Investor incentives

The European Bank for Reconstruction and Development (EBRD) was created by governments to invest in economies in transition. From our headquarters in London’s financial district and from our 27 offices in the transition countries, we have seen exciting, positive change – marked most recently by the accession of eight of these countries to the EU last May.

Across the region there is vast potential for foreign investment in privatising state assets, improving infrastructure and in building the financial, energy, telecoms, real estate, agribusiness, manufacturing, transport, media and tourism sectors. The EBRD exists to assist foreign and local investors in developing these sectors and overall economies.

Investment partners

We work with foreign investors of all sizes and from all parts of the world: with KBC, Raffeisen and Unicredito in banking, Mittal in steel, Cargill in agriculture, General Motors in automobiles and Ikea in retail. We are finding more and more investment partners in the region: Poles investing in Ukraine, Russians investing in the Caucasus, Serbs investing in Bosnia.

The EBRD was created to take the risks that others would not – at least, not without our involvement. The bank is now the largest single investor in the eight accession countries, where our cumulative commitments totalled approximately €10.9bn by the end of 2004. Seventy per cent of our portfolio is in the private sector and every euro we invest triples in value because it attracts two more from other sources whose risk in investing in the region is reduced by working with the EBRD.

Regional reform

The transition from command to market economies is well advanced, particularly in the accession states, where the lion’s share of GDP (over 75%) is now produced by the private sector. Growth rates in the new EU member countries have continuously outstripped those of western Europe in the past few years, reaching an estimated 4.9% for 2004; we expect 4.5% growth in 2005.

Transition, however, is far from complete. Now that the EU prize is in hand, the drive for further reform risks losing steam in the eight central and eastern Europe states. In many parts of the region, there is weariness with reform, with fiscal prudence and with persistently high unemployment. Yet, without continued reform, the anticipated benefits of joining the EU will not be fully realised and eastern Europe will not achieve western Europe’s standard of living.

The accession countries add 20% more population to the EU – but make just a 5% contribution to the EU’s economy. In the best case scenario, it will take a minimum of two or three decades for the accession countries to achieve 70% of current western European income levels.

Now that privatisations are largely complete in the accession countries, FDI has levelled off. Further reform is essential if foreign investment is to continue to support growth in the accession zone and if we are to improve the mobilisation of domestic investment to finance these economies.

Currently, the most ardent reformers among the former communist states are those in the EU waiting room. According to the EBRD’s 2004 Transition Report, Romania, Bulgaria and Croatia are leading the way in economic reform. The more distant prospect of EU membership for Serbia and Montenegro, Bosnia Herzegovina, Macedonia and Albania is helping to promote reform there as well.

There are plenty of opportunities for foreign investors to help all these economies to grow by investing, borrowing and lending, and the EBRD is positioned to assist.

Financial sector focus

The EBRD’s initial focus in central and eastern Europe was building and helping to privatise the banking sector, because attracting foreign investment and encouraging a thriving economy cannot be done without efficient, apolitical, competitive banks.

The banking sector’s development has been very successful: in 2003 total credit available in central Europe and the Baltic states increased by 23%. Now the leading banks in the accession zone, many of which have significant foreign ownership, are strong enough to do without the EBRD’s support in terms of capital or plain vanilla credit.

So in the financial sector, the EBRD has shifted its focus to niche products and promoting non-bank financial services. These include insurance, pension firms, leasing, consumer finance and mortgage finance – services that remain under-developed in these countries but are vital to economic growth.

The EBRD now uses the excellent relationships it has established with local banks to finance small and medium-sized enterprises (SMEs). These engines of economic growth often have difficulty accessing credit, even in western Europe and the US. Yet they offer great promise in terms of GDP growth, job creation and innovation.

Working with the EU, the EBRD has promoted more than 70 projects since 1999. Working with the banks owned by domestic and foreign interests, we provided nearly €800m in EBRD loans complemented with €120m in grant support from the EU (for credit training of small business lenders) by the end of 2004.

In addition, where the local market is unable or unwilling, the EBRD provides long-term debt for medium-sized companies, equity (both directly and via funds) and mezzanine financing. It is now extending its SME efforts to rural communities – another under-served sector of the regional economy.

Infrastructure finance

The EBRD is also blazing a trail working with municipal governments in the accession countries, often in partnership with the private sector. A lot of investment has already gone into the capital cities of the region but secondary cities remain under-served in terms of key infrastructure investments.

There are many opportunities for investing in water, sewerage, roads, railways and bus systems in these cities. The EBRD was the first financial institution in the region to offer loans to municipalities without sovereign guarantees.

Financing infrastructure poses dilemmas for the accession countries: on the one hand, they must meet EU standards for environmental infrastructure while, on the other hand, they must still maintain tight budget limits imposed by EU membership.

EU regional and structural funds coupled with EBRD loans will help to finance many of these projects. Along with money, we bring considerable expertise in municipal debt restructuring to such projects.

To the south and east

As the accession states gradually integrate more deeply into the EU, the EBRD is increasingly emphasising investment southward and eastward: in the Balkans, in Russia and the rest of the Commonwealth of Independent States (CIS). Our portfolio mix has shifted: central and eastern European and Baltic investments accounted for nearly 30% of our business volume in 2003; the estimate is just over 20% for 2004.

The further southward and eastward investors go, the higher the risks – and the higher the rewards should be. Russia’s economic performance over the past two years has been robust, with strong GDP growth based on high oil prices, and a sharp acceleration in domestic investment. Management of public finances has been sound, inflation is down and the exchange rate firm. But recent political developments suggest a concentration of power in the hands of the executive and a drift from democratic practice. The challenge ahead is to build the foundations for consistently good long-term growth and to make the economy less vulnerable to external conditions.

That is why the EBRD uses its investment tools to promote economic diversification in Russia. We are financing the modernisation and restructuring of key industries; seeking to make more equity investments in addition to loans in Russian businesses; supporting improvements and growth in the banking sector; and promoting infrastructure improvements, particularly at the municipal level.

Recent political events in Ukraine have raised that country’s profile to the extent that we are seeing growing interest from foreign investors. The country has been growing at a tremendous rate – 12% in 2004, much of it due to good prices for commodities. We have great hopes for improvements in the investment climate in the coming years, which will promote sustainable economic growth. We will continue emphasising infrastructure and agribusiness investments – from the barley field to the brewery – and further build our support for SMEs.

Elsewhere in the CIS we are working hard to raise investment in what we call the early transition countries. These are the least-developed countries in the CIS: Armenia, Azerbaijan, Georgia, Kyrgyz Republic, Moldova, Tajikistan and Uzbekistan. Our new initiative allows us to consider loans and investments smaller than the EBRD’s usual minimum of $5m; to base agreements on local law rather than English law, saving our clients time and money; and to organise donor funds to improve the investment climate and help promising projects come to fruition.

An evolving role

Throughout the CIS, we are assisting both local businesses and international investors to manage risk and maximise rewards. In the past, strategic investors working with the EBRD have tended to come from the richest industrialised countries. Increasingly, however, our investment partners come from countries nearer to and in the region – Hungary and Slovenia, India and Turkey.