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, 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 (G-8) countries. Our 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 2003.

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 a Governor of the Bank and appoints 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.

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 2003, for every euro the EBRD invested, it mobilized an additional 1.4 euros from the private sector and other multilateral and bilateral agencies.^[1] Commercial co-financing mobilized by the EBRD reached a record volume of 2.6 billion euros in 2003, up 30 per cent from the previous high in 2001.

The Bank’s projects serve a dual purpose. They are intended not only to directly support the transition from a command to a market economy in countries of operations, 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 through financially viable projects, not through subsidies.

Key Economic Developments in 2003

Most of the transition economies experienced economic growth in 2003, showing considerable resilience in the face of sometimes difficult external conditions. Most countries in the region continued to perform well in comparison with other emerging markets. The exception continues to be the poorer countries in the Commonwealth of Independent States (CIS),^[2] where the reform process continues to lag and uncertain climates continue to discourage domestic and foreign investment. The process of transition to market-based economies continued to advance in most of the EBRD’s countries of operations. The results of the Bank’s annual exercise in assessing key transition indicators are summarized in the table on the next page.

Progress in Transition in EBRD Countries of Operations 

Russia

Russia’s economic growth is estimated to have increased by 7.3 per cent in 2003, up from 4.7 per cent in 2002. This stronger growth is largely the result of higher oil prices and an increase in oil production. Buoyant exports have kept the government budget in surplus (1.7 per cent of gross domestic product [GDP] in 2003), despite fiscal slippage in the midst of the election cycle (parliamentary elections were held in December 2003 and presidential elections are scheduled for March 2004). The ruble appreciated by over 9 per cent against the US dollar in 2003, despite active intervention by the central bank. Foreign exchange reserves increased by US$30 billion over the year, reaching a historic high of US$77.8 billion in December (or the equivalent of 18.3 per cent of GDP). The large accumulation of foreign reserves, however, hampered efforts to reduce inflation within the 10–12 per cent target range for 2003.

Economic growth since the 1998 financial crisis has been mainly driven by temporary factors such as the gain in competitiveness from the post-crisis real depreciation of the ruble and the upturn in oil prices. The benefits of these factors, however, are beginning to dissipate.

In order to promote more sustainable growth, Russia would need to diversify its economy by implementing reforms aimed at attracting investment in the non-energy sector and at improving the investment climate more generally. Substantial progress was made in implementing structural reforms in 2001 and 2002, but further progress slowed during the 2003–04 election cycle. Nonetheless, considerable progress has been achieved recently in improving productivity and strengthening corporate governance, and this has put the economy on a stronger footing. The main challenge ahead is to ensure that key structural reforms in the banking and corporate sectors are implemented.

Other CIS Countries

Other oil-exporting CIS countries also recorded rapid economic growth in 2003. This strong growth largely reflected oil windfalls and rising fixed investment in resource-based sectors. Kazakhstan recorded the strongest economic growth in the CIS in 2003, with real GDP estimated to have expanded by 9.2 per cent, down only marginally from the 9.5-per-cent rate in 2002. Azerbaijan’s economy also maintained strong growth momentum, mainly due to a continuing investment boom in the oil and gas-related sectors. This resource-driven expansion, however, has only had a limited impact on the efforts on increasing employment and reducing poverty. As is the case in Russia, these countries face the challenge of diversifying their economic base away from the natural resource sector and managing the complications that can arise from large and volatile foreign exchange inflows.

Among the remaining CIS countries, which are less well endowed with natural resources, Ukraine is estimated to have recorded real GDP growth of 9.3 per cent in 2003, up substantially from the 4.8-per-cent level recorded in 2002. This stronger growth is largely the result of more favourable world market conditions for the country’s principal exports—steel and chemicals. More favourable economic conditions in 2003 provided the government with some room to reduce public debt and to increase foreign exchange reserves.

The poorest CIS countries (Armenia, Georgia, Moldova, Kyrgyzstan, Tajikistan and Uzbekistan) have achieved only modest economic growth over the past few years, with Armenia showing the best progress in the transition process. Per capita income still remains very low in all of these countries relative to other CIS countries. Poverty is widespread and these countries are increasingly reliant on concessional loan and grant financing from multilateral and bilateral donors. Reforms must urgently address the chronically poor investment climates and weak institutions if these countries are to enjoy stronger growth over the medium and longer term.

Central Europe

The economies of Central Europe^[3] again showed considerable resilience in 2003, despite weakness in much of the global economy and poor growth in the EU. The economies of the Central European and Baltic countries are anticipated to have increased by an average of 2.5 per cent in 2003. The Baltic States continued to register the strongest growth, with GDP growth in Latvia reaching 7.2 per cent. A long-overdue resurgence in the Polish economy, where growth is estimated to be up by 3.7 per cent, is also boosting the average growth rate in the region. Poland’s stronger economic growth can be attributed mainly to a significant easing of fiscal and monetary policy.

Large fiscal and current account imbalances have characterized Poland, Hungary, and the Czech and Slovak republics for the past few years, and foreign direct investment is beginning to decline. Consolidated general government deficits in these countries have exceeded 4 per cent of GDP over the past two years. In addition, much of the recent fiscal expansion has resulted from discretionary spending. Fiscal problems have had an impact on the exchange rate of the Hungarian forint, which fell to a historic low in December 2003. The Hungarian finance minister was forced to resign in January 2004, when the 2003 fiscal deficit was reported. The deficit, at 5.6 per cent of GDP, was higher than forecast.

Once the eight accession countries join the EU in May 2004, however, addressing these fiscal problems will need to be a high priority. Under the EU’s Stability and Growth Pact, these countries will have to reduce their deficits to the Pact’s 3-per-cent deficit/GDP maximum. At the same time, however, many of these countries will face pressures to fund various programs to raise internal standards to EU levels.

Southeastern Europe

Recent political and economic stability, fostered by increasing cooperation among Southeastern European countries and closer ties between them and the EU, has helped the region increase economic growth rates over the past few years.^[4] In 2003, GDP in the region increased by an estimated 3.9 per cent, down slightly from the 4.5-per-cent level achieved in 2002. Within the region, growth in Albania has been strongest, with GDP estimated to have grown by 6 per cent in 2003. Growth in the two EU accession candidates (for entry in 2007), Bulgaria and Romania, is estimated to have achieved 4.5 per cent and 4.9 per cent respectively in 2003. FYR Macedonia experienced a substantial increase in growth in 2003, following a contraction in GDP that coincided with a flare-up in inter-ethnic conflict in 2001. Although economic performance is improving in the region, GDP per capita still lags considerably behind the countries of Central Europe. Even in a relatively advanced country such as Bulgaria, which has been spared the ethnic tensions evident elsewhere in the region, GDP per capita remains less than one-third that of the Czech Republic or Hungary.

Southeastern European countries are continuing the difficult process of fiscal adjustment. Fiscal deficits, though still high in some countries in the region, have decreased substantially, with the average for the region estimated to have been 2.9 per cent of GDP in 2003. As in Central Europe, large fiscal deficits tend to be accompanied by large and persistent current account deficits, averaging 8.6 per cent of GDP for Southeastern Europe as a whole in 2003. The risks associated with these twin deficits are exacerbated by the region’s large infrastructure expenditure requirements, falling aid flows and an onerous debt burden.

The region has only had very limited success in financing its high investment requirements through private capital flows. Except for Romania and Bulgaria, most capital inflows to the region have been in the form of official aid, which is now beginning to decline. Southeastern European countries will need to attract higher private flows in order to compensate for falling aid.

2003 Transition Report

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. Given that eight EBRD countries of operations are on the threshold of EU membership, regional integration was chosen as the special theme of the 2003 report. The report notes that the process of the integration of transition countries into the world economy has not been uniform, with more rapid progress in the countries of Central Europe. The accession of most of these economies to the EU will have a significant impact on the structure of regional trade as well as on migration patterns—both legal and illegal. The countries of Southeastern Europe and the former Soviet Union are much less integrated into the world economy, and Central European accession raises a danger of further marginalization of some of these countries.

The 2003 Transition Report outlines three means of dealing with the problem of limited international integration of Southeastern European and former Soviet countries. First is the need to improve market access to EU markets. Second is the need for these countries to press ahead with institutional and structural reforms. The Transition Report recommends that greater EU market access should be granted in parallel with such reforms. Finally, the report suggests that there should be closer regional cooperation to complement the process of international integration. The report points to the EU’s Stabilisation and Association Process with the countries of Southeastern Europe. In the case of the former Soviet countries, where trade is limited by obstructive domestic and regional trade policies as well as distance from other markets, more attention is needed to improving regional cooperation on trade and transit issues.

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