New Europe Weekly

Can FDI be sustained in CEE?

Fri, Jul 4 2008, 15:57 GMT
by Danske Research Team

Danske Bank A/S


Integration into the EU has supported large capital flows into new EU member states. Foreign direct investments (FDI) have hence increased rapidly, and have to a large extent financed large C/A deficits. In the coming years we, however, see large risks that these flows could decline in most countries in CEE, SEE and in the Ukraine and Kazakhstan. Below we present some arguments for this view.

First, historical FDI in the EU8+2 has to a large extent reflected privatisation revenues, and since the privatisation process has more or less come to an end one should not automatically expect the same kind of privatisation- driven FDI flows.

Second, FDI is not only dependent on national characteristics, but also on the global environment. Hence, in the present global environment, for example, with a sharp slowdown in US growth and probably also in European growth, and with rising global risk aversion, one should expect FDI into the EU8+2 to slow down. Similarly, FDI flows into the EU8+2 countries over the past four to five years probably significantly overvalue the long-term trends in FDI, as the global financial and economic environment during those years was usually benign.

Third, 'headline' FDI numbers do not say anything about the 'quality' of FDI. It is, for example, by now quite clear that we have seen a property market bubble in the Baltic States (and probably also in the rest of the region) in recent years. Hence, construction sectorrelated FDI over the past couple of years must to some extent be seen as non-permanent. It is notable, for example, that FDI into Bulgaria has been more than 20% of GDP over the past couple of years. Much of this has probably been construction market-related, and we doubt than Bulgaria will be able to continue to attract FDI flows of this magnitude in the coming years.

Fourth, FDI is often sensitive to cyclical movements and is likely to drop in the event of a C/A crisis as was the case during and immediately after the Russian crisis in 1998.

Published on  Fri, Jul 4 2008, 16:04 GMT

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