Eastern Europe: British firms feel the cold

As the region's fragile economies fear the effects of the Asian crisis, EU plans for enlargement threaten more disruption

THIS WEEKEND 11 central and East European presidents are gathering in Levoca, Slovakia, for their fifth regional summit. Usually, these are innocuous affairs held for the heads of state to get acquainted over a glass or four of fine wine.

But this year will be different because Western investors are scared that the financial crisis sweeping through Asia may spread to the emerging markets of Hungary, Poland, and above all, Russia. There is no doubt now that the Asian crisis is serious enough to wipe out the region's fragile growth which is finally picking up after years of austerity. Last week Yilmaz Akyuz, chief economist at the UN Conference on Trade and Development, described it as "the most serious ... since the breakdown of the Bretton Woods system in the early 1970s".

Such fears could not come at a worse time for UK companies which, after years of restraint, have been steadily increasing their commitment to the post-communist world. Exports over the first 11 months of 1997 increased 9 per cent over 1996. Trade missions have been oversubscribed as British companies - heartened by the region's economic recovery - have jumped on the bandwagon. Even sales to relatively obscure countries have increased dramatically: Kazakhstan took almost 55 per cent more UK exports than in 1996, while weaker economies such as Armenia have markedly increased in importance for the UK.

"We are monitoring the situation but so far there have been few signs of any problems," says Mark Rigby, who co-ordinates sales for Bass, whose main investments - in Prague Breweries and Radegast Breweries - are in the Czech Republic. Others disagree. "There is a certain wariness," says James McNeish of the East European Trade Council. He suggests the Asian crisis could jump to East Europe as investors, and to a lesser extent exporters, withdraw from emerging markets.

"There is an argument that investors withdrawing from Asia could look more favorably at East Europe," says Mr McNeish. "The really cautious are pouring into the US while those active in East Europe look likely to stay with Hungary and Poland rather than risk economies further afield."

At first glance, Eastern Europe doesn't appear a likely candidate to catch the Asian virus. Although South Korea's Daewoo Corporation is the largest investor in Romania, and is active in Ukraine and Uzbekistan, direct south- and East-Asian contact is minimal. Moreover, East European economies are not interlinked like their Asian counterparts. This reduces the potential domino effect in the former communist world.

Meanwhile, illiquidity has kept speculative short-term capital flows to a minimum: most investments have been made with the long term very much in mind. There has been no property boom, certainly nothing to rival Kuala Lumpur or Seoul.

"I don't think it will happen: the region simply doesn't have the same amount of debt exposure," says James Oates, global strategist for UBS.

Yet there are areas of concern. Many currencies are overvalued. Some countries also face burgeoning balance of payments problems: Estonia and Slovakia's deficits, for example, will top 10 per cent of GDP this year; the Czech Republic is not far behind.

Many banks are non-transparent and burdened with non-performing loans. A survey by Control Risks Group found that Western companies considered the region one of the most corrupt, with Russia topping the list. Such findings reinforce fears that the cronyism which undermined countries in Asia could do the same in East Europe.

Despite all this, for now, UK companies remain sanguine. "We have seen no impact at all," says Victoria Proziray, a spokes- woman for Cadbury Schweppes, which has just invested $140m in a state-of-the-art chocolate factory near Moscow. "I remain confident," says David Blake of John Brown, a British company active in Russia for 20 years. He admits, however, that the company - which has just completed a herbicide factory for Dupont Chemicals and has tendered for a nappy factory for Proctor & Gamble - converts roubles into dollars as soon as it can. "In the short term at lEast, Russia is a dog," admits Mr Oates, pointing to the impact of low commodity prices on the stability of the region's largest and highest profile economy. UK companies could be in for a rough time after all.