Do~~7- II

MIe World Dank

iOWCoVIALUSEONlY

&uN.. P-6383-VB

REPORT AMN

OF .WK

PRESIDEIT OF T

IIERNRION D PNET ASSOCIATION

TO THE

ECUIVE DIRECTORS

am A

PROPOSED CREDIT

IN THE AMOUNT OF SDR 103.5 NILLION

TO

SOCTAIST REPUBLIC OF VIET RAN

FOR A

ST1CTURAL ADJUSTHNT PROGRM

SEPTEIER 26, 1994

MIICROGRAPHICS

Report No: P- 6383 VNType: MOP

This doment has a resticted di&buion and may be used by Wmt ondy in the perfomne ofir offieca duies 16 contt may not oterwise be disclosed wtout Wold Bank auhoriaton.

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Cy RRENCY EOUIVALENTS(as of August 1994)

Currency Unit = Dong (D)D 1,000 US$0.09US$1.00 - D 1,00(0

dpEIGEIS AND MEASURES

Metric System

ABBREVIATIONS AND ACRONYMS

ADB - Asian Development BankCG - Consultative GroupDFI - Direct Foreign InvestmentESAF - Enhanced Structural Adjustment FacilityESW - Economic and Sector WorkFSU - Former Soviet UnionGArT - General Agreement on Tariffs and TradeGDP - Gross Domestic ProductGNP - Gross National ProductICB - Intemational Competitive BiddingICOR - Incremental Capital Output RatioIDA - International Development AssociationIFC - Intnational Finance CororationIMF - International Monetary Fund

LDP - Leaer of Development PolicyMOF - Miistry of FinanceO&M - Operations and MainteanceODA - Official Development AssisancePFP - Policy Framework PaperPCR - Project Completion ReportPPAR - Portfolio Performance Annual ReviewPER - Public Expenditure ReviewPEP - Public Investment ProgramSAC - Structural Adjustment CreditSAL - Structral Adjustment LoanSDR - Special Drawing RightSOE - Stat-Owned EnterpriseSPC - State Planing CommitteeUNDP - United Nations Development ProgrammeVNLSS - Viet Nam Living Standards Survey

FISCAr YEAR

January I - Decemiber 31

FOR OFFICIAL USE ONLY

SOCILIST EPUBE IC OF VIET NAM

SICIk NURL QSbS PROGRAM

1. THEECONOMY .......... ,....,..-...

A. Introduction .1B. Reforms Completed to Date. 2C. Recem Econonic Developmnts. 3D. Rationale for IDA Adjustment Lending. 4

U. THE GOVERNMENT'S ADJUSTMENT PROGRAM. 5

A. Macoeconomic Framework .5B. Extemal Fianci Requirements..............I .. 7

m. THE SAC REFORM PROGRAM. 8

A. Budget Management ................... 8B. State Enterprise Reforms ..................-. 11C. Fincial Sector Reforns .13D. Liberaizadon of Foreign Trade .13E. Social CostsofAdjusunent .14

IV. THE PROPOSED OPERATION .............................. 15

A. Background and Credt Objecives ......................... 15B. IMF Status and BankiFund Cooridon .15C. Conditions ofTrancheRelease .16D. Technical Assisac and Aid Coordion .17E. Pocurement .17F. Disbursement .......... 17G. Accoumsad Audits .18H. Monitoring ........ 18I. Benefitsand isks .18

V. RECOMMENDATION .19

This docwnent hW a resticted disbi ad may be used by reci ol in the fa .,;officia dutes. Its conents may o otherw be dslosed withu Word Book trIIztio

An= 1. KeyBconomiIdcatois -..............2.......... 20An E. Leta of DevelopmentPU ........................... 23

Auachent I. Macroeconomic nCriteria . 38Ataichmeutf. P o liot Maii ............................ 39

Anraim. TimutableofK .yE ts -. . 47Am- IeV. StasofBankGroupOpetWons in VietNam .s. 48

: ~ . . -. . ...

aOIAUS ;REPUBLIC OF V-EM N

STRI2Il ADlJ1MNTPROGRAM

Socialist Republic of Viet Nam

Not applicable.-

-SDR 103.5 million (US$15 milliou equivalent)

40 years.

Fee: 0.50% on undisbursed credit balances, begining 60 days after signing, lessany waiver.

Net Present Value: Not applicable.

REPORT AND RECOMMNDATION OF TIHE PIDENTOF TEE IDA TO THE EXECUTV DIRECTORS

ON A PROPOSED CREDIT TO SOCIALIST REPUBLIC OF VET NAMFOR A STRUCTURAL ADJUSTMENT PROGRAM

1. : I submit for your approval the following report and *on on a proposeddevelopment credit to the Sociast Republic of Viet Nam for SDR 103.5 mllion, the equivalent ofUS$150 million, on standard IDA terms, with a matrity of 40 years, to help finance a StructuraAdjustment Program to-support the Goverment's medium-term program of macoeoomic stabiation. -and structural reform. -

I. THE ECONOMY

A. Inoduction

2. Viet Nam has been carryig out an ambitious adjustment and reform program ince 1989and is making a steady- transition to a market economy. The country's achievements are particularlyoteworthy for two reasons: (1) it is one of the poorest countries in Asia with per capita GNP below

US$200 in 1993 and- (2) it carried out a succsl stabilization during 1989-93 without sigifficantiternational financial support. The Country Economic Report, Public Sector Manam and PrivateSctor lives (Report No. 13143-VN, September 1994), reviews developments during the past yearand analyzes the major bottlenecks and issues affectg the economy and the reform progr.

3. The reforms that Viet Nam carried out on its own, without itertional support, icludeddecollectivization of agriculture, price liberalization, unification and devaluation of the exchange rate, andhardening of the budget constraint for state enterprises. At the same time the fiscal deficit that was theroot cause of inQation was reduced through a combination of tax reform, elminion of subsidies, andexpenditure restraint. These reforms produced good results. Real GDP grew at an average rate of 7%during the 1989-93 period, while inflation was brought down from triple digits to 5.2% in 1993.

4. While Viet Nam's achievements are impressive, there are serious weaknesss mn theeconomy that should not be overlooked. The country is still in the process of normalizing relations withits creditors and has large balance of payments fmancing needs in the next few years. In addition, furthersucural reforms are needed to complete the transition to a market system and to put the economy ona sustaed growth path. Many of these reforms require institutionilding measures that will takeseveral years to complete. To a large extent, the reforms that can be implemented quickly, with a strokeof the pen as it were, have been completed.

5. The Government of Viet Nam has worked with the Bank and the Fund to defne a medium-term reform program that is smmazed in its Policy Framwork Paper for the 1994-97 period. Theproposed Stnc Adjustment Credit has been prepared in this context. It is designd to focus oncriical aspects of the larget reform agenda that will be implemented in the net 18 month. Themeasures targeted by the operation focus on the budget, state enterprises, the financial sector, and thetrade regime. The meaures have been selected both because they promote the longer term instion-building agenda and becmse they address immediate bottlenecks to the economy's development. Theproposed focus ilso takes account of the planned ESAF program of the IMF, which will target

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macroeconomic bencmarks, assist with development of monetary policy istmnt, and supportmeasures to reform the tax system and libealize wrade and exchange aragements.

B. Reforms Coipleted ol)ate

6. Viet Nam's progra of "Doi Moi"- (remvation) was launched in the late 1980s in thecontext of byperinflationt and stagndion i real per capita GDP. The goal of the reform progrm was.first, to stabilize the ewnomy, aad, second, to engine a tramition from lentra planning to a marketeconomy in order to promote sustained development. The lack of intnational financial support for VietNam's reform program during the 1989-92 period creae some difflties, but also esred thatownership" of the program was total. Thghout hs period the Govermnent had an active policy

dWoigue with the Bank and the Fund and was very receptive to outside advice; however, remained infirm control of the pace and details of reform. Me Govermment has completed a wide range of reforms -- including stabilization and price refonms often covered in a first SAL - and now planb to move on tomore difficult structural measures.

7. The key measures completed to date under the reform program covet:

* Mhonetary poiifv. The moneY supply and inflation were brought under control by a halt incredit io the-budget, rstained overall growth of credit, and inter rat reforms

* Fiscal reforms. Ambitious fiscreforms were unrken to coslidate the stabilizaion.program. More than 500,000 soldiers were released from the military. Other expeitturerestraint, combined with tax increases, brought the fiscal deficit to a manageable level.

* 3Rral rde. The collective system was largely dismantled, and agriculture returnd tofamily farming. The 1993 Land Law formally gave land use rigbts to peasant households.

* Price liberalization. Sweeping liberalizaion removed virtly all price controls.

Devaluation. The exchange rate was unified and sharply devalued (73% in real term), andis now determined largely by market forces.

* inancial sector reforms. Four state-owned commercial banks were separated frm theState Bank. Interest rates were raised to positive real levels and inter-sectoral differenaeliminated. With entry of private and foreign banks, there are more than 60 commercialbanks opeaing.

* State enterprise reforms. The end of budgetary subsidies and increases in iter rateshardened the budget constmaint for state enterprises and ushered in an era of restrucgt.The proportion of bank credit going to public enterprises was reduced from 90% to 67%,with fiuther reductions expected in 1994. About one-third of the 2.4 million employees inthe state enteprise sector in 1988 have sice moved to the private sector. The mmber ofstate firms has been reduced from 12,000 to 7,000.

* Promotion of the rhiate sect2. After years of discri on against the private sector,the Govermment reversed co.rse and now encourages the private sector.

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* Onenness to direct foreion investment. A liberal foreign investment law and subsequentrevisions succeeded in attracting a growing volume of DFI.

- * Reform of foreign . Quaniative restrictions have been largely *'tinated and replacedwith tariffs. Access to foreign trade permits has gradually been liberalized.

* Social costs of adiastment. The Government initiated a numbe of forward-lookingprograms to deal with the transitional unemploymet caused by the reform progamincluding severance pay, retraining schemes, and soft loans for the small-scale pnvatesector-.

8. f.egal Reform. The Goverment also recognized that a successful transition to a marketeconmy qures the deveopment -of an appropriate egal fameworwk, which will inevitably take someyears to complete. The gradal process of puttinj into place the necessary elements of such a system hasincluded a new constitution and the cnactment of legislation in the areas of conac, company, land, andbankuptcy law. That process is now accelerating with the enactm in June 1994 of a labor code toprotect empleyees and employers alike as the labor market develops and a domestic invesunent promotonlaw to provide incentives for the domestic private sector comparable to those for foreign investors. Thelegislative agenda for the 1994-96 period includes a basic civil cWe as the legal foundation for the systemas a whole and a commercial law to facilitate business activity, ds well as the implementin legislationneeded to give fill play to the land and bankrptcy laws enacted in 1993. Planned amendments in the.company law and the enactment of a state enterprise law as part of the State Enterprise Reform Programare intended to strengthen the legal basis for competition between public and private firms.

9. lmportartly, a major transformation is underway this year in the mechanism for thesettement of economic disputes, which is central to the effectlfeness of the legal framework. Thepeople's courts at the national and provincial levels established economic courts in July 1994, toadjudicate economic disputes and exercise fuctions under the banikruptcy law. These developmenshighlight the need for training of legal personnel to staff these new fiumtions as well as for thestrengthenn of Viet Nam's growing legal profession. A number of technical assistance programs arestarting up in Viet Nam which are intended to assist both in the preparation of legislation and in thetang of legal professionals.

C. Recent Economic Developments

10. The initial response of Viet Nam's economy to stabilization and structural reforms wasgood. These developments are covered in detail in the previous economic reporl, Viet Nam: Transitionto the (ark eport No. 11902-VN, Sepmber 1993). To reiterate briefly, real GDP grew steadilythroughout the adjustment program, with an average growth rate of 7%. Exports were a leading sector,inreasing at more than 30% per anmum during 1989-92. Inflation was reduced from 400% in 1988 tomoderate levels in the 1989-92 period and to 5.2% in 1993. At the heart of the disinflation program wasfiscal restrain that reduced the budget deficit from 10.3% of GDP in 1989 to 3.7% in 1992. Foreignassistance to Viet Nam was withdrawn during this period, with the result that the external current accountdeficit swiftdy declined from more than 8% of GDP in 1989 to less than 1% in 1992.

I. The Bank's report highligted a number of featu of Viet Nam's adjustment that were notlikely to be sustainable, and developments during 1993-94 have borne out this analysis. In particular,the public investment program was sevetely compressed during 1990-91. Furthermore, real civil servicewages feB sharply as wage increases lagged behind inflation, leading to problems with the provision of

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public services. To be sure, the were some real fisca adjustmes during 19&9-92, notably thedownsizg of the military &?d the eliuninatioa of subsidies to state enterpnses. However, thecomWression of public investint and rel civil service waes was not sustainable.

12. In 1993 the Governament moved to expaW its investment progranm and to raise civil seMcesalaries. Both moves are necessay in the long nm, but the Govermment moved too quicldy and withoutadequat planning, with the result that the fiscal deficit grew substantily during the year, to 6.2 % ofGDP. Of greater concern was the fact that much of the fiancing for this deficit came from borrowingat commercial rat that the Goveramera canll WaPord. There was also an alarming icrease in currentexpenditure, which grew by- fhve percage pojnts of GDP in 1993. Tbis emerging fiscal problem hasplaced budget mangement - with the basic fisall system to be defined through a new budgetlaw - as a priority issue in the reform progrm. The Government's success with stabilization was alsothreatened by excessive growth of uomestic credit and by a shatp deteioration in the extenal accounts.it was in this context of excessive expansion that the Government entered into a Standby ArnM mentwith the Fund in October 1993. The key elements of the-program were (1) tax and expenditure reductionpolicies to limit the overall fiscal deficit; (2) monty and credit policies aimed at roducing the growthof domestic credit; and (3) a market-oriented exchange rate policy in which official intervention is limitedto smoothing out short-term fluctuations. Thesm stabilization policies yielded good resuits: both fiscal andexemral deficits declined to manageable levels during 194, and the-growth of credit was moderated.The IMP reviewed-the Sandby Aragemet in June 1994, at which tine Viet Nam ide a seconddrawing under the rTennt. The gsuccessful review.pave the. way for the Government and the Fund to prepare an ESAF.prog - -

) Rationale for IDA Ad"ent Lendin=

13. Viet Nam has the potential to put its fiscal house in good order and its balnce of paymentson a susainable basis. IDA adjustment lending will allow this transition to occur both more rapidly andmore smootly. Thank to a lively policy dialogue and the resumption of project lending, the WorldBank has become a trusted partner of the Govement of Viet Nam in the design and implementation ofreforms. This operation will provide an opportunty to support implementeion of the wide-rangingreommendations set forth in our recent economic reports. The Government indicated, in its strategydocument prepared for the November 1993 Donor Conference, its broad agreement with many of theseremmeaions. Furthrmore, the Baks involvement in the design of the public inveument programand of the broader budget policy, which will be supported by the conditionality of this operation, willprovide assurance that donor resources in general and IDA resources in particular are dircted to theirmost beneficial uses.

14. From the Bank's point of view, the SAC is one piece of a broader, longer term strategy forassisting Viet Nam's transition. In the Country Assistance S (Report No. 13545-VN, September1994), two of the key eement of the Bank's strte are to assist with the development of (1) theinstitutions of macroeconomic manageme and (2) the policies and institutior needed to bring about asmooth tansition to a market economy. The SAC is designed to address these issues. I will help theGoverment to clarify its vision of the division of labor between the public and private sectors, a cruciaarea in which a range of decisions will have to be made in the net five years. The SAC will supporta number of specific reforms that will faciate private sector expansion. In addition, it will resut in anintenified dialogue between the Government and the Bank about the couns overall developmentstategy and the role of the private sector in that strategy. Some of the specific mes supported bythe SAC will lay the foundation for frther reforms of the budget, state enterprises, the financial sector,

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and the trade regime- reforms that could be supported tirough ESW, invetme operations, or a follow-up adjustment credit.

H. THE GO NT'S -ADIE PRQGRAM

15. While Viet Nam has reduced inflaton to one of the lowest levels among tasitionecomies, its stablization is still fragile. Events of 1993 u scored this fragility, as esionaypoli:ies led to increases in the -fiscl -and externa deficits to unsustainable levels. Faced with thesemacroeconomic imbalances, the Goverment moved quickly to adjust its ficl and montay policies.It introduced budget measures that have reduced the fisc deficit to a projected 2.7% of GD? in 1994.Restrained credit policies contributed to an improvement in'the balae of payments situation, with'thecurrent account deficit projected to faU to 4.9% of GDP this year. In order to consolidate thestabilization and to foster long-term growth, the Government has turned to the Bank .nd the Fund toassist it to develop a coordinated program dwat would hold the fisca deficit to a manageabie level, restrainthe growuh of domesdc credit, improve the efficiency of public expdites so that essential services canexpand, and strengthen incentives for private saving, investment, and production.

A. Macroeconomic Framework

16. The macroeconomic famework for the adjustment program is set out in detail in the PolicyFramework Paper. The Goverment's target for GDP growth is 8%. Gim -n that this rate of growth wasachieved in 1992 and 1993, it is certainly feasible. The authorities recognize, however, that it is anambitious target, especially in light of the recent moves to adjust the fical and exteal deicitsdownward. A strong response from private savings and invstment is needed to offset the dmpeningeffect of fiscal and monetary restraint. Furthermore, it will be important to increase Govenruent savingsif public investment is to grovi while the fiscal deficit is held in check. The base scenario (Annex I)illusaes the macroeconomic m4qirements to maintain the 8% growth targeted by the GoQwnment andin particular highlights the key imornce of raising domestic savings.

17. Fiscal _lic. As part of the Struural Adjustment Program, the Government hascommitted itself to reducing the fiscal deficit from the 1993 level of 6.2% of GDP. The Govemmenthas already intoduced measures that will reduce the 1994 deficit to 2.7% of GDP and hold the 1995defieit to about 3.3% of GDP. One of the primary objectives of the Govenment is to increase itssavings, which were close to zero in 1993. Governent savings will finance public iesme directlyand will also have a strong indirct effect because they will inluence the country's ability to make useof foreign savings offered in the form of ODA. The Govenment's target for savings is 3% of GDP in1994 and 4% in 1995.

18. Viet Nam has significantly improved its revenue collecdon in recent years, as a result ofthe boomig economy, some inital success with tax refom, and growing income from oil. Furtherreforms are needed, however, to ensure that revenue is robust as the economy expands and diversifies.An important source of revenue is a unover tax that has many diffent rates and is quie distorting.In conjunction with the IMF program the Govermment will reduce the number of rates during 1995 andconvert the turover tax to a value zdded tax in 1997.

19. After a period of austerity, the share of Govermment xendiue in GDP increasedm Isubtilyfrom 17.3% in 1991to28.5% in 1993. Whiletherearearangeofpublicservicesthatneed

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to expand in Viet Nam, this rate of growth of expenditure was too rapid. in 1994 the Government tooksteps to restain the growth of spending, with the rest that recurrent expenditure as a share of GDP isprojected to decline by one percentage point. Together with higher revenue, this will contribute to thedeired increase in Government savings. In fuue years, the base sceaario projects that recurtexpenditure will be stable as a share of GDP, while capital spending gradually expands as revenue andODA disbursements rise.

20. Preparing and managing the budget in a more traparent mner and analyzing th impactof diffeent Government expenditures are key elements of theX justment program that will help the-Government to ensr that its spending is targeted to priority areas. Reform of the budget, including thePublic Investment Program, is an important measure that will be targeted under the SAC Program. TheSAC will also address furter reforms of state eneprises that are complementy to the budget reforms.The Govemment is preparing a program to clearly identify the strategic fims that will contnue to besupported through the Public Itvestmenm Program and to establish remaining firms as companies thatcompete on a level playing field with the private sector, as a step toward eventual divestiture.

21. Monetarv Policy. Prudent monetary policies will be essential to consolidate the recentstabilization. inflation was brought down to 5.2% in 1993. The growth of domestic credit (59%) wasalarmigly high during that year, however. One positive note is that the fiastest growing category wascredit to the non-state sector. -Nevertheless, this rate of increase could not be sus_ined witout-renewing.:infladon. The State B.ank moved in early 19094to resirain thergrowti of credit,.in the coext of its .Standby Program with the Fund. The medium-term inflation target is to reach the level prevaling intrade partner countries by 1997.

22. Balance of Pavments. The growth of imports was held down during 1990-92 by lack offiancing. Both the trade bance and the cumrnt account balance were essentially zero in 1992. Withrenewed aCcess to face in 1993, and in response to trade liberalizadon measures, imports surged 46%,and the current account deficit expaaded to 8.3% of GDP. Much of the financing for this deficit camefrom sources that camnot be- ssained: high-cost commercial borrowing and the drawdown of reserves.The proposed Structul -Adjustment Program aims to bring the external-deficit into line with reliablesources of finance, namely DFI and ODA. Specific measures that will assist in meeting this objectiveare (1) strict limits on the Govermmn t's commercial international borrowing; (2) streamlined proceduresto accelerate implentauon of projects financed via DFI and ODA; (3) the restained credit policiesnoted above; (4) an exchange rate policy that will limit interveion to smoothing out short-termfluctuations; and (5) strengthened incentives for exporters. Some of these measures have already beenintroduced and are showing results. Export growth accelerated from 12.4% (constant prices) in 1993 toa projected 23.3% in 1994. The current account deficit has been reduced from 8.3% of GDP in 1993to a projected 4.9% in 1994.

23. Incnives for Saving and Invesment. Viet Nam bas been able to grow at 8% for severalyears with an invmestment rate of around 19% of GDP. The ICOR has been below 2.5, very low byinternational standards, becuse of several factors, mcluding the initial impact of price reforms on theefficiency with which capital is utilized. Over the medium term it is likely that the ICOR will rise to thelevel of 3-4 commonly observed in developing economies. As a result, the growth rate will slow downif the investment rate is stable or increases only modestly. To sustain the 8% growth of the base scenariorequis that the investment rate increase to about 26% of GDP by the end of the decade. As notedabove, the current account deficit - and hence the inflow of foreign savings - is projected to decline asa share of GDP, from the very high leve of 8.3% in 1993. Thus, incremen to the investment rate wiUlhave to be financed largely by growth in domestic savings. In the base scenario domestic savings clib

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from 15.0% of GDP in 1994 to about 20.0% by 1999. The pla.med increase in Government savings willmake a cotribution. Private savings will have to expand as well, and spurring the growth of the privatesector ic probably the key to sustning the 8% growth that the Goveament hopes to realize.

24. Surveys of, and discussions with, private firms in Viet Nam reveal that the two critcalbotlenecki holdihg back expansion of investment are (1) weak ias re, especially in the tnsportsector, and (2) the poor fimctonmig of the fiuawnial system. Problems of ir;irastructure wil be addressedthrough the budget reforms discussed above, specifically through msures to increase expenditure onoperatins and nantenace and on priority public investmet that are complementary to privateinvestment. Private investent in irastructue will also be encouaged through frter rfine ofthe regime for forign investment. Turning to the financial sector, there are a wide rang of problems,the most pressing of which is the inability of the commerciu banking system to provide basic servicessuch as check-cleatng, sh-term working capital loans, or lets of credit. Seveal imOrtlnt measurto improve the functioning of the commercial banks wiUl be tageted under the SAC.

25. The foreign trade regime, in particular the incentives to export, will also play an importantrole in spurring private savings and invesment. In the area of imports, quantitadve restrictions have beenabolished in favor of tariffs. A number of measures have been taken to ensure that producers have accessto materials at international prices. An important rmain distortion, however, is the wide dipersionin tariff rates, creatig significant distortions through variaton in effective rates of protection. In thecontext e4 the SAC, the Governmuent will reduce this dispesion of effective protection so as to providemore efficient price signals to produces and to reduce anti-eort biases.

B. Egernal Fiial Rea ents

26. The financig requirements for Viet Nam's program of adjustmen and reform are large.it is efficient for Viet Nam to make use of foreign saviogs offered via DFI and highly concessional ODA.

Xpendi on economic and social infrstructure has been low for a long time and there are large pent-up needs. In the next few years the Government plans to use ODA and domestic borrowing to financeabout half of the public investment program, while coveing the remainder from Government savings.

27. There have been large DPI cotments made in Viet Nam, but so far disb havelagged well behind commitments. Part of this delay is the inevitable startup time required to getfactories and other productive facilities operating. The start-up lme is paiarly long in Viet Nambecause of poor transort, telecounicaion, and power inftructure, on the one hand, andbureaucratic delays, on the other. Cumbesom procedures and buacratic requiremen for theenegotation of contcs, issuance of rlated licenses, and implemention of projects are singled out bymost investrs as major impediment to the expansion of foreign investment. The Govmen hasalready taken some measures to reduce these bottlenecks, and addionl steps to samline the investmeregine will be part of the medim-term program.

28. In the near term, ODA wil account for the lion's sbare of foreign financing as infrastructureneeds are met and the incentive regime is improved. Over time the relative roles of ODA and DFI wilshift, with the latter expected to provide the bulk of exeral finamcing in the long run. The grossextnl financing required for 1994 is about US$1.3 billion, of which one4hird is projected to comefrom DFI. In addition to IMP financig and grant assistance, around US$315 mllion of di sare needed fom concessional and other longterm loans. In 1995 the required fincing from long-termloan dis rises to US$600 million.

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29. The first Donor Conference for Viet Nam, in November 1993. was highly successful ingenerat US$1.8 billion in ODA commitments for Viet Nam. The vast majority of this is for specificprojecats a only about US$150 million of the project omnitments are expected to disburse in 1994,and a further US$250 million in 1995. Thus, Viet Nam has a bance of payments financing problemthat is likely to persist for several years. The Govemen tured to commercial sources for US$100million in the first half of 1994 to help in financing its balance of paymets. The proposed SAC wouldfill the remainder of the gap in 1994. The size of the gap that needs to b¢ filled by quick-dibursingODA in 1995 is estimatd to be US$230 million. Te second tranche of the SAC and an ADB programloan would meet about half of this requirement; and it is anticipated that bilateral sources would providethe remainder. It should also be noted tat a Pais Club rescheduling in December 1993 has made animportant contrbton to puttig Viet Nam's balance of payments on a sustaiable basis. Furthemore,the Govermment is negodating the reheding of its commercial debts through the London Club. In thewake of these rescheduings, projeted debt service is quite reasonable: it should decline from the pre-

sheduling level of 26.6% of exports (1993) to 11.9% in 1994.

30. Looking ahead a few years, the large project commitments being made by major donorshave the potential to provide significant financing for Viet Nan's development program. In order to takemaximum advantage of these commitments the Govemment will need effective institutions and proceduresfor aid management. The early experience with project implementation has revealed some waknessesin ex ist tgtustoudanctprocedures: The Bank, as part of its overall assistance strategy, will contimto work with the G Qovernm to improve ODA m nagement and project nmple ion.

m. THE SAC REFOR

31. The overall objective of the proposed SAC Program is to assist Viet Nam to sustain a highgrowth rate and to make a smooth tansition to a market economy. To that end, the program will helpto establish an efficient division of labor between the public and private sectors. Reforms targeted underthe SAC are part of the Government's larger reform agenda. The Letter of Development Policy. withattached policy nmix (Annex 1), ariculates the Government's overall development and reform strategyand indicates how the specific measures under the proposed SAC fit into the larger program of reforms.In particular, given that the IMP Program concerns macroeconomic bnars and issues of tax reform,the Government has requested that the SAC Program address four areas: (1) budget management, (2) statenterprises, (3) the financal sector, and (4) foreign trade policy. Reforms in these four areas will

conibute to increasing savings and investment, either in the public sector or in the private sector. Asnoted in the macroeconomic discussion, increasing domestic savings will be the lky to sustning highgrowth in Viet Nar, and the measures targeted under the SAC will encourage such savings.Futermore, the focus of the operation is on critical meures to be implemented in the next 15 months.The measures that will be implementd as conditions of second tranche release are underscored in thefollowing text and su_mmrized in paragrh 67.

A. Iud"et Manement

32. The Government has at its disposal a growing volume of resources to provide the publicservices required to make a market economy function well. Govemment revemue as a share of GDPincrea to 22% in 1993, and a substantial volume of foreign aid is now available to the country. Asa result of this increased availability of resores, the Govemment was able to more than double realdevelopment expe between 1991 and 1993. This inuded large increases in spendifg for

-9.

educaton, health, and public investmnta. Th broad alloca of enture between developmen andnondevelopmn purpos in Viet Nam now compa favorably to oe low-icome counes.

33, As noted in praph 12, however, the growth of expeitue in 1993 was too rpid andtreatened m stability. It Is clear hat te grdw f ig must be modeted. Targets

for the fiscal deficit have been stalisd as part of the mncroonoic :fmwork. Inthe coexA ofthe SAC, the Bank will assist the G aovernme to Inrodc measures that will improve the efficiency ofexpenture so a importa setvices can an t the reour evelpe establihdas pa of the -macro frework.

34. Sector studies caried o by tho Bak nd oth provide evdc ta the efficiencmy ofpublic expendiures is cueny low in Vict Nam. he Bak's Trapo Sector Review, for example,found ta the Govemnt is -consiwtg 1or-wnewnvents in roads and other-transportinfrastructure, bu at the same time pwoving adeque fmds for opei and _mntean ofinfastucture. In the case of roads, addiionl funds for would have a highe rate of retrthan some of the projecs under consideration. Lack of adequate fig for O&M is a geal problemtha goes beyond the rmsport sector. The probln has gott more acute in the past few yeas becauseO&M expenditure bas not iceased as rapidly as other items in the budget.

35. The Bank's recent poverty mi found simiar emples of inefficiency in the ddiveyof social services. There are 28 natonay fund socisl progams t reah down to fte commue level.Thes program address very specific problems, for example, got or maria. The funds are notfingible, hcwever, so that a commune can only use funds provided thdough the anti-maaria program toadress that probfem, regardess of its needs. Local authorities would like more discrto in demiinghow to spend funds targeted to social sevices, which should makehe expendtures more effective.

36. Ipoving the efficiency of public expeni will require seal Itegated refrms. TheGovements stra in the SAC Prgrm is to immediaely address a number of clear problems,notably the underfading of O&M and the conmositio of the investment program in the 1995 budget.At the same time, the Govermmn will commence long term intional refoms conceringpreparaton and management of the budget. These refr will enable the Govermen to improve thequality of services, while at the same time building up saving to help finance needed invesmes ineconomic and social .

37. ud S Ihe problems with Viet Nams budget begi with the fact that theprocedures for prepaing and _na the budget are not traspare and ivolv several agencies withoverlapping authority. To rec*t this problem, the Gosvenm is dftg an orgaic budget law. Thislaw would establish the Ministry of Finance as the agency in charge of prepaing and managing thebudget, and clarify the role of other agencies, including the State Plaing Committee, line ministries,and provical goverments. The law would also set out a rational timetable for prepaig the budget.Finally, the law would clarify the asignment of revus and exenditur between cena and localauthorities. The corrent system is bighy lize, a root cause of the specfic inefficiencies notedabove, and the orgamc budget law would introduce greater d a o, allowing local audtoriesmore discretion over level of expende on function that have been assigned to them and over taxesto provide flmcA for thee mendiur_. Uw m= invtend toopeeto Natian1Asebl in I 9an 2MM& bxetlawv. s mn to IDA. thtatwocdte oces for pr _om nthe budget. including the roles of diffeent Mental gom agencies and of cenr and localamhorites.

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38. The expenditre made ad revenue aised at various levels of govenmnt need not balance.Therfore, the budget law would provide In general terms for a system of transfers to provide supportfor pooe localities to mainain appropriate exped levels. The law wil need to be followed byimplementing regulatio to defime the details of the transrs. The Bank's poverty mission identified thisas an important issue, as poor provic currenty are having diffiwlties fiancing social services and asafey net for tbose in need. In conjuncdon with the-SAC, the Governme will conduct a study ofreveme capabilities and expenditure needs by province. The study will provide the basis for improvingthe system of inter-govenmenal transfers to eme that poor areas have adequae resources for theirexpen=nue needs.

39. Recurrent Based on available iormation, it is dffictlt to fault the broadallocation of spendig among major categoies of Viet Nam's budget. The one clear excepdon to thistate is the svere udflding fopations and Ia the rect budget The poor

state of infrastce is universally recognized as a constraint to Viet Nam's development. Sinceinvestm projects inevitably take some years to complete, the only measure that could alleviate thebottlenecks quickly would be enhanced expenditure on O&M. The Government bas taken an important,inidal step to address this problem, increasing the allocation for O&M funds in the 1995 budget pmposlby 30% over the 1994 level. The Goverpent's Letter of Development Policy indicates tat it willconinue to give priority to increasing expenditure on O&M as resour become available.

40. It is dIfiicilt to make other spefic r about the allocation of expendituresthat would improve their-efficiency because the 1-udget lacks aiequa detail and t. As part.of its collaboration with the IM;, the Ministry of Finae is working to improve the functional adeconomic classification of expend . These reforms wil inuease the tasarency of the budget andfacilitate an economic analysis of expenditr. This kInd of analysis will be required before theGovemment can prepare a program to cut inefficient expnde, release reddant staff from the civilservice, and rgnize the public baay. The Govemnt plans to complete by mid-1995 a PublicExpeditur Review, under tems of refeenc saisacory to JDA. to obtai a clear picur ofovemmnent s and to analyze the efficienw of exUs in meen stated objectves.

41. Public gv =. The incased level of domestic and extal resources has enabled theGovemment to expand its ivestment program. Furermore, there has been a significant shift in thecomposion of the investment progam financed from the budget. Commertc fim, including powercompanies, are no longer supported through the budget. The 1995 investment budget focuses oninfrastcture in the tansport, irrigaton, water supply/sanitation, edtion, and health sectors. TheGovermment is suppoting investment in commeil public services such as power trough onlending ofODA resowurces. While progress has been made in the broad composition of the public investmentprogram, there remai a need to improve the allocation of resources withn sectors. Criteria for projectselection are not clear, planning is not done on a multi-year basis, and investme have been chosenwithout adequate concem for the related implications for the recurrent budget

42. To ensure that resources are allocated to priority inestments, the Goverment will preparea muli-year public imvestment progrm (PIP) that looks beyond the annual budget horizon The PIP willestablish priorities among invesnt proposals by developing p dues and strict crteia for selectingprojects. In general, efficient public vstments are ths that are comple to private sectordevelopmentand situated in a well-defid sectoral stategy. The sctoral stategies in turn should takeaccount of the econmic rates of return on differen potendal investments, as well as of the need topromote development in di= regions of the contry. The PIP should be closely linked to the budgetto ensure that it is realistic in tems of (1) domc and extena resurc avalble for the invesunnt

budget and (2) the provision of finds m the recet budget to finance related operatig and maitnncosts. The GovernMe ham completed guidelines that it will use to prepare the Public Inv esProgram for 1996-98. Durin 199S the Govenment plans to adopt an invesment prgm fo 1229-

-Suyto,IA, fgUf on m_v llM jn and humanm= resouro dtIhatarcomlemntary to ,nrJvate inve_en and that are situated in well i scor is.

43. Cvt &g=. The bulk of public inestmt in the medium term will go to i rand commercia pubUc sevices, especially roads, power, urban water supply, irrigation, and seaort.In all of these areas it is impor to chare aoprimate prices for efiency res and in orderto raise fimds for operation, maintenance, ande3pansion of capacity. The Goverment has introducedsom measue of cost recovery in sectors such as power and water supply, in wbich prices are stillregulated. It also roduced an hiport tax on gasoline that is jutfied on ren'nta ground -andaims to coUect resowues from the users of roads (a form of cost recovery). As noted in the TrnsportSector Review, hower, the import tax on diesel fuel has been much lower (12%), despite the fac tatthe trucks that usediesl fue account for most of the wear and tear on roads. The Review Ian appropriate tax on diesel fuel, comparable to taxes on other petroleum products, as an efficient vdeidefor the Government to raise the resources that are needed to increase O&M expenditu in the budget.in response, the Goverment increased the import tax on diesel fuel to 20%, effcdve July 1, 1994.Furtmore, as part of the overall tax reform, the import tax on gasoline will be reduced to 60% andan excise tax on gasoline and diesel fuel inroduced. In 995 the G-oement inte to WM*W inexcise tax on etlum products (includWu diesel fiel) of at least 10%. in order to hrs reven andto make the priCeS Of different petroleum nroducts more comuarabe. In future years, the Governmentplans to increaSe the petroleum excise tax gradualy in order to stngthen cost reovaey for the transportsector without impoSing any sudden shock on the economy. T'he higher revenUes from peomtaxaowIl help finance the increased eqendiu on O&M (paragraph 39).

44. uMMa of Bud_ Meu. Thus, during the preparton of the SAC Pgm, theGoverment inoduced meweurs that have an immediate impact on the 1995 budget, that is, incdfunding of O&M, a tax on diese fiel that will help finance this higher expendiu, and guidelines forpublic imvesment. )uring 1995 the Govermnent will take steps :oward longer term, insutiona refomof the budget, including adoption of a new budget law and system, completion of a Public ExpendiuReview that aalyzes the efficiency of goverment spendig, and preparation of a multi-year investmetprogram.

B. Ste Eatpris Relim

45. The objective of the Govemen's state enterprise reform program is to imnprove theefficiency of firms and to reduce the burden that they place on the budget. The strategy tough whichthis objective will be pursued is to draw a clear disticon between Istrategic firms providig importantpublic services and non-stategic eneps. The segic cegoty will be composed primarily of publicutilities such as power and water. The remaining firms, i.e. in n and other service sectrs,wifl be considered n. The Govenment's plan is to create a level playing field between non-stategic firms and the private sector and to experimet with privaizaton of ese firms an a pilot basis.Government support, thougthe budget or lon guarantees, will then be targetd to the stategc finnsprovng important services.

46. The Government has introduced an initial set of measures to harden budget constan ofpublic firm, including the ii_na of peratg subsidies from the budget and i rat efothat reduced implicit subsidies through the banking system. These policies led to a rationalizati of the

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sector, and several thousad loss-making firms were liquidated. The main problem that remains is thatpublic firms continue to have privileged access to resources, especially capital. The bulk of lending fromthe financial system still goes to state enterprises, though there has been a gradual icra in the sharegoing to the private sector. Addressing tbis problem will require in aed reforms of state enterprisesand of the commercial bks.a-

47. Now that most loss-making fims have been dosed, the main issue on the stat enteprisereform agenda is -to create a level playing field between -public and privae firms in the competitivesectors. In the Bankes view this will set the stage for evental privatizadon of state firms. TheGovernment is not willing to commit at this stage to a large-scale program of privaization, though it hasinitiated a pilot program of 'equitization" in which shares of enterprises are sold to workers and the

eral public. An important step toward creation of a level playing field was the passage of thebankuptcy law, prepared with teclmical assistace executed by the Bank. This law applies to all publicand private entprises. Implement regulations for the bankruptcy law should be promulgated by end-1994 so that the law can become filly effctive for both state and private firms.

48. The Government's long-term plan is to maintain only 'strategic" erpise, mostly innasucture and commercial public services. The _mmdiate agenda is to determine (I) criteria forclassifying sectors and specific enterprises as stategic (all others would be non-strategic); (2) theorganizational and management ichni r enterprises in ech category ind .(3) a timetiable firclassifying state rise i these categorie d for making the necessary legal and insitutonal.;changes.

49. For non-strategic firms, the company law would need amendment to enable state enterprisesto reorgane as single shareholder companes, placing them under the same legal fiiiework as privatecompanies. The process of reorganzig non-strategic firm as companes should take about two years.To manage that process and to manage the Goverment's shares in these companies, a ministry-levelagency or holding co rmy should be established. As a result of this change, the state's ownersip inthese firns would no longer be exercised by line miistnes. These reforms will enable the Governmentto accelerate the completion of its pilot pr of "equitization.2

50. Concerning strategic firms, the Government plans to submit to the National Assembly during1995 a state enterprise law to stplate the managemnt and operatioa suctre of these firms and tospecify how the Govemment will exercise its ownership rights in them. In the meantime the Govermentis working to improve the accounting, auditing, and monitoring of its firms, concening initially onthe largest firms, many of which will eventually be classified in the 'strategic' category. A generaldearment of state enterprises wiUl be established within the Ministry of Finance by early 1995 to caryout this task

51. The reform of the Public lnvestment Program (pagraph 42) will support these stateenterprise refoms. Public invesment in state enerprs , through the budget or through subsidized orguanteed loans, will be restricted to firms providing important public services. he shareholdmgcompanes fully or partily owned by the Goverment will have to find their own investment fundswithout govermment support or guaantees.

52. The GQvernment plans to formally adopt during 1995. a time-bound State EnernReform Action Pror. saisfctor to IDA. to (i) establish and utilize clear criteria to identifv strategicfirns t prMvide essentia nublic seMices. (i! transfor nM atepic ste firms into coManLes that

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compete on a level plaving field with private firns, and (iii) strengthe_n the managemnent of.M=Lc firmsthat will continue to receive government support.

C. Financial Sector Reforms

53. Viet Nam is in transition from a system of cetal planning to a market economy in whichmanagement will be carried out throug:i incentives rather than direct controls. The country is well alongin this transition, but there remain important areas in which the-incentive regime needs to bestrengthened. A recent Bank financial sector mnission identified key weaknesses in the banki systemthat are holding back development of the economy. These- weaknesses include bad debts in the state-owned commercial banks that threaten the solvency of the system and a turnover tax on intermediationthat discourages expansion, especially of new banks. In addition, a poor check-claring systemdiscourages use of domestic cuency.

54. The state-owned counercial banks inherited a sigmficant amount of bad debt when theywere separated from the State Bank. More importantly, it is not clear what the quality of recent lendingis as supervision of banks is weak. The capacity of both the central bank and of the state-ownedcommercial banks is currently being strengthened through technical assistance executed by the Fund, theBank, ADB, and bilateral donors. An inportant complement to this work is determining the exact scopeof the nor.-perforing loans in the banks' balance sheets so that the Government can prepae a programto clean up bad debts and ensure that banks are adequately capitalized. The Government intends. -durin1995. to conMlete initial portfolio audits, under terms of reference satisfactory to IDA. of at least twoof the four state-owned commercial banks. in order to identfy the scone of the bad debt problem and toprenare reliable balance sheets for these banis.

55. One of the most positive features of Viet Nam's financial sector reform has been the entryof about 60 new banks, mostly private, both domestic and foreign. This entry has the potendal to createa vibrant banking sector. The expansion of these banks is hampered, however, by the urnover taxassessed on banks' net interest-income. This tax inpractice discriminates against newly established bankbecause they have little deposit base and initially fund their lending primarily by equity. Thus, they haveinterest income but little interest cost, so that the effective tax rate is extremely high. This burden ispassed on to borrowers in the form of high interest rates and discourages the expansion of the privatebanking sector. As part of its overall reform of the tunover tax in 1995. the Government plans topresent to the National Assembly legislation to exempt banking from the turnover tax. in order toencourage expansion of intermediaton in general and of the new private banks in pUfiglar.

56. By reducing inflation the authorines have taken the hardest steps to encourage resourcemobilization. They will now introduce other measures to encourage the use of domestic currency anddeposits, specifically an increased supply of larger denomination notes - of course draining an equalamount of smaller value notes - and an improved check cleaing system. A proposed IDA project for1995 will support this modernizaion of the payments system.

D. Liberalization of Foreign Trade

57. Liberalization of foreign trade has been an important element of the Government's programto improve the enabling environment for the private sector. Concering imports, nearly all quantitativerestrictions have been removed and replaced with tariffs. In addition, several reforms have beenundertaken to strengthen the incentive to export and to ensure that exporters have access to maerials atinternational prices. First, the requirement that a manufactmer have a minimum level of capital in order

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to obtain a license to export and mport was elimaed, which resulted in better access to foreign tradeby the private sector. Second, bonded warehouses and a duty exemption system were introduced so thatepoers have access to imported materials duty-free, provided that they process them within threemonths after witdrawing them from the warehouse. Finally, shim licen for exports wereeliminated as of July 1, 1994 (except for oil, rice, and wood). The Government indicates in its Lterof Development Policy its commitment to provide exportrs access to inputs at international pries andto review the effectiveness of the above measu on an ongoing basis to ensure that this objective is met.

58. The Govermet is exploring the possPiblity of joining GATT and recognizes that remainingimpedimet to imports will have to be largely removed before it can do so. Thus, the Government'sprogram of reducng amistrtive barriers to tade will contn, with plans for phasing out shipmelicenses for imports during 1995-96.

59. In addition, the SAC program will address the most importan remaining trade distortion,the tariff code. Viet Nam's current code differs significantly from those in place in leading exportingcountries. It is very complex, contning a large mnmber of rates from 0% to 200%. Furthe , rateshave been frequendy changed. In 1995 the Goverment intends to rede the maximn import tax rateto no more than 60%. in order to reduce the distortion in the incentive regime for prdUr. Thischange will be part ofa coehensive tax reform package that will be phased in over several years..The Govem notes in-its Letterof lDevelopment Policy that -its intenion over the wedium term is tofrher reduce the dispersion in effective raties of protction. .

E. Social Cs of

60. Viet Nam's transition experience has been very diferent than tht of other commandeconomies as well as of countries undergoing structural adjustment programs. It stands out for fourpnncipal reaso: First, the relative importance of agricuture rather than industry has heled mostVietnamese households to benefit from the initial price reforms. When reforms were initiated in 1989,most Vietnmmese (72%) were farmers while only a small percentage (15%) were inployed by the statesector. Liberalization of agncultural prices in tandem with decollectivization of farms resulted inimmediate benefits for most Vietnamese households, despite the public sector being reduced in size byonethird (to 10% of the labor force). This outcome is in marked contrast to countries which have large,enenched state ente8pises employing most of the labor force. Second, those laid off from the statesector received adequt copnsatdon packages, on average equivalent to one year's pay. Thi.according to the Ministy of Labor most retenched workers were absorbed by the quickly growingprivate sector within one year, a different structural adjustment experience than that of Europe or Africa.Fourth, ste-owned enterprises in Viet Nam have not served to the same eatent the critial role of.provider of social services as they have in many countries (e.g. PSU, Eastern Europe, China). Hence,the liquidation of SOEs does not directly affect household access to social services. As a result of thesefour factors, the social costs of adjutment in Viet Nam have been milder than experienced elsewhere.

61. Nevertheless, Viet Nam is a very poor country with many vulnerable households.Moreover, while Viet Nan's transition experience has been much more positive than most othercountries, it does share one common problem with other transition economies: the chagn role ofgovermen coupled with fiscal restaint has resulted in problems of financing social services includinghealth, education, fmdy plamning, and assistance for tie most vulnerable. The private sector hasemerged to provide some social services; however, there is a great need to sengthe the public provisionof basic social services as well as the mechm to provide support to the most vulnerable households.

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62. Given Viet Nam's unique transition experience, and the fact that any further en'. 'yees laidoff from the public sector will receive adequate severance pay, the Bank will not focus its wor. e.. *socillcosts of a4ustment on these redundant workers. Rather, it will take a broader approach to aiding themore vulnerable regions and households of Viet Nam. Expanding access to primary education, basichealth services, and famy planning services will be central goals of the itial IDA projects in the socisectors. These projects will be complemented by assistance to improve the system of inter-governmentalfiscal relatis. While the Govermment tends to focus its poverty alleviation efforts on the desig oftargeted relief programs, the inability of the. poorer provinces to implement these progms - as well asother sectoral strategies perting to humah capital and physical inuur- places inter-governmental finances as a priority topic. Aspart of the Bank's ongoing poverty study, the ise ofexpenditure needs, revenue retention, and transfer design are being carefully studied with the goal ofimproving the design of the inter-govemmental stem to enable households in aU provinces to parcipatein the county's economic growth.- Recommnaetions from this work will help to improve the redesignof the budget system, one of the reforms suported by the SAC.

63. Another key compoent of the Bank's strategy involves the Viet Nam Living StandardsSurvey (VNLSS), which has been executed by the State Planning Committee with Bank assistance duringthe past two years. The Bank and the SPC are currently analyzing the data to idenif the mostvulnerable bouseholds, sub-populatons, and geographic regions to enable more effictive targeting ofpublic expenditr. In addition, the Bank organized a four-part, six-mon training course for policyplanners from line ministies to learn how to analyze the VNLSS data to help inform policy decisions.withn their sectors and to target their efforts where most needed. This training will sren theGovernment's capacity to carry out periodic poverty assessments to monitor the country's progress withpoverW alleviation.

IV. THE PROPOSED OPERATION

A. Backeround and Credit Obiectives

64. The proposed IIDA credit wil help strengh the balance of paymets position of Viet Nmnat a time when major changes are being implemented which aim at further inegratng the economy withthe international system. The credit would support the consolidation of a suitable medium-ermfrmework im which structur reform can be pursued in a growth-orieated manner. Tke credit willsupport macroeconomic stability through improved management of the budget and stae enerprises. Itwill strengthen the incentives for private saving and investment through banking and foreign tradereforms. The credit, in the amount of SDR 103.5 million (US$150 million equivalent) to be disbursedin two tranches (equivalent to US$90 million and US$60 million, respectively), would finance generalimports of goods to meet part of the economy's extena fnancing requirements. Intere in paralelfinancing has bee expressed by Japan, France, and Sweden. Together, these sources would help fill theunfinanced gap in 1994 and 1995, according to the Bank's medium-term projections.

B. IMF Status and Banktund Coordination

65. The Governet's reform program contnues to receive the financial support of the IMP.The first review of the Stndby Arrangement, although delayed, was ucessfilly concluded in June 1994.Discussions between the IMF and the Vietnamese authorities on an ESAF program are at an advancedstage. The Bank, the Fund, and the Govemen agreed in September 1994 on a Policy Framework

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Paper for the 1994-97 period. Cooperation betweer. the Bank and the Fund has been very closethroughout the development of the policy program. In general, the Fund has taken the lead with the moremacroeconomic policies, including fiscal and monetary issues, the exchange rate, and tax reform. TheBank has focused more on structural and institutional measures, including reform of legal infrastructureand state enterprises, as well as on sectoral policies and issues of poverty and the environment. Areasin which the Bank and the Fund are working closely together include the budget, the financial sector, andthe trade regime.

C. Conditions of Tranche Release

66. During 1994 the Govenment introduced fiscal and monetary measures that shengtnedmacroeconomic policies and resulted in reductions in the fiscal and external deficits. It also continuedits program of structural reforms. In light of these developments, no additional measures will be requiredbefore the release of the first tranche of the credit. Concerning second tranche conditions, theGovernment's broad reform program is set forth in the Letter of Development Policy, with attached-Policy Matrix and macroeconomic indicators to be monitored under the SAC (Annex I1). Implementationof this agreed program of reform is a condition for second tranche release. In addition to this generalcondition, the Bank and the Government have agreed upon a number of specific measures that would beconpleted before release of the second tranche. These measures have been selected becase they covera range of importat issuds and because -they address imndiate bottlenecks whose removal will result.in accelerated growth and development of the economy.

67. The conditions for second tranche release are:

(a) Maintenance of a sound macroeconomic framework, consistent with objectives of theProgram, as determined on the basis of indicators agreed to by the Borrower and IDA(Annex II, Attachment 1).

(b) Presentation to the National Assembly of an organic budget law, satisfactory to IDA,that specifies the process for prepaing and managing the budget, including the roles ofdifferent central government agencies and of central and local authorities (paragraph 37).

(c) Completion of a Public Expenditure Review, under terms of reference satisfactory toIDA, to obtain a clear picture of government spending and to analyze the efficiency ofexpenditures in meeting stated objectives (paragraph 40).

(d) Adoption of an investment program for 1996-98, satisfactory to IDA, focusing oninvestments in infrastructure and human resource development that are complementay toprivate investment and that are situated in well-defined sectoral strategies (paragraph 42).

(e) Introduction of an excise tax- on petroleum products (including diesel fuel) of at least10%, to increase revenue and to make the prices of different petroleum products morecomparable (paragraph 43).

(f) Adoption of a time-bound action program, satisfactory to IDA, to (i) establish and utdizeclear criteria to identify strategic firms that provide essential public services, (ii) transformnon-strategic state firms into companies that compete on a level playing field with privatefirms, and (iii) strengthen the management of strategic finms that will continue to receivegovernment support (paragraph 52).

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(g) Completion of initial portfolio audijs, under terms of reference satisfactory to IDA, ofat least two of the four state-owned commercial banks, in order to identify the scope of thebad debt problem and to prepare reliable balance sheets for these banks (paragraph 54).

(h) Presentation to the National Assembly of legislation to exempt banking from theturnover tax in order to encouragexexpansion of intermediation in general and of the newprivate banks in puticular (paragraph 55).

(i) Reduction of the maximum import tax rate to no more than 60%, in order to reduce thedistortion in the incentive regimefor producers (paragraph 59).

D. Technical Assistance an Aid Coordination

68. Much of the success of the Government's structural adjustment program hinges uponinstitutional reforms. The Bank is therefore helping the Government to identify grant technical assistanceto design and implement reforms and to train local staff. The proposed SAC would be part of a oohenteffort by the multilateral institutions to support the transition to a market economy in Viet Nam.Coordination is particularly close with the IMP, owing to the joint work on the PFP. The UNDP hasprovided strong support to both the Bank and the Fund and is itself assisting with legal, adminstrative,and civil service reforms and with strengtening the Govermnent's capacity for aid coordination. In theareas of financial market developmnent, private sector development, and foreign investment policy, theBank is coordinating closely with IFC. The Bank Group is also working with ADB in several areas,including capital markets development.

E. Procuremnent

69. The proceeds of the proposed credit would be used for eligible imports, subject to thestandard negative list. Both private and public sector inports are eligible for fnancing. Imports valuedat US$5 million equivalent and more by both public and private sector entities would be procured inaccordance with simplified ICB procedures except for certain commodities which are traded inintemational markets. The Bank's standard bidding documents will be used for ICB procurement.Procedures for procuring commodities traded in intenional markets would be agreed upon beforeprocurement activities are started. Goods valued at less than US$5 million equivalent per contractimported by public sector entities would be procured using their own procurement procedures, whichhave been reviewed and found acceptable to IDA. The specific import procedures followed by selectedpublic sector entities have been reviewed in connection with this operation and determined to besatisfactory. Goods valued at less than US$5 million equivalent per contract imported by private sectorfirms would follow exisdng commercial practices. Expenditures for goods procured under contracts forless than US$10,000 would not be eligible for financing under the proposed credit.

F. Disbursement

70. The proceeds of the proposed credit would be disbursed against the foreign costs of generalimports based on a standard negative list which includes, inter alia, luxury goods, military equipment,and environmentally hazardous products. Retroactive financing up to SDR 20.7 million (US$30 millionequivalent) would be provided to reimburse expenditures for eligible imports incurred after July 1, 1994.No witdrawals would be made in respect of expenditures in excess of an aggregate amount of SDR 20.7million (US$30 million equivalent) for petroleum products and foodstuffs. Disbursemes would beadministered by the Ministry of Finance. For goods valued at less than US$5 million equivalent, the

simplified documentaon procedures for adjustment operations would be followed. For such contracts,each valued at less ihan US$5 million, IDA would reimburse the Borrower on the basis of Statements ofExpendit prepared frm the customs cerfices showing that eligible goods at least equal in vlueto the amount requested from IDA had been imported into the couny durng the period underconsideration. The customs certificates will be retained by the Miistry of Finance for review bysupervision missions and for subsequent audit by the extemal auditors. For conracts ch valued atUS$5 million equivalent or more, IDA would reimburse the Borrower against full documentation.conracts, suWlier invoices, evidence of payment, and evience of shipment. -The proposed credit isexpet to be disbursed over a period of one year. lTe closing date woUd be December 31, 1995.

71. The Ministry of Finace wi}l maintain accounts and supporting documentation in respect ofthe program. Audits will be camed out by independent auditors acceptable to IDA within nie monthsof closing of the fiscal year (December 31) in which disbursements under the credit are made.

H. Mongto

72. The adjusment program is being coordinated by a Steering Committee with representionfrom the State Baik, Ministry of Finance, Staite Plapng Committee, and Miisy of Trade. Thepolicies are alredy. weh in tiain and the Goveent's commite to them is clear. TXe proposedoperation requires monitoring-of the consistency-of the macroeconomicframework, as oudined in theLetter of Development Policy, and the implemeitation of specific actions detailed in pragraph 67. Themonitoring of the macoeconomic performance in particular will be carried out in close coordination withthe IMF. Monitoring of the specific actions detailed in pargraph 67 will be nertaken in the conteof supemsion missions which will visit Viet Nan prior to second tranche release. The COovernment willprepare reports on implementation prior to the supervision missions and an overall e.aluation of theprogram when the credit is closed.

1. 'nft an Risk

73. The benefits of Viet Nam's transition to a market economy are already plainy visible.Growth in per capita income during the 1989-93 period has been stronger than at any tme sincereunification. Viet Nam remains a very poor country and the expected benefits from contied rapidgrowth are very high, especialy reduction of poverty and of associated problems of malnmtrition and poorhealth. Viet Nam's development will depend first and foremost on its own efforts, and the reformprogram supported through the SAC is very much the country's own. The expected benefit rom theoperation is to stregthen the country's adjustment program in two specfic ways: (1) financial andtechnical assistance should result in more rapid reform and accelerated growth, bringing benefits soonerrather than later; and (2) features of the opeation will ensure that benefits are widely dispersed so thatpoverty reduction occus more rapidly than would result fmom merely relying on rapid growth to alleviatepoverty.

74. The main risk associated with the operion is that refonns wil! not proceed as rapidly asplaned owing to weak institutonad capacity and/or lack of trained staff. Design of the operation isaimed at minizing these risks, in that it will be accompanied by a coordiated program of technialassistance fimded from grant sources. There is also a risk that stuctural reforms will be undermined bythe return of macroeconomic instability, as the stabilization is sfill fragile. The Government does,however, have a track record of takdng firm actions when confroted with mounting iflation.

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V. IEC01NION

75. . an. satisfied that the proposed development credit would comly with the Articles ofAgreemen of the Assowiaton, and I recomrend that the Executive Diretors approwve it.

Lewis T. PrestonPresident

Attachments

Washigton, D.C.September 26, 1994

-2QPage I of 3

VIET NAM: KEY ECONOMIC INDICATORS, 1991-1999BASE CASE

1991 1992 1993. 1994 1995 1996 1997 1998 1999

RPd GDP' 60% .6% 8&i% 8.7% 8.0% 8.0% 8.0% 8.0% 8.0%Red -DY 4.8% 6.0% 9.2% 8.0% 7.7% 8.0% 8.0% 7.9% 7.8%Real ODY per Capt 2.5% 3.7% 6.9X 5.7% 5.6% 5.8% 6.0% 5.8% 5.8%

CPI (Annua Avoe) 8W 37.7% 8.3% 8.0% 7.0% 6.0% 6.0% 6.0% 5.0%CPI (Doc. toD.c.) 67.6% 17.5% 5.2% .. .. ..

Debt Swve. (nublil suarmteed-Deb Servie. (US$li --- ,: 504 717 .97i .543 602 480 509 567 . 646Debt ServiceIXOS 19.9% 2215% 26.6% . 11.9% 11.7% 8.5% 8.2% 8.3% 8.5%Debt ServiceIGDP 5.2%t 6.9% 7.6% 3.5% 3.5% -2.6% .2.4% 2.5%-.. 2.5%

Raios to GDP (Current Prim)

Investneat 15.1% 17.0% 19.4% 19.9% 21.8% 23.4% 24.6% 25.2% 25.8%Nafional Savlup 13.1% 16.3% 11.2% 15.0% t6.2% 17.1% 18.0% 19.0% 19.9%Pubic _wemt . 2.8% 5.8% 7.0% 7.2% 7.9% 8.2% 8.5% 8.5% 8.5%Psivate Investment 12.3% 11.2% 12.4% 12.7% 13.9% 15.2% 16.1% 16.7% 17.3%Ratio of PublllhPrFt Investrnat 0.23 0.52 0.S7 0.57 0.57 0.54 0.53 0.51 0.49

Govt. Revenus (inc. Grants) 13.5% 19.0% 22.3% 25.4% 2S.5% 25.7% 25.7% 25.9% 25.9%GovtL EJXpediture (oc. Sched. bnL) 17.3% 22.7% 28.5% 28.1% 28.8% 29.1% 29.4% 29.4% 29.4%Overal Deo"ci (Accrua Baads) -3.8% -3.7% -6.2% -2.7% -3.3% -3.4% -3.7% -3.5% -3.5%Overall De"ict (Cak Bauds) -1.5% -1.7% -4.7% -1.9% .. ..

Oe items:

Export Grwtd Rae (Volume) 23.9% 31.2% 12.4% 23.3% 10.0% 6.9% 6.5% 7.3% 7.7%ExpotSGP 2S.7% 30.9% 28.3% 29.5% 30.1% 29.8% 29.4% 29.3% 29.3%mpoxt Growth Rats (Volume) 15.3% 19.9% 46.4% 12.6% 11.8% 8.7% 7.1% 5.8% 5.5%

IznpozlDP 24.6% 28.5% 32.8% 31.3% 32.6% 32.9% 32.7% 32.3% 31.8%Curet Aco,wt Baance (USS Million):- Before OfiC Trnsfem -188 -75 -1063 -743 -944 -1174 -1352 -1443 -1499

* Percent of GDP (%) -1.9% -0.7% -8.3% -4.9% -5.6% -6.2% -6.5% -6.3% -5.9%- After Officill Tranfer -133 -11 -6 -642 88 -1031 -1234 -1320 -1370

*Prct of GDP (%) -1.4% -0.1% -6.8% -4.2% -4.8% -5.4% -5.9% -5.7% -5.4%Gross R ces in Woes

of Total lmpo .. .. 6.0 8.5 9.8 11.0 11.0 11.0 11.0

A dsta4r Viename authoritie and Bank and Fwud staff atimate.Projctions: Bank staff estites.

-~~~~~~~~~2 --21- A.nex .

Page 2 of 3

VIET NAM: BALANCE OF PAYMNTS, 1991-1999 (US$ mion)BASE CASE

AMd1 Psoqocod199I 1992 199. 1994 199S 1996 1997 1998 19

A. E1ozt ofQFS 2492 3200 3622 4530 5107 S597 6121 6744 74611. Msadibs (FOR) 2042 2475 2850 3600 4086 4514 4956 5461 6041

4fwb3h: am&udoa S81 756 844 899 1024 1141 1274 1423 15892. Non-Fadwr S4rm 449 724 772 930 1021 1083 1165 1283 1420

B. ImpoM of ONPS 2377 2950 4199 4804 5533 6184 6802 7420 803I. madls _(FO 2107 2538 3505 4001 4631 5174 563 OM 67562. Now-Factor Srvu 270 412 694 796 903 10O9 1109 1219 1337

C. Resouce Bal 115 249 -m7 -274 -426 -586 -681 -7 -632

D. Net Facr humc -339 -384 -556 -S6D -618 -679 -79 - -10141. IntAreg Paysects 248 282 327 256 262 285 312 340 363

E. Net Transas 91 123 264 192 237 252 238 256 2761. OfIn Trmnaea 55 64 194 101 136 143 118 123 129

P. Curret Acount Baane -133 -11 -8 -642 -8 -1031 -1234 -1320 -1370(after offiow (kant.)

Current Acowunt Wmeie Chntda) -188 -75 -1063 -743 -944 -1174 -1352 -1443 -1499

G. LAng Tam Caplal hIlows1. Dret Forpign Ivsmat 220 260 300 435 501 575 661 761 8S3

2. Not Lco Tam onnowln -198 52 -442 197 429 725 733 794 790

a. Disbu asoats 59 487 202 484 769 920 930 1020 1073b. Axosrtizm l 256 435 644 287 340 195 197 226 283

3. Mther Capa (Not) -89 -41 -S8 -19 ..

R. Eos and Omndoes 143 8 -76 29 .. ..

I. Ovenll Baance -56 268 -1145 0 122 269 160 235 273

J. Fbiancng 56 -268 114S 0 -122 -269 -160 -235 -273

1. Change in Reserve -276 -463 S27 -254 -269 -269 -160 -235 -273

2. Arrears (net) 332 196 -266 -2459 ..

3.D Reschodullg 1/ ..I. 883 2713 147

Source:Actal dft. Vtnames autoba and Bank and Fund staff edEtIMas.Project : Bank sff edstimates.

22-mexPap 3 of-3

VIET NAM: EXTERNAL FINANCING tEQUIRQtEMS, 1991-1999BASE CASE

Actua Prel.1991 1992 1993 1994 1995 1996 1s9? 1998 1g9g

CurrentAccount Deficit 188 7s 1063 - 743 944 1174 1352 1443 1499Officia M&L Amortzation 256 435 644 287 340 195 197 226 283

Oher.s (Net) 1i -143 -8 76 -29 .. ..

Rwesve Roqulreomts 276 463 -S57 254 269 269 160 23s 273

Total 577 965 12S6 1255 1553 1638 1709 1904 2055

Financing ResourcesOfflcial Grants 55 64 194 101 136 143 118 123 129Long Team BorowIng 59 487 202 484 769 920 930 1020 1073

Direct Foreign Investment 220 260 300 43S 501 575 661 761 853ShorTerm Capital (Net) -89 -41 -58 -19Arears Accumultion (Net) 332 196 -266 -2459 ..Debt Rescheding 2/ .. 883 2713 147

Total 577 965 1256 125S 1553 1638 1709 1904 2055

Note:1/ Errors and omissons for 1991-1994.

21 Based on the Paris Club negotitons.

Source:

Actu daft: Vietnamese authorites and Bank and Fund staff estimats.Projections: Bank aff estimates.

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Letter of Development Policy

September 21, 1994

r.Lwi T. PrestonPresidentInteratonal Developmt Associ-onWashington, D.C.

Re: Struural Adjutm Credit

Dear Mr. Presidet:

The Governmen of the Socialist Republic of Viet Nam is implementing a wide-rangingreform program aimed at transforming our system to a market economy and placing the economy on asustmable growth path. We have been working with your staff to develop a stctural adjustmentprogram that could be supported through IDA resources. The program addresses macroeconomicmanagement, as well as structural reforms of the budget, state eterprises, the fiancial sector, the foreigntrade and investment regime, and legal infrastucture. One of our primary concerns is the social impactof the reform program, and we have worked closely with the staff of IDA to develop projects andprograms that would address our country's pressing social needs. This letter provides an ovemew ofthe Government's reform program, including m ures already taken and concrete plans for furtherreforms.

Wbile this is the first time that we have requested adjustment financing from the WorldBank, we would like to aephasize that the Govermet of Viet Nam has been carrying out its economicreform program for some years already. The prgram of "Doi Moi" (renovation) began late in 1986.After slow progress initally, the Government intuced a comprehensive package of reforms in 1989.These reforms have been sustained for five years now, and have yielded noteworthy resuts. Inflation,which had been as high as 400% in 1988, was reduced to moderae levels and then to less than 10% in1993. MViet Namp's is one of the few cases in economic history in which disinflation was achieved withouta recession. Growth was maintned in the 5-6% range during 1990-91, years of sharp fiscal cuband austerit. After the successful stabilization, growth accelerated to 8% in 1992-93.

The Goverment is proud of the results that have been achieved so far, but is also acutelyaware that the stabilizfaion still needs to be consoLidated and that the remai agenda for strucuralreforms is large and complex. The fragilit of the stabilization was clear in 1993, when both the fiscaland external deficits increased too rapidly. At the heart of the structual adjustment program are fiscaland monetay policies aimed at reducig these deficts as a share of GDP and manag them in asustnable manner. The need for firm fiscal discipline means that we have to plan our expendiuresarefully in order to provide priority public services. Reform of the budget, inchding the publicinvestment program, is thus one of the key areas to be addressed in the nex stage of reform. Thesemeasues will be complemented by furiher reforms of state enterprises that aim to elimit implicitsubsidies and to create a level playng field between public and private fimis.

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Our vision of development has been strongly influenced by the successful economies inour region. We wish to develop an incentive regime that stimes prvate saving and investment, andthat results in a growing outward orientation of our economy. To that end we plan to intuduce measuresto strengthen the fiancial sector, liberalize foreign trade and investment, and furtier extend the legainfrastructure for the market economy.

Thus, the broad objective of the reform program is to create an efficient, well-focusedpublic sector, and a dynamic private sector, which together can bring about sustied and rapiddevelopment of our economy and society.

Mediunm-Term Economic Framewor

The Government plans to conduct its policies and programs within a consistent medium-term framework. The main objective is strong and sustained growth, which is at the har of an effectivestrategy for generating employment and alleviating poverty. To achieve this objective, the medium-termstrategy has three inter-related components: strong macroeconomic mnagement, strucural measures toimprove efficiency of both the public and private sectors, and effective use of foreign resources fordevelopment. To maintain macroeconomic stability will require management of the fiscal and externaldeficits in light of the availabiliy of reliable sources of fiance, pruent monetary policies, and emternalpolicies that permit the build-up of an adequate level of international reserves. Structural measures thatare important in the medium term are reform of the budget and state enterprises, on the public sectorside, and improvements in the incentive regime for the private sector. These measures aim to increasepublic and private savings in Viet Nam, so that development can proceed more rapidly. In addition,effective use of foreign resources is an important component of our medium-term financing plan. Thisinvolves atracting private sources through creation of a good enabling environment for DPI, as well asefficient use of ODA resources to build up our economic and social ift cture. We are working tostrengthen our aid management procedures and insttutions in order to accomplish the latter task. As ourprogram will require significant fmancing, we have asked the World Bank to organize and chair aConsultative Group for Viet Nam to help mobilize and coordinate extemal aid. These aspects of themedium-term program are elaborated in more detail below.

Macroeconomic Prosnects and Objectives

The growth rate of the Vietnamese economy accelerated to 8% in 1992-93, from 5-6%in 1990-91. The Government's medium-term plan is to maintain growth in the 8% range, or higher ifthe context allows. However, several features of the growth pattern in 1993 were not sustainable, andthus we introduced some adjustments to put the economy on a sound expansion path. The exenal deficitincreased too rapidly in 1993, and reached 8.3% of GDP. Part of this was financed from sustinablesources, that is, direct foreign investment and official development assisunce. A substantial share of theexternal deficit in 1993, however, was funded from non-sustanable sources. This included the drawdownof the gross reserves of the banking system and international commercial borrowing at high intest rates.

A key aspect of the Government's adjustment program in 1994 and 1995 is to bring theexternal deficit into line with reliable sources of financing. Projections of the inflows of DFI and ODAindicate that this policy will result in a decline in the external current account deficit, to about 5% of

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Annex R-

GDP in 1994 and 1995. The extemal deficit indicates the inflow of foreign savings to help financeinvestment. As this declined in 1994, it was necessary for domestic savings to increase, as a source offinancing for invesunent, in order to maintain the investment rate.

One of the notable achievements of the reform program has been the rapid increase ininvesmenet. Investment as a share of GDP increased from 11.5% in 1990 to 19.4% in 1993. Over thisperiod our national savings increased from 73% to 11.2% of GDP. The Government's medium-termprogram projects that the investment rate wIll have to rise further in order to sustain 8% growth. Anumber of special factors enabled our economy to grow rapidly, with only a moderate investment rate.We recognize, however, that will be necessary to build up the investment rate toward 25% of GVDP inorder to meet our growth objectives. The fact that the investment rae needs to increase, combined withour plans to carefully manage the external deficit as a share of GDP, means that ongoing increases indomestic savings will be required in order to achieve these targets. -It is for this reason that measures tostrengthen the incentives to save and invest are central to the Govemment's reform agenda.

While we expect the private sector to play the leading role in building up domesticsavings, the Government will also contribute through better fiscal management. In 1993 Govermmentsavings were just slightly positive. Our medium-term plan is to increase Government savings to 4% ofGDP. This goal will be accomplished through a conbination of increased revenue and restraint ofrecumrrent expenditure. Government revenue has increased very substantially as a share of GDP duringthe reform period, rising from 13.5% of GDP in 1991 to 22.3% in 1993. We anticipate further moderateincreases as a result of tax reform and broadening of the tax base. The Ministry of Finance is workingwith the IMF to reduce the number of turnover tax rates and to convert this tax to a VAT by 1997. Weplan to computerize the tax system and have initiated discussions with IDA concerning the financing ofthis project. These measures together should ensure that revenue collections are robust as the economyexpands. However, we recognize that expenditure restaint will also be needed to meet our savingstarget. Hence better planning and management of the Government budget is another key element of ourprogram and is discussed in more detail below.

The expansion of exports is an important component of our growth saegy. Exportgrowth in excess of 25% per year during 1989-92 was a key factor sustaining the Vietnamese economy'sgrowth during a difficult adjustment period. The slowdown in the growth rate of exports to 12.4%(constant prices) in 1993 made us realize that additional measures are needed to promote the expansionof foreign trade on a long-term basis. The Government plans to promote export development focusedon labor-intensive manufactures and processed primary products. Exports of the former are particularlyimportant to our economy, as they will generate large numbers of jobs for our unemployed andunderemployed workers. The growth of these non-radiional exports is already evident, as labor-intensive manufactres - starting from a very low base - were the most rapidly expanding class ofexports in the past two years. In comparison to the traditional exports (rice and oil), development ofthese exports is more complicated, and will require ongoing reform of supporting institutions, especiallythe financial sector and the system for imports and exports. We also plan additional reforms of theregime for foreign investment, as foreign investment will be of major assistance in developingmanufactured exports.

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We are confident that with the provision of adequate financial assistance, the objectivesoutlined above can be achieved. We do recognize, however, that our targets are ambitious and that itwill not be easy to reach them. Stronger macroeconomic management and additional measures to deepenthe structural reforms will be the keys to meeting our program objectives.

External Borrowing StraUv

The Vietnmese econony went through several years of austerity during which littleexternal assistance was available to it. The collapse of the Soviet Union, which-had been a major donoraWd trade partner of Viet Nam, was a large shock to our economy. In the wake of this shock, theextenal deficit was quicldy reduced to zero, as no other major sources of finncing were available at thattime. While this was a difficult period of austerity for the country, it had its positive effects as well, inthat it encouraged the exchange rate devaluation and trade reforms that have subsequenty made it possiblefor Viet Nam to reiegrate quickly into the international economy.

The Government feels that it emerged from this period of isolation with polcies taw willenable the economy. to make effective use of foreign fiincigand-fi tiide. In addition, however, thGoverment is burdened with a significant extemal debt. This includes debt denm in TransferableRubles, as wel as hard-currency debt to official and commercial creditors. Most of the hard-currencdebt was taken on in the late 1970s. Failure to service this debt throughout much of the 1980s resultedin accuuladtion of arrears and build-up of this debt to a significant level.

In December 1993 the Govermnent successfully negotiated a framework for reschedulingofficial debts with Paris Club members. We intend to use this as a framework for negotadng debtrescheduling with other creditors, official and commercial. While these negotiations are still ogoing,we project that the net effect will be to reduce the debt servicing burden to a manageable level for themedium term. Specifically, debt service will decline fro