World Bank Document

Document of The World Bank

FOR OFFICIAL USE ONLY Public Disclosure Authorized Report No. P71 14-RO

REPORT AND RECOMMENDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Public Disclosure Authorized TO THE

EXECUTIVE DIRECTORS

ON A

PROPOSED SOCIAL PROTECTION ADJUSTMENT LOAN

IN AN AMOUNT OF US$50 MILLION

Public Disclosure Authorized TO

ROMANIA

May 9, 1997 Public Disclosure Authorized

Currency Unit = Leu US$l = 7,095 Lei 1 Leu US$0.00014

AVERAGE EXCHANGE RATES Leu US$I

19952 1992 Januar 1997 Februarv. 1997 March, 1997 2,033 3,084 5,146 6,896 7,236

WEIGHTS AND MEASURES metric system

BORROWER FISCAL YEAR Jan. I - Dec. 31

ABBREVIATIONS AND ACRONYMS

IBRD - International Bank for Reconstruction and Development IDA - International Development Association PIU - Project Implementation Unit SOE - Statement of Expenditures MOF - Ministry of Finance MOLSP - Ministry of Labor and Social Protection NGO - Non-Governmental Agency MIG - Multi-lateral Investment Gaurantee FESAL - Finance and Enterprise Sector Adjustment Loan ASAL - Agricultural Sector Adjustment Loan CEE - Central and Eastern Europe

Vice President: JohannesLinn. ECAVP Director: Kenneth G. Lay. EC I DR Division Chief: Ralph W. Harbison. ECIHR Responsible Staff: Mansoora Rashid (TTL). Amtraud Hartmann. Frank Lysy, Sandor Sipos, David Fretweil, Maurice X. Boissiere. Thomas O'Brien. Richard Florescu. Ana-Maria Sandi.Francois Ettori FOR OFFICIAL USE ONLY

REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED SOCIAL PROTECTION ADJUSTMENT LOAN IN AN AMOUNT OF US$50 MILLION TO ROMANIA

CONTENTS

INTRODUCTION ...... 1I

1. THE ECONOMY.

II. THE SOCIAL PROTECTION PROGRAM . . 2 A. Poverty in Romania .2 B. The Social Protection Strategy .3 Child Allowances .5 Minimum Income Guarantee Scheme .5 Social Feeding Programs .5 Temporary Cash Benefits in Substitution of Bread Subsidy .7 Lifeline Rates for Electricity .7 Pension System .7 C. The System of Labor Market Measures .8 D. Fiscal Costs of the Program .10

Ill. THE PROPOSED SOCIAL PROTECTION ADJUSTMENT LOAN . .11 A. Loan Objectives and Rationale.11 B. Composition and Quality of the Bank's Portfolio .11 C. Loan Amount and Tranches .12 D. Disbursement and Procurement .12 E. Reporting, Accounting, and Auditing .12 F. Environmental Implications .13 G. Benefits and Risks .13 H. Coordination With Other Donors .13

IV. RECOMMENDATION .14

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwisebe disclosedwithout World Bank authorization. ANNEX Annex 1: Letter of Development Policy Annex 2: Policy Matrix Annex 3: Timetable for Key Processing Steps Annex 4: Status of Bank Group Operations in Romania Statement of IFC Operations in Romania Annex 5: Romania at a Glance Annex. 6: Tables and Graphs

MAP ROMANIA

PROPOSED SOCIAL PROTECTION ADJUSTMENT LOAN

LOAN AND PROGRAM SUMMARY

Borrower: Romania

ExecutingAgencies: Ministryof Labor and Social Protection

Beneficiaries: The poor: the unemployed,children, pensionerson low pensions and other groups that are likelyto be adversely impactedby the short term impact of the Government's macrostabilizationand structuralreform program.

Loan Amount: US$50 million

Terms: Payable in 20 years, including5 years of grace, at the Bank's standard interestrate for LIBOR-basedsingle currency loans in US dollars.

Objectives: The objective of the loan is to support the Government's effort to strengthenthe agreed social protectionprogram. This program has been developedto assist the most vulnerable groups of society who will suffer from the negative income effects of macro-economicstabilization and structuralreform measuresto be carriedout throughout 1997/1998.

Loan Description: The loan will provide financialsupport for the Government's social protectionprogram. These measures will require additional resourcesfor the protectionof vulnerablegroups. The loan will be disbursed in a single tranche.

Benefits: The loan will support a social protectionprogram which is a crucial element of the Government'smacro-economic and structuraladjustment measures. Implementation of these economicreform and stabilizationmeasures are essentialto reverse Romania's rapidly deterioratingmacro-economic situationand to firmly launch the countryon the path to a market economy.

Risks: Despitethe strong politicalcommitment to economicreform and social protectionmeasures, there is a high risk that programwill not be effectivelyimplemented due to administrativeconstraints or budget reversals.Tight budgetaryceilings, and insufficient allocations for other expenditurecategories, might cause the Governmentto reallocateresources away from the social protectionprogram, and imperil its implementation.There is an additional risk that the implementation of the overall economic reform program may not be sustainable because of faltering social and political consensus. especiallv from those population groups that will not benefit directly from social protection measures, such as Romania's middle class. These groups do not belong to the most vulnerable classes of society, but will still have to face real declines in income throughout 1997.

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

Poverty Category: The social protection program being supported by this loan is a poverty-focused program. The program supports improvements in the adequacv and the targeting of cash and in kind benefits to the most vulnerable groups of the population, and strengthens the institutional capacity for delivering these programs to the truly needv.

Disbursements: FY97 US$ 50 million Cumulative US$ 50 million

Project I.D. Number: RO-PE-50432 Report and Recommendation of the President of the International Bank for Reconstruction and Development to the Executive Directors on a Proposed Social Protection Adjustment Loan to Romania

INTRODUCTION

1. I submit for your approval the following report and recommendation on a proposed Social Protection Adjustment Loan (SPAL) to Romania for US$ 50 million. The Loan will be in one tranche in US Dollars and will be payable in 20 years, including a 5 year grace period, at the Bank's standard variable interest rate for LIBOR-based single currency loans. The SPAL will provide financial support for the Government's Social Protection Program that has its major objective support to the most vulnerable groups of the population against the adverse short term impact of the Government's macro-economic stabilization and structural reform program. As such, the loan forms a integral part of the Government's overall economic reform program and is critical for launching the country decisively on the path to a market economy.

i. THE ECONOMY 2. The present Government of Romania was appointed in November, 1996, and inherited a very difficult economic situation. Although fundamentally a consequence of inadequate structural reforms over the last several years, the situation was brought to a crisis point by especially expansionary monetary and fiscal policies in the year leading up to the elections. With the deficit financed by money creation or by short-term debt, the newly elected Government was faced with a high current account deficit, high inflation, and fiscal pressures. Relieving these pressures in a sustainable way will require not simply tight monetary and fiscal policies, but also adequately addressing the neglected structural measures which lie at the root of the problems. Especially necessary are an acceleration of privatization in the industrial and agricultural sectors, liquidation of non-viable enterprises, liberalization of agricultural prices, and imposition of hard budget constraints combined with sound financial sector policies. Recent political and social developments, the macroeconomic program, the financing plan and the country's credit worthiness are discussed in detail in the new Country Assistance Strategy (1997) that accompanies this report.

3. The Government is determined to implement the stringent macrostabilization policies which will be necessary, and to move forcefully on structural reform, especially in the enterprise, financial, and agricultural sectors. These measures will launch Romania decisively on the path to a market economy. To assist in the implementation of these measures, the Government has requested financial assistance from the World Bank under an Agricultural Sector Adjustment Loan and is implementing the program supported by the ongoing Finance and Enterprise Sector Adjustment Loan (FESAL), which the World Bank approved in early 1996.

4. These measures will come with high social costs in 1997. GDP is expected to decline by 1% to 2%, consumer prices are expected to rise by over 100%, and unemployment is projected to increase sharply. Average real wages will fall. As part of the stabilization program, Parliament approved in March 1997 regulations which stipulate that Regies Autonomes and loss-making state-owned commercial companies cannot increase the average wage for 1997, relative to the average wage for the last quarter of 1996, by more than 75 percent of the projected increase in -2- consumer prices. For all these reasons, there will be significant declines in real income for most of Romania's households. In addition, increasing unemployment will have an especially sharp impact on the households directly affected. Under the enterprise adjustment program which the FESAL is supporting, it is expected that close to 100,000 industrial workers will be laid off due to the need for industrial downsizing and enterprise closures.

5. The Romanian population will be hard hit by these measures. Declining household incomes will at least initially push more into poverty, and increasing unemployment will threaten the whole fabric of society. Economic reform measures are expected to hold especially serious consequences for poorer households. The liberalization of agricultural prices has already led to significant food price increases, with these substantially above average inflation levels. In Romania, as in other countries, the share of food consumption in total expenditure is higher for poor households. Poor households spend 85 percent of their outlays on food, as compared to 42 percent for highest income groups. Poor households will also be seriously affected by price increases for utilities, although here (as described below) life-line rates were established to cushion the impact on the poorest. More broadly, poor households (as in all countries) are least able to cope with the expected economic shocks, as they already are living with the least "margin" to absorb any shock, and because they hold few assets and savings which can be used during a time of economic stress. Poverty will undoubtedly temporarily increase as a consequence of the macrostabilization and structural reform measures, and while these measures (if sustained) can be expected to reduce poverty later, this will not help the poor in 1997.

II. THE SOCIAL PROTECTION PROGRAM

A. Poverty in Romania 6. Poverty is already high in Romania. The World Bank Poverty AssessmentI recently discussed with the Government, estimates (based on 1994 data, the most recent available when the study was done) that 22 percent of Romania's population live below the poverty line defined by the World Bank. This amounts to about 5 million individuals and 1.6 million households that are poor. People living in rural areas are especially seriously affected by poverty. Two-thirds of Romania's poor live in villages, primarily in the north of the country. Population groups particularly affected by poverty are the unemployed, households with many children, farmers, and selected pensioners (Table 1, Annex 6). While pensioners as a group are not particularly poor, there are still significant numbers of old people living in deep poverty, far below any poverty line. These are primarily elderly women, dependent on very low agricultural pensions, living alone and receiving no supplemental income. Evidence in Romania (as found in the Poverty Assessment, for example) and in other transition economies, also points to a close correlation between poverty and the number of children in a household. Children in poor households carry much of the "poverty" cost of transition policies, with important long-term, often irreversible, effects: malnutrition during early childhood, low health status, dropping out from school, and increases in child labor.

7. Poverty in Romania is deep relative to that seen in other countries. With a poverty gap of 25 percent, Romania will need major adjustments and a number of years of strong economic

Romania:Poverty and Social Policy,April, 1997,Report-No, I6462-RO -3- growth before the number below the poverty line is reduced significantly. The long term unemployed, households with many children living on low wages, and the elderly poor in rural areas, will not be lifted above the poverty level solely by economic growth. The Presidency of Romania has launched a workshop series which has as its objective the design of operational strategies to address poverty of children and the unemployed. In order to prepare an operational strategy on how to address poverty in two high priority areas, the Government has presented to the World Bank the terms of reference of a workshop series under the guidance of the Presidency on (i) poverty of children; and (ii) poverty of the unemployed. As a follow-up measure, the Govemment will establish at the Presidential or Prime Minister level a National Poverty Commission to design a long-term poverty alleviation strategy.

B. The Social Protection Strategy 8. The Social Protection Program has been designed taking very much into account the findings of the World Bank Poverty Assessment. The Program will focus particularly on the most vulnerable groups and on those who will be most impacted by the reforms: The unemployed, poor pensioners, households with several children, and individuals and households living on very low incomes well below any poverty line. A particular focus of the Program will be on the protection of children.

9. The Social Protection Program is also designed to complement the ongoing economic reform measures. Its objective is to put in place social protection measures quickly, at the same time as macrostabilization and structural reform measures are being implemented. As time constraints do not permit the establishment of new programs, income support is being provided through existing, functioning, transfer programs. Thus the Social Protection Program uses several existing cash transfer programs (child allowances, unemployment benefits and severance pay, Minimum Income Guarantee Program, and agricultural pensions) directed to the identified target groups, with the benefit levels being adjusted and adequate funding being provided in the budget. The increase in cash transfers required to finance this program-- 2.1% of GDP--will fully substitute for the previous widespread consumer subsidies, which went to everybody through lower prices for selected commodities and which have been eliminated as part of the economic reform program. The shift from consumer subsidies to cash transfers for groups in need of income support, will not have the distortionary economic effects the of earlier price interventions.

10. The seven basic program components of the social protection system are:

a. A significant increase in the level of universal child allowances directed to all households with children, and supplemental payments to families with several children. The increased universal allocation has already been implemented, in February. The supplemental is expected to be put in place in July 1, 1997, as soon as necessary administrative and legislative measures have been completed.

b. The full indexation to inflation for agricultural pensions since February 1, 1997. Note that these pensions are extremely low. Even with these adjustments, the minimum pension would only reach US$10 per month, with the average agricultural pension about $13 per month. -4-

c. Full indexation of the real benefit level in the Minimum Income Guarantee Scheme. The defined benefit level is already below the poverty line, but all that can be provided given the tight budget; the indexation will merely keep it from falling further.

d. A broadening of social feeding programs, through adequate budget for, and increased use of, existing canteens, as well as the quick establishment of simple "soup kitchen" programs in areas with a large number of the very poor who may not be easily reached through income transfer programs.

e. The continuation and possible strengthening of supplemental social protection schemes administered through the education system, such as special student scholarships.

f. Temporary income support to the low income earners to buffer the effects of the elimination of the bread subsidy.

g. Establishment of lifeline rates for electricity, with a very low rate for the first 50 kilowatt-hours per household per month, somewhat higher rates for the next 50, and market rates (equivalent to about 5 cents per kilowatt-hour; about four times the previous rates) for consumption above 100 kwh per month. The lifeline rates are in effect income transfers targeted to households with low electricity consumption, where studies have shown electricity use is a good predictor of household income.

11. In addition to these immediate social protection measures, the Government is committed to implementing essential structural reform measures, which will have medium and longer term effects. These include:

a. An evaluation and subsequent reform of the Minimum Income Guarantee Scheme to improve the coverage and effectiveness of this program.

b. An evaluation and subsequent reform of the entire range of social assistance benefits (both cash and in-kind), that in conjunction with the reform of the Minimum Income Guarantee Scheme, would result in an efficient and well targeted social assistance system.

c. The preparation of a new draft Pension Law to tighten eligibility and improve contribution compliance under the Public Pension Program.

d. The gradual introduction of Private Pension systems in Romania as a complement to the Public Pension Program.

e. The introduction of effective social service provision in all judets, to complement cash benefit systems and to provide alternative care systems (rather than institutionalization) of children, the elderly, the disabled, and other population groups at risk. -5-

f. The preparation of a long-term poverty strategy, addressing deep poverty, particularly among children and the unemployed, which will not be resolved through economic growth alone

12. The rationale and objective of each component of the Social Protection Program is discussed in greater detail below:

13. CHILD ALLOWANCES. Child allowances are a universal scheme paying an equal benefit to each child irrespective of the level of family income, with the added stipulation that school age children must remain in school to receive the benefit. The real level of child allowances has decreased considerably over the past few years. The Government spent only 0.8 percent of GDP on child allowances in 1996 as compared to 2.9 percent of GDP in 1990. Despite this development, child allowances are well targeted to the poor, mainly because families with more children (mainly the poor) receive a larger total benefit than smaller families.

14. Since February 1997, the Government has increased the universal child allowance to Lei 50,000 per month for each child, up from the previous monthly level of Lei 12,000 per child. Starting with July 1, 1997, an additional allowance of Lei 30,000 per month will be paid for families with two children, an additional Lei 80,000 for families with three children, and an additional Lei 110,000 per month for families with four children. No incremental payments will be made for subsequent children. Incremental allowances for multi-children households are being introduced to target income support to households with several children, which are most likely to live below the poverty line. The incremental family allowances will not be included in the calculation of the income base to establish eligibility criteria for the Minimum Income Guarantee Scheme. Inclusion of the family allowance in the calculation of the income base would impose a 100 percent tax on this benefit for very poor households and exempt wealthier households from paying this tax. The Government has approved a Draft Law on (i) the introduction of the Incremental Family Allowances and, (ii) the exclusion of Incremental Family Allowances in the calculation of income to establish eligibility under the MIG Scheme. As administrative measures are necessary to prepare the payment of Incremental Family Allowances according to the number of children, the incremental family allowance will only be implemented starting July 1, 1997. The Government has presented an implementation plan for the Incremental Family Allowance Program to the World Bank.

15. The substantial increase in the universal child allowances and the introduction of family allowances targeted to families with several children, will increase fiscal resource requirements of the child allowance program to 1.8 percent of GDP. However, the increased amount of transfer would constitute an important source of income for single and two earner low wage households, and reduce the depth of poverty they would face without such increases in benefits. (Table 2, ANNEX 6 ).

16. MINIMUM INCOME GUARANTEE SCHEME (MIG). In 1995, Romania initiated a Minimum Income Guarantee Scheme that was designed to become the principle vehicle for income support for households realizing incomes below the guaranteed minimum amount. The scheme has remained modest in size, with a guaranteed minimum income well below the poverty line developed in the Romania Poverty Assessment. In 1995 and 1996, only 0.2 percent of GDP

2Romania: Povertyand SocialPolicy, ibid, 1997. -6- was spent for this scheme. There is growing evidence anecdotal evidence that the MIG has substantial administrative and weaknesses in program design that have led to significant inclusion and exclusion errors in the program. This evidence is difficult to substantiate empirically as Local Governments, responsible for program administration have kept very limited, and largely unreliable, data on recipient profiles and program expenditures.

17. Despite growing concerns about the effectiveness of the MIG, the Government has increased budgetary allocations to the MIG to a total of 0.29 percent of GDP in the 1997 local budget estimations. The MIG benefit level was fully indexed to inflation during the last indexation exercise in March, 1997. The Government has also agreed to continue the full indexation of MIG benefit levels until the program is restructured. There are two reasons for supporting this measure. First, despite its inadequacies, vulnerable groups not covered by other programs can only potentially be reached through the MIG. These groups include the long-term unemployed ineligible for unemployment support or unemployment assistance ,who have exhausted unemployment benefits, or farmers without pension rights. Second, MIG beneficiaries, some of whom are likely to be the truly needy, may well increase as a result of income declines over the course of 1997. The MIG program will therefore need to be maintained, pending further review, in its present form during 1997 to provide for this minimum assistance as a "last line of defense" against poverty.

18. The emerging inadequacies of the program necessitate a comprehensive review of the MIG. In order to properly evaluate the present program, agreement has been reached with Government on the completion of.an evaluation of the MIG program and the preparation of the MIG reform program, including an adequate financing mechanism. Based on the recommendation of this evaluation, reform measures will be undertaken to strengthen the Minimum Income Guarantee Scheme. The Government has prepared the Terms of References for the Evaluation of the MIG Program and appointed an evaluation team through Ministerial Decision. In addition, an evaluation and subsequent reform of the entire range of social assistance benefits (both cash and in kind) would be undertaken, in conjunction with the MIG reform program, to provide an-efficient and well targeted social assistance system.

19. The Government further agreed to monitor the appropriate allocation of funds to MIG financing at the local level. Inadequate allocations of resources has often been the cause for non- payments or delayed payments of MIG benefits to beneficiaries. MIG expenditures are in principle financed through local revenues, but, as local revenues are insufficient, block grants provided by central Governments have been used as an important source of financing for the MIG program. In practice, not all of these transfers are used by local Governments to finance MIG benefits, but are sometimes used for financing other local expenditures. The Parliament has approved the 1997 budget law which specifies that central Government wage tax reallocations would be used giving priority to social assistance expenditures. The Prime Minister has communicated to the Prefects of Judets on the use of Government wage tax reallocations for the MIG program.

20. Complementary measures to the MIG program will continue to be carried out by the Ministry of Education through the provision of special scholarship to needy students. These scholarships, averaging only 25,000 lei/month per recipient and limited to only I percent of the student population, are only provided to obviously needy students selected by the school administration and teachers. Available evidence suggests that this scholarship program is well targeted, providing support to students who are otherwise in danger of dropping out of the school -7- system because of financial constraints. The Government has agreed to fully index social scholarships provided through the school system as a complement to the MIG scheme to inflation in 1997 and in the future. Social scholarships provided through the school system as a complement to the Minimum Income Guarantee Scheme were fully indexed to inflation during the last indexation exercise in March, 1997.

21. SOCIAL FEEDING PROGRAMS. The Government is implementing a strengthened social feeding program. These "in-kind" benefits are desirable as they can reach population groups not typically reached through cash benefits. Feeding programs, combined with income support measures, would help reduce the emerging malnutrition among poor Romanian children and supplement the low caloric intakes of the poor (Annex 6, Figure 5). The program anticipates an expansion of canteen programs and the introduction of soup kitchen programs, from an average of 40,000 meals per day in 1996 to about 120,000 meals in 1997. Soup kitchens will be established in larger towns at points frequented by the homeless and other destitute people. These kitchens would provide for a bowl of soup and a slice of bread free of charge on a first- come-first-served basis. The Government has increased the budgetary allocation to 0.17 % of GDP for social feeding programs in the 1997 local budget projections. The Government has prepared a draft law on social canteens, and prepared the Terms of Reference for the design of the Soup Kitchen Program in major cities. The terms of reference define the preparatory work required to launch the soup kitchen program in major Romanian cities. The design and implementation of the program is expected to be carried out with the assistance of experienced international Non-Governmental Organizations.

22. TEMPORARY CASH BENEFITS IN SUBSTITUTION OF BREAD SUBSIDY. As part of the economic reform program, Government eliminated the bread subsidy in February 1997. With the elimination of the bread subsidy, bread prices increased by 100 percent. Bread is an important staple in the Romanian diet, particularly in the consumption baskets of poorer households. The Government has adopted measures on temporary cash payments (April to September, 1997) to targeted population groups to compensate for the increase in bread price caused by the elimination of previous price controls and subsidies on the price of bread. The cash payments will be targeted to low income groups, and institutions providing for low income individuals. The cash payments consist of: a monthly cash payment of 13,500 lei to: (1) employees in the public and private sector with average wages below 600,000 lei/month; (II) pensioners under the State Pension Fund with average pensions below 300,000 lei/month; (III) unemployed receiving either unemployment benefits or unemployment assistance under the post unemployment scheme; (IV) beneficiaries under the Minimum Income Guarantee Scheme. In addition to these income transfers, 9,500 lei/month will be paid to all agricultural pensioners and 450 lei/day provided as increased food allocations to institutions which provide care to children, elderly, disabled, in hospitals, canteens, etc. The Government has agreed to fully indexed to the inflation of food prices the food budgets in institutions taking care of vulnerable groups (children and families at risk, disabled, elderly, etc.) in 1997 and during future indexation adjustments. The food budgets of these institutions were fully indexed to inflation during the last wage adjustments,

23. LIFE LINE RATES FOR ELECTRICITY. The Government has established life-line rates for electricity, for the first 50 kilowatt-hours per month per household and for the second 50 kwh per month per household. A very low rate (Lei 75 per kwh) is applied for the first 50 kilowatt-hours per household per month. There are somewhat higher rates (Lei 172 per kwh) for the next 50 kilowatt-hours and market rates (Lei 358, or about 5 cents per kwh), about five times -8- the previous rate, for consumption above 100 kilowatt-hours. Lifeline rates are a universal benefit, but have a greater relative impact the poor, who consume less electricity and spend a greater share of their income (relative to richer groups) on utilities.

24. THE PENSION SYSTEM. The Romanian public pension system provides a modest level of pension benefit to contributing individuals, after age of 55 for men and age 60 for women. There are two main pension funds. The State Pension Fund provides pensions to state enterprise workers, while the Agricultural State Pension Fund, much smaller in terms of overall expenditures and beneficiaries, provides pensions to workers of the former agricultural cooperatives, dissolved since 1991. No private pension funds have, as yet, been established. Total spending by both funds amounted to 6.9 percent of GDP in 1996, and remains much below Central and Eastern European norms. The main reason for prudent pension expenditures in Romania is that the pension system has one of the lowest replacement rates of pensions to net wages (30%) in the region (see Figure 4, Annex 6). Pension levels in the agricultural pension system are especially low and explain the high incidence of poverty among older women in rural areas. In order to protect the real level of already low agricultural pensions, the Government has fully indexed agricultural pensions to inflation as of February 1, 1997. The Government has agreed to continue full indexation of agriculture pensions throughout 1997 and in the future.

25. In 1996, after realizing a surplus till 1995, the State Pension Fund realized a deficit of 0.46 percent of GDP. The deficit was occasioned by an increasing number of pensioners, particularly in the disability category, matched by a deterioration in payroll tax compliance by insolvent state enterprises. To prevent the further deterioration of the financial position of the Pension Fund, the Government has proposed to reform the pension system. As such, it is considering potential measures to improve the financial viability of the Pension Fund, that include, among other measures, stricter eligibility conditions, a tighter link between pension benefits and contributions, and improvements in tax compliance. The Government is also committed to facilitate the establishment of private pension funds, that would complement the public pension fund system, deepen capital markets and allow individuals more opportunities to save for old age. The Government has presented a statement of reform intentions for the public pension system including tightening of eligibility criteria and improving contribution compliance in order to maintain financial equilibrium of the State Pension Fund. Detailed preparatory work for the pension reforms will be undertaken during the next few months. The Government has agreed to present a revised pension law to Parliament by September 30, 1997.

C. The System of Labor Market Measures 26. Romania has an administratively well functioning system of temporary income support for the unemployed and a still modest program of active labor market measures for displaced workers. Unemployment benefits, amounting to 55% of the previous wage are paid to the unemployed for a period of 9 months. The unemployed who can demonstrate financial need are eligible for a further 9 months of unemployment benefits, but at a much reduced level of assistance. Much like other benefits, the level of unemployment benefits has decreased in real terms and is likely to fall further over the course of 1997. In order to avoid a further erosion of benefit levels, and in light of high incidence of poverty among the unemployed, the Government has agreed to fully index unemployment benefits to inflation in 1997 and in the future. Unemployment benefits were fully indexed to inflation during the last indexation exercise in March, 1997. -9-

27. Romania has been slow to establish a system of active labor market measures. Under an ongoing Employment and Social Protection Project3, the World Bank provides financial support and technical assistance to establish a national system of labor services to displaced workers. The project provides primarily institution building support and has a small active labor market component directed towards mass-lay offs. Project resources are therefore being reallocated to put more emphasis on these activities. Some important achievements have been made under a PHARE financed program, where active labor market measures have been instituted at local levels, primarily executed through domestic Non-Governmental Organizations. These measures entail a menu of labor support programs, such as counseling, retraining, assistance in job search, support to micro-enterprise creation, etc. They are small scale in nature and are of varying quality, but they have achieved the establishment of a wide network of service providers which can be utilized in providing support services for the large-scale layoffs expected throughout 1997. Until the recent reforms, Romania only had a limited program for severance payments, paid only to enterprises previously placed under "Financial Surveillance", a special regime established for enterprises in financial distress and governed by a special regulatory system. Workers laid off in companies not placed under this regime were not eligible for severance payments and received only temporary income support through unemployment benefits.

28. Labor market programs established before the recent reforms were not sufficient for the large scale lay-offs expected in 1997. The FESAL program anticipates important industrial downsizing and restructuring measures likely to lead to lay-offs of approximately 100,000 workers from state-owned enterprises concentrated in several large -scale enterprises and industries. All workers displaced from work under mass lay-off schemes will need to receive severance payments. A definition of criteria on which displaced workers would be eligible for severance payments had to be established.

29. The Government has issued an Ordinance establishing the eligibility criteria and the amount of payment under the Severance Payment Program, with a financing mechanism. Severance pay will only be available to those laid off under mass-lay off schemes rather than being made available nationwide to all workers who become unemployed. The Ordinance stipulates that: (a) Workers who have worked with the firm up to 5 years will get 6 months of severance pay. Workers with 5 to 15 years will get 9 months, workers with 15 years will receive 12 months of severance pay; (b) if a worker is displaced in a local community having over 12 percent unemployment, the number of months of severance can be increased by 3 months. These severance pay levels are comparable to severance payments made in other restructuring economies in the CEE region and remain below severance payments typically paid in the Western European countries for downsizing industries. Severance payments will be administered through enterprises but financed through a special fund established by the Ministry of Labor and Social Protection. The Government has allocated 0.44% of GDP for severance payments under the 1997 budget law.

30. In addition to income support, active labor market programs will be established to assist the displaced workers in their reintegration into the labor market. Measures would be implemented in the pre-layoff and post-layoff stage. In the pre-layoff stage, enterprises would receive technical assistance to develop labor re-deployment plans, public information materials and campaigns, and promote social dialogue. Plans would be developed in consultation with social partners, including affected workers, representatives from the community, labor,

3Romania: Employment and Social Protection Project, October 31, 1994, Report-No, 12769-RO -10- enterprise management, and the Government. For services in the post-layoff stage, local public and private agencies would be given contracts to deliver in-depth labor re-deployment services to displaced workers (for example employment and relocation services, retraining, public service employment, small business assistance, etc.).

31. The Government has established a Rapid Labor Re-deployment team at the Ministry of Labor and Social Protection through a Ministerial Decision. Technical assistance to establish this service has already been secured. Financing for the provision of services will be provided under the World Bank Employment and Social Protection Project. Agreement has been reached with the Government, that a total amount of US$10.5 million of the World Bank project will be allocated to the Ministry of Labor and Social Protection. The World Bank has received a letter from the Minister of Finance addressed to the World Bank requesting an allocation of US$10.5 million from the Employment and Social Protection Loan to a new disbursement category to provide financing for active labor market measures, and we have approved the request.

D. Fiscal Costs of the Program 32. The implementation of the Social Protection Program will require significant additional resources, amounting to a total of 10.2 percent of GDP in 1997, and representing an increase of 2.2 percent of GDP over the 1996 fiscal allocations. In light of the very low level of past budgetary allocations to social protection and insurance programs in Romania, this significant increase in expenditures is justified, and will place social expenditure allocations in Romania more in line with those of other CEE countries at similar levels of economic development. As noted in section II, the increase in cash transfers required to finance the Social Protection Program will fully substitute for the previous widespread consumer subsidies, which went to everybody through lower prices for selected commodities and which have been eliminated as part of the economic reform program. The shift from consumer subsidies to cash transfers for groups in need of income support will not have the distortionary economic effects of the earlier price interventions..

TABLE 1: FISCAL REQUIREMENTS FOR SOCIAL PROTECTION MEASURES (as percentage of GDP)

1995 1996 1997 Increment al Child Allowances 0.68 0.58 1.80 1.22 Social Assistance 0.23 0.16 0.29 0.13 Bread Subsidy 0.00 0.00 0.35 0.35 Severance Payments 0.00 0.00 0.44 0.44 Unemployment Benefits 0.75 0.58 0.64 0.06 Social Canteens 0.10 0.10 0.17 0.07 Active Labor Market Measures 0.00 0.07 0.07 0.00 State Pensions 5.64 6.07 5.54 -0.53 Agricultural Pensions 0.43 0.46 0.80 0.34 TOTAL 7.83 8.02 10.10 2.08 -11-

III. THE PROPOSED SOCIAL PROTECTION ADJUSTMENT LOAN

A. Loan Objectives and Rationale 33. The proposed quick disbursing Social Protection Adjustment Loan in the amount of US$ 50 million will provide financial resources that will help the Government implement the agreed Social Protection Program. The Social Protection Program, the rationale and objectives of which were described extensively in section II of this report, focuses on increasing the adequacy of existing cash and in kind programs to assist the Government in protecting the poorest and most vulnerable groups in Romania from the negative income effects of macro-stabilization and structural reform measures implemented under the IMF-Standby program, the ongoing Financial and Enterprise Sector Adjustment Loan and the Agricultural Sector Adjustment Loan. Because of the limited time available to put in place a completely reformed social protection system, the short term measures supported by the Social Protection Program rely on existing social protection schemes. However, the Social Protection Program also lays the framework for deeper structural reforms in the social protection system in order to ensure its long term fiscal viability and to improve its effectiveness in protecting the poor. The precise measures supported by the program are summarized in the policy matrix attached as Annex 2 of this report.

B. Composition and Quality of the Bank Portfolio 34. The Bank's portfolio in Romania is young as lending to the country resumed in 1991. Most projects are of FY92 vintage onwards, spanning several key sectors of the economy and supporting the transition agenda. A sizable portfolio has been built since then, with 14 projects approved between FY91 and FY97, totaling $1.9 billion in commitments ,of which $ 1.0 billion disbursed. Of these, two operations (SAL I and TACI) have closed.

35. The November 1996 elections have brought a new govemment that is fully committed to rapid structural adjustment. The recent dialogue between the Romanian government and the Bank has been both intensive and productive. The result has been the galvanization of Bank support for the new Government's comprehensive adjustment and social protection package through: (i) a further tranche of the FESAL which was approved in January 1996; (ii) an adjustment financing in agriculture (ASAL), and (iii) the support of social protection measures. The new leaders will put our other operations, derailed by earlier decisions to suspend price and tariff adjustments, back on track. The Bank's current assistance strategy to Romania, as agreed with the new Government, consists of supporting (i) structural adjustment reforms and private sector development; (ii) human capital development and poverty alleviation; (iii) institutional strengthening; and (iv) environmental sustainability. Two operations (FESAL and the Employment and Social Protection Project) have been redesigned to respond to new country priorities and the accelerated pace of reform.

36. The Bank has supported Romania's efforts to raise external capital by hosting two consultative group meetings, one in 1993 and another in 1994. A third meeting is planned for this fiscal year. Two Country Portfolio and Performance Reviews (CPPRs) have already taken place in Romania. A third meeting may take place later this year. The CPPR's will be geared towards a more active assessment of generic and specific implementation problems, and the establishment of a post CPPR project monitoring to follow up on progress in meeting key targets. -12-

37. The Resident Mission, established in July 1992, furthers the Bank's interaction with the Government in the preparation and implementation of the Bank's assistance program, plays a key role in the dialogue on macroeconomic issues and policy reform, advises policy makers on all aspects of the reform process and assists in maximizing external resource mobilization and coordinating external assistance. The improvement of portfolio management and monitoring is at the top of the Bank's country dialogue, and the Resident Mission has also been given increased supervision responsibilities. Likewise, an increased level of project preparation and follow-up with Govemment agencies have recently been undertaken by the Resident Mission staff.

38. Romania became a member of IFC in September 1990. The IFC has dedicated significant resources in an attempt to provide financial support to privatized enterprises. However, the privatization process has been slow, and has limited the opportunities available. More recently, an improvement in the general business environment and a more positive attitude by both enterprises and government agencies toward the privatization process has been observed. Greater opportunities for a more active IFC role are thus expected, and the present CAS document gives a flavor of how this can be achieved, particularly in support of enterprise privatization, restructuring and private sector development.

39. MIGA has concluded a Legal Protection Agreement and a Use of Local Currency Agreement with Romania. Whilst no guarantee has been issued to date, a contract is nearing fruition to a financial institution covering its equity investment in establishing a bank in Romania. MIGA is also considering providing a guarantee for an investment in the mining sector in the country. In addition, 12 other projects representing an aggregate potential investment of US$934 million in Romania have registered with MIGA. EDI is looking into increasing its support for Romania's current reform program through key activities outlined in the CAS.

C. Loan Amount and Tranches 40. The proposed Social Protection Adjustment Loan would be a one tranche operation. Upon loan effectiveness, US$ 50 million would be released. The loan would be extended at the World Bank's standard interest rate for LIBOR-based single currency loans in US dollars, with a maturity of twenty years, including a grace period of five years.

D. Disbursement and Procurement 41. The Loan will be disbursed in one tranche upon effectiveness. It will provide financial resources which will permit the Government to implement the agreed Social Protection Program described in the Letter of Development Policy, except for the items specified in the negative list in Schedule I of the Loan Agreement. Disbursement arrangements will follow the simplified procedures adopted by the Board on February 1, 1996. The total amount of the Loan will be disbursed into a Ministry of Finance foreign exchange account with the National Bank of Romania. If after deposit in this account the loan proceeds are used for ineligible purposes, the Bank will require the borrower to either (a) return that amount to the account for use for eligible purposes; or (b) return that amount to the Bank, in which case the Bank will cancel an equivalent undisbursed amount of the loan. -13-

E. Reporting, Accounting and Auditing 42. Although the Bank will not routinely require an audit of the Deposit Account, it reserves the right to require an audit by independent auditors acceptable to the Bank. In addition, audit reports would be submitted to the Bank no more than six months after the date of the Bank's request.

F. Environmental Implications 43. In accordance with the Bank's Operational Directive on Environmental Assessment (OD 4.01, Annex E), the proposed operation has been placed in category "C" and does not require an environmental assessment.

G. Benefits and Risks 44. The loan will support a social protection program which is a crucial element of the Government's macro-economic and structural adjustment measures. Implementation of these economic reform and stabilization measures are essential to reverse Romania's rapidly deteriorating macro-economic situation and to firmly launch the country on the path to a market economy. The social protection program would help alleviate poverty by supporting improvements in the adequacy and targeting of cash benefits to the most vulnerable groups of the poor and, by strengthening the administration of existing cash and in-kind benefit programs in order to improve the delivery of benefits to the truly needy groups.

45. Despite the strong political commitment to economic reform and social protection measures, there is a high risk that program will not be effectively implemented due to administrative constraints or budget reversals. Tight budgetary ceilings, and insufficient allocations for other expenditure categories, might cause the Government to reallocate resources away from the social protection program, and imperil its implementation. There is an additional risk that the implementation of the overall economic reform program may not be sustainable because of faltering social and political consensus, especially from those population groups that will not benefit directly from social protection measures, such as Romania's middle class. These groups do not belong to the most vulnerable classes of society, but will still have to face real declines in income throughout 1997.

H. Coordination With Other Donors 46. The Social Protection Adjustment Program has been prepared by a Joint Government/European Union/World Bank Task Force. Regular consultation on all program matters have been conducted with the European Union. Throughout the work of the Task Force, close coordination has been sought with USAID, UNICEF and UNDP. USAID has played an instrumental role in defining the active Labor Market Program supported by this loan. Close coordination with UNICEF has been sought to define the appropriate assistance strategy for children and families at risk and in designing measures to strengthen Romania's social service network. -14-

IV. RECOMMENDATION 47. 1 am satisfied that the Proposed Social Protection Adjustment Loan would comply with the Articles of Agreement of the International Bank of Reconstruction and Development, and I recommend that the Executive Directors approve it,

James D. Wolfensohn President

by Caio Koch-Weser

Washington, D.C. May 9, 1997 ANNEX I Page I of 7

ROMANIA

SOCIAL PROTECTION ADJUSTMENT LOAN

LETTER OF DEVELOPMENT POLICY

Mr. James D. Wolfensohn President World Bank Washington, D.C.

Dear Mr. Wolfensohn:

1. This Letter of Development Policy describes the social protection measures which the Government of Romania is implementing as part of its program of macroeconomic stabilization and structural reform. This program, which involves major adjustments in the enterprise and agricultural sectors, will have serious short-term costs for many in Romania's population. The Government of Romania is hereby requesting the World Bank's assistance, in the form of a Social Protection Adjustment Loan, to help in the implementation and financing of this important program.

Background

2. The present Government of Romania was elected in November, 1996, and inherited a very difficult economic situation. Although fundamentally a consequence of inadequate structural reforms over the last several years, the situation was brought to a crisis point by especially expansionary monetary and fiscal policies in the year leading up to the elections. With the deficit financed by money creation or by short-term debt, the newly elected Government was faced with a high current account deficit, high inflation, and fiscal pressures. Relieving these pressures in a sustainable way will require not simply tight monetary and fiscal policies, but also adequately addressing the neglected structural measures which lie at the root of the problems. Especially necessary are an acceleration of privatization in the industrial and agricultural sectors, liquidation of non-viable enterprises, liberalization of agricultural prices, and imposition of hard budget constraints combined with sound financial sector policies.

3. The Government is, however, determined to implement the stringent macrostabilization policies which will be necessary, and to move forcefully on structural reform, especially in the enterprise, financial, and agricultural sectors. These measures will launch Romania decisively on the path to a market economy. To assist in the implementation of these measures, the Government has requested financial assistance from the World Bank under an Agricultural Sector ANNEX I Page 2 of 7

Adjustment Loan and is implementing the program supported by the ongoing Finance and Enterprise Sector Adjustment Loan (FESAL), which the World Bank approved in early 1996.

4. These measures will come with high social costs in 1997. GDP is expected to decline by perhaps 3%, consumer prices are expected to rise by over 100%, and unemployment is projected to increase sharply. Average real wages will fall. As part of the stabilization program, Parliament approved in March 1997 regulations which stipulate that Regies Autonomes and loss-making state-owned commercial companies cannot increase the average wage for 1997, relative to the average wage for the last quarter of 1996, by more than 75 percent of the projected increase in consumer prices. For all these reasons, there will be significant declines in real income for most of Romania's households. In addition, increasing unemployment will have an especially sharp impact on the households directly affected. Under the enterprise adjustment program which the FESAL is supporting, it is expected that close to 100,000 industrial workers will be laid off due to the need for industrial downsizing and enterprise closures.

6. Poverty is already high in Romania. The World Bank Poverty Assessment recently discussed with the Government estimates (based on 1994 data, the most recent available when the study was done) that 22 percent of Romania's population live below the poverty line that the World Bank defined. This amounts to about 5 million individuals and 1.6 million households that are poor. People living in rural areas are especially seriously affected by poverty. Two-thirds of Romania's poor live in villages, primarily in the north of the country. Population groups particularly affected by poverty are the unemployed, households with several children, farmers, and selected pensioners. While pensioners as a group are not particularly poor, there are still significant numbers of old people living in deep poverty, far below any poverty line. These are primarily elderly women, dependent on very low agricultural pensions, living alone and receiving no supplemental income. Poverty in Romania is also deep relative to that seen in other countries. With a poverty gap of 25 percent, Romania will need major adjustments and a number of years of strong economic growth before the number below the poverty line is reduced significantly. ANNEX I Page 3 of 7

Social Protection Strate2v

7. The Social Protection Program has been designed taking very much into account the findings of the World Bank Poverty Assessment. The Program will focus particularly on the most vulnerable groups and on those who will be most impacted by the reforms the unemployed, poor pensioners, households with several children, and individuals and households living on very low incomes well below any poverty line. A particular focus of our Program is the protection of children. Evidence in Romania (as found in the Poverty Assessment, for example) and in other transition economies, point to a close correlation between poverty and the number of children in a household. Children in poor households carry much of the "poverty" cost of transition policies, with important long-term, often irreversible, effects: malnutrition during early childhood, low health status, dropping out from school, and increases in child labor. Our polices intend to especially limit these damages

8. Our Social Protection Program is also designed to complemnentthe ongoing economic reform measures. Its objective is to put in place social protection measures fast, at the same time as macrostabilization and structural reform measures are being implemented As time constraints do not permit the establishment of new programs, income support is being provided through existing, functioning, transfer programs. Thus the Social Protection Program uses several existing cash transfer programs directed to the identified target groups, with the benefit levels beingz adjusted and adequate funding being provided in the budget, specifically an increase in child allowances to help households with several children, the protection in real terms of agricultural pensions to help rural elderly who are subsisting on very low pensions. the protection in real terms of the level of unemployment benefits and the introduction of severance pay to help the unemployed; and a modest expansion of the Minimum Income Guarantee Scheme to assist people who are living on very low income and who are not protected through any of the other cash transfer programs (such as the long-term unemployed, who have exhausted their unemployment benefits, or elderly who do not have rights to pensions). Cash transfers will fully substitute for the previous widespread consumer subsidies, which went to everybody through lower prices for selected commodities and which have been eliminated as part of the economic reform program. The shift from consumer subsidies to cash transfers for groups in need of income support, will not have the distortionary economic effects the price interventions had

9. The seven basic program components of our social protection system are

a. A significant increase in the universal child allowances directed to all households with children, and supplemental payments to families with several children on a progressive scale. The increased universal allocation has already been implemented, in February. The supplemental is expected to be put in place in July 1997, as soon as necessary administrative and legislative measures have been completed. ANNEX I Page 4 of 7

b. The full indexation to inflation for agricultural pensions since February 1997. Note that these pensions are extremely low. Even with these adjustments, the minimum pension would only reach US$10 per month, with the average agricultural pension about $13 per month.

c. Full indexation of the real benefit level in the Minimum Income Guarantee Scheme. The defined benefit level is already below the poverty line, but all that can be provided given the tight budget, the indexation will merely keep it from falling further.

e. The continuation and possible strengthening of supplemental social protection schemes administered through the education system, such as special student scholarships.

f Temporary income support to the low income earners to buffer the effects of the elimination of the bread subsidy.

g. Establishment of lifeline rates for electricity, with a very low rate for the first 50 kilowatt-hours per household per month, somewhat higher rates for the next 50, and market rates (equivalent to about 5 cents per kilowatt-hour; about four times the previous rates) for consumption above 100 kwhr per month. The lifeline rates are in effect income transfers targeted to households with low electricity consumption, where studies have shown electricity use is a good predictor of household income.

10. The program will rely especially on an increase in child allowances. As the first step in the Social Protection Program, the universal child allowance, paid to every child, was increased in February 1997 from lei 12,000 per month to lei 50,000 per month (equivalent to about US$ 7 per month at the current exchange rate). Starting with July 1997, additional family allowance of (a) lei 30,000 per month for families with two children, (b) lei 80,000 per month for families with three children , and (c) lei 110,000 per month for families with four or more children will be paid. Incremental allowances for multi-children households target income support to households with several children, which the Poverty Assessment showed are particularly likely to live below the poverty line. Inflationary adjustments are only made for Agricultural Pensions, as these pensions are extremely low. No other pensions will be fully adjusted for inflation, as we try to reestablish an equilibrated financial position in the State Pension Fund in 1997, which in 1996 for the first time showed a financial deficit. We only provide for a modest expansion in the Minimum Income Guarantee Scheme as there are still administrative weaknesses in this program; it is relatively new, and its coverage is not yet reliable. Together with expanded social funding programs, and social scholarship to students, the Minimum Income Guarantee Scheme is being ANNEX I Page 5 of 7 maintained as a last line of defense against poverty for those it is reaching, targeted towards population groups which are not reached through other cash benefit schemes.

11. In addition to these immediate social protection measures, we are committed to implementing essential structural reform measures, which will have medium and longer term effects. These include:

a. An evaluation and subsequent reform of the Minimum Income Guarantee Scheme to improve the coverage and effectiveness of this program.

c. The preparation of a new draft Pension Law to tighten eligibility and improve contribution compliance under the Public Pension Program.

d. The gradual introduction of Private Pension systems in Romania as a complement to the Public Pension Program.

f. The preparation of a long-term poverty strategy, addressing deep poverty which will not be resolved through economic growth alone.

12. We intend to improve the administration of the Minimum Income Guarantee Program with the ultimate objective that all eligible households living on income below the defined household will be reached, while such transfers to ineligible households will cease. We also intend to rationalize the entire range of social assistance services, including child allowances, the Minimum Income Guarantee Program, and other cash benefits and in kind transfers, in order to develop a coherent social assistance program that is efficient and well targeted to the poor. On pensions, we intend to maintain a financially sound position in our State Pension Fund by tightening eligibility criteria, by increasing retirement ages and tightening access to disability pensions. We also intend to improve contribution compliance. By establishing private pension funds, we intend to offer additional savings options to provide for old age security. Substantial institutional reforms are anticipated in Romania's social assistance system. Our present system relies almost exclusively on cash benefits for income support and on institutional care for individuals who cannot live alone or with family or relatives. We are in the process of establishing a nationwide system of social services, which will provide assistance to vulnerable families and individuals. These services will also help in the establishment of alternative care systems to the presently use of institutional care, especially for children. ANNEX I PNge6 of 7

Labor Market Measures

13. We intend to address increased unemployment through income support and demand driven labor market measures. A system of unemployment benefits already exists and is functioning well in providing the stipulated benefits to those entitled to them. But poverty among families with an unemployed household head is high, and unemployment benefits are very low. Therefore, as part of the Social Protection Program, we will index unemployment benefits fully to inflation. In addition, a system of severance payments will be paid to workers laid off as part of any large-scale lay-off scheme, such as when a firm will be closed or drastically down-sized under the enterprise restructuring program which the World Bank FESAL is supporting.

14. Active, demand driven, labor market programs will also be established to assist displaced workers in their reintegration into the labor market. Programs will be offered in the pre-layoff and post-layoff stage. In the pre-layoff stage, enterprises will receive the expert help of a specialized team to develop labor deployment plans, public information materials and a public information campaign, and to promote social dialogue. Plans would be developed in consultation with social partners, including affected workers, representatives from the community, labor, enterprise management, and the Government. For services in the post-layoff stage, local public and private agencies will be given contracts to deliver in-depth labor deployment services to displaced workers, such as employment and relocation services, retraining, public service employment, small business assistance and others. These will be demand driven programs, with a menu of choices offered to the workers, for them to choose what will be most helpful in their personal circumstances. Implementation of these measures will be directed through a labor deployment team located in the Ministry of Labor and Social Protection. We will use US $10.5 million of the ongoing World Bank Employment and Social Protection Project to assure financing of the active labor programs.

Fiscal Costs of Program

15. The implementation of the Social Protection program will require substantial fiscal resources. A total of 10.1% of GDP will be allocated in the budget for the individual programs which will make up the overall Social protection Program. This represents an increase of 2. 1% of GDP over what was spent in 1996 for these programs. The principal increases are 1.2% of GDP for family allowances and 0.4% of GDP for severance payment for unemployed workers.

16. To assist in the financing of a portion of these incremental expenditures, in the context of an overall fiscal expenditure program which is consistent with the stabilization goals, we request support through a US$50 million World Bank loan for Social Protection Programs. The reforms described above constitute an essential part of the ongoing stabilization and structural reform programs. But reforms require considerable efforts by the Government, especially in a period of severe fiscal contraction, when fiscal resources need to be reallocated away from other high ANNEXI Page 7 of 7 severe fiscal contraction, when fiscal resources need to be reallocated away from other high priority items. Receiving the financial support of the World Bank for this program will be essential in assuring the full implementation of the social protection measures.

Sincerely yours,

Victor Ciorbea cinjtter

Mircea Ciumara Minister of State Minister of Finance

Alexandru Athanasiu Minister of Labour and Social Protection I ANNEX2 Page 1 of 3

PROPOSED SOCIAL PROTECTION ADJUSTMENT LOAN Policy Matrix

Poltcv Area: Incoine TratisferProgramssfor l'ul,aerable Groups - (i) Child Alloiswnces;(ii,) Alinjinium Incomile Giuarantee Scihemne (MIG); wed(iii) Social Sciholarships.

Objectives MeasuresAdopted by Board Presentation Follow-up Measures

UJtilizeexisting income transfer programis to partially compensate the For child allowances: most vulnerable groups for the iiuimediate costs of the stabilization * htcrease of universal child allowance to Lei 50,000 . Implementation of monthly Incremental Family and adjustment program. per month paid to all childreni as of Febrtary I, Allowance of Lei 30,000 for families with two children, * Provide assistance to children from poor households to remain in 1997. of Lei 80,000 for families with three children, and of Lei school. * Presentation of an Ihplementation Plan for the 1 10,000 for families with four or more children as of July * Make stnictural adjustments in the Social Assistance System to hicremental Family Allowance Program. 1,1997. provide, in the future, for a more efficient income support system for * Government approval of Draft Law on the (i) population groups falling belox the povertv line. hitroduction of hicremental Family Allowances Program and the (ii) Exclusion of Incremental Family Allowances in the calculation of income to establish eligibility under the Minimum Income Guarantee Scheme.

lForAlminntuntr iconme Guarantee Schenie (AIIG): * Full indexation to inflation of benefit levels under a Completion of the evaluation of the NUG program and the MIG program the preparation of the NIG refonn program, including an * Increase of budgetary allocations to tlle MIG adequate finaniciiig meclanism. moiuIItiiigto 0 29 percent of GDP tinder- 1997 local * Until restructured, continued full inidexationiof M G budgets estimations. benetit levels. * Preparation of Tncms of Referenices for the * Presentation of the monitoring reports prepared by evalmution of tle MIIGprograin and appointment of Prefects on tise oftUG tunds by December 31, 1997. the evaluation teani through Ministerial Decision . An evaluationi and subsequent reform of the entire raiige * Parliamentary approval of the 1997 Budget Lax% of social assistance benefits, (both cash and mikind), in which specifies that Central Govenunlent wage tax conjtunictioniwith the refonm of the vI4Gprogram, that rcallocations to Local Govenmncits wvouldbe used would provide aimefiTcienit and well targeted social giving priority to social assistance expenditures assistance sYstem. * PllrimeMinister's communicationi to Prefects of Judets on the use of Central Govenmment "vage tax reallocations, for the MIG program.

For SocialSelmolarslipys. * Full iiidexation to intlationi of social scholarships . Continuation of ftill iiidexatioii of benefits under Social provided through the school s\stem as a Scholarships. complement to the MinimLm Income Guarantee Scheme ANNEX 2 Page 2 of 3

Policy lrea: Direct TransferPrograins (Ii-Kin or l-'nl,erableGro oroSocial Caifeetis anld Souip Kitcheis: * Preparation of the Draft Law oD social canteens. * Governuent approval of a Draft Law on social canteens . Assure access to foodfbr vulnerablepopulationi groups not reachied * Preparationof the Tenns of Referencesfor the by June 1, 1997,and subsequentParliament approval througilMinimumil Incomlie Support Schlieme and other cash transfer designof a Soup KitchenProgram in major cities. includinglegal provisionsfor the Soup KitchenProgram. programs. * Increasedbudgetary allocation amounting to 0. 17 * Designof the Soup KitchenProgram for five major cities i percent of GDP for social feeding programsin 1997 in Romaniain collaborationwith NGOs. I . local budgets projections. * Implementationof the expandedsocial feeding prograns in canteens and through soup kitchens.

For InstituatouualizedCare: * Improveeffectiveness of social programsbv establishingaltemnative, * Full indexation to inflationof foodprices, of the food * In 1998,establishment of Social ServicesDepartments in famiily-basedsocial programs to reduce institutionalization. budgets in institutionstaking care of vulierable all Judets, to assist vulnerablepopulation groups * Assure adeqtiatebudget availabilityin institutionstaking care of populationgroups (cihildren and families at risk, (children and families at risk, disabled,elderly, etc.) and childreni,the elderly,disabled and other populationgrotps dependent disabled, elderly,etc.) dturinglast wage adjustments. to prevent institutionalizationwhere possible. on institutionalizedcare. * Full indexationof foodprices for the food budgets for institutionializedcare units during future indexation adjustments.

CashiPavnments for B,eadSubsidies: . Provide temporaryincomile support to compensatelow incomiiegroups * Adoptionof measureson temporarycash paynenits for increases in bread prices causedby climiniationof bread subsidv. (April to September 1997) to targeted population groups to compensatefor the increase in bread price caused by die eliminationof previous price controls and subsidieson bread.

ElecmrcirvLife LinieRafes. * Reduce impactof electric rate increaseson the incomeof poor * Establishmnentof life line rates for electricity: for the lousehiolds. first 50 kwhiper monthper houselholdand for the second 50 kwh.

Peow9 4Area: Pension Progranis- (i) Agricailtiral Pensionsand (ii) State Pensions.

. Contain povertz amonglpensioniers living on low agricultiural * Full indexation of agrictiutiralpensions to inflationi * Contintiedfull indexationto inflationofagricultural pensionis. as of February 1, 1997. pensions. . Prepare systemicrefonis in PensioniProgramii to limit filture pensioni . Statement of reform intentionsfor the public pension * Presentationof new PensionLaw to Parliament by funddeticits. system(State PensionFund) includingtightening of September30, 1997.The law will tighten eligibilit\ eligibilitycriteria and improvingcontribution cnteria for state pensions and introducemeasures to compliancein order to maintainifinancial improve contributioncompliance, in order to maintain equilibriumof the State PensioniFuiid financialequilibrium ot the State Pension Fund. ANNEX 2 Page 3 of 3

Policy Area: Labor Market Mfeasures- (i) ticonte SupportPrograms and (ii) Active Labor AMarketMeasures.

* Provide support for displaced wvorkerswho become uneiimplovedin For SeverancePavnients and UnenwlpvonentBenefits: * Continued full indexation of unemploymentbenefits to industrial dowvn-sizingimplemented under the FESALprogram * Issuance of GovernmentOrdinance establishing the inflation. eligibilitycriteria and the amount of payment * hiplementation norms for severancepayments to be under the SeverancePavment Program,with the prepared bv end of Mav 1997. financingmechanism * Allocationof 0.44 percent of GDP for severance paymentsuiider 1997 budget law. * Full indexationof unemploymentbenefits to inflation. * Provide assistance to unemiiploveddisplaced workersin reintegratiog Active Labor.MarketAeasures: * Implementationof the agreed active labor market into the labor market. . Establishmentof a Rapid LaborRedeplovment Team program. at the Ministryof Labor and Social Protection tlrough Ministerial Decision * Receiptof a letter from the Ministerof Finaiice addressedto the World Bank requestingan allocation of US$ 10.5million from the Employmentand Social ProtectionLoaii to a ne\Ndisbursement categor\ to providefinancin,g for acttve labor market measuLres.

Policy Area: Povert' Strateg'

* Define operationalstrategies a)r selected povertvgroups serlouslr * Presentationot' the teniis of rcferenice(o the World * Preparationof a Povertv Strategy on hon to address affected b! povertNand define a comprehensivelong-tenn strateg\ Bank on a workshop series under the guidanceot'thie povertyof'chiildreni and the unemploved tor addressingstruictural povert. not likely to be alleviated throuigh Presidencvon ti) thc povertmof chlildren,and (ii) * Establishinentof a National Poverty Commissionat the econoillic gro\ll povertv of thc UneMPploNed. in order to prepare an Presidential or Prime Minister level to design a long- operationalstrategy on ho\Nto address povertvin tenrnpovert\ alleviation strategy. these two high priority areas ANNEX 3 Page I of I

ROMANIA PROPOSED SOCIAL PROTECTION ADJUSTMENT LOAN

TIMETABLE FOR KEY PROCESSING STEPS

(1) Time Taken to Prepare: 30 days

(2) Project Prepared by: Joint Goverment/World Bank/European Union Task Force which met in Bucharest/Romania from Januarv 12 to February 8. 1997.

(4) Operations Committee: April 7, 1997

(5) Appraisal: April 15, 1997

(6) Negotiations: May 1,1997

(7) Board Presentation: June 3, 1997

(8) Closing Date: December 31. 1997 ANNEX 4 Generated: May 7, 1997 Page I of 2

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

Difference Last ARPP Original Amount in US$ Millions Between Supervision Rating expected Loan or Fisca and actual Development Implemeittattois Project ID Credit I Borrower Purpose IBRD IDA Cancellations Undisbursed disbursementsM Objectives Progress No. Year

Number of Closed Loans/credits: 35

Active Loatis RO-PE-8772 L34860 1992 ROMANIA PRIVATE FARMER & ENT 100.00 0.00 0.00 1.82 -2 18 S S RO-PE-8759 L34090 1992 ROMANIA HIEALTH SERVICES REHA 15000 000 000 5600 56.00 S S RO-PE-8771 L35930 1993 ROMANIA TRANSPORT 120.00 0.00 0.00 10.18 -14.82 HS HS RO-PE-8774 L37350 1994 ROMANIA INDUSTRIAL DEV. 175.00 0.00 0.00 140.87 107 37 U U RO-PE-8784 L37240 1994 ROMANIA EDUCATION 50.00 0.00 0.00 46.95 3 15 S S RO-PE-8777 L37230 1994 ROMANIA PETROLEUM SECTOR REH 175.60 0.00 000 150.77 101 17 S U RO-PE-8776 L38490 1995 ROMANIA EMPLOY. & SOC. PROTECT. 55.40 0.00 0 00 54.73 22 63 S S RO-PE-36013 L39760 1996 SNCFR RAILWAY 120.00 000 0.00 120.00 1500 S S RO-PE-8773 L39752 1996 ROMANIA FESAL 20.00 0.00 0.00 17.67 0.00 s s RO-PE-8773 L39751 1996 ROMANIA FESAL 90.00 0.00 0.00 80 46 0.00 S S RO-PE-8773 L39750 1996 ROMANLA FESAL 17000 000 0.00 70.00 9.26 S S RO-PE-8794 L39360 1996 RENEL POWER SECTOR REHAB. 110.00 000 0.00 108.26 49.26 ll U RO-PE-8793 L40960 1997 ROMANIA HIGHER EDUCATION 50.00 0.00 0.00 50.00 7 20 S S RO-PE-8778 L40790 1997 ROMANIA BUCHAREST WATER SUPP 2500 000 0.00 24.97 1 97 S S

Total 1,4110 0.00 0.00 932.68 35601 0

Active Loans Closed Loans Total Total DisbILrsed (tBRD and IDA): 466.45 2.761.39 3,227.84 of which has been repaid: 0.00 2,191.00 2,191.00 Total now held by IBRD and IDA: 1,411.00 571 22 1,982.22 Amount sold: 0.00 19.78 19.78 Of which repaid: 000 19.78 19.78 Total Undisbursed: 932.68 .83 933.51

a listetided disbursements to date minus actual disbursements to date as projected at appraisal b. Rating of 1-4: see OD 13.05. Annex D2. Preparation of Implementation SummaTy (Fonn 590). Following the FY94 Annual Review of Portfolio performance (ARPP). a letter based system will be used (HS = highly Satisfactory, S = satisfactory, U = unsatisfactory, HU = highly unsatisfactory) see proposed Improvements in Project and Portfolio Performance Ratitig Methodology (SecM94-901), August 23, 1994.

Note: Disbursement data is updated at the end of the first week of the sonth

Generated by the Operations Information System (OIS) ANNEX4 Page 2 of 2 Romania STATEMENTOF IFC's Committed and Disbursed Portfolio As of 31 March 1997 In Millions US Dollars

Committed Disbursed ------IFC------IFC------FY Company Loan Equity Quasi Partic Loan Equity Quasi Partic Approval 1992 Alcatel 0.00 0.00 .69 0.00 0.00 0.00 .69 0.00

1994 Romlease 5.00 .45 0.00 0.00 3.00 .45 0.00 0.00

1996 Danube Fund 0.00 2.00 0.00 0.00 0.00 .40 0.00 0.00

Pending Commitments 1997 * EFES BREWERY 12.00 5.00 0.00 8.00

Generatedby the Operations Information System(OIS) ANNEX 5 PNgc1 of 2 Romania at a glance

Europe& Lower- POVERTYand SOCIAL Centrol middle- Romanim Asia Income Developmentdlamond Populationmid-1995 (millions) 22.7 488 1.154 GNP per capia 1995(USS) 1,450 2.240 1,700 Life expectancy GNP1995 (billions USS) 32.9 1.093 1.961 Averageannual growth, 1990-95

Population(%) -0.2 0.4 14 GNP4 Labor1orce(%) 0.1 06 1 pGNP Moat recent estimate(latest year avilablesJnce 1989) per capita K Poverty headcountindex (% of population) 22 Urbanpopulation (X oftot*l popuLaton) 55 65 56 Lifeexpectancy at birth (years) 70 68 67 Infantmortality (per 1,000 lv births) 21 23 36 Child malnutrition(% of childrenunder 5) Accessto safewater (I of popuotion) 100 78 -Romania lliteracy(% ofpopulaton age 15+) . - Lower-middle-incomegroup Grosspnmary enrolWment (% of school-agepopulation) 93 97 104 Malo 94 97 105 Female 92 97 101

KEYECONOMIC RATIOS and LONG-TERMTRENDS

1978 19t5 1994 1995 Economic ratios'

GDP(billions USS) 21.9 47.1 30.1 35.5 Grossdomeste investmenUGDP 40.4 33.0 26.9 25.7 Opennessof economy Exportsof goodsand nont-fatorservices/GDP .. 22.9 24.9 27.6 Grossdomestc savingstGOP . 37.2 24.9 21.2 Grossnational aevings/GDP . .. 25.2 23.6 Currentaccount balance/GDP . 2.9 -1t7 -4.0 Savigs k Investment Interestpayments/GDP 11 0.0 1.1 0.4 0.5 Totaldebt/GDP .. 14.9 18.3 18.7 Totaldebtservie/exports1 0.0 18.7 8.5 12.0 Presentvalue of debt/GDP 1.6.8 Indebtedness Presentvalue of debt/exports . 69.0

197t-84 1985-95 1994 1995 1994-04 (averageannual growth) -Romania GDP 5.1 -4.1 3.9 6.9 3.4 - Lower-middle-incomegroup GNPpercapna 4.2 -4.0 4.1 6.1 4.7 Exportsof goods and nfs -1.9 19.0 11.8 5.4

STRUCTUREof the ECONOMY 1975 1985 1994 1995 (% of GOP) Agricuture 20.1 20.4 Industry 384 39.3 0 Manufacturing . i. . -vc 94 s Services - 416 403 20 .

Private consumption 58 9 61 a 66.5 General govemmentconsumption 3.9 133 12.3 -GOI -GOP Imponsof goodsand non-factorservices 18.7 26.9 32.1

1975484 1985-95 1994 1995 (avenrgeannual growth) Agncuture 2.4 31 4.8 Industry -6.5 5 2 9.4 20 Manufacturing . , -- Services -6 1 31 5779 92 9, 9. 95 Private consumption -0 7 5 2 17 0 .0 - Generalgovemment consumption . 5.4 0 9 -2 4 Grosadomestic investment -3.5 -2.0 1 5 Importsofgoodsandnon-factorservices . 1.1 116 141 -E.Poris iiponev Grossnational product 4.9 -4.1 4 0 5 9

Note: 1995data are preiimmeryestimates. Figures in italis arefor yearsother thanthose specified. Thediamonds shOwfour key indictors in the country(in bold) comparedwith rts income-groupaverage. If daiaare missing, the be incomplete. diamondwill

1/!995 indicatorscaleulated from BOP estimwtes. M MUATASERaOM XLssiS, ANNEX 5 Page 2 of 2

Romania

PRICES and GOVERNMENT FINANCE 1975 1985 1994 1995 Innation (1k) Domestic pnces

(% change) 3°0

Consumer pnres 137.0 32.0 2D0 Implicit GDP deflator 0.4 139.0 35.7 Government finance (% of GOP) 2-

Current revenue 48.9 31.9 32.0 .00 ;2 93 5- 9 Current budget balance 29.7 3.8 2.7 Overall surpius 12.1 -1.9 -2.6 -GDPdf -d CPI

TRADE 1975 1988 1994 1995 Export and import levels (mill. USS) (millions UJS5)

Total exports (fob) 10,174 68067 7.492 2 50 - Chemical products 0 487 707 itom Common metals 0 1,065 1.392 Manufactures 6.949 3.952 3.158 7 500 Total imports(cif) 8.402 8,550 8.750 Food . 160 392 535-

Fuel and energy 4.753 1,907 2.386 2 500 Capitalgoods 1.861 933 1.240 Export pnce index (1987=100) . 8 90 9- 92 93 9. 95 Import pnce index (1987=100)JExpos .lmpofl Terms oftrade (1987= 100)

BALANCE of PAYMENTS 1975 1985 1994 1995 (millions USS) Current account balance to GDP ratioI%) Exports of goods and non-factor services 5.812 10.920 7,097 8.943 'o Impons of goods and non-factor services 5.858 8.926 7.777 10.506 Resource balance -46 1.994 -680 -1.563 5 Net factor income -89 -613 -131 -234 Net current transfers 295 369 0

Current account balance 89 g 3 92 93 -.- 95 before official transfers -135 1.381 -516 -1.428 5 _ - _

Financing items(net) .. -1,698 968 1,362 Changes in net reserves 32 317 -452 66 -o Memo: Reserves including gold (mill USS) 904 1,447 2,085 1 579 Conversion rate (local/US$) - 171 1.655,1 2,033.3

EXTERNAL DEBT and RESOURCE FLOWS

1975 1985 1994 1995 (millions USS) Composition of total debt, 1994 (mill. US$) Total debt outstanding and disbursed 211 7,008 5,512 6,653 IBRD 19 1.633 695 844

IDA 0 0 0 0 ST SRO

Total debt service 1 2.064 619 1,082 IBRO 0 274 32 53 (I/ IDA 0 0 0 0 IiMF

Composrtion of net resource flows °04\ Official grants 0 0 93 100 Otricial crediors 31 -61 642 689 BM, OML Pnvate crediors O -645 92 64 823 5%1 Foreign direct investment 0 0 340 550 Portfolio equity 0 0 76 52 Worid Bank program Commitments 160 0 226 340 A -IBRD8- Bilateral Disbursements 19 49 263 129 B- IDA D -Other -lialenii F.Private Principai repayments 0 146 0 0 C -IMF G- Shon-temm Netflows 19 -97 263 129 Interest payments 0 127 32 53 Net transfers 19 -225 230 76

Intemational Economics Department

M VROMIDATAxSEWOM-G .iLS.3iVS? ANNEX 6 Page I of 4

PROPOSED SOCIAL PROTECTION ADJUSTMENT LOAN Tables and Graphs

TABLE 1: POVERTY INDICATORS Number of Poor (millions) Poverty Gap %

Total 4.88 25.56 Rural 3.04 25.72 Urban 1.84 25.34

Occupation (Household Head) Salaried 1.88 22.66 Self-Employed (non-Agr.) 0.17 27.22 Self-Employed (Agr.) 0.70 30.86 Unemployed 0.56 32.62 Pensioner 1.41 23.22

TABLE 2: INCOME EFFECT OF CHILD ALLOWANCES IN HOUSEHOLDS

Monthly Wage Mothly Child % Child % Deviation Number of Wage Assumption Allowances Monthly Total Allowances in Total from Poverty Earners Children 1997 1997 Income 1997 Household Income Line (+/-) Average Wage I Wage Earner 0 668232 0 668232 0 357 1 668232 56000 724232 7.7 65 3 668232 208000 876232 23.7 20

2 Wage Earners 0 1336464 0 1336464 0 357 1 1336464 56000 1392464 4 218 3 1336464 208000 1544464 13.5 111 Low Wage I Wage Earner 0 218457 0 218457 0 50 1 218457 56000 274457 20.4 -37 3 218457 208000 426457 48.8 -42

2 Wage Earners 0 436914 0 436914 0 50 1 436914 56000 492914 11.4 12 3 436914 208000 644914 32.3 -12 1) Average wage (net) 1996 (fourth quarter) = 426,625 lei/month Projected average wage (net) 1997 = 668.232 lei/month Low wage (net) 1996 (fourth quarter) = 139,500 lei/month Projected low wage (net) 1997 = 218,457 lei/month 2) Poverty line for: I person household 1997 = 146,155 lei/month 2 person household 1997 = 292,310 lei/month 3 person household 1997 = 438,465 lei/month 5 person household 1997 = 730,775 lei/month ANNEX6 Page2 of 4

FIGURE 1: SOCIAL EXPENDITURES, 1990-1994

35%-

30%

25% 131990 3199i F 20% 01992 01993 U 1994 15%

10%

0% Albania Bulgaria Croatia Czech FYRM Hungary Po,land Romania Slovakia Slovenia

FIGURE 2: POVERTY AND OCCUPATION OF HOUSEHOLD HEAD, 1994

50 45 40 35 30 ~25

o20

10 U5

Unemploed SelfEmp, (Agr.) SelffEmp. (non-Agr.) Pensioners Salaried ANNEX6 Page 3 of 4

FIGURE 3: PERCENTAGE OF PENSIONERS IN POVERTY BY PENSION TYPE, 1994

30 -- - - ~ -

20 -

o O~~~~~~~~~~~~~~~~~~~~~0Urban

4.~15 06 a ~~~~~~~~~~~~~~~~~~~Rural I10

0 Industrial Disability Widows Agricultural

FIGURE 4: PENSION REPLACEMENT RATES (NET WAGES), 1993

90% _ __ ...... -______----- ______. __ ...... ______---- ______--__ ___*

80% .|ii......

70%

60% 50% i . l---- - ..

30%

10%

Macedonia Poland Croatia Hungary Slovak Czech Albania Bulgaria Ronmania ANNEX6 Page 4 of 4

FIGURE 5: DAILY CALORIC INTAKE (AVERAGE PER CAPITA), 1994

4000 - --

3500

Y 3000

= 2500 i--F National fl -0+-Urban 2000 -000 Rural

1000 2 3 4 5 6 7 8 9 10 Decile MAP SECTION I IBRD28758

220 , *4 28° K ANE ROMANIA

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MAY 1997

IMAGING

ReportNo.: P 7114 RO Type~ PR