IFC: SEE gov­ern­ments should step up struc­tural re­forms to help spur growth

Top 100 See - - Top 100 Companies - By Ge­orgi Ge­orgiev

Eco­nomic growth in South­east Europe (SEE) is pick­ing up but re­mains be­low the re­gion's po­ten­tial. What can be done to ac­cel­er­ate the pace of eco­nomic ac­tiv­ity?

One of the big­gest is­sues the re­gion is strug­gling with right now is that struc­tural re­forms have not moved as fast as we have ex­pected or hoped for. As a re­sult, SEE coun­tries are sad­dled with rel­a­tively high un­em­ploy­ment and poorly func­tion­ing labour mar­kets and, con­se­quently, the lev­els of growth across the re­gion are not reach­ing full po­ten­tial and are not high enough to ad­dress those kinds of fun­da­men­tal chal­lenges. Ul­ti­mately, if I were to iden­tify what the top pri­or­i­ties for gov­ern­ments in the re­gion should be, it is to take care of much-needed struc­tural re­forms and along­side that also fo­cus on ar­eas of com­pet­i­tive ad­van­tages that their coun­tries may have. And then thirdly, I would say, is to look at how to help un­lock the fi­nanc­ing po­ten­tial in the re­gion, how do you in­cen­tivize banks to lend more ac­tively. That touches the sub­ject of non-per­form­ing loans (NPLs), the sub­ject of delever­ag­ing of Western banks which are present in the re­gion and, to some ex­tent, also the sub­ject of the need for greater devel­op­ment of cap­i­tal mar­kets in the re­gion.

What role do you see for the in­ter­na­tional fi­nan­cial in­sti­tu­tions (IFIs) in this process?

The slow growth and the other macro-eco­nomic chal­lenges in the re­gion are noth­ing new. They started to emerge af­ter 2008. On that back­drop, the IFIs, in­clud­ing the IFC, de­cided to en­gage ac­tively to­gether in de­sign­ing an ac­tion plan. There was the first round of the ac­tion plan in 2008 and an­other round in 2012 when we re­al­ized that growth is not com­ing back to the re­gion. As part of this ac­tion plan, the IFIs have put quite a bit of fund­ing in both the pub­lic and pri­vate sec­tor in the re­gion to help stim­u­late at least the fi­nanc­ing part of the whole equa­tion. Go­ing for­ward, high on the agenda of the IFIs is how to chan­nel fund­ing to sup­port the devel­op­ment of lo­cal cap­i­tal mar­kets. There is also a need for the IFIs to en­gage on NPLs, which have been weigh­ing heav­ily on the re­gion's banking sec­tor, to the ex­tent that we can find ways to help banks re­duce that bur­den and al­low them to lend more to pro­duc­tive en­ter­prises. On com­pet­i­tive­ness, what the IFIs can do is try to find com­pa­nies which are ‘win­ners', com­pa­nies that have a good pool of skills, or a com­pet­i­tive ad­van­tage in terms of tech­nol­ogy or lo­ca­tion. For ex­am­ple, we have worked with some agribusi­ness com­pa­nies in the re­gion on how to im­prove their sup­ply chains. The IFIs can also help cre­ate sus­tain­able ac­cess to in­fra­struc­ture in the re­gion.

When it comes to struc­tural re­forms, this is an area that is dif­fi­cult for a group like IFC to en­gage in di­rectly as we tend to in­vest in in­di­vid­ual projects, in­di­vid­ual trans­ac­tions. This is some­thing where we ex­pect the In­ter­na­tional Mon­e­tary Fund (IMF) and the World Bank to take the lead role and I know that is a pri­or­ity for them. How­ever, IFC does have a joint ad­vi­sory prac­tice with the World Bank proper where we are work­ing with gov­ern­ments on trade and com­pet­i­tive­ness is­sues that have sig­nif­i­cant bear­ing on ef­forts to im­prove reg­u­la­tions and cre­ate op­por­tu­ni­ties for busi­ness to flour­ish.

What ex­ter­nal risks do you see facing eco­nomic devel­op­ment in the re­gion

over the near to medium term?

The re­gion is fairly well in­te­grated into Europe so the pace of growth in the euro­zone is im­por­tant. That is one of the key risks as growth in Europe has not been great. An­other euro­zone-re­lated im­pact is the events un­fold­ing in Greece. That re­lates both to the ex­ten­sive foot­print of Greek banks in some parts of the re­gion but also Greece is an ex­port des­ti­na­tion for SEE coun­tries.

The fis­cal lim­i­ta­tions faced by the SEE gov­ern­ments are also a ma­jor con­cern as there is not enough fis­cal room to stim­u­late growth through pub­lic spend­ing. So the growth will ul­ti­mately have to come from the pri­vate sec­tor. Al­though we are keen to see that hap­pen, if gov­ern­ments are un­able to sup­port pri­vate sec­tor growth through pub­lic mea­sures – be it through pub­lic-pri­vate part­ner­ships or any other types of struc­tures – that may take some steam off the in­fra­struc­ture in­vest­ment.

The other po­ten­tial risk for growth in the re­gion is Russia, al­though the scale of the po­ten­tial im­pact varies from coun­try to coun­try, as Russia is an im­por­tant ex­port des­ti­na­tion for some of the SEE coun­tries.

What can be done to re­verse the de­cline in cap­i­tal in­flows to the re­gion?

The is­sue here for me is boost­ing com­pet­i­tive­ness: how do you make your­self at­trac­tive vis-à-vis all the other places around the world which are try­ing to at­tract in­vestors? When it comes to global com­pa­nies, they need to see what is the com­pet­i­tive ad­van­tage of a spe­cific coun­try – is it its fu­ture mem­ber­ship in the EU, is it its do­mes­tic mar­ket po­ten­tial, is it a plat­form to ex­port some­where else. The pri­or­ity for these var­i­ous coun­tries is how to iden­tify the win­ning sec­tors in your own econ­omy, how to at­tract in­ter­na­tional com­pa­nies. Ser­bia has done some in­ter­est­ing things try­ing to reach out to the Mid­dle East for in­vestors. Cap­i­tal will start to flow into the re­gion once there is a clear per­cep-

Gov­ern­ments, IFIs should jointly seek to un­lock fi­nanc­ing po­ten­tial in SEE re­gion Pri­vate sec­tor growth in SEE should be sup­ported by pub­lic mea­sures

tion of a sta­ble busi­ness environment and of gov­ern­ments that are open for busi­ness. That has not al­ways been con­sis­tent through­out the re­gion. If we can break the cy­cle of chang­ing the rules too of­ten, that would make the SEE coun­tries more ap­peal­ing for in­vestors.

What con­straints are high debt lev­els and vul­ner­a­bil­i­ties in the banking sec­tors putting on eco­nomic growth in SEE and how should these be tack­led?

Un­less the banks are able to lend, it is very dif­fi­cult for com­pa­nies to grow. And banks are lim­ited in lend­ing be­cause of the high bur­den of NPLs and cer­tainly in the case of SEE, the av­er­age NPL ra­tio is rel­a­tively high. What the IFC can do to help deal with this is­sue? One side of this, of course, is reg­u­la­tion. Jointly with the World Bank, the IFC is work­ing in a num­ber of SEE coun­tries to help im­prove the reg­u­la­tion for how to deal with NPLs, how to as­sess them, how to sell them, ba­si­cally how to take them off the bal­ance sheets. Some coun­tries are more ac­tive in this than oth­ers. Ro­ma­nia is prob­a­bly in the fore­front of how SEE coun­tries have dealt with the NPLs sit­u­a­tion. Gen­er­ally, we find that reg­u­la­tions are less of a con­straint in SEE than other is­sues, pri­mar­ily hav­ing to do with are the banks there ready to sell those loans, are they will­ing to rec­og­nize the one-off hit that the sale of an NPL is go­ing to cre­ate on the bal­ance sheet. That is the process that has taken the long­est in SEE - con­vinc­ing the banks that it is in their in­ter­est to exit those ex­po­sures, to move on, fo­cus on core ar­eas and leave the as­pect of deal­ing with NPL port­fo­lios to spe­cial­ized com­pa­nies.

The IFC cre­ated what we call Debt and As­set Re­cov­ery Pro­gram sev­eral years ago and through that pro­gram we are putting in - not just in Europe, as­sets to sup­port com­pa­nies that work out NPLs, that pur­chase NPLs and cre­ate spe­cial­ized mar­ket in­fra­struc­ture to deal with the prob­lem. In SEE, there are some cases, a cou­ple of com­pa­nies that we have sup­ported that do that.

Some of the banking sec­tors in SEE are rel­a­tively small so they would prob­a­bly not be able to at­tract an in­vestor that spe­cial­izes in NPLs res­o­lu­tion. But as long as SEE gov­ern­ments are will­ing to en­cour­age their banks to go through that bal­ance sheet cleanup process and there is a re­gional plat­form fo­cus­ing on 3 or 4 dif­fer­ent mar­kets, an in­vestor may still make an of­fer on a rel­a­tive small port­fo­lio. Then they will be able to ag­gre­gate it with the pool of funds they man­age. So size could be a prob­lem but for as long as the fo­cus is on re­gional plat­forms, it is man­age­able.

What role could the IFIs have in help­ing re­solve the build-up of NPLs in SEE?

The role of the IFC is more on the mi­cro-level – we want to sup­port in­di­vid­ual trans­ac­tions, in­di­vid­ual banks. There are a num­ber of trans­ac­tions in SEE where we are look­ing at spe­cific deals in­volv­ing NPLs.

The sub­ject of how one re­lates to cen­tral gov­ern­ments and reg­u­la­tors on this is be­yond our usual sphere of in­flu­ence. Yes, we are work­ing closely with the World Bank in a num­ber of SEE coun­tries, also the IMF which ob­vi­ously has ex­ten­sive ex­pe­ri­ence in deal­ing with this in many other mar­kets. There is fi­nally more will­ing­ness on the part of the banks to en­gage on the NPLs is­sue and, as a re­sult, there are more op­por­tu­ni­ties for us to sup­port the work­out process. But we all have to ac­cept there is a big po­lit­i­cal com­po­nent.

One rea­son for that is that many of those bad bor­row­ers are state-owned. And this again touches on the is­sue of struc­tural re­forms to the ex­tent that the pub­lic sec­tor is an im­por­tant em­ployer in these coun­tries and the gov­ern­ments

SEE banks show­ing grow­ing will­ing­ness to en­gage on NPLs is­sue

are tak­ing their time to pri­va­tize or re­struc­ture ail­ing en­ter­prises. From our per­spec­tive, we would en­cour­age the gov­ern­ments to take more ag­gres­sive steps on this be­cause it feeds into the sub­ject of com­pet­i­tive­ness: how do you cre­ate com­pet­i­tive economies with bor­row­ers which are not do­ing so well? What we can do as IFIs is pro­vide ex­am­ples from var­i­ous other mar­kets, give sug­ges­tions how cer­tain struc­tures can be put into place and we can cre­ate in­stru­ments that can sup­port this but ul­ti­mately the gov­ern­ments need to take charge.

How is the IFC po­si­tioned to help SEE gov­ern­ments boost eco­nomic growth, cap­i­tal in­flows and job cre­ation?

In most emerg­ing mar­kets, most jobs are cre­ated in the pri­vate sec­tor. So we feel that by sup­port­ing pro­duc­tive and com­pet­i­tive pri­vate sec­tor en­ter­prises we do the most to ei­ther pre­serve jobs or help in­crease em­ploy­ment. We try to iden­tify pri­vate sec­tor en­ter­prises with a busi­ness model that is sus­tain­able over the long term and cre­ate op­por­tu­ni­ties for new hir­ings. Other than that, the IFC is do­ing its part by lend­ing to fi­nan­cial in­sti­tu­tions to help them fund small busi­nesses.

In which eco­nomic sec­tors does the IFC plan to step up its en­gage­ment in SEE?

We could note the sub­ject of cli­mate change which, al­though it takes dif­fer­ent forms and shapes in the dif­fer­ent coun­tries, broadly re­mains a pri­or­ity for IFC in the SEE re­gion, par­tic­u­larly in the area of re­new­ables. We have al­ready fi­nanced some re­new­able en­ergy projects in Croa­tia and prepara­tory work is un­der­way in Ser­bia. The other key sec­tor is re­gional in­fra­struc­ture. I ex­pect ac­tiv­ity in this area will pick up over the next 12 months, es­pe­cially con­cern­ing po­ten­tial road and air­port projects.

SEE coun­tries should play up their com­pet­i­tive ad­van­tages to draw in­vestors Pace of euro­zone growth poses risks for SEE eco­nomic out­look

To­masz Telma, IFC re­gional di­rec­tor for Europe and Cen­tral Asia

IFC, a mem­ber of the World Bank Group, is the largest global devel­op­ment in­sti­tu­tion fo­cused on the pri­vate sec­tor in emerg­ing mar­kets. Work­ing with more than 2,000 busi­nesses world­wide, IFC uses its cap­i­tal, ex­per­tise, and in­flu­ence, to cre­ate op­por­tu­nity where it’s needed most.

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