Foreign direct investment (FDI) inflows to Central and Eastern Europe dropped in 2014, according to a new report. However, the trend varies widely across the region, with recovery in the Eurozone pulling investment into Central Europe, while conflict and geopolitical tension is pushing capital out of Russia and Ukraine. 

Those differences are likely to build further this year, suggests The Vienna Institute for International Economic Studies  (wiiw). 

Overall, FDI into the region totalled €65.5bn last year, a decline of 32% versus 2013, according to wiiw's FDI Report Central, East and Southeast Europe: Recovery in the NMS, decline in the CIS, released on June 11.

Those countries that had a drop in incoming investment should perhaps be particularly concerned given that globally, emerging markets are grabbing a bigger piece of the FDI pie. "In 2014, global FDI experienced a modest decline, while both inflows and outflows continued to shift to emerging economies," wiiw notes. 

Western pull

Central Europe led the pack by some distance, pushing inflows for the 11 regional EU member states to rise 44% overall. That reflects their very close ties to the Eurozone, which has been showing a recovery in demand, as well as their relative insulation - both geographically and as members of the European bloc - from the geopolitical tensions stalking CEE.

Indeed, the report suggests a turning point may have been reached across Europe, with economic growth resuming and cross-border investments invigorated in the second half of last year. That stabilisation of economic growth in Central Europe's EU states is expected to attract growing amounts of FDI this year. 

"FDI took off in the new EU member states (NMS)," the report notes. "Thus the deleveraging which suppressed FDI inflows has come to an end." The Austrian institute suggests government policy in Central Europe in particular should help the region keep up the pace next year, as it focuses on the re-orientation of FDI to higher value-added activities in manufacturing and services. 

"The Central European manufacturing hub (including large parts of the Czech Republic, Hungary, Poland, Romania and Slovakia) has expanded and new ventures targeted ICT services," the analysts point out. "Simultaneously, the support of domestic SMEs and national champions has received more attention and public funding compared to earlier years."

Yet the progress is far from uniform. FDI flows into the Czech Republic leapt 61% last year to €4.45bn;  with a 40% jump to €10.5bn, Poland was close behind. Slovakia, on the other hand, slumped, with its total of just €361mn representing a drop of 19%. 

Hungary did better, with inflows expanding 31%, but it still lags the Czechs - its closest peer in terms of size - for total inflows (€3bn), and especially net inflows, in which it came out in the positive by just €479mn - less than 10% of the Czech result. 

Analysts told bne IntelliNews in May that they expect to see Hungary fall even further behind over the next couple of years. While FDI across the region is likely to continue its recovery, the erratic policymaking of Prime Minister Viktor Orban over the past few years still has investors and banks on edge.

At the same time, its not plain sailing for any state, with Brussels ever more vigilant on government help for investors. Fiscal support to new investment projects has been curtailed by the new EU-wide state aid ceilings, the report says.

wiiw also notes diminishing greenfield investment activity, with FDI mainly flying into existing subsidiaries. FDI inflows are also still meagre in relation to gross fixed capital formation, and about half of pre-crisis levels. 

That illustrates that Central Europe's economic recovery still remains heavily dependent on state-led investment, particularly on the back of EU funds. "An acceleration of economic growth may not be sustainable without a recovery of private investments, both foreign and domestic," the report warns.

Tension

However, the Baltic states - also EU members - have a greater problem to contend with. The geopolitical tension spread across CEE since Russia's annexation of Crimea and the ongoing conflict in east Ukraine has led FDI to drop off alarmingly for the most part. 

The 78% gain in inflows into Estonia's heavily marketed tech paradise looks an outlier compared to the pullbacks of around 50% in both Latvia and Lithuania. The pair are the most vulnerable to reduced trade with Russia - on the back of both the collapse of the ruble and Moscow's sanctions war with the EU. They are also highly exposed to geopolitical tension - they "received much less foreign investment in the wake of the Ukraine crisis", wiiw notes. 

Yet those fall in inflows pale in comparison to the 70% drop in Russian FDI and 81% decline in war-torn Ukraine. 

The crisis has only antagonised the capital flight that has plagued Russia for years now, and it is the only country in CEE  to record negative net FDI flows last year. Capital flight in the form of FDI amounted to €26.7bn in 2014. FDI in Russia is "bound to plummet again", in 2015, the report warns.

With Ukraine's territorial integrity anything but secure, and the economy teetering on the brink, it's hardly surprising FDI has dried up. It's unlikely to recover before political and economic stabilisation is achieved, wiiw points out, which suggests it will be some time before investors return. 

At the same time, the institute hopes the economic crunch could lay the groundwork for a recovery in FDI once calm returns to the country. "Following the devaluation of the local currency the country is now a cheap alternative for component manufacturing and IT service sourcing," the report says. "Structural reforms ... may increase FDI in the future," it adds.

Meanwhile, distanced from both the geopolitical crisis and the benefits offered by the Eurozone recovery, the EU-hopefuls in South Eastern Europe struggled for direction in terms of FDI last year. Turkey remains the giant in the region with inflows of €9.5bn, but that represented a stagnant performance compared with 2013. 

Nominal investment totals are subdued elsewhere, with little clear direction for the region offered by a gain of 96% in Bosnia and Herzogovina alongside a 46% reversal in Kosovo. Overall, the region remained largely at 2013 levels, with FDI inflows growing by just 1%. 

Like others across CEE, many of those small states will hope China will finally put its hand in its pocket after years struggling to put its huge investment war chest to work in the region. However, unable to offer a bridgehead into the EU nor energy assets, they could struggle. 

The traditionally hardball Chinese did however make some headway in expanding their CEE investment outside the Russian and Kazakh energy hubs, wiiw notes. Last year the region hosted 11% of Chinese outward greenfield capital flows, compared with only 6% in 2008. However, the combined share of China and Hong Kong in FDI stock in Central and Southeastern Europe remains a mere 0.1%.