by Georgi Georgiev
IFC, a member of the World Bank Group, is the largest global development institution focused on the private sector in emerging markets. Working with more than 2,000 businesses worldwide, IFC uses its capital, expertise, and influence, to create opportunity where it’s needed most.
Economic growth in Southeast Europe (SEE) is picking up but remains below the region’s potential. What can be done to accelerate the pace of economic activity?
One of the biggest issues the region is struggling with right now is that structural reforms have not moved as fast as we have expected or hoped for. As a result, SEE countries are saddled with relatively high unemployment and poorly functioning labour markets and, consequently, the levels of growth across the region are not reaching full potential and are not high enough to address those kinds of fundamental challenges. Ultimately, if I were to identify what the top priorities for governments in the region should be, it is to take care of much-needed structural reforms and alongside that also focus on areas of competitive advantages that their countries may have. And then thirdly, I would say, is to look at how to help unlock the financing potential in the region, how do you incentivize banks to lend more actively. That touches the subject of non-performing loans (NPLs), the subject of deleveraging of Western banks which are present in the region and, to some extent, also the subject of the need for greater development of capital markets in the region.
What role do you see for the international financial institutions (IFIs) in this process?
The slow growth and the other macro-economic challenges in the region are nothing new. They started to emerge after 2008. On that backdrop, the IFIs, including the IFC, decided to engage actively together in designing an action plan. There was the first round of the action plan in 2008 and another round in 2012 when we realized that growth is not coming back to the region. As part of this action plan, the IFIs have put quite a bit of funding in both the public and private sector in the region to help stimulate at least the financing part of the whole equation. Going forward, high on the agenda of the IFIs is how to channel funding to support the development of local capital markets.
There is also a need for the IFIs to engage on NPLs, which have been weighing heavily on the region’s banking sector, to the extent that we can find ways to help banks reduce that burden and allow them to lend more to productive enterprises. On competitiveness, what the IFIs can do is try to find companies which are ‘winners’, companies that have a good pool of skills, or a competitive advantage in terms of technology or location. For example, we have worked with some agribusiness companies in the region on how to improve their supply chains. The IFIs can also help create sustainable access to infrastructure in the region.
When it comes to structural reforms, this is an area that is difficult for a group like IFC to engage in directly as we tend to invest in individual projects, individual transactions. This is something where we expect the International Monetary Fund (IMF) and the World Bank to take the lead role and I know that is a priority for them. However, IFC does have a joint advisory practice with the World Bank proper where we are working with governments on trade and competitiveness issues that have significant bearing on efforts to improve regulations and create opportunities for business to flourish.
What external risks do you see facing economic development in the region over the near to medium term?
The region is fairly well integrated into Europe so the pace of growth in the eurozone is important. That is one of the key risks as growth in Europe has not been great. Another eurozone-related impact is the events unfolding in Greece. That relates both to the extensive footprint of Greek banks in some parts of the region but also Greece is an export destination for SEE countries.
The fiscal limitations faced by the SEE governments are also a major concern as there is not enough fiscal room to stimulate growth through public spending. So the growth will ultimately have to come from the private sector. Although we are keen to see that happen, if governments are unable to support private sector growth through public measures – be it through public-private partnerships or any other types of structures – that may take some steam off the infrastructure investment.
The other potential risk for growth in the region is Russia, although the scale of the potential impact varies from country to country, as Russia is an important export destination for some of the SEE countries.
What can be done to reverse the decline in capital inflows to the region?
The issue here for me is boosting competitiveness: how do you make yourself attractive vis-à-vis all the other places around the world which are trying to attract investors? When it comes to global companies, they need to see what is the competitive advantage of a specific country – is it its future membership in the EU, is it its domestic market potential, is it a platform to export somewhere else.
The priority for these various countries is how to identify the winning sectors in your own economy, how to attract international companies. Serbia has done some interesting things trying to reach out to the Middle East for investors. Capital will start to flow into the region once there is a clear perception of a stable business environment and of governments that are open for business. That has not always been consistent throughout the region. If we can break the cycle of changing the rules too often, that would make the SEE countries more appealing for investors.
What constraints are high debt levels and vulnerabilities in the banking sectors putting on economic growth in SEE and how should these be tackled?
Unless the banks are able to lend, it is very difficult for companies to grow. And banks are limited in lending because of the high burden of NPLs and certainly in the case of SEE, the average NPL ratio is relatively high. What the IFC can do to help deal with this issue? One side of this, of course, is regulation. Jointly with the World Bank, the IFC is working in a number of SEE countries to help improve the regulation for how to deal with NPLs, how to assess them, how to sell them, basically how to take them off the balance sheets. Some countries are more active in this than others. Romania is probably in the forefront of how SEE countries have dealt with the NPLs situation. Generally, we find that regulations are less of a constraint in SEE than other issues, primarily having to do with are the banks there ready to sell those loans, are they willing to recognize the one-off hit that the sale of an NPL is going to create on the balance sheet. That is the process that has taken the longest in SEE – convincing the banks that it is in their interest to exit those exposures, to move on, focus on core areas and leave the aspect of dealing with NPL portfolios to specialized companies.
The IFC created what we call Debt and Asset Recovery Program several years ago and through that program we are putting in – not just in Europe, assets to support companies that work out NPLs, that purchase NPLs and create specialized market infrastructure to deal with the problem. In SEE, there are some cases, a couple of companies that we have supported that do that.
Some of the banking sectors in SEE are relatively small so they would probably not be able to attract an investor that specializes in NPLs resolution. But as long as SEE governments are willing to encourage their banks to go through that balance sheet cleanup process and there is a regional platform focusing on 3 or 4 different markets, an investor may still make an offer on a relative small portfolio. Then they will be able to aggregate it with the pool of funds they manage. So size could be a problem but for as long as the focus is on regional platforms, it is manageable.
What role could the IFIs have in helping resolve the build-up of NPLs in SEE?
The role of the IFC is more on the micro-level – we want to support individual transactions, individual banks. There are a number of transactions in SEE where we are looking at specific deals involving NPLs.
The subject of how one relates to central governments and regulators on this is beyond our usual sphere of influence. Yes, we are working closely with the World Bank in a number of SEE countries, also the IMF which obviously has extensive experience in dealing with this in many other markets. There is finally more willingness on the part of the banks to engage on the NPLs issue and, as a result, there are more opportunities for us to support the workout process. But we all have to accept there is a big political component.
One reason for that is that many of those bad borrowers are state-owned. And this again touches on the issue of structural reforms to the extent that the public sector is an important employer in these countries and the governments are taking their time to privatize or restructure ailing enterprises. From our perspective, we would encourage the governments to take more aggressive steps on this because it feeds into the subject of competitiveness: how do you create competitive economies with borrowers which are not doing so well? What we can do as IFIs is provide examples from various other markets, give suggestions how certain structures can be put into place and we can create instruments that can support this but ultimately the governments need to take charge.
How is the IFC positioned to help SEE governments boost economic growth, capital inflows and job creation?
In most emerging markets, most jobs are created in the private sector. So we feel that by supporting productive and competitive private sector enterprises we do the most to either preserve jobs or help increase employment. We try to identify private sector enterprises with a business model that is sustainable over the long term and create opportunities for new hirings. Other than that, the IFC is doing its part by lending to financial institutions to help them fund small businesses.
In which economic sectors does the IFC plan to step up its engagement in SEE?
We could note the subject of climate change which, although it takes different forms and shapes in the different countries, broadly remains a priority for IFC in the SEE region, particularly in the area of renewables. We have already financed some renewable energy projects in Croatia and preparatory work is underway in Serbia. The other key sector is regional infrastructure. I expect activity in this area will pick up over the next 12 months, especially concerning potential road and airport projects.