THE NEED TO ADDRESS FINANCIAL MARKETS DEVELOPMENT IN THE REGION

SOUTH CAUCASUS AND UKRAINE INITIATIVE THE NEED TO ADDRESS FINANCIAL MARKETS DEVELOPMENT IN THE REGION Working Group on Financial Markets Development and Impact of Central Banks 17 November 2009 Warsaw, Poland OECD Private Sector Development 1

The Need to Address Financial Markets Development Agenda 1. Financial Markets Development Challenges in the South Caucasus and Ukraine (SCU) region 2. The OECD South Caucasus and Ukraine Initiative and way forward OECD Private Sector Development 2

PART 1: Financial Markets Development Challenges in the South Caucasus and Ukraine (SCU) region Challenging Economic Environment and Financial Markets Environment A focus on Access to Finance for SMEs OECD Private Sector Development 3

GDP growth (per cent) GDP growth in the region is impacted by the financial crisis Average GDP growth falling in 2009 Growth in BSEC-CA Countries 1998-2008 10 5 0-5 -10 LOW & LOWER-MIDDLE INCOME BSEC: Albania, Armenia, Azerbaijan, Georgia, Moldova, Ukraine UPPER-MIDDLE & HIGH INCOME BSEC: Bulgaria, Greece, Romania, Russia, Serbia, Turkey CENTRAL ASIA: Kazakhstan, Kyrgyz Republic, Tajikistan, Turkmenistan, Uzbekistan Source: OECD Development Centre / IMF forecast; BSEC. Black Sea Economic Cooperation Source: EBRD; e. estimate; p. projection OECD Private Sector Development 4

Reliance on external financing is increasing On average 13% of GDP for BSEC region USD Billion External Financing / GDP (%) 330 External Financing - BSEC 14 280 230 12 10 180 130 80 30-20 8 6 4 2 0 External financing/gdp (right-hand axis) External financing Capital inflows FDI Inflows Workers' remittances and compensation of employees Source: OECD Development Centre / IMF, BSEC. Black Sea Economic Cooperation OECD Private Sector Development 5

A measure of competitiveness: FDI growth is slowing down How to support the quality and quantity of FDI? FDI in USD million 35,000 30,000 25,000 20,000 How to improve both quantity and quality of FDI? Central Europe SEE South Caucasus and Ukraine Central Asia Central Europe: First Wave of FDI SEE: Second wave of FDI SCU: Third wave? 15,000 10,000 5,000 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 estimate projection Impact of the financial crisis Source: EBRD Transition report 2008, OECD Analysis OECD Private Sector Development 6

A measure of private sector development: SME fragmented Representing 95% of companies but 37% of GDP SMEs share of GDP Total GDP 65% 60% SMEs share of GDP and of total companies Percentage, 2005 OECD 55% 50% 45% 40% 35% SCU 30% 25% 20% 15% 10% 5% 91% 92% 93% 94% 95% 96% 97% 98% 99% 100% Number of SMEs Total companies Access to finance one of the key elements contributing to SME development Source: OECD, Small and Medium Entrepreneurship sphere in Armenia, Reference book, 2004-2005. OECD Analysis. Data is from 2005. OECD Private Sector Development 7

PART 1: Financial Markets Development Challenges in the South Caucasus and Ukraine (SCU) region Challenging Economic Environment and Financial Markets Environment A focus on Access to Finance for SMEs OECD Private Sector Development 8

Relative high cost of borrowing Lately declining after the impact of the financial crisis Market interest rate Weighted average across maturities Armenia Azerbaijan Georgia Republic of Moldova Ukraine Trend Source: EBRD, Transition Assessment 2009. OECD analysis OECD Private Sector Development 9

Stock market capitalisation impacted by the financial crisis However domestic credit to private sector increasing % of GDP 80 Stock market capitalisation As percent of GDP, 2003-2008 Impact of the crisis % of GDP 60 Domestic credit to private sector As percent of GDP, 2003-2008 70 60 50 50 40 40 30 30 20 20 10 10 0 2003 2004 2005 2006 2007 2008 0 2003 2004 2005 2006 2007 2008 SCU SEE SCU SEE On average, stock market capitalisation 30 percentage points lower in the SCU region. On average, domestic credit to private sector 12 percentage points lower in the SCU region. SEE average based on data for Albania, Bosnia and Herzegovina, Croatia, FYR Macedonia, Montenegro, Serbia Source: EBRD, Transition Assessment 2009. OECD analysis SCU. South Caucasus and Ukraine, SEE. South East Europe OECD Private Sector Development 10

High risk of not servicing external debt according to OECD export credits risk classification OECD Country Risk Classification under the arrangement on Officially Supported Export Credits (2008) OECD Average Measurement of likelihood that a country will service its external debt. Source: OECD 2009 OECD Private Sector Development 11

Liquidity (Broad money share of GDP) is increasing However remains lower than in South East Europe M2 % of GDP 60 Broad Money M2 As percent of GDP, 2003-2008 M2 % of GDP 60 2008 50 50 52% 40 Armenia Azerbaijan 40 30 Georgia 30 29% 20 Republic of Moldova Ukraine 20 10 10 0 2003 2004 2005 2006 2007 2008 Broad money increase follows similar patterns throughout the SCU region. 0 SCU In 2008 broad money is 23 percentage points lower than in the SEE region. SEE SEE average based on data for Albania, Bosnia and Herzegovina, Bulgaria, Kosovo, Montenegro, Romania, Serbia Source: EBRD, Transition Assessment 2009, OECD Analysis Note: SCU. South Caucasus and Ukraine, SEE. South East Europe OECD Private Sector Development 12

Level of reform improving for banking and non-banking sector although below SEE - according to EBRD Index 3.5 4+ EBRD Index of banking sector reform 4+ EBRD Index of reform of non-bank financial institutions 2.2 3 2.5 SEE SCU 2 SEE SCU 2 2003 2004 2005 2006 2007 2008 2009 1.8 2003 2004 2005 2006 2007 2008 2009 SCU and SEE regions follow similar patterns. SCU is closely aligned with the SEE region. The values of EBRD index range from 1.0 to 4.0+, with 1.0 indicating a rigid centralized economy and 4.0+ implying the highest level of reform, which corresponds to a fully industrialized market economy. SEE average based on data for Albania, Bosnia and Herzegovina, Croatia, FYR Macedonia, Montenegro, Serbia Source: EBRD, Transition Assessment 2009, OECD analysis OECD Private Sector Development 13

PART 1: Financial Markets Development Challenges in the South Caucasus and Ukraine (SCU) region Challenging Economic Environment and Financial Markets Environment A focus on Access to Finance for SMEs OECD Private Sector Development 14

Interest rates are not favorable Collateral requirements for loans or line of credit are unattainable Application procedures for loans or line of credit are complex Size of loan and maturity are insufficient Did not think it would be approved It is necessary to make informal payment Other Access to finance perceived as key obstacle to private sector development Is access to finance an obstacle for firms? SMEs represent 80% of respondents, 2007 Why did the firm not apply for a loan? Percentage below includes only firms in need for a credit Do not know 4% 60% 50% 50% Very severe obstacle 13% No obstacle 26% 40% 30% 20% 10% 16% 14% 6% 3% 1.5% 9% Access to Major obstacle finance is an 21% obstacle 70% Minor obstacle 14% 0% Moderate obstacle 22% 70% of firms report access to finance as an obstacle to their business. Interest rates and collateral requirements identified as the main barriers. Source: Enterprise Survey, World Bank group, Data collection 2007. OECD Analysis. OECD Private Sector Development 15

Higher barriers to access to credit than peers Measured by collateral requirement and cost of borrowing Collateral requirements as % of the loan 200% Collateral requirements and interest rate level As percent of the loan, 2005 AS PERCEIVED BY PRIVATE SECTOR 195% 190% 185% 180% 175% 170% 165% 160% 155% 150% 145% MENA Armenia Azerbaijan, Georgia Ukraine Mean SCU = 182 % Republic of Moldova 140% 135% OECD Mean SCU = 18% 130% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% 21% Commercial loan refinancing interest rate (%) Source: Enterprise Survey, World Bank group, Data collection 2005. OECD Analysis. OECD Private Sector Development 16

Sources of financing could be further diversified in the SCU region % share of a specific source in total structure of financing 100 80 60 1 14 Structure of financing for new investments Percentage share, 2005, 2008 0.52 10 6 3 2 6 3 18 21 0.54 Credit cards Leasing arrangement (e.g. land lease) * State financial services (investment funds, special development financing etc.) Borrowings from State-owned banks Equity INDICATIVE 40 Owner's contribution or issued new equity 59 57 Other (moneylenders, family, friends, etc.) 20 Trade credit (supplier or customer credit) Borrowing from private banks 0 Internal funds or retained earnings SCU OECD In the SCU region owner s contribution is one of the major sources of financing. * Leasing arrangement: a contract granting use or occupation of property during a specified period in exchange for a specified rent. Source: Enterprise Survey, World Bank group, 2005, 2008. OECD Analysis. Data for SCU is from 2008 and data for OECD is from 2005. OECD Private Sector Development 17

The Need to Address Financial Markets Development Agenda 1. Financial Markets Development Challenges in the South Caucasus and Ukraine (SCU) region 2. The OECD South Caucasus and Ukraine Initiative and way forward OECD Private Sector Development 18

OECD Initiative for the South Caucasus and Ukraine Enhancing Regional Business Climate Prioritisation of policies to improve the business climate Policy Working Groups Competitiveness report on the South Caucasus and Ukraine Improving National Competitiveness OECD Sector Competitiveness Strategy Surveys of investors and private sector perception Evaluation of policy reforms Supporting in implementing reforms Building Capacity Training and coaching focused on policy makers and SME business intermediaries OECD Private Sector Development 19

Governance: Strong collaboration with regional bodies and the private sector Policy Working Groups: Co-chairs: Poland and Sweden Advisory Council OECD donors and partners SCU country economic teams Investment climate policy and promotion Financial Market Development and Impact of Central Banks Human capital for financial and business services Country specific projects OECD Secretariat Regional Offices and presence: -Republic of Moldova International Organisations and private sector representatives Private Sector Council Eurasia Expert Council Working group on FMD co-chaired by the Czech Republic Collaboration with EU Eastern Partnership OECD Private Sector Development 20

Determining policy priorities across the region PfC SCU results overall Financial Markets Development identified as one of the key policy priorities to support competitiveness Source: OECD Policies for Competitiveness Assessment Framework OECD Private Sector Development 21

Financial markets development Four pillars to address policy reforms PfC Financial Markets Development Level 2 and 4 Initial focus Institutional Framework The Banking Sector The Capital Markets Access to Finance Coordination of supervisory responsibilities Central Bank independence Capital Market Authority Off-shore Financial centres Financial sector openness Financial education Competition Foreign entry and ownership Basel capital adequacy requirements Domestic credit to Private Sector (as % of GDP) Non-Performing Loans Transaction technology infrastructure Stock market depth and liquidity Sophistication of financial instruments Technical Infrastructure Development of the Corporate Bond Market Government benchmark curve Credit guarantee schemes Collateral and provisioning requirements Cadastre Availability of risk capital Registration systems for movable assets Micro-finance facilities Source: OECD PfC Assessment Framework OECD Private Sector Development 22

OECD Policies for Competitiveness Assessment Framework: Example for Access to Finance Effective Regulatory Framework Access to Bank Finance Access to finance Access to Capital Markets Early-Stage Finance Guarantee Schemes Improving Skills Collateral and Provisions Requirements Registration Systems for Movable Assets Cadastre Competition in the Banking System Banking Sector Outreach Domestic Credit to Private Sector Non- Performing Loans Capital Market Authority Stock Market Depth and Liquidity Development of the Corporate Bond Market Sophistication of Financial Instruments Availability of Risk Capital Business Angels Network Micro- Finance Facilities Credit Guarantee Schemes Mutual Guarantee Schemes Export Guarantee Schemes Credit Information Services Financial Literacy Entrepreneurial Training Source: OECD PfC Assessment Framework Corporate Disclosure requirements OECD Private Sector Development 23

Example for Access to finance 3 ACCESS to FINANCE 3.1 Effective Regulatory Framework 3.2 Access to Bank Finance 3.3 Access to Capital Markets 3.4 Early-Stage Finance 3.5 Guarantee Schemes 3.6 Improving Skills (Quality of Demand) 3.1 Effective Regulatory Framework PfC Access to Finance Level 3 and 4 3.1 Effective Regulatory Framework 3.1.1 Collateral and provisions requirements 3.1.2 Registration systems for movable assets 3.1.3 Cadastre Level 1 Level 2 Level 3 Level 4 Level 5 3.1.1 Collateral and provisions requirements Very high collateral requirements (more than 200%). Restrictive collateral definition and/or rigid provisioning requirements for uncollateralised loans. Collateral requirement ranging 150-200% of loan amount. Restrictive collateral definition and/or rigid provisioning requirements for uncollateralised loans. Flexible collateral definition and/or flexible provisioning requirements for loans under EUR 20 000. Flexible collateral definition and/or flexible provisioning requirements for loans under EUR 20 000 and central collateral registry in place. Flexible collateral definition and/or flexible provisioning requirements for loans under EUR 20 000 and central collateral registry covering most bank loans. Source: OECD PfC Assessment Framework OECD Private Sector Development 24

PfC survey for SCU: Access to Finance identified as a key priority Based on a sample of assessments completed by SCU countries, 2009 Level of reform Credit information services Credit guarantee schemes Export guarantee schemes Mutual guarantee schemes Access to finance Level 3 5 4 3 2 1 0 Guarantee Schemes Level 4 Guarantee schemes, improving skills and early-stage finance identified as top priorities. Mutual guarantee schemes and export guarantee schemes identified as priority subsectors to address. Source: OECD Survey, 2009 OECD Private Sector Development 25

Example of next steps: Monitoring the evolution of policy reforms for private and banking sectors OECD SME Policy Index 2009: Access to Finance Example for South East Europe Source: OECD Survey, SME Policy Index 2009, Progress in the Implementation of the European Charter for Small Enterprises in the Western Balkans OECD Private Sector Development 26