International Financial Institutions

Regional Private Sector Initiatives in

South Eastern Europe

Final

European Bank for Reconstruction and Development

Stability Pact Funding Conference

29-30 March 2000

Table of Contents

Executive Summary

1. Introduction and Summary

   1. Summary of New Regional Initiatives

   2. Other Aspects of Private Sector Development

   3. Timing

   4. Kosovo

2. EBRD and IFC Commitments to the Region

3.Cross Border Trade and Investment

3.1.Expanded Trade Facilitation Programme

3.2.Proposed South Eastern Europe Trade Insurance Project

1. Leveraged Political Risk Insurance Facility for Imports

2. Export Support Facility

3.2.3Trade Credit Insurance Facility for Imports

3.3Political Risk Guarantees for Investors

4.0Regional Coverage of SME Support

4.1Balkan Enterprise Facility

4.2.Small Equity Funds

4.3.Micro Finance Banks

4.4Support Facility for the Local Contractors and Suppliers

5. Bank Restructuring

6. Credit Guarantee Pilot

5. Existing (Quick Start) Commitments

5.1.EBRD/EU Finance Facility

2. EBRD/US Trust Fund for SMEs

5. Summary tables of Donor New Funding Requirements including Country Distribution

Annexes

1. EBRD’s Trade Facilitation Programme

1. World Bank Trade Guarantee Facility

1. MIGA Overview

1. IFC Program

1. List of SME Support Programmes

1. Fiches

Executive Summary

• The European Bank for Reconstruction and Development (EBRD) has been asked by the High Level Steering Group (HLSG) for Donor Co-ordination in South Eastern Europe to define and co-ordinate the international response under the Stability Pact for the promotion of Regional Private Sector Initiatives. The paper presented below provides a strategic framework, outlines programmes and projects which are models of “best practice” in the region, and presents those initiatives which have been agreed among the IFIs as suggested priorities for consideration by the donor community and beneficiary countries.

• There are numerous effective bilateral programs benefiting SMEs and private sector activity already underway. The paper does not attempt to catalogue all of them. Nevertheless there are strong synergies and complementarily between IFI projects and grant resources from existing and planned bilateral initiatives. The paper highlights those IFI initiatives that could be extended or implemented on an accelerated basis with grant bilateral co-financing or technical assistance. It is hoped that bilateral donors would find co-financing with an established and proven IFI programme an attractive way to employ their limited grant resources.

• Regional Private Sector Initiatives are divided into two types of programs: the promotion of Cross Border Trade and Investment and regional coverage of SME Support. The first addresses large private projects which promote inter and intra-regional commercial linkages and the second addresses the need for broad access by SMEs to the full range of existing and planned support programmes. The expected important contribution of the private sector in the development of infrastructure (as promoted by the EBRD) is assessed separately in the EIB strategy paper as per project list.

• EBRD and IFC are the two main IFIs involved in private sector investment . They have increased their combined outstanding commitments to the region by € 506 million in 1999 to a total portfolio of €2.6 billion equivalent at end 1999 of which 63 percent is private sector. The total project pipeline has increased strongly with growth of 22 per cent in 1999 reaching a total of € 2.9 billion partly reflecting greater investor confidence created by the Stability Pact. Based on these trends, the IFIs estimate that their combined new amount commitments in the region could increase between € 600 and 700 million annually. Taking into account the multiplier effect created through co-investment by partners, IFI operations would generate annual new investments of €1.2 billion to 1.4 billion .

• Specific new regional initiatives are recommended in immediate support of cross border trade and investment over the next 24 months. Each is based on existing programmes already operational in parts of the region such as: Trade Facilitation Programme (local bank guarantees) ; Trade Insurance Programmes (local specialist insurance institutions) and Political Risk Guarantees (to cover political risk for inward investment). The extension of these programmes to cover all countries and territories of the region would require donor support totalling € 128 million. An analysis of the regional coverage of SME programmes shows that a considerable amount of donor and IFI finance is already committed. However, there are gaps in the provision of specialist micro, small equity funds and enterprise support which require a high proportion of donor funding. In summary the total amount of donor funds requested for extension of these programmes is € 103 million. Second and Third Pillar support for SMEs have important synergies with the finance provided by IFIs. A number of already announced programmes will facilitate coordination of finance and non-finance support including: IFC Balkan Enterprise Facility (USD 35 million) and the EBRD/US Trust Fund for SMEs (USD 25 million). In addition EC/ Phare has made available co-financing of €15/20 million to Bulgaria and Romania under the EBRD/EU SME facility (€125 million). This facility could be further extended to include the Western Balkans.

• Each of the regional private sector initiatives described in the paper have different timing profiles related to their urgency, geographical coverage of existing programmes and extent of institutional infrastructure already in place. As a result it is possible to identify initiatives which can be implemented on a “Quick Start” basis, defined as those initiatives where donor funds could be employed within the coming 12 months (April 2000-March 2001). The IFIs and donors have already committed €186 million for these initiatives. The funding gap for “Quick Start” projects amounts to about €104m. The balance of donor funding requirements (€127m) is for “ Near Term ” projects, i.e. with commitments and/or disbursement occurring approximately during 2001. Most of the projects are based on existing operations or on proven models which can be extended from one country to another. This approach is designed to facilitate the donors ability to identify those projects which will have an immediate impact in the region.

The following table 1 summarises the total high priority additional donor funding needs with a breakdown of those initiatives which require funding on an urgent basis in order to facilitate “quick start” projects. Each project is provided with a short summary description and an indication of the country coverage planned. The amount of funds committed and planned for commitments in 2000 from the IFIs for each “quick start” initiative is presented along side the amount requested from donors either for grant co-financing or grant technical assistance.

Additional tables for each country in the region (and Kosovo) are provided showing the distribution of funding requirements along the established criteria of “quick start” and “near term” for each of the proposed initiatives.

In conclusion, both IFIs and donor funding together could commit up to €288 million for Regional Private Sector Initiatives on a quick start basis. For the quick start programmes, the total “funding gap” for Regional Private Sector Initiatives is about €104 million (€75 million of co-finance and €29 million of technical assistance). IFIs’ own commitments for the same initiatives amount to €186.5 million of which €90 million is already committed and €96 million is planned for commitments in the next 12 months.

Table 1: Donor Funding Requirements for new Regional Private Sector Initiatives by IFIs

Note: The table does not include funding for SME programmes already announced by the US Government totalling approximately €25 million (see section 5).

In conclusion, both IFI and donor funding together could commit up to

€ 288 million for Regional Private Sector Initiatives on a quick start basis. For the “quick start” programmes, the total “funding gap” for Regional Private Sector Initiatives is about €104 million (€75 million of co-finance and €29 million of technical assistance). IFI own commitments for the same initiatives amount to €186.5 million of which €90 million is already committed and €96 million is planned for commitment in the next 12 months.

I.Introduction

The European Bank for Reconstruction and Development (EBRD) has been asked by the High Level Steering Group (HLSG) for Donor Co-ordination in South Eastern Europe to define and co-ordinate the international response under the Stability Pact for the promotion of Regional Private Sector Initiatives. An initial concept paper ¹ was presented to the Working Level Steering Group (WLSG) in September 1999. Subsequently, EBRD hosted an IFI Workshop on Regional Private Sector Initiatives on 21 January 2000 with the objective of reviewing existing programmes, identifying key gaps or duplications and agreeing on a specific list of high-priority initiatives that, in particular, would merit support on a grant basis from the donor community. The paper presented below provides a strategic framework, outlines programmes and projects which are models of “best practice” in the region, and presents those initiatives which have been agreed among the IFIs as suggested priorities for consideration by the donor community and beneficiary countries. The approach defined in this paper is consistent with that described in the World Bank’s Regional Strategy Paper.

The ultimate goal of the regional approach is to create a vibrant private sector exchanging goods and investing freely across borders in a region itself integrated closely with the larger European and world economy. The stimulus to growth and investment, after a long period of relative stagnation, will come from the creation of new small businesses and foreign investment, from market expansion and from building an efficient public and private infrastructure. Private sector led development would be anchored in the perspective of integration into Euro-Atlantic structures that underlies the Stability Pact. This perspective will help mobilise political resources for change, raise investor interest in the region and build confidence in the future stability of the business environment.

FR Yugoslavia (FRY) lies at the heart of south-eastern Europe. Most countries of the region are closely linked to it through trade or transport. In the longer term, any sustainable path of economic recovery and integration must by necessity involve FRY. While none of the initiatives presented in this paper would be directly applicable to FRY – which is not a country of operations of either the World Bank Group or the EBRD – the initiatives could easily be extended to FRY, if and when conditions permit.

1.1Summary of new regional initiatives in South Eastern Europe

This paper proposes to support private sector-led growth and integration in the region through initiatives in two main areas:

• Cross-border trade and investment: Risk perceptions have been an important factor limiting cross-border economic activity, both within and from outside the Stability Pact region. Confidence building would therefore be a major component of any strategy to promote regional private sector activity. This paper outlines a number of initiatives that tackle the risk faced by investors and banks in cross-border business, with a variety of complementary instruments aimed at different players and employing a variety of institutional structures. Facilities are also directed at supporting the financing and guarantee needs of local contractors and suppliers.

• SME support: A second strategic focus is the promotion of Small and Medium Enterprises (SMEs), which contribute to the dynamism and flexibility of economies and help create market-oriented development “at the roots”. The “regional” dimension in the SME initiatives proposed in this paper derives from the aim to ensure “regional coverage” of the full range of products and programmes which have proven to be successful in the past. The paper covers financing programmes (equity, loan, grant co-finance) for SMEs (“Pillar I”), initiatives to improve the business climate for SMEs (“Pillar II”), and technical assistance programmes aimed at institution building and at providing business support (“Pillar III”). Annex 4 provides a list of SME support programmes active or ongoing in the region. It has not been possible to comprehensively review existing bilateral programmes in this paper. However their complementarily and significant synergies with proposed additional regional initiatives proposed here will be an important factor in proposing a dynamic SME sector in the region

.

2. Other aspects of private sector development

Important aspects of private sector development lie outside the scope of this paper. Some are taken up in the context of other tasks agreed under the framework of the Stability Pact, and are coordinated by other institutions. Nevertheless, it is important to re-emphasise two points made in the EBRD paper on “Promoting Private Sector Led Growth in South-Eastern Europe” last September – namely, the contribution that the private sector can make in the development of infrastructure, and the basic role that the investment climate plays in stimulating healthy, private sector led economic development:

• Infrastructure: Major infrastructure investments are needed in the region. ² As much as possible, the private sector should have a role in financing that part of infrastructure investments that can be structured on a commercial basis. The aim is to raise the efficiency of infrastructure construction and management, as well as to minimise the debt burden for the public sector of the beneficiary countries. However, private involvement has been slow to emerge in some countries due to weak legal and regulatory frameworks. It is important that these areas are not neglected by the donor community and that grant funding be made available on a priority basis to improve conditions for private investment in this sector.

• Investment climate: It is clearly not possible to “programme” or direct private sector activity. The fundamental requirement for increased private sector activity is a favourable investment environment. The responsibility for creating such an environment lies with governments. However, working with the governments of the region, the Stability Pact is already having an impact. The initiatives taken under the guidance of the Stability Pact, to develop and implement an Investment Compact and combat corruption, are establishing the “umbrella” under which private sector investors can plan and invest with greater confidence that the region is on a path towards economic recovery and integration. Both EBRD and IFC have witnessed signs of renewed investor interest in the region which in part reflect the success of the Stability Pact.

1.3Timing

Each of the regional private sector initiatives described in the paper have unique features which have an impact on the timing of their implementation. Because a number of initiatives represent the extension of programmes that exist in one country into another country of the region or are already working on a regional basis, a number of initiatives can be implemented very quickly. Initiatives which can employ donor funds before the end of 2000 have been designated “quick start” programmes. If the initiative requires some preliminary design work, consultations with recipient governments, or preparation and/or establishment of local institutions, the initiatives have been designated either short-term (2001) or medium-term (after 2001) depending on estimated timing and needs. In some cases, preparatory work in the form of Technical Cooperation is designated as “quick-start” in the sense that this funding is needed before the financing component (grant or IFI funded) can be put in place.

1.4Kosovo

The initiatives presented in this paper apply to South-Eastern Europe as a region, rather than targeting specific issues in individual countries. Nevertheless, the objective of re-starting economic recovery and integrating Kosovo with its neighbours is important for regional stability. Expanded trade and cross-border investment into Kosovo is required to generate new economic activity, create jobs, and establish a tax base that would support the territory’s public administration under UNMIK. Despite the urgent need for new private capital, Kosovo is facing a fundamental constraint to private sector development, namely the continuing uncertainty over property rights. As a result of this uncertainty, foreign investors with concrete investment plans have been deterred from proceeding with commercially viable projects. Property rights in Kosovo must be clearly defined if the province is to avoid long-term dependency on foreign official assistance.

Section 3.3 provides details of the investment guarantees against political risk provided by the Multilateral Investment Guarantee Agency (MIGA) which are available for investors in all countries of the region to insure against losses due to specifically defined political events (such as expropriation, war, breach of contract, etc). MIGA is, at present, unable to offer similar products for Kosovo because the territory is not a member of the World Bank. Provided that urgent and decisive action is taken on property rights by UNMIK, MIGA could extend similar products to Kosovo.

As soon as the property rights issues are addressed, MIGA would be able to define appropriate insurance contracts for investors and establish premiums based on the risk of property rights not being respected. Initial funding of such a political risk guarantee would need to be on a grant basis. Grant funds employed in this way would encourage private investors to assume the already considerable commercial risks by reducing the high level of political risk.

Because Kosovo is subject to a donor funding conference dedicated to programmes in the territory later in the year and because a significant amount of funds have already been pledged to Kosovo, it is proposed not to request funding for a political risk guarantee fund at this stage. Rather it is expected that an allocation of resources already pledged to Kosovo be made for a political risk guarantee fund depending on the state of progress in resolving the property rights issues at that time.

2. EBRD and IFC Commitments to the Region

EBRD and IFC both have extensive experience in financing commercially sound and profitable investment projects in the Region. Taken together this experience is reflected in a portfolio of loans and equity investments totalling about Euro 2.6 billion equivalent in outstanding commitments at end 1999. ³ New commitments to the Region in 1999 have been sustained despite the difficult investment climate and increased political risk associated with the Kosovo crisis. For example in the most directly affected countries (FYR Macedonia, Albania and Bosnia Herzegovina) total commitments by EBRD actually increased by 36 per cent in 1999. Projects financed by IFC and EBRD typically involve a strategic investor and/or co-financing from major western banks. As a result of co-financing policies, the total value of investment supported or catalysed through IFI involvement is around twice the amounts committed directly by IFIs. EBRD and IFC’s operations encompass a broad range of investment activities which cover both cross border trade and investment and regional coverage of SME finance. In addition, a substantial part of infrastructure investment requirements- about 65% for EBRD and 100% for IFC, are financed on a private sector basis.

With respect to the objective of increasing cross border investment, the standard IFI corporate financial loan or equity investment in the region involves an outside or “strategic” investor which brings necessary additional capital, technology, skills and access to international markets. Each investment of this type has a direct impact on cross-border investment and usually creates or supports an outward-looking export-oriented business able to compete successfully in the international market. Consequently, the acceleration of processing of new transactions in the corporate sector consistent with the IFIs existing lending and investment policies is a cornerstone of the efforts under the Stability Pact to promote regional private sector development.

With respect to regional coverage of SME support programmes, both IFIs have developed over the years extensive experience with local banks and financial institutions. Credit lines to local banks throughout the region have been committed in each country with the objectives of: 1) providing longer term funding which are used by the local banks to make longer term loans to their SME clients, and 2) improving the technical capabilities of the banks through technical cooperation including credit training. In addition, IFC and EBRD have made equity investments in several of the banks in the context of the countries’ bank privatisation programmes. New equity is needed in order to improve the capital adequacy of banks, which in turn allows them to increase safely their total exposure to their SME clients, while ensuring the health of the country’s financial infrastructure. The IFIs also take an important role in corporate governance of the banks in which they invest which further helps to build them into effective financial institutions.

* Pipelines for 1998 and 1999 include pipeline for the year plus commitments expected in the following two years.

Based on the combined pipeline of IFC and EBRD in the region, and the assumption of donor backing for “Quick Start” projects, we expect between 40% and 50% annual growth in annual commitments exclusively in the private sector over the next 24 months. In absolute amounts, this would represent an increase in private sector commitments by these 2 IFI’s by up to € 150-200 million to € 500-600 million in annual new commitments or equivalent to more than €1000 million over the two years 2000 and 2001. Taking into account the multiplier effect of co-financing from local and foreign partners, the total new private sector investment flow would reach approximately €2 billion over the same two years.

Need for Donor Co-financing and Technical Cooperation: Grant co-financing and technical cooperation have important synergies with the investment programmes undertaken by the IFIs. Grant co-finance is appropriate in the context of project finance where a portion of the investment plan cannot attract purely private finance on commercial terms. Examples include major environmental investments (e.g. water treatment), port infrastructure; new road construction, etc. Project finance allows a blending of grant money and commercial funds which together limit the need for sovereign guarantees and minimise the debt burden for the country concerned. In addition, EBRD and IFC both have existing and planned programmes and project pipelines which generate demand for grant funded technical cooperation for:

Project preparation: Many projects require extensive technical studies to assess commercial and economic viability, confirm project assumptions and prepare detailed business plans. Grant financed consultant services have proven utility in accelerating the processing of transactions.

Post-investment support: Large and small businesses alike are often in need of institutional support for training, strategic planning, marketing, financial and accounting systems, etc.

Needs are particularly acute for local financial intermediaries which are instrumental in providing IFI funded finance to SMEs. Grant-funded consultant services can accelerate the institutional development of financial intermediaries and local businesses.

Investment climate work: The investment climate is a critical factor influencing both the development of SMEs and foreign direct investment. Grant funded technical cooperation directed at key legal, administrative or regulatory constraints to investors can have an important impact on the ability of IFIs to attract co-investors, strategic partners and accelerate their programmes.

2. Cross Border Trade and Investment

The promotion of cross border trade and investment is a key strategic focus under the Stability Pact. Trade integration will be driven heavily by policy and administrative changes as well as improved infrastructure. Nevertheless, high transaction costs in trade finance are also a serious obstacle to cross-border activities in the region, and a factor that seriously disadvantages local companies vis-a-vis western competitors. Risk is the principal source of transaction costs in trade finance. Its main sources are transfer and country risk (caused by the unpredictability of political, macroeconomic and regulatory conditions) and the weakness of firms and financial institutions. Local banks are reluctant to lend to or underwrite risk on many firms, and foreign correspondent banks as well as foreign ECAs and firms display the same reluctance vis-à-vis those local banks. Since risk is a function of exposure and duration, trade finance is biased towards short maturities and against larger transactions.

The economic consequences of risk are magnified in south-eastern Europe by the markets' inability to measure and manage risk. Risk assessment and mitigation is hampered by information deficiencies, incomplete legal frameworks and a lack of insurance. The information "institutions" (and related skills) that support credit markets elsewhere are largely missing. Apart from lacking the capital necessary to back their commitments, local banks often cannot assess the risk of local firms. Correspondent banking relationships and the ability of ECAs to provide underwriting services are hampered by a lack of track record (of institutions and countries), the most common source of credit information.

The section below outlines a number of programmes directed at mitigating different sources of risk in trade finance, improving information over time, and strengthening trade finance capabilities in local banks. All these programmes have already proven their worth in terms of practical implementation, commercial viability and development (transition) impact. Most of the programmes can build on existing institutional structures and contractual models, and all can draw on experienced staff to further develop and implement them. They also have a need for grant support in order to extend them to countries or regions not yet covered under existing facilities. They can be implemented in the very near future. They have therefore been selected as priority initiatives requiring donor support.

3.1Expanded Trade Facilitation Programme

EBRD’s Trade Facilitation Programme is designed to reduce risk perceptions between domestic and foreign banks involved in trade finance transactions. The EBRD provides a guarantee on the performance of a local bank to make its commitment acceptable to a counterparty bank outside the country. For this purpose EBRD makes use of the extensive network of local banks in the region which it has developed over the years for its SME lending programmes. Throughout south-eastern Europe, EBRD has client relationships with 33 banks. EBRD has judged the risk it takes on the local bank as acceptable on a commercial basis because of its knowledge of the local bank involved and experience in the region. The impact of the programme is measured by the increase of credit to local companies in support of their intra-regional trade.

The programme in 1999, its first year of operation in south-eastern Europe has proved successful and popular with the client banks. To date, 8 Issuing Banks in four of the six countries of the region have been accepted into the programme with total agreed limits exceeding € 23 million. It is planned that by the end of 2000 there will be 18 or 20 banks and total limits of € 40 million. Over 70 Confirming Banks (usually western banks) have joined the programme. Between July and end-1999, 28 guarantees were issued for a total of € 7 million for banks in FYR Macedonia where the programme is furthest advanced. It is expected that the use of guarantees in the region will accelerate in the year 2000.

New grant funding for the Trade Facilitation Programme would allow the programme to be extended in two respects: a) the total exposure to a single bank could be increased or additional banks could be included; and b) the range and scope of the guarantee cover could be extended to include longer-term exposures. In December 1999 the EBRD signed an agreement with the Swiss Government to provide grant funds amounting to SFR 5 million. The money is maintained in a Guarantee Fund to support the Trade Guarantee Facility portfolio in Albania, Bosnia Herzegovina and FYR Macedonia.

EBRD seeks additional funds from the donor community to expand the Trade Facilitation Programme on a shared risk basis following the model used with the Swiss Government. Based on the demand for trade credit and the capacity of the banking sector to process the guarantees there is a requirement of donor support totalling € 20 million of which € 10 million is need for “quick start” implementation in 2000. Technical assistance funding is required to assist banks in developing their credit analysis and marketing skills and to facilitate risk taking under trade finance activities. An amount of € 1 million is envisaged for technical assistance, principally for Albania, Bosnia and FYR Macedonia . Annex 1 provides details of year 2000 activity .

3.2Proposed South Eastern Europe Trade Insurance Project

Rather than addressing the general risk of exposure to local banks – i.e. the risk that local banks might not fulfil their obligations under documentary credit, due to commercial or country risk events – one can tackle specific risks attached either to the local buyer / seller or the country. This is the aim of three trade finance initiatives proposed by the World Bank and described in the following. In each case, an insurance rather than a guarantee approach is employed, efforts are made to attract the private insurance market into sharing the risk, and a local implementing institution is created (rather than working with existing intermediaries). The schemes build on successful precedents in Bosnia and Herzegovina and Albania. While the pilot cases have so far been implemented country by country, it would be more efficient and less risky if a donor insurance fund could be pooled over the whole region. Nevertheless, to access this pool of funds, there must be a competent local institution. Because of the strong institution building co m ponent and the need to assess each countries needs and existing capabilities, there is initially a large need for Technical Assistance estimated at € 9 million on a quick start basis . Once in local institutions are established each of the three programmes can be implemented by the one executing agency. The three programmes are described in detail in Annex 2 and summarized in the following. The specific amounts of World Bank commitments can only be estimated and will be defined more precisely after more detailed appraisal.

3.2.1Leveraged Political Risk Insurance Facility for Imports

A leveraged political risk insurance facility has already been developed in Bosnia and Herzegovina under the World Bank financed Emergency Industrial Restart Project. It has combined World Bank Funding of USD 10 million and donor support of a matching USD 10 million. This total pool of funds has subsequently been leveraged by a commercial syndicate at a ratio of 2:1 which means a total of USD 40 million is available for political risk. A similar programme is running in Albania with USD 10 million from the World Bank.

It is proposed that the concept be extended to other countries in South Eastern Europe . An immediate requirement of USD 10 million is needed on a “quick start” basis to fund a Political Risk Insurance Facility (and Export Credit Support, see below) for FYR Macedonia . Subsequently, the model could be extended either on a country by country basis or explicitly on a regional basis. A regional facility has the attraction of spreading the risk over a “portfolio” of countries. The proposed facility would operate in the following manner: Donor and World Bank funds would be earmarked for each country participating in the facility. The amount allocated to each country would be based on expected demand, based on the results of a demand survey. These funds would be placed in a trust account to back-up insurance policies and could only be used to pay valid claims. A regional facility may require a dedicated regionally-oriented institution to administer claims and collect premiums. Further consultations with governments in the region is planned to assess the viability of the concept. If the larger countries of the region were to participate, the overall funding need could expand to USD 50 million, at least, of which USD 15 million is needed on a “quick start” basis.

3.2.2Export Credit Support

Exporters in mature market economies can generally rely on a broad range of financial services lowering their or their counterparties’ risks and providing liquidity. Key among these services are Export Credit Insurance, working capital credits for exports and performance bond support. The proposed support programme would encompass initiatives in each of the areas described below. They are already provided in Bosnia on a pilot basis with a World Bank loan of USD 10 million. The extension of the programme to FYR Macedonia is planned using USD 10 million of donor funds as mentioned above.

Export credit insurance could be provided by entering into re-insurance/cut-through arrangements with one of the large international export credit insurers. In participating countries that already have export credit agencies, the quality and sustainability of export credit insurance being provided would have to be assessed. Initially, the foreign export credit agency would re-insure either all or a majority of the risk. As the implementing agency gained experience and capital, it could keep a larger portion of the risk on its books.

Working capital credit guarantees for exports . Donor and IFI (such as EBRD) funds could be used as capital to support a conservatively leveraged guarantee facility whereby the implementing agency would guarantee local banks a percentage of working capital advances tied to and secured by export contracts. It would be a condition of a guaranteed working capital advance that the export transactions supported by the guarantees, are secure i.e. credit insured or covered by a documentary credit. This mechanism should give some balance sheet relief to local banks, depending on attitudes of regulatory authorities in stability pact countries. However, a guarantee mechanism on its own would not address the lack of liquidity or high cost of funds of local banks. The World Bank is currently developing this concept to be implemented on a pilot basis in the most directly affected countries.

Amounts required in total for export credit support are estimated at USD 48 million over the medium term of which USD 10 million is needed on a “quick start” basis.

3.2.3Trade Credit Insurance Facility for Imports

In order to increase impact political risk facilities should be complemented by commercial risk insurance. The commercial insurance market has been slow to cover the Stability Pact countries, partly as a result of the limited information and credit histories in the region. To speed up this process of market entry, mechanisms could be put in place using donor and IFI funds that would allow identification of commercially viable transactions in participating countries. The private sector would be encouraged to provide finance and accept the associated commercial risks through co-insurance mechanisms. So as to limit moral hazard, the facility could be structured so that it would not expose donor and IFI funds to first losses (in contrast to the proposed political risk facility, above). Under a co-insurance scenario, losses would impact equally on donor/IFI funds, as well as on the local bank taking a share of the risk and/or the private insurance market providing commercial risk insurance. It is too early to assess the specific need for donor funds at this stage as the concept is being refined. Over the medium term, however, the World Bank estimates that donor funding of USD 25 would be needed to introduce these products firstly in the most directly affected countries and subsequently (if required) USD 55 million in Romania, Croatia, and Bulgaria. ⁴

3. Political Risk Guarantees for Investors

Political risk guarantee products developed by the Multilateral Investment Guarantee Agency (MIGA) are well established and have been available for investors of debt and equity into countries of the region for some time. The guarantee provides insurance against specific events (such as expropriation, war, etc.) that are considered key components of political risk. The countries of the region benefit from guarantee capacity of up to $ 620 million each from MIGA. To date this capacity is under-utilised with only a handful of guarantee commitments in each country. Better marketing and dissemination of information about this facility is desirable.

With respect to Kosovo, these standard products to not yet exist, partly because the territory is not a member of the World Bank. However, donor funds could be used to set up such a fund provided the international community ensures that UNMIK itself has the tools to establish and enforce basic property rights. It will not be possible to establish a political risk guarantee fund for Kosovo, either in terms of defining what risks are covered, or in terms of establishing the appropriate premium rates, until there is some confidence the UNMIK is getting to grips with the problem. Assuming progress on property rights is achieved, donor funds of between €50 and €100 million could be allocated out of funds already pledged to Kosovo.

4.Regional Coverage of SME Support

An effective SME strategy should be based on support in three related areas (“pillars”): (i) finance, (ii) improvements in the business environment and (iii) the strengthening of the SME support networks. A significant number of support programmes, covering the three pillars, are already in place throughout south-eastern Europe. Nevertheless, there appears to be a need for:

• improving integration of the three pillars on a country-by-country basis,

• introducing new initiatives where gaps have been identified, and

• establishing effective forms of continued co-ordination among the IFIs.

The EBRD Workshop in January 2000 helped to identify where gaps exist in the regional coverage of programmes supporting SME development. While the Workshop concluded that, in many instances, current levels of credit and equity support were sufficient, there were gaps in specific programmes and countries. For example, there are already equity funds under operation in South Eastern Europe of €340 million of which on €80 million has been disbursed. Good quality demand for SME finance was judged to be often constrained by the difficult business environment for small businesses (including high or unclear tax regimes) as well as weaknesses in the financial management and business planning skills of local entrepreneurs – many of which have had little exposure to formal finance.

The objective in the initiatives set out below is to ensure that a broad range of SME finance and non-financial support is available across the region. There are a great number of valuable and successful programmes already existing in support of SME development in the countries of the region. For example KfW and USAID, among others, have extensive programmes in the region benefitting SMEs. Annex 4 provides a list of bilateral donor and NGO supported programmes. The impact of these programmes is significant and clearly complementary with IFI private sector initiatives. Below is a description of the major new initiatives which have been established in the context of the Stability Pact and which would benefit from donor co-financing or parallel programmes supporting the investment climate for SMEs.

4.1IFC Balkan Enterprise Facility

IFC has newly designed and approved the establishment of the IFC Balkan Enterprise Facility specifically aimed at second and third pillar support for SMEs as described above. The facility will pool grant funds and allocate them for technical assistance to SMEs including both pre- and post-financing support. IFC has successfully implemented similar programmes in Africa and the Far East. It is expected that technical assistance provided under the Facility will help SMEs access appropriate financing from IFIs and/or local intermediaries (e.g. funds, agency and credit lines) as well as provide training and education programmes to improve management, accounting, and marketing skills. In addition, funds could be accessed for stand-alone technical studies that would improve the investment climate for SMEs (e.g. tax, regulatory issues, etc.). Coverage would include Albania, FYR Macedonia, Bosnia-Herzegovina and Kosovo. Funding requirements are estimated at USD 35 million over 5 years.

4.2Small Equity Funds

Small equity funds ranging approximately from $ 10 million to $ 15 million in size share with larger equity funds the same principal investment objective: to achieve long-term capital appreciation by contributing to the modernisation, expansion, restructuring and development of small and medium sized private enterprises, through equity and quasi-equity investments in commercially viable companies and projects.

Small equity funds target smaller companies with equity participations which can be as little as USD 50,000-100,000. These funds normally seek to achieve their objectives by taking significant minority stakes in the portfolio companies through negotiated transactions and having an active role in influencing their operations and management.

However, the participation in small companies is an expensive exercise, especially in view of the difficulties in transferring due diligence costs on to the final clients and/or in capitalising such costs.

This is reason why EBRD and other IFIs would usually co-finance equity investment in small funds with parallel investments made available by donors. Donors’ contributions, offered normally on softer terms, provide EBRD and the funds with adequate security cushions to allow a reduction in the average investment size.

In view of such donors’ contributions, small equity funds have proven to be an effective vehicle for channelling resources to revitalise SMEs in risky countries such as Albania, FYR Macedonia, Bosnia-Herzegovina and Kosovo. EBRD has developed an equity fund with co-financing from the Italian Government in Albania (the Albanian Reconstruction Equity Fund - AREF) with matching EBRD and bilateral grant funds of USD 7 million each. AREF is now also operational in Kosovo employing a further Italian Grant of USD 4 million. EBRD is developing a similar programme in FYR Macedonia for which donor funding of approximately USD 9 million has been identified. A similar programme for Bosnia is being prepared. Donor funds of USD 8MM are being sought for “quick start” implementation including TC funds of €3 million for institutional support and strengthening .

4.3Micro Finance Banks

EBRD, IFC, KFW, FMO and other organisations are currently involved in three Microfinance Banks in South Eastern Europe – Micro Enterprise Bank Bosnia (MEB BiH), FEFAD Bank Albania and Micro Enterprise Bank Kosovo (MEBK). In Bosnia and Albania EBRD is a direct shareholder in the institutions, whereas in Kosovo legal constraints have so far meant that involvement is limited to an indirect shareholding and provision of TC.

For such projects to succeed there are three essential ingredients:

• shareholders committed to the development of a commercially sustainable bank focussed on servicing the micro and small enterprise (MSE) sector;

• TC for the first 2-3 years of the operation; and

• medium/long-term funding for on-lending to SMEs.

As far as the project pipeline is concerned EBRD is currently considering the possibility of participating in the creation of a similar greenfield micro-finance bank in FYR Macedonia, Bulgaria, Romania and Croatia. Donor finance will be required in the form of on-lending funds of approximately USD 13 million of which USD 5 could be employed in FYR Macedonia on a “quick start” basis. TC funds totalling € 8 million is needed for institutional support for the new banks in these countries. Additional “quick start” donor finance for MEB in Bosnia is needed of USD 4 million for on-lending to its growing number of clients.

4.4Support Facility for Local Contractors and Suppliers

4.4.1Working Capital

The developmental impact of projects under the Stability Pact umbrella, especially in infrastructure, would be enhanced by the broad participation of local contractors and suppliers. Experience in Bosnia and other countries suggests that companies from the region often face severe constraints in competing for business as contractors or sub-contractors, even where they have the technical quality required for delivery. An important constraint is the weakness of local banks, which would in mature market economies provide guarantees for bid, performance and advance payment bonds, and working capital financing for liquidity needs at the start of construction.

EBRD is considering using the client network of local banks established under its Trade Facilitation Programme to cover the needs of local contractors and suppliers. The advantage is the simplicity of the approval mechanism and the familiarity of local partner banks with the programme. In addition, and given the longer tenors and particular expertise involved in construction finance, a separate “Contractor Credit Support Facility” is under consideration. Credits would be offered, for example, to local contractors which were sub-contracting on a major IFI financed infrastructure project. Donor grant funding would help to leverage the facility through risk-sharing, as discussed in section 3.1. Donor co-finance of €20 million is required of which €5 million is needed on a “quick start” basis. An additional € 2 million is needed for technical assistance to build additional credit skills specific to the construction business in local partner ban k s.

2. Procurement

The procurement opportunities generated by the Stability Pact provide a wonderful opportunity for the local manufacturing, construction and consulting industries in South East Europe to develop their respective capacities. There are, however, a number of serious potential barriers:

• Differences in the applicable IFI procurement rules and approaches.

• Uncertainty whether use of local procurement procedures would be acceptable.

• Difficulty in getting all IFIs to agree on sensible contracting strategies and tender packaging.

• Lack of access to working capital, acceptable tender and performance securities.

• Lack of information in local markets about procurement opportunities arising from the SEE initiative and IFI procurement rules.

• Ignorance by international firms about local supplier and contractor capacity for joint venture or sub-contract purposes.

To address these problems, the actions taken by the IFIs will need to be coordinated. The most effective way to achieve this would be to contract an individual experienced in IFI projects and procurement to play the role of coordinator and facilitator. This individual would initially liase with all of the participating IFIs on questions of programme definition, contracting strategy, applicable procurement rules and packaging, etc. and then during implementation act as overall trouble-shooter. Detailed Terms of Reference will be developed by EBRD, but the cost of such an assignment should not be more than €500,000 over two years.

Lack of information about the procurement opportunities to be generated by the Initiative and about the procurement rules that will apply is also a serious problem. To address this, it is proposed to set up a SEEI information database which would combine information about the status of the programme, links to the various IFI databases publishing tendering opportunities and their applicable rules (in the local languages), as well as information about local firms (which foreign and local firms interested in finding potential subcontractors could use) among other things. A detailed definition of the scope of this database needs to be prepared, but it would be most cost effective to utilise an existing system developed under USAID auspices which already contains valuable information about the local contracting industries in South East Europe. The expansion required to this database should not cost more than €250,000.

4. Bank Restructuring

A sound financial infrastructure consisting of sound banks operating in a competitive environment strongly benefits local private enterprise. Local businesses most often site inefficient banks and expensive banking services as one of their key constraints to growth. It continues to be an urgent priority of the IFIs to assist individual large state-owned (or partially privatised) commercial banks to become efficient institutions in preparation for full privatisation. Donor assistance for technical assistance is required to help:

• train bankers in new skills,

• establish sound balance sheets through financial restructuring,

• introduce new products (such as mortgage lending), and

• ultimately attract new capital (through new investment or mergers)

The needs is particularly strong in respect of large state-owned savings banks which in most countries of the region have been the slowest to adapt to modern market conditions. A total amount of € 7 million is needed divided as follows:

• Romania: € 4 million

• Bulgaria: € 1 million

• Albania: € 0.5 million

• Croatia: € 0.5 million

• FYR Macedonia € 1 million

A well capitalised and competitive banking environment is of clear benefit to SMEs. This is particularly true of former savings banks which in most cases have been slow to adopt market reforms. Savings Banks have extensive branch networks and retain customer loyalty among smaller clients, making them ideal intermediaries for SMEs. The Bank restructuring programme will focus on the region’s savings banks.

4. Credit Guarantee Pilot

Even the better quality local banks in the region find it difficult to expand lending to SMEs given the lack collateral available from the client combined with limited and poor quality information. In limited and focused circumstances a credit guarantee programme is being introduced. A portion of the local bank’s exposure is covered by an outside guarantee which provides the additional collateral that would make a loan possible under strict credit criteria. On a pilot basis, funds are sought from donors to provide the cash collateral which would underpin the guarantee provided by EBRD on the repayment of the SME borrower to a local bank. Alternatively the guarantees could be administered by the local institution established with WB support under their Trade Credit Guarantee Facility (see Section 3.2.3). The project is initially being established in Albania where local banks have been reluctant to begin making loans to SMEs. A modest, focused, and carefully structured credit enhancement would encourage the selected bank to develop an SME lending programme and would provide a demonstration effect to the market as a whole that SME lending can be profitable for financial intermediaries . An initial amount of € 3 million is required for grant co-financing on a “quick start” basis along with €1 million for training in specific skills required for SME lending.

5. Existing Commitments for Quick Start Implementation

Existing commitments have been made by donors to programmes which are currently under implementation. Because they are designed to have an important impact on the development of SMEs and private sector activity in the region, they constitute potential “quick start” initiatives. They do not require additional funding but should be noted in the context of the overall response to the Stability Pact.

5.1EBRD/EU SME Finance Facility

The EU-EBRD SME Finance Facility for the Accession countries was established in 1999. EBRD has committed € 50 million in financing for the Loan Window and € 25 million for the Equity Window, while Phare has made available a Special Fund of € 50 million in assistance to support the programme. Technical Cooperation (TC) for the Loan Window resources are used to train local banks in lending to small businesses, while a performance fee is provided to encourage them to enter a business perceived as costly and high risk. The Loan Window of the programme is rapidly expanding, with commitments to date of € 35 million, with banks particularly welcoming the training component. EBRD would like to encourage donors to support a similar programme to provide training for banks in South-East European countries other than Bulgaria and Romania. Such assistance has a long-term institution building benefit for the banking sector, and provides SMEs with much needed financing.

5.2EBRD/US Trust Fund for SMEs

The United States Trust Fund for South Eastern Europe and Early Transition Countries ⁵ consists of USD 50 million of which USD 34 million will be used to support EBRD’s lending and investment programmes for SMEs and micro enterprises. USD 16 million will be used for Technical Cooperation (TC) to implement the credit programmes and to work on investment climate issues and the elimination of barriers to the growth of SMEs. EBRD has agreed to complement these resources with USD 80 million over a four-year period. The US expects to formally approve USD 15 million in 2000 for the SEE region and between USD 10 and 15 million in 2001. Therefore a total of between USD 25 million and USD 35 million out of the USD 50 million trust fund will benefit countries in the region. In addition the Bank will conduct a policy dialogue with the authorities in each country to encourage policy and regulatory changes (especially in competition policies) required to improve the operating environment for SMEs and Micro-enterprises.

Total

Annex 1

The EBRD’s Trade Facilitation Programme

1.0Rationale

Trading companies in transition countries, just like their counterparts in less developed countries, have a competitive disadvantage against firms in the West because of a lack of specialised financial services. This is true both for exporters and to a lesser extent importers, who often can rely on specialised export finance, provided by the country they import from. One of the major problems that has been identified by a recent UNCTAD survey is the commercial bank’s lack of capital resources to back their L/C’s adequately. In such a situation, third party guarantees, such as a credit insurance or a L/C confirmation from a well capitalised bank are required to support a financing transaction. The same survey also establishes that international banks, which in the past financed traditional exports, show little interest in granting pre-shipment credits to developing countries. In addition there is usually a lack of insurance schemes, specifically for political risk, that are readily available to western companies. Furthermore, the institutional and financial capacity shortage has a particular impact on small and medium sized exporters of non-traditional goods. These exporters only have access, for the most part, to informal local credit sources and are usually liquidity constrained. The absence of comprehensive trade- financing schemes affects intra regional trade even worse than trade with the developed world and should therefore be addressed on a regional rather than a national basis.

All the Balkan countries are affected by similar problems to the ones found in the UNCTAD survey. Trade flows between some of the countries have been traditionally very large but have been negatively affected by the recent Balkan crises. Indeed, the large traditional trade flows between the former Yugoslav Republics put a particular urgency on providing specialised regional trade finance services. The need for these facilities will increase as these countries develop their own national banking systems and independent regulatory bodies.

There are common shortages in all the countries, that need to be addressed. The banking sectors are still very inefficient and high credit risks and liquidity risks in lending to companies are a major issue. The difference between lending and deposit rates is usually higher than 10% in all the countries and reflects the shortages in monitoring capabilities.

Lending is restricted further by the bank’s low capital base and their bad loan portfolios. The vulnerability of the banking systems is well demonstrated by recent experiences. Albania’s and Bosnia’s banking systems basically collapsed and need to be rebuilt from scratch. Romania and Bulgaria both experienced recent banking crises. As a consequence the banks in the Balkans are very vulnerable which undermines their ability to issue L/C’s, that would be honoured by trading partners without a guarantee form a third party.

Most of the countries in the region now have networks of foreign owned banks which in principle could offer specialised trade finance. Nevertheless, the reality is that these banks provide services only for multinationals and a handful of large local companies. Anecdotal evidence suggests that foreign banks’ high transaction costs limit their interest to deals over US$ 5 million, when dealing with local companies that do not have a proven credit record. This is beyond the reach of the SME sectors in the Balkans.

Most of the countries also have institutions for specialised trade finance, which confirm L/C’s but they are highly undercapitalised and unless they have a sovereign guarantee, the value of the guarantee is limited.

Consequently lending to these banks or extending guarantees to them involves major risk taking but also has potentially a high impact on the development of the banking sector. Trade finance guarantees are a good way to get the local banks involved in the real sector. These credits guarantees leave the credit risk with the local banks, giving them incentives to improve their monitoring skills, but they mitigate the liquidity risk.

Thus although there is an urgent need for specialised export finance, the EBRD is currently the only institution providing the service of guaranteeing L/C’s and is likely to be so for the foreseeable future.

The EBRD is in a strong position to provide this service not only because of its proven experience in trade finance in the region but also because of synergies with its other activities. The bank has strong links with both with the SME sector and with the banking sector through SME credit lines and equity stakes in many of the banks in the region.

2.0 The EBRD’s experience with specialised trade finance

The EBRD launched its new Trade Facilitation Programme (TFP) in July 1999, covering all 26 countries of operation and especially SEE. The aims of the Programme are to foster trade, both intra and inter-regional, provide liquidity to the system, assist participating banks create track records with western banks and strengthen their trade finance capabilities.

Under the Programme, EBRD extends guarantees to (usually western) Confirming Banks, taking the risk of participating banks in the region (Issuing Banks) to cover trade transactions. Eligible instruments under trade transactions include Letters of Credit, advance payment bonds, bills of exchange, guarantees, stand-by L/Cs and other instruments. While EBRD provides incentives to western banks to participate in the risk of the transactions, EBRD guarantees up to 100 per cent of the face value of the underlying finance. The procedures to issue EBRD guarantees are highly efficient. Most guarantees are approved and issued during the same day. Limits approved for participating Issuing Banks are uncommitted which reduces costs to the participants, as they do not have to pay commitment fees.

To date, 8 Issuing Banks in four of the six SEE countries have been accepted into the Programme with total limits exceeding EUR 23 million. It is planned that by end March there will be 13 Issuing Banks and by year-end 2000, 18 or 20 banks with total limits of EUR 40 million. It is believed that with the support of grant funding, this amount can be increased to 35 banks with limits of nearly EUR 100 million.

Over 70 Confirming Banks have joined the Programme. Most are western banks, but an increasing number are banks in the countries of operation which facilitates intra-regional trade because EBRD can provide guarantees to these banks while taking the risk of other banks in the region. The Bank circulates information about the Programme to all participants on a regular basis and also publishes it on the web-site which acts as a strong advertising and business development tool for member banks.

Between July and end 1999, 28 Guarantees were issued for a total of EUR 7 million for three participating banks in FYR Macedonia. No guarantees for other SEE countries were issued last year because banks in these countries were only recently, or are only now being approved for participation. EBRD operates on a commercial basis and sound banking principles. It therefore takes time and resources to complete due diligence of prospective banks, and the number of candidates and limits are restricted to conservative levels. However the success of the Banks programme in FYR Macedonia demonstrates the strong need for the facility, its efficient operation and that it can be rolled out quickly to other countries and participants.

In December last year the Bank signed an agreement with the Swiss Government to provide grant funds amounting to Swiss Francs 5 million to TFP. The money will be maintained in a Guarantee Fund at the Bank to support the Trade Facilitation portfolio in Albania, Bosnia and FYR Macedonia. The Fund will cover 50% of losses in the portfolio to a total of CHF 5 million. The funds are fungible and will support a portfolio that is expected to grow significantly in excess of the amount of the Fund. In addition, assuming only minimal losses are encountered, the contribution can be returned to the Swiss government after a defined period or used for other purposes. This type of support fund can be used as a prototype for additional grant funds The EBRD would share both the risks and the premia on the basis of the proportion of grant and EBRD finance contributed. As in the case of the Swiss fund, the donor money could be returned eventually or used for other purposes. A further possibility to be explored in the future is to use the donor funds eventually to capitalise regional export credit agencies.

3. Expansion of Additional Instruments

Additionally, we propose to use the grant funds to expand the TFP by including additional instruments eligible for EBRD guarantees and extend the tenors in the following ways. The EBRD’s Board approval will be requested at end of the first quarter. The increased risk of facilitating these changes would be again shared between the EBRD and the grant funds.

The new instruments and changes are proposed on the basis of past demand could not be served because of the limitations of the existing programme. We suggest broadening the scope of the facility in the following ways:

• Capital equipment finance, leasing and other transactions with longer tenors i.e. transactions with tenors that do not necessarily have to match the underlying “trade cycle”.

• Bid and Performance Bonds

• Other contract or construction guarantees, whether cross border or local.

• Project specific working capital finance – especially for construction purposes.

• Ship building guarantees ( a particularly important issue in Croatia)

4.0 Grant Funding Requirements

Grant funds of approximately EUR 20 million are required. Risks and premia would be shared on the basis of the preparation of grant funds to EBRD funds The transactions that could be covered under the scheme would still only account for a fraction of less than 1% of total exports and less than half a percent of total trade in the region.

In addition to the grant co-finance, it is proposed to request Technical Assistance funding to assist banks develop their credit analysis and marketing skills, to facilitate risk taking under trade finance activities. An amount of EUR 1 million is envisaged, principally for Albania, Bosnia and FYR Macedonia

Annex 2

Proposed South Eastern Europe Trade Insurance Project

A pre-requisite to bringing stability back to this region is re-building these economic ties as well as creating new ties with countries outside the region.

Perception of high political and commercial risk in South Eastern Europe is a significant impediment to private sector-led growth and foreign trade and investment. This perception results in high financing costs or lack of commercial financing for private sector transactions. The recent impact of the Kosovo crisis on FYR Macedonia is a case in point.

In order to achieve the objective of increased trade flows, the project would aim to:

• Crystallize the countries’ commitment to regional cooperation in the area of trade and investment;

• Back-up countries’ political and economic reforms with guarantees and insurance policies against political risks;

• Improve access to political and commercial risk insurance and export credit insurance for trade transactions;

• Leverage the project’s capacity in partnership with private risk insurers; and

• Develop comprehensive cover with export credit agencies/insurers.

Three main project components are proposed to accomplish these goals by addressing political and commercial risks and the barriers they create for trade. They would include:

I.Leveraged Political Risk Insurance Facility for Imports

II.Trade Credit Insurance Facility for Imports

III.Export Support Facility

I.Leveraged Political Risk Insurance Facility for Imports

A.Introduction

1. Companies and banks financing trade transactions in South Eastern Europe charge a high premium due in part to the perception of high political risk. Many companies and banks will not provide financing at all. They may require cash payment or confirmed letters of credit which have to be cash-secured before confirmation. These terms reduce the competitiveness of the region as companies pay a higher price for input and capital goods as a result of political risk. In addition, Stability Pact Countries are given high risk ratings by ECAs and private insurers. Political risk coverage is restricted in terms of amounts and maturities, and ECAs often consider applications on a case by case basis.

2. To address the barriers that political risk creates for increasing trade volumes, the proposed leveraged political risk facility would provide automatic cover to all private sector short and medium-term trade transactions leading to productive activity in the importing country (i.e. it would not cover the import of consumer goods for resale) unless the facility is suspended for defined reasons that would take account of deteriorating conditions or a breach by the Government or implementing agency of the terms of their agreements. This facility would not cover equity investments as the Multilateral Investment Guarantee Agency provides this service.

B.Description of the Facility

3. A leveraged political risk insurance facility has already been developed in Bosnia and Herzegovina (BiH) under the World Bank financed Emergency Industrial Restart Project. A similar approach is being adopted for facilities under preparation in Kazakhstan and Russia and a regional facility under preparation in Southern and Eastern Africa involving potentially nine countries.

4. The proposed facility would operate in the following manner:

4.1. Donor and World Bank funds would be earmarked for each country participating in the facility. ⁶ The amount allocated to each country would be based on expected demand, based on the results of a demand survey. ⁷ These funds would be placed in a trust account to back-up insurance policies and could only be used to pay valid claims.

4.2. The types of trade transactions that could be covered include:

• Sale of goods, usually on credit terms

• Financial lease

• Operational lease

• Import of capital equipment for use by the insured in carrying on its business

• Import of goods to stock for sale

• Import of goods for processing and export

• Loans and prepayments by foreign lenders to local enterprises

• Obligations of confirming banks in respect of documentary credits issued by local banks

4.3. The types of risks that the facility could cover include:

• Government Performance Risks, such as imposition of exchange controls, expropriation, arbitrary cancellation of licenses, retroactive or arbitrary increases in import and export taxes

• Inconvertibility or Inability to Transfer

• War and Civil Disturbance

• Other risks specific to the country (e.g. in BiH, the risk of a United Nations embargo is covered)

4.4 An insurance broker would be selected to assist in the negotiation of the terms of the facility, including the leveraging mechanism, with a syndicate of private risk insurers and in the administration of the facility. This Facility Broker would be specialised in Political Risk and Trade Credit Insurance and would be selected using a transparent tender process.

4.5. It is likely that the outcome would resemble the structure that was recently negotiated for the facility in BiH. In this case, the private risk insurers would issue policies in their name and would have access to the funds placed on trust to pay valid claims. A claim in Country X could only be paid using the funds earmarked for that particular country. The agreement would include a maximum leverage ratio, say 3 to 1, which would mean that the private insurers would be bound to issue policies for up to three times the amount of funds placed on trust. ⁸ If donor funds were to be exhausted, private insurers would be liable for claims from their own funds. This structure is similar to a mechanism known as excess of loss in the private market. ⁹