Will Investors Return to Eastern Europe?

October 28, 2015 11:00 AM

Investors feel increasingly squeamish about their activity in Eastern Europe. In 2015, mergers and acquisitions in the region are expected to reach €55 billion, half the level in 2011. And private equity financing in these transactions is barely €7 billion, against €13.5 billion in 2011. (The data are available in the Emerging Europe M&A report from Euromoney Institutional Investor company EMIS.) This note offers an agenda for restoring investor confidence in Eastern Europe.

Earlier this week, an investor conference in Warsaw detailed the reasons for the falling interest in the region. First, politics in the region have turned populist: a mixture of nationalism and an increased role of the state in the redistribution of taxes. Think Hungary’s Prime Minister Viktor Orban and his policies, or Russia’s President Vladimir Putin and his. Orban and Putin are the most recognizable political leaders who espouse such views.  But the number is growing: from Slovakia’s Prime Minister Robert Fico to the incoming Polish government of former Prime Minister Jaroslaw Kaczynski. Their public comments and actions scare investors who previously saw Eastern Europe as a region with relatively secure property rights and high potential economic growth.

Second, the hope that investors can treat Eastern Europe as if it were a single market has not materialized. The small size of national markets and the continued existence of large differences in regulations on the books and in practice mean that entry and operational costs are high. There are some examples of successful cross-border investments, but these are insufficient.

Third, the crisis in Ukraine and the economic sanctions imposed on Russia in 2014 have essentially stopped foreign investment in two of the largest markets in Eastern Europe. With the Ukrainian economy far from recovery, and with no quick end in sight for Russian sanctions, investors have fewer attractive opportunities.

What can be done to reverse this trend? Measures can be taken to reduce the fragmentation of East European markets and thus reduce the costs of cross-border investments. If investments in large Polish or Czech or Bulgarian companies are seen as investments in regional (not national) industry leaders, the appetite for Eastern Europe will return.

The massive infrastructure investment that has been going on since the accession of East European countries into the European Union will serve to reduce fragmentation. Manufacturing companies, in particular, can move produced goods more easily from one country to another thanks to the construction of new roads and the modernization of rail transport. The service sector has also benefited: It is easier to be a tourist in Bulgaria or Croatia these days, as airports and municipal infrastructure have been upgraded.

The main driver towards a single market in Eastern Europe, however, is the entry of all countries in the region into the European Union. In this respect, the quicker accession of Western Balkan countries will do a lot to spur investor interest. All of these countries—mostly from the former Yugoslavia—have been given indicative entry dates. Keeping these deadlines—most by 2021—would be essential to turn Eastern Europe once again into a favorite destination for foreign investment and increase economic growth.

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Simeon Djankov Former Research Staff

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