Moldova - Pre- export Guarantee Facility

Report No. PIC1777 Project Name Moldova-Pre-export Guarantee Facility Region Europe and Central Asia Sector Multi Sector Project ID MDPA38641 Borrower Government of Moldova Implementing Agency Guarantee Administration Unit Piata Marii Adunari Nationale 1 277033 Chisinau, Moldova Mr. Andrei Cheptine, Interim Manager tel (3732) 23 27 80 fax (3732) 23 40 46 Date PID Prepared March 21, 1995 Appraisal Date November 26, 1994 Board Date March 9, 1995 Country and Sector Background I. The Government of Moldova is undertaking a stabilization program supported by the IMF and a structural reform program with World Bank assistance. The Government's primary objective is to restore production, employment, and exports. A key impediment to that goal is the shortage of working capital inputs. This facility is designed to help the private sector finance the provision of working capital inputs for pre-export transactions so that commercially viable agricultural and industrial enterprises can restore production, improve product quality, and exploit new marketing opportunities in both the FSU and in non- traditional markets. II. As a result of tight domestic credit policy and a capital base that has been severely eroded by inflation, the Moldovan banking system cannot provide a sufficient volume of loans to support sound, commercially viable working capital transactions, and foreign banks will not confirm letters of credit opened by local banks on behalf of their Moldovan clients. In addition, most export credit agencies (ECAs) currently do not cover transactions in Moldova, making even short-term, ECA-guaranteed commercial banking flows highly unlikely in the immediate future. Consequently, even potentially viable Moldovan agricultural and industrial enterprises with good export prospects are having difficulty obtaining working capital. III. In addition to these financial bottlenecks, the perceived government performance risk inherent in doing business in Moldova inhibits foreign input suppliers from providing working capital inputs directly to local enterprises. In previous business dealings in other republics of the former Soviet Union, unfortunately, on several occasions governments revoked export licenses or imposed other retroactive changes in rules and regulations that prevented input suppliers from being paid for the inputs which they had already delivered to the local enterprises. Although trading companies and  input suppliers have not had similar experiences in Moldova, the perceived government performance risk of doing business in a republic of the former Soviet Union has severely limited the flow of working capital to Moldovan enterprises. IV. Another factor inhibiting the flow of commercially viable pre- export transactions is the general perception of war and civil disturbance risk (political force majeure) in countries of the region. While this perception applies to Moldova as well, government policies have maintained peace and stability for nearly two years. This policy is a cornerstone of the Government's program, because it realizes that without it, prospects for economic recovery would be dim. Objectives V. The Pre-export Guarantee Facility (PGF) is designed to attract foreign private finance for pre-export transactions in a manner that will allow the market to select the most viable activities and bear the full commercial risk of each transaction. The facility would help (i) Moldovan industrial and agricultural enterprises establish links with private financial institutions, trading companies and input suppliers who finance commercially viable, self-liquidating pre-export transactions, thereby contributing to the emergence of private input supply and output marketing channels and ensuring that the Government does not bear any of the commercial risks associated with these transactions; (ii) restore employment and production in the short term while longer term structural reforms take hold; and (iii) promote a transparent business climate characterized by the rule of law. Description VI. The operation consists of the establishment by the Government of a Guarantee Administration Unit (GAU) and a standby loan facility from the World Bank. The GAU sells guarantees specified in a Framework Guarantee Contract (FGC) against government performance and political force majeure risks. These guarantees are sold on a first come, first served basis to input suppliers, trading companies, or financial institutions that finance the provision of inputs to local Moldovan enterprises for the production of exports. Through an agent bank hired by the GAU, a standby World Bank loan facility backstops the Government's claims payment obligations on up to $30 million of GAU guarantees outstanding at any given time. Financing VII. Disbursements would occur only if the Government draws on the facility to pay claims to guarantee holders who purchased coverage from the GAU. The facility will be deemed to have been a success if GAU guarantees result in a large volume of pre-export transactions and little or no claims payments occur. Technical Assistance to the GAU for the first year of its operations would be financed by a grant of the Government of the Netherlands. Beyond that, the GAU will finance its operating costs from fee income. Implementation -2-  VIII. A typical pre-export transaction eligible for support under the facility would have the following characteristics: (a) Basic Structure: a foreign (i) trading company, (ii) input supply company, or (iii) commercial bank would provide financing for working capital inputs required for the production of exports by a local enterprise; (b) Eligible Local Enterprises: all corporatized enterprises would be eligible, provided that the foreign financier of the transaction would be prepared to bear the performance risk of doing business with that enterprise; (c) Tenor: to (i) match the production cycle and (ii) would range from short to medium term (with a maximum of three years) and (d) Marketing Arrangements: although many input suppliers and trading companies would attempt to market the output outside the former Soviet Union (FSU), some expressed interest in marketing the output in FSU Republics. Thus, in addition to financing the provision of much needed working capital, these transactions would also help Moldovan enterprises restore traditional trading links that were ruptured by the break-up of the FSU. IX. Risk Coverage. The guarantee sold by the GAU would compensate guarantee holders for losses that occur as a direct result of the following risks, occurring after the effective date of the guarantee: Inconvertibility or Inability to Transfer. This would include coverage for losses arising from the introduction by the Government of any restrictions on the conversion of local currency into foreign exchange or the transfer of foreign exchange out of Moldova. This coverage would also include protection against the Government's failure to permit the conversion of local currency into foreign exchange at the market rate of exchange. However, this coverage would not grant the guarantee holder the right to convert local currency into foreign exchange at a guaranteed future exchange rate. Cancellation of Licenses and Restrictions on Import and Export. This would include coverage for losses arising from the cancellation or non-renewal of an import or export license by the Government of Moldova or the imposition by the Government of Moldova of restrictions on the import into Moldova of working capital inputs or the export from Moldova of outputs which were not previously subject to restriction. Imposition or Increase of Import or Export Taxes. This would include losses arising from the imposition by the Government of Moldova of any new or increased tax, levy or duty relating to the import of inputs or the export of outputs. Seizure of Goods or Prevention of Sale. This would include losses arising from the taking and holding of inputs or outputs by the Government of Moldova without just, prompt and adequate compensation. Political Force Majeure. This would include coverage against losses arising from military action or civil disturbances in Moldova. Other types of force majeure -- e.g., flood, drought, other natural disasters, war in neighboring transit - 3 -  countries, etc. -- would not be covered. Diversion of Voyage. This would include coverage against losses arising from an increase in transport or insurance charges due to the diversion of the inputs to a different destination if any of the other risks occur while the inputs are in transit to Moldova. Sustainability X. The World Bank loan facility would be available for backstopping new guarantees for a period of five years, thereby potentially enabling the GAU to support $150 million of pre-export transactions during this period, assuming that the average tenor of each transaction is one year and that the GAU's guarantee issuance capacity is fully utilized. As Moldova develops a creditworthy reputation in the international pre- export market and as ECA cover becomes more widely available, reliance on the PGF may decline over time.(see 1/) Nevertheless, a five year availability period would be provided so that the Government would have sufficient time to establish a satisfactory track record of not interfering with private pre-export transactions. Lessons Learned from Past Operations in the Country/Sector XI. This is the first facility of its kind. Nevertheless, lessons learned from prior financial intermediary and export development loans point to the following requirements for successful policy performance: (i) macro-economic stability, (ii) a liberal foreign exchange and trade regime, (iii) a structure that can cater to a wide variety of transactions and a broad range of financial providers, and (iv) structures that do not require overly strict and formal security arrangements. Poverty Category XII. Not applicable. Environmental Aspects XIII. The proposed facility has been classified in Environmental Assessment Category C. To ensure that no guarantee would be available to support the importation of environmentally hazardous inputs, the GAU will be provided with a list of products and transactions that do not meet Bank or Moldovan environmental requirements. A negative list of banned pesticides, derived from the WHO categories of "Extremely Hazardous" and "Highly Hazardous" materials would also not be permitted to be imported under the auspices of the PGF.(see 2/) The GAU will hire a local environmental expert who will review and approve applications, in consultation with the Bank when necessary. Program Objective Categories XIV. Economic Management. Project Benefits -4-  XV. The facility would help (i) Moldovan industrial and agricultural enterprises establish links with private financial institutions, trading companies and input suppliers who finance commercially viable, self- liquidating pre-export transactions, thereby contributing to the emergence of private input supply and output marketing channels; (ii) restore employment and production in the short term while longer term structural reforms take hold; and (iii) promote a transparent business climate characterized by the rule of law. Project Risks XVI. The main risks are (i) the reversal of the stabilization and structural reform programs which could lead to a large volume of claim payments and a large debt repayment obligation for the Government. To reduce this risk, the Bank will have the right to suspend the GAU's authorization to issue new guarantees backed by the World Bank in the event of major policy reversals. (ii) the risk mitigation provided by the FGC does not generate increased private financing for commercially viable pre-export transactions. This risk has been minimized by designing the FGC on the basis of well-established market principles. 1/ A mid-term review will consider whether the GAU should be abolished after 5 years or be transformed into a sustainable guarantee institution that would issue guarantees without World Bank back-stop. 2/ World Health Organization, International Programme on Chemical Safety. "The WHO Recommended Classification of Pesticides by Hazard and Guidelines to Classification 1994-1995". Geneva: WHO/PCS, 1978. Task Manager: Onno Rahl, EC4C2 (202) 458-9119 (tel) (202) 477-3378 (fax) Contact Point: Public Information Center The World Bank 1818 H Street N.W. Washington D.C. 20433 Telephone No.: (202)458-5454 Fax No.: (202)522-1500 Note: This is information on an evolving project. Certain components may not necessarily be included in the final project. - 5 -