Moldova - Pre-Export Guarantee Facility Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P6502 MD REPORT AND IEC TION OF THE PREIDENT OF TEE INTERNATIONAL Bt'.W FOR RECONSTRUCTION AND DEVELOpMENT TO THE tCUTIVE DIRECTORS ON A PROPOSED LOAEN IN AN AMOUNT EQUIVALENT TO US$30 MILLION T0O THE REPUBLIC OF MOLDOVA FOR A PRE-EXPORT GUARANTEE FACILITY FEBRUARY 9, 1995 MICROGRAPHIC S Report No: P- 6502 MD Type: PR This document has a restricted distribution and may be used by recipients only in the perfornance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CUTRRENCY EOUIVALENTS (February 1995) US$ 1.00 = Lei 4.35 FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS CAS Country Assistance Strategy CIFCE Chisinau Interbank Foreign Currency Exchange ciS Commonwealth of Independent States ECA Export Credit Agency EU European Union FGC Framework Guarantee Contract FSU Former Soviet Union GAU Guarantee Administration Unit IBRD International Bank for Reconstruction and Development IMF Int. rnational Monetary Fund MIGA Multilateral Investment Guarantee Agency NEAP National Environmental Action Plan PGF Pre-export Guarantee Facility SAL Structural Adjustment Loan WHO World Health Organization  FOR OFFICIAL USE ONLY REPUBLIC OF MOLDOVA PRE-EXPO1t~T GUARANT FACILITY Loan and Project Summarv Borrower: Republic of Moldova. Executiz Agenc: The Guarantee Administration Unit (GAU), an independent entity established by the Govemnment. Benericiaries: Moldovan agricultural and industrial enterprises. Amount: US$30 million. Terms: Ten year "bulet maturity" at the Bank's standard variable interest rate. The standard conmitment fee will be charged. In addition, a 25 basis points fee will be charged for any outsanding GAU guarantees backstopped by the facility. Objectives: The proposed operation is designed to attact foreign private finance for pre-export transactions in a manner that will allow the market to select the most viable activities and bear the full commercial risk of each transacdon. Oescription: A Guarantee Administration Umt (GAU) would sel guarante agant government Performance and POlitical force majeure risks. These guatees would be sold on a first come, first served basis to foreipn input suppliers, trading companies, or financial instiutions that finance the provision of inputs to local Moldovan enterprises. Through an agent bank to be hired by the GAU. a standby World Bank loan facility would backstop the Government's claims payment obligations on up to $30 million of GAU guarantes outstanding at any given time. Bei:efits The facility would help (i) Moldovan industrial and agricultural enterprises establish links with private financial institutions, trading companies and input suppliers who fnmce comnmercially viable, self- liquidatig pre-export transactions, thereby contributing to the emergence of private input supply and output marketing channels; (ii) restre employment and production in the short term while longer temn structural reforms take hold; and (iii) promote a transparent business climate characterized by the rule of law.  - Hi - Risks: The main risks are (i) the reversal of the stabilization and structural reform programs which could lead to a lkrge volume of claim payments and a large debt repayment obligation for the Goverrnent. This is mitigated by covering only those risks that are fully or at least partly in the control of the Government. To further reduce this risk, the Bank will have the right to suspend the GAU'% authorization to issue new guarantees backed by the World Bank in the event of major policy reversals and in the event that a claim was paid using the Bank's resources; (ii) the facility does not generate increased private financing for conmnercially viable pre-export transactions. This risk has been minimized by designing the facility on the basis of well- established market principles. Financif Plan: Not applicable. Disbursements would occur only if the Govemment draws on the facility to pay claims to guarantee holders who purchased coverage from the GAU. The facility will be deemed to have been a success if GAU guarantees result in a large volume of pre-export transactions and little or no claims payments occur. Technical Assistance to the GAU for the first year of its operations would be financed by a grant of the Government of the Netherlands. Beyond that, the GAU will finance its operating costs from fee income. Rate of Return: Not Applicable. Poverty Target: Not Applicable. This report is based upon the findings of preparation and appraisal missions which visited Moldova between June and December 1994, comprising Mmes.JMessrs. Onno RDhl (country officer, mission leader), Alfred Watkins (senior economist, guarantee specialist), Lynn Engstrand (agribusiness specialist), Kalyan Banerji (senior fmancial officer), Stanley Levers (agribusiness consultant), Galina Mikhlin (country lawyer), Carol Oman Urban (export credit consultant), Olga Shklovskaya (summer intern), and Tatsuo Yasunaga (financial officer). David Ferreira, Odo Habeck, Thomas Duvall, Andrew Fitchie and Dariush Malekpour provided support in Washington. Tamara Kanterman provided secretarial support. Documents were reviewed by Luis Dodero and Alan Gelb. Basil Kavalsky and Wafik Grais are, respectively, the Director of the Country Deparunent and Division Chief of the Country Operations Division, responsible for Moldova in the Europe and Central Asia region.  REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF MOLDOVA FOR A PRE-EXPORT GUARANTEE FACILITY TABLE OF CONTENTS PART 1. INTRODUCTION AND BACKGROUND .................. 1 PART II. BANK STRATEGY AND THE FACILITY ............. . 4 A. Bank Strategy ............................... 4 B. Rationale and Objectives ........................ 4 C. Facility Description ..................... ... 5 (1) Pre-export Traisactions ......................5 (2) Guarantee Administration Unit .......... ........ 6 (3) Framework Guarantee Contract ......... ........ 8 (4) World Bank Loan Facility ..................... 10 D. Procurement ............................... 11 E. Environmental Safeguards ...... ................. 11 F. Disbursements .............. ................ 12 G. Auditing, Supervision, and Evaluation ...... ......... 12 H. Lessons of Experience ......................... 13 I. Benefits ................ .................. 13 J. Risks .................................... 13 K. Agreements Reached and Conditions of Effectiveness .... . 14 PART m. RECOMMENDATION ............................. 14 Annex I GAU: Organizational and Administrative Arrangements .... ..... 16 Annex II Overview of Risks Covered and Risks not Covered by the GAU .... 18 Annex m Moldova: Summary of the Foreign Trade Regime .... ......... 20 Annex IV Guarantee Processing and Claims Payment Procedures .... ...... 21  REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF MOLDOVA FOR A PRE-EXPORT GUARANTEE FACILITY 1. I submit for your approval the following report and recommendation on a proposed loan to the Republic of Moldova for the equivalent of US $30 million to support a pre-export guarantee facility. The loan would be at the Bank's standard variable interest rate, with ten years "bullet maturity". Part I. Introduction and Backeround 2. The Government of Moldova is undertaking a stabilization programn supported by the IMF and a structural reform program with World Bank assistance.' The Govermment's primary objective is to restore production, employment, and exports. A key impediment to that goal is the shortage of working capital inputs. This facility is designed to help the private sector finance the provision of working capital inputs for pre-export transactions so that conmmercially viable agricultural and industrial enterprises can restore production, improve product quality, and exploit new marketing opportunities in both the FSU and in non-traditional markets. 3. Lack of Working Capital Finance. As a result of tight domestic credit policy and a capital base that has been severely eroded by inflation, the Moldovan banking system cannot provide a sufficient volume of loans to support sound, commercially viable working capital transactions and foreign banks will not confirn letters of credit opened by local banks on behalf of their Moldovan clients. Consequently, even potentially viable Moldovan agricultural and industrial enterprises with good export prospects are having difficulty obtaining working capital. 4. Most export credit agencies (ECAs) currently do not cover transactions in Moldova, making even short-term, ECA-guaranteed commercial banking flows highly unlikely in the immediate future. ECAs will not open for cover unless they receive a counter-guarantee covering both commercial risk and country risk from either the government or an acceptable local commercial bank. Neither option appears likely. This constraint may eventually be eliminated when the Govermnent has established a tracrk record of implementing a strong reform program. More importantly, however, counter-guaranteeing ECA transactions would shift commercial risk onto the Government, potentially weakening the budget constraint under which enterprises are operating and involving the Government in resource allocation decisions. At present, there are no Moldovan banks that would qualify as acceptable counterparties for ECA transactions. Even if one or two acceptable local banks do eventually emerge, they currently do not have the capital base and technical credit appraisal skills to satisfy the immediate working capital requirements of Moldovan enterprises. 5. In addition to these financial bottlenecks, the perceived govermment performance risk inherent in doing business in Moldova inhibits foreign traders and input suppliers from providing working capital inputs directly to local enterprises. In previous business dealings in other republics of the former Soviet Union, an input supplier or trading company would sell working capital inputs to a local enterprise in exchange for a share of that enterprise's future output. Unfortunately, on several occasions govermments revoked export licenses or imposed other retroactive changes in rules and regulations that prevented input suppliers from being paid for the inputs which they had already delivered to the local enterprises. Although trading companies and input suppliers have not had similar experiences ' For background information on recent developments in the Moldovan economy and the structural reforms that have been supported by the Rehabilitation Loan (Loan 3653-MD and Structal Adjustment Loan (Loan 3815-MD) see the President's Report on the Structural Adjustment Loan (Report P-6444-MD of November 15, 1994).  - 2 - in Moldova, the perceived govermnent performance risk of doing business in a republic of the former Soviet Union has severely limited the flow of working capital to Moldovan enterprises. [See Box 1 for examples of potential transactions that have been stalled due to govermnent performance risk considerations.] 6. Another factor inhibiting the flow of commercially viable pre-export transactions is the general perception of war and civil disturbance risk (political force majeure) in countries of the region. While this perception applies to Moldova as well, government policies have maintained peace and stability for nearly two years. This policy is a cornerstone of the Government's program, because it realizes that without it, prospects for economic recovery woull be dim. 7. A possible solution. Discussions with a wide range of conunercial lenders, input suppliers, and trading company officials indicate that an effective program to mitigate perceived government performance and political force majeure risk would significantly increase the flow of private pre-export finance to Moldovan enterprises. The potential catalytic impact of such a program would be especially strong during the early phases of the economnic transition process, when political and economic uncertainty is greatest and the Government's commitnent to trade liberalization and private initiative is relatively untested. It is during this period that a favorable enabling enviromnent in the fonn of business- friendly statutes, rules, and regulations may not be sufficient to assuage the concerns of private lenders, not because the proposed policy enviromnent is "wrong," but because they are not confident that the new, more liberal rules and regulations will remain in force at least for the life of the underlying input supply transaction. 8. The proposed risk coverage would eliminate a class of risks - retroactive taxes on imports and exports, revocation of import and export licenses, inconvertibility and restrictions on transferring foreign exchange, and war and civil disturbance (political force majeure) - which input suppliers and trading companies cannot manage or control and hence, which inhibit themn from financing the provision of inputs to produce exports. Moreover, commercial banks will not even bother to evaluate the commercial viability of a pre-export transaction brought to their attention by an input supplier or tading company unless they have available lending capacity under their country risk limits. Government performance and political force majeure coverage should eliminate, or at least reduce, the co;intry risk hurdles inhibiting banks from evaluating the cormnercial risks associated with pre-export tranotactions, thereby encouraging more foreign cormmercial banks to begin financing commercially viable pre-export transactions. 9. While the commercial risk of pre-export transactions is substantial, at least some foreign commercial banks, input suppliers, and trading companies believe it can be controlled, managed, and limited, which is not the case of government performance and politicalforce mayeure risk. For example, input suppliers and trading companies can deploy field agents to help ensure that the inputs are used as intended and that the output is produced and exported. Other typical techniques for reducing commercial risk include: (i) providing working capital inputs in exchange for goods that are easily saleable on world markets - e.g., rugs, concentrated apple juice, sugar, etc., in the case of Moldova; (ii) working with sldlled and experienced local counterparts who know how to surmount the typical commercial obstacles encountered in FSU countries; (iii) contracting in advance to sell the output received as payment for inputs to a creditworthy buyer, perhaps secured by a letter of credit from that buyer's bank; (iv) developing sub-contmracting and tolling arrangements whereby local enterprises process semi-finished goods provided by foreign manufacturer; and (v) worling with local enterprises whose management and technical capacity are well known to the trading company or input supplier.  ............... ...... .. . ... ... ..... ........ ........ ... ........ ... ---- - 42 aa L. 1-. I I cn vt .91 06 16. 44 0 cr 0 IL ;N :3 >* in . ... ..... .. la- I A 1 .  - 4 - Part II. Bank Strate" and the Facility A. Bank Strategy 10. The record so far. The proposed loan for the Pre-export Guarantee Facility would be the fourth World Bank loan to Moldova. The first loan, an Emergency Drought Recovery Loan (US $26 million, Ln. 3569-MD), was approved by the Board on March 11, 1993, and financed critical inputs for the 1993 agricultural season. The second loan was the Rehabilitation Loan (US $60 million, Ln. 3653- MD), approved by the Board on October 21, 1993. It promoted reforms in privatization and enterprise governance, the financial sector, agricultural policy, trade and pricing, and the social sector. The third loan was the Structural Adjustment Loan (US$ 60 million, Ln. 3815-MD), approved by the Board on December 8, 1994. The main foci of the program supported by this loan are: privatization; hardening the budget constraint on enterprises; creating a competitive environment; and better targeting of the social safety net within fiscal constraints. 11. Bank disbursements have been rapid. The Emergency Loan of $26 million is fully disbursed and closed, while $56 million of the $60 million Rehabilitation Loan has been disbursed. The Structural Adjustment Loan was declared effective on December 14, 1994, and $12 million has been disbursed so far. 12. Bank Assistance Strategy. The Bank's objectives are to support the rapid adjustment of the Moldovan economy to the recent bout of severe external shocks, including its exposure to a radically different set of relative prices, and to promote sustainable growth. A limited CAS was discussed by the Board when it approved the Rehabilitation Loan in October 1993. Moldova's perfonnance conforms to the high case as set out at that time, involving a rapid transition to a mnarket economy through the sustained implementation of the reform program, leading to enhanced creditworthiness of the country in the medium term based upon improved export performance and adjustment to the energy price shock. While the proposed Pre-export Guarantee Facility was not yet defined when the limited CAS was discussed by the Board, its objectives are central to the strategy. It will promote efficient production for exports and provide opportunities for business partners to build new links, thus improving access of Moldovan enterprises to better inputs, and to their new and traditional markets. As indicated in the President's Report on the Structural Adjustment Loan, in light of Moldova's rapidly changing circumstances, a CAS will be submitted for Beard consideration in FY96. B. Rationale and Objectives 13. By providing credible guarantees against the risks associated with government performance and war and civil disturbanceforce majeure, the Pre-Export Guarantee Facility (PGF) would mitigate the risks that are inhibiting Rrivate input suppliers. trading companies. and commercial lenders from financing the provision of inputs for conmnercially viable production to Moldovan enterprises. A traditional line of credit operation would not allow the Govermnent to exclude the conmercial risk from coverage, and it would not catalyze private foreign financing that is available in the market. As the PGF would support self-liquidating, short term pre-export financing transactions, it would not create a long term debt, either for the Government or for local enterprises. In addition, the costs to the Govemment of running the facility would be very low. The PGF would complement and support the structural reform program by:  - 5 - * enabling the private sector to act as a _,reening mechanism, identifying and channeling private resources to commercially viable enterprises and transactionss; * helping restore employment and viable production for export in the short term, while reforms are taking hold. * helping Moldovan enterprises build links with foreign partners, diversifying their sources of supply and improving their access to markets; * being sufficiently flexible to support more sophisticated financial instruments for the financing of pre-export transactions, as these are introduced in the Moldovan market * promoting a transparent business climate in which the rule of law prevails. C. Facility Description (1) Pre-export Transactions 14. A typical pre-export transaction eligible for support under the PGF would have the following characteristics: * Basic Structure. A foreign (i) trading company, (ii) input supply comnpany, or (iii) comnmercial bank would provide financing for working capital inputs required for the production of exports by a local enterprise. The parties to the transaction would be free to determine their own conmmercial arrangements without interference from the Bank or Government, provided that it could be shown that the inputs would be used for investment or to produce exports. * Eligible Local Enterprises. All corporatized enterprises in Moldova would be eligible, provided that the foreign financier of the transaction would be prepared to bear the performance risk of doing business with that enterprise. * Tenor. The tenor of transactions would be designed to (i) match the production cycle and (ii) would range from short to medium term (with a maximum of three years). For the purchase of equipment, the tenor may not be strictly linked to the production cycle but would coincide with the payment capacity of the enterprise. These slightly longer maturities are particularly important for the agro-processing sector, which has the most potential for export growth.2 * MarketinaArrangements. Although many input suppliers and trading companies would attempt to market their share of the output outside the FSU, some input suppliers and trading companies expressed interest in marketing their share of the output in FSU Republics. Thus, in addition to financing the provision of much needed working capital, these input suppliers would also help Moldovan enterprises restore traditional trading relationships that were ruptured by the break-up of the FSU. Input suppliers and trading 2 For agricultural sector transactions the maturity would probably match the crop cycle and require a tenor of less tban 365 days. Agro-industry transactions, on the otler hand. may require longer maturities, ranging up to three years, to cover the input supplier/trading company for the period from the time the inputs are shipped, the machinery is installed. the agricultural crop is grown and processed, and the final output is delivered.  -6- companies also expressed interest in helping Moldovan enterprises market their entire annual output, with the input supply/trading company retaining only its pre-determined share of the export proceeds as payment for the inputs and marketing services. To the extent that these arrangements become more common, they would help Moldovan enterprises develop non-traditional markets outside the 1PSU. (2) Guarantee Administration Unit 15. A Guarantee Administration Unit (GAU), created by the Government with specific authorization of Parliament, will sell guarantees, backstopped by a World Bank loan facility, against the risks associated with government performance and war and civil disturbanceforce majeure. Consultants financed by the US Trade Development Administration have helped the Govermnent design appropriate adniinistrative and organizational arrangements for the GAU, draft its operating manual, determine appropriate staffing levels, and establish acceptable application and claims administration procedures. A summary description of the GAU's administrative and organizational arrangements is presented in Annex I. A description of the GAU's operating procedures is as follows: 16. Eligibility. Guarantees sold by the GAU would be available on a first come first served basis to any foreign conmnercial entity financing a pre-export transaction in Moldova. Thus, the guarantee holder could be a commercial lender, an input supply company, or a tiading company. The guarantee would be entirely optional in the sense that economic agents would be free to decide whether or not they wish to purchase coverage. 17. Application Procedure. Prospective guarantee holders would file an application with the staff of the GAU containing a detailed description of the proposed transaction. In reviewing the application, GAU staff would verify inter alia, that (i) the transaction is not on the World Bank's negative list of prohibited activities; (ii) the transaction complies with World Bank and Government of Moldova enviromnental standards; (iii) the inputs will be used for investment or to produce exports; (iv) the application specifies the imported inputs, source of foreign financing, and projected exports; (v) the maturity of the proposed transaction is consistent with the production cycle or repayment capacity of the enterprise; and (vi) the World Bank has completed its prior review and issued a no objection. 18. If the GAU staff analysis indicates that the propos.i1 transaction satisfies all requirem,nts and sufficient capacity exists under the PGF, the staff would recorTmend that the General Manager issue the guarantee. In order to expedite processing requirements and in view of the fact that the guarantee will not cover any commercial risks, a final decision would generally be rendered within 30 days of the receipt of the application. The guarantee would enter into force upon payment in advance of the entire guarantee fee applicable to the transaction. 19. Prior Review. In order to ensure that all transactions guaranteed by the GAU and backstopped by the World Bank loan facility comply with the eligibility requirements, the Bank will retain the right of prior review for all guarantees issued by the GAU. The World Bank would review the eligibility of the transaction oased upon the information in the application, and would undertake to respond to each prior review request within five business days. 20. Guarantee Fees. In order to give input suppliers an incentive to minimize their reliance on the guarantee facility, thereby fostering non-Bank guaranteed input supply transactions, the GAU would sell its guarantees for a fee of 300 basis points per year or any part thereof on the covered amount of the transaction. This would bring the GAU's fee in line with the fees for political risk coverage charged by MIGA and ECAs doing business in high risk countries. Guarantee fees would be paid in US  Dollars and deposited in an account that the GAU would maintain for that purpose with the agent bank. One part of the fee collected by the GAU would be used to cover the operating costs of the GAU, including the cost of reimbursing the Government for the conunitment fees owed by the Government on the World Bank loan facility. During the first year, the guarantee fee charged by the GAU would be reviewed quarterly in consultation with the Bank, taking into account the relative supply and demand for guarantees and the fees charged by ECAs for similar coverage in Moldova. After the first year, the guarantee fee charged by the GAU would be reviewed semi-annually, in consultation w-th the Bank. Agreement on the fees charged by the GAU and procedures for the periodic review of the fs structure was reached during negotiations. 21. Agent Bank. To facilitate its operations, the GAU would employ an agent bank to perform the following services: * Letter of Credit Issuance. The agent bank would issue an irrevocable letter of credit, letter of guarantee, or equivalent legal instrument stipulating that it will pay claims on behalf of the GAU with funds withdrawn from the World Bank loan facility. With respect to outstanding guarantees, the agent bank will have an irrevocable right to draw on the World Bank before making payment. In deciding whether to pay a claim, the agent bank would respond to documnents only - either an admission of liability by the GAU, an arbitrator's judgement against the GAU, or documentary evidence of the GAU's default, as stipulated in the guarantee contract. The cge-at bank would not have to assess the underlying validity of a claim, the amount of loss, or become involved in any way in assessing whether a transaction is eligible for coverage. The agent bank would simply pay the amount stipulated in either of the three documents mentioned above, upon receipt of one of those documents. * Pavrment Procedures. When the agent bank is notified of a pending claim and the Government does not provide the agent bank with fumds to pay for the claim, it would withdraw funds from the World Bank's loan facility no later than 14 days before payment is due to the Guarantee Holder, and place them in a guarantee account maintained on behalf of the GAU. When the claim becomes payable, (generally 30 days after the agent bank is notified of a pending claim), the agent bank would pay the clain on behalf of the GAU with the funds drawn on the World Bank and deposited in the guarantee account. * Record Kee=ing. The agent bank will be responsible for ensuring that the outstanding letters of guarantee do not exceed the total amount available under the facility. Thus, the agent bank would keep records of the amount, effective date, and termination date of each guarantee. The agent bank would also keep records of all pending claims and keep the World Bank informed on a regular basis of all newly issued letters of credit. 22. During the initial period of the appointnent, the agent bank would work with the staff of the GAU to devise procedures for issuing letters of guarantee, paying claims, and sharing information about pending claims and pending guarantee applications. These procedures will be incorporated into the GAU's operating manual. The GAU will select an agent bank through a competitive process, according to terms of reference that were agreed to at appraisal. The sinimng of an agency agreement with an agent bank satisfactory to the Bank will be a condition of effectiveness.  - 8 - (3) Framework Guarantee Contract. 23. The precise terms and conditions of the guarantee sold by the GAU would be specified in a framework guarantee contract (FGC) that has been prepared by legal consultants financed by a grant from the US Trade Development Administration. In preparing the FGC, the consultants worked closely with the IBRD and MIGA Legal Departments. Agreement on the text of the FGC was reached at negotiations. 24. Risk Distribution. Each party to the transaction would be expected to bear those risks which it can appraise and control. [See Annex II for a schematic distinction between commercial risks which are not covered by the FGC and govermnent performance and political force majeure risk risks which would be covered.] Thus, private input suppliers. lenders, and trading companies would bear the full comnmercial risk of any transaction they finance. Conmnercial risk would include such risks as inter alia (i) the failure of the local enterprise to deliver the specified quantity of output or goods of acceptable quality, (ii) a decline in the world market price of the products received by the input supplier, (iii) an increase in the price of other inputs, (iv) exchange rate fluctuations, and (v) the failure or inability of the intended buyer of the output to honor its purchase obligations both for commercial reasons or due to the occurrence of political risk outside Moldova. The FGC would cover only losses that are the direct result of government actions or political force majeure resulting from war and civil disturbance in Moldova which is at least partly in the control of the Govermment. 25. Risk Coverage. The FGC would compensate guarantee holders for losses that occur as a direct result of the following risks, occurring after the effective date of the guarantee: 0 Inconvertibility or Inability to Transfer. This would include coverage for losses arising from the introduction by the Govermnent of any restrictions on the conversion of local currency into foreign exchange or the transfer of foreign exchange out of Moldova. Coverage would protect lenders against active or passive restrictions, where active restrictions include such items as a decision by the Government or the central bank denying conversion or transfer and passive restrictions include the failure of the Government or central bank to authorize a legal exchange or transfer to take place, in the event such prior authorization would be required. [A description of the foreign exchange regime is contained in Annex Im.] This coverage would also include protection against the Govermnent's failure to permit the conversion of local currency into foreign exchange at the market rate of exchange. However, this coverage would not grant the guarantee holder the right to convert local currency into foreign exchange at a guaranteed future exchange rate. * Cancellation of Licenses and Restrictions on Import and Exgort. This would include coverage for losses arising from the cancellation or non-renewal of an import or export license by the Government of Moldova or the imposition by the Government of Moldova of restrictions on the import into Moldova of working capital inputs or tV: export from Moldova of outputs which were not previously subject to restriction. * Imposition or Increase of Import or Export Taxes. This would include losses arising from the imposition by the Govenmment of Moldova of any new or increased tax, levy or duty relating to the imnport of inputs or the export of outputs.  -9- * Seizure of Goods or Prevention of Sale. This would include losses arising from the taking and holding of inputs or outputs by the Governnent of Moldova without just, prompt and adequate compensation. * Political Force Maieure. This would include coverage against losses arising from military action or civil disturbances in Moldova. Other types of force majeure - e.g., flood, drought, other natural disasters, war in neighboring transit countries, etc. - would not be covered. * Diversion of Vovage. This would include coverage against losses arising from an increase in transport or insurance charges due to the diversion of the inputs to a different destination if the above risks occur while the inputs are in transit to Moldova. 26. Maximum and Minimum Access by a Single Guarantee Holder. In order to prevent one or two guarantee holders from monopolizing the available coverage under the FGC, the maximum anmount of guarantees that could be outstanding at any one time to support transactions sponsored by a guarantee holder would be $4 million. In order to enable smaller firms to obtain the necessary working capital inputs, the miniimum guarantee size would be $25,000. 27. Role of Local Banks. Although local comnercial banks may not participate in the initial round of transactions, the FGC would also cover acceptance or confirmation of letters of credit or other legal instruments issued by Moldovan banks to finance eligible working capital purchases by their Moldovan clients. The guarantee would cover the same range of risks specified above. Thus, the input supplier, trading company, or foreign comunercial lender accepting or confirming the financial instruments issued by Moldovan banks would have to bear the credit risk of the that bank. This will enable local Moldovan banks to assume their "normal" role in the provision of pre-export finance as soon as they have the necessary technical and financial capacity. 28. Currency Availability and Foreign Exchange Rate Risk. Individual guarantees would be denominated in US Dollars, as contacts with the market consistently revealed that this would be the currency of choice for this type of transaction in Moldova. The guarantee holder would bear all currency risk between the US dollar and the input supplier, trading company, or foreign comnercial bank's domestic currency. 29. Claims Administration and Cure Period. The Bank would make a payment only for losses that are the direct result of damages caused by the risks covered by the FGC (see para. 25). In order to give the Government an opportunity to correct any policy related actions or inactions that would trigger a claims payment, a 30 day cure period would commence when the GAU is notified of a potential claim. In addition, one high level government official, the Chairman of the Supervisory Board of the GAU, would be designated to correct any problems that might lead to a guarantee being called or to notify other officials of the need to correct such problemns. Since the Government would be required to repay the Bank for any amounts paid out under the guarantee, this official would, in effect, protect the Govermnent's financial interests as well as its reputation in international markets. 30. Claims Procedure. Upon expiration of the cure period, a Guarantee Holder has the right to file a claim if the problem has not been resolved satisfactorily. Upon receipt of a claim, the GAU would have 30 days either to (i) accept the claim and make the required payment, or (ii) reject the claim. If the GAU rejects a claim, the guarantee holder would have the right to initiate binding arbitration proceedings. The GAU would pay the claim if the arbitrator rules in favor of the guarantee holder. When the GAU is required to pay a claim the Government could pay the claim with its own resources  - 10- or draw upon the World Bank loan facility. (A more detailed description of the guarantee processing and claims payment procedure is presented in Annex IV.) 31. Arbitration. In the event that a dispute arises between the GAU and the guarantee holder as to whether (i) government action or inaction should lead to a call of the guarantee or (ii) the Government has in fact corrected the initial problem, the guarantee holder has the right to initiate arbitration proceedings, designed according to established international commercial practice and set forth in the FGC. The procedure would stipulate that the arbitrator would be independent, that the arbitration would take place outside of Moldova, and that the decision of the arbitrator would be final and binding on both parties. The losing party would bear the costs of the arbitration; however, if the GAU loses, the arbitration costs would be borne by the Govermnent. The World Bank would not be a party to the arbitration proceedings. The arbitration procedure is stipulated in the FGC as agreed between the Borrower and the Bank during negotiations. (4) World Bank Loan Fadlity 32. A World Bank loan facility would backstop up to $30 million of GAU guarantees outstanding at any given timne. Under the terms of the loan facility, funds that are not used to pay claims on previous guarantees would be available to pay claims on subsequent guarantees. If a disbursement from the World Bank loan facility is made, the amount remaining in the facility and, hence, the amount of future GAU guarantees that could be issued with World Bank support would be permanently reduced by the amount of the claim. Since the loan would be drawn down only if a claim has to be paid to a guarantee holder, the Bank loan would disburse only upon the occurrence of any of the covered risks enumerated in the FGC. 33. The Govermment of Moldova would serve as the borrower of record for the loan and delegate withdrawal authority to the GAU which, in turn, would delegate this authority to its agent bank. The agent bank would have irrevocable right to draw upon the facility to pay claims on outstanding guarantees. However, the World Bank would retain the right to suspend commitments for new GAU guarantees backstopped by the Bank facility if (i) the Govermnent is in arrears on its debt service payments to the Bank such that loan disbursements have been suspended, (ii) the GAU is not being administered in accordance with the project agreement between the Bank and Government, (iii) a payment for a claim is made by the agent bank to a guarantee holder using the proceeds of the Bank loan, or (iv) there is a substantial reversal of the existing trade and foreign exchange regime, even if the changes do not result in outstanding guarantees being called. However, no suspension would affect the Bank's payment obligations for GAU guarantees issued prior to the suspension. 34. Availability Period. The World Bank loan facility would be available for backstopping new guarantees for a period of five years, thereby potentially enabling the GAU to support $150 million of pre-export transactions during this period, assuming that the average tenor of each transaction is one year and that the GAU's guarantee issuance capacity is fufly utilized. Guarantees issued prior to the end of the five year period would remain valid for the rmaining life of the underlying private transaction, which could be a maximum of three additional years. In fact, as Moldova develops a creditworthy reputation in the international pre-export market and as ECA cover becomes more widely available, teliance on the PGF may decline over time3. Nevertheless, a five year availability period would be provided so that the Government would have sufficient time to establish a satisfactory track record of not interfering with private pre-export transactions. A five year availability period would also enable input 3 A mid-term review will consider whedher the GAU should be abolished after 5 years or be transformed into a susaminable guarantee institution that would issue guarantees without World Bank back-stop.  - 11 - suppliers, trading companies, and private financiers to amortize the costs of developing commercial relationships in the Moldovan market over an attractive period of time. 35. Loan Charges and Repayment Terms. The Government would be responsible for all debt service payments. including conmnitmnent fees on undisbursed balances. To the extent that the GAU has sufficient fee revenue after having covered its administrative expenses, it would be required to reimburse the Government for commitment fee and the additional charge paid to the Bank. However, since interest and principal repayments would be dule only as a result of claims payments resulting from Government policies, the GAU would not be required to reimburse the Government for these charges. 36. The following charges and repayment schedules would apply to the loan facility: * Cormnitment Fee and other Charges. The standard commitment fee will be charged. In addition, a 25 basis points fee will be charged for any outstanding GAU guarantees backstopped by the facility. * Repavment Schedule. Ten years "bullet maturity" at the Bank's standard variable interest rate. D. Procurement 37. The facility will stimulate the provision of foreign finance for the purchase of inputs and equipment for Moldovan enterprises expected to generate Moldovan exports. The Bank would only backstop the Government's commitment not to interfere with the transactions being financed by the foreign financiers or guarantee holders, who would be financing the local Moldovan enterprises and bearing the cormmercial risks. Since the Bank would not finance the underlying transactions, procurement requirements for this operation, to be complied with by the participating trading companies or input suppliers, must satisfy standards of economy and efficiency. In practice, this means that they must correspond to established conmnercial practices. Discussions with a large number of Moldovan enterprises during the preparation of the facility reveal that enterprises are generally well aware of their potential sources of supply, and that they select the most appropriate source by seeking multiple quotations from multiple countries. 38. Moreover, the objective of this operation is to help local Moldovan enterprises procure the highest quality working capital inputs at the lowest possible price. By eliminating govermnent performance and politicalforce majeure risks, thereby easing the barriers to entry, competitive forces within the Moldovan market will ensure that local enterprises have an opportunity to shop for the best input supply deal. E. Envomental Safeguards 39. The proposed facility has been classified in Environmental Assessmnent Category C. To ensure that no guarantee would be available to support the importation of environmentally hazardous inputs, the GAU will be provided with a list of products and transactions that do not meet Bank and/or Moldovan environmental requirements. A negative list of banned pesticides, derived from the WHO categories of "Extremely Hazardous" materials would also not be permitted to be imported under the  - 12 - auspices of the PGF.4 The GAU will hire a local environmental expert who will review and approve applications, in consultation with the Bank when necessary. 40. During supervision of the facility, GAU operations and procedures will be monitored by environmental specialists from the Bank to ensure their compliance with World Bank requirements. The Bank will promptly notify the GAU of any changes in the Bank's envirornental regulations specifically regarding pesticides and industrial chemicals. The sub-projects will have to comply with local environmental laws, rules and regulations in force at that time, as set forth in the Operating Manual, during the whole period of operation of the facility. 41. Major environmental concerns in Moldova are water pollution and water conservation, soil degradation. and forestry and nature conservation. These concerns will be addressed in the National Enviromnental Action Plan that is currently being developed by the Government with assistance from the Worlc Bank. The NEAP will provide an environmental agenda for sustainable economic growth and improved social welfare. F. Disbursements 42. The GAU. via its agent bank. would draw upon the Bank loan whenever funds are required to pay claims. In order to facilitate possible disbursements, the agent bank would submit monthly reports to the World Bank on the issuance of new letters of credit under the facility. The GAU would be required to present evidence of all claims payments to the Bank. Since guarantees issued in the fifth year of the loan would have a maximum maturity of three years, disbursements would be made only up to the eighth year. The closing date of the loan will therefore be December 31, 2003. The success of the PGF will be measured by the extent to which the GAU issues guarantees that do not result in claims. While the PGF may never disburse, its impact will be measured by the value of GAU guarantees issued with the backing of 'le PGF. G. Auditing, Supervision, and Evaluation. 43. The GAU would be responsible for maintaining its accounts, for preparing and submitting withdrawal applications (via the agent bank), and for maintaining all records relating to the implementation of the facility. Auditing of the facility would include audits of the GAU's financial statements and the guarantee account. Audit reports will be submitted to the World Bank not later than six months after the close of each year or the closing date of the facility. 44. Supervision would include continuous off-site surveillance of the GAU and the trade and foreign exchange regixne, semi-annual on-site performance reviews by the task manager, and the right of prior review of guarantees issued by the GAU. Supervision would focus initially on the establishment of the GAU, its compliance with the rules and regulations specified in the operating manual, the structure of pre-export transactions supported by the GAU, and the volume of guarantees issued by the GAU. Special attention would be devoted to ascertaining that guarantees have been issued on a first-ome, first served basis and that the GAU has been operating without undue political interference. During the latter years, supervision would focus on the volume of guarantees issued by the GAU and its compliance with the procedures specified in the operating manual. Throughout the life of the PGF, supervision will focus on the volume of claims payments and an assessment of the government policies, if any, giving rise to claims payments. 4 World Health Organization. Internaional Progranune on Chemical Safety. 'The WHO Recommended Classification of Pesticides by Hazard and Guidelines to Classification 1994-1995". Geneva: WHOIPCS, 1978.  - 13 - 45. Evaluation will focus on the performance of the GAU. The principle assessment will be a comparison of the amount of guarantees issued relative to the maximum authorized amount of guarantees. In addition, the analysis will focus on (i) the growth in the volume of pre-export transactions in the economy, (ii) the increase in exports generated by transactions supported by the facility, (iii) the growth in the number of financial institutions, trading companies, and input suppliers applying for coverage, (iv) the extent to which the later rounds of pre-export transactions begin to involve the local banking system, and (v) to the extent it is possible to track, the number of joint ventures or other longer terms investments spawned by the initial pre-export transactions supported by the PGF. H. Lessons of Experience 46. This is the first facility of its kind. Nevertheless, lessons leamed from prior financial intermediary and export development loans point to the following requirements for successful policy performance: (i) macro-economic stability, (ii) a liberal foreign exchange and trade regime, (iii) a structure that can cater to a wide variety of transactions and a broad range of financial providers, and (iv) structures that do not require overly strict and formal security arrangements. 1. Benefits 47. The facility would have the following potential benefits: * It would help Moldovan enterprises, traders and banks establish links with private trading companies and input suppliers who are willing to finance comnmercially viable, self-liquidating transactions; * It would contribute to the emergence of private input supply and output marketing channels and, by creating equal opportunities for all sectors, it would allow private miarkets to determine which enterprises will receive financing. e It would address one of the most pressing financial constraints facing the Moldovan economy, the lack of financing for high priority inputs, by providing non-inflationary finance to support production for exports; * It would foster joint ventures and investmnent relationships by encouraging potential partners to become familiar with each other in the course of short term input supply relationships. It would also help to identify viable enterprises, based on the private sector's willingness to bear the commercial risk of doing business with these enterprises and their assessment of the enterprise's ability to deliver an acceptable quantity and quality of output; * It would help Moldova establish a track record of policy stability, thereby improving its reputation in foreign financial markets. J. Risks 48. The main risk is that private lenders will not be induced to finance pre-export transactions despite the risk mitigation offered by the FGC. This risk is compounded by the novelty of the proposed approach. However, the "novelty" risk has been minimized by following established practices in pre- export finance and credit insurance as closely as possible. In addition, by giving the GAU the flexibility to support a wide range of financial instruments and mechanisms, it will be able to support transactions  - 14 - in the present environment as well as in the future when conventional finance channels becomes more developed. This risk has been further limited by consultations with a wide variety of commercial lenders, input suppliers, and trading companies who have provided useful design suggestions. Market soundings suggest that a number of commercial lenders, input suppliers, and trading companies would be interested in utilizing the facility. These institutions also indicate that there would be a substantial demand for pre- export financing in Moldova. 49. Another risk is that the reversal of the stabilization and/or structural reforms could lead to a large number of claims payments, creating a debt repayment problem for the country. This risk is addressed by the Govermnent's structural reform program which is supported by the Bank's Structural Adjustment Loan. The existence of the PGF will enhance the Bank's leverage in the policy dialogue on this program as it creates a situation where the costs to the Government of reversal in the area of trade and exchange policy are immediate. It is important to note in this context that the risks covered by the FGC are fully or partly in control of the Government, which is aware of the fact that the existence of the facility creates a situation in which its actions can lead to significant financial consequences. Nevertheless, in order to minimize the risk of a large number of calls, the Bank would retain the right to suspend backstop comnmitrnents for new guarantees if there is a substantial reversal of the trade liberalization and foreign exchange reforms supported by the SAL, or if a payment for a claim is made using the Bank's funds. With the Government's awareness of its responsibilities under the facility and these safeguards, this risk is outweighed by the fact that the facility will support Moldova's export-led growth strategy, and will thus contribute directly to the improvement of the country's creditworthiness. K. Agreements Reached and Conditions of Effectiveness 50. During negotiations, agreements were reached with the Borrower on (i) the final text of the Framework Guarantee Contract (para. 23); (ii) the arbitration procedures employed by the GAU (para. 31); (iii) the detailed text of the Operating Manual for the GAU (Annex I, para. 4); (iv) the Bank's prior review procedures (para. 19); and (iv) the fees charged by the GAU and procedures for annual reviews of the fee structure (para. 20). 51. The conditions of effectiveness would be: 3 The appointment by the GAU of an acceptable agent bank; * The appointment of the core staff of the GAU. Part M. Recommendation 52. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and reconmend that the Executive Directors approve it. Ernest Stem Acting President Washington, D.C. February 9, 1995 Attachments  Schedule A REPUBLIC OF MOLDOVA PRE-EXPORT GUARANTEE FACILITY Timetable of Key Processing Events (a) Time taken to prepare 9 months (b) Prepared by: Government, in close consultation with IBRD staff and consultants (c) Preparation Mission June 18 - July 2, 1994 Pre-appraisal Mission September 10 -17, 1994 Appraisal Mission November 26 - December 10, 1994 (d) Negotiations February 1-2, 1995 (e) Planned date of effectiveness April 1, 1995 (f) List of relevant PCRs and PPARs Not applicable  ANNEX I GAU: Organizational and Administrative Arrangements 1. The GAU has been established on the basis of the following organizational and administrative arrangements: 2. Supervisory Board. A Supervisory Board chaired by the Deputy Prime Minister for Economic Reform and consisting of representatives of the Ministry of Economy, Ministry of Finance, Ministry of Industry, Ministry of Agriculture, the National Bank of Moldova, the Bankers Association, and the Union of Employers and Leaseholders would supervise the operation of the GAU, ensure that the GAU is administered in accordance with its operating manual, appoint the General Manager, and delegate to him/her the authority to issue individual guarantees. The presence of government representatives on the Board would help to familiarize government officials with the transactions taking place within the country and the government actions or inactions that could trigger a payment under the guarantee. It would also help to ensure that guarantees are not issued to protect input suppliers/trading companies against policies that the Government is in the process of changing or revising at the time the guarantee is under consideration. 3. Charter and Adinishrafion. The charter as approved by the Parliament establishes the GAU as a distinct legal entity, descnrbes the composition and duties of the Supervisory Board, and stipulates that the GAU is authorized to (i) sell guarantees to foreign providers of credit, (ii) be designated by the Government to make withdrawals under the World Bank loan to the Government, (iii) enter into agency agreement with a foreign bank and a project agreement with the World Bank, (iv) hold a foreign exchange bank account inside Moldova and hold accounts in foreign banks, (v) receive foreign currency payments, (vi) enter into employment contracts and consultant contracts, and (vii) be subject to arbitration outside Moldova in connection with disputed claims under the guarantees. The Charter also describes the GAU's rights, obligations, and activities related to the facility. Among other things, it stipulates that the GAU will have the right to analyze proposed input supply transactions, prepare the necessary documentation, hire consultants to assist with GAU business, and issue guarantees. 4. Operating Manual. A detailed Operating Mamnal provides guidance to the staff and Supervisory Board on detailed operating procedures, including such matters, inter alia, as (i) project eligibility criteria, (ii). application and transaction approval procedures, including the Bank's right of prior approval, (iii) staff responsibilities, (iv) claims administration and arbitration procedures, (v) co-guarantee procedures with participating ECAs, if any, (vi) auditing and reporting requirements, (vii) the general terms and conditions of GAU guarantees and guarantee fees, (viii) environmental guidelines and procedures, and (ix) criteria for the retention and distribution of profits. Changes in the Charter and Operating Manual would require the consent of the Bank. Agreement on the detailed text of the Operating Manual was reached during negotiations.  5. Management and Staffing. A small professional core staff, aided by one or two expert consultants with extensive experience in export credit matters, would manage the GAU's day to day activities. The initial core staff would consist of (i) a general manager who would oversee the operations of the GAU and the guarantee approval process. (ii) a guarantee officer who would prepare the documentation and ensure that each transaction is in compliance with all eligibility criteria, and (iii) an administrative officer. In order to ensure that the GAU can attract high quality local employees, salary levels would not be subject to civil service pay scales. A grant from the Netherlands Government will finance technical assistance and training for the GAU. Beyond that, staff wages, consultant fees, and all other operating expenses will be financed out of the GAU's operating revenues. 6. In deciding whether to issue a guarantee, the staff would be guided only by technical eligibility criteria; it would not have authority to refuse coverage to anyone who satisfies the published eligibility requirements (provided that sufficient guarantee capacity is available), nor would it be authorized to issue guarantees for any transaction that has not satisfied the eligibility requirements as certified by the staff analysis presented to the General Manager and retained in the unit's files. The General Manager would be expected to submit periodic audited financial statements and activity reports to the Supervisory Board. In these reports, the Supervisory Board would be informed on the GAU's work, and especially on the guarantees issued during the preceding period, and on any rejected application and the reason for their rejection. 7. The hiring of a full complement of core staff and consultants would be a condition of loan effectiveness.  Chart 1 ANNEX II Risks Covered by GAU Government Perfemance Risks lolitical Fore War and Civil Dive..ion Disturbance of Voyage IIncrease in ncrease in of Seiure of Import Tax Export Tax Local Moldovan Input or lEntepris oupu Goods Prohibition or Limitation Cancellation Cance lation on Conversion of Import of Export Licenses Licenses Prohibition or Limitation on Transfer  Chart 2 ANNEX II Examples of Risks Not Covered by GAU LAMRI Enterprie t Performance Pie FIUCIU21lons Poor Insufficient Iate or Inlernal Final VAT and Olher [Exchang Quality Quantity Non-Delivery Inputs OUtput General Taxes i Rates I Rcfisal to | ri;; ;41