Report and Recommendation of the President to the Board of Directors

Project Number: 39538-02 November 2009

Proposed Multitranche Financing Facility Socialist Republic of Viet Nam: SOE Reform and Corporate Governance Facilitation Program

CURRENCY EQUIVALENTS (as of 26 October 2009) Currency Unit D1.00 $1.00 = = dong (D) $0.00005540 D18,050.4

ABBREVIATIONS ADB ADF BOM CIEM CSP DANIDA DATC EA FFA FIRR FSC IA GC90 GC91 LIBOR MFF MOF NPV NSCERD OCR PFR PRSC ROE SCIC SEDP SOCB SOE SOWATCO SRCGFP TA WACC Asian Development Bank Asian Development Fund board of management Central Institute of Economic Management country strategy and program Danish International Development Aid Debt and Asset Trading Corporation executing agency framework financing agreement financial internal rate of return facility steering committee implementing agency special general corporation under a line ministry or provincial people's committee general corporation reporting to the Prime Minister London interbank offered rate multitranche financing facility Ministry of Finance net present value National Steering Committee for Enterprise Reform and Development ordinary capital resources periodic financing request poverty reduction and support credit return on equity State Capital Investment Corporation Socio-Economic Development Plan state-owned commercial bank state-owned enterprise Southern Waterborne Transport Corporation State-Owned Enterprise Reform and Corporate Governance Facilitation Program technical assistance weighted average cost of capital

NOTES (i) (ii) The fiscal year (FY) of the Government and its agencies ends on 31 December. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2009 ends on 31 December 2009. In this report, "$" refers to US dollars.

Vice-President Director General Directors

C. Lawrence Greenwood, Jr., Operations 2 A. Thapan, Southeast Asia Department (SERD) J. Ahmed, Financial Sector, Public Management and Trade Division, SERD A. Konishi, Country Director, Viet Nam Resident Mission, SERD P. Srivastava, Senior Regional Cooperation Specialist, SERD D. V. Dung, Public Sector Reform Officer, SERD S. Kawazu, Counsel, Office of the General Counsel V.V. Subramanian, Principal Financial Sector Specialist (Capital Markets), SERD

Team leader Team members

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS Page FACILITY INVESTMENT PROGRAM SUMMARY I. II. THE PROPOSAL RATIONALE: SECTOR PERFORMANCE, PROBLEMS, AND OPPORTUNITIES A. Performance Indicators and Analysis B. Analysis of Key Problems and Opportunities THE PROPOSED FACILITY A. Impact and Outcome B. Outputs C. Special Features D. Cost Estimates and Financing Plan E. Implementation Arrangements PROGRAM BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS A. Economic and Financial Analyses B. Summary of Benefits, Poverty Reduction, and Social Development C. Social and Environment Safeguards D. Risks and Mitigating Measures ASSURANCES A. SPECIFIC ASSURANCES i 1 1 1 3 11 11 11 13 16 18 22 22 23 23 24 25 25 26 27 31 39 41 42 45 54 62 69 72

III.

IV.

V.

VI. RECOMMENDATION APPENDIXES 1. Design and Monitoring Framework 2. State-Owned Enterprise Sector Analysis 3. Development Coordination 4. Detailed Cost Estimates by Expenditure Category and Financing of Tranche 1 Projects 5. Selection Criteria for General Corporation Participation and Approval Procedures for Future Tranches 6. Financial Performance and Projections of Song Da General Corporation 7. Financial Performance and Projections of Sowatco 8. Financial Analysis of Tranche 1 Projects 9. Economic Analysis of State-Owned Enterprise Reform and Corporate Governance Facilitation Program Facility Tranche 1 Projects 10. Summary Poverty Reduction and Social Strategy SUPPLEMENTARY APPENDIXES (available on request) A. Existing Regulations Relevant for General Corporation Equitization and Listing B. Loans to be Restructured under Tranche 1 at Song Da C. Loans to be Restructured under Tranche 1 at Sowatco D. Proposed New Corporate Structure at Song Da E. Proposed New Corporate Structure at Sowatco F. Proposed Measures to Improve Management and Corporate Governance Processes at Song Da, Sowatco, and the Debt and Asset Trading Corporation G. Financial Management Assessment of the General Corporations and the Debt and Asset Trading Corporation H. Procurement Plan

FACILITY INVESTMENT PROGRAM SUMMARY Borrower Classification Socialist Republic of Viet Nam Targeting classification: General intervention Sector (subsector): Public sector management (economic and public affairs management) Themes (subthemes): Economic growth (promoting economic efficiency and enabling business environment), private sector development (privatization), governance (economic and financial governance), capacity development (organization development) Location impact: National (high), rural (low), urban (high) The State-Owned Enterprise Reform and Corporate Governance Facilitation Program (SRCGFP) is category C under the environmental classification system of the Asian Development Bank (ADB), with no significant adverse impact identified. The SRCGFP will not have any involuntary resettlement impact, as it has no component for creating new physical assets. None of the debt and operational restructuring measures in general corporations associated with the facility will trigger activities related to indigenous people. The SRCGFP will support the agenda of the Government of Viet Nam (the Government) for state-owned enterprise (SOE) reform by equitizing and transforming general corporations. Participating general corporations will be restructured under a comprehensive package of corporate and financial restructuring and enhanced operational efficiency and corporate governance. Debt restructuring will strengthen general corporation balance sheets through improved cash flows and debt-servicing capacity, generating additional resources for productive activities. None of the restructured debt will be nonperforming loans. Corporate restructuring will enable participating general corporations to exploit economies of both scale and scope by merging several small joint stock subsidiaries in each general corporation into larger entities organized along lines of business, combined with the divestiture of disparate non-core business units. Additionally, management restructuring will enhance operational efficiency by strengthening corporate management processes and improving governance. Ordinary capital resources (OCR) will be used to support financial and corporate restructuring, while operational restructuring and improved corporate governance will be supported by the complementary loan component funded from Asian Development Fund (ADF) resources. The facility will also provide support for institutions playing key roles in SOE reform, such as the Debt Asset Trading Corporation (DATC), which addresses SOE debt resolution. The Government has requested ADB to support the reform and transformation of general corporations and the strengthening of

Environment Assessment

Investment Program Description

Multitranche Financing Facility

ii

other institutions related to reforming SOEs. Despite political commitment at the highest level, implementation challenges have constrained SOE reform. The complexity and difficulty of SOE reform in Viet Nam engender a concomitant need for flexibility and commitment. This context informs the rationale for the multitranche financing facility (MFF) as the most appropriate lending modality for the SRCGFP. A program loan cluster would be a less appropriate modality because of its emphasis on policy conditions, while what are needed are resources for the SOEs to use to restructure. A sector development loan would also be less appropriate because of the diversity of sector coverage envisioned under the SRCGFP. The SRCGFP fulfills the requirements for using the MFF modality. The Government has a road map for the transformation of the SOE sector consisting of the conversion of SOEs through equitization, seeking to combine or follow equitization with listing to attract new capital for them, increase their efficiency, and narrow the role of state in their management. The road map is supported by policy and legal frameworks. As part of its road map, the Government initially focused on equitizing smaller SOEs to test and refine the process. Subsequently, the Government aggregated many SOEs into general corporations and sought to define and develop a parentsubsidiary company model for them. The equitization and transformation of general corporations is the next challenge for the Government, which recognizes that successfully transforming large SOEs and general corporations will take time and resources. The Government's vision is to reorganize, renew, and restructure SOEs to improve their efficiency, adaptability to market mechanisms, and competitiveness in the context of global economic integration. The Government's policy framework additionally endorses the principle of eliminating the role of line ministries in managing SOEs; separating the ownership and management of general corporations; and enhancing their transparency, accountability, professionalism, and operational efficiency. Nonetheless, the policy framework will need to be strengthened as SOE reform gradually moves into the post-equitization phase. In particular, the Government will need to review the framework for ownership of the state's interest in economic organizations to facilitate the necessary separation of ownership from management of large SOEs and general corporations. Rationale Transforming and reforming SOEs are critical to reducing the dominance of inefficient state production, promoting private sector development, and enhancing economic growth. The Government's Socio-Economic Development Plan 20062010 calls for diversifying ownership to improve the efficiency and competitiveness of SOEs and for narrowing or eliminating the role of ministries and other state entities in SOE governance and management.

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ADB's strategy towards the SOE sector in Viet Nam has two defining characteristics: long-term support and responsiveness. ADB has been engaged with SOE reform since early on, approving the State-Owned Enterprise Reform and Corporate Governance Program in 1999. ADB's country strategy and program 20072011 underlined SOE reform as central to its strategy for business development and private sector-led employment growth. ADB's approach to the SOE sector has been responsive to the evolving contours of the long reform process, which has been both complex and sensitive in Viet Nam, often requiring consensus at the highest levels of decision making. ADB's first loan addressed prevailing constraints, including the creation of a centralized government institution to formulate, coordinate, and lead the implementation of SOE reform, adoption of a modern law on enterprises, and divestiture of small enterprises and gradual reduction in shareholding of large and medium-sized SOEs. A decade later, the context of SOE reform has altered, and new needs have emerged. While thousands of SOEs have been equitized, they account for only a modest fraction of the states total investments. Qualitative results have been disappointing, as many of the equitized entities remained inefficient and dependent on state support for generating business. The equitization that remains to be done is the more difficult part, concentrated primarily in general corporations. SOE reform is stymied for lack of viable approaches toward equitizing and transforming large general corporations. Through the SRCGFP, ADB is again introducing a timely catalyst into the SOE reform process by proposing a comprehensive approach to successfully equitizing general corporations and transforming them into globally competitive entities. Equitization is only one step in a successful transformation process for SOEs and needs to be complemented, even preceded, by a host of other steps, including strategic and business planning, corporate and financial restructuring, attracting investment and corporate financing, forming valueadding business partnerships or alliances, and implementing more transparent governance. Enhancing the market education of management and staff, modernizing management information systems and human resource development systems, and possibly listing on the stock exchange are additional steps and challenges that need to be addressed for effective and comprehensive transformation. The complexity of successfully transforming a large SOE makes it important to keep the first stage manageable by focusing on a select few. After consulting with several general corporations, the Government proposed an initial list of four general corporations

iv

for potential participation in the SRCGFP, from which two have been selected for the first stage. The selection was based on the viability of debt restructuring and readiness, reflected in expressed commitment to undertaking appropriate corporate, financial, and operational restructuring and in approval of the proposed restructuring from the general corporation's board of management and the line ministries concerned. Impact and Outcome The proposed SRCGFP will make equitized and restructured SOEs, including large general corporations and their subsidiaries, more profitable and transparent. The expected outcome will be the transformation of several general corporations and their subsidiaries into focused, efficient businesses with stronger balance sheets and improved corporate governance. By developing a successful and sustainable model for general corporation transformation, the SRCGFP will provide a renewed direction and focus for further SOE reform. The total investment program cost for 20092015 is estimated at $1.77 billion equivalent. The total cost of projects in tranche 1 is estimated at $130 million equivalent.
Investment Program ($ million) Investment Program Component Sector Investment Plan Debt Restructuringa 1,090 Management Restructuring 130 Institutional Developmentb 550 1,770 Total

Investment Program

A. B. C.
a b

Includes financial and corporate restructuring. Includes the transfer of shares of equitized general corporations from the Government to the State Capital Investment Corporation or its equivalent. Source: Asian Development Bank estimates.

Facility Amount and Terms

A $630 million lending facility will be provided to the Government of Viet Nam, comprising $600 million from OCR and $30 million equivalent from ADF resources. ADB will use its OCR to support financial and corporate restructuring in participating general corporations. All provisions of ordinary loan regulations applicable to ADB's London interbank offered rate-based loans will apply to each loan, subject to modifications, if any, that may be agreed in the framework financing agreement, supplemented by any loan and project agreements. The Government will onlend the full amount of ADB's OCR loan to participating general corporations in the same currency as in the primary loan agreement between ADB and the Government and with ADB's lending terms to the Government, plus other costs determined by the Government and acceptable to ADB.

The Government has also requested ADB to provide $30 million equivalent from its ADF resources to support the operational restructuring of the participating general corporations and for strengthening institutions critical to SOE reform, such as DATC. The ADF loan under the first tranche will have an interest rate of 1.0% per annum during the grace period and 1.5% per annum thereafter; a term of 32 years, including a grace period of 8 years; and such other terms and conditions as are substantially in accordance with those agreed in the framework financing agreement, supplemented by loan agreements. The Government will onlend the full amount of the ADF loan to the participating entities in the borrowing currency or in dong, again with the terms of the lending the same as those between ADB and the Government, plus other costs determined by the Government and acceptable to ADB. Period of Utilization The utilization period for the facility will be from December 2009 to 31 December 2015. No periodic financing requests (PFRs) will be accepted after this date, though disbursements of approved PFRs will be allowed until the completion of the projects included in the last PFR. The implementation period of each tranche or loan is expected not to exceed 3 years. The Ministry of Finance (MOF) will be the Executing Agency for the facility and responsible for the supervision and execution of the SRCGFP. Immediately following the approval of the facility, MOF will establish a program management unit and a facility steering committee to monitor SRCGFP implementation. The facility steering committee will consist of representatives of relevant government agencies and be headed by the vice minister in MOF. For the first tranche, Song Da General Corporation (Song Da), Southern Waterborne Transport Corporation (Sowatco), and DATC will be implementing agencies (IAs). IAs in subsequent tranches will be participating SOEs, general corporations, and/or Government agencies promoting SOE sector reforms. The first-tranche project involves comprehensive restructuring of two general corporations, Song Da and Sowatco. The project will also enhance the operational efficiency of DATC in facilitating and supporting SOE reform. Operational restructuring at the three IAs will be facilitated by consultant services and supervised by respective boards of management. The ADF loan will be used exclusively for meeting expenses incurred in operational restructuring, enhancing governance, and building capacity in participating general corporations and institutions. These expenses will primarily be for consulting services to implement restructuring and equipment for information management. In the first stage, the ADF proceeds will be used solely for meeting the expenses to be incurred, or already incurred within the provisions of retroactive financing of ADB, by

Implementation Arrangements

Procurement, Consulting Services and Disbursement

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the three IAs: Song Da and Sowatco for undertaking their agreed management restructuring and corporate governance strengthening, and DATC for enhancing its operational efficiency, as agreed with ADB. Except as ADB may otherwise agree, the three IAs shall each establish immediately after the effective date an imprest account for ADF funds at a commercial bank acceptable to ADB, to be used solely for the purposes stated above. Retroactive Financing Except as otherwise agreed with ADB, eligible expenditures incurred before each loan takes effect but not earlier than 12 months before the loan agreement is signed, and incurred directly for operational and corporate restructuring, will qualify for retroactive financing, up to 20% of the proposed amount of the loans under the facility. The static and dynamic efficiency losses from direct state involvement in the production of economic goods and services are well known and documented. Transforming general corporations will help capture efficiency gains and pave the way for the greater rationalization of government policies at the sector level. To protect its assets in the general corporations, the state has tended to adopt protectionist policies that promote monopolistic power, hinder competitiveness, and curb private sector development. Greater competitiveness in the transformed general corporations will facilitate the states adoption of less restrictive sector and pricing policies, further enhancing efficiency gains for the economy. General corporation transformation will benefit many SOE workers, who were the dominant buyers of now-illiquid shares in the small SOEs equitized earlier on. The proposed corporate restructuring will enable many of the SOE shareholders to trade their illiquid shares of equitized small SOEs for the shares of large, efficient sub-holding companies that may even be listed on the stock exchange. The development of capital markets will benefit from the creation of iconic companies that may shortly evolve into blue chip stocks. Finally, strengthening restructured general corporations' balance sheets with more efficient and profitable operations will ameliorate the problem of nonperforming loans to SOEs from state-owned commercial banks, thus benefiting the banking system. The SRCGFP assumes continued Government commitment towards an increasingly market-oriented economy, and shortterm impact of the current global crisis. Potential risks to the SRCGFP are identified below. (i) Resistance from vested interests to SOE reforms. Reforms and initiatives may be delayed by resistance from vested interests opposed to SOE reform. However, this risk is considered modest, as the Government's approach so far has been sustained, if cautious,

Program Benefits and Beneficiaries

Risks and Assumptions

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commitment to pursuing SOE reform. The Government has indicated it will renew its plan for equitizing large SOEs and general corporations and is looking to the SRCGFP to demonstrate a viable and successful model and to enhance reform momentum. The Government is aware that SOE reform is critical to successfully meeting obligations arising from agreements entered into during the country's accession to the World Trade Organization. (ii) Use of general corporations for noneconomic objectives. The equitized and transformed general corporations may be hindered in operating profitably if the Government uses them for noneconomic objectives through, for example, price controls set at the sector level or requiring general corporations to undertake noncommercial activities. However, the sustained use of such measures would be against the Government's interest in transforming the inefficient SOE sector. In addition, the proposed operational restructuring would confine noncommercial activities, if any, to the general corporation level, which would make them more transparent and distinct from the commercial operations of the sub-holding companies. ADB is also engaged in policy dialog on SOE reform with the Government through the poverty reduction and support credit process. Capacity limitations in general corporations may limit absorption and dilute implementation, particularly for improving corporate governance. The capacity of restructuring institutions to assimilate and absorb change may be low, especially below senior management. This may constrain the quality of operational restructuring. Weak implementation may compromise improved internal governance, particularly of independent directors. To address this, proposed restructuring measures include the development of comprehensive training programs and detailed training on corporate governance and key components relevant to enterprise operations. Detailed measures for improved governance have been approved by the boards of management of the general corporations, including criteria for independent directors and the promulgation of a code of ethics for the directors and other stakeholders. Independent consultants will be recruited under ADF funding to facilitate, supervise, and monitor the implementation of the agreed measures. Corporate restructuring requiring share swaps and buybacks may take too long. Realigning all subsidiaries along focused lines of business in the sub-holding company model may be slow, particularly if consensus is lacking on the relative pricing of shares of the subsidiaries and the parent company. However, shares of many

(iii)

(iv)

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subsidiaries are quite illiquid, and the incentive to swap them for shares in larger companies with better potential for access to capital markets and economies of scale and scope would be strong. This incentive will be further strengthened as the results of financial and operational restructuring become more evident in general corporation balance sheets and performance.

I.

THE PROPOSAL

1. I submit for your approval the following report and recommendation on a proposed multitranche financing facility (MFF) to the Socialist Republic of Viet Nam for the SOE Reform and Corporate Governance Facilitation Program. The design and monitoring framework is in Appendix 1. II. A. RATIONALE: SECTOR PERFORMANCE, PROBLEMS, AND OPPORTUNITIES Performance Indicators and Analysis

2. Long period of reforms. Equitizing state-owned enterprises (SOEs)or converting SOEs into joint stock companies with limited liabilitywas launched in Viet Nam in mid-1992, but by the end of 1997 only 17 enterprises had been equitized. In 1998, following a review of the SOE reform program, several new initiatives were undertaken, including (i) Prime Minister Circular No. 20/1998/CT-TTg, which set out the main policies to guide the restructuring of enterprises, including the framework for classifying SOEs in terms of plans for ownership diversification; (ii) Decree No. 44/1998/ND/CP, which clarified and simplified the equitization process; (iii) the setting up of a national enterprise reform committee to approach SOE reform; and (iv) the announcement of equitization targets up to 2000, including the complete divestiture of small enterprises with capital of less than D1 billion. 3. In subsequent years, the Government has repeatedly refined and revised regulations on SOE conversion (Appendix 2). The current legal framework of SOE reform1 comprises (i) the Law on State-Owned Enterprises, Enterprise Law, and Law on Securities; (ii) decrees, circulars, and instructions on the equitization process; (iii) decrees, circulars, and instructions on other types of SOE conversion (sales, assignments, and management contracts); (iv) decrees, circulars, and instructions on the conversion process applicable to the parent company subsidiary model; and (v) decrees, circulars, and instructions on the financial management and monitoring of SOEs. Nationally, SOE reform is monitored by the National Steering Committee for Enterprise Reform and Development (NSCERD), which is chaired by the Prime Minister in coordination with the Ministry of Finance (MOF). 4. Regulatory refinements reduced the time required for equitization, which initially took 3 years, to 13 months by 2006. Following the issuance of Decree 109 in 2007, it now takes 9 months. The number of SOE conversions each year increased during this decade, with 282 SOEs equitized in 2001, 378 in 2002, 616 in 2003, and more than 800 in each of following 2 years. According to the latest data from MOF, as of 31 December 2007, 4,979 SOEs had been converted, of which 3,369 had been equitized.2 For 20082010, the Government has plans to convert the remaining 1,535 SOEs, of which 948 are proposed for equitization (Table 1). 5. SOEs can be grouped into two categories: state-owned commercial banks (SOCBs) and others. The Government has requested the Asian Development Bank (ADB) to support only the non-SOCB SOEs under the State-Owned Enterprise Reform and Corporate Governance Facilitation Program (SRCGFP).3
1 2

More details on relevant regulations are in Supplementary Appendix A. The Government has converted SOEs through equitization as well as by conversion into single-member limitedliability companies, sale, merger, liquidation and bankruptcy, and management and lease contracts, but equitization has been the dominant method, accounting for almost two thirds of all SOE conversions. For the remainder of the document, SOCBs are thus excluded from the discussion of SOEs. The SOCBs are separated from the state budget, but some fiscal operations are undertaken through the policy banks Vietnam Development Bank and Vietnam Bank for social policies. The International Monetary Fund includes net lending by Vietnam Development Bank in the overall fiscal balance.

2
Table 1: State-Owned Enterprise Conversions, Cumulative and Planned, 20072010 Item Cumulative until 31 December 2007 Planned 20082010 First 6 months of 2008 SOEs converted 4,979 1,535 61 Of which equitization 3,369 948 30

SOE = state-owned enterprise. Source: Ministry of Finance, Government of Viet Nam, 2008.

6. Slow pace. Progress in equitizing SOEs has been below expectations. Detailed data on the progress of SOE equitization are not easily available; until 2006, according to a donorassisted database at NSCERD, fewer than 60% of the targeted SOEs had been converted. As is evident in Table 1, as of end-2007, only 76% of the target had been achieved, despite efforts having begun nearly 15 years earlier. 7. Small SOEs equitized. Most of the SOEs equitized to 2006 were small, with 46% having capital of less than D5 billion, though the size increased marginally over time. The average number of employees in the equitized SOEs was 260, which was equivalent to 36% of all employees of SOEs prior to the start of equitization. The SOEs equitized by mid-2006 accounted for only a third of SOE bank debt at the time. 8. Few outside investors. Early equitization was primarily internal, with employees acquiring more than half the shares in the equitized SOE. The government and employees together held almost 80% of the shares. Very few outsiders such as strategic investors were involved. Over time, the stake of employees declined modestly while that of company outsiders increased, reflecting in part the introduction of Decree 187 in 2004, which required equitized SOEs to auction shares to the public rather than sell them at company premises. 9. State control retained. The state has often retained a dominant share of more than 50% in equitized SOEs. The larger the SOE, the more the state share of capital has exceeded 50%.4 Higher state shares in the larger SOEs equitized later can be attributed in many instances to excessively high valuation and low profitability, resulting in little interest from external investors and undersubscribed auctions. 10. General corporations. In the mid-1990s, the Government organized most SOEs into 17 general corporations, or conglomerates, reporting to the Prime Minister (GC91s) and 77 special general corporations under line ministries and provincial people's committees (GC90s). In 2002, these 94 general corporations included 1,605 member SOEs and represented 28% of all SOEs and 65% of the capital of all SOEs. The general corporations often do not control the equity in all the myriad companies under their umbrella and, hence, exert uneven control over them. The Government has thus been converting general corporations into holding companies or, in a few cases, economic groups.5

4 5

Equitized SOEs with state shareholding of more than 50% are still considered as SOEs because the state retains controlling power in them. An economic group is not yet legally defined, but the term describes enterprises, each with distinct legal status, that are bound together through mutual investments, capital contributions, or other forms of affiliation and are organized under the holding company model. All subsidiaries of economic groups are equitized or otherwise restructured. General corporations are corporate entities consisting of a wholly state-owned parent or holding company and a group of subsidiary companies, which may be wholly state-owned or in which the state holds a controlling interest.

3 11. The real work has yet to begin. The challenge ahead is the equitization and transformation of the GC90s and GC91s into efficient and profitable entities, fully unleashing the potential value of their assets, including their constituent companies. In December 2006, the Prime Minister approved Decision 1729/QD-TTg, a master plan that includes a list of general corporations identified for equitization. The plan was for about 20 general corporations to be equitized every year from 2007 to 2010. As of 31 May 2008, none of the GC91s and only seven GC90s had been equitized.6 B. Analysis of Key Problems and Opportunities 1. Flawed Initial Focus

12. Focus on small state-owned enterprises. An important factor underlying the slow pace of SOE reform was the Government's initial encouragement for equitizing small, lossmaking SOEs rather than large, profitable ones. The Government's approach to the larger SOEs was to make them more competitive instead. The emphasis on first equitizing smaller business units and subsidiaries meant the resulting equitized SOEs were typically too small to be listed. Further, they continued to rely on the larger general corporation for funding, business revenue, and technical and other management assistance. In many instances, the small equitized subsidiaries of general corporations undertook similar business activities, causing duplication of resources, internal competition, and conflict of interest in general corporations. 13. Focus on quantity rather than quality. Little or no emphasis was placed on qualitative factors in designing the equitization plan, to ensure that the business operations of an equitized SOE would be sustainable and that it would be able to operate independently. Under Clause 5 (a) Article 54 of Decree 109/2007-ND-CP, the responsibilities of the SOE reform committee, which is formed in the SOE to oversee its equitization, include directing the formulation of the equitization plan and verifying the value of the enterprise. However, there is no specific guideline on the need to take into account qualitative considerations, including the sustainability of operations and profitability, in the equitization plan. There is also no requirement for independence of the appointed advisors and valuers or for subjecting the equitization plan to due diligence review. Existing practice allows the management of the SOE to play a major role in formulating the equitization plan, which has raised conflicts of interest 14. Focus on corporatization without listing. Equitization and listing have been viewed as two separate exercises, and listing has not been considered a critical criterion during planning for equitization. Coupled with the lack of consideration for other qualitative factors, this has resulted in many equitized entities being too small to be listed. As most of these equitizations were internal, with employees and government taking almost 80% of the equitized shares, many SOE employees-cum-investors are stuck with illiquid assets. The situation is exacerbated by the recent decline in asset markets and the fact that workers often borrowed to purchase shares. 2. Constraints at the General Corporation Level

15. Difficulties in valuation. The valuation of general corporations is complicated by the need to value their shareholdings in subsidiaries that may be engaged in a wide spectrum of businesses, some of which may have been equitized and listed. The boards of management of equitized subsidiaries are generally quite autonomous and distinct from that of the general corporation, and the equitized subsidiaries are typically allowed to make business decisions
6

In August 2009, the Government issued instructions that all remaining general corporations should come under the Enterprise Law by converting into single-member limited-liability companies by 2010, with restructuring to follow later, including conversion into joint stock companies as appropriate.

4 themselves. Hence, it is difficult for others, such as strategic investors, to properly evaluate the extent of influence the general corporation has on the management of subsidiaries. 16. General corporations and large SOEs often face difficulty in documenting such details as design capacity, years of use, year of manufacture, etc., of machinery and equipment, much of which is obsolete and out of production. Valuating general corporations landholdings has also proved difficult. This creates difficulty in obtaining price quotations for enterprise assets as required by regulations. 17. Cumbersome size. Due to the large scale and complexity of operations, management in many general corporations has limitations in terms of skills and capacity to undertake the needed strategic and operational restructuring. In addition, the total value of some of the general corporations together with their subsidiaries may be too great for others, including staff and management and even many outside strategic investors, to acquire a meaningful holding during equitization. Figure 1 illustrates the structure of Song Da General Corporation (Song Da), a general corporation that has confirmed participation in the proposed facility. 18. Financial constraints. A major constraint on transforming general corporations has been the financial weakness of many of them. General corporations have relied on extensive borrowing from the Government and SOCBs to finance their operations, having virtually no access to capital markets. Most of the large SOEs and general corporations have very high debt, with debt-to-equity ratios frequently far in excess of 100%. This has severely constrained their ability to service their debts and contributed to the high number of nonperforming loans in the banking system. High indebtedness also implies that general corporations are ill-equipped to deal with risks and will not have the financial capacity to fund capital investments. The problem is exacerbated by much of the general corporation debt being high cost and short term. 3. Institutional and Capacity Constraints

19. Need to enhance debt resolution. The lack of effective resolution of nonperforming debts has brought stalemate and prolonged the remaining SOE divestitures. The Government established the Debt and Asset Trading Corporation (DATC) in 2003 to acquire and resolve nonperforming loans and uncollectible receivables owned by SOEs and to deal in and resolve interests received from SOEs upon equitization. To date, the recovery ratios of received debts are relatively low, equal to only 10% of total book value.7 Going forward, it will be necessary to consider the legal mechanisms, processes, powers, and financial resources of DATC. 20. DATC needs to improve its internal management, including developing its human resources and enhancing its information system. The current organization lacks important departments such as for internal audit, investment, public relations, and corporate restructuring. DATC needs to review its financial capacity relative to the size of nonperforming loans in the country and to outsource or otherwise obtain the industry-specific expertise necessary to devise workouts. 21. Enhancing management of state capital. In 2005, the Government established the State Capital Investment Corporation (SCIC) to manage state investments in enterprises and to invest and trade in state capital. The primary objectives of SCIC are to accelerate and enhance the effectiveness of SOE reform and to make the utilization of state capital more efficient. SCIC commenced operations in August 2006 and, by December 2007, managed an investment
7

Among 19,526 items of nonperforming assets, 14,764 items with total book value of D659 billion are considered to be irrecoverable (DATC. 2007. Operational Report. Ha Noi).

5 portfolio of 829 enterprises with a total book value of D7,710 billion. Three quarters of these enterprises are very small, with legal capital of less than D10 billion, and operate ineffectively. SCIC plans to divest state capital in more than 700 of these equitized SOEs. An optimal solution would be to enhance the value of the SOEs by restructuring them before divestment. However, such restructuring is difficult to implement, as SCIC is only one of the shareholders in the SOEs.

Figure 1: General Corporation: Song Da

Construction of Hydropower Dam Production of Industrial Products Other Production and Trading of Electricity Transportation Other construction (Road/Building/Bridge/etc.) Equitized (Y/N) Y Y Y Y Y Y Y Y Y Y Y Y Y Y Y Y Y Y Y Y Y Y Y Y Y Y Y Stock's name OTC SD2 SD3 SD4 SD5 SD6 OTC S12 SD9 SDT OTC SDJ OTC SIC OTC SJD RHC NLC OTC OTC OTC OTC VIS SDY OTC SDC SDA % of ownership per audited report 55.04% 74.29% 66.82% 64.00% 78.18% 50.63% 51.38% 52.60% 60.02% 51.33% 69.40% 53.33% 51.00% 42.8%# 51.00% 51.00% 56.88% 52.68% 53.38% 54.14% 58.93% 43.23% # 60.13% 53.33% 54.10% 51.00% 51.00% ($) Plan to be equitized # & Control > 50% Control < 50% Equitized (Y/N) Y Y Y Y Y Y n/a Y Y n/a Y Y Y Y Y Y Y Y Stock's name SD7 OTC SJE MEC SJS OTC OTC OTC OTC OTC OTC OTC OTC OTC OTC OTC SCC OTC % of ownership per audited report 34.39% 37.10% 37.10% 35.70% 36.00% 15.70% 30.00% 28.70% 51.81% 50.00% 41.00% 18.90% 16.50% 20.20% 15.80% 3.70% 38.00% 6.80%

Ministry of Construction Parent Company ($)

Dependant Accounting Members

Subsidiaries

Joint Venture/Associates

1. BOT eo Ngang Company ($) 2. Son La Hydroelectric Project Management 3. Tuyen Quang Hydroelectric Project Management 4. Se San 3 Hydroelectric Project Management 5. Se San 4 Hydroelectric Project Management 6. Pleikrong Hydroelectric Project Management 7. Huoi Quang Hydroelectric Project Management 8. Se Ka Man 1 Hydroelectric Project Management 9. Se Ka Man 3 Hydroelectric Project Management 10. Nam Chien Hydroelectric Project Management 11. Ban Ve Hydroelectric Project Management 12. Ha Long Cement Project Management 13. HH4 My Dinh Building Project Management 14. 1A Highway Project Management (detour in Ha Tinh) 15. General Company Office in Ha Noi 16. Song Da Vocational School ($)

1. Song Da 1 JSC 2. Song Da 2 JSC 3. Song Da 3 JSC 4. Song Da 4 JSC 5. Song Da 5 JSC 6. Song Da 6 JSC 8. Song Da 8 JSC 7. Song Da 12 JSC 9. Song Da 9 JSC 10. Song Da 10 JSC 11. Song Da 17 JSC 12. Song Da 25 JSC g Construction and Fire Protection JSC 14. Song Da Investment and Development JSC 15. Se San 3A JSC 16. Electricity Can Don JSC 17. Ryninh II Electric JSC 18. Naloi Electric JSC 19. Viet Lao Electric JSC 20. Nam Chien Electric JSC 21. Tra Xom Electric JSC 22. Song Da - Hoang Lien Electric JSC 23. VISCO JSC 24. Song Da - Yaly Cement JSC 25. Ha Long Cement JSC 26. Song Da Consulting JSC (Hanoi) 27. SIMCO JSC

1. Song Da 7 JSC 2. Song Da 27 JSC 3. Song Da 11 JSC 4. SUDICO JSC 5. Song Da Urban Investment, Construction and Development JSC 6. Song Da Jurong Construction JV 7. BOT Quoc Lo 2 JSC 8. Thanh Hoa - Song Da JSC 9. Song Da architechture consultancy JV - Ucrin 10. Song Da Garment JSC 11. Song Da Mechanical Assembling JSC 12. Northern Electricity Investment and Development JSC 13. Central Electricity Development and Investment JSC 14. Binh Dien Electricity JSC 15. Huong Son Electricity JSC 16. Cao Su Tan Bien Kampong Thom JSC 17. Song Da Cement JSC 18. Cao Su Phu Rieng JSC

n/a Not applicable OTC Over the counter

JSC = joint stock company, JV = joint venture, N = no, Y = yes. Source: Song Da General Corporation.

6 22. The effectiveness of the SCIC has been limited by the (i) lack of explicit criteria for handing over state interests in large enterprises and general corporations, which is done on a case-by-case basis by the Prime Minister's office; (ii) potential for conflict between SCIC and line ministries that reserve the right to appoint key people to the boards of management of equitized SOEs; (iii) inadequate regulatory framework on financial management in SCIC; (iv) lack of a clear strategy and role for SCIC; and (v) lack of training and inadequate institutional capacity in SCIC to manage investments and improve governance in the equitized SOEs. 23. Developing a clear strategy and role for SCIC is part of a vigorous, ongoing internal debate in the Government on how the state's assets in SOEs should be managed in the future. The particular trajectory of SOE reform in the past has left SCIC far from its envisaged role, saddled with many small SOEs with dysfunctional assets, even as it is unable to meaningfully absorb the state capital in the large general corporations to be transformed, some of which are several times larger than SCIC. Independent of the specific alternative decided by the Government, regarding both the management of its assets in SOEs broadly and specifically SCIC, implementation will require significant time, resources, and capacity development. The SRCGFP is well positioned to facilitate this process over the medium term. 4. Rationale

24. Country strategy. SOE transformation and reform is critical to reducing the dominance of inefficient state production, promoting private sector development, and enhancing economic growth. The slow progress of SOE equitization is disappointing. Yet the continued and declared commitment of the Government to SOE reform over several years has reduced by more than 50% the number of SOEs, starting from a base of more than 12,000 such enterprises in 1990. Most recently, the Government's Socio-Economic Development Plan (SEDP) 20062010 calls for diversifying ownership to improve the efficiency and competitiveness of SOEs. In addition to expanding the scale and scope of SOE equitization, the SEDP envisages narrowing and eliminating the role of ministries and other state entities in SOE governance and management. The Government issued in November 2006 a master plan to support the process of SOE reforms in 20062010,8 which was followed in December 2006 by Decision 1729/QD-TTg from the Prime Minister, which explicitly identified and listed general corporations for equitization by 2010. Since achievement has fallen far short of targets, the Government is reviewing the implementation status of its plans for SOE reforms and will need to develop another mediumterm plan for the period beyond 2010. In July 2009, the Prime Minister issued directive 854/CTTTg directing NSCERD, in collaboration with relevant agencies, to report to the Politburo by the end of the 2009 5-year and 10-year plans on how to restructure and reorganize general corporations and other SOEs to make them regionally and globally competitive. 25. ADB strategy. ADB strategy towards the SOE sector in Viet Nam has two defining characteristics: long-term support and responsiveness. ADB has been engaged with SOE reform since early on, with approval of the SOE Reform and Corporate Governance Program in 1999 supported by an Asian Development Fund (ADF) loan for $57 million equivalent and an ordinary capital resources (OCR) loan for $40 million.9 Two technical assistance (TA) projects were provided to facilitate program implementation. 10 Following program completion in
8 9

Prime Minister's Decision No. 263/2006/QD-TTg. ADB. 1999. Report and Recommendation of the President to Board of Directors on a Proposed Loan to the Socialist Republic of Viet Nam for the State-Owned Enterprise Reform and Corporate Governance Program. Manila. 10 ADB. 1999. Technical Assistance to the Socialist Republic of Viet Nam for Corporatization and Corporate Governance. Manila; and ADB. 1999. Technical Assistance to the Socialist Republic of Viet Nam for SOE Diagnostic Audit. Manila.

7 December 2003, new project preparatory TA was approved in 2006 for preparing the present facility.11 ADB has engaged in policy dialogue on SOE reform through annual poverty reduction and support credit (PRSC) programs. 12 ADB's country strategy and program 13 20072010 underlined SOE reform as central to its strategy for business development and private sectorled employment growth. The country strategy and program called for continued SOE reforms to reduce barriers to private sector development, corruption, and the misuse of public resources and to enhance transparency and corporate governance. 26. Responsive approach. ADB's approach to SOEs has been responsive to the evolving contours of the long reform process, which has been both complex and sensitive in Viet Nam, often requiring consensus at the highest levels of decision making. ADB's first loan addressed prevailing constraints, including the creation of a centralized government institution to formulate, coordinate, and lead the implementation of SOE reforms; adoption of a modern law on enterprises; divestiture of small enterprises and gradual reduction in shareholding in large and medium-sized SOEs; and promotion of commercialization of operations. A decade later, the context of SOE reform has altered, and new needs have emerged. While thousands of SOEs have been equitized, the remaining equitization and transformation is the more difficult part, concentrated primarily in general corporations. Most general corporations have completed equitizing many of their subsidiaries, but the equitization of the general corporation itself has proved to be a thorny problem. SOE reform is stymied by the lack of viable approaches to equitizing and transforming large general corporations. Through the SRCGFP, ADB is again introducing a timely catalyst into the SOE reform process by proposing a comprehensive approach to successfully equitize general corporations and transform them into globally competitive entities. 27. Comprehensive approach needed, including listing. Equitization is only one step in a successful transformation process for SOEs and needs to be complemented, even preceded, by a host of other steps, including strategic and business planning, corporate and financial restructuring, attracting investment and corporate financing, forming value-adding business partnerships or alliances, and implementing more transparent governance. Enhancing the market education of management and staff, modernizing management information systems and human resource development systems, and possibly listing on the stock exchange are additional steps and challenges that need to be addressed for effective and comprehensive transformation. Clarifying the roles of owners and management, improving corporate governance, developing financing accountability, and developing a focused business strategy are substantial challenges for most general corporations. The logical culmination of effective enterprise restructuring and transformation should be listing on the exchange. 28. Demonstrative role. Successfully transforming selected general corporations in the first stage of the proposed facility will provide a strong demonstration and a workable model for undertaking the transformation of other general corporations and thereby benefit the SOE reform process. This is well appreciated by MOF. To address qualitative aspects of SOE reform, the proposed model goes beyond mere equitization to comprehensive transformation of participating general corporations, combining refocused business strategy and operational
ADB. 2006. Technical Assistance to the Socialist Republic of Viet Nam for Preparing the State-Owned Enterprise Reform and Corporate Governance Facilitation Project. Manila. Due to delays in approvals from the Government, TA implementation started in July 2008. 12 The PRSC programs comprise several closely related activities jointly undertaken each year by development agencies to help the Government carry out policy reforms needed to successfully implement its poverty-reduction strategy. The World Bank coordinates PRSC activities. ADB joined the PRSC process in 2003 and has taken part in all PRSC activities since then. See ADB. 2008. Proposed Program Cluster and Loan for Subprogram 1 to the Socialist Republic of Viet Nam for Support for the Implementation of the Poverty Reduction Program V. Manila. 13 ADB. 2006. Viet Nam: Country Strategy and Program (20072010). Manila (September).
11

8 restructuring, improved governance, and corporate and debt restructuring to strengthen the general corporation balance sheet. 29. Selection of general corporations. The complexity of successfully and comprehensively transforming a large SOE makes it important to keep the pilot stage manageable by focusing on a select few. Equally important, it is critical that the selected general corporations themselves be fully and demonstrably committed to transformation, particularly in senior and middle management. Finally, it is critical that the Government be a partner in the effort and receptive to the outcomes and lessons of the pilot initiative for broader SOE reform. The Government needs to have unequivocal ownership in selecting the general corporations, their transformation program, and the outcomes and lessons. After consulting with several general corporations, the Government proposed an initial list of four general corporations for potential participation in the SRCGFP, from which two have been selected for the first tranche. The selection was based on the viability of debt restructuring and readiness, reflected in the expressed commitment to undertaking appropriate corporate, financial, and operational restructuring and approval from the general corporation's board of management and the line ministries concerned of the proposed restructuring. For future tranches, the participation of general corporations in the SRCGFP will be guided by (i) commitment and willingness to reform on the part of the general corporations themselves, their line ministries or agencies, and the Government; (ii) the relevance of the general corporations to ADB's country and sector strategies and to the Government's plans and strategy for the SOE sector; and (iii) the financial viability of the general corporations after restructuring, including their potential for listing.14 30. Lessons. Experience in the SOE sector has shown that strong corporate governance and financial discipline are essential to developing the private sector and capital markets. As the economy transforms and becomes more market based, these aspects need to be upgraded continuously, including through assistance in adopting corporate governance practices across the state and private sectors. Important factors in the success of the previous loan and TA for SOE reform were awareness and knowledge of the sociopolitical environment and sensitivities. 15 Ownership of the project should be ensured during design. The proposed initiatives should be viewed by the Government and its implementing agencies (IAs) as complementing their own reform efforts. ADB's experience with reform in Viet Nam has shown clearly that complex reforms require time and persistence, and that substantial learning and capacity building are needed at various stages of reform. Extensive consultations were undertaken with the Government in developing the SRCGFP, with numerous presentations made at all the agencies participating in the first stage. At general corporations, proposed initiatives for corporate and operational restructuring were presented to middle management and senior management, including boards of management. 31. Multitranche financing facility. The Government has requested ADB to support the reform and transformation of general corporations and the strengthening of institutions related to reforming SOEs. MFF is the appropriate modality for the SRCGFP for various reasons. Viet Nam's strategy and experience in transforming SOEs has the appearance to date of an excessively long fuse. Much of the state's capital remains unaffected several years after the
14

In August 2009, the Ministry of Construction submitted a proposal to the Prime Minister for consolidating five other general corporations in construction into an economic group managed by Song Da, which is participating in the first tranche of the SRCGFP. This initiative is positive recognition of the steps being taken by Song Da, is fully consistent with the measures proposed under the SRCGFP, and strengthens the rationale for the program. The first tranche of the SRCGFP will restructure Song Da, which will be the core of an expanded Song Da under the proposal of the Ministry of Construction. The expanded entity could be further supported under the next tranche. 15 ADB. 2004. Program Completion Report: State-Owned Enterprise Reform and Corporate Governance Program Viet Nam. Manila.

9 fuse was lit. Absent meaningful progress in restructuring general corporations, there is a possibility that the SOE reform process may go dormant at least over the medium term. The present juncture of the reform process, considering the complexity and difficulty of SOE reform in Viet Nam, requires both flexibility and commitment. This context informs the rationale for MFF as the most appropriate lending modality for the SRCGFP. It can allow the SRCGFP to benefit from flexibly adapting to lessons from the first stage by refining the approach for general corporation equitization and transformation, as well as to important longer-term decisions the Government will take relating to the pace and scope of general corporation equitization and the role of institutions addressing critical functions, such as debt resolution and the management of state capital. A program loan cluster would be less able to address the needed flexibility and commitment of long-term ADB involvement because of its emphasis on policy conditions, while what is needed are resources for SOE restructuring. A sector development loan would also be less appropriate because of the diversity of sector coverage envisioned under the SRCGFP. 32. Credibility. The sustained ADB support for SOE reform over the long haul signaled by the MFF will be significant not only for the Government, but also for other donors and potential investors in the sector. The commitment conveyed in the longer MFF horizon will facilitate deeper ADB engagement with the Government as it plans and implements the next phase of SOE reform. This engagement could be broadened through ADB interacting with the Government on program-related policy reforms for the SOE sector under the annual PRSC process. 33. Multitranche financing facility requirements. The SRCGFP fulfills the requirements for using the MFF modality. As MFF requirements are oriented towards projects that undertake physical investments, the present facility is atypical, since there is no creation of new physical assets. It is instead an equitization and restructuring project geared to facilitate the Government's longstanding program for transforming its large SOEs and general corporations. This will require implementation by many enterprises under several ministries and agencies of the Government. The SRCGFP is thus an innovative expansion in the scope of MFF modality in terms of applicability. 34. Road map. The Government has a road map for transforming the SOE sector through equitization, seeking to combine or follow equitization with listing, attracting new capital into SOEs, increasing their efficiency, and narrowing the role of the state in SOE management. The road map is supported by policy and legal frameworks. As part of its road map, the Government initially focused on equitizing smaller SOEs to test and refine the process. Subsequently, the Government aggregated many SOEs into general corporations and sought to define and develop a parentsubsidiary company model for them. The Government has since focused on equitizing and transforming general corporations, while identifying with greater clarity areas or sectors that it intends to retain under full control (e.g., those deemed to be of strategic importance, such as defense and telecommunications). In others, while mostly retaining its stated objective of majority ownership even in listed entities, the Government has also relaxed the ceiling shares of private investors, including foreign investors. Equitizing and transforming general corporations is the next challenge. The Prime Ministers decision 263/2006/QD-TTg provided a plan for 20072010 for equitizing general corporations in terms of the year specific general corporations would be equitized, but it is unlikely that the target of even narrowly defined equitization of all general corporations will be achieved by 2010. Comprehensive transformation of the large general corporations into efficient, competitive corporations maximizing value for shareholders is likely to take substantially more time and resources. The Prime Minister has now issued directive 854/CT-TTg, dated 19 June 2009, asking NSCERD to initiate a review of SOE reforms to date and to prepare a plan aligned with the next SEDP, to 2015. Based on the review and assessment of reforms, the Prime Minister's directive asks for

10 proposals to improve SOE management efficiency and profitability after equitization. The broad elements of the plan are likely to remain consistent with the existing road map, equitizing all remaining SOEs and general corporations, seeking to combine equitization with listing, attracting new capital into the state enterprises, and increasing production and business efficiency. 35. Strategic context and policy framework. SOE reform has been a significant component of the national strategy and ADB strategy. The impact and outcomes of the proposed facility are consistent with the country partnership strategy for Viet Nam. The Governments vision has been clearly articulated as aiming to reorganize, renew, and restructure SOEs to improve their efficiency, adaptability to market mechanisms, and competitiveness in the context of global economic integration. The Government's policy framework endorses the principle of eliminating the role of line ministries in managing SOEs; separating the ownership and management of general corporations; and enhancing their transparency, accountability, professionalism, and operational efficiency. The Government has also developed a comprehensive legal framework for SOE reform (see para. 3). The policy framework will nevertheless need to be strengthened as SOE reform gradually moves into the post-equitization phase. In particular, the Government will need to review the framework for ownership of the state's interest in economic organizations to facilitate the necessary separation of ownership from management of large SOEs and general corporations. There is a need to review and reestablish the role and structure of the SCIC as the holder of the states investments in economic organizations to help enhance accountability, transparency, and the implementation of governance processes. 36. Investment program. The SRCGFP will support general corporations under various ministries at different stages of readiness. Their investment requirements will need to be assessed, including for operational restructuring, and these needs will depend on what the proposed new structures are. An investment program has been estimated based on an assessment of available data on the financing needs of general corporations that may reasonably be expected to undergo transformation in the medium term, until 2015. A third of the estimated financing requirements of $1.77 billion will be generated from general corporations and strategic investors, with the remaining resources divided roughly evenly between the Government and ADB. 37. Development Partner Coordination. The importance of successful SOE reform to the economy generated significant development partner interest in the sector, particularly during 20002005 (see Appendix 3). Danish International Development Aid (DANIDA) and the Department for International Development of the United Kingdom provided capacity building and other technical support to NSCERD until 2004. The International Finance Corporation supported, along with DANIDA, the pilot equitization and restructuring of SOEs, and the World Bank was involved with support for labor redundancy issues in restructured SOEs until 2005. The World Bank administered a large project to support the auditing of 100 major SOEs during 20012005, which was also funded by the European Union and DANIDA. Several development partners, including the French, Swiss, and German aid agencies, have been active with the reforms of SOCBs. SOE reform is always discussed in the context of the annual PRSC process led by the World Bank and supported by a number of development partners including ADB. The Consultative Group meetings on Viet Nam held twice a year always include SOE reform as part of the agenda. ADB has participated in the Article IV consultation mission of the International Monetary Fund, which is also engaged in policy dialog with the Government on SOE reforms. However, development partner participation in the SOE sector at the project level has waned in relative terms in recent years; the present support from ADB is thus a timely initiative for promoting the reform of the SOE sector.

11 III. THE PROPOSED FACILITY

38. The facility for up to $600 million in OCR and $30 million in ADF resources will directly support the Government's agenda for SOE reform and transformation through a comprehensive package involving the strengthening of general corporation balance sheets through corporate and financial restructuring and enhancing operational efficiency and corporate governance.16 Debt restructuring will enable general corporations to strengthen their balance sheets by swapping high-cost, short-term loans for cheaper, longer-term debt, thereby improving cash flow and their debt-servicing capacity, freeing resources for productive activities. Corporate restructuring will enable participating general corporations to exploit economies of both scale and scope by merging several small joint stock subsidiaries into larger entities organized along the same lines of business, combined with divestiture of non-core business units. Additionally, operational efficiency will be enhanced by management restructuring to strengthen corporate management processes and improve governance (see Figure 2). The thrust of the SRCGFP is improved profitability and efficiency in general corporations from operational restructuring, which is the main source of the Program's economic benefits. At the same time, debt restructuring is crucial to enhancing the financial viability of restructured enterprises. OCR will be used to support financial and corporate restructuring, while operational restructuring and improved corporate governance will be supported by the complementary loan component funded from ADF resources. The facility will also provide support for institutions and agencies playing key roles in facilitating SOE reform. A. Impact and Outcome

39. By enhancing SOE reform, the proposed SRCGFP will improve the profitability and transparency of equitized and restructured SOEs, including large general corporations and their subsidiaries. Enhanced SOE profitability will augment the state's financial resources for development and facilitate improved policies for increasing the market orientation of the economy. The expected outcome will be the transformation of several general corporations and their subsidiaries into focused, efficient businesses with strong balance sheets and improved corporate governance. By developing a successful and sustainable model for general corporation transformation, the SRCGFP will renew direction and focus for further SOE reform. B. Outputs

40. The SRCGFP has three main outputs to support SOE reform: (i) restructuring general corporation debt through financial and corporate restructuring; (ii) increased operational efficiency and improved corporate governance in participating general corporations; and (iii) strengthening and enhancing the governance of institutions supporting key aspects of SOE reform, particularly those facilitating the resolution of nonperforming debts and managing state capital in SOEs.17
16

Three types of restructuring are discussed. First, corporate restructuring deals with techniques such as debtequity swaps, capital reductions, new share issues, etc., that change the corporate structure to make it more efficient. Second, financial restructuring generally refers to rescheduling debts, debt forgiveness, debt reclassification, and other techniques that address the companys ability to make principal and interest payments. Corporate restructuring and financial restructuring are jointly referred to here as debt restructuring. Lastly, management or operational restructuring addresses issues such as product quality, product lines, production capability, marketing strategies, production techniques, personnel issues, management changes, and other changes in the operations of the company. 17 The Government has yet to decide on the future role of SCIC. Alternative models for managing equitized state capital are being debated within the Government, and no decision is likely before 2010 at the earliest. The facility can provide support in subsequent tranches to SCIC or any alternative considered by the Government for managing state capital in SOEs.

12

41. Debt restructuring. To address excessively high debt-to-equity ratios and the resulting poor cash flows, the participating general corporations will restructure and strengthen their balance sheets through financial and corporate restructuring. Expensive, short-term debt will be converted into long-term debt with lower interest rates, improving cash flows. Loans identified for restructuring can be to either general corporations or their subsidiaries, but no nonperforming loans will be restructured. Further, corporate restructuring will strengthen general corporation balance sheets while enabling them to exploit economies of scale and scope. All subsidiary companies engaged in the same strategic business will be grouped under subholding companies to be established via share swap and/or buyback arrangements. Subsequent tranches of the facility may consider the use of equity financing and guarantees to facilitate debt restructuring in participating general corporations.

Figure 2: General Corporation Transformation under SRCGFP

Comprehensive review of financial and operational parameters; identify core business areas; analyze strengths and weaknesses; and develop a plan to strengthen balance sheet, business processes, and corporate governance Approval of the transformation plan by apex entity, line ministries, MOF, and the Prime Ministers Office

Preparation for participation in SRCGFP

Financial restructuring, included debt resolution and asset reclassification; corporate restructuring; and operations restructuring (supported by ADB loans) Sub-holding companies aligned with core business areas created that are equitized/ already listed; general corporation becomes pure investment holding company Post-restructuring strengthening (corporate governance, MIS, business strategy, training) Efficient, competitive and profitable general corporation with access to capital markets; Listing on stock exchange if necessary MIS = management information system, MOF = Ministry of Finance, SOE = state-owned enterprise. Source: Asian Development Bank.

SRCGFP participation and support

42. Operational restructuring and enhanced corporate governance. Comprehensive operational or management restructuring will complement debt restructuring to enhance efficiency and corporate governance in general corporations, which will refocus business operations by defining limited core business lines, create sub-holding companies for each business line, and divest non-core operations. Existing subsidiaries will be organized into sub-

13 holding companies, and the charter of sub-holding companies will be aligned with the provisions of the model charter issued by MOF upon listing. Management of companies engaged in the same industry will be centralized in sub-holding companies. Consistent management practices and business processes will be introduced across the group, and financial and management reporting and information technology systems will be standardized. Guidelines and best practices will be introduced for internal audit and enterprise risk management, and manuals and standard procedures will be established for all key processes. Human resource systems will be modernized, and capacity will be built by training workers and managers in key areas like corporate governance, enterprise risk management, and project management. 43. Institutional development. The SRCGFP will strengthen institutions supporting key aspects of SOE reform and improve their governance, such as institutions facilitating the resolution of nonperforming debts and managing state capital in the SOE sector. ADF lending will be used under tranche 1 to (i) develop a training program for DATC personnel and enterprises under DATC; (ii) organize training on debt resolution, corporate restructuring, corporate governance, and investment analysis and management; (iii) develop an appropriate organizational structure with job descriptions for each management position; (iv) establish an internal audit and develop best practices and guidelines; and (v) develop and implement enterprise risk-management processes. C. Special Features

44. Onlending by the Government. Loans under the facility will be provided to the Government of Viet Nam for onlending to general corporations and other institutions. Loans from ADBs OCR will be used to strengthen general corporations' balance sheets through corporate and financial restructuring. Loans from ADF will also be onlent, but for carrying out management restructuring to improve operational efficiency and corporate governance. For the loan from OCR, the Government will onlend the full amount of the ADB loans to participating general corporations in the same currency as in the primary loan agreement between ADB and the Government. The subsidiary loans between the Government and the participating general corporations will have the same terms as the primary loans from ADB to the Government, plus other costs determined by the Government and acceptable to ADB. ADB can help general corporations to mitigate the exchange and interest risks through London interbank offered rate (LIBOR)-based lending conversion options, subject to the necessary approvals from the Government and appropriate market conditions. Implementation arrangements will generally ensure that the funds used for financial restructuring will be transferred, following endorsement by MOF, directly from ADB to the creditor banks of the participating general corporations. 45. Corporate restructuring of general corporations. A general corporation will first define its strategic focus for each business segment it is engaged in and then establish a subholding company for each of identified business segments and align all subsidiary companies engaged in the same industry under it. The sub-holding company can be an existing wholly owned subsidiary or an existing listed subsidiary. The sub-holding company will align the companies engaged in the same industry under it by merging the operation of subsidiaries via share swaps or buybacks. The general corporation will push down all its existing businesses to subsidiaries and consider divesting its investments in non-strategic businesses. This will result in the general corporations only business being holding investments in sub-holding companies (Figure 3).

14

Figure 3: Proposed Operational Restructuring of General Corporations under the SRCGFP

GC = general corporation. Source: Asian Development Bank.

46. Operational restructuring. Participating general corporations will centralize the management of companies engaged in the same industry and operate with a common strategic focus by pooling executives engaged in a particular industry into the sub-holding company. The sub-holding company will be the management agent for wholly owned subsidiaries. If it is not possible to appoint the sub-holding company as the management agent for partly owned subsidiaries, personnel from the sub-holding company will be seconded to manage the subsidiary's operations. Based on the strategic direction set by the general corporation, the subholding company will establish standard procedures and processes for each business segment and define and develop strategies for all subsidiaries. Companies within a subgroup will operate with a common strategic focus, eliminate duplication of resources and conflict of interest, and enjoy economies of scale, thus maximizing value (box). 47. Capital market development. The post-restructuring sub-holding companies depicted in Figure 3 are joint stock companies, some of which may already be listed. The outcome of the restructuring will thus be a general corporation comprising subgroups of companies that can operate independently; secure financial resources from the market on their own, without having to rely on support from the Government; and meet all quantitative and qualitative conditions for eventual listing. The equitization of the general corporation is thus achieved through the equitization or even listing of the sub-holding companies. By listing the sub-holding companies, the general corporations will be able to source financing on their own, thus relieving the state of further financial burden.18 In essence, general corporations will have helped shift credit risk off MOF and the Government onto the market. The creation of such large iconic enterprises listed in the local bourses will increase the supply of quality securities and aggregate market
18

SOE finances, including the MOF's onlending to them, are off budget. However, MOF includes its onlending to SOEs in off-budget expenditure and lending in the budget reports. Once equitized, SOEs will come under Enterprise Law and be treated like any other enterprise. The Government's contingent liabilities arising from ownership of SOEs and SOCBs are likely to be far less than the Government's share of assets.

15 capitalization, develop the capital market, attract local and foreign investors interest, and build their confidence. Box: Select Elements of General Corporation Corporate and Operational Restructuring
Corporate restructuring - Define the key business segments. - Identify sub-holding companies for each segment. - Establish strategic direction of various sub-holding companies. - Consolidate similar business units under a single sub-holding company by means that include share swaps and buybacks, which will need share valuation and valuation of general corporation assets to be transferred to subsidiaries, special audits, and appointment of merchant bankers. - Identify non-strategic holdings in associated companies for disposal. Management restructuring Strategic planning - Develop a strategic plan for each business segment. - Establish budget and forecast and key performance indicators. Improve management structure - Develop an appropriate organization chart in line with the new corporate structure. - Develop descriptions of jobs and responsibilities for each executive position in the general corporation, sub-holding companies, and subsidiaries under the new management structure. - Develop and implement financial reporting of subsidiaries to sub-holding companies and from subholding to holding companies. - Devise improvements to the financial closing process with a view to addressing all audit qualifications, shortening the period to prepare monthly management and financial reports and annual financial statements of the general corporation, and all business segments. Improve corporate governance - Undertake diagnostic review and propose improvements. - Introduce a manual and procedures for the board of management. - Develop a manual for corporate policies and procedures. - Promulgate a code of ethics for directors, managers, and staff and set qualitative criteria for recruitment and performance evaluation. - Introduce best practices and guidelines for internal audit and risk management. - Train staff on corporate governance. Human resource development - Introduce a staff competency model and learning map for all levels in all segments. - Train staff. Improved information management system Source: Asian Development Bank.

48. No new physical investments. No direct investment of funds is expected from the Government to further general corporation transformation under the SRCGFP. Instead, resources will come from other sources such as the internal funds of the general corporations themselves, capital markets, outside investors, and donors. The investment plan for the SRCGFP addresses general corporations that have indicated or will indicate interest in participating in the facility. Four general corporations have already indicated interest, of which two have confirmed participation in the first tranche and two others have indicated readiness in the subsequent tranche. The first tranche of the SRCGFP is intended as a pilot to demonstrate transformation models that work and that can be replicated across other large SOEs. The investment plan of the SRCGFP is, to that extent, endogenous to the implementation of the facility, as the extent to which general corporation transformation in the pilot is a demonstrated success will clearly affect the interest and commitment of other general corporations to participate in the facility. Similarly, the financing plan, particularly the role of capital markets and outside investors, will be endogenous to SRCGFP implementation.

16 49. Public debt sustainability. The most recent debt-sustainability analysis,19 conducted jointly by the International Monetary Fund and the World Bank with ADB participation, notes that public and publicly guaranteed external debt is likely to remain manageable, while domestic public debt management may become more challenging due to the increase in ratios of debt service to revenue, reflecting lower oil revenues over the medium term. A special risk is posed by contingent liabilities associated with SOCBs and SOEs that have traditionally relied on borrowing from SOCBs. An earlier analysis simulating SOCBs losses on the order of 8% of gross domestic product, which would require an issuance of government bonds for recapitalization, found this would not undermine debt sustainability over the medium term but would affect the dynamics of debt, interest rates, and other variables. 20 This result is robust for more extreme scenarios of possible SOCB losses. The latest debt-sustainability analysis also confirms that an increase in debt-creating flows by 10 percentage points of gross domestic product would not destabilize the debt profile over the longer term. D. Cost Estimates and Financing Plan

50. Total SOE sector investment needs for equitizing general corporations and large SOEs are estimated at $1.77 billion equivalent over 20092015, as shown in Table 2. Detailed cost estimates and the financing plan for tranche 1 are in Appendix 4.
Table 2: Cost Estimates for the Investment Program, 20092013 ($ million) Investment Program Component Sector Investment Plan A. Debt Restructuring a 1,090 B. Management Restructuring 130 C. Institutional Development b 550 1,770 Total
a b

Includes financial and corporate restructuring. Includes the transfer of shares of equitized general corporations from the Government to the State Capital Investment Corporation or its equivalent Source: Asian Development Bank estimates.

51. The Government has requested up to $630 million equivalent through an MFF to help finance the SRCGFP. The MFF will comprise up to $600 million equivalent from ADB's OCR. ADB will use OCR to support financial and corporate restructuring in participating general corporations. 21 All provisions of ordinary loan regulations applicable to ADB's LIBOR-based loans will apply to each loan, subject to modifications, if any, that may be agreed in the framework financing agreement (FFA), supplemented by any loan and project agreements. The Government has provided ADB with (i) the reasons for its decision to borrow under ADBs LIBOR-based lending facility on the basis of these terms and conditions and (ii) an undertaking that these choices were its own independent decision and not made in reliance on any communication or advice from ADB. The Government will onlend the full amount of ADB's OCR loan to participating general corporations. The onlending from the Government to the general corporations will be in the same currency as in the primary loan from ADB to the Government and match ADB's lending terms for the Government, plus other costs determined by the
19 20

IMF. 2008. Viet Nam: 2008 Article IV Consultation. IMF Country Report No. 09/110. Washington, DC (April 2009). IMF. 2006. Viet Nam: 2006 Article IV Consultation. IMF Country Report No. 06/421. Washington, DC (November 2006). Recent stress tests by Fitch to simulate the impacts of a weakening economic environment on the banking system, assuming nonperforming loans of up to 20%, find most of the banks remaining solvent while lesscapitalized and more exposed SOCBs would need additional capital. Fitch Ratings. 2009. Vietnamese Banks: Focus on Asset Quality, Three Stress Scenarios. Viet Nam Special Report. Ha Noi (February 2009). 21 Bank charges such as bank transfer fees will be eligible for financing.

17 Government and acceptable to ADB. The financing plan for the SRCGFP and tranche 1 is in Table 3. 52. ADB loans will restructure existing financial assets. No new physical assets will be created from the OCR component of the facility, which will be lent to general corporations through MOF to restructure their existing debt and thereby enhance cash flows and strengthen balance sheets. The loans will be a relatively small proportions of general corporations total assets and liabilities. For example, tranche 1 will support 2 general corporations, Song Da and Southern Waterborne Transport Corporation (Sowatco), through OCR loans of $117.5 million and $2.5 million. As of 31 December 2007, Song Da's total assets were $1.35 billion and liabilities were $971.5 million. Similarly, Sowatco's assets of $48 million were several times the proposed loan. Counterpart funding from the general corporations therefore far exceeds the 90/10 requirement for project financing in Viet Nam. While, under existing regulations, the OCR loan will be onlent to the two general corporations in foreign currency, Song Da can mitigate its exchange risk with revenues from its current and planned operations in neighboring countries. Table 3: Financing Plan
Source ADB Ordinary Capital Resources ADB Asian Development Fund Governmenta General Corporationsb Strategic Investors and/or Othersc Total Tranche 1 ADB Ordinary Capital Resources ADB Asian Development Fund Total Amount ($ million) 600 30 550 100 490 1,770 120 10 130 Share of Total (%) 33.9 1.7 31.1 5.6 27.7 100.0 92.3 7.7 100.0

Includes transfer of government ownership in equitized general corporations into the State Capital Investment Corporation or its equivalent. b Includes internal resources and capital market and other borrowings. c The demonstrative aspect of first tranche project may attract other donors later participation. Source: Asian Development Bank estimates.

53. The Government has asked ADB to provide $30 million equivalent from ADF resources to support operational restructuring in participating general corporations and to strengthen institutions critical to the SOE reforms, such as DATC. The ADF loan under the first tranche of the facility will have the rate of 1.0% per annum during the grace period and 1.5% per annum thereafter; a term of 32 years, including a grace period of 8 years; and such other terms and conditions as are substantially in accordance with those agreed in the FFA, supplemented by loan agreements. The Government will onlend the full amount of the ADF loan to participating entities in the borrowing currency or in dong, with lending terms the same as those between ADB and the Government, plus other costs determined by the Government and acceptable to ADB. The allocation of the ADF resources will be subject to (i) the general availability of ADF resources, (ii) Viet Nam's access to such resources pursuant to ADB' policy 22 and the requirements of the ADF donors, and (iii) the availability of such resources to Viet Nam pursuant to ADB policy.23

22 23

ADB. 1998. A Graduation Policy for the Bank's DMCs. Manila ADB. 2001. Policy on Performance-Based Allocation for Asian Development Fund Resources. Manila.

18 54. The MFF will consist of individual loans to finance a range of subprojects in the SRCGFP to equitize and transform general corporations and strengthen institutions supporting SOE reforms, subject to the Government's submitting periodic financing requests (PFRs) and execution of related loan and project agreements. Details of the selection criteria for general corporation participation in future tranches and approval procedures are in Appendix 5. The Government has entered into an FFA with ADB and is required to comply with its requirements. Pursuant to the FFA, the Government has submitted to ADB the first PFR, comprising an OCR loan for $120 million equivalent and an ADF loan for $10 million equivalent. The allocation and function of the first tranche loans is shown in Figure 4. Figure 4: Flow of Funds in Tranche 1
OCR Loan Debt restructuring Song Da $117.5 million

ADB OCR Loan $120 million

Government of Viet Nam $120 million

Sowatco $2.5 million

ADF Loan $ equivalent SDR

Song Da $6.6 million Government of Viet Nam $10 million D or $ Sowatco $0.7 million DATC $2.7 million

Enhancing operational efficiency by management restructuring

ADB ADF $10 million

ADB = Asian Development Bank, ADF = Asian Development Fund, D = dong, DATC = Debt and Asset Trading Corporation, OCR = ordinary capital resources. Source: Asian Development Bank.

E.

Implementation Arrangements 1. Investment Program Management

55. MOF will be the Executing Agency (EA) for the facility and responsible for the supervision and execution of the SRCGFP, including but not confined to preparing the PFR; inter-ministry coordination as needed; program monitoring and evaluation; and preparing quarterly and annual progress reports. Immediately following the approval of the facility, MOF will establish a program management unit and a facility steering committee (FSC) to monitor the implementation of the SRCGFP. The FSC will consist of representatives of relevant government agencies and be headed by the vice minister of MOF. For the first tranche, Song Da, Sowatco, and DATC will be the IAs. IAs in subsequent tranches will be participating SOEs, general corporations, and/or Government agencies promoting SOE reform. The first-tranche project involves comprehensive reforms to be undertaken by both Song Da and Sowatco regarding corporate, management, and financial restructuring. The SRCGFP will also enhance the

19 operational efficiency of DATC in facilitating and supporting SOE reform. Operational restructuring at the three IAs will be facilitated by consultant services and supervised by their boards of management. 2. Subproject Selection, Preparation, and Approval Procedures

56. The preparation and appraisal of subprojects to be included in the first PFR is completed. For subprojects under the subsequent loans of the SRCGFP, an approval procedure, as outlined in Appendix 5, has been agreed. After ADB's approval and subject to any modification measures required by ADB, MOF will prepare PFRs for ADB financing. The Government will formally submit the PFRs to ADB for further processing. Each PFR will provide (i) the required loan amount; (ii) the subprojects and components to be financed under the loan; (iii) cost estimates and a financing plan; (iv) implementation arrangements; (v) confirmation of the continuing validity of and adherence to the provisions of the FFA; (vi) confirmation of compliance with provisions under previous loan and project agreements, as appropriate; and (vii) other information required under the facility administration memorandum to be prepared and agreed by ADB and the Government to facilitate processing and implementing the facility. 3. Implementation Period

57. The utilization period for the facility will be from December 2009 to 31 December 2015. No PFRs will be accepted after this date, though disbursements of approved PFRs will be allowed until the completion of the projects included for implementation in the last PFR. The implementation period of each tranche or loan is expected not to exceed 3 years. 4. Procurement, Consulting Services, and Disbursement

58. The facility will involve two ADB lending sources: (i) OCR loans that will be used solely for corporate and financial restructuring in participating general corporations and (ii) concessional funding from ADB's ADF window for carrying out management restructuring and capacity building in participating general corporations and other Government institutions related to SOE reforms, to enhance their operational efficiency or role in supporting SOE reform. The use of ADF resources will be subject to availability based on changes arising from existing project cycles, annual performance-based allocation, and other considerations. 59. The ADF loan will be used exclusively for operational restructuring, enhancing governance, and building capacity in participating general corporations and institutions. Expenses will consist primarily of consulting services to implement restructuring and equipment for information management. In the first stage, ADF proceeds will be used solely for meeting the expenses to be incurred, or incurred within the provisions of retroactive financing of ADB, by Song Da and Sowatco for undertaking agreed management restructuring and corporate governance strengthening and by DATC for enhancing its operational efficiency, as agreed with ADB. Except as ADB may otherwise agree, the three IAs shall each establish, immediately after the effective date, an imprest account for the ADF funds, to be managed by the three IAs at a commercial bank acceptable to ADB and to be used solely for the purposes stated above. The imprest accounts shall be established, managed, replenished, and liquidated in accordance with ADB's Loan Disbursement Handbook (2007, as amended from time to time) and detailed arrangements agreed between the Government as the Borrower and ADB. The currency of the imprest account shall be US dollars. For each IA during each tranche of the facility, the imprest amount should not exceed (i) the estimated expenditure to be financed through the imprest account for the next 6 months of project implementation or (ii) the equivalent of 10% of the subsidiary loan amounts to be financed from ADF resources, whichever is less. For each

20 tranche, claims under retroactive financing for expenditures incurred during the past 12 months before loan signing will need to be certified by the auditors of the general corporation submitting the claim and endorsed by the Borrower. 60. All goods financed under the SRCGFP will be procured in accordance with ADBs Procurement Guidelines (2007, as amended from time to time).24 Consultants will be selected in accordance with ADBs Guidelines on Use of Consultants (2007, as amended from time to time). Consulting firms will be selected by quality and cost (80:20). Short-term specialized tasks deemed necessary and arising during or following the implementation of restructuring may be undertaken by individual consultants. 61. Disbursements will be according to ADBs Loan Disbursement Handbook and detailed arrangements agreed among the Government, EAs, IAs, and ADB. Equipment purchased will be primarily for establishing or enhancing an information management system, including software and hardware and its installation. The size of any single contract for the information technology system and its component will not exceed $1 million equivalent. Disbursements for equipment and services will be made by direct payment and commitment procedures. The statement of expenditures procedure will be used to reimburse eligible expenditures and liquidate advances to the IAs. Records will be maintained to substantiate the payments made through statement of expenditures, which will be limited to $100,000 per payment. The IAs will prepare withdrawal applications and submit them to MOF for endorsement. 62. For the first tranche, OCR disbursement will follow the development of a plan for operational restructuring and improved corporate governance and will be based on the debt restructuring schedule of both Song Da and Sowatco, as agreed with ADB. The Government being the borrower, it will onlend the loan proceeds to Song Da and Sowatco solely for the purpose of restructuring their debts. Except as ADB may otherwise agree, ADB will transfer the loan proceeds to the creditor banks of the debts to be restructured in the books of Song Da and Sowatco against valid requests made by Song Da and Sowatco, supported by resolutions from their boards of management and endorsed by MOF. 5. Retroactive Financing

63. Under each loan of the facility, except as otherwise agreed with ADB, eligible expenditures incurred before each loan takes effect but not earlier than 12 months before the loan agreement is signed, and incurred directly for the purpose of operational and corporate restructuring, will qualify for retroactive financing, up to 20% of the proposed loans. The Government has been advised that ADB's approval of retroactive financing does not commit ADB to finance projects under the facility. 6. Anticorruption Policy

64. ADBs Anticorruption Policy (1998, as amended to date) was explained to and discussed with the Government and the EA. Consistent with its commitment to good governance, accountability, and transparency, ADB reserves the right to investigate, directly or through its agents, any alleged corrupt, fraudulent, collusive, or coercive practices relating to the SRCGFP. To support these efforts, relevant provisions of ADBs Anticorruption Policy are included in the loan agreements and bidding documents for the SRCGFP. In particular, all contracts financed by ADB in connection with the SRCGFP shall include provisions specifying the right of ADB to

24

A procurement plan is provided in Supplementary Appendix H and in the periodic financing request.

21 audit and examine the records and accounts of MOF and all contractors, suppliers, consultants, and other service providers as they relate to the SRCGFP. 65. The fiduciary risks of the current public financial management system are assessed as moderate. ADB participated with the World Bank, MOF, and other development partners in preparing a country financial accountability assessment update in 2008 that examined budget development, execution and accounting, internal and external reporting, internal controls, internal and external auditing, monitoring and legislative oversight and scrutiny, and financial accountability risks. Viet Nam has pursued many initiatives to strengthen its financial management and accountability arrangements, systems, and controls. Steady progress has been made in establishing the legislative framework to support PFM reforms. Major public finance management systems are being upgraded and replaced. 66. A financial management assessment of the IAs for tranche 1 found their financial systems adequate (Supplementary Appendix G). It assessed each of the three IAs in the key areas of staffing and organization of the accounting department; accounting standards, policies and procedures; budgeting systems; payment systems; cash and bank policies; safeguards over assets; internal and external audits; information systems; and reporting and monitoring. 67. The disbursement arrangements ensure that the OCR loans used for restructuring bank loans will be paid directly to creditors upon fulfillment of release procedures by the IA and MOF. ADF loans may be disbursed directly to consultants and other service providers under the direct payment procedure. 7. Accounting, Auditing, and Reporting

68. The IAs will (i) maintain accounting, management information, and financial control systems acceptable to ADB; (ii) maintain independent auditors from auditing firms licensed to operate in Viet Nam and acceptable to ADB and authorize them to submit financial statements to ADB at least annually; and (iii) give ADB representatives access to all sites where its activities are conducted, as well as to its books, accounts, and records. The deadline for submitting audited accounts will be 6 months from the end of each fiscal year. A separate audit opinion will be issued on the use of the imprest account. 69. For each tranche of the facility, project progress and performance will be monitored by the FSC, which may draw upon representatives of each of the participating IAs or their line ministries, if appropriate. The FSC will use a comprehensive system for monitoring project performance. Each IA will submit biannual progress reports to the committee recording (i) progress made, (ii) problems encountered during the review period, (iii) steps taken or proposed to remedy the problems, (iv) a proposed program of activities, and (v) progress expected in the following 6 months. The committee and MOF will ensure that these reports are submitted to ADB in a timely manner. Within 6 months of physical completion of a tranche, MOF and the IAs will submit to ADB a project completion report describing (i) the progress of the tranche subprojects in terms of the three main components, i.e., corporate, management, and financial restructuring; (ii) the results of capacity building; (iii) a preliminary assessment of the benefits achieved; and (iv) other project implementation matters requested by ADB. 8. Investment Program Reviews

70. ADB will field inception missions within 3 months of approval of the loan(s) for each tranche and at least two review missions per year. The Government and ADB will jointly undertake a midterm review of the SRCGFP in 2011 that will focus on (i) program impact, (ii) the

22 outcomes of tranches implemented or under implementation, (iii) progress on the policy framework, (iv) the status of compliance with undertakings in the FFA and covenants in individual loan agreements, and (v) any need for midcourse changes in the scope or schedule of the SRCGFP to ensure full achievement of impact. IV. A. PROGRAM BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS

Economic and Financial Analyses

71. Both general corporations participating in tranche 1 have diversified operations. The Song Da group of companies is engaged mainly in four business segments: hydropower plant construction, power trading, property development, and industrial production. Under the proposed corporate restructuring, activities of the general corporation will be shifted to the appropriate subsidiaries and the subsidiaries will be grouped under four sub-holding companies. Each sub-holding company and its subsidiaries will focus on one of the four business segments, while the parent general corporation will become more of a holding company. Similarly, Sowatco is engaged mainly in providing logistics-related services. Under the proposed corporate restructuring, the activities of Sowatco will be shifted down to appropriate subsidiaries engaged in similar businesses, and non-core activities will be disposed off. Subsequently, Sowatco will serve as a holding company with subsidiaries involved in providing logistics-related services, ranging from port services, bulk handling of rice through buy and sell arrangements, and river barge transport. 72. ADB will finance operational restructuring through the ADF loan and corporate and debt restructuring through the OCR loan. There will be no physical investments under ADB lending, and no new assets will be created. Many projects at various stages of implementation underlie the debts to be restructured under the SRCGFP. It is thus neither feasible nor meaningful to calculate financial internal rate of return and net present value for each of these projects. Instead, return on capital employed for each of the subgroups or sub-holding companies is calculated. The overall financial viability of the restructured Song Da and Sowatco is established by appraising the financial position of each of the sub-holding companies and their subsidiaries. The weighted average cost of capital is calculated for each subgroup and compared with the return on capital employed of the subgroup. Sensitivity to adverse movements on the underlying assumptions of each sub-group is also assessed. The analysis shows the financial viability of each subgroup will continue to improve over time, as will that of the parent general corporations. Detailed financial performance and projections of Song Da and Sowatco are in Appendixes 6 and 7 respectively and in the financial analysis in Appendix 8. 73. The economic analysis has reviewed the macroeconomic context and the sector plans and objectives of the Government to assess the project economic rationale and associated costs in the first tranche. The valuation of the costs and benefits of tranche 1 subprojects follows ADB guidelines,25 comparing the with project and without project scenarios to assess the investment from the point of view of the economy. The costs to the society are the investments in the subprojects, comprising the costs of debt restructuring and operational restructuring. In both cases, the incremental costs of the project are negligible. The project benefits are mainly unlocking and unleashing the latent value of SOE assets through increased operational efficiency and improved governance. The project restructures the debts of the two general corporations and pays off existing creditor banks. It is impossible at this stage to state the size, nature, or timing of economic costs and benefits of the new projects generated by the freed resources released into the economy. The ADF loans are not revenue-generating investments
25

ADB. 1997. Guidelines for the Economic Analysis of Projects. Manila.

23 per se. However, their impact is to make the general corporations more efficient by either reducing costs, increasing revenues through better selection of projects, or both. The expected benefits of the investment include increased efficiency of debt resolution in SOE reform achieved by strengthening DATC. B. Summary of Benefits, Poverty Reduction, and Social Development

74. The transformation and reform of the SOE sector is critical to reducing the dominance of inefficient state production, promoting private sector development, and enhancing sustainable economic growth in Viet Nam. While the state has an important role to play in guiding economic transformation and development, and even in participating in economic production in a few cases, the rationale for state involvement in the direct production of goods and services is limited and narrow. The resulting static and dynamic efficiency losses are well known and documented. Transforming general corporations will help capture the resulting efficiency gains for higher growth and pave the way for greater rationalization of government policies at the sector level. To protect its assets in general corporations, the state has tended to adopt protectionist policies towards the general corporations that promote monopolistic power, hinder competitiveness, and curb private sector development. Greater competitiveness in the transformed general corporations will facilitate the states adoption of less restrictive sector and pricing policies, further enhancing efficiency gains. 75. General corporation transformation as proposed under the facility will benefit many SOE workers, who were the dominant buyers of shares in the small SOEs equitized earlier. Many of these small SOEs have continued to languish in inefficiency, dependent upon larger SOEs and general corporations for their survival. Their shares, often sold in the parallel market, have lost value and become more illiquid with the downturn in capital markets. The proposed corporate restructuring under the facility will enable many of SOE shareholders to trade their illiquid shares of equitized small SOEs for the shares of large, efficient sub-holding companies that may even be listed on the stock exchange. To the extent they are listed, the development of capital markets will benefit from the creation of iconic companies that may shortly evolve into blue chip stocks. Finally, strengthening restructured general corporations' balance sheets with more efficient and profitable operations will ameliorate the problem of nonperforming SOCB loans to SOEs, thus benefiting the banking system. C. Social and Environment Safeguards

76. The SRCGFP is classified environmental category C, with no significant adverse impact identified. The SRCGFP will entail no involuntary resettlement, as it has no investment component for creating new physical assets. None of the debt and operational restructuring associated with the facility will trigger any activity related to indigenous people during implementation. 77. No significant direct impact on employment is expected. Normal growth in the restructured companies will be adequate to facilitate the redeployment of any human resources rendered otherwise redundant, resulting in right sizing in the near term through growth and normal attrition. While the proposed restructuring measures are expected to be gender neutral, women are often more vulnerable to adverse employment conditions. The Government will be asked to provide assurance in the FFA that appropriate training is provided for redeploying affected SOE employees and that the general corporations address training and redeployment with gender neutrality.

24 D. Risks and Mitigating Measures

78. The SRCGFP assumes that the Government will continue its commitment to transitioning towards an increasingly market-based economy. Sustained, successful economic performance of the equitized general corporations will be necessary to maintain Government commitment to transition. Also required are macroeconomic stability and that the effect of the current global economic downturn on general corporation be short term. The outcome of the SRCGFP assumes that there will be adequate financial resources, including resources from within SOEs, to support continued restructuring, and that the restructuring process will be supported by the continued strengthening of debt-resolution mechanisms and improvements in state management of its investment capital. Potential risks to the SRCGFP are identified below. (i) Resistance to SOE reform from vested interests. Reforms and initiatives may be delayed by resistance from vested interests opposed to SOE reforms. However, this risk is considered modest since the Government's approach so far has been sustained, if cautious, commitment to pursuing SOE reform. The Government has indicated it will renew its plan for equitizing large SOEs and general corporations and is looking to the SRCGFP to demonstrate a viable and successful model and to enhance reform momentum. The Government is aware that SOE reform is critical to successfully meeting obligations arising from agreements entered into during the country's accession to the World Trade Organization. The Government has provided specific assurances to mitigate this risk, such as developing the new plan and ensuring that participating general corporations will adhere to SRCGFP-proposed restructuring. (ii) Use of general corporations for noneconomic objectives. The equitized and transformed general corporations may be hindered in operating profitably if the Government uses them for noneconomic objectives by, for example, applying price controls at the sector level or requiring general corporations to undertake noncommercial activities. However, sustained use of such measures would be against the Government's interest in transforming inefficient SOEs. The proposed operational restructuring under the facility would confine noncommercial activities, if any, to general-corporation level, which would make them more transparent and distinct from the commercial operations of the sub-holding companies. In addition, ADB is engaged in policy dialog on SOE reform with the Government through the PRSC process. (iii) Inadequate framework for state capital management. SCIC, which currently is responsible for managing state investments, is limited by capacity constraints. It is much smaller than many of the large general corporations, which are therefore reluctant to place themselves under SCIC following equitization. If Government ownership of equitized general corporations is not transferred to SCIC or an equivalent institution, line ministries and other agencies may continue to have some direct control in their management, even after they are equitized. However, the Government is aware of the need to address this issue and actively engaged in a vigorous internal debate to identify and assess options for strengthening the management of state capital. A decision is expected in the near future. Subsequent tranches may support institutional development for effective management of state capital. (iv) Operational restructuring in general corporations may be too complex. The operational restructuring needed in general corporations is quite comprehensive and may prove too complex for the senior management to implement effectively, compromising the quality of outcomes. To mitigate this risk, general corporations will recruit reputed management consultants to help implement restructuring. In addition, the proposed restructuring has been spelled out for the general

25 corporations participating in the first tranche. Preparing subprojects for subsequent tranches will draw upon the models proposed in the first tranche and again provide detailed blueprints for operational restructuring. Capacity limitations in general corporations may limit absorption, diluting implementation particularly for improving corporate governance. The capacity of the restructuring institutions to assimilate and absorb the changes may be low, especially below senior management. This may constrain the quality of operational restructuring. Weak implementation may compromise improved internal governance, particularly by independent directors. To address this, the proposed restructuring includes developing comprehensive training programs and detailed training on corporate governance and key components of enterprise operations. Detailed measures for improved governance have been approved by the boards of management of the general corporations, including criteria for independents directors and the promulgation of a code of ethics for directors and other stakeholders. Independent consultants will be recruited under ADF funding to facilitate, supervise, and monitor the implementation of agreed measures. Corporate restructuring requiring share swaps and buybacks may take too long. Some of the larger general corporations in particular have many subsidiaries, not all of which are fully owned. Realigning all subsidiaries along focused lines of business under sub-holding companies may be slow, particularly if consensus is lacking on the relative pricing of shares of subsidiaries and the parent company. However, shares of many of the subsidiaries are quite illiquid, and the incentive will be strong to swap them for shares of a larger company with better potential to access capital markets and achieve economies of scale and scope. Incentive will be further strengthened as the results of the financial and operational restructuring become more evident in general corporation balance sheets and performance. A minimum critical mass of corporate restructuring may be enough to trigger and expedite the residual restructuring yet to be done. The implementation horizon of 3 years for corporate restructuring is thus adequate to mitigate this risk substantially. V. A. Specific Assurances ASSURANCES

(v)

(vi)

79. In addition to the standard assurances, the Government and MOF have given the following assurances, which are incorporated in the legal documents: (i) The Government will undertake a comprehensive review of the existing master plan for SOE reform and develop a new plan incorporating lessons from the experience so far. In developing the new plan to 2015, the Government will review and incorporate relevant findings from the implementation of the pilot first tranche of the facility. (ii) The Government will develop an enhanced framework for improved management of the state's capital invested in the SOE sector. (iii) Within 18 months of loan effectiveness, the Government shall adopt the legal framework to (a) carry out effective debt resolution and (b) enhance DATCs operational effectiveness in a manner satisfactory to ADB. (iv) The Government will ensure that the entire proceeds of the loans from the facility will be used solely for onlending to the participating general corporations under the appropriate onlending arrangement and ensure that the general corporations utilize the proceeds of the loans for the purposes agreed with ADB.

26 (v) (vi) The Government will ensure borrowing general corporations adopt prudent levels of maximum debt-to-equity ratio, minimum debt-service coverage ratio, minimum self-financing ratio, and other such financial ratios as deemed appropriate. The Government will ensure that all activities under the SRCGFP will comply with ADBs Anticorruption Policy particularly with respect of the sections of the Procurement Guidelines and Guidelines on the Use of Consultants that relate to fraud and corruption. The Government will ensure that the participating general corporations adhere to the agreed corporate and management restructuring measures which shall include the following features: (a) that the general corporation shall transfer all business activities to its subsidiaries operating in the same business or new subsidiaries; (b) that all subsidiaries operating the same business segment shall be grouped under an appropriate sub-holding company, if there is more than one segment; (c) that the selected sub-holding company shall preferably be a listed company; (d) that identified non-core businesses shall be divested at the appropriate time; (e) that key executives of the group shall be centralized at the sub-holding company level; and (f) that the recommended enhancements to the management and reporting process and practices shall be duly implemented For tranche 1, the Government will ensure the OCR proceeds for debt restructuring will be disbursed subject to engagement of the primary consultants for management restructuring at Song Da and Sowatco. VI. RECOMMENDATION

(vii)

(viii)

80. I am satisfied that the proposed multitranche financing facility would comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve the provision of loans under the multitranche financing facility in an aggregate principal amount not exceeding $630,000,000 equivalent (the facility amount) to the Socialist Republic of Viet Nam for the SOE Reform and Corporate Governance Facilitation Program comprising: (i) loans in various currencies not exceeding the equivalent of $30,000,000 in Special Drawing Rights from ADB's Special Funds resources, with interest and other terms to be determined in accordance with the then-applicable policies relating to Special Funds resources and such other terms and conditions as are substantially in accordance with those set forth in the Framework Financing Agreement presented to the Board, subject to the conditions set out in paragraph 53 of this report; and loans in an aggregate amount not exceeding the balance of the facility amount from ADB's ordinary capital resources, with interest and other terms to be determined in accordance with the ADB's London interbank offered rate (LIBOR)based lending facility and such other terms and conditions as are substantially in accordance with those set forth in the Framework Financing Agreement presented to the Board.

(ii)

Haruhiko Kuroda President 6 November 2009

Appendix 1

27

DESIGN AND MONITORING FRAMEWORKa

Design Summary Impact Improved profitability and transparency of equitized and restructured SOEs, including large general corporations and their subsidiaries Performance Targets/Indicators Number of general corporations and large SOEs undergoing operational and financial restructuring during 20092015 increases by at least 50% over that in previous 4 years Profitability of restructured general corporations and SOEs increases by 15% over average of 4 years preceding restructuring Data Sources/Reporting Mechanisms MOF

Assumptions and Risks Assumptions Continued commitment to transitioning to an increasingly market-driven economy Macroeconomic stability Economic growth is adequate to absorb growing labor force

Externally audited annual financial reports of general corporations

Sustained successful economic performance of equitized SOEs Risks Increased resistance from vested interests to SOE reform Government uses transformed general corporations for achieving noneconomic objectives, including using inappropriate pricing policies.

Outcome Participating general corporations are transformed into focused, efficient businesses with strong balance sheets and improved corporate governance.

Debtequity ratios reduced by at least 15% during first 5 years after general corporation restructuring Cash flows from operations are enhanced by at least 20% during first 5 years after general corporation restructuring. At least four general corporations converted into pure holding companies Lines of business of general corporations reduced Number of principles of

NSCERD

Assumptions The effect of global economic downturn on general corporations is short term. Adequate financial resources to support continued SOE restructuring and transformation Continued strengthening of debt-resolution mechanisms and improvements in state management of capital Risk Line ministries control of general corporations may be prolonged due to institutional inadequacy in effective management of state capital.

Externally audited annual financial reports of general corporations Externally audited annual financial reports of general corporations Externally audited annual financial reports of general corporations Externally audited

28

Appendix 1

Design Summary

Performance Targets/Indicators good corporate governance adopted by general corporations Current ratio improves by at least 10% during the 5 years after restructuring Debt-service coverage ratio improved by at least 20% during first 5 years after general corporation restructuring Number of subsidiaries directly below general corporation reduced

Data Sources/Reporting Mechanisms annual financial reports of general corporations General corporation financial reports

Assumptions and Risks

Outputs 1. Debt restructuring implemented, combining financial and corporate restructuring

Assumptions Continued commitment by general corporation management to restructuring No unexpected legal or regulatory impediments to restructuring

General corporation financial reports

General corporation annual reports

Risks Operational restructuring of general corporations may be too complex for the senior management to implement properly. Capacity of the restructuring institutions to assimilate and absorb the changes may be low, particularly below senior management. Middle management and workers oppose operational restructuring. Capacity limitations constrain implementation of operational restructuring and improved corporate governance. Implementation delays in corporate restructuring requiring share swaps and buybacks

2. Increased operational efficiency and improved corporate governance of general corporations and other SOEs

At least five general corporations create subholding companies and bring remaining subsidiaries under them At least five general corporations refocus operations in core business lines Management practices and business processes are rationalized in at least five general corporations. Budgetary controls and financial planning processes are improved. Directors, managers and staff follow a code of ethics.

General corporation annual reports

General corporation annual reports and externally audited financial reports General corporation annual reports and consultant reports

General corporation annual reports and consultant reports General corporation annual reports and consultant reports General corporation annual reports and consultant reports DATC annual reports and consultant reports

3. Institutions supporting key aspects of SOE reform strengthened and governance improved

Surplus employees provided appropriate training for redeployment Improved management systems and processes at DATC

Appendix 1

29

Design Summary

Performance Targets/Indicators Improved internal audit system at DATC Strengthened human resource processes at DATC Improved information management at DATC Improved legal framework for DATC

Data Sources/Reporting Mechanisms DATC annual reports and consultant reports DATC annual reports and consultant reports DATC annual reports and consultant reports Regulations issued by the Government

Assumptions and Risks

Activities with Milestones 1.1 Strategic business plan and restructuring plan for each participating general corporation approved before each tranche approval 1.2 Financial plan prepared and approved by tranche approval 1.3 Financial restructuring initiated within 6 months of tranche loan becoming effective 1.4 Corporate restructuring completed within 3 years of tranche loan becoming effective 2.1 Management restructuring of general corporation initiated within 3 months of tranche loan becoming effective 2.2 Sub-holding company identified or established by general corporation within 6 months of tranche loan becoming effective 2.3 Business activities transferred from the mother company to subsidiaries within 1 year of tranche loan becoming effective 2.4 Management of companies engaged in the same industry centralized at sub-holding company within 1 year of their establishment 2.5 Associate enterprises in non-core areas divested within 3 years of tranche approval 2.6 Standard procedures and processes established for each business segment within eighteen months of tranche loan becoming effective 2.7 Standardized management and financial reporting package devised within eighteen months of tranche loan becoming effective 2.8 Improved cash flow projections prepared within 1 year of tranche loan becoming effective to identify the expected cash inflows and the funding requirements for loan repayment and investment in ongoing and new projects 2.9 Charter of sub-holding companies aligned with the provision of model charter for listed companies issued by the Ministry of Finance within eighteen months of tranche loan becoming effective 3.1 Development of an appropriate organization structure with a job description for each management position by June 2011 3.2 DATC restructured by December 2010; new departments created, if necessary, for internal audit, investment committee, corporate restructuring, and information technology

Inputs ADB $630 million ($600 million OCR and $30 million ADF) Government (through transfer of owned shares) $550 million General corporations $100 million Strategic investors and others $490 million

30

Appendix 1

Activities with Milestones 3.3 Training program developed for DATC personnel and enterprises under DATC by December 2010 3.4 Training organized on debt resolution and corporate restructuring, corporate governance, and investment analysis and management between Q1 2010 and Q4 2012 3.5 Legal framework for DATC reviewed and revised by June 2011; MOF to review legal right of DATC to restructure and rehabilitate poorly performing SOEs in preparation for eventual equitization; preferential tax treatment for creditors transferring nonperforming assets to DATC; role of strategic and special investors to participate in DATC restructuring of debts

Inputs

ADB = Asian Development Bank, ADF = Asian Development Fund, DATC = Debt and Asset Trading Corporation, MOF = Ministry of Finance, NSCERD = National Steering Committee for Enterprise Reform and Development, OCR = ordinary capital resources, Q = quarter, SOE = state-owned enterprise. a Subprojects and tranches under the proposed multitranche financing facility are sequential only temporally, not in content of activities. The general corporations participating in subsequent tranches are expected to undertake similar inputs and activities for the same outputs. The facility thus provides for a parallel set of activities undertaken by participating general corporations but at different times. As a result, the design and monitoring framework for the facility and for each tranche will be the same except for inputs and base values for quantitative indicators. It is for this reason that the performance targets, indicators, activities, and milestones have been specified in terms of number of months or years from tranche approval. A design and monitoring framework in terms of inputs and base values will be provided in each periodic financing request.

J. AHMED Director, SEFM

A. THAPAN Director General, SERD

Appendix 2

31

STATE-OWNED ENTERPRISE SECTOR ANALYSIS 1. The state-owned enterprise (SOE) sector in Viet Nam has historically been an important component of the economy. In 1991, Viet Nam had 12,300 SOEs with total capitalization of D34,000 billion. Following a Government decree to reregister or close SOEs based on commercial viability, their number dropped to 6,300 through liquidations and mergers, though total capitalization increased to D53,000 billion. Most liquidated and merged SOEs were small, locally managed enterprises with fewer than 100 employees. Following government instructions in 1994, another round of mergers and liquidations reduced the number of SOEs to 5,500 by the end of 1997. Many of the over 1 million retrenched SOE workers were employed in private businesses. The SOE sector was highly concentrated, with the largest 200 SOEs accounting for nearly 60% of state capital and 40% of total debt. 2. Drastic reduction in trade and financial flows from the former Soviet Union and its associated economies prompted government policies towards commercializing SOEs. Enterprises were allowed to formulate their own operating plans and shift to market-based relationships with suppliers and customers through the introduction of economic contracts as the bases for transactions among enterprises. However, SOE profitability has been low. An assessment by the Ministry of Finance (MOF) in the late 1990s found that only 40% were profitable in terms of reporting profit over the past 3 years and paying all wages and taxes. 3. Today there are 6,500 SOEs reporting to more than a 100 line authorities, including more than 60 provincial peoples committees, 23 ministries and ministerial-level authorities, and the Prime Minister's office. The SOE sector continues to play a significant role despite a decline in its relative size in recent years. According to the General Statistical Office of the Government, the share of the state-owned (enterprise) sector in the gross domestic product has shown a modest decline but remains near 40%, while the share of the sector in industrial output has declined more, from above 40% in 2000 to less than 30% in 2007 (Figure A2.1).1 SOEs and conglomerates are estimated to account for 60% of outstanding loans from domestic commercial banks.
Figure A2.1: Share of State-Owned Sector 2000-07
41.5 41.0 40.5 % GDP 40.0 39.5 39.0 38.5 38.0 37.5 00 01 02 03 GDP 04 05 06 07 45.0 40.0 35.0 % Industry 30.0 25.0 20.0 15.0 10.0 5.0 0.0

Industrial Output

GDP = gross domestic product. Source: Asian Development Bank.

1

The figures are supposed to be adjusted for equitization of SOEs, but need to be interpreted cautiously since the methodology is not clear. The data can be viewed as providing trends and orders of magnitude for state-owned enterprise sector in the economy.

32

Appendix 2

4. Long period of reforms. SOE equitizationthe process of converting SOEs into joint stock companies with limited liabilitywas launched in mid-1992, but by the end of 1997 only 17 enterprises had been equitized. In 1998, following a review of the SOE reform program, several new initiatives were undertaken, including (i) Prime Minister Circular 20/1998/CT-TTg, which sets out the main policies to guide the restructuring of enterprises, including a framework for classifying SOEs in terms of plans for diversified ownership; (ii) Decree No. 44/1998/ND/CP, which clarifies and simplifies the equitization process; (iii) the setting up of a national enterprise reform committee as a national organization to approach SOE reforms; and (iv) the announcement of equitization targets to 2000, including the complete divestiture of small enterprises with capital of less than D1 billion. 5. The 3rd Central Party Resolution in September 2001 on "continuous rearrangement, reform, development, and improvement of efficiency of SOEs" set the following tasks for the 5 year period 20012005: (i) complete the basic restructuring and structural adjustments of existing SOEs; (ii) equitize SOEs in which the state did not intend to keep 100% ownership; (iii) dissolve or place into bankruptcy inefficient SOEs; and (iv) transfer, sell outright, or lease small SOEs that could not be equitized and in which the state did not seek to retain control. 6. In 2002, the Government ordered all line authorities, including provincial peoples committees, line ministries, and ministerial-level authorities, to submit a comprehensive plan to rearrange and develop the SOEs under their management for the period 20022005. These plans, approved between October 2002 and November 2003, listed for each line authority the SOEs to be retained as 100% SOE administrative revenue-generating units, merged or converted into holding companies, or divested by equitization, assignment, sale, management contract, leasing, conversion into one-member limited-liability companies, or liquidation and bankruptcy, specifying the method and year of implementation. In 2004, the Government issued Decision 155, which presented new criteria for classifying SOEs and their equitization that required updating all line-authority plans. As of mid-2006, the Government had approved only 15 of the updated plans. 7. In subsequent years, the Government has continuously refined and revised regulations on SOE transformation. The current legal framework of SOE reform comprises (i) the Law on State-Owned Enterprises, Enterprise Law, and Law on Securities; (ii) decrees, circulars, and instructions on the equitization process; (iii) decrees, circulars, and instructions on transformation through sales, assignments, business contracts, and management contracts; (iv) decrees, circulars, and instructions on the conversion process applicable to the parent companysubsidiary model; and (v) decrees, circulars, and instructions on the financial management and monitoring of SOEs. SOE reform is monitored by the National Steering Committee for Enterprise Reform and Development (NSCERD), which is chaired by the Prime Minister in coordination with MOF.
8. The process of equitization, which initially took 3 years and was reduced to 13 months by 2006, now takes 9 months following the issuance of Decree 109 in 2007.

9. Slow progress. Progress in equitizing SOEs has been slow. Detailed data on the SOE sector are generally not easily available. Until 2006, a donor-assisted project accumulated detailed data at NSCERD showing that, out of 6,459 SOEs, 5,466 were identified for conversion and 993 SOEs were to be retained as 100% state owned (Table A2.1). Out of the 5,466 SOEs, conversion of 3,201 SOEs (58.6%) was completed, of which 2,356 SOEs had been equitized. Only a few of the equitized SOEs were listed.

Appendix 2

33

Figure A2.2: Equitization Process

Day 1 Equitization decision Day 15 Prepare documentation Day 85 Approve valuation repor t Day 110 Approve equitization plan Day 230 First GSM Day 270 License JSC

15

75

85

105

110

200

230

270

Set up SOERC

Set up Assistant Team

SOE Valuation

Complete equitization plan

Complete share sale

Finalize equitization

GSM = general shareholders meeting, JSC = joint stock company, SOERC = state-owned enterprise reform committee. Source: Asian Development Bank estimates.

Table A2.1: Number of State-Owned Enterprise Conversions by Line Authority, 2001mid-2006

Number of State Owned Enterprises, by Line Authority Line People's GC91 Ministry Committee Total 2001 11 27 244 282 2002 53 57 268 378 2003 40 152 424 616 2004 80 225 509 814 2005 116 254 500 870 2006 (June) 32 93 116 241 332 808 2,061 3,201 Total GC91 = general corporation or conglomerate reporting to the Prime Minister. Source: National Steering Committee for Enterprise Reform and Development database, cited in ADB. 2006. Technical Assistance to the Socialist Republic of Viet Nam for Preparing the State-Owned Enterprise Reform and Corporate Governance Facilitation Project. Manila (TA 4911-VIE). Year

10. The pre-2007 database provides information on several attributes of early SOE equitization. Most of the SOEs equitized were small; 46% had charter capital of less than D5 billion, though the size increased marginally over time. The average number of employees in the equitized SOEs was 260, or an estimated 36% of total employees in the SOE sector prior to the start of restructuring. SOEs equitized by mid-2006 accounted for only a third of SOE bank debt at the time. Very few outsiders such as strategic investors were involved in the process. 11. Early equitization was primarily internal, with employees of the SOEs acquiring far more than half the shares in the equitized SOE. The government and employees together held almost 80% of the shares until 2005. Over time, the stake of employees declined modestly while that of company outsiders increased. This reflected the introduction of Decree 187 in 2004, which required equitized SOEs to auction shares to the public rather than sell them on the companys premises. 12. The proportion of SOEs in which the state retained more than 50% of the charter capital increased. Further, the larger the charter capital, the more the state capital exceeded 50%.

34

Appendix 2

Higher state stakes in equitized SOEs reflects the larger size of SOEs equitized later in the equitization process. Higher state share may also stem from these SOEs achieving relatively low profitability and thus finding it hard to attract external investors. Their shares were often undersubscribed in auctions, and the state could not sell as many shares as it intended. Equitized SOEs with state shareholding of more than 50% are still considered SOEs because the state retains controlling power. 13. According to the latest data provided by MOF, as of 31 December 2007, 4,979 SOEs had been restructured and 3,369 SOEs had been equitized. For the period 20082010, the Government has plans to convert an additional 1,535 SOEs, of which 948 are proposed for equitization (Table A2.2).2
Table A2.2: Planned State-Owned Enterprise Conversions, 20072010 Item Cumulative to 31 Dec 2007 Planned 20082010 First 6 months of 2008 SOEs to be converted 4,979 1.535 61 Of which equitized 3,369 948 30

SOE = state-owned enterprise. Sources: Ministry of Finance, Government of Viet Nam, 2008; and ADB. 2006. Technical Assistance to the Socialist Republic of Viet Nam for Preparing the State-Owned Enterprise Reform and Corporate Governance Facilitation Project. Manila (TA 4911-VIE).

14. General corporations. In 1995, the Government organized many SOEs into 17 general corporations or conglomerates and 77 special general corporations. The 17 conglomerates report to the Prime Minister and are often referred to as GC91s. The 77 special general corporations report to line ministries or peoples committees and are often referred to as GC90s.3 In 2005, the Government initiated the conversion of general corporations into holding companies with a directive from the Prime Minister (33/2005/CT-TTg, dated 13 October 2005) on effectively applying the parentsubsidiary company model on a pilot basis.4 15. Under Decree 111, 5 a parent company can be one of the following: (i) a general corporation, independent member SOE within a general corporation, or independent SOE under a line authority operating under the Law on State Enterprises; (ii) a state-owned single-member limited company operating under the Law on Enterprises; or (iii) a joint stock company operating under the Law on Enterprises. Subsidiaries of a parent company operate under the Law on Enterprises. The prerequisites for reorganizing or converting a general corporation into a parent
2

The most recent MOF estimates for the number of SOEs to be converted differ by 55 from the earlier estimates provided by the donor-assisted project in NSCERD. In addition to underlining the lack of data transparency, this reflects the creation of new SOEs and that some SOEs not considered for transformation went into the equitization process. 3 In 2002, these 94 general corporations included 1,605 member SOEs, representing 28% of all SOEs and 65% of the capital of all SOEs. 4 The Government has allowed a few general corporations in critical industries to reform themselves into economic groups. An economic group is a group of companies with independent legal status formed by associating through investment, capital contribution, merger, buyout or reorganization, or other forms of association; with long-term attachments in terms of economic interests, technology, markets, and other business services; and forming a business complex with two or more levels of enterprises in the form of parent companysubsidiaries. An economic group has no separate legal status. (Art 26 Decree 139/2007/ND-CP.) 5 The legal framework for conversions of general corporations and SOEs into the parent company model consists of (i) Decree 111/2007/ND-CP, on the conversion of SOEs on the parent companysubsidiaries model; (ii) Circular 03/2005/TT-BKH, dated 18 July 2005, on the content and the procedures for developing the charter of a parent company; and (iii) Circular 72/2005/TT-BTC, dated 1 September 2005, which guides the preparation of financial management regulations for a state parent company.

Appendix 2

35

company are that (i) all member companies under it have a plan to convert into joint stock or single-member limited-liability companies and that the general corporation itself be eligible to be converted into a single-member limited-liability company; (ii) the general corporation has charter capital of not less than D500 billion; and (iii) the general corporation has the financial capacity, know-how, brand name, market to invest in other companies, as well as the capacity to operate multiple businesses around one core activity. 16. Little success with general corporation equitization. The SOEs that have yet to be transformed are mainly the GC90s and GC91s and their subsidiaries. In December 2006, the Prime Minister approved Decision 1729/QD-TTg, a master plan that includes a list of general corporations identified for equitization: 1 economic group, 7 GC91s, 52 general corporations under the supervision of line ministries, 1 general corporation under the supervision of MOF, 5 general corporations under the supervision of the State Bank of Vietnam, 5 general corporations under the supervision of Hanoi provincial people's committee, and 7 general corporations under the supervision of the Ho Chi Minh City peoples committee. The plan was for about 20 general corporations to be equitized every year from 20072010. As of 31 May 2008, none of the GC91s and only 7 GC90s had been equitized.6 1. Constraints on Equitizing General Corporations

17. Difficulties in valuation. Valuating general corporations is complicated by the need to value their share holdings in subsidiaries that may be engaged in a wide spectrum of businesses and may be equitized and listed. The boards of management of equitized subsidiaries are generally quite autonomous and distinct from that of the general corporation, and the equitized subsidiaries are typically allowed to make business decisions themselves. Hence, it is difficult for others, such as strategic investors, to properly evaluate the extent of influence the general corporation has on the management of subsidiaries. 18. General corporations and large SOEs often face difficulties in documenting such details as design capacity, years of use, year of manufacture, etc., for machinery and equipment, much of which is obsolete and out of production. Valuating the land holdings of general corporations has also proved difficult. This creates difficulties in obtaining price quotations for enterprise assets as required by regulations. 19. Cumbersome size. The large scale and complexity of operations means management in many general corporations has limitations in terms of the skills and capacity to undertake the needed strategic and rational restructuring. In addition, the total value of some of the general corporations and their subsidiaries may be too great to allow others, including staff and management and even many outside strategic investors, to acquire a meaningful holding during equitization. 20. Financial constraints. A major constraint on transforming many general corporations has been their financial weakness. General corporations have relied on extensive borrowing
6

The seven equitized GC90s were Viet Nam Electronics and Informatics Corporation (VEIC) under the Ministry of Trade and Industry and Vinaconex under the Ministry of Construction in 2006; the Trading and Construction Corporation under the Ministry of Transportation, Bao Viet under MOF, Vietcom Bank under the State Bank of Vietnam, and Sabeco under the Ministry of Industry in 2007; and Habeco under the Ministry of Industry in 2008. In addition, nine general corporations were divested as follows. Six general corporations were liquidated: Vinaplast, Leaprodexim, Viglaceglass, Machinoimport, and VietGoldGem; one general corporation was restructured: Vietnam National AlcoholBeerSoft Drink Corporation; and two general corporations were merged: Vietnam National Gem and Gold Corporation and Vietnam National Minerals Corporation.

36

Appendix 2

from the Government and state-owned commercial banks to finance their operations, with virtually no access to capital markets. Most of the large SOEs and general corporations have very high debt, and debt-to-equity ratios are frequently far in excess of 100%. This has severely constrained their ability to service their debt and contributed to the high numbers of nonperforming loans in the banking system. High indebtedness implies that general corporations are ill-equipped to deal with risks and will not have the financial capacity to fund capital investments. The problem is exacerbated by much of their debt being high cost and short term. 21. Other factors that contributed to the slow pace of equitization, particularly in the earlier phases, were as follows: (i) Some SOEs were reluctant to be equitized because they would lose state support and privileges. (ii) Equitization procedures were complex and required a profound knowledge of them that many SOEs were not prepared to acquire. (iii) Selling shares through outside intermediary financial institutions and by auction was new and it took time for the processes to become streamlined. 22. Weak corporate governance. Poor corporate governance has constrained equitization. A survey of 400 companies conducted by the Central Institute of Economic Management in 2002 revealed that only 26% of those surveyed believed most business people in Viet Nam understood the basic concepts and principles of corporate governance. Promoting sound corporate governance of equitized SOEs is key to the ultimate success of the equitization program in Viet Nam. At present, the appointment of members of the board of management (BOM), its chair, and the general director is determined by the authorized state body. This creates difficulties in allocating duties and responsibilities and the related authority over operational matters between the chair, BOM, and general director, as well as accountability for their actions. The BOM and the board of directors are often uncertain over the strategic direction of the holding company and their operational relationships with fellow subsidiaries and affiliates, or how to create an effective grouping that will grow sustainably. 23. Weak framework for resolving nonperforming debts and assets. The lack of effective resolution of nonperforming debts has brought stalemate and prolonging of the remaining SOE divestitures. In February 2003, the Korean Asset Management Corporation was engaged by the United Nations Development Programme to do a feasibility study in Viet Nam to create the centralized Debt and Asset Trading Corporation (DATC). Based in part on that study, the Prime Minister issued Decision #109, dated 5 June 2003, creating DATC in MOF to expedite corporate restructuring. DATC was created with the Government pledging D2,000 billion from the state budget in total capital, with D500 billion initially allocated in 2004. The three objectives of DATC are to acquire and resolve nonperforming loans and uncollectible receivables owned by SOEs, deal in and resolve interests received from SOEs upon equitization, and provide consulting services to SOEs for resolving their nonperforming loans. 24. The recovery ratios of received debts to date are relatively low, accounting for only 10% of total book value. 7 Decree #69 contains provisions stating that the purchase and sale of nonperforming loans and uncollectible receivables are to be made at market prices through negotiation or auction bidding, or at the price stated by the relevant authority. Currently, DATC is able to obtain outstanding assets only at prices determined by an external auditing and valuation firm and approved by MOF.

Among 19,526 items of nonperforming assets, 14,764 items with total book value of D659 billion are considered irrecoverable (DATC. 2007. Operational Report. Ha Noi.

Appendix 2

37

25. Going forward, it will be necessary to consider the legal mechanisms, processes, powers, and financial resources of DATC. Upon acquiring debts, DATC currently stays on as a creditor to the company. Given the size of the debt relative to the legal capital of the debtor companies and that ownership remains with line ministries or agencies, DATC is unable to impose any changes to enhance or rehabilitate debtor companies. SOEs are largely unwilling to work with DATC to resolve debts because of perceptions that involvement with DATC consumes lots of resources and time. 26. Reforms are needed to limit the layers of authority controlling land, the most popular collateral asset in Viet Nam. There is no specific provision on the transfer or assignment of mortgages in the civil code, the Ordinance on Economic Contracts, or commercial law. This constrains trading in any secondary market for distressed assets since investors, especially foreign investors, are discouraged by the uncertainty of transfer or assignment of mortgages. 27. To effectively play its role in enhancing the debt-resolution mechanism, DATC needs to improve its management processes, including developing its human resources and enhancing its information system. The current organization lacks important departments such as for internal audit, investment, public relations, or corporate restructuring. DATC needs to review its financial capacity relative to the size of nonperforming loans and to outsource or otherwise obtain necessary industry-specific expertise to devise workouts. 28. Enhancing management of state capital. In 2005, the Government established the State Capital Investment Corporation (SCIC) to manage state investments in enterprises and to invest and trade in state capital. The primary objectives of SCIC are to accelerate and enhance the effectiveness of SOE reform and to improve the efficiency of the utilization of state capital. SCIC commenced operations in August 2006 and, by December 2007, managed an investment portfolio comprising 829 enterprises with a total book value of D7,710 billion. Three quarters of these enterprises are very small, with legal capital of less than D10 billion, and operate ineffectively. SCIC plans to divest state capital from more than 700 of these equitized SOEs. An optimal solution would be to enhance their value through restructuring before divestment. However, such restructuring is difficult to implement, as SCIC is only one shareholder in these SOEs. 29. The effectiveness of SCIC has been limited by the lack of explicit criteria for handing over state interests in large enterprises and general corporations, which is done on a case-bycase basis by the Prime Minister's office (many of the general corporations are much larger than SCIC) and the potential for conflict between SCIC and line ministries. Moreover, line ministries reserve the right to retain their interest in general corporations after initial public offerings. Line ministries may agree to ownership of the state interest in equitized SOEs being registered under SCIC, but the ministries reserve the right to appoint key people to boards of management. A further constraint is the inadequate regulatory framework for financial management in SCIC. The current regulations (Decree #199, Circular #33, and Circular #87) allow SCIC to sell state stakes only by auction. Divestments can be made more quickly if sales agreed through direct negotiations between buyers and sellers are also allowed. Under the prevailing regulations, the same set of valuation rules, especially the rules that concern land-use rights, must be used pre and post equitization. These rules impede the ability to unlock the potential worth of the SOE. Current securities law restricts SCICs stock transactions, as SCIC cannot sell state interest at higher than the mandated trading band. Other constraints are the lack of a clear strategy and role for SCIC or of training and inadequate institutional capacity in SCIC to manage investments and improve governance in equitized SOEs.

38

Appendix 2

30. SCIC must improve management processes and corporate governance, in both SCIC and the investee companies it manages. SCICs interests in equitized SOEs are managed through representations in the BOM of the SOE. However, there is a need to provide formal training to its representatives to be effective. Also, corporate governance standards in SOEs, such as on reporting guidelines, need enhancement. SCIC does not have formal investment guidelines to help manage investments or a knowledge database. Portfolio management is currently based on the book value, though market value may be more relevant. SCIC is working with consultants to develop its information and communication technology system and operational manuals. However, substantial management restructuring and operational strengthening is needed to improve its effectiveness and promote enhanced corporate governance, including in the SOEs managed by SCIC.

Appendix 3

39

DEVELOPMENT COORDINATION
Purpose (Implementing Agency) State-owned enterprise PPTA for SOE Reform and Corporate Governance Facilitation Study on investment management of economic groups (CIEM) Acceleration of equitization and restructuring SOEs in the line ministries of industry, agriculture, and construction) and in two provinces Support to capacity building in NSCERD in the SOE reform process (NSCERD) Pilot restructuring of three general corporations: Vinatex, Vinacafe, and Seaprodex (NSCERD) Dak Lak pilot project to equitize and divest 51 SOEs through auctions Study on economic group (CIEM) Support auditing of 100 major SOEs Support to labor made redundant after SOE restructuring (MOF) Donor or Provider ADB World Bank ASEM 5 European (World Bank administered) DANIDA DFID (UK) IFC administered /DANIDA AusAID World Bank, DANIDA, EU (administered by World Bank) World Bank $25,000 $1,470,000 + $400,000 $1,700,000 1,800,000 $410,000 $70,000 $8 million Phase 1, $300,000 (20022004); phase 2, $200,000 (2005) Amount Status Ongoing Completed Completed Start Date 2007 2008 2003

Completed Completed Ongoing Completed Completed Completed

2001 2004 2004

2004 2001 2005 2002 2005

State-owned commercial banks Mekong Housing Bank 1. Information technology and management system, core banking 2. Human resources development 3. Training for internal audit Support for Implementation of ICB Restructuring Plan Advice on the elaboration of a regulation on risk management for commercial banks and supporting pilot banks VCB and CCF in reforming internal audit and risk management Advisory assistance for the Mekong Housing Bank equitization transaction Mekong Housing Bank TA Credit Management, Treasury and Asset Liability Management, human resource management, information technology, and MIS Second Payment System and Bank Modernization Project Payment System and Bank Modernization for VBARD (extension of the World Bank PSBM) AFD GTZ Ongoing Ongoing September 2003 2003 AFD Ongoing 2006

IFC Switzerland (SECO) /Private Sector World Bank AFD

Ongoing Ongoing

2004 2004

Ongoing Ongoing

2005 Sept. 2003

ADB = Asian Development Bank, AFD = Agence Francaise de Developpement (French Agency for Development), ASEM = AsiaEurope Meeting, AusAID = Australian Agency for International Development, CCF = Christian Children's Fund, CIEM = Central Institute for Economic Management, DANIDA = Danish International Development Agency, DFID = Department of International Development, GTZ = Deutsche Gesellschaft fur Technische Zusammenarbeit (German Technical Cooperation), ICB = Industrial and Commercial Bank of Vietnam, IFC = International Finance Corporation, MIS = management information system, MOF = Ministry of Finance, NSCERD = National Steering Committee for Enterprise Reform and Development, PPTA = project preparatory technical

40

Appendix 3

assistance, PSBM = payment system and bank modernization, SEAPRODEX = Sea Products Export Corporation, SECO = State Secretariat for Economic Affairs, SOE = state-owned enterprise, TA = technical assistance , VBARD = Vietnam Bank for Agriculture and Rural Development, VCB = Vietcombank, VINACAFE = Vietnam National Coffee Corporation, VINATEX = Vietnam National Textile and Garment Group. Source: ADB staff discussions with donors.

Appendix 4

41

DETAILED COST ESTIMATES BY EXPENDITURE CATEGORY AND FINANCING OF TRANCHE 1 PROJECTS a

General Corporations Amount ($ million) (%) 0.00 0.00 100 100 0.00 0.00 0.93 b 0.00 0 0 0 0 100

Item A. Investment Costs 1. Debt Restructuring Song Da Sowatco 2. Consulting Services 3. Equipment 4. Taxes and Duties B. Interest and Commitment Charges Total
a

OCR Amount ($ million) (%) 109.59 2.30 0.00 0.00 0.00 8.11 100 100 0 0 0

ADF Amount ($ million) (%) 0.00 0.00 5.32 3.94 0.00 0.74

Total Amount ($ million) 109.59 2.30 5.32 3. 94 0.93 8.85

120.00

10.00

0.93

130.93

ADF = Asian Development Fund, OCR = ordinary capital resources. No new physical assets will be created from the OCR component of the Facility, which will be lent to general corporations through the Ministry of Finance to restructure their existing debt to enhance cash flows and strengthen the balance sheet. The loan amounts will be a relatively small proportion of the total general corporation assets and liabilities. For example, Tranche 1 will support 2 general corporations, Song Da and Sowatco, through OCR loans of $117.5 million and $ 2.5 million respectively. As of 31 December 2007, Song Da's total assets were $1.35 billion and total liabilities were $971.5 million, compared to the proposed OCR loan from the Asian Development Bank of $117.5 million. Counterpart funding from the general corporations therefore far exceeds the 90/10 requirement for project financing in Viet Nam. Breakdown of taxes is as follows: $0.53 million for consulting services, and $0.40 million for equipment.

Source: Asian Development Bank estimates.

42

Appendix 5

SELECTION CRITERIA FOR GENERAL CORPORATION PARTICIPATION AND APPROVAL PROCEDURES FOR FUTURE TRANCHES A. Selection of General Corporations

1. The basic principles guiding the selection of general corporations for participation in the State-Owned Enterprise Reform and Corporate Governance Facilitation Program (SRCGFP) are (i) commitment and willingness to reform on the part of the general corporations themselves, their line ministries or agencies concerned, and the Government of Viet Nam (the Government); (ii) relevance of the general corporations to the country strategy and sector strategy of the Asian Development Bank (ADB) and to the Government's plans and strategy for the state-owned enterprise (SOE) sector; and (iii) the financial viability of the general corporations after restructuring under the SRCGFP, including potential for listing. These selection criteria may be reviewed and agreed upon between ADB and the Government, as needed. 2. Commitment to reform. The core elements of the SRCGFP are financial restructuring, corporate restructuring, and operational or management restructuring. While financial restructuring would always be useful to any enterprise if it enabled strengthening the balance sheet, both corporate and particularly operational restructuring are complex and intangible changes that depend for their success as much on changing mindsets as physical changes. The utility and success of these restructuring measures thus critically depends on an intrinsic, strong, and evident commitment to the envisaged changes. 3. Prior to participating in the SRCGFP, general corporations will need to undertake several measures: (i) Express general interest in participating in the facility to Ministry of Finance (MOF) and the Ministry of Planning and Investment. (ii) Undertake a comprehensive review of their financial and operational parameters, focusing on assessing and identifying core business areas; crystallizing strategic goals and objectives; analyzing strengths, weaknesses, opportunities, and threats in core business areas; and developing a plan of proposed measures to strengthen corporate balance sheets and business processes to enhance their value to strategic and other investors, including through equitization or eventual listing. (iii) Based on internal and external consultations, finalize restructuring plans and obtain firm commitment from the board of management and line ministry or agency for their approval of the proposed restructuring. (iv) Review existing processes for corporate governance, identify gaps, and develop comprehensive plans to restructure operations as necessary to strengthen corporate governance. (v) Include all senior and middle management in consultations to generate broad buy-in and enhance the implementation of the envisaged restructuring and changes, including for strengthening corporate governance. (vi) Make transparent and available all data necessary for analyzing financial and operational performance, including plans and projections for investments in the medium term. (vii) Obtain endorsement from MOF for their participation. 4. Strategic relevance. The selection of general corporations will focus on sectors that are relevant to ADB's country operations as laid out in the country partnership strategy1. General
1

ADB. 2006. Viet Nam: Country Strategy and Program (20072010). Manila (September).

Appendix 5

43

corporation selection will have to be consistent with ADB's strategy for reforming the SOE sector, as well as that of the Government. The Government is developing its plans for the equitization of remaining SOEs and will prepare a new, longer-term plan for development to follow the Socio-Economic Development Plan 20062010. 5. Financial viability. The end result of any general corporations participation in the SRCGFP is the unlocking of the full potential value of its assets through transformation into a globally competitive, efficient, and profitable enterprise with good corporate governance. This will maximize returns to the Government when the enterprise is listed on the exchange. The financial and operational viability of the enterprise is thus a prerequisite for participation in the facility. While it is possible that the general corporation may not necessarily be highly profitable prior to restructuring, it has to be structurally transformable into a profitable entity. The general corporation should thus be in a position to meaningfully benefit from ADB debt and operational restructuring to become profitable and able to maximize value for shareholders and access capital markets. The financial and operational analysis undertaken prior to participation in the facility will be used to assess the viability of the enterprise's operations. This will include the elimination or divestiture of areas of operation that would otherwise preclude the enterprises being financial viable. Similarly, general corporations in areas where financial viability has lower emphasis, such as national defense, may not be appropriate for participation in the facility. B. Approval Procedures

6. The participation of general corporations in subsequent tranches will follow the procedures outlined below. Initial consultations will be held between MOF and general corporations interested in participating. Based on the consultations and consistency with Government plans and strategy, MOF will indicate to ADB the general corporations that can potentially participate. Subject to ADB's endorsement of potential participation, the identified general corporations will need to fulfill the criteria for selection listed above. A comprehensive analysis of the general corporations financial and operations parameters will be undertaken, as well as an assessment of their strengths and weaknesses in core business areas. The general corporations will develop a plan of proposed measures to strengthen their corporate balance sheets and business processes to enhance their value to strategic and other investors, including through equitization or eventual listing. Core areas of weaknesses and challenges in corporate governance will be identified and measures proposed for mitigating them. For general corporations without adequate informational infrastructure or expertise to carry out these preparations, ADB will, at the Governments request, provide technical assistance to the general corporations for undertaking such analyses and preparing plans. The plans and restructuring measures thus identified will then be presented to the middle and senior management of the general corporations, followed by presentation for endorsement to the board of management and the line ministry or agency concerned. The general corporation board of management will provide a formal letter to MOF endorsing the implementation of the proposed plans and restructuring measures and the participation of the general corporation in the facility. In addition, the general corporation will provide in a transparent and comprehensive manner all relevant financial information to MOF and ADB to allow appropriate due diligence and the identification of issues, if any, related to ADB's social and environment safeguards. 7. Based on the information prepared by the general corporations, with possible facilitation by ADB consultants, the projects will be appraised by ADB and MOF, which will provide a sovereign guarantee for the ADB lending. After ADB's approval, and subject to any modifications and measures required by ADB, MOF will prepare periodic financing requests (PFRs) for ADB financing. Each PFR will provide (i) the loan amount required; (ii) the

44

Appendix 5

subprojects and components to be finance under the loan; (iii) cost estimates and a financing plan; (iv) implementation arrangements; (v) confirmation of continuing validity of and adherence to the provisions of the framework financing agreement; (vi) confirmation of compliance with the provisions under previous loan and project agreements, as appropriate; and (vii) other information required under the facility administration memorandum to be prepared and agreed by ADB and the Government, to facilitate the processing and implementation of the facility. The Government will formally submit the PFRs to ADB for further processing. 8. In addition to general corporations, the Government may request the participation of other institutions, such as those dealing with resolving distressed assets and debts and managing the state's capital in SOEs. These roles are currently performed by the Debt and Asset Trading Company, which is participating in the first trance of the facility, and the State Capital Investment Corporation. The Government is reviewing the roles of these institutions, particularly the State Capital Investment Corporation, and will improve either or both institutions, as well as consider alternative institutions. If the Government deems it appropriate to seek further support for such institutions under the facility, MOF will consult with ADB to identify the scope and amount of support sought. Upon agreement between ADB and the Government, MOF will prepare a PFR that may be combined with financing support for general corporations as described above.

Appendix 6

45

FINANCIAL PERFORMANCE AND PROJECTIONS OF SONG DA GENERAL CORPORATION A. Introduction

1. Song Da was established under Decision No. 996/BXDTCLD, dated 15 November 1995, as a GC90, or a general corporation under the direct authority of the Ministry of Construction. The general corporation established a parent company, using the subsidiary model according to Decision 2435/QDBXD of the Ministry of Construction, dated 30 December 2005. It has equitized all of its state-owned enterprises except the dependent accounting members, the Deo Ngang Company and Song Da Vocational School. According to the master plan outlined in Prime Minister Decision No. 1729/QD-TTg, dated 29 December 2006, Song Da is scheduled to be equitized in 2010. The decision of the Ministry of Construction has not yet been issued. 2. The main activities of Song Da are hydropower plant construction, heavy industrial manufacturing, and electricity generation and trading. It operates in all provinces in the country. In addition, it provides trading, consulting, and insurance services. It had 21,665 employees as of 31 December 2007 and total assets of D21,922 billion. 3. Many practices and processes that would be expected in large enterprises in other countries with comparable income per capital are not found in businesses in Viet Nam. There are considerable gaps in the data available on the operations of the general corporations that reflect the structural constraints of an economy in transition from central planning to a marketbased system and accounting and auditing standards and practices still developing. Audited accounts of all the general corporations have comments and/or caveats. There is no information on transactions between companies within groups. There are no market projections. Investment feasibility studies lack adequate data analysis, and most general corporations do not have cash flow projections. Attempts have been made to address the data gaps to the extent possible, but the analysis below remains constrained by the structural constraints on data availability. B. Historical Performance

4. The auditors report on the consolidated financial statements of Song Da to 2007 have been qualified in respect of the non-elimination of intra-group sales and purchases, the related receivables and payables from them, and unearned profits on inventories and work in progress. This affects accuracy of group sales and cost-of-sales amounts. The non-elimination of unearned profits captured in inventories and work in progress results in overstatement of past profits of the group to the same extent. 5. The income statements of Song Da showed continuous improvement in gross profit from 2005 to 2007 (Figure A6.1). The profit margin increased from 6% in 2005 to 10% in 2007, and sales generated from operations were able to cover operating expenses. Financial expenses (mostly interest costs), equaled 5.5% of net sales in 2005, and 7.4% in 2007, showing the considerable impact of interest costs on the profitability of the general corporation. 6. Four main subgroupshydropower construction; electricity generation and trading; industrial production; and the construction of underground systems, buildings, and bridges contribute 73% of Song Das turnover and 85% of its profit. The contribution from the parent company is 23% of turnover and 11% of profit. The remaining 4% of turnover and 4% of profit is from other non-core activities. The subgroup constructing underground systems, buildings, and

46

Appendix 6

bridges alone contributed 8% of Song Das turnover but 38% of its profits, showing that it has promise for future development. Figure A6.1: Song Da's Income Statement, 20052007

COGS = cost of goods sold. Source: Asian Development Bank estimates.

7. The group is expanding its cement capacity by building the Ha Long Cement Joint Stock Company, a project that started in 2002 and is scheduled for completion in 2009. Details of sales, profit, and total assets by each segment, as well as their sales growth rates, are presented in Figure A6.2. Figure A6.2: Performance by Business Segment

Source: Asian Development Bank estimates.

Appendix 6

47

8. From 2005 to 2007, return on equity of Song Da declined from 24.95% to 18.52%, attributed to the decline in asset turnover from 0.88 in 2005 to 0.46 in 2007. The return on equity and other ratios for the past 3 years are shown in Table A6.1.
Table A6.1: Some Performance Indicators for Song Da Ratio Return on equity (%) Profit margin (%) Asset turnover (times) Asset/Equity (times) Source: Asian Development Bank estimates. 2005 24.95 6.20 0.88 4.54 2006 18.35 6.80 0.53 5.13 2007 18.52 9.80 0.46 4.12

9. The decrease in return on equity (ROE) is not attributed to falling profitability but rather to lower asset turnover. According to the management of Song Da, the lower ROE was due mainly to the group's many current investments, some of which have yet to contribute any return. These projects will be significant contributors to future performance. Figure A6.3 indicates the difference in ROE among activities. The ROE for industrial production is only 6.72%, two thirds the ROE from electricity, at 9.66%. These two segments require higher infrastructure investments, with many ongoing projects, but generate relatively low sales.

Figure A6.3: Return on Investments

Source: Asian Development Bank estimates.

10. To meet the continuing need of the Government to increase hydroelectric generation capacity to satisfy fast-growing demand for electricity, Song Da has been constructing and operating more hydropower plants under buildoperatetransfer terms. Hence, cash flow generated from operations is inadequate to finance capital funding. Song Da will continue to rely on bank support to refinance maturing loans and provide new loans. This trend will continue until the cash flows generated from operations surpass further capital funding needs. In this regard, the ordinary capital resources (OCR) loan from the Asian Development Bank to help restructure the outstanding loans to the group will relieve pressure to seek refinancing of maturing loans. Finally, cash flow generated from group operations rose from D1,452 trillion in 2006 to D2,128 trillion in 2007. Details of cash flow in 2006 and 2007 are presented in Table A6.2.

48

Appendix 6

Table A6.2: Song Da Cash Flow (D million) Item Operating Activities Profit before enterprise income tax Adjustments for: Depreciation of fixed assets Provisions Profit (loss) from unrealized exchange gain or loss Interest income from investment Finance costs Operating profit or EBITDA Increase (decrease) in receivables Increase in inventories Increase (decrease) in trade and other payables Decrease in accounts receivable and prepayments Loan interest EIT payables Other cash inflow from operation Other cash outflow from operation Working capital excess (need) in the year Net cash inflow (outflow) from operating activities Investing Activities Payments to acquire property, plant, and equipment Proceeds from sale of property and equipment Providing loans or purchase of debt instruments of other entities Receiving loans provided or sales of debt instruments of other entities Investments in others subsidiaries Recovering of investment in other subsidiaries Interest and dividend received Net cash outflow from investing activities Financing Activities New capital contribution and stock issuance Repayment of capital contribution for shareholder and repurchase of stocks issued Loan received Repayment of loan principle Repayment of financial lease Interest and dividends paid 2006 457,155 452,404 3,905 1,524 (216,144) 347,543 1,046,385 (258,468) (429,100) 1,427,574 (109,239) (239,823) (12,149) 2007 836,439 559,363 2,730 4,644 (291,347) 612,742 1,724,570 480,086 (152,913) 858,924 10,911 (689,968) (22,737) 1,002,568 (1,083,647) 403,225 2,127,794 (5,829,262) 21,098 (704,470) 149,215 (1,712,360) 97,869 270,250 (7,707,660) 3,897,754 (15,221) 8,999,424 (5,642,637) (76,384)

378,794 1,425,179 (2,834,311) 17,156 (706,595) 166,658 (235,174) 24,327 198,988 (3,368,952) 288,641 (2,610) 5,555,884 (3,642,518) (333) (24,881)

Net cash inflow (outflow) from financing activities 2,174,182 7,162,936 Net increase (decrease) in cash and cash equivalents 230,410 1,583,070 Cash and cash equivalents at the beginning of the year 680,551 912,484 Effect of foreign exchange difference 1,524 (915) Cash and cash equivalents at the end of the year 912,484 2,494,638 ( ) = negative; EBITDA = earnings before interest, taxes, depreciation, and amortization. Source: Song Da.

Appendix 6

49

C.

Historical Covenant Compliance

11. In undertaking capital projects in the past under the direction of the Ministry of Construction, Song Da has relied on capital injections from the Government, the proceeds of the equitization exercise, and bank loans to fund the projects. So far, Song Da has been successful in all its projects, and the rate of return realized from projects has been significantly higher than the cost of financing. Hence, it has so far enjoyed strong support from shareholders and bankers. Although some of the maturing loans can be settled only with the proceeds from new loans, these new loans are within the borrowing capacity of Song Da. In any case, the group has no history of default. D. Industry Outlook

12. With gross domestic product growth expected to average 6% in the foreseeable future, the outlook of the industries in which the subsidiaries of Song Da are involvedhydropower generation, hydropower plant construction, manufacturing and distributing such industrial products as cement and steel, and general infrastructure construction and property developmentis generally bright. Moreover, with the strong Governmental support that Song Da enjoys, its operating subsidiaries are poised to benefit from continuing high growth in Viet Nam. The Government has announced the involvement of Song Da in the development of some major infrastructure projects. E. Impact of the Corporate, Management, and Financial Restructuring on the Future Performance of Song Da and Projections

13. Following the implementation of recommended restructuring under tranche 1 of the State-Owned Enterprise Reform and Corporate Governance Facilitation Program, group operations will be restructured under four business segments and managed by four sub-holding companies, each focusing on one business segment. These sub-holding companies and their subsidiaries will enjoy many benefits: well-coordinated and streamlined business activities, economies of scale and scope, enhanced strategic focus, standardized business processes and procedures, enhanced competency and capacity of people, and enhanced accountability and reporting systems. These benefits may be manifested in the future as innovation of more and better products, better market acceptance and confidence, enlarged market share, higher productivity and efficiency, efficient management and reporting processes, and a more controlled but progressive working environment. Standardization of business processes and management procedures will bring about marked operational benefits and savings. All these benefits will contribute to enhanced competitiveness and the long-term sustainability of group profitability. It is difficult, however, to quantify these benefits accurately at this stage. It is nevertheless expected that, in the short term, there will be at least interest savings from the lower interest rate of the OCR loan and other savings from the removal of duplication of resources, in terms of staff numbers and related facilities and equipment, and enhanced utilization of available resources, assets, and equipment. The OCR loan of $117.5 million will help ease the pressure from bank loan repayment obligations and enhance the financial position of the group. It is estimated these restructuring measures will translate into an improvement of at least 5% in general management and administrative expenses of the group. 14. The projections for the group are based on past trends in sales and cost of sales and the relationship between them. Consequently, they are subject to the limitations of the financial information available, particularly due to the non-elimination of intra-group sales and purchases, implying that projected net profits are likely overstated. At the same time, the estimated

50

Appendix 6

projections are based on the minimum estimated reductions of operating expenses. As such, Table A6.3 nevertheless shows the difference in the projected future operating performance and financial position of Song Da between before and after receipt of Asian Development Bank loans and the implementation of the proposed restructuring measures.

Appendix 6

51

Table A6.3: Song Da's Financial Position Before and After the Restructuring Exercise A. Before Receipt of ADB Loans and Implementation of Restructuring Measures
Item Revenue (D million) Cost of goods sold (D million) Gross profit Selling and G&A expenses (D million) Profit before tax (D million) Net profit (D million) Cash flow from operations (D million) New borrowings (D million) Capital expenditures (D million) Debt service (D million) Self financing ratio Debt service coverage ratio Debtequity ratio Return on net fixed assets (%) Current ratio Receivables (days) Return on capital employed (%) FY09F 13,034,583 11,124,219 1,909,927 453,111 933,445 709,562 2,740,365 54,823 3,829,123 579,693 0.7 4.73 1.45:1 8.4 0.85 106.46 9.39 FY10F 14,811,420 12,690,215 2,120,748 496,210 1,040,123 795,569 1,335,528 1,620,884 4,011,030 747,736 0.3 1.79 1.40:1 8.7 0.79 102.44 9.49 FY11F 17,049,671 14,677,016 2,372,177 549,596 1,240,753 957,531 1,473,245 1,582,272 3,101,116 811,976 0.5 1.81 1.39:1 9.7 0.8 98.88 10.05 FY12F 18,695,811 16,005,489 2,689,823 594,509 1,449,614 1,112,621 1,643,758 3,207,951 4,941,788 933,815 0.3 1.76 1.67 10.5 0.78 99.71 10.10 FY13F 20,362,249 17,458,971 2,902,756 623,488 1,575,763 1,212,586 1,980,021 590,455 2,234,184 1,043,990 0.9 1.90 1.51:1 10.7 0.75 98.53 14.92 FY14F 21,713,283 18,635,883 3,076,854 656,768 1,803,655 1,383,079 2,792,096 na. 2,134,831 940,495 1.3 2.97 1.30:1 10.8 0.81 93.02 10.24 FY15F 21,645,220 18,517,180 3,127,470 642,762 1,817,846 1,386,091 2,652,350 n.a. 1,684,609 995,940 1.6 2.66 1.16:1 9.9 0.77 95.58 9.95 FY16F 23,183,786 19,871,033 3,312,158 681,196 1,923,747 1,470,553 2,484,980 n.a. 1,164,123 941,347 2.1 2.64 1.03:1 9.6 0.79 95.14 10.06 FY17F 24,836,644 21,325,811 3,510,211 708,750 2,034,222 1,559,017 2,562,486 n.a. 1,291,398 879,138 2.0 2.91 0.91:1 9.4 0.83 94.72 10.04 FY18F 26,623,489 22,893,207 3,729,632 752,090 2,155,514 1,655,998 2,696,528 n.a. 1,439,604 796,884 1.9 3.38 0.78:1 9.1 0.86 91.54 10.02

B. After Receipt of ADB Loans and Implementation of Restructuring Measures

Item Revenue (D million) Cost of goods sold (D million) Gross profit Selling and G&A expenses (D million) Profit before tax (D million) Net profit (D million) Cash flow from operations (D million) New borrowings (D million) Capital expenditures (D million) Debt service (D million) Self-financing ratio (%) Debt-service coverage ratio Debtequity ratio FY09F 13,034,583 11,124,219 1,909,927 430,455.67 1,572,343 1,491,013 3,645,641 120,248 3,829,123 600,399 1.0 6.07 1.1:1 FY10F 14,811,420 12,690,215 2,120,748 471,399.71 1,696,561 1,597,325 1,855,181 2,406,805 4,011,030 768,884 0.5 2.41 1.1:1 FY11F 17,049,671 14,677,016 2,372,177 522,115.77 1,949,596 1,816,964 2,231,505 1,650,745 3,101,116 833,609 0.7 2.68 1.12:1 FY12F 18,695,811 16,005,489 2,689,823 564,783.92 2,221,580 2,074,822 2,696,496 2,318,801 4,941,788 955,484 0.5 2.82 1.3:1 FY13F 20,362,249 17,458,971 2,902,756 592,313.31 2,428,746 2,237,051 3,044,089 1,099,043 2,234,184 1,061,909 1.4 2.87 1.24:1 FY14F 21,713,283 18,635,883 3,076,854 623,929.68 2,761,089 2,545,368 3,857,077 1,001,480 2,134,831 959,596 1.8 4.02 1.1:1 FY15F 21,645,220 18,517,180 3,127,470 610,623.83 2,895,287 2,686,874 3,745,102 n.a. 1,684,609 1,016,367 2.2 3.68 0.99:1 FY16F 23,183,786 19,871,033 3,312,158 647,136.44 3,110,255 2,882,605 3,431,595 n.a. 1,164,123 959,869 2.9 3.58 0.90:1 FY17F 24,836,644 21,325,811 3,510,211 673,312.58 3,359,557 3,110,557 3,957,897 n.a. 1,291,398 902,331 3.1 4.39 0.81:1 FY18F 26,623,489 22,893,207 3,729,632 714,485.08 3,614,650 3,342,419 4,048,955 n.a. 1,439,604 820,265 2.8 4.94 0.70:1

52

Appendix 6 FY09F 13.2 0.97 106.46 11.58 FY10F 11.5 0.99 102.44 11.34 FY11F 11.0 1.00 98.88 11.37 FY12F 11.1 1.04 99.71 11.28 FY13F 11.0 1.06 98.53 11.66 FY14F 11.7 1.07 93.02 11.93 FY15F 11.8 1.04 95.58 12.25 FY16F 12.3 1.03 95.14 12.61 FY17F 12.9 1.03 94.72 12.77 FY18F 13.4 1.03 91.54 12.99

Item Return on net fixed assets (%) Current ratio Receivables (days) Return on capital employed (%)

ADB = Asian Development Bank, D = dong, FY = fiscal year, F = forecast, G & A = general management and administration. Source: Song Da.

Appendix 6

53

F.

Proposed Covenants

15. Given the continuing need for the country to develop further hydropower-generating capacity, Song Da will continue to incur indebtedness to fund its projects. The group will no doubt generate substantial cash flow in the future as its newly constructed hydropower plants begin operation. In the meantime, there is a need to observe prudent financial management. As the group is engaged in a capital-intensive industry, a maximum long-term debt-to-equity ratio of 4:1 and minimum debt-service coverage ratio of 1.5 are proposed as financial covenants to ensure that the debt and debt-service capacity of the four sub-holding companies of Song Da remain within prudent limits. Although the debt-to-equity position for each of the four sub-holding companies is expected to steadily decrease, and for the debt-service coverage ratio increase, surplus cash flows generated from operations may be inadequate to fund further capital expenditures required during the projection period, depending on the Governments development agenda. Hence, it is important to include a minimum self-financing ratio of 25% to ensure that the sub-holding companies generate adequate cash flows to finance a reasonable portion of their capital investments, so that their leveraging remains within prudent limits. G. Conclusion

16. Despite its ambitious capital expansion program, Song Da would appear to maintain its financial viability operating through four sub-holding companies. It is reasonable to expect that the group and each of the sub-holding companies will be able to comply with the financial covenants over the projection period. Under the proposed new corporate structure of the Song Da group, the sub-holding companies, which are all publicly listed companies, will have the flexibility to source the additional funds required for implementing capital projects from the capital market.

54

Appendix 7

FINANCIAL PERFORMANCE AND PROJECTIONS OF SOWATCO A. Introduction

1. Southern Waterborne Transport Corporation (Sowatco) was established under Decision No 2124/QD-TCCB-LD, dated 13 August 1996, as a GC90, or general corporation under the direct authority of the Ministry of Transport. It is a holding company, following the parent companysubsidiary model per Decision No. 1863/QD-BGTVT of the Ministry of Transportation, dated 26 June 2003. It completed its equitization in 2008. Towards the end of 2008, it undertook an initial public offering, which was completed in January 2009. As of 31 December 2007, the general corporation had 1,059 employees and assets of D920.6 billion. 2. The main lines of business for Sowatco are transportation and logistics services, both of which have seen rapidly increasing demand in the past few years in the Mekong Delta. Sowatco has been able to take advantage of this trend, but, to cope with the future demand for logistics services resulting from sustained economic growth in the Mekong Delta, Sowatco would need to make considerable investments in expanding the scale and scope of its current business and upgrading its business infrastructure and operational facilities. To do this, it requires more financial support to help fund its future growth. 3. Many practices and processes that would be expected in large enterprises in other countries with comparable income per capital are not found in businesses in Viet Nam. There are considerable gaps in the data available on the operations of the general corporations that reflect the structural constraints of an economy in transition from central planning to a market-based system and accounting and auditing standards and practices still developing. Audited accounts of all the general corporations have comments and/or caveats. There is no information on transactions between companies within groups. There are no market projections. Investment feasibility studies lack adequate data analysis, and most general corporations do not have cash flow projections. Attempts have been made to address the data gaps to the extent possible, but the analysis below remains constrained by the structural constraints on data availability. B. Historical Performance

4. For 2005 and 2006, the net contribution from sales was barely sufficient to cover administration and finance expenses. In 2007, sales were supplemented by interest income. In the 3 years to 2007, the operating profit margin stayed low at 0%2%, mainly because the average price of fuel more than doubled, from D4,800/liter in 2005 to more than D10,000/liter in 2007. At the same time, transportation charges could not be increased, as they are controlled by the Ministry of Transportation, thus affecting the gross margin of the logistics activities stevedoring and transportation. The increased cost of lubricants and fuel oil also adversely affected the volume of trade in the Mekong Delta, reducing the utilization rate of barges and related support equipment.

Appendix 7

55

Figure A7.1: Sowatco's Income Statement, 20052007

COGS = cost of goods sold. Source: Sowatco.

Figure A7.2: Return on Equity Trends of Various Components

Source: Asian Development Bank estimates.

5. The significant increase in return on equity and profit margin in 2007 was due to recognition of an exceptional profit of D47.3 billion arising from a change in accounting treatment of the general corporations interest in joint ventures and associates.

56

Appendix 7

Figure A7.3: Sowatco: Current Assets and Liabilities, 2007

Source: Sowatco.

6. Asset turnover is low because of ongoing construction at the Long Binh port. Net current assets, fixed assets, and long-term investment are mainly financed by equity. The asset-to-equity ratio is low, and long-term borrowing accounts for only 9% of net total capital. 7. In the 3 years from 2005 to 2007, return on assets was low, at 1%2%. Cash generated by operations was insufficient to cover loan repayments, which had to be refinancing by other loans. Towards the end of 2008, Sowatco received the proceeds of the initial public offering, which was completed in January 2009. The financial position of the company has since improved significantly.

Appendix 7

57

Table A7.1: Cash Flow Statement of Southern Waterborne Transport Corporation, 2006 and 2007
Item A. Cash Flows from Operating Activities Cash receipts from the sale of goods and the rendering of services Cash payments to suppliers for goods and services Cash payments to and on behalf of employees Cash payments of loan interest Cash payments of income taxes Other cash receipts from business activities Other cash payments of business activities Net cash flows (used in) operating activities B. Cash Flows from Investing Activities Purchase and construction of fixed assets and other long-term assets Proceeds from disposals of fixed assets and other longterm assets Loans to other entities and payments for purchase of debt instruments of other entities Collections from borrowers and proceeds from sale of debt instruments of other entities Payments for investments in other entities Proceeds from sale of investments in other entities Interest and dividends received Net cash flows from (used in) investing activities C. Cash Flows from Financing Activities Capital contribution and issuance of shares Capital redemption Borrowings received Borrowings repaid Finance lease principal paid Dividends paid Net cash flows from (used in) financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year Impact of exchange rate fluctuation Cash and cash equivalents at end year [period] ( ) = negative, = not available. Source: Sowatco. 2006 300,309 (110,861) (37,389) (10,809) (1,681) 48,450 (98,389) 89,630 (1,562) 2,215 (200) 1,274 1,727 18 195,917 (305,067) (505) (109,637) (18,280) 35,750 (7) 17,463 2007 439,175 (123,257) (42,119) (12,357) (2,801) 80,417 (108,828) 230,230 (599) 3,832 (18,000) 6,000 (20) 9,306 519 208,372 (421,303) (1,095) (214,026) 16,723 17,463 97 34,283

C.

Historical Covenant Compliance

8. Sowatco borrowed all its loans from local banks. There has been no instance of the company defaulting or making late payments. D. Industry Outlook

9. The outlook for the development of the logistics industry in the Mekong Delta is affected by the following: (i) Port capacity in Ho Chi Minh City (HCMC) is expected to double between 2010 and 2020, and goods-handling targets for HCMC ports are set to increase from 100 to 200 million tons per year in the same period.1

Vietnam News, 2008. 3 November.

58

Appendix 7

(ii) (iii)

Container cargo is expected to grow at 25% a year. The general corporation transports mostly rice, clinker, fertilizer, and building materials, and this cargo mix is expected to be sustainable. Government plans to move several city ports to the suburbs, while leaving Vietnam International Container Terminals in HCMC. This will increase demand for waterborne transportation within HCMC in the future.

E.

Expected Impact of the Restructuring Exercise on the Future Operating Performance of the Group

10. Sowatco believes that, with the ordinary capital resources (OCR) loan from the Asian Development Bank, pressure on repayment will be greatly reduced. The general corporation will be able to focus on opportunities to invest and improve its service package and service delivery process. It will be in a position to provide integrated service, which is badly needed by the business community along the Mekong River. Sowatco hopes to be the first logistics company in the region to offer door-to-door services and total logistics solutions. This, together with the restructuring the company has undertaken to implement, will bring a significant improvement in the companys scale of operations and operational efficiency. In addition, the commencement of operations at Long Binh port will further complement its operations. All these developments will propel Sowatcos revenue and profitability going forward. 11. The immediate financial benefit of taking on the OCR and ADF loans is that Sowatco will save costs by refinancing with the OCR loan. It will enjoy further interest savings from reduced borrowing as deferment of repayment the OCR loan improves cash flow. Equally important will be the operational benefits, as the implementation of management reorganization and operational restructuring will generate savings from better utilization of existing assets and interest savings attributable to proceeds from the disposal of redundant assets. There will be savings from eliminating unproductive procedures and processes. These improvements are expected reduce general and administrative expenses by at least 5%. 12. Table A7.2 shows the difference in the projected future operating performance and financial position between before and after restructuring.

Appendix 7

59

Table A7.2: Sowatco's Financial Position Before and After the Restructuring Exercise A. Before Receipt of ADB Loans and Implementation of Restructuring Measures
Item Total revenue (D million) Cost of goods sold (D million) Gross profit (D million) Selling and G&A expenses (D million) Profit in JSC (D million) Profit before Tax (D million) Net profit (D million) Cash flow from operations (D million) New borrowings (D million) Capital expenditures (D million) Debt service (D million) Self-financing ratio Debt-service coverage ratio Debtequity ratio Return on net fixed assets (%) Current ratio Receivables (days) Return on capital employed (%) FY09F 589,712 561,777 27,935 26,094 62,759 95,882 71,911 9,895 16,035 15,875 0.62 0.22:1 43.06 1.15 69 13.05 FY10F 636,889 606,719 30,170 29,665 68,407 114,461 85,846 78,657 68,980 121,984 1.14 0.64 0.07:1 35.34 1.19 69 12.89 FY11F 700,578 667,391 33,187 32,631 74,564 111,376 83,532 92,942 159,832 165,209 19,766 0.56 4.70 0.24:1 25.44 1.49 69 11.69 FY12F 770,636 734,130 36,506 35,895 81,275 127,957 95,968 98,424 7,830 20,481 15,553 4.81 1.40 0.17:1 27.20 1.66 69 12.04 FY13F 886,232 708,985 177,246 41,279 88,589 280,601 210,451 179,121 2,048 22,529 14,824 7.95 7.17 0.13:1 60.27 2.36 69 21.49 FY14F 1,019,166 815,333 203,833 47,471 96,562 320,249 240,187 228,076 2,253 24,782 14,173 9.20 9.64 0.11:1 43.69 1.89 69 21.27 FY15F 1,141,466 913,173 228,293 53,167 105,253 358,057 268,542 261,616 2,478 27,260 13,600 9.60 11.65 0.09:1 44.43 2.26 69 20.09 FY16F 1,255,613 878,929 376,684 58,484 114,726 520,229 390,172 387,594 2,726 29,986 13,102 12.93 18.15 0.07:1 58.74 2.89 69 23.91 FY17F 1,381,174 966,822 414,352 64,332 125,051 572,838 429,629 426,733 2,999 32,985 12,679 12.94 20.93 0.06:1 58.88 3.72 69 22.04 FY18F 1,519,292 1,063,504 455,787 70,765 136,306 630,490 472,868 469,159 3,298 36,283 12,328 12.93 24.03 0.05:1 57.71 3.88 69 20.53

B. After Receipt of ADB Loans and Implementation of Restructuring Measures

Item Total revenue (D million) Cost of goods sold (D million) Gross profit (D million) Selling and G&A expenses (D million) Profit in JSC (D million) Profit before Tax (D million) Net profit (D million) Cash flow from operations (D million) New borrowings (D million) Capital expenditures (D million) Debt service (D million) Self-financing ratio Debt-service coverage ratio FY09F 589,712 533,688 56,024 26,094 62,759 123,971 92,978 30,962 15,875 1.95 FY10F 636,889 576,383 60,506 28,182 68,407 147,429 110,572 103,383 70,600 68,980 74,831 1.50 1.38 FY11F 700,578 634,021 66,557 31,000 74,564 173,075 129,806 139,216 28,752 165,209 38,390 0.84 3.63 FY12F 770,636 697,424 73,213 34,100 81,275 174,897 131,173 133,630 63,114 20,481 70,228 6.52 1.90 FY13F 886,232 673,536 212,696 39,215 88,589 325,993 244,495 213,165 6,295 22,529 13,239 9.46 16.10 FY14F 1,019,166 774,566 244,600 45,097 96,562 370,770 278,078 265,966 6,043 24,782 12,835 10.73 20.72 FY15F 1,141,466 867,514 273,952 50,509 105,253 413,314 309,985 303,059 5,801 27,260 12,461 11.12 24.32 FY16F 1,255,613 834,983 420,630 55,559 114,726 573,656 430,242 427,665 5,569 29,986 12,115 14.26 35.30 FY17F 1,381,174 918,481 462,693 61,115 125,051 630,623 472,967 470,071 5,347 32,985 11,584 14.25 40.58 FY18F 1,519,292 1,010,329 508,963 67,227 136,306 693,153 519,865 516,156 5,133 36,283 6,378.78 14.23 80.92

60

Appendix 7

Item Debtequity ratio Return on net fixed assets (%) Current ratio Receivables (days) Return on capital employed (%) Source: Sowatco.

FY09F 0.22:1 55.67 1.18 69 16.05

FY10F 0.12:1 45.52 1.24 69 15.77

FY11F 0.24:1 39.54 1.69 69 15.12

FY12F 0.16:1 37.18 1.98 69 13.97

FY13F 0.13:1 70.02 2.82 69 22.01

FY14F 0.11:1 50.58 2.24 69 21.69

FY15F 0.09:1 51.28 2.57 69 20.48

FY16F 0.07:1 64.77 3.20 69 23.57

FY17F 0.06:1 64.82 3.97 69 21.81

FY18F 0.05:1 63.44 3.97 69 20.40

ADB = Asian Development Bank, D = dong, FY = fiscal year, F = Forecast , G & A = general management and administration , JSC = joint stock company.

Appendix 7

61

F.

Conclusion

13. With strong market growth expected, Sowatco can maintain its financial capacity despite its proposed capital expansion program. This conclusion is further reinforced by the improved outlook for industry development, Sowatcos history of covenant compliance, and the positive impact of restructuring.

62

Appendix 8

FINANCIAL ANALYSIS OF TRANCHE 1 PROJECTS A. Song Da 1. Introduction

1. The Song Da group of companies is engaged mainly in four business segments: hydropower plant construction, power trading, property development, and industrial production. Under the proposed corporate restructuring, the business of the general corporation will be shifted to appropriate subsidiaries, which will be grouped under four sub-holding companies. Each sub-holding company and its subsidiaries will focus on one of the four business segments, while the parent general corporation will be more of a holding company. 2. Asian Development Bank (ADB) lending will finance the operational restructuring through the Asian Development Fund (ADF) loan and corporate and debt restructuring through the ordinary capital resources (OCR) loan. There will be no physical investments under ADB lending, and no new assets will be created at Song Da. Many projects at various stages of implementation underlie the debts to be restructured under the State-Owned Enterprise Reform and Corporate Governance Facilitation Program. It is thus neither feasible nor meaningful to calculate the financial internal rate of return (FIRR) or net present value (NPV) for each of the various projects whose debt will be restructured under the OCR facility. Instead, return on capital employed for each of the subgroup or sub-holding companies is calculated. The financial viability of Song Da following the restructuring supported by ADB must be established. This can best be evaluated by appraising the financial position of each of the four sub-holding companies and their subsidiaries. The weighted average cost of capital (WACC) is calculated for each of the four subgroups and compared with the return on capital employed of each of the subgroups to ascertain the financial viability of each subgroup. Sensitivity to adverse movements of each subgroup was also assessed. These analyses clearly show that the financial viability of each subgroup will continue to improve over time. 3. Financial analysis is constrained by considerable gaps in the financial information available on the operations of the general corporations. The data gaps reflect the structural constraints of an economy in transition from central planning to a market-based system. Audited accounts of all the general corporations have comments and caveats. There is no information on transactions between companies within the group. There are no market projections. Investment feasibility studies lack adequate data analysis, and most general corporations do not have cash flow projections. Attempts have been made to address the data gaps to the extent possible, but the analysis below remains constrained by some of the structural constraints on data availability. 2. Methodology

4. Under the proposed restructuring plan, the operations of Song Da will be grouped under four sub-holding companies. The comparison with and without the proposed lending has to compare, therefore, the present structure and its operations with the operations under the new structure. As such, the projections of each of the sub-holding companies and their subsidiaries are worked out with and without ADB lending. The numbers for each group are then regrouped to arrive at consolidated numbers for Song Da as a whole. These numbers then become the base case for sensitivity analysis.

Appendix 8

63

5. As envisaged in the proposed restructuring plan, each of the sub-holding companies, which are all listed, is set to become an iconic company in its field, with technical and economic capacity to undertake bigger projects and those with more value added and avail itself of cheaper options to meet future financing needs. This may include the possibility of listing in regional bourses in Southeast Asia. All these developments will add to the financial stability of the subgroups. 3. Assumptions

6. The financial analysis is carried out in real terms on an after-tax basis. The projected sales are determined based on planned and expected increases in capacity and normal growth as realized in the recent past. As a conservative estimate, the gross profit margin for each business segment is assumed to be the same with or without reorganization. For the expected scenario of the subgroups, the benefits of reorganization are expected to reduce controllable general management and administrative expenses by 5%. It is assumed that inflation will affect income and expenditure to the same extent. 7. The other assumptions include an international US dollar interest rate of 1%, a tax rate of 25%, and 2.5% for the minimum interest rate test in view of prevailing low international interest rates. The expected capital expenditure of the Song Da group for the next 10 years is envisaged as shown in Table A8.1.
Table A8.1: Capital Expenditure Program of Song Da, 20092018
Hydropower Plant Construction 2,459,296 2,309,487 2,327,682 1,966,100 1,444,700 1,394,700 860,100 230,100 230,100 230,100 Power Trading 331,492 36,464 73,658 1,046,962 177,670 49,812 50,310 50,813 51,321 51,834 Industrial Production 171,362 645,738 527,632 1,742,264 409,733 471,193 361,248 397,372 437,110 480,821 Property Development 856,685 109,551 120,454 132,445 145,633 160,138 351,308 421,421 505,552 606,504 Parent Company 10,288 909,790 51,690 54,017 56,448 58,988 61,643 64,417 67,315 70,345

Year 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Total 3,829,123 4,011,030 3,101,116 4,941,788 2,234,184 2,134,831 1,684,609 1,164,123 1,291,398 1,439,604

Source: Song Da Corporation.

4.

Weighted Average Cost of Capital

8. The WACC is calculated for each of the subgroups assuming there will be no more capital contribution from shareholders and that future financing needs will be funded by retained earnings and loans. 9. The cost of equity of each of subgroup is estimated using the capital asset pricing model. The risk-free rate of 8.5% has been used based as the prevailing rate of government bonds denominated in local currency. The market risk premium for Viet Nam is taken as 11%, based on the average return on listed companies in Viet Nam. The equity beta for each business segment is estimated to be 0.85, based on the listed companies engaged in similar businesses in other developing countries. This results in a WACC for subgroups during 2009 2019 ranging from 8.02% to 11.2% as shown in Table A8.2.

64

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Table A8.2: Weighted Average Cost of Capital (%)

Hydropower Plant Construction 2009 8.51 2010 8.22 2011 8.07 2012 8.03 2013 8.08 2014 8.12 2015 8.23 2016 8.38 2017 8.54 2018 8.71 Source: Asian Development Bank estimates. Year Power Trading 8.2 8.5 8.6 8.1 8.2 8.6 8.7 8.8 8.8 9.0 Industrial Production 8.0 8.2 8.3 8.2 8.3 8.5 8.7 8.8 8.9 9.1 Property Development 10.1 10.2 10.7 11.2 11.2 11.2 11.2 11.2 11.2 11.2

5.

Return of Capital Employed

10. Since the OCR loans are to be given for sub-holding companies to restructure debts incurred to finance projects implemented in the past by subsidiaries, it is neither feasible nor meaningful to calculate FIRR and NPV for each of the projects. Instead, return on capital employed is calculated for comparison. The calculation of return on capital is based on the assumption that profitability will be enhanced with the implementation of restructuring and the resulting estimated reduction of at least 5% in general administrative expenses.
Table A8.3: Return on Capital Employed (%)
Item Return on capital employed FY09F 11.58 FY10F 11.34 FY11F 11.37 FY12F 11.28 FY13F 11.66 FY14F 11.93 FY15F 12.25 FY16F 12.61 FY17F 12.77 FY18F 12.99

FY = fiscal year, F = forecast. Source: Asian Development Bank estimates.

6.

Sensitivity Analysis

11. The sensitivity to adverse movements in sales and cost of sales has been computed to assess the robustness of the financial analysis of Song Da group. Inadequacy in the financial information on the general corporation and the resulting lack of information on the relationship between production or throughput volume or utilization rates of income-generating assets as related to expenses and details of the composition of cost items requires the analysis of sales and cost of sales to be on an aggregate basis. Consequently, the maximum adverse movement considered is a 10% change in sales and cost of sales. 12. The results of the sensitivity analysis in respect of each subgroup are tabulated in Tables A8.4, A8.5, A8.6, and A8.7.

Appendix 8

65

Table A8.4: Sensitivity Analysis for Hydropower Plant Construction

Item 1. Base case Min. SFR Min. DSCR Max. DE ratio Min. ROCE

30% 0.23 2.9:1 10.31% (2010) (2016) (2012) (2012) 2. 10% reduction in sales 23% 0.21 3.25:1 9.27% (2010) (2016) (2012) (2014) 3. 10% increase in COGS 14% 0.07 5.9:1 2.43% (2011) (2016) (2015) (2011) 4. 10% increase in interest rate 30% 0.23 3:1 9.75% (2010) (2016) (2012) (2014) 5. 10% increase in Capex 28% 0.22 4.3:1 10.04% (2010) (2016) (2012) 2012) CAPEX = capital expenditure, COGS = cost of goods sold, D-E ratio = debt-equity ratio, DSCR = debt-service coverage ratio, ROCE = return on capital employed, SFR = self-financing ratio. Source: Asian Development Bank estimates.

Table A8.5: Sensitivity Analysis for Power Trading

Min. SFR Min. DSCR Max. D-E Ratio Min ROCE 60% 0.35 1.6:1 8.42% (2013) (2011) (2012) (2009) 2. 10% reduction in sales 46% 0.23 1.9:1 8.12% (2013) (2011) (2012) (2009) 3. 10% increase in COGS 55% 0.30 1.7:1 9.06% (2013) (2011) (2012) (2009) 4. 10% increase in interest rate 59% 0.41 1.8:1 7.95% (2013) (2010) (2012) (2009) 5. 10% increase in CAPEX 55% 0.35 184% 8.48% (2013) (2011) (2012) (2009) CAPEX = capital expenditure, COGS = cost of goods sold, D-E ratio = debt-equity ratio, DSCR = debt-service coverage ratio, ROCE = return on capital employed, SFR = self-financing ratio. Source: Asian Development Bank estimates. Item 1. Base case

Table A8.6: Sensitivity Analysis for Industrial Production

Min. SFR Min. DSCR Max. D-E Ratio Min ROCE 53% 0.63 2.4:1 7.98% (2012) (2010) (2009) (2009) 2. 10% reduction in sales 45% 0.55 2.5:1 7.40% (2012) (2010) (2009) (2009) 3. 10% increase in COGS -160% -1.11 -0.02:1 -4.60% (2016) (2011) (2018) (2011) 4. 10% increase in interest rate 53% 0.63 2.4:1 8.00% (2012) (2010) (2009) (2009) 5. 10% increase in CAPEX 48% 0.63 2.4:1 8.03% (2012) (2010) (2009) (2009) CAPEX = capital expenditure, COGS = cost of goods sold, D-E ratio = debt-equity ratio, DSCR = debt-service coverage ratio, ROCE = return on capital employed, SFR = self-financing ratio. Source: Asian Development Bank estimates. Item 1. Base case

66

Appendix 8

Table A8.7: Sensitivity Analysis for Property Development

Min. SFR Min. DSCR Max. D-E Ratio Min ROCE 10% 1.51 0.34:1 13.57% (2009) (2010) (2009) (2018) 2. 10% reduction in sales 8% 0.42 1.03:1 8.61% (2009) (2011) 2018 (2018) 3. 10% increase in COGS 5% 0.38 0.7:1 12.92% (2009) (2010) 2010 (1018) 4. 10% increase in interest rate 10% 1.46 0.34:1 13.59% (2009) (2010) (2009) (2018) 5. 10% increase in Capex 10% 0.83 0.34:1 13.73% (2009) (2010) (2009) (2018) CAPEX = capital expenditure, COGS = cost of goods sold, D-E ratio = debt-equity ratio, DSCR = debt-service coverage ratio, ROCE = return on capital employed, SFR = self-financing ratio. Source: Asian Development Bank estimates. Item 1. Base case

13. Subject to the effects of imperfections in the underlying projection numbers, the sensitivity analysis indicates that the financial viability of power plant construction, power trading, and property development subgroups is sufficiently robust to withstand adverse movements in the volume of business and cost of sales. However, the viability of the subgroup manufacturing industrial products is sensitive to an increase in production costs. Hence, greater management attention must be focused on this business segment to enhance the business model of this subgroup. The financial viability of the Song Da group of companies as a whole is affirmed by the sensitivity analysis. B. Sowatco 1. Introduction

14. Sowatco mainly provides logistics and related services. Under the proposed corporate restructuring, the business of Sowatco will first be shifted down to appropriate subsidiaries engaged in similar businesses. Investments in non-core activities will be disposed of. Subsequently, Sowatco will serve as an investment holding company with subsidiaries that provide such logistics-related services as port services, the bulk handling of rice through buy and sell arrangements, and river barge transport. Going forward, management intends to invest in warehousing and land transport services to compliment its current river barge services and enable an integrated door-to-door service. 15. With the implementation of the recommended restructuring, Sowatco is set become a key player in the logistics industry in the Mekong Delta, with technical and economic capacity to expand and attract higher-end customers and at the same time avail itself of cheaper options to meet future financing needs. This may include listing on regional bourses. All these developments will add to its long-term financial stability. 16. Sensitivity to adverse movements was assessed. These analyses clearly show that the financial viability of Sowatco will improve over time. The methodology and assumptions used for Sowatco are identical to those used for the analysis of Song Da.

Appendix 8

67

Table A8.8: Capital Expenditure Program of Sowatco, 20092018 (D million)

Long Binh Port 61,480 61,480

Year 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Total Source: Sowatco.

Lorries 7,500 7,500 3,300 3,630 3,993 4,392 4,832 5,315 5,846 46,308

Barges 62,476 17,181 18,899 20,789 22,868 25,155 27,670 30,437 225,474

Ships 26,666

Warehouse 7,088

Total 68,980 165,209 20,481 22,529 24,782 27,260 29,986 32,985 36,283 428,494

122,959

26,666

7,088

2.

Weighted Average Cost of Capital

17. The weighted average cost of capital (WACC) is calculated using the same assumptions and methodology as for Song Da: no additional capital contribution from shareholders, future financing through retained earnings and loans, a US dollar interest rate of 1.5%, and a tax rate of 25%. 18. The cost of Sowatco equity is estimated using the capital asset pricing model. The riskfree rate of 8.5% has been used, based on the prevailing rate of government bonds denominated in local currency. The market risk premium for Viet Nam is taken as 11%, based on the average return on listed companies in Viet Nam. The equity beta for Sowatco is estimated to be 0.85, based on the listed companies engaged in similar business in other developing countries. The WACC to Sowatco during 20092019 is 11%. 3. Return on Capital Employed

19. As with Song Da, the OCR loan to Sowatco will not finance new physical investments but restructure previous debts. Neither FIRR nor NPV is therefore feasible or meaningful, and return on capital employed is instead calculated for comparison with the WACC. As before, expected enhancement in profitability arising from restructuring has not been taken into account.
Table A8.9: Sowatcos Return on Capital Employed (%)

Year Return on capital employed

2009 13

2010 13

2011 12

2012 12

2013 22

2014 22

2015 21

2016 25

2017 23

2018 21

Source: Asian Development Bank estimates.

68

Appendix 8

4.

Sensitivity Analysis

20. Subject to the same limitations of financial data noted for Song Da, sensitivity to adverse movements in sales and the cost of sales has been computed to assess the robustness of the financial analysis of Sowatco. As before, the analysis of sales and cost of sales is on a total basis, so the maximum adverse movement considered is 10% of sales and cost of sales. 21. The results of the sensitivity analysis are shown in Table A8.10.
Table A8.10: Sensitivity Analysis
Minimum DebtMinimum SelfService Maximum Debt Financing Ratio Coverage Ratio Equity Ratio 40% 1.39 0.3:1 (2009) (2009) (2011) 20% 2.00 0.38:1 (2009) (2009) (2010) 14% 1.95 0.43:1 (2009) (2009) (2010) 39% 1.45 0.27:1 (2009) (2009) (2009) 35% 1.39 0.32:1 (2009) Source: Asian Development Bank estimates. (2009) (2011) Minimum Return on Capital Employed 14% (2012) 10% (2012) 9.8% (2012) 14% (2012) 14% (2012)

Description Base Case 10% Decrease in Sales 10% Increase in Cost of Sales 10% Increase in Interest Rate 10% Increase in Capital Expenditure

22. The sensitivity analysis shows the financial viability of Sowatco and that its operations are sufficiently robust to withstand adverse movements in revenue and expenses.

Appendix 9

69

ECONOMIC ANALYSIS OF STATE-OWNED REFORM AND CORPORATE GOVERNANCE FACILITATION PROGRAM FACILITY TRANCHE 1 PROJECTS A. Macroeconomic Context

1. After a sustained period of high economic growth, Viet Nam's economy has faced significant challenges since 2007. The growth rate declined from 8.5% in 2007 to 6.25% in 2008, the lowest rate in almost a decade. A policy tilt towards growth relative to stability led to high public sector spending. Combined with large capital inflows and spikes in energy and food prices, this caused historically high inflation of about 28% in the second quarter of 2008 and large trade deficits. The dong came under severe depreciation pressure. The Government of Viet Nam (the Government) acted strongly to stabilize the economy and managed to reduce inflation, though growth momentum also slowed. The economy has been affected too by the global financial crisis and economic downturn. The Government has sought to expand its fiscal and monetary polices in response, which has raised concerns about currency depreciation and fiscal deficit. Weaknesses in the banking sector and the state-owned enterprise (SOE) sector compound the difficulties faced by the Government in designing and implementing policies to ensure macroeconomic and financial stability in a challenging global environment. 2. According to the latest debt sustainability analysis of Viet Nam, the country remains at low risk of debt distress despite recent deterioration in its economic conditions, primarily because of favorable indicators of external debt sustainability reflecting access to concessional and long-term external debt and high growth rates for exports. Public sector debt, including domestic debt, will need to be managed more carefully with deterioration in the overall fiscal balance. Contingent liabilities, including those related to addressing problems in SOEs, are an added vulnerability. B. Sector Analysis

3. The Government initiated ambitious and comprehensive economic and structural reforms in the late 1980s to shift the economy towards a more market-oriented system. However, SOE reform has proceeded very slowly. SOE equitizationthe process of converting SOEs into joint stock companies with limited liabilitywas launched as early as mid-1992, but by the end of 1997 only 17 enterprises had been equitized. As of December 2007, nearly 5,000 SOEs had been equitized or otherwise converted, and about 1,600 enterprises remained to be equitized. The SOE sector in 2007 accounted for approximately 40% of the gross domestic product and 30% of credit in the economy. 4. Most of the SOEs equitized early on were small. In the mid-1990s, the Government organized most SOEs into 17 general corporations or conglomerates reporting to the Prime Minister (GC91s) and 77 special general corporations under line ministries and provincial peoples committees (GC90s). In 2002, these 94 general corporations included 1,605 member SOEs, representing 28% of all SOEs and 65% of the capital of all SOEs. The remaining SOEs that have yet to be equitized are mainly the GC90s and GC91s. In 2006, the Government approved a master plan including a list of general corporations identified for equitization. The plan was for about 20 general corporations to be equitized every year from 20072010. As of 31 May 2008, none of the GC91s and only 7 of the GC90s had been equitized. 5. SOE reform has been constrained by several factors. The initial approach of the Government was flawed, focusing primarily on small SOEs and on quantity rather than quality and emphasizing equitization without considering listing as integral to SOE transformation. The

70

Appendix 9

SOEs equitized were too small to be listed and continued to operate inefficiently, dependent on larger SOEs and the state for business. The really difficult partequitizing and transforming large general corporationshas yet to start in a meaningful way. 6. Equitizing general corporations is complicated by their large size and diverse scope of operations through many subsidiaries that are not always controlled by the parent general corporation. This makes valuating the general corporation's shares in its subsidiaries difficult. Valuation is further made difficult by inadequate documentation of SOE assets and land valuation. Another critical constraint on general corporation equitization has been their financial weakness because of excessively high debt. General corporations have relied extensively on loans from the Government and state-owned commercial banks and have gearing ratios of debt over equity considerably higher than 1. This has severely constrained their ability to service their debts and contributed to the high number of nonperforming loans in the banking system. High indebtedness implies that the general corporations are ill-equipped to deal with risks and will not have the financial capacity to fund capital investments. The problem is exacerbated by much of their debt being high cost and short term. 7. The Government is aware that restructuring general corporations is crucial to reforming SOEs and reducing risks to state finances from SOEs. Despite slow progress, the Government remains committed to SOE reform and will review and revise its master plan when it ends in 2010. The Government has agreed that a comprehensive approach to transforming general corporations is necessary, going beyond mere equitization. Equitization is only one step in a successful transformation process for SOEs and needs to be complemented, even preceded, by a host of other steps, including strategic and business planning, corporate and financial restructuring, attracting investment and corporate financing, forming value-adding business partnerships or alliances, and implementing more transparent governance. Enhancing the market education of management and staff, modernizing management information systems and human resource development systems, and possibly listing on the stock exchange, are additional steps and challenges that need to be addressed for effective and comprehensive transformation. The first tranche of the proposed facility will be a pilot project to demonstrate a successful and sustainable model for transforming general corporations. C. Economic Costs and Benefits of Tranche 1 Subprojects

8. Tranche 1 of the proposed facility will provide ordinary capital resources loans to two general corporationsSong Da and Sowatcoto undertake debt restructuring. In addition, Asian Development Fund (ADF) loans to both general corporations will be provided to implement operational restructuring and improve corporate governance. Further, as part of tranche 1, ADF lending will be provided to the Debt and Asset Trading Corporation (DATC) to improve its resolution of nonperforming and distressed assets. DATC will use the funds for operational restructuring and improved governance. The Government will onlend the Asian Development Bank (ADB) loans to the participating general corporations and DATC. 9. The valuation of the costs and benefits of tranche 1 subprojects of the facility follows ADBs guidelines. 1 The costs to society are the investments in the subprojects, with total investment costs at $130 million, consisting of $120 million for debt restructuring and $10 million for operational restructuring. Since the operational restructuring does not impose any changes in the labor force at any of the participating entities and has only modest investments such as in information technology systems to support the restructured management and operational
1

ADB. 1997. Guidelines for the Economic Analysis of Projects. Manila.

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processes, recurrent or operating costs are negligible. Debt restructuring is not expected to lead to investments or improved operation and maintenance, and are akin to transfer payments. For both the debt restructuring and the operational restructuring components, therefore, the incremental costs of the investments are negligible. Given the negligible incremental costs and benefits that, while substantial, are difficult to quantify meaningfully (see below), it was decided not to estimate economic internal rate of return and focus instead on qualitative aspects of the potential economic benefits and returns. 10. Benefits. The project benefits are mainly unlocking and unleashing the latent value of SOE assets. The ordinary capital resources loan is used to restructure the debt of the two general corporations to the tune of $120 million. The general corporations pay off the existing creditor banks and owe the money instead to the Government, which owes it to ADB. The banks can lend the money thus released to other borrowers. In other words, the ADB loan is an injection of additional resources in a resource-constrained system. The net result is that (i) $120 million in new debt from ADB is matched by new projects worth $120 million equivalent launched by new borrowers from the present creditor banks of the general corporations and (ii) these additional resources come at a lower cost to the economy. However, it would not be possible at this stage to quantify the size, nature, and timing of economic costs and benefits of the new projects. 11. For the ADF loan, the investment cost is $10 million equivalent to reorganize the general corporations and DATC. These are not revenue-generating investments per se, but their impact is to make the general corporations more efficient by either reducing costs or increasing revenues through better selection of projects, or both. The result is an increase in net revenues. The financial model has estimated that, with the ADB project improving operations under the new corporate management structure, general management and administration costs will decline by 5% compared with the without project scenario. As a conservative estimate, even if the gross profit margin for each business segment is assumed to be the same before and after implementation, the expected returns are substantial. They remain substantial even if underlying assumptions are revised to incorporate adverse scenarios such as lower savings in general administration and operation costs and higher future inflation or a combination of the two. 12. The proposed investment aims to make DATC more efficient. This would mean being better able to restructure the assets DATC has and sell them at higher prices (an effect that will be magnified if government regulations change to improve the effectiveness of debt and asset resolution and state management of capital). At the moment, DATC has a recovery rate for received debt in terms of book value at only 10%, and 14,764 items of nonperforming assets, out of 19,526 items in its portfolio with total book value of D659 billion, are considered irrecoverable. More important benefits will accrue from DATC being better able to perform its economic role, even if the global economic downturn adversely affects enterprises over the short to medium term.

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Appendix 10

SUMMARY POVERTY REDUCTION AND SOCIAL STRATEGY

Country and Project Title: Viet Nam/State-Owned Enterprise Reform and Corporate Governance Facilitation Program Lending/Financing Modality: Department/ Division: Southeast Asia Department Financial Sector, Public Management and Trade Division

Multitranche Financing Facility I.

POVERTY ANALYSIS AND STRATEGY

A. Link to the National Poverty Reduction Strategy and Country Partnership Strategy

Transformation and reform of state-owned enterprises (SOEs) is critical to reducing the dominance of inefficient state production, promoting private sector development, and enhancing sustainable economic growth in Viet Nam. The Socio-Economic Development Plan (SEDP) 20062010 of the Government of Viet Nam (the Government) called for diversifying ownership to improve SOE efficiency and competitiveness. In addition to expanding the scale and scope of SOE equitization, the SEDP envisaged narrowing and eliminating the role of ministries and other state entities in SOE governance and management. ADB's country strategy and program 20072010 (CSP)a underlined SOE reforms as central to its strategy of business development and private sector-led employment growth. The CSP called for continued SOE reforms to reduce barriers to private sector development, reduce corruption and the misuse of public resources, and enhance transparency and corporate governance. The outcome of the CSP for the SOE sector is enhanced SOE profitability and transparency.
B. Poverty Analysis Targeting Classification: General intervention

Measures for general corporation restructuring and institutional strengthening supported by the State-Owned Enterprise Reform and Corporate Governance Facilitation Program do not have a direct impact on poverty. No new physical investments or assets will be created. Transforming general corporations will help capture the static and dynamic efficiency gains through the improved allocation and utilization of resources to promote higher growth and private sector development. Greater profitability and improved corporate governance of SOEs will reduce the fiscal weight of inefficient state enterprises, freeing up state resources for promoting inclusive growth. Greater access to resources will strengthen the ability of the Government to withstand adverse shocks such as the current global crisis, which often affect the poor and vulnerable most. Successfully transforming general corporations will contribute to the development of capital markets by improving the supply of high-quality issuances from iconic or blue chip companies. Capital market development will strengthen the resilience of the financial sector, reducing the likelihood and severity of financial and economic crises and helping safeguard against a corresponding increase in poverty.
II. A. Findings of Social Analysis SOCIAL ANALYSIS AND STRATEGY

Restructuring general corporations will not directly affect any specific groups. No new physical investments or assets will be created, and there will be only indirect socioeconomic effects. General corporation transformation as proposed under the facility will benefit many SOE workers, who were the dominant buyers of shares in the small SOEs equitized earlier on. Many of these small SOEs have continued to languish in inefficiency, dependent upon the larger SOEs and general corporations for survival. Their shares, often sold in the parallel market, have lost value and become more illiquid with the downturn in capital markets. The proposed corporate restructuring under the facility will enable many SOE shareholders to trade their illiquid shares of small equitized SOEs for the shares of large, efficient sub-holding companies that may even be listed on the stock exchange.

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B.

Consultation and Participation

1. Provide a summary of the consultation and participation process during the project preparation.

Extensive consultations were undertaken with all Government agencies concerned with SOE reform and with general corporations that were potential participants in first tranche. Seminars were held for middle and senior management in participating general corporations and institutions and, separately, for their boards of management.
2. What level of consultation and participation (C&P) is envisaged during the project implementation and monitoring? Information sharing Consultation Collaborative decision making Empowerment 3. Was a C&P plan prepared? Yes No

While formal stakeholder analysis and participation in the preparation of the program are not discrete outputs, the restructuring measures supported under the facility reflect wide-ranging stakeholder consultations and inputs, particularly within the participating entities and other government agencies.
C. Gender and Development

The general corporation restructuring and institutional capacity building proposed under the facility are gender neutral. Nonetheless, to ensure that any redeployment needed is without negative gender impact, assurance will be sought from the Government in the framework financing agreement to address training and redeployment with gender neutrality. Training programs will need to cater to the skills requirements of female workers to ensure that female and male workers alike are successfully retrained and redeployed.
III.

Issue
Involuntary Resettlement

SOCIAL SAFEGUARD ISSUES AND OTHER SOCIAL RISKS Significant/Limited/ Strategy to Address Plan or Other Measures No Impact Issue Included in Design No impact Full Plan Short Plan Resettlement Framework No Action Plan Other Action Indigenous Peoples Framework No Action Plan Other Action No Action

Indigenous Peoples

No impact

Labor Employment opportunities Labor retrenchment Core labor standards

Limited. As the restructured companies will still be in growth mode, there will be mobilization and retraining of surplus human resources for redeployment. The restructured groups will be right sized in the near term through continuous growth and normal attrition over time.
No impact

Affordability

Action No Action

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Appendix 10

Other Risks and/or Vulnerabilities HIV/AIDS Human trafficking Others(conflict, political instability, etc.), please specify

No impact

Plan Other Action No Action

IV.

MONITORING AND EVALUATION

Are social indicators included in the design and monitoring framework to facilitate monitoring of social development activities and/or social impacts during project implementation? Yes No
a

ADB. 2006. Country Strategy and Program: Viet Nam (20072010). Manila (September).