The developments on the world's financial markets and Russia's strategic need to change the tool of gas and pipelines result in new acquisitions on the Central European market.

The growing reach of Russia’s financial arm in Central Europe is only the latest in the cycles of Central European history – cycles marked by outside powers’ influence in the region.

The rotation of influential foreign players in Central Europe is triggered by discrete events that severely debilitate one party or strengthen another. The trigger for the current decline of Western European influence in the region, and the rise of Russian influence, is the financial crisis that began in 2007.

The European Union’s influence in Central Europe was founded on its promises of prosperity and on the creation of liberalized markets in the region. This foundation has been weakened by the global economic downturn, and compounded by the escalating eurozone existential crisis. At the same time, Russia, resurging under the leadership of President Vladimir Putin, has found itself in a position to capitalize on Western Europe’s losses, acquiring assets that will allow it to yield a measure of influence in its former Central European periphery.

Central Europe has historically been a battleground for forces to its east and west. The current shift in influence from Western Europe to Russia is simply a bloodless evolution of this continual struggle.

Geographic Challenges

Without an internal power strong enough to unify Central Europe’s several ethnic groups and often-varied internal interests, the region has suffered from being wedged between the geopolitical forces of Western Europe, Russia, and Turkey.

The players in the historical competition over this region have periodically changed in name: The Ottomans have vied with the Hapsburgs, the Swedish Empire with the Tsardom of Russia, the Soviet Union with NATO and Putin’s Russia with the European Union. So too have the tactics changed, with military conflicts replaced by economic competition. The current contest for Central Europe is fought within boardrooms rather than on the banks of the Danube, pitting corporations and bureaucratic institutions in place of armies.

The game remains the same though: all are vying for a position of strength in Central Europe as a defensive buffer for their own borders, a launching pad for actions within each other’s territories and a way to extend their empires to enrich themselves.

Stuck Between Great Powers

The end of World War I spurred a radical shift in the power structure around Central Europe: the Ottoman and Austro-Hungarian empires, setting aside centuries of strife, had joined Otto von Bismarck’s alliance and suffered an irreparable defeat that led to their dissolution. Austria, which had been the main provider of capital for the region through its cross-Danube banking system, saw its privileged access to the region cut with the fall of its empire. The Russian Empire also collapsed, paving the way for what would eventually become the Soviet Union.

Three decades later, the ravages of World War II once again transformed the forces at play in Central Europe. The war truly crippled Western Europe this time around, setting the stage for the rise of the Soviet Union as a world power. The exhausted West was unable and unwilling to prevent Stalin’s Iron Curtain from cutting off its access to, and influence in, Central Europe. For nearly half a century, the political and financial system of the region was molded and integrated within the socialist bureaucracy of Moscow.

The dissolution of the Soviet Union in 1991 exposed these grievously sclerotic structures in Central Europe. The region embarked on a period of deep restructuring under the aegis of the European Union and NATO, which looked to ensure these countries would turn west for their political, financial and security needs. Simultaneously, the European Union began talks in 1993 with Central Europe to enact joint reform plans that could eventually lead to EU membership. A little less than 10 years after hard economic and political reforms, the Czech Republic, Poland, Hungary, Slovakia, Slovenia and the three Baltic nations became part of the largest EU expansion in 2004. Bulgaria and Romania joined the bloc three years later.

The Western Miracle

The opening of the Central European markets and the promise of political and financial stability guaranteed by NATO and the European Union brought in large amounts of capital from Western Europe. Germany, for example, saw the opportunity to explore untapped consumer and labor markets through massive foreign direct investments into the industrial and manufacturing sectors.

However, the biggest beneficiary of the opening of Central Europe was Austria, which went from a frontier state at the edge of the Iron Curtain to the geographic center of the EU’s eastward expansion. Austria’s robust banking sector also thrived in countries that, after decades under Soviet rule, had neither the expertise nor the capital to open their own banks.

Vienna saw this as an opportunity for financial gain, as well as to reclaim some of the influence it possessed at the height of the Austro-Hungarian Empire. It took advantage of these historical ties in the region to claim the lion’s share during the privatization of formerly state-owned banks, opening its own banks in former Soviet satellites and providing direct cross-border loans. As a result of this process, Austrian banks today hold a market share of almost 20 percent in Central and Eastern European countries.

For the region, this influx of cheap credit from the West was an unprecedented fortune for economies that had stagnated for decades. Central European purchasing power shot up, radically changing the economic and social outlook in all segments of the population. The rising consumption rates and low labor costs relative to Western Europe made Central Europe extremely attractive to Western investors, spurring steady growth for the better part of a decade.

The Decline of the European Union

However, this financial boom came to a halt in 2007 as the global economic crisis took hold of Central Europe and ravaged its financial sector. In particular, Austrian banks and Central European nations found themselves grappling with the issue of foreign-denominated loans. Large parts of the loans in Eastern European countries were issued in foreign currency during the days where the seemingly endless prospects of growth made foreign-denominated debt seem more advantageous. However, when the local currencies began strongly devaluating against the Swiss franc and the euro, these loans became compounding liabilities.

In 2011, more than two-thirds of Austrian bank loans to households in countries such as Hungary, Romania, and Croatia were foreign-denominated. In these countries, foreign-currency household loans exceeded 20 percent of gross domestic product. The result of this process was a dramatic increase in delinquencies, as borrowers became progressively unable to pay their loans – with the average non-performing loan ratio for Austrian banks operating in Central and Eastern Europe being twice that of banks operating exclusively in Western Europe.

Western European banks have therefore had to update their business strategy by tightening credit conditions and lending approval standards, increasing interest rates, and scaling back operations in the region. In this regard, Austrian banks sought to consolidate their presence in a few “low-risk” EU countries such as Poland, where the healthy domestic economy and stable political outlook has maintained market confidence. For “high-risk” countries, loan availability diminished as well as the number and size of subsidiaries. The dearth of credit has become a self-tightening noose for nations already struggling with high budget imbalances and plummeting market confidence.

Beyond the banking issue, the financial crisis in Europe has other grave implications for the Central European nations. Since 2008, the ability of the European Union to project influence in Central Europe through financial assistance and investment programs has waned. The push for austerity measures has dried up funds for infrastructure projects from Lithuania to Bulgaria.

Moreover, the eurozone – the EU core – is looking increasingly inward for solutions to the internal challenges rising from its single currency, the catalyst of the sovereign crisis in the so-called PIIGS countries (Portugal, Italy, Ireland, Greece, and Spain).

EU members that retain a separate currency have been sidestepped in many decision processes at the supra-national level – a trend that Central European countries, particularly Poland, have vehemently protested.

The Rise of Russia

The decline of the European Union’s ability to yield economic influence in Central Europe has coincided with the resurgence of a familiar player in the region: Russia. After 15 years of domestic restructuring, Moscow has become more assertive in its former periphery. With the inclusion of the former Soviet Baltic states into the European Union and NATO, Russian leaders understood that the West was looking to ensure that Russia could never rise again. But it was the 2004 Orange Revolution in Ukraine that forced Russia to react to Western expansionism much more quickly than anticipated.

The tactics changed, but the game remained the same. While Russia could not duplicate the military and political takeover of Central Europe from the Soviet era, it turned to its principle leverage over Central Europe: energy. From 2005 on, Russia used its control over the supply of oil and natural gas to Central and Eastern Europe to gain strategic inroads in the region, threatening supply cuts and price hikes to gain political favor. However, these aggressive energy policies attracted the ire of many European nations, which suffered from lower supply levels during Russia’s spats with its Central and Eastern European neighbors. Despite diversification efforts by Western Europe, Russia continues to supply roughly a quarter of the continent’s energy needs, with an even higher proportion in Central Europe.

Moscow continues to capitalize on its energy wealth through the threat of price hikes and cut-offs, but it also is evolving its tactics in Central Europe. Instead of directly controlling the flow of oil and natural gas, Russia transformed its hydrocarbon wealth (aided by high oil prices) into a high purchasing capacity for aggressive asset acquisitions in Central Europe.

The decline of EU economic influence in the region and the union’s need for recapitalization at home has driven asset prices down, giving Russia the opportunity

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Formerly Analyst and Director of Advisory Services at Stratfor - Texas based Intelligence company.

Eastern European Futures

In 2009, the European Union and six of its Eastern neighbours launched the Eastern Partnership (EaP) with the stated aim of building a common area of shared democracy, prosperity, stability and increased cooperation. A decade on, however, progress has been mixed.

Visegrad Insight is published by the Res Publica Foundation. This special edition has been prepared in cooperation with the German Marshall Fund of the United States and supported by the International Visegrad Fund.

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