New approach needed to plug investment gap, says EBRD report based on unique financial sector data
The EBRD has called for a major change in the financing model for the transition region to plug a US$ 75 billion per year investment gap that is a serious impediment to growth and prosperity.
The EBRD’s Transition Report 2015-16 urges a rebalancing of the finance flowing to a region that includes countries in central and south-eastern Europe, the former Soviet Union and the southern and eastern Mediterranean.
In this year’s Transition Report, the EBRD is specifically looking at the financial sector in transition. Hans Peter Lankes, EBRD’s Acting Chief Economist, looks at the highlights of the report.
At a time of excessive reliance on debt financing, the report says there should be a greater focus on private equity. There also has to be a shift away from foreign currency to local currency funding.
More emphasis needs to be placed on providing finance to the corporate sector, especially smaller firms, and the geographic source of inward investment needs to be broadened out, with stronger investment links with emerging markets and with advanced economies outside western Europe.
“Improving this funding balance will provide a solid basis for the levels of investment that are needed to restore growth and to return to a path of convergence with more advanced economies,” said Hans Peter Lankes, the EBRD’s acting Chief Economist.
“Rebalancing does not mean shifting from one extreme to the other. Instead, this Transition Report calls for the gradual and sustainable optimisation of the structure of the financial system,” Lankes added in the report’s foreword.
The report notes that, seven years after the eruption of the global financial and economic crisis, growth across the transition region as a whole is close to zero and that income convergence with more advanced economies has stalled.
At the same time, a dramatic reduction in external imbalances in the region has come at the expense of investment. “The region needs to invest around US$ 75 billion more per year to bring investment back to the levels expected of economies at this stage of development,” the report says.
The conclusions in the Transition Report – the calls for financial sector rebalancing – are based on analysis of unique data that reflect the EBRD’s unparalleled ties to financial institutions, private equity investors and firms across the region.
A section in the report on the impact of the credit crunch on small businesses uses macroeconomic, firm- and bank-level data to assess the extent to which firms across the transition region have become more credit-constrained since the start of the crisis.
It highlights the importance of relationship banks as a stable source of finance for small and medium-sized enterprises (SMEs) and suggests that efficient SME lending can be stimulated by creating well-functioning credit registries and decisive action to deal with non-performing loans, which continue to weigh on the balance sheets of many banks.
In calling for a better balance between debt and equity financing, the report notes that private equity, in particular, remains an underutilised source of external funding for companies in the EBRD region.
The Bank’s analysis shows that private equity investment in companies in the transition region has a strong positive effect on employment, capital investment and productivity, in fact stronger than in more advanced economies.
Policy-makers in EBRD countries of operations could take steps to increase the flow of private equity funds, such as strengthening the protection of minority shareholders, improving corporate governance and fostering the development of public equity markets.
In calling for increased local currency lending, the report notes that “dollarization” of credit remains exceptionally high by global standards, with around 50 per cent of the total debt denominated in a foreign currency in 2014. Successful rebalancing would need macroeconomic stabilisation and in some cases changes to bank funding models.
The report says that investment finance in the region would benefit from more diverse capital flows and investment partnerships, with other emerging markets and non-European advanced economies playing a greater role.
To read the full report, please visit the Transition Report website.