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Caution has become a desired article

THE MASSES have a short memory and people have already forgotten that back in the 1990s Slovakia had 20-percent unemployment, collapsing companies, ailing banks and 20- to 30-percent interest rates on loans, says Ľuboš Vančo. He believes that although the global downturn is very unpleasant, its impacts on the region and specifically Slovakia are not nearly as grave as the condition of the country’s economy back then.

Ľuboš Vančo(Source: Courtesy of KPMG)

THE MASSES have a short memory and people have already forgotten that back in the 1990s Slovakia had 20-percent unemployment, collapsing companies, ailing banks and 20- to 30-percent interest rates on loans, says Ľuboš Vančo. He believes that although the global downturn is very unpleasant, its impacts on the region and specifically Slovakia are not nearly as grave as the condition of the country’s economy back then.

The managing partner of KPMG, a global audit, tax and advisory services company, also says that caution has now become a desired article, but that this is a rather short-term reaction and with changing economic conditions the approach of firms will also change.

The Slovak Spectator spoke to Vančo about the impacts of the economic downturn on businesses, governmental regulation, alternative sources of capital, outsourcing prospects in Slovakia, as well as the future development of the tourism industry.

The Slovak Spectator (TSS): How has the global economic downturn affected audit and consultancy firms? Has the structure of your client base changed, or have the services that your clients demand been affected?
Ľuboš Vančo (ĽV): Yes, the crisis has affected our operation. I would say that 80 to 90 percent of our clientele are foreign companies, predominantly from Europe, and their financial difficulties are naturally reflected in our type of business. The crisis has not yet been reflected in our audit-related operation. However, historically audit used to be the smaller part as opposed to the larger advisory business including tax, financial advisory (including different types of financial transactions, acquisition of companies, transaction services) and classical consulting. The crisis has had the most visible impact on the advisory, non-audit part of the operation.

In general, when firms start having problems and see their revenues sinking, they start making cuts in places where short-term cuts appear to be least painful: marketing expenses, training, but also fees for consulting. Whenever we get into the weaker phases of the economy, these types of services are more affected. On the other hand, these segments feel the revival first once the economy starts breathing normally.

Though the global downturn is very unpleasant, its impacts on our region and specifically Slovakia are not nearly as grave as the condition of the country’s economy back in the 1990s. People should realise that. But the masses have a short memory and people have already forgotten that back then we had a 20 percent unemployment rate; companies were collapsing and practically losing all their markets. This crisis is for Slovakia considerably milder than the period between 1993 and 1997. At that time, banks were troubled and companies faced immense difficulty getting loans, with interest rates moving around 20-30 percent and the exchange rate of the crown oscillating. It’s only 10 to 15 years ago but people have already forgotten. Economic crises have been around for the past 300 years, but the memory of the masses remains short.

TSS: According to a recent study by KPMG International, companies’ concerns about decreasing trust in business have been growing. Companies are also struggling with the question of how far they should go in checking the background of their partners but also in the supervision of their employees. How is the ‘trust but first check’ principle changing the atmosphere of business?
ĽV: The degree to which companies should now be checking their clients and employees depends on their stage of development but also on the companies themselves. When we look at the last seven to eight years, weak firms which should have not been here were surviving and had revenues; they were selling products; they had cash and they paid. At that stage, there was no need for much caution. Today the situation is different.

Perhaps many thought that the situation five or six years ago was normal, but it wasn’t. Firms were offering products which did not have their justification and should have not been on the market at all, but they were there and got sold. Today, we are in a different stage and credit management has more importance than ever before.

In the past many financial directors attributed less importance to credit management because the business was rolling and there was wide access to cash and loans. Today, the situation has turned around and caution has now become a desired article. This is certainly a normal short-term reaction. With the changing economic conditions, the approach of firms will change as well.

TSS: Do you expect that the situation will also change in terms of state intervention and regulation, a growing trend during the economic downturn?
ĽV: I assume that even this situation will change. I would say that states to a certain degree are large companies and they also have to react and soften some of the negative developments. But then they also have to react in the long term so that they do not cut the branch they are sitting on. Of course we are now living in a period of broad-scale intervention by the governments, though we also need to say openly that it was governments and incompetent politicians who sewed the seeds of many problems.

TSS: Despite the continued fall-out from the financial crisis across the banking industry, it appears that not enough institutions are planning to make fundamental changes to their risk frameworks, another KPMG International survey suggests. What do you think are the fundamental changes that these institutions should make?
ĽV: It had always been the banking sector which was expected to take the conservative approach in business. The balance has been broken. I would not blame just managers. There was an environment in which it was possible to make 5 or 10 percent as a return on investment and suddenly it was not enough for people. Everybody wanted 20 or 30 percent or even 40 percent return annually, which was an abnormal situation. The shareholders, owners and managers pushed the business towards this trend suggesting that it was normal. The firms of course were able to make this money and they had huge increases in revenues and profit. Yet, they knew it was temporary, but had also hoped that it could still go on for many more years.

Yet it is precisely the banking sector which now has to return to conservative banking. The revenues of the investment banks were really high, with the best-paid managers and high dividends paid out to the shareholders. Though they had the word ‘bank’ in their name, these institutions were basically uncontrolled and to a large degree they pushed us where we are today. But banks will return to their status quo, perhaps also because the memory of the masses is short.

There are already signs that we might be reaching the bottom, sometime during this year and I personally expect that it will happen at the end of this or the beginning of next year. Then within five to ten years we will forget about what the banks have done. There will be some new regulation created but then again the banks will start providing loans until the next crisis emerges.
Sometimes we have too much regulation, but then there is a lack of good and high quality regulation and to find the balance is extremely difficult.

TSS: How do you assess the measures that the Slovak government has taken so far to ease the impact of the economic downturn on Slovakia?
ĽV: I personally am not an advocate of large-scale regulation. Put aside all the public relations and marketing, we have to admit that what the government can do is indeed pretty limited.
I would say that the switch to the euro at a strong conversion rate was not necessarily a good thing. I am an advocate of the euro and I am convinced that it was a good move for Slovakia, but the extremely strong exchange rate was unambiguously a political decision. And this is exactly what I wanted to point out: that this intervention was negative, because someone simply negotiated that we wanted to have the exchange rate at 30[Sk/€], while it could have been weaker by as much as 5-7 percent and this would have helped the Slovak economy.

What the strong exchange rate did was that it curbed the revenues of the firms, considering the fact that Slovakia is a pro-export country. It means that if someone was getting €1 for Sk33 and exported its products to the west, now the person is getting only Sk30, which is 10 percent off their revenues: in many cases it means 30-50 percent from the profit. It means that even if there were no crisis, Slovak companies could have been affected by the relatively strong exchange rate. The crisis only emphasised these issues. Slovakia has not learned its lesson from the Slovenian example.

Paradoxically, the strong exchange rate did not really bring huge benefits. Perhaps people can afford to buy more products abroad, but in practice many are losing jobs. It indeed was a price for governmental marketing, which we are now paying with higher unemployment. If the exchange rate was weaker, the companies would have had larger margins – for both profit and revenues – and thus they would not have had to reduce their costs so much.

Neither some flat reduction of taxes or cuts to payroll taxes would greatly help the economy. Moves like the car-scrapping bonus are political decisions made under lobby pressures: someone takes the cars and ignores for example washing machines or irons.

However, what the government can do is to save money. This government has not really been doing this so far, which is a pity. The sooner they reduce the number of people in state administration and cut their expenses, the more effective the savings are. Each week of delay has a significant impact on the state budget. It is really one of the few areas where the government can do something.
TSS: There are voices calling for a new wave of cooperation between governments and the global financial services sector if they want to create alternative sources of capital. What forms should such cooperation take?

ĽV: Alternative sources of capital are in fact different types of public-private partnership [PPP] projects, which represent different interconnections of private and public resources. The main difference is that it is not a classical loan or bond but we rather talk about different long-term relation, for example concessions for running the highway operation, construction of highways, waterworks or other forms.

For example, the pension fund management companies in fact have resources and perhaps it would be desirable if these resources were working. If the government was reasonable, it would enter a dialogue with these companies not by forcing them but rather inviting them to cooperate on a reasonable and commercially defensible basis with the option that the money would be used for unambiguously long-term projects. We are not talking about any short term projects here, but considering the fact that there is a long-term saving in question, which are investments into infrastructure or modernisation for example. These are options which have not been widely used in Slovakia so far, which is a pity. Slovakia does not have much experience with PPP projects. There isn’t a single finished PPP project or one in a reasonable phase for that matter. But it does not mean that we have to be afraid to go into such projects. That said, one also must add that even based on foreign experiences PPP projects are a huge source of corruption abroad. It is the greatest negative of this form. Sometimes the private firms channel away money from the state. However it is the state’s fault that it is unable to guard these projects.

TSS: Could we look at the PPP projects as a form of outsourcing?
ĽV: Yes, we could say that. However, when we talk about PPP projects the variations are quite huge and if we take two projects, we are unlikely to find two identical projects. The advantage for the state, which in some ways too has limited capacities, is in the fact that it can access these capacities through PPP. The state does not have construction capacities; it has certain companies which manage highways, but these also have limited capacities. So all in all, for the state it is advantageous that these firms or the private partners in PPP projects are often firms which have international experiences with the given project, when for example it comes to toll collection, highway construction or the operation of highways. These are all large firms with huge teams of people and developed systems, software, know-how etc. In many cases it means that the state, by using this form, gives up part of the profit, but then it can gain a well functioning project. Then of course the success depends on how the projects are tuned.

TSS: What is the attitude of Slovak firms towards outsourcing?
ĽV: It is hard to generalise in the case of Slovakia. When we look at Slovakia, where 80-90 percent of firms are owned by foreign companies and each of these companies have a different attitude towards outsourcing. Often it is linked to corporate culture, or in the case of foreign-owned companies it depends on what is the general practice at the parent company.

TSS: Has the global economic downturn influenced companies’ decision-making regarding outsourcing?
ĽV: There is no yes or no answer to your question. I would say that companies may now try to manage and cover activities that they can do in-house so that they avoid layoffs. Which is not necessarily the best way to manage things, because as I have said even outsourcing is in some cases a certain form of PPP project in the private sphere and I am in fact trusting part of my processes, part of my activities in return for something else to a different company.

TSS: What is the attitude of the firms towards outsourcing in Slovakia when for example compared to some other European countries? How would you evaluate Slovakia as a country offering outsourcing?
ĽV: We unambiguously fall behind western Europe. It makes sense for us to be compared with the Czech Republic, Hungary and Austria. Poland already has a large enough market to absorb certain trends. I would use the Czech Republic and Hungary as benchmarks for Slovakia even though we do not reach the outsourcing volumes in this sphere as are reached in Hungary or the Czech Republic. So far, firms are not using outsourcing to the degree they use it in these countries. But then Slovakia in general falls behind these countries in some aspects. For example in Slovakia, there is slightly more than half of the direct foreign investment per capita when compared to Hungary and the Czech Republic. In terms of investment we still have immense potential. Somehow it happened that, except for Volkswagen, by the end of the 1990s there was practically not any large direct foreign investment. Slovakia has not yet managed to catch up with the fact that it was precisely in the 1990s that these countries became extremely interesting for foreign capital. Yet foreign investors created there – from storage sites, through production halls up to offices – everything and thus the Czech Republic and Hungary became their centres for the region.

TSS: KPMG has said that the development of tourism will be a key element of the economic prosperity of the region. The economic crisis, however, has quite seriously affected the development of tourism in the central and eastern European region. What is the basis for KPMG’s assumption?
ĽV: The expectation is that along with the growth of disposable income, people will spend more money on leisure activities. It will not happen overnight though. Tourism develops slowly, not in the way, for example, that foreign investment develops. It is always a long-term investment. It is not enough to build a hotel for example. One also has to build a golf course, a residential area and something that will keep the tourists occupied and entertained for more days if they go there. We have to get used to it and start asking for better quality services, for example. If you look at Italy or Austria, the way the ski resorts were created there, it was a long-term development, a sort of evolution. After 20-30 years it seems to us that everything works perfectly there but it took time also there to develop. The investments into tourism are slower and the returns are long-term. The significance of investment in tourism is that those things stay here. Once a hotel is built, it will stay here just as a golf course will. What particularly obstructs the development of tourism in Slovakia is the atomisation of regions and the lack of cooperation between different units and municipalities. Instead of the regions uniting, the regions keep quarrelling. We cannot really talk about the tourism industry; we are only talking about a tourism workshop.

TSS: There has been a lot of criticism that the education system is not sufficiently interconnected with business.
ĽV: Universities should always be at the vanguard of new ideas or new things while walking one step ahead of the business. Here it happens the other way around and people in practice are usually better skilled. Also our universities are average. We have to be realistic about it. We are a small, 5.5-million-strong country and it will take years and years until we would have a top school here. I also would reproach the schools for the lack of continuity, mainly in terms of language training. Especially in languages it is very important that the kids continue at high school at the level where they finished at elementary school, but they do not and sometimes they start learning things all over again.

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