30 October 2006

Croatian FDI flows fast and furious

By Eric Jansson
Published by Financial Times, 30 October 2006

A year ago it appeared certain that British American Tobacco would pack up and leave Croatia. The world's second largest tobacco producer, a prominent investor, declared publicly its view that the investment climate was "hostile".

The tone of the complaint indicated BAT's departure was imminent after an eight-year struggle to make good on an investment, estimated to be $70m, in Tvornica Duhana Zadar (TDZ), a cigarette rolling plant. BAT had once called its "foothold in the Balkans", although major problems culminated in bankruptcy for the TDZ operation last year.

BAT's complaint and TDZ's bankruptcy chimed with a survey published by the World Bank and International Finance Corporation, ranking Croatia 134th in the world for its record on investment protection and rating its economic performance behind all other former Yugoslav republics.

For government officials in Zagreb, who describe Croatia as an excellent, proven destination for foreign investment, this was bitter news.

But a year later, BAT is still there and foreign direct investment is increasing apace.

Rather than walking away, the company has chosen to fight for the shares of TDZ which BAT insists it rightfully owns. Its determination to reclaim a competitive stake in this relatively small country of 4.5m people, now the subject of a multi-faceted legal battle, is indicative of multinationals' settled view of Croatia as a desirable entry point to the broader Balkan market of 60m.

Foreign direct investment topped $1.3bn last year, an 8 per cent rise on 2004, which was equal to 3.3 per cent of gross domestic product. This year, foreign investment figures will rise again, much more sharply, following US-based Barr Pharmaceuticals' $1.9bn acquisition of Pliva, a Croatian pharmaceuticals manufacturer.

The Pliva deal is so big in Croatia's diminutive economy that analysts predict central bankers will need to intervene to minimise the consequent appreciation in the value of the national currency, the kuna.

Damir Polancec, deputy prime minister in charge of economic policy, lists a series of reforms that, he says, keep foreign investment streaming in. However, he adds that Croatia "cannot be satisfied" yet with the current level.

Reforms include a "regulatory guillotine" intended to cut red tape, a "one-stop-shop" enabling new companies to register with the state in four to eight days, tax incentives and a public service reform that Mr Polancec says will help smooth relations with business.

The strong influx in foreign investment, BAT's decision to stay, and the government's actions in favour of business put the alleged hostility in context. But they do not cancel out foreign investors' complaints entirely.

Here BAT's case is instructive. The tobacco company's position in Croatia fell apart last year when the High Commercial Court stripped the company of its majority shareholding in TDZ, cutting its stake from 85 to 25.21 percent, ruling that BAT had acquired shares illegitimately, a claim the company vigorously denies.

But even before the ruling, BAT alleges, the company was undermined by excise taxes that discriminate against foreign cigarette brands in favour of TDR, a local tobacco giant, and "trade blockages", for six years the subject of an unresolved case pending at the Croatian Agency for Protection of Market Competition.

In a statement this month, BAT said: "Although Croatia has started accession negotiations with the European Union and has already harmonised some regulations with EU standards, we believe the Croatian government could do more in terms of pro-actively managing the process of harmonisation of tobacco related regulations and in particular the law on excise.".

Mr Polancec says he believes that BAT has "in no way suffered from discrimination so far", while adding that Croatia's judicial system can be expected to judge fairly if it has.

But other prominent investors echo BAT's allegation of malign neglect and interference by state institutions.

"Most of the problems stem from the fact that the Croatian decision-makers still do not fully understand how a free market economy should function," says Denis Mohorovic, spokesman for MOL, the Hungarian oil and gas company that in 2003 purchased a 25 per cent stake in INA, Croatia's state-owned oil company.

MOL's chief complaint regards the state's regulation of oil prices and debt write-offs to state-owned customers, which Mr Mohorovic claims has "effectively decreased INA's value in excess of $710m between 2003 and 2006."

Mr Mohorovic adds that the government's newly unveiled plan for continued privatisation of INA, through offerings of a 17 percent stake on the London and Zagreb stock exchanges, is "too small to make a significant difference".

Mr Polancec responds that "all we are doing is following the law on INA's privatisation" passed in 2001, and, indeed, MOL remains fundamentally pleased to remain INA's strategic investor. INA's pre-tax profits more than doubled from 2003 to 2005, reaching 1.5bn kuna (€203m) last year. Mr Mohorovic calls Croatia "a good market with solid growth and a skilled and reliable workforce, but also one that still creates some serious challenges for any business wishing to work in it."

In a broader central European and Balkan economy where administrative barriers to investment and corruption remain commonplace, this may be regarded as good enough. But it is far from ideal.


Anonymous said...

Interesting to read your article although not so true when it comes to BAT. But, lets leave it there. It is a long story after all. The truth is: Croatia was among top 3 reformers in the world last year, and the top reformer this year according to World Bank Doing Business report.

Eric said...

Anonymous: thanks for your comment. Please do make note of the fact that the article to which you are responding is well over a year old. Croatia's reform record from last year, which you describe as one of the "top three in the world" -- and I realise you are not alone in saying this -- did not yet exist at time of writing!