rail traffic from the Caspian Basin has increased rapidly and promises to continue to grow strongly, as a substantial amount of crude oil is incompatible with the existing crude oil pipeline consists. In addition, petroleum products pipelines do not exist and production of non-pipeline crude oils has been accelerated by record oil prices. • Caspian Basin petroleum industry growth is driving demand for eastbound commodities through the region, both to support the petroleum industry directly and to respond to GNP growth fueled by petroleum production expansion. • Both Georgia and Azerbaijan are sufficiently convinced of the need for a rail link to Turkey that they are considering investments in a direct Georgia-Turkey rail link estimated to cost as much as $US one billion, even if construction of the link is not supported by international development banks. • If Turkey were to agree to a reopening of the Armenia-Kars route, it would almost certainly be as a substitute for the expensive direct Georgia-Turkey link, as two routes are not required and the completion of the Georgia-Turkey link would make accommodation between Turkey and Armenia difficult, both politically and due to the inefficiencies of splitting the traffic between routes.

The composition of traffic over this connection is likely to be dominated by pipeline incompatible crude oil and petroleum products moving westbound into Turkey, inputs to the Caspian Basin petroleum industry, and containerized products moving eastbound. Shippers would trade-off longer rail hauls of both loads and empties against the delays and uncertainties associated with movements through Georgia ports and onward maritime movements, often traversing the congested Bosporus straits. The route through Ayrum and Gyumri to Kars offers advantages for much of the roughly 12 million tons of traffic now moving through Georgia ports – traffic to or from Turkey itself, traffic to destinations in Greece and the south Balkans, and traffic passing by vessel into the Mediterranean. All of these 12 million tons now pass through Georgia ports and the Black Sea. This traffic is projected to double to 24 million tons by 2015 due to projected substantial growth of Caspian Basin petroleum production, and this projection may already be outdated by continuing escalation of oil prices. Given port congestion issues, Turkey’s reluctance to have increased crude oil movements through the Bosporus, and the multiple rail-vessel transfers the Black Sea route requires, we estimate that as much as 25% of the traffic now flowing through Georgia ports could benefit from an all-rail alternative.

To indicate the scope of potential traffic, the chart below projects that a reopening of the Turkish border to transit traffic can dramatically revive traffic over Armenian Railways. The chart indicates conservatively that if the route through Ayrum, Gyumri and Kars were to capture only 15% of traffic that would otherwise move through Georgian ports (with the corridor share rising from one percent to 15 percent over the first four years after reopening), traffic on Armenian

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Railways would be double that expected in the high forecast scenario including Abkhazia reopening. This projection, moreover, addresses transit diverted from Georgia ports only and does not include any additional transit traffic that might be generated by an all-rail route; nor does it include any estimate of the beneficial impact of a reopening on Turkish-Armenian trade. The forecast also does not depend on any further border re-openings that might flow from the positive step toward regional trade facilitation that Turkish border reopening would represent. While we made consistently optimistic assumptions in presenting the scope of AR traffic potential derived from an Abkhazia reopening and conservative assumptions here, the incremental traffic potential is an order of magnitude greater for the Ayrum-Gyumri-Kars route. This is simply because the latter is driven by ongoing rapid growth in transport demand from a

Armenia Railway High Traffic Forecast, Turkish Border Reopening 9,000

8,000

7,000

6,000

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o 3,000 u s a n

d 2,000

t o n s 1,000

0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

EX-ferrous metal EX-construction materials EX-nonferrous ore EX-other goods-commodities Specialy minerals EX-industrial raw materials EX-cement IM-grain IM-sugar IM-oil products IM-chemical and mine fertilizer IM-other goods-commodities DO-wheat/wheat flour DO-industrial raw materials DO-scrap metal DO- cement DO-others goods-commodities DO-construction materrials DO-nonferrous ore Transit-Turkey major established industry while the former requires new or revived markets to be developed from a low base.

The market analysis and traffic scenarios show that support for those restructuring reforms and investments that contribute to a revived role of Armenia Railways as a vital regional transit corridor could have significant positive effects on the Armenian economy and on the financial condition of Armenian Railway.

It is our view that the Turkey-Armenia border reopening would be facilitated first by a private sector concessionaire able to operate a transit service directly between Tbilisi and Kars with

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 3 - 21 Armenian Railway Restructuring Project: Final Report Market Analysis & Traffic Forecast customs clearance in Georgia and Turkey. This would permit Turkey to open the border initially only for Georgia traffic, if direct trade with Armenia continued to be an insurmountable political obstacle. All restructuring options examined in this Final Report allow for such a private operator. In fact, it is the opportunity presented by the potential border openings that we believe will attract private sector participation and risk taking in the Armenian rail sector. We note, however, that even with the potential for diverting traffic from Georgia port routings, AR would remain a rather small carrier overall—less than nine million tons of rail traffic and less than half the size of Georgian Railway. To the extent that AR’s capital structure remains based pre- independence volumes of four times those levels, cost reduction reforms will still be required.

PASSENGER TRAFFIC Armenian Railways passenger traffic has been in sharp decline, as poor equipment, increasing automobile ownership and cheap bus transport have decreased ridership. 20 As the chart below shows, passenger volume has been nearly cut in half since 2002. This is a positive result for the railway, as passenger fares cover only a small portion of Armenian Railways costs.

The outlook for future ridership is extremely cloudy as it will depend on the Government’s willingness to subsidize fares and, more importantly, to acquire new passenger rolling stock. The current stock of EMU21 equipment is essentially life-expired. Passenger services currently operate at a loss, and continued operation would require a subsidy or require the Government to force a restructured Armenian Railways to cross-subsidize passenger services from freight revenues. A financially viable restructuring is not possible without direct subsidy of passenger services. In short, there is no sound economic basis on which to predict future passenger volumes aside from a discontinuance of the service under conditions of no subsidies. For the purposes of this Final Report, three traffic projections have been prepared. The low forecast assumes that passenger services continue declining as equipment becomes life expired and the economy continues to improve. This forecast would assume that some level of essential services mandated by Government (e.g., winter services required by road conditions) is maintained.

The mid-level forecast assumes, for analytical purposes, that passenger traffic remains constant at 2005 levels. In this case, equipment is projected to be replaced as it reaches the end of its useful life.

In the high forecast, a four percent annual increase in volume is projected to be made possible by renewed equipment and increases in other services. Even the high-level forecast would only bring passenger traffic to the 2000 level by 2020 and would be a minor component of Armenian Railways business (but a significant financial drain, depending on how replacement equipment is funded). Development of summer excursion services (e.g. to Lake Sevan and to Georgian Black Sea vacation points) or subsidized commuter services could bring volumes above this level, but quantification based on economic factors is not possible. The chart below shows all three traffic projections. In the financial analysis, the flat or mid-level forecast is used to estimate the financial impact of continued passenger services.

20 The number of passengers hauled in 2005 (shown in the chart) was 57% of that in 2002; 2005 passenger kilometers were 56% of 2002. 21 Electric-Multiple-Unit, electric passenger trains using self-propelled cars with trailer cars coupled together in multiples.

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Armenian Railway Passenger-Kilometers 55,000

50,000 High Flat Low s 45,000 r e t e

m 40,000 o l i K - r 35,000 e g n e

s 30,000 s a P

d

n 25,000 a s u

o 20,000 h T

15,000

10,000

5,000

0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

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4: Railway Restructuring Analysis

rmenian Railway freight traffic is expected to grow about 50% (or to grow by 1.5 times) over the next fifteen years. In the optimistic case, freight traffic is projected to grow by A80% (or by 1.8 times). Even with significant growth, railway freight traffic is not expected to exceed 4.7 million tons and to generate less than 1 billion gross-ton-kilometers, about 20% (one-fifth) of the 1990 level (see the chart below) s r e t e m o

Projected Armenian Railway Traffic l i

6.0 0.50 K

r e g n

0.45 e Freight - Likely s s a

Freight - High P

5.0

0.40 n Freight - Low o i l l Pax - Likely i B Pax - Flat 0.35 4.0 Pax - Recommended 0.30 Forecast

3.0 0.25

0.20

2.0 0.15 B i l l i o

n 0.10

G 1.0 r o s

s 0.05

T o n n

e 0.0 0.00

K

i 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 l o m e t Givene AMD 55 billion in deferred capital investment (US$122 million) and an annual renewal r costs of nearly AMD 4 billion (US$ 8.9 million), as discussed in the last chapter, it is clear that private sector investors are needed or the entire burden of refinancing the railway will fall on the Government of Armenia. This chapter explores the dimensions of this financial problem in more detail and then examines how the railway might be restructured to maximize the role of the private sector and minimize the cost of railway operations to the government and economy of Armenia. Finally, a restructuring option is recommended and described.

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Armenian Railway’s Future Without Restructuring We analyzed the financial future of Armenian Railway in the event it is not restructured. We assumed the Most-Likely forecast with no border openings as a relevant base-line to evaluate whether AR could continue to survive on its present course.

In this case, we assumed that passenger services were continued at the present (2005) level; that new passenger and freight rolling stock was acquired as existing equipment reached the end of its useful life (and that the railway received estimated scrap value for old equipment as it was retired); and that deferred investment was reduced substantially (but not eliminated entirely) over the next five years. In addition, we assumed that asset renewals take place as scheduled and that the railway network remains about the same size as it is now. Tariff levels were assumed to remain constant as were all prices, at 2005 levels. The overall financial results are summarized in the charts below.22

In summary, the analysis shows that the railway does not have sufficient earnings to support its investment needs and that substantial government subsidies will be required should the railway continue as presently constituted. The chart below shows projected revenue, expenses, net

AR Base, No Change Expenses, Revenue, Investment, Net Operating Income, EBITDA 20,000 Investments Net Operating Income 18,000 Total Revenue Total Expenses EBITDA 16,000

14,000

12,000

10,000

8,000

6,000

4,000 M i l l i

o 2,000 n

D r a 0 m s

( c

o (2,000) n s t a

n (4,000) t )

(6,000) 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 operating income, investments, and EBITDA (earnings before interest, taxes, depreciation, and amortization – a measure of cash generated by business operations).

As AR replaces its aging asset base, depreciation charges increase, driving net railway operating income negative. Investment costs are significant and continue at a relatively high level throughout the period. Investments in the first few years include catching up on deferred renewals. They also include investments for new rolling stock to replace equipment that reaches

22 All figures are in constant 2005 drams and US$.

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 4 - 2 Armenian Railway Restructuring Project: Final Report Railway Restructuring Analysis the end of its useful life (as described in Chapter 2), as well as equipment for growth in railway traffic.

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On a cash basis (that is, ignoring depreciation charges), the railway generates positive cash flow from operations (shown in the blue line above), but investment needs overwhelm cash generation. Over the 15-year period, railway employment would increase from about 4,700 staff recorded in 2005 to about 5,000. Changes in employment that might arise from transferring some

AR Base, No Change Investment Program 20,000 Administration Station Operations 18,000 Signals & Communications Wagon Depot Locomotive Depots 16,000 Track & Structures Electrical 14,000

12,000 s m a r D 10,000 n o i l l i M 8,000

6,000

4,000

2,000

0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 railway staff (for example, the 350 member Security Unit) to Armenia’s military or other units of government would improve the railway’s financial picture somewhat but would not change the

AR Base, No Change Cumulative Subsidy Required 150,000

140,000

130,000

120,000

110,000

100,000

90,000

80,000

70,000 M

i 60,000 l l i o n

50,000 D r a m

s 40,000

30,000

20,000

10,000

0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 total cost to government (since it would continue paying these salaries and expenses anyway, just not from the railway’s accounts).

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Cash requirements grow continuously over the period, as shown in the Subsidy Required chart above, driven by investments of about AMD 167 billion (about US$ 370 million). Over the period, AR will require a cash infusion of some AMD 135 billion (US$300 million). Rather than directly subsidize the railway, the government could lend it the cash it needs. The railway would be unable to pay the interest and principal on any such loans and would have to book that amount as debt, too. The result would be a spiraling debt from which the railway could never recover. Eventually, the Government would have to consider the loans an equity investment in the rail system and pay any financing costs itself.

To consider making no changes in AR feasible, one must assume that the Government of Armenia would provide a substantial direct subsidy on a sustainable basis over the next 15 years. The railway will not be in a position to pay debt service and as a result would be unable to find independent financing. Any railway financing would have to have a sovereign guarantee and eventually the Government would become responsible for interest and debt repayments.

It is unlikely that the Armenian Government can sustain the level of subsidy needed to fund the railway as presently constituted, renew and replace its assets, and equip it to service the most- likely traffic forecast. Even an Armenian Government commitment to subsidize all passenger costs23 would not be sufficient—the railway would still need AMD 90 billion (US$ 200) million more than it can earn.

23 Passenger rolling stock replacement, renewal of stations, and other passenger related investment requirements total about AMD 30 billion (about US$ 66 million) over the period while operating cost subsidy would amount to another AMD 15 billion. Maintaining passenger services at current levels would cost government about AMD 46 billion over the 15 year period (about US$ 100 million).

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Armenian Railway Restructuring Project: Final Report Railway Restructuring Analysis

ARC Financial Analysis Armenian Railway Base Case, No Change to Current Operating Practices Amounts in millions of 2005 drams

Actual Projected Income Statement 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Revenue Freight 8,531 7,558 7,755 7,956 8,163 8,376 8,595 8,819 9,050 9,288 9,532 9,783 10,041 10,306 10,578 10,859 11,147 Wagon Rental 257 289 308 318 329 341 352 365 377 390 404 418 432 447 463 479 495 Equipment Leasing 29 29 29 29 29 29 29 29 29 29 29 29 29 29 29 29 29 Other Freight Revenue (Station Services) 155 150 154 158 162 166 171 176 180 185 190 196 201 207 212 218 224 Passenger 149 134 134 134 134 134 134 134 134 134 134 134 134 134 134 134 134 Passenger Subsidy 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Scrap Sales and Other Operating Income 1,450 304 278 381 411 519 285 329 312 292 292 202 217 123 194 126 81 Total Revenue 10,571 8,464 8,657 8,976 9,229 9,564 9,566 9,851 10,082 10,318 10,581 10,761 11,054 11,245 11,610 11,844 12,110

Operating Expenses By Department Administration 1,775 1,671 1,677 1,678 1,926 1,925 1,676 1,680 1,675 1,678 1,679 1,683 1,684 1,691 1,687 1,689 1,693 Track & Structures 1,267 1,532 1,819 2,053 2,276 2,489 2,680 2,804 2,839 2,846 2,835 2,825 2,817 2,810 2,803 2,798 2,794 Electrical 643 700 759 863 1,141 1,363 1,488 1,631 1,651 1,563 1,492 1,436 1,392 1,357 1,329 1,306 1,257 Signals & Communications 481 520 600 772 969 1,124 1,249 1,348 1,370 1,391 1,407 1,421 1,432 1,441 1,449 1,456 1,461 Station Operations 3,125 2,013 2,131 2,176 2,232 2,284 2,336 2,388 2,435 2,482 2,530 2,578 2,627 2,677 2,727 2,777 2,829 Wagon Depot 555 570 763 843 992 1,141 1,249 1,447 1,527 1,670 1,858 2,051 2,155 2,338 2,595 2,660 2,771 Locomotive Depots 1,175 1,431 1,740 2,043 2,259 2,422 2,494 3,035 3,420 3,719 3,750 3,783 3,773 4,138 4,211 4,207 4,221 Total Expenses 9,021 8,437 9,490 10,430 11,795 12,747 13,172 14,333 14,918 15,349 15,551 15,777 15,881 16,451 16,800 16,894 17,026

Operating Expenses By Cause Office Expenses 1,298 1,131 1,126 1,129 1,133 1,133 1,131 1,130 1,126 1,130 1,132 1,134 1,136 1,138 1,141 1,144 1,145 Salary and Benefits 2,562 3,089 3,199 3,243 3,269 3,261 3,211 3,223 3,123 3,137 3,147 3,168 3,182 3,200 3,218 3,236 3,214 Depreciation 879 1,084 1,749 2,574 3,856 4,779 5,228 6,334 6,999 7,349 7,485 7,632 7,662 8,154 8,419 8,439 8,530 Electricity and Fuel 1,446 1,357 1,577 1,620 1,643 1,664 1,668 1,689 1,688 1,726 1,755 1,787 1,818 1,850 1,884 1,918 1,952 Materials 1,522 1,621 1,681 1,703 1,731 1,744 1,765 1,784 1,807 1,830 1,850 1,872 1,894 1,918 1,943 1,958 1,982 Other Expenses (Car Rental, Prop Tax) 1,313 155 158 160 163 166 169 172 175 178 181 185 188 192 195 199 203 Total 9,020 8,437 9,490 10,430 11,795 12,747 13,172 14,333 14,918 15,349 15,551 15,777 15,881 16,451 16,800 16,894 17,026

Net Operating Income 1,551 27 (833) (1,454) (2,566) (3,183) (3,606) (4,482) (4,836) (5,032) (4,970) (5,017) (4,827) (5,206) (5,191) (5,050) (4,916) EBITDA 2,429 1,111 916 1,120 1,290 1,596 1,622 1,852 2,163 2,317 2,515 2,615 2,835 2,947 3,229 3,389 3,614

Investment Program Summary 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Administration 5 5 255 255 5 5 5 5 5 5 5 5 5 5 5 Track & Structures 5,132 5,233 5,233 5,183 4,116 2,083 1,270 1,270 1,270 1,270 1,270 1,270 1,270 1,270 1,270 Electrical 160 1,055 1,913 1,909 1,413 1,413 509 513 509 513 513 513 513 509 509 Signals & Communications 550 1,100 1,400 1,400 1,400 1,400 1,125 1,125 1,125 1,125 1,125 1,125 1,125 1,125 1,125 Station Operations 300 400 505 505 500 500 400 400 400 400 400 400 400 400 400 Wagon Depot 1,032 1,455 1,965 2,187 2,187 3,473 1,423 2,274 3,396 3,396 3,291 4,556 5,941 1,878 2,987 Locomotive Depots 1,330 4,349 4,432 2,441 835 9,203 7,536 6,133 733 812 1,334 8,921 2,171 835 835 Total Investments 8,507 13,597 15,703 13,880 10,456 18,077 12,267 11,720 7,437 7,521 7,938 16,790 11,425 6,022 7,132

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Selling AR Rolling Stock It has been suggested that AR could sell its current freight wagon fleet to shippers and use those funds to invest in the railway. We considered this proposal and find that it is insufficient to fund the capital needs of the railway by a large margin.

We assumed that the railway could sell its current fleet of freight wagons (say 2,000 wagons that may have some useful life) at an optimistic average price of AMD 6.7 million (about US$15,000 per wagon). This would provide some AMD 13.4 billion (US$ 30 million) for other investments. It would also reduce future capital needs since shippers would buy new wagons and pay for capital repairs to them. New and replacement freight wagons are estimated to cost AMD 27 billion drams (about US$60 million) over the 15 year period.

However, off-setting these gains would be some decreases in revenue. AR revenue would decline since shippers providing private equipment receive a discount from the traditional tariff to compensate them for the capital costs associated with wagon ownership. Such discounts typically average around 15%. In addition, AR would not earn rental charges on AR wagons when they are on other railways. Over the 15 year period, we estimate that AR revenue would be some AMD 19 billion lower (or about US$ 42 million). Summarizing the cash impacts from the sale of AR wagons:

Improvement (+/-) Item AMD (billion) US$ (million) Revenue from Sale +13.4 +30 Investment Reduction +27.0 +60 Revenue Reduction -13.0 -29 Wagon Rental Reduction -6.0 -13 Net Change +21.0 +48

While AMD 21 billion is a significant reduction in cash needs, AR cash needs are still an overwhelming AMD 112 billion (about US$ 248 million) over the period. This mode of restructuring is infeasible even if, in addition to selling freight rolling stock, the government fully subsidized the cash costs of passenger services. The railway freight business would not have sufficient income to finance its cash needs and would still require a subsidy some AMD 67 billion (US$148 million). The sale of AR equipment fleet does not, by itself, represent a significant restructuring opportunity.

ARMENIAN RESTRUCTURING OPTIONS Restructuring the Armenian Railway must focus on several different problems:

• Reducing operating costs to make the railway more profitable • Shrinking the railway asset base to reduce the need for asset replacements and renewals • Providing a structure that encourages private sector investment

Clearly, it has been possible for AR to reduce its operating costs and asset base for many years now. In fact, many consultant’s reports, development bank missions, and earlier studies have

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 4 - 6 Armenian Railway Restructuring Project: Final Report Railway Restructuring Analysis focused on these topics. Some reforms have been achieved—many health, educational, and other non-core activities have been shed since AR separated from the Soviet Union’s MPS. But, AR’s physical condition has not improved over time, rather it has deteriorated and no substantial progress has been made in reducing capital or operating cost structures. The Armenian Railway must evolve from a large national railway organization to become a much smaller, less expensive short-line railway. It is our conclusion that structural change is needed to ensure that all three problem areas are addressed.

In considering how to restructure AR and attract private sector investment, the restructuring program had to address a significant financial problem: the enterprise generated net income of less than AMD 500 million (less than US$1 million) per year in recent years but has projected capital needs of about AMD 11 billion a year (US$25 million) over the next 15 years. The railway has significant road transport competition and limited options for generating additional traffic or revenue. We recommend that the railway pursue an operational restructuring program aimed at reducing costs and eliminating unneeded assets. In addition, we also recommend a new marketing program aimed at understanding railway customer service requirements in the short and long term and developing a means to satisfy those requirements as closely as possible. Both programs will be part of any feasible restructuring effort. AR should start these efforts now by implementing a line of business organization structure, improving its cost accounting systems, and starting a cost reduction effort.

AR Commercial, Operational, and Organizational Restructuring Armenian Railway has a very high cost structure. Its high cost structure keeps employment high, maintains expensive passenger services and supports an infrastructure that was built to a heavier standard than is now necessary. The following cost reduction and organizational changes are considered feasible and would likely be pursued by any railway operating commercially in the private sector.

Organizational Restructuring Following on the reforms recommended in the cost accounting section, the railway should be organized into three management units: Infrastructure, Passenger, and Freight. Each unit would be operated as a profit center (though the infrastructure unit can be managed as a utility, with an approved return on investment to support financing infrastructure investment and renewals). Modifications to AR’s existing cost accounting system will permit the development of income statements and detailed financial reporting for each unit.

The Infrastructure Unit would include all elements of the infrastructure including electric traction, track, bridge and structure units, building repairs and maintenance units, signaling and communications, and dispatching activities. The Passenger Unit would include passenger stations, station staffing, Electric Multiple Unit (EMU) equipment and international passenger train equipment, and may include for a time, a depot in Yerevan where EMU and passenger coach maintenance, repair, and cleaning can be conducted. The Freight Unit would include freight stations, loading and unloading functions, marshalling functions, and staff related to shunting, locomotive drivers and assistants, billing and tariff functions, as well as supervisory personnel. These recommended units are established to facilitate meaningful accounting separation compatible with EU rules and to contribute to better management decision making.

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They would not be independent companies and would be subject to management direction by a single management group.

Before the details of the restructuring structure are finalized, AR should be organized along these lines and an internal “shadow” infrastructure tariff, covering the maintenance and investment needs for infrastructure should be developed and put in place. This will provide revenue to the Infrastructure Unit without the kind of debate and discussion that accompanied the implementation of a similar structure in the late 1990s.

The Freight Unit would be responsible for developing tariff charges and marketing its services to freight shippers in Armenia. Freight tariffs would cover not only the infrastructure tariff but also operating costs, the cost of the equipment used in freight services as well as any financing costs associated with new or replacement rolling stock and provide a profit margin for freight services.

It is unlikely that the Passenger Unit will be able to pay the internal infrastructure access charge – we estimate the annual passenger unit infrastructure charge at about AMD 453 million (about US$1 million) while Passenger Unit revenue was only about AMD 135 million (about US$ 0.3 million) in 2005 and has been rapidly declining. The infrastructure charge does not include the direct costs of operating existing services including electricity, operating staff, or station costs. Passenger losses are unsustainable to a commercially operated enterprise and some further substantial restructuring in passenger services and/or a subsidy payment either from national or local governmental agencies will be required (discussed below).

In addition to these units, a headquarters function should include necessary support staff including legal support, centralized purchasing, human resources, and a centralized finance and accounting unit that would provide accounting services to the business units as well as planning and economic analysis capabilities. An asset management and disposal unit may be necessary as part of the headquarters function. Financial audit and safety groups, substantially reduced in size from current levels, would report directly to the concessionaire’s board.

Most assets directly associated with the various business units should be transferred to them and a branch structure established for each business unit. Land and similar non-moveable assets would be held by an AR unit which would be responsible for managing or disposing of assets not included in the business units.

As these structures are put in place, regulatory and asset management units should be established at MoTC to handle employees, assets that are not part of the railway restructuring plan, and any contracting for railway transport services required by the government. Chapter 7 describes the human resources issues related to the substantial changes in rail sector employment and these structures should also be formulated and put into place.

Passenger Services: Armenian Railways passenger services include services provided by EMUs and now several international passenger trains using locomotive hauled coaches. EMU services are typically local services provided, for example, to and from Yerevan and Gyumri. Our analysis shows

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 4 - 8 Armenian Railway Restructuring Project: Final Report Railway Restructuring Analysis that the passenger business generated annual revenue of some AMD 135 million24 in 2005 but had direct operating costs of about AMD 500 million and allocated operating costs of over AMD 1,000 million. As discussed earlier, continuing passenger services at the current level will require investments of some AMD 37,000 million (US$ 82 million) over the period. Such services are not and cannot be commercially justified.

Our recommendation is that rail passenger services be stopped as quickly as feasible. Services could be phased out as the equipment becomes life expired. Neither AR nor any successor operator can continue to subsidize passenger services when its own cash needs are so great.

We recognize that rail passenger services can be an important public service and that the Armenian Government may wish to continue passenger services in some form. We recommend that MoTC conduct a study of the cost of alternative passenger services and evaluate alternative options including bus, mini-bus, and alternative “on-demand” road transport services as a potential substitute to rail based passenger services.

Should the government decide to continue some or all rail passenger services, it should directly purchase any necessary replacement rolling stock and contract with the operator for what passenger services it requires from the railway. The contract would specify services to be purchased, quality standards, and negotiate a price based on operating costs and services. A separate study may be required to determine how to treat major passenger related facilities (for example, Yerevan Station, passenger related workshops and depots, etc.). Our recommendation is that unique passenger facilities be transferred to a government unit for maintenance and renewal (which would be contracted from the railway), and for eventual disposal, or re- development.

A commercially oriented AR or its successor is likely to consider providing passenger services on a contract basis to the government as a viable and potentially valuable business unit. Any contract to operate passenger services over the network would be assumed to be a for-profit service, and would spread infrastructure costs over a somewhat larger traffic base.

Equipment Depot and Workshops The railway currently maintains five depots for locomotive, wagon, and passenger equipment repairs. The number of depots should be reduced to the wagon and locomotive depots at Gyumri, the most capable depots on the AR system. A single passenger equipment depot could be maintained in Yerevan until final decisions are made about passenger services. Eventually, passenger coach and EMU work could be done at the Gyumri wagon or locomotive depot on a contract basis for the Passenger Unit. In the restructuring analysis, we have assumed that any necessary parts and equipment would be transferred to the Gyumri facilities and that the remaining Yerevan land and buildings are transferred to the MoTC asset management unit for disposal or re-development.

Stations and Train Control Facilities Railway traffic on AR has declined precipitously over the past 15 years. Many factories that received and shipped goods by rail in the past have been closed; most are unlikely to ever open

24 Passenger patronage and revenue have been declining steadily in recent years. Ridership has declined by about 45% since 2002.

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 4 - 9 Armenian Railway Restructuring Project: Final Report Railway Restructuring Analysis again. Some railway lines have not been operated for a number of years because of landslides or border closures. The chart below shows the AR stations with rail freight traffic in 2004.

2004 Wagon Loading & Unloading by Station Shahali Dilijan Pambak Nalband Sovetakan Kober Arabkir Unloaded Tsakhkounk Loaded Artik Karakert Vardenis Spandaryan Akhin Sanahin Tumanyan Khaltakhchi Airyum Dzagur Aragats Armavir Ani Spitak Akhtala Artashat Echmiadzin Bayandour Araks Sevan Kanaker Charentsavan Vanadzor Dalarik Alaverdi Abovyan Gumri Masis Shorzha Hrazdan Karmir Blur Yerevan Zod Ararat

- 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000

The chart shows that the top 5 stations were responsible for more than 70% of AR’s freight traffic in 2004 and the top 25 represented 98% of all traffic. There was freight traffic at only 43 of AR’s 70 stations in 2004. As a part of the operational restructuring, all railway stations should be reviewed to determine which can and should be closed. Stations with no traffic should be closed and station staffing removed, except where necessary for train control purposes.

Two major programs are recommended to help reduce the number of station facilities required. The first is a customer service center to do billing and handle paperwork and cash transactions associated with freight services. A study should be conducted to determine the best location for the customer service station and the facilities and staff required to operate it.

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As the customer service center is established, customer activities (ordering and tracing wagons, receiving rate quotes, negotiating tariffs, paying freight bills) would be transferred to the center for most customer services. AR has a modern communications system that can be used to help smaller customers connect with the customer service center. We estimate that an investment of about AMD 2,255 million (about US$ 5 million) will be required to establish the customer service center, including the acquisition of computer systems and staff training.

The second program is for radio-based control of train operations. Many existing stations serve as train control facilities, where local station operating staff control access to sidings for train meets and passes, and for station related freight and passenger activity. We recommend a radio dispatching system to replace local operation of station facilities except in major terminal and freight facilities. Radio based train control systems are used all over the world for light density train operations (up to as many as 15 trains per day in each direction).25 AR does not have continuous train-radio coverage over all of its lines (particularly in the mountainous areas). Radio coverage can be improved by locating more repeater stations in areas of poor coverage. With relatively low density railways, continuous coverage is not required. The system has proven safe and inexpensive. We estimate that an investment of AMD 2,255 million (about US$ 5 million) will be required for the additional radio facilities and control system software and hardware. The dispatch system would be operated from a single central location, probably Yerevan. In addition, infrastructure work crews would be equipped with train radio to permit direct contact between work crews and trains. Train density on some lines is low enough that radio contact and traditional “dark” railway operating techniques will provide sufficient protection for both trains and crews.

Railway Lines and Infrastructure As a part of the review of stations, a review of railway lines and station tracks should be conducted and little used and unnecessary lines and facilities closed. Infrastructure assets on closed lines, including rail, sleepers, electrical overhead structures, sub-stations, electric switches, signaling equipment and other salvageable assets should be removed and used to maintain lines that will remain in service. This can substantially reduce materials costs for track maintenance purposes. Materials that will not be re-used because they are worn out or of the wrong size (for example, light rail that might be in unnecessary station tracks) should be sold for scrap. In many places, the railway might ask for bids for the removal and scrapping of unnecessary facilities (contractors would pay the railway for the rights to the materials). Further, bridge structures, such as those on the line between Dilijan and Idjevan, should be inspected to determine if any components or spans could be used to replace bridge structures on the lines that will remain open.

MoTC would retain title, ownership and control of the right-of-way land on closed lines in the event that the lines might be rebuilt and opened again in the future.26

The railway should conduct an analysis of train operations to evaluate engineering speed limits. It is likely that main line speeds of, say, 40 kph are sufficient for commercial freight services.27

25 CANAC and GE-Transportation Systems are both major suppliers of such control systems. They are used in many light density rail systems in North America, Australia, and South America. 26 Some lines have been in-operable for a number of years. While some of these lines may be valuable in the future, most will require substantial rehabilitation should they ever be put back into service. The cost of replacing materials, even bridge spans, which have been removed to maintain open lines would be a minor part of such rebuilding costs.

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Reducing the design operating speed can reduce maintenance and renewal costs substantially. We have assumed that an operating speed of 40 kph is sufficient for freight services. Nearly all switches on AR’s main line are electrically operated. The radio dispatching system will eliminate many (though not all) local operators and require either central (or regional) control of main line switches, implementation of a local switch control scheme, or elimination of electric switches at intermediate points. This might require that the locomotive assistant mechanic operate switches when leaving the main line at intermediate control locations and will slow operating speeds somewhat. Given the low densities on the railway, in our view the impact will be insignificant but the cost savings for manual versus electric switches and closure of many operating control stations will be large.

Electric traction systems may be shut down on light density lines and the components used to maintain and improve traction system components on other parts of the line. For the most part, lines with less than a few trains a day could be converted to diesel-electric locomotive operation, especially if the overhead catenary system or local sub-stations require replacement or substantial rehabilitation; or when electric locomotives are no longer available. We expect that the main-line, between the Georgia border and Yerevan would be maintained as an electric operation to preserve compatibility with the Georgian Railway system and take advantage of low cost of electricity.

As electric locomotives are retired, a thorough financial analysis of the cost differences between electric operation and modern diesel-electric locomotive operation should be conducted. Modern diesel-electric locomotives are actually more productive than rebuilt VL-8 and VL-10 3 kV DC electric locomotives and may be substantially less expensive to acquire. New electric locomotives are quite expensive but perform much better than existing technology. We assume that a commercial operator would conduct such an analysis and balance the cost of new or rebuilt locomotives and electric or diesel against increased cost for train energy and the reduced costs of maintaining new locomotives. Our analysis shows little difference between partial diesel operations (where light density lines are converted to diesel- electric operation) and continuing full electric operations. However, the cost of electricity per GTK is about one third the cost of diesel fuel so a full analysis would be required.28 The ultimate decision will be determined by the condition of overhead wire, substations, and electric locomotives, and the availability and performance characteristics of second hand diesel and electric locomotives.

Our recommendation is that a commercial operator be permitted to determine whether, where, and when to convert to diesel services. Should a commercial operator decide to convert some lines to diesel services, the operator should have full use of all materials released (for use in maintaining other parts of the electrical system, or for scrap sales), but that fixed facilities, including the buildings and land would be returned to the government for disposal. A commercial operator may wish to reuse main transformers, or return them to the government

27 Most AR lines are designated as 60 to 80 kph lines for freight services, though few are currently operated at these speeds, in part because of track conditions. 28 Our analysis shows the cost of energy for rail operations will be in the range of about 0.46 drams per GTK while the cost of diesel fuel would be in the range of 1.56 drams per GTK.

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(especially any containing hazardous materials29). No resale or scrap value has been assumed for substation buildings or facilities.

Finally, a commercial rail operator would likely make more use of contractors for many types of infrastructure work. Using contractors is a way to shift capital investment burdens for maintenance and other equipment to private sector operators. Similarly, contracting many types of work, including minor building repairs, civil works, landscaping (brush cutting, vegetation control) as well as for major track work can reduce costs substantially as most private sector contractors have other clients for such work and can achieve better employee and supervisory staff utilization. Rather than purchasing major new maintenance machinery, a commercial railway operator would investigate hiring contractors for such work. Another option is to hire equipment and/or maintenance services from neighboring railways to perform production track and structural repair activities. Such practices will help develop local markets for contract services and reduce capital needs of the railway.

Locomotives AR appears to have some 29 electric locomotives on its books currently but needs only about 15 for daily use (of the 15, only about 8 are required in service). The locomotive fleet should be surveyed and sections that are salvageable for rebuild set aside; those not salvageable should be scrapped. Before scrapping, useful components should be removed and salvaged.

There is a significant shortage of 3-kV DC locomotives in the region. A commercial railway operator would investigate the possibility of leasing currently unneeded and/or inoperable locomotives to other railways in the region. Lease agreements which require the leasing railway to overhaul or put the locomotive back into serviceable condition and return it in such condition after the lease term are common. Where such arrangements are not possible, other railways in the region may still wish to purchase existing in-operable locomotives. Such arrangements are far better than letting unused locomotives sit at depots and lose value every day.

As additional or replacement locomotive units are required, a commercial light density railway operator will seek to purchase or lease rebuilt electric locomotives where possible, rather than purchase new units. The duty cycle of most light density railway locomotives is not demanding and rebuilt or second-hand locomotives should provide sufficient utility. To reduce capital costs, we have assumed that existing units are rebuilt where possible and that second hand units are acquired when additional units are needed.30 A commercial operator is likely to consider increasing its use of existing diesel-electric shunting locomotives. It appears that there are sufficient numbers of diesel-electric shunting units to expand their for local delivery services.

Wagons As with locomotives, AR appears to have many more wagons on its books than it needs,31 the wagon fleet should be surveyed and unsalvageable wagons should be scrapped as quickly as possible after removing usable items (wheels, bogie frames, air brakes, etc). Wagons that might

29 Some transformers contain PCBs used as a coolant and insulator. Poly-chlorinated-bi-phenols are a hazardous material that can be difficult to dispose of. 30 Rebuilt or new locomotives should have modern traction control systems which provide higher tractive-effort (larger trains, fewer locomotives) and greater reliability. 31 AR apparently has some 3,800 wagons on its books, though we estimate that only some 2,000 are able to be used.

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 4 - 13 Armenian Railway Restructuring Project: Final Report Railway Restructuring Analysis usefully be rebuilt should be identified and set aside. According to our estimates, AR has more wagons of some types than it needs and insufficient wagons of other types. The railway should investigate swap or exchange arrangements with neighboring railways to acquire the types it needs, and should begin negotiating different arrangements with customers relative to wagon ownership and usage. For example, wagons requiring capital repairs or wagon types in excess of the railways current and projected needs can be sold or leased to shippers. In such cases, the shipper would receive a tariff discount to acquire or lease wagons, or finance the overhaul and repair of existing wagons. Such arrangements are another way to finance rolling stock and will help reduce capital requirements.

A commercial operator will investigate many options to reduce capital costs and might lease wagons from existing leasing companies in Russia and Ukraine, or encourage shippers to do so. In our financial analysis, we have assumed that used equipment is acquired for wagon additions for traffic growth, or to replace wagons that are retired at the end of their useful life (the established CIS interchange life).

Information Systems The number of railway staff compiling accounting and statistical data by hand is remarkable. A commercial operator will acquire personal computers and the operation of a wide area LAN across its network as a high priority investment item. The increased use of computers can reduce clerical staffing requirements substantially by increasing productivity. An investment of about AMD 2,255 million (or US$ 5 million) for new computer systems for customer service centers and for improved billing and cost accounting systems are included in the investment program.

Fire and Rescue Trains AR currently has three fire and rescue trains, used to pick up wrecks and perform other emergency maintenance activities, each with permanent staffing assigned. We have assumed that the number of fire trains would be reduced to one, stationed at Gyumri. Staffing for this train should be temporary, using workers from the depot for emergency services as needed. While a commercial operator may realize some benefit from scrap sales of such equipment, we have not taken such scrap values into consideration in our financial analysis.

Private Operators It appears that there is no prohibition on the development of Russian style rail operators. The railway should conduct negotiations with its major domestic shippers to establish their interest in becoming Russian style operators (some of Armenia’s freight forwarders are close to this now). This could entail the sale of excess AR rolling stock to customers who were interested. The customers would be responsible for rolling stock renewal and maintenance and would benefit from a secure and well maintained fleet that serves their needs. The AR freight unit would develop discounted transport tariffs or prices for such customers to reflect their acquisition of and responsibility for rolling stock. The railway would continue to provide such services as locomotives, locomotive drivers and assistants, power, fuel, inspection and incidental repair, tracing, and related activities under a negotiated contract arrangement. This is similar to the sale or lease of wagons discussed earlier but goes further to a negotiated contract for services.

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We have not assumed any such sales in our financial evaluations but the sale of some rolling stock to freight shippers is one way that a commercial railway would reduce its investment needs. The outright sale of AR rolling stock is not sufficient to re-finance the railways’ investment needs, but such sales can be a part of a plan to reduce the capital requirements of the railway and improve service to customers. Nothing in the current or prospective railway or transport laws should prohibit such arrangements.

RECOMMENDED RESTRUCTURING OPTIONS In addition to our analysis of an un-restructured AR, we considered two restructuring options as discussed with the restructuring facilitation task force:

1. Full Concession of rail freight services as an integrated system – that is, operations and infrastructure. 2. Concessioning the operation of rail freight along with a management contract for the maintenance and renewal of the infrastructure.

In our analysis, we defined each concession as the transfer of ownership of designated assets to concessionaire with full property rights. This is in contrast to a practice in some international concessions where most property was transferred as a kind of lease—the assets were assumed to be returned at the end of the concession period. Since a concession is typically for 20 to 30 years (we recommend 30 in this case) and many of AR’s assets are already nearly life-expired, we see no economic value in requiring the return of assets at the end of the lease.32 Designated assets in this case include freight rolling stock, components, spare parts, hulks,33 and the contents of designated offices, buildings, and other facilities.

Full Concession

32 Should the concessionaire lose the renewal concession, concession terms will require the transfer of some assets (railway lines, rail, sleepers, ballast, structures, and materials stocks, for example); and allow for sale of rolling stock to the new concessionaire for market value. 33 Hulks refers to partially disassembled rolling stock, frames, inoperable wagons and locomotive sections and related components such as wheels, axles, bolsters and side-frames

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In the full concession option, track materials including ballast, rail, sleepers, fastenings, and all stores of such materials, signal and train control equipment, and electrification equipment would also transfer. Ownership of some assets would not transfer, but the use of the asset will. Land, tunnel bores, grading, and similar immovable facilities are such assets. The government of Armenia would continue to own and control those assets throughout the life of the concession; the concessionaire will have the right to use (and the responsibility to maintain) these assets for the life of the concession but could return them to the government at any time during the concession when they are no longer needed to provide railway services. No value has been assumed from the sale of railway land, buildings, or other immovable facilities.

Some assets, such as buildings are a special case. To provide the concessionaire with maximum flexibility, we recommend the transfer of ownership of operational buildings and most facilities (for example, sub-stations, workshops, fuel and sand storage systems, parts warehouses, communications systems). Non-operational buildings (such as passenger stations) and other major facilities (for example, bridges, retaining walls, slide shelters, fills and other civil engineering structures) would remain in government ownership with concessionaire use and rights designated and fully described in the concession contract. The government may elect to

Full Concession Summary

Transfer of designated assets including • All freight rolling stock, spare parts, hulks, • Depots and freight stations including contents of buildings and facilities including machinery • All track and materials above sub-grade including ballast, sleepers, and rail • Right-of-way materials including signs and signal posts, communications equipment, electrification facilities, sub-stations, main and auxiliary transformers

Agreement specifies: • Term of concession – length, fee structure and cost • Renewal conditions • Obligation to provide rail services • Lines to be operated and methods to change or modify lines operated • Any limitations on asset use (e.g., specific land, buildings, and facilities that must be returned) • Rights of third parties to access to infrastructure and methods to determine access price • Government investment plan (if any) • Passenger services necessary, if any, and fee structure to be paid • Method for resolving disputes with customers and government not to include non-operational lines in the concession (such as the line to Ijevan) but would then be responsible for continuing security and maintenance of these lines and facilities (such services would likely but not necessarily be contracted to the concessionaire). In our financial analysis of concessions, we have not assumed that the concession operator would benefit from the re-use of materials associated with closed lines, though we recommend that such re-use be permitted.

Operating Concession/Management Contract for Infrastructure In the operational concessioning with management contract for infrastructure, the government retains ownership of the assets and negotiates a contract with the concession operator covering infrastructure maintenance and renewal. In the option we analyzed, the Government of Armenia also finances infrastructure renewal and investments to the infrastructure. The management contract provides a management fee for managing and conducting the work. The

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 4 - 16 Armenian Railway Restructuring Project: Final Report Railway Restructuring Analysis concessionaire/management contractor would prepare budgets and negotiate with government for the extent of the investment and maintenance programs, including such issues as track standards to be met, speed limits, and other conditions that affect the cost of the infrastructure and the conduct of operations over it.

Operating Concession with Management Contract Summary

Transfer of designated assets including • All freight rolling stock, spare parts, hulks, • Depots, contents of buildings and facilities including machinery • Freight Station facilities, contents of buildings, material handling equipment

Concession Agreement specifies: • Term of concession – length, fee structure and cost • Renewal conditions • Obligation to provide rail services • Lines to be operated and methods to change or modify lines operated • Any limitations on asset use (e.g., specific land, buildings, and facilities that must be returned) • Rights of third parties to access to infrastructure and methods to determine access price • Government investment plan (if any) • Passenger services necessary, if any, and fee structure to be paid • Method for resolving disputes

Management Contract Specifies: • Rail network to be maintained • Standards to be achieved • Investment plan and schedule in detail • Management fees and pricing schedule • Access charge accounting methodology and audit requirements

In each concession option, the concession operator will publish a network statement and charge an access tariff that provides its infrastructure unit with the necessary funding to maintain and improve the infrastructure as needed or as negotiated with government. In either case, the government may wish to include some work in the concession agreement or management contract that is peripheral to train operations (such as maintaining facilities in lines that are not open to train operations). We recommend that the cost of these activities be kept separate from those involving open lines and their cost not included in track access charges. In our financial analysis, we did not consider any such “additional” work conducted under government contract. However, we did consider that the arms length relationship between government and contract manager would not be as efficient as the relationship within a vertically integrated concession operator. This inefficiency and the political trade-offs required by government would result in increased infrastructure maintenance and renewal costs.

In our concession analysis, we have assumed that passenger services are halted in 2007. Any services continuing beyond 2007 would be operated under contract by the concessionaire on a negotiated contract basis. Passenger services are not further considered in the financial analysis of the concession. As described in Chapter 5 on Regulatory and Legal Issues, we do not recommend any regulation of final freight prices for the concessionaire in either restructuring option.

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Concession Operator and Infrastructure Manager: It would be possible to separate the operating concession from the role of infrastructure manager. We do not recommend that separation. The concession operator has intimate and detailed understanding of its customers and business prospects. The concession operator has a better understanding of customer price and service sensitivities and will be in the best position to evaluate trade-offs between speed, railway freight pricing, and investment needs. Should the roles be separated, the infrastructure manager will have to conduct two sets of negotiations – one with the operator, and another with government. Management of the infrastructure to meet the needs of the railway operator will be more complicated and less efficient. An integrated concession operator/infrastructure manager will be better able to make and communicate those market based trade-offs than two parties separated by a contract.

In our view, an independent infrastructure manager, whose earnings are based on the size of infrastructure spending, would attempt to negotiate higher infrastructure spending levels with government, the result would be either higher government subsidy or higher access charges. Higher access charges will reduce the earning potential of the operating concessionaire and have the potential of reducing rail traffic. On the other hand, the concessionaire with a contract to manage the infrastructure, will work to make the trade-offs necessary to maximize returns from rail traffic. It will be easier for the concession operator to conclude that 40 kph infrastructure in a particular area is sufficient to provide service the market requires at a price it can afford. While an independent management contractor will be more interested in maintaining the line for 80 kph or some other speed because it fits the “standards” agreed with government and it costs more, resulting in higher earnings for the infrastructure manager.

In short, a vertically integrated railway operates more efficiently than a separated one. The concession agreement and management contract would require strict accounting standards and a regular audit of infrastructure costs to ensure that access charges to other operators are fair and equitable. Should the management contract include an element of government subsidy (that is, if all costs are not recovered from the freight operator) a management contract structure inherently provides incentives to be less efficient than an integrated concession.

Finally, given the size of the Armenian railway traffic base, we do not expect any other operators to arise – there just isn’t enough volume to make it profitable. In the most likely case where an independent operator may arise – for international traffic moving from Georgia to Turkey – the Armenian concession operator is likely to be delighted to have this additional traffic over its lines and will negotiate reasonable access arrangements and charges. A standard access charge arrangement (where infrastructure charges are based on both ton and train kilometers) has been used in the financial analysis. This is the form of access charge we would recommend for Armenian railway track access.

Financial Analysis Each concession option and several variations of each were analyzed using a financial model of the railway appropriate to the option analyzed. Common assumptions underlie the financial analysis and no assumptions are made relative to difference in management performance, alternative sources of revenue, or investments in other related business activities (for example, we do not assume that electric locomotives released in a conversion to diesel-electric operation would be rented to other regional rail systems, though a commercial operator would likely try

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 4 - 18 Armenian Railway Restructuring Project: Final Report Railway Restructuring Analysis to arrange such leases or rents). Further, we do not assume that freight wagons would be sold or leased to shippers in one case but not in another. Major assumptions are shown in the box below.

Using this financial analysis mechanism and common assumptions, the concession options can be compared and contrasted. In each case, we have assumed that the concessionaire would make a payment of US$10 million for the concession and pay 2% of freight revenue annually in a concession fee.34 As a means to compare the concessions, the financial model computes the internal rate of return on the cash flows for each concession. To provide a measure to compare

Financial Analysis Assumptions

• Concessions begin 1 January 2007 • Most Likely freight traffic forecast • No passenger services • Prices and exchange rates assumed constant at 2005 values unless otherwise specified • Fuel prices increase 30% from 2005 to 2006, constant thereafter • Concessionaire financing costs are 7% real for a 30 year term • Government financing costs are 5% real for a 30 year term • 25% tax rate • Infrastructure charge includes 10% profit margin on infrastructure costs; a 4% return on assets; and the access charge is split evenly between gross ton kilometers and train kilometers the concession options, the internal rate of return (IRR) on invested capital is computed for each option. Details of each option and the financial analyses are described below.

FULL INTERNATIONAL CONCESSION In this restructuring option, the entire AR system is concessioned as a single vertically integrated entity. To encourage long term investment in the infrastructure, the concession period would be for at least 30 years and the concession could be opened for renewal at 20 years for an additional 20 years (or a maximum of 40 years). At the end of the concession period, the rights to provide freight services would be re-concessioned in another international tendering process. The current operator would control the moveable assets it had purchased (locomotives, wagons, maintenance equipment, etc.) at the end of the concession.

34 These figures are assumptions to provide a benchmark for the financial analysis and comparisons between alternatives, not predictions of what a concessionaire will actually pay in a free and fair bid process..

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We have assumed that the concessionaire will pursue the cost and capital reduction program discussed above. The cost reduction program would be implemented by about 2010. In implementing that program, most freight stations would be closed, keeping only those where Full Concession Deal Structure

Concessionaire Obligations • Up-front payment of US$10 million (evaluated various lump sum payments) • Concession fee payments of 2% of freight revenue (evaluated various concession payments) • Normal business taxes on positive earnings after expenses and interest (25% assumed) • Publish network statement and auditable financial data for infrastructure costs • Operates freight and cargo services • Negotiate transport pricing with customers (free to provide combined rates, or charge for separate services as desired) • Provides drivers, operating services, infrastructure services on negotiated terms to other operators licensed by Ministry of transportation

Concession Terms • 30 years, renewable for another 20 years after the 20th year • Designated assets owned by concession, free and clear • Concession and government negotiate lines to operate and agree on designated assets • No passenger service assumed. Should passenger services be required, they are provided by operator under negotiated contract; government owns rolling stock • Concession agreement confers license to operate • Arbitration process for rate disputes, differences with government

Armenian Government Obligations: • Handles excess employee costs • Responsible for any environmental impacts from prior AR activities • Finances subsidy payments for passenger or infrastructure costs on non-viable railway lines

Ministry of Transport Obligations • Transport policy • Negotiate concession agreement • Can subsidize capital or operating costs to maintain some lines or services • Provide safety oversight • Can contract for additional infrastructure maintenance (e.g., Ijivan line) • Contracts with concession operator for any passenger services • Replaces passenger equipment if needed • Manage contracted services, excess property, concession agreement • Able to license other operators freight loading activity is the greatest. Most direct customer contact will be through the customer service center, which will handle all commercial transactions. Even at the largest stations, freight station personnel will serve as the customer’s interface. To reduce both capital and operating costs, depots are consolidated into wagon and locomotive depots in Gyumri. A new radio-controlled dispatching system is implemented, allowing the closure of operating control stations. More use is made of computer systems to reduce accounting and clerical staff.

We have not assumed any changes in railway pricing structures as a part of the option analysis, though we expect that there will be significant deviations from current domestic rail pricing structures. A commercial railway will introduce pricing changes and greater flexibility in railway pricing structures over time. We would expect the development of customer specific pricing that include typical station services, assigned wagon fleet, and other services. Similarly, international tariffs are likely to adjust to new, more commercial practices. The adjustment process will take longer, in part because there are multiple participants in the transactions and

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 4 - 20 Armenian Railway Restructuring Project: Final Report Railway Restructuring Analysis the transactions are more complex, but also because tariff changes must move through the CIS railway council process. Even so, international tariff structures appear to be fairly flexible and we expect significant pricing changes to evolve over time. The financial analysis for the options does not assume different pricing practices and is not the source of financial differences between options.

In the full concession option, we assumed that some light density lines would be closed and not included in the concession. Specifically, the following lines were assumed closed in 2008 and were not included in the concession after 2008:

• Lines already closed north of Dilijan • Portions of the line north of Hrazdan and branches where there are no freight customers • Southern Armenia (currently closed) • Gyumri to Maralik branch, east of the last customer • Armavir to Arshaluys, north from the main line to the last customer • Station, terminal and side tracks, including tracks at passenger facilities are reduced from more than 400 kilometers to about 200 kilometers

In the full concession, therefore, the railway has a total of 834 track kilometers (in the concession with management contract, we assumed all lines currently operated would be included, so the concession is a total of 1,139 kilometers). We did not assume that materials from these lines could be taken up and reused elsewhere.35 Our analysis assumes that passenger services are halted in 2007. After that, we assume that any further passenger services would be provided under a contract with the concession operator—though to be conservative, we did not assume any contracted passenger services beyond 2007.

As discussed previously, we assumed the concessionaire would overhaul locomotives and wagons where possible, and acquire second hand equipment for growth. The financial analysis does not assume any revenue from the sale or rental of excess wagons or locomotives to third parties. Equipment reaching the end of its interchange life (or 35 years for locomotives) was assumed to be sold for scrap. We assumed greater use of contractors, though we did not assume any significant cost savings from their use. The use of contractors eliminated the need to acquire some maintenance equipment. We assumed that the main line of the railway would be maintained for an operating speed of about 40 kph, reducing renewals costs by about 20%.

We considered an option that eliminated electrification on the line between Hrazdan and Zod. We thought that the cost of maintaining and renewing the electrical distribution system would be much more expensive than using diesel-electric locomotives. Second-hand rebuilt locomotive-units (for example, the GE re-powered TE10 locomotives used in Kazakhstan) require fewer locomotive sections in ownership, are more reliable, and are typically better than 80% available (as opposed to the approximate 50% availability of AR’s electric locomotive fleet). However, the price of electricity (which we estimate at about 0.45 drams per GTK) is much less than the apparent price of imported diesel fuel (we estimate diesel-fuel costs at about 1.6 drams per GTK, based on 400 dram per liter fuel price).

35 A condition survey of individual tracks was not in the scope of this project. Assuming no materials can be re-used is a conservative assumption. The concessionaire should be able to use such materials or receive scrap value for the materials.

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Even so, our financial analyses indicate that the cost of maintaining the electrical overhead for a few trains a day (depending on the gold traffic) is less than the cost of operating the line via a diesel-electric locomotive service, in part because the conversion requires acquisition of several diesel-electric locomotives at the time of the conversion. The decision as to when, or whether, to convert to diesel-electric operations will be driven by many factors—for example the cost of acquiring locomotives (either rebuilt diesel or electric units), the need to renew catenary and power sub-stations, and the price relationship between diesel-fuel and electricity. The decision will also be driven by the availability of financing capital—for example, the concessionaire may be able to lease diesel-electric locomotives on reasonable terms but may not be able to

Full Concession, No Passenger, All Electric finance electrification Expenses, Revenue, Investment and Net Operating Income 13,000 replacements. The Investments 12,000 Net Operating Income concessionaire should be able to Total Revenue 11,000 Total Expenses EBITDA make such trade-offs with little 10,000 interference. 9,000 ) t 8,000 n a t Financial Analysis s n 7,000 o c ( s

m 6,000

a Under the best circumstances, r D

n 5,000 o i

l the Armenian Railways freight l i M 4,000 operation is a marginally 3,000 profitable business with 2,000 significant continuing capital 1,000

0 needs. The cost reduction 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 (1,000) program provides significant long term reductions in cost which permit the railway to move into positive cash flow territory relatively quickly. In the Full Concession option (with full electrification), capital investments total AMD 74 billion (US$165 million) over the 15 year period. Maintenance and operating costs (including concession fees of 2% of revenues, and Full Concession, No Passenger, All Electric Freight Concession Investment Program depreciation charges) over the 9,000 Administration period total AMD 114 billion Station Operations 8,000 Signals & Communications (US$ 254 million). After an Wagon Depot Locomotive Depots initial investment of AMD 7,000 Track & Structures Electrical 4,510 million (US$ 10 million) 6,000 to purchase the concession, and s

m 5,000 providing working capital, we a r D

n assumed the concession o i l l

i 4,000 M operator would finance further 3,000 cash needs at 7% real interest rates over a 30 year period. The 2,000 resulting cash flows, 1,000 summarized in the chart above,

0 provide an internal rate of 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 return of 6% over the 15 year period. The concessionaire ends the 15 year period with debt of AMD 13 billion (US$ 29 million), a debt to equity ratio of 0.38, a renewed infrastructure, locomotive and wagon fleet, and new information systems for accounting and operations controls.

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The variations in expenses and net operating income over the concession period are driven by capital investments which impacts operating expenses as increases in depreciation and financing costs. Details of the capital program are shown in the chart below. Of the total AMD 74 billion investment, AMD 34 billion (US$ 76 million) is for infrastructure, including bridge replacement and renewals, AMD 23 billion (US$ 50 million) is for wagon replacement and renewal and new wagons for traffic growth, and AMD 12 billion (US$ 27 million) is for locomotive renewal and replacement. By the end of the period, the wagon fleet totals about 1,400 wagons, 1,310 of which have been acquired during the next 15 years. The main line locomotive fleet totals 15 units, all of which are either purchased second hand or rebuilt. The

Full Concession, No Passenger, All Electric remainder of the investment Employment Summary program is for station renewals 5,000 and investments in computer 4,500 systems and other productivity 4,000 investments.

3,500 The effect of the cost reduction 3,000 program is shown in the 2,500 employment chart at left. R a

i 2,000 l

w Railway employment goes from a y

S t a 1,500 the current 4,700 staff to about f f 1,270 over the period between 1,000 2007 and 2011. Part of the 500 decline is due to the elimination

0 of passenger services, but most 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 results from the cost reduction programs, including increased use of contracting, closure of stations resulting from the radio dispatching system and customer service centers. Employment in the rail sector is actually greater than the 1,270 shown in the chart as some workers are employed in construction and building repair trades but working for contractors rather than the railway.

The employment chart illustrates the implementation of the cost reduction program and the timing of the concession. It is assumed that the cost reduction program begins immediately, and

Full Concession, No Passenger, All Electric that passenger services are Cumulative Cash Generated or Required 4,000 halted at the end of 2006. The concession is expected to begin 3,000 in 2007 and the transition and 2,000 cost reduction program is

1,000 completed by the end of 2012.

0 s m a High front-end investment needs r D (1,000) n o i l remain a significant concern. l i M (2,000) Based on our analysis, the concession will begin to (3,000) generate positive cash flows (4,000) only later in the concession as

(5,000) investment requirements consume nearly all cash (6,000) 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 4 - 23 Armenian Railway Restructuring Project: Final Report Railway Restructuring Analysis generated. The chart below shows the cumulative cash generated over the concession period. The large dip in cash generated early in the concession period is driven by the initial investment of AMD 4,510 billion (US$10 million) and the front-loaded investment program, most of which goes towards infrastructure investments and spending for cost reduction investments such as radio based train control, computers, and the establishment of the customer service center. Investments later in the analysis period cover replacement locomotives and wagon for traffic growth.

Over the first 15 years of the concession, payments to the government from the concession (including acquisition costs, annual concession fees, and taxes on profits) total AMD 12 billion (US$ 27 million).

It should be anticipated that the concessionaire would seek alternate methods to finance rolling stock and other investments – such as tariff discounts for shipper investments in freight wagons, leasing arrangements, and perhaps more aggressive rebuilding of existing AR wagon fleet. For example, a concession operator might endeavor to work out financing arrangements with the gold operator, selling wagons and perhaps locomotives to the gold company and providing a tariff discount for rail transport services. Such an arrangement could delay some investments contemplated in this analysis. The bridge replacement program, assumed to occur during the 2007 to 2010 period, may be delayed somewhat by the concession operator, electing to prolong slow orders on the bridge structures until a more detailed assessment of the replacement needs is completed. We evaluated several actions that a concessionaire might make to improve financial performance.

An AMD 5 billion (US$ 11 million) reduction in investment requirements provides an IRR improvement to nearly 8% on the cash flows in the first 15 years. The AMD 5 billion reduction in investments represents about 20% of track renewal capital investments over the period and could be achieved either by delaying investments, as discussed above, or through a Government program to subsidize the infrastructure. In this case, the concession ends the period with debt of about AMD 8.8 billion (US$ 19 million) and a debt to equity ratio of about 0.28.

A strong case can be made for government subsidy of rehabilitation of immovable assets such as bridges and other structures as these are not likely to be owned by the concessionaire. Assuming a subsidy of 20% of track and structure renewal costs (about AMD 5 billion over the 15 year period), Government income from the concession would still be AMD 7.7 billion (US$ 17 million).36

Alternatively, the concessionaire could increase prices to generate greater income. In this case, a 5% increase in freight tariffs would provide an IRR of 8.2% over 15 years, a result comparable to the reduction in capital investments. Our interviews with AR customers indicate a great desire for better and more responsive customer service. After years of decline, many of the remaining rail shippers may be relatively price inelastic but not service insensitive – loading either heavy loading bulk commodities such as ore, limestone, and steel scrap, or high value commodities such as blister copper. The fact that AR’s prices are well under half of total

36 The AMD 12 billion in government income in the first case, less AMD 5 billion subsidy for track investments should result in AMD 7 billion in government income. Reduced debt requirements improves the financial performance of the concession and results in an increase of AMD 0.7 billion in tax payments.

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international transport costs, and that international shippers have tolerated major fluctuations in rates and service quality over the years supports this conclusion. We believe that a concessionaire should have substantial upward price flexibility especially if higher prices are accompanied by improvements in service quality. A private sector concessionaire is likely to anticipate such flexibility in evaluating the concession’s prospects. Full Concession, No Passenger, All Electric Cumulative Cash Generated or Required 12,000 Assuming a 5% price increase 11,000 and no loss of traffic, by 2020, 10,000

9,000 the concession would have debt 8,000 of about AMD 9.9 billion (US$ 7,000

6,000 22 million). The Government 5,000 receives payments totaling AMD s

m 4,000 a r D

14 billion (US$ 31 million) over

n 3,000 o i l l i 2,000

M the period, (the amount paid to 1,000 government is higher since the 0 (1,000) concession fee is computed as (2,000) 2% of freight revenue, and the (3,000)

(4,000) concession has higher earnings (5,000) and higher tax payments). (6,000) 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 We also considered the impact of a reduction in the initial concession price. If the concessionaire paid only AMD 451 million (US$ 1 million) for the concession, his IRR at the end of the period would be about 8.5%, comparable to both the price increase and reduction in track investments.

Combining all three variations – an AMD 5 billion reduction in investments, a 5% freight price increase with no loss of traffic, and a reduction in the concession payment from AMD 4,510 to AMD 451 – the concession would have an IRR of over 14%. It would end the period with a debt of AMD 8 billion (US$ 18 million) and a debt to equity ratio of 0.25. The cash generated from this combination of alternatives is shown in the chart at left.

If we assume that the reduction in track investments comes as a result of a government subsidy for track and infrastructure improvements, the government receives net payments of AMD 5.4 billion over the 15 year period (US$ 12 million).

This combination of assumptions reduces the risks associated with the Full Concession arrangement and provides the possibility of a reasonable return for private sector investors.

Summary The concession operator is projected to pay an up-front payment for the concession (AMD 4,510 million, or US$10 million), concession fees totaling 2% of freight revenue, and normal business taxes. Over the analysis period to 2020, the concessionaire pays some AMD 12 billion (or US$ 27 million) to the government in acquisition costs, concession fees, and taxes. Should other operators wish to use the infrastructure, we estimate access charges would average AMD 1.6 per gross ton kilometer and AMD 1,680 per train kilometer for use of the track (this would be the access fee for passenger trains, too).

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Investment needs drive the cash required to operate the concession successfully. A commercially oriented rail operator is likely to use many means to reduce the up-front investments needed to provide rail services. We would anticipate that a close working relationship with customers and judicious decisions on timing of investments and sources of financing, including the targeted sale or lease of wagons to shippers in exchange for contracted rail services at lower tariffs. A commercial rail operator is likely to use overhauls to extend the life of locomotives and may sell or lease excess locomotives and wagon stocks to other rail operations in the region, and use other measures to reduce financing needs associated with replacing assets. We believe that a concession operator would also try to push the prices for its services up as services improved. Both of these actions would reduce risks associated with the concession.

Given the cash requirements and the current state of AR’s assets, it is imperative that any concession operator have a great deal of flexibility in the use and conversion of assets, in the ability to enter into contractual arrangements with shippers where the risks of investment are clearly shared, and in the timing of capital investments.

To reduce risks, the government and concession operator should consider a subsidy for some track investments (particularly bridge and other infrastructure investments). In addition, the government and concessionaire may want to consider a graduated concession fee, one that increased in increments as freight revenue increased. Even if the government subsidizes track investment programs, it receives between AMD 5 and 10 billion over the concession period.

Government will be responsible for managing assets not included in the concession, including passenger stations, passenger rolling stock, and land. A unit within MoTC will be needed to perform this function and to oversee the concession agreement, including providing the human resources safety net discussed in Chapter 6. Government will also need to establish an independent rail safety organization within MoTC. Overall, government costs should be limited to a few dozen staff and proceeds from the management and disposition of these assets may well be greater than the cost of managing the program.

If the government decides to continue passenger services, cost to government would be considerably higher. Those costs were summarized at the beginning of this Chapter – maintaining passenger services at the current level for the next 15 years would cost the government about AMD 46 billion (about US$ 100 million) plus the cost of replacing passenger rolling stock).

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Operating Concession with Management Contract for Infrastructure The financial analysis for this concession/management contract structure is based on the same assumptions as the prior analysis – that is, passenger services are terminated, a cost and capital reduction program is initiated in 2007 to reduce operating costs, convert excess assets into sources of cash, and an investment program that stresses improvements in the infrastructure, locomotive and wagon fleets over time. In this option, the government owns the infrastructure and contracts with the concession operator to carry out renewal and maintenance programs and manage access to the infrastructure. The government is assumed to finance infrastructure investments, not the concessionaire. The structure of this option is summarized in the box Operating Concession with Management Contract for Infrastructure Deal Structure

Concessionaire Obligations • Up-front payment of US$10 million (evaluated various lump sum payments) • Concession fee payments of 2% of freight revenue (evaluated various concession payments) • Normal business taxes on positive earnings after expenses and interest (25% assumed) • Negotiates infrastructure maintenance and renewal contract with government and executes the work either with own forces or with contractors. • Receives management fee of 10% of infrastructure maintenance and renewals costs • Publish network statement specifying access charges • Produces auditable financial data for infrastructure costs • Operating concessionaire pays access charges as specified in Network Statement • Operates infrastructure (controls dispatching and track access) • Operates freight and cargo services • Negotiate transport pricing with customers (free to provide combined rates, or charge for separate services as desired) • Provides drivers, operating services, infrastructure services on negotiated terms to other operators licensed by Ministry of transportation

Concession Terms • 30 years, renewable for another 20 years after the 20th year • Designated assets owned by concession, free and clear • Concession and government negotiate lines to operate and agree on designated assets • No passenger service assumed. Should passenger services be required, they are provided by operator under negotiated contract; government owns rolling stock • Concession agreement confers license to operate • Arbitration process for rate disputes, differences with government

Armenian Government Obligations: • Finances infrastructure capital investments • Handles excess employee costs • Responsible for any environmental impacts from AR operations • Responsible for financing any passenger services and operation of non-viable railway lines

Ministry of Transport Obligations • Transport policy • Owns and is responsible for railway infrastructure • Negotiates contract with concession operator for infrastructure maintenance work • Negotiates concession agreement • Can contract for additional infrastructure maintenance (e.g., Ijivan line) • Contracts for any passenger services • Replaces passenger equipment if needed • Can subsidize capital or operating costs to maintain some lines or services • Provide safety oversight • Manages excess property, concession agreement • Able to license other operators

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 4 - 27 Armenian Railway Restructuring Project: Final Report Railway Restructuring Analysis below. In some ways, a management contract for infrastructure maintenance and renewal is similar to the Full Concession option discussed above with government subsidy for track renewals work. This option presents a less risky concessioning alternative for private sector investors since the contract for infrastructure maintenance and renewal reduces the up-front risks associated with the major investments required to revive rail assets. However, infrastructure costs are likely to be higher and the concessionaire has less flexibility.

In this option, the concession operator/infrastructure contractor earns a return from the infrastructure management contract. But, infrastructure access charges are designed so that rail system users fully pay infrastructure costs and provide a return on assets to the government owner so the concessionaire or other rail operators pay the full costs for infrastructure, including the management fee. In our analysis, all infrastructure costs are borne by the freight sector as we assume passenger services are terminated at the end of 2007.

We consider this option a less desirable form of private sector participation as it limits, or at least complicates the flexibility of the concessionaire to make the best use of necessarily limited capital and is likely to lead to more complex financial relationships between the government and the concessionaire/contract manager. Negotiating the management contract will be fraught with difficult issues. For example, assume that the concessionaire has determined that it can operate freight services over the main line at, say, 40 kilometers per hour and wishes to maintain the track for that speed. But, the government wants the infrastructure to be maintained to a level that provides international train services at speeds of 80 kilometers per hour. The infrastructure would require greater investments than otherwise might be required and track access charges paid by the concessionaire might be higher than the market requires – limiting the concessionaires ability to recover these costs or driving some business from the system. Determining the cost of the increased speed and agreeing who should bear the increased costs would be subject to negotiation with the government.

Further, a management contract will require more complex contract arrangement that would separate facilities maintained at government’s request (for example, passenger stations and facilities, or the maintenance and continued operation of lines that might otherwise be closed) from those required for freight services. In our view, a management contract will be more expensive than a full concession because of these considerations. In the financial analysis such issues result in the elimination of fewer excess facilities and higher infrastructure maintenance costs.

Financial Analysis We have assumed that, under a management contract, no lines are closed (the political incentives make line closures in the face of a private sector concession unlikely), but that other programs and productivity improvement efforts proceed as in the prior analysis. In this option, the government assumes financing responsibility for infrastructure investments but investment costs are recovered from the concession operator in the form of access charges.

Overall expenses for the concession with management contract are higher, AMD 137 billion (US$ 303 million) over the 15 year period analyzed, up from AMD 114.6 billion (US$ 254 million) in the full concession case. The higher costs are driven in part by the greater amount of

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infrastructure that is maintained (1,139 track kilometers versus 834 kilometers in the full concession). The necessary investment program grows to AMD 82 million (US$ 182 million) from AMD 74 billion (US$ 165 Concession with Management Contract, No Passenger, All Electric Expenses, Revenue, Investment and Net Operating Income million). Concession revenue 13,000 increases by about AMD 5 12,000

11,000 billion, to AMD 150 billion 10,000 (US$ 332) from AMD 145 (321) 9,000 from the infrastructure 8,000 Investments 7,000 Net Operating Income management fee collected for Total Revenue 6,000 Total Expenses managing and operating the 5,000 EBITDA infrastructure. As in the Full 4,000 M

i 3,000 Concession option, we assume l l i o

n 2,000

D the concession operator makes r a

m 1,000 s

(

c an initial investment of AMD

o 0 n

s 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 t a

n (1,000) 4,510 million (US$ 10 million) t ) (2,000) to purchase the concession and provides working capital for startup. Investment and other cash needs are financed at 7% real interest rates over a 30 year period. The resulting cash flows, summarized in the chart at left, provide an internal rate of return (IRR) of about 1% over AR Concession, Management Contract, No Passenger, All Electric Freight Concession Investment Program the period. 5,000 Administration Station Operations 4,500 Wagon Depot Investment requirements for the Locomotive Depots 4,000 concessionaire are substantially 3,500 reduced in this case as the

3,000 s Armenian Government is m a r D 2,500 n assumed to finance o i l l i M 2,000 infrastructure costs. Investments for the concessionaire total 1,500 AMD 40 billion (US$ 89 1,000 million) and are shown in the 500 chart below. Major investments

0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 include AMD 12 billion (US$ 27 million) for locomotives; AR Concession, Management Contract, No Passenger, All Electric Government Infrastructue Investments AMD 22.4 billion (US$ 50 7,000

Signals & Communications million) for wagons and AMD Electrical 6,000 5.5 billion (US$ 12 million) for Track & Structures station investments including 5,000 radio based train control, customer service centers, and s 4,000 n o i l l new computer systems. i M

D

M

A 3,000 Infrastructure investments total 2,000 AMD 42 billion (US$ 93 million) and are largely for track 1,000 and structures renewals. Infrastructure operating costs 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 total about AMD 56 billion

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(US$ 124 million) over the 15 year period, including total payments of AMD 5 billion (US$ 11 million) for management fees. These investments are financed by the Government of Armenia and their cost and the operating costs, including management fee, is built into the access charge that is paid by the concession operator. Because the government finances a major portion of the investment program, financing risks to the concession operator are lower. However, all costs, including the management fee, are built into the access charge and ultimately borne by the concessionaire. As a result, operating costs are higher and the concessionaire pays more for infrastructure maintenance over the period and has less flexibility to move Concession, Management Contract, No Passenger, All Electric Cumulative Debt investments to manage risks. 14,000 The concession is less profitable while freight revenue remain 12,000 the same as in the Full Concession case. 10,000

8,000 The cost reduction programs help reduce operating costs and 6,000 eliminate capital renewal M i l

l requirements for many i o n

4,000 D r

a functions. Even so, the higher m s

( c

o fixed charges associated with n

s 2,000 t a n

t infrastructure access charges )

0 result in lower margins. The 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 chart below shows cumulative debt for the combined enterprise. By the end of the 15 year analysis period, the concession has total debt of AMD 12 billion (US$ 27 million) and a debt to equity ratio of 0.46 at the end of the period in 2020.

Concession with Management Contract, No Passenger, All Electric Cash Requirements 2,000 Because investment requirements are much lower, cash requirements are not as significant as in the Full Concession option. However, as in the Full Concession option, 0 cash flows are dominated by investment requirements. While government finances infrastructure investments, both maintenance (2,000) costs and track investments are somewhat M i l l i o higher because there is more infrastructure to n

D r a m maintain and renew. Track access fees s (4,000) average AMD 1.61 per gross-ton-kilometer and AMD 1,688 per train kilometer. Over the 15 year period, the government receives (6,000) about AMD 5.6 billion (US$ 12 million) in 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 total payments, net of its cost for infrastructure investments.

We have assumed that the concessionaire/contract manager bears the somewhat higher cost of the network as it is passed along in access charges. Ultimately, the contract manager may have higher earnings than projected here as contract negotiations may provide additional payment

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from government for maintaining the extra lines and assets assumed to remain open in this case. The contract manager/ concessionaire may also earn fees for managing facilities not transferred in the concession – Concession w Management Contract, No Passenger, All Electric Employment Summary for example, the currently 5,000 closed Ijivan line. This line is

4,500 not included in either concession option but the concessionaire, 4,000 may be asked to provide

3,500 security and minor maintenance services over the life of the 3,000 contract. 2,500 Overall, employment in the R a 2,000 concession is about 1,430 i l w a y (versus 1,270 in the full

S

t 1,500 a f f concession case). Track

1,000 kilometers in the management contract option are the same as 500 AR operates currently: 1,139 0 track kilometers, versus 834 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 kilometers in the full concession case. The full concession option assumes that the operator has an incentive to eliminate light density branch lines as well as unused station and terminal tracks. The elimination of these lines increases scrap recoveries and may reduce maintenance costs through the re-use of material, though no such reuse was assumed.

While the government finances infrastructure investments, its total income, including the cost of the concession, concession fees, and income from access fees and taxes less expenses paid to the contractor, totals about AMD 5.6 billion (US$ 12 million) over the period.

As in the Full concession case, we evaluated several actions that a concession operator might take to improve his financial performance. Since the government is assumed to finance infrastructure costs, an infrastructure subsidy was not considered.

As in the Full Concession option, the concessionaire could increase freight transport prices to improve financial performance. A freight price increase of 5% increases the concessionaire’s IRR to 5.2%. With this increase, the concessionaire ends the period with debt of AMD 6.8 billion (US$15 million) and a debt to equity ratio of 0.25. Net government income increases to AMD 7.8 billion (or about US$ 17 million).

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A reduction in the amount paid for the concession/management contract from AMD 4,510 million to AMD 451 million (US$ 1 million) would improve the concessionaires IRR to 4.2% (from about 1%) and reduce cash requirements. In this case, net payments to government over the period total AMD 1.6 billion (or about US$ 3 million).

Combining the alternatives for this option—a 5% rate increase, and a reduction in initial concession acquisition costs from AMD 4,510 to AMD 451 provides the concessionaire with an IRR of about 11% over the period. The concessionaire/manager ends the period with total debt of about AMD 6.9 billion (US$ 15 million) and a debt to equity ratio of 0.29. Using these assumptions, the government receives total payments of AMD 3.7 billion (US$ 8 million) over the concession – from the lower initial concession payment but higher revenue from access charges which are computed on the basis of a percent of revenue. The lower capital costs and debt associated with this option makes the financial results more sensitive to assumptions about revenue and initial concession payments. Overall, concessionaire/contractor risks are lower as are earnings; returns to government are also lower.

Concession with Management Contract, No Passenger, All Electric Cash Requirements 3,000

2,000

1,000 s m a r D n o i l l i M 0

(1,000)

(2,000) 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

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SUMMARY A sector restructuring based on concessioning freight services, including the transfer of all freight rolling stock and major facilities, is feasible. The option with the highest returns, both to government and for the concessionaire, is the Full Concession option. It also provides greater flexibility. However, it does present certain risks to the concessionaire in that capital costs are higher and returns if freight traffic is lower than projections are reduced.

The Concession with Management Contract option reduces some risks for the concessionaire as the concessionaire’s financing costs are lower. But it introduces other risks, including the risk that government may mandate higher costs than freight customers are willing to pay. The table below shows the major financial indicators for the two options considered over the 15 year period considered in the financial analysis.

Full Concession Concession / Management Item Contract AMD US$ AMD US$ (billions) (millions) (billions) (millions) Revenue 145 321 150 322 Operating Expense 115 254 137 303 EBITDA 82 181 39 90 Investments 74 165 40 89 Employment - 2020 1,270 1,430 Kilometers of line 834 1,139 IRR (at AMD 4,510 price) 6.1% 1% Total Net to Government +12 +27 +6 +12 5% Freight Price Increase IRR 8.2% 5.2 Total Net to Government +14 +31 +8 +17 AMD 5 billion Subsidy for Track & Structures IRR 7.8% NA NA Total Net to Government +7.7 +17 AMD $1 million Payment for Concession (rather than US$10 million) IRR (at AMD 451 price) 8.5% 4.2% Total Net to Government +8 +18 +2 +3 Above Combined IRR 14.1% 10.6% Total Net to Government +5 +12 +4 +8

In either option, passenger services must be eliminated or fully subsidized by government. Elimination is recommended. The government should conduct a further analysis of alternative passenger service options. Should the government decide to maintain the current level of passenger services, the annual subsidy requirement for operating the services is likely to be about AMD 1 billion (US$ 2.2 million) or AMD 16 billion (US$ 35 million) over the next 15 years. In addition, capital cost for rolling stock, stations, and the passenger share of infrastructure renewals would total approximately AMD 30 billion over the period (or about US$ 66 million).

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Investment needs drive the value of the concession. We believe that concession operators with sufficient flexibility will find ways to spread investment risks out to other private sector participants—leasing companies, shippers, forwarders—and will be able to make use of some excess assets to lease or sell locomotives and wagons to other railway operators or shippers in the region. Earnings before taxes and depreciation are positive and, given flexibility in the use of assets and in developing new relationships with shippers, we believe that the concessioning of Armenian Railway will attract international interest. Though we find it difficult to estimate the value of the concession, the government should expect positive bids in the range of US$ 10 million.

Full Concession, No Passenger, All Electric, Low Traffic SENSITIVITY TO CHANGES IN Cumulative Cash Generated or Required 0 TRAFFIC To evaluate the sensitivity of the (1,000) concession to changes in traffic levels, we conducted a financial (2,000) analysis of the Full Concession

(3,000) option with both low and high traffic forecasts. The Low

M (4,000) Traffic forecast assumes that the i l l i o n

D gold traffic remains at low levels r a m (5,000) s and that the railway has difficulty competing with road (6,000) transport. Low Traffic revenues total AMD 118 billion (US$ 262 (7,000) 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 million) over the 2007 to 2020 period, down from AMD 145 billion (US$ 322 million).If traffic levels decline to the Low Forecast level, investment requirements will decline somewhat as fewer wagons and locomotives will be required, but AR’s assets are nearly depleted now and considerable investment will still be required. We estimate that even with the Low Full Concession, No Passenger, All Electric High, Traffic Forecast Cumulative Cash Generated or Required Traffic forecast, a concession 9,000 operator will need to invest 8,000 some AMD 69 billion drams 7,000 (US$ 153 million). The Full 6,000

5,000 Concession internal rate of

4,000 return will fall from 6.1% in the 3,000 Most Likely Traffic case to 2,000 1.2%. Declines in traffic present 1,000

M a large risk for a commercial i l 0 l i o n

D (1,000) concession operator. r a m s (2,000) Government revenue over the (3,000) period (including the concession (4,000) payment, concession fees, and (5,000) tax income falls from AMD 12 (6,000) 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 billion (US$ 27 million) to AMD 7 billion (US$ 15

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 4 - 34 Armenian Railway Restructuring Project: Final Report Railway Restructuring Analysis million). Cash flows are summarized in the chart above.

We also evaluated the financial performance of the concession under the High Traffic forecast. This forecast assumes the Abkhazia connection is completed and that improving operating performance, better service, and renewed assets permits the railway to compete better with road transport. In the High Forecast, revenue totals AMD 164 billion (US$ 364 million) over the

Restructuring Option Comparision For the Period 2007 to 2020 Management Full Concession Full Concession Full Concession Contract Most Likely Low Traffic High Traffic AMD US$ AMD US$ AMD US$ AMD US$ Item (billions) (millions) (billions) (millions) (billions) (millions) (billions) (millions) Revenue 150 332 145 322 118 262 164 364 Expenses 137 304 115 255 105 233 122 271 EBITDA 39 87 82 181 63 139 97 214 Ending Debt (Concessionaire) 12 27 13 29 23 50 11 24 Investments Government 40 89 0 0 0 Concessionaire 42 93 74 164 69 153 80 177 Total 82 182 74 164 69 153 80 177

Government Income (Net) 6 12 12 27 7 15 16 35 Concession IRR 1.0% 6.1% 1.2% 8.3%

Employment 1,430 1,270 1,175 1,350 Wagon Fleet at 2020 1,410 1,410 950 1,745 Locomotive (Electric + Diesel) 14 14 13 16 period. Higher traffic drives investment requirements further and the concessionaire would need to invest some AMD 80 billion (US$ 177 million) but the concession would generate significantly more cash. The Full Concession internal rate of return climbs to 8.3% while total government revenue increases to AMD 16 billion (US$ 35 million). The various options and sensitivities are summarized in the chart below along with significant measures of the options.

RECOMMENDATIONS The Full Concession option is recommended. This option provides the greatest financial returns to both the government and concessionaire. The option requires significant investments and carries with it risks to both government and concessionaire. The risk to the concessionaire is that traffic may not materialize as forecast and financial returns may therefore be lower than expected. Given that the concessionaire will be responsible for substantial investment over the period, the financial risks can become large. The risk to the government is that the concessionaire may delay investments, waiting for traffic to increase sufficiently to permit earning returns.

We believe these risks can be greatly mitigated by developing a concession agreement that shifts some risk to government while offering both government and concessionaire the potential for higher returns should the concessionaire be successful in building traffic. We recommend a concession agreement that includes government subsidy for some infrastructure investments (mostly bridge replacements, fill stabilization, and similar improvements to track and structures) while at the same time providing a graduated concession fee based on volumes. For example, the Full Concession option assumes an annual concession fee of 2% of freight revenue; an alternative arrangement could involve government subsidy of, say, AMD 5 billion

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(US$ 11 million) that would be paid in the early years of the concession in return for concession fees that would climb from 2% of freight revenue to, say 5% of freight revenue at some agreed volume or revenue level. This arrangement would reduce risks to the concessionaire while providing increased revenue to the government over the long term. Using these assumptions in the Full Concession Option with Most Likely traffic, and a shift to 5% concession fees at AMD 10 billion in freight revenues (about 2014) provides the concessionaire with an IRR of 9.5% and the government with total income over the period of AMD 11.2 billion (US$ 25 million), close to the most likely case without these risk mitigating arrangements.

While the Full Concession with Management Contract arrangement seems to mitigate some of the investment risks, the reduced flexibility and likely higher costs provide the concessionaire with political risks that may be hard to evaluate. For this reason, we believe bids for the concession/management contract rights would be lower than bids for the full concession. Government revenues and potential concessionaire returns are higher with the full concession. Government willingness to negotiate a flexible full concession arrangement with early subsidy for track and structures improvements along with higher concession payments should traffic and revenue be higher than expected will draw more interest and larger bids for the concession.

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5: Legal and Regulatory Issues

his Chapter considers the legal and regulatory framework with respect to transport in Armenia. It specifically considers the current legal context under which Armenian T Railway operates as a state-owned transport enterprise and a state controlled monopoly provider of transport services. In this Chapter we also consider legal and regulatory changes that would be necessary to restructure the Armenian Railway and introduce private participation in the rail sector as envisioned in the recommended restructuring options discussed in the previous chapter. We review the new proposed transport law and consider how the law should be modified to enhance the restructuring effort. Finally, this chapter considers changes in legal and regulatory environment that may be required should Armenia join the EU.

TRANSPORT LAW At present Armenia does not have a Railway Law. A general transport law governs railways and other modes of transport. Under the present law, the government has wide-ranging powers to control transport activities, with authority to undertake licensing, taxation, financing, tariff formation, investment, and otherwise control the performance of the transport sector.37 The law, however, is a very broad document that does not spell out the terms or procedures to be followed in licensing, tariff setting, resolution of disputes concerning the relative rights and obligations of transporters and goods consignees/consignors or passengers, safety regulation or other matters, for railways or for other modes. These details are delegated to “the state authorized body for transport,” currently the Ministry of Transport and Communications (MoTC).

There appears to be no legal obstacle to private sector rail transport under the present law. The law envisions that for-hire transport may be provided by private parties under licenses (and licenses appear also to be required for public transporters, such as Armenian Railways, although formal licensing has not, in fact, been applied to AR).38 The inhibition to private sector participation in the rail sector is not in adverse legal or regulatory provisions, but rather that the extensive but vague powers in the law could be subject to interventionist administrative determinations that could undermine the viability of private ventures and the validity of private contract provisions.

To provide a more structured legal framework for the rail sector, MoTC has drafted a proposed Law on Railways that contains greater detail on procedures for governmental administration of the rail sector. We have critically reviewed and provided comments on this draft Law on Railways and, in particular, have assessed the adequacy of the law relative to the proposed

37 Law of the Republic of Armenia on Transport (3 February 1998), Article 4. 38 Grant Thornton Amyot, Independent Auditor’s Report, Armenian Railway CJSC (May 17, 2004). P. 23. Licensing is required not only by the Law on Transport, but also by the Law of the Republic of Armenia on Licensing.

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 5- 1 Armenian Railway Restructuring Project: Final Report Legal & Regulatory Issues restructuring. Our suggestions for revisions to the draft Law on Railways, in the form of a mark-up to the original MoTC draft, are contained in Appendix D. These suggestions were provided to MoTC for review in April 2006. They are included here with modest changes based on our review of the legal implications of the preferred restructuring options.

Considerations in Refining the Legal Framework: The following considerations appear important in revising the legal framework for the Armenian rail sector.

Consistency with Private Sector Participation Strategy Each of the recommended restructuring strategies involves some form of private sector participation in the Armenian rail sector. The alternatives differ and some details in terminology and substantive provisions in the Draft Railway Law might be adjusted somewhat differently depending on what final choice is made, although it is not good policy to tie general enabling legislation too closely to any particular agreement or transaction. All of the options under consideration, moreover, share one common characteristic: in each case there will be a formal agreement (e.g., concession contract; management contract, leasing or sales contract) with a private sector entity. As the authorized public administration body for rail transport, the Ministry of Transport and Communications (MoTC) will be a signatory to that agreement (although possibly not the exclusive governmental signatory). To support the private sector participation strategy, therefore, the railway law must support the contract mechanism. MoTC must have clear authority to transfer activities and property to the private sector and powers retained by MoTC must not undermine the integrity of the contract (while, of course, the contract itself will need to acknowledge authorities retained by MoTC). A number of suggestions made in the mark-up are designed to strengthen MoTC’s ability to negotiate clear contracts that would not be in conflict with provisions of the Railway Law.

Precise Specification of Authorities between MoTC and Other Government Entities While the Draft Railway Law notes that certain regulatory authorities fall outside powers of the authorized public administration body for rail transport (MoTC), notably in the Public Service Regulatory Commission (PSRC), the division of roles and authorities was unclear. After thorough review of the options, we recommend that the PSRC not be given jurisdiction over rail rates and services and that any constraints on the pricing authority of a concessionaire or management contractor be incorporated in the contact agreement negotiated by MoTC (and any other Government parties to the negotiation). The contract should specify any procedures necessary for publication of tariffs or access charges (if any) as well as the process for resolving disputes with cargo transporters, passengers, contract parties and others who might be impacted by the rail transport agreement

Provisions for Potential Multiple Operators on the Rail System Private sector provision of rail transport services for customers is expected to be limited to one private operator, at least initially. However, the current Draft Railway Law provides that additional railway operators are permitted. A framework permitting, but not necessarily requiring, multiple-carrier access may also be desirable for consistency with EU policies. At the same time, potential multi-carrier access may undercut the value of a concession agreement or management contract, particularly if a new operator would be allowed to pay lower access

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 5 - 2 Armenian Railway Restructuring Project: Final Report Legal & Regulatory Issues fees than the operator under the original contract. Provisions are suggested to support the integrity of concession contracts while allowing for potential future entry of new operators on a nondiscriminatory basis. Provision for Liberalization of International Railway Rates Currently, Armenian Railway international tariffs are subject to CIS tariff agreements that have inter-governmental, quasi-treaty status and, as such, both constrain pricing flexibility and are not subject to independent Armenian tariff regulation. As private operators enter the market in other CIS countries, however, the existing arrangements are likely to be liberalized and rail transport provided that is not covered by the CIS tariffs. Consequently, provisions are suggested that would allow for these developments and provide for a degree of regulatory oversight where appropriate.

Our suggestions for specific revisions to the language of the draft Law on Railways are contained in Appendix D.

REGULATORY ENVIRONMENT At the outset of the project it appeared that the Public Services Regulatory Commission (PSRC) would be the designated body to regulate railways in a rather comprehensive fashion. Consequently, we met and communicated with the PSRC, providing advice on principles to use in regulating railways and in particular rail tariffs. As the project proceeded, it became apparent that the scope of prospective PSRC regulatory responsibilities versus those of MoTC and other Armenian Government entities remained uncertain. For example, present law, as noted above, gives licensing responsibility to the MoTC and may involve many aspects of safety/standards and economic regulation. Further, all of AR’s international tariffs, covering two thirds of its traffic, are subject to international agreements that would not be subject to the jurisdiction of an independent regulator. Finally, as PSRC itself stressed, its jurisdiction is limited to natural monopolies. In view of the intermodal competition for domestic traffic that would be open to independent agency oversight, we do not think domestic traffic could be defined as a monopoly.

If PSRC were to be given comprehensive oversight of the rail sector, it has indicated that it prefers traditional public utility regulation under which the regulator, not the industry, sets rates and tariffs and under which the regulator also sets quality of service standards, determines appropriate investment requirements and is heavily involved in all aspects of the regulated firm’s financial arrangements, requiring detailed and extensive reporting. Anything less, such as setting maximum rate levels and ruling on complaints of pricing abuses, was described by a PSRC Commissioner as “not regulation, just oversight.”

We recommend, however, that the reformed Armenian rail sector be regulated lightly, with primary oversight provided by MoTC on matters of safety and licensing, but with a limited dispute-resolution role for an independent entity. By light regulation we mean the following: • Most matters regarding anti-competitive behavior in the railway sector should be regulated according to 1) legislation applicable all commercial enterprises doing businesses in Armenia and not according to public utility standards applicable to natural monopolies and 2) provisions for dispute resolution written into the State’s concession agreement or management contract with the private sector.

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• Safety programs, equipment standards, operator qualifications and similar matters should be administered by the technically qualified agency, i.e., MoTC, constrained by the provisions written into contract agreements with the private sector. • While the above provisions for oversight should provide sufficient pricing regulation, if authority for economic regulation of prices is granted to any entity it should have jurisdiction over a particular price only on the basis of a complaint by a railway customer paying that price. The complainant should have the burden of proof to show that price exceeds an unreasonable level relative to a standard for reasonableness established in advance by that authority. • In the event there remains only a single railway operator, any such authority established above should apply to prices paid by a passenger customer or a business or freight forwarder using railway cargo services. If provision is made for multiple operators (access provisions), so that train operators pay access fees to the infrastructure manager, then authority should apply only to such access charges and not to cargo, passenger or other end-user customers. • In the event of a finding of an excessive rate, any regulatory authority should have the power only to establish a maximum rate and to require refunds or levy fines according to rules established by the authority in advance and consistent with precedents established in earlier complaints regarding similar transport situations.

Again, we recommend that the first two measures discussed above are adequate for the restructuring steps outlined in Chapter 4. The additional regulatory provisions would be necessary only in the event of a more complete privatization.39 The recommendation for light regulation is based on four considerations: • First, the restructuring options recommended do not call for complete privatization, but rather concession agreements and/or management contracts. The State’s interest in public safety, fair employment practices, dispute resolution and other public interest issues can be handled most clearly and efficiently within terms that are specified explicitly within the terms of a management contract or concession agreement or by reference to existing legislation. In other words, the State concession agreement or management contract is LWVHOI a strong instrument for the public sector to control potential abuse of private sector market power. • Second, there is a major distinction between the possibility that an enterprise might have some degree of market power and the conclusion that it is a “natural monopoly” requiring control of prices, service levels, and other matters by public authorities. While some abuses of market power may be possible under a concessioning arrangement, AR does not now have the status of a natural monopoly, nor will it under any of the recommended restructuring scenarios. As discussed in the Market Analysis section, Armenian Railways faces growing competition from roads for both freight and passenger services. Such expanding competition further reduces the need for pricing and discrimination oversight. Like most railways around the world, Armenian Railways has found itself faced with increasingly vigorous competition from road carriers for both cargo and passengers. Most import-export containers are now carried by truck, and trucks (particularly private industry company trucks) dominate transport within Armenia. While both truck and rail traffic within Armenia have increased with the revival of the Armenian economy, the growth in trucking promises to reduce the rail market share substantially more in the future. Meanwhile, Armenian Railway passenger ridership has

39 In a complete privatization, the operator would not be bound by a contract agreement with MoTC. In this event, more regulatory oversight may potentially be necessary, especially in regard to other operators and access provisions. In the concession process recommended here, the concession agreement replaces the

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declined as riders shift to buses or private automobiles. The very short trip distances within Armenia favor road travel and rail passenger losses are likely to continue even with investment and service improvements. • Third, outside of concessioning agreements or management contracts, the future of Armenian Railways is closely tied to Government policy decisions regarding such matters as CIS tariff agreements, trade facilitation, border re-openings and promoting privatization of industries (such as gold ore mining and pricing), where oversight by a line ministry with policy responsibilities may be more appropriate than an independent regulator. • Fourth, since the State’s interests are primarily represented by the entities that are signatory to contracts with the private sector (here MoTC), the need for additional oversight should consist of settling matters of contract dispute between the public sector and private sector signatories rather than creating a structure with broad powers that may undermine the validity of the agreement. Evidence from railway concessioning elsewhere shows that such competing jurisdictions are ineffective and often lead to the failure of the concession.

The Republic of Armenia Public Service Regulatory Commission (PSRC) is the principle regulator for energy, water distribution and telecommunications, all defined as public utilities and as natural monopolies, but its charter does not include transport or railways. The current draft Law on Railways refers to the PSRC without defining its role precisely, an area where we suggest modifications. PSRC had previously provided inputs to the draft railway legislation that assumed it would have extensive authority to regulate the railway sector as a public utility. However, few of the PSRC’s suggestions were included in the draft railway legislation. Railways are not described as a “public utility” at any point in the draft railways legislation. We agree with the Ministry’s decision and recommend that Armenian Railways not be regulated as a public utility. PSRC could conceivably serve as an entity to arbitrate contract disputes, but we think that would require modification of the PSRC’s current charter as a regulator of natural monopolies, as well as a considerable change in regulatory philosophy. We recommend that the concession agreements/contracts designate an international arbitration body for dispute resolution under the terms of the agreement with Armenian courts governing normal contract law issues.

CONCESSION CONTRACTS We recommend that the Law on Railways not contain provisions that would have the effect of specifying the terms of concessions and/or management contracts. Such provisions would unduly constrain MoTC in negotiating for private sector participation in the rail sector. Further, the Law on Railways should not be written to prefer one mode of private sector participation over another. The Railway law should set broader policy direction and define powers in the sector generally but should not be overly prescriptive in how those policies and powers are exercised. If it should happen that a management contract approach is first attempted but proves unsatisfactory, a change in legislation should not be required in order to undertake a more typical long-term concession. Likewise, initial adoption of the concession approach should not be hampered by an Act that would require revision if there was to be later separation of infrastructure and operations, additional third party access arrangements and/or management contracts of scopes yet to be determined. In other words, the Law on Railways should not constrain MoTC unduly in conducting transactions to secure private sector participation, but

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 5 - 5 Armenian Railway Restructuring Project: Final Report Legal & Regulatory Issues should be a vehicle to promote private sector participation in whatever form proves most viable.

While the Law should allow MoTC flexibility to conduct a variety of transactions, we emphasize that private sector participation in the rail industry typically requires long-term agreements, simply because the long life of rail assets and their limited portability require a long-term commitment from a private operator/investor. This implies that licensing provisions and other constraints on operating the rail system must be compatible with the long-term contracting mechanism.

A concession agreement or management contract must constitute a license to operate for the period of the contract, subject to provisions that are encompassed within the contract itself, either as a whole or by reference to existing laws and regulations. Adding annual licensing requirements that are outside of the terms of the contract would increase risk reducing contract viability in the eyes of investors. If MoTC were to seek to retain extensive licensing powers to void private sector contract operating authority on short notice, private sector interest will be diminished greatly, and prospects for a successful transaction reduced.

Thus, MoTC or other authorized Government will need to publish a draft contract as a part of the concessioning process. The draft agreement should define the basic provisions of the concession including:

• The fee structure and other financial arrangements between Government and the concessionaire/contractor and how such fees are to be calculated • Any performance indicators to be used in monitoring the concession or contract • A clear process for removing the concessionaire in the event of-non-performance • An arbitration process for settling disputes between Government and concessionaire and a specification of the entity or entities that will have jurisdiction over such disputes • An arbitration process for settling disputes between railway customers and concessionaire and, as above, a specification of the entity or entities that will have jurisdiction over such disputes • While it is envisioned that land will remain under Government title, specification of the terms and procedures for transfer of rolling stock and facilities, including lease or outright sale arrangements, constraints on disposability of assets including any requirements regarding turn- back to Government or Government right of first refusal

Typically, concession contracts also include provisions for how excess employees will be handled. Privatization/concession transactions, discussed in the Human Resources chapter of this final report, typically provide existing employees with first rights to employment with the concessionaire but do not obligate the concessionaire to accept all or any specific employees. Further, concession agreements typically absolve the concessionaire of any environmental issues that arise from prior operation of the railway. This may be of particular importance in Armenia because of the use of electrical sub-stations which may contain hazardous materials. The concessionaire would be required to obey current environmental regulations but would not be required to assume liability for prior environmental problems. None of the above provisions should be written into the Law on Railways, but the Law on Railways must not undermine the contract with provisions that conflict with, or supersede contract provisions.

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We recognize that the majority of Armenian Railways traffic is subject to treaty-level agreements with CIS railways that provide constraints both with regard to pricing and with regard to technical matters such as wagon exchange. Concessioning or management contracts will not void these agreements, so that a private sector operator may have certain limitations with regard to pricing and operating freedoms as a result of these inter-State agreements. The concession or management contract should describe such constraints. We note, however, that CIS agreements do afford a signisicant degree of flexibility, including volume discounts for shippers, contract prices, and other special arrangements. Flexibility should increase as private sector participation in railways of other CIS countries increases. With private sector participation in Georgian Railway under active consideration, for example, opportunities for transport arrangements outside of the public sector CIS railway agreements should increase.

SAFETY, STANDARDS AND LICENSING As with economic arrangements addressed above, the Law on Railways should not include detailed rules regarding safety, equipment standards, employee qualifications, operator fitness certification or other licensing provisions. Any administrative rules or orders currently in effect should be addressed in the concession agreement or management contract, and any modifications or clarification of those rules will need to be incorporated into the contract.

There is now widespread agreement that best practices with regard to safety and standards are systems that rely substantially on performance based measures. That is, standards designed to achieve a safety-related outcome rather than detailed design specifications and normative rules, as in traditional Soviet practice. Part of this approach is to require a licensee (including a concessionaire or management contractor as part of its long-term contract) to:

• Have an appropriate formal Safety Program. This program would include inspections, training and enforcement of operating practices necessary to function in a safe manner.

• Have an appropriate formal Environmental Program. This program would include inspections, training and enforcement of environmentally safe operating practices, as defined by the appropriate Ministry.

• Be technically fit to provide the services to be licensed. That is, the concessionaire/ licensee’s employees have adequate railway knowledge, training and experience in the specific services to be licensed that Licensee can perform them safely.

• Be financially fit to provide the services to be licensed. As part of the transaction negotiations/ the concessionaire/ licensee should demonstrate that it is financially capable of operating the services to be licensed in a safe fashion.

The Law on Railways should not encompass normative standards inherited from the Soviet Era that would prevent MoTC from negotiating provisions for reasonable safety/environmental programs and technical fitness within the concession or management contract. We recommend that MoTC retain jurisdiction for outcome based safety regulation under existing its licensing

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6: Human Resources & Social Impact Issues

INTRODUCTION AND METHODOLOGY

his Chapter of the Draft Final Report summarizes our findings on the specific sub- components related to AR Human Resources and Social Mitigation. Our findings rely on T the data provided by different departments of Armenia Railways as well as on interviews and observations made during field trips. As part of our consultative approach on the topic of human resources, we created a Human Resources Working Group (HRWG) in November 2005 and expanded it in recent months in preparation of this draft final report.

Since AR Human resource data are not centralized, they necessarily came from a number of different sources (e.g., branches and departments, human resource department, financial and economic department, as well as accounting department). We identified a number of discrepancies between the various data sources. Where possible, with the help of the HRWG, we have reconciled discrepancies in the data obtained.

In this chapter, we review and analyze the structure of the Armenian Railway staffing and characterize AR staff along several different dimensions. Next, we review the staffing needs associated with the restructuring options and estimate the number of staff that may become redundant in a restructuring. A plan for providing a safety net for redundant staff and a mitigation program is described. To streamline this Chapter, we have included most of the supporting tables and other documentation in a series of Appendices that form an integral part of this report. A Human Resources Data Base, listing all AR employees along with specific job titles, salaries, and other related information is provided in a separate data file (CD-ROM) for future reference. Finally, we include a number of summaries of related relevant topics in the following Appendices to this section:

• Appendix E: Armenian Government’s policy with recent public restructuring cases • Appendix F: Community Consultation • Appendix G: Barriers to AR Employment Restructuring • Appendix H: International Experience with Restructuring

We provide recommendations on specific topics as they are covered in this Chapter (highlighted in dark blue italic’s) and include recommended next steps to bring the AR workforce in line with the likely future employment profile of a restructured Armenian Railway.

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HUMAN RESOURCES WORKING GROUP To facilitate the identification of critical issues in Human Resources analysis related to restructuring and to continue the consultative approach that was initiated last November with respect to this sensitive topic, in recent months we expanded the HRWG to include: management and staff of the head office Human Resource Department, a representative from the head office Finance and Economic Analysis Department, representatives from Yerevan Electricity Supply, Yerevan Locomotive Depot, and Passenger Transportation Branch as well as two Trade Union representatives. Two HRWG meetings were held in April to discuss the likely impact of restructuring on AR staff and working group members were invited to provide input into the development of a social mitigation strategy. This report reflects the feedback received by the HRWG with respect to critical HR issues as well as to our suggested social mitigation recommendations related to employment restructuring.

Recommendation: AR should maintain, either in expanded or amended form, the HRWG chaired by the head of the HR Department as restructuring of different functional areas of the railway commences.

ARMENIAN RAILWAY STAFF CHARACTERISTICS The Armenian Railway has an aging workforce with a significant number of workers at or near retirement age. It is predominantly male and reasonably well educated—more than 85% of workers have at least a middle or middle specialized education. The following table provides the age and gender profile for the current AR workforce.

Age range Number Number Total male female 18 to 28 517 98 615 29 to 34 399 75 474

35 to 44 843 200 1,043 45 to 54 1,180 309 1,489 55 to 60 424 116 540 61 to 65 230 52 282 Over 65 194 38 232

Total 3,787 888 4,675 Source: AR HR Department Age and Gender Distribution As shown in the above table and charts below, AR has an aging male dominated workforce

Age Distribution of AR Staff Distribution of AR Workforce by Education Over 65 61 to 65 Low 5% 18 to 28 6% 12% 13% University 55 to 60 15% 12%

29 to 34 10%

Middle Middle education specialized 50% 23%

45 to 54 35 to 44 32% 22%

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(80% of total AR workers are males). A significant number of workers continue to work past the official retirement age of 63.

AR Employee Inventory With input from the HR, and accounting department, we completed an inventory of employees in each of the operational areas of the railway since no consistent data base of employment exists. The complete inventory (included on a CD-ROM and distributed with this report) is organized according to the summary table below. For each employee, the data base includes the name, position, gender, birthday, age, years of service and nominal salary level. The employee inventory is split into 4 sections as shown in the table.

Summary of Employee Data Base Number of Number of Number of Employees Employees Employees by In by Staffing HR Inventory List Department Data Base Database 1 1. Management of Head office 318 309 311 2. Passenger transportation 147 147 149 3. Yerevan station 189 189 182 4. Gumri station 201 200 200 5. Vanadzor station 206 202 210 6. Masis station 76 77 79 7. Karmir Blur station 58 57 58 8. Ararat station 75 73 75 9. Armavir station 44 44 44 10. Abovian station 117 116 116 11. Sevan station 101 101 101 Database 2 12. Yerevan track section 230 212 211 13. Gymri track section 192 186 188 14. Vanadzor track section 165 159 170 15. Sevan track section 141 140 140 16. Ijevan track section 17 17 17 17. Masis mechanized track section 97 89 91 Database 3 18. Yerevan electricity supply section 157 155 159 19. Gymri electricity supply section 197 195 197 20. Hrazdan electricity supply section 192 189 190 21. Yerevan communication and signaling section 157 157 166 22. Gumri communication and signaling section 161 164 169 23. Sevan communication and signaling section 64 64 62 Database 4 24. Yerevan locomotive depot 258.5 247 254 25. Gymri locomotive depot 279 279 280 26. Sanahin locomotive depot 109 110 111 27. Yerevan wagon depot 237.5 211 216 28. Gymri wagon depot 157 158 162 29. Nurnus wagon reparation 14 14 15 30. Restoration and anti-fire trains 105 100 101

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31. Security-guard service 341 315 321 TOTAL: 4,803 4,676 4,745 Source: HWTSK with data provided by AR departments

A review of the HR Inventory indicates that there are a substantial number of middle management positions which are listed as head of unit but where the span of control is small, often as few as two persons. The review also shows considerable duplication and overlap within the organization. This is illustrated by the security service, where, in addition to the Guard Service of 321 employees, there are approximately 113 other guard positions listed in the branches. This means that AR has some 434 guards, or about one guard for every 2 kilometers of line. Inspection of the data base also shows an unusually high number of drivers earning a wide range of nominal salaries, but mostly earning as much as heads of units.

We have not audited the figures provided but observed that there are slight differences between the various lists of employees kept by different departments. These discrepancies and others related to employment data draws attention to the lack of a consistent management information system related to human resources. The explanation for the difference between the staffing list, the HR department employment numbers and the inventory arises in part because of the different periods during which each was compiled and the content of the underlying data. The staffing list contains the nominal list of all AR positions; the HR list contains the current positions as of December 31, 2005; and the data base inventory we prepared contains the actual employees that were on the accounting salary list for November 2005, when the data base inputs were received. We have used the inventory data base for staff analysis purposes and at the end of this section of the Chapter we provide recommendations to strengthen the human resource management information system.

Human Resource Flows The hiring figures shown in the summary tables also include transfers to head office. Fourteen employees were transferred to head office in each of the years 2004 and 2005. Additionally, the entire 94 staff Security Guard Service was transferred to AR in 2004. Data for earlier years were not available. The number of persons hired in the years 2004 and 2005 indicates that new staff intake for those two years is about 22% of Armenia Railway’s total staff. At the same time the reductions indicate a substantial voluntary staff turnover. The railway (HR and accounting departments) accounts for this significant staff turnover by explaining that young inexperienced workers who are hired for entry level positions quit soon thereafter because railway salaries at the entry level are not attractive. However, there is also evidence that older workers (64 years of age) have also been recently hired.

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Employment flow 1999 - 2005 Hiring Reduction End Year New Transfer of Year 1999 4,391 2000 763 613 4,541 2001 514 920 4,135 2002 540 498 4,177 2003 1225 n/a 899 4,503 2004 642 (108) 524 4,621 2005 640 (14) 585 4,676 Source: AR Finance and Economic and HR Departments

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Armenian Railway Restructuring Project: Final Report Human Resources & Social Impacts

AR Employment Flow ( Summary 2003, 2004, 2005) Number of employees Reduced Staff Position

Personal Other Period Total Male Female Pensioners Hired40 Total Reduction Management Specialists Labor Request Reasons Year 2003 4,177 3,353 824 354 1225 899 398 375 126 197 1621 2685 Year 2004 4,621 3,738 883 375 642 524 446 14 64 260 1696 2665 Year 2005 4,676 3,774 902 339 640 585 470 36 79 156 1456 3064 Source: Financial/Economic Department and HR Department Date: 31.12.05

40 Updated information received in May indicates that for the year 2004 hiring figure includes 14 transfers to head office and 94 Guards. For the year 2005, hiring figure includes 14 transfers to head office from other branches. The number of transfers included in the hiring figure for 2003 is unknown.

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Since the reported hiring, transfers and departures as presented in the above tables make it difficult to understand the employment flow and to confirm what a realistic actual attrition rate might be, we requested that the HR department confirm names of employees hired in years 2004 and 2005 and the list of those who quit. This proved to be a time consuming task for the HR department who had to call each department and station to get a list as it appears that there is no consolidated record at head office. From the information that the HR department was able to provide we compiled hiring tables for 2004 and 2005. These tables which follow the format of the employee inventory are included in the HR Annex and identify the employees that were transferred to head office as well as newly hired employees. Since AR appears to be unable to provide a list of employees who quit in 2004 and 2005, to get some idea of turnover of new hires, we compared the names on the hire list to the names on our inventory data base to determine which employees hired in 2004 and 2005 were no longer working as of the date we prepared the employee inventory.

It should be noted that there are some discrepancies in AR’s reported hiring numbers. Data provided by the Economic and Finance Department indicate 642 employees (including transfers) were hired in 2004 compared to 618 new hires reported by Human Resources based on phone calls to the branches. For 2005 the difference is 640 compared to 664. The overall summary below of the hiring tables included in the HR Annex shows the status of newly hired employees in 2004 and 2005 as compared to the inventory data base of employees we prepared and confirms that a significant percentage of new hires are no longer working soon after being hired.

Employees Hired and Employee Departures Total Total Still Employed In Departures % Of Newly Hired Less HWTSK Employee Of Newly Hired Not (based on Transfers Inventory Data Base Hired Working At telephone (all Time Of survey) reasons) Inventory Hired 2004 618 510 435 183 36% Hired 2005 664 650 520 144 22% Source: HWTSK with input from HR Department

Natural Attrition From earlier information we estimated that for 2004 and 2005 the rate of natural attribution was around 9%. The number of quits would indicate an apparent higher overall turnover where in fact updated information indicates about 25% of staff turnover rate would appear to come from the newly hired. Since we only have information of quits related to new hiring for two years it has been it is difficult to verify an actual rate of natural attrition and some employees hired in late 2004 or in 2005 may quit in 2006 (after our review was completed). However, based on the two year experience, the rate of attrition would appear to be about 6% among longer term employees. If normal retirement is enforced and early departure is implemented for workers over the age of 50, experience in restructuring elsewhere shows that under such circumstances a voluntary quitting rate would be modest and cannot be relied upon to reduce employment numbers.

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5HFRPPHQGDWLRQ To improve human resource management information, the head office HR department should be provided with software to keep consolidated computerized records of all staff in a data base similar to the one we prepared for this project. The information should include name, position, whether full time, part-time or temporary, date hired or date of transfer, date of birth, contact information and information on any training in which the employee has participated. The head office HR department and the Accounting Department should also receive timely information from each branch at the time a new employee is hired and when the employee quit or is dismissed for any reason to ensure that the HR and the Accounting Department have consistent HR data. Employees transferred from one department to another should be shown in the records of the HR department as a transfer and not a new hire. Average Number of Employees and Average AR Monthly Salary The national average salary in Armenia as of January 2006 was 55,146 Drams. Nominal AR salaries over the year 2005 were rising to match the national average salary but started to decline in early 2006. The reason given for the decline is that “salaries were adjusted to reflect less robust revenues”. Average Number of Employees and Average Monthly Salary Average Average Number of Monthly Period Employees Salary (dram) Year 2005 January 4,531 47,799 February 4,500 50,390 March 4,536 49,926 April 4,535 47,988 May 4,532 48,478 June 4,536 48,579 July 4,549 49,457 August 4,540 52,570 September 4,506 52,106 October 4,518 51,970 November 4,558 52,911 December 4,532 50,982 Year 2006 January 4,561 52,962 February 4,550 50,211 Source: AR Finance and Economic Department

Recommendation: The current salary structure relies on outdated nominal salaries based on an ill defined assessment of job difficulty and does not promote performance. A new system of employee remuneration is needed; one that links actual salary and promotion to skill level and performance against defined goals, rather than on education levels and personal attributes. In the medium term, this will require that AR conduct an HR Audit. Audit Areas would include:

• Job specifications and descriptions based on the restructuring model • Valid recruitment and selection process for new staff41

41 Currently hiring is based on choosing new employees from a narrow base of applications filed with AR by would-be candidates and familial and other ties often influence the selection process. Job openings should be advertised in public media to ensure that AR gets to choose the best possible candidates from the available labor force.

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• Competency testing for transfers • Formal wage and salary systems/benefits • Employee handbook • Absenteeism and turnover control • Orientation program for new staff • Training and development • Performance appraisal and management system

Recommendation: It is generally accepted that working conditions include more than salary and wages. Currently some offices are poorly heated, light levels are inadequate, and uniforms are falling apart. We recommend that AR make improvements in the physical working conditions of its employees. This will have a positive affect on employee morale and productivity.

AR STAFFING NEEDS NOW AND IN THE FUTURE This section of the report discusses employee impacts related to the restructuring options discussed previously. However, AR can take many steps to improve its productivity before implementation of the selected restructuring option, and, in fact, such prior steps will help reduce AR costs and help the transition to the restructuring program. Abolition of unnecessary functions with corresponding staff rationalization will improve AR productivity.

Stations in 2005 with no activity

Number Wagons Passenger tickets sold Loadings Stations of Stations Tons employees EMU International Loaded Unloaded Vanadzor section 1 Hakhpat station 6 2 Kober station 6 3 Archout station 6 Gumri section 4 Arevik station 5 5 Akhouryan station 5 6 Maralik station 5 Armavir section 7 Archalyus station 6 Yerevan Section 8 Noraghavit station 11 Karmir Blur section 9 9th km station 6 10 Proshyan Station 8 Ararat section 11 Mkhchyan station 7 12 Kapan station 6 13 Megri station 6 Abovyan section 14 Yekhvard station 10 15 Nor-Hadzn station 6 16 Mekhradzor station 8

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17 Kakavadzor station 6 Sevan section 18 Fioletovo station 6 18 Ghoshavan staiton 2 20 Artanish station 6 21 Ijevan station 6 Total Employees 133 From data received from AR passenger traffic and freight departments, we prepared consolidated tables for the years 2004 and 2005. The consolidated tables, which are included in the HR Data Annex (on CD-ROM), provide a listing of stations in all sections, the number of staff in each station, the number of passenger tickets sold (for both electric and international trains), the number of tonnes loaded and the number of wagons loaded and unloaded. In summary, there are some 21 stations with no reported activity highlighted as shown in the table above.

There are also a number of other stations (15) shown in the table below where the overall level of activity is not significant (a combination of under 1,000 passenger tickets sold, less than 1,000 tons loaded and fewer than 100 wagons loaded or unloaded). Many of these and the stations with no activity may be currently train control points. With a radio dispatch train control system as recommended in Chapter 4, these stations and indeed most stations except for the stations with significant volume should be considered for closure or designated for temporary use (e.g., passengers could board and disembark without having a ticket) and freight customers would use the customer service center to conduct any necessary billing and payment activities.

Stations in 2005 with low activity

Number Passenger tickets sold Loadings Wagons Stations of Tons employees EMU International Loaded Unloaded Vanzador section 1 Sanahin station 13 266 34 80 1 64 2 Tumanyan station 7 46 3 Pambak station 6 79 6 4 Nalband station 6 225 4 Gymri section 5 Khaltakhchi station 5 174 1,937 36 21 6 Dzagur station 5 511 10 97 7 Mayisyan station 6 56 5 8 Akhin station 6 414 16 9 Bagravan station 5 703 10 Ani station 8 245 84 2 12 11 Getap station 5 20 12 Arteni station 6 169 13 Karakert station 6 653 40 752 12 40 14 Bayandur station 6 62 149 5 6 Kamir Blur section 15 Spandaryan station 9 32 6 95 Total 99 3,010 74 3,601 77 407

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We have analyzed the current HR inventory against the staffing levels that would be supported to the year 2020 by the restructuring options (see Chapter 4). In each feasible option, different actions are suggested to reduce both capital and operating costs. These include the use of radio- based train control systems to eliminate the need to maintain operating stations, closure of lightly used branches (including closure of the stations beyond Dilijan where the line is closed but some facilities and stations remain staffed), consolidation of freight payment and billing activities into a customer service center, the use of contractors for some infrastructure works projects, consolidation of rolling stock activities into fewer depots, and, in some cases, elimination of electrification on lightly used branch lines. These actions will permit the closure of many of the stations with no or limited traffic generation capability. The stations closed will depend on the Governments choices relative to the continuation of passenger services but many lightly used stations could be closed except to allow passengers to board and disembark while buying tickets either on board or from sales from vendors or other public places.

Restructuring Program Impacts

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The recommended Full Concession Option includes a cost reduction program, increased use of contractors, implementation of a customer service center and radio train control procedures, elimination of many stations and related facilities, and no passenger services. This restructuring plan calls for overall staff reductions of up to 3,400 over the next 14 years, with much of the employment restructuring occurring by 2012. Based on these and other elements of the restructuring program, AR would have fewer but more skilled staff after restructuring and some surplus staff might be able to find employment with contractors who would provide services to the restructured railway. The table above shows the details of projected staffing requirements.

STAFF REDUCTION METHODOLOGIES In this section of the report we discuss how AR could implement phased-in staff reductions. It would not be productive to suggest that staff reductions be implemented with the intended goal being that of simply reducing employment numbers. To be effective and obtain the desired Armenian Railway Full Concession Employment Summary Projected % Employment Summary 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Change Track & Structures Basic Maintenance 440 440 440 344 306 273 267 262 257 252 247 242 237 233 228 224 Traffic Sensitive Track Maintenance 111 114 101 94 88 82 82 83 83 84 84 85 85 86 86 87 Capital Programs 181 133 185 35 52 26 71 68 68 68 68 68 57 65 68 68 Office & Supervision 74 69 73 43 34 23 21 21 21 20 20 20 19 19 19 19 Total 806 757 799 515 479 403 441 433 429 424 419 415 399 403 402 398 -51%

Electrical SubStations 288 288 288 130 97 87 83 81 80 78 77 75 74 72 71 69 Contact Wire 180 180 180 81 61 55 52 51 50 49 48 47 46 45 44 43 Capital Programs 15 48 48 22 17 17 17 17 17 17 17 17 17 17 17 17 Office & Supervision 55 59 59 24 13 9 9 9 8 8 8 8 8 8 8 7 Total 538 575 575 256 189 169 161 158 155 153 150 147 145 142 140 137 -74%

Signals & Communications Control Point Maintenance 243 243 243 137 31 31 31 31 31 31 31 31 31 31 31 31 Communications Maintenance 20 20 20 14 14 13 13 13 12 12 12 12 12 11 11 11 Traffic Sensitive Employement 50 51 45 37 31 31 31 31 31 31 32 32 32 32 33 33 Capital Renewals 7 21 10 11 11 1 1 1 1 1 1 1 1 1 1 1 Office and Supervision 71 74 71 44 19 17 17 17 17 17 17 17 17 17 17 17 Total 391 410 389 244 106 93 93 93 93 93 93 93 93 93 93 93 -76%

Stations & Operations Stations & Operations 438 438 438 178 31 29 27 18 18 18 18 18 18 18 18 18 Volume Variable Station Staffing 311 320 316 294 260 208 122 50 50 51 51 52 52 53 53 54 Freight Specific 135 138 129 111 88 61 57 50 45 40 36 32 29 26 24 22 Passenger Station 14014000000000000000 Passenger Train 929200000000000000 Capital Programs 9 3 2 38 57 23 23 2 3 0 0 0 3 0 0 0 Office and Supervision 72 73 57 34 20 14 10 6 5 5 5 5 5 5 5 5 Total 1,197 1,204 941 655 456 335 239 126 121 114 110 107 107 102 100 99 -92%

Wagon Depots Fleet Variable Expenses 132 122 110 68 50 47 44 41 40 40 41 41 41 41 42 42 Wagon Load Varialbe Expenses 66 68 69 24 29 39 39 39 39 40 40 40 41 41 41 41 Wagon Kilometer Variable Expenses 66 68 70 48 39 39 40 40 40 40 41 41 41 41 42 42 Capital Renewals 50 50 79 39 25 25 24 24 23 23 22 22 22 21 22 20 Office and Supervision 51 50 45 16 11 11 10 10 10 10 10 10 10 10 10 9 Passenger Staff 252500000000000000 Fire Trains 100 100 101 34 34 34 34 34 34 34 34 34 34 35 35 35 Total 489 482 473 228 188 194 191 188 187 187 188 188 188 189 191 190 -61%

Locomotive Depots Loco Drivers and Assistants 241 243 195 157 120 112 104 102 101 100 98 97 96 94 93 92 Locomotive Depot Staff, for Depots 45 45 8 8 8 8 8 8 8 8 8 8 8 8 8 8 Locomotive Depot Staff Variable 172 173 84 66 60 51 44 44 43 43 43 43 42 42 42 43 Electric Train Staff 6600000000000000 Capital Renewals Staff 56 43 13 13 11 11 11 10 10 36 10 10 9 9 9 9 Officce, Supervision, Medical, Drivers, Guards 115 113 44 29 23 21 18 18 17 20 16 16 15 15 14 14 Total 635 622 344 272 221 203 185 182 179 206 175 173 170 168 167 165 -74%

Administration Management 5543333333333333 Infrastructure 33 33 30 22 16 16 16 16 16 16 16 16 16 16 16 16 Operations 35 35 31 23 17 17 17 17 17 17 17 17 17 17 18 18 Rolling Stock 26 26 22 17 12 12 12 12 12 12 12 12 12 12 12 12 Freight 1212118666666666777 Accounting 148 148 133 67 34 34 34 34 34 34 34 34 34 34 34 35 Safety 1515126666666666666 Passenger 5540000000000000 Other 27272414888888888888 Security 316 316 32 31 31 31 31 31 31 31 31 31 31 31 31 31 Total 622 622 303 191 133 133 132 132 133 133 133 134 134 134 135 135 -78%

Railway 4,678 4,671 3,825 2,361 1,773 1,529 1,442 1,312 1,297 1,309 1,269 1,256 1,236 1,231 1,226 1,216 -74%

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 6 - 11 Armenian Railway Restructuring Project: Final Report Human Resources & Social Impacts productivity outcomes staff reductions are tied to organization redesign strategies such as abolition of functions, merging of units, job redesign, and removal of unnecessary layers of management. Such redesign results in the elimination of job positions. In the case of AR, jobs currently continue to exist even when there is little or no operational function, such as that illustrated with passenger and freight traffic and idle stations with the justification being outmoded norms unrelated to business volume and that some stations are control stations. As discussed in the restructuring chapter of the report radio dispatch would be more efficient. Hence, one of the key aspects that would enable AR to achieve efficiencies in a restructuring is better management of its human resources, including the recognition by senior and middle management that AR is overstaffed by normal commercial standards and to start taking steps now to correct overstaffing. A discussion of this important management issue is also included in Appendix G: Barriers to AR Employment Restructuring.

Phased Staff Reductions An incremental approach will be needed to reduce the size of AR’s workforce while mitigating the corresponding social impact on AR’s workers. An incremental approach includes setting a goal of yearly staff reduction targets tied to specific actions such as the consolidation and closure of depots, and closure of stations and other concrete action. Hence, the depth and breadth of actions required to attain the restructured model of AR will require a time based plan to which staff reductions can be linked. This approach would be in line with feedback from the HRWG that one way to mitigate the social impact of restructuring would be to phase in staff reductions as operational changes are implemented. However, certain actions in preparation for a broader restructuring could be implemented immediately to begin to achieve the right number and mix of staff. These actions are included as part of next steps at the end of this chapter

Staff Reduction Potential The age profile of AR with an ageing workforce indicates that there is significant potential to phase in staff reductions over time and mitigate redundancy impacts substantially. To determine the magnitude of potential reductions over time using the age profile in the HR inventory we determined how many staff would be reaching the normal retirement age of 63 between the years 2006 to 2012. As shown in the following summary table below42, there are currently 422 employees that have already reached normal retirement age and an additional 393 employees that will reach normal retirement age by 2012 for a normal retirement potential total of 816. Employment reductions from this potential of 816 normal retirements alone would not accomplish the significant employment reductions recommended, especially given the fact that it may not be desirable to have certain employees with critical skills retire until a replacement is trained, provided that the trade union would agree to such an arrangement43.

Number of AR Workers Reaching Normal Retirement Age by Year Potential Retirement in Total 2006 2007 2008 2009 2010 2011 2012

42 The complete table “Summary of Potential Normal Retirement to 2012 by branch is included in the HR Annex. 43 See Appendix G Barriers and Constraints for a broader discussion of collective agreement.

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Employees 422 39 32 58 79 108 78 816

The scope for employee reductions can be expanded by inducing employees to retire early, as was done in the restructuring of the education sector. We estimated the number of AR staff that would reach the age of 50 in each year between from the years 2007 to 2012. The table below indicates that up to 2,220 AR staff will be reaching the age of 50 over the next six years.

Number of staff reaching the age of 50 Employees Reaching 50 By 2007 2008 2009 2010 2011 2012 Total Employees 1,398 169 158 177 163 155 2,220

Profile of Potential Redundant Staff The profile of potential redundant staff as identified by areas of AR’s operation that are or would be in surplus position as a result of restructuring more or less mirrors the general AR worker profile. Other than the guard service, where the relative age is considerably younger, over 50% of all potential redundant AR employees are 46 years of age or over. Less than 15% have university level education; over 50% of employees have middle education while about 23% have specialized middle education. The profile of potential redundant staff also resembles to some extent the employees who would be most at-risk if they lost employment. The implication of the AR profile is discussed later in this section (see Armenian Labor Markets).

SOCIAL SAFETY NET FOR REDUNDANT AR STAFF We have taken into consideration a number of factors in the design of a Social Mitigation Plan for redundant AR staff. First, we reviewed the critical issues identified by discussions with the Human Resources Working Group related to employment restructuring, including the role of training and retraining as a key component of social mitigation. We also reviewed community issues related to AR restructuring. Additionally, we took into consideration the Government of Armenia’s Policy as exhibited in recent public sector restructuring and reviewed the relevance of recent international railway restructuring. We also reviewed legal and other barriers and constraints as well as the conditions of the Armenian Labor Market. All these issues were used to help design a social safety net for AR employees who might be affected by the proposed restructuring programs. These findings are summarized here.

Critical Issues List We conducted consultations with AR employee and management stakeholders to develop a critical issues list with respect to the human resource implications of railway restructuring on workers. The following comments and concerns related to restructuring and human resources were raised by the HRWG. The box below lists both input and the relevant action to be considered with respect to impact of restructuring on AR’s workforce.

Identification of Critical Employee Issues Input/ Critical Issues from HRWG Actions Required

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“Drastic changes need to be made in AR’s Need to pace staff reductions to the structure but not all at once since change, timetable of restructuring although necessary, is difficult and people need Overcome resistance to change to get over the old mentality” through information and training

“Not just reduce workers but also improve Link the workforce reductions to railway’s competitiveness with road transport visible actions/investments that and the condition of tracks needs improvement” improve the railway’s operation

“Change is necessary but the Government needs Avoid ad hoc actions to have a good strategy, including dealing with Prepare a time based restructuring affected workers” plan Provide a social mitigation program “Not very many people in the branches Develop a communication strategy on understand that restructuring is needed” the need and benefits of restructuring

“Not just salary but other working conditions Include improvements to the work such as sanitary conditions, workplace environment as part of restructuring. environment (inadequate ear protection, poor lighting, inadequate heating etc.) and lack of career opportunity also need improvement”

“To reduce staff, stop hiring, test staff for Performance standards and tests competence, transfer competent staff and train should be used to screen employees only those that pass the tests” Provide training to improve workers’ knowledge, and performance Staff Training and Retraining The feedback received during consultations with the HRWG suggests that training and retraining will be a key component for both the Social Mitigation Plan as well as to ensure a skilled productive workforce for remaining staff and management. According to the Head Office HR Department, there are occasional one day management information seminars on different railway topics. The following table summarizes the limited training courses that AR has been able to support or to provide to its employees in the recent past. There may very well be some ad hoc on-the-job training being provided at the operational level but overall, very little formalized railway skill training is being organized.

Summary of Training Courses supported or sponsored by AR Year Training Type and Duration Institution Number of Providing Training Employees 2003 One – Two Week Duty Person Training Gymri Railway 700 (in groups) Course College 2003 6 year Course in Railway Communication Rostov University Support for 4 2004 6 year Course in Railway Communication Rostov University Support for 3 2005 6 year Course in Railway Communication Rostov University Support for 4 Source: Head Office HR Department

Training and retraining can play a significant role in the restructuring of AR in three ways:

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CRITICAL RAILWAY SKILLS DEVELOPMENT: The first area to consider is how formalized ongoing training can be used to ensure that AR has the skilled workforce to operate an efficient and safe transportation service such that, as older skilled workers retire, trained younger workers are able to take their place. Older workers cannot be relied upon to provide AR’s critical railway skills indefinitely and AR needs a time based skills development program to acquire and replace critical railway skills to ensure that as older workers leave AR is developing a pool of trained workers from which to draw. One way to plan for succession is to identify a core group of technical specialists in locomotives, electrification, signals, and perhaps infrastructure. This approach would be valid for the proposed options since there will be a substantial pool skills to choose from given the magnitude of the proposed staff reductions for the preferred option. Candidates for the core group that would be retained should be selected through competency testing44. This core group could be matched either with existing younger staff with the appropriate qualifications or, eventually, with new hires. If not available from the existing employees, the experience is that many concession operators hire practical engineers and match them with an older supervisory technical specialist who has worked his or her way up through the ranks. We would recommend such teams for each major discipline: track: 3 teams; locos 1 team; wagons 1 team; electrical 3 teams; signal 3 teams.

SOCIAL MITIGATION TOOL: The second role for training is the use of training and retraining as a social mitigation tool, as a means to provide departing redundant employees with new skills valuable in the current labor market in Armenia. The Social Mitigation Program in this chapter includes this aspect of training.

IMPROVEMENTS TO WORK PRACTICES: Thirdly, staff training is useful for the implementation of new work practices and when implementing new technologies. For example, the use of radio-based train control will require training for all duty staff, supervisors, and other staff with access to the railway line; the implementation of a customer service center will require training not only for AR commercial staff but also for major customers.

Recommendation: An analysis of the specific training and retraining needs of redundant staff would be part of the social mitigation plan. However, an overall training needs assessment for AR is recommended as part of the restructuring implementation strategy. Such an assessment is beyond the scope of work in this report. Additionally, for staff that would remain in a restructured AR, we also recommend that the training needs assessment also examine the most effective training delivery mechanisms, as AR’s current capacity to provide training for its staff is limited.

Recommendation: Currently hiring is based on choosing new employees from a narrow base of applications filed with AR by would-be candidates and familial and other ties often influence selection. We recommend that future hiring is done on a transparent basis such as public advertising of railway job openings to ensure that the railway gets to choose the best possible candidates from the available labor force.

44 The Human Resource Working Group has suggested that AR reintroduce competency testing.

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Review of the Armenian Government Policy on Public Restructuring As part of an examination of redundancies in other public sectors, we reviewed the Armenian Government’s policy with recent public restructuring cases. The three cases reviewed are the Armenian Water Utility, the Health and the Education sectors. The review, described in more detail in Appendix E, confirms that restructuring of the workforce in different public sectors is well underway in Armenia and that the Armenian Government has been consistent in terms of providing compensation for redundant public sector workers.

Community Issues Related to Restructuring Road transport for goods and for passengers has been gaining market share over rail transport. As seen in the consolidated table on station activity in the HR Annex, from 2004 to 2005 there has been a decrease in passenger tickets sold, both for the electric trains (decrease of 30%) and international passenger traffic (a decrease by approx. 7.7%). Appendix F provides a description of our community visits and elaborates on our findings. In summary, two significant community issues are identified with respect to railway restructuring. The first is that expanded rural transportation may require road rehabilitation and the second is the need for targeted social mitigation to assist workers in selected railway communities affected by AR restructuring to find alternate employment through redeployment assistance.

Review of the Legal, Political and other Barriers to Restructuring While there are some minimum legal redundancy requirements and collective agreement provisions that would need to be followed, our review has found that there are no insurmountable legal barriers to restructuring or to reducing AR staff levels without restructuring. The barriers and constraints relate primarily to management practices and attitudes. These are discussed in Appendix G: Barriers to AR Employment Restructuring. Since such barriers often exist and were overcome in other restructuring situations both in Armenia and in other countries, we conclude that with effective management practices and discipline, good human resource planning and a feasible social mitigation program the barriers can be overcome to restructure Armenian Railways.

Armenian Labor Market In our review of redeployment perspectives for AR redundant workers we also examined the Armenian Labor Market with respect to its absorption capacity and average redeployment time. According to expert assessments, no less than 70 percent of total employment is located in small enterprises, agricultural livelihoods or self-employment, and a significant proportion of jobs (40-45 percent) are informal sector jobs. The National Statistical Service (NSS) of Armenia reports that official unemployment decreased by 18.4 % from year third quarter 2004 to 2005.

The most recent data available (2004) from the NSS indicates that among those who are unemployed, the largest percentage by age is for those between the ages of 31 to 50 (77.1% for males and 83.7% for females. The highest unemployment by education is for those unemployed with specialized secondary education. The table below indicates a tendency for unemployed to fall into long term unemployed (more than one year). In summary, the redundant workers most

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 6 - 16 Armenian Railway Restructuring Project: Final Report Human Resources & Social Impacts at risk for becoming long term unemployed are those that match the profile of age (between 31 to 50 years of age), and education (specialized secondary education); consequently redeployment assistance would need to be targeted to this group.

Duration of Unemployment 2003 Registered unemployed Total Females Youth (aged Living in 16-29) rural areas Number of unemployed, persons 118,646 81,600 33,398 7,328 Of out of them by duration unemployment: From 1 to 3 months 3,638 2,380 - 423 From 3 to 6 months 6,511 4,293 - 557 From 6 months to 1 year 12,373 7,991 - 916 More than 1 year 96,214 66,936 - 5,432 Source: Armenia National Statistical Yearbook45

PROPOSED SOCIAL MITIGATION PROGRAM The restructuring of AR is likely require a faster reduction in staff levels than can be accommodated by normal attrition—some employees are likely to be made redundant. Since some of these redundant employees may not be ready to leave the workforce due to their financial circumstances, the Government will need to provide a feasible temporary social mitigation safety net including compensation and redeployment assistance. This section of the report recaps the magnitude of potential staff reductions under specific assumptions, discusses compensation options and their related costs and identifies redeployment options, including their assumed take-up and costs. We also discuss safeguards that would need to be put in place to ensure that critical railway skills are not adversely affected by staff reductions. This section ends with recommended actions to bring the AR workforce to the number recommended by the restructuring specialist.

Potential Staff Departure Targets We have identified that there is scope to achieve 3,361 staff reductions using retirement and targeted pre-retirement departure as shown below.

Retirement Assumptions: • We assume that 95% of the 422 employees or 401 employees currently at normal retirement age leave in years 2007 and 2008 ( about 200 in each year) • We assume that 95% of the 394 workers or 374 reaching normal retirement age by 2012 leave as they reach retirement.

45 Most recent data available at the time of this report is 2003.

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Departure Assumptions for Staff over the age of 50: • We assume that 90% of the 2,220 employees or 1,998 reaching the age of 50 between 2007 and 2012 would be surplus and would leave within a year after reaching age 50 • Given the large number of staff reaching age 50 in 2007; we have split the departure over two years (2008 and 2009).

Other Departure Assumptions • There are 1,091 workers under the age of 50 with 5 or less years of service. We assume that an estimated 400 workers from this group may be redundant, may not be candidates for retraining and internal placement, and as they are identified would be subject for normal release according to the Labor Law and for assistance under the Social Program for external redeployment.

Hiring Assumption • Since one of the mitigation tools will be the transfer of competent staff to fill required vacancies as departure of older workers occurs, we assume only about 95 new positions may be needed to improve the skill and management mix. Since we recommend a temporary hiring freeze that is also part of the collective agreement requirement in the event of layoffs, any new hiring would be limited to skills which cannot be filled from the current workforce inventory, and such hiring would not be expected to occur for the first few years of restructuring.

The table below is intended to provide a basis for setting targets to meet the future employment profile expected after restructuring and for preparing an initial estimate of the costs of departure. AR has been unfairly burdened by absorbing the whole security guard branch, with the youngest age profile in AR (only about 39 are age 50 or over). We have recommended that this branch together with its entire staff either go to the defense department (army) or be spun off as a private security service as soon as possible. We have estimated that up to 10% of other workers reaching age 50 may have railway skills that are necessary for operations. If a staff audit and assessment indicates fewer staff than assumed have skills required, this would increase the scope for staff reductions. Likewise, the mix between the categories of departure may change once a restructuring timetable with specific actions is prepared.

Potential Scope for Staff Reductions by Year Year Category of Departure or Hire 2007 2008 2009 2010 2011 2012 2013 Total 1. Normal Retirement 200 37 30 45 75 103 74 575 1.a from eligible in 2006 200 200 2. Early Departure over age 50 629 152 142 159 147 140 1,369 2.a (from 2008) 629 629 Other redundancy* 50 75 100 100 75 400 New hiring (limited) -5 -10 -20 -25 -35 -95 Potential Scope for Staff Reduction 250 942 907 287 289 224 179 3,079 Security Service 282 282 Total Potential Scope for Staff Reduction 3,361 *less than 5 years of service and below age 50(estimated)

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Adverse Selection We make the assumption that a maximum 5% of the staff reaching normal retirement age may have skills for which replacement is not readily available by transferring an AR employee from another part of the operation. Since the AR collective agreement calls for mandatory retirement of workers reaching normal retirement age in the event of employee reductions due to restructuring, the definition of critical skills will need to be agreed with the trade union. Further, to avoid adverse selection, AR will need to negotiate with the trade union the exclusion of retirement age workers having skills critical to the safe and efficient railway operation for workers who have passed the competency test and would be in the small number of teams that we suggested in the training section of this Chapter. Likewise, we assume that a maximum of 10% of employees reaching age 50 to the year 2012 may also have skills critical to the railway’s operation. These workers should also be screened through competency testing. Adverse selection among this group would be avoided because only those who are deemed to be redundant would be targeted for departure.

Compensation Options and Cost We have examined a full array of redundancy compensation options such as pre-retirement benefits, voluntary departure with severance, special job loss compensation, involuntary departure with severance, and other end of service payments, for their feasibility for AR. In some of the international examples provided in Appendix H, substantial voluntary severance payments were provided to redundant railway workers. However, due to the experience of previous recent public sector restructuring we believe AR would need to make a compelling case to the Government for treating its employees differently than those in the health and education sectors. Hence, the special compensation provisions that we recommend for AR redundant workers would be to match the most generous of the recent Armenian public sector employment restructuring provisions, those provided for the education sector, where workers over the age of 50 deemed to be surplus were given a choice of compensation or redeployment assistance.

We have based the Proposed Social Mitigation Program for AR on feasible options, which can also be supported financially. The end of service payment cost for those reaching normal retirement is defined in the Armenian Labor Code as two weeks of severance based on average monthly wage of worker. For surplus workers over the age of 50, the compensation would be six months special compensation based on average monthly salary or alternately redeployment assistance. For other redundant workers, involuntary departure with procedures and severance according to the Labor Code would apply. The table below uses the average monthly salary (the most recent average we received from AR is for February, 2006) to provide an estimate of the cost of departure compensation.

Table: Estimated Cost of Staff Reduction Compensation Average Severance Estimated Potential Monthly week/month Compensation Total Departures Salary per worker Drams USD Normal Retirement 776 50,211 2 weeks 25,106 17,398,112 41,928 Early Departure 1,998 50,211 6 months 301,266 468,167,364 1,369,578 Estimated Other 400 50,211 1 month 50,211 20,884,400 45,698

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Departures Total 641,495,736 $1,457,204 1 USD=439.5 Armenian Drams

Redeployment Options and Costs The objective of redeployment is to mitigate the negative effects of restructuring on workers deemed to be surplus. Redeployment options are aimed at assisting redundant AR employees with provision of counseling, help with job search and job placement in a new employment situation outside the railway, financial assistance to move to a new location associated with new employment, or assistance to redundant employees to start a new small business. The options and the take-up rates in the table below to assist workers are based on previous experience in assisting redundant workers both in Armenia and internationally.

All employees, except those already over normal retirement age and those within one year of retirement who have reached the age of 50 in specific departments and branches that are to be affected by consolidation, closure or other changes would be eligible for compensation of 6 months salary or for the redeployment options provided through the AR social mitigation program. In addition to the options in the table below, redeployment would also involve internal transfer of AR staff between areas (with retraining where required) provided that an opening exists, their skills are not redundant, and they can pass a competency test as recommended in the feedback from the HRWG. We have previously recommended a Training Needs Assessment to determine the overall type, amount, and method of training that remaining AR workers (including transferred) might require. As the results of that assessment are unknown, the cost estimates in the Social Mitigation Program table below do not include such “continuing-worker” training costs—these costs are a part of the on-going railway business, not directly a result of the restructuring program.

We estimate that up 2,398 AR redundant workers would be eligible for assistance under the Social Mitigation Program. Eligible workers for all options would include all redundant workers but not workers who retire at the normal retirement age. The table below summarizes the estimated take-up and costs of staff redeployment and is based on the following assumptions:

• Approximately 80% or 1,918 AR redundant staff use the counseling service • 25% of the 2,398 staff eligible for training take-up the training programs • 5% take-up the Mobility Assistance funds • 2% accept the Small Business Assistance program • Unit costs are based on the NES experience (except for the Small Business Assistance program)

Estimated Redeployment Costs Estimated Estimated Unit Number of Cost Program Option Participants (USD) Total Counseling 1,918 50 95,920 Training 600 200 119,900

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Mobility Assistance* 120 500 59,960 Small Business Assistance** 50 1,000 47,960 Total $323,730 *For family USD 500, USD 300 for single individual **unit cost estimated, to be confirmed

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Recap of Estimated Social Mitigation Program Costs The total estimated cost of social mitigation includes the cost of compensation payments, the cost of redeployment assistance and any technical assistance required to implement the program.

Program Element Estimated Cost Compensation Costs including severance $1,820,934 Redeployment Costs 323,730 Technical Assistance (estimated) 10,000 Follow-up surveys and program evaluation 30,000 Total $1,820,934

Return on Investment When the costs of the social mitigation program are compared to the ongoing cost savings derived from the lower employment, we find a high return on investment related to the compensation payment of six months for redundant workers reaching the age of 50.

Legal Authority Article 6, Paragraph 2 of the draft Railway Law states that the Government of Armenia has the power for the establishment, re-organization and liquidation of the transportation organization of the state. This provides the basis for proceeding with the recommended restructuring. However, the Government must also issue a decree or a regulation to provide the six months of compensation for redundant workers over the age of 50 since this amount is greater than normal severance in the Labor Law.

Implementation Arrangements The Government has been supporting public sector restructuring with an institutional approach that has been providing redundant workers with a social safety net including income support and redeployment assistance delivered through the Social Insurance State Fund (SISF) for payment of redundancy compensation, and the National Employment Service (NES) for delivery of redeployment assistance. AR has no experience with the scale of employment restructuring and social mitigation envisaged. Hence the use of the (SISF) and the NES as agencies for implementing social mitigation for railway restructuring redundancies would provide an opportunity to build on the existing delivery mechanisms.

Responsibility for Staff Reduction and Social Mitigation Program In some cases, as shown in the example of the Brazilian railway (Appendix H: International Experience with Railway Restructuring), reduction of overstaffing is undertaken prior to concessioning since it increases the attractiveness of the property to concession bidders and increases the likelihood of a competitive concessioning process. It also tends to increase the returns to government from the concessioning. We recommend that AR begin the restructuring and cost reduction process prior to the completing the concessioning agreement. The Government should also complete the recommended studies relative to alternatives to rail passenger transport in Armenia (as discussed in Chapter 4) and determine the extent of passenger services that are to be provided under contract with the concessionaire. Employment

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 6 - 22 Armenian Railway Restructuring Project: Final Report Human Resources & Social Impacts reduction numbers may well be less than estimated in the concessioning plan, depending on the outcome of these studies. The concession process will be dependent on these decisions as will the total impact on staffing. Should the government decide on offering no rail passenger services, as recommended in Chapter 4, staff should be notified and the reduction process started prior to the concessioning. Notwithstanding whether employment restructuring would be undertaken by AR or by the government after the concession has been awarded, it should be linked to a time based plan.

As in the international and Armenia examples with public sector restructuring, we recommend that the Government should be responsible for the financial costs of labor reductions and social mitigation resulting from railway restructuring. At the same time the railway has the responsibility to demonstrate its commitment to improving its viability by taking action in advance of broader restructuring.

Recommendation: We recommend the following actions that AR could implement immediately in advance of broader restructuring:: i. Mandatory retirement among employees who have surpassed their retirement age; ii. Announcement of a retirement policy requiring people to retire upon reaching normal retirement age; iii. Implementation of a temporary hiring freeze with negotiations with the trade union on exceptions relative to critical skills (limited range of critical skills to be determined through a staff audit and competency testing). Projections include the potential hiring of an estimated 95 new staff with specialized skills (technical skills, information technology, financial management, etc.); iv. Start planning for transferring workers to cover non surplus positions as a result of retirement. Planning would include competency testing; v. Request to Government that the guard unit and its staff be removed from AR

Next Steps: Employment Restructuring Actions

Recommendation: In addition to the immediate steps outlines above, we recommend the following next steps to start bringing the AR workforce in line with the future employment profile proposed by the restructuring specialist:

• Initiation of employment restructuring consultations with the trade union according to the Labor Law related to the recommendations that would be implemented immediately above and for those associated with broader restructuring.

• Preparation of a schedule of staff reduction targets by year tied to the efficiency improvements and restructuring timetable of actions such as closure of stations, or consolidation of workshops, etc.

• Announcement of a policy on retirement. For example, all workers who have reached normal retirement age to be retired (starting in year 2006). Limited exceptions related to critical railway specific skills to be negotiated with the trade union.

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• Preparation of regulations related to the Draft Railway Law to enable special compensation (six months for workers aged 50 or over).

• Initiation of discussions with the Government on funding and the SISF and the NES with respect to arrangements related to the implementation of the AR Social Mitigation Plan.

• Preparation with technical assistance if required, of a communication strategy aimed at providing information to stakeholders including staff.

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7: Accounting Issues

his Chapter of the Final Report discusses whether or not Armenian Railway has the capability to accurately calculate costs of providing services. Where there are T deficiencies in the capability, this section discusses what is needed to overcome them. In this Chapter we first discuss the current state of AR’s cost accounting capabilities. AR’s current capabilities are summarized and specific topics related to accounting systems and standards are explored. Then, the different capabilities required for adequate cost calculation are defined in light of the different restructuring options, as different business models require different capabilities. The needed capabilities are compared to the current state’s capabilities. Then, the implementation of needed changes and additions to capabilities is discussed. Finally, estimates of the time and other resources need for implementation are given. The Chapter also discusses the interim steps that AR ought to take to gain immediate benefits from simple changes.

This Chapter also provides specific examples of accounting structures by way of providing an appropriate chart of accounts and function code templates for whichever restructuring option is chosen. These templates are not the final accounting structures: that must await the final management of AR and its partners. Nonetheless, the templates closely model final accounting needs.

The railway services AR provides are various and costs need to be calculated for all of these services. It is obvious the railway services include single wagon-load and block train-load movements of cargo; and the movement of passengers. There are, however, other railway services AR can and does provide. These are the transmission of electric power; the repair of private or foreign owned rolling stock and of private tracks and stations; the rental of cargo wagons, locomotives, and even employees; and the operation of special trains, of entire branch lines, and of international movements. A proper accounting system must capture the costs and revenues associated with each of these elements.

METHODOLOGY OF REVIEW The methodology we used to document and understand the current state of AR’s cost accounting involved at least the following steps:

• Studying written descriptions of the legacy accounting approaches (Soviet-era) for background, as well as reviewing HWTSK work in reforming related railways, e.g. in Georgia.

• Traveling to AR originating points of cost data capture and documenting procedures at these points. These points include central offices yards, stations, and workshops. Forms were gathered and translated, interviews conducted, and data flows charted. Operations were inspected and observed so that costs could

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be understood on an activity-based cost level.

• Constructing a table to map headcount onto organization structure, and to map functional/geographical structures onto accounting structure; i.e. mapping the cost accounting world onto the “real world” to see how the two worlds corresponded to one another. Most of AR’s operating cash costs are currently labor, therefore, headcount is a key cost driver to map correctly.

• Reviewing the Annual Reports and audits to learn of past problems and efforts to revolve those problems. Qualifications were investigated in interviews to learn if audit efforts had revealed major problems in the recording of costs, and, further whether management has moved to remedy these shortcomings.

• Analyzing the chart of accounts, one account at a time, to learn the actual practices of “what went where”. The intelligent recording of expenditures and of accruals is the foundation of adequate cost analysis.

• Interviewing and meeting with both senior and mid-level accounting and financial management.

None of the above efforts was an attempt to discover fraud, theft, willful misconduct, gross negligence, or any other illegal undertaking. The findings in this part of the report are not meant to provide, and do not provide, any opinion as to the adequacy of management’s discharge of its fiduciary responsibilities or to management’s compliance with legal regulations.

CURRENT STATE OF AR’S COST ACCOUNTING This section on the current state of AR cost accounting describes our understanding of the approach and basis for AR’s allocation of costs; the approach and methodology for the allocation of revenue; the flow of data for use in management decision-making, the adequacy of cost-centers/enterprise accounting; the adequacy of the general ledger’s chart of accounts, and the use of the data in managing the performance of AR. The current state’s description is broader rather than narrower because the description includes some measure of cost management and control of costs.

A narrow description would confine itself to a description of whether or not expenditures are recorded in ways that permit allocation and direct assignment to cost-collection centers such that specific activities may have their proper costs assigned to these activities. The narrow approach seeks only to see if the accounting structures permit the accounting activities of direct assignment and of allocation.

The broader description adds to the narrow approach. The broader approach also investigates whether or not the railway possesses the additional procedures, management accounting reports, and other structures required to actively manage costs. Another way of stating this is: Does management try to reduce costs by actually using its accounting reports to achieve business objectives? If a management does not use it’s accounting for that purpose, then it is likely, though not certain, that the accounting structures has accumulated flaws and

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 7 - 2 Armenian Railway Restructuring Project: Final Report Accounting Issues inadequacies that make it inadequate for management purposes. Accounting is a tool and if a tool is not used often and used well, it is unlikely any shortcomings of the tool will be remedied. While it is not impossible that an individual or an entire railway will actively use a defective tool that it is free to improve or replace, it is unlikely. The field review of the current state determined that the approach for the allocation of costs is an over-simplification of sophisticated but dated costing formulae using dated data collection practices. The paper and data entry trail was reviewed from their origins at a city’s station and a workshop through to its final arrival at central accounting for payment of receivables. The review shows a series of redundant paper forms – many still bearing revision dates from the 1970’s and 1980’s in Russian. A source of redundancy is the use of over-lapping data entry forms. One set is/was used to control the physical movement of shipments; another set is used to account for and generate payroll, passenger tickets stock, and material additions and withdrawals; and a final set is used to collect expenditures for General Ledger entries. The process is manual until the data reaches very centralized data entry and processing points. The same data, for example, wagon waybill and station number, may be entered several times, by ink and pencil, by the same person on the same day, only on different forms.

We determined that the flow of information from the field to headquarters was largely adequate to calculate costs for pricing, subsidy, and regulatory purposes. Some older data entry fields that are now left blank are still required, e.g. commodity codes, for cost accounting purposes.

Our review found that there are no function/purpose codes on many forms used. These fields need to be added to capture the use of material and labor. Because there are no function codes, many positions are 100% dedicated to cargo or to passenger so that costs may be 100% charged. However, these positions could be combined into just one position and split if function codes were used. The addition of another field of codes is not difficult because AR’s current financial software is database-oriented. AR’s current financial management team appeared unaware of this opportunity to substantially upgrade accounting data quality.

Cost Structure & Allocation Our investigation found that AR’s actual operation is characterized by a high fixed-cost structure, which is inconsistent with the general basis of cost calculation employed at AR. AR’s general basis is to treat all fixed and overhead costs as 100% variable, and then to allocate these costs to direct expenditures on the basis of just one output, tonne-kilometers, after subtracting direct and allocated passenger costs. In short, all inputs are either direct by definition or are a function of one, and only one, output: tonne-kilometers. (Passenger-kilometers are treated as equivalent to tonne-kilometers; i.e., as equally weighted traffic unit-kilometers). Some members of AR’s Financial Management appeared to be less clear than others on how costs were allocated and calculated. However, it was clear that all costs used for subsidy or pricing decisions were based upon fully allocated costs and all costs were allocated to traffic unit- kilometers.

AR operates a signaled, mainline, electrified railway built to carry far more passenger and cargo volume than AR current does or is likely to (see Chapter 3). The former volumes, current volumes, and projected volumes discussed in other parts if this draft Final Report give compelling evidence of high fixed cost design of AR’s plant. Furthermore, discussion of AR’s uses of human resources in this draft Final Report attest to the preservation of large numbers of

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 7 - 3 Armenian Railway Restructuring Project: Final Report Accounting Issues employees, often at idle stations and offices, that could only be used at activity levels perhaps a full order of magnitude greater than current and projected volumes.

The use of a 100% variable cost based on allocation formula is dysfunctional at AR. There are two causes of the dysfunction:

1. Allocating high fixed costs over small volumes overstates costs, thereby overpricing services. In the long run, the solution is to reduce fixed costs. AR has been operating this way for over a decade, overpricing drives away otherwise profitable business; and

2. Obscuring expenditures on unneeded assets and human resources. The process of allocating all of a fixed cost activity to other activities has the effect of making the fixed cost burden non-transparent to management.

The role of accurate costing in setting railway prices is important. Cargo moved by railways is generally more sensitive to transport prices than cargo transported by highway. High value- added cargo, such as clothing or diamonds, is insensitive to the price of transport because transport is a relatively small part of the final sales price. Low value-added cargo, such as ore or cement, however, is more sensitive to the price of transport because transport is a relatively large part of the final sales price. Therefore, for a railway to be commercially successful, it must be able to price its services with an accurate idea of its costs and of its customers’ price sensitivity and competitive position.

Our investigation found that AR’s accounting procedures do not properly consider AR’s deferral of maintenance expenses. This is a major shortcoming of AR’s cost accounting as it is undeniable that routine maintenance and renewals have been postponed. Indeed, the very reason the World Bank has been approached for funding is to help remove these deferrals . The cause of the problem is the discretionary timing of maintenance costs. Many non-transportation enterprises’ costs are immediate and management has little discretion in making expenditures for direct labor, contract services, raw material, energy, or merchandise. But railways can choose to operate for many years without performing maintenance on rolling stock and infrastructure; the problem for railways is that maintenance needs and maintenance expenditures are not always matched in their timing. In AR’s case, this presents a false picture of the viability of the current enterprise. VectoRail’s Cartage Model HWTSK found that the VECTORAIL CARTAGE costing model, provided to AR in 2001 through a World Bank technical assistance project, was not implemented. Completed by VectoRail, a Canadian firm specializing in railway cost procedures, the “Cartage” model and associated software was intended to provide accurate costing both for pricing conventional cargo movements and for calculating the costs of subsidized service, such as, to quote VectoRail:

³3XEOLFVHUYLFHREOLJDWLRQV$SRLQWWRSRLQWFRVWLQJV\VWHPLVSDUWLFXODUO\XVHIXOLQWKHHYDOXDWLRQRI WKHWKUHHPRVWFRPPRQW\SHVRISXEOLFVHUYLFHREOLJDWLRQV • 8QSURILWDEOHSDVVHQJHUVHUYLFHV • 8QHFRQRPLFEUDQFKOLQHV • Non-compensatory rates.”

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As noted, however, we found no evidence of the use of this model at AR nor any evidence of use of the methodology implied in the model. Despite the fact that the VectoRail methodology is consistent with many of the costing approaches of the Soviet era, instead of adopting either the VectoRail approach or the Soviet approach, AR has relied on the use of a single factor to allocate all not-direct costs. Interviews with AR staff yielded the statement that, because VectoRail did not provide detailed instructions on exactly how to implement its Cartage software, AR concluded implementation was not to be undertaken.

Cost & Revenue Centers Our investigations found AR lacked cost centers in sufficient detail to collect costs for both rational management and for calculating direct and indirect costs. The root cause of the problem was the reliance on Soviet-era enterprise accounting. Enterprise accounting requires creating a balance sheet and income statement for a cost center. This requirement is too clumsy and expensive to employ for small cost centers. The term “small” here is a relative term. What was small for the employment and volume levels of the Soviet-era railway is quite large for AR. Enterprise accounting focuses on changes in the balance sheet, on “capital”, rather than on flows of funds caused by activities, e.g. a warehouse that disbursed a million Euros in material during one week and received a million Euros in material during the same week had “nothing” happen at it—its capital stocks remained the same. AR currently maintains thirty cost centers known as “branches”. The Branches model the historic structure of railway enterprises in the region—large, functionally- or geographically-based enterprise units. The branches are often functional locations, such as the Yerevan locomotive depot and the Sevan communication & signaling section. The branches roll up into function departments. Examples include all locomotive depots and all electric traction. The account structure does not systematically include a data field, nor are reports attempted, to permit rolling up a geographic line of business, for example, the entire Sevan district or even a geographic area.

The size of some cost centers is too large to map onto effective spans of control. For example, the Headquarters branch has almost three hundred employees, about six percent of total staff. The entire branch is both the smallest cost center as well as the largest cost center in the branch. There is no cost center for the Finance and Accounting function. The Law department has no cost center and no budget. If a sales and marketing department exists, its cost center – that is to say – its budget, cannot be found. What lacks visibility, is difficult to intelligently manage. Furthermore, many costs that are clearly associated with a particular function, e.g., electric traction management, are included in headquarters, not in the roll-up of electric traction costs.

Several large AR branches have no costs centers within them. To illustrate, the Gyumri locomotive depot, which at the time of the study employed approximately two hundred seventy employees, has no further division, for example, for inspections and running repairs, overhauls, or components. In contrast, an effective accounting system might have not only those components, but also further sub-components divided into, for example, wheelsets, rotating electrical machines, and mechanical components. Such small divisions are a common practice in well-run railway shops to give visibility into particular material or functional uses. Smaller cost centers permit management of not only labor, but of material and major spares.

In summary, AR cost accounting system has cost centers that are too large to permit effective budget management. The ability to assign direct expenditures to general lines of business, such as cargo, passenger, real estate development, or specific lines of business, such as container

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 7 - 5 Armenian Railway Restructuring Project: Final Report Accounting Issues traffic handled for XYZ Freight Forwarders, international traffic, mineral traffic, or Yerevan commuter trains is also unavailable.

Currently AR is not capable of assigning such direct costs. Most of the data gathered at the field lacks a coding structure that would permit the activity and the amount to be aggregated by line of business. This starts at the lowest level of data collection: Material requisitions and employee timesheets. A review of timesheets shows that they do not permit recording what line of business or activity an employee worked on for how-many hours. Current AR timesheet state the presence of an employee, but not the work done. Instead, employees are either assigned 100% to a branch and a line of business, or else assigned to a large collect-and- allocate branch. An attorney, a clerk, or a mechanic cannot record a day as spent, for example, as four hours on XYZ Freight Forwarders, two hours on passenger matters, and one hour on general work.

Material accounting similarly lacks any mechanism to identify purpose of the expenditure. Material requisition forms for wagons do not record what line of business a wagon was used for. The line of business might be inferred by the wagon number, since a wagon-type generally serves only a few lines of business, or even, in the case of passenger or container traffic, just one commodity or even just one consignor. But while a wagon number is recorded, there is no mechanism to cross-reference that number to a wagon type. Such analysis is not done and is not part of current AR management’s frame of reference.

Infrastructure presents a different case. Most infrastructure is shared by many lines of business. Nonetheless, material and labor is not recorded when directly expended to repair or construct a facility directly associated with a branch line or siding, except for capital projects.

Similarly, revenue is difficult to directly assign to a line of business because the commodity codes are no longer filled in on the “Statement of Revenue Waybills” sent to the revenue accounting department from originating freight stations. The text field is filled in, but the three commodity code fields are now left blank. The lack of coding inhibits line-of-business revenue aggregation except by text description. General Ledger The General Ledger Chart of Accounts is a financial map of how an enterprise sees and manages itself. Hence AR’s Chart of Accounts is how AR understands itself and defines its cost structure. Because AR lacks non-financial Key Performance Indicators to judge its performance, AR’s financial statements are almost all AR has to evaluate itself. This makes a sound Chart of Accounts very important.

While AR’s cost and revenue centers lack detail, the current Chart of Accounts has approximately one thousand, one hundred accounts—a huge number for a small dedicated enterprise. This excessive number of accounts speaks to a lack of financial clarity. One may compare this number with a complex government-owned transportation company such as the Southeastern Pennsylvania Transportation Authority, SEPTA, in Philadelphia, USA. SEPTA operates a 1,200+ bus company, a metro system, several tram operations, and a fully electrified commuter railway that has about as much track as AR. SEPTA’s operating revenues are four hundred billion drams per year. SEPTA also must account for its capital expenditures to third parties making grants to SEPTA. These grants are about one hundred billion drams each year.

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SEPTA does not own much of its infrastructure and only has concessions to operate its Metro lines from the City of Philadelphia. SEPTA’s accounting must accommodate these arrangements. SEPTA operates on tracks shared with freight railroad concessionaires and with other passenger railroads, and must account for many joint and common activities. This is all to say that SEPTA is a very complicated enterprise. Despite the size and complexity of this publicly-owned transportation company, and despite SEPTA’S requirements to comply with both GAAP and United States Department of Transportation Section 15 reporting requirements, SEPTA’s consolidated Chart of Accounts has less than three hundred lines, about one fourth that of AR.

Specific Problems with the Chart of Accounts: As indicated above and in our previous reports, a cursory examination of the General Ledger structure showed a surprising number of accounts—approximately one thousand, one hundred lines. This Final Report examines the General Ledger structure in detail and makes recommendations to remedy the problems discovered.

To undertake this assessment, the current AR’s Chart of Accounts was examined, annotated and revised. The revised Chart of Accounts is contained in the CD-ROM in Microsoft Excel format. The exercise of preparing this draft Chart revision revealed many accounting difficulties associated with the current Chart. While the draft Chart of Accounts, shown in Appendix I, should not be taken as a final version of what AR should adopt, it is not far from appropriate, the changes from the current Chart of Accounts illustrate the problems. Before going further, it should be noted that the draft Chart of Accounts reduces the number of accounts from about 1,100 to about 500, despite adding perhaps 100 new accounts to give better management control and improve costing accuracy. Several general problems were discovered during the annotation and revision exercise:

Problem A - Account Aggregation: The accounts aggregate or combine major railway asset and expense categories that have distinct characteristics and require visibility for effective management. This obscures significant changes in balance sheet items and operating expenses fundamental to railway management.

An example of this aggregation is Account 713212, “Maintenance Costs of Fixed Assets of Divisions.” This account includes all infrastructure material. It provides no visibility on whether the material went for track material, paving for container yards, buildings, catenary, bridges, ditch cleaning, passenger stations, or anything else. It is not possible to determine how costs vary with volume except in the grossest average. A more appropriate chart of accounts would separate materials and purposes, for example it ought to resemble the following table.

Infrastructure Material Notes Track … Track, Grading, ballast, ditches signs, and fences … Track: Rail and fittings … Track: Ties, direct fixation foundations Does not include bridge and trestle timbers Traffic Control … Signals, signal cables, signal towers, automatic warning devices, inductive signaling, and traffic control buildings, traffic control panels … Radios for traffic control Includes base stations, towers, and all else

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… Highway Crossing gates and guards’ houses, highway crossing material Environmental Disposal Services & Fees Includes fines … Trash and Garbage Removal Services Bridges, Tunnels, and Track Structures … Tunnels, all lengths … Bridges, trestles, culverts. retaining walls <25 meters long … Bridges, trestles, culverts. retaining walls >25 meters long Repairs to one long bridge can obscure expenditures to all small, routine structures Electric Power Material … Substations & Stand-Alone Transmission Lines Includes substation buildings and AC side … Catenary structures and catenary material Building repair material and services Except as otherwise noted, e.g. substation buildings … Yard and terminal material, paving repairs, drain repairs Includes container cranes, parking lots for passenger stations Other Infrastructure Material and Repairs Services … IT and telecom repair material and services Does not include utility charges … Water, Gas and Sewer Infrastructure Material Does not include utility charges … Parts, material and repair services for trucks, autos, forklifts, and construction equipment … Small hardware, small tools, & general workshop supplies … Other infrastructure material and repair services … Design, engineering and investigation service costs … Leases and rentals of infrastructure, infrastructure repair Includes leased tracks, signal and machines, trucks, and workshops electric power equipment, transmission lines, bridges, land, passenger stations

Problem B - Account Detail: In contrast to Problem A, the current Chart also is sometimes trivial in its detail. While the Chart provides little-to-no visibility on investments to or maintenance of the infrastructure, it provides great detail on “Other small value items at Warehouses”. Asset Sub- account 2131 has ten sub-sub-accounts to carefully record “items of small value”. And there are six more sub-sub-accounts to record the investments in fixtures to warehouses for these items of inconsequential value. By contrast, all rolling stock parts – whether for such distinct and major applications as locomotives, cargo wagons, passenger rolling stock, or for infrastructure maintenance – are lumped into one account, 2115. Hence, for example, an incremental investment for passenger rolling stock parts cannot be quickly identified; similarly, an infrastructure unit’s investment in maintenance wagons cannot be quickly identified. This violates fundamental principles of accounting separation for distinct functions, as well as railway-specific standards established by the European Union and other bodies.

Problem C - Misuse: The Chart is used as a substitute for Accounts Payable and Accounts Receivable modules as well as a substitute for routine spreadsheet analysis. This has the effect of obscuring the financial presentation with excessive clutter. Examples of this include:

• The accounts included in 521331 through 521365 Trade Accounts payable. There are thirty-eight separate accounts for major vendors ranging from the Khirgizian Information Center to Turkmenistan Railway to the Sonora Group. Under generally accepted accounting practices, trade payables should be a separate accounting module, with just two or three major groupings’ totals taken to the General Ledger.

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• Account 626 Exchange Rate Fluctuation Revenue sub-accounts, which is subdivided into 5 accounts that are really no more than 5 columns on a spreadsheet. Better practice would be for the spreadsheet’s balance to be taken to just one account in the General Ledger.

• Account 255 sub-accounts, which are “Short Term Receivables of State Budget”. This should be five sub-accounts, not thirty sub-accounts. This is another example of using the General Ledger for spreadsheet detail.

Problem D - Accounts Not Suitable: The current Chart includes many accounts that are more suitable for a generalized retailing or manufacturing enterprise and divert attention from the primary businesses of the railway. An example is account 215 “Goods”. Asset Account 216 has the following sub-accounts:

• 2161 Goods at Warehouse • 2162 Goods for Retail • 2163 Packing Material • 2164 Goods for consignation and commission sales • 2165 Goods Delivered • 2166 Electricity for Sales

It is unclear how electricity is inventoried for future sale.

Problem E - Old Unnecessary Accounts: The current Chart includes many anachronistic accounts, such as Asset Account 2117 “Agricultural Materials.” Similarly, there are many accounts for livestock breeding. Such void or insignificant accounts need to be removed from the Chart and any residual items entered into a limited number of functionally appropriate miscellaneous accounts.

Problem F - Non-Transparent Uses. The current Chart appears to have been structured over the years to record financial failures, operating losses, and mistakes in a nontransparent manner that obscures true financial results. There are not less than eighty balance sheet and income statement accounts and sub-accounts for special losses, extraordinary losses, prior years’ losses, impairments – a favorite term – and reserves. While there are times when it is quite proper for a Chart of Accounts to include extraordinary items, an overabundance of adjustment accounts to excuse negative results is highly disturbing. The Chart needs to be revised so that extraordinary items are precisely that and that ongoing financial results from the normal course of business are recognized as such.

Problem G - Bookkeeping: The current Chart does not reflect double entry book-keeping. As a result, the chart creates two accounts, one for debits and one for credits. An example is “Owner’s Equity Account 323.” Account 3231 is “Profits from re-evaluation of hedging instruments available for sale by initial value” and Account 3232 is “Losses from re-evaluation of hedging instruments available for sale by initial value”. One may wonder why there are accounts for this kind of thing eventuality when there is no account for “Trade Accounts Payable – Purchase of Passenger Transportation Services from Contractors.” It would seem that the restructuring AR should be about the later and not about trading in hedge funds or petroleum futures.

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Problem H Structure of Accounts: Problems E and G point to another problem. The current Chart does not facilitate restructuring, but rather inhibits it. For example, there are accounts for AR to charge outside parties for raising cattle, but not for providing commuter trains to a regional government. The Chart of Accounts needs to add accounts reflecting current lines of business rather than reflecting old operational enterprises. The table below is an example of what type of new accounts AR needs to replace the old accounts. In this example, the sixty trade payable sub-accounts in 52134 through 5213365 – which are a catalogue of other nations’ railways and specific expeditor companies - are replaced with the eight accounts that capture the various possibilities of a restructured AR, and especially of the current AR. For each provider of services, a vendor code is assigned rather than creating an entirely new sub- account. For example, if Turkey or Iran were to open a border crossing, then a vendor code is simply assigned to each nation’s railway.

Example of Types of Accounts that AR Needs 5215 Trade accounts payables – Freight Transportation Services 52151 Trade accounts payables for transportation services-freight transportation provided by other railways, contractors, consignees, or consignors 52152 Trade accounts payables for transportation services -station and auxiliary services provided by other railways, contractors, consignees, or consignors 52153 Trade accounts payables for transportation services – brokers within Hayastan 52154 Trade accounts payables for transportation services – international brokers, freight forwarders 52133 Accounts payables- CIS countries railway organizations, wagon ferries, and other nations 5216 Trade accounts payables – Passenger Services 52161 Trade accounts payables - International railway passenger services 52162 Trade accounts payables – Purchase Of Passenger Transportation Services from contractors or other Hayastan railways 52133 Trade accounts payables - other organizations and vendors

Summary Problem: While the flow of data from the field is largely detailed and sufficient to calculate costs for pricing and subsidy purposes, this data flows to a badly designed and outdated General Ledger system. The General Ledger does not permit accurate cost calculations for dealing with external parties; nor does it permit good internal management of costs.

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Management Reports We found that the data generated in the field and processed at central functions is not employed to generate reports for field managers. There is little downward flow of information; that is, management financial reporting is only generated for the senior-most levels at AR. To illustrate, no interview or discussion with a unit manager yielded a document, report, or discussion of any budget or any cost targets (except for Gyumri workshops). Reporting, rather, is done at the Branch level. No Key Performance Indicators and no goals for field managers could be identified. This lack of information on budget vs. actual results inhibits a commercial approach to providing transportation services. The lack of goals and performance metrics, such as cost/ton-km, bad-order wagon ratio, percent hold-to-fill stock requisitions, and average receivable write-offs, was pervasive. Virtually all managers appeared unfamiliar with the concept. We have rarely seen a railway with no goals, targets or management objectives, no charts showing performance trends, no managers with ideas about how to achieve his objectives or performance metrics.

The apparent lack of concern over performance appears to be a function of management culture, judging from the interviews and the reports collected from the field. Again, all data flows that were mapped flow upwards towards the Headquarters branch. In only one field interview or meeting with senior management did a manager express a need for greater downward reporting and greater local utilization of financial and operational statistics. The absence of specific goals and performance metrics throughout the organization speaks of a management culture that is not concerned with actively managing the efficiency, or even the effectiveness, of AR’s provision of services, and one that does not welcome transparent performance evaluation of senior management.

AR’s lack of performance monitoring, the gross-oversimplifications in cost calculation and allocation procedures, the absence of downward flow of accounting and financial performance reports, the many qualifications for AR’s Annual Reports, and the lack of resolution of those qualifications raises fair and legitimate questions about whether AR is capable of rectifying its problems or able to implement an improvement strategy on its own.

Auditors’ Findings Independent Auditors have qualified AR’s annual reports and documented many material problems with the accounting of prior period events. Nonetheless, little had been done to remediate these qualifications. In one sense, most of the qualifications do not affect AR’s ability to collect and calculate costs for purposes of pricing and subsidy. Most, but not all, of the qualifications concern extraordinary items. In another sense, however, the persistence of these qualifications, and AR’s senior management’s unwillingness to remedy the qualifications reveals two major problems:

1. A willingness by top management to use the General Ledger and other accounting systems to obscure losses, which strongly implies an indifference towards accurate costing; and

2. An unwillingness by management to include real variable costs in its costing base.

An example of the Independent Auditors’ findings, is the qualification concerning routine bad

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 7 - 11 Armenian Railway Restructuring Project: Final Report Accounting Issues debts. It was found that AR lacks an effective accounts payable system. To mitigate the inability of AR to determine credit policies and to police accounts payable, AR resorts to requiring pro-forma payment before commencing any work for cargo movements originating within Armenia. This inability of AR to grant commercial credit, however, reduces AR’s volume by increasing the difficulty of doing business with the railway relative to motor carriers. The reduction in volume, in turn, exacerbates the problem of overpricing services created by tariff setting on the basis of the 100% allocation of all costs described above.

CHARACTERISTICS OF A NEW ACCOUNTING SYSTEM

The next section of the Accounting Chapter of the draft Final Report investigates what features of an accounting system a restructured AR must have to resolve the challenges the railway faces. We then address what changes should be made in AR cost center structure and cost allocation procedures; in general ledger chart of accounts; in cost center/enterprise structure; and in management reporting to facilitates resolution and management of these challenges.

The final changes will depend upon the new structure of AR. Nonetheless, the steps described in the Final Report to set up interim cost centers, improve the chart of accounts, create interim performance metrics, and create interim function codes should be taken regardless of the restructuring option taken and should be taken immediately. The restructuring process may take several years, the railway should be better managed and have better accounting during that interim period.

A fundamental challenge of AR services is that many costs are joint or shared. Services are provided internationally with other firms. One train may carry cargo or passengers from a number of customers, origins, and destinations. One track or signal may service many kinds of train operations and clients. The proper division of joint and shared costs is a difficult problem to solve. Mitigating this problem requires that as many costs as possible are documented at the source as to the actual use of the asset or resources. For a manufacturing or retail enterprise, some expenditures and revenues may be conveniently recorded in a general cost pool, often called Maintenance-Repairs-Operations, (“MRO”) because they are immaterial to fairly understanding the financial position and costs of the enterprise. However, for a railway, so- called MRO costs—typically infrastructure and machinery maintenance—may be more than one quarter to one third of enterprise expenses. It is important to record the purpose and cost center for these maintenance expenditures.

Another difficult problem is that many costs for AR are fixed. The costs do not vary by volume. AR is constructed and operated as a high volume railway when, in reality, its volumes are quite low. Allocating fixed costs over a large volume does not create dramatic distortions when calculating costs. However, allocating large fixed costs among a small volume does greatly distort things used to set prices or subsidies.

Railways have high fixed-capital requirements. While capital in many other types of enterprises is liquid and easily moved and redeployed, railway investments are illiquid, long-lived, and, except for rolling stock, often literally set in stone (ballast). Therefore, the ability to correctly attribute costs and revenues to lines of business is crucial for making proper investment decisions

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New Accounting System Unit Costs and Cost Allocation The use of ton-kilometers as the sole basis for allocating and calculating costs should be discontinued. If the restructuring options discussed in this Final Report are adopted, then any operator of AR, or maintainer of AR, should be able to prepare at least the unit costs below. It is recommended AR undertake to develop unit costs for at least the following activities:

1. Average cost per locomotive-kilometer for electric locomotive maintenance, because wear on running gear, wheelsets, and motor bearings (armature and support) appear to dominate electric locomotive costs. Motors are not used in braking; traction motor-wheelset “combo” replacement is often prompted by wheelset wear; rheostatic switchgear maintenance is as much a function of distance as it is of watt-hours; pantograph maintenance is a function of kilometers. 2. Average cost per -liter for diesel locomotive maintenance because, for diesel-electric and diesel-hydraulic locomotives, fuel burned is the best single measure of wear on the diesel engine, main generator, traction motors, transmissions, and auxiliary pumps and fans. 3. Average cost per wagon-kilometer for wagon maintenance because wear on brakes, wheelsets, and other running gear is driven by kilometers rather than tonnes carried, especially for empty backhaul movement. 4. Average cost per train-ton for track maintenance because the life of rail, ties, other track material varies the most with the tonnage passing over the track. 5. Average cost per wagon-kilometer for train drivers and other distance crews. However, for block trains, the exact cost of drivers and other distance crew should be specifically calculated. 6. Average labor cost to pick-up and to set-out one or more wagons at a consignor or consignee, except for block trains, or to switch and classify a train in a marshalling yard. 7. Average cost to sell a passenger ticket and then collect the money. 8. Two different Average maintenance costs per passenger coach kilometer. One cost should be for coaches used in international service and one cost for EMUs, or DMUs. 9. Two different Average costs per ton-kilometer for electricity, each determined by installing a watt-hour meter on a typical locomotive, and then conducting experiments. One cost should be for largely straight routes with a low grades and the other cost should be for AR’s busiest distance of curved, steep grades. This effort may be discontinued if AR is rationalized; that is, converted to diesel traction 10. Two different Average costs per ton-kilometer for diesel fuel, each determined by metering the consumption of a typical locomotive, and then conducting experiments. One cost should be for largely straight routes with a low grades and the other cost should be for AR’s busiest distance of curved, steep grades. It is very likely that historic data is readily available for the unit costs in 9 and 10 above. New diesel locomotives may also have published data for their fuel consumption. Amounts recorded in general ledger accounts for maintenance unit costs should not be employed, except for the average amount for minor, daily repairs. There has been substantial deferred maintenance and cannibalizing of components. The solution is the straightforward use of engineering estimates of costs to perform intermediate and major revisions/overhauls of rolling stock, divided in turn by the estimated kilometers between revisions/overhauls and to

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 7 - 13 Armenian Railway Restructuring Project: Final Report Accounting Issues use engineering estimates of the costs to rehabilitate track and replace catenary contact wire, divided by tonnes and kilometers, respectively.

Costs should include the average cost to procure and warehouse per thousand AMD of material or services.

Costs should not include activities that will largely remain fixed over the volume one may expect for AR. These include headquarter branch’s cost center, safety/security, bridge and building maintenance, substation and catenary support structures, signaling and communication, dispatching, and accounting.

Specific Recommendations: Allocation of Common Costs & Use of Arbitrary Allocations AR should not allocate common costs that are fixed costs. Costs should not include activities that will largely remain fixed over the volumes one may expect for AR for immediate and intermediate future. These fixed costs include the headquarter branch’s cost center, safety/security; bridge and building maintenance; substation and catenary support structures; signaling and communication; dispatching, and accounting. Inclusion of such costs will over- price profitable traffic, driving it away from the railway.

AR should not price to recover fully allocated costs from each customer, which is its current practice. Instead, AR should price on a negotiated basis subject to a rate floor of full recovery of variable costs. Rates for some traffic may be too high presently because of the use of fully allocated costs of a high-fixed cost railway over a small traffic volume. At the same time, the railway should seek higher rates from customers willing to pay a higher price. From a financial perspective, however, instead of pricing to recover a high level of fixed costs – from all or even from those shippers with inelastic demand and willing to pay a higher price – AR should focus on restructuring to reduce the high level of fixed costs. Such restructuring could include conversion to track warrant dispatching to eliminate signaling, closing small stations, using PC’s to enter data for headquarters processing; rationalizing its human resources, and closing major, redundant maintenance workshops in the Yerevan area, eliminating electrification on some or all lines.

Cost Centers, Enterprise Accounting, And Function Codes We strongly recommend that enterprise accounting be discontinued at the branch level (AR’s current cost centers). Enterprise accounting should exist only at the level of a major roll-up of branches. If AR restructures the operation in whole or in major part, enterprise accounting should be discontinued altogether. Instead of enterprises, function codes, many of which represent lines- of-business, should be used so that the capital employed in major railway lines-of-activity – including revenue lines-of-business – remain visible. Major railway functions and revenue lines-of- business are shown below for railways the size of AR.

Proposed Functional Units and Lines-of-Business

Example of Functional Units Examples of Line of Business

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• Electric traction; • Passenger rolling stock inventories of parts, land under and parts, passenger stations and land, substations station cash and pre-sold tickets • Most track, bridges, • Freight services, general yards, and land, inventories of material rolling stock, facilities used to provide • General purpose freight services to many shippers wagons and workshops, inventories of parts • Rolling stock and track, • Most locomotives and land for the very largest shippers, such workshops, inventories of parts as a large mine, that cannot be used • Most signaling and anywhere else; associated receivables communication; inventories of parts • • General Corporate: Specific wagon types, such as container, mineral, general purpose – Working capital and short-term vans liabilities not otherwise assigned to a Line of Business • Sales and Lease of – Information Technology Surplus Assets: Land, scrap, rolling – Main office accounting, law, chief stock, buildings officers, dispatch, purchasing – General long term borrowings

Functional units typically have assets, liabilities, income, and expenses that are common or joint to several lines-of-business. Lines-of-business are typically assets, liabilities, etc. that are entirely used by a clearly identifiable set of customers, where the assets, liabilities, etc. can be shed without affecting other lines of business. Using a heuristic that a very large shipper or group of shippers should account for at least ten percent of gross revenue, the current list of “enterprises” shrinks from thirty to not more than ten or fifteen. Note that many of these fifteen enterprises may be privatized, or contracted for, because they are natural lines of activity or business.

Specific Recommendations: Choosing Cost Centers Cost centers should be established within Enterprises. If AR carries out the mandates to restructure, then the contractor (concessionaire and/or contract manager) need not create enterprises. Instead, contractors or new owners need to only use a set of function codes much like – but not necessarily identical to – the function codes shown above. Where there are several cost centers in a location, these should be rolled up before they are rolled up into an Enterprise. Experience in the railway industry yields the following heuristics for establishing the size of a cost center.

• Depots and crew stations may be up to three hundred employees where the nature of the work does not require the use of raw material and parts, except for fuel. If a depot or crew station has separate “employee rosters” for different lines of business (such as freight vs passenger), then separate cost centers should be created for each, but only for the largest of depots and only if there are very few common costs, such as supervisors, instructors, heating and electricity. If there are many costs common to several lines of business, then separate cost centers should be avoided. Separate cost centers should be avoided because the separate centers tend to grow redundant, inefficient, and separate expenses for the same resource, e.g. computers, automobiles, or training instructors. • Workshops and infrastructure up to fifty employees using raw material and parts. Where there are several cost centers in a location or covering a natural distance of a route, then these should be rolled up as a functional location.

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• Professional groups, such as accountants, economists, lawyers, that work as functional unit, and especially if the unit contracts for external professional services, such as legal, accounting, information technology; or it purchases material, insurance, or IT/telecomm, or financial services. • Functional groups that require visibility if AR is to be successful, such as sales/ marketing and procurement.

Solutions for New General Ledger & Chart of Accounts The general solutions to AR’s problems with its General Ledger and Chart of Accounts are three fold. The first part of the solution is implementing the specific changes recommended above for Cost Centers and Enterprise Accounting, as well as adding or restoring certain data fields to source documents at the field, also discussed above. The second part of the solution includes improving the Chart of Accounts to remedy the problems discussed above. The third part of the solution is to create additional fields to append to the Chart of Accounts.

No effort to improve the cost of data collection by automation or to improve the flow of data from the field will yield as much improvement as creating a new accounting template for AR. The changes to the Chart of Accounts are required regardless of whether or not AR retains its present structure. Calculating performance metrics and indicators using badly aggregated expenditures may be worse than calculating none at all. The same problem applies for attempts to calculate unit costs. It is pointless for AR to attempt calculating the cost per cargo wagon- kilometer if AR does not know what it expended on wagon parts and wagon repair labor.

A draft Chart has been drawn up to this end and is shown in Appendix I. An annotated chart of account showing all existing accounts and the recommended changes to achieve the accounts shown in the appendix is included in the data CD-ROM associated with this report. Software formatting issues do make printing the draft difficult; nonetheless, the draft provides the additional accounts to gain necessary visibility, and the draft deletes hundreds of obsolete, obscure, redundant, trivial, or outright incorrect accounts. The exploration of the problems in the current Chart above – as discussed in Problems A through I – gave examples of what should be added and deleted from the current Chart.

Solutions for Management Reporting There are at least two kinds of reports that should flow downward in a restructured AR. One kind of report is purely financial and taken from the General Ledger accounts. These financial reports are generated by the accounting department. Management financial reports should be distributed to the manager of each cost center. The second type of report is one showing various performance measures of Key Performance Indicator, or a “KPI” report.

Management financial reports for cost centers should contain operating expenses, budget vs. actual. The current practice of actual vs. previous year should be discontinued. The practice of actual vs. previous year is a legacy of an earlier era when budget and actual were almost guaranteed to be equal, when growth rates were not dictated by market forces, and when price levels were constant. Supplementary reports for budget vs. actual for specific capital projects should be generated and distributed to project managers. This implies that every cost center and major capital project have a budget prepared – one covering relevant time periods. Roll-ups of

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 7 - 16 Armenian Railway Restructuring Project: Final Report Accounting Issues capital projects may be made at the enterprise level. Balance sheet and sources and uses of fund statements should only be generated for and sent to the managers at the enterprise level. Cost centers within an enterprise are too small and share too many assets with other cost centers to have balance sheets prepared for them.

Each cost center should have two to five KPIs as goals, and no more. Each KPI should be shown in two parts: Goal and Actual. The goal is analogous to a financial budget. Performance is often shown as two time-series graphs. One of the graphs shows each period. The other graph shows the cumulative trend-to-date.

KPIs may be calculated by the cost center itself, and distributed upwards. Commercial experience indicates that if there are more than five KPIs for a specific cost center, then the Performance Indicators are no longer Key—if there are more than five KPIs for a cost center, there are too many KPIs. In general, one should aim for a KPI that captures one of the pricing unit costs, such as “Average cost to sell a passenger ticket and then collect the money” or “Average cost per wagon-kilometer for wagon maintenance”. If a pricing unit cost is not appropriate, then another key cost-per-unit should be measured. Further, AR should aim for:

• One or more KPIs that measures quality of service, such as equipment reliability, percent of orders filled, or average late minutes per train. • One or more KPIs that measures productivity, such as sleepers replaced per man-hour or ton-kilometers per train driver-day • A KPI that measures progress in solving one of the special problems at the cost center. The problem might be absent employee-hours or accidents-per-thousand-employee hours, or percent of trains late more than 30 minutes.

KPIs should not require the intervention of other departments for their achievement. For example, a KPI goal is expressed as follows is a sign of an inadequate manager: “My cost center plans to improve ratio “X” by Y%, if, and only if, another department does Z”. Experience shows that action Z was selected because Z is unlikely to happen. This means X and Y were chosen by a deliberate decision to have others blamed for the failure to achieve Y’s performance targets.

KPIs and cost center reports are tools to improve management culture. KPIs and cost center financial reports, properly executed, focus employees on what progress can be made, rather than on why this year is at variance with last year. Management Span of Control No cost center should have more one manager responsible for financial performance. If a cost center financial report must be given to more than one manager, then it is a clear indication of a failure to create a clear, non-bureaucratic span of control. All of the financial performance of a cost center should be the responsibility of only one manager.

Non-cash items, such as depreciation and amortization, should not be included in cost center financial reports. These items are often both large and beyond the control of the cost center manager. If these large, fixed, non-cash expenses are included, then the large and uncontrollable items obscure the controllable costs.

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Management should focus on setting goals and expressing these as KPIs. If the correct KPIs are chosen, and progress is made in achieving the KPIs, then costs and profitability will follow.

Steps Prior to Restructuring The accounting reform recommendations discussed above need not be implemented before restructuring can proceed, although early reforms may increase the value of a private sector franchise and will certainly improve the financial management of the railway during restructuring. On the other hand, the fewer the accounting reforms AR is willing to implement, the greater the need for immediate restructuring. That is, if AR fails to quickly develop cost and management accounting structures to correctly calculate and manage its costs and operations, then responsibility for this fundamental responsibility should be transferred quickly to private management that will assume this fundamental responsibility. The lack of resolution for several of the qualifications of the 2004 Independent Auditor’s report is an example of management inaction that argues for immediate restructuring to private parties. The longer the qualifications remain open, the greater the need to find new railway leadership with management that can and will implement commercially viable accounting standards.

If AR is to establish itself as a commercially viable, sustainable enterprise, it requires senior financial leadership that is not invested in the legacy workings of the current approach. The new leadership should be able to give direction rather than wait for ministerial direction. Its experience and business model should reflect a service-oriented commercial universe rather than a bureaucratic, process-oriented universe where the concept of serving the market was foreign.

We also strongly recommend that AR commence simple automation of its data-entry functions. Perhaps thirty – forty at the most – inexpensive desktop computers should be acquired for local data entry into electronic forms. Most data is recorded on forms last revised decades ago. Some forms are over thirty years old and still are in Russian. These forms need revision and reformatting. This will permit the easy addition of the function and cost center codes, although the station code field serves the cost center purpose quite well for many forms. It is a relatively simple matter to create an electronic template to enter and then transmit the data for central processing. The conversion of the forms can be done serially and use in-house IT staff.

As with other steps, if AR is unable to carry out simple automation of data entry with in-house staff, then there is more evidence that AR needs speedy restructuring. The inability to carry out the very simple automation would be attributable to Human Resource and Finance failures to recruit and retain at least a few PC-skilled employees.

IMPLEMENTATION OF CHANGES Change should be implemented with the existing in-house staff after new, senior financial leadership is in place to direct the change. Using existing staff to carry out the change gives the benefit of ownership. It also avoids the expense of engaging outside firms. It has been shown that AR’s staffing levels are at least “generous”. Surplus labor exists within AR.

The cost to train a cadre of accounting implementation specialists will be borne whether or not the effort is in-house or contracted out. External efforts using contractors require training the

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 7 - 18 Armenian Railway Restructuring Project: Final Report Accounting Issues contractors to understand how AR currently works and what costs are important to capture and parse. In simple language, either AR will need training on how to do it correctly, or external parties will need training on how it was done the AR way. The key, in both cases, is to have the effort lead internally by someone who knows the correct way and can be advised by direct subordinates on the current AR way.

A proposed implementation schedule is attached as Appendix J. It shows that the entire effort ought to take only a little more than one year. This effort should be pursued regardless of the restructuring option chosen as we assume restructuring will take some years and accurate auditable accounts will help in the restructuring process. We suggested an accounting firm be engaged to assist AR in implementation. Purchasing PC’s, commonly available software, all accessories and supplies, and travel for the fifteen or so remaining enterprises, after rationalization, is likely to cost around US$130,000.

REQUIREMENTS FOR A RESTRUCTURED AR OPERATION A private operator or concessionaire will have very much the same accounting structure as discussed above. In all cases the requirements stem from:

1. Concern that a monopoly operator would either charge excessive rates to captive customers; or, give unwarranted low rates to cronies. While state-owned and state-operated railways are historically prone to such economically irrational behavior, the concern exists that profit-disciplined enterprises may engage in the same disappointing behavior. The operator will require accurate accounting to defend its charges and service arrangements. Of course, some shippers are likely to pay more for transport than others (on an AMD per ton- kilometer basis), this is as it should be in a market economy. But none should pay less than variable cost.

2. The fact that railway interchanges with other nations’ railways. The various railways need to negotiate the divisions of tariffs for these joint moves. Such negotiations and conventions require accurate costing.

3. The need for the railway to perform subsidized services (or to hire someone to perform them for it, or determine accurate charges for another operator who is performing the services for government). Examples of subsidized services might include providing passenger services. The entity providing the subsidy needs to accurately calculate costs so that the entity providing the subsidy can be satisfied that it is not paying too much.

4. The need for property accounting to see that assets and liabilities are attributed to the purpose that they are acquired or retained for, and to justify new investment in, or disposal of, assets; further, the need to monitor capital projects.

5. The need to present in a fair, consistent manner, the financial progress and problems of Armenian’s railways so that investors and the nation of Armenia can understand the true financial position of the nation’s asset.

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8: Conclusions and Recommendations

rmenian Railway is in significant financial trouble. Over the next few years, the railways assets must be replaced and it does not have enough traffic or earn enough Afrom rail transport to do so. As a state-owned enterprise, the government could take on the responsibility to keep the railway operating in its current form. This, however, would require substantial cash infusions which will be difficult to finance. Should the railway continue in its present form, the government of Armenia would have to inject more than AMD 134 billion (US$ 300 million) over the next 15 years.

Rather than pay these costs, the government can restructure the railway into a commercial transport enterprise. The cost to government of the restructuring is significantly less than the cost to continue on the current path. In fact, a restructured railway is likely to generate funds for the government from the sale of the concession, payment of concession fees, and increased tax collections. Two forms of restructuring have been analyzed: a full concession of both rail freight services and assets; and a concession of freight services and assets coupled with a management contract to operate and maintain the infrastructure. Both present significant benefits. We recommend the full concession option. The capital requirements of the railway are significant and present any commercial concession operator with great risks. The full concession option reduces the number of risks associated with the concession and simplifies the management and operation of freight services. A full concession will revitalize Armenian rail services, remove the burden of capital replacement from the government or from Armenia’s shippers, improve rail services, and generate revenue for the government rather than requiring payments from the government. Full concessioning represents a remarkable opportunity for the country and its economy. Rather than costing the government or shippers AMD 134 billion, a restructured railway will provide improved service, result in significant new investments, and generate some AMD 12 billion (US$ 27 million) in new funds for the government.

The Armenian Government must also decide what to do with its rail passenger services. Rail passenger services are hopelessly loss making. Should the government offer a concession of the railway complete with a requirement to provide current passenger services, no commercial operator would bid and the concession and the offer would fail. Rail passenger services must either be stopped or the government must subsidize the services it wishes to provide as a public service. We recommend that the Government of Armenia conduct an analysis of passenger transport alternatives with the view that passenger services for public benefit can be reduced or provided by alternative means that are less expensive (such as commercial bus services, subsidized bus services, mini-bus services, and other road-transport based alternatives). When the analysis is complete, the government should contract with either the rail concession operator or with road transport companies to provide the level of public transport that it

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page 8 - 1 Armenian Railway Restructuring Project: Final Report Conclusions & Recommendations determines is needed. Should rail passenger services be a part of this public transport mix, the government or local governments must acquire the rolling stock (or finance its acquisition) and provide operating subsidies for the services necessary.

Restructuring the railway will require a new law on railways that clarifies the how the industry will be regulated and defines the powers and responsibilities of the Ministry of Transport and Communications and of private sector operators. The legal changes recommended are compatible with either the full Concession or an operating concession with and infrastructure management contract. We recommend that a single concession be granted but that the other rail service operators be permitted to negotiate with the concession operator to provide services over the infrastructure. Such services would operate over the infrastructure provided by the concessionaire and rely on concessionaire drivers and other safety and service personnel. Similar access provisions would be available if the operating concession/infrastructure management contract approach is adopted. The concession and management contracts should provide for commercial arbitration of disputes. The concession operator should be free to set transport tariffs without regulation or oversight, except for the commercial arbitration provisions contained in the concession contract.

Restructuring will have a significant affect on AR employees. The restructuring plan should include social impact and human resources mitigation measures to reduce the impact on current railway employees. We have estimated the cost of such mitigation measures and developed an outline plan for how to proceed with the restructuring while minimizing employment impacts.

A plan for reducing costs and preparing the railway for the transition to concession operation is described in this final report. The recommended restructuring will require some time to implement, during this time, AR management should be charged with starting to implement the reforms and cost reduction programs. One of these reforms is organizing the railway into three business units—Freight, Passenger, and Infrastructure Units—and refining AR’s current accounting system to provide cost accounting and reporting for the management of these units. A plan for updating the accounting systems is described in the report along with a schedule for implementation. As a part of those reforms, it is imperative that the management of AR and Ministry personnel resolve the differences that have prevented the company’s auditors from providing an unqualified audit of AR’s financial position. Concessioning will not be possible

Recommendations In This Report

• Reorganize the existing railway and begin implementing cost reductions • Implement cost accounting system changes to support all other efforts • Initiate a Passenger Services Study to determine more cost effective methods to provide passenger transport services • Revise the railway law to permit concessioning and reduce regulatory burdens • Develop and implement human resources programs to mitigate the impacts from cost reductions and restructuring efforts • Concession the Armenian Railway under a full concession without clear financial statements and a complete inventory of the assets that are to be included in the concession agreement.

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These programs can be initiated and the railway concessioned within 18 months or so. It is our recommendation that the government of Armenia proceed on this course quickly.

IMPLEMENTATION Implementing a concession plan will require substantial effort from government and railway.

Issue Consultants Recommendation Assets Included Offering memorandum nominates, concessionaire selects, parties negotiate, MoTC manages assets not included Asset Ownership Concessionaire owns rolling stock, machinery outright, returns infrastructure in same condition Term 30 years + 10 additional with decision after 20 Passenger Service Concession may provide, but not required MoTC contracts for service if desired Freight Service Offering memorandum nominates minimum service, concessionaire proposes, parties negotiate, MoTC contracts for extra services Employees Concessionaire free to hire only needed staff, remaining staff compensated by MoTC administered program Concession Fees Bid price + 2% revenue Existing World Bank Loan Government responsibility Concessionaire Risk Mitigation Measures Escalating concession fee Financial support for infrastructure investments Many decisions must be made about the concession plan including not only the type of concession but also many decisions on assets, terms, and conditions that are to be included in the concession. The major issues the must be addressed prior to mounting a concession of the railway are shown in the table below. For example, the final concession documents must specify what assets are included in the concession and what ownership rights and structures are part of the concession package. (e.g., will rolling stock be owned or concessioned – to be returned, given fair wear and use, at the end of the concession; a definition of the current condition of infrastructure assets), Other issues include the term or length of the concession and whether it can be renewed or extended; whether and how assets in the concession package can be returned before the end of the concession; whether passenger services are to be subsidized or, should a bidder offer to continue some passenger services, how that will be taken into account in evaluating bids.

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Another set of issues must also be addressed. These define the business environment underwhich the concessionaire will operate, as shown in the chart below:

The regulatory environment will have a profound effect on how the concession will work. It will be a very important factor in determining how bidders view the concession and in determining the ultimate viability of the rail enterprise. Before the railway can be concessioned, the regulatory environment should be well defined and understood and the ability of the concessionaire to control critical railway activities well defined. Our recommendations are for a light regulatory hand providing maximum flexibility for the concessionaire and for settlement of differences though commercial negotiations supplemented by commercial arbitration processes. This would apply even to shipment of goods for government.

Implementation will require the establishment of a high-level Ministerial Group to approve concession package contents and terms. The Ministerial Group should have members from the major ministries affected by concessioning the railway including the Ministries of Transporation, Finance, Economic Development, and Justice, the Presidents office, and the Prime Minister’s office, as well as state regulatory bodies who will be directly involved (for example, the State Property Committee). The function and purpose of this group will be to resolve major issues, make decisions related to their area of responsibility and provide a means to quickly coordinate decision making across the branches of government.

Another group is also recommended—a Working Group composed of technical experts. This group will work with consulting team support to conduct studies, evaluate alternatives for each major issue, and prepare concession documents. The Working Group should, with the consultants, conduct a review of prior concessions within Armenia and world wide rail and other transport concessions to become familiar with key success factors and to develop an understanding of how other concessions have been designed and why. This group will evaluate the alternatives for each of the major issues and make recommendations for final decisions to be made by the Ministerial group. These two groups would be supplemented by consulting and other commercial support – for example, the use of an audit firm to conduct the financial audit process and to supervise an accurate asset inventory that will determine what assets are part of the concession and which are not.

Issue Consultants Recommendation Safety Regulation Concessionaire proposes plan, MoTC advice and consent; MoTC safety department oversight Price Regulation None on combined tariffs Maximum infrastructure access fee (cost based), negotiation, MoTC oversight, arbitration Access Regulation Concessionaire to publish network statement Concessionaire controls path allocation Disputes negotiated, settled by arbitration Other Armenian Laws and Regulations Concessionaire covered as a normal business Regulations covering only railway activities negotiated and disputes handled by arbitration Asset use conversion (e.g., station development) No recommendation. Negotiated with MoTC rail asset management group

The implementation process is expected to take about 18 months. A proposed schedule is shown on the next page.

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Armenian Railway Restructuring Project: Final Report Conclusions & Recommendations

POSSIBLE CONCESSIONING SCHEDULE

Schedule for Armenia Railway Concession Process

Government of Armenia Oct-06 Nov-06 Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08

Establish high level oversight & decision making group Establish team to conduct concessioning process

Revise and pass railway law

Prepare employee redundancy program Determine oversight regime for end tariffs Determine oversight regime for safety Determine oversight regime for access

Agree general terms of concession Draft concession agreement Prepare offering memorandum Road show Prepare Data room/run transaction Evaluate bids Negotiate/award concession

Establish capacity for managing assets not in concession Establish oversight capacity

Armenian Railway Oct-06 Nov-06 Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08

Separate passenger and freight businesses and accounts Obtain unqualified audit (clear audit comments) Conduct Asset inventory Undertake efficiency measures (including staff reductions)

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Appendices

APPENDIX A ...... CUSTOMER AND SHIPPER INTERVIEWS

APPENDIX B...... TRAFFIC FORECASTS

APPENDIX C...... FINANCIAL STATEMENTS

APPENDIX D...... CHANGES TO THE DRAFT RAILWAY LAW

APPENDIX E...... PUBLIC SECTOR RESTRUCTURING IN ARMENIA

APPENDIX F...... COMMUNITY CONSULTATIONS

APPENDIX G...... SOCIAL BARRIERS TO RESTRUCTURING

APPENDIX H...... INTERNATIONAL RAILWAY RESTRUCTURING EXPERIENCE

APPENDIX I...... PROPOSED ARMENIAN RAILWAY CHART OF ACCOUNTS

APPENDIX J...... ACCOUNTING SYSTEM CHANGE IMPLEMENTATION SCHEDULE

APPENDIX K ...... RAILWAY RESTRUCTURING IN NEIGHBORING COUNTRIES

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A: Interviews with Shipping Community

APAVEN (freight forwarder) Arsen Ghazaryan General Director and Founder. APAVEN President, Union of Manufacturers and Businessmen of Armenia Co-Chair, Armenian-Turkish Business Development Council) ------Gagik Aghajanyan Director, APAVEN President, Association of Armenian Freight Forwarders

Ararat Cement, CJSC Arman Barseghyan Commerial Director

Ararat Gold Recovery Company BK Sharma President (2006) ------Sanjay Dalmia President (2005) ------Vardan Vardanyan Director

Armenian Copper Programme George Mezhlumyan Chief of Marketing Department

Armtransforwarder, Ltd. Sergey Sumbatiam, President

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Cascade Capital Jonathan Stark, CEO,

Dicalite Armenia (perlite) Khachatryan Deputy Director

MetEx JSC (construction products importer) Haykaz Bakhshetyan, Founder

Powder Metallurgy, Ltd. (specialty metals) Alfred Andreasyan Director

SATI CJSC (freight forwarder) MakarArakelyan Managing Director

Seaborne International (logistics company) John Sax Executive Director

TransAlliance Ltd.(freight forwarder) Sargis Martirosyan Director General,

Zangezur Copper-Molybdenum Combine CJSC Slavik Avetisyan, Head-Yerevan office

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B: Data Tables Supporting Traffic Forecast

Table B-1: Armenian Railways Low Traffic Forecast (Tons) Table B-2: Armenian Railways Most Likely Traffic Forecast (Tons) Table B-3: Armenian Railways High Traffic Forecast (Tons) Table B-4: Armenian Railways Passenger Forecasts (Passengers, Passenger Kilometers, Revenues) Table B-5: Armenian Railways Kars Route Reopening Scenario (Tons) Table B-6: Armenian Railways Summary Ton-Kilometer Forecast (Most Likely Case) Table B-7: Armenian Railway Summary Freight Revenue Forecast (Most Likely Case)

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Armenian Railway Restructuring Project: Final Report Appendices B

Table B-1. Low Forecast: Gold mine closed or proccessing plant relocated; borders except Georgia remain closed Thousand Tons 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Domestic DO-scrap metal 17.9 5.0 1.7 3.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 DO- cement 78.1 47.0 102.6 47.7 55.1 50.4 51.9 53.5 55.1 56.7 58.4 60.2 62.0 63.8 65.8 67.7 69.8 71.9 74.0 76.2 78.5 DO-construction materrials 19.6 12.3 127.4 107.4 237.8 177.7 183.0 188.5 194.2 200.0 206.0 212.2 218.5 225.1 231.9 238.8 246.0 253.4 261.0 268.8 276.9 DO-industrial raw materials 177.3 169.2 271.2 158.4 24.6 197.0 199.0 201.0 203.0 205.0 207.0 209.1 211.2 213.3 215.5 217.6 219.8 222.0 224.2 226.4 228.7 DO-wheat wheat flour 12.1 12.0 16.5 8.8 13.9 32.8 33.1 33.5 33.8 34.1 34.5 34.8 35.2 35.5 35.9 36.2 36.6 37.0 37.3 37.7 38.1 DO-nonferrous ore 20.8 75.6 281.0 508.3 664.2 480.9 50.0 50.5 51.0 51.5 52.0 52.6 53.1 53.6 54.1 54.7 55.2 55.8 56.3 56.9 57.5 DO-other goods-commodities 7.8 34.3 53.7 57.8 161.7 140.3 141.7 143.1 144.6 146.0 147.5 148.9 150.4 151.9 153.4 155.0 156.5 158.1 159.7 161.3 162.9 Export EX-ferrous metal 35.2 74.9 64.6 76.6 51.1 49.2 49.2 49.2 49.2 49.2 49.2 49.2 49.2 49.2 49.2 49.2 49.2 49.2 49.2 49.2 49.2 EX-cement 4.2 9.5 27.2 103.3 184.3 189.8 195.5 201.4 207.4 213.7 220.1 226.7 233.5 240.5 247.7 255.1 262.8 270.7 278.8 287.1 EX-construction materials 61.0 7.8 1.5 1.3 8.3 11.8 12.2 12.5 12.9 13.3 13.7 14.1 14.5 14.9 15.4 15.9 16.3 16.8 17.3 17.8 18.4 EX-industrial raw materials 4.5 1.4 5.9 61.6 82.3 83.9 85.6 87.3 89.1 90.9 92.7 94.5 96.4 98.4 100.3 102.3 104.4 106.5 108.6 110.8 EX-nonferrous ore 30.4 34.7 49.3 62.9 96.9 44.1 45.0 45.9 46.8 47.7 48.7 49.7 50.7 51.7 52.7 53.8 54.8 55.9 57.0 58.2 59.4 EX-other goods-commodities 58.9 53.6 49.7 69.9 25.7 54.0 55.1 56.2 57.3 58.5 59.6 60.8 62.0 63.3 64.5 65.8 67.1 68.5 69.9 71.3 72.7 Import IM-grain 445.7 368.9 383.9 341.3 459.4 376.5 380.3 384.1 387.9 391.8 395.7 399.7 403.7 407.7 411.8 415.9 420.0 424.2 428.5 432.8 437.1 IM-sugar 60.2 71.7 69.7 86.8 73.1 104.5 105.5 106.6 107.7 108.7 109.8 110.9 112.0 113.2 114.3 115.4 116.6 117.8 118.9 120.1 121.3 IM-oil products 270.4 299.2 356.1 310.2 314.7 294.9 297.8 300.8 303.8 306.9 309.9 313.0 316.2 319.3 322.5 325.8 329.0 332.3 335.6 339.0 342.4 IM-chemical and mineral fertilizer 31.9 17.3 47.7 42.5 51.1 48.9 49.9 50.9 51.9 52.9 54.0 55.1 56.2 57.3 58.4 59.6 60.8 62.0 63.3 64.5 65.8 IM-other goods-commodities 91.4 109.0 133.2 209.5 227.1 282.7 288.4 294.1 300.0 306.0 312.1 318.4 324.7 331.2 337.9 344.6 351.5 358.5 365.7 373.0 380.5 Total 1,423.2 1,398.1 2,019.3 2,125.5 2,629.6 2,612.3 2,215.8 2,251.5 2,287.8 2,324.9 2,362.7 2,401.4 2,440.8 2,481.0 2,522.1 2,564.0 2,606.8 2,650.5 2,695.1 2,740.6 2,787.1

Domestic-nonferrous ore 20.8 75.6 281.0 508.3 664.2 480.9 50.0 50.5 51.0 51.5 52.0 52.6 53.1 53.6 54.1 54.7 55.2 55.8 56.3 56.9 57.5 Domestic other 312.8 279.8 573.1 383.1 493.1 598.2 608.7 619.5 630.6 641.9 653.4 665.2 677.3 689.7 702.4 715.4 728.7 742.3 756.2 770.4 785.0 Export 190.0 176.6 174.6 243.8 346.9 425.7 435.2 444.9 454.9 465.2 475.7 486.5 497.6 509.0 520.7 532.6 545.0 557.6 570.5 583.9 597.5 Import 899.6 866.1 990.6 990.3 1,125.4 1,107.5 1,121.9 1,136.5 1,151.3 1,166.3 1,181.6 1,197.1 1,212.8 1,228.7 1,244.9 1,261.3 1,277.9 1,294.9 1,312.0 1,329.4 1,347.1

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Armenian Railway Restructuring Project: Final Report Appendices B

Table B-2. Mid-Range Forecast: closed borders except Georgia; domestic gold ore traffic revives to over 600,000 tons annually Thousand Tons 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Domestic DO-scrap metal 17.9 5.0 1.7 3.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 DO- cement 78.1 47.0 102.6 47.7 55.1 50.4 52.4 54.5 56.7 59.0 61.3 63.8 66.3 69.0 71.7 74.6 77.6 80.7 83.9 87.3 90.8 DO-construction materrials 19.6 12.3 127.4 107.4 237.8 177.7 184.8 192.2 199.9 207.9 216.2 224.8 233.8 243.2 252.9 263.0 273.6 284.5 295.9 307.7 320.0 DO-industrial raw materials 177.3 169.2 271.2 158.4 24.6 197.0 202.9 209.0 215.3 221.7 228.4 235.2 242.3 249.6 257.0 264.8 272.7 280.9 289.3 298.0 306.9 DO-wheat wheat flour 12.1 12.0 16.5 8.8 13.9 32.8 33.8 34.8 35.8 36.9 38.0 39.2 40.3 41.6 42.8 44.1 45.4 46.8 48.2 49.6 51.1 DO-nonferrous ore 20.8 75.6 281.0 508.3 664.2 480.9 490.5 500.3 510.3 520.5 531.0 541.6 552.4 563.5 574.7 586.2 597.9 609.9 622.1 634.5 647.2 DO-others goods-commodities 7.8 34.3 53.7 57.8 161.7 140.3 144.5 148.8 153.3 157.9 162.6 167.5 172.6 177.7 183.1 188.6 194.2 200.0 206.0 212.2 218.6 Export EX-ferrous metal 35.2 74.9 64.6 76.6 51.1 49.2 49.7 50.2 50.7 51.2 51.7 52.2 52.7 53.3 53.8 54.3 54.9 55.4 56.0 56.6 57.1 EX-cement 4.2 9.5 27.2 103.3 184.3 191.7 199.3 207.3 215.6 224.2 233.2 242.5 252.2 262.3 272.8 283.7 295.1 306.9 319.1 331.9 EX-construction materials 61.0 7.8 1.5 1.3 8.3 11.8 12.3 12.8 13.3 13.8 14.4 14.9 15.5 16.1 16.8 17.5 18.2 18.9 19.6 20.4 21.3 EX-industrial raw materials 4.5 1.4 5.9 61.6 82.3 84.8 87.3 89.9 92.6 95.4 98.3 101.2 104.3 107.4 110.6 113.9 117.3 120.9 124.5 128.2 EX-nonferrous ore 30.4 34.7 49.3 62.9 96.9 44.1 45.4 46.8 48.2 49.6 51.1 52.7 54.2 55.9 57.5 59.3 61.0 62.9 64.8 66.7 68.7 EX-other goods-commodities 58.9 53.6 49.7 69.9 25.7 54.0 55.6 57.3 59.0 60.8 62.6 64.5 66.4 68.4 70.5 72.6 74.7 77.0 79.3 81.7 84.1 Import IM-grain 445.7 368.9 383.9 341.3 459.4 376.5 384.0 391.7 399.5 407.5 415.7 424.0 432.5 441.1 450.0 459.0 468.1 477.5 487.0 496.8 506.7 IM-sugar 60.2 71.7 69.7 86.8 73.1 104.5 106.6 108.7 110.9 113.1 115.4 117.7 120.0 122.4 124.9 127.4 129.9 132.5 135.2 137.9 140.6 IM-oil products 270.4 299.2 356.1 310.2 314.7 294.9 300.8 306.8 313.0 319.2 325.6 332.1 338.7 345.5 352.4 359.5 366.7 374.0 381.5 389.1 396.9 IM-chemical and mine fertilizer 31.9 17.3 47.7 42.5 51.1 48.9 50.4 51.9 53.4 55.0 56.7 58.4 60.1 61.9 63.8 65.7 67.7 69.7 71.8 74.0 76.2 IM-other goods-commodities 91.4 109.0 133.2 209.5 227.1 282.7 291.2 299.9 308.9 318.2 327.7 337.6 347.7 358.1 368.9 379.9 391.3 403.1 415.2 427.6 440.4 Total 1,423.2 1,398.1 2,019.3 2,125.5 2,629.6 2,612.3 2,681.4 2,752.4 2,825.5 2,900.7 2,978.0 3,057.6 3,139.5 3,223.8 3,310.5 3,399.8 3,491.6 3,586.2 3,683.5 3,783.7 3,886.9

Domestic-nonferrous ore 20.8 75.6 281.0 508.3 664.2 480.9 490.5 500.3 510.3 520.5 531.0 541.6 552.4 563.5 574.7 586.2 597.9 609.9 622.1 634.5 647.2 Domestic other 312.8 279.8 573.1 383.1 493.1 598.2 618.4 639.4 661.0 683.4 706.6 730.5 755.3 781.0 807.6 835.0 863.5 892.9 923.3 954.8 987.4 Export 190.0 176.6 174.6 243.8 346.9 425.7 439.4 453.7 468.4 483.6 499.4 515.8 532.7 550.2 568.3 587.1 606.5 626.6 647.4 669.0 691.3 Import 899.6 866.1 990.6 990.3 1,125.4 1,107.5 1,133.0 1,159.0 1,185.7 1,213.1 1,241.1 1,269.7 1,299.1 1,329.2 1,359.9 1,391.5 1,423.7 1,456.8 1,490.7 1,525.4 1,560.9

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Armenian Railway Restructuring Project: Final Report Appendices B

Table B-3. High Forecast: closed borders except Georgia; domestic gold ore traffic rises to one million tons annually; Abkhazia line reopened in 2010 Thousand Tons 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Domestic DO-scrap metal 17.9 5.0 1.7 3.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 DO- cement 78.1 47.0 102.6 47.7 55.1 50.4 52.4 54.5 56.7 59.0 61.3 63.8 66.3 69.0 71.7 74.6 77.6 80.7 83.9 87.3 90.8 DO-construction materrials 19.6 12.3 127.4 107.4 237.8 177.7 184.8 192.2 199.9 207.9 216.2 224.8 233.8 243.2 252.9 263.0 273.6 284.5 295.9 307.7 320.0 DO-industrial raw materials 177.3 169.2 271.2 158.4 24.6 197.0 202.9 209.0 215.3 221.7 228.4 235.2 242.3 249.6 257.0 264.8 272.7 280.9 289.3 298.0 306.9 DO-wheat wheat flour 12.1 12.0 16.5 8.8 13.9 32.8 33.8 34.8 35.8 36.9 38.0 39.2 40.3 41.6 42.8 44.1 45.4 46.8 48.2 49.6 51.1 DO-nonferrous ore 20.8 75.6 281.0 508.3 664.2 480.9 504.9 530.2 556.7 584.5 613.8 644.5 676.7 710.5 746.0 783.3 822.5 863.6 906.8 952.1 999.8 DO-others goods-commodities 7.8 34.3 53.7 57.8 161.7 140.3 144.5 148.8 153.3 157.9 162.6 167.5 172.6 177.7 183.1 188.6 194.2 200.0 206.0 212.2 218.6 Export EX-ferrous metal 35.2 74.9 64.6 76.6 51.1 49.2 49.7 50.2 50.7 51.7 52.7 53.8 54.9 56.0 57.1 58.2 59.4 60.6 61.8 63.0 64.3 EX-cement 4.2 9.5 27.2 103.3 184.3 191.7 199.3 207.3 215.6 224.2 233.2 242.5 252.2 262.3 272.8 283.7 295.1 306.9 319.1 331.9 EX-construction materials 61.0 7.8 1.5 1.3 8.3 11.8 12.3 12.8 13.3 13.8 14.4 14.9 15.5 16.1 16.8 17.5 18.2 18.9 19.6 20.4 21.3 EX-industrial raw materials 4.5 1.4 5.9 61.6 82.3 84.8 87.3 89.9 95.3 101.0 107.1 113.5 120.3 127.6 135.2 143.3 151.9 161.1 170.7 181.0 EX-nonferrous ore 30.4 34.7 49.3 62.9 96.9 44.1 45.4 46.8 48.2 51.1 54.1 57.4 60.8 64.5 68.4 72.5 76.8 81.4 86.3 91.5 97.0 EX-other goods-commodities 58.9 53.6 49.7 69.9 25.7 54.0 55.6 57.3 59.0 60.8 62.6 64.5 66.4 68.4 70.5 72.6 74.7 77.0 79.3 81.7 84.1 EX-specialy minerals 50.0 51.5 93.0 98.6 104.5 110.8 117.5 124.5 132.0 139.9 148.3 157.2 166.6 176.6 Import IM-grain 445.7 368.9 383.9 341.3 459.4 376.5 384.0 391.7 403.5 415.6 428.0 440.9 454.1 467.7 481.8 496.2 511.1 526.4 542.2 558.5 575.2 IM-sugar 60.2 71.7 69.7 86.8 73.1 104.5 106.6 108.7 112.0 115.3 118.8 122.4 126.0 129.8 133.7 137.7 141.9 146.1 150.5 155.0 159.7 IM-oil products 270.4 299.2 356.1 310.2 314.7 294.9 300.8 306.8 316.0 325.5 335.3 345.3 355.7 366.4 377.3 388.7 400.3 412.3 424.7 437.4 450.6 IM-chemical and mine fertilizer 31.9 17.3 47.7 42.5 51.1 48.9 50.4 51.9 54.2 56.7 59.2 61.9 64.6 67.6 70.6 73.8 77.1 80.6 84.2 88.0 91.9 IM-other goods-commodities 91.4 109.0 133.2 209.5 227.1 282.7 291.2 299.9 313.4 327.5 342.3 357.7 373.8 390.6 408.1 426.5 445.7 465.8 486.7 508.6 531.5 Total 1,423.2 1,398.1 2,019.3 2,125.5 2,629.6 2,612.3 2,695.8 2,832.3 2,936.7 3,089.9 3,211.6 3,338.5 3,470.8 3,608.6 3,752.2 3,902.0 4,058.1 4,220.9 4,390.6 4,567.6 4,752.2

Domestic-nonferrous ore 20.8 75.6 281.0 508.3 664.2 480.9 504.9 530.2 556.7 584.5 613.8 644.5 676.7 710.5 746.0 783.3 822.5 863.6 906.8 952.1 999.8 Domestic other 312.8 279.8 573.1 383.1 493.1 598.2 618.4 639.4 661.0 683.4 706.6 730.5 755.3 781.0 807.6 835.0 863.5 892.9 923.3 954.8 987.4 Export 190.0 176.6 174.6 243.8 346.9 425.7 439.4 503.7 519.9 581.3 607.7 635.5 664.5 695.1 727.1 760.7 796.1 833.2 872.2 913.1 956.1 Import 899.6 866.1 990.6 990.3 1125.4 1107.5 1133 1159 1199.1 1240.6 1283.6 1328.1 1374.2 1422 1471.6 1522.9 1576.1 1631.2 1688.3 1747.5 1808.9

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Armenian Railway Restructuring Project: Final Report Appendices B

Table B-4: Passenger Forecasts

Passenger Revenue (Drams - 000) 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2019 2020 High 133,571 138,914 144,470 150,249 156,259 162,510 169,010 175,770 182,801 190,113 197,718 205,626 213,851 222,406 231,302 240,554 231,302 240,554 Flat (after 2005) 133,571 133,571 133,571 133,571 133,571 133,571 133,571 133,571 133,571 133,571 133,571 133,571 133,571 133,571 133,571 133,571 133,571 133,571 Low 133,571 113,535 94,378 80,068 67,915 58,266 49,977 43,352 37,597 33,339 29,558 26,199 23,216 20,568 18,217 16,131 18,217 16,131

Passenger Kilometers (000) High 26,605 27,669 28,776 29,927 31,124 32,369 33,664 35,010 36,411 37,867 39,382 40,957 42,595 44,299 46,071 47,914 46,071 47,914 Flat (after 2005) 26,605 26,605 26,605 26,605 26,605 26,605 26,605 26,605 26,605 26,605 26,605 26,605 26,605 26,605 26,605 26,605 26,605 26,605 Low 26,605 22,614 18,798 15,948 13,527 11,605 9,955 8,635 7,489 6,641 5,887 5,218 4,624 4,097 3,629 3,213 3,629 3,213

Passenger Journeys (000) High 703.2 731.3 760.6 791.0 822.6 855.6 889.8 925.4 962.4 1,000.9 1,040.9 1,082.5 1,125.8 1,170.9 1,217.7 1,266.4 1,217.7 1,266.4 Flat (after 2005) 703.2 703.2 703.2 703.2 703.2 703.2 703.2 703.2 703.2 703.2 703.2 703.2 703.2 703.2 703.2 703.2 703.2 703.2 Low 703.2 597.7 508.1 436.9 375.8 326.9 284.4 250.3 220.3 198.2 178.4 160.6 144.5 130.1 117.1 105.3 117.1 105.3

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Armenian Railway Restructuring Project: Final Report Appendices B

Table B-5. Kars Border Reopening Scenario: Turkish border reopens in 2007, Abkhazia Line Opens in 2010 Thousand Tons 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Domestic DO-scrap metal 17.9 5.0 1.7 3.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 DO- cement 78.1 47.0 102.6 47.7 55.1 50.4 52.4 54.5 56.7 59.0 61.3 63.8 66.3 69.0 71.7 74.6 77.6 80.7 83.9 87.3 90.8 DO-construction materrials 19.6 12.3 127.4 107.4 237.8 177.7 184.8 192.2 199.9 207.9 216.2 224.8 233.8 243.2 252.9 263.0 273.6 284.5 295.9 307.7 320.0 DO-industrial raw materials 177.3 169.2 271.2 158.4 24.6 197.0 202.9 209.0 215.3 221.7 228.4 235.2 242.3 249.6 257.0 264.8 272.7 280.9 289.3 298.0 306.9 DO-wheat/wheat flour 12.1 12.0 16.5 8.8 13.9 32.8 33.8 34.8 35.8 36.9 38.0 39.2 40.3 41.6 42.8 44.1 45.4 46.8 48.2 49.6 51.1 DO-nonferrous ore 20.8 75.6 281.0 508.3 664.2 480.9 504.9 530.2 556.7 584.5 613.8 644.5 676.7 710.5 746.0 783.3 822.5 863.6 906.8 952.1 999.8 DO-others goods-commodities 7.8 34.3 53.7 57.8 161.7 140.3 144.5 148.8 153.3 157.9 162.6 167.5 172.6 177.7 183.1 188.6 194.2 200.0 206.0 212.2 218.6 Export EX-ferrous metal 35.2 74.9 64.6 76.6 51.1 49.2 49.7 50.2 50.7 51.7 52.7 53.8 54.9 56.0 57.1 58.2 59.4 60.6 61.8 63.0 64.3 EX-cement 4.2 9.5 27.2 103.3 184.3 191.7 199.3 207.3 215.6 224.2 233.2 242.5 252.2 262.3 272.8 283.7 295.1 306.9 319.1 331.9 EX-construction materials 61.0 7.8 1.5 1.3 8.3 11.8 12.3 12.8 13.3 13.8 14.4 14.9 15.5 16.1 16.8 17.5 18.2 18.9 19.6 20.4 21.3 EX-industrial raw materials 4.5 1.4 5.9 61.6 82.3 84.8 87.3 89.9 95.3 101.0 107.1 113.5 120.3 127.6 135.2 143.3 151.9 161.1 170.7 181.0 EX-nonferrous ore 30.4 34.7 49.3 62.9 96.9 44.1 45.4 46.8 48.2 49.6 51.1 52.7 54.2 55.9 57.5 59.3 61.0 62.9 64.8 66.7 68.7 EX-other goods-commodities 58.9 53.6 49.7 69.9 25.7 54.0 55.6 57.3 59.0 60.8 62.6 64.5 66.4 68.4 70.5 72.6 74.7 77.0 79.3 81.7 84.1 EX-specialy minerals 50.0 51.5 93.0 98.6 104.5 110.8 117.5 124.5 132.0 139.9 148.3 157.2 166.6 176.6 Import IM-grain 445.7 368.9 383.9 341.3 459.4 376.5 384.0 391.7 403.5 415.6 428.0 440.9 454.1 467.7 481.8 496.2 511.1 526.4 542.2 558.5 575.2 IM-sugar 60.2 71.7 69.7 86.8 73.1 104.5 106.6 108.7 112.0 115.3 118.8 122.4 126.0 129.8 133.7 137.7 141.9 146.1 150.5 155.0 159.7 IM-oil products 270.4 299.2 356.1 310.2 314.7 294.9 300.8 306.8 316.0 325.5 335.3 345.3 355.7 366.4 377.3 388.7 400.3 412.3 424.7 437.4 450.6 IM-chemical and mine fertilizer 31.9 17.3 47.7 42.5 51.1 48.9 50.4 51.9 54.2 56.7 59.2 61.9 64.6 67.6 70.6 73.8 77.1 80.6 84.2 88.0 91.9 IM-other goods-commodities 91.4 109.0 133.2 209.5 227.1 282.7 291.2 299.9 313.4 327.5 342.3 357.7 373.8 390.6 408.1 426.5 445.7 465.8 486.7 508.6 531.5 Transit Transit-Turkey 120.0 260.0 700.0 1,500.0 2,400.0 2,550.0 2,700.0 2,850.0 3,000.0 3,150.0 3,300.0 3,450.0 3,600.0 3,750.0 3,900.0 Total 1,423.2 1,398.1 2,019.3 2,125.5 2,629.6 2,612.3 2,815.8 3,092.3 3,636.7 4,588.4 5,608.6 5,883.8 6,164.2 6,450.0 6,741.4 7,038.8 7,342.3 7,652.3 7,969.1 8,292.8 8,623.9

Domestic-nonferrous ore 20.8 75.6 281.0 508.3 664.2 480.9 504.9 530.2 556.7 584.5 613.8 644.5 676.7 710.5 746.0 783.3 822.5 863.6 906.8 952.1 999.8 Domestic other 312.8 279.8 573.1 383.1 493.1 598.2 618.4 639.4 661.0 683.4 706.6 730.5 755.3 781.0 807.6 835.0 863.5 892.9 923.3 954.8 987.4 Export 190.0 176.6 174.6 243.8 346.9 425.7 439.4 453.7 468.4 486.9 506.1 526.2 547.1 569.0 591.8 615.6 640.4 666.3 693.4 721.7 751.2 Import 899.6 866.1 990.6 990.3 1125.4 1107.5 1133.0 1159.0 1199.1 1240.6 1283.6 1328.1 1374.2 1422.0 1471.6 1522.9 1576.1 1631.2 1688.3 1747.5 1808.9 Transit 120.0 260.0 700.0 1500.0 2400.0 2550.0 2700.0 2850.0 3000.0 3150.0 3300.0 3450.0 3600.0 3750.0 3900.0

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Armenian Railway Restructuring Project: Final Report Appendices B

Table B-6. Armenian Railways Summary Ton-Kilometer Forecast : Most Likely Case based on 2005 TKM Per Ton Relationships Thousand Ton Kilometers 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Domestc DO- cement 6,552 6,814 7,087 7,370 7,665 7,972 8,290 8,622 8,967 9,326 9,699 10,087 10,490 10,910 11,346 11,800 DO-construction materrials 23,101 24,025 24,986 25,985 27,025 28,106 29,230 30,399 31,615 32,880 34,195 35,563 36,985 38,465 40,003 41,604 DO-wheat wheat flour 4,264 4,392 4,524 4,659 4,799 4,943 5,091 5,244 5,402 5,564 5,730 5,902 6,079 6,262 6,450 6,643 DO-nonferrous ore 125,034 127,535 130,085 132,687 135,341 138,048 140,809 143,625 146,497 149,427 152,416 155,464 158,573 161,745 164,980 168,279 DO-others goods-commodities 43,849 45,164 46,519 47,915 49,352 50,833 52,358 53,929 55,547 57,213 58,929 60,697 62,518 64,394 66,326 68,315 Domestic Total 202,800 207,930 213,201 218,617 224,182 229,901 235,779 241,819 248,028 254,409 260,969 267,713 274,646 281,775 289,104 296,641 EX-cement 54,369 60,377 62,792 65,303 67,916 70,632 73,457 76,396 79,452 82,630 85,935 89,372 92,947 96,665 100,532 104,553 EX-industrial raw materials 24,279 25,007 25,757 26,530 27,326 28,145 28,990 29,859 30,755 31,678 32,628 33,607 34,615 35,654 36,723 37,825 EX-nonferrous ore 13,010 13,400 13,802 14,216 14,642 15,082 15,534 16,000 16,480 16,974 17,484 18,008 18,548 19,105 19,678 20,268 EX-other goods-commodities 33,925 34,943 35,991 37,071 38,183 39,328 40,508 41,723 42,975 44,264 45,592 46,960 48,369 49,820 51,315 52,854 Export Total 125,582 133,726 138,342 143,120 148,066 153,188 158,490 163,979 169,662 175,546 181,639 187,948 194,480 201,244 208,248 215,500 Import IM-grain 111,068 113,289 115,555 117,866 120,223 122,627 125,080 127,582 130,133 132,736 135,391 138,098 140,860 143,678 146,551 149,482 IM-sugar 30,828 31,444 32,073 32,714 33,369 34,036 34,717 35,411 36,119 36,842 37,579 38,330 39,097 39,879 40,676 41,490 IM-oil products 86,996 88,735 90,510 92,320 94,167 96,050 97,971 99,930 101,929 103,968 106,047 108,168 110,331 112,538 114,789 117,084 IM-chemical and mine fertilizer 14,426 14,858 15,304 15,763 16,236 16,723 17,225 17,742 18,274 18,822 19,387 19,968 20,567 21,184 21,820 22,474 IM-other goods-commodities 83,397 85,898 88,475 91,130 93,863 96,679 99,580 102,567 105,644 108,814 112,078 115,440 118,903 122,471 126,145 129,929 Import Total 326,713 334,225 341,917 349,793 357,858 366,116 374,572 383,232 392,100 401,181 410,481 420,005 429,759 439,749 449,981 460,460

Total, thousand tkm 655,094 675,881 693,460 711,530 730,107 749,205 768,841 789,030 809,789 831,137 853,089 875,666 898,886 922,768 947,333 972,602

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Armenian Railway Restructuring Project: Final Report Appendices B

Table B-7, Armenian Railway Summary Freight Revenue Forecast. Most Likely Revenue Forecast using 2005 revenue per ton applied to tonnage projections Millions of Drams (2005) 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Domestic DO- cement 52 55 57 59 61 64 66 69 72 75 78 81 84 87 91 94 DO-construction materrials 180 187 195 203 211 219 228 237 247 256 267 277 288 300 312 325 DO-wheat wheat flour 34 35 36 37 38 40 41 42 43 45 46 47 49 50 52 53 DO-nonferrous ore 913 931 950 969 988 1,008 1,028 1,048 1,069 1,091 1,113 1,135 1,158 1,181 1,204 1,228 DO-others goods-commodities 1,044 1,075 1,107 1,140 1,175 1,210 1,246 1,284 1,322 1,362 1,403 1,445 1,488 1,533 1,579 1,626 Domestic TOTAL 2,223 2,283 2,345 2,408 2,473 2,540 2,609 2,680 2,753 2,828 2,905 2,985 3,067 3,151 3,237 3,326 Export EX-cement 500 555 578 601 625 650 676 703 731 760 791 822 855 889 925 962 EX-industrial raw materials 194 201 207 213 219 226 233 240 247 254 262 270 278 286 295 303 EX-nonferrous ore 90 92 95 98 101 104 107 110 114 117 121 124 128 132 136 140 EX-other goods-commodities 495 510 525 541 557 574 591 609 627 646 666 686 706 727 749 772 Export TOTAL 1,279 1,359 1,405 1,453 1,503 1,554 1,607 1,662 1,719 1,778 1,839 1,902 1,967 2,035 2,104 2,177 Import IM-grain 1,244 1,269 1,294 1,320 1,346 1,373 1,401 1,429 1,457 1,487 1,516 1,547 1,578 1,609 1,641 1,674 IM-sugar 432 440 449 458 467 477 486 496 506 516 526 537 547 558 569 581 IM-oil products 1,218 1,242 1,267 1,292 1,318 1,345 1,372 1,399 1,427 1,456 1,485 1,514 1,545 1,576 1,607 1,639 IM-chemical and mine fertilizer 159 163 168 173 179 184 189 195 201 207 213 220 226 233 240 247 IM-other goods-commodities 1,001 1,031 1,062 1,094 1,126 1,160 1,195 1,231 1,268 1,306 1,345 1,385 1,427 1,470 1,514 1,559 Import TOTAL 4,053 4,146 4,240 4,338 4,437 4,539 4,643 4,750 4,859 4,971 5,085 5,203 5,323 5,446 5,572 5,701

Total (million AMD) 7,555 7,787 7,990 8,198 8,413 8,633 8,859 9,092 9,331 9,577 9,829 10,089 10,356 10,631 10,913 11,204 US Dollar (millions) $16.9 $17.5 $17.9 $18.4 $18.9 $19.4 $19.9 $20.4 $20.9 $21.5 $22.0 $22.6 $23.2 $23.8 $24.5 $25.1

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Armenian Railway Restructuring Project: Final Report Appendices C

Appendix C: Financial Results

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Armenian Railway Restructuring Project: Final Report Appendices C

ARC Financial Model Full Concession, No Passenger, All Electric, Operations Improvemetns, Used Equipment Most Likely Forecast Amounts in millions of 2005 AMD Exchange Rate AMD/$ ==> 451 =CUSDx 6.73% = IRR Projected Inputs 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Income Statement Change in Railway Freight Tariffs 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Revenue Freight 7,956 8,163 8,376 8,595 8,819 9,050 9,288 9,532 9,783 10,041 10,306 10,578 10,859 11,147 Wagon Rental 0.026974 312 319 327 338 350 362 375 387 401 415 429 444 459 475 Equipment Leasing 29 29 29 29 29 29 29 29 29 29 29 29 29 29 Other Freight Revenue (Station Services) 0.002346 158 162 166 171 176 180 185 190 196 201 207 212 218 224 Passenger 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Passenger Subsidy 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Scrap Sales and Other Operating Income 517 364 472 322 366 324 317 317 202 223 123 194 79 81 Total Revenue 8,972 9,038 9,370 9,455 9,740 9,946 10,193 10,455 10,610 10,908 11,093 11,457 11,644 11,956

Operating Expenses Administration 849 810 661 402 401 401 402 402 403 405 428 427 427 430 Track & Structures 1,957 1,937 2,051 2,102 2,105 2,106 2,107 2,108 2,110 2,111 2,111 2,105 2,095 2,086 Electrical 825 757 710 793 802 814 824 830 835 839 856 932 914 900 Signals & Communications 590 486 392 337 296 263 236 215 199 185 174 166 159 154 Station Operations 2,044 1,761 3,588 3,203 2,168 1,600 1,564 1,749 1,780 1,814 1,698 1,739 1,776 1,814 Wagon Depot 705 686 760 819 918 999 1,125 1,250 1,375 1,457 1,479 1,526 1,574 1,614 Locomotive Depots Step 1,213 1,151 1,104 1,069 1,033 1,071 1,057 1,043 1,017 1,076 1,176 1,319 1,328 1,337 Concession Fee (% of Frt Revenue) 2% 10,000 159 163 168 172 176 181 186 191 196 502 515 529 543 557 Total Expenses 8,343 7,751 9,432 8,898 7,899 7,434 7,499 7,789 7,915 8,388 8,438 8,743 8,816 8,891

Net Operating Income 629 1,287 (62) 557 1,841 2,511 2,694 2,667 2,695 2,520 2,655 2,715 2,828 3,065

EBITDA 2,670 3,911 4,872 5,175 5,570 5,806 6,016 6,236 6,344 6,292 6,420 6,732 6,852 7,097 US$ 6 9 11 11 12 13 13 14 14 14 14 15 15 16 Revenue from asset related grants 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Operating Expenses Office Expenses 608 388 272 255 247 239 239 239 239 238 239 238 239 239 Salary and Benefits 2,440 1,691 1,257 1,106 1,018 952 939 927 917 907 908 888 880 872 Depreciation 2,041 2,624 4,934 4,618 3,729 3,295 3,322 3,570 3,649 3,773 3,765 4,017 4,024 4,032 Electricity and Fuel 1,436 1,303 1,245 1,234 1,254 1,275 1,301 1,329 1,357 1,387 1,418 1,448 1,482 1,515 Materials 1,501 1,422 1,396 1,349 1,307 1,322 1,339 1,357 1,377 1,398 1,406 1,433 1,456 1,479 Concession Fee 159 163 168 172 176 181 186 191 196 502 515 529 543 557 Other Expenses (Car Rental, Prop Tax) 158 160 161 164 167 170 173 176 179 183 186 190 193 197 Total 8,343 7,751 9,432 8,898 7,899 7,434 7,499 7,789 7,915 8,388 8,438 8,743 8,816 8,891

Interest 273 627 921 935 934 922 908 894 879 863 887 952 931 908

Earnings After Interest 356 660 (983) (378) 907 1,590 1,786 1,772 1,816 1,657 1,768 1,763 1,898 2,157

Taxes 25% 89 165 0 0 227 397 446 443 454 414 442 441 474 539

Net Profit 267 495 (983) (378) 680 1,192 1,339 1,329 1,362 1,243 1,326 1,322 1,423 1,618

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Armenian Railway Restructuring Project: Final Report Appendices C

Cash Summary 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Cash Balance at Beginning of Year 0 868 1,781 2,363 2,638 2,869 3,825 4,228 4,787 5,493 5,212 4,224 4,247 6,060 Revenue (Cash) Freight 6,763 6,939 7,120 7,306 7,497 7,693 7,895 8,102 8,315 8,534 8,760 8,992 9,230 9,475 Wagon Rental 265 271 278 288 297 308 318 329 341 353 365 377 391 404 Equipment Leasing 25 25 25 25 25 25 25 25 25 25 25 25 25 25 Other Freight Revenue (Station Services) 134 138 141 145 149 153 158 162 166 171 176 180 185 190 Passenger 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Passenger Subsidy 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Scrap Sales and Other Operating Income 517 364 472 322 366 324 317 317 202 223 123 194 79 81 Total Revenue 7,704 7,736 8,036 8,085 8,334 8,502 8,712 8,934 9,049 9,305 9,448 9,768 9,909 10,175 Accounts Receivable 0 1,015 1,244 1,317 1,359 1,397 1,434 1,472 1,511 1,551 1,592 1,635 1,679 1,724 Operating Expenses (Cash) Administration 656 424 305 299 298 298 299 299 300 300 301 301 303 303 Track & Structures 882 731 692 650 654 654 654 655 655 656 656 658 660 661 Electrical 545 431 346 302 293 290 287 284 281 278 288 273 271 269 Signals & Communications 253 165 86 84 84 84 84 84 85 85 85 85 85 85 Station Operations 1,526 1,352 1,254 1,227 1,199 1,172 1,195 1,220 1,245 1,272 1,300 1,329 1,359 1,390 Wagon Depot 316 214 195 195 196 197 199 202 207 210 213 217 221 225 Locomotive Depots 736 653 586 529 471 472 475 479 483 489 483 494 500 507 Total Expenses 4,914 3,971 3,465 3,287 3,195 3,167 3,193 3,223 3,256 3,291 3,326 3,358 3,399 3,441 Accounts Payable 0 1,400 1,838 1,932 1,929 2,095 2,252 2,322 2,331 2,340 2,549 2,651 2,739 2,786 Net Cash From Operations 2,790 3,380 3,976 4,183 4,569 4,638 4,700 4,862 4,973 5,225 5,165 5,395 5,450 5,671

Cash Investments Administration 3 253 253 2 2 2 2 2 2 3 3 3 2 2 Track & Structures 3,374 3,422 2,615 1,001 1,041 1,041 1,041 1,041 1,041 1,041 880 840 840 840 Electrical 513 517 967 517 517 517 517 517 517 517 967 517 517 517 Signals & Communications 275 300 300 25 25 25 25 25 25 25 25 25 25 25 Station Operations 65 1,250 1,850 750 750 65 100 0 0 0 100 0 0 0 Wagon Depot 917 1,310 1,195 1,433 1,610 1,475 2,043 2,135 2,083 1,955 1,440 1,818 1,561 1,448 Locomotive Depots 634 418 365 365 365 365 365 365 365 1,715 3,065 3,065 365 365 Total Investments 5,781 7,469 7,544 4,093 4,311 3,491 4,093 4,086 4,033 5,256 6,480 6,267 3,310 3,197 (5,781) (7,469) (7,544) (4,093) (4,311) (3,491) (4,093) (4,086) (4,033) (5,256) (6,480) (6,267) (3,310) (3,197) Loans Received - Net 3,859 5,002 4,149 185 (28) (190) (204) (218) (233) (250) 327 895 (327) (349) Net Cash 868 913 582 275 230 957 403 558 706 (280) (988) 23 1,813 2,125 Cumulative Net Cash Required (868) (1,781) (2,363) (2,638) (2,869) (3,825) (4,228) (4,787) (5,493) (5,212) (4,224) (4,247) (6,060) (8,185) Ending cash balance 868 1,781 2,363 2,638 2,869 3,825 4,228 4,787 5,493 5,212 4,224 4,247 6,060 8,185

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Armenian Railway Restructuring Project: Final Report Appendices C

Balance Sheet 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Price of Concession 4,510 Drams $ 1 0.0 US$ CB of RA Exchange Rates as at 31 December ASSETS Non-current assets Property plant and equipment 4,510 8,249 13,094 15,705 15,180 15,762 15,958 16,729 17,245 17,629 19,112 21,827 24,077 23,363 22,527 Intangible assets 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Investments in subsidiaries 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Other 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 4,510 8,249 13,094 15,705 15,180 15,762 15,958 16,729 17,245 17,629 19,112 21,827 24,077 23,363 22,527

Current assets Inventories 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Trade and other receivables 0 1,268 1,555 1,646 1,699 1,746 1,792 1,840 1,889 1,939 1,991 2,044 2,098 2,154 2,212 Cash and cash equivalents 0 868 1,781 2,363 2,638 2,869 3,825 4,228 4,787 5,493 5,212 4,224 4,247 6,060 8,185 Other 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2,136 3,336 4,009 4,337 4,614 5,618 6,068 6,675 7,432 7,203 6,268 6,345 8,214 10,397

TOTAL ASSETS 4,510 10,386 16,430 19,713 19,517 20,376 21,575 22,797 23,920 25,061 26,315 28,094 30,422 31,577 32,924

EQUITY AND LIABILITIES Capital and reserves Share capital 4,510 4,510 4,510 4,510 4,510 4,510 4,510 4,510 4,510 4,510 4,510 4,510 4,510 4,510 4,510 Reserve capital 0 18 51 51 51 96 176 265 354 444 527 616 704 704 704 Additional capital 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Retained earnings (0) 249 711 (272) (650) (16) 1,097 2,347 3,588 4,859 6,019 7,257 8,491 9,914 11,532 Other reserves 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 4,510 4,777 5,272 4,289 3,910 4,591 5,783 7,122 8,451 9,813 11,056 12,382 13,704 15,128 16,745 Non current liabilities Long term loans 0 3,859 8,861 13,010 13,195 13,167 12,977 12,773 12,555 12,322 12,072 12,399 13,294 12,967 12,618 Assets related grants 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 3,859 8,861 13,010 13,195 13,167 12,977 12,773 12,555 12,322 12,072 12,399 13,294 12,967 12,618 Current liabilities Trade and other payables 0 1,750 2,298 2,415 2,412 2,618 2,815 2,902 2,914 2,925 3,187 3,313 3,424 3,482 3,561 Income related grants 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1,750 2,298 2,415 2,412 2,618 2,815 2,902 2,914 2,925 3,187 3,313 3,424 3,482 3,561 TOTAL EQUITY AND LIABILITIES 4,510 10,386 16,430 19,713 19,517 20,376 21,575 22,797 23,921 25,061 26,315 28,095 30,422 31,577 32,924

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Armenian Railway Restructuring Project: Final Report Appendices C

ARC Financial Model Concession with Management Contract, No Passenger, All Electric, Operations Improvemetns, Used Equipment Summary Financials for Concessionaire Amounts in millions of 2005 AMD IRR=> 1.0% Exchange AMD/$ ==> 451 =CUSDx AR Actual or Estimated Data Projected Inputs 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Income Statement Price Increase 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Revenue Freight 7,755 7,956 8,163 8,376 8,595 8,819 9,050 9,288 9,532 9,783 10,041 10,306 10,578 10,859 11,147 Wagon Rental 0.02697 305 312 319 327 338 350 362 375 387 401 415 429 444 459 475 Equipment Leasing 29 29 29 29 29 29 29 29 29 29 29 29 29 29 29 Other Freight Revenue (Station Services) 0.00235 154 158 162 166 171 176 180 185 190 196 201 207 212 218 224 Passenger 134 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Management Contract Fees 0 353 360 355 353 356 365 363 363 370 367 367 372 368 365 Revenue from Asset Related Grants 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Scrap Sales and Other Operating Income 268 517 364 472 322 366 324 317 317 202 223 123 194 79 81 Total Revenue Dram 8,644 9,325 9,397 9,725 9,808 10,095 10,310 10,556 10,819 10,980 11,275 11,460 11,829 12,012 12,321 US$ 19 21 21 22 22 22 23 23 24 24 25 25 26 27 27 Operating Expenses By Function Administration 1,601 849 812 663 404 403 403 404 405 406 407 430 429 430 432 Infrastructure Costs (Access Charges) 3,250 4,340 4,529 4,557 4,586 4,627 4,745 4,731 4,734 4,816 4,788 4,783 4,845 4,793 4,749 Concession Fee (Percent of Freight Rev) 2% 0 159 163 168 172 176 181 186 191 196 201 206 212 217 223 Station Operations 2,143 2,044 1,782 3,609 3,225 2,190 1,621 1,585 1,771 1,802 1,836 1,720 1,761 1,798 1,837 Wagon Depot 700 762 705 784 851 949 1,031 1,157 1,282 1,408 1,490 1,512 1,559 1,607 1,648 Locomotive Depots 1,569 1,213 1,151 1,104 1,069 1,033 1,071 1,057 1,043 1,088 1,147 1,248 1,319 1,328 1,336 Total Expenses Dram 9,263 9,367 9,142 10,884 10,307 9,378 9,052 9,119 9,425 9,716 9,867 9,899 10,125 10,174 10,225 US$ 21 21 20 24 23 21 20 20 21 22 22 22 22 23 23 Operating Expenses by Cause Concession Fees 0 159 163 168 172 176 181 186 191 196 201 206 212 217 223 Track Access Charges 0 4,340 4,529 4,557 4,586 4,627 4,745 4,731 4,734 4,816 4,788 4,783 4,845 4,793 4,749 Office Expenses 1,134 556 352 246 233 226 218 218 218 218 219 219 219 220 220 Salary and Benefits 3,155 1,360 866 633 569 496 438 433 429 427 424 421 419 418 417 Depreciation 1,576 768 1,103 3,186 2,680 1,815 1,396 1,436 1,694 1,850 1,979 1,977 2,084 2,126 2,162 Electricity and Fuel 1,559 1,175 1,125 1,116 1,132 1,149 1,172 1,200 1,229 1,259 1,290 1,322 1,354 1,388 1,423 Materials 1,681 851 844 818 770 722 731 742 754 770 784 786 803 818 834 Other Expenses (Car Rental, Prop Tax) 158 158 160 161 164 167 170 173 176 179 183 186 190 193 197 Total Expenses 9,263 9,367 9,142 10,884 10,307 9,378 9,052 9,119 9,425 9,716 9,867 9,899 10,125 10,174 10,225

Net Operating Income Dram (619) (41) 255 (1,159) (499) 717 1,258 1,437 1,394 1,264 1,408 1,561 1,705 1,839 2,095 US$ (1.4) (0.1) 0.6 (2.6) (1.1) 1.6 2.8 3.2 3.1 2.8 3.1 3.5 3.8 4.1 4.6

EBITDA Dram 957 727 1,358 2,028 2,181 2,532 2,655 2,874 3,088 3,114 3,387 3,538 3,789 3,965 4,257 US$ 2 2 3 4 5 6 6 6 7 7 8 8 8 9 9

Interest 0 91 237 374 433 480 478 506 520 617 694 833 893 877 861

Earnings After Interest (619) (132) 18 (1,533) (932) 237 781 931 874 648 714 728 812 961 1,235

Taxes 25% 0 0 5 0 0 59 195 233 218 162 178 182 203 240 309

Profit After Tax (619) (132) 14 (1,533) (932) 177 585 698 655 486 535 546 609 721 926 cumulative Taxes 0 0 5 5 0 59 254 428 451 380 340 360 385 443 549

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Armenian Railway Restructuring Project: Final Report Appendices C

Cash Summary 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Cash Balance at Beginning of Year 0 66 42 27 98 30 38 50 62 44 29 26 57 709 Revenue (Cash) % Received in Year Freight 85% 6,763 6,939 7,120 7,306 7,497 7,693 7,895 8,102 8,315 8,534 8,760 8,992 9,230 9,475 Wagon Rental 80% 250 256 262 271 280 290 300 310 321 332 343 355 368 380 Equipment Leasing 80% 25 25 25 25 25 25 25 25 25 25 25 25 25 25 Other Freight Revenue (Station Services) 85% 134 138 141 145 149 153 158 162 166 171 176 180 185 190 Passenger 100% 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Management Contract Fees 85% 300 306 302 300 302 310 309 309 314 312 312 316 313 310 Scrap Sales and Other Operating Income 85% 440 309 401 274 311 275 269 269 172 189 105 165 67 69 Total Revenue 7,911 7,972 8,250 8,320 8,564 8,745 8,954 9,176 9,313 9,563 9,720 10,033 10,187 10,449

Accounts Receivable 0 1,132 1,367 1,453 1,481 1,522 1,556 1,593 1,632 1,660 1,702 1,733 1,784 1,817

Cash Payments % Paid In Year Concession Fees 90% 143 147 151 155 159 163 167 172 176 181 186 190 195 201 Track Access Charges 90% 3,906 4,076 4,101 4,128 4,164 4,270 4,258 4,261 4,335 4,309 4,305 4,360 4,314 4,274 Office Expenses 90% 501 317 221 210 203 196 196 196 196 197 197 197 198 198 Salary and Benefits 90% 1,224 780 569 512 446 395 390 386 384 382 379 377 376 375 Depreciation 0% 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Electricity and Fuel 80% 940 900 892 905 919 938 960 983 1,007 1,032 1,057 1,083 1,111 1,139 Materials 80% 681 675 654 616 578 585 593 603 616 627 629 642 655 667 Other Expenses (Car Rental, Prop Tax) 75% 119 120 121 123 125 128 130 132 135 137 140 142 145 148 Taxes 100% 0 5 0 0 59 195 233 218 162 178 182 203 240 309 Total Payments 7,513 7,019 6,710 6,649 6,654 6,869 6,927 6,951 7,011 7,043 7,073 7,196 7,234 7,311

Accounts Payable 0 942 1,198 1,329 1,394 1,438 1,455 1,487 1,511 1,609 1,696 1,831 1,919 1,929

Net Cash from Operations, After Taxes 398 1,143 1,709 1,795 1,996 1,960 2,128 2,331 2,423 2,571 2,652 2,739 2,819 3,026

Cash Investments Administration 3 253 253 2 2 2 2 2 2 2 3 2 2 2 Track & Structures 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Electrical 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Signals & Communications 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Station Operations 65 1,250 1,850 750 750 65 100 0 0 0 100 0 0 0 Wagon Depot 917 1,310 1,195 1,433 1,610 1,475 2,043 2,135 2,083 1,955 1,440 1,818 1,561 1,448 Locomotive Depots 634 418 365 365 365 365 365 365 1,715 1,715 3,065 1,715 365 365 Total Investments 1,619 3,230 3,662 2,550 2,727 1,907 2,510 2,502 3,800 3,672 4,607 3,535 1,928 1,815

Loans Received (Paid) 1,286 2,063 1,939 826 662 (44) 394 183 1,359 1,086 1,952 827 (239) (256)

Net Cash (1,221) (2,087) (1,954) (755) (731) 53 (382) (171) (1,377) (1,101) (1,955) (795) 891 1,211

Cash at End of Year 66 42 27 98 30 38 50 62 44 29 26 57 709 1,664

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Armenian Railway Restructuring Project: Final Report Appendices C

Balance Sheet 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Cost of Concession 4,510 Drams ASSETS $10 US$ millions Non-current assets Property plant and equipment 4,510 5,361 7,487 7,964 7,833 8,746 9,257 10,330 11,138 13,088 14,782 17,412 18,863 18,665 18,318 Intangible assets 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Investments in subsidiaries 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Other 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Total, Non-Current Assets 4,510 5,361 7,487 7,964 7,833 8,746 9,257 10,330 11,138 13,088 14,782 17,412 18,863 18,665 18,318

Current assets Inventories 3,991 3,991 3,991 3,991 3,991 3,991 3,991 3,991 3,991 3,991 3,991 3,991 3,991 3,991 3,991 Trade and other receivables 0 1,414 1,708 1,817 1,851 1,902 1,945 1,991 2,040 2,075 2,127 2,166 2,230 2,271 2,326 Cash and cash equivalents 0 66 42 27 98 30 38 50 62 44 29 26 57 709 1,664 Other (value of subsidiaries at 2005) 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Total, Current Assets 3,991 5,471 5,741 5,835 5,941 5,923 5,974 6,032 6,094 6,110 6,147 6,183 6,278 6,971 7,981

TOTAL ASSETS 8,501 10,832 13,229 13,799 13,774 14,668 15,230 16,362 17,232 19,198 20,929 23,595 25,141 25,636 26,299

LIABILITIES Capital and reserves Share capital 4,510 4,510 4,510 4,510 4,510 4,510 4,510 4,510 4,510 4,510 4,510 4,510 4,510 4,510 4,510 Reserve capital 0 0 1 1 1 10 39 74 107 131 158 185 215 251 298 Additional capital 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Retained earnings 0 (132) (120) (1,653) (2,585) (2,416) (1,860) (1,197) (574) (113) 396 914 1,493 2,178 3,058 Other reserves 3,991 3,991 3,991 3,991 3,991 3,991 3,991 3,991 3,991 3,991 3,991 3,991 3,991 3,991 3,991 Total Capital and Reserves 8,501 8,369 8,382 6,849 5,917 6,094 6,680 7,378 8,033 8,519 9,054 9,600 10,209 10,930 11,856

Non current liabilities Long term loans 0 1,286 3,349 5,289 6,114 6,776 6,732 7,126 7,309 8,668 9,754 11,706 12,533 12,294 12,038 Assets related grants 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1,286 3,349 5,289 6,114 6,776 6,732 7,126 7,309 8,668 9,754 11,706 12,533 12,294 12,038 Current liabilities Trade and other payables 0 1,177 1,497 1,661 1,743 1,798 1,819 1,858 1,889 2,011 2,120 2,288 2,399 2,411 2,404 Income related grants 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1,177 1,497 1,661 1,743 1,798 1,819 1,858 1,889 2,011 2,120 2,288 2,399 2,411 2,404 TOTAL EQUITY AND LIABILITIES 8,501 10,832 13,229 13,799 13,774 14,668 15,230 16,362 17,232 19,198 20,929 23,595 25,141 25,636 26,299

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D: Revisions to Draft Law on Railways

he following mark-up of a draft Law on Railway Transport developed by the Armenian Ministry of Transport and Communications was submitted in draft form to the Ministry T (in English and Armenian) in April 2006. To clarify suggestions, comments and suggested additions and revisions to the Draft Railway Law have been color-coded:

• Unchanged provisions as provided to HWTSK in translation are in black and white, with no editing of the translation. • Suggested new or partially revised provisions are in blue. • Provisions suggested to be stricken are highlighted in magenta • Comments explaining the reasoning behind each suggested change are highlighted in gray.

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CHAPTER 1.

GENERAL PROVISIONS

ARTICLE 1. SUBJECT OF LAW’S REGULATION

This law stipulates the legal, organizational and economic conditions of the activities of the railway transport of general use; the relations of organizations of railway transport organizations and individual entrepreneurs performing works (services) in railway transport with public administration bodies and organizations, as well as the basics for state regulation of railway transport of non-general use.

ARTICLE 2. THE BASICS OF THE ACTIVITIES OF THE RAILWAY TRANSPORT IN THE REPUBLIC OF ARMENIA

1. In the Republic of Armenia the railway transport is a constituent part of unified transport system. While performing the railway transportations the organizations of the railway transport, as a result of cooperation with the organizations of other types of transport, have an objective to timely and qualitatively ensure the demands of the natural, legal persons and countries and contribute to the development of the economy of the Republic of Armenia.

2. The railway transport in the Republic of Armenia is composed of the railway transport of general use, the railway transport of non-general use, as well as technology railway transport of organizations, which are designated for performing the initial and final activities with the railway rolling stock for their own needs.

Other legal acts of the Republic of Armenia regulate the activities of the railway transport organizations of non-general use that are not regulated by this law.

3. The activities of the railway transport are performed based on the following principles:

a) stability of the work of the railway transport; b) provision of the accessibility, security and quality of the services; c) development of competition and establishment of the services of the railway transport; d) implementation of agreed activities of the unified transport system of the Republic of Armenia. 4. Through effective regulation and supervision in the area of the railway transport, as well as with its participation to the development of the railway transport the Republic of Armenia ensures the solution of the challenges of the railway transport.

5. The property of the railway transport can be of state and other forms of ownership – in accordance with the legislation of the Republic of Armenia.

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ARTICLE 3. THE MAIN CONCEPTS

1. The following main concepts are used in this law:

Railway transport of general use – an industrial-technological complex, which includes the infrastructures of the railway transport, railway rolling stock, other property, which is envisaged for meeting the demands of the natural, legal persons and countries in performing the transportation by railway transport, as well as provision of other works (services), which are linked with such transportations; Railway transport of non-general use – an integrity of industrial-technological complexes, which includes the rails, facilities, buildings and in individual cases also the railway rolling stock of non-general use, which is envisaged for meeting the demands of natural and legal persons in the works (services), which are performed in the places of non-general use – on the contractual basis or for own needs; Infrastructure of the railway transport of general use (hereinafter referred to as infrastructure) – a technological infrastructure, which involves rails and other facilities of general use, railway stations, electricity supply structures, communications networks, signal systems, concentrations and barriers, information complexes and traffic management system, other buildings, structures, facilities and equipment, which ensure the implementation of the activities of that complex; [Comment: As defined in the MOTC draft, infrastructure does not include locomotives or drivers. This is consistent with restructuring strategies under consideration.] Rails of general use – rails in the territory of the railway stations, which are open for incoming and departing trains; receipt and hand over of cargos, hand luggage and parcels; service of the passengers, sorting and maneuver activities, as well as the rails that join such stations; Rails of non-general use – adjacent rails, which directly or on the other rails border with the rails of general use and are envisaged for individual users – for the provision of railway services on the contractual basis or for own needs; Owner of rails of non-general use – legal person or individual entrepreneur, who on the ownership or other right have rails of non-general use, as well as buildings, facilities, structures, other sites that are linked with the implementation of the transport activities and provision of railway transport services; Places of general use – closed and pen warehouses, as well as special areas in the territory of the railway station, which belong to the owner of the infrastructure and use for loading, unloading, sorting, protecting of the cargo, including the protection of the boxes and luggage of the persons using the services of the railway transport; Places of non-general use – rails, closed and open warehouses, as well as special areas in the territory of the railway station of non-general use, which do not belong to the owner of the infrastructure or are not leased by him for loading, unloading, protecting the boxes and luggage of the persons using the services of the railway transport; Railway rolling stock – locomotives, freight cars, passenger cars, motor-car rolling stock, as well as other rolling stock, which is envisaged for ensuring the activities of transportation and infrastructure. Transportation process – an integrity of organizational and technological interconnected activities, which are performed during the preparation, implementation and finishing the transportation of passengers, freight, luggage, cargo by railway transport;

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Users of the railway transport – passenger, freight forwarder (shipper), freight receiver (recipient) or other natural or legal person that use the services (works) provided by railway transport organizations or individual entrepreneur expanding activities in the railway transport area;

Owner or Manager of the infrastructure – legal person, who on ownership or other right have infrastructure and relevant permit (license) and on the contractual basis uses them for the provision of services; Comment: the suggestion is to further clarify that the rights and obligations of the infrastructure operator are applied irrespective of legal ownership.] Network Statement – An annual statement by the owner/manager of infrastructure as to the terms of access to the infrastructure [Comment: Provides a transparent mechanism for providing access terms, desirable for a multiple operator arrangement should this develop] Transporter – legal person, individual entrepreneur or natural person that on the transportation contract are bound to transport the passenger, freight entrusted by the shipper, luggage, cargo by the railway transport of general use from shipment point up to destination, as well as to hand over the freight, luggage to the person authorized to get them, and employing locomotives, other rolling stock, train drivers and other appropriate equipment and staff to perform these functions; [Comment: To clarify the scope of transporter activity.] Freight forwarder – natural or legal person that on the contractual basis acts on his behalf or on behalf of the owner of freight, luggage, cargo and the transportation document says so to assume responsibility as the shipper for the completion of required transportation documents and payment of transportation fees; [Comment: the translation appeared to be scrambled or missing something.] Freight recipient – natural or legal person that is entitled to receive the freight, luggage, cargo; Operator of the railway rolling stock – legal person or individual entrepreneur that on ownership or other rights have cars, freight boxes and on the contractual basis participate with the freight forwarder to the transportation process with the use of aforementioned cars and cargo boxes; Provision of railway transport’s traffic safety and maintenance – a system of economic, organizational-legal, technical and other measures, which is performed by the public administration bodies, local self-governing bodies, organization of the railway transport and other legal persons with an objective to prevent the accidents and reduce the risk to the lives and health of the citizens, environment, property of the natural or legal persons; Transport accident – an event, which occurs during the traffic of the railway rolling stock with the participation of the rolling stock, as a result of which damage is caused to the lives and health of the citizens, environment, property of natural or legal persons; Lands of the railway transport – lands of transport, which are used or envisaged for the activities of the transport organizations and/or/ maintenance of buildings, structures, facilities and railway transport, including lands that are in the layers of railway alienation and protection; Railway alienation layer (hereinafter referred to as alienation layer) – plots of land, which are adjacent to the rails, lands, which are envisaged for the deployment of the railway stations, water drainage and reinforcement structures, forest protection zones along with the rails, communication lines, electricity supply facilities, industrial and other buildings, facilities, structures and other sites; Railway protection layer – plots of lands, which are necessary to ensure the protection, durability and stability of the sites of the railway transport, plots of lands on the movable basis

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page D - 4 Armenian Railway Restructuring Project: Final Report Appendix D that are adjacent to those plots of land that are envisaged for the deployment of the railway transport sites, protection of the rails from snow and sand and other negative impacts; Passenger – person that travels by train with a travel document (ticket) or has a travel document and is in the area envisaged for railway stop, railway station or platform of passengers – right before or after the aforementioned travel; Freight – object of railway transportation that the transporter freight forwarder has accepted by transportation contract with a purpose to transport; [Comment: The reference to freight forwarder, rather than transporter, appears to be an error.] Luggage – property that by an additional fee the passenger sends by luggage care, which ensured by the transportation documents and follows the same route as the passenger; Cargo – object that in established order has been accepted from the natural or legal person with a purpose to transport by passenger, post-luggage or freight-passenger train; Dangerous freight – freight, which with its capacities in special conditions during the transportation, maneuvering, loading-unloading and preserving could become a reason for explosion, fire, chemical or other infections or damage the technical means, equipment, machines or other objects of railway transport, as well as cause damage to the lives or health of the citizens, environment; Special railway transportations – railway transportations, which are envisaged for special state and defense needs, as well as railway transportation of prisoners and arrested people; Train – special composition made of cars with one or several locomotives or engine cares, which are equipped for safe travel; Tariff – A tariff under this law is defined as the publicly announced rate that is offered by a transporter to users of railway transport for a given transport service and that is available to all users of railway transport on an equal (nondiscriminatory) basis. [Comment: Distinguishes tariff regulation of end-user tariffs from access charges, which will be treated under a different provision] Base Tariff – The tariff for the cargo movement or passenger journey from origin point to destination point. Supplemental Tariff Charges – a fee envisaged for additional activities or works that are not included in the base tariff/fare; [Comment: Clarifies that “other charges” refer only to end-user charges.] Combined Tariff – The combination of base tariff and supplemental tariff charges in a single rate. [Comment: Used later to explicitly permit simplified pricing that encompasses all charges.] Contract Rate – A rate provided under an agreement between a transporter and user of rail transport that is reached voluntarily in preference to the public tariff rate or combination of rates for multiple transport services. [Comment: To permit further pricing liberalization.] Access Charge – The fee charged by owner or manager of infrastructure for the use of infrastructure by a transporter; not a tariff under the meaning of this Act [Comment: Permits access charges to be regulated independently of tariff provisions should contract arrangements not provide for another form of dispute resolution and oversight.] Transportation documents – necessary documents that accompany the passenger, cargo, freight and parcel during the transportation in railway transport; Railway station (stop) – point, which divides the railways into junctions or block-parts, ensures the activities of the railway transport infrastructure, it has linear development that enables to receive, depart and transit trains, serve passengers, receive and hand over freights and luggage

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ARTICLE 4. THE LEGISLATION OF THE REPUBLIC OF ARMENIA ON RAILWAY TRANSPORT

1. The legislation of the Republic of Armenia on railway transport consists of the Constitution of the Republic of Armenia, Civil Code of the Republic of Armenia, “Law on transport” of the Republic of Armenia, this law and other legal acts.

2. If international treaties of the Republic of Armenia on traffic transport stipulate other provisions, than envisaged by the legislation of the Republic of Armenia on traffic transport, then the provision of the international treaties will be applied.

CHAPTER 2. STATE REGULATION IN RAILWAY TRANSPORT

ARTICLE 5. THE PRINCIPLES OF STATE REGULATION IN RAILWAY TRANSPORT

The state regulationState policy in the railway transport is implemented by the following principles: a) provision of the interests of the state, users of the services of the railway transport and organizations of the railway transport of general use; [Comment: Policy appears to be the intended translation, rather than narrower meaning of regulation] b) provision of integrated, effective, safe and quality activities of the railway transport, as well as its complex development; c) provision of continuity of transportation process performed jointly by infrastructure owner and transporter; d) provision of protection of rights of the economic entities of railway transport; e) provision of protection of environmental issues.

ARTICLE 6. THE POWERS OF THE GOVERNMENT AND PUBLIC ADMINISTRATION AUTHORIZED BODY IN RAILWAY TRANSPORT AREA

1. The state regulationState policy in the area of the railway transport is performed by the Government of the Republic of Armenia and public administration body authorized by it. [i.e., currently the Ministry of Transport and Communications; in the above paragraph. Again, policy appears to be the intended translation, rather than narrower meaning of regulation]

2. The powers of the Government of the Republic of Armenia in the area of railway transport are:

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a) provision of the public policy in the area of railway transport; b) approval of the railway transport development programs funded by government or requiring governmental authority; c) establishment, re-organization and liquidation of the railway transport organizations by the state; d) identification of the list of dangerous freights; e) other powers envisaged by the legislation of the Republic of Armenia.

3. The powers of the public administration authorized body in the area of railway transport are: a) implementation of the public policy in the area of railway transport; b) provision of international cooperation in the area of provision of the public policy in the area of railway transport; c) adoption of ministerial normative acts and supervision over their execution; d) licensing of the railway transport’s activities in order established by the law; [Comment: Licensing under this provision rests with the Ministry of Transport and Communications, not the PSRC] e) supervision over the implementation of the mandatory requirements and conditions of the organization of the activities of railway transport; f) approval of technical maintenance rules of railway transport; g) other powers established by the legislation of the Republic of Armenia.

4. With an objective to organize provide oversight of the maintenance, security of traffic and other technical means of the railway transport the public administration authorized body of railway transport performs: a) the legal and technical regulation oversight of the maintenance and traffic security of the technical means connected with the transportation process of railway transport, including official investigation and registration of transport accidents and cases of violation of the safety measures connected with the maintenance and traffic security of railway transport; Comment: The MoTC should not be involved in establishing detailed technical standards for maintenance or equipment standards, the industry can do that by itself and will be governed by CIS interchange agreements. However, the Ministry may wish to conduct investigations of safety issues, accidents and other matters to ensure that public safety is secured b) development and implementation of public policy for the maintenance of general use railway transport and traffic safety, as well as maintenance of other technical means connected with transportation process; c) public supervision over the requirements of the environmental security in the area maintenance of the railway transport and traffic, prognosis and elimination of man-made and natural emergencies, receipt and maintenance of other technical means connected with transportation process.

5. Within the powers established by the legislation of the Republic of Armenia the public or private owner or manager of the infrastructure, transporters, freight forwarders and other participants to the transportation process shall ensure: a) the safety conditions for the lives and health of the passengers; b) security of transportation of freights, luggage and cargoes; c) safety of maintenance of railway transport and traffic, d) environmental security.

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Comment: These functions may be performed by a concessionaire, contract manager, or other private infrastructure operator.

ARTICLE 7. LICENSING IN THE AREA OF RAILWAY TRANSPORT

The licensing in the area of railway transport is implemented in order established by the “Law on licensing” of the Republic of Armenia. For the purposes of this Act, a concession agreement or management contract with a private sector entity for the provision of transport operations or infrastructure services shall be considered to be a valid license for the duration of the contract agreement. By concluding such a contract agreement, the public administration body authorized for railway transport signifies that the contract is compliant with the Law on Licensing and no other licensing provisions other than those provided in the contract agreement shall supersede that agreement. Licensing requirements shall encompass an appropriate safety program to protect the public and employees, an appropriate environmental program, a demonstration of technical fitness to serve (including employee and equipment certifications) and a demonstration of financial fitness to serve, [Comment: Concession agreement or management contracts typically incorporate the terms of a license. This provision is needed to avoid conflict between the contract and MoTC terms for licenses that might be issued to third parties without a contract agreement and to assure potential bidders for a contract that contract terms are definitive.]

ARTICLE 8. PROVISION OF STANDARDIZATION AND UNIFICATION OF MEASURING IN THE AREA OF RAILWAY TRANSPORT

The provision of standardization and unification of measuring in the area of railway transport is implemented according to the “Law of provision of unification of measuring” and “Law on standardization” of the Republic of Armenia.

ARTICLE 9. TARIFFS, CHARGES AND FEES IN THE RAILWAY TRANSPORT

1. Tariffs applicable to railway transport within Armenia, issued by the Armenian Railways as a State-owned entity, or by a private entity operating under concession agreement or management contract, are not subject to the jurisdiction of the independent utilities regulatory body [Public Service Regulatory Commission]. The public administration authorized boby for rail transport [MoTC] is responsible for that tariffs set by State-owned entities are in the public interest and that contracts allowing for private sector operation of and pricing of rail services are in the public interest. Any constraints on the pricing of rail services though tariffs, transport contracts or access fees shall be incorporated in concession agreements nor management contracts to which the public administration authorized boby for rail transport is a party. To the extent such constraints are not incorporated in such contracts, private railway entities shall be subject to generally applicable commercial law governing private enterprises in Armenia. [Comment: The above provision applies to domestic tariffs – about one-third of freight and most passenger transport. It excludes rail transport from PSRC review and oversight.

2. The tariffs of international transportation with the participation of via public railway transport are established in accordance with the international treaties of the Republic of Armenia and

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page D - 8 Armenian Railway Restructuring Project: Final Report Appendix D therefore are not subject to modification by the independent utilities’ regulatory body [Public Service Regulatory Commission]. The application of the tariffs of international transportation with the participation of railway transport and order of application are established by the Government of the Republic of Armenia. [Comment: Since current CIS international tariffs have the status of treaties, it appears they cannot be subject to the oversight of the PSRC. This currently applies to about 2/3 of Armenian railway traffic. The above change acknowledges that these agreements apply to the public railway – i.e., Armenian Railway, allowing for subsequent liberalization of international agreements. The deleted last sentence appeared redundant.] 3. The loss of the infrastructure owner and transporter, which emerges as a result of state regulation of tariffs, charges and fees in railway transport, as well as concerning the privileges of the transportation shall be fully compensated at the expense of state budget. The Government of the Republic of Armenia establishes the order for compensation of revenue loss.

ARTICLE 10. PECULIARITIES OF STATE REGULATION OF THE USE OF LANDS OF RAILWAY TRANSPORT

1. The lands of the railway transport of general use are provided free of charge.

2. The use of the lands of the railway transport is implemented according to the Land Code; urban development, environmental, health, fire and other normative acts of the Republic of Armenia.

3. With an objective to ensure the safe maintenance of the rails and other railway sites, as well as the population, staff of the railway transport and passengers in the places of potential landslides, destructions, floods and other negative impacts, they shall be established security zones.

The alienation layers and order for the protection zones are established by the Government of the Republic of Armenia.

ARTICLE 11. THE DESIGN, CONSTRUCTION, RECONSTRUCTION, ACQUISITION AND MAINTENANCE OF THE SITES OF RAILWAY TRANSPORT

1. The design, construction, reconstruction of the rails of general use, including electrification and construction of structures located on those lines, including bridges, tunnels, railway junctures and mobilization support of civil protection for that area, acquisition rolling stock and special significance cars are performed at the expense of public or private infrastructure owner or manager, other natural or legal persons, as well as state budget within the capital investments and other means, which are envisaged for those purposes by the legislation of the Republic of Armenia and from other resources not prohibited.

2. The design, construction, reconstruction, including the electrification and maintenance of railway transport sites, railway stations, including platforms for pedestrian, bridges and passengers, acquisition of railway rolling stock, cargo boxes, electric cars for passengers,

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page D - 9 Armenian Railway Restructuring Project: Final Report Appendix D construction of residential houses and non industrial objects are performed at the expense of the public or private infrastructure owner or manager, other natural or legal persons, as well as from other resources not prohibited by this law. [Comment: To more clearly acknowledge legitimacy of private sector infrastructure management.] The design, construction, reconstruction, acquisition and maintenance of the sites of the railway transport can be performed at the expense of the state budget only in case, when those are envisaged by the relevant target programs.

CHAPTER3

THE MAIN REQUIREMENTS FOR THE ORGANIZATIONS AND OBJECTS OF THE RAILWAY TRANSPORT, PUBLIC OR PRIVATE MANAGEMENT OF THE TRANSPORTATION PROCESS

ARTICLE 12. THE MAIN REQUIREMENTS FOR THE INFRASTRUCTURE OWNER/MANAGER, WHICH MAY BE EITHER A PRIVATE OR PUBLIC ENTITY

1. The infrastructure owner /manager shall: a) have a license for organizing railway transport activities, issued as part of a contract agreement or separately for entities without a contract with the authorized body for rail transport; [Comment: to avoid conflict and reduce contract risk, any licensing conditions should be contained within a long-term agreement, rather than issued separately.] b) have infrastructure, its elements, technical means, special program means, which are used for the organization of transportation process; c) have quality staff according to the criteria established by this law; d) ensure the implementation of commitments stemming from the legislation of the Republic of Armenia and international treaties of the Republic of Armenia, which are regulate the transportation of passengers, cargoes, freights and luggage by the railway transport. e) in the circumstances that more than one unaffiliated transporters are licensed to provide railway transport services on the network, issue an annual Network Statement documenting the terms of access to the infrastructure and providing a precise formula for the calculation of access charges, which terms and charges must be offered equally to all licensed transporters, including any affiliate of the infrastructure owner/manager, and is subject to the review and approval of the public administration authorized body in the area of railway transport. [Comment: This provision permits, but does not require, the Ministry of Transport and Communication to authorize “open access” without a subsequent revision of the Railway Law, since access is granted only after the prior issuance of a license, which is at the discretion of the Ministry.]

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ARTICLE 13. THE MAIN REQUIREMENTS FOR THE TRANSPORTER, WHICH MAY BE EITHER A PRIVATE OR PUBLIC ENTITY

1. The transporter shall: a) have a license to organize activities to transport passengers, freights, luggage and cargoes, issued as part of a contract agreement or separately for entities without a contract with the authorized body for rail transport; b) have railway locomotives, and other rolling stock on the ownership or other rights to perform transportation; c) have qualified staff under criteria established within contracts or licenses under this law; d) conclude relevant contracts to provide with services with the use of infrastructure. The crucial conditions of the aforementioned contracts are organization of the cars’ current, regulation of use of cars and rolling stock, establishment of the technical services and maintenance of railway rolling stock, the responsibilities of the parties of those commitments that emerge while performing transportation by railway transport; e) ensure the performance of the obligations stemming from the legislation of the Republic of Armenia and international treaties of the Republic of Armenia, which regulate the transportation of passengers, freights, luggage and cargos. [Comment: Suggested changes are to establish the primacy of contract agreements reached between MOTC and the private sector.]

2. The terms of access for any contract for concession, management or privatization of transport services (locomotive and rolling stock operations and commercial transactions with users of railway services) will be determined in the concession agreement or privatization contract with the private party. Any subsequent access arrangements with additional shipper-operators or third parties will be granted only under access charge provisions equivalent to those granted the initial concessionaire or private operator and in force at the time additional access may be granted.

3. In the event of multiple transporters operating on the infrastructure, transport operators will abide by the terms of access and pay any access charges that may be required in a Network Statement issued by the infrastructure owner/manager and approved by the public administration authorized body in the area of railway transport. [ Comment: The substitute wording is to proposed to make the draft ;law more consistent with contract-based restructuring solutions under consideration and provides for the contingency of multiple operators through a transparent Network statement and access charges.]

ARTICLE 14. THE MAIN REQUIREMENTS FOR THE ORGANIZATIONS AND INDIVIDUAL ENTREPRENEURS PERFORMING OTHER WORKS (SERVICES) DURING THE RAILWAY TRANSPORTATION

1. The activities of loading and unloading freight, weighting the cargos, services to the passengers in the railway stations and during the traffic in the places of general use, as well as other works (services), which are connected with the organization and implementation of transportation of passengers, freights, luggage, cargos on the railway transport, on the contractual basis with the freight forwarders (shippers), freight receivers (recipient), owner of the infrastructure and transporter can be performed by other organizations and entrepreneurs.

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2. To organize works and services identified in the part 1 of this article the organizations and individual entrepreneurs shall have qualified staff that have relevant professional preparedness and passed qualification exams in accordance with this law. In cases established by the legislation of the Republic of Armenia the aforementioned organizations and individual entrepreneurs shall have a license to organize activities of railway transport.

3. Fees of freight forwarders do not constitute tariffs under the meaning of this act. [Also designed to clarify the scope of “tariff” under the act.]

ARTICLE 15. BASIS FOR IMPLEMENTING TRANSPORTATION OF PASSENGERS, FREIGHTS, LUGGAGE AND CARGO

1. The transportation of passengers, freights, luggage and cargo by the railway transport is implemented by the rules of maintaining the railway transport of the Republic of Armenia, which is approved by the authorized public administration body of the railway transport and transportation contracts concluded in accordance with the legislation of the Republic of Armenia. The international transportation of the passengers, freights, luggage and cargo by railway transport is implemented according to the international agreements of the Republic of Armenia, except if performed by private transporters under the provisions of Article 9 (3). [Comment: Again allowing for the evolution of private transport not in violation of treaties or WTO]

2. The permit to use the infrastructure is issued to the transporters on the equality basis, which irrespective of organizational-legal and ownership form, envisages equal conditions for the services provided by the use of infrastructure, which shall be measured by uniform application of the provisions of Article 12(e) [Comment: this excludes incentives relating to concessioning, including transfer of facilities and equipment, from being factors to be assessed in the evaluation of equal treatment – which is confined to requiring equal Access Charges.]

3. During the implementation of the transportation by railway transport the relationships between the transporters and owner of the infrastructure are established by the contracts about services by the use of infrastructure. [Comment: permits concessioning.]

4. The travel of the passengers by the railway transport is with travel documents (tickets). Except as provided in contract agreements with the private sector, the Government of the Republic of Armenia establishes the forms and order of use of the travel documents (tickets) used in the railway transport.

5. Upon the demand of the users of the services of the railway transport, as well as infrastructure owner the transporter shall present a license, issued as part of a contract agreement or separately for entities without a contract with the authorized body for rail transport, entitling the organization of the railway transport activities established by the legislation of the Republic of Armenia.

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Upon the demand of the users of the services of the railway transport the owner of the infrastructure shall present the list of the services it provides, information about their prices and conditions.

ARTICLE 16. THE MAIN REQUIREMENTS FOR THE RAILWAYS OF GENERAL USE

1. The railways of general use and structures and equipment installed on them shall be kept in such conditions of maintenance of the railway transport and traffic, which are in compliance with a) the terms of a valid contract entered into by the public administration authorized body of the railway transport; or b) in the absence of such a contract, the requirements of the normative legal acts, standards, rules and technical norms. 2) In the event of a conflict between 1) a valid contract entered into by the public administration authorized body of the railway transport and 2) norms, standards and rules otherwise established, the contract terms will prevail. Comment: These suggested additions and deletions are intended to establish the primacy of concession agreements, management contracts, or sales contracts, without which private sector participation will be discouraged,

2. In the organizations providing with services of railway transport the public administration authorized body of the railway transport is entitled to supervise the adherence to the requirements of the maintenance of the railway transport and traffic security, state of the railways, rolling stock and cargo boxes of general use, as well as the performance of loading and unloading activities of cargo cars and boxes.

3. The design and construction of railways of general use is performed in order established by the public administration authorized body of railway transport.

4. The intersection of the railways of general use with new or reconstructed railways of general use is done upon the approval of the public administration authorized body of railway transport.

5. The operation of railways of general use is done upon the approval of the public administration authorized body of railway transport – based on the recommendations of the owner of the infrastructure.

The closure of the railways of general use, as well as railways of low burden and rail parts and the conversion of rail lines from general use to non-general use is done upon the recommendation of the public administration body of railway transport the approval of the Government of the Republic of Armenia. [Comment: To acknowledge the possibility of branch line sales to private industry.] In case of impossibility of closure of the railways of general use of state, social or defense importance the Government of the Republic of Armenia establishes the source of maintaining and financing of those railways.

6. With the purpose to implement all or some activities connected with arrival and departure of trains, loading and unloading, sorting and maintaining (including in cargo boxes) of freights the operation of the railway stations is done either 1)on the basis of contract agreements entered into

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page D - 13 Armenian Railway Restructuring Project: Final Report Appendix D by the public authorized body of rail transport or,2) in the absence of a valid contract, the recommendations of the owner or manager of the infrastructure – upon the approval of the public administration authorized body of railway transport. The public administration authorized body of railway transport cannot refuse the use of the railway stations, if those are in compliance with contract agreements or otherwise with the requirements of design, construction and maintenance and if the technical requirements of this law, other normative acts, as well as relevant norms and rules. In the event of conflicts between contract provisions and other standards of the authorized body of rail transport, contract provisions will prevail With the purpose to implement all or some activities connected with arrival and departure of trains, loading and unloading, sorting and maintaining (including in cargo boxes) of freights the closure of the railway station is done upon the approval of the Government of the Republic of Armenia.

ARTICLE 17. THE MAIN REQUIREMENTS FOR THE RAILWAYS OF NON-GENERAL USE INTERSECTING WITH THE RAILWAYS OF GENERAL USE

1. The railways of non-general use and the structures and equipment installed on them shall ensure the dynamic loading and unloading of the freight, maneuver and sorting activities relevant to the volume of transportation, as well as the effective use and maintenance of the railway rolling stock. The structures and state of the facilities and equipment installed on the railways of non- general use shall be in compliance with construction norms and rules and ensure the release of cares to the railways according to the technical intensity of the railways of general use, as well as ensure the release of the rolling stock envisaged for the services on the railways of non-general use. The owner of railways of non-general use, in compliance with the requirements of the maintenance of the railway transport and traffic security, shall ensure the maintenance of the aforementioned railways at their own expense. If on the railways of non-general use there is transfer of such railway rolling stock, the maintenance of which is implemented also on the line of general use, then the railways of non- general use shall meet the requirements established by the railways of general use.

2. The construction and reconstruction of the railways, facilities for loading and unloading, cleaning and washing the cars and cargo boxes of non-general use, the determination of the place for the railway intersection of non-general use railways with the railways of general use is to be done upon the approval of the public administration authorized body of railway transport.

3. The intersection of newly constructed or reconstructed railways of non-general use with the railways of general use is to be done upon the approval of the public administration authorized body of railway transport.

4. The operation of the railways of non-general use for permanent maintenance, as well as the transfer of the rolling stock is done by the commission established by the public administration authorized body – after accepting the operation of the given railway. The commission is composed of representative of the public administration authorized body of railway transport,

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page D - 14 Armenian Railway Restructuring Project: Final Report Appendix D owner of railways of non-general use and the owner of the infrastructure; with the railways of this the given railways will intersect. Each railway of non-general use shall have a technical passport, design (plan) and drawings of the structures.

5. The public administration authorized body of railway transport is entitled to check the adherence to the requirements of the maintenance of the railway transport and traffic security, state of railways, rolling stock and cargo boxes of non-general use, as well as the performance of loading and unloading activities of freight cars and cargo boxes.

6. Fees charged for transport services on non-general use rail lines shall not be considered tariffs under the terms of this Act and are not subject to regulation by the public utility regulator. [Comment: Again clarifies regulatory scope.]

ARTICLE 18. THE MAIN REQUIREMENTS FOR RAILWAY ROLLING STOCK AND CARGO BOXES

1. The railway rolling stock and cargo boxes envisaged for the transportation of passengers, freights, luggage and cargoes in the railway transport of general use, irrespective of their ownership, shall meet the relevant standards, as well as the requirements of technical maintenance of the railway approved by the public administration authorized body of the railway transport. After the main repair of the cars they check the container mass of the cars.

2. The public administration authorized body of the railway transport establishes the order for transferring of the railway rolling stock from the railways of non-general use to the railways of general use and the opposite.

ARTICLE 19. THE MANAGEMENT OF THE PROCESS OF THE TRANSPORTATION BY THE RAILWAY TRANSPORT OF GENERAL USE

1. The organization of the traffic of the trains is performed according to the trains’ traffic timetable. The timetable of the trains’ traffic is established and approved by the owner/manager of the infrastructure. The public administration bodies, the local-self governing bodies, passengers, shippers and cargo receivers are entitled to submit to the consideration of the infrastructure owner recommendations to improve the traffic timetable. The owner/manager of the infrastructure is obliged to consider the recommendation within 30 days upon its receipt and inform the applicant about the decision made.

2. The management of the transportation process in the railway transport of general use within the infrastructure is done by the owner of that infrastructure or according to the terms of a contract negotiated between the owner/manager of infrastructure and transporter. [Comment: Changes needed to authorize network management contracts.]

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3. The public administration bodies, local self-governing bodies, NGOs and other organizations, natural persons (except for cases established by the legislation of the Republic of Armenia) are not entitled to intervene into the management process of the railway transport of general use.

ARTICLE 20. THE SETTLEMENT OF DISPUTES EMERGED DURING THE RELATIONSHIPS OF RAILWAY TRANSPORT AND OTHER TYPES OF TRANSPORT

The settlement of the disputes emerges during the relationships of the railway transport and other types of transport is done according to the law, other legal acts, as well as based on the contracts and agreements concluded in accordance with the railway transport legislation of the Republic of Armenia.

[Comment: Agency for dispute resolution for contract disputes, which would include access charges, can be determined by contract provisions, as already specified in the MOTC Draft Railway Law. That is, the contract would specify whether the Armenia courts, international arbitration, or other venue would address access charge complaints or other disputes.]

CHAPTER 4

THE SECURITY IN THE RAILWAY TRANSPORT, PROTECTION OF THE RAILWAY TRANSPORT SITES AND FREIGHTS, ORGANIZATION OF WORKS IN SPECIAL CONDITIONS

ARTICLE 21. THE MAIN PROVISIONS IN MAINTAINING THE RAILWAY TRANSPORT AND TRAFFIC SECURITY

1. The railways of general use and railways of non-general use, the railway stations, platforms envisaged for the passengers, as well as other railway transport sites connected with the traffic and maneuver of trains are the zone of more danger and in case of necessity can be fenced at the expense of the owner of the infrastructure (owners of non-general use railways). In the zones of more danger the rules allocating the sites and citizens, the performance of works in those zones by the railways, rules of traffic and intersection of the railways are approved by the public administration authorized body of the railway transport.

2. The facilities, on the territories of which the production, loading, unloading and transportation of dangerous freights, shall be implemented at such a distance of the railways of general use and facilities, buildings and structures allocated on them, which will ensure the safe traffic of the railway transport. The public administration authorized body of the railway transport establishes the minimal distance of the aforementioned sites and facilities, buildings and structures allocated on them, communications lines of the railways of general use, electricity lines, oil and gas

HARRAL · WINNER · THOMPSON · SHARP · KLEIN Page D - 16 Armenian Railway Restructuring Project: Final Report Appendix D pipelines and other ground and underground structures from the railways of general use – upon agreement with the relevant public administration authorized body. The owners of the facilities intersecting or located in the immediate proximity of the communications lines, electricity lines, and oil and gas pipelines are responsible to meet the requirements established norms for the construction and maintenance of the mentioned facilities and security of the mentioned sites. The owners of the aforementioned structures shall appropriately inform the owner of the infrastructure about the emergence of the emergency situations, which might impact the organization of the railway transport, as well as inform about the measures undertaken for the elimination of the emergencies.

3. During the transportation, loading and unloading of special and dangerous freights the shippers and recipients of freights shall ensure the security of such transportation, loading and unloading, as well as have the relevant means for eliminate of emergency states and their consequences. Within their technical and technological possibilities the owner of the infrastructure and transporter shall participate to the elimination of the consequences of the transport accidents with their rehabilitation and fire means.

4. The public administration authorized body in railway transport establishes the order of crossing the railways with the motor ways and rules of intersecting with railways, the order for their operation and closure – in agreement with the relevant public administration authorized body.

ARTICLE 22. THE PROVISION OF THE MAINTENANCE OF THE ENVIRONMENTAL, FIRE, AS WELL AS HEALTH-EPIDEMIOLOGICAL SAFETY MEASURES IN THE RAILWAY TRANSPORT OF GENERAL USE

1. The provision of the maintenance of the environmental, fire, as well as health-epidemiological safety measures in the railway transport of general use is performed by the owner by right or by contract of the infrastructures, transporters and other organizations in compliance with the legislation of the Republic of Armenia. Comment: To clarify that a concession operator or contract manager is responsible for environmental and health issues relative to railway matters

2. The relevant public administration authorized body is responsible for state policy making relative to performs the state supervision of fire security in the railway transport of general use.

3. The relevant public administration authorized body is responsible for state policy making performs the state supervision of environmental security and health-epidemiological protection of the population in the railway transport of general use.

ARTICLE 23. THE PROTECTION OF THE FREIGHTS AND FACILITIES OF RAILWAY TRANSPORT OF GENERAL USE AND MAINTENANCE OF PUBLIC ORDER IN THE RAILWAY TRANSPORT OF GENERAL USE

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1. During the entire process of transportation and in the railway stations the protection of the freights is done on the basis of the contract concluded with the relevant public administration body. [Comment: Primacy of contract here already incorporated in the Draft Railway Law.]

2. The maintenance of public order and fight against the crime in the railway transport of general use is done by the relevant public administration body.

ARTICLE 24. THE ORGANIZATION OF THE RAILWAY TRANSPORT IN EMERGENCIES

In case of emerging natural and man-made emergencies the activities of the participants of the transportation process are established by the public administration authorized body of the railway transport. In this case the freight forwarder, freight receiver shall ensure the immediate trip of their representatives to the relevant places of transport accidents.

CHAPTER 5

THE LABOR RELATIONS AND DISCIPLINE OF THE STAFF OF THE RAILWAY TRANSPORT

ARTICLE 25. THE LABOR RELATIONS AND GUARANTEES OF THE STAFF OF THE RAILWAY TRANSPORT

1. The labor relations of the staff of the railway transport of the general use, including the peculiarities of the employment of the latter, compensations and guarantees are regulated by this law and Labor Code of the Republic of Armenia. The supervision over the safe working conditions, labor protection of the staff of the railway transport of the general use, labor legislation and other legal norms implemented in the railway transport of general use is performed in accordance with the legislation of the Republic of Armenia.

2. The public administration authorized body of railway transport stipulates the peculiarities of the working hours and schedule and the rest hours, working conditions of the individual categories’ staff of the railway transport of general use that are directly involved in the trains’ traffic regulation. Should railway staff be transferred to the private sector for continued employment in railway activity, terms of employment will be determined by the private employer subject to the Labor Code of the Republic of Armenia and other generally applicable legal norms contained within statutes of the Republic of Armenia except for such conditions directly related to train traffic regulation that are explicitly incorporated in the contracts and/or official agreements attending such transfer.. [Comment: This suggested revision is intended to clarify that the powers of the Ministry of Transport and Communications with regard to terms of employment in private sector railway operations are exercised exclusively through the terms of the concession agreements, or management contracts and to thereby simplify any transaction process.]

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3. Subject to terms negotiated by the authorized body for rail transport in a contract agreement, the persons, who are employed for the positions directly connected with the trains traffic and maneuver works and the staff that are doing this kind of work and/or are subject to harmful and dangerous industrial factors’ impact, prior to employment undergo mandatory preliminary medical examination and regular medical examination during the work at the expense of the employer. The staff of the railway transport of general use that performing industrial activities directly connected with trains’ traffic and maneuver activities (the list of the professions of this staff is established by the public administration authorized body of railway transport) shall undergo mandatory pre-traffic and pre-shift medical examinations, as well as upon the demand of the employer – a medical examination for detection of alcohol, drugs or psychotropic substances. In agreement with the relevant public administration body the public administration authorized body of railway transport establishes the order mandatory preliminary (at the employment) and regular (during the working experience) medical examinations, as well as pre-traffic and pre- shift examinations in the railway transport of general use. Those employing railway workers will develop and institute drug detection programs that may include random testing and other means to ensure that railway employees can safely perform their duties Comment: Such regulation is excessive. Even airline pilots do not have to take a medical examination before every flight. The concession operator should be required to institute a drug detection and control program which may be approved by the MoTC

ARTICLE 26. LABOR DISCIPLINE IN THE RAILWAY TRANSPORT OF GENERAL USE

1. The labor legislation of the Republic of Armenia and this law regulate the labor discipline in the railway transport of general use.

2. The strike of the staff of the railway transport of general use, which performs industrial activities connected with the trains’ traffic, maneuver activities, as well as activities connected with the passengers, freight forwarders and freight recipients, as a means of solving collective disputes (bargains), is prohibited.

CHAPTER 6.

OTHER ISSUES OF ORGANIZING THE ACTIVITIES IN THE RAILWAY TRANSPORT

ARTICLE 27. THE UNIFORM OF THE STAFF OF THE RAILWAY TRANSPORT OF GENERAL USE

1. While performing their official duties the staff directly involved in the traffic of the trains and services of the passengers in the railway transport of general use shall be dressed in the relevant uniform.

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2. Except as may be provided under contract agreement, the Government of the Republic of Armenia stipulates the identification signs of the uniform and order to wear it. And the acquisition of the uniform is at the expense of the relevant employer.

Comment: A uniform rule is not necessary. May apply to passenger services to identify railway personnel, however, this is a marketing issue and not an issue that requires state regulation. Security personnel may need to ware uniforms for identification purposes.

ARTICLE 28. THE INSURANCE IN THE RAILWAY TRANSPORT OF GENERAL USE

The insurance in the railway transport of the general use shall be implemented by the insurance contract in accordance with the “Law on Transport” and “Law on Insurance” of the Republic of Armenia.

ARTICLE 29. THE MOBILIZING PREPAREDNESS AND CIVIL PROTECTION IN THE RAILWAY TRANSPORT OF GENERAL USE

1. The mobilizing preparedness and civil protection in the railway transport of general use are crucial to the provision of security of the Republic of Armenia and implemented in accordance with the legislation of the Republic of Armenia.

2. The public administration authorized body in railway transport administers the mobilizing preparedness and civil protection in the railway transport of general use.

3. The measures aimed at the mobilizing preparedness and civil protection is implemented right on time by all the organization of railway transport, irrespective of the ownership type of the latter. The managers of those organizations shall bear responsibility for the appropriate implementation of the aforementioned measures.

ARTICLE 30. RESPONSIBILITY IN THE RAILWAY TRANSPORT

The violators of the legislation of the railway transport shall bear responsibility in order established by the legislation of the Republic of Armenia.

CHAPTER 7

FINAL PROVISIONS

ARTICLE 31. FINAL PROVISIONS

This law becomes effective on the tenth day of its official promulgation.

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E: REVIEW OF RESTRUCTURING IN THE ARMENIAN PUBLIC SECTOR

his Appendix reviews the Armenian Government’s policy with recent public restructuring cases involving staffing reductions. The three cases reviewed are the Armenian Water T Utility, the Health and the Education sectors. The review confirms that restructuring of the workforce in different sectors is well underway in Armenia and provides the foundation for socially acceptable departure and feasible mitigation options for railway restructuring.

SUMMARY OF RESTRUCTURING OF THE ARMENIAN WATER UTILITY (AWU) The analysis of the human resources in the AWU indicated the following:

• The average age of the workforce was high with 27% at or over pension age • The workforce was underemployed • There was an imbalance in skill levels with shortages of technical staff and overstaffing of administrative personnel • There was a low level of professionalism • There was poor morale (due to arrears in salary arrears)

The conclusion of the analysis was that the utility, with a workforce of 2,497 employees, was in poor financial condition with salary and Social Fund arrears and was overstaffed based on the number of customers. The concessionaire of the water utility completed a staffing projection based on the ideal number of employees that should be in the utility (based on an optimum ratio of 6 employees per 1000 customers). This resulted in a projected staffing level of somewhere between 1,650 to 1750 employees and required a staff reduction program.

The Staff Reduction Program is occurring in two steps (phased in over 5 years).

Step 1 has already been implemented with retrenchment of 610 staff in 2005. This will result in total employment in the branches of 1,807 (including 200 vacancies for accountants, engineers and other skills need to be filled). After this stage, total employment including head office (72) and a Water Commission (7) will be close to 2,050.

The first group 610 of redundant workers came from three demographic groups of water utility workers:

1. 167 pensioners over the age of normal retirement 2. 362 workers with less than three years of service; and 3. 248 workers under the age of retirement with more than three years service.

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Each worker was paid the salary owing and severance according to the legal requirements, which in this case was two weeks salary allowance for pensioners and two months salary allowance for other employees.

Step 2 or the second phase of AWU staff reduction program will be implemented between the years 2006 and 2010. The objective of the second phase will be to reach a target staffing level of 1,700 employees. Human resource management strategies will be focussed on day-to-day management of the staffing levels, as opposed to retrenching a large group as in the first step. To achieve a target staffing level of 1,700 employees the following actions are planned:

• The emphasis will be to make sure employees who reach retirement age actually leave • Management will ensure that employees in surplus categories who retire are not replaced • New hiring will be only for critical skill levels such as engineers • Installation of fencing around the water supply area and the reservoirs would permit the reduction of the number of guards by 200 from the current 350

RESTRUCTURING IN THE ARMENIA EDUCATION SECTOR

As part of structural reforms in education, the Government of Armenia has embarked on a staff optimization and social assistance program funded under a World Bank loan. The goals of the program are to improve effective use of public financing in the education sector, efficient use of school buildings and staff, increase of staff salaries and improvement of school performance. Although the total number of teachers in the sector will decrease under the program, the program anticipates an increase in teacher’s average monthly salaries from 19,000 Drams to 55,000 Drams by the year 2006. In spite of opposition in society and by teachers to rationalization and downsizing of the education workforce, the program was implemented in 2003.

According to a Government letter, 9000 teachers out of a total of 46,410 have been made redundant to date as a result of the program of optimizing student/teacher ratio, class sizes, and teaching load. Implementation of retrenchment commenced under the old Labor Law, which included protected of certain individual from redundancy, for example people who had 2 or more persons under their care, who were the only employed in the family, or with work disabilities.

Determining criteria for which workers would be declared redundant involved the following sequence:

• Part time teachers with other employment • Teachers that reached retirement age • Teachers with non-pedagogical education

If insufficient teachers were downsized under the initial criteria, future redundancy criteria would involve selection among equally educated staff based on performance evaluation.

The social mitigation involved a program of assistance that included a menu of services including counseling services, job search and placement, training, retraining, relocation grants, and assistance with self-employment. For redundant teachers aged 50 and over, the program also included a severance option of 6 monthly wages, but not less than USD50.

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The National Employment Service (NES) and Social Insurance State Fund staff and consultants are implementing the program using eligible service providers. The NES reports the data on the employment restructuring in the following table46.

Table: Armenia Employment Restructuring Data March 31, 2006 Total Number of redundant teachers according to school 7,153 data Number registered with NES offices 2,906 Number receiving counselling but not registered with NES 5,023 Number placed in a job 1,463 Number changed place of residence 495 Number reached retirement age 1,065 Number deaths 34

The table below shows assistance provided under the Social Assistance Program.

Table: Summary of Social Assistance Program and unit costs Program Unit Costs Psychological Counseling USD 30- USD50 Severance for aged 50 or 6 months average salary but more not less than USD 50 Training and retraining USD140 - USD200 Mobility Assistance Mobility Grant: up to USD500 if move involves teacher with family and USD 300 for single individual Small Business start-up To be determined assistance

SUMMARY OF HEALTH SECTOR RESTRUCTURING

Modernization of the Health Sector is underway with a program of rationalization that consists of consolidation of hospitals through mergers, training as well as retraining of doctors and family medicine nurses to establish a critical mass of qualified primary health care providers in the country by 2010. A project funded by the World Bank involves a two-phase program designed to a) improve the organization of the health care system and b) optimize and modernize the hospital network. Included in the program is workforce rationalization through staff retrenchment and social mitigation measures. The rationalization is expected to involve 1,000 individuals in pilot hospitals. The staff will be evaluated applying performance appraisal criteria based on qualifications and performance in relation to other staff in the same professional category to identify low performers and avoid adverse selection.

46 The NES reports only on the results of the program on those participants who have registered for receiving assistance.

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The staff optimization program includes three options for redundant staff:

1. Pre-retirement incentive: Redundant medical staff that is staff that is within 5 years of the retirement age of 63 will be eligible for an additional cash payment in the amount of six months’ wages. The average monthly salary of medical professionals, which does not exceed the equivalent of USD50, will result in a cash payout of approximately USD300 and it is expected that no more than 10% of the total number of redundant staff will be eligible to this cash payment.

2. Relocation Assistance: There are approx. 300 medical specialist vacancies particularly in under-serviced areas while at the same time Yerevan is over serviced with medical staff. Relocation support such assistance with vacancy search, real estate services to sell housing in Yerevan and to find housing in the new location, and the costs of moving households will be provided up to a pre-defined maximum (confirm amount?).

3. Redeployment Assistance: Job counseling, job search, training and other forms of assistance will be provided and financed by the National Employment Service from their regular budget. The project will finance training and retraining and small business assistance.

Program Status: The first phase of the above-described program is now being implemented for the first 2 pilot hospitals involving 400-500 medical staff. The second phase will be implemented based on the experience of this pilot phase.

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F: COMMUNITY CONSULTATION

WTSK used field visits and interviews with stakeholders in selected communities that might be affected by restructuring of the railway to identify specific community issues Hthat might be of greatest concern relative to railway restructuring. Interviews were conducted with community leaders during field trips undertaken in November/December 2005 to the towns of Alaverdi, Massis, and Abovyan. Additionally, individual train users were selected and interviewed in Yerevan. Two major issues stood out as of most concern: Access to passenger transport services; the other was employment.

Across Armenia, reliance on passenger train services varies greatly between communities. Some communities, such as Alaverdi and Abovyan, have access to rail services but do not rely much on them. Other communities, mostly closer to Yerevan, such as Massis, have rail passenger transport services and are more reliant on it. Yet other communities do not have rail passenger services. The critical issue for many communities, including those with rail services such as Massis, and those without rail services, is that some rural roads are unable to support mini-bus traffic and road rehabilitation will be an important factor in meeting rural population transport needs in the future.

The other community issue is alternate employment for redundant railway workers. During the field visit to Sanahin station which included a tour of the Loco Depot, the Station, and one of the electric supply sub-stations, we also visited the adjacent town of Alaverdi. Sanahin Station previously played a much larger role with respect to traffic but now there appears to be very little activity. As an example of its limited freight activity, Sanahin loaded 80 tons, 1 wagon loaded and 64 wagons unloaded for the year 2005. During the inspection of the loco depot there was little evidence that a substantial amount of work is being done on a regular basis.

For the year 2005, Sanahin Station, with 13 station employees, sold 34 international passenger tickets and 266 electric train tickets—half the volume of tickets sold in 2004. The main passenger train has 4-passenger wagons and a locomotive and goes from Gymri to Ayrum. The station manager reported that there are only about 4 to 5 persons from Sanahin using the local train daily. Everyone who lives in the hamlet surrounding the station makes his or her livelihood from either the station or the loco depot. However, the town of Alaverdi, population 22,000 is within walking distance.

In Alaverdi, we met with the mayor, who was elected in May 2005 on the platform of expanding economic activity through tourism. The main industry is the ValexMetallurgy Factory (copper, some gold and silver), employing approximately 550 persons. The mayor reported that there is some potential to increase production from an existing granite quarry as well as developing the wood industry, which could also provide local employment. There are a number of cultural/historic tourist sites including three churches and a bridge from the 10th century but Alaverdi has an absence of tourism infrastructure and the town is looking for investors. The city administration with a staff of 33 has person responsible for projects who reported that the town is cooperating with two NGOs on a project for the development of local handicrafts.

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Alaverdi also has its own station with 12 employees. They sold 985 electric train tickets and 53 tickets for the international train, and loaded 39,643 tons, 637 wagons and unloaded 610 wagons for the year 2005. When we asked about the duplication of station activity with Sanahin, the mayor said that as the situation is changing so the railway also needs to change.

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G: Barriers To Restructuring

s part of our examination of constraints that would affect employment restructuring at Armenian Railway, we examined legal, contractual and other potential barriers. While Athere are minimum legal redundancy requirements and collective agreement provisions that would need to be followed, as described below, there are no insurmountable legal barriers. The most significant barriers and constraints relate to employee and management practices and attitudes. These are discussed under the headings of Political Barriers and other Constraints. Such barriers almost always exist but have been overcome in other restructuring situations both in Armenia and in other countries. They should not represent an insurmountable hurdle to effective restructuring of the Armenian Railway. It is clear, however, that more effective management practices, better human resource planning and a clear, time bound social mitigation program will be necessary.

MINIMUM LEGAL REDUNDANCY REQUIREMENTS We reviewed the Armenian Labor Code, the standard Employment Contract, and the AR collective Agreement to establish the minimum legal requirements for AR labor restructuring and to identify any legal barriers and constraints that may affect potential labor divestiture as a consequence of restructuring.

LABOR CODE The new Labor Code adopted November 9, 2004 outlines the minimum provisions to which workers are entitled in the event of involuntary retrenchment (the termination of the employment of workers due to economic, technological, structural or other changes) and with respect to departure of persons reaching the age to which they are entitled to a pension (63). The legal requirements include procedures to be followed by employers with respect to advance notification prior of lay-off, as well as instructions with respect to when, and to whom notification is to be provided. The basic minimum legal requirements for employer-initiated retrenchment are included in Articles 112 to 130. Notification and Severance provisions are summarized in the table on the next page.

Employment Protection Provisions contained in the Labor Code Redundancy provisions are straightforward with respect to pensioners. Prior to implementing any phased employment reductions, employees that would qualify for employment protection provisions as provided in the Labor Code would need to be identified and exempted until their status changed. Articles 117, 118 and 119 stipulate conditions under which certain categories of workers cannot be made redundant and are summarized below:

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• Article 117: Pregnant women are protected from being declared redundant from the day on which employer receives their medical certificate confirming pregnancy, and for another month after maternity leave, as well as with employees taking care of a child till the age of one year.

• Article 118: Paragraph 1: Employees injured on the job or having an occupational disease shall retain their position until they recover or are granted disability status.

• Article 118: Paragraph 2: Employees on temporary sick leave for not more than 120 successive days or for not more than 140 days within the last 12 months.

• Article 119: Paragraph 1: Representative of employees (trade union) may not be made redundant during the period for which they fulfil their authorization without the preliminary consent of the state labor inspector.

Basic Minimum Legal Requirements for Retrenchment and Severance Category Advance Notification Requirements Severance Redundant Notice must include: As agreed in Worker Basis and reason of dismissal Collective Year, month, day of dismissal Agreement of Employment Contract (Full settlement of amount owing must be made on the day of dismissal) Pensioner 2 months notification 2 weeks (based on average monthly wage of worker) Economic Under 10% of total staff: 2 months notice One month Technological More than 10% of total staff: 2 months notice (based on Structural or to workers as well as 3 months advance average monthly other notification to National Employment Service wage of worker)

ARMENIAN RAILWAY COLLECTIVE AGREEMENTS As part of the review of legal requirements we reviewed the AR Collective Agreement (CA) contract between AR and its workers, accepted by the parties to the agreement on June 20, 2005. It is effective for a two-year period and may be extended for a maximum of one year. The contract applies to select and wage-rate based employees of the trade union and outlines remuneration based on tariff wages (official wages), stipulates hours of work, rest periods, vacation, working conditions, and employment guarantees privileges and other compensation.

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The existing Agreement covers extensive provisions related to additional remuneration under specific conditions. Examples include work harmful to health (50%), overtime (double pay) and night shift (2.1 times for each hour from 22:00 to 6:00), remuneration for rest days, memorial days and holidays (double rate) seniority pay (ranging from 10% to 50% depending on years of service and additional pay for workers whose job entails travel (20% of tariff salary).

Paragraph 16.1 stipulates that employment layoffs will be in accordance with the Republic of Armenia Legislation (in this case, the Labor Code). General redundancy criteria provisions in the Agreement stipulate that in the event of layoffs new hiring will cease and that pensioners would be first in line for retrenchment.

The most significant issue in the Collective Agreement general redundancy stipulations relates to retention of critical railway skills. Since the Agreement stipulates that in the event of redundancy pensioners are the first to be declared redundant, AR management and the Trade Union would need to negotiate an exception or strategy to retain critical skills. Part of the strategy would be early identification of critical skills and a survey and skill assessment will be needed, as discussed in the training section in the main report.

EMPLOYMENT CONTRACT All employers including those in the public sector are now obliged to have individual employment contracts stipulating conditions of work, rights and obligations of parties to the contract, payment arrangements, the contract term and the responsibilities of the parties. In the case where workers are covered by a Collective Agreement, the employment contract cannot have conditions that are less than those stipulated in the collective agreement. Our review of several employment contracts indicates that they will not pose significant barriers to employment restructuring.

POLITICAL BARRIERS AND OTHER CONSTRAINTS There is general agreement that to support rather than hinder economic growth in Armenia, AR needs to become more efficient and improve its economic performance. Employment rationalization should not be seen to be an end in itself but an outcome of carefully planned operational changes to improve the railway’s performance. As this report outlines in the section on public sector restructuring, in Armenia as well as in the most recent examples of railway restructuring elsewhere, employment restructuring is occurring and can be managed. However, it requires a strong political will, business oriented management, and a sound implementation strategy with effective communication with all stakeholders involved. It also requires good human resource planning by disciplined management with respect to setting staff reduction targets, a policy related to limited hiring of new staff until reductions targets are met and a social mitigation program to cushion the effect of restructuring on employees and to assist affected employees to adjust.

Management Practices Historically, Armenian Railway has been an employer known for employing large numbers of workers. This legacy continues to shape management attitudes with respect to dealing with the

HARRAL WINNER THOMPSON SHARP KLEIN, INC. Page H - 3 Armenian Railway Restructuring Final Report Appendix G railway’s human resources. As AR restructures to become more a productive operation, it needs to address the issue of more demanding performance standards for its management and workers, including dealing with surplus workers, while at the same time ensuring that management and workers have the appropriate skills to perform to those standards.

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H: International Restructuring Experience

ailway restructuring projects containing staff reduction components have been carried out in many other countries. It is instructive to review some of these restructuring Rprograms. The examples of the restructuring projects that follow were implemented in a context unique to each specific country. Each country had to provide assistance to redundant workers according to their financial means. Nonetheless, despite different country contexts, the brief review that follows provides a useful frame of reference for the design of a social safety net for redundant AR employees.

MACEDONIAN RAILWAY (MZ) Macedonian Railways has recently commenced a restructuring project supported by the World Bank with the following components:

• Component 1: Technical Assistance for restructuring, regulation, preparatory steps for private sector involvement, and implementation capacity building and support • Component 2: Social mitigation for staff retrenchment • Component 3: Increasing Operating Capacity through equipment remanufacturing and procurement of wagons • Component 4: Mechanization of track maintenance and Infrastructure modernization.

With respect to labor retrenchment, the Macedonian Government promulgated a change in the Labor Law in 2003 to provide severance to a maximum of 8 months in cases where a public enterprise cannot finance severance from its own resources. The 8 month severance policy was also in use during the privatization of a number of enterprises prior to the start of railway restructuring.

The collective agreement between MZ and the trade union stipulated severance provisions of 1 monthly salary up for every two years of working experience in MZ to a maximum of 12 monthly salaries. The Government was not prepared to support any proposal that would set a dangerous precedent for state owned institutional restructuring by providing an enhanced severance package over that provided to redundant workers in all state enterprises. Restructuring was delayed while the trade unions protested. The impasse was resolved when the trade unions decided to make up the 4 month difference between the collective agreement and the Government severance as a “solidarity wage”.

The resulting program, still underway, has had the following impacts:

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Macedonia Railway Restructuring Program Year Staff at the Staff reduced Staff retrenched Staff at the end of beginning of the through natural the year year attrition 2003 3,855 106 99 3,650 2004 3,650 41 0 3,609 2005 3,609 30 649 2,930

POLAND RAILWAY (PKP) RESTRUCTURING This project achieved a reduction in employment from 177,000 to 145,000 in two years. The payroll saving resulting from retrenchment of 32,000 employees was almost sufficient to offset the labour restructuring costs that PKP covered out of its operating budget. Employees directly involved in train movement were particularly targeted for retrenchment.

A high level of inter-ministerial coordination and cooperation as well extensive consultation with the trade unions assisted in determining the retrenchment and redeployment aspects of the restructuring program. PKP created a special in-house employment agency that was responsible for implementing labour retrenchment. Extensive management training was provided in support of restructuring. The trade union agreed to the concept of involuntary severance and to the main criteria for redundancies. Selection criteria were simple, objective and transparent; a human resources software program that contained all relevant personnel data enhanced objectivity in their application.

Compensation elements of the social mitigation program consisted of severance payments and pre-retirement benefits and included the following:

• Severance payments were based on length of service and linked to monthly wages (with maximum caps) as well as to regional unemployment rates. Severance maximums for the targeted train movement employees were considerably higher than those for other employees. Eligibility for severance was based on five years of continuous service and six months in the specific post declared redundant. Severance included both voluntary and involuntary departures. Severance payments to train movement employees ranged from U.S. $2,803 to U.S. $11,214.

• Redundant employees with 35 years (females) or 40 years (males) of pensionable service were entitled to pre-retirement benefits: 90% of the normal retirement benefit until the employee reached normal retirement age (60 for females, 65 for males).

• Railway holidays, a form of retirement bridging benefit, were available to employees who were within three years of reaching railway retirement age (55 for females, 60 for males) regardless of years of service. Employees opting for this benefit would be on

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special leave (holiday) until regular retirement. During such leave they were paid 60% of the employee’s normal gross salary (including social security contribution).

CROATIAN RAILWAYS (HZ) Labour retrenchment at HZ was based on voluntary and involuntary severance. Prior to 2000, the severance amount negotiated with the trade unions for voluntary termination was one month of average monthly salary for each year of service (twice the amount of statutory severance). A new plan that included redeployment assistance was developed to begin further labour retrenchment at the end of January 2001. However, such assistance was to be financed by reduced severance payments. Under the new plan, employees were given two choices after which involuntary retrenchment was to begin:

• Employees who chose not to participate in redeployment assistance were entitled to only one-half of the negotiated severance—that is, one-half month for each year of service.

• Employees who participated in redeployment assistance were entitled to the full- negotiated severance—one month for each year of service—if they could not be successfully redeployed.

Involuntary retrenchment bogged down for a number of reasons. There were a number of court challenges based on technical aspects of the HZ personnel data base and selection criteria. Poor communications to managers resulted in uneven support for the restructuring effort. The Government of Croatia was ambivalent in its messages concerning labour retrenchment.

For 2002, instead of the targeted retrenchment of 1,970 employees, only 433 were terminated. Furthermore, HZ hired 294 employees during this period and hence the labour retrenchment program was largely ineffectual. The average cost per retrenched employee was U.S. $23,333.

BRAZILIAN FEDERAL RAILWAY (RFFSA) Labour retrenchment at RFFSA was undertaken in advance of railway concessioning. The target was an 18,000 reduction in employment from the 42,000 that existed as of May 1995. The retrenchment program was implemented in three phases:

• Phase 1 consisted of reductions through early retirement and voluntary departures for selected job categories.

• Phase 2 consisted of an involuntary severance package for redundant employees with severance set at 80% of the amount offered to employees who left voluntarily.

• Phase 3 was the post concession period of one year within which the concessionaire was required to pay the same severance as in phase 2 for any further involuntary retrenchments that were implemented.

Key aspects of the RFFSA retrenchment program were:

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• Early retirement: 5,514 employees volunteered for early retirement at the beginning of the program in 1995. Eligibility criteria included age and status towards retirement (at least 50 years of age and eligible to retire by 1998).

• Voluntary termination with severance: An enhancement was offered in addition to the statutory severance of 10 months. The enhancement ranged from four months for employees with six years of service to twelve months for those with 25 years of service. The amount of the enhancement decreased for employees with more than 25 years of service. Other benefits for employees leaving voluntarily included one year of housing if the employee lived in RFFSA housing plus one year of pension plan payment, which could not be withdrawn from the pension fund.

• Involuntary termination with severance: Redundant employees were involuntarily terminated with 80% of the severance payments made to those who left voluntarily. Selection of redundant employees was based on surplus categories and included criteria such as record of attendance, frequency of penalties, performance and family situation.

The RFFSA retrenchment program was very successful. Its range of compensation options and good communications with employees on their entitlements resulted in a reduction of 17,757 employees by January 1999. The average severance payment was U.S. $8,000 plus U.S. $18,000 of statutory benefits.

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I: Proposed Chart Of Accounts Armenian Railway

1 Non Current Assets Comments 11 Fixed asset 111 Fixed assets 1111 Buildings & Structures 11111 General Administrative buildings 11112 Production buildings 11113 Cargo terminals, buildings, roads 11114 Passenger Stations, ticketing machinery, roads, landscaping 1112 Construction of Right of Way 11121 Railway lines: Grading 11122 Railway lines: track 11122 Signals, traffic control equipment 11123 Railway Lines: Bridges, Tunnels, & Other Track Structures 1113 Electric Transmission means: All 11131 Sub-stations 11132 Catenary and transmission lines 1114 Equipment and machinery: All 11141 Equipment and machinery Workshop & Warehouse 11142 Equipment and machinery Infrastructure maintenance 11143 Equipment and machinery Automobile and Trucks 11144 Equipment and machinery Computers, Software, IT systems and transmission lines 11145 Equipment and machinery Administrative furniture and furnishings 1115 Transportation means 11153 Diesel locomotives 11154 Electric locomotives 11155 EMU/DMU wagons 11156 Freight wagons 11157 Passenger wagons 11158 Rolling stock used for maintenance & for protection of infrastructure 11159 Other transportation means 1119 Other fixed assets 112 Depreciation of fixed assets 1121 Accumulated Depreciation of buildings 11211 Accumulated Depreciation of admin buildings 11212 Accumulated Depreciation Of production buildings 11213 Accumulated Depreciation: Cargo terminals and roads 11214 Accumulated Depreciation: Depreciation: Passenger Stations, ticketing machinery, and landscaping 1122 Accumulated Depreciation of constructions 11221 Accumulated Depreciation of railway-lines: Grading 11222 Accumulated Depreciation of railway-lines: Track 11222 Accumulated Depreciation of Railway Lines: Bridges, Tunnels, & Other Track Structures & other constructions

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1123 Accumulated Depreciation of electric transmission means: all 11231 Accumulated Depreciation: Sub-stations 11232 Accumulated Depreciation: Catenary and transmission lines 1124 Depreciation of equipment and machinery 11241 Accumulated Depreciation: Equipment and machinery: Workshop & Warehouse 11242 Accumulated Depreciation: Equipment and machinery: Infrastructure maintenance 11243 Accumulated Depreciation: Equipment and machinery: Automobile and Trucks 11244 Accumulated Depreciation: Equipment and machinery Computers, Software, IT systems and transmission lines 11245 Accumulated Depreciation: Equipment and machinery: Administrative furniture and furnishings 1125 Accumulated Depreciation of transportation means: All 11253 Accumulated Depreciation Of diesel locomotives 11254 Accumulated Depreciation Of electric locomotives 11255 Accumulated Depreciation of EMU/DMU wagons 11256 Accumulated Depreciation of freight wagons 11257 Accumulated Depreciation of passenger wagons 12258 Accumulated Depreciation of Rolling stock used for maintenance & protection of infrastructure 11259 Depreciation of other transportation fixed assets 113 Fixed assets under the construction Do not depreciate CWIP 114 Depreciation Railway Lines Temporarily not In Use This is probably lines that are cut off or abandoned. Rolling stock, etc. does not meet this criteria 115 Land 116 Natural resources 1161 Depletion of natural resources 118 Construction in progress of non current assets 1181 Construction in progress of fixed assets 1182 Equipment to be installed 1183 Expenditures to be capitalized on Fixed Assets 1184 Fixed assets constructed by subcontractors 119 Fixed assets received under financial lease 12 Non current investment activities 121 Depreciation of Fixed Assets received under financial lease 122 Investment property 1221 Investment property registered by real value 1222 Investment property registered by initial value 123 Depreciation of Investment property registered by initial value 124 Impairment of non current assets 1241 Impairment of depreciated fixed assets 1242 Impairment of land 1243 Impairment of natural resources 1244 Impairment of Construction in progress of non current assets 1245 Impairment of Fixed assets received under financial lease 1246 Impairment of investment property 13 Non tangible assets 131 Intangible assets 132 Amortization of non tangible assets 134 Goodwill 135 Amortization & Impairment of goodwill

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14 Non current financial assets 141 Share capital investments 1411 Share capital investments in daughter companies 1412 Share capital investments in associated companies 1413 Share capital investments in jointly controlled companies 142 Non current investment in related companies by initial value 1421 Non current investment in daughter companies by initial value 1422 Non current investment in associated companies by initial value 1423 Non current investment in jointly controlled companies by initial value 144 Receivables of long term investments before maturity date 145 Receivables for long term borrowings made 146 Receivables for financial lease 148 Non current financial assets as hedging instruments 149 Impairment of financial assets 1491 Impairment of financial assets in statutory funds of related companies 1492 Impairment of financial assets available for sales 1493 Impairment of long term investments to be hold before maturity date 15 Other non current assets 151 Accrued budget taxes

2 Current assets Comments 21 Stocks 211 Materials 2111 Raw and semi-finished materials 21111 Raw & semi-finished materials at warehouse 211111 Raw & semi-finished materials accepted by tax purpose 211112 Raw & semi-finished materials non accepted from tax purpose 21112 Raw & semi-finished materials at responsible persons 211121 Raw & semi-finished materials accepted by tax purpose 211122 Raw & semi-finished materials non accepted from tax purpose 2113 Fuel 21131 Fuel at depots and storage tanks 211311 Fuel at depots and storage tanks accepted by tax purpose 211312 Fuel at depots and storage tanks non accepted by tax purpose 21132 Fuel at responsible person 211321 Fuel at responsible person accepted by tax purpose 211322 Fuel at responsible person non accepted by tax purpose 2115 Spare parts 21151 Spare parts at warehouse 211511 Spare parts accepted by tax purpose 211512 Spare parts non accepted by tax purpose 21152 Spare parts at responsible person 211521 Spare parts at responsible person accepted by tax purpose 211522 Spare parts at responsible person non accepted by tax purpose 21153 Received for holding accepted by tax purpose 21154 Received for holding non accepted by tax purpose 2116 Construction materials 21161 Construction materials at warehouse 211611 Construction materials accepted by tax purpose

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211612 Construction materials non accepted by tax purpose 21162 Construction materials at responsible person 211621 Construction materials at responsible person accepted by tax purpose 211622 Construction materials at responsible person non accepted by tax purpose 2117 Ticket stocks, and other passenger fare media 21193 All scrap 211931 All scrap accepted by tax purpose Include old lubricating oil. Paper, wood, old crossties, other types of scrap 211932 All scrap non accepted by tax purpose 21199 From purchasing without documents-3% 213 Office and train supplies 213111 Office and train supplies, taxable 213111 Office and train supplies; not-taxable Other small value items at responsible persons 22 Trade receivables and other current debtors 221 Trade receivable 2212 Trade receivable for works and services provided 22121 Trade receivables for freight 221211 Trade receivables for freight transportation provided directly to consignors and consignees 221212 Trade receivables for station and auxiliary services provided directly to consignors and consignees 221213 Trade receivables for services provided to freight brokers – domestic to Hrazdan Trade receivables for services provided to freight brokers – 221214 International 221215 Subsidies due for freight services provided under Purchase of Service Contracts 22122 Trade receivables for passenger services 221221 Trade receivables for passenger services provided under direct charter or to travel agencies 221222 Trade receivables for International passenger services 221223 Trade receivables for passenger services provided under Purchase of Service Contracts 22123 Trade revenue for renovation services 221231 Trade receivable for rolling stock renovations– private contracts 221232 Trade receivable for rolling stock renovations– under public contract 221233 Trade receivable for renovation of track and infrastructure – private contracts 221234 Trade receivable for renovation of track and infrastructure – public contracts 22124 Receivables for use of rolling stock in CIS countries Each nation should have a 3 digit sub code, for example, 22124.101 Russian Federation, -.102 Belarus 22125 Receivables for use of rolling stock in non -CIS countries Each nation should have a 3 digit sub code, for example, 22125.101 Turkey

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22126 Receivables for use of rolling stock by privately operated railways and terminals 22127 Receivables for use of rolling stock by shippers and non-railroad entities 2213 Other Receivables 22131 Receivables for financial investments sold 22132 Receivables for fixed assets sold 22133 Receivables for other goods & services sold 22134 Receivables for operational lease 222135 Receivables for spaces given for rent 2222 Receivables of dividends 2223 Receivables for bonds interest registered by initial value 2224 Receivables from insurances 2225 Receivables form penalties 2226 Receivables from reimbursement of damages 22271 Receivables from electricity sold and electricity transmission 223 Reserves of bad debts 224 Prepayments made 2241 Prepayments for material purchases and fuel 2243 Prepayments for non-transportation services and insurance 22431 Prepayments for utilities 22432 Prepayments at transportation services Each transportation firm should have a code, identical to the codes in 22124. 2244 Prepayments-for other purposes 22441 Prepayments-state fees and other fees 22442 Prepayments- WB loan prepayments 225 Short term receivables of state budget 228 Receivables for employee accounts 2281 Receivables for employee accounts for material and services procurements 2283 Receivables for employee accounts for travel 2284 Receivables for employee accounts for other purposes 229 Other current receivables 2291 Current receivables for salary advances to employees 2292 Current receivables for other employee advances 22921 Borrowings made to employees 22922 Receivables for aliments 22923 Receivables for employee injury 2294 Other current receivables 22941 For Ministry and organizations in Ministry system 23 Current financial investments 231 Current financial investments for sales purpose 232 Current financial investments available for sale 233 Receivables of short term investments to be hold before maturity The railway is not a bank date or lending institution after it is restructured 234 Receivables of current portion of long term investments to be hold before maturity date 235 Gross receivables from short term financial investments made 236 Gross receivables from short term portion of long term financial investments made

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237 Gross receivables from short term portion of long term financial lease made 239 Current financial assets projected for hedging instruments Is this the accounting for fuel, electricity, and other hedged supply contracts? 24 Current financial investments 241 Reserve for non collectable portion of short term part of long term borrowings landed 242 Reserve for non collectable portion of short term part of financial lease 25 Monetary assets 251 Cash box- petty cash 2511 Petty cash of national currency Petty cash at cost centers should be managed and recorded on a spreadsheet, and the balance taken to account 2511 and 2512 2512 Petty cash of foreign currency 2514 Operational cash desks at stations Individual passenger stations and freight stations should be recorded and managed on a separate spreadsheet, not in G/L. The balance should be taken to 2514. 25141 Operational cash desks –passenger services - stations 2517 Other foreign currency cash desks 25171 Foreign currency cash desks- EURO 252 Bank accounts 2521 Bank accounts 25211 Bank accounts- AMD in Ardshinbank-Erebuni branch 25212 Bank accounts- AMD in Areximbank 25213 Bank accounts- AMD in Conversebank 25214 Bank accounts- AMD 25215 Bank accounts- AMD in Ardshininvestbank 2522 Bank accounts non available What does Non-available mean? 2523 AMD bank account of Infrastructures in Ardshinbank 2524 AMD bank account of Infrastructures in Arminpexbank 2525 AMD bank account of Infrastructures in Areximbank 2527 AMD bank account of rolling stones in Ardshinbank 2528 AMD bank account of Infrastructures for Sevan branch ASHB 2529 AMD bank account of Infrastructures in Ardshinbank Gumri branch 253 Foreign Accounts 2531 Foreign accounts in Armenia Non-dram denominated accounts should be translated into drams on a spreadsheet, and the effects of currency exchange rates taken to the income statements. 25311 Foreign accounts in Armenia- USD Bank name may be sub- account 25312 Foreign accounts in Armenia- EURO 25313 Foreign accounts in Armenia- CHF 25314 Foreign accounts in Armenia- RR 25315 Foreign accounts in Armenia- USD

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2532 Foreign accounts out of Armenia 2533 Blocked foreign currency accounts 2534 USD infrastructure bank account in Arminpex bank 2535 USD rolling stock bank account in ASHB 2537 RR- Rolling stock bank account Ardshininvestbank 254 Other bank accounts 2541 Acridities ? 2542 Cheque books Are these impress accounts? Cash management should be centrally managed, not managed by “enterprises. This particular account is vulnerable to “black” money 25431 Transit account for revenues 25432 Transit account for revenue department 25433 Transit account for passenger and station revenues 255 cash in transit 2551 Money in the way-transit AMD denominated cash in transit 2552 Foreign currency in transit 256 Financial documents 257 Cash equivalent documents 26 Other current assets 261 Deferred assets for accrued taxes 2611 Deferred VAT – to be off-set 2612 Future period interest cost not calculated

3 Owners equity Statutory capital and emission revenue 311 Statutory capital 3111 Ordinary shares 3112 Preferred shares 3113 Equity in subsidiary companies 31131 Equity in corporations 31132 Equity is Shares in LLCs 312 Non paid Statutory fund 3121 Issued but not allocated stocks 3122 Allocated and non paid statutory fund 314 Emission revenue What are “emission revenues” Are these greenhouse gas credits Differences from reevaluation of non-current assets and intangible 321 assets. 322 Differences from reevaluation of financial assets available for sale registered by initial value 323 Differences from reevaluation of hedging instruments available for sale registered by initial value 33 Financial results (Profit and loss) 331 Financial results (Profit and loss) 3311 Profit from operational activities 3312 Profit from non operational activities Account 323 should be put under 3312 3313 Profit from extraordinary events Accounts 321 and 323 should be put under 3313. 34 Non allocated retained earning

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341 Adjustment of previous years financial results 3411 Adjustment from correction of significant mistakes 3412 Adjustments from changes in accounting policy 342 Previous years earnings 343 Current year net profit 344 Interim dividends 35 Other items of owners equity 351 Reserve capital 3511 Reserve fund 3512 Payment of dividends to state budget 3513 Reserve fund 3514 Production and development fund 35141 Production and development fund-Armenian Railway CJSC 35142 Production and development fund- balance of infrastructure division 3515 Social development fund

4 Non current liabilities 41 Long term financial liabilities 411 Accounts payable for long term bank loans 4111 Long term loans made by World Bank 41111 Long term loans made by World Bank in USD 41112 Long term loans made by World Bank in AMD 4112 Long term loan made by government of RoA in AMD 412 Accounts payable for long term borrowings 4121 Accounts payable for long term bonds given 4122 Accounts payable for long term notes given 4123 Accounts payable for other long term liabilities 413 Accounts payable for financial leasing 414 Non paid interest for depreciated financial investments 4141 Non paid interest for long term bank loans 41411 Non paid interest for Long term loans made by World Bank in USD 41412 Non paid interest for Long term loans made by World Bank in AMD 41413 Non paid interest for Long term loan made by government of RoA in AMD 4142 Non paid interest for Accounts payable for long term borrowings 4143 Non paid interest for long term financial leasing 42 Other non current liabilities 421 Asset related grants 422 Accrued tax liabilities 423 Negative goodwill 424 Amortization of negative goodwill 425 Non current reserves 426 Present value of Assets for reimbursement projects

5 Current liabilities Comments 51 Short term borrowings and loans 511 Accounts payable for short term bank loans 512 Accounts payable for short term portion of long term bank loans 513 Accounts payable for short term borrowings 514 Accounts payable for short term portion of long term borrowings 5141 Accounts payable for short term portion of long term notes given 5142 Accounts payable for short term portion of issued long term bonds 5143 Accounts payable for short term portion of other long term

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borrowings 515 Accounts payable for short term portion of financial lease 516 Accounts payable for non paid interest of short term portion of long term loans 5161 Accounts payable for non paid interest of short term loans 5162 Accounts payable for non paid interest of short term portion of long term loans 5163 Accounts payable for non paid interest of short term borrowings 5164 Accounts payable for non paid interest of short term portion of long term borrowings 52 Trade accounts payables 521 Trade accounts payables 5211 Trade accounts payables for materials purchased and fuel. 5212 Trade accounts payables for electricity and other utilities 5213 Trade accounts payables for IT, telecomm, radio, and similar services & insurance received 5214 Trade accounts payables for professional, legal, audit and similar services 5215 Trade accounts payables for freight transportation services

52151 Trade accounts payables for transportation services-freight Each railway, Hrazdan or transportation provided by other railways, consignees, or consignors foreign, should have its own sub-code and be managed by an A/P module 52152 Trade accounts payables for transportation services -station and auxiliary services provided by other railways, consignees, or consignors 52153 Trade accounts payables for transportation services – brokers within Hyrazdan 52154 Trade accounts payables for transportation services – international brokers 52133 Accounts payables- CIS countries railway organizations 5216 Trade accounts payables – Passenger services 52161 Trade accounts payables- Direct charter and travel agency passenger services 52162 Trade accounts payables- International railway passenger services 52163 Trade accounts payables – Purchase Of Passenger Transportation Services from contractors or other Hydrazdan railways 52134 Trade accounts payables-CIS countries other organizations Moscow central administration, UIC, and similar railway and regional transportation organizations 5214 Accounts payables- for received financial lease 5215 Accounts payables- for received financial lease of Fixed assets 5216 Accounts payables- for other procurements 52161 Accounts payables- state fees and other payments 52162 Accounts payables- to cadastre 5217 Accounts payables- to social fund 5218 Accounts payables- reimbursement for damages 523 Prepayments received 5231 Prepayments received for products, goods and services to be sold 52311 Prepayments received for freight transportation services 523111 Prepayments received for freight services 523112 Prepayments received for station and other services

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52312 Prepayments received- passenger services 52313 Prepayments received- for renovation services 523131 Prepayments received for renovation of CIS rolling stock Includes passenger 523132 Prepayments received for non-CIS rolling stock Includes passenger 523133 Prepayments received- for renovation of shippers and non-railway Includes all privately entities rolling stock owned wagons, passenger, and locomotives, including rolling stock owned or leased by municipalities or the military Prepayments received for renovation and construction of infrastructure 52314 Prepayments received for renovation and construction of infrastructure - total 523141 Prepayments received for renovation and construction of Is a “prepayment” the same infrastructure – from for-profit entities as a “deposit”? 523142 Prepayments received for renovation and construction of infrastructure – from government, NGO, and other public entities 5232 Prepayments received- for non current assets to be sold 5233 Prepayments received- for operational lease 52331 Prepayments received- for rent of space 52332 Prepayments received- for rent of rolling stock 52333 Prepayments received- for rentals of tracks, depots, and other infrastructure 5234 Prepayments received for other purposes 52341 Prepayments received for electricity to be sold and for use of transmission lines 52344 Accounts payables for rented spaces 52345 Accounts payables for other operations 524 Accounts payables To state budget 5241 Accounts payables To state budget- profit tax 52411 Accounts payables To state budget- profit tax 20% 52412 Accounts payables To state budget- profit tax of non residents 52413 Accounts payables To state budget- profit tax according to inspection act 52414 Accounts payables To state budget- profit tax acc. To inspection act for non resident 5242 Accounts payables To state budget- income tax 52421 Accounts payables To state budget- income tax from salary 52422 Accounts payables To state budget- 3% income tax for procurements without doc-s 52423 Accounts payables To state budget- income tax for individual sub- contractors 52424 Accounts payables To state budget- income tax according to inspection act 5243 Accounts payables To state budget- VAT 52431 Accounts payables To state budget- Vat calculated 52432 Accounts payables To state budget- VAT to customs 52433 Accounts payables To state budget- Vat according to inspection act 5244 Accounts payables To state budget- excise tax 5245 Accounts payables To state budget- property tax 52451 Accounts payables To state budget- property tax Yerevan 52452 Accounts payables To state budget- property tax regions 5246 Accounts payables To state budget- land tax 52461 Accounts payables To state budget- land tax Yerevan

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52462 Accounts payables To state budget- land tax regions 5247 Current accounts payable for customs fee 5248 Accounts payable of penalties for non paid taxes 5249 Accounts payables To state budget- other taxes 52491 Accounts payables To state budget- environment tax 52492 Accounts payables To state budget- state fees 52493 Accounts payables To state budget- penalties 525 Accounts payables To Social fund 5251 Accounts payables To Social fund from salary 5252 Accounts payables To Social fund from accrued but non paid salary 527 Accounts payables for payroll 5271 Accounts payables for payroll 5272 Accounts payables to employees for sick leave 5273 Accounts payables to employees for bonuses 5274 Accounts payables to employees for payroll (for few month previous period) 528 Accounts payables to employees for other operations 5281 Accounts payables for employee accounts 52811 Accounts payables for employee accounts –procurement of materials and services 52813 Accounts payables for employee accounts –travel 52814 Accounts payables for employee accounts –other purpose 5282 Accounts payables to employees- other operations 52822 Accounts payables to employees- ailments and injuries 52823 Accounts payables to employees- according to court decision 52824 Accounts payables to employees- personal insurance Employees purchasing insurance for the behalf of the firm record this expenditure in 52814 529 Accounts payables to shareholders: Accrued dividends 53 Other current liabilities 531 Other current liabilities 5311 Accounts payables for operational lease 5312 Accounts payables for penalties to other companies 5314 Accounts payables for business acquisition 5315 Other Accounts payables 53151 Accounts payables- to Ministry and its' organizations 53152 Accounts payables- because of merging of companies 53154 Accounts payables- to internal labor union 53155 Accounts payables- donation to other people 54 Other current liabilities 541 Income related grants What is this? 542 Current liabilities for deferred taxes 543 Current reserves 5431 Current reserves for guaranteed sales 5432 Current reserves for non favorable contracts 5433 Current reserves for guarantees given 5434 Current portion of non current reserves 5435 Future period revenues from grants 56 Beginning balance adjustments 572 Accounts payables- balance of former infrastructure company 573 Accounts payables- balance of former rolling stock company

6 Revenues Comments 61 Revenues from operations

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611 Revenues from sales of products, goods, services 6111 Revenues from sales of products 6112 Revenue from sales of goods 61121 Revenue from sales of electricity 61122 Revenue from communications 61123 Reserve for doubtful accounts 6114 Revenue from sales of services provided 61141 Revenue from freight transportation services 611411 Revenue from freight services 611412 Revenue from station services 611413 Credits and discounts allowed 611415 Reserve for doubtful accounts 61142 Revenue from passenger services 611421 Revenue from passenger services 611422 Revenue from other passenger services 611423 Georgian railway 61143 Revenue from renovation services 611431 Revenue from for renovation of CIS rolling stock 611432 Revenue from non-CIS rolling stock 611433 Revenue from renovation of shippers and non-railway entities rolling stock 61144 Revenue from renovation and construction of infrastructure

611441 Revenue from renovation and construction of infrastructure - total 611442 Revenue from renovation and construction of infrastructure – from for-profit entities 611442 Revenue from renovation and construction of infrastructure – from government, NGO, and other public entities 61145 Credits and discounts allowed 61146 Reserve for doubtful accounts 611515 Reserve for doubtful accounts 614 Other operational revenue 6141 Revenue from routine sales of Assets 61411 Revenue from routine sales of Current Assets Obsolete inventory and parts 61413 Revenue from routine sales of Fixed Assets: land, buildings, large machinery 61415 Extra-ordinary Sales of Fixed Assets, Contracts, and Leases 6143 Revenue from operational lease and leases 61431 Revenue from rent of space 61432 Revenue from rent of wagons 61433 Revenue from rent of shops in tracks –driving shops 61434 Revenue from rent of wagons of CIS countries 6144 Revenue from penalties 61441 Revenue from penalties 6145 Revenue from material damages 61451 Revenue from material damages 6146 Other operational revenues 6147 Revenues from insurance reimbursement 6148 Revenue from capital renovation services to other companies 62 Non operational revenue 621 Revenue from sales of non current assets 6211 Revenue from sales of fixed assets 6212 Revenue from sales of non tangible assets

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6213 Revenue from sales of non current financial assets 6214 Revenue from sales of other non current assets 622 Revenue from sales of current financial assets 627 Revenue from financial investments 6271 Dividends 6272 Interest revenue, net of related costs 6273 Revenue from financial lease, net of related costs 628 Revenue from asset related grants 629 Other non operational revenues 6291 Dividends from related companies 6292 Revenue from supporting instruments considered for owners equity instruments 6293 Revenue from donated fixed assets 6294 Revenue from exchange rate changes of foreign currency Formerly 6251 6295 Revenue from non operational financial instruments’ reevaluation Formerly 624 63 Extraordinary revenues 64 Adjustments to Previous years revenue 641 Previous years revenue 6411 Previous years operational revenue –adjustments of significant mistakes 6412 Previous years operational revenue- accounting adjustments 6413 Previous years non operational revenue –adjustments of significant mistakes 6414 Previous years non operational revenue- accounting adjustments 6415 Previous years extraordinary revenue

7 Expenses 71 Operational expenses: Compensation 711 Direct Compensation 7111 Hourly-Paid Full-Time Employees: Wages at regular rates 7112 Hourly-Paid Full Time Employees: Wages at premium rates 7113 Hourly Paid Part-Time Employees: Wages at all rates 7114 Hourly Paid Employees: Paid Absence Wages 71141 Hourly Paid Employees: Paid Absence Wages: Vacations 71142 Hourly Paid Employees: Paid Absence Wages: Holidays 71143 Hourly Paid Employees: Paid Absence Wages: All Other 7115 Salaried Employees: All Wages 7116 Bonuses: All Employees 712 Indirect Compensation 7121 Medical Insurance

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7122 Company Pension 71221 Payments Made to Pension Trustee/Fund/Employees 71222 Deferred Pension Payments 71223 AR may set up more Services to Employees: cafeteria, education, child-care, accounting detail as housing, uniforms, transportation, free passes for family, use required by tax codes of automobiles 713 Social Taxes 713xx AR may set up more [One account for each payroll tax] accounting detail 714 AR may set up more Compensation not accepted by tax code accounting detail as required by tax codes. This is the old 713119 715 Does not include sales Consultants and Contractors commissions, old account 7125 71321 Depreciation & maintenance costs of Fixed Assets 713211 .1 General & Shared Use .2 General Cargo Only .3 Specific Cargo Depreciation should be by Users .4 Passenger Only, Within Armenia .5 Passenger Only, asset class and activity International .6 Non-railway use .7 Not-in-use, surplus, retired .8 rather than by enterprise. Sold, waiting for payment 72 Operational Expenses: Material & Direct Transportation Customs and freight to be Services added to the cost of the specific material Infrastructure Material Track Track, Grading, ballast, signs, and fences Track: Rail and fittings Track: Ties, direct foundations, highway crossing material Traffic Control Signals, signal cables, signal towers, automatic warning devices, Includes signal cables, inductive signaling , and traffic control buildings, traffic control signal towers, automatic panels warning devices, inductive signaling , and traffic control buildings, traffic control panels Radios for traffic control Includes base stations, towers, and all else Highway Crossing gates and guards’ houses Traction Power & Fuel Diesel & Other Fuel Does not include petroleum products used for heating buildings, such as kerosene or heavy heating oil Other Fuels used in Transportation Electricity Electricity for Traction Electricity for General Use Electricity for Resale Natural & LP Gas, from tanks, pipes, and bottles, Coal, Wood for Heating

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Water & Sewer Fees Environmental Disposal Services & Fees Includes fines Trash and Garbage Removal Services Electric Power Material Substations & Stand-Alone Transmission Lines Includes substation buildings and AC side Catenary structures and catenary material Building repair material and services Except as otherwise noted Yard and terminal material, paving repairs, drain repairs Includes container cranes IT and telecom repair material and services Does not include utility charges Water, Gas and Sewer Infrastructure Material Does not include utility charges Trucks, autos, forklifts, construction equipment material and repair services Small hardware, small tools, & general workshop supplies Other infrastructure material and repair services Design, engineering and investigation service costs Leases and rentals of infrastructure, infrastructure repair machines, Includes leased tracks, trucks, and workshops signal and electric power equipment, transmission lines, bridges, land, passenger stations 73 Rolling Stock Material & Repair Services Electric Locomotive and Systems Material and repair services Diesel & Hydraulic systems Material and repair services General Locomotive Material and repair services Cargo Wagon Material and repair services Passenger and EMU/DMU Material and repair services Containers Material and repair services Trucks, autos, forklifts, construction equipment material and repair services Small hardware, small tools, and general workshop supplies Design, engineering and investigation service costs Leases and rentals of rolling stock and workshop machinery .1 Electric Locomotives .2 Diesel Locomotives .3 EMU/DMU & Passenger coaches .4 Cargo Wagons .5 Containers .6 Infrastructure wagons and repair trains .7 Workshops, workshop machines and forklifts, trucks 74 Common, Small value Material Used by All Operations 75 Office & Administrative Material & Services Office supplies, express and regular post Computing and data processing equipment, including mainframe, personal, and remote terminal equipment, repairs, routine upgrades, and service contracts. Leases of IT equipment Software; routine upgrades, and service contracts Fixed Assets operational lease costs for general offices and furniture Depreciation of non tangible assets

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Maintenance of software Travel and entertainment Travel costs in limits Travel exceeding limits Entertainment in limits Entertainment exceeding limits Post, radio and communication costs Include 71357 here to reduce clutter Security and guard for contract services Audit and consulting costs Bank charges Insurance charges Insurance: Property & Casualty Insurance: Liability Taxes non reimbursable Land tax Yerevan Land tax- regions Property tax Yerevan Property tax-regions Natural tax Cadastre costs State fees Other admin costs Legal & Court Expenses Expenses of court, penalties Penalties and fines acceptable for tax purposes Penalties and fines non-acceptable from tax purposes Losses from damages and spoilage Special accounts of registration Cost of CIS countries wagon and locomotive rentals Cost of Non-CIS wagon and locomotive rentals Cost Rolling stock provided by long-term service contacts Losses from Exchange rate differences Losses from reevaluation and impairment of non operational financial instruments Impairment of non operational financial assets for trading Impairment of non operational financial instruments for trading Impairment of non operational financial instruments available for sales Expenses for loan and borrowings Interest expenses of loans and borrowings Interest expenses for financial lease Expenses for early payment of financial liabilities Cost of Assets donated Other non-operational costs Shares and loss portion of related companies Depreciation of Investment property registered on cost Other non operational costs Ministry expenses Ministry travel expenses Ministry Fixed Assets assets, property and materials Fuel for Ministry Other Ministry costs Expenses from reserve funds Donations to veterans of war Payment to other organizations Payment to Moscow-information center and CIS Railway union

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Amortization expenses for Fixed Assets received as grant Costs non acceptable from tax purposes 76 Extraordinary expenses 77 Expenses of previous years 771 Expenses of previous years 7711 Previous years operational costs (significant adjustments) 7712 Previous years operational costs (accounting adjustments) 7713 Previous years non-operational costs (significant adjustments) 7714 Previous years operational costs (accounting adjustments) 7715 Previous years extraordinary expenses 78 Profit tax expenses 781 Profit tax expenses 7811 Current profit tax 7812 Accruable portion of profit tax 7813 Profit tax registered by tax inspection act

8 Management expenses

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Armenian Railway Restructuring Final Report Appendix J

Proposed Accounting Implementation Schedule Months, by half-months Activity Precedent Action 1.1 1.2 2.1 2.2 3.1 3.2 4.1 4.2 5.1 5.2 6.1 6.2 7.1 7.2 8.1 8.2 9.1 9.2 10.1 10.2 11.1 11.2 12.1 12.2 13.1 13.2 Choose General Director’s co-ordinator previous by WB, MofT&C, General Director

Gen. Dir & co-ordinator monitor progress and problems New G/L Accounts Select New Sub-Accounts

World Bank - Armenia Discuss w/Fin. Top Mgt Armenia Railways Accounting Firm Install in Mainframe AR Co-ordinator Distribute codes to field

Modify Roll-up reports

Discuss w/other top management

Select Trainers, T O T

Train Field Accountants, others

"Cut-in" of current period and future periods

Restate Prior Periods of Current Year New Function previous by HWTSK, GTA, and/or Finance Select New Codes

Discuss w/Fin. Top Mgt

Install in Mainframe

Selected New AR Structure Distribute codes to field Modify Roll-up reports

Discuss w/other top management

Train Field Accountants, others

"Cut-in" of current period and future periods

Restate Prior Periods of Current Year Revised & Additional Cost Centers previous by HWTSK, GTA, and Finance Select Cost Center list review to see that centers match organization Selected New AR Structure

Discuss w/Top and Middle Mgt Discuss w/ Middle Mgt and Other "White Collar"

Discuss w/Shippers. Regulators, Operators, Unions, etc.

Install in Mainframe

Distribute codes to field

Revised Organization Modify Roll-up reports

Interim Audit

Train Field Accountants, others

Write New Management R"CeuRpte-oisnrt"at ostef icPnur riAroerRn Pt ’epsre iopridorsdo oapfn rCdie ufurtrateurnryet YpAecarirocdosunting Software

Draft Reports Selected New AR Structure Writing New Code Test Out Code

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Armenian Railway Restructuring Final Report Appendix K

K: RESTRUCTURING IN NEIGHBORING COUNTRIES

rmenian Railway restructuring must take into account rail sector restructuring activities in neighboring countries. The Russian railway (RZhD) has had a restructuring process Aunderway for some years. Azerbaijan has sought World Bank assistance in developing a restructuring strategy for its rail system. Georgia Railway is well along in its restructuring process. These railways are similar to Armenian Railway both physically, and in the objectives sought from railway restructuring—access to private sector investment for substantial projected capital needs.

Rail traffic is growing rapidly in Russia, Georgia, and Azerbaijan, driven by increased movement of petroleum products by rail as well as increasing Caspian trade and internal and regional economic growth. All these railways suffer from a similar lack of investment over the last 15 years or so. All properties have investment requirements far in excess of their government’s ability to support—to replace aging rolling stock and renew infrastructure after a decade of decline. In each case, restructuring is seen as a way to encourage private sector investment in the rail sector, improve the condition of infrastructure, and improve operations while reducing costs and attracting additional traffic. Higher traffic densities on Russian, Georgian, and Azerbaijani railways will allow them a greater degree of self-financing ability.

Restructuring in Russia has resulted in the formation of RZhD as a JSC and separation of regulatory functions from the former Ministry of Railways. Regulatory functions have been transferred to the Ministry of Transport. RZhD has formed an infrastructure unit and developed pricing and tariff structures that provide significant discounts to owners of private rolling stock (both wagons and locomotives). In addition, the new railway law encourages formation of private railway operators (something like freight forwarders who own railway rolling stock), and of carriers (who own or control locomotives as well as freight wagons, and take ownership responsibility for cargo they transport). Private operators and Carriers contract with RZhD for the movement of their trains over the railway network. RZhD uses its drivers and support facilities. The tariffs include costs for support services such as inspection, shunting and minor repairs needed for movement. These reforms have encouraged significant private investment in railway rolling stock in recent years. Private sector operators and equipment leasing companies have invested more than US$5 billion in new or rebuilt wagons and locomotives.

The Russian railway restructuring program contemplates separation of passenger services into separate companies with local governments responsible for subsidizing commuter and local services and the national government providing subsidies for necessary long-distance passenger services. This part of the reform, originally scheduled to take place this year, has been delayed

HARRAL WINNER THOMPSON SHARP KLEIN, INC. PAGE K - 1 Armenian Railway Restructuring Project: Final Report Appendix K by a decree from the Russian government. As a result, RZhD will continue to subsidize loss making passenger services for a few more years, its revenue swollen by significant increases in oil transport.

Georgian Railways is adopting a restructuring formula that initially forms three strategic business units within a Georgian Railway joint stock company framework. The three business units are an infrastructure unit, a freight business unit and a passenger business unit. The infrastructure unit will be responsible for maintaining and renewing fixed assets. The infrastructure unit will also be responsible for controlling access to the main line and for dispatching and controlling train movements across the railway. A freight business unit will be responsible for wagons and locomotives as well as freight services. The passenger business unit will be responsible for passenger services and will control its own rolling stock including locomotives, coaches, and electric and diesel multiple-unit trains. The passenger business unit has already been setup as a branch under Georgian accounting conventions and is handling the development of railway property, including the station in Tbilisi.

The Georgian restructuring will encourage the development of private operators—as in Russia— freight forwarders or other customers with owned or leased wagons and locomotives, who work directly with customers and facilitate efficient movement of freight but turn whole trains over to the freight business unit for drivers and for access to the infrastructure unit railway for main line operation. Private operators will pay a tariff that reflects a common infrastructure charge regime, their purchase of rail cars, operation of loading and unloading services, and the cost of dealing directly with customers. Their profit margin arises from the development of more efficient train operations and greater utilization of rolling stock.

In our view, both the Russian and Georgian railway restructuring programs meet or could be adjusted to meet EU railway regulatory standards.

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