Nicholas Watson in Prague -

New Europe has overtaken China as the top spot for foreign investment, Unicredit said in a report last week

In the same week that Slovakia challenged China for the fastest economic growth in the world with a record 9.8% rise in the third quarter, a report from Italy's UniCredit Group claims that emerging Europe has actually overtaken China in terms of the amount of foreign investment it gets.

Using data from the latest World Investment Report, published in October by the United Nations Conference on Trade and Development, analysts at UniCredit calculated that net foreign direct investment (FDI) to Central and Eastern Europe (CEE) increased from $38bn in 2003 to $64bn in 2004, compared with $61bn for China in 2004.

In 2005, however, FDI inflows to CEE countries jumped to $86bn compared with $63bn for China, increasing the region's lead over China to $13bn.

"FDI flows both to China and to CEE remained resilient against the decline in global investment activities during the 2001-2003 period," UniCredit says in its CEE biweekly report. But "CEE has profited even more than China from the recovery."

UniCredit's figures are backed up by the latest estimates from the Institute of International Finance, which suggest net private cross-border capital flows to emerging Europe are likely to account for 40% (some $418bn) of total private flows to emerging markets in 2006, compared with 39% in 2005. And this will increase to 42% by 2007. At the same time, the share of the Asia/Pacific region will decline from 41% in 2005 to 38% in 2007.

Keeping up with the neighbours

The growing amount of investment flooding into many of these CEE countries is, needless to say, deeply rooted in the process of EU integration.

FDI inflows into the 10 new EU member states rose by 19% to $34bn in 2005. Most of this increase went to the Czech Republic, which saw its FDI rise by $6bn to $11bn. About a half of this went into the transport and communication services sectors, with real estate and business activities accounting for another 20%.

The Czech Republic's total inward FDI stock has now reached $59bn, making it the third largest FDI recipient in CEE behind Poland with $93bn and Hungary with $61bn.

In Hungary, FDI inflows reached $6.7bn in 2005. In both Hungary and the Czech Republic, FDI is shifting towards high-tech activities, including R&D and other services such as call centres. The laggard in the group was Poland, which saw its FDI inflows decline in 2005 though remain relatively high above $8bn.

Russia of course isn't benefiting from any EU integration, but its FDI is becoming more diverse by spreading beyond natural resources and into manufacturing – a trend that will be particularly welcome to President Vladimir Putin, who has made it a Kremlin policy to modernize Russia's economy.

Some examples of this FDI are Coca Cola's $501m investment in the food and beverage sector, to the $1.3bn invested in the real estate and trading project in

St Petersburg by Baltic Pearl (China).

UniCredit says large privatisations are still a significant factor in the region's FDI, especially as you move further east into countries like Ukraine.

"But the strong performance of the CEE countries is by no means simply the result of large privatization projects," the report says. "The number of greenfield projects has also increased constantly – not in all countries all the time, but clearly for the region as a whole."

The outlook? UniCredit argues the factors that made CEE such a magnet for investment – EU accession and convergence, Russia's continued development and further large privatisations – are set to continue.

As such, the bank forecasts FDI flows to CEE to grow by another €5bn-10bn this year and remain strong into 2007 and 2008. The largest cumulative inflows over the next two years will be Russia with €48bn, Poland with €19bn and Turkey with €14bn.

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