Report on Operations Under the European Bank for Reconstruction and Development Agreement Act - 2000 : 1
- Table of Contents - Next -

Introduction

The European Bank for Reconstruction and Development (referred to in this document as the EBRD or the Bank) was established in 1991. Its aim is to foster the transition towards open, market-oriented economies in Central and Eastern Europe, as well as in the successor states of the former Soviet Union, and to promote private and entrepreneurial initiative in countries in this region that are committed to the fundamental principles of multi-party democracy, pluralism and a market economy (see Annex 4 for a list of the EBRD’s 26 countries of operation).

The EBRD functions as a development bank in much the same way as the World Bank and other regional development banks. The EBRD, however, is distinctive in three areas. First, its overriding focus is on 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, the EBRD’s mandate gives it a particular focus on the promotion of democratic institutions and human rights in its countries of operation. Finally, the EBRD is explicitly committed under its Articles of Agreement to ensuring the environmental sustainability of all its projects.

The Bank seeks to help its 26 countries of operation 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 61 members: 59 countries, the European Union (EU) and the European Investment Bank (see Annex 4 for a list of the members).^[1]

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 2000.

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

• The Minister of Finance is a Governor of the Bank and elects an Executive Director to its 23-member Board of Directors. 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 forward regional development.

• The EBRD provides trade opportunities for the Canadian private sector, allows a diversification of international markets for Canadian business and supports investments by Canadian business in the region.

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 build the institutions necessary for underpinning the 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 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 operation, 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 and bilateral sources of financing, and many foreign private investors remain hesitant to invest in the region, particularly the eastern part. 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 2000, for every euro the EBRD invested, it mobilized an additional 1.9 euro from the private sector and multilateral and bilateral agencies.^[2]

Indeed, the projects of the Bank serve a dual purpose. They are intended not only to directly support the transition from a command to a market economy in countries of operation, but also to create a demonstration effect to attract foreign and domestic investors. Like the World Bank Group’s International Finance Corporation, the Bank is required to operate on a strictly commercial basis and to attract companies to invest in countries through financially viable projects, not through subsidies.

Key Developments in 2000

Strong growth returned to most of the transition countries in 2000. Real gross domestic product (GDP) grew by just over 5 per cent for the region as a whole, up substantially from 2.1 per cent in 1999. The recovery reflects strong growth in the Commonwealth of Independent States (CIS),^[3] which saw real GDP expand 7.4 per cent in 2000 following 3.1-per-cent growth in 1999, largely due to a strong upturn in Russia. In the remaining transition economies of Central Europe and the Baltic States (CEB)^[4] and Southeastern Europe^[5] output increased 4.0 per cent, up from 1.2 per cent in 1999, as the upturn in western Europe increased exports.

Despite the recovery in the CIS, the level of real GDP at the end of 2000 stood at around 60 per cent of its pre-transition level. The recovery in the CIS during the past two years has been driven largely by external factors rather than domestic policy, raising questions about the sustainability of the recovery. In contrast, by the end of 2000 most countries in CEB attained, or nearly so, pre-transition levels of output. This reflects the faster pace of reform in CEB, as well as the fact that at the start of the transition process these countries were more familiar with market principles and market-supporting institutions. Although rapid initial reform efforts in CEB resulted in output and employment losses that were more significant than in much of the CIS, these losses were relatively quickly recouped as competition flourished. In the CIS output and employment losses, though initially less pronounced, continue to persist as incomplete reform efforts have failed to sufficiently unleash private economic activity. As a result, the first decade of transition has seen a significant divergence in living standards between CEB and the CIS, one that is likely to persist.

The year 2000 saw the greatest progress in reform since 1997, as measured by the EBRD’s transition indicators (see table on page 9). Progress was achieved across most countries and dimensions of reform. However, considerable challenges in developing the institutions that are necessary to support a market economy remain throughout much of the region. This is particularly true for the countries in Southeastern Europe and the CIS, where legislative and regulatory changes have often been extensive, but the implementation and enforcement, and hence the effectiveness, of the new laws and regulations remain weak. The continuing weakness of institutions in the CIS and Southeastern Europe means macroeconomic imbalances will remain difficult to manage, with financial sectors vulnerable to bouts of instability.

The following table ranks transition countries according to a number of indicators.

Russia

Macroeconomic performance during 2000 far exceeded expectations. Buoyed by the devaluation of the ruble in 1998 (and its further depreciation in 1999), as well as a sharp increase in average oil export prices over 1999 levels, real GDP grew an estimated 7.7 per cent in 2000, up from 3.5 per cent in 1999. By end 2000 real GDP had surpassed its pre-1998 crisis level, but was still far below its pre-transition level. The federal government’s fiscal position improved markedly as revenues increased substantially due to the upturn in the economy, as well as some modest efforts by the government to re-establish control over public finances. Russia’s external position, as reflected by its current account balance, also improved significantly through 2000 due largely to higher energy exports.

While the improved external position was a positive development, it also complicated macroeconomic management. As Russian exporters sought to convert their foreign exchange earnings into rubles, the strong demand for the domestic currency led to appreciation pressures on the ruble that threatened to overturn the competitiveness gains resulting from the 1998-99 ruble depreciation. To counteract this, the Russian central bank supplied rubles to satisfy the strong demand for the currency, but this contributed to inflation pressures in the domestic economy. Despite limited stabilization tools, the authorities were able to contain these inflationary pressures. As a result, inflation ended the year down from its 1999 level.

Despite strong economic growth in 2000, the Russian economy remains vulnerable to external and internal shocks. The recovery in non-commodity-related production has thus far been largely driven by the ruble’s significant real depreciation in the wake of the Russian financial crisis in 1998, which has led to significant substitution of domestic goods for foreign ones as imports have become much more expensive with the lower value of the ruble. Sustaining competitiveness will require deep structural reforms in the enterprise sector as well as significant new investment to increase efficiency and productivity. Limited progress has been made in this direction over the past year. Despite the government’s approval of a comprehensive 10-year economic development program in July 2000, which includes improving the business climate as a priority, the business climate remains uninviting as witnessed by the still substantial capital outflows from Russia. Similarly, little has been done to strengthen Russia’s financial system. Financial institutions remain under-capitalized and poorly regulated. Efforts to reform the financial sector – through the creation of a bank restructuring agency (ARCO) and enactment of laws on the insolvency of credit institutions – have been largely undermined by the lack of regulatory enforcement by the central bank.

Stronger growth in 2000 was largely export-driven as the upturn in western Europe pulled in more exports from Central Europe and the Baltic States, offsetting the possible detrimental effect of high oil prices on these energy-dependent economies. Strong investment demand, spurred by the prospect of EU accession, also buoyed growth in 2000. The strong performance of exports led to some narrowing of current account deficits in a number of countries, which is particularly striking given the high energy content of imports and the significant rise in energy prices. Current account deficits remained high, however, at close to 5 per cent of GDP or more, in the majority of countries in Central Europe. In most countries, these deficits have been financed by foreign direct investment rather than debt-creating capital inflows, alleviating some of the concerns normally associated with persistent high current account deficits. Rising energy prices also contributed to price pressures in much of the region, though inflation remained under control in all countries.

The sound economic performance of many countries of Central Europe and the Baltic States over the last few years has been fostered by significant gains in competitiveness due to successful enterprise restructuring and by the creation of market-supporting institutions (fiscal, legal, financial and social). Poland and Hungary in particular have advanced significantly in the transition process (see table on page 9) and appear well poised for long-term sustained economic growth.

Growth strengthened in all countries in Southeastern Europe with the exception of Albania, which saw growth remain steady at just over 7 per cent. Like Central and Eastern Europe and the Baltic States, many countries in Southeastern Europe also benefited from stronger growth in western Europe in 2000, which pulled in exports from the region. Export-led growth appeared particularly strong in Bulgaria and Romania. In the latter increased exports contributed to a return to growth following three years of recession. In a number of countries, notably Bulgaria, EU accession prospects also spurred strong investment growth, reflecting significant efforts in recent years to move forward with reform. However, the growth of investment demand in much of the rest of the region was dampened by the lingering political instability in the Federal Republic of Yugoslavia throughout much of 2000 and the slow pace of macroeconomic and structural reforms. However, the recent election of a reform-minded government in Croatia and the election of a new President in the Federal Republic of Yugoslavia brightened the region’s prospects in 2000.

Despite the progress to date, Southeastern Europe faces significant challenges, principally as a result of its uneven commitment to reform and continuing ethnic tensions. In many countries the privatization process is incomplete, and loss-making enterprises and banks continue to operate and accumulate tax arrears, weakening governance. Progress has been limited to date in establishing the legal and social institutions that underpin effective markets and lay the foundation for private investment. Recent increases in ethnic tensions in FYR Macedonia and Kosovo underscore the importance of political stability to the development of the region.

The real exchange rate realignments that occurred in 1998-99 throughout much of the non-Russian CIS are a key factor behind the stronger growth experienced by most countries in the region in 2000. For the first time since the start of transition, Ukraine saw real GDP increase (6 per cent) as the depreciation of its currency in 1998-99 resulted in significant import substitution that stimulated domestic production and strengthened exports. This effect has been repeated in numerous countries across the region. The sharp real depreciation of many currencies in the CIS, while good for competitiveness in the short term, has caused the debt burden of many countries to increase dramatically, as much of what they owe is denominated in foreign currency. As a result, the ability of a number of the smaller economies in the region, such as Georgia, Kyrgyzstan, Moldova and Tajikistan, to service their debt is increasingly in question. In contrast to most of the other countries in the non-Russian CIS, Georgia and Uzbekistan saw real GDP growth slow in 2000.

For oil-producing countries such as Kazakhstan and Azerbaijan, high oil prices have helped buoy growth and improve external and fiscal accounts, contributing to a rapid return to relative macroeconomic stability. Similarly, the strength of other commodity prices has helped to buoy growth in the non-Russian CIS as a whole, where commodities represent over 50 per cent of exports in all but three countries. Relative exchange rate stability in 2000, as well as moderating inflation in the non-Russian CIS and stronger growth in Russia, has supported the rebuilding of intra-CIS trade links disrupted by the Russian crisis.

As with Russia, the non-Russian CIS countries face significant challenges in terms of their central-planning legacy, the extent of structural distortions and the limited capacity of state institutions, and they continue to lag considerably behind countries in Central Europe in implementing structural reforms (see table on page 9). Nonetheless, difficult structural reforms have begun in a number of countries, notably Azerbaijan and Georgia, and they have now experienced a few years of growth. In 2000 Georgia and Tajikistan achieved the greatest progress in reform, as the recovery from civil conflicts provided an opportunity to move forward on long-delayed price and trade liberalization, small-scale privatization and competition policy. In contrast, Belarus, Uzbekistan and Turkmenistan have yet to embark on comprehensive liberalization and privatization reform programs.

The Transition Report is an annual publication of the EBRD that charts the progress of transition from a command to a market economy in each of the EBRD’s 26 countries of operation. Each year the report has a special theme. In 2000 it examines the human dimension of transition by taking a closer look at how employment, skills, poverty and inequality have evolved over the past decade of transition.

A key conclusion of the report is that the countries that have made the most progress on structural reforms have had better outcomes in terms of labour market performance, economic inequality and poverty. In Central Europe and the Baltic States unemployment, poverty and inequality increased early in the reform process. However, the relatively rapid restructuring of enterprises that allowed the development of new firms and activities soon created new labour market opportunities. At the same time, the development of effective social assistance programs facilitated people’s transition to the changing structure of the economy and helped reinforce popular commitment to the reform process. Importantly, as the report notes, the development of competition in product and labour markets has created an incentive for firms and people to invest in skills development. Ongoing investments in education and physical capital will be essential to improve living standards in the face of globalization and the rapid adoption of new technologies abroad.

In contrast, in the CIS and Southeastern Europe, the progress has been generally less positive. Enterprise restructuring has proceeded slowly, impeding the emergence of new firms and activities in a significant manner. In addition, the expectation by many CIS governments that the large enterprises that made up the bulk of the former planned economy would continue to provide a large share of social safety nets, despite the fact that these enterprises no longer have the means or the inclination to do so, has resulted in widespread poverty among the unemployed and among workers not paid for months. The resulting growth of an informal economy has weakened the ability of governments to put in place the types of safety nets that are required for restructuring to proceed. The human cost of these reform failures, as the report notes, has been high. Over a third of households in Russia have fallen into poverty, and inequality and corruption have grown. The report also indicates that there has been little new investment in plant, equipment or employees in the CIS. Skills have depreciated and the quality of the workforce has declined. This, the report notes, does not bode well for future improvements in standards of living.

The report concludes that effective policies to alleviate or prevent poverty require improvements in the capacity of the EBRD’s countries of operation to create wealth and employment. This will require improvements in the business and investment climate. The report also concludes that an effective social safety net is needed not only on moral grounds, but also for the political viability of the reform process.

- Table of Contents - Next -