Document o f The World Bank

FOR OFFICIAL USE ONLY

Report No. 53 1 19-VN

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND

INTERNATIONAL DEVELOPMENT ASSOCIATION

PROGRAM DOCUMENT

FOR A PROPOSED LOAN IN THE AMOUNT OF US$200 MILLION

AND PROPOSED CREDIT IN THE AMOUNT OF

SDR 73 MILLION (US$l 1 1.8 MILLION EQUIVALENT)

TO THE

SOCIALIST REPUBLIC OF VIETNAM

FOR A

FIRST POWER SECTOR REFORM DEVELOPMENT POLICY OPERATION

March 8,20 10

Vietnam Sustainable Development Unit Vietnam Country Management Unit East Asia and Pacific Region

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

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VIETNAM - GOVERNMENT FISCAL YEAR January 1 - December 31

AfD B O T CFL

CURRENCY EQUIVALENTS (Exchange Rate Effective as o f February 28,2010)

Currency Unit Vietnamese Dong U S $ l .oo 19,075 VND S D R l .OO 1.53258 US$

Agence franCaise de DCveloppement M P I Ministry o f Planning and Investment Build, Operate, Transfer MOST Ministry o f Science and Technology Compact Fluorescent Lamp MtCO? Mi l l ion Tonnes of Carbon Dioxide

WEIGHTS AND MEASURES Systkme Internationale

DPO EPTC ERAV

ABBREVIATIONS AND ACRONYMS

Development Policy Operation NPTC National Power Transmission Company Electric Power Trading Company ODA Official Development Assistance Electricity Regulatory Authority o f Vietnam OoG Office o f Government

I AAA 1 Analytical and Advisory Activities I M o F I MinistryofFinance I

GEF GHG GNP

I ADB I AsianDevelopmentBank I M o I T I Ministry o f Industry and Trade I

Global Environment Facility SAV State Audit o f Vietnam Greenhouse Gas SBV State Bank o f Vietnam Gross National Product SDR Special Drawing Right

IBT IDA IFC

I CPI I ConsumerPriceIndex I MW I Megawatt I

Incremental Block Tarif f SMHP Strategic Multipurpose Hydropower Plant International Development Association SMO System and Market Operator International Finance Corporation SOE State Owned Enterprise

I CPS I Country Partnership strategy I N L D C I National Load Dispatch Center I

kWh LSDP LDU

I CPSPR I Country Partnership Strategy Progress Report 1 N P L I N o n Performing Loan I

Ki lowatt Hour V C G M Vietnam Competitive Generation Market Letter o f Sector Development Policy Local Distribution Ut i l i ty W C M Wholesale Comuetitive Market

VHLSS Vietnam Household Liv ing Standards Survey

I EVN 1 VietnamElectricity I PBR 1 Performance-Based Ratemalung I 1 FDI I Foreign Direct Investment I PC I Powercompany I I GDP I Gross Domestic Product I R C M I Retail Competitive Market I

1 GSO I General Statistics Office I SEA 1 Strategic Environment Assessment I I GWh I GigawattHour I SEDP I Socio Economic Development Plan (2006 - 2010) I I IBRD I International Bank for Reconstruction and Development I SFR I Self-Financing Ratio I

I ~ ~~ I IFRS I International Financial Reporting Standards I t/COz I T o n n i b f Carbon Dioxide

I IMF I International Monetary Fund I TNO I Transmission Network Owner I I I JICA I Japan International Cooperation Agency I T O U I Time O f Use

I MDGs I Millennium Development Goals I WTO I World Trade Organization I I MIGA I Multilateral Investment Guarantee Agency I I I

FOR OFFICIAL USE ONLY

DSM & EE PRSC PSRDPOl REDP

IDA PROJECT ABBREVIATIONS

Demand Side Management and Energy Effrciency Project (GEF TF051256) Poverty Reduction Support Credit First Power Sector Reform Development Policy Operation Renewable Energy Development Proiect (Cr. 4564)

SEIER TD2

IRD I Rural Distribution Project (Cr. 4444) I

System Efficiency Improvement, Equitization and Renewables Project (Cr. 3680 and GEF TF05 1229) Second Transmission and Distribution Project (Cr. 4 107)

I RE2 I Second Rural Energy Project (Cr. 4000 and TF054464) I

This document has a restricted distribution and may be used by recipients only in the performance o f their off icial duties. I t s contents may not be otherwise disclosed without Wor ld Bank authorization.

Vice President: James W. Adams Country Director: Victoria Kwakwa

Sector Director: John Roome Sector Manager: Hoonae Kim

Task Team Leader: Richard SDencer

VIETNAM mRST POWER SECTOR REFORM DEVELOPMENT POLICY OPERATION

TABLE OF CONTENTS

1 . INTRODUCTION ........................................................................................................ 3

. I1 . COUNTRY CONTEXT ............................................................................................... 4 Recent Economic Developments in Vietnam ......................................................................................... 4 Macroeconomic Outlook and Debt Sustainability .................................................................................. 9

THE GOVERNMENT’S PROGRAM AND PARTICIPATORY PROCESSES ......... 11 The Macroeconomic Program ................................................................................................................. 11 The Power Sector Reform Program ........................................................................................................ 12 Stakeholder Participation ........................................................................................................................ 18

BANK SUPPORT TO THE GOVERNMENT’S PROGRAM ..................................... 19 Link to Country Partnership Strategy ......................................... ; ........................................................... 19 Collaboration with the IMF and Other Donors ....................................................................................... 19 Relationship with Other Bank Operations .............................................................................................. 19 Lessons Learned ..................................................................................................................................... 21 Analytical Underpinnings ....................................................................................................................... 22

THE PROPOSED OPERATION .................................................................................. 24 Operation Description ............................................................................................................................. 24 Policy Areas ............................................................................................................................................ 27

V I . OPERATION IMPLEMENTATION ........................................................................... 31

Environmental Aspects ........................................................................................................................... 35 Implementation, Monitoring and Evaluation .......................................................................................... 39

Onlending ............................................................................................................................................... 40 R i s k s and Risk Mitigation ....................................................................................................................... 40

I11 .

I V .

V .

Poverty and Social Impacts ..................................................................................................................... 31

Fiduciary Aspects ................................................................................................................................... 39 Disbursement and Auditing .......................................................................................................... : ......... 40

ANNEXES

ANNEX 1 :

ANNEX 2:

ANNEX 3:

ANNEX 4:

Letter o f Sector Development Policy ............................................................. .43

Program Matrix for the Vietnam Power Sector Reform Development Policy Loan Programmatic Series ........................................... .48

Public Financial Management in Vietnam ...................................................... 52

Country At-A-Glance, including Map (No. VNM33551) .............................. 61

The First Power Sector Reform Development Policy Operation was prepared by a team consisting o f

Richard Spencer (Task Team Leader), Beatriz Arizu de Jablonski (Senior Energy Specialist, Co-Task Team Leader), Anh Nguyet Pham (Senior Energy Specialist), Ky Hong Tran (Energy Specialist), Keiko Kubota (Senior Economist), Valerie Kozel (Senior Economist), Douglas J. Graham (Senior Environmental Specialist), Robert J. Gilfoyle (Senior Financial Management Specialist), Cung Van Pham (Financial Management Specialist), Ma i Thi Phuong Tran (Financial Management Specialist), Hisham Abdo Kahin (Senior Counsel), Sameena Dost (Senior Counsel), Peter Meier (Consultant), Lien Thi Bich Nguyen (Program Assistant), Teri Velilla (Consultant).

Peer Reviewers: Ioannis Kessides (Lead Economist), Kari Nyman (Lead Specialist), Tonci Bakovic (Chief Energy Specialist, IFC).

LOAN, CREDIT AND PROGRAM SUMMARY

VIETNAM FIRST POWER SECTOR REFORM DEVELOPMENT POLICY OPERATION

Borrower ~

Implementing Agency

Financing Data

Operation Type

~~ ~

M a i n Policy Areas

K e y Outcome Indicators

Socialist Republic O f Vietnam

Ministry o f Industry and Trade

IBRD Loan terms: commitment-linked IBRD Flexible Loan with variable spread. Final maturity o f the Loan i s 25 years including a 10.5 year grace period and level repayment o f principal.

IBRD Loan amount: US$200 mi l l ion

IDA Credit terms: hard term, standard IDA service and commitment charges. Final maturity o f the Credit i s 35 years, including a ten year grace period. Credit amortization at 2.5 percent for years 11-20 and 5.0 percent for years 21-35.

IDA Credit amount: SDR73 mi l l ion (US$111.8 mi l l ion equivalent)

Single-tranche programmatic operation, the f i rst in a series o f three planned operations.

The program is organized around four main pol icy areas essential to the reform o f Vietnam’s power sector:

Development o f a competitive power market; Power sector restructuring; Electricity tar i f f reform; and Improving demand side energy efficiency.

K e y indicators o f the outcomes are: Hour ly operational reserve o f electricity generating capacity not less than 10 percent at a l l hours f rom a 2008 baseline o f periods with zero hourly reserve; Contracts in place for 90 percent o f demand, for non BOT generation based o n pricing methodologies and standard format published by regulator, and the competitive generation spot market price being published by the system and market operator. Baseline is no such contracts, and no publication; The number and diversity o f electricity generation companies i s increased, with no single company owning more than 40 percent o f capacity from a baseline o f 70 percent in 2008; The system and market operator follows dispatch and system operation rules to ensure no discrimination among generators, as measured by an independent audit. Baseline is no audit because no system and market operator in place;

1

Annual tariff adjustments are approved by March each year with updates o f up to five percent approved by Ministry o f Industry and Trade; Cross subsidies from industrial and commercial to residential consumers are reduced by 50 percent. Subsidies to the poor are targeted to low income consumers. Baseline: cross subsidies from industrial and commercial consumers (of $370 mill ion in 2007), an untargeted subsidy to all residential consumers for the f irst 100 kilowatt hours (kWh) o f consumption, and local distribution utility tariffs higher than Vietnam Electricity’s; and

0 Energy efficiency targets are established by law and Ministry of Industry and Trade and the regulator has capacity to enforce demand side management (DSM) programs and require power companies to undertake energy efficiency actions. Baseline: no energy efficiency law, no DSM program obligation on power companies.

The objective o f the proposed program i s to support the Government o f Vietnam’s implementation o f a market for electricity generation, restructuring o f the power sector and reform o f tariffs that wil l facilitate effective competition, transparency and predictability, encourage timely generation investment, improve system operational reserve and provide incentives for efficient use o f electricity.

The proposed programmatic series supports the Country Partnership Strategy objective o f improving the business environment by better meeting demand for reliable and cost efficient energy. I t also contributes to social inclusion, environment management and governance objectives.

~ ~ ~ ~~~~~~~~

All the supported reform actions have been implemented through appropriate legal instruments and the danger o f their reversal i s low. The four main areas o f r isk identified for the operation are:

Waning ownership o f reform, mitigated mainly by the two-step, pilot and implementation approach designed to build consensus and clear exit points; Complexity and novelty o f reforms, which introduce the concept o f the economic regulator for the f i rs t time in Vietnam. Mitigated by extensive capacity building;

0 Governance and corruption and resistance to greater transparency. Reforms introduce transparency to mitigate this risk; and Unforeseen impacts o f tariff reform on either the poorest or powerful interest groups. Considered low but wil l be monitored.

P115874

2

IBRD/IDA PROGRAM DOCUMENT FOR A PROPOSED FIRST POWER SECTOR REFORM DEVELOPMENT POLICY OPERATION TO

VIETNAM

I. INTRODUCTION

1. Vietnam i s implementing an ambitious long term reform o f i t s electric power sector, with the intention o f discarding the model o f a vertically-integrated utility owned by the State in favor o f a competitive market. The purpose o f the reform program i s to attract a broader range o f participants to invest in the power industry. Transparency and competition are to be introduced, tar i f fs will transition to recover costs, the main power utility wil l be restructured and demand side efficiency will be promoted. The expected outcome i s that the power sector will be better equipped to support economic growth and meet demand for power in terms o f quantity and quality, while ensuring reasonable and fair costs to consumers, and efficiency.

2. The reforms focus on four key policy areas:

Introduction o f competition, starting with the introduction o f a transparent market in which generators compete to supply and in which prices for generation are formed transparently and competitively; Restructuring o f the power sector to create arrangements that enable a market and competition, and eliminate conflicts o f interest between generation and transmission and system operation services; Reforms to the mechanisms by which electricity retail tariffs are set, through introduction o f tariff setting that reflects costs in the supply chain, including power purchase costs in the competitive market for generation, and regulated network and system operation services. The reforms wil l also improve the targeting o f subsidies for the poor; and Improve the conditions for demand side energy efficiency by supporting the Government’s efforts to establish a comprehensive legal framework.

3. The proposed operation, First Power Sector Reform Development Policy Operation (PSRDPO1) i s planned as the first in a programmatic series o f three. The expected timing o f this f i rst operation i s that i t will be completed by mid 2010. The second and third operations are expected to follow in early 201 1 and early 2012. The first operation i s proposed to be in the amount o f U S $3 11.8 million, o f which $200 mill ion would be a loan from IBRD sources and a credit o f 73 mill ion Special Drawing Rights (SDR), equivalent to U S $1 11.8 million, from IDA on hard terms. Each o f the two subsequent operations i s proposed to be loans in the amount o f $200 mill ion from IBRD sources and hard IDA funds if available. Timing, content and size o f subsequent operations will track the progress o f the government’s reform program and availability o f funding.

4. The operation i s consistent with the objectives o f the Country Partnership Strategy (CPS) for 2007 to 201 1 as reviewed in the CPS Progress Report (CPSPR) o f November 2009. As part o f i t s f irst pillar, to improve the business environment, the CPS adopts the broad aim o f better meeting demand for reliable and cost efficient energy. The strategy specifically notes the Bank’s support to facilitate the restructuring o f the power sector. The broadening and deepening o f the dialogue between the Government o f Vietnam and the Bank on power sector reform merits a

3

program that wil l complement the series o f Poverty Reduction Support Credits (PRSCs) that i s the primary vehicle for policy dialogue in Vietnam and the solid investment program in the power sector.

11. COUNTRY CONTEXT

Recent Economic Developments in Vietnam Vietnam and the Global Financial Crisis 5 . The global financial crisis led to a slowdown o f economic growth in Vietnam. International commodity prices declined in the third quarter o f 2008, export orders for garments and other industrial products collapsed in the fourth quarter, and a slowdown in manufacturing became noticeable. The impact was acute in the first quarter o f 2009, when GDP increased by 3.1 percent compared with the same period in 2008, more than 4 percentage points below the historic trend.

6. The global financial crisis was the second major external shock to affect Vietnam in recent years. In late 2007 and early 2008, in the aftermath o f i t s accession to the World Trade Organization (WTO), Vietnam had been confronted with massive capital inflows. Attempts to sterilize them were inadequate to prevent a boom in banking credit, an acceleration o f inflation, a ballooning trade deficit and asset price bubbles. The bubbles were amplified by sizeable infrastructure investments by central and provincial governments. The investment decisions o f large state-owned enterprises (SOEs) and “Economic which took advantage o f their access to finance to diversify into booming sectors, contributed to fanning the flames. The impact o f overheating was further aggravated by the surge in the international prices o f food and energy in early 2008. 7. The government responded to the overheating with a stabilization package. In March 2008, it adopted the “eight groups o f measures’’ to bring inflation down and reduce the trade deficit. This package combined the tightening o f banking credit, enhanced supervision o f vulnerable banks, postponement o f non-urgent public investment projects, modest cuts in recurrent government expenditures, and temporary interventions in international trade. The (unofficial) crawling peg o f the dong to the U S dollar was not abandoned, but the floatation band was broadened.

8. In the fall o f 2008, when the policy response was beginning to work, the government had to change gear fkom stabilization to stimulus, as the effects o f global financial crisis on Vietnam became evident. In November 2008, the “five groups o f measures” aimed at supporting economic activities were announced. This time, the package included cuts and deferrals in tax payments o f corporate and personal income tax as well as in value added tax for small and medium enterprises. It also included a small program o f cash transfers to poor households for the occasion o f the Lunar New Year. Other measures followed in February 2009, including a short-term interest rate subsidy scheme for working capital, which was de facto used to re-

’ “Economic Groups” are groups o f enterprises each with distinct legal status, which are bound together through mutual investments, capital contribution, merger, acquisition, reorganization or other forms o f affiliation; share common long-term economic interests, technology, market andor business services; and constitute a consolidated business entity in which the enterprises are organized into two or more levels, as parent companies and subsidiaries, as set forth in the Enterprise Law o f 2005 and Decree 139 o f September 5,2007.

4

finance enterprise debts contracted on very onerous terms during the stabilization period. This scheme turned out to be instrumental in keeping credit flowing to the economy, and prevented financial distress in the corporate sector.

9. Thanks in part to the stimulus package, economic activity i s recovering. In 2009, GDP grew by 5.3 percent with the second half performance particularly strong (see Table 1). Construction and services, two sectors buoyed by domestic demand, are leading the recovery, while agriculture and manufacturing sectors are s t i l l growing below the historic trend. Agriculture has been affected by unfavorable weather conditions in 2009 while manufacturing was hit very hard by the effects o f the global financial crisis in the developed countries. GDP growth in the last quarter o f 2009 reached 6.9 percent, year on year.

TABLE 1: KEY Ec

Output, Employment and Prices GDP (% change previous year) Industrial production index (% change, previous year) Unemployment rate (%, urban areas) Consumer price index (% change, period-end)

Public Sector Official fiscal balance (% GDP, excl. off-budget items)

General fiscal balance (% GDP, incl. off-budget items)

Foreign Trade, BOP and External Debt Trade balance (BOP definition, US$ million) Exports o f goods, (US$ million, fob) Exports o f goods (% change, previous year) Key exports, (value, % change) - crude oil Imports o f goods, (US$ million, fob)

Imports o f goods (% change, previous year) Current account balance (US$ million ) Current account balance (percent GDP)

Foreign direct investment (BOP inflows, US$ billions) Total external debt -DOD- (US$ billions)

As percent o f GDP Debt service ratio (% exports o f g&s)

Financial Markets Credit to the economy (% change, period-end) Short-term interest rate (3-m deposits, period-end)

NOMIC INDICATORS 2006 2007 2008eJ

8.2 8.5 6.2 17.0 17.1 14.6

4.8 4.6 4.7 6.7 12.6 19.9

1.1 -2.2 -1.1

-1.1 -5.3 -4.5

-2,776

39,826

22.7

12.1

42,602 22.1

-163

-0.3 2.4

19.1

31.5

5.0

-10,360

48,561

21.9 2.7

58,921

38.3

-6,992

-9.8

6.7

23.8

33.4

4.6

-12,782

62,685

29.1

23.1

75,467

28.1

-10,705

-1 1.9

9.3

29.6 33.0

3.9

25.4 53.9 25.4

7.9 7.8 8.1 752 927 31 6 Stock market - VN index (Jul2000 =loo)

e = estimate, p = projections.

2009 e l 2010 p/ 2011 pl

5.3 6.5 7.0 7.6 12.5 14.5

6.5 5.0 4.5 6.5 9.0 6.5

-6.2 -3.8 -2.3 -9.7 -6.2 -5.1

-8,307

57,096

-8.9

-40.2

65,403 -13.3

-7,192

-7.8

8.4

34.0 36.8

5.0

-7,820

64,115

12.3

13.0

71,935

10.0

-7,320

-7.2

8.8

38.1

37.5

5.7

-9,411

72,405

12.9

4.6

81,816 13.7

-8,016

-7.1

9.3

41.1

36.6

6.0

37.7 25.0 25.0

8.5 8.5 7.0

495 ___ __- jund (IMF), and World Bank.

The Government’s Finances 10. The government’s overall fiscal deficit i s estimated to be 9.7 percent o f GDP in 2009, substantially above that o f previous years, as the stimulus package came on top o f an already expansionary budget plan. In addition to the measures adopted to stimulate economic activities, the fall in o i l prices and the slowdown in economic activities have resulted in a large decline in government revenue. This decline was partially offset in the second half o f 2009, as both

5

international commodity prices and domestic economic activities became more buoyant (Table 2). 11. The external balance held up reasonably well during 2009 despite the global crisis. The preliminary data indicate that Vietnamese exports declined by 9.7 percent in 2009, compared with 2008. The decline i s less than in most other developing countries, but makes 2009 the first year with negative export growth since the beginning o f Vietnam’s economic reforms in 1987. The decline would have been larger if the sizeable gold exports o f early 2009 are not included. An even more dramatic decline in imports, by 14.7 percent, succeeded in reducing the trade deficit. Despite the faster recovery o f imports than exports in recent months, and the decline in remittances, the current account deficit i s estimated to have decreased to about 7.9 percent o f GDP in 2009, from 11.9 percent in 2008. FDI inflows are down, but Official Development Assistance (ODA) increased in 2009, resulting in an estimated capital account surplus o f around 10.9 percent o f GDP in 2009.

TABLE 2: GOVERNMENT BU

VND trillion unless otherwise noted

Total revenues and grants Revenues

Tax revenues O i l revenues Non-oil revenues

Non-tax and capital revenues Grants Budget expenditure

Current expenditure Expenditure on investment development

“Off-budget” expenditure and net lending Net lending

ODA financed VDB net lending

“Off-budget” investment expenditure Plan Stimulus

Overall fiscal balance I n percent of GDP

ZETARY OPERATIONS

2007 2008 el 2009pl 2010 E/

326.3 416.8 394.9 462.6 320.3 409.5 388.9 456.6 267.0 359.1 348.6 403.5 77.0 88.8 58.8 66.3 190 270.3 289.8 337.2

53.3 50.4 40.3 53.1 6.0 7.3 6.0 6.0

336.1 434.2 454.7 497.5 231.8 298.3 339.5 390.8 104.3 135.9 115.2 106.7 25.7 49.8 104.5 87.3 7.0 22.8 34.3 48.1

-3.0 9.0 13.4 11.9 10.0 13.8 20.9 36.2 18.7 27.0 70.2 39.2 18.7 27 25.2 39.2

45.0 -35.5 -67.2 -164.3 -122.2 -3. I -4.5 -9.7 -6.2

Source: Ministry o f Finance (MoF), IMF and World Bank staff estimates.

Foreign Exchange and Inflation 12. Even though the capital account surplus was sufficient to cover the current account deficit, international reserves declined in 2009, reversing the recent trend o f slow accumulation. The increasing demand for foreign exchange by importers and the market expectations o f dong devaluation led to a shortage o f foreign exchange, which was particularly severe in May-July, and again in November. Economic Groups were among the entities holding on to their foreign currency earnings. The market’s uncertainty regarding the level o f international reserves also

6

encouraged a precautionary demand for and hoarding o f gold and hard currency. These developments resulted in depreciation pressures on the exchange rate, with the dong trading at the weaker end o f the floatation band for an extended period, and the spread between interbank and parallel exchange rates widening to between a few and more than 10 percent at various times (see Figure 1).

FIGURE 1 : A WEAKENING DONG

Source: SBV and World Bank

13. Since October 2009, the government has taken several measures to allay concerns regarding foreign exchange shortage, inflation and credit growth. Headline inflation had come down sharply from the peak o f almost 30 percent in the middle o f 2008 to single digit levels in recent months. Even though the trend had reversed in the second half o f 2009 (Figure 2) headline inflation ended the year at 6.5 percent, down from 19.9 percent in 2008. The nascent global recovery has already started to increase prices o f primary commodities including food. An expansionary monetary policy during the stimulus period has led to rapid credit growth, reaching 37.7 percent at year end, above the target o f 30 percent for 2009.

14. Policy changes adopted in November 2009 included raising the base rate from 7 to 8 percent (Figure 3), devaluing the dong by 5.4 percent, and narrowing the flotation band from +5 percent to f 3 percent. The interest rate subsidy scheme for working capital was terminated in December 2009 as originally planned, further contributing to monetary policy tightening. The dong was devalued once more in February 201 0, this time by 3.4 percent. Shortly after, the cap on lending rates in dong was abolished in practice, if not in the law. Flexible interest rates should restore the arbitrage between dollar and dong returns, and contribute to a smoother operation o f the foreign exchange market.

7

FIGURE 2: INFLATION I

50

4

361 E t

20

10

0

Year-on-yeaCPI

F M B h - 0 8 Oa-08 F4b-09 b 4 9 Oa-09 Feb-li

Source; GSO FIGURE 3: KEY POLICY RATES

14

12

10

8

6

4 1 2 Baserate ----- Re-rate - Discountrate i -

I o ! , , I

Source; SBV

The Banking Sector 15. The banking sector was adversely affected by the succession o f asset price bubbles, monetary tightening and growth slowdown. The real estate bubble o f end-2007 and i ts subsequent bursting in early 2008 made i t difficult for several commercial banks to recover their loans. The rapid disinflation in late 2008, at a time when interest rates were s t i l l very high, substantially increased the debt service burden faced by enterprises because o f the rapid rise in real interest rates. During the stabilization phase o f late 2007- early 2008, the SBV upgraded i ts supervision efforts, and in parallel, raised minimum capital requirements. By the end o f 2008 all commercial banks, including the nine small joint stock banks that seemed most vulnerable, had met the new requirements. This process continues, with the minimum charter capital set at 3 trill ion dong (about $157 mill ion at today's exchange rate) by end 2010. All banks need to submit plans on how they will meet this target no later than March 2010. Banks which fail to meet this requirement wil l be forced to merge with other larger banks, or wil l have their business licenses revoked.

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16. The profitability o f banks was generally good in 2008, reflecting relatively low credit costs and a strong growth in the volume o f lending. Profitability was also boosted by sizeable capital gains on government bonds, which many banks purchased when foreign investors fled Vietnam in the f i rs t half o f 2008. These capital gains offset the low net interest rate margins, resulting from the cap on lending rates, which was in force until February 2010. So far, profit figures reported by listed banks for 2009 also remain upbeat.

17. The fraction o f bad debt (calculated based on days in arrears) for the banking sector was on the r ise until mid-2009 (generally a few percentage points), and has started to decline more recently. Non Performing Loans (NPLs), calculated using international standards based on borrower risks, would be at a much higher level (2-3 times higher), but are not known with certainty. In the absence o f the interest subsidy scheme, rapidly changing inflation and interest rates combined with the weak orders due to the global financial crisis there would have been an even more substantial deterioration o f bank portfolios. The increase in bad loans came after an overall improvement in the quality o f lending as a result o f several years o f efforts by the State- owned Commercial Banks (SOCBs) to clean up their portfolios in preparation for equitization. The recent reversal o f this trend may suggest that the gradual recovery o f economic activities i s helping enterprises cope with their financial obligations. Employment 18. Assessing the social impact o f the growth slowdown i s difficult in the absence o f a reliable and timely labor force survey, but there i s anecdotal evidence o f increased hardship during the first half o f 2009, especially in industrial parks and in handicraft villages. Overall, it appears that underemployment was more common than open unemployment. There are also disparities across various segments o f the labor market and heterogeneity o f impacts across enterprises and provinces. The market for semi-skilled and skilled workers recovered well after the Lunar New Year (end January 2009). The picture i s different in the industrial parks that serve as the platform for a large share o f manufacturing exports, where the workforce i s generally less skilled. A survey o f such parks reveals that a significant minority o f enterprises was adversely hit during the f i rst half o f 2009.

19. The biggest diversity o f social impacts was across individual workers and households. Rapid impact assessments relying on focus group discussions with workers suggest that major adverse effects, such as falling into poverty, facing food shortages, having to pull children out o f school, having to sell land, or becoming homeless, were relatively uncommon. However, there were numerous job losses, frequent reductions in working hours and wages, reduced remittances, and a shift towards informality. Wh i le job losses were widespread in industrial parks in late 2008 and early 2009, few took the form o f open layoffs. Non-renewals o f contracts and incentives for voluntary departures were more common. Job losses were frequent among seasonal workers, and among those on short-term contracts. However, in 2010 enterprises are once again complaining about unfilled vacancies, suggesting that the labor market i s tightening.

Macroeconomic Outlook and Debt Sustainability Outlook 20. The outlook for 2010 i s challenging. The stimulus program, while succeeding in encouraging economic activities, has also contributed to increased external vulnerability during 2009. Expansionary monetary and fiscal policies contributed to the return o f a large current account deficit, although smaller than that in 2008. Critical macroeconomic information such as

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the real size o f the stimulus package and international reserves were not made clear in a timely manner, which added to uncertainty and exacerbated the foreign exchange shortage. As the world economy recovers, the government i s adopting a tighter monetary stance and fiscal policies commensurate with the available financing. The measures adopted so far can be grouped in three areas. First, a tighter credit growth target o f 25 percent for 2010 was announced. The target i s among the lowest over the last decade. Second, government has clarified the law on interest rate caps, allowing lenders and private sector borrowers to negotiate interest rates. And third, a tighter budgetary stance was endorsed by the National Assembly.

21. The cap on lending rates was introduced in 2008 as a tool to address the overheating economy. The cap was set at 150 percent o f the dong denominated base rate, which was to be announced monthly by the SBV. T h i s decision replaced the previous practice o f allowing negotiated interest rates for commercial lending activities. The cap was effective at containing the overheating, but as the economy entered a disinflation phase, and the policy rate was lowered to boost economic activity, i t had the effect o f squeezing the interest rate margins for banks. The base rate peaked at 14 percent in June 2008, with the corresponding lending rate cap o f 21 percent. With the base rate at 8 percent at present, the cap i s 12 percent and banks’ gross margins are reduced by half compared with barely one year ago. The interest rate subsidy scheme was a second-best solution to alleviate this problem, as i s the recent decision to allow banks to circumvent the regulation. To address this problem more fundamentally, the SBV i s including provisions in the two key banking laws to be passed in May 2010, and to go into effect in 201 1. Article 15 in the draft Law on the State Bank o f Vietnam and Article 91 in the draft Law on Credit Institutions would relax the cap on lending rates. The draft Law on Credit Institutions also includes a provision that the SBV will have the power to stipulate an interest rate management mechanism in case o f market disorders or disruptions. These measures wil l be important as the loans contracted under the interest subsidy scheme begin to mature.

22. Balance o f Payments wil l continue to be a challenge for the authorities in 2010. The trade deficit has been on a widening trend again since mid-2009. Remittances and foreign direct investment inflows were more resilient than observers anticipated, but s t i l l declined compared with 2008. The authorities have made efforts to ease the excess demand for foreign currency and gold since December 2009. State-owned enterprises were instructed to render foreign currency holdings back into the banking system. Administrative measures were introduced to tighten supervision o f gold trading. Gold trading floors will be closed from March 2010 onwards, because they allegedly encourage speculative behavior by the population. The devaluation o f the dong in November 2009 and again in February 2010, and especially the recently decided flexibility o f interest rates in dong, are also expected to bring some calm to the foreign exchange market.

23. Despite the lower credit growth target, the inflationary pressure does not appear to be subsiding. Even when the seasonal effects o f the Lunar New Year are taken out, prices are clearly on an increasing trend, fueled in part by recent increases in gasoline and water prices. Tradable goods carry a heavy weight in Vietnam’s consumer price index. The combination o f a crawling peg for the dollar and increases o f commodity prices in world markets should result in an acceleration o f inflation. The recent devaluation o f the dong wil l also add to the pressure, as will the planned increases in the price o f electricity, in the minimum wage and in civil service wages. The government i s aware o f this challenge, and the rebalancing o f economic policy in end-2009 and early-2010 i s a step in this direction. But keeping inflation in the single digits in

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2010 will be difficult; the government has taken some initiatives to control prices which do not reassure the markets. Debt Sustainability 24. The government i s expected to reduce the size o f the budget deficit gradually. The recently approved budget plan for 2010, which translates into a projected overall fiscal deficit o f 6.2 percent, entails a substantial contraction compared with 2009, but s t i l l an expansionary stance compared with previous years. The government i s expected to finance this deficit with a combination o f bond issuance, including the proceeds o f a recently completed sovereign bond offering o f $1 billion, and increased ODA. A t the Consultative Group meeting held in December 2009, development partners pledged over $8 bil l ion (including both loans and grants), a sharp increase from $5 bil l ion in the previous year. Even with the caveat that the pledged figures do not directly translate into disbursements within the calendar year, the ODA hnds are expected to help finance the budget deficit. In the past, the government has not monetized unhnded expenditure but adjusted capital spending (including on-lending to lower levels o f government) when financing fell short o f expectations.

25. Vietnam’s debt i s likely to stay sustainable if the current economic recovery continues and the authorities revert to the fiscal deficit o f 3-4 percent in the next 2-3 years. A debt sustainability analysis was conducted in early 2009 after the announcement o f the 2009 budget plan, but before the specifics o f the fiscal stimulus package became clear. It found Vietnam’s external debt position to be robust, with the total public external debt o f 25 percent o f GDP (30 percent including private sector) at the end o f 2008. With nearly two-thirds o f the debt contracted on highly concessional terms, the ratio o f debt service to exports was projected to remain at or below 5 percent in the coming years. The stress tests found that the two main r isks to debt sustainability were a one-time nominal depreciation o f the dong o f 30 percent and an increase in debt-creating flows by 10 percentage points o f GDP, which would increase the present value o f public debt by seven to eight percentage points by 2013. Both scenarios were considered unlikely at the time, and are s t i l l unlikely, although the picture has changed somewhat with the large fiscal deficits in 2009 and 2010. How quickly the government reverts to the “normal” levels o f fiscal deficit and how it finances the deficit, as well as whether the new debt i s incurred for productive purposes wil l be critically important to the continued sustainability o f Vietnam’s debt. The next debt sustainability analysis, scheduled for April this year, wil l incorporate all information available regarding the stimulus spending and projected orientations o f the government.

111. THE GOVERNMENT’S PROGRAM AND PARTICIPATORY PROCESSES

The Macroeconomic Program 26. The government’s macroeconomic vision i s articulated in several strategic plans and documents, including the ten-year Socio-economic Development Strategy 200 1-20 10 and the five-year Socio-economic Development Plan 200 1-2006. There was a noticeable acceleration, starting around 2001, in the government’s drive towards relying on market mechanisms, developing a multi-stakeholder economy and hrther integrating with the region and the world. These strategic plans and documents aimed at establishing a market economy with a socialist orientation. They built on the successes o f the renovation process initiated in the late 1980s with &i mbi, while also preserving the strong poverty-reduction focus.

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27. The SEDP 2006-2010, approved in June 2006, emphasizes development outcomes and the policy reforms needed to attain them, unlike previous five-year plans which focused on quantitative targets as if the state was s t i l l in charge o f producing most goods and services. It relies on data and analysis, rather than administrative reporting, to substantiate i t s diagnostics and recommendations. I t has also led to the adoption o f a framework to monitor progress towards attaining development outcomes. The process through which this SEDP was prepared was more participatory than in the past. Extensive consultations were held, going beyond the boundaries o f government, and involving businesses, grassroots communities, overseas Vietnamese and development partners.

28. Other important policy developments have influenced this reform agenda. By mid-2003, the government decided to aim for a rapid accession to the World Trade Organization (WTO). In late 2003, a new anti-corruption strategy started to emerge, with the emphasis shifting from punitive measures to increased transparency and strengthening o f the government systems. The new comprehensive anti-corruption strategy was adopted in May 2009, setting out preventive, demand-side solutions and monitoring mechanisms. The year 2004 saw the coming into effect o f the new Budget Law, which makes the National Assembly and People’s Councils at all levels responsible for resource appropriations. A banking reform roadmap was adopted in 2006 to prepare the banking sector for liberalization in accordance with Vietnam’s WTO commitments. The roadmap included revisions o f the Laws on SBV and on Credit Institutions, as well as preparation o f Bank Supervision Law and Deposit Insurance Law.

29. The SEDP also emphasizes the linkages between macroeconomic goals, and sector-based activities. These include: continued agricultural development to meet domestic demand but also to add value by improvements in processing and production efficiency; industrial development particularly the maintenance o f industrial growth and modernization; and development o f the service sector. Each o f these has implications for the energy sector, which also i s treated within this SEDP largely in terms o f ensuring that increasing demand i s met at least cost.

T h e Power Sector Reform Program 30. To ensure demand can be met, the government has decided to move the power sector towards competitive and market based arrangements that also promote efficiency. The reform program entails a major transformation o f the power market, sector structure, trading and purchase agreements, generation pricing and regulation o f network services and retail tari f fs in Vietnam. The design o f the power market and the restructuring i s intended to change how projects are financed, the interest and participation o f the private sector (both local and foreign investors), how costs o f supply are determined and how they are reflected in tariffs. The goal i s to introduce incentives and regulations to bring about improvements in quality o f service, the efficiency with which energy i s used, and to enable existing and new investors to finance sufficient generation to achieve adequate levels o f electricity generation capacity for security o f supply.

31. Adequate and sustainable investment in the power sector i s necessary to support economic growth and poverty reduction in Vietnam. Vietnam has faced high levels o f demand growth for the past decade, only falling to 10 percent in 2008 due to the global crisis before returning again to the trend rate o f around 15 percent in 2009. This has eroded reserve margins to the point where power shortages leading to load shedding have been an intermittent problem since 2005, especially in dry years. Current estimates are that Vietnam could face a shortage o f about 1,200MW o f capacity in 2010. To achieve a 25 percent system reserve margin - a widely

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accepted norm in the industry to achieve security o f supply and end periodic shortages - Vietnam needs to pursue a large scale generation investment program.

32. Estimates vary o n the amount o f investment required for the power sector and depend mainly on forecasts o f demand growth. Estimates made in 2007 suggested that some $3-4 bi l l ion per year was needed for the power sector as a whole, with about 70 percent being for generation. Recent estimates suggest as much as $6 bi l l ion a year may be needed. ODA has been a significant source o f funding, running at about $1 - $1.5 bi l l ion per year, with the balance coming from domestic resources, especially in recent years from several SOEs. ODA i s l ikely to continue at current levels, though possibly on increasingly hard terms: the power sector for example i s leading the transition from IDA to IBRD. SOEs have indicated continuing interest in investing in the power sector. Nonetheless, to ensure adequate levels o f investment at reasonable prices will require diversification o f sources o f financing for generation, including private sector investment, and diversification o f generation ownership to enable competitive prices, Vietnam aims to achieve this through the development o f a competitive generation market.

33. The objective and the sequencing o f the program are set out in the SEDP, the National Energy Development Strategy, the Electricity Law and the Power Market Roadmap. The four outcomes the government seeks are discussed below.

Market Reforms 34. The reform program will introduce increased transparency and competition in generation prices, ensuring that power purchase costs transferred to consumers’ tariffs are fair. Introducing incentives to improve generation efficiency, reliability and availability through competition should also lead to better pricing and costs. Furthermore, the market framework wi l l include transmission grid, system operation and distribution network planning and operation procedures and performance standards that wil l improve efficiency and reliability o f delivery o f power to consumers. Quality o f service and performance obligations for consumers and transparent connection and operation procedures as wel l as performance standards for NPTC and for N L D C as the system and market operator (SMO) wil l be established.

35. Central to the reform and restructuring i s the Electricity L a w which was passed by the National Assembly in November 2004 and which came into effect o n July 1, 2005. The Electricity Law establishes a new framework for the power sector, comprising:

0 The gradual development o f a competitive power market, starting with a market in which multiple generators compete to generate and sell to a single wholesaler (the Single Buyer), moving later to a wholesale competitive market with multiple wholesale buyers - power companies and large consumers - and sellers - power generators - and, in time the development o f retail competition enabling consumers to choose their supplier;

A planning process to select new generation investment to supply projected demand consistent with security and reliability criteria and government energy policies that wil l gradually evolve f rom the current centralized master planning process. The first step i s to transfer oversight f rom Vietnam Electricity (EVN) to the Ministry o f Industry and Trade (MoIT). In later stages o f reform, master planning is expected to give way to indicative planning, based o n market information, leaving greater discretion to project proponents in choice o f project location, technology and timing; and

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The establishment o f a new agency, the Electricity Regulatory Authority o f Vietnam (ERAV), under the supervision o f the Minister o f Industry and Trade, as the economic regulator o f the sector.

36. Prime Minister’s Decision 26 o f 2006 approved a Roadmap for the development o f the competitive power market within the general framework defined in the Law. The Decision envisages a three phase process, with each phase split into two stages: an initial pilot to test and improve the design and then a stage for full implementation. It also sets pre-conditions to be met for moving from one phase to the next and requirements to restructure the actors in the power sector to match the needs o f the market. In more detail the phases and indicative timetable are:

Phase 1 (2005 - 2014): The transitional phase during which preparation and detailed design, as well as trials lead to the creation o f the Vietnam Competitive Generation Market (VCGM). The VCGM will introduce competition among generators to enter the market based on allocation o f concessions to develop power plants identified in the master plan. I t wil l also introduce competition to be dispatched (that is, to supply electricity into the network). The full implementation stage wil l require all power plants to be contracted to sell a set quantity o f electricity, initially 90-95 percent o f that generated, but declining over time at a set price each year to a single wholesale licensee (the Single Buyer), which will resell to PCs at regulated bulk supply tariffs. A centrally administered spot market wil l manage competition for generation scheduling, dispatch and ancillary services;

Phase 2 (2015 - 2022): Wholesale Competitive Market (WCM), in which generators wil l be able to sell directly to wholesalers, the PCs or qualified large customers. In the pilot stage, selected PCs and large customers wil l be allowed to contract directly with generators and trade in the spot market. In the completion stage, all PCs and large customers will enter and participate in the wholesale market and multiple wholesale licensees wil l be allowed; and

Phase 3 from 2023): Retail Competitive Market (RCM), in which the PCs’ monopoly as retailers to small and medium sized customers wil l be phased out. In the pilot stage, customers in designated provinces and above a specified threshold most likely based on annual consumption or peak demand wil l be allowed to contract with their chosen supplier. During the full implementation stage, the number o f provinces wil l be gradually extended and thresholds gradually reduced.

37. Coal-fired generation accounted for about 21 percent o f all electricity generated in 2009. In i ts Notice o f August 11 , 2009, the Office o f Government announced that the pricing o f coal for electricity production would follow market principles from 2010. The price o f coal wil l consequently rise, in stages, to about twice i t s former price. Both the expected increase in the coal price to market levels and because the VCGM does not change the power system expansion planning method, the policies supported are not expected to increase the amount o f coal fired electricity consumed. Neither the existing fleet o f plants, nor those planned to enter service wil l change as a result o f the f i rst phase o f reforms, since the VCGM will have no role in technology or fuel choice. The reforms to coal pricing and the introduction o f VCGM can be expected to reduce the amount o f electricity generated from older, less efficient coal fired plant, in favor o f the more modern ones; this i s discussed further in Section V I below.

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Restructuring 38. The current sector structure i s characterized by EVN’s dominant share and participation in all segments of the supply chain. EVN currently controls about 70 percent o f all generation plant although it has sold minority stakes in some power plants through an equitization program. All power transmission assets are owned by EVN through i ts wholly-owned subsidiary NPTC. Some 50 percent o f rural customers are served by locally-owned and operated distribution uti l i t ies (LDUs) with the balance receiving service from EVN’s power distribution companies (PCs). Generation outside EVN ownership includes about 12 percent o f power supplied from two international build-own-transfer plant in operation at Phu My (for which IDA and MIGA provided guarantees); PetroVietnam, the State-owned o i l company that owns about 12 percent o f all generation capacity; and Vinacomin, the State-owned mining company that also owns power plants. About five percent o f electricity i s imported from China, and more i s planned to be imported from Lao PDR. Numerous locally-owned small hydro, coal- and gas-fired independent power projects are under construction and the f i rs t are now entering service.

39. The government has set out its principles for restructuring o f the main participants in the power sector to ensure that there i s fair and transparent competition and that conflicts o f interest are addressed. These principles may be summarized as:

Separation o f the ownership o f power generation from the Single Buyer, to eliminate any conflict o f interest between those who sell and those who purchase electricity. With the introduction o f the W C M the monopoly o f the Single Buyer wil l be eliminated since generators and large consumers wil l be free to enter bilateral contracts;

Separation o f monopolistic services (transmission, system operation and distribution network services) from those that compete to ensure they provide transparent and fair treatment to all market participants; and

Restructuring o f generation into successor companies o f similar size and competitive capability to develop conditions for effective competition.

40. Initial restructuring w i l l enable competition and protect consumers and investors from the conflict o f interest that currently exists with the same company, EVN, being the wholesale buyer and seller o f electricity, the provider o f monopoly transmission and system operation services and a major owner o f generation competing with other non-EVN generators. Transparent and non discriminatory transmission, system operation and market administration will provide generation investors, both non EVN SOEs and private, the level o f comfort required to enter the market and to continue building new generation. Diversification o f ownership o f generation i s expected to be achieved as other investors enter the market and EVN’s generation assets are placed in subsidiary generation companies, which wil l be split from EVN.

41. The government has made clear its intention that there will be mixed public and private ownership o f the sector. Generation ownership, which i s currently in State and in private hands, wil l remain mixed. EVN i s carrying out a study on how to restructure i t s generation assets to meet the longer term aspiration o f the Prime Minister’s Roadmap that requires that no single entity wil l be allowed to control more than 25 percent o f generation capacity. Monopolistic services, including the National Power Transmission Company (NPTC) acting as the transmission network owner responsible for expansion and maintenance (TNO) and the National Load Dispatch Center (NLDC) which wil l become the system and market operator (SMO), as well as the large strategic and multipurpose hydropower plants (SMHPs) wil l remain in the

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public sector. The Single Buyer - currently a unit o f EVN called the Electricity Power Trading Company (EPTC) - and the power distribution companies (Power Companies - PCs) will remain owned by the State, but the PCs are intended to be equitized in the longer term as performance based ratemaking (PBR) tariff regulation i s completed and implemented, and to support the development o f the WCM. Tariff Reform 42. Electricity tar i f fs that are reflective o f efficient costs in the electricity supply chain provide predictability for sustainable investment in the power sector, to finance much needed new generation capacity, transmission upgrading and distribution improvements. A key target o f the reforms i s to build investors’ perception that tar i f fs in the power sector wil l be sufficient to cover generation, transmission, distribution and system operation costs. Tariff methodologies and regulations must ensure that electricity market participants know that regulated tar i f fs wil l allow them to recover costs over the lifetime o f their investment. Cost reflective tariffs need to be accompanied with subsidy mechanisms ensuring protection for the poor, especially for rural areas in Vietnam.

43. The reforms have to address two issues. First, the level o f tari f fs must be maintained at a realistic level. Tariffs have fallen in real terms over the past several years, despite increases in January 2007 o f an average o f 8 percent to Vietnamese Dong (VND) 873kWh and a further increase o f an average o f 9.1 percent to VND 948kWh in 2009, which reflects the actual cost o f supply in 2008. Second, tariff setting must move away from the old system under which increases have been promulgated by decision o f the Prime Minister, following a protracted and untransparent process o f negotiation between EVN and the government and then within the government itself. The system must be replaced with one that reflects actual agreed costs, to the greatest extent possible assisted by market mechanisms that support price discovery, to provide predictability for investors.

44. Cross subsidies, estimated at $370 mill ion in 2007, from industrial and commercial to residential consumers are to be gradually eliminated, and targeting o f subsidies to the poor improved initially with changes in the structure o f the residential block tariff. A f i rst and significant step has been taken in putting all households on an equal footing, by extending the existing uniform tariff policy for PCs to all the country by including the tariffs o f rural local distribution utilities (LDUs). Reforms are also focused on ensuring that as much o f the subsidy as possible reaches the poor. In the longer term, introduction o f greater generation competition and consumer choice through retail competition will reduce the needs for tariff regulation and government involvement in price setting. Such a change would require complementary mechanisms to ensure continued protection for the poor which, ultimately, may be delivered through other targeted social programs rather than through the current tariff schedule for households.

45. The Electricity Law assigns responsibility for tariff decisions to the Prime Minister. The Prime Minister’s Decision on electricity pricing in December 2006 (276/2006/QD-TTg) formalized the transformation to market based cost reflective tari f fs with the statement that: “From 2010, the electricity retailprice shall be based on the market price”. More recently, the Prime Minister’s Decision 21/2009 set out the principles to unbundle tariff setting into separate generation (power purchase) costs, regulated transmission and distribution network services revenue requirements, regulated system and market operation costs, and other costs.

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46. Although tariff decisions should ideally be insulated from considerations other than strictly economic and financial, the setting o f tariffs wil l continue to require government approval. Reforms wil l provide significant improvements in the transparency and promptness with which tariff decisions are made. Resetting will be on a regular annual cycle with changes scheduled for March o f each year, based on cost and demand data and objective assessment o f their reasonableness by ERAV. The Prime Minister has delegated to the Minister o f Industry and Trade the approval o f average tariff updates if the proposed average retail tariff change i s below five percent.

Improving Demand Side Efficiency 47. In recent years, the government has encouraged supply side efficiency and demand side management, to reduce the shortages o f energy and the need for new investment in capacity. This has generally shown positive results, with EVN’s compact fluorescent lamp (CFL) program being evaluated to have resulted in reductions in consumption o f about 46 gigawatt hours (GWh) per year and peak demand reductions o f 30 megawatts (MW). I t further targets a reduction o f the peak demand o f 207 MW by 2012, and 450 MW by 2015 at day time peak load. Nonetheless, reductions o f 6,000 GWh per year o f consumption are considered possible. The National Strategic Program on Energy Saving and Efficient Use approved by the Prime Minister in 2006 included targets on energy savings up to 201 5 and instructed Mo IT to draft and submit to the National Assembly the Energy Efficiency Law during the period 2008 - 2010.

48. To promote reductions in electricity demand, the efficiency program i s expected to set efficiency standards for electrical appliances and labeling. Tariff regulations which propose time o f use (TOU) metering and electricity tariffs for all electricity consumers connected at medium and high voltage, create pricing signals to reduce peak demand and energy consumption. In the longer term, TOU metering w i l l be further developed to other consumers, and PCs tariffs wil l be partly set on the basis o f demand side efficiency programs, as well as their own supply side efficiency measures. Managing Reform 49. One o f the major goals o f the market and tariff reform i s to enable adequate level o f investment to end periods o f shortage that have been experienced in recent years as demand has outstripped supply, and to continue to improve access to good quality electricity. Within this consideration, the three phases o f reform over a twenty-year period reflect a pragmatic approach, taking lessons from international experience, avoiding major changes that could disrupt investments required to support growth, and the long time horizons the government adopts in its planning. Design, sequencing and management o f reform are key factors that wil l contribute to a successful outcome.

50. The two-step, pilot-and-implement method allows for learning by doing, analytical work and consensus building at each stage to avoid unintended negative results, reversals or stalling o f the program. I t i s well adapted to the circumstances o f Vietnam and i s a plausible and manageable plan. As an example, there have already been trials o f different designs by EVN using i ts own generation plant, which has significantly influenced the design o f the VCGM now being prepared. The government has pressed ahead with the program despite the global instabilities o f the past two years, demonstrating both the robustness o f the approach and i ts commitment to reform.

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51. The government increasingly depends on ERAV to manage the reform program because o f i t s good track record. I t i s well staffed, with about 60 full time professionals organized in a number o f functional departments, and a capacity building program. Staff are generally from engineering or finance/economics backgrounds, with many from EVN. They have proven to be committed to their work and have built knowledge through working hand-in-hand with specialized international consultants. ERAV has benefited from substantial technical assistance and training over the three years since i ts operationalization from the three main donors working in the power sector and reform field: the Bank, the Asian Development Bank (ADB) and the Agence franqaise de Dkveloppement (AfD). ERAV has been successful in proving i t s credibility with investors and power sector stakeholders, and i s increasingly being called upon to share i t s experience in international forums.

Stakeholder Participation 52. Led by MoIT and ERAV, stakeholder discussions have been extensive. Consensus i s particularly valued in Vietnam and a consultation process has evolved for the power sector reform proposals which are both extensive and inclusive. The process o f development o f policies and regulations follows four steps. In the f i rs t step, ERAV, normally working together with international consultants and technical working groups made up from existing electricity sector participants, prepare draft proposals. In the second step, the proposals are provided in advance o f consultation workshops to which electricity sector stakeholders and the press are invited. The consultation workshops recommend changes to the draft proposals. As part o f the reform, ERAV i s also establishing feedback mechanisms from consumers, including the encouragement o f users’ groups, but these have not so far been active.

53. In the third step, each proposal i s redrafted and submitted to the Minister o f Industry and Trade for approval and issue as a Decision. Before approval, the draft Decisions are consulted within government and with the general public, normally through the MoIT web site. Based on the feedback from this second round o f consultations, the Decision i s redrafted and resubmitted to the Minister for approval. In addition to the redrafted Decision, ERAV provides a record o f the comments received and where and how they have been incorporated into the Decision. They are made available to the press and via a web site, often in both Vietnamese and English. Those Decisions which must be approved by the Prime Minister or higher levels are processed in a similar way, often with additional rounds o f stakeholder consultations.

54. MoIT has held more than 50 workshops over the past three years as part o f this consultative process. In general, workshops are well attended by a diverse group o f stakeholders who participate actively - though plainly different topics are o f interest to different stakeholders, which include various departments o f EVN, current non-EVN electricity sector participants, potential investors (both public and private), consultants and private individuals. Workshops are almost invariably reported on television and in the press. Feedback from the second stage o f consultation i s recorded and must be accounted for.

55. In addition to consultation to facilitate formal decisions, a more ad hoc process o f consultation and feedback operates in Vietnam. The press pursues a lively debate on the power sector, which i s unusually closely scrutinized; i t has had a significant influence on the scope o f the reforms. A recent example o f this scrutiny led to a change in the way in which the Single Buyer was set up in EVN. MoIT i s also open to feedback, particularly from large consumers which are i ts natural constituency.

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IV. BANK SUPPORT TO THE GOVERNMENT’S PROGRAM

Link to Country Partnership Strategy

56. The proposed programmatic series i s a close fit with the Bank’s CPS for 2007 to 201 1, as recently updated in the CPSPR (Report 51659-VN, November 24, 2009). In the four pillars in the CPS, the reform o f the energy sector i s noted as supporting the first, namely to improve the business environment by meeting demand for reliable high quality electricity. The program wil l directly contribute to two CPS outcome indicators, on cost reflective tariffs and diversification o f ownership. Moreover, the program contributes to the second pillar, strengthening social inclusion, which includes expansion o f access to reliable and affordable electricity, the third, which covers improvements to environment management and the fourth, improving governance.

57. NO specific development policy operation (DPO) was identified for the power sector at the time o f preparation o f the CPS, but in discussing how to deliver the strategy, i t was noted that sector-level DPOs might be selectively introduced when policy reforms warrant such intervention. The progress in reform in the power sector has been considerable in the intervening period, and the dialogue i s now at a level where it cannot adequately be covered within the wider-ranging PRSC series. The proposed PSRDPO 1 is one o f the f irst such sectoral reform DPOs.

Collaboration with the IMF and Other Donors

58. Three donors, ADB, AfD and the World Bank have cooperated in their support o f power sector reform. ADB initially financed a major technical assistance project which proposed the general market design, while AfD has financed capacity building o f the regulator through training and through a resident advisor. ADB has also started to fund technical assistance to NPTC, mainly on financial models and capacity building to f i le for annual transmission revenue requirement and transmission charges. The World Bank has financed the development o f the final market design, licenses, regulations and technical codes, as well as led the reform dialogue with MoIT, and supported i ts efforts in donor coordination. In addition to flagging the proposed PSRDPO series to these partners, the Bank has discussed it with Japan International Cooperation Agency (JICA) and the policy actions it covers are being closely coordinated with a proposed JICA-led climate change DPO.

59. Assessments on macroeconomic indicators and projections are discussed regularly with the IMF. The Bank and IMF collaborate on annual debt sustainability analysis. The Bank has discussed the proposed operation with IMF.

Relationship with Other Bank Operations 60. The World Bank Group’s support for the power sector i s based on a dynamic mix o f analytical and advisory activities (AAA), IBRD/IDA lending, guarantees and facilitating involvement o f other parts o f the World Bank Group as needed. I t i s grouped around four themes:

0 Efficient and sustainable expansion o f physical system capacity. The current portfolio reflects the continued need to support expansion o f generation capacity and improvements in supply side efficiency in the transmission and distribution systems. Current projects supporting this area are the System Efficiency Improvement, Equitization and Renewables Project (SEIER, Cr. 3680 and TF051229) and Second

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Transmission and Distribution Project (TD2, Cr. 4107). IDA has also been the most significant financier o f Vietnam's major and quite successful rural electrification and rehabilitation program, with Second Rural Energy Project (RE2, Cr. 4000) and Rural Distribution Project (RD, Cr. 4444) now under implementation. The Trung Son Hydropower Project i s at an advanced stage o f preparation and wil l further support this theme;

Fostering private sector participation. IDA has supported private sector participation through a guarantee operation for the Phu My 2.2 BOT gas fired power plant (GU B-004- 0 VN). The Multilateral Investment Guarantee Agency (MIGA) has provided a guarantee for the Phu My 3 BOT power plant. International Finance Corporation (IFC) i s advising Mo IT on the Nghi Son 2 BOT plant currently being bid;

Promoting renewable energy and energy efficiency. With GEF co-financing through SEIER and now through the stand alone Renewable Energy Development Project (REDP, Cr. 4564), the Bank i s supporting the development o f renewable energy, principally small hydro (below 30MW). Through SEIER and the stand-alone GEF Demand Side Management and Energy Efficiency Project (DSM&EE, TF 051256), the Bank i s supporting improvements to demand side energy efficiency; and

Supporting sector reform. Through both recipient- and Bank-executed technical assistance, the Bank has been involved in sector reform since the start o f the reform process in about 1998. All the projects noted above include some element o f support for sector reform, restructuring o f power sector operations and unbundling o f generation, transmission and distribution and equitization. The current series o f PRSCs has also provided an additional vehicle for dialogue. Outcomes achieved from this include the further development o f policy for BOT power plants, separation o f power transmission assets into NPTC and adoption o f pricing systems for renewable energy. Analytical work supporting reform i s discussed further in the section on analytical underpinnings.

61. The strong program in the power sector i s characterized by an extensive policy dialogue founded on solid analysis, closely integrated with investments. Portfolio performance i s generally good, with high levels o f disbursement (21 percent in FY08, 25 percent in FY09, and projected 20 percent in FY10) with high levels o f realism. All projects completed to date have achieved satisfactory outcomes. The AAA program i s selective and integrated with the four themes discussed above. Other financing instruments include the Global Environment Facility; the Carbon Partnership Facility, for which the Bank i s now preparing the first operation for Vietnam, to support investments made under REDP. A $300 mill ion Clean Technology Fund (CTF) Investment Plan for Vietnam was recently endorsed by the CTF Trust Fund Committee. The Plan includes support for transmission system modernization, projects for which were proposed by ADB and the Bank, energy efficiency proposed by ADB and IFC, renewable energy proposed by IFC and urban transport proposed by ADB.

62. The Bank has also recently restarted work in the gas sector after a hiatus o f some years. This new start i s occasioned by the importance o f gas as a source o f comparatively low carbon energy for power generation. While the introduction o f the V C G M will not have an impact on demand for gas, it i s important to move to a more market-oriented gas sector in time for the introduction o f the WCM. In consequence a key action for PRSC9 i s the initiation o f work on a roadmap for reform o f the gas sector, which will be further supported by the Bank's AAA program in the

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coming years, and may be supported by investments if justified. T o build o n the decision to adopt market based prices for coal for electricity generation, an action to ensure further reforms to coal pricing i s being contemplated under the PRSC series. The reform o f the power sector will provide useful benchmarks for the gas and coal sectors in the coming years.

63. The reforms wil l provide greater clarity about the investment needed to develop further and strengthen the reliability o f Vietnam’s power system. For example, generation revenues and priorities will become more clear and predictable when separate generation companies have been created, contracts have been established with each generating plant and the market rules and technical codes are implemented. Existing investors and potential new investors wil l have a better understanding o f the l ikely returns on projects, and financing options, so private sector and Wor ld Bank Group support can be better designed. Likewise transmission investment needs, financing and priorities will become clearer when ERAV sets and monitors transmission regulations and performance standards for NPTC replacing the informal, internal arrangements within EVN that are used at present.

64. SEIER will also continue to support the technical assistance and capacity building o f ERAV during the current stage o f reform, to complete and enhance the regulatory framework and to continue the general and tailored capacity building program. This will ensure expert advisor support to address problems or concerns identified during the init ial trials and practical implementation, as wel l as continue to build increasing expertise in the details o f market rules and tariff regulation. Additional financing for SEIER i s now being put in place to extend the support to ERAV for a further three years, during which time it i s expected to become financially and technically self-sustaining through the introduction o f a regulatory fee paid by licensees.

Lessons Learned

65. The design o f the proposed programmatic series and o f PSRDPOl has been informed by Wor ld Bank experience in the design o f pol icy operations in Vietnam and in the power sector. It has followed the good practice principles for conditionality (see Box 1). I t draws particularly on the lessons from the PRSC series in identifying an area in which the leadership i s keen to move, where the dialogue is wel l advanced and where capacity to develop and implement pol icy i s in place. Such a window currently exists in the power sector in Vietnam; because economic circumstances have brought supply and demand close to balance while also highlighting the need to ensure that the power sector is an attractive destination for investment. Moreover, after a considerable period o f gestation, nearly al l the enabling legislation is now in place and draft regulations are being completed.

66. There i s a r ich and diverse dialogue centered on expanding and upgrading power service and supporting long-term reforms, backed by a program o f lending designed to support the concomitant investment needs. This twin track approach o f pol icy development and lending within a well-defined but flexibly-structured program has proved effective in achieving major impacts in generation, transmission and distribution, private sector participation in generation, rural electrification, renewable energy and demand side management.

67. The proposed operation is a further development o f this approach which wil l strengthen both the pol icy environment and the ability o f the sector to meet its physical investment needs. In l ine with emerging best practice, i t separates investment operations from pol icy dialogue and reform. This avoids the pitfalls o f hybrid pol icy and investment operations which have generally not l ived up to expectations.

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BOX 1: GoOD PRACTICE PRINCIPLES ON CONDITIONALITY

Principle 1: Reinforce ownership The operation supports one o f the Government’s main reform objectives which enjoy wide national support. The basis for the reform i s set out in legislation approved by the National Assembly and government endorsement supporting legislation in the form o f decisions by the Prime Minister and other ministers. The development o f the V C G M i s an aim o f the SEDP. The actions already taken represent considerable ownership among stakeholders and the proposed operation supports actions based on existing Government requirements. Further evidence o f the Government’s ownership i s to be found in the Letter o f Sector Development Policy (see Annex 1). Principle 2: Agree up front with the Government and other financial partners on a coordinated accountability framework The Bank’s support is summarized in a policy matrix (which is provided at Annex 2) which has been the focal point o f discussion with the government Working Group charged with preparation o f the PSRDPO 1. Principle 3: Customize the accountability framework and modalities of Bank support to country circumstances The operation adheres fully to the principles o f the Hanoi Core Statement on Aid Effectiveness (Vietnam’s localized version o f the Paris Declaration). The operation i s defined as a priority within Vietnam’s own government processes and aid programming; and i s based on extensive preparation. I t i s aligned with Vietnam’s strategies and relies on Vietnam’s country systems for policy- and decision-making as well as for disbursement and financial management; and the outcomes set out in the policy matrix are measured against clear, mutually agreed indicators. Principle 4: Choose only actions critical for achieving results as conditions of disbursement The agreed policy matrix has only seven prior actions across the four selected pol icy areas. All o f these seven actions have now been taken. Triggers for subsequent operations are also limited in number: eight for the second and seven for the third operation. Principle 5: Conduct transparent progress reviews conducive to predictable and performance-based financial support Joint progress reviews by MoIT/ERAV and the Bank on reform have been conducted as part o f project preparation. During the proposed operation, reviews w i l l be conducted twice per year, or if the progress warrants it more frequently. Clear milestones have been set out in the pol icy matrix, and the triggers are expressed in concrete and transparent terms.

68. One o f the main lessons from power sector reform operations is the need to ensure that the reforms do not induce shocks either to the supply or the demand side. In Vietnam consensus i s crucial and is built from the bottom up. In consequence decisions take time, but an advantage i s that proposals are thoroughly assessed prior to approval and the r isk o f shocks inducing opposition i s reduced because the main stakeholders and the public have been involved throughout. The government has adopted a gradualist approach with the carefully prepared phases set out in the reform roadmap. Nonetheless a degree o f f lexibi l i ty i s needed to build consensus, and the timings in the power market roadmap are taken only as indicative, to be adjusted as necessary.

Analytical Underpinnings 69. The pol icy dialogue in the energy sector i s informed by extensive analytical work over the past ten years. Foundation work supported preparation and passage o f the Electricity Law (1 998 - 2004), while work on restructuring o f the electricity sector includes Restructuring the Power Transmission Business (2005), and Equitization of the Power Sector (2006). The Bank provided assistance to M o I T during the development o f the Roadmap for Reform of the Electricity Sector which was issued as a Prime Minister’s Decision in 2006 and Conceptual Design of the Competitive Generation Market (2008). These studies are the basis o n which the V C G M design has been selected for the first phase. These principles o f market design and the consequent contracting and pricing requirements have been a key pol icy area on which Vietnamese pol icy makers have focused. Government - World Bank dialogue has relied extensively o n the analytical work undertaken.

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70. Support for the detailed design and implementation o f the‘reforms has included Electricity Licenses (2006 and 2007), a pol icy note on Restructuring for the Competitive Generation Market (2008), development o f Market Rules for the Competitive Generation Market (2009), and Grid Code (2009), Distribution Code (2009) and Metering Code (2008) and preparation o f Standard PPA and Dispute Settlement and Enforcement Regulation for the Single Buyer Market (2009). Support to pricing approaches and regulations include Bulk Power, Distribution Margin and Retail Tariff Design Study (2005), Retail Tariff Methodology (2008), PC Tariff Calculation and Model (ongoing), and Transmission Pricing Methodology and Model (ongoing).

71. Starting f rom agreed principles and objectives, and taking into consideration lessons learned in relevant international experience, this analytical work developed conceptual market design and tar i f f methodologies. Building from these, the details o f the V C G M design, rules, regulations, procedures and models for tari f f implementation are now being completed. In particular, the technical codes and market rules set transparent and non discriminatory processes to govern the relationships between different market participants and the service providers (NPTC and the SMO), as wel l as with ERAV in its monitoring, enforcement and dispute resolution regulatory role. The studies and international experts’ advice identified both synergies and conflicts o f interest which have informed the restructuring options and needs as the power market evolves, to create the credibility and transparency that wil l attract new players. In particular, transitional arrangements have been assessed including accounting separation, ring- fencing and establishing arms’ length relationships between market actors.

72. Additional work which i s o f relevance to the pol icy framework for the power sector has included Framework for Thermal BOT Tenders (2009), Methodology for the Calculation of Avoided Costs for the Avoided Cost Tariff for Renewable Energy (2008), Standardized Power Purchase Agreement for Small Renewables to be Contracted by PCs (2008). The Bank has also reviewed energy master plans and planning processes, particularly Power Master Development Plan No.6 (2006) and the Gas Master Plan for Southern Vietnam (2008) based on which it has prepared Vietnam Gas Market Development Framework (2009). These studies have helped to set out the sequencing and scope o f the operation, taking account o f other activities going o n outside the planned power market reforms, to ensure that i t addresses key issues but i s not over ambitious.

73. The government’s energy efficiency program has been designed with assistance from analytical reports financed by the Demand Side Management and Energy Efficiency Project including Final Evaluation of CFL Program Phases I and 2 (2007), Evaluation of Time of Use Tariff Program (2007), Em’s Phase 2 DSM Program, (2008). More recent technical assistance has prepared Vietnam: Expanding Opportunities for Improving Energy EfJiciency (20 10). Between them these studies have identified both the significant potential for energy efficiency and the numerous pol icy and regulatory barriers, particularly when addressing demand side management in a restructured power sector. They have contributed to the pol icy agenda for the power sector (by improving pricing signals, as intended in the tariff reforms and the market generation pricing) and in improving regulations for energy efficiency (in particular being addressed by improving incentives for the Power Companies to promote energy efficiency).

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V. THE PROPOSED OPERATION

Operation Description Choice of Lending Instrument 74. The government recognizes that managing reform and ensuring success will have a financial cost and in consequence i s seeking resources to finance the reforms. These costs include:

Public goods: Some o f the activities remaining in state hands necessarily have a public function, including for example continued responsibility for strategic and multipurpose hydropower plant which provides public goods in flood control and irrigation. Bringing electricity to all households - and in many cases improving the supply - has a social equity element, which although mainly covered through the cost recovery mechanism set up in the new tariff methodologies will also incur administrative and management costs when the cross subsidy scheme needed to maintain uniform tar i f fs i s introduced;

Capitalization of new entities: The sector restructuring means that some successor companies have been or will be formed and become independent o f EVN (such as the NPTC). Whereas before they were able to benefit from EVN’s financial umbrella, as stand alone entities they are likely to be insufficiently capitalized to undertake the investment program needed. New successor Gencos may also need capitalization; and

Financing gap: The reforms supported by the program will facilitate greater private participation in generation activities but it wil l take time before the investments materialize. During this time power demand will continue to grow and an adequate reserve margin i s needed for supply security and to enable a well hnctioning electricity market. Although a number o f other SOEs have been investing and financing power generation a significant burden wil l remain on EVN and its successor companies, until private sector finance begins to flow steadily.

75. In designing this program, several options for the lending instrument were considered. The option o f continuing support through the current PRSC series was rejected because the sector specific nature o f the dialogue in the power sector would not f it comfortably with the more macro nature o f the PRSCs. Another choice was between continuing the approach o f investment lending backed by an AAA program to promote reform and a DPO. The main reason for diversifylng into a DPO i s because the reform and restructuring process has now matured to the point where Vietnam will incur significant costs but these are not related to easily identified investments suitable for support through either a Specific Investment Loan or an Adaptable Program Loan series.

Program Objective 76. The objective o f the proposed program i s to support the Government o f Vietnam’s implementation o f a market for electricity generation, restructuring o f the power sector and reform o f tariffs that will facilitate effective competition, transparency and predictability, encourage timely generation investment, improve system operational reserve and provide incentives for efficient use o f electricity. The proposed series o f operations will support the first o f the three phases o f power market reform set out in the road map: the introduction o f the VCGM which provides for competition among generators.

0

0

0

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Sequencing of Operations 77. The first operation will be aimed at setting in place the key secondary legislation concerning the design o f the VCGM, the main requirements for restructuring o f the power sector needed for the VCGM to work in a fair and transparent way; for the tariff mechanisms to set and update tariffs reflective o f efficient costs, and the establishment o f the necessary preconditions for the government to take actions to improve energy efficiency. It w i l l also enable a pilot o f the final design o f the VCGM final design to be run. These are key decisions concerning principles and to authorize implementation, without which the subordinate entities o f government cannot act. The f i rst operation also supports substantive actions on tariffs, metering and efficiency standards which are now being implemented.

BOX 2. PRIOR ACTIONS FOR VIETNAM FIRST POWER SECTOR REFORM DEVELOPMENT POLICY OPERATION

Before presentation to the Executive Board, Vietnam agreed upon and implemented the following prior actions:

Prior Action 1 :

Prior Action 2

Prior Action 3

Prior Action 4:

Prior Action 5:

Prior Action 6:

Prior Action 7:

Through the Ministry o f Industry and Trade (MoIT), issued a Decision (No. 6713-QD-BCT dated December 3 1, 2009) establishing design principles for the implementation o f the Vietnam Competitive Generation Market (VCGM). Through the MoIT, issued a Circular (No. 27/2009/TT-BCT dated September 25, 2009) establishing metering systems standards and procedures for generation plants participating in the VCGM. Through the Office o f Government (OoG), issued a Notice (No. 232/TB-VPCP dated July 3 1,2009) establishing a sector structure to allow for the introduction o f the VCGM. Through the Prime Minister, issued a Decision (No. 21/2009/QD-TTg dated February 12, 2009) (a) increasing the average tariff in 2009 to VND 948/kWh, and (b) implementing transparent annual tariff-setting f iom 20 10- 12 based on cost recovery principles, including the unbundling o f the average retail tariff into power supply cost components and the delegation o f tariff changes o f less than five percent to the MoIT . Through the Prime Minister, issued a Decision (No. 21/2009/QD-TTg dated February 12, 2009) restructuring the residential block tariff system to establish the principle o f the subsidy to the consumer as a percentage o f production cost and extend the subsidy mechanism and residential tariff structure to local distribution utilities. Through the Ministry o f Science and Technology (MOST), issued Decisions (No. 2740/QD- B K H C N dated December 9, 2008 and No. 632/QD-BKHCN dated April 20, 2009) establishing energy efficiency standards for consumer goods accounting for large quantities o f electricity consumption. Through the MoIT, issued a Circular (No. 05/2009/TT-BCT dated February 26, 2009) introducing time-of-use tariffs for industrial zones and commercial, industrial, and irrigation consumer categories.

78. The second and third operations would continue to support the government's reform program. Based on the current path, the second operation would support putting in place detailed rules required to implement the design, restructuring and tariff actions. The third would be aimed at the startup o f the VCGM and moving to PBR regulation for PCs, the legal establishment and operation o f the restructured entities in the power sector and the approval o f implementing decrees for an energy efficiency law. The program, which is summarized in terms o f prior actions for the f i rst operation in Box 2, and indicative triggers for the second and third in the continuation o f Box 2, will mirror the pace and substance o f the government's reform

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program and so adjustments may be required to the timing, size and content o f the operations, which wil l also depend on the availability o f financing.

BOX 2 (CONTINUED). INDICATIVE TRIGGERS FOR VIETNAM POWER SECTOR REFORM DEVELOPMENT POLICY OPERATION

The indicative triggers proposed for the second operation, expected to be completed in early 20 1 1 are:

Trigger #1 D P L 2: M o I T issues Circular setting out market rules for VCGM. Trigger #2 D P L 2: M o I T promulgates standard contracts and i t s pricing methodology for non-BOT generation,

and pricing for each SMHP. Trigger #3 D P L 2: Prime Minister issues Decision on successor generation companies’ structure for VCGM. Trigger #4 D P L 2: M o I T issues regulations to r ing fence costs, revenues and information for NPTC, N L D C

and EPTC until they become independent companies. Trigger #5 D P L 2: M o I T and Ministry o f Finance (MoF) issue joint Circular wi th procedures for retail tariff

annual adjustments. Trigger #6 D P L 2: M o I T issues Circular with methodologies and procedures to determine transmission

revenue requirement and approve transmission charges. Trigger #7 DPL 2: M o I T issues Circular with procedures to determine and approve SMO charges. Trigger #8 D P L 2: Prime Minister sends Energy Efficiency Law to National Assembly.

The indicative triggers proposed for the third operation, expected to be completed in early 2012 are:

Trigger #1 D P L 3: V C G M commercial operation implemented. Trigger #2 D P L 3: SMO completes settlement for two months o f trading in the V C G M and SB completes

payments to generation. Trigger #3 D P L 3: M o I T establishes each successor generation company with no cross ownership with

transmission or Single Buyer, except for SMHP. Trigger #4 D P L 3: M o I T establishes SMO as a company with no cross ownership with other electricity

activities. Trigger #5 D P L 3: M o I T mandates implementation o f PBR through approval o f three year revenue

requirements for each PC. Trigger #6 D P L 3: M o I T issues implementation decree for energy efficiency law. Trigger #7 D P L 3: M o I T Circular promulgates time o f use tariffs based on load profiles.

Rationale 79. The proposed program o f DPOs complements the Bank’s investment and technical assistance operations o f the past several years and those in the pipeline, which are also grouped around the same four themes. By supporting the reforms it wil l lock in the progress made so far, particularly in those areas o f market design (supported by SEIER), unbundling o f the transmission system and development o f NPTC (supported by TD2), and the development o f the PCs’ distribution operations and capacity to operate autonomously (supported by RE2 and RD).

80. Bank support for this program i s justified on four grounds: (a) the reform o f the power sector has taken into account both national circumstances and international experience and as such represents best international practice tailored to Vietnam’s conditions; (b) the need to ensure the power sector’s ability to meet demand for electricity i s o f pressing importance as an input to Vietnam’s economic growth and modernization; (c) this i s the first wide-ranging sectoral reform which wi l l provide a model for reforms in other utility sectors; and (d) the operation i s an

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effective way for the government and the Bank to continue and widen the dialogue on energy sector reform.

81. The expected high level impact o f the operation wil l be to help meet the government’s objective o f ensuring adequate electricity supply at least cost to support economic growth, particularly within the industrial and commercial sectors, and improving efficiency in the power sector. It wil l also better people’s lives by improving quality o f access and the targeting o f subsidies, keeping them at sustainable levels. The proposed operation wil l address a number o f issues o f concern, including: increasing investment needs in generation and diversifying generation sources; improving transparency in contracting and pricing o f generation; ensuring efficient and non-discriminatory monopoly services such as transmission and dispatch; transparent, periodic and regulation-based updating o f tariffs; and the environment for energy efficiency will be significantly improved.

Policy Areas

82. The policy areas supported by the proposed operation correspond with the government’s program for reform. The policy matrix has been arranged around the following four areas. Policy Area A: Development of the Power Market 83. The Decision o f the Prime Minister setting out the road map for power market reform empowers Mo IT to issue the general principles o f market design. The VCGM design has been developed and under consultation for some time, taking into consideration international experience, Vietnam specific conditions and lessons from the earlier trials. With this critical decision by the Minister o f Industry and Trade taken, ERAV i s enabled to complete the detailed design and market rules and necessary market procedures for the pilot market.

84. An intermediate step i s needed to put in place the market infrastructure and software required for the VCGM. The market rules drafts under preparation have already gone through review and comments through workshops, and a stakeholders’ working group organized specially by ERAV to assess and recommend VCGM design and rules. Full commercial start-up o f the VCGM following the pilot w i l l require software and other tools, but these cannot be developed or adjusted until market rules are approved. During this period, VCGM contracts for non BOT generation would be put in place, initiated by MoIT issuing standard contracts and pricing methodologies to create transparency and ensure equal treatment for all interested investors. The final step - the full implementation o f the VCGM with i t s spot market - will then take place once all required software, websites and databases are adapted to the VCGM market rules and tested.

85. The following key policy actions are supported by PSRDPOl :

0 Prior Action I : The establishment o f the design principles for the implementation o f the VCGM. T h i s key measure sets out that the VCGM will be a gross pool with cost based caps on generation bids, market based hourly capacity payments, and standard contracts and pricing for non BOT generation to ensure similar treatment o f investors. I t mandates implementation o f the pilot VCGM for EVN power plants, and ERAV’s submission o f market rules and regulations for Minster o f Industry and Trade approval (for full implementation). Decision 67 13/QD-BCT o f December 3 1, 2009 has completed this action satisfactorily and has delegated to ERAV the preparation o f detailed market design and market rules for the VCGM; and

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0 Prior Action 2: The issuing o f metering systems standards and procedures for generation plants participating in the VCGM. T h i s regulation - the Metering Code - i s required for the spot market hourly settlement by the SMO, and contract invoicing and payment between the Single Buyer and generators. The technical and verification standards will ensure sales quantities are transparent and within similar quality requirements. The Metering Code i s essential to ensure generators procure and install meters and other equipment in time for the start o f the VCGM. Circular 27/2009/TT-BCT o f September 25, 2009 has completed this action.

86. Expected milestones which indicate progress o f the f irst operation are (a) EVN completing proposed VCGM market rules and submitting them to the Minister o f Industry and Trade for consultation and approval; and (b) MoIT issuing a Circular which promulgates the Grid Code. Between them these milestones wil l indicate that MoIT can take the next steps which wil l enable standard generation contracting and market participants to prepare for the initiation o f the VCGM.

87. The second operation would support the final power market rules and implementation o f the transition period with standard contractual arrangements, building upon the principles established in the f irst operation. Indicative triggers for PSRDPO2 are: (a) the issuing by MoIT o f a Circular setting out the market rules; and (b) MoIT promulgating standard contracts and pricing methodologies for non BOT generators, including SMHP. Policy Area B: Power Sector Restructuring 88. Although the power market roadmap has empowered MoIT to decide the power sector structure, there have been different interpretations o f the restructuring required. Experience during the trials for the first phase highlighted the perceived conflict o f interest resulting from keeping generation, transmission, system operation and dispatch under the same ownership. Generation investors other than EVN have also voiced concerns about the independence o f dispatch decisions and delays and difficulties in agreeing contract prices with EPTC. The practice has been that, except for BOTS, contracts are not negotiated until the generating plant i s almost ready to start commissioning tests, creating risks for financiers and thus making financing difficult for non-EVN private or SOE investors.

89. Clarity about the sector structure i s required to address concerns about conflict o f interest and power market roadmap requirements. As a transition step until full restructuring can be implemented and to accompany the implementation o f the contract market in Policy Area A, NPTC, NLDC and Electric Power Trading Company (EPTC), the EVN unit in charge o f generation contracting acting as the Single Buyer, wil l be ring fenced to ensure separation o f cost and revenue accounting and to set up procedures to ensure information disclosure to non EVN players. For VCGM start up, assessment and decisions are needed on generation - both SMHP and non-SMHP successor independent generation companies. Once the portfolio o f successor generators has been decided, the generation companies and the System and Market Operator (based on existing NLDC) can be legally created with adequate assignment o f staff and management, to start VCGM commercial operation.

90. The key policy action supported by PSRDPO1, namely Prior Action 3 i s the establishment o f the sector structure to allow the introduction o f the VCGM, includes the principle o f creating independent generation companies, assigning EVN the responsibility to propose the generating companies structure, and requiring the ring-fencing o f NLDC until it can be created as a separate

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entity. By assigning these tasks with a time-bound requirement for their completion, the government has ensured a sector structure wil l be in place to permit the start up o f the VCGM. This action has been completed satisfactorily with the issuing o f the Notice o f Prime Minister’s Conclusions, dated July 3 1 , 2009, No. 232/TB-VPCP by the Office o f Government.

9 1. Milestones in the progress o f this pol icy action in the first operation are the completion o f studies by EVN recommending the portfolio o f generating plant for each successor generation company, and the studies’ submission to the Prime Minister for consideration, and issuing o f a Circular by the M o I T on the calculation, review and approval o f the costs o f the SMO to ensure adequate resources and staffing.

92. The second loan in the proposed series would support more detailed plans and timing for the restructuring o f generation and ring fencing o f costs and revenues o f NPTC, N L D C and EPTC, and the information provided by them to enable transparent cost recovery calculations for tari f f setting. Indicative triggers for PSRDPO 2 in this pol icy area are: (a) issuing o f a Decision by the Prime Minister on the o f EVN successor generation companies and the portfolio o f generation plants each will own and operate, including the allocation o f projects assigned to EVN in the Power Master Development Plan; and (b) the issuing by M o I T o f Regulations to ring fence NPTC, N L D C and EPTC. Policy Area C: Electricity Tariff Reform 93. The implementation o f transparent, annual tari f f setting based o n cost recovery principles - also allowing for the implementation o f PC multiyear distribution PBR tariffs - requires regulations setting the principles and general framework, and procedures for filing, assessment and approval. This critical action wil l prove to investors the government’s willingness to enable cost recovery and create transparency also for the public and other stakeholders o n cost components o f each activity.

94. Reform i s based on unbundling the average retail tar i f f into power supply cost components: the power purchase costs for generation; approved regulated transmission, distribution and system operation costs; and other administration costs. Fol lowing the general principles on allowed costs for the determination o f retail tariffs set in the Prime Minister’s Decision, ERAV will develop detailed procedures and methodologies to cover al l regulated activities, including the transmission revenue requirement and charges for NPTC to be able to finance the expansion, upgrade, and maintenance o f the transmission grid. Other changes planned include the first implementation o f PC PBR, with a three year tariff period, later to move to a second, five year tar i f f period. Methods to set N L D C and other administration costs (including ERAV’s regulation fees) are also being drafted and should be issued as regulations by MoIT. To ensure consistency between government pol icy on cost recovery tariffs and protecting poor consumers, subsidy principles and mechanisms that are sustainable and better targeted are required.

95. ERAV studies have recommended moving towards multiyear distribution network tariffs that create incentives for improving performance and quality. The government i s targeting elimination o f cross subsidies between industrial and residential consumers, and seeking to improve targeting subsidies to the poor (see also the section below o n poverty and social impacts). At the same time the government has decided to maintain uni form national tar i f fs by consumer category that wil l apply to al l PCs. Implementation o f these arrangements wil l require mechanisms to compensate for the differences in costs and revenues from tariffs between more urban PCs and more rural PCs.

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96. Two key policy actions are supported by PSRDPO1:

Prior Action 4: Increasing the average tariff in 2009 to VND 948/kWh, bringing it to the level o f 2008 costs o f supply. The government has also introduced principles to recover electricity costs based on unbundled components o f electricity activities. These principles will apply from 2010 to 2012 and are expected to allow tariffs to remain at cost recovery levels. The government has delegated changes o f up to five percent to the Minister o f Industry and Trade. Between them, these increase the transparency and predictability o f tariff updates and reduce the level o f political involvement in tariff setting. P M Decision 21/2009/QD-TTgY o f February 12, 2009 on electricity price in 2009 and market-based electricity price 201 0 - 2012 satisfactorily completes this policy action; and Prior Action 5: Restructuring the residential block tariff system to establish the principle that the subsidy i s based on a percentage o f electricity production cost and extending the subsidy mechanism and residential tariff structure to LDUs. The new residential block tariff structure has reduced the upper limit o f the f irst block o f subsidized electricity consumption to 50 kWh per month, applicable to all consumers regardless o f supplier. These changes better target the subsidy to the poor, reducing the burden on other consumers. P M Decision 21/2009/QD-TTg, o f February 12, 2009 on electricity price in 2009 and market - based electricity price 2010 - 2012 satisfactorily completes this policy action.

97. The first milestone indicating progress in this policy area will be a Decision by the Prime Minister promulgating the regulations that establish the calculation method and procedures for appraisal and approval o f market-based annual tariff update. As a first step towards this, the Prime Minister has approved an increase in tariffs o f 6.8 percent to take effect from March 1, 2010, bringing average tariffs to 1,058 VNDkWh. The method used to calculate this increase was based on the principles set out in the P M Decision o f February 2009. A further milestone will be that ERAV completes draft methodologies for calculating transmission operating and capital expenditures for NPTC and submits them to the Minister o f Industry and Trade for consultation and approval.

98. Depending on experience with implementation, possible triggers for PSRDPO2 are: (a) the issuing by MoIT and MoF o f a joint Circular detailing procedures to establish retail electricity tariffs and implement the annual market adjustment mechanism; (b) the issuing by MoIT of a Circular on methodologies to approve transmission revenue requirements for NPTC and the transmission charges to recover those revenues; and (c) the issuing by MoIT o f a Circular on methodologies to assess and approve fees for the SMO. Policy Area D: Improving Demand Side Energy Efficiency 99. Policy actions for energy efficiency must follow a slightly different track, for two reasons. First, the actual implementation o f the energy efficiency measures must to some extent track the reforms since one o f the key measures - to introduce more clear pricing signals for energy efficiency - i s an important feature o f the reforms. Second, to ensure the Energy Efficiency Law i s effective when it i s in place, a number o f preparatory tasks are needed. Hence in this policy area the final task i s to put in place the enabling legislation in the form o f a law and implementing decrees, and to ensure that time o f use tariffs are introduced. The intermediate

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steps towards those actions ensure that up to date and high quality information i s available and that stakeholders have sufficient time to prepare.

100. At the same time, measures need to be taken on data collection and metering to improve load profiling for each tariff category and setting o f TOU tariffs. The proposed actions, milestones and triggers are targeted at creating efficient price signals to end consumers to promote demand side management and increase the availability o f energy efficient equipment.

101. Two key policy actions are supported by PSRDPOl:

Prior Action 6: The issuing o f energy efficiency standards for consumer goods that account for large quantities o f electricity consumption today and which are expected to increase in the future, particularly CFLs, refrigerators, air conditioners and fans. This action has been satisfactorily completed by the issuing o f Ministry o f Science and Technology Decision 27/40/QD-BKHCN o f December 9, 2008 and Decision 632/QD- BKHCN o f April 20,2009; and

Prior Action 7: The creation o f time o f use tariffs for electricity prices for industrial zones and commercial, industrial and irrigation categories o f consumers. The issuing by MoIT o f Circular 05/2009/TT-BCT o f February 26, 2009 completes this action satisfactorily.

102. Expected milestones o f progress in PSRDPOl are the submission by MoIT o f a draft Energy Efficiency Law to the Prime Minister, and that ERAV completes a load research study and submits draft procedures for the periodic implementation o f load research studies by the PCs to MoIT.

103. Further development o f the policy framework for energy efficiency i s being undertaken, and so indicative triggers for PSRDPO2 are more difficult to define than under the other three policy areas. Moreover policy work i s being undertaken at a rapid pace, so indicative triggers suggested at this point may become redundant before PSRDPO2 i s under preparation. One possible indicative trigger i s the submission o f the draft Energy Efficiency Law to the National Assembly.

VI. OPERATION IMPLEMENTATION

Poverty and Social Impacts

104. The high level o f electricity access across Vietnam means that large numbers o f the poor have connections and therefore have the potential to be impacted by changes to tariffs and service levels. Two reforms to the tariff wil l affect the poor:

Beginning March, 2009 the incremental block tariff (IBT) structure i s to be applied equally in all rural and urban areas. The first 50kWh per month o f consumption i s subject to a “lifeline” tariff. The tariff for this l i fel ine block i s set at 35-40 percent o f average 2009 costs (excluding profits) and i s VND 600ikWh. The 51-100 kWh block i s set at VND 865kWh, the average 2009 costs without profit. Higher blocks o f consumption are above average costs (including profits) to provide the lower consumption blocks’ subsidy; and

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0 From 2010 further changes to the subsidy mechanism are under discussion, including (a) limiting subsidies to only those customers consuming less than 50 kWh and (b) targeting subsidies to rural customers only.

105. These arrangements put residential consumers on a more equal footing regardless o f who supplies them, and improve targeting o f subsidies. Previously only those householders which received their supply directly from EVN’s subsidiary PCs received a lifeline tariff, which was for the first block o f lOOkWh o f consumption per month and set at VND 550kWh. The second block o f monthly consumption o f 100 - 15OkWh was also slightly subsidized. PCs supply all consumers in urban areas and a growing number - currently about 50 percent - o f households in rural areas. The 50 percent o f rural consumers not receiving supply from PCs are customers o f local distribution uti l i t ies (LDUs), which are private sector or cooperative suppliers receiving supply from PCs at medium voltage and onselling to consumers at low voltage. Until March 2009, tar i f fs were set by the LDUs with provincial government oversight. Formally these tariffs were capped by the Prime Minister at VND 700/kWh, but anecdotal evidence suggests that many LDUs charge more and that few, if any, apply subsidy for low income consumers. Poverty and Social Impact of IBT Changes 106. The poverty and social impact analysis (PSIA) analyzed expected poverty and social impacts o f changes to the March 2009 IBT including both the reduction in the coverage o f the lifeline tariff and higher electricity prices. The analysis suggests the poor in Vietnam remain well-protected despite the recent tariff adjustments and the narrowing o f the lifeline band, and many rural consumers are likely to benefit from the introduction o f a unified system o f residential tariffs and the expected integration o f many LDUs into the PCs. For those continuing to receive power from the LDUs, benefits are expected not only in terms o f lower electricity prices but also improvements in the quality and reliability o f supply, and improved standards o f safety.

107. There i s a widely shared view - buttressed by experience from many countries - that aligning power tariffs with the economic cost o f supply i s regressive and almost invariably has an adverse impact on the poor, unless adequate protection or subsidies are provided. However this PSIA shows clearly that this i s not so in Vietnam, which has a number o f factors working in i t s favor: very high coverage by the system, timely bill payment and low arrears, low levels o f electricity consumption (particularly for lower income households), and generally low economic

108. An estimated 98 percent o f households were electrified by 20082, including 99 percent in urban and 97 percent in rural areas. Access to electricity i s high even among Vietnam’s poorest households: in 1998, less than hal f o f the poorest ten percent o f households used electricity, compared with 88 percent in 2008. The PSIA estimated a subsistence threshold o f 40-45 kWh for poor households in Vietnam, based on owning several lights, an electric fan, a rice cooker, and a color television. In 2008, households below the poverty l ine consumed on average 42 kWh/month as compared with 103 kWh/month for households above the poverty line.

109. Whi le most o f the poor in Vietnam are low consumers o f electricity, so are many o f the non-poor. In 2008, 65 percent o f all households consumed less than 100 k W m o n t h , including

,

costs o f supply.

* 2008 Vietnam Household Liv ing Standards Survey (VHLSS), households reporting electricity as their main source o f lighting. EVN estimates 96 percent o f households are on grid as o f June, 2009.

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91 percent o f poor urban households and 99 percent o f poor rural households. Thus most o f the electricity consumed by the poor was subsidized under the pre-2009 IBT lifeline. But so was the consumption o f many o f the non-poor: in 2008, only 14 percent o f households in Vietnam lived below the poverty line. Moving to a lower lifeline threshold reduces leakages albeit at some cost to the poor: 30 percent o f households consume less than 50 k W m o n t h , including 60 percent of poor urban households and 78 percent o f poor rural households.

1 10. Despite the tariff increases, electricity remains remarkably affordable to residential consumers in Vietnam. In 2008, households in the poorest 10 percent o f the population paid on average 2.9 percent o f total cash expenditures for electricity. In contrast, the wealthiest 10 percent o f households paid 3.6 percent. And the share o f total spending on electricity has been falling in recent years despite rising consumption; the real price o f electricity (adjusted for inflation) has in fact been falling. Tariff Reform Scenarios 1 1 1. Electricity consumption i s not measured directly in the Vietnam Household Living Standards Survey (VHLSS), but spending on electricity i s recorded. Electricity expenditures were converted into kWh quantities using the relevant prices (IBT structure). The VHLSS does not identify whether rural households are PC or LDU customers and so for this PSIA a unified tariff structure i s assumed to apply to all rural consumers both pre and post-reform. This leads to an over-estimate o f average rural consumption (because LDUs generally charge higher prices) but ensures the PSIA has made a conservative assessment o f the coverage o f the reduced lifeline tariff band. Electricity consumption i s held fixed at 2008 levels and monetary values are adjusted, using the General Statistics Office (GSO) monthly consumer price index to March, 2009. The analysis uses electricity spending as a share o f cash consumption expenditures, a measure o f affordability, as the criterion for comparison.

112. The PSIA developed three tariff scenarios that are assessed against a baseline o f actual patterns o f consumption and electricity spending for 2008.

The f i rst scenario simply compares the baseline against 2009 IBT adjustments.

The second scenario uses the 2009 IBT adjustments but limits those receiving the subsidized rate (VND 600kWh) to rural consumers only. The lowest price band for urban consumers i s set at the average cost o f supply without profits (VND 865kWh).

The third scenario uses the 2009 IBT adjustments, but assumes subsidies are “telescoped” and only are provided to households which consume less than 50 k W m o n t h . In other words, a consumer using 5 l k W m o n t h i s assumed to pay the unit tariff o f VND 865kWh for all 5 1 kWh consumed.

113. The effects o f the different scenarios on different groups are shown in the table below. Across all scenarios, and the key groups o f concern, namely poor and rural consumers, impacts on affordability are small. This i s particularly the case for the f i rst scenario, which models the actual IBTs now in effect in Vietnam. The increase in tariffs was for the most part offset by inflation, and the narrowing o f the lifeline tariff from 100 kwh to 50 kWh only increased the share o f the poor’s spending on electricity by 0.2 percentage points. The other scenarios also had only modest impacts on affordability.

0

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Baseline: 2008 V H L S S (“A spending on electricity)

Location Urban 4.0 4.0 4.2 4.4 Rural 2.8 2.9 2.9 3.3 All Vietnam 3.2 3.2 3.3 3.6

Source: 2008 VHLSS, Staff Estimates Coverage of the Urban Poor - Migrant Workers and Temporary Residents 114. Whi le Vietnam’s tariff adjustments do not on average appear to have

Reform Scenarios (% spending on electricity) Scenario 1: Scenario 2: Scenario 3: 2009 2009 IBT 2009 IBT, Rural IBT, Telescoped

only subsidy 50 kWh

adverse distributional consequences, specific groups s t i l l may be losing out. A study was conducted in one low income, high-migrant neighborhood in each o f Ho Chi Minh City, Hai Phong, and Hanoi to assess service quality and affordability for migrant workers and other temporary residents who live in apartment buildings or rooming houses in densely settled urban areas. Interviews were conducted with residents in the buildings, landlords, and local officials from the wards and districts. In nearly all cases, tenants pay electricity charges based on metered consumption; electricity sub-meters were installed by the landlords in rented rooms and apartments and connected to regulated EVN meters in the building. Electricity contracts are organized between the owners o f the buildings and EVN, and not between EVN and individual tenants or groups o f tenants.

115. In each o f the neighborhoods studied, the vast majority o f respondents are on low incomes and consumes no more than 10-20 k w m o n t h . In Hanoi, landlord-imposed electricity charges range between VND 1,000-2,500/kWh, with VND l7500-2,0O0/kWh being the most common charge. Rates are lower in Hai Phong and substantially higher in H o Chi Minh City, where landlord-imposed electricity rates range from VND 2,500-3,500/kWh. In addition to metered charges, tenants also pay for electricity used for pumping.water. This class o f consumer would therefore appear to be relatively unaffected by tariff changes resulting from reforms implemented in 2009, since they are charged rates by landlords which are weakly linked to the official rates and they do not receive subsidies through the lifeline tariff. Future Analysis 116. Incomes will continue to rise in Vietnam, and expectations and lifestyles wil l change. Vietnamese households will purchase more electrical appliances, use them more intensively, and electricity consumption will continue to increase, including among the poor. Average consumption by poor households has risen from 28.6 kWh per month in 2002 to 42.4 kWh in 2008. As this process continues to unfold, ERAV will need to monitor the effects o f the IBT structure and subsidy mechanism and, if necessary, revisit it.

117. This analysis has been shared with the government. Further analysis will be carried out to explore complementary mechanisms for delivering subsidies to the poorest and most vulnerable groups (such as cash transfers, support provided through Ministry o f Labor, Invalids and Social Affairs poor list and other targeted programs) rather than through lifeline tariffs.

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Environmental Aspects

11 8. Plants that will enter service in the lifetime o f the VCGM have already been identified and many are under construction. As a result, i t i s relatively easy to forecast the environmental consequences o f the reform program, by reference to the system expansion plan and dispatch modeling. Two potential environmental consequences, on air emissions (local and well as greenhouse gases) and on natural resources and forests have been reviewed during project preparation. The policies supported by the operation are not l ikely to have significant effects on Vietnam’s environment, forests or other natural resources. Emissions 119. Power sector reforms potentially affect air emissions in two ways: in the short term by changing the operation o f the existing system (including capacity expansions under construction or committed), and in the medium to long term by changing the timing and type o f fbture capacity additions. Table 4 summarizes the potential impacts on power sector operation and on investment in each o f the reform areas.

TABLE 4: POTENTIAL ENVIRONMENT IMPACTS OF POWER SECTOR REFORMS

Short term Medium to long term (efficiency improvements) (investment consequences)

Power Market development (VCGM)

Strict merit order dispatch reduces coal consumption in the north and reduces gas consumption in the south - but may result in some substitution from gas to coal.

Incentivizes the most efficient technologies (e.g. super-critical rather than subcritical coal projects). Accelerates the inefficient coal projects.

of old

Sector restructuring None Level playing field and a predictable regulatory environment increases likelihood o f private investment, particularly gas projects.

Cost reflective tariffs make private investment more likely, thereby avoiding potentially damaging power shortages.

Tarif f reform Reduction o f cross-subsidies slightly increases industrial and commercial consumption, reduces domestic consumption, with net transmission and distribution (T&D) savings since industrial consumption avoids T&D losses at l o w tension.

Peak shaving reduces higher

reduction reduces generation.

Improving demand side efficiency peak T&D losses; demand thermal capacity expansion.

Lower demand defers need for

120. As a general principle, efficiency improvements are win-win for the environment and economics. I t i s also clear that the most damaging local environmental impacts are those from captive and standby generators whose emissions occur at or near ground level from short stacks, in close proximity to densely populated areas and without state o f the art environmental controls: a World Bank Environment Department assessment o f local air emission damage costs3 estimates these are between one and two orders o f magnitude greater than emissions from large

K. Lvovsky, G. Hughes, D. Maddison, B. Ostrp and D. Pearce, Environmental Costs of Fossil Fuels, A Rapid Assessment Method with Application to Six Cities, World Bank, Environment Department, Paper 78, October 2000.

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grid connected thermal generators. Local air emissions therefore differ greatly from greenhouse gas (GHG) emissions, for which the location o f emissions i s o f no consequence to global damage costs. Endemic power shortages consequent to lack o f generation investment therefore have especially damaging health consequences. The general global experience i s that a more efficient power sector wil l reduce emissionskWh generated and emissions/per kWh consumed. In most cases gross emissions o f GHG will also reduce.

121. Although these consequences will generally apply to Vietnam as well, the impacts may be complicated by substitution effects (from gas to coal). There i s evidence that strict merit order dispatch would result in some (expensive) gas generation in the south being displaced by some (cheaper) coal generation in the north, therefore increasing air emissions, though the substitution i s constrained by the limit on transfer capacity o f the 500kV system connecting the north and south o f the country. However, modeling results show that th is effect i s more than offset by the shift to generation to the more efficient coal projects in the north. That is, old plants are dispatched less, and more modern and efficient plants are dispatched more.

122. Analysis o f the emissions impacts o f the reforms supported by the project has been undertaken through a modeling exercise that i s grounded in the economic optimal expansion plan for the power sector. The optimal expansion plan includes all large and medium sized hydropower sites in Vietnam, which are largely already planned or under construction; a significant expansion o f small hydro projects in part induced by the tariff reforms for small renewable energy generators introduced in December 2008 and modest scaling up o f gas-fired generation.

123. In the baseline, without policy reforms, a significant proportion o f the increase in generation capacity over the 20 10 - 2020 time frame i s expected to come from coal, such that the share o f hydro wil l fall from 39 percent today to 31 percent in 2020, and gas from 37 percent today to 15 percent in 2020. In contrast, coal-fired generation i s expected to increase from 21 percent today to 51 percent in 2020. At the time o f the preparation o f Power Master Development Plan 6 in 2004-2005, the then very high load forecasts anticipated that nuclear power would also be required by 2020, together with pumped storage projects. However, more recent assessments suggest both forecast and early economic viability o f nuclear power may be unrealistic.

124. The main conclusions o f these modeling studies are that the policy reforms w i l l have the following positive effects on the environment. They are summarized in Table 5:

Impact of strict merit order dispatch: This has been modeled by comparing actual 2008 dispatch with that predicted by strict merit order dispatch: gas generation decreases in the south, but coal generation increases in the North, but there i s a net decrease in GHG emissions (of 0.12 mill ion tonnes COz per year - MtC02/y) because the dispatch shifts to the more efficient coal projects. Heavy fuel o i l generation declines in all forecasts.

Impact of DSM and improved energy eflciency: Vietnam has some strongly positive experience o f demand side management, particularly through the adoption o f time o f use tariffs for commercial and industrial users, and expansion o f the use o f compact fluorescent lamps. A recent study prepared for EVN estimated remaining DSM potential at about 1,200MW at the evening peak and a reduction o f about 6,000 GWh o f demand. T h i s estimate would translate into an estimated reduction o f emissions o f 3.8 MtCOz/y in 2020.

0

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0 Impact of VCGM on old coal plants: Several older coal projects (Pha Lai 1, Ninh Binh and Uong Bi 5 & 6) have considerably lower efficiencies compared with more modern plants (such as Pha Lai 2 and Cam Pha), and there have been proposals for their rehabilitation. But even with that rehabilitation, under strict merit order dispatch they would have low plant factors, making rehabilitation uneconomic, and forcing their retirement. Compared with 2008 dispatch levels, retirement rather than rehabilitation would avoid some 3.6 MtC02/y by 2020.

Impact of cross-subsidies: Gradual reduction o f cross subsidies from industrial and commercial categories to residential consumers are also expected to have an impact. Assuming revenue-neutral reductions and constant price elasticities among different consumer classes would result in increased demand from industrial consumers but equal reductions in demand from residential consumers. Because industrial and commercial users take power at higher voltages, transmission and distribution losses are reduced, hence reducing generation needs. The corresponding reductions in GHG emissions are estimated at about 1 Mt/C02 per year in 2020.

Impact of alternative load forecasts: The optimal capacity expansion plan responds to changes in load forecasts by advancing or delaying new units. Studies show that the timing o f thermal units i s affected more than the timing o f the hydro investments - reflection o f the relatively low cost o f hydropower over thermal generation (particularly when thermal generation fuels are priced at international price levels). Thus by 2020, all o f the hydro projects in the pipeline get built under wide ranges o f load forecast, but imported coal plants and nuclear projects are deferred to beyond 2020 and 2025, respectively. It follows that if the impact o f reform i s to lower electricity demands, coal projects would be the most affected - with consequent lowering o f both GHG and local air emissions.

TABLE 5: AGGREGATE GHG SAVINGS FROM REFORM PROGRAM C 0 2 emission savings Efficiency savings, as

($US million) (MtCO'/y in 2020) NFV2

Meri t order dispatch o f plant 0.112 113

D S M and improved efficiency 3.8 2300 Retirement o f old coal projects Remove cross subsidies 1 .o 700 '2008 rather than 2020, based on actual 2008 dispatch 'at 10 percent discount rate over 30 year planning horizon.

3.6

Natural Resources and Forests 125. Power sector reform i s not expected to have any significant impact on natural resources and forests. For reasons noted above, the development o f the rem.aining hydro resources will proceed as planned even were electricity demand reduced, so the number and size o f hydro projects, and their environmental impacts, i s not affected by power sector reforms.

126. development o f pumped storage projects in both the Northern and Southern regions together with additional coal generation. But again this i s not a consequence o f power sector reform. Indeed, to the extent that power sector reforms provides clearer signals about the value o f gas for power

It i s possible that if domestic gas becomes limited, beyond 2025 there may be '

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generation, reforms may help the development o f additional gas resources, and thereby reduce the need for pumped storage hydro projects (whose emissions are clearly higher than gas generation because the pumping energy must come from coal generation).

127. All other things equal, coal projects (whether imported or domestic) will tend to be sited in coastal areas, some o f which have high natural resource value. But the balance between such coal projects and gas projects (whether LNG or domestic gas) will be largely a consequence o f relative fuel prices that are dictated by international trends, and the pace o f reforms in the gas and coal sectors: the reform program itself has a much more limited impact on this balance.

128. Because the reforms wil l support financial and economic efficiency, they may create incentives to reduce compliance with environmental regulations for construction and operation which are normally part o f the permitting process for large power plant. This issue wil l be explored further during program implementation, through a strategic environment assessment (SEA) o f the Seventh Power Master Development Plan. The completion o f the SEA i s a trigger for a separate DPO, the Public Investment Reform DPL (Ln. 7838-VN).

129. A second impact on natural resources might result from large-scale fuel switching by consumers away from electricity to other sources o f energy as a result o f increases in electricity tariffs. Substitute forms o f energy, such as biomass for cooking or kerosene for lighting, may cause impacts on forests and create high levels o f pollution, especially indoors. The risk o f this effect i s considered negligible, because analytical work reveals that few people, and even fewer o f the poor, use electricity for cooking so that substitution o f biomass for electricity i s unlikely. Moreover, electricity expenditures, even in the poorest o f households tend to be small. Empirical studies o f electricity use show people assign the highest priority to using it for lighting and normally forgo other services provided by electricity (such as a fan or TV) rather than substitute for it. Conclusions 130. In summary, the environmental impacts o f the power sector reform program are likely to be positive. The power sector reform program has no impact on the hydro development plan or on the location o f new power plants. The VCGM makes more likely the early retirement o f the inefficient old coal plants, and sends clear signals to encourage the most efficient generating technologies (such as supercritical over subcritical coal projects). The DSM and energy efficiency programs are strongly win-win. The level playing field created by sector reforms and the move to cost reflective tariffs can only improve the ability to mobilize private sector investment in both generation and the development o f domestic gas (which wil l minimize the need for coal plus pumped storage to meet that portion o f the load that would otherwise be met by combined cycle gas generation). The modeling results also suggest that the elimination o f cross-subsidies results in net efficiency savings, and any decrease in consumption due to increased cost-reflective tariffs again reduces demand and emissions.

13 1. The only reform impact that may increase GHG emissions i s the shif t from gas to coal as may be induced by strict merit order dispatch. But given the evidence from 2008, under VCGM dispatch coal plants should be displaced slightly more, and gas plants slightly less. However, modeling results also show that this effect i s more than offset by more efficient dispatch among the group o f northern coal plants, with a small net decrease in GHG emissions.

132. This analysis has been shared with the government during preparation.

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Implementation, Monitoring and Evaluation

MoIT chairs a working group assigned to implement the reform program, which has as i t s members the Office o f Government (OoG, the Prime Minister’s office), MoF, Ministry o f Planning and Investment (MPI), State Bank o f Vietnam (SBV) and EVN. MoIT and in particular ERAV will be responsible for the implementation o f the bulk o f the policy actions under the PSRDPO series.

134. MoIT and the Bank wil l jointly monitor implementation. The program wil l be supervised from the field office, with formal review meetings being undertaken every six months during the program’s lifetime. Milestones indicating progress in implementing PSRDPOl and triggers for PSRDPO2 are clear, wil l be monitored during implementation and, adjustments made, if required.

135. Since the outcome indicators are all information required by ERAV for the execution o f i t s role as the regulator, country systems will be used as the basis for monitoring. The outcome indicators are shown in the Policy Matrix at Annex 2. Power Sector Performance Monitoring Under Reform 136. Monitoring o f power sector performance and quality indicators and the application o f retail tariffs i s the responsibility o f ERAV (EVN oversees and instructs the subsidiaries and entities it owns, as a holding company, but this i s a business function covering costs, revenues, and financial performance, not a regulatory function). The Grid Code and Distribution Code to be approved and implemented as part o f the reforms supported by the proposed DPO series wil l create the basis for the objective monitoring o f the performance o f the power sector in meeting consumer needs.

The Grid Code includes performance indicators for (a) the transmission activity (NPTC) including transmission outages and constraints and their impact in dispatch and supply; and (b) for NLDC - to become the SMO in due course - in maintaining the demand- supply balance, and instructing load curtailments when necessary. It i s expected that these indictors and reporting will improve the transparency on load curtailment decisions and their allocation; and The Distribution Code includes performance indicators for the supply activity from the grid connection up to end customer connection. These indicators should capture interruptions caused by constraints, faults or other problems in the distribution system.

- 133.

0

Fiduciary Aspects Fiduciary Arrangements 137. The fiduciary r isks o f the current public financial management systems (budgeting, accounting, reporting, and auditing) are assessed as moderate. Since the IMF does not currently have a program in Vietnam, it i s not possible to rely on i t s assessment o f the control environment o f the SBV. However, the enactment o f the Audit Law in 2005 helps address the issues related to audit and accounting arrangements. The Audit Law has established the State Audit o f Vietnam (SAV) as an independent institution reporting to the National Assembly with the Auditor General being appointed and dismissed by the National Assembly. Audit reports were made public for the f irst time in 2006. The SBV i s subject to auditing by SAV on an annual basis, but under the current laws, the audited financial statements and audit reports o f SBV are

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treated as a national secret and are not published. A more detailed discussion o f public financial management in Vietnam i s at Annex 3. Dedicated Account 138. To address fiduciary r isks in the foreign exchange control environment, the Borrower will open and maintain a dedicated account in U S dollars for the Borrower's use once the Loan and Credit are approved by the Board. The account wil l form part o f the country's official foreign reserves. An equivalent amount will be credited to an account o f the government available to finance budgeted expenditures. The Bank may request the government to provide written confirmation that this has occurred. If after deposit in the account the proceeds o f the Loan or Credit or any part thereof are used for ineligible purposes, as defined in the Loan and Financing Agreements, the Bank wil l require the Borrower to refund the amount directly to IBRD or IDA as the case may be. Amounts refunded to IBRD or IDA shall be cancelled.

139. The Bank will retain the right to seek an independent audit o f the account established in SBV by an auditor acceptable to the Bank to seek reassurance on the accuracy o f the information relating to transactions from this account provided by the Borrower, including accuracy o f exchange rate conversion; and that funds in this account were not used to finance expenditures excluded under the Agreement. The Government wil l be required to provide audited reports within six months o f deposit o f the proceeds o f the loan and credit.

Disbursement and Auditing 140. The proposed operation wil l follow IBRD/IDA disbursement procedures for DPOs, and the Loan and Credit proceeds wil l be disbursed in compliance with the stipulated release conditions. Various measures have been taken to ensure that the overall fiduciary policies and institutions are adequate to proceed with support from IBRD and IDA. Analytical underpinnings for the operation include the 2002 Country Procurement Assessment Review, the 2005 Public Expenditure Review and Integrated Fiduciary Assessment and the Country Financial Accountability Assessment o f 2007. Disbursement wil l not be linked to any specific purchases and no procurement requirements w i l l have to be satisfied.

Onlending 141. MoF has indicated its intention to onlend the proceeds o f the loan and credit to EVN in U S dollars. It has confirmed that an amount equivalent to the loan proceeds will credited to an account o f the government to finance budgeted expenditures, through a budget l ine specifically for onlending. The onlending terms would be identical to those o f IBRD/IDA plus an onlending fee on the outstanding balances o f the Loan and Credit as determined by Vietnamese regulations. The current fee i s 0.25 percent. The Government i s responsible for the fiduciary risk associated with the on-lending arrangement. The Government wil l provide written confirmation in a form requested by the Bank that the proceeds o f the Loan were disbursed in accordance with the agreed arrangements . Risks and Risk Mitigation 142. Experience with power sector reforrn internationally, and with the reform program in Vietnam suggest that there are perhaps four important risks to be considered with the proposed operation. They are: waning ownership o f reforms; complexity and novelty; governance transparency and corruption; and unforeseen social consequences.

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143. Waning political support, or increased stakeholder resistance to reform may erode ownership and progress o f the reform process and result in the sector becoming increasingly unable to meet power demand growth. In part this r isk i s mitigated by the design o f the reforms, with the two-step, pilot and implement approach adopted in the roadmap. This i s designed to build on the consensus driven approach to decision making in Vietnam, which i tse l f i s an important mitigant. There i s some r isk from the political cycle - senior figures in government will inevitably change over the lifetime o f the reform process, and the environment in Vietnam i s fast-changing. This i s largely mitigated by the design o f the government's reform program in three phases, and the DPO series reflects that mitigation by only addressing one phase at a time. If there are subsequent changes o f policy direction the reform program can accommodate them, and the likelihood o f reversal i s considered low.

144. The role o f EVN - which throughout has been closely involved in the process - has been largely positive. Its active participation in reform proposals has helped build ownership and overcome resistance. I t wil l be important to continue to maintain good working relationships to ensure that i t does not become an obstacle to reform. This can be reinforced through the close and continuing engagement between the Bank and all sector stakeholders through the investment lending, AAA and DPO programs in the energy sector, much o f which supports the reform process.

145. The reforms introduce new concepts, particularly that o f separation o f policy, regulation and operation, into what i s a technically complex sector. Whi le the technical and engineering challenges are unlikely to present major difficulties, the novelty o f an economic regulator which has not been tried before will challenge the capacity o f existing institutions and the willingness o f government to let go. Because this i s the first occasion on which economic regulation has been tried, failure also carries the r isk that i t would be discredited for other infrastructure sectors. The long timescale envisaged - and particularly in the transitional f i rs t phase - has done much to mitigate this risk, because it has permitted the establishment o f ERAV and steady build-up o f i t s capacity by a mixture o f direct capacity building and learning by doing. ERAV, as the champion for power sector reform, has also been instrumental in building the capacity and understanding o f other stakeholders including non-line ministries.

146. Corruption i s a significant and growing problem in Vietnam, and in a rapidly-growing economy corruption vulnerabilities and opportunities for graft could outpace measures to combat them for some time. Resistance to greater transparency for example in the contracting o f new generation may delay or derail reforms. It must, however, be said that the levels o f corruption in the power sector appear low, and an important mitigation w i l l be to ensure that they remain so. The reforms themselves are, in many ways, the main mitigation since they support greater transparency and competition.

147. Last, unforeseen consequences, as a result o f rapid increases in tariffs, have the potential to derail the reforms. Based on the social impact analysis conducted for this operation, the r isk o f this being a broad-based social effect appears to be low and it i s quite unlikely that, barring unexpectedly large increases in the costs o f fuel, there will be major discontinuities in the trajectory o f tariff increases for the poor. The r isk may be more significant for larger consumers from industrial and commercial tariff categories which may object to continued cross subsidization o f the household categories, or diminishing quality o f service, and consumer groups may form. The main mitigation i s to continue to monitor service standards, and to ensure

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that tariffs move towards reflecting cost o f supply, wh ich in effect requires the prompt introduction and even-handed enforcement o f the transmission and grid codes.

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ANNEX 1: Letter of Sector Development Policy

MINISTRY OF INDUSTRY AND TRADE THE SOCIALIST REPUBLIC OF VIETNAM

Hanoi, March 01, 2010

To: Mr. Robert B. Zoellick President The World Bank Washington DC

SUBJECT: Vietnam's Electric Power Sector: Letter of Sector Development Policy

You wil l know that the Socio-Economic Development Plan for 2005-2010 sets out a path for Vietnam's transition towards a market economy with a socialist orientation, and envisions Vietnam wil l attain middle-income status. with a gross national income above US%l,OOO per capita, by 2010. The focus o f our efforts has been on improving the business environment, strengthening social inclusion, strengthening natural resource and environment management, and improving governance. We have put in place and are maintaining an appropriate macroeconomic framework which i s vital to the continued growth of Vietnam in the future.

An efficient and sustainable electricity sector i s vital to the achievement o f our vision for Vietnam's continuing development. A well performing and sustainable power sector i s necessary to support econoin,ic growth. the business environment. social inclusion and better environmental performance. Moreover, improved governance o f the power sector will ensure greater transparency and encourage greater participation by a broader range of stakeholders including potential investors. For these reasons, and above all to ensure that there i s sufficient financing to meet the enormous investment needs o f the sector, we have embarked on a program o f reform o f the electric power sector in Vietnam.

Goals for Reform of The Electric Power Sector

The Government recognizes that sufficient electric power i s needed to support Vietnam's continued social and economic development. It also recognizes that, as part o f Vietnam's transition to a socialist market economy. i t should reduce i ts role in financing the power sector and phase out subsidies to it, other than for limited social objectives. Rapid demand growth over the past years has increased financing needs for the power sector that cannot be met from domestic capital and local borrowing alone. In consequence, private sources of financing. both local and international, need to play an increasingly significant role. We are thus committed to a program o f power sector reforms, the main goals and principles o f which are:

Achieving competitive electricity prices and security o f supply through development o f a power market. Security of supply will be achieved by ensuring adequate investment i s made in time by those best able to do so at least economic cost. At the same time we wish to avoid abrupt changes to the structure or operation o f the sector that may cause disruptions in investment or supply.

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Diversifying ownership and developing a fair and equitable framework for investment to enable competition. We will increasingly rely on investment from non-traditional sources and, in particular, from private investors, both local and foreign. Introducing sustainable and efficient electricity tariffs, including social protection for the poor. Predictable tariffs that fully recover costs are intended to encourage investors by giving them confidence that they will be able to recover their costs over the lifetime of their investment as long as they adequately maintain and efficiently operate it. Fostering energy efficiency through demand side measures, because this will help bring down the total investment required per unit of consumption, as well as improve the environmental and social sustainability of the power sector.

The 2004 Electricity Law established a new framework for the modernization and the introduction of competition into Vietnam’s power sector, comprising:

The gradual development of a competitive power market, starting with a market in which multiple generators will compete to generate and sel l electricity to a Single Buyer, which in turn will sell on to large consumers, namely power distribution companies and some large industrial consumers. Later a wholesale competitive market will be introduced, with multiple companies -generators and wholesale licensees - competing to sell electricity to the power distribution companies and large consumers. In time retail competition will be introduced, in which al l electricity consumers will be allowed to choose their supplier.

0 Gradually withdrawing from central planning o f new generation investment and replacing i t with indicative planning based on projected demand. supply security and power system reliability criteria, and government energy policies. For the time being, the existing power master planning process will continue. but will be increasingly based on market information. The establishment of a dedicated electricity regulatory agency. the Electricity Regulatory Authority of Vietnam (ERAV), under the supervision of the Minister o f Industry and Trade. the first economic regulator in Vietnam.

The Prime Minister issued a Roadmap for Reform in January 2006 which sets out the reform process running from 2005 to 2023. The Roadmap envisages a three phase process, with each phase split into two stages: an initial pilot to test and improve the design and then a stage for full implementation. It also sets pre-conditions to be met for moving from one phase to the next and requirements to restructure the actors in the power sector to match the needs of the market. We are now in a critical period o f Phase 1, which i s scheduled to run from 2005 to 2014. During this phase the reform program i s centered around four main themes: (a) introduction of competition between generators to supply the power market; (b) restructuring o f the sector participants to create an enabling environment for the introduction of the market; (c) reform o f the tariff mechanisms and structures; and (d) introducing measures to improve energy efficiency. I describe our policy for each o f these in more detail in the following paragraphs.

Introduction of the Power Market The Vietnam Competitive Generation Market (VCGM) will introduce competition among generators to enter the market to supply electricity and competition to be dispatched. The VCGM design and its codes and rules are intended to set a level playing field, including standard contracts with benchmark pricing to ensure equal treatment and conditions for generation investors, independent of ownership. We see as crucial to economic development and successful functioning of the power market the need to maintain a sound mix of fuels based on the resources available, choice o f appropriate modem technologies and selection of

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sound investors with the capacity to implement and efficiently operate the projects they sponsor. In consequence, VCGM i s designed to maintain a level o f control by the government in the planning process.

We have already conducted considerable design work and a number o f trials o f the VCGM. Based on these, MoIT has established design principles for the VCGM and has required EVN to start a pilot run o f the design using its own power plant by the third quarter o f 201 0. We expect, provided the pilot goes smoothly, to introduce the VCGM for full implementation by the mid o f 2011 and for i t to run for perhaps three to four years while we prepare the conditions, framework and rules needed for the transition to the next phase, the wholesale competitive market.

Vietnam has an abundance o f small hydropower and other renewable energy resources which can be used for power generation and which have several advantages from the perspective o f sustainable development o f the power sector. We have made specific provisions for power plants o f less than 30 megawatts (MW) for which the transaction costs are too great to be able to participate in the VCGM. We have introduced standard power purchase agreements and avoided cost pricing for small renewables, which wil l support the development o f the small hydro potential by the private sector. Power generation plant using wind and geothermal resources are also exempted from participation in the power market even if they are greater than 30 MW. Our policy i s to continue to support the development o f renewable energy in Vietnam wherever i t i s economically viable and environmentally and socially sustainable.

Restructuring of the Power Sector Implementation o f the market reform program wil l be accompanied with the gradual adaptation o f the power sector structure, to create the environment that enables competition and protects consumers and investors from the conflict o f interest that exists when the same power company i s the wholesale buyer and seller o f electricity, the provider o f monopoly transmission and system operation services, the dominant owner o f generation and that has a role in expansion planning. Transparent and non discriminatory transmission, system operation and market administration rules, pricing and regulations are being drafted and wil l be issued to ensure that investors have the level o f comfort required to enter the market and to continue building new generation.

Our policy is to eliminate real and perceived conflicts o f interest in the VCGM by ring fencing the National Load Dispatch Center (NLDC) from the rest o f EVN before it transitions to become the independent System and Market Operator (SMO); transferring the Institute o f Energy, which carries out the planning function, from EVN to MolT; and by requiring the creation o f independent generation companies. In addition the National Power Transmission Company, which holds all EVN’s transmission assets, has been created as an independent accounting unit within EVN, and will also be ringfenced and in the longer term be fully separate. The Prime Minister’s Roadmap for Reform also limits the total amount o f generation that may be owned by a single entity to 25 percent o f the total system installed capacity and we wil l work towards this goal in the longer term.

The new regulatory framework wil l include transmission grid, system operation and distribution network. I ts planning, connection and operation procedures and performance standards wil l improve the efficiency and reliability o f the power system. The new sector structure wil l have separate licensing and regulation for each electricity activity (generation, transmission, wholesale, distribution and retail supply) in the supply chain from electricity production until delivery to end consumers. The corresponding licensing systems for electricity investors and operators are in place, administered and monitored by ERAV.

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Tariff Reform Our policy i s to introduce electricity tariffs that are reflective o f efficient costs in the electricity supply chain, to provide predictability for sustainable investment in the powcr sector. This wil l support investors in making decisions to finance much needed new generation capacity, transmission upgrading and distribution improvements. Electricity activities in the VCGM wil l be regulated or subject to competition to eliminate existing inefficiencies and achieve reasonable costs, and to transfer part o f cost reductions due to efficiency gains to tariffs for the benefit o f consumers. The Prime Minister’s Decision No 276 on electricity pricing in December 2006 formalized the transformation to market based cost reflective tar i f fs with the statement that: “From 2010. the electricity retail price shall be based on the market price”. More recently in 2009, the government has set out the principles to unbundled tariff setting into separate generation (power purchase) costs, regulated transmission and distribution network services revenue requirements, regulated system and market operation costs and other costs.

In March 2009 we increased average tariffs to the level equivalent to 2009 actual costs. We are preparing tariff regulations that wi l l annually update costs and transfer them to tariffs and at the same time introduce performance and quality o f service standards and incentives for the transmission and distribution systems. We expect there to be a transition period during which the new approach wil l be introduced and refined, and for the time being, the Prime Minister will retain final decisions over the increment tariff increases over five percent. A key part o f the government’s poverty reduction program i s to increase electricity access and quality o f supply in rural areas, at efficient and reasonable tariffs. Our policy i s to provide quality o f access and pricing through a uniform national tariff which all households enjoy. As part o f our effort to target subsidies to the poorest members o f society, we have reformed the incremental block tariff system. Starting in March 2009 we reduced the ‘‘lifeline’’ tariff amount to 5OkWh per month and fixed the price at from 30-40 percent o f the cost o f supply. A l l other consumption i s at least at the cost o f supply, and our analysis suggests that this considerably reduces the leakage o f the subsidy to the non-poor. We will continue to monitor the effects o f this policy and refine it as necessary.

Energy Efficiency The government has encouraged both demand and supply side efficiency with positive results. The National Strategic Program on Energy Saving and Efficient Use approved by the Prime Minister in 2006 included targets on energy savings up to 2015. Notable successes have included the completion o f an energy efficiency and conservation bill, which was submitted to the National Assembly in October 2009, the formation o f central and local energy efficiency and conservation centers to effectively implement activities o f the National Energy Efficiency and Conservation Program across the country. and the introduction and application o f solar water heaters in households and organizations. Almost 3,000 solar water heaters were installed within the framework o f the program. EVN’s program encouraging the use o f compact fluorescent lamps was evaluated to have resulted in reductions in consumption o f about 46 gigawatt hours per year and peak demand reductions o f 30 MW. I t m e r targets a reduction o f the peak demand o f 207 M W by 2012, and 450 M W by 2015 at day time peak load. In 2009, almost 500 large businesses were surveyed in terms of energy efficiency and conservation, more than 200 businesses had their energy use audited, and more than ten experimental energy efficiency and conservation projects were implemented in the fields o f plastics, beer, liquor, textiles, garments, lighting and others.

,Nonetheless we recognize the need to scale up our efforts in the area o f energy efficiency because i t will help to reduce the rate o f growth o f demand for electricity, thus improving the

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sustainability o f the power sector and of Vietnam's economic growth. The Ministry of Science and Technology has introduced standards for electrical appliances that account for large amounts of household consumption, and the Ministry of Industry and Trade has introduced time o f use tar i f fs for electricity consumers connected at high and medium voltage. We intend to continue to broaden the reach of energy efficiency regulations through pricing and other mechanisms, with the aim of achieving the national target for energy efficiency of five to eight per cent of the total energy demand from 2006 to 2015.

Conclusion A number of key policy decisions have already been taken and OUT government i s ready to move forward to complete the rest of the reform program for the implementation of the VCGM. Todate:

MoIT has issued a Decision (6713-QD-BCT dated December 31, 2009) to set up the detailed design and principles for the implementation of the Vietnam Competitive Generation Market. MoIT has issued a Circular (27/2009/TT-BCT dated September 25, 2009) to ensure that plant metering systems in power generation plants meet minimum standards and procedures. The Office of Government has issued a Notice (232lTB-VPCP dated July 31. 2009) to establish broad principles for the power sector structure to allow for the introduction of Vietnam Competitive Generation Market. The Prime Minister has issued a Decision (21/2009/QD-TTg dated February 12. 2009) to increase average tariff in 2009 and to establish principles for electricity cost recovery including unbundling tariffs, annual updates of tariffs, and delegating approval of changes in tariffs of less than five percent to MoIT. The Prime Minister has issued a Decision (21/2009/QD-TTg dated February 12, 2009) to restructure residential block tariffs and to establish principles for subsidy as a percentage o f production cost. Ministry of Science and Technology (MOST) has issued Decisions (2740lQD-BKHCN dated December 9.2008 and 632/QD-BKHCN dated April 20,2009) to establish energy efficiency standards for consumer goods that account for large quantities of electricity consumption. MoIT has issued a Circular (05/2009/TT-BCT dated February 26, 2009) to introduce time-of-use tariffs for industrial zones, and irrigation, industrial, and commercial property categories.

On this basis, we request World Bank support for our power sector reform program by approving the First Power Sector Reform Development Policy Operation and the commitment o f $313.5 million. We firmly believe that the policies set out in th i s letter merit the full support of the World Bank and the international community.

With kind regar? Sincerely

Do Huu Hao Vice Minister of Industry and Trade

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ANNEX 3: Public Financial Management in Vietnam

Background and Analytical Underpinnings 1. Th is operation provides general budget support to the Vietnamese Government and wil l be executed through the Government’s public financial management (PFM) systems. This annex summarizes the current state o f these systems and the ongoing reforms with a view to assessing the attendant fiduciary r isks with respect to the proceeds o f this development policy loan.

2. Vietnam has set itself the goal of becoming a middle income country by 201 0 with promoted social inclusion and public governance: Public financial management reform i s one o f four focus areas within the Government o f Vietnam’s Public Administration Reform (PAR) Master Program for the period 2001-2010. Other focus areas include organizational restructuring, pay and employment reform and institutional development. The Initiative includes five priorities, namely budget management, revenue management, debt management, SOE fiscal risk management and public asset management.

3. Over the past decade Vietnam has made continuous efforts to establish a sound public financial management system in the country: With the adoption o f the first organic budget law in 1996 and its revision in 2002, a solid legal framework for public resource management has been put in place. A centralized treasury system has been set up with branches extending from the center to all provinces and districts to provide basic essential financial services to all government agencies. Steady progress has been achieved in making the budget more predictable and pro- poor and the budgeting process more transparent and participatory. Substantial efforts have also been made in recent years to improve transparency in the use o f public resources through provision to the public o f increased information on detailed government spending as well as wider disclosure o f government expenditure policies, regulations and procedures. Vietnam has been recognized for i t s relatively prudent fiscal policy.

4. Despite positive progress, considerable challenges remain: Although fiscal trends have been positive, a number o f threats to fiscal sustainability exist. These include government bonds issued off-budget to finance infrastructure projects, education facilities and to recapitalize SOCBs, contingent liabilities arising from the operations o f the Vietnam Development Bank, banking sector and other sub-national development funds as well as off-budget balance borrowing o f provinces. In the absence o f a formal commitment control in public expenditure management, some provinces and ministries made capital expenditure commitments off-budget resulting in balances in excess o f their budget and fund availability. That led to the built-up o f considerable amount o f capital expenditure arrears that are not fblly resolved yet. In addition, the re-lending from Government’s borrowings can become Government’s obligations if they are not managed properly. This calls for an urgent need to put in place legal and institutional frameworks to comprehensively manage public debt and monitor government commitments and contingent liabilities.

5. The composition of public expenditure remains imbalanced in favor of capital expenditure that negatively affects the eficiency in the use of public resources: Processes for prioritizing expenditures remain ineffective. The absence o f a credible multi-year fiscal framework means that expenditure planning i s conducted without reference to medium-term resource constraints. Prioritization i s carried out separately for capital spending (by the Ministry/Department o f

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Planning and Investment) and for recurrent spending (by the Ministry/Departments o f Finance), with significant imbalances between the two.

6. There are shortcomings in Vietnam’s public financial management information systems and public accounting regulations: The lack o f a fully consolidated budget makes i t difficult to monitor total revenues and expenditures, as well as the true fiscal position. Extra-budgetary funds and on-lent official development assistance are not consolidated into the budget. The lack o f common accounting structures results in numbers which are inconsistent and hard to compare. The lack o f integrated, electronic data recording and reporting results in laborious manual consolidation and manipulation o f data from multiple satellite databases, and in financial reporting which i s neither timely nor accurate. These deficiencies contribute to the poor flow of budgetary information between government ministries, provinces, donors and the public. Whi le progress has been made with regard to adopting international private sector accounting standards with 26 Vietnamese accounting standards consistent with international accounting standards having been developed and issued, these standards have not been kept up to date, whilst public sector accounting standards are s t i l l lacking, existing government accounting regimes are incomplete and accounting practices have yet to be aligned with international standards.

7. Although the country’s public financial management system has a range o f internal oversight roles and mechanisms, the focus o f the various internal oversight functions i s on inspection rather than systematic review to provide regular and timely feedbacks to management on internal control systems and the use o f public resources. Internal auditing i s recognized as a key element o f a sound public financial management system which helps organization increase effectiveness and efficiency in addition to improving financial controls and procedures. Effective internal auditing i s yet to be developed to provide regular timely review and feedback to management on internal controls in the use and management o f public resources.

8. There are signijkant weaknesses in revenue administration: Vietnamese Customs are still considered unresponsive, inconsistent and vulnerable to corruption. A long-term vision with clear strategic goal i s lacking. The Customs Administration wil l need to change significantly, shifting i t s mindset from a culture o f domestic protection and control o f all transactions to one that facilitates foreign trade and promotes private sector development. The tax administration i s presently characterized by low compliance and vulnerability towards corruption. Five key areas o f tax administration have been identified to need special attention: (1) the fragmentation o f the legal framework related to tax administration; (2) the absence o f effective coordination and information sharing between the tax administration and other government agencies; (3) taxpayers’ lack o f knowledge about the tax laws and compliance procedures; (4) inadequate professional ski l ls and staff training; and (5) ICT system lagging behind the requirements o f a modern tax administration. Tax laws and policies wil l need further reform to broaden the tax base, reduce the number o f rates and exemptions.

9. Independent scrutiny of PFM has increased, with external oversight of budgetary affairs by the National Assembly @A) and the recently independent State Audit of Vietnam (SAV): The NAY i ts functional committees and deputies have been given greater prominence in examining, decision making and oversight o f the state budget. Encouragingly, the SAV audit report has been made public for the f i rs t time, triggering serious debates on the usage o f state budgets. The capacity o f these institutions especially the SAV however i s weak, which limits audit coverage and the scope o f audits and precludes reviews o f value for money. It i s difficult for the SAV to

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manage the increased coverage and scope o f works including compulsory audit for 100 percent o f SOEs. 10. Price control mechanism has not been very effective in controlling price abuse or dumping due to monopoly and collusion: The price valuation profession has only recently been established and i s finding it difficult to meet growing demands for valuation services. The legal framework for price control i s also new and s t i l l incomplete. I ts implementation i s being hampered by a lack o f a strong information base. Developing a complete legal framework for price management and building sufficient valuation capabilities wil l clearly constitute a near to medium priority for the government.

11. Financial market supervision has been fragmented and government bond market is still under-developed At present, there are many agencies participating in supervision o f the financial market, leading to overlapping responsibilities and ineffective market management and supervision. There i s a need to clarify and consolidate market supervision function into one single agency and to separate the state management function from the supervision function. Vietnam's government bond market i s s t i l l o f a small scale and characterized by a maturity structure skewed towards the short-term and low liquidity. The number o f market participants i s relatively small and supporting infrastructure, such as depository and clearing as well and information systems, i s yet to be developed. Considerable efforts, therefore, would be required to develop a full-fledged government bond market and coordinate it with development o f other related markets such as capital, security, money and real estate.

12. Governance and anti-corruption: Since the adoption o f the Law on Anti-Corruption, several detailed implementing guidelines have been issued, anti-corruption measures have started to be implemented by ministries and provinces, and the detection and punishment o f corruption cases has been energized. The enforcement aspect o f anti-corruption has been strengthened through the creation o f specialized units in all the key anti-corruption institutions, through improved coordination among institutions, and their decentralized units at the provincial level.

13. Projects and activities supporting P F M reform of the Bank At the policy level, the series o f Poverty Reduction Support Credits (PRSCs) has been nurturing constant policy dialogue on the strategic elements o f a broad and cross-cutting reform agenda including PFM modernization. Meanwhile, these operations have been strengthening coordination among l ine ministries and government agencies, and triggering chances to reach endorsement on reforms at the highest decision-making level. At the technical level, there are currently three active Bank-funded projects in PFM area, namely the Public Finance Management Reform, Customs Modernization and Tax Administration Modernization projects. In addition, there are two Multi-donor Trust Funds (MTDF) established to attack one o f the main bottlenecks in the implementation o f reform in Vietnam -- limited government capacity -- which mainly finances the needs o f technical assistance and capacity building activities, and analytical and diagnostic work laid out in the government strategy.

14. I n addition, a series of AAA works have been undertaken to provide sound analytical underpinnings to the implementation o f the Government-led PFM reform program. These include the joint IMF-World Bank study o f 1999 "Towards Fiscal Transparency"; the joint 2000 Government-donor Public Expenditure Review; the 200 1 Country Financial Accountability Assessment; the 2002 Country Procurement Assessment Report, and mostly recently are the joint government-donor 2004 Public Expenditure Review and Integrated Fiduciary Assessment and the 2007 Country Financial Accountability Assessment (CFAA). The CFAA 2007 proposes a

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set o f recommendations to help the government design and continue implementing reforms and capacity building programs to modernize and strengthen public financial management and enhance transparency and accountability arrangements in support o f sound economic management and improved governance.

Key PFM Issues - Recent Developments and the Way Ahead 15. Vietnam is pursuing many initiatives to strengthen its financial management and accountability arrangements, systems and controls: There has been substantial progress on budget execution and treasury management (with the Treasury and Budgetary Management Information System, TABMIS , being piloted and i ts associated reforms being undertaken), on budget development and decentralization (greater coherence through the pilots o f the forward- looking medium term expenditure frameworks, MTEFs, and budget allocation norms), on revenue management (with clearer allocation rules and decentralized responsibilities, and with the productivity o f some taxes now close to OECD levels), on debt management (with the adoption o f the first-ever Public Debt Management Law and the establishment o f the Debt Management Office consolidating the management o f domestic and external debts), on external auditing (annual audit report and selected individual audit reports o f the SAV being disclosed publicly), and on accessibility o f financial information (with legislation and the environment established for greater financial accountability and transparency).

16. Steady progress is being made in establishing the legislative framework to support P F M reforms; however the key challenge i s to substantively implement the improvements and enhancements that have been progressively introduced through legislative reforms and development work in recent years. The cross cutting issues o f strengthening strategies for decentralized PFM and developing and implementing action plans to strengthen capacity and accountability for public financial management in line ministries and agencies at all levels o f government are also priority areas for action in the short to medium term.

17. Key stakeholders to the budget process remain committed to further reform through an evolving and pragmatic reform agenda: (i) expansion o f budget coverage in l ine with internationally accepted norms and further unification o f the budget; (ii) roll-out the integrated financial and budgetary management system nationwide (with pilot at selected ministries and spending units) with streamlined business processes; (iii) adoption o f International Public Sector Accounting Standards (IPSAS) for public accounting and further improvement o f the chart o f accounts; (iv) scale up the MTEF and MTFF pilots to other sectors and provinces and mainstream it into the annual budget cycle; (v) introduction o f Treasury Single Account (TSA) for more effective cash management; (vi) improvements to debt management, asset management and ODA management; (vii) improved management o f capital expenditures; (viii) expansion o f external audit coverage and quality and legislative oversight; (ix) improvements to internal control (with priorities given to internal audit); (x) more comprehensive accounting and timely financial reporting based on internationally recognized standards and practices; and (xi) increased transparency and accountability in the procurement process o f public investment.

18. PFM Legal and Institutional Framework New laws and implementing decrees and instructions are replacing old ones and legislative gaps are being filled. Since 2004, implementation o f the 2002 State Budget Law and the 2005 Accounting Law has been in progress and a State Audit Law has been enacted. As recommended in the 2004 Public Expenditure Review and Integrated Fiduciary Assessment, the State Audit Law has provided

The focus o f Government reform i s on the:

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independence for the state auditing body and enhanced transparency by creating the legal basis for audit reports to be made publicly available. Implementation o f the State Audit Law i s steadily proceeding. However, some confusion and overlap in budget responsibilities remain in the budgeting system which i s limiting the participation o f sectors in resource planning, budgeting and budget management and confuses accountabilities between the national and sub- national levels. With the redevelopment o f the government accounting systems and regimes, the Accounting Law i s no longer adequate and needs revision, and the basis for accounting needs to be better defined. The State Budget Law and Accounting Law should be comprehensively updated to provide a comprehensive and consistent basis for modern PFM and to serve as the platform for continued PFM reforms, enhanced transparency and accountabilities.

19. Budget Development: To be an effective instrument o f policy, the budget should be as comprehensive as possible. Vietnam’s budget coverage i s reasonably comprehensive but s t i l l incomplete compared to international practices. The major expenditures o f spending units o f government at central, province, district and commune level are reflected in the State Budget. Budget gaps arise from the lack o f clarity in the state budget coverage o f user fees and charges o f many service delivery units, lack o f integration or disclosure o f the financial positions o f public financial funds, untimely and sometimes inadequate incorporation o f donor financing, and off- budget government bonds. Budget execution variations arise fkom such practices as revenue underestimation particularly for crude o i l revenues, keeping the state accounts open after year end with post year expenditures recorded against previous year unused budgets, and over implementing construction and development plans. Separate preparation o f the recurrent and capital investment budgets hampers effective management o f resources and the composition o f public expenditure remains unbalanced. The introduction o f forward looking budget plans through piloting an MTEF in several sectors and provinces and adopting budget allocation norms has supported greater coherence. The MTEF pilots should be scaled up and mainstreamed in the annual budget cycle.

20. Budget Execution: In State Budget expenditure management, the legal framework for decentralization o f state budget expenditure i s being implemented with decrees on autonomy and accountability to budget spending units. Major public finance management systems are being upgraded and replaced. A new integrated computerized financial management system called TABMIS i s being implemented with ro l l out starting in 2008 - TABMIS will provide the capability to record and control commitments, improve cash flow management and arrears management, and strengthen expenditure management and controls. An updated and improved Chart o f Accounts i s being developed for implementation in 2008 which will provide consistency o f classification o f revenues and expenditures in budgeting, accounting and reporting with expenditures classified on an administrative, economical and functional basis. A roadmap for adoption o f international public sector accounting standards has been issued, which wil l provide the basis for preparation o f whole o f government financial statements in l ine with international practices. Assignment o f responsibility for developing, controlling and overseeing public accounting, financial reporting and the operation o f TABMIS i s needed to consolidate and lead the substantial improvements in budget execution accounting and reporting and most importantly to maintain coordination and consistency in future developments.

2 1. Reforms in the management o f revenue are progressing with clearer allocation rules and decentralized responsibilities; however classification o f revenue in l ine with international standards needs to be introduced and enhanced consultation on revenue targets i s needed to improve the quality o f revenue budgets.

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22. There are positive controls in the government payroll system with segregation o f personnel and payroll functions and maintenance o f continuous employee records. However, with no standard specialized payroll system operating within government the payroll i s calculated manually and processed in bulk by an agency. Systematic and regular (monthly) reconciliations between personnel staff records and payrolls need to be introduced to ensure validity o f payroll changes and early detection o f errors and fraud. In the longer term, implementation o f modern computerized personnel/payroll systems i s recommended to enhance the control o f payroll expenditures which constitute a significant proportion o f the government recurrent budget expenditures.

23. Internal auditing as a key internal control o f PFM has been recognized in the State Audit Law but l i t t le progress and coordination to support its implementation in terms o f law and implementation guidance has yet emerged.

24. Asset Management: The Government’s PFM reform program highlights that state assets budget resources and human resources need to be managed in an integrated way for efficient and effective service delivery, and reforms are being gradually introduced. The legal framework and market principles in asset management and requirements for management reporting systems are being defined. However, asset management reform has been slow. Initially attention i s needed to develop consistent and comprehensive asset accounting and asset management policies in l ine with international standards and practices for future reforms. Further study i s needed to define the government’s accounting and asset management requirements and to determine and implement the most appropriate system solutions for fixed asset accounting and reporting and for asset management which can be integrated as part o f the government’s financial management system. A comprehensive reform program for asset management i s needed starting with passing o f the Law on State Asset Management.

25. Debt Management: The 2004 Public Expenditure Review and Integrated Fiduciary Assessment recommended that assignment o f responsibility for management o f debt be clarified and arrangements for monitoring and managing other fiscal r isks be strengthened. Since 2004, the capacity o f MOF to record and manage total government debt has been strengthened, with a clear division o f debt management functions across government agencies. However much remains to be done. The draft Law on Public Debt Management needs to be introduced to achieve a unified legal framework for debt management; a Debt Management Office in MOF should be established to UnifL government debt management functions; systems and criteria for debt recording should be developed in line with international standards; an early warning system to closely monitor local government and SOE debts i s needed; a domestic debt recording and information system should be implemented; and a TSA should be introduced for more effective government funds management. The priority i s to establish a Debt Management Office.

26. ODA Management: ODA plays in important role in Vietnam’s poverty reduction and growth and ODA disbursements constitute an increasing portion o f the annual budget. The legal framework for financial management o f ODA i s fairly comprehensive and a range o f reforms have been introduced in recent years to enhance the effective use and management o f ODA. Harmonization o f government and donor practices and requirements to reduce transaction costs i s a high priority. As ODA i s part o f the government revenue and expenditure, budgeting,

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Ths recommendation has been implemented: the Government issued the Decree 118 dated 27/11/2008 regarding the hnction, organization and tasks o f MOF, in which the Bureau o f Debt Management and External finance i s established.

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accounting, reporting and oversight follow the state budget management requirements. Areas for improvement include better aligning government and donor budgeting approval cycles, bringing on-budget all ODA (particularly on-lent ODA), revising the government chart o f accounts to enable ODA to be effectively recorded and reported through the government accounting system, more timely accounting for ODA in the government accounts, and institutionalizing systematic M&E tools for use by donors and government. Mechanisms need to be developed to encourage all donors to provide timely information in l ine with the government budget approval calendar and to use the government Development Assistance Information Database. Testing o f the capability o f the new TABMIS system for budgeting, accounting and reporting ODA through government systems i s a priority.

27. Financial Reporting and Transparency: Vietnam has increased levels o f fiscal transparency. Budget plans and budget execution accounts are being made available publicly, and there i s increasing compliance with reporting regulations. However there i s s t i l l room for improvement, particularly in relation to consistency in quality o f reports and their timeliness. To enhance the quality o f financial reporting, consistency between budget and accounting classifications needs to be maintained. The number o f budget execution reports needs to be rationalized. Content and presentation o f financial information needs to be improved in line with existing government regulations in the publicly available budget execution reports to make them more informative. The Government should start producing and issuing annual financial statements in l ine with international practices. The State annual accounts and financial statements need to be issued more timely than the current 18 months after year end to enhance their relevance.

28. Accessibility of Financial Information: Good progress has been made in establishing legislation and the environment for greater financial accountability and transparency o f financial information. Regulations on financial disclosures o f the State Budget Law, Accounting Law and State Audit Law have been issued increasing the scope and range o f required disclosures by entities at all levels o f government. Information i s being made available on public accessible websites. However, implementation remains the challenge. To further increase transparency, the content o f budget documentation and the final accounts could be enhanced by including analysis, explanations and information in l ine with international practices. Disclosure o f financial information, particularly spending at unit level should be actively monitoring to ensure compliance with the enhanced disclosure requirements. Published financial reports should be timely and a calendar for disclosures issued publicly.

29. Accounting and Auditing Framework Given the importance o f accounting and auditing, in both the public and private sectors in the continued growth and development o f Vietnam, the government plays a leading role in regulation o f the accounting and auditing systems, regimes, standards and professions. Accounting and auditing standards for enterprises have been issued but are now out o f date and incomplete when compared to international standards. Mechanisms for maintaining up-to-date standards and consistency between the standards and regulated accounting regimes need to be set up. Considerable reliance i s placed on independent auditing to provide effective review o f financial information o f enterprises, however there appears to be overlap in the regulation o f the auditing profession. Legislative support i s needed for the regulation and oversight o f the accounting profession in Vietnam. A Report on the Observance o f Standards and Codes, reviewing the accounting and auditing framework (including financial reporting standards) has been carried out to determine divergence from international standards and practices. When published this study i s expected to provide policy recommendations to

58

develop a comprehensive country action plan for the long term development o f high quality accounting and auditing in Vietnam.

30. External oversight: Since 2004, there has been steady strengthening o f external oversight. The State Audit Law 2005 established the SAV as an independent supreme audit institution reporting to the National Assembly with publication o f summaries o f the SAV annual audit reports occurring, as recommended in the 2004 PER-IFA. Key challenges remain in implementation o f the state auditing function, with the need for SAV to update i ts organization and staffing requirements and i t s audit strategies and methodologies more in line with international practices so as to be able to provide effective audit coverage o f the public sector. Greater attention needs to be given to assessment o f financial systems and functioning o f internal controls as well as providing opinions on the reliability o f government financial statements. Audit reports on the State Accounts needs to be more timely. Oversight by the National Assembly and Provincial People’s Councils has continued to strengthen. In l ine with the 2004 PER-IFA recommendation, a Finance and Budget Committee was created in 2006 to improve the oversight o f the budget estimates and final accounts. The time reserved for scrutiny by the National Assembly, PPCs and committees should be longer to provide adequate time for quality scrutiny and discussion. The comprehensiveness and quality o f budget information and financial reports as well as the cooperation between committees and government oversight bodies needs to improve to strengthen information sharing and quality o f analysis and decision making.

3 1. Financial Management Human Resource Capacities: Within the MOF, there i s s t i l l a lack o f experienced technically qualified and experienced managerial staff to meet the reform challenges o f the Ministry. The MOF i s moving towards developing a human resource management system which i s synchronized, fair and transparent. Financial management capacity constraints i s a key cross cutting issue within sectors and sub-national government and support i s needed to implement decentralized PFM accountabilities and reforms.

32.Monitoring Framework Progress and impact o f the PFM reforms and development initiatives are difficult to measure as baseline performance measures have yet to be established. The Public Expenditure and Financial Accountability (PEFA) Measurement Framework provides a recognized measurement o f the performance o f the public financial management o f government. Although the Government has agreed in principle to introducing this measurement framework though a se l f assessment process, no decision on timeframe and a firm commitment o f resources for the assessment has been made. It i s strongly recommended that the government prepare a PEFA measurement framework as soon as possible to establish baseline measurements to provide the basis for soundly based measurement o f PFM performance and progress o f the PFM reforms.

33 . There is strong ownership in the Vietnam government of the P F M reform agenda: The government actively engages with donors and demonstrates a strong commitment to PFM reform in Vietnam. The “Single Document” issued in 2007 articulates the government’s strategy for mobilizing both national and international resources to advance reform in PFM. Support to the implementation o f reforms i s coordinated through the PFM partnership group which overarches the activities o f government, donors, and working groups, meeting half yearly to discuss progress.

34. Conclusion: The overall financial management r i sk to proper use, control and reporting o f funds i s assessed as moderate, in l ine with the outcome o f the most recent CFAA. The Vietnam PFM systems are therefore considered adequate to support this operation. Additional fiduciary

59

arrangements are proposed, including a dedicated foreign exchange account and the Bank retaining the right to subject this account to audit.

Vietnam Electricity

35. MoF has indicated its intention to onlend the proceeds o f the loan and credit to EVN in U S dollars. During preparation and supervision o f ongoing investment projects implemented by EVN, aspects o f financial management reviewed have included: organization and staffing; planning and budgeting; f low o f funds, funding channels and treasuryhanking operations; management o f special accounts and disbursements; internal controls; accounting policies; reporting and monitoring; and external audit. These have been acceptable and implementation has been consistently satisfactory, although there have been some dimensions, such as special account monitoring which have been rated as moderately satisfactory from time to time.

36. EVN’s audited financial statements are prepared on an International Financial Reporting Standards (IFRS) basis. EVN incurred a net loss o f VND 7,319 bil l ion ($438 million) in 2008 on net sales revenue o f VND 63,732 bil l ion ($3.82 billion). This i s EVN’s f irst loss since it began IFRS reporting in the mid-1990s. The loss was primarily due to a VND 10,126 bil l ion ($606 million) foreign exchange loss on EVN’s foreign currency debt, occasioned by the impacts o f the financial crisis. Largely because o f i t s weaker cash flow performance, EVN did not meet either the self-financing or debt service covenants. In consideration o f the mitigating circumstances o f the financial crisis, the Bank agreed to waive the SFR and DSCR covenants for 2008.

37. Based on preliminary data for the first six months o f 2009 - the latest data available - net profit over the first half o f 2009 has improved compared with 2008. Furthermore, i t i s likely that any new foreign exchange losses resulting from exchange rate changes in 2009 wil l be significantly less than that incurred in 2008. Over the course o f 2009, the Dong was more stable against the Yen and Dollar. Due at least in part to improved operating cash flows, EVN’s cash balance improved by about 15% over the first six months o f 2009. EVN’s short term investments improved even more significantly, by about 40% over that at year-end 2008. As a result, EVN’s shorter-term liquidity position was considerably better by mid-2009 in comparison with the end o f 2008.

60

ANNEX 4: Country At-A- Glance, Including Map

Vietnam at a dance w9109

POVERTY and SOCIAL East

As ia 6 Low- Vietnam Pac i f i c Income

'2008

GNIpercapita(At/asmethod, US$) 890 Population, mid-year (millions) 86.2

GNI (Atlas method, US$ billions) 76.6

Average annual growth, 2002-08

Population (%) 13 Laborforce(%) 2.2

M o s t recent es t imate ( latest year avallable, 2002-08)

Poverty (%of population belo wnational poverty line) 29 Urban population (%of totalpopulation) 26 Life expectancyat birth (pars) 74 infant mortality(per ZOOOlive bidhs) P Child malnutrition (%of children under5)

LIeracy (%ofpopulation age Gross primaryenrollment (%of school-age population) 0 2

Male 0 5 Female 99

20 92 Access to an improvedwatersource (%ofpopulation)

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

' 1988 1998

GDP (US$ billions) 25.4 27.2 Gross capital formationlGDP l i .8 29.0 Exports of goods and ServiceslGDP 3.9 44.8 Gross domestlc savingslGDP .. 217 Gross Uational savingslGDP .. 24.0

Current account balancelGDP -2.6 -3.9 Interest paymentslGDP 0.0 16 Total debtlGDP 2.4 82.5 Total debt servicdexports 9.1 Present value of debtlGDP Present value of debtlexports

1988-98 1998-08 2007 ' (average annual gowih) GDP 8.0 7.4 6.5 GDP percapita 5.9 6.1 7.2 Exports of goods and services 8 . 9 14.0 , 113

1931 973 2,631 524 5,06 1 510

0.8 2.1 12 2.7

44 29 72 59 22 78 13 28

87 67 93 64 in 96 nz t12 la 95

2007 ' 2008

68.6 89.8 43.1 411 76.9 78.2 26.2 24.6 34.6 29.4

-tl.2 -119 0.9 0.6

34.8 29.1 2.2 19

30.0 22.7 36.9 28.7

2008 2008-12

6.2 6.3 4.9 5.1 5.0 3.1

STRUCTURE o f the ECONOMY

(%of GDP) Agriculture 46.3 25.8 Industry 24.0 32.5

Manufacturing 8.1 l i . l Services 29.7 417

Household final consumption expenditure .. 70.6 General gov't final consumptionexpenditure .. 7.6 Imports of goods and services 15.0 52.2

' 1988 I998 2007 ' 2008

20.4 22.1 415 39.7 214 211 38.2 38.2

66.7 69.3 6.1 6.2

92.7 94.7

(average annual g o wih) Agriculture Industry

Services Manufacturing

1988.98 1998-08

4.0 4.0 a .7 9.9 6.3 116 6.6 6.9

Household final consumption expenditure 7.1 General gov't final consumption expenditure .. 6.6 Gross capital formation 22.4 117 Imports of goods and services 8.5 15.0

Developmentdianond

Life expectancy

T

'1 capita l+enro:-i primary

Access to improvedwatersource

Economlcratbs'

Trade I

Indebtedness

Growth of capital and GDP (%) I

I 03 04 05 OB 07 -0cF -GDP

2007 ' 2o08 I Growthofexportsandlmports(%) I 3.8 4.1 D.2 6.1 13.3 9.9 6.9 7.2

l i .5 9.0 8.9 7.5

30

-10

24.2 6.5 -ExpI1s &Imporb 27.6 7.6 I

Note: 2008 data are preiiminaryestimates. This tablewas produced from the Development Economics LDB database. 'Thediamonds showfour keyindicators in thecountry(in bo1d)comparedwith its income-groupaverage. Ifdataaremlssing, thediamondwill

61

Vietnam

PRICES and GOVERNMENT FINANCE ' 1988 Domes t l c p r i ces (%change) Consumer prices 374.2 Implicit GDP deflator 4no

Government f inance (%oFGDP. includes current grants) Current revenue Current budget balance Overall surplusldeficit

TRADE

(US$ millions) Totalexports (fob)

Rice Fuel Manufactures

Total impprts (cif) Food Fuel and energy Capital goods

Export price index (2000=X)O) Import price index (2000=?JO) Terms o f trade (2000=00)

n 3 -2.8

' 1988

733

14Q

B A L A N C E o f PAYMENTS

(US$ millions) Exports of goods and services Imports o f goods and services Resource balance

' 1988

Net income Net current transfers l 7

Current account balance 6 5 9

Financing items (net) Changes in net reserves

Memo: Reselves including gold (US$ miNions) Conversion rate (DEC, /ocalAJS$) 606.5

EXTERNAL DEBT and RESOURCE FLOWS ' 1988 (US$ millions) Totaldebt outstanding and disbursed 617

IBRD 0 IDA 60

Total debt service IBRD IDA

3 0 0

Composition o f net resource flows Official grants 79 Official creditors -1 Private creditors 0 Foreign direct Investment (net inflows) 8 Portfolio equity(net inflows) 0

World Bank program Commitments Disbursements Principal repayments Net flows Interest payments Net transfers

1998

7.2 8.8

20.0 5.0

-0.5

1998

9,360 884 1 4 0

4,350 ?I500

1 946

3,513

97 0 7 90

1998

?I965 13,481 -1516

-668 1Q3

-1061

2,640 -1579

1765 13,268.0

1998

22,458 0

851

10% 0 5

236 1044 -366 1671

0

427 254

1 253

5 248

2007 ' 2008

7.3 7.3 8.2 217

25.1 26.0 5.0 5.8

-2.2 -11

2007 ' 2008

48,561 62,685 1490 2,894 8,488 0,357

28,783 33,953 62,682 80,713

3 7 7,70 1097

l7,350 2,268

151 174 131 152 115 114

2007 ' 2008

54,591 69,781 65,845 83,398 -?I254 -13,6l7

-2,138 -4,400 6,430 7,3Q

6,992 -0,705

l7.83 qso -0,201 -485

21578 16,666.2 16,450.0

2007 ' 2008

23,865 26,158 0 0

4,549 5,074

1249 1344 0 0

64 75

657 776 1279 1 8 5

-88 -77 6,700 9,579 6,243 -578

973 1097 748 592 30 37

7 8 555 34 38

684 5 7

" I 03 04 05 OB 07

-WP deflator - CPI I

I Export and Import levels ( U S mill.)

80,000

80,000

40.000

20,000

"I 02 03 04 05 OB 07

mExpciis lmpcfts

Currentaccount balance toGDP(%) I

-12

-15

Compositionof 2008 debt(USSmill.)

-. 11.741

A - 18RD E- Bilateral 8 - IDA D - O W mrlSlateral F - Rivate C- IMF G - Shcrt-tmm

Note:This table was produced from the Development Economics LDB database

62

W9IO9

MAP SECTION

1

2

3

45

6

7

89

10

1112

1314

15

1617

18 192021

22 23

24 2526

27

28

29

30

3132

33

34

35

36

37

38

39

41

42

40

43 44

45

46 4748

49

5051

52

63

53

54

55

56

5758

59

60

6162

LangSon

Ho Chi Minh City

Bien HoaThu Dau

Mot

Phan Thiet

DongXoai

Tan An

Bac Lieu

Vi Thanh

Vung TauMy Tho

Ca Mau

Rach Gia

Long Xuyen

Hai Phong

Ha Long

DienBien Phu

Lao Cai

Quy NhonPleiku

Buon MaThuot

Gia NghiaDa Lat

Vinh

Vinh Yen

Nam DinhNinh Binh

Dong Hoi

Dong Ha

Tam Ky

Nha Trang

Tuy Hoa

Kon Tum

Son La

Yen Bai

HaGiang

TuyenQuang Thai

Nguyen

Cao Bang

Bac Can

Soc Trang

Tra VinhCan Tho

Cao Lanh

Ben TreVinh Long

Tay Ninh

Quang Ngai

Da Nang

Ha Tinh

Thanh Hoa

Thai Binh

Hung Yen

Ha Nam

Viet Tri

Hai Duong

Bac GiangBac Ninh

Hoa Binh

Hue

Phan Rang-Thap Cham

HANOIHANOI

An

na

m C

or

di l l e

ra

Central

Highlands

Ngoc Linh(3143 m)

Lai Chau Town

CHINA

C A M B O D I A

THAILAND

LAOPEOPLE'SDEM. REP.

To Nanning

To Hepu

To Tiandong

To BabaoTo

Kunming To Kaiyuan

To Muang Xai

To Luang

Prabang

To Khammouan

To Savannakhet

To Kampong Cham

To KampongChhnang

An

na

m C

or

di l l e

ra

Hainan I.(China)

18°N

1

2

3

45

6

7

89

10

1112

1314

15

1617

18 192021

22 23

24 2526

27

28

29

30

3132

33

34

35

36

37

38

39

41

42

40

43 44

45

46 4748

49

5051

52

63

53

54

55

56

5758

59

60

6162

LangSon

Ho Chi Minh City

Bien HoaThu Dau

Mot

Phan Thiet

DongXoai

Tan An

Bac Lieu

Vi Thanh

Vung TauMy Tho

Ca Mau

Rach Gia

Long Xuyen

Hai Phong

Ha Long

Lai Chau Town

DienBien Phu

Lao Cai

Quy NhonPleiku

Buon MaThuot

Gia NghiaDa Lat

Vinh

Vinh Yen

Nam DinhNinh Binh

Dong Hoi

Dong Ha

Tam Ky

Nha Trang

Tuy Hoa

Kon Tum

Son La

Yen Bai

HaGiang

TuyenQuang Thai

Nguyen

Cao Bang

Bac Can

Soc Trang

Tra VinhCan Tho

Cao Lanh

Ben TreVinh Long

Tay Ninh

Quang Ngai

Da Nang

Ha Tinh

Thanh Hoa

Thai Binh

Hung Yen

Ha Nam

Viet Tri

Hai Duong

Bac GiangBac Ninh

Hoa Binh

Hue

Phan Rang-Thap Cham

HANOI

CHINA

C A M B O D I A

THAILAND

LAOPEOPLE'SDEM. REP.

PhuQuoc

Hainan I.(China)

Mekong

Black

Red

Ma

Gul fof

Tonkin

Gulfof

Thai land

M e k o n g De l

t a

To Nanning

To Hepu

To Tiandong

To BabaoTo

Kunming To Kaiyuan

To Muang Xai

To Luang

Prabang

To Khammouan

To Savannakhet

To Kampong Cham

To KampongChhnang

An

na

m C

or

di l l e

ra

Central

Highlands

Ngoc Linh(3143 m)

22°N

20°N

18°N

16°N

14°N

12°N

10°N

22°N

20°N

18°N

16°N

14°N

12°N

10°N

108°E106°E104°E

110°E108°E106°E104°E102°E

VIETNAM

12345678910111213141516171819202122232425262728293031

Lai ChauDien BienLao CaiHa GiangCao BangSon LaYen BaiTu Yen QuangBac CanLang SonPhu ThoVinh PhucThai NguyenBac GiangQuang NinhHa NoiBac NinhHung YenHai DuongHai PhongHoa BinhHa NamThai BinhNinh BinhNam DinhThanh HoaNghe AnHa TinhQuang BinhQuang TriThua Thien Hue

3233343536373839404142434445464748495051525354555657585960616263

Da NangQuang NamQuang NgaiKon TumGia LaiBinh DinhPhu YenDac LacDac NongKhanh HoaBinh PhuocLam DongNinh ThuanTay NinhBinh DuongDong NaiBinh ThuanT.P. Ho Chi MinhBa Ria-Vung TauLong AnTien GiangDong ThapBen TreAn GiangVinh LongTra VinhKien GiangCan ThoHau GiangSoc TrangBac LieuCa Mau

PROVINCES:

0 50 100 150

0 50 100 150 Miles

200 Kilometers

IBRD 33511R1

JANUARY 2010

V IETNAM

PROVINCE CAPITALS

NATIONAL CAPITAL

RIVERS

MAIN ROADS

RAILROADS

PROVINCE BOUNDARIES

INTERNATIONAL BOUNDARIES

This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other information shown on this map do not imply, on the part of The World Bank Group, any judgment on the legal status of any territory, o r any endo r s emen t o r a c c e p t a n c e o f s u c h boundaries.