Finance economic growth for a more stable and secure world

ANDREA MONTANINI & SAMUEL DORSHIMER*

Ahead of its annual meetings in Lima in October, the International Monetary Fund cut its forecast for global growth to a modest 3.1 percent because of slowing growth in emerging economies. In advanced economies, especially in Europe, growth has remained weak since the financial crisis seven years ago and many economies are still struggling to recover. Such sluggish growth raises questions about traditional strategies to jumpstart the economy and underscores the need for new ideas to create and sustain growth. 
 
Traditionally, governments have relied on the public budget and monetary stimuli from central banks to finance growth. Public debt has, however, risen significantly since the financial crisis. According to the World Bank, in the European Union as a whole, government debt as a percentage of the GDP rose from 42.7 percent in 2007 to 73.2 percent in 2014. In countries that were embroiled in the sovereign debt crisis — Portugal, Ireland, and Greece — debt levels rose to over 120 percent of the GDP, significantly burdening public finances. 
 
Countries with a traditionally low debt to GDP ratio, such as the United States and the United Kingdom, face unprecedentedly high levels of public debt. Growing public debt levels siphon away spending to debt service and limit governments’ ability to spend on programs to stimulate the economy. If governments are unable to manage their debt more effectively, it will become difficult to use traditional fiscal stimulus to finance growth and place a significant drag on long-term growth. 
 
While Turkey does not have the same public debt burden — debt as a percentage of the GDP has fallen to nearly 40 percent from over 50 percent at the peak of the crisis — it has significantly increased its current account deficit over the last several years and is at heightened risk if it can’t adjust to normalization of US monetary policy.    
 
The private sector, meanwhile, faces formidable obstacles in financing growth. Typically, companies have relied on the banking system for funding and loans. Since the crisis, however, lending has slowed in the European Union because of fears about a growing number of non-performing loans. Between 2007 and 2014, the number of non-performing loans as a percentage of overall loans increased nearly fourfold. In Turkey, while the number of non-performing loans is relatively low, companies have borrowed extensively, mostly in dollars. In fact, according to the IMF’s recent Global Financial Stability Report, corporate debt as a percentage of GDP in Turkey increased over 20 percent between 2007 and 2014. If the Turkish lira depreciates further or the US Federal Reserve raises interest rates in the next few months, as expected, companies would have a hard time making loan payments. 
 
In the face of these challenges, central banks have been a bright spot in maintaining liquidity and some stability. The European Central Bank (ECB) has used extensive Quantitative Easing (QE) policies to maintain liquidity in the EU’s banking system and combat low inflation. However, monetary stimulus can only work up to a certain point. Official interest rates have been kept at the lowest level ever by the main central banks, including the Fed, the ECB, the Bank of England, and the Bank of Japan. Despite this, inflation remains low and the economy is  not booming. The economic impact of monetary policy is limited and is only sustainable for short-term recovery and growth. In order to promote long-term growth, most countries will need to find strategies to adjust to a less accommodative monetary policy environment and to an era of high public debt.
 
Capital market reform can promote growth in the EU and Turkey. Currently, alternative sources of financing for European companies are blocked by high costs of compliance and barriers to cross-border investment. Greater integration could provide significant opportunities for economic growth. 
 
The importance of capital markets has been recognized in Turkey. Turkish Finance Minister Mehmet Şimşek, speaking after the Justice and Development Party’s victory in the Nov. 1 parliamentary elections, mentioned the need to deepen capital markets in Turkey so that companies can raise more equity domestically and offset some of the risks created by borrowing in dollars. 
 
A new approach to economic policy is needed — one in which the public and the private sector jointly channel private resources to finance economic initiatives with positive spillover effects. The public sector has to maintain fiscal discipline, raise confidence, and create the right tools to finance the economy through private resources. Especially for Small and Medium Enterprises (SMEs), the lack of equity is dramatic in Europe, Turkey, and many other places in the world where they represent by far the largest part of the economy. The private sector needs to be forward-looking and open up to new ventures, business opportunities, and shareholders. 
 
Today, the EU and Turkey face internal unrest as well as external challenges from Russia, the war in Syria and the resultant migrant crisis, and a slowdown in global economic growth. It is, therefore, critical for both the EU as well as Turkey to deepen their capital markets, carry out fiscal reforms, and promote economic and political stability to ensure long-term growth and enhance their ability to confront global challenges.


 
*Andrea Montanino is Director of the Atlantic Council’s Global Business and Economics Program where Samuel Dorshimer is an intern.