Ukraine - Export Development Project

Document of The World Bank Report No. 15909-UA STAFF APPRAISAL REPORT UKRAINE Export Development Project October 25, 1996 Enterprise and Finance Division Country Department IV Europe and Central Asia Region  CURRENCY EQUIVALENTS (as of September 30, 1996) Currency Unit = Hryvnia (previously Karbovanets) Hryvnia US$0.568 US$I = 1.76 Hryvnia END PERIOD EXCHANGE RATES Karbovanets/Hryvnia per US$1 1994 1995 March 1996 June 1996 September 1996 108,367 179,600 186,900 179,300 1.76 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS AGSECAL - Agricultural Sector Adjustment Loan BIS - Bank for International Settlements CAS - Country Assistance Strategy CEE - Central and Eastern Europe CIS - Confederation of Independent States EBRD - European Bank for Reconstruction and Development EDAL - Enterprise Development Adjustment Loan EDP - Export Development Project EDF - Export Development Fund ESW - Economic and Sector Work EU (TACIS) - European Union Program of Technical Assistance for the Commonwealth of Independent States EXIM - State Export-import Bank of Ukraine FIDL - Financial Institutions Development Loan FTO - Foreign Trade Organization FSR - Financial Sector Review FSU - Former Soviet Union IAS - International Accounting Standards ICB - International Competitive Bidding IMF - International Monetary Fund LIBOR - London Interbank Offered Rate MOFER - Ministry of Foreign Economic Relations NBU - National Bank of Ukraine PMU - Project Management Unit SBA - Stand-by Arrangement SCL - Single Currency Loan SMEs - Small and Medium-Sized Enterprises STF - Systemic Transformation Facility (of the IMF) UCCI - Ukrainian Chamber of Conunerce and Industry USSR - Union of Soviet Socialist Republics UKRAINE - FISCAL YEAR January I - December 31  STAFF APPRAISAL REPORT UKRAINE Export Development Project CONTENTS LOAN AND PROJECT SUMMARY PART I. BACKGROUND .......................................... 1 A. Introduction .......................................... 1 B. Background and Reform Experience ........................... 2 PART II. PROJECT RATIONALE, BANK STRATEGY AND LESSONS FROM BANK EXPERIENCE ................................ . 6 A. Project Summary and Project Rationale .... ................ . 6 A. 1 Project Summary ................................. . 6 A.2 Project Rationale ................................. . 6 Macro-economic Reasons for Export Promotion .............. . 6 Micro-economic Reasons for Export Support: Credit Market Problems and Demand for Credit ............. . 7 1. Credit Market Problems ............................ 7 2. Credit Demand ................................. 8 Micro-economic Reasons for Export Support: Infrastructure Issues . .. 9 The State Export-Import Bank of Ukraine (EXIM) .10 B. Links to Country Partnership Strategy and Economic and Sector Work .11 C. Bank Group Experience in the Export Sector and Lessons Learnt ... ..... 12 PART III. PROJECT DESCRIPTION .............. .. ................... 14 A. Project Objectives and Structure ............................. 14 B. Export Development Technical Assistance ....................... 16 C. Institutional Development Program for EXIM .................... 18 D. Export Oriented Credit Line ............................... 20 E. Terms and Conditions ................................... 21 F. Project Cost and Financing Plan ............................. 23 PART IV. PROJECT IMPLEMENTATION ............ .. ................. 25 A. Implementation Arrangements .............................. 25 B. Procurement ......................................... 26 C. Disbursement ......................................... 27 D. Project Accounting, Auditing and Reporting ..................... 28 E. Environmental Aspects ................................... 29 F. Supervision Arrangements and Performance Indicators ............... 30 PART V. BENEFITS AND RISKS ..................................... 32 PART VI. AGREEMENTS AND RECOMMENDATIONS ...................... 34  - ii - TABLES Table 2.1 - Project Growth of Demand for Export Finance ............... 9 Table 3.1 - Estimated Project Cost (US$ thousand equivalent) .... ......... 23 Table 3.2 - Proposed Financing Plan (US$ thousand equivalent) .... ........ 24 Table 4.1 - Estimated Disbursement Schedule (US$ million equivalent) ... ..... 27 ANNEXES A: Implementation Plan .................................... 35 B: Supervision Plan ..................................... 36 C: Selected Documents Available in the Project File ..... ............. 38  IJKRAINE Export Development Project Loan and Project Sunmmary Borrower: State Export-Import Bank of Ukraine (EXIM) Guarantor: Ukraine Implementing Agency: EXIM Beneficiaries: EXIM and private and privatized Ukrainian exporters Poverty: Not applicable Amount: About US$70 million equivalent Terms: A Single Currency Loan consisting of two portions: US$60 million at the Bank's standard US$ LIBOR-based interest rate and DM15 million at the Bank's standard DM LIBOR-based interest rate; with a proposed 5 year grace period and a 17 year maturity. Commitment Fee: 0.75 percent on undisbursed credit balances, beginning 60 days after signing, less any waiver On-lending Terms: EXIM will pass the funds under the export technical assistance component of the proposed loan on to eligible exporters on a matching grant basis, and the funds under the credit line component in the form of sub-loans denominated in US$ or DM with maturities and market-based interest rates suitable to the sub-projects to be financed. The funds under the institutional development technical assistance component will be used by EXIM to finance a twinning arrangement with an experienced foreign EXIM bank or other suitable institution(s) specialized in trade finance and promotion. Financing Plan: See Part III, Section F Financial Rate of Return Investment sub-projects should have a minimum financial and Debt Service Coverage Ratio: rate of return of 15 percent. All sub-projects should have a minimum debt service coverage ratio of 1:1.5. Staff Appraisal Report: 15909 UA Project ID Number: UA-PA-44851 Vice President: Johannes Linn Director: Basil G. Kavalsky Division Chief: Paul J. Siegelbaum Task Manager: Marie-Renee Bakker   UKRAINE Export Development Project STAFF APPRAISAL REPORT PART I BACKGROUND A. INTRODUCTION 1.1 The State Export-Import Bank of Ukraine (EXIM) has requested a Single Currency Loan (SCL) with two portions of US$60 million and DM15 million in support of a structured program, to be implemented by EXIM, for the development of exports from the newly einerging Ukrainian private and privatized enterprise sector. The Government of Ukraine has endorsed EXIM's export development program and supports its loan request. The Government has also indicated its willingness to provide a sovereign guarantee for the loan. 1.2 EXIM's export development program has three components: (i) provision of technical assistance to private and privatized Ukrainian exporters to assist with preparation and implernentation of comprehensive enterprise level Export Development Plans, (ii) a comprehensive institutional development program for EXIM itself which will take the form of a twinning arrangement with an experienced foreign EXIM bank or other suitable institution(s) specialized in trade finance and promotion, and intended to turn EXIM into an effective and focused export support and financing institution, and (iii) provision of financing to meet export-oriented short term working capital and medium/long term investment financing needs of private and privatized exporters. The proposed loan in support of the Export Development Project (EDP) would fund these program elements with a US$5.0 million export development technical assistance component, a US$2.5 million institutional development technical assistance component,l and a US$60 million equivalent export-oriented credit line component, respectively. To allow flexible use of funds across these three components, the proposed loan also contains a US$2.5 million unallocated reserve. 1.3 This report briefly describes the economic situation in Ukraine within which EXIM's request needs to be judged, the rationale for the suggested project response, and the project itself. The background section (Part I, B) first describes the general economic situation in Ukraine, indicating the substantial progress that has been made over the last two years in both stabilization and structural reform, and the key role exports play in turning the economy around decisively. The section describes in more detail the export regime in Ukraine since the breakup of the Former Soviet Union (FSU), the substantial liberalization of the trade and exchange rate regime which has taken place since late 1994 and the early signs of export recovery in response to this liberalization. In addition, this section contains a profile of EXIM, the proposed Borrower and implementing agency for the project. The project rationale section (Part II, A.2) indicates how the proposed project would assist in putting the nascent export rebound on 1 Grant financing has been requested from the Japanese Govemment for dibs component but an official Japanese response has not yet been received. In order not to delay project implementation, EXIM and the Govemment have agreed to include funding in the loan for the insdtutional development program for EXEM. In case Japanese grant funding materializes, the US$2.5 milLion technical assistance component will be reallocated to other project components.  a firmer footing. It would do so by improving the infrastructure and by providing the financing necessary for sustained export growth. There currently is no institution capable of providing existing and prospective exporters with an integrated package of information, technical assistance and finance services, and the project would address this gap. The project description sections (Parts m and IV) explain the project in detail, including proposed measures intended to address corporate governance and institutional weaknesses in EXIM. B. BACKGROUND AND REFORM EXPERIENCE 1.4 Ukraine became inTidependent at the end of August 1991, achieving independence in economic policy for the first time. The first three years after independence were characterized by poor economnic management and runaway inflation, rapidly increasing external debt, a massive across the board decline in formal economic activity, and a virtual collapse of exports, particularly sales to the FSU. Energy problems played an important role in the decline since as a major importer of energy products, the country suffered a considerable terms of trade loss when Russian and other suppliers raised their supply prices to world market levels. The cumulative formal output decline between 1991 and 1994 was 59.3 percent, substantially bigger than the declines experienced in the Central and Eastern European (CEE) countries, and on a par with the experience in Russia. More information about trends in and features of Ukraine's exports performance is available in the project file. 1.5 However, in October 1994, a newly elected President announced a radical break from past economic policies and introduced a reform program designed to reduce inflation, improve living standards, and promote a sustainable recovery of production. Since then a tenuous stabilization has taken hold, inflation has fallen sharply, trade has been liberalized, as have most internal prices, and a process of tax reform to introduce a modern revenue base for the State has been undertaken. In a major departure from earlier years, the complicated dual exchange rate system in operation late 1993 and early 1994 was swept away and replaced by a relatively open foreign exchange regime, and most export barriers were removed. 1.6 In support of the reform programn, the IMF in October 1994 approved a first purchase under its Systemic Transformation Facility (STF) of US$365 million equivalent, and two months later the World Bank approved a Rehabilitation Loan of US$500 million equivalent. The second purchase under the STF (for another US$365 million equivalent) and a Stand-by Arrangement (SBA) for the maximum 100 percent of quota or US$1,494 million equivalent were both approved by the IMF in April 1995. Ukraine made three purchases under the SBA equivalent to 54 percent of its quota. But due to policy slippage in the second half cf 1995, the remaining amount of the SBA was not disbursed. On May 10, 1996 a new SBA for US$900 million equivalent was approved by the IMF Board and to date remains broadly on track. Meanwhile the World Bank recently approved adjustment loans in support of President Kuchma's reforms in the enterprise sector (the Enterprise Development Adjustment Loan--EDAL) and the agricultural sector (the Agricultural Sector Adjustment Loan ---AGSECAL). 1.7 More specifically, under the reform program, fiscal and monetary policies have been tightened considerably with the fiscal deficit declining from the equivalent of 8.2 percent of GDP in 1994 to about 4.7 percent in 1995. Inflation rates have been reduced from monthly levels which were typically about 20 percent in early 1995 to rates which have been about 5-8 percent through most of 1995 and about 1 percent in mid-1996; as a result inflation in 1995 was about 380 percent as compared to over 10,000 percent in 1993. The lower inflation has been achieved in spite of the removal of most price controls,  - 3 - the adjustment of energy prices to world levels, the reduction of most consumer subsidies, major increases in housing rents, transportation tariffs and charges for communal services. 1.8 Interest rates in Ukraine are now market determined although the National Bank of Ukraine (NBU) maintains some administrative influence through its control of its own refinancing rate which has become the main reference rate in the system. Under the new IMF SBA, the Government has committed to discontinue all direction of credit; during 1996 there has been only one very small directed credit program in violation of this commitment, for the coal mining sector (equivalent to 0.2 percent of GDP), and this credit is on-lent at rates at least equal to the NBU refinance rate. Although interest rates were trending down for much of 1995, inflation declined somewhat faster. Hence, real interest rates on bank loans, already positive in 1994, remained generally positive through most of 1995 and into 1996. 1.9 A decree of November 1994 streamlined the procedures for mass privatization and mandated that 8,000 medium and large enterprises would be privatized through certificate auctions by December 1995. Although the number of enterprises actually privatized was only about 1,000 of the 7,606 enterprises approved for privatization during that year, most of the factors constraining faster progress have been addressed in the context of the sectoral adjustment program which became the basis for the World Bank's EDAL which was approved by the Board on June 27, 1996. The first part of 1996 provided evidence of an acceleration of the process towards sales of 400 enterprises per month. By early October over 3,500 enterprises had met the criteria of transfer to private hands of 70 percent ownership since January 1995. 1.10 Since October of 1994 the trade regime has been substantially liberalized. The weighted average import tariff in 1995 was 6 percent with less than 1 percent of all imports having tariffs greater than 30 percent. There are few quantitative restrictions on imports other than licensing of certain pharmaceutical and chemical products for health and enviromnental purposes, and convertibility of the currency now applies to most current account transactions, although exporters have to sell 50 percent of their foreign exchange earnings (after servicing of any foreign currency denominated debt) at the interbank currency auction; but with exchange rates at this auction now being market determined, this foreign currency surrender requirement no longer constitutes a tax on exports. Importers do face problems in obtaining certification in compliance with Ukrainian standards. However, the Government, as part of the conditionality for the World Bank's EDAL, has agreed to eliminate such controls at the point of importation in favor of random checks at the wholesale level. The extensive system of export taxes and quotas in operation in 1994 has been abolished, although about one half of Ukraine's exports remained subject to export control through the use of minimum prices. But a decree dated September 25, 1995 removed the Ministry of Foreign Economic Relations' (MOFER's) discretionary power to impose controls, although implementation of this decree still seems incomplete. As part of EDAL conditionality, indicative prices will be limited to commodities where anti-dumping problems apply or which are subject to voluntary export restrictions or international contingent agreements. All other export controls will be rescinded. As a result, Ukrainian exporters will be able to operate with minimal restrictions. Thus, the policy regime under which exporters operate has been much improved and will be improved further. 1.11 Along with liberalization and reform of the trade regime, the institutional structure for handling Ukrainian exports has also been undergoing significant change and further development. However, this process has not always been smooth and even. 1.12 Under the structure which existed in the former USSR, special state foreign trade organizations (FTOs) were empowered to conduct almost all export/import transactions with more than 120 countries,  -4 - with the payments being accounted for and settled through the state-owned Vneshekonom Bank (foreign trade bank). In 1988, the central Government allowed the republics to establish their own local state FTOs, which despite decentralization still lacked knowledge and experience in foreign and initially acted simply as intermediaries between domestic enterprises and Moscow-based trading organizations. With the collapse of the USSR, during 1991, the export trade initiative shifted to proactive large state-owned Ukrainian producers and growing private businesses who were allowed by the Law on Foreign Economic Relations to obtain foreign trade status with the right to trade directly with foreign partners, while smaller newly established independent Ukrainian FTOs were still learning existing international standards and trends. 1.13 This development was temporarily hindered in 1992 by MOFER's introduction of export/import quotas and licenses which imposed high administrative costs on private enterprises and small intermediaries for export/import transactions. At the same time, larger and more specialized state-owned FTOs established at the branch ministries were given access to quotas and licenses under simplified procedures, providing them with a competitive advantage over private firms and smaller intermediaries, while at the same time retaining the right to facilitate international trade transactions on behalf of the Government under state orders and intergovermnental contracts. However, as a result of the overall economic crisis in 1994-95, there was a general collapse in the FTO-assisted foreign trade regime due to payment arrears and operational difficulties of Ukrainian manufacturers. The role of the branch ministry FTOs was further undermined by the abolition of the state order system in 1995 and continued liberalization of the foreign trade regime. As a result, today only about 20-25 major FTOs (most of them in the process of corporatization) still continue to work as Governmental agents on interstate contracts and provide services to traditional suppliers in competition with private trading companies. 1.14 The general shake-out among FTOs has led to the emergency of a healthy commercial approach to dealing with export trade skill needs. Increasingly, foreign trade is handled by enterprises themselves, and the remaining FTOs are concentrating on developing their respective commercial niches where they add value because of specialized knowledge of products and markets. As a measure of the dispersion of participants in export trade, in 1995 the Ministry of Statistics registered about 25,000 Ukrainian enterprises involved in different types of operations on foreign markets. Thus, the bulk of Ukrainian trade is now handled at the enterprise level. 1.15 It is critical to the credibility of and continued support for the Government's reform efforts that the various stabilization and structural reform measures already taken result in visible and significant reversals of the negative output and income growth of recent years. Progress in this regard has so far been somewhat discouraging but, with the foundations of greater stability and privatization already laid, there are now good prospects for Ukraine following other transition economies into a period of positive and even high growth. The high growth scenario incorporated in the World Bank's Country Assistance Strategy (CAS) which was discussed by the Board on June 27, 1996 anticipates that GDP will start to grow in late 1996 and grow thereafter at rates of between 4.5 and 6 percent per annum. The experience in countries further ahead on the path of reform, such as Poland, the Czech Republic and Hungary indicates that exports will have to play a key role in leading this recovery from the demand side. In fact, the early response to the substantial improvements in the policy environment of the past year and a half has been encouraging, especially where it concerns exports to non-FSU markets which grew by 18  percent in 1995 2 Sustained export growth of the order of 8 percent per annum could permit the external current account deficit to decline from the equivalent of an estimated 4.2 percent of GDP in 1995 to 2.0 percent in 1998 and to 1.8 percent by the end of the decade. This would mean that external financing requirements would remain in the region of US$2-2.5 billion per annum during the next two to three years. These amounts should be capable of being covered by sustained official flows, combined with an expected increase in private foreign capital flows in later years. The proposed project aims to provide the institutional and financial support necessary to sustain the process of export growth that has so recently gotten underway in response to the radical improvements in the policy environment put in place by the current Government. 2 According to Ukrainian Ministry of Statistics data; the IRF, using counterpart trade stadstics, estinates that the growdt rate was 19 percent.  -6 - PART II PROJECT RATIONALE, BANK STRATEGY AND LESSONS FROM BANK EXPERIENCE A. PROJECT SUMMARY AND PROJECT RATIONALE A.1 Project Summary 2.1 The EDP will assist in the development of Ukraine's emerging private sector export potential by supporting the production of goods and services for export in all sectors of the economy. The project will provide: (i) export development technical assistance to private exporters (US$5.0 million), (ii) technical assistance for the institutional development of EXIM (US$2.5 million), and (iii) credit finance to private exporters (US$50 million and DM 15 million). To allow a flexible use of funds across components, an unallocated reserve of US$2.5 million is also included in the loan. 2.2 Total project cost is estimated at US$84 million equivalent (see Table 3.1). EXIM will be the Borrower of the loan as well as the implementing agency for the project. The Government will provide a sovereign guarantee for the loan. The beneficiaries of the credit finance will be private and privatized exporters. Credit allocation decisions will be taken by EXIM using predetermined conmmercial sub-borrower and sub-project eligibility criteria. The credit risk for sub-loans to enterprises will be borne by EXIM. A.2 Project Rationale Macro-economic Reasons for Export Promotion 2.3 Exports will be the key engine of growth in Ukraine like they have been in all successful CEE countries. In fact, all CEE and other transition countries that have achieved positive growth rates have done so on the back of a strong and continuing surge of exports, especially to Western markets. This should be no surprise: consumption will remain weak after the output drop and increasing fears of unemployment; private sector investment will remain low because of regulatory, tax and general policy uncertainty and slow progress in privatization; and the Government itself will have to retrench under the impact of higher social expenditure and continuing difficulties in tax collection. This leaves exports as the primary engine of growth. 2.4 Experience in CEE and other transition economies confirms that export growth has built predominantly on efforts to more effectively and efficiently use existing capacity. Since there is substantial excess capacity in all potential export sectors in Ukraine, there will be a clear social gain from a macro-economic perspective from a project that leads to efficient export growth by resolving infornational and other problems currently hampering such a recovery. Moreover, further gains can be expected through multiplier effects in the rest of the economy due to the existing excess capacity in both capital and labor markets. Thus, there is a strong macro-economic rationale for this project. However, if a recovery is to be sustainable, it will have to be private sector driven and based on inherently profitable activities. The Government is in no position to subsidize the economy out of its currently depressed state. 2.5 Such an export led recovery, of course, hinges critically on a good environment in terms of trade and exchange rate policies, both of which have recently improved substantially recently in Ukraine.  However, for a sustained, private sector based recovery, adequate informational, technical assistance and credit facilities are equally important. This leads to the micro-economic arguments in favor of the proposed project, which are covered in the following paragraphs. Micro-economic Reasons for Export Support: Credit Market Problems and Demandfor Credit 1. Credit Market Problems 2.6 Although state-owned companies played an important role in the early phase of the export recovery in, for example, Poland, private companies have quickly taken the lead subsequently. Now the majority of hard currency exports of the CEE countries is coming from new private firms. But before such a private led export recovery can take place in Ukraine, major problems need to be resolved, to which the proposed project is designed to contribute substantially. Private companies in Ukraine are mostly new, and certainly new in export markets. Even those with a past history as state-owned enterprises do not have a strong Western orientation. In Ukraine's evolving legal environment, credit relations are largely dependent on both parties knowing each other sufficiently well to have faith in each other's interest in a continuing business relationship and the associated intention to deliver on commitments. 2.7 This characteristic creates catch-22 problems for any company trying to enter a new market, problems that are especially severe for new private companies, the main targets of the proposed project. To be trusted as a commercial partner and maintain effective credit relations, a firm needs a presence in the market; only then will it be obvious to the potential partner that the firm has a sufficient interest in a continuing relation with its financiers to sustain effective business relations in the uncertain legal environment that still prevails in Ukraine. But to establish such a presence requires the very relations for which that market presence is a prerequisite. Given the crucial macro-economic importance of a successful export drive, breaking this deadlock requires urgent attention. 2.8 Such problems are especially urgent across international boundaries. First, legal recourse, as a practical matter, is essentially unavailable in the case of payment conflicts, which greatly increases the importance of mutual trust in establishing credit relations. But the information gap that needs to be bridged to establish such relations is especially large between potential partners from different countries. This problem is exacerbated when the firms involved are new. This is one of the reasons why export financing merits special attention and usually special institutions. 2.9 It should be noted, however, that while this point argues for setting up special export credit agencies, it does not argue for providing credit on subsidized terms. In fact, because the amounts to be made available under this project are likely to be substantially less than credit demand at full cost pricing (see paragraphs 2.11-2.13 below), pricing in excess of cost as an efficient rationing device can be defended. The resulting profits can be used to finance the non-credit export support activities, where the case for a subsidy element is stronger (see paragraph 2.15 below). 2.10 The export sector is also the sector where the demand for financial services is most likely to pick up first. Consumer credit is virtually non-existent, and private investment is barely taking place: a situation which, if the recent history in CEE countries is of any guidance, will not change much for some time to come. Exports on the other hand will surge if proper policies are followed, creating an immediate demand for the associated financial services. Thus, working on credit market problems in other sectors may for some time look like pushing on a string, improving supply while demand is not yet  -8- present. Arguably financial sector support in the domestic market should focus on restructuring, restoration of balance sheets, establishing proper ownership and incentive structures, establishing proper expertise and procedures, etc., and not yet on product development and support. The problem is clearly different in export markets, however, as demand for export finance is demonstrably present and there is a reasonably structured and working institution--EXIM--to act as intermediary. These considerations strongly argue for singling out export finance for a project early on in a wider ranging long term financial sector reform program. 2. Credit Demand 2.11 These general considerations are supported by a survey of the likely demand for export finance supplied at commercial cost. During preparation of the EDP, an assessment was undertaken of both the need for export support services and demand for export oriented financing, through interviews of existing and prospective exporters, MOFER, the Ukrainian Chamber of Commerce (UCCI) and EXIM officials, and a client survey undertaken by EXIM. This analysis has confirmed the presence of large unmet informational, technical assistance and financing needs. An independent survey of enterprises conducted by the World Bank in preparation for a foreign investor conference has corroborated these findings. 2.12 Specifically, EXIM's survey among its own client base of over 20,000 firms indicates that there is current unmet demand for export finance among nearly 500 private firms of about US$1.2 billion equivalent. EXIM management conservatively estimates that about 15 percent of this amount or US$180 million equivalent would translate into bankable projects for an estimated 70 firns. A list of these projects and firms is available in the project file. 2.13 An estimate of the demand for export finance can also be derived from a macro-economic modeling exercise based on a set of assumption about expected export growth, the import content of incremental exports, the growth of the share of the private sector in total exports, and the growth in foreign currency denominated lending by the banking system. If Ukraine's macro-economic and structural reform policies proceed as envisaged under the new IMF Stand-by Arrangement and the World Bank's EDAL and AGSECAL operations, Ukraine is likely to experience much higher private sector driven export growth. Using assumptions derived from the projected export and GDP growth rates as per the CAS, and a set of assumptions about the associated incremental imports, the private sector's share thereof and expected growth in foreign currency lending by the banking system, the resulting incremental demand for export financing would be as follows:3 3 The model and the underlying asumptions are available in the project file.  -9 - Table 2.1 Projected Growth of Demand for Export Flnance (USS million eaiuivalent) 1996 1997 1998 1999 2000 Annual Unsatisfied Financing Requirement 106.52 152.86 212.99 267.21 322.72 Cumulative Financing Gap 106.52 259.39 365.85 480.20 589.93 Micro-economic Reasons for Export Support: Infrastructure Issues 2.14 In most countries, export financing institutions do a great deal more than export financing. In particular, small companies have difficulty justifying the fixed costs of information gathering, promotion of name brand recognition, acquisition of a reputation as reliable supplier, and so on. A substantial part of such costs can be more efficiently delivered by a central agency since organizing support for many firms is not much more expensive than organizing support for one firm. Examples are the setting up of a database with useful contacts in various regions of the world, provision of information on tax regimes and customs regulations in export markets and so on. Because of the non-exclusive nature of such services, substantial efficiency gains can be had by concentrating this type of activity in one place. In addition, exporters will need technical assistance to help them enter into or expand their sales in foreign markets. EXIM would be a natural candidate to provide such infornation and technical assistance services because it already provides export oriented financial services, and because of its established name recognition. In addition, EXIM is well organized and one of the best capitalized banks in Ukraine (see paragraphs 2.17 through 2.21 below). In fact, lessons learned from prior World Bank export development projects indicate that the provision of such services, particularly when they are provided in conjunction with export finance as part of an integrated export support package, is often the most successful element in export development programs (see Section C below). 2.15 Finally, there are a variety of reasons for pricing these non-credit export services at less than full cost. First, there are the macro-economic benefits of an export recovery, surely a point that will not be internalized by any given firm. Once Ukraine is closer to full capacity utilization, this argument will loose force, but that situation is still some years off. Second, there are demonstration effects of a successful early private entry into export markets, again benefits that will not accrue to the original exporter and thus will not be internalized. And third, the effectiveness of export support services will generate more awareness of and demand for them, again a benefit that will not be internalized by the first user. All this argues for pricing below cost for a nunber of years until the service is well established and the financial situation in Ukraine is more regularized. Establishing the optimal subsidy element is obviously an uncertain thing to do; as a start EXIM4 plans to provide these services on a 50 percent matching grant basis (i.e., a 50 percent subsidy), a practice that is in line with earlier World Bank export development projects (e.g., India). Because of the anticipated excess demand for credit at marginal cost pricing, EXIM expects to be able to charge a 4 percent on-lending margin, which at the anticipated credit volume and scale of export support activities proposed under the EDP, and using the projected disbursement profile (Table 4.1) would make the provision of these services self-financing. A spreadsheet  - 10- model with the underlying calculations that has been used to arrive at this margin is available in the project file. 2.16 In summary, jump-starting a private sector based recovery in Ukraine is key to the sustainability of the still fragile reform process. Experience elsewhere suggests that exports are the only likely venue through which such a recovery can come about. This project will thus make a key contribution to consolidating the reform process and establishing the private sector as the dominant factor in Ukraine's economy. The State Export-Import Bank of Ukraine 2.17 EXIM was established by Presidential decree on January 3, 1992 and organized on the basis of the Ukrainian branch of the former all USSR Vneshekonom Bank, taking over its staff and physical assets but not its balance sheet, nor any legal responsibility for Vneshekonom's activities. The bank has authorized capital of Hryvnia 100,000 and about US$45 million and is fully owned by the Government. EXIM holds a general banking license from the NBU and is subject to NBU regulation and supervision. 2.18 EXIM is headquartered in Kiev and operates 24 branches and three representative offices in the principal commercial centers of Ukraine. The bank currently employs around 1,350 staff. EXIM is one of two remaining state-owned banks (the only other remaining state-owned bank in Ukraine at the moment is the State Savings Bank). 2.19 EXIM acts as an agent of the Ukrainian Government in administering inter-Governmental loan agreements on behalf of the Government, receiving loan proceeds from foreign financial institutions and Governments and advancing such amounts to various enterprises within Ukraine based upon separate loan agreements between EXIM and Ukrainian enterprises under the credit responsibility of the Ukrainian Government. Three separate decrees of the Cabinet of Ministers of Ukraine define this agency relationship in more detail, unequivocally establishing the Government's responsibility for the credit risks involved and defining the mechanism to be used to compensate EXIM for any loan defaults. In practice this mechanism has involved periodic negotiations and settlement of such default compensations between the Government and EXIM. It did not provide immediate and automatic compensation to EXIM in case of large and unexpected loan defaults, potentially exposing the bank to a liquidity risk. To mitigate this risk, as a pre-Board action, EXIM and the Government have entered into a more formal agency agreement which provides it with automatic and immediate compensation notwithstanding the size and timing of loan defaults, instead of a lagging negotiation and settlement process. 2.20 EXIM undertook a first restatement of its accounts to International Accounting Standards (IAS) as of end December 1993 and has since been audited by an international auditing firm twice. The first full IAS audit which was based on an audited IAS opening balance sheet and profit and loss statement for the year is the year-end 1995. As per the year-end 1994 audit, EXIM had a capital adequacy ratio of slightly more than 6 percent BIS risk weighted, on an IAS basis. Capital adequacy as of year-end 1995 was 12 percent BIS risk weighted, on an IAS basis. This increase was due primarily to a reversal of earlier year provisions on loans for which the Government subsequently has taken responsibility. EXIM's year-end 1995 IAS financial statements indicated total assets of US$514.9 million equivalent, including net loans made for EXIM's own account of US$70.6 million equivalent. US$804 million equivalent in Government loans were not reflected in the bank's LAS balance sheet due to their agency status.  - 11 - 2.21 The Government and EXIM have expressed the wish to transform EXIM into a dedicated and effective export-import bank, capable of supporting the Government's key policy objective of rapid development of Ukraine's export potential with a structured menu of information, technical assistance and financing services for existing and prospective private sector exporters. For this purpose, the Government and EXIM have requested the World Bank to assist them in arranging and identifying financing for a comprehensive institutional development program for EXIM. This program, which is a component of the proposed EDP, is described in Part III, Section C of this report. B. LINKS TO COUNTRY ASSISTANCE STRATEGY AND ECONOMIC AND SECTOR WORK 2.22 The Bank's lending strategy, as described in the CAS--discussed by the Board on June 27, 1996- is designed to support the development of the private and privatized enterprise sector. One important component of this strategy is the EDAL, which was approved by the Board on the same date. This loan extends the work on enterprise development initiated in the 1994 Rehabilitation Loan and is designed to expedite the completion of the mass privatization of medium and larger enterprises, and to facilitate further small enterprise privatization. In addition, the EDAL will provide post-privatization support to enterprises, by strengthening the main capital markets institutions and by facilitating the restructuring of privatized enterprises and improving governance. Under the current program of the Government in connection with the EDAL, the Government is committed to address remaining issues in Ukraine's trade regime (see paragraph 1.10) in order to encourage the external trade expansion upon which the success of Ukraine's overall reform program depends. 2.23 In 1995, Ukraine's exports of goods and non-factor services totalled over US$16 billion equivalent and imports were in excess of US$17 billion equivalent. These totals are expected to grow significantly during the next few years as reform proceeds. At the same time, an increasingly large part of trade will involve new and newly privatized enterprises, will be to Western and other non-FSU markets and will be arranged strictly on commercial terms. This new trade will need a volume and range of information, technical assistance financing services which does not exist at present but which the EDP is being designed to provide. Hence, the proposed project provides necessary support to the established reform program in the enterprise sector and specifically to the many newly privatized enterprises which will depend on export markets for their future survival and prosperity. 2.24 The EDP is also designed to contribute directly to the strategy for the financial sector as outlined in the World Bank's Financial Sector Review (FSR) of June 1995. This strategy seeks to speed up the differentiation between strong, well capitalized and well managed banks which need to achieve expansion, and banks which are financially and managerially weak and may need to be closed or down-sized. This will be achieved both by bottom-up direct institutional strengthening of individual banks or groups of banks, and through top-down pressures towards improved bank performance through improved regulation and supervision, and a better legal and accounting environment. 2.25 The bottom-up approach is already being pursued in the context of an EBRD line of credit for small- and medium-sized enterprises (SMEs) channeled through the most creditworthy private banks. A Financial Institutions Development Loan (FIDL), scheduled for Board presentation in fiscal year 1998, would complement this work both by extending the numbers of banks eligible for credit line participation, and by providing finance for larger potential sub-projects. As is the case with the EBRD operation, all banks seeking access to the World Bank's credit line will need to implement substantial institutional strengthening both in terms of their capitalization and operational policies and procedures. As part of the  - 12 - preparation of the FIDL, grant funding has been mobilized to finance in-depth institution building support for two of Ukraine's largest banks (formerly state-owned in both cases) through twinning arrangements with reputable Western banks. 2.26 In line with the recommendations of the FSR, the top-down approach is being pursued through extensive technical assistance especially in the areas of NBU regulation and supervision of banks, accounting reform and the reform of collateral and bankruptcy law. For the moment these programs are being delivered mainly by other donors with the World Bank involved as a key player through the donor coordination meetings which it initiated in May 1995, through training initiatives and through other networking activities. The World Bank will take on a more direct role in these and other matters through the Financial Sector Adjustment Loan (FSAL), scheduled for fiscal year 1998, which will also address residual questions about the structure and restructuring of the banking sector. 2.27 The EDP fits into this strategy as an important component of the bottom-up approach. EXIM is already specialized in trade finance, is reasonably well capitalized and benefits from an existing management team which is committed to turn the bank into a focused and competent export-import support and financing institution. By providing strategic direction and extensive technical assistance for institution building in the bank through twinning with an experienced foreign EXIM bank or other suitable institution(s), the EDP can ensure that this large and important bank becomes an important and positive element in the post-privatization reforn agenda of Ukraine. The inclusion of the EDP in the lending program will ensure that three of the five large state and former state banks as well as the strongest private banks are all exposed to significant institutional strengthening via the bottom-up approach. 2.28 At the same time, because of its niche activity (export finance) and its virtual absence from the interbank market, EXIM is relatively isolated from problems elsewhere in the financial sector. Because of this there is no need to wait for progress in financial reform before this project can go ahead. While the availability of credit facilities will profit from financial sector restructuring, the EDP can already function well while the more general process of financial sector reform is still underway. C. BANK GROUP EXPERIENCE IN THE EXPORT SECTOR AND LESSONS LEARNT 2.29 Export development projects have been undertaken by the World Bank in a number of countries, e.g. India, Mexico and Colombia, and a number of useful lessons have been learnt. These are: * Provision of credit to the export sector can have a positive economic impact during the transition from close state control of financial markets to a liberalized policy environment, especially when sectoral allocations in lending were left to the market. * An EXIM bank or a foreign trade bank is an appropriate focus for on-lending, (e.g. EXIM in India, Bancomext in Mexico, Bancoldex in Colombia). These banks are dedicated institutions for developing foreign trade, and did not carry out normal commercial retail operations. Usually they target export financing, and in some cases, they work as wholesale banks and develop lending programs for the first tier banks, in addition to their own direct lending to exporters. * Strengthening the capabilities of both enterprises and financial institutions in designing, implementing and appraising export development programs, and export oriented investments is vital for success. This is usually done by providing: (a) export development technical assistance to help exporters develop export plans and organize marketing, product development and  - 13 - technological know-how; and (b) institutional development technical assistance for improving the financial institutions' capabilities to carry out credit assessment, risk assessment, and optimum pricing, and to promote and appraise export development programs and export oriented investments. * Effective coordination of loan financing and technical assistance is vital for the beneficiaries. Use of loan and grant funds in supporting the same enterprise when administered by different implementing institutions result in duplication of effort and weakening of a unified strategy. * Trade promotion funding and activity through matching grant funds and joint participation by enterprises and financial entities in trade promotion organizations is very important. The matching grant facilities used in India, Indonesia, Singapore, Taiwan, and Colombia for these purposes had the objective of improving information flow between buyers and sellers, and providing advisory services to exporters. * Grant funding helps enterprises' own efforts to begin or extend their markets through market surveys, travels to develop business contacts, and some testing and inspection; and are highly cost-effective when measured in terms of incremental exports. In India, Export Marketing Funds and Productivity funds were set up to provide technical assistance as well as pilot marketing and business promotion assistance on a 50 percent cost sharing basis. Funding for these technical assistance efforts was provided by the Government on a grant basis. 2.31 The proposed EDP for Ukraine will incorporate these lessons by providing an integrated package of export oriented information, technical assistance and financial support services to private exporters, and by transforming EXIM into a dedicated and effective export support and financing institution through a comprehensive institution building effort with the assistance of an experienced foreign EXIM bank or other suitable institution(s) specialized in trade finance and promotion. 2.32 Credit line operations to support the private sector in CEE/FSU countries have also provided a number of useful lessons. There are: * structure: where the financial intermediary/intermediaries are identified in advance and limited in number, they should be the direct borrower(s) of the IBRD loan rather than the Government; such a structure: (i) enhances the ownership of the credit line by the borrower as the commitment fee is paid by the borrowing financial intermediary, thereby creating a strong incentive in favor of utilizing the credit line promptly; and (ii) persuades the financial intermediary(ies) to more accurately project client demand, and therefore the required size of the credit line during the project preparation stage; * sub-loan maturity: the credit line should finance working capital as well as medium- to long-term investment lending without any restrictions on minimum sub-loan maturity period; working capital finance should be for inputs of goods, works and services for strengthening and expansion of existing operations; such a flexible mix of products increases the financial intermediary's incentives to utilize the credit line, by improving its overall risk profile on sub-loans, and reducing the overall processing time, documentation, appraisal, procurement and environmental obligations when spread over all categories of sub-loans;  - 14 - * SCL: availability of SCL terms along with flexible loan repayment options (e.g. 17 year term vs. bullet loans) increases the competitiveness of our loan product; LIBOR-based SCLs as opposed to currency pool loans with unknown future cost also make it easier for the financial intermediary to design its sub-loan pricing structure; * procurement: simplification of procurement rules, especially through the use of local commercial practices, is a very important contributor to the success of any credit line; private sub-borrowers serviced by private banks consider our procurement procedures cumbersome and very intrusive and restrictive in their rights of freedom of business operations in a commercial lending context; and * technical assistance for banks and enterprises: provision of technical assistance to the financial intermediaries and to the enterprise sub-borrowers to assist in preparation of bankable sub-loan applications is critical for efficient and high-quality credit line utilization. 2.33 Lessons learnt from previous Bank operations in Ukraine include the need to increase borrower commitment and project preparation and implementation efficiency, by focusing the lending operation as closely as possible on the implementation agency. 2.34 The design of the proposed EDP incorporates these lessons by directly lending to EXIM as the borrower, and by providing SCL terms, flexible sub-loan maturities and working capital as well as investment finance. In addition, commercial practices are proposed as the main procurement methodology, and the project design incorporates technical assistance for both EXIM and private exporters.  - 15 - PART III PROJECT DESCRIPTION A. PROJECT OBJECTIVES AND STRUCTURE 3.1 The main objective of the EDP is to develop Ukraine's emerging private sector export potential by supporting the production and marketing of goods, works and services for export in all sectors of the economy, and by developing the capacity of EXIM, through a comprehensive institutional development program, to provide an integrated package of information, technical assistance and finance services to private and privatized exporters. The project will provide: (i) export development technical assistance to existing and potential Ukrainian exporters (US$5.0 million), (ii) institutional development technical assistance to EXIM (US$2.5 million) in the form of a twinning arrangement with a successful foreign EXIM bank or other suitable institution(s) specialized in trade finance and promotion; and (iii) export oriented finance to private and privatized exporters (US$50 million and DM15 million). An unallocated reserve of US$2.5 million has been included to allow a flexible use of funds across components. 3.2 Total project cost is estimated at US$84 million equivalent (see Table 3. 1) and will be financed by a LIBOR-based single currency loan of about US$70 million equivalent for technical assistance and credit finance from the World Bank. EXIM will be the Borrower of the loan as well as the implementing agency for the project. The Government will provide a sovereign guarantee for the loan. The beneficiaries of the export development technical assistance and credit finance will be private and privatized exporters. The export technical assistance and credit allocation decisions will be taken by EXIM using predetermined eligibility criteria, which will essentially enable self-selection of qualified beneficiaries. The credit risk for sub-loans to exporters will be borne by EXIM. EXIM will use the institutional development technical assistance to finance the costs of the proposed twinning arrangement. 3.3 The World Bank loan will have a 17 year maturity with a 5 year grace period, and EXIM will therefore have the opportunity to revolve the loan funds several times. The loan will be a LIBOR-based single currency loan with a US$ component of approximately 85 percent and a DM component of approximately 15 percent, and the standard terms and conditions will apply. It is anticipated that EXIM will maintain compliance with a set of predetermined prudential ratios during the life of the project (see Section E below). As a pre-Board action, EXIM entered into a formal agency agreement with the Government of Ukraine, acceptable to the Bank, for all past and future Government directed lending, which unequivocally alleviates EXIM of any credit risk associated with such loans, and institutes an automatic mechanism that will compensate EXIM for any costs incurred as a result of defaults on these loans. EXIM also provided proof based on an IAS audit that as of year-end 1995, it met the prudential ratios mentioned above. 3.4 The technical assistance for export development to private and privatized exporters (US$5.0 million) will be provided by EXIM as a 50 percent matching grant to finance half of all eligible expenditures, with recipient exporters funding the remaining 50 percent out of their own resources. EXIM will recover the cost of providing such grant assistance, as a business cost, through appropriate margins on the sub-loans to eligible exporters to be funded by the credit line. Based on the expected strong demand for export finance and the projected disbursement schedule for both the technical assistance and the credit line components (see Table 4.1), it is estimated that an on-lending margin of around 4 percent can be charged on the proposed credit line amount of about US$60 million equivalent to compensate EXIM for the debt service costs associated with the US$7.5 million technical assistance component (a  - 16 - spreadsheet model with the underlying calculations used to arrive at this margin is available in the project file). 3.5 A new dedicated Export Services Department has already been created in EXIM, and will be responsible for evaluating the Export Development Plans of exporters (see paragraphs 3.8 and 3.9). A general manager for the department was hired in early 1996, and as a pre-Board action EXIM has recruited additional staff allowing the department to effectively manage the export development technical assistance component of the project. 3.6 In addition to technical assistance to exporters, the Bank's loan will also provide institutional development technical assistance to EXIM (US$2.5 million). This assistance will take the form of a twinning arrangement with an experienced foreign EXIM bank or other suitable institution(s) specialized in trade finance and promotion, and will aim to transform EXIM into a leading export support and financing institution in Ukraine by strengthening its capacities in strategic and technical areas and by providing support for EDP implementation (see Section C below for more details). 3.7 All requests for credit financing (about US$60 million equivalent) will be evaluated by EXIM's existing Credit Department. EXIM's Credit Department will also be responsible for environmental screening and assessment of sub-projects. In order to perform these tasks, EXIM's Credit Department will be further strengthened under the proposed institutional development program. The foreign twinning partner(s), by providing a credit advisor, will also assist the department in appraising sub-projects to be financed under the EDP credit line, and preparing adequate sub-project documentation packages (see paragraphs 3.19 and 4.4). B. EXPORT DEVELOPMENT TECHNICAL ASSISTANCE 3.8 There is general agreement between the Ukrainian Government, EXIM and the World Bank that development of institutional capability in EXIM for providing comprehensive export marketing, facilitation and development services to exporters on a sustained basis is a major objective of the project. The initial capacity building strategy is the creation of a new Export Services Department in EXIM, headed by a senior manager, consisting of: (a) an Export Development Fund (EDF) Division, and (b) an Export Information Division. In response to this strategy, the export development technical assistance to exporters under the EDP will be provided in two different ways. First, the EDP will provide US$5.0 million financing for setting up an EDF to provide targeted technical assistance to specific private and privatized exporters; and second the EDP will, in the context of the institutional development program for EXIM, provide know-how and assistance to EXIM to set up and operate an Export Information Division for all exporters. 3.9 The EDF Division will manage the EDF, set up to provide targeted technical assistance to exporters on a 50 percent matching grant basis and initially funded by a US$5.0 million World Bank loan under the EDP. EXIM will recover the cost of passing on the technical assistance to exporters from its on-lending margins on EDP funded sub-loans (see paragraph 3.4). The EDF division will be staffed with four to five locally recruited export marketing and development specialists, who will assist exporters in: (i) developing tailored Export Development Plans, and (ii) obtaining all the required technical assistance identified by these plans. EDF officers will be trained and assisted in this task by EXIM's foreign twinning partner (see Section C below). The beneficiaries of the technical assistance will be eligible for assistance for activities identified in their Export Development Plan prepared by themselves or in collaboration with the EDF officers of EXIM. Disbursement will be against invoices, and pre-approved  - 17 - budgets on a 50-50 matching grant basis. The amount of technical assistance per exporter will be limited to a maximum of US$250,000. Requests for higher amounts will need prior clearance from the World Bank. The range of eligible activities will include: * Market Research and Strategic and Business Planning including: (i) desk market research as a prelude to field research, (ii) overseas field market research, and (iii) assistance in preparation of a business plan or feasibility study needed to obtain export finance. * Technical Services for Products and Processes including: (i) product and process inspection services, e.g. cost of product and process certification by an internationally recognized inspection agency, (ii) product adaptation, e.g. advisory and technical services in product re-design, advice on packaging and product testing for adapting products to export demand, (iii) productivity improvement consultancy to recommend alternative products, process improvements, reduce costs and increase productivity, and (iv) exposure to manufacturing plants of competing countries or foreign collaborators, in order to improve the competitiveness of products and processes and observe and learn about the technology, processes, quality standards and control mechanisms being used by manufacturers of similar products. * Training in Export Strategy and Tactics to encourage a more informed, strategic approach to export marketing as practiced by successful exporting countries. Support will be provided for training in export marketing, including: (i) export marketing methods such as pricing, distribution channels, and promotion, (ii) export market research, (iii) organizing an export department, and (iv) export procedures, shipping, forwarding, and documentary credits. * Export Marketing and Promotion including: (i) product launch services, e.g. initial export advertising and publicity or participation in a trade fair, (ii) overseas business travel for exporters for the purpose of finding and appointing agents and distributors or direct sales channels, (iii) technical and advisory services, and planning and start-up costs for establishing overseas operations, and (iv) travel costs to Ukraine by potential buyers in exceptional circumstances. 3.10 The EDF division will review and prepare recommendations for funding to EXIM management. EXIM management will set up a steering committee to review all requests for funding under the EDF. The committee will approve all EDF proposals, and seek further approval from the World Bank where required (see paragraph 4.8). 3.11 The Export Information Division will provide walk-in services to all exporters on a full cost recovery basis, and will undertake the following activities: * maintain a library of information about export markets, products, present and future trends, accommodate specific information inquiries and search for prospective contacts, and provide information about export incentives, and assistance offered by various organizations around the world, e.g., free display spaces offered by Jetro of Japan and CBI of the Netherlands to developing country exporters;  - 18 - * provide updated information and advice about international standards, and product quality and process requirements for a range of products in different countries; liaison with ISO Geneva for training of exporters' staff and updating information; * maintain a list of names and addresses of international product certification agencies for different types of products, their procedures and requirements, e.g., KEMA of the Netherlands and Underwriters Laboratories, USA for electrical products, TUV of Germany for auto parts, FDA of USA for food products, etc.; * provide on-line instant access to international databases on overseas buyers by means of a dedicated computer with modem work stations in all EXIM's branches, and negotiating a wholesale user-based payment arrangement with providers of such databases, e.g., Dialog of USA maintains a network of 100 such information databases; exporters, with the help of trained EXIM search analysts, could obtain the latest information at a low marginal use cost. 3.12 The technical expertise and advice required by EXIM to set up the infrastructure and build appropriate human resource capability for the Export Services Department, including both the EDF Division and the Export Information Division, will be provided under the proposed institutional development program for EXIM (see below). C. INSTITUTIONAL DEVELOPMENT PROGRAM FOR EXIM 3.13 The institutional development program for EXIM is intended to strengthen EXIM's capability to become a leading export support and financing institution in Ukraine, and to assist EXIM in EDP implementation. EXIM's institutional development needs will be addressed through a twinning arrangement with an experienced foreign EXIM bank or a similarly qualified institution(s) specialized in trade tinance and promotion. Based on the final selection of the foreign EXIM bank, the twinning partner (referred to hereafter as Consultants) could sub-contract some of the work to other banks or consulting firms. but would retain responsibility for the quality of the work provided by any sub-contractors. 3. 14 '[he technical assistance will assist EXIM in developing a strategic plan, develop a new charter for its operations, address corporate governance issues, strengthen its credit, asset liability management, accountinig, and information technology functions, assist in setting up the new Export Services Department, and reinforce EXIM's EDP implementation capability. The specific elements of this institutionial development program cover thirteen key areas, arranged for convenience purposes in three clusters each containing several modules: Strategic, Technical and EDP Implementation. The full Terms of Relerence is available in the project file. 3.15 Strategic. The strategic cluster will concentrate on: (i) strategic and financial planning issues, (ii) EXIM's charter and corporate governance arrangements, and (iii) its organizational structure. The principal objective of EXIM is to become a strong EXIM bank, as an independent, commercially run provider of comprehensive export financing, marketing and development services to exporters, while retaining an agency function on behalf of the Ukrainian Government for foreign export credits. In achievinig these objectives, EXIM needs to build a sound, analytically based strategy and supporting financial plan to achieve its goals of financial strength and growth. It is anticipated that the strategic plan will serve as the primary guide to all the future activities of EXIM. The Consultants, based on joint discussions with the Ukrainian Government and EXIM management will: (i) define the future role of EXIM, and based on this agreed role, work with EXIM staff to develop the strategic plan and specific imiplemlentation actions as well as the supporting financial detail to fit the needs and situation of EXIM, particularly as the premier Ukrainian institution in support of development of Ukrainian foreign trade,  - 19 - (ii) help in the development of suitable export financing products and export promotion services, (iii) examine the viability of continuing the Export Services Department as a permanent operating division, and (iv) assist the Management Board in resolving the strategic implications of investments in retail banking and physical expansion of the branch network. 3.16 EXIM, in transitioning to a more commercially run and focused export support and financing institution serving exporters with trade finance, information and technical assistance, will need to make certain revisions to its structure of governance so as to insure independent decision making. At present the Government is subject to the many conflicts found in simultaneously serving as EXIM's owner, regulator and primary customer. The resulting confused mandate encourages business practices which are inconsistent with safe and sound banking. The current governance structure is without any representation of the private sector. A market economy driven bank dictates diversification in the membership of its governing structure and, as such, there is an expected need for a new charter to facilitate the entry of non-Government representation to the Supervisory Board of EXIM. In addition, EXIM, which is currently regulated by the commercial banking law and subject to NBU regulation and supervision, may under a new charter need to be regulated by a separate law (which will incorporate the new charter). The Consultants will: (i) undertake a comprehensive review of governance and organizational issues, including the function of state ownership, existing governance mechanisms and Head Office/Branch relationships; (ii) review and discuss with EXIM and the Government alternate governance structures utilized in market economies for comparable export finance oriented banks; and (iii) work with EXIM and the Government on the preparation of a new charter and governance structure, and, if appropriate, a draft law regulating EXIM's operations. 3.17 Technical. The technical cluster will concentrate on developing and implementing best practices in the various EXIM operating functions. These will include: (i) credit management, (ii) asset and liability management, (iii) human resource development and training, (iv) internal audit, (v) marketing, (vi) accounting and management reporting, (vii) information technology; and (vii) export support services. Most of the tasks to be performed in this technical cluster are fairly standard, and the details are available in the project file. Export support services which are a specific characteristic of the EDP and a new flunctionial development, are described briefly below. 3.18 Export Support Services. EXIM wishes to develop an institutional capability for providing comprehensive export support services to exporters. Under the EDP, this capacity will be established in the new Export Services Department already created in EXIM, consisting of an EDF Division and an Export Information Division. The Consultants will be expected to: assist in the establishment of the new Export Services Department by suggesting an organizational structure, manpower requirements, job descriptions and staff selection procedures; train and expose EXIM staff to the broad array of export services most suitable to Ukraine; help EXIM staff in the development of both credit and non-credit products designed to assist Ukrainian firms enter into export markets; give guidance in instituting a process to monitor the efficacy of new products and identifying when adjustments are appropriate. 3.19 EDP implementation. The institutional development program will also support the implementation of the EDP by providing assistance to EXIM's: (i) Credit Department, (ii) Export Services Department and (iii) Project Management Unit (PMUJ). In order to assist the Credit Department of EXIM in efficiently identifying, appraising and processing of viable sub-projects, a credit advisor will be provided by the Consultants. The advisor will work exclusively on EDP related activities and have substantial involvement with the credit specialist assigned to the PMU. The credit advisor will help in the review and structuring of sub-loan applications to determine eligibility and prospects for acceptance under the  - 20 - EDP credit line; assist EXIM staff in the preparation of appropriate credit applications by sub-borrowers to insure inclusion of adequate data for consideration of bankable sub-projects; advise sub-borrower applicants, if appropriate, of revisions required to meet World Bank eligibility criteria; provide training to the credit specialist in the PMU so as to facilitate the early identification of prospective sub-borrowers. 3.20 In order to assist the Export Services Department in administering the EDF, the Consultants, or possibly a sub-contractor experienced in similar project management efforts in other transitional economies, will be expected to: establish suggested guidelines for administering the technical assistance targeted to exporting enterprises; provide assistance to the Export Services Department in organizing and staffing the EDF Division; and design appropriate working relationships between the EDF officers, EXIM's Credit Department, and the PMU so as to maximize the utilization of EDF and assist in the development of a pipeline of eligible sub-projects, in the form of enterprise-level Export Development Plans. 3.21 The Consultants will assist the PMU Program Manager in setting up the PMU; train the credit specialist, EDF specialist and the accounting/disbursement officer in their respective project implementation roles as envisaged by the actual EDP loan agreement; develop the project accounting system, provide a customized computerized project accounting package to the PMU and train the accounting officer in its use; assist the PMU in opening a Special Account, in drafting sub-loan agreements to be used under the EDP credit line component, in preparing the initial withdrawal applications and in preparing a format for EDP implementation progress reports to the World Bank and to EXIM management. D. EXPORT ORIENTED CREDIT LINE 3.22 The credit line will finance both short-term imports of inputs into production for export, as well as medium- to long-term investment projects of export-oriented private and privatized firms. Exporters, as part of their business plan, will have to present a detailed Export Development Plan in order to be eligible for financing. Sub-loans shall be made for sub-projects which are each determined on the basis of an appraisal carried out by EXIM to be: (i) consistent with the sub-borrower's business plan, technically feasible, and economically, financially and commercially viable, and (ii) in compliance with all requirements pertaining to environmental protection applicable under the laws and regulations of Ukraine. EXIM's financial appraisal of sub-projects will use creditworthiness criteria, such as maximum debt-equity ratio (70:30), minimum debt service coverage ratio (1:1.5) and minimum financial rate of return (15 percent). 3.23 As a pre-Board action, EXIM provided written proof, based on an IAS audit, that its financial strength qualifies it as an intermediary for World Bank loan funds. EXIM will have to remain in general compliance with all applicable NBU prudential rules, as well as with a set of prudential ratios based on IAS and Bank for International Settlements (BIS) rules determined by the World Bank on a continuous basis during the life of the project and will report to the World Bank on a quarterly basis. The ratios include a minimum capital adequacy ratio, and maximum large and insider exposure (see paragraphs 3.27 and 3.28). EXIM's capital adequacy will be certified annually by international auditors. 3.24 Qualifying private enterprise borrowers under the credit line will be current or prospective exporters, and can be engaged in a broad range of economic activity, including all forms of production as well as the provision of services. Specifically, the EDP credit line component will finance the procurement of inputs for productive purposes, and will include raw materials, spare parts, plant and  - 21 - equipment and consulting services. The credit line will also finance procurement of technology, and all kinds of construction works. E. TERMS AND CONDITIONS 3.25 The following terms and conditions will apply to the drawing of funds under the EDP for the EDF and the line of credit. Beneficiaries of assistance under EDF will not automatically be eligible for the line of credit and vice versa. 3.26 The World Bank loan. The World Bank loan will consist of US$5.0 million for the EDF, US$2.5 million for institutional development technical assistance for EXIM, and a total of about US$60 million equivalent for the credit line, divided into two LIBOR-based SCL portions of US$50 million and DM15 million, respectively, to facilitate those sub-borrowers wishing to have their repayment liability in either US$ or DM based on their expected export revenue profile. In addition, an unallocated reserve of US$2.5 million is included in the loan to allow a flexible use of funds across components. The full loan will be provided to EXIM at SCL terms. In order to be able to withdraw funds under the EDP, EXIM will need to remain in compliance with a set of World Bank determined prudential ratios and EDF and credit line beneficiaries will also have to satisfy eligibility criteria. These are presented below. 3.27 Prudential ratios for EXIM. A set of IAS and BIS-based prudential ratios was used to determine the initial qualification of EXIM for intermediation of the EDF and the line of credit. As of year end 1995, EXIM was required to: * have a minimum BIS risk-weighted capital (as defined under IAS) adequacy ratio of 5 percent; * have exposure to any one borrower as a percent of its IAS equity capital of no more than 50 percent; and = have aggregate exposure to insiders (defined as Supervisory Board members, members of the Management Board, employees in a management position and physical and legal persons related to the aforementioned) of no more than 25 percent of IAS equity capital. 3.28 Ongoing qualification requirements for EXIM are as follows: * have a minimum BIS risk-weighted capital (as defined under IAS) ratio of 6 percent by year- end 1996, 7 percent by year-end 1997, and 8 percent by year-end 1998 and subsequent years; * have exposure to any one borrower as a percent of its IAS equity capital of no more than 40 percent by year-end 1996, 35 percent by year-end 1997, 30 percent by year-end 1998, and 25 percent by year-end 1999 and subsequent years; and * have aggregate exposure to insiders (as defined above) of no more than 20 percent of its IAS capital as of year-end 1996 and 15 percent as of year-end 1997 and subsequent years.  - 22 - 3.29 Terms and Conditions for EDF beneficiaries. The following terms and conditions will apply to the beneficiaries under the EDF: * only private or privatized exporters (50 percent or more private ownership) will be eligible for receiving assistance under the EDF; * EDF funds will be provided on a 50 percent matching grant basis to beneficiary exporters, and exporters will have to present supporting documentation confirming their own contribution; * beneficiaries will have to be either existing exporters or prospective exporters, and will have to prepare an Export Development Plan as a condition for receiving assistance under the EDF. 3.30 Criteria for Sub-Borrowers, Sub-Projects and Sub-loans. The following criteria are proposed: * sub-borrowers will be required to meet the following criteria to obtain sub-loans under the EDP line of credit: * private ownership of 50 percent or more; - a maximum debt:equity ratio of 70:30 (after receipt of the sub-loan); * sub-projects will be required to meet the following criteria to be eligible for financing under the proposed line of credit: * sub-projects must be targeted towards generation of exports consistent with the sub- borrower's Export Development Plan; * sub-projects involving investments should generate a financial rate of return of at least 15 percent (the calculation of economic rates of return will be required only in cases where major price distortions in inputs or outputs are evident); * sub-projects should generate enough cash during the pay-back period to maintain a debt service coverage ratio of at least 1:1.5; * goods, works and services on the World Bank's negative list will not be eligible for financing; * certification from the relevant local or national authorities that the proposed sub-project meets all environmental laws and standards in force in Ukraine, as well as the World Bank policy on environmental assessment; * sub-loans made to exporters will be made under the following conditions: * sub-loans will be made for the financing of raw materials, spares, plant and equipment, works and consultancy services both for working capital as well as investment purposes; * sub-loan applications must include a business plan incorporating an Export Development Plan; * sub-loans will be evaluated in accordance with EXIM's normal project and credit evaluation guidelines, and in addition will be evaluated using a World Bank provided evaluation guidelines (available in the project file);  - 23 - * sub-loans must be denominated in US$ or DM; the foreign exchange risk will be borne by the sub-borrower; sub-loan pricing and maturity will be determined by EXIM based on the needs of the particular sub-borrower and sub-project being financed; * sub-loan review: * EXIM will be required to submit the first five sub-loans and all sub-loans above a free limit of US$2.5 million equivalent (for each sub-loan) to the World Bank for approval. F. PROJECT COST AND FINANCING PLAN 3.31 Project Cost. The estimated cost of the proposed project is US$84 million equivalent, as summarized in Table 3.1 below. Out of the total of US$84 million equivalent, approximately US$70.8 million equivalent (slightly over 84 percent) has been estimated to be foreign expenditures for imports of goods and services, and the balance US$13.2 million equivalent (nearly 16 percent) has been estimated to be local expenditures. The total project cost of US$84 million equivalent consists of US$10 million equivalent for the EDF, US$3 million equivalent for the institutional development program for EXIM, and US$66 million equivalent for sub-projects under the credit line component. Out of the total of US$10 million equivalent of EDF expenditures, about 25 percent or US$2.5 million has been estimated to be for local expenditures, and the balance is for foreign expenditures. With regards to the institutional development of EXIM, about US$0.5 million equivalent of local expenditures is estimated to be incurred by EXIM for the creation and operation of the new Export Services Department, the PMU and the implementation of the institutional development program itself, and the remaining US$2.5 million will finance the foreign exchange costs to be incurred by the foreign twinning partner(s). Out of the total amount of US$66 million equivalent for sub-projects, approximately US$9 million equivalent (nearly 14 percent) is estimated to be local expenditures on these sub-projects, and the balance US$57 million equivalent will be spent on imports. It is estimated that the use of the unallocated component will result in foreign expenditures of US$3.75 million and local expenditures of US$1.25 million. Table 3.1: Estimated Project Cost (US$ thousand eauivalent) Component Local Foreign Total Technical Assistance * EDF (technical assistance for exporters) 2,500 7,500 10,000 * Institutional Development Program 500 2,500 3,000 (technical assistance for EXIM) Sub-total 3,000 10,000 13,000 Credit Line Credit Finance for Exporters 9,000 57,000 66,000 (for raw materials, spares, plant and equipment, consulting services and works) Unallocated 1,250 3,750 5,000 Total Financing Required 13,250 70,750 84,000  - 24 - 3.32 Financing Plan. The total project cost of US$84 million equivalent will be financed by: (i) the World Bank's loan of about US$70 million equivalent (consisting of a US$ tranche of 60 million and a DM tranche of 15 million) on the World Bank's standard terms for LIBOR-based single currency loans, (ii) EXIM's own contribution of US$0.5 million equivalent for its institutional development, and (iii) Ukrainian exporters' own contribution of US$13.5 million equivalent. The World Bank's loan will finance US$5.0 million of EDF expenditures (including local costs of US$1.25 million equivalent and foreign costs of US$3.75 million), US$2.5 million of expenditures for EXIM's institutional development program and about US$60 million equivalent of inputs for supporting exports under the credit line. Exporters will finance US$5.0 million equivalent of matching costs under the EDF, and an estimated US$6 million equivalent as their own contribution to the financing of sub-projects under the credit line. EXIM will finance US$0.5 million equivalent of local costs related to setting up, equipping and staffing its new Export Services Department, the PMU and the implementation costs associated with the twinning. Table 3.2 below shows the financing plan: Table 3.2: Proposed Financing Plan (USS thousand equivalent) Financing Source Local Foreign Total Technical Assistance (i) EDF World Bank 1,250 3,750 5,000 Ukrainian Exporters 1,250 3,750 5,000 (ii) Institutional Development Program for EXIM World Bank --- 2,500 2,500 EXIM 500 --- 500 Sub-total 3,000 10,000 13,000 Credit Line World Bank 3,000 57,000 60,000 Ukrainian Exporters 6,000 ---- 6,000 Sub-total 9,000 57,000 66,000 Unallocated 1,250 3,750 5,000 Total Financing 13,250 70,750 84,000  - 25 - PART TV PROJECT IMPLEMENTATION A. IMPLEMENTATION ARRANGEMENTS 4.1 The implementation of the EDP will be the responsibility of EXIM itself. Within EXIM, the implementation of the institutional development program will be the direct responsibility of the Management Board of EXIM headed by the Chairman. The implementation of the EDF and the credit line components of the project will be administered by a dedicated PMU set up within EXIM and staffed by EXIM personnel. The responsibilities of the PMU will include: (i) general administration of all documentation, information and actions related to transactions under the EDP, including operation of the Special Account and maintaining project accounts; (ii) providing assistance and pro-active advice to the EDF Division of EXIM and beneficiary exporters on all aspects of the EDF, including terms and conditions, procurement, and disbursement; (iii) providing similar assistance to the Credit Department of EXIM and prospective sub-borrowers on all aspects of the line of credit, including terms and conditions, procurement, disbursement and environment; (iv) actively promoting and marketing the EDF and line of credit to exporters; (v) submitting to the World Bank those sub-loan proposals and procurement contracts requiring prior approval; (vi) monitoring, on an ex-post basis, the eligibility of beneficiaries, sub-loans, and procurement contracts below the free limit; (vii) carry out periodic analysis of the EDF and credit line utilization, and the associated sub-project portfolios; and (viii) reporting to the World Bank and EXIM management on the progress of project implementation, as well as preparation of the Project Completion Report. 4.2 PMU. The PMU will be headed by a Program Manager, who will be an existing senior officer of EXIM, and who will be responsible for overall coordination and implementation of the project. The Program Manager will be supported by three specialists, an EDF specialist, a credit specialist, and an accounting/disbursement officer. The EDF specialist will be responsible for coordinating and facilitating the EDF-financed technical assistance, and will closely interact with exporters, EDF officers of EXIM itself, and the World Bank. The functional responsibility of the EDF component of the project will be the responsibility of the new EDF Division set up within EXIM as part of its institutional development and specialization effort. The credit specialist will be responsible for coordinating and facilitating the credit line component of the project, and will liaise with the sub-borrowers, EXIM's own Credit Department and the World Bank. The functional responsibility of credit appraisal, structuring, and processing through EXIM's Credit Committee of sub-loans will continue to be the responsibility of the Credit Department of EXIM. The accounting/disbursement officer will be responsible for maintaining project accounts and all supporting documentation, and for processing all disbursements under the World Bank loan. As a pre-Board action, EXIM has created a functioning PMU with a Program Manager, EDF specialist, credit specialist and accountant/disbursement officer. 4.3 EDF Division. The EDF Division in the new Export Services Department of EXIM will be responsible for implementation of the EDF tasks under the project. The EDF Division will include four to five locally recruited export marketing and development specialists, who will assist exporters in: (i) developing tailored Export Development Plans, and (ii) obtaining all the required technical assistance identified by these plans. The technical expertise and advice required by EXIM to set up the infrastructure and develop the human resource capability for the provision of export services will be provided under the proposed institutional development program for EXIM.  - 26 - 4.4 Credit Advisor. Technical assistance is needed to help EXIM efficiently identify, appraise and structure viable sub-projects to be financed under the EDP line of credit. This assistance will be provided by the Consultants under the institutional development program for EXIM, in the form of a credit advisor dedicated to the successful and efficient implementation of the EDP line of credit. The advisor will work exclusively on EDP related activities and have substantial involvement with the credit specialist assigned to the PMU. The advisor will be an experienced commercial banker or a specialist with substantially similar credit skills in evaluating sub-projects and sub-borrowers. B. PROCUREMENT 4.5 Procurement under subloans will be undertaken by the exporters themselves with assistance from the PMU as necessary. Procurement procedures under the proposed project will be according to the World Bank's procurement guidelines for financial intermediation operations. Goods and works costing less than US$2.0 million equivalent will be procured using local commercial practices, of the beneficiary enterprises, subject to obtaining quotation from more than one supplier. Full International Competitive Bidding (ICB) will be required for goods and works costing more than US$2.0 million equivalent. The World Bank's Standard Bidding Documents will be used for all ICB procurement. Prior World Bank review will be required for: (i) the first five contracts and (ii) all ICB procurement. Procurement of all other goods and works will be subject to the World Bank's ex-post review. 4.6 Direct contracting (single source procurement without competition) will be an appropriate method of procurement under the following circumstances: (a) when the equipment and spare parts being procured are of a proprietary nature; (b) when there is a transfer of technology and licensing situation involved, under which critical parts have to be procured from the license, until and unless exempted by the license from such restriction; (c) when there is a general lead contractor involved for a project, and where such lead contractor has specified specialized parts as quality/performance preconditions, to the extent necessary to procure such specialized parts; (d) when the existing stock of machinery and equipment is predominantly from a single source and new additional equipment and machinery must be compatible with the existing equipment, in the interest of standardization, and efficient performance for purposes of consistency and efficiency with respect to maintenance; (e) when an existing contract already awarded under the World Bank procurement rules would require extension for provision of additional goods, works or services, at the same terms and conditions; (f) when competitive bidding procedures have failed to produce more than one bid, and a direct contract is necessary; and (g) when emergency procurement is required, in case of critical breakdowns, etc. 4.7 All direct procurement for contracts undertaken by exporters shall be subject to prior review and approval by EXIM. Contracts less than US$500,000 equivalent may be directly approved by EXIM, and will be subject to ex-post review by the World Bank, including review of the site or documentation during supervision missions. Contracts with a value of US$500,000 equivalent or higher will be first approved by EXIM, and then sent to the World Bank for prior review and approval. EXIM may seek advise on direct contracting from the PMU and the World Bank. However, the responsibility for ensuring conformance to guidelines, for contracts not subject to prior review and approval will rest with EXIM and EXIM will be responsible for the reimbursement of all World Bank fund disbursed on account of such contracts. 4.8 All consulting services will be procured using "Guidelines for the Use of Consultants by World Bank Borrowers and by the World Bank as Executing Agency." Terms of reference, letters of invitation, short lists and final award of contract for: (i) the first five consultant contracts under the project, (ii)  - 27 - consulting services valued at more than US$100,000 equivalent for finrns and more than US$50,000 equivalent for individuals, and (iii) single source consulting contracts will be subject to the World Bank's prior review and approval. Any goods under the EDF will be procured using local commercial practices, and all contracts above US$50,000 equivalent will be subject to prior review and approval by the World Bank. Contracts below US$50,000 equivalent will be subject to prior review and approval by EXIM. C. DISBURSEMENT 4.9 The World Bank funds will be used to finance: (i) the cost of goods and services required for the implementation of Export Development Plans under the EDF; (ii) the costs of consulting services under the institutional development program for EXIM; and (iii) procurement of goods, works and services, both for short term working capital requirements and for investment purposes under sub-loans. Under the EDF, the World Bank will finance 100 percent of foreign expenditures, 100 percent of local expenditures (ex-factory cost) and 80 percent of local expenditures for other items procured locally. Under the institutional development technical assistance component, the World Bank will finance 100 percent of the actual expenditures incurred for consulting services provided by the twinning partner(s). Under eligible sub-loans, for goods and works, the World Bank will disburse 100 percent of foreign expenditures, 100 percent of local expenditures (ex-factory cost) and 80 percent of local expenditures for other items procured locally, and for consultants' services, 100 percent for of the actual expenditures incurred. 4.10 Projected disbursement under the project, on a straight line basis, is as follows: Table 4.1 Estimated Disbursement Schedule (US$ million equivalent) FY97 FY98 FY99 FY2000 FY2001 FY2002 Technical Assistance (EDF) --Annual disbursement 0.5 1.0 1.0 1.0 1.0 0.5 --Cumulative disbursement 0.5 1.5 2.5 3.5 4.5 5.0 Technical Assistance (EXIM) --Annual disbursement 0.6 1.3 0.6 -- -- -- --Cumulative disbursement 0.6 1.9 2.5 2.5 2.5 2.5 Credit Line --Commitment 7.5 25.0 22.5 5.0 -- -- --Annual disbursement 5.0 15.0 20.0 15.0 5.0 -- --Cumulative disbursement 5.0 20.0 40.0 55.0 60.0 60.0 Unallocated --Annual disbursement 0.0 0.0 1.0 1.0 0.5 0.0 --Cumulative disbursement 0.0 0.0 1.0 2.0 2.5 2.5 Total --Annual disbursement 6.1 17.3 22.6 17.0 6.5 0.5 --Cumulative disbursement 6.1 23.4 46.0 63.0 69.5 70.0  - 28 - 4.11 Applications for payment will be made on the basis of Statements of Expenditure for all disbursement transactions regarding sub-loans and transactions under EDF for expenditures: (i) below US$500,000 equivalent for goods and works; and (ii) all consulting services below US$100,000 equivalent for firms and US$50,000 equivalent for individuals. Statements of Expenditures will provide the following information: name of the sub-borrower or beneficiary, reference to the sub-loan or sub- technical assistance project, amount of the sub-loan or sub-technical assistance project, amount previously claimed, type of expenditure (raw materials, spares, plant and equipment, works capital goods, consulting services, goods and non-consulting services for EDF) and method of payment (Special Account, direct payment, special commitment, reimbursement). In all other cases full documentation will be required. The full documentation will include copies of contract, invoices, and any other documentation as might be reasonably requested by the World Bank. 4.12 Special Accounts. To facilitate the disbursement of funds, one Special Account in US$ and one Special Account in DM will be established in a commercial bank selected by EXIM on terms and conditions satisfactory to the World Bank. The selected bank should: (i) be financially sound as indicated by audited financial statements, and have a significant foreign correspondence network covering all major currencies, (ii) have a reasonable capacity and experience in confirnation of letters of credit, making direct payments and other international transactions, (iii) be willing to issue a Comfort Letter to assure that amounts deposited in the Special Account will not be set off or otherwise seized or attached; (iv) be willing to maintain adequate accounts as required by the World Bank, provide monthly financial statements to the World Bank and EXIM on the use of the Account and any other information as necessary. Special Accounts with an Authorized Allocation of US$6.0 million and DM1.5 million respectively, representing four months average expenditures, will be opened for the purposes of the project. However, during the early stage of the project, the initial allocation to the Special Accounts would be limited to US$2.5 million and DM800,000 respectively. When the aggregate disbursements plus the total amount of all outstanding Special Commitments entered into by the Bank have reached the level of US$5.0 million for the US dollar tranche of the loan and DM2.5 million for the DM tranche, the initial allocations may be increased up to the respective Authorized Allocations. The Accounts will be opened in the name of the Borrower, and will be administered by the PMU within EXIM, which will send requests to the World Bank for replenishment of the Special Accounts every month or when one- third of the initial deposits have been withdrawn. These requests should be accompanied by detailed monthly financial statements on the use of the Special Accounts and all other required documentation. 4.13 Retroactivefinancing for expenditures prior to loan signing but incurred after September 1, 1996 would be eligible for disbursement up to a limit of US$7.0 million equivalent, equal to 10 percent of the proposed amnount of the loan. This would allow EXIM to use the loan for the financing of sub-projects which are already at an advance stage of preparation and which are in accordance with the proposed sub- project, sub-borrower and sub-loan eligibility criteria (paragraph 3.30). The project is expected to be completed by year-end 2001. The proposed closing date is June 30, 2002. D. PROJECT ACCOUNTING, AUDITING AND REPORTING 4.14 Accounting. EXIM, as the Borrower, will be responsible for appropriate accounting for the funds provided by the World Bank under the loan, for reporting on the use of these funds, and for ensuring that audits of the financial statements are submitted to the World Bank in a timely fashion. The PMU, on behalf of the Borrower, will establish an appropriate accounting system, based on IAS, to provide information on the proper receipt and use of the funds in accordance with the Loan Agreement. This  - 29 - system should ensure timely and accurate accounting of all transactions under the loan and clear presentation of financial information. 4.15 Audtits. Audit reports for the project accounts maintained by the PMU, as well as of EXIM's own annual financial statements will be submitted to the World Bank no later than six months after the close of each financial year. Audits will also be carried out, at the same time, and for corresponding periods in accordance with World Bank guidelines, for Statements of Expenditures against which disbursements have been made or are due to be made out of the loan proceeds, and specific reference to the Special Account and Statements of Expenditures will be made in the audit reports accompanying the financial statements. The audit reports should also review the accounting systems and supporting internal procedures and practices for the Special Account, the project accounts and Statements of Expenditures, and recommend any needed changes. The audits will be performed by suitably qualified independent auditors acceptable to the World Bank, and in accordance with international auditing and accounting standards. Exporters, as part of their sub-project documentation, will have to provide audited accounts or accounts which have been approved by the tax authorities. 4.16 Reporting. The PMU will report quarterly on the performance of the project using the performance indicators specified in paragraphs 4.2-4.23 below where applicable, including: (i) EDF commitments and disbursements, (ii) sub-loan commitments and disbursements, (iii) sub-loan portfolio performance, and (iv) a report on sub-loans reviewed and approved according to the eligibility criteria. EXIM management will be responsible for providing a semi-annual progress report on the implementation of the institutional development program for EXIM. A Project Completion Report will be provided by the PMU to the World Bank not later than six months after the closing date. E. ENVIRONMENTAL ASPECTS 4.17 Sub-projects financed under the EDP line of credit must undergo environmental screening to ensure their conformance with Ukrainian environmental legislation and regulations and the World Bank's policy on environmental assessment. The sub-borrowers will be responsible for carrying out any environmental analysis and for confirming that the proposed sub-project complies with national/regional environmental guidelines, and for obtaining the necessary clearance from the appropriate licensing authorities. 4.18 EXIM, as part of its appraisal of sub-projects, will be responsible for environmental classification of sub-projects, and ensuring that each sub-loan proposal includes an evaluation of its environmental impact and clearance documentation from the appropriate licensing authorities. EXIM will also be responsible for monitoring that environmental remedies agreed under a sub-loan are indeed carried out by the sub-borrower. In order to assist EXIM with such environmental classification, an environmental manual will be provided by the World Bank. The manual will also contain a negative list of activities which cannot be financed by the line of credit. In order to meet the manual's requirements and to handle the environmental aspects of loan portfolio development and review, EXIM will need to have adequate expertise at its disposition. EXIM may externally contract such expertise and/or they may hire permanent specialist staff. 4.19 The World Bank will review environmental aspects within the parameters of its normal ex-ante sub-loan review. Other sub-loans will be reviewed on an ex-post basis as part of project supervision.  - 30 - F. SUPERVISION ARRANGEMENTS AND PERFORMANCE INDICATORS 4.20 Supervision. The Project Supervision Plan is shown in Annex B. The plan includes the schedule for World Bank supervision missions, the skill mix required, staff week input and cost. An average of three supervision missions per year is planned. A start-up mission is planned for December 1996, and a mid-term review is planned for mid-1999. 4.21 Performance Indicators. Project performance will be monitored with the help of the following indicators measuring both progress in project implementation and project impact: 4.22 Implementation indicators. These indicators will be both of a qualitative and of a quantitative nature. Qualitative indicators will include: progress made by EXIM in implementing its institutional development program, especially with regards to development and adoption of its strategic plan, adoption of a new charter with a clear mandate for its activities, and an effective and autonomous corporate governance structure, maintaining a functioning Export Services Department, conversion to IAS accounting standards and so on. Since both the EDF and the credit line are expected to disburse within 5 years from loan effectiveness on a straight line basis, utilization can be measured by the following quantitative indicators: * EDF utilization indicator: amount of EDF actually disbursed projected EDF disbursement on a straight line basis * credit line utilization indicator: amount of credit line actually disbursed projected credit line disbursement on a straight line basis * sub-loan performance indicators: * amount of non-performing sub-loans; - interest and/or principal defaults total amount of sub-loans disbursed 4.23 Impact indicators. These will measure the outcome of the project in terms of stated project objectives. Since the main purpose of the project is to enhance the export capability of private Ukrainian exporters, and to ensure EXIM's development into an effective export services and financing provider, these will be measured through qualitative and quantitative indicators as follows: * Qualitative: (i) An assessment of EXIM's development into a viable, competent, modem financial institution, through monitoring of its adherence to the prudential ratios described in Part III, Section E, which are structured in a way to become increasingly demanding over time. To the extent EXIM meets or exceeds these ratios, the project will have achieved a major institutional development impact. (ii) An assessment of EXIM's development into an effective export services and financing provider, through monitoring  - 31 - the dispersion of its products, services and clients; to the extent EXIM would have geared most of its products and services towards exporters, and to the extent that the majority of EXIM's clients would consist of exporters significantly diversified according to size, geographical location, and economic sectors, the project would have had a favorable impact on export promotion and development of a supporting infrastructure in Ukraine. * Quantitative: The main quantitative impact of the project will be measured in terms of export development leverage achieved, by measuring the incremental exports generated as a result of the technical assistance and financing provided under the EDP, as compared to US$ equivalent amount spent. The indicators used to measure this impact will be: * export development multiplier (for EDF technical assistance): incremental average aggregate annual exports generated (measured over 3-5 years for all EDF beneficiaries) total EDF amount spent * export development multiplier (for credit line): incremental average aggregate annual exports generated (measured over 3-5 years for all sub-borrowers) total credit line disbursed  - 32 - PART V BENEFITS AND RISKS 5.1 Benefits. This project complements other World Bank projects in the enterprise and financial sectors by reinforcing Ukraine's stabilization efforts and structural reforms. The project will therefore have a number of economic benefits. These are: * by providing both critical and catalytic technical assistance and financing support to exporters in the short term, and institutional development support to EXIM for developing a strong financing and export services capability in the long term, the project will create a mechanism to boost the growth of Ukrainian exports on a sustained basis; * through the provision of export oriented technical assistance to enterprises, the project will increase the quality of information, technical and financial services required to improve the access of Ukrainian exporters to hard currency markets, thereby increasing the diversification of their export markets, reducing their dependence on FSU markets, and making a vital contribution to a faster rate of growth in hard currency earnings, an essential element in Ukraine's longer term macroeconomic stability and growth; i the project provides a single window packaged source of information, technical assistance and finance to private and privatized exporters, and therefore delivers a comprehensive and efficient solution to exporters' needs; this approach reduces confusion and delays in decision making by multiple agencies on assistance to the same exporter and improves the project's resource leverage and utilization in terms of generation of incremental exports; * an increased and integrated supply of export oriented technical assistance and finance will also be an important element in supporting the restructuring of newly privatized enterprises and ensuring that a sufficient number of these are able to penetrate new markets at an early stage; * the export finance made available to private and privatized enterprises under the project will include longer maturity lending than is presently available in Ukraine, and will therefore support the investment activities necessary for effective enterprise restructuring; * since EXIM is one of the better capitalized banks in Ukraine, has relatively few non- performing loans on its own account, and will, in the context of its institutional development program, introduce modem IAS accounting practices, the project will also help to ensure that an increasing part of total bank lending is made by one of the better capitalized banks in Ukraine, at the same time ensuring that its corporate governance and technical capability is further strengthened. 5.2 Risks. A general risk facing all lending operations in Ukraine is that macro-economic stability is still fragile and a resurgence of high inflation fueled by budget deficits cannot be ruled out. Such a development could lead to further repressive pressures on the banks which in turn would undermine many of the positive changes which the project seeks to advance. However, as indicated before, because of its  - 33 - niche activity and relative isolation from the interbank market, EXIM is likely to be relatively immune from problems in the rest of the financial sector. To mitigate this risk the World Bank will have to depend on the new tranched IMF Stand-by Arrangement. 5.3 Specific risks in this project are: 0 the state ownership of EXIM could leave it exposed to making non-commercial loans for political purposes; this risk will be mitigated by the incorporation of a module in the proposed institutional development program for EXIM to adopt a new charter and strengthen its corporate governance and by the use of tight eligibility criteria for sub- loans and sub-projects; and * there could be a loss of reform commitment due to lack of political consensus and opposition among key constituencies of the old order; this could impact on the support for private sector led export development and result in a reversal of the liberalization of the trade regime and of the relatively open foreign exchange regime; this risk is mitigated partly by developing an increasingly larger base of private and privatized enterprise in Ukraine in the context of the EDAL, thereby strengthening the private sector as a counter-acting force, and by specific contitionality for enterprise sector reforn and trade policy in this loan; and * the operating environment for enterprises in Ukraine (e.g., the legal and regulatory framework and the tax regime) could continue to remain complex and subject to frequent change, thereby hampering successful and rapid enterprise development; this risk is mitigated to some extent by the continued dialogue between the IMF, which is preparing for an Extended Fund Facility Arrangement, and the Bank about further structural reform measure to be taken in these areas and ongoing preparatory work for the Bank's planned legal and public sector reform operations.  - 34 - PART VI AGREEMENTS AND RECOMMENDATIONS 6.1 During negotiations, agreement was reached on the loan and sovereign guarantee documentation. 6.2 The following actions were taken prior to Board presentation: * EXIM and the Government signed a formal agency agreement, acceptable to the Bank (paragraphs 2.19 and 3.3); * EXIM provided documentation confirming that it met, based on its year-end 1995 IAS audit report, the prudential ratios to intermediate the loan funds (paragraph 3.27); * EXIM put in place proper staffing for the newly created Export Services Department, which will administer the proposed export development assistance (paragraphs 3.5, 3.8 and 3.9); and * EXIM set up a functioning PMU with a Program Manager, EDF specialist, credit specialist, and accountant/disbursement officer (paragraph 4.2). 6.3 There are dated convenants in the Loan Agreement and the Guarantee Agreement under which EXIM will agree to enter into a twinning arrangement with an experienced foreign EXIM bank or other suitable institution(s) by end-March 1997 at the latest (paragraphs 3.6 and 3.13-21). 6.4 There are covenants in the Loan Agreement and the Guarantee Agreement under which the agency agreement signed between EXIM and the Government will remain in force at least until the completion of the project. These covenants also specify that any amendment to this agreement during this period would be subject to prior review and no-objection of the Bank. 6.5 The proposed project provides a suitable basis for a World Bank loan to EXIM with a sovereign guarantee from Ukraine. The loan will be a two portion, US$60 million and DM15 million, LIBOR-based SCL for a period of 17 years, including a grace period of 5 years.  UKRAINE EXPORT DEVELOPMENT PROJECT Implementation Plan 1996 1997 l 1998 1999 2000 2001 ;Q3 ;Q4 ;Ql ;Q2 'Q3 ;Q4 ;Ql jQ2 ;IQ3 jQ4 IQ1 Q2 4Q3 QQ4 QQ lQ2 Q3 Q4 ,Q1 ;Q2 AQ3 Q4 Formal Agency Agreement signed Board Presentation o Loan Signing D Loan Effectiveness - EXIM to provide written proof of compliance with prudential ratios Twinning arrangement for IDP* for EXIM signed Implementation of IDP for EXIM. po s --created --operation PMU --created --operation Export Development TA disbursement"*____________________________________________ Credit Line Disbursement Project Launch # Supervision Missions * * Mid-Term Review Project Completion Report IDP = Institutional Development Program TA = technical assistance  - 36 - ANNEX B Page I of 2 UtKRAI EXPORT DEVELOPMENT PROJECr Supervision Plan APPROXIMA TE ACTIVITY STAFF COMPOSITION STAFF DATES WEEKS 12/96 Project launch Task Manager 8 Banking Specialist Export Services Specialist Disbursement Officer Procurement Specialist 2/97 Supervision Task Manager 4 Banking Specialist Export Services Specialist 9/97 Supervision Task Manager 4 Banking Specialist Export Services Specialist 1/98 Supervision Task Manager 4 Banking Specialist Export Services Specialist 7/98 Supervision Task Manager 4 Banking Specialist Export Services Specialist 1/99 Mid-Term Review Task Manager 8 Banking Specialist Export Services Specialist Procurement Specialist Disbursement Officer 7/99 Supervision Task Manager 4 Banking Specialist Export Services Specialist 5/00 Supervision Task Manager 4 Banking Specialist Export Services Specialist 11/00 Supervision Task Manager 4 Banking Specialist Export Services Specialist 5/01 Supervision Task Manager 4 Export Services Specialist Banking Specialist  - 37 - ANNEX B Page 1 of 2 APPROXIMATE ACTIVITY STAFF COMPOSITION STAFF DATES WEEKS 12/01 Project Completion Task Manager 10 Banking Specialist Export Services Specialist Procurement Specialist Disbursement Officer Country Lawyer  - 38 - ANNEX C UKRAINE EXPORT DEVELOPMENT PROJECr Selected Documents Available in the Project File * Terms of reference for the institutional development program for EXIM * Spreadsheet model on financing of the cost of borrowing for export development technical assistance * Sub-loan evaluation guidelines for the PMU * List of prospective sub-borrowers and sub-projects prepared by EXIM * Ukrainian Exports: Trends and Features * Spreadsheet model on projected demand for export finance     IMAGING Report No: 15909 UA Type: SAR