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 4 for a list of the EBRD’s 27 countries of operations).

The EBRD differs from other regional 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, it is explicitly committed under its Articles of Agreement to ensuring the environmental sustainability of all its projects. 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 4 for a list of members).

Canada is the eighth largest shareholder (tied with Spain), following the other Group of Seven (G-7) countries and Russia. 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 2002.

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 represesentation 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 2002, for every euro the EBRD invested, it mobilized an additional 1.2 euros from the private sector and other multilateral and bilateral agencies.^[1]

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 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 2002

Real gross domestic product (GDP) growth in the majority of transition economies slowed in 2002. However, most countries in the region performed fairly well in comparison with other emerging markets, especially given the backdrop of a sluggish global economy. As in the previous two years, real GDP growth for the region as a whole was mainly driven by the Commonwealth of Independent States (CIS) and Southeastern Europe.^[2]

The CIS continued to reap the benefits of high oil and gas prices in 2002. The region’s largest economy, Russia, recorded an estimated real GDP growth rate of 4.3 per cent in 2002, its fourth year of sustained growth since its financial crisis in 1998. In Southeastern Europe growth in 2002 was slightly down from 2001, but improved regional cooperation and enhanced integration with the EU are indicative of a favourable outlook. Real GDP growth in Central Europe^[3] slowed to just over 2 per cent in 2002, the lowest rate since economic recovery began in the region in 1994. This slowdown reflected in part weaker growth in the EU, the main market for the region’s exports.

The following table ranks transition countries by their progress in moving to a market economy, based on a number of indicators.

Progress in Transition in EBRD Countries of Operations

Progress in Transition in EBRD Countries of Operations (cont'd)

Russia

Russia was relatively unaffected by the global economic slowdown in 2002. Higher oil prices and prudent macroeconomic policies led to estimated real GDP growth of 4.3 per cent, down from 5.2 per cent in 2001. Higher-than-expected oil prices enabled the government to exceed its annual revenue target and to post a fiscal surplus for the third consecutive year (estimated at 1.8 per cent of GDP for 2002). The current account surplus shrank, but still remained large at 9 per cent of GDP (down from 11.2 per cent in 2001). This sizeable surplus and a reduction in capital flight allowed the central bank to increase its international reserves by US$11.4 billion during the year to US$47.9 billion. The central bank, however, lacked the instruments to sterilize such a large purchase of foreign exchange, which explains in part why year-end inflation, at 15.1 per cent, exceeded the government target of 14 per cent.

The Finance Ministry recently announced that its financial reserve fund ended 2002 at US$8 billion, nearly US$2 billion higher than planned. This fund, together with the projected US$20-billion current account surplus in 2003 and sizeable international reserves, should facilitate the service of Russia’s external debt payment “hump” in 2003 (obligations are estimated at US$17 billion).

The key risk to Russia’s economic outlook continues to be its dependence on international energy prices. Economic growth since the 1998 financial crisis has been mainly driven by the sharp real depreciation of the ruble and the upturn in oil prices, both of which contributed to a substantial increase in gross fixed investment in resource-based sectors.

In order to diversify its economy and reach a more sustainable growth path, Russia needs to attract more investment in the non-energy sector by implementing reforms aimed at improving the investment climate. Although authorities have made substantial efforts in implementing structural reforms in 2001 and 2002, their main challenge will be to maintain a similar pace in the face of the upcoming parliamentary elections in December 2003 and presidential elections in March 2004. Reforms that are vital to secure sustainable medium-term growth include financial sector reforms (reforming the banking sector, passing a law on deposit insurance and a law on currency regulation and currency controls), energy sector reform and the easing of the bureaucratic burden on the corporate sector.

Other CIS Countries

The other CIS countries also experienced slower economic growth in 2002, with the exception of countries rich in oil and gas resources, such as Kazakhstan. In Azerbaijan increased investment for the exploration and export of the country’s hydrocarbon reserves also led to robust growth.

Real GDP growth in Ukraine is estimated to have slowed to 4.1 per cent in 2002, down from 9.1 per cent in 2001. This remained a fairly strong performance given that exports, which had been the main driver of the economic recovery of the two previous years, were hit by the global slowdown.

High growth rates in other CIS countries in recent years have been mainly driven by strong demand from the booming Russian economy and low capacity utilization, which allowed an increase in production without having to step up investment in fixed capital. Now that their room to manoeuvre in this regard is vanishing, CIS countries desperately need to increase domestic investment and attract foreign direct investment by improving their business environments.

Another challenge faced by Kyrgyzstan, Moldova, Tajikistan, Armenia and Georgia is that their debt levels remain very high despite various recent debt relief initiatives.

Central Europe

The economies of Central Europe showed considerable resilience in 2002, despite anemic growth in the EU. The growth rate of the whole region, however, did weaken slightly from the previous year.

With three quarters of exports destined to the EU, the Baltic States recorded a significant slowdown in 2002. Nonetheless, growth rates remained above those of other central European countries: real GDP rose 4.5 per cent in Latvia (down from 7.7 per cent in 2001), 5.2 per cent in Lithuania (down from 5.9 per cent) and 5.0 per cent in Estonia (same as 2001).

Poland continued its sluggish economic performance in 2002, with real GDP rising by an estimated 1.2 per cent (up from 1.0 per cent in 2001). This weak performance largely resulted from a combination of tight monetary policy and lax fiscal policy, which drove up interest rates. In the Czech Republic, real GDP growth was estimated at 2.5 per cent (down from 3.3 per cent in 2001), reflecting the economic damage from the floods in the summer of last year and reduced EU demand for the country’s exports.

The governments of Hungary, the Czech Republic, the Slovak Republic and Poland continue to face significant challenges in terms of fiscal consolidation. They all ran substantial fiscal deficits in 2002. These deficits will need to be addressed in order to generate the fiscal room to manoeuvre that will be required to implement the EU’s acquis communautaire, particularly given the expected deceleration in privatization revenues.

Southeastern Europe

The outlook for Southeastern Europe is better than at any time since the breakup of the former Yugoslavia. Given the unfavourable external environment, real GDP growth in the region was impressive in 2002, albeit slightly weaker than in 2001.

The two EU accession candidates, Bulgaria and Romania, posted strong macroeconomic performances. Bulgaria’s real GDP growth for 2002 is estimated at 4.0 per cent, the same as in 2001, while Romania’s growth for last year is estimated at 5.0 per cent, down slightly from 5.3 per cent in 2001. The commitment by the European Commission to support these two countries for EU accession in 2007 is also likely to attract substantial capital inflows in the medium term.

In FR Yugoslavia^[4] the economic outlook continued to improve in 2002, following achievements in economic stabilization and reform since late 2000. It is hoped that a strong commitment to the new constitutional framework will bring more stability and foster an increase in external trade and foreign direct investment. For Bosnia and Herzegovina and FYR Macedonia, however, investor confidence remained low as political uncertainty and ethnic tensions persisted. It remains to be seen if the new governments elected in late 2002 will be able to implement much needed structural reforms and improve their countries’ business climates.

2002 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. Agriculture and rural transition were chosen as the theme of the 2002 report. This reflects the fact that – even though over a third of the population of the region lives in rural areas – rural issues have not featured prominently during the first decade of transition. This has been to the detriment of the transition process in rural areas. In view of the importance of the farm sector, reforming agriculture, increasing farm productivity and promoting land reform remain the dominant rural transition challenges. At the same time, rural areas also need to diversify their economic activities by promoting non-farm activity through the development of linkages with markets, financial institutions and other firms.

The report notes that many transition economies have experienced significant and persistent declines in agricultural output since the start of transition. A number of factors are cited as having contributed to this trend. Not surprisingly, the better performers have tended to be those with better starting conditions. Countries that have liberalized and privatized their economies to the greatest extent (including through the promotion of individual or household ownership of farms) have seen positive responses in the agricultural sector. The method of implementing land privatization has also had a clear impact on productivity, with countries following a restitution principle enjoying higher productivity. This may have been because land restitution provided owners with more clearly defined property rights than other methods of land privatization.

The EBRD also finds that progress in agricultural reform is strongly linked to the “methods of political decision-making.” The greatest progress in agricultural reform has been made in stable democracies in which there are high levels of political competition and an active civil society.

Another transition country trend identified in the report pertains to the shift in agricultural trade patterns. In particular, it notes a substantial rise in agricultural trade deficits. This was partly a function of the fact that the transition countries trade primarily in “temperate zone” products such as grains, milk, butter and livestock, which tend to be the most protected commodities in global trade.

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