VIII: TRADE AND INVESTMENT FINANCING Brief Description of Banking System The Russian commercial banking system in Russia is only five years old, but rapid progress has been made in its development in the last two to three years. The 20-30 of the largest banks are approaching western standards, offering a full range of services. About one-third of the banks in Russia derive from the old state banking system, while the rest were newly created, most as late as 1991. Many of the 2,000 registered commercial banks are small -- only 10 percent has a capital base exceeding $1 million. Many banks were founded in 1991-92 by enterprises as an expedient way to draw directed central bank credits and still have the enterprise or person which founded them as main depositor and borrower. Nearly 300 Russian banks are authorized to deal with foreign currency accounts, and close to 150 of these banks have general licenses allowing them to conduct an entire range of banking transactions with foreign currency in both domestic and foreign markets. Foreign exchange operations account for a large part of the business of these banks. The official Central Bank payments, settlements and clearance system is still in the process of development, with delays occasionally up to one month to clear transactions even when both banks are in Moscow. The private sector, however, has moved ahead to develop its own private payments and settlements mechanisms, which can clear transactions within a few days. Cross-border, international financial transactions are now feasible as well. Sixty Russian banks are member of the Society for Worldwide Interbank Financial Telecommunication (SWIFT), and others have correspondent relationships with U.S. and other foreign banks that allow for electronic fund transfers between Russia and other countries. In October 1993, Citibank and Chase Manhattan Bank became the first U.S. banks to receive a general license to open a subsidiary in Russia. While there are now 12 Western banks with operating licenses, only a handful, including Credit Lyonnais (St. Petersburg), BNP/Dresdner (St. Petersburg), and Bank of Austria (Moscow) are operational. A two-year moratorium on foreign banks restricts newly-licensed subsidiaries, as well as already licensed subsidiaries that had not started serving resident clients as of November 15, 1993, to serving nonresidents only. An exception is made for those countries which have an investment agreement in force with Russia. Currency inconvertibility, which used to be a major concern for Western traders and investors, has largely been overcome by the opening of a number of currency exchanges and direct interbank trading throughout Russia. The largest of these is the Moscow Interbank Currency Exchange (MICEX), which holds five trading sessions a week. The recent introduction of a Moscow City turnover tax on MICEX operations has driven at least one-third of MICEX business, primarily to the over-the- counter currency market. U.S. companies are reporting that currency convertibility can be easily arranged through commercial banks in Russia. Nonresidents, including foreign individuals and foreign companies that do not have a local subsidiary or joint venture, can open foreign currency accounts with authorized banks in Russia. Funds in these accounts can be transferred abroad without restriction or exchanged for rubles on the Moscow Interbank Currency Exchange (MICEX) or through interbank mechanisms. Foreign currency held in these accounts may be obtained from various sources, including resources transferred from abroad; payments from residents and non- residents for goods and services sold in Russia; repayment of liabilities to account holder; interest paid by authorized banks; return on investment on Russian territory; and income from other nonresident accounts with authorized banks. In a new development, nonresidents can also now open ruble accounts for maintenance of domestic operations and servicing of export-import activities and for investment activities, including purchasing of privatization vouchers or shares of stock. The two main Russian Government banks involved in trade and investment issues are Vneshekonombank (VEB) and the Bank for Foreign Trade (Vneshtorgbank, or VTB). Their roles and functions break down roughly in the following way. VEB's primary function is to service the foreign debt of the former Soviet Union and to act as an agent of the Russian government in international banking. VTB is also an agent of the Russian government, but has commercial functions as well. It is also involved in collection and holding of Russian foreign exchange, a duty it shares with VEB. VTB officials have indicated that VTB is the agent of the Russian Government for drawing foreign credits for fulfillment of investment projects. Foreign Exchange Controls Affecting Trade In the fall of 1993, the Russian Central Bank issued regulations that went into effect on January 1, 1994 banning the use of hard currency in cash transactions. Under these regulations, businesses in Russia are no longer permitted to accept cash payments in dollars or other hard currency, a practice which had become widespread in major cities as consumers and storekeepers sought the convenience and security offered by a more stable and trusted currency. Non-cash transactions (e.g. credit and debit cards and checks) are not affected by the new regulations, so establishments that previously accepted payment via credit cards can continue to do so. Stores that sell imported goods are still allowed to mark prices in dollars. At the time of purchase clerks convert the dollar price into rubles. Through the exchange rate they employ, merchants pass on the additional costs they will incur when they convert the rubles back into hard currency to restock inventories. Russian resident entities are still required to convert 50 percent of their foreign-currency revenues from exports of goods and services. Russian entities with more than 30 percent foreign ownership are able to sell the entire 50 percent that is subject to mandatory conversion at whatever market rate can be negotiated with an authorized bank, while other entities must sell 30 percent of the 50 percent to the Central Bank at the Bank's official market rate. There has long been discussion in Russian government circles of increasing the mandatory exchange obligation from 50 to 100 percent to further strengthen the ruble, but no such measures have been enacted. The Moscow City Government enacted a 0.1 percent tax on all foreign exchange transactions on the Moscow Interbank Currency Exchange (MICEX) effective March 1, 1994. The result has been that a number of banks have shifted their exchange activity off MICEX to over-the-counter trading operations. The Central Bank is opposed to the tax on efficiency grounds. The Central Bank now intervenes more on the OTC market, a less transparent process. In an effort to limit the outflow of capital, reported to be $10-$12 billion in 1993, the Central Bank introduced a computerized export control system to monitor the flow of goods out of the country and the flow of hard currency back in. The new system, which unites for the first time banking and export controls, requires exporters to obtain a special "passport" from a commercial bank, which enters the trade in a computer database. Customs agents register the actual export of the goods in the database and the commercial bank completes the cycle by entering receipt of the payment. Strategic exports, including energy and several types of metals, were subject to the new regime as of January 1, 1994. The system took effect for all other types of goods on March 1, 1994. Availability of Financing The financing environment in Russia remains difficult as the economy continues to experience great difficulties, and the Russian government and banking system are able to provide little trade and investment financing either to Russian companies or foreign firms. However, a number of new bilateral and multilateral financing programs, outlined below, have opened up for Russia which could provide more opportunities for traders and investors. How to Finance Exports/Methods of Payment The fact that the Russian Government has been unable to date to resolve the issue of outstanding commercial arrears to western companies continues to have a negative impact on the environment for trade financing. Beginning in 1989, Soviet foreign trade organizations began have difficulty making payments for goods they had purchased under contract from U.S. and other Western companies. These cases all involved imports under open accounts, which had been the standard way of doing business in the Soviet Union for decades. When pressed for explanation, the foreign trade organizations claimed sufficient hard currency had been deposited in their accounts at the Bank for Foreign Economic Relations (Vneshekonombank, or VEB, then the only Soviet bank authorized to deal in hard currency), while VEB claimed the FTOs did not have sufficient funds to cover the contracts. The U.S. Government began advising U.S. companies only to sign contracts in the Soviet Union, and then Russia, on the basis of letters of credit or prepayment. Since 1990 when U.S. companies first began reporting payments delays, the Department of Commerce and other U.S. Government agencies have interceded on behalf of more than 70 companies collectively owed more than $350 million. At the end of 1991 the situation grew worse with the effective collapse of Vneshekonombank. In addition to the arrears problem, VEB stopped payment on its letters of credit and froze all hard currency accounts. Currently, according to VEB officials, commercial arrears stand at $5 billion, frozen accounts at $10 billion, and unpaid letters of credit at over $1 billion. In December 1992 President Yeltsin signed a decree announcing that hard currency-denominated bonds with a maturity of three to 15 years and an interest rate of three percent would be issued to account holders. The Russian Government began issuing bonds in 1993, and the first tranche came due in mid- May 1994 and were paid according to schedule. Joint ventures whose funds were frozen will receive payment in three tranches over six years from the date of issuance, and foreign trade organizations (who owe U.S. and other Western companies) will receive their bond payouts in two tranches over fifteen years. Estimates are that bonds have been issued for sixty percent of the accounts. Bankers in Russia and the West have started actively trading billions of dollars of VEB bonds. Reports indicate that of the sixty percent of VEB bonds which have been issued, about $1 billion have been sold on the market. If the market for VEB bonds does grow, it may provide a mechanism for Western suppliers pursuing repayment of their commercial arrears. However, many suppliers are reluctant to accept the VEB bonds as repayment for outstanding commercial debt. In November 1993 Deputy Prime Minister Shokhin announced that the Ministry of Foreign Economic Relations had been given the authority to negotiate the rescheduling of private commercial debts on a country-by-country basis. Negotiations would cover unpaid transactions, but not frozen accounts or unpaid VEB letters of credit. More recent reports suggest that the Ministry of Finance may be taking the lead on repayment of private trade debts with plans to negotiate a single arrangement for all foreign companies. Other reports indicate that the Ministry of Finance is developing a debt-for-equity plan to handle the commercial arrears, which must be approved by the government before it is officially announced. The result of this payments quagmire is that foreign companies now generally trade with Russian companies only on the basis of prepayment. Letters of credit are issued by Russian banks only in those cases where the Russian customer can deposit the requisite funds in its account ahead of time, and Western banks generally will only confirm letters of credit on that basis as well. The financing opportunities that do exist primarily are through Western government trade and investment programs or new programs under international financial institutions. Types of Available Export Financing and Insurance U.S. Export-Import Bank There are several U.S. Government trade financing programs in place which can be of assistance to U.S. companies exporting to and investment in Russia. The U.S. Export-Import Bank provides short- and medium-term insurance, loan and guarantee support for transactions involving VTB and VEB, acting on behalf of the Russian Federation. As of March 1994, Eximbank's overall credit exposure in Russia totalled nearly $400 million. The demand for Eximbank support outstrips the Bank's supply of credit, given its strict interpretation of its statutory mandate to find a "reasonable assurance of repayment." In addition to sovereign risk transactions, Eximbank has extended guarantees on a $15 million credit line to the International Moscow Bank and to Tokobank. OPIC In an agreement ratified at the June 1992 Summit, the U.S. Overseas Private Investment Corporation (OPIC) is authorized to provide loans, loan guarantees, and commercial and political investment insurance to American companies that invest in Russia. By the end of 1993 OPIC had committed more than $400 million in finance and insurance to 25 projects in the NIS having a total investment value of $1.2 billion. In addition, plans are underway to provide some additional $500 million in financing to projects in the NIS within the first half of 1994. OPIC's pipeline for the NIS includes an estimated $2-3 billion in potential financing and more than 500 projects registered for OPIC insurance representing nearly $40 billion in potential investments. To handle larger projects in the NIS and worldwide, OPIC has doubled the amount of insurance and quadrupled the amount of finance -- to $200 million -- it will commit to individual projects. Although OPIC currently does not provide inconvertibility insurance for Russia, it is investigating the possibility of opening coverage on a limited basis. OPIC is also providing a 75 percent guarantee for the Russia Country Fund, a $105 million direct investment fund for Russia which PaineWebber is organizing. The State Investment Corporation of Russia has contributed $5 million to the capital of the fund. The Russia Country Fund will invest in Russian companies which are hard-currency generators or involved in export production businesses across a broad spectrum of industries. The investment size will be $2-15 million per project. The Fund will also provide capital for expansions of projects with proven success. For more information on OPIC programs, please call (202) 336-8799 or 1- 800-424-OPIC, of fax (202) 408-9859. MIGA The Multilateral Investment Guarantee Agency, which is part of the World Bank group, seeks to promote international private investment by providing political risk insurance for eligible foreign investors. Its guarantee program insures investors against losses from currency transfer, expropriation, war and civil disturbance and investment-related breach of contract by host governments of developing countries. MIGA cooperates closely with OPIC and other national investment insurance agencies as well as with private insurers to coinsure or reinsure eligible foreign investments. Russia became a member of MIGA in December 1992. MIGA cooperates with the IFC and IBRD in supporting the World Bank Group's Foreign Investment Advisory Service, which has been providing assistance to the Russian Agency for International Cooperation and Development. TDA In addition, the U.S. Trade and Development Agency (TDA) offers funding for Russia. TDA provides funding for U.S. firms to carry out feasibility studies, consultancies and other planning services related to major projects. While historically TDA projects have been public sector projects, planned by government ministries or agencies, increasingly TDA now considers both public and private sector projects. Where appropriate, TDA may provide funding for training programs, technical seminars, conferences, or orientation visits to the United States. Since it began operating in Russia in early 1992, TDA has funded about 70 feasibility studies and other activities totaling more than $28 million. For more information on TDA programs, please contact Daniel Stein, Regional Director, at (703) 875-4357 or by fax at (703) 875- 4009. USDA The U.S. Department of Agriculture specializes in financing agricultural exports and has nearly $6 billion in annual authorizations, the bulk of which is provided through the Commodity Credit Corporation (CCC). Historically, the CCC has financed large amounts of wheat and other agricultural commodities to the NIS. CCC operates two export credit guarantee programs known as GSM-102 and GSM-103, both of which guarantee market-rate financing based on irrevocable letters of credit from an eligible foreign bank. USDA also operates a number of food aid programs, the largest of which is the Food for Progress Program that comprises mostly medium-term concessional credit sales of agricultural commodities. Since 1991, the CCC has guaranteed over $5 billion in private U.S. bank loans to the NIS, which have helped facilitate purchases of over 33 million tons of agricultural commodities. However, CCC export credit guarantee programs are currently suspended in Russia due to Russia's default on payments in November 1992. Project Financing EXIMBANK In addition to its export financing activities, Eximbank will also consider transactions with security based on production payments or hard currency export sales by Russian industries, as well as applications involving limited recourse project financing in the Russian Federation. Integral to Eximbank's project finance is a Project Incentive Agreement (PIA) signed in December 1993 which calls for the Russian Government to recognize Eximbank's interests in specific projects and to pledge non-interference with project operations. In July 1993 Eximbank signed an Oil and Gas Framework Agreement under which Eximbank may provide financing for $2 billion or more for U.S. exports of oil and gas production equipment and services to rehabilitate and revitalize the Russian energy sector. Under the Framework Agreement, Eximbank will finance equipment and services for Russian oil and gas production facilities which are now closed or producing below capacity; no new facilities will be eligible. Repayment security will be provided by hard currency receipts from oil export contracts deposited in escrow accounts outside Russia and dedicated to service debt owed to Eximbank. For more information on Eximbank programs please contact (202) 566-8990. USAID The U.S. Agency for International Development (USAID) directs its funds to developing countries and emerging markets for specific technical and humanitarian assistance projects. USAID seeks to use U.S. firms and voluntary organizations wherever appropriate. The USAID Bureau for Europe and the New Independent States (ENI) develops and manages programs in the Central and Eastern Europe and former Soviet Union region. USAID has budgeted about $460 million in FY '94 for its Private Sector Initiative Project to assist the NIS in transforming their command economies to ones based on market principles. The Project focuses on privatization and upon new business development activities, including the first voucher auctions in Russia and Ukraine. USAID has provided financing to the World Bank's International Finance Corporation for its privatization programs. USAID has also authorized over $90 million for an Energy Efficiency/Market Reform program to assist in the efficient allocation of resources in production, distribution and consumption, as well as implement sectoral market reforms. Other sectoral programs include those for Environmental Policy and Technology to provide assistance to improve the quality of the environment; Democratic Initiatives to support a system of open democratic principles, Health Care Improvement to improve NIS medical care through transfer of U.S. medical technology, training of medical personnel and U.S.-NIS hospital partnership programs; and Housing Sector Reform to assist reform in this important sector through reduction of Government subsidies and housing and privatization legislation. For general information on the NIS programs and other USAID initiatives, contact USAID's Center for Trade and Investment Service by phone at 1-800-USAID-4-U or (202) 663- 2660, by fax at (202) 663-2670, or contact the USAID Program Office at (202) 647-8094. USAID has also established four field offices in the NIS region, with an office located in Moscow. EBRD The European Bank for Reconstruction and Development is a multilateral financial institution that lends and invests exclusively in the countries of central and Eastern Europe and the NIS. EBRD supports projects that help develop the private sector, foster privatization, increase direct foreign investment, create and strengthen financial institutions, restructure the industrial base, build a modern infrastructure, promote small and medium-sized businesses, and improve the environment. EBRD's charter mandates at least sixty percent of its lending for the private sector and for privatization of state-owned enterprises. The remaining resources will fund public infrastructure and environmental projects that promote private sector development. Russia became a member of the EBRD in 1992. Since then, the Bank has approved $580 million of financing for 17 projects in Russia. Nearly 80 percent of these funds are for oil and gas projects. The remaining projects were spread out over a variety of sectors including forestry, telecommunications, satellites, health care, banking and privatization. The EBRD plans to devote 40 percent of its spending on projects in the NIS through 1994. For Russia, EBRD investments are expected to support economic stabilization and institutional reform. Priority sectors include privatization and enterprise promotion, military conversion, financial sector development, energy, nuclear safety, and agriculture and agribusiness. The U.S. Government is contributing $30 million to the $300 million EBRD Small and Medium Enterprise Fund (SME), which provides equity capital, loans and loan guarantees to strengthen micro and small enterprises in Russia. Equity finance from this fund will be delivered through existing financial institutions, small finance companies, and regional investment companies. Ruble finance is available for enterprises with up to 20 employees. The maximum loan will be about $20,000. Firms seeking involvement in EBRD-funded projects or wishing to be placed on the EBRD mailing list may contact Thomas Kelsey in the U.S. Executive Director's Office in London at 44-71-338-569 or by fax at 44-71-338-6487. Russian-American Enterprise Fund The Russian-American Enterprise Fund (RAEF) grew out of a commitment that President Clinton made to President Yeltsin at the Vancouver Summit in April 1993, and is based on the Eastern European Enterprise Funds that have been in operation for several years. The Fund, which has been operating since January 1994, is funded through USAID and is chaired by Gerald Corrigan, former Chairman of the New York Federal Reserve. The Fund will be capitalized at $340 million over four years. The fund operates as a private, nonprofit corporation, committed to helping develop small and medium-sized privatized or privatizing Russian enterprises (up to 2,500 employees) by providing equity investments and loans, as well as technical assistance in limited circumstances. The fund will also provide trade financing through short-term loans. For more information contact the Fund's New York office at (212) 483- 1177 or fax (212) 483-0999. The Moscow office can be reached at 7-095-941-8483 or fax 7-095-941-8633. The Fund for Large Enterprises The Fund for Large Enterprises in Russia (FLER) is the U.S. contribution to the Special Privatization and Restructuring Program which originated from the Tokyo G-7 Summit in July 1993. FLER is initially funded by the U.S. Congress through a $100 million grant from USAID. Additional resources will be available from FLER's cosponsor, OPIC, and other government agencies such as Eximbank and TDA. FLER will offer financing packages including equity investments, loans and technical assistance and training to medium and large sized enterprises (from 1,000 to 10,000 employees) in mainly two regions of Russia (still to be determined). FLER will engage in activities with a wide range of businesses in Russia including those emerging from the mass privatization initiatives currently underway. For more information please contact (212) 668-8394. FLER is currently sharing an office in Moscow with RAEF and can be reached at the above-listed number. Demilitarization Enterprise Fund The 1994 Defense Appropriations Bill authorizes the Department of Defense to establish a $40 million Demilitarization Enterprise Fund (DEF). DEF will promote private sector investment and restructuring in the Russian defense industry. The Defense Department is currently discussing whether to set up the fund as a private nonprofit corporation or to choose an existing venture capital fund or investment bank to manage the fund. DEF should be up and running in the second half of 1994. IBRD The International bank for Reconstruction and Development (IBRD), part of the World Bank group, makes long-term loans at market-related rates primarily to developing nations, and in recent years its scope of activity has expanded to include Eastern Europe and the NIS. The IBRD works to promote broadly based economic growth and frequently focuses on structural adjustment, sectoral reform and individual project lending. Typically the Bank does not finance the entire cost of a project. Rather, it finances the components of a project purchased with foreign exchange, which on average is about 40 percent of the total project cost. Each project may cover a wide variety of sectors and can involve anywhere from one to hundreds of separate contracts of export business opportunities for suppliers worldwide. Russia became a member of the IBRD in June 1992. In FY '93, the IBRD committed $1.7 billion, comprised of five loans. The five loans include an Import Rehabilitation Loan ($600 million), an Employment Services and Social Protection Project ($70 million), a Privatization Implementation Support Project ($90 million), an Oil Rehabilitation Loan ($610 million) and a Highway Rehabilitation and Maintenance Project ($300 million). In March 1994, the IBRD committed an additional $1.5 billion to Russia. The IBRD's financial support and policy advice will continue to focus on structural and institutional reforms to promote economic stability and self-sustaining growth. Priority will be given to restoring the energy and agricultural sectors, privatizing productive enterprises, developing a functioning commercial financing system and developing a social safety net to protect the most vulnerable groups. For more information on IBRD activities in Russia please contact Janice Mazur at (202) 482-4332 or (202) 458- 0118 or by fax at (202) 477-2967. IFC Russia also became a member of the International Finance Corporation in April 1993. The IFC, an independent member of the World Bank Group, is the largest source of direct project financing for private investment in developing countries. IFC invests in commercial enterprises of varying industries by means of loans and equity financing in collaboration with other investors. IFC does not require government guarantees of repayment. In addition to funding, IFC also provides financial, legal and technical advice to private enterprises. IFC has approved $93 million for four projects in Russia. These comprise two oil and gas projects, a credit line to Russia's leading commercial bank and funding to a venture capital fund to invest in privatized enterprises. The IFC has also been particularly active in assisting Russia in its privatization and economic restructuring efforts. Companies wishing to make project proposals or to obtain additional information should contact the IFC's Business Development Department at (202) 473-1950. List of Banks with Correspondent U.S. Banking Arrangements* Avtovazbank: Chase Manhattan Bank Bank of America Credit Moscow Bank: Republic National Bank of New York Bank of New York American Express Bank Credo Bank: Bank of America Republic National Bank of New York Finist Bank: Bankers Trust Citibank Inkombank: Republic National Bank of New York Bankers Trust Citibank BankAmerica Moscow Business Bank: Bankers Trust Republic National Bank of New York Bank of America Rossiyskiy Credit Bank: Citibank Sberbank: Bank of New York Stolichniy Bank: Bank of America Bank of New York Republic National Bank of New York Tokobank: American National Bank and Trust Co. of Chicago BankAmerica Bank of America Bank of New York Chase Manhattan Bank Republic National Bank of New York United States National Bank of Oregon Vserossiyskiy Birzhevoy Bank: BankAmerica Republic National Bank of New York * This list is not exhaustive.