Nicholas Watson in Prague -

Few doubt that Bulgaria will enjoy another huge year for foreign direct investment (FDI) after enjoying a record year in 2006. Yet while the country continues to be a major destination for low-cost producers, there is a discernible shift in investment as money increasingly moves into industries that serve the nascent domestic market.

According to preliminary figures, Bulgaria attracted an estimated €3.6bn in FDI last year, up from €2.3bn in 2005, Economy Minister Rumen Ovcharov said last week. This sum stands at 13% of GDP, which makes Bulgaria one of the top-three recipients of cumulative stock of FDI in Central & Eastern Europe relative to the size of its economy.

The three largest investors in Bulgaria for the January-October period were the Netherlands with 19.2%, the UK with 19.1% and the Czech Republic with 9.3%, says Razvigor Hristov, a Sofia-based investment advisor.

Other major investors include Austria (the foreign investor with the largest share of total FDI stock at the end of 2005), Greece, Italy and Hungary.

For 2007, InvestBulgaria, the agency that tracks investment, predicts Bulgaria will attract around €4bn in FDI in 2007.

Where is all this money going?

Inevitably, the real estate boom is sucking up a lot of that FDI, about 35%. Hardly a day goes without some foreign developer announcing a new real estate project, whether a shopping mall in Sofia or a resort on the Black Sea coast. Only today Meridian Hotels said it's considering investing in city hotels in the coastal towns Varna and Burgas.

Investment in manufacturing in 2006 made up 25% of the FDI total. Analysts say that since the early stages of transition, Bulgaria has been an important destination for FDI in manufacturing, mainly taking advantage of the lower costs of inputs, including labour. And that won’t change anytime soon.

Ten years ago, the average Bulgarian was four times poorer than the average European; as a result of reforms undertaken as part of joining the EU, the average worker is now three times poorer. When Bulgarians catch up with the rest of the EU in terms of income will largely depend on economic growth, though recent estimates say it will take around 23 years.

"Bulgaria is becoming the EU member with the lowest production costs, even when compared with other CEE countries," say analysts at UniCredit Group. "Apart from low labour costs, other relevant sources of competitive advantages include a well-educated workforce, proximity to the main export markets and good traditions in some sectors like textiles, food and beverages, and tourism."

More recently, however, analysts note that an increasing amount of FDI is being channelled into businesses that serve local market needs, especially in services and utilities.

"Despite being a small market which offers access to less than 8m customers, the dominant part of FDI inflows in Bulgaria was registered in the sectors focused on serving local market needs," says UniCredit.

Buy now, pay later

Tsvetoslav Tsachev, head of research at ELANA Trading in Sofia, says telecommunication and construction firms are increasingly looking for opportunities in the domestic market. "More foreign companies will look at the domestic growth – consumption is rising by more than 7% [per year] and foreign companies are benefiting from this," says Tsachev.

This budding personal consumption can be seen in the changing behaviour of Bulgarians, especially the younger generations, who are junking traditional behaviour of increasing consumption only if they have the available savings and becoming more comfortable with borrowing against future income.

"The desire for greater consumption stimulates the goods and services market, but what is more important, it fosters the growth of qualified and better-paid labour and also encourages the legalization of labour income against which loans can be obtained," says Hristov.

That loan industry inevitably makes the banking and financial services sector especially attractive for FDI, so it's no surprise that there have been several acquisitions over the past few months in this sphere. At the end of 2006 DZI Bank was acquired by Greece's Eurobank and at the beginning of 2007 Bank of Austria bought a 10% capital stake in Central Cooperative Bank.

"Some of the Bulgarian insurance companies are also target for acquisitions from foreign investors," believes Hristov.

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