It is easy to see the western Balkans as a black hole in the heart of the EU: not yet deemed suitable members of the European project, still recovering from the explosive violence that accompanied the break-up of Yugoslavia and, in many eyes, an unknown quantity.

For some investors, however, the region represents the chance of first-mover advantage. “This is the last bargain in Europe,” says one Balkan businessman. “A high-risk bargain, but a bargain nonetheless.” And while many will take a wait-and-see approach, others – such as the UK-based fund that owns 70% of Serbian dairy production – are staking their claim.

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While the outside world still regards the area with some suspicion, the reverse is also true. Serbia and Croatia, for example, are struggling with EU accession. “No-one here has done a real cost-benefit analysis of EU entry. We just know it is somehow inevitable. It will be painful at first, but hopefully bring benefits in the end,” a man involved with the accession negotiations told fDi in Zagreb.

The benefits are apparent. The accession states are stealing a march on Serbia and Croatia, and the cash-stricken economies of Macedonia and Bosnia-Herzegovina. But some people still believe they are better out than in.

The value of cash

“We don’t have ‘cash’ – would you take Mastercard?” reads an increasingly common graffito around Zagreb. The Croat word for cash, gotovina, is also the name of the Croatian army’s former chief of staff. General Ante Gotovina is wanted by the International Criminal Tribunal for Yugoslavia (ICTY) in The Hague. Until the Croatian government hands over ‘General Cash’, formal EU accession talks that were due to start March 17 are on hold. The government insists that General Gotovina is not within its grasp.

The pun works another way too, as Croatia is literally strapped for cash – foreign debt represents 85% of GDP. In fact, what has become known as the ‘Gotovina issue’ is now used to indicate more general problems, such as reactionary elements within the secret services, residual extreme nationalism, intransigence and opposition to EU accession, corruption, and deficiencies in the rule of law.

These are not so much Croatian as Balkan characteristics. Failure to deliver Radko Mladic, the general responsible for the Srebrenica massacre of 1995, and Radovan Karadzic, the Bosnian Serb nationalist, continues to dog Serbia’s relations with the international community.

Accession-related reforms, when they start to bite, will affect everything and everyone from pensioners in Belgrade, shipyards on the Dalmatian coast and smallholdings in Montenegro. But they will also give investors the confidence to establish medium and long-term strategic ventures that can help the Balkan countries pull themselves out of a hole.

Zagreb blues

Despite the Balkan economies having some common issues, from an investor’s perspective there are some neat differences between them. The EU considers Croatia to be a functioning market economy that could withstand accession from the outset; it does not see Serbia in the same light. Croatia has beaches; Serbia, agricultural land. Croatia stopped fighting in 1996, giving it a head start economically. And the Gotovina issue notwithstanding, Croatia is next in line, after Romania and Bulgaria, to join the EU. Serbian accession is at least nine or 10 years away.

For many, the key difference between Croatia (and almost anywhere else in the Balkans bar Greece) is the scale of its tourism industry. Zagreb lawyer Mladen Markoc says that, along with financial services, tourism remains Croatia’s big draw: “Tourism is now the focus of eight out of 10 investors. More than 30% of my clients are interested in tourism, whether it be construction, restructuring or privatisation.”

To encourage more investors, and more visitors, the Croatian government has used bond issues and assistance from the European Bank for Reconstruction and Development to boost the depth and breadth of infrastructure – financing, for example, the construction of a new motorway between Zagreb and Split.

It is generally accepted, though, that the government needs to do more. Development is patchy, leading to extraordinary disparities in the prices of land and property. Dubrovnik property prices are now roughly €3000 a square metre. Elsewhere, the coast is blighted by unattractive and illegal resorts, developed during the war when no-one was paying much attention to the rules.

Despite efforts to ease property ownership, potential purchasers still need to clear burdensome administrative hurdles – typically, investments are made through the establishment of a special purpose vehicle. “You need a good lawyer,” says Mr Markoc.

Legal proceedings are also a headache, with a current backlog of 1.6 million court cases, which in a country with a population of less than five million is noteworthy, if for the wrong reasons. “We need to train our judiciary. Some of our judges don’t have the slightest idea about modern commerce,” complains one lawyer. Typically, commercial disputes take years to settle.

Hard sell

The first wave of privatisation in Croatia during the 1990s was little more than an attempt to fill the war chest. Lacking transparency and beset by cronyism, foreign investment was effectively excluded, and the government of Franjo Tudjman failed to raise capital in any meaningful quantities. But in subsequent rounds, Croatian banks have been bought and turned around by foreign banks, and there have been dual listings of previously state-owned companies.

Tempting targets remain in the energy, insurance, banking and tourism industries. Despite the question mark looming over Croatian accession, the Croatian stock market, Crobex, has been pushed to record performances in the first quarter of 2005, largely by confidence that Croatia is next in line for EU membership. The best performing stocks in the first quarter of 2005 are in the tourism, beverage and textile sectors, and include Hotel Kompas, Grand Hotel Park, Mladina and Kamensko.

The best might be yet to come: key privatisations in 2006 are expected to include disposals of state assets in INA, Croatia Telecom and Croatia Osiguranje (the state-owned insurance company.) And, as Mr Markoc points out, the government has made some strides as part of its pre-accession planning, which already eases the path for investors – not least, the creation of a functioning and easily accessed land registry. A planned relaxation in pension fund rules is also expected to increase market liquidity.

Poles apart

“Serbia is still wild – but the Serbs sell themselves better than the Croatians,” says one Zagreb-based analyst. Judging by the goodie bag of brochures, pens and DVDs handed out in the elegant offices of the Serbian Investment and Export Promotion Agency (SIEPA), that statement might be partly true.

SIEPA director Jasna Matic says that while Serbia “fully expects to be a full member of the EU”, investors should take advantage of the situation as things stand now: cheap labour costs, for example, and less demanding environmental rules.

Something is working; SIEPA has successfully attracted some headline strategic investors. US Steel recently bought a Serbian steel mill out of bankruptcy proceedings (“They’re turning a profit in less than a year – nobody ever thought it could be successful,” says Ms Matic) and tobacco giant Philip Morris bought a Serbian tobacco factory for about $500m.

Serbia has a good story to sell, Ms Matic insists: one of the lowest corporate taxes in Europe (10%) and technological know-how, developed in the 1980s, which just needs awakening from slumber. Already, efforts to encourage foreign participation in the economy are bearing fruit (Serbia, it should be noted, is “the world’s largest exporter of raspberries”) and FDI is set to top $2bn in 2005, more than doubling last year’s figure of $900m, she says.

Export figures are showing comparable growth spurts and, although Ms Matic acknowledges that a new law on VAT might contribute to the latter, foreign investors are also a factor.

Interest grows

And it looks as though there is more to come. During an interview at the Ministry of International Economic Relations, deputy minister Vlatko Sekulovic fielded calls from a US company planning construction of a cargo holding facility at Belgrade airport, and an Italian shoe company producing in Serbia for export to the Russian market.

Mr Sekulovic points out that Serbia is a “good platform” for selling into Russia. “It’s cheap, it’s close, trading links are good, and it’s up for grabs,” he says. “Everything in Serbia will be privatised by 2007.”

In effect, the Balkans business psyche is divided, both on the accession issue and on how it should respond. Even in Croatia, which is considerably further down the accession path than Serbia, there is a suspicion that the Gotovina issue is a ruse to keep the country ‘out of the club’.

Balkan watchers also speculate that the accession programme might yet dissipate if the European Constitution is not ratified – something that EU officials deny but which is gaining currency nonetheless.

Toma Rajcevic, a French lawyer and adviser to the Serbian government on privatisation issues, warns Balkan countries against playing the cheap and outside of the EU card. “There is a lobby in Serbia that says that we should take advantage of our pre-accession position while we can. That lobby argues that investors will leave the recent accession countries – Slovakia, Slovenia, etc – and come to Serbia because it is cheaper,” he says.

However, this argument is without merit, he says. “First, long-term strategic investors will realise that Serbia is going to join the EU eventually and that the apparent advantages will disappear,” he says. “Second, all Serbian legislation is now either wholly or near-wholly compliant with EU and World Trade Organization regulations.” That, he says, applies to a foreign trade act, a new commercial code, company code, environmental laws, customs regulations and rules of origin – all currently before the Serbian parliament.

An eye on profit

Serbia has already privatised vast swathes of its industry, both through cash-raising tenders and auctions, and voucher sales, redistributing a majority stake in a company to its employees.

Dusan Mijic, a Novi Sad-based businessman and director of London-based investment business Emerging Markets Advisory Corporation (EMAC), believes the greatest opportunities lie in the “social companies” created through the voucher redistributions. Yugoslav companies never had to endure the command economy structures of the Soviet bloc proper, and management skills were and remain profit-oriented. Mr Mijic’s colleague in London says that the western Balkans could yet “seize the opportunity to become Europe’s own low-cost manufacturing base without the inherent political risks of China and Russia”.

Investors, however, have reason to be cautious. Most Serbian companies are heavily overstaffed (an obvious socialist legacy) and employment laws are weighted in favour of employees. Foreign purchasers take on onerous undertakings, such as pledging no redundancies within two years of change of ownership. This can be overcome through negotiation with unions, but to do so is not cheap.

Right connections

As anywhere, an entrée to the political machinations of the Serbian system is essential if investors are to avoid getting their fingers burnt. In a recent bidding war for a mineral water bottling company, elements within the government were so keen to attract a household name as strategic investor that rumours say physical pressure was exerted on a key regulator to influence the outcome. (The attempt failed and the winner, a small and largely unknown London-based fund, bought the plant.)

Some areas of business, such as transport and distribution, remain pretty much a closed shop. “It’s true, we need proper implementation of a competition law,” admits one government adviser. A major investor in Serbia told fDi that for all the clout of the multinationals: “The real competition is the locals. They know the turf. They’ve got the connections.”

Serbia hopes or expects to accede to the EU by 2014. This, says deputy minister Sekulovic, is symbolic, coming a quarter of a century after the fall of the Berlin Wall. “But we want to be ready, economically, when we join. We want to have the right framework in place.”

Is there any doubt that the states of the western Balkans will accede? Not in the minds of anyone that has thought through the repercussions of it not happening. An Austrian banker with extensive knowledge of the Balkans says: “There cannot be a black hole in Europe. There must not be such a hole.” But there will be shades of grey before the hole is filled.