Shaping Eastern Europe
Marcus Svedberg, Chief Economist of East Capital looks at current problems affecting Eastern Europe, and solutions for the region.
One of the main takeaways from the global financial crisis was that a lot of emerging markets, especially the ones in Eastern Europe, are too dependent on external sources of funding. In general there is a flight to safety in the US, and in the Eurozone, bringing their money home, which is irrational because they are taking the money to where the problems are, and then emerging markets suffer; even if they are not the source of the problem.
The lesson should have been, that emerging market countries should do whatever they can to increase their domestic sources of capital but how do you do that? Well, in general through reform, but even more important is the domestic pension system. This makes sense from an economic point of view and especially if you have a challenging demographic, which most of these countries do.
Did any of the emerging countries do this? No. In emerging Europe, the two countries that had sensible pension systems: Hungary and Poland, dismantled their systems. They re-nationalised the private part, at least to some extent. They are most likely to increase the equity portion, which is good for equity markets, but in my opinion the fact that they are decreasing the private parts substantially, they are running the risk of actually reducing the financial premium on the Polish market, which is roughly 30% compared to others.
In emerging markets generally, we are seeing the opposite trend of what we would have liked. The few good months that we had are actually being diminished, and being diminished for the wrong reasons which is a worry.
The second negative is that there are just too many small stock markets. Investors, especially global larger investors are concerned about liquidity. As these countries were becoming independent, over the last 20 years or so, there was a push to have regional stock exchanges, one for the Balkans maybe run out of Vienna. One for the Baltics states run out of Stockholm, and Warsaw could become a regional exchange. That didn’t happen. You can say that Warsaw went that way a little bit because they have been stealing business from Ukraine and a little bit from the Baltic States. However I believe that’s more of an exception than a rule. The problem is that there’s a certain level of pride in having your own stock market and I don’t see things changing very rapidly.
We do see some privatisation happening, which is good economic policy and also makes these stock markets, not only more liquid but will tend to make them more balanced. Having new kinds of companies in Russia, for instance, we’ve seen IT companies reducing the heavy focus on oil and gas. In Poland last year there were a lot of IPOs and SPOs, which was very welcome. Right now we are seeing things happen in Romania with some of the energy companies, they are having their first IPO in approximately five years.
What is the driver of more liquidity? Exchanges? Regulation?
I think the stock market can do a lot with regards to cross listing and important areas of reform. In addition they can push governments to actually enact these pension policies. If they don’t, they might risk losing more business, because if there’s no liquidity then firms may go elsewhere. As happened in Ukraine for instance, with firms going to Poland.
There can be stock market or foreign exchange competition – which is not necessarily a bad thing, because then the market will dictate where you list. Lots of Russian stocks have dual listings in London, which is actually very important as that is also a driver for proper governance because when they list in London, a company has to comply by the corporate government standards and accounting standards of the UK. That is an additional benefit of listing abroad, especially when you look for liquidity.
Governments have a big role in this, both in terms of providing liquidity, and the underlying regulatory system, but I don’t believe the way forward is actually to close down stock markets. ETFs are probably a response to poor liquidity, and it’s also a response to these many small markets. We don’t think that is the best way of getting exposure to emerging markets, because you are largely restricted in how you can utilise your information about the companies within a country.
It also appears to be a response to some of these exchanges, not doing their homework. You get ETFs on some of the bigger emerging markets, however there you have the liquidity. It’s also a convenience thing, as it is often cheaper than buying actively managed funds. That I can’t really argue with.
Data and research availability
We see it as important to actually conduct our own research. We do a thousand company visits every year. Even in places like Russia which is well-covered, we go out and we meet the company if they’re not covered by brokers, such as the mid-sized companies and the small caps. The smaller the market, the more value this has, especially when you go to frontier markets. Of course maybe a couple of the banks and a few blue chips are covered but they are not covered by a lot of people, so you want to make your own view. We put a lot of resources into going out and seeing these companies, even in Poland, Russia, and Turkey, which are well-covered. We are probably unique in that sense. Your average investor wants exposure to Eastern Europe, so they get it through a couple of blue chips, a Russian energy company and a couple of banks.
We see a lot of financial market reform, especially in Russia, which is important for a lot of investors as it makes it a lot easier and you can see that on volumes. You cannot, in small markets with limited liquidity, have a huge staff covering stocks that are not traded all that much. Again, it comes down to demand. Over the past five years many brokers have had to downsize. However in terms of markets that have significantly increased in size, Poland has been holding up quite well but it is Istanbul that is really taking off in terms of volumes.
In general it is not quite the same in the emerging markets in Asia, as many of these markets are larger. In emerging EMEA we have Russia, Turkey, Poland and South Africa. In Asia there are a number of fairly sizeable markets and also, large countries, with the potential for the same financial deepening.
What does the future hold?
Over the past five years, I have not seen many positives. If there is anything, it is the increased volumes in Turkey and the financial market legislation in Russia. However in regards to the smaller markets, I have not really seen anything, perhaps a little bit of privatisation going on. If I were to predict the future I think you will see some more action, if not from a regulatory point of view then just from a pure market effect, because right now emerging markets are under pressure. If you’re keen to have stock markets that are working, then I think you should do whatever you can from a regulatory or technology point of view, I certainly hope there will be more action going forward.
It’s a cliché but crisis gives opportunity to reforms. Now there’s not so much of a crisis any more but there is a more negative sentiment towards emerging markets. Hopefully this will spur a little bit more action from the political and regulator’s point of view. But again, I do not think you will see any stock markets being closed or announcements that Central Europe is going to merge into a single stock exchange. Even though it would make sense, it just won’t happen.