Speech delivered by: Jan Fischer
Event: Financial Market Symposium at Alpbach
Date: 11 September 2011
Ladies and Gentlemen
I am honoured to have been invited to give this Keynote Speech. The theme on how to finance the real economy could not be more significant; as many countries are facing the challenges of a weak recovery from the financial and economic crisis, compounded by fiscal consolidation and pressures from the euro-zone crisis.
With such distinguished and seasoned participants here today, I look forward to a fully engaging and dynamic discussion.
I would like to first begin with a brief background about the European Bank for Reconstruction and Development; or in a more speaker-friendly form, its acronym - the EBRD. The Bank was established in 1991, with a unique mandate to foster transition towards open market-oriented economies, and to promote private and entrepreneurial initiative in Central Europe and Baltic States, Eastern and South Eastern Europe, Russia, the Caucasus, Central Asia; and expanding in later years into Mongolia, and more recently into Turkey.
Mostly the EBRD finances private companies, provided in the form of both long-term loans and equity. The Bank also assists structural reforms through a broad range of instruments.
All of our 29 countries of operation are also shareholders, which have proved critical to ensure the ownership of the Bank’s policies by the recipient countries. Moreover, our presence on the ground, through the Resident Offices in our countries of operation, allows us to build strong ties with local governments and private partners.
As Vice President of Operational Policies for the EBRD, I am proud of the important role the Bank has played, in promoting a successful transition to a market economy, in the countries of Central and Eastern Europe. This transition has helped to underpin democratic institutions and thus support the aspirations of millions of Central Europeans to approach Western European standards of living.
Indeed, almost 22 years ago - on the cusp of fundamental change, few understood the challenges and complexities that lay ahead, in making the transition from state-dominated command economies, to well-functioning market economies. And from one-party Communist rule, to vibrant, pluralistic and dynamic democratic political systems. Central European countries’ and Baltic States’ progress in that transition, capped by their entry into the European Union in 2004, has been impressive.
Before the global economic crisis began to hit this region, there was much talk of the more advanced countries of operation ‘graduating’ from EBRD financing, as the transition to the market economy was deemed to be largely completed. My own country – the Czech Republic – graduated as a country of operation at the end of 2007.
Unfortunately, the recent financial and economic crisis has proven to test these previous achievements, as well as our ability to provide policy responses to these new challenges, both at the national and at the multilateral level.
Financial and Economic Crisis
A feature of the crisis, was that although it was global in scope, the impact was very local. Across our Bank’s region of operation, including across Central Europe and the Baltics, the impact of the crisis has been heterogeneous.
• For example, Poland did not suffer a banking or economic crisis. Indeed the only country among the Central European and Baltic States to remain in positive growth, albeit at a slower rate, of 1.6%.
• Both the Czech Republic and Slovak Republic avoided a crisis of the financial/banking sectors.
• Whilst all other countries were affected by both the financial and economic crisis; notably the Baltic States and Hungary.
Among the Central European and Baltic Countries, the Baltic States suffered the worst economic contractions by 2009, with double digit decline, and Latvia falling as low as -18%.
As an overall observation, the region generally witnessed:
• Sharp decline in commodity prices,
• Sharp decline, and a halt in some countries, in the flow of remittances,
• Collapse in output and trade,
• This was matched with rising unemployment, which created upward social pressure for government action, and reverberates until today,
• Contraction in credit availability.
Differences in how the crisis affected countries in the region reflected the level of financial, political, and economic and trade integration with Western Europe. With regard to the systemic financial integration, foreign banks owned large proportions of banking system assets in Central Europe, the Baltics and South-Eastern European countries in strong subsidiary networks: ranging from 60% in Latvia to 99% in Estonia.
The impact of the crisis in this regard was cushioned in five countries, Romania, Hungary, Serbia, Bosnia and Herzegovina, and Latvia; and parent bank support was formalized in the Vienna Initiative/European Bank Coordination Initiative. The Initiative pulled together home and host governments, bank supervisors and regulators, IFIs and parent banks.
• Home governments and supervisors allowed the use of financial sector support packages to Eastern European subsidiaries of Western European banks,
• Whilst, host government and supervisors agreed to implement sound macroeconomic and financial policies embedded in support packages of unprecedented size with the IMF (and the European Commission as appropriate) and banks committed to maintain their exposures to Eastern Europe.
• Thus, a “rush to the exit” of capital outflows was avoided.
Moreover, IFI support was crucial in bolstering confidence, in Eastern European banking systems during the most virulent phase of the global crisis (at end-February 2009). The EBRD, EIB, and the World Bank Group announced their Joint IFI Action Plan, promising support of €24.5bn to financial intermediaries active in the region by the end 2010. This amount was eventually well surpassed by actual support of €33bn.
Given the sheer magnitude of the external shock, overall, the EBRD’s region weathered the crisis reasonably well. Moreover, I think it should be noted that not all countries witnessed economic contraction.
8 out of the Bank’s 29 countries of operation managed to stay in a positive growth trajectory, albeit at a considerably slower pace.
Another legacy of the crisis has been the issue surrounding cross-border finance. Since the mid-1990s, external finance has been a successful driver of long-term growth in many of the transition countries. However, it also contributed to fuelling a large credit boom that went bust in the crisis. Particularly where these loans were made in foreign currencies, immense pressure was put on repayments that threatened to destabilise local currencies – a situation which, thankfully, did not materialise. The cost of bringing the situation under control, did however, require large-scale mobilisation by international crisis lending as well as painful fiscal adjustments by local governments.
As our latest Transition Report demonstrates, local currency finance comes second to foreign currency finance in most countries in emerging Europe, only in the Czech Republic, Poland and Slovak Republic, do local currency loans and deposits exceed 60%. Low share of local currency lending has been a particular feature of domestic bank systems in the Baltic’s over the last decade.
That is why the EBRD has emphasized the need to nurture more sustainable sources of finance. In May 2010, the Bank launched a Local Currency and Local Capital Market Initiative, which aims to address the root causes of high use of foreign currency in domestic financial systems and develop local capital markets using the expertise of other IFIs, the IMF and the World Bank.
Additionally, the Bank has led a private-public sector Working Group on Local Currency and Capital Market under the Vienna Initiative. These call for banks to discontinue the riskiest form of foreign exchange lending, while emphasizing the responsibility of governments, central banks and IFIs for developing capital markets for longer term funding in local currency.
Indeed, EBRD projects continue to explore the possibility of lending in local currency whenever possible. Progress has been made in sourcing local currency and organizing the necessary liquidity management facilities in more countries.
Corporate Sector Operations
The remaining transition gaps in Central Europe and the Baltic States relate to improving efficiency, productivity, competition, and financing challenges of MSMEs, especially in the context of constrained credit volumes as a result of the financial crisis. Credit to the private sector is still weak and continues to provide only limited support to economic expansion in some countries. The Bank’s current activities in the region will also continue to focus on re-invigorating growth. This will include continuing to provide long-term debt to companies particularly where commercial financing is unavailable to meet investment needs.
This will be aligned with restructuring corporate balance sheets for companies in difficulty, including by refinancing existing debt. The efforts in the corporate sector will be coupled with the Bank’s continued efforts in attracting commercial lenders back to the region. Additionally, the Bank will assist countries to move into the next frontier, towards a knowledge-based economy.
Energy efficiency and climate change
The economic crisis pushed the debate on climate change into the background. At the EBRD we have continued to front-load climate change and energy efficiency. Both challenging issues are considered pervasive to the Bank’s operations and form an integral part of all project assessments. The Bank’s business plan reflects our continued support for critical energy, renewable sources of energy, transport and municipal infrastructure projects.
The EBRD has continued its vigorous response to the impact of the global crisis in our countries of operation, financing a record number of projects in 2010; taking overall investments to unprecedented new levels of €9bn, compared to €7.9bn a year earlier.
We are especially proud that we have also signed a record number of projects in 2010, with 386 transactions, an increase of 23% compared with 2009.
Not only did the number of projects increase, the quality improved too: 93% of new standalone signings received a transition impact rating of “good” or “excellent”.
The recovery of the region is reflected in the EBRD’s operations in 2010. Taken together, the €9bn of EBRD finance and the €13bn of external funding generated in 2010, amount to a total project value of €22bn. It was the first time that the Bank, which earlier this year celebrated its 20th anniversary, passed the €20bn mark.
The increase in the number of projects was accompanied by the decrease in the size of individual projects. This reflects successful efforts to find tailor-made solutions, especially for smaller enterprises for which access to finance often remains difficult. With our financing we aim to support the real economy.
Partner and Donor Cooperation
Additionally, the Bank is fortunate to have a highly valued and strong partnership with its donors and other IFIs, all of whom contribute to the success of our ambitious activities in the region.
Donor grants play an essential role in the Bank’s added-value to its clients and its region, by bringing resources and expertise to tackle the numerous challenges that investments alone cannot overcome. In addition to forms of co-investments; technical cooperation has also been pivotal in supporting the EBRD’s core activities in the region, whether it is towards a sustainable financial sector, the global challenges of mitigating climate change or the need to improve energy efficiency.
The Bank remains very grateful for the continued support of its donors, which in 2010, contributed €215m in new funding agreements with the EBRD, particularly given the fiscal pressures on the budgets of our donors. Mindful of these constraints, the EBRD ensures that their valuable resources are used efficiently and with demonstrable impact.
The EBRD has a strong cooperation with the EU, in terms of co-financing and policy dialogue. The EU has provided €1.7bn for co-financing as well as €478m of Technical Cooperation Funds, generating a total of €7bn of projects. This cooperation has gained pace in recent years, with the launching of three new EU facilities: the Neighbourhood Investment Facility (NIF), Western Balkans Investment Funds (WBIF), and the Investment Facility for Central Asia (IFCA).
Additionally, the EBRD has been working closely with some of the recipient national governments of the Structural and Cohesion Funds facing absorption difficulties, together with the European Commission and other IFIs, to help these countries unlock the potential of the funds; such as in Bulgaria and Romania where low-absorption appears to be particularly acute.
Further on from this, the EBRD is one of the founding partners of the JASPERS initiative, which is a partnership between the Commission and key IFIs providing technical assistance to help with the preparation of major projects in the 12 newest Member States of the European Union. This project has helped considerably in speeding up project approvals by the Commission, and generally in improving the quality of projects coming through.
Recovery is now underway across the whole EBRD region. For Central Europe and the Baltics, our Bank’s economists expect growth to reach 3.5% in 2011, compared with 2.7% in 2010. Generally, growth – which was net export driven in the immediate aftermath of the crisis – is becoming increasingly based on domestic demand as capital inflows return and core Europe, the region’s most important trading partner, grows briskly.
We have witnessed the return of net inflows to the region although FDI inflows remain well below pre-crisis levels. Whilst capital inflows were strong at the beginning of the year, they have ebbed or even reversed in May, reflecting possible investor concerns that the region is particularly exposed to the developing debt problems in Europe.
The success of the EBRD’s mandate to foster convergence and integration across the region, means that the malaise of Western Europe bears down on the new EU member states and surrounding countries.
In this regard, the escalating Eurozone crisis, of course, poses mounting risks to the growth outlook for the region, especially in South-Eastern Europe and the new EU Member States; despite the significant external adjustment that has already taken place in the region.
Under a very pessimistic scenario, the deep trade and financial integration with Western Europe, means that Central Europe, the Baltics, and South-Eastern Europe would be exposed to disruptions in financial markets, an increase in bank funding costs and a slow-down in Eurozone growth.
Energy Crisis, Ageing Population, Migration and Unemployment
Whilst the overall outlook is positive, we cannot let it distract us from the salient, future, common global – threats that need to be addressed now. Here, I am referring to the challenges brought by a possible energy crisis, ageing population and migration. Governments have already had to make difficult but necessary reforms, which, as we have witnessed in some countries, have been visibly unwelcome and unpopular.
Also, the sombre labour market remains one of the worst remnants from the crisis. Persistently high unemployment rates – a characteristic feature for many of the new EU member countries, including those with very decent growth rates, are a reminder of the need to strengthen the fundamental drivers of growth: education, diversification and competition. Although, the EBRD focuses on promoting entrepreneurship and private sector growth, we have always recognised that success in transition is fundamentally about improving the lives the of people in the countries where we work.
Finally, the crisis has also altered somewhat the economic map, putting the large emerging countries – China, India, Brazil – in a new light as economic drivers and competitors with the developed world. As China powered its way through the crisis and continued its stunning growth path, passing Japan as the second largest economy in the world, it is now a force to be reckoned with in third markets (like in Africa and Central Asia) and within the major global financial institutions.
This brings me to a new direction in the EBRD’s operations: expansion of the Bank’s mandate to nations of the Southern and Eastern Mediterranean, stemming from the historical changes that have and are taking place in this region. Based on our specific skills and transition experience, the Bank has been encouraged by the international community, to invest in countries in the region, which are engaged in a transition process.
However, I would like to empress upon the strong commitment of the EBRD to our existing countries of operation; is as firm as ever. The Bank’s expansion into the Southern and Eastern Mediterranean will not come at the expense of a lower business volume in our existing region.