Document of The World Bank FOR OFFICIAL USE ONLY Report No. 25141 MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND THE INTERNATIONAL FINANCE CORPORATION TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR THE PEOPLE'S REPUBLIC OF CHINA January 22, 2003 China Country Management Unit East Asia and Pacific Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS (as of October 31, 2002) Currency = Renminbi Currency Unit = Yuan (Y) US$ I 00 Y 8 277 Y I 00 US$ 0 1208 FISCAL YEAR July I - June 30 ABBREVIATIONS AND ACRONYMS AAA - Analytical and Advisory Activities IMF - International Monetary Fund ADB - Asian Development Bank JBIC - Japan Bank for International Cooperation APEC - Asia Pacific Economic Cooperation MIDGs - Millcnnium Development Goals APL - Adaptable Program Loan NMIGA - Multilateral Investment Guarantee Agency AusAID - Australian Agency for International MOF - Ministry of Finance Development MOFTEC - Ministry of Foreign Trade and Economic CAE - Country Assistance Evaluation Cooperation CAS - Country Assistance Strategy NGO - Non-Government Organization CCICED - China Council for International NPL - Non-Performing Loan Cooperation on Environment and ODS - Ozone-Depleting Substances Development OED - Operations Evaluation Dcpartmenit CDF - Comprehensive Development Framework PBC - People's Bank of China CPDF - China Project Development Facility PPP - Purchasing Power Parity DFID - Dcpartment for International QAG - Quality Assurance Group Development (United Kingdom) RAINS - Regional Air Pollution Information and ESW - Economic and Sector Work Simulation EU - European Union SDPC - State Development Planning Commission FDI - Foreign Direct Investment SME - Small and Medium Enterprise FY - Fiscal Year SOE - State-owned Enterprise GDP - Gross Domestic Product SSIF - Sichuan SME Investment Fund GDLN - Global Development Learning Network TA - Technical Assistance GEF - Global Environment Facility TVE - Township and Village Entcrprise IBRD - International Bank for Reconstruction and UNDP - United Nations Development Programme Development ICT - Infonmation and Communication UNEP - United Nations Environment Programmuie Technology IDA - International Development Association WBI - World Bank Institute IFC - Intemational Finance Corporation WTO - World Trade Organization IBRD IFC Vice President: Jemalud-din Kassum, EAP Assaad J. Jabre, CIOVP Country Director: Yukon Huang, EACCF Javed Hamid, CEAHK Task Team Leader: Akihiko Nishio, EACCQ Stoyan Tenev, CEADR PEOPLE'S REPUBLIC OF CHINA COUNTRY ASSISTANCE STRATEGY Fiscal Years 2003-05 TABLE OF CONTENTS Page No. EXECUTIVE SUMMARY . . 1. COUNTRY CONTEXT .................... . .............. .............................. I A. Overview. I B. Macroeconomic Management .1 C. Structural Reform ............................. ............... 3 D. Poverty and Inequality ............................. . 6 E. Economic Outlook and External Environment. 8 2. THE GOVERNMENT'S PRIORITIES .......10..................... ................. 10 3. PROGRESS DURING THE LAST CAS PERIOD AND LESSONS LEARNED . 14 A. Objectives of the Last CAS ........... . ........................................................ 14 B. Major Developments Since the Last CAS .14 C. QAG and OED Assessment. 19 D. Client Survey and Feedback from Consultations ............ .................... .......... 20 4. THEMATIC FRAMEWORK FOR THE BANK GROUP'S ASSISTANCE PROGRAM ...................................................... ...... 22 A. Developing Themes for a Changing Situation .22 B. Improving the Business Environment and Developing the Market Economy .23 C. Addressing Needs of the Poorer/Disadvantaged People and Lagging Regions .25 D. Facilitating an Environmentally Sustainable Development Process ... ................ 28 5. THE BANK GROUP ASSISTANCE PROGRAM . .30 A. Knowledge Agenda/AAA Program ....................... ........ ........... ........ 30 B. Lending Program: Levels, Focus and Selectivity ....... ................................... 32 C. Exposure .37 D. Portfolio Management ................. ......... 38 E. Safeguard Policies .39 F. Partnerships .40 G. Risks .............................................. ............... ... 42 H. Creditworthiness ............. ............................. 44 I. IFC and MIGA Programs ................................. ................ 45 J. Managing for Development Results .............. ................... ...................... 46 ANNEXES A 1: Key Economic and Program Indicators - Change From Last CAS A2: China at a Glance B 1: Progress Made in Achieving Goals of Previous China Country Assistance Strategy (1997) B2: Selected Indicators of Bank Portfolio Performance and Management B3: FY03-05 Lending Program B4: The Knowledge Agenda, FY03-05 B5: Social Indicators B6: Key Economic Indicators B7: Key Exposure Indicators B8: IBRD Medium-tenr Exposure Projections B9(a): Operations Portfolio (IBRD/IDA and Grants) B9(b): Statement of IFC's Held and Disbursed Portfolio BlO: Country Program Matrix (FY03-05) C: Summary of Consultation Results D: The Bank Group Assistance Program E: Global Goals and Corporate Priorities F: Private Sector Development Strategy G: World Bank Support for Good Developmental Governance H: Sumnmary of China Country Gender Review I. Improving the Quality and Client Responsiveness of Core Project Services: Financial Management and Procurement J: Overview of Ongoing External Assistance to China TEXT TABLES Table 1 1: Macroeconomic Indicators ................... ................................. ...... 2 Table 1.2: Key Economic Performance Indicators .. 9 Table 3.1: Operational Performance Indicators .. 14 Table 3.2: IFC Program in China: Approvals 1997-2002 ..18 Table 5 1: The Bank's Evolving Objectives and Instruments: The Case of Energy .. 35 Table 5.2: Key Debt Indicators, 1997-2001 ...................................... ...... 45 TEXT BOXES Box 1.1: Recent Structural Reforms.. 4 Box 1.2: Summary of China's Progress with Respect to the Millennium Development Goals ...... .......... .................................... 8 Box 2.1: Main Features of the Tenth Five-Year Plan (2001-2005) . .10 Box 2.2: Establishing a Framework for Good Developmental Governance . . 12 Box 3.1: Examples of Recent Bank Group Support for Innovation and Change in Chm a ............................................... ................... 19 Box 4.1: Thematic Framework for the CAS ......... .............. .............................. 23 Box 4.2: World Bank Support for Improving China's Financial System . .25 Box 4.3: Helping China's Rural Poor ..27 Box 5.1: Sub-national Development Issues - An Important Area of Bank Involvement .. . 31 Box 5.2: Examples of Support for Innovation and Change ........... ........................... 36 Box 5.3: Blending of DFID Grant and IBRD Loan: Partnership in Action ....... ............ 41 Box 5.4: China's Development Model and How It Compares with CDF ....... ............ 42 TEXT FIGURES Figure 1.1: Headline Economic Indicators (1996-2001) ........... ............................. 2 Figure 1.2: Number of Poor in Rural Areas, 1987-1999 ............ ............................. 7 Figure 3.1: IBRD and IDA Commitments to China, FY93-02 .. . ............................... 15 Figure 3.2: Portfolio Quality ............... ....... ................................................. 16 Figure 4.1: Environmental Issues and Bank Support ................... ....... .............. 29 Figure 5.1: Geographic Focus of Lending . . ........................... .......... ................ 33 Figure 5.2: Lending - Sectoral Composition ....................... ...... . .................. ... 34 Figure 5.3: Bank Operations by CAS Theme ...................................................... 37 CHINA: COUNTRY ASSISTANCE STRATEGY Executive Summary Background i. This is the first Country Assistance Strategy (CAS) for China smce it ceased borrowing on concessional terms from the International Development Association (IDA). The country context now is very different from that of the previous CAS in 1997 and the Progress Report in 1998. In particular, the new CAS coincides with: a shift in China's reforms, from the liberalization phase to the more difficult structural and institution building phase, dynamic growth of the private sector; and a continuing need but reduced availability of concessional external financmg. The CAS also reflects the changing nature of the China-World Bank Group relationship, in particular: the potential gains to both sides, with China positioned not only to receive Bank assistance, but also to share lessons of its development experiences more broadly and contribute to thmiking on global development issues of common concern; the growing importance of the Bank's advisory services; the more active role that the International Finance Corporation (IFC) and Multilateral Investment Guarantee Agency (MIGA) will play, and the recognition of benefits that Bank partnerships with other donors, the private sector and civil society can have. Recent Developments ii. Since the last CAS, China has managed macroeconomic conditions well. It has relied on stimulatory macroeconomic policies and a stable exchange rate to sustain domestic demand and activity and support structural reforms. Economic performance during 1997-2001 was among the best in the world, with annual GDP growth averaging 7-8 percent, and a much strengthened external position At the same time, considerable progress has been made against a broad structural refonn agenda and with respect to the Millennium Development Goals (MDGs) This is remarkable given the depth of the East Asian financial crisis, as well as the dislocations caused in the domestic economy as a result of the policy initiatives implemented during this period, most notably in the enterprise and rural sectors. Chma 's accession to the World Trade Organization (WTO), achieved in 2001, is providing major impetus to continued reforms. Developnment Challenges Facing China iii. Despite the impressive growth, sound macroeconomic policies and large cushion of domestic savings and international reserves, China needs to address the challenges of strengthening its medium- term financial position. Government debt increased; contingent liabilities are also large, mainly as a result of non-performing loans in the banking system, under- funded pensions, and enterprise arrears. Equally, there is need to build on recent reforms to strengthen the fiscal position, especially sub-national finance, and reshape institutions and the business environment in order to address key aspects of China's national development agenda. iv. Despite substantial progress on poverty reduction over the last decade, more than 200 million people m China still live on expenditures of less than US$1 a day (34 million in 1999 11 using the official US$0.67 poverty line). They account for about 18 percent of the globalpoor and are found mostly in rural areas of the lagging inland provinces. Trends in inequality and social indicators suggest that disparities have widened in recent years, between urban and rural areas and also between coastal and inland areas. While China is on track to achieve the MDGs, barriers such as unequal access to health and education are still formidable challenges. Government's Priorities v. The Govermnent's development strategy, as crystallized in its Tenth Five-Year Plan (2001-2005) and reaffirmed in the recent 16th National Congress of the Communist Party, identified as a national goal the achievement of a "well-off society." While GDP is expected to quadruple during 2000-2020, the concept of China's development that is embraced goes well beyond increases in income to stress the quality of such growth and the importance of all-round social progress. Environmental sustainability and the application of modern science and technology, especially information and communication technology (ICT) to raise productivity and generate greater benefits are the cornerstones of the strategy. Entrepreneurship, an increased role for private investment, closer integration with the world economy, and an improwed legal system and stronger protection of property rights have been emphasized. The increased flexibility of resource movements, a continued emphasis on human resource development, active measures to narrow social disparities - especially rural-urban and regional gaps, and better management of the rural urban transition are identified in recent policy statements as key areas of concentration. The Govermnent has stressed poverty reduction, sustainable development of its lagging western region, and informatization as strategic priorities, and for each established a "leading group" with coordination responsibilities that cut across the mandates of individual agencies. After downsizmg the central government administrationdrastically in 1998, the Government has been strengthening governance of the public sector. In particular, it has been fighting corruption aggressively and transforming the function of government from direct involvement in commercial activities to strategic guidance and economic regulation, market supervision, social protection and public service. Developments and Lessons Learned Since the Last CAS in 1997 vi. Operationally, lending declined sharply during this period, due largely to concerns about exposure of the International Bank for Reconstruction and Development (IBRD) to China - since the IBRD single-country concentration limit was being approached - the increased financial cost and preparation requirements of IBRD loans, and the availability of domestic low- interest credit that was provided as part of the Government's stimulus package. However, the Bank's portfolio has remained strong and even improved, while demand for the Bank's Analytical and Advisory Activities (AAA) shifted towards more challenging issues - exemplified by deep-rooted structural problems related to globalization, governance, poverty and sustainable development. Greater emphasis has also been given in AAA to "rapid response" policy notes, and less to the more traditional, comprehensive reports. Institutionally, the Bank's decentralization initiative has made it easier to serve its client, but the complexities in dealing with the Bank's matrix structure along with the application of its environmental and social safeguard policies have been recurnng issues. vii. The Bank's Quality Assurance Group (QAG) and the Operations Evaluation Department (OED) have recently carried out various assessments of Bank-supported activities, including reviews of operations for poverty reduction, forestry, environment, involuntary resettlement related to river basin development, energy development, and transport. These evaluations found strategies to be well directed generally and projects that either in whole or in part set the standard for best practice; they also provided valuable feedback on areas to improve. The OED is now carrying out a Country Assistance Evaluation for China, due to be completed in early FY04 Vill. Since 1997, government officials, project implementing agencies, and representatives of civil society have participated in five formal consultation exercises, and most recently in a broad- based client survey. The private sector has also been extensively consulted by IFC, in particular through a major study of the domestic private sector in China and a Joint Bank/IFC study on enterprise reform and corporate governance. Overall, the views voiced during these consultations have been consistent over time. The Bank's assistance to China has been appreciated, in particular the transferring of knowledge and new ideas through both lending and AAA, while concerns have been raised about the cost of doing business with the Bank and the need to streamline procedures. Thle World Bank Group's Assistanice Progranm ix. Under the overarching theme of supporting China in makmg two historic transitions - from a rural, agricultural society to an urban, industrial society, and from a centrally-planned economy to a more globally integrated market-based economy - the Bank Group's assistance strategy is designed to help China: (a) impr-ove the business environment and help accelerate the transition to a market economy, mostly through an array of knowledge transfer activities; (b) address the needs of the poorer and disadvantagedpeople and lagging regions, through mvestment lending in rural development, infrastructure and social sectors, as well as AAA and training; and (c) facilitate an environmentally sustainable development process, through investment lending in natural resource management, watershed rehabilitation and wastewater treatment, energy, global environment projects supported by the Global Environment Facility and Montreal Protocol, and policy work. x. Given the increasing emphasis on knowledge in the China-Bank Group relationship, a major Knowledge Agenda is planned to facilitate policy discussions and lay the groundwork for future lending. Its key features can be characterized as being: more demand-driven; reliant on a variety of delivery mechanisms including research; and based on the increasing use of local experts and institutions. Under the broad themes identified above, the Knowledge/AAA Agenda is organized to address some specific development concerns identified by the Government. Adjustment to its accession to the World Trade Organization (WTO) is one such area of work, as is sub-national finance. This involves an assessment of domestic as well as regional/international impacts of the wider opening of the Chinese economy, and the need to restructure financial institutions and promote the private sector Equally, issues related to rural- urban migration, labor market flexibility, social protection, and urbanization are being tackled through this program, supported by capacity-building through World Bank Institute (WBI) courses (including distance learning). An important thread that runs through much of this work iv is the need to address China's still-substantial poverty and growing inequality, exacerbated by enviromnental problems, in all their dimensions. xi. An annual IBRD lending program of about US$1.2-1.3 billion is envisioned, larger than in the last two years but less than the US$3 billion peak reached in the mid- 1990s. This is subject to completion of ongoing discussions of an exposure management arrangement. Selectivity has been enhanced by focusing more on the disadvantaged regions and the importance attached to promoting innovation and change through Bank operations, including in the coastal provinces. In terms of geographical distribution, three-quarters of the proposed projects will support the poorer, inner provinces, compared with 62 percent dunng the last CAS period. In terms of sectoral composition, transport - with a focus on completing key segments of the national and provincial highway system and linking the lagging regions - and urban projects focused on environmental mitigation (water, sanitation and air pollution) remain the two largest sectors, accounting for 34 percent and 24 percent of the FY02-04 lending program, respectively. Lending for social sectors including free-standing techmcal assistance accounts for 14 percent, facilitated by blending arrangements supported by the United Kmgdom's Department for International Development (DFID) and potentially by other external partners. Rural development - supporting both poverty reduction and natural resource management objectives - accounts for about a fifth of expected lending. Energy - focusing on raising efficiency and on renewable energy - accounts for less than 10 percent. xii. Support for innovation and change is a major feature of Bank operations. For mstance, the proposed projects would introduce more programmatic and pilot operations, strengthen links to private sector financing, push urban lending down to secondary and smaller cities under an intra-provincial framework, move further toward an inter- modal approach to transport needs within a province and down to local levels, support non-traditional and smaller-scale energy projects, and deepen the focus on social service needs in poor areas. xiii. Over the past two to three years, the Bank has deepened its collaboration with other partners to share knowledge and enhance results. Most notable is the tripartite partnership with the Government and DFID - its cornerstone is the "blending" of DFID grants with IBRD loans to provide concessionary finding for social sector and poverty reduction projects in the post-IDA period, while tapping different types of expertise to enhance the quality of operations. Other important examples are the first formal Bank-European Union (EU) cofinanced project in Asia for natural forest management and AusAID's support for the Bank's Global Development Learning Network (GDLN) activities in one of the poorest western provinces. The ability to attract more concessional finance for China's development will depend upon stronger upstream cooperation by external partners on a complex development agenda as well as on innovative mechanisms that help surmount local financing difficulties. Collaboration has also been increased with the UN agencies - for poverty- related work and in the health sector especially - and with the International Monetary Fund on fiscal reforms. With the greater field presence of the Asian Development Bank, more efforts have been made to align sectoral approaches and hannonize institutional procedures and policies with those of the client xiv. IFC's strategic priorities during the CAS period include: targeted technical assistance to improve the business environment, particularly for financial markets, private participation in v infrastructure and small and medium enterprises (SMEs); SME capacity building and development of alternative sources for SME financing; the financial sector development by supporting private banking and non-bank financial institutions; private sector development in China's western and interior provinces; enterprise restructuring; and expanding the presence of private enterprises in infrastructure, social services, and envirom-nental technology sectors. The focus will be on model transactions that set standards in corporate governance, international accounting, environmental technologies and practices, and efficiency of private enterprise operations, with the aim of creating demonstration effects and helping Chinese companies become internationally competitive players. MIGA's activities are intended to generally complement the Bank Group's strengthened emphasis on sub-national capacities in China, while addressing the interest in guarantees and investment marketing ansing out of China's post-WTO opening. Risks xv. While China's current financial situation remains strong, the medium- tenn fiscal position needs strengthening, mostly due to risks from contingent liabilities. However, in assessing the overall macroeconomic/financial risk for China, the following factors should also be considered: (a) the Government's track record in economic management; (b) on the domestic front, China's impressive growth momentum and its predominant reliance on domestic savings for financing; and (c) on the external front, its remarkable trade performance, the restricted convertibility of the currency on capital account, and its strong external reserves position in relation to overall public indebtedness. As for country risks, the main source would be the economic dislocations that are likely to follow closer global integration in the wake of accession to the WTO. To manage these risks, the Government would need to deal proactively in handling post-WTO accession adjustments, especially in the lagging regions, while continuing to address the longer-term problems of poverty, inequality and urban labor displacement. MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND THE INTERNATIONAL FINANCE CORPORATION TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR CHINA 1. COUNTRY CONTEXT A. OVERVIEW 1. The progress of China over the past two decades is as remarkable as the complexity of the development challenges it faces. So far, it has managed the transition from a centrally- planned to a market-based economy better than most other transition countries. Officially- reported per capita income has increased at an annual average rate of almost 9 percent over the past two decades, reaching US$890 last year. In 2000, China entered the ranks of lower middle- income developing countnes. During the period since the start of economic liberalization in the late 1970s, over 250 million people have been lifted out of poverty. Clearly, framed against international development experience, both its anti-poverty and growth perfonnance are impressive. In this sense, drawing on its know-how, China has much to offer the developing world. 2. But the size of its population (1.27 billion in 2001) and economy, and its vast geographical area (third-largest in the world), expose China to the entire range of development problems confronting large countries These problems are complicated by inadequate human capital formation, a severely degraded natural resource base, and a still-high incidence of poverty. Further, China's rapid economic development is occurring in the midst of major systemic transformations - from central planning to markets, from an agrarian to a manufacturing/services based economy, and from being relatively closed to fast-paced globalization. A decentralized administrative and economic setting makes the management of this complex economic transition even more difficult. 3. There are no simple answers to China's development challenges, but China's success will bring not just national benefits, it will also generate regional and global payoffs. Understanding and helping to address such challenges constitute the core of the Bank Group's country assistance strategy. B. MACROECONOMIC MANAGEMENT 4. Since the last full CAS in 1997, China has managed macroeconomic conditions well. It has relied on stimulatory macroeconomic policies and a stable exchange rate to sustain domestic demand and support continued structural reforms. Despite the debate on reported statistics in tracking China's economy, it is clear that these policies, combined with foreign investment inflows, have delivered strong economic results Economic perfonnance since 1997 has been among the best in the world, especially considering the structural policy and institutional reform program implemented during this period. Specifically, enterprise reform initiatives, increased import competition, and a policy- induced "soft- landing" after 1995 resulted - 2 - in major structural adjustments in the Chinese economy. It is estimated that nearly 26 million (or one in five workers) in state-owned enterprises (SOEs) lost their jobs during Figure 1.1: Headline Indicators (1996-2001) 1998 to mid-2002 (in addition to a 12 250 smaller number of non-SOE layoffs) - of 10 200 which some 17 million have since found 8 W employment. The pace of job-creation 6150 outside farming fell well below the 2.4 -w. 4 - percent rate considered necessary to o 2x - 100X absorb the 8-9 million people who seek o 50 new jobs each year. Moreover, the _ persistence of excess production -2 0 capacity and deflationary pressure 1996 1997 1998 1999 2000 2001 throughout this period suggests that the IGDP r 'CPI -FX reserves macroeconomic effects of structural transitions are still to run their course (Figure 1.1). 5. Nevertheless, neither during the Asian crisis (1997-98) nor in the more recent global slowdown (2000-present) has the Chinese economy suffered from as severe a downturn as its neighbors, or other developing countries. Over this period, GDP growth averaged 7-8 percent annually. Despite strong export growth, the contribution of net external demand (exports less irnports) to economic growth turned negative after 1999. However, consumption and investment demand were supported by a combination of fiscal, quasi fiscal, and monetary policy, aided by the domestic spending resulting from foreign direct investment (Table 1.1). While government revenue rose from 12.1 percent of GDP in 1997 to 17.2 percent in 2001, the government budget deficit increased from 1.8 percent of GDP to 4 percent in 1999, before falling slightly to 3.2 percent in 2001. Governnent expenditure, as a share of GDP, increased by 6.5 percentage points over a fbur-year period. Over the same period, government debt rose from 11.4 percent of GDP to 23.8 percent. Table 1.1: Macroeconomic Indicators | 1996 1997 1998 1999 2000 2001 Growth (% per year) ___IT1 __ GDPgrowth 96 88 78 7.1 80 73 Consumer price index 8 3 2 8 -0 8 -1.4 04 0 7 Non-agricultural employment 2 9 1 6 0 6 1 0 1.9 2 2 Shares (% of GDP) I I Domestic savings 42 43 42 41 39 40 Budget balance -I 6 -1 8 -3.0 -4 0 -3 6 -3 2 External current account balance 0 9 4 2 3 4 2 1 1 9 1 5 Total government debt 11 4 17 8 20 9 22 8 23 8 Levels (US$ billion) _ Net FDI inflow 38 1 417 411 37 0 37 5 37 4 Stock of intcrnational reserves 105 140 145 155 166 212 Stock of external debt a/ 129 147 144 152 146 170 Ofwhich Short-term debt 25 31 17 15 13 51 Source World Bank and IMF staff estimates and official data a/ Coverage was cxpanded in 2001 to include categories excluded earlier, especially short-tenm debt, which is now shown on a remaining, rather than onginal, maturity basis - 3 - 6. Macroeconomic growth has been sustained, but the medium-term financial position needs to be strengthened Not only has recorded govermment debt increased, but contingent liabilities, too, have risen as a result of non-performing loans in the banking system, under- funded pensions, enterprise arrears and other liabilities. Under various assumptions, total public debt could account for a very large proportion of GDP (see Risks: Section 5-G). Despite the rise in govemment debt, China retains a number of cushions to withstand extemnal economic shocks. The external current account surplus has narrowed, reflecting the slower growth of world export markets and a surge in imports as both domestically-owned and foreign- invested finms retooled for the period following accession to the World Trade Organization (WTO), but export potential is good. After rising in 1997-98, external debt - both total and short tenr - had fallen by 2000; by end-2001, it was 14.7 percent of GDP (definitional changes do not penmt a comparison between 2001 and earlier years). The stock of international reserves has doubled from the end- 1996 level, and is 25 percent larger than external debt and more than 9 months of imports. This is an exceptionally high level of reserves for a developing country. There has also been a rapid growth of onshore foreign currency deposits in China's commercial banks which has enlarged the pool of resources available to the economy. China contmues to be the largest developing country destination for direct investment, with annual gross commitment levels of over US$45 billion. The effective exchange rate has been relatively stable. 7. Nevertheless, China's sub-national governments, banks, enterprises and pension funds cannot simply "grow out" of their current problems; sustained structural and institutional reforms are needed. It is likely that their funding gaps are larger today than m 1997 which, even with rising govemment revenues, may reduce the resources available for meeting other development needs and facing economic contingencies. Concerns about these problems existed even before the start of this round of macroeconomic stimulus, but the recent increase in govemment spending has deepened such concerns and stimulated calls for fiscal consolidation and a reappraisal of the efficiency of govermment expenditures. C. STRUCTURAL REFORM 8. The pace of policy and institutional reform accelerated in the mid-1990s, magnifying difficulties while improving longer-term prospects. Following successful liberalization measures in the 1 980s, a second generation of refonns was initiated in the mid- 1 990s to address structural constraints on productivity-based growth that were inherited from the central planning era. Simultaneously, the arduous process began of repositioning the public sector to meet the requirements of an increasingly complex, market-based, and globalizing economy. Central to the refonrn program was the nexus of issues linking govenmment revenue and expenditure, social protection, enterprise performance, and financial stability (Box 1.1). - 4 - Box 1.1: Recent Structural Reforms Tlhe Challenge - a Gordian Knot. The 1979 reforms eliminated some major economic dis tortions and boosted incentives for production, mainly in rural areas By the mid-1990s it became obvious that at the core of China's development challenge was a rigid production structure sustained by increasing budgetary and banking subsidies, and protected by sub-national governments in ways that fragmented the domestic market. Declining enterprise profitability, decentralization and tax evasion caused budgetary revenue to collapse from 35 percent of GDP in 1978 to below 12 percent This limited the scope for public action, especially in public services provision and social protection Also, weaknesses in macroeconomic control resulted in unsustainably high output growth and inflation, which masked a deterioration in banking and enterprise solvency and liquidity A Difficult Economic Environment Comiplicatinig Enterprise Reforms. The second-generation reforms initiated in the mid -to-late 1990s focused on restructuring enterprises - raising efficiency, making them market- responsive, preparing them for globalization They occurred in the context of a policy-induced "soft-landing" in the economy, leading to capital and labor redundancy and a rapid dismantling of guaranteed employment and "cradle-to-grave" social policies. Moderate pressure was exerted by import competition and statutory tariffs falling from over 45 percent in 1993 to 12 percent today, which exacerbated the incipient deflationary pressures that still persist Further, the decision to maintain a stable Renminbi during the Asian financial crisis protected regional economies and world financial markets, but at some domestic cost All of these measures highlighted China's position that the best response to economic contingencies is to stay the course with deep and difficult, but gradual, structural reforms to increase the flexibility of its domestic economy on which, ultimately, its economic performance rests Moving on Multiple Fronts. Because of complex inter-linkages China's policy agenda needs to move on several fronts, and to accelerate the pace of reform because of visible problems in some areas, global competitive pressures (since the mid- 1 990s), and the expectations of its citizens The sequence and pace of recent enterprise-financial system reforms illustrates the challenge Viable, market-responsive enterprises require modern corporate structures, supporting regulations and business and physical infrastructure, competitive markets, and diversified sources of finance The Government is working in all of these areas (e g , easing pnvate entry, developing capital markets, rewriting laws, restructuring auditing and accounting standards and institutions) But it recognized that such measures would be ineffective if the financial condition of enterprises did not improve, including the excessive burden of social obligations inherited from the pre-reform past Systems for the provision of housing and social insurance - traditionally provided in China by enterprises - needed to change The Government liberalized the housing market, created a mortgage lending instrument, and promoted the real estate market to tap household savings while addressing housing shortages In 2000, it introduced an improved unemployment insurance scheme and pilot reforms in social insurance to implement the modern pension scheme that had been under discussion since the mid- 1990s, with risk and financial pooling at municipal and higher levels Efforts are also underway to establish more equitable and sustainable health financing schemes Confronting Financial Sector Reform. Although reform of the financial system has moved at a slower pace, largely because soft-budget constraints on firms and quasi-fiscal stimulus through the banking system have been needed to support employment growth since 1998, several measures were implemented These include actions to help banks (through partial re-capitalization and the transfer of non-performing loans to asset management companies), establishing supervisory authorities for the capital market and insurance companies, current account convertibility, use of indirect instruments of monetary control, and greater attention to portfolio quality in banks With WTO accession and expected foreign entry into China's financial market, the country will need an overhaul of institutions and market structure Fiscal reforms have been implemented to repair government revenues, improve expenditure planning and implementation, and strengthen government financial management Recovering revenues at the Central Government level were accompanied by a higher level of fiscal stimulus This included transfers to sub-national governments during the recent economic slowdown, thus supporting employment and growth while other structural reforms work their way through the economy 9. An important change since the last CAS is the growing recognition of the important role that the private sector can play in addressing China's reform and development challenges. Over the past decade, China's economy has undergone a fundamental transformation, from complete reliance on state-owned and collective industrial enterprises to a mixed economy where private industrial enterprises also play a strong role The private sector (non-agricultural) has emerged as the most dynamic component of the Chinese economy in the 1990s and today accounts for about a third of China's GDP. In recent years, new employment in the private sector has exceeded the combined total for state, collective, and township and village enterprises. The 1999 constitutional amendment giving formal recognition to the country's emerging private sector, along with the buildup of foreign direct investment and the reform of SOEs, is setting China's economy on a course of major structural change. 10 Chinese private companies are the most dynamic players in the economy, and in recent years government policies have been aimed at promoting their growth. However, they still face tough challenges in the current busmess environment in terms of entry restnctions, uneven playing field, weak capacities to partner and compete globally, and inadequate access to intermediated financing (see Annex F). There are significant regional disparities regarding private sector development in China, with the interior provinces lagging behind coastal areas. The continued growth of the private sector cannot be taken for granted without continued progress in market refonms to improve the business environment. Recently, the Government has intensified its reform efforts in this area by promulgating laws and regulations to promote small and medium enterprises (SMEs), introducing measures to improve private enterprises' access to financing, and gradually relaxing restrictions to private sector entry in a number of sectors (see Box 1.1). 11. The recent round of structural reforms was implemented under difficult circumstances. Externally, the Asian crisis and more recently the global economic slowdown tempered the pace of change in several areas, particularly the imposition of hard budget constraints on SOEs and higher standards of banking sector perfonnance. Domestically, effects of the soft landing and lagging employment creation influenced the pace and sequence of reforms. Further, concerns about disparities in social indicators and incomes, emerging gaps in social protection and public services, and increasing rural discontent since 1997 due to declining fann pnces and reduced off- farm employment have played a decisive role in tax/spending and policy decisions. 12. These issues must continue to be addressed systematically, as the Government launches a third- generation of refonns to build the institutions needed to sustain a modern market-based economy. Since 2000, the Government has moved broadly to define a new role for itself in the economy, de- monopolizing sectors such as energy and telecommunications, while selling hundreds of SOEs (chiefly at the sub-national level). China's WTO agreement represents the most radical set of proposals to open its economy ever proposed by a new member. The Government has announced its intention to adhere to both the letter and spirit of this and other multilateral agreements. It views such international commitments as a powerful instrument to revitalize structural reform and build a strong, modern, internationally-competitive economy. 13. One area of structural reform needing more attention is sub-national finance. Today, nearly 70 percent of public expenditure takes place at the sub-national level (province, prefecture, country and township/village), and more than 55 percent takes place at sub-provincial - 6 - levels. In fact, it is the sub-national levels of Government that implement to a large extent the national agenda, but their very heavy expenditure responsib ilities are out of line with international practice and are unsustainable given current revenue assignments. Expenditure assignments at local levels need to be tailored to the revenue that is available. Moreover, the current system of inter- governmental transfers needs to be examined together with the revenue and expenditure assignments. This would help support development priorities more effectively while reducmg the need for ad hoc transfers, which have been growing in recent years. 14. Regional disparities in fiscal spending and service provision are very large by international standards, and have grown rapidly. Fiscal reforms have raised the total tax effort since the mid- 1990s, and a large share of the increase in revenues has been allocated to spending by sub-national governments. Recent measures - such as transferring a high proportion of income tax revenues to sub - national governments - are aimed at strengthening sub - national finances. However, the current program of earmarked transfers is not fully effective in achieving policy objectives, and inadvertently, there can be rigidities in existing social spending that sometimes restnct the ability of sub-national governments to address directly the needs of the poor. Local governments are highly dependent on extra-budgetary revenues, which are not always allocated in ways that support national objectives, and the efficiency of many sub- national expenditures needs to be improved. Ultimately, the ability of the Government to engineer rapid, pro-poor growth, especially in lagging regions, will be determined by its continuing efforts to improve the current system of inter-governmental finance. National and sub- national fiscal issues, considered recently in two detailed studies of central and provincial expenditures, will continue to merit the Bank's attention. D. POVERTY AND INEQUALITY 15. Poverty in China has been a predominately rural issue, although urban poverty is a growing concern. In the first stage of economic liberalization during the 1980s and early 1990s, partial freeing of prices and markets, introduction of individual farming (replacing collectives), and opening to trade and foreign investment resulted in high growth. While rural poverty fell substantially due to increased production, high agricultural prices, and expansion of rural non- farm employment in township and village enterpnses, income inequalities widened as a result of more rapid growth in China's coastal areas. Now, there are signs that, smce the mid- 1990s, falling grain prices and the domestic slowdown that followed the Asian financial crisis have contnbuted to slowing the pace of poverty reduction. By some expenditure measures, the number of poor may even have risen in recent years, while income gaps are high and persistent. 16. Defining poverty either with income of less than US$0.67 a day (the Government 's definition) or less than US$1 a day (international practice), the number of rural poor has declined steadily between 1987 and 1999 (Figure 1.2). The former measure shows that the number of poor people had declined to just 34 million by 1999. Although the number of rural poor with incomes below US$1 a day has also declined (from 129 million to 97 million), the number of poor with expenditures below US$1 a day has increased from 214 million to 235 millionduring 1996- 1999. The detailed poverty data for 2000 and 2001 are still being processed by the statistical authorities, but once all the data are analyzed, it is likely that more recently, China's high overall growth rate is not reducing its poverty as fast as m the 1980s and early 1990s. This does not negate China's impressive past success in poverty reduction but suggests that new approaches - 7 - that are being piloted currently - combining income diversification with improved targeting and safety nets - need to be scaled up rapidly. Figure 1.2: Number of Poor in Rural Areas (1987-1999) 400 -+--officaal estmated number 350 - of rural poor (in million) c with income of less than °0 300 US$0 67/day E 250 > (apprximately) _250-* number of rural poor (in ° 200 - million) with consumpbon 0 X. of less than US$1 /day c 150 - -o E 100_ c - number of rural poor (in 50 - million) with income of O . . . . . , less than US$1/day 1987 1989 1991 1993 1995 1997 1999 year 17. Trends in inequality suggest that disparities have widened. Household surveys show that income inequality within the rural and urban areas widened durng the 1980s and 1990s, as did the gap between the rural and urban areas. At the national level the Gini coefficient index rose from 28.8 in 1981 to 32.1 in 1990, and further to 41.6 in 1999. Information on sub-national per capita income shows that income inequality between the coastal and intenor regions increased during the 1990s, but has declined slightly since 2000, after the Government refocused its attention on the lagging areas. 18. Social indicators tell the same story. From 1960 to 1990, maternal, infant and under-5 mortality rates in China declined at a faster rate than could have been predicted from China's economic growth in the same period. However, this steady improvement slowed or stopped during the 1990s despite high economic growth, and large regional variations have developed. In 1999, for example, the maternal mortality ratio showed a six- fold difference between coastal Guangdong (25/100,000) and inland Guizhou (161/100,000) while infant mortality In inland provinces was three times higher than the rate for coastal provinces Part of the problem is unequal access to health and education. The World Health Report 2000 ranked China 61st out of 191 countries in overall quality of health, but 1881h in terms of faimess in financial contribution This indicates the problems of sub-national finance that force many localities to levy high fees and other charges on users of public healthcare services, adversely affecting the lowest income groups. Similar inequalities in access to education show up in wide provincial and urban-rural disparities in completion rates within the 9-year compulsory education program, in student learning achievement, and in adult illiteracy. Box 1.2 illustrates how China measures up to the Millennium Development Goals (MDGs) on these issues, and the divergence between the country as a whole and lagging areas in this regard. To make the concept more useful in the context of China, the MDGs need to be disaggregated regionally in the future. - 8 - Box 1.2: Summary of China's Progress with Respect to the Millennium Development Goals The MDGs as formally endorsed by the member countries of the United Nations, focus on developing countries' achieving eight major goals and targets by 2015 (UN Millennium Declaration, September 18, 2000) China is currently on course to achieve these goals at the national level Goal 1: Halve the proportion of people living in extrene poverty between 1990 azd 2015 Good progress being made During 1990-99, the number of people with consumption of less than US$1 a day fell from 368 million to 235 million A possible further decline will be confirmed by an ongoing household survey Nevertheless, progress has been much slower in the inland regions Goal 2: Achieve universal access to prinmary education by 2015 Excellent overall progress being made The net enrollment rate in primary education went from 97 8% in 1990 to 99 1% in 1999 Again, regional disparities exist, particularly in poor, remote and/or ethnic minority areas in western China. Goal 3: Promote gender equality and empower wom en by eliminating gender disparities in primary anid secondary education by 2005. Good overall progress being made in basic andjunior secondary education The national ratio of girls to boys is over 90% for primary education but lower for secondary education since China's nine-year compulsory education covers only up to the junior secondary lcvcl The Government is emphaszing helping pupils from extremely poor families to attend school Goal 4: Reduce iiortality of children underfive by two-thirds between I990 and 2015. Good progress made at the national level, with infanit mortality having declined from 50/1,000 live births in 1990 to 32 in 2000 Meeting the MDG will involve lowenng the rate to 17 by 2015 However, improving health services and providing a health security system for western and rural areas remain challenges Goal5: Reduce the naternal mnortality rate (MMR) by 3/4 by 2015 Good progress made at the national level, with MMR declining during 1990-98, from 95 deaths per 100,000 deliveries to 56. To address the sometimes large regional differences, the Government plans to reconstruct rural cooperative health services Goal 6: Combat HI V-AIDS malaria and other diseases Progress is likely on TB and malaria, but rates of HIV/AIDS will probably not decline by 2015 since the disease is only now entering the period of rapid spread Control is made difficult since HIV/AIDS is concentrated in porous border regions Goal 7: Imiprove the envirotinment by impletienting national strategiesfor sustainable development by 2005 (so as to reverse the loss of enavironmental resources by 2015). Progress being made While no national strategy existed in 1990, China now has such a strategy and sustainable development is a focus of the Tenth-Fivc Year Plan (2001 -2005). Still, the widespread environmental degradation that accompanied growth will require concerted action by all stakeholders Goal 8: Develop a global partnershipfor development Progress is being made China's accession to the WTO will accelerate further its global outreach and have broad effects on all aspects of its development. The Bank is assisting this process in various ways, including support to expansion of the Gl obal Development Learning Network in China China is already a founding member of the Global Gateway Foundation (Annex E indicates the link between the MDGs and Bank assistance ) E. ECONOMIC OUTLOOK AND EXTERNAL ENVIRONMENT 19. China's long-term growth rate is likely to moderate to the 7 percent per year range, despite high growth in productivity. The contribution of factor accumulation is expected to be less significant in determining economic growth in the future, as the demographic transition lowers the relative numbers entering the workforce, while higher consumption (lower savings) will bring the rate of investment down to the levels of other well-performing middle- income - 9 - countries. This projection of long-term trends takes into consideration expected changes in foreign investment, a halt to the declining contribution of natural resources, and the effect of increased skills in the workforce. 20. China's external environment over the forthcoming CAS period is affected by the current uncertainties attached to the global economic recovery. Despite this, China's external performance is expected to continue to be strong This will permit the domestic growth rate to be maintained at the present level, even as the fiscal stimulus program tapers off (Table 1.2). It is estimated that China's underlying competitiveness and shifting world consumption patterns will permit a strong growth of exports, so that by 2010 China's share of world exports would rise to about 7 percent, compared to 4 percent today. The external sector is less critical to China's future economic performance than its vast domestic economy; the trade (imports plus exports)/GDP ratio is likely to stabilize at about 55 percent, compared to 42 percent today. Continued strength in the growth of consumption is expected, especially to satisfy pent-up demand for services (housing, education, health care, finance, leisure, travel, and personal services) among the urban population. Together with investment demand, consumption is expected to remain an important contributor to growth, although less so than in the period since 1997. Table 1.2: Key Economic Performance Indicators 2001 2002 2003 2004 2005 Growth (% per year) Gross domestic product 7.3 7.7 7.5 7 2 7.0 Consumption 7 3 7.5 8.0 8 0 7.8 Investment 12.8 11.5 7.2 6.1 5.4 Shares (% of GDP) Budget balance -3 2 -3.2 -2.8 -2.5 -2.1 External current account balance 1.5 1.8 1.4 1.3 0.9 Government debt 23.8 25.1 25.9 26.3 26.3 Levels (US$ billions) _ _ Net FDI inflows 37 4 45.0 45.0 50.0 55.0 Stock of international reserves 212 264 296 323 348 Source World Bank staff esitmiates - 10- 2. THE GOVERNMENT'S PRIORITIES 21. The Tenth Five-Year Plan. Over the last two decades, China has made impressive achievements, particularly in sustained growth and poverty reduction, while managing major systemic transformations. In the process, the Govermnent has accumulated a wealth of knowledge and strengthened its own capacity to deal with developmental issues. However, China is now faced with a number of new and pressing challenges - such as widening income inequality, stresses on the environment, and persisting difficulties with financial sector and enterprise reforms - which are more complex than those which it faced during the earlier years of reform. There is also an added sense of urgency to push forward with reforms, driven by the accelerated integration into the rapidly changmg global economy expected from WTO entry. The Tenth Five-Year Plan (2001-2005) was prepared by the Govermnent in such a context. Box 2.1: Main Features of the Tenth Five -Year Plan (2001-2005) The Plan aims for higher productivity growth, set in the context of increased globalization and a narrowing of regional inequalities It gives special attention to an improved natural environment and to harnessing modern technology more broadly for China's economic development * Growth - targeted at 7 percent per year for 2001-2005 - slightly lower than the actual growth rate achieved over the Ninth Plan - which will help achieve a doubling of total output by 2010 (implying an ambitious 7 4 percent target for 2006-20 10) * Sustainable Development - with increased productivity in agriculture and in industrial SOEs. job creation by promoting labor-intensive activities, including services, and developing collective, private and individual businesses to create 40 inillion new urban jobs, and safeguarding the natural resource base * Economic Restructuring, Rural Reform and Opening to the World- through better macroeconomic management, fiscal reform, and financial stability, establishing modem corporate structures, building competitive and globally-integrated markets; accelerating agricultural diversification and rural reforms to raise incomes, improving science and technology inputs into production, and strengthening cooperation with other countries. * Coordinating Economic and Social Development - by paying greater attention to quality-of-life issues, including investing in human capital (e g , anti-poverty measures, better education), protecting natural capital (e g , by enhanced ecological conservation and environmental protection), improving social protection (e g , by strengthening the social security system), promoting the rule of law; and broadening democratic participation (e g, through political reform and strengthening legislative oversight) The Plan also seeks to promote a progressive and cooperative social fabric * Development of Economically and Socially Lagging Western and Central Provinces - by fostering economic development zones through investments in strategic physical infrastructure for transport, water resources management, energy, and mining, acceleration of other development objectives cited above, and introducing advanced technologies to upgrade local industrlies and increase competitiveness 22. The Tenth Plan ushers in a new era of Chmese economic development. If, as it is sometimes said, China has been "growing out of the Plan" incrementally, the Tenth Five-Year Plan (2001-2005) has pushed this process much further, while changing direction in several sigmficant ways. The nature of the planning exercise has been adapted since the Seventh Plan (1986-90) to accommodate the rapid social and economic development of China's transition - I 1 - economy, progressively reducing the role of detailed physical investment planning and command targets. However, the shrinking role of the Government in the economy and higher levels of economic, administrative and fiscal decentralization have trimmed the ability of the Government to influence economic behavior in ways that would help realize precisely set Plan targets. Moreover, the adverse effects of emphasizing high growth rates based on the accumulation of physical capital and relative inattention to the natural environment had become increasingly visible during the 1990s. Concerns related to the quality of growth surfaced rapidly, and in the Tenth Plan they found comprehensive expression in the Government's economic strategies and public investment programs (Box 2.1). 23. Addressing Cross-Sectoral Priorities. In addition to the overall Plan, specific plans have been prepared for mdividual sectors, normally for implementation by line agencies. However, within the overall Tenth Plan framework the Govermnent has re-emphasized the following three sets of strategic priorities, each of which is the responsibility of a "leading group" with coordination, planning and implementation responsibilities that cut across the mandates of individual agencies: * The Leading Group for Poverty Reduction was reorganized following completion of the Seven-Year Priority Poverty Alleviation Program to address the changing poverty situation in the country. For the period 2001-2010, it will focus on improved rural poverty monitorng and geographic targeting, especially for areas with large ethnic minorities. This will be combined with programs intended to diversify and increase incomes through improved environmental management and, where potentially effective, the application of credit, commercial practices, and increased inputs of science and technology; * The Leading Group for Western Region Developmenit was established in 2000 to accelerate economic growth in 12 western and central municipalities, provinces and autonomous regions. These lagging areas represent 18 percent of China's GDP, 29 percent of the population, 60 percent of the poor people, 72 percent of the minority population, and 72 percent of the surface area of China. This highly publicized initiative seeks to address a key development challenge, and it includes investments in human capital development and health, transport and logistics development, water and other environmental management, and a range of infrastructure. It represents the first major attempt to shift the balance of growth from the coastal areas - which was the strategy taken two decades ago to accelerate growth in China - to addressing the needs of the poorer inner regions; and * Finally, the Leading Group for Informatization was established in 2001 to promote the coordinated development of Chma's information industry, increase the application of information and communication technologies (ICT) in addressing social and economic development challenges, and broaden and enrich the infonnation network in the country while protecting its security. 24. Initiatives to Strengthen Governance of the Public Sector. The March 2002 Report on the Work of the Government noted that national goals for reform must be accompanied by building "an honest, diligent, pragmatic and efficient government." Transformnmg the function of government from planning to economic regulation, market supervision, social protection and public service is one part of the governance agenda. Another is building a clean and honest - 12 - government, which was underlined in the President's speech in 2001, to "fight against corruption to the end." While progress is being made in reorienting public sector management and increasing transparency, as Box 2.2 illustrates, the huge process of institutional reorganization, establishment of a legal framework, judicial reform, capacity building at all government levels, and wholesale procedural reform will be a long-tenn proposition. Box 2.2: Establishing a Framework for Good Developmental Governance The state's role in the economy reduced. In 1998, the Government reorganized and down-sized the central government. The number of ministries went from 41 to 29, ministries overseeing industrial or commercial activities were spun off; the remaining ministries were made more "market-friendly", the number of central government employees was cut in half over three years, the military, police, government agencies andjudicial organizations were ordered to divest themselves of business activities; and the legal and regulatory framework to guide propcr developmcnt of a market-based economy was strengthened. Officials suspected of corruption are investigated and, if found guilty, punished For instance, in 1999 prosecutors investigated tens of thousands of officials suspected of corruption and recovered more than us$200 million Major smuggling and fraud cases were publicly disclosed, and the sentencing of senior officials was given prominence Legal and judicial reform. Judicial reform was formally recognized as a priority at the 15th Party Congress in 1997. The Supreme People's Court is midway through its five-year reform plan China's Constitution was amended in 1999 to include "goverming the country according to law" as an essential principle In tandem, many laws are being amcnded or new laws drafted that will have the effect of enhancing good governance Regulations and procedures for public sector staff- in government and SOEs- promote transparency. Integrity and conflict of interest rules introduced for senior government officials and SOE chief executives A public bidding system for government procurement introduced at central and provincial levels Government institutions and SOEs audited and subjected to public information disclosure Introduction of three reforms support good governance. These include reforrm of the government approval system to reduce opportunities for the "exchange of power for money"; the fiscal and budgetary system to improve budgetary and treasury management, and the government personnel system, by opening official selection to competition, improving performance appraisals and strengthening supervision 25. Guidance from the 16th Party Congress. The 16th National Congress of the Communist Party, which took place in November 2002, signaled the transition from China's "third generation" to its "fourth generation" of leaders. It identified as a national goal the achievement of a "well-off society." Towards this end, GDP is expected to quadruple over the period 2000-2020, an indicative growth rate of a little over 7 percent per year. But the concept of China's development, as articulated at the Party Congress, goes well beyond increases in income to stress the quality of such growth. Government policy in the years ahead would be aimed at promoting "all-round social progress, to constantly better people's lives, and to ensure that all the people share the fruits of dewlopment." The Party Congress reaffirmed the Tenth Plan's emphasis on environmental sustainability and the application of modern science and technology, especially ICT, to raise productivity and generate greater benefits. Attention was drawn to some of the specific areas that the govermment is addressing. Chief among these was rapid job-creation, to be effected through better management of state assets and financial resources, accelerated human capital development, increased integration with the world economy, and measures to "intensify the struggle against corruption." It highlighted the key role that entrepreneurship will play in China's drive towards rapid modernization and transition to a market economy. For this, it underscored the importance of an improved legal system and the - 13 - potential contribution of private initiative and investors, and the need to safeguard their property rights. The Party Congress also stressed the importance of maintaining current initiatives that are aimed at increasing the flexibility of goods, services and resource flows in the economy to facilitate economic restructuring. Addressing the challenge of narrowing social disparities - particularly between urban and rural areas and among the provinces - while managmg the process of labor migration and urbanization to ensure better resource use and raise incomes, at the same time as improving the quality of habitats, will continue to receive close policy attention. - 14 - 3. PROGRESS DURING THE LAST CAS PERIOD AND LESSONS LEARNED A. OBJECTIVES OF THE LAST CAS 26. The five themes for Bank support outlined by both the February 1997 CAS, as well as the CAS Progress Report of May 1998, were: macroeconomic growth and structural reforn; infrastructure development; human development and poverty reduction; agriculture and rural development; and protecting the environrment. At the time, these themes were high priorities for the Government and consistent with the Bank Group's support for a broad spectrum of advisory services and a blend of IDA and IBRD lending in the range of US$2.5-3.0 billion annually The substantial progress made against the benchmarks set out in the 1997 CAS is shown in Annex B1. During this period, the Bank also decentralized responsibilities to the field office and changed the way it carried out its activities. B. MAJOR DEVELOPMENTS SINCE THE LAST CAS 27. Overview. The global context for the last CAS period turned out to be radically different from what was envisaged, with the East Asian crisis and the recent global slowdown. As a result, the Government's prionties shifted, from orchestrating a soft- landing in an inflationary environment to accelerating growth and structural reform. Unlike other Asian countries which needed quick-disbursing external assistance to shore up their external position and to maintain essential budgetary expenditures, China's relatively strong financial position allowed it to sustain growth through deficit financing and an expansionary fiscal policy without recourse to external budgetary support operations. This, in addition to other factors discussed below, led to a reduction in the volume of Bank lending. In the interim, Bank operations also were adjusted to focus more on the poorer interior provinces and to support on-going reformn efforts The Bank's portfolio remained strong and improved further during the period. Key indicators of the Bank Program's performnance are shown in Table 3.1. The above trends and developments are discussed in detail below. Table 3.1: China - Operational Performance Indicators 1997 1998 1999 2000 2001 2002 Commitments (US$ millions) 2,815 2,616 2,084 1,673 788 563 Number of Projccts I1 16 19 8 8 5 Disbursements (USS millions) 2,128 2,094 2,026 1,828 1,820 2,015 Portfolio Size (# of projects) 97 103 110 114 108 101 % Projects Satisfactory 88 90 95 97 95 96 QAG quality at entry (%) China 100 100 88 100 Bank-wide 82 86 89 94 28. Lending - which was expected in the last CAS to be in the range of US$2.5-3.0 billion annually during the CAS period - instead declined steadily, especially over the last two years. As shown in Figure 3.1, total Bank lending declined gradually from US$2.8 billion in FY97 to US$1.7 billion m FY00, then fell sharply during FYO1-02 to US$0.8 and 0.6 billion, respectively. - 15 - Figure 3.1: IBRD and IDA Commitments to China (FY93-02) 4,000 3,000- E 2,000 1,000 0 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY0I FY02 |' 'IBRD -IDA rotaI 29. This outcome was the result of several factors: * The Bank Group's institutional constraints. IDA lending to China, which approached US$1 billion per year in the early 1990s, fell gradually to a low of US$293 million in FY98, the year before the final year that China received IDA credits. The loss of IDA was combined with reduced IBRD lending due partly to concerns that the Bank's exposure to China on IBRD loans might breach the single-country concentration limit at some time m the future, as a result of high lending volumes in the nineties. Thus, for planning purposes the volume of IBRD lending was targeted at around US$1 billion during the last few years. * Improved financial position of the borrower and diminished attractiveness of IBRD resources. Two factors led to increased domestic funding availability. With a rise in the overall revenue/GDP ratio from 12 percent in 1997 to 17 percent in 2001, and the central government's use of expansionary fiscal policy to stimulate the economy in the aftermath of the Asian Financial Crisis, the provinces were able to finance a much larger share of their investment needs through budgetary transfers. In addition, domestic interest rates were lowered to levels well below international rates, reflecting deflation in China's economy, while costs of IBRD loans increased by introduction of the front-end fee and the widening of the lending spread in 1998. IBRD loans were therefore less attractive, despite their longer maturities, and demand dropped significantly. The cost of doing business with the Bank, including lengthy procedures and safeguard requirements, was also perceived to be high by the provinces. More recently, with the sharp declines in IBRD lendmg rates, these cost differences have been become less significant. In addition, the increased flexibility provided by the new financial instruments is seen as a positive step forward. * Disengagement from areas that could be served by the private sector, such as telecommunications and thenrial power generation. These areas represented a significant share of past lending in the form of large capital-intensive projects, but the decision was taken that domestic or foreign financing could be secured without IBRD support. - 16- * Cessation of lending in areas where past projects had proven to be problematic. By the mnd-90s, it became clear that projects supporting industry-specific restructuring, agro- processing and credit lines to state commercial banks were not effective, and lending for these purposes ceased. This coincided with government attempts to shift commercial projects to alternative funding sources, rather than utilize external concessional resources. * Reduction in average size of loans, from US$200 million in FY97-98 to US$140 million m FY99-01 resulted from two factors. The number of large capital-imtensive projects - dams, thermal power generation, major multi-provincial highways - decreased over time And a growing proportion of total Bank lending was directed to the poorer inland provinces (going from 58 percent in FY93-95 to over 70 percent in FY99-01, by number of projects), which tended to borrow in smaller amounts given their constraints in absorptive and repayment capacities. 30. The quality of the Bank's largest portfolio has remained high and improved further since the last CAS. In tenns of the number of projects (over 100), the China portfolio is by far the largest in the Bank, some 50 percent larger than the next tier of borrowers. As illustrated in Figure 3.2, the quality of the portfolio deteriorated in the mid-90s. This was due to %Of u Figure 3.2: Portfolio Quality a variety of factors relating in part to the Projlcts in rapid build-up of the portfolio. With a concerted effort to address these issues and 12% through project closures, the proportion of satisfactory projects has returned to its 8%- traditionally high levels. This was reconfirmed by OED evaluations of 4% completed projects since 1980, which rated 9 percent unsatisfactory, compared with the 0% 9 91 92 93 94 . 96 97 98 99 00 01 02 Bank-wide average of 31 percent. I Unsatisfactory I FY 31. The AAA program was revamped into a more demand-driven and integrated Knowledge Agenda. Since the beginning of the Bank's involvement in China, analytical and advisory activities (AAA) have played a crucial role in the relationship. In the early period, the program addressed the entire spectrum of developmental issues confronted during the initial phase of the transition to a market economy The focus was on basic prnciples, liberalization, and on information for designing institutions and policies with appropriate Chinese characteristics. But, in recent years, the authorities have had to deal with more technical and difficult issues including the need to build, consolidate, or reform the core market institutions that will sustain China's economy in the future. Simultaneously, China needs to address deep- rooted structural problems related to poverty, globalization, governance and sustainable development. The Bank is therefore being asked to help address the most complex institutional and structural policy issues. There has also been increasing client demand for short "rapid response" policy notes, and less for the more traditional and comprehensive reports that take much longer to produce. In response to the above developments, the Bank's policy related program in recent years has been delivered through a wider range of instruments, including policy notes, comprehensive reports, research studies, conferences and training (including distance learning courses), by an improved alignment of instruments with objectives. The - 17- Knowledge Agenda is also carried out flexibly within themes agreed with the Government. These changes have been welcomed by the client. See Section 5A, Knowledge Agenda/AAA Program, for further details. 32. Decentralization has enabled the Bank to better serve its client, but some issues are stiUl being addressed. Decentralization has been a clear success in areas where proximity to the client has resulted in more responsive services. This is best exemplified by the decentralization of core fiduciary responsibilities to the Bank's office in Beijing. This has enabled the Bank to respond more quickly to client demand, for instance by cutting review time for some procurement documents by about 80 percent and the response tlne to disbursement applications by more than 50 percent. It has also allowed the Bank to prepare two emergency projects in record time in the aftermath of natural catastrophes. A greater field presence has also strengthened the policy dialogue, made it easier to deal with lendmg program formulation, and facilitated follow-up on portfolio issues as well as increased contact with other donors. However, coordination problems have arisen in the context of managing the interactions of a large matrix-based country team with the client, and much effort has been required to develop local staff capacity to meet the increased demands in the field and the client's support for a higher level of delegation to field-based staff. 33. Since the last CAS, the application of the Bank's environmental and social safeguard policies has become a significant and recurring issue for the Bank's program in China. This has resulted from several factors. Both globally and in the Bank, scrutiny of safeguard issues, particularly environmental impact, resettlement and treatment of ethnic minorities, has intensified m recent years. The China program has been particularly exposed to this heightened concern since a large proportion of Bank loans to China - mamly for rural development and infrastructure - require various safeguard assessments. Moreover, as mentioned above, the Bank's lending focus has shifted to the western regions, with large concentrations of minority nationalities and fragile ecosystems. 34. However, reviews undertaken by various Bank Group evaluation bodies have acknowledged the comprehensiveness of safeguard policies in China, relative to other countries. Domestic policies and guidelines for handlmg environmental, ethnic minority, and resettlement issues mirror the Bank's policies in many important aspects, although differences exist which the Government believes are needed to reflect local conditions. The increased scrutiny of safeguard- related issues m the lendmg program, coupled with the on-going process within the Bank to refine and clarify its policies, has led to delays m preparation of some operations. China, meanwhile, has voiced concern about what it sees as unwarranted increases in the project costs it must bear as a result of, in its view, excessive nsk-aversion in the application of safeguards policies. During the CAS period, the Bank will continue to work with the Government to apply safeguards policies more effectively, as described later (para. 85). 35. IFC assistance has adapted flexibly to the growth of the domestic private sector and greater needs in inland provinces. Since the last CAS, the IFC has maintained a program of about US$200 million per year on average (Table 3.2). More importantly, there were significant changes in the structure of IFC's investment activities as a result of the emergence of the domestic private sector and continued market-oriented reforms. IFC's objectives laid out in the 1997 China CAS, were to: (a) finance privately- led joint venture projects; (b) assist SOE - 18 - restructuring and corporatization; (c) support Table 3.2: IFC Program in China: Approvals 1997-2002 private participation in infrastructure projects; (US$ million) (d) help Township and Village Enterprises Year Number of Project [FC IFC (TVEs) and domestic private entrepreneurs; Investments Size Gross Net and (e) promote capital narket development. 1997 10 657 335 134 The main changes in the IFC program 1998 8 500 244 151 included: a significant increase in IFC's 1999 4 318 112 82 investment in financial services; broadened 2000 9 578 123 95 support to TVEs and private enterprises; and a 2001 7 425 179 159 steady increase in IFCsinvo2002* 12 624 255 207 steady increase in IFC' Sinvolvement In Total 50 3102 1248 828 private sector-led projects in the interior Note * as of June 30, 2(002 provinces with 11 projects implemented so far. IFC's technical assistance activities durmg the period focused on capacity building in the financial sector, the investment climate for private sector development, corporate governance, and private participation in infrastructure. IFC's portfolio as of end-June 2002 consists of 42 investments with a total exposure of US$774 million (composed of US$304 million A loans, US$192 million in equity and quasi-equity, US$278 million B loans). In addition, 18 investments for a total of US$266 million are approved and pending commitment. 36 In line with evolving country needs, both the Bank and IFC have supported innovation and change with a variety of instruments. These initiatives were designed, for example, to encourage private sector development, implement creative approaches to development of the knowledge economy, and transfer new technologies from other countries. Some recent examples of such support are summarized m Box 3.1. - 19 - Box 3.1: Examples of Recent Bank Group Support for Innovation and Change in China rFC support to developing small and imedium elterprises in tie western provinlces. Two entities have been established recently in Chengdu, capital of Sichuan province The China Project Development Facility (CPDF) is funded by the IFC, Australia, Switzerland and the United Kingdom, but managed by the IFC to improve the environment for SME development and provide financing And the Sichuan SME Investment Fund (SSIF), managed by the United States' Small Enterprise Assistance Fund, provides equity and quasi- equity financing for SMEs in Sichuan. Other investors include New York Life, Germany's DEG, Swedfund and Norfund. Knowledge Econtomy report. The well-received Bank report China and the Knoivledge Economy - Seizinig the 215' Century (2001) recommended, inter alia, that China address its declining international competitiveness by improving productivity, shift away from resource-intensive development and towards services and knowledge- based development, integrate more with the global economy, leapfrogging to take advantage of evolving technologies, refonn education, and promote greater use of information and communication technologies (ICT) The Global Development Learning Network (GDLN) and Global Developmgent Gateway to help develop Clzina * kntowledge economy. ICT development- a priority of the Tenth Plan that was reemphasized at the recent 16'h Party Congress - is supported by the Bank, with a focus on promoting distance learning to achieve various development goals A GDLN center in Beijing has been delivering World Bank Institute (WBI) programs. WBI is also helping develop Chinese versions of the courses for delivery through institutions like the National Accounting Institute in Beijing A major breakthrough has been linking GDLN with the China Education and Research Network (CERNET), which connects more than 800 institutions, enabling low-cost connectivity with all members. In October 2001, a GDLN center was established in the western province of Ningxia, funded by AusAID under the Virtual Colombo Plan China has sought assistance from donors to establish GDLN centers in other western provinces. In May 2002, China became a founding member of the Global Gateway Foundation The Water Coonservationt Project (FYOI) addresses serious water scarcity in China's Northern Plain - where increasing demand can no longer be met by constructing hydraulic infrastructure and where groundwater overexploitation continues The project is disseminating an innovative approach used in the United States and Israel to increase "real" water savings by reducing non-recoverable water losses from evapo-transpiration (ET) and losses to unusable water bodies like the ocean This approach uses an integrated package - of soil moisture management, improved irrigation, and agronomic measures - to boost agricultural production per unit of water use. This can alleviate groundwater over-exploitation and significantly increase agneulture production per unit of ET. C. QAG AND OED ASSESSMENT 37. Assessments of the China portfolio by the Bank's Quality Assessment Group (QAG) and Operations Evaluation Department (OED) have for the most part been favorable. QAG ratings of supervision quality and of project quality at entry to the portfolio normally rank China in line with or, more often, above Bank-wide averages. When judged on the basis of OED evaluations of completed projects, China has by far a greater proportion of satisfactory projects than the institutional average. One OED report attributed the generally strong implementation performance of Bank-supported projects in China to the high level of client ownership and the "responsibility system," requiring direct project beneficiaries to repay their share of the financing. 38. Aside from their standard evaluations, QAG and OED have carried out various assessments focused on Bank-supported activities for poverty reduction, forestry, the environment, involuntary resettlement related to river basin development, the energy sector and the transport sector. All of these evaluations found strategies to be well directed generally and - 20 - projects that either in whole or in part set the standard for best practice. 1 For example, resettlement and livelihood restoration under the Shuikou Hydropower Development Project, considered best practice, had "substantial and well-directed Bank involvement . .. with an equally dedicated govermment and excellent results (Recent Experience with Involuntary Resettlement: Overview, page 54)." And "China's forest work has been remarkably successful; it is a high point in one of the Bank's highest-quality portfolios (China - From Afforestation to Poverty Alleviation and Natural Forest Management, page 91)." 39. These evaluations have also been helpful in indicatmg areas where strategies or project design might be strengthened, and such advice has been heeded in both current and subsequent work by, for example, taking extra precautions to ensure the sustainability of poverty projects, pursuing a dialogue on the difficult issue of energy sector tariff refonn, and participating directly in China's influential Task Force on Forestry and Grasslands in order to increase our impact on forest policy. D. CLIENT S URVEY AND FEEDBACK FROM CONSULTATIONS 40. The size of the China portfolio and the seriousness with which China approaches its partnership with the Bank have prompted regular consultations with clients on the Bank's policies, procedures and program. Since 1997, governmeit officials, project implementing agencies and, lately, representatives of civil society have participated in five formal, focused consultation exercises (see Annex C). The private sector has also been extensively consulted by IFC, in particular through a major study of the domestic private sector in China and a joint Bank/IFC study on enterprise reform and corporate governance. Based on the feedback obtained from the various consultations, the Bank has sought to improve its client services and respond to client concerns. 41. Most recently, in the context of OED's ongoing preparation of a Country Assistance Evaluation (CAE), a series of consultation workshops took place during June-July 2002 in Beijing, in several coastal provinces, and in a western province. Attending the workshops were representatives of all stakeholder groups - key government ministries, officials from a broad sampling of provinces, project staff from throughout China, and leaders of civil society involved in areas such as economic reform, poverty reduction, environment, rural development, and health. This recent consultation made use of the Bank's increasing outreach to civil society, which has been spurred by several Bank programs supporting development of non-government organizations (NGOs). A client survey, covering not only the govermnent but also the private sector, research institutions, the media, civil society organizations and other development partners, is being carried out. Preliminary results are consistent with the earlier consultations. The results will be used as an input for shaping the Bank's program in the future. 42. Overall, the views voiced dunng these consultations have been consistent over time. The Bank's assistance to China is appreciated, particularly in transferring knowledge and introducing l These included QA G Quality at Entry Assessment Report (1997), Recent Experience with Involuntary Resettlement (1998), Transport in China-An Evaluation of World BankAssistanice (1999), China - From Afforestration to Poverty Alleviationi and Natural Resource Management (2000), The Bank's Assistance to China's Energy Sector - An OED Country Sector Evaluation (2001), and China - A Review ofDevelopment Challenges Across Selected Sectors and Performance Assessment Reports (2002) - 21 - new ideas and innovations through lending and non- lending services. The Bank's contributions in areas such as water resources management, poverty reduction, environmental protection and infrastructure services were noted Civil society representatives, most of whom had participated in Bank projects, were generally positive about the Bank's support to China and hoped that the Bank would provide more concessional funding for NGO development and projects. 43. Although recent consultations also indicated major progress in making non-lending support more timely and responsive to client needs (see para. 31), concerns about other issues remain, the principal ones being: (a) project complexity, given multiple objectives and conditionality; (b) costly and lengthy project preparation due to the Bank's preparation, documentation and clearance requirements; and (c) implementation procedures that do not sufficiently recognize China's own growing capacity. 44. Safeguards requirements have attracted particular comment as being complex and unclear, costly to comply with, and at times inconsistent with Chinese regulations, which are considered to be of reasonable standards. In addition, the Bank's financing terms are often seen as unattractive, considering the front-end fee, the lack of IDA funds, and a perception that local terms are better. 45. Over the past five years, measures responding to these concerns have been taken by the Bank - by streamlining some of the Bank's project preparation procedures and clearance requirements in the late- 1990s; providing more timely service to Chinese borrowers with the help of project, procurement and financial management staff now decentralized to the Bank's Beijing office (see para. 32); and issuing guidelines on practical solutions to deal with differences between Chinese and Bank safeguard policies (see paras. 33-34, 85). The Bank's collaboration with the United Kingdom's Department for International Development (DFID) has also reduced the cost of borrowing for social sector and poverty reduction projects (see para. 89, Box 5.3). 46. However, the views among stakeholders are quite diverse and the Bank needs to do more to develop agreed positions. Institutional policies - such as for procurement - are not easily modified. Also, depending on their responsibilities, clients often have different perspectives. While some officials appreciate the benefits of international competitive bidding, others find it inefficient and costly. While some welcome the Bank's role in knowledge transfer, others worry that projects may become overly complex in introducing innovation and change While safeguard objectives are welcomed by some parts of society, they are often questioned by those charged with the more technical aspects of project implementation. 47. In the ongoing dialogue between the Government and the Bank, the Bank continues to discuss with the Government how to address client concerns by finding mutually acceptable ways to deal with differences and foster better understanding. - 22 - 4. THEMATIC FRAMEWORK FOR THE BANK GROUP'S ASSISTANCE PROGRAM A. DEVELOPING THEMES FOR A CHANGING SITUATION 48. The first Bank Group's assistance program for China in the post-IDA period is matched to the Government's priorities as identified in the Tenth Plan and related strategic th pronouncements including the recent 16 Party Congress, our own assessment of future development trends, lessons from recent evaluations of program effectiveness, and results of client survey/consultations. Global goals (in particular the Millenmium Development Goals) and the Bank's corporate priorities (Annex E) were also taken into account in shaping the program. 49. The CAS is framed m a country context which is different from that in the previous CASes. In particular, the new CAS coincides with: the shift in China's reform process, from the liberalization phase to the more difficult stnictural and institution-building phase; the dynamic growth of China's private sector; and the continuing need but reduced availability of concessional external financing. It also addresses frontally the two critical challenges that have emerged from past patterns of growth - social inequalities and environmental sustainability. 50. The issues to be addressed in the forthcoming CAS period are linked inextricably with each other. Therefore, the planned program of lendmg and AAA support will need to grapple with the emerging challenges that are more complex and multi-sectoral than the issues addressed during the last CAS period, using a wider range of instruments (lending, studies, technical assistance and traming) to assist the Government to achieve its objectives. 51. Under the overarching objective of supporting China in making two historic transitions - from a rural, agricultural society to an urban, industrial society, and from a centrally-planned economy to a more globally integrated market-based economy - the Bank's operational strategy for China is organized around three main themes that are designed to: * Improve the business enviromnent and help accelerate China's transition to a market economy; * Address the needs of the poorer and disadvantaged people and lagging regions; and * Facilitate an environmentally sustainable development process. 52. Box 4.1 identifies the major sub-themes that will be addressed through a mix of lending and AAA services. Annex D contains a detailed description of the core activities planned within these sub-themes, including initiatives in individual sectors. The remainder of this section uses the thematic framework to describe the strategic thrust of the planned assistance program. - 23 - Box 4.1: Thematic Framework for the CAS Overarchiing Objective: Supportinig China's Two lhistoric Transitionts -from a Rutral, Agricultural Society to an Urban, Inidustrial Society andfrom a Centrally-Planned Economy to a More Globally Integrated Market-based Econonily - and to do it oni a Sustainiable Basis. 1. Improving the Business Environment and Accelerating Transition To a Market Economy A Strengthening Macroeconomic Management B Promoting China's Integration into the Global Economy in the WTO Era C Reforming the Financial Sector D Promoting Private Sector Devclopment and Entcrprise Reforms E Improving Public Sector Management and Delivcry of Services It. Addressing the Needs of the Poorer and Disadvantaged Peopl e and Lagging Regions A Increasing Employment and Productivity Off and On the Farm B Strengthening Transport Links within and to Lagging Regions C Developing Human Resources D Strengthening Social Protection E Improving Targeted Poverty Reduction Programs III. Facilitating an Environmentally Sustainable Development Process A Strengthening Effectiveness of Environmental Institutions B Improving Air Quality C Managing Water Resources D Managing Land and Natural Resources E Protecting Global Environmental Commons B. IMPROVING THE BUSINESS ENVIRONMENT AND DEVELOPING THlE MARKET ECONOMY 53. Today, many, if not most, resource allocation decisions in China are market-based. Nevertheless, it is necessary to level the playing- field between public and pnvate financial and non- financial institutions, and in some cases to eliminate major inefficiencies. With accession to the WTO in December 2001 - a process that is largely to be completed by 2007 - the Chinese authorities decided to hasten the pace of reform by making far-reaching commitments to further liberalize entry into economic activities. In some cases, the direction of changes in the economy can be foreseen. Successful adjustment to such changes will require an intensification of the policy reforms that are underway - for example, deploying market-based instruments for macroeconomic management, resolving banking system distress, and trade and investment policy reform. In others, new institutions are required to improve the investment climate and to promote the functioning of broader, deeper and more dynamic markets for stable and sustained economic growth. These include, for example, legal and judicial institutions, competition and private enterprise support policies, improved corporate governance, and better provision of public services. 54. The key to sustained economic and employment growth in the future lies less in factor accumulation and more on economy-wide growth in productivity. Towards this end, there is a need to ensure that China's financial institutions and enterprises are competitive and viable. The - 24 - Bank Group Private Sector Strategy (see Annex F) will assist this process through interventions designed to (a) help deepen and broaden the financial sector and support the growth of private financial institutions; (b) support industrial restructuring and ownership diversification; (c) improve the busmess environment by assistmg government's efforts to build the legal and institutional foundations of a market economy; (d) support the adoption and dissemination of environmentally and socially responsible and sustainable business practices by the Chinese private sector; and (e) promote private sector participation in social and physical infrastructure services. More generally, the ability to pursue the national development agenda depends for the most part on the performance of sub-national governments, as mentioned earlier. Addressing the unsatisfactory state of inter-governmental fiscal relations will enhance the ability of the public sector to support growth in a sustainable way. This is specially important to tackle the urban transition that is underway in China today. Productivity in urban areas - where the overwhelming majoonty of jobs will be created - and the provision of improved urban living conditions depends crucially on better municipal management and the availability of adequate financial resources. 55. The assistance program in these areas has three important characteristics: * They can rarely be addressed by IBRD investment lending On the other hand, IFC's investments can have a significant demonstration effect and play a strong catalytic role regardmg the private sector's response to market openings and improvements in the business environment. Therefore, Bank Group involvement will be mostly through an array of activities including technical assistance supported by trust funds, and direct financial support by IFC to private enterprises and financial institutions (Annex F contains a fuller description of the Bank Group strategy for private sector development in China). * More so than m other thematic areas, there is exceptional synergy among the many reforms and activities needed to lmprove the business environment and develop market mstitutions. There are numerous actors and channels for interaction, and need for coordinated and well- sequenced actions. The Bank Group has the breadth and the quality of resources and instruments to provide the type of assistance that the Goverunent expects on addressing the complex issues of improving the business environment. This will however require good coordination of resources and activities, particularly between IBRD and IFC. Box 4.2 illustrates the complexity of objectives and activities in the financial sector, where sustained commitment will be required to ensure the effectiveness of the assistance program. * Progress on several components under this theme will depend on the Bank's ability to be extremely sensitive to the pace of the reforms envisaged. In addition to financial sector, SOE and inter-governmental fiscal reforms, this is especially true of better governance of the development process. The Government's actions in this sphere have demonstrated that an adequate platform exists for designing and implementing a sensible program of assistance. See Annex G for discussion on the Bank's ongoing assistance in developmental governance. - 25 - Box 4.2: World Bank Support for Improving China's Financial System Targets and Problems Proposed Activities Systemiiic Issues Reform strategy Vision note on future of China's financial sector Financial sector integration Background study and policy note on financial conglomerates Financial Intermediaries and Markets Restructuring the bankitng system State-owned banks Policy notes on (a) restructuring strategy, (b) building effective * poor governance supervision Technical assistance on institution building in policy banks * insolvency IFC's investments and assistance in the resolution of distressed assets * low profitability Medium and small banks Policy note on failure -resolution strategies * poor governance IFC investment in city commercial banks * financial distress IFC's technical assistance to medium and small banks. Rural credit cooperatives Studies on rural financial reform * poor governance Technical assistance on rural finance * insolvency Capital market development Policy notes on development of institutional investors, and technical * stunted bond market assistance on (a) government bond market reform, (b) government * low institutional investment cash management, (c) risk management for securities and futures, * limited products (d) infrastructure finance, and (e) corporate bond market development IFC investments and technical assistance in asset management, fixed income, housing finance, consumer finance Finance for smnallfirmns Study, policy note, technical assistance and pilot programs on small and medium enterprise finance, and study and technical assistance on credit guarantee and information systems CPDF technical assistance to banks in the interior in building capacity for SME lending and helping SMEs in the interior to improve thelir access to financing SSIF direct equity funding for SMEs in the interior of China Regional Outreach Finance & Development Co-chairmanship with MOF of annual APEC Forum Program ofAsia Region-wide technical assistance program for (a ) government bond Pacific Economic market development, (b) finance for small firms, and (c) corporate Cooperation (APEC) governance and financial institutions. Research on cross-border finance and economic development C. ADDRESSING NEEDS OF THE POORER/D ISADVANTAGED PEOPLE AND LAGGING REGIONS 56. Over the past decade, Bank Group support for China's development has shifted from the increasingly well-off coastal areas to the disadvantaged inland provinces and, within therr, to designated poor counties. There has been intensive collaboration on multi- sector diagnostic studies, intensive involvement in poverty analysis and poverty- focused and other projects in the lagging regions of the country. On the basis of these, a clear strategic framework has evolved for continued assistance to the Government's programs for the lagging regions, specifically for the - 26 - central and western provinces (which are the primary focus of the Tenth Plan efforts) and the largely-urbanized "rust belt" areas of the northeast. 57. Bank assistance will be focused upon five nodes that are intended to accelerate pro-poor growth and target the specific needs of disadvantaged groups. The program consists of new investments in rural development, transport and education, as well as AAA, including distance learning. * It will stimulate employment and productivity growth, recognizing that poorer endowments and sparser populations require the implementation of strategies that are in many ways fundamentally different from those seen in the better-endowed and densely-populated coastal areas. Rural development and technology initiatives, agglomeration and urbanization issues, and private sector promotion and support services are key areas of work. * In addition to endowments, the integration of the vast domestic market requires a set of policies, infrastructure investments, and logistics development to combat the geographical remoteness of the disadvantaged regions. * There will be continuing emphasis on basic education, skills development, and improvements in the unfavorable human and social indicators in such regions. Special attention will be given to rural health issues particularly accessibility to services and insurance schemes as well as HIV/AIDS. This will enable disadvantaged groups, including a high proportion of the minority population, to take advantage of employment and income diversification opportunities within and outside these areas. More analytical work will be conducted on gender issues (Annex H), as mputs into the Bank-China dialogue on the relevance of gender issues in development assistance and for identifying effective gender components in Bank- supported projects where appropriate. * In order to address social concerns and promote risk-taking, the Bank will continue its analytical and capacity building support for social protection. In this regard, the program intends to go beyond urban pension reforms, to a broader array of urban social 'issue s including migration, retraining and unempbyment. * The program will address two divergent trends in the nature of poverty in China, building upon our strong support to the poverty reduction successes since the early-80s, which resulted from growth as well as targeted policies Starting from a position of high and ubiquitous poverty, China has now reached a stage where poor people are concentrated in geographic clusters that are amenable to poverty targeting through the use of a tested package of interventions (e.g., rural roads, basic education, childhood vaccinations, public services for income diversification). Box 4.3 illustrates the nature of multi-sector/multi- instrument interventions that will be deployed for this purpose and reflecting the need for both growth, empowerment and poverty targeting as elements of an effective strategy. At the same time, increasing labor market mobility has meant that the focus of poverty reduction efforts has to shift gradually towards household targeting, as in the developed countries. This is an area of policy expertise that is severely under-developed in China but one in which the Bank has considerable expertise to offer. Therefore, the Bank will play an enhanced role in supporting the next stage of poverty reduction. - 27 - Box 4.3: Helping China's Rural Poor THE CHALLENGES AND HOWV THEY ARE ADDRESSED BY THE FVORLD BANK IDENTIFY THE CAUSES OFPOVERTY + Overcoming Rural Poverty (2001) Report INCREASE FUNDING FOR THE TRULYNEEDY. + Provincial Expenditure Review (2001-02) and Sub- More efficient and equitable fiscal transfer national Economic Reports (FY03 -04) systems needed along with better targeting of * TA for Poverty Mapping, Improved Targeting of Poverty poor communities Funds IMPROVEACCESS TO SOCIAL SERVICES. * TA to Monitor indicators for social sector spending and its impact, Strengthen financing and improve access to social services for rural poor * Projects Tuberculosis Control (FY02), Basic Education in Western Areas (FY03), and ongoing social projects RAISE ON-FARM PRODUCTIVITY THROUGH: - SUPPORTIVE INFRASTRUCTURE * Inner Mongolia, Hubei and Third Shaanxi Highways Projects (FY02-04) with Roads in Poverty Area (RIPA) components and the Hubei Hydropower (FY02) and Renewable Energy (FY04) Projects to make power available in poor areas - RESEARCHAND TECHNOLOGYTRANSFER * TA to develop a new approach to rural development in to serve mountainous areas and assist poverty counties with degraded lands shift to higher-value crops * Projects like Sustainable Forestry Development (FY02), Jiangxi Integrated Agriculture Development (FY03), Agriculture Tcchnology Development (FY04) * IFC's support to industry-agriculture linkages through investments in resource-based industries - MICRO-CREDIT. * Analytical work on rural finance issues * Credit provided under ongoing/proposed rural poverty projects * Possible IFC support to micro -finance institutions PROMOTE MORE OFF-FAR,M EMPLOYMENT * Studies of labor market reform and development AND LABOR MOBLITY TO URBANAREAS + IFC capacity building and funding to SMEs in western areas * IFC's support to rural community development through projects in forestry and agribusiness EMPOWER THE POOR * TA for empowering poor women in western China * Highly participatory approach in projects, e g , Sustainable Forestry Development (FY02), Gansu/Xinjiang Pastoral Development (FY03), Poor Rural Communities Development (FY04) * TA Support to Water Users' Associations * Increased local control of schools in basic education projects MAKE THEM MORESECURE in terms of land + TA to introduce land tenure reforms, promote water use rights, access to markets and information, users' associations improved water use efficiency to protect * Agriculture projects improving water use efficiency and against drought, etc market access 58. Sustainable improvement in the living standards of poorer and disadvantaged regions will require accelerated development of the private sector in the Western provinces. The Bank Group will give special focus In its advisory and investment activities to issues related to private sector development m China's interior. IFC will continue to support private sector-led projects in the - 28 - mterior and, through the China Project Development Facility (CPDF, see Box 3.1), improvement in the business climate there. Supporting growth of SMEs in the Western provinces will be a high pnonty for IFC and support in this area will be delivered through CPDF, the Sichuan SME Investment Fund (SSIF, see also Box 3.1), and SME linkages as part of larger projects. Following its successful experience in Sichuan, IFC is widenng its focus to cover a second intenor province, Shaanxi. IFC's experience in Sichuan suggests that focusing on one province pays off in terms of what IFC can accomplish, in terms of visibility, critical mass of developmental impact and knowledge of local business conditions. D. FACILITATING AN ENVIRONMENTALLY SUSTAINABLE DEVELOPMENT PROCESS 59. Despite the Government's efforts of the last decade, China's rapid economic growth poses a major challenge for the management of its natural enviromnent. Increasing land degradation, severe deficiencies in water quality and the distribution of the available water, high levels of air pollutants, and declining natural forests threaten the sustainability of long-tenn growth. The causes and impacts of such environmental problems are mtertwined across sectors and regions in complex ways, sometimes even beyond China's geographical borders. Mostly, they require coordinated solutions that cut across domestic admimstrative boundaries, using state-of-the-art mitigation technologies and participatory policy interventions. Moreover, environmental deterioration and the declining productivity of many natural resources are associated with poverty and unsustainable production practices, especially in the environmentally fragile central and western provinces. Consequently, sustainable development is a primary theme of both the Tenth Plan strategy and the Western Region Development program. 60. The Bank has a major program of environmental cooperation in China, as illustrated in Figure 4.1. The planned Bank Group program includes new investments in energy conservation, natural resource management, watershed rehabilitation and wastewater treatment, global environment projects supported by the Global Environment Facility (GEF) and Montreal Protocol, and AAA. This is also an area where strong partnerships have been built with other multilateral (e.g., UJNEP, UNDP), bilateral (e.g., Norwegian Government), and NGOs (e.g., World Wildlife Fund, Ford Foundation) The program during the CAS period is shaped by the findings of a major study, China: Air, Land and Water - Environmental Priorities for a New Millennium, which was jointly produced in 2001 by China's State Enviromnental Protection Agency and the Bank. The study suggested mainstreaming environmental considerations in the planning processes of all major government agencies; providing the funding necessary for environmental agencies to fulfill their mandates; and developing diversified approaches and tools to deal with the country's wide-ranging needs. Stemminmg from that study, as shown below, an intensive level of support is planned for the forthcoming CAS period to help shape environmental institutions, manage China's air, land and water resources, and protect the global commons. 61. A major focus of IFC's investment activities in China will be to support the adoption and dissemination of environmentally and socially responsible and sustainable business practices by the Chinese private sector. IFC will continue to pursue investment opportunities in sustainable forest management and renewable energy. IFC will give a special priority in its business development strategy to projects that support the development of China's environmental - 29 - industries, including those bringing international envirortnental technology to China, as well as those that manage wastewater and sewage treatment plants. IFC will also, as it does globally, seek to help investee companies find profitable opportunities to reduce waste and emissions Figure 4.1: Environmental Issues and Bank Support Issues Bank Support Grants v * Global Environmental Facility- comprehensive program of investments Global Environment: in biodiversity protection and reduction in greenhouse gas emissions Think globally but act locally * Phase-out of Ozone Depleting Substances (ODS) How China deals with its environmental TA/Studies problems has global implications. It is a key * National Strategy Study for the Clean Development Mechanism of the stakeholder in intemational environment Kyoto Protocol conventions * Preparation for the Phase-out of Persistent Organic Pollutants (POPs) Program (with the potential for future grant assisted projects) Environment Institutions & Regulatory Framework: Lending/Grants Comprehensive but gaps exist * Environmcntal TA and Economic Law Reform Projects Existing framework requires continuous TA/Studies updating and refinement to improve * Strategic Environmental Impact Assessment Study effectiveness and cover emerging issues * Environmental Administration Study (e g , post-WTO) * Environmental protection regulations, procedures and guidelines Air Quality: Lending/Grants A major health issue in China e Renewable Energy Scale-up Program While national emission of major air Heating Reform and Building Energy Efficiency pollutants have declined in the 1990s, * Urban Projects emission from vehicles has worsened and TA/Studies continued reliance on coal and other high carbon fuels will reverse the trend * RAINS-Asia Program (Phase 111) Water Quality and Quantity: Lending/Grants Nearing crisis proportions in some parts * Urban Environmental Improvement Projects with major wastewater of the country treatment components e Some progress has been made in pollution . Tarim Basin I and 1I Projects control of industnal wastewater discharges, but A* Water Conservation Project municipal wastewater and agncultural . Hai River Integrated Water Resources Management discharges are worsening . TA/Studies * Water scarcity is becoming acute in some * North China Water Study areas, particularly in northem China Lending/Grants Land and Natural Resources: * Loess Plateau Projects (I and 11) Degradation is widespread and * Forestry Projects (1, 11, and 111) increasing * Biodiversity Projects - Nature Reserves Management Project and Lake * Rapid growth has accelerated the land Dianchi (new) degradation process making China one of the * Coastal Zone Management Project most senously eroded countnes in the world * Gansu and Xinjiang Pastoral Development Project (new) * Loss of cultivated land, grassland * Sustainable Forestry Development Project (new) degradation, and decline of natural forests are TA/Studies increasing as well as important biodiversity. * Livestock Sector Note . Task Force on Forestry and Grasslands of China Council for International Cooperation on Environment and Development - 30 - 5. THE BANK GROUP ASSISTANCE PROGRAM 62. Operationally, the program would be shaped by factors reflecting the changing nature of the relationship between China and the World Bank Group, in particular: * The potential gains to both sides, with China positioned not only to receive the Bank group's assistance, but also share lessons of its successful experiences more broadly and contribute to the thinking on global development issues; * The growmg importance of the Bank's advisory services relative to lending m the coming years and the more active role that IFC and MIGA will play as part of the Bank Group's program; * With the array of choices available to China for both policy advice and financing, selectivity and specialization will be an important consideration in formulating the Bank Group's program (although the size and diversity China's economy will inevitably draw the Bank Group into a range of issues and activities); and * Recognition of the benefits that Bank partnerships with other donors, the private sector and civil society can have, given the changes in China that have occurred over the past decade. A. KNOWLEDGE AGENDA/AAA PROGRAM 63. As mentioned earlier, the Bank is now asked to assist with the most complex institutional and structural policy issues. Requests for collaboration could be extremely narrow in focus (e.g., the momtoring of local government fiscal risks) or strategic and sweeping in scope (e.g., education or environmental strategies to meet near-term challenges). These depend on China's own assessment of where the Bank's contribution would be highest. 64. Therefore, the general strategy for collaboration on the Knowledge Agenda can be characterized as: (a) demand-dnven; (b) balanced between activities that inform or otherwise support specific policy events or decisions, and those that address strategic development issues where the authorities feel that the Bank can make unique contributions; (c) grouped around themes of high priority, which are discussed intensively with the authorities and approved by the State Council (cabinet); (d) reliant on a variety of delivery mechanisms, including policy notes, detailed operational studies, face-to-face and distance learning courses, seminars and workshops, study tours for Chinese officials, and research; and (e) based on the increasing use of local experts and institutions. 65. For the three-year period FY03-05, the Bank's Knowledge Agenda is organized internally under eight sub-themes consistent with the three CAS objectives shown in Box 4.1: economic monitoring; economic management,financial sector development; markets and enterprises; revitalizing lagging economies; human/social development; environmental management; and infrastructure and urban development. The major activities under each of these themes are listed in Annex B4-The Knowledge Agenda, FY03-05. A significant characteristic of the Knowledge - 31 - Agenda is the closer integration of economic and sector tasks containing a high operational content with capacity building conducted through WBI, and trust funds and research on strategic issues undertaken by the Bank in collaboration with local and international researchers and institttions. Typically, major economic and sector work (ESW) is carried out in tandem with WBI courses, including use of GDLN programs, in order to transfer cutting-edge analytical methods or international experience to local counterparts, or to disseminate findings more broadly. Bank Group-assisted research will be instrumental in deepening understanding of the Chinese development experience, building local research capacities, and feeding into the design of policies and projects in which the Bank Group and other developirent partners are mvolved in China. In addition, in this way the Bank Group can bring longer-termn development problems to the Governnent's attention while also assisting policymakers to grapple with the more immediate economic and social agenda. The dissemination of the Bank Group's research through a Chinese- language website will facilitate the transfer of international development experience to local researchers. At the same time, high quality evaluation of the Chinese projects, policies and institutions - through diagnostic and advisory ESW and research - is planned in order to scale up China's development experience to other countries. Box 5.1: Sub-national Development Issues - An Important Area of Bank Involvement The Issue Differences in endowments and geography have interacted with economic policies to exacerbate disparities among regions. At the same time, weaknesses in the operation of China's intergovernmental fiscal system weaken the implementation of the national policy agenda Due to a mismatch between the major expenditure responsibilities of sub-provincial governments - particularly for providing vital public services such as education and health - and their funding capacities, extremely large - and growing - regional disparities have emerged in fiscal spending, service provision and people's welfare While a system of earmarked budgetary transfers exists, it has not achieved policy objectives The problems are especially severe in the lagging regions of westem and northeastern China. Diagnosis Together with SDPC, the Bank has addressed some of the issues related to sub-national economic development, focusing initially on economic constraints, trade and logistics issues, human development needs, private sector development, and environmental infrastructure in three western provinces More recently, working with the Ministry of Finance, the Bank has addressed the fiscal issues in its report, China - National Development and Sub-National Finance A Review of Provincial Expenditures (Report No 22951, April 2002) The report recommends reforms to improve expenditure and revenue assignments for the various levels of government, to distribute fiscal resources more equally, and to improve use of these resources through better budget managcment at all government levels A comprehensive effort to re-gear all components of the inter- governmental fiscal system is called for since selective interventions on specific issues create perverse incentives Piloting Reforms The report was welcomed by senior government officials, who requested Bank support in implementing the recommendations Planning has therefore begun for a multi-year pilot effort to provide several western provinces with technical assistance for introducing fiscal reforms that reduce regional inequality and improve provision of key services to local populations A collaborative effort of China, the Bank Group and selected external development partners is envisioned Simultaneously, research on the business environment, investment promotion, removal of inter-regional barriers to trade and resource mobility, and on the development of economic belts is proposed This is to be complemented with increased capacity building efforts for lagging regions, including the use of WBI programs targeted towards the western provinces, and the use of the Ningxia GDLN node and related ICT to reach target audiences in the lagging provinces 66. Within the overall Knowledge Agenda shown in Annex B4, which covers not only AAA but also efforts by WBI and the Bank's research units, there are three areas where better - 32 - integration of ESW, capacity-building and research is likely to be most effective. The first is a deepening focus on sub-national issues, motivated by the need to address regional and other inequalities while reforming local institutions in order to accelerate growth and the reduction of poverty (see Box 5. 1, Sub-national Development: An Important Area of Bank Involvement). The second is in the closely related area of the investment climate, both at a national level and specifically for the lagging regions, where the need for improvement seems greatest. In addition to ESW on specific elements of corporate and local governance and impedLments to the expansion of private business, particularly in lagging regions, the planned research program includes an intensive assessment of firm- level surveys of the business environment. The third area where ESW, capacity-building and research complement each other closely is m managing the adjustment to post- WTO global integration. A major research project on the policy and poverty linkages of WTO accession is being completed with the assistance of DFID, while a number of WBI and GDLN activities deliver international knowledge and build local skills for actions needed to modermize and strengthen public institutions and domestic markets, and to benchmark and reach international standards of competitiveness (see Annex B4). 67. Interactions between the Chinese economy and the rest of the Asian region have become an important area of policy interest as China increased its participation in world trade, investment and payments processes. The Knowledge Agenda contains a solid program of work in this area, whlch is intended to respond to the request from Governnent for policy advice as well as to feed into regional discussions. A set of studies addressing the effects of China's WTO accession on trade and investment in Asia is nearing completion. A region-wide study is looking at broader issues associated with China's emergence as a low-cost manufacturing base and destination for a huge volume of foreign investment, as well as behind-the-border issues to help regional integration. A specific study assessing China's strategic choices in terms of regional cooperation is also underway. Finally, a set of AAA activities that is planned for supporting the development of lagging regions will also examine linkages with bordering countries, and ways in which they could be strengthened. As several other externa I agencies are simultaneously assessing regional cooperation issues in other bordering areas (e.g., Mekong, Northeast Asia, Central Asia), a vast body of knowledge and potential policy recommendations is being developed to guide China's emergence as a major player in the world economy. B. LENDING PROGRAM LEVELS, FocUS AND SELECTIVITY 68. The case for lending to China. Although China is now a lower middle-income developing country, continued Bank financing remains relevant for the following reasons: * China sees Bank lending to be a vehicle not only to transfer resources but also to transfer knowledge, build institutions, share advanced managerial experience and support innovation and change at a critical tume in its transition. Continued mvestment lending, for example, m infrastructure for both the inner and coastal provinces, also reflects the strength of the portfolio over the years and perceptions that the Bank projects have contributed significantly to China's growth performance and improving the quality of domestically funded investments; - 33 - * Although China has made significant progress on poverty as mentioned earlier, there are still more than 200 million people with expenditures below US$1 a day, who account for about 18 percent of the global total. The gains in poverty reduction have been uneven geographically, leaving the vast majority of the poor in China concentrated in the lagging regions, hence making their development a national priority; and * Although China has taken steps to strengthen its fiscal position, the Government's revenue to GDP ratio remains very low and there is not yet an effective mechanism to transfer resources from the central to the poorer sub-national governments. In the meantime, the Bank can play a significant financial intermediary role in supporting mvestments in poor areas. 69. Lending Levels. An annual lending program fluctuating in the range of US$1.0-1.5 billion and averaging about US$1.2-1.3 billion is envisaged. This would be about one third to one-half of the peak amounts reached in the mid-90s but higher than the last two years. A higher lending level is neither feasible given the Bank's nsk-bearing capacity nor commensurate with client demand. The planned lending program is consistent with the client's financial needs and, purely from the viewpoint of the program's operational impact and administrative cost, may be seen from both sides as the minimum effective size in relation to the developmental challenges facing China. China, however, is projected to become IBRD's largest borrower during the CAS period, and in the absence of arrangements to manage exposure, projected debt outstanding under such a lending program would risk exceeding IBRD's portfolio concentration limit, currently US$13.5 billion. In order to ensure that any new lending does not involve projected exposure in any future year exceeding the concentration limit, the authorities and the Bank have agreed to the text of a Framework Agreement, which will provide a mechanism for flexibility in the lending program while keeping projected effective exposure within the concentration limit. (See Section 5C below and Annex B8.) 70. Within the US$1.0-1.5 billion range, actual annual lending amounts will depend on a number of factors, including implementation of the exposure management framework and the cost of IBRD financing relative to domestic and other external sources. Given China's decentralized structure, the Bank is effectively dealing with some dozen or more local authorities coordinated by certral agencies. Borrowing provinces typically will weigh the potential value- added that Bank projects bring before seeking assistance from the Bank, while the Bank has to judge the effectiveness of its program against progress on structural reforms and poverty reduction - which can vary from province to province. 71. For discussion of financial and country risks, see section G. In the case of a major deterioration of the economy, a substantial slowdown in structural reforms or any Figure 5.1: Geographic Focus of Lending significant increase in risk, the implications for (by number of projects) the Bank's assistance program would be 80% 76% discussed in a CAS Progress Report 60% 58 72. Selectivity and Focus. Consistent with 40% 42 the CAS themes, the lending program in Annex 20% 24% B3 focuses on the poorer inland provinces and 0% FY93-95 FY96-98 FY99-01 FY02-04 I + Coastal (B Inland| - 34 - typically addresses poverty and/or environmental objectives. Many projects also have innovative features or are designed with knowledge transfer as an important objective. In terms of geographical distribution, three-quarters of the proposed projects will support the poorer, inner provinces, compared with about 62 percent since the last CAS progress report (see Figure 5. 1). 73. Regarding the sectoral composition (see Figure 5.2), transport - with a focus on completion of the main transport links to and within the inner and western provinces - and urban projects - focused on environmental mitigation (water, sanitation and air pollution) - are the two largest sectors, accounting for 34 percent and 24 percent, respectively, of the FY02-04 lendmg program. The increasing prominence of urban lending, both in coastal as well as inner provinces, is a natural consequence of the rapid urbanization process underway in Chma and the priority being given to environmental issues. The transport lending reflects the client's continued concerns over promoting growth and its lmks with poverty reduction by strengthening regional integration and competitiveness through a well functioning multi-modal system (highways, inland water transport, railways and urban transport services). Nevertheless, while these two sectors have a slightly increased share of lending compared to the previous period, the actual amounts lent will be less than m the mid- 1 990s. Compared with the past, the increased share of urban lending is mitrrored in a decreased share of rural development projects as the Bank moves away from financing large-scale rural infrastructure (e.g., dams and major irrigation systems) and credit/agro-processing projects to assisting natural resources management (water, forestry, and grasslands). Lower lending for the social sectors and TA in FY02-04 (down 4 percent from the previous period) points up the fact that lost IDA resources have been only partially compensated by blending arrangements supported by DFID (and possibly other bilaterals in the future). Energy - with a concentration on renewable and efficiency objectives is more likely to be supported by GEF assistance in the future than with IBRD lending. These projected sectoral shares represent a continuation of trends that enmrged durmg implementation of the previous CAS. They reflect client preferences and China's system of decentralizing repayment obligations to the local beneficiaries - which shapes both the size and nature of projects selected. Figure 5.2: Lending- Sectoral Composition (by number of projects) FY99-01 FY02-04 Transport Rural/Env Transport Rural/Env 32% 26% 34% 21% _m11~EnvS Urban/Env SociaVTA N _D \ ~~~~~~~~~~~~~~~~~14% R al - So~~~cial/TAv f Urban/Env 18% Energy/Env 18% Energy/Env Urban/Env 7% 1 ~~~~6% 124% 74. Consistency with sectoral strategies and the potential for mnovation/knowledge transfer form the criteria for project selection. The nature of the Bank's lending relationship with China has been grounded historically on support for agreed sectoral policy objectives. Operations were - 35 - designed to reflect the client's strong ownership and reform objectives developed to bring about incremental but significant and sustained progress over time. This principle remains valid. Thus at the sectoral level, there needs to be consistency in the strategies as agreed between China and the Bank, and our financing role must be evaluated periodically, relative to overall progress in the sector. Table 5.1: The Bank's Evolving Objectives and Instruments: The Case of Energy 1996-1997 | 2001-2002 Strategic Objectives Expand and modernize supply capacity to support Transit the energy sector to a diversely owned, market - rapid economic growth based system. * Support construction of least cost large scale projects * Accelerate the transition by assisting the government to with modem technology and environmental facilities clarify policies and solidify strategies for sector * Assist in transfemng new technologies for large restructunng, market development and regulation coal-fired and hydropower projects, applying modem * Support implementation of restructunng and power power system operation methods market development at regional and provincial levels Promote energy sector reform to improve the financial Improve fuel mix, increase energy efficiency and limit performance of energy companies environmental impacts * Promote the transition from a vertically integrated . Promote transmission, distnbution and use of natural industry to a purchase agency model gas, and cleaner coal technologies * Commercialize/corporatize power, oil/gas companies * Improve demand side energy efficiency especially * Upgrade management capabilities and systems to through marked-based mechanisms enable the energy enterpnse to operate efficiently * Promote expanded use of renewable energy Develop a legal and regulatory framework Develop effective institutional and regulatory capacity * Delineate ownership and regulatory functions * Develop regulations and institutions consistent with the * Separate govemment from enterpnse management increasingly competitive and privately owned sectors to and establish separate regulatory institutions replace "old style" administrative framework Promote private participation/new sources of Reduce social inequities finalicing * Promote electricity access to remote, sparsely populated * Encourage altenative financing strategies for energy areas through renewable energy development development * Coordinate electricity service provision with efforts to * Gradually increase the overall tanff level to cover alleviate poverty and reduce inequities among regions supply cost and simplify the complex tanffs * Promote west to east transfer of energy through assisting * Develop model agreements to govern the in policy development to maximize development impact commercial relationship among energy entities Meains anud Tools * The choice of investnent projects was consistent * The choice of investment vehicles reflects increasing with Government objectives of eliminating energy availability of capital for mainstream generation, shortage, modernizing the sector and improving its infrastructure constraints to market development, and efficiency. Lendinig mainly supported large scale the need to convert to clean fuels and increase energy mainstream projects equipped with modem efficiency. Lending is limited to niche markets not well- technology served by others * Limited sector work focused on defining each sub- * Very wide range of sector work and TA focus on sector's strategic reform options and developing the assisting the central government to develop legal and roadmap for sector restructuring and the policy frameworks, define asset divestiture options and establishment of legal and regulatory frameworks clanfy market development strategy * Accompanied at provincial level by TA to * Parallel TA at provincial levels to support design and commercialize and corporatize power companies, implementation of power markets, transmission pricing upgrade institutional capacity and consumer tanffs - 36 - 75. This approach is exen-plified above with respect to the energy sector. Table 5 1 contrasts the nature of the issues in the mid-90s with the situation today and illustrates both the progress that China has made and how the Bank's program, in terms of lending and non-lending services, has responded to these changes. In the absence of policy-based lending and tranchmg, Bank lending m support of continued reforms in the case of China is validated by the country's strong track record and mirrored by the evolution of the Bank's assistance program. 76. At the project level, the Bank continually looks for opportunities to transfer new approaches and technology as part of project design and implementation. Each project is designed to build on the lessons of earlier ones and where the situation is appropriate, to introduce innovation as part of project selection and design. Examples of key innovative features in the lending program are illustrated in Box 5.2 and Annex B3, page 2. Box 5.2: Examples of Support for Innovation and Change Recent and Proposed Projects Project Name Support for Innovation and Change Shanghai Urban First Adaptable Program Loan in China Supports development and Environment APL (FY03) implementation of new financing mechanisms - in particular issuance of long- term infrastructure bonds by the municipality that can serve as a precedent for future long-term revenue bond issues in China - and private sector participation Hunan City/Regional First Bank project in China for comprehensive development of an integrated Development (FY04) urban region including three large cities in a river basin Project follows City Development Strategy exercise Second Energy Supports energy-efficiency investments and associated reductions in pollutants, Conservation Project through the development of China's nascent Energy Management Contract (GEF) (FY03) (EMC) industry EMCs are a new concept to China and patterned on energy service companies in North America and Europe The EMCs undertake energy conservation investments in "host" enterprises, based on contracts between the two, and carry out project design, procurement, installation, financing, etc Agricultural Technology Focuses on development of dryland and environmentally sound technologies, (FY04) targeted to the poor western provinces Inner Mongolia Highway Pilots private sector implementation of maintenance Addresses regional (FY02) inequalities and improves access of low-income areas Supports trade between China, Russia and Mongolia Sustainable Forestry Pioneered concept of protecting natural forests and associated biodiversity in Development (FY02) support of Government's new forestry policy along with sustainable forest plantations First formal co-financing in Asia with the European Commission and complemented by GEF grant. 77. Lending and AAA - Supporting Sectoral Objectives and Innovation Bank Group support can be provided through lending and/or AAA, as appropriate. In some instances, issues - such as those in developing a market economy - are more effectively addressed through policy studies or TA - often on grant terms - and through Bank partnerships with bilaterals and non- governmental institutions. In other cases, such as addressing inequality and environmental issues, Bank lending provides a multi-year framework for collaboration and hands-on expenence, both vital to knowledge transfer and institution building. The Bank's program therefore builds on synergies between lending and AAA supported by both the Bank's budget and donor grants. - 37 - 78. As illustrated below, lending tends to be concentrated in support of the second theme - addressing the needs of the poorer and disadvantaged people and regions - and the third theme - facilitating a more environmentally sustainable development process. While AAA, as measured by the amount of the budget spent, both from the Bank's administrative budget and trust funds, is more concentrated in the first theme on improving the business environment and helping to accelerate China's transition to a market economy. Overall, this pattern in the use of the Bank's instruments provides a more accurate sense of the role that the Bank plays in supporting China's developmental needs. Figure 5.3: Bank Operations by CAS Theme (A) Lending by Theme (FY96-04) (B) AAA Expenditures by Theme (FYOO-01) #of $million Projects9 20 18 c 8- 16 - 7- 14 - 6- 12 - 5_ 10 4- 8 6 - 3 4 2 2 - 1 0 0 - I II Iil Theme I II Il Theme O FY96-98 i FY99-01 ° FY02-04 |O Adm Budget l Trusi Fund LEGEND: Theme I Improving Business Environmcnt/Accelerating Transition to Market Economy Theme 11. Addressing the Needs of the Poorer and Disadvantaged People and Regions Theme III Facilitating an Environmentally Sustainable Development Process C. EXPOSURE 79. IBRD Exposure. Since FY02, IBRD's largest exposure has been to China. Large IBRD commitments in the mid-1990s led to a rapid build-up m the exposure from US$2.5 billion at end-FY1990 to US$11.4 billion at end-FY2001. Continuation of lending commitments at the rate of the mid-1990s would have led to IBRD's single country concentration limit of US$13.5 billionbeing exceeded within a very few years. Partly in response to this, new commitments from IBRD were reduced. Over FY01-02 lending was projected at about US$1 billion per year but the outcome was lower, and if these recent levels were to continue, the concentration limit might not be exceeded, provided that disbursements, cancellations and exchange rates stayed within a certain range. However, in view of the agreed lendmg program (Annex B3), which reflects higher demand for IBRD loans and the potential role that the Bank can play in China's development, China and the Bank jointly developed a proposed arrangement (described in para. 81) to manage IBRD exposure, which would provide China with greater upward flexibility in borrowing from IBRD. 80. Loans outstanding to IDA and IBRD are projected to increase to US$21.5 billion by 2005, including gross debt to as much as US$14.5 billion to IBRD, although IBRD would have - 38 - protection under the special arrangements described in para. 81 against exposure above the concentration limit of US$13.5 billion. Total debt to IBRD and IDA would be about 1 0-1 1 percent of China's total external loans outstanding. See Annex B7 for Exposure Indicators. 81. Management of IBRD Exposure. The arrangement developed jointly would allow China access to the lending levels planned in this CAS, while protecting IBRD against cash-flow losses from principal exposure above the concentration limit, in the unlikely event that China's loans were to go into non-accrual. The arrangement includes a menu of measures that China might take, including cancellations, prepayments, lower lending or the purchase of special private placement bonds from IBRD. This arrangement was endorsed in principle by the Board on August 6, 2002 (Board Paper R2002-0135), subject to further Board approval of the application of the approach in a specific case. Management expects to seek Board approval shortly to use the approach in the case of China, and if approval is obtained, the legal documents detailing the arrangements would likely be signed shortly thereafter. In brief, IBRD will carry out an Annual Review around imd-August each fiscal year, and will notify China of any projected exposure above the concentration limit in light of the out-turn of the previous year and the prospective lending program for the fiscal year in question. IBRD will also notify China of any shortfall between projected interest due on China's loans above the concentration limit and interest payable by IBRD on special Private Placement Bonds held by China in the year ahead. In any fiscal year, new lending to China within the CAS program will be available to the extent that it does not involve either projected net exposure above the concentration limit in future years or any shortfall m such net interest payments. Any loans approved by the Board beyond this would have as a condition of effectiveness that China had taken the necessary measures to protect IBRD against any projected net exposure above the concentration limit and any shortfall in such net interest payments. D. PORTFOLIO MANAGEMENT 82 As discussed in Section 3 (para. 30), China has the largest portfolio in the Bank and its quality is among the best performing. OED and QAG assessments have confirmed satisfactory project implementation, outcomes, and portfolio management. 83. In view of the portfolio's strength, as well as its complexity and size, the strategy has been to identify particular issues that have been seen as posing particular risks or impacting negatively on the quality Many of these come from the past OED and QAG reviews, the annual reviews of the portfolio and sector-specific reviews done by the region. Several of the issues coming out of these reviews - largely directed at streamlining and accelerating project preparation, procurement and disbursement procedures - were implemented as part of the Bank- wide streamlining of procedures and program decentralization in FY98 and continue to be the focus of ongoing efforts. Any cross-cutting issues identified are addressed in a focused manner, e.g., through thematic supervision or assessment and discussion with relevant sector or local authorities. This has proven to be more effective in achieving results than trying to address such issues through a more general process of Country Portfolio Performance Review, given the nature and size of the portfolio in China. - 39 - 84. Nevertheless, the portfolio is under pressure in dealing with safeguard and fiduciary issues and coping with the shuft toward the poorer, inner provinces where implementation capacity is weaker. In response, fundmg for supervision has been steadily increased in recent years, staffing of the Beijing office has been considerably expanded to deal with sector issues as well as core services, and project-specific supervision has been supplemented by thematic supervision of safeguard and fiduciary issues as part of our efforts to reduce risks. In addition to the various measures on safeguard policy implementation (described below), the Bank's Beijing units dealing with fiduciary issues also provide training in procurement, financial management, disbursement and auditing requirements to project implementing agencies To achieve a broader impact, the Bank has been working with one of China's leading universities to deliver procurement courses and has prepared an Operational Procurement Review. On financial management, the Bank has contributed to a broad study carried out by the Asian Development Bank on financial management issues in China. Also, the Bank has been working with the Government to address identified financial management and procurement issues (see Annex I) and to pilot improved financial management in a province. E. SAFEGUARD POLICIES 85. Given the Bank's increasing support to the western regions, which represent the bulk of the minority nationalities and are characterized by fragile ecosystems, the Bank is addressing systematically the application of its safeguards policy m China. These efforts are designed to clarify understandings on the objectives and application of such policies and harmonize Bank and national guidelines, with the view of reducing the costs mvolved in project preparation and implementation. The elements of the strategy for more effective safeguards policy application in China include the following: * Policy Dialogue: The Bank will continue efforts to clarify and ensure hannonization between Bank safeguard policies and domestic law or regulations. This includes reviewing differences between Bank and client sequencing of safeguard assessments in relation to project preparation and approval. The intention is also to establish a specific institutional arrangement whereby designated government and Bank officials meet regularly to discuss issues more broadly. * Project Preparation: The Bank will promote project preparation procedures that lead to earlier identification and resolution of potential issues of safeguard policy application. This will include increased efforts to provide project- level counterparts with basic safeguards policy orientation during project conceptualization. * Project Supervision: Through intensive supervision, the Bank will endeavor to identify safeguards-related problems at an earlier stage of project implementation. In additionto regular supervision of individual projects, "thematic supervision" has proven to be a useful vehicle for supervision of safeguard aspects across multiple projects. The main objectives of this approach have been to identify recurring or cross-cutting issues, explore synergies across sectors, and achieve cost effectiveness due to economies of scale realized from covering multiple projects. Sector-specific thematic supervision exercises regarding involuntary resettlement have been undertaken for all the major sectors over the past three years. - 40 - Environmental thematic supervision was undertaken for rural and transport projects in FYO 1/02. Training and Capacity Building: Considerable domestic capacity already exists for environmental and resettlement planning and monitoring. While these areas will continue to be supported through Bank activities, support for development of domestic capacity m social assessment techniques is an immediate priority. F. PARTNERSHIPS 86. The donor community in China has played a relatively small financial role in supporting China's development over the past two decades but its impact cannot be assessed by simple comparisons with financial aggregates. China utilizes around US$5 billion of official financial flows per year, which accounts for less than 1 percent of China's GDP. Thus compares with the more than US$40 billion m direct foreign investment that has been corning in annually in recent years. However much of the FDI is for purely commercial activities and external assistance needs to be assessed against the implications of a still relatively weak fiscal system. Given recurrent expenditure obligations, external financing has in fact accounted for a significant share of financial support provided through the budget for "public goods" types of investments over the past decade, averaging about 15-20 percent. 87. Financial assistance in the form of investment loans from the World Bank, the Asian Development Bank (ADB) and the Japan Bank for International Cooperation (JB IC) has traditionally accounted for about 80-90 percent of total official financial flows in recent years. Both ADB and JBIC loans have supported mfrastructure (energy, transport, urban), environmental investments (e.g., urban wastewater management) and to a lesser extent rural development. However, reflecting shifting priorities in China, lending strategies have begun to evolve - ADB towards projects in poorer areas, and JBIC towards greater emphasis on education, poverty, natural resources management and the environment in poorer areas. The United Nations agencies and a range of bilaterals, includmg the European Union (EU), provide mostly grants for technical assistance and training in such areas as poverty reduction, social development, governance and environmental management. The International Monetary Fund (IMF) is heavily involved in fiscal reform issues. Among the bilaterals, DFID is working toward scaling up the impact and effectiveness of its program through enhanced collaboration with other donors including the Bank. 88. Traditionally, the Government has tended to allocate certain types of projects to each donor reflecting both regional specialization as well as project size and complexity, leaving each donor to work alone on different geographical areas, sector issues, etc. While donors have been working more closely in recent years, as discussed below, the split in coordinating responsibilities within the Govermment - basically with Chma's Ministry of Finance (MOF) being responsible for loan and selected grant assistance and the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) for bilateral grants - is an issue which needs to be addressed in achieving broader donor coordination. The emphasis of support provided by China's variDus donor partners is shown in Annex J. - 41 - 89. China and its partners have begun to work more closely with each other over the past two -three years, recognizing that knowledge sharing and capitalizing on each partner's comparative advantage can improve the effectiveness of their programs and thus help China to address its complex challenges. Over the past few years, the Government has begun to encourage donors and other partners to share knowledge and collaborate. Donors, including the Bank, have done so, while also demonstrating selectivity in their involvements, based on their particular strengths and capacities. Further, the Government has encouraged the Bank to seek cofinancing with bilateral donors to soften the overall financing package for social sector and poverty reduction projects, while also strengthening their effectiveness by building on complementary interests and capacities. This is exemplified by the innovative "blending" partnership between the Government, DFID and the Bank as described in Box 5.3. DFID is also considering expanding this lending partnership through possible establishment of an arrangement to support Bank-DFID collaboration for policy work in a number of areas. Box 5.3: Blending of DFID Grant and IBRD Loan: Partnership in Action The Government, DFID and the Bank started by considering different variants of cofinancing to "blend" DFID grants with IBRD loans to lower the costs of financing and improve the quality of the project being supported A key consideration for all parties was to have a mechanism which generates a single stream of blended funds to the Government, to achieve simplicity and low transaction costs to the recipient At the same time, a more coordinated approach would encourage the development of a project which tapped the relevant skills and interests of both partners In the end all parties agreed on an approach where, in essence, the Bank administers the DFID grant in a trust fund, and uses the grant to prepay an agreed proportion of the IBRD loan at regular intervals during project implementation For the Tuberculosis Control Project, a DFID grant of US$37 million is used to prepay 36 percent of the Bank loan amount disbursed and outstanding, every six months over seven years of project implementation, effectively reducing China's liability from the full loan amount of US$104 milllon to US$67 million These parameters were agreed in such a way that, if the assumptions hold, the net effect to China would be a loan of US$104 million at about 2 percent interest per annum MOF will guarantee an interest rate of 2 percent per annum when passing on the loan to the 16 beneficiary provinces Under this financing model, not only are the administrative and transaction s aspects kept to the minimum for both the Government and DFID, but more flexibility is also created for DFID and the Bank to work with the Government on the policy and project issues Administratively MOF will have to deal with only one stream of funds (the Bank loan) and the procedures of only one donor (the Bank), which is not the ease with conventional parallel orjoint cofinancing A key by-product of this approach was the realization of a mutually agreed policy framework among all three parties, with technical expertise from the World Health Organization, and thus preparation of a potentially more effective and larger scale project than if more traditional cofinancing arrangements had been utilized 90. Two other notable partnerships also provide useful models: cofinancing by the EU, the Bank and GEF to support the Sustainable Forestry Project - the first formal cofinancing arrangement with the EU in Asia; and an Australian Agency for International Development (AusAID) grant-financed distance learning center in the poor western province of Ningxia, for which the Bank is the implementing agency. These partnerships make good use of comparative advantages of each donor, lead directly to results on the ground, and are highly appreciated by the Govermnent. HIV/AIDS prevention and control in China will likely be a future focus of the Bank's partnership activities, involving the Global Fund and other donors now active in this area. - 42 - 91. The Bank is also deepening its cooperation with civil society groups in China. In view of the increasing importance of civil society groups m contributing to China's development, the Bank has assisted them in a variety of ways, namely through the Small Grants Program - whuch for instance awarded a grant to the Women's Federation in Xishuangbanna Dai Nationality Autonomous Prefecture in Yunnanprovince, where HIV/AIDS infection rates have been increasing dramatically, to finance a series of workshops on AIDS prevention and control. Also local NGOs have been involved in implementation of some Bank-supported projects - for instance the local women's federation is part of the steering committee of the Anmnng Valley Development Project and plays a leading role in mobilizing local women to participate in project activities and provides training for poor women. 92. China's approach to development exemplifies many of the key benchmarks of the Comprehensive Development Framework (CDF) concept - in particular client ownership, the holistic approach and the importance of ensuring that institutional structures are in place as part of the reform process. See Box 5.4. One CDF concept which China is trying to benefit more from is making better use of partnerships - with donors, private sector and civil society. Box 5.4: China's Development Model and How It Compares with CDF China already exemplifies many of the key benchmarks embodied in the CDF concept. The main themes underpinning the CAS flow directly from client requests and China's Tenth Five-Year Development Plan - which is a comprehensive statetnent of the country's objectives encompassing the various structural, social and institutional prerequisites for sustainable growth and poverty reduction The Plan is well targeted to the country's major challenges and has therefore been broadly endorsed by donors. And, equally reassuring, poverty reduction has remained a dominant theme of its development approach over the past two decades But there are somc gaps. Thus, if one axis of the CDF - the holistic approach - is well covered, the other axis - showing the development players - indicates a program that is strongly client-driven but more selective than other developing countries in terms of drawing directly on the intellectual capital available both internally and externally It has, therefore, been cautious about making maximum use of partnerships in drawing on outside experience The CAS, while fundamentally grounded on a continued poverty reduction-cun-knowledge-enhancing role for the Bank Group, also aims at promoting a broader dialogue over the coming years and taking a step-by- step approach in piloting activities As mentioned in Section F, the Bank has made good progress with the Govcrnment/DFID/Bank partnership to address priority issues in the social sectors, environment and poverty, and are now scaling this up Our interaction with representatives of a broader spectrum of civil society has also been growing gradually The May 2002 visit to China by thc Bank's President generated momentum on both fronts Over the CAS period and beyond, the Bank will continue to assist the Government in forging partnerships which leverage results on the ground, and in engaging a wider spectrum of the society in its developmcnt process G. RISKS 93. Financial Risks. As noted in Section 1, China's near-term economic prospects continue to be favorable but there are financial weaknesses embedded in the domestic economy. Non- performing loans (NPL) in the banking system have been targeted by the Government since 1998, when it partially recapitalized the matn state-owned banks, and subsequently transferred nearly 14 percent of loans to newly formed asset management companies for collection and debt- equity conversions. Despite this, according to government statistics, NPL for the four major - 43 - state-owned commercial banks averaged an estimated 25-30 percent of outstanding loans at end- 2001. At the same time, other hidden government liabilities exist, both for other financial institutions as well as for under-funded pension obligations and enterprise arrears. Although a precise determination of such quasi- fiscal liabilities is constrained by data limitations, the total potential burden on the Government could be a very large proportion of GDP. Consequently, the medium-tenn fiscal outlook remains a source of concern, although the explicit public debt is relatively low by international standards. Slower economic growth, combined with the lack of fiscal consolidation and a failure to address the underlying weaknesses in the enterprise and financial sector could exacerbate these risks and undennine investor confidence. However, in addition to the Government's track record in macroeconomic management, there are the following factors which make China a creditworthy borrower. On the domestic front, China's substantial growth momentum and its predominant reliance on domestic savings for financing provide a cushion. On the external front, its strong trade performance, the restricted convertibility of the capital account, and its substantial external reserves position in relation to overall public indebtedness are sources of comfort. Nevertheless, these factors do not lessen the urgency for fiscal consolidation as well as for exerting finn and contmnuous pressure on enterprises and banks to improve their operational efficiency and profitability. 94. Country Risks. The central country risk arises from the pattern of domestic response to the adjustments that are likely to follow closer global integration in the wake of accession to the WTO. The risks of adverse effects are especially high in the lagging interior regions of China, which are generally disadvantaged in tenrs of incomes, geography and endowments. Increasingly, social cohesion will be a concern both in rural and urban areas, and will place pressures on the Government. In rural areas, where more than half of the population live, there are already pressures from stagnant grain prices, liberalization of agricultural trade, and persistence of multiple fees and other burdens on fanners. These pressures may encourage more farmers to seek work in urban areas, far beyond the current level This would exacerbate imbalances in urban employment, expected in the wake of WTO accession-related restructuring. The resolution of rural discontent, as a consequence, is being accorded high priority by the Government, as reiterated at the recent 16ih Party Congress. Recent efforts to convert onerous rural fees into more equitable taxes are a prime example of key government measures to improve rural conditions. Despite the Government's policy effort, in some urban areas unemployment is likely to continue rising. The above pressures also make acceleration of pension reform more pressing, because of the rapid aging of China's population where the ratio of workers to retired persons is projected to decline to about 3 to I by 2050, from 10 to 1 in 1995. The mitigation of both rural and urban social concerns is hence urgent. 95. Flexible markets and a supportive business enviromnent, coupled with adequate arrangements to smooth the transition for finns and farms and provide safety nets for those worst affected, are needed to maximize the potential benefits from joining the WTO. At the same time, the capacity of all levels of Govermnent to understand and monitor the adjustment process, and design appropriate growth-enhancing responses to them, needs to be developed. Thus, the main risks to China's growth prospects over the forthcomng CAS period stem from its ability to act pro-actively m handlng post-WTO accession adjustments, especially in the lagging regions, while continuing to address the longer-term problems of poverty, inequality and urban labor - 44 - dislocation The state of natural resources and environuental management is another area to be monitored carefully. 96. Risk Monitoring and Mitigation. The types of systemnc risks identified above require close monitoring, and a special focus on the nodes at which they occur. Together with the authorities, the Bank Group's assistance strategy addresses the most critical of these nodes The Bank has developed a major advisory program in the financial sector, which supports reforms of banks and supervision, and the introduction of better credit practices and a wider array of financial instruments for savings and risk diversification. The monitoring and evaluation of domestic fiscal nsks, together with comprehensive debt management and budgetary reforms intended to strengthen public finances and budget management, are also important components of this program. Earlier work on pension reform is being extended to broader urban labor market and social protection issues. Finally, a linked program of activities is aimed at improving the transparency, integnty, and flexibility of resource allocation mechamsms in China, in order to strengthen the ability of the economy and society to absorb domestic and external shocks. Such measures range from improved bankruptcy procedures to facilitating resource movements within the dynamic enterprise sector, to the development of flexible market-based systems of macroeconomic management. These also include the application of better risk-pooling, financing, and risk-sharing methods in areas such as the provision of municipal services, social insurance, credit, construction and operation of infrastructure, and interventions to provide stable livelihoods for low- income groups. H. CREDITWORTHINESS 97. Although China's government debt (domestic and external) has increased sharply from 11.4 percent of GDP in 1997 to an estimated 23.8 percent in 2001, it is still well below levels for comparable middle- income countnes (see Table 5.2 below). The increase m public debt was driven entirely by the domestic fiscal stimulus program of the Government, which was undertaken to counteract the slowdown in growth and employment in the period since the last CAS. External public debt rose from 4.0 percent of GDP in 1997 to a peak of 4.8 percent in 1999, before falling to 4.5 percent in 2001. Total external debt stood at US$170.1 billion at the end of 2001, or 14.7 percent of GDP, of which short-term debt (on a remaining maturity basis) amounted to US$50.6 billion. Total external debt service to exports of goods and non-factor services fell from 8.7 percent in 1997 to 7.9 percent in 2001, and is projected to decline further to 5 9 percent in 2005. Interest payments on external debt remained relatively unchanged at 3 3 percent of exports of goods and non- factor services from 1997 to 1999, before dropping to the current level of 2.6 percent. 98. China's international liquidity situation has improved significantly since 1997. Foreign exchange reserves rose from US$140 billion (7.1 months of imports of goods and non- factor services) in 1997 to US$212 billion in 2001 (9.4 months), and further to US$259 billion in September 2002. A continued mcrease to US$348 billion in 2005 is projected (Table 1.2). In addition, the net foreign assets of the banking sector increased from US$5.2 billion in 1997 to US$85.4 billion in 2001. International reserves are equal to more than nine months of imports and 416 percent of short-term debt, which should provide a cushion against debt servicing problems over the CAS period. - 45 - Table 5.2: Key Debt Indicators, 1997-2001 Actual Estimated 1997 1998 1999 2000 2001 External Debt Outstanding and disbursed (DOD) 146.7 144 0 152 1 145 7 170 1 (US$ billion) DOD/GDP(%) 163 152 153 135 147 IDA-IBRD-DOD/GDP (%) 1 8 1 9 2 0 1 9 1 8 Debt service (DS) (US$ billion) 18 4 18 4 26 9 27 1 24 3 Dcbt service ratio (DSR) (%) 8 7 8 7 11 7 9 3 7 9 IBRD debt service/DS (%) 4 6 4 6 4 3 4 3 6.3 Public Debt Domestic (RMB billion) 551 1050 1321 1671 1851 Domestic/GDP (%) 7 4 13 4 16 1 18 7 19 3 Extemal (RMB billion) 298 345 394 365 434 Extemal/GDP (%) 4 0 4 4 4.8 4 1 4 5 1. IFC AND MIGA PROGRAMS 99. Given China's size, liquid banking system, and attractiveness to foreign direct investment, IFC's comparative advantage is not primarily its ability to provide long-term risk capital, despite the fact that Chinese private companies continue to face many difficulties in accessing intermediated financing. The main differentiatmg factors that underpin IFC's role in China are IFC's cross-country experience as a global developmental institution which domestic banks do not have, its clearly focused strategy on the interior of China which international financiers do not share, and its unique capabilities in the areas of corporate governance, environmental and social sustainability, and SME development (see Annex F for more on IFC role). In its business development strategy IFC focuses on sectors and projects where these differentiating characteristics are potentially of the highest value. 100. IFC's goal in China during the CAS period is to support rapid development of the domestic private sector through investments and advisory services, in conjunction with the World Bank. Strategic priorities are: (a) improvmg the business environment, particularly as it relates to financial markets, private participation in infrastructure and SMEs, through targeted technical assistance, (b) encouraging development of small and medium sized enterprises through capacity building, and the development of alternative sources for SME financing; (c) helping deepen and broaden the financial sector by supporting private banking and non-bank financial institutions; (d) supporting pnvate sector development m China's western and interior provinces; (e) enterprise restructuring through model transactions promoting industry consolidation and restructuring and by cooperating with China's Asset Management Companies; and (f) expanding the presence of private enterprises in infrastructure, social services, and environmental technology sectors (see Annex F-PSD Strategy). The focus will be on model transactions that are setting standards for private sector investments in corporate governance, international accounting, environmental technologies and practices, and efficiency of operations, with the aim of creating demonstration effects and helping Chinese companies become global and internationally competitive players. 101. China is the Corporation's ninth largest country portfolio. The portfolio mainly supports general manufacturing, followed by the financial sector, chemicals, and mfrastructure. China is - 46 - significantly underweighted in IFC's portfolio relative to its share in emerging markets GDP, but much less so if we correct for the share of the private sector in China's GDP. With the rapid expansion of private sector's share in GDP, the emergence of larger and more sophisticated private companies, and the continued opening of new sectors to private sector participation, IFC expects to see a significant increase in its China program despite the challenging environment. During the CAS period, projected volumes of investments are expected to double the historic average of about US$200 million per year on the assumption of continued improvement in the business climate. IFC's investment program will be complemented by targeted technical assistance with a focus on the general business environment for private sector development, SMEs, financial markets, and private participation in infrastructure (see Box 4 2, Annex B4, and Annex G and Annex F). To deliver this larger program IFC has strengthened considerably its field presence in Beijing, Chengdu and Hong Kong as part of its decentralization strategy. 102. MIGA will continue to provide China with demand-based guarantees and investment marketing services. As of April 30, 2002, MIGA's gross exposure to China stood at US$87.0 million, representing 1.8 percent of the Agency's outstanding exposure. The portfolio, consisting of 12 contracts, is diversified with about half of the exposure in the infrastructure sector and the remainder in manufacturing projects. MIGA is receiving a significant number of inquiries for projects m the oil and gas sectors, and for infrastructure projects. In particular, it is underwriting a project in the water sector, which is expected to be concluded in FY03. In addition to its guarantee activities for projects m China, MIGA will also cooperate in training and staff exchanges with "Sinosure," China's national export credit and investment insurance agency. Technical assistance provided by MIGA m investment marketmg services has gone to regional and provincial investment promotion entities, largely on an ad hoc basis. The Government is now considering establishing a national investment promotion organization, and if this should go forward MIGA stands ready to provide support to the new entity in defining and implementing an investment promotion strategy. J. MANAGING FORD EVELOPMENT RESULTS 103. China has always had strong ownership of its development strategy, and hence a keen interest in achieving tangible goals, tying instruments closely to their achievement, and maximizing results from irmplementing agreed measures. However, as the transition from central planning has evolved, the detailed quantitative targeting (tied mostly to physical achievement) contained in previous development plans has been largely abandoned. This can be seen, for instance, in the Tenth Five-Year Plan, which contains indicative targets with respect to broad outcomes (e.g, annual employment creation of 8 million, growth in per capita rural mcome of above 5 percent per year) and processes. Moreover, where new programs and processes are concerned, China has made good progress in absorbing practical and up-to-date knowledge, tracking information about what is happening on the ground in a timely manner, and building the capacity to evaluate various projects and programs. A good mdication of the progress already made in this regard is the way Chma has been able to identify development models that work, and then to scale them up to cover vast numbers of beneficiaries and geographical areas. 104. Over the years the Bank has been helping China devise development goals and monitor them. At the broadest level, a number of activities are clustered around assisting in the transition - 47 - from a Soviet-type statistical system to a modernized, internationally-harmonized system that is more m line with development planning and decision making in a market-based economy. Strengthened capacity for auditing and accounting, monitoring social disparity, social spending, rural poverty and pollution, and new capacity for tackling emerging development problems such as migration and urban poverty, corruption, natural resource degradation, services sector growth, and private sector development are some areas of continued engagement. As China's development agenda grows increasingly complex and the basic infrastructure of statistics for monitoring is built, the Bank is ready to assist the Government further. Specifically during the CAS period, the Bank will make particular efforts to assist the Government develop and track results-focused indicators in the following areas: * Macroeconomic. In addition to the standard indicators such as fiscal balances, external position and direct foreign investment, key indicators will be identified to monitor the reform process, especially modernized national accounts, risk indicators, and improved measures of public sector and inter-governmental fiscal performance. * Poverty/social. To track progress made in reducing poverty, including the effectiveness of the Government's programs in the poorer western provinces, the Bank will assist the Government in developing sub-national MDGs. Other relevant indicators to be developed for this purpose may include better measures of rural consumption and income, returns to land and labor, infant/maternal mortality, educational achievement (especially the mne years compulsory requirement), as well as more complex but key indicators such as quality of basic education, direction and nature of migration flows, and domestic PPP-adjusted measures of economic well-being. * Environmental. Measures will be designed to track changes in ambient environmental quality and the factors impinging on it. Specific ambient environmental quality parameters include air and water quality, surface and groundwater availability, land use patterns, forest cover, and status of the biotic environment. Factors impinging on ambient environmental quality include air and water pollutant discharges, net ground and surface water consumption rates, deforestation rates, desertification rates, and areas of land in nature reserves and other land protection classes. 105. The progress made through the Bank-China collaboration in the above areas will be shared with the Board through a CAS Progress Report, currently planned for Board presentation in early FY05, and will thus contribute to the effort of the development community as a whole to make headway in managing for results. James D. Wolfensohn President By. Shengman Zhang Pieter L. Woicke Washington, D.C. CAS Annex Al Page 1 of I China -Key Economic and Program Indicators - Change from Last CAS (as of November 15, 2002) Forecast in Last CAS Actual Current CAS Forecast Economy (CY) 1998 1999 2000 1998 1999 2000 2001 2002 a/ 2003 b/ 2004b/ 2005b/ Real growth rates (%) GDP 7.5 7.4 7.4 7.8 7 1 8 0 7.3 7.7 7 5 7.2 7.0 Exports (GNFS) 6.0 8.7 8.8 7.2 15.2 30.6 9.6 10.2 11 1 10.9 11.6 Imports (GNFS) 11.8 14.1 11.2 3.1 22.6 24.5 10.8 16.1 11.9 11.2 11.4 Inflation (%) -CPI 3.8 4.2 4.4 -0.8 -1 4 0 4 0.7 0.4 1.7 2.1 2.9 - GDP deflator -2.4 -2.2 0 9 0.0 1.0 1.5 2.0 2.5 National accounts (% GDP) Current account balance (BOP) 1 6 0 7 0.3 3 4 2.1 1.9 1 5 1 8 1.4 1.3 0 9 Gross investment 37 8 38.8 39.7 37 7 37.4 36.1 37 9 39.4 39.5 39.3 38 9 Public finance (% GDP) Fiscal balance -0 8 -0.5 -0.5 -3.0 -4 0 -3.6 -3 2 -3.2 -2 8 -2.5 -2 1 Foreign financing -0 2 -0 3 -0 3 0.0 0 0 0.0 0.0 0.4 0.4 0.4 0.3 International reserves 10 2 9 9 9.6 10 6 9.8 7.9 9.4 9 8 9.3 8.7 8 1 (as months of imports) Program (Bank's FY) FY98 FY99 FY00 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 Lending (S million) 2619 2270 2630 2616 2083 1673 787.5 563 1271 1229 1275 Gross disbursements 2250 2300 2350 2094 2026 1828 1820 2015 1570 1316 1140 ($ million) a/ Estimated year b/ Projected year CAS Annex A2 Page ] of 2 China at a glance 11/15/02 East Lower- POVERTY and SOCIAL Asia S middle- China Pacific Income Development diamond' 2001 Population, mid-year (millions) 1,271 9 1,826 2,164 Life GNI per capita (Atlas method, US$) 890 900 1,240 GNI (Atlas method, US$ billions) 1,129 3 1.649 2,677 Average annual growth, 1995-01 Population (%) 0 9 1 1 1 0 Labor torce (%) 1 0 1 3 1 2 GNI G r, Gross Most recent estimate (latest year avaliable, 1995-01) per primary Povertv (% of population below national poverty line) S Urban population (% of total population) 38 37 46 Life expectancy at birth (vears) 71 69 69 Infant mortality (per 1,000 live births) 32 36 33 Child malnutrition (% of children under 5) 10 12 11 Access to improved water source Access to an improved water source (% of population) 75 74 80 Illiteracy (% of population aCe 15+) 15 14 15 Gross primarv enrollment (% of school-aqe population) 107 107 107 China Male 106 106 107 - Lower-middle-income group Female 109 108 107 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1981 1991 2000 2001 Economic raUos' GDP (US$ billions) 228 3 4026 1,077 5 1,150 1 Gross domestic investment/GDP 32 5 34 8 36 1 37 9 Exports of qoods and services/GDP 8 6 19 4 25 9 25 8 Trade Gross domestic savinqs/GDP 32 9 38 1 38 8 40 3 Gross national savinqs/GDP 32 8 38 5 38 0 39 4 Current account balance/GDP 04 38 1 9 15 Domestic K. Interest payments/GDP 02 07 0 6 05 Investment Total debt/GDP 2 5 15 0 13 5 14 8 savings Total debt service/exports 6 9 101 9 3 7 9 Present value of debt/GDP 12 5 11 7 Present value of debt/exports 46 0 43 5 Indebtedness 1981-91 1991-01 2000 2001 2001-05 (averaqe annual qrowth) GDP 10 0 9 7 8 0 7 3 7 3 China GDP per capita 8 4 8 6 7 1 6 6 6 5 Lower-middle-income group Exports of qoods and services 12 1 17 0 30 6 9 6 11 0 STRUCTURE of the ECONOMY 1981 1991 2000 2001 GrowthofinvestmentandGDPI%) (% of GDP) Aqriculture 31 8 245 159 15 2 20T _ _ _ _ Industry 46 4 421 509 511 'St Manufacturinq 38 5 32 7 34 5 35 4 ~ s o z Services 21 8 334 332 336 ol Private consumption 52 6 488 482 46 0 96 97 9, 99 OD 51 General qovernment consumption 14 5 13 1 13 1 137 Imports of qoods and services 8 2 16 1 23 2 23 4 GDI 0 GOP 1981-91 1991-01 2000 2001 Growth of exports and imports (average annual growth) Aqriculture 52 40 2 4 28 Industry 114 12 6 9 6 87 30 , - Manufacturinq 11 1 11 6 9 1 90 20 - Services 12 6 87 7 8 7 4 10,- O Private consumption 90 80 8 7 64 General qovernment consumption 9 9 8 5 12 2 11 5 ss 97 9O 99 Os 1 Gross domestic investment 10 4 10 3 4 2 12 8 Exports o Imports tmports of qoods and services 9 6 14 8 24 5 10 8 Note 2001 data are preliminary estimates The diamonds show four kev indicators in the country (in bold) compared with its income-qroup averaqe If data are missinq, the diamond will be incomplete CAS Annex A2 Page 2 of 2 China PRICES and GOVERNMENT FINANCE 1981 1991 2000 2001 Inflation I%) Domestic prnces (% change) 20 Consumer prices 25 7 3 4 0 4 0 7 15 Implicit GDP deflator 2 3 6 7 009 000 11 Government finance s (% of GDP, includes current grants) Current revenue 24 2 16 9 15 3 17 2 -5 93 97 98 99 o0 01 Current budqet balance 2 3 0 6 1 0 -GDP deflator t Pi Overall surplus/deficit 0 8 -1 1 -3 6 -3 2 TRADE (US$ millions) 1981 1991 2000 2001 Export and import levels (US$ mill) Total exports (fob) 22,007 71,843 249,210 266,155 300,000 Food 2,924 7,226 12,282 12,780 250.000 Fuel 5,228 4,754 7,851 8,420 200.000 Manufactures 11,759 55,698 223,752 239,800 200..L. i Total imports (ctf) 22,015 63,791 225,097 243,610 150,000 trt E Eb11 1 Food 3,622 2,799 4,758 4,980 100,000 Fuel and energy 83 2,113 20,637 17,490 50 I U il Capital goods 5,866 19,601 91,934 107,040 Export pnce index (1995=100) 16 51 67 65 Import price index (1995=100) 13 49 75 73 0 Exports * Imports Terms of trade (1995=100) 118 103 90 90 BALANCE of PAYMENTS (US$ millions) 1981 1991 2000 2001 Current account balance to GDP (%) Exports of goods and services 24,410 78,909 279,561 299,410 5 Imports of goods and services 23,426 65,339 250,688 271,324 s Resource balance 984 13,570 28,873 28,086 4 Net income -124 840 -14,666 -19,173 3 _ Net current transfers 830 6,311 8,492 2 - Current account balance 860 15,240 20,519 17,405 1 l _ _ Financing items (net) 4,149 -9,971 29,920 o0 II | n __ Changes in net reserves -11,091 -10,548 -47,325 95 93 97 98 99 00 01 Memo: Reserves including gold (US$ millions) 48,154 171,753 219,970 Conversion rate (DEC, locallUS$) 2 1 54 83 83 EXTERNAL DEBT and RESOURCE FLOWS 1981 1991 2000 2001 (UJS$ millions) Composition of 2001 debt (US$ mill) Total debt outstanding and disbursed 5,798 60,259 145,706 170,137 IlRD 3,494 11,217 11,660A IDA 3,672 8,771 8,654 G 41,6800 8.654 Total debt service 1,744 8,305 27,092 24,297 / \D 6,476 IBRD 357 1,291 1,550 IDA 23 131 151 / f F~~~~ 8~~ 23,704 Composition of net resource flows Official qrants 19 406 147 2,5 Official creditors 506 2,044 1,497 2,156 Private creditors 2,493 -4,668 -4,017 Foreign direct investment 4,366 42,096 47,052 Portfolio equity 0 565 7,814 2,404 F 77,963 World Bank program Commitments 196 2,622 1,536 1,230 A - IBRO E- Bilateral Disbursements 0 1,280 1,907 1,791 B - iOA D - Other multilateral F - Pnvate Principal repayments 0 131 644 904 C - IMF G - Short-term Net flows 0 1,149 1,263 887 Interest payments 250 778 797 Net transfers 899 485 90 Development Economics 11/15/02 CAS Annex B I Page 1 of 5 Progress Made in Achieving Goals of Previous China Country Assistance Strategy (1997) Development Government Progress Benchmarks Achievements/Results Issues Outstanding Objectives Strategy/Actions l. Promote * Strengthen indirect * Expanded use of open * PBC increasingly engaged in open market operations for . Lack of progress in developing fixed- Growth with instruments to manage market operations adjustment of base money supply, with total transactions income instruments (corporate bonds mainly) Macro-economic aggregate demand reaching RMB 1 5 tnllion m 2001. Since June 2002, it has continues to distort the transmission Stability been issuing central bank notes for repo (repurchase option) mechanism for monetary policies Also, operations in lieu of fiscal instruments -about RMB 200 coordination between monetary and fiscal billion so far Despite continued interest rate regulation policies needs strengthening these actions are seen to affect interest rates on the interbank market and those for bill discounting Contmue structural * Increased revenue to * Revenue collections rose from 12 1 percent of GDP in * Medium-term fiscal sustainability needs to reforms of public GDP ratio by 2000 1997 to 17.2 percent in 2001, and are projected to rise to 18 be managed through improved revenue finance system * Improved percent in 2002 mobilization and consolidation of expenditure management of extra- * Extra-budgetary revenues of five govemment . Majonty of extra-budgetary revenues, and budgetary funds departments have been incorporated in the budget spending that results from them, still need to * More equitable * Total transfers to subnational govemments rose from 3 8 be brought under effective budget control intergovemmental fiscal percent of GDP in 1997 to 5.8 in 2001 Fixed subsidies and * Inter-governmental fiscal relationships still arrangements those for income equalization rose from 0 5 percent of GDP need restructurng to reduce vertical and established to 1 5 percent, and specific purpose transfers rose from 0 7 honzontal imbalances, and to address the percent to 2 percent of GDP A new sharing formula for national development agenda on growth and income (enterpnse and personal) taxes was introduced in poverty reduction more effectively The first 2002 It will provide additional transfers to poorer regions step is to take an integrated view of expendi- Moved responsibility for salary payments for teachers from ture and revenue assignments/transfers, rather township to county level to ensure adequate financing for than continue refomung each separately rural education * Lower tariffs and * Reduced tariffs and * The average import tariff rate fell from 17 percent in * China's WTO accession agreement non-tanffbamers barriers totrade 1997 to 12 percent. As a result ofjoining the WTO, they contains a radical set of trade and investment will fall to about 6 percent within five years Quotas, liberalization programs, by the end of the licenses and specific tendering requirements have been accession penod it will have one of the most partially or fully abolished on wool, cotton, acrylic fibers, open trading and investment regimes among polyester, fertilizer, automobile tires Foreign entry into the developing countries services sectois has been liberalized greatly * Continue structural * Credit plan for com- * Credit ceilings for state-owned commercial banks * Lending decisions sometimes influenced reforms of financial mercial banks abandoned in 1998 and replaced with indicative credit plans by policy pressures rather than commercial system eliminated . Greater margm of float around regulated interest rates criteria * Administered rates Financial institutions can charge 10% below and up to 30% . Rates insufficient to allow sustainable bank adjusted more often above regulated lending rates, with deposit rates unchanged lending to SMEs or to cover loan losses and * Increased tax- Experiment to further relax controls in rural area underway operational costs of rural finance deductibility of loan-loss * Along with new, risk-based loan classification methods, * Tax-deductibility insufficient incentive for provisioning banks allowed more autonomy m bad debt wnte-off and financial institutions to provison adequately loan loss provisioning, subject to discretionary tax Tax rules need to be made consistent with deduction loan classification methods CAS Annex B I Page 2 of 5 Development Government Progress Benchmarks Achievements/Results Issues Outstanding Objectives Strate2v/Actions * Continue structural * Progress in phasing * Some 20,000 SOEs went through bankruptcy procedure * Draft Bankruptcy Law could not be reforms of SOEs out commercially since 1997 Due to liquidation and closure, the number of reviewed and passed by the National People's unviable SOEs SOEs fell from 262,000 in 1997 to about 180,000 in 2001 Congress in 2002. * Takeover of SOEs by private firms now far more * Creditors' protection needs strengthening common Regulations on merger of SOEs with foreign companies/domestic private firms under review by State Council * Four AMCs set up to dispose of Y I.4 trillion in non- performing loans Increased * Corporatization with diversified equity structure now * Many SOEs slow to corporatize due to corporatization of SOEs accepted by govemment as basic approach for large SOE difficulties in attracting new investors to reform More large and medium SOEs corporatized in past diversify ownership structure five years Number of listed compames tncreased from 745 Corporatization, diversificationuandeP in 1997 to over 1,200 in 2002 had a vanable effect on SOE performance Improve legal . Progress in key . Central Banking Law and Banking Law (1995) * Bankruptcy Law modermization - revised framework and economic legislation, * Other laws Sole Enterprises (1999), Trust (2001), Small drafts discussed but not enacted, the main strengthen i e , laws for securities, and Medium Enterpnscs (2002) issue being relationship to social security implementation bankruptcy, banking and * Intellectual property laws and foreign trade laws revised reform central banking and for WTO * Company Law revisions - still pending company H. Alleviate * Improve legal and . Establish legal and * Smce 1997, regulations and implementation rules for . Electncity Law and related regulations Infrastructure regulatory frameworks regulatory framework power sector promulgated, and in 1998, the State Economic require revision appropriate to new industry Constraints appropriate for a based on Electncity Law and Trade Commission assigned responsibilities for sector and market structures A Gas Law needed to socialist market . Power industry regulation promote gas development economy restructuring plan * In 2002, decision made to establish separate State Power * Decision to establish SPRC only start of submitted to National Regulatory Commission (SPRC), which is now being long, intensive process to develop effective, People's Congress for created, and in early 2002, China's leaders appioved well functiorung institution approval comprehensive power sector restructuring plan * Govemrment's power sector reform plan * Railway Law revised . While no recent revision of Railway Law, smce 1999 provides vision for future, but detailed to separate state and Ministry of Railways has declared intent to undertake analysis and implementation rules still needed enterpnse functions market-based reform, which is slowly being elaborated and __________________ .________ _________ ___________ im plem ented Increase supply of * Expand power * Installed generation capacity increased from 260 GW in * Generation capacity is over-weighted environmentally generation capacity, 1997 to 338 GW in 2001 or an avcrage 19 5 GW a year towards base-load generation and there is a sustainable national roads, railways, * Since 1997, about 16,000 km of expressways added to lack of seasonal energy storage capacity in infrastructure mland waterways, and National Trunk Highway System, railways system expanded grids with a large proportion of hydropower water- sanitation by 4,500 km (8% increase) and inland waterways by 10,500 systems km (9 5%) High level of watcr supply service coverage in urban areas Significantly increased investments in sewerage and wastewater treatment systems CAS Annex B 1 Page 3 of 5 Development Government Progress Benchmarks Achievements/Results Issues Outstanding Objectives Strategy/Actions Introduce price * Average power tariffs * Average power prices now cover costs in most provinces, * No separate tanff for transmission and reforms and user fees approach LRMC, even higher than LRM C in coastal provinces distnbution Consumer tanff structures do not to provide particularly on coast Railway fares adjusted several times since 1997 and reflect the cost of supply infrastructure * Railway tariffs railways said to be operating at a profit Ministry of companies with adjusted to approach Railways now uses traffic management information system investment funds LRMC that allows more accurate LRMC calculation * Develop * Implementation of * Three pilot BOT projects procured through competitive . Pilot BOT projects had mixed results framework for private pilot BOT projects public bidding * Because 1995 BOT circular did not participation in . Issuance of BOT * While planned BOT decree and law not issued, BOT is address whole legal and regulatory infrastructure decrees not the only appropriate model for private participation in framework, it did not expand BOTs China, as shown by variety of models through which private * Govemment consensus not yet reached on investment channeled into infrastructure in China policy measures, legislative changes and regulatory provisions needed to foster and regulate pnvate participation in infrastructure Diversify intemal * Use of domestic * Government issued Y 488 billion in 2001, distributed * Lack of intermediaries and restrictive financing sources, capital markets 47% and 16% into mterbank and stock exchange market as institutional investor base, need for hedging using domestic capital promoted, especially book-entry bonds, and 37% to public as non-marketable instruments and better market & regulatory markets bond market savings certificates infrastructure, cumbersome issuance/listing * Govemment bond matunty profile extended to 30 years approval process in 2002. * Fragmented bond market, Govemment * Improved transparency of Govemment funding through, bonds pnced at "administered' yields, absence e g , appointment of pnmary dealers/underwnters, use of of Govemment T-bill program, inadequate master underwriting/repurchase agreements, quarterly credit culture to further develop corporate announcement of Govenmment funding schedule bond market * In equity market, Y 110 billion raised from 84 IPOs and * Equity market - overly speculatative, - 126 nghts issues The number of domestic listed companies dominated by SOEs, mnadequate corporate increased from 745 m 1997 to 1,160 in 2001 govem ance/transparency. Ill. Promote * Under national . Increased poverty * Funding for China's poverty reduction program increased Human poverty program, raise spending to RMB 15 to about RMB 30 billion by 2000 (end of 9th Plan Period) Development per capita income in billion in gth Plan period poor counties * Improve access of * Education access and retention improving, percent of * Maintain efforts to improve quality poor/minorities to cohort reaching grade 5 increased by about 6% to 94 5% in * Provincial education financing strategies basic education 2000 not yet developed * Raise education * National Education Curriculum revised for pnmary and quality. for lower secondary levels and being piloted Reform supports key elements to improve education quality * Studies have recommended provincial education financing systems and financing formulae/criteria CAS Annex B 1 Page 4 of 5 Development Government Progress Benchmarks Achievements/Results Issues Outstanding Objectives Strategy/Actions * Decentralize * Govemnment took initiatives providing health services to * Rural health finance system still to be education financing/ the poor, e g, national TB control program and targeted improved. administration and interventions to meet basic health needs of poor While reform rural health China still lacks a comprehensive national plan for rural finance system health services risk-sharing, initiatives have been taken up * Expand programs and are expanding for communicable and * Government has announced major health initiatives, non-communicable including Five-Year Plan for HIV/AIDS control and diseases mcreased emphases on childhood immunization and control of hepatitis B epidemic Efforts initiated to increase funds for preventive health activities under local budgets * Strengthen the . Pension system * Framework of new pension system introduced m 1997 . Pension coverage still limited and many social safety net by refonmed to reduce and national pilot begun in 2001 groups not covered, system still fragmented reforming social fragmentation, increase . Pension arrears reduced with strong fiscal support, and level of poolmg low insurance (pension, coverage, unify benefit pension coverage expanded beyond state sector, pension . Inadequate program monitoring, unemployment, etc) structure, and allow for benefit calculation method unified nationwide, differences in compliance rate low due to informal sector higher level pooling contribution rates narrowed * Benefit structure still overly genero us (esp . Long term financial * Pension payment responsibility for most pensioners retirement age), leading to heavy fiscal viability of pension being shifted from enterpnses to local social insurance burden; no funding strategy to transit to a system assured agencies partially funded scheme * Policy on safety net * Income -tested cash transfer program (minimum living * Financial mechanism for safety net needs developed, with high allowvance program) established for urban residents in 1999, improvement, strategy to provide cash percent of the poor 82% of estimated eligible urban poor now receive benefits. assistance to rural poor unclear receiving benefits * Special benefit program created m 1998 for SOE laid-off . Lack a transparent financing arrangement * Employment support workers Unemployment insurance (UI) policies refined and of Ul program, Ul coverage needs to be mechanism developed, key regulation issued in 1999 Social benefit program being expanded to cover a wider group of employed unemployed get financial phased out and Ul to become pnmary benefit program for workers support/ employment the unemployed In some municipalities, this transition services completed IV. Promote * Protect agricultural * Increased number of * Provinces in process of finalizing coastal zone Agricultural land provinces with coastal management plans in accordance with "Law of Marine Development and . Upgrade marginal zone management Resource Use of the People's Republic of China" passed by the Rural land and water * Increased forest Government in January 2002 Economy resources cover * Bank-assisted forest development projects established about 1 02 million ha of forest plantations, increasing forest cover by about 0 1% of China's land area CAS Annex B I Page 5 of 5 Development Government Progress Benchmarks Achievements/Results Issues Outstanding Objectives Strategy/Actions . Invest in water * Acreage imgated . Total imgated area increased by 2 million under Bank- transfer, storage and supported projects alone imgation . Improve efficiency * Reduced marketing * Although all grain has traditionally been marketed * Continue liberalizing grain trade of grain distnbution margm and increased through government channels, since August 2001 eight proportion of grain sales provinces have more or less fully liberalized grain trade at market prices V. Safeguard the * Prevent and control . Reduced deterioration . Significant investments in sewerage and wastewater . Within data limitations, air and water Environment industrial pollution rate in water and air treatment in major urban areas, followed by ambitious pollution measurements suggest declines in pollution national targets set (60% to be treated m all cities by 2010, latter quarter of 1990s but levels still high and m all provincial capitals by 2005) . Complete national * Good progress being made China adopted Euro I auto . Implementation of regulations needs to be vehicle pollution emission standards for new cars/trucks in 2000 and proposes strengthened control action plan to introduce Euro 2 in 2004 (2003 in Beijing) China has also phased out use of unleaded gasoline * Expand * Progress continues to be made, with about 150 laws, environmental legal regulations and other environmental regulatory documents system issued by National People's Congress, State Council or Minister for Environment * Improve use of . Increased excise tax . Pollution levies being increased progressively. . Pollution levies insufficiently punitive economic incentives on major pollutants and . Some progress made on user charges for environmental (effluent fees/fines) increased collection rate services (e g, wastewater collection, solid waste and environmental for pollution levies management), particularly in larger cities taxes * Improved level and structure of user charges for environmental services * In rural areas, * Government continues to invest heavily in "ecological governmentpolicies an construction," i e, afforestration, reforestation and investments in watershed protection soil/water/forestry, expansion of protected areas CAS Annex B2 Page 1 of I China: Selected Indicators* of Bank Portfolio Performance and Management As of 11/12/2002 Indicator 2000 2001 2002 2003 Portfolio Assessment Number of Projects Under Implementation a 114 108 101 101 Average Implementation Period (years) b 3.8 4.4 4 9 5.0 Percent of Problem Projects by Number a, c 2 6 4.6 5.0 5 0 Percent of Problem Projects by Amount a, c 1.4 5 5 2 5 2 5 Percent of Projects at Risk by Number a, d 2.6 4.6 5.0 5 0 Percent of Projects at Risk by Amount a, d 1.4 5.5 2.5 2 5 Disbursement Ratio (%) e 17 4 18 5 23 5 9 0 Memorandum Item Since FY 80 Last Five FYs Proj Eval by OED by Number 140 40 Proj Eval by OED by Amt (US$ millions) 18,041 4 6,652 1 % of OED Projects Rated U or HU by Number 8.7 7.5 % of OED Projects Rated U or HU by Amt 8.0 6.5 a As shown in the Annual Report on Portfolio Performance (except for current FY) b Average age of projects in the Bank's country portfolio c Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP) d As defined under the Portfolio Improvement Program. e Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the beginning of the year Investment projects only * All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio, which includes all active projects as well as projects which exited during the fiscal year CAS Annex B3 Page 1 of 2 China: FY03-05 Operational Lending Program (Includes Standby Projects) FY03 FY04 FY05 Project Name Loan Amount Project Name Loan Amount Project Name Loan Amount (US$ Million) (US$ Million) (US$ Million) Tianjin 11 Urban Development 150 Zhejiang Urban Development 140 Chongqing Small Cities Urbanization 150 and Environment Shanghai Urban Management APL 200 Hunan City/Regional Development 150 Shanghai Urban Management APL 200 (Stage I) (Stage II) Liaoning Urban Development 110 Lake Tai Water Quality 110 Henan Medium-Sized Cities 150 Jiangxi Integrated Agricultural 100 Poor Rural Communities 100 Liuzhou (Guangxi) Environment 100 Development Development Gansu and Xinjiang Pastoral 66 Agricultural Technology 100 Upper Yangtze Watershed 100 Development Rehabilitation Third Xinjiang Highway 150 Inner Mongolia Highway 11 100 Heilongjiang Dairy Development 100 Hubei Highway 250 Inland Waterways IV 95 Fuzhou Urban Transport 100 Yi-Xing Pumped Storage 145 National Railway II 200 Henan Highway IV 175 Basic Education in Westem Areas 100 Wuhan Urban Transport 200 Hubei Highway II 200 Economic Reform Implementation 30 Distance Leaming/Knowledge 4 Dissemination Subtotal 1,271 Subtotal 1,229 Subtotal 1,275 Stanidbys Sta ndbys Standbys Second Anhui Highway 250 Guangdong-Pearl River Delta 150 Sichuan Urban Environment 11 or 100 Environment Ningbo Water Management Acquaculture 10 Shaanxi Highway III 200 Rural Village/Cities Water Supply & 50 Sanitation Taiyuan Integrated Urban 150 Development Education or Health Project 75 Irrigated Agriculture Intensification III 200 Total 1,531 Total 1,579 Total 1,850 Notes I This table presents the operational lending program agreed by the Govemment and the Bank for the next three years Since the table includes stand-by projects (which should be ready for possible Board presentation in the year specified if other operations slip) and, in the outer year, tentative projects still being identified, actual lending each year is expected to be less than the total shown The actual lending volume is also subject to penodic reviews for management of IBRD exposure Lending amounts for individual projects are also provisional, subject to developments in project preparation and consultations with the Govemment The lending program will be updated annually in consultation with the Govemment 2 A GEF program complementing World Bank lending is expected to comprise FY03 - Grassland Management (US$1 I m), Energy Conservation (US$26 m), FY04 - Hai Basin (US$17 m), Renewable Energy (US$50 m), Integrated Coal Gasification Combined Cycle (USSI5 m), and FY05 - Heating Reform and Building Energy Efficiency (US$18 m) CAS Annex B3 Page 2 of 2 CHINA: Special Features of Selected Operations, FY03-04 /a Project Name Special Feature Rural Development Jiangxi Integrated Agricultural Design features fully vertically integrated agricultural development Also a high level of participation and Modermization strengthening of farmers' institutions Gansu & Xinjiang Pastoral Development Exclusive focus on improving degraded pasture lands. Poor Rural Communities Development State-of-the-art poverty targeting, including of disadvantaged minority peoples Transport Third Xinjiang Highways Promotes trade by improving last section of road linking Kazakhstan border and a coastal China port Hubei Hilghway Improves accessibility to low-income areas, increases commercialization and contracting out of maintenance Wuhan Urban Transport Develops institutions to regulate competitive transport services and reduce pollution. Strengthens institutions to pa,mnge and finance urban transport Third Shaanxi Highway Improves access in poor areas of Shaanxi, promotes trade between western region - Qinghai, Gansu, Ningxia and Inner Mongolia - and eastern metropolitan areas Fourth Inland Waterways Completes Pearl River Waterway Development to improve access to isolated regions - Guangxi, Guizhou, and Yunnan - and to low-income areas - Guangdong Further commercializes waterway agencies and promotes intermodalism and containerization Second Inner Mongolia Highways Supports China, Russia and Mongolia trade by building highway from Manzhouli, largest international land port between China and Russia, to Hailar, major city in northern Inner Mongolia Corridor connects to Harbin port and on to Vladivostok Urban Development Tianjin Urban Development and Water pollution control in river basin and international sea, with GEF funding First Bank-assisted project in Environment 11 China with significant water reuse and pern-urban development work Zhejiang Urban Environment 11 Includes integrated infrastructure upgrading in famous medium-size ancient city and smaller canal town (cultural _ hertage preservation) Guangdong - Pearl River Delta Regional environmental management with strong linkages to iHong Kong within regional economic development Environment plan Advanced PPI in broad-based environmental improvements Energy Development Yixing Pumped Storage First Bank project in China to support implementation of a wholesale power market and the direct access to the generators by big consumers Human Development Basic Education in Westem Areas With DFID's support, scales up in poorest townships of five western provinces the Government's new quality focused child-centered cumculum /a Excludes projects mentioned in Box 5 2 in text Examples of Support for Innovation and Change in Recent and Future Projects CAS Annex B4 Page 1 of 4 China - The Knowledge Agenda, FY03-05 CAS Themes AAA Core Written Outputs Technical Assistancea Researchb" Sub-Themes (D-Diagnostic; A-Advisory) 1. Business Economic FY03 FY03 FY03 environment and Monitonng * CEM Shanng Opportunities and Wealth * WBI-WTO Issues for China * WTO Accession, Policy market economy at the Time of Globalization (D) * Improved Monitonng Indicators for Social Reform and Poverty Reduction * Economic/Social Monitonng Bnefs (D) Spending A Macroeconomic * WTO Accession Impacts Growth, management Poverty, Trade, Investment, Regional B. Post-WTO Cooperation (A) global integration FY04 FY04 C Financial sector * Public Expenditure Review/CFAA (D) * Enhancing Government Audit Capacity D PSD and * Economic/Social Monitonng Bnefs (D) enterpnse reform FY05 E Pubmc sector * Development Policy Review (D) management and * Economic/Social Monitonng Bnefs (D) service delivery Economic FY03 FY03 Management * Reform of Public Service Units (A) * SDPC Policy Modeling * Country Procurement Assessment Report * Building Government Debt Management Follow-Up (A) Capacity * Procurement Post-Review (A) * GDLN Devt for Knowledge Management . WBI-lntergovemmental Relations and Local Government Management of Finance FY04 FY04 * Evaluation and Management of Domestic * Statistical Capacity Building Debt Risks (A) * Decentralization (Regional Project) * Subnational Fiscal Issues in Westem Provinces (A) FY05 * Knowledge Management Piloting Fiscal Reforms in Western Provinces Financial Sector FY03 FY03 Development . Policy Note on Domestic Finance for * Finance for Small Firms Infrastructure (A) * APEC Forum TA * Policy Note on State Commercial Bank . WBI-Non-bank Financial Institutions Restructunng (A) . WBI/DLFrontiers of Infrastructure Finance * Policy Note on Development of * Development of Deposit Insurance System Institutional Investors (A) * Bad Dept Resolution for Banks * IFC Capacity Building in Secunties Industry a/ Covers self-standing TA, other capacity-building, and WBI activity, including distance learning (WBIUDL) b/ Covers research programs being camed out by the Bank Group's Development Economics (DEC) staff CAS Annex B4 Page 2 of 4 CAS Themes AAA Core Written Outputs Technical Assistance Research Sub -Themes (D-Diagnostic; A-Advisory) FY04 FY04 Strategic Framework for Financial . Govemment Secunties Market Reform Conglomerates (A) Markets and FY03 FY03 FY03 Enterpnses * Corporate Govemance of Enterpnse . Power Generation Divestiture, Regulation . Industnal Competitiveness, Groups (A) and Pricing the Investment Climate and . Gas Development (A) * Oil and Gas Sector Regulation Development of SMEs . Energy Sector Policy Notes (A) * State Enterprise Debt Restructunng and Loan . Judicial/Legal Reform (A) Workouts * IFC/WB Transformation of Small and * WBI/DL-Corporate Govemance/Strategy Medium Sized SOEs (A) * WBI-Accession to WTO Issues * Improving the Investment Climate * IFC Corporate Govemance-Training for (WB/IFC/CPDF/FIAS) Company Directors . Improving the Business Environment in the Intenor (WB/CPDF/IFC/FIAS) Govemance FY04 * Legislative Drafting, Court System Reform and Judicial Training 2. Disadvuantaged Revitalizing FY03 FY03 FY03 people and lagging Lagging * Trade, Transport Services and Logistics . Post-WTO Reform of Ministry of Agnculture * Lagging Poor Areas regions Economies (A) . WBI-Rural Poverty Reduction in Westem Breaking Geographic Poverty * PSD Strategy in Lagging Regions (A) China Traps A Employment . WBI/DL-Ecological Agnculture and * Uninsured Risk and and productivity FY04 Sustainable Development Poverty B Transport * Skills Development for Competitiveness * WBI/DL-Agncultural Production, Rural . Causes for Changes in C Human (A) Growth and the Environment Income Distnbution resources . WBI-Sustainable Livestock Management & * Poverty Monitoring and development Pastoral Development Evaluation D Social * WBI-Rural Devt training of trainers * Land Tcnure Impacts on Protection * WBI-Decentralization Farm Investment and E Targeted * Development/Improvement of Land Tenure Productivity poverty reduction Reforms programs ~frn * New Model for Rural Development Poverty Reduction and Environmental Protection * Lagging Regions Development Plan * Strengthening Management of Poverty Reduction Funds CAS Annex B4 Page 3 of 4 CAS Themes AAA Core Written Outputs Technical Assistance Research Sub-Themes (D-Diagnostic; A-Advisory) FY04 * Strengthening Farmer's Associations in Sichuan Province (A) * Removing Inter-Provincial Trade Bamers to Achieve Market Integration (A) Human/Social FY03 FY03 Development * Improving Financing for Effective * Social Assessment Manual Delivery of Basic Social Services (A) * Mainstreaming Gender * Monitonng and Evaluation for Better * Improving Health Care Access of Rural Poor Social Service Delivery Outcomes (A) * Capacity Building for Urban Medical Insurance Reform * WBI-Poverty Identification, Policies, and Evaluation * WBI-Health Sector Financing and Reform * WBI-SPS on Rural Health Training of Local Health Bureau Directors FY04 FY04 . Country Gender Assessment (D) * Poverty Mapping * Empowenng Poor Women in Westem Areas * Managing Health Sector Adjustment FY05 * Poverty Assessment (D) 3. Sustainable Environmental FY03 FY03 FY03 development Management * Policy Note on Environmental * New Cost Model for Environment * Industnal Pollution Control Administration (A) * CCICED Forestry and Grasslands Task Force A Environmental * Environmental Protection-Post WTO (A) * Reducing Persistent Organic Pollutants institutions . WBI-Environmental Economics and Policy B Air quality . WBI/DL-Urban Air Quality Management C Managing * WBI-Urban Project Analysis/Management water resources * Sustainable Development of Livestock and D Land and Grasslands in the Northwest Provinces natural resources FY04 FY04 E Global environmental * Strategic Environment Assessment (D) * Energy Efficiency in Buildings commons * Clean Development Mechanism * Industnal Pollution Prevention * WBI-Environmental Directors Training . WBI-Environmental Compliance/Enforcement CAS Annex B4 Page 4 of 4 CAS Themes AAA Core Written Outputs Technical Assistance Research Sub-Themes (D-Diagnostic; A-Advisory) Infrastructure and FY03 FY03 FY03 Urban * Urban Restructunng Policy Note (A) * WBI/DLSustainable Urban Development and * WBI-Regulatory Reforn In Development * Housing Maintenance/Operations Policy Management China's Infrastructure Sectors Note (A) * WBI/DLTransparency in Infrastructure (research and dissemination * Urban Transport Policy Note (A) Concession activities) * Consolidating Commercialized Toll Roads Policy Note (A) * Road Traffic Safety Agenda Note (A) FY04 * City Development Strategy CAS Annex B5 Page I of I China Social Indicators Latest single year Same region/income group East Lower- Asia & middle- 1970-75 1980-85 1994-00 Pacific Income POPULATION Total population, mid-year (millions) 9164 1,051 0 1,262 5 1,855 2 2,047 6 Growth rate (% annual average for penod) 2 3 1 4 1 0 1 1 1 1 Urban population (% of population) 17 3 22 6 32 1 35 2 42 0 Total fertility rate (births per woman) 34 24 1 9 2 1 2 1 POVERTY (% of population) National headcount index 4 6 Urban headcount index <2 Rural headcount index 46 INCOME GNI per capita (US$) 200 280 840 1,060 1,130 Consumer pnce index (1995=100) 109 135 146 Food price index (1 995=100) INCOME/CONSUMPTION DISTRIBUTION Gini index 40 3 Lowest quintile (% of income or consumption) 59 Highest quintile (% of income or consumption) 46 6 SOCIAL INDICATORS Public expenditure Health (% of GDP) 21 20 2 3 Education (% of GDP) 17 25 23 29 46 Social secunty and welfare (% of GDP) Net primary school enrollment rate (% of age group) Total 91 91 91 Male 90 91 91 Female 92 91 91 Access to an Improved water source (% of population) Total 75 75 80 Urban 94 93 95 Rural 66 66 69 Immunization rate (% under 12 months) Measles 88 90 85 89 DPT 78 90 85 89 Child malnutntion (% under 5 years) 10 10 11 Life expectancy at birth (years) Total 65 68 70 69 69 Male 64 67 69 67 67 Female 66 70 72 71 72 Mortality Infant (per 1,000 live births) 48 37 32 35 33 Under 5 (per 1,000 live births) 120 65 39 45 41 Adult (15-59) Male (per 1,000 population) 249 185 161 183 192 Female (per 1,000 population) 180 148 115 132 125 Maternal (per 100,000 live births) 60 Births attended by skilled health staff (%) 85 Note 0 or 0 0 means zero or less than half the unit shown Net enrollment ratios exceeding 100 indicate discrepancies between the estimates of school-age population and reported enrollment data 2002 World Development Indicators CD-ROM, World Bank CAS Annex B6 Page I of 2 China - Key Economic Indicators Actual Estimated Projection Indicator 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 National accounts (as % of GDP) Gross domestic producta 100 100 100 100 100 100 100 100 100 101 Agnculture 20 19 19 18 16 15 15 14 13 13 Industry 50 50 49 49 51 51 51 50 50 49 Services 30 31 32 33 33 34 35 36 37 38 Total Consumption 58 57 58 59 61 60 59 60 60 61 Gross domestic fixed investment 34 34 35 36 36 38 38 39 37 36 Govemment investment 2 2 3 3 4 4 2 2 2 2 Pnvate investment 32 32 33 32 32 34 36 37 35 34 Exports (GNFS)b 21 23 22 22 26 26 27 29 30 32 Imports (GNFS) 19 18 17 19 23 23 26 28 30 31 Gross domestic savings 42 43 42 41 39 40 41 40 40 39 Gross national savings' 40 42 41 40 38 39 41 41 41 40 Memoranduoi iteois Gross domestic product 816490 898244 946301 991356 1079961 1159031 1260763 1375650 1504191 1649721 (US$ million at current pnces) GNP per capita (US$, Atlas method) 620 710 740 780 840 890 940 1000 1060 1120 Real annual growth rates (%, projections calculated froii 2001 pnces) Gross domestic product at markct prices 9 6 8 8 7 8 7 1 8 0 7 3 7 7 7 5 7 2 7 0 Gross Domestic Income 9 8 9 3 6 9 6 3 4 8 7 2 7 9 6 8 6 7 6 2 Real annual per capita growth rates (%, projections calculated from 2001 prices) Gross domestic product at market prices 8 5 7 7 6 8 6 2 7 1 6 6 6 9 6 7 6 4 6 3 Total consumption 9 1 5 5 6 4 8 4 5 2 6 5 6 7 7 2 7 2 7 1 Pnvateconsumption 11 1 5 2 5 8 8 0 3 7 5 4 4 0 5 9 6 7 7 0 Balance of Payments (US$ millions) Exports (GNFS)b 171678 207239 207425 220964 279561 299410 342241 395455 453952 520100 Merchandise FOB 151077 182670 183529 194716 249131 266075 303439 350064 400824 457340 Imports (GNFS)b 154127 164416 163589 190323 250688 271324 324059 383131 444728 515068 Merchandise FOB 131542 136448 136916 158735 214657 232058 277053 328366 381468 442906 Resource balance 17551 42823 43836 30641 28873 28086 18182 12324 9224 5032 Netcurrenttransfcrs 2129 5143 4278 4943 6311 8492 8662 8835 9012 9192 Current account balance 7243 36962 31471 21114 20519 17405 22583 19493 19301 14403 Net pnvate foreign direct investment 38066 41674 41118 36978 37483 37356 45000 45000 50000 55000 Long-temi loans (net) 1744 5381 -8822 -16713 -8237 -7868 -10000 -12000 -11000 -10000 Official 4401 4315 2288 3387 1496 2156 997 1509 1943 2420 Private -2657 1066 -11110 -20100 -9733 -10024 -10997 -13509 -12943 -12420 Other capital (net,incl errors &oninssions) -15391 -48293 -57341 -32875 -392 18 432 -8890 -20300 -3 1200 -35000 Change in reservesd -31662 -35724 -6426 -8505 -10548 -47325 -48693 -32193 -27101 -24403 Memloranduoi ilents Resource balance (% ofGDP) 2 1 4 8 4 6 3 1 2 7 2 4 1 4 0 9 0 6 0 3 Real annual growth rates ( YR90 prices) Merchandiseexports (FOB) 246 232 77 146 31 9 93 95 105 104 11 1 Primary 257 101 -68 56 320 60 40 56 46 45 Manufactures 245 253 100 159 320 97 96 105 104 112 Merchandiseimports(CIF) 307 68 2 1 245 284 108 160 11 6 109 11 3 CAS Annex B6 Page 2 of 2 China - Key Economic Indicators Actual Estimated Projection Indicator 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Public finance (as % of GDP at market prices)' Currentrevenues 113 120 130 150 153 172 175 185 190 196 Current expenditures 10 6 11 5 12 6 13 7 147 16 3 17 5 18 3 18 7 19 0 Current account surplus (+) or deficit (-) 0 7 0 5 0 4 13 0 6 1 0 0 0 0 2 0 3 0 6 Capital expenditure 2 3 2 4 3 5 4 6 4 2 4 1 3 3 3 1 2 8 2 7 Foreign financing 0 4 0 4 0 4 0 3 Monetary indicators M2/GDP 112 1 122 2 133 4 146 1 150 6 165 0 170 0 179 2 186 9 194 4 GrowthofM2 (%) 25 3 196 14 8 14 7 12 3 17 6 12 0 15 0 14 1 14 1 Private sector credit growth / 66 0 685 730 total credit growth (%) Price indices( YR90 =100) Merchandiseexportppnceindex 1777 1745 1630 1507 146 1 1427 1485 1550 1608 165 1 Merchandise import pnce indcx 182 7 175 4 169 2 160 6 169 9 166 0 162 8 172 9 181 2 189 0 Merchandise terms of trade index 97 3 99 5 96 3 93 9 86 0 86 0 91 3 89 7 88 7 87 3 Real exchange rate (US$/LCU)r 107 4 112 2 112 4 106 9 107 7 110 5 Real interest rates Consumer pnce index (% change) 8 3 2 8 -0 8 -1 4 0 4 0 7 0 4 1 7 2 1 2 9 GDP deflator (% changc) 5 9 0 8 -2 4 -2 2 0 9 0 0 1 0 1 5 2 0 2 5 a GDP at market prices b "GNFS" denotes "goods and nonfactor services c Includes net unrequited transfers excluding official capital grants d Includes use of IMF resources e Consolidated central govemnment f "LCU" denotes "local currency units " An increase in US$/LCU denotes appreciation CAS Annex B7 Page I of I China - Key Exposure Indicators Actual Estimate Projection Indicator 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Total debt outstanding and 128817 146697 144007 152086 145706 170137 182596 195032 210665 212336 disbursed (TDO) (US$m)' Net disbursements (US$m)' 13936 18506 -14185 -1611 -5272 -33 -4660 -4620 -4200 -3992 Total debt service (TDS) 15756 18445 18435 26862 27092 24298 28227 29522 30292 31379 (US$m)' Debt and debt service indicators (%) TDO/XGSb 68 8 67 6 66 3 49 8 55 0 52 7 48 4 45 3 39 9 TDO/GDP 158 163 152 153 13.5 147 145 142 140 129 TDS/XGS 87 87 117 93 79 82 73 65 59 Concessional/TDO 145 123 186 195 212 180 163 148 13 1 125 IBRD exposure indicators (%) IBRDDS/publicDS 56 51 74 77 87 121 136 87 75 73 Preferred creditor DS/public 7.4 76 109 11 2 196 233 176 182 189 187 DS (%)C IBRDDS/XGS . 04 04 05 04 05 06 03 03 02 IBRDTDO(US$m)d 7616 8239 9644 10400 11217 11660 11973 12564 13033 13379 Of which present value of guarantees (US$m) 99 1 110 2 122 119 2 110 8 97 6 Share of IBRD portfolio (%) . 92 9 6 98 10 2 10 7 11 1 IDA TDO (US$m)' 7579 7830 8693 8907 8771 8654 8560 8455 8320 8120 IFC (USSm) Loans 67 122 161 210 186 177 215 na na n a Equity and quasi-equityc 30 48 43 48 88 110 157 n a n a. n a MIGA MlGAguarantees(US$m)f 112 99 131 133 121 113 87 na na n.a a Includes public and publicly guaranteed debt, pnvate nonguaranteed, use of IMF credits and net short- tenm capital b "XGS" denotes exports of goods and services, including workers' remittances c Preferred creditors are defined as IBRD, IDA, the regional multilateral developmenit banks, the IMF, and the Bank for International Settlements d includes present value of guarantees e Includes equity and quasi-equity types of both loan and equity instrumenits f MIGA's outstanding gross exposure, as of end FY CAS Annex B8 Page 1 of 3 Medium-term IBRD Exposure Projections The rapid rise in IBRD exposure to China during the 1990s and the risk that exposure would exceed IBRD's single borrower limit of US$13.5 billion prompted management and the Chinese authorities to implement in 2000 a periodic monitoring system with reports to the Board, and then recently to agree on a draft framework for achieving flexibility in the lending program while respecting effectively the concentration limit. The framework is designed to protect IBRD against either cashflow interest losses or principal losses on exposure above the concentration limit in the unlikely event that China was to go into non-accrual. Implementation of the framework, however, requires careful projections of IBRD exposure. These projections are sensitive to not only the lending program itself but also cancellations of undisbursed balances of already approved loans where these are no longer needed for projects, and prepayment of outstanding loans, where the borrower wishes. In addition, exposure in future years will vary with the pace of disbursements, e.g., faster disbursements of the pipeline of loans will increase exposure more quickly while slower disbursements will result in a less rapid rise in exposure. Exposure in US$ terms, in which the concentration limit is denominated, will also vary with exchange rate valuation effects, e.g., depreciation of the dollar will increase the dollar value of the 20 percent of China's loans in other currencies while appreciation of the dollar will reduce the value of exposure in dollar terms. Chart 1: IBRD Projected Exposure to China - US$1,000m Lcnding per Year With 10% US$ depreciation and disbursements 10% above plus 10% US$ appreciation and disbursements 10% below 160- 15 5 - 15 0 - 14 5- 140 135 13 0- - - -Concentrato-0- 0li Bas Cae-~ ( - DSBlw5 p+ I boe$Dw 11 5- 10 10 5 10 0 FYO0I FY03 FY05 FY07 FY09 FYI1I FY13 FY15 FY17 FY 19 -- - Concentration Limit ~~Base Case --) --DI S Below S Up --*DIS A:bove $ Down In order to assess the likelihood that lending within the range envisaged in the CAS might result in IBRD exposure exceeding the concentration limit, and hence require remedial actions by China before new loans above the concentration limit can become effective, exposure projections have been prepared on different assumptions. Chart I shows exposure projections in CAS Annex B8 Page 2 of 3 the medium-term on the assumption that lending is at the lower end of the CAS range, i.e US$1 billion a year not only during the CAS period FY03-05 but also beyond. On the base case assumption of a normal rate of disbursements in line with past long-run trends, similar cancellations to the current year and that exchange rates would be unchanged from their end- FY02 levels, exposure would be projected to peak slightly below the concentration limit m FY06 and peak at around US$13.6 billion in FY07, which would require China to take modest corrective measures. Chart 1 also shows the range of outcomes for exposure if disbursements and exchange rates varied. If disbursements were 10 percent faster than normal and the dollar depreciated by 10 percent a year during the CAS period and then remained constant, exposure might exceed the limit in FY04 and peak at more than US$14 billion in FY07, requiring more substantial corrective measures by China before such a lending program could be sustained. If disbursements were 10 percent slower and the dollar appreciated by 10 percent a year, however, exposure would peak at less than US$13 billion, i.e. within the concentration limit and the lending program could go ahead without measures by China. The range of outcomes demonstrates the uncertainties about future exposure levels. Chart 2: IBRD Projected Exposure to China - US$1,500m Lending per Year With 10% US$ depreciation and disbursements 10% above plus 10% US$ appreciation and disbursements 10% below 160 15 5- 15 0- 14 5 140 135 13 0 - 120 - 11 5- 11 0 10 5- 10 0 . . . . FY01 FY03 FY05 FY07 FY09 FY11 FY13 FY15 FY17 FY19 - Concentration Limit Base Case - - - DIS Below S Up + DIS Above $ Down Chart 2 shows the same sensitivity analysis for lending of US$1.5 billion a year during both the CAS penod and beyond. In the base case, exposure would exceed the concentration limit in FY06 and would then peak at slightly less than US$15 billion in FY11. If disbursements were faster and the dollar depreciated, then exposure might exceed the concentration limit as early as FY04 and peak at around US$15.3 billion in FY10. Conversely, if disbursements were slower and the dollar appreciated, exposure might peak at around US$14.6 billion, rather later, in CAS Annex B8 Page 3 of 3 FY12. In all these cases, substantial remedial measures would need to be taken by China to allow the lending program to go ahead. These projections show the sensitivity of exposure to alternative assumptions. They also show a wide range of possible outcomes. Different disbursement and exchange rate assumptions might, in turn, offset each other leading to outcomes within these relatively wide ranges. Management, therefore, intends to monitor actual and projected exposure carefully at the annual reviews within the framework agreed with China, and to inform the Board of the lending program which can be accommodated each year in light of measures taken by China, where necessary, to protect IBRD against cashflow or principal losses on exposure above the concentration limit in the event that China was to go into non-accrual. CAS Annex B9 (a) Page I of 3 China: Operations Portfolio (IBRD/IDA and Grants) (as of October 31, 2002) Closed Projects 145 lBRD/IDA - Total Disbursed (Acbre) 8,775 78 of which has been repaid 387 83 Total Disbursed (Closed) 18,887 06 of which has been repaid 5,942 82 Total Disbursed (Active I Closed) 27,662 84 of which has been repaid 6.330 64 Total Undisbursed (Active) 6,481 94 Total Undisbursed (Closed) 0 95 Total Undisbursed (Active + Closed) 6,482 89 Active Projects Difference Between Last PSR Expected and Actual Supervision Rating Original Amount in US$ Millions Disbursements' Project ID Project Name Development Implementation Fiscal Year IBRD IDA GRANT Cancel Undisb Ong Frm Revd Obtectives Progress P040513 2nd Henan Prov Hwy S S 1996 210 60 63 60 6 5 64 P003619 2nd Inland Waterways S S 1998 123 74 21 60 2 P058844 3rd Henan Prov Hwy S S 2000 150 11833 233 P051856 ACCOUNTING REFORM & DEVELOPMENT S S 1999 27 4 5 61 21 16 20 7 P049665 ANNING VALLEY AG DEV S S 1999 90 30 4977 114 P050036 Anhul Provincial Hwy S S 1999 200 84 77 22 6 P042109 CH-BEIJING ENVIRONMENT II S S 2000 349 32877 1167 P036952 CN-BASIC ED IV S S 1997 85 1 86 4 7 P003566 CN-BASIC HEALTH (HLTH8) S S 1998 85 3794 20 2 P003646 CN-CHONGQING IND POL CT S S 1996 170 164 8 2 72 167 5 2 72 P049436 CN-CHONGQING URBAN ENVIRONMENT S S 2000 200 188 33 27 2 P003589 CN-DISEASE PREVENTION (HLTH7) S S 1996 100 15 31 25 4 P003603 CN-ENTERPRISEHOUSING&SOCSECREF S S 1995 275 75 20 10028 1188 6573 P060270 CN-ENTERPRISE REFORM LN U U 1999 5 347 53 118 P003632 CN-ENVIRONMENT TECH ASS S S 1993 50 249 32 2 86 P036414 CN-GUANGXI URBAN ENVIRONMENT S S 1998 72 20 7815 517 1 79 P036953 CN-HEALTH IX S S 1999 10 50 41 85 117 P045910 CN-HEBEI URBAN ENVIRONMENT S S 2000 150 140 03 28 3 P046051 CN-HIGHER EDUC REFORM S S 1999 20 50 3111 294 P047345 CN-HUAI RIVER POLLUTION CONTROL S S 2001 105 5 102 05 -3 5 P003602 CN-HUBEI URBAN ENVIRONMENT S S 1996 125 25 283 48 31 78 8 37 61 P034618 CN-LABOR MARKET DEV S S 1996 10 20 5 54 78 P051859 CN-LIAO RIVER BASIN S S 2001 100 87 60 3 P003598 CN-LIAONING ENVIRONMENT S S 1995 110 1225 123 818 P003637 CN-NAT'L RURAL WATER 3 S S 1997 70 965 10 8 84 P058308 CN-PENSION REFORM PJT S S 1999 5 2 53 2 7 P057352 CN-RURAL WATER IV S S 1999 16 30 31 04 14 2 -2 38 P040185 CN-SHANDONG ENVIRONMENT S U 1998 95 29 69 24 1 P003586 CN-SHANGHAI ENVIRONMENT PROJECT HS S 1994 160 24 94 24 9 12 94 CAS Annex B9 (a) Page 2 of 3 Active Proiects Difference Between Last PSR Expected and Actual Supervision Rating Original Amount in US$ Millions Disbursements~ Project ID Project Name Development Implementation FiclYa IBO DAGNT Cne Udsb riFmRed Objectives Progress FiclYa IBD IAGAT Cne Unsb OgFrRvd P003648 CN-SHANGHAI SEWERAGE II S S 1996 250 82 06 82 1 1 07 P043933 CN-SICHUAN URBAN ENVIRONMENT S S 1999 100 2 97 50 394 6 67 P003600 CN-TECHNOLOGY DEVELOPMENT S S 1995 200 3 10 16 13 2 P071`147 CN-Tuberculosis Control Project 5 5 2002 104 103 33 -0 7 P003635 CN-VOC ED REFORM PROJ 5 5 1997 10 20 0 16 1 3 P003599 CN-YUNNAN ENVIRONMENT PROJECT S 5 1996 125 25 82 43 77 7 50 09 P003473 CN-ZHEJIANG MULTICITIES DEVELOPMENT 5 5 1993 110 1 06 1 3 -3 01 P003647 China Economic Law Reform -LEGEA 5 5 1995 10 4 20 4 9 P003653 Container Transport S U 1999 71 3 1 20 34 23 2 P051736 E CHINA/JIANGSU PWR 5 5 1998 250 86 73 10 159 1 2 50 P037859 EGY CONSERVATION PRO S 1998 22 506 5 5 P003606 ENERGY CONSERVATION 5 5 1998 63 45 70 12 9 P046952 FOREST DEV POOR AR 5 S 1998 100 100 74 23 -38 4 45 64 P035693 FUEL EFFICIENT IND 5 5 1997 32 812 915 11 7 P051705 Fujian II Highway 5 5 1999 200 121 67 85 2 P003626 Fujian Prov Highway 5 5 1994 140 18 1 12 29 30 4 30 38 P003594 GANSU HEXI CORRIDOR 5 S 1996 60 90 88 70 62 2 P003627 GRAIN DISTRIBUTION P 5 5 1993 325 165 29 60 30 4 20 44 P051888 GUANZHONG IRRIGATION 5 5 1999 80 20 5945 28 8 P046564 Gansu & Inner Mongolia Poverty Reduction S U 1999 60 100 89 20 33 6 -5 85 P058843 Guangxi Highway 5 5 2000 200 152 68 35 2 P003614 Guangzhou CityTransport 5 5 1998 200 129 54 126 2 P038988 HEILONGJIANG ADP 5 5 1997 120 21 20 19 8 P035698 HUNAN POWER DEVELOP 5 5 1998 300 100 163 70 227 7 15 64 P068049 Hubei Hydropower Development in Poor Are 5 5 2002 105 105 00 3 5 P07044 1 Hubei Xiaogan Xiangfan Highway 2003 250 250 00 P049700 IAIL-2 5 5 1998 300 31 51 1 2 P039838 IV ODS PHASE OUT PRJ 5 5 1998 350 25 245 49 -36 8 P070459 Inner Mongolia Highway Project 2002 100 100 00 P058845 Jiangxi II Hwy 5 5 2001 200 182 10 3 1 P003540 LOESS PLATEAU S S 1994 150 1 58 -0 2 P056216 LOESS PLATEAU 11 S 5 1999 100 50 79 06 52 6 P041890 Liaoning Urban Transport 5 5 1999 150 69 02 48 8 P003654 Nat Hwy2lHunan-Guangdong 5 S 1997 400 99 72 99 7 P036949 Nat Hwy3-Hubei 5 5 1998 250 47 29 -0 2 P041268 Nat Hwy4/Hubei-Hunan 5 5 1999 350 167 67 56 4 P058846 National Railway Project 5 S 2002 160 95 20 -2 3 P003590 QINBA MOUNTAINS POVERTY REDUCTION 5 5 1997 30 150 53 29 56 7 P003571 RAILWAYS VII 5 5 1995 400 109 69 48 177 5 26 50 P003595 RED SOILS 11 AREA DEVELOPMENT PROJEC S 5 1994 150 5 85 1 2 1 16 P003592 REF INST'L & PREINV S 5 1993 50 2 65 3 1 2 72 P046829 RENEWABLE ENERGY DEVELOPMENT 5 5 1999 13 12 87 924 P038121 RENEWABLE ENERGY DEVELOPMENT S 5 1999 35 26 65 14 3 P003638 SEEDS SECTOR COMMER S 5 1996 80 20 9 4 15 03 25 5 -2 75 P044485 SHANGHAI WAIGAOQIAO S 5 1997 400 174 77 102 8 19 31 P003649 SHANXI POVERTY ALLEV S S 1996 100 6 57 15 9 CAS Annex B9 (a) Page 3 of 3 Active Proiects Difference Between Last PSR Expected and Actual Supervision Rating Original Amount in US$ Millions Disbursementsi Project ID Project Name Development Implementation Fiscal Year IBRD IDA GRANT Cancel Undisb Ong Frm Revd Obiectives Progress P003585 SHENYANG IND REFORM S S 1995 175 4152 41 5 P003609 SICHUAN GAS DEV & CONSERVATION S S 1994 255 51 50 51 5 P003404 SICHUAN GAS DEV CON S S 1994 10 0 02 0 8 P036947 SICHUAN TRANSMISSION S S 1995 270 95 12 15 107 2 0 93 P045264 SMALLHLDR CATTLE DEV S S 2000 93 5 43 55 20 2 P003639 SOUTHWEST POVERTY REDUCTION PROJE HS S 1995 475 200 11 87 364 3643 P003591 STATE FARMS COMMERCI U U 1998 150 80 8 8 45 83 7 3 00 P003539 SUSTAINABLE COASTAL RESOURCES DEV S S 1998 100 2 3 49 09 33 9 P064729 SUSTAINABLE FORESTRY DEVELOPMENT P S S 2002 93 9 93 90 0 5 P056596 Shijiazhuang Urban Transport S S 2001 100 96 00 32 9 P060029 Sustainable Forestry Dev(Natural Forest) S S 2002 16 16 82 P046563 TARIM BASIN II S S 1998 90 60 2 7 67 53 53 4 P042299 TEC COOP CREDIT IV S S 1999 10 35 3917 -4 5 P003409 THIRD ODS PHASE OUT S S 1995 120 1 36 40 6 4 P056424 TONGBAI PUMPED STORA S S 2000 320 304 94 55 3 P003650 TUOKETUO POWER/INNER S S 1997 400 1025 6543 1448 -1881 P056199 Third Inland Waterways S S 2001 100 96 00 0 5 P058847 Third Xinjiang Highway Project # 2003 150 150 00 P045788 Tn-Provincial Hwy S S 1998 230 67 42 34 6 P045915 Urumqi Urban Transport S S 2001 100 70 04 24 7 P036405 WANJIAZHAI WATER TRA S S 1997 400 75 50 61 124 1 -4 39 P056516 WATER CONSERVATION S S 2001 74 59 12 4 2 P034081 XIAOLANGDI MULTI II HS S 1997 430 92 63 123 5 120 19 P003644 XIAOLANGDI RESETTLEMENT S S 1994 110 2 04 0 1 -1 51 P003643 Xinjiang Hwy II S S 1997 300 60 11 71 717 6 71 P003596 YANGTZEBASIN WATER S S 1995 100 110 270 57 568 P003641 YANGZHOU THERMAL POW S S 1994 350 11 5 3 32 14 8 2 17 P064730 Yangtze Dike Strengthening Project S S 2000 210 166 61 79 6 P003642 ZHEJIANG POWER DEVT HS HS 1995 400 58 95 64 6 Overall result Result 13962 8 2532 61 586 162 971 50 6821 53 3983 2 506 00 a Intended disbursements to date minus actual disbursements to date as prolected at appraisal CAS Annex B9 (b) Page 1 of 2 China Statement of IFC's Held and Disbursed Portfolio As of 6/30/2002 (In US Dollars Millions) Held Disbursed FY Approvw Company Loan Equity Quasi Partic Loan Equity Quasi Partic 1997 Onent Finance 9.52 0 0 11.9 9 52 0 0 11.9 1997/00 PTP Holdings 0 0.03 0 0 0 0 03 0 0 1997 PTPHubei 11 72 0 0 2329 11.72 0 0 2329 1996 Pacific Ports 0 2.54 0 0 0 2 54 0 0 2001 Peak Pacific 0 0 25 0 0 0 0 0 1998 Rabobank SHFC 0.9 0 0 09 09 0 0 0.9 2000 SSIF 0 6 0 0 0 0.45 0 0 1998 Shanghai Krupp 30 0 0 68.8 19 74 0 0 45.26 1999 Shanxi 17 87 0 0 0 15.32 0 0 0 1993 Shenzhen PCCP 3 76 0.99 0 0 3.76 0.99 0 0 2001 Sino-Forest 25 0 0 0 20 0 0 0 1995 Suzhou PVC 0 2 48 0 0 0 2.48 0 0 1998 WIT 5 0 0 5 0 0 0 0 2000 Wanjie Hospital 15 0 0 0 15 0 0 0 1996 Weihai Weidongn 1.92 0 0 0 1 92 0 0 0 1993 Yantai Cement 11.13 1 95 0 0 11 13 1 95 0 0 1998 Zhen Jing 0 2 0 0 0 2 0 0 2002 Advantage 0 0 25 0 0 0 0 0 0 1999/00/02 Bank of Shanghai 0 24 67 0 0 0 24.67 0 0 1996 Beijing Hormel 2.5 0.5 0 1.65 2 5 0 5 0 1 65 1998/00 CIG Holdings PLC 0 3 0 0 0 0 0 0 2002 CPEF 0 20 0 0 0 0 0 0 1996 Caltex Ocean 18.53 0 0 28 64 18.53 0 0 28.64 1998 Chengdu Huarong 7.4 3.2 0 8.6 3.7 3.2 0 4.3 1998 Chengxin-IBCA 0 0.36 0 0 0 0.36 0 0 1987/92/94 China Bicycles 0 0 0 0 0 0 0 0 1994 China Walden Mgt 0 0.01 0 0 0 0 01 0 0 1994 China Walden Ven 0 0.21 0 0 0 0.21 0 0 1994 Dalian Glass 0 2 4 0 0 0 2 4 0 0 1999 Dujiangyan 25 59 0 0 30 16 11 0 0 18.89 1995 Dupont Suzhou 12.46 4.15 0 10.4 12.46 4 15 0 104 1994 Dynamic Fund 0 9.75 0 0 0 8.09 0 0 1999 Hansom 0 16.1 0 0 0 16.1 0 0 2002 HuarongAMC 31.5 0 0 0 0 0 0 0 2002 IEC 20 0 0 0 0 0 0 0 1996 Jingyang 32.5 0 0 69 23 32.5 0 0 69.23 1998 Leshan Scana 6.1 1 35 0 0 4 5 1 35 0 0 2001 Maanshan Carbon 9 2 0 0 0 0 0 0 2002 NCCB 0 26 58 0 0 0 26.46 0 0 1996 Nanjing Kumho 6.82 3.81 0 19.38 6.82 3 81 0 19.38 2001 New China Life 0 30.7 0 0 0 23.32 0 0 1995 Newbridge Inv. 0 1.95 0 0 0 1.95 0 0 Total Portfolio: 304.22 166.98 25 277.79 206.13 127.02 0 233.8 CAS Annex B9 (b) Page 2 of 2 Approvals Pending Commitment Loan Equity Quasi Partic 2002 Darong 10000 1500 0 8000 2002 Narada Battery 6600 0 0 0 2002 ZhongChen 25000 0 0 32000 2002 ASIMCO 0 1500 13500 0 2002 Sino Mining 5000 0 0 5000 2002 ShuangDeng 12500 2800 0 0 2002 KHIT 0 3000 0 0 2002 SML 0 6000 0 0 1996 Jingyang 4000 0 0 0 1998 PTP Hubei BLINC 0 0 0 1500 2000 CIG Zhapu 6000 0 5000 0 2000 Meijing 9000 0 0 7300 2000 CIMIC Tile 15000 0 5000 15000 2001 Daning Coal 0 2000 0 15000 2001 AACI 0 2000 0 0 2001 Minsleng 0 0 23500 0 2002 HuarongAMC 15000 3000 0 0 2002 IEC 0 0 5000 0 Total Pending Commitment: 108100 21800 52000 83800 CAS Annex BlO Page 1 of2l COUNTRY PROGRAM MATRIX (FY03-05) Thematic Framework Overall Theme: Supporting China 's Two Historic Transitions -from a Rural, Agricultural Society to anl Urban, Industrial Society anidfrom a Centrally- Planned Economy to a More Globally Integrated Market-based Economy - and to do it on a Sustainable Basis. I. Improving the Business Environment and Accelerating Transition To a Market Economy A Strengthening Macroeconomic Management B. Promoting China's Integration into the Global Economy in the WTO Era C Reforming the Financial Sector 1. Establishing an Overall Sector Policy Structure 2 Restructuring of Banking System 3. Improving Govemance and Regulatory Structures 4. Establishing Capital Markets D. Promoting Private Sector Development and Enterprise Reforms 1. Improving the Environment for Private Sector Activity 2 Corporate Restructuring, Ownership Diversification and Industrial Reorganization 3. Strengthening Corporate Governance 4 Promoting Private Sector Participation in Infrastructure E. Improving Public Sector Management and Delivery of Services 1. Improving the Regulatory and Incentive Environment for Good Governance 2. Strengthening Management of Cities 3. Strengthening Performance of Public Utilities in Delivering Infrastructure Services II. Addressing the Needs of the Poorer and Disadvantaged People and Lagging Regions A Increasing Employment and Productivity Off and On the Farm B. Strengthening Transport Links withm and to Lagging Regions C. Developing Human Resources D Strengthening Social Protection PE Improving Targeted Poverty Reduction Programs III. Facilitating an Environmentally Sustainable Development Process A. Strengthening Effectiveness of Environmental Institutions B Improving Air Quality C. Managing Water Resources D. Managing Land and Natural Resources E. Protecting Global Environmental Commons CAS Annex B10 Page 2 of 21 China Country Assistance Strategy: Country Program Matrix (FY03-05) Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/IFC/ AAA Other Donors MIGA/GEF I. Improve the Business Environment and Accelerate Transition To a Market Economy I.A. Strengthening Promote macroeconomic Low inflation, sustainable macro Advise on interest rate Two ongoing TA projects TA to PBoC on Interest Rate ADB TA on Institutions for stability to support balances, improved vulnerability liberalization, extemal China Reseaich, Liberalization (FY02 -03), Intergovemmental Fiscal Macroeconomic sustained investment indicators, nsing pnvate investment payments, and fiscal Institutional Support and Country Economic Report Transfer, Budget Law, Management spending and job-creation levels and more newjobs across sustainability issues, and share Preinvestment Project (FY03), Policy Notes on Macro Coordination of Fiscal- China information on investment (CRISPP) and Fourth Management (FY02-04), Fiscal Monetary Policy, etc climate and labor market Technical Cooperation Policy (FY02-04), TA for AusAID: Tramining in policies Project (TCC IV) macro-modeling (FY02-04), taxation issues Statistical capacity building CIDA Public Policy (FY03), WBI course on fiscal Options Program implications of WTO accession EU: Public Administration Strengthen fiscal New systems and capacity for better Advise on reforms to improve Ongoing Fiscal TA Project (FY02) Co-op Program, training in management capacity management of the govemment analysis and management of Bond Market Development national statistics budget, debt and fiscal nsks govemment budget, debt and (FY02-03), TA for Debt GTZ: TA to Structural fiscal risks Management Capacity (ASEM) Reform Commission & to NPC's Finance/Economic Committee Strengthen framework for Further adjustments i revenue and Advise on inter-govemment Provincial Expenditure Review IMF: Proposed TAm tax inter-govemment finance expenditure assignment and transfers finance issues (FY02), Sub-National Fiscal adminstration, tax policy, between local, provincial and TA public expenditure mgt, national goverments govt finance statistics, etc OECD: TA m statistics, fiscal reform, monetary I.B. Promoting Build capacity for Implementation of revised laws/ Advise on design and Ongoing Economic Law WBI distance leaming on ADB WTO-related studies China's conforming with WTO administrative practices relevant to implementation of trade -related Reform Project Globalization and China's AusAID training officials Integration into regime intemational trade and investment laws and regulations, and Accession to WTO (FY02) in WTO and market issues the Global support training CIDA: WTO Capacity Economy Continue reforms on Measures to unify currently Advise on issues of trade de- Evaluation and Reform of Building Program trade & business fragmented export processing regime licensing, simplification of Export Processing Trade (FY02) EU: Co-op Programs on environment to maximize and encourage outward investment business processes, and TA by MIGA on outward WTO & Information benefits of open by Chinese firms competitiveness, and collaborate investment from China (FY01- Society, major scholarship trade/investment for on impact analyses 03) program Chinese economy and Research on WTO Accession, ILO: vanous studies on poor Policy Refonm and Poverty WTO impact Continue stnuctural Actions to liberalize labor markets Advise on structural reform of Reduction (FY02) Japan: Focus Area of reforms to smooth impact and reduce bamers to trade within factor and product market Study Inter-provincial Bamers Future Support of increased globalization the national market to National Market Devt OECD: TA for intellectual property nghts Accelerate service sector Reduction of govemment Advise on strategies for service Ongoing Container Services Sector Development UNDP Customs Reform development monopolies and govemment sector liberalization and Transport Project and Competitiveness (FY02) for WTO interference in service activities development CAS Annex B IO Page 3 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/IFC/ AAA Other Donors MIGA/GEF Promote China's Improvements in R&D capacity, Advise on knowledge strategies Distance Leaming Project Using Knowledge for China's knowledge economy national and intemational to strengthen global (FY04) Development (FY02), Senior information flows, quality of higher competitiveness and leverage Pohcy Seminar on Knowledge education, and in bndging the digital new ICT technologies for Strategies (FY02), Structure of divide knowledge shanng Agncultural Research (FY02), GDLN Pilot Program in Ningxia Province (FY02), Development Gateway (FY02), WBI I.C. Reforming the I) Establish an overall Govemment to reach a consensus on Advice on long-term strategies Strategic and policy advice on IMF: Proposed TA to Financial Sector financial sector policy its long-term financial sector and policy reformns ( I ) key issues in making PBC, workshops on central structure appropnate to a objectives and its appropnate future transition from planned to bank accounting and capital market economy role in the sector market-onented financial account, training in money system, arid (2) specific areas and banking statistics like interest rate liberalization, WTO entry and financial servies industry integration 2) Continued Steady progress in commercializing Advice on strategies and policy Bank/IFC advice on SCB refomi AusAID Training in restructunng of banking the operations of four major state reforms and technical assistance and restructunng, bank super- finance and banking system to one capable of commercial banks (SCBs) along on key aspects of the reform vision/regulation, deposit DFID Financial Sector serving the needs of a with diversifying their ownership process insurance, credit nsk Traimng Program market economy, while Pnvatization of other banks management, promoting EU: ASEM grants, training minimizing fiscal and restructunng of small/medium of financial sector social stability banks regulators & supervisors implications ASEM-funded TA on asset management company/bad debt resolution Expanded and conimercially Policy advice/TA on finance for sustainable access to financial small finms, IFC advice on products and services by households, leasing legislation/regulation firms and govemments, including in IFC/Bank policy advice/TA to rural areas pilot urban SME lending Policy advice and TA on restructunng rural financial institutions. 3) Improve govemance Improved govemance, management, Advice on policy refomis and China Development Bank Medium and Small Bank, and ADB TA in Banking Law structures and regulatory profitability, capital base and technical assistance on key component of TCC IV Failure Resolution components & Regulation, Improving systems for financial intemal controls in financial aspects of the reform process Accounting Reform of CRISPP Information Disclosure, institutions capable of institutions (banks, secunties firms, Project Studies isn Trading Rules, serving the needs of insurance companies) Workshops/policy advice to Compansons of Financial firms, households and IFC investment in Bank of Secunties and Insurance Sector Regulatory & governments in rapidly- Includes improved financial services Shanghai and Nanjing City Regulatory Commissions Supervision Regimes growing market economy industry infrastructure - accounting, Commercial Bank, in IIF: Proposed TA in auditing, disclosure, regulation and insurance companies, IFC advice on banks' auditing banking nsk analysis and supervision fiunds, secunties practices, WBI training of bank bank supervision companmes, housing supervisors. OECD: TA in govemance Participation of pnvate domestic and finance of financial institutions, foreign financial institutions in taxation of financial banking, insurance, capital markets markets CAS Annex B 10 Page 4 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/IFC/ AAA Other Donors MIGA/GEF 4) Establish sound capital Reform of govenmment secunties Strategic and policy advice, TA Financial Sector TA Policy advice on govt secunties ADB: Capital Markets markets capable of market, including introduction of and training to responsible Project market reform, IFC advice on Devt TA serving the needs of treasury bills, strengthening debt govemment units, official think secunties law EU: China Financial firms, households and management capabilities and tanks and quasi-governmental Services Cooperation govemments in a rapidly - reducing portfolio nsks institutions on long-term TA for improved cash Project growing market economy strategies and pnonty refonms management by govemment IMF/World Bank: Develop inter-bank money market debt issuer Regional workshop on and improved liquidity management Developing Bond by banks/finance institutions Policy advice on interest rate Markets liberalization and the Central Growth of institutional investors Bank's role in money market (mutual funds, insurance companies, development etc ) Policy and strategic advise for Development of market -based promoting growth of infrastructure finance mechanisms institutional mvestors, and for infrastnicture finance Initial steps to develop the bond IFC investment in bond mechanism market rating company I.D. Promoting I) Improve business Private Sector environment and Implementation of specific Support development and Ongoing Economic Law Bankroptcy Study (FYOI), On- ADB SME Business Development and encourage greater commitments made underWTO improved judicial enforcement Reform Project going WBI funding support to Advisory Support, TA for Enterprise Reform private sector activity accession discussions such as of modem business laws CASS Institute for Regulation pnvate sector devt Open markets to greater IFC projects with the local and Competition Policies AusAID/DFID/Swiss/lFC competition and provide - Non-discnminatory national Advise on streamlining fiscal pnvate sector China Project Developmen level playing field for all treatment of all enterpnses Revision and user charges, implementing IFC/IBRD study of Post- Facility types of pnvate sector of investment guidelines in full new bankruptcy law, and IFC public-pnvate sector Pnvatization Needs of EU major business firms Strategy is to conformity with the WTO agreement competition and regulatory forums to improve SME Enterpnses (FYO 2), WBI course tramining program, junior implement commitments and repealing all laws and policies business environment on Regulatory Economics and managers training, under WTO covenng regulations inconsistent with WTO particularly in Westem Incentive Theory Enterpnse Reform - Improvements in legal rules on national treatment Advise on pnvate sector Provinces Project for SME Devt framework and - Eliminate dual pncing practices development, particularly in the Research on China's Industnal Japan Focal Area of enforcement capacities to - Publish in official joumal list of intenor provinces, and support IFC capacity building and Competitiveness and Investment Future Support provide increasingly goods and services subject to state for access to new technology funding to SM Es in the Climate (ongoing) OECD TA on SME equal opportunities to pncing together with price-setting and management know-how intenor thiough China development policies firms of all ownershup mechanisms and policies Project Development Technical assistance in the classes - Formulate Law on AntbMonopoly Funding and TA support to the Facility in Chengdu and development and utilization of - Reduction of bamers to - Implement commitment to grant all pnvate sector, and support for Sichuan Investment Fund online infonmation services entry and exit enterprises nght to conduct development of business (FY02) - Transparency and intemational trade within three years services rationalization of after accession WBI TA for implementation of domestic laws and measures identified in the regulations Knowledge Economy study ASEM trust fund supported study on corporate restructunng WB I workshop on corporate restructuring and enterprise _____________________________ ~~~~~~~~~~~~~~~~refom ms CAS Annex B IO Page 5 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objective s Strategy/Actions IBRD/IFC/ AAA Other Donors MIGA/GEF Specialization/consoli- Progress in moving from Advise on investment promotion MIGA guarantees dation of firms to approval-based system to policies, encourage the use of IFC/FIAS/MIGA improve investment registration and disclosure-based nsk mitigation techniques, and assistance in building efficiency in system in areas like company facilitate access to global capacity of investment manufactunng/service law, business licensing, and knowledge and capital promotion intenmedianes sectors capital market debt Provide business Enactment of a comprehensive support services, e-oommerce law especially for small, remote, and high-ech firms 2) Corporate Announcement of Advise on legal and regulatory ASEM-supported study on corporate ADB: TA for industnal Restructunng, comprehensive policy on frameworks to support hard restmictunng enterpnse and SOE Ownership Diversi- mergers/acquisitions budget constraint restructunng fication and Industnal IFC/UKTA for ownership ADB/OECD:Anti- Reorganization Harder budget constraints on Support efforts to reduce excess transformation in Leshan corruption Initiative mn enterpnses, further separation of capacity and number of loss- East Asia SOE from Govt control, fewer making enterpnses, and the WBI workshop on corporate DFID SOE Reform loss-making SOE and SOE- development of support schemes restructunng and enterpnse refonn Project in Sichuan/ related non-performmg loans at to assist laid-off workers Liaonng four largest state-owned banks EU: ASEM grants GIZ Training managers Progress in disposing/ Ongoing Shenyang of medium-size restructunng assets acquired by Industnal Refonm Project enterpnses, advice to the asset management Ministry of Labor companies including through foreign investor participation Substantial transfer out of SOE Advise on separating the IFC support to AMCs for of hea Ith/education facilities, provision of both education and disposal and/or health insurance schemes, and health services from SOEs restructunng of assets housing Assist in corporatization of Ongoing Enterpnse Accelerate the program of sector oompanies and improve Reform LIL pnvatizing or liquidating small their creditworthiness industnal and service sector SOEs CAS Annex B IO Page 6 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/IFC/ AAA Other Donors MIIGA/GEF 3) Strengthen Appoint and use Board Advise on corporate govemance Ongoing Projects for FY0 I Bank study of Bankruptcy of ADB Study on Corporate Committees such as audit and issues, train trainers, assist in Accounting Reform, SOEs Improving Corporate Governance compensation committees developing distance training Enterprnse Refomm and FY02 IFC- Bank stLdy, Corporate Govermance and facilities Economic Law Reform Govemance and Enterpnse Reform in Financial Performance of China SOEs, enterpnse Introduce/enforce accounting, Support the development of FY03 study, Corporate Govemance of accounting system reform auditing and disclosure accounting, reporting and Enterppnse Groups OECD: TA for corporate standards consistent with auditing standards consistent WBI distance training in corporate govemance intemational practices with international practices govemance and training of trainers in executive development program Further strengthen CSRC regulations 4) Promote Private Assist in attracting pnvate sector PPIAF/Bank Group study on Sector Participation financing Framework for Pnvate Participation in in Infrastructure Infrastructure (FY01) Energy Promote All oil &gas companies listed TA for Public/Pnvate Partnership in pnvate sector Gas Distnbution (proposed FY04) investment Increased number of IPPs, listed power companies and decision to further divest generation assets New policies opening access to pnvate sector implemented Transport Services. Transport Services. Creation of Encourage pnvate regulatory agencies, liftmg of transport operations tanff constramints and guidelines Develop instnrments to on transport services encourage, manage and regulate competitive transport services Roads. Expand Roads. Investment in toll road Toll Roads Protects Highway Sector Study (FY01) Japan ongoingJBIC market-based projects to foster growth, trade Ongoing projects and TA for Consolidating Commercialized toll road construction development, financuig and poverty alleviation, with Hubei Highway (FY03), Toll Roads projects and maintenance of pnvate sector partlicipation or Shaanxi Ill Highway roads potential for asset secuntization (FY04), Henan IV and Promote policy for Hubei 11 Highways (FY05) commercialization, consolida- tion, and market financing of public toll roads companies Assist in reform of road agencies to focus on policy and regulation _________________________ _________________________ roles CAS Annex B1O Page 7 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/IFC/ AAA Other Donors MIGA/GEF Promote competition in highway management and development of pnvate contractors Assist reform of legal and regulatory framework, develop policy for pnvate participation in roads servingthe poor Railway Separate Railways Create railway Railways. Support the Railwavs. National regulatory from operating enterpnses restructunng process of Ministry Railway P roject (FY02) operational Develop tools needed by railway of Railways and proposed project in responsibilities in to operate in market economy Process railway loans only as FY04 railways Spin off non-rail activities benchmarks achieved Contract out services Separate transport Concessioning or franchising of operations from operating functions manufactunng SOEs in railways Water Transport. Water Transport Wholly Water Transport. Assist WaterTransport Ongoing Introduce more open pnvately owned, shipping commereialization of inland 2 Inland Waterways policies for pnvate operating companies, with waterway agencies Project participation foreign investors 3d Inland Waterway Further commercialize SOE Project (FY01) shipping companies 4Ih Inland Waterway Pnvate sector participation in Project (FY04) terminal operations Ongoing IFC investments Commercialize waterway in transportation sector agencies I.E. Improving Public 1) Improve Financial management training ADB Planning devt of Sector Management regulatory/incentive provided in conjunction with projects legaUjudicial system and and Delivery of environment for good further support proposed Services governance ADB-OECD Anti- Corruption Initiative AusAID Governance Program, legal reform Improve Improved procurement guide- Help to introduce transparent Tramining of govemment procurement support, Human Rights legaVregulatory lines and expanded capacity for govemment procurement specialists and local trainers (WBI), TA Program framework & their implementation procedures and strengthen Country Procurement Assessment CIDA Civil Society transparency of procurement capacity Report Program, Legal Aid government financial Better coverage, quality and Assist in strengthening Ongoing Projects for WBI course on Fiscal Project, Procuratorat e management, timeliness of publicly available govenmment fiscal management, Fiscal TA, Accounting Decentralization (FY02) Reform Project procurement practices reports and audit statements reporting and auditing systems Reform and Economic EU LegaUJudicial Co-op Law Reform Program Strengthen responsive- Greater use of performance Support the development of Ongoing and new projects France:Judicial Training ness and accountability standards and consumer public service standards support the use of public GTZ: Devt of economic, in the delivery of feedback in the delivery of service standards labor and admin laws public services public services CAS Annex B1O Page 8 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/IFC/ AAA Other Donors MIGA/GEF Strengthen legal pro- Improving independence and Support court reforms, Ongoing Economic Law Support training and workshops for Japan Focal Area of fession/judicial system capacity of lawyers and judges professionalization of the Reform Project govt officials dealing with corruption- Future Support judiciary and training of lawyers related issues Support analytical work SIDA TA for legal & Reduce conruption in Decline in instances of reported to strengthen anti-corruption efforts, judicial training in the public sector conouption in the public sector Assist govt identify factors building on work in areas like pro- Shanghai, NGO devt contnbuting to conuption and curement policy, accounting rules, UNDP Legal systan implement structural reforms project-related financial mgt policies reform, public admini- addressing conuption stration reform, govemance support Develop official legal Ongoing Economic Law US Support for legal and information system by Refomi Project judicial reform proposed compiling natl /local legislation/ regulations to be made available to public through intemet 2) Strengthen Management of Cities Promote sound urban Acceleration of urban job Support establishment of policy Tianjin Urban Urban Restructunng (FY03) ADB: TA-Urbanization devt, especially small creation and absorption of rural framework to facilitate factor Development and Liaonmng Urban Poverty (FY03) Strategy, Urban Devt & cities/towns, to improve surplus labor mobility, urban economic Environment 11 (FY03) Urban Transport (FY03) Envir Improvement, rural-urban interface, restructunng, and rural-urban Chongqing Small Cities Urban Poverty (FY04) Medium Cities Devt econ efficiency, equity interface Urbanization & Envir City Development Strategy Programs CIDA Integrated (FY05) (FY03-05) Municipal Devt Program Strengthen plans & Hunan City - Regional Sustainable Urban Development and Cities Alhance:City policies to facilitate Urban economic restructunng, Help design and fin ance projects Development (FY04) Management Training (FY03-05) Development Strategy economic/spatial esp tertliary sector devt in large to support development of urban Shanghai Urban City networking (FY03 -04) Program restructunng, relax cities, diversification of urban clusters, metropolitan regions, Environment APL 11 Beijing Metro Restructunng and DFID: City Develop- household registratlon economies, stronger economic and small cities and towns (FY05) Management (FY03 -05) ment Strategy Program restnctions ties between localities Municipal/ Utility Finance (FY04-05) Improve urban Corporatization of utilities Provide TA to strengthen the Beijing #10 Water Utility Operation/Management EU: Liaoning Integrated management and Streamlined and focused planning and regulatory Treatment Plant PPI (IFC (Proposed) Envir Program planning govemment units functions of local govenmments, FY03) PPI for Water, Wastewater, and Solid UNDP City Planning, strengthen the finance, operation Waste Management for Shanghai, Mgt /Devt in 21 - Separate govt/market Enhanced technical and and management of utilities Sichuan, Chongqing (FY03-04) Century functions, improve management sklls and regulatory capacity, organization in govemments and Support the above with TA and strategic planning, consulting industry project-related action plans investment/services management - Improve urban/utility Increased cost recovery for Encourage financial Zhejiang Urban financing, increase cost transportaton and utilities improvements through TA and Development 11 (FY04) recovery, diversify action plans urban financing, and Expand pnvate participation in Facilitate PPI with TA and facilitate PPI infrastructure and utilities cofinancing Improve housing and Complete housing reform steps, Provide analytical support for Housing maintenaiice and operations housing market diversify housing industry and assessment and development of (FY03), Ilousing market development mechanisms finance products the markets (Proposed FY05) CAS Annex B IO Page 9 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/IFC/ AAA Other Donors MIGA/GEF Maximize utilization of Preservation, restoration, and Provide technical assistance and Several ongoing projects Building Codes, Planning and cultural hentage assets use of cultural assets limited financing for restoration and FY04 Zhejiang Urban Cultural Assets Management (FY04) and utilization of cultural assets Environment 11 Project 3) Strengthen Performance of Pubhc Utilities in Delivering infrastructure Services Introduce appropriate Corporatization/ Assist in designing and Energy projects for Work on new waves of reforms ADB TA to establish regulatory and corporate commercialization of power implementing competitive commercialization and (FY00) National Electricity and structures for the energy companies well advanced power markets corporatization of TA and PPIAF Study on Oil & Gas Regulatory Commission, sector power/gas SOEs Regulation (FY02) Study on Tanffs for Inter- State Council approval of Assist in establishing and YLxmg Pumped Storage Revised Paper on Power Regulation provincial Power proposal to develop competitive implementing a sound regulatory Project to restructure (FY02) Transfer (FY02), power markets framework Jiangsu Wholesale Power TA for Power Regulatory Bureaus proposed Power Tanff Market (FY03) (FY 02) Strategy, all projects Decision to separate generation providing urban services from transmission/distnbution and energy Oil and gas sector restructured AusAID Study to Develop Regional Power Market in East China Improve efficiency in Commercially viable pncing of Support improvement of PPI Shanghai APL and Tianjin PPIAF for Chongqing water OECD: TA for provision of urban water supply and wastewater framework, including Urban Development 11 supply/wastewater mgmt regulatory pohcy services mgmt services regulations (FY03), ongoing Beijing Utility Refonm and Regulation (part of development Corporatization of utilities Help improve mgmt/pncing of Envir 11 N China Water Quality Mgmt Study) water supply and sanitation Broadened scope of PPI, with services local company participation in utilities PPI or corporatization in toll Support pnvate provision of Public transport Highway Sector Strategy Review roads, bus and mass transport public transport systems, components of ongoing (FY02) especially bus services and new urban transport Stipport restructunng of Public projects Transport Companies Improve quality of Road sector oriented to market, Advise on legal and regulatory Institutional strengthening, highway and railway with improved framework policy reform and road services govemance/sustainability of For sustainable road mgmt, safety components in road maintenance balance expenditures for highway projects construction and maintenance of different road classes Help fonmulate policy for road financing, e g, introduction of road user charges Support broader approach to road safety Railway restructured and Support railway reform National Railway Project reformed (FY02) and proposed railway project in FY04 CAS Annex B 10 Page 1O of21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions 1BRD/IFC/ AAA Other Donors MIGA/GEF Providing More Create market -based business Assist in prepanng legal and Urban Transport Projects ADB urban transport Efficient Urban framework for PTCs, including regulatory framework for range in Unumqi (FY01), projects Transport Services & removing responsibility for of models for pnvate Shijiazhuang (FY01), Networks redundant labor and housing, participation in Public Trans- Wuhan (FY04), Fuzhou and developing intemationally port, including concessions (FY05) benclhmarked perfomiance Assist devt/promulgation of targets performance targets for opera- Public Transport Concession tional and financial performance Law enacted, including and advise on how to meet them provisions for pnvate sector Encourage transparent provision participation of compensation by govt to Create regulatory agencies, lift transport enterpnses for public tanff constraints and have service obligations guidelines on transport services H. Address the Needs of the Poorer and Disadvantaged People and Lagging Regions II.A. Increasing 1) Spur Off-Farm Job Employment and Creation Productivity Off Build on local Rising investment efficiency and Share successful intemat exper- IFC and WB projects in Multi-sector studies/work-shops on ADB: TA to develop - and On the Farm comparative advantages, diversification of local economic ience in regional devt and in intenor provinces development constramints and on how Provincial Development promote pnvate activities, increasing number of promoting local investment to accelerate pro-poor growth in Strategies for selected investment, support off- SMEs, growing absorption of climate with central and sub- lagging regions (FY02-03), Sub- lagging Provtnces fanm job creation rural surplus labor in off-farm national Govts, promote devt of national Economuc Reports (FY03- initiatives, and facilitate employment, and nsing rates of SMEs, support policy reforms 04), Labor Market Reform study, migration local GDP growth creating more flexible markets Pnvate Sector Devt Strategy in for land, labor and capital Lagging Regions (FY03) TA on better monitonng indicators for TA for legislation to promote Ongoing Economic Law social spending (ASEM), TA for environmentally sustainable Reform Project poverty mapping (ASEM) econ devt in westem region 2) Enhance Agricultural Productivity Further refonm Increasing trend in introduction Support agncultural reform, Ongoing projects Jiangxi Major report on Rural China ADB Study of Structural agnculture sector from of higher-value crops, livestock, based on market cntena Integrated Agncultural Transition and Development (FY99) Adjustment of Agnc focus on gratn production aquatic products and high Modemization (FY03) basis for dialogue Sector to higher-value quality grains and declimng Gansu & Xinjiang Pastoral TA for Refonm of Ministry of AusAID: Agnc Devt in production as signaled by trend in area planted to standard Development (FY03) Agnculture (FY03), Livestock Note liebei and Inner Mongolia market demand grain crops Heilongjiang Livestock (FY03), TA on Food Safety (04) for the poor, Qinghai Sector (05) Community Devt Strengthen land property Formali7ed land use market and Promote policies permitting (a) Land Titling TA (IDF, 02), follow-up CIDA: Projects in nghts to stimulate pnvate increased market participation devt of land use market, (b) use TA on land management issues livestock, drylands on-farm investment of land as collateral for credit, fanming, and grasslands and (c) incentives for quality OECD MOA reform of enhancing land investments by agricultural policies, TA on farmers rural finance WFP/IFAD Wuling Mountains Rural _________________ ___________________ ___________________________________________________________I __I__I_Developmeentmes CAS Annex BIO Page 11 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/IFC/ AAA Other Donors N1IGA/GEF Increase investments in Ongoing Projects Loess ADB Songhua River imgation, water saving, Plateau I & 11, Flood Management and flood protection Heilongjiang ADP, Tanm infrastructure, and soil Basin 11, Anning Valley, and water conservation Guanzhong Imgation, lmgation Agnculture Intensification Promote policy and Reforms adopted for water Build key reforms into water Water Sector Strategy for North ADB TA for legislative institutional reform for management resource projects, support China, Slhu Integrated Basin Water support for water sector sustainable water strategic studies Management Study, TA to establish resources management training centers for SIDD Promote sustainable Restructure, revitalize and Agnculture Technology Agncultural Research Study (FY01) agricultural development increase investments in research (FY04) through expanded and extension, focused on research program pnonty areas Refonm system of Raise agncultural taxes if administrative fees and appropnate and abolish taxes in rural areas administrative fees imposed only on farmers Encourage pnvate sector Increase proportion of Publicize/enforce intellectual Studies done for Laggmg Region involvement in sector agncultural commodities property nghts to encourage Development Program marketed by non-State entities transnational firm participation TA on Farmer's Associations in Increase in agncultural FDI and in provision of agncultural Sichuan (04) in non-state research and inputs extension Increase proportion of rural Promote pnvate sector enterprises and the proportion of participation in input marketing output under non-collective and technical advice ownership Promote conducive policy framework to transform TVE ownership (collective) into more efficient pnvate/corporate structures Gradually remove constraints to Reduce agncultural population CEM (03) migration and to urban and alleviate labor migration enterpnses employing migrants constraints Strengthen O&M of rural credit cooperatives and enable them to provide the majonty of financial services in rural areas CAS Annex B10 Page 12 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/IFC/ AAA Other Donors MIGA/GEF 3) Promote Strengthened capacity to address Develop environmental Sustainable Forestry Environment Sector Report (FY01) DFID/IBRD Loess environmentally environmental issues in Westem capabilities in regional planning Development (FY02) Plateau 11 Project sustainable Development Promote better management of GEF for Protected Areas TA on Strategic Environmental GTZ Sustainable Devt development in Western natural resources Management Assessment of Great Western of Mountainous Area of Regions Development Plan (Norway) Jiangxi, Participatory New Model for Rur-al Devt (Norway) Approach to Agnculture Westem China forest/grasslands task and Forestry force - CCICED 4) Assist poor western Poor region production and Increase system efficiency Hubei Hydropower in Poor Paper on transfer of energy from west JBIC Small areas to develop their consumption of energy (pumped storage) Areas (FY02) to east (FY02) hydro projects in Gansu energy resources and & Hubei provide poor provinces ADB Northwest Gnd with increased access to Super High Voltage energy Transmission Project I I.B. Strengthening Improve road transport to Major progress in developing Finance higher class roads in the Highway projects in Highway Sector Strategy Review ADB Road projects in Transport Links and within Western areas road networks in and to Western Central and Westem provinces Xinjiang, Hubei, Anhui (FY02) six western provinces, within and to in accordance with long- provinces, measured by number at economicallyjustified (FY03), Shaanxi, Inner Railway Projects in Lagging Regions term plan covenng of km of roads built in vanous standards Mongolia 11 (FY04), Yunnan and other - devt of 8 East -West and road classes, toward GOC Henan, Flubei (FY05) western provinces, North-South comdors objectives Assist GOC design road Ongoing highway projects Studies for Rural Road totaling about 18,000 km development plans for Westen in Gansu, Guangxi, Inner Development Strategy to link the intenor region provinces, based on economic Mongolia, and Ningxia and of Gansu Road Devt to coastal area and to link analysis and design cntena to Japan: Ongoing JBIC Westem provinces ensure efficiency of investments Inland Waterway IV Road Construction toget her, Project (FY04) and Projects in areas like - rehabilitation/upgrading Promote development of small ongoing waterway projects Gansu, Henan, Hunan, of technical standards of and medium enterpnses in road and Chongqmg about 180,000 km of road construction, road transport network in western area, services and supporting services and (freight forwarding, - devt of about 150,000 warehousing, etc) km of rural access road to alleviate poverty in ural villages Improve logistical Multiplication of internodal Support measures to reduce Transport Services and Logistics services tenminals operating in inland transport component in total (FY02-03) provinces logistics costs Extend railway system to National Railway Projects underserved areas CAS Annex B IO Page 13 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/IFC/ AAA Other Donors MIGA/GEF II.C. Developing 1) Improve coverage ADB Study for Reform Human Resources and quality of education in Compulsory Education Financing, TA for Expand Access to Increase inter-govemmental Policy notes on Financing for distance education Quality Basic Education earmarked funds for poor Effective Delivery of Basic Social AusAID Textbook provinces and counties Services, and Better Monitonng Project for Poor and Strengthen Indicators for Social Spending Mionties intergovernmental CIDA: Capacity transfer systems for Strengthening in Westem Areas EducationMonitonng Ensure high quality Achieve UBE, with report of Raising the quality of Basic Education in DFID Support to WB universal basic education student participation by educational inputs and outputs Westem Areas (FY03) and Basic Education in (UBE) education level, gender, ethnic Ongoing Fourth Basic Westem Areas Project, minonty, county/province and Education Project also Basic Education for income quintile Poor in Gansu, Yunnan, Tibet, and Distance Decentralize education Decentralized responsibilities for Increasing autonomy of Leamung Project for planning and budgeting staffing, budgets, setting enroll- educational institutions teachers in westem ment targets, and development provinces of Provincial Education EU: Basic Education for Strategies and financing formula Poor in Gansu Rationalize rural education Rationalizing the financing of ASEM-funded TA to monitor and Japan Focal Area of finance system as the Education System strengthen financing of Chinese Future Support education surcharges are education- advice on restructunng UNDP Knowledge replaced by comprehensive local finance of education Transfer to Strengthen tax system Westem Provinces Promote equity in terms Strengthen delivery of pro-poor Assist in improving access to of educational outcomes education strategy of basic life education and ensunng that - increased support for and lifelong learning skills access is equitable poor and minonty children Note on Monitonng & Evaluation for Achieve Education for Monitor EFA, IDG, and girl's Better Service Delivery Outcomes All (EFA) and enrollment data Intemational Bank financing of DLC centers in Development Goals Ningxia and Guizhou, and assistance (IDG) in education in secunng financing for centers in Increased use of ITC for Development of GDLN- distance education supported DLCs in province sites Reorient Education and AusAID Chongqing Training Vocational Education Study on Strategic Goals for Chinese Reform Project Realize Education for All Hiigher completion rates in 9- Advise on the possible use of Education in the 21 " Century (FY00) goals year education intemet and IT in ensunng Govemment to build and utilize a Education for All global distance leaming center CAS Annex B1O Page 14 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/IFC/ AAA Other Donors _MIGA/GEF Accelerate the Higher enrollment rates in Encourage the strongest parts of Ongoing Higher Education Japan Ongoing JBIC development of high tertiary education and larger the education system, pnmanly Reform Project Higher Education skills, particularly in number of available high-skill in urban and coastal areas, to Projects in many Western science and technology training programs increase their quality, with the Provinces, MOFA grant Better quality of curncula and aums of enhancing equity and for voc-ed equipment teacher training responding tu needs of a OECD: Program of competitive economic International Student environment Assessments in Shanxi UNDP Professional human resources devt & mgt for westemn region Strengthen adult literacy, Market-based and demand- Advise govemment on effective Ongoing Projects for Study on Skils Development in EU: Vocational Training, skill development and dnven tramining programs literacy instnuments and demand Vocational Education Lagging Regions Science & Technology improve effectiveness of Enactment and enforcement of dnven train ing and skill Reform and Labor Market TA for the development of China's Programs training and retraining pnvate education law development approaches Development Pnvate Education Law (under TCP IV GIZ Vocational TA Project) Training Program, support for Continuing Education Centers Develop supporting Advice on development of the Ongoing IFC support to environment for new pnvate education law pnvate education establishment of pnvate/non-state delivery TA for pnvate education law Ongoing Economic Law of education services Reform Project 2) Protect Health ADB/DFID Yunnan Services/improve HIV/AIDS Control Health Outcomes Policy notes on Financing for AusAID Health Increased resources channeled to Help in modermizing public Effective Delivery of Basic So cial programs is Xinjiang, Provide full public health sector health system, particularly to Services, and Better Monitonng HIV/AIDS support to funding of defined meet the growing challenges of Indicators for Social Spending Health IX Project essential public health HIV, TB, NCD, injury and aging WBI course on Sustainable Health DFID HIV/AIDS functions Sector Funancing and Reforms Projects Note on Monitonng & Evaluation for Japan Focal Area of Improve health system's Improved quality and Support cost-effective Ongoing Health VII Better Service Delivery Outcomes Future Support Ongoing efficiency and affordability of health services interventions ("best buys") for Project for health Distance learning on Getting Health MOFA grants for TB responsiveness to demand China's public health pnonties promotion un 7 cities Sector Reform Right Control in Poor Areas Promote standards and Enhancement and better Assist in developing strategies to Ongoing Health IX Project Review Health V health promotion fectious diseases n 7 awareness on public enforcement and public build public awareness on issues for improved prevention institutionalization western provmices health issues awareness of standards for of safety and personal health, and control of UNnDP HIV/AIDS occupational and road safety and including HIV/AIDS prevention HIV/AIDS/STDs Care/Prevention n Hcnan public hygiene and control UNICEF Mekong Study on modernizing public health HI V/AIDS Program Ensure appropnate Implementation of "Regional Support promising provincial functions as provincial level includes Yunnan planning of health Hlealth Planning" framework, as and local public health Grant funds as seed money for cities resources and provision endorsed by SDPC initiatives and promote their comminted so public health of health services at the demonstration effect country- subnational level wide CAS Annex B1O _____________ _______________ ~~~~~~~~~~~~~~~~~~~~~Page 15 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/IFC/ AAA Other Donors MIGA/GEF Improve health outcomes Improved health outcomes Assist the govemment to meet TB Contxl (FY02) Focused empincal analysis of poverty DFID Support to Health and rational use of health among disadvantaged groups basic health needs of Major Ongoing Projects and health, economic development, VIII and TB Control resources in underserved disadvantaged population Health VII - Immunization health and productivity (HD Poverty Projects, urban health and poor areas. Increased health care and health promotion funds) reform for vulnerable affordability, quality and Reform the role of govemment Health VIII - Basic Health groups Ensure optimal health of effectiveness from provider to regulator and Services for poor rural Five studies of health fund use and SIDA: TA and trainig to workforce and reduce enabler of health programs, and population Covers health accounts (ASEM) improve health services adverse effects on health Increased per capita public funding of essential public improved funding, of economic development health funding in rural areas health, and services for the poor management, facilities, Study of costs and sources of funds initiatives in lagging compared with urban areas service quality, and for health safety net and Insurance regions affordability Coverage for the Poor Increased linkage of provider Health IX - for matemal payment to service utilization health and child develop- TA for Improving Access to Health ment in poorest areas of Care by Rural Poor (Japan TF) Rationalization of investment China planning and staffing of health care facilities Ensure safe dnnking Reduced incidence of water- Support to improving rural water Potential Fifth Rural Water ADB TA for Rural water in rural areas bome diseases and sanitation facilities Supply Project following Water Supply & Sani on ongoing Rural Water tation Supply and Sanitation AusAID: Programs in Projects several provinces DFID Pilot programs in ______________________ _______________________ ~~~~~~~~~~~~~~Yunnan & Sichuan II.D. Strengthening 1) Develop a country. Clanty in national social Advise govemment on TA for Social Secunty Refonm and ADB: TA program for Social Protection wide strategy for social protection pnonties reforming social protection Social Aspects of Corporate Social Secunty Reform protection policies and institutions Restructunng (ASEM) AusAID Training in Social Secunty Reform Establish municipal Full municipal management of Help improve the ability of DFID Pilot management of all all social insurance in selected municipalities to identify and Unemployment Insurance aspects of social municipalities meet the needs of the poor Project insurance EU Social Secunty Reform Program Strengthen the Timely payment of living Advise govenument on income Ongoing Labor Market Study of Urban Labor Adjustment UNDP Support to trade unemployment insurance allowances to laid-off workers support systems Development Project and (FY0 1, FY03) unions in assisting laid- system SOE reform projects off workers 2) Reform the Pension System Continue reforms to Enact national policies and Facilitate policy decision s and Ongoing Pension Reform Continue reforms to ensure financial ensure financial implement pilots to provide a their implementation on a pilot Project sustainability of the pension system sustainability of the basic benefit, fully fund basis and country-wide to pension system individual accounts, reduce promote financial sustainability contnbutory non-compliance, adjust parameters of provincial pooling and unify benefit formula CAS Annex B1O Page 16 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/IFC/ AAA Other Donors MIGA/GEF Facilitate continued Municipalities collect pension Support development of analyti- Support to Liaoning Pilot unification and increasing contnbutions, manage pension cal tools and municipal Activity under ongoing coverage of pcnsion accounts/disbursements, and management information Enterpnse Housing and system at the municipal allow for portability systems to further strengthen the Social Secunty Project and provincial levels Municipal contnbution rates are pension system at municipal and increasingly unified within provincial levels provinces and across similar types of enterpnses 3) Develop Functioning Labor MNarkets and Capacity for Managing Labor Dislocation Strengthen market based Improve capacity/quality of Policy advice and building Ongoing Labor Market CEM (03), Policy Notes on labor OECD: TA on enforcing institutions and services employment services forlob national and local capacity to Development Project and issues (03-05) labor laws, devt of social seekers adapt to change SOE Reform Projects protection programs for laid-off workers Improve effectiveness of Evaluate ongoing programs and Advise govemment on retraining and re- introduce demand-dnven and improving effectiveness and employment program demand-side financing in develop capacity for monitonng retraining and evaluation Support Job Creation & IFC capacity building and ADB: SME Business SNME Development for funding to SMEs in Advisory Support Disadvantaged Areas & lagging areas via China EU Enterpnse Reform Vulnerable Groups Project Development Project for SME Devt Empower the vulnerable Skills development and Provide support and opportunity Facility in Chengdu and OECD SME devt group through skill entrepreneunal training for to the vulnerable group for nsk Sichuan Investment Fund policies piloted in development unemployed and laid-off coping sk ills and employment JSDF Grant - Empowenng Chongqing workers, especially women Poor Women Improve access to capital, Capital and skills for small Direct support to the target opportunity for business creation groups for SME development employment/enterpnrse II.E. Improving Strengtlieii financiiig, Continued reduction in the Advise on anti-poverty strategy Poor Rural Communities Rural Poverty Study (FYO1), ADB NGO Partnerships Targeted Poverty targeting and numbers of those in absolute and policies and on effectiveness Development (FY04) Netherlands TF Study on New for Poverty Reduction Reduction effectiveness of anti- poverty in both rural and urban of poverty reduction programs Ongoing poverty reduction Approach to Rural Development in ADB/Dutch: Poverty Programs poverty programs in areas projects in the southwest, Poverty Counties with Degraded Planning Methodology lagging areas Qinba mountains and the Lands AusAid Chongqing west Research on Income Inequality Issues Comprehensive Poverty Reduced leakage of poverty Assist in promoting better Bank-funded TA for poverty CIDA Fund for Local funds to non-poor targeting and accountability targeting, ASEM-funded TA on Initiatives, poverty reduction projects under poverty reduction Poverty Mapping, Better Monitoring DFID Poor Rural programs Indicators for Social Spending Communities Devt GTZ Poverty Alleviation Projects Japan Japan Social Development Fund UNDP Poverty Reduction ProPects CAS Annex BIO Page 17 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/LFC/ AAA Other Donors I ________________ I I___________________ j M IG A /G EF III. Facilitate an Environmentally Sustainable Development Process III.A. Strengthening 1) Strengthen Revised environmental laws, Advise and help the authonties - Ongoing Environmental FY02 Follow up to Environmental CIDA leading multi- Effectiveness of environmental laws, regulations, procedures, and to strengthen the environmental Technical Assistance Sector Review and related ministenal, donor support for Environmental administrative guidelines legal, regulatory, and Project NGO, donor workshop (FY0 1) CCICED Institutions procedures and institutional framework, and Water Strategy Study (FY0 1) DFID: Supports institutions develop better assessment tools Environmental Administration Study CCICED Environ Econ (FY03), Pollution Cost Model (on- Working Group going) EU: Environmental Mgt Co-op Program Strategic Environmental Impact GTZ Supports SEPA & Assessment development (ongoung) State Council's Intemat'l WBI/Bank training in environmental Envir Advisory Board policy, legislation and NORAD Major support enviromnentally sound decision- to improve envir policy making training & envir mgt tramining Workshop on Clean Air SIDA TA for sustainable devt IDF to strengthen envitonmental UNDP/Sweden Chia laws/procedures/guidelines Human Devt Report 2002 Making Green TA to Strengthen Environmental Devt a Choice Protection in post -WTO Era 2) Improve Pollution Monitoring/Enforcing Clean up major nver Increase municipal sewage and Support sustainable expansion Ongoing Environmental Urban Wastewater Management SIDA Envionmental systems through major solid waste collection and and improvement of urban Technical Assistance (FY02) Monitonng Projects in investment and regulatory treatment, and reduce discharge sewage and solid waste Project Update of Urban Envir Services Kunming and Qingdao programs of industnal wastewater, to management All ongoing new urban Report (FY02-03) iniprove water quality of urban environment projects Water Pollution Prevention Initiative streams and major rivers National Strategy Study for Clean Development Mechanism Improve urban air quality Reduce emissions from coal Support measures for conversion All ongoing energy RAINS-Asia, Phase I & 11 by increasing the use of buming and vehicles, and hence to clean fuel, energy efficiency, projects All ongoing and cleaner energy and reduce ambient air pollution and emission control new urban transport stncter vehicle emission projects control CAS Annex B IO Page 18 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/IFC/ AAA Other Donors NIIGA/GEF Improve enviromnental Increased compliance of Support strengthening of Pilot on environmental enforcement in regulations and their enterpnses with pollution pollution monitonng and control selected municipalities (DEC) enforcement Increase standards, increased collection measures, Provide technical and pollution levies to of pollution levies and sewerage policy advice and finance further Indoor Air Pollution Study provide incentives for tariffs technical support to help increased compliance improve regulations and their enforcement Increase use of economic Increased public awareness of incentives and public environmental quality and participation for pollution improvement programs control and treatment Preserve, rehabilitate and Improved regulatDns for Help identify and finance high improve the use of preservation of built assets pnonty rehabilitation or hentage hentage assets, pnmaniy in partnership Optimized existing assets with other donors III.B. Improving 1) Assisting Conversion Air Quality to Clean Fuels Promotion of cleaner Delivenes of natural gas Support use of natural gas, clean Ongoing Beijing TA on Clean Coal Technologies Vanous Donors: ADB, fuels Increased focus on renewable coal technologies, small hydro, Environment 11 CIDA, UNDP/UNF, energy and energy efficiency in renewable energy sources and WB/GEF Renewable Clean Coal Technology Study (2'd World Bank/GTZ support the i1'0 FYP energy conservation Energy Scale-up Program phase with ESMAP) Clean Development Support for town gas conversion (FY04) and Ongoing Mechanism Initiative through urban environment Renewable Energy Project National Strategy Study on Clean ADB Wind Power Devt improvement projects Ongoing Sichuan Gas Development Mechanism Project, Gansu Clean Project Energy Devt, Coal Bed Integrated Coal Methane Devt Gasification (FY04) Increase gas and Gas penetration to increase from Reduce adverse health effects of Passive Solar Energy for renewable energy 2% in 2000 to 6% by 2010 domestic indoor airpollution Health Climcs (GEF) penetration (IAP) GEF Heating Reform and Energy Efficiency in Buildings (FY05) Renewable energy share to be Judicious support for pnonty Renewable Energy EU: Energy & Environ- maintained at the 2000 level or investments which have low Development Project ment Program for renew- increased (more than 5%) prospects to attract pnvate (restnuctured in 2001 with able energy & natural gas financing in conjunction with focus on PV markets in CTZ Wind/Solar Energy Program to close small and increased penetration of gas and northwestem provinces) in Inner Mongolia, polluting power plants under renewable energy Reduction of Industnal implementation C02 Emissions Improve efficiency of Increase in energy efficiency, Increased financially viable GEF Energy ConservatDn TA/studies in parallel with investment SIDA: Distnct Heating energy use measured in project perfonmance investments thru market -based 11 (FY03) projects Projects indicators mechanisms GEF Heat Reform and Building Efficiency CAS Annex B1O Page 19 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/IFC/ AAA Other Donors MIGA/GEF 2) Providing Efficient Energy Delivery Increase efficiency on the Energy Conservation Law Promote energy efficiency and Jiangsu Wholesale Power PPIAF Study On Pnvate Sector DFID/IBRD/GEF: supply and demand sides enacted and being implemented optimal use of existing capacity Market (in Yixing Pumped Participation in Gas Distnbution Energy Efficiency Storage Project, FY03) (FY2002) EU: Energy & Environ- Tanff gradually increased to GEF Energy Conservation ment Program for energy cover costs of supply 11 (FY03) Study on Power Pncing (FY 2002) efficiency GEF Heating Reform and GTZ: TA for power Energy Efficiency in TA for energy efficiency in the water station technology, Buildings (FY05) sector (FY 2002) energy mgt , rehab of GEF Passive Solar for hydro plants Rural Clinics (FY02) Conversion of coal-fired Trends mn conversion rates GEF Energy Conservation industnal fumaces to Issuance of new standards II (FY03) and ongoing larger, more efficient New standards on coal quahty GEF/WB Energy units Conservation Project Tighten national standards on fuels, engine designs and exhaust emissions Tighten standards on coal quality III.C. Managing - Water conservation Increased water use efficiency - Investments in water saving Water Conservation Water Strategy Study (FY01) ADB urban environment Water Resources technologies and Project (FY01 ) projects and TA for measures Ongoing Wanjiazhai Water Environmental Sector Study (FY01) Legislative Support for - Rational water pncing - Support for improved water Transfer Project Water mechanism pricing All urban/rural water Urban Wastewater Management Sector/Conservancy - Imgation and drainage Increase in imgated area - lmgation and drainage rehab projects (FY02) AusAID Yangtze River system rehabilitation to covered by self-financing water and self-financing water Ongoing imgation projects Flood Control Project increase delivery enterpnses enterpnses for Guanzhong (Shaanxi DFID Water Equity and effliciency, more efficient Province), Anning Valley Yunnan Environmental imgation technologies (Sichuan), Tanm Basin, Devt Projects and water saving IAIL 11 EU Water Resources practices Ongoing Yangtze Dike Conservation Program - Improved flood control Reduction in damages and - Comprehensive flood Strengthemng Project Japan: Many ongoing through dam and dike deaths caused by floods prevention and control program Upper Yangtze Watershed JBIC projects, e g, constnuction Rehabilitation (05), IAIL Water Saving lmgation - Develop water-efficient III (05) in Gansu, model city industnes Hai Basin Management projects for provinces/ - Promote reuse of water -Studies and pilot investments in GEF (04) municipalities throughout - Promote integrated nver wastewater reuse Wastewater reuse China basin management -Investments in nver basin component in Tianjin - Improved water mgmt Urban 11 (FY03) distnbution systems Lake Tai Pollution Control, Pearl River Delta Environment (FY04), Sichuan Urban Devt 11 (FY05) CAS Annex B IO Page 20 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/IFC/ AAA Other Donors MIGA/GEF Water transfer from Ongoing Wanjiazhai Water Yangtze basin to Transfer Project Northem China and development of remaining sustainable water supplies in North Improve water quality Expand urban sewage treatment Help improve planning, design, North China Water Quality Kf%W: Training program through expanded urban to 45% construction, and operation of Management (FY03 -5) for wastewater treatment sewage treatment, environmental infrastructure & plant operations, regulation, and Clean up three most polluted Urban Environmental Management Sewage Treatment strengthened nvers and three lakes, and Bohai Help finance key or model (FY04-05) Projects management of water bay investments SIDA Sewage Treatment resources over nver basin Projects, Flood Control Establish working models for TA, small envir projects wastewater reuse throughout China Ill.D. Managing Promote soil andwater Increase in erosion control and Introduction of integrated Loess Plateau Watershed ADB TA for Land and Natural conservation tn Yellow, decrease in desertification watershed planmung and Rehabilitation Projects I & Implementing Nat'l Resources Yangtze, and Pearl River management, Analysis of 11 (ongoing) Guidelines for Water/Soil watersheds conflicting NRM policies Upper Yangtze Watershed Conservation, Western Rehabilitation (FY05) Region Soii Erosion Rehab Banned commercial Decline in loss of natural forests Analysis of the impacts of the WB/GEF/EU Sustainable Dryland Farming in logging of natural forests logging ban on local Forestry Development Participation in Chuna Environment Northem Region Project in upper reaches of governments, communities, and Project (FY02) Council's task force on AusAID Qinghai Erosion Yangtze and Yellow enterpnses, and promotion of forest/grasslands Control and Forest Rehab Rivers and promote sustainable management and Projects, Chongqing water sustainable protection and protection of remaining natural Participation in the National Working supply/sanitation for poor management of forests Group on forest certification AusAid/UNDP Wetlands remaining natural forests Resource Management Convert steep agriculture Increase in forest and grassland Analysis of the impacts of the CIDA Biodiversity land back to forest and areas in mountainous areas program on local communities Protection/Sustainable grasslands and enterpnses Agric in Inner Mongolia Strengthen management Active management on-the- Investment in umproving Ongoing Nature Reserves Grassland Note (03) EU Natural Forest Mgt of biodiversit y and nature ground technical and managenal Management Project Grassland/Sheep management study Project, Bliodiversity reserves capacity (WB/GEF) Protection Program Lake Dianchi (GEF-MSP) GTZ Pesticide Residue Promote large-scale Increase mn commercial forest Investments in commercial tree WB/GEF/EU Sustainable Participate m GoC/ADB/GEF KfWV: Rural smallholder reforestation for areas and protection forest cover plantations Forestry Development partnership on dryland management afforestation programs ecological protection and along cntical watersheds Project (FY02) and Japan. Ongoing JBIC to meet increasing ongoing Nature Reserves Study on New Rural Development forestry projects, MOFA demands for wood Management Project Model (Norway TF) grants for afforestation Prevent further land Decrease in rate of Analytical inputs into ongoing IBRD/GEF degradation encroachment of deserts and efforts Gansu/Xinjiang Pastoral land degradation Development (FY03) Improve solid waste Shanghai Environment APL (FY03, management FY05) CAS Annex B1O Page 21 of 21 Development Government Progress Benchmarks Bank Group Strategy Instruments Objectives Strategy/Actions IBRD/IFC/ AAA Other Donors MIGA/GEF III.E. Protecting Participate in Multilateral Calibrated Reduction of ODS Support ODS phase-out in ODS-111 and ODS-IV ADB/GEF Shanxi Global Fund for the Montreal consumption and production in wrld's largest remaining Greenhouse Gas Environmental Protocol (MFMP) China by 2010 producer/consumer while Abatement Project, Commons ensunng no accompanying loss Integrated Ecosystem of industnal capacity Management, Program for Land Degradation Participate in Convention Improved conservation of Support access to GEF resources Ongoing GEF projects Ongoing support to MOF to develop AusAIDIUNDP/GEF: on Biological Diversity, biodiversity of global Nature Reserves Mgt, capacity to administer the GEF Capacity building for Convention on Climate significance, reduced Sichuan Gas, Efficient rapid commercialization Change, Convention on greenhouse gases, desertification Industnal Boilers, Energy of renewable energy Combating and land degradation Conservation, Beijing DFILD/GEF Energy Desertification Envir 11, Renewable Efficiency 11 Energy Devt, Energy GEF/PRC: Partnership Efficient Rural Health on land degradation in Clinics, Sustainable Forest dryland ecosystems Development, Energy GIZ Substitution of Conservation 11 CFC in Refngeration Proposed GEF projects SIDA Greenhouse Gas Hai River Basin, Emission Reduction Renewable Energy Scale- Program Up, Integrated Coal UNDP/GEF Wetlands Gasification Combined biodiversity conservation Cycle, Heating Reform & Building Energy Efficiency, Guizhou Medicinal Plants National Strategy Study on Clean Development Mechanism Gansu and Xinjiang Pastoral Development Project - GEF (FY03) Participate in Clean Support CDM process Various Donors: ADB, Development Mechanism CIDA, UNDP/UNF, (CDM) under Kyoto World Bank/GTZ support Protocol Clean Development Mechanism Initiative Participate in Phase out of POPs Capacity building and analytical Training on POPs program Intemational Convention work Case studies on temiite control and on Persistent Organic PCB disposal Pollutants (POPs) I I ADB - Asian Development Bank, AusAID- Australian Govemment Overseas Aid Program, ASEM -Asia-Europe Meeting Trust Fund, CIDA- Canadian Intemational Development Agency, DFID- Department for Intemational Development (UK), EU - European Unmon, GTZ- Gesellschaft fur Technische Zusammenarbeit (Germany), ILO- Intemational Labor Organization, IMF- Intemational Monetary Fund, JBIC - Japan Bank for Intemational Cooperatio n, KfW - Kreditanstalt fur Wiederaufbau (Germany), NORAD - Norwegian Agency for Development Cooperation, OECD Organization for Economic Cooperation and Development, SIDA - Swedish Intemational Development Cooperation Agency, UNDP- United Nations Development Programme CAS Annex C Page 1 of 4 China-Bank Consultations: A Summary of Findings Over the past five years, China and the Bank have exchanged views during five formal consultation exercises that considered various aspects of our work. These included: (a) a 1997 Cost Effectiveness Review that sought client opinions on how the Bank might improve its services and reduce transaction costs for borrowers and the Bank; (b) a consultation in 2000 with China and other Middle-Income Countries on their perspective of the Bank's role and operations and how the Bank could serve them better; (c) a Cost of Doing Business Assessment in 2001 focused on fiduciary and safeguard policies; (d) a meeting with selected project managers from various ministries with the Bank's Regional Vice-President to get feedback on the Bank's activities; and (e) a major consultation exercise carred out in June-July 2002 in conjunction with preparation of a Country Assistance Evaluation (CAE). The views shared during those consultations are summarized below. Cost Effectiveness Review. This consultation, carried out to make the Bank a more results-onented and cost-effective institution, sought the views of China's officials (and those of selected other borrowing countries) on the overall Bank-borrower relationship, areas of strength in the Bank's services to the client and areas where the client would like to see changes and improvements. That consultation indicated that China was generally satisfied with the Bank's work but had a number of concerns. Issues Addressed. * Borrowers sought faster and better support to core services and other aspects ofproject preparation and implementation, which would be facilitated by the devolution of decision- making authority to the field and expansion of the Bank's office in Beijing. Shortly thereafter, the Chma Department was decentralized, and the Beijing office now has a substantial contingent of procurement, disbursement and sectoral staff. * Borrowers sought a new approach to non-lending services, with policy advice delivered with shorter, more quickly prepared reports, prepared by teams of Bank and Chinese specialists. * Borrowers sought new and more concessionalfinancial proclucts to replace loss of IDA (as of July 1999), so the Bank worked with DFID to develop a blending mechanism to reduce the cost of IBRD loans while enhancing project quality. * Borrowers asked the Bank to delegate more responsibility to thefield where staff are more familiar with local conditions. Now, field staff are managing a much larger share of lending and non- lending operations. Other Concerns of Some Borrowers. * That the Bank's institutional policy objectives increase project complexity. The Bank tries to work with clients receptive to policy reform or assists clients to understand the rationale and benefits of reforms. * That the Bank's project preparation process is lengthy and costly. Since the Bank's safeguard policies often trigger such concerns, the Bank often mobilizes grant assistance and encourages clients to prepare required environmental and social protection assessments as soon as possible * That use of expensive international consultants should be judged more rigorously against the quality of their services. The Bank tries to be judicious in determining when such expertise CAS Annex C Page 2 of 4 is critical and will bring important benefits to clients. Client appreciation of such expertise varies significantly. * That Bank procurement guidelines, particularly ICB, cause complications and delays and inefficiencies Many clients, however, also appreciate the benefits of international procurement practices, which have lowered costs and reduced distortions. Consultations in 2000 and 2001. Three different types of consultations with government were carried out in 2001/02. One sought China's views from the perspective of a lower- middle- income country, another looked at the cost of doing business with the Bank, and the third, led by the Bank's Regional management, solicited the views of government project managers in various sectors and provmces. In the course of these exchanges, China praised the improvement in Bank services as a result of decentralization and, in 2002, expressed appreciation for the concessional lending allowed via the Bank-DFID blend. China stressed the importance for increased lending for infrastructure projects to develop its inland areas It also looked to the Bank for a more flexible lending menu, and in the past few years the Bank has introduced new lending products including LILs and APLs. However, China also noted the financial costs of Bank loans, which were seen as increasingly uncompetitive with other financing sources. While China endorsed the Bank's general policies and goals, it noted that their application was sometimes problematic, and suggested developing borrower capacity in these areas. The Bank therefore provides significant training to Borrowers in fiduciary and safeguard areas. In response to a request to hannonize China's and the Bank's safeguard policies, differences in the respective polices were identified and practical solutions to the differences are being discussed. Guidelines for applying various Bank safeguard requirements were also published. In addition, some concerns voiced earlier were repeated concerning cumbersome procurement procedure requirements, excessive loan conditionality, the length and cost of the Bank's project preparation procedures; and the complexity and cost of safeguards policies - despite Bank efforts to the contrary. Country Assistance Evaluation Consultation in June/July 2002. In conjunction with preparation of a Country Assistance Evaluation by OED, a series of consultation workshops were held in Beijing, Liaoning and Zhejiang Provinces on the coast, and Ningxia Hui Autonomous Region in western China. Attending the workshops and sharing their views were representatives of all stakeholder groups - key govermnent ministnes, officials from these and many other provinces, project staff gathered from throughout China, and leaders of civil society involved in economic reform, gender equality, poverty reduction, environment, national minorities, rural development, health, and non-profit agencies. The results of those exchanges are described below. Consultation with Representatives of Civil Society * The Bank's major contribition to China is the transfer of knowledge. The Bank has introduced new ideas, supported refonns and helped to change management systems. * The Bank's support to basic and higher education and the development of science and technology contributed significantly to China's development. CAS Annex C Page 3 of 4 * Inclusion of social assessments in Bank projects is helpful and has improved project design and beneficiary participation. * The Bank used to work only with the government, but in recent years provided support to infonnation sharing and capacity building of China's NGOs. Since NGOs play a complementary role to the government and are more innovative, the Bank should expand its support for development of civil society/NGOs in China, particularly NGOs in western provinces and those dealing with issues such as sustainable development, laid-off workers, urban poverty, AIDS, etc. Consultations with Central Ministries and Agencies, Provincial Government Officials, and Project Management Offices They Value the Bank's Contributions and Procedures * The major benefit is the Bank's advice on policy and management, technology transfer, human resources development, and introduction of knowledge and innovation. * Bank projects also introduced international best practice to China, such as competitive bidding procedures ensuring project quality and cost savings, a project supervisory system promoting successful implementation, use of international consultants, and helpful approaches to enviromnental and resettlement assessment. These all supported changes and reforms in the way institutions function As a result, Bank-assisted projects have higher quality and better management than domestic projects. * The Bank's project preparation cycle, procurement procedures and the stpervision system improve the chances for success. All civil works projects in some provinces have adopted the Bank's project management procedures as standard practice * The Bank's environmental assessment and resettlement policies take a new, thoughtful approach to these issues. * Competitive bidding, whether mternational or national, has reduced mvestment costs to levels much below original budgets. Bank procurement procedures maybe less flexible than for some other donors but they also provide more bene fits. * Bank expertise and the quality of its non- lending services are viewed as high quality. * Bank assistance is particularly valued for health, water resources management, forestry, environmental protection, poverty reduction, and infrastructure. Future assistance was requested in some of these areas and for post-WTO training, rural employment and cross- sectoral studies, * The Bank's decentralization to Beijing facilitated efficient comrmunications, timely Bank responses, and faster loan disbursement. But Some See Room for Improvement, Sometimes in Areas Valued by Others * Project Preparation Procedures. The preparation and approval process for Bank-assisted projects should be further streamlined. Current procedures require borrowers to carry out duplicate tasks and should be harmonized with local approaches. * Project Design - projects sometimes have components that the Borrower does not want and subsequently has difficulties in implementing. CAS Annex C Page 4 of 4 * Procurement procedures should be more flexible. For example, the Bank requires award of contracts to the lowest responsive bidder, which in China might encourage bidders to offer very low pnces to get contracts, with the result that prices must be increased later or quality suffers. * The Bank should reduce the time for reviewing bidding documents by setting a deadline. In the case of procuring computers, borrower problems with the bidding and review process can cause delays and result in the purchase of already obsolete equipment * Use of International Consultants for Project Supervision and TA Components. The cost and benefits of foreign technical assistance were queried, particularly for consultants unfamiliar with China. Borrowers favor use of local experts, given the experience they have accumulated over the past decades. * Chinese collaboration on studies is particularly important to ensure quality and relevance. * Safeguard Requirements are often seen as excessive and complicated * Bank Lending Terms. Representatives of poor western provinces sought concessional financing for projects, particularly those for rural development. * Bank lending terms are not attractive. The front-end fee is too high and a major burden. If indirect costs such as for international consultants and training are included, the costs of Bank loans are higher than financmg from other sources. * Counterpart funding requirements may be too high for poorer provinces. * Loan commitment and front-end fees should be rebated when project components are adjusted and part of the loan is cancelled. * Supervision. While missions are effective and useful, the timing (twice a year) may be too frequent and the length of missions too long. The number of supervision missions should be decided flexibly on the basis of implementation performance, so as to lower costs for both the Bank and the Borrower. * Geographical Focus. While the shift in the Bank strategy to the western provinces is correct, the eastern provinces still need new, innovative ideas, institutional improvements and lessons from the Bank's experience which come from continued lending. CAS Annex D Page 1 of 10 The Bank Group Assistance Program China is in the midst oftwo major transitions - from a rural, agricultural society to an urban and industrial power, and from a centrally planned economy to one that is more globally integrated and market-based. While the results have been impressive, the process is far from complete, and important aspects of the reform agenda have not been fully addressed. These overarching trends - the two historic transitions and growing concerns about the challenges to China's growth - are at the heart of the Tenth Five-Year Plan and also form the basis for the three themes of the Bank's operational strategy for China. That strategy is designed to: * Improve the business environment and help accelerate China's transition to a market economy; * Address the needs of the poorer and disadvantaged people and regions; and * Facilitate a more environmentally sustainable development process. A. Improving the Business Environment and Developing the Market Economy From virtually nothing, the private industrial sector now accounts for about a third of China's industrial and commercial activities, although among the larger enterprises some form of mixed private/public ownership is often the case. Although the current operating environment still leavily favors SOEs, whether m providing access to markets or to finance, government policy has increasingly been directed at advancing the interests of the private sector. Improving the domestic business environment and building institutions to release the full productive forces of a well-functioning, knowledge-based market economy will require stable macroeconomic management and public finance, enterprises - increasingly in the private sector - and banks that are competitive in a global environment, as well as an efficient public sector which is a facilitator, regulator and server of the market rather than its controller. The Bank Group's work on this strategic theme focuses on five - often overlapping - issues: macroeconomic and public expenditure imnagement; challenges posed by China's further integration with the global economy as exemplified by WTO membership; refonn of both the corporate and financial sectors; and strengthening public sector management. Since these issues are often not amenable to IBRD investment lending, our involvement will be largely through an array of AAA activities including technical assistance supported by trust funds and direct financial support to private enterprises/banks provided by IFC. Macroeconoitic Maniagemenet. Macroeconomic advice will continue to be largely client driven, as the Bank Group responds to China's requests for assistance on specific topics of immediate concern. However, more in-depth and longer-gestating analytical work will also be done in areas of particular importance. For example, the Country Economic Memorandum now being prepared investigates the effects of China's accession to the WTO on its economic structure, regional growth and poverty reduction. National and sub-national fiscal issues, considered in a recent Provincial Expenditure Review, will continue to ment attention in view of CAS Annex D Page 2 of 10 the need for improvements in inter-governmental fiscal relations, which currently inadvertently contribute to inequality and create impediments to poverty reduction. Integration withi tde Global Econony. China's WTO accession agreement will open most segments of its economy to foreign competition, and will have profound effects on resource allocation and the efficiency of resource use. Governing rules and institutions, agnculture, services, and some manufacturing sectors are likely to experience rapid and wrenching changes, although the net effect of Chma's WTO accession is expected to be strongly positive for economic welfare both in the country and in the rest of the world. The Bank Group's non-lending program is designed to help the authorities cope with this challenge. This will be achieved partly through strategic analysis of the links between increased globalization, trade policy and poverty, reform of the financial, enterprise, and social protection sectors, commercialization and privatization of sectors that have been dominated by public sector monopolies, modermization of economic laws and macroeconomic management systems and institutions, and steps to improve the investment climate. This will be reinforced by capacity building and technical assistance, including those for the lagging regions. Illustrative of the Bank's support for China's WTO transition and its emergence as a regional and global player is our collaboration with the Ministry of Finance in co-chairing the three-year APEC Finance and Development Program (AFDP). The AFDP - to improve financial intermediation for Regional economic growth, stability and development - combines traming workshops, research, and an annual forum to disseminate research findings. In addition, a dialogue has been initiated recently with the government to explore technical assistance and trainig possibilities to strengthen the anti-money laundering and combatmg the financing of terrorism. Financial Sector Reforot. The Bank Group's involvement m the financial sector buttresses both market development and integration with the global economy. The challenges inherent in transforming China's financial system to meet the needs of the country's increasingly market-oriented economy and to take advantage of the entry of foreign financial services providers under WTO are formidable. The Bank has therefore made a substantial multi-year commitment to support tl- authorities with a wide-ranging program of strategic and policy advice, studies, workshops and support for TA programs. The overall framework includes support to strengthen the policy environment and infrastructure that would help develop more efficient financial intermediaries and capital market. Its ultimate objective is to create more effective market-based channels to link savers/lenders with borrowers/users Given the complexities and magnitude of the challenges, the Bank is annually targeting specific issues within this broader framework - issues seen as critical and receiving high- level attention. This would include anti- money laundering and combating the financing of terrorism (AML/CFT) for which a dialogue has been initiated recently. The program has five pillars: * Overallfinancial sector reform through work outlining the broader dimensions of financial sector development, with the objective of assisting the Govenmment to reach a consensus on a comprehensive sector strategy; CAS Annex D Page 3 of 10 * Banking System Restructuring, covering various aspects of banking system reform, including addressing policy issues that would support the recapitalization and restructuring of the four state-owned commercial banks that account for two thirds of total bank assets and half of all financial assets. This would include assistance to smooth the process of bad debt resolution in tandem with corporate restructuring; * Capital Market Development to assist China in establishing a more balanced financial system to meet its increasingly sophisticated financial services needs. This effort includes support for strengthening the government bond market to facilitate domestic borrowing on sustainable termns, development of institutional investor, adoption of market-based infrastructure finance mechanisms, and improvement in regulation and supervision of the securities industry. IFC will support private financial institutions - such as the emerging private banks, life insurance companies, credit rating agencies, and housing finance institutions - to broaden and deepen the sector; * Finance for Small Finns, which now face limited access to credit and other financial services but are potentially important engmes of innovation, job creation and growth. This is a priority for IFC as exemplified by the newly established facility in Sichuan supporting development of small and medium enterprises (SMEs); and * Rural Finance System Reform to address problems like the high share of non-perfonning loans and poor governance, which restrict rural entrepreneurs' (both farmers' and other rural residents') access to financial services and thereby present a major obstacle to higher rural growth. The Bank will assist China with these problems through studies and technical assistance. The feasibility of channelng project funds through rural financial institutions will also be explored. Private Sector Development antd Enterprise Reform. Similarly cross-cuttmg is the Bank Group's involvement to reform state-owned enterprises and nurture emerging private companies, all in the context of greater competition from abroad and a need to develop China's inland provinces. The Government is subjecting SOEs to greater market discipline and China's commitments under the WTO will materially expand the scope of private sector activities and level the playing field. However, growth in the pnvate sector is constrained by the lack of fully developed legal, regulatory and judicial systems for transparent commercial dealings And in many sectors, the existence of SOEs discourages private entry, restricts competition and reduces the volume of debt and equity financing available to other investors. The Bank Group and IFC would support development of a domestic private sector by. * Improving the business environment by building the legal and institutional foundations for a market economy; * Supporting SOE reforms and ownership transformation in order to improve the competitiveness of domestic firms and expand the scope for private sector activities; and * Promotingprivate sector participation in infrastructure in order to supplement state investment in infrastructure services required by the private sector. CAS Annex D Page 4 of 10 Policy advice and technical assistance will be provided in all three areas. This would include continuation of support for developing more effective institutional arrangements for exercising state ownership rights in large enterprise groups; protecting public shareholders against expropriation by state-owned parent companies; and helping asset management compames manage their holdings in converted corporate equity more effectively. Such issue- specific assistance may well lead to other opportunities to help the Government develop or implement reforms in the areas of insolvency, corporations, securities, mergers and acquisitions and competition law. Other planned efforts include IFC support to Asset Management Compames in structuring international auctions of non-perfonning loans, and a major Bank-IFC study of Private Participation in Infrastructure in China. In the urban and transport sectors, World Bank loans will be used to leverage policy and regulatory reforms and expenment with greater private sector participation, building on the past securitization of Bank- financed expressways (see Box 1). IFC investments will focus on developing model transactions that have demonstration effects, are located in the interior provinces and support introduction of international environmental technology to China. A fuller discussion of the Bank Group-IFC strategy for corporate sector development in China is given in Annex F. Box 1: Leveraging Private Capital from Existing Toll Roads in China During the 1990s, China's demand for capital to finance its highway program triggered an estimated US$12 billion in new highway capital from private sources, without sovereign guarantees This represented about 10 percent of total investment in the road sector Private capital flows peaked in 1996-97 then steeply dropped in the wake of the Asian financial crisis However, private investors are showing renewed interest in road projects Investment came in the form of equity from Hong Kong and the domestic markets as well as creative use of existing toll highways and bridges, including World Bank-funded assets, to leverage new private finance During the 1990s, 20 such asset securitization transactions were completed with the issuance of shares to foreign or domestic investors Total capital raised from these listings exceeds US$2 billion The World Bank participated in five separate transactions which helped pioneer this approach, in which operating road and bridge assets that it had earlier financed were injected into the balance sheets of newly-listed provincial expressway development companies for share listings on the Hong Kong and Shenzhen stock exchanges The procecds were used to build or expand additional expressways in the province The Bank's reputation and assets have contributed greatly to the initial creditworthiness of the listed development companies, and very likely given an added level of comfort to investors as well Governance and Public Sector Maniagement. The Government places a high priority on improving public sector management in the broadest terms, including, inter alia, supporting good governance, strengthening municipal management, improving service delivery by public utilities and reducing fraud and corruption. Bank Group support of such efforts has been in areas in which the Bank has a comparative advantage, and this approach would continue during the CAS period. Government-Bank collaboration would center on completion and revision of economic laws to confonn with WTO standards, judicial reformn and institutional strengthening to help in promoting the rule of law (see Box 2), sub-national fiscal refonn - particularly to eliminate off-budget revenues that are subject to malfeasance, training of public sector staff in international approaches to government administration, and promotion of transparency in financial management and procurement. The Bank would also continue to share with local governments its expertise in countering corruption, and to support activities like the Anti- Corruption Workshop held at the Tsinghua University in April 2002, which the Bank co- sponsored CAS Annex D Page 5 of 10 Box 2: Legal and Judicial Reform in China and Bank Assistance Over the last decade, China has been creating a framework of laws, regulations and related institutions necessary for the transition to a market economy Some legislation enacted earlier in the reforrm period are now being revised to reflect experience (e g, laws on companies, lawyers and bankruptcy) and to comply with WTO requirements Difficulties in implementing the new legal framework have underlined the need for institutional reformns, e g, the incrcased role of the court system in resolving disputes, and the conversion of the legal profession from government offices to private practitioners Judicial reforn was recognized at the 1 5th Party Congress in 1997 Despite certain progress, major reforms are still needed to address such daunting problems as local protectionism, weak enforcement ofjudgments and interference withjudicial independence, and these reforms will require deeper structural reforms outside the court system The Bank has directly supported the gradual devclopment of China's national "economic" laws and regulations and strengthening of key lcgal institutions through an ongoing technical assistance project, the Economic Law Reform Project (ELRP), which has supported the drafting of about 50 laws and regulations, training at 4 legal educational institutions, as well as institutional development at the National Peoples Congress, the State Council, the Ministry of Justice, and now the Supreme Court Bank support during the CAS period would prinimrily focus on legislative drafting of strategically important laws and regulations, developing China Legislative Information Network Systems (CLINS) that will give the government and the public electronic access to Chinese local and national legislation and regulations, court administration and other court reforns, judicial training, and the national judicial exam (unified for lawyers, judges and prosecutors) Good governance in the dealings of local authorities as well as improved standards of public service provision would further benefit from Bank involvement in improving municipal management. Since about 80 percent of China's economic growth originates in cities and towns, national growth objectives would also be served. The Bank has therefore increased support for improving the institutions and infrastructure delivering urban environmental services in both coastal and inland areas, including use of a multi-phased APL in Shanghai to introduce institutional and financial innovations to city management over the next ten years. In the energy sector, we will build on past policy work to help implement the next wave of power sector reforms involving creation of new and separate companies to separate generation from distribution and creation of competitive power markets. B. Addressing the Needs of the Poorer and Disadvantaged People and Regions Over the past decade, Bank Group support for China's development shifted from the increasingly well-off coastal areas to the disadvantaged inland provinces and, within those provinces, to nationally and provincially designated poor counties. The Bank has welcomed the Government's emphasis on spurring development in the particularly disadvantaged western provinces - where most of the very poor also reside - and has collaborated with it on multi- sectoral diagnostic studies identifying investment constraints and skills needs in the west. The findings of those studies were discussed last year at an international seminar aimed at mobilizing donor assistance in addressing the development challenges facing this area. Based on the studies' recommendations and the Bank's particular strengths developed over the years, future Bank Group support to the lagging areas - both in the west and in the traditional industrial belt of the northeast - and for the poor will focus on the five cntical areas of employment generation off CAS Annex D Page 6 of 10 and on the farm, infrastructure provision, human development, social protection, and targeted poverty interventions: Enhaancing Employment anid Productivity Off and On the Farot. China's agricultural sector faces challenges such as WTO accession, insufficient technological change for production of hlgh- value, high-quality products, inadequate marketing infonnation, unclear land use rights, inadequate financial services, and environmental degradation. The Tenth Plan aims to correct some of these deficiencies, and the Bank will assist with investments to demonstrate improved approaches to hlgh- value, diversified agricultural development, natural resource management, watershed rehabilitation, and agricultural research addressing China's specific needs. Analytical work will focus on issues related to WTO accession, agricultural market institutions (farmers' associations), livestock production, water resource use, and rural credit, among others. This includes continued support in addressing relevant tax and fiscal policies, issues of providing public and private financial services in rural areas, and land tenure issues. Private economic activity was the main engine of growth in the coastal provinces but lags far behind in the western region. Promoting private investment and private entrepreneurship in the west has thus been a key Bank-IFC objective. In addition to Bank-IFC support for enterprise reform described above, IFC has taken an mnovative approach by providing targeted assistance to Sichuan Province through investments, support to improve the environment for SME investment as well as establishment of a Fund for this purpose. With the expenence gained, IFC is now working in another western province, Shaanxi, to assist the province attract FDI and develop a pipeline of potential investments. Improving Transport Links for and to Lagging Regions. Economic development of the lagging provinces will depend on improving their transport sectors in order to lower transport costs and gain a competitive edge in China's major domestic markets on the coast. Currently, however, transport in the interior provinces is inadequate in terms of infrastructure scale and quality, service efficiency, institutional structures, mul4- modal arrangements, and competitiveness. These deficiencies have been magnified with China's entry into the WTO, which will end protection of the inland provinces' outputs of coal and minerals and the manufacture of industrial and consumer goods. Once protection and rail subsidies are removed, it will be possible to import most products in the fast-growing coastal markets more cheaply than they can be delivered from inland provinces. Thus, without a substantial reduction in transport and other logistics costs, regional development will face an uncertain future. The Bank Group program addresses these challenges with investments in roads, inland waterways and the railway, upgrading of local transport institutions, and, starting with a study of Trade, Transport Services and Logistics, improving transport logistics. Hunman Development. China and the Bank have addressed increasing regional disparity in educational attainment through a series of basic education projects in poor areas, higher education reform involvmg tertiary institutions in poorer areas, and - recently - expansion of the Global Development Learning Network to China's western provinces. Currently under preparation in collaboration with DFID is a Basic Education Project targeted on the poorest communities in five western provinces to increase access to primary schooling among ethnic minorities where enrollment rates have lagged behind. Based on the findings of ongoing Bank studies such as one on Skills Needs for Competitiveness with a focus on the lagging regions, a CAS Annex D Page 7 of 10 program of future support will be identified. Health and other social service delivery to disadvantaged groups would be supported under ongoing lending, including a recent TB Control Project which supports a national program to eradicate TB in China over the coming decade. Future financial assistance, in partnership with other donors, is likely to focus on the deteriorating health situation in rural areas, emerging concerns such as HIV/AIDS and rural water supply and sanitation. These efforts are being supported by some ongoing TA programs, notably with support of the Asia-Europe Meetmg (ASEM) Trust Fund, and policy studies addressing the quality and financing of social services both in rural and urban areas. Social Protection. The lack of a national social safety net puts vulnerable groups in lagging regions, including the vulnerable northeast, particularly at risk. The Bank has been supporting the Government's search for an appropriate national social protection system through very well-received policy advice on pension reform, training in long-term pension system analysis, development of labor market information systems, and technical assistance and lending for labor redeployment During the CAS penod, the Bank will continue analytical support and policy advice on these issues and will provide financing and TA to the Government's primary pilot program for social security reform, which is being implemented in northeastern Liaonmg Province, an area with substantial labor retrenchment and pension liabilities. Targeted Poverty Reductioni Efforts. Assisting China's rural poor continues to be one of the Bank's main objectives. However, as indicated in various studies, most notably Overcoming Rural Poverty (March 2001), done jointly by the World Bank, China's Leading Group for Poverty Reduction and United Nations Development Programme, helping the poor has become more difficult since a constellation of factors contribute to their plight. The lessons of China's experiences in reducing poverty will be the focus of a global conference on poverty alleviation planned for later next year in Shanghai. By showcasing China's successes with the similar successes in other developing countries, it is hoped that best practices will be shared and national efforts can be scaled up accordingly. Focusing on individual problems in a range of poor areas, as in our basic education, childhood vaccination, roads or rural water supply projects, is one instrument in the Bank's anti- poverty toolkit. Another - and a very effective one - is addressing a range of problems in a limited geographic area. Working in collaboration with China's Leading Group for Poverty Reduction, the Bank has found that one of the best means of assisting the poor is to take an integrated, multi-sectoral approach to assisting areas of severe poverty. This approach - which benefited about three million people under the recently completed Southwest Poverty Reduction Project and millions more under several ongoing projects - is being further refined with the Poor Rural Communities Development Project to begin next year. The latter aims to improve livelihoods security and achieve sustained participation of the poorest rural people in targeted poor counties in four western provinces. The project would improve on previous interventions by introducmg a participatory approach to project design, implementation, monitoring and impact assessment. C. Facilitating an Environmentally Sustainable Development Process Economic growth is overwhelming environmental protection efforts in many respects, although China has done many things right in the environmental area over the past decade, CAS Annex D Page 8 of 10 including large-scale afforestation and massive investments to reduce air and water pollution. Some major signs of stress are the following: * land degradation is widespread and increasing - China has some of the worst water-caused erosion problems m the world, the highest ratio of actual to potential desertified land in the world, and rapidly degrading grasslands; * water availability and quality was a critical problem throughout the 1990s, particularly in the north, and is likely to worsen over the next decade, requiring decisive action on the growing problems of municipal wastewater discharges and agricultural emissions; and * while national emissions of major air pollutants, such as sulfur dioxide and particulate matter have declined since 1996, the economy continues to rely heavily on coal and oil, constraining efforts to mitigate acid deposition and carbon dioxide emissions The causes and impacts of these environmental problems are intertwined across sectors and regions in complex ways. In the Loess Plateau area, for example, environmental deterioration and poverty are closely inter-linked, as more than 50 million poor farmers use totally unsustainable fan-ning practices, which has caused one of the highest erosion rates in the world, very low crop yields and high sedimentation of the Yellow River. Water availability and quality problems can only be addressed effectively through concerted actions extending beyond sectoral or regional boundaries, including reforestation of upstreamwatersheds, reduction of effluent and more efficient use of water, among others. Added to these complexities are the environmental protection and remediation aspects of developing the environmentally fragile western region and the environmental implications of WTO accession. The World Bank has a major program of environmental cooperation in China which supports the Government's plan to mainstream environmentally sustainable development in its national development programs. The Bank provides and/or administers assistance in the form of lending and non- lending services, with financial support provided through IBRD loans and Bank-administered bilateral/multilateral grants from the Global Environment Facility (GEF) and the Montreal Protocol (MP). The Bank also works in partnership with the Norwegian Trust Fund for Environmentally and Socially Sustainable Development (NTF-ESSD), agencies including UNEP and UNDP, and NGOs such as the Ford Foundation and World Wildlife Fund. IFC's investments m China are helping companies introduce and improve environmental standards and practices. In addition, IFC has made a number of investments in sustamable forest management which have helped to reduce pressures on Chma's natural forest resources. IFC will continue to support the development of China's enviromnental industries through investments in a range of projects, including those bringing international environmental technology to China, as well as those that manage wastewater and sewage treatment plants. IFC will also, as it does globally, seek to help investee companies find profitable opportunities to reduce waste and emissions. The Bank program to be carried out during the CAS period is shaped by the findings of a major study, China: Air, Land and Water -Environmental Prioritiesfor a New Millennium, which was completed in 2001 by China's State Environmental Protection Agency (SEPA) and CAS Annex D Page 9 of 10 the World Bank. Based on the study's analysis, Bank support for China's environmental agenda would have five main dimensions: general institutional issues, protecting and managing air, land and water resources, and cooperating with institutions protecting the global commons. Strengthening the effectiveness of environomental institutions. The broadly rangmg Bank program of support includes technical assistance and training in environmental administration and regulatory reform, strengthening of SEPA's technical capacity for environmental enforcement and management related to WTO accession, strengthening of enviromnental impact assessment procedures, development of a pollution cost model for China, and - with WBI - providing traming in environmental policy, legislation and environmentally sound decision-making. Inproving air quality. In the near term, Bank Group support would focus on: development of clean coal technologies and expanded use of renewable energy sources that decrease dependence on high-sulfur coal; promotion of energy use efficiency for heating and in buildings; stricter vehicle emissions controls supported under urban transport projects; and continued involvement in the Acid Rain and Emission Reduction in Asia (RAINS-Asia) program to help policymakers and researchers anticipate effects from acid depositions resultmg from sulfur dioxide emissions and identify cost-effective control options. Water resource nianagemnenit. China is improving its water resources management through actions like finalizing revision of the Water Law and highlighting water management in the Tenth Plan. Bank assistance on this issue will be governed by a Country Water Resources Assistance Strategy developed jointly by the Ministry of Water Resources (MWR) and the Bank. Key activities will include: a North China Water Study, recommending initiatives to address severe water shortage in the area and following up on a Water Sector Stuidy prepared last year; TA in integrated river basin management; a Water Pollution Prevention Initiative; projects taking a river-basin approach to water management - for Upper Yangtze Watershed Rehabilitation (FY05) and Hai Basin Water Resources Management (FY04; GEF-funded); wastewater treatment in Shanghai, Liaoning, and the Pearl River Delta under urban environment projects; wastewater re-use under a proposed Tianjin Environment Project; and implementation of ongoing projects for Water Conservation in northern China and Water Transfer in Shanxi. Managing land and natural resources. Proposed Bank Group lending for watershed rehabilitation in the Upper Yangtze and Upper Pearl River Basins, sustainable pastoral development, and ongoing project support for, among others, sustainable forestry, rehabilitation of the Loess Plateau and a GEF-funded Nature Reserves Management Project will address several of China's most critical land degradationand natural resource problems. Complementing this will be continued Bank Group support for various influential groups, such as the China Environmental Council's Task Force on Forests and Grasslands in western China. Upcoming work for the Task Force will focus on analyzing key issues for reform of China's forestry sector, including land tenure insecurity, tax and fiscal policies, and forest resource management and marketing regulations. Land protection will also be addressed in the Alternative Rural Development Model and technical assistance following up on findings of Air, Land and Water. Protecting theglobal environmenttal conmlmonis. The Multilateral Fund for the Montreal Protocol (MFMP) and, to a somewhat lesser extent, the GEF have made significant contributions CAS Annex D Page 10 of 10 to addressing global environmental issues in China. The China MFMP program (US$323 million) is the biggest in the world. About 67,000 tons of ozone-depleting substances have been phased out under the program, which far exceeds the combined perfonnance of all other signatones to the Montreal Protocol. Most GEF-funded investment - US$128 million - has been for greenhouse gas reduction projects, but an additional US$30 million went to biodiversity conservation. During the CAS period, further GEF support to China totaling almost US$120 million is proposed for renewable energy development, energy conservation, energy efficiency of buildings, integrated river basm water resources management, land degradation and biodiversity restoration in the western region. Discussions are also underway on China's participation in three additional global programs: the new Prototype Carbon Fund (PCF), a Bank-administered pilot program to assist participants prepare green house gas reduction projects and market carbon credits on the global market; the Clean Development Mechanism (CDM) under the Kyoto Protocol; and the Program for the Phase-out of Persistent Organic Pollutants (POPs). D. A Cross-cutting Theme: Urban Development and Environment As the 1 0th Plan recognizes, urban development holds a key to China's economic growth and equity. Cities and towns generate over half of the national product and over 80% of growth, but the relatively small urban population - at some 36% of the national total - is growing slowly and increasing the large rural-urban income gap In addition, decentralization of fiscal authority and economic management functions to urban areas makes local governance important for Bank support. The Bank will therefore expand assistance to development of small and medium-sized cities and towns and to provision of jobs for the urban unemployed and the large pool of rural surplus labor. Such urban development will be a necessary ingredient for the development of the western provinces. Along with actions under projects, policy studies and TA will be carried out on urbanization, finance, and planning and management, along with more technical mfrastructure studies and knowledge-sharing. The Bank will particularly extend assistance in four urban development needs: (a) Next Stage of Utility Reform: toward more efficiency and sustamability via support for improved monitoring and regulation, financial innovations, asset management, and private sector participation; (b) Addressing Urban Poverty: an increasingly important issue as a result of economic restructuring, migration, and urbanization of rural areas; (c) Beyond Individual Cities: supporting small cities and semi-rural areas, the most dynamic yet the most needy part of the urban system, and recognizing the fact that most environmental issues needs to be addressed at the scale of river basms and/or larger metropolitan areas; and (d) Broad urban management and policy: increased assistance for central policy formulation, city-level strategic planning, and learning among cities, in search of new ways of managing the urbanizing economy. As this assistance agenda broadens, the cross-sectoral integration will increase. CAS Annex E Page 1 of 3 Global Goals and Corporate Priorities A. China's Progress with Respect to the Millennium Development Goals The Millennium Development Goals (MDGs) as formally endorsed in September 2000 by the member countries of the United Nations, focus on developing countries' achieving eight goals and targets by 2015 (UN Millennium Declaration, September 18,2000) China is currently on course to achieve most MDGs by 2015 Goal): Halve the proportion of people living in extrenme poverty between 1990 and 2015 Good progress being made During 1990-99, the number of people with consumption of less than US$1 a day fell from 368 million to 235 million An estimated further decline will be confirmed by an ongoing household survey. Similarly, using China's more austere poverty line of US$0 67 a day, its poor population went from 250 million at the end of the 1970s to 30 million in 2000 This success resulted from overall economic growth, the Government's National Poverty Reduction Plan begun in 1992 to wipe out poverty by the year 2000, and substantial government funding of poverty alleviation prograrm in 1994-2000 Despite the progress, results varied by region, with the most success in high-growth coastal provinces but sluggish progress in the central and western regions The Government therefore launched a Western Development Initiative to narrow regional disparities, while a new National Poverty Reduction Plan for 2001-2010 takes a more comprehensive approach with better targeting The World Bank continues to assist this effort with, inter alia, targeted projects for poverty reduction, rural health and basic education, lending concentrated on lagging regions, studies on ways to accelerate growth in those provinces, and TA to improve poverty targeting. Goal 2: Achieve universal access to primnary educationt by 2015 Excellent progress is being made The net enrollment rate in primary education went from 97.8% in 1990 to 99 1% in 1999 Again, regional disparities exist, particularly in poor, remote and/or ethnic minority areas in western China The Government has funded a range of initiatives to improve education access and quality, and the Bank is assisting through sub-national fiscal studies to address education funding problems in poor areas, multi-sectoral poverty reduction projects and stand-alone basic education projects focused on educating the poor, girls and minorities in the western provinces, and support to bringing the GDLN to all western provinces Goal 3: Elimniniate gender disparity in primary and secondary education by 2005. Good progress is being made in basic and junior secondary education The national ratio of girls to boys is now over 90% for primary education but lower for secondary education since China's nine-year compulsory education policy covers only up to the junior secondary level Progress at the higher secondary level has also been made The good results on basic education for girls should continue as the Government gives emphasis to helping pupils from extremely poor families to attend school World Bank support for this goal includes education projects focused in part on girls' education in poor, western areas and efforts to mainstream gender considerations in project design Goal 4: Reduce mortality of children under -five by two-thirds between 1990 and 2015. Good progress being made Infant mortality went from 50/1,000 live births in 1990 to 32 in 2000 Reaching the target of 17 would bring China into the ranks of middle-income countries The main obstacle is the need for rural health insurance. The Bank is assisting through projects aimed at child health, including basic inoculations, and support for developing rural health insurance Goal 5: Reduce the miaternial mortality rate (MMR) by '/4 by 2015 Good progress being made The MMR was almost halved from 1990 to 1998, going from 95 deaths per 100,000 deliveries to 56/100,000, and the proportion of women of child-bearing age with access to contraception is 83% Concerns exist, however, that the transition to a fee-based health care system has halted the decline in MMR in the western provinces and rural areas The Government aims to improve rural primary medical care, and the Bank supports women's health with projects for maternal and child health, rural roads to facilitate energency transport and assistance in overall development of the Western region Goal 6: Combat lIl V/AIDS, malaria and other diseases Progress is likely on TB and malaria, but rates of HIV/AIDS will probably not decline by 2015 since the disease is only now entering the period of rapid spread Control is made difficult since HIV/AIDS is concentrated in porous border regions, where drug users and migrants cross back and forth The Government has a control program that can combat the rising incidence, but a broader strategy is needed TB prevalence has declined but better results could be achieved by fully implementing the CAS Annex E Page 2 of 3 WHO-recommended DOTS strategy The Bank's TB Control Project supports this effort HIV/AIDS is also addressed in a current Bank project Goal 7: Improve the environimient by imiplemilentinig latiollal strategiesfor sustainable development by 2005 (so as to reverse the loss of environmiienital resources by 2015). Progress is being made While no national strategy exlsted in 1990, China now has such a strategy and sustainable development is a strategic focus of the Tenth-Five Year Plan (2001-2005) Still, the widespread environmental degradation that accompanied economic growth will require concerted action by the Government and its development partners The Bank is helping in this effort through major studies of problems, TA to strengthen environmental institutions, cooperation with other institutions involved in protecting the global commons, and projects for urban environmental management, sustainable rural development and land management, renewable energy and energy conservation, innovative water management improvements, and watershed rehabilitation Goal8: Develop aglobalpartiiershiipfordevelopmenit Progress is being made. China's accession to the WTO will accelerate further its global outreach and have broad effects on all aspects of its development The Bank is assisting this process in various ways, including support to expansion of the Global Development Learnig Network in China China is already a founding member of the Global Gateway Foundation B. Alignment of China CAS with Corporate Priorities The Bank's corporate priorities are outlined in the Strategic Directions Paper i under two groups the Corporate Advocacy Priorities (CAPs) and the Global Public Goods Priorities (GPGPs) CAPs are defined as the "the critical enablers of poverty reductiol that the Bank is particularly well-qualified to champion by sharing knowledge (both research and experience) and building awareness with clients, development partners, and other stakeholders " They build on two key pillars of the Strategic Framework Paper (a) building the climate for investment, jobs and sustainable growth and (b) empowering poor people to participate in development and investing in them Regarding the first pillar, the CAPs advocate that the Bank should play a catalytic role in improving investor confidence and boosting private sector investment With reference to the second pillar, the CAPs advocate treating clients as participants rather than recipients of development aid The China CAS plans to support policy and institutional reforms as outlined in the Government's Tenth Five-Year Plan to create an environment conducive to investments by the private sector And, by supporting widely ranging human development initiatives and increased participation in the development planning process, it helps to make development recipients into participants Table 1: Corporate Advocacy Priorities and their Alignment with the CAS Corporate Advocacy Priorities CAS Strate CAP 1: Building the Climatefor !nvestlnent, Jobs and Sustainiable Growth Investment Climate Improving the Business Environment The CAS * Support for urban and rural development supports macroeconomic stability, sound fiscal * Infrastructure services to support private sector management, establishing a business environment development suitable for global trade, financial sector reform, * Regulatory reform and competition policy private sector development and reform of the * Financial sector reform enterprise sector, improvements in public sector Public Sector Governance management - through tightened governance as well as legal and judicial reform, and delivery of public , Rueo Lw( At-oruto)services - by cities and utilities - that meet commercial * Public administrationi and civil service reforn standards (mcl Public expenditure accountability) Addressing the Needs of the Disadvantaped The * Access to and administrationi ofjustice judicial CAS supports rural development, particularly in the reform) disadvantaged lagging regions of western and central China World Bank, Strategic Directionsfor FY02-04 Implementing the World Bank's Strategic Framework, March 28, 2001 CAS Annex E Page 3 of 3 Corporate Advocacy Priorities CAS Strategy CAP 2: Empowering Poor People to Participate in Development and Investing in Them Empowerment, Security and Social Inclusion Addressing the Needs of the Disadvantaged The * Gender mainstreaming, civic engagement and CAS supports human development and social participation protection, with an emphasis on developing a national * Social risk management (mcl risk mitigation) social protection system, girls' education, skills Education development for competitiveness in lagging arcas, and * Education for All- with emphasis on girls' health care aimcd at communicable diseases, mothers education and children and provision of basic infrastructure to * Building human capacity for the knowledge poor areas economy Improving the Business Environment The CAS Health supports China's development of a knowledge economy as It continues its integration with the global * Access to clean water, air and sanitation by poor economy people * Maternal and child health care The second group of corporate priorities focuses on the global public goods priorities (GPGPs) These require a relatively higher level of intcrnational coordination since they involve extcrnalities, and the succcss of achieving them will depend on the extent to which global programs are implemented at the country level. Table 2 lists the GPGPs and their alignment with the CAS Table 2: Global Public Goods Priorities and Their Alignment with the CAS Global Public Goods Priorities CAS Communicable Diseases * HIV/AIDS, tuberculosis, malaria and childhood Addressing the Needs of the Disadvantaged The CAS diseases, mcl the relevant link to education supports improving the access and quality of health * Vaccines and drug development for major services for the poor TB Control and childhood communicable diseases in developing countries vaccination projects are ongoing Environmental Concerns * Climate change, water, forests Facilitatine Environmentally Sustainable * Biodiversity, ozone depletion and land Development The CAS supports improving air and degradation water quality, countering land degradation, and * Promotion of agricultural research protecting the global environmental commons Addressmg the Needs of the Disadvantaged The CAS supports agricultural research A project for this purpose, for needs of poorer areas, is being prepared Trade and Integration * Market access Improving the Business Environment The CAS * Intellectual property rights and standards supports establishing the policy and institutional framework needed for China's continuing global integration Information and Knowledge * Redrcssing the Digital Divide and equipping Addressing the Needs of the Disadvantaged The countries with the capacity to access knowledge CAS supports using the GDLN to promote * Understanding development and poverty development of China's lagging areas. The Bank reduction helped establish two GDLN centers in the west and is helping the govcrnment find additional funding for other centers International Financial Architecture * Development of international standards Imprroving the Business Environment Thc CAS * Financial stability (mcl sound public debt supports financial sector reform and development, management) public debt management, accounting and legal * International accounting and legal framework refonm. Policy advice and lending in all these areas are ongoing CAS Annex F Page 1 of 10 China Private Sector Development Strategy China is undergoing a major transformation. Over the past decade, the economy has made the transition from complete reliance on state-owned and collective enterprise to a mixed economy where private enterprise also plays a strong role. China is emerging as a global manufacturing powerhouse and as the world's top destination for foreign direct investments. China's nse to economic prominence is not without its nsks, however The extent to which China can realize its great promise will depend to a large extent on decisive actions to resolve structural weaknesses and improve the business environment for private enterprise. This annex provides an overview and analysis of key developments in China's enterpnse sector and outline the Bank Group's strategy in this area. I. China's Enterprise Sector: Restructuring and Organic Growth The size, structure and performance of the Chinese private sector are shaped by two increasingly interrelated processes: the restructunng and ownership diversification of the state sector and the organic growth of China's de novo private sector. 1.1 Painful Enterprise Reforms Over the last three to four years the reform of China's state enterprise sector has accelerated and has acquired some qualitatively new features. First, the scale of change has expanded to affect almost every kind of State-owned Enterpnse (SOE) - small, medium, large and very big, under both central and local control. Second, the role of the wholly state-owned non-financial company has declined substantially in many areas. Third, the range of restructuring mechanisms being used has expanded dramatically to include bankruptcies, liquidations, listings and de-listings, debt-for-equity swaps, sales to private parties - domestic and foreign, auctioning of state firms, their assets or liabilities, standard corporate governance technmques, etc. Finally, mass layoffs, something unheard of just four or five years ago, have become a widespread phenomenon. At the grassroots level, local governments have been particularly active in implementing corporatization and ownership diversification in SOEs, taking the most decisive actions to grapple with the financial burdens and unemployment pressures resulting from loss-making SOEs. More than 80 percent of small- and medium-sized SOEs have been transformed through corporatization, liquidation, bankruptcy, leasing to private parties, and sales to insiders and outsiders. Local governments' approach to divestiture of state assets is influenced mainly by concerns to minimize immediate budget outlays on unemployment insurance, minimum living allowances and pensions related to layoffs, early retirement and laid-off (xiagang in Chinese) workers. This is not necessarily conducive to a process of meaningful restructunng and leads to significant regional variations in the extent and depth of restructuring. Most of the SOEs that are being sold to insiders remain over-leveraged and overstaffed. In instances where outsiders with money and ideas have taken over some of these SOEs, we do see positive and rapid changes. However, in many cases the problems have been postponed, but not solved Hence, although the process of ownership diversificationlprivatization is likely to be formally completed over the near term, the restructuring challenge will remain and will take longer to resolve. Regarding larger SOEs, more than 1,200 companies have been listed over the last decade. Their market capitalization is about 60 percent of GDP and they have about 65 million individual shareholders that have become more assertive over the years. A significant challenge is preventing parent SOEs from expropriating minority shareholders through related party transactions. The regulator - China Securities Regulatory Commission (CSRC) - has stepped up efforts to strengthen corporate governance practices among Chinese listed companies. Of systemic importance for China is the process of divesting state assets through the initialpublic-offenng (IPO) process to fund the national social secunty system. CAS Annex F Page 2 of 10 Some restructuring of SOEs is expected to occur through the four Asset Management Companies (AMCs) which have been created to takeover more than US$170 billion in non-performing loans from the four big state-owned banks As part of their program, 580 SOEs accounting for about 40 percent of the state sector's assets and sales have been selected for debt-equity swaps The AMCs have emerged as important and often majority shareholders in a number of large SOEs The AMCs have multiple objectives; the desire to maximize immediate financial retums to Government may conflict with the need for meaningful restructuring of fimis in their portfolio. Recent regulatory measures, however, making it easier for foreign investors to buy significant and controlling shares in SOEs, are likely to expand the exit options for these AMCs and create more opportunities for diversification of state ownership through the AMCs. The Government has been implementing industry rationalization programs in a number of industries, closing obsolete plants and reducing capacity to combat oversupply and deflationary pressures The initiative has so far shown mixed results. In many industries such as glass and textiles, for each unit of closed capacity several additional units have been created. This demonstrates the difficulties the Govemment is facing in fighting against market forces. In the present business environment, these market forces are not necessarily sending signals that are consLstent with economic efficiency, given still rampant local protectionism resulting in market fragmentation. In the strategically important infrastructure and energy sectors, while the regulatory framework is still evolving, monopolies have been broken and competition introduced, many companies corporatized and some listed in China and internationally. China has nurtured over 20 giant corporations and conglomerates that have proven competitive in the international market. Some of these companies are laying off tens or even hundreds of thousands of employees, not because they are in a financial distress- in fact some of them are hugely profitable-but because they want to position themselves as important international players. As of last year, the top 12 Chinese transnabional corporations, mainly SOEs, controlled over US$30 billion in foreign assets with some 20,000 foreign employees and US$33 billion in foreign sales. This process of transformation of China's state sector has been, and will be, socially panful. Some 25 5 million SOE workers have been laid off since 1998, and according to official government statistics, 8.7 million of these have not found new jobs. The practice is so widespread that almost every SOE has laid off employees. This has quite understandably led to social discontent. The number of labor disputes of all kinds has been increasing. Two economic factors have emerged with cntical importance for alleviating the social cost of restructuring development of the national social security system (there has been a significant increase in central budget expenditures on social security in recent years: from 1 percent in 1997 to 6.3 percent in 2002), and promoting the growth of the new private enterprises to absorb laid off workers from the state sector. 1.2 China's Private Sector: A Growth Engine That Shouldn't Be Taken for Granted From very humble beginnings in the early 1 980s, the private sector has emerged as the most dynamic component of the Chinese economy in the 1990s. While the role of state firms and collectives has declined, output and employment by private domestic finrs have been growing rapidly. In recent years, new employment in the private sector has exceeded the combined total for state, collective, and township-and-village enterprises. Today, the pnvate sector has come to be viewed notjust as an appendage of the state economy, but rather as a key player in the reform process. The private sector has grown to a stage where it is populated by firms at different levels of development Most of the domestic private enterprises are smaller and younger than their counterparts in the SOE, collective, and foreign-invested sectors, although some private firms have reached a size CAS Annex F Page 3 of 10 comparable to the size of large public state-owned enterprises. There are significant regional disparities regarding private sector development in China, with the inland provinces lagging behind coastal areas in tenms of domestic and foreign private investment. In terms of industries, private enterprises play a much more important role in some labor-intensive service sectors - such as retail, catering, and construction - than in the manufacturing sector. There is a marked shift away from manufacturing: while in the late 1980s and early 1990s, almost 70 percent of all private enterprises were in the manufacturing sector, by the late 1 990s this was reduced to less than 40 percent. In contrast, the services sector is growing increasingly important, reaching a combined share of 55 percent of all private enterprises. This shift reflects the competitive advantage of private enterprises in the services sector as a result of low entry bamers, relatively small capital requirements, and responsiveness to customer demand It may also reflect problems with over-capacity and crowding out in the traditional manufacturing sectors. However in some of the more strategic sectors such as banking (see Box 1), airlines and port operation sectors, the participation of private enterprises is negligible. Box 1: Negligible Private Sector Presence in Financial Intermediation At present, ownership structures of the real sectors do not align with those of the financial sectors Despite the existence of a large number of othier financial institutions and the growing number of private or near-private banks, the state-owned commercial banks' share of deposits and assets continucs to be overwhelming This contributes to the current disparity between the share of the private sector in the economy and its share in credit allocation while the private sector accounts for about 40 percent of the economy it absorbs only 15 percent of total credit Non-state banks like Minsheng Bank, the Development Bank of Shenzhen and Everbright do not face the challenges that the Big Four banks face These non-state banks tend to intermediate capital without much political interference Although small, these non-state banks are well positioned to fill a number of niches such as providing better retail banking services and catering to the needs of small- and medium enterprises (SMEs). They can be a catalyst of change in banking regulations in China because they provide evidence to policy leaders that banks in China can be run the right way-with good standards of corporate governance, risk management and incentive structures However, the growth of private banking and non-banking financial institutions is constrained by serious structural as well as internal obstacles The 5 percent tax on gross revenues, limited tax deductibility on losses and the lack of reliablc access to a Renminbi interbank market make it difficult for banks to achieve profitability Internally, the new private financial institutions nced to strengthen their management structures, corporate governance practices, and risk management capacities Domestic private companies are exposed to greater market discipline includtng bankruptcy or closure. This is a major difference relative to SOEs, whlich historically have not faced a market-based threat of bankruptcy or closure. An important implication of this is that the performance of the private sector is more volatile than that of other segments of the Chinese economy'. On one side, this is simply a restatement of the fact that private firms are subject to exit discipline, and are younger and smaller than other firms. But it also reflects the fact that other sectors of the economy and particularly the state-owned sector react more slowly, if at all, to business opportunities and exit pressure Because most of the pnvate enterpnses grew up in a period when the Govemment's commitment to the private sector was weak and the benefits (in tenms of better access to bank financing or listing) of being more formal were practically non-existent, the domestic private sector is organized in a very informal way. Many enterprises possess only the vaguest of property nghts, corporate govemance mechanisms, and financial records. Related to the issue of informality is the extent of diversification in the domestic private sector. Chinese private companies, not unlike those in other Asian economies, are I For example, the volatility of the UBS Warburg China private chip index is on average 1 5 times higher than the volatility of the Hang Seng index and is significantly higher than the volatility of Chinese SOEs and govemment-affiliated companies listed on the Hong Kong stock exchange CAS Annex F Page 4 of 10 often part of complex groups of companies, spanning many different activities. They show quite a high degree of diversification, even at relatively small sizes. The excessive diversification can be understood partly as a defensive mechanism in a hostile environment in the past, partly as the result of a deliberate effort to become more opaque, and partly as the result of poor business judgment and decision- making. The high degree of opacity makes it very difficult for outside investors to protect themselves against expropriation through related party transactions. However, there are private entrepreneurs that have reached a stage in their development where they are ready to invest in becoming more formal. With further progress in reforms and the associated higher benefits of formality, the shift from informal to a more formal way of doing things in the private sector is likely to accelerate. Chinese pnvate companies are the most dynamic players in the economy, but they face tough challenges in the current business environment, and their continued growth cannot be taken for granted without continued progress in market reforms. The majority of domestic private firms face difficulties accessing intermediated sources of financing. The discrepancy between the dynamism of the private sector and its limited use of intermediated financing suggests that the pnvate sector may not be able to sustain its current rate of growth unless it can increase its access to financing. Even if domestic private companies are able to grow and achieve relatively large sizc, they often find that opportunities for further growth are quickly exhausted by lack of market-driven exit mechanisms, restricted entry in a number of sectors and local protectionism. While there is a gradual but steady improvement in the business environment, entry barriers remain high in China.2 A growing number of private enterprises compete with SOEs that operate under soft budget constraints and have poor compliance with environmental and safety norms. Smce exit mechanisms are underdeveloped in China, excess capacity situations tend to develop quickly and exert downward pressure on profitability. With low margins and declining asset turnover rates, many relatively large Chinese private companies are unable to accumulate enough capital to upgrade their operations. Under significant competitive pressure and facing an uneven playing field, private entrepreneurs tend to actively seek opportunities to circumvent regulations and make themselves less transparent. Deprived of the benefits of scale, firms avoid specializing, and instead diversify into new business lines - local lines, for the most part - simply to insure cash flow. The concem for the future is that to the extent such finrs fail to achieve the benefits of both scale and specialization, they will find it increasingly difficult to partner and compete globally. Sustaining the dynamism of the non-state sector will require concerted actions at several levels. At the enterprise level, Chinese companies need to take on a more sustainable path of development by improving corporate govemance, transparency and disclosure, and by adopting better environmental and social practices in order to enhance their access to intermediated financing and compete successfully in the post-WTO environment. The Chinese financial system needs to develop capacities to serve better the financing needs of private enterprises and to intermediate resources more efficiently toward the areas of growth and job creation. Banks and other financial institutions need to improve their own corporate governance practices, and to develop skills and expertise in areas such as project finance, risk management, and SME lending. To enhance the pnvate sector's access to intermediated financing, the role of private financial institutions in China's financial markets should expand. China's private sector has evolved to a stage where it is populated by firms at different levels of development with different financing needs. In this context, altemative sources of financing need to evolve rapidly, particularly non- banking financial institutions. Finally, at the policy level, the process needs to be supported by continued improvement in the business environment. The Tenth Five-Year Plan commits the Government to improving the domestic 2China's capital requirements for pnvate limited companies are among the highest in the world In a recent Bank survey among 75 developed and developing economies, China ranked 51 in terms of start-up delay, and 43 in terms of start-up cost Some localities have recently undertaken steps to reduce entry costs CAS Annex F Page 5 of 10 business environment, establishing a stable financial system, facilitating modem corporate structures, building globally competitive firms, increasing the scientific and technological intensity of production and narrowing regional inequalities. Through implementation of this strategy, entry and exit regimes should become more market-based and transparent, and domestic private enterprises should be granted national treatment regarding market access, land use, listing, tax treatment and import and export nghts ahead of market opening in the context of WTO agreements. A number of factors influence the extent of private participation in areas such as infrastructure Developing a more favorable legal and regulatory framework would be helpful. Of critical importance for the overall business environment will be to improve commercial legislation regarding investment approvals, credit security, bankruptcy, and use of more sophisticated financial instruments. II. World Bank Group Private Sector Strategy The Bank Group's private sector strategy is an integral part of the overall Bank Group CAS It underpins the three main themes of the Bank Group's operational strategy of improving the business environment and helping accelerate China's transition to a market economy, addressing the needs of the poorer and disadvantaged people and regions, and facilitating an environmentally sustainable development process by supporting rapid development of the pnvate sector in China. 11.1 The World Bank Group Comparative Advantage and Role in Promoting Private Sector Development in China China is facing a number of reform challenges that are more complex and multi-sectoral than before. Private sector issues are intrinsically linked with financial sector reform and development, SOE reform, social safety net issues, and regional disparities. The Bank has a comparative advantage and is typically asked to assist with the most complex institutional and structural issues, many of which address constraints to private sector development. While domestic and .foreign investments in China are high in absolute terms, they are unevenly distributed regionally and there are concems about their quality and sustainability 3 The Bank Group has a comparative advantage in helping to catalyze pnvate investment to the intenor provinces and to improve the productivity of private sector investment by building capacity, assisting government reform efforts, and promoting the adoption and dissemination of sound business practices in the area of corporate govemance, environmental and safety standards, and efficiency of operations This comparative advantage is based on the Bank Group's diverse range of products and instruments suitable for promoting private sector development in challenging environment, its global presence, the Bank Group's leadership in sustainable development, as well as the Intemational Finance Corporation's (IFC's) expenence and track record in investing in the interior of China, in assisting small companies, and its strong presence in the field. IFC's role in China is influenced by the fact that the domestic private financial sector is still very small and that international financial institutions have limited access to the domestic market. In this environment, IFC can play an important role in addressing the needs of the domestic private sector in long-term financing, in supporting the growth and institutional strengthening of domestic private financial institutions and in promoting the opening of financial markets. The Government is seeking to open up many markets to private competition, although often slowly and cautiously, and with a good deal of internal dissent by those who will now need to compete. In this situation, IFC participation has often been sought by both the Government and private investors to serve as an "honest broker" in the early 3The Western regions have attracted only 4% of China's cumulative FDI and the ratio of FDI per capita between the Coast and the Interior is 18 tol CAS Annex F Page 6 of 10 transactions. Speed of liberalization often depends on how successful pioneering transactions are, and IFC has an important role to play in promoting such investments. 11.2 Bank Group Strategic Priorities in the Area of Private Sector Development The Bank Group Program will support Government's efforts to accelerate the transition to a market economy and improve the business environrment. The focus is on the following areas: * Improve the business environment by assisting the Government's efforts to build the legal and institutional foundations of a market economy, * Help deepen and broaden the financial sector and support ownership diversification; * Support industrial restructuring and ownership transformation in order to improve the competitiveness of domestic firms and expand the space for private sector activities, * Support the adoption and dissemination of environmentally and socially responsible and sustainable business practices by the Chinese private sector; and * Promote pnvate sector participation in social and physical infrastructure services. Across all these dimensions of the Bank Group's private sector strategy, special attention will be given to supporting pnvate sector development in the interior provinces of China. The Bank Group will meet these objectives by providing policy advice; technical assistance for revising laws and regulations; and building regulatory capacity. In the water and transport sectors, Bank loans will be used to leverage policy and regulatory refonns and experiment with greater pnvate sector participation. IFC investments will focus on developing model transactions that create demonstration effects and set standards for private sector investments in corporate govemance, international accounting, environmental technologies and practices employed, and efficiency of operations Where appropnate, IFC financing will be supplemented by technical assistance and advisory services to build capacity at the enterprise level and at the level of the regulator. 11.3 Business Environment The goal is to assist the Government in creating a market-friendly legal, regulatory, and financial environment to accelerate further development of China's private sector. The Bank Group will support. improvements in the legal framework and enforcement capacity; greater transparency and consistency of laws and regulations consistent with WTO commitments; and establishment of better incentives at the enterprise level to improve business practices and compliance. The Bank Group's approach will be to maximize synergies between the Bank's expertise in policy advise and IFC's sector-specific knowledge gained through its transaction experience (see Box 2). The specific delivery vehicles are: Supportfor Small and Medium Enterprise Development. TFC has established the China Project Development Facility (CPDF) and Small Enterpnse Investment Fund in Sichuan Province. These facilities will focus on strengthening the capacity of financial institutions to work with SMEs, on training entrepreneurs and on addressing business climate issues for private sector development in the intenor. IFC has recently invested in a financial intermediary utilizing an innovative lending technology to small businesses aimed at relaxing the collateral constraint on SME lending by making it easier to base credit decisions on the use of accounts receivable as collateral, as opposed to real estate, for instance. IFC will continue to explore opportunities to assist similar financial institutions focusing on SME lending. Through policy notes and seminars, the Bank Group will continue to provide advice on financial and market reforms and capacity-building to develop pnvate enterprises in rural and western regions. This CAS Annex F Page 7 of 10 work will address issues such as providing forms of business organization appropriate for small private enterprises, micro-finance, special financial institutions serving the needs of small pnvate enterprises. Box 2: Business Environment Issues as Reflected in IFC's Portfolio Experience While IFC's portfolio experience in China has been positive overall, there are a number of business environment issues of a general nature that have resulted in hligher transaction costs, worse than expected project performance, and limited opportunities for IFC to reach and serve certain categories of private enterprises in China Distorted market behavior of state-owned Chinese comnpanies operating under soft budget constraints and benefiting from localprotectionism have resulted in excess capac2tt in many sectors, in segmented national markets, and unfair conietition Poor compliance with, and correspondingly inadequate enforcement of, safety, environmental, copyright, and othcr industry regulations, have produced similar effects Such practices have penalized companies that introduced modern technologies, offer quality products, and follow strictly the rules of the game Control over market entry and interference by local governments in selection of oint venture (JV) partners have often produced sub-optimal and overly complicated JVstructtires This has often impeded the capacity ofjoint- venture companies to provide adequate project completion support, to agree on a coherent business strategy and react quickly and appropriately to the dynamic business conditions in China Projects whose financial performance relied on expectations of imminent sector refonrs, have often suffered from delavs in promulgation and implemie,ntation of reform initiatives An example is the IFC-supported credit rating agency, which relied on announced government plans for reduction in administrative controls over the corporate bond market IFC has extensively used self-standing and project-related technical assistance projects to build regulatory capacity and promote market-oriented reforms in various sectors, particularly in the financial sector Controls over foreign currency borrowving by domestic private enterprises have limited IFC's ability to reach such enterprises This has a particular impact on the interior provinces where foreign investors are scarce, and on frontier sectors for China, such as private health and education, where local financiers are reluctant to invest Corporate governance and financial reporting practices are poorly developed in China This underscores the need for more intense monitoring, including through an increascd field presence to follow up project performance At the same time, this is an area where IFC has a strong role to play by introducing domestic companies to international practices in corporate governance and accounting Assistance in enhancing public and corporate governance. This may include advice on issues related to a government-business relationship conducive to a modem market economy, and efficient public sector management. Following the assistance provided to CSRC on developing capacity for training of independent directors in corporate governance, IFC will continue to support efforts to establish and strengthen institutions for training and capacity building in these areas and in securities markets. There will be further technical advice on specific issues raised in the recently completed Bank Group study on corporate governance and enterprise reform in China, such as the role of institutional investors in improving corporate governance and the corporate governance of enterprise groups Ongoing Bank Economic Law Reform Project This project, currently under implementation, will continue to assist the government to strengthen and further rationalize the commercial law framework and build human capacity and skills within the government and the judiciary. WBI will provide support to the Chinese Academy for Social Sciences Institute for Regulation and Competition Policies. Building capacity of investment promotion intermediaries. IFC's Foreign Investment Advisory Service (FIAS) has completed a diagnostic study of investment approval policies in one of the provinces Building on this, at the request of provinces, the Bank Group will support implementation of programs aimed at promoting private investments in the interior provinces CAS Annex F Page 8 of 10 11.4 Support to Private Financial Institutions In the context of WTO entry, the Government has been gradually liberalizing the financial sector, and this opens opportunities for domestic and foreign private institutions. The Bank's support for improving China's financial system will be mainly in the form of advisory services and is expected to cover all major areas of financial sector activities. Of particular importance for the growth of ownership diversification among financial institutions are the Bank's planned AAA services on finance for small firms, the collateral regime, corporate bond market development and infrastructure finance, and in these areas the Bank and IFC will work closely together to implement proposed activities. IFC has been active in the financial sector, having undertaken several pioneering transactions and advisory/TA assignments, including investments in commercial banks (Bank of Shanghai, followed by Minsheng Bank and the Nanjing City Commercial Bank), a major life insurance company (New China Life), a credit rating agency, plus technical assistance in reviewing leasing legislation and regulation, securities law, insurance regulation and strengthening of institutional capacity of a number of financial institutions (see Box 3). IFC will be looking to support other private and city commercial banks, especially in the westem regions, as well as non-banking financial institutions, such as housing finance and asset management companies. IFC will also explore with the Chinese authorities ways to help develop the local corporate bond market. The CPDF will continue to work with commercial banks and other financial institutions from the interior provinces to strengthen their capacities to serve the needs of SMEs. The share of financial market transactions in IFC's China program is expected to increase over the CAS period. Box 3: Institutional Development at Bank of Shanghai The Bank of Shanghai was established in 1995 through a merger of urban credit coopcratives as part of the reform and development of China's financial sector The bank's lending is oriented primarily toward support for local small and medium enterprises. The Bank of Shanghai's strategy for transforming itself into a modem banking institution focuses on entering into technical assistance arrangements with reputable international banks and attracting strategic investors IFC has supported the bank's efforts since 1995 through technical assistance and direct investments A total of US$1 3 million in wide-ranging technical assistance in the areas of corporate governance and risk management was provided through grants from the govcrnment of Japan, the European Union, and IFC and was executed by Allied Irish Bank, ABN/AMRO Bank, and IFC In 1999, IFC made a US$22 million equity investment in the Bank of Shanghai, representing 5 percent of the bank's expanded share capital Corporate governance practices in the bank have improved significantly An independent director was appointed to the board, and the board has become nore engaged in active discussions with the management on strategic development of the bank The board has set up three committees - those for audit, compensation (both chaired by independent directors), and risk management The management team has introduced various improvements in all the operational areas, particularly in credit risk management and internal controls In 2001 the Bank of Shanghai was able to attract two strategic foreign investors the Hong Kong and Shanghai Banking Corporation and the Shanghai Commercial Bank, the first time foreign commercial entities have invested in a Chinese domestic bank CAS Annex F Page 9 of 10 11.5 Corporate Restructuring and Ownership Diversification Significant transformation and ownership diversification have taken place in the SOE sector, but there are many remaining challenges. A joint IFC/World Bank study will examine the financial, technical and manpower needs of recently privatized enterprises This may lead to advisory work on structural reforms needed for Chinese companies to cope with the expected restructuring, including the role of foreign investors in SOE reform and restructuring; further privatization of small and medium or selected large SOEs; the institutional framework for exercising state ownership rights in remaining large SOEs and groups; exits from non-viable SOEs; and development of safety nets and private sector employment altematives for redundant workers. Another area of possible Bank Group assistance is in evaluating the potential impact of post- WTO intemational competition on the Chinese corporate sector and the effectiveness of the Government's planned response. The Bank Group may assist in evaluating the impact of WTO- liberalization on key industrial sectors and the social, financial, and fiscal implications. The Bank may also provide or marshal advice to the Government on intemational experiences and potential effectiveness of strategies that might be used to cope with post-WTO competition, such as industrial policy, enterpnse grouping, government-led reorganization and IPOs. China's four AMCs have been given responsibility - as the largest creditors - for the financial and operational restructunng of a large number of distressed SOEs. It will be important for the Chinese AMCs to leam from the recent experiences and shortcomings of AMCs in other countries. Technical assistance to China's AMCs will be designed to facilitate the resolution of remaining NPLs, manage converted equity more effectively, and facilitate follow-on operational restructurng and ownership transformation. Knowledge dissemination activities will be organized to provide local practitioners with international experience in the market-based restructuring of large companies IFC facilitated the first major sale of distressed assets in China by one of the four AMCs. The success of this landmark auction is expected to set a precedent for future sales and provide momentum to the development of a NPL market IFC will pursue other opportunities in this field through participation in resolution of NPLs and through pilot projects to demonstrate model enterprise-level restructunng. 11.6 Support the Adoption aiid Dissemination of Environmentally and Socially Responsible Business Practices by the Chinese Private Sector China's high economic growth has been associated with significant local environmental costs Addressing these, and reconciling economic growth with improved water and air quality, are prionties for the Government. As described in the main CAS document, the Bank is proposing an intensive level of support in this area to help shape environmental institutions, manage China's air, land and water resources, and protect the global commons. IFC's investments in China have helped companies improve their environmental and safety practices. In addition, IFC has made a number of investments in sustainable forest management. These investments have helped to commercialize in an environmentally sustainable way the use of plantation resources, some of which were created with Bank assistance, and have strengthened the relationship between these companies and the rural communities where forest resources are located, thus contnbuting to improvement of the communities' living standards. IFC will continue to support the development of China's environmental industries through investments in a range of projects, including those bringing intemational environmental technology to China, as well as those that manage wastewater and sewage treatment plants. IFC will also, as it does globally, seek to help investee companies find profitable opportunities to reduce waste and emissions. CAS Annex F Page 10 of 10 11.7 Expanding the Presence of the Private Sector in Social and Physical Infrastructure The goal is to prevent social and physical infrastructure from becoming a bottleneck in the expansion of private investments and trade. Investments required for establishing a world-class infrastructure are huge. The Bank Group will leverage its lending in the infrastructure sector to support the creation of a regulatory regime that facilitates competition, encourages pnvate entry and mobilizes private risk capital. Bank support for infrastructure development will be delivered through: * TA for public private partnership in gas distribution; and wind-power concessions; * Support for asset securitization under Bank-assisted highway projects; * A highway sector study to examine commercialization and market financing of public toll road companies and promote competition in highway management and development of pnvate contractors; * National railways projects to support the Government's railways reform program; * Ongoing and proposed Inland Waterways Projects to assist commercialization of inland waterway agencies; * TA and a study by the Bank's Public and Private Infrastructure Advisory Facility (PPIAF) for design and implementation of a regulatory framework for competitive power markets, as well as TA and study on deregulation of the oil and gas sector; and * Energy projects to support development of wholesale power markets. Due to the relatively underdeveloped regulatory framework in China for private participation in infrastructure (PPI) and constraints on local currency financing, IFC's transactions in this sector have so far been limited. Looking forward, given the Government's commitment to open up this sector, IFC should be able to engage, especially in close coordination with the Bank. IFC's focus in the area of physical infrastructure is likely to be on small-scale power plants with industrial clients, transportation (ports), water (utilities), logistics and distnbution and gas distribution. In the area of social infrastructure, IFC has recently approved its first health care investment in China. IFC will continue to pursue opportunities in health and education, including the establishment of financing mechanisms in these areas, i.e., student loan programs and life and health insurance products IFC has already launched a study to explore opportunities for private sector investments in health and education in Shanghai, Shaanxi, and Sichuan Provinces 11.8 Focus on Promoting Private Sector Development in the Interior A special focus in the Bank Group's advisory and investment activities related to private sector development in China will be given to the interior provinces. Given the high developmental priority of the western areas and the difficulties of doing business there, this region has been a key focus of IFC's strategy in China. IFC has undertaken a number of transactions in Sichuan province, including establishment of the CPDF and Small Enterprise Investment Fund, and with the expenence gained, is able to widen its focus to cover a second interior province, Shaanxi IFC's experience in Sichuan suggests that focusing on one province pays off in terms of what IFC can accomplish, in tenrs of visibility, critical mass of developmental impact and knowledge of local business conditions. CAS Annex G Page 1 of 3 World Bank Group's Support for Good Developmental Governance Government Efforts to Improve Governance and Fight Corruption With the objective of pushing China more rapidly toward a market-based economy, a noticeably accelerated program of refonns was introduced in March 1998 by the then newly installed Government. A top priority area smce that time has been state sector reform, including public sector management and state enterprise rationalization. The major objective underpinning these refonns is to address many of the institutional issues which have led to increased corruption over the past decade. The thrust of public sector reform has been to streamline the govermnent organization and staffing and to take it - and the military - out of operating commercial activities. China's leaders are clearly concerned with issues of accountability, fostering a more competitive environment and the establishment of a public sector that is "honest, diligent, pragmatic and efficient." Some of the bold initiatives taken include: * The State's Role in the Economy Reshaped In 1998, the new adminstration reorganized and down-sized the public sector. The number of mimstries went from 41 to 29; ministries overseeing industrial or commercial activities were spun off; the remaining rmnistries were made more "market- friendly"; the number of public sector employees was cut in half over three years; the military, police, government agencies and judicial organizations were ordered to divest themselves of business activities; and the legal and regulatory framework to guide proper development of a market-based economy was strengthened. * Officials suspected of corruption are investigated and, if found guilty, punished For instance, in 1999 prosecutors investigated more than 30,000 officials suspected of corruption and recovered more than US$200 million. Major smugglmg and fraud cases were publicly disclosed, and the sentencing of senior officials was given prominence. * Legal and judicial reform. Judicial reform wNas formally recognized as a priority at the 15th Party Congress in 1997. The Supreme People's Court is midway through its five-year reform plan. China's Constitution was amended in 1999 to include "governing the country according to law" as an essential principle. In tandem, many laws are being amended or new laws drafted with provisions encouraging good governance. * Regulations and procedures for public sector staff - in government and SOEs - promote transparency. - Integrity and conflict of interest rules introduced for semor government officials and SOE chief executives. - A public bidding system for government procurement introduced at central and local levels. - Government institutions and SOEs audited and subjected to public information disclosure. * Introduction of Three Reforms Support Good Governance. These include reforrms of: the government approval system to reduce opportunities for the "exchange of power for money," the fiscal and budgetary system to improve budgetary and treasury management; and the government personnel system, by opening official selection to competition, improving performance appraisals and strengthening supervision. CAS Annex G Page 2 of 3 In tandem with the campaign for clean government is a broader program addressing economic and financial crime in all parts of the society. This accords with senior leader directives that "The fight against corruption should be intensified both to resolve the current problems and to eliminate the root causes." In this, it is recognized that corruption in all forms is a threat to social stability and modernization. Ongoing Bank Support. In China, the Bank has been supporting, according to its mandate, better developmental governance in areas where it has the greatest levels of expertise, experience and comparative advantage, for instance in the areas of economic law, procurement, accounting and financial sector management. More recently, the Bank co-sponsored an international seminar on anti-corruption with Tsinghua University and the Carnegie Endowment for Peace, where it presented the latest m analytical tools concerning corruption. Our major areas of involvement are as follows: * Promoting the Rule of Law. It might be argued that the government's chief advance in its 1998 reforms was to recognize the importance of the rule of law, which is now reflected in China's Constitution. While China's transition to a legally oriented society will take some time to accomplish, the Bank is supporting the process by helping develop an adequate legal framework and training officials who will improve the current level of law enforcement. Under the Economic Law Reform Project, for example, the Bank has provided technical assistance to the government in (a) assisting in the preparation of economic legislation in prionty areas; (b) promoting implementation of laws through traminng of government officials, judges and legal professionals; and (c) strengthening key institutions responsible for legislation and implementation of economic laws. Fifteen laws and regulations supported by the project have been already enacted, and more than 25 others are being drafted. Four universities/institutes have received support to provide continuing legal education Further, both lending and non- lending activities frequently help develop the legal underpinnings for market-based operations in the various sectors - the energy sector probably realizing the greatest achievements in this regard. * Promoting Good Governance, Both in Government and Corporations. The Bank is well positioned to help the Govermnuent achieve its objective of improving the attitudes of civil servants, in terms of responsiveness to the people served and in tenrns of developing greater probity. It has, among other things, worked with the National School of Administration, responsible for training civil servants, to develop appropriate standards for public service and develop a national civil servants training system. With WBI, we plan to follow up the latter work by developing corruption-prevention training programs. Further, to strengthen China's low-yielding tax system that has led to the imposition of mynad fees and opened the door to corruption and predatory behavior, our Fiscal Technical Assistance Project has been helping to strengthen the tax administrationand collection systems. Short policy studies focused on specific fiscal issues have also been provided, as well as a Public Expenditure Review that looks at the severe provincial- level fiscal problems that give rise to a variety of abuses. * In the corpomte arena, the Bank is using a range of activities to encourage the reform of state enterprises into market-oriented entities employing transparent practices. Among these activities are: a major joint Bank/IlFC policy study on corporate governance in enterprise refonn, collaboration with the World Bank Institute on delivery of corporate governance training CAS Annex G Page 3 of 3 programs (one Internet-based), IFC-led training for independent directors of Chinese listed companies, provision of advisory assistance on transparent disposal of assets by Asset Management Companies, review of the business environment of private enterprises, and ensuring that ownership diversification mechanisms are open and transparent. Promoting Financial Transparency. Bank support for good financial practices takes many forms, in keeping with the government's key goal of strengthening financial management and auditing at all levels of the public sector, among SOEs and private sector firms, and in the financial sector. At the most basic level, the Accounting Reform Project is (a) training government and enterprise staff in international accounting and auditing standards, (b) training a special cadre of senior auditors charged by the Premier to mspect enterprises for the purpose of curbing waste and corruption; and (c) strengthening financial management in state enterprises and government bodies. More generally, financial management trainng is provided to implementing agencies country-wide by our in-country team. To bolster government efforts preventing waste and fraud within the banking system, the Bank is supporting a Financial Sector Technical Assistance Project and a range of TA activities that, inter alia, strengthen the competence of banking staff, deal with the financial dimensions of enterprise restructuring in an open and orderly way, and develop new corporate governance mechanisms for China's largest banks. IFC's investment in the financial sector are typically accompanied by technical assistance to improve corporate governance, regulatory compliance and risk management skills at the level of financial institutions and to strengthen regulatory capacity particularly in areas that are being opened to private sector entry. * Promoting International Procurement Practices. Since corruption significantly increases economic inefficiency as uncompetitive firms win contracts and deliver poor services, a focus of Government and Bank attention has been to improve transparency in goods and services procurement, making the process more fair, equitable and economic. Bank efforts were initially directed at safeguarding World Bank-assisted projects, but in recent years have extended to general govermnent procurement procedures Assistance has been provided to the Government to: (a) formulate and disseminate its Bidding Law, containing measures and sanctions against fraudulent practices; (b) train large numbers of civil servants, project staff and others in international procurement procedures, with discussion of corruption issues; (c) develop a procurement training program at Tsinghua University, with coverage of anti-corruption activities; and (d) update guidelines and model bidding documents for Bank- financed projects by introducing, in particular, fraud and anti-corruption measures. Knowledge Sharing. Increasingly, the Bank has helped bring to China international experience with governance issues. For example, the Bank, Tsinghua University and the Carnegle Endowment for International Peace organized a seminar on "Economic Reform and Good Governance: Fighting Corruption in Transition Economies," held at the Tsinghua University in Beijing during April 11-12, 2002. This was the first international conference held in China on the topic, and attracted in situ about 150 high level participants. The Bank contributed two speakers, both underlining the usefulness of new governance and anticorruption diagnostic tools, complemented by cross-country governance indicators. CAS Annex H Page 1 of 3 Summary of China Country Gender Review A China Country Gender Review, as a basis for producing the more in-depth Country Gender Assessment, was completed in June 2002. The document is expected to promote dialogue between the Bank and China on the relevance of gender equality to effective development assistance. It also is intended to contribute to nmainstreaming of gender-related activities in World Bank projects when appropriate. The following summarizes review findings Chinese women's journey over the last hundred years from feudalism to emancipation to full equality under the law has prompted justifiable pride in China. It is remarkable that such radical social change could have been accomplished within a few generations. However, officials and experts on gender issues in China share concerns whether socioeconomic changes in the past decade have led to some regression in the status of women In fact, the vanous gaps separating men and women's status, income and power keep shiftmg in response to constantly changing social, economic, cultural and political realities in China. Several trends related to the changing role of the State in citizens' lives continue to affect gender equality in China. These include: * Devolution of central government responsibilities to lower admmistrative levels; * Increasing reliance on the rule of law; the emergence of NGOs and the participation of civil society in the policy and legislation process; * The deepening of economic reforms and accession to the WTO; * The disappearance of the "iron rice bowl" and gradual creation of a social security system; * Introduction of market forces m health care and education; and * The growth of rural urban migration and rapid urbanization. These social and economic shifts interact with underlying cultural beliefs about gender roles, which - despite 50 years of advocated equality - remain deeply institutionalized and socialized. The enabling environment for gender equality is good, and includes the following: * A comprehensive legl and regulatory framework; * The adoption of a comprehensive framework for the development of women coordinated and monitored by the National Working Committee on Women and Children (NWCWC), which was established in 1992 with leading officials from 24 Ministries and 5 mass organizations; * The adoption of international conventions and commitments such as the international Convention to Eliminate Discrimmation Against Women and the Beijing Platform of Action; * The evolution of the All China Women's Federation into a more advocacy-oriented non- governmental orgamzation; and * An extended networks of individuals, universities and research institutes, and NGOS devoted to promoting gender equality. CAS Annex H Page 2 of 3 Trends toward progress in gender equality are notable and include closing the gender gap in school enrollment rates (48 percent of pupils enrolled in primary school in 1998 were girls compared about 45 percent in 1980) and increasmg the number of female school teachers at both the primary and secondary levels (in 1998, female teachers comprised 47 percent of primary and 36 percent of secondary schools teachers compared to 37 percent and 25 percent, respectively, in 1980). An overall decrease in the birth fertility rate also means more opportunity for more women to pursue activities beyond those associated with family life or child-rearing. Yet there are still barriers to gender equality. Key gender issues included: * Gender inequality in the labor market in terms of income gaps, discrimination in hirmg and firing, unequal access to credit, and uneven impact of economic reform of men and women; * Growing gender poverty gap in both rural and urban areas due to male out-migration, feminization of agriculture, lack of opportunities; * Unequal access to education m rural areas: illiteracy rates (26 percent of females over 15 year old compared to 9 percent of males over the same age). Uneven gender impacts of the introduction of market forces in health and education; * The very strong preferences for male children in rural families; * Vulnerability of women and girls, particularly in rural areas, to abuse and other ills; and * Little progress over the last decade in women's participation in political decision-making and governance. Given the situation described above, Chinese researchers and scholars have identified the following areas as priorities for gender equality interventions: * Legal and civil society reform to improve the enabling environment and reduce gender gap, including greater clarity on equal rights, and greater gender awareness among public officials and legal/judicial personnel; * Measures to identify and address the growing gender poverty gap including gender- sensitive research and analysis, gender-sensitive poverty reduction strategies, and better enforcement of equality guarantees in labor and land laws; * Measures to address gender inequalities in the labor market including labor adjustment programs, revision of retirement age, and effective maternity insurance programs; * Measures to mitigate the uneven impacts of market refonns and changes in provision of health care and education, and to address the gender impacts of the family planning policy; * Measures to mitigate the vulnerability of women and girls to violence, abduction, and suicide; and * Measures to improve the participation of women in political decision- making and administrations at all levels. CAS Annex H Page 3 of 3 Possible Areas of World Bank Involvement The Country Gender Review includes an analysis of the country context and a review of the current portfolio. In the past, gender issues have been integrated into social sector studies and projects, but not into other sectors where they can be expected to be relevant, such as agriculture. Specific recommendations for areas of possible Bank intervention, both to address specific gender issues and to mamstream gender-related activities into the project pipeline, include the following: * Research and analysis activities, including technical assistance in generating sex- disaggregated data to support the development of social policy, social programming and legislation; * Policy oriented research in areas such as regulatory frameworks for the enforcement of equal nghts protection when relevant to economic development; instruments to support the growth of not-for-profit social services delivery; gender-sensitive modalities to improve social services delivery; and promotion of greater women's participation in public life in economic activity; * Support of civil society especially the budding women's NGOs movement and a network of scholars specializing in gender issues; and * There is scope for developing projects or project components targeting barriers to gender equality. There also is some scope for effectively mainstreaming gender analysis and activities in new and existing Bank projects, supported by capacity building on gender issues for Bank staff and partners in China. Methods to Increase Gender Mainstreaming in Bank-financed Projects Recent experience suggests that several steps can be taken at relatively little additional cost to improve gender analysis during project preparation, and to improve effectiveness of project implementation in tenns of gender equity, for instance, conducting an initial gender baseline study and gender needs assessment during identification stage; including project activities or components which by their nature promote more equitable participation or access to benefits in project preparation stage; and collecting gender-disaggregated participation information and reflected in project progress reports in project implementation stage. CAS Annex I Page 1 of 4 Improving the Quality and Client Responsiveness of Core Project Services: Financial Management and Procurement A. Financial Management Background. China realizes the importance of establishing and maintaining a sound financial management system to ensure transparency and accountability and to minimize potential fraud or corruption. Consequently, various measures have been introduced, as follows: * Two Bank assisted projects are under implementation to bring China's accounting standards to international levels (International Accounting Standards - IAS). Sixteen new accounting standards have since been promulgated; * The quality of services of various governing agencies, such as the China National Audit Office (CNAO), Chinese Institute of Certifie d Public Accountants (CICPC), China Security Regulatory Commission (CSRC), has greatly improved in recent years; * As economic reform further proceeds, services provided by auditors in both the public and private sectors are getting increased attention; and * The role of media in disclosing publicly financial irregularities has drawn praise. However, diagnostic work completed thus far (Country Profile of Financial Accountability in FY97, a study of Corporate Governance Issues in China's Enterprise Reform in FY01, and a major study of Financial Management and Governance Issues in China by the Asian Development Bank in 2000) identified the following areas that require further improvement: * The pace of harmonizing China's accounting standards with IAS has been slower than expected, and the issues to be addressed more complex than envisaged; * Increased collaboration between standards setting and regulatory bodies needs to be encouraged to minimize inconsistency in information disclosure practices; * Capacity building for major supervising bodies (CNAO, CSRC and CICPA, etc.) in supervising techniques, examination and certification systems, and strategic planning for professional development warrants more attention; and * Shortage of qualified professionals has rendered enforcement weak, and coordination among governig agencies with overlapping accounting and auditing responsibilities needs to be improved. Risks to Bank Funds. The portfolio has not encountered significant problems in use of Bank funds, due to the general awareness of the importance of project financial management. However, reviews of audit reports for the IBRD/IDA portfolio indicate some cases of the following: * Withholding offunds by financial bureaus at lower government levels or project management offices (PMOs), though usually temporary, tends to slow down implementation; * Late submission of audit reports has been a problem in the past few years, potentially leading to delays in taking corrective measures; and * Temporary transfer offunds to non-project activities by local levels experiencing cash-flow problems, although these may be officially sanctioned and short-lived in most cases, creates an undesired financial burden on project implementation, and opens up opportunities for financial irregularities. CAS Annex I Page 2 of 4 Addressing the Risks. One response to addressing fiduciary risks has been to "ring fence" project financial management. This has been done through financial management assessment at project entry to ensure establishment of a financial management system meeting the requirements of OP/BP 10.02; reviews of annual audit reports, and subsequent follow-up on corrective measures taken to address audit findings. The Bank uses its own staff and consultants to (a) verify whether project accounts are being properly set up and identify internal control weaknesses, (b) determine whether supporting documentations for disbursements made via Statement of Expenditures are available and legitimate, and (c) identify areas in financial management and disbursement that require further improvement. Planned Systemic Initiatives. Rather than "ring fencing" project financial management, fiduciary risk reduction would be significantly enhanced by a more systemic approach to the issues This would involve a streamlining of China's financial accountability system and upgrading the system to international levels. Such an approach would lessen the burden of "ring fencing" investment projects, and provide the Bank with a basis for engaging the Government on strengthening and improving its financial management and accountability systems. A fiduciary risk mitigation and capacity building strategy will therefore be undertaken in FY03-05, entailing in-depth analytical work and targeted technical assistance by the Bank. The following work is planned * Build on ADB's study of Financial Management and Governance Issues in China in 2000, and analyze areas that have changed rapidly in the past few years or that deserve further scrutiny, and over time cover all major areas usually assessed as part of a full CFAA exercise; * On a sectoral basis, identify obstacles to the smooth flow of funds from the Bank to the ultimate beneficiaries and propose corrective measures; and * Conduct an extensive peer review as well as on-site reviews of audit fieldwork to determine the quality of audit reports and propose corrective measures. TechlnicalAssistance in building capacity of key public accountability oversight institutions will be provided through policy dialogue, as well as provision of Bank-administered trust funds. The following technical assistance programs are planned: * Contin ued training of CNAO staff, particularly at the municipal or county levels. CNAO training is well justified since it is well positioned to audit Bank projects, mainly due to its association with the Government and the sanction powers given to it by the State Council. CNAO's organizational structure at various administrative levels is also well defined and staffed; * Tlte APEC Finance and Developmtent Program, co-chaired by China and the Bank, was proposed by China as a means of addressing the need for capacity building in finance and economics among APEC members; * Project Support. The National Accounting Institute component of the Bank-assisted China Accounting Reform and Development Project will be monitored to ensure achievement of objectives, i.e., establishment of three residential training facilities (in Beijing, Shanghai and Xiamen), which are expected to have major impact on training professional financial managers and accountants; * Borrower Training. Continue to provide borrowers with training in FM/disbursement procedures, using FM assessments, project launch workshops, regular training programs, provision of training materials, and speedy response to ad hoc assistance requests; and CAS Annex I Page 3 of 4 * Donor Cooperation. The Bank would continue to collaborate with other major donors (e g, ADB, DFID) and provide assistance in addressing capacity building needs for major supervising bodies, such as CICPA, CSRC and CNAO. Joint Goverintent-Bank Supervision. Starting in FY03, joint supervision missions involving MOF, CNAO and the Bank will be carried out, with a focus on a specific industry or sector, or a specific geographical area. These exercises will supplement annual audit work, provide better and consistent coverage, help identify weaknesses in financial management specific to a given industry, sector or area, and assist in designing counter measures. Full decentralization of the Bank's FM/disbursement function to the Beijing office, expected to be completed in early FY03, has been well received by borrowers, as follows: * FM assessment at project entry and subsequent participation in supervision missions by Bank staff close to project implementation have helped ensure that sound FM systems and practice are in place and functioning as intended; * With the World Bank Office in Beijing serving as a focal point, communications that used to be hindered by language barriers, time differences and cultural differences have since improved; and * The volume and turnaround of withdrawal applications processed and flow of Bank funds to ultimate beneficiaries have been accelerated since decentralization was introduced. Response time to queries from PMOs has been reduced considerably and the quality of advice on project expenditures has also improved. B. Procurement Procurement Environment. The procurement environment in China has improved substantially during the transition from a planned to a market economy. One of the key improvements is that the principle of competitive bidding is now firmly anchored in Chinese bidding law and procurement practices and is the norm in government capital construction projects. Conversely, the newly enacted Government Procurement Law, which deals with public procurement funded from fiscal resources, can be strengthened further to reflect current best practices. Procurement under Bank-financed projects in China has generally been satisfactory, as reported in the Procurement Audit carried out in April 2001. The Audit concluded: "generally the contracts subject to prior review are procured in accordance with the procedures laid down in the loan/credit agreements. Procurement work for the China portfolio is managed effectively and efficiently." Since decentralization to country offices was introduced in China several years ago, there has been a dramatic improvement in the quality of our procurement services to our Borrower. Turnaround time for the review of procurement documents has been reduced from 20 to 30 days to 2 to 3 days. The number of procurement documents being reviewed locally in Beijing has quadrupled Furthermore, the Beijing office provides advisory, troubleshooting and training assistance to implementation agencies. Although procurement processing has improved substantially in China, project procurement assessment reviews and an Operational Procurement Review indicate some areas require more attention: * Procurement Legislation and Procedures: The Government's Tendering and Bidding Law which became effective in January 1, 2000 needs to be widely disseminated. Differences between government and Bank procurement procedures sometimes result in CAS Annex I Page 4 of 4 misunderstandings and delays in the bidding process, causing inefficient and uneconomical procurement results; * Procurement Training Program: Unfamiliarity with the Bank's procurement procedures results in lower quality documents and prolongs the processing time and increases the cost of doing business; * Still Developing Contracting, Manufacturing and Consultinig Industries give rise to problems. Inadequate designs, lower-quality technical standards and specifications, unreasonably low bid prices, and inadequate contract management lead to a high amount of works contract variations, substantial delay of contract implementation, excessive revisions of costs and contract disputes, and low quality of some manufactured equipment, causing poor utilization of resources; and * Internal Review Process Govemment agencies' involvement in bidding document and bid evaluation review, in particular for mechanical and electronic products, and inadequate communication between the parties involved sometimes seriously delay the procurement process. Diagnostic Work. The following has been completed: some 30 specific project procurement capacity assessments carried out in the last three years, a procurement audit carried out in April 2001and a recent Operational Procurement Review. These review activities confirm that while procurement is generally carried out in an efficient, economic, transparent and fair manner, there are still some areas needing improvement Risks Mitigation. The Operational Procurement Review proposes a risk mitigation and capacity building strategy. Tentative recommendations and an action plan include: * Extending the Outreach of a Sustainable Procuremenit Training Program would produce a major improvement of the govemment procurement process, and establishment of such a program is a key recommendation of the Review. To this end, the Bank would assist in the implementation of the training program in five Chinese universities and help the universities deliver training courses on a country-wide basis in a sustainable manner, * The Bank would continue to work with the Govemment and other multilateral agencies like ADB in supporting China's public procurement reforms, actively participate in the preparation of the proposed Govemment Procurement Law, and assist in the Disseminlation Program of Procuremenit Legislation throughout China; * The Bank would continue to provide assistance to the Govemment in drafting and updating Model Bidding Documents, contract forms and manuals, and guidelines for use in both IFI- and govemment-funded procurement; and * Procurement processing would benefit greatly from improvement in the intemal Procurement Review Process and in the Bank's own review process through increased decentralization. The Bank will, therefore, provide technical assistance aimed at identifying the bottlenecks and recommend methods to streamline the process. To support the Coontracting, Manufacturing and Consulting Industries in China, the Bank, in collaboration with other international financial institutions, would continue to provide assistance such as business opportunities seminars, and help develop specific training courses for industries to enhance competitiveness and strengthen their capabilities in the procurement process. CAS Annex J Page 1 of 1 Overview of Ongoing External Assistance to China Theme 1: Improving the Business Theme 11: Addressing Needs of Poorer and Theme Ill: Facilitating an Environmentally Environment and Accelerating the Transition Disadvantaged People and Regions Sustainable Development Process to a Market Economy c7 E J c'EE0 0- 0 ~~OC ~ -~~ 0-0)C ~~ 0 -0~rt 0)CE e-o>~~~ ~ co~~~- o~~cc cE s - - ~ E~0 c~~ ~ .~to t ~ 2 2 E C)>2 to~- >~ Tn -2 Multilateral s ADB X X X X X X X X X X X X X X X European Union X X X X X X X X X X X X X X IMF X X X X OECD X X X X X X X X X UN Agencies X X X X X X X X X X X X X World Bank X X X X X X X X X X X X X X X Bilaterals Australia X X X X X X X X X Belgium X Canada X X X X X X X X X X Denmark _ X X X X Finland X X X France X X X X X X Germany X X X X X X X X X X X X X X X Italy X X X X X X Japan X X X X X X X X X X Luxembourg X X X Netherlands X X X X X Norway _ X X X X X Spain X X X Sweden X X X X X X X X United Kingdom X X X X X X X X X X X Other Institutionsi Ford Foundation X X X X X x ;WNdd, i. c, ,S,iV': ,oi rtV *i. l I* Ir "'Y4~~V'I 'i -iN-H I t O;* h C ,IRtteeZ"rws f,> 1'vII$|t^>zl>>s'NIHDN 1 '1 , 4 ,, , , . - l . 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