In the last few years, China has emerged as a major investor in Central and Eastern Europe. Initially, Chinese firms focused on extraction and construction, especially roads, airports and power stations. Subsequently, they have extended their interests into an array of other sectors including steel, hydroelectricity, car production, hotels, banking, telecommunications, beverages, real estate, football clubs, airlines and travel companies. These investments have been underpinned by deepening political relations with Beijing, at a bilateral and regional level. At the present time, China’s biggest new investments in the region include a EUR722m thermal power plant in Bosnia, a high-speed rail line connecting Belgrade and Budapest, and a new highway connecting Albania to Macedonia.

 

Various factors that explain China’s interest in Eastern Europe. Primarily, China sees the region as an entry point for access to the all-important Western European market which lies at a crucial position on its ‘One Belt, One Road’ vision of twenty-0first century Silk Road connecting Europe and Asia. Not only are assets cheaper and the operating environment less competitive, but much of Eastern Europe has tariff-free access to the EU’s single market, making it a favourable location to base Chinese operations. In addition, as non-members of the EU, regional states such as Serbia are able to offer Chinese investors tailor-made investment packages that include subsidies and tax-breaks. China is also interested in breaking into the Eurasian Economic Union, fueling investment in states such as Belarus. These pull factors in Eastern Europe are supported by push factors at home, including a slowdown in GDP growth and overcapacity in China’s state-owned enterprises, which is encouraging firms to look abroad for new potential markets.

 

Alongside this, China has a political rationale for establishing a presence in Eastern Europe. For one thing, it can use its presence in countries in the EU’s east, such as Hungary and Poland, to lobby for recognition as a market economy by the EU, which would confer advantages such as effective immunity from anti-dumping duties. In addition, by increasing its leverage, China can also garner support on issues of strategic importance closer to home, such as its various territorial disputes in the South China Sea.

 

For their part, states in Eastern Europe are also keen to promote Chinese investment in order to modernise their economies and close their development gap with Western Europe. In part, they look to China because of the difficulty in leveraging investment funds from traditional partners. Private firms are often averse to entering difficult investment environments such as the Western Balkans and the former Soviet Union. Multilateral lenders such as the IMF and the World Bank are bureaucratic and unwieldy, and usually insist on market reforms as a condition for lending. The EU, while a lucrative source of development only makes available to member states, which must first meet stringent political and economic conditions. Meanwhile, Russia, another traditional investor, is economically troubled and imposes its own, self-interested political conditions on new investments.

 

By contrast, China is easy to do business with. It has huge reserves of foreign capital which it has earmarked for spending in the region (including EUR10bn allocated under the 16+1 programme). And deals are quick to negotiate, usually involving agreement at an intergovernmental level followed by a quick and efficient process for the approval of funding. In this respect, Eastern Europeans are expanding into a practice which began in communist Albania and continued in Yugoslavia in the 1990s of looking to China when they cannot get what they want from the West. Around the edges, states in Eastern Europe also hope to gain access to the Chinese market where there is huge demand for imported agricultural products.

 

While there are demonstrable benefits, China’s growing presence in Eastern Europe also carries risks. Most important is the cost. Most Chinese investment is financed in the form of lending by a Chinese export bank to a Chinese company, which carries out a project in Eastern Europe and accrues the immediate financial benefit while passing on the debt to the relevant host government. In some cases, the host government can ill afford the additional debt burden. Meanwhile the compulsion to use a nominated Chinese firm effectively rules out alternative, and potentially better contractors, risking overpriced and substandard work. In extremis, struggling economies such as Belarus are utilising Chinese credits as a means of providing short-term fiscal stimulus by carrying out projects which are not economically viable while adding heavily to public debt.

 

There are also political risks to the region. In many cases, Chinese investors bring a Chinese workforce with them, creating resentment among local workers, who may be unemployed or underemployed and in need of full-time work. In Belarus, more Chinese have been awarded work permits in 2016 than any other nationality. There are also security risks involved in allowing Chinese firms access to the local economy, in the context of intense Chinese espionage. An additional risk is security, given the prevalence of Chinese commercial espionage. Some local governments are also concerned about giving operational control to Chinese firms in strategic sectors such as energy, transportation and technology in case this power is used nefariously in the future.  

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Forecast

 

In China’s drive to penetrate the Eastern European market is likely to continue. With huge reserves at its disposal, and a combination of push and pull factors, Chinese companies will continue to seek out new market opportunities abroad. For their part, the recipient countries will also seek Chinese finance as a short cut to acquiring the kind of investments that they cannot get from the West. Meanwhile, diplomatic collaboration between China and the states of Eastern Europe will continue, and potentially gain strength as long as the EU’s economic environment—and therefore accession prospects for some nations—remains uncertain. This will weaken the EU’s policy of conditionality. The main limitation on future investment is market volatility in China, which could prompt Beijing to limit outflows of capital.

 

Immediate Impacts

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• Easy access to Chinese loans will lead to a damaging buildup of government debt.

 

• Bilateral deals and state-subsidised contracts for Chinese projects can crowd out andundercut local businesses.

 

• China’s unconditional funding of infrastructure technology will weaken the resolve of local governments to enact internal political and economic reforms.

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Potential Impacts

 

• China acquisition of stakes in strategic sectors, industries and technologies could pose a risk to national security, if the viability of such industries is reliant on good political relations.

 

• Public mistrust over the growing Chinese presence, especially if there is a suspicion of corruption or the investment incurs social costs such as pollution, could lead to civil unrest.

 

• Deepening integration with an emerging economy with an unorthodox economic model at risk of eventual slowdown creates new uncertainties for Eastern Europe’s economies.

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