Transition report press conference

Transition report 2007 press conference, Tuesday 13 November 2007

MR TONY WILLIAMS: I am Tony Williams, head of Media Relations. I should like to introduce Erik Berglof, Chief Economist, and Alan Rousso, who is head of Strategy and Analysis. This is a briefing which will last until about half past one, which is on the record, and there is an embargo until 15.00. As I think most of you have seen the report, Erik will make a few brief introductory remarks, but I should like to be able to use most of our time for questions and answers. With that, I shall hand over to Erik to make a few introductory remarks.

MR ERIK BERGLOF: Let me say first that this report is a product of the Chief Economist’s Office in which several people here in the room have been involved, namely Simon Commander, Peter Sanfey and Fabrizio Coricelli, who can answer questions that I may not be able to address.

I guess that what is on everyone’s mind at the moment is how the current financial turmoil will affect our region. Perhaps the most surprising observation is how well the region has coped so far with these pressures. It is growing at a very rapid rate. We have recorded the highest growth rate that we have seen since we started, at 7 per cent for this year, up slightly from last year, and we expect only a slight moderation next year. This growth is very much driven by domestic demand. Consumption is up; investment is up. What is noticeable is the increase in investment in the former Soviet Union countries, particularly in Russia. The growth stories are slightly different in different parts of our region. In central and eastern Europe it is consumption plus very high investment, fuelled by foreign direct investment, and very strong credit growth; and the penetration of foreign banks has been important. On the whole, I think the picture is very positive in central and eastern Europe and it is also, on balance, very positive in south-eastern Europe, where there were also large improvements in living standards and investment, with sustained very large flows of foreign direct investment, complemented by remittance inflows. There is concern in some countries about the pace of growth and of credit growth, but on balance the development has been very positive. In the CIS domestic demand is strong and in some countries, particularly Russia, there is a strong increase in investment, financed by internally generated funds but also by an increase in foreign direct investment.

There are strong fundamentals, helped by strong institutional development over many years. However, there are vulnerabilities, and we should not ignore them. Some countries are already feeling the pinch from what is happening in international financial markets. I think one should distinguish between two aspects. One of those is the immediate liquidity effect, the fact that, as markets are grappling with the current problems, some institutions have problems obtaining liquidity. We do not think that that is the main issue in our region, though there are exceptions, one of which I shall come to. The main issue in our region is the long-term consequences in terms of increased borrowing costs. This becomes more important the more dependent one is on external funding, so countries and institutions that rely on external funding will feel this more strongly.

I think it is useful to look at the case of Kazakhstan, which is feeling the liquidity effect and will feel long-term impact from these international pressures. Kazakhstan has been downgraded by Standard & Poors and it is very difficult, if not impossible, for Kazakh banks to raise funding from abroad. This has a definite impact on companies and on consumers. On balance, the situation is under control, but it is having an impact on growth in the short term and will also have an impact in the long term. It is important to see why Kazakhstan is being hit and why I think this is not an indicator of what will happen in the region as a whole.

First, Kazakh banks are very dependent on external funding. The unprecedented penetration of foreign banks in much of our region has been very important for the stability of many of our countries, but this has not been the case in Kazakhstan. Secondly, the banks and oil wealth have become too strong for the country’s institutions, which are not as strong relative to the actors in the economy.

The strong development over many years of the key institutions, the central banks, the supervisory agencies and the banking systems themselves in our region has been remarkable. I have already mentioned the penetration of foreign banks. In those countries that are already part of the European Union this results in resilience against the pressures. In the region as a whole, this is remarkable and we are optimistic that the region will weather the problems, but there will be an impact on growth, and that is reflected in our slight downgrade for next year.

Each year in the report we assess the progress of reform in the region. Given the current vulnerabilities, and given that we are seeing for the first time a real test of what has been achieved over the past decade, it is particularly important to pursue reforms. We now see in the region a slower pace of reform than previously. The explanations for that are different for different sub-regions. Of course, the countries which have joined the European Union had done a lot before they joined and so there is less left for them to do. There may also be less incentive to do more once they join the European Union. In south-eastern Europe we see continued reform progress, some countries having achieved significant improvements, not least in the financial sector and in terms of competition policy.

There is a lot of variation in the former Soviet Union countries, the CIS and Mongolia, but in general the reform has been slower. It is particularly striking that the pace of reform is slower in the resource-rich countries. Our star reformer this year is Mongolia. We should remember that these countries start from lower levels. We should also remember, when looking at the number of upgrades in terms of reform achievements in south-eastern Europe, that they too started from a lower level and that there is a lot of variation within south-eastern Europe.

There are many reasons for this slow-down in the pace of reform. It is not unique to this year. It happens to be slower this year, but it is part of a longer trend and has to do with the fact that, many of the earlier reforms having been implemented, countries are now facing what we call the third phase of reform, involving market supporting reforms, where the reforms have to do with governance, competition policy, infrastructure and public services, which are much more difficult. These reforms are also proving difficult in central and eastern Europe, even though they have come quite far. It is the area of reform where there are still things to do. In other parts of our region, and particularly in the CIS, the delivery of public services, governance and competition policy are serious issues.

Each year we have a theme for the Transition Report, and this year the theme focuses on the issue of satisfaction and trying to understand, given the pain and disruption to which transition has exposed people in the region, all the labour market transitions, the geographic displacements, and so on, the impact on people’s levels of satisfaction and perception of what is going on and their aspirations for the future. We have reported on this before but here we have a chance to go in greater depth into the details of the difference in concerns and aspirations in the region. You will see that there are some regions, particularly in south-eastern Europe, where there remain concerns about what has happened in the transition process. Particularly striking is the emergence of a middle class in many of our countries, as we see clearly both in the survey and in other data. We try to show how this goes together with support for democracy and market institutions, which are closely correlated with the size of the middle class.

There is a group of people who have lost out in various ways. These are older people, people with less education, people who have become unemployed, people who are poor. There is a high level of concern and we try in this report to see how policies can be adjusted to reach this group and to give them a stake in future reforms. One chapter discusses public services, using healthcare as an example. When we ask people, healthcare and education are the issues that they care about most, but they are quite discontent with the quality of public services in general. We think that public services are an area where these disgruntled people and people who are suffering most from the costs of transition can be brought into the process. We try to look at what we have learned from central and eastern Europe and, as we move deeper into the region, take this experience and see what the lessons are in order not to make the same mistakes again and to be able to learn from success stories. The objective is to look at people’s levels of satisfaction and their aspirations and understand how we can bring those who are less satisfied into the reform process. We believe that that will help the reform process as a whole and also solidify the achievements of transition more generally.

MR ALEKSANDR SMOTROV (RIA Novosti): I have two questions, one for Erik or Alan and one for Tony.

If we look at the predictions of the EBRD in the report on the key Russian indicators, such as GDP and inflation, the GDP forecast is more or less the same as that of the Russian Government, but the inflation prediction of the EBRD is 8.5 per cent while the Russian Government predicts that it will be 10 to 11 per cent. How do you explain such different forecasts?

My second question relates to the events in Georgia. How have they affected the EBRD's operations?

MR ERIK BERGLOF: Let me answer the first question. The Russian Government’s figure for inflation was very recently revised upwards, there having been some developments over the past couple of months that led to that revision. One is the increase in food prices, which is a global phenomenon but also a local and regional phenomenon and is something that has been taken very seriously by the Russian Government. The other is the very large amount of resources put into the banking system to support liquidity. Those are the two main factors, another factor being energy. Unfortunately, there is a time-lag between the preparation of the report and its publication. These are very recent developments which may not have been fully incorporated in the report. I would subscribe today to a figure that is much closer to that forecast by the Russian Government.

MR TONY WILLIAMS: On an operational basis, Tbilisi is our central hub for the Caucasus region and for Belarus. The office is there, it is working and functioning. Obviously, we are monitoring the situation very carefully. As of this morning, when I last looked, everything was operating normally.

MR ASHLEY SEAGER (The Guardian): I have a couple of questions. First, can you say something about the rise in oil prices to a record level and the rise in gas prices? How will that alter economic relations between Russia and the rest of the region? How dependent is the rest of the region on Russian energy and how could that upset the importing economies?

MR ERIK BERGLOF: While it is true that the dependence of many of the countries on Russian oil is very strong, it is, of course, not only Russian oil that is increasing in price; all oil is increasing in price. The countries’ dependence has been increasing over a long period of time. A section in the report discusses the energy security situation in individual countries, which will give you a reasonable picture of the variation across countries. Countries are trying to address the problem by diversifying supply but maybe more importantly by trying to deal with the very large inefficiencies in the use of energy in the region, which is something that the Bank is heavily involved in. We believe there are huge opportunities here that we think can be utilised. The most dependent countries are already taking strong measures to support energy efficiency, and we very much want to be part of that.

In some countries there are other opportunities in terms of shifting fuel composition, particularly towards renewables, but I think the main opportunity is improved efficiency. These countries are extraordinarily inefficient. We are talking about large orders of magnitude. Some countries are 10, 15 or 20 times more inefficient than others in the use of energy and I think that improving this situation is the cheapest and quickest way to address their dependence.

MR ASHLEY SEAGER (The Guardian): My second question concerns labour markets. I saw in the report that unemployment remains high in eastern Europe and labour-force participation remains low. In Britain we have the big issue of eastern European immigration. I should like to know your views about how that emptying out of these young people from Poland, in particular, but from other countries too, is affecting economies on the ground in the east and what you think the likelihood is, now that we have had a change of President in Poland and Poland is growing quite strongly, that that flow might reverse at some point. Are you producing
projections on that sort of thing?

MR ERIK BERGLOF: All you have said is true. Over time the participation ratio in these economies has come down and there have been high levels of unemployment. I must say, though, that in many countries this position is changing and while there is some exodus, as you describe, some economies are growing very quickly. For example, we see very large immigration into the Czech Republic this year, primarily from Ukraine but also from other parts of eastern Europe and even from outside the region, and this has become an issue for countries that have in the past not had to cope with immigration. The Czech Republic started growing by taking in Slovak workers but now Slovakia is hitting its labour force strength so people are moving back from the Czech Republic to Slovakia. I think that in the long term that is what we shall see happening with immigration from eastern Europe.

You mentioned Poland. My experience of working with many Poles is that they would much prefer in the long term to work in Poland. Poland is a large country with a very strong gravitational force, and I think that that is where they will realise their long term goals and objectives. That does not mean that they will not stay here for quite some time, and, of course, we need to adjust and to deal with that, but I think that the long-term growth in the region will resolve these issues.

MR ASHLEY SEAGER (The Guardian): Is growth in the region being held back at the moment by the fact that so many skilled young people are moving to Britain and other western European countries? Have you put a figure on how much faster growth would be if they were all still living at home?

MR ERIK BERGLOF: No; I do not think one could do that. We should not ignore the fact that there is some brain drain.

MR ASHLEY SEAGER (The Guardian): You have not done a quantification of it?

MR ERIK BERGLOF: No, we have not done that.

MS JUSTYNA PAWLAK (Reuters): It is not really a brain drain. It is unemployed people who are leaving, so they would not be contributing to the economy anyway.

MR ERIK BERGLOF: Having said that, even in Poland there are serious problems in finding qualified labour. The wage costs for skilled labour have gone up very rapidly and in Poland, the Baltic States and many of our countries of operation this is a very serious issue.

MS JUSTYNA PAWLAK (Reuters): Do you think there is a risk in some of the countries in south-eastern Europe which rely even more on foreign direct investment which aims to utilise a cheaper workforce that this kind of brain drain will discourage FDI and large foreign manufacturers will stop coming because there will be fewer and fewer workers and those who remain will become more and more expensive? That seems to be a complaint in countries like Romania and Bulgaria. Do you see it as a long-term risk for the economy?

MR ERIK BERGLOF: Rising wage costs are a serious issue in many of our countries. Having said that, it is remarkable, when one considers the competitiveness of the region, how successful these countries have been overall in competing in international markets. Most countries have increased their shares. Some countries – and you mentioned Romania – have an issue because they have a very similar profile to that of China. There is a special box in the report on China and the extent of competition with that country. Romania is an example. Increased labour costs in Romania are a concern.

MS JUSTYNA PAWLAK (Reuters): Have you seen evidence of FDI being discouraged by this?

MR ERIK BERGLOF: No, not to date, but I think that that is another aspect of what I was talking about. If Romanian companies or Romanian subsidiaries of foreign companies face increased labour costs, that will in the long term pose a competitive threat to them as a destination of foreign direct investment, as well.

MS GULNARA KASMAMBETOVA (BBC Central Asian Service): Kyrgyzstan did not join the HIPC Initiative, which would have helped it to reduce its foreign debt, but your outlook on this republic talks about growth in this country. How do the two go together, on the one hand unpaid huge foreign debt and at the same time a prospect of growth?

MR ERIK BERGLOF: I think there are several such puzzles in our region. I would not have focused on the HIPC issue, as you did; that is not the main puzzle. I think the main puzzle in the Kyrgyz Republic is the extent of constitutional turmoil and the shifts back and forth between fundamentally different principles for organising political life and democracy and all the confusion that that entails, on the one hand, and very strong growth in the economy, on the other. We see similar things in Poland, which has had some political difficulties and turnover, and in Ukraine, and yet we still see quite strong growth. That suggests that in the short term these can coexist, and private-sector growth is very important. We think that in the longer term this is not a good thing because the necessary reforms will not be implemented.

As regards the HIPC Initiative, I think this was an option open to the Kyrgyz Republic, but they decided not to take it up. Personally, I think it would have been an opportunity, but there were many issues involved.

MS GULNARA KAZMAMBETOVA (BBC Central Asian Service): I ask questions on behalf of colleagues in other services, as well. I have studied your reports on Tajikistan and Uzbekistan. You have just mentioned that reforms and democratic establishment are very important. I have noticed that Uzbekistan received the biggest share of investments and attention by the EBRD. Human rights issues are high on the agenda with regard to Uzbekistan, yet at the same time that country receives the highest amount of foreign investment. How do the two go together?

MR ERIK BERGLOF: The EBRD's level of activity in Uzbekistan is very low and over time what we can do there has become even more restricted because we have a number of serious concerns, not only about the political situation as a whole but also about issues of child labour, and so on. There are many reasons why we feel very constrained and are struggling to find ways to support the private sector in Uzbekistan. I think your perception is wrong. It is one of the countries where we are most restricted in terms of our activities. There are only a few countries comparable to Uzbekistan in this regard.

MR JUSTIN KEAY (Freelance): Looking at your People in Transition indicators, Hungary seems to have had a 35 per cent increase in GDP since 1989 yet only 10 per cent or so of people actually think the situation is better. Another figure seems to tell a similar story. Is there something uniquely Hungarian there, or what?

MR ERIK BERGLOF: You do not know any Hungarians?

MR JUSTIN KEAY (Freelance): Quite a few, actually.

MR ERIK BERGLOF: There are several points. An important reason is that we measured this at a time when social unrest in Hungary was almost at its peak, and that influenced the numbers, unfortunately. It is striking, when one looks across the different countries, that the figures are an accurate reflection. When you ask people whether they are better off today than in 1989, the result is strongly correlated with actual GDP numbers today. That is not the case for Hungary but is for other countries. People cannot always accurately assess their situation today relative to 1989, but if you look at the actual numbers – and I think to some extent that is the validation of the exercise – what people think is not just plucked out of the air. In the case of Hungary, I think it was influenced by special circumstances.

MR JUSTIN KEAY (Freelance): (No microphone) Does it reflect the political situation and the various domestically opposed political parties?

MR ERIK BERGLOF: That came to the fore in the social unrest. I discussed this at some length with János Kornai, a colleague of mine and someone who is very familiar with the Hungarian situation. On the one hand, he acknowledges quite a widespread disgruntlement with transition but he also says that, compared to other countries he is familiar with, these numbers seem to be high.

MR YASUHISA MASUMOTO (JiJi Press): I have two questions about relations with other Asian countries. It says in the press release that trade with China is growing rapidly. What about other Asian countries, such as India, Japan and Korea? Is there any difference between European countries and Asian countries with regard to trade? I should appreciate it if you could elaborate on that.

MR ERIK BERGLOF: Do you mean the region as a whole or some specific countries?

MR YASUHISA MASUMOTO (JiJi Press): The region as a whole.

MR ERIK BERGLOF: As I said, there is quite an extensive discussion in the report on trade between China and the region. There are different patterns between, on the one hand, the position in Russia where there are still very low levels of trade, focused mainly on natural resources and, to some extent, consumer goods, and, on the other hand, the position in other parts of the region where the trade is focused more on consumer goods.

I have not looked recently at the figures for trade with India, but certainly trade between Russia and India is still very small. India used to be a very important trading partner of the Soviet Union but it has nowhere near the same levels of trade with Russia, though I think there is some prospect that this will change.

With regard to other Asian countries, economists like to do gravity models which look at the size of an economy in terms of GDP and distance. I would argue that Asian economies in general are probably underrepresented. Even though they are far away from the economic centre of gravity in the region, they are still below their potential, so I think there is room for more trade. I think there is quite a lot of Korean interest in the region. Certainly in central Asia and Mongolia there is a very large Korean interest and a strong Japanese presence. I think that in the long term the Japanese will play an important role in developing natural resources in Siberia. They are also making large investments in the car industry in Russia.

I am sorry that I cannot give you exact figures, but I think there is a lot of potential for trade with Asian countries and a lot of interest, certainly on the Chinese side, to develop trade ties further.

MR VITALY MAKARCHEV (Itar Tass): I have two questions. First, you support macroeconomics and big projects but do you support small and medium sized business in countries such as Russia and Ukraine and what are the difficulties you meet in supporting it? Are they political or structural? I refer to private business.

MR ERIK BERGLOF: The core mission of the EBRD is to support small and medium sized enterprises and entrepreneurship more generally, which were a very underdeveloped part of the economy in these countries. There were many reasons for that, such as the way central planning was organised and the lack of a service sector. The service sector was often very small, involving very small companies.

We do a lot of work, such as microfinance, SME lending, through banks. Our main model has been to work through existing banks rather than creating new institutions, though in some countries we have been involved in that, as well. We are doing a lot of work to understand the obstacles to SMEs. Every three years – and this will happen next year – we carry out the Business Environment Enterprise Performance Survey (BEEPS), which looks in particular at the obstacles faced by small and medium sized firms. SMEs face a lot of issues, but I must say that in many of our countries they have been a very strong force for growth. In Russia in recent years the development of the small and medium sized enterprise sector has been quite dramatic. This has clearly been a result of some of the changes in regulation, the removal of bureaucracy and change in rules to simplify them and provide fewer opportunities for corruption, and so on. These changes are very important for SMEs.

MR VITALY MAKARCHEV (Itar Tass): My second question concerns China. Do you see a specific Chinese economic policy towards the Russian Far East and central Asian countries? We know that China has such a policy for Africa. Do you think that China could bring some difficulties in future by exporting their problems, controlling the national currency and ecological measures?

MR ERIK BERGLOF: There is some tension between Russia and China based on claims of very large immigration, partly illegal immigration, into the eastern part of Russia. As to whether ecological impact could spread, I guess that that is a possibility. The growth of China is having an impact on neighbouring countries in many different ways. I certainly see that very strongly in Mongolia, which is even more a prey to it because, in terms of population, it is a small country which has resources which are very attractive for the Chinese. We certainly see those kinds of tensions with China. However, there are also a lot of opportunities, and I guess the objective is to create benefits out of this kind of asymmetry in that the Chinese are very good at certain parts of production, for which they need resources, and Russia has a lot of the resources that they need. Therefore I think there are also a lot of opportunities for growth. There is a lot of interest now in developing links among academics and policy-makers in order to try to come up with productive ideas.

MR MICHAEL MAISCH (Handelsblatt): Apart from Kazakhstan, which countries in the region will be worst hit by the traumas in the credit markets, in your opinion?

MR ERIK BERGLOF: I wanted to emphasise in my introductions that we think it is remarkable how well the countries have fared so far, and we are quite optimistic about their ability to do so in the future. There are certain countries that have already been exposed to some pressure. I mentioned Kazakhstan, which I think is the clearest example. There are pressures on Latvia, on Hungary and on some countries in south eastern Europe, such as Bulgaria, Romania and, to some extent, Serbia. I think one has to do an individual analysis for each of these. In Latvia there is reliance on the foreign banks to give stability to the financial system, to slow down credit growth and to manage the process of a soft landing. Hungary, I think, has made substantial improvements in terms of creating fiscal balance. There is more to do but I think we share the assessment of the international markets, which is that they have shown that they are willing and they are making progress in fiscal terms.

In south-eastern Europe, as I also said in my introduction, there have been very large inflows of capital, not always into productive investments. In some of the countries there have been substantial inflows into real estate, which may contribute less to productivity. These countries are exposed but for now we think that they are coping very well with the pressures. As an example of their exposure, in Romania there has been a depreciation of the exchange rate, which is a reflection of these pressures, and there is room in the Romanian economy to adjust. Of course, this has consequences for the economy, which they are already feeling.

MR ANDROS SWIDLICKI (Polish News Agency): I have two questions which may be interrelated. The first concerns the effects of capital flows as a factor contributing to the strengthening of local currencies, which is a feature of many countries in the region, particularly Poland, Slovakia and the Czech Republic. What consequences does this strengthening of local currencies have and how much longer can it go on?

Secondly, do you see a danger of the formation of consumer bubbles in countries like Poland? The Poles have been enthusiastic takers of debt and invest heavily in real estate. Should there be an economic downturn, how would this affect the economy?

MR ERIK BERGLOF: With regard to the appreciation of exchange rates, we know from international experience that as economies develop and become richer they will have a currency appreciation, so this is a natural phenomenon. It has been reinforced by the factors that you mention. I think this is an issue and is something that these countries are so far coping with reasonably well, but it does affect their competitiveness internationally.

As to consumer bubbles, I mentioned in my introduction that there has been very rapid credit growth in many of the countries, in the Baltics and in south-eastern Europe but also in central Europe. It is something that is also reflected in housing prices, the expansion of mortgage finance and the fact that people can now buy their homes. Of course, this is on balance a very good thing, but it carries the risk of creating bubbles. I am reluctant to use the word “bubble” because I think people mean different things by it. I think there is a need for moderation in the price of housing, and we see some of that already as part of the credit squeeze. Certainly in the Baltic States real estate prices have come down and I seem to remember seeing figures that suggest that the same thing has happened in Poland. A slowdown in the creation of credit may be a good thing. I talked about a soft landing; I think that what we are looking for in Poland is a long and slow soft landing.

A SPEAKER: (No microphone) Perhaps I may add to that. I saw a report about a Latvian … (inaudible) … (housing ?) crisis. Is that still valid or is it perhaps out of date as events run ahead of this? You talked of a moderation of price rises but have we already gone beyond that?

MR ERIK BERGLOF: I think that in the case of Latvia there is some fall. It is not a large fall, within 10 percentage points, I think, but, as I said, that is from very high levels.

A SPEAKER: (No microphone) You do not necessarily expect that to become widespread quite rapidly?

MR ERIK BERGLOF: No. When I talk about this slow and soft landing, that is what we think is the main scenario in these countries. Again, we do not want to ignore the risks; I think there are very real risks. I think that our assessment, compared to that of some other institutions, relies more on the institutions. We think that what has been achieved in terms of development in these countries of both supervisory and regulatory institutions and of the financial institutions themselves has made them capable of resisting this outside pressure, perhaps to a greater extent than the pure figures suggest. On balance, we try to put a little more emphasis on the institutions. On top of that there is the whole context of EU membership, which I think also provides some long-term prospects of improvements in regulation and supervision.

MR TONY WILLIAMS: Are there any more questions? Thank you very much for coming.