Private equity investment into Central and Eastern Europe is still hampered by falling inflows into funds, while growing state intervention is crowding out investments, according to participants at the 18th annual conference of the Hungarian Private Equity and Venture Capital Association (HVCA) in Budapest on June 8.

Andras Simor, vice-president of the European Bank for Reconstruction and Development (EBRD), said that falling private equity inflows into the EBRD region were a “striking” and  “extremely worrying trend”.

Private equity remains a relatively untapped source of funding, compared to public equity markets and foreign direct investment, in a region where it could play a key role in accelerating convergence with Western Europe. “It is not money that is missing from the region but risk capital,” Simor pointed out.

While portfolio and foreign direct investment (FDI) into the region had returned to the levels prevailing before the global financial crisis, private equity investment hadn’t, and it had even fallen back again after 2011.  While the region represented 9% of global FDI and 2% of portfolio investment, it made up only 1% of the world’s private equity investment.

According to the EBRD’s 2015 Transition Report, while private equity investment represents more than 1% of GDP in advanced countries such as the US, it makes up only 0.1% of GDP in large EBRD region countries such as Russia, Turkey and Poland.

The report blamed weaker private equity activity in Russia, changes to the pension system in Poland and the slowdown in economic growth that have hit returns, as well as structural factors such as poor contract enforcement and protection of minority shareholders.

Simor said the EBRD had only invested in one private equity fund in 2015, its lowest ever commitment, because of lack of interest from co-sponsors. “We can only invest if others invest with us,” said the EBRD’s chief financial officer. “What we have found challenging is to find others to invest with us.”

His staff has assured him there was a “promising pipeline”, he said, but so far “this year we have not seen much of an improvement compared to the last few years”.

Nevertheless in Hungary, according to local private equity managers, the venture capital (VC) market has been turbocharged by the EU’s Jeremie programme (Joint European Resources for Micro to Medium Enterprises), where the EU puts up 70% of the available funds.

Jeremie-financed funds were present in three-quarters of Hungary’s 109 private equity and VC deals in 2015, according to a report by the HVCA and consultants EY, though the overall disclosed value of the transactions in the Hungarian market was just $103mn.

Levente Zsembery, HVCA chairman and chief executive of X-Ventures, said there were already a further 26 deals in the first quarter. “It’s a booming market,” he said. “In such a small market it’s great.”

However, the end of that programme’s current investment round this June now poses a risk of a slump. Funds have become addicted to EU cash – there was no fundraising reported last year, according to the EY report – and there may now be a rush to exit their investments. “There will be a lack of capital,” said Zsembery. “It will be very important to continue this programme”.

Some fund managers argued that the Jeremie programme had also poisoned the private equity well in Hungary, by encouraging inexperienced funds to take majority stakes, reducing incentives for company founders. “For us [these companies] are uninvestible,” said Michael Schuster, partner at Austrian fund Speedinvest.

Reduced room

Other participants were particularly worried by the growing trend of state intervention, largely in Hungary and Poland, which is reducing the space for private equity in certain sectors, though the smaller-sized VC market is largely unaffected. Both countries have or are planning taxes and new regulations on sectors such as banking, retail, energy and telecoms, reducing profitability and disadvantaging foreign investors.

In Hungary, the state has even begun renationalising the banking sector. “Recently there has been very little that [private equity] funds could do in Hungary,” said Simor, who battled with the populist rightwing government as central bank governor until 2013.

“These parts of the economy are becoming more difficult for private equity to invest in,” said Tamas Szalai, investment director of CEE Equity Partners.

“It comes down to picking industries, companies that are not targeted by these trends,” said Bela Lendvai-Lintner, partner at ARX Equity Partners.

Robert Chmelar, investment partner at internet investment group Rockaway Capital, said this trend can offer opportunities as well. For example, the Polish government’s planned retail tax does not affect online shops, thereby benefiting the kind of operations Rockaway invests in, though “long term these developments are worrying”.

Erratic state interference has helped make Hungary a buyers’ market, with little competition for deals, a good chance of winning exclusivity early, and attractive and stable pricing, according to participants. By contrast, the Czech Republic and Poland remained sellers’ markets, with increasing asset prices.

Overall, fund managers said the slowdown in economic convergence in the region and the problems of expanding operations over very different local markets meant they were more and more looking for companies that could be successful on a global basis.

“Regular ‘buy and build' has proved very painful,” said Raluca Nita, managing director of Private Equity Markets. “We are not similar markets.”

“Unless you are in Poland, Russia or Turkey, from day one you have be targeting a regional or global strategy [if you are seeking a €100mn valuation],” said Laszlo Czirjak, partner of iEurope Group.