Thursday, December 9, 2010

Geo-political and economic shifts in Russia-Western Europe relations create opportunities in Emerging Europe

We start this note with a picture of one of the most important elements of the European Infrastructure: the pipelines that connect Russia with Western Europe. With gasoline prices in Europe hitting record levels again, we felt that it was good to use the attached article (see below) from the excellent Frontier Markets blog for this note.

It is of course not totally coincidental that we wrote our previous entry on Gazprom, the Russian energy powerhouse, and one on our Facebook page on the fact that Russia was awarded the World Championships Football in 2018. Add to that the fact that the country will also organize the 2014 Winter Olympics in Sotchi and you know that a lot of good infrastructure dynamics will be going on during the next 3-5 years and beyond. Another indication is the fact that Sotchi will be on the calendar soon as a new spot on the Formula 1 car racing map. Gossip even states that it was Vladimir Putin himself who translated his personal love for motorsports into sponsoring by the Russian state after Russian driver Petrov's great performance in the last race of this season in Abu Dhabi. It was to quite some extent Petrov's driving that ensured that Vettel and not Alonso took back home the world championship.

Eastern Europe = Central Europe 
Dynamics characterized by one thing: sufficient money to create an infrastructure boom in Russia. If you add to that ongoing tensions in the Middle East and European suspicions about Asian domination, it is not totally impossible that old geopolitical enemies will find each other: Western Europe / EU and Russia. OK, this will not be a marriage of passionate love, but it will be one of two parties who need each other. They might even continue to live separately. Or at least meet each other often at neutral territory. And that neutral territory between them is Central Europe, often called Eastern Europe in the past.

Eastern Europe consists of three parts according to the Frontier Markets blog:

  1. A central core consisting of Poland, Czech Republic and Slovakia where the banking system is already developing and proximity to Western Europe has already translated to some substantial integration. Budget deficits and debts are still worrying (and so are Polish actions against the second pension pillar), but all in all - helped by substantial investments from Western European parties - these countries are already transitioning. Large infrastructure investments go hand-in-hand with positive stimulus derived from industries like logistics and transportation (just drive through Europe and it seems that all trucks are from these countries!) and Polish workers flocking labor markets in Western Europe offering their services for far less than their Western European counterparts, followed by a weekend drive back to their country where they are then relatively rich citizens who have something to spend.
  2. The Baltic States. Still struggling with the aftermath of the Global Crisis, but we believe that there are some indications that the fact that these states (especially Lithuania and Latvia) have invested heavily in education over the last 10-20 years will translate into opportunities in IT, Banking and other industries heavily dependent on higher education. The proximity to markets in Scandinavia - where labor costs are high - has already led to the first large foreign direct investments by corporations from Sweden and Finland active in these sectors.
  3. The Balkans (including Hungary and the Ukraine). Still struggling and trying to ignite positive fire. But take a look at our map. The likelihood of these - now cheap - countries not benefiting from an increased interest in increased West-East lateral business and political contact in Europe is highly unlikely. The fact that they are mainly financed by now expensive loans from abroad a problem? Well, might be in the short run, but then again: taking into account their relative size compared to Western Europe and Russia we do not believe that this will be a big problem. Short-run tension will - as so often - translate into low valuations and low valuations are basically something that makes those countries interesting in the longer run for those who have a longer run agenda.
And we believe that the longer run agenda in Europe will be one of increased interest of Western Europe in Emerging Eastern / Central Europe. And the other way round? The Russians know about their linkage with Western Europe and interest in German exports. LMG believes that quite a few of the Eastern European negatives and low valuations do therefore translate into opportunities for Emerging Markets investors.

Click here to see the original Frontier Market Blog article on Eastern Europe

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