Has Southeast Europe come of age as an investment destination?

Has Southeast Europe come of age as an investment destination?
/ bne IntelliNews
By Clare Nuttall in Glasgow March 15, 2023

There has been a flurry of investment into Southeast Europe recently. Not only is the region attracting a growing amount of export-oriented investment, most notably in car parts factories, but the post-pandemic revival of its economies has encouraged retailers and other consumer-oriented businesses to expand there too. 

Southeast Europe, especially the six Western Balkan countries that are outside the EU, has long lagged behind the richer and more advanced economies of Central Europe. However, faced with high wages and tighter labour markets in Central Europe, and the war in Ukraine and related sanctions cutting off potential destinations to the East, has Southeast Europe’s time as an attractive investment destination finally arrived? 

It has taken several decades. Investments into the post-socialist region came in waves. First, Western firms looking for a skilled and relatively low-cost workforce came to Central Europe, even in the early transition days. As that pool of labour tightened, investments fanned out south and east, with Romania, in particular, becoming an exciting new destination for manufacturing and outsourcing investments. 

Today Romanians are no longer just fielding customer complaints at call centres and assembling widgets; the country now hosts sophisticated tech development centres, a thriving local IT industry and high value-add manufacturing sectors. Now it is the turn of the Western Balkan countries on the fringes of the EU to see a new wave of investment into the lower tech industries such as textiles and auto parts manufacturing. 

North Macedonia outperforms

The latest Greenfield FDI Performance Index (published in mid 2022 but based on pre-war data) puts North Macedonia in third place worldwide for foreign direct investment (FDI) relative to the size of its economy, after Costa Rica and the United Arab Emirates (UAE). 

North Macedonia had the most significant increase in ranking, rising by 41 places, after experiencing a significant decline in FDI between 2019 and 2020. The country's recovery and growth in FDI attractiveness can be attributed to its Nato membership, which was announced in March 2020, and the ongoing membership negotiations with the EU, the report said. In 2021 the country attracted significant projects in the renewable energy and IT sectors.

In fact, Emerging European countries from both Central and Southeast Europe were highly visible on the index, with the region escaping the hit to FDI seen in other emerging markets regions such as Africa. Bosnia & Herzegovina, Bulgaria, Hungary, Lithuania, Poland, Romania and Serbia were all among the top 10 FDI destinations from the region.

Automotive leads the way 

North Macedonia is particularly strong in the automotive sector. The country saw a series of investments announced in the second half of 2022. Among them, German maker of seating systems for cars, buses and trains Kiel started the construction of new production facility; the local unit of German car parts maker Kostal is set to produce systems for Volkswagen's hybrid vehicles; Yanfeng and ARC Automotive opened a car airbag application factory; Canada-based car part maker Magna International inaugurated its first plant in North Macedonia to produce car mirrors, and German producer of automotive cables Kromberg & Schubert is investing €25.8mn to expand its plant near the city of Bitola.

Serbia too has received a lot of recent investments into the automotive sector, helped by generous government incentives. Among just a few of the most recent investments, Continental Automotive Serbia opened a new factory in Novi Sad in February 23 with an investment of €140mn; Swiss automotive supplier Etampa opened a facility in Krusevac in January; India’s Sona Comstar agreed to buy Serbia’s Novelic for €40.5mn to boost its presence in the advanced driver assistance systems (ADAS) sensors segment; German supplier to the automotive industry Tristone Flowtech Holding unveiled plans to build a car parts factory in Paraćin; and, German car part manufacturer IGB Automotiv said it will expand in Serbia with a new production facility in the municipality of Lajkovac. 

Perhaps most significantly, Serbia is entering the EV space. US-based electric vehicle manufacturer Rivian opened a technological centre in the Belgrade, and Slovakia-based EV battery technology company InoBat signed a declaration of intent with the Serbian government on the construction of a major new EV battery factory. These came after Stellantis, owner of the automotive factory at Kragujevac started preparing to switch to electric car production.

A well-trodden road 

The Western Balkan countries are following the path already established by Central European countries that emerged as a prominent hub for Europe's automotive industry during the transition period, with industrial towns in the Visegrad countries supplying West European companies and consumers. 

The development made sense due to the strong industrial and manufacturing base already present in Central Europe from the communist era and earlier. Following the fall of communism, Central European countries had access to a skilled workforce that was less expensive than those in Western Europe, and which was located close to Germany, Europe's largest economy. Today, Slovakia has the highest per capita car production rate in Europe, and other Central European countries are also among the top manufacturers on the continent.

Accordingly, the auto-manufacturing plants in Central Europe became attractive acquisition targets for Western auto giants, with VW Group acquiring Skoda in 1991, and Renault purchasing Romania's Dacia in 1999. Additionally, a significant network of component manufacturers emerged across the region, supplying local automakers and exporting to Western Europe.

Since then, the sector has evolved. Basic manufacturing is still there, but increasingly firms are also relocating R&D, engineering and other more sophisticated functions to the region. It is also becoming increasingly involved in electromobility.

Romania moves up the value chain 

Romania has seen a similar evolution, albeit some years behind Central Europe. Given the large size of its population at over 19mn it is second among the eastern EU members after Poland Romania has become an attractive destination for manufacturing and outsourcing firms looking for new large pools of labour as it became increasingly hard to keep and retain workers in the Visegrad countries. 

Initially seen as a low-cost, low-wage destination, in recent years Romania has attracted much higher-value activities. 

In the automotive sector, for example, Porsche Engineering, the technology service provider and wholly owned subsidiary of Porsche, has opened tech hubs in first Cluj-Napoca and then in Timisoara. Romania, the location of two major car factories, is also becoming increasingly involved in electro mobility. The German company Dräxlmaier will invest €200mn in a factory in Timisoara, western Romania, in the next six years, where it wants to produce batteries for electric cars.

There has been a similar evolution in Romania’s thriving ICT sector, where one of the earlier high-value investments was by Deutsche Bank, which set up an international tech centre in Bucharest. This was followed by a further investment in 2019. As well as the international arrivals, Romania’s domestic tech scene has been thriving. It has produced champions such as Uipath and Bitdefender, as well as strong companies in a variety of sectors such as independent digital engineering firm Fortech that was recently acquired by Hitachi’s GlobalLogic, or Bucharest-based game development agency Amber Studio that now has six offices in four countries. 

And in another fast-growing sector, it was recently reported that German investor AE Solar will build a €1bn PV panel factory in Romania aimed at meeting one-third of the EU market’s demand when it reaches full capacity as Europe seeks to reduce dependence on solar panel imports.

Central Europe’s consumer boom 

The growth of manufacturing and services industries, and the steady upward pressure on wages as labour markets tightened, led to a consumer boom in the Central Europe region, with consumption emerging as a major driver of growth right up until the pandemic struck three years ago. 

Now as economies recovery from the two shocks of the COVID-19 pandemic and the war in nearby Ukraine, retail sales are somewhat sluggish. 

However, wage growth in the Visegrad Four countries of Central Europe plus Romania is still outpacing the eurozone as well as emerging markets more widely, even though fears of wage-price inflationary spirals were dismissed as “overblown” by economic consultancy Oxford Economics in September 2022. 

Thriving retail markets

Dented by the pandemic and economic chaos following the war in Ukraine, Romania’s retail sector is bouncing back unexpectedly strongly.

This comes after Romania experienced several years of booming consumption driven, as in Central Europe, by rising wages and disposable incomes.

Most of the retailers active in Romania have been expanding rapidly. Recently German discounter Rewe boosted the capital of its Romanian subsidiary with €160mn in December-January in order to support the expansion of its chain operated under the Penny brand. Meanwhile, the two chains operated by Schwarz in Romania, Kaufland and Lidl, expanded by 13% year on year in 2021, and the European Bank for Reconstruction and Development (EBRD) extended a €100mn loan to the German group to finance the expansion of its Kaufland retail chain in Romania and Moldova. 

While the average Western Balkan consumers are still poorer than their counterparts in the EU, investments into retail continue apace, and there are already tentative signs the region will at some point enter a consumer boom just like Central Europe did. 

International retailers are already expanding. Germany’s Lidl, for example, is pursuing growth across first Serbia and now North Macedonia, whose citizens used to have to take day trips to Serbia to visit its stores, with both store and logistics centre openings announced. Other EU-based chains expanding in the region include Greece’s Veropoulos

Sweden-based furniture retail IKEA has deemed an increasing number of Southeast European countries are ready for a store. IKEA has been open for years in Romania, but more recently entered the smaller markets of Croatia, Serbia and Slovenia. 

Malls are springing up too. Balfin Group recently announced a loan from the International Finance Corporation (IFC), part of the World Bank Group, to expand Albania’s biggest mall, Tirana East Gate. The opening of Prishtina Mall in the Kosovan capital, billed as the biggest in the region, took place in mid-March. 

Online retail is growing too, albeit from a low base, and Serbia’s Ananas E-commerce was launched with the aim of creating the ‘Amazon of the Balkans’. It has already snapped up North Macedonia’s Grouper and other Macedonian online shopping brands. 

Labour market crunch 

A large part of the rationale for the shift eastwards in the auto industry was the relatively lower costs chiefly wages but also, for example, for industrial land – in the Central and East European countries. That has changed dramatically in the last few years as economies across Central Europe started to run up against the constraint of labour shortages. Even with the economic slowdowns caused by first the pandemic and then inflation in 2023, plus the arrival of millions of temporary economic migrants mainly from Ukraine, labour markets remain relatively tight. 

The same happened, though to a lesser extent, in Southeast Europe too. In Romania, for years companies have been fanning out from Bucharest to major cities like Cluj and Iasi and to smaller university towns and critics across the country, as well as offering generous benefits, which have driven other industries such as private healthcare. Amid large-scale emigration, Croatia regularly struggles to get enough workers especially for seasonal jobs in tourism and construction. 

Cross-border recruitment has been ongoing for years, facilitated by the EU single market among members of the bloc. Traditional ties between the countries of former Yugoslavia have encouraged thousands of jobseekers from countries like Bosnia and North Macedonia to seek work in Slovenia (the richest country in Emerging Europe) and fellow EU member Croatia. There are also reports of companies seeking workers as far afield as Nepal or Bangladesh. 

Accordingly, for some years companies have been looking further south and east in search of both workers and new investment destinations but after Russia’s invasion of Ukraine, one of the most populous countries in Europe, the range of options diminished. 

Even though a massive post-war boom is expected in Ukraine, access to the Russian and Belarusian markets are expected to be restricted even after the war ends. 

That leaves the six small and mostly Westward-leaning economies of the Western Balkans as the main option in the region. 

On the nearshoring radar

It was anticipated that the Western Balkans would benefit from the nearshoring trend, but it is still unclear whether the recent increase in investment is due to this trend or a result of pent-up pandemic-era investment.

There are a number of reasons for international firms looking for manufacturing destinations relatively close to home to consider the region.

Countries in the region are geographically and culturally close to Western and Central Europe; the region is surrounded by EU members Croatia, Slovenia, Hungary, Romania, Bulgaria and Greece. 

Five of the six Western Balkan countries are already EU candidate states, while Kosovo aspires to become one. There are, however, concerns that should Serbia persist in refusing to align with EU policy on sanctions on Russia it could damage its attractiveness among investors. Analysts interviewed by bne IntelliNews for a recent feature stressed that since the invasion nearshoring has been overtaken by "friendshoring", where companies reduce their exposure to political risk by investing into countries with shared values. 

At the same time, the region is much cheaper than its neighbours to the north and west. GDP per capita and actual individual consumption (AIC) remain well below even the poorest EU member, Bulgaria. Eurostat data puts Bulgaria’s GDP per capita at 43% below the EU average. Both GDP per capita and AIC are below Bulgaria’s in the EU candidate countries.

All this led to the region being seen as a potential destination for nearshoring as the pandemic exposed the vulnerability of international supply chains and promoted companies in Europe to shifting their manufacturing strategies to prioritise destinations closer to home. 

North Macedonia has already seen a doubling of investments in the first three quarters of 2022 compared to the same period in 2021, with several other countries experiencing a rise of around 30-50%, on top of strong inflows in 2021.

The region also boasts a relatively skilled workforce, and although each individual country is relatively small, it has a large pool of unemployed workers. With a population of approximately 20mn people, it is estimated that up to 1mn people are unemployed.

On the other hand, reforms in areas from improving the business environment to investing into education and infrastructure, are necessary to attract potentially billions of euros in FDI.

Productivity remains low

Another disadvantage is that large-scale emigration continues, mainly to Western Europe but also to richer countries in Emerging Europe. This is a particular problem, as it is often educated young people who leave, or those with sought-after skills and experience.

According to a 2019 report from the Vienna Institute for International Economic Studies (wiiw), with the exception of Bosnia, countries in the region experienced a slowdown, stagnation or even a decline in labour productivity during the year before the pandemic. This is in contrast to EU member Romania, where Eurostat data shows a rapid rise in productivity. 

A World Bank report makes a similar point. “When compared to productivity, the apparent labour cost advantage of the Western Balkan countries disappears and the two most direct EU competitors, Bulgaria and Romania, with similar or even lower labour costs than some Western Balkan countries, seem significantly more competitive,” said the report.