EBRD chief economist: Fight corruption, improve governance, invest in connectivity

By Nevena Krasteva

Sergei Guriev, chief economist of the European Bank for Reconstruction and Development (EBRD)

Emerging economies need to reassess their economic model to deliver the governance, skills and infrastructure that will finance sustained economic growth, according to the EBRD report Eight Things You Should Know About Middle-Income Transitions. What are the main challenges facing countries in Southeast Europe (SEE) in particular?

Basically, the region consists of two different parts. The EU member states and the Western Balkans share some common challenges but the opportunities in member states and non-member states are very different. The challenges for the Western Balkans and for Bulgaria and Romania are emigration, ageing and brain drain. For Bulgaria and Romania they are aggravated by the fact that Bulgarians and Romanians have much easier time to get jobs in the West, and so the exit of skilled workers is much more painful.

However, Romania and Bulgaria can benefit from EU structural funds and can build infrastructure. In the Western Balkans too there is EU investment, as well as EBRD investment, but it is on a different scale. Yet investment in infrastructure in the Western Balkans is key to growth. Why? Because these countries are small. If they stay unconnected, they cannot really develop, they cannot really invest, they cannot really create knowledge-intensive jobs. Connecting markets creates jobs. These are the main challenges basically – emigration, ageing, infrastructure and connectivity.

Another issue not just for Southeast Europe, but one that is especially [big] in Southeast Europe, is governance and corruption. As you know, Romania has not yet exited the Cooperation and Verification Mechanism (CVM), so the EU does not believe Romanian governance is up to the European standards. You see major corruption issues in the Western Balkans, as well. I think Bulgaria is on the way out of the CVM but initially the CVM was supposed to be ended in two or three years after a country’s accession and the fact that it took ten years [for Bulgaria to end it] is also suggestive. These are the major constraints to growth and investment. They are fixable and other countries did fix them.

Also, we know that political competition and media freedom is the most effective tool to fight corruption. Unfortunately, in some Westеrn Balkans countries media freedom is not moving in the right direction.

The latest EBRD economic outlook projects that growth in SEE will slow down to around 3.0% in both 2019 and 2020 from 3.4% in 2018. What are the main global risks impacting this region?

In the Western Balkans almost every country is growing at 3% except for Albania and Kosovo where we project 4% growth but starting from a much lower base. The biggest challenge globally is the US-China trade war, which has escalated again. Our countries are not directly affected, but they are affected indirectly. If the Chinese economy slows down, the German economy slows down, and our countries are very much dependent on the German and the West European economy.

How about Brexit?

Brexit is a problem for the UK and its largest trading partners – Western Europe – but not for our countries, where we do not see a major impact. Southeast Europe is affected more than Central Asia for example but we see risks in the order of magnitude of decimal points of percentage points.

The EBRD economic outlook report says that the region’s economic slowdown reflects a deceleration of the Turkish economy. Do you think its impact will continue to be felt in the future?

The average GDP figure for the region has been brought down by the Turkish figure because Turkey is a big part of the region. This year Turkey is going to be in recession and next year Turkey will rebound and our regional numbers also are affected by this. But there is no big spillover from Turkey to other countries. Overall, we hope that Turkey will start growing next year and that depends on policy response. We will see.

Would a possible interest rate hike by the Fed and ECB affect FDI into SEE?

If interest rates in the U.S. and Europe go up, this will have a major negative impact on our economies, and the more they go up, the more tangible the impact because it will result in an outflow of investment from our region. Last year we did see a tightening and higher cost of capital and things became more difficult. But even last year by historical standards the tightening was not too painful and in 2019 that trend reversed because the U.S. said it is not raising interest rates any further and the ECB is not increasing interest rates, either.

Moving on to the banking sector in the region, do you think it is stable and how would you comment on the level of NPLs?

We see that the situation with NPLs is improving. When we talk about a high share of NPLs, we talk about countries outside SEE like Greece and Ukraine. We have the Vienna Initiative where we bring together international financial institutions and banks and try to coordinate and share best practices on handling NPLs. Overall, we do not see major reasons for worry in the banking system. One big issue was of course the Romanian policy change which raised a lot of concerns and we are monitoring the situation closely.

What would you like to say in conclusion?

We mentioned the biggest challenges of this region which are emigration, ageing, skills, governance, connectivity and so when you think about overcoming those problems, reforming the education systems, fighting corruption, investing in infrastructure and overall EU approximation is the way forward. Whatever we do, this region will be integrated with the EU in whatever modality over the long term, which means the issues related to brain drain will intensify. We see this in Western Europe and in Central Europe. Once Western markets are open for East European workers, brain drain becomes even stronger. The Western Balkans will also suffer, unless they create high-value added jobs. And to do that you need to fix corruption problems, you need to improve governance, you need to invest in innovation, research and development and skills. And again, connectivity is important even now, not only with the Western markets but in the region, because these countries are small and for innovation and for knowledge- intensive industries you need size, you need scale. This is why we promote this idea of regional integration before European approximation works out.