49457 Project Paper Data Sheet CROATIA Science and Technology Project Date: July 2, 2009 Task Team Leader: Paul0 G.Correa Country: Republic o f CROATIA Sector ManagedDirector: Lalit Raina/ Project Name: Science and Technology Fernando Montes-Negret Project Acting Country Director: Theodore Ahlers Project ID:PO80258 Environmental category: C Borrower: the Republic o f Croatia Responsible agencies: Ministry o f Science, Education and Sports (MSES), Business InnovationCenter o f Croatia (BICRO), Rudjer Boskovic Institute/RudjerInnovations, Brodarski Institute, University o f Zagreb and University o f Rijeka Revisedestimated disbursements(Bank FY/ million) FY 2007 2008 2009 2010 2011 Annual 1.7 5.6 4.9 8.8 8.9 Cumulative 1.7 7.3 12.2 21.0 29.9 Current closingdate: November 30, 2009 Revised closing date: proposed to extend untilMay 31,20 11 The restructuring i s Board approved. Yes Does the restructured project require any exceptions to Bankpolicies? No I s approval for any policy exception sought from the Board? No The revised project development objectives/outcomes are: (a) to enable research and development institutionsto commercialize research outputs; and (b) to increase the ability ofenterprises, particularly small andmediumsized companies, to invest inresearchanddevelopment (R&D) activities. Does the restructureduroiect trigger anv new safeguard uolicies? N o Source Local Foreign Total Borrower 2.7 3.0 5.7 IBRD/IDA 21.9 8.0 29.9 Total 24.6 11.0 35.6 PROJECTPAPER PROPOSALTO RESTRUCTURE CROATIA SCIENCE AND TECHNOLOGY PROJECT (LoanNo. 7320-HR) IntroductoryStatement 1. This Project Paper seeks the approval o f the Executive Directors for the introduction o f changes in the Croatia Science and Technology Project (STP), Loan 7320-HR (P080258), to the Republic o f Croatia (the Borrower) and any accompanying project legal documents. It follows a formal request by the representative of Borrower, Ministryo f Finance of June 16, 2009 and each of the Project entities (Business Innovation Center of Croatia (BICRO) and Brodarski Institute (BI)), which resulted from the discussion o f the findings o f the Joint Portfolio Review andan initialrequest for the extension o f the project by the Ministry of Science, Educationand Sports o f October 1,2008. 2. The key proposed changes are: (a) revised Project Development Objective (PDO) and associated outcome indicators, removing the objective o frestructuring research and development institutions and therefore focusing on the objectives o f enabling the commercialization o f public research and fostering private sector R&D; and (b) the extension of the closing date of the project from November 30, 2009 to May 31, 2011 and the reallocation o f Loan h d s between disbursement categories, cancelling the sub-component related to the creation o f a venture capital fund (VENCRO) and increasing the allocation to programs that directly and indirectly support business R&D (RAZUM Program and Unity Through Knowledge FundComponent). 3. The revision o f the PIX) aims to reflect more accurately what can be achieved with the available funds andgiventhe prevailing institutionalconditions inthe country andthe level o f ownership for this specific objective. As concluded during the mid-term review o f the project, progress achieved towards the objective o f restructuring public research and development institutions was very limited while results achieved in terms o f the commercialization of publicly-funded research and research capacity surpass original expectations. 4. The reallocation o f loan funds and the extension o f the project closing date aims to, within the original scope, adjust the project to country's needs given the current global financial crisis. With the reduction o f access to credit by enterprises and the downturn o f the economic activity, the Government o f Croatia i s eager to ensure that sufficient public funding i s made available for the support of private R&D, thereby mitigating the impact o f the global crisis on private investments inR&D. 5. As a recent World Bank report shows, Croatia is one o fthe countries o f South East Europe where larger R&D expenditures and better commercialization o f knowledge would generate higher development impacts.' By focusing on achievable objectives and adjusting the For a detailed discussion on this topic, including estimates o f the impact o f higher R&D expenditures on economic growth in Croatia see Croatia's EU Convergence Report: Reaching and Sustaining Higher Rates of Economic Growth. World Bank Report, 2009. Washington DC. 2 use o f proceeds to the country's needs, the restructured project i s more likely to contribute to the achievement ofthese impacts. BackgroundandReasonsfor Restructuring 6. The STP consisted originally o f a 31 million loan distributed among four components: (i) restructuring research and development institutions (RDIs) and supporting knowledge commercialization by public research institutions; (ii) strengthening private R&D and innovation; (iii)engaging Croatian scientific Diaspora in joint projects and other initiatives, to transfer their knowledge and skills for the benefit o f Croatian economy; and (iv) capacity buildingo f the National Innovation System. The Project was approved in July 2005, became effective inMay 2006 andhas a closing date o fNovember 30,2009. 7. Duringits first two years, STP achievements were lower than the targets agreed in the established results framework and the project performance was rated "moderately satisfactory". In essence, the project performance was hindered by the lack of readiness o f local counterparts at the start o f the project.2 With the conclusion of this capacity building phase in 2008, the STP started to generate effective results reflected in patents applications; new research contracts with the business sector, and a strong pipeline in most sub-financing component^.^ 8. Despite this positive trend, the mid-term review o f the project showed two major structural deficiencies inproject implementation: (a) the very limitedachievements interms o f restructuring RDIs, one o f the goals stated in the PDO and (b) the failure to develop the venture capital component (VENCRO) totaling 4.5 million or almost 15% o fthe total loan. 9. After using more than half o f its original allocation, BI failed to achieve self- sufficiency ratios that would convincingly indicate a successful advancement o f the restructuring process. Despite the opening of new sources o f revenues, BI's long-term sustainability i s still jeopardized by high and growing costs, especially salaries and maintanance, particularly heating costs, which in turn are associated to the costs o f maintainance o f the hydrodynamic laboratory, its major asset.4This inturnreflected the lack o f ownership towards a complete restructuring, as originally envisaged inthe project document. 10. Moreover, the participation o f Rudjer Boskovic Institute (RBI), originally envisaged as the second institution to be restructured, became de facto restrictedto the support o f activities related to the management and commercialization o f the institute's intellectual property. As an institute involved in applied as well as basic research, the extent and nature o f such restructuring was indeed unclear. At the same time, political resistance to a shift in the financing sources o f one o f the most prestigious research institutions in the country was mounting. For instance, delays in achieving two major covenants postponed the project launch. The covenants were the adoption of a Science and Technology Policy and the inclusion o f Rudjer Boskovic Institute as one of RDIs to be restructured. Several institutions required to implement the project had to be established - from staffing and training, to procedural rules and analytical frameworks for the program implementation that had to be built from scratch. See Project Implementation Status and Results Report (ISR) o fJanuary 2009. Another structural factor is an incentive regime inadequate to attract and retain young and well qualified researchers. As a result, BI is not in compliance with the two legal covenants, namley the self-sufficiency targets and the required contributions to the Institutional Renewal Account (IRA). A detailed analysis of the financial and economic situation o f BI, as well as its milestones for a successful restructuring process is available in the Aide Memoire of the October 2008 Mid-Term Review Mission. 3 11. Inthe meantime, STP had successfully launched several activities that enabled the commercialization o f research results and research capacity. For instance, it accepted the requests o f support to the creation o f technology transfer offices from two major Croatian Universities; Rudjer Innovations (RI), the technology transfer office for RBI had already generated two spillovers Rudjer Medikol Cyclotron; and Rudjer Medikol Diagnostics*, filed several patent applications and licensed a handfulo f licenses to the business sector. 12. In sum, while the goal of restructuring at least two RDIs with the purpose of guaranteeing their long-term sustainability appearedhighly unlikelyto be achieved at mid-term review, the objective o f supporting the commercialization o f research had shown to be highly promising. Overall, the risk for the implementation o f the restructuring of research institutions had been assessed as "significant" during the project appraisal phase. Under those circumstances, the Government of Croatia and the Bank agreed that STP should remove the goal o f restructuring R D I s and focus on the objective o f enabling the commercialization o f research results andresearch capacity o f those institutions. 13. The several attempts to establish the venture capital fund during 2008 failed as the companies selected to manage the initial capital provided by STP were unable to mobilize the necessary co-financing from the private investors. While aspects o f the financial regulation in the country may have contributed to this result, factors related to the size and maturity o f Croatian financial market were originally known to represent a "high" risk to the implementation of this component at project appraisal. The subsequent deterioration o f global financial markets further increased this risk. 14. Moreover, with the global economic crisis, the conditions under which credit is available for Croatian firms worsened significantly. The economic downturn also reduced the amount of internal resources available for the business sector to finance their own R&D expenditures. Inthis context, the Government of Croatia and the Bank agreed that the proceeds originally allocated to the establishment o f the venture capital fund should bereallocated to the programs supporting R&D expenditures by the private sector and that project duration should beextended thereby allowing for the full absorption ofthese funds. ProposedChanges 15. A revisedProjectDevelopment Objective: i. OriginalPDO:(a) tostrengthenandrestructureresearchanddevelopmentinstitutions and to promote commercialization o f the research outputs and (b) to upgrade technological capabilities o f enterprises. ii. RevisedPDO:(a) toenableresearchanddevelopment institutionsto commercialize research outputs; and (b) to increase the ability o f enterprises, particularly small and mediumsized companies, to invest inresearch anddevelopment (R&D) activities. Rudjer Medikol Diagnostics is ajoint venture (JV) with RBI's department for molecular medicine, which runs genetic testing of hereditary breast cancer (and has been certified with the European protocol for breast cancer screening) in the field of preventive medicine care. Rudjer Medikol Cyclotron is ajoint venture of RBIand private health-care provider, which provides highly sophisticatednuclear medicine services (radionuclides) for diagnostics o f cancer (PETICT), not available in Croatia so far, andwill also work on R&D of new radionuclides and other research connectedto cyclotron ingeneral. This i s the PDO as stated in the Loan Agreement (p. 16). The objective as stated in the PAD (p. 4) i s as follows: (a) to strengthen and restructure selected research & development institutions to promote applied research, while maintaining their scientific excellence; and (b) to increase the ability of enterprises to develop, use, adapt and commercialize technology. These differences will also be correct for by the proposed project restructuring. 4 16. The new results framework and project outcome indicators, as described in Table 1. A comparison between original PDO and results framework and the newly proposed one is presentedinAnnex 1. 17. The elimination ofthe venture capital sub-component (originally 4.5 million). 18. A reallocation ofthe loan funds among the differentproject agencies, realigningthe use o f loan proceeds and the new project objective; including the increase in the percentage o f expenditure from loanproceeds for RAZUMprogram to 100percent (originally 80 percent), to help alleviate the shortage of counterpart hnding due to financial crisis, as well as cancelling a total of1.O million of the original loan amount o f 31million as described inTable 2. 19. The extension o f the closing date from November 30,2009 to May 31,2011. 20. The following additional changes: a) the cancellation of the BI's implementation covenant requiring maintaining an Institutional Renewal Account (IRA)7; and (b) the cancellation o f the BI's sustainability clause (Project agreement with BI, Article IV, Section 4.02 (a)). Amendments duringproject implementation, as well as measures adopted to simplify Bank's approval of sub-financing programs andprocedures, will also be integrated to the legal project documents.* Revised project cost/disbursement estimates and financing plan are presented inthe Annex 2. Analysis 21. Envisaged to become the backbone o f Croatia's innovationpolicy, STP represented part o f the Government's efforts to strengthen the competitiveness o f Croatia. Inthe context o f raising labor costs and living standards inlight o f the upcoming EU accession, the project was envisaged to enable the country's transition towards a knowledge economy. With that purpose inmind, and given Croatia's untapped stock of scientific knowledge, the commercialization of research results and research capacity seems to have a larger economic impact than the restructuring of selected RDIs, which would have helped to guarantee their long-term sustainability. Having overcome the resistance o f large part o f the scientific community to the commercializationo fresearch outputs, project results a more likely to be achieved. 22. In this sense, the proposed change in the PDO does not significantly alter the original economic, social and institutional aspects of the project. Rather, with the elimination of the objective of restructuring RDIs, the loan will no more finance the severance pay for eventual lay-off of redundant workers. The proposed changes in the project do not involve any exception to Bank policies. The proposed changes do not raise the environmental category o f theprojector trigger any new safeguardpolicies. 'TheBI ~~ i s required to set up an internal revolving fund account (the IRA) (completed) and to make quarterlyreplenishments from its revenues to the account totaling 1.5 million by 2010 (not done) and to use the amounts on deposit in said institutional renewal account for the purpose of financing its institutional renewal requirements, under terms and conditions acceptableto the Bank. Actions undertakento streamlinethe project implementationinclude: (i) the Bank provides one no-objectionto the Business plan, Procurementplan and Training plan package of each RDI once a year (as comparedto previous multiple submissions at different times), whereas the procurement and training plans may be revised on as needed basis to address project implementation status and developments; (ii) the task team leader (TTL) has delegated authority to sign off on procurement actions to the field-based procurementexpert pursuantto Office Memorandum dated October 7, 2005 from Armando Araujo, Director OPCPR, and consistent with AMs 1.30 (c) and any regional requirements; (iii) the Bank's prior review to UKF projects that exceedthe value of 200,000. With current strong commitment inthe Ministry of Science, Education and Sports (MSES), the Bank is also considering delegating more authority to MSES inapproving certain select activities instead of the Bank. 5 ExpectedOutcomes 23. The expected project outcomes include: a) mure research outputs and research capacity commercialized by RDls, as measured by the number o f contracts concluded with the business sector raising from 2 to around 30 between 2006 and 2011;the number o f spill-over companies increasing to approximately 8; and the volume o f licensing agreements signed between RDIs and the business sector reaching a sum o f 1 million; and b) more innovation andprivate R&D, as measured by the share o f small and medium size companies introducing products new to the market maintainedat the pre-crisis level o f roughly 7 percent in 2011and a volume o fR&D expenditures by SMEs in 9.2 million inthe period. BenefitsandRisks 24. With the project becoming the backbone of Croatia's S&T Policy and disbursements picking-up, the proposed changes will (i)increase the likelihood and the magnitude o f commercialization of research andprivate sector innovation, thereby contributing to Croatia's transition towards a knowledge economy and (ii) extend the availability o f funds for private R&D in a context o f illiquid financial markets. This will help mitigate the effects o f the global economic crisis inthe country. In addition, the extension o f the project would allow more time for the full consolidation ofnewly created policies and institutions. 25. Two main factors present risk to the achievement o f the expected outcomes: (a) a renewed resistance to the commercialization o f research outputs, in light o f the increased global resistance to market-oriented reforms and for which we attribute a "medium" risk level; and (b) the lack o f counterpart funding, that could result from the tightening o f the fiscal policy, for which we attribute a "high" risk level (as compared to "medium" risk level during project appraisal). 26. The following are mitigatingfactors: (a) Despite the project's orientation towards market-reforms, its implementation has and will continue to seek synergies with EU programs and policies, aiming to have the EU accession agenda as an institutional anchor for STP related activities. In addition, newly appointed administrations to the University o f Rijeka and RBI have explicitly manifested their support to the project. Finally, the goal o f restructuring RDIs, a source o f major resistance, was removed; (b) With respect to an eventual reduction incounterpart funding, the Government and the Bank agreed to increase the financing ratio from loan proceeds, as allowed by the Country Financing Parameters, and should the need arise. This in particular refers to selected sub- financing categoriesg. Furthermore, as a result o f the Joint Portfolio Review o f February 2009, the Government recommended, through its Conclusion adopted on March 25, 2009, more intensive disbursement of loan and grant funds financed by the Bank. Finally, the proposed restructuring raised the value o f the project to the government as it better addresses its needs, and particularly in the context o f the current global crisis, as demonstrated during the Joint Portfolio Review. Currently, the increase inthe financing ratio has only beenproposed for the RAZUMprogram (p.6 ofthe Project Paper). 6 27. Evaluations during the mid-term review and discussions held with the project counterparts on the restructuring of STP suggest that the overall risk associated to the implementation of STP may be moderately reduced due to the above described mitigating measures. 7 Tabb 1: ProposedResultsFramework Table 1.a: New Project Outcomes Project Objective DescriDtion ' Baseline Actual Target (Primarisource) 1..EnablingRDIsto commercialize iI 2006 ' 2008 May 2011 researchoutputs as measuredby: Increasednumberandvalue ofresearch BI's contracts with pnvate , 1 2 I 10 30 contracts with the industry( million) , financed by the business sector , companies, UKF contracts co- 0 5 ' 1.8 ' 8.0 andresearchcontracts signed by TTO's and not dlrectly '1 i Increasedcommercialization._of R&D results, ............ - . finpcedbl_STP . -. i - ~_ --___ _ I as measuredby: As signedby RIandother ~ a) Number andvalue of spillovers (including TTOs , None , 3 , 8 .............................................................. ....................................... joint-ventures) ....................... - _ 8 _ b) Number and value of licensingagreements As signed by R i&d other - -None , 5,000 2,860,000 2 . -1 , 6 signedwith the businesssector TTOs 323,000 1,000,000 ............................................................................................................................................. ............... - .___, - 1 .. __I 2. Increaseddevelopment, use and adaption of technologybythe enterprisesector as . . . . . . . . . . . . . . . . . . . . measYred.!?Y:.. . . . . . . . . . I SMEs that havenew or significantly improved Source: Community Innovation , 7.22% ' N.A 7% productsnew to the marketmaintained(as Survey share oftotal enterpcises)" __ i" Volume of private R&D mobilized (through At least 30% ofRAZUM " ' 6.0......................I 6.8 , 9.2 programs supportedby STP-in million) uroiects; 20% o fUKF j ~ coh& with industry and 1 50% of SPREAD projects Table 1.b: New_ProposedIntermediateOutcomes _ IntermediateObjective Baseline Actual , Target- , Contributionto 2006 PDO ComponentA - Encouragmgthe co&nerciahzationof- 2008 i' May2011- - * I- publicly-funded R&D I (a) BI's share ofrevenuesfromprivate companies 22% 31% ' 35% I to enable IPtakento protection fromRBIandthird parties None -- '. 55 t 1 research and 60 , development Number ofpatents grantedto RI i None 2 6 institutions i . , ' to commercialize ... .............................................................. IPtransferredto Zagreb andRijeka's TTOs None & , 2o I researchoutputs ~ Numberofpatentsfiledbythe TTOs i ........................................................... :....................................... ...................... None............... j ^ i................ None None 8 i ....... ............. ............................................................................................................................................................................................. :............................................. ComponentB.......-R&Dfinancingprogramfor enterprises ). ............................................................. ............................................................................ ~ (b) 37 i i ........i 60 78 .........I, to increase the ability .. Number of SMEs directly supportedby BICRO programs......i........................................ ... ~ !................. i........ of enterprises, ~ ~ ~ j ~ L RAZUMprogram(million) 18.03 28.54 33.68 ! ParticularlYSMEs~to invest inR&D ~ ~ ~ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ~ TECHCRO program(number o fprojects) 1'' 7- - ' ''I ' "None , I 12 activities I............................................. L ........................ ............................................ SPREADprogram(million) None I 0.08 .+. 1.5 i j ~ ComponentC: UKF j (a) to enable Number ofprojects (total) None 38 i 50" research and ,la. ml*-ma..+ UGV C ; l V p U k G U L ProjectswithCroatians limngabroad ' None 'i 18 i 30 ' institutions Projectsinvolving cooperationwith the industryi2 ' None ' 15 ' to commercialize - . : research outputs Projectswkh young scientists 8 .. 'i None . r . . . . .18 , .... 15 (b) to increase the Projectssuccessfullycompleted(as evaluatedby UKF j 1._........ ... .: None i 2 2 , 30 Of evaluationcommittee) i particularly SMEs, to .................................... ............................................................................................ I /.. invest in R&D " ".... lo Preliminary results of BICRO sub-financingprogramsindicatethat mobilization of the private investmentfrom SMEs could be expected; hence the proposalto benchmarkthe share of firms performing R&D as per the results of Community Innovation Survey, carriedout bythe EU. ''This target hasbeen decreaseddue to increasedshare o fprojects of higher value as comparedto medium-valueprojects. l2Includestheprojectsprimarily orientedto industry sectorandother UKFprojectswhere industry investedmatchingfunds. 8 Table 2: Proposalfor Reallocation of Loan Proceedsby Components( million) I ~ 1Project Component /_Activiy Original _ql!ocation ; projosedAllowkon , __ Difference- , I 1 ComponentA I 10,500,000 , 10,600,000 100,000 BI I 4,000,000 3,000,000 -1,000,000 RBI/-RI . - - _- - -_4~0007000 - - 6,000,000 -__ - . . 2,000,000 ~ i > _ '' Unyersity o fZagreb- --I - ~ i . 2,500,000 1' ---- .800~000i - - _ _ __ - - - - --900,000 . - - - -_ Uniyers!tyOf Rijeka . i - _.. _-- ,_- - - - . 8!0,000 I - - - - - I I . .- ComponentB 14,000,000 11,868,124 ; -2,131,876 BICRO InstitutionalBuildng - . 700,000 1 0 RAZUMProgram 3,000,000 ' 5,143,124 2,143,124 Venture-Capital . 4,500,000 - - - ~ 0 ' -_ -4,500,000_ . . _ -1 I Technology Centers I 4,300,000 4,525,000 , 225,000 ~ Technology-Incubators ,t _1,600,000 . . 1 1,600,000 _ _ - - MARIBIC R&D Center 1,600,000 ; 1,600,000 ~ New andExistingTCs . - 1,100,000 1,325,000 225,000 3 . SPREAD Program 1,500,000 9 1,500,000 I ComponentC . . 3,700,000 . 4,550,000 850,000 Operational Support i 300,000 !. 450,000 150,000 UKFFund - 1 - -3,400,000 4,100,000- - r 700,000- - > Project Implementation 1,640,000 , 1,900,000 , 260,000 ~ , Implementation Unit, Other i 1,200,000 , . - 1,450,000 I 250,000 Croatian InnovationSystem & I Croatian Accredtation Council 1, 440,000 , 450,000 - . ~ 10,000 , I Other (Unallocated Fees) 1,160,000 , 1,077,500 -82,500 1 Unallocated -- __ 1,000,000 1,000,000 i _. 0 Fees 160,000 77,500 . -82,500 ~ 8 ' Total Project Expeqditure 31,000,000 29,995,624 -1,004,376 * * * * * * 9 . Lc! 3 w 0 0 N h m e d A- m 3 0 0 0 c B e, 9 h 9 E 3 `3 E e, -B.- 8 ..c a= cd 3 7 LE E .c: 0 .-e z3 .-e n 0 6 M .I 2 - m m o 3 v .9 Q) m r -$00 \o 0 & O C 0 0 0 0 c u n 02 En 0 W \o i 0 10 t Y 3 2 ... 0 . n 3 ... n u - E ? 3 e . 3 ?a3 I I I 31 3 3 di 5 >>5 I I E i e3 ? . 2 I I ! 1 4 0 r 3 3 i 5 >5 . 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