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Country Report Romania

Country Report

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Romania has embarked on a gradual export-driven economic recovery, but domestic demand has yet to pick up. Amid rising domestic political tensions, policymaking could come to a standstill until presidential elections are held in November.

Strengths (+) and weaknesses (-)

(+) Favorable geographic location & natural resources endowment

Thanks to its geographic location, transportation routes to adjacent major markets and industrial production centers in Central Europe/Germany and Turkey are fairly short. Romania is endowed with various natural resources, like oil, gas, gold, timber, and wide stretches of arable land.

(-) High external debt load & large gross external financing requirement

Given external debt of about USD 130bn (70% of GDP), considerable euroization of its financial system, and a gross external financing requirement of about USD 50bn (25% of GDP), Romania is strongly exposed to a worsening of external funding conditions and a depreciation of the leu.

(-) Weak public administration and widespread corruption

Despite Romania’s EU membership, the quality of institutions remains poor and obstructs effective policy implementation. Corruption is perceived to be present at all levels of government, which undermines Romania’s attractiveness for foreign investors.

(-) Lingering political instability

Romania’s political system still lags seriously behind EU standards. While personal conflicts between policymakers tend to overshadow policymaking, the political elite’s commitment to the common good is perceived to be weak, which tends to affect policy acceptance by the public.

Key developments

1. A gradual economic recovery on the back of strongly rising exports and a good harvest

Romania’s fragile economic recovery regained steam last year, as growth strengthened from a mainly drought-driven 0.7% in 2012 to 3.5% last year, but it remains highly vulnerable to external shocks. Soaring exports, particularly in the automotive sector, drove growth, as did a bumper harvest. Domestic demand remained subdued, however, as banks, corporates and households continued to deleverage. Elevated unemployment levels and high debt servicing costs have depressed a meaningful rebound in household consumption so far, while efforts to reduce the local banking sector’s dependency on foreign parent bank funding, as well as very poor asset quality, undermined credit growth. Meanwhile, fiscal and monetary policy space to boost domestic demand remains limited by the need to uphold investor confidence, as Romania’s sizeable external debt load exposes the country to a marked depreciation of the local currency. Economic growth this year is expected to come in at about 3%, as domestic demand is expected to pick up on the back of improving consumer confidence, more gradual fiscal consolidation and a strengthening of investment. Meanwhile, the growth contribution of net exports should remain positive in spite of rising imports. The risks to the outlook are slightly tilted to the downside, as risk aversion vis-à-vis Romania may increase due to its large gross external financing requirement (26% of GDP in 2014) and very weak and deteriorating asset quality of the local banking sector. Foreign banks in particular may feel tempted to further reduce financing for Romania’s economy, as an ongoing review of non-performing loan (NPL) reporting standards is expected to yield a markedly higher NPL-ratio than reported in November 2013 (22% of total loans), forcing banks to raise provisions and possibly even add capital if currently adequate capitalization levels were to be eroded. 

Figure 1: Growth performance
Figure 1: Growth performanceSource: EIU
Figure 2: Current account
Figure 2: Current accountSource: Central Bank of Romania

 

2. Laudable fiscal performance, but progress on structural reforms remains slow

Reflecting Romania’s successful fiscal consolidation, the country exited the EU’s excessive deficit procedure (EDP) in June 2013, as the government’s budget deficit had been reduced from 7.3% of GDP in 2009 to 2.5% of GDP in 2012. While leaving the EDP, Romania’s government remains staunchly committed to its conservative deficit targets, which partly reflects its obligations under a recently completed provisory IMF standby-agreement the cabinet intends to extend this year. After having kept last year’s deficit at 2.5% of GDP, the government is aiming for a budget shortfall of 2% of GDP this year. As fiscal consolidation measures were initially dominated by major public expenditure cuts, last year’s austerity efforts focused on reducing capital expenditure and raising excise rates on luxury goods, as weak domestic demand depressed VAT-receipts. In contrast to Romania’s successful fiscal consolidation, progress on structural reforms, particularly regarding the privatization of the country’s various loss-making state-owned enterprises (SOEs), remains slow, however. While privatizations could boost both economic growth and (tax) revenues, they remain highly contentious. There are fears that they would increase unemployment, as SOEs are often inefficient and employ about 10% of the labor force.    

3. Lingering political tensions hamper policy formation and dent trust into the political elite

Romania’s political stability improved in the aftermath of the failed impeachment of incumbent President Traian Băsescu and the resounding re-election of Prime Minister Victor Ponta in 2012. Yet, the still unresolved conflict between the two politicians will continue to overshadow the country’s political life and hamper policy implementation until presidential elections will be held in November this year, when Mr Băsescu cannot re-run for office. Tensions may increase until then, following the announcement of Mr Ponta’s four-party coalition government early this year that the toppling of the ‘Băsescu regime’ would constitute its main policy objective. While possibly boosting the cohesion of the relatively disparate alliance, the statement led to a major confrontation with the incumbent president. Besides initially refusing to sign the 2014 budget, which was needed for the important renewal of the provisory IMF standby-agreement completed last year, the president accused the cabinet of abusing its two-third parliamentary majority to undermine the independence of the judiciary and weaken the rule of law in favor of political clients. Tensions between the presidency and the government are likely to subside after the presidential elections in November, as the candidate of the ruling coalition, Crin Antonescu, leads in recent polls. Yet, the ongoing mudslinging and recent high-level corruption cases seriously undermine people’s trust in the political elite and contribute to the rising incidence of protests against various policy initiatives, ranging from the culling of stray dogs to the extension of mining concessions. While protests have so far been limited in size and focused on particular issues, growing frustration with the country’s political elite may lead to large-scale protests on a national level.

Factsheet of Romania
Factsheet of RomaniaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

 

Background information

Given a  nominal GDP of USD 186bn (2013) and a population of about 21m, Romania is the largest former Communist economy in South-Eastern Europe. It joined the European Union in 2007, but in spite of strong pre-crisis growth, GDP per capita at PPP still amounts to a mere 50% of the EU-28 average. So far, Romania’s poor business climate that is characterized by weak public institutions and widespread corruption prevents a better exploitation of the country’s favorable  geographic location and the availability of various natural resources like hydrocarbons, gold, or timber, as well as vast stretches of arable land. Agriculture constitutes one of the most important sectors of the Romanian economy and generates about 10% of national output, whereas industrial production accounts for one-third. Following the acquisition of local factories by Ford and Renault (Dacia), car production has gained considerable importance in Romania, while the proximity to automotive factories in Central Europe and the availability of low-cost (German-speaking) labor, particularly in the Transylvania region, attracted various producers of car components. Other important industrial sectors comprise the production of chemical products, electrical appliances, machinery and textiles. Romania’s banking sector is dominated by foreign- owned banks from Austria, France and Greece. Following strong pre-crisis lending growth, oftentimes in foreign currency, it struggles with very high and rising levels of non-performing loans that depress profitability and threaten to undermine currently adequate bank capitalization levels. While foreign banks remain committed to the market, external funding has been reduced as financial institutions strive for a healthier balance between local funding and credit. Romania’s political situation remains relatively volatile, as personal conflicts between politicians tend to dominate policy-making, while recurrent corruption cases at all levels of government undermine people’s trust in the political elite. Presidential elections will be held in November 2014 and general elections are scheduled for 2016.  

Economic indicators of Romania
Economic indicators of RomaniaSource: EIU
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Author(s)
Fabian Briegel
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 64053

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