EBRD slams lack of reform in Southeast Europe but still says grounds for optimism

By bne IntelliNews September 18, 2014

Andrew MacDowall in Belgrade -


Southeast Europe (SEE) is only slowly recovering from the 2009 economic crisis and is held back by failure to reinvigorate reform efforts, the European Bank for Reconstruction and Development’s (EBRD) regional economist tells bne as the bank’s growth forecasts were published.

But Peter Sanfey also highlighted reasons for optimism in a region which has suffered a more difficult transition from communism than its neighbours to the north. From Croatia’s tourism sector to Bulgaria’s competiveness as an foreign investment destination, there are long-term economic upsides on which SEE countries can capitalise if they tackle structural limitations and fiscal issues. “We have dropped our growth forecast for SEE from 2.2% in May to 1.9%, whereas in Central Europe and the Baltics we raised it from 2.5% to 2.8%,” Sanfey tells bne. “For SEE, we have pencilled in 2.6% growth for 2015.”

By some margin the region’s biggest economy, Romania, is also set to be the best performer – the small states of Macedonia and Kosovo aside. The EBRD was more pessimistic than most when it forecast 2.6% growth for 2014 back in May; following disappointing second-quarter growth figures, the bank’s judgement looks prescient. It has stuck with the figure, which Sanfey concedes is now more optimistic than the average, while projecting 2.8% next year, suggesting that the 5.2% growth racked up in the fourth quarter of 2013 may have been a flash in the pan.

Nonetheless, Sanfey is upbeat about the country’s prospects and impressed by the country’s tough policy response to a savage recession and near fiscal crisis in 2009. “Romania has turned around impressively in recent years,” he says. “This is not just about getting some growth back, its about inflation coming down, fiscal deficit really coming under control, from 9% a few years ago 3% now. In 2013, Romania exited the EU’s Excessive deficit procedure. It has the advantages of relatively large economy, strategic location, diversification. There has not been so much [foreign direct investment] in recent years, but investors are there and there will be more to come in future.”

Bulgaria blues

To the south, fellow EU member state Bulgaria has endured an unenviable year that saw anti-government protests over ties to oligarchs, the suspension of EU funds and ostracism from Brussels over Bulgaria’s persistence with Gazprom’s South Stream gas pipeline in the wake of Russia’s seizure of Crimea and its role in the fighting in East Ukraine. Most recently, a banking crisis has shaken faith in the system, called the national bank into question and once again revealed links between politicians and controversial businessmen. The EBRD has lowered its growth forecast to 1.5% this year, and expects 2.0% in 2015 – sluggish for a relatively poor country that was an investor darling until 2008. “For a country that has GDP per capita still below 50% of the EU average, there should be a lot of catch-up potential, but it requires Bulgaria to really seize the opportunity and start reforming again – there’s a big job ahead,” says Sanfey.

The unloved and Russophile Socialist-led government resigned after just a year in power in July, paving the way to a snap election on October 5, that the nominally rightist, Atlanticst GERB is almost certain to win. “It will be important to have government in place that has a mandate and medium-term perspective, which has been lacking,” says Sanfey. “The problem with Bulgaria is that there hasn’t been a stable political situation for some time and that has held back economic policy making and held back transitions in sectors like energy – and of course there has been the banking crisis."

Since before the last government, Bulgaria’s policymaking has been inconsistent, and, as elsewhere in the region, structural reform has stalled. “The energy sector is very important in Bulgaria and is in a mess at the moment,” says Sanfey. “You cannot expect to attract serious investment in the sector if you cut energy prices as Bulgaria has. It’s very short sighed in our view, though we understand that the last government but one fell because of energy prices. More generally, there are a lot of petty obstacles to doing business that our clients point to. The government can do a lot more to really tackle those and sell Bulgaria as an investment destination.”

On the other side of the Balkan Peninsula is the EU’s newest member state, Croatia. Accession has not provided the hoped-for fillip to Croatia’s economy, which has not registered meaningful growth since 2008, and where the left-leaning government, hobbled by the electoral cycle, seems unwilling or unable to tackle reform. “Year after year the performance has been disappointing,” says Sanfey. “If it’s another year of negative growth, it’ll be the sixth year in a row of downturn – we expect minus 0.5%, and have pencilled in a very modest positive number for next year, 0.5%. We gave Croatia credit as everyone did for joining the EU, but they didn’t address underlying issues. The state is very bloated, and the labour market rather inflexible. Reform efforts have been a bit hesitant and for that reason we don’t see any sign of a major turnaround yet, and indeed next year is an election year.”

The EBRD economist tempers his concerns about stalled reform with optimism about Croatia’s potential, pointing out that it is a small economy open to Western Europe, and an economic recovery in the Eurozone would help bring growth into positive territory. There is scope for “quality upgrading” in tourism, which generates more than 10% of GDP – an observation with which many in the Croatian tourism sector would agree as they seek to develop businesses beyond sun, sea and sand – while some tourism businesses are still to be privatised. The EBRD is also active in the promising agribusiness sector, where big local companies such as Agrokor have become great success stories.

Floods of problems

Landlocked Serbia to the east has been hit hard by catastrophic flooding in May, the worst on record. The EBRD expects the economy to shrink by 0.5% this year, recovering to 2.0% in 2015.

The Progressive Party of Aleksandar Vucic won an absolute majority two months before, with a mandate for sweeping reform, including privatisation and changes to the labour code, but its appetite for austerity has yet to be proven. “Serbia faces a very difficult situation in the short term, particularly the fiscal situation,” says Sanfey. “The level of the deficit [is worrying] and public debt is now somewhere between 65% and 70% of GDP and still rising, whereas it’s supposed to be capped at 45%. This has been recognised by the government.”

Serbia’s last standby agreement with the International Monetary Fund (IMF) was suspended in January 2012 due to its fiscal incontinence. Since then, the prospect of a new deal has been much-discussed, with little concrete progress. “Serbia needs to really demonstrate that it’s getting its fiscal situation under control as a matter of priority, and an IMF agreement would help in that regard, so I expect one to be signed. This would give some comfort to investors.”

While some in Serbia doubt Vucic’s commitment to reform and liberal democratic values, Sanfey is upbeat about the outlook. “I see Serbia as a country with a lot of potential in the region, they have a government with a strong mandate which cal look forward to being in power for a few years. They have started the EU accession process, negotiations are underway, and they have been very pragmatic on the Kosovo issue [Serbia refuses to recognise the breakaway state but is normalising relations under EU supervision].”

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