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Costs grow but Eastern Europe still lures Western firms

An awkward mix of strong currencies, rising pay expectations and a slowdown in key export markets has hit producers in emerging Europe but Western firms still see the region as a good place to set up factories.

Despite a sharp jump in costs in Poland, Hungary, the Czech Republic and Slovakia, the region is still much cheaper than most of Western Europe when it comes to making goods. Moreover, strong local currencies have cushioned the impact of higher commodity prices and Western European wages are rising more quickly than in the past due to accelerating inflation.

Add a skilled workforce, shared cultural values, and good transport links to both Western and Eastern markets -- all reasons why firms from older EU states often prefer the region to cheaper sites like those in Asia -- and the answer is simple. “It’s still cheaper than in Germany,” said Sebastian Holtgrewe, head of communications for the German-Czech Chamber of Commerce and Industry. “The conditions here are pretty good.” Nor is the Czech Republic the only ex-Communist newcomer to the European Union to catch companies’ eyes. A recent German Chamber of Industry and Commerce (DIHK) survey showed the proportion of manufacturing firms wanting to invest abroad rose to 35% in 2008 from 29% in 2007. Of those, 43% were eyeing Central and Eastern Europe, up from 36% last year.


The Polish zloty, Hungarian forint and Czech and Slovak koruna have jumped around 10% against the euro each since the start of the year, and as much as 30% or more since the countries joined the European Union in 2004. That has a big impact on exporters, whose prices spiked this year for Western consumers if companies did not cut prices or hedge their bets. In any case, profits are suffering. “The strong forint does affect us,” said Lajos Korom, Managing director of German-owned drugs maker B.Braun Medical in Hungary. “We have to pay less for imported goods. But it’s very bad for production, as we generate our revenues in euros.” Volkswagen’s Czech unit, Skoda Auto, exports 90% of its production. The strong koruna cut into its H1 operating profit by 2.3 billion koruna ($149.7 million), despite an 18% increase in the volume of cars sold.

Inflation, which was 4.6% in Poland and 6.7 in both the Czech Republic and Hungary in June, has also cut demand from domestic consumers in country and is boosting wage demands. That has compounded a problem with already slower demand in Western Europe, the main market for Central European exports. Nevertheless, producers say they are well placed. Strong currencies have helped offset a jump in the prices of commodities crucial to production.

Also, firms like Skoda and French PSA Peugeot Citroen, which owns factories in both the Czech Republic and Slovakia, have seen a jump in sales volumes for the small Central European produced cars. PSA, which is finalizing a 100 million euro investment project at its Slovak plant, may benefit when the country joins the euro zone next year, as its currency can no longer strengthen against the euro. PSA will then face higher costs only through inflation, as prices and wages eventually converge with the richer West. “We had incorporated these economic tendencies into our plans when we were making them,” said Peter Svec, spokesman for PSA’s Slovak factory. “We do not see fading interest to come to this region among our suppliers. Their inflow has been more or less constant over the past three years.”


Of course, not all investors are staying. Germany’s Siemens will lay off around 1,000 workers from a Prague rail car factory in 2009 and cable maker Alcoa Fujikura said it may let 850 go and move to cheaper Romania. But in June, Daimler said it would build an €800 million car plant in Hungary, the biggest such project there. And although production rates are lower, average hourly labor costs are less than a third of those in Germany, while fast transport within the tariff-free EU means savings on fuel and other costs compared with cheaper production sites in Asia. In Germany, the introduction of minimum wages in some sectors and a lack of skilled staff have also pushed many firms in Europe’s economy to head eastwards. And some German industries have seen the biggest wage deals in over a decade in 2008, including a 5.2% rise for steel workers and a provisional 11% rise for train drivers.

J.P.Morgan estimates unit labor cost growth will exceed 20% in the Czech Republic and Poland this year. But even then, the overall hourly rate in manufacturing will stay much cheaper than Germany’s, which was €33.0 last year. “labor costs remain low in comparison with Western Europe’s,” JP Morgan analyst Miroslav Plojhar wrote in a report. “We estimate that labor costs (i.e. wages plus related expenses) rose to 30-35% of the level in Germany this year, from 23-27% two years ago.” (Reuters)