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Southeast Europe Construction Industry Capacity Building Final ReportAssignment 1: Assessment of Local Construction Industry Capabilities and NeedsEuropean Bank for Reconstruction and Development Table of Contents

CONTENTS

1 Executive Summary.......................................................................................................................1

1.1 Introduction...............................................................................................................................1

1.2 Main Issues in the Local Construction Industries.....................................................................2

1.3 Main Recommendations...........................................................................................................3

2 Objectives and Methodology........................................................................................................5

2.1 Objectives of the study.............................................................................................................5

2.2 Methodology.............................................................................................................................8

2.3 Study Context.........................................................................................................................12

3 General Background on Bosnia and Herzegovina...................................................................15

3.1 Brief Economic Overview of Bosnia and Herzegovina...........................................................15

3.1.1 Institutions and Governance...............................................................................................15

3.1.2 Economic Overview of Bosnia and Herzegovina...............................................................15

3.2 Characteristics of the Construction Industry in Bosnia and Herzegovina..............................16

3.2.1 Structure of the Construction Industry................................................................................16

3.2.2 Demand for Construction...................................................................................................19

3.2.3 Industry Capacity................................................................................................................20

3.3 Survey of Local Construction Companies..............................................................................20

3.3.1 Construction Companies Interviewed.................................................................................20

3.3.2 Constraints and Difficulties.................................................................................................21

3.3.3 SWOT Analysis..................................................................................................................28

3.4 Survey of Local Financial Institutions.....................................................................................31

3.4.1 Financial Sector Overview and Trends Affecting Construction Financing.........................31

3.4.2 Financial Institutions Interviewed and their Construction Industry Business......................31

3.4.3 Financial Products for Construction firms, requirements and terms..................................34

3.4.4 Constraints in financing construction industry....................................................................35

4 Overview of the Construction Sector in Bulgaria.....................................................................36

4.1 Brief Economic Overview of Bulgaria.....................................................................................36

4.2 Characteristics of the Construction Industry of Bulgaria........................................................37

4.2.1 Structure:............................................................................................................................37



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4.3.3 SWOT Analysis..................................................................................................................50



4.4.2 Financial products for construction firms, requirements and terms....................................56


5 Overview of the Construction Industry in Macedonia.............................................................61

5.1 Brief Economic Overview of Macedonia.................................................................................61

5.2 Characteristics of the Construction Industry of Macedonia....................................................62

5.2.1 Structure:............................................................................................................................62



5.3 Survey of Local Construction Companies in Macedonia........................................................68



5.3.3 SWOT Analysis..................................................................................................................72

5.4 Survey Of Local Financial Institutions In Macedonia:............................................................73

5.4.1 Financial Sector Overview, Trends affecting construction financing..................................73



6 Survey of the construction companies in Romania.................................................................77

6.1 Characteristics of the Construction Industry in Romania.......................................................77







6.2.3 SWOT Analysis..................................................................................................................88


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7 Overview of the Construction Sector in Yugoslavia................................................................97

7.1 Brief Economic Overview of Yugoslavia.................................................................................97

7.2 Characteristics of the Construction Industry in Yugoslavia....................................................97


7.2.2 Demand for Construction.................................................................................................101

7.2.3 Industry Capacity..............................................................................................................102

7.3 Privatisation Plans and Impact on the Construction Industry...............................................103

7.3.1 Overview of the Privatisation Process in Serbia...............................................................103

7.3.2 Overview of the Privatisation Process in Montenegro......................................................104

7.3.3 Impact of Privatisation on the Construction Sector..........................................................104

7.4 Survey of Local Procurement Rules and Their Impact on the IFI’s investments..................105

7.5 Survey of Local Construction Companies............................................................................105

7.5.1 Construction Companies Interviewed...............................................................................105

7.5.2 Constraints and Difficulties...............................................................................................107

7.5.3 SWOT Analysis................................................................................................................111

7.6 Other Companies Interviewed..............................................................................................114

7.7 Survey of Business Related Services..................................................................................114

7.8 Survey of Local Financial Institutions...................................................................................116

7.8.1 Financial Sector Overview and Trends Affecting Construction Financing.......................116

7.8.2 Financial Products for Construction Firms, Requirements and Terms.............................123

7.8.3 Constraints in Financing Construction Industry................................................................125

8 Risk Management in Construction in South Eastern Europe...............................................128

8.1 The Problems of the Construction Industry..........................................................................128

8.2 Risk Allocation and Factors Restricting the use of the Local Industry.................................129

8.2.1 Risk Allocation..................................................................................................................129

8.2.2 Factors Restricting the Utilisation of Local Industry.........................................................131

8.3 Risk Management – What can be done...............................................................................132

8.3.1 The Financier’s Perspective in Risk Management...........................................................132

8.3.2 The International Constructors’ Perspective....................................................................136

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8.4 Insurance for Project-Financed Construction Projects in Countries with Undeveloped Insurance Markets......................................................................................................................137

8.5 Optimal Procurement Package............................................................................................140

9 Leasing and Plant Hire Environment.......................................................................................142

9.1 Introduction...........................................................................................................................142

9.2 Leasing Overview.................................................................................................................142

9.3 Environment for Leasing......................................................................................................144

9.4 Local Operations of Main Equipment Manufacturers...........................................................148

9.5 Local Equipment Rental Practices.......................................................................................149

10 Survey of the International Contractors................................................................................152

11 Recommendations...................................................................................................................159

11.1 Recommendations to EBRD..............................................................................................159

11.1.1 Recommendations in Support of Financial Enhancements.............................................159

11.1.2 Recommendations in Support of Procurement Procedures Improvements.....................167

11.2 Recommendations to EBRD and other IFIs.......................................................................168

11.2.1 Recommendations in Support of Procurement Procedures Improvements.....................168

11.2.2 Recommendations in Support of Training and Advisory Services...................................173

11.3 Recommendations to other Organisations.........................................................................176

11.3.1 Recommendations in Support of the Construction Sector...............................................176

11.3.2 Recommendations in Support of the Business Environment...........................................180

11.4 Conclusions........................................................................................................................182

12 ANNEXES

12.1List of Contractors Interviewed12.2List of Banks Interviewed12.3List of International Contractors12.4List of Other Organisations Interviewed12.5Screening Questionnaire12.6Detailed Questionnaire12.7Financial Questionnaire12.8List of Main Equipment Vendors’ Offices in Southeast Europe12.9General Information about Main Construction Equipment

Manufacturers12.10 List of Main Rental Companies in Bucharest Romania

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Southeast Europe Construction Industry Capacity Building Final ReportAssignment 1: Assessment of Local Construction Industry Capabilities and NeedsEuropean Bank for Reconstruction and Development Section 1

1 Executive Summary 1.1 Introduction

This report forms part of the Southeast Europe Construction Industry Capacity Building and was commissioned by the European Bank for Reconstruction and Development and financed by the United Kingdom Cooperation Fund for South East Europe.This report refers to the first assignment, which is essentially the assessment stage: Assessment of Local Construction Industry Capabilities and Needs.The report covers four countries through the initial contract: Bosnia & Herzegovina Bulgaria Macedonia Romaniaand one country through a contract extension: Yugoslavia, including Serbia and Montenegro.This report is organised as follows: Section 2 explains the objectives and methodology employed

as well as setting the context of the projects with the benefit of defining the boundaries of the analyses

Sections 3, 4, 5, 6 and 7 are the respective country reports all following a common structure. The objectives of these sections are to present:− The local construction industry− The main findings of the surveys and questionnaires

emphasising the difficulties and constraints faced by the local construction companies when tendering and implementing IFIs’ projects.

− Country specific strengths, weaknesses, opportunities, threats (SWOT) analyses.

The most important issues have been translated into recommendations.

Section 8 is an addition to the requirements of the Terms of Reference. We considered it necessary to highlight the main issues specific to the construction industry in general and translate them into South-Eastern European context:

− Risk allocation and risk management; − Insurance strategies;

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− Procurement packages. Section 9 has been added as a requirement of the Terms of

Reference related to the contract extension covering Yugoslavia, which required recommendations related to the investment climate for the establishment of a leasing or plant hire facility in Yugoslavia. We have presented in this section the main issues to be considered when assessing the feasibility and viability of a leasing or plant hire operation.

Section 10 encompasses the feedback received from the international contractors interviewed.

Section 11 is dedicated to the recommendations prepared based on the analysis of the constraints encountered by the industry in each country. Considering the significant similarity between the countries, this section is common to all countries.

1.2 Main Issues in the Local Construction Industries

The construction industries in all the countries are at a similar developmental stage. The old large construction companies are trying to restructure and adapt to competitive practices. The newly established small contractors are concentrated in the building industry, with a few capable and willing to grow. There is an emergent middle size sector (less evident in Yugoslavia) that is willing to employ a commercial approach to business and to improve their general and project management skills.

Some consolidation is likely to occur specially in the small to middle size sector, either to increase capacity or to expand the area of expertise to work on larger and more complex projects.

The construction sectors in Bosnia & Herzegovina, Bulgaria, Romania and Yugoslavia are under-utilised. In Bosnia & Herzegovina, the overcapacity is greater amongst small contractors whose expansion was triggered by the reconstruction effort, now largely completed. Montenegro is a very small market with a construction industry capable of undertaking building and road works. For larger and more complex projects, it lacks the experience and workforce skills.

Most of the construction companies interviewed have expressed worries related to the way the local authorities evaluate tenders and implement public projects.

In all countries surveyed, the procedure for developing the estimates needs to be updated to cater for new technologies and a more appropriate breakdown of costs, reflecting more accurately the “true costs” of the work. There is also a need to allow in the cost estimates for specific financing and insurance risks.

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The majority of contractors, regardless of their size, are aware of the need to improve project management skills related to performance, schedule and quality monitoring.

Raising loans and guarantees (such as bid and performance bonds) is difficult for contractors in all countries surveyed. Local banks generally have onerous collateral requirements - typical values of up to 2 or 3 times the amount of a loan or guarantee.

Financing on medium and long-terms is especially difficult as almost all banks are reluctant to offer affordable terms. This affects the capacity of financing plant and equipment purchases, thereby inhibiting productivity growth.

1.3 Main Recommendations

The set of recommendations proposed are not ranked. Any further action should consider a clear layout of the principles and objectives governing the specific action, including a cost benefit analysis, identify the up-front and operational costs as well as staffing. Setting out measurable goals as well as the financing sources (grant, loan, equity) and their nature are also critical in defining the structure of the programme to be put in place.The main recommendations can be summarised as follows: Equipment procurement support

We have looked into local banks, local leasing company and rental company funding as possibilities. Any leasing programme requires additional assessment of the critical issues for its viability: legal environment, regulatory environment, taxation, accounting, business environment in the construction industry and pricing.In addition to these options, we also suggested that the EBRD procurement packages could require a separate pricing for providing a project equipment fleet. This option opens the question of equipment disposal at the end of the project, i.e. the ownership of equipment. It also opens the discussion on ways to pass down to local contractors the benefits of using the equipment fleet – a monthly charge could be considered here. The ownership issue is more complicated and needs further detailed analysis:− is the borrower willing to own the equipment?− is it desirable for the borrower to be the owner of the

equipment?For example, if EBRD’s borrower is a local public utility, we could envisage that after a few years of working under several EBRD funded projects, it would have acquired a significant equipment base. This equipment base could be spun off and privatised and thereafter function on a commercial basis.

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Alternatively, rather than the borrower own the equipment, this can be diverted into a special purpose leasing company.

Develop a forfaiting scheme that can help the local contractors to increase their liquidity by being able to sell completion certificates to local banks. An additional benefit would be the reduction of inter-enterprise debt.

Promote flexible insurance requirements broad enough to satisfy lenders with reinsurances of adequate security rating but not too demanding for the local industry as this may make it difficult to achieve. Practically this means that the insurance requirements for subcontractors are limited to that required by the law. One main project insurance can cover all subcontractors as additional insured. This allows for an overall adequate level of insurance and keeps the costs for the local contractors low.

Promote alternative contracting strategy if EBRD’s intention is to support the local contractors to become prime contractors, then contracts need to be split into packages appropriate to the local industry. Small projects below USD10 are manageable by the local contractors. Large projects around US$100 million would attract large, reputable international companies. The range of projects values between these two limits could be made more attractive to the local construction industry by splitting them so that local contractors can manage the risks.EBRD’s internal project review cycle should explicitly address the question: How much extra cost or risk would be created by dividing procurement packages into smaller units?

In association with the above action, EBRD should consider reviewing the level of funding available for the design phase of the project. For countries surveyed, where there are insufficient experienced prime contractors able to execute lump sum turnkey projects or where the use of small and medium enterprise (SME) contractors is desirable, more detailed design work allows for a better risk management and smaller packages.

Cost estimate and pricing improvements. The desired outcome is to improve the quality of cost estimates. This can partly be achieved by improving the definition of the scope of work (more detailed design) and more importantly by updating the industry norms for cost estimates so that they are a “rue reflection” of the actual cost. Consequently, this will eliminate false pricing common in the countries surveyed.Initially the reviewing and updating of the costs estimating norms could be done on a subsidised basis, possibly with EC Phare funds. This would be necessary in order to cover the

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significant up-front investment in setting up such an operation. An open tender could be organised and allow participation of public as well as private companies. For the future, a market solution can be envisaged whereby a commercial company produces estimating guides for the construction industry. Such companies exists within Western Europe and USA. They have a strong interest in keeping their product up to date.

A whole range of training related programmes, especially for contractual, legal and project management aspects should be considered. These actions may be more appropriate for other IFIs unless special ways of incorporating them into projects are found.

Considering the ubiquitous feedback received from contractors in all countries surveyed, we need to emphasise that there is at least a strong perception that much of the procurement process is not transparent and fair. It is not so much the content of the procurement requirements that are a hurdle in accessing the public projects, but rather the enforcement of laws and contractual terms. A particular aspect of this is the compliance of local implementation agencies with the contractual deadlines. The financial position of the local contractor would be improved by untieing assets and improve working capital if the implementation agencies abide by the deadlines imposed. Local contractors believe that the entire profit margins may be absorbed by the cost of servicing guarantees during lengthy evaluation processes making it uneconomic to participate to bids.

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Southeast Europe Construction Industry Capacity Building Final ReportAssignment 1: Assessment of Local Construction Industry Capabilities and NeedsEuropean Bank for Reconstruction and Development SECTION 2

2 Objectives and Methodology 2.1 Objectives of the study

The primary objective of this report, as indicated in the Terms of Reference, is “to provide a critical independent assessment of the local construction companies and other infrastructure-related industries, business opportunities, capabilities and the problems they face, especially regarding financing availability in the Project Countries, in order to help the Bank to identify the financing and / or other assistance required for the local contractors to participate in the infrastructure reconstruction in the region”.

This reports represents the Assignment 1 deliverable related to the Assessment of Local Construction Industry Capabilities and Needs. A further assignment refers to the organisation of several seminars in the countries surveyed. This assignment will be undertaken after the approval by EBRD of this report.The countries covered in this report are: Bosnia and Herzegovina, Bulgaria, Macedonia, Romania and Yugoslavia (Serbia and Montenegro). In order to achieve this objective, we proposed in our offer to undertake several analyses. The table below highlights our achievements in the context set out in our Technical Proposal.

What We Proposed What We Have Achieved

Comments

Conduct a survey of local construction firms in Bosnia and Herzegovina, Bulgaria, Macedonia, Romania and Yugoslavia to determine their expertise, overall capacity and difficulties in competing for IFI’s contracts on the domestic market.

A representative sample of at least 13 firms in each country will be assessed.In Yugoslavia, a representative sample of at least 15 firms should be assessed and at least 10 of these should be private.

Overview of the construction sector in each country, highlighting the structure of the industry, the demand for construction works and the industry’s capacity to meet the demand.

We have identified the constraints and difficulties related to tendering and executing work.

Developed SWOT analyses of the industry with the purpose to emphasise the key areas where initiatives can be put in place to promote the development of local contractors.

The demand analysis undertaken is not a comprehensive market survey but rather a framework to guide us towards areas of future growth in the construction sector.

We extended the area of our assessment to issues pertaining to execution of projects and not only to the tendering stages.

Conduct a survey of at least Understanding of the The recommendations

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Comments

12 large and medium-sized international construction firms to determine the factors that influence their use of local subcontractors and the methods used to enhance relationships.

main concerns international contractors have when prospecting the market and potential partnering arrangements, when tendering and implementing projects either as locally based companies, or as project based companies.

Proposed recommendations on what can be adjusted to local circumstances and overview of risk allocation between players.

prepared will need further assessment in respect of:

− Identifying target groups

− Clearly laying out the principles of programmes and their objectives. Thorough cost-benefit analysis.

− Identifying the costs (up-front recruiting staff and operations).

− Identifying source of finance.

− Setting out precise and measurable goals.

Carry out a survey of local financial institutions to determine the level of support offered to local construction firms to assist them in competing for contracts in their country.

An understanding on how local banks work with construction companies and their capability to meet the demand for financial services.Survey of the financing and financial products available in each country.

Our recommendations are in line with general good banking practices and are not meant to represent interventions in a competitive market.

Determine which financial and other tools that are needed are not currently offered in the local markets.Provide suggestions how EBRD can assist banks to provide financial products, within the EBRD’s constraints.

Recommended variety of ways to improve access to financial services.Proposed innovative approaches: lending and other products that EBRD could use to increase access to financial services.

The recommendations will need further assessment in respect of clearly determining the objectives and desired effects and a cost-benefit analysis with consideration of the sources of funds.

Survey the local tendering and contracting regulations that exist in the region, particularly as they impact upcoming IFI and other donor-financed investment.

An understanding of the key procurement issues that limit the capacity to access work on a competitive basis.

Proposed policies to improve access to work and improvements in tendering procedures that would create a level field.

We did not undertake a comprehensive analysis of the national procurement rules but focused on those issues that were considered to have an impact on bidding for, and in implementing IFI’s projects.

Training related recommendations, though not falling under EBRD’s mandate, are an important enhancement initiative. Some of these could be integrated within actual project to

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Comments

achieve better results. Following discussions with the

EBRD project team, we prepared a brief overview of leasing. This is not a feasibility study for a leasing operation but a list of the main issues to be analysed prior to making the decision to undertake a feasibility study.

Survey local business support services available to the construction industry such as adequacy and availability of plant and equipment hire facilities.

Made an investigation of the business support services offered to domestic contractors.

Made an overview of training and professional organisations and their activities in each country.

Proposed an innovative approach based on international contractors experience in Eastern Europe related to insurance, leasing and plant hire.

Proposed various training programmes with emphasis on enhancing contractors and project management skills.

Project Achievements

2.2 Methodology

The general approach we took in addressing the project objectives has been in accordance with the proposed methodology in the Technical Proposal. In our technical offer we highlighted a methodology based on an iterative approach whereby a wider spectrum and number of companies had to be contacted in the first instance. Once the fundamentals of the industry, the interaction between various segments and players in the construction industry in each country were established, we narrowed down the analysis to a representative sample of local contractors, international contractors, local banks, various players in the construction industry and relevant programmes (SME, financial and /or industry oriented).

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The methodology applied is described in the table below. The basis of our methodology relied on gathering information with the help of dedicated questionnaires and interviews.The information gathered in each country is presented at the beginning of each country section of this report. The next level we dedicated to analysing the information and to formulating the overview of the industry and the main difficulties and constraints encountered by local contractors.Finally, we prepared conclusions and made recommendations. Not all of these hold the same importance.There are instances where the information is repeated but in a different context that is meant to capture the many perspectives we had to consider: local contractors, international contractors and financiers.Ultimately we sought to achieve a unitary report that would lead the reader through the facts and findings, their meaning in the context of the project’s objectives and, ultimately, to a meaningful set of recommendations.

DELIVERABLES WHAT WE ACHIEVED

Inception Phase

Inception meeting at EBRD’s headquarters in London

Reviewed project schedule and work plan together with a list of sample firms to be interviewed in each country. All these had been presented in the Inception Report. The first Inception Report covered Bosnia & Herzegovina, Bulgaria, Macedonia and Romania. The second inception report covered Yugoslavia (Serbia and Montenegro) and responded to the requirements set in the project extension.

Inception meeting focused on clarifications of the scope of work and execution plan.

Agreed with EBRD that the objective is not to make an assessment of the IFI’s procurement rules but to highlight the main areas of concern related to the national procurement rules, potentially affecting the IFI and other donor financed investment.

Focused the work on the tendering issues but incorporated key implementation aspects that may affect the access to IFI’s projects.

Structured the surveys of the local contractors considering that the main focus of EBRD is in infrastructure projects.Mobilisation of local consultants.

Task 1.1 – Establish Background and Focus of Work

Establish focus of work in terms of key areas of the construction industry to target relevant industry players who can

Establish focus of work in the light of the Stability Pact and EBRD’s pipeline of infrastructure projects. In selecting the construction activities, we also considered the development needs of each country as viewed by various players in the

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participate having satisfied some basic criteria.

Establish a wide list of companies with the potential and the interest to respond to our survey

construction industry and government organisations.

Updated the preliminary list of construction companies to be screened in order to ensure that we captured a representative sample of construction companies from a technical and financial standpoint as well as size.

Identified companies active in other segments of the construction industry: design firms, equipment and material suppliers and hire companies.

Identified local banks and non-financial institutions (insurance and leasing) in each country.

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Task 1.2 – Initial Survey

Questionnaires applicable to construction companies and materials and equipment suppliers, banks and other organisations. These will be prepared in both English and the local language.

Dissemination of questionnaires and data collection.

Review findings.

Selection of a minimum of 13 construction companies and 15 in Yugoslavia to be later interviewed by the project core teams.

Prepare a list of local banks and financial institutions that supported local firms in bidding and to be later interviewed.

Local construction industry capacity overview.

Assessment of the local procurement rules.

Prepared a screening questionnaire (see Annex 12.5) addressed to construction companies. This was translated in all local languages.

Prepared a detailed questionnaire in English (see Annexe 12.6) addressed to construction companies.

Prepared a questionnaire in English addressed to local banks (see Annexe 12.7). This was translated in all local languages.

Sent the screening questionnaire to local contractors interviews and reviewed their responses. Based on these responses, our understanding of the local construction industry and the nature of foreseeable construction works needed in each country, we selected at least 12 companies in each country to be interviewed and 15 in Yugoslavia. The list of construction companies interviewed is presented in Annex 12.1.

Selected the local banks to be interviewed via consultation with EBRD (a list and summary of discussion presented in Annexe 12.2).

Selected some insurance companies in each country (a list is presented in Annexe 12.4).

Made first visits to each country and held interviews with local contractors and various organisations.

Reviewed findings of the survey based on the responses from the detailed questionnaires and interviews.

Developed industry overviews in each country emphasising the structure of the industry and the capacity of local contractors, including small and medium size companies, to meet the construction demands in their own country (see Sections 3.1, 4.1, 5.1, 6.1 and 7.1).

Assessed the local procurement rules. The results are incorporated in Sections 3.21, 4.2.1, 5.21, 6.2.1 and 7.2.1– Procurement Related Constraints and Difficulties.

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Task 1.3 – Focus Groups

Comprehensive understanding of the issues infringing the ability of local contractors to enter into international contracts.

A SWOT analysis of the construction industry in each country.

Revisited the countries and met with other contractors, material suppliers, design institutes, insurance companies, local banks and various financial programmes sponsored by IFI’s. The summary of these surveys as well as an analyses of the findings are presented in sections 4.4, 5.4, 6.3 and 7.4.

Made the first contact with international contractors active in each country

Task 1.4 – Enhanced Assessment

Recommendations and solutions.

Comprehensive overview of the sector and its problems, including a SWOT analysis and review of the local procurement rules and their compatibility with international procurement rules.Draft Final Report.

Continued discussions with the international contractors. Their views are captured in Section 10. The list of these interviews is presented in section 12.3.

Prepared sets of recommendations (see Section 8) in support of:

− procurement procedures improvements ;− construction industry;− business environnement ;− training and advisory service;− financial enhancements.

Prepared a presentation of the main risks involved in contracting in Eastern Europe and ways of minimising these risks.

Prepared an overview of the main issues involved in assessing the feasibility of a leasing operation in S/E Europe

Task 1.5 – Present Results

Final Report Draft Final Report

Methodology applied to achieve the objectives of Assignment 1 – Assessment of Local on Industry Capabilities and Needs.

This report starts with an overview of the construction industry in each country, including SWOT analyses. The results of the surveys are presented by country. We presented our recommendations in one common section for all countries and highlight those recommendations that are country specific.

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2.3 Study Context

The scope of work requires the analysis of a wide range of aspects concerning the construction industry in terms of industry players, activities and products together with related services. In an industry characterised by complex and variable contractual arrangements, heavily influenced by the overall local economic situation and the nature of projects, there are also added elements related to government policies that may have a serious effect on the structure of the industry and its competitive position. Therefore, considering all potential interactions between players and outside effects, it can be difficult to co-ordinate all levels of analysis and develop a structured set of recommendations.In support of better structuring the assessment, we felt it was necessary to set some clarifications on the concepts and definitions used and set up the boundaries of our analysis. We have covered within our analysis the need to place the small and medium size contractors in the context of the projects envisaged by EBRD and other IFI’s. The potential role for smaller contractors, beyond the obvious role of subcontractors, is not easy to envisage and define.Contract size

Size of contract is clearly a major determinant of the number of firms who can undertake work. A large contract requires more of all possible inputs than a small contract and only some of the total contractors in the countries surveyed have these inputs available to them.Large projects generally involve a more complex technology, and as their complexity increases, so too does the technology gap between large and small contracts widen. However, the relationship between the size of the project and the size of the contractor is not always directly proportional. In practice, the smaller projects can bring some management difficulties coming from location and access to labour, material and equipment.Statistically, the small contractors interviewed can undertake projects up to US$500,000, the medium-sized contractors can undertake projects up to US$10 million and the large contractors can undertake projects up to US$30 million with just a few exceptions who could commit to higher value contracts.Location of projects

The effect of location on the capacity of smaller contractors is important. One reason why smaller contractors do not venture outside a certain area is that the costs (transportation of materials and work-force) become excessive in relation to other costs.

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The larger and more expensive the project, the less the proportion of transportation costs in the total costs. This can seriously restrict the interest of smaller contractors to go for projects outside their usual coverage area. One possibility to encourage the use of local smaller contractors is by splitting the project. Another possibility is to target projects at the municipal level, which due to their size, nature and location could be more appropriate for smaller contractors.Nature of projects

It is important to identify the nature of projects as this, together with the project’s size and location, can have a serious impact on the capacity of the contractor to participate and his potential role. It appears that in all countries surveyed, the main areas where there is a need to undertake construction works, in the short and medium term, are: Large infrastructure: roads, motorways, bridges, railways, and

ports. Municipal infrastructure: water distribution, wastewater

treatment, district-heating rehabilitation, and pipelines. Social purposes: hospitals, schools, housing.The determinants of the demand for these categories are different and so are the skills required to undertake them. This too has a direct impact on the potential role of a small contractor.Nature of services

For the purpose of this report, we have considered the following classification of works: Building construction and architectural. Civil works (e.g. constructing roads and bridges). Electrical & Instrumentation. Mechanical & Piping.We focused on the first two categories. Building and civil works contractors form the majority of the interviewed companies.Perspective of analysis

There are three major entities involved in the construction of projects: the owner, the financier and the contractor. Our analysis is founded on the perspective of the local

contractors – what are the difficulties they encounter and what do they have to do when accessing projects financed by international financial institutions.

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We have prepared recommendations addressed to financiers: EBRD and other IFIs.

We have also brought into the analysis the perspective of the international contractor whose involvement, especially on large infrastructure projects, is to be expected. This extra dimension of the analysis completes the picture of the overall demands on local contractors to access the type of projects considered.

Capacity

The term capacity as applied in the construction industry is less defined than in other sectors. In our case capacity indicates the industry’s ability to meet the demand. Since construction companies have so little control over their demand, the construction companies can operate at variable levels over time. Furthermore, construction companies are numerous and diverse. The mix of demand varies considerably in time All these make the capacity assessment difficult in the construction industry.Our efforts in assessing the industry capacity have been based on the sample of companies who responded to the screening questionnaire. It is however unreliable to try to extrapolate the aggregate value of contracts undertaken by the responding companies to the country scale as the sample chosen may not be statistically relevant and the answers provided may not be very accurate as the firm tend to overestimate their capabilities.

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3 General Background on Bosnia and Herzegovina 3.1 Brief Economic Overview of Bosnia and Herzegovina

3.1.1 Institutions and GovernanceBosnia and Herzegovina (B&H) is a complex state composed of two equal constituent entities: Federation of Bosnia and Herzegovina (FB&H) and Republic of Srpska (RS).The Dayton Peace Accord, signed in 1995, regulates basic principles of governance arrangements. The bicameral parliament on the state level is formed of the House of Representatives and the House of People. The head of the state is a three-member Presidency with each member coming from different constituent nations. The Council of Ministers is the central government.The constitution of B&H, as a part of Dayton Peace Accord, confers considerable autonomy to entities, which have exclusive responsibility for defence, internal affairs, economic and social sector policies, reconstruction activities, industry policies, justice, tax and customs administration. Institutions of B&H have a restricted role related to matters of foreign affairs, customs and monetary policies, external debt and inter-entity infrastructure. The entities have a different structure. FB&H consists of 10 cantons with their own institutions. The highly centralised RS is organised as a unitary entity, with 64 municipalities. The city Brcko is a separate administrative unit operating as District.3.1.2 Economic Overview of Bosnia and HerzegovinaThe war in B&H had a devastating effect on the country. The conflict and the political uncertainty have fragmented the society and destroyed institutions and infrastructure, disrupted normal economic activities and created an uncertain business climate.B&H, is a country emerging from the conflict. It has to go through a transition period to reach a sustainable stage from humanitarian aid to a commercial stage, and transition to market-oriented economy.In addition to the challenges common for other transition counties, B&H has very specific disadvantages and problems to solve. One in particular affects the demand for infrastructure projects: a very small domestic market that is administratively divided in even smaller markets.The revival of the economy and the economic reforms are part of the Dayton Peace Accord. According to its obligation from the Dayton Peace Accord, the international community created the system of Donor Conferences as the main vehicle for coordination of international community assistance. The framework for both post-war reconstruction and donor activities

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was a three to four years Priority Reconstruction and Recovery Programme (PRRP). The PRRP has been lead by the World Bank and the European Union together with other multilateral and bilateral donors. Aid of US$5.1 billion has been directed to the reconstruction of damaged infrastructure, revival of companies and social sector, economic restart and job creation, building and strengthening key institutions and facilitation and implementation of basic economic / social reforms.The basis for internal reorganisation and direction for economic development is the Central Bank. In mid 1998, the convertible mark (KM) was introduced as the only official currency in the whole country. Solid domestic currency has been since then a very important stimulus to the integration process in B&H and its market. Industry and mining formed the largest sector of the B&H economy during the war. In the post-war period industrial production has been growing rather quickly, but it is still just a fraction of the pre-war level. Two sectors have grown rapidly since the end of the war: Trading; The construction industry, revived due to the volume of

expenditure directed at reconstruction of infrastructure and housing.

The donor assistance is lessening and will continue to do so in years to come. Sustainable development can be built only by private investments that will provide long-term economic and business success and employment, increased income and improvement in living standards. According to EBRD 2000 Transition Report, only 35% of GDP has been generated by B&H private sector. The poor progress in the development of the private sector is caused by a very slow privatisation process.Business Environment

Constraints to new private business development and investments, including foreign ones, are mostly related to the overall business climate, general political uncertainty, the highly complex and demanding registration process and the amount of paperwork required by business laws and regulations.Additional negative elements are related to the slow and inefficient court system and complicated tax structure. In order to create a favourable business climate that will attract foreign investments so that private capital can replace diminishing donor flow, B&H will also have to address the problem of anti-competitive practice.

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3.2 Characteristics of the Construction Industry in Bosnia and Herzegovina

3.2.1 Structure of the Construction IndustryThe construction sector in Bosnia and Herzegovina was well developed before the war and was one of the most important export sectors. Many of the B&H companies executed contracts abroad, mainly in Non-Aligned Movement countries in the Middle East, Far East and Africa as well as in the former Soviet Union with annual export revenue of nearly US$500 million. Research institutions, training facilities and a skilled labour force were key elements in placing the sector as one of the most developed compared to other centrally planned countries. With a work force of approximately 100,000 in the late 1980s, it was one of the major sources of employment.The construction and building materials sector held a significant position in the B&H industry before 1992 with approximately 15% of the total employment in industry and 12-14% of the industrial national gross product.The construction share in the total investment was approximately 50%, and as a considerable consumer of various products, it absorbed approximately 12% of industrial production.The most important construction capacities were located in the Sarajevo region, although other industrial centres had well organised capacities and construction materials production facilities.A few of the construction companies managed to continue operating internationally during and after the war and now have new contracts. This is a reflection of their good general reputation on the international market. The value of contracted works by FB&H contractors abroad was approximately US$91.5 million in 1996 and US$491.5 million in 1990 (source: Statistical Yearbook 1993-1998, Federal Institute of Statistics). The value of contacted works abroad is, however, declining.The reason for such continuous reduction of contracted works abroad is related to the increased competition in the international market, general lack of large construction jobs and withdrawal of the state support. The domestic contractors tendering for works abroad encounter some other disadvantages. Some of them are related to the poor quality of B&H financial services required for big international projects. Local banks cannot support BH contractors in issuing requested bank guarantees. Undercapitalised B&H banks cannot facilitate export activities and international operations. B&H construction companies working abroad are mostly state-owned companies. They have excess work force and consequently suffer from the considerable burden imposed by

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the social security charges and other payments. The conditions related to labour payments are much more demanding for state-owned companies, due to an Agreement signed between FB&H Union and the Government of F B&H representing state-owned companies. The Agreement does not oblige private local companies. This puts the state -owned companies at a disadvantage.The overall capacity of the construction sector is in excess of the current levels of demand. The result is a signifact share of inactive capacity. This situation has worsened due to the establishment of numerous new companies attracted by low barriers at entry and potential for foreign funding.Contractors

The existing 3,400 construction companies employ a total of 24,000 staff. Most of them are small size companies and are generally geographically spread with some concentration in Sarajevo. Almost all companies that existed before the war were state-owned. Some of these are at least partly state-owned.State-owned companies have various limitations due to their ownership structure. Almost all of the state-owned companies interviewed pointed out the limitations of some employers in awarding contracts to these companies (e.g. USAID) and their problems in establishing partnerships with foreign companies. A few of the largest and most reputable companies in the country, e.g. Hidrogradnja, have been placed on the privatisation list of strategic companies in the country (tender sale of 67% of state-owned capital to strategic partner) The timing of their privatisation was still is unclear in September 2001.Hidrogradnja, together with a few others such as Unioninvest, GP Bosnia and ZGP represent the small minority of local construction companies that could act as prime contractor for large infrastructure projects either on their own or in partnership with international constructors. Small, private companies proliferated over the last few years driven by low barriers to entry into the market and by a lax regulation regarding authorisation and qualification requirements at registration (such as qualified staff, equipment, experience, etc.). These companies are mostly engaged in the grey market activities, working for small private projects.The construction market in Bosnia and Herzegovina is very fragmented, with a lot of small players working on small projects. For example, only in the Canton of Sarajevo in year 2000, a volume of work valued at DEM95 was executed by 460 construction companies employing a total of 9,700 people. This means that, on average, a company employed 21 staff on a project and had a turnover of DEM207,000.

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The barriers to entry into the sectors are low and consequently the small construction companies have proliferated especially in larger towns such as Sarajevo and Banja Luka. In the year 2000, the statistics showed that 460 companies had been active in Sarajevo Canton, but there are 813 registered in the official records. The proliferation of the number of small contractors has been driven by the funding available for the reconstruction works.Material Suppliers

Generally all construction materials are available on the B&H market, being either produced in the country or imported. The construction materials production sector in pre-war B&H managed to meet the demands of the local market. Many of the production facilities were affected by the war activities, either by direct war damages or lack of proper maintenance and finance. Some of them, however, managed to operate even during the war period.The donor funded reconstruction activities attracted foreign competitors also, the major part coming from the neighbouring countries. Some new production plants were developed in the country mostly related to the production of ready-mix concrete, prefabricated concrete elements and wood products.Basic construction materials produced locally are: cement (cement plants in Kakanj and Lukavac) brick products (IGM - Visoko, Cazin, Busovaca, Jelah-tesanj) granite tiles (Granit -Jablanica, Bihacit - Bihac) lime and hydraulic lime (Srebrenik, Breza) water proofing materials (Bitumenka - Sarajevo) gypsum (Donji Vakuf, Kulen Vakuf) ceramic tiles (Sanski Most) construction aggregate and gravel (Hidrogradnja Sarajevo,

Bosnaputevi, Misoca, Radava and many other quarries spread all around B&H)

prefabricated concrete elements (Hidrogradnja, Breza and several producers in almost each canton as well as in RS)

prestressed building panels (Sirbegovic) , wood and metal structural products etc.

B&H cement market has been of interest to foreign investors. In the year 2000 Heidelberger Zement of Germany, being the first case of large-scale privatisation with strategic foreign investor, became the major owners of the cement factory in Kakanj. This

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was the very first case of large-scale privatisation with strategic foreign investorEquipment Suppliers

B&H does not have local construction equipment producers. Products of former Yugoslavia (e.g. Radoj Dakic in Montenegro and 14 October in Serbia) and foreign suppliers had been the main source of equipment.The main foreign suppliers have traditionally been the large, well know suppliers: Liebher, Caterpillar, Pocalin, Homatcou, Fiat Hittachi and Atlas Tamrock. They operate either directly from abroad or in cooperation with local companies that act as their agents.The type of equipment mostly required in B&H are trench hoes, loaders, compressors, cranes, rollers, generator sets, mini dredgers.In general B&H contractors have not developed the practice of hiring equipment from specialised companies. Due to the limited demand there are not many hiring companies active in the country. Very often, local contractors hire equipment from other contractors and this fulfils a significant share of the equipment needs in the market.3.2.2 Demand for ConstructionOver the last five years the construction activities have been concentrated in the areas of rehabilitation and reconstruction work related to the transport and telecommunications network, water and electricity distribution and generation systems as well as airports and various other buildings. As most of this work is completed and most of the funds allocated to these are running low, the focus should move towards viable projects linked to the economic strategic development of the country.However, Bosnia and Herzegovina is a small country with limited industrial facilities and so far only a small number of large projects have been identified: motorways, hydro-electric power plants, underground garages and housing developments. Furthermore, important challenges remain in finding the financing for all future projects, especially the large ones.General business and investment framework and political uncertainty in the region effected the possibilities to obtain funds. The efforts of Federal Government to implement the Sarajevo - Zenica motorway project based on DBOT approach failed last year, after 2 years of negotiations with the French company Bouygues. The newly elected government has been facing even more demanding challenges to attract foreign investments after such a failure.

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The reconstruction objectives have been met almost entirely. It is estimated that basic services (road network, electric power, urban water supply, telecommunications) are almost at the pre-war level. With completion of the PRRP programme, public donor assistance programme will be phasing down and B&H has to start both reducing dependence on international aid and strengthening its own capacity for economic and social development. The remaining reconstruction needs are mostly related to housing and community services to provide for the return of refugees or displaced persons. Recently announced was a 4-year USAID funded programme amounting up to US$70 million and consisting of more than 100 projects in the fields of water supply, transport, electric power, education and health related facilities.Infrastructure

It is anticipated that some construction work would be created by the privatisation of railway, water and gas utilities, telecommunications and power generation and distribution. However, these represent a limited amount of work. Moreover, their timing is still unclear because of the ethnically defined political and administrative structures and the divergences between them. There have been attempts to define a common approach to planning and maintenance in the area of transport infrastructure, but efforts are hindered by the devolution of power between Republika Srpska and the Federation as the officials are blocking the integration. Despite this, both EBRD and EIB have plans to invest some EUR40 in works next year. A few examples can be brought here. Railway freight can play a significant role in the country where there is a high degree of trading in products such as oil, gasoline, bauxite, wood and various goods.Local officials consider it essential to upgrade the main road from Samac in the Republic Srpska via Banja Luka and Sarajevo to the Adriatic, as it will ease connection with Europe as well as helping with the physical integration of the country. The development of the north-south corridor (Corridor V) is considered a high priority project, which could materialise in the near future. Some of these projects could be suitable for concessional arrangements The construction companies that could commit themselves to these projects are the largest ones (e.g. Hidrogradnja, Bosnaputevi and GP Put). Such large infrastructure projects would create jobs for the construction industry, including small and medium contractors and construction materials producers.3.2.3 Industry CapacityThe present capacity utilisation in the construction industry is around 45%. The cause is widely considered to be the lack of jobs. At the same time there is recognition that there have been

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little local effort in developing feasibility studies and attracting investors. Until now most of the work has been rehabilitation work and almost no new projects have been undertaken.However, the fundamental issue is whether the existing capacity can be better utilised if the volume of work increases. Considering the nature and size of potential projects, it is very likely that some of the excess capacity could not be utilised. We consider that some consolidation in the industry will occur and this will help the construction sector in B&H to have a better chance of becoming a sustainable industry.3.3 Survey of Local Construction Companies

3.3.1 Construction Companies Interviewed During the first phase of the survey, we approached a large number of construction companies located throughout the country. The screening questionnaires were disseminated and we received 48 responses from companies based in Sarajevo, Banja Luka, Mostar, Biheljina, Visoko, Prnjavor, Gracanica, Caplijina, Laktasi, Zenica and Tuzla.16 companies were selected and interviewed. These were based in Sarajevo, Banja Luka, Laktasi, Bijeljina, Graganica and Mostar.A list of the companies interviewed is presented in annex 11.1. The main findings are captured in the following section 3.3.2 Constraints and Difficulties. In addition to this, we would like to emphasise that: Value of assets owned by a small and medium-sized

contractor ranges between US$75,000 to US$3 million; Value of assets owned by larger contractors ranges in the

value of US$3 million to US$22 million; The value of assets purchased over the last three years is

fairly small for all companies regardless of their size, i.e. between US$12,000 and US$75,000 and up to US$200,000 for the larger contractors;

The profitability of the companies, regardless of their size, seems to range between 1% and 4% of the annual turnover;

The SMEs have undertaken projects ranging from US$85,000 to US$2.5 million. The largest lump sum contracts mentioned are between US$0.5 million and US$1.5 million;

The large contractors have undertaken projects in the range of US$10 million and US$110 million. They also work on small size projects. The largest lump sum contract is US$34 million, but the most common values are around US$5 million – US$10 million;

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More than 40% of the companies that responded to the screening questionnaires have ISO9000 accreditation. Two of the screened companies were in the process of implementing ISO9000;

Only 30% of the companies interviewed declared that they borrowed from local banks. The values of funds borrowed were US$12,000 to US$25,000 regardless of the size of the borrowing company.

3.3.2 Constraints and DifficultiesBusiness Environment Related

Procuring work on a steady basis with possibilities to plan for the futureBosnian construction companies, large and small, operate in a business environment that has been dominated by foreign sources of funds due to the major reconstruction effort undertaken over the last five years. The scale of the IFIs’ grant involvement is set to diminish over the next few years. The construction works needed will have to be financed from other sources: international financial institutions, Government and local municipal and canton authorities.Almost all construction companies interviewed have mentioned the lack of a national economic national strategy and hence the lack of perspective on the future demand for construction works as one of the main hurdles in planning their business. In the absence of a national strategy and policy on economic development, the contractors, especially the smaller ones, cannot plan their resource skills, equipment and finances to achieve continuity of work. As a consequence, they tend to rely on small private projects.Another factor constraint identified by the majority of interviewed contractors is the size of the market. Bosnia and Herzegovina is a small market in geographic terms as well as in demand for work. A lot of companies, including medium-sized companies, have started to work in other countries such as Croatia, or have prepared themselves to enter Yugoslavia. Some of the bigger construction companies managed to be present on the international market during the war and post-war period (e.g. Hidrogradnja operating in Libya, Jordan, Germany and Malaysia).There is also the perception that unless a project is financed by IFIs, it is almost impossible to obtain work in the other entity of the if not registered there. This further limits the amount of work available.Central and local authoritiesSome of the construction companies have mentioned that a serious administrative burden with implications on completion

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schedule is presented by the way property issues are dealt with. Considering the current legislation and the way local administration operates, obtaining the permits for execution of the works is cumbersome, time-consuming and causes delays.Shortages of skilled labourGenerally speaking all companies considered that they have the right mix of skills. However, there are concerns related to the capacity of small firms to attract and maintain a skilled workforce because this often means working on small, cheap projects with no security of employment.During the war there was movement of educated construction personnel towards better-remunerated sectors, especially in the case of young staff. It seems that there is a structural imbalance between age groups and experience with a strong bias towards the more mature workers. Most companies have now the experience required through the older generation of staff. There are now fewer people in the middle generation and even fewer in the younger generation involved in construction activities. This is expected, in time, to have an impact on the resources available and result in a shortage of labour.There is a shortage of skilled personnel experienced in design activities. On one hand there are not enough good design institutes and on the other, they have not been able to retain the experienced staff. There is also a tendency to under price the design services. A similar problem exists in the consulting services sector.Delays and uncertainties with respect to supplies and price of materialsBasic materials e.g. cement, concrete and aggregate, is available in Bosnia and Herzegovina and no particular problems have been reported in terms of availability, quality or price. There is also a range of products such as dry mortars, concrete additives, painting materials, glass and insulation materials, that are imported in most cases from Croatia, Italy, Germany, Hungary and Austria. This has caused delays in transportation and delivery, and higher costs. Access to hired plant and equipmentMuch of the construction equipment has been destroyed in the war. Since then companies have tried to procure equipment, in most cases through their own funds, to prepare themselves for upcoming projects. In some case, companies solve their equipment problems by subcontracting the work to those that have the necessary fleet. Generally speaking, the small building contractors are not concerned with hiring equipment or plant. Most of them seem to own trucks and small equipment, even their own concrete

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mixers. It is only when they venture into civil works or larger and more complex projects that they begin to need more plant and equipment. This is rented on a hourly or daily basis from other contractors.Most companies purchase the equipment, usually with their own cash, under favourable conditions offered by foreign suppliers. The contractors use bank loans very rarely because of high interest rates.Companies engaged in equipment hire are very limited in number. In general B&H has not developed the practice of hiring the equipment and only a couple of the interviewed companies used hired equipment.Access to leasingThere are leasing schemes in Bosnia and Herzegovina offered by local companies and all equipment is imported, as there is no local manufacturing capacity. There is also no regulation in place related to either leasing or tax incentives associated with it. Very few contractors expressed interest in leasing, as it is perceived as an expensive route to improving the equipment fleet. More often we came across cases where local contractors entered into leasing arrangements directly with the equipment manufacturer. This is only the case for larger companies who have the reputation and financial position to deal outside their country. There were a few attempts to begin leasing operations both by foreign and local companies. Although there is no special legislation, i.e. no special tax treatment, they did not experience legal restrictions (or facilitations). The main constraints encountered were the unpredictability and inconsistency of the administrative bureaucracy and legislation. However, the viability of the leasing operations was jeopardised by the lack of demand.In practice, a modified lease is being used whereby the equipment is imported on a temporary basis up to one year. The buyer pays a custom duty and a rental payment covering capital and interest. This is treated as an operational leasing. At the end of the one-year period the buyer has the option of buying the equipment.Problems mentioned are uncoordinated operations of certain custom branch offices and complicated custom procedures. The lack of attractive legislation is another reason for not developing the leasing services in the country. However, more than any of these reasons, insufficient demand is the main obstacle of developing leasing operations in B&H.Availability of supporting servicesContractors generally complain about the limited external training and the absence of active professional organisations. At

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the time of the survey (March-August 2001) there were no current training programmes at the canton or entity levels. Before the war the professional organisations used to be strong and active. During the war organisations such as the Association of Engineers and the Association of Civil Engineers suffered the consequences by separation into ethnic entities. In addition, lack of facilities, staff and financial support for their operations further diminished their capacity to undertake any activity.Regarding the internal training, there is little corporate culture to train the staff. The problem is more acute within the small and medium enterprises. These local contractors develop familiarity through experience. It is only when they want to expand or diversify that this problem becomes critical. This could be the case when smaller contractors try to access projects financed by IFIs’.Availability of information generally does not present a problem. The companies that have the capacity to bid know where to look for information and the most sophisticated ones monitor the Internet sites of various IFIs. Smaller contractors tend to work for private clients and some do not appear to want to expand into competitive bidding for IFIs or local authorities because they consider that the system lacks transparency and therefore any costs incurred with bidding would not be justified by the end results.InsuranceThere is no lack of insurance products in Bosnia and Herzegovina and most of the basic products are offered. What is missing is the custom of providing an insurance policy. Only when the client strictly requires this, the contractor will obtain an insurance policy. This is however not critical to the industry’s capacity to bid for IFI’s projects.Problems can occur in relation to the value insured. For larger projects, as for those typical for EBRD, the local contractor may obtain an insurance policy from the local market, but this would be expensive. In most cases these policies would have to be reinsured with foreign reinsurers, and this adds to contractor costs.TaxesThere is a very complex tax structure at all levels: canton, entity and federation, and no clarity as to how this operates and what the implications for the contractor. This situation also effects the possibilities for attracting foreign investment.The state-owned companies are required to pay a very high level of social contribution - 86%. This puts a heavy burden on companies with direct consequences on the level of permanent

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staff they can maintain, and the higher level of costs reflected in the price.PermittingPermitting and property rights in Bosnia and Herzegovina are somewhat more complex due to the consequences of war – restitutions and complex legislation frameworks at canton, entity and federation levels. This creates a considerable burden and administrative inefficiency with repercussions on planning and scheduling. Procurement Related

Survey of local procurement rules and their impact on the IFI’s investmentsThe major local procurement mechanism is public tender, with a possibility of a pre-qualification stage for projects exceeding KM1 million (US$0.5 million). Small-scale procurement (less than KM50,000 – US$23,000) can be done by restricted tender, and in some special cases, and with the priors approval of the Ministry of Finance, by direct negotiations.The rules are not applicable for the procurements funded by foreign and private aid (donations). In this case the usual approach is to apply the rules imposed by the funds provider. Therefore, the contractors are familiar with procurement rules of various international organisations (the WB, EC, EBRD, USAID, GTZ, etc.).In cases where internationally funded projects are not implemented directly by the international organisation, mostly local public or governmental organisations are engaged, for example: Directorate for Transport, Canton Development Institute etc. and they use the procurement rules of the donor. Access to informationAccess to procurement related information is a problem for local contractors. Both in the case of IFI and locally funded works, the information is available either from local sources or the internet.Capacity to Comply: technical, administrative, legalWith more than five years experience in working with IFIs in B&H, local companies have become familiar with the IFIs procurement rules. The only complaint is related to the fact that the rules of various IFIs require different forms of the same data. This seems to be difficult and expensive to produce for small companies without experienced staff.State-owned companies face limitations related to possibilities in competing for some jobs due to IFI regulations restricting participation of state-owned companies (e.g. USAID funded projects).

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Employer Related

Tendering requirementsThe major hurdles local contractors face at the tendering stage are: (i) requirements for past experience with similar projects over the last few years with similar projects, (ii) bank guarantees and (iii) cash requirements in proportion to the value of contract. Even well positioned and experienced companies have limited capacity for bonding. Another factor affecting the competition is the selection criteria. Most of the projects financed by international agencies, such as World Bank, GTZ and SFOR would consider only the lowest offer. The consequences for the industry are: Lower quality standards; Unrealistic pricing triggering higher completion risks.Delayed interim and final paymentsThis has been quoted as a serious problem especially when the employer is local. It is recognised that the situation is much better in the case of IFIs. In order to avoid bureaucratic delays in processing valuation certificates and authorising payment, EBRD is very often paying contractors directly.The statistics presented to our team by the Transport Project Implementation Directorate in Banja Luka are signalling a lower rate of problems arising out of late payment: only 5% of projects seemed to be affected by cash problems in the case of 2 or 3 contractors.Liquidity problems can arise from non-payment from other clients, which can overall affect the contractor’s financial position.Incomplete documentationA particular problem seems to be the timely availability of drawings and coordination between various drawings. This is partly connected to the employer and partly to the local design firms. Clients should recognise that the clearer and more detailed the drawings and specifications are, the easier it would be for the contractor to comply. Contractor Related

Cost EstimateCost estimates according to the existing procedure do not allow for a clear breakdown of costs in direct costs, indirect costs (including financing costs) and other costs (including contingency, risk and anticipated level of profit). Consequently, the costs estimate does not reflect the “true cost” of the works

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and are less dependable. The lack of jobs and the employers’ most common practice of selecting the lowest bidder have generated much pressure on prices. This can affect the project completion and quality.Lack of suitable equipmentThough the situation has improved over the last few years, there is still concern with the limited range of equipment available on the market and the poor maintenance.Contract awareness and complianceAlthough there is an important number of contractors who have participated in competitive tenders according to the international procurement rules, there is no common practice to actively monitor the contract or, even worse, to comply with the terms, specifications, performance and pricing. More dedicated contract staff is needed.In some cases misuse of funds and materials have been reported. The contracts have been paid, but the funds and materials are used for other, usually private projects. Closer supervision by the client can only partly solve this problem.Environmental Safety and Health (EH&S)Overall local contractors pay limited attention to EH&S aspects. Most of the private companies do not have safety engineers. Moreover, legislation related to safety is not enforced which further reduces the interest of companies in making provisions for EH&S.Adequate SkillsThe construction sector in B&H shares a common feature with all other countries surveyed. There is a certain lack of non-technical skill in the construction companies in the areas of marketing, planning and management, commercial, economical and legal. Only a few companies interviewed, mainly the large ones and a few growing medium ones, have taken an active attitude towards marketing themselves.Planning and management represent stumbling blocks among small-scale contractors. Most of them are unfamiliar with formal planning and management techniques. It is fair to mention that the small construction projects need not involve sophisticated techniques. However, small projects involve low level of profits in absolute terms and the margin for error is quite reduced. Contract management is another important problem area as local contractors, regardless of their size, are, generally speaking, not used to actively managing contracts and documenting the process.

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Economist and financial specialists are not attracted to the construction industry as they find better pay and more secure jobs in other sectors of the economy. Therefore, most of the construction companies interviewed did not have such skills among their permanent staff. They use these skills only when needed, especially for financial and bookkeeping activities. Legal skills experienced in the contracting business are even more scarce in B&H and expensive to hire. This limits further the capacity of smaller contractors to undertake bids. However, the likely candidates for IFI’s project will not find legal and contractual aspects major hurdles in competing for these projects.Finance Related

The difficulties related to the availability, terms and conditions for financing and financial products are detailed in section 3.4.In additional to these, most of the contractors interviewed highlighted administrative and procedural difficulties in working with local banks and this in both entities. The main complaints were: Bank staff is not specialised in dealing with construction

companies and they have limited understanding of the sector; Repeat request for the same information even when the

contractors have several projects running at the same time and even if the contractor is the bank’s client. There is no overview analysis of the contractors’ business, which results in treating each application independently, with the corresponding fees and time to provide the service;

There is no client relationship culture and the services offered are not efficient. Some companies can obtain contract agreement covering a wide range of services the bank can provide to them. However, even in the presence of such agreements, the contractor perceives the banks’ requests for information as cumbersome;

Lack of overdraft facilities to suit the fluctuating cash flows typical for construction companies;

Registering an asset for the purpose of offering it as collateral is not expensive but it is lengthy.

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3.3.3 SWOT Analysis

STENGHTHSIMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY EBRD

Experienced and committed staff, willing to make an extra effort to complete work.

Positive in terms of time limits observance and quality of executed works.

Reputation and significant previous record.

Facilitate fulfilment of qualification criteria.

Previous experience on international markets.

Familiarity with international performance standards.

Willing to introduce modern management approaches and to improve company operations.

Increased capacity for performance and schedule compliance.

WEAKNESSESSIMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY EBRD

Too many small jobs. Skills and experience are dispersed and companies cannot qualify because they cannot offer the range and depth of skills required by the EBRD projects.

Lack of specialisation within the small and medium contractors, most are building and civil works contractors.

Reduced possibilities to compete for more complex projects.

Lack of management and planning skills combined with control tools especially for larger and more complex project.

Can affect the project execution with direct implication on budget and project completion.

Insufficient structured QA / QC (quality assurance / quality control).

Cannot meet the qualification criteria.

Lack of knowledge and/or experience with contractual terms.

Problems can occur especially with contract variations, risk allocation and rights and obligations affecting thus schedule and budget.

Unfamiliarity with new and sophisticated equipment.

Potential scarcity of skills for more complex projects.

Capacity to retain staff, especially by smaller contractors.

Cannot meet the qualification criteria.

Lack of safety procedures and qualified staff to implement and monitor.

Can diminish the chances to qualify especially when JV or subcontracting arrangement with foreign partner.

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WEAKNESSESSIMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY EBRD

Limited technical understanding of new technologies or complex drawings among smaller contractors.

Constraining factor for the more ambitious companies.

Inadequate estimating procedures Risk of offering “about right” estimates with the serious risk of underestimating the costs.

Managers do not pay too much attention to the broader external circumstances and their focus is not on improving the external environment.

No direct implication but affecting general business climate improvements and development.

Low use of IT, internet and e-mail service.

No direct implications but effecting overall business effectiveness.

Too few companies working abroad. Reduced possibilities to become familiar with international markets rules and improve overall operations.

Lack of continual education (professional and managerial).

No direct implication but can effect the overall sustainability.

OPPORTUNITIESIMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY EBRD

Consolidation among the small end of the industry.

Better-qualified companies with potential to approach more complex projects.Increased bargaining power in acquiring materials at better prices and hence more advantageous project budgets.

Cooperation with foreign companies in B&H market.

No direct implication but possibilities for overall sector to prolong the cooperation with international companies abroad and enter new markets.

THREATSIMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY EBRD

Lack of young skilled and trained work force.

No direct and immediate implication, but a potential threat to the industry's sustainability.

Delayed interim and final payments. Incapacity to continue work and, in the worst cases, to purchase the equipment and materials.

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Limited capacity to commit to more or larger project.

Bank procedures to obtain credit or guarantees are long and cumbersome.

Can add extra cost to be reflected in the offer price.

No active professional organisations. None directly, but much lower standards exist in the industry.

Lack of overall economic strategy and hence difficulty to plan and expand.

None directly, but companies are not capable of complying with selection criteria: lack of previous experience, lack of adequate equipment, lack of positive cash flow.

Privatisation process still underway. If companies are not fully privatised they can be precluded from projects and therefore well-established companies cannot qualify.Inefficient management and company structure with direct effect on project costs and efficiency in execution.

Overcapacity. Companies bid sometimes too low with potential implications on schedule and performance compliance. Too may players and hence more difficult to select contractors.

Lack of coordination and transparency on taxes and decision making process at municipal, cantonal and federative level.

Project do not materialise and hence companies do not acquire enough experience to be able to qualify and to expand their business.

Low barriers to entry in terms of qualifications and requirements.

Too many small companies operate and therefore the market is too segmented making difficult choice of the right contractor.Too many companies that cannot undertake more complex projects.

National professional standards and quality standards still to be coordinated with the EU ones.

Maintain low standards in the industry overall and can distort competition through unreasonably low prices and completion and quality risks.

Permitting and property rights. Additional risk to project completion.

R&D funds not available Difficulty in adopting new technologies.

Lack of training facilities for skilled work force.

Threat to sector’s sustainability.

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3.4 Survey of Local Financial Institutions

3.4.1 Financial Sector Overview and Trends Affecting Construction Financing

The financial sector in Bosnia and Herzegovina, like Bulgaria and Romania, is in the process of major transformation with foreign commercial and developmental financial institutions driving that change. An increasing number of its financial institutions are being integrated into recognised international financial groups and are adapting their procedures and products to the modern standards of those groups.Unlike the other two countries, Bosnia has major internal differences in the financial sector and with the basic financial system. Banks in the Republika Srpska are still operating more in the style of the previous socialist system. In the Republika Srpska the catalysing international influence is felt mainly through newly opened branches of Raiffeisen Bank and Micro Enterprise Bank. In Herzegovina, Croatian nationalism may be slowing the transformation and the spread of Sarajevo-based institutions. This transformation is starting to bring improved financing opportunities particularly for the small and medium sized enterprises in the construction industry.Special credit facilities from KfW, USAID, EBRD and others offered through some banks have also helped to strengthen firms by market forces, and assistance through donor funded programmes is slowly making more of them credit worthy.3.4.2 Financial Institutions Interviewed and their

Construction Industry BusinessFor the financial institution survey, we interviewed six banks, two insurance companies, three construction companies and two international assistance and financing programmes, and met with EBRD’s Sarajevo office team. Additional input was also provided through EBRD and SME studies and through construction industry studies prepared in 2000 by IFC and USAID.Banks

Of the six bank interviewed, four (Turkish Ziraat Bank, Micro Enterprise Bank, Zagrebacka Bank and Raiffeisen Bank) are foreign-owned and managed. All have made major changes and capital increases recently thus demonstrating improved lending capacity and showing market commitment that will take time to translate into improved access to credit by borrowers.RZG acquired Market Banka and changed its name to Raiffeisen in 2000 and Zagrebacka Banka, Croatia, bought Hvraska Banka in December 1999, and Universal Banka and Kommercialni

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Banka, Tuzla, in October 2000 combining all three under the Zagrebacka name.Turkish Ziraat Bank increased its capital by 150% in 1999 and MEB had a capital increase in 2000. Both UPI Banka and Kristal Banka have had substantial international technical assistance and special funding lines.Three of the banks have significant levels of construction industry credits: Raiffeisen – 25% of its portfolio, UPI – 10% - 15%, and Kristal 6% of its loans and 24% of guarantees. MEB has only 1.6% construction business, partly due to its perception that construction firms are especially risky. Ziraat has very little construction business but is interested in developing some if it is of good quality. Turmoil in Mostar did not permit a visit to Zagrebacka’s head office and the manager of its Sarajevo office, whom we interviewed, had no information on the industry breakdown of his bank’s business.The table shows the responses from each bank on its construction business:

BOSNIA

Name of Organisation

% Portfolio % of Construction Portfolio

Mortgage

Construction Gty ST LT

SME Large

Contractor

Suppliers

Other

Financing

Raiffeisen Bank 25% N/A N/A N/A N/A N/A 20% 15% 65% YesKristal Bank 6% + gty 37% 58% 5% N/A N/A N/A N/A N/A Zagrebacka Banka N/A N/A N/A N/A N/A N/A N/A N/A N/A YesTurkish Ziraat Bank very little N/A N/A N/A N/A Mostly N/A N/A N/A SomeMicro enterprise Bank 1.60% N/A N/A N/A

100% 0% 50% 40% 10% N/A

UPI Bank 10-15% 24% 40% 36% 30% 70% 98% 2% 0% N/AUSAID Business Fin 3% - 12% N/A N/A N/A N/A N/A N/A

Insurance Companies

Of the four insurance companies that offer insurance on construction projects, we interviewed two, BH Osiguranje and Aurum. BH is owned by Bosnia Re, UPI Banka and Zagrebacka Banka, and Aurum is now 51% owned by Raiffeisen, which plans to bring new capital next year plus added strategic partners.Bosnia and Herzegovina law only requires auto, ship aircraft and public transport insurance so there is no legal requirement for

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coverage on construction projects, unlike most other countries that require proof of insurance for registration and licensing. However, if insurance is used on a project it must come from, and be offered first for, reinsurance to a Bosnian company. Before the war there were liabilities against which construction firms needed insurance, and even now it is rarely used. The USAID Business Finance Programme is the only one that requires insurance. None of the banks do. Insurance is also very rarely a covered cost on construction contracts so contractors have no incentive to use it. Insurance bonds are used in place of bid and performance guarantees but this is not practiced in B&H, although B&H has arranged such bonds through London for Bosnian firms with foreign projects.Leasing Companies

There are no Bosnian firms leasing construction equipment, but some banks report that they do some type of leasing. Some large firms have leased equipment from foreign firms, but find it very expensive. MEB tried leasing and found that there were problems in the law and that it was too expensive. Equipment is also rented from companies whenever it is not needed at the time.International Assistance and Financing Programmes and Auditors

In addition to meetings with the staff of EBRD’s Resident Office in Sarajevo, we met with the IFC’s South East Europe Development project (SEED), and USAID’s Business Finance Programme. SEED is a US$33 million, five year project, in Bosnia and Herzegovina, Macedonia, Albania and Kosovo, with its headquarters in Sarajevo. Funding is being sought by them to implement plans for expansion in Yugoslavia.SEED supports SMEs and institutions that serve them. It works to improve the legal and business environment in which they work. It considers construction to be a major target sector and funded a study that it had hoped would identify SMEs working on internationally funded projects. It plans to work with SMEs to help them win more international contracts, and is training bankers to understand and work with them. It sees barriers in attitudes and law in SME development and is working on improving specific laws and regulations. SEED’s many activities supporting SMEs will help SMEs in the construction industry. USAID Business Finance is part of a $278 million programme, which has disbursed over $137 million in loans to private sector Bosnia and Herzegovina firms since 1996, making it a very major lender in the country. Unlike most other international loan programmes in Bosnia, programme managers make all the loan decisions and the Bosnia and Herzegovina banks act only as agents, taking little risk. Employment generation is a significant factor considered in its approval process.

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USAID Business Finance says that 3% of its portfolio is composed of loans to construction companies and another 9% is construction related. Viewed in another way, it claims that about 50% of all of its loans are used for construction purposes. USAID Business Finance also gave us the Sector Study of the Construction Industry in Bosnia they completed last year. The study focuses on SME contractors and suppliers who received USAID Business Finance loans and concludes that there is a major need for continuing foreign investment, especially in housing and related infrastructure, and for privatisation of the industry. USAID Business Finance noted that both Volksbank and Raiffeisen have started mortgage finance programmes. The audit firm we met noted that the major firms not yet privatised were very powerful before the war, but now have significant problems with liquidity and inadequate equipment. Most of their equipment was destroyed during the war. This has made it very difficult for them with international tenders. The auditor commented that banks are happy to finance construction firms, especially on international contracts with payments tied to the contract. All guarantees and loans require a high level of collateral and interest rates are still very high. Most construction companies cannot meet the banks’ requirements. A proposed IFC line for the construction sector has not gone forward because of the industry’s problems. The auditor felt that loan tenors are too short with maximums of two to three years and equipment difficult to finance.3.4.3 Financial Products for Construction firms,

requirements and terms All banks interviewed offered bid and performance guarantees, short term loans and some longer term loans that could used for equipment purchase financing. The table below shows the terms they offered on each product:

NAME OF ORGANISATIONFINANCIAL PRODUCT TERMS

Guaranty Fee, Qtrly Interest Rate ST Interest Rate LT Max No

of YearsRequired %Collateral

Raiffeisen Bank N/A 13-16% 9.5-11% 3-5 N/AKristal Bank 0.3-1% 15-17% 12% N/A N/AZagrebacka Banka N/A N/A N/A N/A N/ATurkish Ziraat Bank 1% 12% + 1% 12% + 1% 3 200%Micro enterprise Bank 1% 12% 12%, + 2% 5 VariesUPI Bank 0.45-0.70% 10.75-13% 13%(LIBOR+8) 3-5 200%USAID Business Finance N/A 7.5%/LIBOR+4 N/A 3-5 N/A

N/A means not available, not given or not applicable

Terms and conditions offered by banks in Bosnia & Herzegovina

Guarantees

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The banks reported that no confirmation of their guarantees is ever required if related to projects within the country. Kristal may be an exception since it was the only bank interested in an EBRD guarantee confirmation line. However, one of the contractors mentioned that the United States Embassy required confirmation of the guarantee it obtained for work on an Embassy project. Even for foreign project guarantees and letters of credit, Raiffeisen claimed it had no problem in getting confirmation by its correspondents, especially since they changed their name.The pricing on all guarantees is similar except for Kristal Bank and UPI Banka. Kristal charges a half percent up front plus 0.3% - 0.4% per quarter on performance guarantees and 1% quarterly on payment guarantees. UPI charges 0.45% per quarter if the client is fully cash collateralised and 0.70% if their collateral is not cash.Short-term Loans

Short term loan pricing varies largely based on whether the loan has a purpose that can be funded under a credit line from an international organisation or from the banks own funds. Turkish Ziraat Bank is very liquid and MEB is funded by concessionary loans from foreign organisations, so their pricing is a bit lower that the others. Collateral requirements are strong, 200% of the loan amount on fixed assets, where reported.Fixed asset collateral also takes long to approve. Medium-term Loans, Leasing (equipment finance)

Medium term loans are more likely to be made under internationally funded programmes than from banks own funds. Kristal Banka, which has few of these lines, has only 5% of its construction portfolio in medium term loans.3.4.4 Constraints in financing construction industryProblems and their causes

The major and medium size construction firms with whom we met to discuss financing issues agreed that financing costs were excessively high, e.g. 1% front-end plus 0.2% per month on guarantees and 18-20% on six month loans. It is not clear why the fees are so much higher than the fees that the banks claim to charge. They also agreed that collateral requirements were harsh, e.g. 200% - 300% of the credit, and that banks are slow and inflexible with credit application procedures. The documentation is much too cumbersome, requiring an international contract be translated into Bosnian and certified or, a new set of the same basic corporate documents for each transaction the firm carries out with the bank.The larger firms complained that the banks were all too small and, to finance large projects, needed to make syndications

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which is a very difficult task to achieve. The smaller firm mentioned one bank that had required 100% cash collateral and charged a fee of over 3% per quarter for a guarantee. They both claimed that they got better financing terms though joint venture partners, from foreign banks supporting the project’s investor and from foreign suppliers of equipment. The equipment sellers require 30% to 40% as a down payment. An indication that much of these problems are caused by inefficient banking practices is shown in the report of the relationship the smaller firm has with Raiffeisen Bank. Starting originally with Market Banka, it has had a legal agreement committing a multipurpose line of credit allowing it to get guarantees and loans up to the line’s limit without delay. Although its position as part owner of Market Banka, before it sold out to RZG, may have influenced the bank in granting the original line, Raiffeisen has now doubled the line. The cost is still very high, but the ability to act quickly makes the firm more competitive and able to respond to bids.Regional differences in bank products still exist with firms working with banks in the RS most negatively affected. Hopefully Zagrebacka will lead the way in Herzegovina and the new Republika Srpska branches of Raiffeisen and MEB will have a major impact in the RS.Products not offered

Guarantees are easily obtained, even though they are expensive and out of reach for the smaller SME’s with no significant assets to pledge. Working capital short-term loans are also available for those with collateral and may be slightly more affordable if funded through one of the international programmes. The product least available is equipment financing. We were not able to get any information on the Federal Investment Bank’s loans, but the terms of other available products do not seem to fit the needs and abilities of the construction firms.Possible ways to overcome the problems

Market forces should overcome the problems with credit terms eventually as competition increases among well managed banks, and the weaker construction industry firms are not accepted. This will leave stronger and more credit worthy survivors. Encouragement of specialised equipment financing institutions and improving the conditions for leasing would help, or programmes and training of bankers.

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4 Overview of the Construction Sector in Bulgaria 4.1 Brief Economic Overview of Bulgaria

The first transition years in Bulgaria were marked by political instability, slow restructuring of the old planned economy and a very uncertain business environment. Not surprisingly, the country experienced a major economic and financial crisis in 1996 and 1997 that brought almost all sectors of the economy to the verge of collapse. The crisis brought an important political change, a new reformist majority in the National Assembly for the first time since the start of transition. The crisis of 1996/1997 had a tremendous positive impact on the construction sector; a number of inexperienced but politically connected contractors that have been cannibalising the construction industry since the end of central planning went bankrupt. All large public and municipal construction companies were quickly privatized. Major construction material industries such as cement factories, brick and clay tile manufacturers, ready mix concrete producers, limestone and marble quarries and gypsum plants, were sold off to international strategic investors such as Italcementi (Italy), Heidelberger Zement (Germany), Holderbank (Switzerland), Knauf (Germany), Standard (USA). The new investors have started implementing various investment projects in order to modernise production, improve distribution, and boost competitiveness and exports to West European and Balkan markets. In December 1999 Bulgaria started accession negotiations with EU, which necessitated personnel changes and a streamlining of ministerial functions and administration of the public procurement process. The government passed important legislation creating a better market environment for the construction sector. A law on Public Procurement was passed in 1999 and amended in 2000 facilitating the development of a fair, transparent and competitive market for local and international construction companies to work on public and municipal projects. The Government started addressing public concerns about corruption in the administration, especially scandals around public financing of construction projects. Although the changes in the last four years have brought a positive response and more confidence in the construction business community, the construction sector in Bulgaria is still far away from the pre-transition revenue figures when Bulgarian builders worked in major international markets such as the Middle East and the Soviet Union. The Bulgarian construction industry has scaled down to providing services locally with very few firms occasionally working internationally, mostly in Russia, Kazakhstan, Israel and Germany. Total estimated construction industry output for the year 2000 is over US$1.5 billion, including consultancy and professional work.

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The local construction markets in Bulgaria over the last ten years have included housing, infrastructure and industrial facilities projects. Greenfield work has accounted for a smaller portion of the construction industry output. It has been more repair and maintenance work, which is set to continue to account for the major part of construction industry output. Over the last two years there has been growth in non-residential and infrastructure sectors with commercial work mostly related to offices and tourist/leisure industry. Large-scale industrial work has been slow due to the lack of massive new investments in the industry. At the same time there is a long list of internal factors negatively influencing the construction industry in Bulgaria including: an ageing workforce; skilled workers leaving the country for overseas assignments with international construction companies; the growth of the proportion of construction work undertaken in the hidden economy being still high; and the lack of sufficient Government spending on infrastructure.4.2 Characteristics of the Construction Industry of Bulgaria

4.2.1 Structure:Contractors

The Bulgarian construction industry contains over 20,000 contracting firms, of which over 50% are one-person firms. Different surveys undertaken by various Bulgarian construction industry trade organisations indicate that most of the construction firms in Bulgaria are small businesses with less than seven employees concentrated in all major cities of Bulgaria. Most of the small and medium sized companies have been established over the last ten years by former employees of state-owned construction firms and design offices. Only less that 500 contracting firms employ more than 7 people. Most of the medium size and large contractors are located in the four largest cities in Bulgaria (Sofia, Plovdiv, Varna and Burgas). Most of the small companies are involved in the construction and commissioning of small residential and industrial projects with a TIC less than US$300,000. There are around ten large construction companies in the country. These are mostly former state-owned organisations, privatised over the last five years. At the end of the year 2000, the construction industry trade organisations announced that the construction sector was over 90% privately owned. There are still a few municipal construction firms in the process of privatisation. When reviewing the existing types of activities of local contractors in the light of EBRD’s classification of large, and SME contractors in Bulgaria, it is important to compare these against benchmarks used by the construction industry worldwide such as project size and sector. Total Installed Costs (TIC) is a key industry indicator for project size. The figure below shows how

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Bulgarian contractors compare against international project size benchmarks.

Size of Projects Undertaken by Contractors

There is no existing construction company in Bulgaria in a position to show experience with large, super and mega projects over the past ten years. This limits the opportunities for Bulgarian firms to act as prime contractors on large, super and mega projects even within Bulgaria.The particular sectors of operation for the local contractors is the other important indicator to judge if they have the expertise and skills to implement up-to-date technologies and complete these on time, within budget, and to the technical requirements of the project sponsor. The sectors are identified according to international construction industry practices. The major sectors can be divided into: Greenfield construction of process related plants and facilities:Liquid and solid chemical plants. Greenfield construction of non-process related plant and

facilities: Power plants, manufacturing plants, civil works/commercial buildings. Repair and maintenance of process related plants and

facilities Repair and maintenance of non-process related plant and

facilities

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Figure 1 - Contractors Capacity per Sector

In the survey we have identified typical large, medium and small companies and analysed in more detail their activities and capacities. Material Suppliers

A number of major international manufacturers of building materials have representative offices or agents in Bulgaria including well-known firms such as Knauf, Rigips, Crackstop, Movinord, Rehau, Dalsan, Cerezit, AMF, ABS, and Vedag. Most of them provide goods on credit to qualifying contractors and continue to improve their distribution networks.Due to the improving business environment in Bulgaria over the last four years, a number of international building materials manufacturers have acquired Bulgarian plants making flooring, tiling, plaster boards, cements, additives, metal rods and sanitary ware. They have brought in positive changes to the local building materials market by improving the local product quality, packaging and distribution.Other less attractive state-owned manufacturers of building materials have been privatised by management buy-out.Some of the newly privatised plants have already been turned around and are increasing sales on the local market and exports to neighboring countries. It is important to note that there are a growing number of local and international companies investing in new manufacturing facilities, for example Astral (plastic windows), Ytong (light concrete blocks), Teraco (plasters and latex paints), Ataroclima (a wide range of materials for HVAC

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installations), Isola Petrov (insulation materials) and Bramak (roof tiles).However, there are still many privatised companies facing huge difficulties in raising finances for upgrading the facilities and improving product quality and distribution networks. In addition, the management skills available in these companies are poor and the companies are virtually being driven to the ground. Major areas for improvement are: product quality, delivery time, ability to deliver straight to site; competitive cost; and payment terms.Equipment Suppliers

The big names of the construction machinery industry such as Caterpillar, CNH of the USA, Volvo of Sweden, Komatsu of Japan, JCB of UK, and Liebherr of Germany have sold very limited amounts of equipment to Bulgarian contractors or plant hire firms over the last 10 years.Over the last three years an increase in sales of new excavator and loaders have been registered. Caterpillar is even considering setting up a representative office and service centre in Bulgaria. The demand for construction machines is expected to increase when the large-scale building and infrastructure projects announced by the Government of Bulgaria come into being.As the existing equipment fleets are dating back to the 1980s, there is an urgent need for new machines such as mobile cranes, access platforms, mini excavators, hydraulic excavators, crawler dozers, crawler loaders, wheeled loaders, backhoe loaders, skid-steer loaders, motor graders, rough terrain lift trucks, compaction equipment, asphalt finishers, mobile compressors, concrete mixers, mobile concrete pumps and dumper trucks. Only a few large construction and plant hire firms can afford to buy such machines.Small equipment such as mini-excavators used to dig trenches for cable laying, small compressors, mini-compaction equipment and power tools are more popular with medium sized contractors. The power tools market in Bulgaria is very well developed. Major power tools manufacturers such Sparky (Bulgaria), Hilti (Luxemburg), Bosch (Germany), and Husqvarna (Sweden) have established good distribution and after sales services.

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Plant and Equipment Hire

Most of the plant and equipment hire companies, who rent out heavy equipment needed for construction projects, were set up in the 1960’s. In their best years their fleet numbered thousands of various machines made in the Soviet Bloc countries as well as in the West. The local construction industry has known western companies such as Liebherr, Grove, Volvo and Caterpillar for many years. Due to the recession in Bulgaria over the last ten years, the plant and equipment hire companies could not afford new equipment. At the moment all the plant and equipment hire companies are privately owned, in most cases privatised by management buy-out. These companies have little access to capital for new equipment. The high cost of capital and lack of stable workload makes it difficult for them to implement large-scale fleet upgrading programmes through equipment leasing or bank loans. Consulting Services and Design

Due to low start up costs and abundance of qualified engineering specialists, there are huge numbers of private consulting firms with wide raging areas of expertise. Most firms are very small (1 - 5 employees). Many firms are equipped with modern computers and software and offer services to Western standards.Western firms have set up office in Bulgaria providing services to local and international clients.Former stated-owned design and consulting firms have been privatised by management buy-out. Most of them are on the verge of bankruptcy due to poor management of human resources. There are few firms such as Energoproject that have survived the turbulences and enjoyed success after privatisation. Sector Specific Services

After the end of planned economy, various construction industry support organisations emerged such as professional associations, trade organisations, construction industry newspapers, and guilds. All these organisations are striving to increase the visibility of the construction industry, enhance the skills of their workforce, and provide support and better understanding in the market place, and they have been very dynamic over the last ten years.For example, Izdatelstvo Standartizatsia provides information about Bulgarian standards and legislation with regard to the construction industry; the national weekly newspaper “Stroitelstvo Grada” covers all the events in the construction sector; Stroiko organises regular exhibitions.

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4.2.2 Demand for ConstructionFood Processing Industries

Over the last few years a number of technical assistance programmes sponsored by international institutions have been involved in developing the necessary institutional and legal framework as well as in setting up financial schemes that allow agricultural producers and processors to obtain working and investment capital. Due to this and the extensive direct financial support from the EC Special Accession Programme for Agriculture and Rural Development (SAPARD), the agriculture and food processing industries in Bulgaria have be growing much faster than any other sector of the economy.Local construction firms have successfully executed major capital greenfield and renovation projects in wineries, wheat mills, and fruit processing plants, slaughterhouses and farms.Further opportunities exist for the small and medium sized contractors with regards to rehabilitation of the aging food processing plants, grain warehouses, and farms. The typical project size in agriculture and food processing tends to be small, between US$50,000 to US$5 million, which is within the capacity of the local construction industry. Commercial Buildings

The structure of the Bulgarian economy has experienced a continuing shift away from the heavy, capital and energy intensive industries towards a pattern more in line with Bulgaria’s long-term comparative advantage such as tourism, commerce, and computer technologies.There is a growing demand for office buildings, leisure facilities, warehouses, stores, hotels, bars, restaurants and shopping malls.There are good opportunities for repair and maintenance of the existing building stock as well as for new construction. Such projects, costing from US$50,000 to US$50 million, are well within the range of projects the local contractors can undertake. For example, the German tour operators Neckermann and TUI have already invested over US$10 million for refurbishment and upgrading of aging hotels along the Black Sea coast. Local firms carried out most of the works. In addition, major European chains such as Metro Cash & Carry (Germany), Billa (Austria), Ena (Greece) and Koc Holding (Turkey) have opened super and hypermarkets over the last four years in major cities, with ambitions to build more stores. Local contractors built all the stores costing an average of US$2 million.Power Plants and Transmission Lines

Recent studies carried out by EC and local consultancies have indicated that there is an urgent need for the construction of new

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power plants in preparation for the decommissioning of the oldest units of the Kozlodui Nuclear Power Plant in 2004. In addition, the Government of Bulgaria has given a high priority to reconstruction and upgrading of interconnection transmission lines with the Union for Co-ordination of Production and Transport of Electricity (UCPTE), which operates the interconnected European high-voltage network.The IFI’s have strongly supported the restructuring of the power sector and upgrading of the transmission network in Bulgaria. EBRD has already earmarked around US$175 million for transmission lines and around US$800 million for new power plant construction and coal handling and waste disposal facilities. The Government of Bulgaria has forecasted that the investments in the power sector over the next five years will be in excess of US$2,000 million. Most of the power sector projects are too large in size for the local contractors. Local contractors participate alongside of major international contractors providing specialist services and labour. Civil Works/Infrastructure Projects

The Bulgarian infrastructure has suffered from lack of investment and has been grossly neglected over the last ten years. It needs urgent repair and proper maintenance.The Government is now implementing an Infrastructure Investment Programme (IIP) for the period 1998-2001 focusing on telecommunication networks, motorways, bridges, ports, and water systems.A new legislation has been adopted over the last three years paving the road for large foreign investments in both rehabilitation of existing system as well as in green field projects. The IIP and the new legal framework aim to create the right business environment that will attract foreign investors to take part in the privatisation of the sector or to take over the operation of the infrastructure facilities under concession. All major IFI’s are supporting the Bulgarian Government in this process. Due to the improving business environment, international investors such as Enron (USA), IWL (UK), Vivendi (France) and others have been actively pursuing business opportunities in Bulgaria. For example, International Water, the concessionaire of Sofia Water Utilities, has already started the first stage of rehabilitation of the aging water system in Sofia. Most of the financing for this project comes from EBRD. This is around US$95 million earmarked for upgrading of Sofia water and wastewater systems. Local contractors have been carrying out most of the construction works that are currently underway. Roads

Bulgaria is an important transit country on the route from the Middle East to Europe. There are a number of pan-European

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transport corridors crossing Bulgaria’s territory from Romania via Sofia to Greece and Turkey, from Macedonia via Sofia to Burgas and Varna ports, from Yugoslavia via Sofia to Greece and Turkey.With financial support from the EC and the IFI’s, the Government of Bulgaria has launched a series of projects for the repair and modernisation of existing roads focusing on upgrading the main east-west roads linking the key industrial centres and the integration of Bulgaria’s road system with the international network.Most of the roadworks have been publicly tendered and awarded to international firms such as Todini Construzioni Generali Spa (Italy), Granit (Macedonia), MotMacdonald (UK) and local contractors such as Patishta AD, Patni Stroeji AD, Transstroi and Injstroi AD. Most of the local road contractors are privatised state-owned firms with over 40 years of experience in roads works. Bridges

Within the framework of the Stability Pact, the construction of a bridge over the Danube at the town of Vidin is due to begin in July 2001 with financing from the European Investment Bank and the Government of Bulgaria. The total projected value is expected to be around US$180 million. Such projects are beyond the capacity of the local contractors. In addition, NATO has announced plans to finance the strengthening of existing bridges on major roads. Local firms will carry out most of the work. Municipalities will also undertake construction and repair of small bridges contracting local firms through open tendering. Ports and airports

Bulgaria has four major ports: Varna and Burgas on the Black Sea and Russe and Vidin on the Danube that need upgrading. Some works have already started. For examples, Union Miniere has already invested in the rehabilitation of some of the port of Varna facilities. It has been estimated that the ports of Varna and Burgas could attract substantial oil transit from the central Asian republics to West European markets. If this happens, a massive amount of construction work can be expected. Bulgaria has four international airports: Sofia, Plovdiv, Varna and Burgas. There are plans for upgrading all of them. The airport in Sofia has already been remodeled. Local contractors have carried out all the works.

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Plants and Facilities

Bulgaria has experienced a massive decline in the state-owned heavy industry sector. A huge number of large industrial enterprises were propped up by soft bank loans and subsidised energy prices until the crisis of 1996. Over the last four years many industrial plants have been privatised, for example the largest Bulgarian refinery, Neftochim, was sold off to Lukoil (Russia) in 1999. The new owner has already launched its modernisation programme. Lukoil takes the view that international contractors such as Kellogg have the expertise and capacity to undertake upgrades at the refinery. Other industries with ambitious modernisation plans include: pharmaceuticals, cement, mining and metal. For example, the cement company in Zlatna Panega, owned by Heidelberger Zement (Germany) has spent over US$4 million on refurbishment of its furnaces. The zinc and lead smelter, OTZ, in Plovdiv is implementing a US$70 million investment programme. Local contractors are carrying out many repair and maintenance projects.4.2.3 Industry CapacityDue to the slow down of the economy and the colossal decrease in investments over the last ten years, the local construction industry has been in a position to meet most of the local demand including small-scale housing, commercial building, infrastructure and industrial facilities rehabilitation projects. As the workload in the construction industry in Bulgaria has varied widely over the last ten years depending very much on the economic situation, it has been more economical for most contractors to employ a very small core staff team of their own and staff projects using “off the street” labour or “teams” of independent labourers. Such a mode of operation has not allowed the local contractors to undertake more complex projects where the qualification of the workforce is key.Over the last two years there has been a growing demand for upgrading some of the existing industrial facilities requiring contractors with specialist expertise. Such expertise has proven to be difficult to source in Bulgaria. For example, for upgrading of oil refining equipment at the Neftochim, a specialist international contractor, Kellogg, was hired to complete specific tasks requiring specialist skills and knowledge of the latest technologies. In addition, the local construction industry lacks financial resources to cover any working capital, guarantees and work experience requirements that developers and bank financing large-scale projects may require. 4.3 Survey of Local Construction Companies

4.3.1 Construction Companies InterviewedWith the assistance of the construction industry national newspaper “Stroitelstvo Gradt” and the construction industry

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trade organisations in Sofia, Plovdiv, Varna and Burgas, we carefully selected over hundred construction industry companies from various sectors and regions of Bulgaria to take part in this survey. The list is annexed to this report. A screening questionnaire was circulated to these companies to complete and return to the local consultants. After analysing the information in the screening questionnaires we selected a representative sample of twelve constructions sector companies to interview including nine SME contractors and three large contractors as well as two international contractors operating in Bulgaria. Based on the representative sample of companies interviewed, several key observations are important: Most of the medium size and large contractors that can

participate in projects funded by IFI’s are located in the four largest cities in Bulgaria (Sofia, Plovdiv, Varna and Burgas);

Most of the companies are privately owned and involved in the construction of projects with a TIC between US$10,000 to US$15 million. The road contractors tend to handle the bigger projects;

There are less than ten large contractors such as GlavBolagrStroy that do projects with TIC over US$15 million. These are mostly former state-owned organisations, privatised over the last five years. There are few Bulgarian firms to act as prime contractors on infrastructure projects over US$5 million;

Most of the SME contractors do not have very strong balance sheets. The total value of assets is between US$10,000 to US$5 million. A great part of these assets are plant, equipment and land;

International contractors are primarily interested in projects with TIC over US$1 million;

Most contractors pay cash to small materials suppliers or importers. Larger manufacturers and suppliers of products such as cements, concrete, sand, metal rods, and sanitary ware provide goods on credit only to qualifying contractors;

The survey has shown that equipment fleets are ageing, however only a few large contractors can afford to buy new bigger equipment. Most of the medium size contractors tend to buy small equipment such as mini-excavators, small compressors, mini-compaction equipment, and power tools. The SME contractors rent larger plant and equipment from the hire companies or from the large contractors;

Local construction firms have successfully executed major capital green field and renovation projects such as housing

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developments, food processing industries, leisure facilities, office buildings, and shops. However, they do not have the capacity to undertake industrial facilities rehabilitation projects requiring contractors with specialist expertise;

Most of the international contractors have employed local SME and large construction firms that have satisfied their financial and professional requirements;

Most of the SME contractors employ a core staff of 5 to 180 employees and are making efforts in providing further training to their key people;

Most of the SME contractors indicated difficulty securing the services of skilled labour, to work either as direct employees or as sub-contractors;

Most prominent is the concern felt over the effects of tax legislation, making the SME contractors not competitive against “firms” that are not registered;

Most large companies and some of the SMEs acknowledged that ISO 9000 certification is becoming an important issue in winning international work as well as getting jobs from international customers explicitly requiring ISO 9000 certification.


Unsteady Demand for Construction WorkThe demand for construction work depends very much on the economy. Due to the consecutive crises in Bulgaria over the last ten years very few contractors have shown organic growth. Only larger contractors working on projects outside Bulgaria and contractors working for growing niche markets such as mining and metals, roads, gas pipelines, have been able to grow their businesses and maintain steady cash flows.Although over the last three years Bulgaria experienced an increase in the demand for construction work due to an increase in financing from IFI’s for infrastructure projects, it is a shared opinion of the contractors that a long term Government strategy for the infrastructure projects may help them make long term strategic commitments. Labour related issuesDue to the unsteady workload in Bulgaria skilled workers are leaving the country for overseas assignments with international construction companies.International contractors operating in Bulgaria have complained that due to the low level of knowledge and skills of local labour,

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quality and schedules suffer. This is especially true when working with larger local contractors that often have difficulties in staffing bigger projects with temporary work force. Smaller companies tend to be more flexible, innovative, and tend to offer better quality people. Often site managers assigned on larger projects are not properly qualified causing delays in reaching scheduled milestones.International contractors working in Bulgaria have recommended that it would be beneficial to the sector if there are training programmes to bring the skills of local labour up to international standards, especially in project and product management, procurement rules and procedures, client relationship management and site safety practices.Delays and uncertainties with respect to supplies of materialsThe unstable demand for construction services influences the building material supplies. The distribution system for building materials has been improving over the last two years but it is still not to western standards. Supplier financing is fairly limited but on the increase with some companies extending credit up to three months.Most contractors report delays of sometimes up to two months in the supply of imported materials. With locally manufactured basic products, such as bricks, plaster, flooring, cement, the delay in the supply can take up to maximum of one week. Problems in materials supply delay a project's progress and this in turn delays the contractor's ability to finish the job on time and start the next job as scheduled.Access to hired plant and equipmentThe existing heavy and expensive plant and equipment is aging and new and reliable machines are not easily available. If the demand for construction machines increases after the large-scale building and infrastructure projects announced by the Government of Bulgaria get off the ground, then there would be an urgent call for heavy equipment such as mobile cranes, access platforms, excavators, dozers, loaders, graders, compaction equipment, asphalt finishers, mobile compressors, concrete mixers, mobile concrete pumps and dump trucks. The plant and equipment hire companies are not prepared to meet such a demand.Access to leasingLeasing is at an early stage of development in Bulgaria and tends to be expensive. It is easily available for small equipment up to US$50,000. Leasing for equipment up to US$1 million is also available to qualifying contractors. Due to the high costs associated with leasing, contractors do not use this option as a way of financing their equipment needs. Gas StroyMontaj, a pipeline construction contractor and one of the largest Bulgarian

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construction firms, told us that it has leased equipment from foreign companies, but knew of no Bulgarian company leasing construction equipment.Gas StroyMontaj does obtain equipment needed for a project through subcontracts with firms that have the equipment needed or by renting it from them, a practice common in all the countries surveyed. It has used equipment from rental companies in Europe such as MAATS B.V. and rented specialized pipeline welding equipment from CRC – Evans in Houston. It noted that Caterpillar also rents equipment, but at a very high price. The Head of the Marketing and Investment Department of Gas StroyMontaj recommended that EBRD help create a South East Europe regional equipment rental company, which he thinks would work easily. He stressed that it would need to operate regionally because the equipment rental market in Bulgaria, and other countries individually, is too small. Such a project would require a strategic partner that is a good credit risk itself and has the expertise to manage such rentals in the very difficult legal and operating environments of the Balkan countries.Gas StroyMontaj also has had financing from equipment suppliers, which usually require that it make a 50% downpayment. BACB noted that equipment suppliers have established local agency arrangements in Bulgaria, which not only provide marketing and service support, but also may help arrange financing.In summary, the Bulgarian construction companies obtain equipment through supplier, bank and lease financing, through some international rentals, and through intercompany rental and subcontracting. Equipment leasing is still in its infancy, bank financing is expensive and requires substantial collateral. Availability of supporting servicesDue to the “hire and fire” nature of the construction industry in Bulgaria, the contractors do not provide “on the job” training for the temporary staff. However, temporary staff accounts for over 70% of the work force in the construction industry. There are apprenticeship schemes only for permanent staff. Most of the formal training of the construction industry work force is carried out by educational establishments such as professional schools of construction as well as the departments of civil engineering at the universities.Site securitySite thefts happen but not to an unexpected level. Site security costs and insurances policies against theft are expensive.Procurement Related

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Survey of local procurement rules and their impact on the IFI’s investmentsA Law on Public Procurement, passed in 1999 and amended twice in 2000, facilitates the development of a fair, transparent and competitive market for local and international construction companies to work on public and municipal projects. The Government has been extremely committed in addressing public concerns about corruption in the administration, especially scandals around the public financing of construction projects.Generally speaking, the law on procurement provides a good legal framework, however, the enforcement seems to be weak and calls for further actions from the Government in order to provide a fair and competitive environment. Many contractors do not bid for public works due to the low credibility of the public administration, which often uses various creative approaches to restrict the competition and assist favorite firms. Often the civil servants responsible for the execution of the procurement process are not well trained. This causes delays in processing tenders and payments.The Law on Public Procurement has a provision restricting the direct participation of international firms. Only entities registered under Bulgarian Commercial Law can enter into contracts for public or municipal work in Bulgaria. This provision does not affect directly works financed by IFI’s which is undertaken under an agreement between IFIs and the Government of Bulgaria. In such cases the procurement rules and procedures of the IFI’s prevail.The Law on Public Procurement requires all bids to be accompanied by a tender security but the law does not spell out the amount of such a security.It is a common practice in Bulgaria for the public and municipal project employers to have very tough financial requirements such as securities of over 100% of the value of the contract. They do this for two major reasons: 1) do not want to deal with small firms that may fail to perform; 2) larger firms would offer some free services to them against restricting the competition. The favours may include free computers for schools, refurbishment of the mayor's office, etc. No cases for corruption, only a vehicle to redistribute the budget. For large firms 100% securities of the value of the contract is easy to furnish as they have a lot of fixed assets to pledge such as plant and equipment, buildings, warehouses, inventories and do not tie up working capital while smaller firms tend to have less fixed assets but more productive working capital.For smaller companies securities are very costly and they have no interest in bidding. It is interesting that neither IFI's nor local procurement rules place a ceiling on the securities; therefore they assist the large firms in monopolizing the public and

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municipal markets. Many SMEs contractors cannot afford to tie up capital in such tenders and they are virtually removed from the market. The local SME share the opinion that an increase in their participation in tenders, can be achieved through making the information about procurement opportunities easily accessible as well as harmonise the procurement procedures and rules of all the donors. The harmonised procurement rules and procedure will facilitate the procurement process, especially when several organisations provide finance to a single project. A common set of procurement rules agreed between the IFI’s such as EBRD, WB and EIB will be very helpful for both civil servants and contractors.The local SME’s consider that it would allow them to bid for more work financed by IFI’s if the large complex projects are broken up into smaller lots.Access to informationThere are plenty of Internet sources of information about public and municipal procurement opportunities on the site of the Bulgarian Government Procurement Opportunities Register (http://www.government.bg/rop/). In addition, information and support to SME contractors is provided through the Government Agency for Small and Medium Enterprises (http://www.asme.bg/).An Internet database SEEBN created with funding from USAID provides information on procurement opportunities that result from efforts financed by international donor organisations and IFI’s. However, this database is not updated on a regular basis and is not of much use.Unfortunately, many SME contractors are not aware of all the information available on the Internet. Moreover, most of the IFI’s procurement opportunities are in English, which is not widely used amongst the contractors’ community in Bulgaria.Capacity to Comply with international requirements and standardsWe have identified that only a few large contractors in Bulgaria have good understanding of international design standards and codes (symbols, layouts, etc). For most of SME contractors international design standards, contract term and conditions used in international tender documents are new. Some SME contractors reported that international tenders are difficult to prepare and take extra time and effort to reconcile standards and various requirements. Particularly, the amount of the paperwork required in international tenders is a problem as well as the project administration in a foreign language.

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http://www.asme.bg/

http://www.government.bg/rop/


Local SME contractors expressed preference to act as subcontractors only without getting involved in the cumbersome proposal preparation process.Local contractors sometimes have problems executing change orders requested by prime contractors working on IFI’s funded projects. Employer Related

Tendering requirementsThe local SME contractors that had participated in international tenders complained that documents had been ambiguous and too legalistic, requiring an excessive amount of company time to put together a proposal. In addition, the SME contractors have had very disappointing experiences with the tender evaluation and contract award process. They pointed out that often these procurement steps had not been well defined in the tender documents. It was mentioned that in one particular case the evaluation had dragged for over a year. During that time the bidder had to maintain a bid bond and a performance bond that not only tied up his capital but also eroded his gross margin.Tender requirements for securities are also an issue. In addition, there have been complaints that the government agencies engaged in the procurement of works do not always comply with the procedures of IFIs and in this way does not provide a fair and competitive environment for the bidders.

Delayed interim and final paymentsThe SME contractors in Bulgaria who have already been awarded contracts as prime contractors on projects financed by IFI’s have been experiencing delays in payments and other problems due to poor administration of the contract by the civil servants in charge. A delayed payment is a big issue for SME contractors tying up working capital in excess of what has been budgeted for.Local contractors subcontracted by international contractors on international projects reported no problems related to payments. Payments to subcontractors were usually made on a monthly basis.Contractor Related

Poor site management and contract planningIt has been identified in the interviews that the site management and contract planning and monitoring has been a major weakness of SME contractors. Due to lack a stable workload that allows them to retain experienced staff, there are often delays due to poor site management and contract planning.

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Compliance with ISO 9000A few contractors interviewed have suggested that ISO 9000 certification is becoming an important issue in winning international work as well as getting jobs from international customers explicitly requiring ISO 9000 certification. Due to this, SME contractors in Bulgaria expressed their interest in taking part in quality certification programmes backed by IFI’s or donor agencies. In addition, international contractors expressed views that the quality of works carried out by local contractors is often an issue. Local contractors are not always able to do the work right “the first time”.Cost estimatesCost estimating is a major area for improvement, especially for local SME contractors. Detailed cost estimating was not an important activity and was often neglected in the old central planning system. Most of the companies surveyed have insufficient personnel dedicated to detailed cost estimating. As cost estimating is dependent on the detail of design work undertaken, local employers and SME contractors tend to economise on design work, consequently the cost estimates suffer leading to overruns and delays.Finance Related

Construction industry firms were hit hard by the 1996-7 crisis and many went bankrupt causing buyers who had prefinanced construction to lose their investment. The stronger firms survived but demand for construction slowed and obtaining financing has been difficult. The biggest firms that work internationally have been hit by a global decline in construction but survived better than those limited to the Bulgarian market. Even they have some problems financing equipment. SMEs contractors reported that they have difficulty getting finance for equipment, although new SME focused banks and special SME lines have helped some SME contractors buy small equipment such as small excavators and compactors.Small contractors complained that the financial institutions in Bulgaria do not provide adequate working capital financing/overdraft facilities. Usually smaller firms tend to have working capital problems and require upfront payments to finance their building materials and labour costs. All the medium-sized and most of the small contractors can borrow locally against a collateral, however, this is very costly and makes their prices more expensive. Also, small contractors cannot afford tying up capital in inventory; hence occasionally they run out of some imported materials and subsequently fall behind schedules.All contractors agree that the local banks offer very expensive financial products that are not attractive to them. Cost of capital

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is high which adds significantly to the cost of the contractor’s product.4.3.3 SWOT Analysis

STENGHTHS IMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY IFI’s

Local contractors provide cheaper service. Reduce capital costs and debt service obligations of the borrower.

Local contractors have good local knowledge and can cope better with local problems that can cause delay and overruns.

Reduce risk of delays due to unforeseen local problems.

Local contractors experience in international contracts in Russia, Germany, Israel.


Local contractors are robust against competition from well resourced and low cost contractors (e.g. from Turkey).

No conflicts with Government requirements to provide employment to local people.

New private SME contractors with Western partners have emerged over the last four years that have the financial and technical capacity to undertake quality work.

Increase the participation of local firms in international contract as prime contractors.

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WEAKNESSESS IMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY IFI’s

Local SME contractors do not have adequate resources to fund the business development work and lack sufficient knowledge of the bidding process and international procurement rules.

Limited participation of local contractors in international tenders. Competition restricted to only international contractors.

Local SME contractors have limited ability to work in international languages (e.g. English).


Local SME contractors have enough resources to handle small and simple projects.

Local SME cannot bid for bigger projects. Competition restricted to only international contractors.

Local SME contractors cannot expand raising finance due to lack of proven track record and borrowing history and lack a stable workload.


Local SME contractors are under invested in systems and computer software.


Local SME contractors do not have proper quality assurance and quality control systems in place.

Limited opportunities to works as subcontractors to international firms implementing IFI’s projects.

Local SME contractors cannot undertake more complex projects for technology upgrade of industrial facilities.


Local SME contractors have poor site management and contract planning.

Poor project execution that leads to delays and overruns.

Local SME contractors have no sufficient personnel dedicated to detailed cost estimating.

Poor project execution that leads to delays and overruns.

Only few SME contractors use IT, internet and e-mail service.

No access to procurement opportunities.

Only few SME contractors pursue international work.

Limited opportunity to become more competitive.

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OPPORTUNITIES IMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY IFI’s

An increase in Government spending on infrastructure leading to more stable workload for local SME contractors.

Opportunities for local SME contractors to grow and handle projects financed by IFI’s.

An increase in cooperation with international firms working on larger projects.

Enhancing the capacity of the local SME contractors, makes them more competitive in international tenders.

THREATS IMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY IFI’s

Most of the workforce is aging. No direct and immediate implication, but a potential threat to the industry's sustainability.

Most of the equipment is aging. No direct and immediate implication, but a potential threat to the industry's sustainability.

Delayed interim and final payments. Inability to grow the capacity of the local SME contractors.

Bid bonds and performance bonds issued by local banks at high costs and also require cash collateral of over 125% of the value of the guarantee, i.e. funds blocked.

Limit the opportunities of local contractors to bid. Increase the cost of local contractors’ services.

Not enough work for the SME contractors. Companies bid sometimes too low with potential implications on schedule and performance compliance.

The growth of the proportion of construction work undertaken in the hidden economy.

Unfair competition and the law in disrespect.

National professional standards and quality standards still to be coordinated with the EU.


Lack of training, research and development funds.

Threat to present and future operations.

Skilled workers leaving the country for overseas assignments with international construction companies.

Threat to sector’s sustainability.

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4.4.1 Financial Sector Overview and Trends Affecting Construction Financing.

The survey of the financial institutions in Bulgaria has revealed that the local banks have been consolidated and have strengthened their operations. As in other countries in the region, many have recently been bought by major foreign financial institutions, continuing the transition process. This has led to continuing improvement in banking services and healthy competition and also to conservative policies and regulations requiring that all loans be secured.Equipment leasing firms exist in Bulgaria but have limited construction industry business. Residential mortgage lending is growing, but is still in initial stages, as is the related financing of housing contractors.Financial Institutions Interviewed and their construction industry business

For this project, six banks, an investment fund and a leasing company were interviewed. We also met with a representative of EBRD’s Resident Office.Again, few banks completed our questionnaires but most were willing to provide verbal answers. To get an understanding of regional views of construction financing, some of the interviews were conducted in Plovdiv.All the financial institutions interviewed, International Commercial Bank, BNP Bulgaria, Bulgarian American Credit Bank, First Investment Bank, Hebros Bank, United Bulgarian Bank and Interlease, are foreign owned, as are almost all of the major banks. Most recently, Unicredito Italiano bought over 90% of the largest bank, Bulbank. In addition to the financial and training resources of their new parents, many of these banks have special credit lines from EBRD, IFC, KfW or others and have had foreign advisors. The resulting increased level of expertise and sophistication was clear and has an impact on financing options for the construction industry.As was the case in other countries, few of the financial institutions completed the questionnaire that we had sent well in advance of our meetings, and meeting participants were sometimes unwilling or unable to tell us the information requested. Several banks refused to participate at all and one even cited a price we would have to pay to have our questionnaire completed. In spite of that, the questionnaires provided focus to our meetings and helped us gather much useful information.At none of the banks interviewed did construction industry business account for more than 10% of its portfolio, although

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some banks had definite interest in developing construction related business. The Bulgarian American Credit Bank has played an important

role in developing financing for the smaller construction companies. Its Managing Director for Real Estate and Mortgage Finance said that they have a structured construction lending programme for loans, ranging from $150,000 to $500,000, to carefully selected builders/developers of apartment housing. Loan tenor is 2-2 1/2 years covering both the construction and the selling time. The bank claims a very good repayment record on these working capital loans, which comprise 100% of the bank’s construction financing business;The bank also offers 10-year residential mortgages to qualified individuals wishing to buy apartments completed by these builders/developers, and the bank’s parent, the Bulgarian American Enterprise Fund, takes equity positions in real estate projects and is considering establishing a real estate investment fund for which it would seek other investors. The loans outstanding under the programme only account for 3-5% of the bank’s portfolio, but residential mortgage loans equal about 15% and a similar programme of loans for small hotels equals 20%-25% of the portfolio. The pioneering development of these programmes included work with the government to improve the legal functioning of the business and has been followed by other banks, some of which are now starting residential mortgage programme and exploring related construction finance;This combination of project based loan and equity construction financing with buyer financing supporting the repayment/takeout, is common in the USA and EU but rare in South East Europe.

The foreign CEO of the International Commercial Bank is also very interested in developing this business for both residential and commercial building projects. The amount of construction business is small, limited to three customers, and accounts for only 3% of the bank’s portfolio now, but the bank has a construction engineer/lending officer responsible for marketing it. Of this exposure, 99.2% is for working capital loans, some of which have maturities of over a year. It has only one small bid guarantee for a medium sized firm. Almost 100% of the bank’s construction business is with SMEs so its focus and operations are a bit different than those whose market is the large firms. As Chair of the Bulgarian International Business Association, Finance Section, the CEO is lobbying for improvements in the new law authorizing mortgage-backed bonds that can refinance mortgage loans. He claims that the State Savings Bank and the Post Bank are both starting mortgage lending programs and UBB says that it

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has also started. First Investment Bank is planning one and Hebros Bank is considering it.

The First Investment Bank is planning to start a $1 million trial mortgage lending program for upper income individuals and employees, referred by corporate clients, who have their salaries paid through the bank. Its construction business had been 6.8% of its total in 1995, dropped to less than 1% during the crisis, and increased to 4.2% in 1999 and was 5.2% in January 2001. Its main focus is on big firms (over 250 employees) especially in the construction industry.

United Bulgarian Bank (UBB) had less than 3% of its loans to construction companies in 1998 and 1999, but, as of 3/31/01, this loan exposure has grown to 4%. If guarantees are added, the construction share of total credit exposure was estimated to be about 10%. It was estimated that 60% of total exposure was for guarantees, less than 20% for working capital loans and the balance for equipment financing. The bank views construction as an important sector and mostly finances large and medium size firms, especially those building infrastructure. As the successor bank to the former bank for construction, Stroybank, it has well-established relationships these larger firms. They estimated that their credit exposure is divided about equally between the three sub-sectors: contractors, suppliers and technical subcontractors/others, and it prefers existing customers to new ones. Suppliers are favoured over contractors because they have more reliable cash flow and have inventory, which can be liquidated to pay loans and usually have more fixed assets to mortgage.UBB has started to make residential mortgages of up to 20 years duration. It sees this as an important new business. Although it is making a cautious start, it wants to be a market leader.

The Hebros Bank manager with whom we met estimated construction industry financing to be less than 5% of the bank’s exposure and concentrated on medium size firms. The large firms mainly bank with UBB or Bulbank. Small firms are also important customers, but less interesting because they are less informed about bank loan procedures, because their investors on projects are primarily individuals whose ability to make contract payment is often unclear and because the housing market, on which they focus, has low demand now.BNP (Bulgaria) concentrates on large customers with annual turnover of at least $1 million. Again we received no statistics or questionnaire answers, but were told that construction is a very important sector, a focus of one of four lending teams, and probably at least 10% of the bank’s exposure.

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Leasing and Equipment Rental

We interviewed only one leasing company, but discussed the subject with a major construction firm and with some of the banks. Interleasing is 77% controlled by National Bank of Greece (NBG) with minority ownership by the IFC and the Bulgarian Industry Association, but is not part of NBG’s regional strategy. It makes financial leases covering equipment for industry and has only a 5% exposure in the construction sector. All of that has been to materials suppliers and has primarily been for trucks and equipment for processing inert materials. It prefers suppliers over contractors because they have cash flow that can be forecasted using normal projection techniques, whereas contractors’ cash flow is based solely on contract payment difficult to project beyond the end of existing contracts. Suppliers usually are also not as subject to “the political risk” inherent in many construction contracts. Interleasing does see potential for leasing to contractors with good infrastructure contracts. Interleasing said that leasing has a good legal basis in Bulgaria, but there is a problem in repossessing leased equipment because the procedural delays in the bureaucracy and courts can stop repossession up for up to one year. They summarised that Bulgaria is still a risky and difficult environment for leasing, which is based on cash flow without collateral other than what is leased, and that the banks are more likely to finance equipment.Local leasing companies concentrate on leasing cars and home appliances. UBB does some equipment leasing itself directly in addition to the business of its sister company, Interleasing. First Investment Bank also has a sister company, Unilease, which does some business equipment leasing. BNP is also looking at leasing. Neither Hebros nor any related firm does leasing, but it does finance some leasing firms, none of which do equipment leasing.Investment Fund

We met with the regional General Director of the Small Enterprise Assistance Fund (SEAF) and a representative of its local subsidiary, CARESBAC (Bulgaria). SEAF and its subsidiaries make equity investments in SMEs in six South East Europe countries, including some that are construction related. In Bulgaria, these include a plastic pipe and a marble company. He gave us his views on the construction industry and mentioned a number of other investment funds, noting that Romania had the most investment funds operating locally.4.4.2 Financial products for construction firms,

requirements and termsAll the banks offer the usual types of contract-related guarantees, short term loans and some long-term loans. Banks with large and medium size construction firms reported that

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guarantees were the most used product, but banks concentrating on the small firm, had limited demand for guarantees and have most of their exposure in short term loans. The small firms have direct personal contact with the investors/buyers of their services who are usually residential housing buyers. Therefore, they usually do not need bid and performance guarantees, but do need short term debt to cover working capital needs during the relatively short construction and sales period of their small projects. The small companies have less equipment financing needs, using less expensive manpower instead of machines in most cases. Where equipment, more specialised than the older, used trucks and other basic equipment that they own, is needed, they subcontract for it or rent it from another company. These small firms usually do not work on IFI funded projects, unless the projects have small subprojects. They may grow to become potential subcontractors on IFI projects, and they are steady customers for building materials. They also generate small but sustaining jobs for technical contractors, e.g. electricians, and for firms that have the more specialised equipment that small firms occasionally need. Those suppliers, technical firms and larger small/medium size contractors, all of which work on IFI projects, keep busy between big contracts with jobs generated by the small firms. This gives them strength and makes them better choices for the IFI projects and other large jobs.Collateral requirements again are a major stumbling block for some firms. Bulgarian banking regulations require a minimum of 125% collateral for all credit usage. Accounts receivable can be collateral only in conjunction with other collateral, but receivables reportedly cannot legally be assigned to the bank. According to UBB, commercial property cannot be used as collateral. All banks interviewed require more than minimum collateral, in some cases up to 200% of the credit amount. BNP requires that at least a third of the credit be covered by cash collateral, combined with the other forms of collateral needed to meet its required levels. The table below shows the information gathered on credit terms, for those banks that gave us the information we requested.

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Name of OrganisationGuaranty Interest Interest Max Required %Fee, Qtrly Rate ST Rate LT # Years Collateral

Internat. Comml. Bank 0.40% 14 +1.5% 12-14% N/A min. 125%BNP Bulgaria 2% N/A N/A N/A 130-140%Bul. Amer. Enter. Fund N/A N/A 18 + 3% 2 ½ N/AFirst Investment Bank 0.75% 16.60% N/A N/A min. 125%Hebros Bank, Plovdiv 0.3-0.6% N/A N/A 3-5 130-150%United Bulgarian Bank 0.5-1% 10.5-12% 15-16% 7-8 150-200%Interlease N/A N/A N/A 4 0Bulgaria uses Floating rate, BB+spread N/A means not available, not given or not applicable

Construction companies reported the banks were much too bureaucratic and that approval took 10-20 visits to get approval, but many of the banks reported expedited approval within a week or two or even less, if the borrower had all information in order.Guarantees

In contrast to some other countries surveyed, Bulgaria had no reports of banks issuing guarantees on payments by construction firms to foreign equipment suppliers financing their equipment sales. As elsewhere, banks, except those exclusively serving SMEs, have more guarantee credit exposure than loan exposure to the construction sector. As noted before, UBB estimated that 60% of its construction industry credit exposure was from guarantees. BNP said that all of its exposure consisted of guarantees. Other banks serving larger firms also said that guarantees were important, but BACB and International Commercial Bank had very little or no guarantees issued. Reported guarantee fees, shown in the table above, vary considerably between the banks. No bank expressed any problem with getting confirmation of its guarantee, when requested. Hebros Bank said that it makes 3 year revolving credit agreements covering bid and performance guarantees up to the facility’s limit.Working Capital Loans

As noted above, banks, such as BACB and the International Commercial Bank, are financing the working capital needs of SMEs primarily. There is no breakdown on how much of this working capital financing is short term, but it is clear that a substantial part of it is made for tenors over one year. Medium size and large firms use less short term financing, with coverage of cash flow gaps caused by contract pay receipt delays and normal differences in timing between receipts and disbursements being their major use.Equipment Finance Loans and Leasing

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The only bank, reporting any significant level of “investment loan” plant and equipment financing, was UBB, which guessed that it accounted for over 20% of its construction industry financing. On this term loan financing, UBB noted that it has been increasing its maximum loan maturity from a prior limit of 3 years to 5,6,7 and even 8 years in some cases. As noted above, construction equipment leasing is in its infancy, rental of new or recent model equipment from foreign sources is very limited in number of transactions, and supplier financing is similarly limited. Interleasing makes financial leases typically $50,000 - $1 million in US$, DM or Euros for up to four years.4.4.3 Constraints in financing construction industryAgain there are big differences between the constraints faced by the large and the sophisticated medium sized firms and those faced by the smaller SMEs, and between contractors and suppliers. Problems and their causes

1. One common complaint from the financial institutions is that none of the firms present good credit proposals that include all information needed. BNP noted that not even the biggest firms present complete, well-prepared proposals and that big firms do not want to give data and small ones have only raw data. SMEs lack knowledge of financial management and many have no experience with credit. SME owner/managers especially try to keep total control not only withholding information from banks but also from their own key personnel, and not delegating authority or establishing a management structure.Firms generally have the idea that loans are made on the basis of personal contacts instead of project quality demonstrated in proposals that need as much work as a sales proposal. They are reluctant to disclose financials, ownership information, project work history, technical experience, etc. to the banks. This makes it harder for the firms to get financing and for the financial institutions to make good credit approval decisions.

2. Financing equipment is a problem in the construction industry. The larger firms that are likely to work on infrastructure projects have equipment issues similar to those found in other countries. The biggest firms that work internationally can get loans from banks, supplier financing, leases and even international rentals, but not always all that they need. One bank commented that even the biggest firms lacked the equipment and capacity to win major international tenders.

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The smallest firms do not need much equipment beyond old, second hand trucks and similar basic equipment, and equipment rented locally or subcontracted for a short period or a special task. However, it is worth noting that the equipment needs of the small firms may be underestimated because the costs of operation, maintenance and down time of the older equipment increases the operating costs for the small companies.The medium size firms need good equipment to be selected as subcontractors on large projects and for their own smaller projects. The medium sized firms and larger small firms have the most trouble financing equipment purchase. The medium and smaller sized firms have limited fixed assets to provide as collateral, have very little or no foreign income or foreign bank relationships, and weaker relationships with Bulgarian banks than the biggest companies.

3. Another problem is that the contractors usually have special difficulty obtaining financing. As noted before, most Bulgarian banks consider the building materials suppliers to be better credit risks than the contractors. Their production and sale of product produce income and cash flow that is steadier and easier for the banks to predict than the “sales” from the winning of contracts and cash flow from contract payments. Contractors are viewed by all interviewed as risky clients. Several of the banks commented that there are not enough good construction companies for them to finance.

4. Meeting even the minimum collateral requirements mandated by regulation is a problem for the smaller firms.

5. Payments under city and government contracts are sometimes delayed.Products not offered

The main product not offered to many of the contractors is equipment financing.

Possible ways to overcome the problems

1. Encourage and support assistance programs to help construction firms, especially the SMEs, understand the mechanics and value of good financial management and of credit relations with banks. Similarly, assist interested banks to understand and develop credit programs for construction firms based on best practices elsewhere.Several banks said they spent extra time with these clients both to get good and accurate data for analysis and to help the clients understand the process and their needs. It was also noted that the companies have learned much the hard way from the bankruptcies and their own problems during

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the 1996 - 1998 crisis period. Hebros pointed out that there has already been a great weeding out of weaker firms, e.g. in 1995 there were 250 construction firms in Plovdiv, but now there are only 30 to 40. The remaining firms are now apt to be conservative and to self-finance to a significant extent. Most understand that their reputation, quality of work and record of completion are the strengths that bring them work now. They should be able to learn that good general and financial management are equally important. Those that can adapt will have advantages over those that do not, continuing the weeding of the firms.The banks interested in building construction business, in turn, need to become less bureaucratic, to continue streamlining their procedures to efficiently process credit applications and to understand the financing of contractors and apply that understanding. The revamping started by the new foreign owners should help this process. The competition that these new banking methods has brought is also encouraging further efficiency. The banks that do not adapt and hold on to old methods will face declining business and worse performance.

2. There are several options in making equipment financing more available. Leasing can be encouraged to develop. Supplier financing can be encouraged. Expansion of rentals from foreign companies can be explored as proposed by Gas StroyMontaj. Providing equipment through procurement by major projects is another option to explore. The medium sized and larger firms, which have the main need, should benefit most from the implementation of any of these options. Better financial management by the smaller firms and careful analysis and structure term lending may help the smaller firms to at least get newer and better used equipment.

3. Financing of construction contractors can be made easier. It is a specialty that requires a different approach from that of financing producers of goods and services. The key is analysis of the projects and the investors plus assurance that the contractor can meet the terms of the contract and keep its expenses within budget. If the investor is a low risk one, e.g. the government or an IFI, and the contract payments are paid through the financing bank, the bank’s risk is significantly decreased. Most of the banks have experienced construction experts on staff and have a general awareness.For contracts where the project funding is not as assured or is dependent upon buyers not committed in advance, the risk increases significantly. In the US and the EU, bankers usually require that there be a significant equity investment in the project before they provide any project financing. In

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some cases, they, or related companies, take a piece of this equity themselves to get some of the high yield it can generate. Analysis of the market for the completed object constructed, usually a building, is key to this. The Bulgarian American Credit Bank has pioneered this method in Bulgaria by financing small contractors building apartment buildings. It does a very careful analysis of the contractors and only finances the few that meet all of its qualifications. It also reviews each project and may recommend that its parent organisation make an equity investment in the project. It also closely studies the market for new apartments and arranges mortgage loans for buyers, if they meet its credit requirements.Larger firms reportedly have been financed by or through the support of foreign joint venture partners, or by the general contractors if they are subcontractors. Some small construction firms are getting financing based on their businesses in other sectors. A small construction firm said that it had a loan on manageable terms from Eurobank, which says it does not do any construction business, but the loan was for furnishings for a café the firm had built and owned. The loan was approved in spite of the firm’s construction business and not because of it. Firms may be getting more financing than the statistics indicate. Some of the short-term loans reported may be, in effect, longer term loans because they are not repaid within a year. A few banks told us that a significant amount of the short term loans were “evergreen” with no fixed repayment schedule, no requirement to be fully repaid at some point during the year and usually renewed for the next year without repayment. Such permanent working capital loans can be used for many purposes, including equipment finance. Evergreen loans are not usually considered good banking practice, but they are helpful to borrowers, such as many in the construction industry, who have difficulty getting term loans. They do carry risk for the borrower because the bank has the right to demand payment at any time.

4. Collateral requirements could be lowered when the credit risk is low enough, if Bulgarian regulations requiring collateral were lifted or modified. Commercial properties should also be allowed as collateral, with restrictions if necessary. Firms that have other businesses, a building materials operation is a fairly common example, will have fixed assets useable as collateral. To the extent that non-bank financing can be used, collateral requirements may not exist at all. However, collateral requirements are likely to

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remain, and those contractors that have none to offer will continue to have problems getting bank financing.

5. Procurement advice to the Bulgarian cities and other government entities making contracts may end payment delays, but until that comes to pass, short term loans repaid by the payments when they come, should be easy to arrange. A firm with good financial management should plan for such contingencies and be able to cover such delays from its own resources.

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5 Overview of the Construction Industry in Macedonia 5.1 Brief Economic Overview of Macedonia

The transition process in Macedonia has been very slow due to internal and external factors such as the crisis in Kosovo, the political and ethnical polarisation, the weakening of the position of the ruling coalition, bureaucratic obstacles, and inconsistencies in the legislation. However, with the support of the international community channeled through IFI’s, the Stability Pact and other bilateral donor programmes, the transition in Macedonia is set to continue.The primary objective of most of the programmes is to support the restructuring and privatisation of state owned enterprises, encouraging the development of private sector small and medium size enterprises, and the creation of new jobs. Additionally, as part of the Stability Pact initiative for South-Eastern Europe, a number of infrastructure projects in Macedonia are being targeted under the “Quick Start” programme, coordinated by the European Commission and the World Bank. These projects include new roads on the east-west and north-south corridors and a programme to improve water utilities. Donor funding is being provided for the reform of Macedonian legislation creating a better market environment for the construction sector. A law on Public Procurement was passed in 1998 facilitating the development of a competitive market for local and international construction companies to work on public and municipal projects. The construction sector companies in Macedonia are being extensively privatised through management-employee buy-outs. Due to the high risk associated with Macedonia, grey areas in the property law, and over-valuation of firms, the sector has not attracted significant foreign strategic investors to bring in fresh capital and know-how. A major foreign investment was made by Titan/Holderbank of Greece and Switzerland who paid US$30 million for the Usje cement factory. There have also been a few smaller investments in building material enterprises by firms such as Knauf (Germany), KUPPBALL und Transthandel (Germany), Duferco (Switzerland) and SCMM (France). Unfortunately, most of the privatised and state-owned companies have shown very poor performance, mostly due to the low demand for their products and services and lack of working capital, affecting small and medium-sized enterprises in particular. Many companies also lack investment capital to modernise production, improve distribution, and increase competitiveness and exports. Until recently many small contractors used to work in the “grey” economy due to the very restrictive labour laws and high taxes that smaller operations prefer not to pay. However, since the

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beginning of this year income tax rates and payroll contributions payable by the employer have been significantly reduced and this may lead to more of the smaller contractors moving out of the “grey” economy, boosting the private sector.According to the Macedonian Statistical Bureau, the construction industry contributed around 6 % to the GDP of Macedonia in the year 2000. Over the last ten years the construction market in Macedonia has mainly comprised housing, commercial buildings and infrastructure projects. There has been some greenfield work, mostly housing but more repair and maintenance, which is set to continue to account for the major part of construction industry output. Large-scale industrial work has been slow due to the lack of new investments in the industry. Over the last year there has been an increase in export of construction services and building materials to Serbia. As Serbia has traditionally been an important market for the Macedonian construction sector, there are expectations that the positive changes in Belgrade will stimulate a further increase in the demand for construction work and materials over the coming years. 5.2 Characteristics of the Construction Industry of

Macedonia5.2.1 Structure:Contractors

Construction is one of the major industries in Macedonia employing approximately 27,000 people. According to the Macedonian Chamber of Commerce, the construction sector has an annual turnover of US$400 million - approximately 20% is export of building materials to neighbouring countries and construction works abroad.In the past there were a few large state owned engineering, procurement and construction type companies, similar to other Eastern European countries. They worked on projects in Yugoslavia and around the world, especially the Middle East, Russia and other Soviet Bloc countries. They employed a large number of staff and covered most of the industry chain: material and equipment suppliers, design, construction, and commissioning. Over the last few years, these companies have significantly downsized, losing traditional markets and work mainly locally, and occasionally in neighbouring countries such as Bulgaria and Albania, on public and municipal projects financed usually by the World Bank and EC. Many of the key executives of these firms worked abroad managing big projects and are very familiar with international bidding and project execution practices. Large companies include Granit Construction Company, Mavrovo Construction Company, Pelagonija Construction Company, Pelister and Beton. Most of the former

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state-owned organisations have been privatised by management-employee buyouts over the last two years. Similar to Romania and Bulgaria, there have been a lot of spin-offs from these large companies and, as a consequence, there are now emerging new small and medium sized specialised firms, mainly active in the housing and commercial building sector. It is estimated by the Macedonian Chamber of Commerce that there are over 5000 companies operating in the construction sector of which over 90% are small to very small. These represent a large category of companies facing critical barriers to accessing international work due to lack of capital, awareness of opportunities and necessary skills and resources to prepare international bids. Typical examples of such companies are: Bortas Engineering, UPA Enterprises, Unija, TIM, Continental Engineering, Makedonia Proekt and Granit Proekt. Most of the small companies are involved in the design, construction and commissioning of small residential and industrial rehabilitation projects with a TIC less than US$ 100,000. When reviewing the existing types of activities and recourses of local contractors in the light of EBRD classification of large and SME contractors in Macedonia, it is important to compare these against benchmarks used by the construction industry worldwide such as project size and sector. The size benchmarks have been derived from common denominators such as scope of services, number of drawings, major equipment items, and the home office and field labour hours, converted into international prices to determine the Total Installed Costs (TIC). TIC is a key industry indicator for project size. The table below shows how Macedonian contractors compare against international project size benchmarks.

Project Size(TIC in US$)

SME Contractors% of revenues

Large Contractors% of revenues

Very Small Projects: Under $1 million

100% 70%

Small Projects:$1 million to $10 million

No 25%

Medium Projects:$10 million to $50 million

No 5%

Large Projects:$50 million to $200 million

No No

Super Projects:$200 million to $600 million

No No

Mega Projects:Over $600 million

No No

Resources of contractors in Macedonia

It is essential to point out that there is no existing construction company in Macedonia in a position to show the past ten years

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experience with large, super and mega projects. This limits the opportunities for Macedonian firms to act as prime contractors on large, super and mega projects.The particular sectors of operation by the local contractors is the other important indicator to judge if they have the expertise and skills to implement up-to-date technologies and complete these on time, within budget and to the technical requirements of the project sponsor. The sectors are identified according to international construction industry practices. The major sectors can be broken down into: Greenfield construction of process related plants and facilities; Greenfield construction of non-process related plant and

facilities; Repair and maintenance of process related plants and

facilities; Repair and maintenance of non-process related plant and

facilities.The table below shows the abilities of the Macedonian contractors per sectors.

Sector SME Contractors% of revenues

Large Contractors% of revenues

Greenfield construction of process related plants and facilities:

No No

Greenfield construction of non-process related plant and facilities:

25% 50%

Repair and maintenance of process related plants and facilities

No 10%

Repair and maintenance of non-process related plant and facilities

75% 40%

Type of Activities of Contractors in Macedonia over last ten years

In the survey we have identified typical large, medium and small companies and analysed in more detail their activities and capacities. Material Suppliers

Macedonia has a number of local manufacturers of basic building materials such as aggregates and sand; lime and gypsum; marble and other stones; clay ceramics (bricks and tiles); sanitary ware; cables and wires; wood products. The major international manufacturers of building materials have access to the Macedonian market via representative offices in Macedonia or through their offices in neighbouring countries, namely Greece and Bulgaria.It is possible to buy products of well-known international firms such as Rigips, Crackstop, Movinord, Rehau, Dalsan, Cerezit,

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AMF, ABS, and Vedag. Most of the international firms provide goods on credit to qualifying contractors and continue to improve their distribution networks in Macedonia. Due to the increase in demand for building materials in neighbouring Kosovo, the local building materials industry has experienced growth and has also attracted a few international building materials manufacturers such as Knauf (plaster boards) and Titan/Holderbank (cement). They have brought in positive changes to the local building materials market by improving the local product quality, packaging and distribution.A great number of state-owned manufacturers of building materials have been privatised by management-employee buy-out. Most of these companies are facing huge difficulties in raising finance for upgrading facilities and improving product quality and distribution networks, and the management skills available within are poor, leaving some of them struggling to survive.Major areas of improvement are: defects (product quality); delivery time; ability to deliver straight to site; competitive cost; and payment terms. There are also a number of idle facilities such as crushing plants, asphalt and concrete mixing facilities. Equipment Suppliers

The big names of the construction machinery industry have sold very little new equipment to Macedonian contractors or plant hire firms in the last 10 years. In the past three years there has been an increase in sales of second hand equipment from Western Europe such as excavators, loaders and trucks. The demand for construction machines is expected to increase when the large-scale building and infrastructure projects announced by the Stability Pact get off the ground. As the existing equipment fleets are dating back to the 1980’s, there is an urgent need for new machines such as mobile cranes, access platforms, mini excavators, hydraulic excavators, crawler dozers, crawler loaders, wheeled loaders, backhoe loaders, skid-steer loaders, motor graders, rough terrain lift trucks, compaction equipment, asphalt finishers, mobile compressors, concrete mixers, mobile concrete pumps and dump trucks. Only a few large construction firms can afford buying such machines providing they win enough work to pay for the upgrading of their fleet. The power tools market in Macedonia is well developed. Major power tool manufacturers such Sparky (Bulgaria), Hilti (Luxemburg), Bosch (Germany), and Husqvarna (Sweden) have established a good distribution and after sales services. Plant and Equipment Hire

There are a few plant hire firms with a small number of machines, for example the typical fleet will consist of 1 – 2 loaders, 1 - 2 trucks, 1 mixer and 1 excavator, most of it aging but well maintained. Some of the large contractors that own

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equipment act as plant hire companies, providing, on a rental basis, the heavy equipment needed for various construction projects. In their best years their fleet numbered hundreds of various machines made in the Soviet Bloc countries as well as in the West. Local contractors have known western companies such as Liebherr, Grove, JCB and Caterpillar for many years. Due to the recession in Macedonia for the last ten years, the construction firms and plant and equipment hire companies could not afford new equipment. The average amount spent on new and second hand plant and equipment is around US$4 million per year. The local companies usually purchase these with their own capital. High cost of capital and lack of a stable workload makes it difficult for them to implement large-scale fleet upgrading programmes through equipment lease or bank loans. Consulting Services and Design

Due to low start up costs and abundance of qualified engineering specialists, there are huge numbers of private consulting firms with wide ranging areas of expertise. Most firms are very small (1-5 employees) and many are equipped with modern computers and software, and offer services to western standards. There are no western firms with offices in Macedonia providing services to local and international clients. Former stated-owned design and consulting firms have been privatised by management buy-out. Most of them are on the verge of bankruptcy due to poor management of human resources. Sector Specific Services

It is important to point out that there are certified laboratories in Macedonia responsible for quality control in the sector. These laboratories make sure that construction industry companies comply with regulations and standards. The Institute for Testing Building materials certifies that all the manufacturers and suppliers of building materials products comply with Macedonian regulations and standards. The Civil Engineering Institute and Macinspekt carry out the quality control of civil works. Under the EC Phare programme, the German Institute for Testing Materials has been providing consulting services to these laboratories to make them compliant with EU standards. There are two construction industry professional organisations in Macedonia: the Macedonian Association of Civil Engineers and the Macedonian Association of Architects that organise training seminars and conferences for their members. Recently they have launched a new programme teaching Eurocodes and western best practices. The consultant is not aware of any other construction industry support organisations such as trade, construction industry newspapers, and guilds.5.2.2 Demand for ConstructionFood Processing Industries

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The agricultural and agribusiness sector is well developed and currently contributes over 20 per cent of GDP. Privatisation of the sector is largely complete through sales to existing managers and farmers. The ideal climatic conditions for growing high-value early-season fruit and vegetables and the good opportunities to supply to neighboring Yugoslavia, have attracted investors and new facilities upgrading programmes backed by IFI’s, focusing on producing canned and bottled fruits and vegetables.Wine making is becoming an important hard currency earner, bringing in annual revenue of over US$25 million. However, the sector needs substantial investments in modern wineries to increase volume and improve quality.Local construction firms have executed successfully major renovation projects in wineries, wheat mills, tobacco fermentation and fruit processing plants, slaughterhouses and farms. Further opportunities exist for the small and medium size contractors with regards to rehabilitation of the aging food processing plants and farms. The typical project size in agriculture and food processing tends to be small, between US$50,000 to US$5 million, which is within the capacity of the local construction industry.Commercial Buildings

There is a growing demand for office buildings, leisure facilities, hotels, bars, restaurants and shopping malls. There are good opportunities for repair and maintenance of the existing building stock as well as for new construction. Such projects, costing from US$50,000 to US$50 million, are well within the range of projects the local contractors can undertake. For example, there is investors’ interest in refurbishment and upgrading of aging hotels along the Ohrid Lake. Local firms can carry out most of the works. It is also expected that major European chains such as Metro Cash & Carry (Germany), Billa (Austria), Ena (Greece) and Koc Holding (Turkey) may consider opening super and hypermarkets in the coming years. Local contractors have the ability to build such stores at an average cost of US$2 million.Power Plants and Transmission Lines

All power plants and transmission lines are owned by the state electricity utility Elektropanstvo na Makedonija (ESM). Over the past five years there has been a few upgrading and rehabilitation projects including the construction of several transmission lines financed by IFI’s. Local firms acting as both prime and subcontractors carried out most of the construction work. Major international energy firms have expressed interest in the sector and are holding talks with the government. If the sell-off of ESM goes ahead, there will be many good opportunities for local contractors to work on a number of rehabilitation and new projects such as power plant, dams, and transmission lines with neighbouring countries. As most of the power sector projects are

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too large in size for the local contractors, local contractors can join with major international contractors providing specialist services and labour.Civil Works/Infrastructure Projects

The infrastructure of Macedonia has not seen much investment over the past ten years and is in need of repair and proper maintenance. All major IFI’s, EC, NATO and the US Government have been supporting the Government of Macedonia in the process of upgrading the infrastructure. Local large contractors such as Mavrovo, Granit, Pelagonia, EMO and Beton built most of the existing facilities. These companies are also carrying out most of the construction works that are currently underway. Recently five Macedonian water utilities have raised financing of US$57.7 million to investment in the construction, rehabilitation and extension of water and waste-water infrastructure that could be a good opportunity for local contractors to pursue. Roads and railways

Macedonia is an important transit country in the Balkans; however, all links to the neighbouring countries are in need of renovation. A number of major projects have been completed or are in progress, financed by IFIs including the EU, the EIB and the World Bank as well as by bilateral programmes with Greece and Taiwan. Two key Pan-European Transport Corridors cross the country, Corridor 8 (from Durres, Albania via Tirana, Skopje and Sofia to Varna, Bulgaria) and Corridor 10 (from Thessaloniki, Greece via Skopje, Belgrade and Zagreb, Croatia). Various parts of these corridors have been upgraded or have plans for future upgrades. Most of the roadworks have been publicly tendered and awarded to local contractors such as Granit, Scopje, Ilinden Struga and other large local contractors. The country railway network is under-developed and the country has no east-west railway route. Construction of a 55-kilometre railway route from near Kumanovo on the FR Yugoslavia border to the Bulgarian border began in 1995 but is making very slow progress due to lack of funding. Local firms do most of the work.Bridges

Within the framework of the Stability Pact and NATO programmes there are plans to finance the strengthening of existing bridges on major roads. Local firms can carry out most of the work. In addition, municipalities also undertake construction and repair of small bridges contracting local firms through open tendering. Airports

Macedonia has two airports, Skopje and Ohrid. The Scopje Airport has undertaken a major rehabilitation project to the value of DEM17.8MM, financed by EBRD, to improve the runway,

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taxiways and the lighting system. There are further investment plans for the airport’s long-term development that could be a good opportunity for local contractors. Plants and Facilities

Macedonia has experienced a massive decline in the state-owned heavy industry sector. Over the last four years many industrial plants have been privatised, for example the country’s only oil refinery, OKTA, was sold off to Hellenic Petroleum, the largest industrial company in Greece in 1999. The new owner has already launched its modernisation programme and the construction of an oil pipeline. Hellenic Petroleum takes the view that international contractors such as Aegek of Greece have the expertise and capacity to build the pipeline and undertake upgrades at the refinery. Other industries with ambitious modernisation plans include: pharmaceutical, chemical, cement, mining and metal. For example, the steel producer Makstil, recently privatised by Duferco of Switzerland, has spent over US$10 million to modernise Makstil’s casting facilities and its Skopje plate mill plant. Large local contractors are carrying out most of the industrial repair and maintenance projects.5.2.3 Industry CapacityDue to the slow down of the economy and the break up of Yugoslavia, the local construction industry has downsized enormously to meet the tiny local demand for small-scale housing schemes, commercial buildings, infrastructure and industrial facilities rehabilitation projects. As the workload in the construction industry in Macedonia has varied widely over the last ten years, only the large contractors have been able to survive on the back of government contracts. The local contractors have undertaken relatively simple projects such as roads, commercial and residential buildings and very little complex industrial projects where the qualification of the workforce is key.Over the past two years there has been a demand for upgrading some of the existing industrial facilities requiring contractors with specialist expertise. Such expertise has proven to be difficult to source in Macedonia. For example, the construction of the US$122 million Crude Oil Pipeline linking the Greek port of Thessaloniki and the OKTA Refinery in Skopje has been awarded to Aegek, a Greek construction group. In addition, the local construction industry lacks financial resources to cover any working capital, guarantees and work experience requirements that developers and banks financing large-scale projects may require.

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5.3 Survey of Local Construction Companies in Macedonia

5.3.1 Construction Companies InterviewedDue to the conflict in the Republic of Macedonia, there has not been much interest from the local contractors to participate in the survey. Nevertheless, the consultant team managed to interview a representative sample of SME contractors, large contractors and financial institutions in Skopje and other major towns. The profiles of the construction companies interviewed by the consultant are appended to this report. Based on the representative sample of companies interviewed, the consultant can confirm the following key observations of the state of the construction industry in Macedonia: The construction industry in Macedonia is dominated by a few

large construction firms established in the 1960’s and most of them privatised by management-employee buy outs over the last 2 - 3 years;

SME contactors are privately owned companies with a very small market share and very little resources to take major roles in projects funded by IFI’s;

Most of the large contractors that can participate in projects funded by IFI’s are located in Skopje. There are a few large contractors outside Skopje such Pelister in Bitola, Ilinden (Struga);

Most of the contractors are privately owned and over the last three years have been involved in construction projects of TIC between US$5,000 to US$10 million. The large contractors handle the bigger projects;

There are four large contractors Granit, Mavrovo, Pelahonija and Beton that do projects with TIC over US$10 million. These are former state-owned organisations, privatised over the last three years;

The industry leader is Granit Construction Company that is well ahead of the rest of the large contractors with an annual turnover of over US$160 million, assets of over US$150 million and contracts not only in Macedonia but also in Albania, Bulgaria, Yugoslavia and Russia;

The four largest contractors have no problems in financing their activities. Also, they are the preferred contractors on large-scale public and municipal projects in the country;

Most of the SME contractors do not have very strong balance sheets. The total value of assets is between US$10,000 - US$400,000. A greater part of these assets consists of plant and equipment or plots of land;

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SME contractors have limited access to financing. Collateral requirements are a key. SME contractors report collateral requirements of around 200% of the credit amount and one of the larger and best private SME contractors faced requirements of up to 300%;

Most contractors pay cash to materials suppliers or importers. Larger manufacturers and suppliers of products such as cements, concrete, sand, metal rods, and sanitary ware provide goods on credit only to the large contractors and some qualified SME contractors up to 90 days;

The survey has shown that equipment fleets of the large contractors are ageing. Only a few large contractors such as Granit, Pelister have purchased new heavy equipment over the last three years. Most of the medium size contractors tend to buy small equipment such as mini-excavators, small compressor, mini-compaction equipment, and power tools. The SME contractors rent larger plant and equipment from the hire companies or from the large contractors;

Local construction firms have recently executed mostly housing developments, commercial buildings, and infrastructure projects such as roads and dams. However, they do not have the capacity to undertake industrial facilities rehabilitation projects requiring contractors with specialist expertise;

Most of the SME contractors indicated difficulty securing the services of skilled labour, to work either as direct employees or as sub-contractors.


Unsteady Demand for Contraction WorkThe demand for construction work in Macedonia has crashed over the last ten years. Due to international sanctions against Iraq, Libya and the turmoil in Yugoslavia and the Middle East, the Macedonian contractors lost their major international markets. Almost all larger contractors have downsized their operations.Due to the unsteady workload in Macedonia many skilled workers have left the country for overseas assignments with international construction companies.In addition, skilled workers left the large contractors to set themselves up in business as small contractors or work in the grey economy providing repair and maintenance services.

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Delays and uncertainties with respect to supplies of materialsThe distribution system for building materials has been improving over the last three years but it is still hard to source good quality building materials when needed.Vendor financing is fairly limited but on the increase with some companies extending credit up to three months. Most contractors report problems with the quality and the price of imported materials. Due to the high demand in neighbouring Kosovo of Macedonian manufactured basic products, such as bricks, plaster, flooring, cement, there are often uncertainties in their supply to local sites.Access to hired plant and equipmentThe existing heavy and expensive plant and equipment is aging and new and reliable machines are not easily available. Availability of spare parts is an issue. Usually it takes a few weeks to be delivered.Access to leasingLeasing is at an early stage of development in Macedonia and is virtually not available for SME contractors.Availability of supporting servicesThere are no organisations providing skills enhancing training for the construction industry work force such as seminars on contract management, cost control, specialist skills.Procurement Related

Survey of local procurement rules and their impact on the IFI’s investmentsA Law on Public Procurement, passed in 1998 provided the legal framework for local and international construction companies to work on public and municipal projects, however, the enforcement is reported by SME contractors to be weak.SME contractors complained that they have virtually no access as prime contractors to public and municipal work. Public and municipal work is usually awarded to the “big four”: Mavrovo, Granit, Pelagonia and Beton.Access to informationThe local SME raised their concerns about the availability of the information about procurement opportunities. Many of them were not aware that such information is available on the Internet sites of IFI’s. Moreover, most of the IFI’s procurement opportunities are in English, which is not widely used in Macedonia.There are number of other Internet databases that provide information on procurement opportunities that result from efforts

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financed by international donor organisations and IFI’s. SME contractors are not aware of these either.Capacity to Comply with international requirements and standardsThe consultant has identified that only the large former state-owned contractors in Macedonia have had exposure to international tender requirements, design standards and codes (symbols, layouts, etc). SME contractors reported that international tenders are difficult to prepare due to high costs and lack of experience with international contracting.Employer Related

Delayed interim and final paymentsThe SME contractors in Macedonia complained that they have been paid in kind on several public projects. Delays of payments on public and municipal jobs happen often.Contractor Related

Unfamiliarity with the legal aspects of contract work, contract law, preparation of claimsSME contractors have no legal support and use very simple one page contracts. Large contractors are more sophisticated. They usually have legal counsels.All contractors lack knowledge and experience with international claims. Training in contract management will be very useful. Compliance with ISO 9000Two large contractors interviewed have suggested that ISO 9000 certification is becoming an important issue in winning international work as well as getting jobs from international customers explicitly requiring ISO 9000 certification. SME contractors in Macedonia take the view that ISO 9000 is not needed and will not help them win more work.Restructuring of the large formerly stated-owned contractorsThe big firms also have problems adjusting their operations from being instruments of the government to being fully private competitors in the market. Their contracts are no longer arranged politically and some are having difficulty preparing winning bids. Their performance may in some cases been purposefully weak in order to lower their value and make a management buy-out easier.There are also reports that many of the best employees at the big firms have left the company to run their own small private firms and bad management and corruption among some of those remaining is significant. All have cut staff at least in half, and

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one of the big companies, which in trouble has had its staff decrease from 8,000 to about 1,000. Countering these problems are reports that these companies are getting major international contracts, including some in Albania and even Bosnia, are sharing work among themselves when one of the group gets a major contract, and are even slated to get some work on Olympic Games facilities in Greece. Their problems are affecting their credit worthiness and there are some indications that even the better big firms are starting to find that getting financing is more difficult.5.3.3 SWOT Analysis

STENGHTHSIMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY IFI’s

Local contractors provide cheaper service. Reduce capital costs and dept service obligations of the borrower.

Local contractors have good local knowledge and can cope better with local problems that can cause delay and overruns.

Reduce risk of delays due to unforeseen local problems.

Large local contractors have experience in international contracts in Albania, Bulgaria and Yugoslavia.

Familiarity with regional legislation, standards, suppliers and subcontractors.

Local contractors are robust against competition from well resourced and low cost contractors (e.g. from Turkey)

No conflicts with Government requirements to provide employment to local people.

WEAKNESSESSIMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY IFI’s

Local SME contractors do not have adequate resources to fund the business development work and lack sufficient knowledge of the bidding process and international procurement rules.


Local SME contractors have limited ability to work in international languages (e.g. English).


Local SME contractors cannot expand raising finance due to lack of proven track record and borrowing history and lack a stable workload.


Local SME contractors are under invested in systems and computer scheduling and cost control software.


Local SME contractors do not have proper quality assurance and quality control systems in place.

Limited opportunities to works as subcontractors to international firms implementing IFI’s projects.

Local SME contractors cannot undertake more complex projects for technology upgrade of industrial facilities.


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WEAKNESSESSIMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY IFI’s

Only few SME contractors use of IT, internet and e-mail service.

No access to procurement opportunities.

Only few SME contractors pursue international work. Limited opportunity to become more competitive.

Lack of stable workload to retain good quality staff Limited ability to deliver.

Aging heavy equipment and lack of reliable supply of spare parts.

Can cause significant project delays and increase completion risk.

OPPORTUNITIESIMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY IFI’s

An increase in Government spending on infrastructure leading to more stable workload for local SME contractors.

Opportunities for local SME contractors to grow and handle projects financed by IFI’s.

An increase in cooperation with international firms working on larger projects.

Enhancing the capacity of the local SME contractors makes them more competitive in international tenders.

THREATSIMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY IFI’s

Most of the workforce is aging. No direct and immediate implication, but a potential threat to the industry's sustainability.

Delayed payments and in kind payments. Inability to grow the capacity of the local SME contractors. Cash flow constraints.

Bid bonds and performance bonds issued by local banks at high costs and also require cash collateral of over 200% of the value of the guarantee, i.e. funds blocked.

Limit the opportunities of local contractors to bid. Increase the cost of local contractors’ services.

The growth of the proportion of construction work undertaken in the hidden economy

Unfair competition and law reliability.

National professional standards and quality standards still to be coordinated with the EU

Maintain low standards in the industry overall and can distort competition through unreasonably low prices and completion and quality risks

Lack of training, research and development funds Threat to present and future operations

Skilled workers leaving the country for overseas assignments with international construction companies

Threat to sector’s sustainability

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5.4 Survey Of Local Financial Institutions In Macedonia:

5.4.1 Financial Sector Overview, Trends affecting construction financing

Macedonia was the least developed republic in Yugoslavia before it broke up, but it has, until very recently, escaped the conflict that so damaged most of the other ex-Yugoslav republics. In spite of its opportunity for peaceful development, the financial sector has changed slowly. Under the Yugoslav version of Communism, companies, in theory, were worker owned and the banks were created and owned by these companies. The bank was responsible for taking care of its owner companies and the companies did all their banking business with their “house” bank. The worker/socially owned firms were organised according to a Yugoslav state plan, so they tended to be large and had a very strong influence on their bank. This pattern was broken to a significant degree by the conflicts in Bosnia and elsewhere as the big socially-owned firms failed or sold their ownership in their bank.In Macedonia, especially in the construction sector, which is dominated by four to six old giants, this old arrangement still exists to some extent. Only recently, with the conversion of companies to private ownership and through purchase of some of the banks, has this pattern started to change.The recent National Bank of Greece’s purchase of 70% of Stopanska Banka does not as yet seem to have produced major changes in its operations, but the bank did put less emphasis on serving its large customers than Komercijalna.Financial Institutions Interviewed and their construction industry business

Because of the uncertainty about permission to travel to Macedonia in May 2000, and the limited time available, meetings had to be arranged with the banks at the very last minute. With the kind help of EBRD Resident Office staff, three of the most important banks, Stopanska Banka, Komercijalna Banka and Export & Credit Bank, were interviewed. In spite of having received the questionnaires well in advance of the meetings with requests that these be completed whether or not a visit was possible, none were done in advance. Stopanska and Komercijalna completed a questionnaire, but not until much later. Stopanska forwarded it two weeks after the meeting, and Komercijalna didn’t send it until the fourth week after the meeting requiring revisions after the reporting deadline.Regarding the importance of the construction sector in their overall portfolio, Stopanska had the most construction business, about 8% of its exposure, DEM37.7 million for 91 customers as of 31 March 2001. Of that business, 77% for 6 large firms and the rest to 85 SMEs. Its exposure within the industry was 93% to 80

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contractors and the balance to building materials suppliers. Stopanska has special products for construction firms and expects construction to continue to be an important business for it. The Manger of the Construction and Transport Sector of the Corporate Division of Komercijalna gave us no information on the Sector’s share of the portfolio, but the fact that the bank has a sector devoted to it indicates that construction is a significant business for them. The President of Export & Credit Bank said construction accounted for less than 5% of his bank’s business did not foresee any increase until the large firms were restructured and the smaller ones become more credit-worthy. He added that legal problems related to who owns the land and regarding satisfaction and release of mortgages needed to be resolved.Leasing Companies

Leasing is essentially non-existent in Macedonia. A local representative of major construction equipment manufacturers has created a leasing company but has yet to be able to complete a deal because the costs are too high. Good laws on leasing are also reported as being needed.International Assistance and Financing Programs

Macedonia has the array of international loan programmes found in other Balkan countries, e.g. KfW, EBRD, World Bank, etc. EBRD is part owner of all three banks visited and has lines to Stopanska and Export & Credit. The Taiwan government has had special lines through the banks for housing and school sports facilities construction and for equipment purchase by SMEs. 5.4.2 Financial products for construction firms,

requirements and termsBoth Stopanska Banka and Komercijalna Banka provided details on their terms, but the Export & Credit Bank did not, noting that its construction portfolio was small, included non-performing loans and that the bank was not granting new credits to construction firms. Komercijalna requires 200% collateral and Stopanska’s collateral requirements are 100% for strong foreign currency cash collateral, 130% for Dinar collateral, and about 200% for other collateral.Guarantees

For Komercijalna, guarantees formed the majority of its construction exposure, but they formed only 31% for Stopanska. There is a huge difference reported on the questionnaires in the fees charged by these two banks. Komercijalna charges 0.25% - 0.50% per month on bid guarantees and 0.50% per month on all other guarantees. Guarantees on payments to equipment suppliers can extend up to five years. Stopanska charges 0.18% per quarter to its very best customers and up to 0.32% per quarter for bid, performance and loan payment guarantees.

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Neither bank has any problem with confirmation of its guarantees. If this difference is accurately reported, it is surprising that Komercijalna’s customers have not all moved their business to Stopanska. This may show the continuing strength of “house bank” relationships.Working Capital Loans

Working capital loans are usually short-term and the conditions vary. In addition to collateral requirements, Komercijalna’s interest charges average 17% per year, variable based on who is funding the construction project, e.g. interest rates for loans to a firm with a World Bank funded project will be lower than on one funded privately. Stopanska does not make short-term loans for general working capital purposes, but only to cover specific payment gaps, especially those on which it has a payment guarantee which will be triggered as a result of contract payments to the company, covering a guaranteed amount payable, being received after the guaranteed payment’s due date. These loans accounted for 50% of its construction exposure as of March 31, 2001. The Stopanska’s interest rate for these loans varies between 9% and 17% plus a 2% fee. Some of this exposure may be for loans or revolving credits made with maturities of more than a year.Equipment Finance Loans and Leasing

It is estimated that about 20% to 30% of the construction equipment needed in Macedonia was sourced directly from the manufacturers. Approximately 30% of this was financed by loans, mostly from suppliers guaranteed by Macedonian banks. The 70% balance was paid in cash, although it is possible that some of the cash came from bank loans. This demonstrates the need for increased equipment finance, the lack of it domestically and the important role supplier financing has played.Equipment finance loans are almost by definition term loans. Komercijalna makes no medium term loans from its own funds, only those funded by its World Bank line. For those it charges 14% - 15% on loans up to 3-5 years tenor. Stopanska statistics show that as of 31 March 2001, equipment financing accounted for 19% of its exposure on construction sector business. As with working capital loans, Stopanska charges 9% - 17% per annum plus a 2% front end fee on these investment and fixed asset term loans to a maximum maturity of three years. In addition to its term loans and payment guarantees, Stopanska is helping finance the equipment needs of its customers by providing special customs guarantees covering their rental of construction equipment from foreign sources.5.4.3 Constraints in financing construction industryThe difficulty for construction SMEs getting financing is a continuing problem. The contractors claim that all the financing

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goes to the big firms and there is nothing available for them. Although the banks say that their loans are made on the basis of credit worthiness, which is doubtful for some big firms, and that they welcome new customers, the old “house bank” relationships still have not been fully severed. When SMEs are offered financing, they generally most SMEs cannot afford it. Fee or interest charges may be manageable but collateral requirements are a problem. With limited assets and tight cash flow, they usually are not able to provide collateral conservatively valued at 2 - 3 times the amount of the loan or guarantee. There are also reports that the SMEs lack information on loans and loan programmes and on how to prepare presentable business plans and apply for loans.The big firms also have problems adjusting their operations from being instruments of the government to being fully private competitors in the market. Their contracts are no longer arranged politically and some are having difficulty preparing winning bids. Their performance may, in some cases, be purposefully weak in order to lower their value and make a management buy-out easier. There are also reports that many of the best employees at the big firms have left the company to run their own small private firms and bad management and corruption among some of those remaining is significant. All have cut staff by 50% at least, and one big company in trouble has had its staff decrease from 8,000 to about 1,000. Countering these problems are reports that these companies are getting major international contracts, including some in Albania and even Bosnia, are sharing work among themselves when one of the group gets a major contract, and are even slated to get some work on Olympic Games facilities in Greece. Their problems are affecting their credit worthiness and there are some indications that even the bigger reputable firms are experiencing more difficulties in getting financing.Affordable credits of all types are needed by the SMEs, but equipment financing is difficult for all, reportedly increasingly so for some big firms and impossible for most smaller ones. As elsewhere in the region, most equipment financing is done by suppliers not by financial institutions. Stopanska Banka’s customs guarantee experience shows that there is an active market in renting equipment from international rental firms. As noted above, there is virtually no leasing in Macedonia.

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Southeast Europe Construction Industry Capacity Building Draft Final ReportAssignment 1: Assessment of Local Construction Industry Capabilities and NeedsEuropean Bank for Reconstruction and Development SECTION 6

6 Survey of the construction companies in Romania 6.1 Characteristics of the Construction Industry in Romania

6.1.1 Structure of the Construction IndustryHistorically, the construction industry in Romania was well established. Prior to 1989 the level of infrastructure and industry related investments were high and an entire central and regional network of construction companies, design institutes, material and equipment manufacturers were active. They employed some 10% of the total number of workforce in the country. At the same time various ministries had their own dedicated construction companies and design institutes. Additionally, there were approximately 200 construction companies grouped under the Ministry for Industrial Constructions.The existence of these companies was ensured via a wide programme dedicated to almost every industrial and infrastructure sector. Moreover, some of the larger contractors were involved in projects abroad, either on a project basis or having a permanent office operating in foreign country (e.g. ARCOM in Germany). Many had the support of the Romanian Government and sometimes built projects under barter arrangements with countries such as Iraq.After 1990, the investment programme that had been managed by the Government decreased considerably and had a profound effect on the nature and structure of the construction industry and related sectors, especially the construction materials.Soon after 1990, and over a relatively short period of time, most of the construction companies had been privatised, but no real money had been brought into the new companies as in most cases the management and employees bought the assets. The large construction companies considered strategic and active in the energy, oil and gas and mining sectors have not yet been privatised.In most cases, prior to privatisation, the construction companies had been split and, as a consequence, a significant number of companies are now registered.It is also important to mention that a lot of construction companies have been established as a completely new, private initiative. The same applies to design firms and consulting companies.The structure of the Romanian construction industry, including related sectors, comprises several types of players. Their activities, resources and skills are described below.Contractors

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Large ContractorsGenerally speaking, the large contractors are the former state-owned general contractors and most of them still own a diversified business including design and plant and equipment facilities. They also employ a significant number of staff, organised in divisions or as separate entities. In either case, they operate as holding companies.It is generally considered that there are only a few general contractors (no more than ten) in Romania that would be able to work on large infrastructure projects with foreign partners. Our survey, included some of these companies because of their extensive exposure to projects and clients in Romania and abroad.The large Romanian contractors have tried to update their own plant and equipment bases in order to overcome all difficulties encountered with procuring them. As a consequence, some are developing their own plant facilities allowing for larger than needed capacities and following a horizontal development strategy. Whereas this can offer in theory the advantage of readily available equipment and basic materials, the consequences are easily foreseen: own capacity is under-utilised because of lack of projects, high up front investment costs and high maintenance costs. The reality is that the advantages of this strategy can quickly be overcome by the disadvantages, which ultimately can translate in uncompetitive prices.ARCOM, based in Bucharest, represents the diversification trend amongst the large contractors. Having lost international markets (Africa, Middle East) and in the absence of sufficient work on the domestic market, ARCOM has developed a diversification strategy whereby, besides construction activities, it engages in services activities such as equipment hire and materials manufacturing, as well as investments in real estate.Of greater importance is the trend amongst the larger contractors to expand their area of specialisation. For example CCCF used to be dedicated to transportation works but have expanded into other types of large infrastructure works and various civil works.A few large companies have started to split their operations and form separate legal entities qualifying as SMEs. The purpose, besides a more efficient management of the operations, is to benefit from the advantageous SME legislation adopted by the Romanian government.Small and Medium ContractorsThese can be classified according to the Romanian legislation (similar to the EU classification) into medium companies employing up to 250 permanent employees, and small

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contractors employing between 10 and 100 employees. There are more than 3,000 construction companies falling into this category and they are present in all regions of the country. However, a more significant presence has been noticed in large cities driven by a more dynamic industrial activity e.g. Timisoara, Cluj, Brasov, Ploesti and PitestiThe small contractors such as Arhitarva , Scorillo and Compania pentru Servicii in Constructii, all based in Brasov, share the most common features of small, private, recently established Romanian contractors: prefer to work for private clients on a sole source basis; nurtures client and suppliers relationships to achieve some

flexibility in payment terms and suppliers’ credits; work mostly in the building sector, simple projects where they

can apply a significant share of manual works; try to work on 5-7 project at the same time to ensure working

capital; employ low skilled staff as the qualified ones, though

available, are too expensive.Some of the mid size companies had been established between 1992 and 1996 as spin-offs of the larger contractors during their privatisation. There are few companies in the middle range that are good candidates for medium-sized EBRD projects e.g. Bogart and Stizo.Material Suppliers

Since 1989 the construction material sector has been developed considerably in range and quality of the products offered. Generally speaking, all materials are available either from internal sources or imports. In the latter case, the delivery time is around 4 - 6 weeks and there are no significant complaints about the sector.Foreign investors have bought some of the Romanian material manufactures. One example is Lafarge of France who now has more than 80% of the cement market share. Although there are complaints about the lack of competitive pricing, it is widely recognised that Lafarge has brought a fresh approach to business: guaranteed quality, prompt delivery and clear, firm contractual terms, imposing thus a discipline that the contractor will have to follow and possibly reflect it upon others.Before 1989 Romania had a capacity of 13 tonnes of cement and used a vast majority of this, some 11 tonnes. Now the capacity has decreased to 11 tonnes but only 4.5 tonnes are consumed per year. This leaves the sector with the capacity to meet a much greater demand.

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The cement distribution is done either ex-works or ex-customer. The latter is generally applicable to large construction companies who have the capacity to buy in large volume. The wholesale providers, suitable to small and medium-sized contractors, represent around 50% of total volume. As in other countries, the smaller contractors are at a disadvantage as they pay less advantageous prices and then it is on a cash and carry payment term. Moreover, they have to arrange their own transport of materials, which adds to the cost. The same distribution methods are also applicable to other types of materials.There are no shortages of more modern and diverse materials produced by local companies with foreign participation: ceramics – Cesarom, tiles – Sanex, grout (Baumit) – in general, materials used in commercial and social buildings.Triggered by the expensive credits, the constructors have been forced into reducing the construction period and consequently have started to look into less labour intensive technologies. An example is a wider availability at a convenient price of steel framed structures, which in the past were used exclusively in industrial works, but are now available to go to commercial and civil destinations.Several of the companies interviewed expressed their concern that still far too little is being done in introducing new, more efficient materials, capable of reducing the execution schedule and the quality of the works.There is also a significant need to invest in distribution systems, packaging and hand delivery of materials.Equipment Suppliers

There are two trends within construction companies to solve the equipment problem and these depend largely on the company’s size.The large contractors have generally preferred to start developing their own fleet are planning to do so considering that this is the route to minimising risks and costs. They also lease equipment, to date mostly from western manufacturers benefiting from leasing programmes supported by export credit agencies in France or Germany. Construction companies such as CCCF has now gained enough experience to start comparing the best offer to finance equipment needs: vendor financing, local credit lines or leasing from local companies.The other trend applies to medium and smaller contractors, which prefer to hire the special equipment.Plant and Equipment Hire

Until 1990 each county had an organisation that centrally handled the plant and equipment hire. These have now been

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privatised and own the same assets as ten years ago: old, poorly maintained and limited in type and size. In some counties, e.g. Brasov, one of these companies called Prescon, has formed a monopoly on the market and imposed terms that are drastic for smaller contractors. Like in all other countries surveyed, though there is a need for new and modern equipment, the demand is probably not sufficient at the actual level of works to make an equipment hire business profitableThe equipment hire companies do not generally guarantee the performance of the equipment and therefore considerable risk for small and medium companies exists. Very few of the equipment hire companies are in a situation to update the fleet because of lack of capital and sufficient demand to justify high up-front costs.There is an acute need to update the existing equipment with mobile cranes, access platforms, excavators, dozers etc. adapted in size and performance to a variety of works so that smaller sites can be run more efficientlyConsulting Services and Design

Construction design is a sector well represented by a variety of companies due to the low barriers to entry and abundance in workforce and expertise. The design and consulting services are not covered by the law and therefore there are many misunderstandings and misconceptions regarding their role. SMEs Organisations

The National Council of Small and Medium Enterprises (CNIPMMR) was established in 1992 as a non-profit, non-governmental organisation. It has a wide network of branches thought Romania. Its activities are focused on industry, construction, manufacturing, trade and tourisms. The Council’s aims are: creating a favourable legislative and institutional framework

for private capital; providing economic , managerial, social, technical, legal and

educations assistance for private entrepreneurs; stimulating and promoting international cooperation; promoting awareness of financial schemes and programmes.The Council also publishes a monthly magazine containing information on EU financing programmes, economic, financial legal, technical, fiscal and training for business as well as promoting business opportunities.The Council has also produced a ranking of the top 5,000 private companies.

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The Council could, through its Technical Centre for SMEs, provide a range of consulting services packaged to suit the needs of the construction companies, for example, dedicated to bid preparation or contract management.The Council already employs some staff with construction expertise but should a wider and more focused support activity be considered, this would require careful assessment of the staffing needs, financing sources and operating capability on a decentralised manner. Such an initiative would be appropriate for grant funding.6.1.2 Demand for ConstructionThere is a wide range of construction activities envisaged by the Romanian authorities. A certain emphasis is put on housing developments but several infrastructure projects are also considered. These are at various stages of development - prefeasibility or feasibility studies or seeking finance. Airport infrastructure modernisation including commercial,

administrative offices, parking spaces and other facilities with individual predicts ranging between US$5 million to US$10 million to US$12 million and an estimated TIC of US$55 million.

Railway works including modernisation of rolling stock and signalling amounting to US$800 million. An additional US$30million is considered for the modernisation of the ticketing system.

A wide range of port facilities, including terminals and handling systems on the Danube River, and at the Black Sea port of Constanta.

National roads modernisation by passes etc under various programmes with or withought committed funds at present. The amounts still to be committed for programmes V and VI are around US41.4bn and would cover 1,400km throughout the country.

Motorways. Urban roads infrastructure modernisations for an estimated

amount of US$100 million. Free trade zone developments in Braila, Curtici-Arad, Galati,

Giurgiu and Constanta Sud for more than USD250. These developments include a variety of works: industrial zone, port traffic improvements, warehouses and terminals.

There are also prospects for a wide range of urban infrastructure developments and improvements related to: water and waste water infrastructure, commercial and social purpose buildings and waste management.

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6.1.3 Industry CapacityAccording to the official statistics, in 1999 the structure of the construction industry by size of companies was as indicated in the table below. The capacity of these companies in terms of annual turnover is also shown in the table.

Number of Registered Companies

Total Annual Turnover by Category (USD1999)

Micro enterprises (< 9 employees) 6,740 900mil

Small enterprises (10-49 employees) 2,424 900mil

Small enterprises (50-249 employees) 1,066 870mil

Large companies (>250 employees) 291 1.4bn

Each category has undertaken most of the work in the private sectors, more than 85% for the SMEs and 700 for the large contractors.It is also important to mention than an increasing number of projects, though small value, are undertaken as lump sum turnkey rather than unit price. This trend could bring more stability to offer prices.Since 1996, when most of the large construction companies were privatised, the official statistics recorded a drop in productivity by 25%. The main causes have been a reduction in size of the large construction companies and the of the project size. Smaller companies are working on smaller projects with lower productivity rates amplified by a lack of modern equipment.The Romanian construction industry is under-utilised mainly because of its lack of large projects. Some consolidation especially among the small contactors is likely to occur and form more robust companies.The large contractors are trying to improve their systems and cooperate with international contractors. The concern for these is how to optimise operations in this period of low significant investments without impairing the ability to respond to larger and more complex infrastructure projects.The labour force is available and with appropriate training and supervisions could improve performance.Considering the Romanian construction industry as a whole, it is fairly labour intensive. There is a common expectation that the level of technology will have to increase. In doing this (import and /or adapt techniques) care should be taken in the relevant design and consulting skills. Some contractors are aware or have suggested that the best way of achieving this is to use joint ventures with international firms to promote technology transfer.

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But most of them are not aware or reluctant to consider this option. This approach requires the active support of international companies willing to transfer their expertise and local partners in a position to learn.6.2 Survey of Local Construction Companies

6.2.1 Construction Companies InterviewedWe distributed the screening questionnaires to around 100 companies located in 18 different counties and to 22 design companies, material and equipment suppliers. 46 construction companies responded to the screening questionnaire. These companies were then requested to complete the detailed questionnaire and from this request, we have received responses from 28 large contractors and 7 small and medium sized contractors. The following represents a summary of our findings based on the analysis of the responses: An equal number of screening questionnaires were sent to

large and smaller contractors. The fact that we received three times more responses from the large contractors shows that the SMEs have limited resources to handle non-productive activities.

Most of the large contractors have a high value of assets in comparison to their annual turnovers. This is explained by the fact that some of them own assets such as land, building or simply other business non-construction related.

The profitability ranges between 1% and 13% with an average value of 4%

75% of surveyed companies considered their lack of access to finance a constraint. They rely heavily on self-financing for both start-up and expansion.

Outside equity plays an insignificant role. The relative importance in sources of financing amongst

surveyed firms depends on their size. Internal sources tend to become less important as firms grow larger.

Medium size contractors have a bonding capacity of up to USD5mil for the more active ones.


Access to hired plant and equipmentThere is a general lack of equipment to hire. The equipment available is old, poorly maintained and generally geared for high volumes of works. They are, in most cases, inappropriate for smaller contractors. The price of acquiring new, modern and fit to

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the scope equipment is hindered by the modest financial position of the construction companies and the expensive credits. Consequently, the smaller contractors undertake some work manually. The trend for small and medium contractors is to buy small size multifunctional equipment and only hire the specialised equipment.InsuranceInsurance polices are now starting to be available in the country, including those dedicated to the construction industry such as construction all risk. It is however very difficult to sell these policies because the Romanian law does not require construction specific policies, the contractors cannot cover the costs and the client are not familiar with the purpose and the way the insurance policies function. Despite the general unawareness of the role and benefits of insurance, especially if compared to bank guarantees, more effort should be made to support insurance and promote it as a risk management mechanism.Procurement Related

Contracting StrategiesThe Romanian legislation allows for several types of contracting strategies, from unit price to lump sum turnkey contracts. In all cases the general contractor is required to execute at least 51% of the works through own resources. Consequently, the contractor is mainly interested with executing the works rather than managing works. This, combined with limited financial resources and limited experience and /or interest in managing all aspects of the work, materialises in limited capacity and interest in lump sum projects. Traditionally, the Romanian construction market has preferred unit price contracts.Cost Estimate Procedure.This seems to be one of the most important procurement problems that has an impact on both the tendering and the implementation stages of a project. All activities are described in terms of quantities of labour, materials, equipment and transportation, which are then multiplied by prices indexed for inflation. The final number generally speaking is disconnected from the real value of the works and, though offered as firm price at the tendering stage, offers no guarantee that it can be realised.The prescription of the works as explained above relies on old norms and they have not been updated to cater for technology and equipment improvements.The breakdown of costs does not allow for a clear identification of items such as financing costs or insurance costs. These are incorporated in a global item called Other Costs or General Costs.

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Moreover they are still limited to values (or percentages) calculated before 1989 and therefore again have no resemblance to the present reality.At the tendering stage the issues mentioned might impact the evaluation of the price as it does not accurately reflect the true costs of executing the works. Though presented as a firm price at the bidding stage, most of the Romanian construction companies apply during the project implementation a cost plus invoicing procedure, which is legally allowed. As a consequence, the construction companies do not take full responsibilities for execution within budget and very often the result is that the works are stopped before completion because of lack of funds.PermittingThe legislation relating to building permits is sometimes confusing and creates potential for errors through inadequate interpretation. Moreover, the requirements cannot be fulfilled because (i) they are sometimes interdependent and it is difficult to establish priorities, and (ii) the entire process cannot be controlled by the contractors. In all cases this means additional costs to the project and potential delays. Quality of construction works. The law nr. 10 / 1995 referring to quality is compatible with ISO 9000. However, there are some practical issues related to authorisation of works, which are rather bureaucratic eventually adding to the cost of the project. Moreover, the ultimate authority in approving the quality of works is a state organisation “Inspectoratul de Stat pentru Constructii” (State Inspectorate for Constructions). Not only its mandate is obsolete (central control) but also its attributes, responsibilities and functioning rules are producing undesirable effects.The law stipulates that the investors have to contribute a percentage (0.7%)of the volume of the works towards the State Inspectorate for Constructions. The funds collected are disbursed 30% to review and improve the legislation and 70% to quality control activities. The control activities are undertaken by State Inspectors but very often the results are discretionary and generate abuse. Moreover, the responsibilities are distorted: the owner of the project (as a public institution) and /or the design firm are not incentivised to undertake an active role in monitoring quality. Ultimately the existence of the organisation does not guarantee quality and those that should be responsible for it do not have authority to monitor it. The rational of the mandate of this organisation is debatable and merits consideration.

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The Romanian law does not require contractors to posses an ISO 9000 certification. This is only required by IFIs and most of the foreign investors. The majority of the small and medium contractors do not have funds available to implement and maintain the ISO 9000 standards. However, the lack of ISO 9000 certification is not perceived, especially by the international contractors operating in Romania, as a critical barrier against their eligilibility to perform work.Qualification CriteriaLike in the other countries surveyed, the insufficient opportunities have triggered a modest experience accumulation rate for both large and smaller contractors. For example, for a major railway rehabilitation project, one of the requirements was similar experience for similar size projects over the last 5 years. Considering that over the last ten years no railway works have been executed makes it impossible for any contractor to comply.The smaller, private contractors established over the last few years have equal difficulties to expand to larger and more complex projects because of lack of experience.Client Related

Evaluation and Award of TendersThe great majority of the construction companies interviewed expressed serious concerns about the transparency of the bidding process in the case of public funded works at central or local governmental level. The public bidding process has become unattractive for these reasons. None of the SMEs interviewed have either bid or won work following a public tender.Definition of ScopeThe scope of work not properly translated in Romanian and understood by the local contractors can cause inadequate scheduling and overall poor performance. Most of the local contractors are very weary of the consequences of misunderstandings caused by unclear scopes of work. Therefore they are strongly biased in favour of making available as many written documents as possible and all translated in Romanian.One consequence of incomplete documentation is the occurrence of an increased number of supplementary works that can be compensated, thus affecting the project budget. This can, and has effected IFI’s projects, according to our findings.PaymentsDelayed interim and final payments have been quoted as a serious problem especially when the employer is local. It is recognised that the situation is much better in the case of IFIs.

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The payment delays are even more acute at subcontractors’ level.Sometimes public clients pay contractors with promissory notes. Contractors have complained about this practice as it defers the payment and reduces liquidity. The promissory notes can be exchanged for cash before maturity at a discount but we do not know whether contractors resort to this possibility. Some contractors use the promissory notes to pay suppliers having links to the emitent of the note.Role of Implementation Units for EBRD ProjectsMost contractors would welcome a more objective and effective implementation monitoring of public IFIs projects. The views are shared with regards to the best-suited consultant for this role. Some argue that the most effective and objective would be a western consultant.Some say that a partnership between a western consultant and Romanian expertise would be the best solution as it offers local knowledge and the opportunity for know-how transfer.Another issue is the experience of the Romanian staff involved in monitoring the supervisions of public projects especially if decentralised such as at the municipal levels. This is considered insufficiently trained, leaving room for discretionary actions.Subcontractors’ Role and ResponsibilitiesSome of the smaller contractors can get involved in executing small parts of a larger project for which they have to provide guarantees. If the works have been undertaken at an early stage of the overall project execution, the subcontractor’s guarantee is held until the final project completion or expiry of the warranty period.The domestic prime contractors do not wish to take risks and therefore the guarantees are not released until such date has arrived. This impacts the subcontractor’s capacity to provide guarantees and ties up his funds for long periods of time.Contractor Related

Unfamiliarity with the legal aspects of contract work, contract law, preparation of claims against contract variationsLack of familiarity and understanding of legal and contractual issues includes a wide range of aspects: language, terminology, internal skills, systems to manage contracts actively are all major hurdles in working for international clients or IFIs.Even where a foreign language is accepted by all parties as the contract’s language, this is not recognised in the Romanian courts and the contractors are asked to provide authorised translations. This still leaves open the issue of what contract

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prevails in the court. Most of the contractors consider that the most practical solution is having a recognised Romanian translation bearing the same weight as a the language one. This could apply to all contractual documents including bill of quantities, instructions manuals, special rules and conditions, completion and authorisation documents.Whereas some larger contractors can bear the costs of these translations, the small ones cannot and therefore some assistance in these respects, possible grant money, would eliminate the problem.Lack of diligence in keeping schedule performancePartly due to ignorance and partly due to lack of discipline in complying with contractual terms, the schedule is often poorly monitored. It is not necessarily the absence of sophisticated management tools (techniques and software) that is the most concerning aspect but rather the little importance paid to it. As in other aspects related to project management, there is not enough discipline in project management. Managers are also generally less interested to learn from experience and incorporate the lessons learnt in the new projects.Compliance with ISO 9000Very few Romanian construction companies, apart from the large ones, have ISO9000 accreditation. The international contractors interviewed who are active in Romanian consider that ISO9000 certificate is not an essential condition for the corporation with domestic companies. They prefer to build relationships and rely on this as a guarantee for quality.Management skillsGeneral management skills are old fashioned and allow for limited responsibility at a decentralised level. The authority stays almost entirely with the top management who foster a climate whereby staff are not empowered or allowed to make some decisions. There is also very poor feedback in the system.There are also specific management skills that have been considered by managers themselves as relatively poor: financial records, analyses of performance – schedule and prices, contract management, business development and business plan preparation especially in the large companies, they are not always properly utilised. In many cases these tasks are perceived as bureaucratic and therefore allocated to staff based in the headquarters of the company, with limited practical experience. Some of the records are still keep manually because management is not familiar with IT.

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StaffingGenerally speaking there are no significant problems with the availability of a skilled labour force.The skills are mostly traditional with less emphasis on new technology. There is a lack of appropriate operating staff for new equipment.It is not easy to maintain and motivate staff. Due to low level salaries, the skilled workforce tend to get involved in the black market activities. Also, over the last few years a significant number of skilled workers have been working abroad on temporary projects in Israel, Germany and the Middle East.TrainingThere has been limited attention paid to training over the last few years because of lack of funds and management’s concerns with day-to day operations. One of the categories most affected is the young graduates who come out of universities with limited knowledge in the economics of the sectors. Furthermore, they have limited opportunities to gain experience on projects.Finance Related

Bank proceduresRomanian banks complained about the poor quality (content and presentation) of projects seeking financing, but what they consider bankable projects depends partly on the procedures they use to screen them. These procedures, both formal and informal, rely on collateral and personal relationships rather than on project appraisal. Most contractors informed us that they have not been able to obtain credit or guarantees on the basis of the project cash flow even though the banks informed us that this is possible and in fact practised.Collateral requirementsAccording to the firms surveyed, the inability to meet collateral requirements is the main reason for not being able to obtain a bank loan. Although, in theory, a number of assets qualify as acceptable collateral, in practice real estate assets appear to be the most common. Small and medium-sized contractors have limited assets that can be pledged.

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6.2.3 SWOT Analysis


A few large contractors with extensive experience that could be JV partners for international contractors.

Share the responsibilities and therefore be able to become involved in larger and complex projects. Know-how transfer.

Emergent private middle size construction companies run by ambitious management and more commercially driven.

Become exposed as subcontractors to large infrastructure projects.

Emergent private middle size specialised construction companies introducing new technologies.

Become exposed as specialised subcontractors in complex projects and enhance their future capacity to bid.

Technical competencies. Can embark on more complex projects and be trained.

WEAKNESSESS IMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY EBRD

Cost estimates does not reflect the true costs. Implications on schedule and price performance with the risk of underpricing.

Lack of modern project management skills combined with insufficient IT systems.

Can affect the project execution for large and complex projects with direct implication on budget and project completion.

Lack of knowledge and / or understating of contractual terms.

Problems can occur with contract variations, risk allocation and rights and obligations affecting schedule and budget.

Not enough large and complex projects, too many small projects.

Skills and experience are dispersed and companies cannot qualify because they cannot offer the range and depth of skills required by the EBRD projects.

Insufficient managerial, financial and economic skills, too much emphasis on the physical execution of works with limited feedback into the system on performance.

Auto limitation on performance and increased efficiency improvements.

Limited understanding of new technologies or complex drawing among smaller contractors.

Constraining factor for the more ambitious companies.

Limited understanding of legal aspects of FIDIC contracting. Limited training available.

Limited capacity to understand risk and therefore limited capacity to quantify and price it.

Training when available and education systems still favouring technical aspects and less emphasis on the economics of the sector.

No direct implication but affecting the professional standards in comparison with western practices.

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OPPORTUNITIES IMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY EBRD

Cooperation with international contractors. Gain experience with modern project management techniques.

Improve procurement and quality assurance legislation in line with the EU legislation.

Companies will become familiar and will be in a position to be better prepared for international tenders.

Create legislation for design and consulting services in construction.

None directly, but responsibilities and roles are unclear and can create confusion and conflict of interest.

Introduce rating and ranking in the industry and incentives for good performance to be considered in the price.

None directly, but will increase the level of professional standards in the industry and create sound competition.

THREATS IMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY EBRD

Penalising qualification criteria even for large contracts related to similar experience (nature and size of projects).

Reduced number of qualifying bidders.

Lack of disciple in applying contractual terms and general lax attitude towards compliance on the contractors’ side as well as on the clients’.

Increased schedule, quality and price performance risks.

Limited capacity to modernise equipment fleets. Cannot comply with tender requirements and cannot execute work efficiently.

Divert funds from IFI’s projects towards other project.

Incapacity to continue work and divert staff to other projects with implication on schedule performance.



The financial sector in Romania, further along in the transition process than in Bosnia and Herzegovina, still has a long way to go to reach EU standards. As the result of major financial sector problems through 1999, bank regulations have tightened, loanable funds been diverted by high yield government securities and a number of weak banks were liquidated. The strengthening of the banking system is being recognised and is attracting foreign investment.Most banks have been privatised, with only a few exceptions such as the huge Banca Comerciala Romana, (BCR) with bank purchases by foreign banking groups becoming a major factor during the last two years, improving bank procedures, controls and efficiency. For example, Raiffeisen Zentralbank (RZB) and the Romanian American Enterprise Fund (RAEF) bought Banca

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Agricola during our trip. Several major banks, primarily foreign-owned ones, are mainly focused on the SME market, or are greatly increasing their attention to it. For borrowers such as SMEs in the construction sector that need financing this environment has been difficult. The stringent restrictions, especially the universal requirement for 120% collateral enforced on the banks by reserve requirements, and the high interest rates supported by the shortage of loan funds have hit them very hard. The donor and IFI supported SME lines and more efficient operations by SME oriented banks, have eased these difficulties but even they are expensive for many SMEs.Financial Institutions Interviewed and Their Construction Industry Business

We interviewed eleven Romanian financial institutions for this survey: six banks, two insurance companies, one guarantee fund, an investment fund and a microcredit organisation. We also met with EBRD’s resident office staff, with a World Bank representative and with an auditor. Few of the financial institutions completed our questionnaire that we had sent them well advance of our meetings, and meeting participants were sometimes unwilling or unable to tell us the information requested. In spite of this the questionnaires provided focus to our meetings and helped us gather much useful information.Banks, microcredit and investment organisations

To get a good understanding of the financial products being offered and introduced, we arranged meetings with leading financial institutions, focusing on those that had equity investments or credit lines from EBRD or other IFIs. All but two of these banks were foreign owned.Even BCR has changed; a senior manager, Director of the International Department, informed us that only 28% of its loans are now made to state firms and a credit scoring system has been introduced with extensive assistance from EU PHARE advisors. However, even he conceded that BCR had a reputation for difficult documentation requirements.A prime objective of the survey was to learn from the banks their extent of financing of the construction industry and the sectors of the industry that they served. BCR said that less than 10% of its portfolio was construction

related, with loans to contractors accounting for only 2.3%. The leading bank financing construction, was Romanian Development Bank/Societe Generale ( RDB), which claimed that 50% of its entire portfolio, and 15% of its SME portfolio, was construction related. RBD said that this business is mainly with the larger firms, and therefore concentrated in the Bucharest region where they are based, presumably a

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heritage of its former development bank focus. BCR is pursuing smaller companies but must use IFI SME lines to do so as many SMEs do not accept its terms or meet the conditions for its loans. As one result of this, RDB has disbursed 70% of its line from EBRD for “investment loans”, in loans with maturities from 2 to 7 years.

Demir Bank, which told us that construction business accounted for 10% of its total, 70%-80% with contractors and 15%- 20% with suppliers. 60% of the construction related business was guarantees and only 40% represented loans. Demir did not distinguish between SMEs and larger firms but stressed that its main focus is on building relationships with all size good clients and with firms referred by clients. It noted that there were no Turkish related firms in this part of its portfolio.

Banca Comerciala Ion Tiriac has less than 10% of its business with constructions firms and estimates that even the construction industry exposure in its contingent liability portfolio is less than 10%. It had no estimates on other breakdowns of its exposure to the industry.

Alpha Bank does about 15% of its business with construction related firms, mostly with larger ones or those with foreign parents. Less than 10% of its total business is with local SMEs. The impact of the investment by Monte dei Paschi di Seina in Alpha Bank may change this. An Alpha Bank Italian Deputy Manager told of the bank’s efforts to increase business in Romania for Italian SMEs. They are developing ties with SMEs in northwest Romania, which is within one day’s transportation distance to Italy. Supporting its Italian owner’s interests and following its example may generate more SME interest at the bank.

Bank Post is naturally SME focused, with 95% of its business with SMEs, but it gave us no information on its business with the construction industry. Its specific comments on lending to construction firms indicated that it does do enough business with them to understand their business.

Micro Credit Romania gave us one of the most detailed responses to our questionnaire. It is, by definition, only doing business with small and micro enterprise customers, but it does 6% of its business with construction firms, 60% working capital to 40% f or equipment/fixed assets. Not surprisingly, half of this business is with suppliers and 39% with consultants and similar construction services providers, both of which are more often small firms, and only 11% contractors. However, their entire construction portfolio consisted of only 18 clients with a total outstanding amount of just over $200,000.

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The Romanian American Enterprise Fund (RAEF) has transferred its loan portfolio to its subsidiary, Banca Romaneasca. It now only manages micro loans administered through nongovernmental organisations and a few loans, including some construction industry loans, under a programme to offset the damage to neighbouring countries by the Kosovo conflict.

Recommendations by the banks

Several banks mentioned that they would prefer doing business with a firm that is working on an internationally funded project, especially one that will make payments directly to the bank partly because of payment delays on common domestically funded contract. Bank Post reported a precedent for such direct payments on IFI related projects, e.g. the EBRD funded motorway one, but said that it did not occur on government projects.One bank mentioned that it is very difficult to get information on the SMEs and that it would help if there was a credit bureau like Standard & Poors. Another bank suggested that a club or consortium of local SMEs should be encouraged to improve chances of getting contracts and financing. Such a consortium reportedly has been very successful in Kosovo. Insurance companies

As in Bosnia, construction firms take insurance only as the exception rather than the rule, and usually only if their contract requires it. Anglo Romania Insurance, the sister firm of ROBank since it is also controlled by the Bally Group in the UK, has insured the airport construction project, but not many more. It said that firms, at most, take accident insurance on workers. State contracts have no provision for including insurance in cost estimates, in spite of efforts by insurance firms to encourage such inclusion. Anglo Romania has advertised contractor insurance with little response. At present, these do not represent more than 1% of their total portfolio.Anglo Romania Insurance used the experience of Bally Group insurance firms in other countries to develop, for the State Housing Agency, a proposal for issuing insurance surety bonds in place of bank guarantees on contracts. The Italian representative at Alpha Bank noted that such bonds are not used even in Italy and are unlikely to be used in Romania. A contractor noted that even EBRD contracts require bank guarantees with no provision for insurance bonds.Generali Asigurari estimated its construction related activities at around 6% of their portfolio. They too offer Construction All Risks policies but there is very little demand for it. The lack of sufficient databases, uneducated local clients and no legislation imposing higher requirements limits the creative use of insurance

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policies. For example, Generali tried to provide an insurance for a client’s credit guarantee but was not accepted even by EBRDLoan Guarantee Funds

We met with the Romanian Loan Guarantee Fund, which was originally state owned but is now privatised with no direct state ownership, though state owned banks remain owners. The Fund prepares its own analysis and does not take collateral, with loss experience reported at less than 1%. It guarantees up to 70% of the loan amount, with the average being about 40%. It does not issue construction bid or performance guarantees, but it can issue counter guarantees to banks on the construction contract guarantees that they issue. This would reduce collateral requirements for the construction firms.This Fund has also been pushing a Canadian developed proposal for a residential mortgage loan guarantee programme. The Government has also proposed a new, public sector, guarantee programme to be established regionally but is facing opposition from the IMF and others. EBRD’s Resident Office staff is doubtful about the Romanian Loan Guarantee Fund because it is small and slow, doing a limited number of transactions and has a management company with a scarred reputation from its previous mutual fund work.Leasing

We interviewed no leasing companies in Romania, but did get comments from construction companies and banks on the status of leasing. Based on these, Romanian law covering leasing is good, but here again, leasing is in its early stages of development. Several of the financial groups, e.g. Alpha and Demir, include leasing companies, but very little leasing of construction equipment is done by local firms, aside from the leasing of some trucks. Some leasing of construction equipment is done by foreign equipment suppliers to the larger firms. There are some signs that leasing is growing, e.g. a major contractor reported that although Romanian leasing companies are very expensive, their prices are coming down. Romanian Leasing Association (UNSLR) is a professional and non-profitable organisation, established in 1996. The members of this association are local banks and leasing companies such as Creditanstalt Leasing, Finans Leasing, General leasing, International Leasing, Demir Romlease and ABN Amro Bank. The goals and objective of this organisation are to promote the interests of the industry, cooperation with international leasing organisations, national and international authorities and to organise fairs and seminars. The association is also trying to promote the idea of an investment fund specialised in leasing operations. We have not obtained details about this initiative.

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A brief analysis of the Romanian leasing legislation and accounting treatment shows the following: Both operational and financial leasing has the advantage as

being an off balance sheet item for the lessee. The rental payments are tax deductible. The legislation allows for an accelerated depreciation;

The financial leasing is registered in the balance sheet of the lessee. The rental payment has to be split into capital payments and interest payments. The level of interest is limited by the law to the average interest rate practices by the local banks. In the case of a higher interest rate, the difference is not tax deductible;

The insurance premiums are tax deductible for the lessee for both operational and financial leasing;

The rental payments are subject to VAT (19%) with the exception of the interest payment in the case of a financial leasing.

In comparison with leasing, the legislation covering equipment hire activities indicate that: The rented equipment is an off-balance sheet item; The rental payment is tax deductible in its entirety; The rental payments are subject to VAT tax at 19%, the same

as for leasing.The comparison between operational and financial leasing and direct hire are shown in the table below. These apply to a domestic operation as opposed to a cross border operation.

Financial Leasing Operational Leasing

Direct Hire

Fiscal Regime Deductible in line with the depreciation allowed; interest deductible for the level comparable with average bank interest rates.

Deductible Deductible

VAT 19% on the capital payment, interest payment is VAT deductible.

19% on the rental payment.

19% on the rental payment.

The Romanian legislation also allows for cross border leasing operations. In this case the import duty legislation is important. The Romanian legislation offers the possibility to import temporarily the equipment and all importing duties are exempt if the leasing contract is valid for a least 1 year but less than 7 years.

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The principles of leasing transactions are established in Romanian and they cover all aspects of legal and fiscal. We can conclude that legal requirements and taxation regulations in Romanian are not a deterrent in establishing leasing operations. In determining the viability of a leasing operation in Romania it will be critical to assess the demand and to provide flexibility in timing and amounts of rental payments and term financing related to use of equipment during the project, and the cash flow of the project. One concern, shared by international manufacturers, is the payment guarantee. This applies not only to Romania, but also to the whole region.Ultimately, leasing will have to be faster and simpler than the use of a medium-term loan from a bank.6.3.2 Financial products for construction firms,

requirements and termsThe Loan Guarantee Fund currently provides very little to no service for construction firms, and Micro Credit Romania do not issue guarantees. Aside from them, all others banks interviewed issue performance and bid bonds and loans to construction firms. Contractors generally view the pricing very high and the collateral requirements to be onerous or impossible. Several banks have basic collateral requirements over the 120% requirement, up to 150% in at least one case. In contrast with the other two countries, foreclosure is reportedly relatively easy in Romania so collateral margins should not need to be as high to insure recovery of a significant amount on a credit gone bad.Guarantees

Only ROBank has an EBRD Trade Facilitation Programme line. The banks that we met seemed to have no problem with confirmation of their guarantees or letters of credit if one should be requested, which it usually is not. Guarantee pricing varies greatly. For bid and performance guarantees, Banc Post charges 0.25% to 0.35% per quarter with minimum fees of $75 million - $90 million. The Romanian Development Bank told us it charged 1.5% - 2.5% for bid guarantees but that those fees are negotiable, 1.5% per quarter on advance payment guarantees, 2.5% per year on performance guarantees, but only 0.2% - 0.5% per year for performance guarantees in dollars. Alpha Bank indicated that its that it charged 0.25% per quarter for guarantees but had a 1% - 3% issuing fee a 1% - 3% risk commission. Contractors view these fees as expensive but can be managed without the collateral requirement.Short Term Loans

The cost short term loans varied mostly by currency with interest on Lei loans 45% - 65% and dollar loans priced at 10% - 14%

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plus a 2% fee. Volksbank is reported to have especially low pricing. The RAEF officer we met, believed that SMEs could manage the terms of the short-term loans that are now offered and do not need special help. The market should level these differences out eventually.Medium Term Loans, leasing (equipment finance)

Term loans appear to have pricing similar to short-term loans in Romania, but down payment requirements of 20% - 40% and the collateral requirements plus the absence of leasing and other alternatives continue to make financing of equipment difficult, especially for smaller construction companies.6.3.3 Constraints in financing construction industryWe interviewed two construction firms for the financial survey in addition to the ones interviewed as part of the survey on the technical capacity of construction companies. Most of their problems have been outlined above. There is a general agreement that the financing situation is getting better for construction firms, including SMEs. In addition to the comments about improvement for SMEs from the Resident Office and from the Enterprise `Fund, the Guarantee Fund’s President saw SMEs becoming more professional, with better management, better capacity and better prospects. Problems and their causes

The biggest problem cited by all contractors is the inflexible collateral requirements currently enforced in a “one rule fits all situations” manner. It may have been necessary to apply strong medicine to a sick financial sector, but the sector is rapidly improving and a more appropriate way of enforcing good credit discipline should be sought. If a way is found, then the better SMEs and construction companies will have a better chance to develop and grow and become more able to perform well on major infrastructure projects.Pricing, availability and services seem to be improving, lead by increasing competition among the private banks spearheaded by changes brought by sophisticated and credit quality focused foreign strategic investors. This is happening to the extent that in some situations, the IFI provided special credit lines might be coming out of the market.Products not offered

Leasing, and other targeted equipment finance facilities are the primary products needed by the construction industry. Possible ways to overcome the problems

It is important to continue searching for an appropriate leasing vehicle for EBRD to support, and to explore possible ways to

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increase vendor financing and/or more efficient rental of construction equipment.

.

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7 Overview of the Construction Sector in Yugoslavia 7.1 Brief Economic Overview of Yugoslavia

The current economic situation in Yugoslavia is difficult. The new government is a confronted with major political and social problems. The structural, institutional and governance problems are seriously affecting the economy. Insolvent banking system, excessive public expenditure, shrinking tax base and inefficient operation in the state-owned corporate sector are only a few examples.Since the beginning of 2001 the main focus has been in reforming the fiscal system and the preparation of the new privatisation law.Yugoslavia is also searching for ways of reducing the debt burden. At the time of the preparation of this report, Yugoslavia was engaged in discussions with the World Bank on restructuring the debt and on measures prompted to alleviate the situation, such as: Give Yugoslavia a blended IDA status until creditworthiness

can be restored. This could involve a period of three years of IDA financing;

Disburse structural adjustment and investment loans slightly in excess of the interest payment that the country has to service.

Yugoslavia is also hoping to agree a debt relief from Paris Club creditors, comparable to similar initiatives in the early 1990’s in Poland.Should the debt service payment stay unchanged, the growth of the economy will be limited. It will also deter private investors.Yugoslavia is hoping to raise at least US$1 billion over the next several years at the forthcoming Donor Conference in support of a reconstruction-processed establishment of a special safety net. An estimate a US$300 million is needed to restructure the banking system. The debt burden, illiquid banking system, social and political issues are all limiting the government’s capacity to invest in capital projects.7.2 Characteristics of the Construction Industry in

Yugoslavia

7.2.1 Structure of the Construction IndustryContractors

SerbiaAccording to Yugoslav Clearing and Payment House data, pursuant to the semi-annual statement of accounts for year

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2000, in Serbia (without Kosovo) there were around 5,000 active companies in the construction sector, including construction companies, project engineering and material suppliers. The majority of these were private – around 85% and the rest were socially owned. A more detailed industry structure is shown in the table below

Field of Activity

Total Numbers of Companies

Socially Owned Private

Total Number

% Total Number

%

Construction Companies

2,782 418 15% 2,364 85%

Building contractors

961 159 15% 802 83%

Roads, railway, tunnels contractors

349 73 21% 276 79%

Installations 1,472 186 13% 1,286 87%

Project Engineering

1,787 170 10% 1,617 90%

Source: Chambers of Commerce of Serbia, May 2001

According to this statistic most of the construction companies are private. The socially owned companies will further change ownership structure by allowing a certain degree of private ownership.The construction industry represents around 6% of the GDP and the expectation is that this will increase.Over the last few years this has decreased between 3% and 8% of the workforce engaged in construction activities. Lack of work and more attractive jobs and better payment terms in other sectors have been the main causes.Most of the civil engineering companies, about 60%, are concentrated in Belgrade. Also, the biggest ones such as Energoproiect, Ratko Mitrovic, GP Mostogradnja and Planum are based in Belgrade.It is also important to mention that the construction companies in Serbia are either very large, employing at least 1,000 permanent employees (some more than 4,000 employees) or very small with less than 50 employees. The majority of the construction companies, especially the building contractors are small companies. There is a significant gap between these two categories, with very few medium sized companies operating in the country.

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MontenegroMost of the construction companies are small and medium sized. These are also very specialised in two directions: buildings and roads. Construction companies in ex Yugoslavia used to carry out a significant volume of works abroad. Years ago, approximately 50% of the construction output was produced abroad in African and Middle Eastern countries. Large companies in Serbia such as Energoproiect are an example. They benefited from strong state support and back-up, they also operated on barter. All this made it possible to operate abroad. The fundamental issue is how can these companies restructure themselves so that they can be competitive in bidding for international tenders without state support. Yugoslavian construction companies consider that the loss of the African and Middle Eastern markets is the main cause of their under-utilisation. Some contractors, e.g. Energopproject, are seeking to compensate this loss by undertaking new roles. Energoproject could become a developer of real estate projects (houses and office space) if more demand and credible clients are emerging in the country.Material Suppliers

The availability and quality of materials produced on the domestic market is more problematic than in the other countries surveyed, with some shortages occurring in the building materials sector. The causes are multiple: The sector has suffered from lack of investments and under

utilisation over the last ten years. Only 30% of the overall capacity has been used during this period of time and is in need of modernisation;

No research and development has been done over the last ten years and consequently the materials produced are technologically less advanced and efficient than in Western Europe;

High taxes which makes the final product expensive compared with the imported ones;

Electricity and gas supply cuts which undermine production.In particular, the companies interviewed highlighted that: The building and civil works materials are generally available

locally and the existing capacity could support an increased level of works;

Reinforcing steel has been in short supply and the quality of the locally produced steel is inferior. The main supplier used

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to be Zenica in Bosnia and Herzegovina. Nowadays Yugoslavia is importing steel from Romania or Ukraine;

Prices are generally higher on the domestic market than the imports, and both above the international market prices.

Under the previous government, a few companies were licensed to import materials and they were allocated preferential quotas and therefore were in a position to influence the market. There are signals that the quotas system is being changed and hence the impact of distorted market prices to be less significant even though the prices of imported materials are still above the international market prices. Some of the larger contractors like Energoproiect have importing licenses themselves and therefore are capable of bypassing intermediaries and negotiate better prices.Some smaller contractors have expressed concern with their inability to directly access the supplier and therefore have to pay very high prices to wholesale suppliers. Cement is one such example, with prices up to 2.5 more expensive than the factory prices.In Montenegro there is no cement manufacturer. This is imported from Croatia. One organisation in Montenegro is monopolising the import of cement in bulk and therefore can influence the price. There are more suppliers for cement in bags, which is more appropriate for the small works.There is also a shortage of asphalt in Montenegro even for the current low level of construction activities. Procuring materials for more infrastructure works in Montenegro would have to rely on imports, as there is not enough local capacity for most of the civil works as well as specialised materials.The payment terms practiced by domestic suppliers or wholesalers vary and depend on the relationship with the contractor. Some room for negotiating better payment terms exists also with Western suppliers, especially if the contractor is a large known company. If materials are sourced from other Eastern European countries such as Romania or Ukraine, contractors have to pay in advance.Equipment Suppliers

There are very limited sources of new equipment in the country. The most common practice is intercompany hiring. In some other cases contractors recourse to temporary imports. Similar to the situation in B&H, equipment can be temporarily imported for up to one year with exemptions of custom duty payments. The age of the equipment that can be imported is however limited to 5 years. Many contractors would welcome a relaxation of this rule, as it would allow them to utilise older equipment more economically.

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There are no equipment manufacturers in Montenegro. Most of the equipment, when not hired from other contractors, is sourced as second hand equipment from Germany, Italy or Austria.Plant and Equipment Hire

There are only a limited numbers of dedicated companies offering hire services, mainly because of lack of sufficient demand to make such a business viable. This businesses deal primarily with small equipment – small cranes, excavators and compressors.Plant hire is almost unknown as the perception has always been to rely on own resources. Most of the companies own plant facilities sufficient to meet their needs sell the excess production where they are not fully utilised.Consulting Services and Design

Yugoslavia has more tradition and experience in consulting services in the construction industry than for example Romania. We refer mainly to the project supervision / management activities. There are dedicated companies offering design and /or project supervision services such as CIP in Belgrade. These skills are however scarce and in need of updating. Project supervision is based on DIN standards, which provides a good basis for further development.In Montenegro it seems that there is a lack of good design institutes. A current project involving the construction of a tunnel to connect Podgorica with the coast was designed by a Slovenian company. Larger and more complex projects in Montenegro would probably have to be supported with services from other countries.A specific problem that one has to be aware of in Yugoslavia is the crossed shareholding structures whereby a design company owns a construction company or vice versa. This can create a conflict of interest if a design institute, authorised for approving construction completion, is requested to approve the construction undertaken by the construction company to which it is linked. Surprisingly, this is perceived as good business practice by the local industry. The problem can be further amplified if the design company is involved in project management as well.7.2.2 Demand for ConstructionThe construction industry is geared to service an increased volume of works and it is seen as an essential factor in the recovery of the Yugoslav economy, especially in Serbia where there is a wider range of economic activities than in Montenegro.A lot of the reconstruction work has been completed but the list of urgent projects, considered by the Ministry of Urban planning and Construction of Serbia, includes:

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Rehabilitation of the thermal power plant Kolubara – estimated investment US$500 million;

Bridges over Sava river amounting to a total of US$40 million; Roads and highways part of the European E network

(Hungarian border – Novi Sad – Belgrade; Nis-Bulgarian border and Nis- Macedonian border) for an estimated investment of US$1.6 billion;

Dams and related works estimated at US$600 million; Airports modernisations estimated at US$10 million.A significant importance is placed on the introduction of new transport technologies and modern organisational and management methods, especially related to large systems like the railway.Besides these large projects, there are significant needs in: Rehabilitation and improvements of water and waste water

infrastructure; Commercial buildings such as offices; Schools and hospitals maintenance and rehabilitation.In Montenegro the scale of immediate infrastructure needs is much smaller and includes: Tunnel – this project is being constructed by a Slovenian

construction company and financed by the Montenegrin Government;

Bridge at Verige, estimated at US$65 million; Water and waste water infrastructure; Schools and hospitals rehabilitation and maintenance; Tourism industry.Activities relating to public infrastructure construction in Montenegro are controlled by the newly established Directorate for Public Works.7.2.3 Industry CapacityThe Serbian capacity to meet the present demand in terms of volume and range of activities is good. In fact, the industry is operating below capacity. The overcapacity is explained to a large extent by the significant concentration in Serbia of the largest construction companies that used to be active in the ex-Yugoslavia. Like in other countries, it is difficult to rely on the data presented to us in the questionnaire. Simply adding the amount of work the companies believe they can undertake is

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very likely to deliver an overestimate of their capabilities. However, it is accurate to describe the industry as under-utilised, most of the companies, especially the larger ones operating at about 30% - 60% of their capacity.Due to the lack of projects, larger companies tend to get involved in small projects in order to survive. To a large extent, middle sized companies do not exist, leaving opportunities for the larger companies to undertake smaller size projects.The small, mostly private contractors are under-utilised too. Some of the most dynamic ones have started to prepare themselves for larger projects and consider formal partnering arrangements with similar size companies with complementary skills. Some others are planning to specialise in growing sectors such as wastwater, infrastructure. In doing so, a few medium-sized contractors are seeking cooperation with western companies to bring new technology into the country.The associations of larger contractors are also common. Driven by the lack of recent experience and sufficient financial resources, large contractors in Belgrade, have formed an association called Yugoslav put. This association fronts tenders for larger and more complex projects.In our opinion the construction sector in Serbia will undergo several transformations: Ownership structure – some of the larger contractors, socially

owned or partly state-owned will change the ownership structure following privatisation. Though none of the interviewed companies mentioned restructuring plans prior to privatisation, it is expected that privatisation will trigger management and operational changes;

Consolidation amongst smaller contractors to diversify their services or to grow in size and be able to complete for larger and more complex projects;

Gradual reduction of the amount of works undertaken in the grey economy. This phenomenon involves rather small contractors active in the building sector.

The factors limiting capacity in the Serbian construction industry are: Shortages of skilled workers in new technologies; Shortages of operators for new types of equipment; Outdated management skills in the areas of schedule, quality

and contract management.Montenegro is to a certain extent different to Serbia both in the supply and the demand patterns for construction works.

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On the supply side, most of the companies are private. The larger ones, still state-owned, socially owned or mixed, are in the range of middle-sized companies by EU standard for annual turnover. There are no Montenegrin construction companies capable of undertaking larger projects, more than probably US$30 million. The work force is generally inefficiently utilised in the non-private companies either because management constraints or because demotivation.There is also a real shortage of some skills that affect the building sector.The profile of demand in Montenegro is more limited in both volume and type of projects. Besides the buildings sector, which constitutes the base workload for the majority of the existing companies, there is some potential for roads and tunnel works.7.3 Privatisation Plans and Impact on the Construction

Industry

7.3.1 Overview of the Privatisation Process in SerbiaThe latest information available to us related to the privatisation process dates back to year 2000. During our visits to Yugoslavia and the preparation of this report the parliament of Yugoslavia was reviewing and planning to ratify the new legislation. It is therefore difficult at present to make a judgement on how the privatisation laws will be amended and put into practice.In 2000, the privatisation in Serbia, often referred to as the ownership transformation, was based on the following principles: The law covered socially and state owned companies; The companies have the authority to decide and choose the

privatisation model; The privatisation framework provided legal guarantees for the

process and its outcome;The following privatisation mechanisms were used: Sale of shares for the purpose of selling capital (with or

without discount). All proceeds were transferred to various funds;

Sales of shares for the purpose of raising additional capital or recapitalisation (at a discount). All proceeds were transferred to the enterprise itself and therefore represented the most attractive method;

Conversion of debt into share capital (at a discount).All these mechanisms represent in fact a voucher approach to privatisation, and therefore only a limited amount of fresh capital was injected into the newly privatised companies. It is also

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important to mention that this stage of privatisation undertook in the year 2000, followed an initial stage whereby 60% of the shares had been distributed gratis to present, former and pensioned employees.Very few companies interviewed were willing to share the details of their privatisation plans either because they were still developing them and waiting for official ratifications of the new laws or considered them too sensitive to disclose. No matter what modality they will eventually choose, it has became apparent that: The biggest limitation to the privatisation is the unsettled

arrears between banks and companies and between companies themselves;

Most of the modalities proposed, similar to many other Eastern European countries do not bring new fresh capital into the company.

At present, the enforcement of the existing law, whose basic principles are outlined above, has been postponed until the enactment of the new law. This is expected to happen by the end of the year 2001.One of the large construction companies informed us that they plan to sell some 75% of the shares to the employees and management and sell up to 25% to strategic investors. It would be a long way until strategic investors are attracted to the construction industry in Yugoslavia. They have been slow and few to appear in other Eastern European countries. Based on the experience in other countries, such as Romania, international companies preferred to enter into the market by establishing a new company and hiring local staff rather than acquiring existing companies.The construction sector has already reached a high level (compared with other industries) of ownership transformation – some 10% of the construction companies had been privatised.7.3.2 Overview of the Privatisation Process in MontenegroThe Montenegrin authorities defined three categories of companies, each one of these following a different privatisation model: Development Fund which groups 196 companies and 36% of

their estimated value is offered for mass voucher privatisation;

The second group is formed of 20 large enterprises (Aluminium Works, Electric Power Industry etc.) and 51% of their capital is reserved for foreign investors. The difference of 49% is subject to mass voucher privatisation;

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The third group involves 34 enterprises intended to be sold by auction and recapitalised, with a certain percentage offered to mass voucher privation.

The vouchers can be exchanged for shares in companies or in Privatisation Funds.Like in Serbia, the companies were not willing to disclose information about the process as in most cases it was still unofficial. Some construction companies mentioned the third option as the one to be applied. The construction industry represents 9% of the companies undergoing ownership transformation.7.3.3 Impact of Privatisation on the Construction SectorConsidering the early stage of the privatisation process during the preparation of this report, it is difficult to make a judgment on the impact this would have on the way companies are managed and operated. However, based on the findings of our surveys and on the experience in other countries, we can say that: Most of the companies undergoing privatisation have

distributed around 60% of their capital to exiting and former employees. This reflects a tendency of the companies to restrict the circle of shareholders to insiders;

Most of the enterprises that started up their ownerships transformation did so under the earlier laws, showing that some were determined some time ago to restructure and privatise;

There is a strong tendency to maintain the status and power of the existing management. Having too many small shareholders, in most cases, the pressure that they can exercise on the management to improve the company’s position is likely to be limited. This can be associated with the desire of the employees-shareholders to maintain the existing status quo for fear of losing their jobs.

Most of the construction companies undergoing privatisation could benefit from the reduction or elimination of the arrears in the industry.

Some construction companies take the view that a more powerful management can take action quicker and act in the interest of the company. At present they consider that their actions are limited by the ownership structure, and labour regulation.

7.4 Survey of Local Procurement Rules and Their Impact on the IFI’s investments

We have not been able to obtain the present rules governing procurement and contracting neither in Serbia nor in Montenegro

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because they being reviewed and updated within the Ministries for Public Works in both countries.The present procurement rules do not preclude and do not favour any particular type of company depending on their ownership structure. Though there is considerable knowledge of the international contracting rules in the large construction companies, the majority of the companies interviewed expressed their concern with the lax interpretation of the present rules and regulations. There is no standard form of contract and the use of the FIDIC rules is limited, both in Serbia and Montenegro. This has a direct impact on the industry as it lowers the professional standards.The cost estimate process and procedures are other areas of concern. These have not been updated and therefore do not capture new technologies and processes. The cost estimate is not itemised and therefore costs are hidden in the price with no possibility to assess the real value of works. Similar to the other countries surveyed, indirect costs (insurance, bonds, safety etc.) as well as provisions for contingencies and risks do not exist or are not transparent.However, a lot of companies interviewed indicated that they were familiar with the World Bank procurement rules and that the Yugoslav procurement rules are modelled along the lines of the World Bank’s rules.7.5 Survey of Local Construction Companies

7.5.1 Construction Companies InterviewedDuring the screening phase of the survey, we targeted a large number of construction companies fulfilling the following criteria: Target active companies with no declared losses; Include in the survey at least ten of private companies; Prepare a balanced portfolio of construction companies in

terms of the number of employee and revenues.We distributed 56 screening questionnaires. Out of these, 27 companies responded to the detailed questionnaires but only 23 of them have been retained as candidates for interviews. The other four have been rejected either because they were too specialised or have been known as having associations with the previous regime.The main conclusions of the responses received are presented below. The findings based on these questionnaires had been corroborated with interviews and the results presented in section 7.4.2 – Constraints and Difficulties.

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Almost 80% of the companies claimed experience in both buildings and civil works, in most cases associated with structural steel activities;

Around 45% of them own some plant facilities sufficient to meet their own needs. The excess production is usually sold to other contractors;

Size and ownership structure of the companies that responded to the detailed questionnaires was as follows:

Nr employees Private Socially Owned Mixed State-owned

<100 7

100 - 250 1 1 1

250 3 5 2

Value of assets owned by SMEs ranges between US$90,000 and US$2 million;

Value of assets owned by large contractors range between US$1 million to US$12 million;

The annual turnover for SMEs ranges between US$0.5 million to US$3 million. Only a few declared their operating profit with values between 2% and 12%;

The annual turnover for large contractors ranges between US$2 million and US$150 million, with most of them concentrated in the range of US$10 million to US$30 million. None of the large contractors declared profitability figures;

The largest contract values are between US$12 million and US$15 million, only a few rising to US$45 million;

SMEs have been able to work for lump sum contracts in the range of US$0.2 million to US$0.5 million and only rarely up to US$1 million;

The larger contractors have managed lump sum contracts around US$20 million with only one declaring a higher value of US$50 million;

Most of the contracts have been unit rate. The lump sum contracts usually represent 10% - 15% of the value of the works contracted. The maximum reported share of lump sum contracts was 35%;

The value of assets purchased during the last three years was limited to US$60,000 for SMEs and US$0.5 million for larger contracts;

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Almost all contractors declared that they finance their activities through advance payments and their own cash or capital. In a few cases, purchase of assets was possible with revenues acquired from selling land;

Almost 25% of the companies interviewed had ISO 9000 accreditation;

About 50% of the companies interviewed had not participated in tenders according to international procurement rules. Some of these are not interested in bidding for work and some others know that they cannot fulfil qualification criteria;

Most of the companies mentioned that they knew where to look for information about prospects, usually in the local newspaper or other domestic sources. Around 40% of the interviewed companies were monitoring Internet sites.


Shortages of skilled labourLike B&H, Yugoslavia suffered a loss of trained and educated construction specialists either because they left the country or they retired. Fewer people are attracted to the sector and in time there may be a lack of qualified staff.In Montenegro this is already a problem and skilled labour is attracted from neighbouring countries such as Romania, Serbia and Croatia The issue is exacerbated in Montenegro by the overall insufficient number of people willing to engage in productive labour (80,000 people out of a total population of 675,000).A certain number of construction workers are not officially employed in order to avoid paying taxes and social burden, which the smaller contractor cannot afford. This further limits the chances of training the staff and amplifies the scarcity of skilled labour force.Delays and uncertainties with respect to supplies and price of materialsThe availability and quality of materials is more problematic than in the other countries surveyed with some shortages occurring in the building materials sector. The sector has also suffered from lack of investments and under-utilisation over the last ten years. Some 30% of the overall capacity has been used and consequently is in need of modernisation.The most common construction materials are produced in Serbia and Montenegro, such as cement, aggregates, bricks, tiles, plates and profiles. Reinforced steel products have to be imported generally from Ukraine or Romania. There is a small, reinforced

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steel facility in production in Montenegro. If the materials dedicated to civil works and buildings seem to be available, the more specialised and technologically advanced ones are imported, e.g. rail tracks imported from a Chinese subsidiary of Krupp.The procurement of materials from abroad is more problematic for smaller contractors because they have to buy all the quantities needed in one order at the beginning of the project. The advance payment is to a large extent, in some cases up to 80%, tied up in purchasing materials and equipment.Access to hired plant and equipmentThe most common form of procuring equipment is intercompany hiring. The equipment is generally 15 - 20 years old and there are no internal sources for new or second hand equipment. A significant number of interviewed companies indicated that temporary imports are used as an alternative source of equipment. The current legislation allows for a temporary import of up to one year, renewable.Procuring work on a steady basis and possibility to plan for the futureMost of the construction companies are currently preoccupied with survival due to the lack of investments in infrastructure. As in Bosnia & Herzegovina, it is difficult to create a basis for further development.Availability of Supporting ServicesThe current level of industry supporting services (training, information, seminars) though limited in nature, was not quoted as a critical hurdle in gaining access to internationally funded work. However, a large number of the interviewed companies suggested that the creation of a centralised pool of sources of information, industry performance indices, industry issues and standards updates would increase the speed of access to information, benefit the business development process and keep companies informed about the construction sector development.Procurement Related

Access to InformationThough most of the companies interviewed declared that they actively monitor the IFIs project opportunities, they also mentioned that the sources are too diverse to be tracked down properly and stay well informed. Some would welcome a centralised source of information of all investments in the country.

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Transparency of the ProcessMost of the smaller contractors do not work for public authorities because of fear of wasted efforts and prefer to stay in the private housing sector. Larger contractors working for public authorities on infrastructure related projects is a common occurrence. The main concern is not related to the requirement of the procurement package but to the way this is implemented.Client Related

Supervision during implementationThere has been limited experience over the last few years with implementing large projects and it is estimated that the public clients would lack enough experience and staff to monitor the execution. Most of the construction companies suggested that the best option would be to involve foreign supervision. In Yugoslavia there is a tradition for engineering consulting services. Engineering consulting companies could be involved in the monitoring of project execution. In fact, traditionally the Ministry for Public Works always appointed a consultant to run the project and was not directly involved in monitoring project implementation.PaymentsDelayed payments and even insolvent clients have hindered day-to-day operations. In some cases payment is made in kind which reduces the Contractors’ liquidity.Unreliable clientsUnreliability of both public and private clients has been quoted as a serious risk. The unreliability encompasses deferred payments, suspension of works and cancellation of contracts due to the client’s own difficulties. Some contracts have been cancelled because of the political situation and sanctions over the last few years but the concern is that the contractual relationships are not reliable. An increasing number of cases end in arbitration.Permitting and Urban PlansIn Serbia there is a concern with the level of administration, content, coordination between municipality and state and procedures related to obtaining building licences. In Montenegro this is less of problem as the procedures are simpler.There is also a genuine concern that the aerial plans are seriously out of date or simply missing. The lack of accurate information can have an adverse effect on projects costs and schedules due to the unknown conditions that can occur.

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Insufficient DocumentationThis ranges from the quality of the design, the accuracy of quantities in the bill of quantities to inadequate records of changes and project reporting.Contractor Related

Lack of experience in modern site management and contract planning techniquesPoor construction planning and monitoring exacerbated by lack of adequate software dedicated to evaluation and monitoring could prejudice the project execution. The smaller contractors are generally not familiar with formal planning and management techniques. This may not be necessary for small and simple projects but it can jeopardise their chances to embark on larger contracts.Lack of diligence in keeping financial records and general book-keepingThis affects the company’s capacity to produce accurate financial reports and raise finance. It also impairs its capacity to monitor performance at the project level.Compliance with ISO 9000Six of the 25 contractors who responded to the detailed questionnaires have ISO 9000 accreditation. A few more were either planning to apply for it or in the process of applying for the accreditation. Generally they were aware of the ISO requirements and familiar with the DIN standards.Information technology and systemsLack of new IT as well as information systems are hindering efficient operations. Data recoding, book-keeping and accounting, project management tools and reporting are a problem equally for small and large contractors.Ownership Structure

Some of the socially owned companies consider that the present ownership structure triggers a slow decision making process and does not motivate staff to work.Finance Related

LiquidityThe whole economy in Yugoslavia is affected by limited liquidity. For contractors this means very limited working capital. In some cases subcontractors are paid in kind, e.g. apartments built. The contractors are also adversely affected by the high level of arrears in the economy and deferred payment by public clients.

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Social and tax burdens and employment conditionsThe large construction companies in Serbia are state-owned, socially owned or mixed ownership. They are generally overstaffed for the current level of work in the construction industry and burdened with high levels of social security contributions. The financial problems are amplified by rigid and unfavourable labour rules such as large severance packages, which constitutes a serious deterrent in restructuring the company.For small and medium private companies the fiscal burden is equally heavy and causes tax evasion with some companies declaring bankruptcy but continuing to operate in the grey economy.Non-convertibility of national currency in SerbiaThe lack of hard currency pushed contractors into purchasing low quality materials from abroad.Banking Procedures and OperationsSome Yugoslavian banks do not have relationships with international banks. The lack of corresponding banks makes payments abroad a difficult task. Also, the guarantees issues by local banks are not recognised abroad or by international clients active in Yugoslavia.GuaranteesAlmost all contractors are unable to provide guarantees neither at the tendering stage nor at the execution stage. The limitation occurs because of the contractors’ low value of assets or cash needed as collateral. It also occurs because of bank’ reduced capacity to issue guarantees. The few guarantees that can be arranged through the local banks are not recognised by foreign clients.

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7.5.3 SWOT Analysis


Previous experience on international markets.


Some familiarity with a wider range of contracting structures including lump sum turnkey projects.

Greater chances to approach a more complex risk allocation structure, especially the large structure of construction projects.

Capacity to prepare feasibility studies. None directly, but if projects are promoted at early stages contractors can anticipate, plan and prepare for future needs.

Availability on the domestic market of consulting services related to ISO 9000, though too expensive at present for SMEs.

Potential to spread international quality standards and meet EBRD’s and international partners’ requirements.

Low labour cost for qualified and skilled staff.

Potentially a better offer price, though the advantage can be offset by low productivity.

WEAKNESSESIMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY EBRD

Limited capacity for bonding. Cannot undertake large and complex projects without foreign partner.

Serious limitation (lack of cash and collateral) in providing guarantees over the last 10 years.

Cannot fulfil the bidding requirements.

Small and medium contractors in Montenegro lack specialisation (most are building and civil works contractors).

Reduced possibilities to compete for more complex projects.

Lack of management and planning skills combined with limited control tools, especially for larger and more complex projects.

Can affect the project execution with direct implication on budget and project completion.

Serious limitation in fulfilling the usual qualification criteria: past experience, structure of workforce, equipment and financial positions.

Limit the number of potential candidates for IFIs tenders and execution and completion risks.

Lack of knowledge and/or experience with contractual terms.

Problems can occur especially with contract variations, risk allocation and rights and obligations, thus affecting thus schedule and

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WEAKNESSESIMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY EBRD

budget.

Unfamiliarity with new and sophisticated equipment.

Potential scarcity of skills for more complex projects.

Insufficient skilled workers in Montenegro and reliance on foreign workforce.

Cannot meet qualification criteria and execution and completion risks.

Limited number of quantity surveyors. Can diminish the quality and efficiency of project supervision.

Lack of safety procedures and qualified staff to implement and monitor them.

Can diminish the chances to qualify, for JV or subcontracting with foreign partner.

Weak technical understanding of new technologies or complex drawings among smaller contractors.

Constraining factor for the more ambitious companies. Less efficient projects due to the use of old and less performing technologies.

Estimating techniques based on bill of quantities, with no clear identification of indirect and other costs. Problem exacerbated by the dominance of lowest price selection criteria.

Risk of offering “about right” estimates with the serious risk of underestimating the costs.

Unreliable or low quality of materials on the domestic market.

Can affect the project execution and quality.

Limited use of IT, internet and e-mail service as well as information systems (accounting and project management).

Effects overall business effectiveness.

Weakness of the insurance sector: limited availability of policies, no international recognition and uncompetitive pricing.

Very limited capacity to obtain adequate insurance polices at affordable prices.

Limited vocational and craftsman training.

Skilled staff shortages.

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OPPORTUNITIESIMPLICATIONS ON THE CAPACITY TO ACCESS AND EXECUTE PROJECTS FINANCED BY EBRD

Potential consolidation among the small and medium sized contractors.

Better-qualified companies with potential to approach more complex projects.Increased bargaining power in acquiring materials at better prices and hence more advantageous project budgets.

Privatisation. Transform some of the large socially owned companies into more efficient companies with focused and incentive giving management.

Cooperation with foreign companies on the domestic market.

Technology transfer and penetration of new project management techniques.

Harmonise the tendering and procurement rules with the international rules.

Impose from the outset an adequate framework and learn from EBRD’s experience over the last ten years in the neighbouring countries.


Delayed interim and final payments. Incapacity to continue work and, in the worst cases, to purchase the equipment and materials.Limited capacity to commit to more or larger projects.

Incapacity of the banking system to offer adequate financing, together with obsolete and inefficient credit assessment procedures.

Cannot meet guarantees requirements, risk of stopping the work because of lack of financial resources.

Intercompany arrears. Limits the contractors’ liquidity.

Uncertainty of demand. None direct but companies are not capable of accumulating experience, improve equipment fleets and generate positive cash flows.

Low barriers to entry in terms of qualifications and requirements.

Too many small companies operate and therefore the market is too segmented making difficult choice of the right contractor.Too many companies that cannot undertake more complex projects.

National professional standards and quality standards still to be coordinated with the EU.


Cross shareholding structure is a Cross ownership between design and

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potential source for conflict of interests. construction companies can affect the approval and commissioning processes, if both companies have a role in the same project.

7.6 Other Companies Interviewed

Design Firms and Consultants

We interviewed one company based in Belgrade offering design and project management services – CIP, owned by the Serbian Railways Company. Though a state-owned company, employing a large number of specialists (around 700) it is active in the private market as well, which is providing at present some 40% of their annual revenues. Unlike the other countries surveyed, the Serbian construction industry benefits from specialised services in project management and supervision.Insurance

The largest Yugoslav insurance company “Dunav Group – Dunav Insurance” is a state–owned company employing more than 3,000 employees. It has a large network of branch offices throughout Yugoslavia. According to the existing law, there are no minimum insurance requirements specific to the construction sectors. As like in B&H, the minimum required is vehicles, air passengers and maritime traffic insurances. Construction All Risks or third party liabilities are not compulsory. This explains the very low level of insurance taken by the construction companies. They represent no more than 3% of the company’s portfolio. Other insurance companies are DD Novi Sad in Vojvodina and Loveen in Montenegro, both state owned. Most of the 53 insurance companies registered in Yugoslavia are private. They are very small and operate mainly in the field of vehicle insurance.According to our findings, the existing legislation does not require the insurance to be arranged through a domestic insurer.7.7 Survey of Business Related Services

Construction Industry Related Services

In Yugoslavia the Association of Engineers and Technicians exists for each engineering activity. The Association of Civil Engineers is quite important and has a network of branches at the republic, province and regional levels. The Association of Civil Engineers encompasses various organisations such as: Yugoslav Association of Structural Engineers;

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Hydraulic Association; Construction Association.These associations provide information services, primarily supported by the organisation of seminars and conferences. They are sponsored through membership fees.Besides the professional activities, the Association of Civil Engineers is officially authorised by the Ministry for Urban Planning and Construction to carry out vocational examinations that are compulsory for all young engineers and technicians on the elapse of a two-year training period. The specialists who have passed the exam are consequently authorised to approve projects and execute managerial tasks in construction projects. Moreover, companies wishing to obtain a licence for executing construction works must employ a minimum number of authorised engineers. This good practice ensures a higher level of standards in terms of managerial skills. Countries like Bosnia & Herzegovina or Montenegro who do not enforce such requirements suffer from lower professional standards. It is however questionable how much the requirements are enforced considering that over the last few years a lot of construction companies have been engaged in the grey economy or have declared bankruptcy. This has been the case especially with the small companies.The Chamber of Commerce is also covering construction activities. Although they are not very active in Serbia or Montenegro, they are in the process of updating their database and assessing the construction industries in both countries. They also issue trade publications relating to the construction companies.The Federal Institute for Standardisation has been a full member of ISO since 1950. Its main objective is to update standards, collaborate with international organisations and publish periodicals. Although it has not been very active lately due to lack of funds, the Institute has been engaged in implementing the regulations relative to the World Trade Organisation. The Institute also owns a vast library of standards both Yugoslavian and international.The institute is keeping a record of all certified assessors for the purpose of the certification process. Besides this, a great contribution to the introduction of quality systems is also made by consulting companies that undertake training in this area. It is considered that once the economic activity is revitalised, more activity in the area of standardisation will take place, such as updating the standards. The best support for standardisation in Yugoslavia is considered to be in the creation of Federal Government Quality Council to promote the current needs in the industry and the creation of agencies for information and assistance in this area.

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Generally speaking, the standards applicable in the construction industry are well developed and none of the construction companies considered that the lack of ISO 9000 certificates is a hindrance in winning work.In Montenegro the organisations mentioned above are even less active. Moreover, independent business associations are a novelty in the country. There is awareness of the need to develop these to promote not only professional interests but also larger scopes such as market and free competition development. In this context, it is important to mention that a newly established Montenegrin organisation was put in place which deals with rating the most successful enterprises. This organisation is called Business Rating 300 and it is sponsored by Centre for Entrepreneurship based in Podgorica. Should the rating become more recognised and possibly formalised, it could become an effective tool of promoting performance standards at company and industry levels.SMEs Related Organisations and Legislation

The recently established Serbian Association of SMEs (SIGMA) prepared in collaboration with GTZ of Germany, an action plan in support of the construction sector’s development. However, there are no specific laws and legislation encouraging the development of these companies. The criteria for classifying enterprises into small, medium and large is determined by the Accounting Law and relate to the number of employees, amount of income and value of assets.

Generally, the SME sector in Yugoslavia is not competitive because of the lack of financial and fiscal discipline, mainly by the socially-owned companies. The SME sector is very often not collaborating with large companies, one of the reasons being late payments. There are other burdens that make the situation even worse for SMEs: General lack of capital in industries and large arrears; Large companies are trying to shift the financial burden to

small subcontractors by imposing deferred payments; The current taxation policy makes the SMEs feel insecure (e.g.

tax liability established retroactively) and heavy taxation (high taxes on wages and social security);

Lack of institutional infrastructure that limits the training possibilities and communication with foreign partners.

As a consequence, a lot of SMEs are closing down official businesses and continue to work in the grey economy. It is interesting to notice that despite all these negative factors, almost 99% of the total number of private enterprises is represented by SMEs, a large proportion of which are construction companies.

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Montenegro has been more active than Serbia in promoting the development of SMEs and has started to give loans to small business. It also plans to invest a significant proportion of future revenues from privatisation to develop the private and SME sectors.7.8 Survey of Local Financial Institutions


The two constituent republics of the Federal Republic Yugoslavia, Serbia and Montenegro, have different financial sectors. Serbia is just emerging from the destruction, isolation and corruption caused by the Milosevic government, and is facing the daunting task of rebuilding the economy. Its banks are now in the process of adjusting to the new conditions. In contrast, Montenegro, which has separated itself from the Milosevic regime since 1998, has received significant foreign support and escaped the destruction of the conflict with NATO.The new Yugoslav government is revising its banking regulations to bring the system closer to international standards, but is just starting to implement them. The resulting restructuring of the Serbian banking system should eliminate many banks, especially the smaller weaker ones. The large, “socially-owned”, banks, which were founded before Yugoslavia broke up, carry ancient past due loans and have other problems that stem from that breakup, sanctions and government policies. Some of the problems stem from government decrees freezing foreign currency deposits, stopping interest payments during the sanctions and decentralising banking groups united in the 1980s without fully resolving interbank obligations. Most of the largest banks would be bankrupt if normal EU or USA standards were applied. Those banks favoured by the former regime are being investigated and all are clearly out of favour with the government and the majority of the general population. While most Serbian banks seem apprehensive about their future, a few are enthusiastic about the opportunities. The first foreign-owned bank has just started operating in Serbia and Societe Generale (France) has a joint venture bank. Raiffeisenbank has received banking licenses and reportedly plans to open in September. Local banks are showing varying degrees of interest in being purchased by one of the foreign groups that are exploring opportunities.Montenegro has not waited for federal government action on the banking system. During the past few years, Montenegro has started the process of restructuring its banks and companies and has implemented new banking laws for the Republic based on international standards and is at odds with Yugoslavian federal

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law. A new foreign-owned bank, chartered under these laws, is operating and a German bank has invested in an existing bank. The republic uses the Deutsche Mark instead of the Yugoslav Dinar and is actively discussing becoming an independent country. Montenegro also has a much smaller economy than Serbia’s and similarly limited potential and is linked with its federal partner in many ways.Both republics share, with Macedonia, the disadvantages of the corporate structure established under the old Yugoslavia. Under the Yugoslavian version of Communism, companies in theory were worker-owned and the banks were created and owned by these companies. The bank was responsible for taking care of its owner companies and the companies did all their banking business with their “house” bank. The worker/socially-owned firms were organised according to a Yugoslav state plan, so they tended to be large and had a very strong influence on their bank. This pattern was broken in Bosnia by the conflict, but in Serbia and Montenegro it still exists. Many new private banks, started since the collapse of the old system, are also tools of their corporate owners. A change has started in this pattern and is further along in Montenegro than in Serbia, but communist era giants still dominate both economies, including the banking and construction sectors.Because only the smallest private firms were allowed under the communist Yugoslavian system, few medium size firms have developed. An extensive, January 2001 draft study of the SME sector, prepared by Developpement et Finance International (DFI) for KfW, shows that in 1998 Yugoslavian privately owned firms had less than forty employees on average and that over 52% were in the trade sector. Construction firms accounted for only 2.7% of the total and averaged just over 20 employees. The same study showed that about 49% of those firms surveyed borrowed from family and friends, over 20% never borrowed and only 12.7% had borrowed from a bank.The construction sector has suffered like the rest of the economy during the last several years. The decline in the global market for construction has hurt the large firms and the sanctions denied them a chance even to bid on most projects. Some of these firms are in serious trouble but others, although cutting back, still have the reputation and financial strength to survive. Many old, large banks often cannot support these traditional clients because of their own major problems, and other banks are too small or unwilling to do so. The recovery process starting in Yugoslavia should help the construction companies to pull through. There has been significant damage to, and neglect of the country’s infrastructure interest by IFIs and the EU in financing much of it. Hence there should be a good deal of work for both the large and smaller

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construction companies, thus improving their cash flow and creating more possibilities for the local banks to finance them. Financial institutions interviewed and their construction industry business

As noted above, the financial sector in Yugoslavia is in poor shape. In Serbia, the large institutions are saddled with unresolved bad loans and other problems from the past. In many cases, they, and most of the small banks, are organised to fund their owners and friends and not as efficient, modern banks with good risk management procedures. In Montenegro, the situation is only slightly better. The privatisation and the bank processes are further along and some new banks with foreign support are starting to change the market. The large banks formed during the communist era are feeling the competition but are still acting as house banks for their owners and carrying the burdens of the past.The ten banks surveyed, seven in Serbia and three in Montenegro were asked in advance of our meeting to complete the survey questionnaire. One in each republic had started operating too recently to have any meaningful statistics, but only half of the other banks completed the questionnaire. The interviews with the other four banks yielded good information, but data obtained was based on the personal estimates of those who were interviewed, and are not therefore fully reliable and comparable the with the verified, written statistics requested.BanksThe ten banks interviewed included: Beogradska Banka, Jugobanka, Zepter Banka and Micro

Finance Bank in Belgrade; Novosadska Banka, Kulska Banka and Vojvodjanska Banka in

Novi Sad; Podgoricka Banka, Euromarket Bank and Montenegrin

Commercial Bank in Podgorica, Montenegro.The main findings show that: Beogradska, Jugobanka, Novosadska, Vojvodjanska and

Podgoricka are all “old” large banks created in the communist era. Micro Finance Bank and Euromarket Bank are both foreign owned and have only just started operating. Zepter Banka, Kulska Banka and Montenegrin Commercial Bank are all “new” small private banks, founded in 1992, 1995 and 1997 respectively.Beogradska Banka (Beobanka), Belgrade, was founded in 1982 and since then has been the main bank in Serbia and was one of the biggest banks in the old Yugoslavia. It is still the largest bank, with up to half the banking sector, but it has

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massive problems. It was the favoured bank of the Milosevic regime and is now out of favour, under investigation and likely to be restructured on that basis alone. As the house bank for the government and for all the large Serbian firms, it has changed the least of all the Yugoslav banks. It also has high levels of bad loans and of claims for frozen deposits and of demands for compensation relating to banks merged into Beobanka.

Beobanka’s questionnaire indicates that it has over $137 million in credit exposure to the construction industry, 15.22% of its total credit exposure. It gave no information on how much of this is long past due. The bank has credits outstanding to about 25 construction industry firms, 83% for guarantees and letters of credit, 10% for working capital loans and 7% for equipment and plant financing. It has 90% of its exposure with 20 large contractors, 6% with technical service firms and 4% with building materials suppliers. It lists only 4 small firms as having credits. We were told that over 200 firms, 70% of all construction companies, had accounts with the bank and that they want to increase that number. To manage this business, the bank has a construction industry division staffed with construction engineers and other specialists.Beobanka is seeing the results of its current problems. Customers, no longer tied to the bank are moving their accounts to other banks. One reason for this it that the bank is unable to make loans. It has made no term loans for “a long time” is now no longer making short-term loans. Many of the big contractors that the bank serves have their own major problems, and the bank’s lending to them has declined, even before the current lending restrictions. In the past, construction loans reportedly accounted for over 10% of the banks portfolio, but now stands at around 1% - 2%.

Jugobanka, Belgrade, is the other big bank in Serbia. It was founded in 1955 and for years was the international bank for the country with operations in all republics and provinces of the old Yugoslavia. The break up of the country and the sanctions hit Jugobanka especially hard. It lost a large percentage of the bank as the newly independent former Yugoslav republics closed or took over its branches and subsidiaries. Because it operated largely in the world market, Jugobanka was not as hampered by the “house bank” procedures of funnelling credit according to directions and seems more aware of good banking practices. Based on the brief survey meetings, it seems more focused on the future and on restructuring itself than does Beobanka. It is rebuilding some of its Balkan network and recognises that it is overstaffed and under capitalised and needs foreign investment, assistance and strategic planning. That said it

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has many of the same problems as the other old banks plus significant foreign debt, which it cannot service. Jugobanka was very active with construction companies in the 1980’s, especially on their international projects, but has been less active in recent years. It reports that its current construction industry exposure is about DM40 million, about 10% of its total. Of that, contingent liabilities (guarantees and letters of credit) make up 60%, working capital loans 40% and equipment and plant financing 10%. It lists no small companies among its credit customers, but over 44% of its exposure is with medium sized firms. Building materials suppliers account for 50% of its exposure, contractors 40%, technical service firms 8% and other construction consulting and service firms the balance.

Zepter Bank, Belgrade, is a fairly small, rapidly growing bank with over DM40 million in assets and a legal lending limit of DM5 million. It was founded in 1992 and is owned by the Zepter Group, headquartered in Switzerland, which is controlled by Peter Zepter, a Serbian who is now a citizen of Monaco. The Group includes over 120 firms, in a number of countries, mainly in trading and production. The Groups main product is a very successful line of metal dishes. The bank has three branches, is opening three more and plans a further three. Zepter focuses on financing SMEs, which form over 80% of its business, and reportedly has over 4,000 corporate clients. No more than 5% of its business is with Zepter Group companies. It claims doubtful loans totalling only 0.67% of its portfolio and a reputation for quick and efficient action. The bank also manages a DM8 million, US based fund for loans from DM20,000 - to DM150,000 million. The fund apparently was organised by Mr. Zepter is and supported by Serbian expatriates in the United States and Europe. Zepter’s questionnaire reports exposure to the construction industry of DM2,931,940, a total of 12%. This exposure is to six small firms with less than 100 employees each, 88% for guarantees and the rest for working capital loans. Five of these companies are contractors and have 99% of the exposure with the rest to a building materials supplier.

The Micro Finance Bank, Belgrade, the newest of the microcredit institutions established and run by IPC, Frankfurt, started operations on9 April 2001. It has $6 million in capital and $9 million in assets and is 33.3% owned by EBRD, and 16.7% each by Commerzbank, FMO Netherlands, KfW and IMI, which is IPC’s sister investment company.The bank plans to make loans from DM1,000 to DM100,000, averaging DM8,000 initially. It views Yugoslavian bank regulations as very non-transparent and complicated making the bank’s development of good banking business more

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difficult. The General Manager is very interested in the construction industry, which he sees as one of the best for them, but as of 22 May 2001, the bank had not received much attention from construction firms.

Novosadska Banka, Novi Sad in Serbia’s northern province of Vojvodina, is another old bank with five main branches, 160 sub branches, and 880 employees. It has assets totalling approximately $265 million and statements audited by Coopers. Because of privatisation, half of its owners are now private companies and the local, agricultural-based economy is in a better condition than in most other parts of the country. The bank’s general manager, Professor Bjelica, sees himself as an expert in banking and finance. His objectives are to help the restructuring of the bank’s clients, to honour old obligations, to resolve the problem of frozen savings of individuals and to find a strategic partner for the bank. He noted that if standard credit criteria were applied, no one would be able to meet it.He estimated that construction industry accounted for not more than 5% - 6% of the bank’s exposure. He said that the bank could not give support to the big construction firms especially if they are socially-owned, and that small firms do not come to the bank their needs were not great anyway. The last five months were the worst for the international construction industry, and there is not enough business in Yugoslavia for the big firms. He noted that many do not have positive cash flow and so would not be able to manage even interest free loans.

Kulska Banka was founded in 1995 by converting a five-year-old savings bank, and had just moved its head office from Kula, Vojvodina to the province’s main city, Novi Sad. It is another small bank with about $43 million in capital, and $59 million in assets. There are three branches in the province, one in Belgrade with approximately 70 employees. Based on its year-end balance sheet for 2000, 45% of its assets were short-term loans, 13% long-term loans and 17% securities and investments of various kinds. Its owners are “leading local companies”. It has aggressive management and reportedly is making speculative equity investments. Management claims to have offered EBRD 20% ownership. It claims that half of its business is with small companies and that it is forming a SME strategy.Kulska does very little business with construction firms although it has a couple of the large firms as customers.

Vojvodjanska Banka, Novi Sad is the largest in Vojvodina and an old bank with a difference. The bank claims to be the only one in Yugoslavia that has a credit approval process that meets international standards, it is the only one that manages

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its capital in accordance with Basle Agreement standards and the only one that has an asset and liability management committee. In 1999, it reduced its staff by over 46% to less than 2,000 and has used Deloitte & Touche as its advisor on risk management and reorganisation changes. It has developed its retail and investment banking lines of business and has a broker / dealer and an insurance company among its subsidiaries. Before the crisis with NATO, it managed World Bank and IFC loans for SMEs and some export facilities. It still has a special unit for IFI related business.Based on its 1999 annual report, the bank had 11,273 shareholders, none of which owned more than 2% of the bank, but jointly account for about 13% of the bank’s exposure. Its stock is held 53% by private companies, 30% by public socially owned firms, 12% by individuals and 5% by cooperatives. The bank claims to represent 60% of the banking market in Vojvodina and to have the highest level of deposits in Yugoslavia. It has 15 branches, including at least 4 outside of Vojvodina and several specialised subsidiaries.Those interviewed estimated that the bank’s exposure to the construction industry is less than 10% of the total. However, the annual report listed all industries to which the bank’s exposure was over 6% and did not list construction, so construction may account for less than 5%. One of the bank’s subsidiaries, VOBING, is in the construction design, consulting, engineering and real estate business and also performs real estate valuation services for the bank. Through VOBING, the bank takes an active part in design of construction works, supervision of construction projects and real estate trading.

Podgoricka Banka in Podgorica, Montenegro, is an old bank, formed in 1992 with the breakup of the former Montenegrin united banking group of which it was the dominant part, but its roots date back to 1908. It has total assets of about DM300 million and equity of about DM32 million, 4 branches and 200 employees. It is still a public institution with only 20% private ownership. It is the bank for most of the big Montenegrin firms, but it also has many small clients. Podgoricka is feeling the effect of the changed banking market, noting that its customers are moving to smaller banks to get loans and cheaper transactions.The bank gave no estimate of its exposure to construction companies, but stated that construction is the most attractive business in Montenegro making big profits. The bank is so interested in this business that it is planning to create a subsidiary, or a joint venture with Atlas Banka, to build apartment buildings and sell the apartments.

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Crnogorska Komercijalna Banka (CKB), Podgorica, translated into English as the Montenegrin Commercial Bank, is a new bank founded in 1997. It is 75% privately owned, with the balance held by Telecom Montenegro. Most of its owners are companies and about 3% are individuals. In February 2001, DEG, Germany invested DM1 million in the bank in return for a 13.5% ownership and CKB claims to also be discussing an EBRD investment.The bank has equity of about DM8 million, four branches and 33 employees. Its staff are active and marketing oriented, led by seasoned bankers, and claims a good credit risk management culture with a loan committee that meets 2-3 times a week. CKB is SME focused and has had a DM1 million SME financing line from KfW since the year 2000. That line is fully disbursed and CKB and KfW are now finalising a second line for DM3 million. The Austrian government has a similar but smaller SME line to CKB, and the bank has had advisors on micro and SME lending from the firm, Max, in Germany.Its exposure to construction industry companies is about DM1,700,000, around 10% of its total exposure, all to seven small firms with less than 100 employees each. Approximately 70% of this construction firm exposure is from working capital loans, 30% from equipment and plant financing and a small percent from contingent liabilities. This exposure is divided between two contractors for 40% of the total, four building materials suppliers for another 40% with the balance to a technical services firm.

Euromarket Bank, Podgorica, was the first bank chartered under the new Macedonian banking law in November 2000 and is still striving to become fully operational. It is also the first foreign owned bank in Montenegro. Its owners are Raiffeisen Banka in Bosnia, DEG, Futura Investment and Soros Economic Development. The name came from Market Banka in Sarajevo before these investors bought it and changed its name to Raiffeisen Banka. It has capital of DM11.2 million.It is focusing on SME and retail business, and has outstanding DM4 million in loans and DM1 million in guarantees but has no construction industry business yet.

In summary, the big old banks have most of the construction industry business, especially that of the big companies. This dominance has started to change because the big banks’ problems make them unable to meet the needs of their clients and because the new environment encourages open competition between banks and also encourages companies to move their business to the banks that offer them the most.

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The new banks are small and frequently SME oriented. They are in a good position to serve the small construction firms and may grow with them, but they have credit limits too small for many of the bigger companies, even if they were willing to finance them. Restructuring of the banking system is just beginning in Serbia is and not much further along in Montenegro, with foreign banks now making an entrance into the market. As it changes, and as the large construction firms restructure themselves, financing of construction firms should improve. Meanwhile, the large firms without strong foreign banking relationships or very strong finances will probably have problems.Leasing and Equipment Rental Companies

This survey identified no companies leasing equipment in Serbia or Montenegro, although Vojvodjanska Banka said that it had very serious talks about leasing before the crisis. There are apparently no foreign rental companies doing business in Yugoslavia, but rentals from owner/operators and between construction firms are common in Montenegro with some coming from Macedonia, Serbia and even Bosnia. Based on an interview with a contractor in Belgrade, there are no owner/operators renting equipment in that region. A number of interviewees expressed strong interest in some type of rental company, even if it only rented second hand equipment.7.8.2 Financial Products for Construction Firms,

Requirements and TermsAll the banks issue guarantees, though Micro Finance Bank has not yet done so, but not all are able to lend and lending for terms over one year is more rare. In Serbia, the National Bank of Yugoslavia has applied severe restrictions on the big old banks effectively stopping them from making new loans. The new banks, which do not have the problems the bigger banks encounter, can make loans in spite of the NBY restrictions. Reportedly, the National Bank also sets rates, but the reported rates vary quite significantly and even the bank that mentioned of this noted that many banks to not observe it. The banks have compensated somewhat by guaranteeing their clients’ payments to suppliers and others financing the clients. This method also has problems because the banks’ guarantees are often not accepted without cash collateral or a confirmation by a foreign bank. The collateral is very expensive and the confirmation is also expensive and hard to obtain for the Belgrade banks.In Montenegro, the rates and credit terms are different, reflecting the different laws governing the financial sector and the differing environment. However, even there, Podgorica, the old bank interviewed, is not making term loans.

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Collateral requirements to clients for loans and guarantees are very high, usually at least 200% and up to 300% frequently, a very difficult situation for the small firms. There is reason to doubt the protection offered by most collateral, which is mortgage based. The Micro Finance Bank reported that it found mortgages not useful in Serbia because they are very expensive to register and are very difficult to foreclose. It does take mortgages, mainly for psychological reasons, but does not register them. A few of the other banks may be recognising this problem by requiring that part of their collateral requirements be covered by cash.Guarantees

In Serbia, based on reports from the Belgrade banks, guarantees and letters of credit account for 60% to 90% of the exposure the banks have to the construction industry. That high level is understandable, given the firms’ normal major need for construction project related guarantees, and their need for payment guarantees resulting from the restrictions on loans. Fees range from 0.3% a quarter at Beobanka and Vojvodjanska Banka to 0.5% a month at Kulska Banka and a planned 1% a month by Micro Finance Bank, which has made no guarantees yet. The Beobanka and Jugobanka report major difficulties in having their guarantees accepted and in getting confirmation as does Kulska Banka to a lesser extent. However, Vojvodjanska and Novosadska say that they have no such difficulty, and Vojvodjanska claims its guarantees and L\Cs were accepted even during the sanctions. Micro Finance Bank said that Commerzbank would confirm any of its credits if needed.Montenegrin banks are closer to the lower end of that fee range. CKB charges 1.5% and Podgoricka charges 2% on short-term guarantees. No rates were quoted for longer-term guarantees. CKB has no guarantees outstanding for construction firms. Podgoricka reported that its guarantees were usually not accepted internationally, but Volvo did accept its guarantee covering two orders for 30 trucks without collateral or confirmation. It was also noted that Kreditna Banka, Maribor, Slovenia had offered to confirm its credits.Working Capital Loans

In Serbia, Beogradska is making no loans, and Jugobanka is making them for no more than 30 days and they have a problem with this. Zepter is making working capital loans every day, limited only by it’s funding, and they are the main credit product of Micro Finance Bank. Working capital loans make up 45% of Kulska Banka’s total assets and about 14% of Vojvodjanska’s, which usual grants them for maturities of 3 - 6 months. Novosadska is also making loans but no information was received on the amount and type of loan it was making or if there were

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difficulties when making them. In any case, it is not interested in making loans to construction firms.Interest rates vary from the 9% charged by Zepter, 9.5% by Jugobanka and the 2.5% a month charged by Micro Finance Bank. Novosadska, says it charges 2% a month for foreign currency loans, plus a 1% front-end fee, and 5% a month for dinar loans. Kulska reports its rates as 4% to 5% a month. Since Jugobanka told us that it charged the official National Bank rates, it seems that those are only a small fraction of market rates in Serbia. The loan fund managed by Zepter Banka has loans from DM20,000 to DM 150,000 for up to five years tenor with grace periods to one year. They are made at 6% pa interest plus a 2% front-end fee.In Montenegro, CKB is primarily focused on making working capital loans, as demonstrated by its report that 70% of its construction exposure is for working capital loans. It charges 10% - 12% a year plus a 1% fee. Euromarket Bank is similarly focused and Podgoricka reports making loans, charging 12% to 18% with no fee.Equipment Finance Loans and Leasing

As noted above, there are the most constraints are on term lending which is needed to finance the purchase of construction equipment. Jugobanka and Beobanka, which were major financers of construction equipment in the 1980s and into the 1990s, and Zepter, are making no term loans at all. The first two do have some remaining term (equipment loan exposure left from those times) and Vojvodjanska’s term exposure is primarily from the same period. Kulska’s balance sheet shows term loans equaling about 14% of its total assets, but when interviewed it mentioned only payment guarantees for equipment purchase. The absence of term loans, combined with the lack of leasing and equipment rental and the difficulties noted with trying to use payment guarantees to get supplier, or other foreign, financing, causes major problems. There is essentially no way for firms to finance the equipment needed in Serbia. If the firms do not have the financial resources to buy equipment for cash or based on their own credit with sellers and foreign banks, they must do without it.The situation is only marginally better in Montenegro. The Montenegrin Commercial Bank is making loans to construction companies with tenors of 3 to 4 years, but it has only about DM 500,000 outstanding and Podgoricka Banka, a tradition term lender, may not be making term loansThe situation is also a bit better in Montenegro because of the active rental market among the companies and with owner/operators.

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7.8.3 Constraints in Financing Construction IndustryThere are many constraints facing the construction companies in Yugoslavia. The macro economic, political and legal problems from the communist and Milosevic eras have damaged the both the banks and the companies seriously. The banks can’t make loans and the big construction companies are often not credit worthy. The small ones fear banks and do not use them, and there are almost no medium size construction companies.Problems and their causes

The big firms face problems similar to those of the big construction companies elsewhere in the Balkans, but made worse and added to by the situation in Yugoslavia. They face stiff international competition and a decreasing international construction market. They hold ancient receivables from Iraq, Libya, Russia and other countries and from domestic clients and payments due under intercompany loans. As elsewhere, they are suffering a brain drain as the most able employees leave to start or join small private firms. They are very much overstaffed for their current business and are often losing money by underbidding to be sure of winning contracts in order to keep the company busy. Their incomes have usually fallen significantly and their expenses have not, causing losses and liquidity problems that make them not credit worthy.The big companies share with the small ones problems of liquidity and the need to self-finance. The also share the problem of owning obsolete equipment which needs to be replaced. Neither big nor small firms currently have a way to finance that replacement. One of the biggest construction companies in the region, Energoprojekt, illustrated the problems of the big firms and, in their case, the continuing strengths of some of them. It has been working internationally since the 1960s, reaching its peak in the late 1970s and early 1980s working primarily on major projects in Africa. It has had good ties with Citibank and Barclays Bank, and still banks with Coutts Bank in Switzerland, but had not used credit lines much because it financed itself. The economic condition of most African countries is weak and the governments are now favouring local construction firms. This has led to a major decrease in Energoprojekt’s traditional business, which, combined with a global depression in construction and the sanctions, has greatly reduced it. Its annual turnover has fallen to $120 million, which is about one third of its former level, and its capacity is very much underemployed. The company knows that it must reorganise and identify its opportunities and risks and has used its excess capacity to build a successful housing, office and retail complex near its headquarters. Clearly, it is still a strong company with

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internationally well-regarded expertise. It understands that it needs to reduce staff and sweeten the cuts by giving stipends and medical expense coverage to personnel on exit.Some of the other large construction companies are in a much worse condition, with some of the biggest going bankrupt.The small firms often do not have knowledge of how to obtain and manage suitable bank credit, but need at least guarantees if they are to work on any but the smallest jobs. Their experience with banks has been bad. A small infrastructure contractor, with an average of 43 employees and international contracts, stated that its bank has been holding, for a long time, a payment made to it from Iraq. Frozen foreign currency deposits have also damaged bank relationships with small businessmen. Credits are very expensive for them and the collateral requirements often can not be met.In Montenegro, 10 years ago the republic had a strong construction industry with internationally known firms. Then the market became smaller and funds for large projects dried up. In the last two or three years the market has improved greatly with a strong market for housing and commercial buildings developing and some big infrastructure projects starting. However, obsolete equipment dating from the 1980s is again a major problem, limiting the ability of firms to participate in the new projects. The major construction company, Gorica, interviewed about its financial issues, has reorganised itself from a big well-known communist era firm into a “fresh, modern, agile, up-to-date enterprise” ready to abandon conservative patterns and prejudices, to accept new ways of doing business and new styles of work. The firm used to work in Russia and now is discussing some business in Albania. It constructs housing, commercial buildings, tourist resorts and infrastructure and has a number of building materials operations. It advertises that it is a single stop complete building service.Lack of new equipment is a major problem for the firm, as is financing. It views the terms of bank credit available as poor, with high interest rates and no term financing, and equipment sellers offer only limited term financing. It has a good and close relationship with Podgoricka Banka, but the bank’s guarantees are not accepted. It also has a problem with payments due under government contracts, they are sometimes 3 to 4 months delayed. Prime contractors on major projects usually pay subcontractors immediately. It has strong competition locally from Serbia and Bosnia.Possible ways to overcome the problems

Financing the replacement of obsolete equipment is clearly the biggest common problem for construction firms in Yugoslavia. Large firms with resources can make some

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purchases, with cash or with suppliers’ credit, with or without a bank guarantee. Firms can find the needed funds within the company if cash flow needs to be increased, or unneeded assets sold. For example, Gorica stated that it had sold property to finance the purchase of an excavator. It also had at least one vendor offer to finance its sale for up to two years. Vendor financing is now being encouraged by bank guarantees. These guarantees could be further supported by confirmation, but that would be risky, operationally difficult and not certain to produce good results;

Firms can rent equipment from each other when one is not using the equipment that the other wants. Renting of new and recent model used equipment might also be feasible if the right firm could be identified and is interested. Equipment leasing does not exist and may be hard to start in Yugoslavia, but it is worth exploring;

Financing is also possible through the projects. Foreign general contractors have arranged financing for subcontractors on their projects. Some more may come from foreign contractors that are developing agreements with Yugoslav ones. Small firms are also making agreements with large firms and with each other partly to get contracts, but also for operational synergy and improved financing. These agreements may include joint ventures on major projects or purchase of the local firm. A procurement-based solution would be possible if equipment could be bought by the project and sold at its end. This would clearly increase project cost;

A funding line to one or more carefully selected banks for equipment financing via term loans to construction companies is a more traditional solution. However, it is one that would not be easy to implement given the current status of the banking system.There are some positive aspects to these difficulties. The firms, especially the big ones, have good skills and often have good reputations. The banks also have skilled employees. Both will have to be restructured, and almost all will shrink as they adapt. The gap in both industries, of no medium sized firms or banks, will be filled as surviving big firms shrink and the good small ones grow.

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8 Risk Management in Construction in South Eastern Europe

This section covers several issues, some indicated in the Terms of Reference and some additional elements that contribute to the defined problems we are addressing in this report: Risk allocation and contracting strategies; Factors limiting the use of local industry; Optimal procurement package; Views of international contractors; Insurance strategies.We have analysed these from two perspectives: the financier and the international contractor. There are a number of aspects in attempting to determine what would be an optimal procurement package. We have concentrated our analyses on the main issues and risks encountered in the local construction industries and provided ideas to mitigate these. 8.1 The Problems of the Construction Industry

Too often, purchasers think of buying a plant or a building, as though it is analogous to buying a piece of equipment. The nature of the construction industry is very different to manufacturing and is much closer to being a Service Industry – i.e. the Construction Industry delivers a service to the owner by assembling the various components of a structure, building or plant on the owner’s site. As in other services, it is hard to compare the value being offered by different suppliers, since this service is intangible and difficult to specify exactly before or after the project is finished. The characteristics of the industry include: Projects are generally one-offs; The majority of the work is carried out at the site and progress

can be interrupted by adverse weather conditions and other factors;

There is a wide variety of specialist work required to complete a project and highly complex interfaces between these specialists on plants;

The site if often distant from the contractor’s head office and supervision can be difficult;

Design responsibility is often separated from the construction work. When problems arise it is often difficult to determine responsibility;

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Activity in the industry often varies significantly during economic cycles;

This reduces the level of capital investment a contractor can justify in mechanising the construction process; most contractors have very low levels of assets;

Consequently, the industry is easy to enter and therefore highly competitive.

The owner wishing to implement a project is then faced with a large number of contractors, most of which have weak or non-existent balance sheets and may have only a very short track record. The reality for the owner is that he will be faced with carrying a much higher level of risk than he would for a conventional purchase of a discrete item of equipment.From the financier’s perspective, the industry has some additional problems. These are generally centred on the financiers desire to see the project completed on time and to budget (Completion Risk): The owners may be a special purpose company, whose only

asset is the project. The security of balance sheet lending is not available;

The new construction is almost always relatively large in relation to the owner’s balance sheet and therefore presents real risks of insolvency;

Owners may implement projects infrequently and do not have the ability to manage projects from in-house resources;

The asset is immobile and cannot be repossessed and moved to a new owner. It has to be used where it is;

Governments or local authorities account for a high proportion of construction activity. They often do not have the necessary expertise to manage projects effectively and have no real incentive to ensure timely completion.

Again the reality is that financiers, such as EBRD or other IFI’s, cannot avoid being faced with higher risks for construction projects. The issue is then how to manage the risk.8.2 Risk Allocation and Factors Restricting the use of the

Local Industry

8.2.1 Risk AllocationEarly discussions with the bank indicated a need to determine what could be done to encourage international construction companies to make more use of the local construction industry. This discussion focussed on construction related risks in emerging and developing markets and, more specifically, in the countries surveyed.

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Risk allocation was subsequently discussed with several international construction companies, either operating in the target countries or interested in expanding their presence into the region (the list of international contractors interviewed is presented in Annexe 12.3. The first step was to define a list of risks, common to the region as well as to the industry. The following list refers to a lump sum turnkey project because we understood from EBRD that this is the preferred contracting strategy for the region.Potential Risks in a lump sum turnkey (LSTK) Environment

Price; Quantity; Schedule; Escalation; Completion; Performance; Execution; Quality; Sub-Contractor/supplier/vendor; Labour availability and skill; Weather/Seasonality; Bonding; Insurance; Banking; Design Specifications; Partial Permitting Risk; Sub Surface Conditions Risk; Unidentified Utility Risk; Political Risk; Land Acquisition Risk outside of the Right of Way; Site Security Risk; Force Majeure; Termination Risk; Currency Non-convertibility Risk;

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Corporate Reputation Risk.Contracting strategy often involves placing the risk of an activity with the party most able to influence and control the outcome of that activity. Each project faces a unique set of risks which depend on, scope of work, location, client, stability, Rule of Law, and contract type – this is to name just a few. When these variables are applied to a relatively ‘new’ market, it becomes very difficult to ensure a place for the local industry to take part.EBRD is most concerned about the completion risk. The essence of determining the risk mitigation route from a contractual pint standpoint is shown in the graph below.

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Figure 2

The traditional approach (e.g. unit price contract), in order to provide the risk mitigation factor IFI’s expect, relies on the involvement of a consultant, in most cases a western one. As explained earlier, in order to avoid the completion risk if unit price contracting strategy is chosen, the IFI’s should invest more in the design phase, up to 5% of the total installed costs of the project. Should a lump sum turnkey strategy be preferred, the local contractor, usually less familiar with managing this type of contract, is handling more risks than he probably can manage. The alternative approach could be to contract a western contractor as a main contractor under a lump sum turnkey contract. The Western contractor could subcontract the local contractor under unit price contracts. This approach is not risk proof but it facilitates more local input. It also has the disadvantage of allowing for a limited knowledge transfer as most of the work that the consultant performs is undertaken by the Western contractor.8.2.2 Factors Restricting the Utilisation of Local IndustryContractors seeking local participation in a project are looking for companies who can be relied on to: Conform with specification; Complete on Schedule; Provide Surety; Operate Safely;

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Risk Allocation and Contracting Strategies

COMPLETION RISKCOMPLETION RISK

CONSULTANTCONSULTANT

BILL OFQUANTITIES

BILL OFQUANTITIES

LOCALCONTRACTOR

LOCALCONTRACTOR

WESTERNCONTRACTOR

WESTERNCONTRACTOR

UNITPRICEUNIT

PRICE

RISK MITIGATION:2-5% OF TOTAL INSTALLED COSTS

RISK MITIGATION:2-5% OF TOTAL INSTALLED COSTS

RISKS:•PRICE•MANAGEMENT•COMPLETION

RISKS:•PRICE•MANAGEMENT•COMPLETION

TRADITIONALAPPROACH

TRADITIONALAPPROACH

LUMP SUM TURNKEYAPPROACH

LUMP SUM TURNKEYAPPROACH

Disadvantage of the alternative approachto lump sum contracts:limited know-how transfer to local contractor

Alte

rnat

ive

Appr

oach


Maintain Quality; Build to Estimate.Even in a mature market, prime contractors will seek protection from a failure to comply with any of these parameters. Due diligence is done on subcontractors and suppliers to ensure that delivery can be ‘guaranteed’. This is not always possible in an emergent or developing market. In the specific case of the target countries, it is frustrated by the fact that for the last 10 plus years, very little development has occurred. Without steady and predictable workloads, the industry has stagnated. Investment capital has not been available. Companies have not been able to modernise equipment fleets, office equipment and space, nor have there been steady advances in the use of new technology, training programmes, safety platforms, etc. Finally, the financial support mechanisms that are standard in the west are still not available.These factors have created a situation where risk allocation cannot be supported by the local industry and limits their participation in the development activity that is either planned or ongoing. By example, the following list provides a summary of the risk that accompanies the use of the local industry market.Local Level Risk to International Contractors: Inadequate Pricing (at the subcontractor/supplier level); Inadequate Schedule Forecasting (at the

subcontractor/supplier level); Completion and Liquidated Damages when delay is by local

industry; Performance of Locals; Execution by Locals; Quality of Locals work; Labour availability and skill of Locals; Bonding; Insurance; Banking; Design Specifications using Local Regulations.

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8.3 Risk Management – What can be done

8.3.1 The Financier’s Perspective in Risk ManagementThe owner and financier can manage risk on the project by ensuring that the entity best able to manage the risk does so. The risk can then be dealt with by: Designing out the risk entirely; Mitigating or anticipating the risk by careful planning and

active management; Transferring the risk to a third party.Designing Out Risk

The most productive area for dealing with risk is during the early stages of a project. Significant risk can be eliminated through design and estimating. However, particularly on International Financial Institution projects, such as those implemented by EBRD, the cost of this preparatory work is beyond the resources available. Typically, to fully design and estimate any project would require an expenditure of about 5% of the total project cost – IFI budgets for preparatory work are rarely more than a tenth of this. Commercial clients are different from IFI projects in that they are able to finance the cost of this work from their own in-house resources. A typical commercial project cycle differs from an IFI cycle. In a commercial project, the Feasibility Study is intended only to justify the expenditure of money on the more detailed design. Once this is complete, the final approval to proceed will be given based on definitive cost estimates. Most IFI’s expect a Feasibility Study to provide justification for proceeding straight to financing.There are disadvantages with fully designing the project before making commitments: Some projects may not proceed beyond the design stage,

leaving significant costs to be recovered from someone. For projects being implemented by companies, this is accepted as a normal part of their business – better to stop implementation of a bad project than to keep spending money. For IFI’s with weak borrowers, this is a greater problem – loans made for design work may become unrecoverable. As already indicated, the grant funds available to EBRD are not sufficient to pay for this work;

The completeness of the design needs to be carefully optimised. A fully complete design might result in the plant or equipment becoming obsolete before the project is started. This has been a problem with projects in the Former Soviet

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Union, where the permitting process requires a lengthy review of the complete design.

Designing out risk is a useful strategy, particularly if there is an objective of placing work with smaller contractors. More detailed preparatory work allows the work to be specified in more detail for the less experienced and qualified small contractor and ensures that interfaces between the larger numbers of contractors are properly designed.Recommendation – EBRD reviews the level of funding available for the design phase of a project. For countries, where there are insufficient experienced prime contractors able to execute Lump Sum Turn Key projects, or where the use of SME contractors is desired, design phase budgets should be set in the 2% - 5% range of total installed costs. In this context, it should be noted that experienced prime contractors means contractors with prior knowledge of the country and the potential sub-contractors.Mitigation Strategies

Prequalification - Owners and Financiers can mitigate their risk through prequalification procedures to ensure that only competent contractors can reach the bid list. Prequalification procedures should test: The contractor’s recent experience in the location and of the

type of work; The total resources available to the contractor and their

quality; The quality of the contractor’s management, systems and

technical resources (often evidenced by a formal Quality Assurance scheme, such as ISO 9000);

The contractor’s financial security and ability to complete the project.

The most useful criteria for rating a contractor is the owner or financier’s recent experience of the contractor. Prequalification exercises can be costly for both the owner and the contractors.Bank bonds guaranteeing the performance of the contractor are another way of screening out contractors with weak balance sheets, since bonds can usually only be raised on the basis that the contractor can fully cover these from cash at the bank or overdraft arrangements. However, as noted in the country sections, the level of collateral required for bonding in the region is prohibitive and far above that required from western firms.Incentive Arrangements - For some types of project, e.g. where it is not possible to fully define the design or specification, incentive fees and target price mechanisms can be used to implement a project. These mechanisms leave the owner with

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the risk of cost over-runs, but provide the contractor with an incentive to work with owner to ensure that the lowest cost is achieved. These mechanisms require good knowledge and negotiation skills to set the target price. For incentive mechanisms to function correctly: They must be designed to ensure that the contractor’s

incentives exactly align with the owner’s interest; They should be symmetric and not asymmetric (such as

greater penalties for delays than for early completion). If an owner has no reason to offer an incentive for early completion – he probably has no justification for a penalty for late completion;

They should never attempt to move all or the majority of the owner’s risk to the contractor – for example - if an owner is fully indemnified against delays or cost over-runs, he has no reason to work constructively with the contractor to ensure the project is completed.

Supervision / Inspection / Quality Control – Third party inspection by a consulting engineer or by specialist inspection companies is often used as a form of risk mitigation. Inspection needs to be adequately funded and frequent / continuous to ensure that problems are identified. The problem with this strategy is that it usually only identifies problems after they have started to arise.EBRD already use all of these mechanisms to manage projects. There are no obvious ways to quickly improve the situation. As experience is gained, EBRD’s knowledge base of contractors in the region will improve and this will reduce risks.Transferring Risk

Conventional Insurance- Insurance with a specialist company is the most commonly encountered mechanism for transferring risk entirely to a third party. Usually, insurance is only viable for risks that are infrequent and have large consequences – such as death or injury or major damage to the facilities. We have provided a separate section detailing some thoughts on sound insurance principles. The most important principle with insurance is that an asset only needs to be insured once – requiring through the contract for each contractor to insure the works is wasteful and, in the event of a claim, may result in delays in the claim being settled.Insurance in place of Bank Guarantees - Insurance is used in the United States as a substitute for Bank Guarantees for contractors. This has advantages to smaller contractors in that they do not need to tie up capital to provide the full cover required by banks for the Bank Guarantee. For this mechanism to be successful, insurance companies need good knowledge of:

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their clients, the contractors, the risks involved and the claims history. There are no insurance companies with this capability available in Europe or in the regions that EBRD operates in. If this was pursued as a potential solution to the problems of SME contractors, it would take many years to develop the necessary knowledge base in the insurance companies.Government Guarantees - Risk can be passed over to Governments. In some projects, sovereign guarantees are provided, for example to improve the credit rating of owners. Lump Sum Turnkey (LSTK) and Design Build Contracts – Risk can apparently be eliminated by use of this type of contract, where the full completion risk is passed to the contractor. Since all the risk is transferred to the contractor, all the control is also passed. The specification that the contract is based on has to exactly reflect the client’s requirements. If the specification is a Performance Based one, where the contractor fully designs the works to suit a purpose, there can be difficulties in ensuring that the client’s full life ownership costs are properly taken care of. The contractor obviously has an incentive to use the cheapest and lowest quality equipment possible to maximise his profit. If the specification is a detailed one defining the quality of each aspect of the works, then the cost of preparing this specification is very high and the knowledge of the contractor in how to build at least cost is not fully incorporated.Few domestic contractors in the region are capable – either in terms of their experience, technical knowledge or balance sheet, of bidding significant contracts on a lump sum basis. It is always possible then to invite bids from international contractors. In reality, since foreign contractors do not have resources in the countries the risk is transferred to the LSTK contractor who is effectively “insuring” the local sub-contractors. He can do this more effectively than an insurance company, since an LSTK contractor has the systems and knowledge to actively manage sub-contractors. However, this has some disadvantages: Foreign contractors will be resented by governments, local

contractors and the labour force; The foreign contractors may not have the knowledge of local

conditions and the reliability of subcontractors to accurately bid work. They will tend to include large contingencies in their price – resulting in higher than necessary costs for the project. Foreign contractors could reduce their contingency by spending money in investigating the competency of local subcontractors and local conditions. However, they will not do this, if they perceive that the client is only interested in this one project. The possibility of a programme of work would encourage the foreign contractors to invest in learning.;In Kazakhstan, a few foreign contractors were encouraged to establish there. They did become successful. However, policy

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then shifted. It was felt that a few contractors were getting too much of the business and situations were engineered to allocate work to others. This experience has discouraged western contractors.

The specification needs to be very well written to ensure bids can easily be compared.

Recommendations- If EBRD wishes to encourage the use of LSTK contracts to reduce its risk, then, where it is able to influence the contracting strategy, it needs to either: Encourage major international contractors to learn about the

region and become established there, by clearly signalling that there is a pipeline of work that the bank wish to see placed on LSTK basis with major contractors, or

Encourage Local Contractors to take LSTK contracts by dividing major projects into smaller sub-projects more appropriate to the balance sheets of these contractors. These contractors, at least initially, will only be able to handle detailed specifications – this will require a substantial input from Engineering Consultants to prepare the bid packages. Projects will need to be designed with these budgets in mind, as previously indicated, this will probably be in the 2% - 5% range.

8.3.2 The International Constructors’ PerspectiveInternational contractors were then asked what steps could be taken that would allow them to pass more work onto the local industry. The responses include (some incorporated in more detail, in the Recommendation Section):The determination to what extent, if any, the client wants international participation in the project. This is a very real concern in a number of states. The idea of international participation is not welcomed with open arms, but instead provokes very real feelings of resentment in the client country. This resentment spreads across the spectrum including the client organisation through to local construction firms and suppliers. It is seen as very close to an invasion by the foreign international contractor with all the perceptual baggage that entails.Most international contractors these days are aware of this perception. This increases their reluctance to become involved in these areas, particularly if a project is seen as a ‘one-off’ with little in the way of future continuing work. Coupled with some of the other constraints such as those below, this goes a good way to explaining a reluctance to take on more risk in this part of Europe:

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Lack of knowledge of the local market in terms of availability and quality of labour and material;

Unfamiliarity with knowledge of local laws, regulations, and procedures;

Perceived financial weakness of local firms and companies and the financial infrastructure. On this point, it might be as well to point out that just having a mechanism in place that would guarantee payment directly to an international contractor by EBRD for example, may not be sufficient inducement if the trade off is that the international contractor has to deal with the local banking system and ensuring that local subcontractors get paid;

Almost paradoxically perhaps the emphasis on competition by lending institutions such as EBRD can contribute to the risk avoidance by international contractors, as they do not see projects generating the gross or net margins to enter the market. This is particularly so with ‘one-off’ projects;

Specifying New Equipment in the Contract. The contracts could require International Contractors to provide modern equipment fleets to local firms. This equipment would then be made available to the local industry for use in conducting the work. By making it a contractual requirement, it will be mandatory for all competitors and can therefore be used in a competitive environment;

This action could improve the performance, quality and schedule compliance of the locals. At the end of the project, this equipment can either be sold to the local industry in conjunction with item 2 above, or be made the property of the state. During construction, maintenance of the fleet would be the responsibility of the prime contractor with incentive programmes developed for the locals should the actual cost of maintenance be lower than the programmed maintenance cost;

Creating incentive programs for technology transfer. Create tax breaks, develop subsidised loans, or develop supportive training programs that will allow companies to use hard to come by resources for technology transfer;

Incentivise quality control, quality assurance. For unit price contracts, allow a unit price specifically for quality control, testing, reporting, etc. Pay for quality. A developing industry will not automatically be focussed on quality in the early days of development;

Provide working capital to locals through advance payments or mobilisation payments that are guaranteed by a third party source;

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Allow prime contractors to advance payments to sub-contractors that are guaranteed by international sources or by the government. This would fill a gap in the current situation whereby these types of financial services are not available.

8.4 Insurance for Project-Financed Construction Projects in Countries with Undeveloped Insurance Markets

Romania, Bulgaria, Macedonia, Bosnia & Herzegovina and Yugoslavia have undeveloped or developing insurance markets and share characteristics with insurance markets in many other countries around the world. When arranging insurance programmes for construction projects that are being financed by lenders on a limited or non-recourse basis in those countries, there are certain issues that need to be addressed as described below.Project-Finance Insurance

First, we must understand the significance of insurance programmes in relation to limited or non-recourse financed construction projects generally. The entity sponsoring the project will usually be an association of interested companies which will invest a certain amount of equity and arrange loans for the balance of the finance required. The lenders in turn will require the greatest degree of security possible for the repayment of those loans and will, as a consequence, be analysing the amount of risk retained by the sponsor. Lenders will generally be looking for the sponsor to carry as little risk as possible and that will be achieved through the transfer of risk to other parties, for example, by contract to construction contractors on a lump sum turnkey basis. Insurance is another form of risk transfer and lenders will be looking for a significant degree of insurance protection to be in force usually for the benefit of all participants to the project – lenders, sponsor, contractors and subcontractors. Lenders will appoint an insurance advisor to review the insurance programme and propose recommendations on the terms and conditions of the insurance. This leads to a requirement for a comprehensive insurance programme arranged with insurers of a good security rating including such features as: Broadest cover available; Relatively low deductibles; Insurers meeting a minimum standard of security rating; Non-vitiation clauses; Broad waivers of subrogation; Lenders having first call on insurance proceeds;

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Letters of undertaking from the insurance brokers arranging the programme

Often these requirements are onerous and can be a challenge to those arranging the insurance.Insurance Availability

The insurance regime for those countries with an undeveloped or developing insurance market often has the following characteristics: Lack of stringent requirements for the establishment of

domestic insurers; Domestic insurers (consequently) inadequately financed and

with inadequate capacity; Compulsory cessions to domestic reinsurers; Lack of experience of domestic brokers and insurers with

regard to specialist areas of insurance such as construction projects;

Active participation of major reinsurers who will attempt to control the terms and conditions of insurances for specialist areas of insurance and major projects;

A statutory requirement for insurance of risks in that country to be arranged with domestic insurers.

It can be seen that these characteristics lead to a lack of availability of broad insurance cover and a credit risk in relation to the domestic insurers. There is usually limited opportunity for negotiation of terms and often that negotiation will not be with the parties that are controlling the insurance i.e. the reinsurers that often control the market. This leads to problems when considering the typical requirements of financed projects.The Insurance Solution

It is clear that non-recourse or limited-recourse financed projects are carried out in countries with undeveloped or developing insurance markets so how is the apparent conflict between lenders requirements and the domestic market’s abilities reconciled?There is an international insurance market consisting of major insurers and reinsurers represented in countries with developed insurance markets. Often these companies will have global networks or associations with foreign insurers and will have acceptable security ratings. Specialist areas of insurance such as those required by construction projects will be handled by these companies.

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In addition the major insurance brokers such as Marsh, Aon and Willis have a global presence and expertise in specialist forms of insurance such as those required for project-financed construction. These brokers will often have business relationships with insurers in these domestic markets.The combination of these two factors has enabled project-financed insurance programmes to be developed which satisfy lenders demands. These programmes can be used on a reinsurance basis to support domestic markets whose ability alone would not satisfy lenders.Typical Insurance Programme

Let us take as an example a country with a limited number of domestic insurers with security ratings unacceptable to lenders but also possessing a statutory requirement to insure risk with those domestic insurers. In this situation how would the insurance programme be arranged to satisfy the usual requirements of lenders?A typical solution would be to negotiate terms and conditions broad enough to satisfy lenders with reinsurers of adequate security rating. The element of competition in the reinsurance market is necessary to achieve this. Then negotiations would be undertaken with a domestic insurer to secure their agreement to issue a local insurance policy based on those terms and conditions and at the same time ceding a majority of the reinsurance to those reinsurers on facultative basis. The critical issues to include in this arrangement are: A very low retention by the domestic insurer, which can be as

little as less than one per cent; Claims control clauses allowing the reinsurers to control

claims; Cut through clauses or assignments allowing the insured

parties direct access to the reinsurers to secure claim proceeds – necessary, as there is no direct contract between the insured and the reinsurers;

Awareness of any compulsory cessions to domestic reinsurers with which there must be simultaneous negotiations.

This kind of arrangement can be completed in most countries although each presents its own particular problems and challenges. The view of the insurance advisor to the lenders is critical – if they or the lenders themselves are too demanding this makes it difficult to achieve the maximum level of protection. Negotiations with domestic insurers can often be sensitive with compromises required on both sides. Domestic Contractors

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In respect of the main project insurances, for example, Construction All Risks and Third Party Liability insurances, any local contractors would be covered as additional insured. Therefore no specific problems exist for them in relation to these insurances.Other insurances required such as Employer’s Liability, Workman’s Compensation and Motor Liability insurance may also be required by project participants. Attention needs to be paid to the requirements imposed on domestic contractors in respect of these covers. It is not unusual for lenders or their advisors to require high limits of liability in excess of those legally required or indeed insurances not necessarily imposed in local markets, for example, requiring all contractors to arrange Employer’s Liability insurance even though this is not required by law in the country concerned. These types of requirement could jeopardise the opportunity for domestic contractors to participate in projects as these limits or types of insurance may not be available in domestic markets. It is recommended that any requirement for such insurances is limited to “that required by law”.Conclusion

It is possible to satisfy the requirement of lenders on most financed projects in countries with undeveloped or developing insurance markets after some effort. The strength and ability of the domestic market in that country is not necessarily the prime factor which will contribute to the success of the endeavour. Indeed it is quite possible that a more developed market may hinder such an arrangement, for example, by requiring larger retentions. Success will be achieved by all parties concerned – lenders, sponsors, contractors and their advisors - having a good understanding of the domestic markets, and a well defined and thought out strategy and good co-operation at a working level.8.5 Optimal Procurement Package

Given all the issues captured in this section, there are some scenarios that might be considered for an optimal package.If there is local reluctance to involve international contractors, the project should very likely be split into discrete sections such that any one local contractor (and the client) is not over-exposed. This is, we believe, very largely dictated by the financial constraints that have already been highlighted in the countries reviews and surveys (sections 3 - 6). Thought then needs to be given to a break-out along natural division lines, probably regionally. When the project is cut into pieces it becomes less attractive for international contractors as the cost of mobilising in a new country and trying to move up the learning curve on how to do business there (in a competitive bid context) cannot, in fact, be competitive against the locals.

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If there is a desire for international participation, we would suggest that in the first instance, consideration should be given to a Procurement Management Construction (PMC) role for the international contractor with the idea again of dividing the project into discrete sections. This would be particularly appropriate where the international contractor (i) does not have extensive experience in the region but may be considering a presence in the area; and/or (ii) it is a ‘one-off’ project with little or no prospect of medium to long term follow-on work. PMC, programme management is less risk to the contractor but also gives less of a margin. It also attracts a different type of international contractor;

If there is a medium term programme of work of several projects, then the first phase for an international contractor with little experience could be a PMC role expanding to Engineering Procurement Construction Management (EPCM) for the follow-on work. For a market where there are international contractors with some experience in the region, then one could well start with EPCM leading to Joint Venture arrangements in the later stages. Then one faces the problems of risk that are captured in section 9.2 above;

For a longer-term programme, we would suggest that the optimal approach would be EPCM leading sooner to Joint Venture. With a longer-term programme of work, there is an incentive for the international contractor to make the initial investment in capital, time and personnel in developing a presence in the region. There is also an incentive for local firms to make the investment in developing and upgrading their capabilities in areas such as project controls, skills training and equipment fleets;

Consideration of how the international contractors are encouraged to work in Eastern Europe, i.e. performing well in the market versus restricting its access to work for fear of monopolising the work available. This is the fall out factor which affects those international contractors who do make the effort and investment to develop an in-country presence. This is the perception that arises in both clients and lending sources that ‘too much’ work (a perceptual rather than probably a strictly percentage factor) is being given to one contractor so that company is penalised by not being given new work or excluded from the bid process. The impact of this as relates to this study is that it does not encourage a company to take on a greater risk profile in a country.

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9 Leasing and Plant Hire Environment 9.1 Introduction

The Terms of Reference relating to Yugoslavia are specifically asking for recommendations related to the “investment climate for the establishment of a leasing / plant hire facility”. We have made a preliminary assessment of the leasing operations as potential business in the countries surveyed in this study. We have also discussed with the KPMG office in Belgrade the current legislative and accounting rules applying to leasing. The findings are incorporated in this section.We would like to emphasise that the ToRs have not required a pre-feasibility study for a leasing operation. Nevertheless, during our discussions with EBRD, based on the findings in countries, we have decided to make a general presentation of the leasing business and the main issues that have to be considered. Whenever we could, we made country specific remarks.9.2 Leasing Overview

The acquisition of a capital asset by using leasing involves three parties: The equipment vendor; The acquirer of the asset (lessee); and The leasing company (lessor) who will finance and own the

asset.Conventionally, there are two main classes of leasing arrangements and these are often treated differently for taxation and accounting purposes: Financing Leases – are where the lessee company accepts

the risks for the performance of the asset and the leasing company is only providing finance. Typically, on a Finance Lease, if the equipment is out of action for repair, then the lessee must accept the loss of use of the equipment;

Operational Leases – are where the leasing company is accepting risks of the performance of the asset. Using the same example as above, with an Operational Lease, the leasing company would often be required to provide a substitute machine or meet payments.

Leasing contracts are inherently more complex than sales agreements, since they include: provisions regarding the financing of the asset; conditions regarding protecting the value of the asset throughout its life; arrangements to follow on disposal of the asset. Operational Leases will also include provisions concerning the level of performance to be expected from the asset. Leases in general work best where the asset is a

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discrete item that has value to others (such as a vehicle) and that can be repossessed by the lessor if the lessee is unable to meet their commitments.Why Leasing? Leasing offers some advantages, primarily: It is a very flexible investment instrument and can be used to

finance relatively small and short-lived assets; It is an efficient way to finance capital investment in

companies with relatively weak balance sheets. In most forms of leasing, the asset remains on the books of the leasing company, who can fully utilise any tax allowances due on the capital expenditure (depreciation). The lessee company does not need the balance sheet or credit history that would be required for a loan;

It broadens the options available to companies for financing their capital investments;

Leasing is attractive to small and medium scale enterprises as a major source of financing.

Plant hire arrangements involve only two parties; the owner of the equipment and the hirer. Hire arrangements may be on a long or short-term basis and may include the provision of an operator. Plant hire companies themselves need to finance the extensive capital investment they require for their fleets of equipment. Finance leasing is a viable option for a Plant Hire company. Normally a Plant Hire company has its own front line maintenance staff and can efficiently maintain their equipment – an operational lease is therefore less attractive.Why Plant Hire? Plant hire offers some additional advantages: Equipment utilisation levels can be much higher, since

specialist equipment can be used by a large number of companies. This lowers the costs of using the equipment;

Best use can be made of trained operators, since they can be hired with the equipment;

Plant hire significantly increases the productivity of small and medium construction enterprises by allowing them to use the same equipment as major contractors, but on an as needed basis.

The applicability of Plant Hire or Leasing to the construction industry can be summarised in the table below:

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Assets frequently used

(such as back-hoe shovellers (JCB’s) or fork lift trucks)

Assets required occasionally

(such as large mobile cranes, specialist tools)

Large Construction Companies

Lease or outright ownership. Plant Hire usually with operator, except for specialist tools

Small Construction Companies

May lease, but will often Plant Hire usually without operator

Plant Hire usually with operator, except for specialist tools

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9.3 Environment for Leasing

To realise the advantages that can be obtained from leasing type arrangements, a detailed review of each country is needed to establish if the elements of the business environment are attractive for leasing. Conventionally, this detailed study should examine the following areas: Legal environment; Regulatory environment; Tax treatment of leasing; Accounting treatment of leasing; Business Climate; Pricing.In the particular situation in the Balkans, where there are relatively small markets in each country, the study should also consider the implications of cross border leasing and plant hire. The critical issues for each of these areas are detailed below. The study should focus on determining the issues raised for each country where a leasing operation is planned:

Issue Details Commentary

Legal Environment

Specific leasing law, including a clear definition of the three party structure and their obligations.

Conventional banking laws may not fully recognise the rights of the lessor.

Law should protect leased assets from being claimed by other creditors should a lessee become insolvent.

The basis of the transaction is that they remain the property of the lessor.

The right of the lessor to repossess the assets should be defined and the mechanisms exist in law to implement this right of repossession.

The assets are the security for the financing and the lessor must have both the right to repossession and legal system must be able to efficiently permit this.

The recognition of cross-border leasing arrangements.

All the countries in the region are relatively small and a major international equipment lessor will be faced with high costs if it must establish legal entities and operations in every country.

Regulatory Environment

Banking laws, particularly on minimum capital ratios can inhibit the development of leasing companies.

Leasing companies are different from banks and do not take term deposits. The laws to protect depositors can become a hindrance to leasing companies.

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Leasing companies generally need minimal direct regulation, particularly in the early stages of developing the industry.

However, any financing by EBRD may include covenants to encourage prudent management, such as:Limiting the debt / equity ratio (Leasing companies can tolerate high levels of debt and ratios as high as 10:1 may be tolerable)Limiting the foreign currency liabilities in relation to total debt and cash flow. Leasing companies are often used to finance imported equipment and are likely to be carrying significant exposure, since lessees will not always be able to accept or manage the exposure.Limiting the systemic risk of the lessor – e.g. to one lessee or to a sector of the economy. A dedicated leasing company for the construction sector will have higher risk than one with a diversified portfolio. However, excessive diversification should be discouraged, since lessors must understand the business sector and the value of the assets they own.Limiting the leasing company’s mismatches in terms of maturity – i.e. the lives of the leases compared with the term of borrowings.

Legislation in some countries may limit or prohibit the options for a leasing company with regard to the importation and leasing of second hand equipment. Total prohibition is undesirable.

Intra-regional movement - All of the countries are relatively small. There would be considerable advantages in being able to move equipment easily across borders to meet demand. Almost all of the countries severely restrict or prohibit this, particularly for equipment over five years old.Inter-regional movement - Some of the heavier construction equipment has long lives, despite the tough environment it works in. Often equipment is reconditioned by the original manufacturer or a specialist to extend its life. This type of equipment may be well suited to the Balkans, where the latest machinery is hard to justify.Where a currency is freely convertible, there should be freedom to import used equipment. In countries with non-convertible currency, some form of control of this type of activity is required – e.g. careful pre-shipment inspection by independent inspectors. If this is not done, double-invoicing scams can be used to facilitate capital

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flight.

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Insurance laws and markets should permit efficient and adequate coverage of the asset.

Some countries have laws requiring all insurance to be channelled through state insurance companies. Often, these are unable to efficiently meet claims or have limits to the amount of insurance available. This forces a prudent leasing company to seek additional insurance (insurance for excess) on the international market, which can be difficult and costly.

The local insurance market may not be able to provide cover that reflects the foreign exchange cost of replacing equipment.

Taxation Leasing is often used because of its tax efficiency. The tax system needs to be designed to ensure that there is no discrimination when compared with other forms of finance.

Small companies, particularly in their early years, often do not have the profits to fully utilise the depreciation tax allowances. The leasing company usually can utilise these tax allowances and can pass on this advantage in lower lease payments.

The lessee is usually allowed to deduct the lease payments over the life of the lease, which is shorter than the economic life of the asset. Often the lessor can also depreciate the asset over the life of the lease. Overall, the effect can be to accelerate the depreciation effects and result in less tax being paid in early year. This area can be abused and tax authorities may reasonably control the tax deductibility of leases.

Indirect taxes, such as Sale Tax and VAT should not discriminate against leases.

There can be effects here, since the lease payment would usually attract indirect tax, whereas the interest on a bank loan would not.

In countries, such as Serbia, which apply a sales tax (20%), leases will be discriminated against and will be a less attractive financing option.

Due to the complexity of allowing a VAT reduction on the portion of the lease that is in fact “interest” on the financing, most countries do not offer any relief from VAT. However, the overall effect should be only in terms of cash flow for a properly functioning VAT system, since the businesses can reclaim input VAT. An inability to reclaim input VAT efficiently would inhibit a leasing industry.

Accounting Prudent accounting practice, as It is important that the contingent

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defined by International Accounting Standards (IAS) requires that leases are accounted for as a form of off-balance sheet financing and should be shown in the lessees books as an asset that is depreciated. This is different from the tax treatment, where the asset is depreciated on the leasing company balance sheet.

This means that the Financial Accounts of the lessee have to be restated to calculate the tax treatment and the local accounting code should permit this.

liability is shown on the lessee’s balance sheet in this way. Otherwise, the long-term liability would not be visible.

IAS provides different treatment for Operating and Financial leases to reflect the differences in risk allocation.

Business Environment in the Construction Industry

The profile (age and type) of the existing fleet of construction equipment is important in determining if the size of any potential leasing business in this sector will be viable.

In the aftermath of the problems in the region, there was a significant amount of aid financed construction activity. This may have led to an over supply of relatively new construction equipment in some countries. In addition, due to regulations regarding the import and export of equipment, some major international companies imported equipment into the region for specific projects and now find it trapped. This can result in oversupply of equipment.

The demand for construction in the country.

A growing demand for construction would signal favourable conditions – it is always easier to penetrate a growing market.

Quality of the lessee. Leasing companies need reliable clients who will keep the equipment secure, maintain it in good condition, and will allow easy location of the equipment. Some plant hire companies in Europe are now using hidden radio beacons to protect their expensive mobile construction equipment assets from theft and unscrupulous hirers. It is normal for lessors to require lessees to follow the manufacturers recommendation for maintenance and to require verification of this. Often the manufacturer will be involved in this and in tracking that the asset is being properly maintained.

Pricing Terms must be not only attractive to clients, competitive and economically variable to attract new clients, but also provide sufficient return on investment.

The rental is the key element in its attractiveness but other factors have an import impact too: the lease term, type of rents(fixed or variable); residual options; non-standard payment profile or early termination option.

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9.4 Local Operations of Main Equipment Manufacturers

The main equipment vendors are present in the countries surveyed through sales offices and operation and maintenance services. We have presented in Annex 12.8 a list of the local offices (local dealers) identified. We have obtained only limited information related to the nature of their business and their annual turnovers. The analysis undertaken, though not comprehensive, demonstrated however that very few leasing operations have been developed so far. The reasons are primarily related to the poor demand triggered by lack of sufficient work and reluctance of the construction companies to embrace financing methods less understood and considered expensive.Large international equipment vendors are often, diversified, investment-grade multinationals, sophisticated financial players, self-financing and self-supporting entities. When assessing a new market, these companies review evaluation criteria that are consistent with that that construction companies use. To the extent to which EBRD activities can lead towards improving the conditionality outlined below, EBRD’s can have a direct positive impact. Specifically, they review the following:

Governmental stability: Stability provides some assurance, especially when long-term development strategies are being supported and indeed transferred from one election to the next, that a sustainable business can be maintained. Stability is displayed through projections of GDP figures, inflation indices, and the percentage of GDP that is being generated by a specific industry.

Import/Export regulations: Regulations that allow companies to freely move equipment, whether as a single unit or as a fleet, into and out of a market in response to the supply and demand requirements of that specific market are important. Customs regulations that allow for temporary import in the short term market as well as affordable long term import of equipment, especially when this equipment is not present in the market, allows a responsiveness to the cyclical trend of the construction industry.

Payment: A very real issue of the leasing companies is surety of payment by the local market. Many of the same financial instruments needed for bonding, insurance, loans, and letters of credit are also applicable for equipment leasing. As these services are not provided on the local market, the risk of payment becomes a limiting factor in the attraction of the market to international sources. Cases were sighted that exposed the leasing companies to delinquent payments, even non-payment for the

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equipment. In some extreme cases, the equipment was completely written off as a loss.

To the best of our knowledge, there is no evidence of partnerships between main construction equipment vendors to form leasing companies in the countries surveyed. However, we do not see impediments in developing up-front individual leasing contracts between main vendors and a leasing company in which the vendors would not have an equity stake. Two financing options that can be analysed by EBRD are presented in section 11 of this report – Funding a leasing operation of construction equipment and enactment of laws and regulations favouring leasing.

General Information about main construction equipment manufacturers is presented in Annex 12.9. The information presented there is general in nature and more research is needed in assessing the size of the operations of the main equipment manufacturers in Eastern Europe and their strategies in terms of products and services, pricing and risk mitigation. At present, the majority of the services provided in these markets are sales and maintenance oriented. Leasing arrangements seem to be the exception rather than the rule.9.5 Local Equipment Rental Practices

EBRD asked our team to analyse potential financing of a rental company in Southeast Europe. Specifically, the bank was interested in rental companies that are spin-offs of large construction companies. We undertook a preliminary assessment of this segment of the construction market. The findings are included below. The transition of large construction companies into successful leasing or hire companies was not found to be common practice in the region. In most cases this is driven by the fact that there simply is not a continuous demand for the equipment. With no long term and stable market for construction activities it is difficult to support a viable hire business. Actually, what happens is that, without such market stability, the equipment cannot be maintained in good working order. Another problem with a transition to hire companies is that the equipment fleets are not dynamic; instead it is a fixed asset. The companies do not have the capability to replace or offer any other pieces than those already owned. This is most evident when comparing the local construction companies’ fixed fleet to an international equipment supplier’s fleet. Without the flexibility to move equipment into and out of a market the user is restricted to using whatever is available, not applying the proper sized equipment for the work. A resulting decrease in performance ends up increasing the overall cost or decrease profitability for the local contractor.

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The present situation shows, because of the reasons mentioned above, a limited size of the construction equipment hire business in the countries surveyed. We made a preliminary investigation into the Romanian rental market for construction equipment because the market in this country is somewhat larger than in the other countries surveyed. However, without a proper due diligence assessment, it is difficult to say whether any of the Romanian rental companies presented below has a credible business plan and if they are creditworthy to consider them as candidates for EBRD’s investment.In Romania, the players in hire business are: SUT and IUGT companies. These used to be either part of

large construction companies or dedicated state-owned companies. At present they are privatised and:− can be partly owned by construction companies, e.g. SUT

Arcom or SUT Carpati− can be newly established companies , e.g. Apolodor SRL− had inherited the assets of the ex state-owned SUT

companiesThe size of one of the best established SUT in Bucharest is around US$1.5 million per year. This includes their transportation business. According to the information obtained there are about three or four established hire companies in the Bucharest region, with a similar size business. Most of them seem to be also involved in the transportation industry. The construction companies themselves. One of the largest

construction companies in Romania, Arcom, has only limited revenues from the equipment rental business up to US$250,000 per year, i.e. around 5-6% of their annual turnover.

Various small hire business owning small equipment and plant.

The equipment fleet these hire companies have is relatively old. They have recently made investments in new or second hand equipment, either as direct purchase, in most cases, or as a lease arrangement. The companies interviewed did not disclose the size of the leasing deals. The largest construction equipment hire companies in Bucharest, Romania, based on year 2000 annual turnovers, are: FF & E Leasing Romania SRL, active since 1999, US$580,000 Beruc SA, active since 1991, US$350,000 Meva Romania SRL, active since 2000, US$260,000 SUT Com SRL, established in 1994, US$250,000

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I.T.S.C. 94 Srl, active since 1994, US$260,000 SUT PREST SRL, active since 1994, US$110,000A list with their contact details is presented in annex 12.10.The range of equipment traded by these companies is small to medium size and includes: concrete mixing pumps; excavators; mobile cranes telescopic; mobile cranes 25-40t; mobile cranes 40-80t; compressors 3-5mc/min; compaction equipment up to 10t and bulldozers. The time utilisation (based on number of hours on hire per year) varies between 65% and 90%. However, further analysis is needed to determine what would the breakeven utilisation times be in relation to the optimal portfolio of equipment. The success of an equipment rental company depends on how efficiently it utilises and manages its rental fleet. A detailed assessment of a rental company should include at least the following: Utilisation of the rental fleet, usually measured as return on

investment (ROI) and analyses of the key factors affecting the ROI: time utilisation, rental prices and product mix influence;

Management of the rental fleet: transfer to various locations, ratio new equipment to old equipment, pricing polices, maintenance and repairs, portfolio of equipment;

Market demand and rental prices.It is also important to mention that traditionally the South-Eastern European construction companies own equipment fleets. This can adversely affect the development of a sustainable rental market unless customers are becoming more aware of the cost advantage of outsourcing. It is therefore a virtual circle. The growth of the industry depends on the demand. In reverse, availability at convenient prices is key to potential customers.A possible financing scheme for a rental company presented in section 11 of this report – Financing of companies renting construction equipment.

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10 Survey of the International Contractors This section describes observations made by the interviewed international contractors about the local construction industries as well as ways for the local industry to be prepared for: Participation in growth; Characteristics that may attract international players to

include the local industry in major projects; Ways in which the international community can assist the

local industry to take part.The feedback was received from a range of international contractors already active in the countries surveyed, with the exception of Yugoslavia. There are no large multi-national contractors active yet in Serbia and Montenegro. Another category is represented by international contractors who have made attempts to enter the markets or have plans to do so. A complete list of the contractors interviewed is presented in 12.3. We present in this annex an example of a project undertaken by an international contractor in Bulgaria, Cibex International.In order to structure the findings, the progression of activities across a projects’ life have been divided into three distinct phases, namely, the Pre-Tender, Tender, and Execution phases. Aspects of each phase will be approached from the point of view of the local industry. Potential solutions to assist the local industry will be introduced for further development.We have mentioned below the risk allocation issue. However this has been dealt with in detail (Section 8). Also, some of the solutions suggested here have been incorporated in Section 11, Recommendations.PRE-TENDER PHASE

Marketing

ObservationsThe local industry does not have a long history of marketing itself. Regional based specialised firms were insulated from competition. Ownership and tendering regulations supported both efficient and inefficient businesses alike. Market expansion was largely frustrated by the lack of projectsIn a localised market, this activity is usually conducted through word of mouth or through buyer experience. Local contractors are known for what they do and are called upon to perform those services. When International Financing Institutes (IFI’s), regional, or international companies participate in an emerging market, it is important to find the proper local support, whether this is for the

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provision of materials, goods, or services. A passive local market does not readily make itself known to this new source of development. The local markets area of influence is limited and there is no exposure to regional and international firms who are interested in penetrating the market.SolutionsProviding training and seminars for local Contractors on how to: register with different international agencies and organisations, complete Pre-qualification questionnaires, determine how to classify services correctly, register with foreign embassies, become involved with Chambers of Commerce or existing local syndicates will help in identifying and expanding the potential for participation in an expanding market.Pre-Tender Evaluation

ObservationsStructured pre-tender evaluations are not often conducted at the prime, sub-contractor and supplier level, especially when projects are supported by local or private funding. However, in an expanding market that is utilising international funds, it would be productive to establish a system that requires confirmation of a firm’s ability to perform prior to asking that firm to perform. Owners and funding agencies often define evaluation criteria to be used when selecting participants, even final contractors that will be used on the project. The same criteria is often passed down from prime contracts to sub-contracts and even further, to suppliers. The local industry, interested in competing at any of these levels needs to research participation criteria and ensure that compliance is within their reach, well in advance of any specific tender announcement. If, during this compliance evaluation, a company finds that it does not satisfy the qualification requirements, it may select to develop a programme aimed at mapping out a process to reach the desired level of compliance.SolutionIFI’s can publish their pre-bidding criteria well in advance of the intended project. Local development can set standards for pre-tender evaluations. Seminars can then be scheduled to help the local industry evaluate their relative position. If necessary, follow-up training or assistance programmes can be established to assist local contractors in reaching acceptable levels.Once these are established, companies can be classified based on their compliance with each of the measurement categories and can be placed on pre-qualified bid lists for use by regional and international competitors. This pre-qualification could list companies by discipline, i.e. Mechanical, Electrical, Civil, by their

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ability to perform work, by past experience, by value of past works, and by the displayed quality of works performed.The key to having a successful pre-qualification programme is to regularly monitor and update the classification listing which allows companies to move up in scoring and therefore move up to larger and more complex projects.Compliance with Tender Documentation

ObservationsIn the past tenders were won without a good understanding of the tender requirements. The goal was to provide the lowest price or the most attractive offer without really understanding how to perform effectively to that price. A common approach to staying in business was to “get your foot in the door” and then figure out how to increase the price or compromise on the performance to stay within that entry price. Bid Request documentation from IFI’s and international companies don’t support this approach. They are often more complex than that historically used by the local market. Therefore, during the pre-bid phase, local companies should fully research the tender process, the performance requirements, and their own limitations in preparation of tender announcements.SolutionOne possible recommendation is to develop workshops to educate and assist the local industry in understanding and complying with tender documentation.Standardisation

ObservationMost countries have an established set of technical and professional standards that are applied to development projects. However, these standards have not always kept pace with technology advances nor business and professional development advances. Therefore, they may not be recognised across a regional market, nor by the funding agencies who support those projects. Developing updated regional standards for design, quality control, technical specifications and company classification could be beneficial to the industry as a whole. Regional standardisation allows the industry to develop seamless levels of service across borders. This in turn allows companies to compete on a wider geographical level and promote transparent competition, based on equal levels of performance, within the industry. SolutionProfessional bodies can be united under a regional programme and directed to develop such standards. The

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standardisation can be applied to technical licensing of individuals as well as to establishing design and construction standards and general technical specifications.TENDER PHASE

Awareness & Compliance with Contract Requirements

ObservationPrior to reaching a decision on participating in a project, at any level of contractual arrangement, an awareness of the contracting requirements must be gained to insure that the individual company can comply. Compliance can be measured at the technical level, at the experience level, at the performance level and at the pricing level. Compliance, with international and/or regional contractors using international funds, takes on even more significance. Therefore, specific contractual knowledge must be harmonised with performance capability during the tender development.SolutionTraining and maintaining contract personnel is an important consideration for companies intent on competing in regional development. Often new forms of contracts are being implemented that require a completely new sensitivity to standard and specification compliance. Cost Estimation

ObservationOften in the past, cost estimates were developed from catalogue price indexes maintained by the industry or from past tender documentation kept with each individual company. Often this data was based on tender documentation and not on out turn cost data. This approach to estimating did not truly define the actual cost of individual projects and perpetuated a false pricing level. In a competitive market, attention to the cost estimate takes on a crucial role in the successful acquisition of works and in the perpetuation of the industry. A full understanding of each and every cost that will be encountered must be developed. This is best conducted through the development of a work breakdown structure whereby the project is subdivided into pieces small enough to allow an estimator to determine a precise cost for the performance of that piece. The estimator starts from the smallest defined portion of the work and then builds the estimate from the “bottom up”. Production rates are calculated for the specific type of work which determines the man-hours and equipment-hours necessary to perform that work. Material costs and any defined sub-contract

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work is then added to the production figures to determine a Direct Cost for the work. Direct Costs are defined as costs that are directly attributable to the installation of the works, (including labour, equipment, materials and subcontractor costs). A second set of costs, namely, Indirect Costs are then determined. Indirect Costs are defined as those costs incurred in the support of the actual installation of the works. This category of costs includes such items as supervision, insurance, bonds, camp facilities, safety, training, and small tools, to name only a few.A final set of costs needed to complete the estimate include a calculation of contingencies and risks that may be encountered during the works as well as the establishment of an anticipated profit level. SolutionWorkshops and educational seminars can be conducted within the industry on estimating techniques. A structure and a process are needed to continuously update estimating information to provide accurate and dependable cost estimating data that supports the tender process.Schedule Performance

ObservationProject schedules (programmes) have often been a mandatory deliverable but in fact have not been used as a tool to manage the works. In the past, if a contract even required a schedule it would be in the form of a simple bar chart that once delivered would be forgotten. In other cases, no contract schedule was required. Contractors would simply promise to do the work in the time allocated by the Client or the Main Contractor without having a calculated basis. Thus the forecasted schedule completion dates were many times neither accurate nor achievable. New techniques and new software are now available for project scheduling which is supported by simple and inexpensive computer software. These techniques provide management with improved scheduling capability that can warn management of potential problem areas and distribute limited resources in the most cost effective and schedule effective manner.SolutionIt may be appropriate for prime contractors and even lending institutions to provide schedule training and schedule software to the local industry. Scheduling software companies could also provide subsidised software to the local industry.Definition of Scope

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ObservationA clear definition of the scope of the work is difficult to obtain when contracts are formed in multiple languages. International competitive tenders often utilise English, which is supplemented by the same contract in the local language. If the scope is not properly defined, translated and understood, the estimate will be faulty, the schedule will not be adequate and overall poor performance of the project will result. SolutionProgrammes may be developed that educate and train the local industry on the importance of understanding the entire scope of the project. This will include contractual scope as well as performance scope. Contract Type / Form / Language

ObservationContracts in the Balkan region have not developed at the same pace as those in other parts of the world. One and two page “agreements” are still being used as a standard form of contract. This trend is slowly changing, with the industry moving towards standard forms of contract readily understood by the international industry. However, in some cases a combination of international contracts and local agreements are implemented which can cause a host of difficulties when trying to resolve issues and conflicts. SolutionLocal contractors should seek training in western contracting parameters not only to establish an adequate estimate for the works but also to ensure an understanding of their rights and obligations with respect to the General and Special Conditions of the Contract. Alternately, international participants need to be sensitive to the local capability in terms of contract risk and reward profiles. Risk must be captured at the proper level. Risk Allocation / Control

ObservationRisk allocation is a misunderstood aspect of contracting. Because it is misunderstood it is often ignored or not adequately defined and priced, which in turn leads to significant execution problems. The time to define risk allocation is prior to contract award, not when the contract is operational. SolutionsWho takes the risk? How is it priced? How is it controlled or contained? All these questions need to be defined within the market. Strategies that identify who is most logically situated to take these risks, (locally, nationally, even internationally), what the different forms of risk are, and how to mitigate them could result in a more stable market and an overall reduction in

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contract pricing. One solution is to define the different risks. A clear determination of what risk the local market can bear and what risk the international contractor can bear is then possible to define.We have dedicated a separate section (see section 8) discussing in more details the risk management issues.EXECUTION PHASE

Compliance with Design Standards & Codes

ObservationStandards and codes are defined at the regional and local levels but enforcement, inspection and observation of these standards and codes are often lax. This creates a false pricing regime. The installed works are not compliant with the standards but the pricing is compliant with the quality of works. If inspection indicates non-compliance, the industry does not have the budget necessary to supply a finished product at the right level of quality and performance.SolutionAn introduction to internationally recognised levels of QA/QC can be provided to the local industry. Upgrading the existing standards can be conducted, even at a regional level to allow for a seamless transition, in terms of infrastructure, from on nation to another. Financial assistance could be provided to cover the costs of certification for firms interested in making this investment. Copies of standards and codes like the ASTM and BS could be provided to the local market.Establishing professional associations such as the ASCE and the ICE, which maintain resource libraries and certify Engineers and have standardised testing. Also they hold regular meetings and seminars for the transfer of knowledge and experience.Quality Assurance/Quality Control (QA/QC)

ObservationQuality is obtained through enforcement of the standards and specifications, adequate pricing, and warranty periods that require sufficient incentive to supply and install properly in the first instance. While each country typically has their own set of standards and quality control procedures, the parameters have not been applied in a consistent and predictable manner. This situation must be corrected. QA/QC must be achieved at all levels of involvement: owner, engineer, supplier and contractor. Contractual requirements for a structured QA/QC program are common in most international tenders or tenders involving international money.

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SolutionLocal contractors need to enhance their individual programs in line with international practice or conversely they should acquire internationally recognised quality assurance qualifications. Training and budgetary support of the local industry could allow this transition to occur in a rapid yet structured timeframe. Lessons learned could be applied to the market that depicts consequences of a lack of enforcement.Schedule Compliance

ObservationThe need for schedule compliance comes as part of the fulfilment of the contractual obligations. Without a clear understanding of scheduling trends, production rates, efficiency factors and critical path, management is not truly in control of a project. This often leads to serious impacts being identified too late in the program that result in financial penalties and damages.When schedule delays do occur, the impacts are not understood, nor are they recorded and only show up when milestones are not achieved. At that instance, it becomes a very tedious, if not impossible task to find out where things went wrong and more importantly how to get things back on track.SolutionThe need for training of planners and schedulers, with specific focus on planning the work during the tender phase is critical. Management also needs to be made aware of the importance of the schedule as a tool to assist in completing a project profitably. Reports on delays if given promptly can assist in developing action plans to recover those delays.Environmental Safety and Health (ES&H)

ObservationOverall, there seems to be reduced levels of attention to environmental, health and safety issues in the region. This is often driven by the inherent high costs associated with these programs as well as a misunderstanding of how important these elements can be to reducing overall operational costs of the industry.SolutionProviding training, videos, lectures and guidebooks on the importance of these issues to the industry, the employees and the communities is one answer. Showing how a good safety program can actually save money over the long term is probably more convincing. Insurance costs can be reduced, liabilities can be reduced, and running costs of the industry can be normalised. All of this can be provided under the ES and H umbrella.Monitoring / Reporting

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ObservationsSchedule, cost, revenue, safety, environmental compliance, laboratory testing and standard compliance are but a few items that should be consistently monitored and controlled over the life of a project. These elements are often overlooked and or ignored. Without such monitoring and reporting it is often difficult to predict the ultimate outcome of a contract. With no warning system in place, any of these items could lead to a disastrous project, harmful either to the local or the international contractors.SolutionTraining and education are important. Defining and implementing specific programs that focus the industry on what is to be monitored and reported can provide early warning systems on problems and then follow up with lessons learned that can keep the industry healthy. This is an ongoing effort and one that cannot be replaced in terms of importance.

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11 Recommendations As in many other areas of economic policy, recommendations and appropriate action plans do not readily present themselves even when the difficulties have been identified. The question of how to intervene and the decision whether to intervene at all depends on: Defining a clear scope and objectives of the policy

(programme or action); Identifying target groups; Developing options and corresponding implementation

mechanism, assuring an objective and correct administration; Assigning resources, responsibilities and outcome; Assessing the cost effectiveness; Coordinating with other relevant programmes; Developing a cost- benefit analysis that also requires that

clear outcome can be measured.There are common traits of the difficulties faced by local contractors in Bosnia and Herzegovina, Bulgaria, Macedonia, Romania and Yugoslavia. There are also particularities to each country. The recommendations below are drawn from the assessment undertaken specifically for this project (research, field surveys and interviews) as well as from the experience of international contractors we interviewed. We have highlighted the recommendations that we believe to be appropriate for EBRD to act upon.However, we would like to emphasise that some institutional action would be needed if the most pervasive benefits were to be achieved especially related to the small and medium contractors. We have structured the recommendations under three headings: Measures falling under the EBRD’s remit; Measures that could be implemented by EBRD as well as

other IFIs; Measures that can be addressed by governmental and local

authorities, professional or trade organisations;The order in which these recommendations follow do not represent a ranking.

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11.1 Recommendations to EBRD

11.1.1 Recommendations in Support of Financial Enhancements

Equipment Finance

General AimTo make equipment acquisition feasible and allow firms to have the equipment necessary to compete for and work as subcontractors on internationally funded infrastructure projects and increase their productivity.What can EBRD do?Funding or ownership influence to encourage banks to make equipment-financing loans

EBRD already has lines available to selected banks for loans to SMEs. They are not restricted as to purpose and can be used to finance construction equipment. During our trip, we heard that these lines have not been fully utilised in many cases because the borrowers have found the resulting loans too expensive. They are not available to larger firms, some of which reportedly have created SME sister organisations to access internationally funded SME loans. The banks in turn state that they have difficulties finding enough credit-worthy borrowers for these loans. It should be noted that some of the banks with these EBRD lines do limited business with the construction industry. We did not do any detailed analysis of the usage on these lines and our information is based solely on our meetings and on the EBRD reports provided. It may be that usage would increase if these loans were marketed to the construction industry as equipment financing products. EBRD could use its influence to encourage such marketing, which would necessarily have no impact on credit standards. Perhaps some relatively minor modifications in the programme would improve its usage for this purpose. A quick, targeted study should clarify the issues involved and the options available to make this existing funding used more for equipment financing. If that study reveals significant problems with using the existing programme for equipment financing and a narrowly focused programme fits within EBRD’s guidelines, EBRD should explore the possibility of creating a separate programme for construction equipment finance through qualified banks. Such a new programme could also be used to finance equipment for larger construction firmsThis option has the advantage of using an existing programme with the possibility of implementation occurring quickly.Funding a leasing operation of construction equipment and the enactment of laws and regulations favouring leasing

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Any leasing programme should include in its design the leasing of construction equipment. A regional approach would be preferable to a country approach because there is a limited market in any one of these countries for some of the more specialised equipment. EBRD should also include in any leasing programme, assistance to the governments for improving the legal framework, including obstacles that inhibit the movement of construction equipment between countries. A leasing programme is not a quick fix to the construction equipment-financing problem, as it would take time to develop and implement minimisation of the risks. Financing Option 1The equipment vendors may be interested in discussing with EBRD framework leasing programmes where the credit risk can be split between a commercial bank (EBRD), an export credit agency, the vendor, a private risk insurer and other investors, whilst the funding programme could be structured as a senior secured commercial/corporate loan. It is our understanding that EBRD has a very cautious approach vis a vis any form of transaction which could be considered vendor financing. In this framework, further investigation should be considered in identifying and developing operating, credit risk structures and special purpose vehicles (or corporate structures) that meet EBRD Charta. The local subsidiaries of these manufactures, in the EBRD countries of operation, very likely would not require financial support facilities such as commercial loans. All their treasury and corporate borrowing policies are centralised and take advantage of the good credit rating of their holding companies. Financing Option 2Local leasing companies are interested in updating their equipment fleet but need financial support. This could be in the form of payment guarantees offered to the leasing company or even equipment allowances inserted into the bid documents. These deals may be small in size, so potential opportunities should be directed to the various SME or micro-lending EBRD credit lines in place with existing banks. Financing of companies renting construction equipment to firms in the region and the creation of a rental brokerage business

Equipment hire could be a more attractive solution compared to leasing because it can ensure a higher utilisation level and therefore a lower cost. It can also provide trained operators and increase the productivity of small and medium construction companies by enabling them to use the same equipment as major contractors on an as needed basis.

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A detailed assessment of a rental company should include at least the following: Utilisation of the rental fleet, usually measured as return on

investment (ROI) and analyses of the key factors affecting the ROI: time utilisation, rental prices and product mix influence;

Management of the rental fleet: transfer to various locations, ratio new equipment to old equipment, pricing polices, maintenance and repairs, portfolio of equipment;

Market demand and rental prices.It is also important to mention that in Southeast Europe traditionally the construction companies own equipment fleets. This can adversely affect the development of a sustainable rental market unless customers are becoming more aware of the cost advantage of outsourcing. It is therefore a virtual circle. The growth of the industry depends on the demand. In reverse, availability at convenient prices is key to potential customers.Financing Option - Regional Rental Company or National Rental CompanyIt is worth exploring to what extent financing to a unique regional or national rental company is a bankable project meeting EBRD size, additionally and sound banking principles criteria.It is our initial impression that a sole rental company, renting out equipment to retail rental companies would be a bankable business case under the following assumptions:

A unique rental company renting to ‘retail’ rental companies would bring size, economies of scale, risk diversification across the region and businesses;

Renting to a small pool of retail companies, would leave the marketing and Operating & Maintenance services to be executed by the retail rental companies; collection could go directly into an escrow account, therefore individual risks could be excluded; alternatively if the retail rental companies enjoy a good local, long-term rating, they could take the credit risk;

Know-how can be transferred at the level of these retail companies using EC-Phare consulting budget and encouraging private-public partnerships with seasoned EU firms.

Purchase of new or used equipment for major internationally funded infrastructure projects with the equipment auctioned off at the end of the project.

This is more a procurement proposal than a financial one but it could have a significant impact on firms participating in EBRD funded construction projects. It would lessen the need for

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equipment financing because it would remove the requirement that local firms have all the equipment required for work on the project. That should increase bidding on those projects and competition for contract under them. It would give more opportunity to smaller firms with excellent technical ability and experience to increase their involvement in major infrastructure projects and to grow in strength and ability without stressing their limited liquidity and asset base trying to meet equipment-financing requirements.The sale of high quality, used equipment through auction at the end of the project should also help equipment financing by allowing local companies to buy better construction equipment at a lower price than would normally be the case. Unless there are procurement issues that would make this difficult, this option could be quickly implemented. It would directly respond to one of the major objectives stated in the terms of reference of this project, to identify ways to increase involvement of local firms, especially SMEs, in the infrastructure reconstruction in the region.One drawback of this could be that the construction companies end up with owning a variety of equipment, manufactured by different suppliers in various countries. At the industry level this is inefficient as it can cause maintenance and availability of spare parts problems as well as additional costs. This problem will be reduced as contractors realise that the best prices for reselling their equipment will come from buying only equipment that can be easily serviced.Also important to the effectiveness of this solution is clarification of the recipients - who owns the equipment at the end of the project. As already mentioned above, the equipment could be auctioned off at the end of the project.Another alternative could be that the project owner, if a public client, may consider retaining the equipment on its balance sheet. If the public client is undertaking several EBRD or IFI’s projects, it could accumulate over a period of two to three years a significant base of equipment. A spin-off of this non-core business can then be considered together with its privatisation. The newly created commercial company could operate as a leasing or rental (hire) company.If the public client does not wish / cannot own the equipment, another mechanisms could be designed – such as the one shown in the figure below.

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This mechanisms combines project financed equipment with a leasing operation. From EBRD’s point of view this means two things:

(i) EBRD can require through the procurement package a price for the works and a price for procuring the project equipment fleet as part of the tender documents

(ii) EBRD can make a capital investment in the form of equity and /or debt to a local leasing company.

The leasing company can own the equipment procured for the project. In this case the borrower (public client) should have a stake in the leasing company. To avoid uncompetitive pricing, the public utility’s stake should be a minority.The contractors bidding for the project could procure equipment from this leasing company or from any other supplier.Other parties can / should have a participation in the leasing company such as vendors and Export Credit Agencies.Benefits to the construction firms More modern and efficient equipment Better ability to meet contract requirements for equipment Less down time and project delay caused by equipment

breakdown and maintenance. In general, improved performance and ability to work on

major infrastructure projectsImproving payment procedures - Transform completion certificates into collaterals

General AimIncrease the local contractors’ liquidity and strengthen their financial position.

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Equipment Financing Mechanism

EBRDEBRD

CONTRACTORSCONTRACTORS

VENDORSVENDORS

OTHER EQUIPMENTSUPPLIERS

OTHER EQUIPMENTSUPPLIERS

MARKETPRICES

MARKETPRICES

BORROWERPUBLIC CLIENTBORROWER

PUBLIC CLIENTLOCAL LEASING

COMAPNYLOCAL LEASING

COMAPNY

Com

petit

ive

Tend

er

Equity / Debt

Minority Stake

EXPORT CREDITAGENCIES

EXPORT CREDITAGENCIES

Debt


Who can be responsible and what to doLocal banks could, for their established clients for example, accept the completion certificates as collateral for extending an overdraft for working capital. Local banks have to play the primary role in developing and implementing this procedure. This action should be coordinated with EBRD, who can through their procurement rules, impose interest payment for delayed payments to contractors when the client or owner is at fault. Transforming the completion certificate into a security (i.e. using it as collateral) is closer to classic senior secured bank lending and per se has the merit of making local commercial banks aware of a new class of security instrument. Since it is tradable and fungible, banks can put it in custody and lend against it. EBRD could encourage one of their existing SMEs and micro-lending operations to start considering this type of collateral.This form of borrowing has the disadvantage of keeping the short-term or medium term liability and hence credit risk on the construction firm’s books. It does require heavy legal and due diligence work (like in any project finance transaction) and implies, considering the poor level of standardization of credit documentation and IT integration within the local banking sector, that one commercial bank be the counterpart on all legs of the transaction. This new category of financing instruments has the benefit of monetising a new class of assets (other than fixed assets) – completions certificates. In the absence of clean-cut procedures to enforce bankruptcy and liquidate/auction/sell assets in a bankruptcy process, monetising or pledging a more liquid class of assets, e.g. invoices, would be a major step forward for improving contractors’ liquidity.Benefits to the construction companies Would protect the contractor and offer alternatives for

working capital sources; Increase /improve the liquidity or treasury operation of the

small contractors and reduce their cash flow cycle duration; Support SMEs and local industry creation and entrepreneurs.Improving payment procedures – Development of a forfaiting scheme

General AimTo monetize the completion certificate as an invoice/receivable and forfait (factor) it. This will help alleviate the financial arrears issue, an issue widely spread within the Southeastern European economies. The development of a forfaiting scheme has also the benefit of introducing in these markets a different quality of assets that can be monetised.

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Who can be responsible and what to doEncouraging the emergence of a professional, formalised, forfaiting1 market is a broad and beneficial outcome for the Southeastern European countries and implicitly for their SMEs sector. The development of a market for debt discounting instruments such as forfaiting, including the discounting of construction completion certificates, is an interesting option which can be developed, for example, via EBRD funding or micro-lending programmes.The forafaiting of invoices can: Bring-in much needed liquidity and produce an improved risk

transfer/allocation from SMEs (including construction firms) to entities (e.g. banks) better equipped to diversify and mitigate risk and ensure smooth operation of the market;

Improve the transparency and mark to market parts of both sides of the SMEs and construction firms balance sheet;

Address the write-off issue associated with potential delayed (bad – debt) liabilities;

Bring-in up-front cash whilst allowing the market to recognise and to price accordingly the (poor) credit quality of the trading books of corporates inter alia the construction companies:

Allow for trade receivables (e.g. invoices, short-term payables, other current liabilities and long-term invoices) to be marked to market.

The forfaiting process is based on an appreciation of the credit risk of the obligor (client or project owner in the case of the constcrution completion certificates). This risk is a payment or credit risk and has to be stripped of any contingent 1 Forfaiting (factoring) is the purchase of a series of credit instruments such as drafts drawn under time letters of credit, bills of exchange, promissory notes, other freely negotiable instruments and, in our case, completion certificates on a nonrecourse basis (nonrecourse means that there is no comeback on the seller (construction company) if the obligor - client or project owner - does not pay). The Forfaiter deducts interest (in the form of a discount), at an agreed rate for the full credit period covered by the notes. The debt instruments are drawn by the seller (construction company), accepted by the forfaiter, and will bear an unconditional guarantee. The guarantee will normally be issued by the obligor’s (client or project owner) bank, but some strong corporates can be accepted without a bank guarantee.

In exchange for the payment, the Forfaiter then takes over responsibility for claiming the debt from the importer. The Forfaiter either holds the notes until full maturity (as an investment), or sells them to another investor on a nonrecourse basis. The holder of the notes than presents each receivable to the bank at which they are payable, as they fall due.

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obligation/liability. In the construction business, payment terms are complex, spread over a longer period of time and contain clear contingent liability specifications i.e. the ability of the client to retain payment if the constructor does not perform on time, or within the agreed (tendered) budget or up to a specified quality.

The forfaiting of construction completion risks involves not only the obligor risk (late payment / default risk) but also constructor’s risk (completion and latent default risks). It is important to understand how the constructor’s risks can be stripped in order to structure a stream of receivables of debt instruments that have only clean-cut obligor risk. The underlying risks associated with the use of a completion certificate are as follows: The latent default risk. This can be covered via insurance. The completion risk. This risk can be covered by the

contractor through a bank guarantee or a suretyship or an insurance policy (usually cheaper than the bank guarantee) for up to 10% of the value. This part can be covered by EBRD putting together a small regional SME residual completion risk funding the late payment / default risk by the client.

The late payment / default risk. The client is usually a state-owned entity (proxy to the sovereign risk), a municipal entity (again a good proxy to the sovereign risk) or a corporate (seldom case). This is a risk that local commercial banks can buy, sell, re-sell, syndicate or repackage in, what one would call, commercial paper.

EBRD could be instrumental in providing leadership, credit risk expertise and execution skills by providing lines of credit towards establishing this type of programmes or encourage the banks receiving EBRD SME credit lines to buy this type of risk i.e. quasi-sovereign or sovereign.The extension of credit is short-term (3 to 6 months) and could be considered de facto lending against quasi sovereign T-bills. However this programme could have good spreads above the local sovereign, bring-in liquidity and provide a good answer for mismatches situations like end of year shortages in the budget and SME payment obligations.

Benefits to the construction companies

Would protect the contractor and offer alternatives for working capital sources;

Increase /improve the liquidity or treasury operation of the small contractors and reduce their cash flow cycle duration;

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Bring/develop new, simple, pragmatic financial instruments aimed at providing liquidity, reducing inter-enterprises debt, improving credit risk allocation and risk diversification;

Develop/transfer skills and know-how – at no/low costs – to local financial intermediaries whilst bringing market discipline and standardisation;

Support SMEs and local industry creation and entrepreneurs.11.1.2 Recommendations in Support of Procurement

Procedures ImprovementsSplitting large projects

General AimImprove volume of work that is accessible to smaller contractors.This recommendation has to be treated with care as splitting of projects as a matter of principle may not be appropriate as it may: Increase the total costs of the project; Increase the risks; Prejudice the quality; May not provide the best value for money.Good management can mitigate all these disadvantages. However, there are various types of works that are suited for being broken up into smaller contracts such as roads and housing. In these types of projects, the management problems can be easily solved.Who can take responsibility and what to do The most common situation is whereby the main contractor slices a road projects to suit activities e.g.: supply of aggregates and construction of culverts are suited for small subcontracts. Another approach would be to split the large road projects into shorter ones that can represent manageable undertaking for small contractors. This can be done at the planning stage and through the tendering stage. EBRD could assess the effectiveness of splitting the project at the feasibility study stage both from a technical point and financial (to include total project cost).Other candidate for splitting would be housing projects, which have generally a lower level of technology, are by their nature large numbers of discrete units and therefore are a suitable market for small contractors.The major implication of splitting up larger projects is an increase of administrative work for the project owner (several tenders,

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more drawing, extra coordination between documents, several contracts to monitor). As ultimately it would be the owner’s responsibility to implement it, it is very much a question whether a public client (owner) has the resources to supervise this. Benefits to the contractorsThis is a benefit to the small-scale and large constructors if they wish to participate in large projects.11.2 Recommendations to EBRD and other IFIs

11.2.1 Recommendations in Support of Procurement Procedures Improvements

Prequalification procedures

General AimWithin the general objective of ensuring competition, some adjustments to the qualification criteria could support a target group such as the smaller contractors. This would increase the chances of small contractors to participate to bids and to develop and expand their business, in order to create a competitive market at this end of the construction industry.Who can take responsibility and what to doEBRD procurement department and local public clients through national procurement rules could enhance the chances of smaller contractors to access to work. Link the prequalification criteria to the contractor’s annual

turnover. As seen in all countries surveyed, one difficult hurdle to overcome is the cash requirement in proportion to the value of the contract. One company could work on more than one project at a time , e.g. one a small firm working on two contracts each of $50,000 million, but cannot qualify for a single project worth $100,000; million

Introduce an evaluation ranking based on quality and past performance and include this into a score which could be the basis of the award rather than the lowest price, which is the most common practice for public clients and some international financial institutions (e.g. USAID in Bosnia and Herzegovina). The idea of rewarding performance can be taken further by introducing a merit system. A good example in this respect is the Singapore Housing and Development Board, which has a system whereby contractors are awarded points for good performance and are awarded notional, discounts to their offer in proportion to the points won. If their offer after the deduction becomes the lowest, they can be awarded the contract. This process must be objective, open, transparent and public, otherwise this mechanism could be abused.

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The implementation of this would rely on some clear and objective methods for evaluating contractor’s performance. A possibility would be to create an independent body or to be the responsibility of the Contractors’ Organisation.

Benefits to the contractors / construction industryBetter chances especially for small firms to access work and sustain their business as well as creating a more competitive sector.Relaxation of performance bonds

General AimReduce the amount of working capital or assets (as collateral) tied up in one project.Who can take responsibility and what to doIFI’s could advise the borrowers to be realistic with their requirements for performance securities and intervene when amounts of over 10% of the contract value are requested in the tender documents. Large amounts of performance securities not only tie up working capital but also increase the contractor’s costs. Often clients are unaware that the Contractor usually has to leave on deposit with the bank the full cash value or pledge fixed assets twice the full value of any security issued. Beneficial effects could be obtained if the requirement for performance bonds are relaxed or abandoned. Small contractor can have difficulties in executing work but it happens rarely that the client is pursuing the guarantee because it could be expensive, time consuming and fairly easy to counter claim (no adequate drawings and supervision etc). It is felt, including by many of the main contactors active in the region, that bonding small local contractors in relation to performance is not worthwhile. The qualification criteria and /or selective tendering should protect the client against bad performance. The use of bonds should not be a substitute for knowing the capabilities of contractors.Benefits The contractor eliminates some costs and reduces the amount

of collateral tied up in one project, offering the possibility to use the assets as collateral for other projects.

Improving access to and understanding of contracts – types; form; language; jurisdiction; arbitration

General AimAll countries surveyed, but especially Romania, have raised the issue of understating the contractual terms when drafted in English. Romanian contractors have also questioned the

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practicality of having the English language as the only recognised language in the IFIs’ contracts. Though accepted by the Romanian Government, in practice Romanian authorities cannot / do not want to use a contact expressed in English. Romanian language is the applicable language in a Court of Law, even if the contract says otherwise.The first issue is familiarity with contractual terms, which can be solved by training. It is also worthwhile mentioning that in Bosnia and Herzegovina and Romania there are no official translation of the FIDIC contracts. It is therefore a matter of the contractor itself having to pay for a translation from its own resources. Very often, the costs of translation and especially legal advice are beyond the financial resource of smaller constructors.Another issue is facilitating the understating of the contractual terms and hence the capacity to handle contracts by smaller contractors who do not usually have internal legal staff.Who can take responsibility and what to doEBRD could impose the local language as the second language of the contract. It could also support, maybe with EC Phare funds, the translation and dissemination of the FIDIC contract in the local language. This initiative could be extended for example to universities that benefit from various Phare programmes and give the possibility to the young construction engineers graduates to become familiar with the concepts and terminology.This responsibility could be also taken by an existing professional organisation such as the Association of the Construction Companies in Romania.Another issue is the lack of Alternative Dispute Resolution (ADR) mechanisms – i.e. arbitrators. These can be very effective in dealing with problems in construction contracts, where disputes are best solved quickly. It would be highly beneficial to establish a local venue for arbitration with certified arbitrators, since most local contractors will not be able to afford overseas arbitration.Benefits to contractors Better understanding of the risks in a contract; Reduced costs for contractor related to translation; Increased capacity to monitor the projects from a contractual

point of view, a better understating of risks and responsibilities and in long term more discipline in complying with contractual terms;

If ADR is implemented – a lower cost and more rapid means of resolving disputes.

Promote flexible insurance requirements

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General AimIFI’s to tailor their insurance requirements imposed on domestic contractors not to exceed what is “that required by law” that is normally also within the strength and ability of the domestic insurance market. Who can take responsibility and what to doOften IFI’s or their advisors require insurances such as Employer’s Liability, Workman’s Compensation and Motor Liability insurance with high limits of liability in excess of those legally required or indeed insurances not necessarily imposed in local markets, for example, requiring all contractors to arrange Employer’s Liability insurance even though this is not required by law in the country concerned. These types of requirement could jeopardise the opportunity for domestic contractors to participate in projects as these limits or types of insurance sometimes may not be available in domestic markets. It is recommended that any requirement for such insurances is limited to “that required by law”.Also, it is recommended when local contractors are subcontractors to large international construction firms that in respect of the main project insurances, for example, Construction All Risks and Third Party Liability insurances, the prime contractor covers any local subs as additional insured. This removes these insurance costs for the subcontractors. It also avoids wasteful duplication of insurance – since an event is now insured once.Benefits to contractors Reduce project cost – no wasted duplication of insurance; Allow them to obtain coverage on the local insurance market; Reduces the delays in processing insurance claims, as only

one insurance company is involved.Enhance the pre-bid evaluation process

General AimDifferent owners and funding agencies often define evaluation criteria to be used when selecting a list of participants. These criteria are often passed down from prime contracts to sub-contracts and even further, to material suppliers. The local industry, interested in competing at any of these levels needs to research these participation criteria and ensure that compliance is within their reach, well in advance of any specific tender announcement. If, during this compliance evaluation, a company finds that it does not satisfy the qualification requirements, it may select to participate in the development of a programme aimed at mapping out a process to reach the desired level of compliance.

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For example, the ISO standard series may be a target goal for contractors. Who can be responsible and what to doIFI’s can publish their pre-bidding criteria well in advance of the intended project. Seminars can then be scheduled to help the local industry evaluate their relative position. If necessary, follow-up training or assistance programmes can be established to assist local contractors in reaching acceptable levels.Once these are established, companies can be classified based on their compliance with each of the measurement categories and can be placed on pre-qualified bid lists for use by regional and international competitors. This pre-qualification establishes lists by discipline, i.e. Mechanical, Electrical, Civil, by their ability to perform work, by past experience, by value of past works, and by the quality of works performed in the past.The key to having a successful pre-qualification programme is to regularly monitor and update the classification listing which allows companies to move up in scoring and therefore move up to larger and more complex projects.The Contractors’ Association could be responsible for maintain the list, with support and input from IFIs. In allocating this responsibilty to a contractors’ association, care has to be paid to avoiding conflict of interest with the member contractors. This role could also be allocated to a rating agency (similar to Standard & Poor’s) dedicated to the construction industry. The establishment of such an agency, on a local but preferably on a regional basis, requires a lot of effort and resources. Once in place, the rating agency could however undertake whole range of technical and financial assessments of the companies active in the construction industry.Benefits Better chances for local contractors to meet requirements; Increased chances of successful partnerships with

international contractors.

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Improve quality of the tender documentation and particularly the quality of the technical specifications

General AimA few SME contractors interviewed participated in tenders for projects funded by IFI’s. They complained that the tender documents had been ambiguous with poorly defined evaluation criteria. Many SME contractors expressed the opinion that the tender documents were being drafted by the borrower in a way to best suit large contractors. Many considered taking part in these tenders as a waste of time and money. This happens because performance based tender specifications can often look attractive to IFIs as: They costs less to produce since no work need be carried out; They allow innovative solutions to be proposed in contracts

with detailed specifications; Are less costly for contractors to bid, since he does not have

to fiancé design work for a project he may not win; Allow easier evaluation of offers.Who can take responsibility and what to doIFI’s should set standards for tender documentations. This could be achieved through appointment of a professional independent body to review and verify the tender documents before sending these out to bidders. Often, when the specifications are loose then the lowest price bidder can win in compliance with the tender rules but runs into trouble later when executing the project. Benefits to the contractorsEncourage SME contractors to bid for projects financed by IFI’s. Better quality specifications will potentially save significant sums of money in the execution phase of the project. The cost of completing the detailed design sufficiently well for good quality bids to prepared only amount to approximately 5% or less of the total costs on large complex projects. IFI’s should be carefully review the budgets of the borrower for design work and relate these back to the total project cost. Industry experts should be requested to provide the borrower with the typical range of costs for this activity for a variety of project types.Improving the process of evaluation of tenders and award of contracts

General AimSME contractors have had very disappointing experiences with tender evaluation and contract award processes on several tenders for projects financed by IFI’s. They complain that often these procurement steps have dragged for a very long period of

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time, in one particular case for over a year. During that time the bidder had to maintain a bid bond and later a performance bond that not only tied up his capital but also eroded his gross margin. The major reason for the delay is considered to be the poor experience of the government organisation responsible for managing the procurement process.Who can take responsibility and what to doIFI’s should monitor closely the procurement process including a review of the bid package or require a professional independent organisation, preferably a reputable international consulting firm to supervise the procurement process from issuing the bid package to signing the contract. IFI’s may consider training programmes in procurement for civil servants managing procurement on public projects funded by IFI’s. To enhance this process, IFI’s could impose a time limit for bid bonds beyond which the owner should pay the cost of these.Benefits to the contractors / construction industry Encourage them to bid for projects financed by IFI’s; Reduce their bidding costs.Improving payment procedures

General AimStreamline the approval procedures for payment. This is easier said than done as in all countries, in various degrees, the public administration is far from being objective, transparent and effective. Though we have not analysed the approval process in any of the countries surveyed, it is clear that one difficulty into the process is the issuance of the completion certificates and another the release of payments. Who can be responsible and what to doLocal banks could, for their established clients for example, accept the completion certificates as collateral for extending an overdraft for working capital. This action should be coordinate with IFI’s, who can through their procurement rules, impose interest payment for delayed payments to contractors when the client or owners is at fault. The IFI’s have a powerful mechanism for disseminating good and fair forms of contract.Benefits Would protect the contractor and offer alternatives for

working capital sources; Incentivises the implementation unit / government

department to avoid delays.

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11.2.2 Recommendations in Support of Training and Advisory Services

There are several important factors and issues that have to be considered when formulating training programmes. These refer to target group, location and timing and content. The analyses of these factors can give the answer to whom the training should be addressed and what form to take. A start into the assessment of the training needs was done by the Stability Pact Human Resources Working Seminar on SME Skills held in Tirana in November 2000 and continued within this study. During our survey, we asked all contractors what they considered their weak areas and what type of training would be beneficial. The most important ones are included in the recommendations below.There are potentially several ways of undertaking effective training: Dedicated training programmes to contractors and /or SME.

This can be undertaken via grant funds from various IFIs. It could focus on specific subjects: raising finance and how to grow a business and management skills related to project implementation and monitoring;

On the job training, when an international contractor is involved. This could be financed for example via a grant and could include purchase of dedicated software, e.g. for scheduling and monitoring performance;

Training and seminars organised by local professional organisation and /or chambers of commerce, making sure that the right trainers are brought.

Training must be timed to coordinate with major projects and to provide relevant training to allow local contractors to effectively participate in these. Academic training disconnected from real demand for services should be avoided.In addition, promotion materials related to the industry performance with benchmarking from other countries and management issues for SMEs are needed. The responsible bodies should be the professional organisation or organisations dedicated to SMEs such as the one existing in Romania. The training approach as outlined here lends itself to international technical assistance on a bilateral or multilateral basis. Rather than having foreign experts controlling the training programme, no mater how familiar with local conditions, we believe it would be essential to involve a pool of national experts, professional and trade organisation.Marketing Training

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General AimIt has been generally indicated by the international contractors that the local companies, especially the smaller ones, are not sufficiently promoting themselves. Unless an international contractor has already worked in the country or has a local presence, it has to go through a sustained effort of identifying the local potential JV partners or subcontractors. The local construction industry needs to be better motivated and be more active and proactive in promoting itself. In addition, one should aim at increasing the chances of complying with the qualification criteria and give contractors the knowledge to prepare themselves.Who can take responsibility and what to doThis action calls for the combined effort of the contractor itself and local authorities supported by a training programme. Eventually, some responsibility could be taken by the national professional association.The training programme should cover: Marketing objectives and techniques; How to register with different agencies and organisations; The promotion and use of prequalification questionnaires and

promote undertaking as to how to classify services in accordance with international practices;

How to register with the trade departments of foreign embassies;

How to become involved in chambers of commerce.Benefits to contractorsExpand the potential for participation in an expanding marketQuality Assurance / Quality Control (QA/QC)

General AimImprove use and implementation of standards in a consistent and predictable manner at all levels of involvement: owner, engineer, supplier and constructor.Quality is obtained through enforcement of the standards and specifications, adequate pricing, and warranty periods that require sufficient incentive to supply and install properly in the first instance. While each country surveyed has their own set of standards and quality control procedures, the parameters have not been applied in a consistent and predictable manner. This situation must be corrected. QA/QC must be achieved at all levels of involvement: owner, engineer, supplier and contractor.

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Contractual requirements for a structured QA/QC program are common in most international tenders or tenders involving international money. Who can take responsibility and what to doIFI’s tenders should require an integrated QA/QC programme.BenefitsLocal contractors need to enhance their individual programmes in line with international practice or conversely they should acquire internationally recognised quality assurance qualifications. Training and budgetary support of the local industry could allow this transition to occur in a rapid yet structured timeframe. Lessons learned could be applied to the market that depicts the consequences of a lack of enforcement.Improving schedule compliance

General AimThe need for schedule compliance comes as part of the fulfilment of the contractual obligations. Without a clear understanding of scheduling trends, production rates, efficiency factors and critical path, management is not truly in control of a project. This often leads to serious impacts being identified too late in the programme. These then result in financial penalties and damages.When schedule delays do occur, the impacts are not understood, nor are they recorded and only show up when milestones are not achieved. At that point, it becomes a very tedious, if not impossible task to find out where things went wrong and more importantly how to get things back on track.Who can take responsibility and what to doThe need for training of planners and schedulers, with specific focus on planning the work during the tender phase is critical. Management also needs to be made aware of the importance of the schedule as a tool to assist in completing a project profitably. Reports on delays if given promptly can assist in developing action plans to recover those delays.IFI’s training programmes should consider this action.BenefitsContractors’ increased ability to perform and control the execution of the project.Improving monitoring and reporting skills

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General AimImprove the capacity of local contractors’ to monitor schedule, cost, revenue, safety, laboratory testing and standard compliance over the life of the project. Focusing the industry on what needs to be monitored and reported can provide early warning systems on problems. The contractors could then follow up with lessons learnt and this will keep the industry healthy.Who can be responsible and what to do?IFIs could define and implement specific monitoring and reporting programmes. This is suitable to on-going efforts rather than a one off action. Local professional and contractors’ organisations should be also involved. First staff of these organisations can be trained and afterward they can become trainers.BenefitsA healthy industry where contractors can compete and performance criteria become more pervasive.11.3 Recommendations to other Organisations

11.3.1 Recommendations in Support of the Construction Sector

Permitting

General aimHistorically, permitting under the socialist system required a large number of, often-bureaucratic overlapping approvals from different agencies to the final design of a project, prior to any work starting. This process creates delays and the opportunity for corruption. The objective of this task would be to streamline the procedures and if possible create one stop facility, possibly at the municipal level, to ensure that contractors can easily determine which information is needed in order to obtain the construction permits, what permits are required and who is responsible for issuing them. One could try to go even further and put in place an integrated approval process in relation to all permits needed for a project.Permitting is not a problem unique to Eastern Europe but it is specific to the construction industry. To be able to handle permitting effectively requires local knowledge. Some aspects of permitting, particularly on large projects are in the process of being harmonised as part of the accession to the EU process, for example, the requirement for Environmental Impact Assessments.

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Who can take responsibility and what to doEBRD could play a role in facilitating the permitting process by promoting the development of a transparent permitting process and defining permit requirements at an early stage in a project. This of course is dependant on the chosen implementation vehicle. For major public infrastructure projects, this is often a Project Implementation Unit, which could initiate the identification of the permitting requirements at a very early stage. In any case, this is an area where a governmental department can take responsibility.We recognise that permitting is a complex and resources intensive process, usually requiring substantial preparatory work. It also requires a high level of transparency in order to avoid corruption.Benefits to the contractors Easily determine the requirements and the decision making

factors; Better control the process and its outcome, therefore better

possibilities to plan the work and comply with the schedule; Allows for adequate pricing and time lines to be developed.Benefits to the owner Greater transparency and hence lower costs; Faster schedule to completion; Legal disputes with permitting authorities post construction

can be reduced.Regional Standardisation and compliance with design standards and codes

General AimStandardisation can bring major advantages: Particularly if carried out over a number of countries, it

creates economies of scale in the building materials industry – since standard products can be mass-produced;

Well-researched standards and codes of practice can embody the best practice in the building industry. This is a very effective way to disseminate high quality procedures;

It allows bids from different contractors to be compared easily, thereby encouraging transparency in the bidding process and hence lower costs;

It allows for contractors to be active on a regional basis at the standards that are common to the regions.

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The objective is to promote harmonisation of standards and codes where possible with the EU standards and codes. Where standards are not to be fully harmonised, it needs to be documented clearly which local standards are to be used and which local standards are thought to be equivalent to international standards. There is often a catch-all phrase in the tender document to the effect that “equivalent codes and standards are acceptable” but it then becomes incumbent on the contractor to demonstrate that the local code is equivalent. This imposes a burden on small contractors that they cannot economically handle.Harmonisation could include developing regional standards for design and quality control. This could be beneficial to the industry as a whole. Regional standardisation allows the industry to develop seamless levels of service across nations, borders and regions. This in turn allows companies to compete on a wider geographical level, and promote transparent competition within the industry. An international initiative in the area of construction products standardisation has been undertaken by the European Union of Agreement (UEAtc), which is a network offering voluntary approval services for the construction products. Romania is already a member of this organisation, which has its headquarters in the UK.A related organisation to UEAtc is the European Organisation for Technical Approval (EOTA). A construction product having a European Technical Approval issues by EOTA can carry CE marking and can be placed on the market in any of the EU Member States. In Romania, the Institute for Research and Economics in Construction (INCERC) is a member of UEAtc. Their activities should be integrated into a coherent programme addressed to the construction industry with the general purpose of (i) harmonising the standards to the extent possible on a regional basis and with EU standards and codes, (ii) coordinate with professional and trade organisations and (iii) develop a matrix of equivalent standards and codes in each country. The outcome of these activities would be to reduce or remove the technical barriers related to standards applicable to the construction industry. An indirect effect would be to strengthen the activity of the local professional and trade organisation, raising their profiles and ultimately their influence in developing a well performing industry.Who can be responsible and what to doThe European nature of the programmes already in existence suggest that this is an appropriate activity for the EU to assist and one that is implicit in the Accession Programme. Although it

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is true that even in the EU, much of the work by UEAtc and EOTA is voluntary.In the countries, the existing institutes, such as INCERC in Romania or similar in Bulgaria and Bosnia and Herzegovina, design institutes or professional organisations would be the focal pointIn addition to products and construction techniques, the harmonisation process is also being extended to professional qualifications.. FEANI Fédération Européenne d'Associations Nationales d'Ingénieurs European (Federation of National Engineering Associations) has a programme for harmonising these qualifications in the EU and issues qualifications such as the Euro Engineer. This programme could be extended to the countries targeted in this study.A grant could be considered for the funding of this initiate. Improving cost estimates

The quality of bills of quantities and subsequent cost estimates are often not fully developed. This leads contractors to submit widely different prices for the same apparent scope of work. Often the low bidder is then unable to complete the work for the contractual price.General AimImprove the definition of the elements of work to be included in the scope and improve the quality of costs estimates. A full understanding of each and every cost that will be encountered is required. The outcome will be an estimate that accurately reflects the scope of work and the execution costs needed to perform that work as well as a suitable level of contingency, risk and profit. In effect it will allow for, transparency as well as for accurate price comparison and contractor selection.Who can be responsible and what to doThe responsibility is dual: (1) the contractor who has to develop the costs estimate and (2) the public or private organisation in charge of developing the scope of work documentation which includes the Bill of Quantities, normally through a set of the national performance norms.The contractor clearly needs to be trained. Estimating and bidding work was not a key feature of the old central planning system and the depth of knowledge and experience is limited. In the old system, there were national bodies responsible for setting the construction industry norms that bills of quantities could be developed from. These have not been updated for a very long time. These public organisations need to be encouraged and supported in updating the standards and

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national public procurement rules. Alternatively, a market solution must be found. In the UK and USA, there are a number of commercial companies who market estimating guides for the construction industry (e.g. the very detailed “Spon’s” guides to cost estimating in the UK). These commercial companies have a strong interest in keeping their product up to date – both because they seek to sell a new copy to each customer every year and because they need to compete with other suppliers of information.There are three main components of the cost estimate: direct costs (directly attributable to the installation of the works), indirect costs (costs incurred in support of the works) and contingency, risk and anticipate level of profit.In all countries surveyed, the preparation of direct costs relies on out dated standards that do not allow for the effect of new technologies. Also, in all three countries, indirect costs were not calculated as a separate calculation of costs that support construction. Risk appreciation was minimal and therefore pricing did not include for eventual increases in the cost of the work. This approach to estimating does not truly define the actual costs of the project and perpetuates a false initial pricing level. As the works progress, many projects face substantial claims and potential cost growth from the contacting community. The solution lies in educating the contractors through workshops and seminars. In support of this will have to come the improvement of the national procurement rules and professional organisation that could provide up to date pricing information. Also, subsiding a Western pricing guides company to enter Eastern Europe could be envisaged.BenefitsThe sector overall will benefit from fairer competition and minimisation of unrealistic pieces that can impact the adequacy of governmental loans, local or regional budges and artificially impact the make-up of the competition.11.3.2 Recommendations in Support of the Business

EnvironmentPlanning and formulating public sector demand

General AimManaging capacity is the most difficult problem facing the management of the construction industry. A stable demand for construction would ease this problem. Governments could manage their flow of construction projects and minimise fluctuations in the number and value of projects.Governments, especially at the level of local authorities in the case of smaller contactors, are a significant customer for the

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construction industry and have a major influence on the pattern of demand. There are signs that over the last few years’ governments in Romania and Bulgaria have started to develop programmes mainly aimed at the housing sector. These programmes are highly suitable for small domestic contractors. This gives these governments the opportunity to manage demand in a key development sector and base it on a rolling programme over a substantial period.In many other countries a spurt of government-initiated activity in the construction sector has been used as a way of kick starting the overall economy. This can be a very powerful tactic, but can lead to problems if the other sectors of the economy are not ready to take up the slack in the economy once the construction boom is complete.Who can take responsibility and what to doGovernment offices can initially plan out for the formulation of a Master Plan at a central level and then require local and regional offices to monitor and control implementation. The programme could start with publishing a list of potential projects, including their nature, value, and location. It can then issue permits based on the master plan for development and subsequently monitor against this master plan on a yearly basis.Of course, this programme will have to be coordinated with the Ministry of Finance for governmental initiated projects. It should also be coordinated with regional and local planning and permitting originations at the private sector level. Benefits to the contractors / construction industryIncrease the contractors’ capacity to better plan the activities and take even preparatory action in view of upcoming projects such as making investment in updated plant and equipment and training of labour force.Attract foreign investment should also be a corollary. International contractors would be more willing to incur the set up costs in a country knowing that there is a continuing potential for work.Introduction of banking codes of practices

General AimFinancing for working capital and obtaining guarantees has been indicated as one of the main difficulties in undertaking work, planning and expanding it. Though we haven’t heard major complaints from the local banks about the companies’ capacity to understand and comply with the banks requirements, we noticed during our interview that only a minority of contractors (large and

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some medium ones) are familiar and confident in working with banks. Though the typical candidate for an EBRD project would be the larger contractors and the most dynamical and ambitious medium ones, we believe that raising the general awareness would be beneficial. Areas to target are: (i) requirements for credits and guarantees; (ii) general polices and interests rates structure, (iii) structure and use of banking services and (iv) registration of mortgages.Who can take responsibility and what to doLocal banks, at headquarters and through the whole network of offices and branches in the countries. The banks could produce simple leaflets, in an accessible language highlighting: Guidelines related to the documentation needed in support of

credit and guarantee application, some dedicated to the construction industry. It would be advisable for the local banks to work with a construction industry specialist so that the policies are clear to the end-users;

Structure of the interest rates and how they are calculated; considerations and assumptions in assessing the assets for collaterals;

How to work with the bank and the account manager.BenefitsIncrease confidence on both sides, the contactor and the bank when working together

Develop a contractor organisation

The existing organisations in the countries surveyed are not very effective and their roles are not very well defined. We recommend that a further study is dedicated specifically to analysing the structure, ownerships and operations of such an organisation and compare it with successful practices in the world. Of course, the decision of supporting the development of such an organisation is a political decision and the government’s support is crucial in developing the framework for its operational and in setting the responsibilities in accordance with the existing regulations. These organisations are independent and financed through memberships schemes, as is the case in Romania and Bulgaria.We acknowledge that this enterprise is not easy and critical to its success is its performance and gain of local recognition.If the target group is small and medium contractors, the contractor development organisation could be part of the SME organisation such as the one operating in Bucharest, Romania.The development organisation could provide support in the following areas:

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Training and advisory services, including some of the training activities recommended in our study;

Source of information for industry practices and benchmarking;

Legal advice in the areas of construction contract issues, claims disputes and arbitration;

Price information on materials and equipment; Assess the construction industry on a periodical basis as well

the local contractors and their performance. The agency could also become the repository for a database of good performance and ranking and award system.

Also critical to the development of a contractors’ agency are funding and staffing. Even if the financing were done through membership fees, it would be necessary for some additional funds (public, grants form IFIs) to sustain the agency especially during the first few years. In time, the question would be whether to charge for services, especially the advisory services, so that on one hand the agency can sustain itself an on the other hand the smaller contractors can afford the services.Staffing would also be important, as it is essential to bring in engineers, quantity surveyors, lawyers etc. accustomed to working in a commercial environment.This type of assistance could be provided by the EU Phare and appropriate role models exits in EU countries.11.4 Conclusions

In this study we have analysed the nature of the development problems of the construction companies, especially of the small and medium ones. We have presented several recommendations addressing various areas. These recommendations fall under the remit of EBRD, other IFIs or various national and local organisations and they have the following features: Transaction oriented measures corresponding to EBRD’s

mandate; Procurement oriented recommendations applicable to EBRD

and other IFIs. Institutional measures aiming at improving the infrastructure

necessary for markets to function. We referred to these as macroeconomic measures;

Recommendations addressed to improvements in the construction sectors itself. We named these microeconomic measures. In support of these, procurement procedures improvements in the remit of national organisations and international financial institutions are presented too.

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The table below represents a summary of these recommendations.

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EBRD EBRD and other IFIs Other Organisations

Transaction Procurement Training Macroeconomic Microeconomic

Recommendations to EBRD

EBRD Funding or ownership influence to encourage banks to make equipment financing loans

Funding a Leasing Operation of Construction Equipment

Financing a Rental Company

Purchase of new equipment for major internationally funded infrastructure

Improving payment procedures – transform completion certificates into collateral

Improving payment procedures – development of a forfaiting scheme

Recommendations to EBRD and other IFIs

Splitting large projects

Prequalification procedures

Relaxation of performance bonds

Improving access to and understanding of contracts

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Promote flexible insurance requirements

Enhance the pre-bid evaluation process

Improve quality of tender documentation and the quality of the technical specification

Evaluation of tenders and award of contracts

Improve payment procedure

Recommendations in Support of Training and Advisory Services

Marketing training

Quality Assurance / Quality Control

Improve schedule compliance

Improve monitoring and reporting skills

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Recommendations to Other Organisations

Recommendations in Support of the Construction Sector

Permitting

Standardisation and compliance with design standards and codes

Improve cost estimates

Recommendations in Support of the Business Environment

Planning and formulating public sector demand

Introduction of banking codes of practice

Improving payment procedures

Develop a contractor organisation

In setting the recommendations, we considered that some intervention was needed in improving the sector and transforming it into a competitive and self-sustaining industry. There is a range of recommendations that governments could take to facilitate and support this and at the same time, there is much that contractors can do to help themselves.

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Documents

1 This is heading One - World Banklnweb90.worldbank.org/ECA/Transport.nsf... · Web viewPromote alternative contracting strategy if EBRD’s intention is to support the local contractors