In 2009 Eastern Europe suffered the sharpest decline in FDI inflows of any emerging-market region. After reaching a record total of US$183bn in 2008, FDI flows into the region plummeted to US$97bn in 2009. In no year since 1994 had FDI to the region declined before, neither in 1998-99 nor in the global slump of 2001-03. FDI flows to the region were flat in 2010. Although they recovered modestly in 2011, to an estimated US$125bn, another significant decline is estimated for 2012. FDI inflows are unlikely to return to former levels for some time. Eastern Europe will be less attractive to investors than faster-growing emerging markets, such as those in Asia and even in Latin America.
First-half 2012 data is available for 20 countries in the region. For these countries FDI inflows in January-June 2012 were 27% down on the same period in 2011—far higher than the 8% drop in global FDI inflows in this period, and a much sharper drop than in any other emerging market region (in Latin America and Africa FDI inflows actually increased over this period). There was considerable variation in country performance across the region. In the first half of 2012 13 of the 20 countries recorded year-on-year declines in FDI, while seven saw increases.
Almost all subregions were affected. The sharpest year-on-year decline (by 56%, from US$2.7bn to US$1.2bn) was in the three Baltic economies. Inflows into East-Central Europe declined by 21%, from US$13.4bn to US$10.5bn. FDI inflows to the Balkans were flat because of a large year-on-year increase in flows to Bulgaria, while inflows declined in each of the other seven states in the subregion. FDI flows to the eight EU member states from the region are expected to be a mere US$25bn in 2012, lower by US$10bn than in 2010 and far below record totals from a few years ago, belying the once prevalent view that EU membership stimulates FDI inflows.
Investor confidence has been hit
Weak growth has hit investor confidence. This is the main reason for the decline in FDI. Growth has weakened as the euro zone, the region's most important market and source of investment, has sunk into recession. Several countries in Eastern Europe have also tipped into recession. The recession in the euro zone is acting as a brake on economic activity in Eastern Europe, through weaker trade, investment and financing through the banking channel. Exports and industrial output in Eastern Europe have weakened and business and consumer sentiment remains fragile. In addition to faltering external demand and the weak outlook for credit, domestic demand remains generally anaemic. Fiscal consolidation is under way in much of the region.
The drop in FDI flows occurred despite some recent improvement in the quality of business environments. According to the World Bank's latest Doing Business report, as in some previous years, several east European countries feature prominently in the list of top reformers, based on changes in regulations over the past year. Five east European economies were among the ten economies improving the most across three or more categories. As in some recent years, in the past year eastern Europe had the largest share of economies registering improvements, with 88% of economies implementing at least one institutional or regulatory reform making it easier to do business, and 67% implementing at least two.
Poland and Russia record sharp drops
There was a considerable drop in FDI flows in the first half in the two main recipient countries—Russia and Poland. This offset significant increases (often from low levels) in some other countries during this period (Slovakia, Bulgaria, Ukraine and in particular Hungary). Although Poland has avoided the recession that has afflicted most of its neighbours, FDI inflows into Poland were actually negative in January-June 2012, compared with inflows of US$9.5bn in the first half of 2011. FDI flows into Russia in the first half of 2012 were 39% lower than in the year-earlier period. FDI flows into Russia slipped to US$16.3bn, significantly down from US$26.8bn in January-June 2011. Base effects account for a large part of this drop. There were several large transactions in January-June 2011—for example, PepsiCo completed its US$5.4bn buy-out of Wimm-Bill-Dann, in one of the largest ever foreign acquisitions of a Russian company.
Poor short-term prospects
Short-term prospects are poor, as also revealed by investor surveys. The euro area recession and weak performance across Eastern Europe suggest that there will be no recovery of FDI inflows soon. Eastern Europe will be less attractive to investors than faster-growing emerging markets, such as those in Asia.
Chinese FDI into Eastern Europe
Chinese FDI into Eastern Europe has been attracting increased attention. Most obviously, investment in the new EU member states of the region gives Chinese firms untrammelled access to the EU market. Nonetheless, we should not overemphasise this factor—China is also showing a great deal of interest in investment opportunities in western Balkan countries with no immediate prospect of EU membership, including Serbia, Montenegro, BiH and Macedonia.
However, just as Chinese FDI in the EU as a whole is a small item within the global investment picture, so Chinese FDI in the new member-states of the EU is a very small item within the EU picture. The proportion of Chinese FDI accounted for by small, family firms, usually working in low-tech sectors, is higher in central and eastern Europe than in the EU as a whole. Hungary is the only country in this region with a stock of more than €1bn of Chinese FDI (largely on account of the €1.1bn takeover of isocyanate producer BorsodChem by Wanhua in 2011).
During 2012 China has signed a number of new investment agreements with Hungary. In Romania, negotiations continue on possible Chinese investment in the Cernavoda nuclear plant. In Poland, cumulative Chinese FDI stands at a modest US$250m (€195m). There is plenty of political will on both sides to make these figures grow. On his visit to Poland in April 2012 the Chinese prime minister, Wen Jiabao, announced the setting up of a US$10bn credit line for joint investments in the areas of infrastructure and technology, and a US$500m investment fund for central and eastern Europe. The Polish side has responded positively, and in October 2012 more than 30 Chinese companies participated in a China-Poland Trade and Investment Co-operation Forum in Warsaw, the Polish capital.
Against these bright prospects must be weighed a number of disappointments in relation to Chinese involvement in these economies. In Poland, the picture is clouded by the disaster of the A2 motorway. The tender for construction of the new road was awarded to a Chinese construction firm, Covec. The firm fell down badly on the job, and the road had to be completed by Polish firms. The Chinese side has been accused of dragging its feet on investment projects in Hungary, and has notably failed to step in to save Malev, the Hungarian national airline, from bankruptcy.
China is being as cautious in Central and Eastern Europe as it has been in relation to other investment destinations. However, there are good, practical reasons why Chinese investment should expand and prosper. If negotiations on an investment accord between the EU and China start 'as soon as possible', as agreed between the two sides at their September 2012 summit, China can look forward to an easier passage through the formalities of investment in the region.
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