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European Affairs
Interview
European Development Bank Will Go Where It Is Needed
Jean Lemierre
President, European Bank for Reconstruction and Development
Question: The EBRD has been considering major new investments in Russia, including possible loans to help liberalize the energy sector. How big are the Bank's operations in Russia?
Answer: Since the Bank's inception, it has altogether committed nearly $12.2 billion, which comes to about $54.15 billion if you add in the investments by the private sector that our activities have generated. Russia accounts for about 21 percent of the total. The Bank has always operated in Russia, but it originally concentrated its efforts on Central and Eastern Europe.
The Central European countries remain important, but the strategy for the next five years will be to go where help is most needed to aid the transition to a market economy. That means focusing more on Russia, Ukraine, and Central Asia.
Q: To what extent have Russia's financial difficulties been a problem for the EBRD?
A: The Bank felt the effects of Russia's difficulties throughout 1998. In 1997, the Bank directly invested a700 million in Russia. In 1999, just after the worst of those difficulties, that figure fell to e220 million. The Bank did not desert Russia, but the number of its projects was reduced, notably in the private sector.
In 2000, the Bank invested e570 million, more than double the previous year. This demonstrates that the Bank and its investments are returning to Russia. In 2001, I would like to return to our 1997 level, with a steady growth rate that would rise to around e1 billion in the years ahead.
Q: The private sector seems rather reluctant to invest in Russia at a time when the Russian government has been giving mixed signals as to its readiness and ability to repay creditors according to the usual rules. What conditions do you require with regard to better governance, and to ensure that financial operations will be conducted on a normal basis?
A: To begin with, we operate on a project-by-project basis. As a general condition, we are increasingly requiring respect for international standards of accounting and transparency.
Q: That is what international organizations have always said. But up to now such recommendations have not proved too effective.
A: Yes. But the EBRD is making its loans conditional on these requirements. Either these conditions are respected, and the borrower attracts additional private funds through competition on the financial markets, or the conditions are not respected and we do not participate in the project.
Q: Which plays the leading role, the EBRD or the private sector?
A: That is a question of "which comes first, the chicken or the egg?" Personally, I would say that both come at the same time. The fundamental role of the EBRD is to promote investments that would not happen without our participation. This does not mean that we do whatever we want. The private sector would not follow the EBRD in investing in projects if they did not look as if they were going to be commercially successful.
Q: Could you give an example of an investment that the Bank has made in Russia that the private sector would not have made?
A: We decided to back General Motors in its plans to invest in Russia. The management of General Motors wished the Bank to participate in the financing of its operations and they would not have decided to invest without the Bank.
In the project, we take part of the risk, both financially and also by providing a top quality team of analysts.
Our partners generally appreciate the Bank's ability to conduct a political dialogue with decision-makers in the countries in which we operate.
Q: The EBRD is an institution in which the United States and Europe cooperate to promote economic and political development in Central and Eastern Europe and the former Soviet Union. How is this cooperation working out?
A: The United States is the largest individual shareholder, with 10.5 percent of the Bank's capital. In aggregate, the Europeans are bigger shareholders, since the member states of the European Union, the European Commission and the European Investment Bank (EIB); taken together, make up over 50 percent of the total.
Japan has 8.5 percent, sharing the position of second largest individual shareholder with Britain, France, Germany and Italy, which each hold the same amount. There is obviously cooperation among the United States, Europe, Asia and indeed all the countries where the Bank operates.
In addition, the board of directors consists of 24 members, including an American, a Canadian, a Japanese and a Korean. More than 50 nationalities are also represented among the Bank's 1250 employees.
Q: How does the work accomplished by the Bank reflect this cooperation? What are you trying to achieve?
A: The EBRD was created ten years ago with a specific mandate to promote the transition of the region from a non-market to a market economy.
Three important principles guide the Bank's activities. The first is the need to evaluate financial risks, which is a sound banking principle. The second is the principle of conditionality: we give no loans unless preconditions are set for the improvement of governance and business practices and for associated reforms. The third important principle is "additionality." EBRD cannot be a substitute for the private sector, but it can complement it.
Q: In the World Bank, there are discussions about the amount of business generated by World Bank loans that goes to corporations from the various countries that are shareholders of the Bank. The question is whether the business that countries receive is proportional to their financial commitments to the Bank. Is that an important issue for the EBRD - the nationality of the companies that receive contracts to work with you in the private sector?
A: Receive is a dangerous word. The conditions under which we operate are based on prices that reflect the market. There are no quotas. The EBRD interventions are de facto equally apportioned between the United States and Europe. We see a lot of large American companies who want us to intervene, as do many European companies. However, we have no internal debate in the Bank or among its shareholders on this issue.
Q: Are Americans or Europeans more dynamic in Central and Eastern Europe?
A: They are more or less the same. In the beginning, everyone was very active in the region, and this continues to be true. We are also seeing significantly increased interest on the part of European medium-sized enterprises. The proximity of the two regions clearly encourages businesses that may not have the financial means to take on large projects, but that may still undertake projects that have significant benefits for employment and industrial development.
Q: Is proximity really so much of a factor? In particular, does Germany play a leading role in European investment in the region?
A: Whether the companies are American or European, the vision is the same, as are the stakes - and their risk appreciation is very similar. I really don't detect any differences. Where medium-sized enterprises are concerned, it is clear that the European side has a bit more aptitude, but we also work with American medium-sized companies.
Q: The EBRD is now active in Yugoslavia. How important is that for you? What are your plans there? Is it a problem or an opportunity?
A: It is an opportunity. Yugoslavia is important because there is much to be done there. It is now rejoining the group of countries with transitioning economies that are about ten years ahead of it. The EBRD is the first international institution to work with and help Yugoslavia.
We are trying to implement three financial sets of rapid measures. First, there are financial measures to support and reactivate SMEs. Second, we are looking at what we can do to help medium-sized enterprises that are able to export but do not do so because they lack cash. Then, we are examining the situation of the banking sector. At the request of the central bank, we would like to recapitalize some banks to allow a number of them to begin to finance the next economy.
As the first institution to intervene in Yugoslavia, we are trying to work with the real economy, i.e., private industry and banking, rather than governmental institutions. The needs in Yugoslavia are considerable.
With regard to the infrastructure, such as bridges and roads, there are a number of large international organizations such as the EU, the World Bank and the EIB that are ready to help with investments. The EBRD is focusing especially on a few, select objectives. We have proposed to the Yugoslav authorities that we concentrate on the real economy, so that too big an influx of capital at the national level would not disturb the private sector.
In fact, Yugoslavia presents an extraordinary opportunity for the Balkans. The advent of a new government in Belgrade will hopefully create more stability in the region. It should lead to the coordination of regional infrastructure investments. You cannot make major investments in the infrastructure of a country without affecting its neighbors.
The development of trade within the region should also have a stabilizing effect. We are currently active in every country, including the Kosovo region, where we have created a financial action plan for SMEs.
Q: Is it difficult to attract private investment to the region?
A: It is still early for Yugoslavia. There is a lot of serious interest. There are many European enterprises that are beginning to consider the possibilities, and banks are closely watching the banking sector. Several big equipment and cement manufacturers are studying what they can do.
Many business executives are visiting Belgrade. There is a real interest developing in the Balkan region and the opportunities it offers. But it is still too early to translate that interest into real business.
Q: The environment is one of the major issues in Central and Eastern Europe and in Russia, as well as one of the most important sectors in which the EBRD operates. It is one of the areas in which Europeans and Americans have difficulty agreeing, because they have different policies. What is your policy as far as environmental protection is concerned? You are occasionally accused of supporting nuclear industries. Do you consider that fair?
A: The environment is a problem in our area of operations, owing to the region's past history and its current living conditions. Dealing with this question is fundamental for outsiders, but even more so for those who are living and investing in the region. Investors will not pay for the past. For these reasons environmental issues present fundamental challenges.
To answer your question on the Bank's support of the nuclear industry, we are actually doing the opposite. We manage very significant funds devoted to ending nuclear activities. We are involved in the decommissioning of nuclear plants, most notably at Chernobyl. Funds for this operation are managed by the EBRD.
In addition, we are currently lending money for the decommissioning of several nuclear plants in the region. It is necessary. We can only hope that the appropriate funds will be mobilized to complete the achievement of this goal.
As for the future, the EBRD was been asked by the Group of Seven leading industrial countries five years ago to take a look at the financial requirements for replacing Chernobyl with another nuclear power plant named K2R4. We completed a study and the board of directors agreed to finance a replacement.
But the decision is on hold until four preconditions are met. The first is that the existing plant at Chernobyl be permanently closed. The second is that the Ukrainian nuclear regulatory agency improves its regulations and that European regulators agree to present an annual performance report on the Ukrainian agency. This means that we would also be strengthening surveillance over other Ukrainian nuclear plants. It is crucial for improving the safety of the system.
The third condition is that Ukraine adheres to the economic program it negotiated with the International Monetary Fund, and the fourth is that all our financial partners agree on how to finance the project.
The EBRD is by no means the biggest partner is this venture. The total projected cost is $1.5 billion, of which we would provide $215 million. Euratom, the EU's nuclear energy arm, would be a bigger contributor, with $585 million, and the rest would be covered by national export credit organizations.
Our second type of operation is environmental clean up. Near St. Petersburg, at a site called Krasni Bor, chemical waste had been dumped into open holes in the ground for 50 years. The Bank financed the treatment of the site, in cooperation with the Nordic countries bordering the Baltic Sea, because there were devastating leaks into the drinking water of St. Petersburg, and into the Baltic.
We are building a plant that will burn these chemical products in an enclosed site, and then we will destroy the plant. So everything will be clean.
Q: Are these projects funded by public funds?
A: Yes. There are loans from us and there are also public funds, for instance, from the EU to reduce the cost of the project. Another example is Krakow, in Poland, where water is being treated to avoid polluting the drinking supplies of Warsaw or the Baltic. We also have water treatment projects in Romania and many other places.
Q: Is the Bank doing anything with regard to the blocking and pollution of the Danube following the War in Kosovo?
A: Not at this time.
Q: And in the Balkans more generally?
A: Yes. We have water treatment projects and we frequently finance other operations. Our activity in the environmental field is very extensive. One example is a e69.5 million program coordinated by the Bank, including an EBRD loan of e21 million, which will solve severe water supply and wastewater services in five cities in FYR Macedonia.
Q: How many years will it take to return the environment to normal and pay for the past?
A: The effort will be considerable because the region is enormous and the needs are great. We cannot just have one, big single project to fix everything.
Q: You are now preparing your capital resource review and your strategy for the years to come. What is the outcome of this review?
A: Every five years, the Bank must present a five-year plan to its shareholders for their approval. One of the reasons for this procedure is to determine whether or not the Bank has enough capital. At the last capital resource review, my predecessor, Jacques de la Rosière, requested a capital increase, and it was agreed by the shareholders. I am not going to ask for more capital.
Q: That is unusual! Presidents of international financial institutions usually ask for more money.
A: We have the resources we need, in great part because we can now begin to reinvest the returns on the portfolio that has been created over the last ten years.
The second important point is that we emphasize the need to work gradually. We must go where the need is greatest, and reduce our role where our presence is less needed. Ten years ago, for instance, it was necessary to help the telecommunications sector in Poland. The Bank will now exit from this sector, and move into areas where private investment flows will not go alone. The transition is gradual.
Q: This means that, in the long term, if you succeed you disappear?
A: Yes. Our efforts must be in addition to the usual operations of the private sector. When the region's investment needs can be financed through normal channels, the market will be functioning and we will no longer be needed.
Q: But you will still probably be in operation for some time?
A: Probably! In some of the Central and Eastern European nations negotiating to become members of the EU, confidence is rising because EU directives will be applied to them, and because they will have made great progress by the time they join. But this does not apply to some other countries in the region. There are differences from country to country, and from sector to sector in the same country.
It is clear, for instance, as I said, that the Polish telecommunications sector no longer needs our help. On the other hand, there are enormous needs in the area of industrial restructuring. We are currently working with the Polish authorities to restructure the Polish railroad system.
In some Central and Eastern European nations, the capital city is rather developed, but much still needs to be done to develop the business infrastructure in the rest of the country. Promoting venture capital activities and the financing of industrial imports are also important objectives for us.
I am also proposing to the board of governors that we evolve in the services we provide. We
must increase what we are doing with our own funds, by making more equity investments and taking more risks.
We shall try to ask for a state guarantee in fewer cases of loans to the public sector and to rely on the quality of these projects, in Central and Eastern Europe, because the state guarantee weighs on public finances, and these countries are going to have considerable financial needs to meet EU standards.
Q: What lessons do you draw from the last ten years, and the Bank's accomplishments since its inception in 1991?
A: A lot of work has been accomplished by all concerned, mainly by the people and the governments of the countries in the region. Several conclusions can be drawn, the first of which is that the earlier reforms are started, the more quickly you see results. This is not always understood.
Q: This means that if you want to achieve reforms it is better to accept sacrifices early in the process?
A: Yes. That is exactly the conclusion. Where it is necessary to destroy the old structures, many people lose their jobs. They find themselves neglected. One of the great lessons of the last few years is the need to provide social safety nets. Otherwise the populations may refuse the reforms.
The EBRD does not have the mandate to provide those safety nets. Our role is to support the transition to a market economy. The initial effects of reform, however, should not be to spread poverty and misery. We must offer assurances that there will be a bridge from one stage of development to the next.
A second lesson is that we have not reformed the institutional framework too well. It is a crucial issue. The market economy does not function without a minimum of public rules. An example is the tax administration. It is capable of taking money and redistributing it to where it is needed. It can be useful for social cohesion and for fighting poverty, but it must be organized.
Another example is the judicial system. The law is not just something written on paper, there are judges, too. The proper functioning of a financial market involves laws, but also jurists and accountants capable of enforcing and applying those laws. Banks need to be supervised.
All these points show the importance of a flexible and efficient coordination between the international financial institutions. The EBRD, focused on the transition process to market economy, needs the support of the World Bank and the Asian Development Bank to promote the required institutional framework and social safety nets.
May I add that we pay a special significance to financing small and medium-sized enterprises? We have developed, with the help of the United States and the EU, programs all over the region that are a real success. These SMEs are a real hope for the future.