Czechs in driver's seat as auto industry shifts east

PRAGUE, Oct 30, 2002; Jan Lopatka wrting for Reuters sumitted this feature article. You may have never sat in a Czech car, but many European models are likely to have brakes, lights, tyres or air conditioning made in this central European country.

The EU candidate state is fast becoming a centre of the automobile industry, buzzing with new investments in stark contrast to the closures brought about by excess capacity and the ugly business mood in the west.

The Czech Republic's automotive business has attracted scores of foreign investors thanks to skilled cheap labour and rising political and economic stability as the country approaches European Union membership, now seen in 2004.

The sector now has annual sales of $10.3 billion and 280 companies led by Skoda, which Volkswagen has turned into the most successful symbol of post-Communist reforms and a showcase of the enormous shifts in quality it is possible to achieve in the region.

"There is no real difference in productivity or organisation of work from western Europe," Skoda's head Vratislav Kulhanek told Reuters, referring to the whole automotive sector.

After a 6.8 billion euro (dollar) investment in the past 12 years, car and parts makers employ 130,000 people. They account for 17 percent of the country's overall manufacturing output, most of it geared for exports to the EU.

A stream of the world's leading component and car makers, including Toyota and PSA Peugeot Citroen, who are jointly building a 1.3 billion euro factory to make 300,000 small cars a year, promise to swell output in the years to come.

"The inward investment success story in countries like Poland, Hungary and the Czech Republic is far from over. This story has a long way to go," said Mathew Pottle, head of Regional Automotive Practice with PriceWaterhouseCoopers (PWC)

A PWC study predicts central Europe as a whole will see a healthy rise in car industry, but the Czechs will remain at the forefront. Further east, Turkey is also growing fast.

At a recent car conference in Prague, executives lined the halls talking expansion and exports. The packed rooms were a striking difference from some deserted IT conferences held in recent months.

TOP MAKERS POUR IN

Martin Jahn, the head of Czechinvest, the Czech government investment promotion agency, said that within three years the Czechs will be second only to Belgium in terms of European per capita production, and have potential for further growth.

He said more than half of the world's top 50 components firms have production bases in the Czech Republic.

Germany's Continental is expanding its tyre factory to become the world's biggest, making 18 million tyres a year.

Japanese firms such as Mitsubishi Electric which makes alternators or air conditioning maker Denso Corp have been at the forefront, alongside German companies such as Robert Bosch which has four plants for fuel injectors and gas pedals.

The whole region has the advantage of being cheaper than inside the EU, so what sets the Czech Republic apart from countries like Poland, Hungary or Slovakia?

The Czechs have a strong manufacturing tradition, access to western markets through highways to Germany, an EU-compliant package of subsidies and aggressive marketing. And they have Skoda, "a tremendous advert" added PWC's Pottle.

Poland had been considered the leader, but saw a slump in its domestic market coming amid a sharp economic slowdown, which has hurt Fiat's operation there. The collapse of South Korea's Daewoo has left its Polish plant in the cold as well. Britain's Rover is negotiating to buy its assets.

PWC says Poland should see recovery. Car sales are already beginning to rise and investments are picking up. Toyota said this month it would build a 167 million euro engine plant in Poland.

Investors are also looking increasingly at Slovakia, following the victory of a reformist government last month's election which removed fears that nationalist politicians unacceptable to the EU would divert the country from joining it.

Further ahead there is potential in Romania, Ukraine and even Yugoslavia and Russia, said Michael Weidokal, a business development leader at PWC's division Autofacts.

WAGE ADVANTAGE WANES

Central Europe has cashed in on its low labour and material costs. But this advantage is slowly waning as the region's wage and price levels gradually converge with western Europe, both through nominal growth and exchange rate appreciation.

This may mean some producers start shifting further east, but that does not worry experts who see increased inflows of higher value-added production.

"Of course there is a risk, and that is mainly in simple productions like cable harnesses," said Skoda's Kulhanek.

"Other productions are more sophisticated, and I am not worried that companies like Bosch would leave, there would have to be a real turnaround," he said.

Czechinvest aims to attract more research centres and other parts of the car production chain, hoping that companies which build bases including everything from development to marketing will be more likely to stay for the long term.

Another risk factor for foreign manufacturers lies in exchange rate movements. Moving towards the EU has led to currency firming, through nominal gains and higher inflation, which makes local goods more expensive abroad.

Fierce competition does not allow for price hikes, and manufacturers therefore suffer from thinning margins. This, along with sluggish demand abroad, has hit Skoda, which expects to sell 445,000 cars this year, down from last year's 462,000.

LEADING INDUSTRY

These risks point to the danger of the economy becoming over-reliant on the car industry and its business cycle. But Czechinvest's Jahn said he wanted to bring in more car firms because of their large knock-on effect, and rely on spreading the risk within the sector.

"This is going to be the leading industry here and we will be a dependent on it a lot," he said, adding that the automotive industry was not as cyclical as electronics, for example.

"A new car plant creates 10,000 to 15,000 jobs in two to three years by its multiplication effect, there is no other way to come across those."

That is why Czechinvest aims to win one or two more large factories to add to Skoda and Toyota-Peugeot.

PSA Peugeot Citroen announced in late October it was looking at the Czech Republic, Poland, Hungary and Slovakia as the site of yet another east European factory worth 700 million euros to make 300,000 cars from 2006.

Eyes are also watching Asian makers who are examining ways of penetrating the European market by setting up inside the enlarged EU to avoid tariffs and shipping costs.

Experts say Hyundai or Mitsubishi could decide over the next year to build a plant in the region.

"We have shown with Toyota that it works and that we can do it, and everything else plays into our hand," said Jahn.