Making a Case for Investing in Markets of the Emerging Europe

During the Gold Rush in the United States during the first half of the 19th century, a common mantra was “Go West”.  If you weren’t quick to act, however, you missed out. The initial discovery of gold nuggets was said to occur in the Sacramento Valley during 1848. The Gold Rush peaked in 1852, and $2 billion USD ($60 billion in today’s dollars) of precious metals was extracted from the greater San Francisco area during this short period.

Fast forward to the early 21st century and a new “rush” of sorts is happening. The emerging European markets are in the midst of renewed growth. In this case, the mantra is “Go East”. Emerging European markets generally refer to the following countries:

Albania	Armenia	Azerbaijan	Belarus
Bosnia Herzegovina	Bulgaria	Croatia	Czech Republic
Estonia	Georgia	Hungary	Kosovo
Latvia	Lithuania	Moldova	Montenegro
Poland	Republic of Macedonia	Romania	Russian Federation
Serbia	Slovakia	Slovenia	Ukraine

Overall emerging Europe has been experiencing moderate growth of 3% to 4% since the crash of 2015. This growth was offset by a recession in the Commonwealth of Independent States (CIS – Belarus, Moldova, Russian Federation, and Ukraine).

Over the medium-term, greater reform efforts to increase productivity, support further capital deepening, and improved labor supply are needed to lift growth and re-accelerate convergence. If you’re looking for quick returns you may prefer to invest elsewhere.

The Bet – Emerging Europe Will Close the Gap with Developed Europe

Investing in emerging Europe is different than the “Gold Rush” in that the time horizon to realize a solid ROI will take more than a year or two. Based on data compiled from the CIA World Factbook, the estimated GDP per capita measures $34,408 in “Developed” Europe compared with $21,991 in “Emerging” Europe. This is a significant gap, and it has widened significantly since the crash in oil prices.

Emerging Europe is 36.1% less productive than developed in Europe in terms of GDP per capita. This means there is a gap of $4.25 trillion USD that emerging Europe needs to close if it wants to achieve its goal of convergence with developed Europe. This appears to offer a substantial opportunity to investors who are willing to take on some risk and who have a long-term view.

Read further to learn what opportunities exist.

The Top Industries in Emerging Europe

Economic reform as well as emerging Europe’s favorable location makes the region an ideal place for foreign direct investment (FDI). The 10-year average prior to the 2015 crash was $131.4 trillion USD.  Primary areas of foreign investment included the following:

• Manufacturing (mainly the automotive and electronic goods sectors);
• Research and development;
• Financial services;
• Telecommunications and IT.

Other industry sectors to keep a close watch on include oil & gas as well as real estate development and construction. Expected growth in oil & gas will be realized as oil prices gradually increase from recent lows of around $45 per barrel to anticipated normalized prices of up to $60 per barrel.

The growth in real estate development will result from a backlog in demand for commercial space, including retail and office space. Poland, Hungary, the Czech Republic, and Slovakia are the leading countries in terms of investment activity. These top locations experienced record transactions totaling 2 million square meters of office space completed in the CEE region in recent years.

In order to validate the sentiment that these are the leading industries, we looked at several index funds focused on emerging Europe. These funds include USD and GBP funds managed in the US and UK. The current composition of a representative fund included oil & gas (23.7%), financial services (18.7%), manufacturing and other industrials (13.8%), precious metals, timber and other raw materials (10.9%), consumer products (10.5%), telecom and IT (10.2%) and other industry segments (12.2%).

Speaking of FDI, is Emerging Europe Poised for a Rebound?

During the 10 years leading up to the crash in 2015, the average FDI (net) was $131.43 trillion USD. This 10-year average does not include 2 pre-crash years in 2007 and 2008, where FDI in emerging Europe spiked at $238.4 and $242.9 USD (net), respectively.

Predictably FDI tanked in 2015 by just under 53% to $43.3 trillion USD. We saw a healthy 49.7% rebound in 2016 to $ 64.8 trillion USD. Although this level remains 49.3% below the pre-crash average, this is clearly a positive sign going forward.

Challenges remain yet we remain optimistic about continued growth in emerging European markets moving forward. Risks include the following:

• Slowing growth in developed Europe in part because of Brexit and related issues.
• Tighter global economic conditions and weakened economies in other developing regions (e.g. MENA region).
• The population continues to decline in the region largely due to residents migrating to developing Europe and other countries to pursue the opportunity. This as well as an aging population is causing strain on the workforce.

We believe several positive factors will favorably impact FDI.

• We expect FDI to continue to normalize to pre-crash conditions, providing funding to make important investments in infrastructure and other initiatives that are made available.
• The US is showing signs of financial improvement during the early days of a new presidency. A related benefit is that the new US leadership is showing an interest in collaboration with and investing in Russia and other countries in the region.
• Tighter global economic conditions and weakened economies in other developing regions (e.g. MENA region).
• Oil prices are forecast to increase steadily over the next several years into 2021
• Continued investment in the growing telecom and IT sector will provide technology solutions to enable companies and governments to help improve productivity.

According to the IMF’s “Survey of Emerging European Countries”, Russia and other leading economies in the region must deal with continuing declining productivity. The survey specifies that “…the analysis in this report suggests the largest efficiency gains are likely to come from improving the quality of institutions (protection of property rights, legal systems, and healthcare), increasing the affordability of financial services (especially for small but productive firms), and improving government efficiency.”

Where Does Turkey fit in this Discussion?

When one looks at the various economic organizations across the world, Turkey appears to be a country without a home. They’ve been involved in discussions with the EU to join that group for almost 2 decades, with initial discussions as far back as 1999. The EU continues to be Turkey’s largest trading partner accounting for around 50% of Turkish trade.

Additionally, Turkey collaborates with the Middle East and North Africa (MENA) region, yet is not a formal member of this group. Turkey shares borders with three MENA countries (Syria, Iran, and Iraq); and with three eastern European countries (Armenia, Bulgaria, and Georgia). As Turkey is located in eastern Europe and is so closely tied to the EU, it feels as though any discussion of emerging European markets is remiss if Turkey is not excluded.

Turkey’s growth over the past 15 years has been impressive. Their GDP is $1.7 trillion USD, second behind only Russia in the emerging European countries. Turkey’s stated goal is to achieve a per capita income of around $25,000 by 2023 compared with only $3,500 in 2000.

Turkey’s largely free-market economy is driven by its industry and service sectors. Its traditional agriculture sector still accounts for about 25% of employment. The automotive, petrochemical, and electronics industries have risen in importance and surpassed the traditional textiles and clothing sectors within.

Whether Turkey is officially part of the emerging European markets, it appears to offer a strong are to consider investing in.

Are you interested in learning more about investment options in emerging European countries? Click here to contact our team of experts at Blueback Global.