Viewpoint The World Bank December 1995 Note No. 64 A Pre-export Guarantee Facility in Moldova Mitigating political risk in transition Onno Rahl and Moldovan firms wanting to export face severe Moldova asked the World Bank to help design Alfred Watkins financing constraints. The local banking sys- a pre-export guarantee facility, but with the tem has neither the capital base nor the techni- proviso that the facility should not require the cal capacity to finance their working capital government to assume commercial risks. Un- requirements. And export credit agencies ei- der this facility, which became operational on ther are not willing to provide cover or, if they October 30, 1995, the Moldovan government are, require a full government counterguaran- guarantees financiers against political risk, and tee covering both commercial and political risks. the World Bank provides a backstop guaran- Thus, to enable viable local firms to attract pri- tee of the government's claim payment obliga- vate working capital, the government of tions. A similar approach could be used in other transition economies, where firms face much the same constraints. This Note briefly describes the development THEPOIICALRISKS)OFPRE-4PRT FNANCE of the facility and offers suggestions for de- signing a "line of guarantee" modeled on it as A We~tcnihahasiB-einEvmpeannetad-nw kw U ougasaReng - a way to help attract private finance for a rela- fruts and vege asto buyers inRssia andKeazltan woukld fke tively large number of small projects. t: atad sellng hem Moldbman canned fuils and Kegkhsta risk s Catering to risks and opportunities -iocriiasafe prf There is n*a0paitd"tVdIffi)roan beftwe -t:WeseurnEwpeandlMoldovanproim.TheMoldovancam;nin Although local and international banks are fact -ssuffiient excess capacity tm meettbe anicipated unwilling to provide pre-export finance to demnad. bout needsto inprove its labeJing and canning equipment Moldovan enterprises, many foreign trading tlW~esferllEqllaittslant lary s. - - companies and input suppliers have indicated that they would be willing to bear the com- mercial risk of supplying inputs on credit. But .Thetrmg ayiswi hingtoproYidethWeemoenttbefactry . these nonbank financiers need assurance that -needstoupgrade Ald ishe the mpayonsplyads y eIlisled the Moldovan government would not impose commerci.. omiationslpswit ssiandlKazalilbuVmes,tiis retroactive changes in rules and regulations that wihgin toaccept theplcatand co riassoka ntedwitb would prevent their being paid. Discussions - - selli~agihefeinerSovietstates.Buttheperceivedgov with a wide range of input suppliers, trading * - peimnskipiodaXga4Mol as companies, and commercial lenders suggested that an effective program to mitigate political *,e~~doeq -detlt_fr mXu grE erisk could do much to boost private finance foreclosing a potetl newexpoetopportnty forthe c . for commercially viable pre-export transactions. Political risk coverage would also encourage many trading companies and input suppliers Financial Sector Development Department . Vice Presidency for Finance and Private Sector Development A Pre-export Guarantee Facility in Moldova not now active in Moldova to look into the to have sufficient credibility in the private fi- possibility of doing business there. nancial community. Finally, the design had to be flexible enough to accommodate the diverse These factors defined the basic design issues. pre-export financing structures expected to First, the noncommercial risks inhibiting the emerge in Moldova in the short to medium term. private sector from financing viable pre-export transactions in Moldova had to be identified and The facility is designed to be an instrument of mitigated. Second, the risk coverage, risk defi- transition. Its potential catalytic effect would nitions, and claim adjudication procedures had be especially strong during the early stages of the economic transition, when political and economic uncertainty is greatest and the gov- ernment's commitment to trade liberalization FIGURE1 STRUCTUREOFTHEMOLDOVANPRE-EXPORT and private initiative relatively untested. It is GUARANTEE FACILITY during this period that a favorable enabling environment-in the form of a liberalized trade Counter- and foreign exchange regime-may not suf- guarantee fice to assuage the concerns of private lend- ers. The reason is not that the proposed policy U,- ~ ~~~~~~~~~~~~~environment is "wrong," but that potential lend- ers are not confident that the new, more lib- eral rules and regulations will survive the underlying input supply transaction. Once these Access to rules and regulations have achieved some trac- loan facility, Righttosell tion, investor perceptions of political risk will umbrella guarantees diminish, and the guarantee facility can give way to more mainstream financing techniques. Confilmation of approval The architecture The pre-export guarantee facility was designed -U,. to work in the following way: - A foreign trading company, input supply Confirmation company, or commercial bank would agree of funds to finance working capital inputs for a Moldovan enterprise. The local firm would Letter of credit Guarantee repay the working capital advance with a portion of the revenues from exporting the resulting outputs. To ensure repayment, in- put suppliers would act as a marketing agent for the Moldovan enterprise, arranging for the sale of the output to a creditworthy buyer l0 l l l l l l |outside Moldova. In this way, input suppli- ers would also help Moldovan enterprises de- velop new markets and restore old markets ruptured by the breakup of the Soviet Union. - A government-owned guarantee administra- tion unit would sell political risk coverage on a first-come, first-served basis to any for- eign creditor willing to bear the commercial risk of financing a pre-export transaction in World Bank contingent loan facility was de- Moldova. signed to backstop the government's claim A framework guarantee contract outlining the payment obligations on up to US$30 million of terms and conditions of the political risk guar- outstanding guarantees. The facility works as antees would protect the holders against follows: An agent bank employed by the guar- losses arising from retroactive government antee administration unit issues standby letters interference with a guaranteed pre-export of credit to accompany each guarantee con- transaction. The contract would cover such tract sold by the unit. If a claim must be paid risks as currency inconvertibility or inability and the government does not remit funds to to transfer foreign exchange out of Moldova, the agent bank by the payment deadline, the government seizure of inputs or outputs, gov- agent bank can draw funds from the World emnment expropriation of the local enterprise, Bank loan facility, to which it has irrevocable the retroactive revocation of import or ex- access. Under the terms of the World Bank fa- port permits, the retroactive imposition of cility, funds used to pay claims on guarantees other import or export restrictions, and po- would be permanently deducted from the fa- liticalforce majeure related to war and civil cility, reducing the amount of future govern- disturbance on the territory of Moldova. All ment guarantees that could be issued with but the last risk are entirely within the con- World Bank support. trol of the government, which simply has to refrain from retroactive interference with a The World Bank facility is available for back- transaction to avoid liability. Thus, the gov- stopping new guarantees for five years. Thus, ernment accepts responsibility only for risks the guarantee unit could potentially support at least partly within its control. It bears no US$150 million of pre-export transactions, as- financial responsibility for any of the com- suming that the average length of each trans- mercial risks typically associated with pre- action is one year and that the unit's guarantee export transactions, such as an unexpected issuance capacity is fully utilized. Guarantees decline in world market price, the failure of issued during the five-year period would re- the local enterprise to deliver goods of main valid for the remaining life of the private acceptable quantity or quality, or the failure transaction, which could be up to three years. of the foreign buyer to fulfill the purchase contract. Using the design in similar Bank Under the terms of the framework guarantee operations contract, the government would pay only for damages caused by government actions or Other transition economies also face problems inactions specified in the contract. The guar- in financing private firms' pre-export transac- antee holder would be required to notify the tions. For these countries, it would be relatively guarantee administration unit thirty days be- straightforward to develop a pre-export guar- fore filing a claim. During this thirty-day antee facility similar to Moldova's, adapting it "cure" period, the government would have as needed. Preparation would be relatively an opportunitv to correct the actions that trig- quick, since a generic framework guarantee gered the potential claim. If the problem is contract and an operating manual for a guar- corrected, no claim would be filed and no antee administration unit already exist and payment made to the guarantee holder. would require only minor modification. Efforts to develop such facilities are under way in The World Bank's role Ukraine, Russia, and possibly Armenia. Because political risk guarantees issued by the To be feasible, such a facility requires a rela- government of Moldova do not yet have suffi- tively open trade and foreign exchange regime, cient credibility in international markets, a to give the private sector confidence that there 1t1 A Pre-export Guarantee Facility in Moldova The Note serieS is an en co ur a ge d is se mimna- best practices for sector. The views published are those of the authors and should not be attribLuted to the is scope for viable pre-export transactions. relatively small private municipal inftastructure World Bank or any of its World Bank support would help assure the pri- investments or small hydropower investments. affiliated organizations. Nor do any of the con- vate participants in pre-export transactions that In either case, a government unit would sell a clusions represent the relatively open regime will remain in place World Bank-backed guarantee contract cover- official policy of the for at least the life of a transaction. ing the discrete government compliance risks- Torde n Note seie itsan.y -4f Executive Directors but none of the commrcial risks-associated or the countries they Using the "delivery mechanism' with private investment in the sector. represent. for capital investment Comments are welcome. or infrastructure projects Onno Rahl, Country Deparment IV, Europe Please call the FPD and Central Asia Region, and Asured Watkins, Not be attoriueadvte a While Moldovabs guarantee facility is designed relativ al prte muncpal intructure Worldsank or2-581 any of itTol akspotwudhl suetepi nestmntsa orpasmall hydropoer investmentAs.a or contact Suzanne to support pre-export transactions, the general and Middle East and North Africa Regions Smith, editor, Room approach could also be used to deliver a gov- G8105, The World Bank, ernment iline of guarantee" with World Bank x cHutiv D itrect backstop for a large number of relatively small or Internet address projects. For example, a framework guarantee osmith7eworldbank.oru. contract could be developed to promote fixed ePrinted on recycled capital investments in small or medium-scale paper. enterprises, or to support a large number of