Early this year, alarmist headlines appeared proclaiming things like,“Failure to save East Europe will lead to worldwide meltdown” and “Eastern crisis that could wreck the Eurozone”. What they failed to point out was that Central Europe (CE) is neither economically nor geographically one common region.
In fact, there is relatively little trade between CE countries, and states such as the Czech Republic and Slovenia have GDP per capita figures not dissimilar to “old” EU members such as Greece and Portugal, yet with much better debt and deficit dynamics. According to the IMF, CE countries with the highest debt levels are only around the European Economic and Monetary Union average.
In the global economic downturn capital flows to CE have fallen dramatically, but there are several reasons for investors to remain confident, most notably the significant funding and support available to European Union (EU) member states that commit to fiscal austerity measures and currency devaluation (and those that peg to the euro have been given a break on this). The EU has already doubled payment assistance to CE member states, and the G20 has doubled the IMF’s lending capacity for low income countries such as Poland. This support is giving CE countries time for their attractive longer-term fundamentals to return to the fore.
Most funding in EU member states is long-term foreign direct investment. More than half of the 500 largest companies in CE are foreign-owned, as well as many CE banks, and their parents have invested substantial sums in the region for the longer term. In 2008 for example, 97 percent of the aggregated net income of the three leading Austrian banks active in the region was generated in CE.
Investment is all about timing, and taking a three- to five-year investment horizon, investing in CE is currently extremely attractive. By 2013, productivity in the EU countries of CE is projected to grow by 3.7 percent, 6x growth in the Euro zone overall. Hourly labour costs, however, are projected to be only 35 percent of those of the Euro zone. GDP per capita is projected to grow at 4x the rate of the Euro zone in the next five years. These key convergence drivers will produce real growth well in excess of most developed markets, including the “old” EU. Additionally, convergence is a structural driver, and there are highly appealing cyclical factors such as CE’s educated and flexible workforces and attractive tax regimes.
The outlook for the region as a whole remains challenging: external demand is weak, capital inflows are limited and some countries are constrained in their policy response to the radical deterioration in the near-term growth outlook. But the region should not be treated as a homogenous block. For investors with a medium- to long-term horizon, the region will provide highly attractive investment opportunities over the coming years.
Ben Edwards is managing partner of Syntaxis Capital, a Central Europe-focused mezzanine fund manager.