Doc. 10950
8 June 2006

The contribution of the European Bank for Reconstruction and Development to economic development in central and eastern Europe

Report
Committee on Economic Affairs and Development
Rapporteur: Mr Bernard Schreiner, France, Group of the European People’s Party

Summary

Over the fifteen years of its existence, the European Bank for Reconstruction and Development (BERD) has earned the reputation of a highly successful international financial institution which has grown considerably in financing capacity and ranks as the largest institutional investor in its 27 countries of operations from central Europe to central Asia.

2005 was an exceptionally prolific and profitable year for the EBRD, reflecting the quality growth in the Bank’s activities, prudent risk management and strong economic performance of its client countries and of financial markets. As their reform efforts have produced spectacular results in central European countries that have recently joined the European Union (EU), the EBRD will, as from now, gradually phase out its funding there in favour of more needy countries to the east and south of the EU.

The report calls for additional donor funding and strengthened co-ordination between the EBRD and the EU in these countries in order to support ongoing reforms and foster investor confidence against a background of high perceived risk. It also points to a huge energy efficiency challenge and a continued need to improve the business environment and enterprise performance in the EBRD client countries in a global race for growth and development.

A.Draft Resolution

1.       The Parliamentary Assembly, acting as parliamentary forum of the European Bank for Reconstruction and Development (EBRD) under the 1992 Agreement of co-operation between the Council of Europe and the EBRD, has reviewed the Bank’s work in 2005 in its 27 ‘countries of operations’ reaching from central Europe to central Asia. While most of the Council of Europe member and observer states are among the key donor and recipient countries, five countries of central Asia, where the EBRD is increasingly active, belong to the Council of Europe’s close neighbourhood.

2.       Fifteen years ago, the Council of Europe and the EBRD joined forces to promote democratic and institutional reforms, the rule of law, human rights and transition to market-oriented economies in states emerging from behind the ‘iron curtain’. The Council of Europe’s monitoring mechanism and the EBRD’s annual transition reports show uneven progress in the political, economic and social domains in the countries under scrutiny. However, the Parliamentary Assembly wishes to pay tribute to the EBRD’s valuable – and growing – contribution to economic integration and growth across the eastern and south-eastern parts of Europe and central Asia, where the Bank remains the largest institutional investor.

3.       The Assembly notes with satisfaction that the Bank’s 2005 results significantly exceeded its operational and financial targets, reflecting the quality growth in the Bank’s activities, prudent risk management and strong economic performance of its countries of operations and that of financial markets. This is all the more important given a welcome trend to invest in a larger number of smaller, often more complicated projects of the private sector and a geographical focus on countries in the south and east of the region, as well as a greater recourse to innovative financial arrangements.

4.       The Assembly welcomes the continued diversification of EBRD operations and strengthening regional presence in the Russian Federation which remains by far the largest EBRD country of operations and the largest recipient of its funding. By acting as a reliable strategic partner at a time of heightened investor uncertainty and a catalyst for business growth, by stimulating improvements in corporate governance and offering leadership to investors, the Bank helps to consolidate this country’s economic foundations and further integration into the world economy.

5.       Owing to inter-ethnic conflicts and widespread social and political upheaval, the last fifteen years have been extraordinarily turbulent for the countries of south-eastern Europe and the Caucasus. Economic reforms and new partnerships in this region have therefore progressed hesitantly. The EBRD’s involvement in reconstruction and enterprise development, whether through direct project financing in the countries concerned or through regional schemes, is crucial for creating new interdependencies, especially in transport, energy and trade, in favour of lasting stability, growth and welfare in the region. The Assembly believes that co-operation between the EBRD and the European Union should be further intensified in these countries in the framework of the EU’s pre-accession instruments, stabilisation and association agreements and the European Neighbourhood Policy.

6.       Half the population of Armenia, Azerbaijan, Georgia, Kyrgyzstan, Moldova, Tajikistan and Uzbekistan, considered as ‘early transition countries’, lives in abject poverty. Economic development in these countries has been hampered by the slow pace of democratic and legal reform, widespread corruption, weak but prevalent state enterprises, poor infrastructure, fragmented domestic markets, lack of employment opportunities and low levels of investment. Reiterating its strong support for the EBRD’s Early Transition Countries (ETC) initiative designed as a multi-donor fund to provide technical assistance for capacity building and preparation of investment projects, the Assembly calls on the Bank’s donor countries to allocate more resources to the ETC initiative so as to enable the EBRD to pursue grass-roots investment opportunities and support reforms in favour of the most needy populations.

7.       2005 was a tumultuous year for Ukraine and, in the EBRD’s view, the country has reached a critical moment in its economic transition. Whereas the recent parliamentary elections demonstrated strengthened multiparty democracy, the new country’s leadership is under pressure to act swiftly in multiple domains. In this context, the Assembly wishes to stress the importance of Ukraine-EBRD co-operation in reforming the energy sector, notably energy efficiency and nuclear safety, improving corporate governance, taxation and regulation, curbing corruption, ensuring transparency of ownership and industrial restructuring. It urges the EBRD to do its utmost to ensure smooth and timely implementation of the Chernobyl Shelter project.

8.       As energy intensity from central Europe to central Asia is three to seven times higher than the EU average and energy costs keep on rising, energy efficiency stands out as a major priority to fight such waste. A key objective for the EBRD and its client countries is therefore the creation of energy systems that meet market economy needs and help increase the competitiveness of all economic sectors. This is closely linked with the Bank’s commitment to the environment in so far as it supports projects designed to improve the quality of energy services while minimising any negative impact on the environment. The Assembly looks forward to the forthcoming publication by the Bank of its revised energy strategy and an expected increase by over 50% in a five-year period of EBRD’s investment in energy efficiency and renewable energy projects.

9.       Agriculture remains vital for many of the EBRD’s client countries through that sector’s contribution to raising incomes and providing sustainable livelihoods in rural areas, where between one and two thirds of the region’s population lives, as well as through its potential for boosting GDP and export growth, employment and import substitution. The EBRD’s rural credit schemes, support for leasing facilities and policy advice are particularly valuable in non-European Union countries. It is therefore important that the EBRD persevere in this field with its key institutional partners, including the World Bank, the UN Food and Agriculture Organisation and the Central European Initiative.

10.       The EBRD’s 2005 study, in partnership with the World Bank, on the business environment and enterprise performance in its countries of operations provides useful insight for policy makers as regards constraints on growth and development. Problems of taxation, access to finance and macroeconomic instability appear as the top three barriers faced by enterprises in both mature and transition economies. The Assembly asks its member states concerned to pay special attention to a policy dialogue with the EBRD on these issues.

B.       Explanatory memorandum by Mr Schreiner, Rapporteur

Table of contents

I.       Introduction

II.       Background and general overview

III.       The Bank’s 2005 transition report and ‘BEEPS’ (Business Environment and Enterprise Performance Survey) survey

i.       Highlights of the report

ii.       Institutional reform and governance

iii.       Macroeconomic conditions

iv.       A local view of business conditions

v.       BEEPS challenges commercial performance assumptions

IV.       A closer look at some specific areas

i.       Agribusiness and rural communities

      a. Examples of partnership in agribusiness

      b. Overcoming the remaining barriers

ii.       Energy-efficiency and ‘clean energy’ projects

a. Examples of major investments

b. Emission trading

c. Raising public awareness on energy conservation

iii.       Cooperation with other institutional investors

      a. The Chernobyl Shelter Fund (CSF)

V.       Prospects for regional integration and development in south-eastern Europe and the Caucasus

i.       Better management of remittance inflows

ii.       The Western Balkans Multi-Donor Fund
iii.       The ‘Early Transition Countries’ Initiative

VI.       The Bank’s work with Russia and Ukraine

i.       Russia: a robust economy but a continuous need to reassure investors

ii.       Ukraine at the crossroads

VII.       Prospects and challenges

I.       Introduction

1.       In October 1989, as the Soviet Union’s power crumbled, the then President of France François Mitterrand, told the European Parliament at Strasbourg: “The most important event for Europe, perhaps for the world, since the Second World War is what is happening in eastern Europe”. He went on to ask: “What can Europe do? So much more! Why not establish a bank?”.

2.       Two years later – and in spite of some criticism that such a bank was not needed since normal banks could do the job on their own – the European Bank for Reconstruction and Development was formally created. With 60 national governments, the European Union and the European Investment Bank as shareholders, the EBRD’s articles of foundation gave it a pioneering mandate: to help foster the growth of market-oriented economies in countries committed to democratic principles, across a region stretching from central Europe to central Asia. Today, it is the largest single investor in its area of operations, with projects in all its 27 ‘countries of operations’¹.

3.       The Council of Europe and its Parliamentary Assembly have consistently supported the EBRD’s objectives and is a long-standing partner in the development of the Bank’s role. Under their Agreement of Co-operation, signed in 1992, an annual report on the Bank’s activities is prepared by the Assembly’s Committee on Economic affairs and Development for subsequent debate by the Assembly. Over the years, these debates have proved a valuable means of bringing together the social, political and economic aspects of the Bank’s work, comparing views and experiences, and offering a forum for the Council’s 46 member state parliaments (and those of observers Canada and Mexico, which are also EBRD members) – among which are many of the key donor and recipient countries – to provide input that can help to guide the Bank’s future direction.

4.The present report is intended to provide an overview of the EBRD’s current projects and priorities, particularly since the Assembly’s last report and debate in June 2005. It addresses several areas of particular topical interest in detail and highlights some of the key questions and challenges confronting the Bank today. It is based on public and media sources, EBRD publications, preliminary conversations with Bank officials and discussions during the meetings of the Assembly’s Committee of Economic Affairs and Development. On behalf of the Committee, the Rapporteur wishes to thank the EBRD for their generous assistance in this undertaking and looks forward to the report’s formal presentation for a debate in the Assembly in June 2006.

II.       Background and general overview

5.       The EBRD’s terms of reference are distinctive in several ways. While its shareholders are widely spread (EU governments predominate, but the USA and Japan also have important stakes), its area of operations is focussed on the countries of central and eastern Europe (CEE), south-eastern Europe (SEE) and the Commonwealth of Independent States (CIS). Although its shareholders are all public bodies, it has a particular focus on investing in projects led by the private sector, generally in concert with other commercial partners. In addition, the Bank has an overt – and unique – requirement that the countries in which it invests must be committed to democracy, the rule of law and human rights; no other development bank operates under a charter that incorporates political aims.

6.       Primarily, the EBRD provides project financing for local banks, industries and businesses, supporting both new ventures and the development of existing companies. In so doing, it explicitly aims to support a country’s transition to market-based economics: to strengthen the local business environment, to mobilise domestic capital, and to act as a catalyst for additional foreign direct investment (FDI). This latter element is crucial to the Bank’s impact for while its own investment portfolio is in the region of € 30 billion, its projects (about 1300) have attracted – through co-financing – additional investment from partners totalling some € 64 billion. Every euro invested by the EBRD mobilises about 2.1 euros from other sources and the Bank’s risk-taking is also shared accordingly with other stakeholders.

7.       Under operational principles adopted in 1999, the EBRD aims in particular to:

- assist in the creation of sound financial sectors that serve the needs of local businesses and individual consumers;

- develop commercial approaches and financial frameworks targeted toward infrastructure development;

- encourage business start-ups and the proliferation of small and medium sized enterprises (SMEs);

- provide leadership in finding effective means for redressing ailing larger enterprises;

- assist in building equity investments;

- promote a sound business climate and stronger public institutions in recipient countries.

8.       It is worth noting that, as these principles imply, some of the Bank’s activity involves publicly-owned companies (the proportion has been declining for some years and is currently around 15%). Public sector investment generally takes place where the priorities are to support restructuring and sector reform, to underpin privatisation and to stimulate the upgrading of local services and infrastructure projects that will, in turn, support private enterprise.

9.       Such investments must satisfy the Bank’s commitment to stimulate competition and entrepreneurship, and be in keeping with its principle of 'additionality' – that is, supporting and complementing the private sector rather than competing with it. Similar principles apply in terms of other international financiers: the EBRD prioritises projects which private lenders are wary of undertaking alone, and generally works in partnership with private institutions; it is careful, too, not to undercut the private sector, by pricing its investments at market rates.

10.       In addition, the Bank is directed by its charter to promote social responsibility, as well as environmentally sound and sustainable development, in the full range of its activities. There are also stringent requirements for commercial integrity and good governance applying to procurement, contracting and management in all projects that the Bank supports, and these are enforced through its rigorous inspection, appraisal and monitoring process.

11.       But despite the ambitious nature of the EBRD’s mandate, it has a primary duty to operate on the basis of sound banking principles. Given the intrinsically high risk of its activities and its regional concentration, the Bank remains exposed to a range of potential downside risks which can significantly affect its performance. This vulnerability was clearly seen during Russia’s financial crisis in the late 1990s; but the Bank has made considerable efforts to mitigate these risks, and the financial community regards its present performance and strong operating base as highly creditable – reflected in high ratings from Moody’s (Aaa) and Standard & Poor’s (AAA).

12.       With a capital base now in excess of € 20 billion (a quarter of which is paid-up capital, and the remainder callable funds), and with reserves of around € 4.7 billion (up from € 1.7 billion – restated – in 2004), the Bank is well on track to meet the financial objectives set out in its Medium Term Strategy. Against this strong background, the 2005 budget has been set with the following objectives:

• Net portfolio growth of € 1.4 billion.

• Underlying annual business volume of € 3.8 billion, with a high transition impact target.

• Net operating asset growth base case of € 0.7 billion with underlying base case disbursements of € 2.7 billion.

• A net income base case of € 230 million.

13.       The Bank’s audited results for 2005, published in March 2006, show an operating profit of € 1.325 billion, and net profit of € 1.526 billion (almost quadruple the figure achieved in 2004). A drastic reduction in bad debt provision has helped in achieving these results, as has increased income from dividends and equity investments, and continued administrative savings. Meanwhile, the Bank committed some € 4.3 billion in financing for 151 projects during 2005 (compared with € 2.7 billion in the year 2000), and its net cumulative business volume rose to € 30.3 billion (see the table below). Overall, the Bank’s 2005 results significantly exceeded its operational and financial targets, reflecting the quality growth in its activities, prudent risk management and strong economic performance of its client countries and of financial markets. This is all the more important given a welcome trend to invest in smaller, more complicated projects and a geographical focus on countries in the south and east of the region. 2006 will mark a planned contraction in business volume to € 3.7 billion – a level which will remain stable and will reach € 3.9 billion in 2010.

Table 1. EBRD’s financial and operational highlights

Source: EBRD; * Rounded figures; ** Restated

• Maintaining a balanced portfolio across corporate, financial and infrastructure sectors.

• Expanding the equity portfolio and enhancing the efficiency and value added in the management of the equity portfolio.

• Assessing transition impact objectives in terms of a project’s expected potential and risk at portfolio level, as well as in relation to expected potential at signing.

• Completing control systems to manage operational and financial risk more effectively, by integrating a formal control framework into the Bank’s existing structure and by implementing an operational risk policy and strategy.

15.       The Bank also plans to integrate the management of its successful TAM/BAS programme more closely within its operations, so as to support overall transition objectives and maximise the effectiveness of its small and medium enterprise (SME) and micro-enterprise financing. TAM/BAS – or Turn-Around Management/Business Advisory Service – is a series of complementary enterprise restructuring programmes, specially designed for use with privatised SMEs.

16.       The current spread of EBRD financing by sector is fairly stable, with around 30% committed to financial institutions (which includes bank equity and lending, small business finance and non-bank financial institutions), while infrastructure accounts for around 20%, as do specialised industries (such as agribusiness, telecommunications, property and tourism), and energy sector projects, where there has been some increase in commitments. General industry projects make up the remainder of the total.

17.       The regional spread of investment, though, is changing substantially. According to the Bank’s Medium Term Strategy, sustaining high activity in the early and intermediate transition countries is the current strategic priority, along with achieving better coverage in the regions of Russia and encouraging the growth of SMEs across the whole area of operations. In 2005, some 58% of investment was directed to early and intermediate transition countries in the Caucasus, central Asia, eastern and south-eastern Europe (up from 47% in 2004 and about 38% during the 1990s). This represents a continued increase in funding priority. Meanwhile Russia, the largest country of operation, remains the largest single recipient of funding, with its share around 26% of the total; the volume of EBRD funding has been stable since 2002 with a slight contraction in 2005. A further 16% was directed toward countries in an advanced state of transition, primarily those in central Europe and the Baltic states, a decline from previous levels of around 40%.

III.       The Bank’s 2005 transition report and ‘BEEPS’ survey

18.       Each year, the EBRD issues an update on the progress made toward economic transition in its area of operation. Its latest report incorporates the 2005 findings of a major survey conducted among 9,500 local companies, the Business Environment and Enterprise Performance Survey (known as BEEPS), which has been regularly updated since 1999, in partnership with the World Bank.

i.       Highlights of the report

19.       Overall, the Bank reports that:

• Central Europe achieved significant progress over the last year, as markets reacted vigorously to previously-enacted reforms. Amongst the Commonwealth of Independent States (CIS), some countries have benefited from domestic political developments, and have new opportunities for building sustainable growth. But elsewhere, particularly amongst early transition countries and in south-eastern Europe, serious impediments remain.

• Across the transition countries as a whole, economic growth has slowed – reflecting the world economy – although it still reached an average 5.6% during 2005. Sustained expansion of the financial sector is boosting demand but also increasing potential risks.

• Foreign direct investment has broadly recovered from its slowdown in 2003, to reach record levels.

• According to the findings of the BEEPS survey, there are fewer business constraints on companies across central and eastern Europe and the former Soviet bloc than at any time since the start of the transition process. In fact, the business environment has generally improved across the whole region, but business obstacles are still much more severe than in mature market economies. The most dynamic operations, such as foreign-owned firms and new private companies, are naturally most affected by this.

ii.       Institutional reform and governance

20.       Much of the progress made recently has been in improving market-supporting institutions. The countries of central Europe and the Baltic states (CEB) have led the way, introducing a host of structural and institutional reforms in recent years, and this has had a dramatic effect, with growth accelerating. In south-eastern Europe (SEE) there was relatively slow progress among the candidate countries for EU accession, although Serbia and Montenegro introduced a number of useful measures and was seen by the Bank as the best performer in terms of reform.

21.       In the Caucasus and the western CIS, there was a much-needed quickening of pace by new or re-elected leaders who have affirmed their commitment to democracy and market development. There was particular progress in trade and foreign exchange liberalisation, and banking-sector reform. Russia proceeded in some aspects of promised reforms, but also undermined confidence in the privatisation process by regaining state control over sizeable assets in the energy sector. The Bank views Russia as the least successful country in terms of such reforms, over the period.

22.       Reforms in governance and enterprise restructuring were stronger than they have been in previous years. The data collected by BEEPS confirms that there is a steady improvement in economic governance overall but that in many countries there are still significant issues needing attention. CEB countries are well ahead of SEE and the CIS in terms of economic governance; indeed, they are now moving towards levels attained by other EU countries. The most significant business obstacles in CEB include labour regulations and corruption, especially in the awarding of government contracts. Most SEE and CIS countries have experienced improvements in economic governance, but are still constrained by regulatory barriers and widespread corruption.

iii.       Macroeconomic conditions

23.       In the face of a slowdown in global growth, the transition countries have maintained a strong macroeconomic performance, with growth at 5.6% for 2005 and 5.3% expected for 2006, while medium term growth is forecast in the range of 4-5% per year. However, in many countries the management of large government deficits and/or trade imbalances presents a serious challenge.

• In CEB growth averaged 4.6% in 2005 (5.2% in 2004), although the Czech Republic, Hungary and Poland are still struggling to bring their government deficits into line with EU requirements, and several CEB countries continue to run large current account deficits.

• Growth of 4.5% was recorded in SEE in 2005 (6.5% in 2004). Most SEE countries have managed to reduce their public sector deficits, and inflation is kept on a downward trend. Nevertheless, the growth of external trade deficits is proving difficult to manage.

• The CIS grew by 6.6% in 2005 (8% in 2004), supported by continuing high oil prices. Some countries are now suffering from capacity constraints, however, and domestic investment levels are inadequate. At the same time, inflation and fiscal spending are increasing in some of the bigger CIS countries.

24.       Strong domestic demand, which has underpinned growth across the transition region, has been fuelled by a rapid expansion in domestic credit to the private sector, including to households. Credit growth primarily reflects a deepening of financial systems, which is itself a sign of increasing income levels and institutional development. Financial reforms have strengthened confidence in banking systems, intensifying competition. However, the dangers posed by rapid credit growth coupled with weaknesses in individual banks or financial systems as a whole call for effective banking supervision.

iv.       A local view of business conditions

25.       The BEEPS survey makes an in-depth measurement of the business environment, using a basket of issues, such as labour, regulation, taxation, institutions, infrastructure, access to finance, and macro instability. The results reveal clear differences in the way that business obstacles are perceived by firms across the transition region. This can partly be explained by variations in the business environment between countries: for instance, it is notable that companies in the CIS have more difficulty in obtaining credit and have to pay much more for it. And while companies in most countries report having to spend less time than previously dealing with public officials, there are notable exceptions (Armenia, Azerbaijan and “the former Yugoslav Republic of Macedonia”). There are also differences in the way that particular types of firms are affected by certain business constraints – for example, while bribery is generally less of a problem than in the past, it seems that new private firms still have to pay much more than earlier privatised companies. The identification of these differences allows policy-makers to focus on the constraints that are particularly limiting the firms with the strongest potential for growth.

26.       According to the survey, there has been a general improvement in the business environment, with only the issue of labour regarded by most respondents as having worsened. But companies still face significantly more difficulties than those in mature market economies, as a benchmark survey conducted in mature economies makes clear; although it is perhaps reassuring that companies in mature and transition countries nowadays agree on the top three barriers they face – taxation, access to finance, and macroeconomic instability.

27.       Nevertheless, the scale of the obstacles in transition countries suggests that business regulation, poor-quality institutions, weak property rights and an unstable macroeconomic environment will continue to hamper businesses for some time to come. Analysis of the BEEPS data suggests that the firms most constrained by the current environment are those that would be most likely to generate growth and new jobs – private firms, exporting companies, profitable firms that re-invest profits, and micro and small firms. Access to finance is most difficult for smaller firms and enterprises located outside major cities – a finding that supports the need for financing programmes aimed at these firms. Foreign-owned firms tend to access finance more easily, suggesting that policies encouraging foreign direct investment will tend to boost overall growth in the short term.

v.       BEEPS challenges commercial performance assumptions

28.       The BEEPS results also highlight the factors that support the growth and productivity of enterprises in transition countries. The survey shows that the impact of firm ownership on performance is not as clear-cut as is often thought. Foreign-owned firms have generally had higher levels of efficiency. However, this appears to result primarily from their having acquired local firms that were better-performing in the first place, or established brand new operations, for which they could more easily obtain investment finance. While foreign-owned firms continue to be more efficient than domestic firms, their competitive advantage is not increasing.

29.       Interestingly, the performance of domestically owned firms does not vary much between different types of firms as market forces and budget constraints have tended to even out any variations in performance. All the same, firms that started in private ownership have tended to be more efficient than privatised firms. Competition has had a positive impact on how quickly a firm improves its performance but less so on the overall level of efficiency. Although shortcomings in the business environment have hindered enterprise growth, they have not influenced as strongly as might have been expected a firm’s overall level of efficiency or how quickly it changes.

IV.       A closer look at some specific areas

i.       Agribusiness and rural communities

30.       Agriculture is a vital sector for many of the EBRD’s client countries, and the introduction of modern and more commercial practices is therefore a priority. Having suffered in the political upheavals of the early 1990s, the agricultural sector in former communist countries has rebounded, and was the main force in impressive growth for many countries of the region during 2004: 12% in Ukraine, for example, and 7% in Serbia and Montenegro.

31.       Across the region, the advantages of plentiful land and fertile soils are still counterbalanced by insufficient processing and transport infrastructure, restrictive tariffs, high levels of indebtedness and regulation, and poor organisation. But increasingly, agricultural production offers countries the chance of rapid export growth (in 2004, for the first time, Ukraine and Russia became net exporters of grain) as well as import substitution. The sector is crucial for raising incomes in rural areas, where between one third and two thirds of the region’s population typically lives; but success now depends less upon increasing production, than adapting it to meet the rapidly-changing lifestyles in towns and cities. And so, with over € 4 billion invested in more than 250 projects, the Bank has become the region’s largest agribusiness investor.

32.       In this sector, the Bank aims to promote the development of industry throughout the food chain (achieved by traditional corporate finance), to provide tailor-made investment products (involving structured agribusiness financing), and to improve the investment environment for the sector overall, via partnership and policy dialogue. In line with policy objectives set in 1993, the Bank concentrates its resources ‘downstream’ of agricultural production: it focuses on food processing, packaging, marketing, retail and distribution. Accordingly, some 40% of the Bank’s support is directed towards commodities and local banking operations, 15% to distribution and retail activities, and 20% to brewing, malting and beverages.

33.       Given the high levels of risk associated with direct financing to primary agriculture, the Bank’s approach has been a cost-effective means of supporting a country’s entire agricultural sector, since it provides farmers with a modern and reliable cash market for their produce, as well as working capital and the opportunity for technology transfer. In addition, the Bank has developed schemes aimed at providing seasonal working capital directly to farmers when needed, which have proved highly successful; as a result, further new financing initiatives geared to primary producers and processors are being tested.

34.       Agribusiness investments are widely spread, with almost 30% directed toward Russia, 20% to the Balkans, 19% to the countries of central Europe and 11% to the Baltic nations, Ukraine and Belarus. There is great variety in the types of projects covered, not only between advanced and early or intermediate transition countries, but also within the countries themselves. Individual solutions, and a careful choice of partners, are required.

35.       With increasing demand for better food and wider choice in a market of 400 million people, the Bank sees no shortage of investment opportunities. Economic growth is driving up disposable incomes and changing consumer behaviour: for example, supermarkets account for just 5-10% of today’s food sales in Russia, compared to 40% in the Czech Republic (and 80% in the United States). But Russia’s supermarket revenues are growing by 30% per year, and in 2004, this was the world’s number one destination for foreign direct investment in the retail sector.

a. Examples of partnership in agribusiness

36.       While direct support to primary agriculture is selective, and depends on the application of sound banking principles, there is an emphasis on supporting the emergence of successful local agribusiness companies. This includes developing a range of local products, particularly rural credit schemes that promote lending to agribusiness SMEs through local intermediaries, warehouse receipt programmes, and machinery-leasing facilities. These initiatives involve credit and risk-sharing arrangements, and in some cases, technical assistance to local banks and institutions.

37.       A good example of this kind of scheme is in Kazakhstan, where the agriculture sector has declined from 35% of the country’s economy to 10% over the last decade. Since 2002, Kazakh farmers have been able to secure finance against warehouse receipts, so as to buy seed, fertiliser and fuel for machinery. This has particular benefits for small farmers, allowing them to plan their planting cycle more effectively, and helping to make year-round exporting possible, which in turn brings more money into the economy and finances new machinery to produce higher yields. The EBRD has structured a financing scheme with local partner banks, particularly Kazkommertsbank and Bank TuranAlem, involving some € 60 million.

38.       In other sectors, the EBRD looks for partnership opportunities that will demonstrate the viability of investing in the region, so as to attract further capital in the future – and this leadership role is especially important in agriculture, given the relative lack of enterprise and employment that still afflicts many rural areas. For example, the Bank works with international agribusiness companies such as Migros, Ulker Group of Turkey, and US-based Cargill, to provide a range of financial products for commodity producers, processors and traders. Under these schemes, commodities held in warehouses act as credit security.

39.       With assistance from the Bank, foreign investment is now building business for local agricultural suppliers. Danone, for instance, replaced its imported yoghurt with local production (and found that the reduced price sent demand soaring). France’s President Group has also taken advantage of low-cost dairy production, and now makes cheese in Poland. In Russia and Kazakhstan, the Anadolu Efes Group is buying local malt to make beer for local consumption, while in Ukraine, two Swedish entrepreneurs have created one of Ukraine’s leading consumer brands, Chumak, making sauces. Although established only in 1996, sales already exceed US$ 80 million, with exports booming all across the region, and the Bank announced support for new expansion by the company in December 2005. Meanwhile, Cargill’s recently-opened oilseed plant in the Crimea has boosted the sunflower seed sales of local farmers, and created huge export opportunities.

40.       Along with providing finance, the EBRD is working with the World Bank, the UN Food and Agriculture Organisation (FAO), the Central European Initiative (CEI) and private sector partners to improve business integration in the food sector. In essence, this means bringing production into line with changing consumer demand by improving connections between growers, processors, and the fast-changing retail industry.

41.       Research in eastern Europe by the FAO suggests that better supermarkets drive improvements in the quality of farmers’ produce and their incomes, guaranteeing timely payment and continuity, while improved distribution systems lower prices to consumers and boost demand. It is not only in Russia that supermarket activity is expanding: the Bank is currently backing a host of projects, including the expansion of the Louis Delhaize Group in Hungary and its arrival in Romania and Serbia (using a € 160 million loan arranged by the EBRD and supported by a group of banks led by RZB of Austria), and the expansion of Finland’s Kesko in Estonia and Latvia.

b. Overcoming the remaining barriers

42.       For a host of social and political reasons, the reform process in the primary agriculture sector has been slower than in other sectors of the economy. The need for change is all the more pressing, given that the contribution of agriculture to GDP and employment in the Bank’s countries of operations remains significantly higher than in the developed countries – in some cases, its share has even increased because of the collapse of other economic sectors. The potential for new investment is huge but to follow through on restructuring, transfer technologies, increase competition and develop new markets, the financing needs are equally immense.

43.       Many of the barriers in this sector are structural. All too often, for example, institutional delay in privatising land and the dysfunction of the land registration process have conspired to deprive rural communities of access to capital. As the EBRD has demonstrated, it is possible to use commodities as collateral so that farmers can obtain credit, and countries should look at revising their laws to enable this on a wider scale. More broadly, regulations need to be developed that stipulate and enforce high standards for food quality and hygiene which will encourage consumers to spend more and receive better produce. Similarly, if archaic cross-border rules and tariffs that hinder regional trade were addressed, it would be to the long-term benefit of all.

ii.       Energy-efficiency and ‘clean energy’ projects

44.       The EBRD’s current policy for the energy sector, incorporating energy conversion, transportation, distribution and consumption, was agreed in 2001. A key objective is the creation of energy systems that function according to market principles and help increase the competitiveness of other economic sectors, but this goes hand in hand with the Bank’s commitment to the environment. Projects are sought to improve the efficiency and quality of energy services, hence enhancing environmental performance; this includes a specific recognition of the need to take action on climate change. The Bank has been working on a new energy strategy (to be released in mid-2006) with a view to boosting its financing (by over 50% over a 5-year period) for energy efficiency and renewable energy that are considered a key priority. During its 2006 annual meeting, the EBRD formally launched the Sustainable Energy Initiative that will channel up to € 1.5 billion of its own funds into efficient, renewable and clean energy projects in the next three years. The Bank’s partners could boost this investment further to nearly € 5 billion and provide additional € 100 million in donations.

45.       The Bank has introduced a series of initiatives to measure the environmental impact of the projects and proposals it considers. Environmental Impact Assessments (EIAs) of environmentally sensitive projects are available for public review. In addition, the Bank worked with experts to create an efficient way of estimating greenhouse gas emissions during environmental assessments. It developed its own system suitable for its projects, drawing on the work undertaken by other institutions, government agencies and private sector companies. To promote this message further, the Bank offers Corporate Environmental Awards, recognising companies that have reduced damage to the environment with innovative products, services or systems or by introducing clean technologies or recycling techniques.

46.       In every sphere of its operations, the Bank lays emphasis on energy efficiency. This is crucial, for in all the countries where it operates, energy intensity is well above the EU average – in some cases by a factor of five to seven. Meanwhile, companies and institutions are facing increasing and unsustainable energy costs as formerly subsidised prices increase towards international levels (which have also risen sharply in the last couple of years). Nowhere is this brought home more clearly than in Ukraine, where the Russian gas company Gazprom in early January 2006 halted the gas supply after price negotiations broke down. Ukraine had up to then been buying gas at US$ 50 per 1000 m³ – but Russia demanded a price of US$ 230, which is close to average market rates in western Europe. A compromise was found and gas shipments resumed but Ukraine had to accept a nearly twofold increase in price (US$ 90). The Rapporteur against this background considers the EBRD’s work in the energy sector as being of the utmost importance.

47.       Reforming and modernising the energy sector in Ukraine and other CIS countries poses immense challenges: poor quality operations, large losses during transmission and distribution, as well as high levels of consumer wastage mean that energy use is inefficient at every stage from production to consumption. Non-market mechanisms and subsidy regimes still hamper development, with prices often insufficient to cover operating costs, let alone fund investment, and low levels of cash collection.

48.       In most countries, too, environmental management standards are inadequate, leading to air, water and ground pollution, and to safety concerns. In particular, there remain ageing Soviet-designed nuclear power plants, which the Bank wants to see shut down as soon as possible. The Bank manages six nuclear safety and decommissioning funds, which apply funding from the international community to assist with technology upgrades, plant closures, and the safe treatment and storage of nuclear fuel and radioactive waste; the largest of these funds concerns the Chernobyl site, and an update on its work is included later in this report.

49.       The EBRD has its own Energy Efficiency Team made up of nine project specialists. The role of this team, which is unique amongst international finance institutions, is to seek out suitable projects across the Bank’s field of operations, to provide credit lines for these projects and to create specialised energy efficiency investment mechanisms. One of the most interesting of these is the ESCO, or Energy Service Company, concept; for some years, the Bank has been encouraging the local establishment of ESCOs, which offer modern energy-efficient services to public and private enterprises that pay for the services out of the savings generated. In addition, the team promotes renewable energy projects and seeks opportunities to sell carbon credits from EBRD-funded projects. As part of the Early Transition Countries Initiative, to be examined later in this report, the Bank has created a special Sustainable Energy Programme.

50.       There is also a wide range of technical co-operation programmes with governments and institutions, which provide resources to assist the EBRD in promoting energy efficiency investments. Partners include the governments of Greece and the Netherlands, the Central European Initiative and the Kozloduy International Decommissioning Support Fund (which is involved in the closure of Bulgaria’s Kozloduy nuclear plant, and funds technical assistance for the implementation of other such projects).

a. Examples of major investments

51.       The Bank provides direct finance to projects of a significant scale which save energy, whether located in the public or private sector, and whether concerned with energy generation, distribution or end-use.  In particular, this includes industrial projects in energy-intensive industries, co-generation projects, and new or existing ESCOs (especially those involving social facilities, such as schools and hospitals). For smaller projects, the Bank seeks to develop sustainable finance mechanisms using local banks, and it supports innovative finance vehicles, such as equity funds targeted at the development of renewable energy.

52.       When supporting projects in the energy generation and distribution sectors, the Bank aims to encourage sector reform via a mix of liberalised markets and effective regulation. This process is essential for winning the confidence of the international finance community, and thereby achieving the long-term investment which will improve energy efficiency, but it is at very different stages across the region. It is perhaps not surprising, then, that many of the Bank’s major power projects are in countries, where markets have been liberalised, and rapid improvement is required in order to comply with EU legislation.

53.       During 2005, for instance, projects were announced in Poland and Bulgaria, replacing outdated and inefficient electricity-generating plants. The Bulgarian project is particularly significant, as it is one of the country’s largest foreign investment projects to date. The Bank hopes that a strong “demonstration effect” will be provided by the pioneering operation of a privatised generator in a liberalised market and the environmental benefits of introducing improved technology which will lead to compliance with EU environmental standards.  It will also contribute to the advancement of the current restructuring of the sector, which is a condition in connection with Bulgaria’s planned EU accession by 2008.

54.       Slovalco, based in the Slovak Republic and one of the most efficient aluminium processing plants in the world, is a showcase for innovative EBRD investment in energy-intensive industry. The company was established as a subsidiary of ZSNP, a state-owned aluminium company, and was supported by EBRD financing thus enabling ZSNP to close its original, polluting smelter capacity. As part of this agreement, ZSNP committed part of the proceeds from its share sale to the completion of an Environmental Remediation Programme (ERP), which has helped to restore the local environment. A large storage facility has been built, to international standards, housing hazardous and solid waste, while all process waters are recycled and waste water is no longer discharged from the site. While the company’s smelting capacity has doubled, Slovalco consumes only 10% more energy than the original ZSNP complex. Building on this success, new EBRD investment is expected to expand Slovalco’s production capacity by 34%.

55.       Several large EBRD-led projects have been implemented in Russia, especially since 2001 when the power sector reform accelerated. The Bank helped the financial restructuring of the RAO UES (a major holding company in the Russian power sector that owns and operates the national grid and controls many power stations) prior to privatisation and funded urgent priority investments to improve efficiency of operations. In 2005, it financed the modernisation of TogliattiAzot, Russia’s biggest ammonia producer, and urgent rehabilitation investments through Mosenergo, Russia’s largest vertically integrated utility in charge of producing and supplying the major part of energy and heat in Moscow and the surrounding region. These two projects enabled huge energy savings and the latter was particularly relevant following a large-scale power outage (May 2005) in the Moscow region which revealed the poor operational state of local power substations and the lack of back-up generation capacities around the country’s major hub. It is expected that in 2006 the greater part of Russia’s electricity market will be liberalised in striking contrast with the gas sector where the state holds a monopolistic grip through Gazprom. The EBRD is also planning substantial investment in the development of renewables, especially hydropower and geothermal energy. One such project is now well underway (Mutnovsky power utility in Kamchatka region).

56.       In Ukraine the EBRD has financed Starobeshevo power modernisation project aimed at cutting greenhouse emissions via ‘clean coal’ technology, Odessa high voltage grid upgrades necessary for low-loss-high-reliability power transmission, several district heating improvement schemes and the safety and modernisation programme of the K2/R4 reactors at Khmelnitsky and Rivne nuclear power stations. Jointly with the EU’s TACIS programme it also supported the setting up of UkrESCO, a leading company in promoting energy-efficient technologies. While implementing the Odessa project the Bank has launched a vast co-operation programme with UkrEnergo (national grid operator) on corporate governance, transmission tariff methodology and steps for linking Ukraine’s energy system with the EU’s internal energy market, starting with joining the UCTE (Union for the Coordination of Transmission of Electricity).

b. Emission trading

57.       As mentioned above, the EBRD also seeks to take advantage of the growing trade in emission credits. This improves the financial potential of all sorts of emission-cutting projects, such as energy efficiency, conversion to renewable sources, fuel switching and methane capture. 'Carbon finance' is the term used when CO₂ emission credits are sold in order to help finance greenhouse gas reduction projects. A current example of this is an investment at Bulgaria’s BFS paper mill facility. The plant’s switch from hydrocarbon to biomass is reducing emissions and thereby generating emission credits which are being purchased for the account of the Netherlands government.

58.       The main role of the Bank in the field of carbon finance is to act as financier of emission reduction projects. In line with its principle of additionality, and given its good relations with governments and financial institutions, the Bank is also well positioned to facilitate the purchase of emission credits from emission reduction projects. 

59.       In October 2003, the EBRD established, together with the Dutch Government, its first ‘carbon fund’. The fund buys Joint Implementation Carbon Credits from its 13 countries of operations eligible for this mechanism. The credit vendors benefit from the close coordination that EBRD can provide between their project financing and the carbon buying process. During the annual meeting of its Board of Governors in May 2006, the EBRD launched, jointly with the EIB (European Investment Bank), the 'Multilateral Carbon Credit Fund' which will buy carbon credits generated from energy efficiency investments under the European Union carbon trading scheme and will also aim to facilitate the direct trading of carbon credits between some of its shareholders (so-called Green Investment Schemes). 

60.       With the Bank currently working on an updated Energy Strategy, such initiatives seem destined to take on a more and more important role in their investment policy. The Rapporteur applauds the EBRD for its initiative and endeavour in this field, which he believes will prove to be of utmost importance in creating a sustainable future for Europe.

c. Raising public awareness on energy conservation

61.       Energy inefficiency is so deeply rooted in people’s minds and economic structures of central and eastern Europe that even the most advanced countries of that region use considerably more energy than western European countries do on average, notably in terms of energy intensity (GDP produced per unit of energy use). All EBRD countries of operations need to cut their energy consumption in order to improve competitiveness, security and affordability of supply, as well as to take advantage of the emission trading schemes.

62.        However, very few among them have adopted ambitious and comprehensive energy efficiency policies. While competitive pressures have compelled some entrepreneurs in eastern Europe to tackle energy costs more carefully, much remains to do to foster energy conservation at the household and public levels. Huge economies on energy bills can be realised through better insulation of habitats and public buildings, improved district heating services and simply more rational consumption patterns. There is also a need to increase the share of renewable energy in these countries’ energy mix.

63.       The EBRD’s involvement in residential and municipal energy efficiency programmes – financially and through technical assistance – contributes to the general raising of living standards, the reliability of energy services, more effective collection of user-fees and the disinflation of energy bills, thus also reducing the environmental impact of growth and stimulating investment in the diversification of energy supplies. Through energy policy dialogue with governments in client countries the Bank is working further to assist with the fixing of sustainable growth strategies, including awareness raising and participation of both private and public sectors, so that energy efficiency and renewable energy be considered as a high priority.

iii.       Co-operation with other institutional investors

64.       Various commercial banks, export credit agencies international financial bodies and institutional investors are EBRD’s key co-financing partners. Co-operation with other institutional investors in Europe remains crucial for the achievement of the EBRD’s objectives. Working in synergy with the EU is particularly important. Over the 1992-2004 period the EU support to EBRD projects has totalled about € 2.8 billion, including € 500 million for technical assistance, € 900 million for nuclear safety and € 1.4 billion for investment co-financing (notably to municipality projects in the framework of the EU pre-accession strategy).

65.       One of the past year’s major initiatives in this field has been the launch of JASPERS, or Joint Assistance for Preparing Projects in European Regions, in partnership with the European Commission and the European Investment Bank (EIB). While the European Union is ready to offer assistance in the 8 new EU member states and the candidate countries (Bulgaria, Romania and Croatia) from its Structural and Cohesion Funds, recent experience has shown that the successful absorption of this funding is a challenge. The JASPERS initiative is intended to help in the preparation of high-quality proposals which are eligible for EU support, and which have the necessary administrative capacities in place to make the proposal successful.

66.       This programme, which is complementary to the preparation work undertaken by local and national authorities, is to be run by a team of experts from the European Commission, the EIB and the EBRD. For maximum effectiveness, JASPERS will focus on certain specific sectors of investment, such as transport infrastructure and municipal/environmental projects, and most of its operations will be based in central and eastern Europe, so as to be more accessible to potential recipient countries. The EBRD will pay special attention to the preparation of public-private partnership projects, regional and municipal investment schemes, as well as energy efficiency and renewable energy projects. While applicants may also seek funding from the EIB or the EBRD, there will be no obligation to do this.

67.       The launch of JASPERS has been particularly championed by the EU’s commissioner for regional policy, and it is hoped that the initiative will enable the European Commission to streamline project evaluation and accelerate its approval process. Additionally, the EBRD plans to cooperate with the European Commission and the European Investment Fund (EIF) in the implementation of a second policy initiative put forward by the Commission, entitled JEREMIE (Joint European Resources for Micro to Medium Enterprises), which aims to enhance support to SMEs and micro-enterprises.

68.       Moreover, with a specific focus on the SME sector, the Bank participates in the EU/EBRD SME Finance Facility, now in its sixth year of operation, with € 880 million lent to 68 local financial intermediaries who have disbursed some € 1.3 billion to about 57,000 companies, mainly outside capital cities. Bank finance to the private sector, and to SMEs in particular, in central European economies tends to be low, since many SMEs do not have sufficient collateral and cash-flows to meet the banks' risk guidelines. The Facility therefore provides medium and long-term funds to banks and leasing companies with the aim of improving access to finance for the small and medium-sized enterprises (SMEs) in the EU’s new member states and accession countries.

69.       Under the scheme, a ‘Performance Fee’ is also offered to compensate financial institutions for the additional costs involved in financing SMEs and for the risks of entering a new market segment. Technical assistance is also provided to enhance risk management, streamlining operations and for product development related to SME financing. The facility itself is substantial, totalling over €1 billion – and to date, the European Commission has contributed nearly €150 million to support the institution-building element of the project.

70.       Alongside this, the EBRD and EIF have established an SME Guarantee Facility, first launched in 2003. This € 100 million project aims to encourage banks to provide SMEs with access to credit guarantees to enhance their risk-taking capacity. Eligible banks will apply for a guarantee under the European Commission's Multi Annual Programme (MAP) managed by the European Investment Fund. The banks must lend to SMEs which would not qualify for loans under current risk guidelines. The Guarantee Facility is intended to improve medium-term financing, by allowing a larger number of SMEs to access bank finance, and to improve the services provided to SMEs, by allowing banks to offer more favourable terms and conditions, particularly in terms of reduced collateral. The project will enable banks to build their experience in SME finance, and is open to those also participating in the Finance Facility. There is also a special Western Balkans SME Facility approved in 2004 and supported by various donors (including Canada, Italy and EU Agency for Reconstruction).

71.       In the CIS countries, EU co-funding (about € 51.5 million) has been essential for the implementation of EBRD’s projects in microfinance (notably the Russia Small Business Fund (RSBF), the Ukraine Micro Lending Programme (UMLP), the Tajikistan Micro and Small Enterprise Finance Facility (TMSEFF), the Kyrgyz Micro and Small Enterprise Financing Facility (KMSEF), the Japan-Uzbekistan Small Business Programme (J-USBP), and the Kazakh Small Business Programme (KSBP)) and municipal infrastructure support (essentially in early transition countries), while co-operation is rapidly gaining ground on energy efficiency and renewables. Much technical assistance has also been co-financed by the British DFID (Department for International Development), USAID (US Agency for International Development), Japan and the Early Transition Countries multi-donor fund.

72.       The EBRD also cooperates with the Council of Europe Development Bank (CEB). The CEB today has 38 members, and in particular aims to finance social projects with an emphasis on employment and income generation. A framework agreement between CEB and the EBRD was signed in 1999 and given the convergence in the aims of the two institutions, co-financing operations in central and eastern Europe were recently announced. Once again, the focus is upon SMEs and micro-business, as well as municipal and environmental infrastructure, all of which are areas of priority concern for the CEB.

a. The Chernobyl Shelter Fund (CSF)

73.       Managed by the EBRD, this is perhaps the most complex and sensitive of its partnerships. Set up in 1997, at the initiative of the G7 group of countries and the European Union, the CSF aims to finance the ‘Shelter Implementation Plan’ which was developed by western and Ukrainian experts². Under these plans, intended to contain the destroyed Reactor 4 in an environmentally safe state, an arch-shaped enclosure with a height of 100 metres and a span of 250 metres (which weighs 20,000 tons and will be the world’s largest free-standing construction) will be assembled in a safe area near the site and eventually slid across the old sarcophagus as the final step of the plan. It will incorporate equipment for work that will be necessary in the future, such as the deconstruction of unstable parts of the site and the removal of radioactive materials. The stabilisation works on the old sarcophagus which has been showing multiple signs of structural weakness are more than 70% complete and are scheduled for finalisation later this year.

74.       Implementation of the plan has been fraught with difficulty, in part because of the unique nature of the project and the need to agree on technical strategies and to define the scope of the project, and in part because of political concerns and difficulties. In fact, Chernobyl was not fully closed until late in 2000, against a backdrop of international pressure, and Ukraine’s previous government was widely perceived as obstructive in advancing subsequent planning.

75.       These issues have exacerbated the difficulties of budget planning. Initial funding commitments were doubled, to US$ 700 million in 1999. With 28 contributing countries and renewed commitments by the G8, the fund has continued to increase. At a London conference in May 2005, a further € 200 million was contributed, so that the fund is now in excess of € 800 million. With total costs currently estimated at more than US$ 1 billion (about € 800 million), the project can now move toward completion, which is scheduled for 2010/11.

76.       With the election of a new government in Ukraine and clear commitments on the subject from President Yushchenko, there has been renewed optimism about the prospects for this project, though the Bank makes clear that there is an urgent need for resolution of the various detailed licensing, regulatory and legal obstructions that have delayed progress. Speaking at the London conference, the EBRD President, Jean Lemierre, especially welcomed a donation by the new Ukrainian government, underlining that this demonstrated the country’s determination to finalise the project as planned. Also appearing in London, Ukraine’s Minister for Emergency Situations, Davyd Zhvaniya then answered concerns voiced by contributors, and reassured the meeting that all agreements relating to this project, whether involving the shelter’s design, or the application of EBRD procurement rules and procedures, would be honoured. The Rapporteur calls upon the Ukrainian government to ensure that this is the case, and that all possible assistance is provided for the speedy completion of the Chernobyl Shelter Fund project.

V.       Prospects for regional integration and development in south-eastern Europe and the Caucasus

77.       With a series of wars and civil conflicts, and widespread social and political upheaval, the last fifteen years have been extraordinarily turbulent for the countries of south-eastern Europe and the Caucasus, and in many areas that turbulence continues. The Bank is devoting increasing attention to the region, and seeks to build on the many emerging opportunities for growth, as command-style economies are reformed and new relationships are created between countries.

78.       In particular, the Bank is seeking to restore and modernise financial systems, both by improving government finances and supporting local banks. This latter element is especially important in encouraging small-scale enterprise, which in many countries offers the best opportunities for development and growth. EBRD support (€ 1.3 billion by 2005) has been channelled through direct project financing in the countries concerned and through regional schemes, such as Western Balkans SME Facility, the Danube Investment Support Facility and the CARDS programme. Infrastructure projects and a series of bilateral trade agreements are linking up countries and creating new interdependencies, especially in transport, energy and trade. The following initiatives provide a perspective on the region’s key challenges, and how they can be tackled.

i.       Better management of remittance inflows

79.       The World Bank estimates that global remittance transfers – that is, money sent home by migrant workers – now total around US$150 billion a year. Some US$ 14 billion of such funds arrive each year in the EBRD region through the official channels of the financial sector. While it is hard to be sure of the exact figure, it is clear that transfer levels are increasing rapidly, and are now comfortably in excess of the aid funding allocated by developed countries to the developing world. The EBRD estimates that in several countries, such as Albania, Bosnia and Herzegovina, Moldova, Serbia and Montenegro, and Tajikistan, remittances account for no less than 10% of GDP. For over a third of the EBRD’s client countries remittances exceed FDI flows and are steadier than FDI. Hence they are becoming increasingly important for investment financing and small enterprise development in these countries.

80.       In much of central and eastern Europe, where movement was previously controlled or restricted, this concept is fairly new but it is rapidly becoming a significant economic factor. Remittances often exceed 15% of a country’s gross domestic product. In Moldova, for instance, the figure is already 23%, with around US$ 600 million in officially-recorded remittances (more than 600,000 Moldavians are believed to be working abroad) and there are, very likely, high levels of unofficial income, too. With somewhere between 500,000 and a million workers travelling abroad, Uzbekistan receives around US$ 500 million annually; yet this is thought to be only a fraction of the true total, since many workers are undocumented. Uzbek workers are particularly found in Russia and in Kazakhstan, where they join the annual cotton harvest or find jobs in the booming construction and oil sectors, and endure official harassment because neither government acknowledges their legal working status.

81.       It is certain that, across the region, official figures very much understate the level of remittance transfers. This is often for the most legitimate of reasons: emigrants may not trust local banks, for instance, or there may not be banks operating near them, so in many transition countries most remittances enter through informal channels, often in the back pockets of workers travelling home on visits. In Albania, for example, the Central Bank estimates that, until recently, 77% of emigrants used unofficial means to transfer cash, usually bringing it home themselves. This means that significant amounts of money bypass official financial systems, money that could otherwise contribute to building the official economy.

82.       Last year the EBRD hosted a seminar on remittance policy, sponsored by the Swiss government, and attended by banking officials from central and eastern Europe and the Commonwealth of Independent States, in order to share views and experience with senior staff from international financial institutions, the Bank for International Settlements and representatives other regions, such as the USA and the Philippines. The seminar aimed to raise awareness of the growing importance of remittances, to discuss better ways of channelling them, and to build on the various lessons learned by different countries so that these sums are better used.

83.       It is clear that if countries can develop more formal routes for remittances, these can be better integrated into the wider economy; this, however, depends on improved legislation and regulation, thereby improving workers confidence in the safety and predictability of bank transfers. The role of local banks, and the attitude of workers to them, is therefore crucial. In the EBRD’s view, “it is a question of educating people to use local banks and open an account“ and of banks using the opportunity of remittances to offer specifically tailored products. Also, banks must reach out more through extended branches or agencies”.

84.       It is hoped that such initiatives will create a win-win situation for the whole economy, with local banks commercially strengthened, and encouraged to offer new financial products and expand credit availability, while customers will have access to new services (such as interest on savings), loans and mortgages – services they may never have known to exist. Specifically for those sending money, increased competition should see a reduction in the current high fees charged for money transfers, thereby further encouraging the legitimisation of the sector.

85.       The EBRD is now considering opportunities for launching programmes and products to help drive forward these ideas. The Bank could, for example, work directly with local banks to create new remittance-based products while addressing business obstacles, such as high charges and administration costs, which deter people from using them. It could also help banks to set up international transmission networks to benefit senders and receivers of remittances. As this issue shows, the countries of the region have much to gain from building a modern and creative banking system, which has the confidence of consumers.

ii.       The Western Balkans Multi-Donor Fund

86.       Announced in the second half of 2005 and launched in May 2006, the Western Balkans Multi-Donor Fund is a new EBRD-led initiative designed to stimulate private business investment, infrastructure development and regional co-operation in Albania, Bosnia and Herzegovina, “the former Yugoslav Republic of Macedonia” and Serbia and Montenegro, including Kosovo. Supported by Austria, Canada, Finland, Ireland, Luxembourg, the Netherlands, Norway, Slovenia, Spain, Sweden, the United Kingdom and hopefully soon by other countries, the Fund will be endowed with €10 million in donor finance. It is intended to work through local banks and institutions to improve finance opportunities for micro, small and medium-sized enterprises (MSMEs), as well as for housing, rural businesses and improved access to basic services, such as clean water, energy and transport.

87.       The Fund’s objectives are to develop enterprise and ‘grass-roots’ entrepreneurship in the region, while simultaneously aiding post-conflict reconstruction and strengthening the local banking sector; as it develops, further co-financing should enable it to expand both in scale and geographical coverage. With commercial financing being still hard to obtain locally due to perceived high risks, the Bank hopes that this will prove a catalyst for long-term private sector investment.

88.       This Fund in fact builds on another similar EBRD initiative, namely the ‘Early Transition Countries’ initiative described below. It is hoped that fresh donor financing will boost EBRD’s and other investors’ investments in the region. The Bank is currently considering some € 800 million of new investment over the next two years for the countries of the Western Balkans.

iii.       The ‘Early Transition Countries’ Initiative

89.       The poorest countries in which the EBRD operates are Armenia, Azerbaijan, Georgia, the Kyrgyz Republic, Moldova, Tajikistan and Uzbekistan. Formerly part of the Soviet Union, and now members of the Commonwealth of Independent States, they are known as ‘Early Transition Countries’ (ETCs). In all seven cases, their economies have been slower to develop and adopt market-based practices than elsewhere in the region, and around 50% of their populations are currently living below the poverty line.

90.       Amongst the ETCs, development has been hampered by the slow pace of democratic and legal reform, the continuing prevalence of state enterprise and obsolete or non-existent infrastructure, and high levels of national debt. Local circumstances are intrinsically challenging, too, with small domestic markets, harsh climates and terrains, huge point-to-point distances and poor linkages at frontiers. All these factors have contributed to a serious lack of investment, both domestically and from foreign sources.

91.       In early 2004 the Bank launched an initiative specifically designed to stimulate economic activity, with a streamlined approach to financing a greater number of small, market-driven projects, which can help to deliver sustainable employment and prosperity. As well as financing, advisory services are offered to local businesses and banks. In 2005, donor funding for the ETCs reached € 18 million which allowed the EBRD to prepare the ground for 61 projects worth € 250 million (including € 100 million for a road project in Azerbaijan while the rest of the projects were on average the size of € 2.5 million). So far, nearly 100 projects have been financed under the ETC programme.

92.       As part of the initiative, the Bank has developed, or in some cases adjusted, specific financing instruments dedicated to the funding needs of enterprises in this region. It has also decided to finance projects with higher levels of risk than it would normally accept (although without compromising the principles of sound banking). To increase its investment capability and expertise in these countries, the Bank has dedicated more staff to work on ETC projects, creating a project team dedicated to the initiative.

93.       Some Bank structures have proved to be particularly effective in the ETC context, where small-scale enterprises need advice as well as funding. The TAM/BAS initiative has been highly successful, as has the Sustainable Energy Programme, which was specially designed for use in this area. The programme offers an energy audit, so that the correct efficiency solutions can be determined, together with credit to achieve them, via the Clean Development Mechanism Project Support Facility.

94.       Taken together with a strategy of policy dialogue with the governments concerned, and work on institutional reform in key sectors, the ETC Initiative should have an overall impact on a country’s transition to democracy: new business owners will, after all, have an interest in the creation of fair, transparent laws and regulations, in efficient implementation and compliance, and in reducing corruption. This should provide an impetus for general economic and legal reform, raising standards of commercial protection and property rights, and thereby encouraging future foreign investment.

95.       Specific priorities for each of the ETCs are being set out in country strategy documents, and these will take into account national poverty reduction strategies. Naturally, support from international donors is a key element in the Bank’s strategy here, and the ETC Initiative's eventual impact will depend on a successful coordination of efforts. The Rapporteur applauds the Bank’s efforts to give priority to ETC needs, and calls for it to receive maximum support from the international donor community.

VI.       The Bank’s work with Russia and Ukraine

i.       Russia: a robust economy but a continuous need to reassure investors

96.       By far the largest economy in its area of operation, Russia has always been crucial to the EBRD's work. As of end-December 2005, the Bank had more than 228 signed investments in the country, totalling € 7.23 billion (with an additional € 12 billion of investment mobilised for these projects), more than 80% of which were in the private sector. The Bank is a key supporter of the Foreign Investors Advisory Council, maintaining close contact with the government so as to pursue coordinated policy objectives.

97.       The reduction of Russia’s dependence on its natural resource exports, and thereby its vulnerability to external shocks, is a priority. To enable other businesses to grow, the Bank emphasises improved corporate governance standards, and improvement of the country’s legal framework, both of which are needed to improve the investment climate and must involve clarification of the role of the State, and the ‘rules of the game’ for commerce. Alongside this, the Bank has consistently worked to deepen the microeconomic foundations of the economy, to assist with the upgrading of infrastructure, and to increase commercial access to local finance and credit.

98.       The EBRD applauds Russia’s recent robust economic growth, with growth surpassing 7% in 2004, but urges the government to speed up institutional reforms so that this can be maintained. The urgency of reform is increasing as traditional growth sources become exhausted, requiring steady increases in efficiency and productivity. Meanwhile, the partial renationalising of the energy sector and delays in reforming state institutions have begun to have an effect on the transition process. While foreign investment has recently increased, it does so from a very low base: the accumulated stock of FDI amounts to about 6.5% of GDP, about a fifth of the average level of the other European transition economies – and meanwhile, after years of decline, private capital outflows have markedly increased.

99.       The sheer scale of the Bank’s local operations, its good relationship with government and its influence in attracting additional inward investment give it an important role as a champion of change in Russia. By being a reliable strategic partner at a time of increased investor uncertainty, by accepting unusual levels of risk, and offering leadership to investors, the Bank aims to help to build mutual confidence and further Russia’s integration into the world economy.

100.       Infrastructure modernisation is a priority, and St Petersburg’s current projects to combat serious pollution illustrate both the scale of the challenge, and the partnership-based nature of the Bank’s response. Alongside the completion of a new sewage system to protect the Baltic, opened this year by President Putin, the city is installing modern waste incinerators to deal with the exhaustion of its landfill sites. For this project, € 24 million is financed by the EBRD, while the Nordic Investment Bank is lending € 9 million, and the Northern Dimension Environmental Partnership is providing a € 6 million grant. In addition, € 10 million has been contributed by Sweden, which has also provided € 2.5 million in institutional support, while the United Kingdom has provided grants to finance the project’s environmental analysis.

101.       Under its current strategy framework for Russia, agreed in November 2004, the Bank is extending its assistance to SMEs through the Russia Small Business Fund. It is also seeking to introduce new mechanisms of non-sovereign financing in areas of activity that would traditionally have been funded directly by the state. The Bank has moved forward to issue Rouble Bonds and is already using local currency financing instruments on a wider scale for SMEs, consumer lending, domestically oriented companies and municipalities alike. With a renewed programme of privatisation underway in Russia, the Bank aims to broaden its participation in the process by providing direct assistance to IPOs (Initial Public Offerings or the first sale of stock by a company to the public), and encouraging more active use of equity participation in its clients’ share capital.

102.       For some years, the Bank has sought to increase and modernise business activity outside the metropolitan centres of Moscow and St Petersburg. This approach is paying off, for today there are some 273 projects under development in 44 Russian regions. The scope of these projects is incredibly diverse: they include investing in the manufacture of modern domestic appliances for the home market, installing new paper-mill plant to help the forestry industry, and supporting the development of power-plant technology and of a new cargo aircraft, designed for export markets. With around 85% of the Bank’s core projects being regionally located, the trend looks set to continue, and to provide further impetus. The Bank is reviewing resource allocation to its field offices across Russia, with the intention of strengthening its regional presence during the coming Strategy period.

103.       Some international experts have signalled concerns that lenders may be relaxing their criteria too much and that risk-taking is not being properly priced. However, all expect high and growing volume of business in Russia over the coming years. It is no surprise that the EBRD has decided to hold its 2007 annual meeting in Kazan, one of Russia’s oldest and most vibrant towns.

ii.       Ukraine at the crossroads

104.       2005 was a tumultuous year for Ukraine and in the EBRD’s view, the country has now reached a critical moment in its economic transition. The election of President Yushchenko has re-affirmed Ukraine’s commitment to multiparty democracy, and the institutions of the state were visibly strengthened as a result of the election process. The new government is, naturally, encountering difficulties as it brings forward a programme to enhance Ukraine’s economy and strengthen its relationship with the European Union. 

105.       As the largest investor in Ukraine, the EBRD is committed to supporting the new government, and the new conditions in the country give it an enhanced opportunity to play a leading role in policy dialogue. As of December 2005, the Bank had achieved a total of 74 signed investments in the country, totalling € 2 billion (with an additional € 1.8 billion of investment mobilised), 70% of which were in the private sector. The Bank has a strong presence in the country, with a team of specialist staff based locally. The support provided is diverse. While the focus has been upon the financial sector and small and medium-sized businesses, there is an increasing emphasis on agribusiness and infrastructure development, including transport and municipal services such as telecommunications. Support for reforms of the energy sector, notably energy efficiency and nuclear safety, is particularly relevant here.

106.       Investment is critically needed in every sector. For while Ukraine’s recent growth has been impressive, reaching 12% in 2004, inward investment has remained weak, and despite the banking sector’s expansion, the poor capital base of many banks is a serious constraint. With overall economic growth slowing markedly during 2005, the challenge for the EBRD in the next few years is to continue to provide necessary finance, to help reinforce the banking system and to work with the government to improve the investment climate so that growth can be sustained in future years. Specific priorities include:

• Attempts to reduce corruption, involving a stronger judiciary, a commitment to the rule of law, a reduced and reformed bureaucracy, and a fairer, more transparent tax code and regulatory regime.

• Better corporate governance with the introduction of a new joint stock company law that increases protection for minority investors; and further industrial restructuring, with privatisation continued by a process that is open and transparent, thus enabling Ukraine’s integration into the world economy.

• Continuing improvement of the financial sector’s regulatory framework, to increase confidence, ensure transparency of ownership and encourage consolidation, thereby strengthening the sector’s capital base.

107.       During 2005, the new government embarked upon a programme which comprehensively addresses these issues – and while all are aware that success will be difficult to achieve, the potential benefits are enormous. Following the agreement with the EU in February 2005 to implement a three-year Action Plan and following the obtaining of market economy status from the EU in December 2005, the government’s next steps in integrating the country into the European and world economy are expected to include WTO membership. The Bank can play an important role in supporting the implementation of key elements of the Action Plan.

108.       The EBRD’s current strategy for Ukraine was agreed in May 2005, and it is hoped that the government’s commitment to reform, positive attitude to Europe and willingness to work with international finance institutions will transform the environment in which the strategy is implemented, so that the Bank can achieve much more than in earlier strategy periods.

109.       The new country strategy is ambitious, seeking to support the new government’s priorities by increasing both the range of its clients and the sectors in which it operates, while expanding the financial products and resources it makes available. It focuses on assisting the development of the private sector while supporting much needed public infrastructure projects and reforms in the transport, energy and municipal sectors. In order to meet the demand for funding, the Bank is seeking to develop local currency financing instruments based on the approach used already in Bulgaria, Romania and Russia, subject to the appropriate legal and regulatory changes being made. 

110.       To increase the impact of its activities, the Bank will:

• Encourage and share risk with foreign investors, and scale up investment in large local manufacturing, service, property and agribusiness projects.

• Offer additional equity and debt with longer maturities, promote syndications, and initiate smaller direct investments.

• Increase its work with local banks, and begin working with insurance companies and other financial institutions. It will also support consolidation in the banking sector by providing new equity finance, particularly in the context of mergers of domestic banks or market entry by foreign investors.

• Provide specialised credit lines for micro and SME finance, and for mortgage, leasing, energy efficiency and warehouse receipt programmes. It will also provide pre-privatisation and merger finance.

• Support the restructuring and modernisation of the infrastructure and energy sectors by financing sovereign guaranteed projects that help promote transition goals, and promoting new non-sovereign guaranteed structures.

111.       In 2004, following several years of decline, the EBRD’s investment in Ukraine recovered to reach € 248 million, and in 2005 it peaked with € 324 million. As the government’s aspirations will require an increased level of support from the donor community, the Bank will aim to identify these needs rapidly and effectively, and to work in coordination with all parties to fulfil them. The Parliamentary Assembly of the Council of Europe should pledge its support for this effort, which is of huge importance for the people of Ukraine, and for the prosperity of the region.

VII.       Prospects and challenges

112.       As this report has suggested, the Bank has achieved a great deal – and its very success is helping to bring about a debate as to its future role. The economies in which the Bank invests are very different now than they were in 1991 – and several are now fully-fledged members of the European Union (who have already, in total, received over € 9 billion of the EBRD’s investment). At the same time, countries that have been slow to embrace reform are taking up the challenge, while far-away Mongolia is moving toward EBRD membership. Given that the Bank’s mission is one of transition, when should its support for a successful country end? Would its resources be better used if further concentrated on countries in a less advanced state of transition, and if so, how should its methods be adapted to suit these countries’ needs?

113.       These very questions were aired during the Bank’s 2005 Annual Meeting, when EBRD President Jean Lemierre told the Board of Governors: “The EBRD, too, must change, and even faster than our countries of operations…It means both renewal and fundamental change within the Bank”. Some shareholders feel that the bank should set a date for withdrawal from the most advanced countries, while others suggest that even in the countries that have joined the EU there is still much to do, especially in areas such as small-business lending. They point out, too, that private-sector banks like to have the EBRD alongside them as ‘a stamp of good housekeeping.’ Following the EBRD’s 2006 annual meeting, it is now clear that the EBRD’s focus will shift, over the next few years, toward the South and the East at an even greater pace than it has so far. The just-agreed new five-year strategy recognises the substantial economic progress of the eight central European countries that joined the EU in 2004 and provides for a gradual disengagement of the EBRD by the end of 2010.

114.Work has also begun on a new business model, which will aim to deliver a new version of the cutting-edge and value-added service that the Bank pioneered a decade ago – and which distinguishes still more clearly between the needs of countries in different stages of transition. While privatisation and structural reform are still important, there is thought to be a growing demand for creative ways to introduce more equity investment – for instance, so as to help mid-sized businesses become bigger international enterprises. Equally, new mechanisms are needed to bring the market to work in traditional public sector projects, such as municipal services, where the challenge in less developed countries is often awesome.

115.       This type of approach will involve developing local capital markets, and using them to promote investment; in Russia, for instance, the Bank has recently begun financing in local currency. As we have seen, the Bank has begun to focus on problems such as improving the use of remittance flows to boost revenues and growth in the poorer countries; and there are plenty of opportunities in sectors such as energy for incentives and innovation.

116.       The structure of the Early Transition Countries Initiative and the Western Balkans Multi-Donor Fund indicates some of the themes, and the challenges, that will be involved. As described earlier, it was designed to enable the Bank to take more risk and to develop a wider range of financial instruments so that more projects could be completed in these countries, taking account of the fact that working in more difficult environments requires a large number of small projects. In so doing, the Bank is likely to make a noticeable contribution to poverty reduction and employment.

117.       But if this approach were to grow in scale, the Bank’s operations could be significantly impacted. Not only will its risk exposure increase, but project management costs will increase greatly. And as the number of large projects in the more developed countries declines, overall bank profitability could be hit, while today’s balanced portfolio would be difficult to maintain. These are significant questions for the Bank’s shareholders, and customers, to consider – and it is healthy, and reassuring, for those who support the Bank’s work, that they should be openly considered.

118.       The Rapporteur is happy to be able to conclude this report by saying that the EBRD is eager to embrace its own future. Its new business model is being developed as part of the Bank’s next strategic review, due for completion in 2010. The Rapporteur welcomes this initiative, and hopes that this year’s Assembly debate will provide useful input for those undertaking it, while offering support to this exciting process of renewal. It is in this spirit that the Rapporteur submits the present report for discussion.

* * *

Reporting committee: Committee on Economic Affairs and Development

Reference to committee: Standing Mandate

Draft resolution adopted by the Committee on Economic Affairs and Development on 23 May 2006

Members of the Committee: Mr Evgeni Kirilov (Chairperson), Mrs Antigoni Pericleous Papadopoulos (Vice-Chairperson), Mr Márton Braun (Vice-Chairperson), Mr Konstantinos Vrettos (Vice-Chairperson), MM. Ruhi Açikgöz, Ulrich Adam, Hans Ager, Abdülkadir Ateş, Mrs Doris Barnett, Mrs Veronika Bellmann, MM. Radu-Mircea Berceanu, Akhmed Bilalov, Vidar Bjørnstad, Jaime Blanco (Alternate: Mrs Elvira Cortajarena), Luc Van den Brande (Alternate:Geert Lambert) Patrick Breen, Milos Budin, Erol Aslan Cebeci, Mrs Ingrīda Circene, MM. Valeriu Cosarciuc, Ignacio Cosidó, Giovanni Crema (Alternate: Andrea Rigoni), Iván Farkas, Joan Albert Farré Santuré, Relu Fenechiu, Mrs Urszula Gacek, MM. Carles Gasóliba (Alternate: Joan Puig Cordón), Francis Grignon, Alfred Gusenbauer, Kristinn H. Gunnarsson, Nick Harvey, Norbert Haupert, Anders G. Högmark, Ivan Ivanov, Ms Verica Kalanović, MM. Karen Karapetyan, Orest Klympush, Anatoliy Korobeynikov, Zoran Krstevski, Jean-Marie Le Guen, Harald Leibrecht, Rune Lund, Gadzhy Makhachev (Alternate: Ms Liudmila Pirozhnikova), Edward Maniura, David Marshall, Jean-Pierre Masseret, Miloš Melčák, José Mendes Bota, Mrs Ljiljana Milićević, MM. Neven Mimica, Gebhard Negele, Bujar Nishani, Conny Öhman, Mrs Ganira Pashayeva, MM. Jakob Presečnik, Jeffrey Pullicino Orlando, Luigi Ramponi, Maurizio Rattini, Maximilian Reimann, Dario Rivolta, Mrs Maria de Belém Roseira, MM. Volodymyr Rybak, Kimmo Sasi, Bernard Schreiner, Samad Seyidov, Panagiotis Skandalakis, Leonid Slutsky, Ms Geraldine Smith, Mr Christophe Spiliotis-Saquet, Mrs Aldona Staponkienė, MM. Frans Timmermans, Dragan Todorović, Mrs Ágnes Vadai, Mrs Jelleke Veenendaal, MM. Oldřich Vojíř, Varujan Vosganian, Robert Walter, Paul Wille, Tadeusz Wita, Mrs Rosmarie Zapfl-Helbling, Mr Kostyantyn Zhevago.

N.B: The names of the members who took part in the meeting are printed in bold

Head of Secretariat: Mr Newman

Secretaries to the committee: Ms Ramanauskaite and Mr de Buyer

¹ Albania, Armenia, Azerbaijan, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Georgia, Hungary, Kazakhstan, Kyrgyzstan, Latvia, Lithuania, “the former Yugoslav Republic of Macedonia”, Moldova, Poland, Romania, Russian Federation, Serbia and Montenegro, Slovak Republic, Slovenia, Tajikistan, Turkmenistan, Ukraine and Uzbekistan.

² See also Resolution 1246 (2001) on “Fifteen years after Chernobyl: financing a lasting solution” (Rapporteur: Lord Ponsonby; doc. 9017) and Resolution 1451 (2005) on “contribution of the European Bank for Reconstruction and Development Bank (EBRD) to economic development in central and eastern Europe” (Rapporteur: Ms Liudmila Pirozhnikova; doc. 10571) at http://assembly.coe.int