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Report No: AUS0001925 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized

Tracks from the Past, Connectivity for the Future: Revitalizing Moldova’s Railway Sector

October 2020 Public Disclosure Authorized

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ACKNOWLEDGMENTS

This report was prepared by a World Bank team led by Elena Lungu (Transport Specialist, Task Team Leader), Fiona Collin (Lead Transport Specialist, Task Team Leader), Victor Aragones (Senior Transport Economist), Vasile Nicolae Olievschi (Consultant, Lead Railways Specialist), and John Arnold (Consultant). Jamie Lee Brown (Transport Specialist), Iuliana Stratan and Graciela Tejeda (Program Assistants) supported the team throughout the study.

The team would like to acknowledge the contribution of Gregoire F. Gauthier (Senior Transport Specialist), Sevara Melibaeva (Senior Transport Economist), Dominic Patella (Senior Transport Specialist), Svetlana Vukanovic (Senior Transport Specialist) and Ramon Munoz-Raskin (Senior Transport Specialist).

The team is grateful for the guidance provided by Karla Gonzalez Carvajal (Practice Manager for Europe), Anna Akhalkatsi (Country Manager), Baher El-Hifnawi (Program Leader) and Carolina Odobescu (Senior Country Officer).

The World Bank team would like to formally thank the Ministry of Economy and Infrastructure of Moldova and Moldovan Railway Company (CFM) for fruitful discussions, consultations, ideas, information and data.

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Table of Contents Table of Contents ...... i Note on COVID-19 ...... iii Document Structure ...... v EXECUTIVE SUMMARY ...... 1 WHY DOES MOLDOVA NEED RAILWAYS? ...... 7 GENERAL ASSESSMENT OF RAILWAY SECTOR ON TRANSPORT MARKET ...... 8 ORGANIZATION AND ASSETS OF RAILWAY ...... 8 DEMAND FOR FREIGHT TRANSPORT SERVICES AND THE MODAL CHOICE ...... 10 SUPPLY CHAIN PROBLEMS ...... 13 TRAFFIC OPERATED BY THE CFM ...... 15 LIMITATIONS IN THE OPERATING PLAN OF CFM ...... 18 BENCHMARKING TO MEASURE THE PERFORMANCE OF THE RAIL SECTOR ...... 21 CHALLENGES FACED BY THE RAILWAY SECTOR...... 22 DECLINE OF THE RAILWAY TRANSPORT MARKET ...... 22 CHRONIC UNDERINVESTMENT IN THE RAILWAY ASSETS ...... 26 AGING OF CFM’S LABOR FORCE ...... 30 DOWNGRADING OPERATIONAL PERFORMANCE OF CFM ...... 31 CFM'S FINANCIAL PERFORMANCE ...... 36 GENERAL RAILWAY SECTOR REFORM CONCEPTS ...... 43 GENERAL RAILWAY SECTOR RESTRUCTURING PRINCIPLES IN MOLDOVA ...... 43 ENHANCEMENT OF RAIL SECTOR COMPETITIVENESS IN MOLDOVA ...... 48 GOVERNMENT ROLES IN ENHANCING RAIL SECTOR PERFORMANCE ...... 51 GOVERNMENT AS POLICYMAKER ...... 52 GOVERNMENT AS BUYER OF SERVICES ...... 53 GOVERNMENT AS OWNER ...... 54 GOVERNMENT INSTITUTIONAL CAPACITY STRENGTHENING ...... 54 ORGANIZATION FORMS TO SUPPORT RESTRUCTURED RAILWAYS ...... 55 PROPOSED ACTIONS FOR RAILWAY SYSTEM RESTRUCTURING IN MOLDOVA ...... 57 ORGANIZATIONAL FORMS FOR SUPPORTING RAILWAY RESTRUCTURING PROCESS ...... 57 HOW TO ACHIEVE RAILWAY INSTITUTIONAL UNBUNDLING IN MOLDOVA?...... 60 WHEN TO OPEN ACCESS TO RAILWAY INFRASTRUCTURE IN MOLDOVA? ...... 61 IS SEPARATE TRACTION COMPANY USEFUL IN MOLDOVAN CONTEXT? ...... 63 RAILWAY REFORM IMPLEMENTATION ...... 64 Annex 1: Comprehensive Action Plan for Railway Reform Implementation in Moldova...... 71 Annex 2: Time Sequence of Execution of Main Tasks for Railway Reform Implementation in Moldova 78 Annex 3: Recommendations on Existing Railway Reform Documents in Moldova ...... 81 Annex 4: Regional railway network map, Central and Eastern Europe ...... 85

Abbreviations and Acronyms

ABC Activity-based costing system CFM Railway Company of Moldova DAP Delivered at Place (Incoterms) DMU Diesel multiple unit – multiple-unit train powered by on-board diesel engines EBRD European Bank for Reconstruction and Development EC European Commission EIB European Investment Bank EU European Union EU NIF European Union Neighborhood Investment Facility EUROSTAT European Commission Directorate-General that provides statistics to the European Union institutions ICT Information and communications technology INCOTERMS International Commercial Terms or shipping trade rules GDP Gross domestic product HR Human resources IFRS International Financial Reporting Standards are accounting standards issued to provide a common global language for business affairs so that company accounts are understandable and comparable across international boundaries Kph Kilometers per hour KPI Key performance indicator MACRI Multi-Annual Contract for Railway Infrastructure Quality MoF Ministry of Finance MEI Ministry of Economy and Infrastructure (absorbed MoT in 2017) MoT Ministry of Transport (absorbed by MEI in 2017) OECD Organization for Economic Co-operation and Development Pass-km or pkm Unit equivalent to the movement of one passenger by one kilometer PSC Public Service Contract Route-km Kilometers of commercially operated railway route in network R50 Rail track with load capacity of 51.7 kg per meter R65 Rail track with load capacity of 64.7 kg per meter SoE State-owned enterprise SYSTRA International engineering and consulting group in the mobility sector, whose fields of activity include, but are not limited to, rail and public transport TAC Track access charge TEU Twenty-foot equivalent unit, standard unit for containers Ton-km or tkm Unit equivalent to the movement of one ton of freight by one kilometer Ton Metric ton of 1,000 kilograms Track-km Kilometers of railway track in the network TU Traffic unit (pkm plus tkm) UIC International Railways Union UZ Ukrainian Railways (Ukrzaliznytsia)

Note on COVID-191

The conclusions and recommendations formulated as a result of this assignment do not address any of the potential COVID-19 crisis impacts, since it had already been conducted and finalized before the outbreak of COVID-19 in Moldova.

In the couple of months running up to May 2020, governments the world over have adopted containment measures to fight the spread of the pandemic, affecting almost all economic and social activities. This period has been particularly challenging for railway transport companies since they have not been able to completely suspend their activities and instead have had to support governments’ efforts to mitigate the crisis impacts by providing essential transport and freight services to the society.

Major COVID-19 crisis impact on railway industry The COVID-19 outbreak has had a major disruptive impact on domestic and international transport and on mobility. The entire transport sector has faced a huge drop in the mobility demand due to many transport customers having been forced to temporarily suspend their activities and international borders having been closed.

A preliminary analysis of the freight volumes shows that the Railway Company of Moldova (CFM) lost about 29 percent of its business in March 2020 compared to March 2019, with the trend likely having worsened in April and May 2020, as the social distancing and lockdown requirements remain in place. 2019 2020 Ratio 2020 / 2019 Variation 2020 / 2019 Traffic type Tons Tons % % Export 103,947 97,196 94% -6% Import 144,372 124,533 86% -14% Transit 163,561 50,999 31% -69% Local 51,102 54,393 106% +6% TOTAL 462,982 327,121 71% -29%

The most worrying aspect is CFM losing about 69 percent of its most profitable business, the transit traffic. The traffic loss is a real threat to CFM’s financial sustainability, which was already fragile before the crisis.

The coronavirus outbreak has not only halted regular operations, but it may also have a severe effect on the ongoing rail investments. The difficult financial and operational situation faced by contractors is translated into delays in construction works and delivery of railway equipment or rolling stock and sometimes even into a complete stoppage of construction works.

1 This section was added after the main analysis had been finalized in March 2020

iii

Railway industry must adapt its activities during the crisis

As the COVID-19 situation continues to evolve worldwide, the railroads must remain focused on working to deliver the necessary freight and passenger transport services, while safeguarding the health and safety of the rail workforce and their customers.

In many countries, the railway community has cut the frequency of their services in parallel with mitigating the risks of spreading the virus. They have closed the passenger lounges at stations, suspended on-board catering, and are trying to maintain a three-meter distance between passengers inside trains (e.g. in Spain, the national railway operator (Renfe) restricted the capacity of each coach to 30 percent to ensure a safe distance between passengers).

Railway companies have implemented workplace social distancing, made sanitizers and wipes broadly available to their employees, introduced pre-shift screening of workers, expanded the frequency of cleaning and sanitation of trains and stations, maintenance facilities, railway offices, dispatching centers, and locomotives. The meetings and briefings are conducted via phone or radio, access to mission-critical locations like operations and dispatching centers is restricted to only essential staff who must be present to perform their duties. Telework is promoted where possible for staff not directly involved in train operations.

The International Union of Railways (UIC) has formed a task force to assist railways in dealing with the rapidly escalating situation and has published a Guidance on the Management of COVID-19 for Railway Stakeholders.2

Governments support is critical for the railway industry to survive If the crisis continues, the revenue losses could become unsustainable for many companies, prompting aggressive cost-reduction measures that include service and staff cuts.

In this context, the governments are expected to undertake adequate measures to mitigate the financial losses of the railway companies and provide protection to the staff affected by the crisis. The European Commission recently adopted the State Aid Temporary Framework, creating the framework for the member states to take initiatives and ensure fair and adequate support for railways vis‐à‐vis other transport modes.

CFM may need guaranteed short-term liquidity to ensure that its businesses stay afloat and its workforce is safe during the pandemic. Unfortunately, the Moldovan legal framework still does not allow the use of Public Service Contracts (PSC) and Multi-Annual Contracts (MSC) for Infrastructure (used in EU countries and recommended for CFM in this document), which would establish mechanisms for sustaining the railway transport. If necessary, the Government may assess various solutions, including aid in the form of direct grants or tax deductions to mitigate the bankruptcy risk of CFM.

2 Please see: https://uic.org/IMG/pdf/uic-management-of-covid-19-guidance-for-railway-stakeholders.pdf

COVID-19 crisis requires acceleration of railway industry restructuring in Moldova The crisis will produce massive changes, impacting social and economic activities in Moldova. The railway transport sector will need to be reshaped to respond with greater flexibility to the risks associated with pandemic outbreaks. The pandemic has only further exposed the already existing weaknesses of the railway system in Moldova and therefore the issues identified in this document remain valid, with many of them becoming even more critical in the wake of the pandemic crisis. The conclusions of this document highlight the need for the Government to lead the successful railway sector reform implementation, with the pandemic’s impacts making the case for the even greater urgency of the railway sector reform. The survival and recovery of the railway transport sector will require a much stronger political commitment to address the recommendations outlined in this Policy Note.

Railways can strengthen transport sector resilience in Moldova As experience in other parts of the world has shown, railways can be well-positioned to maintain freight operations and carry out cross-border operations under more stringent health requirements. This is because railways can use a designated employee pool to carry out cross-border operations and ensure health and safety standards. Additionally, more freight can be moved by fewer employees when compared to the trucking sector. Enabling the railway by establishing the proper contingency plans that identify the infrastructure and equipment required to operate under such conditions is key for the railways to support the supply chain and prevent the core economic activities from collapsing due to poor transport services. Document Structure

This document provides an assessment of the major challenges faced by railway transport in Moldova, formulating a strategy proposal for a profound sector restructuring. The report looks in detail at the following aspects: a) Industry structure. This chapter provides an overview of the railway sector infrastructure and network specifications. b) Challenges. This chapter includes a detailed assessment of the main challenges faced by the railway sector in Moldova, for both freight and passenger services. c) General railway sector reform concepts. This chapter outlines and advises on a common set of required actions to be implemented by any country undertaking a railway reform. d) Organization forms to support restructured railways. This chapter describes the possible existent forms of organization of railways in the world, with a special attention to EU requirements. e) Proposed actions for restructuring the railway system in Moldova. This chapter assesses different possible organizational options for Moldova railways, also advising on how to achieve the railway institutional unbundling, as well prepare for market opening. f) Railway reform implementation. This last chapter includes specific recommendations for the reform implementation set-up in Moldova.

EXECUTIVE SUMMARY

1. The development opportunities in the current global economy are related to the mobility of people and goods. A robust growth cannot happen without a strong transportation system. Railways, known for their affordability, high safety, and environmental friendliness, are an important component of the transportation system. Efficient railways reduce costs in many sectors and provide enhanced economic and social opportunities and benefits, while poorly performing railways jeopardize the economic and social development.

2. Following a 5.2% increase in the first semester of 2019, Moldova’s growth by the end of the year was estimated at 3.5%, fueled by public spending and household consumption and counterbalanced by a weak export performance. Moldova's economy is expected to shrink by 0.1% in 2020 due to the COVID-19 outbreak, but gross domestic product (GDP) growth should bounce back to 3.8% in 2021. The transport sector accounts for almost 5% of GDP and may record a sharp deceleration of activity with the current disruption of trade, economic lockdown, and limited public transportation, particularly in the second quarter of 2020. Amidst the lockdown, the transport and logistics sectors continue to play a critical role in the delivery of essential products. Moving forward, the rail sector will be vital in boosting and mobilizing investments and supporting the recovery of the economy.

3. The railway transport in Moldova lost important volumes of transport during the last two decades. Consequently, the rail freight market share decreased from 63.8 percent in 2007 to 20.8 percent in 2018 and the passenger rail market share decreased from 13 percent in 2007 to only 1.59 percent in 2018. The market lost by rail is currently operated mainly by the road transport.

4. The loss of volumes transported by rail was mainly driven by four factors. The first factor has been the changing geopolitics beginning with dissolution of the Soviet Union, that triggered an economic collapse; with both freight and passenger market turnover dropping by over 50 percent. The second major factor has been fluctuations in the growth of the regional economy, most notably the global financial crisis in 2008, followed by a reduction in average rates of economic growth. The third one has been the fluctuation in the production and export of grain and vegetable oil which are traditionally rail market products. The last factor has been the CFM’s failure to properly maintain and renew its physical assets due to long-lasting neglection of investments in railway infrastructure compared with the road sector.

5. The weakness of the rail sector in Moldova puts in danger the economic development of the country, as it reduces the competitiveness of many participants in the economic flow: a) Exporters, who need to be reliable suppliers offering a satisfactory level of order fulfillment, b) Importers, who need to limit their inventories without compromising the ability to fulfill orders,

c) Producers/processors, who maintain a lean operation by synchronizing the arrival of inputs with their processing schedule while still being responsive to individual orders from their clients, and d) Shippers of transit cargo, who have to coordinate transport services in multiple countries.

6. The railway in Moldova is still an important component of the transportation system of the country (the freight market share of 21 percent is higher than the average market share of 17 percent achieved by the EU-28) and can play a vital role in developing green transportation system and providing safe and affordable transport services inthe country3. Considering the EU ratio of GHG emission by modes of transport (railways generates only 0.6% of the total GHG emissions produced by the transportation system while the road transport produces 71,7%), a developed railway system will significantly help Moldova to accomplish its aims on GHG reduction.

7. Railway can also provide a much safer system of transport for the benefit of the entire society. In 2018, 366 persons were killed on road transport, while the rail transport recorded 7 fatalities only.

8. The following aspects are key to support the improvement of the currently unsatisfactory performance of the railway sector in Moldova, as identified by this Policy Note:

a) Develop and support a strategy for railway sector revival. Long-lasting neglection of investments in railway infrastructure compared with the road sector contributed to the gradual decrease of the quality of services of transport by rail and to the ultimate market loss During 2007 – 2016, the Government of Moldova spent for the rehabilitation and development of the road network in Moldova more than 1 billion Euro (about 600 million Euro IFIs funded projects and more than 400 million Euro funded from the Road Fund), while for the railway infrastructure the funds allocated are less than 150 million Euro. The revival of the railway sector will not be possible without a clear strategy for large investments in infrastructure and rolling stock.

b) Stop the decline in passenger and freight market-share. The volumes of transport operated by the railway sector have been on a constant decline since 2007, while the road transport volumes have seen a constant increase over the same period. The volume of freight transported by road in 2019 was 118.1 percent higher compared to 2007, while the freight volume transported by rail in 2019 represented only 32.5 percent of the volumes achieved in 2007. Similarly, for passenger transport, in 2019 CFM operated only 20.7 percent of the passengers transported in 2007.

c) Improve the quality of the infrastructure and rolling stock. The main railway infrastructure components are very old and completely depreciated. About 45 percent of CFM’s railway

3 In 2014, Moldova adopted the Environmental Strategy for 2014-2023, which sets a GHG reduction target of 20 percent by 2020 compared to 1990 levels to be achieved through energy efficiency

track and signaling systems were installed over 30-40 years ago. The average technical speed on the railway network is currently 34.5 km/h. The chronic under-investment in the rolling stock has resulted in an obsolete fleet of locomotives, coaches, and wagons. All of CFM’s locomotives and more than 60 percent of freight wagons have outlived their economic lifespan. Consequently, huge transport capacity is lost due to the assets’ inadequate technical status, with customers preferring road transport because of its better-quality services.

d) Increase staff motivation. A shake up of existing railway staff and bringing in new management and marketing skills more appropriate to commercial operation is key. . CFM is an aging company and a large number of staff will reach the retirement age over the next 5-10 years, while young professionals do not seem attracted to join the industry. This will exacerbate the problem as currently more than 10 percent of the staff (769 employees) are older than 65 and could retire immediately. About 52.3 percent of the employees of CFM are over 51, and 77.4 percent are over 41. Only 6.4 percent of the staff are under 30 years of age. It is a serious challenge for CFM to attract new, young staff, capable of sustaining the difficult company restructuring process and changing the current declining business trend. Creating rail-attractive working conditions while correctly balancing staff age distribution is a prerequisite for enhancing the Co’s operational performance.

e) Improve operational performance. CFM’s performance indicators related to the asset and staff productivity show that it is placed far below the average operational performance in the EU countries.4 The productivity of locomotives deployed by CFM (in 2018) represents only 60 percent of the productivity recorded in the EU-28; similarly, the productivity of wagons or coaches is only 30 percent compared with the EU-28. Despite the painful staff reduction actions, CFM’s current labor productivity represents only 18.4 percent of the EU-28 average productivity, meaning that CFM uses far more locomotives, wagons, coaches and staff per unit of production compared with the EU railways. This has serious negative cost impacts, limiting the chances of CFM to compete successfully in the open international market.

f) Enhance financial sustainability. Since 2012, CFM’s average cost per unit of operation has been constantly higher than the average revenue per unit. Its current transport operations do not generate sufficient revenues to cover the operating costs; therefore, the company keeps accumulating financial losses on an annual basis. This Policy Note analyzes in detail the financial performance for CFM’s each major business unit (freight, passengers, infrastructure).

9. The multiple challenges faced by the railway sector in Moldova jeopardize the future of the Railway Company of Moldova (CFM), but also have a direct negative impact on the country’s economic development. Currently, CFM is not competitive compared to the road

4 The Policy Note includes the charts comparing the CFM’s productivity with the average values achieved by the EU-28, and with the values achieved by six selected railways that are more or less similar to the railway in Moldova (Croatia, Slovenia, Portugal, Ireland, Lithuania, Latvia)

transport in the market. Also, in its current form, CFM cannot compete with other European railways. The present situation in the railway sector in Moldova will not be solved with a “do nothing” scenario. There is a significant risk that the loss of market share will continue at an even greater pace over the coming years if the Government and CFM fail to take strong actions needed to profoundly reform the entire system.

10. The discussions on the reform of the railway sector in Moldova have been excessively focused on the organizational aspects and less on the real substance of the reform. The government of Moldova signed in 2014 an Association Agreement with the European Union which includes the legal and institutional reforms agreed by the two parties in all domains of activity. It is highly recommended to follow the provisions of the Association Agreement for the railway sector, which clarify the organizational option, by enumerating the specific provisions of selected directives and other documents of the European Union to be implemented in Moldova. It is important to notice that the Association Agreement does not include the obligation of Moldova to introduce the open access for international railway operators or the obligation of unbundling the CFM in three independent companies.

11. This Policy Note presents a summary table with all institutional unbundling solutions adopted by the EU-28 member states and recommends the following decision-making process to guide the unbundling of the railway industry in Moldova:

a) The first recommended step is the financial unbundling, which will be implemented in parallel with the profound reform addressing the operational and financial performance of the CFM and accompanied with important investments in infrastructure and rolling stock. b) The second recommended step is the institutional unbundling of CFM, to be undertaken by putting in place subsidiaries of CFM for management of infrastructure and for the provision of freight and passenger transport services. c) The third step could be the opening of access for more operators on the railway infrastructure of Moldova.

12. The implementation of the first step will reconfirm Moldova’s political commitment to the EU integration and will mark the fulfilment of the provisions of the Association Agreement with the EU for the railway sector. The continuation of the reform with the steps two and three must be carefully planned by the Government of Moldova and be implemented at an appropriate time in line with the progress of the political agreements for accession of the country to the European Union while also allowing CFM to compete in an open environment. While CFM can improve certain aspects of its operational efficiency, other constraints such as labor rightsizing and financial support for passenger transport and infrastructure are to be decided by the Government of Moldova. Irrespective of the time to open the market, these efficiency reforms need to be pursued.

13. The railway sector’s transformation into a nimble industry that is able to adapt to changing market conditions requires much more than unbundling or new organizational structure of the company. The railway reform has proved to be extremely difficult, especially in the new

EU member states, and therefore the implementation of the reform requires strong political consensus. Currently there is no one single “correct” answer for rail reform and not all reform processes in the world have been equally successful. Moldova must define its own solution that is tailored to its conditions.

14. In the process of revival of the railway sector political commitment is considered key for success, as the Government and Parliament of Moldova play a leading role to champion the framework and policies that are needed for CFM to develop and implement the reforms. This Policy Note describes in detail a set of issues that are to be clarified by the Government of Moldova to build a new business-oriented culture in the railway industry and create an enabling environment for the successful reform implementation:

a) Clarify the role of the State in its relationship with the new railway company(ies); b) Address historical debts of the railway sector; c) Adopt a commercial approach for all activities of the railway company(ies); d) Outsource non-core activities which are not financially viable; e) Establish tariff policy consistent with the commercial approach of railway activities; f) Implement reliable costing system in railway company(ies); g) Identify mechanisms for financing the public transport of passengers; h) Identify mechanisms for financing the railway infrastructure; i) Strengthen the corporate management of railways; j) Implement mechanisms to measure the performance of railway company(ies); k) Decide on the role of the private sector in the railway sector.

15. The Policy Note identifies three broad strategies to improve the competitiveness, as the paramount goal of the restructuring program: (i) the capital investments to improve quality of service while limiting long-run marginal costs, (ii) the modification of operating practice to increase efficiency and quality of services, and (iii) the introduction of a system of pricing based on competitiveness and quality of service.

16. A framework for building of a new business culture in the railway sector, for both the government and railway companies, needs to be accomplished through a two-pronged action:

a) Railway sector governance relates to the sector’s public policies made by the government, including allocation of public funds for public policy implementation.

b) Railway corporate governance relates to the operational and financial performance of CFM or future entities to be unbundled from CFM.

16. The railway reform is a very complex task and its successful implementation depends of the existence of adequate political and social environment. The following are key pre-requisites for the reform:

a) Need to secure a broad political support for the railway sector reform before starting the process; b) Ensure agreement in the Parliament for a minimum 5-7 years period of continuity in the policies for the implementation of the railway reform.

WHY DOES MOLDOVA NEED RAILWAYS?

17. The railway transport in Moldova plays an important role in the transport market of the country. Historically, railway transported very large volumes of freight and provided important services for passengers in Moldova. Railways lost important volumes of transport during the last two decades for various reasons, culminating with the crisis starting in 2007. The current Policy Note assesses in detail the causes of the decreased market share of railways and will propose solutions for the recovery.

18. Revival of the railway transport sector is vital for Moldova. Railways are a very important component of the transportation system in Moldova which may play a vital role in developing green transportation system and providing safe and affordable transport services. There are many reasons for achieving this purpose; according with the statistics of the European Union, railways are by far safer and more friendly to environment than other modes of transport:

a) Railway is a safe mode of transport: According with the EU statistics, in 2017, the rail transport recorded 977 fatalities compared with 25,257 persons killed in the road traffic. More important, only a fraction of the registered fatalities were railway passengers (15 railway passengers killed in the European Union in 2017). Most victims result of rail accidents are persons who enter without authorization in the train circulation area (62% of fatalities in 2017), and the level crossing users who ignore the signals of train arrival (30 % of fatalities in 2017).

b) Railway are friendly to environment: A report of the International Energy Agency published in 2020 highlights that rail provides about 8% of the world’s motorized passenger movements and 7% of freight transport yet uses just 2% of the world’s transport energy demand. In 2018 in the EU-28, railways generated only 0.6% of the total GHG Figure 1. GHG emmisions by mode of transport emissions produced by the transportation system, while the road transport produced 71,7% (Figure 1). Maritime Road 13.3% transport71. Railways, 19. Railway transport system is a climate-smart and a 7% 0.6%

safe way to move people Aviation Other and freight. Railways promote economic growth 13.9% modes, 0.5% while cutting greenhouse gas emissions. They are a clean and compact way to move millions of passengers and millions of tons of goods at affordable prices. A restructured railway transport system of Moldova will support the sustainable development of the country.

GENERAL ASSESSMENT OF RAILWAY SECTOR ON TRANSPORT MARKET

Organization and Assets of Railway

20. Railway transport services in Moldova are provided by Calea Ferată din Moldova (CFM), a single state-owned enterprise in charge of the railway infrastructure management and passenger and freight transport service provision. As at December 31, 2018, CFM had 7,475 employees and had transported 4.93 million tons of freight and 1.71 million passengers.

21. The Moldovan railway infrastructure description. The Moldovan railway system consists of 90 stations along 2,001 km of lines, out of which 1,150 km are operational (about 74 km of which are double track).5 There are no electrified railway lines in Moldova. For the large majority of lines, the railway gauge is 1,520 mm. This means that Moldovan rail network can interchange more efficiently with the former Soviet railways as they share the same gauge, but it differs from the main EU standard gauge network (1,435 mm). In terms of the signaling system, 422 km of the Moldovan network lines are equipped with an automatic block system, which has been in use over 35 years, while 589 km of the railway lines have a semi-automatic block system that uses unreliable open-air electrical wires. 80 stations and 1,660 track points (railway switches) are equipped with centralized control. Nine stations still use manual control of switches and signals, with the control system design dating back to the 1940s.

22. There are 226 level crossings on the network, out of which 37 are guarded, 181 are equipped

Table 1: Railway Network Specifications Between Length Capacity Average km trains/day trains/day Sakirjani Bălți 102 18 3-5 Rîbnița Bălți 123 16 0.5 Bălți Ungheni 87 22 3-5 Ungheni Ravaca 118 21 3-5 Ravaca Bender 49 41 0.5 Ravaca Căinari 46 15 5 Bender Căinari 95 32 1.5 Căinari Basarabeasca 67 12 2 Basarabeasca Abaclia 10 17 2 Abaclia Ceadîr-Lunga 35 17 2 Ceadîr-Lunga Bolgrad 47 17 2 Bolgrad Etulia 43 17 2 Abaclia Bugeac 33 6 1.5-2 Bugeac Cantemir 57 6 1.5-2 Cantemir Cahul 49 6 1.5-2 Cahul Giurgiuleşti 54 6 3 Data Source: CFM with automatic signals, 39 with traffic barriers, and 37 with protecting railway signals. The

5 Statistics extracted from the Republic of Moldova Government’s 2013-2022 Transport and Logistics Strategy or communicated by CFM

speed is limited in some places because of low curve radii (as severe as 150 m). Most of the network is designed for the trains with up to 57 wagons (14 meters in length) and loads of up to 23.5 gross tons/axle. The network operates on a station-based fixed-block system. The train capacity varies by section between 12-17 trains per day. The exceptions include: • higher-density corridors connecting to Ungheni and Bender that can handle 21-22 trains per day and 32-41 trains per day respectively (Table 1). • low-density corridor on the southwest line between Abaclia and Giurgiuleşti (via Cantemir) that can accommodate only six trains per day.

Figure 2: Moldovan Rail Network (including Transnistria)

23. The latter section from the previous paragraph (Abaclia-Giurgiulesti) is also limited in terms of gross train weight due to the track bed condition. The limit for Cahul-Barlad section is 1,000 gross tons, while that for Barlad-Bugeac section is 1,500 gross tons. The average demand for daily train movements at present does not exceed 20 percent of the nominal capacity for all sections, except for the low-density section.

24. The network includes ten cargo border crossings (see Table 2). Most of the rail freight crossing the border is iron ore moving from Ukraine to Romania. A unit train enters Moldova

via Tiraspol6 and then crosses back into Ukraine at Etulia and continues through Giurgiuleşti to the gauge change7 at Galaţi on the border with Romania. Metal products moving in the opposition direction are another large cross-border movement. Scrap iron imported from Romania is the principal cargo crossing the border at Ungheni, with cement and limestone as the principal cargoes crossing at Kolbasna on the Ukrainian border. The other border crossings have relatively little rail traffic.

Table 2: Rail Border Crossing Traffic (000 tons) With Ukraine Etulia Fricatei 791.6 Valcinet Moghilev-Podolsk 222.5 Kobasna Tymkove 222.3 Tiraspol Kuchurhan 29.2 Ocniţa Sokireani 26.3 Criva Mamaliga 17.4 Larga Kelmenti With Romania Giurgiuleşti Galaţi 1,328.4 Ungheni Ungheni 337.7 Prut Falciu Data Source: CFM

25. CFM’s rolling stock. CFM currently owns 132 locomotives (only 44 of which are operational), 4,690 freight wagons (2,971 operational), 245 passenger coaches (129 operational), and 5 Diesel Multiple Units (DMUs) (4 operational).8 A low number of operational vehicles, resulting from the obsolete fleet that requires replacement, is illustrative of a very poor general technical status of the railway assets.

Demand for Freight Transport Services and the Modal Choice

26. The railway sector must be fully focused to enlarge the volumes of transported freight. The railway transport sector provides both passenger and freight transport services. The freight transport services are in principle the most profitable services for railways and the most relevant source of revenues. This is true also for Moldova where the CFM achieves about 80% of its operating revenues from the freight transport. Increasing the volume of transported freight is the highest priority for the CFM, but this is a very challenging goal, due to the fierce competition with the road transport.

27. Moldova’s foreign trade. Moldova’s major exports, as measured in value, are manufactured goods. Most of these are shipped by road. However, most of the agricultural products, which accounted for about one sixth of the total value of exports in 2018, are transported by rail.

6 Transnistria border crossings entail additional checks and tariffs 7 From 1,520 mm to 1,435 mm 8 The operational fleet data were communicated by CFM as at December 31, 2018

The principal destinations for Moldovan exports are Romania, Germany, Italy, and Russia. These countries accounted for 56 percent of the value of exports in 2018. Turkey, Poland, Belarus, and Ukraine accounted for an additional 14 percent.

28. Moldova’s exports of dry bulk commodities, as measured in volume, increased by one third over the last five years. Maize, limestone, gypsum, barley, and cement accounted for about two thirds of the 1.6 million tons shipped in 2018. The principal destinations were Italy, Ukraine, Belarus, Romania, and Switzerland. The volume of dry bulk imports has fluctuated over the last five years, increasing however to 1.3 million tons in 2018. Almost all of it was sourced from Romania, Russia, and Ukraine.

29. Moldova’s major imports are also manufactured goods delivered by road. The principal imports delivered by rail are fertilizer, and iron and steel. They accounted for only about 7.5 percent of the total value of imports in 2018. Most imports are sourced from Romania, Russia, China, Ukraine, and Germany.

30. Moldova also handles a large amount of transit cargo. It is primarily dry bulk cargo shipped between Ukraine and Romania. In 2018, about 1.9 million tons of dry bulk were shipped from Ukraine to Romania, including 1.4 million tons of iron ore and concentrates, and about 200 thousand tons of iron and steel. The exports from Romania to Ukraine were much smaller and consisted primarily of building materials.

Figure 3: Principal Commodities Shipped by Rail Figure 4: Other Commodities Shipped by Rail Rail Freight Ton-Km Rail Freight Ton-Km 1.8 2.5 1.6 2.0

1.4

n o

o 1.2 1.5

Other

Iron Ore n

n 1

i o

l Coal

l i

l 0.8 1.0 l

i Grain M Raw materials

M 0.6 POL, Veg oil 0.5 Ferrous metal 0.4 Fertilizer 0.2 Bldg Material 0.0 0 2013 2014 2015 2016 2017 2018 2013 2014 2015 2016 2017 2018 Data Source: CFM Data Source: CFM

31. Since nearly all of the rail cargoes in Moldova are low-to-medium value bulk commodities (such as building materials, fertilizer), the primary factor determining the choice of transport mode is the cost of movement from origin to destination. For most shipments, cargo is loaded at the production site or nearby railyard and delivered to a railyard close to the destination. If there is no rail access close to the source or destination, rail is at a significant disadvantage especially since the distances between origin and destination are relatively short.

Table 3: Major Shippers Type of Goods Shippers Volume % of All Goods Cement 2 301.1 6.9% Fertilizers 1 103.4 2.4% Grain 3 370.9 8.4% Gravel 4 513.2 11.7% Iron 1 560.7 12.8% Subtotal 11 1,849.1 42.1% Source: CFM

32. There is a significant competition between road and rail for domestic traffic. Road transport has several advantages, especially its dense local collection and distribution coverage. It is often less costly because the distances are relatively short, opportunities for backhaul cargo are greater, and the State often bears the costs of maintaining and operating the road networks without passing those costs to road users.9 Finally, some routes are significantly shorter by road than by rail, such as some of the major routes like the connections between Chisinau and both Rîbnița and Bender (see Table 4). This difference means that the railway has a price disadvantage because CFM’s rates are set based on distance.

Table 4: Distance by Road and Rail Road Rail Border Tiraspol 78 57 East Bălți 135 205 Chișinău Ungheni 168 118 West Giurgiuleşti 217 248 South Sokyriany 250 307 North Ungheni 86 87 West Bălți Sokyriany 111 102 North Giurgiuleşti 329 453+ South Ungheni Tiraspol 186 175 East Rîbnița Sokyriany 189 225 North Tiraspol 254 297+ East Giurgiuleşti Sokyriany 444 555+ North Source: CFM

33. Rail transport is more efficient in handling large shipments, especially bulk cargoes in excess of 1,000 tons. In this regard, most of CFM’s traffic involves relatively large shippers, eleven of whom accounted for over 42 percent of its freight in 2018 (Table 3).

34. The logistics are less favorable for shipments requiring intermodal movements. However, rail can compete over longer distances, especially when serving a large number of small- scale producers or medium-scale consumers. The latter applies to grain produced in the north of Moldova and to the distribution of building materials.

35. Rail usually has a competitive advantage for long-distance movements of imports from and exports to Romania and Ukraine, as well as for shipments in transit between the two,

9 Unless fuel costs associated with road asset management and operation are passed to road users through tolling, vignettes or other forms of road-user levies.

especially if there are direct rail connections to producers and logistics centers for aggregation and distribution. Both Romanian Railways (CFR) and Ukrainian Railways (UZ) provide good connections to major sources of their exports and destinations of their imports.

36. The System of pricing of services plays an important role in modal choice. CFM’s current system of tariffs are based on a structure dating from Soviet times. Charges for individual shipments are based on fixed rates per ton-kilometer adjusted for inflation. The tariffs are also based on assets provided rather than quality of service provided. This is reasonable given the difficulty in guaranteeing quality of service, however, it does not allow rationing of the limited assets based on willingness-to-pay. Because of difference in distances by road and rail, the rail tariffs on some routes exceed those for road transport. On other routes, the rail tariffs are set well below the shipper’s willingness-to-pay. Although discounts can be offered to encourage specific types of shipments, these are usually designed to address short-term concerns rather than long-term objectives.

Supply Chain Problems

37. Additional factors affecting the modal choice for freight transportation are the characteristics of the supply chains used to deliver these cargoes (Table 5). The most important characteristics are reliability and travel time. Reliability is measured in terms of order fulfillment (delivery on-time of type specified and, in the quantity, ordered). This is important for raw materials that are consumed in continuous production activities. Travel time is critical for shipments that require coordination of inter- and intra-modal connections. It is also important for reducing the delivery times for individual orders.

Table 5: Supply Chain Characteristics Sensitivity to1 Activity Shipment Commodity Delivery Order Origin Destination Size Period Frequency Storage Private Time Fulfill Wagons Iron Ore 3 1 Mining Production Unit Annual Regular Open X Train Scrap Iron 2 1 Collection Production Unit Annual Regular Open X & Steel Train Processing Grain 2 1 Collection Port Seasonal Orders Silo X Storage Metal 2 2 Fabrication Annual Orders Warehouse Products Mineral 3 3 Collection Set of Seasonal Scheduled Warehouse Fertilizer Wagons, Cement 2 2 Production Annual Scheduled Warehouse Distribution Gravel, Other Open, 3 3 Quarry Annual Orders Building Warehouse Material Petroleum 3 2 Production Annual Scheduled Tanks Source: WB Team’s Estimate 1 High=1, Low=4

38. Iron ore is transported via Moldovan railways from Eastern Ukraine to the Liberty Steel plant in Romania using private wagons in a unit train configuration. This is a regularly scheduled movement for which CFM provides a relatively reliable service. Although the blast furnace is operated in batches, production is continuous in order to achieve efficient use of available capacity. Since the production involves a mix of ores from different sources, order fulfillment is important. However, cost remains important as demonstrated by the diversion of some shipments to barge transport through the Ukrainian port of Ismail to the barge terminal in Galaţi.10

39. Exports of grain are shipped from the growing areas through Giurgiuleşti and the Ukrainian port of Reni to ports along the Mediterranean. Trucks are used in growing areas close to the port and for smaller shipments. Larger shippers use private wagons in large batches to increase reliability. Since the grain is exported in response to specific orders and loaded on designated chartered vessels, these shipments are sensitive to order fulfillment. They are less sensitive to delivery time since the grain must be consolidated into shiploads at the loading port. At present, shipments are limited in size by the type of vessels able to call at these ports. There is potential to export larger shipments to the Asian markets, but this would require shipping through a deep-water port. This would require more reliable rail connections to Odessa.

40. Cement is produced from domestic and imported inputs shipped to the factory in bulk form. The cement is then distributed in both bagged and bulk form. Due to the fact that this is a low-value product, modal choice for its transportation is based primarily on cost, but this may be less important for smaller shipments. At present, the value of cement and size of shipments are not sufficient to justify the use of private wagons. This may change in the future in which case reliability would become more important.

41. Limestone is exported to Ukraine for steel making. Modal transportation choice is based on cost, but since the production is a continuous process, reliability is also important. The current lack of reliability results in the producers being designated as second-class suppliers, thereby limiting their export market.

42. Gravel is shipped using either road or rail transport depending on the size of shipments as well as the cost of transport. Reliability is less important since large shipments can be stored in open yards. However, there is limited space available for storing gravel destined to specific construction sites, thereby increasing the importance of delivery times and order fulfillment. Also, access to these sites usually requires road transport.

43. Scrap iron and steel are used for production of steel in arc furnaces. These inputs are imported from Romania in unit trains. Both public and private wagons are used because of the limited availability of the former. Since arc furnaces are more flexible and are generally used to fulfill specific orders rather than to provide continuous production, they require a

10 This is thought to be due to cost reduction as a result of discriminatory pricing by Ukrainian Railways rather than issues of reliability.

reliable source of supply to limit the cost of inventories. Therefore, delivery time and order fulfillment are both important.

44. Mineral fertilizer is imported in bulk by rail from various factories and collection points. It is then distributed in both small (50 kg) and jumbo bags using rail or road depending on size of shipments. Since demand is relatively peaked, there is need for significant inventories. Therefore, reliability is less important than delivery time given the uncertainty in demand.

45. Metal products are shipped to both domestic and export markets. For most shipments, road transport is used for the domestic market and rail for exports. However, the use of rail depends on the size of the shipments. It is preferred for delivery to major distribution centers. Because these are mid-value goods, reliability in the form of availability of wagons is as important as cost.

Traffic Operated by the CFM

46. Moldovan Railways (CFM) is responsible for the internal movement of all rail cargo including domestic, import, export and transit cargoes. The volume of freight carried on CFM decreased significantly over the last quarter-century. More details on traffic evolution and on the reasons traffic decrease are presented in the chapter presenting the Challenges Faced by the Railway Sector.

FigureRa 5i: lVolume Traf fofi cFreight - Fr bye iComponentght Ton s 2.50 2.25 2.00

1.75

s 1.50 n

o 1.25

n 1.00

l l

i 0.75

M 0.50 0.25 0.00 2011 2012 2013 2014 2015 2016 2017 2018

Transit Import Export Domestic Source: CFM 47. The largest component of rail traffic in terms of both volume of freight and transport services (ton-km) is transit cargo. The smallest is domestic traffic which accounts for only about 10 percent of total freight versus 38 percent of transit cargo. Most of the variation in traffic has been associated with transit and export cargo (Figure 5).

48. In 2018, the total traffic carried by CFM included 535,000 tons of domestic cargo and 4.39 million tons of international cargo. Iron ore, grain and other building materials such as gravel accounted for about half of CFM rail freight by weight (Table 6). The iron ore was mostly transit cargo, whereas grain was an export. The other building materials were both exports and transit cargo. Of the remaining cargo, scrap iron, steel, fertilizer and petroleum were primarily imports. Metal products were exports and transit cargo.

Table 6: International Rail Cargo by Commodity, 2018 Type of Cargo Iron Ore 25% Other Building Mat. 13% Grain 12% Mineral Fertilizer 10% Scrap Iron & Steel 9% Petroleum 8% Metal Products 7% Cement 5% Coal 3% Other 8%

49. In terms of the diversity of rail cargo, transit cargo is the most concentrated with iron ore accounting for 72 percent of the volume (Figure 6). The main origins of the transit cargo are Ukraine and Russia, whereas the main destination is Romania.

50. The export cargoes are mainly grain, metal products, and other building materials. These three market segments account for over 80 percent of the volume (Figure 7). The main destination for exports is Ukraine with 40 percent of the tonnage. Romania, Poland, Italy, and Switzerland account for an additional 5 percent. Import cargoes primarily originate from Russia and Ukraine (72 percent of the cargo by tonnage), and Belarus and Romania with an additional 24 percent. The domestic cargo is primarily building materials, especially

Figure 6: Distribution of TRailra Transitnsit CCargoarg oes

4% 1% 6%

7% Iron Ore

10% Mineral Fertilizer Other Petroleum Coal 72% Scrap Iron & Steel

gravel transported from the production sites in the north to the Chișinău metropolitan area.

Figure 7: DistributionExpo ofrt Rail Ca rExportgoes Cargoes 4% Figure 8: DistributionImp oofr Railt Ca Importrgoes Cargoes 12% 3% 2%1% 5% 23% Scrap Iron & Steel 42% Grain 11% Other Building Mat. Mineral Fertilizer 19% Metal Products Petroleum Other Building Mat. Other

Cement 16% Coal Cement 21% 22% Other Iron Ore Metal Products 18%

51. The largest rail freight flows are presented in Table 7, accounting for approximately 60 percent of the total cargo volumes transported by rail in 2018.

Table 7: Major Rail Freight Transportation, 2018 Commodity Tons Origins Destination Trade Iron Ore 970,806 Ukraine Romania Transit Mineral Fertilizer 111,539 Russia Hungary Grain 384,676 Moldova Other Cement 159,990 Moldova Ukraine Export 222,543 Moldova Ukraine Other Building Materials 320,988 Ukraine Moldova Import Scrap Iron & Steel 257,068 Ukraine Moldova

Petroleum 103,993 Belarus Moldova Total 2,531,603 Data Source: CFM

52. By improving the quality of its service, CFM could increase its market share. However, the increase would be limited, especially for transit cargo, which depends not only on trading relations between neighboring countries, but also routing decisions by shippers in these countries. Thus, productivity improvements are needed, so that CFM can offer competitive pricing, reliability, and time advantages, to win market share. The potential for increasing the shipments of agricultural goods would also be limited, as agricultural shipments depend primarily on the volume and location of production. For the remaining shipments of raw materials and intermediate goods, modal share is sensitive to cost, while the volume shipped depends on the performance of the regional economy. The main factor to consider is that railways must be able to meet the needs of customers, be it service, price, or both.

Limitations in the Operating Plan of CFM

53. The average train length varies by type of commodity.11 More than fifty wagons are used for unit trains transporting iron ore. Shorter trains, 30-40 wagons, are used for domestic movements and for a significant portion of imports and exports. The average cargo tonnage per train is currently estimated to be about 2,400 tons, equivalent to about 40 wagons of high-density cargo or 50 wagons of medium-density cargo. The hauling capacity of a single locomotive is limited in several sections of the network due to steep grades and condition of the track (Table 8). As a result, many of the trains use two locomotives to haul the heavier loads on steeper grades.

Table 8: Train Capacity in Gross Weight for Single Locomotive Route Tons

Mogilev - Ocnita 2,700

Ocnita - Balti 3,800 Balti - Ungheni 3,600 Ungheni - Chisinau 2,200

Chisinau – Bender (Tighina) 4,400 Bender - Basarabeasca 4,000 Basarabeasca – Etulia 3,200

Etulia-Galati 5,000

54. Based on current traffic data, it is estimated that the average annual distance traveled per locomotive is about 95 thousand kilometers (Table 8). Assuming an average train speed of 40 kph, this implies an average of about 2600 hours hauling wagons per locomotive per year. It is also assumed that relatively little time is spent in the yards since the locomotives operate on a hook-and-haul basis. These figures imply that there is extra capacity under normal operating conditions, but this is not the case. The calculations do not include the

11 The maximum train length as determined by the available station space is 57 wagons

time lost due to breakdowns enroute which significantly reduces the availability of these locomotives.

Table 9: Estimated Demand for Locomotives Parameters Amount Units Average train load 2,400 Tons Total annual freight 4.6 Million tons Empty return trips 80% Annual loaded trips 1,920 Total one-way trips 3,200 Average distance one-way 215 Km per trip Total train movement 688 '000 km per year Average traction 1.35 Locomotives per train Operational locomotives 15 Average Utilization 62 '000 km per locomotive Source: WB Team’s Estimates

55. Although CFM has a fleet of over 7,000 wagons, only about 4,000 are classified as operational. Most of these have exceeded their nominal operating life (Table 10). Furthermore, it is expected that within a few years all but about 1,200 wagons will have exceeded the maximum age at which Moldovan wagons are allowed to operate on the Ukrainian and Romanian rail networks.12 In recent years, the shortage of wagons has been further exacerbated by the practice of renting out CFM’s wagons to UZ for about $23 per day in order to generate additional revenue.

Table 10: Available Wagons by Type Age Wagons Operational 1-24 25-29 30-34 35-40 40+ Tankers 426 1 11 86 117 211 Hoppers 921 0 50 385 370 116 Covered 653 0 83 277 115 178 Open 1186 0 215 544 384 43 Flat 612 1 98 244 126 143 Total 3798 Source: CFM

56. The shortage of wagons affects only exports and domestic shipments. Transit cargoes and most imports are carried in foreign wagons, primarily Ukrainian, Romanian, and Russian. The greatest impact of this shortage has been on exports of commodities requiring special wagons, e.g. grain and cement. Some exporters have used foreign wagons to carry their shipments as backhaul cargo. Others have invested in private rail wagons.

57. In order to address the current shortage of wagons, CFM has instituted a three-stage dispatching process. Initially, the domestic shipper submits a monthly plan including the number and type of wagons required, the cargo to be loaded, and specific dates and locations for loading. CFM responds with an approval for a specific number of wagons to be

12 35 years unless they have recently been rebuilt

allocated for these shipments. This is usually less than requested (see Box 1 below). Three days before loading, the shipper submits a final request for those wagons that have been allocated. CFM arranges for the movement of wagons to the designated locations, subject to the availability of equipment at that time. Due to delays in the scheduled movement of trains and uncertainty concerning the location of wagons, the number of wagons available is usually less than agreed to.13 It is expected that future efforts to address the shortage of wagons will include improved utilization of the operational fleet as well as acquisition of new wagons by the private sector.

58. The movement of foreign wagons is more easily managed by CFM. For imports and transit cargo, movements are planned well in advance and the arrivals at the border are more predictable. There are fewer delays waiting for locomotives at the border crossings. As a result, the time required for wagons to cross the border is less than four hours for the major crossings as shown in Table 11. The movement of wagons across the Romanian border requires a change in gauge from Russian gauge to European standard gauge. This is done primarily by swapping bogies at the gauge change yards on either side of the border. There is also a rail yard across the border in Iasi where cargo can be transferred between wagons rather than changing gauges.

Table 11: Average Time for Border Crossing in 2019 Border Crossing Hours Ungheni Track (1.520 m) 3.6 Cristesti Track (1.435 m) 4.7 Cuciurgan - Causeni (Novosavitskaya) 3.0 Etulia - Reni 6.2 Giurgiulesti - Galați 1.5 Giurgiulesti - Reni 1.3 Colbasna - Slobodca 2.0 Ocnita - Mogilev-Podolsky 5.0 Ocnita - Sochireni 1.7 Source: CFM

59. In most cases, unit trains with transit cargo return to the originating country with empty wagons. For trains transporting imports, a large portion of the cargo is sold at the border on DAP terms.14 After delivery, most of the wagons are returned empty to the same border for reassignment unless they have been reassigned to carry cargo to another destination. The remaining empty wagons are returned to the owner of the wagon or rented by CFM for local shipments. In some cases, local exporters rent these wagons to compensate for shortage of domestic wagons.

14 Delivered-at-place

BENCHMARKING TO MEASURE THE PERFORMANCE OF THE RAIL SECTOR

60. This Policy Paper uses benchmarking to measure the performance of the railway sector in Moldova and to identify best practices and opportunities for improvement. Considering the aim of Moldova to gradually harmonize its economy to the European Union standards, the comparison railways will be chosen from the EU community.

61. The comparison of CFM’s performance with the EU-28 average railway performance is used in this document to set up improvement targets to be achieved by the CFM in the future. At the same time, the performance of CFM is compared in this document with the performance, of selected EU railway companies that are not very different of CFM. Considering the diversity of the EU-28 railways (large and small networks, preponderantly freight and preponderantly passenger railways, transit or domestic traffic oriented), six railways have been selected for comparison based on the fact that they operate on the railway networks of approximately the same size as CFM (see Figure 9 below). Figure 9 - Selected Railways Based on Track Length [km]

Portugal 3,164

Croatia 2,859

Lithuania 2,363

Latvia 2,227

Moldova 2,075

Slovenia 1,539

Ireland 1,502

Source: UIC Statistics – 2016

CHALLENGES FACED BY THE RAILWAY SECTOR

Decline of the Railway Transport Market

62. Mixed transport market evolution in Moldova. For the purpose of this paper, the traffic volume realized in 2007 is considered as the reference for the traffic evolution trends. The total annual passenger and freight traffic volumes achieved by all modes of transport since 2007 have in general followed the Moldova’s GDP evolution, although with a lower annual growth (see Figure 10). Following a slight decrease in 2009,15 the passenger transport grew every year and was 69.8 percent higher in 2018 compared with 2007. In contrast, the freight transport market in Moldova suffered a significant drop of almost 42 percent in 2009,16 barely reaching the 2007 level in 2018 in spite of the annual increases that followed.

Figure 10 - GDP and Transport Evolution

240.0% 221.7%

184.1% 184.3% 187.6% 190.0% 163.2% 168.8% 150.2% 156.5% 137.6% 135.3% 140.0% 123.6% 161.9% 169.8% 106.5% 95.2% 130.5% 136.8% 90.0% 102.1%112.6% 116.2% 119.0% 120.3% 100.0% 99.5% 96.2% 99.6% 91.2% 87.0% 75.7% 78.7% 80.0% 83.2% 40.0% 58.2% 66.3% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2,018

Passenger-km [Thou] Ton-km [Thou] GDP [Thou US$]

63. The railway sector operated transport volumes have been on a constant decline. The volume of freight carried by rail in Moldova decreased significantly over the last quarter- century. The most significant decline was in 1993 when the volume decreased from 22 million tons to 14 million annually. Thereafter, the volume fluctuated between eight and 14 million tons until 2007 at which time there was another sharp drop. Since then the average volume has been about 4 ½ million per year.

64. Factors which determined the railway traffic drop. The loss of volumes of transport by rail was driven by four factors. The most important has been the changing geopolitics beginning with dissolution of the Soviet Union. The second major factor has been fluctuations in the growth of the regional economy, most notably the global financial crisis in 2008, followed by a reduction in average rates of economic growth. The third factor has been fluctuation in the production and export of grain and vegetable oil. The last factor has been the CFM’s failure

Source: National Bureau of Statistics of Moldova

16 Triggered by the 2008 global financial crisis

to properly maintain and renew its physical assets due to long-lasting neglection of investments in railway infrastructure compared with the road sector.

65. Unbalanced investments in road and rail infrastructure. During 2007 – 2016 the government spent for the rehabilitation and development of the road network in Moldova more than 1 billion Euro (about 600 million Euro from international donors and the rest from the road fund), while for the railway infrastructure the funds allocated were less then 150million Euro. This has caused a decline in efficiency and reliability while the quality of road transport has improved continuously.

Consequently, most of the freight and passenger traffic in Moldova has been captured by the road sector. In 2018, the road sector transported 3,859 million ton-km, representing a robust increase compared with 1,769 million ton-km in 2007. As a comparison, the railway sector lost significant volumes over this same period, transporting only 1,013 million ton-km in 2018 compared with 3,120 million ton-km achieved in 2007. As it can be noted in Figure 11 below,

Figure 11- Freight Traffic Evolution by Mode [ton-km]

210.0% 218.1% 200.0% 182.7% 173.6% 185.4% 163.1% 166.7% 150.0% 129.0% 112.7% 141.6% 100.0% 101.0% 100.0% 50.0% 92.1% 38.3% 39.3% 37.9% 0.0% 33.9% 30.7% 30.8% 30.9% 25.3% 31.6% 32.5% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Road Rail

the freight volume transported by road in 2018 was 118.1 percent higher compared with 2007, while the freight volume transported by rail in 2018 represented only 32.5 percent of the volume achieved in 2007.

66. The railway freight market share decline. The direct consequence of the freight transport volume losses was a reduction of the railway transport market share from 63.8 percent in 2007 to 20.8 percent in 2018 (see Figure 12). The road transport increased its freight market share from 36.2 percent to 79 percent during the same period. The significant loss of freight had a serious impact on CFM’s performance, which has not recovered to its previous levels to date, affecting the financial balance of its operations. Considering the general transport market trends in Europe, it is very unlikely that the railway sector in Moldova will ever recapture the lost freight transport market share, but this is not to say that the reforms to improve its operational efficiency should not be implemented. The current railway freight market share in Moldova is 21 percent, which is still higher than the average railway freight market share in the EU-28 countries (see Figure 13).17 It is important for the railway sector in

17 The EU-28 freight market share for railways was about 17 percent in 2016 (according to the UIC Statistics).

Moldova to be able to preserve its current market share and operate competitively, but this requires a major sector reform and new approach to addressing the transport market challenges. Figure 12 - Moldova Freight Transport Figure 13 - EU-28 Freight Transport Modal Share, 2018 Modal Share, 2016

Road Rail 77% Road 21% Rail 79% 17% Inland water…

67. Railways lost important volumes of passengers. Despite a robust increase in the volume of passenger traffic in Moldova of about 69.8 percent since 2007, the railway sector transported only 94,572 thousand pass-km in 2018 compared with 468,175 thousand pass-km realized in 2007. As illustrated in Figure 14, in 2018, the railway sector transported only 20.2 percent of the passengers transported in 2007, while the road sector increased its volume of transported passengers by 36.6 percent. This means that the road sector succeeded to divert important volumes of passenger traffic from rail to road and to attract a high portion of the new volumes of passengers. Figure 14 - Passenger Traffic Evolution by Mode [pass-km] 136.6% 121.3% 121.4% 126.5% 110.4% 114.5% 109.9% 114.5% 100.0% 105.0% 92.9% 97.6%

100.0% 103.7% 90.3% 85.2% 77.6% 74.2% 70.4% 54.9% 38.6% 26.0% 21.1% 20.2% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Road Rail Source: National Bureau of Statistics of Moldova

68. Dramatic loss of railway passenger market share. The railway sector’s market share of passenger transport went down from 13 percent in 2007 to only 1.59 percent in 2018. Figures 15 and 16 show that the railway passenger market share in Moldova is currently lower than the average market share in the EU-28, which was 7 percent in 2016. Considering the important role of the railway transport in preserving the environment and its higher safety in comparison with the road transport, the drastic reduction in the rail passenger transport in

Moldova may have a long-term negative impact on the country’s economic and social costs, requiring urgent action to rebalance the transportation market.

Figure 15 - Moldova Passenger Figure 16 - EU-28 Passenger Transport Transport Modal Share, 2018 Modal Share, 2016

Buses 10% Air 41% Passenge Trains r cars 7% Road 83% 57% Rail 2%

69. Small railways can achieve high traffic volumes. The comparison with the selected six railways illustrates that the small size of the Moldovan railway network must not be perceived as a barrier to achieving higher annual traffic volumes. Figures 17 and 18 below show that CFM operates the lowest passenger volume and second lowest freight volume compared with

Figure17 - Selected Railways' Annual Figure 18 - Selected Railways' Annual Ton-km [mill] Pass-km [mill] 3,803 Portugal Latvia 15,879 Ireland 1,916 Lithuania 13,790 Croatia 836 Slovenia 3,963 Slovenia 680 Portugal 2,064 Latvia Croatia 1,870 584

Moldova 993 Lithuania 248

Ireland 96 Moldova 94

the selected railways. The comparison of data presented below must be done cautiously even for similar railway network dimensions, as the railway network’s geographical position in the continent, traffic structure, market conditions, and many other specific factors differ from one railway to another. For example, concerning the freight volume, we must notice that Ireland, which operates a lower volume than Moldova, is an island and the coastal shipping plays an important role, justifying the lower tonnage transported by rail. Also, some of the selected railways (e.g. Latvia, Lithuania) are in a very favorable geographical position for large transit traffic, explaining their excellent freight transport performance. However, the significant differences in the passenger transport volumes achieved by the selected railways

or large freight volume transported by railway in Portugal, which is not a transit country and has major competition in coastal shipping, are good examples to incentivize the railway sector in Moldova to achieve better results.

70. Need to stop the Moldovan railway sector’s traffic decline. The downward trend in CFM’s traffic volumes that started more than a decade ago will not stop in case of “do nothing” scenario. There is a significant risk that the loss of market share will continue over the coming years and may even accelerate if the Government and CFM fail to take strong actions urgently. It is vital for the Moldovan railway sector to act to preserve the current freight transport market share and to recapture a portion of the lost passenger market, but these targets require a major sector reform and new approach to the transport market challenges by CFM.

Chronic Underinvestment in the Railway Assets

71. Infrastructure status. The railway assets in Moldova suffer from a legacy of chronic underinvestment that has resulted in today’s significantly degraded infrastructure. The low- quality railway infrastructure is the main obstacle to attracting more railway clients. The railway infrastructure is old and completely depreciated. About 45 percent of the railway tracks were installed over 30-40 years ago. 77 percent of the automatic block equipment and 87 percent of the semi-automatic block equipment are over 41 years old. 62 percent of interlocking systems are also over 41 years old. The infrastructure’s obsolete and poor state is one of the main factors of poor operational performance. Currently, the average technical speed on the railway network is 34.5 km/h. Huge transport capacity is lost due to low speed, with many customers preferring road transport because of its better-quality services. CFM had identified in 2013 the main line sections requiring maintenance. These accounted for over one third of the network, including 163 km with 84 speed restrictions. Ever since then, CFM has been making efforts to complete the scheduled maintenance, but the needs by far exceed the possible allocations. There is currently a backlog, with 24 percent of the main network requiring periodic maintenance. Additionally, 17 percent of the main track require renewal. The deterioration has resulted in 27 percent of the network having speed limitations.

72. There are significant backlogs accumulating and delaying modernization of the telecommunications, signaling, and interlocking systems. Numerous failures of the automatic and semi-automatic block systems along the lines indicate the urgency of renovation of these rail traffic safety systems. According to CFM, 77.6 percent of the control systems are in critically bad condition, impacting safety and reliability. The same applies to the communications system, which has been in use since the 1970s and has not been renovated or upgraded since. Figure 19 shows the concerning status of the railway infrastructure equipment’s age structure.

Figure 19 - Main Infrastructure Components' Age Structure

Track [km] 13.1% 25.8% 17.3% 24.0% 19.8% 3.2% Automatic block [km] 20.1% 76.7% 4.9% Semi-automatic block [km] 8.2% 86.7% 2.8% Interlocking systems [nr] 9.7% 13.9% 11.1% 62.5%

Dates of installation 0 - 10 years Dates of installation 11 - 20 years Dates of installation 21 - 30 years Dates of installation 31 - 40 years Dates of installation > 41 years

73. The fully depreciated infrastructure components require higher maintenance costs. Due to CFM’s financial difficulties, the company has not been able to properly maintain its assets, resulting in accumulation of a large railway infrastructure maintenance backlog. CFM estimates that the railway infrastructure in Moldova needs annual track renewal works of about 40 km to preserve the designed parameters of operations18 on the existing railway network. The number of kilometers of executed track renewal during the last decade has been lower than necessary (under 10 km every year), and the accumulated backlog has imposed additional speed restrictions on many lines, which are required to maintain acceptable safety levels. Figure 20 presents the track renewal works that have been annually executed since 2013 compared with the planned works and annual needs. The consequence of failing to execute the necessary annual volume of works is that CFM now needs to urgently renew a backlog of 410 km of track. Figure 20 - Annual Track Renewal Works – Executed vs Planned vs Needed

50 40 40 40 40 40 40 40 30 18 19 20 8 11 10 6 6 4 6 2 1 0 1 0 2013 2014 2015 2016 2017 2018 Track Renewal Planned Track Renewal Executed Track Renewal Necessary

Source: 2018 CFM Statistics

18 Based on the annual traffic intensity and life cycle of the railway systems critical to traffic safety, CFM calculates, like any other railway company in Europe, the annual number of km of track renewal works needed to maintain the existing transport capacity.

74. The low levels of infrastructure components’ repairs and renewals have multiple negative impacts: i) they increase the railway infrastructure operating costs, ii) additional costs are passed to the railway operation costs (and finally to tariffs), reducing the railway transport’s attractiveness, and iii) deferred maintenance increases the cost of assets over their life cycle, creating an additional burden on CFM. It is evident that the current railway infrastructure operating, and financing practices need to be reviewed and completely new approach must be implemented.

75. Rolling stock is obsolete. The same chronic underinvestment in the rolling stock resulted in an obsolete fleet of locomotives, coaches, and wagons. All of CFM’s existing locomotives and over 60 percent of freight wagons have outlived their useful economic lifespan. Figure 21 shows the age structure of the different rolling stock categories used by CFM. Major investments are needed for the general overhaul and renewal of CFM’s current fleet. These investments must be corelated with the traffic levels and real operational vehicle needs. Currently, CFM’s freight capacity is limited by the availability of mainline locomotives. Even though there are 148 locomotives in the fleet, only 15 are considered operational and these vary in age from 30 to over 40 years. Frequent breakdowns result in a relatively low productivity and substantial delays in train movements. Figure 21 - Fleet's Age Structure

2.3% Locomotive 72.7% 25.0%

DMU 100.0%

Passenger coach 17.1% 82.9%

Freight wagon 28.8% 57.0% 14.2%

Dates of acquisition 0 - 10 years Dates of acquisition 11 - 20 years Dates of acquisition 21 - 30 years Dates of acquisition 31 - 40 years Dates of acquisition > 41 years

76. Low rolling stock availability. Large rolling stock general overhaul and maintenance backlogs have also been accumulated. The obsolete assets and lack of funds for proper fleet Figure 22 - Rolling Stock Availability

76.2% 73.4% 71.5% 70.2% 68.6% 66.8% 64.7% 63.3% 55.5% 53.7%

41.7% 36.6% 36.8% 37.7% 36.9% 39.5% 34.1% 34.8% 33.3% 33.3%

2011 2012 2013 2014 2015 2016 2017 2018

Passenger Fleet Freight Wagons Locomotives

maintenance are the cause of frequent breakdowns, while many of the existing units must be scrapped. Consequently, CFM faces a chronically low fleet availability and low fleet operational efficiency (see Figure 22). According to the data reported by CFM, in 2018, the company achieved a 54 percent availability for the passenger coaches, 63 percent for freight wagons, and 33 percent for locomotives. These figures are very low and generate higher freight and passenger operating costs for CFM, leaving it unable to compete with road transport, jeopardizing its market position, and making it vulnerable to continuing to lose customers to other transport modes.

77. Reform of the railway transpport in Moldova cannot be successful if it is not accompanied by wise investment strategy. The government has a vital role in promoting the right investments in infrastructure and rolling stock for eliminating the current barriers on railway performance induced by the obsolete assets. The current program of modernization of infrastructure started with the EBRD must be continued with the rest of the segments of the European Corridors crossing Moldova and with the rolling stock identified as necessary for addressing the critical customers.

Aging of CFM’s Labor Force

78. Downsizing the number of CFM's employees. CFM made efforts to address the negative impact of the dramatic traffic reduction on the company's operational and financial

Figure 23 - Staffing Levels

11,837 11,600 11,148 10,890 10,141 9,254 8,392 7,475

2011 2012 2013 2014 2015 2016 2017 2018 performance by adjusting its staffing levels. As shown in Figure 23, CFM’s staff was reduced by 36 percent since 2011 to 7,475 employees in 2018.

79. CFM’s share of labor costs is within the European railways’ average limits. The share of salaries in CFM’s total operating costs varied between 25 percent and 35 percent since 2011; it was 29 percent at the end of 2018. As railways are service oriented companies, it is normal to have a higher weight for labor costs compared with firms in other sectors of the economy. In the EU, labor costs for railway companies are in the range of 40 to 45 percent of total costs. CFM's average monthly cost for an employee in 2018 was the equivalent of about 160 euros, which is significantly below 405 euros representing the equivalent of the average monthly salary in Moldova.19 Salaries are low to make CFM an attractive employer in the country. This is an additional challenge that will need to be addressed to have a profound restructuring process. Both the restructuring process and need to increase the rail sector’s competitiveness will require highly skilled and motivated staff.

80. CFM's staff is aged. An analysis of CFM staff’s age has shown trends that are similar to Moldova’s demographic trends. As can be seen in Figure 16 below, about 52.3 percent of the employees are over 51, while 77.4 percent are over 41. Only 6.4 percent of the staff are under 30 years of age. Under the current conditions, CFM’s labor force is likely to continue to increase in age and large number of staff will reach the retirement age in the next 5-10 years. Currently, more than 10 percent of CFM's staff (769 persons) are over 65 years of age and can retire immediately. This trend is a serious challenge for CFM to be able to attract young staff. As noted above, younger labor force in the sector is needed to manage the difficult company restructuring process and reverse the rail business decline.

19 National Bureau of Statistics of Moldova

81. Need to adapt the staff structure to the company's new organization. The imminent company restructuring cannot be started without a consistent strategy for attracting new staff, skilled to address the company reform challenges and familiar with the commercial approach to the railway activities.

Downgrading Operational Performance of CFM

82. CFM’s operational performance benchmarking. Successful rail operations are directly linked to the volume of traffic operated, traffic density, and level of utilization of assets. The evaluation of CFM’s performance during the previous years and the comparison with a selected number of railway companies from Europe may be useful for identifying the ways for enhancing CFM’s operational performance. The conclusions drawn from the international comparisons must be prudently evaluated, and the analysis should be developed based on the correlation of various indicators, bearing in mind the local conditions of each railway. Considering these restrictions, the following basic indicators have been used for comparison: a) Length of railway tracks20 b) Traffic density on infrastructure21 c) Average distance of transport for freight and passengers22 d) Rolling stock productivity23

20 Length of track: the combined length of all tracks in the network, calculated in km. Thus, a double track line (route) will have a track length twice as long as its route length 21 Traffic density: length of tracks of the railway divided by the total volume of traffic units realized during a certain interval of time (usually one year) 22 Average distance: result of dividing the total number of ton-km (or pass-km) by the total volume of tons (or passengers) achieved during an interval of time (usually one year) 23 Rolling stock productivity: result of dividing the total volume of traffic units achieved during an interval of time (usually one year) by the total number of units of rolling stock used for the transport of those traffic units (ton-km and/or pass-km depending on the type of traffic)

e) Labor productivity24

83. Traffic density – essential element of the efficient railway infrastructure use. In general, the railway infrastructure costs include capital and maintenance costs for track, engineering structures, such as bridges and tunnels, train signaling, communications systems, power supply in electrified sections, and terminals. At least 70 percent of these costs are fixed costs. Due to the high percentage of fixed infrastructure costs, a low traffic density makes the railway transport more expensive and less successful when competing with the road transport. Normally, railway networks also have economies of density which means that higher traffic levels lead to less than proportional increase in operating costs. The assessment of the traffic density on the railway network in Moldova will help to better understand CFM's market competitiveness challenges.

84. Traffic density evolution in Moldova. According to the statistics reported by CFM, the traffic density decreased almost every year since 2010, reaching 888,526 traffic units/km of track in 2018.25 As shown in Figure 25, it represents approximately one third of the EU-28 railways’ average traffic density. Lower density puts CFM at a disadvantage as it makes the access to the country’s infrastructure more expensive than on other railway networks.

Figure 25- Traffic Density - Evolution and Comparison [traffic units/km] 2,426,044

1,244,608 1,272,705 1,166,937 1,047,024 929,853 872,512 888,526 746,166

2011 2012 2013 2014 2015 2016 2017 2018 EU-28 (2016)

Source: 2018 CFM Statistics and 2016 UIC Statistics

85. Higher traffic density can be achieved by small networks. Comparison with the six selected railways (see Figure 26) illustrates that Moldova has the lowest traffic density of all. The chart below also illustrates that small railways can achieve remarkable traffic density, higher than the EU-28 average (e.g. Latvia, Lithuania, Slovenia). CFM must develop a detailed traffic density assessment of each line to identify the low-density traffic lines and to inform decision-

24 Labor productivity: result of dividing the total number of traffic units (ton-km and/or pass-km depending on the type of traffic) achieved during an interval of time (usually one year) by the total number of staff involved in the realization of that traffic 25 Moldova is in a special situation as it currently uses only 1,224 km (1,149.6 km of single track + 74km of double track) of its length of tracks. For the calculation of traffic density, we have used only the operational track length in Moldova (1,224 km)

making depending on the potential for traffic development. It is known that more than 80 percent of the traffic is achieved on less than 40 percent of the network for most railways. The list of railway lines in descending order of traffic density can be used as a tool to prioritize the Moldovan railway network modernization projects.

Figure 26 - Traffic Density [traffic units/km] 7,392,456.22 Latvia Lithuania 5,940,626.32 Slovenia 3,016,894.09 Average EU-28 2,426,044.30 Portugal 1,854,298.36 Ireland 1,339,547.27 Croatia 946,484.78 Moldova 888,525.66

86. Average distance of transport. The higher distance of transport means higher competitiveness for railway transport. This is especially true for freight transport, where the railways are more competitive on longer distances. For the passenger transport, railways are competitive even on small distances of transport (e.g. commuter trains), when taking into consideration the external costs of transport (e.g. environment, traffic congestions, accidents, fatalities). The average distances of transport achieved by CFM in comparison

Figure 27 - Freight Average Distance Figure 28 - Passenger Average Distance [km] [km] Average EU-28 76 Average EU-28 977 Latvia 332 Lithuania 56 Lithuania 289 Moldova 55 Slovenia 234 Slovenia 49 Portugal 226 Ireland 48 Croatia 219 Croatia 40 Moldova 201 Latvia 34 Ireland 178 Portugal 33

with the EU-28 and selected railways are presented in Figures 27 and 28. The two charts illustrate an average distance for freight (201 km) achieved by CFM, in the same range with the performance of the six selected benchmark railways, even though it is much shorter than the EU-28 average of 977 km (due to the size of the network). However, the average distance of transport achieved by CFM for passengers is similar to the six benchmark railways. As the selected benchmark railways achieve much higher operational and financial performance than CFM, the comparison of the average distances of transport shows that CFM has a good chance to improve its operational performance despite relatively short distances of transport.

87. CFM fleet productivity decreased during the last decade. The efficient use of wagons, coaches, and locomotives has a direct impact on cash generation in railway operations. High utilization of rolling stock is an important indicator of railway efficiency, as higher volumes of transport are achieved with a smaller fleet. The evolution of fleet productivity26 at CFM shows mixed results. Compared with 2011, the productivity achieved by CFM in 2018 (see Figure 29) was 42 percent lower for passenger coaches, and 14 percent lower for locomotives. Only freight wagon productivity increased by about 33 percent (this is compared with 2015 as

Figure 29 - Fleet Productivity Evolution Figure 30 - Fleet Productivity Compared with in Moldova EU-28 100.0% EU-28 Wagons 132.8%

Locomotives 62.3% Coaches 57.7%

Wagons 30.2% Locomotives 85.3%

Coaches 30.1% Moldova (2018) Moldova (2011)

there is no earlier data available). CFM’s fleet productivity was significantly lower than in the EU-28 railways as CFM coaches and freight wagons were only 30 percent and the locomotives 62 percent of the EU-28’s average (see Figure 30).

88. Fleet productivity benchmarking. Comparison with the productivity of utilization of the wagons, coaches, and locomotives by the six selected railways points out again that good

Figure 31 - Locomotive Productivity Figure 32- Wagon Productivity [traffic units/locomotive] [ton-km/wagon] 82,315,000 2,787,746 Latvia Latvia Lithuania 1,654,866 Lithuania 61,568,860 Slovenia 1,324,532 Portugal 51,464,912 Average EU-28 1,107,829 Average EU-28 39,664,820 Portugal 651,104 Slovenia 30,546,053 Croatia 351,108

Moldova 24,709,091 Moldova 334,164 Ireland 213,808 Croatia 10,288,973

26 Measured as ton-km/wagon and pass-km/coach

productivity of asset utilization can be obtained on small networks (see Figures 31 and 32). Latvia, Lithuania, Slovenia, and Portugal achieved better productivities than the average EU- 28 values for at least one productivity indicator. CFM must strive to improve the efficiency of utilization of its assets and obtain similar productivities to those of the railways of comparable size with Moldova. It is Figure 33 - Coach Productivity [pass-km/coach] important to highlight 2,293,007 Average EU-28 that the productivity data for the rolling stock in Portugal 2,066,848 Moldova was calculated Ireland 1,807,547 taking into consideration Latvia 1,528,796 only the operational Croatia 1,128,205 fleet, while the entire Lithuania 724,269 fleet is taken into Moldova 689,051 consideration for the

Slovenia 639,699 railway benchmarking. Knowing CFM’s low rolling stock availability, it can be concluded that in reality the differences in productivity are even more detrimental to Moldova. Low fleet productivity generates higher freight and passenger traffic costs for CFM, leaving the company unable to compete with road transport, jeopardizing its market position, and making it vulnerable to continuing to lose customers to other transport modes.

89. Labor productivity. As service-oriented companies, railways are labor intensive entities and the weight of labor cost in the total costs of the railways can easily reach 45 percent or even more. For this reason, labor productivity is one of the most important indicators for railway operational performance. Figure 34 - Evolution of Staff Productivity [Traffic CFM achieved a slight Units/Staff) improvement in labor productivity by 12 percent 788,971 in 2018 compared to 2011 (see Figure 34). The downsizing of the number of staff from 11,837 to 7,475 during the same 140,662 145,445 129,687 111,328 131,910 112,415 98,855 127,467 interval helped increase labor productivity. Despite

2011 2012 2013 2014 2015 2016 2017 2018 EU-28 the painful staff reduction (2016) actions, the current labor productivity at CFM represents only 18.4 percent of the EU-28 railways’ average productivity (see Figure 34). CFM labor productivity is also the lowest compared with the productivity level in benchmark railways (see Figure 35). It means that CFM uses more staff than benchmark railways per unit of production, which would prevent CFM from competing successfully in the international market. There are two well-known ways to improve labor productivity: reduce staff or increase volume of traffic. If CFM's current transport market remains unchanged, in order to

achieve the average productivity attained by the EU-28 of 789,000 traffic units per staff, CFM would need a drastic downsizing of staff to about 1,400 employees. It is clear that this is not the ideal option as CFM already reduced labor force significantly and further reductions may not solve underlying organizational-institutional issues in the railway, but potentially cause undesirable implications in the sector. The most appropriate solution for CFM is to carry out an integral reform which would lead to the recovery of volumes transported. If needed, carry out strategic, well-thought downsizing in labor force that would systematically improve CFM’s position to serve the market. It is key to design a strategy for the improvement of labor productivity in the next 5-10 years.

90. CFM operational performance is below current EU standards. All indicators used for measuring CFM’s operational performance compared with specific railways or with the European Union railways’ average performance illustrate the important efforts that CFM must make to bridge the current gap. CFM's operational performance is adversely affected by low traffic density, poor rolling stock productivity, and low labor productivity. The values achieved by CFM for all these indicators are largerly inferior to benchmark railways. Low productivity has a significant negative impact on the operating costs, making the services provided by CFM more costly than those provided by other EU railways.

Figure 35 - Compared Staff Productivity [traffic units/staff] 1,426,596 Lithuania Latvia 1,280,669 Portugal 1,001,195 Average EU-28 788,971 Slovenia 614,967 Ireland 530,871 Croatia 311,034 Moldova 145,445

CFM's Financial Performance

91. CFM’s current financial performance is unsatisfactory. Based on collected financial data, CFM does not generate sufficient revenue to cover its operating costs (let alone its infrastructure costs). Figure 36 illustrates the evolution of average unit operating costs and of the average unit revenues at CFM since 2011 (both indicators are calculated in eurocents per traffic unit), showing that since 2012, the average unit cost of operation at CFM was constantly higher than the average unit of revenue. It also highlights that the unit costs and unit revenues at CFM are unchanged during the last decade, which means that CFM was not able to improve its average operating costs. The main conclusion is that the current transport operations do not generate sufficient revenues and the company accumulates annual

financial losses on a rolling basis. Indicators illustrate CFM’s failure to improve its operating performance (despite bold efforts to downsize the staff). Figure 36 - Evolution of Average Unit Cost / Revenue [€ ] at CFM 6.6 6.1 5.2 5.4 5.0 5.1 5.1 5.0 5.1 4.9 4.9 4.5 4.6 4.7 4.9 4.8

2011 2012 2013 2014 2015 2016 2017 2018

Average Unit Cost [€cent] Average Unit Revenue [€cent]

92. Operating costs allocated per main railway activities. In order to make more accurate evaluations of CFM’s costs and competitiveness, it is necessary to assess the average unit costs/revenues for each major type of transport (passengers by type of service, freight by main commodity). In a multi-product railway like CFM, these costs cannot be derived directly from general corporate accounts. CFM, like many other railways, uses specific methodologies for allocation of common costs (e.g. costs of railway lines used for mixed traffic or the costs of corporate overhead), and of joint costs (e.g. locomotives and crews used both for freight and passenger trains) to specific activities. The data presented in Figure 37 have been provided by CFM and illustrate the allocation of costs to main activities. CFM’s accounting system records the costs on six major units of activity, but on the request of the World Bank team, data have been provided for consolidated costs on CFM’s three major business units (freight, passengers, and infrastructure), and in a second iteration, the cost of infrastructure has been allocated to freight and passenger sectors.27 Figure 37 – CFM’s Cost Allocation by Units of Activity Operating Costs by Units [Thou MDL] 2016 2017 2018 Freight 60,526.97 63,640.80 50,244.67 Passengers 176,910.53 154,165.16 146,007.20 Infrastructure 362,757.40 369,766.15 362,120.74 Six Units Traction 236,245.19 268,493.47 306,371.16 Rolling Stock Maintenance 118,750.24 163,531.67 167,727.83 Corporate 93,483.29 134,531.00 136,404.84 Freight 320,595.35 401,564.24 426,573.70 Three Business Units Passengers 313,446.76 306,094.17 302,223.44 Infrastructure 414,631.49 446,469.83 440,079.30 Freight 599,766.73 728,752.05 756,052.06 Two Business Units Passengers 448,906.86 425,376.20 412,824.38

27 The accuracy of the cost allocation mechanism used by CFM was not assessed by the World Bank team.

93. Operating costs of infrastructure. It is highly important to accurately separate the costs of railway infrastructure (maintenance and traffic control) from CFM’s total costs, as the Government intends to open the access for more operators in the future and the costs of infrastructure must be paid by the licensed railway operators. According to the data reported by CFM, the share of costs of infrastructure in CFM’s total costs varied between 37 percent - 40 percent since 2016 to 2018. As most of the infrastructure costs are fixed (their variation with the volume of traffic is low) and considering the low traffic density on CFM’s railway network, it will be Figure 38 - Cost of Infrastructure covered difficult for CFM or by access charges paid by users other licensed operators to transfer

Latvia 85.0% to their tariffs all infrastructure costs Hungary 54.9% and to remain Italy 47.7% competitive in the market. Railway Romania 36.9% infrastructure in Portugal 35.0% Moldova will need to Switzerland 26.2% be commonly financed by the users (licensed Bulgaria 13.8% railway operators) and Croatia 9.5% by the Government. This is the system used by the European railways through the implementation of track access charges (TAC) for the users of infrastructure (the freight and passenger transport services providers). The identification of the right level of TAC for freight and passenger transport services (how much the market can bear to pay?) is a complex task and depends very much on the local conditions of railway transport market in Moldova (traffic density, preponderance of freight or passenger services, tonnage of trains, and technical characteristics of railway lines). Some examples from the European Union countries illustrate the level of coverage of costs of infrastructure by the TAC (see Figure 38). The large variation of cost coverage shows that the specific conditions of each country are the main factor for setting up the right level of TAC. Generally, in the EU-28, the revenue from user charges (TAC) only covers about 30 to 50 percent, with outliers at 10 percent and 100 percent. An audit of CFM’s infrastructure costs and a transport market study are necessary to identify which are the bearable levels of track access charges for various types of the railway transport services. The mechanism of joint financing of railway infrastructure by the users (TAC) and by the Government must be introduced in Moldova as soon as possible, before the opening of the market for more operators. It will help CFM to better control its operating costs and to establish adequate key performance indicators for improving the operational performance of the company.

94. Operating costs for the provision of freight and passenger transport services. The accounting system used by CFM allowed the calculation of the total operating costs for the freight and the passenger business units of the company by allocating parts the costs of Figure 39 - Annual Costs and Revenue Consolidated on Freight and Passenger Business Units Cost / Revenue by Business Units 2016 2017 2018 Freight 599,766.73 728,752.05 756,052.06 Annual Passengers 448,906.86 425,376.20 412,824.38 Costs Infrastructure costs attributed to Freight 67.3% 73.3% 74.9% Infrastructure costs attributed to Passengers 32.7% 26.7% 25.1% Annual Freight 580,408.00 664,493.00 625,115.00 Revenue Passengers 182,867.00 156,456.50 152,047.80

infrastructure to the operating costs of the two business units. Figure 39 presents the total costs of the two sectors of activity (freight and passengers), percentages of infrastructure costs as they have been allocated according to CFM’s allocation method, and annual revenues obtained by CFM from the provided freight and passenger transport services. Based on the available cost and revenue data for CFM’s two lines of business, a rough estimation of efficiency of each sector can be done.

95. Efficiency of freight and passenger transport. The comparison of the unit costs and unit revenues realized by CFM for the lines of business is presented in Figures 40 and 41. The two charts illustrate that the unit operating costs for both freight and passengers are higher than the unit revenues in the conditions of including 100 percent of the infrastructure costs in their operating costs. However, the losses of passenger line of business are significantly higher than for the freight. If the difference is only about 10 percent between the unit cost and the unit revenue for freight transport, the costs are about three times higher than the revenues in the case of passenger transport. The balancing of accounts for the provision of passenger transport services is a serious challenge for the Government of Moldova, but the examples

Fig. 40 - Freight Unit Costs / Revenue Fig. 41 - Passenger Unit Costs / [€cent] Revenue [€cent]

3.8 22.0 3.6 20.7 3.3 3.4 3.3 3.2 16.7

8.1 6.8 7.6

2016 2017 2018 2016 2017 2018

Average Unit Revenue Average Unit Revenue Passenger Average Unit Cost (CFM allocation) Average Unit Cost Passenger (CFM allocation)

of the passenger traffic successfully operated by similar railways with small networks presented in this paper show that solutions exist and only need to be implemented.

96. The mechanism used by CFM for the allocation of costs of infrastructure to passenger and freight lines of business should be reviewed. The allocation of costs of infrastructure to freight and passenger transport operators depends on many factors, but the most important factor is the volume of traffic generated by each operator (line of business in the case of CFM); this is measured by the volume of train-km operated on the railway network. In the case of CFM, most of the trains operated on the network are the passenger trains. The percentage of the operated train-km by freight and passenger business units compared with the percentage of infrastructure cost allocation to the two business units is presented in Figure 42. It illustrates that most of the costs of infrastructure are allocated to the freight business unit, although the passenger sector operates a higher volume of train-km on the railway network. For Figure 42 - Volume of train-km Operated for Freight example, in 2018, and Passengers and Allocation of Infrastructure Costs to Two Sectors CFM's freight transport operated only 37.4 percent of 71.4% the total trains using 63.1% 62.9% 64.7% 62.6% 57.2% the railway infrastructure, but the 42.8% sector paid 64.7 37.1% 36.9% 37.4% 35.3% percent of the total 28.6% costs of infrastructure. Such unbalanced allocation of costs between the two lines of business is not Freight Passenger Freight Passenger Freight Passenger totally uncommon. 2016 2017 2018 The practice to cross- subsidize the Train-km Infra cost allocation passenger sector from the revenues of freight sector was used by other railways over time, but it was never successful, especially if applied for long periods of time. By raising the tariffs of freight too much, in order to cover the losses of passenger transport services, in fact, CFM became less competitive. This in turn results in CFM losing more freight traffic and further worsening of its financial performance.

97. Proposed allocation of infrastructure costs is based on the volume of traffic.28 Figure 43 below presents a cost allocation method for infrastructure costs that considers the annual volume of train-km operated for the freight and passenger sectors. The costs of infrastructure

28 The correctness of the allocation of other categories of costs (traction, maintenance of rolling stock, corporate, etc.) to passengers and freight are not evaluated in this paper. The evaluation of all cost allocation keys may change the final cost figures presented in this paragraph, but the general message will remain the same.

are allocated in a higher percentage to the passenger line of business, in accordance with its use of infrastructure (volume of annual train-km operated).

Figure 43 - Allocation of Costs of Infrastructure Based on Traffic Volume Freight 320,595.35 401,564.24 426,573.70 OPEX of the Three Passengers 313,446.76 306,094.17 302,223.44 Business Units Infrastructure 414,631.49 446,469.83 440,079.30 Total 2.13 2.08 2.12 Annual Train-km Freight 0.61 0.77 0.79 [Mill] Passengers 1.52 1.31 1.33 Percentage Train- Freight 28.6% 37.1% 37.4% km Passengers 71.4% 62.9% 62.6% OPEX of Two Freight 439,228.18 567,003.02 591,058.27 Business Units Passengers 609,445.41 587,125.23 577,818.17

98. Evaluation of the efficiency of freight and passenger services in case of revision of allocation of infrastructure costs. Unit freight and passenger costs change with the new cost allocation method as presented in the Figures 44 and 45 below.

Fig. 44 - Unit Passenger Costs / Revenue Fig. 45 - Unit Freight Costs / Revenue [€cent] [€cent] 32.8 29.3 21.8 22.0 3.8 20.7 3.4 3.6 16.7 3.3 3.3 3.2 2.6 2.6 2.7 6.8 7.6 8.1

2016 2017 2018 2016 2017 2018 Average Unit Revenue Average Unit Cost (CFM allocation) Averarge Unit Cost (World Bank allocation) 99. The freight business line seems to cover all its costs and to be financially viable, while the passenger business line faces even more serious challenges. This calculation is only an exercise to illustrate that more precise cost allocation formulas must be identified by CFM for a more realistic calculation of operating costs of each business unit.

100. The risk of cancellation of passenger transport by rail should be avoided. The preliminary results of the financial analysis presented above should not lead to the idea of closing

passenger services by rail in Moldova. Similar financial results can be provided for all railways in Europe when assessing the costs of the passenger transport services vis-à-vis the revenues collected from the customers. The solution is not to close the railway services in Moldova, but to adjust the railway system to the best international practice. This means the Government should put in place a new legal framework for the operation of passenger transport services by rail in Moldova, so that that the operations are separated and not cross- subsidized. The Government of Moldova should implement the EU mechanisms for balancing the accounts of passenger rail transport services. It requires a deeper assessment of the sector to identify the routes where the railway transport can become competitive, modernize the train-set fleet, establish the right frequency of services on each of the selected routes, and implement the Public Service Contracts (PSC), similar to all European railways. Obviously, after careful analysis there may be services that would be better to discontinue so that CFM can allocate those assets and labor resources to more attractive passenger services. It is key to see the Moldovan passenger market as a dynamic marketplace that needs to be continuously reassessed by CFM as to the needed service modifications to meet the emerging needs of customers. Current situation is a sign that CFM was not able to keep up with the changes in the market since roads became an important player in Moldova and in the region.

101. The weakness of the rail sector in Moldova put in danger the economic development of the country. The challenges presented in this chapter indicate multiple threats to the railway sector in Moldova with major negative impact to the entire economy of Moldova, as it reduces the competitiveness of other participants in the economic circuit: e) Exporters, who need to be reliable suppliers offering a satisfactory level of order fulfillment, f) Importers, who need to limit their inventories without compromising the ability to fill orders, g) Producers/processors, who maintain a lean operation by synchronizing the arrival of inputs with their processing schedule while still being responsive to individual orders from their clients, and h) Shippers of transit cargo, who have to coordinate transport services in multiple countries.

102. The profound reform is the only solution to mitigate the risks currently faced by the rail industry in Moldova. Current difficulties are a combination of factors such as the continuous decline in transported volumes, obsolete and under-financed infrastructure and rolling stock, aging and unmotivated staff, low operational productivity, and unsatisfactory financial performance. The “do nothing” scenario in this situation is the most dangerous approach which will perpetuate the vicious circle for CFM. Closing the financial year with financial losses forces the company to take undesirable cost cutting measures that have a negative effect on CFM’s ability to compete. Usually these measures mean cutting staff, but also reducing budgets for materials, spare parts, and consumables. This results in a lower labor productivity, poorer state of repair of the infrastructure and equipment, and ultimately, worsening of the services. The result of this policy will be a lower availability of assets and quality of services provided to the customers. The direct consequence will be less customers every year, lower revenues, lower capacity to pay salaries, and less budget for maintenance

of assets and acquisition of fuel. It creates a downward vicious circle until the company is forced to stop its activities.

GENERAL RAILWAY SECTOR REFORM CONCEPTS

General Railway Sector Restructuring Principles in Moldova

103. Government should urgently start the process of restructuring the railway system. The negative trends in the railway industry of Moldova highlighted in the previous chapter are not putting in danger only CFM, as the provider of railway transport services, but also have a much larger impact on the entire country, affecting the economic development of Moldova. Economic opportunities are related to the mobility of people and goods, and robust development requires a strong transportation system. Efficient transport system reduces costs in many sectors, providing enhanced economic and social opportunities and benefits, while inefficient transport systems increase these costs. In this context, a profound reform of the railway industry in Moldova is urgent for the revival of the sector and for supporting the development of Moldova. In the process of revival of the railway sector, the Government and Parliament of Moldova must play a leading role to champion the framework and policies that are needed for CFM to develop and implement the reforms.

104. Railway reform is a complex process with no single solution. The railway sector reform is a process that needs to be designed by each country depending on the local conditions. Even if specific policies and solutions must be specific, experience on the subject matter offers a common set of required actions that can be identified for all countries that are embarking on a railway reform:

a) Clarify the role of the State in its relationship with the new railway company(ies) b) Addressing historical debts of the railway sector c) Adopt a commercial approach for all activities of the railway company(ies) d) Outsource non-core activities which are not financially viable e) Establish tariff policy consistent with the commercial approach of railway activities f) Implement reliable costing system in railway company(ies) g) Identify mechanisms for financing the public transport of passengers h) Identify mechanisms for financing the railway infrastructure i) Strengthen the corporate management of railways j) Implement mechanisms to measure the performance of railway company(ies) k) Decide on the role of the private sector in the railway sector

105. Clarify the role of the State in its relationship with the new railway company(ies). The State must establish the legal and regulatory framework to enable the restructured railway sector to assume its role as a provider of transport services. Under the new framework, the railway companies are no longer self-regulated entities with self-created conditions for providing transport services, customer rights, or safety standards. Policy and regulatory direction is given by the State and this enables it to provide direction on these and other matters. The restructuring process of the railway industry cannot start before creating the institutional capacity of the public sector to accomplish the multiple roles that the state must fulfill. These aspects are presented in detail in the next chapter of this paper (Government Role in enhancing Rail Sector Performance).

106. Address the historical debts of railways. In all countries, the traditional railways accumulated with time large debts to the State and to their suppliers (fuel, spare parts, materials, etc.). The railway sector reform had to include mechanisms for solving the historical debts, including cancellation of debts (partial or total) and/or re-scheduling of payments for a number of years. The newly created companies must start their activities without debts or based on an affordable payment plan of rescheduled debts agreed with the government.

107. Adopt a commercial approach for all activities of the railway company(ies). The key to designing and implementing the new structure of the railways is to adopt a commercial approach for all activities. In principle, it means to restructure the railway company along three major business units: (i) management of infrastructure, (ii) operation of freight transport services, and (iii) operation of passenger transport services. The staff and the assets shall be allocated to the three units, which will be in charge of developing their own business plans and their annual budgets.

108. Outsource the non-core activities that are not financially viable. The principle of commercial approach must include what to do with the non-core activities. The restructured railway companies may decide to keep in their structure the non-core activities which are proven as profitable (e.g. leasing of land or leasing of buildings). All non-core activities which are not profitable must be outsourced during the restructuring process. Being in competition with the road transport, restructured railways cannot afford to cross-subsidize loss-making non- core activities which historically have been developed by the traditional railway companies (hotels, hospitals, schools, resort locations, sport clubs, etc.).

109. Implement reliable costing system in railway company(ies). In order to be able to promote a commercial approach in the market and to establish accurate tariffs, railways must implement appropriate costing systems. Each of the lines of business of a railway company will need to design and implement its own activity-based costing (ABC) system. The ABC is a costing method that identifies activities in an organization and assigns the cost of each activity to all products and services according to the actual consumption by each. In a well-run railway, commercial managers need to know costs and financial performance for each market segment, disaggregated by route and other factors, sometimes even a specific train or freight customer. For freight customers services might be tailored, for example, to bulk freight customers, container forwarders, and general freight. Passenger services might include inter-

city, regional and suburban services. Each broad freight or passenger group will contain multiple market segments. This is not an easy job as the railways have many common costs (e.g. a railway line which is used both by passenger and by freight trains) and join costs (e.g. locomotives or train crews which are used for freight but also for passenger trains). The charts of accounts must be modified, and a specific methodology of cost allocation must be defined.

110. Establish tariff policy consistent with the commercial approach of railway activities. It is vital to give to railways more freedom to set up their tariffs. Tariffs for freight transport services should be established by the railway companies, based on their operating costs and taking into consideration the tariffs of the competitors in the market. The decreasing freight volumes transported by CFM illustrate that there is enough competition in the market to ensure that high non-commercial tariffs could not be sustained even if CFM would attempt to impose them. Of course, the railway regulatory entity will have an important role in supervising the behavior of railway company(ies) in the market, addressing the complaints against the abuse of monopolistic position, especially for the “captive” customers, which do not have the possibility to choose between more transport operators (e.g. mining products which cannot be transported by road). It is recommended that tariffs for passenger transport services be established by the railway companies, considering their operating costs for each type of services (short distance, inter-city, international). For the services which are socially necessary, but are not commercially viable, the government should establish the maximum level of ticket prices and the difference up to the tariffs calculated by the railway companies will be paid as a financial compensation to the railway company(ies).

111. Identify the mechanisms for financing the public transport of passengers. The EU approach to the railway system reform is based on the commercially driven concept. Most of the passenger transport services are not commercially viable, however, there are no governments in Europe prepared to take the extreme measure of cutting passenger services. On the contrary, the governments in the EU countries agreed to sustain this type of transport for social reasons (mobility of population, connectivity, access to work or schools, safer transport, reduced pollution and traffic congestion on roads). The railway companies (state- owned or private) can help in the accomplishment of these objectives; however, none of them (especially the private companies) are interested in operating loss-generating services. The set of documents adopted by the European Union for the Public Service Regulation helped railway companies from the member states by ensuring that governments have to specify ex ante what level of service they require and then agree with the selected operator on the associated costs. As a result, on the one hand politicians are confronted with the financial consequences of their political choices; while on the other, operators have strong incentives to meet the quantitative targets listed in the contract in a cost-efficient way. Addressing the important issue of passenger railway transport services requires a cultural change in the way the government acts as a client of railway transport services. In this capacity, the government must protect the users of social transport services by paying to service providers the right compensation for potential losses resulting from the difference between operating costs and revenues from regulated tariffs. The compensation is not for supporting the railway companies, but instead protects the passengers.

112. Identify the mechanisms for financing the railway infrastructure. The correct financing of the railway infrastructure adapted to the local conditions of the country is one of the crucial aspects of the railway reform. Road freight operators usually do not have to pay the full costs that they incur in the provision and maintenance of road infrastructure. Exceptions are the toll roads where the road operator finances all or part of the capital and maintenance cost of the road in exchange for availability payments or toll revenue, and the rest is provided from the public partner. In contrast, railway operators are often expected to finance the costs of infrastructure in full, from their own revenues, or at least to cover the full infrastructure maintenance and assets’ replacement costs. However, there are very few railways in the world able to pay the full cost of the infrastructure. As most of the costs of infrastructure are fixed costs, railways with a very high density of traffic (usually higher than 30 million traffic units per km of track) may self-finance the cost of infrastructure (see Box 2). The current railway traffic in Moldova, like most of the European railways, does not generate sufficient revenue to finance the railway infrastructure. In line with the provisions of the draft of the new Railway Code, the Government of Moldova is expected to adopt the European model for the railway infrastructure co-financing, as a prerequisite condition for starting the railway sector restructuring.

Box 2 – Railway Infrastructure Financing

There are very few railways which cover the full cost of infrastructure including the rebuilding of bridges, tunnels, track, and signal systems. In most cases, the governments contribute up to a certain level to support the investments in railway infrastructure, and even to support part of the maintenance works.

If we take as example the North American railways, which are on the top of financial and operational efficiency, not all of these companies are self-financing their track renewal works. The freight railroads in the USA are categorized into three classes based on earnings: 7 large Class I railroads, 21 regional/Class II railroads, and 547 short line/Class III railroads. Usually, the Class I Freight Railways are able to finance the costs of renewal of infrastructure, while the Class II and Class III often rely on state and local funding to finance their investments or even maintenance of infrastructure.

The U.S. passenger railway transport is financially much weaker. Amtrak, the most important passenger railway company in the USA, covered 94 percent of its operating costs in 2016 with ticket sales and other revenue, but does not own infrastructure and relies heavily on government funding for capital investments.

Most of the European railways finance from their own revenues only part of the current and periodical maintenance of infrastructure (through the track access charges collected from the railway operators). As a general rule, the governments support the rest of the operating costs of infrastructure and the investments. The EU Directive 2012/34 of the European Parliament and of the Council of 21 November 2012 establishing a single European railway area (recast) defines the obligation of states to take the responsibilities for the railway infrastructure. Nonetheless, even under this legal framework, when the market conditions allow, the governments incentivize the railway companies to take the responsibilities for financing of some of the track renewal works. There are certain European railways (e.g. France, Germany, Latvia) which are able to cover part of their investment needs from their own revenues, by using specific methodologies for the calculation of the level of track access charges and of state contribution for operating costs of infrastructure.

113. Strengthen the corporate management of railways. An enhanced governance structure of railway company should:

a) support efficient use of staff and assets;

b) ensure that management decisions are based on financial and efficiency measures, not political patronage;

c) enable a revamped Board of Directors to measure management performance;

d) incentivize a commercial- and customer-mentality for the operation of transport services; and

e) offer a system of incentives for managers who improve financial and efficiency outcomes.

114. It is highly recommended to enhance the competencies and objectives of the Board of Directors and to strengthen its oversight role by implementing the OECD Guidelines of Corporate Governance of State-Owned Enterprises. The strengthening of the management should be based on cultural changes beginning with implementing a performance-based management linked to pay incentives, enforcing a merit-based manager selection process, transparency of decisions, and accountability of managers. Mid- and upper-level managers, and railway engineers must acquire new skills to become market-focused business managers—familiar with business change management and commercial culture. They should be trained in up-to-date marketing, pricing, costing, finance, and customer service, in order to take the right decisions on market responsiveness of the company, staff rightsizing, asset rationalization, etc. All railway employees must become client-driven and business-oriented rather than production-oriented. These targets are not easy to be achieved but are critical for the successful railway reform.

115. Implement mechanisms to measure the performance of railways. Setting up annual rolling targets for improving operational and financial performance of railways is essential for measuring the performance of the organization. The management of the new railway company(ies) will need to identify a set of key performance indicators (KPIs) as tools for achieving a number of pre-selected goals. In this context, a sound system of KPIs will be necessary to serve three major purposes: (i) to Safety illustrate the performance of the railway company at a Competitiveness certain moment in time, vis-à-vis a set of Financial Sustainability established objectives, (ii) to show the evolution of Operational Performance the performance of the company in time, and (iii) Infrastructure Management to allow the comparison of the performance of the company with other railways in the world. In this context, a high-performing railway must be safe, commercially viable, financially sustainable, achieve high operational efficiency, and provide a good management of the infrastructure. For measuring the performance of the railway system in Moldova, the

indicators used in the present documents (traffic density on infrastructure, productivity of assets and staff, availability of assets, financial performance, etc.) are very useful examples to be followed in setting up annual targets for CFM. Realistic targets must be defined to bridge the gap in performance compared to the EU railways. A sound KPIs system will include a limited number of indicators assigned in line with the following ideas:

a) specific KPIs shall be allocated to specific units of the company,

b) the management of each unit will receive the necessary resources under their control to achieve the targets specified by the KPIs,

c) the staff and management of each unit will become accountable for fulfilling precise targets,

d) the railway company will become more results oriented.

116. Decide on the role of the private sector in railways. The government must decide in the early stage of defining the strategy for the railway sector restructuring what role will be allocated to the private sector. There are many forms of attracting the private contribution to railway industry: management contracts, concession of some operations, full privatization of some activities. In Europe, there are good examples of privatization of passenger and/or freight transport services, forms of PPP for infrastructure management, privatization of maintenance activities for rolling stock or for infrastructure, etc. In general, the EU member states opened the market for private operators for freight or passenger transport services but preserved a state-owned national operator (with very few exceptions).

Enhancement of Rail Sector Competitiveness in Moldova

117. Strategies to improve the competitiveness of rail. There are three broad strategies that CFM can use to improve its competitiveness, as the paramount goal of the restructuring program. The first involves capital investments that improve quality of service while limiting long-run marginal costs. The second is modifications to operations that will increase efficiency and quality of services. The third is introduction of a system of pricing based on competitiveness and quality of service.

118. Capital Investment. The railway reform is not possible without targeted investments identified in the early stages of the reform. The challenge in developing an investment strategy is to prioritize the investments according to their impact on operational and financial performance of railway. The investments need to be directed to the modernization of the railway infrastructure and of the rolling stock: a) Infrastructure. Presently, the government of Moldova started a program for capital investment, funded by EBRD, which includes a major renewal of the track connecting

Bender to Giurgiuleşti. The information on the impact of this section of track on overall network performance and quality of service is limited. Furthermore, the government and the CFM must clarify which other sections of the railway network need investments, and to develop programs for the improvements in track maintenance to reduce the deterioration in the rest of the network, as well as to ensure that the sections being renewed are properly maintained. b) Locomotives. One of the major bottlenecks in the competitiveness of CGM is the low reliability of the locomotives, which limits the number of train movements, increases transit times and reduces the reliability of service and productivity of the rolling stock. The procurement of twelve new locomotives should significantly improve the quality of service. A reformed CFM must be capable to generate sufficient revenues to finance further investments for the modernization of the fleet of locomotives. c) Shunting Locomotives. An important factor affecting the productivity of the rolling stock is lengthy turnaround time in the rail yards. This has several causes, one of which is the lack of shunting locomotives. While there has been some discussion of the requirement for new shunters, there has been no analysis of their impacts on performance in the railyards. New shunters could be procured by CFM, but there would be benefits to allowing private locomotives to be used for this purpose. d) Wagons. The railway traffic in Moldova has an important transit component (more than 40% of the traffic). Currently, CFM suffers of shortage of wagons certified for operation in Ukraine and Romania. The current shortage affects specialized wagons, e.g. hoppers, and has the biggest impact on large shippers. Since the CFM has limited financial resources, future investment in wagons will likely be made jointly with the private sector. In parallel with this, the CFM should adjust its tariffs to encourage private investment while simultaneously leasing part of the existing fleet to domestic shippers.

119. Increase efficiency and quality of services. While capital investment can play an important role in improving the quality of service, they should be complemented by improvements in both operations and maintenance. The following enumeration presents the major directions of action for improving operation practice: a) The scheduling of train movements and allocation of wagons. Problems with equipment availability have prevented implementation of an effective computer-based system for planning operations and dispatching equipment. It has also increased reliance on station masters to arrange last-minute delivery of wagons based on verbal and written instructions. b) The scheduling of availability of equipment. In order to benefit from the investment in locomotives, a new system will be required not only for managing rail services but also for scheduling equipment availability. It will allow to implement a program of scheduled maintenance that reduces the current reliance on repairs to insure equipment availability c) Management of loading / unloading activities. The typical turnaround time for wagons is 10 days even through the transit time for a round trip is typically 2-4 days. Most of the time is spent repositioning, loading and unloading wagons. Since the private sector is responsible for this activity, it should also be responsible for procurement of cargo- handling equipment. The CFM can provide incentives for this investment by introducing

a fixed schedule for train movements and increasing demurrage charge on CFM wagons waiting to be loaded or unloaded. d) The scheduling of track maintenance. At present, there does not appear to be a problem with track capacity, but the practice of deferred maintenance has created a serious risk that it will become so in the future. For this reason, a schedule for maintenance and renewal that is prioritized according to projected demand needs to be implemented. Priority should be based not only on the volume of traffic on different corridors but also on the importance of time and reliability for the cargoes being shipped. Furthermore, expenditures for maintenance should be given priority over proposed investment in additional track capacity.

120. System of pricing of services. A review of the tariffs is highly recommended. Any adjustment should be consistent with a strategy for improving the quality of service rather than simply applying accounting formulae. This requires a shift in emphasis from rail transport as a commodity to rail transport as a service. This should be supported by an analysis of the shippers’ requirements in terms of volume, consistency and predictability. Different strategies would apply for individual origin-destination. Given current problems with level of service, the rates could be differentiated by quality of service offered to individual shippers. While such an approach is preferable to the current rationing of equipment and services based on the order of receiving requests and subjective criteria, it would not be required once the quality of service improves.

121. Recommended initiatives to support the three proposed strategies. The following initiatives are recommended to support the development of the strategies for increasing the competitiveness of the railway transport services: a) Financial and operational analysis of potential capital investment in equipment, b) Technical assistance to improve CFM’s ability to allocate locomotives and rolling stock and to maintain track and equipment, and c) A multi-year plan for and essential short-to-medium term maintenance of sections of the rail network as well as renewal of critical sections

122. Financial and operational analysis of potential capital investment in equipment. Among the capital investments to be evaluated are those required to meet short and medium-term requirements for shunting locomotives, wagons for handling domestic and export traffic, rail yard equipment for loading/unloading wagons and improvements in gauge-change equipment. The required investments should be determined based on four assumptions regarding future operations: a) Efficient allocation of the new locomotives, b) Improvements in scheduling and coordination of train movements, c) Increased private sector investment in rolling stock and cargo-handling equipment, and d) Provision of rolling stock and gauge-change equipment by railroads in neighboring countries. The evaluation of these investments should take into account not only benefits from improvements in performance and reduction in life-cycle costs but also the impact of financing requirements on CFM’s short-to-medium term cash flow.

123. Technical assistance to improve CFM’s ability to allocate locomotives and rolling stock and to maintain track and equipment. The technical assistance should be in the form of foreign advisors seconded to the CFM. They would provide guidance in developing procedures and introducing ICT systems to improve a) Scheduling and dispatch of locomotives and rolling stock, b) Scheduling, monitoring and evaluation of maintenance of equipment and track, c) Setting of tariffs and monitoring financial performance, and d) Client management. They would also assist in introducing a system for collection and reporting of data as part of a system of management by KPIs

124. A multi-year plan for short-to-medium term maintenance of sections of the rail network as well as renewal of critical sections. This would take into account not only the impacts on to handle future traffic but also budgetary constraints. The plan would be prepared by foreign consultants and include: a) Forecast of demand for train movements on different sections, b) Calculation of the time and cost for improvements in separate sections of the network, and c) Analysis of the impact on the routing of major cargo flows in terms of time and cost. Alternative plans would be prepared based on different scenarios for projected demand and budget constraints.

Government Roles in Enhancing Rail Sector Performance

125. Governments pursue the public interests in the railway transport. For the transport industry as whole, public interests are that: (i) the transport industry should be efficient, (ii) it should be responsive to market needs, (iii) it should be affordable to the public and (iv) that it should be safe and meet Moldova’s environmental standards. The Government of Moldova must enhance its institutional capacity to fulfill these roles.

126. The various roles of the State in Moldova’s rail industry—policymaker, regulator, owner, and client require a cultural change as the Government has to optimize the balance among public policy choices, entity management constraints, and available fiscal space. In addition to the cultural change, the proper institutions must be established within the government so that the State can fulfill the following roles:

a) As policymaker, the Government must establish the strategies for the development of the railway sector as part of the transportation sector, including setting levels of State support for railway infrastructure and for passenger services socially necessary.

b) As regulator, the Government must create the environment for economic and environmental regulations, safety supervision, and protection of the transport participants against discrimination in the market.

c) As owner, the Government must enhance the corporate governance mechanisms and skillfully supervise the transport companies—defining annual targets for the railway industry and holding management accountable by monitoring performance outcomes— without meddling in management decisions.

d) As client, the Government must put in place transparent contractual relationships with railway company(ies) selected to: (i) provide public passenger transport services requested by the State, and (ii) to manage the railway infrastructure.

127. Clear separation of the role of the State and of the railway companies. The new framework for the restructured railway industry defines a new relationship between the railway company(ies) and the State. The State will manage the railway system by playing its roles as defined above and will supervise the activities and performances of the state-owned railway without interfering in its day-to-day management. Wisely selected KPIs will be a strong instrument for the government to supervise the activities of the railway companies. According to the new legal framework, the railway company(ies) will act exclusively as a service provider. This will make the railway company management accountable for their results and will reduce the risks of interference of the Government in the management of railway business.

Government as Policymaker

128. The recommended objective for the Government as policy maker in the railway industry is to create a railway sector that is: (a) market effective—producing services that customers value and use, (b) cost efficient, and (c) financially sustainable. This requires policies that target limited Government funds for the services most valued by customers, and policies that use the Government’s roles in setting the industry structure, purchasing services, and exercising ownership oversight to create incentives for cost efficiency and financial sustainability. Governments exercise their roles in the railway industry through the line ministry, which in case of Moldova is the Ministry of Economy and Infrastructure (MEI).

129. Develop a financially sustainable core railway network. Currently, the railway network in Moldova seems large relative to the amount of traffic carried by CFM. The existing costs for maintenance, traffic control, station operations, and security are difficult to be justified by existing traffic volumes. Overall, the density of traffic was 882,526 traffic units/km of track in 2018 representing approximately one third of the EU-28 railways’ average traffic density. To increase the traffic density and reduce the costs of railway infrastructure, the Government should evaluate the realistic increase of traffic over the coming years and identify if there are unproductive railway lines to be closed for operations. The infrastructure investment funds should be targeted to the financially sustainable core network of Moldova.

130. Identify the sustainable passenger railway transport services. The Government of Moldova will have to promote the social agenda for passenger transport, while a thorough assessment

of the modal shift between road and rail transport should be considered. Therefore, when the Government wishes to support access and mobility for the low income, elderly, or isolated populations, it must assess options and identify the cases when better value for money will be achieved through using roads instead of rail transport. For the situations when railways are identified as the preferable mode of transport, the policy of fair compensation of the railway company(ies) must be put in place.

Government as Buyer of Services

131. Public funds are allocated by the governments to buy services from the railway industry. As it was already presented in this paper, governments transfer public funds to railway company(ies) for two major activities: (i) maintenance and investments in railway infrastructure, and (ii) provision of passenger transport services which are commercially not viable but are necessary for social reasons. Governments in various regions of the world use various mechanisms for these transferred funds, in most cases on contractual basis with the service providers. In the case of Moldova, it is recommended to use the well-known instruments used by the EU countries: (i) the Public Service Contracts (PSC), and (ii) the Multi- Annual Contracts for Railway Infrastructure (MAIC). These instruments must be used by the Government to support achieving of its goals for the railway sector, as follows:

a) Market effective - using the available public funds to support services most valued by citizens and creating incentives in the contracts for good quality service;

b) Cost efficient - creating incentives in the contracts for cost efficiency of rail companies;

c) Financially sustainable - ensuring that the services purchased under the contracts are fully funded.

132. Multi-annual contracts for rail infrastructure (MAIC) represent a long-term financing arrangement for infrastructure maintenance and for investments signed by the EU states (owners of railway infrastructure) with the railway infrastructure manager. The MAIC describes the policy goals of the State for railway infrastructure and the necessary activities for achievement of these goals, the level of track access charge and of other charges for various services offered by the infrastructure manager, the contractual obligations of the infrastructure manager regarding the quality of the network, and the budget provided by the Government to achieve these goals. The MAIC is signed for a period of 4-5 years and includes performance indicators to measure the quality of infrastructure services and performance incentives for the infrastructure manager. MAIC must be used as an instrument for efficient utilization of public funds. The prerequisite for public financing of railway infrastructure is that operational KPIs confirm that the railway company is well managed (no public financing for wasted resources or for poor management practices).

133. Contractual relationship for the provision of socially necessary passenger transport services by rail. The Government should implement Public Service Contracts for the passenger

transport services which are not financially viable but are socially necessary in Moldova. The Government shall elaborate a detailed service plan under budget constraints based on comprehensive studies of the number of passenger trains to be operated on each transport link on the railway network. Local governments are an important stakeholder in this process; they should be consulted on their needs and they may have to consider financial contributions for services they deem necessary. The adequate KPIs will allow the Government to measure the quality of the services provided by the railway companies and to make payments only if the agreed conditions are fulfilled.

Government as Owner

134. CFM’s corporate governance structures could be enhanced through (a) appointing highly qualified, professional, independent boards with non-executive directors, and (b) establishing adequate board committees. CFM should be prepared to implement IFRS- compliant financial statements, and in order to improve transparency and disclosure of information, should make the IFRS-audited financial statements easily accessible to the public. 135. To enhance the commercial management of the railway entities, MEI, as the owner, should set general goals for CFM, appoint the board members, and hold them accountable for results. MEI shall promote its sector goals by reflecting them in the objectives established for the companies. The Board should require management to produce regular business plan updates that cover the companies’ markets, human resources, other operating costs, investments and finances, and present how the entity will be financially viable over the coming period. These business plans should be consistent with the Multi-Annual Contract for Infrastructure and with the Public Service Contract, as agreed with the Government.

Government Institutional Capacity Strengthening

136. The Government must adopt adequate organization and hire skilled experts to be able to manage the new relationships with the railway industry. The Government’s new relationships with the railway transport system will be based on transparent allocation of important public funds for the railway infrastructure and for the operation of railway transport services. Therefore, the Ministry of Economy and Infrastructure will need to strengthen its institutional capacity to develop railway transport policies, negotiate on equal terms with the railway companies affordable Multi-Annual Contract for Railway Infrastructure and Public Service Contracts, and exercise stewardship of state ownership rights in the state-controlled railway companies. To address these problems, MEI needs to create adequate departments in this structure and to appoint skilled staff with responsibilities, authority, and adequate professional qualifications to carry out these responsibilities.

ORGANIZATION FORMS TO SUPPORT RESTRUCTURED RAILWAYS

137. Organizational structure of railways provides the general framework for implementing the railway reform. Any restructuring process includes actions for the identification of new forms of organization of the companies to better respond to the reform challenges. In many cases, the organizational aspects dominate the restructuring debates, and critical activities of the restructuring process are neglected. A specific organizational structure of a railway can support the implementation of the reform but does not address the specific reform challenges. Simply adopting a new organizational structure of CFM will not solve the poor technical status of its assets, the poor quality of services, market shrinking, financial losses, and all other challenges highlighted by this document.

138. Various solutions for reorganizing the railways. Presently, there are many forms of organization of railways in the world (vertically integrated companies, companies for transport services separated from the infrastructure management, single or multi-railway companies in competition between themselves, state-owned or private railway companies, etc.) and debates remain open on which the best form of organization is.

Box 3 – What railways carry the world’s rail traffic?

More than 97% percent of traffic is carried on networks owned by vertically integrated railways.

Around 2% percent of passenger traffic and 40% percent of freight traffic (heavily concentrated in North America) is carried by private railways.

The EU railways operate about 6% percent of the rail’s world traffic (freight & passengers).

139. The main element which makes the difference between a traditional railway and a restructured railway is not the organizational structure, but the business-oriented approach. All restructured railways in the world, vertically integrated or separated, state- owned or private, follow, in one way or another, a common organizational pattern for implementing the business-oriented approach. A vertically integrated structure for a railway company is as good as an unbundled structure or any other forms of organization, as long as the following are put in place:

(i) Structure the railway departments on business units around the three major activities:

a) Management of railway infrastructure

b) Operation of Freight transport services

c) Operation of Passenger transport services

(ii) Allocate to each business unit of the company:

a) the necessary assets for the scope of its work,

b) the related human resources, and

c) the related operating costs.

(iii) Allocate the operating costs to specific activities (Activity Based Costing - ABC29) for each of the three major activities:

a) Management of railway infrastructure

b) Freight transport services

c) Passenger transport services

140. Organization of the restructured railways outside of the EU. The restructured railways outside of the EU are all business-oriented companies organized in various forms, in order to better answer to their commercial interests. In most cases they are organized as vertically integrated companies. It means that the railway companies include in their structure the management of the infrastructure and the operation of freight and/or passenger transport services. However, this is not always true:

a) In North America (USA and Canada) the freight railways (more than 650 companies in total), are fully private and include also the infrastructure in the same organization, while the passenger railways, which are state-owned companies usually do not own infrastructure, but they get the right to use the infrastructure of the freight companies30.

b) In Asia, the major railways of China and India are state-owned and vertically integrated companies, while in Japan there are more than 100 railway companies, all private and all owning their own infrastructure as vertically integrated companies.

c) In Australia, there is a single major state-owned company that owns, leases, maintains and controls the majority of railway infrastructure (main line standard gauge railway lines on the mainland of Australia), and many state-owned or private railways separated for freight or passenger transport may use the infrastructure. There are also a number of vertically integrated freight and passenger railways in Australia.

d) In Europe, outside of the EU, the important railways (Russia, Ukraine) are state-owned and vertically integrated.

29 The ABC is a costing method that identifies activities in an organization and assigns the cost of each activity to all products and services according to the actual consumption by each. In a well-run railway, commercial managers need to know costs and financial performance for each market segment, disaggregated by route and other factors, sometimes even for a specific type of service, specific train or customer. 30 Amtrak, the main railway passenger company in the USA has also some lines under its management, but most of their services are provided by using lines owned by the freight railways.

e) In Africa, the largest railways of Egypt and South Africa are state-owned and vertically integrated. However, the large majority of the rest of African railways are operated under concession agreements with private operators, which are in charge of both infrastructure and transport services.

141. The specific organization requirements for the EU railways. The EU model for railway industry follows the same commercial principles as the restructured railways in North America, Asia, Africa, or Australia. It has the same final scope to put in place financially sound railway companies, free of debts, competitive in the transport market, and able to generate profit. But, beyond these objectives, the EU has the scope to achieve the integration of the railway industry across the entire Union. The key principles which lie at the heart of the EU and underpin the single market, are the freedom of movement of goods, people, services, and capital over borders. The separation of the infrastructure managers from the operation of transport services and the open access for all licensed railway operators (state- owned and private) over the entire railway network of the EU, are the specific instruments used for the integration of the railway industry in the EU. Vertical Separation and the Open Access are instruments for the transport market integration of the EU countries, but they do not provide by themselves miraculous solutions to the complex railway reform issues.

PROPOSED ACTIONS FOR RAILWAY SYSTEM RESTRUCTURING IN MOLDOVA

Organizational Forms for Supporting Railway Restructuring Process

142. Open issues concerning the railway reform in Moldova. The most discussed subjects concerning the restructuring of the railway system in Moldova are not related to the methods of reducing CFM’s operating costs and increasing its competitiveness, but to the appropriate organization form. In this context, discussions are focused on the concept of railway unbundling, open access to infrastructure, and role of a potential independent Traction Company.31 The following paragraphs provide support information for correct decision- making on the choice of the organizational forms which shall better support the railway reform in Moldova.

143. Is the unbundling of railways necessary? Traditional railway companies are a mixture of very different activities: maintenance of infrastructure, traffic management, provision of passenger transport services, provision of freight transport services, maintenance of locomotives, wagons, or coaches. These activities require staff specialized in different domains, specific organization of specialized units, and specific management skills. For a

31 The creation of a separate Traction Company has been considered by the Moldovan Government during the implementation of the assignment

modern railway company, it is key to introduce a certain unbundling of such different activities in order to better and more efficiently manage the entire organization. This process happened all over the world starting in 1970, first in North America, and then in Europe and other regions of the world.

144. What type of unbundling of the railway system? There are two important aspects to be considered on the railway unbundling. Firstly, there is no one single solution for the unbundling of the railways and the decision must be taken based on the specific conditions of each country. Secondly, there are two types of unbundling to be considered: (i) financial unbundling, and (ii) institutional unbundling.

145. When to implement the financial unbundling? The financial unbundling along the main lines of business (Infrastructure, Freight, Passengers) is a required condition in the early stages of the reform, no matter what organizational solution will be finally adopted. It facilitates the reform of the costing system and the correct allocation of costs to the separate lines of business. It is not possible to approach the restructuring of the railway companies without a financial unbundling of specific activities. We strongly recommend accelerating the implementation of the financial unbundling at CFM, which means the quick implementation of the first two stages of the railway reform proposed by the EGIS & KPMG study (corporatization – operationalization).

146. When to implement the institutional unbundling? The institutional unbundling of the railway infrastructure from the transport operations is absolutely necessary only when the open access to infrastructure is granted, and more operators are licensed to compete with each other in the market. The open access is a specific requirement for the railways in the EU member states.

147. The government of Moldova signed in 2014 an Association Agreement with the European Union which includes a number of legal and institutional reforms; the Annex 10 of the Association Agreement enumerates the specific provisions of selected directives and other documents of the European Union for reforming the railway sector in Moldova. The agreed reforms do not include the obligation of Moldova to introduce the open access for international railway operators. In this context, it is the decision of the government of Moldova to decide what will be the best timing for the implementation of the institutional unbundling – open access – private operators triad, based on the assessment of the following factors:

a) poor technical status of the railway transport sector,

b) very limited market dimension (around four million tons transported per year) vis-à-vis of the large capital costs necessary for new operators on the market,

c) current status of Moldova as non-EU member state, and

d) CFM’s lack of competitiveness in a potential open market

148. Is there a best solution for the institutional unbundling? The mode of achieving the institutional unbundling of railways is one of the most disputed decisions on the railway reform in all of the EU countries. It raises complex implementation issues and may generate strong resistance in the railway community. The setting up of independent entities for the management of infrastructure, and for the provision of passenger transport services, and the provision of freight transport services can be achieved in many ways in the EU. Currently, there are several models of organization of railways in place in the European Union member states under the umbrella of the institutional unbundling principle (see Figure 46 below).

Figure 46 - Mode of Implementation of Vertical Separation Principle and Open Access in EU-28 [Source: CER - Public Service Rail Transport in the European Union: An Overview – June 2017] Domestic N Country Infrastructure Passenger Freight Pass Open o. market 1 Austria OBB Y 2 Belgium INFRABEL SNCB N 3 Bulgaria NRIC BDZ Y 4 Czech Rep SZDC CD CD Cargo Y 5 Croatia HZI HZP HZC N 6 Denmark Banedanmark DSB Deutsche Bahn Y 7 Estonia EVR Various Operators OpeRail Y 8 Finland Finish Transport Agency VR N 9 France SNCF N 10 Germany Deutsche Bahn Y 11 Greece OSE TrainOSE (bought in 2017 by FS) N 12 Hungary MAV MAV START OBB Y 13 Italy FS Y 14 Ireland IR N 15 Latvia LDZ Y 16 Lithuania LG Y 17 Luxemburg SNCFL N Nederlandse Y 18 Netherlands Railinfratrust Spoorwegen Deutsche Bahn 19 Poland PKP Y 20 Portugal IP (for road + rail infra) CP Various Private N 21 Romania CFR CFR Călători CFR Marfa Y 22 Slovakia ZSR ZSSK Passenger ZSSK Cargo Y 23 Slovenia SZ N 24 Spain ADIF RENFE N 25 Sweden Swedish Transport Adm. SJ Y 26 UK Railtrack Various Private Various Private Y Legend Single rail company with separate business units for Infra., Freight, and Pass. Governmental Agency, not SoE for infrastructure management Institutional fully separated entities NOT open access for domestic passenger services (June 2017)

149. Very different institutional unbundling adopted by the EU member states – all in line with the EU Model for Railways. As shown in Figure 46 above, ten countries (marked in green in the table above) adopted a model with a vertically integrated railway with separate companies (various forms of subsidiaries) for the three major activities. Among these are some of the most important railways in Europe (France, Germany, Italy, Austria). Other six countries have chosen to separate only Infrastructure and to keep freight and passenger transport activities in the same company. Finally, nine countries (marked in blue in the table above) opted for full institutional separation on infrastructure manager, freight operators, and passenger operators.

150. What is the solution for the institutional unbundling of the railway in Moldova? As it was already presented, the documents elaborated in Moldova support two different solutions:

a) institutional unbundling based on three independent companies organized as CFM’s subsidiaries is proposed by: (i) the Study for the Restructuring of the Railway Sector in Moldova CFM, financed by EBRD, and (ii) the 2018-2021 Railway Sector Restructuring Concept, approved by the Governmental Decree 1042 of 2018. This solution is close to the concept currently adopted by ten EU countries, including Austria, Germany, France, and Italy. b) institutional unbundling based on three independent companies and CFM’s dissolution is proposed by: (i) the Decree 385 to approve the Action Plan for the Implementation of the 2018-2021 Railway Sector Restructuring Concept, and (ii) the drafted Railway Transport Code. This solution is close to the concept adopted by nine EU countries including Croatia, Netherlands, and Romania.

Both solutions are correct and in line with the EU legislation and both have advantages and disadvantages. We appreciate that the institutional unbundling model under the coordination of a single company proposed in the study supported by EBRD fits better to the current conditions in Moldova. The following chapter includes few considerations for the evaluation of the two solutions described by the documents elaborated or approved by the Government of Moldova and for final decision-making.

How to Achieve Railway Institutional Unbundling in Moldova?

151. Discussion on the proposed institutional unbundling. Two types of institutional unbundling are under discussion: (i) institutional unbundling into a number of separate independent companies,32 or (ii) institutional unbundling as one company with different independent divisions33 (subsidiaries). Here are some considerations for choosing between the two solutions (both solutions under discussion are compliant with the EU requirements).

152. Institutional Unbundling into independent companies

32 E.g. Croatia, Denmark, Netherlands, Portugal, Romania, Slovakia 33 E.g. Austria, France, Germany, Italy, Poland

a) Pros: ▪ It is the preferred solution by the staff of the European Commission ▪ Offers a more transparent use of public funds allocated for infrastructure and passengers ▪ Best solution for the full privatization of all railway transport services, while the infrastructure remains public

b) Cons: ▪ In countries with small railways, the costs of separation appear to be disproportionate to its potential benefits: — three Boards of Directors, three management teams, three corporate structures, — complex contractual relationships between parties for utilization of common assets (shops, depots, stations, etc.) ▪ Legal separation of assets between companies takes a long time ▪ Requires stronger supervision of safety issues due to the shared responsibility between more parties involved in transport activities ▪ The investment programs are not always corelated between the companies (increase in infrastructure capacity vis-à-vis increase in fleet, or procurement of rolling stock fitted to the infrastructure characteristics)

153. Institutional unbundling into independent companies as CFM's subsidiaries

a) Pros: ▪ More easily accepted by the railway staff as it maintains an easier control of existing technical interdependencies in the railway activities (e.g. wheel – track contact, correlation of investments, easier shared access to common resources, etc.) ▪ Less complex and less costly to be implemented ▪ More appropriate structure for the limited railway market in Moldova

b) Cons: ▪ Additional national authority necessary for allocation of railway track slots ▪ Requires legislation for holding structures in place ▪ Not the preferred solution by the European Commission ▪ These companies maintain a stronger hold to market access limiting other operators and use of competitive PSO

When to Open Access to Railway Infrastructure in Moldova?

154. EU introduced the Open Access concept for creating a single railway transport market. The open access allows any number of railway operators licensed in a member state to circulate on any route across the EU railway network without any discrimination. The importance of

the open access for railways is mainly related to the general principle of single railway transport market across the EU, required by the political and economic integration.

155. Discussion on the timing of open access in Moldova. There is no question that establishing rail open access in Moldova is part of the process of European integration. The real question is choosing the right timing for granting access to more railway operators in Moldova. The following aspects must be evaluated before making a decision on this matter:

▪ The adoption of open access is a mandatory requirement of the EU for all its members and will transmit a strong signal to Brussels about Moldova’s commitment to joining the EU

▪ Open access creates the legal conditions for the private sector (domestic and international) to enter the rail transport market in Moldova without any discrimination

▪ The competition created between multiple railway operators in Moldova will induce better quality services and lower transport charges

▪ Multiple operators in Moldova may generate additional revenue for the infrastructure manager and increase rail network utilization (if the current annual volume of about four million tons will increase significantly to provide an important share to each of them to cover the operating costs).

▪ The transit and import traffic, currently the most profitable business of CFM, will become an important target for the international railway operators. This traffic would be easily lost by a fragile CFM if the open access is granted before the consolidation of the company's operational and financial performance. The Government must consider what would be the implications of losing this traffic to international or new cargo operators. In addition, the Government must determine what will be the role of the reorganized cargo company in the new railway setting and if public ownership and protection is granted in order for the important strategic policy objectives to be achieved.

▪ Moldova is not yet a member of the EU and opening of the market before the EU accession will not bring similar advantages to CFM as to the railways of the member states. In general, the new member states of the EU asked to delay the open access in order to consolidate national railway carriers.

▪ Consequently, it is important to assess carefully the right timing for opening of the market for freight transport and for domestic passenger transport.

156. Decision to open the market will be taken by the Government. Based on the elements presented above, it is recommended to implement the restructuring program in more steps in time:

a) The first step should be the financial unbundling, which will be implemented in parallel with the profound reform addressing the poor operational and financial performance of the CFM and with important investments in infrastructure and rolling stock. b) The second step should be the institutional unbundling by putting in place subsidiaries of CFM for management of infrastructure and for the provision of freight and passenger transport services c) The third step should be the opening of access for more operators on the railway infrastructure of Moldova.

157. The implementation of the first step will reconfirm Moldova’s political commitment to the EU integration and will mark the fulfilment of the provisions of the Association Agreement with the EU for the railway sector. The continuation of the reform with the steps two and three must be carefully planned by the government of Moldova and be implemented at an appropriate time in line with the progress of the political agreements for accession of the country to the European Union while also allowing CFM to compete in an open environment.

Is Separate Traction Company Useful in Moldovan Context?

158. Is it appropriate for Moldova to consider an independent Traction Company? One of the ideas expressed during the dialogue with the stakeholders engaged in the railway restructuring process in Moldova was the intention of putting in place an independent Traction Company. This topic also needs to be debated, not simply as an organizational variant, but considering the benefits to getting a higher operational and financial performance of the restructured railway system as a whole.

159. The study Restructuring of the Railway Sector in Moldova (CFM – Roadmap for Restructuring, funded by EBRD), addresses the idea of an independent traction company and explains that it is not a recommendable solution for the specific case of Moldova. We fully concur with the opinion expressed in the study and we advise against the creation of an independent traction company in Moldova, for the following reasons:

a) The railway sector in Moldova requires a very small fleet of locomotives, which does not motivate the creation of a separate company for their management.

b) Traction Company will be the only supplier of traction services in Moldova (a classical monopolistic structure) and will provide services without having direct contract with the transport market. However, the traction activities are tightly related to the operating costs of the transport service and represent an important share of the operating costs of railway operators (allocation of locomotives, allocation of crews, fuel consumption, maintenance cost of locomotives, etc.). A separate Traction Company will obviously add its administrative costs to the transport services, making railway transport less competitive, no matter what their business approach will be:

▪ The natural interest of the Traction Company will be to cover its operating costs which are not driven by the market, but by its internal cost centers. Being interested in their own profit, its traction tariffs will have negative impact on the total cost of transport services provided by the Freight and Passenger companies

▪ Even if the Traction Company would be perfectly market oriented and will establish its tariffs considering not its own profit (which is very unlikely to happen!), but the benefit of the Freight and Passenger companies, it will still add its own administrative and management costs, which do not exist if the traction activities would be part of the Freight and Passenger companies

c) The Traction Company will provide locomotives mostly for the freight transport as the passengers will probably focus with time, for commercial reasons, mainly on DMU trainsets (it means Traction Company will most probably have only one customer!)

d) Independent Traction Company will not be able to develop investment plans for acquisition of new locomotives as only the railway operators will know their needs depending on their business plans.

e) It will be very difficult for the railway operators to execute their business plan as the provision of transport services depends on a different company (e.g. imagine a bus transport company providing transport services when it does not own buses or drivers!).

f) Each time the Freight Company would face financial difficulties, it would postpone the payments for the services provided by the Traction Company, causing it to always face serious financial distress. The Traction Company in Moldova (with only one or two customers) will always find it challenging to convince the commercial banks about its financial reliability in order to get loans for its recurring activities or investments.

g) The setting up of an independent Traction Company in Moldova would create a monopolistic entity in the newly restructured railway market, which would by definition be contrary to the main scope of the railway reform to eliminate the monopolistic structures and create competition between multiple service providers.

h) The attempts in Bulgaria and Croatia to create an independent Traction Company failed in about two years after the setting up of the company, with traction activities currently incorporated in the independent companies for Freight and Passenger transport.

RAILWAY REFORM IMPLEMENTATION

160. The implementation of the railway reform is a very complex process, which may create the risk of endless debates on the best solution to be adopted. The reform of the railway sector is a very ambitious project in any country and the decisions on its structure and

implementation require a broad political consensus and strong support. Currently, there is no one single “correct” answer (one size fits all approach does not work!) and not all reform processes in the world have been equally “successful”. However, no one railway is currently in a worse situation than before starting the reform process; the only option for guaranteed failure is the lack of action and delay in the reform.

161. Major role of the policymakers in railway reform. It is not possible to develop and implement a profound railway sector reform without a strong support of the policymakers. The actions or the lack of actions on the side of the Government will have a decisive role in boosting or hindering a successful railway industry. It is the task of the Government and Parliament to agree on a clear transport strategy, and to support its implementation over a minimum 5-7 year period, without making major revisions to the strategy.

162. Recommended set-up for the implementation of the reform. The following conditions must be fulfilled for putting in place a successful strategy for the implementation of the railway reform:

163. Condition 1: Create the adequate political and social environment for the implementation of the railway restructuring in Moldova. Here is a highly recommended set of actions for mitigating the inherent risks of managing the railway restructuring:

c) Secure a broad political support for the railway sector reform before starting the process

d) Agreement in the Parliament for a minimum 5-7 years period of continuity in the policies for the implementation of the railway reform. Continuity of the process is essential.

e) Appointment of the new railway entities’ governance bodies, which are fully convinced of the advantages of the restructured railway sector and committed to implementing the provisions of the agreed Action Plan

f) Elaborate a Comprehensive Action Plan with measurable results every 6-8 months to give a boost to the expectations of all parties involved (policymakers, Government, public, railway staff, etc.) to sustain the reform

g) Prove flexibility in making corrections to the proposed restructuring solutions based on the feedback from the railway system or transport market

h) Explain on an ongoing basis the advantages of the restructured railway sector to the railway staff and public, in order to reduce the resistance to change (there was strong resistance to the reform in all EU railways, without any exceptions!)

i) Invest in creating a new market-oriented mindset of the railway employees

164. Condition 2: Put in place a Railway Reform Steering Committee. The MEI must appoint by a ministerial decree a permanent body to manage the railway reform. This body must include experts from the Government (MEI, MoF, and others) and CFM. The Steering Committee members must be fully committed to the railway reform and charged with specific railway reform implementation tasks. The Chairperson of the Railway Reform Steering Committee must be a person with professional and institutional authority, who is appointed by the Minister and has a direct access to the Minister for any issue related to the railway reform.

165. Condition 3: Identify the major political and social risks generated by specific aspects of the railway reform. A detailed analysis of the railway reform’s impact on the society in Moldova should be developed by the Steering Committee, with the implementation strategy updated depending of the feedback from the railway system or society, considering the following aspects: a) How will the continuity of transport contracts for CFM’s existing customers be ensured during the reform’s implementation? b) How will CFM's debts be addressed? c) How to set-up the right framework for the newly created railway entities to start their activities debt-free? d) How to mitigate the risk of the newly created companies starting to accumulate new debts? e) What is the right timing for opening of the access to the railway infrastructure in Moldova? f) How long it will take to put in place a trustworthy regulatory structure with skilled experts, able to guarantee the fair calculation of track access charges, railway safety management, non-discriminatory open access rights, etc.? g) How shall the reform of the railway sector be synchronized with the absolutely necessary railway infrastructure and rolling stock investments?

166. Condition 4: Evaluate the existing institutional capacity of the entities of Moldova for the implementation of the railway reform. The implementation of the railway reform will require skilled people charged with addressing specific aspects of the reform (reform of costing system, PSC, MAIC, TAC, etc.) for which CFM or MEI may not have sufficient resources currently. External expertise will be required for the successful accomplishment of some of these objectives. The areas requiring external technical assistance and necessary funding sources must be identified. It is recommended to explore the possibilities of putting in place twinning programs funded by the EU member states or getting financial support from the IFIs.

167. Condition 5: The Comprehensive Action Plan must be elaborated by the Railway Reform Steering Committee and approved by the MEI and the Government. The Railway Reform Steering Committee will need to manage the implementation of the railway sector reform based on a consolidated action plan, using as a starting point the current status of execution of the two existing Action Plans:

a) Action Plan on Corporate Governance to be implemented in the framework of the ongoing Restructuring of the Railway Sector Project in Moldova, financed by EBRD.

b) Action Plan for the Implementation of the 2018-2021 Railway Sector Restructuring Concept, approved on February 8, 2018, by the Decree 385 issued by the Ministry of Economy and Infrastructure.

168. The paramount aim of the reform is to transform CFM and its successors into competitive and financially viable companies. Therefore, this note presents a Comprehensive Action Plan for the Railway Reform. This Plan clusters the reform activities into distinct phases, ensuring measurable results of the reform implementation.

169. In this context, the following constraints on the three steps of the railway reform (corporatization – operationalization – commercialization), as defined in the documents already presented to the Government, have been identified:

a) Corporatization alone does not bring any visible change from the perspective of transforming CFM into a financially reliable company. Reorganized as a joint stock company, CFM will continue to operate in the same way as before, i.e., losing market share, and accumulating financial losses.

b) Commercialization is a very complex step, requiring a long time to be implemented and consisting of too many activities, including sensitive decisions on the institutional unbundling – open access – private operators’ triad.

170. Consequently, the following three phases of the restructuring process are recommended:

a) Financial Unbundling – includes the activities for the transformation of CFM into a joint stock company structured in three financially unbundled business units for Freight, Passengers, and Infrastructure. This phase will introduce cost control for main activities and will facilitate the implementation of important reform tools (costing reform, PSC, MAIC, KPIs by lines of business, etc.), which may put an end to CFM’s financial losses. This phase must include also all activities described in the chapter about Enhancement of Rail Sector Competitiveness in Moldova.

b) Institutional Unbundling – includes the activities necessary to create independent companies for Infrastructure Management, Freight, and Passengers (it is recommended to be achieved through the transformation of CFM into a group).

c) Open Access & Private Operators – includes the opening of access for all licensed operators (state-owned or private from Moldova or from other EU countries).

The table below illustrates the new phasing of activities compared with the steps previously proposed for the restructuring process:

Table 13. Proposed Sector Restructuring Phasing Phases proposed PHASE 1 PHASE 2 PHASE 3 based on the Institutional Open Access & findings of this Financial Unbundling Policy Note Unbundling Private Operators Steps proposed in STEP 1 STEP 2 STEP 3 the existing Corporatization Operationalization Commercialization documents

171. The phases of the railway sector reform in Moldova. Each of the three phases recommended by this note are intended to achieve concrete restructuring targets with visible impact on the performance of the railway transport system in Moldova. Each finalized phase requires a certain interval of time for consolidation, before proceeding to the next phase. In the same time, each finalized phase leaves the railway system in a functional status, better than that of the previous phase. This proposal, therefore, allows the Government to adapt the pace of reform implementation along the way. The first phase of the reform process should start as soon as possible. For each of the following two phases, the Government can decide on the most appropriate timing to activate them (Figure 47) without any major risks to the railway system’s stability.

Figure 47. Railway Sector Reform Phases in Moldova PHASE 1 PHASE 2 PHASE 3

Financial Unbundling Institutional Unbundling Open Access & Private Operators

•Legal framework for reform •Independent •License of more •Capital Investment Staregy companies for operators Infrastructure, Freight, •Activity Based Costing •Open competition and Passengers between rail •Business Units financially •Access Rights companies separated Contracts •Contracts with government •Consolidation of •New Pricing Policy newly created •Increased Efficiency of Operating companies Practice •Business Plans •Consolidation of the financial unbundling

As it can be seen in the above Figure above, the most complex restructuring activities take place during the first step of the process, in order to achieve the financial unbundling. This is the step which must be accomplished by the Moldovan Government to change the current descending trend of railway business in the country and to accomplish all provisions of the Association Agreement with the EU (Annex 10 of the Agreement). The second and the third steps of the reform will be undertaken at the time of implementing the program of accession of Republic of Moldova to the EU.

172. The Comprehensive Action Plan. Building on the existing documents on the railway sector reform in Moldova and findings of the present paper, the Comprehensive Action Plan is proposed to the representatives of the Government of Moldova and CFM to facilitate the railway reform implementation. A proposed draft of the Comprehensive Action Plan is presented in Annex 1 to this document. In order to facilitate the implementation process management, the Comprehensive Action Plan is structured in two layers: (i) main reform tasks, and (ii) activities for the accomplishment of each such task.

173. Estimated duration of the railway reform implementation in Moldova. For the management purposes, the tasks included in the Comprehensive Action Plan are presented in their successive order and with their estimated duration in Annex 2 in a Gantt Chart format, also highlighting the activities on the critical path. The duration of the activities described in Annex 2 represents an optimistic estimation. Consequently, the predicted railway reform implementation timeline structured on three phases and presented below can be accomplished only if there are no discontinuations in the execution of the Comprehensive Action Plan, and no deviations from the agreed program:

a) 16 months are necessary for setting up the legal framework joint stock CFM with financially independent business units for Infrastructure, Freight, and Passengers becomes operational, and the contractual relationships with the State are in place.

b) 32 months are necessary for implementing the vertical unbundling of the three independent companies for Infrastructure, Freight, and Passengers (as institutionally independent companies or as part of the CFM group). This is possible only if the first phase of the reform is successfully finalized.

c) 12 months are necessary to implement the open access to the railway infrastructure in Moldova. This is possible only if the first and the second phases of the reform are successfully finalized.

174. In order to accomplish the above ambitious timeline, maintaining of the political consensus throughout the duration of the implementation process will be required, as well as making on an ongoing basis of necessary adjustments to the implementation program, depending on the feedback received from the railway industry and market.

Conclusions

175. The Railway Company of Moldova is currently in a vicious circle of underinvestment and decrease in the demand for its services, with fixed costs remaining high and requiring government support to avoid bankruptcy. The traffic levels have reached minimum levels for both freight and passenger transport, while the company still employs about 7,475 staff. The adoption of new structural arrangements to comply with the EU railway acquis, as part

of the ongoing restructuring, represents a good opportunity to reconsider how best to capture the regional railway market gains.

176. The principal markets for growth of CFM’s freight traffic are expected to be domestic and international trade. This growth will depend on both the economic growth and CFM’s ability to improve the quality of service provided to existing and potential shippers. The exports of grain and other agricultural products will depend on the increase in productive capacity, while exports of cement, steel, and other building materials depend on improvements in the supply chains for inputs and quality of service delivery to export markets. Any new opportunities for expanding existing cargo flows will require significant improvement in the quality of service provided by CFM.

Annex 1: Comprehensive Action Plan for Railway Reform Implementation in Moldova No. Task Selected List of Main Activities (other Timeline Entity / Comments / adjacent activities may be identified during Person in Results the execution of tasks) Charge 1. New legal framework 1.1 Update the draft ▪ Introduce the licensing of a new rail 4 months MEI, CFM World Bank may Railway Transport operator function support these Code ▪ Take out the term “subsidy” from the text activities ▪ Assess the possibility of adopting a separate railway safety law, establishing the Railway Safety Authority as an independent entity ▪ Safety Authority’s functions must focus exclusively on safety monitoring and control (see the recommendations in the main text of this document) ▪ Take out the rules on the carriage of freight and passengers (given that they are presented in an incomplete form, it is better to address them in a separate law / decree) ▪ Include a special section, describing the transition from the current CFM to the reformed railway law (three steps) 1.2. Update the SoE ▪ Selection of the Board members 6 months International governance law ▪ Appointment of the CEO expertise ▪ Independence and Accountability of required Managers ▪ Remuneration KPIs 1.3. Railway Safety ▪ Area of the Law 4 months Law ▪ Common safety standards ▪ Common safety methods ▪ Common safety goals ▪ National safety norms ▪ Safety Management Systems ▪ Safety Certification & Authorization ▪ Railway Safety Authority ▪ Railway Accidents Investigation Body ▪ Sanctions 1.4. Decree on the ▪ Freight 6 months CFM International Rules on the o Contracting of freight, acceptance of expertise Carriage of Freight goods, contract of carriage required and Passengers on o Content of consignment note Railways o Dangerous goods o Payment of transportation costs o Examination of goods o Loading, unloading, packing of goods o Delivery of goods o Contract modifications o Liabilities, compensations, claims ▪ Passengers

o Contract of carriage, tickets o Payment and refund of carriage charge o Right to be carried, exclusion from carriage o Hand luggage, animals, parcels, vehicles o Damages in case of death, personal injury o Liability in case of cancellation, late running of trains or missed connection o Compensation for loss or damage of registered luggage o Liabilities of passenger 1.5. Develop the ▪ Object of activity 2 months CFM, Statute and ▪ Public ownership, equity, shares MEI, PPA documents ▪ Rights and obligations arising from stock concerning the ▪ General Assembly of Stockholders (tasks, reorganization of organization, convening, voting rights) CFM into a joint ▪ Board of Management (organization, tasks) stock company ▪ General Manager (CEO) with financially ▪ Financial control and administration independent units ▪ Auditors ▪ Personnel ▪ Accounting, balance sheet, profit calculation and allocation ▪ Modification of legal status, dissolution, liquidation ▪ Litigations 2. Railway assets 2.1. Inventory of ▪ Inventory of wagons, coaches, 6 months CFM railway assets locomotives on the ground and in the books ▪ Inventory of railway infrastructure components ▪ Legal clarification of public properties administered by CFM and CFM’s private properties (land, buildings, etc.) ▪ Update the railway assets register 2.2. Legal clarification ▪ Public properties administered by CFM 12 months CFM of CFM's ▪ CFM's private properties of (land, properties buildings, etc.) 3. Identification of non-core assets and activities 3.1. Identification of ▪ List of non-core activities 6 months CFM non-core activities ▪ Identification of assets for non-core activities ▪ Separation of staff used for non-core activities ▪ Accounting separation of non-core activities 3.2. The outsourcing ▪ Outsourcing plan elaboration 6 months plan for non-core ▪ Outsourcing plan approval activities

4. Financial separation of railway activities into business units 4.1. Restructuring of ▪ Setting-up of the formulas for the cost 6 months CFM International CFM’s costing allocation to activities for each business expertise system unit (Infrastructure, Freight, Passengers) required 4.2. Financial ▪ Rolling stock 3 months CFM separation of ▪ Land railway assets into ▪ Stations and other buildings main business ▪ Loading/unloading facilities units ▪ Depots ▪ Workshops 4.3. Financial ▪ 100 percent of activities and staff 4 months CFM separation of allocated to Passenger, Freight, activities and staff Infrastructure into main business ▪ Allocation method for rolling stock units maintenance (activities and staff) to Passenger, Freight, Infrastructure) ▪ Allocation method for management and administrative activities and staff to Passenger, Freight, Infrastructure 4.4. Separation of the ▪ Setting-up of the new charts of accounts 3 months CFM International accounting system for CFM’s each business unit (Passenger, expertise into main business Freight, Infrastructure) required units 5. Contractual relationships with the Government and infrastructure users 5.1. Elaboration of the ▪ Assessment of full cost-based charges 4 months International methodology for versus marginal cost-based charges plus expertise infrastructure mark-ups when market can bear required access charges ▪ Charges for passengers and freight trains ▪ Types of lines charges ▪ Presentation of scenarios for cost sharing between the access charges and the governmental contribution to railway infrastructure 5.2. Elaboration of the ▪ Identification of correct annual cost of 3 months International first Multi-Annual maintenance of infrastructure with expertise Infrastructure improvement KPIs required Contract (MAIC) ▪ Identification of correct annual cost of operation of traffic on infrastructure with improvement KPIs ▪ Identification of the annual needs for track rehabilitation works with related costs ▪ Identification of the necessary infrastructure investments over the coming five years with related costs 5.3. Elaboration of the ▪ Assessment of transport market to 4 months International first Public Service identify the routes and type of services on expertise Contract which railway will be competitive required? ▪ Identify the list of services (types of trains, composition, frequency, quality of services, etc.) ▪ Tariff Policy for a five-year period

▪ Ticket sale revenue estimates for each route ▪ Estimate the necessary compensation for each route ▪ Regularization of payments at the end of the year ▪ Formula for the operating costs escalation for the annual correction of compensation 6. Business plans structured in financially separated business units 6.1. Business plan for ▪ Description of the railway network 6 months International the Infrastructure (technical status, transport capacity) expertise ▪ Transport market assessment (annual required? number of freight and passenger trains on routes and types of traffic) ▪ Traffic management activities and cost ▪ Infrastructure maintenance activities and costs ▪ Railway Infrastructure Annual Operating Plan ▪ Operations and Cost analysis and improvements (KPIs) ▪ Investment Planning 6.2. Business Plan for ▪ Transport market assessment and strategy 6 months International the Freight ▪ Analysis of market opportunities by types expertise Transport of traffic (import, export, transit, required? domestic) ▪ Analysis of domestic and export traffic by main commodities ▪ Contracting and pricing structure ▪ Requirements for Freight operating plan for the estimated traffic ▪ Cost analysis and cost improvement (KPIs) ▪ Revenue improvement ▪ Investment planning 6.3. Business Plan for ▪ Types of passenger transport services 6 months International the Passenger ▪ Market assessment and market strategy expertise Transport ▪ Analysis of services by each proposed required? route (number of trains, costs of operation, revenues) ▪ Requirements for Passenger operating plan for the estimated traffic ▪ Cost analysis and cost improvement (KPIs) ▪ Revenue improvement ▪ Investment planning 7. Investments to support the railway reform process 7.1. Five-Year ▪ Assessment of the technical status of the 3 months CFM, Investment Plan infrastructure MEI, MoF for the railway ▪ List of investments required to modernize infrastructure the infrastructure and its systems (signaling, level-crossings, stations, etc.)

▪ Priority list of projects with financing costs, duration of execution and proposed financing sources 7.2. Five-Year ▪ Assessment of the technical status of the 3 months CFM, Investment Plan freight rolling stock MEI, MoF for the Freight ▪ List of investments required to renew / transport modernize freight wagons and locomotives ▪ Priority list of projects, including advantages for operation of services (additional revenues and lower operating costs) ▪ Priority list of projects, including financing costs, delivery deadlines, and financing sources 7.3. Five-Year ▪ Assessment of the technical status of the 3 months CFM, Investment Plan passenger rolling stock MEI, MoF for the Passenger ▪ List of investments required to renew / transport modernize passenger rolling stock (mainly train-sets) ▪ Priority list of projects, including advantages for operation of services (additional revenues and lower operating costs) ▪ Priority list of projects, including financing costs, delivery deadlines, and financing sources 8. CFM’s corporatization & financial unbundling 8.1. Approval of the ▪ Railway Transport Code, including the 9 months Parliame legal framework timetables for corporatization, nt of for the railway commercialization and opening of access Moldova, reform on railway infrastructure Governm ▪ SoE governance law ent of ▪ Railway Safety Law Moldova, ▪ Decree on the Rules on the Carriage of MEI Freight and Passengers by Rail ▪ Statute and documents concerning the reorganization of CFM into a joint stock company with financially independent units 8.2. Reorganization of ▪ Internal reorganization of CFM SA into 1 month MEI, CFM CFM as a joint three financially independent business stock company units with financially ▪ Notify the Public Services Agency independent ▪ Register CFM SA with the Public Services business units Agency ▪ Register the rights transferred to CFM SA with the Real Estate Register ▪ Register the shares issues by CFM SA with the National Commission for Financial Market 8.3. Consolidation of ▪ Publishing of Annual Reports 24 months CFM SA, CFM as a joint MEI

stock company ▪ Annual performance analysis of the newly with financially created CFM SA by the Government independent ▪ Annual evaluation of CFM SA by the Board business units and information to MEI 9. Development of the railway regulatory framework 9.1. Creation of ▪ Licensing rules for railway operators 3 months MEI Railway ▪ Economic regulation Regulatory Body 9.2. Creation of ▪ Elaboration of safety standards and 3 months MEI Railway Safety targets Agency ▪ Acceptance of safety management systems ▪ Safety supervision, inspections ▪ Fines and suspension of operation rights International 9.3. Creation of ▪ Settlement of railway disputes 3 months MEI expertise Railway Appellate required? Body 9.4. Creation of ▪ Investigate accidents and incidents on 3 months MEI Railway Accident railways Investigation Body 9.5. Consolidation of ▪ Railway Regulatory Body 12 months The the institutional ▪ Railway Safety Agency railway capacity of the ▪ Railway Appeal Body authoritie regulatory entities ▪ Railway Accident Investigation Body s 9.6. Adapt CFM SA to ▪ Getting the license for infrastructure 12 months CFM SA, the new management and provision of transport The regulatory services railway framework ▪ Getting acceptance of the Safety authoritie Management System for each business s unit (Infrastructure, Freight, Passengers) ▪ Getting the authorization of the locomotive drivers and other staff in safety critical positions under the new safety rules 10. Institutional Unbundling of the railway sector 10.1. Reorganization of ▪ Statute of the newly created companies 6 months MEI, CFM CFM as a joint and documents concerning CFM’s SA, New stock company reorganization or dissolution Rail SoEs with independent ▪ Notification of the Public Services Agency subsidiaries for ▪ Putting in place of the new railway Infrastructure, company(ies) Freight, and Passengers or the dissolution of CFM and setting up of three independent companies for Infrastructure, Freight, and Passengers 10.2 Transfer of ▪ Legal transfer of the existing licenses 2 months New Rail licensing and SoEs, Rail safety certification

to the new railway ▪ Reevaluation of the safety management Authoriti company(ies) systems for the safety certification and es authorization of the new companies 10.3 Transfer of the ▪ Legal transfer of the existing contracts to 2 months New Rail PSC and MAIC to the newly created entities SoEs, MEI the new railway company(ies) 10.4 Consolidation of ▪ Publishing of Annual Reports 12 months CFM SA, the new railway ▪ Annual evaluation by of the rail SoEs the MEI company(ies) Board and information to MEI ▪ Annual performance analysis of the newly created railway SoEs by the Government

11. Open access to railway infrastructure 11.1 Assessment of the ▪ Opportunity for opening of access for 6 months MEI, open access multiple operators to be evaluated by the Governm introduction in Government ent Moldova ▪ Submission to the Parliament of the proposal of the date for opening of access to be adopted as an amendment to the Railway Transport Code

Annex 2: Time Sequence of Execution of Main Tasks for Railway Reform Implementation in Moldova

Nr. Task / Months 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 …...... 40 41 42 43 44 45 46 47 48 49 …...... 60 61 62 63 64 65 66 1. Elaboration of new Legal Framework Update the Code for Railway 1.1. Transport 1.2. Law of governance of SoE

1.3. Railway Safety Law Decree on Rules for Carriage of 1.4. Freight and Passengers on Rail The Statute for CFM stock 1.5. company 2. Railway Assets 2.1. Inventory of railways assets Legal clarification of the 2.2. properties of CFM 3. Identification of non-core assets and activities Identification of non-core 3.1. activities Plan for outsourcing the non- 3.2. core activities 4. Financial separation on business units Restructuring of the costing 4.1. system 4.2. Financial sepration of assets Financial separation of activities 4.3. and staff Separation of accounting system 4.4. on business units 5. Contractual relationships with government and users of infrastructure Elaboration of methodology for 5.1. charges of using infrastructure 5.2. Elaboration of MAIC

5.3. Elaboration of PSC 6. Business Plans structured on financially separated business units 6.1. Business Plan for Infrastructure Business Plan for Freight 6.2. Transport Business Plan for Passenger 6.3. Transport 7. Investment for supporting the railway reform process Five years Investment Plan for 7.1. Infrastructure Five years Investment Plan for 7.2. Freight transort Five years Investment Plan for 7.3. Passenger transort

Nr. Task / Months 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 …...... 40 41 42 43 44 45 46 47 48 49 …...... 60 61 62 63 64 65 66 8. Corporatization & Operationalization of CFM Approval of the legal framework 8.1. for the railway reform Reorganization of CFM like joint 8.2. stock company Consolidation of CFM as joint stock 8.3. company 9. Development of the railway regulatory framework Creation of Railway Regulatory 9.1. Authority 9.2. Creation of Railway Safety Agency Creation of Railway Appellate 9.3. Body Creation of Railway Accidents 9.4. Inverstigation Body Consolidation of the institutional 9.5. capacity of the regulatory entities Adaptation of the CFR SA to the 9.6. new regulatory framework 10. Commercialization of the railway sector Three independent companies (CFR 10.1. Group or dissolution) Transfer of the PSC and MAIC for 10.2 the new railway company(ies) Transfer of licensing & safety 10.3 certification for new company(ies) Consolidation of the new railway 10.4 company(ies) 11. Open Access on railway Infrastructure Assessment of the introduction of 11.1 open access in Moldova

Annex 3: Recommendations on Existing Railway Reform Documents in Moldova

Current Railway Reform Preparation Status

A3.1. The Government of Moldova acted to define the main railway reform directions, including the railway system reorganization. The railway reform concepts assessed by the Government of Moldova are based on the Agreement between the Republic of Moldova and the European Union ratified by the Law 112 of June 2, 2014, providing for the gradual implementation of the Acquis Communautaire in the railway sector.

A3.2. Since 2016, a number of documents have been already elaborated on the railway reform in Moldova. All major documents related to the railway reform in Moldova have been reviewed and evaluated, as follows:

a) In December 2016, CFM’s Council of Administration and Ministry of Transport and Road Infrastructure approved an Action Plan on Corporate Governance. This document is specifically focused on specific governance aspects, including the planned rules for the appointment of the Board and Board Committees, code of ethics and protection against conflict of interest, Board remuneration, management’s independence and accountability, internal audit, procurement transparency, etc.

Comment: The document is useful for the governance aspects, but the legal framework recommended in the Action Plan should be developed as a general law for the governance of all state-owned enterprises (SoEs) in Moldova. It does not make sense to create a special legal framework for corporate governance of state-owned railway companies only, when the state-owned railway companies must be organized according to the general framework existent in the country for all SoEs.

b) In March 2017, the consultant (EGIS & KPMG) developed CFM Restructuring Roadmap as part of the Railway Sector Restructuring Project in Moldova. This document makes a comprehensive analysis of the railway system and recommends a complex set of reform actions, including addressing of CFM’s historical debts, clarification of the legal status of railway assets, CFM’s transformation into a commercial company, managers’ independence and accountability, business plan elaboration for Infrastructure, Freight, and Passengers, new contractual relationships (PSC and MAIC) with the Government, track access charge for infrastructure use, etc. The document also comprehensively evaluates CFM’s reorganization options and proposes three consecutive reform steps (corporatization – operationalization - commercialization). It will allow CFM’s gradual reorganization into a commercial company with three independent branches (subsidiaries) for Infrastructure, Freight, and Passengers.

Comment: The document CFM –Restructuring Roadmap can be considered as the basic document for the railway sector restructuring in Moldova.

c) In July 2017, the consultant (EGIS & KPMG) finalized the document Multi-Annual Infrastructure Agreement (MAIC) as part of the Railway Sector Restructuring Project in Moldova, presenting a general structure of a Multi-Annual Contract between the Government and the future railway infrastructure manager for the railway infrastructure maintenance and operation in Moldova.

Comment: This is a very good document, but the proposed MAIC’s model can be used only as the “frame” of the contract. Significant efforts and adequate expertise are necessary to “fill” the skeleton of the contract with specific information: real annual costs of railway infrastructure maintenance and operation in Moldova, need for railway infrastructure investments and planning for the next 5-10 years, levels of the track access charges for accessing the railway infrastructure, target values of selected KPIs for increasing the railway infrastructure performance, network statement for the railway infrastructure, etc.

d) In August 2017, the consultant (EGIS & KPMG) finalized the document PSOs Methodology & Options for Moldova as part of the Railway Sector Restructuring Project in Moldova, introducing the principle of compensation of railway operators for the passenger transport services socially necessary in the country and the general structure of the Public Services Contract (PSC).

Comment: Complex activities are still needed to clarify the real needs for passenger transport by rail in Moldova, identify the routes where railways present an advantage compared to bus transport, define the number of trains, composition, and quality of services for each route, level of tariffs to be used, level of compensations per year, required investments for acquisition of new passenger train-sets, target values of KPIs for enhancing the quality of provided services, etc.

e) On December 5, 2017, the Government issued the Decree 1042, approving the 2018-2021 Railway Sector Restructuring Concept. This document presents in an annex thereto the CFM Restructuring Roadmap report elaborated by the EGIS & KPMG and financed by EBRD, proposing a restructuring solution to be achieved through three consecutive steps (corporatization – operationalization - commercialization).

Comment: The 2018-2021 Railway Sector Restructuring Concept, which is an annex to the Governmental Decree 1042 and the main text of the Decree contain different railway reform solutions: — The Decree approves: “CFM’s unbundling into three independent joint stock companies for Infrastructure, Freight, and Passengers” and consequently, CFM's dissolution — The Annex proposes: “three independent companies as CFM’s subsidiaries, organized as a group”.

f) On February 8, 2018, the Ministry of Economy and Infrastructure issued the Decree 385 to approve the Action Plan for the Implementation of the 2018-2021 Railway Sector Restructuring Concept. The Action Plan includes activities for the elaboration of the new railway law (code), clarification of the legal status of railway assets, operational and financial separation into three lines of business (Infrastructure, Freight, and Passengers), clarification of the status of CFM’s non-core activities, elaboration of MAIC and PSC, establishing of the Safety Authority, Accident Investigation Body, Appeal Body, and CFM’s legal separation into three independent commercial companies.

Comment: The Plan includes the railway system restructuring actions, based on the solution approved by the Decree 1042 of December 2017 (setting up three independent companies and CFM’s dissolution. As a general structure, the document is a good starting point for a Comprehensive Action Plan for the Railway Reform in Moldova. As the deadlines for most of the actions have passed and the Plan does not include all necessary activities for the transition step from corporatization to dissolution, the present Policy Note includes an updated railway reform implementation plan in Moldova.

g) On July 1, 2019, the Ministry of the Economy and Infrastructure requested the registration of the drafted Decree of the Government for the approval of the Railway Transport Code. The new Railway Transport Code was drafted based on the main concepts of the EU railway legislation, providing that the Infrastructure Manager and the railway operators are independent of each other and have financial autonomy.

Comment: The most important aspect to be corrected is that the current form of the Railway Code creates the legal framework only for the final form of organization of the railway system (Commercialization) described in the 2018-2021 Railway Sector Restructuring Concept and does not include provisions for the transition process. The current form of the Railway Code adds to the confusion about the final form of organization of the railway sector in Moldova, as it does not include any provision about CFM’s future, but only formulates that infrastructure manager will be an independent company, and railway operators for freight and passenger transport services will be licensed according to the provisions of the Code. Additional comments to this document are presented separately in the next chapter of this Policy Note.

A3.3. Conclusion on the elaborated documents on the railway reform in Moldova. The elaborated documents contain valuable information about railway reform, but they do not communicate a unitary message on the proposed solution. Considering the sensitivity of the railway reform, this may generate further Government 82

or Parliament discussions during the debates on approval of the railway system restructuring. The comments and recommendations in this Policy Note may help in eliminating the lack of clarity and conveying a unified vision for the implementation of the railway reform in all documents proposed for approval.

Recommendations on Current Railway Transport Code’s Provisions

A3.4. The draft railway code is mainly focused on the organizational issues. The Government of Moldova has prepared a new railway code based on the Railway Directives issued by the European Union, which is aimed at supporting the railway industry restructuring in the country. In principle, the new law proposes a new structure for the railway industry in the country along the following main principles:

a) Institutional separation of the railway infrastructure management from the provision of freight and passenger transport services

b) Setting up of independent companies for freight and / or passenger transport

c) Opening of the railway transport market for competition between multiple railway operators (state- owned and private)

d) Putting in place a new relationship between the Government and railway industry, based on the establishment of the Railway Authority, Railway Supervision Council, and Independent Authority for Railway Accidents Investigation

e) Transparent involvement of the State in the railway infrastructure and public passenger service financing

A3.5. Recommendations on the draft Railway Transport Code improvements. The proposed new railway transport code may be improved by making the adjustments to it implied by the following recommendations:

a) It is recommended that the term “subsidy” be taken out of the law. According to the new legal framework, the railway system is not expected to receive subsidies, but compensation for provided services. The government will simply compensate the railway operators for their social services provided on commercial basis and shall finance (partially) the railway infrastructure using an approach similar to the road infrastructure (which is not considered a subsidy for road transport companies). The term “subsidy” in the law might lead to ongoing discussions with the MoF, which will always be interested in cutting the subsidies form the public budget.

b) The railway operators licensing and railway economic regulation functions must be included in the code (it can be a department in the MEI)

c) The Railway Authority, which is the Railway Safety Authority (Agency) under the EU directives, must have exclusive railway safety attributes and be completely independent of any railway activities (e.g. no elaboration of safety rules but elaboration of safety targets, no involvement in the calculation of track access charges, no review of the revenues and expenditures of railway companies, no obligation for examination of locomotive drivers, etc.). If the Railway Safety Agency assumes responsibilities for developing specific railway activities, it will be part of the transportation process and will no longer be an independent entity for controlling the safety.

d) The current draft code includes in fact three different laws, according to the international railway legislation practice in: (i) railway transport law, (ii) railway safety law, and (iii) regulation on the carriage of goods and passengers by rail. It would be good to evaluate the advantages of focusing strictly on the railway transport law per se and addressing the other two aspects in separate laws. Anyway, the rules on the carriage of goods and passengers are only partially addressed in the current law and need to be tackled exhaustively. 83

e) The current draft code needs to include a distinct section, describing the transition from the current situation to the new railway system structure in Moldova (corporatization – operationalization - commercialization). This process may take several years and the main activities during that period need to be defined by law, including financing support for the reform implementation. Otherwise, the Government may run the risk of reaching the point where CFM no longer has the legal basis for its existence, but the new structures defined by the code cannot be put in place yet. This would result in an impasse in the railway transport system in Moldova, with serious economic and social implications. It is recommended that the formulation of the provisions in the draft Code be reviewed for clearer wording, as the current text is hard to read and may create confusions.

Annex 4: Regional railway network map, Central and Eastern Europe