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Stimulating tales

Emerging Europe governments are pushing forward with much needed investment initiatives to boost the long-term development of their economies. Much of Eastern Europe, and to a lesser extent Turkey, has suffered from under-financing for more than 20 years and poor infrastructure is one of the main obstacles to improving economic growth.

The Russian government estimated recently that the equivalent of more than 2 per cent of GDP is lost each year due to the poor state of its infrastructure. Over the last five years, it has boosted its fiscal revenues via excessive export taxes on Russia’s most plentiful resource, oil. As the global price of oil has risen, its government has built up a significant war chest of cash which is now being diverted to improve other parts of the economy and $400bn will be spent on infrastructure alone over the next five years.

One region which is set to benefit is Sochi, where the 2014 Winter Olympics will be held. Russia will spend over $15bn to provide modern infrastructure and reliable transport links. Construction and resource-related sectors will profit in the short term but long-term benefits will be seen throughout the economy.

With its fiscal coffers now full, the Russian government has proposed a gradual reduction in the tax burden on the oil industry. This is marginal to begin with but will stimulate a round of reinvestment by the oil companies, boosting the relevant service sectors.

Meanwhile, the EU’s cohesion policy calls for “economic and social cohesion through the reduction of developmental disparities between its regions” and it has earmarked a significant proportion of its 2007-13 budget to 10 new member states from central Europe.

In the biggest of these markets, Poland, the ministry of regional development has indicated that it will receive euro 67.3bn during this period – a significant amount when you consider the total GDP of the country in 2007 was around euro 300bn.

The investment of these flows will have a significant impact and over half the funds are being directed towards the redevelopment of roads and railways. Logistics in Poland have suffered from a prolonged period of neglect. A 138km journey between Warsaw and Lodz, its two biggest cities, takes at least one hour and 56 minutes, implying an average speed of only 71 kph (44 mph).

The awarding of the 2012 European football championships to Poland, in a joint hosting with Ukraine, has incentivised the government to accelerate its modernisation programme which will also provide significant benefits to the wider economy.

The final major economy in the region is Turkey, which does not benefit from a big taxable resource base or a steady stream of EU subsidies that could boost domestic investment spending. Instead, its government is dedicated to a reform agenda which should boost private foreign direct investment. Turkey has targeted the privatisation of state-owned industries that have been neglected due to previous governments’ weak fiscal discipline in sectors where improvement could provide a significant contribution to the country’s competitiveness.

The low quality of products from the petro-chemical sector means that Turkey’s top-end carpet producers import 80 per cent of their synthetic fibre requirement. The automotive and white goods sectors also use a much higher proportion of imported rather than domestically produced steel. Turkey has a huge surplus of low-quality long steel but lack of investment under state ownership has meant that it is a net importer of the higher-valued flat steel products craved by the manufacturing sector.

By fast-tracking the privatisation of sectors such as these, accompanied by incentives for capital expenditure investment, as well as gradual labour market reforms, Turkey is looking to stimulate import substitution by previously neglected domestic industries.

Stuart Richards is lead manager of the Hexam Capital emerging Europe fund

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