UNUnited Nations Economic Commission for Europe

Press Release


Geneva, 2 May 2002

Capital flows to the transition economies weather the global slowdown

UNECE releases its Economic Survey of Europe, 2002 No.1

Despite the global economic slowdown and bouts of market turbulence, the transition economies have avoided major contagion. In fact, many of them attracted more capital and received higher international credit ratings in 2001. Mrs. Brigita Schmögnerová, Executive Secretary of the Economic Commission for Europe, observed that this favourable outcome was due to continuing structural reforms (including privatisation), some strengthening of official reserves, upgrades in international credit ratings and the willingness of investors to differentiate among countries. In particular, the approach of EU accession has helped to bolster foreign investors' interest in the candidates for EU membership. The changes in the external financial positions of the transition economies are one of the issues addressed by the United Nations Economic Commission for Europe (UNECE) in the first issue of Economic Survey of Europe 2002.

Net financial flows to Eastern Europe increase; outflows from Russia slow

Despite the challenging international environment and weakening capital flows to many emerging market economies, net financial flows to eastern Europe (including the Baltic States) rose in 2001, to $28 billion (table 1). This is still somewhat smaller than in the peak years 1998-1999, but the composition of inflows has improved, shifting towards relatively stable FDI. The preponderance of net FDI inflows ($20 billion in 2001) suggests that the bulk of capital imports has been used for economic restructuring, and because FDI is generally non-debt creating, there has been only a moderate increase in foreign debt. In Russia, the large net outflow of capital slowed in 2001, although significant capital flight continued. This outflow has been possible because of the country's huge current account surpluses ($34 billion in 2001), which also resulted in record official reserves. Overall the financial account of the transition economies (including errors and omissions) is estimated to have moved from a small deficit in 2000 to a small surplus in 2001.

Foreign direct investment rises again

FDI in the transition economies proved resilient in the wake of the Asian and Russian financial crises (1997-1998) and again during the global slowdown in 2001, increasing to over $28 billion (table 2 and the chart). There had been some concerns in early 2001 that FDI would diminish as global economic prospects weakened. While this may have occurred in some transition economies, the strategic goals of multi-national corporations - acquisition of assets undergoing privatisation, lowering costs with efficiency-seeking investments and establishing a presence in EU candidate countries - seem to have dominated cyclical considerations. In general, FDI flows in the ECE transition economies remain heavily influenced by governments' privatisation decisions, but the role of this factor will diminish as the stock of state assets is exhausted. FDI flows to Russia remained relatively small while resident investment abroad continued, resulting in a net outflow for the second year running. Russia has a huge potential for attracting FDI, especially in the oil and gas sectors. However, foreign investors continued to have doubts about the investment climate in 2001, despite the fact that significant economic reforms were under way.

International credit ratings continue to improve

Although the global market environment weakened, Fitch, Moody's and Standard & Poor's have upgraded the international credit ratings of ten transition economies since the beginning of 2000 (table 3). As of February 2002, eight EU accession countries - the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, and Slovenia - had received investment grade ratings (as had Croatia). Bulgaria and Romania are rated sub-investment risks, although both have been upgraded recently. The better credit ratings reflect improvements in macroeconomic fundamentals and policies, progress in economic reform, including meeting the requirements of EU accession (i.e. adoption of the Acquis Communautaire) and stronger financial positions. Azerbaijan, Kazakhstan, and Russia received upgrades in 2001 but they remained in the sub-investment grade category. Since early 2000, Russia has been moved up three notches, thanks to its much-improved fiscal and liquidity positions. Only Hungary had been rated prior to the transition.

Bond issues show signs of recovery

Bonds issued by the transition economies amounted to some $6.3 billion in 2001, about $1 billion more than in 2000. The majority were sovereign and municipal issues, but there were also a few corporate bonds from energy producers in Kazakhstan, Russia and Romania. Terms on the new issues of several countries continued to improve despite the unpropitious climate and many were heavily oversubscribed. This reflects international investors' search for higher yields while seeking what are perceived as less risky investments. The modest overall level of issuance by creditworthy countries reflects the availability of alternative finance, especially FDI. Several countries borrowed to finance government budget deficits.

Although the emerging market economies as a whole have suffered from heightened risk aversion, creditworthy transition economies have benefited from the increased willingness of investors to differentiate between borrowers. The combination of economic restructuring and macroeconomic stabilization, improved financial indicators, credit rating upgrades and closer association with the EU is likely to make the accession countries less vulnerable to external shocks and financial crises. The absence of serious contagion from Argentina and Turkey supports this view. Further credit upgrades will depend inter alia on a continuation of structural reforms and keeping imbalances in check.


Table 1 - Net capital flows into the ECE transition economies, 1998-2001

Table 2 - Foreign direct investment in the ECE transition economies, 1998-2001

Table 3 - Fitch credit ratings for the transition economies and changes in 2000-2002


Chart 1 - Foreign direct investment in the ECE transition economies,
(Billion dollars)

Source: UNECE secretariat, based on national balance of payments statistics.


For further information please contact:

UNECE Economic Analysis Division
Palais des Nations
CH - 1211 Geneva 10, Switzerland
Tel: +41(0)22 917 24 79
Fax: +41(0)22 917 03 09
E-mail: info.ead@unece.org
Web site: http://www.unece.org/ead/ead_h.htm


Ref: ECE/GEN/02/11