THE VIEW FROM MITTELEUROPA: Reconfiguring Chinese economic strategies in CESEE

Barely four years ago, as China carved out an increasingly large space in the global economy, Gunter Deuber of Raiffeisen Research and I argued in a piece for bne IntelliNews that its much-vaunted presence in Central and Southeastern Europe (CESEE) was not only overstated but had peaked politically.

Today, the common refrain in CESEE  is that the prospect of a strategic relationship with China has already passed. Since 2020, nine CESEE states have received no new Chinese foreign direct investment (FDI) at all. The blame is laid squarely at the door of Beijing: not only did the Belt and Road Initiative (BRI) massively undershoot expectations, China’s mealy-mouthed response to the Russian invasion of Ukraine added insult to injury in a region whose governments are increasingly coupling investment policy with security.

On the Chinese side, CESEE has some relative advantages – such as its cheaper labour and looser regulatory standards – but it is small change in the grand scheme of Beijing’s investment priorities. As China faces its own increasing economic headwinds, barnacles are likely to be scraped from the boat.

Moreover,  the deepening geo-politicisation of global economic relations has driven a wedge between CESEE and China, with governments in the region choosing either to proactively align with US policy priorities, balance the two poles, or otherwise keep their heads down.

Cold hard numbers

Despite the stated grand ambitions of Beijing in CESEE, the region has never become structurally important in investment terms, such as M&A, greenfield or brownfield projects.

Naturally, these are not the sole bellwether of economic penetration. Chinese companies are a force in terms of providing goods, financing and construction services. And dependence on China for imports has created a large trade imbalance: in 2012, the trade deficit amounted to just over 1 per cent and 2 per cent in Southeastern Europe and Central Europe, respectively, by 2022 it had increased to 2.5 per cent and 6 per cent, according to data from the IMF and Raiffeisen Research.

Yet investment reflects ownership of concrete assets, of which China has little in CESEE. According to data from the Vienna Institute for International Economic Studies (WIIW), the inward stock of Chinese FDI has never exceeded 1% in any of the states in the EU-CESEE and Western Balkans – with the exception of Serbia and North Macedonia.

Data pertaining to FDI is not wholly representative. Indeed, precise measurements of Chinese foreign investment are challenging as it is often routed to its host markets indirectly through offshore centres, mostly commonly Hong Kong, the Cayman Islands and the British Virgin Islands. Within the EU, the Netherlands and Luxembourg are also channels through which Chinese investment may flow.

Nonetheless, it is safe to say that CESEE as a region is relatively unimportant for China in gross terms. According to Rhodium Group data, the UK, Germany and France received 68% of Chinese investments into the EU plus the UK in 2022. While Hungary received a whopping 20% of the total for the year, this was a one-off: between 2013-2022, EU-CESEE approximately received an average of 4.5% of Chinese investments.

Shifting goalposts 

There is little reason to expect that this share will increase as the growing importance of geopolitics and national security shapes strategic policymaking and the regulatory environment in CESEE.

Previously, the primary forum for engagement between CESEE governments and China was the China-CEEC forum (currently known as the 14+1 format). It was advantageous for Beijing because it circumvented EU channels and enabled bilateral engagement – which critics argued undermined EU unity. Yet since 2021, when the last summit was held, it has died a death: in 2021-2022, the Baltic states departed the format, while Czechia, Romania and Poland remain participants in name only.

Geopolitical disputes, such as the tendency to now group China together with Russia, whilst deepening cooperation with Taiwan, show no signs of abating – but such skirmishes are not the only reason for the drift in relations. The Western bloc is exerting an inexorable pull on CESEE states, especially those within the EU.

EU member states are coordinating more closely as they attempt to develop strategic autonomy in numerous policy areas, not least technology. That is driving protectionism, one of the key instruments of which has been screening mechanisms for foreign direct investments from third countries in assets of strategic importance. There is no single EU screening mechanism, but all member states have adopted one, with varying degrees of stringency, thereby increasing the hurdles for Chinese capital.

Such developments are already having an impact on Chinese investment in the EU (+UK). According to data from MERICS and the Rhodium Group, Chinese FDI fell year-on-year by 22% to  €7.9 billion in 2022, which is at the level of 2013 – and well below the peak of €47.4 billion in 2016. Meanwhile, the number of publicly disclosed reviews of Chinese investments increased from 11 to 16 between 2021-2022. Although none of these were in CESEE states, they are unlikely to buck the trend.

Blowing hot and cold

This is not to argue that bilateral economic relations with China are becoming impossible. Hungary and Serbia, although outliers, have positioned themselves as hubs for Chinese capital. Indeed, CESEE states are characteristically variegated in their respective approaches to China – and these may also be vulnerable to the election cycle.

For example, the Slovenian government led by Janez Jansa’s Slovenian Democratic Party (SDS) adopted a hard line on China, announcing economic and cultural initiatives with Taiwan. After the Jansa government was replaced by a coalition led by Robert Golob’s ecologist Freedom Movement in 2022, it opted to ditch Jansa’s initiatives and emphasise economic cooperation; or, in other words, to keep its powder dry and head down, much like Croatia.

Slovakia may follow a similar pattern ahead of the likely formation of a government led by Robert Fico’s Smer party, effectively suspending the attempts of recent years to deepen cooperation with Taiwan. Much like Slovenia, policy changes are unlikely to be bold but reflect that not all EU-CESEE are destined to become, or remain, hawks on China. In any case, small states have very limited diplomatic resources and expertise and may choose to reprioritise them.

Yet even hawks may not close the door entirely. Estonia and Latvia may have departed the China-CEEC forum in August 2022 but, unlike Lithuania, they did not go out swinging, leaving quietly instead, stating that they wished to continue cooperation – albeit on the EU level.

Likewise, the confrontational rhetoric of the Polish government, especially Prime Minister Mateusz Morawiecki, drowns out more conciliatory strands of opinion, the most prolific proponent of which is President Andrzej Duda. Indeed, in April, Duda criticised Morawiecki for going “overboard” in warning that a Russian victory in Ukraine would embolden China to invade Taiwan. At the very least, Duda is playing good cop, not least because Poland is estimated to have the third largest volume of Chinese FDI in the EU, beaten only by Germany and France.

Romania has adopted an approach to China that may be characterised as carrot-and-stick; or, less charitably, as one of confusing ambivalence. On the one hand, it is one of the most challenging states for Chinese capital from a regulatory perspective. It has one of the strictest screening mechanisms for third country investments and has restricted the participation of Chinese companies in public tenders. It barred Huawei from its 5G network and forced the removal of its equipment, and cancelled negotiations with China General Nuclear Power Corporation on the upgrading of the Cernovada nuclear power plant.

Such proactive steps served Bucharest well in Washington DC. At the same time, the government sought to avoid triggering Beijing by poking the hornet nests of Taiwan and human rights. This trend was reinforced in November 2021, when the Social Democratic Party (PSD) entered a grand coalition with the ruling National Liberal Party (PNL). In June 2023, PSD leader Marcel Ciolacu assumed the prime ministership as part of an agreement that it would be rotated.

The PSD, which is opportunistically multi-vectoral in its foreign policy, had originally spearheaded Romania’s brief dalliance with China under the prime ministership of Viktor Ponta in 2013. Those days appeared to be long past. Not so: In August, the government approved the participation of Chinese tech group Lenovo in the 5G network. The Presidential Administration, which is more hawkish, also backed the decision, explaining that Lenovo operates under Hong Kong law, thereby assuaging its concerns about the rule of law and judicial independence in China.

Between two stools

In the Western Balkans, the direction of travel is unclear. That is partly because Chinese companies have been far more successful in establishing a strategic foothold in the Western Balkans, where FDI is much coveted and the regulatory environment more permissive.

Serbia, in particular, has systematically courted Chinese FDI since 2016. Of the 122 Chinese projects active across the Western Balkans, 61 of those are in Serbia, amounting to €18.7 billion of the regional total of €27.5 billion. In 2022, China drew level with the EU in terms of annual FDI inflows, providing €1.4 billion.

The projects in which China is investing in Serbia are across a range of sectors, including automotive, energy, telecoms, infrastructure and mining. Not all the promised projects have got off the ground. For example, the ambition of the Budapest-Belgrade-Athens high-speed railway – a flagship initiative of the BRI – has been downgraded considerably.

Yet the deepening of cooperation shows no signs of abating: In the spring, negotiations for a Free Trade Agreement (FTA) were launched. If completed, it would be the only CESEE state to have such an arrangement with China – and this could threaten future accession to the EU customs union. Belgrade may be gradually decoupling from Russia in strategic areas such as energy, but any such break with China is highly unlikely.

Elsewhere, Chinese FDI remains of systemic importance in Montenegro, which has become a poster child for debt trap diplomacy as a result. Indeed, the Bar-Boljare highway, the first section of which was built by the China Road and Bridge Corporation (CRBC) and mostly financed by a loan from the China Exim Bank, has the dubious honour of being one of the most expensive highways in the world, amounting to one quarter of Montenegrin GDP. Bosnia-Herzegovina also courts Chinese FDI in strategic sectors, such as power and infrastructure.

Nevertheless, even the scope for Chinese strategic engagement in the Western Balkans is narrowing, especially among the states that are members of Nato, namely Albania, Montenegro and North Macedonia (as well as Kosovo, which is a protectorate). At its 2022 summit in Madrid, the alliance outlined a security concept for China, raising concerns over its technological advancements and the economic dependencies it may have established.

These reflect the policy priorities of the US with respect to China. And given that the US retains huge influence in most Western Balkan states, its will is likely to prevail. That is already proving to be the case. For example, in 2020, Albania, North Macedonia and Kosovo signed up to the Clean Network Initiative pushed by the US, which commits them to barring “untrusted vendors” from deploying 5G technology, not least Huawei and other Chinese companies. Even Serbia formally committed to such a clause in the Washington Agreements, which sought to normalise relations with Kosovo.

None of this necessarily means that doors will completely close to China. Relations warmed during the COVID-19 pandemic when Beijing supplied vaccines to states in the region, which felt abandoned by the EU. In 2022, Albania – the most pro-Nato state in the region, whose relations with China were frayed by bungled Chinese investments into certain strategic assets – decided to waive visas for Chinese nationals.

Likewise, after halving the interest rate paid on its Chinese loan through hedging with Western banks, the Montenegrin government has not only been considering proposals by the CRBC to build the second and third stretches of the highway, but it in June it also signalled that it would contract a consortium led by the Shandong International Economic and Technical Cooperation Group to build an urgently required highway between the coastal cities of Tivat and Budva.

These case studies indicate that while Western Balkan states are cautious on China, they will not let geopolitical pressures and burned fingers get in the way of a good deal.

Brave new world

It is our assessment that the regulatory environment for Chinese investment in CESEE will remain challenging for the foreseeable future. That will also increasingly be the case in the Western Balkans as the states in the region integrate with the EU.

Yet while greater challenges for Chinese companies will likely decrease the volume of investment, there will still be market opportunities. Indeed, despite the challenges, Beijing is already exploring ways in which to adapt to this brave new world, while European governments remain open to cooperation, albeit on a conditional basis.

Based on current trends, indirect Chinese investment is likely to increase, even as headline FDI stagnates or falls. Investments from jurisdictions such as Hong Kong, the Cayman Islands and the BVI will still be subjected to EU screening mechanisms, but the case of Lenovo in Romania demonstrates that their Western-influenced legal systems may provide geopolitical cover to host governments looking to turn a blind eye.

Alternatively, Chinese corporates may seek to circumvent screening mechanisms by establishing special purpose vehicles to facilitate specific projects rather than acquire local subsidiaries. They may also be hired by Western corporates as part of consortia. For example, green energy group CHINT has partnered with Turkey’s Intec to build solar power plants in Hungary, Poland and Romania on behalf of Western investors.

Elsewhere, even as the volume of Chinese M&A transactions has collapsed, greenfield investments – though modest – are steadily increasing in the EU. A commanding share of those investments is flowing into the automotive sector, including battery plants, which form a key node in the value chain of China’s electrical vehicles (EV) sector. Indeed, producing in – as opposed to exporting to – Europe spares the cost of transport and tariffs. On the European side, Chinese investments in EV as well as renewable power are far less strategically sensitive than digital and nuclear, for example.

Individual CESEE states are set to benefit from this trend, albeit most likely on a one-off basis. Hungary, Slovakia and Poland have become strategic nodes in the Chinese EV supply chain, hosting nine of the 20 facilities Chinese corporates have established in Europe for the manufacturing of EV batteries, battery components, as well as actual EVs.

For example, in 2023, China’s CATL announced that it would establish a 100 GWh battery factory in Hungary, which will receive €7.8 billion in investment. Likewise, in 2022, China’s Geely automotive group announced that its Swedish subsidiary, Volvo, would invest €1.2 billion in building a new EV factory in Slovakia.

In this sense, the reverse of “nearshoring” is underway. Chinese EV producers are choosing to increase their geographical proximity to the European market in order to hedge against the risk of supply chain disruptions emerging from geopolitical turbulence.

On paper, Chinese FDI is not likely to recover to its previous levels in Europe, let alone CESEE. Connectivity is on the decline overall. Yet that masks the niche profile that Beijing is carving out for itself in the region.

Marcus How is head of research & analysis at ViennEast Consulting in Vienna. He thanks Gunter Deuber, head of research at Raiffeisen Bank International in Vienna, for his help with this opinion piece, which was originally posted on BNE Intellinews. 

*Image: bne IntelliNews