Identifier
Created
Classification
Origin
05PRAGUE204
2005-02-11 12:23:00
UNCLASSIFIED
Embassy Prague
Cable title:  

FIRMS WITH FOREIGN INVESTMENT ADD MORE VALUE, HAVE

Tags:  EINV ECON EZ 
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This record is a partial extract of the original cable. The full text of the original cable is not available.
UNCLAS SECTION 01 OF 03 PRAGUE 000204 

SIPDIS

STATE FOR EUR/NCE, EB/CBA AND EB/IFD/OIA
COMMERCE FOR 4232/ITA/MAC/MROGERS
TREASURY FOR OIA

E.O. 12958: N/A
TAGS: EINV ECON EZ
SUBJECT: FIRMS WITH FOREIGN INVESTMENT ADD MORE VALUE, HAVE
CHANGED FACE OF CZECH INDUSTRY. HOW TO KEEP THEM COMING?


UNCLAS SECTION 01 OF 03 PRAGUE 000204

SIPDIS

STATE FOR EUR/NCE, EB/CBA AND EB/IFD/OIA
COMMERCE FOR 4232/ITA/MAC/MROGERS
TREASURY FOR OIA

E.O. 12958: N/A
TAGS: EINV ECON EZ
SUBJECT: FIRMS WITH FOREIGN INVESTMENT ADD MORE VALUE, HAVE
CHANGED FACE OF CZECH INDUSTRY. HOW TO KEEP THEM COMING?



1. Summary: Much of the Czech Republic's economic growth
over the past several years has been attributable to
significant flows of foreign direct investment (FDI) that
have made the country the destination for more such
investment per capita in recent years than any other country
of central and eastern Europe. FDI has transformed the Czech
economy with new capital, technology and management methods.
Foreign investors pay above-average wages that have boosted
real incomes over the past five years and advanced the
convergence of the Czech economy with that of its EU
partners. Besides contributing directly to GDP, FDI has
helped to increase the quality of Czech exports to the extent
that they have easily held up under the pressure of a rising
exchange rate. On the other hand, some resentment among
Czechs has surfaced recently over foreign investor's
supposedly "excessive" repatriation of earnings and their use
of government investment incentives. The USG will have to
formulate a position on continuation of investment incentives
if the opposition ODS, which opposes them, takes power in

2006. The ODS has no plans to disturb incentives already
granted. The challenge for the Czech Republic in the near
future will be to continue to attract high levels of foreign
investment, or to find new factors that can contribute as
strongly to growth. End Summary.


2. The Czech Republic has been remarkably successful in
attracting foreign investment, based on its relatively lower
labor costs compared to Western Europe, its well-educated
workforce, its central location in Europe, and the incentives
it offers to investors. Using OECD figures on investment
from 1994 to 2003, the stock of foreign investment in the
Czech Republic per capita was $3715, compared to $3176 in
Hungary, $2037 in Slovakia and $1347 in Poland. 2003 was a
relatively slow year in the Czech Republic for FDI, but the
Czechs still edged out the Hungarians for the per capita
honors among the Visegrad countries, according to the OECD.
Investor interest revived in 2004 and the Czech Republic
should again be drawing significantly more per capita on an
annual basis than its neighbors, if the trends of the first

two quarters of 2004 continue.


3. A recent study by the Czech Statistical Office indicates
that firms under foreign control with more than 100 employees
are one-third more productive than similarly-sized Czech
firms. Firms under foreign control are 26% of registered
companies with more than 100 employees. However, among such
large companies, they produce 43% of added value, 47% of
total revenues, 52% of gross profits, and 70% of exports.
The major sectors into which foreign investment flowed over
the 1990's are banking and finance, telecommunications,
packaged food and drink, automobiles and auto parts, and
tobacco. Interestingly, some Czech subsidiaries are doing
better financially than their foreign parent firms. This is
true of some of the banks. Another example is Skoda Auto,
which is not burdened by over-employment and strikes that
hamper its parent Volkswagen. Skoda is becoming a foreign
investor itself, with assembly plants in Ukraine, Bosnia and
India.


4. Foreign investment has transformed the face of Czech
industry over the past ten years. The list of the twenty
largest Czech firms in 1994 was almost exclusively composed
of firms in the iron, steel, energy and chemical sectors,
along with the telephone and tobacco monopolies. The 2003
list contains some of the same names, such as CEZ, the
state-owned electrical utility, but now features Foxconn, a
computer and electronics producer based in Taiwan, retailers
such as Holland's Makro and Ahold, auto parts maker Bosch,
and mobile phone operators Eurotel and T-Mobile. Other
foreign names on the 2003 list are Siemens and Ispat, the
Anglo-Indian firm that owns the steelworks at Nova Hut.
Steel and chemicals have not disappeared from the list and
are still key Czech products for both domestic use and
export.


5. The government recognizes that the Czech Republic cannot
continue forever as a low-wage manufacturing economy, and is
trying to sharpen the focus of its investment incentive
scheme to attract research and development and business
support services. Forty percent of the investment going
through the investment promotion agency CzechInvest is now
flowing into such businesses. Companies such as Exxon-Mobil,
DHL, IBM, Honeywell, Accenture and others have located R&D or
services centers in the Czech Republic over the past few
years.


6. The 600 million euro Toyota-Peugeot-Citroen joint venture
in Kolin is scheduled to begin producing its first cars for
sale in February 2005. However, CzechInvest rates the
likelihood of another such gigantic single investment in the
future as low. Ford Motors recently decided to locate a
plant in Slovakia -- the Czech Republic's closest competitor
for major investment. Legislators in the Czech Republic are
warily eyeing Slovakia's flat 19% tax and more advanced
pension and health care reforms. CSSD legislators are
doubtful that a flat tax could produce the needed level of
revenue in the Czech Republic, and the chances of major tax,
pension and health care reforms are dwindling away as the
2006 elections approach.


7. The ODS made a flat tax a feature of its election
campaign in 2002 and will do so again in 2006. They promise
a host of reforms that will benefit the climate for doing
business in the Czech Republic, if they can force them
through parliament after taking power. However, the ODS is
conceptually opposed to incentives as an economic distortion
of investment decisionmaking, a drain on government finances,
and unfair to domestic companies who cannot invest above the
threshold amounts for receiving incentives. The generally
free-market ODS politicians are not hostile to foreign
investment per se, but they feel no urge to give it special
advantages over domestic companies. The likely advent of an
ODS government in 2006 would present the USG with a dilemma
over whether to support the continuation of investment
incentives. In a recent meeting, the governor of the
Moravian-Silesian region, Evzen Tosenovsky, assured us the
ODS would never touch incentives already granted. He also
foresees that doing away with incentives will not be
accomplished as easily as some in the ODS suggest, because of
the wide range of laws that would have to be amended.


8. Investments of $10 million can qualify for incentives
that include relief from corporate taxes for ten years, job
creation grants, retraining grants and opportunities to
obtain low-cost land. The current system of incentives was
developed with input from the European Union and was not
affected by the Czech Republic's entry into the EU. It is
relatively transparent, with clear rules about who is and is
not entitled to incentives. If it were abolished, it is
quite possible that the government would not be able to
resist offering ad hoc incentives if presented with a large
new investment proposal that would go to a neighboring
country if the GOCR were unwilling to step up to the plate.
Too-frequent resort to such ad hoc incentives would be less
desirable than the system in place.


9. Doing business in the Czech Republic is still an exercise
in red tape that probably affects domestic small and medium
businesses even more than well-heeled foreign investors who
have the support of the investment promotion agency
CzechInvest. The judicial system still operates glacially.
More and more often, the European Court of Justice is
imposing stiff penalties on the GOCR, recompensing citizens
whose cases have languished for so long the Court deems their
rights to have been violated. Corruption is an ongoing
problem, with 21% of Czechs sampled by the 2004 Transparency
International Global Corruption Barometer poll admitting to
having given a bribe in the past year. Corruption can be
particularly off-putting to American firms that face tougher
standards than many of their foreign competitors. The
American Chamber of Commerce and the Embassy have stressed
repeatedly to Czech politicians the importance of such basic
reforms as simplifying the process of registering companies
and modernizing the unwieldy bankruptcy laws -- changes which
would also have a healthy impact on corruption. The
parliament recently amended the company registration law
favorably. It will likely soon amend the bankruptcy law to
strengthen the rights of banks that lend to small businesses.
However, a much-needed comprehensive overhaul of the
bankruptcy code is tied up in discussions within the
government.


10. According to the Ministry of Finance, the final count of
inward flows of foreign direct investment is expected to
reach a satisfactory $4-4.5 billion in 2004, compared to $2.5
billion in 2003. The Czech Republic still retains its
natural advantages: a skilled workforce, average wages only a
quarter of those in the EU, a central location in Europe, a
well-developed communications and transport infrastructure.
The country is a pleasant place for managers to live, a
factor that should not be discounted in investment decisions.
However, Czech politicians cannot ignore the competition for
the investor's dollar or euro. They must pay attention to
fundamentals of the tax, legal and ethical environment that
are just as important to investor's decision-making.

CABANISS