Not only is war-torn Kosovo faring better, but the EBRD seems to have recaptured some of its initial promise.
By James Drake
April 2001
Institutional Investor Magazine
Not only is war-torn Kosovo faring better, but the EBRD seems to have recaptured some of its initial promise. What's it doing differently?
Since its founding in 1990, the European Bank for Reconstruction and Development has earned a reputation as an irresponsible spender. Its first president, flamboyant French economist Jacques Attali, was forced out in 1993 after he plunked down more than $300 million , nearly twice what he had lent to member countries , on sumptuous London headquarters complete with motion-sensitive lighting, Carrara marble and white leather boardroom chairs. Then, in late 1995, the EBRD loaned $100 million to KamAZ, Russia's third-largest auto company, so it could revamp its manufacturing operations. Three years later KamAZ defaulted on the debt, and the bank and carmaker spent two years trying to figure out how much was owed; in January they agreed to a compromise $70 million repayment plan stretched over the next decade.
Attali is long gone (though not forgotten: He was arrested and held overnight by French authorities last month as part of a probe into illegal arms sales). His legacy, however, lingers. To critics, the development agency dreamed up by the European Union has never met its ambitious original brief: to provide Central and Eastern Europe's small and medium-size businesses with capital, to help build durable financial institutions and to create basic infrastructure for fledgling democracies trying to develop free-market economies. One factor that may have contributed to this failure, critics say, is the fact that the EBRD was supposed to accomplish these aims while simultaneously making a profit, improving the environment and steering clear of industries like tobacco.
Such conflicting goals prompted the development bank to sink money into large industries with close or direct ties to governments, where it felt confident of returns. But, as in the case of KamAZ, its judgment was often flawed. And when it invested wisely, the EBRD drew criticism for retaining its stake for too long. For instance, it still has a 7.5 percent holding in Ceskoslovenská obchodní banka, the Czech Republic's largest bank , even though Belgium's Kredietenbank (now known as KBC Bancassurance Holding), which has a big presence in Central Europe, bought a majority stake from the Czech government 18 months ago. By retaining profitable investments like CSOB, opponents say, the EBRD has created a long-term equity portfolio with holdings in valuable companies stretching from Prague to Vladivostok when it should have sold its positions once these firms were privatized.
The EBRD is "supposed to serve as a source of capital for small businesses where none would otherwise exist, but I can't say they have lived up to that," says Tomás Jezek, the former Czech privatization minister and chairman of the Prague Stock Exchange. "They have usually invested in big, old-fashioned industries, or in infrastructure projects that are the natural target of strategic investors. They only seem to touch small and medium projects if they are risk-free . . . and then, if those businesses are successful, they don't exit as they are supposed to, but stay on."
Critics like Jezek would do well to visit Kosovo, where the EBRD is struggling to fulfill its original promise as it helps to rebuild a war-ravaged province. Since it entered Kosovo (and where it still has only two full-time staffers), the EBRD has opened a successful microlending bank that caters to individual and small-business accounts. Its venture capital operation is reviewing as many as 80 small enterprises for investment, with the stated intention of exiting them within three to five years. Although the EBRD hasn't yet engaged in any huge infrastructure projects, it has begun to put together a long-term proposal to deal with the area's massive telecommunications problems. The agency , among the first multilaterals to arrive in Kosovo after the NATO bombing ended in June 1999 , has established itself as the primary financial institution for a very receptive and hardworking local population used to paying its own bills. What makes its achievements all the more remarkable is that the development agency has done all this even though , or possibly because , it hasn't been able to invest directly in Kosovo. When the EBRD first arrived in the province, its board decided it shouldn't use its own money because Kosovo, governed by the United Nations, was not an EBRD member, and neither was Yugoslavia (Yugoslavia became a member in January). As a result, the EBRD has had to be creative in finding outside investors to participate.
Critics are starting to take notice. "The EBRD in Kosovo isn't so much reinventing itself as going back to what it was supposed to be doing in the first place," says Sam Vaknin, general manager of Capital Markets Institute, a consulting firm that advises several Central and Eastern European governments. "It's about time."
Kosovo, too, is enjoying a renaissance of sorts , albeit from a grim starting point. With the removal of Yugoslavian president Slobodan Milosevic and the election of Vojislav Kostunica, Serbian goods are again starting to flow across the border. Recent elections of moderates to key political posts in Kosovo should further improve the chances of an economic revival. Streets in Pristina are full of people hawking goods, and employment is now higher than it was before the war. According to one recent U.N. count, 70 percent of Kosovo's small businesses are operating again.
To be sure, recent talk of an "economic miracle" in one of Europe's most impoverished lands , where fighting again broke out last month, this time along the border with Macedonia , is premature. Although the U.N., the EU and some 300 humanitarian associations are providing thousands of jobs for Kosovars, those organizations will one day depart. Translators, drivers, receptionists, security guards and clerks all earn above-market wages from these groups. Michael Luhan, project manager for Czech charity People in Need, which is rebuilding war-damaged houses, compares the situation to that in Saigon in the 1960s and '70s, at the height of the U.S. military presence there. "A toilet cleaner at UNMIK [U.N. Mission in Kosovo] earns twice as much as a doctor at a public hospital," Luhan says. "There are no English teachers in the schools, because they are all working as interpreters for ten times the wage they'd command in the state sector."
When the EBRD rolled into the capital, Pristina, after the cessation of NATO's bombing campaign against Yugoslavia, the U.N. offered a decrepit downtown villa as the site for the bank's first project, the Micro Enterprise Bank of Kosovo. No Carrara marble there. "There was a hole in the wall where a bomb had hit, and there was dirt everywhere. My first job was to roll up my sleeves and assemble our Ikea furniture myself," says the bank's 30-year-old general manager, Koen Wasmus, a bespectacled, boyish-looking Dutchman who spent more than three years in Uganda advising a local bank on small and micro-credits. Following a quick and inexpensive renovation (the door frames still don't quite fit), the bank was ready for business.
Outside the hastily refashioned bank facade, the devastation of the war is much more evident. Around Pristina many roads remain pockmarked by the NATO bombings, and most parts of Kosovo are periodically without electricity , sometimes for weeks on end. Garbage collection is sporadic. Farmlands remain littered with land mines and unexploded ordnance, devastating for a country where agriculture counted for 50 percent of prewar employment. The flour mills and food-processing factories, most of which once belonged to the Yugoslav state and were run by Serbs, lie empty. In some cases, the NATO bombs rendered them inoperable; more often, the lack of a legal system makes ownership impossible to certify.
Because Yugoslavian law no longer applies, the U.N. administration is formulating a replacement code. In the meantime, Kosovo is in a state of legal limbo. Traditional forms of collateral don't exist. Land and property carry no clear titles of ownership. There are no trademark or copyright laws. And the decade of economic apartheid that Milosevic imposed on the ethnic Albanian majority means that most of the EBRD's customers have no credit history. The Yugoslavian system of "social ownership," whereby workers held a nominal equity stake in their employers' businesses, has further confused things. "Try telling a Western businessman to invest in a business whose ownership is unclear, where there is no commercial law and where he has no recourse if he falls out with his partners," muses Agron Dida, an economist with the Banking and Payments Authority of Kosovo, the makeshift central bank fashioned by the U.N. "The only way [to revive the local economy] has been to start from scratch and improvise."
In this void the EBRD has chosen to focus on the basics. The agency's first priority was to establish MEB Kosovo. "When the NATO bombing campaign stopped, the Yugoslav banks all closed down," says Giulio Moreno, the energetic 42-year-old Italian who is EBRD chief for Kosovo and neighboring Albania. "So it was obvious that the first thing returning Kosovar refugees needed was a place to stash their cash to start businesses. Otherwise society couldn't have functioned."
MEB Kosovo opened in January 2000 with $2.3 million from such donors as the German government, Commerzbank, the Netherlands Development Finance Co. (a Dutch banking agency focused on promoting private enterprise in the emerging markets), Bosnia's Micro Enterprise Bank , itself backed by the EBRD , and the World Bank's International Finance Corp. MEB, managed by a German consulting company, Internationale Project Consult, with microfinance experience, serves as a retail bank for individual customers and a lender to small enterprises. Demand for its services has been so strong (it now has nearly 30,000 customers) that the bank broke even after just four months.
To date, MEB and its four outlying branches have disbursed some Dm8 million ($3.7 million) through 850 loans that range in size from $350 to $35,000 and have funded everything from newspaper kiosks to bottling factories and even a popular rock band, TNT, whose equipment had been carted off by retreating Serbs. Every evening long lines of local entrepreneurs stretch around the block, guarded by U.N. peacekeepers, waiting to bank their day's take. On Fridays old men in traditional white felt fezzes, who once labored abroad in countries like Turkey and Germany to survive, queue up for their EU pensions. The bank also caters to another group , the U.N. peacekeepers. "The only alternative is keeping my money under the bed," says one American soldier.
Lending money in an impoverished province with no legal system simplifies the relationship between banker and borrower: MEB makes loans only on collateral it can drive off or carry away. The emphasis, says Wasmus, is on "repayment capacity and repayment willingness. Our loan officers are trained in interviewing techniques to draw out that information." The officers' approach can be very direct and simple. "They came and visited my house, ticking off all the things that they could carry away if they needed to," reports Pristina businessman Enver Gashi, whose retail business owes its existence to an MEB start-up loan. "In the end, they settled for the deed to my car."
Remarkably, no one has yet defaulted on a loan. Wasmus says the Kosovars' excellent repayment record is a good thing: "It's debatable whether we would have much recourse if they did default, because of the wild and woolly legal structure here."
Working side-by-side with the MEB is AREF-Kosova, a venture capital company financed by the Italian government but controlled by the EBRD. The company, which began operations with initial capital of E5 million ($4.5 million) shortly after the bank opened, is an offshoot of the Albania Reconstruction Equity Fund, which was established in that country in 1998. Day-to-day management is handled by Economisti Associati, an Italian consulting firm based in Bologna that won the assignment through an open bidding process. All business proposals are evaluated by its staff and then submitted to an investment committee that meets regularly in Pristina.
AREF is evaluating nearly 80 investments , in everything from wood processing and furniture manufacturing to plastics, agriculture and wine production. The disbursements, usually minority equity positions of 35 to 40 percent, can range from E50,000 to E500,000. The idea is to sell them back to the founding entrepreneurs or another entity within three to five years. AREF expects to invest E3 million by the end of this year in enterprises that are unquestionably small.
The bank and the venture capital operation are more interested in the soundness of a business plan than an enterprise's outward appearances. "Some of these businesses might not pass muster in countries with more robust regulatory environments," concedes one EBRD representative. "But the important thing is, these businesses are both profitable and legit. We teach corporate governance in the companies we're involved in; we force them to pay taxes and do proper paperwork."
Because of Kosovo's unusual legal status, Moreno has had to patch together a network of bilateral donors and investors, some of them EBRD-supported entities outside Kosovo, to fund his projects. These "backers are very particular about seeing where their money goes," says Meni Styliadou, a Greek lawyer specializing in telecommunications issues who serves as EBRD's legal counsel on Kosovo. The increased scrutiny means money isn't doled out as easily, and repayment is clearly demanded at the outset. "That's got to be a good thing, no?" adds Styliadou.
The tightened terms and commercial aspect of the EBRD's Kosovo project have allowed the bank to sidestep many of the social and political problems that have ensnared it and other multilaterals in the past. "What we saw in Bosnia is that reconstruction funds were based on 'joint use.' For example, agencies would only okay the reconstruction of a hospital in a formerly Muslim-Croat area if it was to be used by both sides," says People in Need's Luhan, a Balkan aid veteran. The problem with that approach, he notes, is that "neither side could bear to be in the same building as the other, so either it never got built or it did get built but nobody wanted to use it." The EBRD's programs in Kosovo, with their commercial emphasis, don't face those problems. So long as a businessman's plan meets the EBRD's financial and environmental guidelines, "we loan him the money," says Styliadou.
Much less far along is the rebuilding of infrastructure. The EBRD is devoting most of its attention to telecommunications, which were virtually wiped out in the war. Even before the NATO bombing, there were only 50,000 phone lines for 1.7 million people , less than half the number per capita boasted by neighboring Macedonia. Bringing Kosovo into any sort of parity with EU averages will take two decades or more, estimates Moreno, who notes that Poland and Hungary, following a decade of building, are only now starting to approach European norms.
As a first step, Moreno this summer begins hosting meetings with telecom companies from neighboring countries on ways to supplement the current fixed-line and GSM monopolies now controlled by the U.N. administration. "We'd like to see a Bulgarian, say, or Greek telecom come in and capitalize on the increase in cross-border traffic," says Moreno. "But Kosovo is a risky place to invest, and that could put investors off. That is where our role comes in. We provide finance, but we are also designed to mitigate some of the political risk. We are providing a partnership with strategic investors: to supplement and encourage , but not replace , free-market forces." Any major telecom project, however, will have to await the clarification of legal property rights.
This regional approach to the telecommunications project exemplifies an institutionwide change begun in recent years. Under Atalli, the EBRD was split between a development banking wing, designed to lend to the public sector, and a merchant banking wing, which focused on the private sector. Atalli's successor, Jacques de Larosire, former head of the International Monetary Fund and the Bank of France, replaced this structure with a more decentralized, country-centered operation. Today, under Jean Lemierre, who has pushed economic reform, cooperation among multilaterals and local institution-building, the EBRD has 26 resident offices, one for each member country (a branch will open this month in Belgrade for the newest member, Yugoslavia).
Both the EBRD and other EU-sponsored groups have recognized the need for a broad-based approach to these projects. In late 1999 the EBRD set up the South-East European Regional Action Plan to tackle projects that affect all of the Balkans, where the EBRD, with commitments of more than E3 billion, is now the largest investor. "To help, you have to ignore borders. Ideally, we'd eventually be looking at something resembling the early European Union , a free-trade zone," says Dominique Larsimont, a spokeswoman for the European Agency for Reconstruction, the EU unit in charge of postwar rebuilding in Kosovo; the agency coordinates and cooperates with the EBRD on regional strategy. "In the meantime, it makes more sense to plan a major highway, or an electricity grid that stretches from the border of Hungary all the way to the Adriatic, because that's how you cement trade relationships" among various countries and provinces.
As Moreno concedes, much of the shift in approach is a result of the realization five years ago that meaningful change and reconstruction require more time than the EBRD originally envisioned. "The transition in places like this [Kosovo] will take much longer, a generation at least," he notes.
This longer-term, regional approach has led to initiatives such as the Regional Trade Facilitation Program, which offers guarantees to approved local banks to support their trade activities. "The EBRD recognizes that trade in a high-risk environment is often blocked by the high cost or unwillingness of foreign banks to accept exposures on local banks. So it guarantees the financing provided by local banks, permitting these banks' clients to import or export using standard trade-credit mechanisms, rather than paying cash up front," says Moreno. Facilitating trade across the Balkans may ultimately help tie the region together. The EBRD has now signed up 12 local banks in the Balkans, with total approved limits of $55 million.
In part, these changes at the EBRD and other development banks were prompted by growing unease in Western government circles about the way taxpayers' money was being disbursed. Last year, for example, Alia Izetbegovic«, the recently retired president of Bosnia and Herzegovina, had to answer questions, raised in World Bank and U.S. State Department memos leaked to the press, about the whereabouts of $1 billion in aid to his country. He denied any knowledge of wrongdoing. At about the same time, a report by a committee of the U.S. House of Representatives found that the World Bank, which employs 17,000 people in 170 countries and each year hands out $50 billion in loans, has an astonishing 55 to 60 percent failure rate among projects it funds. The report spoke witheringly of "too much energy devoted to making loans, rather than following through." The World Bank concedes that it has learned some lessons. "I'd say we do now understand better than we did before the importance of institution-building before we start disbursing funds," says Giuseppe Zampaglione, the World Bank's representative in Pristina.
These criticisms have prompted all the multilateral agencies to reexamine how they recover their funds. One conclusion they reached was to link repayment more closely to basic human instincts rather than to larger social objectives. "The profit motive is more effective than Western know-it-alls telling the natives not to go around [doing] ethnic cleansing," explains Wojtek Mlodziejewski, the U.N.'s enterprise development director in Pristina. "The reasoning was that if people had the chance to make money, then that could overcome even the most visceral hatreds." As a result, in the Balkans during the past few years, the EBRD has focused more on microlending programs, in which individuals and small businesses actively participate, than on huge infrastructure projects. Among the more common refrains heard from EBRD officials in Kosovo: "Commercial solutions to social problems."
The EBRD's new hard-nosed commercial ethic may have found a perfect audience in Kosovo, where many people are used to eking out a meager living, sometimes by working in a foreign country for months at a time and sending their earnings back home to support their families.
"They understand business, they know how it works, and they'll sell to anyone," says Wasmus, who is looking to take the EBRD's mercantilist approach a step further. One of his new bank branches will be located in Mitrovica, a divided city where Serbian and Albanian communities are separated by a rubble-strewn strip of no-man's land policed by British peacekeepers in tanks. MEB has acquired land in the neutral zone and hopes to build an office there next year. Separate teams of Kosovar and Serbian loan officers , likely working in different parts of the building , will conduct business with their own communities. "My staff aren't happy about it, but I tell them business is business," shrugs Wasmus.
The Kosovars seem to get the message. And ultimately, says Moreno, it is their own money and drive, not aid from Western taxpayers, that will have to see them through. "They're used to taking responsibility for their own lives, paying taxes, working hard to better themselves," he reflects. "You don't see groups of men sitting around on their asses waiting for handouts , they're all too busy making money. I've never seen anything like it. I'd say there's hope for this place yet."
And, increasingly, hope for the ERBD, too.
