INTERNATIONAL DEVELOPMENT ASSOCIATION Acting as Administrator of the Interim Trust Fund
FOR OFFICIAL USE ONLY
Report No P-6999-AM
MEMORANDUM AND RECOMMENDATION OF THE
MANAGING DIRECTOR TO THE
PRESIDENT OF THE
INTERNATIONAL DEVELOPMENT ASSOCIATION ON A
PROPOSED INTERIM FUND CREDIT IN AN AMOUNT OF SDR 11.6 MILLION
TO
THE REPUBLIC OF ARMENIA FOR
AN ENTERPRISE DEVELOPMENT PROJECT
November 27, 1996
Currency Unit = Dram Dram I = US$0.0023
US$1 = Dram 433.83 AVERAGE EXCHANGE RATES
Dram per US$1
1995 (Avg) June. 1996 August. 1996 October 1996
406.40 409.82 417.00 418.14
WEIGHTS AND MEASURES Metric System
ABBREVIATIONS AND ACRONYMS BAU - Banking Advisory Unit
CBA - Central Bank of Armenia
EBRD - European Bank for Reconstruction and Development
EDIPA - Enterprise Development and Foreign Investment Promotion Agency ESAF - Extended Structural Adjustment Facility
ESF - Enterprise Support Fund
FACC - Foreign Aid Coordination Center FStJ - Former Soviet Union
GAC - Grant Approval Committee
IAS - International Accounting Standards
IDA (ITF) - International Development Association (Interim Trust Fund) IF - Investment Fund
KfW - Kreditanstalt for Wiederaufbau LOC - Line of Credit
MOE - Ministry of Economy MOF - Ministry of Finance
N BFI - Non Bank Financial Institution NGO - Non-governmental Organization
PFi - Participating Financial Institution
PIIRD - Population and Human Resources Development Pi FCA - Private Investment Finance Corporation of Armenia
PMIJ - Project Management Unit SA - Special Account
SAC - Structural Adjustment Credit SMS - Securities Market Supervision Unit SRO - Self-regulating Organization YSE - Yerevan Stock Exchange
ARMENIA - FISCAL YEAR January I-December 31
ENTERPRISE DEVELOPMENT PROJECT Credit and Project Summary
Borrower: Republic of Armenia
Implementing Agencies: Ministry of Economy, EDIPA, PIFCA, PFIs Beneficiaries: PFIs, PIFCA, EDIPA, SMS, Private Enterprises Poverty Category: Not applicable
Amount: SDR 11.6 Million (US$16.75 million equivalent) Terms: IDA terms, payable in thirty-five years, including
ten years of grace with 0.75% service charge.
Commitment Fee: 0.50% on undisbursed credit balances, beginning 60 days after signing, less any waiver.
Onlending Terms: The proceeds of the IDA (ITF) Credit would be passed on by the
Government in foreign currency through the Ministry of Economy--Foreign Aid Coordination Center, Project Management Unit (PMU). The PMU would receive a spread of 0.5% on the amount onlent under the investment financing component to the PFIs, to cover its administration costs. The credit would be onlent on the following terms: for investmentfinancing; to eligible financial institutions including the PIFCA and the domestic banks as a subsidiary loan repayable over ten years at a rate of LIBOR plus 2%; for technical assistance; to the EDIPA as a grant, and to the PIFCA for
institutional support as a loan at IDA borrowing cost plus 1.25%. The PIFCA and the domestic banks would lend to subborrower private enterprises at market-determined interest rates and margins, with subloan maturities of up to seven years. The subborrowers would take the exchange risk and the financial intermediaries would take the credit risk. The
difference between the cost of the IDA (ITF) credit and the interest rate on subsidiary loans under the credit lines, less an administrative fee for the PMU, would be retained by the Government.
Project Costs US$ million equivalent
Local Foreign Total Component
Line of Credit 7.00 25.00 32.00
Project Management Unit 0.10 0.27 0.37
Enterprise Support Fund 1.05 3.50 4.55
Business adviser 0.03 0.29 0.32
Banks, capital market 0.40 2.69 3.09
ITOTAL 8.58 31.75 40.33
Local Foreign Total IDA (ITF) 0.00 16.75 16.75 USAID 0.00 1.00 1.00 EBRD 0.00 7.00 7.00 KfW 0.00 5.00: 5.00 Private Investors 5.00 2.00 7.00,
Other cofinancing 1.00 0.00 I1.00
Govermnent 0.58 0.00 0.58
Local Banks 2.00 0.00 2.00l
TOTAL
~~~~~
~~~8.58
31.75 .40.33Completion Date: January 1, 2002 Financial/Economic
Return to Project: Subprojects approved under the line of credit would be expected to earn a financial rate of return above their cost of borrowing from the PFIs. At current rates and spread to the PFIs this rate of return would be at least 15%. Subborrowers would assume the exchange risk, which would generally necessitate competitive production at world prices. They would produce mainly tradable goods under relatively low
prevailing levels of trade protection. Economic returns would therefore approximate financial returns. The technical assistance to the banks, the PIFCA, the capital market and the ESF would be expected to earn a
satisfactory economic rate of return taking into account likely external benefits associated with creating new markets.
ACTING AS ADMINISTRATOR OF THE INTERIM TRUST FUND) TO THE REPUBLIC OF ARMENIA
FOR AN ENTERPRISE DEVELOPMENT PROJECT
1. I submit for your approval the following memorandum and recommendation on a proposed Interim Fund Credit for the equivalent amount of $16.75 million to help finance an Enterprise Development Project.
The credit would be on standard IDA termns, over a thirty-five year term with a ten year grace period. Country and Sector Background
2. Investment constraints. The Government of Armenia is undertaking an ambitious economic recovery program supported by IDA under a SAC, and by the Fund under an ESAF, both approved in February 1996. The main objectives of the program are to restore economic growth and to continue reorienting the State away from the management of the economy. One of the key constraints to recovery is the rate of investment, which has been severely reduced, with significant disinvestment in some areas. The low rate of investment is due to: (i) the collapse in domestic production and demand since the breakup of the FSU, and; (ii) the effect of external trade disruption particularly on energy supplies. These factors have until recently combined with constraints on enterprise development to deter private investors and to make Armenia a high-risk investment location.
planned to be sold in 1996. The rate of progress so far is slightly below target but has accelerated recently and may be regarded as impressive.
5. Despite the encouraging progress, Armenian enterprises continue to face constraints. In particular, many years of centrally planned production within protected markets have cut business off from trade, technology, and investment exposure to non-FSU countries, and have discouraged the development of essential business skills such as financial planning and marketing. Accounting methods are also still based on the FSU chart of accounts. These problems have reduced international competitiveness, a situation exacerbated by the lack of financial resources over the past few years to update plant and equipment. The proposed project is designed to address these needs.
6. The banking sector. Since the break away from the Soviet Union in 1991, the Armenian financial sector has developed rapidly in terms of number of institutions. The Central Bank (CBA) has defined its role and greatly strengthened its capacity to regulate and supervise the banking system, supported by amended laws on the central bank and commercial banking. In 1993, a liberal approach to new entry resulted in the establishment of almost 60 new banks, but 26 banks have closed since March 1994, partly because of increases in minimum capital requirements, and the number currently licensed by the CBA is 35, of which one is foreign owned. The sector is still dominated by the four traditional specialized banks: together, they account for 65% of total bank assets and 70% of total loans outstanding. A fifth bank which remains from the Soviet period - the Savings Bank - is small in asset terms but still accounts for the majority of the branch network. Private banks are, however, penetrating the market and the Midland-Armenia bank, which opened in April 1996, will be an important force for improving banking practices. Bank intermediation of domestic savings will expand as a result of the increase in interest rates to highly positive real levels during 1995, with a decline towards more sustainable, but positive, real rates and margins in 1996.
7. These generally positive developments in the sector are still overshadowed by the problems of Armenia's fragile economy. Hyperinflation resulted in total bank credit outstanding falling from 67% of GDP in 1991 to less than 10% of GDP by 1993, and the limited credit available was lent on very short maturities. During the first half of the 1990s, the banking system was downsized and marginalized as a source of finance to real economic activity as many banks saw their capital diminish under the weight of bad loans. The capital positions of the former state banks remain particularly poor. Adjustment for loan losses would eliminate a number of the poorer banks. However, satisfactory portfolio audits completed during project preparation have shown that a group of about six banks, apart from Midland-Armenia, are financially sound. With continued building up of their capacity under the project's TA component, they have potential to achieve in the near future the accreditation standards required for a credit line. In addition, the sector will be broadened by the establishment of the proposed Private Investment Finance Corporation of Armenia (PIFCA), supported by the EBRD and private investors, in which the Bank has had an important mobilizing role, and which is expected to be a line of credit intermediary.
Objectives
9. The major aim of the project is, on the demand side, to increase the viability and bankability of Armenian companies through improved planning, and development of export links and joint venture deals to enhance investment, imports, exports and technology, and, on the supply side to strengthen the lending capacity of the banking system, especially for export oriented projects, and to provide term finance for investment by private enterprises. The project's objectives are: (i) to assist in financing such productive facilities and resources in the Republic of Armenia as will contribute to the economic and social development of the country, (ii) to strengthen commercial banks and other financial institutions and the capital market, and (iii) to strengthen investment and export market development capacity of private enterprises.
Bank (IDA) Strategy
10. Bank (IDA) strategy is to support the adjustment and growth of the Armenian economy. The program developed through an Earthquake Reconstruction Credit, an Institution Building Loan, Highway, Power Maintenance and Irrigation projects. A Rehabilitation Credit was approved by the Board along with a limited CAS, on February 28, 1995, a Social Investment Fund in October 1995, and the SATAC and SAC in February 1996. This project is in accordance with the current CAS, which will be upgraded to a full CAS, to be submitted during FY97. A priority for future assistance is the rapid growth of private enterprise, through new starts and privatizations. This requires an environment to attract and support foreign and local private investment, and the strengthening of Armenia's financial institutions. The proposed institution building program and line of credit are central to this strategy. The project requires IDA (ITF) funding, which is in short supply and constrains the scale of financing. IBRD lending to Armenia depends on a favorable creditworthiness assessment, which has yet to be made, and, following such an assessment, a determination of the scale of lending. The proposed project is a priority for the Government and is supported by a number of
public agencies and private investors. Project Description
12.
The Enterprise Support Fund (ESF) would provide matching grants to promote and support
export and imnport
trade, investment and technology partnerships for specific companies. It would be
transaction-based and proactive, and would be located in the Government's recently established
Enterprise Development and Foreign Investment Promotion Agency (EDIPA), an autonomous public
agency under the Ministry of Economy. The ESF would be under the direction of a fund manager
recruited internationally, and would aim to provide ongoing specialist assistance to targeted companies
throughout the export market research, identification and transaction process, and the selection of
intermediaries to identify foreign partners and follow through negotiations to closure of deals. The
project would also include a business advisory office in the EDIPA, to assist inter alia in preparation of
bankable loan applications.
13. Institution Building Assistance to the Financial sector. This component would consist of
resources to support on-the-job training and consultancy in the commercial banks, to bring them
towards improved standards of performance (also required for accreditation to the line of credit), and to
support capital market institutions, including the Securities Marketing Supervision Unit (SMS). The
banking support would be provided through a Bank Advisory Unit, which, in order to create synergy,
would work alongside a Bankers Training Center established with the assistance of USAID, who have
also started an accounting conversion program in the banks and enterprise sector. The capital market
assistance would finance training and consultancy to support securities trading and regulation. IDA
(ITF) funds of US$0.25 million would also be onlent (at 2% per annum over ten years) to cover the
local staff development costs of the PIFCA.
14.
The Line of Credit would be made available through a PMU in the MOE to eligible
participating financial institutions who would sign subsidiary loan agreements with the MOE
represented by the PMU. The commercial banks would qualify subject to meeting a set of
accreditation conditions including solvency measured against IAS norms, adequate management and
credit absorptive capacity, and adherence to banking regulations as stipulated by the Central Bank of
Armenia. The proposed PIFCA would qualify subject to meeting separate conditions including, inter
alia, adoption of a charter and institutional development plan acceptable to IDA, and subscription of
share capital by its investors. Subloan decisions would be made by the PFIs in collaboration with IDA
in cases which fall outside free limits. The Government would not have any role in onlending
decisions. The line of credit would finance fixed investment and permanent working capital.
Subsidiary loans from the PMU would carry a ten-year maturity at an interest rate of LIBOR plus 2%.
The onlending interest rates, initially at market levels, would be subject to review during supervision to
determine whether excessive spreads were being derived by the intermediaries, and to recommend
appropriate action.
Demand for the Credit
Financing
16. The project is financed through the IDA Interim Trust Fund (ITF). The total project cost would be US$40.33 million. The IDA (ITF) component is estimated to cost US$16.75 million. The EBRD, KfW, and private investors are expected to provide loans and equity capital of about US$14.0 million for the PIFCA. Cofinancing of US$1.0 million has been provisionally agreed with USAID to support bankers training, and cofinancing is also being sought from other sources. The local contribution, from the Government, banks and private investors, would be about US$8.58 million over the project life. PHRD grant funds have financed the bulk of the preparation costs of the project.
17. Retroactive financing for subprojects procured according to the Guidelines after November 1, 1996 is proposed up to a limit of US$1.6 million equivalent, equal to about 10% of the amount of the loan.
Inplementation
18. The PMU would administer the credit to the participating financial institutions, and the grants for technical assistance. It would be responsible for accounting (including management of the special account), reporting, auditing, disbursement, procurement, environmental and compliance reviews. In the case of the line of credit, the PMU will cooperate with the CBA who will monitor the eligibility compliance of the participating banks. In the case of the TA component, the PMU will either directly administer the program or will enter into agreements with managing entities, i.e. the EDIPA, the SMS, the PIFCA and the BAU.
Sustainability
19. The project would mobilize foreign private investment in Armenia which would be self-sustaining in the appropriate business environment which is now developing. The experience gained in term lending and enterprise support combined with the capacity building program in the commercial banks and the securities market institutions would improve productivity and growth rates of enterprises, and increase the efficiency of the banks as intermediators of savings and investment. Institutionally, the Project will support the development of the EDIPA, an agency which will coordinate enterprise assistance in Armenia, and will also assist in establishment of a banking advisory service, which will build capacity in the banks, and the creation of a regulatory body for the securities market and improved professional expertise in stock exchanges and other market institutions.
Lessons Learned from Past Operations
20. Nine operations have been approved in Armenia, of which four have substantial disbursements (the IBL, the Earthquake Reconstruction Project, the Rehabilitation Credit, and the SAC). Useful implementation experience has been built up, and implementation has accelerated as physical and political circumstances improve and the reform effort renews momentum. The Foreign Aid Coordination Center, which will also house the PMU for this operation, has built up a good level of administrative capacity.
* an adequately strong group of participating financial institutions capable of making loan decisions without Government interference;
* sufficient defined demand for subloans at applicable terms;
* clear onlending procedures, and simplified procurement (including the use of private commercial practices); and
* provision of technical assistance to the PFIs and the borrowing enterprises to assist in preparation of bankable projects.
22. While the stronger banks need time to strengthen their capacity, the participation of the proposed PIFCA would ensure adequate disbursement capability. The demand for credit in a risky environment has to be speculative, but the results of the credit demand study backed up by additional investment information suggests that private investment is becoming very active and there is satisfactory demand.
23. Export assistance funds have been undertaken by the Bank in a number of countries, including India and Kenya, and have had a good record in terms of generation of incremental export revenue in relation to costs of operation. Lessons of experience have been:
* credit to export-oriented projects has a positive impact during the transition from state to market * a combination of technical assistance, to prepare export programs, and financing, is critical to
success
* matching grant funds for trade promotion, involving joint participation by both enterprises and financiers, are effective in ensuring enterprise commitment and satisfactory impact.
24. Investment match-making (which is a part of the ESF program) has too recent a history to assess, but is a promising concept in that it is demand driven, targets funding and works with particular companies, and is likely to be measurably cost-effective.
25. The design of the proposed project takes these lessons into account through provision of a line of credit combined with a range of assistance measures, with particular emphasis on export and investment matchmaking.
Rationale for IDA Involvement
26. Institution building. IDA involvement in direct enterprise strengthening through the enterprise support fund is particularly timely as the Armenian private sector, including both newly privatized and newly formed private companies, is at a take-off point, and public sector support is likely to yield important externalities reflected in faster growth. This intervention would also be a critical complement to the enhancement of lending capacity through boosting demand for finance by viable (e.g. export-oriented) enterprises. IDA assistance in the area of banking and capital market development is similarly justified because of the incipient and fragile state of the financial sector, at which juncture targeted support could yield external skill-generation benefits. Support to the financial sector would also be an essential complement to the project's financing component as it would directly strengthen financial institutions. This would be coordinated with donor agencies, in particular USAID, and would be gap-filling, targeting specific inputs.
Armenia and the Credit would enhance this advisory role because the commercial banks would have to be initially accredited and then subject to continuous accreditation compliance reviews under their agreement with the Government. Overall, IDA has acted successfully as a catalyst in reforming the banks and capital market, and restructuring the enterprise sector through privatization and improvement of the environment for private business. The SAC has supported a broad reform agenda, including privatization, and the proposed project follows on from this.
28- The PIFCA is expected to be established early in 1997 by the EBRD and private investors. The Bank played a catalytic role in mobilizing of the investors. The participation of the PIFCA is important because of the current relative weakness of the domestic banks and the need to provide an alternative channel for investment funds, both equity and debt, over the next few years. The PIFCA itself would be the first term-financing vehicle in Armenia capable of mobilizing significant investment resources, and is being established at an opportune moment as the economy stabilizes and inflows of foreign investment become sustainable. The presence of the Bank as a lender is regarded as important by the Government because targeted investment lending complements the key role that the IDA has played through its adjustment lending, and because the reform program is still at an early stage. The Bank's role is also seen by the private sector as important within a risky environment. Discussions have also taken place with IFC who have expressed interest in providing finance to the PIFCA when the supply of private capital is further developed.
Economic Analysis
29. Country Strategy This operation is an integral part of the country strategy. It is part of the transition from the rehabilitation and macroeconomic adjustment stage of IDA's support to Armenia, to intervention at the post-privatization and sectoral restructuring stage. The operation focuses on the rationalization and recovery of production within the newly forming private sector by addressing key bottlenecks in enterprise financing, business skills and institutional development.
30. Economic Background Armenia's macroeconomic position is improving rapidly. Its budget deficit was reduced very substantially over 1994 to 1996, while the monthly inflation rate has fallen to a low level. Stabilization of the domestic currency has started to stimulate capital inflows. Export taxes and quantitative import restrictions have been removed, and the maximum import tariff reduced to 10%. Interest rates have been positive in real terms for the past 1 8 months. The interest rate on subsidiary loans under the proposed operation would be dollar denominated and therefore positive in real terms. The exchange rate is stable, and foreign exchange is purchased at regular inter-bank auctions. Commodity prices in both domestic and foreign trade have generally been liberalized. Overall, price distortions have been greatly redu,..ed.
3 1. Core Economic Objective. The main objective of the project is to stimulate a market-driven private sector investment and production response complementing the stabilization and structural adjustment program. The resumption of economic growth in Armenia, the increase in capacity utilization, and the reasonably rapid rate of privatization, will create a good basis for the rapid growth of private business.
32. Achievement of Core Economic Objective. Technical assistance inputs will meet critical
locally. The provision of financing through the domestic banks, and through the PIFCA, would provide the resources to finance efficient private sector investment projects in a range of production and services, :hereby stimulating the recovery of production. The provision of finance will be complementary to technical assistance to promote international marketing, technological and trade contacts between foreign and Armenian companies, thereby promoting growth and diversification. Access to finance will also provide incentives to the banks to improve their performance.
33. Fiscal Impact. The line of credit will provide budgetary resources to the Government through the spread between the cost of IDA (ITF) funds, and the onlending rate of the subsidiary loan (10 years at LIBOR plus 2%) from the Government to the participating financial institutions, less the cost of administering the PMU. Part of the spread to the Government should also be seen as coverage for its credit risk in the event of default by a PFI. The direct net budgetary benefit will depend on the rate of disbursement of the credit line. Based on a 7% net spread to Government, the present value at 10% of the net fiscal benefit accruing to the Government from the line of credit would be about US$2 million over the 6 year life of the credit line. The ESF consultancy funds, along with the funding of the associated administrative costs, are expected to be passed on a grant basis to the EDIPA. The Government would therefore bear a fiscal cost amounting to the cost of funds (0.75% per annum) and its own share of the operating cost of the EDIPA. This would be offset by the copayments by recipient banks averaging about 25% of costs. The net present worth of the net fiscal expense associated with the financial provision for the ESF would be about US$100,000. In the case of PIFCA institutional support, funds are expected to be onlent by the Government at IDA borrowing cost plus a margin for administration, with a zero net budgetary impact. Copayments for assistance from the BAU and the
Business Adviser would result in a small net positive budgetary impact.
34. The positive direct fiscal impact would be enhanced by indirect fiscal benefits from the creation of new productive capacity. The technical assistance should therefore be seen as an investment yielding an enhanced stream of future fiscal inflows. The successful implementation of the line of credit and technical assistance will result in the broadening of the tax base through new businesses and employment.
35. Analysis of Alternatives. During project preparation, a number of alternative approaches were considered for the project. The main considerations were on the one hand the weakness of the financial sector and on the other hand the critical need for investment finance. The former consideration suggested either waiting for additional reforms to take effect or focusing on a technical assistance operation alone to strengthen the banks and enterprise borrowers. However, the latter consideration implied strongly the need to find appropriate channels to mobilize investment finance. Mobilization of investment through a guarantee operation was initially considered, but the progress of preparation of the PIFCA suggested that the PIFCA would be an appropriate alternative. The participation of the domestic banking sector has also now become feasible as a result of strengthening of the financial positions of several banks over the past year, as shown through the portfolio audits. Also, there is an expected strong incentive effect on the banks to fulfill accreditation criteria. The final design has therefore combined institution building with a line of credit accessible to both the banks and the PIFCA.
37. Analysis of the sensitivity of the estimated rates of return to possible policy changes and sovereign risks can only be tentative. However, the continuing progress in improving the policy environment and implementing strict macroeconomic measures, and the growing geopolitical stabilization, strongly indicate that the number of opportunities for profitable business will grow. The proposed line of credit can easily be topped up if it proves successful.
38. The residual effects of the blockade, especially on oil supply, have the effect of increasing cross-border transport costs, thereby lowering real export FOB prices, and increasing import CIF prices. Thus the alleviation of the blockade will allow export prices to rise and import prices to fall. Economic analysis of subprojects under the proposed operation would have to take account of these movements in estimating future border prices. Aside from this complication, the absence of major distortions means that financial rates of return on subprojects would be close to economic rates; and the stability of the reform process means that a divergence is relatively unlikely to occur in the future, so that financial rates of return will continue to approximate real rates.
Actions agreed
39. A number of important policy measures relevant to the proposed operation have already been taken during project processing, relating to the legal framework for the private sector and the banks:
* a law on real property was passed in 1995;
* a revised joint stock companies law was passed in 1996;
* a revised bankruptcy law has been submitted to parliament in 1996;
amended laws on central banking and the commercial banks, bank insolvency and bank secrecy have been submitted to parliament or adopted during 1996;
* tax deductible bank loan loss provisioning has been introduced according to CBA guidelines; * new IAS reporting forms have been introduced in the commercial banks;
* portfolio audits have been completed in all banks; and
* amendments to the existing collateral law are under preparation and will be submitted to Parliament in early 1997, to include: flexible provisions on: the amount of required collateral cover in relation to asset value, out-of-court execution of collateral claims, and the rights of multiple parties to specific collateral.
40. Project Implementation actions taken Prior to negotiations were:
* the PMU was established and local procurernent and disbursement staff were hired.
* the EDIPA was established and a foreign fund manager and local counterparts for the EDIPA are in post.
41. Project Implementation Actions taken prior to Submission of the Creditfor Approval were: * a contract was signed for the line of credit adviser to the PMU and the local counterpart
accountant/manager is in post.
* the Grant Approval Committee has been established within the MOE. * a draft operations manual has been prepared for the ESF.
* for the line of credit: at least two PFIs would have been accredited, and a subsidiary loan agreement, acceptable to IDA, signed between the PMU (MOE) and each accredited PFI.
* for the technical assistance to PIFCA: a subsidiary financing agreement acceptable to IDA would have been signed between the MOE and PIFCA.
Poverty Category: 43. Not applicable.
Program Objective Category:
44. The project focuses on private sector development and finance. Environmental Aspects
While there are not foreseen to be any direct environmental effects since this is primarily an intermediated credit, subprojects may have environmental impacts, and the project would therefore be rated category B. Each subproject would be subject to an environmental assessment, according to a manual of assessment guidelines.
Participatory Approach
45. This project has been thoroughly discussed with the appropriate organs of Government in Armenia. In addition, the PIFCA has been extensively discussed with the EBRD and potential private investors. The commnercial banks who may participate in the credit have been visited on a number of occasions and presentations have been made to town meetings sponsored by the Commercial Bankers Association. The Securities Market Supervision Unit, American University of Armenia and the Yerevan Stock Exchange have been extensively consulted, and NGOs and donor organizations have been similarly consulted on various aspects of the design of the project. A survey of public and private enterprises (reported above) was carried out to determine the extent of demand for each component of the project.
Project Benefits
46. Line Of Credit. Given the shortage of domestic savings and the lack of investment finance available on prevailing terms, the benefits are expected to be provided through the easing of the financing constraint, and the development of capacity in the banking system inter alia to develop and appraise projects. A total of about 30 to 50 subprojects (at US$120,000 to US$200,000 per subproject) are expected to be financed under the IDA (ITF) credit to the PIFCA, and 40 to 80 subprojects (at about US$50,000 to 100,000 per subproject) under the remaining line of credit if used by the domestic banks. 47. ESF. The ESF would contribute to exports by: (a) assisting 80 to 100 private Armenian firms to
matchmaking assistance, based on fees of around 3-5% of the transaction value and an average copayment rate of about 50%, a $1 million aggregate intervention could result in an aggregate inflow of over $40 million in direct foreign investment of various forms.
48. Banking and Capital Market Assistance. This program is expected to yield direct benefits through skill enhancement within the banks, the securities regulatory agency (SMS) and the main securities marketing entities, and development of the regulatory environment. PIFCA Institutional support is expected to yield benefits through localization of management by year 3 of operations.
Project Risks and Risk Management
49. General. The reforn progress of the past few years suggests that the risk of policy reversals or loss of momentum in Armenia is low. An IDA (ITF) investment in such an environment may therefore be regarded as being an acceptable risk.
50. The Enterprise Support Fund faces three particular risks: (i) the environment may be constrained by underdeveloped legal and institutional structures that discourage foreign firms from entering into long-term relationships with Armenian firms; (ii) working capital and investment finance constraints may prevent firms from implementing export, import, or technological upgrading plans; and, (iii) EDIPA is a new institution with limited experience in delivering enterprise support services that are valued by firms. The first risk is being addressed since, with IDA assistance, the Government is rapidly implementing laws and establishing institutions for a well-functioning market economy. In the second, with IDA assistance, the Government is implementing reforms aimed at improving the financial viability of the banking system and in the interim the IDA is providing financial resources through the Line of Credit. The third risk is being addressed by providing EDIPA with the services of an experienced international manager to implement the ESF program and by providing local staff with overseas and on-the-job training. For the banks and capital market assistance program, and for the Business Adviser, the main risk is failure to deliver effectively the know-how to the banks and securities agencies. A risk facing the BAU is that it will not be able to deliver advisory services soon enough for timely bank accreditation. These risks will be mitigated through careful design of the program, and include cost-sharing provisions in order to ensure adequate commitment by the agencies involved, and in the case of the BAU by the early hiring of advisory staff, which is in process.
Recommendation
52. I am satisfied that the proposed Interim Fund Credit would comply with Resolution No. 184, adopted by the Board of Governors of the Association on June 26, 1996, establishing the Interim Trust Fund and I recommend that the President approve it.
Caio K. Koch-Weser Managing Director
Attachments: Schedules A - E Washington DC
REPUBLIC OF ARMENIA
ENTERPRISE DEVELOPMENT PROJECT Estimated Costs and Financing Plan
Project Costs US$ million equivalent
Component
Local Foreign Total
Financing: Banks/PIFCA 7.00 25.00 32.00
Project Management Unit 0.10 0.27 0.37
Enterprise Support Fund 1.05 3.50 4.55
Business Adviser 0.03 0.29 0.32
Banks, capital market 0.40 2.69 3.09
TOTAL 8.58 31.75 40.33
Financing Plan US$ million equivalent
Local Foreign Total
REPUBLIC OF ARMENIA
ENTERPRISE DEVELOPMENT PROJECT Summary of Procurement Methods
(US$ million equivalent)
Component ICB Other NBF TOTAL
Financing 1.00 10.00 21.00 32.00 (1.00) (10.00) (0.00) (11.00) ESF/Bus. Adviser TA 0.00 3.79 1.08 4.87 (0.00) (3.79) (0.00) (3.79) Banks, Capital Mkt TA 0.00 1.69 1.40 3.09 (0.00) (1.69) (0.00) (1.69) PMU 0.00 0.27 0.10 0.37 (0.00) (0.27) (0.00) (0.27) TOTAL Lo.0 15.75 23.58 40.33 (1 00) (15.75) (0.00) (16.75) 1. Figures in parentheses are the respective amounts financed by the IDA (ITF) credit.
2. "Other" procurement arrangements are expected to include goods and works procured under commercial practices, direct contracting, and consultancy services procured under the standard Guidelines for Use of Consultants.
Estimated IDA Disbursement (US$ million equivalents)
FY96 FY97 FY98 FY99 FY2000 FY2001 TOTAL
Line of Credit (Banks, PIFCA) 0.00 1.65 2.75 3.50 2.20 0.90 11.00
PMU 0.05 0.22 0.00 0.00 0.00 0.00 0.27
ESF/Bus. Adviser 0.07 0.96 1.44 1.33 0.00 0.00 3.79
Banks, Capital Market TA 0.00 0.76 0.76 0.17 0.00 0.00 1.69
TOTAL 0.12 3.58 4.95 5.00 2.20 0.90 16.75
CUM. TOTAL 0.12 3.70 8.66 13.65 15.85 16.75
DISBURSEMENT AMOUNTS
Category % fof Expenditures to be Financed'" Goods 100% of foreign expenditures, 100%
of local expenditures (ex-factory cost) and 80% of local expenditures for
other items procured locally
Works 80%
Consulting services and training 100%
Operating Costs 100%
REPUBLIC OF ARMENIA
ENTERPRISE DEVELOPMENT PROJECT Timetable of Key Project Processing Events
(a) Time taken to prepare the project: 17 months (Identification to Board)
(b) Prepared by: Government with World Bank assistance
(c) First Bank/IDA mission: July 1995
(d) Appraisal mission departure: March 1996
(e) Negotiations: November 1996
(f) Board Presentation: December 1996
(g) Planned date of effectiveness: January 1997 (h) List of relevant PCR's and PPAR's N.A.
The project was prepared by David A. Phillips, Senior Enterprise Reform Specialist, Enterprise and Finance Division, Country Department IV, Europe and Central Asia Region.
REPUBLIC OF ARMENIA
ENTERPRISE DEVELOPMENT PROJECT STATUS OF BANK GROUP OPERATIONS
(As of October 31, 1996)
US$ Million
Loan/Credit No. FY Borrower Project Loan Undisbursed
L3585 1993 Rep. of Armenia Institution Building 12.00 2.80
C2562 1994 Rep. of Armenia Earthquake Rehabilitation 28.00 2.40
C26831 1995 Rep. of Armenia Rehabilitation 60.00 0.00
C2666 1995 Rep. of Armenia Power Maintenance 13.70 8.90
C2667 1996 Rep. of Armenia Irrigation Rehab. 43.00 28.90
C2776 1996 Rep. of Armenia Highway 16.00 9.10
C2784 1995 Rep. of Armenia Social Investment Fund 12.00 11.00
C2824 1996 Rep. of Armenia Structural Adj. Credit 60.00 29.20
C2825 1996 Rep. of Armenia SAC TA 3.80 2.80
TOTAL 248.50 95.10
Of Which: Repaid 0.00
Total Held by Bank
Total amount sold 0.00
Of Which: Repaid
This credit is closed.
Armenia at a glance
Pagelof
2Europe &
POVERTY and SOCIAL Central
Low-Armenia Asia income Development diamond'
Population mid-1995 (millions) 3.8 488 3,188 Life expectancy
GNP per capita 1995 (US$) 570 2,240 460
GNP 1995 (billions US$) 2.1 1,093 1,466
Average annual growth, 1990-95
Population (%) 1.2 0.4 1.8
Labor force (96) 1.4 0.6 1.9 GNP
per
Most recent-estimate (latest year available since 1988) capita
Poverty: headcount index (% ofpopufation)
Urban population (% of total population) 69 66 29
Life expectancy at birth (years) 73 68 63
Infant mortality (per 1,000 live births) 21 23 58 Access to safe water
Child malnutrition (% of children under 5) .. .. 38
Access to safe water (% o(population) .. .. 75
Illiteracy (% of populaton age 15+) 1 .. 34 Armenia
Gross primary enrollment (% of school-age populati 90 97 105 Low-income group
Male 87 97 112 -Lwicm ru
Female 93 97 98
KEY ECONOMIC RATIOS and LONG-TERM TRENDS
1975 1985 1994 1995
F
Economic ratios'GDP (billions US$) 5.1 0.7 1.3
Gross domestic investmenUGDP . 27.8 10.8 8 8 Openness of economy
Exports of goods and non-factor servicesi .. .. 39.5 23.7
Gross domestic savings/GDP .. 32.8 -29.1 -29.5
Gross national savings/GDP .. .. 11.7 -9.7
Current account balance/GDP (exct grant .. .. -35.5 -33.9 Savings Investment
Interest paymentslGOP .. .. 1.1 1.0
Total debt/GOP .. .. 30.7 28.9
Total debt service/exports .. .. 3.1 20.5
Present value of debtGDP .. .. 7.9
Present value of debt/exports .. .. 79.6 .. Indebtedness
1975-84 1985-95 1994 1995 1996-04
(average annual growth)
GDP -1.1 -11.4 5.4 6.9 6.3 -Armenia
GNP per capita .. -12.2 4.5 3.9 4.8 -Low-income group
Exports of goods and nfs .. .. 3.0 13.2 12.5
STRUCTURE of the ECONOMY
1975 1985 1994 1995 Growth rates of output and investment I% I
(% of GOP) s Agriculture .. 14.7 44.9 44.3
T
Industry 55.3 37.0 35 4 30t\ Manufacturing 25.9 24.9 ...29 9 Services .. 30.0 18.2 20.3 |4 9S Private consumption 117.7 116.4 .4446.4 -60General government consumption .. 20.8 11.5 13.1 -001 -oGDP
Imports of goods and non-factor services .. .. 79.5 61.9
(average annual growth) 1975-84 1985-95 1994 1995 Growth rates of exports and imports 1%)
Agriculture .. .. -12.0 5.1 40
Industry .. .. -20.0 1.9
Manufacturing .. .. .. 2.6 20
Services .. .. 70.5 19.1 20
Private consumption .. .. 8.8 18.0 i -.
General government consumption .. .. -13.3 35.3 o
Gross domestic investment .. .. 57.0 23.2 90 91 92 93 94 9S
Imports of goods and non-factor services .. .. 5.0 32.8
Gross national product .. -10.9 5.4 4.2 -Exports aImports
Armenia
PRICES and GOVERNMENT FINANCE
Domestic prices 1975 1985 1994 1995 Inflation I%)
(% change) l
Consumer prices .. .. 5,273A4 176.7 4D00
Implicit GDP deflator 0.4 -3.7 5,273.4 161.2
Government finance 2000 0
(% of GOP)
Current revenue (excl grants) .. .. 15 8 16.2 |
Current budget balance (excl grants) .. .. -18.5 -6.3 9
Overall surplus/deficit (exci grants) .. .. -28.3 -13 5 -GOP del. -CPI
TRADE
(millions US$) 1975 1985 1994 1995 Export and import levels (mill. USS)
(millions USS)
~~~~~~~~~~~~~~~~~~~~~~5,000
Total exports (fob) .. .. 209 271 T
n.a. .. . .40...
n.a. .
Manufactures . .. 119 112 3.000
Total imports (cit) 401 673 2,000
Food . .. 71 141 2,0T
Fuel and energy .. .. 160 209 1,000
Capital goods .. .. 43 72 o
Export price index (1987=100) . .. 91 92 93 94 95
Import price index (1987=100) . Exports 9:mpsrts
Terms of trade (1987=100) .. .. .. E.. __
BALANCE of PAYMENTS
1975 1985 1994 1995 Current account balance to GDP ratio 1%)
(millions USS) _________________
Exports of goods and non-factor services .. .. 257 304 89 90 91 92 93 94 95
Imports of goods and non-factor services .. .. 518 796 |
Resource balance .. , -261 -492
Net factor income . .. -7 -9
Net current transfers .. .. 36 65 I-20
t
Current account balance, j
before official transfers .. .. -231 -436 -30
Financing items (net) ., .. 238 465 I
Changes in net reserves .. .. -7 -29 40
Memo:
Reserves including gold (mill. US$) .. .. 32 107
Conversion rate (locallUSS) .. 8.14E-03 96.3 252.7
EXTERNAL DEBT and RESOURCE FLOWS
(millions US$) 1985 1993 1994 1995 Composition of total rebt, 1994 (mill. US$)
Total debt outstanding and disbursed .. 134 200 371 5
IBRD .. 1 2 5
IDA .. 0 5 94 B
94
Total debt service .. 2 8 63
IBRD 0 0 0
IDA ., 0 0 0
Composition of net resource flows E
Official grants .. 78 237 199 4
Official creditors .. 87 41 72 1
Private creditors .. 0 0 0
Foreign direct investment 0 3 19
Portfolio equity .. 0 0 0 \/ 69
World Bank program D
Commitments .. 12 28 149 A -IBRO 37 E -Bdarerat
Disbursements , 1 7 92 B - IDA 0 - Other multilateral F -PrNate
Principal repayments .. 0 0 0 c -IMF G-
Shot-Nel flows .. 1 7 92
Interest payments .. 0 0 1
Net transfers 1 7 91
Internalional Economics Department 91101996
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