Eastern Europe: Investing in Tough Times

Economic times are tough in Eastern Europe.  The rest of Europe no longer is a growth engine and the Euro crisis hangs over the future.  Russia remains important and Chinese companies are investing more, but not yet enough to drive growth.

However, there are important signs of hope.  For instance, in the first half of 2012, private equity firms raised more money in Central and Eastern Europe than they did all last year.  Indeed, the increase was the greatest since 2008.  Investors obviously expect future growth in the region.

New firms also are prospering.  In 2009, three members of the Carlyle Group left to start Resource Partners.  The new company has made several acquisitions in Poland and Latvia.  Last year the fund almost doubled its resources, so future investments will come.   Founding partner Aleksander Kacprzyk explained:  “In 2009, when everybody was telling us to forget about fundraising, we said, ‘This is the moment to do something.’”

Mark Mobius, who focuses on emerging markets, also sees opportunity.  He pointed to Eastern Europe:  “We are finding a lot of the opportunities there for long-term holdings.”

IT also is becoming bigger business.  Several governments in Central and Eastern Europe are establishing subsidized accelerator programs in Silicon Valley.  And much is happening locally.

For instance, Prague hosts a digital start-up/accelerator space called Node 5 and held two major conferences earlier this year.  Christoph Raethke of VentureVillage explained that he was told by Prague funders that “there was actually enough seed money available locally; quite a few wealthy individuals were pouring cash into the market.”

IT outsourcing in Ukraine has increased dramatically in recent years, up nearly tenfold in a decade, and now tops $1 billion in revenue.  The country produces some 16,000 new IT specialists every year, and the Yanukovych government recently agreed to legislation cancelling the VAT for IT firms and cutting income tax rates on sector employees.  The Financial Times declared that “Looking to the future, the sector has the potential to become a real force for Ukraine’s modernization.”

However, Ukraine is just playing catch-up.  Observed Vladimir Bek of Sigma Ukraine:  “Russia and Belarus already provide extensive preferences for their IT sectors, not only tax preferences, but also support for training development, and changes to customs and labor legislation.”

Even fashion design is expanding in Central and Eastern Europe.  Kamil Szlaga, an analyst for Warsaw-based KBC Securities, opined:  “clothing companies from [the region] have big growth potential.  The region still has room to catch up with Western Europe.  Surely, Russia is their key target.”

Moreover, official numbers understate economic progress in the region.  Economic crisis and government attempts to raise revenue have encouraged growth of the informal “shadow” economy.   No one knows how big it is for sure, but it likely grows as one moves east.  The EU average is thought to be about 19 percent.  Poland’s shadow economy may be 25 percent of GDP.  Bulgaria’s informal sector has been estimated as high as 32 percent of GDP.  Although the authorities work to bring these activities under their control, Charlotte Gueriaux observed in the New Eastern Europe journal:  “For some, during this global crisis, the world shadow markets are for the better, adding jobs and improving the lives of millions of people.”  The best way to move these activities into the light is to remove the structural impediments to entrepreneurship, business development, and job creation that characterize countries once stuck under Soviet rule.

Further economic hardship is inevitable, but there nevertheless are signs of hope throughout the region.  Governments need to adopt budget and regulatory policies designed to let their people most prosper as economic conditions improve.

Image Copyright Shutterstock.com/ Steve Heap