Hungary loses renowned investment appeal

Hungary, long a favored destination for multinational investments in Eastern Europe, is losing its appeal among foreign investors due to rising production costs and the growing strength of the nation's currency.

After topping the list of destinations for foreign direct investment in former communist states in the 1990s, the country has now slipped to third place behind Poland and the Czech Republic, all three of which are set to join the European Union in May 2004.

"After waves of massive privatization in the 1990s, we have arrived at saturation," proclaimed a recent study by the Economic Institute of the Hungarian Academy of Sciences.

Saturation is an apt description. Of the world's top 50 largest multinational companies, 45 have set up operations in Hungary, accounting for one-third of the country's gross domestic product, according to this study.

Nearly 73 percent of the industrial sector is foreign-owned, accounting for 47 percent of industrial output, 72 percent of sales and 89 percent of exports.

Having absorbed an average 2.2 billion euros of foreign capital annually between 1990 and 2000, the country received only 1.6 billion euros of foreign direct investment in 2001, according to statistics from the National Bank of Hungary.

"The opportunities of privatization in the energy and industrial sectors have practically run out. For the past two years we have seen a decline in the number of operations and in their size," the economics department of the French Embassy said.

Analysts have attributed the slowing flow of foreign capital into Hungary to recent salary raises and inflation, which have a direct impact on production costs.

In real terms, salaries are expected to rise by 8 percent this year, double the rate of expected GDP growth, according to one forecast.

But the appreciation of the forint - Hungary's currency - against the euro has also caused foreign investors' interest in Hungary to wane, sending Hungarian authorities scrambling to reverse the trend.

After the forint strengthened by about 16 percent against the euro since October 2001, the central bank slashed its interest rates in a bid to weaken the Hungarian currency to make the country's exports more attractive.

With the central bank's key interest rate at 6.5 percent - three percentage points lower than in November - the cost of borrowing has decreased sharply while the government is taking measures to facilitate financing for foreign companies on the domestic market.

"Foreign investors will be able to obtain long-term state loans, which has not been the case until now," said Economy Minister Istvan Csillag in a recent interview.

"To support investment, the Finance Ministry has decided to reduce the costs of employment and to gradually cut the social charges of enterprises," he said.

For Judit Lamperth of ITDH, a state body responsible for promoting investment and commerce, "the Hungarian economy is undergoing a structural change as EU accession nears. For investors, the emphasis is being shifted from a low-skilled, cheap work force toward work of a higher added value."

"Hungary is preparing for this change with its recently launched 'Smart Hungary' program that seeks to provide specific programs for investors who are building on this higher added value and on Hungary's innovative abilities," she said.

Germany generates one-third of the total foreign direct investment in Hungary, with the bulk coming from the likes of electronics and engineering giant Siemens and car maker Audi.

U.S. groups account for one-quarter of the total with big investors such as IBM and Flextronics in technology and General Motors in car manufacturing.