The Czech business environment in 2009 was dominated by dramatic restructuring and downsizing. Now, when the growth curve is taking off again, many managers need to reconsider the future and be ready for new investments. However, the country can?? endlessly rely on its strategic geography to attract investments; experts claim it also needs to put through painful reforms if it wants to stay on top.
- Why would they come?
- A heavy crown
- Wider purse for reinvestments, rather than FDI
- Banks won’t loosen purse, despite public declarations
- All eyes on the post-election landscape
Market observers can’t agree whether the Czech Republic is still holding the top position for attracting new foreign direct investments (FDI) in Central and Eastern Europe (CEE). While on one hand the country still has a key strategic position in CEE as Germany’s closest neighbor and the bridge between Western and Eastern Europe, some experts point at the time lost avoiding essential reforms that would have provided an attractive business environment, even in times of downturn.
“Slovakia looks far more promising. It is the 42nd easiest country to do business in, as opposed to the Czech Republic, which is the 74th. Compared to that, Georgia is the 11th,” said Colin MacGregor, a financial planner with advisory PIC Europe.
MacGregor’s opinion is shared by other private entrepreneurs as well. Jan Brazda, managing partner with the executive search firm Constellation and vice president of the American Chamber of Commerce (AmCham) in the Czech Republic, pointed at two reasons why the country is losing its attractiveness. “First, the recent political developments lead to a perception of instability and significant corruption in some parts of the society. Second, the country has no clear strategy and is sending very negative messages about how it wants to resolve its fiscal situation,” Brazda said.
On the other hand, investors still understand the talent here and the country’s valuable role as a bridge between the European Union and Eastern European markets, he added.
Other major investors’ complaints are more concrete, revolving around the lack of flexibility of the Czech labor market or the lack of qualifications of the technical staff. “The country has some competitive advantages and some disadvantages. These do not change abruptly from one year to another,” said Pavel Sobíšek, chief economist with UniCredit Bank in Prague.
Yet, some other experts argue that the country still hasn’t exploited its advantages to the maximum. “The Czech Republic still belongs among the most attractive countries for investments. However, we should be aware that the reasons why foreign investors come to this country are changing and they are different compared to those a few years ago,” said Jan Linhart, a partner in the department of tax advisory with global consultancy KPMG Česká republika.
Why would they come?
“Certainly, the Czech Republic and the CEE region as a whole should remain attractive for foreign investors on the mid-term horizon,” said Vojtěch Benda, a senior economist with ING Wholesale Banking. He noted that two or three years ahead, we will see the economic growth in the region outpacing the EU15 countries, accompanied with a relatively stable performance of the equity market. “On the other hand, the favorite markets for investors this year should certainly be Asia and [parts of] the Americas, namely China and Brazil,” he said.
However, Benda said he thinks the country will secure a top position thanks to its positioning among countries with one of the lowest public and private indebtedness, lowest interest rates and higher economic growth.
KPMG’s Linhart said that one of the major advantages of the Czech Republic is indeed its strategic position and very good infrastructure. “Even though, in comparison with Western Europe, the Czech Republic still has a relatively cheap labor force, costs with the labor force aren’t the most important reason why investors place their investment in the Czech Republic, as it was the case some five to 10 years ago,” he said. Now, the Czech entrepreneurial environment is very stable, in comparison with other CEE countries. “This doesn’t mean, however, that everything is all right. There is a range of sectors that must improve in the long term,” he said.
Michael Mullen, a partner with the Czech law firm Havel & Holásek, said that the Czech Republic still fares well in terms of attractiveness compared with its neighbors. “If you look at Poland, it has a miserable transport infrastructure. It’s sad, but I talked to my Polish colleagues and they say that roads are terrible there,” he said. Mullen noted that Poland is making improvements and there have been a lot of investments, especially in public works, thanks to the approaching 2012 UEFA European Football Championship, but “there are still strategic reasons to be in the Czech Republic.”
Second after Germany in terms of FDI flows into the Czech Republic, U.S. firms are carefully observing the development of the Czech business environment. “American businesses are drawn to the Czech Republic because of its technically skilled and relatively low-cost workers, proximity to Western European markets, and solid infrastructure,” said Greg O’Connor, senior commercial officer with the U.S. Embassy in Prague. In addition to investment in new manufacturing facilities, a growing number of U.S. companies are establishing research and development centers and shared-services support centers in the Czech Republic, he said.
The current situation is also being observed by AmCham. The chamber is working on a competitiveness report through the Council of Czech Competitiveness to compare the neighboring countries. The report will be issued Feb. 1, 2010, Brazda said.
Too much banking regulation could harm investments
Vojtěch Benda, a senior economist with ING Wholesale Banking, noted that, apart from the obvious pros of the Czech economy, there are also some risks worth mentioning, as they could have negative effects not only for the Czech economy but for the whole CEE region. First, Benda said there is still big uncertainty regarding the impact of regulatory measures imposed on the banking sector. “Should the banking regulatory framework have become too strict, funding costs of investment into risk-weighted assets would rise, which would certainly have negative effects on the global investment sentiment,” he said. The second risk is associated with the public aid to banking and nonbanking sectors in developed countries. “Politicians in those developed countries could be tempted to make banks and corporations … pull back from emerging markets. We can already recognize signals of this in some eurozone countries,” he observed.
A heavy crown
One of the major concerns of foreign investors in CEE is the volatility of local currencies. This was illustrated in 2009 by up and down swings that made many companies redefine their business plans. That’s why many experts argue that having the euro as a unique currency is a preferable alternative. All experts polled by CBW agreed that by introducing the euro in 2009, Slovakia gained a major competitive advantage in CEE. “Five years ago, you were getting Kč 22–24 to the dollar and Kč 40–42 to the pound. That alone has had a huge impact on tourism. Now, Prague is the sixth-most visited city in Europe, but it used to be the second. Investors want value for money and low overheads, something that the Czech Republic is no longer known for,” MacGregor said.
Oldřich Körner, an analyst with the Confederation of Industry of the Czech Republic (SP ČR) told CBW that, despite the fact that the country doesn’t have such an attractive factor as the euro is in Slovakia and Slovenia, the country maintains the advantage of low costs, export competitiveness and successful exports to Western Europe. “Compared to the CEE average, we’ll also have the most consolidated public finances, despite a record public deficit in 2009 that reached 6 percent of GDP. Also, the macroeconomic environment is more stable here,” he said.
Other risks that could keep FDI away from the Czech lands in 2010 relate to the production capacities built in the years of growth, experts say. “The key factor right now is the excessive production capacities that face a lingering weakness of demand in the Czech Republic and in the eurozone,” ING’s Benda said.
Another obstacle he mentioned was the still relatively tight lending conditions in EU countries. “During the period of economic rebalancing, we can expect further decrease of fixed investments and hence also muted FDI inflow into the CEE region,” he said.
Brazda added that major risks for FDI flows are the access to capital, Germany’s economic recovery and whether the Czech parliamentary spring elections will result in greater political stability and a longer-term plan for economic growth. “The government should decide on how to use the EU funds for research centers. This can either result in world class, commercial facilities or a bunch of empty research labs spotted in every region of the country,” he said.
MacGregor added that one of the biggest barriers in entering the Czech market is the difficulty of entrance. “If you are a new company, it’s not an inviting prospect. I feel strongly that something needs to be done that will encourage new investors. At the minute there are far too many hoops to jump through, documents to be stamped and government buildings to be visited,” he said.
Despite such a gloomy view, Körner noted that in the Czech entrepreneurial environment, a couple of positive changes have been made. He mentioned the company registration in the Commercial Register through the Internet, which was simplified. Also, a unique contact point for setting up firms has been implemented, shortening the set-up process significantly. “Taxation remains, as in a large number of other CEE countries, nontransparent and difficult. During the crisis taxes won’t go down; on the contrary, we could expect they will increase,” he said. Moreover, investors can also face quite difficult environmental regulations dealing with waste, water and air. What can also be unfriendly for a person interested in investing in the Czech Republic is the relatively high level of corruption, Körner said.
“The fact that the parties use taxes as a campaign tool and not an economic growth formula is harming investment and job creation. We need a more responsible policy that does not change every election or every time a parliamentarian has an idea how to change it,” Brazda said.
Wider purse for reinvestments, rather than FDI
KPMG’s Linhart said that the global economic situation is so complicated that it’s difficult to assess which source of investment will dominate in 2010 in the Czech Republic and in CEE. However, several experts agree that 2010 will bring more investments from companies already active on the Czech market into new operations rather than new investments.
“The investment activity will be in general depressed in 2010 and projects financed through FDI will be no exception,” Sobíšek said. “Within the FDI inflow, reinvestment of existing firms will prevail over new entries. New entries will include more frequently acquisitions of existing firms than greenfield projects,” he said.
Benda agreed and added that the trend toward having more companies reinvesting their earnings as FDI rather than newcomers has become visible during the past two years. “Should there be a sustainable growth of reinvested earnings, such a development would be fine for stable and sufficient economic growth,” he said. On the other hand, a massive FDI inflow as it was in the early years of the decade could have a negative effect on the labor market, inflation and currency, he said.
With regard to new investors, they could also come from the West and from the East. “Before the crisis, it was very difficult to close a factory in Ireland or France or England. Now it’s easier; workers understand that and it could be a motivating reason for more investments [of Western companies in CEE],” Mullen said. “I can already see that as a trend or at least a pick up.”
In terms of geographical regions, he pointed at the U.S. companies that go to Western Europe first, but then they might close something and refocus toward CEE. Other sources of money could be China, Japan and South Korea. “I don’t see investments from the Middle East, but I could see money from the Middle East coming here, in real estate and other projects. I could see that happening,” Mullen said.
“I think there will be investors coming from the East—Armenia, Ukraine or Bulgaria, as they see the Czech Republic as a stable base from which they can work,” MacGregor said.
Except for new investments, the after-crisis scenario is also stimulating companies in good enough shape to buy into their competitors. KPMG’s Linhart noted that in 2010 many firms will be losing breath. “This is why we can expect a wave of forced sales of parts or of entire companies,” he said. This year, the majority of investments will take the form of acquisitions of existing firms. This is also connected with supplementary investments into property, technology or know-how that the new owner will try to use in order to match the new acquisition with his strategic goals. Greenfield investments will be rather an exception, Linhart said. However, there will be more of them than in 2009. “On the mid-term horizon, we can expect a gradual rise of the volume of investments in greenfield projects rather in the heavier industries,” he said.
Experts expect more investments to go into services, energy and real estate. Körner said that in the future more investments can be expected mainly in services, for example to support technological centers and centers for strategic services. “We can also expect a return of investments into film production, and this after the investment incentives are being implemented,” he said.
“No single sector comes to my mind as a would-be success story for 2010. That said, there might be interesting companies for investment within each sector,” Sobíšek said.
“We should definitely look for a greater investment into green energy—wind farms and solar power as the Czech Republic is among the most wasteful users of energy in Europe,” MacGregor said. “There are EU recommendations that have been outlined for member states regarding carbon footprints and energy conservation, and the Czechs must get a move on if they wish to make the deadline,” he said. Most probably, such investments would be public, financed or driven by EU grants and directives.
“It will be also interesting to follow the developments on the real estate market, mainly the large commercial and industrial projects. These are the best indicators for the development of the whole economy,” Linhart said.
Interest in large commercial properties has been rising, according to the latest figures from state-run investment promotion agency CzechInvest. For example, interest in 2,000 to 5,000 square meter production spaces has been skyrocketing, while the interest in large production surfaces of more than 5,000 square meters has been catching up as well. The highest interest is in Stříbro and Tachov in the Plzeň region. This shows the growing trust of investors in the Czech economy, CzechInvest noted in a press release.
Incentives aren`t everything – but they will still matter
Jan Brazda, managing partner with the executive search firm Constellation and vice president of the American Chamber of Commerce (AmCham) in the Czech Republic, said that AmCham isn’t expecting any mass investment in 2010. “If any occurs, it will likely be from existing investors. That is why we have asked the government to consider establishing a temporary incentive package aimed at current investors who already have major, long-term investments here,” he said.
“We have a large U.S. client right now who’s balancing between the Czech Republic and Hungary. He’s still in the game because Hungary is promising significant investment incentives,” Michael Mullen, a partner with the Czech law firm Havel & Holásek said. Mullen noted that it’s a question whether states can actually perform on those investment incentive promises because of European financial assistance and aid restrictions. Yet, “we’ll see a lot of competition from other countries in making promises to investors to attract them to their country,” he said. Asked whether this is the case for boosting investment incentives in the Czech Republic, Mullen said that one of the greatest things about investment incentives in the early days was that it just brought companies here and exposed them to the Czech Republic.
“You had a lot of companies where workers would be just turning screws. This is great because it fixes a short-term problem of unemployment and introduces international companies to doing business in the Czech Republic and maybe in the future they could bring more added-value work to the country. Yet, in the long term, if the Czech Republic wants to compete in the world economy, it can’t compete in turning screws,” he said. Mullen pointed at countries of similar size in the EU, from Austria to Belgium, Sweden and Denmark. “They are somewhere else. I agree with the change in focus of investment incentives to benefit high-value added investments, but at the same time there should be a bit more of a transition. So, maybe you can shorten the investment incentive period for turning screws and condition it on further investments in high value-added sectors,” he said.
“I generally think that long-term investment incentives, if there are going to be any, should be focused on high net worth sectors,” he said. However, one shouldn’t forget that in many sectors, investors don’t choose to come to a country just because of investment incentives. “They choose to come because universities are good or because the skill set of workers is good. So, in the long term it’s probably not the investment incentives that should be focused on, but on creating centers of excellence and on providing areas where there’s almost a Silicon Valley type of expertise,” Mullen said. This doesn’t have to be necessarily in software, he emphasized. It can be in engineering, glass technology or anything else. “Creating centers of excellence would act as a magnet to attract companies in that sector or related sectors. However, this requires some strategic thinking about where the Czech Republic is now and where we want it to be vis-à-vis the world economy going forward,” he said.
Banks won’t loosen purse, despite public declarations
Linhart said that in 2009 cash was extremely important and the situation will most probably remain the same in 2010. “The majority of firms don’t have an oversupply of cash. On the other hand, it could however happen that there is a significant amount of financial means that certain investors are now holding in liquid form as a result of uncertainty on the market. These investors are waiting for the right opportunity to commit to postponed investments,” he said.
Experts agree that in the Czech Republic new investments are mostly financed with bank loans. “The majority of firms finance their projects via bank loans or credits from other firms in the group. Investments are thus relatively sensitive to the change in behavior of banks and development of the cash price on the market in general,” Linhart said.
“In line with this country’s tradition, bank loans are set to be the key source of funds for new investment projects. Banks are becoming eager to lend for good projects. What inhibits them from granting more credits is a lack of demand from corporations but definitely no lack of funds,” Sobíšek said.
MacGregor said that 2009 wasn’t financially difficult for everyone. “Actually, last year was a great year for investing, especially the first six months. Many people missed this opportunity, and 2010 will definitely flatten out with a possible dip before rallying again in 2011,” he said, adding that the International Monetary Fund (IMF) has also predicted a varied speed of recovery for different countries throughout Europe.
The Czech Republic is one of those that definitely fared better than some of those in the West. “Currently, there is no destabilization of any of the banks here, but I feel they are still reluctant to go ahead with lending. Many companies here used the crisis as a way to cut costs and shave off some dead weight, so I feel they are still going to be dipping into their cash supplies before talking to their bank managers,” he said.
“Despite the massive monetary policy loosening we saw during 2009, lending conditions will likely remain relatively tight also in 2010. Restoring trust of the banking sector will take longer than a few quarters,” Benda said. He added that one should not forget that even the FDI inflows that we saw during the last 10 years were mainly money investors borrowed abroad so they could invest them in the Czech Republic or elsewhere.
“Banks lend to healthy investors. The problem is to find money for the regular operations, particularly for those firms that are challenged by the current situation,” Körner said.
In the Czech economic environment, private equity or public listing is unlikely to become the predominant source of financing in the mid-term horizon.
“Liquidity will be king for at least another year until companies are absolutely certain that the crisis has hit the bottom and that growth is built on solid fundamentals,” Brazda said.
All eyes on the post-election landscape
“2010 is set to be a rather stable year in terms of the business environment. However, investors’ focus should be on potential adjustments to be made after the general elections and affecting the environment in the next years. Needless to say, abrupt changes are harmful for business,” Sobíšek said.
Linhart said that in the Czech Republic, the post-election landscape will be important. “A strong government with clearly defined priorities in the economic sphere could absolutely influence investors much more than the continuation of uncertainty,” he said.
In a word, the boom years of FDI are gone. Now, the Czech Republic has no other option than to make the best of what it has already attracted—and hope to improve after elections.
“The Czech Republic’s economic transformation is not yet complete,” the U.S. Embassy’s O’Connor said, noting that while the business climate is largely good—as evidenced by the significant number of foreign investors—there are issues that must be addressed. “The government still faces challenges such as the slow pace of legislative reforms and industrial restructuring, lingering inflexibilities in the work force, nontransparent governmental decision making, a costly social network, and increasing difficulty in recruiting skilled engineers, technicians and managers. If unresolved, these conditions could have an adverse effect on the business climate and competitiveness of the Czech Republic,” he concluded.
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This article was originally published by Czech Business Weekly journal. Author: Cristina Muntean
