The economic and political map of Europe is being radically and rapidly transformed, as market reforms and privatisation proceed apace in Central and Eastern Europe. The final preparations are being made for monetary union and the introduction of a single currency by the European Union (EU) Member States. The interaction of these events will have profound implications for continental Europe in the opening decades of the next millennium, providing new opportunities, as well as challenges, for the business community.

Countries in Central and Eastern Europe (CEE)¹ are committed to closer ties with 15 EU Member States. Five of the CEE states have already begun formal negotiations for EU membership (the Czech Republic, Estonia, Hungary, Poland and Slovenia). One of the most important issues that now faces the EU will be how to integrate these countries into the framework of the Union. Therefore, developments in CEE will have a major impact on the process of European integration.

Economic development in the CEE

Following the collapse of socialism in 1990, the market reform process underway in CEE countries has been strikingly rapid, opening up huge potential for long-term economic development and business opportunities. Already, EU Member States are by far the most important trading partners for CEE states.

Over the last two years the transition countries have continued to make progress, albeit at a slower pace than in the past. Economic growth in CEE countries as a whole decelerated in 1996 to 3.8 per cent, down from 5.2 per cent in 1995. This deceleration primarily reflected short-term factors, including a drop in Western Europe's output. However, it also mirrored some internal weaknesses, as well as a tightening of macroeconomic policies in some countries.

Investment continued to grow at high rates, reflecting the positive expectations of investors. Foreign direct investment (FDI) has continued to flow into the region at a rapid pace, covering an increasingly broad range of countries. Poland was the region's leading recipient of FDI in 1996/97, replacing Hungary which had held the position since 1989. Latvia and Lithuania have both caught up with Estonia as investment locations.

By the middle of 1997, the private sector share had reached or exceeded the 50 per cent mark in all CEE countries. With privatisation nearing completion in the Czech Republic, Estonia, Hungary and the Slovak Republic, the future growth of the private sector share will primarily come from the formation of new firms and higher growth rates in private enterprises.

Following the rapid liberalisation and privatisation of the earlier years of transition, plus the impressive progress in macroeconomic stabilisation, transition is entering a new phase. However, great diversity remains. While some of the more advanced countries are already into the second phase of transition, a few are still mired with the problems of the first phase. Whatever the individual country circumstances, the central challenge is the same for all countries - to build and strengthen the institutions and policies which underpin a well-functioning market.

The next few years will be crucial in shaping the future developments of CEE economies. The EU enlargement process will represent great challenges, but also opportunities for reform and investment.

Financial support

Longstanding cultural and historical links, as well as economic and political ties, have led EU Member States to become the main investors, creditors and donors of aid in CEE. Following the political upheavals at the end of 1989, the EU rapidly set up a programme to help countries in the region move towards market economies and the establishment of democratic institutions.

A grant aid facility was launched by the European Commission, the so-called PHARE programme. This has been extended to cover all CEE states. The Board of Governors of the European Investment Bank (EIB), the EU's long-term financing institution, gave approval for the Bank to support priority projects in the region as part of the EU's co-operation policy. Between 1990 and 1997, the EIB has committed no less than ECU 6.3 billion in loans for investment projects in CEE. Between 1998 and 2000, the EIB will provide a further ECU 5.5 billion of loans to the region. Part of this will be in the form of a special Pre-Accession Facility, to give further help to the candidate countries in preparation for their EU membership.

The EU's loan financing arm

The EIB is owned by the EU Member States. Its principal aim is to contribute towards the balanced development of the Union, in particular supporting capital investment in the Union's less favoured regions. Over two-thirds of EIB lending is normally made available in the economically weakest regions of the Union, mainly Greece, Spain, Ireland and Portugal, as well as Southern Italy and Eastern Germany.

Thus the main focus of EIB activity is within the EU Member States, where it finances projects that further Union economic policy objectives. The Bank specialises in providing long-term funds (up to 20 or more years), depending on the assets being financed. In 1997 the Bank lent a total of ECU 23 billion for projects in the EU, and was again the world's largest multilateral financing institution.

The EIB finances sound projects in both public and private sectors. It co-operates with corporate enterprises, major organisations and with banks. The EIB raises its resources on the world's capital markets through bond issues, which enjoy the best AAA credit ratings. The EIB is a supplementary source of finance, providing up to half of the capital cost of an investment project.

EIB activity in CEE countries

At the request of the Council of Ministers, the EIB also supports EU external development and co-operation policies, by making loans in over 120 countries outside the EU. A cornerstone of this policy is to support economic development in CEE countries and their integration with the EU. Last year it lent a total of ECU 3.2 billion in non-EU member countries, of which ECU 1.5 billion was in CEE states.

In CEE, the EIB's activity is concentrated on investment to prepare these countries for eventual membership of the Union, much as the Bank has done with Greece, Portugal and Spain. A particular emphasis for EIB activity is on the integration of infrastructure in the region with that of the Union, especially the trans-European networks of transport, telecommunications and energy.

To date, the EIB has made more than ECU 2.4 billion available for transport infrastructure investment in CEE states. Examples include the Dresden-Kiev motorway, the E20 Berlin-Warsaw-Minsk-Moscow railway, the Czech section of the Berlin-Prague-Vienna railway, and numerous road projects in Slovenia, Hungary, Bulgaria, Romania and the Slovak Republic. The Bank is also supporting a co-ordinated programme to develop air transport, in particular air traffic control systems.

Port development was financed in Albania, Estonia, Latvia, Lithuania and Romania, while in the energy sector the EIB has financed projects for the construction of gas and oil pipelines, storage facilities, power station modernisation and expansion, and upgrading of electricity distribution systems. Similarly, investment to modernise and expand telecommunications networks has been financed in eight of the CEE states.

Since 1990, over ECU one billion has also been advanced by the EIB for projects in the industrial sector, particularly for small and medium-sized enterprises. Such projects frequently involve direct investment in joint ventures by EU firms. The largest industrial projects have concerned automobile assembly, glass works, consumer electronics, wood processing, agro-industry and tourism. Most were financed through EIB global loans - in effect EIB lines of credit - arranged with local banks to lend to small and medium-sized companies.

The EIB also attaches special priority to environmental protection projects. These have included a sewage treatment plant in Warsaw, the rehabilitation of water and waste water systems in Riga, and the upgrading of lignite-fired power stations to reduce flue gas emissions in the Czech Republic. Through its strict and thorough project appraisal procedures, which includes an assessment of the environmental impact of each investment, the EIB also contributes to environmental protection.

Co-operation with other sources of finance

If they are to catch up with even the weaker of the EU economies, CEE states still have a long way to go. Consequently, their investment needs are huge. Therefore, co-ordination between the EIB and other sources of finance, such as the EU grant aid programme PHARE, the World Bank and the European Bank for Reconstruction and Development (EBRD) is essential. The EIB frequently provides finance on a joint basis with these bodies, as well as with other public and private financing institutions.

In the past, PHARE funds were mainly oriented towards technical assistance, feasibility studies, and other pre-investment expenses. However, they are increasingly moving towards co-financing infrastructure projects. Examples of such EIB/PHARE co-operation include the modernisation of the Berlin-Warsaw-Minsk-Moscow rail line, and the upgrading of the Wroclaw-Gliwice section of the A4 motorway in Poland.

References

1 Albania, Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, the former Yugoslav Republic of Macedonia, Poland, Romania, Slovakia and Slovenia.

Biography

Sir Brian Unwin became President of the European Investment Bank and Chair of its Board of Directors on 1 April 1993. In 1985, he became Deputy Secretary in charge of the Economic Secretariat in the British Cabinet Office. He was appointed Chair of the Board of Customs and Excise in 1987, where he was closely involved in fiscal and other preparations for the Single Market. He served as President of the International Customs Co-operation Council in 1991 and 1992