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Foreign Direct Investment in Central and East Europe

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Foreign direct investment (FDI) in Lithuania is projected to have grown by at least 15 percent this year. Its FDI stock - accumulated in its decade of independence - reached c. $4 billion, or c. $1000 per capita. Pace has picked up dramatically in the past four years in many second-tier investment destinations in central and east Europe, including Slovakia, and formerly war-torn Macedonia and Armenia. Of the latter's $600 million in post-communist foreign inflows - two thirds have been placed since 1999. 

Prime investment locales, like the Czech Republic, or Hungary, are still attracting enthusiastic fund managers, multinationals and bankers from all over the world. In a startling inversion of roles, Russia became a net exporter of FDI. According to official figures - which are thought to under-report the facts by half - Russia invested abroad more than $3 billion every single year since 2000. This is double the figure in 1999 and translates into $300-500 million in annual net outflows of foreign direct investment. 

Moreover, the bulk of Russian capital spending abroad is directed at rich, industrialized countries. The republics of the former Soviet Union see very little of it, though Russian stakes there have been growing by 25 percent annually ever since the 1998 meltdown. Russia's energy behemoths compete, for instance, with western mineral and oil extraction companies in Kazakhstan and Azerbaijan. 

Levels of worldwide FDI declined by more than 50 percent - to c. $730 billion - between 2000 and 2001. Yet, astoundingly, the major downturn in emerging markets FDI in the last three years has hitherto largely bypassed the region. Net private capital flows - both FDI and portfolio investment - shot up six-fold from $1 billion in 2000 to $6 billion a year later. Most of the surge occurred in the Balkans and the Commonwealth of Independent States (CIS).

According to the European Bank for Reconstruction and Development (EBRD) in its latest Transition Report Update, the region grew by 4.3 percent in 2001 and by 3.3 percent last year. This is way more than most developed and emerging markets managed. Eight countries in central and east Europe drew rating upgrades, only two (Moldova and Poland) were downgraded.

But all this may be changing. The global recession is already one of the most prolonged, trenchant and all-pervasive in history. Its effect on the region's traditional export markets is pernicious.

Central and east Europe were spared the first phase of financial gloom which affected mainly mergers, acquisitions and initial public offerings. But now that multinationals are scrapping projects, scaling back overseas expansion and canceling long-planned investments, the countries in transition are bound to hurt.

According to the latest report by the Vienna Institute of Economic Studies, FDI flows to the countries of central Europe were halved in the first quarter of last year, despite their looming membership in the European Union in May 2004. Export transactions were frequently delayed and privatizations attracted scant interest. 

The Vienna Institute predicts a particularly bleak year for Poland and a Czech economy redeemed only by sales of state assets in the energy sector. Still, the statistics do not cover reinvested profits. These amount to $1.5-2 billion in Hungary alone - equal to its average annual FDI. 

The picture is mixed. Forecasts prepared in November 2002 by the United Nations Conference for Trade and Development (UNCTAD) showed marked declines in FDI in Moldova, Estonia, Hungary, Poland, Slovakia, Macedonia and Ukraine. Flows should rise in Albania, Bulgaria, the Czech Republic, Latvia, Lithuania and Slovenia, and remain unchanged in Bosnia and Herzegovina, Croatia, Romania and Russia, said UNCTAD. 

Some countries fare better than others. Slovakia sold, last March, 49 percent of its gas transport company for $2.7 billion. Slovenia will book yet another record year in 2002 due to the long-deferred privatization of its banking sector and to the sale to foreign investors of assets originally privatized to cronies, insiders and communist-era managers. The Slovenian Business Weekly expects the country to have drawn in more than $600 million last year - up 50 percent on 2001.

In the western Balkans, only Croatia stands out as an inviting and modernization-bent prospect. Yugoslavia is reawakening, too. It has privatized cement companies and rationalized the banking sector with a view to becoming a preferred FDI destination. In the first 6 months of 2002, it garnered $100 million in realized deals and another $60 million in commitments.

Romania and Bulgaria are laggards, though intermittent privatization in both countries is counterbalanced by cheap and skilled workforces in their growing and labor-intensive economies. Macedonia is reviewing, with a view to annulling, at least 30 suspect privatization deals. This will not endear it to anyhow reluctant multinationals. 

Per capita, FDI stock is highest in the Czech Republic ($3000), Estonia ($2600) and Hungary ($2400). These are followed by Slovenia ($2000), Slovakia ($1800), Croatia ($1700) and Poland ($1200). All, with the curious exception of Croatia, are slated to join the EU next year.

The total realized FDI in 2000-2002 in central Europe amounted to more than $50 billion, with Poland and the much smaller Czech Republic attracting the most ($14 billion each), followed by the Slovak Republic ($7 billion) and Hungary ($5 billion). The regional FDI stock comes to a respectable $100 billion.

Southeastern Europe (the politically correct name for the Balkans), excluding Greece and Turkey, attracted rather less - c. $12 billion in realized FDI since 2000. Croatia tops the list with $3.8 billion, followed by Romania ($3.3 billion), Bulgaria ($2.3 billion), Macedonia ($1.1 billion), Yugoslavia ($0.7 billion) and Albania and Bosnia-Herzegovina ($0.5 billion each). 

Yet, the Balkans, impoverished and war-scarred as it is, accumulated a surprising $22 billion in FDI stock. According to the 2003 Investment Guide for Southeast Europe, published by the Bulgarian Industrial Forum, the share of FDI per GDP is much higher in the Balkans than it is, for example, in Russia. In 2001, the ratio was c. 5 percent in Bulgaria, 7.5 percent in Croatia and about 12 percent in Macedonia.

The former USSR as a whole enjoyed $57 billion in FDI since 1991. The bulk of it went to Russia ($23 billion) and the Baltic states ($8 billion). In the last 3 years, Ukraine absorbed $1.9 billion in FDI flows - one half the receipts of the puny Baltic trio: Lithuania, Latvia and Estonia. Belarus and Moldova scarcely register, each of them with barely above three fifths the FDI in Albania, or ravaged and precariously balanced Bosnia-Herzegovina.

The weight of FDI in the local economies cannot be overstated. Two fifths of the exports of countries as disparate as the Czech Republic and Romania are produced by foreign affiliates. In some countries - like Romania - 40 percent of all sales are generated by foreign-owned subsidiaries. The banking sectors of many - including Bulgaria, Croatia, the Czech Republic and Macedonia - are mostly owned by outside financial institutions.

Foreigners bring access to global markets, knowledge and management skills and techniques. They often transfer technology and train a cadre of local executives to take over once the expats are gone. And, of course, they provide capital - their own, or gleaned from foreign banks and investors, both private and through the capital markets in the west.

Initially, foreign investors provoked paranoid xenophobia almost everywhere in these formerly hermetically sealed polities. Deficient legal and regulatory frameworks, rapacious insiders, venal politicians, militant workers, opaque and politically compromised institutions, disadvantageous tax regimes and a hostile press obstructed their work during the first half of the 1990s. 

Yet, gradually, the denizens of these countries came to realize the advantages of FDI. Workers noticed the higher wages paid by foreign-owned plants and offices. The emergent class of shareholders, invariably members of the powerful nomenclature, having sucked their firms dry, sought to pass the carcasses to willing overseas investors. Currently - with a few notable exceptions, such as Belarus and Ukraine - multinationals and money managers are actively courted by eager governments and keen indigenous firms.

Proofs of this grassroots turnaround in sentiment and priorities abound.

FDI is a good proxy for a country's integration with the global economy. It is an important component in A.T. Kearney and Foreign Policy Magazine's Globalization Index. The Czech Republic made it this year to the 15th place (of 62 countries), higher than New Zealand, Germany, Malaysia, Israel and Spain, for instance. 

Croatia in 22nd rung and Hungary in the 23rd slot compare to Australia (21) and outflank the likes of Italy (24), Greece (26) and Korea (28). Slovenia is not far behind (25), followed by Slovakia (27), Poland (32) and Romania (40). Even hidebound Ukraine made it to the 42nd place, ahead of Sri Lanka (44), Thailand (47), Argentina (48) and Mexico (49). Russia lags the rest at the 45th location.

A.T. Kearney's Global Business Policy Council - a select group of corporate leaders from the world's largest 1000 corporations - publishes the FDI Confidence Index. It tracks FDI intentions and preferences. Its September 2002 edition ranked 60 countries which, together, account for nine tenths of global FDI flows. The companies interviewed were responsible for $18 trillion in sales and seven out of every ten FDI dollars.

Revealingly, central and east European countries made it to the first 25 places. Poland, right after Australia, preceded Japan, Brazil, India and Hong-Kong, for instance. The Czech Republic, Hungary and Russia - closely grouped together - were found more alluring than Hong-Kong, the Netherlands, Thailand, South Korea, Singapore, Belgium, Taiwan and Austria. Russia - whose economy improved dramatically since 1998 - leaped from beyond the pale (i.e., below the top 25) to 17th place. Hungary moved from 21 to 16.

The report concludes with these incredible projections:

"Russia ... could well be a target for almost as many first-time investments as the United States ... China, Russia, Mexico and Poland combined ... are expected to accumulate about one quarter of all proposed new investment commitments."

This is part of a more comprehensive trend:

"Europe has become the most attractive destination for first time investments. More than one third of global executives are expected to commit investments for the first time in Europe over the next three years (especially in) Russia, Poland and the Czech Republic."

A relatively new phenomenon is cross-border investments by one country in transition in another's economy and enterprises. At four percent of Slovene FDI stock, the Czech Republic has invested in Slovenia as much as the United States, or the United Kingdom. Slovenes and Bulgarians have ploughed capital into the banking, industrial and food processing sectors in Macedonia. Hungarians in Serbia, Czechs in Romania, Croats in Slovenia - are common sights.

Traditional FDI destinations feel threatened by the surging reputation of central and, to a lesser extent, east Europe. In a series of articles he published on radio Free Europe/Radio Liberty, Breffni O'Rourke summed up Irish anxieties expressed by his interviewees thus:

"There's a certain unease developing in Ireland as the 10 Central and Eastern European candidate countries move toward full membership in the European Union. The Irish are not unaware that the Czechs are heirs to a fine tradition of precision manufacturing; that the Poles are considered quick-thinking and innovative; that Bulgarians have a way with computers; that the Baltic nations have powerful Scandinavian supporters; and that Romania has extraordinarily low costs to offer investors. In fact, rising costs -- in comparison to the Eastern candidate nations -- are one of Ireland's main worries. The question troubling the Irish is: Could incoming Eastern member states prove so attractive for foreign investment that the country would find itself eclipsed?"

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