Publication overview

Transition report 1996: Building an infrastructure for transition and promoting savings

The 1996 Transition Report has two special topics: the status of inherited infrastructure in transition economies and the need to commercialise its services; and the role and character of domestic savings by enterprises, households and governments. The Report also provides an assessment of macroeconomic performance and medium-term prospects.

Summary

Seven years after the fall of the Berlin Wall, difficult tasks at the heart of transition remain to be tackled, says EBRD's 1996 Transition Report.

Since the fall of the Berlin Wall, impressive advances towards a market economy have been made in the countries of eastern Europe, the Baltics and the Commonwealth of Independent States (CIS) but some of the more difficult tasks at the heart of transition have yet to be tackled, according to the 1996 Transition Report, published by the European Bank for Reconstruction and Development (EBRD) today.

"From a historical perspective it is likely that the pace of progress will be seen as remarkably rapid in much of the region. However, the legacies of a command economy cannot be overcome in a few years. Major tasks remain in taking reform forward" said Nick Stern, Chief Economist at the EBRD.

Key tasks such as price and trade liberalisation and the privatisation of small-scale enterprises have been undertaken relatively quickly, but more lengthy and complex processes such as enterprise restructuring, the rehabilitation and rebuilding of infrastructure, and the building of strong financial and legal institutions are only now being addressed.

As in previous years, the 1996 Transition Report combines cross-country studies with detailed analysis of the reform process country by country. The attached transition indicators table summarises each country's progress in transition. The Report also analyses the challenges of the coming years. With up to seven years of experience in some countries, the process of change and the challenges of differing stages of transition are now better understood.

Key developments in market-oriented transition over the past year

• Albania, Romania and most of the CIS have made substantial advances in the privatisation of large state-owned enterprises. The preferred method of privatisation has been a "mass" transfer of ownership.
• The financial sector continues to lag behind other reform areas, such as price and trade liberalisation and privatisation. Bulgaria, the Czech Republic, Kyrgyzstan, Latvia, Lithuania, and Russia have witnessed a new spate of banking troubles over the past year.
• The countries most advanced in market-oriented transition, notably the Czech Republic, Estonia and Hungary, have begun to privatise major utilities and transport. Hungary has achieved the most comprehensive privatisation of utilities and been the most ambitious in introducing private sector finance and risk-taking in road construction.                                                      
  
  This year's Report has two special topics: the status of inherited infrastructure in transition economies and the need to commercialise its services; and the role and character of domestic savings by enterprises, households and governments. The Report also provides an assessment of macroeconomic performance and medium-term prospects.

Efficient, reliable and user-oriented infrastructure is a basic ingredient of a well-functioning market economy. The infrastructure inherited from the old regime reflects its misplaced priorities. The environmental implications of infrastructure were given little attention, leaving a legacy of pollution and inefficient energy usage. Certain services were abundantly supplied, while others were neglected. Because of this, sectors such as telecommunications, waste water treatment and road transport remain underdeveloped compared to the demands that would be expected in a market economy. Yet in the electric power sector, declines in economic output, including the contraction of heavy industries, mean that capacities must adapt to decreased demand. Electricity generation, though, needs to respond to the increased concern for the environment.

While tariffs have been raised from their very low levels under central planning, especially in the countries of central Europe and the Baltics, they do not yet reflect the true costs of service delivery and the financial constraints on governments. Tariff collection remains weak and political and social considerations have led to a slow pace of tariff reform.

Faced with these concerns and the tight financial constraints of transition, a number of governments have sought to encourage greater private participation in overhauling infrastructure. Telecommunications, where the gap between capacity and demand is particularly wide, has attracted the most investor interest. Some electric power generation and distribution companies have also been privatised.

A total of US$ 6 billion of foreign investment flowed into the region's major infrastructure companies between 1990 and early 1996, primarily in telecommunications and, to a lesser extent, the electric power and gas sectors. This represents 20 per cent of the cumulative flow of foreign direct investment during that period. International commercial banks have also become more active in the region, although in 1995 twice as much lending flowed into Latin American infrastructure (a region with a population of about 450 million compared to 400 million in the EBRD's countries of operations).

On the role of domestic savings, the Report underlines the relationship between the level of investment and improvement in living standards, and emphasises that such gains can be sustained only with high levels of domestic savings. Investment and domestic savings in the region have fallen substantially since 1990, having reached very high levels (albeit wastefully used) under the old regime. This mainly reflects sharp falls in company surpluses, which were the dominant source of domestic savings under the previous system. In many countries it also reflects an increase in government budget deficits. Meanwhile, household savings have increased, but not enough to offset the deterioration in the enterprise and government sectors.

Policies that should help to reverse this trend include reducing government budget deficits to raise public savings, and reforming social security systems and public pensions to boost private savings.

An important element of transition is to increase the types of savings instruments and institutions. New life insurance companies and private pensions institutions remain at the early stages of development. They are, however, beginning to expand the range of financial services on offer in a number of countries. Such instruments and institutions can help the development of local markets for long-term debt and equity, including for infrastructure, and can facilitate reform of public pension systems.

Macroeconomic performance

• Full-year growth in real GDP for eastern Europe and the Baltics is expected to drop to around 4 per cent in 1996, from 5.2 per cent in 1995 (see the attached macroeconomic indicators tables).
• While Russia and Ukraine still await positive growth, five of the smaller CIS countries are expected to record positive full-year growth for 1996.
• Whilst inflation has continued to fall in most countries, hard won gains in macroeconomic stabilisation have slipped away in Bulgaria, Romania and Albania, which have seen significant increases in inflation.
• The trade balance in a number of countries has deteriorated over the past year, mainly due to a sharp pick-up in domestic investment and consumption, alongside sluggish growth in export demand from the European Union.
• A deterioration in export competitiveness appears so far to have played less of a role because increasing productivity has offset the impact of rising real exchange rates on competitiveness. However, major industrial restructuring will be required if productivity is to continue to rise.
• The manufacturing sector has seen a rapid increase in labour productivity of about 10-20 per cent in 1995 in Bulgaria, the Czech Republic, Hungary, Poland, and Romania. Further increases were recorded in early 1996.
• A comparison of wage costs in eastern Europe with those of Germany indicates that the export competitiveness of the manufacturing sector of the Czech Republic, Romania, and especially Hungary improved in 1995 and early 1996. The export competitiveness of Bulgaria, Poland, Russia and the Slovak Republic deteriorated.
• Declining growth in eastern Europe is a reflection of short-term developments, including a tightening of fiscal policies (in Bulgaria and Hungary) and slow growth in the main export markets in the European Union.
• The medium-term growth prospects for eastern Europe, the Baltics and the CIS are likely to be determined to a greater extent by the organisation and better usage of labour, raw materials and capital as well as the level of high-quality investment in human and physical capital. In this regard, prospects look bright. For eastern Europe, forecasters typically expect growth of about 4-5 per cent per year for the remainder of the decade.
• Due to insufficient data, Bosnia and Herzegovina, which became a member of the EBRD in April 1996, has not been included in this year's Report.