Emerging outpost

The European Union is expanding to the east and global investors are seizing the new low-cost manufacturing opportunities on offer at the heart of one of the world's most affluent consumer markets. But while China is slowly turning its gaze to Eastern Europe, experts say it is not focusing quickly enough.

According to Professor Linda Sprague of the China Europe International Business School, the term "China-Eastern Europe relations" is a bit of an exaggeration. "I think [Eastern Europe] sees China as an opportunity but the opportunities closer to home are right there now and easier to take advantage of. It's not easy coming over here," she said. "For China, dealing with Poland is like dealing with a city in China. Business will be done through the EU."

The Sino-European academic's disinterest is supported by trade and investment figures. Total Chinese exports to Eastern Europe in 2004 – excluding boundary countries like Russia and Turkey, which are generally excluded from analysis of the region – amounted to US$10 billion, while China imported US$3.25 billion worth of goods from the region.

Bilateral investments were also negligible, with Eastern Europe sending around US$141 million to China, and China not much more in return. Tamas Venekei, commercial counselor for the Hungarian Commercial Office in Beijing, said China had invested a total of US$120 million in Hungary in the whole history of bilateral relations. Michal Novota, spokesman for the Slovak Investment and Trade Development Agency, reported no Chinese investments through his agency, while Chinese data showed US$45 million was invested in Poland in 2003.

Given China's total outbound investment was US$5.5 billion in 2004, it is clear that Eastern Europe is not on the radar. But this figure is just a fraction of the US$648 billion in global outbound investment flows in 2004 and the 26% rise in China's outgoing investment to US$6.9 billion in 2005 will have made little or no difference to the situation.

On the other side of the ledger, the latest Foreign Direct Investment Confidence Index by global management consulting firm A.T. Kearney confirms China as the most preferred destination for worldwide FDI for the fourth year running.

Immediate action
A.T. Kearney research also indicates that China should act now if it is to make the most of investment opportunities in Eastern Europe. According to the Foreign Direct Investment Index, an annual survey of executives from the world's largest companies, Poland is the fifth most popular FDI destination, Hungary 11th, the Czech Republic 12th and Romania 25th. Poland aside, these are all record highs.

The interest has been sparked by EU entry, which has created greater market access, reduced trade and investment barriers and increased stability. Meanwhile, the anticipation of EU entry for countries like Romania has also stimulated investor confidence, acting as a further sweetener to a series of other attractions such as relatively fast growth rates, lower corporate taxes and favorable productivity levels.

In both 2004 and 2005, global capital inflows into Eastern Europe increased 30%, according to Marcin Sadowski, senior economist with publishing, consulting and market research company PMR Publishing. Although he doesn't expect the region to usurp China as a key destination for global foreign direct investment anytime soon, Sadowski believes Eastern Europe provides an opportunity that China can't match.

"The huge potential of China's economy and low cost of labor makes China an essential investment," he said. "But what is important is that when companies are looking to enter the EU market, if they invest in the EU newcomers, they can easily enter Europe. The competition is not in terms of labor costs but more in terms of accessibility to the big EU market."

According to Paul Laudicina, managing director of the Global Business Policy Council, which conducts the A.T. Kearney study, market accessibility is emerging as a business essential in an increasingly globalized world. He warned that global investment confidence had waned slightly from 2004 highs, with many companies backing a cash-position against expansion to mitigate perceived investment risks. "However, those companies that fail to position themselves globally with strategic investments will be the most vulnerable to competitive pressure," he said.

By moving operations beyond domestic borders, companies can benefit from business behind the trade and tariff barriers of other economies. The globalization of operations also allows companies to break into new markets, particularly in higher-value sectors, which often require sellers to operate in close proximity to buyers.

So while Eastern Europe provides China with competition it can't match, it also provides an opportunity that China can't afford to miss. And Eastern Europe is well aware of its allure, setting its sights on China as partner as well as competitor. The thinking is that as China looks offshore for ways in which to diversify its economy away from inbound investment and export-led growth, capital hungry countries like Hungary can provide the answer. "There is already overcapacity in China so getting nearer offshore markets is essential," Hungary's Venekei said.

China initiated a "Go Out" policy in 2002 to help achieve its globalization goals, aiming to create between 30 and 50 Chinese companies able to compete with global giants such as Coca-Cola, Microsoft and Wal-Mart by 2010. An instrumental part of the policy was that China's vast foreign exchange savings were made available to companies like Huawei Technologies, which received a low-cost US$10 billion loan to promote international operations.

Not all of these efforts have been successful. The World Bank recently reported that one-third of Chinese enterprises had lost money on their foreign investments and that 65% of joint-ventures had failed.

However, an Accenture report concluded that emerging markets such as Eastern Europe are the place for Chinese companies to start if they are to build a global presence. "Their better understanding of emerging markets provides a stronger guarantee of success in their initial overseas expansion plans, improving chances of a smoother entry into more developed western markets later on," the report said.

Emerging economies are also crying out for capital, reducing the political obstacles that are sometimes placed in the way of China's expansion efforts. The likes of Huawei and its high-tech rival ZTE Corporation are now using their experience in building China's own markets to develop new ones in other emerging economies, before tackling developed world consumers. Both companies have representative offices in Hungary.

Small successes
Venekei says the potential is greatest for larger companies, but smaller players have made the biggest effort to date. Around 3,000 Chinese firms have established operations in Hungary, the majority of them small entrepreneurships involved in trade. A notable exception is Chinese television maker Hisense. In 2004, it established a factory in the Hungarian town of Sarvar, after previous occupant Microsoft moved its production lines to China.

Hisense Hungary spokesman Jason Yang said the move was a strategic decision to gain greater access to its major markets in Europe. The company plans to produce around 250,000 LCD flat panel CRT television sets in 2006, building to an annual output of one million in two to three years. Hisense now has 3% of France's LCD market share and the largest export volume of flat panel TVs of any Chinese brand.

In Sadowski's view, the future is likely to see stronger ties as Eastern Europe looks to China for cheap labor and China looks back for market access. For example, while Hisense is taking advantage of EU proximity in Eastern Europe, Czech carmaker Skoda has made plans to produce its Octavia model in China.

And companies from third party countries, such as UK in-store display manufacturer RMD, are following suit. RMD outsourcers manufacturing to China and Poland, but keeps its research, development and design activities in the UK. "We're in China because it's cheap and we're in Poland because it's close," Managing Director Stuart Willis said.

Though there is still a long way to go, the gently warming trade relations between China and Eastern Europe highlight the value of market access in terms of achieving corporate success. With emerging economies at the heart of the lucrative European markets on the lookout for investment dollars, the time appears ripe for Beijing to put its "Go Out" strategy into effect.

But whether China has the will or ability to move fast enough to seize the opportunity is the important question. As Sadowski points out, first-mover advantage is critical in the increasingly competitive global marketplace – and the low-hanging fruit is going fast.