Report No. PID10869

Project Name Yugoslavia, Fed. Rep. of-Export Finance (@) Facilitation

Region Europe and Central Asia Region

Sector Trade

Public Disclosure Authorized Project ID YUPE74484

Borrower(s) FEDERAL REPUBLIC OF YUGOSLAVIA

Implementing Agency Address SERBIA AND MONTENEGRO EXPORT CREDIT AGENCY Address: Mihajla Pupina 2, 11070 Belgrade Contact Person: Mr. Miroljub Labus, Deputy Prime Minister Tel: 381 11 311 4157 Fax: 381 11 311 2979

Environment Category F Public Disclosure Authorized Date PID Prepared June 17, 2002

Auth Appr/Negs Date April 8, 2002

Bank Approval Date July 18, 2002

1. Country and Sector Background 1. Enterprise Sector The Serbia's economy is dominated by unprofitable and inefficient state and socially owned enterprises characterized by a weak and highly politicized governance. Until recently, their operations had been strongly subsidized by the Government through the banking sector. Efforts to privatize state and socially owned enterprises have not been successful. However, with the assistance from the World Bank, the Public Disclosure Authorized Government has recently launched an ambitious enterprise privatization program. The first measure of this program is the adoption of a new privatization law which is expected to speed up the privatization process and ensure its transparency by facilitating the identification of the enterprise's owners, and eliminating the preferential treatment of the employees and managers in the sale of the enterprise. Serbia has established a privatization agency to implement the privatization program and only economically viable enterprises shall continue operations. Non marketable enterprises will be liquidated. The Government has also expressed its commitment in promoting and attracting foreign direct investment and supporting the creation and development of SMEs. A necessary measure to achieve these goals is business environment deregulation. With the assistance from the World Bank and FIAS, the Government has initiated a deregulation process aimed at stimulating economic growth by removing administrative barriers to businesses, Public Disclosure Authorized simplifying relevant legislation and procedures, and increasing their transparency. A decade of wars, years of isolation caused by economic sanctions, and lack of structural reform have severely damaged the Yugoslavia's economy. Today, in Serbia real GDP is only 40% of its level in 1989, and in Montenegro only 53% of its 1989 level. In 1990 exports from Serbia and Montenegro amounted to US$ 5.8 billion. Exports were dominated by non-ferrous metals, iron and steel, garment, road vehicles and machinery, while imports mainly consisted of oil and derivatives, raw textile, fibbers, textile products and road vehicles. Imports represented 78t of total exports. The main trading partners were represented by European countries (49%-), while developing countries and countries in transition accounted, respectively, for 33? and 10t of total exports. In 1990 the first twenty exporters accounted for 44.6%- of total exports. In 2000 exports amounted to only US$ 1.7 billion. Yugoslavia has switched from being a net exporter to being a net importer of food and energy. Over the past years, the balance of payments has been constantly in deficit. Yugoslavia's trade is spread fairly widely across a large number of countries, and unlike most other South East European economies its leading markets remain to the West rather than the East. In 1999, 20.3%- of total exports went to Bosnia-Herzegovina. 2. Heavily Indebted and Illiquid Banking SectorThe banking system consists of about 80 banks. The vast majority suffers from severe liquidity problems and losses. According to the central bank, (National Bank of Yugoslavia, NBY), uncovered losses in the banking system amount to DM 10.4 billions (about US$ 5 billions), equivalent to around 40%- of the country's GDP. There are few private banks which are solvent. However, their size is too small to respond to large companies' financial needs or support a significant number of SMEs on a sustainable basis. Public confidence in the banking system has been severely undermined by the freezing of large household foreign currency deposits for an amount of US$ 3.4 billion decided by the regime in 1992 to help fund the war effort and the collapse of a series of pyramid savings schemes in 1993. The result is a very low level of deposits which restricts the capacity of the banking system to sustain the enterprise sector's growth. In Serbia, collateral legislation and enforcement process do not contribute to a conducive environment in support of lending activity. In Serbia collateral enforcement is practically inefficient as it takes 5-7 years for banks to sell the collateral in the event of borrower default. Existing legislation heavily favors debtors over creditors, making the collection of bad loans very difficult. The Yugoslav authorities need to take urgent action to improve the collateral laws and the effectiveness of the judicial system to promote viable economic activity and growth. 3. Security and Political RisksThe high perception of the country's political risk may result in enterprises postponing/canceling their transactions in Yugoslavia. Political risk insurance required to address this perception is currently not available in the private market or from official agencies. It is expected that cover from the private market and official credit agencies would become available on a consistent and comprehensive basis in about two to three years unless adverse circumstances intervene. Experience in Bosnia and Herzegovina indicates that demand for political risk insurance under the facility provided by the local export credit agency is waning as official export credit agencies progressively come on cover. In meantime, the political risk insurance facility would serve as a temporary remedy pending private export credit agency's entrance into the market.

2. Objectives The main objective of the project is to support sustainable economic growth by catalyzing and facilitating trade transactions associated with productive activity in Yugoslavia. This would be achieved through the creation of the Serbia and Montenegro Export Credit Agency (SMECA) that will support both import and export activities. In particular, exports will be supported through the following facilities: Export credit

-2 - insurance;Working capital loans and guarantees; Exporter performance insurance; Medium term import insurance/guarantee supporting the import of machinery to be associated with export activity; andTechnical assistance to Yugoslavian exporting enterprises on marketing/match-making.Imports will be facilitated through:Political risk insurance; and Limited comprehensive import credit insurance. SMECA will also provide credit information on Yugoslav exporting enterprises and financial institution, thus supporting both import and export activities. The political risk insurance will attract foreign entities making investment or extending credit to entities in Yugoslavia by mitigating their perceived country risk. The import credit insurance combined with credit information will improve transparency of the Yugoslav banking and enterprise sector and facilitate the supply of essential inputs to Yugoslavian industry.The export support facilities will provide Yugoslav enterprises with security for their export income and assist allow them to expand their export activity thereby promoting growth and addressing the balance of payments deficit. The medium term import insurance/guarantee component would permit SMECA to support a Yugoslav exporter to acquire machinery on medium payment terms, not exceeding five years.

3. Rationale for Bank's Involvement The Bank's support adds value to : (i) the agency's good governance by the review and no objection process and assisting the staff in structuring each transaction; (ii) the agency's credibility in the market place in its difficult start-up period, by assisting the agency in creating and developing partnerships with both the local and foreign financial community; (iii) the agency's skill development, by assisting the agency in the acquisition and development of skills necessary to operate according to good practices.

4. Description The project will establish the Serbia and Montenegro Export Credit Agency to implement a wide range of facilities aimed at supporting import and export activities. Facilities facilitating imports comprise: (i) a political risk insurance facility supporting trade exposure of foreign entities in Yugoslavia, and (ii) limited comprehensive import credit insurance. Export support facilities comprise: (iii) working capital loans and guarantees (iv) export credit insurance, (v) exporter performance insurance, and (vi) medium term import insurance policies/guarantees. SMECA will also provide credit information on both Yugoslav and foreign banks and enterprises.

5. Financing Total ( US$m) BORROWER $0.50 IBRD IDA $11.50 ITALY, GOV. OF (EXCEPT FOR DEV. COOP. DEPT. - MOFA) $9.39 FOREIGN MULTILATERAL INSTITUTIONS (UNIDENTIFIED) $10.11 Total Project Cost $31.50

6. Implementation The project is designed to lead to the creation and development of the Serbia and Montenegro Export Credit Agency (SMECA) as a permanent and viable export credit agency that will, when appropriate in say 5 to 10

- 3- years, follow the same path as agencies in other emerging European countries such as Slovenia, and undertake a privatization process. The Government has set up SMECA to manage the project's facilities. SMECA has been created by Parliament legislation as a corporation fully owned -for the time being- by the State and operational in both Serbia and Montenegro. The law establishing SMECA was approved by the Federal Parliament on January 16, 2002.In order to encourage good governance and independent decision making within the agency, extensive use will be made of technical assistance and operations manuals. Under the project, assistance will be provided to develop the capacity of SMECA's staff to structure the transactions and assess the viability of the exporters and their proposed export contract through the provision of consultants. The World Bank will also require "no-objection" procedures as well as review the quality of the due diligence and decision making process for transactions involving significant liabilities, at least until the agency has demonstrated its viability.

7. Sustainability The project if successfully implemented will assist in the expansion of cross border trade. It will assist in the restoration of lost markets and the creation of new opportunities to expand exports. The thrust of the project is to provide opportunity and security for exporters; opportunity through facilitating working capital to perform contracts and assistance to identify new markets, and security through export credit insurance and technical assistance in documenting and perfecting export procedures. The project focuses on creating partnerships and links between foreign and local enterprises and financial institutions which will develop into a permanent source of financial assistance to Yugoslavian enterprises and viable local banks and will the hasten the process of integration of Yugoslavia into global trade finance markets.The project also has as its objective, the creation of SMECA as a permanent financial institution operating as Yugoslavia's export credit agency. The project design which emphasizes detailed operations manuals, high levels of technical assistance and no objection procedures will contribute significantly to achieving this objective.

8. Lessons learned from past operations in the country/sector The wide range of facilities included in the project and its design reflects lessons learned from other World Bank projects that are being implemented in other countries of the region such as Bosnia and Herzegovina and Albania. Experience gained in Bosnia and Herzegovina has shown that flexibility is necessary to be able to adapt instruments to the specific circumstances of exporters, changes in the country's banking/financial system, and the availability of financing/insurance from the foreign private market. In light of these lessons the project is designed to build in as much flexibility as possible in the use of the funds and give the implementing agency the instruments it needs to respond to diverse and changing needs of enterprises and local banks. The allocation of funds among the different types of facilities will be driven by market demand, thus optimizing the use of funds.

9. Program of Targeted Intervention (PTI) N

10. Environment Aspects (including any public consultation) Issues The Export Finance Facilitation Project is

- 4 - classified as a financial intermediary project and as such is not expected to have any adverse environmental impact. No major environmental issues are expected. The main environmental concern associated with this project is that working capital loans/guarantees, contract bonds or credit insurance could support import of environmentally hazardous inputs, the production and export of environmentally hazardous outputs, and environmentally hazardous activities. SMECA will conduct an environmental screening and review of the enterprise applying for SMECA's facilities in accordance with the rules and procedures spell out in the Environmental Section of the Operations Manual to verify that the enterprise meets the environmental requirements of appropriate national and local authorities as well as the Bank environmental requirements. During project preparation, an assessment of the capacity of SMECA for environmental screening and review was conducted. In order to develop SMECA's capacity to carry out environmental due diligence, SMECA's staff responsible for the environmental screening and review received training on the national and local environmental legislation and on the use of the Environmental Manual. This training activity was funded under a PHRD Grant. In addition, the project allocates funds to provide technical assistance to SMECA's staff responsible for appraising proposals to further strengthen their skills in the area of environmental screening and review, as necessary.

11. Contact Point:

Task Manager Lloyd Edgecombe The World Bank 1818 H Street, NW Washington D.C. 20433 Telephone: (202) 458 5982 Fax: (202) 522 3687

12. For information on other project related documents contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-5454 Fax: (202) 522-1500 Web: http:// www.worldbank.org/infoshop

Note: This is information on an evolving project. Certain components may not be necessarily included in the final project.

- 5 -