Structural issues hold back SEE's growth potential, governments should not let up on reforms
Southeast Europe (SEE) has benefitted from low oil prices and the gradual recovery in the Eurozone but, with the notable exception of Romania, economic activity remains subdued. Where do you see the biggest constraints to growth?
The general energy price environment is an opportunity for countries to do better than in previous years but the growth prospects, except for Romania, have not been overwhelming. From our perspective, what is really important and what is missing lies in the category of structural issues. Basically, for many years structural challenges in many of these countries are holding back their growth potential. The labour markets are relatively weak, the unemployment rates are relatively high, in many countries labour force participation rates are relatively low, and in a sense it is really hard to see how the external factors such as energy prices can make a greater impact on GDP growth rates.
I see most of the constraints as being in the space of the investment climate and the low efficiency of the public sector, to the extent that the countries are not finding ways to bring in capital and improved efficiency into
the public sectors. We often talk about infrastructure because without a strong and efficient infrastructure it is really hard to build a basis for other sectors of the economy. There are also one or two more specific aspects that vary across the different countries in the region. We can also talk about the need for improved connectivity, for physical and institutional linkages among the countries themselves and to the European Union and the rest of the world. Some of the countries could also make a little bit more effort to focus on their competitive advantages, on how they make themselves more attractive to investors. Those four categories of issues are probably the biggest constraints from my perspective in improving the growth prospects in the region.
However, I would say that it is not all doom and gloom in the region. There is growth and there are opportunities. Some countries have set particularly interesting examples of being able to attract foreign investors. Romania is one such case but some countries of former Yugoslavia too have done it. I think the message that is important to keep in mind, and it is sometimes not an easy message for the governments, is: Don't let up, don't think that a temporary relief because of the lower energy prices gives you an opportunity to delay some of the difficult decisions. The countries that embark on a structural reform path begin to see the benefits of it after a while. Those difficult decisions usually pay off because you create a better environment for businesses and attract investment.
What areas of support does the IFC prioritise?
For international financial institutions the focus is certainly on private sector development. This is a fairly general term, almost anything can go into it, but we try to focus on transactions, on investment that would support increasing competition and the competitiveness of the various companies. We also help increase exports and the connectivity and linkages between companies. The policy advice generally tends to be reserved for big players like the International Monetary Fund and our colleagues at the World Bank, we take the view that our strengths and experiences are in working with the companies on a micro-level and ideally through transactions, although we too have advisory activities in helping the companies improve their corporate governance or their environmental and
In SEE one priority area for us is the development of the capital market. The eurozone crisis has taught us that extensive dependence on the eurozone can be quite dangerous to the economies in terms of the ability of the domestic banks to fund projects, unless over the medium term these countries develop their capital markets. Together with our World Bank colleagues we work through our joint advisory practices, which engage the countries' regulators, in designing standards and clarifying the rules of the game. In those kinds of engagements our World Bank colleagues can use examples from many different countries around the world, both developed and developing ones, and by showing the standards they explain to the governments and regulators what can be done. What IFC does is talk about what works and what doesn't. We take it beyond the books of regulations, to focus on the practicalities and what investors want in order to participate more actively on the capital markets. We also participate in bond issues by companies, both eurobond and domestic issuances, in Romania and elsewhere in the region.
Agribusiness is another priority area, where we are working across the entire supply chain, from farm to fork, including farmers, traders, agri-processors and logistics companies.
The third category is infrastructure, which is the basis for growth. We try to improve the access to basic services by financing infrastructure projects but also by helping the governments create public private partnerships and concessions as ways to attract investment into the infrastructure sector.
There is one other area which is cross-cutting for us, addressing issues across many different sectors, and that is climate change and finding ways to improve the energy efficiency of different sectors of the economy through financing, through creating access to renewable energy, through cleaner production which generally means lower and more efficient use of resources.
What are the main hindrances to private investment in the region and how can the countries boost their competitiveness?
The governments should know that they are competing for capital, for the interest of investors, with many other places around the world. Each one of those international investors has a choice where to invest. It is the job of the governments to create as attractive opportunities as possible for investors, both domestic and foreign, to work out private sector development policies that make the regulations transparent and improve the business environment and the opportunities for companies to make investments and to compete from a domestic basis. What is most important is how to make a structural change, how to implement structural reforms in a way that creates the most attractive investment environment and opportunities to increase the competitiveness of the economy.
Inefficient public sector, poor infrastructure, need for improved connectivity curb growth in SEE.
We have examples of certain countries in the region doing this in particular sectors, such as Macedonia in the automotive sector. Macedonia has really made a special effort to attract global companies, to create incentives for them to make investments and to use this fairly small country as a basis for exporting and supporting supply digits in other countries.
Some countries can be a little bit more deliberate and persistent in going through the mapping of their economy and trying to figure out how to make themselves attractive to those foreign investors who are making choices. Serbia too has been doing this, at least for a while in the auto industry by attracting Fiat. There are other examples too from the region where the governments are actually opening opportunities. It is about competition among the governments themselves, as well.
Difficult decisions pay off because they create a better environment for business.
Non-performing loan (NPL) ratios in the region have been declining but
remain high. What other steps can the governments and the lenders take to address the issue and how can the IFC assist them?
In SEE following 2008 there has been quite a bit of a buildup of NPLs in the banking sector. Yet in order for the economies to grow, you need active banks and if the banks are burdened with a lot of NPLs, their ability to make new loans is more limited both in terms of their capital capacity but also in terms of the time that does not have to go into managing the bad portfolios.
Our role goes in two or three different areas. One is related to individual transactions, just like we do in all our work, and that is basically us working with individual commercial banks or companies that specialise in purchasing and working up those portfolios, on efforts to move the NPL portfolios off the balance sheets of banks and treat them separately as a different asset pool. We have done this quite a lot around the world in different emerging markets, we are also doing it in SEE.
In Romania for example, which has been a little bit more active than other countries in the region in how they are dealing with NPLs, we have made two investments worth almost 100 million dollars in total to finance the acquisition and servicing of portfolios of NPLs, to improve the distress assets secondary market, to promote liquidity and to allow the banks to spend more time on new transactions as opposed to managing their NPLs.
One direction of our work is clearly to focus on transactions, both to work with banks and to work with platforms as we call them, i.e. companies that build portfolios of NPLs from banks and then work them out in a systematic and transparent way. However, we also engage with the regulators, either together with the IMF and the World Bank, or sometimes more directly ourselves, to explain to them how various countries around the world have dealt with the NPL regulations. This tends to be a fairy complex area in terms of tax treatment, calculating of the capitaliz sation of the banks, and the evaluation of those portfolios.
Through our Western Balkans Debt Resolution Programme - a joint effort with the World Bank, which is being implemented in Serbia, Albania, and Bosnia and Herzegovina, with other countries expected to join in later, we are working on improving the insolvency framework in order to improve the prospects for the recovery of the loans and increasing the returns to lenders. The programme works with businesses to return assets back to productive use, rather than closing the companies and recovering the collateral, and that involves also the regulators, as well as the judicial system. It is a fairly wide-ranging programme, more on the advisory side than on investment. We hope that investments in these countries will come over time, and they do not even have to be our investments. If the infrastructure in place is satisfactory, there will be other investors, not necessarily just international financial institutions.
Our expectations are generally positive but because the countries of former Yugoslavia are relatively small and the pools of loans that might be available for distress asset transactions are relatively small, they do not enter the radar of specialised investors who tend to be big international hedge funds and distress assets funds. Even on that scale Romania is much more attractive with the larger size of portfolios.
However, if the regulatory and insolvency framework in these countries becomes more transparent and more efficient, transactions will begin to happen, companies will be able to build regional platforms and pick up portfolios from multiple countries. Working just on Montenegro for example is not enough for an international group, the portfolios are not large enough, the overall size of the market is not large enough. But if you combine three or four smaller countries you can actually come up with a size of a business that is worth the attention of a specialised group. We strongly believe that it is not efficient for banks to be dealing with this, it is better to pass it on to specialised investors. As long as the rules of the game are clear for everybody and the scale is large enough, the investors will come.
Going forward, what are the biggest risks to the economic development of the countries in the region?
In order to implement the structural reforms the governments sometimes have to make difficult decisions - to privatise companies, to undertake efforts at fiscal consolidation, to cut costs - and in the short term the public may view those structural reforms with a lot of anxiety and discomfort. It takes quite a bit of persistence and commitment on the part of the governments and a lot of ability to convince your electorate that what you are doing is in the medium or long-term benefit of the country. Obviously, those are often very difficult decisions and we cannot underestimate the fragility of some of the political establishments in the different countries, and that is certainly one of the risks.
More efficient insolvency regulations will allow regional platforms to pick up NPL portfolios from multiple countries.
I think the other risk that most people would agree on is the fact that being relatively small, these economies are quite vulnerable to what is going on in the eurozone, in Russia, in Turkey, or in Central Europe. Even the best internal policies on designing competitive business environment or investment framework are not going to be enough to restart or stimulate growth if the immediate neighbourhood is in a difficulty. Basically, the external factors are quite relevant and the ability of these countries to export or attract financing depends very much on the regional context and not just on the effort of the individual governments.
Some of the countries in the region have also been affected by the migration flow through the region. The movement of refugees has not created a huge cost so far on most of these economies but is a bit of a risk area as the countries try to manage their fiscal space more carefully and are under a lot of pressure to cut costs in different parts of the economies to support the structural change. That is why it is a very sensitive issue.
As long as the rules of the game are clear for everybody, the investors will come.
IFC, a member of the World Bank Group, is the largest global development institution focused exclusively on the private sector. Working with private enterprises in more than a hundred countries, IFC uses its capital, expertise, and influence to help...