The projections are based on the Economist Intelligence Unit’s model of business environment rankings, which captures current and future trends in business environments and reflects the main drivers of FDI. The model shows that differences in market size, quality of the overall business environment, wage costs, natural resource endowments, privatization methods, and market access explain almost the entire intercountry variation in FDI receipts in the region in 1996–2000.

Lower growth in countries of the Organisation for Economic Co-operation and Development and increased risk perceptions will dampen FDI inflows into the transition economies in the near term. However, this will be offset by the increased relative attractiveness of the region compared with most other emerging markets, a politically-driven positive impact of recent events on FDI prospects for Russia and Central Asia, large sales of state assets, and increased cost-cutting pressures on Western companies that will enhance the attractiveness of relocating operations to Eastern Europe. Thus even though global economic activity is not expected to pick up until the second half of 2002, FDI inflows into the region are forecast to reach almost $32 billion in 2002, which will represent a new record total.

About half of all inflows into the region in 2001–05 will go to the countries of East Central Europe (table 1). Inflows into Russia are projected to average $6.6 billion per year in 2001–05, more than double the modest $3.2 billion annual average recorded in 1996–2000. FDI will be a significant share of GDP in many countries of the region, up to 7 percent in the Czech Republic, Slovakia, and some countries of the Commonwealth of Independent States. As privatization opportunities wind down, new greenfield investment and follow-on investment by established investors will play an increasingly important role.

The region’s real GDP grew by 6 percent in 2000, by far its best performance since the start of the transition. Average growth is projected to slow to a still respectable 4.5 percent in 2001 and 3.8 percent in 2002. However, strong investment growth, rapid structural change, and dramatic improvements in competitiveness (driven mainly by FDI) in recent years have put most Central and Eastern European economies in a strong position to withstand the short-term slump in demand in the European Union. Growth of 4 to 5 percent per year should be sustainable over the medium term, driven by the returns to earlier reform, the effect on productivity of rising imports of capital goods and technology, and the improvements in infrastructure.

Improved business environments will be the main spur to FDI inflows, especially as privatization opportunities wind down in the region’s more advanced economies. Productivity growth will tend to offset the negative impact of rising wage costs on FDI. Estonia is expected to retain the best business environment in the region in 2001–05. The Federal Republic of Yugoslavia is expected to record the greatest absolute and relative improvements, jumping from the bottom spot to 16th place (table 2). Macedonia is expected to suffer the sharpest decline in rank, by six places, between the two periods.

Even though the implementation of reforms will remain a serious problem, Russia is nevertheless expected to substantially improve its business environment in the medium term. The refashioning of Russia’s political relations with the West in the aftermath of the September 11 terrorist attacks could have a major impact on FDI by facilitating Russia’s integration into the global economy (including through World Trade Organization membership), by altering perceptions of Russia in the West, and by eroding hostility toward foreign capital in Russia.

Table 1.  Foreign Direct Investment Inflows, Selected Transition Economies, 1996-2005
($ millions, annual averages)

1996-2000 2001-05
Percentage of Percentage of
Country Total of GDP $ per head Total of GDP $ per head

Table 2. Business Environment Scores and Ranks