Foreign direct investment (FDI) by transnational corporations (TNCs) into Central and Eastern Europe increased by more than 40 per cent to a record US$19 billion in 1997. The Russian Federation accounted for one-third of the region´s total. Its FDI increased dramatically, to US$6.2 billion last year from US$2.5 billion in 1996, according to the World Investment Report 1998: Trends and Determinants (WIR98), released today by the United Nations Conference on Trade and Development (UNCTAD).
More than three-quarters of the 1997 FDI inflows to the region was due to inflows to the Russian Federation, Poland, Hungary and the Czech Republic. The next 4 largest FDI recipients were Romania, Ukraine, Bulgaria and Latvia, which boosted their share of total regional FDI from 10 per cent to 15 per cent in 1997.
The United States was the largest single source of foreign investment into Central and Eastern Europe last year, followed by Germany and the Netherlands. United States TNCs were the most important sources of FDI into the Russian Federation, Poland and Ukraine, while German TNCs took the lead in the Czech Republic and in Hungary and were the second most important source for Poland and Slovenia.
FDI flows to the Russian Federation were mainly in natural resources and infrastructure development. In the other Central and Eastern European economies, most of the FDI growth occurred in manufacturing and services.
While there are a wide range of factors influencing FDI flows to the region, a primary stimulus appears to be the degree to which the countries have made progress in their transition to modern, market-based economies. This is especially true for the Czech Republic, Estonia, Hungary, Poland and Slovenia, which have been the forerunners.
WIR98 states: "It can reasonably be expected that this group is more attractive to foreign investors than those countries which are still facing considerable transitional uncertainty."
Today´s report notes that recent developments in FDI patterns have implications for future FDI trends in Central and Eastern Europe.
- Countries that are relatively attractive to FDI whether because of the pace of transition or of economic growth, opportunities in privatization or for other reasons will have a better chance to overcome economic recession.
- New competitors for FDI among the latecomers in the transition process may attract additional flows to the region, without impairing FDI prospects for the currently most attractive countries. For example, the potential of privatization-related FDI is still seen as untapped in several countries, such as the Russian Federation. It could play a lead role in these countries in the immediate future.
- Countries in the region that are in negotiation to join the European Union may become more attractive to foreign investors, as their economic systems and regulatory frameworks become more like those of the European Union and as the dynamic effects of the Union association become more evident.
Is the region obtaining as much FDI as could be expected?
Today´s report questions whether the region is obtaining as much FDI as might be expected given its economic development. Its share in world inward FDI stock is still very low: only 1.8 per cent in 1997. To a large extent this is explained by the fact that the majority of the countries opened up to inward FDI fairly recently; their accumulated FDI stocks are therefore small.
WIR98 says the low FDI inflow levels may also be partly due to: "legal and regulatory problems, a deeper and longer than expected transition-related recession, a prolonged privatization process, and the lack of local experience in business facilitation."
Outflows remain low
Outflows of FDI trebled last year from the region. Nevertheless, they remain low at just US$3.4 billion. About US$2 billion of this was accounted for by the Russian Federation and the next largest sources were Hungary, Croatia and Estonia. However, in a cautionary note, the report stresses that statistical methods of data collection in the region are incomplete and some domestic firms may be reluctant to report their outward investments.
WIR98 suggests that part of the FDI outflows from the Russian Federation may be motivated by a desire by investors to diversify assets as a safeguard against domestic instability. Almost all of this FDI went outside of the Commonwealth of Independent States.
In the longer run, states the report, outward FDI is likely to gain in importance as firms, especially in Central Europe, begin to lose competitiveness based on low wages, particularly in industries such as textiles, footwear and other labour-intensive industries. Indeed, firms from some more advanced transition economies such as Hungary and Slovenia have already started to invest abroad in labour-intensive industries.
UNCTAD surveys region´s investment-promotion agencies
An UNCTAD survey of the region´s investment-promotion agencies, conducted earlier this year, indicated that most respondents did not believe the Asian financial crisis would have a significant effect on FDI flows into the region. This evaluation appears to be based on the assumption that the attractiveness of the region to market-seeking FDI will continue to improve. At the same time, Asia is expected to become a tougher competitor for cost-sensitive FDI.
The respondents to the UNCTAD survey were optimistic overall of prospects for inward FDI flows and saw various locational determinants of FDI changing in the 1998-2002 period. They said that improvements are likely in the region´s physical and financial infrastructure. They noted that increased economic integration with investor countries is probable, which suggests that the possibility of wider regional markets would improve prospects for market-seeking, and possibly efficiency-seeking, investment.
On the policy front, the survey respondents said the stabilization of the legal environment is the single most important factor expected to boost FDI flows in the future. Other positive factors noted were advances in enterprise restructuring, improved macroeconomic stability, major advances in privatization, and more welcoming attitudes toward FDI on the part of local firms. In addition, most respondents forecast improved country images, reflecting improvements in the regulatory and economic determinants, coupled with better information about investment opportunities.