Impulsores de riesgo y perspectiva general

Romania is currently facing a period of robust growth, increasingly supported by domestic demand on the back of improving labour market conditions, low inflation and supportive fiscal and monetary policies. A price-competitiveness advantage continues to foster exports to an increasingly diverse range of countries. Despite lagging behind and remaining negative during the last two years, credit to corporates is expected to regain ground this year. These factors contribute to a positive evaluation of the country’s systemic commercial risk. However, generalised corruption and a volatile tax policy hamper the business environment. All in all, our category for the commercial risk assessment is B on a scale of A-C.

Our short-term political risk category (the lowest risk category, i.e. 1 out of 7) is largely determined by Romania’s membership of the European Union (EU), which allows exclusion of the possibility of (long-term) capital controls within the Union and enables the control of macroeconomic balances. Inner positive factors, such as a good level of foreign exchange reserves, covering more than the relatively low level of short-term external debt (including, moreover, an important share of intra-company debt), strengthen our positive view. Regarding the medium- to long-term assessment of the political risk (category 3 out of 7), the country’s solvency remains negatively impacted by the rather high level of external debt. However, the large reduction of the fiscal and current account deficits which has occurred during recent years has enabled them to reach very reasonable levels. This has allowed the country not to be the privileged target of the recent capital outflows from emerging markets. Recurrent episodes of instability on the political scene have not hindered those positive adjustments, although this factor is certainly a drag for the further structural reforms which need to be implemented in order for Romania to catch up with the other EU countries.

Hechos y cifras

Pros

  • Low fiscal and current account deficits
  • Increased diversification of export products and destinations
  • Good liquidity (foreign exchange reserves) position
  • Availability of EU Cohesion and Structural Funds

Contras

  • Gross external debt quite elevated
  • Difficult business environment (tradition of poor corporate governance, corruption…)
  • Banking sector threatened by various risks
  • Political instability

Main export products

  • Motor vehicles and parts (13.3% of current account receipts), food products (8.1%), electrical industrial machinery (7.9%), transport services (6.2%)

Income group

  • Upper middle income

Per capita income

  • USD 9,050

Population

  • 20 m

Head of State

  • Klaus Iohannis

Description of electoral system

  • Presidential: 5-year term, next elections in 2019
  • Legislative: 4-year term, next elections in December 2016

Prime Minister

  • Victor-Viorel Ponta (PSD)

Evaluación Riesgo País

Promising outlook for economic activity

Although the country was hard hit by the 2008-2009 financial crisis, economic activity has regained momentum, mostly since 2013, and today has almost recovered its pre-crisis GDP level. Although private demand has now taken over, the recovery originated mainly from the robustness of exports, with a noticeable increase in the services trade (transportation and business services) and with the highest growth in food and agriculture products as far as the exports of goods are concerned. With less than 3% of goods exports going to Russia (70% going to the EU), the recession there has only a slight impact.

The development of economic activity is also influenced by one sector in particular, the value added of which is the biggest among EU countries with respect to GDP: agriculture. Indeed, a good harvest year, such as in 2013, can contribute quite markedly to GDP growth.

Economic growth looks robust in the short term (2.7% and 2.9% of real GDP growth in 2015 and 2016 respectively according to the IMF), supported mainly by private consumption and by a return of investment to positive growth. Improving labour market conditions, low inflation and (recently implemented or yet to come) VAT cuts should induce growth in real disposable income and explain the strength of household consumption. Private investment will be helped by low interest rates and should reflect the EU Economic Sentiment Indicator, which reached a seven-year high in April this year. The growth in public investment will greatly depend on the absorption rate of EU funds, which is expected to improve. Net exports are forecast to contribute less than in the past, due to the strong domestic demand reinvigorating imports.

Graph1_Romania_June2015

A strong achievement in the reduction of large macroeconomic imbalances

In the period before the 2008-2009 global financial crisis, Romania, like other Central and Eastern European countries, registered fast growth rates fuelled by a credit boom. As a matter of fact, the annual real GDP growth rate averaged 6.3% between 2001 and 2008. Stemming from the availability of cheap credit from foreign parent banks to their Romanian affiliates and from an enthusiastic movement of investors towards the region, foreign funds contributed largely to the financing of the boom. The growing domestic demand (consumption and investment) resulted in a strong demand for foreign goods and the development of a large current account deficit. At the same time, the increase in public investment caused the health of public finances to deteriorate. As a result, Romania faced twin current account and fiscal deficits before the unfolding of the crisis, with a very large current account deficit in particular (13.4% of GDP in 2007).

With the increase in risk aversion amid the outbreak of the financial crisis, those factors led to a reversal of sentiment among foreign investors and parent banks towards the country and to massive capital outflows that resulted in a major depreciation of the leu and to the sovereign losing access to capital markets in 2009. In order to fill the ensuing funding gap, a joint IMF/EU programme was set up for two years. This allowed confidence to be restored and access to financial markets was fully restored as soon as mid-2011. Two further two-year IMF/EU programmes were granted to Romania in 2011 and 2013, which have been treated only as precautionary lines. They have allowed financial stability to be maintained while improving Romania’s creditworthiness and safeguarding the economic policy course and lower sovereign borrowing costs.

The current account deficit has been reduced considerably since its peak in 2007 (reaching 0.5% in 2014), mainly thanks to the strong rebound of exports, which is a positive factor. Exports of goods and services accounted for 45% of GDP in 2014, while they represented only 33% of GDP in 2007. Analyses suggest that the price-competitiveness factor was the major source of the growth performance of goods exports. This also allowed Romania to increase its market share in exports. Moreover, the country is now exporting to a wider range of countries, thereby becoming less dependent on EU markets. These factors indicate a positive structural change in the composition of economic growth.

Under successive international lenders’ loan programmes, public finances had to be cleaned up as well. Austerity measures, mainly taking the form of spending cuts (cut in public sector salaries by one quarter, dramatic reduction in pension and social benefits, etc.), permitted the fiscal deficit to narrow from 7.1% of GDP in 2009 to 1.9% in 2014. In 2012, the country exited the EU Excessive Deficit Procedure. However, the fiscal consolidation path is about to be reversed from next year, since the government approved a draft new fiscal code in March (which will be put to the vote in Parliament in June), including a large set of tax cuts such as a reduction of VAT rates by 4 pps, reduced excise rates, the removal of dividend taxation and the abolition of a special constructions tax. This move is designed to sustain economic growth but also to generate a shift of activity from the informal to the formal sector and should be accompanied by progress in tax collection. While remaining well below the Maastricht ceiling of 60% of GDP and being only the fourth lowest in the EU, public debt jumped from 13.4% in 2008 to 39.8% in 2014.

The endorsement of the draft new fiscal code could complicate the adoption of a new precautionary IMF/EU programme from September 2015, when the current one expires, although Prime Minister Ponta has expressed his desire not to renew it.

Pockets of external vulnerability subsist

Indeed, pockets of external vulnerability subsist. Gross external debt in particular remains relatively high (63% of GDP in 2014) despite being on the decline since 2012. Two thirds of it is private but only a fifth of the total gross external debt is at short-term maturity (with half of it being intra-company loans), limiting the rollover risk. Also, the country’s external liquidity, as reflected by the foreign exchange reserve level, is adequate in spite of recent large reimbursements to the IMF. Foreign exchange reserves currently cover more than five months of imports (three months being the standard risk threshold).

Another weakness is the high degree of euroisation of the private sector balance sheet (more than 50% of loans to the private sector are foreign exchange loans). In times of financial strain, this entails large exchange rate risks. Adoption of the euro, which would eliminate this currency mismatch risk, has been set for 2019 by the Romanian authorities. While some of the formal economic criteria for joining the euro area (fiscal discipline and long-term interest rate) were found to have been fulfilled during an evaluation in 2014, those relating to exchange rate stability and price stability had not yet been met.

However, progress has recently been made with respect to the two latter criteria. The exchange rate has been relatively stable compared to the euro during the last two years and has relatively well endured the different episodes of stress on the emerging markets following the Fed announcement of tapering in mid-2013. Inflation fell considerably in 2014, accompanied by falling oil prices, a cut in VAT on bread and a good harvest. It is now at a record low (the HICP showed an annual rate of change of 0.8% in March 2015), mainly when compared to the rates above 4% generally registered up to mid-2013. This has given way to an easing of monetary policy and interest rates too are now at particularly low levels.

A banking sector weighed down by old and new risks

The financial sector is largely foreign-owned, with 90% of the total assets belonging to non-domestic groups, mainly with Austrian, French and Greek capital. Overall, the system is liquid and seems adequately capitalised. However, profitability has been bad in recent years due to high funding costs (in particular for lenders with Greek and Cypriot parents) and high provisioning, as the sector is not immune to risk. First of all, foreign parent banks are in the process (which has been orderly up to now) of reducing their exposure to Romania. Nonetheless, an accelerated move could weigh on financial stability. Second, non-performing loans remain high, although their share of total loans was reduced considerably in 2014 thanks to a National Bank action plan. The large (but diminishing) share of foreign exchange-denominated loans remains another source of threat for the sector. Moreover, legal risks are pending as a series of lawsuits regarding abusive clauses in lending contracts have recently been introduced following the enactment of the new Civil Code. A generalisation of such lawsuits could be devastating for the stability of the system. Finally, events related to liquidity problems in Greece could translate into funding difficulties in their Romanian affiliates, representing about 15% of the banks’ total assets.

Deleveraging by foreign parent banks partly explains the decline of credit to the private sector in 2013 and 2014, both for households and for non-financial corporates, but factors on the demand side (such as the deleveraging of domestic households and companies) have reinforced that trend.

Necessary reforms in state-owned enterprises and the agriculture sector

The Romanian economy and public finances are badly hampered by inherited structural inefficiencies, such as governance difficulties and poor economic performance in state-owned enterprises (SOEs). SOEs, whose importance in the economy has shrunk, are still largely present in some sectors, such as energy, postal services and transport. Three quarters of them are local government-owned. Most SOEs make little profit or even make a loss (except the four large SOEs in the energy sector, which have benefited from the deregulation of the electricity and gas sectors) and have a weak labour productivity, reflecting poor governance. Reforms of central government-owned SOEs (regarding the introduction of private capital or a better governance framework) are part of the conditionality of the 2013 IMF/EU programme, but implementation delays have been registered in that respect, contributing to the poor evaluation of infrastructure quality, mainly road and rail.

Graph2_Romania_June2015

Agriculture is another sector in which progress is badly needed. Indeed, while its value-added represents about 5% of GDP, it represents 30% of total employment (six times the EU average). It consists mainly in subsistence farming with a high level of self-employed workers. Although the sector has shown a structural trend towards improving performances thanks to a better equipment endowment, higher-quality seed usage and the application of modern technologies, yields remain well below the EU average. Also, access to insurance and credit and obtaining credit at a reasonable cost are major problems for farmers and impede investment. In 2012, bank loans to farmers were 15-16 times lower (per hectare) in Romania than in the EU27.

Corruption still hinders the business environment

In the last 20 years, Romania has made significant progress in developing institutions and implementing reforms to make the country compatible with a market economy. Joining the European Union in 2007 was also a driving force for this. However, corruption remains a problem and Romania scores low compared to other EU Central and Eastern European countries in that respect. Romania stood at 69th position in the Transparency International corruption index last year. It seems that “low-level” corruption is generally accepted, though the fight against “high-level” corruption has now been stepped up, in particular through the action of the National Anticorruption Directorate (DNA). The DNA has recently brought many cases before the courts and the pace of charging politicians in particular has increased (in 2014 the DNA secured the convictions of 1,138 people, including a former prime minister, Adrian Năstase), showing a resoluteness for tackling the problem. At the beginning of June, it has also pursued PM Ponta for forgery, money laundering, conflicts of interest and complicity in tax evasion when he was a lawyer and member of parliament, between 2007 and 2011. With the election of Klaus Iohannis last November, the more intensive crackdown is likely to continue, as the new president has made this one of his priorities.

Graph3_Romania_June2015

Political instability curbs growth potential

The fight against corruption is one of the causes of the instability characterising the political scene. Prime Minister Ponta is now leading his fourth cabinet since he came to power in May 2012. The current cohabitation between President Iohannis (from the National Liberal Party, PNL) and Prime Minister Ponta (from the Social Democratic Party, PSD) is another source of latent instability due to personal animosities between the two men, despite close political programmes. Iohannis’s call for Ponta’s dismissal expressed during last year’s presidential election or recently after the investigation opened against Ponta by the DNA confirms that the President will offer no support in the event of recurrent street protests or withdrawal of a junior party from the coalition. The ruling coalition could not hold to the next parliamentary vote at the end of 2016. However, support to the government has been confirmed through a no-confidence vote after the corruption case opened against its PM and his political immunity has been maintained. This type of instability due to personal frictions in the framework of a cohabitation was observed during the previous presidential mandate held by Băsescu, when Ponta’s government tried to impeach the president on the grounds that he was overstepping his powers. The troubled current cohabitation is an impediment to the adoption of structural reforms, notably those related to SOEs and the gas price deregulation, and the frequent cabinet reshuffles imply no tax policy continuity, which is an obstacle for business.

The EU Structural and Cohesion Funds are a source of funding intended to help boost the country’s growth potential through efficient investments. However, the absorption rate of allocated funds is the lowest in the EU (in November 2014, Romania had absorbed about 50% of the 2007-2013 programme funds, which can be paid until 2015; the average absorption rate in other new member states was 71%), due to administrative deficiencies. Irregularities in the public procurement procedure and suspicion of corruption also recently blocked the disbursement of EUR 1 billion and necessitated the reimbursement of some EU funds already transferred. However, efforts have recently been made by the authorities (under the EU/IMF programme and with World Bank assistance) to better prioritise public projects and increase the absorption rate. Under the new 2014-20 programme, Romania is entitled to EUR 22.5 billion (13.7% of estimated 2014 GDP) as for EU Structural and Cohesion Funds. With a higher rate of absorption and efficient use of those funds, the potential for growth could be increased substantially and Romania could catch up with the other European economies more quickly. Indeed, the country still has a long way to go to reach the convergence level of some other Central and Eastern EU member states.

Graph4_Romania_June2015

Analyst: Florence Thiéry, f.thiery@credendogroup.com