Fundamentals outweigh investor risks in central and eastern Europe

If central and eastern Europe has over the past few years become a tougher place to do business, nobody seems to have told Daimler.

The German automotive group will spend at least €500m building a new factory producing engines for its Mercedes-Benz brand in Jawor, in Poland’s south-west, after shortlisting Hungary, Slovakia and Romania for the project.

In the news for all the wrong political reasons over the past year, eastern Europe nonetheless remains an important destination for global companies. Caution has increased, but not at the expense of spending.

Manufacturing, media, property and financial services companies have so far shrugged off political upheaval and constitutional crisis in Poland, the rise of the far right in Slovakia, a Romanian government collapse, and the wider effects of the EU’s migrant crisis.

Economic growth that well outstrips the EU average, rising consumer spending and still untapped reserves of skills and customers continue to lure western companies and investors keen to gain exposure to a growing market. 

“Stronger GDP growth and improving macro-stability is visible in [central and eastern Europe], differentiating it positively from the emerging markets universe,” says Michal Krupinski, chief executive of PZU, Poland’s largest insurer, with businesses across the region. “Poland in particular is well placed to continue converging with more affluent EU countries.”

“In the longer term the main challenge is to avoid the ‘middle income trap’,” says Mr Krupinski. “Transition to the model of a more innovative economy is needed, producing higher value-added goods and services, with local firms going global.” 

According to the International Monetary Fund, the economies of the Baltic states and Visegrad Group of Poland, Hungary, Slovakia and Czech Republic are on track to grow around 3 to 3.5 per cent this year. 

Further south and east in the Balkans, in Romania and Bulgaria, average growth will be slightly lower at 2.4 per cent, according to the IMF’s predictions, comfortably above the expected EU average of 1.9 per cent.

While the economic fundamentals appear sound, and the investment returns are still strong, political risk has returned as a problem in discussions taking place among investors in the region or eyeing up an entry. A string of election results signals a shift towards the populist, nationalist right in some states.

Most clients want clarity: ‘should we worry?’ We say ‘it depends’

Most prominent has been the return to power of the Law and Justice party in Poland, which won a sweeping majority last October. The biggest economy in the region by far, and typically its entry-point for new investors, Poland is important beyond its size: it can set the tone for the international outlook on eastern Europe.

Since it took office, Law and Justice has moved to take control of institutions including state-owned media, the public prosecutor, security services and some of the country’s biggest companies. The party’s most controversial move, to change the workings of the country’s highest court, which has left it paralysed and prompted a constitutional crisis, has raised fears over the rule of law in the country, unsettling some foreign investors.

Poland’s ministry of economic development is holding meetings with three or four investors each week, according to a person involved, to soothe fears and explain the new government’s intentions.

“For foreign investors, Poland’s image is blurred. Rough political rhetoric from the government and often-dramatic news reporting are contradicted by good macro indicators and a booming economy on the ground,” says Wawrzyniec Smoczynski, managing director of Polityka Insight.

His Warsaw-based company, which provides business and policy analysis on Poland to multinationals, investors and banks, has seen a marked increase in interest from foreign clients keen to assess the political risk for their business in the region’s largest market.

“Most clients want clarity: should we worry? We say it depends,” Mr Smoczynski says. “For many sectors nothing has changed because they are domestic, unregulated or without state-owned players. For others political risk has risen exponentially, but there are some for which the environment has actually got better.”

Concerns over Poland’s political direction echo those voiced half a decade ago regarding Hungary. Prime minister Viktor Orban’s pledge to pursue an “illiberal democracy” and increase taxes on foreign investors hit investor sentiment. Worries linger today in spite of efforts by Budapest to placate investors. In Slovakia, too, an election this spring saw nationalists and fascists enter parliament, and a shaky ruling coalition government formed.

Politics aside, the region is pushing ahead in terms of making itself more attractive to investors.

One focus is to foster enough start-ups to form hubs in central and eastern Europe that can challenge the entrepreneurial clout of London, Berlin, Tel Aviv — not to speak of Silicon Valley — as part of a long-term push to advance their economies away from a reliance on low-cost manufacturing and physical exports.

Central and eastern Europe has 35,000 start-ups, according to Don Grantham, Microsoft’s president for the region. The US technology company works with 9,000 of them and invested over $130m last year in funding and technology support.

“What I find with central and eastern Europe compared with the west is an attitude of wanting to embrace the future, embracing opportunities,” says Matt Brittin, head of Google in Europe, which last year opened a Google Campus in Warsaw, its fifth in the world, to support start-ups.

“If we can help expand the digital skills in this region, then we can help businesses grow, build careers and increase productivity,” he adds. Google has launched training schemes in 14 countries in the region, where most rank among the lowest in the EU in terms of digital skills in the labour force.

Most countries have adopted ambitious digital governance plans, seeking to follow the examples set by Estonia and Latvia in jumping straight from Soviet-era bureaucratic processes to online platforms. Countries are keen to make life easier for businesses and streamline their own government administration channels.

Initiatives such as the “Digital Gateway to Administration” project by Poland’s IdeaBank are part of that push. The corporate lender is integrating its online banking platform with the nascent online administration systems at the country’s social services, tax and company registration authorities. 

“Keeping in touch with public administration is a very important and time-consuming part of running a business,” says Jarosław Augustyniak, the bank’s chief executive. “This will not only simplify communication with public administration, but also increase business security . . . we will help entrepreneurs avoid these problems.”

Non-profit support organisations such as Start IT in Serbia are seeking to provide platforms to promote entrepreneurs, many of whom struggle to find finance or expertise due to the lack of funding networks or the risk profile of countries in the region but outside the EU. 

Some, such as Serbia’s Nordeus, a software developer that built one of the world’s most popular social sports games, Top Eleven, manage to grow their business without external funding, but many more struggle to reach critical mass.

Other countries in the region are betting on a trickle-down effect from global technology investors into homegrown successes.

Romania hosts research and development centres and service offices for companies such as HP and Oracle that employ over 60,000 people, a number that analysts expect will more than double to 150,000 over the next five years.

Keen to follow Poland’s model, which over the past decade has become a leader in providing technology services to western finance companies, Romania produces more than 100,000 IT graduates every year. That is expected to help it swell its IT services market to a forecast €4bn by the end of the decade.