Charts of the Week

Resilience of capital flows in Central Europe

Central Europe*: net capital flows

In Central Europe, capital flows (foreign direct investments, portfolio flows and bank lending flows) have resisted rather well despite geopolitical uncertainties. Similarly, they do not seem to be affected, for the time being, by the weakening of economic activity in the region. In H1 2023, they reached EUR 22.9 billion, an amount worth more than a full year track record during the pre-Covid period. Portfolio flows accounted for the largest share, most likely supported by the very favourable yield differential of government bonds vis-à-vis Germany.

One important fact to note is that in 2021 and 2022, capital flows reached EUR 55.1 billion and EUR 72 billion respectively, levels close to the records observed in 2007/2008. Poland, Romania and, to a lesser extent, Hungary received almost all of these flows, mainly through foreign direct investment (FDI) flows. The boost in FDI flows can be explained by the combined effect of several factors. There is probably a catch-up effect from postponed investment projects during the Covid-19 pandemic. But near-shoring activities, that is, the process of reorganising production activities in the euro zone, - as a result of the recent supply shocks are also supporting FDI flows. More specifically in 2022, plant closures in Russia and Belarus, linked to EU sanctions, redirected part of production activity to neighbouring countries.

In the short and medium term, Central Europe remains an attractive region for FDI. To be sure, geographical proximity with the EU and the associated advantages in terms of delivery times and transport costs are a couple of the arguments that are often put forward. Competitivewages compared to the Euro zone, as well as a skilled workforce, are still significant assets. In addition, FDI regulations are considered to be among the least binding according to an index calculated by the OECD for 69 countries, which takes numerous criteria amongst which restrictions on capital participation, profit repatriation and land ownership.