Transition Report 2010 Transition Transition Report 2010 European Bank for Reconstruction and Development One Exchange Square London EC2A 2JN United Kingdom Switchboard/central contact Tel: +44 20 7338 6000 Fax: +44 20 7338 6100 SWIFT: EBRDGB2L Information requests For information requests and general enquiries, please use the information request form at www.ebrd.com/inforequest Project enquiries Tel: +44 20 7338 7168 Recovery and Reform Fax: +44 20 7338 7380 Email: [email protected] EBRD publications Tel: +44 20 7338 7553 Fax: +44 20 7338 6102 Email: [email protected] Web site www.ebrd.com www.ebrd.com/transitionreport ISBN: 978-1-898802-33-1 ISSN: 1356-3424 European Bank for Reconstruction and Development The EBRD is an international financial About this report institution that supports projects from central The EBRD seeks to foster the transition to Europe to central Asia. Investing primarily in an open market-oriented economy and to private sector clients whose needs cannot promote entrepreneurship in countries from fully be met by the market, the Bank fosters central Europe to central Asia. To perform this transition towards open and democratic market task effectively, the Bank needs to analyse economies. In all its operations the EBRD and understand the process of transition. The follows the highest standards of corporate purpose of the Transition Report is to advance governance and sustainable development. this understanding and to share our analysis with our partners. The responsibility for the content of the Transition Report is taken by the Office of the Chief Economist. The assessments and views expressed in the Transition Report are not necessarily those of the EBRD. All assessments and data in the Transition Report are based on information as of early October 2010. All rights reserved. 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Photography Andy Lane (iv) © European Bank for Reconstruction and Development Contents Executive summary 01 Chapter 1: Progress and Foreword measurement PG transition 02 Transition indicators: a brief history 03 Traditional indicators: scores in 2010 03 Sectoral indicators: coverage and methodology 07 Sector scores 07 Regional overview 14 Annex 1.1 16 Annex 1.2 28 Chapter 2: From crisis to recovery 46 Chapter 3: Developing local 30 An export-led recovery currency finance 30 Legacy of the crisis weighs 48 Local versus foreign currency finance on private domestic demand 50 Why is foreign currency lending 34 Fiscal tightening, partly so prevalent? mitigated by monetary policy 53 Fundamental determinants 34 Core inflation remains subdued of local currency finance: 35 Easing external financing how countries differ pressures interrupted by eurozone 62 Strategies for developing sovereign debt market turmoil local currency finance 35 Prospects for 2011 42 Annex 2.1 66 Chapter 4: Invigorating trade 78 Chapter 5: Evaluating and improving integration and export-led growth the business environment 69 Export performance since 2000 80 Interpreting the BEEPS: 72 Exporting and innovation: a novel approach firm-level evidence 83 Top business obstacles 75 Creating an enabling environment 84 Cross-country comparisons: for exports insights from outliers 76 Conclusion 86 Comparisons of constraints in selected country pairings 88 Changes over time: 1999-2008 89 Regression analysis 90 Conclusion 94 Annex 5.1 95 Country Assessments 156 Methodological Notes 164 Acknowledgements i Executive Summary incipient recovery of the world economy through higher exports; fiscal policies; and the unwinding of pre-crisis imbalances, Progress and which continue to weigh on credit growth in many countries. Commodity exporters, countries with export concentration in measurement intermediate inputs such as machinery, and countries with large of transition real exchange rate depreciations during the crisis are benefiting disproportionately from the recovery of global trade. In addition, the recoveries in Russia and Germany are contributing to a return of remittance flows to some of the smaller countries in the region. In contrast, capital inflows are generally recovering more slowly than in other emerging market countries, with the notable The past year has been another difficult one for policy-makers exception of Turkey and Poland. in most countries of the region. Not surprisingly, the pace of new Looking ahead, the multi-speed recovery is expected to reforms has slowed further. Nevertheless, there have been very continue. Exports will continue to drive growth in most countries few examples of reform reversals, highlighting the resilience of in the next year, as domestic demand growth generally remains the reforms introduced in most of the region over the previous muted due to fiscal adjustment. Downside risks arise from the two decades. The low number of upgrades and near absence international environment, but also from pre-crisis legacies – of downgrades to the EBRD transition indicators support the particularly large stocks of foreign currency-denominated debt – view that the past year has generally been a period of reform as well as counterproductive taxation and regulation decisions stagnation (or slow reform at best) rather than reform reversal. in response to fiscal and sometimes populist pressures. Only two countries – Poland and Tajikistan – received more than one upgrade. This year’s Transition Report takes the first step towards reforming the EBRD transition indicators, both to expand their sectoral coverage, and to place more emphasis on the quality of market-enabling institutions. In addition to presenting a number Developing local of new sector-level indicators, particularly in the corporate and energy sectors, an alternative set of financial sector indicators currency finance is introduced. Both “old” and “new” transition indicators are reported. While the two sets of indicators are highly correlated across countries, significant differences arise between traditional and new scores in the financial sector. This is mostly attributable to the fact that the traditional indicators emphasised financial deepening and placed comparatively little weight on the quality of regulatory and supervisory institutions. Developing local currency finance is key to both vigorous and In common with the traditional indicators, the highest sectoral less volatile growth in the transition region. Local currency debt scores are typically in central Europe and the Baltic states, followed markets help mobilise domestic savings and make countries less by Turkey, while the lowest scores are uniformly in Central Asia. dependent on capital imports. And reducing unhedged foreign Even in EU member countries, however, significant reforms are currency borrowing, which continues to be commonplace in most necessary in some areas, particularly in sustainable energy, banking systems in the region, is critical to making countries less transport, and some areas of the financial sector. vulnerable to a depreciation of the currency. However, it is critical to address the causes of unhedged foreign currency borrowing rather than just its symptoms. Three factors stand out: inflation volatility, which may imply that the macroeconomic risks of local currency borrowing are even higher than those of foreign currency borrowing; fixed or heavily managed From crisis to recovery exchange rates, which create the perception of low currency risk; and a lack of domestic funding sources, which leads banks to turn to foreign currency borrowing to fund credit expansion. The extent to which these causes apply varies widely across transition countries, and so should strategies to develop local currency finance. In some eastern European and Central Asian countries, inflation has been traditionally volatile and hard to predict. These countries need to reform their macroeconomic institutions and policy frameworks before undertaking other Over the last year, most countries in the EBRD region have steps to develop local currency finance. In contrast, countries started to recover at varying speeds. In some central European with reasonable track records of macroeconomic stability can countries, and most commodity-rich countries in eastern Europe use several tools, including: allowing more exchange rate and Central Asia, the recovery has been solid, although growth flexibility; developing local currency bond markets, which with remains significantly below its 2005-08 average. In a few cases, few exceptions are still in their infancy; and reforming bank such as Armenia, Moldova, Poland and Turkey, capital inflows or regulation to encourage local currency use. renewed remittance inflows have contributed to growth in 2010. In contrast, the recovery in most south-eastern European countries is progressing slowly. Three main factors contributed to these differences: the capacity