Kazakhstan-Leveraged Insurance Facility for Trade and Development (LIFTAD)

Transcription

1 Public Disclosure Authorized Project Name Region Sector Project ID Borrower(s) Report No. PID8599 Kazakhstan-Leveraged Insurance Facility for Trade and Development (LIFTAD) Europe and Central Asia Private and Financial Sector Development KZGU65963 Republic of Kazakhstan Public Disclosure Authorized Implementing Agency Environment Category Date This PID Prepared December 14, 1999 Projected Appraisal Date March 1, 2000 Projected Board Date June 30, 2000 Kazinvest, part of Agency of Investment of Republic of Kazakhstan (IARK) FI 1. Country and Sector Background Public Disclosure Authorized Public Disclosure Authorized Impediments to Private Sector Development I. Enabling Business Environment Weak Legal and Administrative Framework: The legal framework in Kazakhstan has proven to be a major impediment in the past. The major weakness with the existing laws and regulations is their administration and implementation. The most common complaint by both Kazakhstani and foreign businessmen has been the difficulty in dealing with Government officials at all levels. Based on published surveys of foreign investors and mission interviews with both foreign and domestic investors, the major problems in dealing with the Government include (i) Corruption, (ii) Licensing and regulation, (iii) Tax administration, (iv) Customs procedures, and (v) Land ownership. Without the ability to attract substantial volumes of insured private finance for commercially viable transactions, many of the enterprises will have difficulty surviving as viable going concerns. In addition, potential private investors and lenders have a perception of an unstable investment climate characterized by the absence of the rule of law, and/or arbitrary application of existing laws and discriminatory Government actions after an investment has been made. II. Foreign Direct Investment Effective Incentives for Foreign Investors: The Government has attempted to encourage foreign capital flow by providing incentives for projects in selected priority sectors. However, incentives such as subsidies, grants, and tax holidays create biases and invite corruption in their granting. If the Government insists on such programs, at a minimum, incentives should be standardized and granted automatically to qualified investors rather than allocated on a case by case basis. In addition, the Government should specify objective criteria that a foreign investment operation should meet and the associated incentives that would be provided. According to the foreign

2 investors' opinion expressed in a detailed marketing survey conducted in two stages during the project preparation, the effectiveness of the current Government incentives in attracting foreign investment to Kazakhstan is questionable and inconsistent. III. Privatization Transparency in the privatization process: Though Kazakhstan has privatized thousands of enterprises, many large important enterprises remain in majority state owned. According to the foreign investors, transparency in Government procedures should be increased, as a necessary prerequisite to fight corruption in the privatization process. In addition, without the ability to receive substantial volumes of foreign funds for commercially viable transactions, the productive sectors will not be able to continue to exist; In this context, any further progress in the privatization process depends on the country's ability to mobilize foreign sourced finance for productive activity. In choosing appropriate privatization method for these large and very large enterprises, the Government should consider simply selling most, or all of the shares in the enterprise to a strategic investor (either domestic or foreign) that offers the highest cash bid in a competitive auction. The process should avoid complicated requirements on how the new owner should manage the company. This way, the Government will avoid becoming involved in the management of these companies after privatization and avoid disputes over whether the new owners have satisfied the requirements of the sale contracts. IV. INFRASTRUCTURE DEVELOPMENT Need for political risk insurance for foreign suppliers and financiers: Providing efficient infrastructure services to business sector is crucial to establishing an environment that is conducive to investment and greatly affects the international competitive position of Kazakhstan. The Government policy in the power and telecommunications sectors should be, therefore, targeted to ensure that these provide efficient services to the business sector. However, Kazakhstan's lack of track record, and the perception of high political risks often prevent lenders from risking their funds without some type of guarantee or insurance. Thus, by providing suppliers and lenders to a particular infrastructure project with an insurance policy against non-payment of debt obligations as a consequence of Government actions, or certain events of political force majeure, the project could facilitate a long-term financing inflow in the sector. Government Strategy The World Bank worked closely with the Government of Kazakhstan (GOK) to design and develop an integrated approach to effective Private Sector Development. It includes careful-targeted lending and specific non-lending services, a major part of which are political risk guarantees. To identify priority issues in the rapidly evolving development agenda in the country, and map out the strategy to be undertaken by the Government addressing these issues, a Joint Private Sector Assessment for Kazakhstan, was prepared by the World Bank Group, including the International Finance Corporation and the Foreign Investment Advisory Services, in consultation with the Ministry of Finance for Kazakhstan, Agency for Strategic Planning and the National Bank of Kazakhstan. The main pillars of the strategy leading to private sector - 2-

3 growth are: (a) an enabling environment for private business; (b) the privatization and restructuring of state-owned enterprises; (c) the efficiency of the infrastructure sector; and (d) the deepening of the financial system. Promotion of foreign direct investment is a special component of the Government's strategy to create sound business environment, which hinges upon the availability of commercial financing for productive activities in the country. In addition, infrastructure reforms focus on private participation in the power and telecommunications sectors, which triggers the need of political risk insurance policies for the potential foreign lenders. Finally, the financial system development calls for establishing of partial risks guarantees schemes to unbundle political and credit risks, which would allow it to focus on evaluation of commercial risk. Thus, the Facility directly addresses the goals set out in the Joint Private Assessment Report, by providing political risk insurance policies for financiers of productive transactions in Kazakhstan involving strategic foreign partners. 2. Objectives The main objective of the Facility is to encourage privatization, private financial flows and foster the private sector development in Kazakhstan's industry, agriculture, oil and gas, and services sectors, thereby creating employment and alleviating poverty. A Leveraged Insurance Facility for trade and Development (the Facility) would mitigate the perceived risks that are preventing private sector companies from having access to commercial financing for productive transactions. The Facility would issue noncommercial risk insurance policies against a discrete list of government interference risks and war and civil commotion. Currently, and in the foreseeable future, the perceived country risk for both foreign and local commercial financiers is very high, which prevents Kazakhstan from obtaining much needed private capital to finance what would otherwise be sound commercial transactions. A preliminary market survey conducted at the initial stage of the Facility preparation suggests that these insurance policies, by covering Government interference risks that are of greatest concern to foreign suppliers, financial institutions and investors, would help to attract substantial volumes of commercially viable private capital flows to private and newly privatized enterprises. The key performance indicators to measure the Project Development Objectives would be the volume of transactions directly supported by the Insurance Facility, as well as the volumes of non-insured private investment and trade flows catalyzed by the Facility. Other key performance indicators would be the level of employment in, production and exports of the enterprises benefiting from the insurance policies. In addition, the Facility output would be measured by the value of issued policies. 3. Description (1) Method of Implementation - "Cash Backed" versus leveraged The project involves a loan to the Government of Kazakhstan. The loan would be used to give security and credibility to the mechanism of issuing insurance policies. This is achieved by one of two methods. The first method - 3 -

4 is for the implementing agency (Insurance Administration Unit or IAU) to appoint an "Agent Bank", which would be a first class international commercial bank. The IAU issues policies of insurance to applicants with financial exposure in Kazakhstan in respect of transactions involving a productive activity e.g. sale of capital equipment on credit terms for the manufacture of building materials. The Agent Bank provides credibility to the insurance policies issued by the IAU by issuing standby letters of credit covering the same risks as the IAU policies. The Agent Bank holds the loan funds in an escrow account as fully cash backed security for its obligations as Agent Bank. Under the second method, insurance policies are issued by major private insurance corporations under an agreement whereby the commercial insurers are committed to issue policies of insurance involving liabilities up to a maximum of an agreed multiple of the World Bank loan funds. In return for this obligation, the Government of Kazakhstan places the World Bank loan funds into a trust account and allows the insurers access on agreed terms to pay valid claims. This arrangement is similar to a reinsurance technique called "excess of loss" and allows World Bank funds to be effectively leveraged without the Government of Kazakhstan assuming any additional liabilities. If a decision is made to provide insurance policies issued by the IAU backed up by standby letters of credit issued by an Agent Bank, the Agent Bank will be selected following a competitive tender process. If a decision is made to use a leveraged "excess of loss" arrangement with the private insurance market, the IAU will use the services of an insurance broker to arrange for the most competitive terms. A decision as to which method should be adopted will depend upon the terms offered by the private insurance market for Kazakhstan's political risk. The IAU has already selected a broker following a tender process. Early indications show that the private insurers rate Kazakhstan as a high political risk market with a consequent effect on terms and premium rates. This may change as the market realizes the very considerable risk mitigating measures that the Facility provides. However, in order to provide cover to commercial risk takers on terms that reflect the actual risk of a World Bank supported Political Risk Insurance Facility and do not provide a disincentive to undertake commercial risk in the market, it may be necessary to start the Facility on the basis of a fully cash backed arrangement with an Agent Bank issuing standby letters of credit. This will permit the IAU to establish a track record of issuing policies of insurance that do not result in claims. A decision on which method to adopt will depend upon the outcome of final negotiations with the private insurance market. It will be necessary for the arrangements under one of the two proposed possible methods to be finalized before the loan is made effective. (2) Implementing Agency/Operational Procedures/Insurance Policy and Claim Payments The IAU selected by the Government to be the implementing agency is Kazinvest, a corporation which currently carries out the function of investment promotion. It is based in Almaty and has a Director and a staff of six persons. -4-

5 Kazinvest would need to recruit additional staff to be effective in implementing the facility. The most suitable persons available in Almaty would be currently located in commercial banks and be experienced in international trade transactions. It may be difficult to recruit persons with this background into Kazinvest due to the relatively low salaries payable in Government institutions compared with private sector commercial banks. Emphasis will therefore need to be given on providing adequate technical assistance to ensure that the staff are capable of implementing the facility in a competent manner. A detailed Operations Manual would provide guidance to the staff and Steering Committee of the IAU on operating procedures, including such matters, inter alia, as (i) transaction eligibility criteria, (ii) application and transaction approval procedures, (iii) staff responsibilities, (iv) claims administration and arbitration procedures, (v) cooperation procedures with ECAs, MIGA and private risk insurers, (vi) auditing and reporting requirements, (vii) the general terms and conditions of IAU insurance policies and premium rates, and (viii) environmental and social assessment guidelines and procedures. All eligibility criteria specified in the manual would be objective, transparent, and public to ensure that all applicants are treated fairly. Insurance policies would be sold on a "first come, first served" basis to applicants who satisfy the eligibility criteria, including environmental safeguards. The terms and conditions of the insurance policies sold and administered by the IAU are subject to agreement between the Bank and GOK and would be set out in a standard form of transaction documents which would cover most of the type of trade related transactions that are likely to be encountered. (3) Private Risk Insurers Private risk insurers are interested in providing political risk coverage, even under the current economic and financial sector conditions in Kazakhstan. However, they are cautious of undertaking large exposures and currently cover is confined for the most part to prepayments of working capital to enterprises that repay the loan from by producing and exporting goods with the working capital. Private risk insurers welcome the opportunity to enter the Kazakhstan's market in partnership with the Bank and the GOK, and in the context of the risk mitigating mechanisms that are an integral part of the Facility. (4) Working with MIGA It is anticipated that most of the transactions submitted for cover under the Facility will either be shorter than 3 years or pure trade transactions which would not be eligible for MIGA cover or not referred to MIGA in the normal course. However, some transactions, such as a commercial loan supported by foreign owners of the borrower i.e. an "investment loan", may be considered by MIGA as eligible for coverage. To ensure that the Facility does not compete with MIGA for business that MIGA would wish to participate in, transactions that are over 3 years in tenor can be referred to MIGA before a binding offer of insurance is provided to an applicant. If MIGA wishes to provide cover, the IAU must decline interest in favor of MIGA. Alternatively, MIGA can define a class of transactions which it would wish to have first - 5 -

6 refusal, such as proposed investment loans beyond three years, and the IAU would refer these transactions for MIGA to indicate its interest. The Operations Manual will set out the arrangements to be made with MIGA which will be binding on the IAU. (5) Tenor, Availability Period, Currency, Legal Agreements Policies issued by the IAU and backstopped by the Bank and private risk insurers will be denominated in one currency, most likely in US dollars. A final decision will be made following further consultation with the Government and the IAU's broker. It is expected that policies of insurance could be issued for a period of five years following the anticipated date of effectiveness. It is unlikely that there will be significant demand for cover on transactions with a credit period of longer than five years plus a reasonable period to allow the insured to complete its obligations to the insured to export goods, or where pre-export cover is required, to complete manufacture of goods. Thus, the Operations Manual should provide that the maximum length of insurance available for transaction is six years, with the credit period not to exceed five years. This is consistent with the terms agreed with the private market under the Bosnian Leveraged Facility for Trade. The project's Loan Agreement will include the usual provisions in any IBRD loan agreement, the Loan Agreement applicable to this project will have several special provisions dealing with issues that are relevant to this type of Facility. In addition, in order to ensure that the GOK is provided with the appropriate incentives not to cause claims, the Loan Agreement will provide that in the event of a claim for all "government performance" risks (all risks other than war or civil commotion) which results in loan funds held in the trust account being applied in payment of such a claim, the GOK is obliged to replenish the account. Failure to replenish the account, is a breach of this covenant entitling the IBRD to suspend operation of the Facility and demand prepayment of all loan funds. In addition to the Loan Agreement, the IBRD will enter into a Project Agreement with the IAU. The Loan Agreement will, amongst other things, require the IAU to administer the Facility and operate the trust account according to sound principles and practices and in accordance with the Operations Manual. A detailed description of the project structure, legal agreements and covered risks is included in Annex 2. 4.Financing Leveraged Foreign Up to At least Insurance 20% Facility for Trade and Development Component Category Indicative % of Bank- % of Costs Total financing Bank- (US$M) (US$M) financing -6-

7 Total Up to At least 20% Currently, GOK and the World Bank have been exchanging information and working in partnership with private risk insurers to finalize leveraging opportunities. The Bank has taken the lead in pulling together these cooperative efforts and arranging the respective institutional mechanisms, project architecture, operational arrangements, and legal agreements. It is expected that the arrangements with the private risk insures will be finalized shortly. 5. Sustainability The project is aimed directly at allowing the private sector to build business links on a fully commercial basis. If the underlying transactions are successful, this will help foster viable private business activity in the productive sectors which is not dependent on government subsidies. The project will be completely market-driven and, thus, highly sustainable. Additionally, the earlier described monitoring and risk prevention mechanism, employed in similar Bank projects, based on systematic evaluation and monitoring of the Kazakhstan's legal, regulatory, and institutional framework, will help to ensure that commercially viable private transactions are permitted to proceed without government interference. If private transactions proceed successfully, Kazakhstan will have built a track record of allowing commercial transactions to go forward in the forestry sector without political interference, and relevant players will no longer perceive political risks to be too high to conduct business in that sector. During supervision of the project, the Bank would promptly notify the IAU of any changes in the Bank's environmental regulations specifically regarding pesticides and industrial chemicals. The sub-projects would have to comply with local environmental laws, and rules and regulations in force at that time, as set forth in the Operating Manual, during the whole period of operation of the project. In addition, the leveraged project structure, which includes private risk insurers, will enhance the project sustainability by introducing a perpetual source of political risk insurance to the Republic of Kazakhstan. 6. Lessons learned from past operations in the sector The Facility is very similar to the Amended and Restated political risk insurance facility developed in Bosnia and Herzegovina (Emergency Industrial Re-start Facility (BA-PA-45820), and has some similarities to the Moldova Pre-export Guarantee Facility (3851-MD), Albania (Private Industry Recovery Facility, ALB) and Ukraine (Pre-export Guarantee Facility Report, P UA). The main lessons learned from these projects are (i) the importance of surveying potential users to understand their concerns and to develop a strong database of prospective clients, and (ii) the importance of consulting with potential users to ensure that the proposed risk coverage and draft guarantee contract/insurance policy meets the legitimate needs of private sector players while remaining consistent with the general principles of allocating all commercial risks to the private sector and leaving the government responsible for its own actions and behavior. - 7-

8 7. Environmental Aspects The Bank will review the adequacy of the Kazakhstan environmental requirements applicable to the Facility and the proposed arrangements for sub projects, including arrangements for environmental screening, EA review and monitoring. The Bank will also review the relevant proposed IAU arrangements and procedures. If deemed inadequate or inappropriate, the Bank will assist the IAU in developing appropriate arrangements. As the Facility may involve Category A sub projects, the IAU will provide to the Bank a detailed assessment of the institutional mechanisms for its sub projects EA work. Clear agreement with the GOK will be required to ensure that the IAU and other relevant agencies and institutions will be able to properly supervise proposed projects from an environmental perspective. Specifically, the mission will confirm the sources of required expertise, existence of adequate funding and the appropriate division of responsibilities for environmental management among the beneficiaries/project sponsors, IAU and Kazakhstan environmental authorities. The Bank will also undertake as appropriate, to review EA reports for select Category A and Category B sub projects in accordance with OP/BP/GP The proposed operation will not deal directly with a specific investment or technical assistance Facility. IAU will act as a financial intermediary and therefore an FI rating for the Facility is justified under provisions of OP 4.01 (paras. 8(d), 11, and 12). IAU will develop, as a part of its Operations Manual, a set of procedures for carrying out appropriate EA for each - project. Before approving a sub-project, IAU will verify that the sub-project meets all Kazakh environmental requirements, approvals and procedures, and is consistent with World Bank environmental policies and procedures, as well as the guidelines of the Bank's Pollution and Prevention Handbook. Moreover, the Facility will likely result in positive environmental benefits through expected improvements associated with private investment and related transfer of technology and managerial know-how, in production and safety management and reduction in the frequency of accidents, pollutant discharges, and other adverse situations. During supervision of the Facility, the Bank would promptly notify the IAU of any changes in the Bank's environmental regulations specifically regarding pesticides and industrial chemicals. The sub-facilities would have to comply with local environmental laws, and rules and regulations in force at that time, as set forth in the Operating Manual, during the whole period of operation of the Facility. 8. Participation The Bank has developed this project with the full participation of the Government. Possible commercial lenders and foreign investors have been surveyed through an massive two-stage marketing campaign in order to assess their interest and conditions for participation, and their views have been taken into consideration. As the project is demand-driven, those enterprises that want to participate will come forward and express their interests and concerns directly. 9. Project Benefits The project will have the following benefits: The project would help Kazakhstan to establish itself as an attractive - 8 -

9 business environment. The target population consists of: (i) workers employed in enterprises receiving flows of private investment for commercially viable transactions. Those will experience greater job stability and growth prospects; and (ii) the unemployed who find new jobs because of new business creation or business expansion. The project will have the following benefits: It would rely on the private sector to act as a screening mechanism to identify and channel private resources to commercially viable enterprises and transactions in the productive sectors; It gives the Government an opportunity to correct problems before they give rise to claim payment obligations; The Government bears responsibility only for the non-commercial risks under its direct control; it has no responsibility for any of the commercial risks inherent in individual transactions; Because of the deterrence and umbrella- effects of the Bank support, relatively small insurance policies should be sufficient to catalyze much larger volumes of private capital flows that are not supported by either the Bank or the Government; It does not increase the pressure on Kazakhstan's balance of payments; It would help Kazakhstan enterprises build links with foreign partners and markets; It would help generate new jobs in all of the Kazakhstan's productive sectors and would secure the labor force employed in commercially viable enterprises thereby helping to alleviate poverty; It would help promote a transparent business climate in which the rule of law prevails. 10. Project Risks The main risk is that private lenders will not be induced to finance transactions despite the risk mitigation offered by the insurance facility. This risk is compounded by the novelty of the project. The "novelty" risk is minimized by following established practices in export finance and credit insurance, and by involving private political risk insurers from the very beginning. This risk will be further limited through consultations with a wide variety of commercial lenders and potential foreign partners that will indicate the level of demand for the insurance facility, and provide suggestions for the design of the project. Contact Points: The InfoShop The World Bank 1818 H Street, N.W. Washington, D.C Telephone: (202)

10 Fax: (202) Lloyd Edgecombe, ECSPF The World Bank 1818 H Street N.W. Washington, DC Telephone: (202) Fax: (202) Note: This is information on an envolving project. Certain components may not be necessarily included in the final project. Processed by the InfoShop week ending January 14,