PROJECT INFORMATION DOCUMENT (PID) CONCEPT STAGE Report No.: AB7183 Project Name Partial Credit Guarantee (PCG) for the Croatian Bank for Reconstruction and Development (HBOR) Region EUROPE AND CENTRAL ASIA Sector ECSPF Project ID P133471 Borrower(s) Croatian Bank for Reconstruction and Development (HBOR) Implementing Agency Croatian Bank for Reconstruction and Development (HBOR) Environment Category [ ] A [ ] B [ ] C [ ] FI [ ] TBD (to be determined) Date PID Prepared 11/28/2012 Estimated Date of March 2012 Appraisal Authorization Estimated Date of Board May 2012 Approval 1. Key development issues and rationale for Bank involvement Protracted recession, volatile global capital market and weak investor sentiment are severely constraining financing options for Croatian exporters. The crisis has impacted investment financing and the availability of long-term sources of funding. The short-term maturities seen lately in corporate borrowing are inadequate to support growth-enhancing investments. Instability in the euro area is having a continued negative effect, exerting pressures on bank funding, constraining credit growth and fueling financial sector deleveraging. In the first eight months of 2012 alone, foreign owners of the banks reduced their exposure by 1.8 percent of GDP, thus reducing their share in financing sources from 20.5 percent in 2011 to 18.7 percent of total bank financing by August 2012. In the first half of 2012 there was a mere EUR 154.4mn of FDI, compared to the EUR 600-700mn in the same period of crisis 2010-11. Prior to the crisis, this type of financing was averaging EUR 1.3 Billion. Unfavorable domestic financing conditions are accompanied by a slowdown in external corporate financing, as foreign creditors are holding back on lending under the impact of uncertainty in global financial markets and pessimistic expectations. Global investors are growingly risk-averse, reflecting a generalized uncertainty about the outlook. The risk appetite for sovereign borrowers remains weak, whilst the interest in sub- sovereign borrowers such as HBOR is particularly weaker thus making it a challenge for it to raise funds. Yields for HBOR have remained well above pre-crisis levels and ability to borrow long term constrained. Moreover, yield differentials between sovereign Croatia and sub- sovereign HBOR have widened to near historical highs, despite the similar rating for each. The spread between the yields on most liquid bonds of 5 year maturity, for example, figures today at near 250bp. Markets are clearly differentiating across the credit spectrum and showing a discrete preference the most well-known investable and liquid instruments. In such an environment, a partially-secured type of financing structure could facilitate HBOR’s access to market funding at a longer tenor under more competitive terms. The proposed PCG operation would: (i) provide medium and long-term funding for exporters and FX earners for investments, (ii) provide incremental market access to HBOR; (iii) improve HBOR’s market borrowing terms; and (iv) leverage the Bank’s capital better than an investment loan. The funds would enable continuation of extending credit to exporters and foreign exchange earning enterprises (project beneficiaries) in an environment of constrained funding due to the impact of the eurozone crisis on the financial sector thus ensuring these companies remain competitive. Beyond the current turmoil, the PCG would help HBOR in preserving continued market access at reasonable terms and establishing its credit in the financial market as well as diversify HBOR’s funding sources. The latter is particularly important, as HBOR’s funding strategy envisages a gradual shift from borrowing with official assistance to market based funding. 2. Proposed objective(s) The main PDO is tosupport exporters and foreign exchange earners in Croatia by enhancing HBOR’s capacity to mobilize medium and long term financing.. 3. Preliminary description The design of the project underlying the proposed IBRD guarantee is driven by the unmet demand for medium and long-term funding adequate to support growth-enhancing investments and HBOR’s debt management objectives. The proposed project would provide a Bank PCG to enable HBOR to raise funds from the international loan or bond markets. A PCG is a partial credit guarantee provided by the World Bank to commercial banks for who provide financing to HBOR. As a result of this coverage HBOR will be able to get at improved terms from what would be possible by HBOR on its own creditworthiness under market conditions. HBOR is rated by Moody's (Baa3) and Standard & Poor's (BBB-). The structure should allow HBOR as borrower to secure the much-needed financing at reasonable costs, while also minimizing transaction risk in a climate of volatility. In addition, the targeted volume of Euro 250-300 million is matched against HBOR’s ability to support project beneficiaries quickly and efficiently, in order to minimize any potential negative carry costs, associated with disbursing the funding early and paying interest while returns are marginal as project lending is organized. 4. Safeguard policies that might apply Safeguard requirements: Under the Bank’s gurantee policies investments carried out by the final beneficiaries would need to comply with the same Bank safeguard requirements as normal FILs. Goods and works on the World Bank's negative list will not be eligible for financing. Given that HBOR has extensive experience with the Bank’s requirements and that Croatia has advanced standards the compliance with these requirements should be standard procedure. 5. Tentative financing Source: (Euro. m.) Commercial banks 250/300 IBRD Partial Credit Guarantee [•] Total 250/300 6. Contact point Contact: Isfandyar Zaman Khan Title: Sr Financial Sector Spec. Tel: (202) 458-7688 Fax: (202) 614-7688 Email: ikhan2@worldbank.org