Matti Vikkula, chief executive of Ruuki, a Finnish forest products group, is ready to bet the company on an €1.1bn ($1.7bn) investment in Russia.
If the venture pays off, he will more than triple the company’s annual turnover from €250m-€300m to €1bn. If the plans go wrong, Ruuki’s future could be at risk.
Mr Vikkula says he wants to invest in Russia because, along with South America, it contains the world’s largest reserves of undeveloped forests. He is proposing to establish a pulp mill and forestry and timber processing operations that would together employ 2,500-3,000 and create up to 30,000 jobs in the local economy.
Although Russia holds unique attractions for forest products groups, it is a measure of the country’s growing appeal to foreign investors that a medium-sized Finnish company is ready to contemplate the risks of investing in Russia.
“I am very impressed how fast Russia is developing overall,” says Mr Vikkula. “I believe in the next five to 10 years we will see a major positive change in the economy.”
Central and east Europe last year received an estimated $365bn in private capital flows according to the Institute of International Finance (IIF), the US-based research group. The region (including Turkey) passed emerging Asia as the top destination for foreign funds. With the global credit squeeze biting, the IIF forecasts inflow to fall to $333bn but to remain far ahead of east Asia on $227bn in 2008.
This is a reflection of the region’s investment attractions, as Mr Vikkula’s plans show. But, with international financial markets in crisis, it is also a weakness.
As the IIF says: “Capital flows into the region are likely to remain heavily debt-dependent, which leaves the region with an important degree of risk not so evident in other regions.”
Foreign investment is growing strongly, from $48bn in 2006 to $61bn last year and a forecast $89bn in 2008, according to the IIF. But local borrowers are piling up debt even faster – with total external debt from private sources growing from $187bn in 2006 to $304bn last year. The IIF predicts a decline this year to $245bn.
The biggest borrowers are Russian banks and companies, accounting for $150bn of 2007 inflow, followed by Turkey. Hungary and Romania also “remain heavily dependent on external debt inflows” says the IIF.
Not surprisingly, the global financial upheaval has prompted investors and creditors to pay more attention to the risks of emerging markets. In late March, the Russian stock market was down by about 11 per cent from its 2007 peak, Poland’s by 26 per cent and Romania’s by 31 per cent.
But the region’s modest equity markets play a small role in the overall economy. Far more important are changes in debt markets, where risk aversion has increased the spreads borrowers must pay and in some countries made access to international credit more difficult, especially for banks. Kazakh banks have been particularly hard hit. Some smaller Russian banks, heavily dependent on international financing, have also suffered.
Lenders are differentiating between countries, with the advanced central European economies enjoying better terms than the more vulnerable countries of the former Soviet Union and south-east Asia. At the time of writing, the credit default swap – which benchmarks risk against US treasury bonds – had widened by 237 basis points for Kazakhstan since last June and by 214 points for Romania. But Poland’s increase was just 87 points and the Czech Republic’s 36.
However, location is not the only factor. Hungary, where the government is battling to reduce big budget and current account deficits, saw its CDS spread increase by 173 points.
Commercial bankers insist that the region can weather the global financial storm because economic growth is solid; because most countries are following sound policies and because in the EU member states, banking is dominated by big international groups with the resources to manage local difficulties.
But bankers are still cautious. Federico Ghizzoni, head of central and east Europe activities at Unicredit, the Italian bank, says: “We are monitoring the situation day by day. The situation is not alarming. We don’t see a credit crunch yet. Maybe we have some signals of liquidity problems in a few countries like Kazakhstan.”
Meanwhile, as Ruuki’s example shows, direct investment in acquisitions and projects is still going strong. Daimler, the German car company, plans to build its first car plant in eastern Europe – in either Poland or Romania. Rival car companies, including Renault and Volkswagen, are also expanding production in Russia. Banks have been busy pushing through acquisitions, notably in Ukraine. In business services, multinationals are accelerating the development of centres in central and eastern Europe to support clients in western Europe and further afield. Boris Nemsic, the Croatian-born chief executive of Austria Telekom, the Austrian telecommunications group with big east European investments, says: “Investors want to work with the talented and dynamic people that the region has to offer. And they want to work with foreign investors to develop their careers.”
But direct investments plans are typically implemented over 12-18 months. So the current flow of projects has yet to feel the full effect of the credit crunch. Sooner or later, the new-found caution of financial investors is likely damp the enthusiasm of direct investors.
