Nicholas Watson in Prague -

The global economic crisis halved the amount of foreign direct investment (FDI) going into emerging Europe last year. Data for the first quarter show investment is flowing again, but unevenly: most is being directed toward the larger countries that are recovering fastest, like Poland and Russia, while smaller countries with weaker growth prospects are seeing less.

According to the United Nations Conference on Trade and Development, global FDI fell to $1 trillion in 2009 from $1.7 trillion the previous year. The tail-off in FDI into Europe was smaller than that recorded for the US and Japan, with Eurostat showing that FDI coming into the EU in 2009 increased by 12% from the year before to €222bn, while FDI flowing out of the EU fell by 24% to €263bn. Interestingly, EU27 investments into Russia fell in 2009 to a disinvestment of €1bn from investment of €26bn the previous year. "In 2009, the EU27 was a net investor in the rest of the world, with outflows higher than inflows by €41bn. In 2008 outflows were also higher than inflows, by €149bn," Eurostat said.

Within Europe, a study by the Vienna Institute for International Economic Studies (wiiw) showed that the FDI situation in 2009 was worse in Central and Eastern Europe (CEE) than in other parts of Europe. And within CEE, the new EU member states suffered more than Southeast Europe and the four Commonwealth of Independent States (CIS) Belarus, Moldova, Russia and Ukraine. The report notes that in general FDI inflows to CEE countries halved in 2009, falling to about 2005 levels. But the setback was most serious in the new EU members, where inflows fell to levels nearly as low as those in 2003 when the "dotcom" crisis choked off investment; Southeast Europe and the CIS inflows declined significantly, but only to levels near those of 2005. "One reason that international investment has been more resilient during the current economic crisis than during the dot.com bubble crisis relates to the role that governments have assumed as major international investors," notes Michael Gestrin of the Organisation for Economic Co-operation and Development (OECD). "This significantly-increased government involvement in international M&A took place through two channels: financial packages that resulted in de facto ownership of foreign assets and a significant increase in international investments by sovereign wealth funds."

Two of the new EU members, Slovakia and Slovenia, actually booked negative FDI inflows in 2009, implying that accumulated capital reserves were repatriated. In some countries the FDI setback was more than 50%, such as in the Czech Republic, Hungary, Latvia and Lithuania. Less hit was Poland, which had the strongest economic performance overall, and Romania. "Long-time favourites Czech Republic and Hungary and also in Slovakia, the modern export-oriented manufacturing sector built up by foreign investors in the past was hit particularly hard by the decline of demand in Western Europe so that FDI lost momentum," says Gabor Hunya, research economist at wiiw.

Southeast European countries are still at a lower level of development and most of them attracted relatively less FDI than the new member states, especially in the export-oriented sectors. However, ongoing privatization boosted FDI in Albania and Montenegro, and mitigated the decline in Serbia. Inflows to Croatia fell to less than half of the previous year's level, but continued to be the second highest in the region, as this is the only country in the Western Balkans where not just equity FDI is significant, but other forms are strong too. "As investors rarely set up export-oriented projects, the Western Balkan countries have not yet succeeded in becoming part of international production networks as have the new member states. This may have been a short-term advantage during the current crisis when shrinking exports aggravated economic decline and FDI flows," says Hunya.

In all four European CIS countries FDI declined in 2009. Belarus suffered least because it's so far behind the transformation process, while Moldova was the most severely hit, where the inflow of FDI almost stopped completely. Inflows to Russia dropped by nearly half compared with the previous year, in line with the severe GDP decline. "The consumption boom that had fuelled domestic market-oriented FDI [in Russia], including real estate development and retail trade, in the past few years came to a halt and investors postponed projects," says Hunya.

Onwards and upwards

In today's very uncertain climate, forecasting the amount of FDI inflows for 2010 is tricky, though the most recent data on global FDI points to improvements in the climate for international investment.

The OECD says that 22 of its member countries that have reported data for the first quarter of 2010 more than doubled their FDI inflows over the year-earlier period, while outflows were up 40%. Based on global trends and the results in the first quarter, wiiw expects FDI inflows to modestly increase in the CEE region as a whole by 14% this year. "Overcoming the setback in FDI in CEE countries is subject to overcoming the economic crisis in Europe," says Hunya. "A return to economic growth is expected in a number of countries, but the growth will continue to be very weak. Under slack demand, supply may not need the expansion of capacities, thus new equity investments will not be necessary."

wiiw notes there are two countries that indicate a stronger revival of FDI - Poland and Russia - where economic growth will be the strongest in 2010; Polish finance ministry said GDP growth should be at least 3% this year, while the Russian government's latest projections put GDP growth at 4%.

In Russia, the number of projects decreased only slightly to 85 in the first quarter compared with 93 in the first quarter of 2009. The new EU states saw a decent rise to 275 in new projects in the first quarter versus 230 in the first quarter of 2009. The number of projects increased in most countries except in Bulgaria, Latvia and Lithuania. The two largest countries, Poland and Romania, were consistently ahead in 2008 and 2009 and also should be ahead in 2010, though the deteriorating economic situation in Romania and the ineptitude of the politicians there cast a shadow over the country's prospects this year. "Poland and Russia (the largest countries) as well as the Czech Republic, Hungary, Slovakia and Ukraine are expected to contribute to the revival of FDI," says Hunya.

About one-quarter of the projects in the new EU states will go to the retail sector and one fifth to manufacturing, with the rest distributed among all other activities. Some of the upswing in foreign investment is expected to be generated by growing export demand, while some will come from the resumption of projects that had been delayed a year before, for example the construction of a new Mercedes factory in Hungary and Ford's investment in Romania.