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Eastern/Central Europe: Foreign Investment Sets Record

Washington, 20 September 1996 (RFE/RL) -- The nations of Central and Eastern Europe drew foreign investment of $12 billion in 1995, a sharp 150 percent increase over 1994, according to the Institute of International Finance (IIF).

The institute, the largest private international group of commercial banks, investment houses, pension funds and insurance companies, says that foreign investment in the region is expected to decrease slightly this year, hitting around $10.3 billion.

IIF Managing Director Charles Dallara says the dip in equity investment this year has more to do with the pacing of privatization in these nations and the "cyclical nature of portfolio equity flows." He says the institute's member banks and investors have "no dramatic concerns" about the level of investment going into the region.

In reports prepared for next week's start of the annual meetings of the International Monetary Fund (IMF) and the World Bank, the institute notes that the composition of the investment money going into East and Central Europe is changing.

In 1995, nearly 90 percent of the equity flows into the region -- around $10.6 billion -- were in the form of direct investment. The rest -- around $1.4 billion -- was in the form of portfolio equity investment or stock shares.

This year, however, direct investment is expected to account for only about 70 percent of the investment flow. The institute says "the strong performance of, and increased foreign interest in, regional stock markets have boosted portfolio flows." It says that improved stock market infrastructures and a general perception that companies in this region are "generally undervalued, together with improved prospects for financial stability, has attracted investors."

The institute says the experience of Central and Eastern Europe reflects a worldwide pattern of capital flows shifting dramatically from the public arena to the private sector. It says that this year it expects net private capital flows to developing nations to top $225 billion, up from $208 billion last year.

This compares to capital flows from official sources such as the IMF, the World Bank and others, which are expected to total only about $14 billion this year, or less than 10 percent of total net flows.

Dallara says the "key challenge now facing the international community is how to sustain and expand these record net private flows." He says that pension funds, mutual funds and insurance companies have become "important participants alongside banks and investment banks" in fueling this flow of private capital.

In a letter to the IMF's policy making Interim Committee, Dallara said it is vital that the global institutions and the markets work together in "crisis avoidance."

He said everyone must understand that there is "no substitute for timely" adjustments when countries find themselves facing imbalances and misalignments; that improved transparency of information on each country's economy can help markets and officials forestall problems; and the need for authorities everywhere to remain alert to the "signals from the marketplace" that often warn of impending problems.

The institute praised recent IMF and World Bank moves to open more data to public scrutiny, make the process of economic decision making more transparent and encouraging the development of the private sector everywhere in the world.

While there is a role for the fund and bank in helping to avert crises, there is general agreement among the institute's 220 member banks and investment groups that official bailouts are not desirable.

"Private investors are absorbing loses and realizing profits every day in emerging markets," says Dallara. While some will "inevitably take heavy losses" in a crises, this is "an essential element of the risk-reward equation in any healthy market, and will sharpen risk management skills."

The way a child learns to jump over a barrier is to trip on it first, says Dallara, and part of the free enterprise system is learning to recognize dangers and how to avoid them.