Sir Suma Chakrabarti, EBRD President
Organised by the Official Monetary and Financial Institutions Forum (OMFIF)
Sir Suma Chakrabarti discusses re-energising transition
It is a pleasure for me to be here today and I would like to thank David Marsh for his kind invitation.
As you probably know, I am the head of the European Bank for Reconstruction and Development. So, before I get in to the topic of my speech, a quick commercial on the EBRD. What is the EBRD?
The EBRD is an International Financial Institution, similar to the World Bank, and other multilateral development banks like the Asian Development Bank, the African Development Bank, and so on.
But, as International Financial Institutions go, we are relatively youthful. The EBRD was created as recently as 1991 after the fall of the Berlin Wall to foster transition towards market economies and democracy in the post-communist world.
Unlike other development banks, the EBRD’s mandate reflects a particular political and economic model. In the words of its founding document it assists only those countries “committed to and applying the principles of multi-party democracy [and] pluralism”. Safeguarding the environment and a commitment to sustainable energy are also central to the Bank’s activity.
Our focus is on the private sector – the ratio of private sector operations is around 80% -- and we provide no budget support and balance of payments lending, but we finance projects.
Other regional IFIs such as the ADB or AfDB have names that describe their geographical scope: the “A” means they work in Asia or Africa. The “E” in EBRD was always misleading. We operate in CEE certainly, but also in Russia and Central Asia from day 1, back in 1991. Since then, Mongolia became a Country of Operation (COO) in 2006, Turkey in 2008, and we started investing in Morocco, Tunisia, Egypt and Jordan in autumn 2012. From Casablanca to Vladivostok!
Like other IFIs, the EBRD is owned by governments: 64 of them plus the European Union and the European Investment Bank. But “E” is again misleading – our shareholders are not limited to European countries and our countries of operations. They include countries outside Europe such as the USA, Canada, Japan, Korea, Australia, New Zealand, and Mexico.
We have a strong capital base of €30 billion and currently invest € eight to nine billion annually in approximately 400 projects. Our “triple A” rating allows us to play a catalytic role and help mobilise further funding into our countries of operations. The total value of our projects is about two-and-a-half times larger than our own financial contribution.
In the majority of our countries of operations, we are the largest non-oil and gas investor and the biggest foreign investor.
In Eastern Europe, our success was very much linked to our intimate knowledge of local markets. We have a strong team on the ground - with support and expertise from sector bankers based in London. This model has proved its value. We are now replicating this model in Tunisia, Morocco, Egypt and Jordan: opening and staffing local offices.
This model allows us to provide tailor-made financing. We can provide a wide range of financial instruments- virtually everything. Secured and unsecured senior debt. Junior debt and quasi equity instruments. Full equity.
Since 1991 we have financed some 4,000 projects with cumulative investment volume of €90bn in our COOs. We work across a wide range of sectors, working on privatisations and large corporate restructuring as well as with SMEs.
So, we matter in volume and our opinions can influence: from project lending to policy impact in COOs, eg on investment climate and tackling corruption.
We bring a unique expertise of the private sector and middle income countries, complementary to other IFIs. We have remained true to our original vocation.
By developing the private sector in the countries where we operate, change can be encouraged:
- the more private companies thrive, operate across borders and become part of the global fabric of exchanges and ideas, and the more we can empower smaller enterprises and the Mittelstand,
- the more we see a middle class emerging which is open to the world, which will want to protect the progress that they have made, and which will want to be heard: these are the roots of a functioning market economy and of democracy.
In summary: we are a long term investor. And, if you allow me, the Bank has had a major impact on the development and transition of our region of operations.
With this in mind allow me now address the important question David has invited me to discuss and I will do my best to put to you what I believe is a nuanced answer.
What is the issue in a nutshell? Growth is returning but it is anaemic and, according to the IMF, likely to remain so. In the aftermath of the global financial crisis and then the eurozone's existential struggle, potential growth has reduced significantly both in advanced and in emerging market economies. This is the result of years of underinvestment and high long- term unemployment with permanent loss of skills and qualified human capital.
The policy dilemma is what to do about this. Should government policies focus on the demand side, providing stimulus, or on the supply side, accelerating structural reforms?
We at the EBRD have been discussing these issues for quite some time. Our seminal Transition Report 2013 presents a far from satisfactory picture: economic growth remains well below pre-crisis levels. In fact, in most of our countries reforms have lost momentum before the global financial crisis hit. Slowing reforms from the mid-2000s have led to a drop in productivity. As the report says, much of the EBRD region is “Stuck in Transition”.
Long-term forecasts suggest that under current policies and institutions, productivity growth will remain modest over the next decade and decline further in the following decade. At that rate, convergence with living standards in western Europe would stall in some countries and slow to a crawl in many others.
In contrast, if countries do restart reforms, long-term growth can be increased between 0.8 to 1.5 percent a year over the longer term. The policy implication is very clear: structural reforms have high growth dividends. In order to reinvigorate growth, governments must accelerate structural reforms.
In which areas are the reforms most “stuck”? Without going into too much details, let me highlight a few key areas:
- Energy sector reform reversals have taken place in the advanced transition region of central Europe. We have seen administrative tariff reductions in Hungary and Bulgaria, which are pushing prices to below cost recovery levels. This deters investment in the sector and, over the longer term, risks undermining competitiveness in the economy. This sector has also seen re-nationalisations.
- Capital market development has progressed in many countries, but has also suffered setbacks in the form of curbing or de factor eliminating the fully funded private pension leg of the pension system (in Hungary and Poland, for example). While there have been some justified concerns with high fees in the private sector industry, the main motivation has been improved fiscal revenues and flexibility. This comes with risks of undermining the domestic investor base of local capital markets and more generally progress towards shifting funding from foreign to domestic sources.
- Delays in privatisation have occurred; renationalisation has taken place and in general state interference has risen in quite a few countries. This was part of the initial 2008/9 global crisis response, for example in Kazakhstan, Russia, Ukraine, or even Latvia where failed banks had to be nationalised. But today there is little justification for the government to permanently keep productive assets in competitive sectors - Russia is a good example for this. Privatisation remains an unchartered territory in major central Asian countries.
- Lack of independence of regulatory bodies or competition agencies remains an issue, particularly outside the EU or EU candidate countries as well as in our new region MENA/SEMED. Actually in several SEE countries inadequate regulatory frameworks have been a key culprit for failed privatisation efforts.
- Anti-corruption and the lack of good governance and a predictable business environment is a major concern in many CIS countries, but even in southern Europe. I can mention the countries where we have geared up with the country authorities to tackle these problems proactively: Ukraine, Albania, as well as Moldova. Other countries, particularly in Central Asia, have yet to face up openly and forcefully to these issues.
I will stop here. The list is unfortunately much longer, but the above examples can give you the gist of the problem.
We have been advising our countries to re-energise reforms but it will not happen unless countries themselves decisively pursue structural reforms and take on vested interest. Reform agendas are naturally country-specific, yet the above list can give you the main cross-cutting reform themes.
Let me re-emphasize: to reignite growth, the most important task is to reignite reforms.
That said, it is becoming clear that growth is also suffering from the effects of low demand in the aftermath of the financial crisis. Larry Summers has brought back the idea of "secular stagnation" from the times of the late 1930s to describe this permanent loss in demand and many agree with him.
We as major investors in our countries are also asking if there is any room for any fiscal policy action in EBRD countries.
I have asked my staff to investigate this issue, posing the following question: can the impact of much needed structural reforms be enhanced by also applying stimulus on the demand side? As supply-side bottlenecks are being tackled, the aggregate demand could in theory be boosted through action on public expenditure.
Of course, as all of you know in this room, there is no clear consensus on the effect of looser fiscal policy on economic growth. Among other things, the size of the fiscal multiplier is a subject of continued debate.
But fiscal stimulus can work under certain circumstances. We have identified twin conditions for this: (1) when countries can afford fiscal stimulus, and (2) when they can efficiently absorb it.
Let us examine these two conditions:
- (1) "Can countries afford it?" means that the stimulus does not endanger debt sustainability and trigger counter-productive rises in interest rates. Indeed, increasing government borrowing over a certain limit runs the considerable risk of losing investor confidence in the sustainability of fiscal health. This might lead to markets demanding higher returns on sovereign debt investments.
- The current fiscal health of transition countries varies substantially. But most transition countries have public debt levels below 60 per cent of GDP and deficits below 5 per cent of GDP – both favourable figures relative to many Eurozone countries, though rather high when compared to levels markets many consider healthy for emerging economies.
- (2) The second condition is the existence of good absorptive capacity. Countries that are struggling to recover are likely to be better in absorbing a stimulus as they are likely to have a surplus of production capacity, idle labour and possibly funds available for investment. Therefore an increase in aggregate demand is more likely to lead to a supply response. Government borrowing is also less likely to increase interest rates and result in crowding out the private sector. Poorer countries tend to grow faster as they catch up and enjoy comparative advantages in terms of labour costs.
- Likewise, absorption capacity will be weaker in countries with high propensity to spend additional income on imports. Therefore a high ratio of imports to GDP would generally indicate that the fiscal multiplier could be smaller.
Analysing the above factors we have found that the largest group of transition economies is somewhere in the “middle ground”: they may have some, but limited, fiscal space or absorptive capacity. Overall they probably should not resort to fiscal stimulus.
The few EBRD countries that seem to be able to "afford" fiscal expansion and likely to absorb it well are Georgia, Bulgaria and Estonia (the latter two subject to their exchange rate regime constraints).
Does this mean that there is no room for fiscal policy action in support of growth?
No. Even if in most cases there is little or no room for fiscal stimulus, we do know that certain expenditure items have a higher effect on growth than others - their so-called “multiplier effect” is higher. For instance, infrastructure spending and targeted assistance to liquidity-constrained consumers have been shown to have higher growth-generating effects. It could thus be argued that even without additional fiscal demand, i.e. increasing the fiscal deficit and debt, there could be a positive stimulus from shifting, within the existing fiscal envelope, expenditures towards higher domestic demand generating items such as infrastructure or towards individuals on high propensity to spend, mainly on domestic goods and services.
Let me conclude:
- To re-energise transition it's largely a role for governments of EBRD countries of operation to have the political will, courage and leadership to take on vested interests and implement structural reforms.
- There is only room for a more activist fiscal policy in a few countries. That said, even where there is no room for fiscal stimulus, countries with weak demand prospects can get some boost from shifting spending towards spending that would generate more growth in the future, such as infrastructure.
- The EBRD's task is to put to use our project- and sector-based experience to engage more wholeheartedly in policy advice to support the reformers. In the process we can help build independent, market-supportive institutions and market structures and as such help cement the system of checks and balances and good governance. And with our projects in infrastructure and other growth-enhancing areas we can help support growth from the demand side.