South-East Europe A Region in Competition for FDI January 2004

Transcription

1 SEEReport Economics Department X P L I C I T South-East Europe A Region in Competition for FDI January 2004 A Member of HVB Group

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3 THE VIENNA INSTITUTE FOR INTERNATIONAL ECONOMIC STUDIES (WIIW) South-East Europe A Region in Competition for FDI January 2004 A study commissioned by Bank Austria Creditanstalt A Member of HVB Group

4 Contents Contents 1. Summary Political situation: Improvements are impressive, but they still need to be carried through Path towards EU accession: Joined by all from different angles and with diverging speed Albania Bosnia and Herzegovina Bulgaria Croatia FYR Macedonia Romania Serbia and Montenegro including Kosovo The overall economic performance: Growth taking off, whereas much is still left to be done on the ground SEECs compared to Central East European Countries (CEECs) Territory, population, GDP and GDP growth Foreign trade and current account General government budgets Structural aspects Sources of growth Outlook A country-by-country situation report Albania Bosnia and Herzegovina Bulgaria Croatia FYR Macedonia Romania Serbia and Montenegro Privatisation: Fairly advanced at least in the relatively successful SEECs Albania Bosnia and Herzegovina Bulgaria Croatia FYR Macedonia Romania Serbia and Montenegro Foreign direct investment has gained momentum in all SEECs Overview Albania Bosnia and Herzegovina Bulgaria Croatia FYR Macedonia Romania Serbia and Montenegro

5 Contents, Imprint 7. Plenty of FDI potential, to be increasingly tapped over time Three reasons why countries will continue struggling for more FDI FDI will continue to be required for closing the gaps in the current accounts and the governments budget FDI is paving the access to international markets The need for technological update Factors that could play a key role for the promotion of massive FDI inflows in the future Low costs thanks to low wages, low tax rates Appropriate institution settings Macroeconomic stability Easy access to a large market The performance of domestic enterprises Which SEEC industries are candidates for future FDI? Being better informed makes the SEE region less risky Comments on the individual countries Albania Bosnia and Herzegovina Bulgaria Croatia FYR Macedonia Romania Serbia and Montenegro Conclusions and recommendations Conclusions Recommendations Recommendations to SEECs Recommendations to potential investors References Appendix Imprint: Published and edited by: Bank Austria Creditanstalt A-1030 Vienna, Vordere Zollamtsstraße 3 A-1010 Vienna, Am Hof 2 Economics Department tel. +43 (0) economic.research@ba-ca.com Publication service tel. +43 (0) (answering machine) fax +43 (0) pub@ba-ca.com Printed by: Domus FM Druckmanagement Graphics: Skibar Grafik Design, Austria January 2004 Disclaimer: The opinions of the authors do not necessarily reflect those of Bank Austria Creditanstalt and those of the companies which have engaged the services of the authors. No part of this publication may be reproduced in any form without written permission from the publisher. All reproduced material must quote the sources used. While efforts have been made to ensure the accuracy of the materials published, we cannot accept any responsibility for the contents. 5

6 List of abbreviations and acronyms List of abbreviations and acronyms* BiH Bosnia and Herzegovina (Bosna i Hercegovina) CARDS The Community Assistance for Reconstruction, Development and Stabilisation CEE Central Eastern Europe CEEC-5 The five CEE countries Czech Republic, Hungary, Poland, Slovakia and Slovenia COMECON Council for Mutual Economic assistance, economic association of socialist countries in former soviet bloc CTF Consultative Task Force, an EU technical advice body DFID The UK government's Department for International Development EBRD European Bank for Reconstruction and Development EC European Communities ECHO European Commission's Humanitarian Aid Office ER Exchange rate EU European Union EU-15 The 15 EU member states prior to the enlargement from 1 May 2004 FBiH Federation of Bosnia and Herzegovina FDI Foreign direct investment FYR Former Yugoslav Republic GDP Gross domestic product GMP Gross material product ICTY International Criminal Tribunal for the Former Yugoslavia IFC International Finance Corporation, a member of the World Bank Group IMF International Monetary Fund KFOR Kosovo Force (NATO-led international force) NATO North Atlantic Treaty Organization OBNOVA EU reconstruction aid programme for Western Balkan countries OECD Organization for Economic Cooperation and Development OHR Office of the High Representative PHARE Poland, Hungary: Aid for the Reconstruction of the Economy, EU programme created in 1989 to assist Poland and Hungary, later on extended to the 10 CEE candidate countries and until 2000 also to Albania, BiH and FYR Macedonia. PPP Purchasing power parity RS Republika Srpska SAA Stabilisation and Association Agreement SAP Stabilisation and Association Process SCG Serbia and Montenegro (Srbija i Crna Gora) SEE South East Europe SEEC-7 The seven SEE countries Albania, BiH, Bulgaria, Croatia, FYR of Macedonia, Romania, SCG SEFTA Southeast European Free Trade Area UNCTAD United Nations Conference on Trade and Development UN United Nations UNMIK United Nations Interim Administration Mission in Kosovo USAID US Agency for International Development wiiw Vienna Institute for International Economic Studies Wiener Institut für Internationale Wirtschaftsvergleiche WTO World Trade Organization *excluding abbreviations of company names 6

7 List of graphs and tables List of graphs and tables Graph 1: GDP development Graph 2: Exports in Euro, growth Graph 3: Trade balance Graph 4: Current account Graph 5: GDP structure Graph 6: Employment structure Graph 7: Inward FDI stock per capita Graph 8: Albania, FDI stock by sectors Graph 9: BiH, FDI stock by sectors Graph 10: Bulgaria, FDI stock by sectors Graph 11: Croatia, FDI stock by sectors Graph 12: FYR Macedonia, FDI stock by sectors Graph 13: Share of foreign affiliates in manufacturing industry sales in Romania Graph 14: Gross monthly wages in manufacturing Graph 15: Gross value added in industry per person employed Table 1: Basic indicators Table 2: Private transfers in SEEC Table 3: SEEC-7 General government expenditures and balances Table 4: Shadow economy Table 5: Overview developments and outlook Table 6: Progress in transition in SEECs Table 7: Serbia: Privatisation of former socially owned enterprises, 2002 and Table 8: FDI inflows Table 9: SEEC-7 Main trading partners, commodity groups, FDI countries, and FDI target industries in Table 10: Basic Tax Features in SEEC Countries,

8 Introduction 1. Summary This study analyses the recent past s flow of foreign direct investment into the Balkans and its economic background and discusses the potential of future investment. It was prepared by the Vienna Institute for International Economic Studies (wiiw) on behalf of Bank Austria Creditanstalt. It is based on the institute s expert knowledge of economic transformation in Europe and especially also in the Balkans region. The main sources of information were the wiiw database, a number of recent wiiw studies on South East European developments, contacts with the region s agencies for the promotion of privatisation and foreign direct investment, international sources such as the EBRD transition report 2003, the UNCTAD investment report 2003, OECD publications and, last not least, a wiiw workshop in late November 2003, in which experts from the region discussed the latest developments. This study deals with foreign direct investment (FDI) in seven South East European countries (SEEC-7): Albania, Bosnia and Herzegovina, Bulgaria, Croatia, FYR of Macedonia, Romania and Serbia and Montenegro. An entrepreneur s decision whether to invest in a country depends on a number of variables, either of an industry-specific or a more general nature. The target country s political situation and its foreseeable future development is one of these aspects, the macroeconomic framework and its presumable advance is another one. Important for investors is also how much progress a country has achieved in terms of privatisation, as it is an indicator for the country s functioning as a market economy; at the same time, unfinished privatisation projects can offer opportunities of entering the market through acquisition. This whole set of variables contributes essentially to a country s foreign investment potential. From a political point of view, the whole SEEC-7 region consists of functioning democracies, where the transfer of power is no problem when opposition parties win an election. In all countries, this has happened in recent years. A division of power between legislation, public administration and judiciary is in place. The frequency of crime and violence is low by international standards if we disregard a few sensitive areas in the region. All these achievements were reached despite low average income and, especially in some of the countries, in spite of a large proportion of people living under extremely difficult economic and often also social conditions. A new outburst of widespread violence in the region is unlikely for the foreseeable future. Economically, in the last few years the GDP growth of the SEEC-7 was better not only than that of the EU-15, but also than that of the Central and East European countries (CEECs). A catching-up process seems to be going on finally. The region is very much in need of such progress, as it has fallen far back during the nineties. This is obvious from the low GDP per capita, and it is also clear from the poor state of the manufacturing sector. While this is essentially true for all SEECs, Bulgaria and Romania in the east and Croatia in the west of the region are better off in this respect. One consequence of the lack of strong manufacturers are high deficits in the balance of trade, measured in % of GDP. From 1990 to 2003, export revenues in Euro terms did not grow much or not at all in the SEECs, except for Romania. The countries current account deficits, again in % of GDP, were much less alarming. Bulgaria and Croatia profited from tourism and other West Balkan countries received high transfers from abroad. As regards privatisation, a divergence is visible in the SEEC-7 region. In Albania, Bulgaria and Romania the whole corporate sector had been state-owned, and during transition the public did not care much about new owners emerging from the privatisation process. In the countries on the territory of former Yugoslavia, companies had been socially owned, which was quite different from state ownership. Up to now, social ownership has still not been fully abolished in some countries. Employees are owners or shareholders in many companies, and in some cases such circumstances make it more difficult for the government to hand a company over to a strategic investor. Nevertheless, in the meantime privatisation has made big progress almost everywhere in the region. The easy part was the privatisation of small and medium-sized enterprises, whereas for large enterprises the situation differs largely depending on a company s profitability or prospective profitability. For the governments, it is relatively easy to sell companies like tobacco factories, breweries, cement producers, telecom companies or restructured banks to foreign strategic investors. In other cases, no acceptable investor may express interest if a company is offered for tender. 8

9 Introduction During the next few years, FDI inflows will increase all over the region. However, for most countries the inflow will not yet become as massive as it was in the Czech Republic or Hungary (in % of GDP or per capita). For companies interested in investing in the SEEC region, this can be an advantage. Competition between foreign investment enterprises within the region is less fierce. Prices for acquisition tend to be relatively low. Such enterprises can use the advantage of being an early bird in their field of activity. First and foremost, the risk that others are afraid of can be minimized if they can rely on first class information sources and business services specialized in the rules of the game investors have to face in the SEECs. Among the SEEC-7, Romania, the largest country, and Croatia have accumulated the biggest FDI stock by end-2002 (EUR 8.5 billion and 6.4 billion). Most likely, this will be so also in the next few years. Romania is attractive as a larger market characterized by very low wages in Euro terms, so it is a good location for final goods and also the production of industrial components. Croatia s wages are not low by transition country standards, but the country is close to the giant EU market, and the business culture is fairly well-developed, as is even more the case in neighbouring Slovenia. Bulgaria is also a low-wage country. In the past, it specialised in electronics. Some revival of this tradition cannot be excluded. Costal areas have a strong potential to attract foreign investment in tourism. However, so far only Croatia could profit from that potential to a larger extent. FYR of Macedonia can become an attractive location for foreign investors as soon as there are signs that the big traffic lines again become fully functional and are upgraded with the help of the EU. The same is true for Serbia. Seeing their own country as an EU member in the foreseeable future is a main hope for many SEEC citizens, and it is the government s declared target. It will materialize for Bulgaria and Romania in 2007, for Croatia probably in one of the subsequent years, and for the other SEECs progress will depend on their willingness and ability to reform their institutions and companies. The progress is likely to gain momentum as soon as a final solution for the Kosovo will be found. This could happen in In that case, in ten years time or even less the whole region could be fully integrated into the EU. 9

10 Political situation 2. Political situation: Improvements are impressive, but they still need to be carried through Compared to ten years ago, the political landscape has changed completely in the Balkans or more precisely in the West Balkan countries 1. In all countries the members of parliament have been elected under fair conditions; the transfer of power from a ruling party to an election-winning opposition party occurred in all countries and did not cause problems anywhere. It is true that there are a few areas where there is danger of politically motivated violence, but in general the number of crimes per 1,000 inhabitants is low by international standards. Both the functioning of the states as democracies and the low frequency of crimes have become a reality in spite of a low average standard of living and even mass poverty in countries like Albania, Bosnia and Herzegovina (Bosna i Hercegovina BiH), Former Yugoslav Republic (FYR) of Macedonia and Serbia and Montenegro (Srbija i Crna Gora SCG). Barriers for all kinds of contacts between West Balkan countries are much lower now and may well disappear within a few years. In the not too distant past, autocratic nationalist parties still dominated the political arena in Bosnia and Herzegovina, Croatia and also Serbia. Then, at some point of time the majority of voters wanted a change, so former opposition parties came to power, which were much more open to both regional co-operation and EU accession. In economic terms, however, progress did not meet the voters expectations; in Bosnia and Herzegovina and Croatia a disappointed electorate has brought the former parties to power again. In Serbia, the radical nationalists did not achieve a majority of votes in December 2003 elections, but political stability will become a major problem. It seems likely that such shifts will not change fundamental government policies, but may slow down the speed of ongoing processes. A rally for EU membership is going on. Slovenia s accession in 2004 will have a speeding-up impact on this rally. Bulgaria s and Romania s accession in 2007 will intensify this impact even in advance. An especially strong signal will be Croatia s accession; it could take place soon after 2007, depending on the Croat government s readiness for reforms and cooperation. In the West Balkans, a few political problems are still pending or have not yet been completely resolved: (1) The EU and the international community as a whole are urging Croatia to facilitate as much as possible the return of citizens of Serb origin who fled Croatian territory in the course of the violent conflicts of the nineties. The Croat government s response will either speed up or slow down the process of EU accession. Another aspect in this context for other countries of the region as well will be cooperation with the International Criminal Tribunal for the former Yugoslavia (ICTY). (2) It is not yet clear whether Serbia and Montenegro will survive as a union or commonwealth of two loosely linked republics. At present, the two republics have different legal tenders: Serbia has the Dinar, Montenegro the Euro. The union is based on a treaty mediated by the EU in early 2003; it concedes Montenegro the right to decide about independence in 2006 at the earliest. If it comes to a referendum, the outcome is open. The population is divided over this question. (3) Bosnia and Herzegovina (BiH) consists of two entities the Federation of Bosnia and Herzegovina (FBiH) and Republika Srpska (RS) plus Brcko as a small third territory with its own status. The federation (FBiH) is divided into ten cantons. The representative of the international community in Sarajevo, called High Representative, equipped with the Office of the High Representative (OHR), has the power to issue laws and directives if the country s parliaments are unable to do so themselves, and he has also the power to modify legislative or administrative decisions if they are contradictory to the spirit of the Dayton Agreement from Together with the Central Bank, the OHR has been the main engine for increasing cooperation across ethnic lines within the Bosnia and Herzegovina territory as well as within the West Balkans as a whole. The success of these efforts is evident everyday as well as economically. However, this means that the political structures have become inadequate. The parallelism of too many legislative and administrative bodies and the unclear allocation of competencies to different levels are causing both confusion and last not least also high costs. Yet the political situation is not mature for negotiating a new, more adequate constitution. 1) Albania, Bosnia and Herzegovina, Croatia, FYR of Macedonia, and Serbia and Montenegro. 10

11 Political situation As a result, some doubts still exist about the long-term sustainability of Bosnia and Herzegovina as a state. (4) From the point of view of international law, the Kosovo is still part of Serbia. De facto, it is under administration of the United Nations Interim Administration Mission in Kosovo (UNMIK). The majority of people are ethnic Albanians; the largest minority are Serbs. The UNMIK Police and the Kosovo Force (KFOR), the NATO-led international force responsible for establishing and maintaining security in Kosovo, cannot always prevent ethnically motivated local incidences of violence. (5) In 2001, ethnically motivated violence spilled over from Kosovo to FYR of Macedonia, a country populated by a Slavic majority and an Albanian minority. International intervention managed to keep the conflict within limits and finally mediated a compromise envisaging more rights to be given to the minority. In 2003 the EU has replaced NATO in its peacekeeping mission, first through its Concordia military mission and since December 2003 through its Proxima police mission. These efforts are successful, but within FYR of Macedonia the peace agreement is being realised only slowly. (6) Parts of Serbia s territory east of Kosovo are ethnically mixed and were also infected by violence in The Balkan population s desire for EU membership is at the same time the desire to get rid of inherited structures. The EU cannot eliminate all kinds of ethnic conflicts within EU territory, as we know from Ireland, northern Spain or Corsica. However, conflicts of that kind have lost the potential of escalating into a veritable civil war or a war between neighbouring countries. In this sense, EU membership will be a big achievement for the region as a whole. Hopefully, the EU will be fast in clearly defining the conditions the individual countries will have to fulfil on their way into the EU, including a time schedule. The question of the future status of the Kosovo has not yet been solved. In the last few years, the international community regarded it as a better strategy to leave the question unsolved for the time being, focusing instead on economic progress and the strengthening of democratic institutions. This should enable the problem to be solved sometime in the future in a more relaxed atmosphere. Theoretically, a number of solutions are feasible: an indefinite continuation of the protectorate under the auspices of the United Nations Mission in Kosovo (UNMIK), a cantonization of Kosovo which is an ongoing process anyway, a loose federation without a formal change of sovereignty and borders, some form of commonwealth, a decision by an international panel by a certain date, conditional independence, independence within existing borders at a certain date or, finally, independence with partition 2. Each of these alternatives, if put on the negotiation agenda, would face fierce opposition from one or the other side. However, the subject has not merely two sides, but more. Whatever the solution will be, it has an impact on the whole neighbourhood: on the relations between Slavic and Albanian Macedonians, on Bosnia s political stability, on the position of Albania within its neighbouring countries, on the relations between the majority and minorities in Serbia and Montenegro and last not least on the relations between Albanian and Serb Kosovars. In the meantime, the propensity to provoke new conflict and violence has become low. However, some minor incidents in some villages in the region always have the potential to scare the international business world. Even without such events happening, the unsolved final status of Kosovo has the potential of slowing down the EU accession process of the West Balkan region except for Croatia. With regard to the stabilisation and association process, the EU has established a separate track for Kosovo. A roadmap, setting the policy standards to be implemented, was initiated in December Pressure for negotiation between Belgrade and Pristina will become stronger in the course of Probably, negotiations will become substantial in Results will have to be approved by the Security Council. With some luck, in a ten years time, in the West Balkans the frequency of cross border contacts will be almost as intensive as it is at present between Switzerland and France or between Austria, Slovenia and Italy all of them countries where the political border is not determined by ethnic affiliation of the citizens. If the EU is able to make significant contribution to such a development, it will be big success for the EU as political unit, and it will strengthen the idea on which the Union is based. At the time being, all Balkan countries behave as if they were mesmerized by the EU. Contacts, also economic ones are not intensive between Bulgaria and Romania, and in the Western Balkans they are strong mainly along ethnic lines: Croatia trade within the region is mainly with the Federation of Bosnia and Herzegovina, Serbia trades mainly with Republika Srpska and FYR of Macedonia. On the political level, too, each country hopes for support from some global player, but in the end regional cooperation too will gain ground. 2) For details on such solutions see Kosovo Final Status Options and Cross-Border Requirements, US Institute for Peace, Special Report 91, July

12 Path towards EU accession 3. Path towards EU accession: Joined by all from different angles and with diverging speed For all Southeast European countries, accession to the EU will remain on top of their political agenda for the next few years. The starting points on the path towards EU accession differ greatly, and the speed of the accession process will widely differ for individual countries. With high probability, Bulgaria and Romania will join the EU in Major accession problems emerging after the EU enlargement of 2004 could lead to a postponement of a further enlargement, but nobody discusses such a scenario at it is not at all likely. A very cooperative attitude of Croatia s new government may enable Croatia to join the EU jointly with Bulgaria and Romania. In autumn 2003, the EU released its annual Progress Reports on Bulgaria and Romania 3. They explicitly confirm the common objective of the EU and the two countries for accession in 2007 and leave no doubt that Bucharest and Sofia will sign a single joint accession treaty with the EU. To leave enough time to organize accession in 2007, the treaty will have to be signed before the end of 2005 and negotiations must be concluded in due time before the signing ceremony. At the same time, the reports put Bulgaria firmly ahead of Romania. Departing from its usual refined gradations, the commission said Romania can be considered as a functioning market economy once the good progress made has continued decisively. Bulgaria s progress, on the other hand, is acknowledged with the more usual wording that the country is a functioning market economy. The EU Enlargement Commissioner Guenter Verheugen did not exclude that negotiations could finish during the lifetime of this commission that is, before November The reports on Bulgaria and Romania say both countries will receive EU positions on financial issues such as agriculture, regional aid funds, and budget contribution in early In an interview 4, Commissioner Verheugen said the positions will use the same principles and methodology that were used for the present accession countries in other words, full access to direct farm aid will be deferred by 10 years after accession, and EU aid contributions will be capped at 4% of GDP. At present, the Balkans are more integrated with the EU than with itself. This is true even for the relations between Bulgaria and Romania, and it is even more the case for the West Balkans. The EU is the most important trading partner, even in the cases of landlocked countries or territories. To become substantial and sustainable, economic growth will have to be export-based, and the EU will play a key role in this respect, just as it has been and still is the case for the Central European transition economies. This is true for both goods and services; the Balkans have comparative advantages in tourism, in transport and perhaps in some other sectors too. Most of these services will be absorbed by EU member states. The SEECs receive foreign financial support in various forms, from private and public sources. A large proportion comes from the EU. Due to the long history of more or less continuous migration from the Balkans, the inflow of transfer payments from private sources is high enough to play a fairly crucial role for the sustainability of the balance of payments. Private transfers as a whole range from 5% of GDP in Croatia to 15% in Albania. Recently, increases in private transfers have been reported for Romania and Bulgaria too. Most of these originate in the EU, though in some cases the share of money coming in from overseas is also quite significant. The EU is also the main source of aid and public transfers. In the Western Balkans, most of these inflows have in the past been linked to reconstruction and humanitarian aid. In Bulgaria and Romania, the public transfers have increasingly been linked to the transition and to EU integration. In the future, the EU is likely to shift its financial support for West Balkan countries towards targets such as macroeconomic stability, employment growth and institutional changes required for EU integration. 3) 2003 Regular Report on Bulgaria s progress towards accession, 2003 Regular Report on Romania s Progress towards Accession. 4) Ahto Lobjakas, EU: Progress Report Puts Bulgaria Ahead Of Romania, But Says Both Will Join Together, Radio Free Europe, 5 November 2003, 12

13 Path towards EU accession The Balkans are dependent on, if not integrated with, the EU. The dependency goes beyond the economic relations. The EU plays a quite significant political role, in some cases a direct one, e.g. in Bosnia and Herzegovina, Kosovo, FYR of Macedonia and Serbia and Montenegro. Currently on the Balkans the EU is committed to the enlargement process for Bulgaria and Romania and to the Stabilisation and Association Process (SAP) for the Western Balkan countries. The latter is aimed at leading to a Stabilisation and Association Agreement (SAA). The EU proposed a Stabilisation and Association Process (SAP) for Albania, Bosnia and Herzegovina, Croatia, FYR of Macedonia and Yugoslavia (now Serbia and Montenegro) in In June 2000, the Feira European Council stated that all the SAP countries were potential candidates for EU membership. The SAP uses various instruments: The Community Assistance for Reconstruction, Development and Stabilisation (CARDS) programme technical advice, trade preferences, co-operation in fields such as justice and home affairs, and political dialogue. The aim is helping the countries to undergo a political and economic transition which prepares them for a new form of contractual relationship: Stabilisation and Association Agreements (SAAs). The SAAs focus on respect for democratic principles and strengthening links of the countries of the region with the EU single market. They foresee the establishment of a free trade area with the EU and set out rights and obligations in areas such as competition and state aid rules, intellectual property and the founding of companies establishment, which will allow the economies of the region to begin to integrate with the EU 5. The CARDS programme is specifically designed for the SAP countries and replaces the Phare 6 and OBNOVA programmes. No contractual relations: Bosnia and Herzegovina, Serbia and Montenegro, with SAAs to be offered some time in the future. However, in November 2003 the European Commission has approved a Feasibility Study assessing the readiness of Bosnia and Herzegovina (BiH) to take the next steps towards European Integration. Given its role as a trading partner and a source of direct investment, aid and transfers, it is up to the EU to take an even more positive role for the economic and political development in South Eastern Europe. The region would require guidance and support on both the macroeconomic and microeconomic levels. Fiscal sustainability is probably one of the key issues for the future. As for monetary policy, for the Balkan countries and territories, the euro serves either as legal tender (Kosovo, Montenegro), or is the most important foreign currency. Apart from Romania, the countries follow an official or unofficial policy of a constant exchange rate in relation to the euro. It has proved to be good for price stability but may not have been supportive to the region s competitiveness. The creation of an appropriate monetary and exchange rate policy is an issue that will stay on the agenda. To address the microeconomic problems, the instruments of institution building and micro-financing have proved to be promising. The reliance on public resources, which may turn out to be the preferred approach, may not be the best one. Public money tends to be misused as a rule, and especially in the Balkans. Thus, the key issue will probably be the availability of private money and of the mechanism of its mobilization and utilization. As transition experience from Central and East Euopean countries shows, a positive development of the domestic business sector makes an economy more attractive for foreign direct investors. If such a development can be achieved in the Western Balkans too, the inflow of foreign investments will increase and improve the economies structure. This will contribute to an acceleration of export growth, which has to be one of the engines of real convergence. EU guidance will be extremely helpful in this whole context. At the end of 2003, the relations of SEEC and the EU were as follows: Candidates for membership: Bulgaria and Romania SAAs: FYR of Macedonia and Croatia (signed with the EU and in the process of ratification by the individual member states) Cooperation agreement, SAA negotiations in progress: Albania 5) 6) PHARE is a pre-accession instrument financed by the European Communities to assist the applicant countries of Central Eastern Europe in their preparations for joining the EU. Until 2000 the countries of the Western Balkans (Albania, Bosnia and Herzegovina and FYR of Macedonia) were also beneficiaries of Phare. 13

14 Path towards EU accession The following pages briefly describe the individual SEEC countries progress related to EU accession. The EU support figures as mentioned in some of the cases are related to EU commitments. For at least part of the programmes involved, the beneficiary countries are unable to absorb the full amount committed. For example, depending on the specific EU programme access to EU project funding may require the elaboration of a proposal on the beneficiary side; as a next step, its quality has to be examined by EU authorities. If it is appropriate, a contract has to be negotiated. As experience shows, project managing bodies often lack of the technical capacity to meet the conditions that would allow them to make use of the full amount of negotiated funds. As the Financial Times 7 has reported, in the case of FYR of Macedonia, about 58% of the amounts allocated between 1991 and 2000 have been contracted and only 34% has been disbursed. To improve FYR Macedonia s absorption capacity, the EU has established a Unit for Coordination of the Implementation of the Framework Agreement in May Even such support cannot increase the share of disbursed funds substantially, at least not in the short run Albania On 31 January , Romano Prodi, president of the European Commission, officially launched the negotiations for a Stabilisation and Association Agreement (SAA) between the EU and Albania. These negotiations are presently ongoing. Already in 1992, Albania had signed a trade and cooperation agreement with the EU and became eligible for funding under the EU Phare programme. The EU offered Albania autonomous trade preferences in 1999 and extended dutyfree access to EU markets for Albanian products. In June 2001, the Gothenburg European Council invited the Commission to present draft negotiating directives for the negotiation, which in October 2002 were finally adopted. For the period from 1991 to 2004, the amount of financial assistance the EU has committed to allocate to Albania totals EUR 1,273 million. Most of this, EUR 813 million, was Phare assistance between 1991 and 2000 and CARDS assistance starting from The second and third largest amounts were loans granted by the European Investment Bank and, especially between 1997 and 1999, humanitarian support. For 2002 to 2004 the annual totals of commitments reach an average of about EUR 50 million. Of course, the gap between commitments and realized payment may turn out to be quite substantial Bosnia and Herzegovina In 1996, the EU started assistance under the Phare and OBNOVA programmes. One year later, the EU Council of Ministers established political and economic conditionality for the development of bilateral relations. In 1998, the EU announced the establishment of the EU/BiH Consultative Task Force (CTF), a joint vehicle for technical and expert advice in the field of administration, the regulatory framework and policies. In 2000, the EU extended the duty-free access to EU markets for Bosnia and Herzegovina products. On the one hand, the EU member states contributed over EUR 1.8 billion in assistance between 1996 and the end of On the other hand, out of European Community funds almost EUR 2.5 billion have been committed to Bosnia and Herzegovina since From 1991 to 2000 humanitarian assistance provided by ECHO, the European Commission s Humanitarian Aid Office, totalled EUR 1.03 billion. In the period Bosnia and Herzegovina received assistance under the OBNOVA and Phare programmes amounting to EUR 0.89 billion. In 2001 the European Commission adopted a Country Strategy for Bosnia and Herzegovina which covers the period and provides a framework for EU assistance. Since 2001 assistance of more than EUR 240 million has been committed under the CARDS Programme, supporting BiH s participation in the Stabilisation and Association Process. The annual amount of total EU assistance peaked with EUR 440 million in 1996 and fell gradually to EUR 70 to 80 million annually in In 2003, the EU started a feasibility study for the opening of negotiations on a Stabilisation and Association Agreement. This decision was based on results of the EU Road Map published in 2000, a list of 18 essential steps to be undertaken by Bosnia and Herzegovina. SAA negotiations could start in 2004 if significant progress is made in fields such as the completion of a single BiH economic area and compliance with international obligations 9. 7) Financial Times, 10 December 2001, quoted in Putting Peace into Practice: Can Macedonia s New Government Meet the Challenge? US Institute of Peace, Special Report 91, July ) 9) IP/03/1563 Brussels, 18 November

15 Path towards EU accession 3.3. Bulgaria The start of accession negotiations with the EU in 1999 was a landmark in Bulgaria s systemic reforms. Negotiations comprise 31 chapters paving the way to the adoption of the EU s acquis communautaire. The chapters cover virtually all aspects of a nation s macroeconomic and microeconomic environment and the related policy areas. Closing each of these chapters in the negotiation process signifies that the country has harmonized its respective legislative, regulatory or institutional environment with that of the EU. One of the obstacles that Bulgaria still faces is a dispute with Brussels over the fate of its Soviet-era Kozloduy nuclear plant. By the end of 2003 Bulgaria managed to close 26 chapters with the remaining five due to be closed in The EU Progress Report of November 2003 confirmed Bulgaria s progress as a functioning market economy Croatia Croatia submitted an application for EU membership on 21 February In January 2000, a change in Croatia s political landscape had triggered a rapid improvement of relations with the EU. All of the following steps were subsequently undertaken in 2000: (1) An EU Croatia Consultative Task Force was established to provide Croatia with expertise and technical assistance in preparation for the Stabilisation and Association Process. (2) The EC Office of the Special Envoy in Zagreb was upgraded to a permanent delegation of the European Commission. (3) The Commission adopted a positive feasibility report on the opening of negotiations for a Stabilisation and Association Agreement (SAA). (4) The EU extended the duty-free access to the EU market for products from Croatia. (5) Negotiations for an SAA were started in November in the periphery of the Zagreb Summit. In October 2001, Croatia signed the Stabilisation and Association Agreements. The SAA provides for wide-ranging co-operation and will guide Croatia in harmonising its structures with the EU. The SAA includes the establishment of a framework for political dialogue and the promotion of economic and trade relations with a view of establishing a free trade area after a transitional period of 6 years. The agreement also provides a basis for cooperation in the field of Justice and home affairs, and identifies the acquis communautaire which Croatia will have to adopt in order to be able to effectively participate in the European integration process. The SAA needs to be ratified by all member states. At the end of 2003, not all EU member states had ratified the SAA. The UK and the Netherlands have declined to ratify as long as the UN chief war crimes prosecutor Carla del Ponte is unsatisfied with Croatian co-operation. So far an Interim Agreement, which was concluded in 2001 in parallel with the SAA, covers trade and trade-related measures. At the end of 2001, the European Commission adopted a country strategy for Croatia which covers and provides a framework for EC assistance. This assistance will be provided through the CARDS programme. The strategy paper is complementary to the actions of EU member states and other donors. From 1991 to 2003, the EU has committed assistance amounting to a total of EUR 550 million. Of that amount EUR 240 million was allocated in From 1995 to 2000, the amounts were relatively small. From 2001 to 2003 they reached a size of about 60 million per year FYR Macedonia In April 2001 a Stabilisation and Association Agreement (SAA) was signed in Luxembourg. At the same time, an Interim Agreement was signed so that the trade-related matters of the SAA could enter into force on 1 June The FYR of Macedonia had become eligible for funding under the EU Phare programme in In 1997 the EU Council of Ministers established political and economic conditionality for the development of bilateral relations. In 1998, a co-operation agreement entered into force, offering benefits from asymmetric trade preferences with the EU. The EU supports the FYR of Macedonia through a number of programmes. Support from 1992 to 2003 totals somewhat over EUR 600 million; the amounts for 2002 and 2003 were 63.5 million annually, mainly in the context of the CARDS programme. In the economic sphere, the EU supports the FYR of Macedonia in its efforts to make the economic and commercial legislation compatible with that of the EU through technical assistance to draft new laws. The EU also supports a credit line it helped establish in 1998 to make loans accessible to micro, small and medium-sized enterprises. During its first five years, the credit line has financed over 600 loans and created an estimated 2500 jobs. The Micro-Credit Line is a revolving fund, which means loan repayments are immediately made available as new loans. The objective of the scheme is to increase the number of start-up enterprises, to support the transition of micro enterprises into small businesses, and to reduce the bank- 15

16 Path towards EU accession ruptcy rate of SMEs. The project will also encourage the development of export-oriented and technology-based production enterprises. In 2001 the European Commission gave a quick response to the political and security crisis of February August, adopting an emergency package of assistance worth EUR 26.5 million. Funds were drawn both from the CARDS Programme (EUR 13.7 million) and the Rapid Reaction Mechanism (EUR 12.8 million). Projects financed under the programme include for example the reconstruction of more than 1200 conflict-damaged houses, the rehabilitation of electric lines or the improvement of water supplies Romania Romania s accession process started with the European Council of Helsinki in December 1999, when the country was invited to consider the prospect of EU membership. The EU Progress Report on Romania, dating from November 2003, has granted Romania the long-sought status of a market economy, but with a warning that the status will only become permanent next year, and only if ongoing reforms are concluded. This assessment relates to privatisation, the fight against inflation, fiscal discipline, and other macroeconomic indicators. The report says weaknesses in Romania s legislative process remain and the adoption of EU law would suffer as a result. Also, in a number of sectors a serious gap is said to exist between updated laws and the country s ability to implement and enforce them. 10 By the end of 2003, Romania had concluded accession talks on 20 of the 31 negotiating chapters Serbia and Montenegro (including Kosovo) In late summer 2003 the EU Commissioner for External Relations, Chris Patten, initiated a Feasibility Study on the prospects for Serbia and Montenegro to take the next steps towards strengthening relations with Europe: the opening of negotiations for a Stabilisation and Association Agreement. This EU move came at a time when the three parliaments of Serbia and Montenegro had adopted the Action Plan on Trade and the Internal Market 11. The Feasibility Study will consider Serbia and Montenegro s performance in upholding democratic standards, the rule of law, human rights including media freedom, the fight against organised crime and co-operation with the International Criminal Tribunal for the former Yugoslavia. The Study will also examine the extent to which the Constitutional Charter and the Action Plan are being adhered to and implemented. Commissioner Patten will voice continuing concerns about the lack of common tariffs for key agricultural products, and the failure to harmonise import levies. In 2004, the European Commission will begin developing a new European Partnership with the country to support Serbia and Montenegro s ambition to join the European Union one day. EU sources record a total support figure of EUR 2.9 billion for the years 1991 to EUR 1,570 million went into reconstruction, especially in Kosovo (close to EUR 900 million) and Serbia (EUR 600 million). Humanitarian aid for all three was 660 million and macro-financial aid 560 million. 10) Ahto Lobjakas, EU: Progress Report Puts Bulgaria Ahead Of Romania, But Says Both Will Join Together, Radio Free Europe, 5 November 2003, asp 11) IP/03/1227 Brussels, 9 September

17 The overall economic performance 4. The overall economic performance: Growth taking off, whereas much is still left to be done on the ground 4.1. SEECs compared to Central East European Countries (CEECs) Territory, population, GDP and GDP growth The territory of the SEEC region is relatively large: its size does not differ too much from the territory covered by Austria, Belgium, Denmark, Germany, Luxembourg, Netherlands and Switzerland together. At the same time, it is also comparable to the territorial size of the five Central Eastern European countries Czech Republic, Poland, Slovakia, Slovenia and Hungary (CEEC-5). The number of inhabitants of the SEEC region is by far smaller than that of these seven Western European countries mentioned above. The CEEC-5 region too is more populated, but the difference is not overwhelming. Both regions went through a transition phase during the nineties, so it makes sense to compare them. Table 1 presents some basic data regarding population, the size of the different economies, their GDP per capita levels (both at current exchange rates and in purchasing power parity) and, finally, the level of the respective GDPs in relation to the 1990 levels 12. Inside each of the two groups a lot of heterogeneity is observable with respect to most of the indicators. Within each group, one country is predominant in terms of population, and to a minor degree also in terms of the GDP volume: Romania in the SEEC group and Poland in the CEEC group. 12) In the case of the SEECs, macroeconomic data are rough estimates at best, even if there are differences between the countries in this respect too. To give an example, reliable trade data for Bosnia and Herzegovina are lacking, so that IMF statistics have to derive BiH current account statistics from trade data of partner countries (IMF Country Report No. 03/204, July 2003, p. 7). Table 1: Basic indicators 2002 Population GDP GDP pc GDP pc real GDP persons mn EUR mn at ER EUR at ER* EUR at PPP** 1990 = 100 Albania ,115 1,653 3, Bosnia and Herzegovina ,574 1,464 Bulgaria ,668 2,125 7, Croatia ,820 5,377 9, FYR Macedonia ,916 1,917 5, Romania ,384 2,230 6, Serbia and Montenegro ,601 1, SEEC-7 total ,078 2,350 Czech Republic ,855 7,248 14, Hungary ,852 6,487 12, Poland ,549 5,168 9, Slovakia ,144 4,675 12, Slovenia ,367 11,208 17, CEEC-5 total ,766 5,831 11,365 1) Population data ) Population data ) Real GDP growth is based on Gross Material Product (GMP). * Gross domestic product per capita (GDP pc); calculation based on exchange rates (ER). ** Calculation based on purchasing power parities (PPP). Source: wiiw database 17

18 The overall economic performance Two features characterize South East Europe: firstly, the region with the exception of Croatia has a level of GDP per capita which is significantly below that of the CEEC region; secondly, an important reason (in the case of some countries, the exclusive reason) for this developmental gap is the loss in output after It is clear that the 1990s was a decade in which the SEEC region has significantly fallen behind the CEEC region. During the past two to three years a reversal of this trend has become apparent. Graph 1: GDP development at constant prices, 1990 = Graph 2: Exports in Euro, growth = Bulgaria Croatia FYR Macedonia Romania SCG CEEC-5 Source: wiiw database Bulgaria Croatia FYR Macedonia Romania SCG CEEC-5 Source: wiiw database Graph 1 depicts the whole SEEC region s poor performance compared to the CEEC-5. No SEEC was able to reach the pre-transition level up to The CEEC-5 region surpassed that level by about 30%. The big loser within the SEEC region, however, was Serbia and Montenegro. The GDP fell to about 50% of the level in 1990 and did not recover. The Kosovo war led to a significant setback. Croatia, on the other hand, recovered considerably from 1993 on. Four countries, Bulgaria, Croatia, FYR of Macedonia and Romania all reached about 90% of the pre-transition level in The civil war in 2001 temporarily halted Macedonia from a quite positive growth trend Foreign trade and current account The contrast between the SEEC-5 region and the CEEC-5 region becomes most obvious with respect to foreign relations or, more exactly, current account items. Graph 2 shows developments of total exports over the transition period. The export volume of the CEEC-5, measured in Euro at current prices, declined in the first phase of transition, but strongly expanded later on and in 2002 reached 4.7 times the level of The export development pattern as displayed by Romania corresponds to that of CEECs, but with a shallower curve. Bulgaria s export development looks extremely poor; in 1991, exports in Euro terms fell to one quarter of the 1990 level, but increased afterwards. Euro export figures as used for this diagram reflect two influences: changes in the export volume in domestic currency at current prices, and changes in the exchange rate. Taking Bulgaria s 1991 figure as a reference point would produce a curve similar to that of Romania, but less steep. The development in countries on the territory of former Yugoslavia reflects the region s disastrous political and economic developments in the course of the nineties. From a comparison of the three more successful SEEC countries Bulgaria, Croatia and Romania one cannot exclude that exchange rate policies did play a role for the development of export revenues in euro terms; Bulgaria opted for a currency Graph 3: Trade balance in % of GDP, BiH SCG Croatia Albania FYR Macedonia Bulgaria Romania Slovakia Poland Czech Republic Hungary Slovenia Source: wiiw database 18

19 The overall economic performance board in 1997, Croatia achieved a constant euro exchange rate through managed floating. Romania s authorities allow for a continuous depreciation of the currency taking into account a high, but declining inflation. It also fits into the picture that the CEECs avoided a fixed peg. Their export performance was impressive most probably thanks to a number of different factors. While SEEC exports more or less stagnated, a huge deficit in foreign trade with goods emerged. Graph 3 shows the trade deficits in % of GDP for the year The contrast between CEEC-5 and the SEECs is obvious. Only Romania plays in the same league as the CEEC-5, and also Bulgaria is better off than the other SEEC countries. Albania, Bosnia and Herzegovina, Croatia, FYR of Macedonia and Serbia and Montenegro all recorded deficits, which were extremely high by international standards. In two of the SEEC economies (Bulgaria and Croatia) revenues from tourism tend to offset part of the high deficit in trade with goods. In other countries transfers from relatives living abroad play a similar role, as becomes visible from Table 2. These transfers imply that the population has more income at its disposal than would be indicated by the GDP. Consumption may even exceed GDP. Most of the tradable goods that people consume orginate from producers outside the country. In this way, money comes to the country via private transfers and leaves it as import expenditures. Reliance on a substantial tourism sector for foreign exchange earnings is in itself not detrimental to an economy. However, if the country is mainly dependent on one single industry, it becomes vulnerable to disturbances in this sphere. Also, the country may start suffering from a kind of Dutch disease phenomenon. Revenues may support the maintenance of an exchange rate, which does not give room for a positive development of manufacturing, the main producer of tradable goods. Croatia is a clear candidate for such a scenario BiH SCG FYR Macedonia Source: wiiw database Graph 4: Current account Albania in % of GDP, 2002 Croatia Bulgaria Thanks to revenues from services and income transfers, the current account deficit of the SEECs gives a much less alarming impression compared to the trade deficit. Graph 4 shows the current account deficit in % of GDP for the year The deficit of Slovakia and the Czech Republic is higher than that of Bulgaria and Romania, and the difference between FYR of Macedonia, Albania and Croatia on the one hand and Slovakia on the other is not large. However, the high current account deficits of Slovakia and the Czech Republic are related to high inflows of foreign direct investment. In its initial phase, such investment triggers imports, especially of machinery and intermediate goods. In the subsequent phase, foreign investment enterprises tend to reinvest their profits within the host country, and these reinvested profits figure as foreign direct investment in the financial account, but at the same time also as income outflow in the current account, in this way adding to the deficit. Romania Slovakia Czech Republic Hungary Poland Slovenia Table 2: Private transfers in SEEC Albania Bosnia and Croatia FYR Serbia and Herzegovina Macedonia Montenegro Private transfers (EUR mn) ,067 1, ,228 1,897 Private transfers (% GDP) Private transfers (EUR per capita) Source: IMF 19

20 The overall economic performance Table 3: General government expenditures and balances in % of GDP A. General government expenditure Albania Bosnia and Herzegovina Bulgaria Croatia FYR Macedonia Romania Serbia and Montenegro B. General government balances Albania Bosnia and Herzegovina Bulgaria Croatia FYR Macedonia Romania Serbia and Montenegro Source: EBRD Transition Report p. 59; 2002 data are mostly official government estimates. Data for 2003 represent EBRD projections General government budgets In % of GDP, expenditures from the general government budgets vary considerably between SEECs: in 2002 from 29% in Albania up to 50% in Croatia and 56% in Bosnia and Herzegovina. FYR of Macedonia and Romania are close to 42%, Bulgaria is at 37%. On average, the SEEC-7 budgets are slim compared to the CEEC-5 region, where the average is around 47% (regardless of whether it is weighted or not). All general government budgets of the SEEC-7 showed a deficit in recent years, in 2002 ranking from 6.3% in Albania to 0.6% of GDP in Bulgaria. Romania s deficit was relatively small, 2.7%. All in all, in this respect too, the SEEC-7 countries had better results compared to the CEEC-5, with a 6.7% deficit in the Czech Republic, 9.2% in Hungary, 6.7% in Poland and 7.2% in Slovakia in Only Slovenia recorded a much lower deficit, 3.2% of GDP, which was high by Slovenian standards Structural aspects The shares of the primary, secondary and tertiary sector in the GDP and in total employment are shown in Graph 5 and Graph 6. In terms of GDP, the SEEC economies have, compared to the CEEC-5, a higher share of agriculture in total economic activity. Interestingly, with the exception of Serbia and Montenegro and Romania, they do not have much of a deficit with regard to the share of tertiary activity. Usually, a large share of services figures is an indication of a higher stage of economic development. Here, such an argument would be wrong. Rather, the relatively large share of services in SEEC economies reflects a weakness of industry. In the SEEC economies relative to the more advanced transition economies, a massive de-industrialization took place in the 1990s, which was much more pronounced than that of the CEEC economies. From a sector perspective, a signifi- Graph 5: GDP structure % of total in Bulgaria Croatia FYR Macedonia Romania SCG Czech Republic Hungary Poland Slovakia Slovenia Tertiary sector Secondary sector Primary sector Note: Serbia and Montenegro year Source: wiiw Handbook of Statistics

21 The overall economic performance Graph 6: Employment structure % of total in Bulgaria Croatia FYR Macedonia Romania SCG Czech Republic Hungary Poland Slovakia Slovenia Tertiary sector Secondary sector Primary sector Note: For FYR Macedonia and Serbia and Montenegro employee data. Source: wiiw Handbook of Statistics cant recovery of industry in SEEC will be an indispensable component for catching-up on the more successful CEEC economies Sources of growth The analysis of imbalances is important for an understanding of the sources of growth in the past and those that may be important in the future. The periods of growth in the Balkans have been the consequence of one or more of the following: post-conflict reconstruction, increased consumption, and increased investment, in a number of cases public, but in some cases foreign direct investment. Only in the last case, and only when growth was based on foreign investments, did it not lead to imbalances with possible negative growth consequences. Even in these cases, the decisive fact was the target of foreign direct investments. In most cases in the Balkans, foreign direct investments have targeted sectors like telecommunications, banking and some industries with predominantly domestic markets (breweries, tobacco, oil, energy). Their contribution to the efficiency of resource allocation has been significant, but not so much to sustainable growth. A good example is the banking sector. The share of foreign owned banks in the Balkans is higher than in Central Europe. However, their contribution to the growth of output has been rather modest. The main reason is that the banks are ready to finance consumption, but to a much lesser extent investment. This became quite clear during the euro conversion in 2002 when the liquidity of the banks in many countries increased quite significantly. Most of it went to loans to households, which were spent mostly on durable consumption goods. That contributed to the increase in imports, but had little effect on the growth of output. Comparing sources of growth in Central European transition countries with those in the Balkans, it seems reasonably clear that export growth is quite important. Most of the Balkan economies are small, one exception being Romania. Therefore, probably the best strategy for growth is that of market integration. The Balkan economies, however tended to increase market disintegration. The introduction of sanctions and embargoes contributed to that. The situation started to change after the war in Kosovo in Indeed, since then, the Balkans have been doing better, with the exception of the FYR of Macedonia which went through a severe ethnic conflict and is still recovering from it. Impediments for trade, however, are still significant. Probably the more important ones are the non-tariff barriers. If one looks at the political barriers, imposed in one way or another, as prohibitively high non-tariff barriers, i.e., zeroquotas to trade between two countries and territories, it becomes clear that the impediments for trade in the Balkans are quite high. This still accounts for low levels of trade within Bosnia and Herzegovina, between Serbia and Kosovo and between Serbia and Croatia. To address the tariff barriers, the Balkan countries have signed a series of bilateral free trade agreements. The next step is the creation of the Southeast European Free Trade Area (SEEFTA). In addition, and more importantly, the European Union has unilaterally removed all tariff and most nontariff barriers to imports from the Western Balkans (Albania, Bosnia and Herzegovina, Croatia, FYR of Macedonia and Serbia and Montenegro). These measures have proved to be helpful, though there have not yet been any dramatic increases in foreign trade. Still, there is no doubt that the issue of market access is quite important for sustained and faster growth in the Balkans. The same may be said of enterprise restructuring. Unlike in Central European economies, a new private sector has not emerged in the Balkans, at least not to the extent that had 13) In fact, developments in CEEC were also characterized by a pronounced de-industrialization process in the early phases of the transition process, but this was followed in the case of quite a few of the CEEC economies by some degree of recovery of industry, very often accompanied up-grading in product quality (Michael Landesmann, Structural Change in the Transition Economies, , in UN-ECE, Economic Survey of Europe, 2000, No. 2/3). 21

22 The overall economic performance been expected, except for the one to be found in the informal economy. The small and medium-sized sector that has developed, either in the formal or in the informal economy, has concentrated mainly on trade and other services. The growth of a new private sector in industry has been much less pronounced, with some exceptions. As the new private sector has failed to emerge quickly, the bulk of the enterprise sector, except for the informal economy, has remained with the former state-owned (or socially owned, in the case of former Yugoslavian countries) sector. Its performance, however, has depended very much on the speed of privatisation, as the restructuring and the revitalization of the state and socially owned enterprises has not proved to be a big success. Privatisation, however, has in a number of cases been guided by special interests and not by an increase in the efficiency of the use of resources. Thus, the post-privatisation process, which has proved to be rather slow, should bring about the necessary improvements in ownership and the structure of corporate governance. Competition policy could contribute to the restructuring of enterprises. The state sector is run through with monopolies, but the structure of the privatized sector and even of the informal economy is not necessarily one that could be associated with a free market economy. To some extent, the combination of post-socialist structures with the lack of rule of law keep the incentives for exit low and the costs of entry high. Table 4: Shadow economy Schneider (2002) using currency demand, physical input and DYMIMIC 1 approach in % of GNP, 1999/2000 SEEC Albania Bosnia and Herzegovina Bulgaria 36.9 Croatia 33.4 Romania 34.4 Serbia and Montenegro CEEC Czech Republic 19.1 Hungary 25.1 Poland 27.6 Slovakia 18.9 Slovenia ) dynamic multiple-indicators multiple causes model. 2) Due to war and political unrest unreliable figures. Source: Schneider (2002), p.14. This has been changing with the increased openness of the Balkan economies, but the process is slow and is standing in the way of changes in the structure of the economy. This is partly so because of the large share of the informal economy (Table 4). Apart from the elements of informality associated with the state sector and with the private sector that is able to extract special concessions from the authorities in exchange for bribes, the rest of the informal economy mostly consists of small and medium sized firms in low value added sectors. Informality puts a cap on the size of firms, except in the case of so-called captured states. Even if there is no rule of law, the sheer fact of informality works against large scale production. Thus, there are limits to the growth of the informal economy. As argued here, sustained growth can probably be based on the growth of exports. There, the issue of competitiveness comes in. Unlike the more successful Central European transition economies, most Balkan economies adopted one or the other version of a fixed exchange rate. This was a consequence of the lack of belief in the ability of the monetary authorities to withstand pressures to monetize the fiscal deficit. Apart from other problems that this has created, the depressed exports and runaway imports are probably the most serious ones. There is a hope that real restructuring could eventually validate the adopted exchange rate policy, but that has not really happened yet. In any case, there is no doubt that competitiveness is a prerequisite for sustained growth and eventual convergence with the more developed transition economies and with the EU Outlook In 2004, in almost all SEEC-7 the growth rate of real GDP will be above the CEEC-5 average (Table 5). This trend may continue also in the longer run. With regard to inflation, most of the SEEC-7 are in the same league as the CEEC-5. Only Romania will still have to struggle for a single-digit inflation rate. Unemployment is a problem both for most of the CEEC-5 and the SEEC-7. In Romania, the most populated of the SEEC countries, the rate is relatively low, but this is mainly because those who lost their job in industry often took advantage of the offer for the restitution of agricultural land and started small-scale farming. To some degree, this was also the case in other SEECs, as for example Albania. With respect to the current account balance in % of GDP, in 2004 all SEEC-7 will probably run deficits above the CEEC-5 average, as was the case in the past also. 22

23 The overall economic performance Table 5: Overview developments and outlook GDP Consumer prices Unemployment, based on LFS 1 Current account real change in % change in % rate in %, in % of GDP against previous year against previous year annual average forecast forecast forecast forecast Czech Republic Hungary Poland Slovak Republic Slovenia CEEC Albania Bosnia and Herzegovina Bulgaria Croatia FYR Macedonia Romania Serbia and Montenegro ) LFS Labour Force Survey, refers to ILO definition. For Albania registered unemployment end of period, for BiH registered unemployement, annual average. 2) Consumer prices correspond to retail prices. 3) Excluding Kosovo and Metohia. Source: wiiw database and wiiw projections A country-by-country situation report Albania Albania is a country with a low GDP per capita. The manufacturing sector is almost non-existent, a large proportion of the population lives from agriculture or trade and other services. Private transfers from relatives play a significant role. Starting from a low basis, in recent years Albania s economy has grown fast, with rates between 13% and 6% from 1998 to 2001 and at rates of over 4% in 2002 and The IMF expects growth rates of around 6% for future years up to About one third of Albania s GDP originates from agriculture, but only one eighth from manufacturing. Industrial production of primary inputs contributes another eighth; the remaining amount, almost one half of GDP, comes from services. Albania is rich in mineral resources, notably oil, lignite, copper, chromium, limestone, salt, bauxite, and natural gas. By 1992, most agricultural land had been privatized. Farmers grow grains (especially wheat and corn), cotton, tobacco, potatoes and sugar beet and raise livestock. All this should create a good basis for industries such as mining, food processing, and the manufacture of textiles, clothing, lumber and cement. Albania also has chemical, and iron and steel plants and several hydroelectric power stations. However, many enterprises were not profitable and closed down, and the large majority of the surviving plants are in bad shape in many respects. Privatisation enjoys high priority, but many of the industrial plants did not attract strong investors which would be more or less equivalent to investors from abroad. The way out was voucher privatisation, a method that has proved to be problematic wherever it was applied. Not surprisingly, the country s trade deficit is high almost one quarter of GDP. Exports merely cover some 23% of imports. Mainly thanks to a strong net inflow of private transfers, the current account deficit is much lower, but still high: somewhat over EUR 450 million or 9% of GDP in

24 The overall economic performance About 1.3 million persons had a job in 2002, half of them in agriculture. About 260,000 persons were registered as unemployed, but a considerable part of the population is supposed to be engaged in shadow activities (see table 4). Some 20% of the labour force works abroad, mostly in Greece and Italy. They continuously send remittances, which are to a large extent spent for imported consumption goods. Albania exports materials and foodstuff and imports mostly machinery, other industrial products, and consumer goods. Albania s predominant trading partner is Italy with a share of some 70% in Albania s exports and an over 30% share in imports. Neighbouring Greece holds the second position. With a high deficit in the current account and a meagre inflow of foreign direct investment or other private capital, the country remains highly dependent on international aid. In the early 1990s Albania joined the International Monetary Fund and the World Bank. Both institutions support an intensive restructuring programme Bosnia and Herzegovina With regard to the GDP per capita, there is no reliable figure available. First, the GDP compilation is still non-standard and second, there was no population census after the end of war in In economic sense, the Dayton agreement of December 1995 was the starting point for a turn for the better for Bosnia and Herzegovina (BiH). Economic activities restarted and expanded, trade and cooperation between the country s two entities the Federation of Bosnia and Herzegovina and the Republika Srpska have become daily routine, and the same is true for trade and cooperation between the cantons inside the Federation. Arrangements with neighbouring Croatia as well as Serbia and Montenegro have eased the country s integration into regional and international markets. Comprehensive reforms have established the rules and institutions typical for market economies. The currency s external and internal value is, thanks to a currency board arrangement, stable, and the banking sector has attracted a number of foreign investors. Nevertheless, the overall economic situation is not yet satisfactory. Economic activities mainly focus on services. Agriculture and food processing have not yet recovered, so that the population s food consumption relies heavily on imports, whereas exports of unprocessed agricultural products and of processed food are small. In other segments of industry, especially manufacturing, most of the inherited capacities did not enjoy post-war repair; maintenance was poor and technological update only occurring in some cases. Based on their size, the larger factories were intended to service larger markets in the Balkans or markets worldwide, whereas the post-war situation left them without adequate market access. As a result, the existing industrial capacities remained underutilized. In the factories, production recommenced on a small scale at best and remained unprofitable in many cases. Not surprisingly, under these conditions privatisation attempts had to face the lack of strategic investors with experience in the specific field of production. Due to the lack of access to markets, nobody was willing to invest large sums into technological renewal. In other words, the economy lost its industrial backbone. If there was a hope that small and medium-sized enterprises would fill the gap, in industry it did not materialize. As a result, production of tradable goods has remained low, and so did exports. In 2002 for example, the country s export revenues, somewhat above EUR 1.1 billion, covered merely one third of import expenditures. Mainly thanks to a half billion EUR net inflow of unrequited private transfers the current account deficit was not higher than about 20% of GDP. In recent months, the Balkan region s non-tariff trade barriers have become a major topic. With the removal of unjustified barriers, Bosnia and Herzegovina again could again become interesting as an industrial location Bulgaria Bulgaria s GDP per capita reached EUR at purchasing power parities and is thus the second highest in the region, after Croatia. If calculated via exchange rate, the GDP p.c. was merely EUR 2,000 in In the same year, agriculture had a share of 26% in total employment, the industry had less: 24%. Two branches of manufacturing, textiles and food, had a share of about 55% in total employment of manufacturing. Bulgaria has gone through a radical re-orientation of exports after Now, with a share of 15% Italy is the most important trading partner on the export side. On the import side, it is still Russia, closely followed by Germany, both with shares of around 15%. Exports cover about three quarters of import expenditures, their composition is dominated by miscellaneous manufactured and basic manufactured goods. After 1997, the year of crisis, Bulgaria s economy grew relatively fast: 5.4% in 2000, and always more than 4% thereafter. In the first half of 2003, industrial output achieved real growth of 15% year on year. Exports in current euro terms also grew by 15%, but were outpaced by imports (+17%). The current account deficit tends to be a weak point for several countries with a currency board arrangement, and in the case of Bulgaria it widened to 11% of GDP in the first 24

25 The overall economic performance half of Foreign trade exerted a strong, negative impact on GDP, whereas the engines of growth were private consumption and gross fixed capital formation. Apart from the external imbalance, the economy did not suffer from major imbalances: Inflation is low, the rate of unemployment has declined, and the government s budget is more or less balanced. The budget is a matter of dispute with the IMF, as the government would like to win the general elections in 2005, whereas the fund claims that more fiscal austerity is required to keep the current account deficit under control. An inherited high burden of debt makes the government dependent on agreements with the IMF Croatia Croatia is the high-income country within the SEEC-7. With a GDP per capita of EUR 9,200 in purchasing power parities (PPPs) in 2002, the country comes close to the level of Poland. In terms of the GDP at exchange rates it is even slightly superior to Poland (EUR 5,400 vs. 5,200): Croatia s overall price level is higher and the difference between PPPs and exchange rate is therefore smaller. The country s biggest physical asset is a long coast with excellent opportunities for tourism. The danger is that sectors other than tourism will keep lagging behind in their development. The producers of tradable goods have problems to be competitive; in recent years, exports amounted to less than a quarter of GDP, imports to almost 50%. The former government started large infrastructural projects and also support programmes for small and medium-sized enterprises all over the country. Croatia s GDP growth has climbed to over 5% in 2002 and will remain above 4% in 2003 and Government investment in motorways and housing plays an important role in this context. In the first half of 2003, construction expanded correspondingly, by over 20% (at constant prices, year on year), and gross fixed capital formation rose by 17%. Industrial output grew by 6% and thus more or less with the same speed as in 2001 and This is good news, as it means that de-industrialization did not continue. However, the trade deficit remained and even expanded: export revenues covered merely 45% of imports in the first half of 2003, less than in the same period of the previous year, whereas the current account balance improved: from 16% in the first six months of 2002 to 10% of GDP in the first half of Tourism is strengthening again FYR Macedonia The FYR of Macedonia is the smallest of the SEEC-7, but not the poorest: the GDP per capita at PPPs amounted to EUR 6,000 in Manufacturing has a share of about one third in the total number of employees, but only a share of 16% in GDP. In the second half of the nineties, the FYR of Macedonia entered a phase of high real GDP growth, up to 4.5% in This phase ended abruptly with the outbreak of ethnic conflicts in the northwest of the country. In 2001, the GDP shrank by 4.5% and started slowly recovering later in the two subsequent years. The impact of the crisis was not limited merely to the FYR of Macedonia. It reinforced the image of the Balkan region as an area of risks, regardless of the fact that in the end the international community, especially the EU, was able to allay the conflict. The FYR of Macedonia follows a strategy of managed floating of the exchange rate, keeping it constant in relation to the Euro already for several years. Inflation has been low during the last few years, and in 2002 its annual average was 1.5%. Exports covered about two thirds of imports in the second half of the nineties, but merely some 57% in Most probably, the result will not be much better for 2003 and The current account deficit climbed to almost 9% in In contrast to that, the government s budget balance improved slightly. The FYR of Macedonia was admitted to the World Trade Organisation in April 2003 and has harmonized its trade regime with WTO rules. FYR of Macedonia has signed a free trade agreement with all non-eu countries on the Balkans including Slovenia and Turkey. The country has concluded a Stabilization and Association Agreement with the EU. Industrial products originating from FYR of Macedonia are granted free export to the EU member countries, whereas agricultural and food products are subject to quotas. About one half of the country s exports went to the EU in 2002 mainly to Germany (21%) and neighbouring Greece (10%), and not much less than one quarter to Serbia and Montenegro. Apart from the countries just mentioned, Central East European countries played a significant role in the regard to imports, with a share of nearly 20% of total imports. The production and processing of agricultural output including tobacco accounts for about 20% of GDP and contributes somewhat less than 20% to total exports. Tobacco has a long tradition, and processing plants have already attracted foreign direct investment. Food exports in the narrower sense cover less than one-third of food imports. 25

26 The overall economic performance Romania Romania is the largest country among the SEEC-7, both in terms of territory and population. With a GDP per capita of about EUR 6,300 in purchasing power parities, it is a lowincome country. At the same time, it is well equipped with natural resources: fertile agricultural land and mineral resources such as oil and gas, lignite and iron ore. At the beginning of transition, heavy industry dominated the economy. 3.8 million persons were employed in industry, compared to 1.9 million in In the worst years, over 1 million persons were registered as jobless, whereas in the first half of 2003 their number was close to 630,000. Many of those who lost their jobs in industry, but were granted restituted farmland, started engaging in farming, frequently on a subsistence level. Romanian governments are under pressure to restructure or close down the remaining non-privatised industrial plants, but as they are often the main regional employers, there is also pressure to avoid massive labour layoffs. A number of these plants also constitute a challenge with respect to the environmental rules of the EU. Romania s GDP has been growing with rates of at least four percent after 2000, and most probably it will continue to do so also in 2003 and Industrial growth tends to be more modest; construction growth has been rather accentuated. One legacy of the setback in the second half of the nineties is a rather high but declining inflation rate in tandem with the continuous nominal depreciation of the currency. The national bank s discount rate is above the rate of consumer price inflation so financial conditions for the business sector are tough. The way out for many is, still, poor financial discipline, no matter that a large proportion of the sector is in private hands now. In October 2003 the IMF approved the final review of the stand-by agreement, mainly thanks to the government s commitment to privatise large loss-making industrial enterprises. For the largest commercial bank, BCR, an interim, partial privatisation solution with the involvement of international banks has been found. The privatisation of the national oil company Petrom is also underway Serbia and Montenegro Serbia and Montenegro is an atypical confederation of two states that are fully sovereign internally and only share some elements of external sovereignty. They have a foreign representation as the Union of Serbia and Montenegro, but not necessarily the same foreign policy. They also share a common army, but its responsibilities are mostly for the security of Serbia rather than Montenegro. The Union is not a customs and currency union, because tariff rates differ and Montenegro is using the euro as its legal tender. As a consequence, economic and political developments within the confederation are not necessarily synchronized, though they are not altogether independent of each other. For Serbia, for 2003 one can expect a stagnation of industrial output at best. Agricultural production fell by some 10% due to severe drought. Official construction activities declined as well. In other words, the GDP growth as forecasted officially would have to be realised through a further expansion of the tertiary sector. On the demand side, there is no sign of growth of fixed capital investment, and rising unemployment dampens consumption growth. The inflow of foreign direct investment was considerable in 2003, more than EUR 1 billion. The major contribution comes from the sale of the country s two tobacco plants and one gas station chain. The government wants to spend most of this money in 2003 and 2004 for wages, salaries and pensions. Montenegro profited from industrial output growth and good results from tourism, but is confronted with the necessity of fiscal consolidation. Foreign sources of fiscal support are drying out. For 2001, the estimate for Kosovo s GDP was EUR 1.7 billion or about EUR 940 per capita. The official currency is the Euro. Kosovo has fertile agricultural land and is rich in mineral and natural resources 14. Exports amounted to EUR 330 million or 19% of GDP in 2001 and covered about one fifth of imports. Investment was EUR 960 million or 55% of GDP; one third of the sum was donor-financed. About half a million Kosovars live outside the country, and remittances amount to over EUR 500 million per year. Diaspora funds have contributed to investments into housing and small businesses. Commercial and industrial enterprises have so far been socially-owned; commercialisation and privatisation is planned. 14) Debra Wahlberg, Bekim Kastrati, Kent Ford, Investment in the future A trade and investment guide to Kosovo, 2nd edition, Kosovo Business Support (funded by the USAID), May

27 Privatisation 5. Privatisation: Fairly advanced at least in the relatively successful SEECs In the SEECs the citizens perception of privatisation differs between two sets of countries. It still plays a role that in the one group Albania, Bulgaria and Romania the state owned the majority of enterprises, especially the large ones, whereas former Yugoslavia had created decentralized social ownership. In the first group of countries the population has learnt not to care much about who will be the owners of the existing stock of enterprises. In former Yugoslav countries current privatisation programmes in most of the cases include a compensation of employees in some way. Thanks to reforms at the beginning of the nineties, socially owned companies were free to become joint stock companies, with part of the shares being given to the employees. In the second half of the nineties international and domestic experts identified labour participation in ownership as a main source of the obvious lack of industrial growth, so ways had to be found to eliminate co-ownership completely or to push it into a minority shareholder position. From a political point of view it was advisable to provide some kind of compensation not only in this context, but also for foreign currency deposits that had been frozen in the first half of the nineties or for claims resulting from the governments arrears in the context of unpaid salaries and pensions. The need for some kind of compensation of such claims made voucher privatisation schemes extremely attractive for SEEC governments. With respect to co-ownership of employees, Slovenia is no exception among former Yugoslav economies and a proof that such a strategy per se is not a hindrance to successful transformation. Slovenia had no problem to enforce the rule of law and effective budget constraints. Reports on privatisation results achieved in SEECs and also other European transformation countries tend to lead to the conclusion that the privatisation of large manufacturing companies was often a problem, whereas it was much more easy to privatise small and medium-sized enterprises. However, also in the latter context problems emerged in some of the countries. For example, persons who bought a company at an auction usually had no cash at their disposal, so they had to borrow money in one way or another, which they for instance did by availing themselves of installment loans. After the purchase, the new owners frequently were confronted with losses, so that the question of a soft budget Table 6: Progress in transition in SEECs Private sector share Enterprises Markets and trade Financial institutions % of GDP Large scale Small scale Governance Price Trade and Compe- Banking reform, Other (mid 2002) privati- privati- and liberalisation foreign tition interest rate financial sation sation restructuring exchange system policy liberalisation mediation Albania BiH * 4 4 ** Bulgaria * Croatia 60 3+* FYR Macedonia * Romania SCG 45 2+* * 1) Measurement scale: 1 represents little or no change from a rigid centrally planned economy, 4+ represents the standards of an industrialised market economy 2) * indicates a positive change from the previous year, ** a strongly positive change. Source: EBRD Transition Report 2003 p

28 Privatisation constraint became an issue once again. The whole arrangement made it very difficult for new owners to accumulate funds available for investment. Achievements in the field of privatisation and in other transformation issues differ considerably between SEECs. The European Bank for Reconstruction and Development (EBRD) has developed a scheme for measuring achievements in privatisation and other transformation targets (Table 6). As the table shows, in mid-2002 the share of the private sector in total GDP was highest in Albania and Bulgaria, but lowest in Serbia and Montenegro and also quite low (50%) in Bosnia and Herzegovina. Among SEECs, Bulgaria also maintains a leading position with regard to small and large-scale privatisation as well as in the development of markets including the foreign exchange system. In general, the table reports remarkable achievements in price liberalization, trade and foreign exchange rate handling, but much less progress in competition policy and in the development of the financial sector (banking, insurance, stock exchange) Albania There is not much large-scale privatisation going on in Albania, in spite of an ambitious programme. Potential foreign investors are reluctant to get involved in Albania on a larger scale. A major hindrance may be political uncertainty and the lack of authority of government institutions. The privatisation tender of Albtelecom, the state-owned fixed-line telecommunications company, failed in January The government is now trying to make the company more attractive for foreign investors by some restructuring measures and by offering a buyer an additional mobile operator license, which would be the third one in the country. Albtelecom however lost its monopoly position in local fixed-line services in mid-2003 and will lose it in international services at the end of Preparations for the privatisation of Albpetrol, Albania s oil and natural gas production company, and AMRO, the refinery, should have been completed by the end of Several attempts failed when trying to privatise the Savings Bank, Albania s largest bank and at the same time the last large state-owned bank. In September 2003, the government announced that it would try to sell the bank via tender. The EBRD and the IFC each announced that they would buy a 20% stake in INSIG, the state-owned former insurance monopoly, whereas a strategic investor is supposed to buy 51% Bosnia and Herzegovina Mass privatisation was completed by 2001 in Republika Srpska and by 2002 in the Federation far behind the initial time schedule 16. It transferred some 78% of small enterprises in the Federation and 55% in the Republika Srpska into private ownership 17, without obliging the new owners to commit themselves to any conditions. Another approach, tender-based privatisation, was stepped up only in late For this method, the starting point is a list of relatively attractive companies and a definition of obligations to be observed by the new owner: the amount of future investment, the minimum number of employees and the amount to be paid in cash. The programme has faced several impediments: the concepts promoted by foreign experts or by organisations providing technical assistance differed from those suggested by local actors; local authorities sometimes used obstructive tactics, partly because such enterprises frequently beefed up the budget of political parties. A debate over the usefulness of an international loan aimed at assisting privatisation started and went on for almost two years. One argument of locals was a fear that most of these funds would end up in the pockets of foreign consultants. By the end of 2002, in the Federation only some 25% of a list of 1,064 larger enterprises with socalled strategic enterprises not being included were fully privatised, and not much happened in For the Republika Srpska, the respective figure was 41%. As regards strategic enterprises, by May 2003 out of 108, 19 had been sold 19. The power sector is a good example of the kind of difficulties privatisation plans have to face in Bosnia and Herzegovina. Both entities have adopted action plans for a restructuring, splitting and privatizing of the sector, but later on failed to build up an institutional structure at the state level as defined as indispensable by the international financial institutions: a state regulatory commission for electricity transmission, an independent system operator and a transmission company ) EBRD Transition Report ) Vesna Bojicic-Dželilovic, Fikret Cauševic, Rajko Tomaš, Global development network understanding reforms: Bosnia and Herzegovina , draft version presented at the Global Development Network workshop in Vienna, 22 November ) EBRD Transition Report ) Tender sales were temporarily suspended in the Federation in early 2000, and resumed only after the changes demanded by the international community had been implemented. 19) EBRD Transition Report ) EBRD Transition Report

29 Privatisation Republika Srpska has completed the privatisation of commercial banks; the Federation has almost reached the same result. About two thirds of the bank capital is in private ownership. The increase in the minimum capital requirement (EUR 7.6 million) in January 2003 led to a decline in the number of banks from 49 to The strong involvement of foreign banks will strengthen financial discipline within the non-financial sectors. In the first half of 2003 both the Federation and the Republika Srpska adopted new bankruptcy laws, which still have to be harmonized. Altogether, in terms of speed and other respects in most sectors privatisation and privatisation effects remained below the expectations initially expressed by the international community. Under the pressure of these expectations, in 2003 the entity governments pledged to step up the privatisation process Bulgaria In Bulgaria 22, a first wave of voucher-type mass privatisation took place in In 1997 a severe crisis hit not only Bulgaria s financial sector, but also the real economy and the political arena. Fully supported by the new government, the IMF de facto took, at least for the initial post-crisis period, direct control over Bulgaria s economic policy. The main precondition for new funding from the IMF which was vital for the country, given its ragged finances was both the establishment of the currency board implying the abandoning sovereign monetary policy, and radical steps in systemic and structural reforms. A whole set of systemic and structural reforms such as the rehabilitation and privatisation of the banking system, the restructuring and privatisation of the corporate sector, the reforms in the tax administration, the complete overhaul of the health care system, the comprehensive pension reform, etc. were designed under the IMF s guidance. The sweeping reforms in the health care and pension systems, which are still under way, are also considered to be a success. The reform of the pension system aims at the introduction of a three-pillar pension system. One of the centerpieces of the reform was the creation of a National Insurance Institute (first pillar) and legislation for the establishment of private pension funds (second mandatory pillar). The reform measures included the establishment of a Health Insurance Fund and the commercialization of health services. A subsequent privatisation is envisaged. After 1997, privatisation started to become substantial. The government declared that in its privatisation efforts sales to strategic foreign investors would have the highest priority. In the subsequent years, foreign investors took over a number of important non-financial enterprises. The government tolerated the liquidation of some enterprises and started the reorganisation of others by putting them under permanent observation. Mass privatisation also continued, mostly involving smaller and medium-sized enterprises. As a result of these measures, the process of ownership transfer in the country rapidly gained momentum. By 2003, most of the corporate sector in the country were already in private ownership. A reorganization of non-viable banks and, most importantly, an acceleration of their privatisation was part of the programme. Foreign banks control about five sixth of Bulgaria s banking sector. In May 2003, OTB Hungary bought DSK Bank, the former savings bank, which is the second largest bank in Bulgaria. Total domestic credit as a percentage of GDP remains low: at the end of 2002 it amounted to 25% of the same year s GDP. Privatisation procedures tend to be time consuming and thus sometimes troublesome in Bulgaria. A series of court decisions has delayed the privatisation of Bulgartabac and the Bulgarian Telecommunications Company, two of the largest state-owned monopolies. Small and medium-scale privatisation has progressed with sales of 275 companies in 2002 and 95 in the first half of The state still holds a majority interest in 355 companies 23. The Privatisation Agency has decided to sell minority stakes in 11 large state-owned Bulgarian companies on the stock exchange: e.g. an up to 30% stake in the Bulgarian Maritime Shipping Company, 20% both in the Bulgarian Telecommunications Company and the State Insurance Agency, and up to 12.8% in Bulgartabac. 21) EBRD Transition Report ) Dimitar Dimitrov, Nasko Dochev, Rumen Dobrinsky, Rumyana Kolarova, Nikolai Markov and Boyko Nikolo: Understanding Reform A country study for Bulgaria, draft version presented at the Global Development Network workshop in Vienna, 22 November ) EBRD Transition Report

30 Privatisation 5.4. Croatia In Croatia s case 24, privatisation and other transformation-related reforms were implemented in war-time and alongside the war, under the guidance of one dominant political party. These were not the proper preconditions for transparency of the whole process and for achieving positive results such as the enforcement of the rule of law and of hard budget constraints. A decisive first step was the nationalization of social ownership. The privatisation of non-financial enterprises was the next step, which implied a quasi-automatic privatisation of the commercial banks they owned. By 1998 close to 2,500 companies were in private ownership, but in most cases the state held a minority share. Privatisation failed to bring about a restructuring to firms. All the time the population took a sceptical stance with regard to the legitimacy of the new owners. Economic and public governance remained weak, cronyism and corruption spread. Towards the end of the decade, discussions concerning a revision of past privatisation deals gained momentum. When in 2000 a new government came to power, it was under pressure to start a new privatisation wave. In June 2000, the government s portfolio contained shares in 1,850 companies. In most of them, 1,111 companies, the shares were between 0 and 25%; in 432 they were between 25 and 50% and in 307 shares were over 50%. The list included attractive companies in industries such as mineral oil, electricity, insurance and tourism, as well as notorious loss makers in industries such as shipbuilding, steel and again tourism. The process that followed was slow and led to tensions between the ruling parties. The coalition government failed to reform privatisation procedures, but tried, with some success, to improve corporate governance in state controlled firms. It also increased the transparency of sales, improved the quality of contracting with buyers concerning their obligations and it also improved the protection of shareholders. In July 2003, the Hungarian oil and gas company MOL acquired 25% plus one share in INA, the Croatian monopoly in gas distribution that is also active in oil exploration and refining. MOL committed itself not to sell its shares in INA for five years and to reinvest all profits in INA over the next three years. The price was about USD 360 million. In February 2003, a controversial privatisation of a tourism company ended with the dismissal of the management board of the Croatian Privatisation Funds and, as a further consequence, to a slow down of the privatisation process. Over 90% of the assets of commercial banking are controlled by eight foreign banking groups. The Unicredito/ Allianz group alone controls over one third, whereas Intesa- BCI controls about 20% through Privredna Banka Zagreb. Two banks, Croatia Banka and Croatian Post Bank, are still state-owned, but are also waiting for privatisation FYR Macedonia In the same way as in the other republics of former Yugoslavia, in FYR of Macedonia 26 the Law on Social Capital led to a first wave of enterprise privatisation in the early nineties: the full privatisation of 67 and partial privatisation of some one hundred large and medium-sized enterprises. Privatisation restarted in late A new law opened the door to the selling of enterprises on a case-by-case basis. The existing managements were permitted to choose the method of privatisation and to apply to the privatisation agency for approval. To become the new owners, the managers had to pay 10 to 20% of the price in cash, for the rest they were offered an interest-free loan payable within five years. In the case of large enterprises this rule blocked all privatisation of large companies: nobody wanted to risk their own cash. New rules, again in favour of insider privatisation, followed. By March 1998, through a number of privatisation methods insiders had acquired roughly 87% of privatised companies, if weighted by the number of employees. The low degree of outsider, and particularly foreign, involvement in privatisation meant that unlike in Central European transition countries privatised companies did not benefit from an injection of fresh capital or from an upgrading of the level of know-how. The insider-dominated ownership had serious adverse implications for corporate governance and restructuring. The small-scale privatisation is close to completion, whereas the privatisation of large enterprises proves to be troublesome. Many of them are notorious loss-makers, so it is difficult to sell them, and it is also difficult to liquidate them for political reasons. In contrast to other command economies, FYR of Macedonia, within the former Yugoslav Federation, has had a two- 24) Ivo Bićanić and Vojmir Franićević, Global Development Network understanding reforms: The case of Croatia, paper presented at the Global Development Network workshop in Vienna, 22 November ) EBRD Transition Report ) Mihail Petkovski and Gligor Bishev, Understanding reforms in Macedonia, draft version, presented at the Global Development Network workshop in Vienna, 22 November

31 Privatisation tier banking system since A system of universal commercial banks was inaugurated after monetary independence, i.e. in April The Central Bank undertook the role of banking supervision. Low entrance barriers allowed for a rapid increase of the number of banks: from four before independence to 24 in The functioning of the new banks was as poor as that of the old banks. Their founders were primarily domestic manufacturers; in most cases, the main goal of the owners was to collect funds in order to finance their own businesses. Thus, from the very beginning the new banks did not observe prudential rules. The restructuring of the banking system started late, in 1995, as a large part of the non-financial corporate sector profited from soft budget constraints. At that time, the restructuring of the non-financial sector was still not an issue. In the meantime, the restructuring of the state-owned companies has started. Macedonian Railways, a big lossmaker, is an example. The government plans, in cooperation with the World Bank, to split the company into two independent units: one responsible for the infrastructure, the other for current operations. The main goal of the financial restructuring of the banking system was to clean up the bad loans from the portfolio of the old banks. The costs of the rehabilitation were high, referring to the cleaning of bad loans from the balance sheet of the banks as well as to foreign currency deposits of households that had been frozen in The old banks had granted soft loans to non-financial corporations as an implicit form of subsidies; now, they have become visible explicitly. The privatisation of the old banks did not require a specific programme. As they were owned by enterprises under social ownership, the privatisation of these banks followed automatically from the privatisation of their owners. The lack of financial discipline within the corporate sector is probably attributed to the special relations between banks and their clients, as it is typical for countries on the territory of former Yugoslavia. The FYR of Macedonia had over 22 banks and 17 savings banks at mid-2003, which is quite a lot for a country of 2 million citizens. By end banks were completely private, the share of private capital in all banking assets was over 80%. The Macedonian Development Bank is the only state-owned bank, its restructuring is on track. Interest rates on loans are high, around 13 to 15% compared to the year 2003 average consumer price inflation of 1.5% for Banks are free to place their funds in foreign currency loans. Only substantial involvement of foreigners has ultimately changed the situation, and for the non-financial sector the budget constraints are not that soft any more Romania Most of the small and medium-sized enterprises have been privatised by now. For large enterprises, however, privatisation performance is behind the schedule agreed with the international financial institutions. In its Progress Report 2003, the EU urges Romania to speed up privatisation. Some companies are still under the control of the state. A number of these companies are notorious loss-makers, so it is difficult to sell them. In the first half of 2003, the government gave the go-ahead for the dismissal of over twenty thousand employees in these companies, but this did not improve their performance substantially. The privatisation of the state-owned gas and oil company SNP Petrom was on track at the end of The privatisation procedure of electricity distribution companies started at the beginning of Electrica Banat and Electrica Dobrogea were offered for sale. But only one investor, the Italian company Enel, submitted an offer at end-july 2003, which, however, was of a non-binding nature. The privatisation procedures of two other distributers, Electrica Oltenia and Electrica Moldova, started in March 2003 with consultancy support of the Bank of America. Finally, consultancy services provided by Credit Suisse First Boston should help to successfully privatise two natural gas distributors, Distrigaz Sud and Distrigaz Nord. Without increases in energy prices a successful completion of these privatisation projects will hardly be possible 27. Out of 31 banks, 24 were foreign-owned at the end of The state still owns three larger banks with over 40% of total banking assets. Attempts to privatise the largest, Banca Comerciala Romana (BCR) so far have failed. In a first round, bids from Bank Eulia (France) and from a consortium of Bank Austria Creditanstalt and OTP Hungary did not qualify according to Romanian banking regulations. The second round was not countered by any expression of interest. A third attempt will involve the EBRD and the IFC and should help to attract a strategic investor by ) EBRD Transition Report

32 Privatisation 5.7. Serbia and Montenegro Serbia In October 2000, the elaboration of a new privatisation strategy started. It became operational at the beginning of At that time, somewhat more than 3000 socially owned firms still existed 28. A new plan envisages sales of majority stakes in these firms 70% shares of the total shareholding and a transfer of a minority stake to employees and citizens in general. Large enterprises are to be sold through tenders, medium-sized and small firms through auctions. Apart from these types of companies, the state holds also minority packages in the previously privatised firms and is supposed to sell them as well. To accelerate the procedure, in mid-2002 and early 2003 two legal amendments were made. Table 7: Serbia, Privatisation of former socially owned enterprises, 2002 and 2003 Number of enterprises Employment 2002 Jan Oct av Tenders ,130 Auctions ,851 Minority packages ,010 Total ,991 Source: Pavle Petrovic, Serbia: Understanding reform, manuscript presented at the Global Development Network workshop in Vienna, 22 November The pace of privatisation increased in 2003 in terms of the numbers of firms. This was mainly due to the sharp increase in the number of firms that were sold through auctions (Table 7). Experience from 2002 and 2003 shows that privatisation of small and medium-sized enterprises, if done by auctions, is the easier part of the whole program. Over 80% of the firms offered could be sold. Most of the firms that in one or the other way have been offered for sale had recorded poor economic performances prior to privatisation. Thus out of the 700 firms to be privatised through auctions, 77% ran losses in 2001, i.e. before privatisation. Quite possibly, the firms earmarked for tenders had recorded an even weaker performance. However, in the course of the preparation of the sale, the firms were relieved of their heavy burdens of fiscal debt. This removal of fiscal debt helped to improve the success rate of the tenders. The pool of viable large enterprises is small. The large firms that in one way or another have been offered through tenders, usually need restructuring, implying labor shedding and investment into the modernization of the plant. In 2002, the government was able to sell over 50% of the large companies ranking in its list of companies to be privatised, but only 38% from January to October However, the privatisation receipts amounted to close to EUR 370 million in 2002 and close to EUR 900 million in Jan Oct Within these totals, tenders generated privatisation revenues in the size of EUR 200 million or 2.2% of GDP in 2002 and EUR 600 million or about 5% of GDP in the first ten months of The good result of the year 2003 is mainly the outcome of three major deals: In June 2003, US steel acquired the steel conglomerate Sartid, and in August Philip Morris and BAT each bought a tobacco company. Estimates expect that two thirds of the 2,000 enterprises will be privatised smoothly, whereas in one third of the cases enterprises will have to pass a bankruptcy procedure first. There is an important segment of the corporate sector that has not been tackled by the privatisation process: 41 large enterprises in need of restructuring. For the time being, these enterprises receive considerable amounts of subsidies from the budget. Their restructuring and privatisation is likely to take several years from now on, and some of them will have to pass through bankruptcy procedure. To facilitate the latter, the parliament passed a new bankruptcy law in mid Given the privatisation dynamics in 2003, experts hope that the privatisation of small and medium-sized enterprises through auctions and of large enterprises through tenders can be completed through Privatisation of public utilities is yet to come. In 2003 the installation of the required institutional setting has started. The central bank is responsible for the banking sector. The auditing of the large socially owned banks, i.e. banks owned by socially owned enterprises, had started soon after the political changes as from October However, the authorities formulated and signed their bank privatisation plan only in September It contained radical measures such as closing down the four largest socially owned banks at the beginning of January The plan enjoyed the support of the World Bank and the IMF. The fiscal costs of this first step were relatively small. The next move followed in mid 2002, when the authorities nationalized other major socially owned banks and announced that they should be sold. Pri- 28) Pavle Petrovic, Serbia: Understanding reform, draft version presented at the Global Development Network workshop in Vienna, 22 November

33 Privatisation vatising these banks will take several years, and it will first require the injection of capital first. In late 2002 the government took over Paris and London Club debt in debt-for-equity procedures and in this way became the majority shareholders of 16 Serbian banks. It developed a plan to sell these banks step by step. Montenegro In a first phase of Montenegro s privatisation campaign, lasting from 1996 to 1999, insider privatisation dominated: selling shares to employees at a discount and handing over shares to managers 29. The subsequent second phase of privatisation followed expert advice from USAID and DFID. Emphasis was put on the improvement of the legal and institutional infrastructure for privatisation. Batch-sale tenders in the case of medium-size companies, and voucher privatisation for small businesses became the main instruments. As regards the most important companies, the programme tries to privatise or re-privatise them through the sale of shares on capital markets or through selling them to strategic investors from abroad. 30 By 2001, about half of the corporate sector consisting of former socially-owned and former state-owned companies have been privatised. Of the former state-owned enterprises, more than 80% have been privatised completely or have a private capital share of over 50%. In 19 of the biggest companies the government still holds a controlling stake of 51 to 66%. In practically all companies private capital is involved. International sources acknowledge the transparency level of the ongoing second wave of privatisation. Insider privatisation and voucher privatisation turned about 90% of adult citizens into shareholders. 66% of Montenegrin citizens invested their vouchers in privatisation funds. They could choose between six different funds run by both domestic and foreign financial institutions: banks and insurance companies and particularly investment funds from Slovenia. Emphasis was also put on the development of the capital market. USAID helped to train and license about 160 people as professional investment managers and brokers. In October 2002, Hellenic Petroleum of Greece bought 54% of the oil company Jugopetrol. In February 2003 the government opened tenders for hotels, but there was hardly any interest from foreign investors. The government is also trying to sell a large aluminium conglomerate and a steel mill. The central bank is playing the leading role in the restructuring of FYR of Macedonia s banking sector. In 2002, five banks were state-owned and two were private banks. In July 2003, Nova Ljubljanska Banka of Slovenia bought Montenegro Banka, Montenegro s largest bank. At the end of 2003 around 76% of the bank s capital was privatised. Only one single state bank, the Podgoricka bank is still waiting for new owners. 29) Veselin Vukotic, Elements for understanding reforms in Macedonia, draft version presented at the Global Development Network workshop in Vienna, 22 November ) A popular or populist slogan with respect to privatisation reads: We do not sell our companies, we are buying good owners. 33

34 Foreign direct investment 6. Foreign direct investment has gained momentum in all SEECs 6.1. Overview From a global point of view, foreign direct investment (FDI) is targeted first and foremost at developed countries: Both in 2001 and 2002 they absorbed almost three quarters of the world s FDI inflows. This proportion remained unchanged in spite of the 25% year-on-year decline in the total amount of FDI inflows in 2002, from EUR 919 billion in 2001 to EUR 692 billion. The amount flowing into the EU fell much less, by 9%, whereas the amount attracted by the European transition countries even increased: by 9%, from EUR 28 billion to 31 billion. The share of these countries in the world s total jumped from roughly 3% to 4% 31. Most of this investment went to the CEEC-5 however, and not to the SEEC-7. In 2002, from a total of EUR 25 billion flowing into these two regions, 85% went to the CEEC-5 and only 15% to the SEEC-7 (Table 8). The allocation of the accumulated FDI stocks at end-2002 shows roughly the same proportion. Graph 7: Inward FDI stock per capita in EUR, Albania Bosnia-Herzegovina BiH Bulgaria Croatia FYR Macedonia Romania Serbia-Montenegro SCG Czech Republic Source: wiiw database 31) UNCTAD World Investment Report 2003 p. 7 Hungary Poland Slovakia Slovenia Table 8: FDI inflows EUR million forecast Albania Bosnia and Herzegovina Bulgaria Croatia ,375 1,178 1,743 1, FYR Macedonia Romania ,076 1, ,127 1,292 1,210 1,100 Serbia and Montenegro SEEC ,713 3,430 3,471 3,966 4,989 3,923 4,100 Czech Republic ,982 1,140 1,152 3,317 5,933 5,404 6,296 9,886 5,500 Hungary 2, ,751 1,886 1,973 1,857 1,913 1,834 2, Poland 1,468 1,581 2,831 3,592 4,343 5,676 6,824 10,334 6,372 4,371 3,600 Slovakia ,089 1,763 4,260 1,800 Slovenia ,950 1,800 CEEC-5 1 4,315 3,610 8,882 7,041 7,957 11,654 15,135 19,810 17,882 21,375 13,300 1) Sum of available data. Source: National bank of the respective countries and IMF according to balance of payments statistics. 34

35 Foreign direct investment Table 9: SEEC-7, Main trading partners, commodity groups, FDI countries, and FDI target industries in 2002 including shares in total exports, imports and FDI stocks Main trading partners Main commodity groups Foreign direct investment (and their shares of the total) (and their shares of the total) (stock) and shares of the total Most important Most important investor target Export % Import % Export % Import % countries % industries % Albania 1 Italy 71 Italy 36 Textiles 38 Machinery 16 Italy 48 Wholesale trade 27 Greece 13 Greece 28 Footwear 29 Miner.prod. 13 Greece 43 Textiles, footwear 21 Bosnia and Italy 24 Croatia 16 Basic metals 24 Machinery 17 Croatia 17 Industry 56 Herzegovina Croatia 12 SCG 16 Wood, -prod. 20 Miner.prod. 9 Kuwait 15 Services 17 Bulgaria Italy 15 Russia 15 Raw materials 42 Raw mat. 35 Greece 12 Manufacturing 40 Germany 10 Germany 14 Cons.goods 35 Capital goods 25 Germany 12 Finance 19 Croatia 2 Italy 24 Germany 17 Mach., Trp.equ. 30 Mach., Trp.equ. 34 Austria 24 Telecomm. 26 Germany 15 Italy 17 Misc. manuf.g. 21 Materials 19 Germany 22 Finance 21 FYR SCG 22 Germany 14 Misc. manuf.g. 35 Mach., Trp.equ. 21 Hungary 41 Telecomm. 41 Macedonia Germany 21 Greece 12 Materials 28 not classified 20 Greece 25 Manufacturing 11 Romania Italy 25 Italy 21 Textile, leather 35 Machinery 31 Netherlands 18 Industry 54 Germany 16 Germany 15 Machinery 22 Textile, leather 22 Germany 10 Services 16 Serbia and BiH 14 Russia 12 Manuf. Goods 90 Manuf. Goods 76 Germany 17 Montenegro 3 Italy 14 Germany 12 Agric. Goods 6 Mining, qu. 12 USA 10 1) FDI data for Albania relate to stocks at end ) Data concerning Croatia's main trading partners from ) Data concerning SCG FDI stock from 2001 Sources: Investment guide for Southeast Europe 2004, published by Bulgaria Economic Forum; wiiw database The FDI stock per capita is very low in the SEECs, much below the levels reached in the CEEC-5. This we can see from the year 2002 figures (Graph 7). There is one exception: Croatia outperforms all other SEECs by far and is even ahead of Poland. With respect to the FDI p.c., Croatia belongs to the league of CEECs. As Table 9 shows, there is a considerable gap between the countries generating the largest amounts of FDI into the SEEC-7 and countries acting as the most important trading partners. For five of the SEEC-7 Italy is the most important export market: Albania, Bosnia and Herzegovina, Bulgaria, Croatia and Romania. In the case of Serbia and Montenegro, Italy holds the second position. Only FYR of Macedonia exports mainly to Serbia and Montenegro and to Germany. Italy is less important as a source of imports: Only for Albania and Romania is Italy the main source. For Croatia, Italy comes closely after Germany. Italy s role is still weaker with respect to the main investor countries. It figures as the main investor in Albania, but does not hold any first or second position in other SEECs. Rather, Greece is strong as an investor holding first place in Bulgaria and FYR of Macedonia, and second place in Albania. Compared to the list of top trading partners, the list of top investor countries is more diversified; Germany and the USA came equal with some countries with small economies such as Austria, Bulgaria, Croatia, Kuwait and Netherlands. In Table 9, the classification of industries is not harmonized; some of the countries use rather broad categories such as manufacturing for FDI target industries. However, it is clear that in the case of Romania industry was the major target and that machinery was the largest import and the second-largest export item. It is an indication of intra-industrial trade import, processing and export of industrial components. Something similar is visible in the case of Croatia: first place for machinery and transport equipment both on the import and export side. The fact that exports of machinery and transport equipment is at the top of Croatia s exports creates a similarity to the CEEC-5, where this is also the case. In some of them, this product category has increased its share tremendously in recent years and contributes more than 50% to overall exports. Textile and leather products hold the lead in Albania s and Romania s exports; the related industries predominantly produce products ordered by Italian and other EU companies; they are competitive thanks to low wages in these countries. 35

36 Foreign direct investment 6.2. Albania In Albania, after the collapse of the former regime, it has always been questionable how much effective authority was attributable to the state. The situation in this respect has improved in recent years, but not completely solved; the country s division into two political camps is prefound and makes it difficult to consolidate state authority. In some phase of transition, the market economy developed in a chaotic, uncontrolled manner. The focus was on trade and other services, whereas industrial plants had to downsize production or to shut down completely. A large part of the population secured survival through farming on a subsistence level. About one quarter of the population lives on less than 2 euro per day. As regards the official economy, the state has privatised small and medium-sized enterprises through employee buy-out or auctions. To become viable and competitive, some 80 large companies would need capital injection, but the interest of foreign investors was lacking. To make these companies more interesting, the problem of inter-company arrears would have to be solved. Graph 8: Albania, FDI stock by sectors end-2001 Others 24.3% Wholesale 27.2% Wood, woodprod. 4.6% Chemicals 4.8% Non-metal 5.3% Clothes, footwear 21.2% Construction 6.2% Food 6.4% Source: wiiw Database Only in 2000, the FDI inflow gained momentum. The inflow reached EUR 230 million in 2001, a level that could not be reached again in 2002 and Graph 8, including data up to end-2001, confirms the strong position of trade and services and of textile and footwear processing in manufacturing. The government has sold the Albanian Mobile Communication, and several companies engaged in the processing of natural resources such as chromium and copper. The intention is to find an investor for the whole corporate sector including monopolies in the area of public utilities Bosnia and Herzegovina Graph 9: BiH, FDI stock by sectors end-2002 Manufacturing 55.5% Others 13.0% Tourism 0.7% Transport 0.9% Trade 6.2% Services 6.8% Banking 16.5% Source: Investment guide for Southeast Europe, 2004 From May 1994 until the end of 2002 foreign direct investment in BiH accumulated to some EUR 830 million. With respect to the main sectors, 55% of FDI went into the manufacturing sector, 17% into the banking sector and 13% into trade and services (see Graph 9). The strong position of industry (steel, cement) indicates basically that FDI inflows to other industries was meagre. Top investor countries were Croatia (15%), Kuwait (14%), Slovenia (12%), Germany and Austria (11% each). The biggest single foreign direct investment was the Kuwaiti investment in the BiH Steel Company. Other major investors were Coca Cola Netherlands, Germany s Heidelberg Zement, Islamic Development Bank, wood processor Finest from Croatia, and the engineering company Gama from Slovenia. Two thirds of the banking sector are controlled by foreign banks. Croatia s Zagrebacka Banka and Austria s Raiffeisen both maintain a large network of branch offices. Apart from the financial sector, FDI was not concentrated in one single area, but spread over the Bosnia and Herzegovina territory. From 2001 to 2002, the inflow of FDI increased dramatically, from EUR 140 million to over 300 million, but the results of 2003 remained below this figure Bulgaria Up until 1997, inflows of foreign direct investment to Bulgaria were low. Since then however, FDI inflow speeded up due to the acceleration of the reform process including privatisation and the gradual improvement of the legal and institutional environment. The main factors behind this latter process were the introduction of the currency board arrangement, the acceleration of the legal harmonization process with the EU, the establishment of the stock exchange, as well as two subsequent governments with pro-eu and pro-nato orientation. Privatisation was the major source of FDI in 1994 and in 1997 only. In the period , the sum of FDI 36

37 Foreign direct investment through greenfield investment, joint ventures, reinvestment and additional investment exceeded the FDI through privatisation, with the latter accounting for only 23% of the FDI volume. 32 The stock of accumulated FDI in 2002 reached about EUR 3.1 billion, close to EUR 400 per capita. Hereof, the manufacturing industry absorbed some 40% (see Graph 10). Within manufacturing, FDI concentrated on petroleum & chemical & plastic products as well as on non-metallic mineral products. Graph 10: Bulgaria, FDI stock by sectors end-2002 Others 12% Manufacturing 40% Tourism 4% Comm., Transport 8% Trade 16% Finance 19% Source: Investment guide for Southeast Europe, 2004 In manufacturing, the major investors were Belgium s Solvay in the chemical industry, Belgium s copper smelter Umicore, Russia s petrochemical company Lukoil, the Italian textile producer Miroglio and in cement production Heidelberger Zement (Germany), Marvex (Italy) and Holderbank (Switzerland). In the distribution of petrochemicals, investors were Lukoil (Russia), Shell (UK), OMV (Austria) and UCOS (Cyprus). In services, major deals were with OTE (Greece) and EMTF (Austria) in the telecom sector, and Metro (Germany) in trade. In the financial sphere, investors were Unicredito (Italy), National Bank of Greece and Bank Austria Creditanstalt. FDI target regions are the capital Sophia, the second largest city Plovdiv and locations in the vicinity of the Black sea. In 2002, FDI had concentrated on energy (Czech Republic) as well as machinery (Sweden) and electrotechnical production (Hungary, Austria). In 2003 major FDI transactions with the privatisation agency were related to the food processor Sofia MelAD by an investor from Cyprus, the trading company Interpred STC, Sofia, by an investor from Luxemburg and the mining company Navan Chelopech AD by a Dutch investor. OTB Hungary bought DSK Bank, the second largest bank in Bulgaria, and about 85% of the assets of the banking sector are now foreign-controlled Croatia Until the end of the war in 1995, inflows of foreign direct investment to Croatia did virtually not exist. In the following years FDI inflows were low due to: the lack of transparency of business conditions and the lack of financial discipline, missing foreign trade agreements with neighbouring countries, no institutional relations with the EU, no WTO/CEFTA membership as well as an unfavourable climate for FDI (unwelcoming attitude of the government at that time). 33 Only since 1998 have inflows of foreign direct investment gained momentum. In 1999, with the death of president Tudjman, the political isolation of the country ended. Following the political changes that took place at the beginning of 2000, Croatia embarked on the road of key political and economic changes and foreign investors were encouraged to come to Croatia. In 2000, the Croatian government adopted several measures to attract foreign investors such as the Law of Investment introducing investment incentives, the reduction of the payroll and corporate taxes, revision of the privatisation framework and the drafting of plans for the liberalisation of the energy and telecom sectors. In recent years, FDI has been mostly directed towards large privatisation deals, greenfield investment has been slow to take effect. The hitherto largest FDI inflow was recorded in 1999 when Deutsche Telekom acquired a 35% stake in Hrvatski Telekom; later on, in 2001 Deutsche Telekom acquired another 16% stake. 90% of the assets of the banking sector are foreigncontrolled, in the insurance sector foreign participation is still much lower. Others 27% Wholesale 2% Hotels 3% Extraction 3% Cement 4% Pharma 14% Graph 11: Croatia, FDI stock by sectors end of Q Source: Investment guide for Southeast Europe, ) Investment Guide for South East Europe ) Ministry of Economy ( Telecom 26% Finance 21% 37

38 Foreign direct investment The total FDI stock in Croatia came close to EUR 6.5 billion (EUR per capita) in About one quarter of the total went into telecommunication and not much less into financial services. Pharmaceuticals the company Pliva had a share of about 14%, the cement industry 4% (including Dalmacijacement-UK). There was also some foreign investment in food & beverages (e.g. Coca Cola, brewing industry) and electrical & optical equipment (e.g. Siemens, Ericsson). The leading countries from which FDI has originated are Austria, Germany and USA, accounting for 60% of total FDI stock. Graph 11 shows the significance of the telecom deal as well as the strong inflows into financial services and into the pharmaceutical industry. In mid-2003, the Hungarian oil and gas company MOL signed a EUR 450 million deal with the Croatian state to become the strategic investor in INA, the Croatian integrated oil and gas company. The agreement envisages a purchase of 25% plus one share stake in INA by MOL. The alliance will also include the leading Slovakian oil company Slovnaft, also controlled by MOL FYR Macedonia Cumulated since 1994, the FDI stock in FYR of Macedonia reached some EUR 970 million by the end of 2002, out of which two thirds were invested only in 2000 and There are many reasons for the low FDI inflows in the 1990 s in FYR of Macedonia. Beside the political factors, also the privatisation process that started in 1993 had some negative impacts on FDI as many former socially owned firms were sold to the employees or to the management. However, FDI picked up in 2000 and 2001 as a result of the sale of some of the large companies to strategic foreign investors. By the end of 2002 the privatisation process was far-reaching. Only the privatisation of a few large industrial loss makers is still proceeding slowly. Graph 12: FYR Macedonia, FDI stock by sectors aggregated inflows Others 1% Industry 23% Top single investor in FYR of Macedonia so far was the Hungarian MATAV company investing over EUR 350 million in the Macedonian Telecom Company in 2001, about one third of the FDI stock total accumulated up to the end of The second largest privatisation FDI inflow was through the sale of the Stopanska banka Skopje (see below). Other deals were the sale of Pivara Skopje brewery to the Greek Balkanbrew Holding. Thus, not surprising, Hungary is the number one investing country in FYR of Macedonia followed by Greece. Hence, FDI in transport and communication has by far the largest share in total FDI with a share of close to 50%. Financial services contribute another quarter to the total. Within manufacturing, most FDI went into the sector of food products, refined petroleum and metal & mechanical products. Graph 12 shows the predominance of FDI in telecommunication and financial services. The first foreign bank appeared in 2000, initiating a process of operational restructuring of the banking industry. The largest bank Stopanska Banka Skopje, was sold to three foreign institutional investors: National Bank of Greece S.A. Athens, European Bank for Reconstruction and Development (EBRD) and International Finance Corporation (IFC). Precondition for this development was an effort to restructure the bank, which was done at the end of 1999 by replacing EUR 125 million of non-performing receivables with government bonds. The total costs of the rehabilitation of the banking industry increased by 3.5% of GDP. Alfa Bank from Greece took over a second Macedonian bank, and Nova Ljubljanska Banka Ljubljana acquired the third largest bank. Simultaneously, at the end of 2002, Bank Austria Creditanstalt opened a representative office in FYR of Macedonia. Thus, at the end of 2002 more than half of the banking industry was in the hands of experienced foreign financial institutions. The takeover of banks by foreigners broke the link between enterprises who were at the same time owners of banks, forcing these to provide them with soft loans. Respecting the rules of prudential banking has become the normal attitude. The soundness, efficiency and credibility of the banks have increased thanks to a reduction of the banks bad loan portfolios. Interest rate margins have narrowed, capital adequacy ratios increased. Finance 24% Trade 3% Transport, Comm. 48% Source: wiiw Database 38

39 Foreign direct investment 6.7. Romania Typical for countries where the transformation policy was hesitant and privatisation proceeded with delay, FDI inflows to Romania have been low in comparison with the size of the country. Privatisation picked up a bit after 1997 due to changes in the privatisation law and the introduction of new and more transparent privatisation mechanisms supported by the World Bank. Starting from 1997, inflows averaged over EUR 1.2 billion annually. Increasingly, it was linked to post-privatisation restructuring. The large manufacturing companies offered for privatisation are either sound (and therefore the government keeps waiting for a high-price offer), or heavily indebted and in arrears with taxes, requiring financial restructuring prior or during the privatisation process. In 2001 about half of the industrial value added was still produced by stateowned enterprises. Most of the small and medium-sized manufacturing companies have already been transferred to private ownership Graph 13: Share of foreign affiliates in manufacturing industry sales in Romania El. Equipment Vehicles Food in , per cent Leather Materials Textile Metallurgy Pulp, paper Rubber B. metals Chemistry Fuels Wood Metal prod. Machinery Other Total quite considerable in leather & leather products, textile & textile products and other non-metallic mineral products, but low in manufacturing n.e.c. (furniture mainly) and in machinery & equipment. In some industries, foreign penetration has been rising very strongly in the last three years, e.g. in transport equipment (Renault) and basic metals (Marco International). With the takeover of the main steel producer Sidex S.A. Galati by LNM Holdings (Netherlands) in 2001 the foreign penetration in this sector further increased substantially. In April 2002, the parliament approved a new privatisation law in an effort to accelerate the process. 34 Companies to be privatized will have their budget arrears written off fully or partly. The law introduces a provision for selling off companies for a symbolic value ( 1 euro ). The amount of FDI inflows was rather stable in recent years and is likely to remain so for the time being. On their list of both big and successful FDI deals Romanian authorities first and foremost mention the following deals: Iron and steel plant SIDEX, Galati, sold to LNM Holdings, the refinery Rompetrol sold to Rompetrol Group B.V., Netherlands, Mobifon S.A. sold to Clearwave Holdings, Automobile Dacia S.A. sold to Renault, Raiffeisen Bank S.A., Daewoo Automobile Romania S.A., Colgate-Palmolive (Romania) S.R.L., Romtelecom SA sold to OTE International Investment s Ltd., the oil and natural gas extractor and processor Rafo S.A., Onesti, sold to a consortium of Imperial Oil S.A. Bacau and Canyon Seervicos LDA Portugal. The deals just mentioned account for about a quarter of the whole FDI stock at the end of Source: wiiw database The total FDI stock in Romania reached EUR 8.5 billion (EUR 377 per capita) in No disaggregated data on the sector-specific distribution of FDI exist for Romania s manufacturing sector. As an alternative, we may use the share of foreign investment enterprises (companies with at least 10% foreign share in their nominal capital) in the sale of different industries; data were available only up to the year These shares reflect the different degree of foreign penetration across industries. Compare to those CEECs that also offer an opportunity to calculated such ratios, the distribution of foreign penetration is relatively flat in Romania. In 2000, foreign involvement was highest in electrical & optical equipment, transport equipment and food & beverages. It was also 34) EBRD (2002) 39

40 Foreign direct investment 6.8. Serbia and Montenegro Serbia After the telecom sale in 1997 FDI inflows were very low about EUR 100 million per year or less. They increased only in 2001 to EUR 186 million and even more in 2002 (around EUR 500 million). Serbia and Montenegro is the SEEC with the lowest FDI stock per capita: EUR 193 in The following listing of FDI deals indicates that the projects were not concentrated in Belgrade, but targeted mainly other locations as well. A subsidiary of the largest Greek aluminium producer started building a new plant in Stara Pazora, which should be finished in A German producer of floor coverings signed a joint venture contract with a company in Packa Plananka. The WAZ Media Group signed a joint venture with Politika AD. French Cora signed a cooperation deal with Delta on building a number of hypermarkets in Belgrade and Novi Sad. In Preljini near Čačak, the Cypriot company European Tobacco started to build a tobacco factory. Slovenia s leading retailer Mercator opened a shopping center with a hypermarket in Belgrade. The Spanish producer of wooden floors and coverings EMMSA started a new company, Eurolink, in cooperation with a local producer. Michelin forming a new company Tigar MX with the leading local producer of car tires. Austria s oil company OMV opened petrol stations in Serbia. Greek Veropulos invested in building a hypermarket in Belgrade with the intention of building 10 other centers later on. US company Van Drunen Farms engaged in the production of canned food, has started constructing a plant for the production of organic food products. Austria s Bramac invested in a building material plant. The Italian company Graphic Zanini and the domestic pharmaceutical company Hemofarm have formed a joint venture company Zanini Hemofarm for the production of packaging materials for the pharmaceuticals industry. Philip Morris and British American Tobacco have won bids for Serbia s two largest tobacco factories. 70% of the staterun Duvanska Industrija Nis was sold to Philip Morris Holland B.V for EUR million, while British American Tobacco PLC will pay EUR 87.7 million for 70% of Duvanska Industrija Vranje. Belgium s Interbrew signed a EUR million strategic partnership agreement with the largest Serbian brewer Apatinska Pivara in September Interbrew pledged not to cut jobs over a five-year period and to invest EUR 66 million in the company over the next seven years and a further EUR 34 million in marketing. The entry of foreign banks was one of the crucial events for restoring the confidence in the banking system, and resulted in an increase of foreign exchange savings. At the beginning of economic reforms, foreign banks could set up banks locally on the basis of a licence issued by the National Bank of Yugoslavia. However, at some point the Central Bank announced that in the future it would decline issuing new licences, so that for foreign banks there was only one way left for entering the market: the purchase of local banks either small private banks unable to meet the new capital requirements or state-owned banks waiting for privatisation. Recently, Volksbank purchased Trust Banka when the minimum capital requirement was raised from EUR 5 to EUR 10 million. Of the three banks that are scheduled for privatisation in 2004, Novosadska Banka is expected to be sold to Uni Bank, Kontintal Banka to Nova Ljubljanska Banka, while it is still not known who will possibly buy JuBanka. Montenegro Montenegro s sale of companies to foreign investors started late. Starting from 1997, 16 larger deals were contracted, among them Helenic Petroleum purchasing an oil company with its headquarters in Kotor, the purchase of a brewery in Niksi by Interbrew, a coal mine near Berane bought by a Slovak company; a hotel purchased by a Slovenian company. In the banking sector, the Slovenian Nova Ljubljanska Banka took control of Montenegro Banka. 40

41 FDI potential 7. Plenty of FDI potential, to be increasingly tapped over time 7.1. Three reasons why countries will continue struggling for more FDI FDI will continue to be required for closing the gaps in the current accounts and the governments budget Except for Bulgaria and Romania, the SEECs are plagued by high current account deficits, and just simply from this point of view, the authorities in these countries would wish to see an FDI inflow much higher than that of recent years. FDI implies long-term commitments by the investors, so that the deficit being covered by FDI inflows is generally considered as sound. At the same time, the governments still hold share packages in the corporate sector. They are eager to sell them and to use the revenues for closing gaps in their budgets. The more indebted governments are, the more urgent is their need for privatisation revenues. With regard to general government data, government debt has grown in the last few years due to negative primary balances in all SEECs apart from Bulgaria and Romania. At year-end 2002 the external debt of the economy as a whole amounted to 100% of GDP in Serbia, to over two thirds of GDP in Bulgaria and in Croatia, and to over 50% in Bosnia and Herzegovina. In FYR of Macedonia and in Montenegro it was around 40%, in Albania it was only 25% of GDP FDI is paving the access to international markets Another reason, why FDI is important, is the following: in most of the transition countries in Central Eastern and South Eastern Europe, the foreign trade networks that had existed some 15 years ago no longer exist. The CEEC-5 networks were almost exclusively linked to Central and East European planned economies and the rules of the game were totally different from those to be observed in market economies. When they started transition, from one day to the next, those networks lost their relevance; the countries business sector was suddenly confronted with the task of winning market share in market economies. Fulfilling this task exclusively through their own efforts was again beyond the capacities of the countries corporate sector. This is true also for the SEEC countries Bulgaria and Romania, and to some extent also for Albania. In the case of the countries on the territory of former Yugoslavia, the starting conditions for transformation were completely different. The individual companies had much more independence the fact that they were socially owned and not state-owned definitely made a difference. Many companies in former Yugoslavia had been very active in creating links with trading partners all over the world. The trade statistics of former Yugoslavia looked quite different compared to those of the CEECs. A relatively high share of exports went to developed western countries and to developing countries. This global orientation was probably the biggest asset that the former Yugoslav republics had at the beginning of the nineties. It gave them a big advantage in comparison to the CEECs. As we know by now, only Slovenia has been able to fully profit from this advantage. Slovenia could avoid getting directly involved in the region s violent conflicts of the nineties. Thanks to the country s geographical location, even the indirect impact of these conflicts was much less compared to, say, FYR of Macedonia. Some of the region s long experience in international networking has been retained and is in the process of being reactivated. To become substantial, this reactivation needs backing from outside especially through FDI. The countries human capital is characterized by a spirit of international orientation, which in other transition countries had to be consciously forced much less so in Hungary or Poland, very much so farther to the east. One of the comparative advantages of the former Yugoslav countries is this heritage. Foreign investors can profit from it and at the same time contribute to an upgrading of the countries human capital The need for technological update The SEECs have experienced a painful period of de-industrialisation, and the capacities still available would urgently require a technological update. This is a most difficult and comprehensive task that goes beyond the capacities of domestic forces. The elites inside the countries as well as international support institutions hope that increasingly FDI could act as a substitute a more than perfect one for 41

42 FDI potential domestically financed investment, which has remained small in most SEECs. Graph 14: Gross monthly wages in manufacturing with and without indirect labor costs, Factors that could play a key role for the promotion of massive FDI inflows in the future Not only the SEEC central banks and governments are interested in an expansion of FDI inflows. The main players on the international stage are also eager to see economic progress. It would make it much easier to terminate the peacekeeping mission in the region successfully. For the EU or at least some of its members, it is important not to be burdened with a crisis-prone neighbourhood, but rather to profit from economic prosperity there. Achieving this goal is a challenge for the EU Commission as well as for the international financial institutions. Researchers and analysts have been invited to provide an answer to the question how to stimulate the region s economic growth. It is common sense that this will require massive investment, which cannot be generated from domestic resources alone. Consequently, the key question has become how to make the SEEC region appealing for large amounts of FDI Low costs thanks to low wages, low tax rates One approach with regard to preconditions for high FDI inflows stresses the significance of low wages as a basis for low unit labour costs. The idea is that within the international business community at least part of the companies with a transnational orientation put emphasis on opportunities for production at low unit labour costs. This cost-oriented approach usually also identifies low tax rates and low social security contributions as decisive factors and pleads for a removal of trade barriers as a strategy that makes imported inputs cheaper. Graph 14 shows the level of gross monthly wages in manufacturing, computed in euros via exchange rates, for the CEEC-5 and six of the SEEC-7; data for Bosnia and Herzegovina are lacking, as BiH statistics only report net monthly wages. For some countries, estimates for wages plus additional labour-related monthly expenditures were also available. The data are related to the year 2001; there is evidence that in the meantime wage levels have increased considerably. However, the interesting feature is rather the gap between individual countries as well as between the two groups of countries. Off all the countries included in Graph 14, the wage level 1,200 1, Bulgaria Albania Serbia-Montenegro SCG Romania FYR Macedonia Croatia wages plus indirect costs wages only wages plus indirect costs wages only * Comparable data for BiH not available. Source: wiiw Handbook of Statistics, is highest in the CEE country Slovenia, one of the countries on the territory of former Yugoslavia, with an average of over EUR 820 in Taking into account that Slovenia in recent years has always been able to keep its current account balanced, one can conclude that the corporate sector can afford to pay such wages. The country with the second-highest wage level in 2001 was Croatia (EUR 600) in combination, however, with a trade deficit that is too large to be fully offset by other current account items among them especially tourism. In the remaining five SEECs, the wage level was below EUR 180 and thus far below CEEC-5 levels. Nevertheless, the trade deficits of these countries exceeded clearly those of the CEECs. Graph 14 (wage levels) and Graph 7 (FDI per capita) together give the impression that for the countries under consideration there was no negative link between wage levels and FDI per capita. Rather, the contrary was the case. The link, if any, seems to be positive in general: the high-income countries are also the target countries of inward FDI. Compared to EU-15 countries, even Slovenia s wage level was low: about 40% of Austria s. Figures calculated in purchasing power parities would increase the ratio to two-thirds, but this consideration has little relevance for, say, an EU company contemplating an investment in Slovenia and therefore investigating how high the wage bill would be. The gap between SEEC and CEEC wage levels, one could argue, did not attract large FDI inflows because the labour productivity gap between SEECs and CEECs was even higher. Graph 15 shows this gap for the year Slovakia Hungary Czech Republic Poland Slovenia 42

43 FDI potential 25,000 20,000 15,000 10,000 5,000 0 Graph 15: Gross value added in industry per person employed Romania SCG Bulgaria FYR Macedonia in Euro, 2002 Croatia * Data for BiH not available. Source: wiiw Handbook of Statistics, The graph shows the industry s gross value added per person employed in industry. In Slovenia, the average person employed generated a value added of EUR 23,000, the Czech Republic took second place with EUR 14,800, the amount also reached by Croatia from the SEEC group. Other SEECs were far below Croatia, especially Romania and Serbia and Montenegro with EUR 2,000 to 2,500. The CEEC-5 average was EUR 14,000, the SEEC-5 average merely EUR 3,100. So in fact, when comparing CEECs and SEECs, the productivity gap was much larger than the wage gap. Such productivity figures could have the potential to deter potential investors from investing in SEECs. This is, however, not necessarily justified. The figures say something about the state of the industrial sector as it was in They show that on average industrial companies were in bad shape. The figures do not, on the other hand, say anything about the labour productivity that a foreign investor can achieve if she or he purchases an existing plant, introduces new management practices, installs some new machinery Slovakia Hungary Poland Czech Republic Slovenia and knows what to do with the forthcoming output. The same is of course true for greenfield investment. There is a lot of evidence that the labour productivity in a so-called foreign investment enterprise in a transition country can reach or even surpass west European levels. Tax rates in the SEECs, at least those targeting corporate income, are low by international standards. The corporate income tax rate is between 20% and 25% in most countries; only in the FBiH is it 30%, whereas in FYR of Macedonia it is only 15%. The employers social security contribution differs significantly: the rate is 47% in FBiH, but merely 8% in Croatia. Another aspect of interest in this context are the various FDI incentives: tax holidays (BiH, Croatia, FYR of Macedonia, Serbia), partial profit exemption (BiH, FYR of Macedonia), preferential corporate income tax rates (Croatia, Romania), accelerated depreciation (Bulgaria, Croatia, FYR of Macedonia, Romania, Serbia), investment allowance (BiH, FYR of Macedonia), reinvestment allowance (Romania), investment tax credit (Bulgaria, Serbia), customs duty exemptions (all except for Albania and Bulgaria), customs duty deferral (Albania), VAT exemption (Romania), VAT deferral (Albania) Special conditions for FDI in special zones such as customs duty exemption (all SEEC-7), VAT exemption (Bulgaria, Romania), corporate income tax holiday (BiH, Croatia, FYR of Macedonia, Romania) and other tax exemptions (BiH, FYR of Macedonia, Romania) ) OECD, Tax Policy Assessment and Design in Support of Direct Investment: A Study of Countries in South East Europe, prepared by the OECD Tax Centre for Tax Policy and Administration and the Investment Compact Team, Paris, 2003 Table 10: Basic Tax Features in SEEC, 2002 FRY Albania BiH Bulgaria Croatia Mace- Romania Serbia Montein % (FBiH; RS) donia negro Standard Corporate Income Tax ; /20 Maximum Personal Income Tax ; Social Security: Employer Contributions ; Social Security: Employee Contributions / Standard VAT 20.0 Sales tax Sales tax 17.0 Source: Tax Policy Assessment and Design in Support of Direct Investment: A Study of Countries in South East Europe, prepared by the OECD Tax Centre for Tax Policy and Administration and the Investment Compact Team, OECD, Paris

44 FDI potential A recent OECD publication stresses that there is no correlation between a country s ability to attract FDI and its overall tax level or corporate tax burden, arguing that companies looking for a target country as a first step put some countries on a shortlist; only then, when selecting the target country from the shortlist, aspects such as the tax system, particularly the corporate income tax, are taken into consideration Appropriate institution settings Another approach, an institutional one, stresses the importance of the rule of law as well as of well-functioning institutional settings such as bankruptcy procedures and efficient and reliable public administration. The basic idea of this approach is that an inadequate institutional framework means increased costs and above all risks for foreign companies, so that they may decide to invest in a less risky region. In this context, frequently mentioned aspects are also corruption and the grey economy. The SEECs have a bad reputation in this respect. Increasingly, western companies are reluctant to engage in countries where bribing is a precondition for arrangements to be negotiated with representatives of private companies and government bodies. Apart from the problem of legality, such conditions make it more difficult to estimate the costs to be expected from FDI projects. The grey economy also has the potential to increase investment-related risks. For example, the output produced by the foreign investment company may have to compete with illegally imported goods. A few years ago this was the case when the new Coca Cola plant in Bosnia and Herzegovina was confronted with cheap illegal imports of Coca Cola from Hungary. The grey economy is also risk-hiking if greymarket bosses are monopolizing segments of local markets by reinforcing different kinds of entry or exit barriers. Institutional shortcomings are most probably a serious entry barrier for foreign small and medium sized enterprises. For companies on the list of the world s largest enterprises, such aspects may have less relevance, at least in the case of a big investment project. Any country in the region would be eager to facilitate their involvement as much as possible. Even in the case of medium-sized companies some analysts argue that companies, when they have taken a risk and entered the country, may regard these barriers even as an advantage; they can be sure of not too many other foreign investors showing up in their newly entered domain. They may also feel satisfied about the low price that they have paid for their acquisitions, thanks to the region s reputation as being risky Macroeconomic stability A third approach puts emphasis on macroeconomic aspects. The importance of avoiding all macroeconomic imbalances is given high priority in the FDI promotion debate as well as in the discussion on stimulating GDP growth. The diagnosis that most countries are burdened with lots of inherited unnecessary legal and administrative barriers to business activities both within the countries and between countries is also very relevant. The idea behind these claims is that private sector growth will take on a momentum of its own once the government and the central bank have done their job. Of course, doing a good job includes also positive prospects in terms of political stability and thus confidence building. In this approach, the result is a positive investment climate. It may happen that a country s economic policy has successfully stabilized the internal as well as external value of the country s currency. It may also have succeeded in balancing the government s budget and the current account. Finally, economic policy may also have removed all regulations that could hinder investors. Nevertheless, even in such a situation there is no guarantee that investment, no matter whether from domestic or external sources, will start expanding quickly and become the powerful engine of economic growth. Present and past examples for such macroeconomically balanced, but slowly growing economies can be found in different parts of the world. In the SEEC-7 region, FYR of Macedonia is more or less such an example 37. Inflation was as low as 1.5% in 2002, the euro exchange rate approximately the same as in The central government s deficit was merely 1.7% of GDP 38. The only major imbalance was in the current account. In the two years before 2001, the current account had been nearly balanced. On the other hand, there are examples of countries growing rapidly over long periods, in spite of incomplete stabilisation of prices and exchange rates and in spite of major budget and current account deficits. China and India are prominent large-scale examples for that. The results achieved qualify Hungary and Poland as European examples on a smaller scale. The three approaches described above try to identify the factors which are significant for the stimulation of foreign direct investment. In fact, wage levels, institutional arrange- 36) OECD Progress in Policy Reform in SEEC Europe Monitoring Instruments, Investment Compact for SEEC, Paris, ) see Appendix, FYR Macedonia country table. 38) The EBRD Transition report reports relatively high general government deficits for 2001, the year of the outbreak of ethnical conflicts, and for 2002 as well, but estimates a deficit of merely 1.5% of GDP for

45 FDI potential ments and macroeconomic performance are such factors, at least to a certain extent. The aggregate FDI inflow of a given year is always the outcome of a number of individual entrepreneurial decisions, and the underlying motives may differ from case to case. In some branches, the wage level plays a major role, in others it does not. The same is true for institutional arrangements and even for macroeconomic aspects. For example, it is probably because of low wages that the production of textiles and leather products plays a significant role in the SEE region. For some companies in some branches low wages may play a very important role. A wiiw analysis of exports to the EU by commodity groups shows that the composition of SEEC exports differed considerably from that of the CEEC-8 39 in the years 1997 to Romania was the country where exports of labourintensive goods had the highest share in total exports to the EU. It was constantly close to 50%. Albania s ratio grew over time, to over 40%, Bulgaria s ratio grew too, but remained below 40%. FYR of Macedonia s share, also over 40% in most of the years, did not show a clear pattern. In the CEEC- 8, the relevance of exports of labour-intensive industries declined. Their share fell significantly below 25% of total manufacturing exports, whereas the share of technologydriven industries climbed up to almost 30% in Easy access to a large market Two factors not yet mentioned may play a quite important role in the context of motives to invest in one or the other country. First, many of the companies intending to invest abroad may look for a location where they have easy and cheap access to a large market say 100 million persons with an average income of thirty thousand euros annually. This may be the reason why most of FDI goes to highly developed countries such as the EU or the US. It is certainly not because of low wage rates, and also not because of low tax rates. The massive FDI inflow to China, on the other hand, illustrates that low-wage countries can also qualify as preferred destinations. The Central East European transition countries have become attractive for foreign direct investors by offering free access to the huge future EU-25 market. Production costs are still low in the CEEC-5, even if much higher than in most of the SEECs. In other words, in the case of the CEECs it is the fine neighbourhood which makes them an attractive location for industrial and services activities. For more than two decades, Greece has been an EU member country but never attractive for FDI on a large scale. The main reason for this may be that the domestic market is small and the neighbourhood poor The performance of domestic enterprises Besides the size of the market that can be accessed from the place where the FDI is located, a second factor may also help to explain why SEECs have not become prominent FDI targets yet. In developed countries there is no systematic performance gap between domestically and foreign owned companies. In less developed countries, on average the performance of domestically owned companies is poor, that of foreign investment enterprises is much better. Quite possibly the latter scenario is not that desirable for different categories of the transnational enterprises. Depending on the character of their core activity, they may be interested in a cooperation with strong local partners or in the sufficient availability of skilled labour. Should such motives be widespread, this would imply a complementary relation between foreign and domestically owned enterprises. It would be misleading to regard foreign-controlled enterprises as a substitute for viable domestically enterprises. In other words, it may be a wrong strategy to offer foreign investors all kinds of favourable conditions if at the same time domestic-owned enterprises suffer from neglect. This has been very much the case in most of the SEECs. For example, small and medium-sized domestic SEEC enterprises are confronted with financial problems unconceivable for transnational enterprises. For working capital and investment purposes, they have to rely predominantly on retained earnings. They have hardly any access to long-term credits especially at conditions they could cope with. They try to avoid disputes for example by insisting on prepayment or payment on the spot in the case of output delivery, and they tend to restrict their activities to long-term relationships on the input as well as on the output side. This is the way in which companies impose tough budget constraints to their individual business environment. On the other hand, however, it is still a widespread habit, also largely exercised by privatized companies, to leave public utility bills unpaid, either forever or for a long time. In this whole context, Croatia has achieved more progress. The institutional arrangements are more advanced and the government has tackled these issues with quite good success through the support of micro-credit schemes and other support to small and medium-sized enterprises. 39) The CEEC-5 plus the Baltic states (EU accession countries in 2004). 40) Vladimir Gligorov, Mario Holzner and Michael Landesmann, Prospects for Further (South-)Eastern EU Enlargement: from Divergence to Convergence? wiiw Research Report No 296, June

46 FDI potential 7.3. Which SEEC industries are candidates for future FDI? For individual companies, it may make sense to start doing business in a region or country that the mainstream prefers to avoid. However it is clear that for the time being foreign direct investment in most of the West Balkans Bulgaria, Croatia and Romania are already more advanced will remain concentrated on a few industries and affect the rest of the economy only sporadically. In a few SEEC industries, foreign involvement has achieved some progress already, and they will remain on the agenda of potential investors. Examples are telecommunication, banking, tourism, wholesale trade, department stores and petrol stations in the tertiary sector. In manufacturing, foreign investment has focused on the production or processing of metals, chemicals, cement, wood, textiles and leather, tobacco, beer and non-alcoholic beverages and food. Some investment targeted mining and quarrying, whereas foreign investment in agriculture was marginal. Compared to domestic companies, foreign investment enterprises have better links and skills available with regard to exports. The more export-intensive SEEC items were food and drinks, textile and leather products, light machinery and equipment as well as electrical appliances. As regards future FDI targets, it is an open question whether the SEEC region will follow the example of the CEEC-5. The manufacturing sector of the CEEC-5 has specialised on machinery and transport equipment; in Hungary, the Czech Republic and Slovakia, these products accounted for 57% and 49% of all Hungarian and Czech exports into the EU. Quite possibly, the industrial specialisation of SEEC manufacturing will take the same course. If yes, the question is which countries will take the lead. Romania s Renault-controlled car factory Dacia has not been all that successful so far, but this may change. For Romania and other SEECs more involvement in the production of components of cars and other machinery could be a starting point for more specialisation in machinery and transport equipment. For the time being, the West Balkan region consumes much more food than it produces. This is remarkable given that at least in some SEEC territories the preconditions for agriculture are good, and that there is a know-how available in the field of food processing. Food processing will have to face competition, however, from subsidised EU-exports. Tourism is likely to be an important future FDI target. The countries on the Adriatic coast are of course particularly significant in this respect. For Bulgaria Black Sea tourism has become an important source of export revenue. Croatia is leading the rally for FDI in tourism, because of several reasons, as for example the prospect of a complementary development of small and medium-sized domestic enterprises and big foreignowned premises. FYR of Macedonia is eager to develop tourism too, but a precondition for major success would be an exceptionally well-prepared marketing strategy combined with a comprehensive internal development strategy. Bosnia is trying to attract investors for winter tourism. The construction industry should also have good prospects. So far, the infrastructure is underdeveloped. Motorways are rare, roads have lacked maintenance in the last two decades or so. Railways would need a comprehensively overhaul, especially new roadbed and track. Otherwise trains will be too slow to be competitive, and only the few main lines will survive in the longer term. The Danube has to regain its former role as an important means of transportation in the next few years. The overall investment requirements in infrastructure are huge. They need to be financed primarily from foreign sources. Investors in this area should have experience with projects financed by the EU and international financial institutions. The SEEC governments are preparing the sale of public utility companies to foreign investors. To do so, in many cases they split existing companies. For example, in the case of electricity the restructuring separates production, transmission and distribution. An additional geographical split on each of these levels is also a standard strategy. The countries in the region have signed cooperation agreements, so parts of the industry will further stimulate foreign companies interest. Possibly simultaneous tenders from several countries will compete. So far, FDI in the SEEC s manufacturing has not been concentrated predominantly on the countries capital cities. So far, these cities have not developed into big agglomerates that would contain a large proportion of the population. There is no hint that FDI will contribute to an essential change of the situation Being better informed makes the SEE region less risky Foreign direct investment in regions like SEEC-7 is a process in which some pioneers take a risk, possibly motivated by low initial investment costs. Cases of poor results or disputes have a discouraging effect on potential investors. If 46

47 FDI potential however such a pioneer has visible success, other investors will follow suit. In this way Austria has become a strong investor in Croatia, or Italy in Romania. Central European countries such as Austria, Germany, Hungary, Italy or Switzerland can rely on more pioneer experiences compared to, say, Scandinavia or the USA. Not only the experience of the pioneers and of the subsequent generations of followers grows. If investment activities become more frequent, a supportive service sector emerges and has an opportunity to broaden its own experiences. Companies interested in investing in SEECs can find support from specialised service industries in those countries where SEEC investors have been mushrooming in recent years. For example, several EU banks are running subsidiaries in SEEC countries, so they should be useful partners for non-financial companies looking for investment opportunities. A number of lawyers in EU countries have also developed expertise in investment in SEECs, and some of them have even opened affiliates there. Other types of consultancy may have also accumulated knowledge on investment in SEECs. All this forms a cluster of services that helps to make foreign investment projects less risky Comments on the individual countries Albania In recent years, foreign companies have not been too keen on taking over large Albanian enterprises. Even attempts to find a strategic investor for the fixed-line operator Albtelecom have so far failed. The activities of the international financial organisations compensate as much as possible for the lack of interest of private investors. They aim at improving the preconditions for foreign investment by promoting the improvement of the infrastructure, with a special focus on the energy sector as well as on the road and railway network. In early 2003, international financial organisations recommended the government not for the first time to step up efforts to sell large companies to foreign strategic investors, In May 2003, the government drafted a schedule for the privatisation of key sectors including the energy corporation KESH, the general directory of railways, the sea port of Durres, the oil and gas sector, the coal mining and water supply sectors, and Albtransport. The programme envisaged also the continuation of the process of privatisation of the Savings Bank, the telecommunication company Albtelecom and the state insurance company INSIG. As regards the latter, the International Finance Corporation (IFC) and the European Bank for Reconstruction and Development (EBRD) signed an agreement in October 2003 concerning the purchase of 39% of the shares for approximately EUR 10 million. The IFC and EBRD announced that they would supervise INSIG operations for one to two years. As a result, it is hoped that a strategic foreign investor will buy additional shares in INSIG. Two measures are hoped to make Albtelekom attractive for foreign strategic investors: (1) The government decided to issue a third wireless license to Albtelekom. (2) IFC and EBRD intend to invest over EUR 60 million in Albania s fixed-line telecommunications industry by The wireless market in Albania is expanding rapidly with the existing operators seeing an increase from 20,000 subscribers in 2001 to nearly 800,000 in Selling a majority stake in the state-run oil company ARMO to foreign strategic investors has also been on the agenda since mid ARMO processes Albanian crude oil and markets its by-products. According to the proposal, the investor should undertake to process exclusively Albanian oil in the first five years. In mid-2003, subsidiaries of the Austrian company OMV and the Greek company Hellenic Petroleum have begun drilling for oil in southern Albania. In early 2005, Albania should have a second national airport in the northeast city of Kukes, near its border with Kosovo. The project includes a road link between the port city of Durres and Kosovo. Financial support for the project comes from the United Arab Emirates. In 2002, Albania, Italy, Bulgaria, Greece, FYR of Macedonia and Turkey have signed a memorandum of understanding on the development of Corridor 8. Part of the project is a road connecting the port of Varna in Bulgaria via FYR of Macedonia with the port of Durazzo, Albania. In its planned ultimate dimension the project is even more ambitious: the corridor should connect Europe with the Caucasus and Central Asia. It would be 1,270 km long and would include harbours, airports, streets and railways. The estimated costs for the entire project reach EUR 2.2 billion. Another project, an intra-albanian one, is a toll road connecting the cities of Tirana and Rogozhina. Other plans focus on the construction of new or the reopening of existing rail connections. A World Bank project presented in mid-2003 envisages the re-establishment of the rail link between Albania and Montenegro, a 150 kilometre length of track. The project will connect the Albanian rail system to the European network. Another plan foresees a rail connection with FYR of Macedonia. A third plan is already at an advanced stage: General Electric and the Albanian government have signed a contract to reconstruct the intra-albanian rail line between Tirana and the port city of Durres, along with a connection to the international airport near Tirana. 47

48 FDI potential According to estimates, the modernisation of Albania s whole electricity system would require up to EUR 100 million per year up to A World Bank Energy Project supports this target. The Italian and Greek governments and the German Bank for Reconstruction and Development (KfW) plan to jointly finance the construction of a 440 kv electricity transmission line between Elbasan, Albania, and Podgorica, Montenegro. Preparations relating to the modernisation of a thermal-power plant in the south of Albania are at an advanced stage. Companies selected in an international tendering process should perform the modernisation. Albania has also the potential to become a destination for international tourism, but it would require larger investment. Probably, this will happen only in a few years time Bosnia and Herzegovina Tourism, wood processing, metallurgy, energy production and export, food processing, construction industry, business and other services, trade these are the fields where Bosnia and Herzegovina has a development potential. As regards telecommunication, in 2002 the High Representative had imposed a state communication law clarifying the distribution of responsibilities between the state and the entities and introducing international standard practices. However, the entity authorities were slow in taking the next steps. Possibly, privatisation of one or the other of the three companies (BH Telecom, Telecom Srpske and HT Mostar) will occur sometime in The EBRD granted a 30 million euro loan to support preparations 41. In 2003, an independent special auditor publicly identified mismanagement and corruption in each of the companies. Past foreign direct investment was not concentrated in primarily one area. Neither political nor economic power is very much concentrated. A poorly developed and poorly maintained road and railway system adds to this fact. For citizens of Banja Luka, the capital of the Republika Srpska entity, it is easier to travel to Zagreb than to Sarajevo or Mostar. The Mostar region, on the other hand, is primarily oriented towards the coastal area of Bosnia and Herzegovina and Croatia. Tuzla in the northeast has quick access to the Zagreb Belgrade motorway and railway line, but not so much to the rest of the country. Large railway and road construction projects are under discussion. They will have to be financed primarily through foreign funding, which could happen in the next few years in the context of preparation to EU accession sometime in the next decade. 41) EBRD Transition Report ) GTZ, Promoting Cluster Approaches for EU Association and Accession Countries: Bulgaria Bulgaria Manufacturing so far specialized on labour-intensive products such as the production of textiles, leather and leather products as well as on capital-intensive industries: coke & petroleum products, chemicals and basic metals. In addition, Bulgaria has continued to maintain a relatively large food & beverages and machinery sector as compared to the other transition countries. In 2002 the government identified branches considered as particularly promising: information technology, tourism, energy, textiles and clothing, other manufacturing products and food processing. Before transition, Bulgaria had specialized in information technology within the Council for Mutual Economic Assistance (COMECON). After the collapse of the East European market this industry was not competitive any more, and a large number of qualified hardware and software specialists lost their jobs. Many of them started small private IT companies. In 1999, over 1000 such companies existed, half of them employing up to 10 persons. With the aid of international organisations, efforts to form an IT cluster are under way 42. A well-trained workforce, especially in mathematics and natural science is an asset of the country. Less widespread are corporate management skills and properly trained judiciary and public administration experts. Another tradition may also be of relevance for the future: Bulgaria was strong in agriculture and is, among the eight EU accession countries, one of only two net exporters in the category of agricultural goods and food products. The further restructuring of the energy sector is under way. The sector has been split already. NEK, the former national electricity company has concentrated on transmission and has retained a monopoly position. In July 2003, electricity prices were raised by an average of 15%; districtheating prices increased by around 10%. In October 2003 the government officially started the privatisation process. It will commence with hydro and thermal generation. Depending on the targeted industry, foreign direct investment will flow mainly to Sophia, to the Plovdiv region in the centre of the country and to the Black Sea area where tourism has started to recover Croatia Both in geographical and industrial terms, manufacturing in Croatia is quite diversified and less concentrated than in other transition countries. It offers a wide range of opportunities for FDI: in labour-intensive industries such as textiles, leather, wood processing and furniture, in capital-intensive industries such as coke & refined petroleum products, chemicals and basic metals, and last not least in high-technology 48

49 FDI potential industries such as machinery, electrical & optical equipment and transport equipment (mainly shipbuilding). The Croatian food & beverages industry is also large. Recent developments point to an ongoing shift from textiles and leather to hightechnology industries. However, active restructuring of the economy, involving thoughtful business projects, modernization of productive equipment, progress in ownership transformation and financial reform, seems to be dragging along. The main reason may be the privatisation strategy applied in the nineties. It relied mainly on management and employee buyouts, which left companies with a lack of fresh capital. Hence, active restructuring still has to intensify. FDI can profit from ongoing privatisation procedures, a dozen special economic zones and a well-educated workforce. On the negative side, progress in judicial reform is slow, and Croatia is no exemption in terms of widespread corruption and bribery. The road sector s funding has been made fully independent from the central budget. A dedicated fuel levy is the nearly exclusive source of funding of Hrvatske Ceste, in charge of development and maintenance of non-tolled state roads. Another fuel levy and 30% of the revenue from motorway tolls contribute 70% of the funds available to Hrvatske Autoceste, the organisation responsible for the development and maintenance of tolled roads. The privatisation of HEP, the Croatian Electricity company and the sale of the remaining government shares in HT, the Croatian Telecom, could take place in A precondition for privatisation will be the completion of the companies restructuring. Up to the end of 2004, a new law protects Croatian Telecom from competition in fixed-line services. A tender for a third mobile operator was launched in autumn FYR Macedonia One of the sectors with potential for FDI is the textile industry. The sector contributes about 10% to total manufacturing production. Most FDI in the context of privatisation in this sector took place already in , e.g. by German, Dutch and Italian companies. Another important export sector is mining and metallurgy. FYR of Macedonia has large deposits of lead-zinc ores, some copper and chromium. A large number of ferrous and non-ferrous metallurgy facilities have been developed. Key products include hot and cold rolled sheet steel, aluminium bars, rods and profiles, ferrous alloys, seamed tubing and ferrous nickel products. The food & beverages sector, being the largest of the Macedonian manufacturing sectors is a relatively developed industry, with companies producing canned and bottled fruits and vegetables, as well as wine and beer for export. The government plans the restructuring of the Electric Power Company of Macedonia as an initial step, which should be followed by the privatisation of individual components. The government s restructuring and privatisation adviser is a consortium led by Meinl Bank AG from Vienna. Another group of advisers, financed by USAID, has worked on sector restructuring, market design and tariff reform. The power company announced that it would stop deliveries to non-paying clients and increased its electricity prices by mid In November 2002 several governments of the region, among them that of FYR of Macedonia, signed a memorandum of understanding with which they undertook to create a regional electricity market in southeastern Europe by A first free economic zone, an area of ca 150 ha located 10 km east of Skopie should become operational in The purpose is to promote activities such as manufacturing, export-supporting services, banking and other financial activities, life and non-life insurance and reinsurance. In the free economic zone, a foreign investor will enjoy tax exemptions with regard to VAT, profit and property tax and will be granted tax advantages in the case of the reinvestment of profits within the zone Romania Romania offers special FDI opportunities thanks to the still ongoing privatisation of large enterprises, cheap labour and rich natural resources. Manufacturing has so far focused on labour-intensive products (textiles, leather, furniture). However, recent foreign direct investment in electrical and optical equipment, transport equipment and basic metals seems to offer fresh opportunities for other industries as well, upstream or downstream. In 2003, the government sold three factories belonging to Romania s giant and at the same time loss-making machine construction industry, one of the factories at a symbolic price of EUR 1. In total, FDI is still low given the size of the country, but it will most probably gain momentum thanks to the envisaged EU accession and also thanks to plenty of opportunities to acquire corporate assets at moderate prices. There are some prospects for success in the privatisation of energy distributors, whereas energy generation is in a very poor shape. Thermal generating plants produce about 60% of domestic electricity, but are in urgent need of renovation and investment. Otherwise, they will not meet EU environmental standards. Romania is member of the Union for the Coordination of Transmission of Electricity and is also member of the Southeast Europe Regional Energy Market. 43) EBRD Transition Report

50 FDI potential Two attempts to find a foreign strategic investor for the biggest of the three state-owned commercial banks, BCR, have failed. A third attempt will follow with the support of the EBRD and IFC. By 2006 a strategic investor should have taken over the bank Serbia and Montenegro Serbia A large chunk of the economy is still in the hands of (mostly) socially-owned enterprises. The private sector s share of GDP in mid-2001 was still only 40% compared to 60% in Croatia and 70% in Bulgaria. 44 The privatisation process currently underway concerns 4,500 socially owned and state-owned enterprises. Purchasers of capital or property may be domestic or foreign legal entities or individuals. All socially owned capital will be privatized by June Should a company with social capital fail to initiate the privatisation process by this deadline, the Agency for privatisation will carry it out. 45 A large number of privatisation projects should materialize in 2004 and probably still also in For companies outside Serbia and Montenegro considering investing in SEECs, it should be interesting to follow the process carefully and to participate in upcoming tenders. 46 Textile and clothing may remain a sector of interest for foreign investors. Capacities are severely underutilised. Investors will profit from the low wage levels and the improved access to international markets. Bulgaria, a comparable country, exports over six times more wearing apparel than Serbia and Montenegro. Investment in new machinery will be indispensable. The paper industry is currently operating at a fraction of its total capacity. Because of this, imports of paper products amount to over EUR 150 million annually. However, much of the machinery is obsolete, so investment in new machinery is a requirement in this sector too. The domestic petrochemical industry only covers 40 to 60% of the requirements of the domestic market. The reasons are a lack of some types of raw materials or strong competition from foreign companies. The import of plastics into Yugoslavia is free, with customs duties of 5% levied on products, which are produced in Yugoslavia as well, and 1% for products which are not available locally. On the other hand, the production capacities for liquid resins are disproportionately large, thus providing a high potential for exports. The Danube River is the most important link from the SEE Free Trade Area countries to Western Europe and should gain economic significance again in the next few years. A projected new railway and road crossing between Bulgaria and Romania, situated in the lower part of the Danube near Kalafat Vidin, will add to the potential of the region. Serbia s financial sector should be of interest for potential foreign investors. At the beginning of economic reforms, foreign banks could set up banks locally on the basis of a licence issued by the National Bank of Yugoslavia. Later, the Central Bank stopped issuing new licences, so that the purchase of existing banks is the only way for foreign banks to enter the local market either small private banks unable to meet new capital requirements or state-owned banks that are being privatised. Volksbank has purchased Trust Banka, when the minimum capital requirement was raised from EUR 5 million to EUR 10 million. Three banks are scheduled for privatisation in 2004; Novosadska Banka is expected to be sold to Uni Bank, Kontintal Banka to Nova Ljubljanska Banka, while it is not yet clear whether a buyer of JuBanka is already envisaged. Four foreign brokerage houses are currently present on the local market: three from Slovenia and one from Hungary. Between EUR 50,000 and 300,000 are required for the setting up of a brokerage house, depending on the range of planned activities (activities could range from just performing trading activities to portfolio management, providing investment advisory services, and underwriting of new issues). Approximately 170 brokerage houses were operating in Serbia in This number is expected to drop substantially once a new law comes into effect, as the most of them will not be able to meet the capital requirements. Parts of the former ZOP, the centralized institution previously in charge of payment operations will be transformed into rating agencies. Montenegro Tourism definitely has a development potential in Montenegro. So far, investors were reluctant to get involved. Most probably, unsolved political questions play a role. In the last few years, tourists started rediscovering Croatia, whereas Montenegro certainly was not yet a favoured destination for international tourism. During the next few years, this may change. What the country needs is gaining the confidence of tourists, tourist agencies and tourism investors. A crucial question will be whether prices in Montenegro will be somewhat lower compared to Croatia. 44) EBRD (2002). 45) Source: Serbian Investment and Export Promotion Agency (SIEPA) 46) The main official source of information is the Serbian Ministry of Economy and Privatisation: 50

51 Conclusions and recommendations 8. Conclusions and recommendations 8.1. Conclusions The Southeast Europe region has finally weathered the long-lasting decline or stagnation of economic activity. GDP is growing in all seven countries of the region, the SEEC-7 including Albania, Bosnia and Herzogovina (BiH Bosna i Hercegovina), Bulgaria, Croatia, FYR of Macedonia, Romania and last not least Serbia and Montenegro (SCG Srbija i Crna Gora). The growth rates even outperformed those of the five Central and East European countries Czech Republic, Hungary, Poland, Slovakia and Slovenia (CEEC-5), and of course also the EU-15 growth rates. In other words, a moderate catching-up has become evident, and it could prove to be sustainable over a longer period. In parallel with the resumption of economic growth, FDI inflows have become more substantial, and they will expand further. At least during the next few years the bulk of FDI inflows to the SEEC region will go to Bulgaria, Croatia and Romania. The expansion of the FDI flow into Albania, Bosnia and Herzegovina, FYR of Macedonia and Serbia and Montenegro will not become voluminous all of a sudden, no matter what the efforts of the government will be. FDI into Bulgaria and Romania may expand faster, as it has become most likely that both countries will join the EU in Also Croatia has the potential to attract substantial FDI inflows during the next few years. EU accession briefly after 2007 is likely, and in many respects the country has reached a level comparable to the CEEC-5. The search for strategic investors in large companies is still going on all over the region. In segments where companies have been already privatised, as is the case for most medium-sized enterprises, transactions involving a change in ownership are nevertheless still on the agenda. A number of SEEC industries have good chances to become targets of FDI inflows. Some of them have absorbed some FDI already during the last few years, but will stay on the agenda of potential investors. These industries are telecommunication, banking, tourism, wholesale trade, department stores and petrol stations in the tertiary sector. In manufacturing, foreign investment has focused on the production or processing of metals, chemicals, cement, wood, textiles and leather, tobacco, beer and non-alcoholic beverages and food. Some investment targeted mining and quarrying. It still is an open question whether the SEE region will follow the example of the CEEC-5, where export activities have, within a few years time, specialized on machinery and transport equipment; industrial specialisation of SEEC manufacturing could take the same path. If yes, the question is which countries will take the lead. SEEC food processing is sometimes mentioned as a potential future FDI target. At least in some territories the preconditions for agriculture are good, and there is a knowhow available in the field of food processing. Food processing will have to face competition, however, from subsidized exports of other parts of the world. For the time being, the West Balkan region consumes more food than it produces. Tourism will be an important future FDI target. The countries on the Adriatic coast are a principal tourist destination in this respect. Croatia is leading the rally for FDI in tourism for several reasons, as for example the prospect of a complementary development of small and medium-sized domestic enterprises and big foreign-owned companies. For Bulgaria Black Sea tourism has become an important source of export revenue. FYR of Macedonia is also eager to develop tourism, but a precondition for major success would be an exceptionally well-prepared marketing strategy combined with a comprehensive internal development strategy. Bosnia is trying to attract investors for winter tourism. The construction industry should also have a future. So far, the infrastructure is underdeveloped. Motorways are rare and roads have lacked maintenance in the last two decades or so. Railways would need a comprehensive overhaul, especially new roadbed and track. Otherwise trains will be too slow to be competitive, and only the few main lines will survive in the longer run. The Danube has to regain its former role as an important means of transportation in the next few years. The overall investment requirements in infrastructure are huge. They need to be financed primarily from foreign sources. Investors in this area should have experience with projects financed by the EU and international financial institutions. 51

52 Conclusions and recommendations The SEEC governments are preparing the sale of public utility companies to foreign investors. To do so, in many cases they splitted existing companies. For example, in the case of electricity the restructuring separated production, transmission and distribution. An additional geographical split occured on each of these levels. The countries in the region have signed cooperation agreements, so parts of the industry will stimulate foreign companies interest. Possibly simultaneous tenders from several countries will compete. To what degree investors will make use of the FDI potential in the next few years, depends on several factors. One factor will be the political situation. Compared to ten years ago, the political arena has changed completely in the Balkans or more precisely in the West Balkan countries. Both the functioning of the states as democracies and the low crime rate have become a reality in spite of a low average standard of living and even mass poverty in countries like Albania, Bosnia and Herzegovina, FYR of Macedonia and Serbia and Montenegro. Barriers for all kinds of contacts between the West Balkan countries are much lower now and may well disappear within a few years. In the West Balkans, several political questions are still pending. The EU and the international community as a whole are urging Croatia to facilitate as much as possible the return of citizens of Serb origin. Another aspect in this context for other countries of the region as well will be cooperation with the International Criminal Tribunal for the former Yugoslavia (ICTY). It is not yet clear whether Serbia and Montenegro will survive as a union or commonwealth of two loosely linked republics. In Bosnia and Herzegovina, the political structures have become inadequate. The parallelism of too many legislative and administrative bodies and the unclear allocation of competencies to different levels are causing both confusion and last not least also high costs. Yet, the political situation is not mature for negotiating a new more adequate constitution. From the point of view of international law, the Kosovo is still part of Serbia. De facto, it is under the administration of the United Nations Interim Administration Mission in Kosovo (UNMIK). Whatever the solution will be, it has an impact on the whole neighbourhood: on the relation between Slavic and Albanian Macedonians, on Bosnia s political stability, on the position of Albania within its neighbourhood, on the relations between the majority and minorities in Serbia and Montenegro and last not least on the relations between Albanian and Serb Kosovars. With some luck, in ten years time, in the West Balkans the frequency of cross border contacts will be almost as intensive as it is at present between Switzerland and France or between Austria, Slovenia and Italy all of them countries where the political border is not determined by the ethnic affiliation of the citizens. EU accession prospects will be a powerful FDI stimulating factor. For all Southeast European countries, accession to the EU will remain at the top of their political agenda for the next few years. Currently on the Balkans the EU is committed to the enlargement process for Bulgaria and Romania and to the Stabilization and Association Process (SAP) for the so-called Western Balkan countries 47. The latter is aimed at leading to a Stabilization and Association Agreement (SAA). The EU proposed a Stabilisation and Association Process (SAP) for Albania, Bosnia and Herzegovina, Croatia, FYR of Macedonia and Yugoslavia (now Serbia and Montenegro) in In June 2000, the Feira European Council stated that all the SAP countries were potential candidates for EU membership. Drafting a time-table for the accession of all countries would stimulate reforms in the SEECs and also the inflow of FDI. Macroeconomic performance is definitely a factor of significance for potential foreign investors. GDP growth, rate of inflation, unemployment, current account and budget deficit are closely monitored variables. Too big imbalances can produce a negative shock. On the other hand, it is empirically not justified to assume that macroeconomic stability is the necessary and at the same time also sufficient condition for economic growth and high FDI inflows. The wage level is an important aspect for investors interested in labour-intensive production. SEEC wages are very low by west European standards. They are even much lower compared to the CEEC-5, if we disregard Croatia for a moment. If we compare CEECs and SEECs, the gap in labour productivity is even larger than the gap in the wage level measured in euro. Thus on average unit labour costs are not that low. This average, however, is of little relevance for a foreign investor who imposes a new management, updates technical equipment, economises with respect to labour and has well-developped sales links at his disposal. 47) Albania, Bosnia and Herzegovina, Croatia, FYR of Macedonia, and Serbia and Montenegro. 52

53 Conclusions and recommendations Possibly, the most significant influence on many investment decisions is whether a location provides access to a large market. The Balkan region cannot offer such assurance. Small countries such as the SEEC-7 can attract larger FDI inflows only if qualifying, in the eyes of some transnational manufacturers, as an ideal export platform. Otherwise, the FDI inflow will be generated only by companies focusing on domestic markets. Clear examples for the latter case are Albania, Bosnia and Herzegovina, FYR of Macedonia and Serbia and Montenegro where FDI concentrates not exclusively, but predominantely on sectors such as telecommunication, finance, energy distribution, shopping centers, beverages, tobacco or cement. It may well be that there is no way to kick-start massive FDI inflow on the Western Balkans. The situation is different for Bulgaria and Romania, their presence on EU markets is stronger. For the West Balkan countries it is important that the EU has opened its doors to imports from the southeast region. Also the free trade agreement that has been signed between the SEECs will help to create attractive regional markets. Only a country with sound domestically owned enterprises is attractive for a larger number of foreign investors. Depending on the character of their core activity, some types of transnational enterprises are interested in a cooperation with strong local partners on the upstream or downstream side of the product line. Also, sufficient availability of skilled labour can be important for them. It may be a mistake to see FDI as a substitute for sound domestic enterprises. It should make sense to run programmes that offer companies advice and support in different areas. Companies may need advice with regard to selling abroad, taking part in international trade fairs; or, they may need better access to credits. FDI in financial services targeted mainly capital cities. Other investment was geographically more diversified. FDI was not concentrated on only a few places. This will be the case also in the future. Within the two Black Sea countries, part of the FDI will go to the coast; another part will rather head more to the west where in Bulgaria is Sofia, in Romania Transylvania, a relatively developed area. In Croatia too, coastal locations will compete with Zagreb in terms of attracting FDI. The SEEC capital cities have not become copies of a big third world metropolis Recommendations Recommendations to SEECs Economic policy should take stabilisation and macroeconomic equilibrium serious, but not assume that a stabilized and equilibrated economy will start growing quasi automatically. The development of domestic companies deserves more attention. FDI cannot make domestic enterprises dispensable. Sound domestic enterprises contribute to a favourable overall investment climate; for foreign investors, they are interesting both as potential business partners and investment targets. In countries like the SEECs, where foreign investors are looking primarily for acquisitions in the context of privatisation, it is possible to exaggerate concessions being offered to foreign investors. For that kind of investors they are not that decisive, but can in a sense be unfair to the rest of the economy and a loss for the government budgets. More sense far-reaching concessions could make in the case of green-field investment Recommendations to potential investors It is worth to be aware of the human capital available in the countries. Prior to taking an investment decision the experience of other companies should be studied carefully. In the countries that are most active in investing in southeast Europe, a lot of experience has been accumulated, and some segments of the service sector have developed an expert knowledge about the techniques that investors should employ. Lawyers in EU countries have acquired such knowledge and even opened affiliates in SEECs, banks in EU countries have also collected experience, and some of them have affiliates in SEECs. Something similar is true for the insurance sector. Some of the risks connected with FDI in SEEC can be reduced through insurance facilities. It is worth contacting SEEC information and support agencies. The quality of their services differs considerably amongst the countries, and the degree of openness and transparency also differs a lot. In some of the SEECs, these services are highly professional. A profound knowledge about the specifics of the SEECs offers the investor a head start, which implies good chances for success where others might fail. 53

54 Referen ces 9. References Bićanić Ivo and Franićević, Global Development Network understanding reforms: The case of Croatia, paper presented at the Global Development Network workshop in Vienna, 22 November Bojicic-Dželilovic Vesna, Cauševic Fikret, Tomaš Rajko, Global development network understanding reforms: Bosnia and Herzegovina , draft version presented at the Global Development Network workshop in Vienna, 22 November 2003 Bulgaria Economic Forum, Investment guide for Southeast Europe 2004 Dimitrov Dimitar, Dochev Nasko, Dobrinsky Rumen, Kolarova Rumyana, Markov Nikolai and Nikolo Boyko: Understanding Reform A country study for Bulgaria, draft version presented at the Global Development Network workshop in Vienna, 22 November EBRD Transition Report 2002 EBRD Transition Report 2003 EU Regular Report on Bulgaria s progress towards accession, 2003 EU Regular Report on Romania s progress towards accession, 2003 Gligorov Vladimir, Holzner Mario and Landesmann Michael, Prospects for Further (South-)Eastern EU Enlargement: from Divergence to Convergence? wiiw Research Report No 296, June GTZ, Promoting Cluster Approaches for EU Association and Accession Countries: Bulgaria. IMF, Bosnia and Herzegovina Country Report No. 03/204, July 2003, Kosovo Final Status Options and Cross-Border Requirements, US Institute for Peace, Special Report 91, July Landesmann Michael, Structural Change in the Transition Economies, ,UN-ECE, Economic Survey of Europe, 2000, No. 2/3 Lobjakas Ahto, EU: Progress Report Puts Bulgaria Ahead Of Romania, But Says Both Will Join Together, Radio Free Europe, 5 November 2003 OECD, Progress in Policy Reform in SEE Europe Monitoring Instruments, Investment Compact for SEE, Paris, OECD, Tax Policy Assessment and Design in Support of Direct Investment: A Study of Countries in South East Europe, prepared by the OECD Tax Centre for Tax Policy and Administration and the Investment Compact Team, Paris, 2003 Petkovski Mihail and Bishev Gligor, Understanding reforms in Macedonia, draft version, presented at the Global Development Network workshop in Vienna, 22 November Petrovic Pavle, Serbia: Understanding reform, draft version presented at the Global Development Network workshop in Vienna, 22 November Schneider Friedrich, The value added of underground activities: Size and measurement of Shadow economies of 110 countries all over the world, Paper for the workshop of the Australian National Tax Centre ANU, Canberra, June 2002 US Institute of Peace, Putting Peace into Practice: Can Macedonia s New Government Meet the Challenge?, Special Report 91, July Vukotic Veselin, Elements for understanding reforms in Macedonia, draft version presented at the Global Development Network workshop in Vienna, 22 November Wahlberg Debra, Kastrati Bekim, Ford Kent, Investment in the future A trade and investment guide to Kosovo, 2nd edition, Kosovo Business Support (funded by the USAID), May wiiw Handbook of Statistics 2002 wiiw Handbook of Statistics 2003 Internet Sources Albanian Economy Development Agency AEDA Bulgaria Foreign Investment Agency BFIA Croatia Ministry of Economy Foreign Investment Promotion Agency of Bosnia and Herzegovina FIPA Macedonia Investment Promotion Department Radio Free Europe Romanian Agency for Foreign Investments Serbian Investment and Export Promotion Agency (SIEPA) Serbian Ministry of Economy and Privatisation The European Union on-line 54

55 Appendix 10. Appendix Table A1: Albania, Selected Economic Indicators Table A2: Bosnia and Herzegovina, Selected Economic Indicators Table A3: Bulgaria, Selected Economic Indicators Table A4: Croatia, Selected Economic Indicators Table A5: FYR Macedonia, Selected Economic Indicators Table A6: Romania, Selected Economic Indicators Table A7: Serbia and Montenegro, Selected Economic Indicators Table A8: Inward FDI stock, EUR million, end of year Table A9: Inward FDI stock per capita, EUR Table A10: FDI inflow per capita, EUR Table A11: Inward FDI stock in SEECs by investing country, Table A12: Bulgaria, Selected indicators for manufacturing sectors Table A13: Croatia, Selected indicators for manufacturing sectors Table A14: Romania, Selected indicators for manufacturing sectors Table A15: Bulgaria, Selected indicators for manufacturing sectors in trade with the EU (15) Table A16: Croatia, Selected indicators for manufacturing sectors in trade with the EU (15) Table A17: Romania, Selected indicators for manufacturing sectors in trade with the EU (15) Table A18: Free trade agreements in SEEC as of 13 November

56 Appendix Table A1: Albania, Selected Economic Indicators forecast Population (th pers.) 1 3,283 3,324 3,354 3,373 3,401 3,069 3,100 3,131 3,162 Gross domestic product (ALL mn) 315, , , , , , , , ,499 annual change in % (real) GDP/capita (EUR at exchange rate) ,221 1,546 1,653 1,730 1,850 GDP/capita (EUR at PPP, wiiw estimates) 2,660 2,460 2,650 2,900 3,200 3,360 3,700 Gross industrial production annual change in % (real) Gross agricultural production annual change in % (real) Employment total (th pers., average) 1,116 1,107 10,85 1,065 1,068 1,063 annual change in % Reg. unemployed (th pers., end of period) Unemployment rate (in %, end of period) Monthly wages in public sector (ALL) 8,638 9,559 11,509 12,708 14,963 17,218 annual change in % (real) Retail prices (% p.a.) General government budget Deficit ( ) / surplus (+) (% GDP) Money supply (ALL bn, end of period) M1, Money Broad money Refinancing rate (% p.a., end of period) month treasury bill rate (% p.a., eop) Exports total (fob, EUR mn) Imports total (cif, EUR mn) ,047 1,164 1,484 1,569 1,505 1,596 Current account (EUR mn) Current account (in % of GDP) Currency reserves (EUR mn) Gross external debt (EUR mn) ,036 1,269 1,336 1,250 Average exchange rate ALL/USD Average exchange rate ALL/EUR (ECU) ) Until 2000: population estimates; 2001: census data; thereafter: projection. 2) IMF estimates based mostly on demand side developments. 3) Excluding official transfers. Source: IMF, INSTAT, Bank of Albania, EBRD; wiiw forecasts. 56

57 Appendix Table A2: Bosnia and Herzegovina, Selected Economic Indicators forecast Population (th pers.) 3,646 3,651 3,700 3,750 3,800 3,800 3,800 Gross domestic product (BAM mn) 4,125 6,116 7,559 8,603 9,611 10,480 10,879 11,342 11,932 Federation BiH 3,049 4,748 5,602 6,141 6,723 7,274 7,596 7,959 Republika Srpska 1,076 1,368 1,957 2,462 2,734 2,993 3,061 3,151 GDP annual change in % (real) GDP/capita (EUR at exchange rate) 857 1,045 1,173 1,293 1,410 1,464 Gross industrial production annual change in % (real) Employees (th pers., average) annual change in % Reg. unemployed (th pers, average) Unemployment rate (in %, average) Average net monthly wages (BAM) Federation BiH Republika Srpska Consumer prices (% p.a.) General government budget Deficit ( ) / surplus (+) (% GDP) Money supply (BAM mn, end of period) M1, Money ,100 1,402 2,692 3,008 2,929 M2, Broad money 1,178 1,547 2,165 2,467 4,669 5,071 5,199 Exports of goods & services (EUR mn) 1,238 1,317 1,509 1,554 1,573 Imports of goods & services (EUR mn) 2,699 2,652 3,040 3,299 3,550 Current account (EUR mn) Current account (in % of GDP) Currency reserves (EUR mn) ,404 1,221 1,192 Gross external debt (EUR mn) 3,606 2,688 2,903 3,175 2,856 2,625 Average exchange rate BAM/USD Average exchange rate BAM/EUR (ECU) ) BiH average (entities weighted with the share of entity employees in total BiH employees). Source: IMF, CBBH, wiiw forecasts. 57

58 Appendix Table A3: Bulgaria, Selected Economic Indicators forecast Population (th pers.) 8,341 8,283 8,230 8,191 8,150 7,891 7,846 Gross domestic product (BGN mn) 1,761 17,433 22,421 23,790 26,753 29,709 32,324 34,600 37,500 annual change in % (real) GDP/capita (EUR at exchange rate) 956 1,106 1,377 1,481 1,674 1,920 2,125 GDP/capita (EUR at PPP, wiiw estimates) 4,630 5,400 5,760 6,010 6,460 7,100 7,670 Gross industrial production annual change in % (real) Gross agricultural production annual change in % (real) Gross fixed capital formation annual change in % (real) Employment total (th pers., average) 3,286 3,157 3,153 3,088 2,980 2,968 2,992 annual change in % Reg. unemployed (th pers, end of period) Unemployment rate (in %, end of period) Average gross monthly wages (BGN) annual change in % (real, gross) Consumer prices (% p.a.) Producer prices in industry (% p.a.) Central government budget Deficit ( ) / surplus (+) (% of GDP) Money supply (BGN mn, end of period) 1 M1, Money 241 2,434 2,961 3,302 3,976 4,884 5,543 Broad money 1,329 6,163 6,814 7,662 10,061 12,600 14,147 Base rate of NB (% p.a., end of period) Exports total (fob, EUR mn) 2 3,901 4,368 3,841 3,734 5,253 5,714 6,063 6,800 7,200 Imports total (cif, EUR mn) 2 4,048 4,361 4,476 5,140 7,085 8,128 8,411 9,400 9,800 Current account (EUR mn) ,300 1,000 Current account (in % of GDP) Currency reserves (EUR mn) 386 1,867 2,396 2,717 3,426 3,676 4,680 Gross external debt (EUR mn) 7,660 9,204 9,722 10,255 12,164 11,862 11,851 Average exchange rate BGN/USD Average exchange rate BGN/EUR (ECU) ) According to International Accounting Standards. 2) From 1999 new methodology. Converted from the national currency to EUR at the official exchange rate. Source: wiiw Database incorporating national statistics; wiiw forecasts. 58

59 Appendix Table A4: Croatia, Selected Economic Indicators forecast Population (th pers.) 1 4,494 4,573 4,501 4,554 4,437 4,437 4,443 Gross domestic product (HRK mn) 107, , , , , , , , ,600 annual change in % (real) GDP/capita (EUR at exchange rate) 3,531 3,891 4,284 4,102 4,502 4,916 5,377 GDP/capita (EUR at PPP, wiiw estimates) 5,830 7,130 7,570 7,510 8,050 8,560 9,240 Gross industrial production 2 annual change in % (real) Gross agricultural production annual change in % (real) Gross fixed capital formation annual change in % (real) Employment total (th pers., average) 3 1,330 1,311 1,385 1,365 1,341 1,348 1,359 annual change in % Reg. unemployed (th pers, end of period) Unemployment rate (in %, end of period) Average gross monthly wages (HRK) 3,243 3,668 4,131 4,551 4,869 5,061 5,366 annual change in % (real, net) Retail prices (% p.a.) Producer prices in industry (% p.a.) Central government budget 4 Deficit ( ) / surplus (+) (% GDP) Money supply (HRK mn, end of period) M1, Money 11,369 13,731 13,531 13,859 18,030 23, ,70 Broad money 36,701 50,742 57,340 56,659 73, , ,142 Discount rate (% p.a., end of period) Exports total (fob, EUR mn) 5 3,602 3,666 4,046 4,027 4,818 5,210 5,183 5,400 5,600 Imports total (cif, EUR mn) 5 6,220 8,060 7,477 7,324 8,588 10,232 11,316 12,400 12,500 Current account (EUR mn) 1,197 2,840 1,630 1, ,512 2,256 1,785 Current account (in % of GDP) 4,8 12,5 6,7 7,0 2,5 3,7 7,2 7,3 5,3 Currency reserves (EUR mn) 2,898 2,870 3,158 3,224 3,251 4,213 5,544 Gross external debt (EUR mn) 6,647 8,423 10,862 10,633 10,198 10,136 14,396 Average exchange rate HRK/USD Average exchange rate HRK/EUR (ECU) ) From 2000 according to census March ) Enterprises with more than 20 employees. 3) Including persons employed at the Ministry of Defence and Ministry of Internal Affairs. 4) Methodological changes in June 2001 and January 2002 with respect to the stepwise inclusion of extrabudgetary funds. 5) From 2000 new method of statistical processing. Converted from the national currency to EUR at the official exchange rate. Source: wiiw Database incorporating national statistics; wiiw forecasts. 59

60 Appendix Table A5: FYR Macedonia, Selected Economic Indicators forecast Population (th pers.) 1,983 1,997 2,008 2,017 2,026 2,035 2,044 Gross domestic product (MKD mn) 176, , , , , , , , ,000 annual change in % (real) GDP/capita (EUR at exchange rate) 1,777 1,658 1,590 1,709 1,921 1,887 1,917 GDP/capita (EUR at PPP, wiiw estimates) 3,850 5,170 5,410 5,700 6,020 5,850 5,990 Gross industrial production annual change in % (real) Gross agricultural production annual change in % (real) Gross fixed capital formation annual change in % (real) Employment total (th pers., average) annual change in % Reg. unemployed (th pers, end of period) Unemployment rate (in %, end of period) Average net monthly wages (MKD) 8,817 90,63 9,394 9,664 10,193 10,552 11,279 annual change in % (real, net) Retail prices (% p.a.) Producer prices in industry (% p.a.) Central government budget Deficit ( ) / surplus (+) (% GDP) Money supply (MKD mn, end of period) M1, Money 12,143 13,983 15,178 19,694 22,388 25,324 26,406 M2, Money + quasi money 18,490 22,724 26,003 33,720 41,957 69,785 64,222 Discount rate (% p.a., end of period) Exports total (fob, EUR mn) ,091 1,170 1,117 1,431 1,292 1,178 1,250 1,250 Imports total (cif, EUR mn) 3 1,283 1,568 1,709 1,665 2,266 1,891 2,077 2,180 2,290 Current account (EUR mn) Current account (in % of GDP) Currency reserves (EUR mn) Gross external debt (EUR mn) ,003 1,247 1,350 1,560 1,613 1,644 Average exchange rate MKD/USD Average exchange rate MKD/EUR (ECU) ) Excluding small enterprises; from 2001 according to NACE. 2) Based of Labour Force Survey data. 3) Converted from USD to EUR using the ECB EUR/USD foreign exchange reference rate. 4) Including grants. 5) Medium- and long-term. Source: wiiw Database incorporating national statistics; wiiw forecasts. 60

61 Appendix Table A6: Romania, Selected Economic Indicators forecast Population (th pers.) 22,608 22,546 22,503 22,458 22,435 22,408 21,698 Gross domestic product (ROL bn) 108, , , , , , , , mn annual change in % (real) GDP/capita (EUR at exchange rate) 1,247 1,387 1,651 1,491 1,789 2,001 2,230 GDP/capita (EUR at PPP, wiiw estimates) 6,110 5,150 5,000 5,050 5,240 5,680 6,310 Gross industrial production annual change in % (real) Gross agricultural production annual change in % (real) Gross fixed capital formation annual change in % (real) Employment total (th pers., end of period) 9,379 9,023 8,813 8,420 8,629 8,563 annual change in % Reg. unemployed (th pers, end of period) ,025 1,130 1, Unemployment rate (in %, end of period) Average gross monthly wages (ROL) 426, , , , , , ,097 annual change in % (real, net) Consumer prices (% p.a.) Producer prices in industry (% p.a.) Central government budget Deficit ( ) / surplus (+) (% GDP) Money supply (ROL bn, end of period) M1, Money 11,173 18,731 22,110 29,669 46,331 64,309 88,305 M2, money + quasi money 30,335 62,150 92, , , , ,713 Discount rate (% p.a., end of period) Exports total (fob, EUR mn) 3 6,376 7,434 7,412 7,956 11,219 12,711 14,685 15,900 16,800 Imports total (cif, EUR mn) 3 9,019 9,946 10,569 9,896 14,128 17,363 18,903 20,800 22,200 Current account (EUR mn) 2,052 1,864 2,592 1,352 1,473 2,482 1,613 2,500 2,500 Current account (in % of GDP) Gross reserves (EUR mn) 439 1,943 1,222 1,436 2,685 4,380 6,479 Gross external debt (EUR mn) 4 5,753 7,605 8,283 8,253 11,168 13,315 16,106 Average exchange rate ROL/USD 3, , , , , , , ,700.0 Average exchange rate ROL/EUR (ECU) 3, , , , , , , , ) From 2000 excluding various social security contributions of employees. 2) Reference rate of NB from February ) Converted from USD to EUR using the ECB EUR/USD foreign exchange reference rate. 4) Medium- and long-term. Source: wiiw Database incorporating national statistics; wiiw forecasts. 61

62 Appendix Table A7: Serbia and Montenegro, Selected Economic Indicators forecast Population (th pers.) 10,577 10,600 10,617 8,373 8,343 8,326 8,305 Gross domestic product (EUR mn) 1 12,995 14,478 13,827 9,458 9,383 12,889 16,601 19,500 20,900 annual change in % (real) GDP/capita (EUR at exchange rate) 1 1,229 1,366 1,303 1,130 1,124 1,459 1,999 Gross industrial production 3 annual change in % (real) Gross agricultural production annual change in % (real) Gross fixed investment annual change in % (real) Employment total (th pers., average) 4 2,367 2,332 2,504 2,298 2,238 2,243 2,201 annual change in % Reg. unemployed (th pers, end of period) Unemploym. rate (in %, end of period) Average net monthly wages, (CSD) ,063 1,309 2,588 5,545 9,113 annual change in % (real, net) Consumer prices (% p.a.) Producer prices in industry (% p.a.) General government budget Deficit ( ) / surplus (+) (% GDP) Money supply (CSD mn, end of period) M1, Money 5,495 9,148 10,807 16,332 26,954 52,686 88,839 Broad money 7 31,435 38,948 62,352 75,394 65, , ,966 Discount rate (% p.a., end of period) Exports total, fob (EUR mn) 8 1,593 2,360 2,518 1,391 1,808 2,097 2,399 2,500 2,600 Imports total, cif (EUR mn) 8 3,251 4,245 4,283 3,081 3,892 5,391 6,647 6,600 6,600 Current account (EUR mn) ,039 1,620 1,054 1, ,828 1,770 1,700 Current account (in % of GDP) Currency reserves (EUR mn) ,315 2,408 Gross external debt (EUR mn) ,098 9,259 10,269 11,728 12,453 13,202 12,501 Average exchange rate CSD/EUR* ,40 Average exchange rate CSD/EUR (ECU)* *) CSD: New international currency-code for Dinar. From 1999 excluding Kosovo and Metohia. 1) Estimates based on World Bank method. From 1999 based on market exchange rate. 2) Based on gross material product in dinar. 3) Excluding private enterprises. 4) Employees plus own account workers, excluding individual farmers. 5) In % of unemployed plus employment. 6) From 2001 including various allowances for Serbia. 7) From 2000: at official exchange rate, excluding Montenegro, government deposits, household frozen foreign currency saving deposits. 8) Converted from the national currency to EUR at the official exchange rate. 9) From 2000 including official grants, 2003 Serbia only. 10) Converted from USD. 11) In 2003 including a part of Montenegrin foreign debt. Source: wiiw Database incorporating national statistics; wiiw forecasts. 62

63 Appendix Table A8: Inward FDI stock, EUR million, end of year Albania Bosnia and Herzegovina Bulgaria ,363 2,392 2,426 3,129 3,100 Croatia ,309 1,622 2,568 3,821 5,336 6,443 FYR Macedonia Romania ,128 3,783 5,447 6,966 8,656 8,455 Serbia and Montenegro ,099 1,600 SEEC ,385 2,221 5,235 8,074 12,053 15,417 20,376 22,281 Czech Republic 3,054 3,732 5,741 6,910 8,367 12,255 17,479 23,323 30,717 36,675 Hungary 5,002 5,785 10,108 12,216 14,807 16,125 19,439 21,659 26,503 29,526 Poland 2,058 3,105 6,122 9,229 13, ,47 25,946 36,792 46,686 45,739 Slovakia 737 1,013 1,660 1,888 2,464 3,174 5,112 6,327 8,185 Slovenia 851 1,081 1,376 1,612 2,000 2,369 2,675 3,110 2,952 3,918 CEEC ,965 14,440 24,359 31,626 40,268 52,460 68,712 89, , ,043 1) Sum of available data. Source: National bank of respective countries according to international investment position (IIP). Cumulated USD inflows for Albania, Bosnia and Herzegovina, Bulgaria till 1997, Croatia till 1997, FYR Macedonia, Serbia and Montenegro. Table A9: Inward FDI stock per capita, EUR Albania Bosnia and Herzegovina Bulgaria Croatia ,203 1,450 FYR Macedonia Romania Serbia and Montenegro SEEC Czech Republic ,191 1,701 2,272 3,010 3,594 Hungary ,186 1,440 1,573 1,902 2,123 2,605 2,911 Poland ,208 1,197 Slovakia ,176 1,522 Slovenia ,007 1,198 1,346 1,563 1,481 1,964 CEEC ,033 1,353 1,705 1,881 1) Estimate over available data. Source: Own calculation and wiiw Annual Database. 63

64 Appendix Table A10: FDI inflow per capita, EUR Albania Bosnia and Herzegovina Bulgaria Croatia FYR Macedonia Romania Serbia and Montenegro SEEC Czech Republic Hungary Poland Slovakia Slovenia CEEC ) Estimate over available data. Source: Own calculation and wiiw Annual Database. Table A11: Inward FDI stock in SEECs by investing country, 2002 Albania 1 BiH 2 Bulgaria 3 Croatia 4 FYR Macedonia 5 Romania EU Austria Germany Greece France Italy Netherlands Other CEEC SEEC USA Japan Cyprus Russia Turkey Kuwait Other countries Total ) According to survey data of 449 enterprises. 2) FDI stock between ) FDI inward stock 1999 as of BNB increased by the cumulated annual USD inflow. 4) Cumulated USD inflows ) Cumulated USD inflows Source: National statistics. 64

65 Appendix Table A12: Bulgaria, Selected indicators for manufacturing sectors Production Employment Produc- Employ- Production ment tivity at current prices, annual average growth rate in % in EUR mn in % in persons in % D Manufacturing total 8, , DA Food products; beverages and tobacco 1, , DB Textiles and textile products , DC Leather and leather products , DD Wood and wood products , DE Pulp, paper & paper products; publishing & printing , DF Coke, refined petroleum products & nuclear fuel 1, , DG Chemicals, chemical products & man-made fibres , DH Rubber and plastic products , DI Other non-metallic mineral products , DJ Basic metals and fabricated metal products 1, , DK Machinery and equipment n.e.c , DL Electrical and optical equipment , DM Transport equipment , DN Manufacturing n.e.c , Source: wiiw Industrial Database based on national statistics. Table A13: Croatia, Selected indicators for manufacturing sectors Production Employment Produc- Employ- Production ment tivity at current prices, annual average growth rate in % in EUR mn in % in persons in % D Manufacturing total 10, , DA Food products; beverages and tobacco 2, , DB Textiles and textile products , DC Leather and leather products , DD Wood and wood products , DE Pulp, paper & paper products; publishing & printing , DF Coke, refined petroleum products & nuclear fuel 1, , DG Chemicals, chemical products & man-made fibres 1, , DH Rubber and plastic products , DI Other non-metallic mineral products , DJ Basic metals and fabricated metal products , DK Machinery and equipment n.e.c , DL Electrical and optical equipment , DM Transport equipment , DN Manufacturing n.e.c , Source: wiiw Industrial Database based on national statistics. 65

66 Appendix Table A14: Romania, Selected indicators for manufacturing sectors Production Employment Produc- Employ- Production ment tivity at current prices, annual average growth rate in % in EUR mn in % in persons in % D Manufacturing total 31, , DA Food products; beverages and tobacco 6, , DB Textiles and textile products 2, , DC Leather and leather products , DD Wood and wood products , DE Pulp, paper & paper products; publishing & printing , DF Coke, refined petroleum products & nuclear fuel 4, , DG Chemicals, chemical products & man-made fibres 2, , DH Rubber and plastic products , DI Other non-metallic mineral products 1, , DJ Basic metals and fabricated metal products 6, , DK Machinery and equipment n.e.c. 1, , DL Electrical and optical equipment 1, , DM Transport equipment 1, , DN Manufacturing n.e.c. 1, , Source: wiiw Industrial Database based on national statistics. 66

67 Appendix Table A15: Bulgaria, Selected indicators for manufacturing sectors in trade with the EU (15) Exports Imports Trade balance Exports RCA 1 RCA-change Av. annual change in % in EUR in EUR in EUR /96 mn mn mn /02 D Manufacturing total 3, , DA Food products; beverages and tobacco DB Textiles and textile products 1, DC Leather and leather products DD Wood and wood products DE Pulp, paper & paper products; publishing and printing DF Coke, refined petroleum products & nuclear fuel DG Chemicals, chemical products & man-made fibres DH Rubber and plastic products DI Other non-metallic mineral products DJ Basic metals and fabricated metal products DK Machinery and equipment n.e.c DL Electrical and optical equipment DM Transport equipment DN Manufacturing n.e.c ) A positive value of the Revealed Comparative Advantage indicator (RCAi = ln (xi / mi) / (xtot / mtot) *100) points to the industry's above-average export-import ratio Source: Eurostat COMEXT Database Table A16: Croatia, Selected indicators for manufacturing sectors in trade with the EU (15) Exports Imports Trade balance Exports RCA 1 RCA-change Av. annual change in % in EUR in EUR in EUR /96 mn mn mn /02 D Manufacturing total 2, , , DA Food products; beverages and tobacco DB Textiles and textile products DC Leather and leather products DD Wood and wood products DE Pulp, paper & paper products; publishing and printing DF Coke, refined petroleum products & nuclear fuel DG Chemicals, chemical products & man-made fibres DH Rubber and plastic products DI Other non-metallic mineral products DJ Basic metals and fabricated metal products DK Machinery and equipment n.e.c DL Electrical and optical equipment DM Transport equipment , DN Manufacturing n.e.c ) RCAi = ln (xi / mi) / (xtot / mtot) *100 Source: Eurostat COMEXT Database 67

68 Appendix Table A17: Romania, Selected indicators for manufacturing sectors in trade with the EU (15) Exports Imports Trade balance Exports RCA 1 RCA-change Av. annual change in % in EUR in EUR in EUR /96 mn mn mn /02 D Manufacturing total 10, , DA Food products; beverages and tobacco DB Textiles and textile products 3, , , DC Leather and leather products 1, DD Wood and wood products DE Pulp, paper & paper products; publishing and printing DF Coke, refined petroleum products & nuclear fuel DG Chemicals, chemical products & man-made fibres , DH Rubber and plastic products DI Other non-metallic mineral products DJ Basic metals and fabricated metal products DK Machinery and equipment n.e.c , DL Electrical and optical equipment , DM Transport equipment , DN Manufacturing n.e.c ) RCAi = ln (xi / mi) / (xtot / mtot) *100 Source: Eurostat COMEXT Database 68

69 Appendix Table A18: Free trade agreements in SEEC as of 13 November 2003 Albania Bosnia and Bulgaria Croatia FYR [Moldova]* Romania Serbia and Herzegovina Macedonia Montenegro 1 Albania Signed Applied Applied Applied Signed Signed Signed 28/04/03 01/09/03 01/06/03 15/07/02 13/11/03 21/02/03 13/11/03 Ratified Ratified by Albania by Albania 10/07/03 10/07/03 To be Applied 01/01/04 Bosnia and Signed Signed Applied Applied Signed Signed Applied Herzegovina 28/04/03 16/10/03 01/01/01 01/07/02 23/12/02 08/04/03 01/06/02 Ratified Applied Applied by by Albania 01/01/04 01/01/04 10/07/03 Bulgaria Applied Signed CEFTA Applied Preliminary CEFTA Signed 01/09/03 16/10/03 01/03/03 01/01/00 Consultations 13/11/03 Croatia Applied Applied CEFTA Applied Under CEFTA Signed 01/06/03 01/01/01 01/03/03 11/06/97 Negotiation 01/03/03 23/12/02 Revised Ratified 11/06/02 by Croatia Applied by 07/05/03 11/07/02 FYR Applied Applied Applied Applied Under Signed Applied Macedonia 15/07/02 01/07/02 01/01/00 11/06/97 Negotiation 07/02/03 7/10/96 Revised 11/06/02 Applied by Applied by 01/01/04 11/07/02 [Moldova] Signed Signed Preliminary Under Under Applied Signed 13/11/03 23/12/02 Consultations Negotiation Negotiation 17/11/94 13/11/03 Applied by 01/01/04 Romania Signed Signed CEFTA CEFTA Signed Applied Initialled 21/02/03 08/04/03 01/03/03 07/02/03 17/11/94 13/12/02 Ratified Applied by Applied by by Albania 01/01/04 01/01/04 10/07/03 To be Applied 01/01/04 Serbia and Signed Applied Signed Signed Applied Signed Initialled Montenegro 1 13/11/03 01/06/02 13/11/03 23/12/02 7/10/96 13/11/03 13/12/02 Ratified by Croatia 07/05/03 Source: Stability pact for South Eastern Europe 69

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71 Network Bank Austria Creditanstalt Network in South-East Europe Serbia and Montenegro e 103 m 4 branches Romania e 548 m 7 branches Total assets as per 30 Nov ) incl. Central Profit Banka Croatia e 2,200 m 78 branches Headquarters Bosnia and Herzegovina e 221 m 31 branches 1 Macedonia representative office as of March 2003 Bulgaria e 543 m 155 branches Bosnia and Herzegovina HVB Bank Fra Andela Zvizdovica 1 Tower B BA Sarajevo tel.: ( ) fax: ( ) Bulgaria Commercial Bank Biochim 1, Ivan Vazov Ul. BG-1026 Sofia tel.: (+359 2) fax: (+359 2) Croatia Splitska Banka R. Boskovica 16 HR Split tel.: ( ) fax: ( ) Macedonia Bank Austria Creditanstalt Representative Office Ulica Makedonija br. 53/4 MK-1000 Skopje tel.: (+389 2) fax: (+389 2) office@ba-ca.com.mk Romania HVB Bank 37 Strada Dr. Grigore Mora RO Bucuresti 1 tel.: (+40 21) fax: (+40 21) Serbia and Montenegro HVB Bank Rajiceva YU Beograd tel.: ( ) fax: ( ) Bank Austria Creditanstalt is the leading international bank in Central and Eastern Europe. Within HVB Group, Bank Austria Creditanstalt is responsible for this region. The Group operates a network of 900 offices in 11 countries. 18,000 employees serve more than 3.8 million customers. The commitment of Bank Austria Creditanstalt was awarded by numerous international financial magazines: In May 2003, the bank was named Best Bank in Central and Eastern Europe by Global Finance. In September 2003, Bank Austria Creditanstalt received the titles Bank of the Year in CEE from the British magazine The Banker and Best Bank in Central and Eastern Europe from Euromoney.