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About FIAS FIAS, the multi-donor investment climate advisory service managed by the International Finance Corporation (IFC) and supported by the Multilateral Investment Guarantee Agency (MIGA) and the World Bank, is an integrator of services to improve the business-enabling environment of member countries. In particular, FIAS advises governments of developing and transitional countries on regulatory simplification, investment policy and promotion, and industry-specific investment climate issues. In its 20 years as a donor-funded operation, FIAS has completed more than 760 projects in all regions of the world. For more information, visit www.fias.net. The Invest in the Western Balkans (IIWB) program, based in Vienna, is an independent, pan-regional program administered by FIAS. IIWB’s primary objective is to promote foreign direct investment in the region. More information is available at www.iiwb.org. For more information, contact:

FIAS and IFC Advisory Services, Southern Europe Beograd, Serbia t.+ (381) 11 302 3750; f.+ (381) 11 302 3740; E-mail: [email protected]

Invest in the Western Balkans, FIAS Vienna, Austria t.+ (43) 1 5355 382 2115; f.+ (43) 1 5355 382 5115; E-mail: [email protected]

FIAS Headquarters Washington, D.C., USA t.+ (202) 473-7517; f.+ (202) 473 1000; E-mail: [email protected]

Attracting Investment to South East Europe

Survey of FDI Trends and Investor Perceptions

November 2007

FIAS

The Multi-Donor Investment Climate Advisory Service

The World Bank Group

Acknowledgements

This report was undertaken by FIAS, the investment climate advisory service of the World Bank Group. The project team was led by Margo Thomas, FIAS Regional Program Coordinator and IFC Advisory Services Business Enabling Environment Manager, and Dermot Coffey, Manager of the Invest in the Western Balkans program. The report benefited from the contributions of several team members: Peter Kusek authored most of the report and also served as overall project coordinator; Wim Douw, Madalina Papahagi, Patricia Steele and Christine Bowers also made substantial contributions to the content and/or the process to transform the research findings into a publication. David Brown of McInvest Economic Development advised the team on the report’s recommendations. Several peer reviewers offered thoughtful and greatly appreciated feedback on the draft report, including Gjergj Konda, John Varney and Mathew Verghis. Zai Fanai and Madan Gera assisted with finalizing the report.

The team was especially grateful for the collaboration and expertise of Marc Lhermitte, Paul Catsiapis, Fabrice Reynaud and Vincent Raufast of Ernst & Young.

Table of Contents

Executive Summary...... 1 Methodology ...... 1 Findings ...... 1 Conclusions ...... 3 Moving Forward...... 4 Introduction ...... 6 Regional Overview ...... 6 Report Approach...... 7 Report Structure...... 7 Audience ...... 8 Further Resources...... 8 Survey Methodology and Sources...... 9 I. World Bank Group/Ernst & Young: Investor Perception Survey of the South East European Region ...... 9 II. Multilateral Investment Guarantee Agency/Oxford Intelligence: FDI Trends Analysis of South East Europe...... 12 FDI Trends Analysis Findings ...... 13 Summary Findings ...... 13 Investor Survey Findings...... 17 Investor Optimism about Reforms and Performance, Past and Future ...... 17 Level of Awareness and Knowledge about Business Conditions ...... 24 Comparative Advantages and Disadvantages ...... 28 Priorities for Increasing Attractiveness ...... 31 Regional Competitiveness for Company Units and Production Functions ...... 38 Future Investment Prospects ...... 42 Country Profiles...... 45 Albania ...... 46 Bosnia and Herzegovina...... 50 Bulgaria ...... 54 Croatia...... 58 Macedonia, FYR ...... 62 Moldova ...... 67 Montenegro ...... 72 Romania...... 76 Serbia...... 81 Appendices...... 85 Appendix 1: Acronyms and Glossary of Terms...... 86 Appendix 2: Regional Classification of Countries ...... 87

Attracting Investment to South East Europe iii

Figures and Tables

FIGURES

Figure 1: Sectors of surveyed companies ...... 10 Figure 2: Origin of surveyed investors ...... 11 Figure 3: Investors’ perceptions of market conditions ...... 17 Figure 4: FDI inflows to South East European countries...... 18 Figure 5: FDI inflows to regions in Europe ...... 19 Figure 6: Doing Business in South East Europe ...... 20 Figure 7: Global competitiveness of South East Europe’s economies...... 21 Figure 8: Expectation of future attractiveness...... 22 Figure 9: Future attractiveness of South East Europe vs. Western Europe ...... 23 Figure 10: Investors’ awareness of business conditions ...... 24 Figure 11: Companies’ knowledge of investment climate (by sector) ...... 25 Figure 12: Level of awareness among potential investors ...... 26 Figure 13: Awareness of market conditions (by investor’s origin)...... 27 Figure 14: Comparative advantages of regions in Europe ...... 28 Figure 15: Comparative disadvantages of regions in Europe...... 29 Figure 16: Priorities for South East Europe’s markets...... 31 Figure 17: Political stability as top priority...... 32 Figure 18: Economic policy and regulations as #2 priority ...... 33 Figure 19: Infrastructure development as #3 priority...... 33 Figure 20: Determinants of FDI in South East Europe ...... 34 Figure 21: Importance of political stability for all sectors ...... 35 Figure 22: Differences in priorities for established vs. potential investors...... 36 Figure 23: Regulatory quality and administrative burden in South East Europe ...... 37 Figure 24: Forms of business expansion...... 38 Figure 25: Regional attractiveness for warehousing and logistics centers ...... 39 Figure 26: Western Europe’s attractiveness by business units ...... 40 Figure 27: Regional comparison of attractiveness for various business functions ...... 41 Figure 28: Expansion plans by established investors ...... 42 Figure 29: Disinvestment plans in regions of Europe...... 43 Figure 30: Investors’ preferred modes of market entry ...... 44

TABLES Table 1: Position of surveyed investors ...... 12 Table 2: FDI projects in South East Europe: Top 20 source countries (1997– Q1 2006) ...... 14 Table 3: Number of investment projects in Western Balkans (1997 – Q1 2006) ...... 14 Table 4: Regional composition of FDI projects in SEE (1997 – 2005) ...... 15 Table 5: FDI projects in South East Europe: Top 20 sectors (1997– Q1 2006)...... 15 Table 6: Trends in manufacturing and services FDI projects in Europe (1997– Q1 2006)..... 16 Table 7: Growth of FDI projects in selected industries...... 16

iv Attracting Investment to South East Europe

Executive Summary

This report presents the results and implications of a survey of foreign business executives on investment opportunities and challenges of South East Europe (SEE).1 The region is increasingly seen as a new frontier for investment and business activities within Europe. Gradual integration into European and trans-Atlantic institutions, growing regional cooperation, and improving governance and investment climate are factors which have contributed to rising trade and investment flows in recent years. Investment location decisions are, however, based not only on hard facts and data. Opinions, perceptions and anecdotal experience play a crucial role in shaping the investors’ image of a country’s attractiveness. This study intends to inform potential investors, domestic policymakers and international partners of the views and priorities of foreign investors as they assess the SEE region’s performance and potential.

METHODOLOGY

FIAS, the multi-donor investment climate advisory service of the World Bank Group (WBG), commissioned Ernst & Young (E&Y) in October 2006 to conduct a survey of international investors on their perceptions of the South East European region, encompassing Albania, Bosnia and Herzegovina, Bulgaria, Croatia, the former Yugoslav Republic of Macedonia, Moldova, Montenegro, Romania and Serbia. The objective of the study was to evaluate key barriers to and opportunities for foreign direct investment (FDI) in the region. Over 300 senior executives of multinational corporations from Europe, North America and Asia were surveyed. The sample included companies that have already invested in the region (43 percent) as well as corporations from countries with strong investment and trade ties to the region (57 percent). To provide further context on FDI trends in the region, the Multilateral Investment Guarantee Agency (MIGA), also of the World Bank Group, commissioned a complementary 2006 study that analyzed actual investment flows and sectors. Results of these two projects are presented in this report.

FINDINGS

An overwhelming majority of foreign investors are encouraged by South East Europe’s past performance and are optimistic about its future investment prospects. This sentiment is particularly positive among resident investors already established in the region. Existing investors were twice as likely as potential investors to say that the investment climate in SEE had improved over the last year. Eighty-five percent of in-region investors said the conditions have improved, vis-à-vis only 44 percent of out-of- region companies. Furthermore, as many as 19 of 20 investors already operating in

1 The SEE region encompasses Albania, Bosnia and Herzegovina, Bulgaria, Croatia, FYR Macedonia, Moldova, Montenegro, Romania and Serbia.

Attracting Investment to South East Europe 1

the Western Balkan countries said that the business environment had improved over the last year.

Less than 6 percent of respondents were concerned about the possibility that in the future the SEE region’s appeal to foreign companies could decrease,2 vis-à-vis 18 percent in the case of Western Europe’s future attractiveness.3

Almost half of foreign businesses established in the SEE region reported plans to further expand their operations. The preferred form of growth is through establishing subsidiaries and extending existing facilities, both of which indicate investors’ focus on their long-term presence in the region. Only 12 percent of established businesses said that they were considering scaling down their operations and relocating to other countries. In Western Europe, every fourth investor has disinvestment plans.4

Almost half of existing and interested potential investors would prefer to grow their businesses by establishing subsidiaries. In contrast, only 8 percent would prefer to acquire financial interests in other companies.

Investors’ optimism has translated into increasing FDI flows. SEE outperforms Western Europe and even Central Europe in the rate of average annual increases in FDI inflows. FDI inflows into SEE grew on average by over 70 percent per annum between 2000 and 2005. During this time, Central Europe experienced a 60 percent annual growth rate, while the European Monetary Union (EMU) comprising mostly Western European economies witnessed only 12 percent growth per year.

Most investment projects in the Balkan region are in manufacturing, although the fastest growing sectors are business services, plastics and rubber, and transport services.

The principal competitive advantages lie in the low labor costs, flexible labor policy and increased future productivity potential. In all three of these important investor criteria, the region ranks as Europe’s most attractive investment destination.

Forty-one percent of surveyed investors ranked the SEE region as most appealing for its low labor costs.

The SEE region trails behind other European countries in the quality of infrastructure, research and development (R&D) and governance.

South East Europe is the continent’s most attractive region for establishing factories and other production units. The region’s appeal is driven primarily by the opportunities in Romania and Bulgaria.

2 This figure is consistently low for all SEE countries, ranging from 3 percent for Croatia to 8 percent for Moldova and FYR Macedonia. 3 Data on Western Europe is derived from the Ernst & Young European Attractiveness Survey 2006. 4 Data on Western Europe is derived from the Ernst & Young European Attractiveness Survey 2006.

2 Attracting Investment to South East Europe

One out of three respondents selected SEE as a preferred European location for establishing factories and other production units. The region is also popular as a location for warehouses and logistics centers.

Western Europe remains an undisputed leader in other business functions, including headquarters operations, R&D centers, administrative and accounting back offices, and design centers.

Foreign investors have limited knowledge of the SEE region’s business climate and investment opportunities. Over 60 percent of surveyed investors felt they were not well informed on aspects of the countries’ investment environments.

Two out of three respondents acknowledged a low level of knowledge on Albania, Moldova, FYR Macedonia and Montenegro.

Investors are poorly informed even about the best performing economies in the region—Croatia, Romania and Bulgaria. About 50 percent of respondents felt inadequately familiar with these countries’ business environments.

North American investors have less knowledge about the region’s economies than their counterparts in Europe.

Investors see political instability as the single most important impediment to increased FDI flows, followed by inadequate infrastructure and an insufficient economic policy and regulatory framework. More than one third of investors felt that increased political stability should be the top priority for the governments of SEE countries in improving their countries’ investment attractiveness.

Every fourth respondent also placed improvements in regulatory frameworks, transportation networks and information and communication technology (ICT) infrastructure among the top three suggested priorities for national development.

Manufacturing is the key type of investment activity undertaken in SEE. The main emerging sectors are business services, food, non-metallic mineral products, automotive components, electronics, plastics, and chemicals. Movement from manufacturing to services in SEE investment flows is following a natural evolutionary trend of gradually diversifying FDI flows among sectors. This trend is reflected in all of Europe.

CONCLUSIONS

Based on its per capita FDI inflows, SEE has already demonstrated that the region can competitively satisfy the requirements of foreign investors. In 2006, per capita FDI for South East Europe was $492,5 nearly matching the $499 per capita FDI average of Central Europe’s

5 The Vienna Institute for International Economic Studies, June 2007.

Attracting Investment to South East Europe 3

new EU members.6 Moreover, on an FDI per capita basis Serbia ($635) outperformed the Czech Republic, Poland and Romania.

Increasing optimism and dynamism within SEE are substantiated by the survey’s findings. Feedback from investors underscores that the region is no longer blighted by deep-rooted negative perceptions. In fact, there is now unparalleled confidence in SEE and its prospects for investors. Yet there is still considerable scope to more effectively and widely promote the benefits the region offers investors seeking to profitably serve existing customers and to access burgeoning new markets from locations within the region.

Respondents ranked SEE as the best location in Europe for manufacturing. Of greater significance were the survey’s findings regarding the higher value-added business support services, which has been a particularly successful segment for Central Europe. The survey respondents, most encouragingly, ranked SEE higher than Central Europe for headquarter operations, back office functions and call centers. They also considered that the SEE region, for design centers, could match the intellectual capital and academic quality offered in Prague and Budapest.

The fact that about one third of respondents outside SEE said they are considering locating operations in SEE and nearly half of existing investors said they are planning incremental investment is a clear vote of confidence for the region, not only for manufacturing but also for business services and ICT-related activities.

MOVING FORWARD

The main message to potential investors is that SEE’s improved competitiveness within key target sectors, including automotive, agribusiness, business support services and ICT, coincides with the acute pressures on labor availability within the leading recipients of FDI in Central Europe. This convergence enhances the prospects for SEE to increase its share of European FDI.

The report also highlights that while palpable progress is being made by most of SEE’s national governments to improve the business climate, there is no room for complacency. The country profiles presented within this report, coupled with the feedback from survey respondents, underscore the areas where improvements are most needed. In this regard, the results show why there must be even greater resolve on the part of host governments to fully implement recommendations FIAS has previously made to create an environment within which both domestic and international companies can prosper.

A brand identity is generally considered to be a significant source of value for an organization, country or region. In this case, brand positioning of the region’s locations in the minds of investors will be critical to the actual value created. Given that perception testing is an essential component of branding, the onus is now on SEE country investment promotion agencies (IPAs) to exploit the findings of this study to realign respective marketing and communications strategies.

The underlying message from the 304 respondents was that they need to be better informed about the attributes of SEE and its benefits relevant to their sectors and companies. Consequently, the region’s IPAs must be more proactive in terms of establishing and sustaining dialogue with their target audiences, while implementing marketing strategies to bridge the gaps between current investor perceptions and future positioning relative to the

6 Czech Republic, Hungary, Poland, Slovakia, and Slovenia.

4 Attracting Investment to South East Europe

competition. This requires adopting a competitive stance and actively promoting to investors in key target sectors.

Finally, this survey represents one of many FIAS initiatives aimed at helping Western Balkan countries improve their investment climates to increase private sector activity and investment with development impact. To that end, regulatory simplification and investment generation represent the two main pillars of the FIAS product range.

Attracting Investment to South East Europe 5

Introduction

“The western part of the Balkan Peninsula stands at an important crossroads between the past and the future. It is now clear that economic progress through domestic reform, regional collaboration, foreign business investment, and eventual European Union accession are the most important challenges and opportunities facing the entire region. The stage is now set for the next phase of Balkan development, where economic cooperation in areas such as trade, energy, communications, and infrastructure runs parallel with the process of “Europeanization.” The most successful Balkan leaders will be measured according to their ability to move their countries into the European fold and to attracting significant foreign investment.”7

REGIONAL OVERVIEW

South East Europe has undergone a remarkable transformation since the introduction of market-based economic policies and, for the Western Balkan countries specifically, since the cessation of ethnic conflicts toward the turn of the century. The region is now at a critical juncture as its countries continue the transition process. Those that have not yet acceded to the European Union (EU) are embarking on the implementation of critical reforms to improve their investment climates and to further integrate with the rest of Europe in terms of trade and investment. More than half of the region’s population resides within the EU, and virtually all SEE countries have a formal relationship with the EU.8

The region offers a unique opportunity for investors both in terms of the size of its internal market and as a base for export into Western Europe. With over 50 million people, the growing purchasing power of its consumers, cumulative gross annual national income of over $2 billion9 and geographic proximity to Central and Western Europe, the SEE region presents an attractive destination for market-seeking foreign investors. Membership of all Western Balkan states in the new Central European Free Trade Agreement (CEFTA) and the associated matrix of bilateral free trade agreements are an indication of liberalizing trade relations that have resulted in increased trade and investment linkages among the region’s economies. The CEFTA is thus another step toward eventual integration of the SEE countries into the EU. Furthermore, accession of the region’s two most robust economies, Romania and Bulgaria, into the EU on January 1, 2007, offers producers from these countries direct access to the EU’s other 25 economies.

7 Center for Strategic and International Studies, 2006. “Economic Development and Investment Promotion in Southeast Europe.” CSIS Policy Report. 8 Status with the EU for SEE countries ranges from full membership (e.g., Romania, Bulgaria), candidate country status (e.g., Croatia, FYR Macedonia), Stabilization and Association Agreement signed (e.g., Albania), finalized (e.g., Bosnia and Herzegovina), initiated (e.g., Montenegro) or under negotiation (e.g., Serbia). Moldova's relationship with the EU is governed by the European neighborhood policy arrangement. All information is current as of June 2007. 9 Measured in current U.S. dollars in 2005; World Development Indicators, World Bank Group.

6 Attracting Investment to South East Europe

The rate of increase in FDI flows into SEE has in recent years surpassed that of Central Europe, and is significantly faster than the rate of increase in Western Europe.10 Improvements in macroeconomic performance as well as microeconomic reforms have resulted in an average economic growth of 5 percent in recent years. Other factors contributing to robust economic growth include strong domestic demand fueled by credit growth, and the revival of export markets. Further strengthened economic performance is expected as a result of political stabilization and consolidation, improvements in transparency and the rule of law, and removal of administrative impediments to business. In particular, finalization of the status of Kosovo and governance of Bosnia and Herzegovina is expected to further improve the perceptions of potential investors currently concerned about apparent socio-political instability in certain areas of the region.

Moreover, it is not only the official macroeconomic statistics and performance indicators that are signaling positive trends. From an investor’s perspective, the strongest vote of confidence in a market’s performance and business-friendliness is reinvestment and expansion of operations by businesses that have already entered the market. In SEE, almost 50 percent of surveyed foreign investors operating in the region said they are currently considering growing their presence. Furthermore, four out of five resident investors stated that conditions for doing business in South East Europe are improving. Such declarations based on experience, rather than just impressions and perceptions, are powerful affirmations of the region’s growing attractiveness for foreign investment.

REPORT APPROACH

This study identifies key opportunities and challenges to investing in the SEE region from the perspective of foreign investors. Over 300 senior executives of European, American and Asian corporations in all major sectors were asked to comment on their experiences and perceptions of SEE11 as an investment destination. Encouraging findings detailed in this report highlight the critical fact that the positive trends in the region’s transformation have been registered by foreign investors around the world. This opinion-based data is intended to complement factual information gathered and presented through various comprehensive and expert reports on the progress of the SEE region in adopting, implementing and enforcing economic policies.12 Investors’ decisions are, after all, influenced by a combination of this subjective and objective data which together provides a picture of a country or a region as an investment destination.

REPORT STRUCTURE

The data presented in this report’s two key chapters is based on two projects: (1) the FDI Trends Analysis section draws on an Oxford Intelligence report commissioned by MIGA and looks at the origin, destination and sectoral distribution of FDI flows into SEE; and (2) the Investor Survey Findings section presents results of a recent survey by E&Y, conducted at the request of FIAS, an investment climate advisory service of the World Bank Group. The report analyzes investors’ opinions on the region’s past and future performance, areas of

10 As reported later in this report, over the last five years FDI inflows have on average grown by over 70 percent per annum in SEE, 60 percent in Central and Eastern Europe, and 12 percent in the European Monetary Union. 11 Geographic scope of the survey encompasses the following nine SEE countries: Albania, Bosnia and Herzegovina, Bulgaria, Croatia, FYR Macedonia, Moldova, Montenegro, Romania and Serbia. 12 Examples of such reports include the EBRD Transition Report, regular EC reports and others.

Attracting Investment to South East Europe 7

comparative advantage and disadvantage, key impediments to future investment growth and other aspects of the region’s investment climate.

The report is organized as follows: this introduction is followed by a section on methodology and sources. Next, there are the two principal data and results chapters on FDI trends and investor perceptions. In the final chapter, individual country profiles discuss survey findings for each of the nine countries covered by this report. Two appendices include the glossary of terms and acronyms, and information on country classifications.

AUDIENCE

This report is intended to be useful for multiple purposes among a wide audience. For prospective investors, it presents the investment performance and potential of the SEE region as seen by other foreign company executives. Furthermore, it is expected that this assessment of the region, until recently perceived as war-torn and unstable, as a whole will encourage potential investors to consider its markets in their investment location decisions. For foreign investors already operating in SEE, this report places their experiences in the context of a broader appraisal of the countries by their colleagues, partners and/or competitors.

For governments and policymakers, the findings may be useful in stimulating further reforms of the investment climate and business environment areas identified as key impediments to investment and enterprise growth.

FURTHER RESOURCES

Further resources are available from:

FIAS: The Investment Climate Advisory Service – www.fias.net Invest In The Western Balkans – www.iiwb.org FDI Promotion Center – www.fdipromotion.com IFC Advisory Services, Southern Europe – www.ifc.org/pepse Ernst & Young International Location Advisory Services – www.ey.com/fr

8 Attracting Investment to South East Europe

Survey Methodology and Sources

I. WORLD BANK GROUP/ERNST & YOUNG: INVESTOR PERCEPTION SURVEY OF THE SOUTH EAST EUROPEAN REGION

In October 2006, the World Bank Group commissioned Ernst & Young to undertake an expanded survey of investor perceptions on the attractiveness of the SEE region. The telephone survey was carried out by CSA, an independent market research firm, and included 304 senior executives of multinational corporations from Europe, North America and Asia. Two types of investors were surveyed, and they will be referred to throughout this report as:

Resident investors – multinational corporations which have already established operations in the South East European region. As such, it can be assumed that their responses to the survey questions were based on their practical experience operating in the region, rather than only their perceptions. Resident investors comprised 43 percent of the sample.

Potential investors – multinational corporations which have not yet established operations in the South East European region. To increase the likelihood that these respondents were familiar with the SEE region, they were selected from countries with strong investment and trade ties to the region. Potential investors comprised 57 percent of the sample.

The survey was administered over the telephone in one of several world languages based on the preference of each respondent, and it required about 20 minutes to conduct. It consisted of a set of multiple choice and open-ended questions, which were then recoded by the interviewer. The questionnaire included a set of questions that have been tried and tested in other country studies, as well as additional questions on a few issues specific to the transition economies in the South East European region. These questions covered several areas of information: investors’ criteria for choosing locations for their international set-ups; their intentions to invest in the subject countries; sectoral, functional and regional factors; and an overview of competitive locations. On average 15 calls to various companies were needed in order to conduct one interview.

Regional classifications

The survey was undertaken in two phases that separately addressed investment conditions in two sub-regions of SEE comprising the following countries:

South Central Europe: Albania, Bosnia and Herzegovina, Croatia, FYR Macedonia, and Montenegro.

Attracting Investment to South East Europe 9

South East Europe: Bulgaria, Cyprus, Greece, Moldova, Romania, Serbia and Turkey.

Wherever possible, this report presents data only for the nine countries covered by the scope of this report:

South East European region: Albania, Bosnia and Herzegovina, Bulgaria, Croatia, FYR Macedonia, Moldova, Montenegro, Romania and Serbia.

This report is based on two primary sources of data covering these same countries in addition to Greece, Turkey and Cyprus. Since the data was not collected and organized with the original intent of presentation in a single report, there are some inconsistencies in the inclusion of some countries in the sub-regional groupings depending on the data source. To the extent possible, the data is disaggregated and presented either for specific countries, or for the nine-country South East European region framed by this project. When such disaggregation of the original data was not possible, the findings are presented in sub-regional groupings as defined by the E&Y investor survey and the European Investment Monitor (EIM). For the most part, the regional classifications in the various sources of data overlap; however, if further clarification is required about the precise composition of each grouping, please note the source of the data and refer to Appendix 2.

Industrial sectors

The surveyed companies encompassed all major sectors of business activity. The industry breakdown, presented in Figure 1, captures the predominant industrial sectors of production and service provision in the region. Manufacturing, energy, transport and consumer goods represent over 50 percent of the sample. Business-to-business services, including banking, insurance and legal services are also well represented.

Figure 1: Sectors of surveyed companies

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

10 Attracting Investment to South East Europe

Nationality and location of companies

Foreign investors from over 25 countries in Europe, North America and Asia were included in the survey sample. The precise composition was determined by actual investment flows into the SEE region tracked by Ernst & Young’s European Investment Monitor. Given the predominance of Western European investors in the region, they comprised 72 percent of the overall sample. The rest of the sample included 16 percent that were incorporated in North America, 8 percent in Central Europe and 4 percent in Asia. Figure 2 shows the distribution of the survey sample by regional location/origin. The breakdown by nationality was very similar for established and prospective investors.

Figure 2: Origin of surveyed investors

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

This wide geographic distribution of the investors in terms of their home countries helped ensure that the results accurately captured the experience and sentiment of a wide range of global businesses. Throughout the report, disaggregated data helps to illustrate how opinions can vary based on the origin of the surveyed companies and their status as existing or potential investors.

Respondents

The survey was targeted at senior managers of multinational corporations. Over half of the respondents (56 percent) were financial directors, managers or accountants, and one quarter were top executives (CEO, Chairman, President, Managing Director, and Vice President). The detailed breakdown of positions is shown in Table 1.

Attracting Investment to South East Europe 11

Table 1: Position of surveyed investors

Position Title % of Sample

Finance Director / Manager 56 Managing Director / Vice President 13 Director of Development / Establishments 9 Chief Executive Manager 9 Director of Strategy 4 Chairman / President 4 Administrative Director and Manager 3 Secretary General / Administrator 1 Director of Unit / Site <1 Consultant <1 Other <1

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Company size

The majority of the respondents (61 percent) were companies with an annual sales turnover of less than 150 million euros (approximately 200 million U.S. dollars). Twenty-nine percent of surveyed companies had turnover between 150 million and 1.5 billion euros (approximately 200 million – 2 billion U.S. dollars), and the remaining 10 percent of the sample comprised large multinational corporations with annual turnover of more than 1.5 billion euros (approximately two billion U.S. dollars).

II. MULTILATERAL INVESTMENT GUARANTEE AGENCY/OXFORD INTELLIGENCE: FDI TRENDS ANALYSIS OF SOUTH EAST EUROPE

The other principal source of data for this report is a recent study on FDI trends in South East Europe, conducted by Oxford Intelligence at the request of MIGA. This study is based on actual greenfield FDI projects into the SEE region, as tracked by the E&Y European Investment Monitor since 1997. Investment project details recorded include the country of origin of the parent company, city as well as region and country receiving the investment project, the type of investment (new, expansion or co-location) and the industry sector and activity (e.g. contact center, manufacturing plant). Additional information—available in some cases— includes: jobs created, capital expenditure of the project, and the start-up date or estimated launch date of operations.

The geographic groupings used by the EIM are similar to those in the investor survey, and include the following two classifications:

Western Balkans: Albania, Bosnia and Herzegovina, Croatia, FYR Macedonia, Serbia and Montenegro (including Kosovo).

South East Europe: Western Balkans, plus Romania, Bulgaria, Greece and Moldova.

12 Attracting Investment to South East Europe

FDI Trends Analysis Findings

In 2006, MIGA commissioned a study of greenfield FDI in Southeast Europe, which reviewed the number of projects, sectors and origin of greenfield investments and investment announcements in the various countries of SEE.13 This study was intended to provide a broad context on actual FDI inflows to complement the perspective indicated by the findings of the investor survey. It focuses on the Western Balkan countries, and also examines a broader geographic grouping of Southeast Europe, which includes the Western Balkans as well as Romania, Bulgaria, Turkey and Moldova. Central and Eastern Europe (CEE) is used as a comparator.

SUMMARY FINDINGS

FDI growth and origin of investors

FDI into South East Europe is increasing. Post-2001 has seen a steady growth in FDI projects into South East Europe. This trend has accelerated post-2003 with strong investment flows to Romania, Bulgaria, and to a lesser extent, Croatia and Serbia.

Western Europe and the United States are the primary and secondary sources respectively of investment into South East Europe. For Western Balkan countries, the main source of investment is companies in countries with close ties to the region. Slovenia is the most important source of projects; Austria, Germany and Italy are also important sources of greenfield FDI for the Western Balkans. Similarly, the main source of investment for Central and Eastern Europe is companies located in Western European countries, in particular Germany and Austria, but also the United Kingdom, France and the Scandinavian countries. In all three destination markets analyzed (CEE, SEE and Western Balkans), the United States is the second most important source of greenfield FDI. (See Table 2.)

13 Please note that all FDI data reported in this section of the report is presented in terms of FDI projects, rather than monetary value of FDI stocks or flows.

Attracting Investment to South East Europe 13

Table 2: FDI projects in South East Europe: Top 20 source countries (1997 – Q1 2006)

Q1 Numbers of Projects 1997 1998 1999 2000 2001 2002 2003 2004 2005 Total 2006 Germany 10 8 2 8 21 19 14 28 29 6 145 United States 7 9 9 10 9 8 12 28 19 6 117 Austria 4 5 3 3 1 6 9 14 23 3 71 Italy 1 1 1 2 11 11 9 16 14 3 69 France 5 1 3 4 3 7 7 10 14 .. 54 Greece 1 2 1 3 8 10 9 8 5 .. 47 Slovenia 1 .. .. 1 2 9 6 9 9 .. 37 United Kingdom 3 .. 7 1 1 5 2 12 1 2 34 Netherlands .. 3 3 1 5 2 .. 11 5 1 31 Turkey .. 3 .. 2 1 7 5 7 4 .. 29 Sweden 2 2 2 1 4 .. .. 5 10 1 27 Switzerland 2 1 1 1 3 1 .. 8 10 .. 27 Japan ...... 2 3 3 5 3 1 17 Belgium 1 2 1 .. 1 1 .. 2 2 1 11 Spain 2 .. 1 .. 2 2 1 2 1 .. 11 Hungary .. 2 1 .. .. 1 .. 6 .. 1 11 South Korea 4 2 ...... 1 .. .. 2 1 10 Denmark 1 ...... 1 .. 1 3 .. 6 Poland .. 1 ...... 3 2 .. 6 Israel ...... 1 1 1 .. 2 1 .. 6 Other 4 5 3 5 14 18 9 36 21 3 118 Total 48 47 38 43 89 113 86 213 178 29 884

Source: Ernst & Young European Investment Monitor, powered by Oxford Intelligence.

As FDI into the Western Balkans accelerates, Croatia and Serbia have emerged as market leaders. As shown in Table 3, about 75 percent of the investment projects in the Western Balkans in the last 10 years were initiated between 2002 and the first quarter of 2006. Clearly, subsiding conflict by 2000 encouraged the resumption of investment into the region. Investment into Serbia resumed after the arrest of the former president in 2004.

Table 3: Number of investment projects in Western Balkans (1997 – Q1 2006)

Number of Projects by Destination Country for Western Balkans

Year 1997 1998 1999 2000 2001 2002 2003 2004 2005 Q1‘06 Total Croatia 9 5 2 3 11 9 11 12 21 1 84 Serbia and Montenegro 4 1 .. 3 9 4 7 22 19 1 70 Bosnia and Herzegovina 1 2 3 2 3 8 7 8 7 .. 41 FYR Macedonia ...... 1 2 2 2 4 .. 11 Albania ...... 4 3 1 .. 8 Total 14 8 5 8 24 23 31 47 52 2 214 Source: Ernst & Young European Investment Monitor, powered by Oxford Intelligence.

Furthermore, investment flows into the Western Balkan region account for an ever increasing share of investment in SEE. As shown in Table 4, while in 1999 the Western Balkan countries attracted only 13 percent of the SEE FDI, by 2005 their share had more than doubled to 29 percent.

14 Attracting Investment to South East Europe

Table 4: Regional composition of FDI projects in SEE (1997 – 2005)

Other SEE countries compared to Western Balkans’ % share of projects

Numbers of Projects 1997 1998 1999 2000 2001 2002 2003 2004 2005 Total Romania / Bulgaria / 71 83 87 81 73 80 64 78 71 76 Greece / Moldova Western Balkans 29 17 13 19 27 20 36 22 29 24

Source: Ernst & Young European Investment Monitor, powered by Oxford Intelligence.

Sectors and activities Manufacturing is the main investment activity in South East Europe. Although manufacturing is the key overall type of investment projects undertaken in both SEE and CEE, the most prominent sectors in each region vary widely. Across the broader Eastern European region (including CEE, SEE and the Western Balkans), 60 percent of all projects since 1997 have been in manufacturing sectors. However, the leading investment sectors in SEE have been food, business-to-business services, non-metallic mineral products, automotive components, electronics, plastics and chemicals. (See Tables 5 and 7.)

Table 5: FDI projects in South East Europe: Top 20 sectors (1997 – Q1 2006)

Q1 1997 1998 1999 2000 2001 2002 2003 2004 2005 Total Number of projects 2006

Food 4 3 5 3 9 10 12 26 12 3 87 Non-metallic mineral 11 5 2 .. 8 6 8 19 17 .. 76 products Automotive 2 2 2 4 7 8 8 19 16 2 70 Components Financial 8 8 3 5 3 1 2 9 9 4 52 Intermediation Electronics 1 1 3 4 6 5 2 7 12 3 44 Chemicals 3 5 2 5 4 1 5 8 8 .. 41 Machinery & 1 2 .. 3 1 5 4 8 12 2 38 Equipment Business Services .. .. 3 2 1 2 1 8 17 1 35 Plastic & Rubber 1 .. 2 4 3 3 10 8 3 34 Electrical .. 1 1 1 6 7 2 10 5 1 34 Other Transport 1 .. 1 1 1 5 1 13 8 1 32 Services Pharmaceuticals 3 3 1 .. 4 6 1 10 3 1 32 Software 1 1 1 4 4 1 1 4 8 2 27 Furniture & Sports 1 .. .. 1 3 2 9 8 3 .. 27 Equipment Automotive Assembly 4 2 2 3 3 6 .. 4 2 .. 26 Textiles .. .. 1 .. 4 6 3 6 4 .. 24 Clothing .. 1 1 1 2 6 5 5 3 .. 24 Wood .. .. 1 .. 3 6 2 1 7 .. 20 Telecommunications & .. 1 1 2 1 3 .. 3 4 .. 15 Post Basic Metals .. 3 .. .. 1 3 4 2 2 .. 15 Other Sectors 7 9 6 4 14 21 13 33 18 6 131 Total 48 47 38 43 89 113 86 213 178 29 884

Source: Ernst & Young European Investment Monitor, powered by Oxford Intelligence.

Attracting Investment to South East Europe 15

Recent growth in manufacturing FDI has evolved similarly in South East Europe and the Western Balkans. In the SEE region, prior to 2001 there were relatively fewer projects and approximately half of these were in manufacturing. Since 2001, the overall number of projects has increased, and the majority of projects (65–70 percent) have been in manufacturing. Likewise, in the Western Balkans, few projects were established prior to 2001, a “watershed” year in terms of growth. The majority of early projects were generally in non- manufacturing sectors, often in sales or logistics. Since 2001, the majority of Western Balkan projects (over 60 percent) have been in manufacturing. For comparison, in Central Europe manufacturing projects peaked at 74 percent by 2000 (from mid-60 percent in earlier years) and have since gradually declined to the mid-60 percent level.

Manufacturing is declining and service projects are increasing in South East Europe, a trend reflected in all of Europe. The general trend in manufacturing relative to services projects is the same for both Western Europe and Eastern Europe (including CEE, SEE and the Western Balkans)—the economy of Europe will become majority service-driven over the longer term cycle (see Table 6). Currently, service-based projects constitute almost 50 percent of all activity in Western Europe, but represent less than 30 percent of investment projects in SEE and CEE. It is expected that service sector projects will shortly constitute the majority of all investments in Western Europe. Similarly, manufacturing activity in CEE and SEE will continue to account for a majority of total projects, but will likely trail services within 10 to 15 years.

Table 6: Trends in manufacturing and services FDI projects in Europe (1997 – Q1 2006), % of total projects

Manufacturing Q1 1997 1998 1999 2000 2001 2002 2003 2004 2005 Average Projects 2006

Europe 74 70 66 56 58 63 70 62 57 55 64 Western Europe 73 67 63 50 50 56 64 55 52 52 59 Central & Eastern 83 82 84 84 78 80 84 79 71 63 79 Europe South East Europe 77 70 74 67 83 81 87 76 69 62 76 Services Projects Europe 26 30 34 44 42 37 30 38 43 45 36 Western Europe 27 33 37 50 50 44 36 45 48 48 41 Central & Eastern 17 18 16 16 22 20 16 21 29 37 21 Europe South East Europe 23 30 26 33 17 19 13 24 31 38 24 Source: Ernst & Young European Investment Monitor, powered by Oxford Intelligence.

Business services is the fastest growing sector in both SEE and the Western Balkans. In order to identify the fastest growing sectors in Eastern Europe and the Balkans, the total number of projects in each sector since 1997 was divided by the number of projects in that sector in the past two years. This analysis revealed that the top four fastest growing sectors—business services, plastics and rubber, transport services, and machinery and equipment—are the same for both SEE and the Western Balkans, though in a slightly different order. (See Table 7.)

Table 7: Growth of FDI projects in selected industries Top 10 Emerging Sectors (% growth since 1997) Western Balkan Countries South East Europe Countries Business Services 73 74 Business Services Plastic & Rubber 71 69 Other Transport Services Other Transport Services 69 62 Plastic & Rubber Machinery & Equipment 67 58 Machinery & Equipment Chemicals 56 57 Fabricated Metals Automotive Components 55 57 Construction Food 50 53 Automotive Components Software 50 52 Software Fabricated Metals 50 50 Electronics Electrical 50 47 Non-metallic mineral products

Source: Ernst & Young European Investment Monitor, powered by Oxford Intelligence.

16 Attracting Investment to South East Europe

Investor Survey Findings

INVESTOR OPTIMISM ABOUT REFORMS AND PERFORMANCE, PAST AND FUTURE

Foreign investors are increasingly optimistic about investment opportunities in South East Europe.

Although most of the countries in South East Europe are only gradually emerging on the maps of foreign investors as potential investment destinations, executives of multinational corporations are increasingly encouraged by the recent progress of these countries, and more importantly, the future prospects of SEE countries. Over 60 percent of surveyed respondents stated that the SEE region has improved its attractiveness as an investment destination over the last year. In comparison, when foreign investors considered Western European destinations such as Italy, France and Germany, only 33, 36 and 42 percent of executives, respectively, felt the investment conditions have improved. (See Figure 3.)

Figure 3: Investors’ perceptions of market conditions

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Attracting Investment to South East Europe 17

Among those respondents with a negative perception of Europe’s investment conditions, the differential was even greater. While 16 percent thought that the investment climate and opportunities in all of Europe had deteriorated over the last year, only 3 percent felt the same about the SEE region.

Investors’ rising optimism has also translated into actual investment activity, as evidenced by gradually increasing FDI flows into the SEE economies. As shown in Figure 4, FDI per capita inflows into the region are on an overall upward trajectory.14 Croatia is a clear leader, with FDI per capita inflows in 2004 at almost $300. Moldova and FYR Macedonia, on the other hand, trail all other countries in the region, with inflows of only about $20 and $70 per capita in 2004, respectively.

Figure 4: FDI inflows to South East European countries

Source: World Development Indicators, World Bank Group.

The average growth rate of foreign investment inflows into the SEE region has on average surpassed that of the EMU, and even Central Europe (Figure 5).15 While in the EMU economies the average FDI growth rate since 2000 has been around 12 percent, the SEE region has experienced an average annual increase of FDI inflows of over 70 percent.

14Occasional year-to-year fluctuations and disruptions of this upward trend are primarily due to large privatization projects, a phenomenon which underlies FDI statistics in all transition economies usually in the first decade after the transformation from a command to market economy. 15 Faster growth rate of FDI inflows in the SEE region are primarily due to two interrelated factors: (1) the lower absolute base in terms of FDI stock, which results in a greater increase in the rate of growth with each additional investment project; and (2) the wave of privatization, which has swept through the SEE region later than through Central Europe. While the Central European EU8 economies experienced most of their FDI inflows throughout the 1990s and early 2000s, the SEE region is now in the “catch-up” phase.

18 Attracting Investment to South East Europe

Figure 5: FDI inflows to regions in Europe

Source: World Development Indicators, World Bank Group.

Interestingly, all regions of Europe perform comparably on another measure of investment flows—FDI net inflows as a percentage of gross domestic product (GDP). In EMU and SEE, FDI/GDP has averaged slightly above 4 percent since 2000, while the figure is slightly higher in Central and Eastern Europe, where it stands at a little over 5 percent. Furthermore, there is no distinct trend in annual fluctuations that would set any of these regions apart from each other. However, given the large size of the Western European economies, it is obvious that in absolute terms the EMU markets have received much more investment than CEE and SEE economies.

The perception of surveyed investors of the improving investment conditions in SEE are echoed by other sources of data as well. The Doing Business project of the World Bank Group,16 which benchmarks conditions for opening and operating a company around the world, finds that South East Europe as a region has reformed more than most other economies. The region was ranked 93 in the world in 2005, and 86 in 2006.17 In the same period the rank of a typical Central and Eastern Europe slipped one position from 43 in 2005 to 44 in 2006.18 The SEE region has, for instance, steadily simplified the process of starting a business, which is one of the areas measured by the Doing Business indicators. As shown in Figure 6, while this process required 44 days in 2003, it required only 30 days in a typical South East European country by 2006. Interestingly, on this measure of administrative and institutional efficiency, SEE ranks above Central and Eastern Europe.

16 The Doing Business project is an initiative of the World Bank Group providing measures of business regulations and their enforcement in 178 countries worldwide. 17 The regional rank is calculated as a simple average of the individual countries’ ranks. 18 Similarly, Central and Eastern Europe’s rank was determined by taking a simple average of the ranks of countries which comprise the region.

Attracting Investment to South East Europe 19

Figure 6: Doing Business in South East Europe

Source: Doing Business 2007 — How to Reform, World Bank Group.

Similarly, global competitiveness of the economies in SEE is growing (Figure 7). In 2006, eight out of nine countries in the region improved their performance in the World Economic Forum’s Global Competitiveness Index, which encompasses a wide array of areas including quality of institutions, infrastructure, macro-economy, education, market efficiency, and others.

20 Attracting Investment to South East Europe

Figure 7: Global competitiveness of South East Europe’s economies

Source: Global Competitiveness Index, World Economic Forum.

Furthermore, the expectations of foreign investors indicate that the increasingly positive perspective on investment conditions in SEE will continue. When asked about the region’s future prospects, more than 55 percent of respondents considered the region increasingly attractive for their companies’ possible near- to medium-term investments. Some countries, such as Croatia and Romania, lead the group with a near 70 percent investor confidence rate. The smaller and less-developed regional economies, Moldova and Albania, fared worse with slightly more than 40 percent of investors positive about the countries’ increasing future attractiveness. (See Figure 8.)

Attracting Investment to South East Europe 21

Figure 8: Expectation of future attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Perhaps even more significant is the fact that few executives felt that the region’s attractiveness might decline in the next three years. Fewer than 6 percent of surveyed investors expressed a concern over the countries’ future development by stating that the region’s appeal to foreign companies would actually decrease. This reflects a significantly more positive investor sentiment than was expressed about Western Europe, where over 18 percent of investors expected investment conditions and opportunities to deteriorate.19 For some countries (for example, France), as many as 32 percent of investors expressed negative views of the economy’s investment prospects. (See Figure 9.)

19 Data on Western Europe is derived from the Ernst & Young European Attractiveness Survey 2006.

22 Attracting Investment to South East Europe

Figure 9: Future attractiveness of South East Europe vs. Western Europe

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Attracting Investment to South East Europe 23

LEVEL OF AWARENESS AND KNOWLEDGE ABOUT BUSINESS CONDITIONS

Foreign investors have limited knowledge about the SEE region’s business climate and investment opportunities.

A strikingly high number of foreign investors claimed they are poorly informed about South East Europe’s investment climate. Over 60 percent of respondents stated they had “very bad or rather bad knowledge” of the SEE countries’ business conditions. Even in cases such as Romania and Bulgaria, which have received widespread international press coverage on their recent accession to the EU, around 50 percent of business executives felt their understanding of the economic and business conditions was inadequate. The level of familiarity with the region’s countries decreases with the size of the economy and level of development. Almost 80 percent of investors felt they had insufficient knowledge about countries such as Albania and Moldova. (See Figures 10 and 12.)

Figure 10: Investors’ awareness of business conditions

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Clearly, it is difficult for small countries from a recently war-torn region to compete for investors’ attention. However, lack of awareness is a problem affecting not only prospective

24 Attracting Investment to South East Europe

foreign investors, but also those already established in the region. Only 47 percent of foreign investors in Serbia felt they had good knowledge of the country’s business environment. For resident investors in Albania, Moldova and Montenegro, only 35, 28 and 21 percent, respectively, said they were well-informed. As shown in Figure 11, the lack of knowledge was evident in all respondent sectors; more than half and up to 70 percent of respondents in each of the four surveyed sectors said they had bad or rather bad knowledge of SEE business conditions. The investors’ level of knowledge was a function of the distance of the respondent company’s home office from the SEE markets. In particular, more North American than European investors said they were poorly informed about the investment conditions in the SEE region, and Central European companies claimed the most familiarity as a whole (Figure 13).

Figure 11: Companies’ knowledge of investment climate (by sector)

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

These results highlight the necessity for the region’s IPAs and other promotion intermediaries to continue to improve their awareness building and information provision services internationally as well as domestically. Furthermore, the difficulty in accessing necessary information, even for the resident foreign businesses in SEE, suggests there are insufficient public information services in the region.

Attracting Investment to South East Europe 25

Figure 12: Level of awareness among potential investors

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

26 Attracting Investment to South East Europe

Figure 13: Awareness of market conditions (by investor’s origin)

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

The low level of investor familiarity with the SEE region is evident throughout the survey results in various contexts. When asked to name three priority areas for the region’s development, more than one quarter of surveyed investors found it difficult to express an opinion. Even for Serbia, which has recently been discussed extensively in the media related to the unresolved status of Kosovo, as many as 29 percent of investors were unable to suggest three priority areas for improving the country’s attractiveness.

Attracting Investment to South East Europe 27

COMPARATIVE ADVANTAGES AND DISADVANTAGES

Low labor costs, productivity potential and flexible labor policy are South East Europe’s key comparative advantages.

Investors rank South East Europe as the continent’s most attractive region due to its low labor costs, potential future productivity gains for their companies, and flexibility of laws and policies regarding employment. Forty-one percent of surveyed investors ranked the SEE region as Europe’s most appealing when asked about the availability of low-cost labor.20 Central Europe placed second with a 17 percent respondent rating, likely a reflection of rising labor costs in CEE. The higher-cost Western European and Nordic markets were selected by 8 and 4 percent of respondents, respectively. (See Figure 14.)

Figure 14: Comparative advantages of regions in Europe

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

20 The predominance of low labor costs in respondents’ rankings of the most significant comparative advantage of SEE is in part due to the fact that over 50 percent of survey respondents were directors and managers of their companies’ finance departments. CFOs and their equivalents are more likely to evaluate investment locations based on costs, while CEOs and chairmen may focus on other strategic factors as well as costs.

28 Attracting Investment to South East Europe

The region’s gradual shift toward higher value-added production, accelerating adoption of modern technologies, and a well-educated, technically-skilled labor force was reflected in SEE’s leading position as Europe’s most attractive location in terms of potential for productivity increase. Thirty-one percent of respondents ranked SEE ahead of Central Europe (21 percent), and the traditional economic powerhouse of Western Europe (18 percent). Most of this positive sentiment can be attributed to the region’s leading markets of Romania and Bulgaria. When asked to rate the productivity potential of the Western Balkan countries, only 6 percent of investors picked the region as Europe’s most attractive.

Investors have also recognized the progress of the SEE countries, and specifically the region’s new EU entrants, in liberalizing and simplifying their labor policies. Thirty percent of the surveyed companies selected SEE as Europe’s leading investment destination in terms of flexible labor legislation. Again, the labor policies of the Western Balkan countries were ranked behind those of their southern neighbors, with only 7 percent of investors identifying the Western Balkans as Europe’s most business-friendly region.

Figure 15: Comparative disadvantages of regions in Europe

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

As shown in Figure 15, investors gave the SEE region low marks for competitiveness in governance, R&D and infrastructure. The Western Balkan region was one of the lowest ranking European regions in terms of “transparency and stability of political, legal and regulatory environment.”21 Similarly, the respondents cited the availability and quality of R&D as a comparatively weak area in the Western Balkan countries, as well as in Romania, Bulgaria and Moldova. Lastly, investors considered both transport and ICT infrastructure in South East

21 This report uses the term “governance” to refer to the interrelated set of policy areas encompassing transparency and stability of the political, legal and regulatory environment.

Attracting Investment to South East Europe 29

Europe as the most disadvantageous areas relative to other parts of Europe, except Russia, Ukraine and Belarus.

Ensuring political stability, improving the rule of law and increasing transparency are the fundamental prerequisites of any well-functioning business-enabling environment. Foreign companies are deterred by opacity and unpredictability of the markets in which they invest. As noted later in this report, the perception of political instability is the single most critical impediment to increased foreign investment in the SEE region.

Improved communications networks and R&D quality are critical if the region wants to continue to attract higher value-added production. For some time the CEE countries and the Baltic states have recognized the importance of high-technology development and manufacturing in diversifying their industrial base. As the SEE economies move up the value chain of production and gradually shift the focus of their economic activity from manufacturing to services, R&D and infrastructure will become increasingly fundamental factors spurring this transformation.

30 Attracting Investment to South East Europe

PRIORITIES FOR INCREASING ATTRACTIVENESS

Political instability is the single most important impediment to increased FDI flows into SEE, followed by the low level of infrastructure quality and the underdeveloped economic policy and regulatory framework.

More than one third of surveyed investors felt that increased political stability should be a top priority for the SEE governments in improving their countries’ investment climates (Figure 16). This comes as no surprise for a number of reasons, including the fact that media coverage of the SEE region has focused on issues such as the unresolved political status of Kosovo, the political fragmentation of Bosnia and Herzegovina, and ethnic strife in FYR Macedonia as well as other regions of former Yugoslavia, all of which influence the impressions of investors.

Figure 16: Priorities for South East Europe’s markets

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Attracting Investment to South East Europe 31

Whether significant investor concern about political instability accurately reflects the reality in each of these countries is a valid question, but not particularly germane in the context of how investors choose their project locations. Investment decisions are not based on stated facts, but rather on investors’ perceptions of and confidence in the validity of those facts. In the case of the SEE region, the survey findings indicate that political uncertainty in some countries is casting a shadow over the entire region, and regardless of how stable certain countries might actually be, they are perceived in their regional context of relative political instability and uncertainty. (See Figure 17.)

Figure 17: Political stability as top priority

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Investors ranked harmonization of economic policies and regulatory frameworks with EU standards as the second most salient issue in improving the countries’ investment attractiveness. Rather consistently, about one fourth of investors named issues related to meeting European economic regulation standard as a top-three priority for the national public authorities in order to improve investment attractiveness. This figure was slightly lower, around 20 percent, for the less-developed countries that are further from EU integration, such as Moldova and Albania. (See Figure 18.)

32 Attracting Investment to South East Europe

Figure 18: Economic policy and regulations as #2 priority

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Inadequate transportation networks and ICT infrastructures are the third most critical set of areas for improvement, as cited by about one out of five investors. As shown in Figure 19, infrastructure modernization is an important issue for investors in Romania and Bulgaria; 29 percent of investors said infrastructure improvement should be a top-three priority for national authorities in these countries. The relative better rankings of the Western Balkan countries, where infrastructure quality is often below the level found in the new EU member countries, is most likely due to the large geographic size of Romania and Bulgaria, and the associated importance of the transport networks. Additionally, the heightened interest of investors in these two markets may be reflected in the high priority that investors placed on infrastructure development. Figure 19: Infrastructure development as #3 priority

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Attracting Investment to South East Europe 33

This ranking of priorities is confirmed by a recent survey of business executives conducted by A.T. Kearney. According to the results reported in the FDI Confidence Index, political stability and quality of the regulatory environment are two of the most critical determinants of FDI flows into the SEE countries (Figure 20).22 Market size, as expected, trumps all other variables. This comes as no surprise, given conclusions drawn from econometric analyses23 that the size of the economy and other inherent characteristics, such as proximity to home markets and natural resource endowment, are typically the leading explanatory variables of FDI flows worldwide.

Figure 20: Determinants of FDI in South East Europe

Source: FDI Confidence Index, A.T. Kearney.

Surveyed investors in all industrial sectors ranked political stability as the region’s top priority (Figure 21). The highest percentage of respondents citing political stability (42 percent) was in the manufacturing sector. The findings suggest the manufacturing industry is also concerned with infrastructure quality, likely given the importance of transportation and utilities to business operations. Improvements in the quality of life and flexibility of administrative procedures were consistently ranked as the fourth and fifth most important regional priorities by a rather consistent share (15-20 percent) of executives in all industrial sectors.

22 Infrastructure quality was not on the list of options for respondents to choose, and does not, as a result, appear in the chart. 23 Examples of econometric literature on FDI determinants: (a) Lim, Ewe-Ghee (2001), “Determinants of, and the Relation between, Foreign Direct Investment and Growth: A Summary of the Recent Literature,” IMF Working Paper, IMF; (b) Loree, D.W. and S.E. Guisinger (1995), “Policy and Nonpolicy Determinants of U.S. Equity Foreign Direct Investment,” Journal of International Business Studies, Second Quarter, pp. 281-299; (c) Schneider, F., and B.S. Frey (1985), “Economic and Political Determinants of Foreign Direct Investment,” World Development, Vol. 13, pp. 161-75.

34 Attracting Investment to South East Europe

Figure 21: Importance of political stability for all sectors

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

The order of the priority areas for improvement is remarkably consistent for both resident and potential investors. Both were most concerned with political stability and infrastructure quality. As shown in Figure 22, the only three areas where their preferences differed are: (1) adoption of EU economic policies, (2) improvement in the quality of life, and (3) improvement of the education system. In these instances existing investors, who are more familiar with the actual operating conditions, assigned a higher degree of urgency to improving these three policy areas. The differential between their assessment and that of potential investors is about 10 percentage points. While 29 percent of the resident investors stated that policy harmonization with EU standards ought to be a top priority for improving the countries’ attractiveness, only 20 percent of potential investors shared this view. Similarly, 26 percent of respondents established in the region felt that improvement of living standards ought to be among the top-three priorities of the region’s governments, while only 15 percent of potential investors stated the same preference. Lastly, a greater share of resident investors (25 percent) than potential investors (14 percent) found the region’s quality of education lacking. These results highlight additional areas for improving the SEE investment climate, not only in order to attract foreign investors, but also to retain those who have already invested in the SEE markets.

Attracting Investment to South East Europe 35

Figure 22: Differences in priorities for established vs. potential investors

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Other sources of data reinforce these results. According to the Business Environment and Enterprise Performance Survey (BEEPS) of local enterprises in transition economies, undertaken through a collaborative effort by the European Bank for Reconstruction and Development (EBRD) and the World Bank, many businesses continue to be burdened by costly and complex regulation. In 2005, on average one out of three firms in SEE found that business regulation was an impediment to its operations and growth. This question particularly focused on the administrative procedures and regulatory policies governing licensing, labor, trade and customs. While the situation overall has slightly improved over the last few years (33.4 percent of firms indicated regulation was an impediment in 2002 as compared to 32 percent in 2005), three countries experienced a negative trend (FYR Macedonia, Moldova and Romania). A comparison of these results to those of Central and Eastern Europe, which scores better, indicates that improving the business-enabling environment needs to continue to be a priority for SEE governments’ trying to support business creation and growth. (See Figure 23.)

36 Attracting Investment to South East Europe

Figure 23: Regulatory quality and administrative burden in South East Europe

Source: Business Environment and Enterprise Performance Surveys (BEEPS, 2002 & 2005), EBRD – World Bank.

These results imply important timing considerations for policymakers. Political stability is of preeminent importance to investors; yet it is difficult to achieve and sustain, and it depends on a plethora of complex issues and relationships that cannot always be influenced by policymakers in the short-run. Infrastructure quality, another driver of paramount importance in attracting FDI, takes time and resources to improve. Attaining EU-quality regulations, however, can be a relatively quick process that requires a certain degree of political will and technical competency, but can be effectively accomplished in the short- to medium-term. Countries looking to capitalize on the current investor interest in the region by improving the investment climate should devote greater attention to strengthening the regulatory policy framework to align with the European and global standards expected by multinational private investors.

Attracting Investment to South East Europe 37

REGIONAL COMPETITIVENESS FOR COMPANY UNITS AND PRODUCTION FUNCTIONS

South East Europe is investors’ most desirable European location for establishing factories and other production units.

Availability of skilled and low-cost labor and a relatively low tax burden, reported earlier as some of the key comparative advantages of South East Europe, make the region Europe’s most attractive destination for establishing production units of foreign corporations. Almost one third of surveyed business executives selected the SEE region as their preferred location for building plants and production capacities, as compared to 22 percent of respondents for Central Europe and 16 percent for Western Europe (Figure 24). This finding is consistent with the recent rise in labor-intensive manufacturing FDI in the region. According to the analysis of FDI flows, more than 60 percent of foreign investment projects in the SEE countries are in manufacturing sectors.

Figure 24: Forms of business expansion

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Analyzing the evolution of FDI flows in and out of various European regions reveals a recurring pattern of declining share in manufacturing FDI and an increasing ratio in services as the regions develop. Western Europe’s historic data undoubtedly confirm this trend; and more recently, Central and Eastern Europe have exhibited a similar model. In 2000, manufacturing investment projects as a share of all FDI projects in CEE peaked at 84 percent, and have since steadily declined to a percentage in the mid-60s.24 Manufacturing investment in the SEE countries has either plateaued at the current mid-60s percentage, or is still slightly growing. However, Oxford Intelligence concludes that while “in CEE and SEE manufacturing projects will continue to account for a majority of projects, within the next ten to 15 years they could give way to service sector projects.”

24 See previous report section, “FDI Trends Analysis Findings,” for a more detailed discussion.

38 Attracting Investment to South East Europe

Survey respondents found warehousing and logistics, functions closely associated with manufacturing, appealing as business propositions in SEE. As shown in Figure 25, investors ranked SEE’s attractiveness for investment in warehousing and logistics centers as competitive with both Western Europe and CEE; each of these regions was selected by approximately the same number of investors as their preferred location. Western Europe was the undisputed leader in most other business functions, including headquarters operations, R&D centers, administrative and accounting back offices, and design centers (Figure 26).

Figure 25: Regional attractiveness for warehousing and logistics centers

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Attracting Investment to South East Europe 39

Figure 26: Western Europe’s attractiveness by business units

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

In an analysis of a geographic sub-sample of survey data for CEE and SEE, two rapidly transforming regions competing for FDI, SEE leads CEE in FDI attractiveness across virtually all business functions. This result is due to the inclusion of Romania and Bulgaria in the SEE regional sample. When these countries, along with Turkey and Greece, are eliminated from the sub-sample in order to isolate the results on the attractiveness of only the Western Balkans, the rankings plunge (Figure 27). Thus, while production, storage and logistics are areas in which the Western Balkan region has a comparatively stronger potential than other business functions, investors evidently do not yet consider the Western Balkan countries in the same tier as their northern and western neighbors.

40 Attracting Investment to South East Europe

Figure 27: Regional comparison of attractiveness for various business functions

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

One remaining question not covered by the survey is the extent to which SEE competes for investment with markets outside of Europe, such as India and China. In recent years, these emerging economies have been particularly successful in attracting a rapidly growing volume of FDI drawn to these markets not only by their large size, rapidly growing middle class, and lower cost of labor than the SEE countries can offer, but also by their growing importance as back office administrative/accounting locations and call centers. It is therefore critical for the SEE countries to evaluate their competitiveness not only vis-à-vis their geographic neighbors, but also against competitors in other regions of the world. In this regard, infrastructure modernization, which has already been indicated as a priority in improving SEE’s attractiveness to investors, is of great relevance. Geographic proximity to Western and Central European markets is one distinct area where the SEE countries have a natural comparative advantage over Asian markets, and a reduction of transport costs through improvements in infrastructure networks would leverage this benefit.

Attracting Investment to South East Europe 41

FUTURE INVESTMENT PROSPECTS

Existing investors demonstrate their satisfaction by planning to further develop their business activities in the SEE region.

One of the most telling indicators of existing investors’ perceptions of business opportunities in a particular economy is their desire to further expand their operations. As shown in Figure 28, nearly half of the surveyed resident investors in the SEE region reported plans to grow and strengthen their presence in these markets. Furthermore, relatively few foreign companies with established operations in SEE said they were considering disinvestment and/or relocation to other countries or regions (Figure 29). In fact, existing investors in Western Europe were twice as likely to consider relocating as foreign companies in SEE (24 and 12 percent, respectively).25 This finding both validates the satisfaction of existing investors and indicates their confidence in the future business opportunities in the SEE markets.

Figure 28: Expansion plans by established investors

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

25 Data on Western Europe come from Ernst & Young European Attractiveness Survey 2006.

42 Attracting Investment to South East Europe

Figure 29: Disinvestment plans in regions of Europe

Sources: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006; Europe Investment Attractiveness Surveys, E&Y, 2006.

The strong positive attitude of existing investors in SEE is in marked contrast to the views expressed by prospective investors. Only about a third of surveyed investors outside SEE were considering establishing activities in the region. Their apparent caution is underpinned by the survey’s finding that investors have a low level of knowledge about the economic opportunities in the region, and by mostly negative media coverage on the countries’ socio- political developments. Highlighting the positive experience of resident investors is therefore a critical task for the region’s IPAs and other organizations looking to improve the region’s image and attract more investment into SEE.

About one half of those surveyed companies with investment and reinvestment plans in the region said that setting up a subsidiary is the preferred means of establishing or expanding their presence in a SEE market. Other forms of direct investment—acquiring companies or plants and extending existing locations—were selected by less than 15 percent of investors. Fewer than 10 percent of respondents said they prefer providing financial and productive capital to local firms, and acquiring financial interest in domestic companies. The respondents’ stated preference for greenfield investment, which is considered the most stable form of direct investment with the greatest development impact, is an encouraging indication of the investors’ intentions to establish a long-term business presence in the SEE countries. (See Figure 30).

Attracting Investment to South East Europe 43

Figure 30: Investors’ preferred modes of market entry

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

44 Attracting Investment to South East Europe

Country Profiles

The following nine country profiles provide survey results disaggregated for each country in the survey sample. They combine a numerical and graphical presentation with qualitative interpretation. Each country profile is organized in four sections:

Economic Performance Fact Sheet presents longitudinal data on macroeconomic indicators and investment climate quality indices of competitiveness, business conditions, corruption, economic freedom and governance.

Priorities for Improving Investment Attractiveness section reports investors’ views on key challenges and impediments to stronger investment growth in the SEE economies.

Future Attractiveness section illustrates the degree of investors’ confidence in the continued improvement of the SEE investment conditions over the next three years.

Investors’ Awareness of Business Environment section compares levels of investors’ knowledge of investment conditions in the SEE countries. Data is stratified by the nationality and industry of the surveyed investors.

Attracting Investment to South East Europe 45

ALBANIA

I. Economic performance fact sheet

2002 2003 2004 2005 2006 Trend2

Economic Indicators1

GDP per capita, PPP (constant 2000 international $) 4,055 4,258 4,511 4,757 .. ↑ GDP growth (annual %) 2.90 5.70 5.90 5.52 .. ↔ Foreign direct investment, net inflows (% of GDP) 3.03 3.17 4.62 3.13 .. ↔ Trade (% of GDP) 66.25 66.63 64.70 67.61 .. ↔ Exports of goods and services (% of GDP) 19.54 20.76 21.50 21.75 .. ↑ Imports of goods and services (% of GDP) 46.72 45.87 43.20 45.86 .. ↔ Gross capital formation (% of GDP) 31.89 25.48 25.89 23.60 .. ↔

Business Environment Indicators Global Competitiveness Index (higher score = better ...... 3.4 3.46 .. performance, World Economic Forum) Time required to start a business (number of days, .. 47 47 41 39 ↓ Doing Business) Time required to pay taxes (hours per year, Doing ...... 240 240 .. Business) Time required to obtain a license (number of days, ...... 344 344 .. Doing Business) Time required to export (number of days, Doing ...... 37 34 .. Business) Rigidity of Employment index (0 to 100, lower values = .. .. 30 48 38 ↔ better performance, Doing Business) Corruption Perception Index (1–10, higher score = 2.5 2.5 2.5 2.4 .. ↔ better performance, Transparency International) Index of Economic Freedom (lower score = better 3.24 3.23 3.1 2.93 2.75 ↓ performance, Heritage Foundation) Rule of Law index (-2.5 to 2.5, higher score = better -0.99 -0.9 -0.87 -0.84 .. ↑ performance, World Bank Institute) Government Effectiveness index (-2.5 to 2.5, higher -0.48 -0.42 -0.26 -0.49 .. ↔ score = better performance, World Bank Institute) Regulatory Quality index (-2.5 to 2.5, higher score = -0.40 -0.44 -0.23 -0.27 .. ↔ better performance, World Bank Institute) Notes:

1 Source: World Development Indicators, World Bank Group.

2 An up/down trend indicator requires a change of at least 1% in the same direction within the last two years.

Albania, despite being one of the poorest economies in the region, has exhibited steady economic growth at over 5 percent during the last three years. Inflow of FDI has also been relatively stable; however, it still constitutes only 3-4 percent of GDP. Relative to other regional economies, Albania is less integrated into the global economy, with the overall value of trade equaling only about two thirds of its aggregate economic output. The gap between Albania’s exports and imports is also much greater than that of its neighbors, resulting in a growing trade deficit.

Albania’s business environment is slowly improving. The country’s economy has undergone gradual liberalization, as demonstrated by the Index of Economic Freedom scores since 2002.

46 Attracting Investment to South East Europe

Governance indicators of the rule of law and regulatory quality also show signs of progressive improvement, albeit still not very quickly.26 The conditions for starting and operating a business, as measured by selected Doing Business indicators, have improved only slightly. Overall, while slowly improving, the pace of reform in Albania lags behind its neighbors.

II. Priorities for improving Albania’s investment attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Almost one half of surveyed investors felt that ensuring stability of the political environment should be the top priority of the public authorities in strengthening Albania’s investment environment. This policy area includes improvements in governance, rule of law and corruption. Improvements in infrastructure and economic policies were selected as the other two top priorities by about one quarter of respondents. This ranking of Albania’s priorities is consistent with investors’ perceptions of the SEE region as a whole.

26 The Worldwide Governance Indicators project, World Bank Institute.

Attracting Investment to South East Europe 47

III. Future attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Almost one half (45 percent) of surveyed investors said that Albania’s investment attractiveness will continue to improve over a three-year horizon. While this figure is lower than for most of Albania’s neighbors, it is nonetheless a signal of confidence on the part of foreign investors. Only one out of fifteen respondents was concerned about the possibility of deteriorating investment conditions in Albania in the near future.

IV. Investors’ awareness of business environment conditions

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

48 Attracting Investment to South East Europe

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Albania does not yet play a prominent role in investors’ consideration sets of possible project locations, a fact which correlates with their relatively low level of familiarity with the country’s business conditions. Approximately two thirds of investors felt rather or very poorly informed, and this figure does not vary much depending on the nationality of the company. Similarly, low awareness is exhibited across all industrial sectors. While ICT investors reported feeling somewhat better-informed, almost all foreign businesses in consumer goods and heavy manufacturing said they have a very bad or rather bad knowledge of Albania’s business environment. (See two figures, above and on previous page.)

Attracting Investment to South East Europe 49

BOSNIA AND HERZEGOVINA

I. Economic performance fact sheet

2002 2003 2004 2005 2006 Trend2 Economic Indicators1

GDP per capita, PPP (constant 2000 international $) 5,679 6,004 6,437 6,824 .. ↑ GDP growth (annual %) 5.30 4.00 6.20 5.00 .. ↔ Foreign direct investment, net inflows (% of GDP) 4.36 4.94 6.58 3.01 .. ↔ Trade (% of GDP) 103.2 105.8 108.1 116.9 .. ↑ Exports of goods and services (% of GDP) 26.37 28.25 32.00 36.22 .. ↑ Imports of goods and services (% of GDP) 76.82 77.56 76.11 80.70 .. ↔ Gross capital formation (% of GDP) 20.10 20.40 18.80 19.20 .. ↔

Business Environment Indicators

Global Competitiveness Index (higher score = ...... 3.58 3.67 .. better performance, World Economic Forum) Time required to start a business (number of .. 59 54 54 54 ↔ days, Doing Business) Time required to pay taxes (hours per year, ...... 100 100 .. Doing Business) Time required to obtain a license (number of ...... 476 467 .. days, Doing Business) Time required to export (number of days, Doing ...... 32 22 .. Business) Rigidity of Employment index (0 to 100, lower .. .. 49 42 42 ↔ values = better performance, Doing Business) Corruption Perception Index (1–10, higher score = better performance, Transparency 3.4 3.3 3.1 2.9 .. ↓ International) Index of Economic Freedom (lower score = better 3.89 3.54 3.3 3.16 3.01 ↓ performance, Heritage Foundation) Rule of Law index (-2.5 to 2.5, higher score = -0.99 -1.01 -0.75 -0.74 .. ↑ better performance, World Bank Institute) Government Effectiveness index (-2.5 to 2.5, higher score = better performance, World Bank -0.88 -0.70 -0.55 -0.53 .. ↑ Institute) Regulatory Quality index (-2.5 to 2.5, higher score = better performance, World Bank -0.94 -0.79 -0.52 -0.53 .. ↔ Institute)

Notes: 1 Source: World Development Indicators, World Bank Group. 2 An up/down trend indicator requires a change of at least 1% in the same direction within the last two years.

Since declaring independence, Bosnia and Herzegovina has exhibited sustained economic recovery. Real GDP growth has averaged 5 percent over the past several years. Despite impressive output expansion, the economy has yet to reach its prewar levels. The inflow of foreign investment grew steadily from 2002 to 2004, although privatization of state-owned companies has occurred at a pace slower than elsewhere in the region. Bosnia and Herzegovina has pursued a liberal trade policy; however, several restrictions were introduced in 2005.

50 Attracting Investment to South East Europe

The conditions for starting and operating a business, as measured by selected Doing Business indicators, have improved only slightly. Faster reforms are needed for Bosnia and Herzegovina to compete with other transition economies, as it strives for deeper integration into the European and global markets. Progress in transparency and governance is evidenced by the improving Corruption Perception Index27 and selected governance indicators of the World Bank.28

II. Priorities for improving Bosnia and Herzegovina’s investment attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Almost half of investors (44 percent) identified increased political stability as the top priority for Bosnia and Herzegovina. Harmonizing economic policies and regulatory standards with EU norms was perceived as the second most critical area for improvement by almost 30 percent of investors. Other priorities, each selected on average by one out of five investors, cover a wide array of issues, including transport and ICT infrastructures, improved quality of life and the education system.

27 Corruption Perception Index, Transparency International. 28 The Worldwide Governance Indicators project, World Bank Institute.

Attracting Investment to South East Europe 51

III. Future attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

More than a half of investors (54 percent) said they believed that Bosnia and Herzegovina’s investment attractiveness will increase over the next three years. One out of seven respondents said that investment conditions will improve significantly. Only 5 percent of surveyed investors felt that conditions might deteriorate in the coming years, of which only 2 percent were concerned that this worsening could be significant.

IV. Investors’ awareness of business environment conditions

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

52 Attracting Investment to South East Europe

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

On average, one half to two thirds of investors said that they have rather bad or very bad knowledge about business conditions in Bosnia and Herzegovina. European firms reported being better informed than firms from North America. Forty-three percent of investors from Central Europe and 30 percent from Western Europe claimed they have rather good or very good knowledge of Bosnia and Herzegovina’s investment climate, while only 23 percent of American businesses claimed the same level of knowledge. Thus, degree of familiarity with Bosnia and Herzegovina’s business environment appears to correlate negatively with the distance of the investor’s home country from the host market, a trend evidenced throughout the region; the farther away the investor’s origin, the less likely the investor was to be well informed about the investment destination’s conditions. Investors in the ICT and professional services sectors claimed more familiarity with Bosnia and Herzegovina’s investment environment than firms in the consumer goods, automotive and energy sectors.

Attracting Investment to South East Europe 53

BULGARIA

I. Economic performance fact sheet

2002 2003 2004 2005 2006 Trend2

Economic Indicators1

GDP per capita, PPP (constant 2000 international $) 6,633 7,080 7,424 7,866 .. ↑ GDP growth (annual %) 4.90 4.50 5.70 5.50 .. ↔ Foreign direct investment, net inflows (% of GDP) 5.81 10.52 10.92 9.81 .. ↔ Trade (% of GDP) 112.88 116.59 126.21 138.16 .. ↑ Exports of goods and services (% of GDP) 53.13 53.55 57.98 60.80 .. ↑ Imports of goods and services (% of GDP) 59.75 63.04 68.23 77.36 .. ↑ Gross capital formation (% of GDP) 19.81 21.74 23.45 28.00 .. ↑

Business Environment Indicators

Global Competitiveness Index (higher score = ...... 4.04 3.96 .. better performance, World Economic Forum) Time required to start a business (number of days, .. 30 32 32 32 ↔ Doing Business) Time required to pay taxes (hours per year, Doing ...... 616 616 .. Business) Time required to obtain a license (number of days, ...... 212 226 .. Doing Business) Time required to export (number of days, Doing ...... 26 26 .. Business) Rigidity of Employment index (0 to 100, lower .. .. 28 44 47 ↑ values = better performance, Doing Business) Corruption Perception Index (1-10, higher score = 4 3.9 4.1 4 .. ↔ better performance, Transparency International) Index of Economic Freedom (lower score = better 3.28 3.26 2.98 2.74 2.8 ↔ performance, Heritage Foundation) Rule of Law index (-2.5 to 2.5, higher score = -0.07 -0.06 -0.08 -0.19 .. ↓ better performance, World Bank Institute) Government Effectiveness index (-2.5 to 2.5, higher score = better performance, World Bank 0 -0.07 0 0.23 .. ↑ Institute) Regulatory Quality index (-2.5 to 2.5, higher score 0.59 0.58 0.64 0.63 .. ↔ = better performance, World Bank Institute)

Notes: 1 Source: World Development Indicators, World Bank Group. 2 An up/down trend indicator requires a change of at least 1% in the same direction within the last two years.

Over the past several years, Bulgaria has made impressive progress toward long-term stability and sustained growth. Average economic growth reached close to 5 percent per annum in 2000-05. An EU member since January 2007, Bulgaria has benefited from increased economic integration and improved investor confidence, and has attracted rising FDI (inflows reached 10 percent of GDP in the last three years). The vitality of Bulgaria’s economy and its private sector is also evidenced by the steadily growing gross capital formation, which reached 28 percent of GDP in 2005.

However, despite the encouraging macroeconomic performance and outlook, more needs to be done to further Bulgaria’s improve investment climate. The conditions for starting and operating a business, as measured by selected Doing Business indicators, have not changed

54 Attracting Investment to South East Europe

significantly over the past few years. Governance needs to be strengthened through aggressive implementation of anti-corruption measures, public administration and judiciary reform. Unresolved issues remain in these areas, as demonstrated by the Rule of Law29 and Corruption Perception indices.30

II. Priorities for improving Bulgaria’s investment attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Bulgaria and Romania are the only two countries in this report’s nine-country geographic sample for which “ensuring political environment stability” was not reported as the leading cause of concern for foreign investors. Both countries are members of the EU, which is a clear signal and assurance for investors that improvements in governance, rule of law and transparency (which in the survey constitute the category “political stability”) are taking place. Nonetheless, more than a quarter of investors still reported that this area is among three key issues Bulgaria should tackle if it wants to continue to strengthen its investment attractiveness. Improvement in the transport and ICT infrastructures was identified as the top priority for Bulgaria by almost 30 percent of surveyed investors.

29 The Worldwide Governance Indicators project, World Bank Institute. 30 Corruption Perception Index, Transparency International.

Attracting Investment to South East Europe 55

III. Future attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Almost two out of three investors (62 percent) were confident that Bulgaria’s investment attractiveness will continue to increase in the coming years. Over 20 percent of respondents felt this increase will be significant. About one out of four businesses (24 percent) did not expect any change in Bulgaria’s investment climate in the next three years. As was the case for most other countries in the region, only one out of twenty foreign investors was concerned that conditions might deteriorate.

IV. Investors’ awareness of business environment conditions

56 Attracting Investment to South East Europe

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

On average, foreign investors said they were better informed about business conditions in Bulgaria than they were about most other countries in the region. Disaggregating the data by the home region of the investor reveals that 75 percent of Central and Eastern European businesses said they have very good or rather good knowledge of Bulgaria’s investment climate, followed by Western European (47 percent), Asian (33 percent) and North American firms (26 percent). Businesses from the ICT sector reported a higher level of knowledge about Bulgaria than companies from other sectors. While 22 percent of ICT investors claimed to have very good knowledge, this level of familiarity was shared by only 15 percent of companies in the industry/automotive/energy sectors, 13 percent of providers of professional services, and 9 percent of firms in the consumer goods sector. (See two figures, above and on previous page.)

Attracting Investment to South East Europe 57

CROATIA

I. Economic performance fact sheet

2002 2003 2004 2005 2006 Trend2 Economic Indicators1

GDP per capita, PPP (constant 2000 international $) 10,364 11,022 11,204 11,779 .. ↑ GDP growth (annual %) 5.60 5.30 3.80 4.28 .. ↔ Foreign direct investment, net inflows (% of GDP) 4.88 6.94 3.47 4.57 .. ↔ Trade (% of GDP) 101.74 104.96 104.11 102.85 .. ↔ Exports of goods and services (% of GDP) 45.35 47.07 47.41 47.08 .. ↔ Imports of goods and services (% DP) 56.39 57.89 56.69 55.77 .. ↓ Gross capital formation (% of GDP) 29.10 31.07 30.92 31.29 .. ↔

Business Environment Indicators

Global Competitiveness Index (higher score = ...... 4.01 4.26 .. better performance, World Economic Forum) Time required to start a business (number of days, .. 50 49 49 45 ↔ Doing Business) Time required to pay taxes (hours per year, Doing ...... 232 196 .. Business) Time required to obtain a license (number of days, ...... 278 278 .. Doing Business) Time required to export (number of days, Doing ...... 35 26 .. Business) Rigidity of Employment index (0 to 100, lower .. .. 57 57 50 ↔ values = better performance, Doing Business) Corruption Perception Index (1-10, higher score = 3.8 3.7 3.5 3.4 .. ↓ better performance, Transparency International) Index of Economic Freedom (lower score = better 3.34 3.06 3.06 2.95 2.78 ↓ performance, Heritage Foundation) Rule of law index (-2.5 to 2.5, higher score = 0.04 0.05 0.05 0 .. ↔ better performance, World Bank Institute) Government Effectiveness index (-2.5 to 2.5, higher score = better performance, World Bank 0.24 0.18 0.31 0.44 .. ↑ Institute) Regulatory Quality index (-2.5 to 2.5, higher score 0.17 0.29 0.33 0.45 .. ↑ = better performance, World Bank Institute)

Notes:

1 Source: World Development Indicators, World Bank Group.

2 An up/down trend indicator requires a change of at least 1% in the same direction within the last two years.

Croatia is the SEE region’s richest economy in terms of its GDP per capita, which in 2005 reached nearly $12,000 in terms of purchasing power parity. Real GDP growth, after slowing somewhat in 2004, accelerated to 4.3 percent in 2005. Growth has been underpinned by strong foreign investment and capital formation. Investors’ interest in Croatia’s long-term opportunities has been further strengthened since EU accession talks started in October 2005.

Croatia’s economy has undergone gradual liberalization, as demonstrated by the country’s Index of Economic Freedom31 scores since 2002. Governance indicators32 of the regulatory quality and government effectiveness also show signs of progressive improvement. Furthermore, Croatia has also recently improved its standing in the Doing Business

31 Index of Economic Freedom, Heritage Foundation. 32 The Worldwide Governance Indicators project, World Bank Institute.

58 Attracting Investment to South East Europe

indicators.33 But, as indicated by the Corruption Perception Index,34 strengthening the rule of law still remains an important issue. To meet its objective of EU membership, Croatia needs to implement reforms that will improve the investment climate, boost private sector activity and increase economic competitiveness, both in the EU market and globally.

II. Priorities for improving Croatia’s investment attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Almost 40 percent of respondents identified “ensuring political environment stability” as the top priority for strengthening Croatia’s investment attractiveness. The political environment category encompasses factors such as governance, rule of law, transparency and corruption. This percentage might seem surprisingly high given Croatia’s relative stability. However, the survey measures investors’ perceptions; it suggests that regardless of the reality in Croatia, many foreign investors continue to have the impression that these areas require the priority attention of the public authorities. The country’s progress in modernizing its ICT infrastructures and transportation networks was recognized by survey respondents, and these areas rank much lower on the list of priorities relative to their rankings for other SEE countries. Harmonization with EU economic standards, on the other hand, was viewed as critical by 25 percent of respondents. The high tax burden was also identified among the top three areas for improving Croatia’s investment attractiveness by more than 20 percent of investors.

33 This report is confined to a period ending on August 31, 2007. Since then, the new rankings published in Doing Business 2008 have placed Croatia among the top 10 reformers worldwide. 34 Corruption Perception Index, Transparency International.

Attracting Investment to South East Europe 59

III. Future attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Foreign investors were most optimistic about Croatia of all countries in the SEE region. Almost seven out of ten surveyed businesses (69 percent) were confident that Croatia’s investment attractiveness will continue to increase in the coming years. Furthermore, only 2 percent of firms stated that conditions might deteriorate over a three-year horizon.

IV. Investors’ awareness of business environment conditions

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

60 Attracting Investment to South East Europe

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Croatia was one of the region’s highest rated countries in terms of foreign investors’ familiarity with the country’s business conditions. On average, less than 25 percent of investors claimed to have very bad knowledge of Croatia’s investment climate. As was true for other countries, European investors felt better informed than their American counterparts. Businesses in the ICT sector reported higher levels of familiarity than companies in the other sectors—33 percent of ICT investors said they have very good knowledge of Croatia’s business environment. Only 22 percent of firms in professional services, 18 percent in consumer goods and 16 percent in the industry/automotive/energy sectors claimed the same familiarity. (See two figures, above and on previous page.)

Attracting Investment to South East Europe 61

MACEDONIA, FYR

I. Economic performance fact sheet

2002 2003 2004 2005 2006 Trend2

Economic Indicators1 GDP per capita, PPP (constant 2000 international $) 5,771 5,914 6,146 6,392 .. ↑ GDP growth (annual %) 0.85 2.82 4.08 3.96 .. ↔ Foreign direct investment, net inflows (% of GDP) 2.05 2.08 2.92 1.73 .. ↔ Trade (% of GDP) 96.19 92.70 100.73 107.56 .. ↑ Exports of goods and services (% of GDP) 38.03 37.88 40.25 45.08 .. ↑ Imports of goods and services (% of GDP) 58.16 54.83 60.48 62.48 .. ↑ Gross capital formation (% of GDP) 20.61 19.99 21.38 19.98 .. ↔

Business Environment Indicators Global Competitiveness Index (higher score = better ...... 3.84 3.86 .. performance, World Economic Forum) Time required to start a business (number of days, .. 48 48 48 18 ↓ Doing Business) Time required to pay taxes (hours per year, Doing ...... 96 96 .. Business) Time required to obtain a license (number of days, ...... 214 222 .. Doing Business) Time required to export (number of days, Doing ...... 32 32 .. Business) Rigidity of Employment index (0 to 100, lower values .. .. 38 54 54 ↔ = better performance, Doing Business) Corruption Perception Index (1-10, higher score = 2.4 2.3 2.7 2.7 .. ↔ better performance, Transparency International) Index of Economic Freedom (lower score = better 3.35 3.17 3.09 3.0 2.8 ↓ performance, Heritage Foundation) Rule of Law index (-2.5 to 2.5, higher score = better -0.46 -0.34 -0.37 -0.38 .. ↓ performance, World Bank Institute) Government Effectiveness index (-2.5 to 2.5, higher -0.39 -0.29 -0.16 -0.28 .. ↔ score = better performance, World Bank Institute) Regulatory Quality index (-2.5 to 2.5, higher score = -0.12 -0.2 -0.2 -0.2 .. ↔ better performance, World Bank Institute) Notes: 1 Source: World Development Indicators, World Bank Group. 2 An up/down trend indicator requires a change of at least 1% in the same direction within the last two years.

FYR Macedonia has made considerable progress since 2002. With the economic environment improving and stability restored, growth is gradually increasing. In recent years, the recovery has accelerated with an economic growth rate in 2004 and 2005 of 4.1 percent and 4 percent, respectively. The country has a relatively high, and rising, degree of economic openness (foreign trade accounts for over 100 percent of GDP). Rising private transfers and a shrinking trade deficit have resulted in a strong improvement in the current account balance.

Recent reforms aimed at improving the business environment have paid off. The conditions for starting and operating a business, as measured by selected Doing Business indicators, are gradually improving. However, much remains to be done to create an environment that will generate well-paid and stable jobs through private sector-led growth. Several governance indicators, including the Rule of Law, Government Effectiveness, and Regulatory Quality

62 Attracting Investment to South East Europe

indices,35 have been stagnant or volatile without an evident positive trend over the last few years. FYR Macedonia's overarching goal is to join the EU. It signed the Stabilization and Association Agreement with the EU in April 2001 and received EU-candidate country status in November 2005.

II. Priorities for improving FYR Macedonia’s investment attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

As is the case of all other countries of former Yugoslavia, ensuring political environment stability was perceived as the top priority for FYR Macedonia by more than 40 percent of investors. Alignment of domestic laws and policies with EU economic standards was viewed as a top three priority by one out of four surveyed businesses. Improved quality of life was ranked next (18 percent), above improved transport and ICT infrastructures (16 percent) and increased flexibility of labor market regulations (15 percent).

35 The Worldwide Governance Indicators project, World Bank Institute.

Attracting Investment to South East Europe 63

III. Future attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Nearly half of surveyed investors (49 percent) said that FYR Macedonia’s investment attractiveness will improve fairly or significantly in the next three years. While this percentage is lower than those for most other countries in the SEE region, it is nonetheless a strong endorsement by the investment community of FYR Macedonia’s improving investment climate. Furthermore, only 8 percent of businesses reported concern that FYR Macedonia’s attractiveness might decrease in coming years.

64 Attracting Investment to South East Europe

IV. Investors’ awareness of business environment conditions

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Investors reported being relatively poorly informed about business conditions in FYR Macedonia. More than half of Western European investors (56 percent) felt they have very bad knowledge of FYR Macedonia’s investment climate. This figure is slightly better for Central and Eastern European, and North American investors (29 and 39 percent, respectively, reported very bad knowledge). Low levels of awareness among foreign investors are also apparent in the sector-specific results. While in most other SEE countries ICT investors

Attracting Investment to South East Europe 65

reported being relatively better informed than firms in other sectors, in the case of FYR Macedonia, firms in professional services and consumer goods claimed to have better knowledge of the investment environment. (See two figures, previous page.)

66 Attracting Investment to South East Europe

MOLDOVA

I. Economic performance fact sheet

2002 2003 2004 2005 2006 Trend2

Economic Indicators1

GDP per capita, PPP (constant 2000 international $) 1,462 1,491 1,589 1,707 .. ↑ GDP growth (annual %) 7.80 6.60 7.40 7.10 .. ↔ Foreign direct investment, net inflows (% of GDP) 5.06 3.72 3.30 6.81 .. ↔ Trade (% of GDP) 130.67 140.73 132.87 144.46 .. ↔ Exports of goods and services (% of GDP) 52.74 53.48 50.77 53.13 .. ↔ Imports of goods and services (% of GDP) 77.93 87.25 82.10 91.33 .. ↔ Gross capital formation (% of GDP) 21.66 23.18 25.31 29.79 .. ↑

Business Environment Indicators Global Competitiveness Index (higher score = better ...... 3.58 3.71 .. performance, World Economic Forum) Time required to start a business (number of days, Doing .. 42 30 30 30 ↔ Business) Time required to pay taxes (hours per year, Doing ...... 250 250 .. Business) Time required to obtain a license (number of days, Doing ...... 122 158 .. Business) Time required to export (number of days, Doing Business) ...... 33 33 .. Rigidity of Employment index (0 to 100, lower values = .. .. 54 68 54 ↔ better performance, Doing Business) Corruption Perception Index (1-10, higher score = better 2.1 2.4 2.3 2.9 .. ↔ performance, Transparency International) Index of Economic Freedom (lower score = better 3.25 3.16 3.09 3.11 3.1 ↔ performance, Heritage Foundation) Rule of Law index (-2.5 to 2.5, higher score = better -0.58 -0.60 -0.63 -0.59 .. ↔ performance, World Bank Institute) Government Effectiveness index (-2.5 to 2.5, higher score -0.62 -0.63 -0.79 -0.75 .. ↔ = better performance, World Bank Institute) Regulatory Quality index (-2.5 to 2.5, higher score = -0.19 -0.39 -0.54 -0.43 .. ↔ better performance, World Bank Institute)

Notes:

1 Source: World Development Indicators, World Bank Group.

2 An up/down trend indicator requires a change of at least 1% in the same direction within the last two years.

Since 2000, Moldova’s economic performance has been commendable. The country has successfully stabilized. Real GDP growth has been strong, reaching 7.4 percent in 2004 and 7 percent on average during the last three years. Yet Moldova’s impressive growth performance remains largely consumption-led, driven mainly by overseas remittances. While gross capital formation has increased in recent years, it has not yet reached the levels experienced by most other economies in the region, and Moldova continues to be one of the poorest countries in Europe. Foreign and domestic investment is insufficient for growth. More investment and technological innovation will be needed to sustain growth over the medium term. The gap between Moldova’s exports and imports is growing, resulting in an increasing trade deficit.

Attracting Investment to South East Europe 67

A significant reform agenda remains in the area of the business-enabling environment, improving governance and fighting corruption. Doing Business indicators of conditions for starting and operating a business in Moldova have not improved substantially in recent years. The prevalence of corruption, as measured by the Corruption Perception Index,36 has decreased in the last few years, yet it remains higher than in most other SEE countries. Furthermore, several of the governance indicators, including the Rule of Law and Government Effectiveness indices,37 have shown a worsening trend between 2002 and 2005.

II. Priorities for improving Moldova’s investment attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Nearly 30 percent of investors said that ensuring political environment stability needs to be the top priority area for strengthening Moldova’s investment attractiveness. One out of five respondents felt that improving transportation and ICT infrastructures was the second most critical area for improving the investment climate. A number of other factors were selected by approximately the same number of responding investors (15 to 18 percent): improving the quality of life (18 percent), meeting EU economic regulatory standards (17 percent), improving Moldova’s image abroad (16 percent), improving the education system (15 percent), implementing more flexible and simple administrative procedures (15 percent) and reducing taxation (15 percent).

36 Corruption Perception Index, Transparency International. 37 The Worldwide Governance Indicators project, World Bank Institute.

68 Attracting Investment to South East Europe

III. Future attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Almost four out of ten businesses (39 percent) believe that Moldova’s investment attractiveness will increase in the next three years. While this is an encouraging signal, the level of optimism regarding Moldova’s future is nonetheless the lowest among all SEE countries. As many as 40 percent of investors said that Moldova’s future attractiveness will remain unchanged in the coming years. More encouragingly, however, few investors are concerned that Moldova’s conditions might worsen; only 5 percent stated that the country’s attractiveness might fairly deteriorate, and only 3 percent felt that the degree of deterioration might be significant.

Attracting Investment to South East Europe 69

IV. Investors’ awareness of business environment conditions

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

On average, one half of surveyed investors reported having “very bad knowledge” about Moldova’s business conditions. When those investors who claimed to have “rather bad knowledge” are added to those with “very bad knowledge,” it is often the case that as many

70 Attracting Investment to South East Europe

as three out of four investors from a particular region or representing a particular sector felt poorly informed about Moldova’s investment environment. Central and Western European businesses reported being somewhat better informed than businesses in North America, and particularly, in Asia, all of whom said they have bad knowledge about the business climate in Moldova. Sector-specific analysis reveals little variation among industries. On average, a little less than 80 percent of businesses in all sectors reported poor knowledge.

Attracting Investment to South East Europe 71

MONTENEGRO

I. Economic performance fact sheet

2002 2003 2004 2005 2006 Trend2

Economic Indicators1

GDP per capita, (US$) 1,999 2,638 3,077 3,286 .. ↑ GDP growth (annual %) 1.7 2.3 3.7 4.1 .. ↑ Foreign direct investment, net inflows (% of GDP) 6.7 3.1 3.3 n/a .. ↔ Trade (% of GDP) ...... Exports of goods and services (% of GDP) 37.98 33.19 45.71 48.14 .. ↑ Imports of goods and services (% of GDP) 62.93 50.98 63.19 67.52 .. ↑ Gross fixed capital formation (% of GDP) 15.3 14.43 ......

Business Environment Indicators Global Competitiveness Index (higher score = better ...... 3.67* 3.69* .. performance, World Economic Forum) Time required to start a business (number of days, Doing .. 44* 51* 15* 24 ↔ Business) Time required to pay taxes (hours per year, Doing ...... 168* 208 .. Business) Time required to obtain a license (number of days, Doing ...... 212* 179 .. Business) Time required to export (number of days, Doing Business) ...... 32* 19 .. Rigidity of Employment index (0 to 100, lower values = .. .. 23* 28* 34 ↑ better performance, Doing Business) Corruption Perception Index (1-10, higher score = better 2.6* 2.3* 2.7* 2.8* .. ↑ performance, Transparency International) Index of Economic Freedom (lower score = better 4.21* 4.28* ...... performance, Heritage Foundation) Rule of Law index (-2.5 to 2.5, higher score = better -0.99* -0.97* -0.78* -0.81* .. ↔ performance, World Bank Institute) Government Effectiveness index (-2.5 to 2.5, higher score -0.61* -0.5* -0.12* -0.31* .. ↔ = better performance, World Bank Institute) Regulatory Quality index (-2.5 to 2.5, higher score = -0.62* -0.68* -0.52* -0.53* .. ↔ better performance, World Bank Institute) Notes:

1 Sources: (i) World Bank Country Brief; (ii) The Vienna Institute Monthly Report 2006/12.

2 An up/down trend indicator requires a change of at least 1% in the same direction within the last two years.

*Data is for Serbia and Montenegro; disaggregated data for Montenegro was not available.

With only about 620,000 inhabitants, Montenegro's domestic market is small. EU integration thus remains fundamental to enhancing the country’s growth and prosperity, and to ensuring stability. Real growth of output was sluggish over the past few years and below the regional average. In 2005, real GDP grew by 4.1 percent, higher than the average annual real GDP growth of 2000-2004 (about 2 percent). The level of FDI rose at the beginning of the period, driven largely by privatizations. A significant inflow of foreign investments is expected to enhance private sector-led growth, especially related to the service sectors (tourism, trade and transport), which have strong potential.

The Doing Business report shows that Montenegro’s business climate continues to be in need of further improvement. The challenges ahead also include improved public sector governance, strengthened institutions for accountability and transparency, and enhanced administrative and institutional capacity for EU integration.

72 Attracting Investment to South East Europe

II. Priorities for improving Montenegro’s investment attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Priorities for Montenegro’s development follow a pattern similar to most other countries in South East Europe. Ensuring political environment stability was selected by 40 percent of investors, followed by meeting European economic regulatory standards (28 percent) and improvement in transport and ICT infrastructures (24 percent). Investors did not indicate much concern about the tax burden and labor policy. This result is consistent with previously reported findings in this study on the region’s key comparative advantages, which include low labor costs, flexible labor policy and future productivity potential.

Attracting Investment to South East Europe 73

III. Future attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Almost 60 percent of respondents expressed confidence that Montenegro’s investment attractiveness will continue to increase in the next three years. One out of seven investors felt that this increase will be significant. One out of ten respondents did not state an opinion on Montenegro’s future attractiveness, while only 4 percent said that it might fairly or significantly deteriorate in the coming years.

IV. Investors’ awareness of business environment conditions

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

74 Attracting Investment to South East Europe

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Investors seem better informed about business conditions in Montenegro than they are about the conditions in other small economies in the SEE region. However, while 43 percent of Central and Eastern European businesses reported very good or rather good knowledge of the investment climate, lower percentages among Western European and North American firms (21 and 8 percent, respectively) reported the same levels of knowledge. Sectoral analysis illustrates that one out of three investors in the ICT and professional services sectors has good knowledge of the business environment in Montenegro, while this percentage is much lower for the consumer goods and industry/automotive/energy sectors (19 and 16 percent, respectively). (See two figures, above and previous page.)

Attracting Investment to South East Europe 75

ROMANIA

I. Economic performance fact sheet

2002 2003 2004 2005 2006 Trend2 Economic Indicators1

GDP per capita, PPP (constant 2000 international $) 6,750 7,214 7,996 8,236 .. ↑ GDP growth (annual %) 5.10 5.20 8.40 4.10 .. ↔ Foreign direct investment, net inflows (% of GDP) 2.50 3.10 8.53 6.73 .. ↔ Trade (% of GDP) 76.57 76.92 80.96 76.47 .. ↔ Exports of goods and services (% of GDP) 35.44 34.71 35.93 33.04 .. ↔ Imports of goods and services (% GDP) 41.14 42.20 45.03 43.44 .. ↔ Gross capital formation (% of GDP) 21.68 21.85 22.32 22.70 .. ↑

Business Environment Indicators Global Competitiveness Index (higher score = better ...... 3.98 4.02 .. performance, World Economic Forum) Time required to start a business (number of days, .. 27 28 11 11 ↓ Doing Business) Time required to pay taxes (hours per year, Doing ...... 188 198 .. Business) Time required to obtain a license (number of days, ...... 291 242 .. Doing Business) Time required to export (number of days, Doing ...... 27 14 .. Business) Rigidity of Employment index (0 to 100, lower values .. .. 63 59 51 ↓ = better performance, Doing Business) Corruption Perception Index (1-10, higher score = 2.6 2.8 2.9 3 .. ↑ better performance, Transparency International) Index of Economic Freedom (lower score = better 3.78 3.71 3.71 3.58 3.19 ↓ performance, Heritage Foundation) Rule of Law index (-2.5 to 2.5, higher score = better -0.23 -0.22 -0.23 -0.29 .. ↓ performance, World Bank Institute) Government Effectiveness index (-2.5 to 2.5, higher -0.32 -0.16 -0.11 -0.03 .. ↑ score = better performance, World Bank Institute) Regulatory Quality index (-2.5 to 2.5, higher score = 0.01 -0.20 0.13 0.17 .. ↑ better performance, World Bank Institute) Notes:

1 Source: World Development Indicators, World Bank Group.

2 An up/down trend indicator requires a change of at least 1% in the same direction within the last two years.

An EU member since January 2007, Romania has experienced robust economic growth for five consecutive years. Romania is now a visible and attractive destination for international investors and, as a result, the inflow of foreign investments constituted more than 6 percent of GDP in the last two years. In absolute terms, Romania is the region’s undisputed leader in attracting FDI, given the country’s large domestic market and relatively robust economy. While export growth has remained strong, import growth has accelerated and the trade deficit has widened since Romania joined the EU.

Romania’s business environment is improving. Its economy has undergone liberalization, as demonstrated by the Index of Economic Freedom38 scores since 2002. The conditions for starting and operating a business, as measured by selected Doing Business indicators, have improved over the past few years. Romania was among the top 10 reformers in the

38 Index of Economic Freedom, Heritage Foundation.

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2005/2006 Doing Business report. Relative to the other regional economies, Romania ranks first in the ease of starting a business. Spurred by the EU accession process, regulatory quality and government effectiveness in Romania have also improved during the past five years.39 Romania has also made progress in reforming its judiciary system and tackling corruption, as illustrated by the Corruption Perception Index40 scores since 2002, even though shortcomings remain that need to be addressed.

II. Priorities for improving Romania’s investment attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Although investors stated concerns primarily about political stability, economic policy and regulatory frameworks in most other countries of South East Europe, these issues do not rank high among investors’ stated priorities for Romania. Instead, investors indicated that Romania’s investment attractiveness would be most enhanced by improving transport and ICT infrastructures (29 percent of investors) and by simplifying administrative procedures (28 percent).

39 The Worldwide Governance Indicators project, World Bank Institute. 40 Corruption Perception Index, Transparency International.

Attracting Investment to South East Europe 77

III. Future attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

More than two thirds of investors said they are optimistic about Romania’s future investment attractiveness. Among surveyed firms, 29 percent felt that improvement in Romania’s attractiveness will be significant, which was a sentiment expressed more often about Romania than for any other country in the region. Only one surveyed investor expressed a concern that Romania’s investment climate might experience a significant worsening in the next three years.

78 Attracting Investment to South East Europe

IV. Investors’ awareness of business environment conditions

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Romania is one of the region’s clear leaders in terms of the level of awareness among its foreign investors about the country’s business conditions. When the data is disaggregated by the investors’ regions of origin and sectors of operation, the findings reveal that, by some measures, more than half of surveyed investors are well informed about Romania’s investment environment. Western European investors in particular reported high familiarity with the country; 24 percent of firms said their level of knowledge is very good, and an additional 31

Attracting Investment to South East Europe 79

percent reported rather good knowledge. While ICT companies lead sector-specific rankings of familiarity about most of the other SEE countries, ICT firms lag behind firms in the industry/automotive/energy sectors concerning Romania. (See two figures, previous page.)

80 Attracting Investment to South East Europe

SERBIA

I. Economic performance fact sheet

2002 2003 2004 2005 2006 Trend2 Economic Indicators1

GDP per capita, (US$) 2,107 2,719 3,285 3,511 .. ↑ GDP growth (annual %) 4.2 2.5 8.4 6.2 .. ↔ Foreign direct investment, net inflows (% of GDP) 3.0 6.7 4.0 5.9 .. ↔ Trade (% of GDP) 61.1 61.6 71.3 71.4 .. ↑ Exports of goods and services (% of GDP) 20.5 20.5 22.6 25.2 .. ↑ Imports of goods and services (% of GDP) 40.6 41.1 48.7 46.2 .. ↔ Gross capital formation (% of GDP) 17.2 22.6 32.0 22.5 .. ↔

Business Environment Indicators Global Competitiveness Index (higher score = better ...... 3.67* 3.69* .. performance, World Economic Forum) Time required to start a business (number of days, Doing .. 44* 51* 15* 18 ↓ Business) Time required to pay taxes (hours per year, Doing ...... 168* 168 .. Business) Time required to obtain a license (number of days, Doing ...... 212* 211 .. Business) Time required to export (number of days, Doing Business) ...... 32* 11 .. Rigidity of Employment index (0 to 100, lower values = .. .. 23* 28* 38 ↑ better performance, Doing Business) Corruption Perception Index (1-10, higher score = better 2.6* 2.3* 2.7* 2.8* .. ↑ performance, Transparency International) Index of Economic Freedom (lower score = better 4.21* 4.28* ...... performance, Heritage Foundation) Rule of Law index (-2.5 to 2.5, higher score = better -0.99* -0.97* -0.78* -0.81* .. ↔ performance, World Bank Institute) Government Effectiveness index (-2.5 to 2.5, higher score -0.61* -0.50* -0.12* -0.31* .. ↔ = better performance, World Bank Institute) Regulatory Quality index (-2.5 to 2.5, higher score = -0.62* -0.68* -0.52* -0.53* .. ↔ better performance, World Bank Institute)

Notes:

1 Source: World Bank Country Office.

2 An up/down trend indicator requires a change of at least 1% in the same direction within the last two years.

*Data is for Serbia and Montenegro; disaggregated data for Serbia is not available.

Serbia was the last country in the region to initiate transition processes due to regional conflicts, political turmoil and economic sanctions. Since 2001, after a delayed transition, the country has progressed steadily toward a modern market economy. Serbia’s economy grew on average 5.4 percent per annum, peaking in 2004 with 8.4 percent GDP growth, one of the highest growth rates among transition economies south of the Baltic region. In 2005, growth remained strong at 6.2 percent. The levels of FDI have risen (particularly in 2003 when net FDI, driven largely by privatization, was exceptionally large), but FDI has yet to play a large role in overall investment. While export performance has increased steadily since 2002, more needs to be done to reduce Serbia’s growing trade deficit.

The business environment in Serbia is gradually improving. Serbia led the list of the “top ten reformers” globally in the Doing Business in 2006 report. Serbia also has improved its ranking

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in the Corruption Perception Index.41 Building effective state institutions and implementing comprehensive legal and judicial reform remain essential to increase foreign investment and to ensure sustainable growth.

II. Priorities for improving Serbia’s investment attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Investors’ perceptions of Serbia’s investment climate were rather similar to their views of the SEE region as a whole. Increasing the stability of the political environment was considered the most important measure toward increasing Serbia’s attractiveness by 30 percent of surveyed investors. Improvement of infrastructures and adoption of EU regulatory standards were also viewed among the top three government priorities by about a quarter of respondents. Almost a third of investors did not express an opinion when asked to name three priority areas that the national public authorities should address in order to improve the country’s attractiveness.

41 Corruption Perception Index, Transparency International.

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III. Future attractiveness

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

One half of investors said they believe that Serbia’s investment climate will continue to improve, fairly or significantly, in the next three years. One out of three investors said that Serbia’s level of attractiveness will not change in this period, while only 6 percent of firms reported concern that conditions might deteriorate. These results for Serbia—of all subject countries covered by the survey—are the most typical and representative of the SEE region as a whole.

IV. Investors’ awareness of business environment conditions

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

Attracting Investment to South East Europe 83

Source: South East Europe Investor Perceptions Survey, WBG and E&Y, 2006.

One half of surveyed Central and Eastern European investors reported having very good or rather good knowledge of Serbia’s business conditions. Western European investors also said they are better informed about Serbia (36 percent) than about many of the other countries in the region. In contrast with the results for most of Serbia’s neighbors, Asian investors claimed better knowledge of Serbia’s investment climate than North American investors (33 and 20 percent, respectively). Sector-specific analysis reveals relatively little variation. Companies in the professional services and industry/automotive/energy sectors reported being somewhat better informed than those in ICT and consumer goods. (See two figures, above and previous page.)

84 Attracting Investment to South East Europe

Appendices

1. Acronyms and Glossary of Terms

2. Regional Classification of Countries

Attracting Investment to South East Europe 85

APPENDIX 1: ACRONYMS AND GLOSSARY OF TERMS

BEEPS Business Environment and Enterprise Performance Survey CEE Central and Eastern Europe CEFTA Central European Free Trade Agreement EBRD European Bank for Reconstruction and Development EIM European Investment Monitor EMU European Monetary Union EU European Union EU8 eight Central and Eastern European countries which entered into the EU on May 1, 2004; namely Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, Slovenia E&Y Ernst & Young FDI foreign direct investment FIAS Foreign Investment Advisory Service, a multi-donor service of the World Bank Group FYR Macedonia the former Yugoslav Republic of Macedonia GDP gross domestic product Greenfield FDI investment project to build new facility, rather than to use existing facility ICT information and communication technology IFC International Finance Corporation IIWB Invest In the Western Balkans Program IPA investment promotion agency MIGA Multilateral Investment Guarantee Agency Potential investors multinational corporations which have not yet established operations in South East Europe PPP purchasing power parity Resident investors multinational corporations which have established operations in South East Europe R&D research and development SEE South East Europe SEE region South East European region WBG World Bank Group Western Balkans Albania, Bosnia and Herzegovina, Croatia, FYR Macedonia, Moldova, Montenegro and Serbia

86 Attracting Investment to South East Europe

APPENDIX 2: REGIONAL CLASSIFICATION OF COUNTRIES

The geographic scope of this report encompasses the South East European region comprising the following countries: Albania, Bosnia and Herzegovina, Bulgaria, Croatia, the former Yugoslav Republic of Macedonia, Moldova, Montenegro, Romania and Serbia.

This report is based on two primary sources of data covering these same countries in addition to Greece, Turkey and Cyprus. Since the data was not collected and organized with the original intent of presentation in a single report, there are some inconsistencies in the inclusion of some countries in the sub-regional groupings depending on the data source. To the extent possible, the data is disaggregated and presented either for specific countries, or for the nine-country South East European region framed by this project. When such disaggregation of the original data was not possible, the findings are presented in sub-regional groupings as defined by the E&Y investor survey and the EIM. For the most part, the regional classifications in the various sources of data overlap; however, if further clarification is required about the precise composition of each grouping, please note the source of the data and refer to the following table.

Differences in Regional Country Classifications:

WBG / E&Y MIGA / Oxford Investor Perception Intelligence This Report Survey FDI Trend Analysis Albania, Bosnia and Herzegovina, South East Bulgaria, Croatia, FYR Macedonia, European region Moldova, Montenegro, Romania and Serbia. Bulgaria, Cyprus, South East Greece, Moldova, Europe Romania, Serbia and Turkey. Romania, Bulgaria, Greece and Moldova + Western Balkans (Albania, Bosnia and Southeast Europe Herzegovina, Croatia, FYR Macedonia, Serbia and Montenegro (including Kosovo). Albania, Bosnia and Herzegovina, Croatia, South Central FYR Macedonia and Europe Montenegro.

Albania, Bosnia and Herzegovina, Croatia, FYR Western Balkans Macedonia, Serbia and Montenegro (including Kosovo). Central and Czech Republic, Estonia, Hungary, Eastern Europe / Latvia, Lithuania, Poland, Slovakia, EU8 Slovenia.

Attracting Investment to South East Europe 87