Bank of Estonia head: Real estate projects not of national importance ({{contentCtrl.commentsTotal}})

President of the Bank of Estonia Madis Müller.
President of the Bank of Estonia Madis Müller. Source: Priit Mürk/ERR

Providing work to local construction companies can be an important argument when deciding on state support measures. However, it is probably better to use traditional public procurement channels, rather than to use taxpayer funds to prop up struggling real estate firms writes Madis Müller, in the wake of the Porto Franco KredEx loan controversy.

The government's actions in helping Estonian companies survive in the conditions of the coronavirus crisis and to preserve as many jobs as possible is certainly justified. 

There is also no reason to question the objective of further supporting certain strategic industries.

One of the Bank of Estonia's overarching recommendations for providing state support to the economy has been to target aid as precisely as possible. 

Following the same general recommendation, we have also referred in our comments to some principles which could be taken into account when providing support for companies. 

I will explain these in more detail below.

State aid cannot last too long

First of all, it is worth offering financial support to companies through a guarantee from KredEx, rather than lending state money directly to companies. 

When using guarantees, less money has to be issued from the state coffers, to achieve the same result.

In the case of loans guaranteed by banks, the perspective of the private sector is useful in evaluating projects. 

In leaving some of the risks to the banks, this also makes banks financially interested in ensuring that taxpayers' money is not spent on companies that are not really viable. 

In the case of direct loans from the Rural Development Foundation (Maaelu Edendamise Sihtasutus) or KredEx, the risks are much higher, the understanding of the market is not as strong, and ultimately the taxpayer likely will have to spend more money.

There may also arise situations where projects already financed by the bank before the crisis which later become hopeless get refinanced by the state. 

In essence, this would reserve taxpayer money for projects that have already soured from the banks' perspective, in other words they would foot the banks' losses unnecessarily.

Second, when it comes to state support for companies, it must be stressed that broad-based state aid to companies, be it in the form of wage compensation or something else, cannot be prolonged for too long. 

If, with state support, jobs are retained for too long, but there is no long-term prospects for them, this will work against economic recovery. 

It is preferable to let the economy adapt quickly and to help people find new jobs instead.

However, a third principle is vital when it comes to supporting companies with a strategic significance.

It is very easy to get into a situation where the state is helping, not so much a strategic sector, but simply the owners of a few companies.

It should be clear that this is not a sensible use of taxpayer money. But how do you establish when support for a strategic industry crosses the line into support for a select few business owners?

First of all, one might ask whether it is an economic sector that is important to the state which is at stake, or rather, whether the profitability of only a few companies operating in that sector is at stake. 

If a company applying for state aid is also able to get financed by private investors or banks, then the company is likely to be commercially viable, and would be able to continue its operations without state aid.

When the state offers a loan on more favorable terms than private financiers in such a situation, then it is not so much strategic economic activity which would be supported (this would continue anyway), but rather more the owners of that company. 

A cheaper loan means lower interest rate costs, and thus better business profitability for business owners.

It is also likely that by offering better conditions than private financiers, the state will evaluate risks wrongly, in other words risking the taxpayer's funds without receiving a return commensurate with the risk. 

It is also likely that by offering better conditions than private financiers, the state will evaluate risks wrongly, in other words risking the taxpayer's funds without receiving a return commensurate with the risk. 

It is also likely that by offering better conditions than private financiers, the state will evaluate risks wrongly, in other words risking the taxpayer's funds without receiving a return commensurate with the risk. 

As a result, the state might better invest alongside private investors, rather than compete with them. 

In this way, it would be possible to resolve situations where banks or private investors would not venture to finance an otherwise viable company during the crisis, due to excessive risk.

By contributing to co-investors on reasonable terms, the state can also avoid the takeover of strategic companies by unsuitable foreign partners.

One example of well-structured public funding during a crisis is the German government's loan to airline Lufthansa. 

The state was ready to support the strategically important airline, but also set conditions which were balanced from the taxpayer's point of view, taking into account the risks taken.

Thus, among other conditions, Lufthansa's existing shareholders had to transfer to the state a 20 percent of the shares, and agree to restrictions on future dividend payments.

Porto Franco development

It is certainly difficult to assess which companies or industries are sufficiently strategically significant to justify wide-scale state aid. 

It is certainly difficult to assess which companies or industries are sufficiently strategically significant to justify wide-scale state aid. 

Here again, it is worth thinking about what might have happened had the government not opted to support this company. 

It is very possible that the completion of the development project would have been delayed, in this case. Would that have been a problem for the country, however?

The seriousness of the problems arising from the postponement of real estate development can be assessed according to how acute the shortage of new commercial real estate, and apartments, in the center of Tallinn, is. 

In the worst case scenario, the company responsible for the development could have failed and gone bankrupt.

However, the developer's bankruptcy would not be a problem of national importance, since in this case a project with a sufficiently prime location would get snapped up by the next investor, who could presumably finish the project.

However, the developer's bankruptcy would not be a problem of national importance, since in this case a project with a sufficiently prime location would get snapped up by the next investor, who could presumably finish the project.

In conclusion, the question once again is whether a sufficiently strategic economic area could in fact be identified, and whether a project of national significance was supported, or only a specific enterprise.

Providing work for local construction companies can also be an important argument when deciding on state support measures. 

However, it is probably better to use traditional public procurement methods than to have the facility to fund construction projects which are privately owned, with taxpayer funds.

How should be contribute to future trends?

There are surely many dilemmas in providing state support to companies during a crisis. 

It is really tough to assess how long, and based on what criteria, it is sensible to provide broad-based support to companies to recover from crisis.

It is also not clear which larger companies justifiably need to be treated separately, and which industries should be considered strategically important. 

However, what is clear is that the conditions of the aid offered must be very well thought through, especially when supporting large companies.

If not, the state ends up not supporting a strategic industry but only the owners of an few companies. 

This would be neither necessary for economic recovery nor commendable from the taxpayer's point of view.

An additional challenge for the government will be to find ways to make a wise contribution to future improvements as we emerge from the crisis, looking beyond the very immediate concerns.

If the government is already planning an additional boost to economic recovery, then in doing so it is also worth emphasizing, for example, the acceleration of the digitalization of the economy, the achievement of climate goals, and other similar trends supporting Estonia's long-term competitiveness

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Editor: Andrew Whyte

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