Guy de Blonay says Greece's experience since joining the EU is a good example of how financial services are both the cause and the effect of economic growth
An investment portfolio always requires a theme, and every stock bought as part of its construction must reflect that. The theme of Eastern Europe is, obviously, above average economic growth and, I believe, one of the best ways to capture that trend is through financial services.
Eastern Europe is a blanket term, but the region can now be separated into two distinct categories. Members of the EU, such as the Baltics, Poland, Hungary, Czech Republic, Slovakia and Greece, and non-EU, such as Bulgaria, Romania and Turkey, which hope to gain entry in 2007. Their chances, however, may have receded following the recent 'No' votes on the EU constitution.
The Greek model is a perfect example of how financial services are both the cause and effect of economic growth. The sharp increase in retail banking services over the past few years is providing the power behind the economic development, by feeding consumer spending, and yet, at the same time, is being driven by it.
It is also the only Eastern European country that is a member of the euro zone, having swapped the drachma for the euro in 2001 and adopted the European Central Bank's rulings, although other EU members should follow in 2007.
Undoubtedly, much of Greece's strong economic performance in recent years - the government projects an economic growth rate of 3.9% in 2005 - is attributable to its membership of the euro zone, and the effect of interest rate convergence.
The lower cost of borrowing boosted demand for credit. Consequently, retail banking is booming within Greece. Indeed, according to Citigroup, three Greek banks featured in the top 10 European banks for revenue growth last year. Only recently HSBC announced plans to expand operations within the country, and Piraeus, the country's fourth largest bank by market capitalisation, reported that net income had climbed 37.6% in the first quarter against last year as a result of growth in its retail business.
Consumer credit has grown at about 30% in the last four years while mortgage growth was 25% year-on-year. But, because consumer borrowing is a relatively new phenomenon in Greece - until June 2003, personal loans had an upper ceiling of E3,000 - the population is not heavily indebted. George Alogoskoufis, the Greek finance minister, has pointed out that household debt levels are less than half the EU average, indicating that there is plenty of potential for further expansion.
The government has also adopted a progressive tax policy to attract foreign companies. Corporation tax is being cut in stages from 35% to 25% by 2007, while a revised development law offers generous incentives and financial support to boost regional growth.
Companies will also be attracted to the prospect of investing in a euro zone economy, with steady inflation, low interest rates and a single currency. Much of the market risk in the region has therefore been reduced.
Already Microsoft and IBM have set up operations within Greece, alongside other foreign companies, such as Vodafone.
The young, well-educated labour force is also an attraction, just as it has been in Ireland over the last decade or so. In many respects Greece today is comparable to Ireland in the 1990s, and I believe, in two or three years, Poland and Hungary will be similarly positioned.
These international companies move in and bring with them expatriates who, traditionally, although this has not been the case in Greece, look to rent historic properties within the city centre, thus boosting the rental market. They also start hiring local people (unemployment in Greece stood at 10% last year) and creating wealth.
As this new affluence filters through, these locals start demanding a better standard of life. They look to borrow money and, as a result, establish a track record of their credit worthiness, which enables banks and financial institutions to sell more products.
For example, there is a potential for a credit card market which is, as yet, extremely underdeveloped in Greece, given the country has traditionally been a cash-based society. Only one in five people in the country own a car, so there is also potential for product sales and the financing arrangements that support purchases. Although the mortgage market has experienced heady growth rates in recent years, it remains relatively inefficient and immature. Greek mortgage volumes stand at about 20% of gross domestic product, which is half the penetration of more mature markets like the UK.
In common with other Eastern European economies, home ownership at over 80% is high, but young people still living at home will, with their increased wealth, seek to buy properties. This creates opportunities for real estate companies.
positioned for profit
When the other East European economies join the euro they will likely have similar experiences as their interest rates converge with the EU, boosting consumer demand for credit. This all takes time to feed through but it is this lag which creates opportunities for fund managers who must predict potential outcomes and take positions accordingly.
However, there are already some promising signs within the other Eastern European members of the EU. The economies of Czech Republic, Poland and Slovakia are growing at about 4% per year, while the Baltic states of Estonia, Latvia and Lithuania are expanding by more than 6%.
This growth is partly being fed by the arrival of foreign companies that are predicting that these economies will follow the model of other euro zone members, such as Greece, and benefit from the convergence of local interest rates to the euro zone level.
They have also been lured by labour costs that are about 40% of those in Germany, the region's enthusiasm for public-private partnerships and an array of tax incentives that many Eastern European governments have put into place. Slovakia, for example, has a rate of 19% on corporate profits and personal income while Poland is expected to introduce a flat rate of 18% in 2008. The corporate tax rate in Estonia is 19%. These compare with a Western Europe average of more than 30%.
The tourist trade and the arrival of overseas investors seeking holiday homes or buy-to-let properties have also boosted these economies. Ryanair, for example, recently announced plans to fly to seven airports in Poland. This effect has been less apparent in Greece, which is traditionally seen as a holiday destination.
A direct play on the potential convergence of Eastern European economies is Orco Property Group, which is listed in Luxembourg and Prague, and is developing real estate projects in Hungary, Poland and the Czech Republic.
Many banks have already expanded operations within the Eastern European bloc. For example, around 20% of the retail portfolio of France's Société Générale is exposed to Eastern Europe, while Swedbank derives 25% of its revenues from the region.
UniCredito Italiano's acquisition of Germany's HypoVereinsBank (HVB) may be one of the biggest takeover deals this year, but it also provides another attractive investment opportunity to gain exposure to Eastern Europe.
UniCredito's domestic market in Northern Italy is performing yet mature, but 20% of the bank's net profits come from its operations in Eastern Europe. In contrast, HVB's local market in Bavaria is both under-performing and mature, but the bank's attraction to UniCredito was its majority stake in BankAustria, which derives around 60% of its profits from Eastern Europe.
UniCredito saw a good fit between the two banks and, if it succeeds and strengthens its position, the Italian bank could become a dominant player in the fastest growing European bloc. Whether this translates into the share price straight away is debatable, but on a strategic basis, UniCredito is building a strong commercial bank in the most attractive business location.
In the past, the exchanges in Eastern Europe have lacked the liquidity and transparency of the western stock exchanges and this has meant I have tended to gain exposure to the region through western based companies or where Eastern European financial companies have a dual listing on a mature exchange.
The economies and institutions within Eastern Europe have begun to build their reputation, however, and I am becoming increasingly confident about taking direct investments in companies on their local exchanges. The ongoing convergence with Western Europe can only serve to heighten this process and I believe the region should continue to offer some of the most attractive growth rates among financial companies.
Focus on those countries in Eastern Europe that are EU members, eg Greece, Poland, Hungary and Baltic States.
Plenty of scope for household debt to grow, it is very low by European standards.
Real estate companies will benefit as property prices pick up.
Time to get exposure to the region direct via local stock exchanges.
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