1. Introduction
1. The global financial and economic crisis was the
major factor to affect all the EBRD’s countries of operation during
2008, although most countries were not affected until later in the
year and will only experience the full impact during 2009 as the
recession in most industrial economies takes hold. From the third
quarter of 2008, the EBRD experienced increasing difficulties in
attracting project finance from private sources (especially banks),
and at the same time experienced a surge in demand for financing
from the region. The EBRD’s profitability will also be affected,
although to what extent is unclear at present. There were, however, a
number of other important developments during 2008 which will affect
the EBRD’s operations over the next few years. These included:
- Thomas Mirow succeeded Jean
Lemierre, who had been the EBRD’s President for eight years, at
mid-year;
- In early 2008, the EBRD announced record profits of €1.9
billion following the successful outcome of its activities in 2007.
The Board subsequently decided to add the bulk of these profits
to reserves so that paid-in capital and reserves amounted to almost
€14 billion, equivalent to a little over 40% of assets – a high
level of capitalisation;
- At the annual meeting in Kyiv in May, the governors decided
to pay a portion of the previous year’s net income into a Shareholder
Special Fund to supplement the recent growth in technical co-operation funding
and grant financing. The latter are essential components of the
EBRD’s increasing focus on the poorer countries of the region. It
remains to be seen whether such allocations will be repeated, as
the EBRD’s profitability is likely to fall in the immediate future;
- The Board of Directors also agreed that Turkey, a founder
member of the Bank, should become a country of operation, with up
to €600 million to be committed in the years 2009 and 2010. The
decision partly appears to have reflected the fact that Turkish
companies are active as traders and investors in the region, especially
in the Balkans and the Caucasus, and it could thus give a boost
to cross-border co-operation and regional projects. However, as
Turkey will be the second largest country of operations in terms
of population, it remains to be seen whether an overall limit on
commitments might be required, so as not to affect potential flows
to other countries;
- The Board also agreed that operations should not only
continue, but should be increased (up to the total value of €800
million in 2009) for seven of the eight countries in the region
which joined the EU in 2004 and which were due to graduate from
the Bank in 2010 (the eighth, the Czech Republic, having already done
so). Although the policy of graduation is still in place, the result
is that the timing has been put back;
- In December, the Board confirmed that the EBRD would increase
its planned commitments to €7 billion in 2009, a 20% increase compared
with 2008. This was partly in response to the request from the Group of
20 (G20) at their conference in Washington in mid-November that
all International Financial Institutions (IFIs) should work at full
capacity in response to the crisis. Activity in 2009 is expected
to focus on support for banking sectors, small and medium enterprises
(SMEs) and promoting trade flows through an expansion of the Trade
Facilitation Programme.
2. These factors contributed to the President’s decision to bring
forward the next Capital Resources Review (to 2010) to ensure that
the Bank is best placed to meet the new challenges it will face
over the next few years.
2. Impact
of the credit crunch on the EBRD’s activities
3. The main ways in which the credit crunch would most
likely affect the region were set out in a prescient article in
the Bank’s Transition Report 2007,
written
in August of that year, at about the time the severity of the sub-prime
crisis in the United States began to affect financial markets. It
identified the countries most at risk in the region as those with
large external financing requirements, especially if export growth
were to weaken, and those with weak banking sectors, especially
where there had been a rapid growth of credit. In practice, during the
second half of 2007, the growth of syndicated lending did begin
to slow, while Kazakhstan experienced serious banking problems.
Among the reasons why the region was not seriously affected until
the third quarter of 2008 were the contribution that strong economic
growth had made to ensuring that the public finances in many countries
were in reasonable shape, the overall progress in reform and the
opportunity for the exporters of natural resources to build up large
reserves as commodity prices rose. Indeed, up until mid-2008, for
most countries the concerns related mainly to the rapid growth of
domestic credit and inflationary pressures, accentuated by higher
food and energy prices.
4. The full impact of the crisis began to strike the region in
August 2008, when it became clear that western banking sectors had
been severely weakened, the process of deleveraging (cutting debt)
began to affect emerging markets, commodity prices were falling
and that world economic growth in 2009 would be appreciably lower
than originally forecast.
With
the prospect of much weaker growth in 2009 in many of the region’s
main markets, including the EU, Russia and China, in its Transition
Report the EBRD lowered its growth forecasts for the region, with
GDP growth expected to slow from 6.3% in 2008 to 3.5% in 2009. The EBRD
subsequently revised these estimates downwards in late January with
growth in the region (excluding Turkey) estimated at 5.5% in 2008
and 0.8% in 2009.
5. The crisis will affect most countries in the region, although
to different extents. If Kazakhstan was the first victim of the
crisis, certain other countries also experienced significant capital
outflows and depreciation pressures in the second half of 2008,
necessitating immediate and large-scale financial assistance from
the IMF (including Hungary, Latvia, Belarus and Ukraine), while
Serbia also concluded a precautionary loan from the IMF. Furthermore,
this is an unfolding crisis. Despite the action taken by the authorities
in industrial countries to support their banking sectors and stimulate
growth, not only will these measures take time to have effect, but
there is a risk that weaker economic growth will adversely affect
asset values in the financial sector, so that financial conditions
will remain tight for some considerable time to come. Furthermore,
the longer the recession, the greater the strain on public finances
in some countries.
6. The onset of the crisis resulted in a slowdown in the growth
of domestic credit, accompanied by a toughening of payment terms
in many countries, after several years of very strong credit growth.
Syndicated lending – a major source of external funding for countries
in the CIS in recent years, especially Russia, Kazakhstan and Ukraine
– slowed markedly as the availability of funding from interbank
markets became increasingly difficult and costly to arrange. As
country credit ratings were adjusted in some cases, bond investors
increasingly focused on high quality issuers. The financing of foreign
subsidiaries by parent banks in continental Europe, relatively more
important in central and South-Eastern Europe, as well as foreign
direct investment (FDI) flows, traditionally longer term and more
stable, therefore became even more important. However, both of these
are also likely to have slowed in the final quarter of the year
and there are uncertainties over future volumes. Thus, most sources
of private external finance for the financial and corporate sectors
in the region either vanished or became highly uncertain, a critical
factor for those countries with large external debt obligations
and/or external deficits.
7. There have been a number of immediate implications for the
EBRD in terms of financing its existing projects. Perhaps the main
effect, and one not wholly foreseen a year ago, was the potential
impact on local subsidiaries in the region owned by parent banks
from Austria, Italy, France and other countries, including Russia.
These banks, such as Raiffeisen Zentralbank and UniCredit, made
strategic decisions to expand their operations in the region some
years ago, supporting their subsidiaries with credit lines, subordinated
debt and capital. Over time, this has not only meant that a majority
share of the assets in some banking sectors were foreign owned (for
example, in the Baltic states and some Balkan countries), but several
of these banks also became important financing partners for the
EBRD.
8. This development was rightly viewed as a major contribution
to strengthening domestic banking sectors.
However,
as some of these foreign banks may have to seek financial assistance,
such as extra capital or loan guarantees, from their own authorities,
there is now some uncertainty as to the volume of financing they will
be able to provide to their subsidiaries in the region in the future.
To date, most indications are that the parent banks will continue
to support their subsidiaries. However, in practice the amount of
this support will depend on the parent bank’s own results for 2008
as a whole and how balance sheets are affected in future by increases
in non-performing loans as the recession takes hold during 2009.
In addition, for those banks that receive support from public sources,
it remains to be seen whether European national authorities will
seek to impose any restrictions on cross-border lending.
9. In general, the scope for bank financing either via syndicated
lending or through bank subsidiaries in the region has fallen sharply,
contributing to a marked fall in the number of projects that the
EBRD processed during the final quarter of the year. A further complication
has been that in some cases, the assumptions on which existing projects
were approved, for example, with respect to economic growth or the
exchange rate, are now very different. Depending on the robustness
of the project this may affect the project’s cash flow and financing
requirements.
3. The impact of Russia
10. Although the origins of the credit crunch lie in
the United States sub-prime market, the extent to which it affects
Russia is also crucial for other countries in the CIS, given that
Russia is a major market, that some of its banks own subsidiaries
in the CIS and, for certain countries, including Armenia and Moldova,
that it is an important source of workers’ remittances, which contribute
to these countries’ external funding needs. Thus, developments in
the Russian economy will also have a major bearing on developments
in the region.
11. The Russian economy grew strongly up until the first half
of 2008 (with some signs of overheating), reflecting strong credit
growth, high oil and gas prices – the latter contributing to further
large fiscal and external surpluses – and strong government spending.
However, investor sentiment was adversely affected by events initially
unconnected with the credit crunch, including the authorities’ handling
of the TNK/BP issue, evidence of government intervention in the
stock market and the conflict with Georgia. These factors, combined
with western banks’ reluctance to lend and the collapse of the domestic
stock market (which resulted in many foreign creditors having to
be repaid), resulted in substantial capital outflows in the third
quarter. This, in turn. put additional pressure on domestic banks,
contributing to a slowdown in the growth of credit and sharp falls in
industrial production by the year end. Although the Russian Central
Bank had accumulated substantial foreign exchange reserves, the
preference of Russian companies to finance their expansion via debt
rather than FDI meant that by mid-2008, total external debt exceeded
the value of reserves. The latter came under pressure during the
final quarter of the year.
12. The authorities have responded to the crisis with a large-scale
package of support for key sectors of the economy, including the
financial sector, estimated at some 10% of GDP,
as
well as allowing the rouble to depreciate. Russia therefore begins
2009 with the prospect of much slower growth (the EBRD forecasts
GDP growth of just 1% compared with 6.5% in 2008), and sharply lower
fiscal and external surpluses, especially if the oil price remains
low. These trends will inevitably affect growth in other CIS countries,
while a recent package of economic stabilisation measures announced
by Premier Putin in December includes a limit on the quota for foreign
workers, which could have a direct impact on remittances.
13. These developments and the implications of Russia’s conflict
with Georgia (see below) had little direct impact on the growth
of the EBRD’s operations in Russia during 2008. Although provisional
results suggest the Bank’s new commitments were slightly below the
level recorded in 2007, they nevertheless amounted to €1 816 million
in 2008, so that Russia accounted for 35% of the EBRD’s operations.
With the Bank’s focus on the private sector, activity was mainly
affected by the difficult investment climate. Despite progress with
an anti-corruption plan and the enactment of a Law on Foreign Investment
in Strategic Industries during the year, investors’ concerns over
the continuing absence of clear property rights and the extent of
corruption remain. For the second year running, the EBRD did not
raise any of the main transition indicator scores for Russia, although
some progress has been made within the infrastructure sector, suggesting
that the government has largely missed a period of strong growth
in which to accelerate reforms.
4. Ways in which the
impact of the credit crunch can be minimised, including those involving
greater regional co-operation
14. Given the severity of the global economic crisis,
the immediate challenges are the need to limit the extent of the
current crisis and strengthen financial regulation. The main response
to date has been that of the G20 in mid-November, which recommended
fiscal measures to stimulate demand, improved transparency and supervision
of financial markets, as well as a greater role for the main emerging
market economies in multilateral institutions, such as the IMF.
Most of the steps would need to be taken at either the national
or international level.
15. One of the main lessons of earlier crises which affected the
region – for example the Asian and Russian crises of the late 1990s
– was that those countries in the region with sound macroeconomic
policies and which had progressed with economic reform were best
placed to withstand the shocks. This remains true and thus the main
focus of economic policy should be to address economic imbalances
to reduce external financing requirements. In a number of cases
where there has been a de facto exchange rate peg, as for example
in Ukraine, greater exchange rate flexibility is likely to ease
the adjustment process.
16. With respect to the banking sectors, there will be a need
to ensure that banks have adequate capital, that liquidity management
is strengthened in the ways recommended by the Basel Committee and
that prudential regulations are improved, especially those relating
to risk management procedures. The EBRD is likely to face strong
demand for additional support from some existing clients in the
financial sectors of many countries, a point noted in a letter the
President wrote to the Board on ways in which the Bank could assist those
countries and private sector clients under the greatest stress.
17. The crisis has, however, revealed two issues on which further
action is required. Given the important role played by foreign banks
in the region, the crisis has highlighted the need to improve cross-border
co-operation between the relevant supervisory authorities. Although
a national supervisor may take the necessary steps to strengthen
the position of one of its major banks, if this is an international
bank with foreign subsidiaries, there is a risk that this will impact
on cross-border lending. The local supervisory body has little say
in this situation at present. Although this may ultimately be a
matter for ensuring consistent supervisory practices across all countries,
it is encouraging that the EBRD participated in a regional conference
in Vienna in January 2009 with the major banks and other interested
parties to address this particular issue. Secondly, where there
were concerns that depositors might withdraw their deposits from
particular institutions, some authorities moved quickly to increase
the amount of deposit protection, in some cases to effectively 100%.
This had the potential to accentuate the problems in neighbouring
countries with lower levels of protection, even if the ability of
the national authorities to finance the new level of guarantees
was uncertain.
5. Political stability
and economic development
18. The EBRD’s mandate is to assist countries to make
the transition to open market economies within a democratic framework.
The Bank therefore continually monitors each country’s application
of the principles of multiparty democracy, pluralism and market
economics to ensure that Article 1 of the Agreement Establishing the
EBRD is being met. From the most recent country strategy documents,
it
may be seen that six of the 10 countries reviewed here are described
as either meeting the conditions or committed to and applying the conditions,
(Albania, Bosnia and Herzegovina, “the former Yugoslav Republic
of Macedonia”, Montenegro, Serbia and Ukraine).
19. The descriptions relating to the remaining countries (Armenia,
Azerbaijan, Georgia and Moldova) were qualified in certain respects,
generally along the lines that although they were committed to applying
the principles, progress had either been slow or uneven in certain
respects during the previous strategy period. It should be noted
that this is not necessarily the EBRD’s latest assessment, although
it is the most recently published one. Furthermore, in none of the
four countries was the assessment regarded as sufficiently serious to
affect either the extent or nature of the Bank’s activities in that
country, as has occurred, for example, in a few other countries
where shortcomings relating to the rule of law and human rights
have been very serious.
20. In 2008, there was further progress in reform in the region
as a whole, according to the latest transition indicators reported
in the Transition Report 2008.
The
five countries in South-Eastern Europe (SEE) reviewed here all recorded
upgrades for the third successive year. The majority of these upgrades
(of which there were eight in total) reflected improvements in the
banking and financial sectors. In the case of Bosnia and Herzegovina,
Montenegro and Serbia, these upgrades mainly reflected the relatively
late starting point rather than any significant reform effort this
year. Among the remaining countries, both Armenia and Moldova recorded
upgrades (for improvements in securities markets and small scale-privatisation,
respectively).
21. The countries in central Europe and the Baltic states have
made the most progress in transition since 1989. This is generally
attributed to a combination of sound policies, a political consensus
over the need to reform and the important contribution of the EU
in providing assistance to enable these countries to harmonise their
legislation with that of the EU, thus enabling them to join the
EU in 2004. Countries in SEE were at a broadly similar stage of
transition as those in the CIS in 1998 in all three categories of
indicators. However, since then reform has generally slowed in the
CIS while progress remained steady in the SEE group as a whole (which
includes Bulgaria and Romania, also now members of the EU). By 2008,
despite a later start to the transition process, SEE as a whole
was well ahead of the CIS.
22. Progress in reform is important since it almost certainly
contributes directly to stronger economic growth at a later stage.
In its latest Transition Report, the EBRD updates some analysis
first undertaken in 2004, which confirms that increases in transition
indicator scores have a strong and positive effect on growth in
the subsequent period. Furthermore, the analysis suggests that it
is the market-sustaining reforms, the most difficult to achieve,
which have the most pronounced effect on growth.
23. Whether economic progress in these countries can be directly
linked to improvements in democracy is more difficult to show. Clearly,
strong economic growth is possible under more authoritarian regimes.
However, a priori there are good reasons for believing that the
more democratic a regime, then the greater the respect of the rule
of law, the less the corruption and the greater the media freedom
enabling more general scrutiny of government policy, all of which
might be expected to contribute to sustained growth over the medium
term. For the 10 countries in question, a comparison of their transition
scores and the Freedom House democracy indicator (for 2008) suggests
there is no clear link. While there is a marked difference in the
average levels of the democracy indicator for the two groups of
countries, their overall transition scores are similar. The answer may
be that the countries in SEE have better prospects in so far as
their rate of progress in reform is currently higher, and their
progress in democracy will allow these achievements to be translated
into stronger growth in the future.
24. A related aspect is the relationship between the growth of
a middle class and democracy, drawn from information contained in
the Bank’s “Life in Transition Survey” and published in the Transition
Report 2007. This showed a striking correlation between the proportion
of the population defined as “middle class” and the stage of democracy.
Although the data did not allow any conclusions to be drawn as to
whether the growth of a middle class was associated with demand
for stronger democracy, there are a priori reasons for thinking
that a growing middle class is more likely to support democratic
values for reasons associated with income and status.
25. Corruption remains pervasive throughout the region, a function
of too many regulations which provide the scope for corruption,
and low wages which provide the incentive for it, often combined
with weak judicial procedures. The consequence is usually that the
business environment is made more difficult and firms face additional
costs, both in a financial sense as well as in time spent in dealing
with essentially unnecessary procedures/inspections, etc. The 10
countries under review fall mainly in the middle range of all countries surveyed
by Transparency International in 2008. Georgia was the least corrupt
of all 10 countries, although in general the countries in SEE have
better ratings than those in the CIS group.
26. Integrity issues have always been important to the EBRD, given
that its main shareholders are governments and that it seeks to
promote high standards of governance in all its activities. In 2008,
the EBRD was rated as the most accountable of all the intergovernmental
organisations (and second overall) by the One World Trust in their
annual Global Accountability Report. The EBRD scored particularly
highly in areas such as transparency, due to its information disclosure
policy, and evaluation, where the Audit Committee and Board have
overall responsibility. It also received relatively high ratings
for its complaints procedures, especially those relating to internal
(rather than external) complaints. The EBRD nevertheless implemented
various measures during 2008 to strengthen its integrity procedures,
including a review of the independent recourse mechanism, to address
some of the concerns related to the handling of complaints from
external sources.
6. Co-operation with
other institutions
27. Co-operation with other institutions has intensified
as a result of the financial crisis. Two specific examples are the
closer contacts with the IMF to share expertise and contribute to
broader sector programmes, such as is likely to occur in the banking
sector in Ukraine once the IMF has completed its diagnostic studies. Secondly,
the EBRD played an important role in the multilateral assessment
of Georgia’s financing needs following the conflict with Russia.
28. Co-operation with donors has strengthened, especially following
the EBRD’s decision to establish a Shareholder Special Fund, as
noted above. In practice, this will be linked to both the Early
Transition Countries Fund (ETCF)
and
the Western Balkans Fund (WBF),
whereby
the EBRD will match donors’ contributions. Active co-operation with
donors has always been important for the EBRD, mainly to fund the
costs of technical assistance incurred in project preparation and
leverage capital investment. In recent years, these arrangements
have developed further with the creation of a number of specific
funds, such as those mentioned above. This has contributed to an
increase in the total funding that donors have committed to technical
co-operation, which rose from some €70 million in 2006 to €98.2
million in 2007, although it fell back to €82 million in 2008, which
in turn has had a direct impact on projects on the ground.
29. The ETCF, launched in 2004, and the WBF, launched in 2006,
are similar in so far as they are untied, multi-donor funds with
the objective of improving the co-ordination of TC support among
the donor community and providing grant co-financing to countries
in the respective country groups. The Western Balkans Local Enterprise
Facility (WB-LEF), also launched in 2006, amounts to €32 million,
funded mainly by Italy and to date has provided loan and equity
finance to SMEs in this region. This supplements the Western Balkans
SME Finance Facility, which provides loans to local banks and leasing
companies for on-lending. Other funds are functional in nature,
for example the Sustainable Energy Initiative (SEI), which seeks
to promote energy efficiency and renewable energy across the region
as a whole. The SEI was established in 2006 with a three-year financing
target of €1.5 billion and achieved this in its first two years
of operation.
30. The Bank has also been active in 2008 in helping to establish
the Western Balkans Infrastructure Initiative with the European
Commission, the European Investment Bank (EIB) and the Council of
Europe Development Bank (CEB). The initiative is expected to have
joint loans from both the EBRD and the EIB amounting to €1 billion
and will be supported by grants from the European Commission and
member states. An important role for the framework will be to increase
co-ordination and avoid overlap among the many agencies and donors
which are active in developing the region’s infrastructure.
31. Co-operation with the EU has also intensified following the
adoption of the EU’s main programmes in the region – the pre-accession
instrument (including the Western Balkans), the Neighbourhood Partnership (including
Armenia, Azerbaijan, and Georgia) and the Neighbourhood Investment
Facility (including Ukraine and Moldova). The main aim of co-operation
is to ensure that EBRD projects support the aims of EU policy and ensure
leverage for EU budget funds.
32. Co-operation with the EIB has also strengthened, especially
after the EC, the EIB and the EBRD signed a Memorandum of Understanding
in 2006 on the co-financing of projects, following an increase in
the EIB’s funding for infrastructure projects in the neighbourhood
countries. Although the EIB can offer lower financing costs than
the EBRD for most infrastructure projects, where there is potential
for co-financing then the EBRD would take the lead in project preparation,
reflecting its greater experience in the region, with the client benefiting
from blended finance. In late 2008, the EBRD reached an understanding
with respect to Turkey, mainly to ensure that it worked in geographical
areas where the EIB was not active. Such arrangements have included
other development banks, such as the Council of Europe Development
Bank.
7. The EBRD’s activities
in 10 countries in 2008
33. In this section the 10 countries are divided into
two regional groups. Each section starts with a review of some of
the main regional developments, before focusing on the EBRD’s activities
in each country and some of the factors which have affected the
growth of activity.
7.1. The Western Balkans
34. The region continued to make progress during 2008.
Economic growth averaged over 6% for these countries and it was
not until towards the end of the year that they began to be affected
by the credit crunch. All these countries made further progress
with reform, as noted above. There were also a number of positive political
developments. A Regional Co-operation Council was established in
early 2008 (which replaced the Stability Pact) and, inter alia, included a mechanism
for financing projects of a regional nature. The EBRD was invited
to join the Council. In Serbia, there was little serious adverse
reaction to Kosovo’s declaration of independence, while the elections
in May produced a pragmatic coalition government intent on securing accession
to the EU. In December, the EU (and the UN) finally reached an agreement
with Serbia to allow its large civilian mission, EULEX, to commence
its activities in Kosovo (replacing those of the UN). In addition, both
Bosnia and Herzegovina and Serbia signed Stabilisation and Association
Agreements (SAAs) with the EU during the year; in December Montenegro
applied for EU membership (“the former Yugoslav Republic of Macedonia”
is already an accession candidate), while Albania is expected to
apply fairly soon. All these factors resulted in continued stability
in the region and past experience indicates that regional political
stability is critical for further economic and social progress.
35. Given the success of the EU’s policy during the first round
of enlargement, eventual EU membership would appear to be the most
obvious way of securing further progress and stability in this region.
In its latest Enlargement Strategy,
the European
Commission noted that all five countries have made further progress with
both political and economic reform, not least because greater focus
is now given at an early stage to the rule of law and good governance.
In the case of Serbia, the Commission noted that it could be possible
to grant it candidate status during 2009 if all the conditions are
met, including further co-operation with the International Criminal
Tribunal for the former Yugoslavia.
36. The volume of EBRD activities grew strongly in 2008, especially
in Albania, Bosnia and Herzegovina and “the former Yugoslav Republic
of Macedonia”, with the net cumulative business volume increasing
to €3 391 million. The Bank was also successful in mobilising additional
resources so that the total project value increased to €8 216 million
over the same period in the previous year. The scope of the EBRD’s
operations reflected the main elements of each country strategy,
which in general terms require the Bank to focus on support for
the enterprise, financial and infrastructure sectors, with much
of the growth for local companies in light manufacturing and the
agribusiness sector. The growth partly reflected the cumulative
effect of greater political stability, as well as several years
of sustained reform and economic growth in the region.
37. The growth in EBRD operations was also due to the contribution
of some of the newer funds such as the WB-LEF, the WB Financing
Facility, as well as growth in micro-lending. The small size of
these economies means that the average size of private sector projects
is quite small (about €5 million) and thus potentially relatively
costly to prepare and administer. However, not only do these funds
allow the Bank to widen the scope of its potential client base,
but also they allow faster and more streamlined procedures for project
approval, thus increasing the efficiency of the EBRD’s operations.
38. The credit crunch did not have a major impact on the Bank’s
activities in the region, partly because syndicated lending was
relatively unimportant while the region is not heavily integrated
into the world’s capital markets. In addition, the banking sectors
have proved to be fairly resilient with no serious run on deposits. There
are, however, several concerns. Foreign banks are estimated to own
the majority of banking assets, so much will depend on their decisions
as to the scale of their future operations. A slowdown in credit
growth is inevitable. FDI flows, hitherto an important source of
financing, are expected to slow in 2009, while there is also uncertainty
regarding the flow of remittances as job opportunities decline in
other countries. Growth slowed towards the end of the year, mainly
because of lower demand from the EU, which accounts for approximately half
of the region’s exports. These trends could cause problems for those
countries with high external deficits and will inevitably have an
effect on the growth of EBRD operations in 2009. On the positive
side, funding from International Financial Institutions and donors
remains relatively important in the region and pre-accession funding
from the EU will continue, especially for infrastructure projects.
There may also be some new opportunities for the EBRD to fund projects
mainly geared to supplying the domestic market.
39. In Albania, the EBRD’s commitments rose strongly in 2008,
increasing by €88 million, with continued support for SMEs in the
private sector. Infrastructure projects focus on restructuring of
the energy sector and development of transport and communications
networks, most of which are public sector projects. The EBRD has
also made increasing use of the WB-LEF, the Co-Financing Facility
(CFF) and the Energy Efficiency Finance Facility to channel funds
to medium-size enterprises. Albania’s economic fundamentals remained sound
in 2008, with growth estimated at 6.1% and moderate inflation (4%).
Further progress was made with economic reform, especially with
large-scale privatisation and banking, both of which received upgrades
in the latest Transition Report. There was also a marked improvement
in the ease of doing business, according to the latest World Bank
survey of “Doing Business”, reflecting improvements in registration
procedures.
40. In “the former Yugoslav Republic of Macedonia”, the EBRD’s
commitments rose by €55 million. The main focus of the Bank’s operations
is on job creation in the private sector, especially via support
for SMEs and trade facilitation. This partly reflects the government’s
decision to limit the use of sovereign borrowing, but also the very
high rate of unemployment. The latter remains well over 30%, despite
another year of steady growth (estimated at 5.3%). Faster progress
towards EU accession would boost FDI flows, which remain relatively
low. However, there is currently no date foreseen for negotiations
on accession to commence. In its latest assessment, the Commission
acknowledged the progress made over the past year, but drew attention
to the need for free and fair elections (following an outbreak of
violence during the elections in June 2008) as well as for more
progress in a number of areas including judicial reform. Progress
towards EU accession (as well as NATO membership) is also hindered
by the dispute with Greece over the name of the country.
41. The EBRD’s commitments to Bosnia and Herzegovina rose sharply
in 2008 by €249 million. The Bank’s operations continue to be focused
on support for private local companies, SMEs, especially through
the TAM/BAS (TurnAround Management (TAM) and Business Advisory Service
(BAS)) programmes and infrastructure projects, including the Pan-European
(road) Corridor Vc. This was supported by strong economic growth (estimated
at 6% in 2008), the success of the Currency Board in maintaining
exchange rate stability despite a rise in inflation and also by
further progress in reform (reflected in EBRD upgrades for progress
in trade liberalisation and banking reform). However, the share
of the private sector at 31% remains relatively low because of the
disparity between the size of private and public sector projects.
The Stabilisation and Association Agreement (SAA) with the EU was
signed in mid-2008, but as the Commission notes in its Enlargement
Report, political consensus between the two entities is urgently
required to enable the agreement to be implemented and for EU-related
reforms to proceed.
42. The EBRD’s operations in Montenegro rose by €16 million, a
similar amount to that recorded in 2007. Operations focused on support
for enterprises in the property and tourism sectors, including SMEs
through the WB-LEF, continuing support for micro-lending institutions
in the financial sector and co-operation with the EIB, EU and the
World Bank on infrastructure projects. However, the small size of
most of the private sector projects has meant that the infrastructure
sector continues to dominate the country portfolio and the private
sector ratio is only 27%. GDP rose by 7% in 2008, with strong capital
inflows, partly linked to growth in the property sector. Much of
the banking sector is foreign owned, while the euro provided currency
stability. Progress has been made with the SAA, including the adoption
in April 2008 of a multiyear plan to harmonise the legal framework with
that of the EU. The problems are partly structural. Output from
KAP, the large aluminium producer, accounts for a significant share
of both exports and GDP. Furthermore, this sector will be affected
by weaker export prices in 2009 and ultimately the need to adjust
to higher electricity prices. The current account deficit now exceeds
30% of GDP and is highly dependent on FDI flows for financing, although
these flows could be affected by the recent fall in property prices.
43. In Serbia, the EBRD’s
new commitments were some €127 million in 2008, well below the level
attained in 2007. This mainly reflected the time it took establish
a government following the parliamentary elections in May, which
resulted in significant delays in the signing of certain large public
sector projects. Much of the new business was therefore to support
new private companies and the rapidly emerging non-bank International Financial
Institutions’ sector. With Serbia’s ambitious plans to develop its
infrastructure, especially the major road corridors, the EBRD has
established strong working relationships with the EU, EIB, World
Bank and agencies such as the KfW, all of whom are heavily involved
in these projects. The banking sector, with a large degree of foreign
ownership, is well capitalised and withstood an initial run on bank
deposits (partly reflecting memories of banking crises in the early
1990s) in the autumn. Supported by an increase in the level of deposit protection,
the sector remains vulnerable, however, to adverse macro-economic
developments, such as currency depreciation.
44. After a period of political uncertainty in early 2008, there
were a number of positive developments. These included strong GDP
growth of 6.5%, further progress in reform, especially in banking
and trade liberalisation, as well as the signing of an SAA with
the EU in April. However, the economy did exhibit some signs of overheating,
including a growing current account deficit, which was increasingly
financed by foreign borrowing. The IMF programme, supported by a
precautionary 15-month Stand-by Agreement (SBA) of US$518 million (approved
by the IMF Board in January 2009), should assist in securing greater
stability. However, with weaker external demand and a general hardening
of payment terms from the banking sector, GDP growth will inevitably
slow in 2009.
7.2. The CIS countries
45. The conflict between Georgia and Russia, which commenced
on 8 August and was followed by a ceasefire on 12 August, with Russia
also unilaterally recognising the disputed territories of South
Ossetia and Abkhazia, highlighted the inherent instability of this
region. Tension inevitably remains between Georgia and Russia and
in December Russia vetoed a proposal for the OSCE to extend its
mandate for a further year in Georgia, arguing that it should set
up a separate mission within an “independent” South Ossetia.
46. However, apart from some initial disruption to trade routes,
especially for Armenia, and political repercussions in Ukraine as
to how to respond to the crisis, so far the conflict does not appear
to have had significant wider repercussions in the region. In fact,
there is some evidence that it has prompted a renewal of attempts
to resolve the other “frozen conflicts” of Nagorno-Karabakh and
Transnistria. At the beginning of November, the Russian Government
hosted a meeting of the presidents of Armenia and Azerbaijan in
an attempt to accelerate the negotiations which have proceeded slowly
in the Minsk group. Building on the recent efforts of President
Voronin of Moldova to settle the dispute with Transnistria, Premier
Putin visited Moldova in November with proposals for the reintegration
of the breakaway territory into Moldova, although these are likely to
be difficult for the West to meet. Further progress may also have
to await the outcome of the presidential election in Moldova.
47. These developments partly reflect Russia’s policy that the
Georgian episode was not a precedent. This may have reflected the
desire to avoid giving encouragement to some Russian republics who
want greater autonomy and Russia’s interest in securing oil and
gas supplies from Azerbaijan. But the conflict was also a stark
reminder to other countries in the region of the force of Russian
power. The West also appears to have chosen the path of greater
co-operation, with the EU backtracking from its initial decision
that negotiations on a Partnership and Co-operation Agreement with
Russia could not resume until all Russian troops had withdrawn to
positions held immediately before the conflict with Georgia had
begun (a condition that was not met). In December, NATO members
agreed on a programme of further co-operation with Georgia and Ukraine, with
no commitment to immediate membership.
48. The EBRD’s operations in Georgia increased strongly for the
second successive year, with commitments increasing by €215 million.
Much of the growth was in the first half of the year, a reflection
of strong economic growth and the successful implementation of reforms,
including a favourable business environment reflected in the high
ranking under the World Bank’s “Doing Business” survey for 2009
(15th out of a total of 181 countries). In addition, the EBRD’s
decision in 2006 to make Tbilisi the regional hub for its operations
in the Caucasus has also been beneficial. These factors contributed
to investor confidence and buoyant FDI flows, at least during the
first half of the year. Provisional data also suggest a sharp rise
in the value of the additional resources mobilised to over €2.5
billion. The EBRD’s activities were broad based, although primarily
in support of the enterprise sector, infrastructure (especially
power) and the banking sector, with a private sector share of 86%.
However, the main banks began to experience problems at mid-year, reflecting
their large foreign currency liabilities, so that refinancing became
difficult. The conflict resulted in a run on bank deposits and severely
affected investor confidence, given the large current account deficit. Economic
growth slowed sharply in the second half of the year.
49. Soon after the conflict with Russia ended, several multilateral
institutions undertook a joint assessment of Georgia’s financing
needs. The EBRD played an important role, especially with respect
to the banking, power and municipal sectors. In total, these needs
were assessed at US$3.2 billion, primarily for budget support, repairs
to and investment in the infrastructure and strengthening the banking
sector. Donors and IFIs subsequently pledged a total of US$4.5 billion
at a conference in Brussels in October (including an SBA with the
IMF for U$750 million), more than sufficient to meet Georgia’s immediate
needs and to replace the absence of FDI. The main focus of the EBRD’s
support is likely to be on some of the larger banks, but the range
of assistance pledged by other donors could provide the opportunity
for projects in other sectors. In addition, the government has responded
with a marked improvement in the arrangements for donor co-ordination
to ensure the pledged monies are received and spent efficiently.
50. The EBRD also recorded a further significant increase in its
operations in Moldova, with new commitments of €107 million. The
focus was on support for private companies, intermediary finance
through local banks and some infrastructure projects, including
the modernisation of Chişinău airport (with the EIB). The growth
partly reflects progress with the government’s reform programme,
reflected, for example, in improvements in trade arrangements with
the EU and in progress in small-scale privatisation, supported by stronger
economic growth following the partial resumption of wine exports
to Russia. Although there are several foreign banks in Moldova,
the banking sector has not to date been seriously affected by the
financial crisis, reflecting the high deposit base, a strengthening
of reserve requirements and the relatively large share of borrowing
from IFIs. However, the currency did fall sharply in September (after
two years of steady appreciation), but has since stabilised. Growth
is, however, likely to be affected by weaker demand for agribusiness
exports.
51. The EBRD’s commitments in Armenia rose by €52 million in 2008,
below the level recorded in 2007, but following several years of
growth in commitments. The focus was on support for the corporate,
property and financial sectors, including credit lines for SMEs
and agribusiness. This was supported by strong growth in the economy
(GDP rose by 6.8%), which was not seriously affected by either the
political tensions following the disputed presidential elections
in February or the credit crunch. Armenian banks are well capitalised
and profitable, while most foreign banks have indicated their intention
to continue to support their local operations. Trade routes were
severely disrupted for a period following the Russian/Georgian conflict
(about 75% of trade is via Georgia). However, there are some suggestions
that this could ultimately lead to a more proactive approach on
the need to open up trade routes, involving further dialogue with
Turkey and ultimately Azerbaijan. Meanwhile the government intends
to continue to invest in upgrading the transport and energy infrastructure.
52. The Azerbaijani economy grew strongly in 2008 with GDP estimated
to have increased by 10.8% according to the EBRD, mainly because
of high prices and volumes of oil exports. The financial sector
has not been seriously affected by the credit crunch, partly because
of the limited amount of short-term capital flows, but also because
of measures taken by the central bank earlier in the year to limit
credit growth. However, lower oil prices and slower world growth
are expected to result in slower GDP growth in 2009. Although the government
has taken steps to improve the business environment, which resulted
in a significant jump in its overall ranking in the World Bank’s
“Doing Business” survey from 97th in 2008 to 33rd in 2009, the EBRD recorded
more modest progress in its activities. New commitments rose by
€81 million, less than the amount recorded in 2007, largely explained
by the Bank’s focus on the banking and non-oil corporate sectors,
where in practice the problems surrounding corruption as well as
the impact of the real appreciation of the exchange rate on profits
continue to affect progress. The EBRD’s portfolio is nevertheless
dominated by projects in the natural resources, energy and infrastructure
sectors.
53. Of the 10 countries under review, Ukraine has been the most
seriously affected by the credit crunch. General concerns over macro
imbalances in the first half-year, including excessive credit growth,
were accentuated by signs of overheating and then adverse terms
of trade movements as oil and gas prices rose and steel prices fell,
thereby widening the trade deficit. The onset of the credit crunch
led to significant capital outflows and a re-assessment of Ukrainian
risk so that Ukrainian entities could no longer raise funds from capital
markets. This led to a sharp slowdown in credit growth, exposing
the currency and maturity mismatches in the banking sector, and
contributing to further problems, including a run on bank deposits
and the failure of the country’s sixth largest bank. As downward
pressures on the currency intensified, in early November the government
secured a substantial US$16.4 billion emergency SBA from the IMF
to enable the country to meet its external financing obligations
during 2009, supported by a programme to address some of the imbalances. This
included a flexible exchange rate, as well as measures to reduce
demand and to recapitalise the banking sector. The latter is likely
to be supported by funding from other IFIs once the IMF has completed
the diagnostic studies of the main banks.
54. Weaker demand, both domestic and external, is likely to lead
to a fall in GDP in 2009 (by 5% according to the EBRD) – indeed
there was a very sharp fall in industrial production in November.
The success of the SBA programme depends on the government implementing
a tight fiscal policy and avoiding further large falls in the currency,
which could lead to further deterioration in bank’s balance sheets.
The formation of a revised Orange coalition in December, after some
months of uncertainty surrounding the prospects for an early general election,
was an important step towards ensuring that the government takes
the appropriate policy actions. However, the eruption of a dispute
with Russia at the end of the year over gas payment terms was a
stark reminder of both countries’ mutual dependence on orderly gas
trading arrangements, as well as the need for Ukraine to improve
its energy efficiency.
55. The EBRD’s commitments to Ukraine continued to grow strongly,
with new commitments growing by €835 million. Much of the increase
took place in the months before August, when projects involving
syndicated lending to the real economy became much more difficult
to complete. By the end of 2008, the Bank had invested in 213 projects
with a net cumulative business volume of just over €4 billion, sufficient
to make Ukraine the Bank’s second largest country of operations.
The EBRD’s activities in Ukraine under the current strategy are
focused on support for the corporate sector, developing domestic
capital markets, promoting energy efficiency (where rapid progress
was made with the Energy Efficiency Facility designed to support
firms investing in energy efficiency or renewable energy projects),
and improving infrastructure (which included further co-operation
with the EIB). The EBRD also continued to provide direct policy
advice through its participation in the Energy Sector Task Force
and the Transport Working Group. Important progress was also made
with the two major donor-funded programmes which the EBRD administers
– the Chernobyl Shelter Fund and Nuclear Safety Account – including
the signing of the contract for the new safe confinement for Unit
4.
56. One immediate effect of the financial crisis in Ukraine for
the EBRD is that serious consideration is being given to a sharp
increase in its investments in the banking sector, reflecting the
importance of the sector to the EBRD, both in terms of its direct
exposure (about 20% of the portfolio) and as a means of channelling
funds to micro and small enterprises. Given the urgent need for
substantial amounts of additional capital in the sector (the IMF
estimates that recapitalising the main domestic banks is equivalent
to 3.5% of GDP), the EBRD could participate in the broader IFI programme
for the sector, providing funding, especially equity capital, for
selected banks.
8. Conclusions
57. Looking forward, it is clear the EBRD will face some
real challenges as it seeks to expand its activities during 2009
as economic growth, including that of exports, weakens. The main
challenges are likely to include the difficulties of raising adequate
volumes of finance from private sources to finance projects and
the problems of accurately pricing risk in current economic conditions.
This applies to projects for the corporate sector, where exports
have not only been an important source of growth for many enterprises,
but have also constituted an obvious currency hedge for clients
who borrow foreign currency from the EBRD. It also applies in the
financial sector, where a period of weak growth will impact on the
balance sheets of some banks in the region, at a time when some
have already been weakened or where there are uncertainties over
the intentions of foreign owners. Furthermore, the EBRD is also
likely to have to accept some temporary reversals in the progress
of reform, as some potential investment partners may be governments
seeking to support ailing industries or institutions, albeit on
a temporary basis, as is occurring in many industrial countries.
58. At the same time, the EBRD is likely to find some new opportunities
given the strong demand for finance from clients in the region.
There is no question that extra EBRD financing for the region will
be essential and that it will be additional given that private sector
flows are likely to remain limited for some time to come. The strong
demand for finance will enable the Bank to be selective with respect
to the projects it undertakes. Overall, providing the EBRD can attract
some additional finance from partners, then even on a fairly conservative
ratio of 2:1, the EBRD’s activities will make a significant contribution
to meeting the region’s demand for finance
59. Building on the successful degree of co-operation that the
Bank has forged with other institutions, agencies and donors, there
should be scope for continuing with important infrastructure projects,
even if these are mainly those in the public sector. Although this
may affect the desire to improve the private sector ratio in some
countries, such projects could promote regional stability in areas
such as the Balkans through the improvements to transport and trade
links and provide a sound basis for the eventual recovery.
60. The share of financing for the financial sector as a whole
will grow sharply in many countries. This is likely to reflect the
need to support individual banks, which are intermediaries in the
EBRD’s own lines of credit (for SMEs and energy efficiency, for
example) or, more exceptionally, to participate in a wider IFI programme to
support a severely weakened banking sector, for example in Ukraine.
As to the means of financing, the EBRD will most probably have to
consider an increase in equity financing, partly because of the
difficulties in securing adequate volumes of loan finance from partners.
In some cases – in the case of banks, for example – this may be
the desired option in order to ensure better governance. It will,
however, have implications for Bank staff resources, as well as
ensuring conflicts of interest do not arise.
61. It appears that the most urgent policy initiative that the
EBRD can pursue is to promote measures to improve the co-operation
between national supervisors with respect to the implications for
cross-border lending. This reflects not only the importance of foreign
banks in the banking sectors of much of the region, but the fact
that these banks, through their local subsidiaries, are an important
means whereby the EBRD can assist in the financing of many smaller-sized
entities through its credit lines. The steps that the EBRD has taken to
date in order to promote a regional approach to this issue are encouraging.
62. There are good reasons for believing that the more democratic
a regime, then the greater the respect of the rule of law, the less
the corruption and the greater the media freedom enabling more general
scrutiny of government policy, all of which might be expected to
contribute to sustained growth over the medium term.
***
Reporting committee:
Committee on Economic Affairs and Development. Reference to committee:
Standing Mandate. Draft resolution unanimously
adopted by the committee on 18 May 2009.
Members of the committee:
Mr Márton Braun (Chairperson), Mr Robert Walter (1st Vice-Chairperson), Mrs Doris Barnett (2nd Vice-Chairperson),
Mrs Antigoni Papadopoulos (3rd Vice-Chairperson), MM. Ruhi Açikgöz, Ulrich Adam, Pedro Agramunt Font de Mora, Roberto
Antonione, Robert Arrigo, Viorel Riceard Badea (alternate: Mr Traian Constantin Igaş), Zigmantas
Balčytis, Mrs Veronika Bellmann, MM Vidar Bjørnstad, Luuk Blom (alternate:
Mr Tuur Elzinga), Mrs Maryvonne
Blondin, MM. Predrag Bošković, Patrick Breen, Erol Aslan Cebeci,Lord David Chidgey, Mrs Elvira Cortajarena Iturrioz,MM. Valeriu Cosarciuc, Joan Albert Farré Santuré,
Relu Fenechiu, Guiorgui Gabashvili, Marco Gatti, Zahari Georgiev, Paolo Giaretta,Francis Grignon, Mrs Arlette Grosskost,
Mrs Azra Hadžiahmetović, Mrs Karin Hakl, MM. Norbert Haupert, Stanisław
Huskowski, Ivan Nikolaev Ivanov, Igor Ivanovski, Čedomir Jovanović,
Mrs Nastaša Jovanović, MM. Antti Kaikkonen,
Oskars Kastēns, Emmanouil Kefaloyiannis,Serhiy Klyuev, Albrecht Konečný, BronisławKorfanty (alternate: Mr Piotr Wach), AnatoliyKorobeynikov, Ertuğrul Kumcuoğlu, Bob Laxton,
Harald Leibrecht, Mrs Anna Lilliehöök,
MM. Arthur Loepfe, Denis MacShane, Yevhen Marmazov, Jean-Pierre
Masseret, Miloš Melčák, JoséMendes
Bota, Attila Mesterházy, Alejandro Muňoz
Alonso,Mrs Olga
Nachtmannová, Mrs Hermine Naghdalyan, MM. Gebhard Negele, Jean-Marc
Nollet, Mrs Mirosława Nykiel,Mrs Ganira Pashayeva, Mrs Maria Pejčinović-Burić, MM. VictorPleskachevskiy, Jacob
Presečnik, MM. Maximilian Reimann, Andrea Rigoni, Mrs Maria de Belém
Roseira (alternate: Mr MaximianoMartins), MM. Giuseppe Saro, Hans Christian Schmidt,
Samad Seyidov, Steingrímur J. Sigfússon, Leonid Slutsky, Serhiy
Sobolev, Christophe Steiner, Vyacheslav Timchenko (alternate: Mr Nikolay Tulaev), Mrs Arenca Trashani,
Mr Mihai Tudose, Mrs Ester Tuiksoo, MM. Oldrich Vojir, Konstantinos Vrettos, Harm Evert
Waalkens, Paul Wille, Mrs
Maryam Yazdanfar (alternate: Mr Göran
Lindblad).
NB: The names of the members who took part in the meeting
are printed in bold. Secretariat to the committee: Mr
Newman, Mr de Buyer, Mr Chahbazian, Mr Pfaadt.