The general business environment remains weak in Romania

The Romanian business environment remains poor, with a high share of informal activities and lack of infrastructure. Red tape and corruption are still major obstacles to doing business.

Madrid - 07-nov-2011

Romania, together with Bulgaria, entered the EU on the 1 January 2007. As a condition of entry, Romania is subject to strict monitoring by the European Commission, mainly of its progress in reforming the judiciary and fighting corruption. In several of its bi-annual monitoring reports the European Commission strongly criticised Romanias lack of progress on corruption, and accused the country of having breached its EU accession commitments. The disbursement of some EU funds has been repeatedly delayed, and recently Romania has been blocked from joining the Schengen zone [the area of passport-free travel for EU citizens] as some member states objected.

Romania was severely hit by the economic crisis

After years of high GDP growth the domestic economy was hit hard by the global economic crisis. GDP contracted by 7.1% in 2009 as exports [-5.5%], private consumption [-10.3%] and investments [-38.4%] decreased sharply. Industrial sectors [especially export-oriented, such as steel and automotive] suffered a steep decline in output. Due to limited new bank lending and falling turnover, business sector investments dropped by more than 25%. Capital inflows fell sharply, with foreign direct investment decreasing by around 55% year-on-year in 2009, and the currency suffered a massive depreciation.

The economic boom of 2004 to 2008 went hand in hand with a massive increase of private sector debt. The element of that debt denominated in foreign currencies [euro, US$ and Swiss francs] tripled, due largely to heavy external borrowing by the private corporate and banking sectors.

A rebound in exports [+13%] has triggered a weak recovery since 2010, and in 2011 only a modest recovery is expected. In Q2 of 2011 real GDP grew 1.4% year-on-year as the private sector gradually recovers from the heavy burden of the private sector debt. However, the deleveraging process of these debts is progressing only slowly. Industrial production grew at two-digit rates year-on-year in the first three months of 2011, but has slowed somewhat since then [+5% in July 2011].

The banks, mainly subsidiaries of EU-based parent banks, are still burdened with a large exposure to highly indebted private sector borrowers, a much of which is denominated in foreign currencies. However, as long as the parent banks are committed to their Romanian investments, no major problems are expected, although servicing the debt continues to be a drag on Romanias external finance.

Economic policy: a massive IMF support package became necessary

Years of lax fiscal and incomes policy have led to rising twin deficits: in 2008 the current account deficit was 12%, and the public sector budget showed a shortfall of more than 5% of GDP. Despite austerity measures, spending overruns and falling revenues contributed to an even higher fiscal deficit in 2009 [8.5% of GDP]. To address the sharp drop in capital inflows, external and fiscal imbalances, and to strengthen the financial sector, in May 2009 Romania agreed to a massive bailout loan, worth 20 billion, from the IMF, the EU and some other institutions. The IMF provided 12.95 billion under a two year stand-by arrangement, while the EU has pledged 5 billion. The loan package was designed to restore faith in the economy, help with the current deficits, prop up the exchange rate, strengthen fiscal policy, bring inflation within the central banks target, and provide liquidity in the domestic financial markets.

The IMF package has been conditional on further fiscal consolidation, reforms of the debt-ridden public sector, the financial industry and monetary restraint. In order to meet the budget deficit targets agreed with the IMF, the government has had to take harsh measures to curb public spending, including a 25% cut in public wages, a VAT increase from 19% to 24% and cuts in transfer payments.

Although the level of public sector debt is still moderate [33% of GDP], the budget deficits in 2010 [6.4% of GDP] and 2011 [4.5% of GDP] are still too high, and the IMF is urging more fiscal consolidation. The debt-ridden state enterprises in particular need to be reformed and/or privatised, while the public sector wage bill needs to be reduced by cutting salaries and the numbers employed.

The general business environment remains weak

The Romanian business environment remains poor, with a high share of informal activities and lack of infrastructure. Despite some progress in reforms, red tape and corruption are still major obstacles to doing business in Romania. There is also a pressing need for reforms in the pensions and healthcare systems and in the public sector.

The economic upswing will be moderate, with real GDP growth growing 1.7% this year, as the IMF urges further fiscal consolidation, to further reduce the high budget deficits, and reforms of the public sector. As a consequence, domestic demand will be negatively affected by additional austerity measures.

In 2012 the economy will rebound with 3.6% real GDP growth still below its long-term potential and the budget deficit is forecast to decrease to 3.4% of GDP. Inflation will decline in 2012 [4.1%] after its rise this year [which was triggered by tax increases and higher commodity prices].

Excellent payment repudiation, but downward risks remain

After the steep decrease in 2009 and 2010, the current account deficit is forecast to increase modestly in 2011 and 2012, to 4.8% of GDP respectively, thanks to a recovery in import volumes. So far, Romanias sovereign debt service record is excellent, and the country still quite easily taps the international capital markets to cover its amortisation payments and current account deficits. The roll over of bank credits, use of reserves and IMF funds are considered to be sufficient to cover the large financing gaps in the coming years despite the rather weak solvency position [high debt service].

However, the country remains susceptible to external shocks. The exchange rate remains strongly vulnerable to adverse market sentiment, and also depends on the level of confidence in the coherence of the governments economic policy. A sudden plunge of the leu would again increase the credit risk of the [foreign currency indebted] private corporate/banking sectors. Therefore the central banks policy has to focus on the exchange rate developments as well as monitoring inflation.

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