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Southeast Europe Construction Industry Capacity Building Final Report
Assignment 1: Assessment of Local Construction Industry Capabilities and Needs
European 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 ............................................................................. 21
3.3.1 Construction Companies Interviewed................................................................................ 21
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 ..................... 32
3.4.3 Financial Products for Construction firms, requirements and terms .................................. 35
3.4.4 Constraints in financing construction industry ................................................................... 36
4 Overview of the Construction Sector in Bulgaria .................................................................... 38
4.1 Brief Economic Overview of Bulgaria .................................................................................... 38
4.2 Characteristics of the Construction Industry of Bulgaria ....................................................... 39
4.2.1 Structure:........................................................................................................................... 39
4.2.2 Demand for Construction .................................................................................................. 43
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Southeast Europe Construction Industry Capacity Building Final Report
Assignment 1: Assessment of Local Construction Industry Capabilities and Needs
European Bank for Reconstruction and Development Table of Contents
4.2.3 Industry Capacity .............................................................................................................. 46
4.3 Survey of Local Construction Companies ............................................................................. 46
4.3.1 Construction Companies Interviewed................................................................................ 46
4.3.2 Constraints and Difficulties ................................................................................................ 48
4.3.3 SWOT Analysis ................................................................................................................. 53
4.4 Survey of Local Financial Institutions .................................................................................... 56
4.4.1 Financial Sector Overview and Trends Affecting Construction Financing. ........................ 56
4.4.2 Financial products for construction firms, requirements and terms ................................... 59
4.4.3 Constraints in financing construction industry ................................................................... 61
5 Overview of the Construction Industry in Macedonia ............................................................. 65
5.1 Brief Economic Overview of Macedonia................................................................................ 65
5.2 Characteristics of the Construction Industry of Macedonia ................................................... 66
5.2.1 Structure:........................................................................................................................... 66
5.2.2 Demand for Construction .................................................................................................. 70
5.2.3 Industry Capacity .............................................................................................................. 72
5.3 Survey of Local Construction Companies in Macedonia ....................................................... 72
5.3.1 Construction Companies Interviewed................................................................................ 72
5.3.2 Constraints and Difficulties ................................................................................................ 73
5.3.3 SWOT Analysis ................................................................................................................. 76
5.4 Survey Of Local Financial Institutions In Macedonia: ............................................................ 78
5.4.1 Financial Sector Overview, Trends affecting construction financing ................................. 78
5.4.2 Financial products for construction firms, requirements and terms ................................... 80
5.4.3 Constraints in financing construction industry ................................................................... 81
6 Survey of the construction companies in Romania ................................................................ 82
6.1 Characteristics of the Construction Industry in Romania ...................................................... 82
6.1.1 Structure of the Construction Industry ............................................................................... 82
6.1.2 Demand for Construction .................................................................................................. 86
6.1.3 Industry Capacity .............................................................................................................. 87
6.2 Survey of Local Construction Companies ............................................................................. 88
6.2.1 Construction Companies Interviewed................................................................................ 88
6.2.2 Constraints and Difficulties ................................................................................................ 88
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Southeast Europe Construction Industry Capacity Building Final Report
Assignment 1: Assessment of Local Construction Industry Capabilities and Needs
European Bank for Reconstruction and Development Table of Contents
6.2.3 SWOT Analysis ................................................................................................................. 94
6.3 Survey of Local Financial Institutions .................................................................................... 95
6.3.1 Financial Sector Overview and Trends Affecting Construction Financing. ........................ 95
6.3.2 Financial products for construction firms, requirements and terms ................................. 100
6.3.3 Constraints in financing construction industry ................................................................. 101
7 Overview of the Construction Sector in Yugoslavia ............................................................. 103
7.1 Brief Economic Overview of Yugoslavia.............................................................................. 103
7.2 Characteristics of the Construction Industry in Yugoslavia ................................................. 103
7.2.1 Structure of the Construction Industry ............................................................................. 103
7.2.2 Demand for Construction ................................................................................................ 107
7.2.3 Industry Capacity ............................................................................................................ 108
7.3 Privatisation Plans and Impact on the Construction Industry .............................................. 109
7.3.1 Overview of the Privatisation Process in Serbia .............................................................. 109
7.3.2 Overview of the Privatisation Process in Montenegro ..................................................... 110
7.3.3 Impact of Privatisation on the Construction Sector ......................................................... 111
7.4 Survey of Local Procurement Rules and Their Impact on the IFI’s investments ................. 111
7.5 Survey of Local Construction Companies ........................................................................... 112
7.5.1 Construction Companies Interviewed.............................................................................. 112
7.5.2 Constraints and Difficulties .............................................................................................. 113
7.5.3 SWOT Analysis ............................................................................................................... 117
7.6 Other Companies Interviewed ............................................................................................. 120
7.7 Survey of Business Related Services ................................................................................. 120
7.8 Survey of Local Financial Institutions .................................................................................. 122
7.8.1 Financial Sector Overview and Trends Affecting Construction Financing. ...................... 122
7.8.2 Financial Products for Construction Firms, Requirements and Terms ............................ 129
7.8.3 Constraints in Financing Construction Industry ............................................................... 131
8 Risk Management in Construction in South Eastern Europe ............................................... 135
8.1 The Problems of the Construction Industry ......................................................................... 135
8.2 Risk Allocation and Factors Restricting the use of the Local Industry ................................. 136
8.2.1 Risk Allocation ................................................................................................................. 136
8.2.2 Factors Restricting the Utilisation of Local Industry......................................................... 138
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Southeast Europe Construction Industry Capacity Building Final Report
Assignment 1: Assessment of Local Construction Industry Capabilities and Needs
European Bank for Reconstruction and Development Table of Contents
8.3 Risk Management – What can be done .............................................................................. 139
8.3.1 The Financier’s Perspective in Risk Management .......................................................... 139
8.3.2 The International Constructors’ Perspective ................................................................... 143
8.4 Insurance for Project-Financed Construction Projects in Countries with Undeveloped
Insurance Markets..................................................................................................................... 144
8.5 Optimal Procurement Package ........................................................................................... 147
9 Leasing and Plant Hire Environment ...................................................................................... 149
9.1 Introduction ......................................................................................................................... 149
9.2 Leasing Overview................................................................................................................ 149
9.3 Environment for Leasing ..................................................................................................... 151
9.4 Local Operations of Main Equipment Manufacturers .......................................................... 155
9.5 Local Equipment Rental Practices ...................................................................................... 156
10 Survey of the International Contractors ............................................................................... 159
11 Recommendations ................................................................................................................. 167
11.1 Recommendations to EBRD ............................................................................................. 167
11.1.1 Recommendations in Support of Financial Enhancements ............................................. 167
11.1.2 Recommendations in Support of Procurement Procedures Improvements..................... 175
11.2 Recommendations to EBRD and other IFIs ...................................................................... 176
11.2.1 Recommendations in Support of Procurement Procedures Improvements..................... 176
11.2.2 Recommendations in Support of Training and Advisory Services................................... 181
11.3 Recommendations to other Organisations ........................................................................ 184
11.3.1 Recommendations in Support of the Construction Sector............................................... 184
11.3.2 Recommendations in Support of the Business Environment .......................................... 188
11.4 Conclusions....................................................................................................................... 190
12 ANNEXES
12.1 List of Contractors Interviewed
12.2 List of Banks Interviewed
12.3 List of International Contractors
12.4 List of Other Organisations Interviewed
12.5 Screening Questionnaire
12.6 Detailed Questionnaire
12.7 Financial Questionnaire
12.8 List of Main Equipment Vendors’ Offices in Southeast Europe
12.9 General Information about Main Construction Equipment Manufacturers
12.10 List of Main Rental Companies in Bucharest Romania
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Southeast Europe Construction Industry Capacity Building Final Report
Assignment 1: Assessment of Local Construction Industry Capabilities and Needs
European 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
Romania
and 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;
− 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
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Southeast Europe Construction Industry Capacity Building Final Report
Assignment 1: Assessment of Local Construction Industry Capabilities and Needs
European Bank for Reconstruction and Development Section 1
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.
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.
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Assignment 1: Assessment of Local Construction Industry Capabilities and Needs
European Bank for Reconstruction and Development Section 1
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.
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
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Assignment 1: Assessment of Local Construction Industry Capabilities and Needs
European Bank for Reconstruction and Development Section 1
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 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 Report
Assignment 1: Assessment of Local Construction Industry Capabilities and Needs
European 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 Comments
Achieved
Conduct a survey of local Overview of the The demand analysis
construction firms in Bosnia construction sector in undertaken is not a
and Herzegovina, Bulgaria, each country, comprehensive market survey
Macedonia, Romania and highlighting the but rather a framework to
Yugoslavia to determine structure of the guide us towards areas of
their expertise, overall industry, the demand future growth in the
capacity and difficulties in for construction works construction sector.
competing for IFI’s contracts and the industry’s
on the domestic market. capacity to meet the
We extended the area of our
assessment to issues
demand.
A representative sample of pertaining to execution of
at least 13 firms in each We have identified the projects and not only to the
country will be assessed. constraints and tendering stages.
In Yugoslavia, a difficulties related to
representative sample of at tendering and
least 15 firms should be executing work.
assessed and at least 10 of
these should be private.
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.
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Southeast Europe Construction Industry Capacity Building Final Report
Assignment 1: Assessment of Local Construction Industry Capabilities and Needs
European Bank for Reconstruction and Development SECTION 2
What We Proposed What We Have Comments
Achieved
Conduct a survey of at least Understanding of the The recommendations
12 large and medium-sized main concerns prepared will need further
international construction international assessment in respect of:
firms to determine the contractors have when
factors that influence their prospecting the market − Identifying target groups
use of local subcontractors and potential partnering − Clearly laying out the
and the methods used to arrangements, when principles of programmes
enhance relationships. tendering and and their objectives.
implementing projects Thorough cost-benefit
either as locally based analysis.
companies, or as − Identifying the costs (up-
project based front recruiting staff and
companies. operations).
− Identifying source of
Proposed finance.
recommendations on
− Setting out precise and
what can be adjusted to
measurable goals.
local circumstances
and overview of risk
allocation between
players.
Carry out a survey of local An understanding on how Our recommendations are in line
financial institutions to determine local banks work with with general good banking
the level of support offered to construction companies and practices and are not meant to
local construction firms to assist their capability to meet the represent interventions in a
them in competing for contracts demand for financial competitive market.
in their country. services.
Survey of the financing and
financial products available
in each country.
Determine which financial and Recommended variety of The recommendations will need
other tools that are needed are ways to improve access to further assessment in respect of
not currently offered in the local financial services. clearly determining the objectives
markets. Proposed innovative and desired effects and a cost-
Provide suggestions how EBRD approaches: lending and benefit analysis with consideration
can assist banks to provide other products that EBRD of the sources of funds.
financial products, within the could use to increase
EBRD’s constraints. access to financial services.
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Southeast Europe Construction Industry Capacity Building Final Report
Assignment 1: Assessment of Local Construction Industry Capabilities and Needs
European Bank for Reconstruction and Development SECTION 2
What We Proposed What We Have Comments
Achieved
Survey the local tendering An understanding of We did not undertake a
and contracting regulations the key procurement comprehensive analysis of the
that exist in the region, issues that limit the national procurement rules but
particularly as they impact capacity to access work focused on those issues that
upcoming IFI and other on a competitive basis. were considered to have an
donor-financed investment. impact on bidding for, and in
Proposed policies to
implementing IFI’s projects.
improve access to work
and improvements in Training related
tendering procedures recommendations, though not
that would create a falling under EBRD’s
level field. mandate, are an important
enhancement initiative. Some
of these could be integrated
within actual project to
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 Made an investigation
services available to the of the business support
construction industry such as services offered to
adequacy and availability of plant domestic contractors.
and equipment hire facilities.
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
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Southeast Europe Construction Industry Capacity Building Final Report
Assignment 1: Assessment of Local Construction Industry Capabilities and Needs
European Bank for Reconstruction and Development SECTION 2
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).
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.
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Southeast Europe Construction Industry Capacity Building Final Report
Assignment 1: Assessment of Local Construction Industry Capabilities and Needs
European Bank for Reconstruction and Development SECTION 2
DELIVERABLES WHAT WE ACHIEVED
Inception Phase
Inception meeting at EBRD’s Inception meeting focused on clarifications of the scope of work
headquarters in London and execution plan.
Reviewed project schedule Agreed with EBRD that the objective is not to make an
and work plan together with a assessment of the IFI’s procurement rules but to highlight the main
list of sample firms to be areas of concern related to the national procurement rules,
interviewed in each country. potentially affecting the IFI and other donor financed investment.
All these had been presented
in the Inception Report. The Focused the work on the tendering issues but incorporated key
first Inception Report covered implementation aspects that may affect the access to IFI’s
Bosnia & Herzegovina, projects.
Bulgaria, Macedonia and
Romania. The second Structured the surveys of the local contractors considering that the
inception report covered main focus of EBRD is in infrastructure projects.
Mobilisation of local consultants.
Yugoslavia (Serbia and
Montenegro) and responded
to the requirements set in the
project extension.
Task 1.1 – Establish Background and Focus of Work
Establish focus of work in Establish focus of work in the light of the Stability Pact and
terms of key areas of the EBRD’s pipeline of infrastructure projects. In selecting the
construction industry to construction activities, we also considered the development
target relevant industry needs of each country as viewed by various players in the
players who can construction industry and government organisations.
participate having
satisfied some basic Updated the preliminary list of construction companies to be
criteria. screened in order to ensure that we captured a representative
sample of construction companies from a technical and
Establish a wide list of financial standpoint as well as size.
companies with the
potential and the interest Identified companies active in other segments of the
to respond to our survey 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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Southeast Europe Construction Industry Capacity Building Final Report
Assignment 1: Assessment of Local Construction Industry Capabilities and Needs
European Bank for Reconstruction and Development SECTION 2
DELIVERABLES WHAT WE ACHIEVED
Task 1.2 – Initial Survey
Questionnaires applicable Prepared a screening questionnaire (see Annex 12.5)
to construction addressed to construction companies. This was translated in
companies and materials all local languages.
and equipment suppliers,
banks and other Prepared a detailed questionnaire in English (see Annexe
organisations. These will 12.6) addressed to construction companies.
be prepared in both
English and the local Prepared a questionnaire in English addressed to local banks
language. (see Annexe 12.7). This was translated in all local
languages.
Dissemination of
questionnaires and data Sent the screening questionnaire to local contractors
collection. interviews and reviewed their responses. Based on these
responses, our understanding of the local construction
Review findings. industry and the nature of foreseeable construction works
needed in each country, we selected at least 12 companies in
Selection of a minimum of each country to be interviewed and 15 in Yugoslavia. The list
13 construction of construction companies interviewed is presented in Annex
companies and 15 in 12.1.
Yugoslavia to be later
interviewed by the project Selected the local banks to be interviewed via consultation
core teams. with EBRD (a list and summary of discussion presented in
Annexe 12.2).
Prepare a list of local
banks and financial Selected some insurance companies in each country (a list is
institutions that supported presented in Annexe 12.4).
local firms in bidding and
to be later interviewed. Made first visits to each country and held interviews with local
contractors and various organisations.
Local construction
industry capacity Reviewed findings of the survey based on the responses from
overview. the detailed questionnaires and interviews.
Assessment of the local Developed industry overviews in each country emphasising
procurement rules. 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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Southeast Europe Construction Industry Capacity Building Final Report
Assignment 1: Assessment of Local Construction Industry Capabilities and Needs
European Bank for Reconstruction and Development SECTION 2
Task 1.3 – Focus Groups
Comprehensive Revisited the countries and met with other contractors, material
understanding of the issues suppliers, design institutes, insurance companies, local banks and
infringing the ability of local various financial programmes sponsored by IFI’s. The summary
contractors to enter into of these surveys as well as an analyses of the findings are
international contracts. presented in sections 4.4, 5.4, 6.3 and 7.4.
A SWOT analysis of the Made the first contact with international contractors active in each
construction industry in each country
country.
Task 1.4 – Enhanced Assessment
Recommendations and Continued discussions with the international contractors.
solutions. Their views are captured in Section 10. The list of these
interviews is presented in section 12.3.
Comprehensive overview
of the sector and its Prepared sets of recommendations (see Section 8) in support
problems, including a of:
SWOT analysis and
review of the local − procurement procedures improvements ;
procurement rules and − construction industry;
their compatibility with − business environnement ;
international procurement
− training and advisory service;
rules.
Draft Final Report. − 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.
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
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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.
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.
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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 Governance
Bosnia 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 Herzegovina
The 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 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.
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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.
3.2 Characteristics of the Construction Industry in Bosnia and
Herzegovina
3.2.1 Structure of the Construction Industry
The 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.
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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 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.
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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.
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)
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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 was the very first case of large-scale privatisation with strategic
foreign investor
Equipment 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 Construction
Over 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.
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The newly elected government has been facing even more demanding challenges
to attract foreign investments after such a failure.
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 Capacity
The 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 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
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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;
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 Difficulties
Business Environment Related
Procuring work on a steady basis with possibilities to plan for the future
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Bosnian 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 authorities
Some of the construction companies have mentioned that a serious administrative
burden with implications on completion 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 labour
Generally 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
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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 materials
Basic 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 equipment
Much 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 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 leasing
There 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.
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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 services
Contractors generally complain about the limited external training and the absence
of active professional organisations. At 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.
Insurance
There 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.
Taxes
There 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
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consequences on the level of permanent staff they can maintain, and the higher
level of costs reflected in the price.
Permitting
Permitting 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 investments
The 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 information
Access 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, legal
With 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).
Employer Related
Tendering requirements
The 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
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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 payments
This 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 documentation
A 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 Estimate
Cost 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 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 equipment
Though 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 compliance
Although 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
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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 Skills
The 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.
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;
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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.
3.3.3 SWOT Analysis
IMPLICATIONS ON THE CAPACITY TO
STENGHTHS ACCESS AND EXECUTE PROJECTS
FINANCED BY EBRD
Experienced and committed staff, willing Positive in terms of time limits observance and
to make an extra effort to complete work. quality of executed works.
Reputation and significant previous Facilitate fulfilment of qualification criteria.
record.
Previous experience on international Familiarity with international performance
markets. standards.
Willing to introduce modern management Increased capacity for performance and schedule
approaches and to improve company compliance.
operations.
IMPLICATIONS ON THE CAPACITY TO
WEAKNESSESS 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 Reduced possibilities to compete for more
and medium contractors, most are complex projects.
building and civil works contractors.
Lack of management and planning skills Can affect the project execution with direct
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IMPLICATIONS ON THE CAPACITY TO
WEAKNESSESS ACCESS AND EXECUTE PROJECTS
FINANCED BY EBRD
combined with control tools especially for implication on budget and project completion.
larger and more complex project.
Insufficient structured QA / QC (quality Cannot meet the qualification criteria.
assurance / quality control).
Lack of knowledge and/or experience Problems can occur especially with contract
with contractual terms. variations, risk allocation and rights and
obligations affecting thus schedule and budget.
Unfamiliarity with new and sophisticated Potential scarcity of skills for more complex
equipment. projects.
Capacity to retain staff, especially by Cannot meet the qualification criteria.
smaller contractors.
Lack of safety procedures and qualified Can diminish the chances to qualify especially
staff to implement and monitor. when JV or subcontracting arrangement with
foreign partner.
Limited technical understanding of new Constraining factor for the more ambitious
technologies or complex drawings companies.
among smaller contractors.
Inadequate estimating procedures Risk of offering “about right” estimates with the
serious risk of underestimating the costs.
Managers do not pay too much attention No direct implication but affecting general
to the broader external circumstances business climate improvements and development.
and their focus is not on improving the
external environment.
Low use of IT, internet and e-mail No direct implications but effecting overall
service. 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 No direct implication but can effect the overall
and managerial). sustainability.
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IMPLICATIONS ON THE CAPACITY TO
OPPORTUNITIES ACCESS AND EXECUTE PROJECTS
FINANCED BY EBRD
Consolidation among the small end of Better-qualified companies with potential to
the industry. approach more complex projects.
Increased bargaining power in acquiring materials
at better prices and hence more advantageous
project budgets.
Cooperation with foreign companies in No direct implication but possibilities for overall
B&H market. sector to prolong the cooperation with
international companies abroad and enter new
markets.
IMPLICATIONS ON THE CAPACITY TO
THREATS ACCESS AND EXECUTE PROJECTS
FINANCED BY EBRD
Lack of young skilled and trained work No direct and immediate implication, but a
force. 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.
Limited capacity to commit to more or larger
project.
Bank procedures to obtain credit or Can add extra cost to be reflected in the offer
guarantees are long and cumbersome. price.
No active professional organisations. None directly, but much lower standards exist in
the industry.
Lack of overall economic strategy and None directly, but companies are not capable of
hence difficulty to plan and expand. 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.
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IMPLICATIONS ON THE CAPACITY TO
THREATS ACCESS AND EXECUTE PROJECTS
FINANCED BY EBRD
Lack of coordination and transparency Project do not materialise and hence companies
on taxes and decision making process at do not acquire enough experience to be able to
municipal, cantonal and federative level. qualify and to expand their business.
Low barriers to entry in terms of Too many small companies operate and therefore
qualifications and requirements. 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 Maintain low standards in the industry overall and
quality standards still to be coordinated can distort competition through unreasonably low
with the EU ones. 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 Threat to sector’s sustainability.
force.
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.
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3.4.2 Financial Institutions Interviewed and their Construction
Industry Business
For 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 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.
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The table shows the responses from each bank on its construction business:
BOSNIA
% Portfolio % of Construction Portfolio Mortgage
Name of
Organisation 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% Yes
Kristal 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 Yes
Turkish Ziraat
Bank very little N/A N/A N/A N/A Mostly N/A N/A N/A Some
Micro
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/A
USAID
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 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.
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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.
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.
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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:
FINANCIAL PRODUCT TERMS
NAME OF ORGANISATION Guaranty Fee, Max No Required
Interest Rate ST Interest Rate LT
Qtrly of Years %Collateral
Raiffeisen Bank N/A 13-16% 9.5-11% 3-5 N/A
Kristal Bank 0.3-1% 15-17% 12% N/A N/A
Zagrebacka Banka N/A N/A N/A N/A N/A
Turkish Ziraat Bank 1% 12% + 1% 12% + 1% 3 200%
Micro enterprise Bank 1% 12% 12%, + 2% 5 Varies
UPI 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
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.
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3.4.4 Constraints in financing construction industry
Problems 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 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.
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.
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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 Bulgarian contractors
compare against international project size benchmarks.
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PROJECT SIZE (TIC IN US DOLLARS) SIZE OF PROJECTS UNDERTAKEN BY CONTRACTORS
SME Contractors
Very Small: Under 1M
Large Contractors
Small: 1M - 10M
International Contractors
Medium: 10M to 50M
Large: 50M - 200M
Super: 200M - 600M
Mega: Over 600M
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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SECTOR CONTRACTORS CAPACITY PER SECTOR
International Contractors
Repair and Maintenance of Process Large Contractors
Related Plants and Facilities
SME Contractors
Repair and Maintenance of Non-
Process Related Plants and
Facilities
Greenfield Construction of Non-
Process Related Plants and
Facilities
Greenfield Construction of Process
Related Plants and Facilities
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 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.
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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.
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.
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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.
4.2.2 Demand for Construction
Food 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
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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 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.
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Roads
Bulgaria is an important transit country on the route from the Middle East to
Europe. There are a number of pan-European 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 Capacity
Due 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 Interviewed
With the assistance of the construction industry national newspaper “Stroitelstvo
Gradt” and the construction industry 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.
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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 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;
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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.
4.3.2 Constraints and Difficulties
Business Environment Related
Unsteady Demand for Construction Work
The 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 issues
Due 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, 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 materials
The 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
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delays the contractor's ability to finish the job on time and start the next job as
scheduled.
Access to hired plant and equipment
The 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 leasing
Leasing 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 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 services
Due 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
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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 security
Site thefts happen but not to an unexpected level. Site security costs and
insurances policies against theft are expensive.
Procurement Related
Survey of local procurement rules and their impact on the IFI’s investments
A 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 municipal markets. Many SMEs contractors cannot afford to tie up
capital in such tenders and they are virtually removed from the market.
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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 information
There 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 standards
We 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.
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 requirements
The 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
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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 payments
The 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 planning
It 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.
Compliance with ISO 9000
A 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 estimates
Cost 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
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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 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 Reduce risk of delays due to unforeseen local
and can cope better with local problems that problems.
can cause delay and overruns.
Local contractors experience in international Familiarity with international performance
contracts in Russia, Germany, Israel. standards.
Local contractors are robust against No conflicts with Government requirements to
competition from well resourced and low cost provide employment to local people.
contractors (e.g. from Turkey).
New private SME contractors with Western Increase the participation of local firms in
partners have emerged over the last four international contract as prime contractors.
years that have the financial and technical
capacity to undertake quality work.
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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 Limited participation of local contractors in
resources to fund the business development international tenders. Competition restricted to only
work and lack sufficient knowledge of the international contractors.
bidding process and international
procurement rules.
Local SME contractors have limited ability to Limited participation of local contractors in
work in international languages (e.g. international tenders. Competition restricted to only
English). international contractors.
Local SME contractors have enough Local SME cannot bid for bigger projects.
resources to handle small and simple Competition restricted to only international
projects. contractors.
Local SME contractors cannot expand raising Limited participation of local contractors in
finance due to lack of proven track record international tenders. Competition restricted to only
and borrowing history and lack a stable international contractors.
workload.
Local SME contractors are under invested in Limited participation of local contractors in
systems and computer software. international tenders. Competition restricted to only
international contractors.
Local SME contractors do not have proper Limited opportunities to works as subcontractors to
quality assurance and quality control systems international firms implementing IFI’s projects.
in place.
Local SME contractors cannot undertake Limited participation of local contractors in
more complex projects for technology international tenders. Competition restricted to only
upgrade of industrial facilities. international contractors.
Local SME contractors have poor site Poor project execution that leads to delays and
management and contract planning. overruns.
Local SME contractors have no sufficient Poor project execution that leads to delays and
personnel dedicated to detailed cost overruns.
estimating.
Only few SME contractors use IT, internet No access to procurement opportunities.
and e-mail service.
Only few SME contractors pursue Limited opportunity to become more competitive.
international work.
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OPPORTUNITIES IMPLICATIONS ON THE CAPACITY TO
ACCESS AND EXECUTE PROJECTS
FINANCED BY IFI’s
An increase in Government spending on Opportunities for local SME contractors to grow
infrastructure leading to more stable and handle projects financed by IFI’s.
workload for local SME contractors.
An increase in cooperation with international Enhancing the capacity of the local SME
firms working on larger projects. 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 Limit the opportunities of local contractors to bid.
local banks at high costs and also require Increase the cost of local contractors’ services.
cash collateral of over 125% of the value of
the guarantee, i.e. funds blocked.
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 Unfair competition and the law in disrespect.
work undertaken in the hidden economy.
National professional standards and quality Maintain low standards in the industry overall and
standards still to be coordinated with the EU. can distort competition through unreasonably low
prices and completion and quality risks.
Lack of training, research and development Threat to present and future operations.
funds.
Skilled workers leaving the country for Threat to sector’s sustainability.
overseas assignments with international
construction companies.
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4.4 Survey of Local Financial Institutions
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 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;
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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 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
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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.
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.
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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
terms
All 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 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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Guaranty Interest Interest Max Required %
Name of Organisation
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% 2½ N/A
First 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 0
Bulgaria 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
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.
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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 industry
Again 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.
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.
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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 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
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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 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.
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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 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 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
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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 Macedonia
5.2.1 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 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
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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 SME Contractors Large Contractors
(TIC in US$) % of revenues % of revenues
Very Small Projects: 100% 70%
Under $1 million
Small Projects: No 25%
$1 million to $10 million
Medium Projects: No 5%
$10 million to $50 million
Large Projects: No No
$50 million to $200 million
Super Projects: No No
$200 million to $600 million
Mega Projects: No No
Over $600 million
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 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.
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Sector SME Contractors Large Contractors
% of revenues % of revenues
Greenfield construction of process No No
related plants and facilities:
Greenfield construction of non- 25% 50%
process related plant and facilities:
Repair and maintenance of process No 10%
related plants and facilities
Repair and maintenance of non- 75% 40%
process related plant and facilities
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, 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
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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
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
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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 Construction
Food Processing Industries
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 too large in size for the local
contractors, local contractors can join with major international contractors
providing specialist services and labour.
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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, 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
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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 Capacity
Due 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.
5.3 Survey of Local Construction Companies in Macedonia
5.3.1 Construction Companies Interviewed
Due 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;
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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;
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.
5.3.2 Constraints and Difficulties
Business Environment Related
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Unsteady Demand for Contraction Work
The 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.
Delays and uncertainties with respect to supplies of materials
The 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 equipment
The 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 leasing
Leasing is at an early stage of development in Macedonia and is virtually not
available for SME contractors.
Availability of supporting services
There 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 investments
A 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.
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Access to information
The 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 financed by international donor
organisations and IFI’s. SME contractors are not aware of these either.
Capacity to Comply with international requirements and standards
The 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 payments
The 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
claims
SME 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 9000
Two 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 contractors
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 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
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least in half, and 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
IMPLICATIONS ON THE CAPACITY TO
STENGHTHS 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 Reduce risk of delays due to unforeseen local
can cope better with local problems that can cause problems.
delay and overruns.
Large local contractors have experience in Familiarity with regional legislation, standards,
international contracts in Albania, Bulgaria and suppliers and subcontractors.
Yugoslavia.
Local contractors are robust against competition No conflicts with Government requirements to
from well resourced and low cost contractors (e.g. provide employment to local people.
from Turkey)
IMPLICATIONS ON THE CAPACITY TO
WEAKNESSESS ACCESS AND EXECUTE PROJECTS
FINANCED BY IFI’s
Local SME contractors do not have adequate Limited participation of local contractors in
resources to fund the business development work international tenders. Competition restricted to
and lack sufficient knowledge of the bidding process only international contractors.
and international procurement rules.
Local SME contractors have limited ability to work in Limited participation of local contractors in
international languages (e.g. English). international tenders. Competition restricted to
only international contractors.
Local SME contractors cannot expand raising Limited participation of local contractors in
finance due to lack of proven track record and international tenders. Competition restricted to
borrowing history and lack a stable workload. only international contractors.
Local SME contractors are under invested in Limited participation of local contractors in
systems and computer scheduling and cost control international tenders. Competition restricted to
software. only international contractors.
Local SME contractors do not have proper quality Limited opportunities to works as
assurance and quality control systems in place. subcontractors to international firms
implementing IFI’s projects.
Local SME contractors cannot undertake more Limited participation of local contractors in
complex projects for technology upgrade of industrial international tenders. Competition restricted to
facilities. only international contractors.
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IMPLICATIONS ON THE CAPACITY TO
WEAKNESSESS ACCESS AND EXECUTE PROJECTS
FINANCED BY IFI’s
Only few SME contractors use of IT, internet and e- No access to procurement opportunities.
mail service.
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 Can cause significant project delays and
spare parts. increase completion risk.
IMPLICATIONS ON THE CAPACITY TO
OPPORTUNITIES ACCESS AND EXECUTE PROJECTS
FINANCED BY IFI’s
An increase in Government spending on Opportunities for local SME contractors to
infrastructure leading to more stable workload for grow and handle projects financed by IFI’s.
local SME contractors.
An increase in cooperation with international firms Enhancing the capacity of the local SME
working on larger projects. contractors makes them more competitive in
international tenders.
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IMPLICATIONS ON THE CAPACITY
THREATS 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 Limit the opportunities of local
banks at high costs and also require cash collateral contractors to bid. Increase the cost of
of over 200% of the value of the guarantee, i.e. local contractors’ services.
funds blocked.
The growth of the proportion of construction work Unfair competition and law reliability.
undertaken in the hidden economy
National professional standards and quality Maintain low standards in the industry
standards still to be coordinated with the EU 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 Threat to sector’s sustainability
assignments with international construction
companies
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.
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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 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.
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5.4.2 Financial products for construction firms, requirements and
terms
Both 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. 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
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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 industry
The difficulty for construction SMEs getting financing is a continuing problem.
The contractors claim that all the financing 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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6 Survey of the construction companies in Romania
6.1 Characteristics of the Construction Industry in Romania
6.1.1 Structure of the Construction Industry
Historically, 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
Large Contractors
Generally 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
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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 Contractors
These can be classified according to the Romanian legislation (similar to the EU
classification) into medium companies employing up to 250 permanent
employees, and small 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 Pitesti
The 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;
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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.
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
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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 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 profitable
The 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 efficiently
Consulting 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;
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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.
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 Construction
There 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 Capacity
According 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 Total Annual Turnover by
Companies 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. 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.
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6.2 Survey of Local Construction Companies
6.2.1 Construction Companies Interviewed
We 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.
6.2.2 Constraints and Difficulties
Business Environment Related
Access to hired plant and equipment
There 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 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.
Insurance
Insurance 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
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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 Strategies
The 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. 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.
Permitting
The 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
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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.
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 Criteria
Like 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 Tenders
The 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.
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Definition of Scope
The 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.
Payments
Delayed 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.
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 Projects
Most 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 Responsibilities
Some 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.
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Contractor Related
Unfamiliarity with the legal aspects of contract work, contract law, preparation of
claims against contract variations
Lack 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 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 performance
Partly 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 9000
Very 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 skills
General 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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Staffing
Generally 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.
Training
There 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 procedures
Romanian 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 requirements
According 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
IMPLICATIONS ON THE CAPACITY TO
STENGHTHS ACCESS AND EXECUTE PROJECTS
FINANCED BY EBRD
A few large contractors with extensive Share the responsibilities and therefore be
experience that could be JV partners for able to become involved in larger and complex
international contractors. projects. Know-how transfer.
Emergent private middle size construction Become exposed as subcontractors to large
companies run by ambitious management and infrastructure projects.
more commercially driven.
Emergent private middle size specialised Become exposed as specialised
construction companies introducing new subcontractors in complex projects and
technologies. 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 Can affect the project execution for large and
combined with insufficient IT systems. complex projects with direct implication on
budget and project completion.
Lack of knowledge and / or understating of Problems can occur with contract variations, risk
contractual terms. allocation and rights and obligations affecting
schedule and budget.
Not enough large and complex projects, too Skills and experience are dispersed and
many small projects. companies cannot qualify because they cannot
offer the range and depth of skills required by
the EBRD projects.
Insufficient managerial, financial and economic Auto limitation on performance and increased
skills, too much emphasis on the physical efficiency improvements.
execution of works with limited feedback into the
system on performance.
Limited understanding of new technologies or Constraining factor for the more ambitious
complex drawing among smaller contractors. companies.
Limited understanding of legal aspects of FIDIC Limited capacity to understand risk and
contracting. Limited training available. therefore limited capacity to quantify and price it.
Training when available and education systems No direct implication but affecting the
still favouring technical aspects and less professional standards in comparison with
emphasis on the economics of the sector. 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 Companies will become familiar and will be in a
legislation in line with the EU legislation. position to be better prepared for international
tenders.
Create legislation for design and consulting None directly, but responsibilities and roles are
services in construction. unclear and can create confusion and conflict of
interest.
Introduce rating and ranking in the industry and None directly, but will increase the level of
incentives for good performance to be professional standards in the industry and
considered in the price. create sound competition.
THREATS IMPLICATIONS ON THE CAPACITY TO
ACCESS AND EXECUTE PROJECTS
FINANCED BY EBRD
Penalising qualification criteria even for large Reduced number of qualifying bidders.
contracts related to similar experience (nature
and size of projects).
Lack of disciple in applying contractual terms Increased schedule, quality and price
and general lax attitude towards compliance on performance risks.
the contractors’ side as well as on the clients’.
Limited capacity to modernise equipment fleets. Cannot comply with tender requirements and
cannot execute work efficiently.
Divert funds from IFI’s projects towards other Incapacity to continue work and divert staff to
project. other projects with implication on schedule
performance.
6.3 Survey of Local Financial Institutions
6.3.1 Financial Sector Overview and Trends Affecting Construction
Financing.
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 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.
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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 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
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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.
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
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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
policies. For example, Generali tried to provide an insurance for a client’s credit
guarantee but was not accepted even by EBRD
Loan 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.
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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.
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.
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Financial Leasing Operational Direct Hire
Leasing
Fiscal Regime Deductible in line with Deductible Deductible
the depreciation
allowed; interest
deductible for the
level comparable with
average bank interest
rates.
VAT 19% on the capital 19% on the rental 19% on the rental
payment, interest payment. payment.
payment is VAT
deductible.
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.
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
terms
The 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
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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% 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 industry
We 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
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It is important to continue searching for an appropriate leasing vehicle for EBRD
to support, and to explore possible ways to 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 Industry
Contractors
Serbia
According to Yugoslav Clearing and Payment House data, pursuant to the semi-
annual statement of accounts for year 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
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Field of Activity Socially Owned Private
Total Numbers of Companies Total % Total %
Number Number
Construction 2,782 418 15% 2,364 85%
Companies
Building 961 159 15% 802 83%
contractors
Roads, railway, 349 73 21% 276 79%
tunnels
contractors
Installations 1,472 186 13% 1,286 87%
Project 1,787 170 10% 1,617 90%
Engineering
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.
Montenegro
Most 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
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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 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.
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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.
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.
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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 Construction
The 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:
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.
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Activities relating to public infrastructure construction in Montenegro are
controlled by the newly established Directorate for Public Works.
7.2.3 Industry Capacity
The 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 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;
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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.
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 Serbia
The 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 important to mention that this stage of privatisation
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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 Montenegro
The 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;
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.
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7.3.3 Impact of Privatisation on the Construction Sector
Considering 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 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.
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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 Interviewed
During 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.
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%;
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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;
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.
7.5.2 Constraints and Difficulties
Business Environment Related
Shortages of skilled labour
Like 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.
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Delays and uncertainties with respect to supplies and price of materials
The 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 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 equipment
The 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 future
Most 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 Services
The 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 Information
Though 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 Process
Most 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 implementation
There 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.
Payments
Delayed 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 clients
Unreliability 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 Plans
In 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.
Insufficient Documentation
This 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 techniques
Poor 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
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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-keeping
This 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 9000
Six 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 systems
Lack 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
Liquidity
The 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.
Social and tax burdens and employment conditions
The 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 Serbia
The lack of hard currency pushed contractors into purchasing low quality
materials from abroad.
Banking Procedures and Operations
Some Yugoslavian banks do not have relationships with international banks. The
lack of corresponding banks makes payments abroad a difficult task. Also, the
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guarantees issues by local banks are not recognised abroad or by international
clients active in Yugoslavia.
Guarantees
Almost 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.
7.5.3 SWOT Analysis
IMPLICATIONS ON THE CAPACITY TO
STENGHTHS ACCESS AND EXECUTE PROJECTS
FINANCED BY EBRD
Previous experience on international Familiarity with international performance
markets. standards.
Some familiarity with a wider range of Greater chances to approach a more complex risk
contracting structures including lump allocation structure, especially the large structure
sum turnkey projects. 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 Potential to spread international quality standards
consulting services related to ISO 9000, and meet EBRD’s and international partners’
though too expensive at present for requirements.
SMEs.
Low labour cost for qualified and skilled Potentially a better offer price, though the
staff. advantage can be offset by low productivity.
IMPLICATIONS ON THE CAPACITY TO
WEAKNESSES 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 Cannot fulfil the bidding requirements.
collateral) in providing guarantees over
the last 10 years.
Small and medium contractors in Reduced possibilities to compete for more
Montenegro lack specialisation (most are complex projects.
building and civil works contractors).
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IMPLICATIONS ON THE CAPACITY TO
WEAKNESSES ACCESS AND EXECUTE PROJECTS
FINANCED BY EBRD
Lack of management and planning skills Can affect the project execution with direct
combined with limited control tools, implication on budget and project completion.
especially for larger and more complex
projects.
Serious limitation in fulfilling the usual Limit the number of potential candidates for IFIs
qualification criteria: past experience, tenders and execution and completion risks.
structure of workforce, equipment and
financial positions.
Lack of knowledge and/or experience Problems can occur especially with contract
with contractual terms. variations, risk allocation and rights and
obligations, thus affecting thus schedule and
budget.
Unfamiliarity with new and sophisticated Potential scarcity of skills for more complex
equipment. projects.
Insufficient skilled workers in Montenegro Cannot meet qualification criteria and execution
and reliance on foreign workforce. and completion risks.
Limited number of quantity surveyors. Can diminish the quality and efficiency of project
supervision.
Lack of safety procedures and qualified Can diminish the chances to qualify, for JV or
staff to implement and monitor them. subcontracting with foreign partner.
Weak technical understanding of new Constraining factor for the more ambitious
technologies or complex drawings companies. Less efficient projects due to the use
among smaller contractors. of old and less performing technologies.
Estimating techniques based on bill of Risk of offering “about right” estimates with the
quantities, with no clear identification of serious risk of underestimating the costs.
indirect and other costs. Problem
exacerbated by the dominance of lowest
price selection criteria.
Unreliable or low quality of materials on Can affect the project execution and quality.
the domestic market.
Limited use of IT, internet and e-mail Effects overall business effectiveness.
service as well as information systems
(accounting and project management).
Weakness of the insurance sector: Very limited capacity to obtain adequate
limited availability of policies, no insurance polices at affordable prices.
international recognition and
uncompetitive pricing.
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IMPLICATIONS ON THE CAPACITY TO
WEAKNESSES ACCESS AND EXECUTE PROJECTS
FINANCED BY EBRD
Limited vocational and craftsman Skilled staff shortages.
training.
IMPLICATIONS ON THE CAPACITY TO
OPPORTUNITIES ACCESS AND EXECUTE PROJECTS
FINANCED BY EBRD
Potential consolidation among the small Better-qualified companies with potential to
and medium sized contractors. 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 Technology transfer and penetration of new
the domestic market. project management techniques.
Harmonise the tendering and Impose from the outset an adequate framework
procurement rules with the international and learn from EBRD’s experience over the last
rules. ten years in the neighbouring countries.
IMPLICATIONS ON THE CAPACITY TO
THREATS ACCESS AND EXECUTE PROJECTS
FINANCED BY EBRD
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 Cannot meet guarantees requirements, risk of
adequate financing, together with stopping the work because of lack of financial
obsolete and inefficient credit resources.
assessment procedures.
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.
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IMPLICATIONS ON THE CAPACITY TO
THREATS ACCESS AND EXECUTE PROJECTS
FINANCED BY EBRD
Low barriers to entry in terms of Too many small companies operate and therefore
qualifications and requirements. 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 Maintain low standards in the industry overall and
quality standards still to be coordinated can distort competition through unreasonably low
with the EU. prices and completion and quality risks.
Cross shareholding structure is a Cross ownership between design and
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
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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;
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.
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.
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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.
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
7.8.1 Financial Sector Overview and Trends Affecting Construction
Financing.
The two constituent republics of the Federal Republic Yugoslavia, Serbia and
Montenegro, have different financial sectors. Serbia is just emerging from the
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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 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,
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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
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.
Banks
The 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.
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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 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 has many of the same problems as the other old banks plus
significant foreign debt, which it cannot service.
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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 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.
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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 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%.
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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.
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
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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.
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
Terms
All 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.
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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.
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 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
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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 loans
The situation is also a bit better in Montenegro because of the active rental market
among the companies and with owner/operators.
7.8.3 Constraints in Financing Construction Industry
There 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.
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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 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
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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 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;
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.
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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 Allocation
Early 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.
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;
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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;
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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Risk Allocation and Contracting Strategies
COMPLETION RISK
COMPLETION RISK
TRADITIONAL
TRADITIONAL LUMP SUM TURNKEY
LUMP SUM TURNKEY
APPROACH
APPROACH APPROACH
APPROACH
Alternative
Approach
RISKS:
RISKS:
RISK MITIGATION:
RISK MITIGATION: LOCAL
LOCAL •PRICE
•PRICE
2-5% OF TOTAL
2-5% OF TOTAL CONSULTANT
CONSULTANT
INSTALLED COSTS CONTRACTOR
CONTRACTOR •MANAGEMENT
•MANAGEMENT
INSTALLED COSTS •COMPLETION
•COMPLETION
WESTERN
WESTERN
CONTRACTOR
CONTRACTOR
BILL OF
BILL OF
QUANTITIES
QUANTITIES UNIT
UNIT
PRICE
PRICE
Disadvantage of the alternative approach
to lump sum contracts:
limited know-how transfer to local contractor
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 Industry
Contractors 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;
Maintain Quality;
Build to Estimate.
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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.
8.3 Risk Management – What can be done
8.3.1 The Financier’s Perspective in Risk Management
The 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
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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 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;
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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 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
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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: 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.;
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In Kazakhstan, a few foreign contractors were encouraged to establish there.
They did become successful. However, policy 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’ Perspective
International 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:
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
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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;
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
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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;
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.
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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.
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;
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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
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
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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.
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 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
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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:
Assets frequently used Assets required
occasionally
(such as back-hoe shovellers
(JCB’s) or fork lift trucks) (such as large mobile
cranes, specialist tools)
Large Construction Lease or outright ownership. Plant Hire usually with
Companies operator, except for specialist
tools
Small Construction May lease, but will often Plant Plant Hire usually with
Companies Hire usually without operator 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 Specific leasing law, including a clear Conventional banking laws may not
Environment definition of the three party structure fully recognise the rights of the lessor.
and their obligations.
Law should protect leased assets The basis of the transaction is that they
from being claimed by other creditors remain the property of the lessor.
should a lessee become insolvent.
The right of the lessor to repossess The assets are the security for the
the assets should be defined and the financing and the lessor must have
mechanisms exist in law to implement both the right to repossession and
this right of repossession. legal system must be able to efficiently
permit this.
The recognition of cross-border All the countries in the region are
leasing arrangements. 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 Banking laws, particularly on Leasing companies are different from
Environment minimum capital ratios can inhibit the banks and do not take term deposits.
development of leasing companies. The laws to protect depositors can
become a hindrance to leasing
companies.
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Issue Details Commentary
Leasing companies generally need However, any financing by EBRD may
minimal direct regulation, particularly include covenants to encourage
in the early stages of developing the prudent management, such as:
industry. 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 Intra-regional movement - All of the
limit or prohibit the options for a countries are relatively small. There
leasing company with regard to the would be considerable advantages in
importation and leasing of second being able to move equipment easily
hand equipment. Total prohibition is across borders to meet demand.
undesirable. 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
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Issue Details Commentary
inspection by independent inspectors.
If this is not done, double-invoicing
scams can be used to facilitate capital
flight.
Insurance laws and markets should Some countries have laws requiring all
permit efficient and adequate insurance to be channelled through
coverage of the asset. 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 Small companies, particularly in their
tax efficiency. The tax system needs early years, often do not have the
to be designed to ensure that there is profits to fully utilise the depreciation
no discrimination when compared tax allowances. The leasing company
with other forms of finance. 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.
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Issue Details Commentary
Indirect taxes, such as Sale Tax and There can be effects here, since the
VAT should not discriminate against lease payment would usually attract
leases. 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
defined by International Accounting liability is shown on the lessee’s
Standards (IAS) requires that leases balance sheet in this way. Otherwise,
are accounted for as a form of off- the long-term liability would not be
balance sheet financing and should visible.
be shown in the lessees books as an
asset that is depreciated. This is IAS provides different treatment for
different from the tax treatment, Operating and Financial leases to
where the asset is depreciated on the reflect the differences in risk allocation.
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.
Business The profile (age and type) of the In the aftermath of the problems in the
Environment in existing fleet of construction region, there was a significant amount
the Construction equipment is important in determining of aid financed construction activity.
Industry if the size of any potential leasing This may have led to an over supply of
business in this sector will be viable. 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.
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Issue Details Commentary
The demand for construction in the A growing demand for construction
country. 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 The rental is the key element in its
clients, competitive and economically attractiveness but other factors have
variable to attract new clients, but an import impact too: the lease term,
also provide sufficient return on type of rents(fixed or variable); residual
investment. options; non-standard payment profile
or early termination option.
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.
vehiclestypes As suchmultinational, they do not require financial support
facilities.
When assessing a new market, these companiescompanies 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:
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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
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
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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.
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 Formatted: Bullets and Numbering
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 companies
The 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 Formatted: Bullets and Numbering
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 Formatted: Bullets and Numbering
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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
I.T.S.C. 94 Srl, active since 1994, US$260,000
SUT PREST SRL, active since 1994, US$110,000
A 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
Observations
The 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 projects
In 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 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.
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Solutions
Providing 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
Observations
Structured 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.
Solution
IFI’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
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
Observations
In 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
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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.
Solution
One possible recommendation is to develop workshops to educate and assist the
local industry in understanding and complying with tender documentation.
Standardisation
Observation
Most 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.
Solution
Professional bodies can be united under a regional programme and directed
to develop such standards. The 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
Observation
Prior 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.
Solution
Training and maintaining contract personnel is an important consideration for
companies intent on competing in regional development. Often new forms of
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contracts are being implemented that require a completely new sensitivity to
standard and specification compliance.
Cost Estimation
Observation
Often 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 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.
Solution
Workshops 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
Observation
Project 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
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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.
Solution
It 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
Observation
A 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.
Solution
Programmes 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
Observation
Contracts 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.
Solution
Local 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
Observation
Risk allocation is a misunderstood aspect of contracting. Because it is
misunderstood it is often ignored or not adequately defined and priced, which in
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turn leads to significant execution problems. The time to define risk allocation is
prior to contract award, not when the contract is operational.
Solutions
Who 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 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
Observation
Standards 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.
Solution
An 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)
Observation
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 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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Solution
Local 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
Observation
The 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.
Solution
The 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)
Observation
Overall, 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.
Solution
Providing 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
Observations
Schedule, 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
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items could lead to a disastrous project, harmful either to the local or the
international contractors.
Solution
Training 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.
11.1 Recommendations to EBRD
11.1.1 Recommendations in Support of Financial Enhancements
Equipment Finance
General Aim
To 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.
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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 firms
This 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
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 1
The 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.
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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 2
Local leasing companies are to and to the local market interested in updating their
equipment fleet but One proposed solution to this situation is to provideneed
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.
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 Company
It 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.
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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;selecting
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 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.
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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
Equipment Financing Mechanism
Equity / Debt
EBRD
EBRD
EXPORT CREDIT
EXPORT CREDIT
Debt
AGENCIES
AGENCIES
BORROWER Minority Stake LOCAL LEASING
BORROWER LOCAL LEASING
PUBLIC CLIENT
PUBLIC CLIENT COMAPNY
COMAPNY
VENDORS
VENDORS
Competitive
Tender
MARKET
MARKET
PRICES
PRICES
CONTRACTORS OTHER EQUIPMENT
OTHER EQUIPMENT
CONTRACTORS SUPPLIERS
SUPPLIERS
could be designed – such as the one shown in the figure below.
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.
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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
projects
Improving payment procedures - Transform completion certificates into
collaterals
General Aim
Increase the local contractors’ liquidity and strengthen their financial position.
Who can be responsible and what to do
Local 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 Ithas 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.
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Improving payment procedures – Development of a forfaiting scheme
General Aim
is To monetize the completion certificate as like 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.
(fund or securitize/collateralise) it. T
Who can be responsible and what to do
Encouraging 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.
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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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
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.
This can be achieved, i.e. the various risks (outlined below) can be separated so
the forfeiting house takes only one class of risks. Let’s assume that:
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
Improvements
Splitting large projects
General Aim
Improve 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, 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.
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Benefits to the contractors
This 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 Aim
Within 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 do
EBRD 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.
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 industry
Better chances especially for small firms to access work and sustain their business
as well as creating a more competitive sector.
Relaxation of performance bonds
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General Aim
Reduce the amount of working capital or assets (as collateral) tied up in one
project.
Who can take responsibility and what to do
IFI’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 Aim
All countries surveyed, but especially Romania, have raised the issue of
understating the contractual terms when drafted in English. Romanian contractors
have also questioned the 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.
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Who can take responsibility and what to do
EBRD 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
General Aim
IFI’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 do
Often 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
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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 Aim
Different 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. For example, the ISO standard series may be a target goal for
contractors.
Who can be responsible and what to do
IFI’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.
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Benefits
Better chances for local contractors to meet requirements;
Increased chances of successful partnerships with international contractors.
Improve quality of the tender documentation and particularly the quality of
the technical specifications
General Aim
A 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 do
IFI’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 contractors
Encourage 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 Aim
SME 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 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
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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 do
IFI’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 Aim
Streamline 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 do
Local 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.
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
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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
General Aim
It 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 do
This 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;
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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 contractors
Expand the potential for participation in an expanding market
Quality Assurance / Quality Control (QA/QC)
General Aim
Improve 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. 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 do
IFI’s tenders should require an integrated QA/QC programme.
Benefits
Local 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 Aim
The 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.
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Who can take responsibility and what to do
The 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.
Benefits
Contractors’ increased ability to perform and control the execution of the project.
Improving monitoring and reporting skills
General Aim
Improve 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.
Benefits
A 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 aim
Historically, 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.
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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.
Who can take responsibility and what to do
EBRD 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 Aim
Standardisation 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.
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,
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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 do
The 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 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 point
In 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.
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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 Aim
Improve 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 do
The 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 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.
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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.
Benefits
The 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 Environment
Planning and formulating public sector demand
General Aim
Managing 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 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 do
Government 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.
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Benefits to the contractors / construction industry
Increase 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 Aim
Financing 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 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 do
Local 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.
Benefits
Increase 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
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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:
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,
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procurement procedures improvements in the remit of national organisations
and international financial institutions are presented too.
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
Page 192
Southeast Europe Construction Industry Capacity Building Final Report
Assignment 1: Assessment of Local Construction Industry Capabilities and Needs
European Bank for Reconstruction and Development SECTION 11
EBRD EBRD and other IFIs Other Organisations
Transaction Procurement Training Macroeconomic Microeconomic
Improving
access to and
understanding
of contracts
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
Page 193
Southeast Europe Construction Industry Capacity Building Final Report
Assignment 1: Assessment of Local Construction Industry Capabilities and Needs
European Bank for Reconstruction and Development SECTION 11
EBRD EBRD and other IFIs Other Organisations
Transaction Procurement Training Macroeconomic Microeconomic
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.
Page 194
