Doc. 9116

7 June 2001

European Bank for Reconstruction and Development (EBRD) and the state of transition in central and eastern Europe

Report

Committee on Economic Affairs and Development

Rapporteur: Mrs Maria Stoyanova, Bulgaria, Group of the European People’s Party

Summary

As the European Bank for Reconstruction and Development - for which the Parliamentary Assembly of the Council of Europe serves as parliamentary forum - enters its second decade, opportunities abound as do challenges. The EBRD is now present in all of its 27 countries of operations and continues - on the strength of an increased capital base and profitability restored following the 1998 financial crisis - to make what the report calls a "tangible contribution" to the transition process.

However, difficulties remain, in the form of continued poverty in many countries, uneven progress on reform and hence growth, high unemployment, social suffering and unsolved environmental problems. As the EBRD is paying increasing attention to the project needs of its less economically developed members in these and other areas, it is also placing more and more emphasis on ‘institution building’ and ‘good governance’ at both public and corporate level - qualities which the report sees as cornerstones for lasting development.

Finally, the report welcomes the recent accession of the Federal Republic of Yugoslavia to the EBRD and encourages the Bank further to intensify co-operation with the Council of Europe in accompanying that country - as well as many others - along the road to an ever stronger democracy and market-oriented economy.

I. Draft resolution

1.       The Assembly, in its capacity as parliamentary forum of the European Bank for Reconstruction and Development, has taken note of the report prepared by its Committee on Economic Affairs and Development on the Bank’s activities. As the EBRD enters the second decade of its existence, the Assembly commends it on its tangible contribution to economic development in its 27 countries of operations. With a total of 700 projects worth € 12.5 billion, it is the largest foreign investor in the region. The Bank can also take pride in the assistance it provides in promoting market economy reform in such areas as privatisation, banking and finance and credit facilitation for small businesses.

2.       This notwithstanding, the Bank continues to face significant challenges. Widespread poverty from Russia to south-eastern Europe and central Asia, uneven progress in the transition to a market-oriented economy as much as between countries, high unemployment and new social problems following restructuring and reform continue to call for efficient, flexible and prompt EBRD action.

3.       The Assembly welcomes the EBRD’s increasing focus on the less developed countries of operations, especially those that have made little progress on the road towards a market, democracy-based economy. It urges the Bank to increase its role and assistance in building a better corporate culture and ‘good governance’ in these countries.

4.       Several EBRD countries of operations are preparing to join the European Union. Accession to the EU has proven to be a strong incentive for them to press ahead with reform. The Assembly supports the EBRD’s commitment to continued operations in these countries. It believes the Bank could best promote EU accession by focusing on long-term investments less sought by private investors, by assisting privatisation and restructuring projects, and by increasing support for rural and agricultural projects at municipal level that serve to facilitate integration into EU structures.

5.       The Assembly welcomes the Bank’s major contribution to the Stability Pact for south-eastern Europe and salutes the accession of a democratic Federal Republic of Yugoslavia to the Bank’s fold. It notes, however, that although start-up projects within the Pact appear to be yielding first results, delays in the implementation of other projects have caused considerable frustration in recipient countries and risk jeopardising long-term investment and overall reform. It is therefore important for the Bank to help to speed up Stability Pact procedures and to work in particularly close partnership with beneficiary countries in identifying opportunities and building on local initiatives and entrepreneurship potential. The Bank should give priority to cross-border programmes and joint projects among neighbouring countries as a means of fostering regional understanding and economic interdependence.

6.       The Assembly supports the Bank’s commitment to assisting Russia in taking reform forward. The rapid recovery of the Russian economy since the 1998 financial crisis and that country’s great but not yet fully used human potential should be reasons to press ahead with measures to build a strong, ethical corporate culture and to foster ‘good governance’ at all levels of society. The Bank should build on the success of its Russia Small Business Fund and strongly support any positive aspects of the country’s new efforts to reform fundamentally the functioning of state institutions, the social sector and the interplay between different levels of government.

7.       The Assembly notes with satisfaction that the Bank has drawn important lessons from its first decade – in particular as regards the need to develop open procedures, standard norms and the rule of law in order for markets and democracy to work well. It welcomes the Bank’s decision to put institution building and corporate governance at the top of its agenda. In this context the Assembly recalls its Resolution 1218 (2000) on the EBRD and the progress of transition and in particular that resolution’s emphasis on the need to build strong public institutions and administrations capable of supporting markets and private enterprises within a rule of law framework.

8.       Ten years of operations have given the Bank and its local partners considerable experience in all countries of operations. In order for the Bank to achieve one of its principal objectives for the next decade, that is to say institutional strengthening and the establishment of sound corporate rules, the Bank may need to decentralise further its operations and responsibilities. The Assembly calls upon it to provide the necessary expertise and training to its local partners and local offices, so that the latter may assume greater responsibilities in project management, implementation and monitoring.

9.       The Assembly welcomes the contribution of the Bank to market and trade liberalisation in transition countries in the interest of European integration. It calls on the Bank to take its assistance further in this field and provide appropriate incentives for countries of operations to keep markets and trade free from excessive government red tape, in order to advance liberalisation where it is incomplete and to sustain it where it has been achieved.

10.       Ten years of operations by the Bank have demonstrated that successful reforms and restructuring can only be achieved if due attention is paid to the human dimension and social aspects. The Assembly calls upon the Bank to assist its member countries in identifying and setting up adequate social safety nets and employment programmes in order to tackle the problem of poverty and ensure the sustainability of reforms and restructuring. It calls on the countries concerned to press on with social, institutional and legal reforms in order to reach a business and investment climate capable of generating increased wealth and employment.

11.       The Assembly fully shares the Bank’s conclusion that a successful transition progress critically depends on the availability of workers with appropriate skills, rapid technological change and increased use of information and communications technologies (ICTs). The Assembly calls on countries of operations, with EBRD support, urgently to define public policies in this field, speed up the diffusion of ICTs and offer adequate education and training programmes for their workforce.

12.       The Assembly supports the Bank’s increased emphasis on supporting small and medium sized businesses via local banks, and its intention to double such lending within the next five years. ‘Micro-finance lending’ has proved to be an innovative and successful way to build a culture of commercially sound project planning at local management level.

13.        The Assembly welcomes the EBRD’s financial and other support for the improvement of nuclear safety, the decommissioning of nuclear power stations and the construction of the Chornobyl sarcophagus. In this context, it encourages the EBRD to initiate and support additional projects aimed at promoting energy conservation and the use of renewable sources of energy. Overall, environmental standards should play a greater role in EBRD decisions on credits for new projects.

14.       The Assembly strongly supports the Bank’s adherence to both economic criteria and its statutory political principles by attempting to relate the volume of operations to the adherence by recipient countries to democratic principles. It calls upon the governments of all the Banks countries of operations – and in particular Belarus and Turkmenistan – fully to abide by democratic principles and thereby facilitate the Bank’s task. The Assembly encourages the Bank to seek even closer corporation than heretofore with the Council of Europe’s Parliamentary Assembly and especially its Committee on the Honouring of Obligations and Commitments by Member States of the Council of Europe (Monitoring Committee).

15.       The challenges of structural reform cannot be overcome by any one country or institution alone. The Assembly therefore encourages the Bank to develop further its co-operation with other multilateral institutions such as the World Bank, the International Monetary Fund, the European Investment Bank and, in particular, the Council of Europe’s Development Bank, for which the Parliamentary Assembly likewise serves as a parliamentary forum. In this context it is particularly important for these institutions to avoid any overlap in, or conflicting effects of, their respective actions.

16.       Finally, the Assembly encourages the Bank to modify its information policy so as to issue wherever possible project related information in the national language or languages of the countries concerned, facilitate public access to information regarding projects, and consider the establishment of a body to hear appeals and grievances from the public.

II. Explanatory Memorandum by the Rapporteur

Table of contents

I. INTRODUCTION: THE EBRD’S MISSION AND THE ROLE OF THE

      PARLIAMENTARY ASSEMBLY

II.        THE MAY 2000 RIGA ANNUAL MEETING AND BEYOND.

THE 2000 TRANSITION REPORT

III.        THE FOCUS OF THE EBRD’S FUTURE WORK. THE PARAMOUNT

IMPORTANCE OF ‘GOOD GOVERNANCE’

      3. Investment in Financial Institutions

IV.        OPERATIONS IN RUSSIA

V.        SOUTH-EASTERN EUROPE

VI.        CENTRAL AND EASTERN EUROPE

VII.       EBRD’s 10th ANNUAL MEETING (London, 23-24 April 2001)

VIII.        FOLLOW-UP TO THE ASSEMBLY’S RESOLUTION 1218 (2000)

IX.        CONCLUDING REMARKS

I.        INTRODUCTION: THE EBRD’S MISSION AND THE ROLE OF THE PARLIAMENTARY ASSEMBLY

1.       When the EBRD - or ‘the Bank’, as it will intermittently be referred to in this report - was established in 1991, its mandate was framed with the aim of fostering the post-communist transition towards open market-oriented economies, and of promoting private and entrepreneurial initiative. It set out to invest finance and know-how in the, eventually, 27 so-called ‘countries of operations. These include countries in Central and Eastern Europe (CEE), the Commonwealth of Independent States (CIS) and South Eastern Europe (SEE), which declared they were committed to and would apply the principles of political pluralism and market-oriented economies.

2.       Operating within these terms of reference, the EBRD has since sought to implement structural and sectoral economic reforms and promote competition, privatisation and entrepreneurship, while taking into account the particular needs of countries at different stages of transition. The different stages are actually more clearly discernible today than they were ten years ago. Through its investments it has attempted to promote private sector activity, strengthen financial institutions and legal systems and develop the infrastructure needed to support the private sector. As a financial institution, the EBRD has also been given the responsibility of applying sound banking and investment principles in all of its operations. More recently, as will be seen later, the Bank has come to pay greater and greater attention to the need for ‘good governance’, perhaps sometimes in exasperation at seeing some of its well-intentioned lending operations come to nought in an environment of ‘bad governance’ in some countries of operations.

3.       Thus, ten years after the start of the transition, difficulties and challenges still abound, testing the resolve of transition countries to pursue reform. Even though overall progress has been observed, there are significant variations in the achievements of different countries. The prospect of a European Union membership for some countries has added incentive for reform, even as it may strain the capacity for certain among them to absorb assistance usefully.

4.       In the large majority of the countries concerned, however, central planning and a command system over the economy have indeed been set aside by the introduction of markets and prices. Furthermore, allowing for some exceptions, democratic elections have also been taking place. In 21 out of the 27 countries, the private sector today accounts for over half the aggregate output, an astounding achievement. In the more economically developed transition countries of Hungary, Estonia or the Czech Republic, it is, at 80%, closer to, or indeed surpassing, western European levels,.

5.       These developments have generated a degree of commitment to the market economy that should not be underestimated. However, for most of the countries within the EBRD's ambit, the transition to a functioning market-based economy and a pluralist democracy continues to be a difficult journey with mixed results. There has, understandably, been a wide variation of achievements across such a diverse region, due to a number of differing domestic conditions to which we shall return.

6.       Nevertheless, after ten years of transition questions have been asked as to whether the EBRD has done enough to encourage entrepreneurship, improve corporate governance and enhance private property rights. There is a concern, that if the EBRD does not help to allocate economic resources efficiently and is not fully equipped to monitor its vast portfolio, then it is, by implication, unwittingly collaborating in the perpetuation of some of the less desirable features of the transition countries, for example tax evasion and corruption. The difficult trade-offs that the EBRD has had to make between investment banking and development banking – a dilemma referred to by several previous Assembly Rapporteurs - have come under much scrutiny, along with the credibility of some of its project commitments. There are also doubts whether, after ten years of reforms, EBRD ‘special treatment’ is still justified or whether transition is effectively over for some more economically developed countries of operations. Should these countries still be treated any differently from, say, developing countries with a similar level of per capita income, such as Brazil?

7.        In response to these issues, the EBRD now faces the dual challenge of building a new momentum for reform and rapidly helping to lift the level of development in the less economically developed transition countries towards that of countries that are now candidates for EU membership. The EBRD must create, consolidate and strengthen the institutions, policies and behaviour that underpin a well-functioning market economy, in order to produce an attractive climate for investment that can in turn generate long-term growth. This report will look at the factors that will determine the EBRD's ability to fulfil its mandate by meeting the challenges posed in the next phase of transition.

8.       Before entering the body of her report, the Rapporteur wishes to thank Mr Jean Lemierre, EBRD President, for the very interesting exchange of views the Committee on Economic Affairs and Development was able to hold with him and his senior staff during its visit to EBRD headquarters on 18 January 2000.1 She is also most grateful to her colleagues on the Committee for their valuable contributions, including at the report’s adoption in its draft form in Sevilla, Spain, in May 2001.

II.        THE MAY 2000 RIGA ANNUAL MEETING AND BEYOND. THE 2000 TRANSITION REPORT

9.        In May 2000, the EBRD met for its Annual Meeting in Riga, with the Parliamentary Assembly of the Council of Europe represented by Mr Kittis. The meeting served to install Mr Lemierre as new President, after the departure of Horst Köhler to the post of Managing Director of the International Monetary Fund. It also defined the EBRD's strategy after a more uplifting year of profit of 1999, following the loss of € 261m ($291m) in 1998. Much of this loss resulted from the Russian financial crisis in 1998, when the EBRD was hit heavily by the country’s default of many of its financial obligations and the depreciation of the rouble. Some recovery in Russia and the surrounding region has since taken place, with the EBRD counting on economic growth of around 5% in the CIS in 2000.

10.       The Rapporteur attended the annual meeting of the EBRD’s Board of Governors in London in April 2001, which will be discussed in greater detail in Chapter VII. Suffice it to say here in the introduction that the Bank on this occasion carried out a five-year review of its operations and examined ways of raising its lending capacity to about €3.5 billion over the coming years. The Bank will try to move toward more investment in venture capital and toward using its regional offices in the countries of operations more fully. It also seeks closer cooperation with the Council of Europe’s Development Bank and the European Investment Bank, not least in order to enhance action in favour of greater social and economic cohesion. No doubt the Assembly’s Committee on Economic Affairs and Development, which now assumes the main role in accompanying the Development Bank and also maintains close relations with the EIB, will do its utmost to assist in this process.

11.       The EBRD’s Transition Report 2000 makes for highly interesting reading. Its key message is that there has been a generally strong recovery in the Bank’s countries of operations and that reform gains brighten the outlook for the countries that have undertaken them. It is now essential, it says, to upgrade and sustain growth and to insist on further privatisation and liberalisation in the economies concerned. Furthermore, the EBRD sees a large untapped potential in the region, particularly as regards the people and their skills. (The report has the appropriate sub-title “Employment, Skills and Transition.)

12.       However, transition challenges and risks remain. It is particularly important to safeguard macro-economic stability and improve the performance of institutions. The EBRD has its own ‘transition indicator’, purporting to measure the pace of reforms. It finds, for instance, that the reform pace has been highest in central and eastern Europe and the Baltics, followed by, in that order, south-eastern Europe, the CIS countries, the Caucasus and central Asia. Growth in 2000 is estimated to have been 4.8% on average in the EBRD’s area of operations - up from 2.5% in 1999 and a negative growth of 1.1% in 1998. The economic recovery in the European Union area, leading to better export opportunities toward that region, has brightened the outlook in central and eastern Europe and the Baltics in particular. Some of the CIS countries were helped by high oil and gas prices.

13.       Another conclusion in the EBRD’s Transition Report 2000 is that investors increasingly differentiate among countries. Thus, of the total $27 billion in foreign direct investment going to the 27 countries of operations in 2000, close to $20 billion went to central and eastern Europe and the Baltics, but only slightly over $5 billion to the CIS countries. The report concludes that it is not natural for the 27 countries of operation of the EBRD to have only $ 1 trillion in combined GDP, when a single country in western Europe, the United Kingdom, has a GDP of the same order. Similarly, the region has only slightly more foreign direct investment coming to it ($27 billion), than that going to Brazil alone. Finally, exports from the regions, amounting to $200 billion in 2000, are not much larger than those of Korea, at $144 billion.

14.       Darkening the picture somewhat in certain of the countries, especially the CIS, is the fact that the upturn is being largely driven by higher oil prices (which are, however, more recently coming down again) and by currency devaluations following the Russian financial crisis in 1998. While these conditions may have boosted competitiveness, they are a weak and highly vulnerable basis for sustainable growth. Therefore, the more recent efforts of the Russian government to shape appropriate macroeconomic policies for the elimination of fiscal deficits and for reducing public domestic borrowing are highly welcome. There is now widespread consensus that much more needs to be done to improve the investment climate in order to bring about such long-term growth.

15.       The EBRD notes that the benefits of reform have not been evenly distributed. While countries such as Poland, Hungary and Slovenia have achieved more than the 5% average growth, large regions still face poverty, high unemployment and severe skill shortages. There is a widespread view that sustainable growth will only be achieved by further structural reform and the strengthening of the social safety net.

16.        Although the CIS region has been receiving a boost from the rise in the price of commodities like oil, it has not been fully utilising its other most precious resources – the relatively unique combination of its high level of human capital and low labour costs. This has had detrimental consequences for economic and social development. As the EBRD's chief economist Willem Buiter, who addressed the Economic Committee at its January 2000 meeting in London, put it:

17.        While stressing the work that remains to be done in the region, the EBRD points out that the countries of western Europe also have a part to play in the transition. The Bank cautioned against having a ‘Brussels lace curtain‘ go up where the old ‘Iron Curtain’ once came down.

18.       Political instability has lessened in the south-east, with a new, reform-oriented, Croatian government in place and democratisation under way in the Federal Republic of Yugoslavia. FRY became a member of the Bank on 18 January 2001. The recent acceleration in EU economic growth should help to increase exports and investment also within this region.

19.       The Bank warned that procrastination over the timetable for the first wave of eastern and central European countries joining the EU could set back the applicant countries – not only in their reform efforts but also by turning so far EU-friendly populations into latter-day ‘Euro-disappointees’. It stressed that the EU needs to maintain an open market stance towards countries in SEE and the CIS after the first wave of enlargement, in order to maintain development throughout the region.

III.        THE FOCUS OF THE EBRD’S FUTURE WORK. THE PARAMOUNT

IMPORTANCE OF ‘GOOD GOVERNANCE’

20.       The EBRD has outlined some key areas for the second phase of transition. These include disseminating "best practices" and creating sound and appropriate financial sectors directed at the needs of small and medium-sized enterprises (SMEs) and individual households. The EBRD is seeking to promote SMEs by instituting enterprise restructuring projects, introducing commercial approaches to infrastructure development and designing effective methods for equity investment.

21.       With this in mind, a number of areas have been targeted for reform. They include:

22.       The absence of a well-functioning tax system throughout much of the region, and particularly in the CIS, has diminished fiscal resources at this most critical time. Fiscal reform needs to increase revenue in a way that limits discretion of the authorities and minimises disincentives to entrepreneurship.

23.        The Rapporteur devoted a considerable part of her talks with the EBRD to the issue of governance, especially against the background of several reports on economic crime and corruption emanating from the Committee on Economic Affairs and Development and recently adopted by the Parliamentary Assembly of the Council of Europe.2 It is natural that the EBRD should over time come to devote more attention to governance, as it discovers that the money it lends may fall on barren ground where it is not observed. To visualise the dimensions of bad governance, the Bank has prepared graphs in the form of ‘cobwebs’ with 10 dimensions of governance, permitting the reader to see immediately how big the area of ‘bad governance’ is as it forms a kind of spider’s web on the clock’s surface. The bigger the web in all or some directions, the worse the governance. Similarly, the smaller the web, the better the governance. The dimensions are: political instability; inflation; exchange rate; finance; taxes and regulations; infrastructure; functioning of the judiciary; corruption; street crime, theft and disorder; and organised crime. Countries like Kyrgyzstan, Moldova, Russia and Ukraine show large webs, while Slovenia, Poland and Hungary show comparatively small webs.

24.        The EBRD emphasises that corruption should be seen as part of a broader picture of institutional dysfunctioning. Often it is a matter of reducing the role of the state, where corruption etc can occur, through liberalisation of the economy and increased competition. At other times the problem can be ‘too little state’, that is, ‘too little good state’.

25.        The EBRD has also produced convincing statistics showing that foreign direct investment shuns countries with bad governance, especially where ‘state capture’ in the form of high levels of corruption is found. The Bank tries to fight corruption by dialogue, stringent conditions for loans, and by giving as wide publicity as possible to its findings in this field.

26.        Corruption is both a fundamental cause, and effect, of weak state authority. Corrupt and clientelistic behaviour has become commonplace in some countries. Corruption in the CIS is commonly recognised to be more severe than in all of the other regions in transition and the common occurrence of illegal behaviour has eroded norms. In such a situation not only is economic productivity lowered, but the enforceable authority of government is undermined.

27.        State structures and behaviour that offer weak support for an open and competitive market economy must now be identified with a view to reform. It is clear that the prospects for investment and growth are heavily dependent on removing the obstacle of bureaucratic interference in business. Impediments to effective reform - such as bureaucratic intrusion and a limited civil service understanding of the appropriate role of government in relation to the private sector - must now be addressed.

28.        The relationship between central and regional government must also be clarified and codified. In Russia, for example, there has been a major devolution of power to the regions over the past decade, even though more recently Russia’s new president has tried to reverse the trend. The management of such decentralisation has generated much conflict and confusion regarding the separation of powers and responsibilities at different levels of government. Rather than instituting a clear framework for devolution, there has been an assortment of bilateral and ad hoc arrangements that do little to aid efficiency, transparency or accountability. The results have been particularly detrimental to the system of fiscal federalism which, combined with other economic and cultural factors, has led to a disparity in the nature of business and investment conditions across the regions.

29.        Making progress in addressing these issues is underway in the countries of central eastern Europe (CEE) and the Baltic states (CEB). However, the countries of southern-eastern Europe (SEE) and the Commonwealth of Independent States (CIS) have seen less success in improving institutional performance. It is clear from the variable performances in the first phase of transition that steady progress towards strengthening the performance of market-supporting institutions is not something that can be taken for granted. One strategy for the second phase of transition must therefore be to ensure that the newly established economic and political freedoms provide a firm foundation for substantial ,and fair, economic and political competition.

30.        The EBRD has a rather elaborate performance evaluation policy. Performance reviews are important not only to draw lessons from the past but also to ensure accountability and transparency before shareholders. Evaluation applies to all projects and normally starts within a year or two after the disbursement of funds. Expectations and performance are compared with basic criteria such as ‘transition impact’ (how the project has helped transition), ‘additionality’ (how the EBRD’s contribution adds usefully to the efforts of other lenders), the respect of sound banking principles, the fulfilment of objectives, environmental performance and the contribution of the project to the Bank’s own profits.. Occasionally, studies are carried out on specific sectors of activity, such as SMEs or environmental projects. Lessons learned are disseminated throughout the organisation and to the outside world through publications. A total of 210 projects has been evaluated to date, of which three-quarters are judged to have had a medium or high transition impact. Infrastructure projects are deemed to have the highest impact on transition, whereas investments in industry and commerce were seen as more risky. The highest overall scores has, predictably, been in central and eastern European countries and the Baltic states.

2. Promoting small and medium-sized enterprises (SMEs)

31.       It is now generally recognised that SMEs are a driving force behind innovation, growth and popular involvement in market reform. In order to promote these new companies, the EBRD is increasing its focus on developing cooperation between SMEs and local and regional partners. The EBRD is also encouraging the banking sector to foster a clear commitment towards SMEs. Indeed, in trying to reduce the cost of handling projects it works with the SMEs via local and regional banks.

32.       The EBRD is, however, also helping to restructure large and potentially viable enterprises as a demonstrable model for other companies and investors. By encouraging restructuring along with SME projects, regional venture capital funds and municipal infrastructure projects, the Bank aims to give regions a firmer basis for economic and social development. In SEE, for instance, there is to be a ‘bottom-up’ approach emphasising the need for a better investment climate through the setting up of micro-finance institutions, building SME finance capacity in local banks, and dismantling impediments to SME development.

33.       When coordinated with the projects of other international financial institutions, for example the World Bank, these moves are expected to further the development of SMEs, restructuring and the enhancement of local infrastructure. It is additionally expected to create new employment for those affected by restructuring. Reorienting infrastructure to the needs of the market is conditional on the process of the establishment of corporate responsibility, an orientation towards consumer demands, a focus on service and the controlling of costs and risks.

34.       The Rapporteur supports and commends all of these moves. However, such projects should find their place within a new strategy. What must clearly be avoided in future is the channelling of precious resources into the emerging SME sector through a domestic banking system that may be decrepit and mismanaged. Not only does this impede the introduction of corporate responsibility but, in the past, when these banks went bankrupt, they also wiped out whole portfolios of EBRD SME funds, which were guaranteed, at least in theory, by the respective government.

3. Investment in Financial Institutions

35.        Given the importance of instituting a healthy financial environment for investment, investment in financial institutions has become another focus for the Bank. The EBRD sees good local banks as a crucial part of viable financial markets.

36.        However, the reality is that the financial sector in many countries of operations is still unable to offer the necessary intermediation for sustaining growth, even in some of the more economically developed transition countries. For the most part, these banks are unable or unwilling to finance enterprises and develop infrastructure for an expansion of retail banking. Large, state-controlled banks and insurance companies are still in place in many of the EBRD’s countries of operations and cannot always be counted on to act in a financially prudent or accountable manner. In the case of Russia, both banks in which the EBRD took equity stakes - Tokobank and Inkombank - collapsed in 1998. It was alleged that one bank's liquidator left the country with its remaining assets, while in the other lawsuits continue. EBRD losses are estimated to be in the tens of millions of dollars.

37.        One recent move the Bank has made to underpin reforms in the finance and investment sector has been to instigate legal action over investors' rights. For example, the EBRD went to court after Chernogorneft, an oil concern in Russia, was forced into bankruptcy and then sold cheaply to a Russian rival. The EBRD initially lost the case but after launching several appeals it is now optimistic about recovering most of its investment. The EBRD has often found, however, that the Russian legal system favours powerful locals. Thus, litigation is widely seen to be both symbolically and financially important. As the Bank's Vice- President, Charles Frank, put it: "We have to take a lead on shareholder rights, because we can make ourselves felt."

4. Social and environmental protection to underpin reform

38.       There has been severe social hardship throughout the region in the transition to market-based economies and democracy. Vast inequalities in the distribution of the gains and losses resulting from transition, both regionally and socially, have emerged. Not only has there been a substantial decline in the living standards of large sections of the populations, but there has also been an absolute increase in poverty. Life expectancy has dropped in several countries. Consequently, there has been a major increase in the level of insecurity and instability in everyday life. This has had obvious and deleterious political ramifications.

39.        This severe social strain not only has implications for political stability, but poverty and income inequality can in itself pose a challenge for fiscal policy. Social protection and redistribution come from the expenditure side of the budget not only in terms of a social safety net, but also by enhancing human capital through education and health, which are necessary for a productive participation in the economy. Increased revenue is vital for augmenting public expenditure on health, education, social infrastructure and social safety nets. These sectors all serve to raise living standards of the poor and promote participatory growth.

40.        At the adoption of the present report it also became clear how strongly the Economic Committee stresses the need for environment protection to continue to figure prominently in the EBRD’s actions. Support was expressed for the Bank’s efforts to improve nuclear safety in countries of operations, to decommission nuclear power stations and to complete the Chornobyl sarcophagus. Members went on to encourage the EBRD to initiate and support more projects aimed at promoting energy conservation, the use of renewable sources of energy and the clean-up of soil, rivers and seas. The committee agreeed that environmental standards should play an even greater role in EBRD decisions on credits for new projects than has so far been the case.

5. The prospect of joining the European Union

41.       For the EU candidate countries of the region, the second phase of transition and reform will be very much shaped by how the process of accession shapes up. The Copenhagen criteria for accession, drawn up at the June 1993 European Council, closely resemble the transition indicators set by the EBRD.

42.        The conditions for accession contain even more detailed obligations. They concern the strengthening and adjustment of public institutions to ensure product standards and competition. Other conditions attach to the transformation of enterprises, the strengthening of financial institutions and the building of a fully functioning market economy. The momentum of transition will be given a boost by these obligations, along with the commitment to institute EU rules for health and safety in the workplace and environmental standards. Accession to the EU offers an added incentive for reform. On the other hand, delays and obstacles in the accession negotiations, such as now observed all too frequently, could have an adverse effect in that disappointment could slow down the reform zeal.

6. The Importance of Macroeconomic stabilisation

43.        A precondition for economic recovery during transition is successful macroeconomic stabilisation. The Rapporteur’s own country, Bulgaria, knows this only too well from bitter experience. While there is a limit to the benefits to be gained from depressing the level of inflation, a low rate of inflation and smaller budget deficits are generally associated with higher growth rates. The financial overexposure the EBRD suffered during the Russian financial crisis of 1998 also underlined the importance of maintaining macroeconomic stability on the long road of transition.

7. The Importance of Structural Adjustments and the Pace of Reform

44.       Carrying out liberalisation and privatisation reform has paid off for countries in transition. Indeed, even modest steps to liberalise prices and trade and encourage SMEs and small-scale privatisations may be enough for those further behind in transition to achieve growth rates comparable to those in economically developed countries - at least for some time before even more profound reform is called for. However, the EBRD increasingly argues, the fruits of liberalisation and privatisation depend intimately on institutional reform capable of benefiting the majority of the population. The Bank’s policy advice in favour of rapid liberalisation and privatisation and its particular focus on SMEs still hold, but it now equally stresses the importance of an institutional environment underpinning such reforms. Such an environment loses none of its significance – indeed it can be seen as even more important - in the second phase of the transition process.

8. Internal conditions in countries of operations

45.       EBRD studies of the relative importance of conditions at the outset of the transition process for subsequent growth suggest that they played a certain role. Certain characteristics of centrally planned economies have, to varying degrees, left their mark on economic structures and still remain deeply embedded in the overall culture. They include a preference for industry, particularly heavy industry, over services; high rates of investment in physical and human capital; an insufficient financial system capable of channelling savings into investment; and the lack of legal and institutional frameworks to underpin a market economy.

46.        Although some countries did ‘defy the odds’, as it were, in overcoming unfavourable initial conditions through firm commitment to rapid reform, it has been argued that differences in starting points were perhaps as important as resolve itself. Whatever may be the case, EBRD data show that while the effects of inherited conditions wane over time, the will to undertake reform, and the quality of reform, will determine success in the longer term. In other words, countries can overcome initial unfavourable conditions through resolute and consistent commitment to reform.

47.       Clearly, ten years of transition is a fairly short time and the process is far from over. Most of the countries in transition can be positively characterised by possessing a more extensive physical infrastructure and a higher proportion of their population in secondary and tertiary education than other countries, even though the infrastructure and education in question may be in need of renewal. However, they also exhibit a higher share of employment in industry and a greater energy consumption per capita than do established market-economy countries. Finally, the financial and institutional framework needed in a market economy will have to be strengthened more in the CIS and SEE regions than in the CEE and Baltic states regions.

IV.        OPERATIONS IN RUSSIA

48.       The Rapporteur and the Committee chose to deal at length with the EBRD’s Russian operations in their talks with the Bank. One reason is that the EBRD has been questioned intensely in the press and in political circles over its decision to involve itself anew and so intensely in Russia after its significant losses there in 1998, and its reduction of operations in the country that year.3 The importance attached by the EBRD to Russia is of course also due to the country’s size and population. About one-third of the total population of central and eastern Europe and the CIS countries (147 million out of 450 million) live in Russia, and a considerable portion of the region’s vast natural resources is in Russian territory.

49.       In October 2000, the EBRD Board of Directors approved a new Strategy for Russia for the 2001-2002 period, within the framework of its Medium Term Strategy. One objective is to use EBRD projects as a means to establish a dialogue about their implementation to support confidence building at local level. The most prudent EBRD scenario provides for a minimum yearly commitment of € 300-400 million. If the investment climate improves further, this figure could reach € 800-1000 million per year, corresponding to 30 percent of total EBRD commitments in all countries of operations. Preliminary data show that 18 projects were implemented in Russia in 2000, representing € 580 million (up from € 220 million in 1999).

50.       The Bank’s return to Russia comes at a time when many international investors may be overcoming their earlier hesitations about investing in the country. Economic recovery has been assisted by higher oil prices and a depreciated currency favouring exports.

51.       Russian growth in 2000 seems to have been broadly based, within raw materials production and manufacturing in particular. Production is reported by our Russian colleagues to have increased in all sectors, the largest growth rates being observed in manufacturing sectors such as textiles (22%) and machinery (16%). It therefore seems that there is not only output growth per se but also an improvement in the overall structure of the Russian economy. The Rapporteur very much hopes that these encouraging signs are part of a wider trend for the Russian economy to move away from an excessive dependency on raw materials and comparatively unsophisticated products, which are particularly susceptible to price fluctuations.

52.       Furthermore, our Russian colleagues have informed the Committee that the total volume of foreign investment increased by 14.6% in 2000 over the previous year, reaching $11 billion. (This includes direct foreign investment of $4.4 billion, up by 40% over the previous year). During the same year, they say, a number of changes were introduced into the tax legislation. These include a reduction in the tax burden amounting to approximately 2% of GDP; a switch from progressive to proportional personal income tax, along with a sharp reduction in the tax rate to 13%; a change from proportional to regressive social taxes and measures to bring the Russian external trade regime closer to WTO standards in view of the country’s efforts to become a WTO member.

53.       The EBRD’s increased activities in Russia have also no doubt been helped by the country’s progress in repaying or restructuring its foreign debt. Our Russian Committee colleagues inform us that the share of Russian banks in the total credit portfolio of the EBRD bearing no interest decreased from € 383m in 2000 to € 261m at present (May 2001), i.e. from 85% to 72% following repayment and restructuring of debt. They at the same time regret that the Paris Club of international creditors has been unwilling to restructure Russian debts inherited from the Soviet Union, on terms similar to those granted by their peers of the London Club of creditors. Furthermore, they consider the IMF position vis-à-vis Russia unjustifiably rigid when compared to those adopted as regards countries in similar difficulties, such as Argentina, Turkey and Ukraine.

54.       EBRD officials point to impressive economic growth in Russia. According to Russian members of the Economic Committee, growth reached 7.7 percent in 2000. They also said that industrial production grew by 9 percent that year.

55.       The EBRD also welcomes reform proposals in a number of areas where they are badly needed. These include taxes and tax collection (including customs), anti-trust legislation, the pension system, administration, the fight against corruption, privatisation, land ownership, red tape, banking and the judiciary. Administrative barriers to business activities are also being targeted, as regards for example licensing, registration, and the streamlining of government supervision.

56.       The Rapporteur expressed concern in the first version of her report that these laudable proposals were facing a slow parliamentary process. However, since then the pace seems to have quickened, with renewed optimism in its wake. Reform prospects have brightened also because the Russian president seems to be largely in command of the political situation in the country and to enjoy wide support in parliament.

57.       The EBRD also notes that reforms in the banking sector, judicial system, administration and social sector have become top priorities on the governmental and parliamentary agendas. Some progress has been achieved in the banking sector. Reform in the latter is particularly urgent. Until it comes about, there will be little public confidence in banks and hence little stimulus for the economy. Money stored in mattresses does not produce growth. Any increased confidence in banks would also contribute to reversing capital flight from Russia.

58.       The EBRD nevertheless sees a ‘race against time’ as being underway in the country. The ‘window of opportunity’ now offered through higher oil and gas prices must be used. In other words, now that the economy is being stabilised due to the relatively high prices for these and other raw materials, the time must be used to carry out reforms that may be economically painful and politically unpopular in the short term, but which will yield very positive results over the longer term.

59.       The Bank also cautions against the risk posed to continued growth by the stronger external value of the rouble, itself naturally a consequence of the improved situation. Furthermore, if energy prices were to fall and the world economy worsen, due for instance to a weakening of the US economy, this would have obvious consequences also for the Russian economy. To sustain further growth, Russia will therefore have to push ahead resolutely along the path indicated above.

60.       The EBRD’s various programmes directed towards promoting SMEs in Russia provided over €200 million in loans in 2000. The instrument is the Bank’s Russia Small Business Fund, which has so far assisted some 40,000 companies through the EBRD’s links with local financial institutions. Russia’s SME sector, which accounts for only 10% of GDP and employment, has often been overlooked by national banks and unable to influence national policy in their favour. It has been particularly difficult for SMEs to operate in a still often arbitrary market economy, especially when compared to larger businesses with better political contacts. This has led many SMEs to seek refuge in the shadow economy, which in turn has hindered the development of civil society.

61.       The pre-1998 EBRD portfolio generated a total of 94 projects in Russia. Although the bulk of EBRD credits were geared towards traditional ‘smokestack’ industries - such as mining, food processing, pipelines and rubber – the importance of the Russia Small Business Fund should not be underestimated. The Bank often uses local banks as middlemen since helping each SME individually would prohibitively increase handling costs. Some of the credits given to such intermediary banks have suffered due to the difficulties they encountered in the wake of the 1998 financial crisis, but the worst may now be over. At any rate, the EBRD’s efforts to assist SMEs in Russia is to be commended and should be expanded.

62.       Part of the criticism against the EBRD's Russia portfolio has focussed on the fact that many of its loans are directed to a few large conglomerates such as Lukoil and Gazprom, which are seen as not in need of external credits due to currently high energy prices and as enjoying already strong, some would say monopolistic, market positions. (Each of the two companies are expected to have cash flows of $3 billion in 2001.). While the EBRD has granted Lukoil a € 150m loan (now in the final stages of approval) in exchange for the company’s adherence to international accounting standards, Gazprom has been asked to improve its standards of corporate governance to improve prospects for a € 250 million loan it is seeking.

63.       EBRD thinking seems to be that the prospect of its seal of approval will make Russian managers reform faster. The counterargument would be that if the managers want to show they are honest they have every opportunity to do so without EBRD involvement. One suggestion is to demand the cessation of the use of offshore companies that may siphon off profits for undisclosed owners. Indeed, the best way for major Russian companies to find the extra money needed for investment would be to manage cash flows better, treat existing investors better so as to encourage others to follow and to borrow from commercial banks.

64.       This being said, it is clear that there are difficult trade-offs for the EBRD, not least those arising from the difficulty in reconciling strict investment criteria with politically inspired goals and principles. Russia is an eminently important country for overall European stability and prosperity. The EBRD, like the Council of Europe, must do whatever is possible to assist it. However, then we must also redouble our efforts - together with our Russian friends and colleagues, not least in the Russian parliament – to ensure the respect of good corporate governance, encouraged by the Bank's presence and practices.

V.        SOUTH-EASTERN EUROPE

65.       The EBRD has already provided € 2.7 billion to south-eastern Europe. It has defined five major areas of priority: trade finance; SMEs; equity funding; investment risk mitigation; and financial support for local contractors. An equity fund for SMEs has been set up along with a trade guarantee facility, in order to channel aid for business start-ups and facilitate intra-regional trade. In 2000 alone the EBRD committed €550 million to six SEE countries. A significant share of these funds went toward co-participation in infrastructure projects forming part of the so-called ‘quick start package’ under the Stability Pact for the region.

66.       Emerging operations in Yugoslavia present a case of their own. The enormous funds required and the special nature of projects needed call for a comprehensive effort on the part of donors. The EBRD has chosen to focus much of its assistance on SMEs and the banking sector in that country, and to help in the restructuring of the country’s external debt.

67.       While there has been an increase in the number of projects undertaken –especially as part of the EBRD’s participation in the Stability Pact - sustained growth will not be possible in the second phase of transition in this area without a huge increase in private investment. However, such investment is unlikely to be forthcoming unless a more conducive financial environment is created. This is imperative, because within the SEE region public investment, whether from external or internal sources, will not be able to muster the resources necessary for achieving sustainable growth.

68.       Turning to the Stability Pact, the EBRD maintains it is still on track. However, it also feels that its pace is too slow when compared with the desperate needs of the peoples in the region – a belief very much echoed in the Assembly’s recent report on the “Implementation of the Economic Aspects of the Stability Pact for South-Eastern Europe” (See Recommendation 1493 (2001) and Doc. 8905). The Bank told us it will try to simplify the administrative procedures under the Pact. Better coordination of different aid projects is also considered crucial. This was also very much stressed by the Economic Committee as it adopted the present report. It warned against any overlap in, or conflicting effects of, the actions of all the international financial agencies involved, whether it be south-eastern Europe or elsewhere.

69.        A priority, the Bank said, should be given to investments in the real economy that create jobs and produce results quickly. The EBRD itself is focussing much of its work under the Pact towards support for small businesses, banking institutions and projects aimed at restoring public utilities such as roads and water treatment plants. Environmental concerns lead it to allocate a significant share of its lending to projects such as sewage treatment plants and drinking water stations.

70.       While the EBRD stresses its commitment to the development of the private sector, the latter’s presence is not strong in the list of projects that the Bank drew up for the ‘former Yugoslav Republic of Macedonia’, for example. Here the electricity and telecoms monopolies were prime beneficiaries, along with the country’s main airport. The EBRD is also a passive shareholder in two big banks criticised by some observers as being conduits of state mismanagement.

71.       The EBRD's sharing out of credit lines for SMEs and trade facilitation among five domestic banks in the ‘former Yugoslav Republic of Macedonia’ has also been questioned, since four of these banks have allegedly observed poor corporate governance or had their operations curtailed for other reasons. There is some dispute as to whether all the earmarked EBRD money actually reached its intended recipients. Further criticism was that EBRD could have contributed more in the vital areas of fostering management culture, developing proper corporate governance, safeguarding property rights and protecting minority shareholders. The Rapporteur looks forward to clarifying these and other critical points raised in her report in further contacts with the EBRD.

VI.        CENTRAL AND EASTERN EUROPE

72.       Central and Eastern Europe is the region that has advanced furthest along the path of transition. There are still some problems with structural adjustment, including the fact that a higher proportion of workers remain in industry than looks warranted from the point of view of these countries’ economic development. Some of the countries still suffer from a relatively low rate of productivity and a rather high energy consumption when compared to output. Nevertheless, they maintain relatively high growth rates and a stronger financial and institutional framework than other regions where the EBRD is active.

73.       Generally speaking there is a clear divide between the more economically developed countries that constitute the most serious candidates for early EU enlargement and the rest of the transition region, particularly CIS and SEE. It is against this background that the debate on whether or not the EBRD should pursue a "graduation policy" has been waged in recent years (and also raised in earlier Assembly reports on EBRD activities, such as Resolution 1192 (1999); Doc. 8422; Rapporteur: Mr Lotz) . ‘Graduation policy’ is the Bank's own term for winding down its activities in the more economically developed countries, such as Hungary and Poland, to free resources for the less economically developed regions.

74.       In the period 1991-1999, committed cumulative EBRD financing was highest in Hungary, at €110 per head of population, although this is the country which in the meantime has reached the highest per capita GDP, close to € 5000. Ukraine, on the other hand, received less than €20 in EBRD money per citizen, although its GDP per head is a mere €576. In 1999, the Czech Republic, Estonia, Hungary, Poland and Slovenia, who are the five countries closest to joining the EU, together received all of a quarter of the Bank's new commitments.

75.       The Bank's critics say it must start to reduce its lending in the more prosperous central and eastern Europe, and cease lending altogether when a country enters the EU. Furthermore, they argue that, while the Bank is supposed to finance private projects, it should restrict itself to those where commercial lenders are reluctant to invest without multilateral collateral help. (For instance, in 1998 the EBRD invested $100 million toward the privatisation of the Polish bank Pekao, although the latter could presumably with ease have found other investors to do the job.)

76.       The Bank has responded to such criticism by arguing that it has already moved out of sectors in the richer countries, such as telecoms, which are already attracting large amounts of private investment. The Bank maintains that there is still a need for a public investment bank of its kind to make long-term loans to municipalities and to help restructure industries such as mining and railways, in addition to encouraging privatisation and reform. The Bank indeed argues it is the only institution available to offer such help at this time.

77.       While this may be the case, the Bank should now contemplate divesting itself of stakes in the most efficiently managed firms in the CEE region, to avoid competing with other investors and commercial banks – some of the latter perhaps themselves enjoying EBRD lending. If this is not done, the Bank may well experience increasing conflicts between its complex set of goals.

VII.        EBRD’s 10th ANNUAL MEETING (London, 23-24 April 2001)

78.        Your Rapporteur attended the annual meeting of the EBRD held in London on 23 and 24 April 2001. She is happy to report that there was a high degree of consensus as regards the bank’s future strategy. Thus, there will henceforth be more concentration on Russia and countries in Eastern Europe and Central Asia, especially in countries that have made little progress on the road towards a market, democracy-based economy. Particular emphasis was laid on the promotion of democracy in recipient countries and the introduction of internationally recognised rules for company management.

79.        The social dimension was also repeatedly raised in the discussions, especially by donor countries. There was general agreement that there could be no economic progress so long as large parts of the population were excluded from sharing in the fruits of progress. The EBRD President recognised that social problems do not form part of the bank’s mandate. However, he underlined the fact that the welfare of citizens of the region is an important motivating factor in the projects the Bank undertakes. Furthermore, the EBRD is trying to fight poverty and unequal distribution of wealth by promoting lasting economic growth. It also seeks closer co-operation with other development banks that have more of a social mandate, such as the Council of Europe’s Development Bank, the World Bank and the Asian Development Bank.

80.        The EBRD has contributed substantially to the building of the local banking system and to the gradual dissemination on the SME environment of a culture of commercially sound project planning and management. It has also encouraged Western private capital to participate more substantially in the local markets – either through the joint financing operations or simply through the references given by the bank to local operators. Across the former Soviet bloc alone 100,000 small companies have started up or expanded with loans that the EBRD helped finance. Great emphasis was placed on the need to continue assisting small and medium sized enterprises in the future.

81.        With EBRD support, the transition economies have been able to initiate market and trade liberalisation, together with reforms of their institutions. Such changes have provided significant trade and investment opportunities with the West and contributed to the further strengthening of European integration.

82.        Many speakers stressed the importance of institution building and corporate governance. The President of the Bank acknowledged that one of the main lessons from the Bank’s operations in the last decade has been that “markets do not develop of their own accord but need the support of strong institutions, including corporate governance rules”. The Bank can draw upon some important lessons learned from the first ten years of its operations related to a minimum required set of institutional conditions for sustained success and development, in particular the need for strong or well-functioning markets; tax and legal reform; clear and well protected property rights; democratic accountability of governments; a minimum degree of social cohesion; an adequate system of public administration and the rule of law. The EBRD will therefore focus on having recipient countries and companies introduce internationally recognised management standards. Credits are only to be given to companies that respect sound accountancy rules that clearly show transactions and relations between companies and protect minority shareholders. The Bank recognises that the challenges of structural reform cannot be met by any one institution acting alone, therefore the Bank is keen to encourage co-operation with other multilateral institutions such as the World Bank and the EIB.

83.        Contrarily to what is the case with other development banks, the EBRD has a political mission, namely the promotion of democracy. Belarus has already been warned by the Bank on its lack of progress toward democracy. The Bank will also in the near future review its position vis-à-vis Turkmenistan. However, there is no clear yardstick for measuring the fulfilment of the political mandate. For this the Bank relies vary much on the Council of Europe and the Parliamentary Assembly, especially the latter’s so-called ‘Monitoring Committee’, officially known as the Committee on the Honouring of Obligations and Commitments by Member States of the Council of Europe. President Lemierre advocated a case-by-case approach and did not directly clarify whether measures by the Bank could also be envisaged vis-à-vis larger and more important recipient countries.

84.        There was some criticism of the Bank’s policies in the environmental field. Thus, some governments, such as that of Austria argued that the ‘K2/R4’ project in Ukraine had been based on political rather than sound economic or environmental considerations – very much echoing the position adopted by the Parliamentary Assembly in its Resolution 1246 (2001) adopted in April 2001 (Doc. 9017; Rapporteur: Lord Ponsonby). Others criticised the EBRD for having done too little to ensure the closure of the most dangerous nuclear reactors in Eastern Europe, apart from Chornobyl, whose closure is largely financed by it.

85.        CEE Bankwatch Network has been critical regarding EBRD Public Information Policy and problems related to it, in particular regarding project related information in national languages, access to information and the establishment of a body that the public can approach with appeals and grievances, including those related to access and information.

86.        To conclude, there is clear evidence that the Bank has carved out a role, in particular in the development of banking and financial services. With its ups and downs, the Bank has fulfilled the mission it was set up for – that is help ex-Communist countries towards democratisation and market economy reforms. It was also underlined that it now time for the Bank to move away from the more economically developed countries and focus more of its operations and activities more east and in Russia where it is most needed. It can draw upon lessons learned from a decade of its activities and put greater emphasis on the need to maintain and develop the state and market supporting institutions and put institution building and corporate governance at the top of its agenda. While strong recovery and several reform gains have been achieved during year 2000, as a result of the slowdown in the global economy, significant risks might lie ahead and have a negative impact in the process of reform in transition countries. This could be neutralised by making better use and investment in the considerable potential that exists in the region, in particular, the people and their skills.

VIII.        FOLLOW-UP TO THE ASSEMBLY’S RESOLUTION 1218 (2000)

87.        As far as the implementation by the EBRD of the Assembly’s last Resolution 1218 (2000) on the EBRD and the progress of transition adopted in June 2000, it is first to be noted that the EBRD’s co-operation with the Council of Europe has indeed intensified further, in line with the Assembly’s request. Co-operation between the EBRD and the Council of Europe Development Bank, formalised in an agreement concluded in 1999, now expresses itself in the joint financing of many projects. The EBRD also maintains close consultation not only with the Assembly’s Committee on Economic Affairs and Development but also with its Committee on the Honouring of Obligations and Commitments by Member States of the Council of Europe, responsible for scrutinising the state of democracy and human rights in individual countries. Similar consultations are undertaken with the Council of Europe’s Directorate General of Political Affairs.

88.        Furthermore, iin line with the recommendations in Resolution 1218, the EBRD is increasingly focusing on the promotion of small and medium sized enterprises, using local banks as intermediaries and regional partners as interlocutors.

89.        A further requirement of the Assembly was that the EBRD should actively encourage host country policies conducive to ‘good governance’. The EBRD President told the Economic Committee that such exhortations are now central themes in his meetings with leaders of countries of operations, and increasingly conditions for EBRD lending. Furthermore, it was clear from our meeting in January that the EBRD President Mr Jean Lemierre pays major attention also to recipient countries’ providing an adequate social safety net as part of their reform policies, even though social recommendations are strictly speaking not enshrined in the Bank’s statutes.

90.        The Assembly in its Resolution 1218 also asked the Bank to “remain committed to Russia and the countries of Eastern Europe as a long-term, reliable partner”. It is clear from the present report that this is indeed being done and that in fact the EBRD’s operations in the countries concerned have increased both in absolute and relative terms. Whether we are talking of Russia and Eastern Europe or of South-Eastern Europe, there is every reason to conclude that the EBRD has also become more “circumspect in its selection of bodies and partners, so as to ensure good business conduct [and] implementation of commitments …”, as called for in Resolution 1218. The EBRD now routinely consults with the World Bank’s Foreign Investor Advisory Council before engaging in project commitments to any country.

91.        Furthermore, south-eastern Europe is receiving an ever greater share of EBRD attention. As has already been mentioned, the Federal Republic of Yugoslavia has now joined the Bank, which has increased operations not only in that country but in all the countries of the region. In accordance with the wish expressed in Resolution 1218, numerous cross-border projects have also been supported, in particular involving Slovenian and Croatian investments in Bosnia and the Federal Republic of Yugoslavia.

92.        Furthermore, the EBRD has stepped up its co-operation with other international financial institutions as called for in Resolution 1218, notably the World Bank and the European Investment Bank. Co-operation has been particularly intensive in South-Eastern Europe, including, more lately, the Federal Republic of Yugoslavia. Many of these projects do have social and environmental dimensions, in accordance with the Assembly’s wishes. Finally, in line with the call made in Resolution 1218, the Bank is at last able to undertake projects in Montenegro, now that the latter has become - together with the Federal Republic of Yugoslavia of which it forms part – a member of the EBRD.

IX.        CONCLUDING REMARKS

93.        The first phase of transition has now been concluded in many transition economies that now grow steadily after the extreme economic dislocations and rapid falls in output experienced during the early and mid 1990s and the turmoil following the 1998 financial crisis in Russia. Such growth can, however, only be sustained in the medium and long term if institutions and policies at national level manage lastingly to attract private investment.

94.       In order to be effective, the EBRD must therefore intensify its work to promote the development and implementation of a sound financial and institutional framework capable of carrying a fully functioning market economy. It is only with the emergence of an accountable and transparent economic environment that its projects to develop SMEs and local infrastructure can flourish. An emphasis on improving legal and regulatory norms and countering corrupt and clientelistic behaviour is vital in order for the majority of the population to reap the benefits of economic restructuring.

95.       Although the Bank's very presence in these transition countries may help to instigate good corporate governance by virtue of the example it sets, the EBRD also runs the danger of being implicated by its association with interlocutors who engage in questionable practices. Some critics have argued that instead of ‘westernising the Easterners’, the Bank may run the risk of being ‘easternised’ by some of its clients. The Bank has initiated legal action against some irregular practices in which it has unwittingly become involved. While such remedial action is necessary both to protect EBRD resources (or more precisely those of tax payers in EBRD member states) and to set an example in the recipient countries in question, it does not in itself encourage sustainable growth and create an attractive investment climate.

96.       The EBRD must be seen to be acting effectively, through soundly based investment in essential projects that are unable to attract other investors without EBRD participation. ‘Crowding out’ must be avoided by revising resource allocation according to need rather than prestige. The criteria of accession to the EU are closely related to the aims of the EBRD. Indeed, the prospect and realisation of accession will accelerate the very reforms that the EBRD seeks. Resources should therefore increasingly be reallocated to countries less advanced in the transition process. Resource reallocation could lead to a more efficient strategy of producing a convergence in transition between the more economically developed region of CEE and countries that have fared less well.

97.        The involvement of the EBRD is necessary in the second phase of transition, when other international financial institutions such as the IMF and World Bank are placing increased emphasis on the notion of "ownership" by the recipient country in the carrying out of reform.

It is increasingly emphasised that it is the responsibility of government to establish effective policies, strengthen the institutional framework and conduct itself in a manner that will allow competition to work to its full potential. In the case of Russia, a major recipient of EBRD funds, such a development is particularly needed.

98.       Indeed, Michel Camdessus, the former Managing Director of the IMF, defended the IMF's failure to predict or prevent the Russian and Asian financial turmoil in 1998 by arguing that this was the result of a more subtly suffered failure to persuade governments to take responsibility for their own economic policies. He said: "We neglected the dimension of ‘ownership’ which is indispensable for a policy to be sustainable.”

99.       After a decade of transition, some commentators now suggest that EBRD recipient countries should no longer be treated differently from other countries at the same level of development, and that, consequently, EBRD ‘special treatment’ is no longer justified. Not only, goes the argument, are the problems that these countries face common to all developing countries, but most of the solutions to the problems encountered in transition can be more effectively dealt with at national level without the help of outsiders. Furthermore, the promise of eventual accession to the EU is potentially a more effective incentive for reform than anything the EBRD can offer.

100.        The Rapporteur, however, would not go so far. She sees the EBRD as still having an essential role to play in its 27 countries of operations, even as it may diminish its role in some, increase it in others, and lay added emphasis on ‘good governance’, as evidenced in the talks the Economic Committee held with it. Assistance to transition countries is still needed, as is help toward developing and many other countries in the world.

101.       This being said, there is a clear divide between the most economically developed countries constituting the most serious candidates for EU enlargement on the one hand, and the rest of the region on the other. This holds particularly for the CIS and the SEE countries, where successful transition is still, alas, distant. These regions are characterised by a relatively weaker financial and institutional framework for a market economy and a greatly underdeveloped private sector. Further help is clearly needed from public funds. There is still a case for EBRD involvement in the second phase of transition because much of the region still faces grave problems in creating credible market based institutions and financial systems capable of attracting investment from private sources. It is for the EBRD to ensure that such aid and involvement is carefully designed with a view to promoting SMEs and the development of local infrastructure, in an environment of legal and rational behaviour.

Reporting committee: Committee on Economic Affairs and Development.

Reference to committee: standing mandate

Draft resolution adopted by the committee on 28 May 2001.

Members of the committee: Ms Zapfl-Helbing (Chairperson), Stepova, Kirilov, Blaauw (Alternate: Duivesteijn) (Vice-Chairpersons), Adam, Agius, Agramunt (Alternate: Yanez-Barnuevo), Akgönenç, Aleffi (Alternate: Lauricella), Aliyev, Anusz, Arnau, Aylward, Berceanu (Alternate: Baciu), Billing, Blattmann, Bonet Casas, Braun, Brunhart, Budisa, Burbiené, Calner, Cerrahoglu, Clinton-Davis, Cosarciuc, Cunliffe (Alternate: Etherington), Cusimano (Alternate: Turini), Dokle, Elo, Eyskens, Freyberg, Gülek, Gusenbauer, Haupert, Hoffmann, Hovhannisyan, Hrebenciuc, Jung, Kacin, Kestelijn-Sierens, Kittis, Kosakivsky, Leers, Liapis, Lotz, Makhachev (Alternate: Slutsky), Mateju, Mitterrand (Alternate: Durrieu), Mortensen, Naumov, Patarkalishvili, Pereira Coelho (Alternate: Cesário), Ponsonby (Alternate: Jones), Popa, Popescu, Popovski, Prokes, Puche, Ragnarsdottir, Reimann, Riccardi, Rigo, Schmitz, Schoettel-Delacher, Schreiner (Alternate: Mariot), Schütz (Alternate: Behrendt), Seyidov, Squarcialupi, Stoyanova, Suslov, Tallo, Townend, Tsekouras, Ustiugov, Valleix; Wielowieyski (Alternate: Wojcik).

N.B. The names of those members present at the meeting are printed in italics.

Head of the Secretariat: M. Torbiörn

Co-Secretaries of the committee: M. Bertozzi, Ms Ramanauskaite and Mrs Kopaçi-Di Michele.

1 The Committee’s meeting was preceded, on 17 January, by talks between the Rapporteur and EBRD officials specialising on the situation in Russia, south-eastern Europe and the concept of ‘good governance’.

2 See for instance Recommendation 1507 (2001) on Europe’s Fight Against Economic and Transnational Organised Crime: Progress or Retreat? (Doc. 9018; Rapporteur: Mrs Squarcialupi); and Resolution 1214 (2000) on the Role of Parliaments in Fighting Corruption (Doc. 8652; Rapporteurs: Mr Leers and Mr Tallo)

3 85% of the EBRD’s non-performing loans and 50 per cent of its non-performing equity investments are in Russia and some €500 million in provisions for bad loans had to be put aside after 1998, with much of the equity investment in fact written off. This seriously affected the Bank’s overall results. The Bank’s overall profitability has since, however, been restored and record profits were registered in 2000.