Mixed news for EU-10 as investment disappoints and labour costs increase

Date: 25/11/04

By Anna McLauchlin

THE investment climate in the new member states may not be as rosy as some expect, the latest report from the Economist Intelligence Unit (EIU) has warned.

Fears of corruption and poor infrastructure could hinder foreign direct investment (FDI), while tougher EU business and fiscal rules threaten growth. Governments will have to work hard to keep their markets attractive.

In its latest Regional Overview for eastern Europe, the EIU admits that accession to the EU has provided the “anchor” for governments in the ten new member states to make their markets more attractive.

In the run up to the 1 May accession, politicians were desperate to push reform through and adopt the necessary regulatory environment.

Growth in the region has outstripped most of western Europe in recent years and, for the next few years, the EIU expects the annual growth rate to reach at least 4%.

This is thanks in part to the economic recovery of its wealthier neighbours boosting exports, healthy FDI and strong domestic consumption.

This year has been a particularly strong one as a result of softened monetary and fiscal policy, strengthening demand in the rest of Europe and a surge in consumer spending ahead of accession because of fears that prices would soar afterwards.

Poland is currently experiencing the best growth rates, with gross domestic product (GDP) rising by 6.5% in the first half of 2004.

For the whole year the EIU expects 5.5% growth for Poland (the European Commission projects 5.8%).

Growth in Slovakia is expected to reach 3.5% in the same period (the Commission expects nearly 5%) and Hungary 4.1%.

But the EIU warns that 1 May has not been a watershed for investment as many expected. And the improved risk climate and positive impact of joining the EU's internal market on FDI could, it argues, be offset by the more punishing elements of EU regulation, higher wages and the possibility that policymakers will lose the pre-accession momentum to make their markets more business-friendly.

During the first half of 2004, FDI inflows into central Europe grew by 16.3% in dollar terms compared to 2003, but less than 10% in euro.

The booming Baltic countries - Estonia, Latvia and Lithuania - fared slightly better with a 26.6% rise in FDI from last year (in dollar terms), but that is largely because they were late to begin the privatization process.

In 1999-2003, FDI flows to all new member states accounted for less than 4% of total FDI into the 'old' EU-15.

Increasing labour costs in the new member states seem to be a particular problem, with cheaper labour costs in Asia stealing potential FDI.

An EIU survey, World Investment Prospects 2004, published earlier this year found that the new EU countries are losing out to India on wage costs and skilled labour force and to China as an R&D investment location.

The EIU still expects FDI to be “robust”, even after the remaining privatizations are completed.

But it estimates that figures could be one-third higher if wage costs were closer to the l270 per month average in eastern Europe. Wages in central Europe range from l1,080 gross per month in Slovenia to l360 in Slovakia (2004 figures).

Global consultant AT Kearney has also found that investor interest in the new member states is slipping.

In its October 2004 FDI Confidence survey, investors cited poor infrastructure (67% of respondents) and corruption (60%) as well as rising costs (53%) as the main threats to investment.

Poland has fallen most out of favour, dropping from fourth most popular country for investors in 2003 to twelfth. Hungary fell to 19th from 17th while the Czech Republic fell to 14th from 13th last year.

The next FDI surge, the EIU says, is set to come when the new member states join the euro. Frontrunners Estonia, Lithuania, Slovenia - which have already joined the exchange rate mechanism - and Latvia are expected to be first in line for the renewed boom.

But joining the euro will require many governments to impose a tougher fiscal policy, which is likely to curb growth.

Poland's recent growth, for instance, has been given a shot in the arm by looser fiscal policy, but the Commission projects a 5.9% budgetary deficit for 2004 - almost 3% higher than the level needed to join the single currency.

The report warns that growth is also being driven largely by domestic consumption, which could wane as governments rein in their budgets and wages grow more slowly.

High levels of unemployment (such as those in Poland and Slovakia) could also curb consumption.

But the EIU still expects the investment climate in the new member states to improve “at a fairly rapid pace over the medium term”.

For Poland and Slovakia, the EIU has raised its expectations for the business environment from 'moderate' in 1999-2003 to 'good' in 2004-08. And the 'business environment scores' for the Czech Republic and Hungary have risen from 6.55 and 6.58 out of ten to 7.3 and 7.17 for the same periods.

The EIU estimates that it could take new member states six decades to match average GDP enjoyed in 'old' Europe'.

In its Regional Overview for Eastern Europe the Economist Intelligence Unit (EIU) warned that the investment climate in the new Member States might not be as rosy as some expected. It said that fears of corruption and poor infrastructure could hinder foreign direct investment (FDI), while tougher EU business and fiscal rules threatened growth. Governments would have to work hard to keep their markets attractive.