Capture the solid growth in Central Europe but don’t forget about the challenges

Despite concerns about the political environment in Central and Eastern Europe, caused by the consistent slide towards conservative populism, regional economies have not only managed to sustain a consistent rate of economic expansion, but have also managed to attract plenty of new FDI projects. In fact, a recent report conducted by the EY on FDI attractiveness revealed that Central European markets have seen a strong year-on-year (YOY) rise in FDI projects (Table 1). However, strong growth has also brought several structural factors that have begun to weigh on MNCs and their partners and are calling for the need to develop new long-term business strategies that will alleviate some of the pressures.

Competition pressures are increasing

The strong economic growth that regional markets are experiencing has attracted numerous new market entrants, which has increased competitive pressures. Indeed, the Global Competitiveness report of 2017-2018 shows a consistent rise in foreign competition, especially in the Central Europe’s biggest markets – Romania, Hungary, and Poland. The entrance of relatively cheap imports from Asian manufacturers that offer a viable alternative to more expensive Western brands and the expansion of Chinese companies in the region has exacerbated these pressures. Local companies are also expected to pose a risk to MNCs’ market share as regional governments have become increasingly aware of the need to strengthen SMEs, for example by boosting fiscal incentives to small local companies. Since consumers in the region are used to a lower price environment and remain less confident than their Western European counterparts, these trends will raise pricing pressure for MNCs and their ability to maintain their share of the market.

Labor market and producer prices continue to increase

Traditionally, companies were attracted to Central Europe because of the cheap, yet well-educated and skilled labor force that was in direct competition to Western European workers, which incentivized them to set up factories and service facilities. While this has opened plenty of new job opportunities, leading to a surge in private demand, ongoing migration dynamics and a rapidly aging population are beginning to cause significant staffing challenges. For example, the Polish Business Tendency Survey from August 2018 revealed thatnearly half of Polish companies are experiencing considerable labor shortages that are beginning to limit business activity. Similar trends can be observed in other Central European markets, especially ones that are near full-employment, such as Hungary and the Czech Republic. The matter is exacerbated by the fact that skilled labor is becoming increasingly difficult to attract, with many companies in the region reporting that they experience severe skill mismatches.

These trends have raised costs for companies, including MNCs, because of upward pressure on wages, which has raised consumer purchasing power but have also started to weigh on business profitability through higher labor costs (Graph 1). Economists are increasingly concerned that labor costs growth can outpace productivity growth, which will raise inflationary pressures, but will adversely impact the region’s investment attractiveness. While regional governments have sought to address the issue by relaxing some of the regulations dealing with the hiring of non-EU citizens, the problem will persist over the long term. Consequently, countries such as Poland, have seen the number of Ukrainian expatriates growing exponentially to over 1.5 million.However, the issue of hiring non-nationals is also being seen as increasingly controversial by the public, indicating that further regulatory relaxation by populist regional governments is unlikely. Additionally, policies that have introduced Public Service Schemes, aimed at reducing unemployment and increasing low labor participation rates, have in many cases backfired, because they have failed to provide employees with the necessary skills to seek a successful career in the private sector, while concurrently shrinking the pool of available labor.

Long-term strategic planning will be key to outperforming in Central Europe

Central Europe is expected to remain on a stable and elevated growth path in 2019 and will continue to offer new business opportunities to MNCs. However, the solid macroeconomic developments have also attracted new market entrants and, combined with worsening demographic trends, served to tighten regional labor markets. Therefore, to not only protect, but also expand their markets shares, executives must ensure that they are well-versed in the intricacies of each individual market, but also ensure they are aware of the trends in the operational environment.

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