Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 15239

PROJECT COMPLETION REPORT

VENEZUELA

PUBLIC ENTERPRISE REFORM LOAN(LOAN 3223-VE)

DECEMBER 29, 1995

Public Sector Modernization and Private Sector Development DivisionCountry Department IILatin America and the Caribbean Regional Office

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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Currency Equivalents

Currency Unit: Venezuelan Bolivar (Bs)

US$ 1.00 = Bs 65.00 (May 1992)Bs 1.00 = US$0.015

ABBREVIATIONS AND ACRONYMS USED

GOV -Government of VenezuelaIDB -Inter-American Development BankJEXIM -Japan Export-Import BankLRMC -Long Run Marginal CostPE -Public EnterprisePERL -Public Enterprise Reform LoanSAL -Structural Adjustment LoanAEROPOSTAL -Linea Aeropostal VenezolanaALCASA -Aluminio del Caroni, S.A.BAUXIVEN -Bauxita Venezolana, C.A.CANTV -Compaiiia An6nima de Admistraci6n y Fomento

EldctricoCADAFE -Compafiia An6nima Nacional de TelefonoCARBOSUROESTE -Carbones del SuroesteCAVN -Compania An6nima Nacional de Navegaci6nCORDIPLAN -Oficina Central de Coordinaci6n y Planificaci6n

de la Presidencia de la Rep(iblicaCVG -Corporaci6n Venezolana de GuyanaEDELCA -Electrificaci6n del CaroniENSAL -Empresa Nacional de SalFERROMINERA -Ferrominera del OrinocoFIV -Fondo de Inversiones de VenezuelaIMAU -Instituto Metropolitano de AseolNAVI -Instituto Nacional de la ViviendaINOS -Instituto Nacional de Obras SanitariasINP- -Instituto Nacional de PuertosIPOSTEL -Instituto Postal TelegraficoPDVSA -Petr6leo de Venezuela, S.A.SIDOR -Siderirgica del Orinoco, C.A.VIASA -Venezolana Intemacional de Aviaci6nVENALUM -Industrias Venezolanas de Aluminio

FOR OFFICIAL USE ONLYThe World Bank

Washington, D.C. 20433U.S.A.

Offkc of the Director-General December 29, 1995Opeations Evaluaton

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT

SUBJECT: Project Completion Report on VenezuelaPublic Enterprise Reform (L-3223-VE)

Attached is the Project Completion Report for the Venezuela Public Enterprise Reformn (PERL, Loan3223-VE, approved in FY90 and closed on June 30, 1994), prepared by the Latin America and the CaribbeanRegional Office. This PCR does not contain Part II (the Borrower's contribution).

The Loan, in the amount of $350 million, was a three-tranche adjustment loan, one of a package ofseven operations (approved by the Board between June 1989 and December 1990) through which the Bankcommitted $1.7 billion in support of Venezuela's program of structural adjustment. The loan included a debtreduction component of $87.5 million. The objectives of PERL were to reduce the role of the public sector,improve competition; rationalize pricing policy in public enterprises; and reduce transfers and promotetransparency in the relationship between the Central Government and public enterprises.

Achievement of these objectives was poor. There was some reduction in public employment andfimancial transfers to PE (partially due to privatization), plus a moderate success in restructuring smallenterprises. Also, about 24 public enterprises were privatized, yielding about $2.5 billion in proceeds. But theGovernment failed to adjust important public enterprise prices. The prices of gasoline and diesel relative totheir economic levels are lower now than at the time of Board approval and the Govermnent did not sufficientlyadjust the prices of electricity, telecommunications and water. Restructuring of major public enterprises wasalso not achieved. Overall, only some modest results were achieved in ensuring a level playing field betweenprivate and public enterprises, and the program did not significantly reduce the state's role in the productivesectors. The Bank canceled the third tranche ($107.5 million) after a one year extension of the closing datebecause the Government failed to meet the conditionality.

The PCR concludes that the PERL program was not successful because: (a) the lack of specificity inthe conditionality reduced the Bank's leverage; (b) the program was over-ambitious and unrealistic, and theresistance to change was under-estimated; (c) the program emphasized restructuring instead of privatization;(d) insufficient attention was given to restructuring sectors (e.g. electricity), rather than enterprises; and (e)transferring responsibilities to local government was not accompanied with capacity building.

The project outcome is rated as unsatisfactory and the institutional development as negligible.Sustainability of the privatization achievements, however, is rated as likely.

The PCR draws two major lessons: (a) that privatization is not sufficient if sector issues are notaddressed; these include: increasing competition, improving the price structure and limiting the time duringwhich a privatized company can remain a monopoly, and (b) that restructuring of sectors, not only ofenterprises, is needed to achieve increased efficiency.

No audit is planned.

Robert Picciottoby Francisco Aguirre-Sacasa

AttachmentThis document has a restricted distribution and may be used by recipients only in the performance of theirofficial duties. Its contents may not otherwise be disclosed widhout World Bank authorization.

FOR OFFICIAL USE ONLY

PROJECT COMPLETION RlPORT

VENEZUELA

PUBLIC ENTERPRISE REFORM LOAN

PERL (LOAN 3223-VE)

Preface ............................................ iEvaluation Summary ........................................... . iii

PART I: PROJECT REVIEW FROM BANK PERSPECTIVE ............................................ 1

A. Project Identity ............................................ IB. Background ............................................ IC. The Economic Reform Program ............................................ 2D. Public Enterprises in the Economy ............. ............................... 3

(i) The Public Enterprise Sector ............. ............................... 3(ii) PE Issues ........................................... 3

E. Loan Objectives .4F. Program Components and Results .. 5

(i) Price Adjustmentss 5(ii) Improvement of the Competitive Enviroment .7(iii) Legal, Financial, and Institutional Framework

Governing Public Enterprises .8(iv) Restructuring of Public Enterprises .9(v) Privatization Program .14(vi) Labor reduction and cost .15

G. Evaluation and Conclusions ............................. 15Bank Performance ............................. 18Project Sustainability and Evaluation ............................. 20

PART II: (From the Government Perspective (not received)

PART IHI:

Statistical Tables

This report was prepared by Mr. Juan Luis Moreno V. (Long Term Consultant)

This document has a restricted distribution and may be used by recipients only in the performance of theirofficial duties. Its contents may not otherwise be disclosed wihhout World Bank authorization.

i

IMPLEMENTATION COMPLETION REPORTPUBLIC ENTERPRISE REFORM LOAN

(LOAN 3223-VE)

PREFACE

1. This is the Project Completion Report (PCR) of the Public Enterprise Reform Loan ofVenezuela (Loan 3223-VE). The three tranche $350 million adjustment loan was approved onJune 1990, signed October 15, 1990 and became effective on December 1990. The first trancheand debt reduction component were disbursed upon effectiveness, and the second tranchedisbursed in January 1992. The closing date was extended once by 12 months, from June 30,1993 to June 30, 1994. The Loan was closed on June 30, 1994 and the $107.5 million thirdtranche was canceled.

2. The PCR was prepared by the Mr. Juan Luis Moreno Villalaz, LA2PS under the supervisionof Mr. Robert Taylor, Task Manager, Private Sector Development Department (PSD). The PCRwas sent to the Government of Venezuela for comments.

3. Preparation of the PCR started in October 1994, and is based on the Staff Appraisal Report,Supplementary Documents, the Supervision Reports, interviews with several high level membersof the Government of Venezuela that participated in the program, and a short evaluation missionto Venezuela.

4. Staff Asignments:

(a) Through Board approval

Task Manager: Constance BernardDivision Chief: John PageDepartment Director: Ping-Cheung Loh

(b) Supervision through loan closing before July 1994

Task Manager: Robert TaylorDivision Chief: Krishna Challa/Gobind T. Nankani/Asif Faiz/

Stephen Ettinger

Department Director: Ping-Cheung Loh/Armeane Choksi/Rainer Steckhan

Supervision after July 1994

Task Manager: Robert TaylorDivision Chief: Robert LaceyDepartment Director: Edilberto Segura

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iii

VENEZUELA

PROJECT COMPLETION REPORT

PUBLIC ENTERPRISE REFORM LOAN

PERL (LOAN 3223-VE)

EVALUATION SUMMARY

The Loan Objective and History

i. The Venezuela Public Enterprise Reform Loan (PERL) was a three-tranche $350 millionadjustment loan approved in June 1990. It was one of four adjustment loans approved by the Bank in1989/90 to support the structural reform program initiated by the Perez Government. In addition tothe Bank PERL loan, JEXIM provided $300 million in co-financing, and the IDB approved a $300million parallel PERL with identical conditionality.

ii. The reform program objectives included: (a) adjustment of public enterprise (PE) prices toeconomic levels; (b) reforms to enhance the role of the private sector and ensure that PEs operate ina fully commercial manner; (c) reduce the subsidies to PEs and implement legal, financial, andinstitutional reforms governing the relationship between PEs and the Government; (d) restructuringmajor PEs, to improve their efficiency and productivity; and (e) a privatization program.

iii. As a result of the stabilization and structural reform program initiated in 1989, the economyrebounded strongly in 1991. During this period, significant reforms under the PERL wereaccomplished, including the privatization of the telephone company (CANTV) and national airline(VIASA), and continued progress in implementing phased price adjustments, particularly forgasoline and diesel fuel. The approval of the PERL second tranche in December 1991 capped a yearof significant progress in the reform program.

iv. After a coup attempt in early 1992, the Perez Government halted the reforms. Prices ofpetroleum products and electricity were frozen. Privatization slowed considerably. Many of the mainreformers left the Government. After President Perez was forced out of office in mid-1993, therewere two interim Presidents in six months, and the reform program remained stalled. The newGovernment, that started in early 1994, immediately faced considerable economic problems relatedto bank failures, and did not pursue the PERL reforms.

v. The PERL closing date was extended one year, to June 30, 1994. However, little progresswas made during that period, and the Loan was closed without disbursing the Bank's $107.5million third tranche nor the JEXIM and IDB third tranche. At that time, there were four majorunfulfilled conditions: (a) macroeconomic policy was unsatisfactory; (b) fuel prices remainedfrozen; (c) the electricity price adjustment program was not satisfactory; and (d) the steelcompany, SIDOR, had failed to implement the agreed restructuring program.

iv

Implementation Experience.

vi. The PERL program included five components: (a) price adjustments; (b) improvement of thecompetitive environment; (c) legal, financial, and institutional reforms governing the relationshipbetween PEs and the Government; (d) restructuring of priority enterprises; and (e) a privatizationprogram.

vii. The price adjustment program was not achieved. Petroleum prices, relative to theireconomic levels, were lower at the closing date than at beginning of the program. The shipping andport sectors were liberalized and restrictions on private sector participation were eliminated. Modestprogress was made in the legal framework governing the relationship between PEs and theGovernment including: the transformation of the Fondo de Inversiones de Venezuela (FIV) into aprivatization-restructuring entity, and the enactment of the Privatization Law. The program succeedin reducing operational subsidies to PEs, from $400 million to $75 million, and capital transfers from$875 million to $356 million. PE employment was reduced by 52,000 (including privatization),though with a severance cost of $420 million.

viii. With respect to the restructuring programs, CANTV, was privatized, INP and CAVN wereliquidated, and the port and shipping sectors were opened to the private sector. CADAFE, theelectrical enterprise, started regional companies. INOS, the water enterprise, was liquidated, andregional firms with less employees were established. The restructuring of SIDOR, the steel company,failed to improve efficiency or promote privatization. More progress was made on the smallerentities, including IPOSTEL (postal service), AEROPOSTEL (domestic airline), INAVI (publichousing), IMAU (garbage collection), ENSAL (salt mines and refineries).

Evaluating the Experience

ix. On balance, the PERL had mixed results. Important objectives of the loan, such as priceadjustment, restructuring, improving private sector participation by creating a level playing field, andtransforming the legal environment governing public enterprises, were not implemented as envisagedin the original program. On the other hand, reducing PE financial transfers and employment, and inparticular, the privatization program, were very successful.

x. The price adjustment program failed for political reasons. To eliminate the fuel-price subsidywould exclude part of the population (including the middle class) from what they perceive as theirshare of the national oil income. Increasing the price of oil is therefore considered as a tax,transferring income from consumers to the Government. This was resisted given the lack of trust inthe Government due to past corruption and inefficiency.

xi. Restructuring did not work in the priority PEs. It was only successful when limited tofinancial restructuring or work force reductions as part ofprivatization or liquidation. Otherwise, itfailed to improve the finances, productivity, or efficiency of the public enterprises involved.Somewhat better results, particularly in employment reduction, were obtained in restructuring thesmaller PEs. Regionalization of PEs was not accompanied with capacity building. The strategy ofenterprise reform rather than sector reform left some important sector issues unresolved.

xii. In retrospect, the PERL supported a parallel agenda, a reform process. This wassuccessful in reducing the size of government via liquidation, and implementing a largeprivatization program, that brought proceeds of $2.3 billion in less than 2 years. The success of

v

these measures attest to the ownership of the program by the Perez Government, which wasfuirther demonstrated by its efforts to continue the program, even when confronting negativepolitical conditions. One can infer that the commitmnent, support and coordination by theinstitutions involved was necessary to achieve so much in the little time when the programeffectively functioned.

I

VENEZUELAPROJECT COMPLETION REPORT

PUBLIC ENTERPRISE REFORM LOANPERL (LOAN 3223-VE)

PART I: PROJECT REVIEW FROM BANK'S PERSPECTIVE

A. Project Identity

Name Public Enterprise ReformLoan Number 3223-VERVP Unit Latin America and the Caribbean RegionCountry VenezuelaType of Loan Adjustment

B. Background

1. The Venezuela Public Enterprise Reform Loan (PERL) was a three-tranche $350 millionadjustment loan approved in June 1990. It was one of four adjustment loans approved by the Bank in1989/90 to support the reform program initiated by the Perez Government, which took office inFebruary 1989. The Structural Adjustment Loan and the Trade Policy Reform Loan were approvedin May 1989 and supported the first phase of the structural reform program, including liberalizationof trade, exchange rates, and most prices. In June 1990, the Board approved the $300 millionFinancial Sector Adjustment Loan and the $350 million PERL to support further reforms. In additionto the $350 million PERL approved by the Bank, JEXIM provided $300 million in co-financing forthe PERL, and the IDB approved a $300 million parallel PERL with identical conditionality.

2. The Loan was signed October 15, 1990. The $70 million first tranche and $87.5 million debtreduction component were disbursed in December 1990 upon effectiveness. The $85.0 millionsecond tranche was approved in December 1991 upon fulfillment of second tranche conditions anddisbursed in January 1992. The closing date of the Loan was extended by 12 months until June 30,1994. The Loan closed on June 30, 1994 and the remaining undisbursed $107.5 million third tranchewas canceled.

3. The initial success, and subsequent failure, of the PERL mirrored the overall economicsituation in Venezuela. As a result of the stabilization and structural reform program initiated in1989, the economy rebounded strongly in 1991, after initially contracting by 7.8% in 1989, and a6.9% recovery in 1990. GDP grew by 10.1% in 1991, inflation fell from 84% in 1989 to 34% in1991, and foreign investment increased sharply, reaching roughly $ 4 billion in 1991. During thisperiod, significant reforms under the PERL were accomplished, including the privatization of thetelephone company (CANTV) and national airline (VIASA), and continued progress inimplementing phased price adjustments, particularly for gasoline and diesel fuel. The approval ofthe PERL second tranche in December 1991 capped a year of significant progress in the reformprogram.

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4. After the first coup attempt in February 1992, the President shifted his priority towardnegotiating with political groups for support. A price was paid with respect to the liberalizationprogram in general and the PERL in particular, in terms of delaying decisions and suspending orreducing the legislative program. The personal difficulties of the President, accused ofimproprieties, increased and ended with his removal in mid-1993. In a period of less than a year,four persons were president. As a result of the political crisis, the entire reform effort collapsed in1992 and virtually no progress was made in 1993, in spite of some efforts to maintain the program.Prices of petroleum products and electricity were frozen. Privatization slowed considerably andmany of the main reformers left the Government. After President Perez was forced out of office inmid-1993, there were two interim Presidents in six months. The new Government that started inearly 1994 faced considerable economic problems related to banks failures, and did not continue thereforms initiated under the PERL.

5. The PERL closing date was extended in mid-1993 by 12 months, to June 30, 1994. However,little progress was made during that period. The Loan closed on June 30,1994 and theundisbursed $107.5 million third tranche was canceled. The JEXIM in turn canceled theircofinancing of the third tranche and the IDB canceled the third tranche of its parallel PERL. At thetime of loan closing, there were several unfulfilled third tranche conditions, principally: (a) themacroeconomic policy framework was unsatisfactory as a result of the re-introduction of foreignexchange and price controls, and the large fiscal deficit, due in part to government support for thebanking crisis; (b) fuel prices remained frozen and no plan was in place for any unfreezing orincreases; (c) the electricity price adjustment program was not satisfactorily correcting distortionsbetween residential and industrial/commercial rates; and (d) SIDOR the steel company, had failedto implement the agreed restructuring program or achieve the 1992-93 performance targets.

C. The Economic Reform Program

6. Venezuela's economic policy, up to the end of 1980's, followed an import substitution strategy,involving multiple exchange :-ates, administered and rationed allocation of foreign exchange, importprohibitions and licenses, high ad-valorem and specific tariffs, tariff exoneration and exportsubsidies. This resulted in high levels of effective protection and restrictions that distorted the pricesystem, had an anti-export bias, and produced a misallocation of resources. In addition, theGovernment intervened in economic activities through regulations, subsidies, price controls and thecreation of a large public enterprise sector. This led to rigidities, dependency on oil exports, a lowrate of growth, internal and external imbalances, and a pattern of instability followed by booms,related to oil price changes.

7. From February 1989, the incoming Perez Government implemented a stabilization andstructural reform program that involved: a) replacing the administered multiple exchange rate systemwith a unified market-determined exchange rate; b) rationalizing and liberalizing the trade regime,by eliminating exonerations, reducing the coverage of quantitative restriction, and setting amaximum tariff of 80%, with further reductions to follow; c) allowing most interest rates to bemarket determined; d) increasing the price of petroleum products in the domestic market; e)dismantling most of the domestic price controls; and f) curtailing fiscal expenditures.

8. The economic program improved the internal and external imbalances. Also, the significantimprovement of both public finances and the balance of payments, together with a tight monetarypolicy, led to a stabilization of inflation and exchange rates. The Government's medium-term policy

3

was to strengthen the market-friendly environment, revise the role of the State and increase theefficiency of public enterprises. These measures were aimed at increasing productivity and growth.

D. Public Enterprises in the Economy

9. The Public Enterprise Sector. Public enterprises dominated many sectors, particularly large-scale capital-intensive industry, such as petroleum, mining, steel, and aluminum. This was the resultof a strategy initiated in the mid-1970s with the nationalization of the oil and iron ore industries,followed by heavy public investment. This led to a large public sector, with public enterprises in: (a)the financial sector (commercial and development banks, insurance companies, specialized creditagencies); (b) the petroleum sector (a holding company - PDVSA - with seven subsidiaries); (c)basic industries in the Guyana region - the Corporacion Venezolana de Guyana (CVG); (d) 15 majorpublic enterprises involved in the provision of public services (e.g. electricity, water, telephone,shipping and ports); and (e) 120 smaller enterprises operating commercially in a variety of activities(e.g., light manufacturing, agro-industry, tourism).

10. The state-owned petroleum sector included petroleum production, natural gas, petroleumdistribution, fertilizers, and petrochemicals. This sector dominated the economy, with oilaccounting for more than 73% of exports in 1989 and 70% of fiscal revenue.

11. The Guyana-based CVG companies included basic industries such as steel (SIDOR);aluminum (VENALUM and ALCASA); iron, bauxite and coal mining (FERROMINERA,BAUXIVEN, and CARBOSUROESTE); hydropower (EDELCA); and others. In the 1980s, thedevelopment strategy for these companies focused on self-sufficiency and expansion, with anambitious investment program financed with external debt (serviced by the companies in Bolivaresat a fixed exchange rate). The companies operated behind protective tariff barriers and with lowlevels of productivity. Trade and exchange rate liberalization in 1989 had dramatic consequences onthe companies. First, they were exposed to import competition in the domestic market. Second, theirexternal debt burden (the Bolivar equivalent) increased substantially with devaluation. As well, theGovernment virtually cut off further equity investment and access to further government-guaranteeddebt. As a result of these changes in the external policy environment, the CVG companies werefaced with the challenge of shifting to an outward-oriented strategy, focusing on profitability (notexpansion) and relying on private sources for investment financing.

12. The group of state-owned companies providing public services (electricity, telephone, waterports, etc.) had been subject to Government intervention to achieve social and political objectives.These companies were characterized by extremely low prices relative to costs, inadequate salaries,substantial over employment, and poor accounting/billing systems. Moreover, quality of service wasgenerally poor, which impeded productivity, export growth, and the ability of the economy torespond to the new economic incentives. The reform program was aimed at adjusting prices toeconomic levels, improving company efficiency, professionalizing hiring practices, and improvingquality of service for consumers.

13. The last group of enterprises included many small companies operating in commercialcompetitive sectors. Many began in the private sector, but were taken over by previous governments,often to avoid closure and job losses.

14. PE Issues. The policy and institutional framework governing the operation of publicenterprises did not generate an efficient allocation nor use of resources. Important issues include:

4

* Inadequate pricing policies that subsidized local consumption. Domestic prices were afraction of the economic cost for both tradables (export opportunity cost) and non-tradables (long-run marginal cost). As well, maintenance of low prices and cross-subsidies distorted relative prices.

* Public enterprises were protected from competition through various policies whichexcluded the participation of private finns in these sectors. They also had privilegedaccess to foreign exchange and financial resources.

* These firms were a fiscal burden, accounting for 14% of Government outlays, or 3.4% ofGDP. As well, they had large external govemment-guaranteed debt (roughly $7.5 billionat end- 1989). With exchange rate and trade liberalization, many were unable to servicetheir external debt, which was either assumed or paid by the Government.

* The performance of PEs was unsatisfactory. Productivity of resources used was low. Inthe late 1980s, PEs accounted for 24% of national investment, yet their value addedaveraged only 6.2% of GDP. The incremental capital output ratio (ICOR) frompetroleum enterprises was 60, compared with 10 for the overall economy. Theseenterprises showed little or no profitability, with an average return on assets of less than1%. Labor productivity in PEs had declined by 2.7% annually during the 1980s.

E. Loan Objectives

15. The Public Enterprise Reform Loan (PERL) was aimed at supporting institutional and policyreforms directed at changing the role of the public sector in the economy. The main goals of theprogram were to: create an environment in which PEs were subject to market forces; provideappropriate regulation to natural monopolies; make the non-petroleum PE sector a positivecontributor to government finances; and maximize opportunities for investment and production forthe private sector.

16. The PERL was a broad adjustment operation with a number of specific objectives, includingto:

* reduce the scope of the public sector in the economy through fiscal restraint,deregulation, and privatization of selected public enterprises;

* maintain a level playing field by minimizing policies or practices which discriminatedbetween public and private enterprises and restricted competition;

* substantially reduce government transfers to PEs to improve public finances;

* minimize PE monopoly powers and establish regulatory mechanisms as needed;

* improve the efficiency and quality of public services provided by PEs, particularly thoseservices deemed critical for growth of the productive sectors;

5

* enhance the efficiency of resource use by allowing PEs to adjust their prices to economiclevels (i.e. tradable goods prices at export opportunity cost and non-tradable goods pricesat economic opportunity cost);

* redefine the legal and institutional framework governing PEs to promote a moretransparent and efficient financial relationship between the Government and PEs;

* change the role of the Fondo de Inversiones (FIV), a government-owned financialholding company which had financed the development of PEs with oil revenue from1974-89, and reorganize CVG (the industrial holding company);

* restructure priority enterprises; and

* implement a privatization program

F. Program Components and Results

17. The program supported by the PERL included five components: (a) price adjustments; (b)improvement of the competitive environment; (c) legal, financial, and institutional reformsgoverning the relationship between PEs and the Government; (d) restructuring of priority enterprises,(9 major PEs plus 5 other unspecified ones); and (e) a privatization program. Outlined below is adescription of each component, including the reforms accomplished under the PERL.

18. Overall Results. The price adjustment program was not done; in some cases prices relativeto their economic level are worse at present (March 1995) than at the time the loan was approved.This was the most significant failure of the PERL. With respect to restructuring the results weremixed. CANTV, the telephone company was privatized, INP and CAVN were liquidated, and theport and sea transport sectors were opened to the private sector without restrictions. INOS, the waterenterprise, was liquidated; regional firms, with less employees, were established but have not beenable to achieve financial independence. The restructuring of SIDOR, the steel company, failed toimprove efficiency or promote privatization. A complete success was the privatization program,from a modest conditionality of $150 million brought to point of sale, to actual sales of $2.3 billionin public assets. Also another accomplishment was the reduction of government employment by52,000 and the reduction of operational subsidies to PEs from $400 million to $75 million, andinvestment subsidies from $875 million to $356 million. In the other components of the program theresults were modest. Only in the port and shipping sector did the Government eliminate restrictionson private sector participation. In the institutional and legal public sector enviromnent, FIV wastransformed and its functions were redefined, redirecting its primary efforts towards privatizationand restructuring of government firms.

Price Adjustments

19. Under the structural adjustment program (supported by the earlier SAL), price controls wereeliminated for most goods and services. For the remaining goods/services (e.g. gasoline, electricity,telephone), the Government initiated a program of phased price adjustments with the medium-termobjective of adjusting prices to full economic levels. In tradables (e.g. petroleum products,fertilizers), the objective was to adjust prices to export opportunity cost, whereas in public services,the objective was to progressively adjust prices to long-run marginal cost and correct distortions in

6

the tariff structure (e.g. between residential and commercial users). The PERL was designed tosupport the completion of the Government's price liberalization and adjustment program, focusingparticularly on: fuel, fertilizer, electricity, telephone, water, and natural gas prices.

20. In domestic petroleum products, fuel prices were virtually the lowest in the world when thePerez Govemment took office in 1989. Following phased price adjustments, domeE-ic fuel pricesreached 40% of export opportunity cost by mid-1990 (in accordance with the SAL target). The PERLobjective was for oil prices to reach full export opportunity cost by January 1993 (i.e. 30 monthsfollowing loan approval). The rationale was economic, not fiscal, based on the premise that ifVenezuela's petroleum sector were deregulated and competitive, ex-refinery prices wouldautomatically reflect export opportunity cost, and consumer prices would be set at ex-refinery prices,plus transport/marketing costs, plus retail taxes.

21. There was progress on this issue until February 1992. A program of monthly price increaseswas adopted and maintained until the coup attempt in February 1992. Afterward, domesticpetroleum product prices were frozen and have remained frozen since (as of March 1995). Givendomestic inflation, the ratio of ex-refinery prices to export opportunity cost fell to less than 20% forgasoline and diesel by February 1994, in spite of the decrease in international petroleum prices,below the ratio when the PERL was approved in June 1990.

22. In electricity, the program objectives were also not achieved. Under the PERL, theGovemment agreed to undertake a study on long-run marginal costs (LRMC) and then implement aprogram to adjust rates to LRMC. The preliminary phase of the LRMC study was completed in mid-1991. The study showed substantial distortions and cross-subsidies in the tariff structure betweenresidential rates (far below LRMC) and commercial/industrial rates (above LRMC), particularly inCaracas, where residential rates were less than 40% of LRMC and commercial rates were more than200% of LRMC.

23. The Government initially proposed to the Bank a 4-year program of phased priceadjustments to be implemented from 1992-95 inclusive, but the February 1992 coup attempt derailedthis plan. Prices were subsequently frozen for six months. A new three-year program was eventuallyimplemented, starting in November 1992, but it did not adequately correct the major distortions inthe tariff structure, given that it was based on the overall financial needs of the companies, ratherthan on economic efficiency objectives.

24. In telecommunications, the PERL objective was similar - to carry out a study on long-runmarginal costs, followed by a phased program of price adjustments. In fact, the proposed study wasnot carried out because the Government subsequently decided to privatize the state-ownedtelecommunication company (CANTV), and a new tariff structure and adjustment program wereincorporated in the privatization plan. To facilitate successful privatization, significant telephonerate increases were implemented in July 1991 prior to privatization, and again in January 1992, whenthe privatized operator took over the company. Under the concession contract with the privatizedoperator, rates were grouped into three baskets, to be regulated on a price cap basis, with fullinflation indexing until 1996, followed by partial indexing until 2001. Phased rebalancing of localand international rates would commence in 1994 to progressively remove the cross-subsidy frominternational to local rates.

25. In water, rates were far below marginal costs, particularly for residential users where rateshad not been increased since 1981. The Government's new financial and rate policy for the water

7

supply and sewerage sector was aimed at making the newly-established local/regional publicenterprises financially self-sufficient, i.e., with revenue from tariffs sufficient to meet alladministrative, maintenance, and operating cost, debt service requirements, and allow an adequatecontribution to financing new investment. In October 1991 the Government increased industrial andcommercial tariffs, but not residential tariffs. Consequently, the water companies continued torequire subsidies. Furthermore, low residential rates were a major factor behind the Government'sunsuccessful attempt in 1992 to privatize the Caracas water system.

26. In tradables, an important component of the PERL price adjustment program was theelimination of all subsidies for fertilizer products and the adjustment of prices to export opportunitycost. Under the PERL, subsidies were to be phased out by July 1993. This was essentiallyaccomplished with the exception of phosphate rock (which accounted for only 10% of fertilizerconsumption) where subsidies were to be eliminated over a longer period. As well, imports wereliberalized, the Government monopoly on pa'm oil was canceled, and price regulations on importedand privately-distributed fertilizer were elii-inated.

27. In CVG companies the PERL sought to ensure that all transfer pricing between CVGcompanies (e.g. iron ore to be used for steel production) was on a fully commercial and economicbasis. During the 1980s, there were extensive cross-subsidies between CVG companies throughtransfer pricing. These subsidies were eliminated as part of the structural reform and liberalizationprogram. According to CVG officials, all preferential pricing for CVG affiliates was eliminated andall companies paid fully commercial prices for inputs from other CVG companies.

Improvement of the Competitive Environment

28. There were many restrictions in Venezuelan legislation that limited competition and privatesector activity. In some cases (e.g. petroleum, iron ore), the Constitution reserved these areas for thepublic sector. In addition, foreign investment was prohibited in certain public utilities, insurance, thefinancial sector, domestic transportation, and consulting services, and allowed only limited minorityshareholdings in domestic trade, administration of public concessions, export services, basicindustries, garbage collection and the postal system. In other sectors (e.g. shipping), publicenterprises had preferential rights.

29. Under the SAL and Trade Reform Loans, the Government enacted a number of measures tostimulate competition and private investment, including: eliminating import controls; simplifying theoperating environment for the private sector; creating a debt-equity swap mechanism; openingsectors to foreign investors (with the exception of banking, Spanish language newspapers andrestriction on the petroleum sector); and liberalizing restrictions on remittance of profits andreinvestment. Under the PERL, the Government's objectives were to ensure a "level playing field"between private and public enterprises, reduce the state's role in the productive sectors (excludingpetroleum) and limit government's role to investment in social and economic infrastructure.

30. The results in this area were modest. The most significant reforms were enacted in theshipping sector, where the Government eliminated prior restrictions on competition and on the useby Venezuelan importers/exporters of private and foreign shipping companies. As a result of thesereforms, shipping costs dropped substantially, and there was much greater use of private and foreignshipping companies. Apart from shipping, a new Ports Law was enacted which inter alia allowedprivate participation in the sector. As well, the Government monopoly on telecommunications andpostal services was canceled. However, in other sectors dominated by public enterprises (e.g.

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petroleum, electricity), no significant new legislation was enacted to reduce the role of thegovernment or otherwise promote competition and private sector participation. Even though this wasnot a loan conditionality, some reforms were expected.

Legal, Financial, and Institutional Framework Governing Public Enterprises

31. Legal, regulatory and administrative changes implemented during the prior two decadesresulted in unclear and diffuse accountability relationships between PEs and the Government, withlittle effective Government control over PEs. This undermined macroeconomic and sectoral policy-making, and caused substantial delays in decision-making. As well, PEs were a heavy drain ongovernment finances, accounting for 70% of public investment. During the 1980s, they receivedsubstantial Government support through budgetary transfers, through loans and equity contributionsfrom the FIV (established in 1974 to invest windfall oil revenue) and through guaranteed borrowing.Many PE investment projects were approved without economic justification or adequate integrationinto the Government's overall investment plan.

32. Under the PERL, the Government's medium-term objective was to substantially reducetransfers to PEs. It was recognized, however, that in the short term, some financial support would berequired for companies being restructured or privatized, to cover one-time costs such as severancepayments, unfunded pension liabilities, and settlement of guaranteed debts to third parties. As well,some transfers may continue to be necessary for public policy reasons (e.g. lifeline rates for publicservices) and, accordingly, these transfers were to be incorporated in performance agreements signedwith the Government. Based on these considerations, the PERL objective was to phase out operatingtransfers to PEs over a three-year period for those PEs not covered by restructuring programs orperformance agreements.

33. This objective was essentially achieved. Operating transfers to PEs were sharply reducedfrom $400 million in 1990 to $75 million in 1993 (excluding one-time severance costs associatedwith restructuring or privatization), with the latter primarily for covering interest charges on thesubway external debt (not part of the PER). Capital transfers for investment dropped from $875million in 1990 to $356 million in 1993, primarily for the metro, the new regional water companies,and the public housing company.

34. While direct current transfers were significantly reduced, the Government (through the FIV)provided financial support for one-time restructuring costs (principally severance pay) consistentwith the PERL objectives. Restructuring agreements ("convenios de reestructuraci6n") were signedwith 12 public enterprises, setting out the restructuring measures to be undertaken by the companiesand the amount of financial support to be provided by the FIV. The FIV's advances to financeseverance pay and settlement of debts (amounting to about $800 million from 1991-94) were to berepaid from proceeds of privatization or budgetary reimbursements.

35. One area that was inconsistent with the PERL objective was the transfer of the FIV's sharesin CVG companies to the CVG holding company. During the 1980s, the FIV had become themajority shareholder in many CVG companies through equity injections and capitalization ofoutstanding loans. In 1990, the Government issued a decree authorizing the transfer of the FIV'sshares to CVG. However, while CVG took ownership of the shares, no money was actuallytransferred to FIV. This was effectively a recapitalization of CVG. Moreover, it was notaccompanied by any restructuring of CVG or its companies to improve efficiency and profitability.

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36. With respect to the legal framework governing public enterprises, two significant new lawswere enacted. In 1991, a new FIV Law was enacted which redefined its functions, withdrawing itfrom direct lending and investment, and redirecting its primary efforts towards privatization andrestructuring of government firms. Second, a Privatization Law was enacted in 1992, formalizingthe legislative and administrative arrangements for the privatization program and specifying how theproceeds would be allocated.

Restructuring of Public Enterprises

37. An important component of the PERL program was restructuring of public enterprises toimprove efficiency or reorganize the firm as a first step toward privatization. The PERL focused onrestructuring six priority PEs, including: CANTV (telecom); CADAFE (electricity); INOS (water);INP (ports); SIDOR (steel); and CAVN (shipping). These companies were targeted due to theirimportance to overall economic growth and productivity and/or the extent of their financialproblems. The Government established an inter-ministerial Restructuring Commission (withCORDIPLAN as the Executive Secretariat) to oversee the design and implementation of therestructuring programs. Studies were undertaken to identify the major issues and develop detailedrestructuring programs, approved by the Restructuring Commission, and restructuring agreementswere signed with the FIV, specifying the short-term financial support to be provided by the FIV (e.g.severance pay, retraining, payment of arrears, studies) and the restructuring measures to beundertaken by the companies. The companies pledged to the FIV sufficient marketable assets tocover the FIV advance, and the FIV was to be repaid from the subsequent proceeds of privatizationor sale of surplus assets.

38. This component had mixed results. Restructuring of the major enterprises was onlysuccessful where it was limited to financial restructuring or work force reductions as part ofprivatization or liquidation. The economic benefits were greatest when the reforms wereaccompanied by sector liberalization. Otherwise, restructuring efforts aimed at rehabilitating the firmand improving efficiency and performance were unsuccessful. The restructuring of the fiveadditional PEs was more successful, with important reductions in personnel and, some cases,redefining the function and improving the performance of the PE. These public enterprises wereIPOSTEL (postal service), AEROPOSTAL (domestic airline), INAVI (public housing), IMAU(garbage collection), and ENSAL (salt mines and refineries). The results of the restructuring PEprogram are summarized below.

39. CANTV (telecommunication). CANTV was a government-owned company with a nationalmonopoly on all telecommunication services. There were many deficiencies in the company. Unmetdemand for new telephones exceeded one million customers (an 8-year waiting period on average).Rates were very low, particularly for local service. Network quality was low, with extensivecongestion and low call completion rates. CANTV had excessive staffing and low productivity.

40. When the PERL was approved, the objective of the Loan was to restructure the company tooperate commercially and efficiently. But, in late 1990, the Government adopted a more ambitiousplan to privatize the company to an experienced international operator, in order to enable rapidexpansion and service improvement. During 1991, the Government, with external advisers,developed a detailed privatization plan, including a new tariff structure and regulatory framework.The process culminated with the sale to an international consortium of a control block of shares

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(40% of common shares, but with majority voting on the Board of Directors). The control block wassold for $1.9 billion. A further 11% of shares were sold to CANTV employees.

41. Under the concession contract, the privatized operator was granted an exclusive monopolyon basic local and long distance services for a 9-year period; in exchange, the operator was requiredto install 3.6 million new and replacement lines and improve quality of service (targets for callcompletion, etc. were included in the contract). Competition was permitted in non-basic services(e.g. data transmission, value-added). Tariffs were to be adjusted quarterly according to a price capformula (inflation less a productivity factor), with a phased rebalancing of tariffs from years 4-9 toeliminate distortions between local and long distance rates. A new Tele-communications Law wasprepared, but it stalled in Congress. To enable a successful privatization, the Government issued aseries of decrees which, inter alia, established a new telecom regulatory agency (CONATEL).

42. The privatization of CANTV represented the most important success of the PERL program.The preparation and execution of the transaction was praised by investors for its thoroughness,professionalism and transparency. In the first two years following privatization, the privatizedCANTV met or exceeded its targets for service expansion and improvement. In 1992-93, CANTVinvested $1.1 billion and installed 850,000 new or replacement lines (a 50% increase in the installednetwork). The company added more than 450,000 new clients. As well, CONATEL approvedlicenses for more than 30 other independent operators providing non-basic services, and theseoperators invested a further $370 million in 1992-93.

43. Some problems, however, have emerged for the privatized CANTV, including: the failure bythe Government to pay more than $100 million in government bills; delays in implementing thequarterly rate adjustments in accordance with the formula in the concession contract; and theintroduction in mid-1994, of foreign exchange controls which have severely hampered CANTV'sability to service its external debt and finance its investment program (and hence meet its serviceobligations).

44. INP (Ports). The national ports agency (INP) operated 11 public ports located on the NorthCoast and in Lake Maracaibo. These ports handled general cargo, containerized cargo, and somebulk cargo. Operations of the public ports had long been regarded as costly and very inefficient, andhence a major impediment to exports. The agency had more than 11,000 employees. Service was sopoor that the international shipping conferences applied various cargo surcharges forcongestion/inefficiency in INP ports, amounting to roughly $30-50 million annually.

45. In 1991, the Government decided to liquidate the INP, privatize cargo handling, and set upnew regional port authorities to administer the ports. All 11,000 INP workers were laid off andcargo handling/stevedoring activities were transferred to the private sector. In accordance with thecollective contracts, employees received severance pay equivalent to one month's pay for year ofservice. The total cost was roughly $200 million, or $18,000 per employee.

46. As a result of these measures, productivity immediately doubled, resulting in a substantialreduction in shipping costs. The responsibility for port administration and maintenance wastransferred to the new regional port authorities. Some of the regional authorities, with technicalassistance from the national government, launched initiatives to privatize specific terminaloperations.

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47. CADAFE (electricity). CADAFE is responsible for electricity distribution for most of thecountry, excluding a few major cities (e.g. Caracas). During the 1970s and 1980s, its mandate was toprovide electricity throughout the country, with little economic or financial consideration. Itprovided service to the majority of medium and smaller sized cities, as well as towns and villages,with large geographical dispersion, and low volume average usage. Yet, the company had a highlycentralized organizational structure and administration, with rigid procedures, dominant laborunions, and a lack of coordination with other entities operating in the power sector.

48. The Government's restructuring plan for CADAFE was aimed at decentralizing andregionalizing its operations. The program involved reorganizing CADAFE into a holding companywith four regional distribution companies, a generation company (comprising CADAFE's thermalplant and its hydro facility which was under construction), a transmission company, and one or morecompanies providing non-power related services. It was expected that CADAFE's holding companywould be phased out and that the regional distribution companies would be established with fullautonomy, as a first step towards privatization.

49. Results were disappointing. The regional companies were established, but were not grantedautonomy from the holding company in operations and investment. Despite regionalization ofdistribution, CADAFE maintained a large corporate head office. And the financial situation of thecompany deteriorated, as it accumulated large arrears with other PEs. Most importantly, therestructuring of CADAFE was not accompanied by broader sectoral reform or restructuring. TheGovernment launched some initiatives in 1991 to consider sector reform, but these efforts werelargely unsuccessful.

50. INOS (water). INOS, the national agency responsible for providing water and sewerageservices in the country's urban areas, was facing a severe crisis by 1989, and was unable toadequately operate and maintain the water supply systems under its responsibilities. Service wasinefficient and costly; water losses and billing arrears were unacceptably high; the company washeavily overstaffed and politicized. The firm was incurring substantial operating losses, in fact itcould not cover its wage bill.

51. The restructuring of INOS, as with the ports, was aimed at liquidating the national agency,establishing new autonomous and financially self sufficient regional water companies, andprivatizing operations through concession agreements with private operators. A small, new agencywould be responsible for sectoral policy, normative and regulatory functions, sector-widemonitoring, and providing technical assistance and training to the operating entities. In the transitionperiod, the entity was also to have limited engineering/project management functions for majorongoing capital projects. Responsibility for managing and operating water supply and seweragesystems was expected to be transferred to municipal, state, or regional enterprises (publicly orprivately operated). The new operating companies would be responsible for negotiating their laborcontracts. INOS employees would receive severance pay as a result of the liquidation of the nationalagency. The restructuring plan also called for major water tariff adjustments.

52. Results were mixed in this sector. The national agency (INOS) was liquidated and newregional water companies were established. The new institutions have 3,408 employees versus14,388 of INOS, a substantial reduction. A new national agency (Hidroven) was established to carryout policy and regulatory functions. Nevertheless, residential tariffs remained very low relative toeconomic cost, and no adequate regulatory framework was put in place for the sector. TheGovernment launched a major effort in 1991/92 to privatize the Caracas water/sewerage services, but

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in the end, there were no bidders at the public tender. Low residential tariffs, lack of reassurancesover private property rights on the installations, and an unclear regulatory framework wereconsidered to be major factors in the reluctance of companies to bid for the water company.

53. SIDOR (Steel). With abundant energy and iron ore, Venezuela should be a world classcompetitor in steel. The country invested more than $3 billion in SIDOR during the 1970s and 1980s.But SIDOR focused its efforts in producing for a highly-protected domestic market. Faced withtrade and exchange rate liberalization in 1989, the company needed to alter its product mix,formulate a new marketing strategy, and improve operations to ensure competitiveness and financialviability. In 1990, SIDOR closed four obsolete mills and began a phased program to reduce its workforce by 4,000 employees (from 18,000 to 14,000).

54. In October 1991, the Cabinet approved a restructuring program involving: cost/efficiencyimprovements in SIDOR's flat product operations (with specific targets); phased privatization of itsnon-flat operations (the unfinished seamless pipe mill and the rod and bar mills); a minimalinvestment program; and assumption by the Government of $900 million of SIDOR's $1.5 billion inexternal debt. The restructuring program included specific performance improvement targets to beachieved in the following two years (1992-93).

55. The debt assumption did substantially improve SIDOR's financial situation, but the companydid not achieve the operating and technical performance targets set out in the restructuring program,as outlined below:

SIDOR Performance 1992-1993

1993Target Actual Target Actual

Reduction in UnitProduct Cost (Constant Bs) 11% 6.6% 15% 6%

Labor Productivity (tones/man hour) 200 189 300 194

Sales (million tones) 2.4 2.1 2.6 2.1

Inventories (% of sales) 90% 60%

56. There was also little progress in the privatization of the non-flat operations. A preliminaryagreement was completed in 1992 with a majority-private consortium to complete and operate theunfinished seamless pipe mill. However, the deal subsequently fell through and no other buyer hasbeen found. In early 1994 SIDOR published an ad seeking interest in a strategic association tooperate the rod and bar mills, but as of March 1995, no activities or operations had been privatized.

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57. CAVN (shipping). Prior to sector liberalization, importers/exporters were faced withnumerous restrictions on the use of private and foreign shipping companies. The state-ownedshipping company (CAVN) operated with substantial protection, yet was very inefficient, with lowproductivity and an obsolete fleet. In this particular case, the Government combined restructuringwith sector reform and liberalization. In 1990/91, the Ministry of Transport eliminated many of theprior restrictions on shippers, including those pertaining to transshipment, opening new routes androute extensions, and the obligation to use CAVN for all shipments financed through letters of credit.As well, the Government signed a series of bilateral agreements with several countries to eliminatethe "cargo reserve requirement", thereby allowing shippers freedom of choice in selecting a carrier.

58. A restructuring program was approved for CAVN, involving: the sale of three ships; a 15%work force reduction; improved marketing; and capitalization of CAVN's debt by the FIV. Somemeasures were implemented and FIV absorbed part of the financial debt of CAVN. However, as aresult of liberalization of shipping, CAVN continued to lose market share and was near bankruptcyin 1994. While the company was not successfully restructured, the overall economic benefitsresulting from liberalization of shipping were substantial.

59. Other Restructuring Programs. Apart from the six priority PEs, five other PEs preparedrestructuring programs and signed restructuring agreements with the FIV. The results aresummarized bellow.

60. IPOSTEL (postal service) The work force was reduced by 45%, important parts of thefunction of mail delivery were contracted to the private sector, as well as non-postal services to theenterprise (security, external auditing, maintenance).

61. AEROPOSTAL (domestic airline). The restructuring included a 26% reduction inpersonnel, closing of some agencies, selling assets, payment of debts, a small reduction of freetickets, and improvement in its operations. But it was not sufficient. After a failed attempt toprivatize the firm, bankruptcy was declared in Nov. 1994 , and the company is in the process ofliquidation.

62. INAVI (public housing). The institution was reorganized, its personnel reduced by 70%(1500 employees were given early retirement), and finances were improved. Many of its activitieswere privatized (e.g. mortgage collection was transferred to the commercial banks), and many of itsproperties and mortgages were sold. The institution was reorganized to become a promoter of lowincome housing, rather than a direct provider. This was a case of successful restructuring.

63. IMAU (garbage collection). IMAU was liquidated and its activities were transferred to thelocal municipalities, which contracted private sector firms to perform the services. The governmentabsorbed IMAU's debt with the private operators.

64. ENSAL (salt mines and refineries). Its work force was reduced from 1100 to 300, and thefirrn is being transferred to the regional government for privatization.

65. The government television stations and coffee processing plants were considered forrestructuring or privatization, but nothing was accomplished.

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Privatization Program

66. The initial structural reform program did not emphasize privatization. The Governmentrecognized that there was considerable political and labor opposition to privatization. The initialgroup targeted for privatization was modest and included firms in the financial, tourism and lightmanufacturing sectors thought to be financially viable and attractive to investors. This was similar tothe strategy followed in Mexico. Consequently, the Loan targets were modest (bring to point of sale$150 million in assets). However, both the Bank and Government officials were hopeful that initialsuccesses would generate stronger public support for privatization, and enable an expansion of theprogram.

67. In late 1990 (after Loan approval) the Government broadened the scope of the program to,include important enterprises such as CANTV (telecom) and VIASA (national airline). In 1991-92,the Government successfully privatized 24 enterprises (yielding $2.5 billion in proceeds), includinginter alia VIASA (national airline), CANTV (telecom), three state-owned banks, ASTITNAVE(shipyard), several sugar refineries, and several hotels. As well, the Government auctioned thesecond cellular band to an international company and privatized cargo handling in the ports. This farexceeded the modest privatization targets under the Loan.

68. Privatization was the greatest success of the PERL program. The privatization program wassuccessful in many respects. First a Privatization Law was enacted, creating the administrative andlegal process for a broad program, and laying the basis for future privatizations. The Law alsospecified that 25% of the proceeds would be allocated to finance social programs, with the remainderto be used for debt payment and financing expenses related to future privatization and restructuringefforts.

69. Second, to confront the opposition to the privatization of the telephone company,Government officials launched an extensive and well-organized program to sell the idea. This wasdone inside the Government, with the political groups and with the public in general. This broke theice and the ideological opposition to privatization. The successful privatization of CANTV (yielding$1.9 billion in proceeds) and the positive results in the initial post-privatization period ($600million/year in new investment) provided convincing arguments in favor of privatization.

70. Third, an institutional capacity was developed within the FIV, with the reorientation of theFIV's mandate towards privatization. The FIV established a formal and transparent process formanaging the pre-qualification and bidding process. Investors praised the program for itsprofessionalism.

71. One important issue that should be noted about the privatization of CANTV is the length ofthe monopoly period (9 years) granted to the privatized operator for basic services (local and longdistance). A key issue is whether this is excessive and constrains economic efficiency, particularlygiven worldwide trends toward competition (at least in long distance service). In adopting thismodel, Venezuela followed the example of the recently-completed 1990 telecom privatizations inMexico and Argentina where the operators had been granted monopolies of 6 years in Mexico and 7years, extendible to 10 (if performance targets are met) in Argentina.

72. The Venezuela Government's rationale for granting the 9-year monopoly was not to increasesales revenue. Rather, it reflects two factors. First, there were substantial distortions in the rate

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structure, with long distance rates (far above economic levels) cross-subsidizing local rates (farbelow economic levels). Introduction of competition would have led to a significant reduction inlong distance rates (through new entrants), but required a significant increase in local residentialrates to enable local service and network expansion to be financially viable without continued cross-subsidies. Given the political sensitivity about price increases in general, the Government wanted toavoid such a "rate shock". Hence, rates were to be rebalanced to economic levels over a 9-yearperiod, during which the privatized operator would be required to undertake a major networkexpansion and service improvement program.

73. A second factor reflects the Government's objective to attract a first-class internationaloperator. In discussions with potential investors, all emphasized that, given the unbalanced ratestructure and aggressive service expansion obligations, a significant monopoly period (similar toMexico and Argentina) would be necessary to finance such a program (through cross-subsidies fromlong distance of local, and from commercial to residential).

74. Despite this rationale, it appears that there was insufficient economic analysis undertakenwhen designing the privatization, particularly at the crucial early stages when the Government wasmaking important decisions on the future sector structure. An effort was made to strengthen theeconomic analysis and advice through additional consultants, but this may have come too late tosignificantly change the model adopted by the Government.

75. The post-privatization experience in Venezuela has shown that, given the proliferation ofnew telecom services and technology, considerable disputes have arisen about whether new servicesare "basic" (and hence subject to the monopoly). Moreover, even where services are deemed to bebasic, the monopoly has been difficult to enforce, given that technology now allows "bypass" of theoperator's network (often without detection). To the extent that bypass is occurring on a significantlevel, this reduces the revenue available to the operator for network expansion and undermines theoriginal rationale for the monopoly model.

Labor reduction and cost

76. By end- 1993 about 52,000 employees were retired or laid off in addition to 35,700 thatwere transferred to the private sector as a result of privatization. One drawback of Venezuela's PEprogram was the high cost related to severance payments, $420 million. Because of labor contractsand/or agreement, severance payment was twice the level defined in the labor legislation, that is,two months for each year of service, (rather than one month per year, as set out in the Labor Law.For some workers, an additional 5% after 10 years service was given.

G. Evaluation and Conclusions

77. The PERL was part of the Government's structural reform program. Public sector enterpriseswere a major source of inefficiency in the economy. The PERL program was conceived as a first stepto reform them through privatization or restructuring, and to reduce the state's dominance andpreferential position in the economy. But it was recognized that the overhaul of public sectorenterprises would be a long-term reform that could take at least five to ten years.

78. Four issues should be highlighted in evaluating the design and implementation of the PERL.These include: (a) the price issue; (b) political conflict and public support for the program; (c)

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strategies issues: privatization vs. restructuring, sector reform vs. enterprise reform; and (d) WorldBank commitment to a process more than to a program. These issues are discussed below.

79. The price issue. The adjustment in prices was the most difficult part of the program. ThePERL aimed at adjusting public enterprise prices to economic levels (export opportunity cost fortradables, like fuel and fertilizer; long-run marginal cost for non-tradables like electricity, water,natural gas, and telephones). After some initial price adjustments in 1990-91, the program stalled in1992, as a consequence of political difficulties and little progress was made in 1993-1994.

80. Subsidized gasoline prices are a sensitive issue in Venezuela, related to the socialarrangement on how to distribute the income from oil. Some activities, like protected industries andgovernment employees, receive their share indirectly, due to monopoly rents, income above theiralternative opportunities or excess employment. Employees in government enterprises earn higherwages and have special fringe benefits, as the severance payments under the PERL programcorroborated. The rest of society receives transfers either through subsidized government services(education and health, for example) or via direct subsidies on prices. To eliminate the fuel pricesubsidy would exclude a significant part of the population (in particular the middle class) from whatthey perceive as their share of the oil income. Increasing the price of oil is therefore perceived by alarge portion of the population as a tax, transferring income from consumers to the Government.This would be resisted, in particular given the lack of trust in Government because of historicalcorruption and inefficiency.

81. The Government did not give sufficient consideration to the political nature of fuel pricesand the tax-transfer implication of price increases. To build public consensus for price adjustments,the Government needed to provide compensatory measures But this was not done. Consequently,there was no public understanding or support for the fuel price adjustments, and prices wereimmediately frozen when political difficulties arose, after the first coup attempt in February 1992.

82. Political conflict and public support for the program. The structural reform program, ofwhich the PERL was a part, involved fundamental changes in the society's social contract andeconomic organization, such as: redefining accepted ideological or cultural tenants - the role of thestate as an economic agent; eliminating existing institutions, for example, dismantling publicenterprises which affects many political interests; and changing the structure of production.

83. In addition, the Government implemented important reforms in the electoral system. Forexample, under a new law provincial governors would be elected, rather than appointed by the partyin power, as in the past. Furthermore, election of individual legislators by district became the norm,rather than choosing them according to each party's proportional votes. In both cases, thissubstantially reduced the power and presence of political parties.

84. Thus, these policies generated considerable political and social opposition, which strainedthe relationship between the President and the political groups, including his own. However, theGovernment did not form a political alliance with those that would benefit from the program,whereas those opposed articulated a strong opposition and publicly campaigned to undermine theprogram. Moreover, the structural reform program was essentially designed and implemented by atechnical team of new ministers, who were not members of the President's own political party. As the

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reform measures unfolded, little attention was paid to improving the understanding and promotingsupport for the reforms on the part of the public or major political groups.

85. After the first coup attempt in February 1992, the President shifted his priority towardnegotiating with political groups for support. A price was paid with respect to the liberalizationprogram in general and the PERL in particular, in terms of withdrawing key actors, delayingdecisions and suspending or reducing the legislative program. As the political situation deteriorated,a campaign developed accusing the Government of corruption and questioning the benefits of thereform program. Some of the interest groups that lost economic privileges as a result of the reformssupported this campaign. The personal difficulties of the President, accused of improprieties,increased and ended with his removal in mid-1993. There were two interim Presidents prior to theyear-end elections. In a period of less than a year, four persons were President. As a result of thepolitical crisis, the entire reform effort collapsed in 1992 and virtually no progress was made in1993.

86. Part of the problem was that the Government, at the moment of the crisis, apparently feltlimited in its capacity to appeal to the public for support of the reform program. As the program wasnot previously sold to the public or politically oriented sectors, 'there were doubts about its support.A public dialogue was not taken into account in the design of the PERL program nor in the structuralreform program generally. With the exception of the privatization program, little was done to explainor justify the adjustment program.

87. A large part of the opposition to structural reform and adjustment comes frommisunderstanding, which can be clarified. Political and economic opposition can be reduced iflarge sectors of the public better understand the program and the need for reform. It is notnecessary to convince everybody; it is sufficient to create credibility and to reduce the intensity ofthe opposition. For this reason, an effort should have been made to explain the cost of not doingthe reforms, the meaning of the reforms, the objectives and expected results, and to clarify issues,respond to questions, etc. The reform program as a whole did not contemplate a plan of going tothe public, to professional sectors and political groups. The technical group that promoted andimplemented the reform was small; their efforts were directed towards implementation, and noprogram was designed to promote or discuss the program with the public. Only in the case ofprivatization this was done.

88. In the case of privatization, it is common that strong opposition develops. Privatization isperceived as selling the national wealth (patrimonio nacional). Hence, selling the concept ofprivatization as a policy alternative becomes a political and conceptual battle. In the case ofVenezuela, as a response to the critics and opposition to the privatization of CANTV, an effortwas made to explain, defend and sell the program. As a result of these efforts opposition toprivatization diminished, and the idea of privatization became more acceptable.

89. To promote the structural reform program, some benefits for the public should exist fromthe beginning. In this way the success is perceived earlier, and it is also expected for the rest ofthe program. The evaluation of success of an adjustment program is some times measured by thesuccess in the implementation of its measures. But the true success is in the resulting benefits.The public will support the program when they see that it solves problems. That is the case offiscal constraint to reduce inflation. An immediate measure of success is perceived. For this

I See also Performance Audit Report. The World Bank

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reason, the design of the program should take this into account and implement measures whichproduce early results. This was one shortcoming of the structural reform program in general andthe PERL program in particular.

90. Strategies issue: Privatization vs. Restructuring. Sector Reform vs. EnterprisesReform. The PERL program was designed with an emphasis on restructuring public enterprisesto improve their efficiency, as a first step toward privatization. Direct privatization objectiveswere modest (bringing only $150 million in assets to point of sale), although both the Bank and theVenezuela's technical group had higher expectations.

91. The results clearly demonstrate that privatization was successful in improving efficiencyand performance, but restructuring failed in the large PEs. In many cases, the companies usedrestructuring as an alternative to privatization or to avoid it. Although restructuring agreementswere signed with more than 12 enterprises, none demonstrated major improvements in financialperformance, productivity, or efficiency. In fact, many were in worse financial condition by end-1994 than before the restructuring process commenced. In several cases, the companies hadalready undertaken several restructuring exercises in recent years, involving varying degrees ofreorganization, decentralization, etc. None was successful. Venezuela's lack of success withreforming and restructuring public enterprises is not unique. International experience in bothdeveloped and developing countries is similar in virtually all countries (with a few exceptions).But, when the PERL was being designed, this experience was not known. Better results withrestructuring were obtained in the small PEs.

92. The program strategy was to emphasize enterprise reform, rather than sector reform. The"enterprise approach", to look at the public enterprise as if it were the sector, apparently wasbased on the monopolist nature of the public firms. It was thought that privatization of thegovernment firm would solve the sector liberalization problems. This was not so. There are sectorissues that are independent of privatization, or that should be looked as sector optimizationpolicies, such as increasing competition, optimal price structure, etc. In the case where the publicenterprise was not privatized, as in electricity, no sector issues were resolved (such as privatesector generation). Even in the case of privatization, as in the telephone company, sector issueswere not properly addressed (like the duration of the monopoly) or are still pending (like therelative price distortion). On the other hand, in the case where the program followed a sectorapproach, as in the shipping sector, the success was complete. Venezuela's experience reinforcesthe idea that in the design and implementation of public enterprise reforms the issue of sectorreform, as well as enterprise reform, should be addressed.

93. One important lesson from Venezuela's privatization experience was that privatization wasonly accomplished when persons committed to the reform program and privatization were namneddirector of the institutions involved, and sector minister. Without these charges, managers remainedcommitted to maintaining the enterprises and delayed the privatization efforts. This experience inVenezuela tends to confirm international privatization experience.

Bank Performance

94. World Bank commitmnent to a process more than to a program. The PERL wasdesigned under special circumstances. There was no prior economic or sector analysis. Venezuelahad been outside the Bank from 1974-89, so that the Bank did not have background informationand analysis on public enterprises in the economy. At the same time, the Government wished to

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move urgently on the reforms, and the Bank wanted to provide continued support at that criticaltime in the reform process. Conditionalities were loosely defined, with the understanding thatspecific measures would be developed as further analysis/studies were undertaken and the reformprocess continued to unfold.

95. In practice, two programs developed. On one hand, there was the formal PERL programcovering a large number of reforms (price adjustments, legal/institutional reforms, restructuring,privatization, etc.). On balance, this program was not successful, for a number of reasons: (a)conditionalities were not very specific which reduced the Bank's leverage; (b) the resistance tochange was under-estimated, which delayed the process; (c) the program was over-ambitious andunrealistic, particularly given the fragility of support; (d) the program incorrectly emphasizedrestructuring (which failed) rather than privatization; (e) insufficient attention was given torestructuring sectors (e.g. electricity), rather than enterprises, which would have gone muchfurther in promoting competition and private participation, as well as imposing much greatermarket discipline on the remaining public enterprises; and (f) transferring responsibilities to localgovernment was not accompanied with capacity building. Nevertheless the program did achievereduction in employment and financial transfers to PE (partially due to privatization), plus amoderate success in restructuring small enterprises.

96. In retrospect, nevertheless, one can argue that the PERL supported a parallel agenda ofreforms, a reform process, (not specifically put forward in the Loan covenants) which wassignificantly accomplished. This consisted of: (a) technical support to the group that wascommitted, with the endorsement of Venezuela's President, to the overall reform program; (b)financial support to the Government's investment program and to give some leverage to thereform-oriented actors; and (c) reducing the role of govermnent through privatization anddismantling of institutions that had been the source of inefficiency, bloated employment, andcorruption.

97. While the formal PERL program largely failed, the major goals of the parallel program orprocess were achieved. Important firms were privatized successfully. The legal framework andinstitutional capacity for privatization was established. A group of government enterprises, insteadof being restructured to improve their efficiency, was liquidated. A group of governmententerprises, instead of being restructured to improve their efficiency, were liquidated or privatized.These results were achieved during a short window of opportunity, from late 1989 to the end of1991, which validated the Bank's decision to strongly support the program in spite of its risk.

98. The success of these measures was beyond the formal loan conditions, and attests to theownership of the program by the Perez's Government. This was further demonstrated by theefforts to continue the program even under the negative political conditions. Political developmentsundermined the support and cut short the implementation of the structural reform program and thePERL program. The new Government, which took office in February 1994, did not continuethem, and at the end the loan was closed. Nevertheless, in particular with respect to the PERL, theachievements in privatization and the reduction of the size of public enterprise remains.Venezuela's experience show that commitment to a process was more important than programspecifics.

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Project Sustainability and Evaluation

99. One can infer that the existence of ample and efficient technical support from thoseinvolved, as well as good coordination between the Bank and Venezuela's team, was necessary toachieve what they did, given the short time available and difficult environment.

100. The project success can be evaluated as adequate, due to privatization. Privatization andliquidation reduced the size of the Government and, by eliminating inefficient enterprises,increased the Government and country productivity. The program also contributed to reducing thegovernment deficit from public enterprises. The achievements of the project in terms ofprivatization, liquidation and restructuring have been sustained to date and are likely to continue tobe so.

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PART Il: (From the Government's Perspective)

(Not received at time of printing)

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VENEZUELA

PROJECT COMPLETION REPORT

PUBLIC ENTERPRISE REFORM LOAN(LOAN NO. 3223-VE)

PART m: STATISTICAL INFORMATION

PROJECT TIMETABLE

Initiating Memorandun March 2, 1990Letter of Development Policy May 17, 1990Negotiations May 11-14, 1990Board Approval June 12, 1990Loan Agreement October 15, 1990Effectiveness December 7, 1990Original Loan Closing June 30, 1993Actual Loan Closing June 30, 1994

CUMULATIVE LOAN DISBURSEMENTAmount (US$ million)

FY91 FY92 FY93Appraisal Estimate 157.5* 242.5 350.0Actual 157.5 242.5 242.5Actual as % ofFinance 100.0 100.0 69.2

* Including the debt set-aside of USS87.5 million

DATES OF TRANCHE DISBURSEMENTS

AmountTranche .US$ million) DateFirst 157.5 December 1990Second 85.0 December 1991Third 107.5 Cancelled

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MISSION DATA

Stage of Project Month/Year No. of Weeks No. of Persons Staff WeeksPreparation 9/89 2.0 10 20.0Preappraisal 11/89 2.0 4 8.0Appraisal 3/90 2.0 1 2.0Negotiations n/a 2.4 1 2.4Supervision I 10/90 2.0 3 6.0Supervision II 2/91 1.5 5 8.0Supervision mI 6/91 2.0 3 6.0Supervision IV 11/91 2.0 2 4.0Supervision V 1/92 1.0 2 2.0Supervision VI 7/92 1.0 1 1.0Supervision VII 5/93 1.2 1 1.2

STAFF INPIITS(in Staff Weeks)

GRANDFY89 FY90 FY91 FY92 FY93 FY94 FY95 TOTAL

LENP .5 63.6 64.1LENA 6.1 6.1LENN 13.4 13.4SPN .2 62.4 35.7 9.6 5.7 113.6PCR 9.0 9.0TOTAL .5 83.3 62.4 35.7 9.6 5.7 9.0 206.2

IMAGING

Report No: 15239Type: PCR