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Feature: New Daimler factory may help Hungary avoid recession

03/16/2012 | 04:49pm US/Eastern

Real estate agent Laszlo Eckert was one of the first to profit from German luxury car maker Daimler's (>> Daimler AG) construction of an 800 million euro factory in Kecskemet, a town of about 110,000 an hour's drive southeast of Budapest.

Real estate agent Laszlo Eckert was one of the first to profit from German luxury car maker Daimler's (>> Daimler AG) construction of an 800 million euro factory in Kecskemet, a town of about 110,000 an hour's drive southeast of Budapest.

The project is the largest new investment by far in recent years in Hungary and one which highlights the centre-right government's ambivalent relationship to investors.

Prime Minister Viktor Orban has said he supports big manufacturing investments, but his combative rhetoric toward foreign capital and a raft of extra taxes that hurt western companies already present in Hungary have raised red flags even with business groups who were spared the blow.

That could erode the chances of future projects like the one in Kecskemet, where the excitement is palpable.

"The Germans rented about 330 houses so far," Eckert said. "They have taken all the energy efficient homes they could find, and they have often paid more than 1000 euros a month, far more than is usual around here."

"Their presence is very visible everywhere, in schools, in medical offices, in banks, in restaurants," he said. "I think this is very positive for this town."

After a construction, recruitment and training period whose efficiency awed Hungarians, the factory will begin commercial production at the end of this month.

Once it reaches the full planned capacity of 120,000 cars a year, the plant and its local suppliers could add as much as 5 percent to Hungary's overall industrial output and may make the difference between the economy growing and contracting this year, Takarekbank analyst Gergely Suppan said.

"The added value of the plant is very high as they have most production units on site, and the cars they make will be on the expensive side," Suppan said. "The contribution to GDP could be as much as 0.5-0.6 percent."

"Because of Daimler, we hope that Hungary avoids a technical recession. We might dip into negative territory in the first quarter, but I expect growth to return in the second quarter."

GOOD AND BAD INVESTORS

The Germans' arrival comes as the government tries to reboot its still-developing economy with a string of IMF and EU-defying policies that have angered big business but helped keep up some public spending to prop up growth.

A very public row with Brussels, which has prevented a deal for EU and IMF aid, is centered around a raft of legislation aimed at reinforcing the position of Orban's Fidesz party in Hungary's civic institutions.

That has included attacks on the position of judges, the central bank and a respected fiscal watchdog, all of which worries financial investors and has prompted intervention by U.S. Secretary of State Hillary Clinton.

With foreign investment falling everywhere in Central Europe, the risk is that the resulting bad press will undermine the country's ability to attract big investors like Daimler - whose deal was done under a previous government - in the future.

Moves to renationalize parts of the pension system - wiping out some foreign-owned pension funds - and slap special taxes on the telecom, banking and energy sectors have also hurt those who invested in Hungary previously.

Orban casts this as ensuring ordinary Hungarians do not pay for a crisis caused partly by foreign companies who treat the country as a market to exploit.

"Hungary needs foreign investment so we must differentiate between allies and colonists," he told parliament earlier this month. "Those who need only our markets are colonists. Those who need our work, our knowledge, are allies whom we deal with happily."

The difficulty is that, with credit harder to come by and western banks keen to reinforce their own balance sheets with capital they would have previously lent out, eastern Europe's investment-hungry developing economies cannot be too choosey.

Hungary actually exported (FDI) capital to the tune of nearly 1 billion euros in the first three quarters of last year compared to average inflows of around 4 billion annually over the decade before the crisis.

Companies hit by the taxes include Hungarian units of Deutsche Telekom (>> Deutsche Telekom AG) and E.On (>> E.ON AG), and the main local lobby group for German firms say they feel separating investors into good and bad groups is counterproductive.

"It's a mistake to think such a distinction is sustainable," said German-Hungarian Chamber of Commerce spokesman, Dirk Woelfer.

"If other sectors are constantly under negative influence from the decisions of the government, sooner or later that begins to influence the behavior of executives in preferred industries as well."

CAR BOOST

Not that Hungary is alone. FDI in Romania and the Czech Republic both dropped by around 80 percent, while in Bulgaria it fell to one-sixth of that in 2008. Even the region's most robust and largest economy, Poland, has seen FDI nearly halve.

That makes the car industry's huge investments in the region all the more precious, with most countries counting on auto makers for a very large chunk of investment and economic output.

In Slovakia, which produces the most cars per capita in the world, vehicle manufacturing was the key factor that helped the economy grow by an annual 10 percent for the better part of the decade before the economic crisis.

Daimler will employ a total of 2,500 people, mostly locals, its Hungarian factory to make models of the compact Mercedes Benz B-Class and one model of the new A-Class.

The plant is a late follower of other car makers that put Hungary on the automotive map in the 1990s, including Audi <NSUG.DE>, General Motors (>> General Motors Company) and Suzuki (>> Suzuki Motor).

Although GM and Suzuki have seen ups and downs, unbroken global demand for Germany's high-end cars prompted Audi to break ground on a 900 million euro expansion of its Hungarian plant last year.

Together, the plants will help Hungary catch up closer to the Czech Republic and Slovakia, where the sector has grown manifold over the past decade.

"Seeing dismal household consumption and banks' reluctance to lend, plus a big government fiscal adjustment program, we will have to rely on exports for growth," Suppan said. "Luckily, this will be the decade of our main trading partner, Germany."

THINGS WORK

As investment flows to a trickle elsewhere, Kecskemet itself has been an anomaly, with 100 projects, including very small ones as well as Daimler's giant investment, completed since 2008, plus another 60 pending, mayor Gabor Zombor said.

Unemployment is around 8 percent, well below the national average of about 11 percent, and when Daimler's production ramps up and suppliers begin to hire in earnest it could drop further, local employment data shows.

The town uses a dedicated team of bureaucrats to attract investors, cut local taxes by 20 percent, and has readily available real estate to develop, the mayor said.

The factory, a mile-long grey slab of a building with a 15-foot Mercedes star on one corner, is surrounded by virgin land and Daimler designed it in a way that it can scale up capacity progressively if demand is high enough.

"Daimler arrived at a place where things worked already," Zombor told Reuters. "This factory has great potential, and there is a realistic chance of further investment."

On a recent weekday, German-language chatter could be heard widely in local cafes and restaurants and Mayor Zombor also says there is concern among locals that the town will simply be overrun by the German influence.

But generally, as elsewhere in a region overrun by the Germans during the second world war, people have long forgotten such old scores and are prepared to put the economic benefits of such investment first.

"The main thing is, they rented houses that nobody could afford to rent here," says Eckert. "Some home owners got very lucky."

(Reporting by Marton Dunai; editing by Patrick Graham)

By Marton Dunai

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