Archived - Report on Operations Under the European Bank for Reconstruction and Development Agreement Act - 2005 : 1

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Introduction

The European Bank for Reconstruction and Development (referred to in this document as the EBRD or the Bank) was established in 1991. Its aims are to foster the transition towards open, market-oriented economies in Central and Southeastern Europe, as well as in the successor states of the former Soviet Union,^[1] and to promote private and entrepreneurial initiative in those countries that are committed to the fundamental principles of multi-party democracy, pluralism and a market economy (see Annex 3 for a list of the EBRD's 27 countries of operations).

The EBRD differs from other multilateral development banks in four ways. First, its overriding focus is the private sector and support for the transition from central planning to stable market economies. Its charter stipulates that not less than 60 per cent of its financing commitments should be directed either to private sector enterprises or to state-owned enterprises implementing a program to achieve private ownership and control. Second, it has a particular focus on the promotion of democratic institutions and human rights in its countries of operations. Third, while all multilateral development banks are committed to ensuring the environmental sustainability of their projects, the EBRD is the only such institution where this commitment is explicitly written into its Articles of Agreement. Fourth, the EBRD does not provide concessional financing.

The Bank seeks to help its 27 countries of operations to implement structural and sectoral economic reforms, taking into account the particular needs of countries at different stages in the transition process. In particular, its private sector activities focus mainly on enterprise restructuring, including the strengthening of financial institutions, and the development of infrastructure needed to support the private sector. The EBRD has 62 members: 60 countries, the European Union (EU) and the European Investment Bank (see Annex 3 for a list of members).

Canada is the eighth largest shareholder (tied with Spain), following the other Group of Eight (G8) countries. Canada's formal participation is authorized under the European Bank for Reconstruction and Development Agreement Act, which was promulgated in February 1991. Article 7 of the Act states that:

The Minister [of Finance] shall cause to be laid before each House of Parliament by March 31 of each year or, if that House is not then sitting, on any of the thirty days next thereafter that it is sitting, a report of operations for the previous calendar year, containing a general summary of all actions taken under the authority of this Act, including their sustainable development aspects within the meaning of Article 2 of the Agreement, and their human rights aspects.

This report responds to this requirement and reviews the activities and operations of the Bank for the year 2005.

Benefits of Membership

As a major trading nation, Canada has a stake in global peace and stability, which the successful integration of Central and Southeastern Europe and the former Soviet Union into the world economy and global institutions helps to promote. By fostering continued political and economic reform in the region, the EBRD is contributing to its integration into the world economy and to its stability.

The Minister of Finance is Canada's representative on the Board of Governors at the Bank and nominates a Director to its 23-member Board. This representation allows Canada to have high-level influence on decisions taken by the EBRD on investments in the region and on policies to move countries through the transition process. The EBRD also provides trade opportunities for the Canadian private sector, supporting a diversification of international markets for Canadian businesses.

Details on Canada's financial contributions to the EBRD are provided in Annex 1.

The EBRD fosters the transition of former centrally planned economies of Central and Southeastern Europe and the successor states of the former Soviet Union towards market-oriented economies; promotes private entrepreneurial initiative by targeting at least 60 per cent of its resources to private sector projects, with the balance in support of commercially viable state sector projects that promote private sector development; operates only in countries committed to applying the principles of multi-party democracy, pluralism and market economics; promotes environmentally sound and sustainable development; and operates on a self-financing basis.

Role and Mandate of the EBRD

The EBRD's operations to advance the transition to a market economy are guided by three principles: maximizing transition impact, additionality, and sound banking. Financing is provided for projects that expand and improve markets, help to build the institutions necessary for underpinning a market economy, and demonstrate and promote market-oriented skills and sound business practices. EBRD financing must also be additional to other sources of financing and not displace them, further ensuring that the Bank contributes to the transition process. Finally, Bank projects must be sound from a banking perspective, thus demonstrating to private investors that the region offers attractive returns. Adherence to sound banking principles also helps to ensure the financial viability of the EBRD and hence its attractiveness as a co-investment partner for the private sector.

In promoting economic transition in its countries of operations, the Bank acts as a catalyst for increased flows of financing to the private sector. The capital requirements of these countries cannot be fully met by official multilateral or bilateral sources of financing, and many foreign private investors remain hesitant to invest in the region, particularly the central Asian republics. By providing an umbrella under which wider funding for private sector investment can be assembled, the EBRD plays a catalytic role in mobilizing capital. In 2005, for every euro the EBRD invested, it mobilized an additional 1.5 euros from the private sector and other multilateral and bilateral agencies.^[2]

The Bank's medium-term operational priorities are premised on: the key role that the private sector can play in creating dynamic, competitive and more equitable economies; and the relevance to the transition process of the Bank's mandate to support countries committed to and applying the principles of multi-party democracy and pluralism.

To achieve these priorities the Bank focuses on:

• taking an active approach in its equity investments to improve corporate governance;
• developing sound financial sectors linked to the needs of enterprises;
• providing leadership for the development of lending to micro, small and medium-sized enterprises;
• developing market-based and commercially oriented infrastructure;
• demonstrating, effective approaches to restructuring viable large enterprises;
• engaging governments in policy dialogue to strengthen institutions and improve the investment climate;
• promoting transparency and accountability in public sector management;
• taking a regional approach where appropriate; and
• promoting sustainable development and environmental due diligence.

Operational Environment in 2005

The transition countries experienced strong macroeconomic performance in 2005 with an average growth rate of 5.3 per cent, down from 6.6 per cent in 2004. Growth in 2005 was supported by domestic demand and, to a lesser extent, net exports. Rapid expansion in domestic credit sustained consumption and investment, but in many instances it widened external imbalances.

Strong growth in domestic demand, which underpinned growth across the transition region, was fuelled by a rapid expansion in domestic credit to the private sector. Much of this expansion reflected the increase in financial services that accompanies economic development and convergence with the full-fledged financial systems of advanced economies. Cyclical factors and possibly temporary gains in asset valuations also played a role.

The transition countries made progress in structural and institutional reform in 2005. Market improvements in Central and Eastern Europe, following EU accession in May 2004, were driven largely by favourable market responses to recent progress in strengthening financial institutions. Advances in some countries in the Commonwealth of Independent States (CIS),^[3] meanwhile, followed significant political change. There was, however, a slowdown in the pace of reform in much of Southeastern Europe.^[4] This reflected not only continuing political uncertainty but also a pre-EU-accession pause in reform by candidate countries. Russia was the only transition country to see some transition reversal, given the effective renationalization of large private companies in the oil and gas sector (e.g. Gazprom, selected Yukos Oil Company assets).

Russia

Russian economic growth is estimated to have slowed to 6.0 per cent in 2005 from 7.2 per cent in 2004 due to lower growth in oil extraction and exports and slow progress in structural reforms. Although high oil and gas prices helped boost the Russian economy, the economy remains overly reliant on these sectors and is therefore vulnerable to negative price shocks. The federal budget continued to benefit from high oil prices, registering a surplus of close to 7 per cent of gross domestic product (GDP). The Oil Stabilization Fund, which increased substantially to nearly US$80 billion by end-2005, was used to prepay US$15 billion of Paris Club debt. Further early debt repayments are planned for 2006. Inflation was 10.9 per cent in 2005, slightly below the revised target range of 11-11.5 per cent.

Other CIS Countries

Growth in the other CIS countries remained strong in 2005 at 6.2 per cent, following growth of 7.9 per cent in 2004. Growth was supported by high commodity prices (particularly for oil and gas but also for metals and agricultural products) and strong domestic demand. Despite the moderation of growth, the outlook remains generally favourable due to the continued strength of oil prices. The most significant slowdown was in Ukraine, where growth fell to 4.0 per cent in 2005 from 12.1 per cent in 2004. This is due to a sharp drop in external demand for its steel and a decrease in investment given uncertainty over the business and political environment.

Central Europe^[5]

In 2005, average growth in Central Europe fell to 4.2 per cent from 5.1 per cent in 2004, reflecting the curtailment of investment and export subsidies. In particular, growth in Poland slowed to 3.5 per cent from 5.4 per cent. The Czech Republic was the only country in the region to post higher growth in 2005 (5.0 per cent) than in 2004 (4.4 per cent). The Baltic countries continued to register strong growth in 2005, led by Latvia, which grew by 7.5 per cent.

Southeastern Europe

The maintenance of political stability, further progress with structural reforms and the prospect of EU accession for Bulgaria, Croatia and Romania continue to support growth. Bulgaria and Romania have set 2007 as their indicative date for accession, while Croatia does not have an indicative date, as it only began accession negotiations in October 2005. Average GDP growth in Southeastern Europe was 4.8 per cent in 2005, moderating from 6.5 per cent in 2004. Growth in Bulgaria (5.5 per cent), Croatia (3.5 per cent) and Romania (5.5 per cent) has been driven primarily by private consumption, fuelled by rapid credit growth with the further development of banking systems. Investment has been driven by EU-accession expectations, ongoing privatizations and lower inflation and, in the case of Romania, capital account liberalization leading to sharp reductions in interest rates.

Transition Report for 2005

The Transition Report is an annual publication of the EBRD that charts the progress of transition from a centrally planned to a market economy in each of the Bank's 27 countries of operations. The Transition Report is recognized as the leading publication analyzing the progress of transition in the former Soviet bloc. The 2005 report focused on the theme of "Business in Transition", specifically examining the changes in transition countries' business environments. Drawing on the third round of the joint World Bank-EBRD Business Environment and Enterprise Performance Survey, the report argued that substantial progress has been achieved in Central Europe: markets have responded favourably to ongoing reforms. In the CIS, nascent political change has provided benefits to the private sector in a number of countries. In almost all areas of the transition region, the business environment has improved steadily as a whole; specifically, most countries have shown improvements in their approaches to regulation, taxation, the judiciary, and crime and corruption.

While the business environment has improved on average, barriers to business are still much greater in transition countries than in mature market economies. The survey notes that the costs of business regulation, poor-quality institutions, weak property rights and an unstable macroeconomic environment all remain major obstacles to businesses in transition countries. Dynamic firms such as private start-ups are the most severely affected. The report also shows that the business environment is not static for firms in any given country. Geographic analysis shows that firms in remote areas face more obstacles than do those in major cities. In addition, the type of ownership has substantial impacts on businesses: foreign-owned and new private firms tend to be more efficient than privatized and state-owned enterprises. The report also notes that the shortcomings in the business environment have hindered enterprise growth, but that other factors such as competition must be addressed in order to improve firms' overall level of efficiency and their responsiveness to change.

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