Struc­tural is­sues hold back SEE's growth po­ten­tial, gov­ern­ments should not let up on re­forms

Top 100 See - - Top 100 Companies - By Nevena Krasteva

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

so­cial stan­dards.

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.

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 ex­clu­sively on the pri­vate sec­tor. Work­ing with pri­vate en­ter­prises in more than a hun­dred coun­tries, IFC uses its cap­i­tal, ex­per­tise, and in­flu­ence to help elim­i­nate ex­treme poverty and pro­mote shared pros­per­ity.

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