The all CEE-ing eye

The Central and Eastern region of Europe is thriving – in all aspects of business – so Corporate Finance presents this special profile on the countries in this market

Since the peoples of Eastern and Central Europe threw off half a century or more of shackles in the 1990s, investment from the West has been one of the most important forces in modernising their economies and creating new businesses and jobs With the current global financial turbulence looking likely, according to many experts, to continue for the rest of 2008, foreign direct investment is probably going to be an even more important plank in capital investment and job creation, from Slovenia to Russia.

Last year saw FDI in Europe continues to grow, pushed largely by projects in Eastern Europe, to hit a record $291bn. Russia, for the fifth year in a row, remained the top European location for investment in terms of job creation and investment, with Romania and Poland also in the top 10.

However, the results of a survey on the appeal of countries to venture and private equity investors carried out by Navarra University in Spain and Strategic Capital Management and announced earlier this year were not so good. The survey measured a country's attractiveness in terms of investment opportunities, market size, growth forecasts, the capital market, tax conditions and local business sentiment. Bulgaria ranked fourth from bottom with 79 points, ahead only of Romania on 77 points, Slovakia on 76 and Greece on 69 points. Hungary, Slovenia, the Baltic states and Poland were the top performers in Central and Eastern Europe, with Hungary and Slovenia ranked ahead of some "old" EU members such as France and Italy.

The report said that although countries in Central and Eastern Europe countries were in transition, they offered excellent investment opportunities for risk and private capital. The human and social environment reaches Western European standards thanks to a high level of education, good labour regulations and low crime rates. Their weak points were their high unemployment, poorly developed capital markets and their relatively small economies. In addition, bribery and corruption are higher than they are in the West. Entrepreneurship also lags behind: the burden for starting a business is high and R&D expenditure is small. The average score of the entire Central and East European region was 85 points, against 100 points for the "old" EU 15 countries.

High growth rates
In those Eastern European countries outside the EU, s the sector looking most juicy for FDI is residential real estate, where construction came to a stop during the violent break-up of Yugoslavia in the 1990s and has not picked up properly since. Now, with the economies of countries such as Serbia and Albania showing high growth rates, high demand for accommodation and low availability is seeing prices soar. Serbian analysts say that in Serbia the local commercial real estate market attracted $880 million in foreign direct investment in 2006 and 2007, a figure that is only a fraction of its real potential, according to Serbian analysts.

Merrill Lynch's director of global principal investment, Rob Schweizer, told Reuters in an interview recently: "The main obstacle that every foreign investor will cite when you talk about the Balkans is political instability." Nevertheless, he said, "we are optimistic the region is going to continue to enjoy significant growth and really outperform compared to the rest of Central Europe." With that vision, Merrill Lynch has signed partnerships with local companies to build shopping centres in Belgrade, Sarajevo, Zagreb and Skopje. Schweizer told Reuters: "Our strategy is to become the dominant city centre retail shopping developer. In the capital centres you see the wealth effect spill over."

Serbia's main disadvantage is that it is still outside the European Union, a door that Brussels says will remain shut until the country delivers the remaining ethnic Serb war crimes suspects from the wars of the 1990s to the United Nations tribunal in The Hague. At the same time the country's Nationalist Prime Minister, Vojislav Kostunica, opposes ties with the EU because of its backing for the independence of Kosovo, which Serbia continues to regard as an integral part of its nation. Schweizer told Reuters: "Serbia has traditionally been the economic hub of the region, but because of the political situation it has seen more direct investment going to some of the neighbouring countries."

Among Eastern European nations one problem starting to hit several economies is inflation, which, with growth starting to fall, is raising the spectre of "stagflation". In Hungary, for example, inflation was 7.1 percent year-on-year in January, well above the central bank's target of three percent, while GDP growth slowed to 0.8 percent year-on-year in the fourth quarter of 2007. Lars Christensen, senior analyst at Danske Bank in Denmark, said: "This stagflationary situation in Hungary is something we're likely to have repeated in a number of eastern European countries. There is a theme there. Large imbalances lead to inflationary pressures and that eventually leads to busts in the boom."

Solid position
As growth slows, the Baltic states of Latvia, Lithuania and Estonia, together with Romania, and Bulgaria, are among the most vulnerable to this scenario, while Slovakia and the Czech Republic appear to be in a more solid position, Christensen said. Slovakia, which is due to adopt the euro in 2009, has seen underlying growth thanks to a great deal of foreign direct investment, particularly in the automotive sector. The country reported GDP growth of a whopping 14.1 percent in the fourth quarter of 2007, driven largely by substantial stock-building. However, Christensen said, Slovakia's growth was "in our view too strong. That is generating inflationary pressures down the road."

Romania and Bulgaria have been the winners in south-eastern Europe in attracting foreign investment, with outsiders regarding their membership of the EU as a big plus in terms of safety and stability. In Romania, for example, the Chinese company BYD Electronics, a long-time supplier for Nokia, is preparing to launch production in the town of Jucu, where Nokia recently moved its German production. BYD plans to produce three million plastic mobile phone holders a year, beginning in November. Romania has seen eight years of economic growth averaging more than six percent a year, and foreign direct investment has accelerated sharply in the past two years,

However, inflation is again a threat. The country's current account deficit is estimated at more than 14 percent of gross domestic product, having trebled year-on-year, as a credit-financed boom in consumption pulls in imports from the rest of the EU. Fortunately foreign direct investment of almost €700 million covered 61.2 percent of the current account gap in January. But wages are rising at 25 percent a year, and skilled labour is in short supply, aggravated by emigration, mainly to Italy and Spain. The National Bank of Romania has raised interest rates three times since October, by 200 basis points, to nine percent, as inflation hit 6.6 percent at the end of 2007, against a target of 3.9 percent.

In Bulgaria the volume of FDI in 2007 rise by 20 percent on the year to around €5.2bn, around a fifth of total investments in the South-East European region. In the seven months from January to August 2007 FDI in the country totalled €3.39bn, equal to about 12.7 percent of Bulgarian GDP, up by 1.6 percentage points on the same period in 2006, The leading investor was the United Kingdom, with 12.5 percent of total FDI, followed by Austria with 11.2 percent and Belgium with 9.4 percent.

Looking to improve
Two countries looking for more FDI between now and 2012 are Poland and Ukraine, the joint holders of the Euro 20112 football championships. Hryhory Nemyrya, Ukraine's deputy prime minister, told Reuters in a recent interview: "Ukraine is lagging behind most of its eastern European and central European neighbours in terms of foreign direct investment in total and FDI per capita, There is huge room for improvement, a several times increase between 2008 and 2012," he said.

Foreign direct investment in Ukraine rose to a record $7.9bn in the 2007, from $4.8bn in 2006. But Nemyrya estimated $23bn was needed to put the required infrastructure in place, with the bulk of this money having to come from the private sector. "We have 1,500 kilometres in roads to be built or modernised and almost 100 hotels to build," he said.

One of the few Eastern European countries itself making foreign investments is Slovenia, always the wealthiest and most stable of the ex-Yugoslav republics, where, for example, the Slovenian retailer Mercator runs stores in its neighbours. However, the still-spiky nature of Balkan politics means problems arise: when Slovenia, t o Serbia's anger, expressed strong support for Kosovo independence, a small bomb was detonated outside a Mercator store in Belgrade.

All the same, this is unlikely to halt the continued investment by Slovenian companies in Serbia, looking to expand outside their own small domestic market. At the end of 2005, the most recent period for which detailed data is available, around 17 percent of Slovenian foreign direct investment or €501m, was located in Serbia (and Montenegro at the time), up from four percent in 2001, while the number of Slovenian companies invested in Serbia grew to 309,5 from 128 in 2001. Since the end of 2005, an additional €1.7bn has been invested abroad by Slovenian companies, much of that probably invested in Serbia.