New wiiw Report on FDI in Central, East and Southeast Europe

11 June 2015

Recovery in the New EU Member States, stagnation in Southeast Europe and decline in the major post-Soviet countries.

FDI inflows to Central, East and Southeast Europe (CESEE) as a whole declined in 2014 with significantly  diverging  trends  in  the  three  sub-regions:  increase  in  the  New  EU  Member States,  stagnation  in  Southeast  Europe  and  decline  in  the  major  post-Soviet  countries.

Austria could, on the whole, maintain its CESEE market share. In 2015, the CESEE region is exposed to two main factors that drive FDI into opposing directions. One is the stabilization of economic growth in the NMS which is  expected to spur  FDI. The other  is the  Ukraine– Russia  conflict  which  depresses  economic  growth  and  increases  investment  risk  in  the affected countries leading to capital flight.

In 2014 global FDI experienced a modest decline while both inflows and outflows continued to shift to emerging economies. A turning point may have been reached in Europe; economic growth was resumed and cross-border investments invigorated in the second half of last year. 

FDI took off in the New EU Member States (NMS) – thus the deleveraging which suppressed FDI inflows has come to an end. There has been diminishing greenfield investment activity, however. Consequently, FDI has flown mainly into existing subsidiaries, strengthening established capacities. 

FDI  inflows  are  still  meagre  in  relation  to  gross  fixed  capital  formation,  about  half  of  the before-crisis  level.  Economic  recovery  is  based  on  other  growth  drivers  including  private consumption  and  EU  transfers.  However,  an  acceleration  of  economic  growth  may  not  be sustainable without a recovery of private investments, both foreign and domestic. 

Government policies for attracting FDI have focused on the re-orientation of FDI to higher value-added activities in manufacturing and services. The Central European manufacturing hub (including  large  parts  of  the  Czech  Republic,  Hungary,  Poland,  Romania  and  Slovakia)  has expanded and new ventures targeted ICT services. Simultaneously, the support of domestic SMEs and national champions has received more attention and public funding compared to earlier years. However, fiscal support to new investment projects in more developed regions has been curtailed by the new EU-wide state aid ceilings.

The CIS countries as well as Latvia and Lithuania received much less foreign investment in the wake of the Ukraine crisis. Russia is the only country among the CESEE which has negative FDI net, meaning that outflows outpace inflows by a wide margin: inflows declined to less than one third, whereas outflows only to two thirds in 2014; consequently the capital flight in the form of FDI amounted to EUR 26.7 billion. 

In  Ukraine FDI  has  dried  up  and may  not recover  before  political  and  economic stabilization  is reached.  But  structural  reforms  including  competition  policy  and  regional  decentralization  may increase FDI in the future. Following the devaluation of the local currency the country is now a cheap alternative for component manufacturing and IT service sourcing.

Austria  is  the  third  most  important  investor  in  the  NMS  and  SEE  behind  the  Netherlands (which  is  a  location  of  international  headquarters)  and  Germany.  FDI  outflows  from  Austria were in line with the global decline in the past eight years. Meanwhile a redirection from CESEE to Asian and American destinations took place; the share of CESEE fell from about two thirds to one third of the outflows.

China – one of the largest global investors with outflows doubling since 2008 to some EUR 100 million – has recently started to also build positions in CESEE beyond Kazakhstan and Russia. In 2014 the region hosted 11% of Chinese outward greenfield capital flows after only 6% in 2008. However, the combined share of China and Hong Kong in the FDI stock is still marginal in the NMS  and  SEE  (about  0.1%);  it  is  close  to  1%  in  Russia  and  Belarus  and  more  than  3%  in Kazakhstan.

The stabilization of economic growth in the EU and most prominently in the NMS is expected to  attract  growing  amounts  of  foreign  investment  in  the  latter  region  in  2015.  Even  if  first quarter  data  do  not  support  this  expectation  yet  we  believe  FDI  activity  to  gather  momentum.  A recovery of private investment activity in the more developed EU members would mean that more cross-border investments will target the NMS. FDI in Russia is bound to plummet again except from China which has announced several large manufacturing projects.

The Report was prepared by Gabor Hunya (concept and analysis) and Monika Schwarzhappel (statistics and layout).