Structural Reform

A number of countries in south-eastern Europe (SEE) and eastern Europe and the Caucasus (EEC) have increased their ATQ scores for competitiveness, mainly owing to further improvements in the business climate. Several economies in the EEC region have also seen progress in the area of good governance. Meanwhile, many countries have achieved modest improvements in their green scores, following ratification of the Paris Agreement and the adoption of legislation strengthening their commitment to reducing greenhouse gas emissions and tackling climate change.

Developments across the three components of the inclusion score – youth, gender and regional inclusion – have been uneven. Some progress appears to have been made with financial aspects of youth and gender inclusion, but progress in other areas is still lacking. The picture is also mixed when it comes to resilience. Progress in the area of financial resilience has been very modest, but energy resilience appears to have improved in many economies across the EBRD regions. Ukraine has been the standout performer in this area, thanks to significant improvements in the legal and regulatory framework governing the energy sector. Lastly, the SEE and EEC regions have also seen some improvements in integration scores, largely owing to improvements in the quality of logistics services and related infrastructure.

Within certain indicators, one notable development is an increase in the risk of inadequate compliance with frameworks aimed at combating money laundering and the financing of terrorism (AML/CFT frameworks), particularly in a number of southern and eastern Mediterranean (SEMED), Central Asian and SEE economies. Moreover, several economies have seen declines in the perceived transparency of government policymaking. A number of indicators of financial resilience have worsened as well, with further increases in non-performing loan (NPL) ratios being observed in Kazakhstan and Ukraine, and banking-sector liquidity deteriorating in certain Central Asian countries. Meanwhile, net FDI and non-FDI capital inflows have, with few exceptions, generally remained unchanged or declined as a percentage of GDP.

A number of SEE and EEC countries have also taken steps to support the development of SMEs, with Greece, Romania, Serbia and Ukraine all seeing improvements in the EBRD’s SME index.4 Meanwhile, Azerbaijan has established a new Agency for the Development of Small and Medium-Sized Enterprises, which aims to improve and better coordinate the provision of public services to SMEs. Similarly, Georgia has eased the tax burden for small businesses, increased the number of firms that fall into this category and abandoned the requirement for advance payment of tax, significantly improving the business environment for these firms.

Most countries have made modest progress in the area of the knowledge economy. This year, a knowledge economy index was added to the competitiveness index in order to measure progress in this area.5 A number of countries have implemented further reforms, which are expected to bear fruit in the near future. For example, a presidential decree on the development of the digital economy was issued in Belarus at the end of 2017. The decree increases the number of activities that are subject to preferential regulatory treatment, expanding that category to include services relating to software development, marketing and advertising. In Tunisia, meanwhile, the country’s parliament recently approved the Start-Up Act, which incentivises local entrepreneurs to launch new ventures. The new legislation aims to increase the number of Tunisian start-up companies, with a particular focus on the tech industry, with a view to boosting innovation and increasing the country’s international competitiveness.

A number of changes – both positive and negative – have been observed in the perceived transparency of government policymaking. Scores have tended to be revised downwards overall, with notable declines being seen in Egypt, Latvia and Mongolia, but improvements have been observed in Hungary and Ukraine. Increases in the perceived regulatory burden have also been seen in a number of countries, particularly in Jordan, Kazakhstan and Latvia, while some improvements have been observed in Azerbaijan, Hungary and Morocco.

There has also been an increase in the risk of inadequate compliance with AML/CFT frameworks (as measured by the Basel AML Index). These risks have increased in Egypt, Hungary, Kazakhstan, Morocco, Serbia, Tunisia and Uzbekistan. However, some countries are making efforts to address this issue. For instance, Serbia recently agreed a 30-month Policy Coordination Instrument with the IMF, which involves commitments aimed at addressing weaknesses in the country’s AML/CFT framework.

In line with commitments made under the Paris Agreement, a total of 18 CEB, EEC, Central Asian and SEMED economies have now formally submitted final versions of their climate plans (termed “nationally determined contributions” or NDCs). For example, Uzbekistan’s green score has been revised upwards as a result of the country signing up to the Paris Agreement and submitting its NDC (albeit it has done so slightly later than its neighbours). As regards biodiversity measures, a number of countries have seen improvements over the past year, particularly in the South Caucasus region, but notable deteriorations have been observed in Greece, Hungary, Lebanon and the Slovak Republic.

Overall, significant challenges remain across the EBRD regions in the area of green transition, particularly as regards (i) reducing emissions in the construction, industrial and energy sectors, (ii) strengthening resistance to the negative impact of climate change in the area of agricultural production, and (iii) increasing protection for land and marine areas. In many parts of the EBRD regions, additional work also needs to be carried out with a view to increasing the amount of electricity that is derived from renewable sources.

Ukraine’s banking system has now been stabilised, following three years of intensive operations aimed at cleaning up and consolidating under-performing and poorly governed banks. At the same time, systemic risks remain, with high NPL ratios and a high degree of state ownership. After much delay, the Law on the Corporate Governance of State-Owned Banks was finally approved in 2018, which represents a positive development and is expected to reshape state-owned banks’ supervisory boards. In Azerbaijan and Tajikistan, meanwhile, weak capital buffers, low levels of provisioning, rising NPL ratios and deficiencies in terms of banking regulation and supervision all represent significant challenges. Moldova’s efforts to restore fit and proper ownership and governance in systemically important banks continue, following the successful sale of a 39.2 per cent stake in Victoriabank to a Romanian strategic investor in January 2018. And in Egypt, banks have weathered the aftermath of the currency depreciation seen at the end of 2016, with the chronic shortage of foreign currency in the economy having largely been resolved. In Turkey, meanwhile, the weakening of the lira, worsening asset quality and volatile investor sentiment are all weighing on the country’s macroeconomic prospects, but its banking sector has proved resilient thus far.

While financial sectors in the EBRD regions remain bank-dominated, efforts are under way to foster the development of local capital markets, non-bank financial institutions, and venture capital and private equity funds. The availability of non-bank funding has the potential to enhance the corporate sector’s ability to finance firms’ expansion, which is particularly important for innovative firms that may not be in a position to obtain bank loans with high collateral requirements. In the EEC region and Central Asia, major challenges include further improving the adequacy of legal and regulatory frameworks, strengthening the independence and capacity of financial regulators, and introducing modern risk management and corporate governance practices.

Improved legal frameworks can also be found in Egypt, FYR Macedonia and Moldova. Moldova transposed the EU’s Gas Directive in 2016 and has made significant progress in the area of implementation. In Egypt, midstream and downstream gas sectors continue to be dominated by the state monopoly, but the country’s new Gas Market Law, which was approved by parliament in summer 2017, and the executive regulations that were approved in February 2018 have established the legal basis for unbundling and third-party access, supporting private-sector participation. A gas regulator has also been established, and that body has taken important steps with a view to building capacity. In FYR Macedonia, meanwhile, a new Energy Law was passed in May 2018. That law sets out a timetable for full retail market liberalisation and requires the competitive procurement of new renewable energy capacity, which is to be subsidised via a premium paid on top of the wholesale price.

In Kosovo and Latvia, significant progress has been made with the unbundling of the electricity and gas sectors respectively. In Kosovo, the unbundling of the transmission network has progressed further, with parliament assuming control of the transmission system operator KOSTT in line with the 2016 Electricity Market Law. Latvia, meanwhile, has chosen a model involving full unbundling of ownership for its gas sector, with unbundling of transmission, distribution and retail taking place throughout 2017. In Egypt, credible tariff reforms are ongoing and are being pushed through against an inflationary backdrop, although there remains uncertainty as to when cost reflectivity and market pricing will be achieved.

In Turkey, the private sector’s role in the energy sector has grown significantly over the past few years, with further progress being achieved in 2017. In the area of power generation, new investment is predominantly carried out by independent producers, and the privatisation of existing public plants (especially small to medium-sized hydropower plants) is ongoing. According to the latest figures, 77 per cent of Turkey’s total installed capacity (78.5 MW) is either owned or operated by private entities.

Despite recent progress, much remains to be done in terms of improving domestic and inter-country connectivity, boosting private-sector participation in the energy sector, implementing tariff reforms and further improving regulatory frameworks across the EBRD regions.

In many economies, domestic integration needs to improve further. While indicators of the quality of logistics services facilitating domestic trade and the timeliness of shipments have largely improved in the CEB and EEC regions, they have declined or remained unchanged in several Central Asian and SEMED economies. Further reforms aimed at improving the quality of domestic and international logistics and enhancing critical infrastructure are necessary across the EBRD regions.

When it comes to other aspects of integration, the degree of financial integration in the EBRD regions is yet to recover from the global financial crisis of 2008-09. In most economies where the EBRD invests, inward FDI has declined or remained unchanged over the past 10 years as a percentage of GDP. The strongest declines have been seen in Estonia, Hungary, Kazakhstan, Mongolia and Montenegro.

The results of this analysis point to a number of positive trends. Over the period 2010-17, there were marked improvements in competitiveness and integration across the EBRD regions, with weaker progress being observed in respect of the other qualities of sustainable market economies.

Indeed, the competitiveness of the EBRD regions has improved in a number of ways since 2010 (see Chart S.2). The general business climate and the business environment for SMEs have improved in many economies, particularly in Central Asia and the EEC region (albeit from a relatively low base). Significant declines in import tariffs (particularly in the SEMED region) have contributed to that improved environment. Gradual improvements have also been observed in the quality of logistics and related services.

Progress in respect of selected indicators of good governance was uneven over the period 2010-17. Although the perceived regulatory burden declined in many of the economies where the EBRD invests, the perceived transparency of government policymaking did not generally improve (with the exception of certain specific countries, such as Kazakhstan, Romania and Ukraine). Moreover, judicial independence and the availability of frameworks for challenging regulation were assessed as having weakened in some countries. Major obstacles remain as regards frameworks for challenging regulation, the protection of property rights, the transparency of government policymaking and the efficiency of legal frameworks for settling disputes.

The longer-term picture is also mixed as regards inclusion. Youth unemployment has declined somewhat, particularly in the SEE region, but it remains a key challenge for many countries. There have been marked improvements in the perceived quality of education (particularly in Armenia, Azerbaijan and Tajikistan), but some worsening has been observed in Morocco, Tunisia and a number of SEE countries. Meanwhile, the flexibility of hiring and firing practices appears to be declining, albeit with some exceptions. Significant challenges remain as regards ensuring access to critical services and infrastructure (such as heating and ICT) in economically disadvantaged regions, improving labour force participation rates among women, increasing the number of female employers, increasing the flexibility of hiring and firing practices, and improving the quality of education.

Long-term trends in the area of financial resilience have also been mixed. NPL ratios have declined in most countries in the CEB and SEE regions (aided by reforms in the context of an EBRD-supported regional NPL initiative). The stock of NPLs in Greece remains large, but thanks to increased provisioning, banks are making progress with the resolution of those impaired loans, with the sale of loan portfolios forming part of that approach. Meanwhile, credit has contracted in inflation-adjusted terms in a number of CEB, SEE, EEC and Central Asian countries, with deleveraging by subsidiaries of eurozone banks contributing to this trend in the CEB and SEE regions.

The overall level of integration and the quality of supporting hard and soft infrastructure both improved over the period 2010-17, with the exception of selected SEMED economies. The cost of trading across borders declined substantially over this period, with the largest cost reductions being observed in Central Asia. Exceptions to this trend include Egypt, Lebanon and Tunisia.

Sensitivity analysis can help to shed light on the extent to which final rankings are dependent on the choice of methodology. Two separate exercises have been carried out to this end, looking at both the indicators that are included in the composite index and the weights that are assigned to those various indicators when calculating an aggregate score.

In the first exercise, up to 50 per cent of the indicators included in each ATQ index were randomly excluded from the calculation in each simulation run. And in the second exercise, weights were subject to random shocks. In each exercise, the distribution of scores and rankings for each economy and each quality were obtained on the basis of 1,000 simulation runs. Charts S.1.1 and S.1.2 show the results of the first exercise, and the results of the second exercise (which are similar) are available on request.

Overall, decisions regarding the specific indicators that are included in composite indices and the weights that are assigned to those indicators have a limited effect on the rankings and average ATQ scores of economies at the top and the bottom of the distribution of scores. However, the estimated variation in rankings is larger for economies in the middle of the score distribution. This needs to be taken into account when analysing the results of the EBRD’s ATQ assessments. In particular, while the differences between the top-scoring economies and those at the bottom of the score distribution tend to be statistically significant, that is not necessarily the case when economies have relatively similar scores.

This approach measures the state of each quality and its components in a given country, as compared with the other countries in the EBRD region and a few select developed economies,1 against a frontier. The frontier is set either by the best performance in this group of economies or by an unobserved theoretical value and provides a common benchmark against which all countries are assessed consistently and comparably. The same frontier values are also applied across the years to ensure that computed scores are comparable and capture changes in underlying indicators through time.

Assessments of Transition Qualities (ATQs) are composite indices combining information from a large number of indicators and assessments in a consistent manner. The underlying indicators within each ATQ are constructed using a wide range of sources, including national and industry statistics, data from other international organisations and affiliated databases (World Bank, IMF, UN); surveys (The Business Environment and Enterprise Performance Survey (BEEPS); Life in Transition Survey (LiTS) and assessments prepared internally by EBRD experts (see Table M.1 below for the list of indicators).

The computation of ATQ indices involves multiple steps, namely: data preparation, normalisation and aggregation. Details of each of these steps are provided below.