EUROPEAN BANK FOR RECONSTRUCTION AND DEVELOPMENT ANNUAL MEETING, LONDON, Chief Economist s Press Briefing. Friday 18 May 2012

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1 EUROPEAN BANK FOR RECONSTRUCTION AND DEVELOPMENT ANNUAL MEETING, LONDON, 2012 Chief Economist s Press Briefing Friday 18 May 2012

2 MR WILLIAMS: Good afternoon, ladies and gentlemen. Thank you for coming to this press briefing by Erik Berglöf, the Chief Economist, who is presenting the latest forecast from EBRD for the region and for the first time including an assessment of what is going on in our new region of operations, in the southern and eastern Mediterranean, the four countries where we are planning to invest. Erik will give a brief introduction. I think most of you will have seen the forecast and have the press release and the report itself. Many of Erik s colleagues are here, the regional and national economists. During the main bit of the press conference, I would like you to restrict your questions to the broad outlook for the region. We are happy to accommodate individual requests on individual countries once the press conference is over. I hand over to Erik for his brief introduction. (Slide presentation) MR ERIK BERGLÖF: You are welcome. It is always exciting to have these press conferences. We did not choose the theme of this Annual Meeting by accident. Managing in turbulent times is very much what we are facing. We worked hard to find the right balance in our title Transition region in the shadow of the eurozone crisis: managing the fallout. What we want to capture here is that on the one hand the region is doing quite well in terms of addressing the challenges that the eurozone crisis and the global crisis present, but it is also clear, and we see it now in the growth numbers that we will show you, that the region is also suffering from what has been happening in a very real way. Let me summarise very quickly what is going on. We have seen and will be seeing a slowdown in 2012 relative to Something has been going on since the third quarter of last year. We have already seen the effect on growth in the fourth quarter of last year but we are also seeing it now in the first quarter of this year. Of course, a very important channel here for this impact is exports; exports from the region to the eurozone are down quite significantly. Chief Economist PC 1

3 Capital flows were quite dramatic. The capital outflows in the third quarter of 2011 have levelled off but this is still a source of concern. We see cross-border deleveraging banks drawing down on their exposures in the region. Again, we think we are seeing somewhat of a slower pace to this but it still continues and of course the result is an impact on credit in the region. As I said, the downside risks not our main baseline scenario but the downside scenario are very troubling and that is already impacting on expectations in the region. To repeat, the region will have slower growth and it is very much externally driven. We see here a lower growth in 2012 and we hope for higher growth in 2013 and hope that the rest of the world will turn around. We can discuss later how confident we are of that. This is based on the notion that the rest of the world will turn around this year and we hope to see the same thing impacting on our region. As Tony has said, this is the first time we have done the same exercise for the new countries of operation, what we call SEMED the Southern and Eastern Mediterranean and these are Egypt, Tunisia, Morocco and Jordan. When you look at the macro side, the challenges are quite different. Eastern Europe has managed to make strong improvements in their external balance, while in the SEMED countries we see a deteriorating situation. In terms of levels, of course they are in relatively good shape, but what we see there is quite worrying. The fiscal impact of what is happening in these countries is quite significant. We have spoken about the weaker growth. That is something that we see in some of the European countries but we also see it to some extent in countries like Kazakhstan and the Kyrgyz Republic and also in parts of the SEMED region. We see rising unemployment in particular in south-east Europe; we also see it in some other countries that are important to the region, such as Ukraine and Moldova. There is a slowdown through weaker exports. All the countries in both our old region and in our new region suffer from the same impact. What is going on in the eurozone is Chief Economist PC 2

4 absolutely critical. We also see an impact on capital outflows. From an improved situation in the first half of 2011, we can see from the third quarter of last year a deterioration. FDIs are holding up but other capital is flowing out. In terms of the eurozone impact we are hopeful that the effect on capital flows is coming down. You can see here that there is somewhat of an improvement in the countries that are most vulnerable to the eurozone crisis. Portfolio flows may be returning. They are volatile but it is positive that we see them coming back into the region. I said something initially about cross-border deleveraging. That is slowing down and there may be some signs that to some extent the pace is reducing but it is still very much an issue in the region. You can clearly see here the impact on credit. We have seen a tightening of credit conditions essentially since mid-2011, some slight tendency towards an improvement, but it is very much a real constraint to growth in the region. We can see here shrinking credit, particularly in central Europe, while in some other parts of the region there is a recovery of credit, particularly in the Caucasus. In looking at our combined region the old region and the new region and dividing it into sub-regions, we see that those parts of our countries of operations that are closest to the eurozone and most dependent on the eurozone are the ones most affected by what its going on. In the final slide we are looking at the downside. If you look at the baseline scenario, you see continued growth, again with a lot of diversity within the region and of course here the fact that Russia seems to have stable economic growth helps to bring up the average. The downside scenario is very much driven by what happens in the eurozone and also what could happen from an oil shock would also affect both the eurozone itself and many of the countries in central Europe that do not have those kinds of resources. Chief Economist PC 3

5 To summarise, growth is affected. We have seen the results from the first quarter. We still think it is holding up reasonably well but we have to be aware of the downside scenario. I am happy to take questions. MR WILLIAMS: It would be very useful if you give your name and organisation. QUESTION: In the release that you sent with the data in it you are talking about growth of more than 3 per cent but there is also talk about recession within the next 12 months. That does not seem quite to add up together. Can you put a probability on the likelihood of recession? MR BERGLÖF: As I said, the average numbers are holding up in the region because of the development of Russia and the important weight that Russia has if you put the whole region together. If you look at countries closer to the eurozone and more dependent on it, we are much more pessimistic about the growth expectations there. As you have said, some of these countries are already technically in recession. That is the reality. There is a lot of variation within the region, even though the weighted average looks reasonable stable. MS AGNES LOVASZ (Bloomberg News): Have you contemplated a scenario whereby Greece leaves the euro? What would that mean for the region? MR BERGLÖF: We do a lot of contemplation. Obviously, when we look at the downside scenario, that is part of it. We do not spell out in great detail what it means but the possibility of some further deterioration in Greece is clearly part of that and the some spill-over from that. Whatever you think, the fact that we are now having this discussion in the open is probably a good thing and I do not think we should be resigned to desperation here. It is important that we are discussing the options for Greece and the Chief Economist PC 4

6 other countries. Luckily, this is beyond what EBRD can do anything about in the immediate future. EGYPT TEAM: I wondered if you could comment on how you see the eurozone crisis affecting the SEMED region. You showed an interesting graph of EBRD in the SEMED. The graph went down steeply and you mentioned that you had a lot of concerns about the economies of the SEMED region. I wondered if you could expand on that as well. MR BERGLÖF: There are a number of impacts from what is happening in the eurozone for the SEMED countries. The most obvious one is of course the export channel and as you know for Egypt, for example, this is the most important export target. By the way, that is true for the other countries in North Africa as well. But that is only one of the channels. You also have financial linkages. Perhaps the most important channel is the focus of leaders in the eurozone and of people working in Brussels who are thinking about various strategic issues in the region; their focus on SEMED or what we call North Africa is not very high at the moment. I think that is a serious concern because we need to pay attention to this; we need to have a stronger response and a continued focus on how we can support what is happening in these countries. Once we can get more confidence and a more stable environment in North Africa, FDI (foreign direct investment) will be an important part of bringing growth and more sustainable growth to the region. Another important channel to a varying extent in the countries is the remittances. To the extent that the eurozone contracts, that very much influences remittances as well. MR HASSAN CHAKRANI (Al-Akhbar, Lebanon): You mentioned two factors in the downside scenario: the first one is that the euro crisis is getting worse and the second one is the oil shock. I was wondering if you could explain on the second factor how the oil shock could affect the SEMED countries. Chief Economist PC 5

7 MR BERGLÖF: Clearly, a possible oil shock is not our main scenario but it is something that we thought was useful to look at because it is clearly something that is out there as a possible shock to the economic stability of the region. The main impact is obviously coming from the fact that all the countries with which we are engaging at the moment are oil importers; that is a very direct link. Also, the link through the eurozone and the impact of high oil prices is very real. Together, this is something that clearly impacts those parts of our old region that depend on oil imports as well, while of course it would benefit Russia and the countries that are trading with Russia. Again, we know that these windfalls that come from higher oil prices in a country like Russia have two sides and they postpone reform; they feed parts of the economy and we want to see other parts of the economy growing in Russia. There are many impacts that we need to think about when we look at the impact of an oil price increase. QUESTION: Growth in the Baltic countries is quite robust or even recovering. Are the any lessons we can learn from the Baltics or are they just too small to give a model? MR BERGLÖF: We should definitely study the experience of these countries. As you say, there has been a remarkable turnaround. Very few people expected this turnaround, particularly Latvia because Latvia did not really have much of an export sector when it came into this crisis. Estonia and Lithuania as well have managed really to turn around and continue building their exports and raise the quality of them. We should clearly study these countries. We should be very careful about transferring this experience without reflection. The circumstances there are very different. They had a very short period of affluence and boom and they have had a lot of crisis experience. The people in these countries are very used to sacrifices and they have flexible labour markets. They have also managed to do a lot to improve their institutions. If you look at the main lesson from what has happened in these countries and why this adjustment happened so quickly and so smoothly, it was Chief Economist PC 6

8 because they had institutions in place. If you look at the business environment and more broadly at how they approached the political process and the labour market adjustments that needed to happen, all those things seem to work much better. There are important differences in the assessments of these countries compared, for example, to the southern Mediterranean or, for that matter, to North Africa. You need to think about how you can improve these institutions to get more flexibility and an ability to adjust to changing circumstances. MS AMIRA AHMED (Daily News, Egypt): Some have argued that EBRD is currently stretched too thinly with the euro crisis and with its expansion into the very turbulent economies of the SEMED region. How do you address these concerns and as far as the resources of the Bank, how do you plan on mitigating these effects? MR BERGLÖF: It is a good question. What we have said about our SEMED expansion is that this will not happen at the expense of our old region, so we are sticking to the targets that we had in our long-term plan for We have not started investing in this expansion into our new region. We hope to do be able to start this summer. Of course, there is always competition for resources but what I think is an even stronger point and I said it in the opening panel this morning is that, if you look at the organisation, the inspiration and the enthusiasm that comes from trying to look at how we can use our old experience in this new region and draw on that will make us more efficient in both regions in the end. MS VERONIKA GULYAS (Dow Jones): You mentioned the central European region as the most stressed by shrinking credit. Could you comment on that and how can that be stopped and will the Vienna II Initiative be enough for that? MR BERGLÖF: Thank you for bringing up the Vienna II Initiative. Clearly, behind the numbers that I have shown on deleveraging in the region there are many concerns about Chief Economist PC 7

9 what is happening to cross-border banking in our region. Cross-border banking has been an absolutely integral part of the growth model in central Europe and beyond. What is Vienna II is trying to address? We realise that there may have been elements of over-extension and maybe, given the nature of the regulations, the supervisory framework, that we have in Europe there was a need to adjust. Probably the level of debt was too high in many of the countries, but in the light of that adjustment, what we want to do with the Vienna II Initiative is to make sure that this happens in an orderly way. We do not think that the banking system is going to look the same after the crisis as it did before the crisis but it is important that this adjustment in the Bank s business model, in how the subsidiaries of these banks operate and so on, happens in an orderly fashion. We need to make sure that the host and home authorities of these banks work more closely together. That is what the Vienna II Initiative is about; it is about strengthening the institutions at the European level, making sure that the host countries respect the systemic impact of the decisions taken in the capitals of the home countries and in the headquarters of the banks, and that these decisions reflect the host country perspective. That is the bottom line of the Vienna II Initiative. MS CELESTE HICKS (The Guardian): I was at the press conference this morning and I was interested in the Tunisian Governor s comments about privatisation and liberalisation. I know that you are still working on your programme on what exactly you will be doing in the SEMED region. I wondered whether you could give a response to what he said this morning. MR BERGLÖF: You may have heard that that is exactly one of the things I said in my opening remarks. One thing that we are learning, and we are trying to do this both by bringing in new people and by doing our homework ourselves, is that these countries have their own transition experiences. All the things that have happened in the past will influence how people see privatisation. This is not unique to the SEMED region. If you look at our region today, the understanding of privatisation, particularly of what I call the large-scale privatisation, the large companies, that view is very different today from what Chief Economist PC 8

10 it was at the beginning of transition. We have had experience in many countries where these privatisations have been flawed, where assets have been grabbed by inside interests, where large fortunes have been built very quickly in illicit ways and so on. We need to understand that experience better in our new countries of operation. I think we are sensitised to that because we have seen that this is not easy to do; it is not necessarily becoming easier either. Once you have a botched privatisation process, you then have to fight against those interests that benefited from it because they may not have an interest in future privatisations being fairer and more open and more transparent. QUESTION: I would like to add my pennyworth on the thought that the additional experience from the region is that when you privatise in the right way, as Erik has described, it is very important at the same time in parallel to reform the regulatory framework and the pricing framework. We have seen that even if privatisation is done well but you do not move on pricing side, then privatisation alone cannot deliver sustainable development in the sector. Privatisation together with regulatory reform is very important. MR BERGLÖF: This is an important point. Even more critical is the broader institutional reform or competition policy, reform of corporate governance. All those things need to be done at the same time or preferably beforehand. That is the only way you can affect the position. QUESTION: Are you doing that? MR BERGLÖF: Yes, absolutely. We are very much trying to do what we did in our old region. We are closely monitoring what is happening on the institutional side. Every year we have a detailed survey of all the competition authorities in our region. We are also working directly with the companies in which we invest to reform their corporate governance. Sometimes we give technical support to competition authorities and we are working with the other IFIs to help improve this environment around privatisation. Chief Economist PC 9

11 MR DAVID GOW: I am semi-retired from The Guardian. I work freelance for some papers. If the eurozone crisis is responsible for most of the revised downward growth in the core region of EBRD, what measures should they adopt next Wednesday evening in Brussels to restore confidence in the region and buttress growth; i.e. send it back? MR BERGLÖF: As I have said, we are not immediately involved, of course, in these decisions, but we realise that we depend a lot on what is happening, particularly in the financial sector. We are trying to influence and provide input into these decisions. I do not want to go into exactly what they should do next Wednesday. I think that the Vienna II Initiative is absolutely critical to making sure that when these decisions are taken, they take into account the systemic impact, particularly in the countries in central Europe. MR MIHA JENKO (Slovenia): Our country used to be a success story as the first post-communist country to adopt the euro. Now, according to these figures, we are the black sheep as we are in the highest recession. What lessons could be taught from our experience and what is your advice to other countries so as not to repeat our mistakes? MR BERGLÖF: Slovenia has positive points and also negative points. Trying to explain what has happened to Slovenia in the last few years is a culmination of a number of things that were not done. Slovenia did not open up its financial system to the same extent; it did not open up the ownership structures in the economy. It has maintained a very Slovenian-centric insider system. The lesson here is that you need to go more deeply into re-thinking how your financial sector is governed, how your corporate sector is run. These are the main lessons. Of course, Slovenia also suffers from very strong dependence on the rest of the eurozone and the impact from that. Chief Economist PC 10

12 MR JOHN RUMSEY (Emerging Markets): I would just like to know when you put the data together for your predictions, do you now think you need already to reassess them, given the changing nature of Greece? People are talking about 50 to 75 per cent possibility of a default. Does the prognosis that you have actually encompassed the likelihood now of a Greek default or would you have to re-look at all your numbers? MR BERGLÖF: As I have said, in our baseline scenario it does not and in our downside scenario it is essentially captured there. As you have said, the likelihood of the baseline scenario may have come down a bit from this. Again, when I look at what we said at the beginning of the fall last year, the main predictions that were made then are pretty much still on target. Yes, there is some variation between different countries in our region but if you look at the overall forecasts that were made and the view that we also had of the downside scenario, the picture is pretty much the same. QUESTION: Going back to the Vienna Initiative, is there much practical that the EBRD can do besides adding to the moral suasion and saying, Please do not take your liquidity out of these countries? Are there steps? MR BERGLÖF: It is important to stress when we are talking about the Vienna Initiative mark 2 is that it is not the same focus. The focus is now on making sure that the framework that surrounds this delveraging is working much better. It is about getting better coordination between the home and host countries. It is about getting the host country perspective better reflected in key decisions. These are deep, long-term structural changes that we hope we can contribute to through this initiative but they need short-term efforts. To an extent in our own investments we are of course guided by the ambitions and vision of the Vienna II Initiative, so we are trying to participate in helping subsidiaries in our region that may suffer from what is going on. Some of the cross-border banking groups are trying to engage support. We are trying to deal with subsidiaries that may need additional capital in the region. There is a link between what we are doing in our Chief Economist PC 11

13 operations and trying to push this very important agenda in terms of regulation and supervision and resolution. QUESTION: Mr Berglöf, do you see the need to build some ring of defence for Serbia, Romania and Bulgaria because the Greek banks are so strong there? MR BERGLÖF: I think we have been involved for quite a while in building such a ring of defence. It is about many things that have to work together. It is about making sure that the authorities are completely in tune. There is no question that they are very concerned about what is going on. It is also to ensure that there is proper communication between the Greek authorities and the authorities in these countries. It is about what other institutions can do and about the IMF having the right preparation to support these countries if there were additional problems in Greece. It is about what we have done to invest in the subsidiaries of these Greek banks to try to wean them off the dependence of their parents. That all comes together. So far it has worked. If you look at what has happened to savings in these countries, with some exceptions essentially there has been very little drawdown on savings. I think that that reflects the sense that this wall has so far been credible. We need to do more work to make sure that it remains credible. It is not going to be easy but it has those components. The local authorities are aware of the preparation by international institutions that are willing to support subsidiaries if they were to get into trouble. MS ANTONIA OPRITA (CNBC): As for these countries and especially Romania and Bulgaria that are now in the EU so they cannot really put regulatory measures in place such as capital controls, do you think the EU should be granting an exception for cases like these? For instance, if Greece does exit the eurozone and there is a flight of capital, do you see this as a measure? What other measures can be taken, apart from those that you have already listed, to ring-fence these countries? MR BERGLÖF: We do not speak about it much but there are in fact already measures in place. It is not something that we should condone in the long term but it is Chief Economist PC 12

14 understandable in these conditions that there are those measures and that preparation in those countries. In the long-term we must stick to openness to capital flows but in these times of crisis one has to understand that financial stability is a very important consideration. QUESTION: My question is about your baseline scenario which, as stated in the press release here, describes the assumption that the eurozone will be able to contain its crisis. Given the events in Greece and the uncertainty regarding the elections coming up, would it be worth perhaps revising that baseline scenario? Should we consider other baseline scenarios? In relation the euro and the countries that you have added into your mandate, I am a reporter for Arabic News Al-Arabiya and we have noticed that the eurozone crisis has actually affected FDI from Europe, which is the largest foreign investor in a country like Egypt. The figures came out just two days ago and investment is down. Do you see that trend continuing, given the eurozone crisis? MR BERGLÖF: First, on the different scenarios, as I said, the baseline scenario is the one that has been playing out since we first identified it at the beginning of last fall. In terms of what has actually happened, that is still the reasonable baseline scenario. The probability of the downside scenario has probably increased; it is essentially the same scenario as we had eight to nine months ago but the probability over the last few weeks has increased. For the present at least, we see no reason to change the substance of these two scenarios. In terms of the impact on investment in Egypt or in other countries in the SEMED region, it is very clear, and I have said this already, that there is an impact from what is happening in the eurozone. It is an impact in terms of strains in terms of credit but it is also in terms of confidence and who today is willing to commit a lot of capital to risky markets. There is a flight to safety. It is not easy to come to corporate boardrooms to Chief Economist PC 13

15 bring in investment in any of our countries right now. This is something that has clear and direct impacts. MR NEIL BUCKLEY (Financial Times): Erik, I have two related questions. Is the downside scenario for an orderly exit of Greece from the eurozone or a disorderly exit? If it is orderly, then should there be a downside and a down downside scenario? The second question is this. Consultancy Capital Economics this week put out a note saying that if there was a disorderly exit of Greece from the eurozone, this would be disastrous for central and eastern Europe because of the impact it would have on confidence both in the countries and in their export markets and what it would mean for parent bank funding for subsidiaries. Do you think that they are overstating the impact of a disorderly exit? MR BERGLÖF: I think one should be very humble about spelling out the details of these downside scenarios. Whether it is exactly an exit from the eurozone, I do not even necessarily think that is necessarily what we have in mind but there is a deeper Greek crisis with the possible addition of payment problems and some contagion to other parts of the eurozone. That is what we have in mind. There are, of course, even more disastrous scenarios we could paint. That is not the one that we have chosen that we believe is the most likely. We still think there is a lot of willingness in Europe and some hope that there will be a solution in Greece itself. Yes, one can always speculate about complete and catastrophic scenarios but that is not what we are doing in this exercise. MS MERCY EZE (African Press Agency): I do not know how active your interventions are in Africa but I was highly impressed when attending the workshop by the World Bank review that your Bank encouraged lending in local currency. Africa is going through a crisis now and the currencies on the continent are fragmented across the European currencies. I do not know how you consider this measure when you are lending. Chief Economist PC 14

16 MR BERGLÖF: First, for now we are restricted to operating in three countries in Africa: Egypt, Morocco and Tunisia. The issue that you bring up is absolutely critical and it is certainly not unique to Africa. We face it across our region and it became very clear that we need to develop local currency finance in local capital markets. We saw that in the crisis. Some of the very large exposures that have been built up in foreign exchange are absolutely critical. We are working with the IMF and the World Bank on an initiative to push this in our region. The reasons for the problems in building local currency markets and promoting local currency finance are very different. If you go to countries in the early stages of transition, it is about macro issues; it may be that the IMF is best placed to help there. When you come to countries closer to the eurozone that may be more advanced, the issues there are very different and are often about building a local investor base for long-term funding and so on. You need to make the assessment first. The same would apply if you look at Africa. There are many differences across Africa in the parts where we do not operate and you need to make the assessment before you say what exactly should be the role of an institution like EBRD or any other multilateral institution. MR WILLIAMS: We will take one last question quickly. The Board of Governors meeting starts at 2 o clock. QUESTION: I came in late. I hope you have not dealt with this earlier. You revised your forecast for growth in Poland for this year. Is there any particular reason for doing that? MR BERGLÖF: We remain positive about Poland. We realise that Poland is not immune to what is happening in the eurozone. It is not immune to what is happening in the banking system in Europe. It is a little bit more shielded than other countries but we are still confident that Poland will come through this relatively well. MR WILLIAMS: Thank you very much, Erik, and thank you all for coming. Chief Economist PC 15

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