Report No. 19450-POL

PolandStrategic Priorities for the Transport Sector

June 1999

Infrastructure UnitEurope and Central Asia Region

Document of the World Bank

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ACRONYMS AND ABBREVIATIONS

CEE Central and Eastern EuropeEBRD European Bank for Reconstruction and DevelopmentEC European CommissionECU European Currency UnitEDI Electronic Data InterchangeEIB European Investment BankEU European UnionGDP Gross Domestic ProductIFI International Financial InstitutionJSC Joint Stock CompanyMTME Ministry of Transport and Maritime EconomyPHARE (EU) Technical Assistance for Central and Eastern EuropePKP Polish State RailwaysPPL Polish Airports AuthorityPPP Public-Private PartnershipPSO Public Service Obligation(s)TEU Twenty-foot Equivalent Units

Vice President Johannes F. LinnDirector Ricardo A. HalperinSector Leader Eva MolnarStaff Member Graham Smith

POLAND

STRATEGIC PRIORITIES FOR THE TRANSPORT SECTOR

CONTENTS

Page

Executive Summary ....................................... i

I. Overview ........................................ 1

II. Taking a fresh look at motorways ........................................ 2

III. Creating a competitive railway system ........................................ 5

IV. Balancing public transport and car use in cities ....................................... 12

V. Reconciling road transport and the environment ...................................... 18

VI. Strengthening roads to handle EU heavy trucks ....................................... 20

VII. Modernizing Poland's ports to serve globalized industry ......................... 23

VIII. Civil aviation: partly open skies .25

IX. Private participation in transport infrastructure and services .28

X. Strategic recommendations to the Polish Government .29

Attachment 1: The Government's Strategy for Restructuring PKP .30

Attachment 2: "Alternative Transport Policy" .33

Table 1: Transport Investment Plan, Fall 1998 .35

Map IBRD 30363

EXECUTIVE SUMMARY

(i) As the Polish government pursues its negotiations for EU accession, it isreassessing its options as to construction of the proposed motorway network, especiallyas regards private participation, debating options for restructuring and privatizing thenational railways, and coming to grips with the environmental impacts of rapid growth inroad transport. At the Minister of Transport's request, the Bank has prepared this shortnote identifying the main policy choices and investment priorities, and suggesting astrategy for transport in the pre-accession transition.

(ii) EU competition policy will require that the prime duty of the Ministry ofTransport and Maritime Economy (MTME) becomes that of setting and maintaining alevel playing field among competing transport modes, and among competing operatorswithin a mode. But important responsibilities remain for planning, financing andmanaging the provision and maintenance of infrastructure.

Taking a fresh look at motorways

(iii) Major investments in transport infrastructure, including motorways, are clearlyrequired as Poland's economy continues its rapid growth and as it prepares for accessionto the EU. However, the cost of the planned motorway program will be very high: nearly$1 billion per year (0.7% of GDP) sustained over some 15 years. Considering thecompeting demands on the State budget for financing many other investments in socialand physical infrastructure, we recommend that the Motorway Agency and the Ministryof Transport revisit the timing and phasing of the motorway program and look at otheralternatives which could still meet Poland's transport needs in the coming years, but atlower cost.

(iv) The assumption that the motorway program could be built without significantgovernment financing has turned out not to be viable. The firms selected as the first twoconcessionaires (for the A2 and Al) are projecting inadequate financial retums andseeking substantial government financial contributions. The feasibility studies carriedout over the past four years, however, are inadequate to answer the question of how muchthe Government should contribute, and how.

(v) The Al and A2 sections as now planned are separate segments which would notfor the time being be linked with other motorway segments, but yet would be built as fulldual carriageways with grade-separated interchanges. This phasing is not the mosteconomic. Several other options could be considered. One would be to look again atoptions for improving existing roads (including bypasses around major cities and/oradding additional lanes) as a first step and postpone major motorway construction untiltraffic is much higher. Another option might be to start work on the motorway program,but to concentrate first on completing the main trans-European motorway (workingoutwards from Warsaw) with a first carriageway where traffic will be below (say) 12,000

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vehicles per day and with overpasses or underpasses at only the busiest intersections.Studies need to look into the construction costs and try to assess the willingness of roadusers to pay tolls.

(vi) All this will require rewriting of the Motorways Law. The Motorways Agencyhas received abundant advice on options before it; the time has come for decisions.Which sections should be built first? What staging strategy will be most economic?Which risks should be borne by the State and which by the concessionaire? What formshould the State contribution take: up-front contributions in kind, contingent cashcontributions, shadow tolls or guarantees (full or partial)? What decision criteria shouldbe adopted? What procedures and sequence of steps will elicit the desired solutions?

Creating a competitive railway system

(vii) Since the start of the economic transformation at the turn of the 1990s, theMinistry of Transport has been addressing the need to adapt Polish railways to thedemands of a market economy. The Government should pursue, with strengthenedresolve, the downsizing and restructuring of Polish State Railways to cut the workforceby at least 60-70,000 and separate train operations organizationally from infrastructure(track, yards and signaling), and freight operations from passenger operations. Amnongother reasons, this is to allow open access for any operator of freight trains andinternational passenger trains, a policy now being required by the EU. Privateparticipation in train operations will likely follow. Responsibility for suburban passengerservices will be devolved to r egional and municipal governments.

(viii) Immediate priorities are to seek technical assistance to advise on (i) establishing atrack access and pricing regime and (ii) a regime for regional governments to contract forloss-making passenger services, (iii) drawing up a labor compensation plan, and (iv)allocating assets to the future independent units and establishing legal title to assets duefor sale.

Balancing public transport and car use in cities

(ix) In urban public transport, Poland made long strides in the early 1990s by sharplyincrnasing cost recovery from fare revenues, introducing service agreements betweenmunicipal governments and public-owned operators, and preparing the legislative basisfor competitive tendering of services to both public and private-owned operators. Thereform has since lost steam, so cost savings and service improvements linked tocompetition remain out of reach. The role of the private sector is minimal. Cost recoveryin major cities is still too low to generate sufficient capital for replacing and modernizingbus and tram fleets. Fare increases alone will not suffice to close the gap; adifferentiated subsidy policy linked to social assistance programs is needed. Cities do notyet have the financial capacity to tap capital markets without state guarantees.

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(x) Traffic and parking management improvements are on the rise in response torapid growth in private car use, whereas road investments, some of which are crucialeven in a green-tinted transport policy, are lagging. The new system of road finance,based on an allocation formula applied to a portion of fuel taxes, may be biased againsturban roads, and in principle has limited uses as a tool to manage urban traffic and modalsplit.

(xi) The State has gone too far in decentralizing all public transport responsibilities tothe cities and has not faced squarely the complicated issues related to urban roads. IfPoland is to synchronize its urban public transport policies and practices with those of theEU, the Ministry of Transport should build its capacity to assist cities in making strategicdecisions, in areas such as competitive tendering, subsidy reform, road and publictransport investment policies, and road use pricing, as well as getting access to capital inthe period before cities reach fmancial self-sufficiency.

Reconciling road transport and the environment

(xii) The growing use of clean automotive fuels will be accelerated, as will the phasingout of vehicles without catalytic converters. The pump price of fuels may have to bedoubled, thanks to a substantial increase in taxes to charge for road use and the socialcosts of emissions. Priorities for policy development are to: (a) research and analyze thecosts of environmental extemalities; (b) review alternative charging mechanisms; and(c) review policy objectives related to fuel prices, to arrive at a target level of fuel tax andto set the pace of increase to get from here to there.

(xiii) Road accidents are becoming a leading cause of death. Accident rates are doublethose in Western Europe. In response, a national road safety program has been prepared;now it needs to be implemented. This will require adequate funding and close co-operation among the Ministry of Transport, the police, and other agencies, under theguidance of the National Road Safety Council. Further attention should be paid toanalysis of the causes of accidents and the cost-effectiveness of various remedialmeasures.

Strengthening roads to handle EU heavy trucks

(xiv) The EU allows heavier trucks than Poland. The state investment budget will needto double allocations for road rehabilitation (from about 0.5 to 1.0 percent of GDP), ifmain roads are to be strengthened to accommodate trucks up to the EU weight limits.Poland may require transitional exemptions to keep out the heaviest trucks and/or largetransfers from EU funds to bring its roads up to standard quickly.

(xv) Priorities for developing policy are to: (a) refine estimates of the investmentrequired to strengthen the road network to bring it into line with EU truck weightstandards; (b) revise user charges on heavy trucks to make sure they fully cover the

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"wear and tear" costs they impose on the roads; and (c) review permits for overweighttrucks, prescribed routes for transit traffic, enforcement mechanisms, and penalties.

Modernizing Poland's ports to serve globalized industry

(xvi) With the nature and directions of Polish trade evolving rapidly from year to year,investing in ports has been a risky business. International road transport, railways andpipelines are competing for the same traffic as the Polish ports. There is also strongcompetition among alternative routes for cargo between major hub ports (Rotterdam,Hamburg) and eastern Baltic destinations. New port infrastructure -breakwaters,channels, and land access-- is lumpy, fixed and costly; the State can ill afford the largeminimum investments needed without assurance that the new capacity will be well used.

(xvii) In parallel, the country has lacked any regulatory framework for orderly,transparent competition among private port operators. To provide such a framework, thesetting up of landlord port authorities, mandated by the 1997 Ports Law, is well behindschedule and needs to be consolidated soon. MTME and the new port authorities need tostrengthen their capacity to evaluate the choice between concentrating all traffic of agiven type in one terminal (to gain economies of scale) or promoting competition(spreading traffic among several smaller terminals). To help streamline Customsclearance, a critical requirement for attracting new traffic, they also are recommended toset up consultative bodies of port users and operators to advise Customs on streamliningtheir procedures.

Civil aviation: partly open skies

(xviii) The Union's policy of open skies among member states, which took effect inApril 1997, will bring more foreign airlines into Poland, encourage the start-up of privatePolish carriers, and put pressure on LOT to lower fares. In anticipation of thesepressures, LOT, already commercialized and profitable Oust), will soon sell shares toprivate investors for the first time and/or strengthen ties to its strategic partners,American Airlines and British Airways. This gives grounds for expecting few if aniydifficulties as regards state aids to LOT. Demand will grow for investment in regionalairports, making it easier for traffic to bypass Warsaw. Policy priorities are to: (a)support LOT in renegotiation of bilateral air traffic rights to exploit the opportunitiescreated by EU Stage 4 liberalization; (b) pursue privatization of the appointed portion ofLOT's shares; and (c) remove any barriers to exit from loss-making routes.

Private participation in transport infrastructure and services

(xix) As one of the few "emerging markets" to remain largely unscathed by theSoutheast Asian and Russian banking crises, Poland stands to attract considerable privateinvestment to transport, as to other sectors. If this process is to succeed, the Govenamentneeds to move away from ad hoc approaches and establish clearer "rules of the gamne".Priorities are to: (a) review barriers and disincentives to private investment in trans port

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infrastructure and services -legal, fiscal, regulatory and financial; and (b) establishpermanent consultative mechanisms for the removal of these barriers and the setting oftransparent rules of the game.

World Bank assistance strategy

(xx) The World Bank strongly supports the Polish government's economic strategy toprovide an enabling framework for development of the private sector, to devolveresponsibilities to regional and local governments, and to build up the public sector'sinstitutional capacity to manage a market economy and meet the requirements of EUmembership. Recognizing the importance of transport to the economic transformnation,the Bank is willing to provide support, where justified and clearly of national priority, toany mode of transport. It has already made two loans for roads and one each for railwaysand ports. Further lending for railways and ports is under preparation, and we are open toconsidering how best we can help the motorway program.

(xxi) World Bank financial support for the motorway program could take variousforns. The simplest is to provide a sovereign loan to finance a road segment to beconstructed under a stand-alone contract awarded by international competitive bidding.The segment could constitute a State contribution to a private concession. A secondoption is to provide a partial risk guarantee to private lenders to a concessionaire to coverpolitical risk. However, we are unable to decide on the most appropriate forrn until theeconomic and environmental feasibility of the motorway program has been more clearlydemonstrated, including the viability of the two initial projects now being studied, andthe Government's contribution to the motorway investment can be fully justified.

(xxii) The World Bank strongly supports the proposed reform program for Polishrailways. It contains all the elements we believe are needed to revitalize the railtransport industry and serve customers well, while keeping the burden on the State andregional budgets light. Accordingly the Bank is willing to consider providing financialsupport wherever it will help carry the reforms forward, consistent with the limitedinvestment role to be retained by the State. Our emphasis will be on severance payments,information systems, legal and financial advisory services and other expenditures directlyfacilitating the restructuring, and infrastructure upgrading (if clearly contributing to therestructuring) -all through a sovereign loan to the State or loans to the enterprises backedby a sovereign guarantee. We are the only IFI that lends for severance payments. Wecould finance information systems, signaling and telecommunications to help implementthe new open-access regime. And we could finance renewal of track and signaling ofsuburban passenger services to be concessioned out to private operators.

(xxiii) Roads account for nearly 60% of all World Bank lending in Central and EasternEurope to date; Poland is no exception. They are likely to continue to be the largestabsorber of investment in Poland's infrastructure sectors. They also offer the least riskyproject prospects. The Bank is therefore willing to consider further financing of roads, tothe extent that its combined policy/institution-building work can be demonstrated as

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probably critical to reduction of the road sector's burden on general tax revenues(whether by reduction of public-sector costs or increase of user taxation).

(xxiv) The Bank has been supporting the development of an efficient administrative set-up for managing the major ports and promoting private investment and operation, as wellas financing priority physical facilities. The first project concentrated on improved land-side access to the ports of Gdansk, Szczecin and Swinoujscie, as well as vessel trackingand safety-enhancing systems. The second loan under preparation aims to helpconsolidate the role of the new port authorities as landlords with municipal participation,and to finance berths, storage areas and other port infrastructure needed to accommodatenew cargo flows.

(xxv) In 1995 the World Bank published an extensive report on Polish urbantransport, which confirmed a strong justification for World Bank lending to support thereforns to public transport recommended above. No lending followed because thenational government was not willing to guarantee municipal debt for this purpose. TheBank is no less willing today to lend for urban transport. If the national governmentattaches importance to these reforms and is willing to provide the necessary guarantee(s),a good basis exists for quickly preparing a lending operation. An alternative to directlending to municipalities is a line of credit through Polish banks, similar to that which theBank approved in 1997.

(xxvi) The general expectation is that the World Bank will phase out lending to Polandwhen it joins the European Union. Our assistance strategy, in transport as in othersectors, aims to help it reach that goal. Until then, beyond the operations listed above, weare ready to offer policy advice and consider lending in any transport mode where theGovernment shows a clear and firm commitment to reform.

POLAND

STRATEGIC PRIORITIES FOR THE TRANSPORT SECTOR

I. OVERVIEW

1.01 As the new Polish government begins negotiating EU accession, it is reassessingits options as to construction of the proposed motorway network, especially as regardsprivate participation, debating options for restructuring and privatizing the nationalrailways, and coming to grips with the environmental impacts of rapid growth in roadtransport. At the Minister of Transport's request, the Bank has prepared this short noteidentifying the main policy choices and investment priorities, and suggesting a strategyfor transport in the pre-accession transition.

1.02 The European Union's laws and regulations governing transport will intensifyincentives and pressures to increase the degree of competition in the transport market andincrease private participation in the provision of transport services. These are changeswhich are already under way, so no major discontinuity in policy will be required. Thepace, however, may quicken, forcing painful adjustments which might otherwise havebeen stretched out, especially as regards downsizing employment in the railway and otherpublic enterprises. The economic benefit should be strongly positive in net terms, thoughit may create distributional issues and claims on EC cohesion funds to upgrade the mainroad network and other mechanisms for transfers to poorer regions to ease social tensionsand increase the mobility of labor. The environmental impact should also be positive asregards air quality, though continued monitoring may be needed to ensure that unitreductions in air pollution (such as per vehicle) are not outweighed by rapid growth intotal travel. A substantial increase in fuel taxes may be warranted to charge for road useand the social costs of vehicle emissions.

Future role for Ministry of Transport

1.03 The Ministry's regulatory role will need to be clearly distinguished from its roleas owner of most transport infrastructure and those transport operations which theGovernment chooses to retain in the public sector at national level. A regulatorymechanism will need to be set up to oversee the level of road use charges and rail accesscharges, and existing mechanisms to protect against anti-competitive practices may needto be strengthened or modified.

1.04 Poland deregulated commercial road and water transport early in the 1 990s, andwill therefore be able to "hit the ground running" in these sectors when it joins thecommon market. This note focuses on those sectors which retain monopolistic featuresand which may therefore require adjustment to comply with the Union's competitionrules. Environmental and social laws are also important, not only in their own right but

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also to the extent that an enterprise which cuts its costs by not complying withenvironmental and social laws distorts competition in the single market.

1.05 Some areas of EU competition legislation are of long standing among the presentmembers; some took effect in 1993 with the creation of the single market and theiirimpact is still rippling through (e.g. the abolition of quotas on international truck trips);while yet other areas are brand new even among today's 15 members. In civil aviation asingle liberalized market within the Union took effect only in April 1997, while therequirement that all railway networks should provide open access to any qualifiedoperator of freight trains and international passenger trains is now a declared policy butfew countries have yet passed the necessary legislation. Accordingly, it may be easier forPoland to secure transitional exemptions in the latter areas than in the former. Theobverse is that the present member states are having to adjust in parallel with theprospective new members, so Poland is -at least in principle-- at less of a disadvantage.

II. TAKING A FRESH LOOK AT MOTORWAYS

2.01 When it was conceived and agreed in 1993-4, the Motorway program assumedthat most of the 2,600 km network could be built without any significant governmentfinancing. Based on this assumption, the Government set up a toll road agency whosemain task would be to manage the award of concessions to private investors andoperators. However, this approach has turned out not to be viable. The only motcrwaysections now under construction are being financed by sovereign borrowing (from EIB,EBRD and EU-PHARE). The firms selected as the first two concessionaires (for the A2from the German border to Konin and the Al from Gdansk to Torun) are projectinginadequate financial returns and seeking substantial government financial contributions.The Government has acknowledged that State contributions in one form or another willbe needed if the motorway program is to move ahead. The feasibility studies carried outover the past four years, however, are inadequate to answer the question of how much theGovernment should contribute, and how. It is therefore timely for the Government toreview the feasibility and phasing of the entire Motorway program, including the Al andA2 sections as now planned.

2.02 Major investments in transport infrastructure, including motorways, are clearlyrequired as Poland's economy continues its rapid growth and as it prepares for accessionto the EU. However, the cost of the planned motorway program will be very high: $13-15 billion at today's unit prices', or nearly $1 billion per year (0.7% of GDP) sustainedover some 15 years. Considering its high cost and the competing demands on the Statebudget for financing many other investments in social and physical infrastructure, werecommend that the Motorway Agency and the Ministry of Transport revisit the timingand phasing of the motorway program and look at other alternatives which could stillmeet Poland's transport needs in the coming years, but at lower cost.

12,600 km at $5-6 million per km

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2.03 For example, both the Al and A2 sections as now planned are separate segmentswhich would not for the time being be linked with other motorway segments, but yetwould be built as full dual carriageways with grade-separated interchanges. This phasingis not the most economic. Several other options could be considered. One would be tolook again at options for improving existing roads (including bypasses around majorcities and/or adding extra lanes) as a first step and postpone major motorway constructionuntil traffic is much higher. Another option might be to start work on the motorwayprogram, but to concentrate first on completing the main trans-European motorway(working outwards from Warsaw) with a first carriageway where traffic will be below(say) 12,000 vehicles per day and with overpasses or underpasses at only the busiestintersections; and combine this with upgrading of existing roads, with other motorwayconstruction postponed until later. Based on our experience in other countries, webelieve it quite likely that at this stage of Poland's development State financing forbypass construction and upgrading of major road sections where traffic is alreadyextremely heavy, could result in much higher benefits to the economy, than a similaramount of State investment in motorways.

2.04 The feasibility work, drawing on traffic and revenue studies already carried outunder the supervision of EBRD with respect to the Al and A2, should provide some ofthe answers needed about the proposed investments. These studies need to look into theconstruction costs (construction cost for one of the concessions remains high, even aftersome trimming), and try to assess the willingness of road users to pay tolls. Recentexperience in Hungary has shown unexpected reluctance on the part of users to pay tolls,driving the private concessionaire for the motorway between the Austrian border andBudapest (the Ml) into bankruptcy and "nationalization" by the State. Until theKatowice-Krakow section of the A4 motorway opens soon, there is nowhere in Poland totest road users' willingness to pay.

Revising the Motorways Law for Public-Private Partnerships

2.05 The Government accepts that it will have to contribute at least part of thefinancing for future motorway concessions. This will require rewriting of the MotorwaysLaw. It has received abundant advice from the IFIs and consultants on options for suchcost-sharing. The time has come for decisions. Which sections should be built first?What staging strategy will be most economic? Which risks should be borne by the Stateand which by the concessionaire? What form should the State contribution take: up-frontcontributions in kind, contingent cash contributions, shadow tolls or guarantees (full orpartial)? What decision criteria should be adopted? What procedures and sequence ofsteps will elicit the desired solutions?

2.06 An option proposed for the Al (Gdansk-Torun) concession entails theGovernment taking the full traffic and revenue risk and narrowing the risks to be borneby the concessionaire to financing, construction, completion and operation of the road.This approach has often been used in the USA and Germany. Its logic requires one toaccept that the private sector is not willing to accept revenue risk on Polish motorways.

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This would be a radical step back from the earlier policy, but the Polish experience todate supports it. Few observers would dispute that the traffic volumes in the near futurefall far below those normally required to make a motorway profitable in its first decade2 .In response, concessionaires may make troublesome demands for exclusivity. Oneconcessionaire has asked for a freezing of improvements to "competing" roads in acorridor 75 km wide on either side of the motorway. The Government understandablyfinds this unacceptable. A more appropriate response would be to focus attention onstaged construction -such as postponing construction of the second two lanes andoverpasses. In principle a private concessionaire has strong incentives to optimizestaging, but the process followed so far in Poland has failed to elicit effective stagingstrategies. The future public/private approach may need to provide a two-stage bicldingprocess, whereby bidders can propose staging in the first round before final bids aresought in the second round.

2.07 Another approach which would attract more traffic to the motorways but notcompletely shift revenue risk to the State is a partial shadow toll. The concessionairewould charge actual traffic tolls at a low rate per vehicle stipulated by the Governmentand the State would "top up" the revenue with a shadow toll. The concession wou:ld beawarded to the firm bidding the lowest shadow toll. The State could share the traffic riskby paying a larger shadow toll for the first (say) 12,000 vehicles per day and a smallersum for traffic above that threshold. The Agency is weighing the merits of thismechanism.

2.08 The recent proposal for the Al recommends that a motorways fund be set up,funded from an annual tax on cars, as the source of seed money (public equity) to back upthe floating of revenue bonds until operating revenues build up. The Bank would riotsupport this, since it is earmarking for a narrowly defined category of investments of atax/charge unrelated to use of the resulting highways. We would find it easier to supporta broader road fund, funded from use-related charges on vehicles, with a govemancebody representing road users and ensuring accountability and transparency. Thegovernance body would have to decide on the allocation of funds between motorwaysand other roads, and between construction and maintenance. Alternatively we mightsupport a temporary mechanism -say for 3-4 years-to get the motorways financinglaunched. The EU's recent policy paper on transport infrastructure charges3 supports thefirst option.

2 For example, 20,000 vehicles per day saving an average of 5 cents per veh-km, at a construction cost of$5 million per km, would yield an acceptable economic return (10-12%). Lower traffic, lowersavings or higher construction cost require pro-rata off-setting changes in the other variables.

3 "Fair Payment for Infrastructure Use: a phased approach to a common transport infrastructure chargingframework in the EU', white paper, July 1998.

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Recommendation

2.09 MTME should revise policy toward, and legislation governing, motorways,expanding the scope for "traditional" public-sector financing and operation, and creatingtransparent mechanisms for combining public and private financing and management("public-private partnerships").

World Bank assistance strategy

2.10 The World Bank remains prepared to consider financial support for the motorwayprogram. It could take various forms. The simplest is to provide a sovereign loan tofinance a road segment to be constructed under a stand-alone contract awarded byinternational competitive bidding. The segment could constitute a State contribution to aprivate concession, as EU-PHARE is doing for the Poznan bypass. A second option is toprovide a partial risk guarantee to private lenders to a concessionaire to cover politicalrisk. World Bank financing of a cash shortfall facility or a stream of shadow tollpayments raises a number of difficult questions for us, including how to make itcompatible with financing from other multilateral institutions, such as EBRD. However,we are unable to answer these questions until the economic and environmental feasibilityof the motorway program has been more clearly demonstrated, including the viability ofthe two initial projects now being studied, and the Government's contribution to themotorway investrnent can be fully justified.

111. CREATING A COMPETITIVE RAILWAY SYSTEM

3.01 Since the start of the economic transformation at the turn of the 1990s, the PolishMinistry of Transport has been addressing the need to adapt Polish railways to thedemands of a market economy. Traffic has fallen to about half what it was in the late1980s, requiring a substantial cutting back in employment and other measures to reducecosts, such as the abandonment of services on numerous low-traffic lines and the closingof nearly 100 marshalling yards. This process is continuing. A 1995 law restructuringPolish State Railways (Polskie Koleje Panstwowe - PKP) stipulated that PKP should bereorganized along lines of business, separating freight train operations, passenger trainoperations, rolling stock and infrastructure. The new organization went into effect in thesecond half of 1998, after testing in PKP's Eastern Region. In 1998 PKP lost PLN 1.3billion (about $330 million), due mainly to the shrinking of coal traffic, a strike, andrevaluation of its assets. In the first quarter of 1999 losses continued at the same rate.Corrective measures are urgently needed.

EU policy on railway restructuring

3.02 The 1998 reorganization applies the same principles as the European Union hasbeen pursuing for reform of railways since 199 1, when it issued its Directive 91/440.They are:

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(a) Railway enterprises should be independent entities operating at arms length fromgovernments in competitive markets. Historical railway debt at levels whichimpede a new commercial start should be tackled by governments.

(b) Rail infrastructure (track, yards and terminals) must be separated from trainoperations, at least at the accounting level, and organizational separation isencouraged.

(c) Generalized subsidies should be phased out and any support for public serviceobligations (PSOs), such as uneconomic passenger services provided for reasonsof social policy, must be provided through formal contractual relationshipsbetween the railway enterprise and the government.

(d) Track access rights must be made available at fair prices to groupings of railwayenterprises offering international services (between EU member states) and to anyoperators of international inter-modal freight transport services (including privatecompanies).

3.03 In 1995 the EC issued two further directives to guide implementation of thesereforms: Directive 95/1 8/EC on the licensing of railway enterprises and Directive95/19/EC on the allocation of railway infrastructure capacity and the charging ofinfrastructure fees. By March 1998 13 of the 15 member states had transposed Directive91/440 into national laws, while only four had transposed the latter two directives.

3.04 In August 1996, the EC published a "white paper" (policy statement) seekingsupport for policies to strengthen and extend the 1991 directive. In it, the Commissionurged the following actions:

Finances: Member states should fulfil their obligations to relieve railway debt andlink any future state aid to restructuring programs. The Commission wouldhenceforth apply Community rules on state aid to progressively move railways toviability.

Market forces: Open access should be extended to all international passenger andfreight services (not just inter-modal services). Network and train operationsshould now be fully separated into distinct business units. The Commissionwould promote trans-European rail "freeways" for freight with simple accessregimes for freight operators.

Loss-making passenger services: The Commission proposed that the contractingframework for provision of PSOs throughout the EU be generalized andstrengthened and measures introduced to bring competition to the allocation ofcontracts for such services.

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Inter-modalfreight services4 : Community policy would support improvement ofinter-modal freight terminals, development of the inter-modal freight system andthe launching of pilot projects for inter-modal services. The Commission alsoproposed a new directive to increase road use charges for heavy goods vehicles.

The Government's restructuring strategy

3.05 The PKP Law mandating separate accounting for each of the railways' main linesof business, passed in July 1995, was not implemented until three years later, July 1998.However, already in June 1997 a second major legal step was taken with the passage ofthe Rail Transport Law, which mandated the end to PKP's monopoly through allowingmultiple train operating companies and organizationally separate rail infrastructurecompanies. The main features of the restructuring plan underlying the Rail TransportLaw were set out in a policy paper5 issued by the Ministry of Transport in July 1998.They are summarized in Attachment 1.

3.06 On July 1, 1998 infrastructure, freight operations, passenger operations, andtraction became organizationally separate departments. Each is a profit center with itsown accounts, charging other sectors internal transfer prices for the services it "buys"from them and collecting revenue for the services it "sells" to them.

3.07 The approach is broadly as expected, except that locomotives are to remain in acommon pool rather than be allocated to the separate freight and passenger "sectors".This is motivated by the desire to ensure labor peace. It carries with it the risk that thetrain operating departments will lack full control over key assets and the train drivers'trade union could hold them hostage, buffered from market forces.

3.08 A second departure from a "clean" unbundling is that a dozen support serviceswill remain centrally managed. Some, such as real estate, health care and pensions, arelogical; power engineering, telecoms and data processing are less so, since they wouldnormally go with infrastructure.

3.09 Key processes remain to be worked out. One is the track access pricing regime.Another is dispatching (train path allocation). These are crucial functions. A further keyissue is the channel for State subsidies. The broad intent is to channel them to the trainoperating departments, not through infrastructure, and that the new regional governments(the 16 "super-voivodships" created on 1 January 1999) will be expected to play a majorrole in deciding on public service obligations and funding resulting deficits. PKP wantsto put such a regime in place by 1 July 1999. It is even willing to tender out suburbannetworks in Warsaw and the Gdansk/Gdynia conurbation to private concessionaires.

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also known as "combined transport": containers and swap bodies carried on rail flatcars

MTME, "PKP Restmctuning: Commercialization and Privatization Concept", Warsaw, 13 July 1998

8

3.10 The concept of open access is broadly accepted, including by PKP managernent.There is also consensus that, in a second stage, the "sectors" will become joint-stockcompanies, 100% State-owned under a PKP holding company. And in a third stage aminority of shares in the train operating companies will be offered for sale, whileinfrastructure will remain 100% State-owned.

3.11 This restructuring is to be codified in a PKP Restructuring and CommercializationBill. It has been debated whether, as the next step, the Minister of Transport shouldseparate infrastructure from train operations institutionally, or whether PKP should beconverted as a whole into ajoint-stock company under commercial law. The Banksupports the former sequencing, but the latter would be acceptable, provided that theMinistry retained sufficient powers to avoid delay in the implementation of subsequentsteps. In light of the growing interest shown by strategic investors in buying into PKP'sfreight operations or setting up private competitors, priority should be given to sepatratingfreight operations from passengers, so that "PKP Freight" is unburdened of the obligationto cross-subsidize passenger losses and can perform commercially and competitively.

3.12 Uncertainty over ownership of land used by PKP is causing concern and may holdup progress while lawsuits are settled. The Ministry of Finance wants to see the burdenon the State budget (and regional budgets) reduced as soon as possible, and argues thatPKP should sell off surplus real estate -which it has in abundance-to finance therestructuring. PKP counters that it holds title to only 7% of the 90,000 parcels on itsasset list; the legal status of the rest is cloudy. Legal fees to compile a cadaster, valueproperties and confirm titles will be huge.

3.13 A business plan for PKP through the year 2005 (7 years) is also underpreparation. It may propose an investment program of $40 billion over the coming 20years. Considering present revenues of about $2.5 billion per year, a target of half that($1 billion per year) would be more realistic.

3.14 Much of PKP's labor force is surplus to future needs, but the pace of downsizingwill depend on the restructuring approach adopted.

Should Polish train operations be privatized?

3.15 The EC White Paper calls for commercialization rather than privatization of theexisting railways. The EC Directive does not mandate privatization of any rail services.The only EC requirement with regard to private participation is to provide access rights tointernational operations of inter-modcl freight, whether public or private (currently lessthan 5% of total railway freight). Among EU members, only the UK has as yet privatizedits railways -which it has done completely, including the infrastructure; Germany aindthe Netherlands have reorganized their rall systems in preparation for privatizing parts.

3.16 Nevertheless, the logical consequence will be that many rail freight train andterminal operations in the EU will gradually transfer to private ownership. This is

9

because, if plivate train operating companies obtain widespread access to theinternational network, the state railway freight operators who operate internationalservices will need to be set free of government to compete successfully. And if theprivate sector is seen to be successful in intemational freight operations, the logic ofretaining domestic freight train operations in public ownership will be increasinglyquestioned.

3.17 However, these developments are not going to happen overnight. Most EUcountries and CEE countries (other than Estonia6 and Romania) have no plans toprivatize at this time. The 1991 Directive is only now beginning to have an impact. Thefirst independent inter-modal freight trains are now running between Denmark andnorthern Italy and preparations are well advanced for similar services between Englandand western Hungary; but it will arguably take 5-10 years or more for the private inter-modal freight sector to become fully established. As regards other international freightservices, the EC is preparing amendments to the three rail reform directives to clarifypolicy and remove certain obstacles to their implementation. The amendments are likelyto be issued in 2000, with pre-accession countries introducing their own legislation acouple of years later. Privatization of domestic freight train operations will also probablyoccur in some countries under their own legislation, following the UK's lead. The railfreight privatization timetable is therefore as follows:

1998-2010: steady growth of privately operated international inter-modal freighttrain services competing against public operators

2002 -2010: steady growth of private operators of international bulk and generalfreight services

1998-2010: privatization of domestic rail freight train operations in some specificcountries, although many, if not most, European countries are likely still to retaina major publicly-owned domestic rail freight operator at the end of the period.

Recommendations

3.18 Based on the Bank's experience in a number of countries where rail restructuringhas moved forward, we recommend that the Government divide PKP into a number ofnew joint-stock companies (JSCs), initially 100 percent owned by Government and underthe tutelage of the Ministry of Transport. The new companies would be NationalInfrastructure, Freight Operations, National Passenger Operations, a series of Regionaland/or Suburban Operations (each ofwhich might have its own infrastructure witharrangements, where appropriate, for joint use of national infrastructure), and Non-railOperations. The current PKP would continue to exist as the receiver of labor, debt and

6 Estonia privatized international passenger services in 1998 and in 1999 is inviting private participation inits freight company and domestic passenger services.

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assets not needed by the new companies. In addition, this approach would permit MTMEto transfer one or more of the new JSCs to private control when appropriate.

3.19 We also recommend that priority be given to defining the Polish portion of the"rail freight freeways" proposed in the EC White Paper and setting up the "one-stopshop" administrative mechanism to manage their use. The Rotterdam-Berlin-Warsaw-Moscow route is an obvious first candidate.

3.20 Five actions are needed to support Poland's process of further reform:

(a) Allocation of assets: PKP's assets need to be carefully reviewed and evaluated inorder to assign them to the appropriate JSC, or be allocated as surplus fordisposal. Clear title will need to be developed where surplus assets are to be soldto the private sector or transferred to local authorities. In particular, disposad ordevelopment of non-rail real estate assets should be entrusted to agencies havingexpertise in real estate development.

(b) Labor redeployment and compensation: An agreed program for laborredeployment and compensation should be developed and announced for PUPrestructuring as soon as possible. This will require detailed analysis of the ageand experience profile of PKP's existing labor force, along with an initialassessment of the labor force needed in the future JSCs. It will also need to bebased on comparisons with other Government labor compensation programs,notably that for coal miners, as well as the specific rights to which PKPemployees are entitled.

(c) Track access and pricing regime: MTME needs to assess rail infrastructuresupport policies and access pricing in other European countries (especially E_Ucountries) and develop the approach to be used in Poland. This will beparticularly important at the stage that private-sector participation is invited, as itwill be impossible to calculate a JSC's value until the cost of infrastructure use isknown.

(d) Transfer of responsibility for subsidizing commuter and regional services to localgovernments: A legal framework and uniform procedures need to be establishedfor cities and regional governments to enter into contracts with the operators ofcommuter and regional services, with the corresponding transfer of fiscalresponsibility for subsidies from the national to the sub-national governments.

(e) Financial forecasts: Projected income statements and balance sheets forinfrastructure and for each of the operating companies need to be developed. Thiswill include market forecasts as well as assets and labor to be assigned.

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World Bank's assistance strategy

3.21 The World Bank strongly supports the proposed reform program for Polishrailways. It contains all the elements we believe are needed to revitalize the rail transportindustry and serve customers well, while keeping the burden on the State and regionalbudgets light. It is a potential leader in this regard not only among the central Europeancountries applying to join the European Union, but even among the present members.

3.22 Accordingly the Bank is willing to consider providing financial support whereverit will help carry the reforms forward, consistent with the limited investment role to beretained by the State. Our emphasis will be on severance payments, information systems,legal and financial advisory services and other expenditures directly facilitating therestructuring, and infrastructure upgrading (if clearly contributing to the restructuring) -all through a sovereign loan to the State or loans to the enterprises backed by a sovereignguarantee.

3.23 We could finance renewal of track and signaling of suburban passenger servicesto be concessioned out to private operators (as in Buenos Aires). We have offered tofinance the upgrading of track on routes carrying coal traffic to allow heavier axle loads;the chances for success would be best if coal were transported by a specialized companyable to enter into long-term contracts with power stations and other major users whowould simultaneously invest in rapid-unloading technology. We could also financeinformation systems, signaling and telecommunications to help implement the new open-access regime. We are the only IFI that lends for severance payments (as in Brazil). Ifwe do so here, our 'project' will be the entire restructuring, commercialization and de-monopolization program, designed to ensure that the reforms will be irreversible and thatthose who receive severance packages will not be rehired. It will probably span the nextfive years or so. Our appraisal will focus on the quality of the restructuring plan, thebusiness plans of the newly independent entities, and the human resources plan for allaffected employees.

3.24 We propose to co-finance the restructuring program with EBRD. Their emphasiswill be on traction and rolling stock, with a view toward launching independent trainoperating companies which they can subsequently finance without sovereign guarantees.Accordingly, EBRD is offering to finance rehabilitation of locomotives and supply ofnew freight rolling stock, including for intermodal (combined transport) operations, tohelp put the freight department/operating company on a firm footing to compete withroad transport. It is less disposed to finance passenger trains, on the grounds that theeconomically justified needs can only be established after the restructuring, when themanagers of passenger operations will face more appropriate incentives (and marketdiscipline) than today. EBRD has agreement with PKP to launch two key studies: (a)design of the track access regime and charges, and (b) design of the framework forcontracting regional passenger services to regional governments.

3.25 EEB is financing the upgrading of infrastructure on international corridors, mainlyto raise the maximum speed of intercity passenger services. It will probably continue to

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do so, as part of the EU accession process. The Government has made no request toPHARE to include railway restructuring in its future program -which is to be muchenlarged as the accession process heats up.

3.26 To prepare for eventual lending on a large scale, we offer to help the Governmenton the above five initial actions, in cooperation with EBRD.

IV. BALANCING PUBLIC TRANSPORT AND CAR USE IN CITIES

Changing demands on urban public transport

4.01 Poland's recent rapid economic growth and expansion of domestic car productionhas raised car ownership to above 300 per 1,000 inhabitants in major cities, and 400 inthe largest cities such as Warsaw and Poznan7 . The registered vehicles have grown at 5-10% peryear since the mid-1980s and more than 20% by 1998. Counts on major screenlines in Warsaw show traffic growth in recent years at just under 7%. Concurrently,urban public transport has been losing passengers, from 9.1 billion trips in 1986 to 7.2billion in 1990 to 5.2 billion in 1997 (this last excluding informal private operators'. Thesplit between private car travel and public transport, once 10/90, is now estimated at30/70; cars' share continues to grow.

4.02 On the supply side of urban transport, the 1990s were spent adapting localinstitutions to systemic changes introduced by the nation: liberalization of economicactivities, transformation of public enterprises, and decentralization. This last wasespecially important, since it turned jurisdiction over urban services and infrastructure,including public transport and local roads, to elected municipal governments. Majorroads stayed in state hands until the introduction in January 1999 of county govermnents,and are financed from dedicated funds fed by fuel taxes.

4.03 The cities have had only modest funds available to support their extensive publictransport industry, which have faced declining demand and the consequences ofdisinvestment since the 1980s. They nonetheless made long strides in the early 1990s bysharply increasing cost recovery from fare revenues of urban public transport operators,and reorganizing them in a variety of ways to increase production efficiency. Systemiclaws adopted by the country in its transition to liberal capitalism gave cities severalinnovative options: (i) change of status of urban transport operators, from that of publicenterprises or municipal departnents to limited-liability, joint-stock companies, initiallywith 100% city ownership; (ii) serviee agreements and/or contracts between operatorsand city governments; (iii) multiple operators in a given urban area; (iv) tendering forservices; (v) setting up of public transport authorities, to regulate the sector and generally

7The fleet statistics probably fail to net out vehicles which are scrapped or too old to be used any more. Ifso, these values should be reduced by 20-30%.

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represent city interests vis-a-vis public transport operators; and (vi) private sectorparticipation.

Introducing competition

4.04 As the cities considered the new menu of options, there were several expectations.Since the existing public transport operators sorely needed to replace and modernize theirfleets, fare increases were failing to generate much extra revenue, and cities were unableto provide more funds, it was hoped that the private sector would step in to bring bothcapital and expertise, mainly from outside the country. The gradual introduction ofcompetitive tendering was expected, through competition between diverse public-ownedand private operators, to bring lower costs and better services. And third, the nationalgovernment was expected to come back into the sector, to take the lead in some of themore sensitive policy changes, but mainly to provide some form of assistance in fundinginvestment programs.

4.05 As the end of the decade is reached, actions have been mixed and their resultsmodest. Several major cities have adopted progressive policy statements, recognizing theneed to balance the use of public and individual transport modes to increase personalchoice and spur economic growth, while protecting the poor and the environment. It hasbeen difficult to implement these policies. The extent to which the new institutionaloptions listed above have been adopted varies widely. Public transport operators retainthe status of a budgetary unit in about half of all cities, among them Warsaw, Poznan,Gdansk and Szczecin. Service contracting has come into wide use, but only in cities likeGdynia has the process of tendering started to acquire features of genuine competition.In most other cities, contracts are of the gross costs type8 and are based on negotiationwith one or more operators. Cities retain the entire revenue risk and also provideinvestment funds.

4.06 There are some interesting and successful cases of private-sector partnership withthe local operator in smaller cities (Olsztyn, pop. 167,000; and Kalisz, pop. 107,000), butby and large the traditional operators still dominate, even if broken down into severalcompanies. Apart from unregulated private services based on small vehicles, the mainformat of private sector participation is sub-contracting for marginal routes, using ownsecond-hand vehicles or leasing them from the main operator. It has proved difficult formunicipal governments in most cities, acting on their own without State leadership andsupport, to overcome the resistance of unions to letting alternative operators compete toprovide large-scale services, just as it has been difficult for them to find funds to invest inmodernizing their fleets and infrastrutture.

8 The operator who bids the lowest price per bus-kIn to operate a specified service wins the franchise. Thecity retains all fare revenue and pays the operator the product of the bid price per bus-km and thenumber of bus-km actually performed.

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4.07 Only gradually have operators gained autonomy to decide what services todeliver, and how to improve or maintain frequency, punctuality, cleanliness. Quality is aprominent feature of service agreements, and is being carefully monitored by thecontracting authority. The pressure on operating costs has been handled by somerestructuring, e.g. spinning off non-core activities, but also by reducing servicefrequencies. Overall, the level of service to passengers appears to have erodedsomewhat, the most obvious being low travel speeds on tramway lines (14-15 km/h) andthe proportion of unused vehicles (peak-to-fleet ratio of 70%). Fare increases have beensharp and continue to be made. (It is said that in 1995 the average net salary bought 2.5times more gasoline than 6 years before, but one third the number of single ride tickets).In the largest cities, cost recovery ratios are now 50-66%, with lower scores for citieswith large tram networks. In smaller and bus-only cities, cost recovery is in the rainge 70-100%. The position of public transport as a competitor to private autos has weakened inthe larger cities, but the captive passengers still get a reasonably good deal, especiallymiddle-income travelers using season tickets.

Investment priorities

4.08 The most promising action is in speeding up the replacement of older vehicles,and investing in rehabilitation of infrastructure (for trarnways), which will loweroperating cost and improve service quality. Vehicle replacements have picked upsomewhat, as financial constraints on the municipalities have eased. In 1997 new busesmade up about 7% of the fleet, a significant improvement over the 2-3% replacement rateprevalent in the early 1990s; but it is still too low given the years of neglect and a desiredrate of at least 10% per year. Unfortunately, this has not been the case with the replacingof trams, where purchases are only 0.6% of the fleet (against a target of about 4% peryear). Some of these purchases involved second-hand vehicles, so tram fleets are ineffect not being renewed. Aged vehicles, dilapidated infrastructure, and absence ofpriority at intersections result in the low operating speeds and generally low quality ofservice (breakdowns, high steps, lateral jerk). Since "tramway" in Polish cities is nearlysynonymous with "reserved right-of-way", this means that the opportunity to create high-quality public transport on major urban arteries is being missed by some 30 cities wherethis mode exists. The same is true of suburban railway lines, whose modernization hasbeen tied to the major and politically sensitive project of restructuring the Polish StateRailways.

4.09 Rare exceptions are found in Poznan, where an entirely new line using light-railtechnology was completed in 1995, with some assistance from the State, and impendingtramway modernization projects in Krakow and Katowice. Warsaw illustrates the samepoint from the opposite angle: the metro was dug beneath a potentially efficient, at-gradetram line, while the existing tram network languished for lack of investment. The City ofWarsaw is intent on extending the metro (encouraged by the central government, which isco-financing the project from the State budget), without much regard for its financial/economic implications or the fact that it will crowd out investments in other publictransport modes. Fortunately other cities have abandoned similar ideas and projects.

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4.10 The Warsaw Metro notwithstanding, urban public transport in Poland appears tobe tending towards its cheapest but also lowest-service category: buses operated inmixed traffic. This may be the right approach for cities under 500,000 inhabitants andeven acceptable in larger cities, if the policy objective is only to make public transportaffordable to the captive market. It is not acceptable if this mode is to compete againstthe auto. For that, seeking reserved right-of-ways for bus lines and improving selectivelythe existing tram right-of-ways is a must. That this is not being done is partly 'due to apersistent conceptual confusion, but is much more a matter of weak financial capacity,and the absence of leadership and assistance from the national government.

Cutting costs

4.11 The fact that at least some public transport operators are now fully covering theircosts shows that there is some room for improvement in both cost and revenuedimensions, even with capital assets in their present state. Unit costs vary greatly fromcity to city, ranging from 2.0 to 4.1 PLN per vehicle-km in 1998. This range appears toolarge to be explained by capital intensity, fleet size, or level and pattern of utilization.Very few systematic studies of operating costs in the industry have been made in recentyears to shed light on this subject, and more systematic study is highly recommended.The most promising approach for cutting operating costs rapidly may be competitivetendering for the market. Some local experts are doubtful about this, believing that thehigh capital cost of the modern technology which expatriate private operators wouldbring in, would wipe out any potential savings on operations and maintenance. It isdifficult, and perhaps not necessary, to pre-judge this. Moreover, competitive tenderingdoes not necessarily involve either expatriate or private firms. Few real attempts havebeen made in cities to have open competitive tendering, to see what the results might be.There are however notable exceptions -such as Katowice, Tarnowskie Gory andGdynia-which have awarded contracts by competitive tendering. Some of thesecontracts have gone to public firms and some to private, with the latter operating up to aquarter of all services. Further pilot attempts to do this should be undertaken, to gaugemarket interest on the supply side more widely and assess benefits. Thisrecommendation, the tendering aspect and the neutrality between different owners, isfully in line with current EU thinking.

Fare policy objectives

4.12 As regards revenues, actions have included fare increases, introduction of time-zone fares, and some fare restructuring to favor frequent users. It is not clear how muchscope there now is for increasing fare revenues. Research based on end-1993 datashowed that monthly fares were onerous for low-income travelers, and this is not likely tohave changed much since. In 1997, monthly tickets were 10-12% of average monthlyexpenditure per capita, suggesting a much higher burden for poor families. No attempthas been made to redesign the subsidy system, in the sense of introducing means-testingand targeting, as is done with social assistance in Poland. At this time of rapid socialchange and increased motorization, fare policy must pursue two sometimes conflicting

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objectives: to take care of affordability at the lower end of the market, and keep publictransport attractive compared to private cars at the upper end. There is no establishedhabit to do market studies to assess affordability and preferences. Even passenger countsare scarce. Only recently have new ticket-selling technologies been introduced whichmake it easy to collect passenger information.

Fina-ncing urban roads

4.13 As for urban roads, the pressure for investment is even greater, as they face risingdemand. An oft-heard statement is that the funds available for urban roads are too low, inpart because the national funds allocation formula does not give enough weight to trafficloads. 1993-1998 data from Warsaw indicate that road expenditures for maintenance andcapital investments were always a fraction of the planned budget, ranging from a low of27% in 1996 to a high of 59% in 1997. The pattern of expenditures shows jumps of morethan 100% in 1994 and almost as high in 1997, in real terms, suggesting the fundingprocess has been haphazard. The visual evidence of stop-and-go traffic and unfinishedroad projects started years ago shows that funding has been inadequate. On the otherhand, the scarcity of funding for large new urban roads has forced city authorities tostress traffic control and metered street parking. Major projects in this regard are beingundertaken in Poznan, Warsaw and other cities. This is positive, but will not suffice.

4.14 A careful look at the way fuel taxes are being allocated may be warranted, butgiven the variety of funding sources for urban roads this will tell only part of the story.Altogether, national funding of urban roads through fuel taxation has not succeeded inresolving either the funding problem or congestion in any country of the world. Theproblem is complex; drivers in congested urban networks pay far less than the costs theirtravel imposes on society. As an outreach action, city-based road use pricing, such as inOslo and Trondheim (Norway) holds promise to regulate the use of cars as well asgenerate revenue. It is recommended for study, but it may be an idea whose time in.Poland has not yet come.

4.15 The modest scale of investments in bus fleets, and the low level of investment inmore capital-intensive projects on both roads and public transport (with Warsaw metro asan exception), indicate that improvements in city finances are quite slow. A few citieshave managed to get the State to underwrite their loans for water and flood protectionsystems, but not for transport improvements. World Bank finance for a MunicipalDevelopment Fund has been secured with a national guarantee, but provides only smallloans and has come up against the problem of project preparation capacity. Krakow is tofloat bonds, and it is finalizing arrangements for a EUR 45 million loan from the EEBRDfor a new rapid tramway project, using city cash income as collateral. As co-financing,EIB is providing a loan of the same size, guaranteed by a bank in an EU member country.Katowice is rehabilitating a 20-km tramway line on its own. Other cities, e.g. Lodz, haveidentified similar projects, but have not found a way to implement them. The country'scities may be moving in a direction where their economic growth (in the form ofmotorization) will choke them because their incremental strategy does not suffice. It

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would appear that the State has gone too far in decentralizing all public transportresponsibilities to the cities, without giving them the instruments equal to the emergingproblems. This needs to be corrected, but cannot be done until sophisticated institutionalcapacity has been built up at the national level, probably but not necessarily in theMinistry of Transport.

Recommendations

4.16 In short, efforts need to be mobilized in all the following directions:

(a) Improve traffic flow by low-cost measures such as advanced traffic managementsystems (co-ordinated traffic lights, lane marking, redesign of intersections, etc.).

(b) Upgrade existing tramway lines on reserved rights-of-way and introduce similarbus-based lines, to keep public transport services attractive.

(c) Introduce competitive bidding for award of service contracts, first as a means toreduce operating costs, then as a possible way to raise capital.

(d) Carry out a country-wide, comparative econometric study of public transportoperating costs to identify potential reserves of cost savings and/or operationalimprovements.

(e) Focus on market assessments as the basis for evolving better fare/service policies,possibly linking subsidy policies with the social assistance system.

(f) Study the adequacy of the national and city-based road funding systems as theyapply to congested urban roads and identify alternatives.

(g) Create a national-level capacity to assist cities in conceiving and implementingnon-incremental policies and investments.

World Bank assistance strategy

4.17 In 1995 the World Bank published an extensive report on Polish urban transport,which confirmed a strong justification for the Bank to support, through lending, thereforms to public transport recommended above. No lending followed because thenational government was not willing to guarantee municipal debt for this purpose. TheBank is no less willing today to lendfor urban transport. If the national governmentattaches importance to these reforms and is willing to provide the necessary guarantee(s),a good basis exists for quickly preparing a lending operation. An alternative to directlending to municipalities is a line of credit through Polish banks, similar to that which theBank approved in 1997.

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V. RECONCILING ROAD TRANSPORT AND THE ENVIRONMENT

5.01 Air pollution: EC environmental legislation calls for the elimination of lead fromgasoline and the reduction of the sulfur content of diesel fuel. Among possible measuresto reduce emissions these two will have potentially the biggest beneficial impact onipublic health. On eliminating lead, Poland is already in compliance in that all cars firstlicensed after July 1995 have had to be equipped with catalytic converters. This ruleapplies even to second-hand cars, which goes beyond current EC law. Unleaded fu.el issaid to be available throughout the country.

5.02 A catalytic converter is ruined if the car is run on leaded gasoline, so it has to beasked how widespread (if at all) misuse of leaded gasoline may be. Since the ex-refinerycost of unleaded fuel is slightly higher than leaded, many governments levy a smaller taxon unleaded fuel than on leaded, so that the consumer sees a saving in buying unleaded.This is now practiced in Poland and needs to be sustained.

5.03 The part of the fleet lacking catalytic converters is today estimated at 65-70percent of the total9 . If cars are scrapped when 15-18 years old and the fleet continues togrow at its present fast pace -up to 10 percent per year, net of scrappage-- by the enLd ofyear 2003 about one quarter of the fleet will still be non-compliant. The governmenit maywant to adopt administrative measures or further fiscal incentives to accelerate theirscrapping, such as the Swedish practice of paying a "bonus" to owners who scrap theircars in an environmentally sound way.

5.04 The EC's recent green paper on internalizing the external costs of transport is notyet law, but it argues for improved estimates of the costs to society of air pollution andthe incorporation of those costs into the prices road users face in making their travel andhaulage decisions. The most practical instrument for charging is an explicit "emissionsfee" or tax on fuel. It also comes closest to reflecting the variation from vehicle tovehicle depending on engine size and distance driven. It is extremely hard to measure thepublic health cost of exhaust gases, but one estimate cited in the EC green paper isequivalent to $300-500 per car per year or, for an average car, $0.20-25 per liter ofgasoline. The equivalent emissions externality for trucks is estimated at $3,000-5,000 peryear, corresponding to an emissions fee on diesel at the similar rate of about $0.25 perliter. °

5.05 Charging for road use: Apart from the social costs of emissions, the cost of roaduse also needs to be internalized, if conditions of competition are to be equalized. TIhiscan be divided into two components:* "wear and tear" (the marginal contribution of a

9 Owners of some cars not equipped with catalytic converters will nonetheless use unleaded fuel; but wehave no data on this practice.

10 The simplifying assumption that all cars are gasoline-powered and all trucks are diesel-powered createsno great distortion as long as the resulting fees are similar. If they were, some offset could beprovided for diesel-powered cars or gasoline-powered trucks through differential annual license fees.

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single trip to the cost of maintaining and rehabilitating a road) and congestion. Wear andtear is reasonably well researched and its variation from one trip to another correlatesadequately with fuel consumption. Some indicative values are given below. In contrast,the costs of congestion are highly variable from trip to trip, hard to quantify, and hard torelate to any practical charging mechanism. They therefore warrant a considerable effortto research, as the EC has recommended.

5.06 Many current EU member states have defacto levied substantially higher taxes onautomotive fuels than Poland: e.g. up to EUR 585 compared to EUR 245 per ton ofdiesel". The expectation is that member states will soon be raising their fuel taxes evenhigher, to incorporate an explicit emissions charge. The implication for Poland is that itshould aim to bring its fuel taxes into alignment by the time of accession, meaningroughly doubling the pump price over the coming 4-6 years. During 1998 theGovernment repeatedly raised the levels of excise taxes on vehicle fuels by smallamounts, partly to replace annual registration fees and partly to raise revenue, offsettingthe decline in the wholesale prices of fuels. The net increase in pump prices, however,did not keep pace with zloty inflation; in dollar terms the prices declined. The Ministryof Finance has noted that it will have to raise excise taxes on liquid fuels between 32 and60 percent by 2002 to bring Polish regulations into conformity with EU requirements-at 70-90 US cents per liter.

5.07 Road safety: Road accidents are also a major environmental concern, since Polishaccident rates are twice as high as in western Europe'2 . In 1997 7,300 people died inroad accidents (equivalent to a full jet plane crashing every week) and 83,000 peoplewere injured. Traffic accidents have become one of the most frequent causes of deathand injury, especially among children and young adults. They are estimated to cost theeconomy $1.5 billion each year, substantially more than the State spends on roads andmotorways.

5.08 A National Road Safety Council was set up several years ago, but has onlyrecently become active. A nationwide traffic safety program (known by its Polish initialsGAMBIT) has been agreed upon and now needs to be implemented. It defines theresponsibilities of each of the many agencies which need to be involved: besides theCouncil itself, these are the Road Safety Unit in the Ministry of Transport, the nationalroad agency (GDDP), the Ministry of Interior (in charge of the police), the Ministries ofEducation and Health, justice and environmental protection agencies, insurancecompanies and non-governmental organizations. The initial period of GAMBITimplementation puts special emphasis on the provision of good equipment and trainingfor the national traffic police.

The minima as of January 1998 were 337 EUR for leaded gasoline, 287 EUR for unleaded, and 245EUR for diesel.

12 18 fatalities per 100,000 inhabitants as against 6-9 in Western Europe, and 7 fatalities per 100,000vehicles as against 3-4.

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5.09 Further discussion on transport's impact on the environment is to be found inAttachment 2.

Recommendations

5.10 Further work is warranted to strengthen the analytical basis for fuel tax increaseswhich, inevitably, will cause adjustment stresses and be politically difficult. The MTME,in collaboration with the Ministry of Finance, should (a) research and analyze the costs ofenvironmental externalities; (b) review alternative charging mechanisms; (c) reviewpolicy objectives related to fuel prices, to arrive at (d) target levels of fuel tax and thepace of increase to get from here to there. The decline in oil prices ex refinery in 1998presents a favorable opportunity to increase fuel taxes.

5.11 The agencies involved in road safety need to work together to implementmeasures to lower the risk of accidents and reduce their severity, and to monitor the cost-effectiveness of the various measures. The program includes several targets; animportant one, in the face of 5-10% annual growth in car use, is the reduction of fatalitiesfrom the 7,300 of 1997 to 6,000 in 2001.

VI. STRENGTHENING ROADS TO HANDLE EU HEAVY TRUCKS

6.01 The centrally planned economies planned for all heavy long-distance freight tomove by rail. Accordingly, Polish roads were designed to accommodate the relativelylight truck traffic prevalent until the 1990s -light in the sense few in number and light inweight. The maximum permitted weight for a single axle was 8 metric tons on nationalroads and 6 tons on regional and local roads. Asphalt-concrete pavements werecorrespondingly thin. The economic transformation of the 1990s has radically changedroad traffic. Truck traffic has grown rapidly -at about 10 percent per year-- and heaviervehicles have been introduced. Larger trucks make economic sense: all costsconsidered, they lower the cost of transporting freight.

6.02 In the early 1990s the Government raised the maximum permitted weight for asingle axle to 10 tons13 on a little over half the national network (26,000 km out of46,000) and 8 tons elsewhere, and the Roads Directorate is embarked on a large-scadeprogram of road rehabilitation and pavement strengthening to cope with the heavierloading. With the help of the World Bank's First Highway Loan, the investment budgetfor upgrading national roads was raised from about $350 million equivalent in 1992-1994to $525 million in 1996 and further to $580 million in 1997. So far the 26,000 km ofnational roads have been upgraded to accommodate 1 0-ton axles, the rest of the national

13 The maximum permitted weight for twin axles has also been raised proportionately, as has themaximum gross weight per vehicle.

21

roads and 80 percent of the regional roads have been adapted to 8 tons, and the rest of thenetwork remains at 6 tons. 14

6.03 Nonetheless, one heavy vehicle in four has been found to exceed the weight limitsand only a quarter of the national roads are in good condition, so a continued sustainedeffort is required. The economic return on road rehabilitation expenditures is high andthe effort so far is reasonable considering all the other demands on the national budget.The total roads budget, including for regional roads, corresponds to only 0.7 percent ofGDP, which is still below the median for developing countries (0.9-1.0 percent).

6.04 It will therefore be hard to adapt quickly to the even heavier load limits requiredby the European Union and the further growth of truck volumes which membership willinduce. The EU's maximum permitted single axle is 11.5 tons, a compromise betweenthe 13 tons allowed in France and the 10 tons hitherto allowed by Germany and theUnited Kingdom. In 1992 it was estimated that about $1.4 billion was needed to adaptthe bearing capacity of Poland's then existing international roads to the EU standard (notcounting alignment and lane capacity improvements).

6.05 The strategy which the MTME has adopted makes good sense. In a policy studyconducted in 1995'5 it was decided to give priority to those roads most likely to be usedby trucks involved in international trade. All motorways will be built to the EU standard,and national roads will be strengthened according to a hierarchy determined byinternational traffic flows. Enforcement of controls on truck weights is being tightenedand broader powers granted to impose fines; trucks in transit across Poland are requiredto follow specified routes. During 1994 some 20 percent of trucks in transit were foundto be overweight by up to 25 percent. Consideration is being given to negotiatingtransitional restrictions on the entry of the heaviest trucks, and specifically a 10-yeargrace period to bring the system into full conformity.

6.06 The road budget may be raised yet further: it is not difficult to make theeconomic case for doubling again spending to strengthen national roads (i.e. adding afurther $400 million per year). And cost recovery from road users is being reviewed.Comparable studies in other countries estimate the variable "wear and tear" cost imposedby a typical truck at about $0.10 per km (and that imposed by a typical light vehicle atabout $0.02 per kin). If charged entirely as a tax on fuel, this is equivalent to about $0.30per liter of diesel fuel"6 . A truck driving 50,000 km per year would pay $5,000 per year,less than 10 percent of its annual operating cost. Polish truckers may well protest,

4 As part of the reform of regional governments introduced in January 1999 26,000 km of national roadswere transferred to the new, enlarged voivodships, who now have the task of strengthening thosewhich need it.

15 Ministry of Transport and Maritime Economy, "Basis for Heavy Vehicle Traffic Including Vehicleswith Excessive Total Loads and Axle Loads", August 1995

16 The typical truck consumes 30 liters per 100 km.

22

particularly if the road use fee is added to the emissions fee advocated above, but the twotogether would bring the price of diesel up to no more than the average price in presentmember states (from about $0.45 per liter to about $1.00). The equivalent charge forlight vehicles is about $0.20 per liter of gasoline.

6.07 International truckers would no doubt object to continuation of Poland's presentfines. A truck 5-15 percent over the weight limit is fined the equivalent of about half thetruck's operating cost (e.g. travel from the German border to Warsaw costs a typicaltractor-trailer about $500 and the fine is about $250). In exchange for easing or droppingthese restrictions, Poland will no doubt negotiate with the European Commission for acontribution from the Cohesion Fund toward the cost of strengthening its road network tobring it into compliance with the EC weight limits. In connection with the World ]Bank'sSecond Roads Project, the Finnish government is providing a grant for technicalassistance to quantify these effects more exactly.

6.08 Under the new system of regional government introduced in 1999 the annual taxon motor vehicles collected hitherto by gminas has been replaced by an excise tax onfuels collected nationally and distributed (in part) to the three levels of local governmentin compensation. Of the total revenue 40% will go for national roads and 60% will bedistributed to the voivodships, poviats and gminas, earmarked for use on subnationalroads. Each jurisdiction's share will depend on the length of its road network, trafficdensity, number of accidents, and the need to balance the development of roadinfrastructure, including border infrastructure.

Recommendation

6.09 GDDP needs to refine its estimates of the investments required to strengthen theroad network to bring it into line with EU truck weight standards. MTME should reviewits regulations and criteria for issuing permits for overweight trucks, prescribed routes fortransit traffic, enforcement mechanisms, and penalties. It should work with the Ministryof Finance to provide the analytical underpinning for increased taxes on fuels, and withthe regional and local governments to share with them its pavement management systemand technical criteria for setting budgets for road maintenance.

World Bank assistance strategy

6.10 Roads account for nearly 60% of all World Bank lending in Central and EasternEurope to date; Poland is no exception. They are likely to continue to be the largestabsorber of investment in Poland's irtfrastructure sectors. They also offer the least riskyproject prospects. The Bank is therefore willing to consider further financing of roads, tothe extent that its combined policy/institution-building work can be demonstrated asprobably critical to reduction of the road sector's burden on general tax revenues(whether by reduction of public-sector costs or increase of user taxation).

23

VII. MODERNIZING POLAND'S PORTS TO SERVE GLOBALIZED INDUSTRY

7.01 In recent years the globalization of the world's industry has driven -and beendriven by-- developments in ports and international shipping. Three trends have beendominant:

* Cargoes have been concentrated in containers and other unitized forms amenableto rapid, mechanized loading and unloading;

* Larger ships have been used for long-distance hauls between international mega-ports, fed by small ships from regional ports in hub-and-spoke operations; and

* Specialized port terminals have attracted greater private ownership andinvestment, and competition among such operators has spread.

7.02 A common aim is to reduce the time ships spend in port, since a large ship's timecosts tens of thousands of dollars per day. Cargo also needs to spend less time in transitthrough the port. Shippers want more security from loss and pilferage, greaterpredictability in delivery to destination, and hence greater control over handling andprocessing. Lower inventories and greater reliance on just-in-time processes make it allthe more critical to be able to rely on efficient and secure port operations at the seaflandinterface.

7.03 At the beginning of the 1990s Poland's ports lagged behind these trends. Theyare now struggling to catch up to:

* develop efficient container terminals.

* modernize cargo-handling techniques, relying more on road transport in-land andless on rail, requiring redesign of quays and storage facilities.

* restructuring port institutions, devolving State responsibilities to local portauthorities acting as landlords responsible for infrastructure, and promotingprivate participation and competition among operating companies responsible forhandling equipment.

7.04 This has created several problems:

(a) With the nature and directions of Polish trade evolving rapidly from year to year,investing in ports has been a risky business. International road transport, railwaysand pipelines are competing for the same traffic as the Polish ports. There is alsostrong competition among alternative routes for cargo between the hub ports(Rotterdam, Hamburg) and eastern Baltic destinations.

(b) New port infrastructure -berths, channels, and land access-- is lumpy, fixed andcostly; the State could ill afford the large minimum investments needed.

24

(c) The country lacked any regulatory framework for orderly, transparent competitionamong private port operators (who inevitably enjoy a degree of naturalmonopoly).

(d) Faced with a choice between concentrating all traffic of a given type in oneterminal (to gain economies of scale) or promoting competition (spreading; trafficamong several smaller terminals), which is to be preferred?

(e) Poland's main ports are in congested old cities. In-land transport has had to passthrough town centers. Is it better to rebuild the accesses or relocate port activitiesaway from the city centers?

7.05 The shift in roles between public and private sectors has been difficult andhesitant. The legislation passed in 1996 devolving State responsibilities to separateauthorities for each port and they are starting to operate as intended. Full concentrationon their landlord functions is however much delayed; the transition process needs to becompleted quickly. Accesses to the three main ports are being improved under the WorldBank's Port Accesses and Management Project. Most specialized terminals have beenturned over to specialized joint-stock companies with varying degrees of privateownership.

7.06 Szczecin is modernizing navigational aids to speed up ships' access to its port.Plans are being prepared for improved aids to make access to the other main ports fasterand safer.

7.07 Much remains to be done to enhance the efficiency of the container terminals.Gdansk is proposing to develop a major new container terminal, which looks a riskcystrategy since Gdynia has a clear head start and is very close.

7.08 The national government, still responsible for smaller regional ports, is looking atways to increase their capacity at moderate cost. This runs contrary to the internationaltrend towards concentration of cargo flows in a few large ports, and its economicjustification is doubtful.

7.09 EU accession will require considerable strengthening of Customs administration.To help streamline Customs clearance, a critical requirement for attracting new traffic,efforts will need to focus on standardizing documents, simplifying processing (e.g.sample testing), expanding electronic data interchange, and establishing consultativemechanisms bringing together port users, operators and Customs.

Recommendation

7.10 MTME should consolidate the new port authorities without delay and strerLgthenregulatory mechanisms for transparent competition among port operators. It should setup consultative bodies of port users and operators to advise Customs on streamliningtheir procedures.

25

World Bank assistance strategy

7.11 The Bank has been supporting the development of an efficient administrative set-up for managing the major ports and promoting private investment and operation, as wellas financing priority physical facilities. The first project concentrated on improved land-side access to the ports of Gdansk, Szczecin and Swinoujscie, as well as vessel trackingand safety-enhancing systems. The second loan under preparation aims to helpconsolidate the role of the new port authorities as landlords with municipal participation,and to finance berths, storage areas and other port infrastructure needed to accommodatenew cargo flows.

VII. CIVIL AVIATION: PARTLY OPEN SKIES

8.01 LOT's prime markets are Germany, USA (particularly the ethnic market inChicago), and other EU destinations. Traffic has been growing since 1993 at 10-15percent per year. Business traffic is growing strongly, as is charter traffic forMediterranean destinations. LOT is well aware of the dangers of pursuing traffic forpolitical rather than commercial reasons. It has already canceled some loss-makingroutes and is considering withdrawing from others.

8.02 LOT's fleet is exceptionally young, since in 1993-4 all its Soviet aircraft werereplaced with new Boeings and ATRs. Five new Boeings were added in 1997. Theseplanes are fuel-efficient and achieve high utilization. However, the consequences ofrapid fleet growth on cash flow -large lease payments at regular intervals-- have to bemanaged prudently.

8.03 Almost alone among European airlines, LOT was profitable in 1994 and 1995, bya small margin, made relatively small losses in 1996 and 1997, and broke even in 1998.Where it makes money and loses money is open to discussion, depending whereoverheads are allocated. It sets its fares in US dollars and pays for its aircraft in the samecurrency, so its foreign exchange risk is modest. Its low wage rates vis-a-vis EU andNorth American airlines give it a competitive advantage, and the number of employeeswas cut by more than 40 percent from 1990 to 1994. However, its work force isrepresented by 5 unions, all strong, and its compensation levels are rising.

8.04 LOT has a cooperation agreement with American Airlines and its alliance partner,British Airways, which is beneficial in feeding connecting traffic to and from thepartners' international destinations. It also gains LOT full display in AA's SABREreservation system.

Airports

8.05 Warsaw airport handled about 4 million passengers in 1998, close to the designcapacity of the terminal, whereas the capacity of its runway is about 14 million. Plans to

26

augment the terminal's capacity are to be made public shortly. The state-owned airportcompany, PPL, is also modernizing and expanding the airports at Krac6w, Katowice andGdansk airports -Poland's three other international airports-as well as at Wroclaw andother regional airports. A second airport for Warsaw is under consideration toaccommodate long-term traffic growth. MTME's Development Plan foreseesexpenditure of $2.5 billion over the decade 2006-2015; such a large investment willwarrant careful scrutiny.

The Government's role in aviation

8.06 The Polish government, through the Ministry of Transport, plays three roles:regulator, sponsor in negotiating bilateral rights, and LOT's majority shareholder. LOTperceives MTME as having exerted little or no pressure in recent years to operate routesthat are commercially non-viable, nor to impose non-viable fares. Likewise, theGovernment has not interfered in LOT's wages recently.

8.07 In 1991 a law was passed to allow private shareholding in LOT, subsequentlytargeted to occur by 1996, but it was not activated until late 1998, when advisors werefinally appointed. 51 % of shares must remain in domestic hands, and so far are held bythe Government. 15% are to go to employees, and 10 % is to be sold to a strategicpartner. The company's capital is then to be increased by 30-50%, with most of theincrease being subscribed by the strategic partner, bringing its share up to 38% of the newtotal. LOT sees its code-sharing with American and BA as bringing in good business,but has hesitated to sell a large share-holding to a foreign major carrier for fear of losingcontrol over routes.

EU aviation policy

8.08 The EU has been liberalizing its civil aviation in four stages since 1988. Theintermediate stages have provided greater flexibility in the capacity allocation betweenpaired carriers under bilateral 3rd and 4th freedom rights (trips to and from home). Thefourth and final stage, which took effect on April 1, 1997, allows all airlines belonging tonationals of EU member states to operate routes within the 15 states without restriction.This means "open skies" on intra-Union routes for EU carriers, though structuredbilateral operating rights will remain in effect for external routes and non-EU carniers.

8.09 LOT's bilaterals are outside EU law, but are following the trend with a lag. Thus,its bilaterals with some EU states allow unequal capacity up to 55/45, and proposals arebeing considered for going to 60/40. This allows one of the paired carriers to increasefrequencies unilaterally, as British Airways has done. Poland's bilaterals with Belgiumand Sweden now allow for multiple carriers, but they have not been taken up. Fifthfreedom operations (to pick up at an intermediate stop to carry to a final destination in athird country) are gaining ground, as are sixth freedom operations (to pick up in onepartner country, fly back to the home hub, and transfer to another partner country --asfrom Vilnius to London via Warsaw). Yet another form of liberalization is inter-regional

27

flights into non-hub airports, which have proliferated between Germany and Gdansk,Poznan, etc. Provided the aircraft have fewer than 70 seats, they do not count against thecapacity quotas set in the bilaterals. Poland's Europe Agreement stipulates that anaviation agreement will be negotiated to liberalize capacity, but it has not yetmaterialized.

The future of Polish civil aviation

8.10 The future for Polish aviation is very promising. As the economic turnaroundgathers pace, Poles are traveling more and further. Increasingly they are taking vacationsin the Mediterranean. Polish air traffic may well continue to grow at 12-15 percent peryear, doubling in 5-6 years. Experience in the USA after airline deregulation suggeststhat the liberalization of EU laws will cause the EU market to become dominated by alimited number of mega-carriers, while small "niche" carriers will proliferate, somesucceeding, some failing. New gateways will be opened, diversifying routes away fromnational capitals to regional cities.

8.11 Faced with this prospect, LOT recognizes that it cannot be everything to allmarkets, and will accord top priority to international routes out of its home market. Itmay consolidate its network, dropping the least profitable routes. It may decide to leavethe domestic regional market to new carriers. It sees that the scope for internationalhubbing through Warsaw is limited; LOT may succeed in channeling some traffic fromthe Baltic republics and western Ukraine through Warsaw to the USA, for example, butthese markets are inherently small.

8.12 Thus LOT is likely to lose some of its traffic if EU competition rules apply. Thepresent trend will erode its share of the Polish market from its present 65-70 percent tobelow 50 percent, and EU accession would accentuate this, putting pressure on LOT tolower fares and trim costs further, particularly wage costs. It will review carefully itsoptions for selling shares to private investors. Its commercial policy is very sound andaugurs well for the future.

8. 13 The opening of routes from regional cities will create opportunities for start-upcarriers operating smaller (non-jet) aircraft. This process is already visible and PPL'splans to upgrade the regional airports are an appropriate response.

8.14 In short, the traveling public stands to gain; but LOT will be relatively wellpositioned to compete successfully in the single market.

Recommendation

8.15 The Government should pursue LOT's privatization. MTME should support LOTin renegotiation of bilateral air traffic rights to exploit the opportunities created by EUStage 4 liberalization. It should also remove any barriers to exit from loss-making routes.

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IX. PRIVATE PARTICIPATION IN TRANSPORT INFRASTRUCTURE AND SERVICES

9.01 As one of the few "emerging markets" to remain largely unscathed by theSoutheast Asian and Russian banking crises, Poland stands to attract considerable privateinvestrnent to transport, as to other sectors. If this process is to succeed, the Governmentneeds to move away from ad hoc approaches and establish clearer rules of the game.

9.02 There are common elements to the problems of attracting private investors to takepart in financing motorways, operating independent trains, handling cargo at ports, andmodernizing urban public transport. Disincentives are to be found in existing laws onproperty ownership and transfer, taxation, and banking (laws governing collateral andbankruptcy). Procedures for awarding concessions by competitive tender are largely adhoc. Poland has as yet no experience with negative tenders, under which a privatecompany bids to provide a public transport service for the smallest subsidy.

9.03 Nor has it any good models of shared financing of transport infrastructure by thepublic sector and the private sector; criteria and procedures are lacking for determiningwhen this is appropriate and how large the State contribution should be. Not only thenational government but also regional and municipal governments are showing interest inpublic/private partnerships. But decisions on which projects should qualify for sovereignguarantees are only ad hoc.

9.04 The use of credit ratings (as the basis for banks to assess the creditworthiness ofpublic-private partnership projects without sovereign guarantees) is only starting to gaincurrency as the larger cities get rated for the first time. The use of partial risk guaranteesto enhance private finance remains to be explored.

9.05 Some of these issues need to be addressed at the level of the economy as a whole,but may also warrant special attention within the transport sector. Guidance needs to beoffered to the sub-national levels of government. The practical applications of the PublicService Obligation concept and the awarding of tenders for a market are largelytransport-specific. General guidelines for deciding on sovereign loans and guaranteesneed criteria specific to transport for applications in the sector.

Recommendation

9.06 MTME, in consultation with the Ministry of State Treasury, should reviewbarriers and disincentives to private investment in transport infrastructure and services -legal, fiscal, regulatory and financial.* They should establish permanent consultativemechanisms for removal of these barriers and the setting of transparent "rules of thegame".

29

X. STRATEGIC RECOMMENDATIONS To THE POLISH GOVERNMENT

10.01 Strengthen the capacity of the Ministry of Transport to define the appropriateroles in transport for the public sector and the private sector, and for the nationalgovernment, regional and local governments.

10.02 Revise policy toward, and legislation governing, motorways, expanding the scopefor "traditional" public-sector financing and operation, and creating transparentmechanisms for combining public and private financing and management ("public-private partnerships").

10.03 Implement restructuring of PKP as soon as possible along lines of business, withtechnical assistance to advise on (i) establishing a track access and pricing regime and (ii)a regime for regional governments to contract for loss-making passenger services, (iii)drawing up a labor compensation plan, and (iv) clarifying ownership of lands occupiedby PKP and allocating assets to the future independent units.

10.04 Set up an urban transport policy and support unit in the MTME (or the Ministry ofInterior).

10.05 Research and analyze the costs of environmental externalities. Review alternativecharging mechanisms. Review policy objectives related to fuel prices, to arrive at atarget level of fuel tax and pace of increase to get from here to there.

10.06 Fund and implement the agreed action program to increase road traffic safety.

10.07 Refine estimates of investment requirements to strengthen the road network tobring it into line with EU truck weight standards. Review permits for overweight trucks,prescribed routes for transit traffic, enforcement mechanisms, and penalties.

10.08 Consolidate the new port authorities in their landlord role. Strengthen regulatorymechanisms for transparent competition among port operators. Set up consultativebodies of port users and operators to advise Customs on streamlining their procedures.

10.09 Support LOT in renegotiation of bilateral air traffic rights to exploit theopportunities created by EU Stage 4 liberalization. Pursue privatization. Remove anybarriers to exit from loss-making routes.

10.10 Review barriers and disincentives to private investment in transport infrastructureand services -legal, fiscal, regulatory and financial. Establish permanent consultativemechanisms for removal of these baniers and the setting of transparent "rules of thegame"'.

30

Attachment 1

THE GOVERNMENT'S STRATEGY FOR RESTRUCTURING PKP

1. Within the next 3-5 years the present monolithic public enterprise, Polish StateRailways, will be "unbundled" into the following independent companies:

* freight operations (possibly with subsidiaries specializing in containers andcertain commodities)

* long-distance passenger operations* commuter passenger operations (three companies for Warsaw, Silesia, and the

Gdansk-Sopot-Gdynia "tri-city" urban area)* track and other infrastructure/ network of national importance* track and other infrastructure/ regional/local "voivodship" lines (several

companies)* track and other infrastructure/ industrial lines (subsidiaries of their new owners)* specialized service units: rail maintenance, manufacturing, etc.

2. The Ministry proposed a 4-step process:

* separation into business units (profit centers) on an mid 1998accounting basis

* commercialization: bringing PKP under the law on End 1999commercialization and privatization of state enterprises

* sectors and departments become separate companies under End 2000commercial law, privatization: sale of shares to the public, while retaining a End 2005State "golden share"

3. Social services, housing and health services will be spun off to national andmunicipal providers of such services.

4. It will probably be necessary to set up a Railway Property Agency or similar bodyto handle residual State obligations. No decision has been taken yet.

Policies

5. State financing will be limited to:

• capital expenditures on infrastructure of national importance.* compensation to operators for nationally mandated discounts on certain categories

of passengers (children, the disabled, etc.) on conmmuter and regional passengerservices. (Operators will not receive subsidies for specific routes.)

31

6. Operating companies will be otherwise free to set their own tariffs.

7. Railway companies will be subject to civil law suits and anti-trust laws.

8. Freight operators will have the right of access to all three levels of infrastructure.

9. Operating licenses will be issued by the Ministry of Transport, through the officeof a "chief inspector" (as regulator). Licenses to operate international services will inaddition be subject to international bilateral agreements.

10. Safety will also be regulated by the Chief Inspectorate (the first Inspector wasappointed in April 1998).

11. The State (represented by the Ministry of the Treasury) will remain owner ofinfrastructure of national importance, but revenues must cover everything exceptGovernment-approved investment projects.17

12. It is expected that these policies will lead to the ending of "national" railoperations on 6-8,000 km of line, shrinking the national network from about 23,000 kmto 15-17,000. The redundant lines will be offered to regional governments and userindustries.

Human resources planning

13. The staffing needs of the above independent, downsized companies will beassessed. Account will be taken of the introduction of more flexible operating practicesand a shift of skill requirements towards commercial, marketing and financial skills.

14. As a function of the age profile and skill mix of the present workforce, estimateswill be made of the number of staff who will be surplus to requirements. They will bedivided among

* early retirement (age 50 and over) --known as "railwaymen 's leave"* separation packages (age under 50)

15. Pensions are a State responsibility. It is expected that the State pension schemewill be reformed radically in 1999.

16. Training priorities (including retraining) will be identified. Preliminary estimatessuggest that at least 60,000-70,000 employees will be redundant, while staff withuniversity education will be in short supply.

7 Poland will apply the general rules for rail infrastructure management to be adopted by ECMT inCopenhagen in May. Operators will be required to cover long-run marginal cost of their use of theinfrastructure, as in the UK and Germany (and unlike Sweden and the Netherlands).

32

Laws and regulations

17. The restructuring will adhere to:

* transport law of 15 November 1984 with amendments* law on PKP enterprise of 6 July 1995* law on rail transport of 27 June 1997* law on commercialization & privatization of public enterprises of 30 August 1996

(requires amendment if it is to cover PKP, at present exempt)* EU Directive 91/440* EU Directive 95/18 on licensing railway enterprises* EU Directive 95/19 on allocation of routes and fees for access to infrastructure* EU White Paper. "A Strategy for Revitalizing the Community's Railways"

18. A prerequisite to implementing the restructuring is to confirm the railways' rightto permanent use of the land they now occupy.

33

Attachment 2

"ALTERNATIVE TRANSPORT POLICY"

The World Bank was host to a day of lively debate between the Ministry of Transport,headed by the Minister himself, and several environmental organizations which advocatea more environment-friendly transport policy for Poland. This epitomized a broadereffort being made by the World Bank, at the initiative of its president, James Wolfensohn,to foster the inclusion of civil society -non-governmental organizations-in debate overpublic policy issues.

In April 1998 the World Bank co-hosted a one-day seminar on AlternativeTransport Policy for Poland, organized by the Institute for Sustainable Development andthe Polish Ecological Club. Among its Central European neighbors, Poland is notable forits vigorous community of organizations concerned about the environment. As thenumber of private cars on Poland's streets proliferates, rail transport and urban publictransport lose market share, and urban air quality deteriorates, these organizations havebeen vocal in lobbying the Government to give more weight to environmental concernsand develop a transport system which is environmentally sustainable. Earlier this yearthe sponsors issued a report entitled "An Alternative Transport Policy for Poland". Thenew government was interested to understand better their point of view as it fine-tunes itsown strategy and business agenda. This seminar gave both sides an opportunity to debatethe issues, in the presence of representatives of the European Commission and theinternational financial institutions.

The seminar's main topics were:

- How will Poland's application to join the European Union affect and shape thetransportation policies it pursues?

- Can transportation policy in Poland be made more environmentally friendlywithout curtailing democratic freedoms?

- How can the international financial institutions contribute to finding the bestsolutions?

The report issued in February by the Institute for Sustainable Development andthe Polish Ecological Club set out alternative long-term scenarios for development of thetransport system. It evaluated each against criteria of environmental sustainability. Thisshowed that extrapolation of the Government's present policies --supportive of privatecar use and road transport generally, construction of motorways, and neglect of urbanpublic transport-- would carry a much higher environmental cost than a strongly pro-public transport, pro-rail, anti-private cars policy. The analysis omits assessment of theeconomic benefits from greater travel and transport, so remains only partial. It does not

34

address the question of what policy instruments could achieve the environmental]ly-friendly scenarios, and what effort --chiefly political-- would be needed.

The summing up on behalf of the Ministry of Transport is worth noting.

* Yes, the Ministry will take environmental concerns into account.

* It will be hard to stop the motorway program.

* As part of Poland's preparing for EU accession, the EU, through its TransportInfrastructure Needs Assessment initiative, is encouraging investment in mnajortransport infrastructure supported by IFI financing.

* We will try to factor externalities into our project evaluation, but much rernains tobe done to give them monetaiy values.

* We agree that rail has an economic advantage for long-distance, masstransportation.

* Rail lines not of national interest can now be devolved to regional governrents.

* We accept that the State should take urban transport under its wing in a "strategicthinking process".

* Limiting mobility goes against our basic policy of free choice in transport, so it isasking a lot to suggest the Government do so.

35

Table 1: POLAND - TRANSPORT INVESTMENT PLAN, Fall 1998

1998-2001 2002-2005 2006-2010 Total 1998-2010PLN USD PLN USD PLN USD PLN USD

penod per year period per year period per year period per year------------------all monetary amounts in billions-------------------

MinimumRoads 7.7 0.6 9.0 0.6 11.8 0.7 29.6 0.7Motorways 2.0 0.1 2.0 0.1 1.5 0.1 5.7 0.1Railways 5.1 0.4 6.9 0.5 7.6 0.4 20.5 0.5Airports 0.2 0.0 0.1 0.0 1.2 0.1 1.5 0.0Seaports 0.2 0.0 0.2 0.0 0.1 0.0 0.5 0.0

Total 15.2 1.1 18.2 1.3 22.1 1.3 57.9 1.3% of GDP 0.7% 0.9% 0.8% 0.8%

DesiredRoads 8.2 0.6 10.1 0.7 13.7 0.8 31.9 0.7Motorways 2.0 0.1 2.0 0.1 1.5 0.1 5.5 0.1Railways 9.9 0.7 12.0 0.9 13.0 0.7 34.9 0.8Airports 0.3 0.0 0.3 0.0 1.3 0.1 1.9 0.0Seaports 0.6 0.0 0.6 0.0 0.4 0.0 1.6 0.0

Total 21.0 1.5 25.0 1.8 29.7 1.7 75.7 1.7%ofGDP 1.0% 1.2% 1.1% 1.1%

GDP 1998 ($ billion) 150XR PLN/$ 3.50

Source: Ministry of Transport and Maritime Economy, "Plan of Development of TransportInfrastructure in Poland till 2015", Warsaw 1998

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