Andrew MacDowall in Sofia -

Bulgaria's flagging economy is in need of some good news. It appears that this may have come at last in the shape of an investment by a Chinese car firm in a factory in the country, a deal that may have far-ranging implications for both Bulgaria and the Chinese automotive sector.

Great Wall Motor Company, one of China's biggest automotive manufacturers, signed a joint venture (JV) deal with Bulgarian diversified holding company Litex Commerce in the presence of Chinese Vice President Xi Jinping and Bulgarian Prime Minister Boyko Borisov on October 15.

According to a statement by the Chinese partner, the plant will have an annual production capacity of 50,000 units and assemble four different models - a sports utility vehicle (SUV), a pickup and two passenger car models. The first vehicles are expected to roll off the line in 2011. The total initial investment is around €80m, potentially reaching €300m if the project is successful. The cars are expected to be sold under the Great Wall badge, boosting the firm's output from around 400,000 at present.

If the development is a significant step for Great Wall, it is something of a coup for Bulgaria. The country does not currently produce any passenger vehicles, though it does have a modest but successful automotive components industry. Other Central and Eastern European countries are important vehicle exporters, in some cases building on existing but outdated Communist-era infrastructure. The Czech Republic, Slovakia, Hungary, Slovenia and Romania, amongst others, have substantial automotive sectors, but Bulgaria has been left behind. Lack of a strong automotive tradition (unlike, for example, the Czech Republic) is a factor, as are the relative poverty and small size of the domestic market.

Press reports have dwelt upon Bulgaria's last post-Communist experiment in the industry, a JV between the UK's Rover and a Bulgarian partner, which closed down in 1996 after barely a year, having produced 2,200 vehicles. And it must be said that, at first glance, this seems an inauspicious time to launch an assault on the European automotive market. Sales have fallen dramatically in 2009, and the diminutive Bulgarian market is no exception, with only 23,700 new cars sold in the first 11 months of the year, down 52% on the same period of 2008. According to the BTA news agency, prices have slumped by 20-25%, seriously affecting dealers' margins.

However, there is some reason to doubt that the outcome will be the same as 13 years ago. The plant will surely be positioned squarely towards export markets - Europe and the Middle East have been cited - and by the time production commences, the automobile market is expected to be experiencing a post-slump upswing.

And Great Wall has chosen Bulgaria with good reason. The country has several competitive advantages, not least EU membership and therefore free trade with the rest of the bloc (tariff barriers having been a central cause of the Rover project's failure). Labour costs are relatively low, the 10% flat tax on corporate and personal income is one of Europe's lowest, and Bulgaria is located on key developing transport corridors between the Eastern Mediterranean and Central Europe, facilitating exports to growing markets. Therefore the factory will be an important toehold for Great Wall in Europe. Thus far, Chinese manufacturers have largely failed to tap into the European Union market of almost 500m people - China's top five vehicle exporters sold a paltry 745 units to the bloc in the first nine months of 2009, with Great Wall accounting for 675 of those, according to the European Automobile Manufacturers' Association (ACEA).

It is clear that change is afoot, however, and Chinese firms are finally realising their long-term European ambitions. Chery, Changan and Dongfeng are all looking to set up plants in Turkey as a base for exports to the EU. But by establishing a base within the EU's borders, Great Wall may be hoping to steal a march on its rivals. "The plant would essentially position Bulgaria as a strategic entry point into the EU for low-cost Asian manufacturers who seek proximity to the European markets through new East European member states," Paulius Kuncinas of the consultancy Oxford Business Group tells bne.

Indeed, from Bulgaria's point of view, the advantages are equally clear. Having grown at a brisk clip for several years, the economy has crashed, with the International Monetary Fund (IMF) expecting a 6.5% contraction in 2009. With previous growth drivers - particularly construction and real estate - in the doldrums after the bubble burst, and a gaping current account deficit, the IMF has warned that the country "will need to shift to a new growth pattern relying more on the tradable sectors".

Other traditional foreign currency earners, such as steel, tourism and power, also have their own problems, so the hope is that the Lovech plant will create the sort of positive multiplier effect that investments in Romania had which helped it become a regional leader in the automotive industry. Bulgaria's northern neighbour exported 211,318 vehicles in the first 10 months of 2009 - up 50.5% on year. Renault subsidiary Dacia, until recently the country's only passenger car manufacturer, has benefitted greatly from scrappage schemes in its export markets, but this is nonetheless a more than respectable performance in a recession. "If it goes ahead, the Great Wall plant will be a landmark event in Bulgaria's [foreign direct investment] history," Kuncinas says. "Bulgaria's closeness to Romania, which already has an advanced automobile sector, would essentially create a hub in the Balkans attracting new spare part manufacturers. As we know from investment by Renault in Romania, the automobile sector is all about creating a viable and efficient supply chain. One large investment is usually followed by a number of smaller entries. The impact on the economy would be huge. It would also potentially prop up the flagging fortunes of Bulgaria's steel and electronics sectors, while boosting transport, logistics and services."

It may be too early to open the champagne, however. Chinese companies have displayed a preference for assembling complete knocked-down kits (CKDs) imported from China, rather than using local suppliers. While this won't necessarily be the case in Lovech, it will take time for Bulgaria's automotive sector to grow, let alone reach the size of Romania's. The plant's proposed capacity is moderate, after all.

Great Wall will also face the same challenges as other manufacturers in the country: relatively low labour productivity, patchy infrastructure and the old bugbear, corruption. Nonetheless, the automotive industry should watch with interest.