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Central and eastern Europe are courting China

Hungarian Prime Minister Viktor Orban
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Hungarian Prime Minister Viktor Orban

Joining hands with Chinese and Serbian prime ministers in Bucharest, Romania on November 25, 2013, the beaming Viktor Orbán, Hungary's Prime Minister, was ecstatic about China's acceptance to finance and lead the modernization of an antiquated rail connection between Budapest and Belgrade.

No stranger to dustups with his European Union (EU) partners and the EU Commission, he seemed pleased to emphasize that an estimated 2.4 billion euro project financed by China could not be done by (cash-strapped and austerity-ridden) Brussels.

Two days later, the Chinese were at it. China's engineers were surveying the clunky rail line and riding the slow-moving railway cars between these two European capitals, committing to a detailed project presentation within the next six months.

(Read more: As you were? Europe deflation fears despite upbeat data)

But it was Romania, the host of the second annual summit between China and 16 central and east European countries held in Bucharest on November 26, 2013, who reportedly got most of the $10 billion the Chinese brought with them for infrastructure investments in these relatively poor former communist nations (Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, FYR of Macedonia, Hungary, Latvia, Lithuania, Montenegro, Poland, Serbia, Slovakia, Slovenia and Romania).

According to Romanian sources, 13 trade and investment contracts have been signed with Chinese companies for an estimated value of 8 billion euros in the area of energy, infrastructure and railway networks.

And all that with Chinese Prime Minister Li Keqiang's compliment that "Romania is a tiger of central and east Europe," an accolade savored by the local media at a time when some of the country's EU partners want to limit access to Romanian (and Bulgarian) immigrants in a flagrant contravention of EU rules.

A large development potential

By most accounts, the summit was a great success as apparently the interest of central and east European countries far exceeded what the Chinese side was prepared to deal with. There will probably be an active follow-up of summit discussions between some 300 Chinese businessmen and more than double that number of their European counterparts who participated at the Bucharest meeting.

The potential for commerce and investments is enormous. The current annual trade volume of some $50 billion between China and these 16 countries is just one-tenth of what China does with the EU, or roughly the equivalent of China's bilateral trade with Italy. Also, China invests less in the entire central and east Europe than it does in Sweden.

(Read more: China reforms put railways back on track)

There is a wide range of areas where the two sides' business interests coincide.

China – which consumes about one-fifth of the world's food supplies – is mainly interested in high-quality farm products the vast plains of central and east Europe can produce in abundance.

And here is an interesting aside. With only 9 percent of the world's arable farmland, China last year signed a deal with Ukraine to farm an area of 11.6 million square miles (that is larger than the U.S. State of Massachusetts). Ukraine will get from China a $3 billion loan to modernize its agriculture. Ukraine will also get seeds, farm equipment, a fertilizer plant a highway in the Crimea and a bridge across the Strait of Kerch, an important industrial center and a channel between Ukraine and Russia connecting the Sea of Azov and the Black Sea.

"A piece of candy perhaps?"

No wonder Ukraine's President Viktor Yanukovich was sniggering at the 610 million euros – which he called "a nicely wrapped piece of candy" – offered by the EU to upgrade the economy to Brussels standards and to accept a free trade agreement he refused to sign last week at the EU Eastern Partnership meeting in Vilnius, Lithuania.

(Read more: Ukraine and EU fail to salvage trade pact)

This hopefully temporary break between Ukraine (which did not participate at the Bucharest summit with China) and the EU had prompted a wry commentary from one of Kiev's influential papers (The Weekly Mirror): "Today, Ukraine does not need perspectives, it needs money."

What China offered Ukraine is only part of what it could bring to central and east Europe. Despite notable economic progress over the last two decades, this area is still far behind the rest of its EU partners. Beijing can help with badly needed investments in roads, railroads and ports, as well as with energy generation based on coal, nuclear, solar and wind technologies. In all these areas, China is offering favorable financing conditions and a proven engineering and construction know-how.

China's investment and construction companies have also been well accepted by many countries in that area. A 1.5 km bridge over the Danube in Serbia, using nearly half of local content and manpower, and costing 170 million euros was mainly financed by China and is affectionately called the "Chinese Bridge."

The positive experience with this project has led to many other deals involving Chinese companies, ranging from highway construction to railway modernizations and power plants.

Some investment thoughts

First, ignore the widely publicized chitchat that China is trying to divide and break up the EU. These are sour grapes from some rich EU countries running to Beijing to sell what China does not need and does not want, and then coming back empty-handed as a result. They are now accusing Germany of leading a "pro-China" group, because Germans stayed the hand of an EU trade commissioner who – pushed by these disappointed salesmen to China – wanted to unleash a trade war with a 47 percent import tariff on Chinese solar panels. Germany urges a negotiated settlement with China – and there is nothing wrong with that.

Second, with a well-educated and a relatively inexpensive labor force, central and east Europe needs modern infrastructure and a rejuvenated capital stock to enhance its competitiveness and become a true economic powerhouse. Tied up in austerity knots and in endless fiscal consolidation, the EU Commission and EU countries cannot provide investments this developing part of European economy badly needs. But China can do that – to mutual benefit.

(Read more: China plenum to 'surprise' on reforms: Stephen Roach)

Third, China is not in the business of dispensing some politically motivated charity. These are all hard-headed deals providing China with access to what it needs in exchange for Chinese finances and technological expertise.

Fourth, China is diversifying its markets and asset purchases. At the moment, central and east Europe is a small part of that, but it is in the area of Beijing's policy concern. In the year to September, China's foreign currency reserves increased by a whopping $376 billion. But, over that period, China's purchases of the U.S. Treasury debt rose only by a puny $40.2 billion. What did China do with the rest?

Fifth, licking their wounds for grossly mismanaging Ukraine and the whole half-baked concept of Eastern Partnership, Herman Van Rompuy, President of the European Council and José Manuel Barroso, President of the EU Commission, wrote a vacuous commentary in a French center-left daily Le Monde last Wednesday (November 27, 2013) whose only merit was a good title: "The future of Europe is in the east."

I agree with that title, and I think investors should be encouraged that China is beginning to contribute to the formidable economic potential of the "young" Europe in the east.

Follow the author on Twitter @msiglobal9

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.

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