Glimmers in the East bloc: Investment by the West in countries of the former Soviet bloc is proving to be a slower and more difficult process than first thought. Peter Torday looks at the reasons for reluctance

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The Independent Online
AS THE annual meeting of the European Bank of Reconstruction and Development begins in London tomorrow, Jacques Attali, the bank's president, has some hard explaining to do. Shareholders want to know why the bank, despite spending pounds 200m on its own running costs since it was set up two years ago, appears to have lent little money to Eastern European countries that are desperate for Western cash.

The countries that are shareholders are in no mood to be sweet-talked by the flamboyant Mr Attali, who apologised last week for the extravagant spending by the EBRD - a total of pounds 55m in refurbishing its new headquarters in Broadgate, plus hundreds of thousands on staff parties and chartering private jets. The bank has, meanwhile, disbursed pounds 190m in loans to East European countries, although more than pounds 1.5bn in total loans has been approved.

The EBRD argues that disbursements are slow because the money is only paid out as it is needed. It has also invested cautiously. But the EBRD will use this week's meeting to point out the enormous difficulties inherent in the transition from centrally planned economies in Eastern Europe to those of the free market. Its performance highlights the fact that investment in Eastern Europe by Western banks and businesses is considerably slower and more tortuous than anyone imagined when the Berlin Wall came down more than three years ago.

The collapse of communism in Eastern Europe has not yet produced a flood of foreign investment. Caution over political stability, the unsteady progress of reforms and the failure to pass laws favourable to foreign investors have all played a part in limiting the flow. But as countries in the region adjust - particularly Poland, Hungary and the Czech and Slovak republics - the EBRD believes foreign investment will rise this year to Ecu3bn (pounds 2.4bn), a 50 per cent gain on 1991.

A key problem in the attempt to privatise large chunks of the old state-owned economies has been the question of ownership. Who owned the enterprises before privatisation? Was it the workers, the management or the state? Privatisation has often meant handing firms to former communist managers.

Even where privatisation was more orderly, workers exert a strong influence on company policy. Many transformed companies also still expect to pile up debts with state banks, as they did in the past.

This leaves foreign investors cold. But the gradual introduction of bankruptcy laws and a more disciplined approach to privatisation have helped.

However, the transition has plunged the region into an economic depression comparable to the collapse of the 1930s. The demise of communism left many countries with heavy foreign debts and the threat of sky-high prices as former controls were lifted. At the same time, heavy industries dependent on state subsidies had to manage on their own, as many of their traditional markets disappeared, almost overnight.

But amid all the gloom, chinks of light have appeared in Eastern Europe, if not in the former Soviet Union. 'During the course of 1992, industrial output stabilised in Czechoslovakia and Hungary, and picked up significantly in Poland,' the EBRD says in its latest Economic Review of the region. 'Assuming these developments are more than temporary flukes, real output in central and eastern Europe looks poised to grow in 1993.'

Poland, the first East European country to embrace a big-bang economic reform programme to crush inflation and usher in the free market, has managed the transition with surprising success. The real economy looks set to grow, after industrial production collapsed by 40 per cent between 1989 and 1991. Only a slump in agricultural output last year prevented a recovery in industrial production from producing growth in the overall economy. Some experts expect an expansion of 3 per cent or more. Inflation, though still at 45 per cent last year, has slowed considerably. But unemployment has risen from near zero to 14 per cent.

The transition is well under way. Prices of imports are almost completely freed, while a legal and institutional framework to support commerce, trade and foreign investment has been strengthened. The number of private companies totals 50,000, and the government estimates that they now contribute about 45 per cent of national output.

Privatisation has been an outstanding success for small businesses. But a question mark hangs over large-scale privatisation; enterprise councils, with strong employee representation, have sometimes frustrated the attempt. But a new Enterprise Pact will grant employees 10 per cent of a company's shares, and it is hoped this will allow the programme to succeed.

Foreign investment - though smaller than in Hungary and the Czech Republic - has grown and bankruptcy laws are becoming effective.

The former Czechoslovakia started out with little foreign debt and low inflation but was slow to introduce reforms. Now the country - which split into two last year - has overtaken Poland and Hungary. Enterprises accounting for a third of national output were privatised last year, with more than 8.5 million citizens joining the voucher privatisation scheme in 1,500 enterprises.

However, separation may take its toll. The sharp divide between the pro-free market Czech Republic and the Slovak Republic, which is more interventionist, could undermine the customs union and the common currency.

Hungary had a head start thanks to a tradition of gradualist market reforms begun in 1968. It is still one of the biggest recipients of foreign investment. Structural reforms, such as a workable bankruptcy law and the ending of state subsidies for prices and production, have helped.

Hungary has also shown itself readier than other countries to allow market failure to deal with 'inter-enterprise' debts - a hangover of the central planning culture that encouraged enterprises to default on suppliers and borrow from state-owned banks. But the country has been slow to privatise. Less than 20 per cent of state-owned industry is in private hands.

After a three-year decline, the real economy is likely to pick up slightly this year, helped by a strong export drive in Western markets and a willingness to revive trade with former communist countries. Exports have helped to reduce the country's foreign debt - once the highest per capita in the world - by 10 per cent to dollars 18bn (pounds 11.6bn).

A key problem is the budget deficit. Without a recently announced austerity package, the shortfall was set to grow to 13 per cent of national output, because of spending on pensions and unemployment. The government now hopes to hold it to 7 per cent of GDP, and a renewed commitment to privatisation should make 1993 a better year for Hungary.

----------------------------------------------------------------- HOW THE STATES STACK UP Rated from 1 (best) to 5 (worst) ----------------------------------------------------------------- Country Business Political Credit opportunity risk rating Poland 1 2 2 Czech Republic 2 2 2 Hungary 3 2 2 Bulgaria 3 3 3 Slovenia 4 3 3 Slovakia 4 3 3 The Baltics 4 3 3 Romania 3 4 4 Albania 5 4 4 ----------------------------------------------------------------- Source: Ernst & Young -----------------------------------------------------------------

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