Earlier this year we worked with TVE to sponsor part of their Biomovies competition, an initiative that invited film-makers to create short films on environmental themes.

It has been a huge success with many more entries than last year’s event and a number of excellent, creative films making it to the final shortlist. The batch of best movies is now available to watch on Youtube, where viewers are invited to help select the ultimate winner.

The category supported by the EBRD was The Impact of Water.

The availability of safe and reliable water and wastewater treatment are vital for the health and quality of life of people everywhere. Since the Bank was established 20 years ago we have invested in numerous water projects and this is expected to become even more of a priority area as we start to work in the countries of the Southern and Eastern Mediterranean. Many of these countries are among the most water-stressed in the world, a situation that will become even more uncertain as a result of climate change.
Biomovies has inspired amateur film makers from across the globe to use their imagination and creativity to highlight these issues. This year it attracted entries from 39 different countries.

As well as Water, the competition focuses on Energy, Forests, Oceans and Living With Nature. The final 10 films will be shown at the UN Climate Change Conference in Durban, South Africa and the overall winner will be the film that receive the most views, and will be announced at the start of February 2012. Visit the Biomovies Youtube page to see the finalists and help pick the winner.

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Two things have been widely acknowledged about the business climate in Russia: that the business environment is difficult; and that it varies substantially from region to region.

However, little is known about the exact nature of regional differences in terms of constraints to doing business. Broadly, two sets of indicators of the regional business environment are available. The first is objective measures of its various components, such as infrastructure, financial deepening or registered crime.

The second is subjective expert assessments of the quality of institutions and investment risk in the regions, such as investment potential and investment risk ratings compiled annually by Expert Rating Agency.

Objective indicators suggest, for example, that the most striking differences in terms of business environment are related to financial deepening: the ratio of corporate credit (issued by bank branches in a given region) to gross regional product (GRP), varies greatly across regions: from 3 per cent in Sakhalin to over 80 per cent in Moscow.

However, based on these data alone, it is not possible to ascertain whether these differences are supply driven and represent a major constraint to firm growth, or whether they simply reflect a lack of demand for credit due to various other factors that hold back business development.

Subjective indicators based on expert assessments allow regions to be ranked according to various components of business risk—legislative, crime-related, social, financial and so on. The 2009 Expert risk indicators show for instance that risks related to social cohesion were lowest in Moscow and highest in Chechnya, while risks related to changes in legislation were lowest in St Petersburg and highest in Chukotka.

However, these ratings do not give a clear indication of how large these differences are, how much these differences matter for an average business, and which differences matter most.

A recent EBRD working paper tries to shed light on differences in various business environment components across Russian regions using firm-level data from the Business Environment and Enterprise Performance Survey (BEEPS) conducted in 2008-09 by the EBRD and the World Bank.

The latest round of the survey, completed in 2008-09, covered over 1,250 manufacturing and services firms in Russia across all federal districts, including the Far East. As part of this survey, respondents – top managers of the surveyed firms – were asked the following set of questions about each of the 17 potential obstacles to their firm’s operations:

“I would now like to ask you questions about the overall business environment in your country and how it affects your firm. Can you tell me how problematic are these different factors for the operation and growth of your business”.

The answers were given on a five-point scale: negligible (coded 0) – minor (1) – moderate (2) – major (3) – or very severe (4).

Chart 1 plots the average severity assigned to each obstacle by the respondents. Managers complained most about tax rates, workforce skills, corruption and electricity supply.

Political instability and access to finance were also viewed as more-than-moderate obstacles to firms’ operations. At the other end of the spectrum are labour regulations, trade regulations and customs and compulsory certificates, which were on average viewed as minor obstacles.

This may reflect that perhaps only a minority of firms have to deal with customs and certification agencies. Informal sector competition, crime and courts also received relatively moderate average scores.

Chart 1. Average absolute severity of perceived business environment constraints

              (on a 0 to 4 scale)

Sources: World Bank/EBRD BEEPS Survey, authors’ calculations.

The paper then turns to the analysis of regional variation in terms of relative severity of these constraints. Table 1 shows survey coverage by region (in terms of number of responses to the questions about key obstacles to firms’ operations; ten more regions, which account for the remaining 250 or so observations (averaging just over 20 observations each) are aggregated as a control group).

Table 1. Regions and their selected characteristics

Sources: RosStat, Central Bank of Russia, BEEPS survey, authors’ calculations. Based on 2008 data

The paper then estimates propensity of a firm to complain about certain elements of business environment as a function of firm characteristics controlling also for regional effects and taking into account firms general “propensity to complain”. A number of interesting findings emerge.

For half of the identified business environment components regional differences appear to be statistically significant at the one per cent level, while for five constraints the inter-regional differences are statistically insignificant at the 10 per cent level (see Table 2).

Table 2: Testing for inter-regional differences in business environment components

(Null hypothesis: all regional fixed effects are equal)

 Note: Values significant at the 10% level are marked with *; at the 5% level, with **; at the 1% level, with ***

Lack of significant differences in perception of access to finance as a constraint is particularly striking given that large objective differences in terms of levels of financial deepening are well documented (see Table 1).

In 2008 the ratio of corporate loans issued by branches of banks in a given region to gross regional product (GRP) varied between 81 per cent in Moscow and 12 per cent in Krasnoyarsk (the country average was 36 per cent). However, differences in credit-to-GDP ratios appear to be very weakly correlated, if at all, with the perception of access to finance as a constraint by firms operating in the regions.

This indicates that inter-regional differences in the levels of financial deepening largely reflect differences in terms of demand for finance (stemming from quality projects requiring financing).

The differences in demand are in turn likely to be explained by a number of other factors, such as the level of economic development, as well as differences in other components of business environment, which constrain firms’ ability to undertake and finance profitable projects.

It has long been acknowledged that financial development follows economic development and GDP per capita tends to be the key determinant of the level of financial deepening in cross-country. At the same time, numerous studies showed that financial development in turn has a significant positive impact on economic growth.

If finance is an important determinant of growth, one would expect firms in financially underdeveloped regions to feel more constrained by access to finance, as better access to finance would enable them to realise their growth opportunities. However, in the absence of strong property rights firms will be unwilling to invest, whether using retained profits or bank loans.

Therefore, in a weak institutional environment, strengthening property rights and other institutions may be key to stimulating growth, while the availability of bank finance would not necessarily constitute a binding constraint for business expansion.

The results of the BEEPS survey in Russian regions also appear to be consistent with demand for finance being constrained by various institutional factors. Strengthening institutions and addressing related business environment constraints will go a long way towards promoting economic development and financial deepening in the less financially developed regions.  

The paper also looks in detail at two other key questions that help to identify region-specific policy priorities in terms of improvements in business environment: which business environment constraints appear to be the most binding in each region; and which region-specific constraints are statistically significantly different from those in other regions (as perceived by a representative firm).

Examples of the latter include access to land and trade regulations and customs in the Primorsky region, where the regional fixed effects estimates are statistically significantly higher than in all other regions; transport in St Petersburg; workforce skills in Moscow region; electricity supply in Nizhny Novgorod and others.

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We’ve just published our latest update on Emerging Europe and Central Asia’s economic outlook which indicates that the recovery in the transition economies is progressing with important exceptions, and highlights the key factors behind this diverse picture.In many countries economic activity was strong in the first half of the year, but the outlook is dimmer, due to the short-term negative demand impact of fiscal austerity  packages and/or global exiting from crisis-related macro policy loosening: (i) in advanced EU countries (main export markets for emerging Europe), (ii) in transition countries themselves  (dampening domestic demand); and (ii) globally, as the rest of the world exits from crisis-related expansionary macro economic policies, weakening global demand for natural ressources and commodities.  Balance sheet pressures on banks active in the region also weigh on credit growth. Significant uncertainty remains both on the downside and upside; however, the balance of risks has shifted to the downside since May.

As a result, the growth forecast for the EBRD’s region of operations has been revised downward by 0.2 percentage points since the last EBRD forecasts in May to 3.5 per cent in 2010, and by 0.1 percentage point to 3.9 percent in 2011:

• The downward revision is most pronounced in both years for South-Eastern Europe where the recession appears to be lingering.
• In Central-Eastern Europe, stronger than projected recent growth, while lifting 2010 growth, is expected to fade in 2011. Some Central European countries have recently witnessed stronger than expected growth, which may spill into 2011; at the same time policy uncertainty can also affect investor confidence in cases such as Hungary.
• Central Asia is expected to grow somewhat more than previously projected on the back of good prospects for commodity exports.

A recovery appears to be underway in the second quarter of 2010, although with notable exceptions. On the back of a global recovery in trade, growth in industrial production and exports increased in most countries in the second quarter. In the largest emerging market countries of the region (Russia, Turkey and, since the presidential election, Ukraine), a return of capital inflows has also contributed to growth. Strong commodity prices, despite some market volatility, have benefited commodity exporters (Russia, Kazakhstan, Armenia and Mongolia).

In contrast, output growth continues to be near zero or negative in most countries of south-eastern Europe, and neighbouring Croatia and Slovenia. Here, recovering exports were offset by weak domestic demand, and financial systems suffered some pressure from the turmoil in Southern European sovereign debt markets. In several countries, net capital inflows remain subdued and credit to the private sector contracted or stagnated. In addition, flood damage reduced GDP in some countries. Another exception to regional recovery is the Kyrgyz Republic where political turmoil has disrupted economic activity.

Inflation pressures continued to subside across the region. In those countries where inflation has picked up since end-2009, the increase was caused by hikes in administered energy prices (FYR Macedonia, Kazakhstan, Moldova and Slovenia), VAT and excise tax rises (Bosnia and Herzegovina, Bulgaria and Estonia), or sharp depreciations (Georgia).

Source: CEIC database and national statistical offices.

The outlook for the remainder of 2010 and for 2011 is generally weaker than recent economic activity suggests. Central and Eastern European countries depend heavily on trade and financial links with the EU. Given the weakening outlook for the Eurozone – as fiscal austerity programmes are implemented and financial markets are likely to remain volatile – the external environment may be less benign than previously projected. Credit growth is expected to remain weak as long as banks’ balance sheets remain under pressure, regulatory uncertainty lingers, and the cost of capital are elevated. In addition, country-specific developments will constrain growth. Several countries have announced additional fiscal tightening measures (e.g., Lithuania, Romania and Serbia). Resource-rich countries in the Caucasus and Central Asia will be affected by a slowdown in commodity prices resulting from shrinking demand from Asia.

Downside risks, mostly due to the external environment, have intensified. The “fan chart” below, which is estimated for EU member states in the transition region plus Croatia, illustrates how the risks have become increasingly tilted to the downside. Fiscal consolidation in Europe and monetary tightening in China may still trigger a sharper slowdown in global growth than currently projected. In this downside scenario, trading partner growth could turn negative in the second half of 2010 and remain negative in 2011. This could be compounded by further deleveraging in the financial sector if capital and liquidity remain scarce and risk aversion rises. Financial market volatility could rise significantly. In addition, if market nervousness over fiscal sustainability intensifies, several countries may require austerity packages to convince markets of the sustainability of public finances. While expenditure-based fiscal consolidation may benefit competitiveness in the medium-term, it would dampen growth in the short-term.

At the same time, prospects for fiscal sustainability are better than in many advanced economies and may result in upside risks. Compared with advanced economies and other emerging markets, public debt-to-GDP ratios in the region are generally low. Many countries are implementing significant fiscal consolidation programmes which, if focussed on expenditure cuts that typically produce more lasting improvements in fiscal balances than revenue increases, should improve fiscal sustainability as well as competitiveness. In addition, medium-term growth prospects are typically stronger than in advanced countries which are planning to implement austerity programmes. As a result, capital flows in search of yield may be attracted to debt markets in the EBRD’s region of operations, helping to push growth in the whole region possibly above 4 per cent this year and closer to 5 per cent next year.

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