"Threat of insolvency for not only current liabilities but"
MINISTRY OF TRANSPORT AND MARITIME ECONOMY RESTRUCTURING PROGRAM FOR POLISH STATE RAILWAYS Adopted by the Council of Ministers on 7 September 1999 As amended by the Council of Ministers 7 September 1999 TABLE OF CONTENTS Introduction ................................................................................................................................ 3 1. GOAL .................................................................................................................................. 5 1.1 Targets of PKP restructuring ................................................................................................ 5 1.2 Strategic background ............................................................................................................ 7 2. EXAMINATION OF PKP STANDING ................................................................................ 8 2.1 Organizational structure ....................................................................................................... 9 2.2 Economic and financial situation in 1998 ............................................................................ 9 2.2.1 Financial result .................................................................................................................. 9 2.2.2 Liabilities ......................................................................................................................... 10 2.2.3 Situation in the first half of 1999 .................................................................................... 11 2.3 Level of employment .......................................................................................................... 12 2.4 Assets ................................................................................................................................. 13 2.5 Traffic, trends, demand forecast ......................................................................................... 14 3. PKP RESTRUCTURING PROGRAM ................................................................................ 16 3.1 Scope .................................................................................................................................. 16 3.2 Financial restructuring ........................................................................................................ 17 3.3 Restructurization of assets .................................................................................................. 18 3.4 Restructurization of employment ....................................................................................... 19 3.4.1 Pre-retirement benefits .................................................................................................... 20 3.4.2 One-time severance pay for employees made redundant under restructuring activities . 22 3.4.3 One-time re-qualifying training for employees, professional and social advisory and other forms of professional animation...................................................................................... 23 3.5 Organizational and legal restructuring ............................................................................... 23 4. COSTS AND SOURCES OF FINANCING RESTRUCTURING ACTIONS AND RESULTS THEREOF .............................................................................................................. 27 5. PKP RESTRUCTURING AND ITS SETTING .................................................................. 29 6. CHANGE IN FINANCING PASSENGER SERVICES ...................................................... 32 7. TASKS OF RAILWAY MARKET REGULATOR ............................................................ 35 8. MEASURES TO SECURE CONTINUITY IN OPERATIONS AND TRAFFIC SAFETY IN 1999 ..................................................................................................................................... 35 9. SCHEDULE OF PKP RESTRUCTURING ACTIONS ..................................................... 37 10. RECOMMENDATIONS ................................................................................................... 38 2 Introduction During last year, overall situation of “Polish State Railways” state enterprise significantly deteriorated. Structural changes implemented since 1990, including cutting down on employment, separation of railway ancillary units and most recently health care units proved to be insufficient. While in 1991 the net loss was PLN 715.1 mln, in 1992 - 1997 it fluctuated between PLN 85 and 261 mln, which with total sale in the range of PLN several billion enabled PKP to operate without much disturbance. Possibly, in more favorable external circumstances, the above mentioned changes would allow PKP to adapt to market requirements and modal competition by means of evolution. In 1998, PKP revenues on economic activity reached PLN 9,603.8 mln with related costs at the level of PLN 10,961.3 mln. Comparing with 1997 results, the costs increased by 14.3% while revenues only by 0.7%. In 1998 the net loss on overall activity of PKP amounted to PLN 1,370.1 mln. PKP effectively lost financial liquidity (data supplied by financial statement F-01 as of 31 December 1998). Outlook for 1999 is dim – in first six month of 1999 the net loss was PLN 965.7 mln. Liabilities climbed from PLN 4,158.9 mln (end of 1998) to PLN 4,741.5 mln (30 June 1999). Positive trend in labor productivity over last few years broke down despite shrinking employment in the enterprise. Rapidly cumulating loss of financial liquidity (calculated by means of III degree indicator) from 140.6% in 1997 to 101.2% in 1998 and 92.7% as of 30 June 1999 (at least 200% required) and huge increase in the net loss made the management board of the Ministry of Transport and Maritime Economy and involved members of parliament intensify their works on PKP restructuring. Shortly, it led to development of three subsequent concepts of recovery works in PKP. The heart of cumulating difficulties remains with adaptation process of the enterprise to structural changes in the economy, which is too slow. Freight operations are the base of PKP income, and until the end of 1997 generated profits, which with state budget subsidy for passenger operations allowed to cover the deficit of passenger operations and high, in comparison with other railways, labor costs. In freight operations traditionally coal is in the lead (generating about half of the revenues) and other bulks, eg. steel, grains and liquid fuels. Limited extraction of coal (still insufficient to meet economic needs of the industry), lower import of grains, difficulties in iron and steel sector and increased transport capacities of pipeline networks for liquid fuels, working together, brought further deterioration of railway performance indicators in 1998 and 1999, which in turn made most of traffic forecasts obsolete. Additionally, most of the factors show rather permanent trends and counting on radical changes in this respect would be a major mistake. To diversify freight operations means to invest in rolling stock (average age is about 20 years now). Passenger rolling stock is 18 years of age in average. In order to maintain the level of services offered in qualified sector of the market (EuroCity, InterCity, etc.) – for which the future as regards market potential and profitability looks promising – PKP needs to invest heavily in rolling stock and infrastructure (quality of railway lines). In its current status, PKP lost ability to invest (the 1999 level of own investment shrank to 15% of 1998); mounting liabilities and losses limit credibility of the enterprise. Annual procurement of rolling stock dropped to just a few pieces. At the same time, infrastructure investment financed by the state budget also dropped as a result of general limitations of investment expenditures in the state budget. Deteriorating investment, loss of liquidity and declining quality of transport operations adversely affect external economic subjects 3 cooperating with PKP, particularly manufacturers of related materials and products, and contracting enterprises. Railway agglomeration operations are in difficult position – they should be subsidized to promote public transport use in cities with visible congestion and environmental problems. Their efficiency however requires also to improve the quality of railway operations through direct measures like investment in rolling stock, traffic control systems, and improved management but also through stronger influence to increase user benefits with higher participation of local governments in financing railway operations. It is vital to implement related reforms as early as it is possible and not wait until further decrease in operations, increased liabilities and deterioration of overall position of PKP become more visible. Coordinated actions should enable PKP to maintain the market position, mitigate adverse impacts on the state budget and economy caused by expanding liabilities, and - upon first wave of employment lay-offs – reach better labor rotation indicators and expand cooperation with contractors. In 1998 several concepts of PKP reforms were developed. In July 1998, the first concept of PKP restructurization, commercialization and privatization was presented to the Economic Committee of the Council of Ministers (KERM). KERM recommended supplementing the concept with diagnosis of PKP financial standing and forecast of railway traffic. KERM advised also to separate railway infrastructure within the first stage. In September 1998, subsequent second concept of PKP restructurization, commercialization and privatization was submitted to KERM including draft of the law. The program provided for separation of infrastructure sector – Railway Infrastructure – under Article 44 of the law dated 6 July 1995 on “Polish State Railways” state enterprise, to form the basis for future railway infrastructure state enterprise. In the scope of restructurization of assets, labor restructuring, ownership rights, both the program and the draft law included concepts similar to solutions proposed earlier, in July 1998. During 5 November 1998 session, this program was approved by KERM in terms of directions. The concept brought strong hostility of labor unions active in PKP, as well as the Management and Supervisory Boards of PKP itself. In October 1998, third concept developed by the members of parliament was brought to Sejm – draft law on commercialization, restructurization and privatization of PKP, which is currently considered by the Parliamentary Commission. The Government faces the necessity to select one of the following options: First – to continue without changes in the situation leading to constant social distortions and tensions (difficulties in payments and rises of salaries), inability to modernize – directly leading to gradual deterioration of infrastructure, no development and difficulties in maintaining positive history of railway operations. Basically, it means delaying the decision on how to bear the costs – subsidize (directly or indirectly) deficient infrastructure. Second – to implement the strategy of small steps, which means gradual reduction of costs, incurring restructurization expenditures but also not reaching the critical point, where profits, investment and development start. This is the model advocated by managers from some companies due to the fact that it delays a catastrophe and you never reach this critical point where extensive managerial input is required to keep the company floating. Radical programs are the starting points, however with slightly overestimated sale output, prices, etc. which are rather based on wishful thinking than reality. Thus, upon development of a radical program and making required expenditures the company still lacks effects in profitability and restructurization is on-going forever. The system drains money from the state budget and does not drive the company towards a development path. 4 Third – means radical changes in relatively short period of time, including rapid reduction of employment and privatization in order to reach the stage of profitability and sustainable growth, maybe at higher budgetary expenditures and social tensions than in previous scenarios. Implementation needs focusing on several activities at the same time – to settle the cost competition within one year and maximum in two years to cut down on long-term costs. This scenario requires political and social support. Modes of its operation should focus on means to improve railway transport standing, protect human resources in this process and abolishion of structures inadequate for new situation. Preparation and implementation of the reforms should as much as possible make use of public information practices to provide reliable information to each and every of the involved employees. Proposed third scenario of restructurization eliminates possibilities to create another inefficient state enterprise in place of PKP – a concept advocated in both previous options. Presented herewith the program of restructurization is practically dealing with security measures to prevent railways from further deterioration. Its goal is to reshape relations in the sector and its legal and economic proximity in order to attract capital for further development, which would enable stabilization of state budget participation at a level required to guarantee adequate quality of cross regional passenger operations, compensating for loss of revenues due to recognition of discounted and free rides. In agglomeration and regional operations, new possibilities to involve local budgets will be opened. Railways will remain a crucial transport sector for the economy, its market share will be maintained at the high level until 2005 (see Table 1 below). Table 1. Modal split in traffic operations (freight) Specification 1980 1985 1990 1995 2000 2005 mln bln mln bln mln bln mln bln mln bln mln bln tons tkm tons tkm tons tkm tons tkm tons tkm tons tkm 1 2 3 4 5 6 7 8 9 10 11 12 13 Railways 473.2 134.5 412.8 120.5 278.1 83.5 228.9 69.1 172.0 51.6 164.0 49.9 Roads 2167.9 44.5 1393.7 36.5 945.7 30.0 1086.7 51.2 1330.2 83.6 1587.6 72.8 Inland 22.2 2.3 14.5 1.40 9.8 1.0 9.3 0.9 8.7 0.8 8.1 0.7 waterways Pipelines 40.7 17.1 38.7 17.0 32.9 13.9 33.3 13.5 33.8 13.1 34.4 13.4 TOTAL 2704.0 198.4 1859.7 175.4 1266.5 128.4 1353.6 134.6 1569.2 156.0 1819.1 163.7 Sources: statistical data and own forecast for 2000 and 2005. Efficient railways adapted to market requirements – limited but more effective and representing much higher technical sophistication – are a prerequisite to maintain fast track of further economic transformations and to discount benefits of favorable location in Europe. Railways will also remain an important factor strengthening Poland’s position in accession negotiations with the European Union. Actual railway performance indicators, particularly as regards traffic, will be carefully monitored and in case of significant deviations forecasts will be verified. Despite assuming a drop in traffic volumes and operations, the reform should critically revitalize PKP traffic operations. 1. GOAL 1.1 Targets of PKP restructuring To increase railway share in the market It is desired to increase railway share in the transport market due to various reasons – eg. railways are safer and more environmental friendly mode of transport than road transport. Operating companies established as a result of restructurization of PKP S.A. would have to 5 produce intensive marketing policy and at the same time expand the offer of rendered services. They will experience market pressure to become competitive against other railway operators and road transport or even air transport. The minimum target is to stop traffic decline and maintain current level of service. To achieve profitability and to decrease costs The reforms should lead to creation of conditions to render profitable railway services. Railway activity can and should be profitable undertaking. Railway companies would have a possibility to expand under market restrains with subsidies from local governments for public transport obligations, mainly in agglomerations and regions. Such companies should endeavor to cut costs in a competitive environment. Implementation of this target would: prevent growing liabilities, allow to reach reliability to secure development on the basis of credits and capital injections from stock exchange and private investors, in order to bring about: modernization or railway lines and rolling stock, implementation of investment programs, higher wages and salaries. To improve passenger and freight offer It is necessary to improve railway transport offer in order to: facilitate connections between large municipal centers, in competition with road and air transports, putting too much stress on municipal and national roads networks. Geographical features of Poland offer railways huge potentials on the market substantiated by the performance indicators for Warsaw – Kraków/Katowice and Warsaw – Gdańsk connections. enable solution of transport problems in agglomerations (scale of possibilities is visible – Warsaw metro, Warsaw Commuter Railways and Tricity Commuter Railways), increase the role of railways in freight traffic to lower the stress of roads networks, particularly as regards the heaviest traffic. To increase safety Polish railways – even after recent accidents – are safe. It is important to maintain and improve traffic safety, to make the safety perception objective, to conduct independent safety audits and accident investigations. Increased economic pressure creates certain dangers before the railway companies realize that it is not wise to economize on safety. To this effect, in 1998 the General Railway Inspectorate, independent of PKP, was established – it is proposed to reinforce its role. To be ready for competition within EU Accession to the European Union means also an obligation to make railway lines accessible to foreign railway operators. The law on railway transport requires railway administration to make railway lines available to railway operators, including of foreign origin (if so stipulated in international agreement, of which the Republic of Poland is a party). Implications are straightforward – railway lines should be ready to serve a number of operators and provide a standard, which would make use of railway infrastructure profitable in Poland. On the other hand, Polish railway operators should be ready to compete with foreign operators, particularly in the scope of rolling stock. Consequently, they need to invest, improve administration, labor efficiency and marketing systems. 6 On-going reform of railway transport and the need to adapt to European standards require introduction of transitional period before full liberalization of market access is possible. To develop public transport in agglomerations Improving operation of railways is one of the crucial factors in finding solutions to congestion problems in big agglomerations. In this case, marker intervention is necessary. For normal intercity roads, excise tax (included in fuel price) makes the user pay for external costs of transport means he uses. In city centers, user charges are not adequate to cover for actual costs of infrastructure construction and maintenance. Consequently, there is no possibility to find the equilibrium between supply and demand in the market of “vehicle accessibility to municipal road networks”. Its is impossible to solve this problem waiting for the demand to find its equilibrium point. That is why national transport policy should on one hand provide for possibilities to levy charges to cover for municipal infrastructure costs (within the scope of overall municipal traffic management schemes) – charges for parking, access to particularly congested areas, traffic calming and pedestrian zones in centers – and on the other hand to encourage to use means of public transport. In this respect, railways could be most efficient and attractive mode, particularly where railway networks cover city centers (Warsaw, Upper Silesia and Tricity). To integrate railway networks into municipal transport system requires introduction of common tariff regimes, time-table coordination, provision of safe parking areas for cars and bicycles around railway stops, but also reliable and relatively frequent railway services in clean and safe rolling stock. MT&ME is currently working out a transport policy document comprising overal concept to support public transport. The concept would provide for integration of administration powers, systems for selection of operators and financing (cost sharing) of public transport in an agglomeration or region. To this end, we propose to enact uniform public transport law to replace existing individual acts on rights to free and discounted rides, and compensation for bus and railway operators. The law would regulate responsibilities for public transport, provide means of financial support to operators (railway and bus), stipulate means of organizing tenders for public obligation services to improve quality of service and reduce subsidies. Therefore, solutions proposed in this program and related law are of temporary nature. To animate railway employees Labor restructuring processes aim at rationalization of level and structure of employment. Therefore, significant reduction of employment, re-training programs and professional advisory services are necessary. The program provides for active approach to this issue to create job opportunities outside PKP S.A. and its subsidiaries, however using existing PKP assets and within the restructuring measures. 1.2 Strategic background Taking into account development scenarios adopted in the European Union, national policy as regards railway transport is determined by strategic goals for next years and would focus on: integration of Polish transport system with UE and other European systems, antimonopoly actions (establishing new operators in railway transport, entrusting the General Railway Inspector with regulatory functions related to access to the infrastructure), regional aspects of passenger services, 7 completion of upgrading and modernization investment in the railway lines covered by AGC and AGTC Agreements, making competition fair between transport modes and within transport modes, making railway operators active in competitive commercial operations. The law dated 27 June 1997 on railway transport is compatible with acquis of the EU. It enables demonopolization of railway industry. The PKP reforms will accelerate this process opening access to railway infrastructure to new railway transport operators. Railway administration (infrastructure management body) being a natural monopoly requires supervision in the scope of maximum possible elimination of related negative aspects (including elimination of discriminating practices in providing access to railway infrastructure to new operators). Focusing on regional aspects of passenger services flows directly from the position that decision making process should be as much as it is possible related to implementation, in terms of location, which should lead to rational allocation of operations reflecting actual needs of local inhabitants and rationalization of costs. It would consist in vesting local authorities with powers and rights to organize and finance passenger services (under “applicant pays” principle). Gradually, charges levied for the use of infrastructure are becoming an important factor influencing conditions of intermodal competition. In order to make this competition fair, charges should take account of external costs (congestion, pollution, transport accidents, noise, climate changes). Infrastructure access charges are elements of tariffs decisive in selecting a given mode of transport. In the first stage, charges will cover operating costs (maintenance and administration of infrastructure, including traffic management) with the state budget financing for investment in other railway lines of national importance. Ultimately, investment outlays would be reflected in infrastructure access price. The same would go for externalities. Due to lower external costs of railway transport than road transport – railway transport would be most advocated in the system. Investing in railway infrastructure should adapt selected railway corridors to the speed of 160 km/h for passenger trains and 120 km/h for freight trains, and axle load of 225 kN. Territory of Poland is crossed by four priority European transport corridors (modernization works have been already started): 1. Corridor I (Helsinki) Tallin – Riga – Kaunas – Warsaw (Gdańsk), 2. Corridor II Berlin – Warsaw – Minsk – Moscow, 3. Corridor III Berlin/Drezden – Wrocław – Kraków – Lvow, 4. Corridor VI Gdynia/Gdańsk – Warsaw – Zilina – Ostrava – Breclav). Investments in railway lines of international importance are financed by the State Budget, bank credits and loans of International Financial Institutions, grant facilities and PKP own funds. 2. EXAMINATION OF PKP STANDING “Polish State Railways” state enterprise acts on the basis of the law dated 6 July 1995 on “Polish State Railways” state enterprise and is an enterprise of public transport nature. Under the above mentioned law, PKP main areas of operations include: 1. transport of passengers and goods and rendering related services, 2. local and international forwarding services, 3. construction, modernization, overhaul and maintenance of railway lines. 8 2.1 Organizational structure Organizational structure of PKP based on regions prevented efficient management of the enterprise in market reality. As a result of reorganization, since 1 July 1998 operations of PKP are split into four sectors and eleven functional areas, reflecting a divisional structure of enterprise. In operations, PKP established the following “sectors”: 1. Railway Infrastructure, 2. Passenger Operations, 3. Freight Operations, 4. Traction and Ancillary Services. In supporting services, eleven areas were installed. Additionally, the PKP structure comprises other organizational units of supporting nature directly subordinated to the Management Board of PKP. 2.2 Economic and financial situation in 1998 2.2.1 Financial result Despite early reforms, economic activity of PKP between 1992 - 1997 was characterized by negative financial result, only in 1997 almost reaching balance in costs and revenues. Positive trends in freight operations and profitability increases culminated in 1997. In 1998, PKP state enterprise showed net loss in the amount of PLN 1,370.1 mln on the total of operations. On economic activity in 1998, PKP’s revenues reached PLN 9,603.8 at costs of PLN 10,613.2 mln – loss on economic activity was PLN 1,357.5 mln. Costs increased by 14,3% and weren’t compensated by related increase in revenues (only 0.7% growth). That was a major reason for the financial result deteriorating so rapidly in 1998 (net loss of PLN 84.9) – costs rose by PLN 1,372.3 mln (from PLN 9589.0 mln in 1997 to 10,961.3 mln in 1998) while revenues rose only by 62.4 mln (from 9,541.4 mln in 1997 to 9,603.8 mln in 1998). Basic factor influencing loss of revenues in PKP lays with lower freight volumes transported. In 1998 PKP carried 20.6 mln tons of cargo less than in 1997, ie. by 9.1%. In structure of costs, depreciation costs increased the most – by PLN 484.8 mln (35,7%), then salaries, wages and employment benefits by 547.6 mln (11.8%) and debt servicing costs – by 136.3 mln (125.3%). Salaries, wages and employment benefits include expenditures in the amount of 86.1 mln on account of severance pay and compensations for 8.300 employees made redundant in 1998 under Labor Guarantee Pact. It needs to be stressed that other cost elements, like for example “materials and energy” noted a decrease in 1998. 9 Structure of costs in 1991-1998 100% 15,14 14,41 12,84 90% 19,63 19,07 20,72 21,14 18,65 80% 21,07 18,28 22,34 70% 22,09 21,02 22,71 23,07 22,89 60% 13,8 13,74 18,02 12,18 50% 21,83 19,2 13,76 11,14 40% 30% 50,78 50,86 42,82 44,65 46,28 48,73 20% 36,45 40,71 10% 0% 1991 1992 1993 1994 1995 1996 1997 1998 Salaries, wages and benefits Depreciation Materials and energy Other Profitability of freight operations in 1998 fell to 14.42%. In previous years, profitability had been much higher and reached 51.1% in 1995, 54.1% in 1996, and 36.4% in 1997. Profitability of passenger operations was negative and in 1998 was –49.0%. In previous years: -47.1% in 1995, -53.4% in 1996 and –42.9% in 1997. For several years PKP has been cross subsidizing deficits in passengers operations with profits on freight operations. In 1997 the cross subsidy was PLN 1.508.7 mln. In 1998, PKP ability to cover for losses in passenger operations fell sharply. Growing deficits in passenger operations, peaking at PLN 2692.2 mln in 1998, were only to some extent compensated by profits on freight operations – in the amount of PLN 696.4 mln. 2.2.2 Liabilities In 1991-1997 long term liabilities of PKP increased from PLN 46.0 mln as of 31 December 1991 to 1,335.1 mln as of 31 December 1997 and 1,599.4 mln in 1998. Rapid growth of liabilities resulted from fast disbursing loans taken from the World Bank, European Investment Bank and European Bank for Reconstruction and Development to co-finance among other things construction and modernization works on national importance railway lines (E-20, E-65). In 1991-1997, PKP liabilities didn’t exceed levels guaranteed by own capitals, assets and cash generation abilities. Until 1998, PKP easily took credits and was treated as a credible and reliable client of banks. In 1998 the situation changed. Total PKP liabilities rose respectively from PLN 1,253.5 mln in 1991 to 2,967.8 mln in 1997 and 4,158.9 mln in 1998. The increase was particularly visible in long-term liabilities, which boosted from PLN 46.0 mln in 1991 to 1,599.4 mln in 1998 – 35-fold increase during 8 years. 10 Structure of liabilities by major creditors is shown in the table below: No. Specification of liability Amount (PLN mln) 1 2 3 1 State Budget 87.5 of which: income tax on natural persons 48.5 Value Added Tax 38.1 2 Social Insurance Office (ZUS) 580.0 3 Labor Fund 26.3 4 National Fund for Rehabilitation of 73.3 Disabled (PFRON) 5 on account of deliveries and services 1,336.1 6 bank credits 1,741.7 of which: loans for modernization of national 815.7 importance railway lines 7 other 274.8 TOTAL 4,158.9 Status of liabilities shown in the table above generated financial costs in 1998 in the amount of PLN 244.66 mln. Liquidity problems of PKP are serious. Liquidity ratios are lower than safe levels: Financial liquidity safe level 31.12.1997 31.12.1998 31.03.1999 30.06.1999 I degree 20.0 24.2 12.8 9.6 15.7 II degree 100.0 107.9 82.1 75.7 77.3 III degree 200.0 140.6 101.2 94.7 92.7 2.2.3 Situation in the first half of 1999 First half of 1999 brought further decrease in operations. Freight operations fell by further 9.5 mln tons when compared to first half of 1998, and passengers operations by some 0.8 mln passengers. Consequently, despite increase of tariffs by 10.5%, revenues declined by PLN 50.1 mln. Economic situation of PKP worsened at significantly higher pace than in 1998. There were two reasons for such situation: - inability to react with better offer to market changes, which would guarantee relative stabilization in revenues on freight operations despite slumping transport needs of coal industry, - not efficient economic mechanisms in PKP, which would enforce cost cuts with declining operations. This position is substantiated by higher costs in first half of 1999 (by some 3.5% when compared with first half of 1998), while revenues on transport operations fell by some 0.1%. Performance of PKP within first six months of 1999 brought further loss of PLN 968.1 mln (F-01). The loss on core activities reached PLN 789.9 mln. Liabilities increased from PLN 4,158.9 as of end of 1998 to 4,741.5 mln as of 30 June 1999. Only in the month of June PKP liabilities towards ZUS boosted by some PLN 100 mln (97.7 mln) and total increase in liabilities between 31.05.1999 and 30.06.1999 was PLN 187.1 mln. II degree liquidity indicator, decisive in evaluating the solvency (ratio of receivables, claims, cash and securities to short-term liabilities) dropped from 82.1% as of end of 1998 to 77.3% as of 30 June 1999. Only in the month of June, the indicator decreased from 80.3% to 77.3%. 11 Threat of insolvency for not only current liabilities but also long-term credits taken for modernization of railway lines of national importance guaranteed by the State Treasury became imminent. Growing liabilities towards suppliers of energy and contractors in overhauling works started to hurdle railway operations – because of sanctions against PKP – cutting off energy supply, terminating contracts etc. To make diagnosis of PKP objective it is necessary to carry out an appraisal of economic situation of PKP by independent auditing firm. The Ministry of Transport and Maritime Economy is making attempts to contract a well- known auditing firm to carry out such financial appraisal of PKP for the first six months of 1999, in order to: - provide reliable information on current financial situation of PKP, - evaluate financial and accounting systems of PKP, - evaluate management regimes, - recommend options to improve current financial system, with particular attention to emergency actions. 2.3 Level of employment As of 31 December 1998 PKP employed 211,712 persons, including 4.1% of higher education. When compared to 31 December 1997 data, employment level fell by some 5%. Remuneration costs in 1998 reached PLN 5,202.6 and accounted for 50.84% of the total operating costs. The table below shows employment structure by ages as of 1 April 1999, including sectors: Specification Age (years) 35 and less 35-50 51 and more Totals Total of PKP 60,321 126,835 21,717 208,873 of which: Infrastructure 24,792 43,726 8,014 76,532 Passenger operations 8,272 12,490 1,806 22,568 Freight operations 6,539 14,350 2,306 23,195 Traction and ancillary serv. 13,164 37,125 5,415 55,704 Other units 7,554 19,144 4,176 30,874 The level of employment is inadequate to operational needs of PKP, which recently have shown a negative trend. This results in relatively low labor productivity indicator in thousand substitute tkm per one employee, which in 1995 was 397.7 thousand of substitute tkm (similar to 1990 level – 397.2 thousand substitute tkm), in 1997 – 417.0 thousand substitute tkm, but in 1998 only 401.1 thousand substitute tkm, which was lover than for some European railways, eg. in 1997 Germany – 565.0 thousand substitute tkm, France – 659.6 thousand substitute tkm, Italy – 592.5 thousand substitute tkm. Majority of labor redundancies in recent years was by means of so called “natural drop outs” and restricted employment opportunities. In 1997, the Management Board of PKP signed with labor unions active in PKP Labor Guarantee Pact. The pact provides for more favorable employment conditions than stipulated in legal regulations: The Management Board of PKP guaranteed: 12 not to implement group lay-offs by means provided for in Article 1 of the law dated 28 December 1989 on particular procedures to terminate employment relationship on account of reasons pertaining to the employment unit, to make three different employment offers for employees, whose posts would be made redundant as a result of reorganization. For example, if: 1) such employee accepts an offer to work in another locality, and a travelling time between his place of residence and place of work exceeds 3 hours both ways, he is entitled to receive during one year a relocation benefit in the amount of 100% of monthly accommodation costs in the new place of work, not more however than PLN 10 per day (calculated on the basis of 30 day month), 2) does not accept any of the offers, his employment relationship will be terminated due to reasons pertaining to the employment unit. Therefore, he will be entitled to on-time compensation pay in the amount of 6-fold monthly salary calculated as for equivalent of annual leave (irrespectively of severance pay he is entitled to receive under the above mentioned law), 3) his employment relationship is terminated on account of reasons pertaining to the employment unit and he is entitled to receive an old-age or disability pension, he will be also entitled to a compensation pay in the amount of 4-fold monthly salary calculated as for equivalent of annual leave. Implementation of the Labor Guarantee Pact enabled to reduce employment in PKP by some 8,300 persons in 1998. As of 30 June 1999, the employment level in PKP was 205,333 persons. 2.4 Assets Fixed assets of PKP are characterized by: Excessively extensive network of railway lines – total length of railway line network in Poland is 22,289 km and covers almost entire territory of Poland. Lines of national importance account only for 13,880 km, including the lines covered by AGC and AGTC Agreements and lines located in pan-European transport corridors of 5.5 thousand km in length. Vast majority of passenger and freight operations takes place on railway lines of the total length of 11,000 – 12,000 km. PKP own financial means are not sufficient to finance maintenance costs of the total network. Recent years have shown the critical situation in this respect, which requires reductions in length of railway network. It is assumed that over 6,000 km of railway lines generating high costs and low revenues (revenues cover only 30% of related maintenance costs) need to be closed down. 12,000 km of railway lines of national importance would remain intact. Remaining lines could be transferred to local authorities. Detailed criteria on when to suspend operations and close down railway lines will be developed by PKP to be approved by the minister relevant to transport. Underinvested and decapitalized railway infrastructure – in 1990-1998 railway infrastructure was significantly underinvested. Financial restrains in PKP resulted in backlog in upgrading and modernization works – technical and technological gap between PKP and other European railways currently exceeds 10 years in the area of infrastructure. To make up for this gap, average annual expenditures to improve technical state of railway infrastructure, traffic safety and quality of offered services should reach PLN 3 bln in 1998-2005. 13 Excessive rolling stock not adapted to market requirements – amortization level for fixed assets is some 67%. There are too many traction units, diesel and electric locomotives. Due to outdated technologies, age (on average 18 years of age), high operating and maintenance costs, it is necessary to upgrade the rolling stock and halt decapitalization process for currently operated traction vehicles. Generally, locomotives are adapted to V = 120 km/h. However there is a need for locomotives to serve qualified traffic, fast container trains and heavy freight traffic but also modern electric traction units to serve agglomeration traffic. For wagons, issues are the same. In terms of quantity and quality, passenger cars and freight wagons are not adequate to provide required level of service. There is a need for fast cars, hotel cars, restaurant and luggage cars. In freight rolling stock, there is still to many covered and platform cars and lack of specialized cars. Generally they are characterized by high degree of wear (average age of 17.5 years, V max = 100 km/h and axle load of 20 t/axle). Only 648 cars are suitable to travel at V = 120 km/h and with axle load of 22.5 t/axle. Technical and technological gap between PKP and European railways is estimated now at the level of 15-18 years in terms of rolling stock (PKP estimates). Too high share of buildings and structures in the total value of assets – buildings and structures account for 70% of the total value of assets. PKP is burdened with maintenance costs of some 115 thousand housing apartments. PKP holds the right to hereditary tenure of lands, under the law on management of lands and expropriations. However the problem is that in 90% of cases PKP lacks confirmation of such right in form of relevant administrative decisions. PKP manages also lands without any management title as of 5 December 1990. 2.5 Traffic, trends, demand forecast The following figures show railway traffic in 1998 (most recent available annual data): freight traffic 206.4 mln tons 61769.0 mlm tkm passenger traffic 401.5 mln passengers 25664.0 mln pkm Annual volumes of traffic in 1998 fell sharply: in freight traffic the number of tons carried decreased by 9.1% and freight operations in terms of tkm decreased by 10%, in passenger traffic the number of passengers carried decreased by 3.8% and passenger operations in terms of pkm decreased by 0.6%. Freight traffic declined mainly due to rapidly decreasing volumes of coal carried by rail – by 12.8 mln tons (12%) but also suffered from decreasing volumes of metals (by 1.7 mln tons), artificial fertilizers (by 1.0 mln tons), grains and cement (by 0.8 mln tons each) and ores (by 0.8 mln tons). In 1998 coal traffic accounted for 46.1% of all freight transported by rail (in 1997 for 47.6%). 14 In 1995-1998 PKP traffic generally showed a decreasing trend: 1995 1996 1997 1998 Freight traffic mln tons 228.9 223.5 227.0 206.4 bln tkm 69.1 68.3 68.6 61.8 Passenger traffic mln 465.1 433.1 416.6 401.5 bln pkm 26.6 26.6 25.8 25.7 Source: “1997 PKP Annual Report” and “PKP brief on basic performance indicators for 1998”. Slight increase in passenger traffic in 1997 was caused by growing international traffic (by 5.4%) and to some extent local carriages of metals and metal products, stones, oil and oil products, while the volume of coal traffic decreased by 1.3 mln tons. In 1997, the Ministry of Transport and Maritime Economy developed a document titled: “Comprehensive forecast for Polish transport system until 2020”. The document included a traffic forecast for passenger and freight transport by rail, which assumed gradual increase in traffic volumes and operations. Data currently available on passengers and freight transported by rail in recent years indicate that such forecast should be verified shortly. For the purpose of restructuring program, the following freight and passenger traffic forecast was adopted. The forecast was prepared by PKP. Traffic 1999 2000 2001 2002 2003 2004 2005 Freight mln tons – min option 175.0 172.0 170.0 158.0 166.0 165.0 164.0 mln tons – max option 196.7 195.3 192.8 190.6 188.4 186.2 184.0 bln tkm – min option 52.5 51.6 51.0 50.7 50.3 50.0 49.9 bln tkm – max option 59.0 58.6 57.8 57.2 56.5 55.8 55.2 Passengers mln – demand forecast 382.6 380.2 381.1 382.2 383.4 384.7 386.9 mln – scenario 382.6 208.8 209.4 210.8 211.2 211.6 212.0 bln pkm – demand forecast 25.2 24.8 25.1 25.3 25.6 25.9 26.2 bln pkm - scenario 25.5 16.6 16.5 16.7 16.8 16.9 17.1 Source: PKP own sources. The forecast of traffic in basic option took account of: March 1999 forecast of coal extraction and trade, current macroeconomic indicators and national economy growth rate, decreased coal and coke traffic due to restructurization of the sector, decreased traffic of steal works raw materials and products resulting from the restructurization program for iron and steel industry in Poland, expected economy upturn in the second half of 1999, increased international traffic. The minimum option assumes a sharp decrease in forecasted freight traffic volumes chiefly due to deteriorating coal extraction. Business plans developed for coal companies in February 1999 were updated in June. The forecast takes into account assumptions for new business plans developed by the Ministry of Economy and National Agency for Restructurization of Coal Industry, including in particular: decrease in extraction from 116 mln tons to 106 mln tons, decrease in coal volume traded internally from 92.5 mln tons to 79 mln tons. 15 Additionally, the forecast takes account of coal quotas imported from Russia and Czech Republic. Moreover, it builds on the most recent available data of the Governmental Center for Strategic Research on the status of economy that include: dwindling rate of foreign investment, lower external trade figures, indirect consequences of economic recession in Russia (downturns in neighboring countries and the European Union), lower than assumed rate of economic growth (4-4.5% GDP at time of drafting basic forecast, 3.5% in minimum option). Semiannual PKP freight traffic data (28 June 1999) were also used, which substantiate gradual shrinking of freight traffic market, in particular as regards coal. The forecast calls for an upturn in passenger operations, which can be attributed to increased: responsiveness of an offer, in particular in cross-regional and agglomeration traffic, activities of local governments in contracting out regional services, competitiveness of PKP versus road transport operators. The above proposed traffic forecast needs continuous following up on the factors lying in the basis. The factors may significantly change due to increased quality of services offered and more intensive marketing strategies, which in turn largely depend on the pace and methods of restructuring process. 3. PKP RESTRUCTURING PROGRAM 3.1 Scope Restructuring activities include: financial restructuring of PKP enterprise (conversion of liabilities into shares and stock of companies to be established by PKP S.A.), restructuring assets – rationalization of assets (including restructuring housing estates) and clearing of ownership titles, labor restructuring – rationalization of level and structure of employment through application of social security schemes (pre-retirement benefits, one-time severance pay, re-qualification and professional advisory), organizational and legal restructuring – systematic transformations of current division structure into holding structure and provision of conditions to privatize. In order to prepare and implement restructurization processes properly and smoothly, the Ministry is planning to use experience of consulting firms. Scope of works for the most important consultant for overall retsructurization issues to cooperate with the Minister of T&ME has been established in the schedule. Another consultant would evaluate value of primary companies, among others PLK S.A. and a company for passenger qualified services. On the other hand PKP S.A. plans to take external consultant for privatization of the following companies: CARGO, Telecommunications and Energy Supply; to work out accounting and financial system for the holding; to advice in issues related to the Fund of Workers’ Ownership; and as an agent in bond issue. Currently, under the World Bank loan administered by the Ministry of State Treasury, two studies on PKP restructuring are being prepared: feasibility study for labor restructuring in PKP and financial audit of PKP in two stages: for the first half of 1999 and for the total of 1999. 16 The ministry is going to apply to secure similar financing for railway market study and consulting services to advise to the Minister of T&ME. 3.2 Financial restructuring Due to extremely difficult economic and financial situation of PKP, financial restructurization is proposed in advance of any other restructurization activities of the enterprise. It would accelerate reaching of the targets. Scope and means of decreasing liabilities Financial restructuring would relate to financial liabilities of PKP including interest thereon, excluding additional penalties or charges thereon, as of 30 June 1999, towards: State Budget – excluding financial liabilities on account of income tax on natural persons, Social Insurance Office (ZUS) on account of premiums payable, Labor Fund (FP) on account of premiums payable, National Fund for Rehabilitiation of Disabled (PFRON) on account of amounts payable. PKP liabilities including interest thereon, as of 30 June 1999, was: 124.1 mln towards the State Budget (excluding liabilities on account of income tax on natural persons), 977.0 mln towards ZUS, 33.5 towards FP, 120.5 towards PFRON, in total PLN 1,255.1 mln. Financial restructurization of PKP would consist in conversion of liabilities into shares and stock of PKP S.A. held in its subsidiaries established under restructurization processes. Shares and stock will be taken over on behalf of the State Treasury, Social Insurance Fund and National Fund for Rehabilitation of Disabled. Rights derived from shares and stock held by the above mentioned national legal persons, including disposal thereof, will be executed by the minister relevant to transport. Execution of rights derived from shares and stock held by the Funds, results from the fact that such funds do not have legal personality. Upon disposal of shares and stock, financial revenues will be transferred to respective accounts of such Funds and the State Treasury. The minister relevant to transport in agreement with the minister relevant to public finance will specify, by means of a resolution, subsidiaries and number of shares, and volume of stock subject to conversion. The minister relevant to public finance, acting on behalf of public creditors, in agreement with the minister relevant to transport, as well as the debtor are entitled to make a proposal to convert liabilities into shares and agree on conditions of such conversion. If within 30 days from the date such offer is made, the parties fail to agree on conditions of the conversion, the creditors will be entitled to claim from PKP S.A. - owner of the shares - conversion of liabilities into shares according to the following principles: 1) when the net book value of the subsidiary is not negative, a creditor in exchange for the liability shall hold a part of the subsidiary stock in proportion to the quotient of the liability value and subsidiary book assets, reduced by debts of the subsidiary otherwise not converted into shares, 17 2) when the net book value of the subsidiary is negative, the liability shall be converted into a part of subsidiary stock in proportion to the quotient of the liability value and total subsidiary liabilities as of the date the balance sheet is made. Upon the conversion of liabilities into shares, relevant liabilities of the debtor will be terminated. Liabilities towards public creditors contracted between 1 July 1999 and 31 December 1999 may also be converted into shares and stock held by PKP S.A. in its subsidiaries, upon their consent. A pre-condition to negotiations held with the creditors will be for the minister relevant to transport to confirm, before 31 March 2000, inability to pay such liabilities. In 2000-2003, PKP, PKP S.A. and companies established by PKP S.A., until at least 51% of shares and stock of such companies is sold, will be obliged to limit average monthly salaries to not more than annual average consumer price index stipulated for a given year in the draft budget law, and to restrain from giving any guaranty or surety. Observance of these requirements will be supervised by the minister relevant to transport. Additionally, PKP or PKP S.A. will be entitled to sell liabilities payable under public procedure, against a market price. It is foreseen that the sale would take form of: open tender, sale offer publicly announced, negotiations opened as a result of public invitation. 3.3 Restructurization of assets The draft law on commercialization, restructurization and commercialization includes regulations relevant to lands owned by the State Treasury and held by PKP as of 5 December 1990, to which PKP has no evidence of legal title - on the date the law becomes effective, such lands will be given PKP into hereditary tenure (without obligation to pay the first installment on account of hereditary tenure). This regulation will not apply to lands located within the borders of Tatra National Park. Decision on transfer of the above lands to PKP is taken by the relevant Voivode. PKP will become the owner of any buildings, structures and other premises fixed on such lands. Total area of lands operated by Polish State Railways state enterprise is 105,678 ha. Currently, PKP holds legal title to only 10% of this land. In many cases, PKP is unable to evidence its management right to properties as of 5 December 1990. Provisions of the law to give State Treasury lands held by PKP into hereditary tenure and transfer ownership of related buildings and structures to PKP - free of charge - will enable fast regulation of ownership issues for properties held by PKP. Clear legal title to assets is a precondition for privatization of the enterprise. Under Article 42 of the law dated 6 July 1995 on PKP state enterprise, under affranchisement procedure, PKP is entitled to acquire railway lines free of charge and organize parts of properties no matter who financed their construction. The draft law on commercialization, restructurization and privatization of PKP provides for extension of existing rights of PKP to cover all buildings, structures, premises and facilities fixed on such lands (Article 200 of the law dated 21 August 1997 on management of properties). It is a legal confirmation of current practice of local authorities to treat such structures as organized parts of properties. Implementation of affrancisement procedures for railway properties requires radical acceleration of administrative procedures of local authorities and registration procedures in courts of law. 18 Another problem related to railway assets is management of housing estates. Under Article 1.2 of the law dated 17 December 1998 on amendment to the law on PKP, the enterprise started to dispose of housing apartments - because the process is time consuming, relevant provisions have been included in the law on commercialization, restructurization and privatization of PKP. It is proposed to transfer housing estates to be sold to tenants or rightful purchasers, to local communities under the law, similarly to cases of other state enterprises. From the point of view of efficient operation of PKP and future management of railways it is crucial to close down or change the status (to railway sidings) of some 6 thousand km of railway lines, which are unable to generate revenues. Redundant lines may be also transferred to local authorities. Acceleration and improvement in efficiency of restructurization of assets will bring about financial means to cover for restructuring costs. To this end, it is also proposed to introduce to management of assets a factor of professional and active administration of such process. Naturally, PKP is not an agency experienced in management of properties (although PKP efforts in this respect are appreciated) and the program provides for very sophisticated solutions in this regard. Therefore, but also in order to limit the related risks of public sector, special procedures will be introduced, eg. extensive training program, development of real- estate data base, contracting real-estate management agencies (payment against effects), tender for development and management contracts, etc. 3.4 Restructurization of employment Restructurization of employment is one of key elements of the program owing to the fact that PKP costs related to salaries, wages and employment benefits account for 50% of the total PKP operating costs. Restructurization of employment means transformations in employment structure of PKP enterprise justified both in economic terms and in terms of quality. Various studies recommend decrease in PKP staff to some 160,000 (JICA study) or 115,000 (MERCER study). Different target levels proposed in those studies are the result of diverse approach to the restructurization concept of PKP. In recommending target employment level in PKP, JICA study is based on UIC classification and draws from experiences of other railway restructuring programs. Employment levels for individual business units of PKP were calculated on the basis of TUE (traffic employment units) for UIC classification related to traffic sector (where TUE is an indicator of labor intensity taking account of a ratio of total production to number of staff). Following the JICA forecast analyses expected level of employment in 2005 should fell to about 160,000 employees. According to consultants from MERCER, the scope of employment restructurization in PKP is based on efficiency analysis of European railways calculated by means of substitute traffic volume per employee. Due to the fact that higher efficiency of labor is attributed in part to application of modern technologies and better equipment, it is assumed that PKP shall need 20% staff more than in equivalent European countries to fill the technical and technological gap. Taking account of such technical adjustment factor, target employment of PKP should be somewhere between 110,000 and 120,000 in 2005. As of 1 April 1999, PKP employed 208,873 persons, of which 177,999 employed in core activities (four sectors). According to MT&ME, before the end of 1999, target employment should amount to 145,000 persons, based on the following assumptions: 19 1. decrease in passenger services from 382.6 mln passengers in 1999 to 212 mln of passengers in 2005 consequent upon levels of state budget and local budget subsidies to cross regional and regional traffic and closing of selected railway lines, adopted from 2000 onwards, 2. decrease in freight traffic from 175 mln tons in 1999 to 164 mln tons in 2005, 3. reducing the length of operated railway lines from 22.2 thousand km in 1999 to 16 thousand km in 2005, 4. subsidizing loss making passenger operations by the state budget, from 2000 onward, at the constant level of PLN 720 mln annually (split into regional and cross regional traffic) with additional support for regional services directly from local voivodeship budgets in the amount of between PLN 100 and 180 mln annually, from 2001 onwards, 5. maintaining operating subsidy (i.e. compensation for railway operators engaged in local passenger services on account of recognition of legal rights to discounted or free rides). It is estimated that between 1999 and 2003, approx. 17,000 employees can claim old-age or disability pensions and leave PKP. In 1999 in PKP: - 425 employees reached retirement age, of which - 189 employees are in the process of terminating their employment relationship due to reaching retirement age, employment relationship of remaining 236 would be terminated this year, - 350 employees hold part time jobs. In order to minimize adverse effects of employment restructurization in PKP enterprise it is proposed to adopt the following social security schemes: 1) pre-retirement benefits, 2) one-time severance pay, 3) one-time re-qualification training as well as professional and social advisory and other forms of professional animation, free of charge. Proposed social security schemes take account of recommendations suggested in restructurization programs developed for other sectors of economy and suggestions included in draft of the law on commercialization, restructurization and privatization of PKP prepared by the members of parliament. The social security schemes shall cover employees with employment relationship terminated on account of reasons pertaining to the following employment units: Polish State Railways state enterprise, Polish State Railways S.A., subsidiaries owned in 100% by PKP, established after 31 August 1999 under Article 13 of the law on Polish State Railways state enterprise, enterprises established after 31 August 1999 under Article 44 of the law on PKP, companies established under the law on commercialization, restructurization and privatization of Polish State Railways state enterprise. 3.4.1 Pre-retirement benefits It is assumed that upon adoption of a resolution by the Council of Ministers under Article 37k, paragraph 9 of the law dated 14 December 1994 on employment and counteracting unemployment, female employees with 33 years of employment period required to acquire retirement rights and male employees with 38 years of employment period required to acquire retirement rights will be entitled to receive pre-retirement benefits. Such benefit will be in the amount equal to 100% of future railway pension. 20 On 22 July 1999, the Council of Ministers adopted the labor restructuring program for Polish State Railways in part related to 1999 and a resolution on establishing pre-retirement benefits for employees made redundant on account of reasons pertaining to the employment unit of PKP state enterprise under the restructurization program for Polish State Railways (Dziennik Ustaw No. 63, item 716). Consequently, pre-retirement benefits could be claimed by 4,300 employees made redundant on account of reasons pertaining to the employment unit between 1 October 1999 and 31 December 1999. In calculating costs of pre-retirement benefits it was assumed that: the average amount of pre-retirement benefits is equal to 100% of average railway pension, the railway pension amounts to 60% of average monthly remuneration in PKP for 1999, the average monthly remuneration in PKP amounts to PLN 1,579.60. Pre-retirements benefits in 1999 Period Number of Number of Cost of new Cost of on-going Total cost of leaving to receiving benefit benefits benefits benefits receive benefit (PLN mln) (PLN mln) (4+5) (PLN mln) 1 2 3 4 5 6 October 1999 1433 1433 1.36 0 1.36 November 1999 1433 2866 1.36 1.36 2.72 December 1999 1434 4300 1.36 2.72 4.08 Total 1999 4300 - - - 8.2 2000 0 4300 0 48.9 48.9 2001 0 4300 0 40.7 40.7 2002 0 0 0 0 0 2003 0 0 0 0 0 Total 1999-2003 4300 - - - 97.8 It is assumed that in 2000-2001, on the same basis as above, additionally 3000-3550 PKP S.A. employees and its subsidiaries (PLK S.A. and operating companies) could claim pre- retirement benefits. Pre-retirement benefits will be financed by PKP S.A. until the beneficiaries reach retirement age and be entitled to receive pension. Funds for pre-retirement benefits will be transferred by PKP S.A. to the account of Labor Fund maintained by National Labor Office by means set forth by the minister relevant to labor. Pre-retirement benefits may be established upon submission to the minister relevant to transport of an application agreed with the minister relevant to public finance and the minister relevant to labor. The application should include in particular: 1) designation of the names of companies in the form entered into the commercial registers, 2) monthly schedule of lay-offs due to reasons pertaining to the employment unit by any of the companies until December 2001, approved by the minister relevant to transport, 3) designation of periods of receiving pre-retirement benefits by persons laid-off in individual months, 4) designation of costs of the pre-retirement benefits to be incurred until the end of a period, 5) proposal for PKP S.A. on how to transfer financial means to the account of Labor Fund, 6) source of financial means, referred to in paragraph 4, as evidenced by PKP S.A. 21 3.4.2 One-time severance pay for employees made redundant under restructuring activities A one-time severance pay may be granted to employees recommended by the employer, with employment relationship terminated on account of reasons pertaining to the employment unit, who do not qualify for pre-retirement benefits or railway pension. Employees who received one-time severance pay are not entitled to: receive termination pay under the law dated 28 December 1989 on particular principles to terminate employment relationships on account of reasons pertaining to the units of employment and amendments to related laws, receive other financial benefits. Its is estimated, that the level of severance pay will depend on posts held by the beneficiaries: directly related to train movements or other posts. The table below shows levels for posts directly related to train movements. Other employees will receive a maximum of PLN 10,000. General principles of one-time severance pay for employees made redundant under restructurization activities: the right to receive a severance pay is vested when the employer takes a decision to lay- off the particular employee under restructurization activities, a severance pay may be granted to employees, who were employed in PKP enterprise, PKP S.A., subsidiaries established under the law, companies owned in 100% by PKP, established by PKP after 31 August 1999 under Article 13 of the law on PKP and enterprises established after 31 August 1999 under Article 44 of the law on PKP, during at least 5 continuous years on the basis of employment contract and at least 6 months on the post before the severance pay was granted. employees who received one-time severance pay shall refund such pay in case he or she is employed in PKP S.A. or the subsidiaries established as a result of restructuring PKP and PKP S.A., within 6 months from the date he or she receives such pay. whole process of labor restructuring is administered and supervised by PKP S.A. One-time severance pay for employees holding posts directly related to train movements. The involved posts include: gate-keeper, station inspector, driver of a rail vehicle, conductor, including conductor of rescue and maintenance trains, ticket inspector, official car attendant, switchman, train engineer and his assistant, fitter of traffic control devices, route controller, locomotive fireman, car inspector, foreman ganger, foreman shunter, signalman. Currently, some 103,500 employees hold such posts and it is estimated that severance pay would cover 18,278 persons. A severance pay may be granted if an employee holds such post for at least 6 month before the severance pay is received. Such employees will be entitled to receive a maximum of 24-fold his/her monthly salaries, calculated as an equivalent of annual leave, not more however than PLN 30,000. The level of severance pay will depend on the unemployment rate in the region, the beneficiary lives in. Unemployment rate Level of severance pay Expected number of Costs of severance in the region in monthly wages beneficiaries pays (%) (PLN mln) Above 15 24 – not more than PLN 30,000 2,422 72.7 Above 10 to 15 18 – not more than PLN 25,000 6,288 157.2 Above 5 to 10 12 – not more than PLN 18,000 9,568 172.2 5 and less 6 – not more than PLN 10,000 Σ = 18,278 Σ = 402.1 22 One-time severance pays for other employees Employees holding other posts will be entitled to receive a severance pay in the amount of 6- fold their monthly salaries calculated as an equivalent of annual leave, not more however than PLN 10,000. 3.4.3 One-time re-qualifying training for employees, professional and social advisory and other forms of professional animation Training programs will cover employees receiving one-time severance pay and employees to be made redundant in the near future. In the latter case, training would be of preventive nature. Their scope would cover qualifications to acquire a new job and skills to find a new job. The training programs will be addressed mainly to employees whose qualifications are not needed on the local labor market. It is estimated that the training would cover some 10,000 employees in 2000 and some 7,000 in 2001. Related costs are estimated at the level of PLN 20 million in 2000 and 14 million in 2001 and it is assumed that the beneficiaries will cover 20% of related training costs. Training will be organized and co-financed by PKP S.A. with participation of professional companies selected by means of an open tender. Professional and social advisory services aim at enabling employees with terminated employment relationship to come to a decision on how to start their own businesses or find other jobs outside PKP and PKP S.A. Such services will be implemented in 2000 and 2001 by four-person teams in eight locations – premises of former Regional Railway Directorates. Such teams would provide legal and economic counseling for employees made redundant in railways in the related region. Assuming that unit man-month cost for such services is PLN 5,000, estimated costs of such services would amount to: 8 teams x 4 persons x 24 months x 5,000 = PLN 3.84 million. Total costs of one-time training programs and professional and social advisory would reach: 20.0 + 14.0 + 3.8 = PLN 37.8 million Other forms of professional animation mean co-financing of training programs organized by regional administration, prevention training for employees to be made redundant, low interest bearing loans for employees made redundant to start up their own businesses. The bridge loan and proceeds from the bond issue would finance only training and professional and social services provided for in the draft law. Other forms will be financed or co-financed by PKP S.A. from other sources. The Management Board of PKP S.A. will be required to prepare detailed labor restructuring program and submit it to the General Assembly for approval. PKP S.A. will maintain central register of employees made redundant. 3.5 Organizational and legal restructuring Commercialization of PKP PKP will be converted into a state owned joint stock company under the law on commercialization, restructurization and privatization of PKP state enterprise. The commercialization will be done by the minister relevant to transport within three months from the date the above law becomes effective. In PKP S.A. interests of the State Treasury will be represented by the minister relevant to transport. 23 Regulations of the law dated 30 August 1996 on commercialization and privatization of state enterprises will not be applicable to commercialization of PKP and functioning of PKP S.A. Otherwise provisions of the Commercial Code will apply. According to the law, PKP S.A. will dispose of shares and stock held in its subsidiaries by means and under principles provided for in the law dated 30 August 1996 on commercialization and privatization of state enterprises. Generated financial means will be appropriated in the first order to restructure and then to appreciate individual companies: managing railway lines and operating, in order to enable investment in development of railway infrastructure and rolling stock. Sale of shares in the company managing railway lines will require permission of the Council of Ministers. Establishing and functioning of the companies and disposal of shares and stock Within six months from the date the enterprise is entered into the commercial register, PKP S.A. will establish companies to carry out core activities, ie.: transport companies - for railway passenger and freight services; a joint stock company to manage railway lines, which under regulations of the law on railway transport will act in the capacity of railway administration - Polish Railway Lines Joint Stock Company (PLK S.A.). PKP S.A. will be also entitled to establish other subsidiaries. The companies will be separate economic entities, and their viability will depend on growing efficiency, active marketing strategies, diversified attractive offers, etc. Disputes arising between transport operating companies and PLK S.A. and other railway administrations as regards availability of infrastructure will be resolved by an independent entity acting in the capacity of railway market regulator. Subsidiaries will be established on the basis of tangible and intangible assets (per net book value) required to carry out statutory activities. They will take over only sufficient number of employees and should be burdened only with current liabilities and receivables (not overdue), including credits taken for modernization of national importance railway lines. To take over only sufficient number of employees, PKP needs to fix the number of permanent posts and develop the program of redundant labor dislocation at the same time. The dislocation program should include such elements as substitute jobs, training programs, paid leaves, unpaid leaves with twinning programs. Crucial element from the point of view of national economy is the company managing railway lines - Polish Railway Lines, which progressively - depending on the degree of legal regulations - would take responsibility for railway infrastructure. In any given year, state budget subsidies allocated to finance national importance railway lines would increase the stock capital of PLK S.A., and shares in the increased capital will be held by the State Treasury. Due to responsibility for national importance railway lines, the minister relevant to transport will approve of the PLK S.A. statute and recommend own representatives in the supervisory board. The statute will specify number of member of the supervisory board. Additionally, disposal of PLK S.A. shares will be subject to restrictions, although it is thought that the company should attract an external investor. In case PKP S.A is privatized and liquidated, shares of PLK S.A. held by PKP S.A. will be taken over by the State Treasury. The draft law on commercialization, restructurization and privatization of PKP provides for 51% of votes belonging to the total stock capital of PLK S.A. to remain with PKP S.A. at any time. Due to unclear legal title to properties held by PKP, the law provides for a possibility to transfer such properties to the subsidiaries into lease on the basis of a contract stipulated in the law. Such leased properties would be included into fixed assets of the leasee and he would be 24 subsequently responsible for depreciation Leasing fees would constitute long-term liabilities of such companies not payable to PKP S.A. until receivables are converted into shares or stock. Proposed concept on how to dispose of properties with not clear title is crucial for PLK S.A., which will take over management of railway lines from PKP S.A. MT&ME assesses that PLK S.A should take over all operated railway lines and consequently be responsible for depreciation to secure financing for replenishment of assets. In implementing tihi formula, PLK S.A. would effectively manage its assets and incorporate all related railway lines into its strategies. Number and scope of transport operating companies will be established in detailed restructurization program developed from the point of view of establishing entities able to compete in monopoly-free environment. Sale of shares and stock of transport operating companies, Polish Railway Lines and other subsidiaries will be preceded by development of PKP S.A. program for privatization of subsidiaries. Such programs would be approved by the General Assembly of PKP S.A. Another element of privatizing subsidiaries would be the development of related business plans. Privatization of PKP S.A. PKP S.A, scope of activities will include: to develop and implement development strategy for the capital group, to carry out restructurization in organizational and legal issues, assets, finance and employment, to privatize subsidiaries. As the restructuring program and privatization of subsidiaries is implemented, nature of PKP S.A operation would change from steering restructuring processes to financial management of the enterprise. Its scope of activities would be more similar to investment fund activities. Minister relevant to transport will privatize PKP S.A. The privatization will be subject to respective regulations of Chapter 1 Section IV of the law dated 30 August 1996 on commercialization and privatization of state enterprises. The Fund of Workers’ Ownership Material participation of PKP employees in the privatization process of PKP S.A. would by implemented by means of participation in the PKP Fund of Workers’ Ownership. Establishment and operation of the Fund will be subject to regulations on investment funds. PKP S.A. will transfer to the Fund financial means in the amount of 15% of revenues from each sale of properties and related rights, sets of assets and shares and stock held by PKP, within next ten years. Each subsequent deposit made by PKP S.A. to the Fund would increase the value of participation certificates to be given to entitled employees. Only the following entitled employees could participate in the Fund: 1) persons employed by PKP on the date the PKP was effectively deleted from the register of state enterprises, 2) persons employed in PKP during at least 10 years with employment relationship terminated due to retirement or disability, or due to reasons provided for in Article 1, paragraph 1 of the law dated 28 December 1989 on particular principles to terminate employment relationship on account of reasons pertaining to the employment unit, 3) persons who after being employed in PKP during at least 10 years have been taken over by other employers by means provided for in Article 23 of the Labor Code, 25 including the right to inherit participation certificates. Persons who on the basis of relevant regulations exercised the right to procure the State Treasury shares free of charge, will not be entitled to participate in the Fund. Total value of financial means transferred by PKP S.A. to the Fund will not exceed the product of the number of entitled workers and the amount equal to 18-fold average monthly salaries in the sector of enterprises, excluding profit sharing, calculated for six months preceding the month, PKP S.A. is registered. Establishing and operating costs of the Fund of Workers’ Ownership will be borne by PKP S.A. The law provides for restrictions as regards redemption of participation certificates. The restrictions should enable gradual increases in value of participation certificates and prevent the Fund from loosing financial liquidity. Reorganization of PKP 1999 has been another year of restructuring organization of the enterprise. Within the frame of reorganization activities, organization units or organized parts of property in the field of supporting services will be separated out of PKP and made independent within new organizational structures. The Minister of Transport and Maritime Economy - upon completion of preparatory works - is going to separate, under Article 44 of the law dated 26 July 1995 on Polish State Railways state enterprise, the following units currently included into the organization of PKP: Directorate of Commuter Railways, Railway Center for Technical and Scientific Research, Warsaw Commuter Railways Unit in Grodzisk Mazowiecki (WKD), Center for Diagnostic and Welding of Railway Pavement to established on their basis state enterprises or to contribute them to other companies. On the other hand, PKP will contribute to the companies, under regulations of Article 13 of the above mentioned law and the Commercial Code, the following internal units of PKP: National Cable Railways in Zakopane, Sleeper Regeneration Plant in Ostrów Mazowiecka, General Office for Traveler Services “Polres”, Railway printing houses in Warsaw, Kraków and Poznań, Agglomeration Traffic Unit in Gdańsk (SKM), Directorate of Railway Power Supply in Warsaw, Directorate of Railway Telecommunications in Lublin, Directorate of Social Services in Gdańsk, Directorate of Housing Management in Warsaw, Trade Directorate “FERPOL”, Railway Center for Training and Development of Staff, Track Machines Plants in Gdańsk, Kraków and Wrocław, Center for Railway Information in Warsaw. Additionally, PKP plans to contribute to the companies organized parts of property - so called “Infrastructure Repair Units” currently located within infrastructure sector. The process should be completed before PKP S.A. is entered into the commercial register. 26 COSTS AND SOURCES OF FINANCING RESTRUCTURING ACTIONS AND RESULTS THEREOF Costs of PKP restructuring may be split into the following categories: labor restructuring costs, financial restructuring costs, organizational and legal restructuring costs, costs of restructurization of assets. Some of the costs are not quantifiable at the moment, particularly costs related to establishment of new companies, clearing legal title to properties and disposal of redundant and excessive assets. Costs of labor restructuring has been calculated at PLN 970.0 mln in total - including: pre-retirement benefits PLN 97,8 mln, one-time severance pay PLN 834.4 mln, training and advisory PLN 37.8 mln. The table below shows annual costs of pre-retirement benefits and one-time severance pay in PLN mln. Pre-retirement benefits Severance pays Year Average Expected PKP costs Cumulative Expected Costs Total Level of Benefits monthly redundancies (law of costs redundancies annual employment on salary in 28.12.89) costs reduced PKP labor (PLN) 1 2 3 4 5 6 7 8 9 10 X.99 1433 6.8 1.36 208000 XI.99 1433 6.8 2.71 XII.9 1434 6.8 4.08 9 IVQ 1579.60 4300 20.4 8.2 28.6 203700 1999 2000 48.9 34800 607.9 656.8 168900 97.8 2001 40.7 23900 226.5 267.2 145000 889.6 2002 1433.4 2003 1433.4 TOTAL 4300 20.4 97.8 58700 834.4 952.6 Sources of financing PKP FP Bonds The costs presented above do not include possible pre-retirement benefits to be paid in 2000- 2002 to 3500 employees, which should not exceed the total of PLN 82 mln through these years. In case the benefits are paid out, automatically the number of employees entitled to receive severance pay will decrease. One of the possible PKP S.A. sources of financing restructuring costs will be revenues on disposal of redundant assets (sale, lease, etc.). According to initial analysis, fixed assets and inventories in the next years, ie. till 2005, should bring to the company revenues estimated at the level of PLN 1.5 bln - however verification of such initial data, resulting in revaluation of revenues coming from sale or lease of redundant assets has shown that in real terms, after taking account of related costs, in 1999- 2005 PKP S.A. can only count for net revenues of PLN 620 mln instead of 1.5 bln. Rapid sale of redundant assets has been hampered by unclear legal title to numerous properties. Again we stress the importance of radical acceleration of administrative procedures by local authorities and courts of law. 27 Assets to be sold or otherwise disposed off on commercial basis, could be split into four categories: a) housing apartments (some 100,000 apartments to be sold), b) attractive lands including buildings, located in cities mostly around railway stations, c) redundant rolling stock and supporting fixed assets, including means of transport and free spaces in production plants, d) other assets, eg. redundant materials and spare parts. However, majority of PKP S.A. financing would come from: bank credits, guaranteed by the State Treasury, bond issue, guaranteed by the State Treasury. In order to secure financing for labor restructuring and current operating costs, it is assumed that PKP S.A. would issue restructurization bonds in 2000-2001. The State Treasury would provide guarantee or surety to PKP S.A. liabilities under the bonds. Such State Treasury guarantee or surety would be in turn secured by a collateral in form of alienation of shares and stock held by PKP S.A. in its subsidiaries for the benefit of the minister relevant to public finance. Statutes and contractual documents of companies, shares and stock of which would be alienated for the benefit of the State Treasury, should provide for such legal possibility. Redemption of bonds should by financed by revenues on privatization of PKP S.A. assets, including sale of shares and stock in daughter companies. It is assumed that the bond issue (with preferential interest rate) of a face value of PLN 3.1 bln would be implemented in two traches. The first tranche of the face value of PLN 2.0 bln in mid 2000, the second one, of the face value of PLN 1.1 bln in the IV quarter of 2000 or in January of 2001, depending on the pace of restructuring actions. Revenues from first tranche of bonds will in the first order finance debt service of the bridge loan in the amount of PLN 1.5 bln. Thereafter, the revenues from bond issues would finance: 1) repayment of the total of bridge loans including interest thereon and other charges, 2) one-time severance pay, pre-retirement benefits for redundancies in 2000-2001, re- qualifying training programs, professional and social advisory services - in the amount of PLN 1.0 bln. 3) current operations, including: procurement of materials and services, rolling stock overhauls, modernization of railway traffic devices - in the amount of PLN 1,353.0 mln. 4) railway traffic safety, including investment expenditures - in the amount of PLN 445.0 mln. 5) support to local passenger services, excluding qualified traffic (express, InterCity and EuroCity trains), 6) liabilities of railway health service units separated out of PKP in order to establish self- standing public health service units - in the amount of PLN 45 mln. 7) privatization consulting services for PKP S.A. - in the amount of PLN 6 mln. 8) costs of bond issues, excluding redemption costs and interest payments or payments on account of the discount. The law on commercialization, restructurization and privatization of PKP is to enable PKP S.A. to receive the State Treasury guarantee or surety for bond issued to collect financing for other items than provided for in the law on State Treasury guarantees and sureties. Due to 9 month preparation period to issue bonds, it is proposed to secure a bridge financing, ie. for PKP S.A. to take loans in local and international financial institutions providing adequate level of financing until the bonds are issued. Due to the fact that a State Treasury guarantee or surety for other items than provided for in the law on State Treasury guarantees 28 and sureties needs to be approved by the parliament in the form of the law, such bridge financing in form of sovereign loans would be only possible when the law on commercialization, restructurization and privatization of PKP becomes effective. Under this law, the State Treasury is authorized to provide a guarantee or surety for the bridge financing in the amount of PLN 1.5 bln. The credit would finance the same items as the bond issues and additionally remuneration and preparation for the Y2000 problem. The minister relevant to transport will supervise expenditures financed by the loans and bond issues. Proposed expenditures on account of reduction of employment by some 63,000 persons - at the level of PLN 952.6 mln - would bring fruits in reduced labor costs as a result of limited remuneration expenditures (including ZUS, FR, Company Fund of Social Benefits - ZFSS - and PFRON) for such redundancies - by some PLN 3.9 bln in 2000-2003. Conversion of liabilities into subsidiary shares and stock will reduce overall liabilities by PLN 1,255.1 mln. Forecast of operating revenues, for 2000 for the whole PKP, and since 2001 for PKP S.A. and a group of daughter companies shows PLN 10378.8 mln in 2000 up to PLN 9693.2 in 2005. Freight operation will remain profitable, while passenger operations, after subsidies, will bring a loss of some PLN 330 mln in 2000 and 136.0 mln in 2002. In 2002 passenger operations should brake even and thereafter bring small profits. - see Table 3. Increase in earning capacity of passenger operations in 2000-2001 can be achieved through higher charges for the use of infrastructure for freight traffic than for passenger traffic. In that case, we would have a case of willful subsidizing passenger services by all freight operators - on a temporary basis. Table 4 shows forecast of financial result in 2000-2005 for core railway activities. We would like to comment on the financial result forecast for infrastructure. It is assumed that in first years activities as regards railway infrastructure management will not be profitable - in order not to increase costs of operators on account of charges for the use of railway lines. Ultimately, operators would cover all costs of operating infrastructure, including development costs. 5. PKP RESTRUCTURING AND ITS SETTING Long term and annual investment plans of PKP give idea on how big is the market for producers of railway materials and contractors of railway works, created by the enterprise. Polish railway network constitutes an important and attractive segment of the European transport system, therefore it is hard to overestimate importance of its modernization. By acceding to international agreements on major international railway lines (AGC) and major international lines in combined transport and related facilities (AGTC) Poland is obliged to modernize over 5000 km of railway lines included into trans-European network and upgrade technical and operating parameters to the levels stipulated therein. Lines covered by AGC and AGTC agreements and the lines of primary importance from the point of view of economy, social and defense issues, form a scheme of investment priorities in 5660 km of network (25% of the PKP network and 40% of the national importance network). Programmed outlays for modernization of infrastructure are significantly insufficient to make up for modernization backlog. The backlog only in the field of general overhauls of track reached 10,454 km during last 10 years (only 46.6% of needs), in the field of replacement of turnouts - 14,328 pcs. Severe backlog exists in the area of modernizing traffic control devices. 29 The above synthetic characteristics of backlogs in modernization and general overhauls together with actual financing possibilities directly influence the railway industry, and in particular producers of materials and railway construction sector. Investment activities of PKP in 1993-1998 created annually some 94,200 job opportunities in the sector of production of railway materials and overhaul and construction industry, on average. Particularly difficult situation exists in sleeper manufacturing plants and railway turnouts. In 1999 demand for materials under general overhauls of track has secured the following levels of production capacity: Specification Actual level of production capacity (%) Pre-stressed concrete sleepers for track 36 Pre-stressed concrete sleepers for 100 turnouts Steel turnouts 20 Source: Program of pavement needs for 1999 - material of PKP. 1999 plan calls for overall replacement of 184 km of track, replacement of 161.2 km of rails and procurement of 283 thousand of concrete sleepers. Additionally, PKP plan to use 556 stes of turnouts (including 98 with concrete sleepers). Modernization of traffic control devices is required throughout the network. Currently, the only modernization of traffic control devices takes place on the E-20 line. Problems of companies directly related to the existence of PKP, are also shared by rolling stock repair units. Taking into account the modernization program resulting from: 1. repair needs stipulated in the “Rolling Stock Policy”, 2. repair capacities of ZNTKs (Rolling Stock Repair Units) - assessed on the basis of own data, 3. specialization of individual ZNTKs, including qualification certificates given by Railway Center for Technical and Scientific Research, 4. the need to maintain competition in the scope of services rendered by ZNTKs to the benefit of PKP (a condition of more than one unit for a given type of rolling stock), 5. quality of ZNTK services as evaluated by PKP, PKP enterprise has specified the following units to cooperate in order to safeguard own interests and needs: in the scope of overhauls of electric locomotives: - ZNLE Gliwice, - ZNTK Oleśnica, in the scope of overhauls of electric traction units: - ZNTK Mińsk Mazowiecki, - another ZNTK - unable to be specified at the moment, in the scope of overhauls of diesel locomotives: - ZNTK Nowy Sącz, - ZNTK Poznań, in the scope of repairs of passenger rolling stock: - ZNTK Nowy Sącz, - ZNTK Opole, - ZNTK Bydgoszcz, in the scope of repairs of freight rolling stock: - ZNTK Ostrów Wielkopolski, 30 - ZNTK Gniewczyna, - ZNTK Łapy. Planned level of production capacities in relation to PKP needs in 2001-2010 is presented in the below table: No. Rolling Repair needs of PKP PKP repair needs in relation to Estimated repair capacity of stock ZNTK estimated repair capacity of ZNTK Repairs Repairs Repairs % Total Overhaul Current Total Overhaul Current Total Overhaul Current 1 Electric 4497 671 3826 12328 1350 10978 36.48 49.70 34.85 locos 2 Electric 4766 523 4243 7223 1138 6085 65.98 45.96 69.73 units 3 Diesel 8797 1526 7271 19065 4846 14219 45.14 31.49 51.14 locos 4 Passenger 26152 1488 24664 64525 9202 55352 40.53 16.71 44.56 cars 5 Freight 169217 51033 118184 620080 163000 457080 27.29 31.31 25.86 cars 6 Total 213429 55241 158188 723221 179536 543714 29.51 30.77 29.09 rolling stock Source: Planned level of cooperation between PKP and ZNTKs as regards periodic maintenance and overhauls of rolling stock in 1999-2010. To stop further reduction of production capacity in specialized railway supporting plants (production of materials and rendering of services) PKP needs to: provide for adequate state budget allocations - annual average financial expenditures for repairs and modernization of fixed infrastructure at the minimum level of PLN 1,765 mln, make adequate budget allocations - annual average level of investment expenditures of PLN 2,281.6 mln. Due to difficult financial situation, PKP takes steps to secure the following forms of external financing: private and foreign capitals (also for infrastructure expenditures generally within the responsibility of the state), private capital consortia, by means of leasing assets, revenues from bond issue. Current extremely complicated financial standing of the enterprise, lack of financial possibilities to carry out efficient investment activity in the scope of modernization of rolling stock and main railway corridors results in gradual loss of market share both in passenger and freight operations. Dramatic reduction of investment expenditures in 1998 and 1999 translates into deep economic crisis of PKP supporting units. Difficult financial situation of such units is caused by overdue payments for executed works or supplied materials. Improvement of PKP payment performance and decrease in liabilities and ultimately timely payments would be possible in case of: legal clearing of PKP liabilities, smooth inflow of state subsidies for modernization of railway infrastructure, preferential credits granted to PKP by external financial institutions and organizations. One of the instruments which would influence improvement in timely payment of PKP liabilities towards contractors of modernization works on national importance railway lines will be for the Ministry of Transport and Maritime Economy to pay out the subsidy directly 31 against contractors’ invoices. It is foreseen to strengthen supervision over PKP expenditures under sovereign loans granted by international financial institutions and grants cofinancing investment tasks. Possibilities to make use of such funds for other purposes (even temporary) than stipulated in respective agreements will be reduced. An instrument which should bring stabilization to railway supporting units will be for PKP S.A. and the daughter companies to contract out long-term services (eg. for 3 years) under open tendering procedure. 6. CHANGE IN FINANCING PASSENGER SERVICES PKP restructurization will bring fruits only if the labor force is significantly reduced and a new system of financing passenger services is introduced. Currently used subsidies for the enterprise on account of legal discounts, supporting the enterprise, are not sufficient. Except for qualified traffic (express, InterCity and EuroCity trains) operating in the commercial environment, other passenger operations are deep in the red. The highest losses are generated by regional traffic. For regional (within a voivodeship) traffic it is proposed to transfer responsibility for organization and financing to local voivodeship authorities, for agglomeration traffic - to local community authorities, and for cross-regional traffic (except for express, InterCity and EuroCity trains) operating in the commercial environment to the minister relevant to transport, acting in the scope of agreement reached with the minister relevant to public finance. Related financial allocations would be included in the budget law and respective budgets of local authorities for each year. Operations would be contracted out to relevant by size, licensed operators under negotiable contracts. The operator would agree with the local authority on ticket prices and timetables in the scope provided for in such contract. Due to loss-making character of passenger services it is necessary to specify sources of financing from the start. Basic source of cofinancing passenger services should be state budget subsidies. On temporary basis (in 2000), passenger services would by supported also from: savings in subsidies (given to operators as a compensation for revenues lost as a result of recognition of rights to free or discounted rides in public transport), financial means generated by the restructurization bonds issued by PKP. The scope of beneficiaries of the rights to free and discounted rides in the means of public transport was considered adequate, while the scope of the rights themselves will be limited only to rides in class II of all types of trains. The below scheme shows desired model for financing loss-making passenger services to be implemented in 2005. The level of subsidy to loss-making passenger services. Because it is assumed to: close down the most loss-making passenger services on 6000 km of railway lines in 2000, which would bring about reduction in passenger services from 382.6 mln to 208.8 mln of passengers in 2000, gradually increase passenger services in 2000-2005 as a result of higher standards (thanks to planned subsidies) and improved conditions to carry out agglomeration and regional traffic, there is a need to secure: 32 permanent subsidy for cross-regional services, increase in the subsidy for agglomeration and regional traffic to maintain the level of such services (increase in subsidies will enable improvement in cost coverage by revenues from 19.8% to 44.5%). 33 Desired System of Financing Railway Transport - 2005 TERRITORIAL STATE GOVERNMENT TREASURY Passenger Operations Polish Railway Lines Freight Operations Company j.s.c. Company Own revenues Revenues from other Own revenues PLN 1050.0 operators PLN 5451.5 mln PLN 198.0 mln State budget subsidy - Revenues from charges Own costs incl. compensation for loss of for making railway lines maintanance and rolling Contracted out revenues (PSO) available stock PLN 2471.1 mln PLN 352.2 mln PLN 3066.0 mln Subsidy from local Own costs Charges for use of authorities PLN 180.0 mln + PLN 3264.0 mln railway line state subsidy for loss making infrastructure operations 720.0 mln PLN 2115.3 mln Own costs incl. maintenance and rolling stock PLN 1318.2 mln Charges for use of railway line infrastructure PLN 950.7 mln Result on core activity Result on core activity PLN 0.0 PLN 865.1 mln Result on core activity Investment subsidy PLN 33.3 mln PLN 861.1 mln 34 7. TASKS OF RAILWAY MARKET REGULATOR Regulating relations between operators and the manager of railway lines - a natural state monopoly - needs to take place under control of a state body, independent of economic subjects. Therefore, it is proposed to trust the General Railway Inspectorate (GIK) with this function in order to deal with problems of tensions between the natural monopoly and private subjects to the best social benefit. Major regulating task would be to clear issues related to charges for the use of related infrastructure, which should find the balance between “adequate” improvement of railway infrastructure and safeguarding of user needs. Additionally the regulator would be responsible for: licensing economic activity in the field of management of railway lines and railway operations, consulting on closing and liquidation of railway lines, resolving disputes between railway administration and operators, cooperating with relevant bodies to counteract monopolistic practices of railway administrations and railway operators, cooperating with national and local government bodies in shaping of railway sector, defining priorities and standards of cooperation between railway administrations and operators acting on local and international markets. GIK activities will be supported by a Consultative Board and regional consultative boards in Regional Parliaments, giving opinions on quality of railway services. They would represent consumer interests, particularly giving opinions on: liquidation and construction of railway lines, evaluation of punctuality and reliability of services offered by railways operators, efficiency and accessibility of information on offered services. The General Railway Directorate will start performing duties of railway regulator on 1 July 2000. 8. MEASURES TO SECURE CONTINUITY IN OPERATIONS AND TRAFFIC SAFETY IN 1999 Financial performance of PKP in the first half of 1999 and unfavorable traffic forecast for freight operations for the next six moths will bring further difficulties as regards liabilities. Operations in the first half generated a net loss of PLN 968.1 mln and the liabilities plummeted to PLN 4278 mln. Despite intensified mitigation measures taken by PKP to reduce expenditures and increase revenues, in PKP’s opinion it is impossible to cover expected operating loss on passenger operations with profits generated by freight segment. According to PKP, limited possibilities to attract credit financing and a necessity to secure minimum financing to implement required investment and secure continuity in operations would result in a financial deficit of PLN 1337.29 mln. Currently, the Ministry of Transport and Maritime Economy is considering a PKP request to secure State Treasury guarantees for credit financing of such magnitude. The hardest problem are difficulties in securing financing to pay out salaries and wages. Of the amount of PLN 1337.29 mln, a deficit in financing salaries and wages for the second half 35 of 1999 would reach PLN 420 mln. In case salaries and wages are not paid out on timely basis, there is a great risk of social tensions among PKP employees. The analysis of what action should be taken to secure traffic safety as regards operation of railway lines proved that for 1999 the following quantities of materials should be used: pre-stressed concrete sleepers - 600 thousand pcs., turnouts on pre-stressed concrete sleepers - 300 sets, turnouts on wooden sleepers - 450 sets, rail joints - 2400 thousand pcs. (or application of joint-free devices - eg. axle counters). To produce such quantities of materials would require financing in the amount of PLN 445.2 mln. In order to improve currently tragic financial standing of the enterprise, the General Directorate of PKP proposed the following set of actions: 1) included in the scope of verified financial and material plan, which would bring about: a decrease in expenditures PLN 580.3 mln an increase in revenues PLN 375.5 mln an improve in financial result PLN 255.2 mln 2) outside the scope of verified financial and material plan, which would bring about: a decrease in expenditures PLN 63.4 mln an increase in revenues PLN 79.3 mln an improve in financial result PLN 100.6 mln Financial effects of proposed actions are insufficient to cover financial deficits and secure continuity in operations and traffic safety. In order to re-establish financial liquidity and ability to implement basic investment programs PKP would need the total of PLN 1800.0 mln. Such financing would be secured through bank credits and issue of restructurization bonds described in section 4. Detailed composition of financing is the following: 1. to maintain continuity in operations: remuneration PLN 400.0 mln materials and services PLN 412.0 mln rolling stock repairs PLN 454.8 mln modernization of traffic control devices PLN 40.5 mln Y2000 problem PLN 45.5 mln 2. to secure traffic safety - procurement and application of railway infrastructure elements such as: sleepers, turnouts, rail joints - PLN 445.2 mln. The amount of PLN 450 mln would be allocated for railway supporting units under works and services contracted by PKP and PKP S.A. 36 9. SCHEDULE OF PKP RESTRUCTURING ACTIONS No. Assignment Deadline 1 The Council of Ministers adopts PKP restructuring program and the 7.09.1999 draft law on commercialization, restructurization and privatization of PKP 2 The Parliament enacts the law on commercialization, 11.1999 restructurization and privatization of PKP 3 Consultant is selected to analyze economic standing of PKP and before 30.11.1999 develop privatization strategy 4 PKP and the Minister of T&ME establish companies not related to before 31.12.1999 core activities, under Articles 13 and 44 of the law dated 6 July 1995 on PKP 5 PKP submits relevant questionnaire of state enterprise to be before 30.11.1999 privatized 6 PKP is privatized under the relevant law before 31.12.1999 7 Labor restructuring is commenced 02.2000 8 Preparations to establish companies as recommended by the before 03.2000 consultant and with full participation of PKP structures are completed 9 Final report on tasks 1-6 is delivered. Consultant scope of work: before 30.04.2000 1) legal status of properties, before 02.2000 2) development prospects, before 15.02.2000 3) implementation of obligations on account of protection of the before15.02.2000 environment and historic monuments, 4) modal analysis of railway transport including privatization before 03.2000 strategy, 5) actions to privatize individual subsidiaries under the general before 03.2000 strategy, 6) structure of subsidiaries and valuation of assets to be privatized 04.2000 in the first order, 7) recommendation of possible investors. 10 PKP S.A. establishes transport operating companies and the manager before 31.05.2000 of railway lines 11 Other companies are established before 30.06.2000 12 Potential investors in transport and other companies are attracted 05-07.2000 13 Agreements with investors are negotiated III q.2000 14 PKP issues restructurization bonds II-III q.2000 15 First privatization transactions are concluded IV q.2000 16 The Fund of Workers’ Ownership is established before 31.12.2000 37 10. RECOMMENDATIONS The Minister of Transport and Maritime Economy recommends the Council of Ministers: 1. to adopt the PKP restructuring program; 2. to approve pre-retirement benefits on conditions stipulated in the law on commercialization, restructurization and privatization of PKP for 3550 employees to be laid-off by PKP S.A. and its subsidiaries in 2000-2001. PKP S.A. will finance costs of related benefits to be paid out by the Labor Fund; 3. to oblige the minister relevant to transport to carry out an audit of economic standing of PKP by independent auditors. Related costs would be financed out of the proceeds of the World Bank loan held by the Minister of State Treasury for restructurization purposes; 4. to grant guarantees and sureties of the State Treasury to credits to be taken by PKP or PKP S.A. in local and international banks to secure a bridge financing in advance of proposed bond issue, to finance labor restructuring, secure continuity in operations and railway safety, repay liabilities of railway health services as of the day they are separated out of PKP and privatization consultants – in the amount not exceeding PLN 1,500 mln; 5. to make a provision in the state budget for 2000 to include the total amount of PLN 52.0 mln, of which: to support the Labor Fund to finance pre-retirement benefits for railway-men – transferred costs – PLN 48.9 mln; to support operations of GIK – in the area of railway regulation – PLN 3.1 mln; 1. to oblige the minister relevant to transport to carry out periodical evaluation of PKP restructuring actions every three months and to submit relevant report to the Council of Ministers. 38