In 2015, the Romanian economy continued to expand at one of the highest paces in the region for the fourth consecutive year, by 3.8% [fig. 1]. In terms of growth composition, a common trend emerged in Europe, with private consumption as a main driver, compensating for the lower exports on the back of a slowdown in external demand. At the same time, investments contributed positively to the economic expansion, driven by a pickup in EU fund absorption, given that 2015 was the last year for absorbing funds under the 2007-2013 programming period. We expect investments to slow down as the absorption of EU funds will temper this year for all countries, because of the usual delays at the start of a new programming period. In Romania, the launch of the 2014-2020 Programme was not accurately prepared in advance and the country still finds itself in the preliminary phase of fulfilling ex-ante conditions.
Additionally, on 23 June, the United Kingdom held a referendum on EU membership and the British people voted to leave the Union. This is an unprecedented decision, which will create prolonged uncertainty and will likely determine companies to postpone investments while trying to gauge the impact. The exit negotiations will be complex and will take around two years after the Great Britain formally informs the EU about its decision. Looking at the medium-term, the UK’s exit from the EU would affect Romania through: trade relations, migration and EU funds, given that UK is a great contributor to the EU budget. The more diligent countries might absorb more and faster, leaving less funds available for the laggers, among which Romania.
By comparing the growth rates of consumption among CEE countries, we see that Romanian consumption has been growing faster by around 2pp than any of the other countries in the region [fig. 2]. This was caused by the fact that besides the stimuli from which consumption benefitted throughout the region (the low inflation following the collapse of oil prices, wage growth, consumer confidence and the recovery of lending), Romanian consumers also benefitted from: i) several hikes to the minimum wage to RON 1250 currently (up almost 40% in comparison to its level at the end of 2014), ii) salary increases for public sector employees1 , iii) fiscal relaxation through two waves of VAT cuts2 , iv) the recovery of consumer lending in local currency.
The VAT cuts led to a sharp decline in prices and increased the purchasing power of individuals, with wages higher by around 16% in real terms in the first five months of 2016 than in the corresponding period of 2015. As a consequence, we expect consumption to maintain the highest growth rate in the region throughout 2016. In turn, this should translate into an economic growth rate above 4% in 2016. However, a growing share of the additional demand will be absorbed by imports, which could result in a slowdown of economic growth during 2017. Additionally, UK’s decision will temper growth throughout Europe and implicitly in Romania as it will lead to lower investments and to trade frictions within Europe, depressing the value of both Romania’s direct exports to the UK and indirect ones through the eurozone (which use Romanian intermediate goods).
The increasing consumption of imported goods limits benefits for local producers
In spite of the booming consumption, local companies do not reap the full benefits and depend mostly on external demand. As a consequence, both exports and industrial production have been decelerating in line with those of our main trading partner, Germany [fig. 3], which accounts for 20% of Romania’s total exports and imports. Romanian industrial production slowed down to only 2% in 2015 from 3.7% in 2014 and grew by only 0.5%yoy during the first quarter of 2016. With Brexit around the corner, we expect the demand for Romanian exports and thus for the local industrial production to temper further during the following years. This is taking place in a context in which the pressure on local companies is mounting from various sources: i) the above-mentioned minimum wage hikes pressure fixed costs, ii) the new Fiscal Code includes no significant fiscal easing for them and iii) the EUR-RON exchange rate was the most stable starting from 2013, in contrast with the remaining countries in the region which had been depreciating, making their exports more appealing. In this context, we saw a decoupling of wage and productivity growth, a common trend in the region.
However, in Romania investments remained at the lowest level in CEE, at only 60% of their 2008 level, because of the very low absorption of EU funds and low public investments. Since the outburst of the crisis, spending for investments was the first category of expenditure to be sacrificed in order to contain the budget deficit, with negative impact on the long-term growth potential of the country. The ambitious fiscal easing during the following two years is geared towards consumers and it is already threatening the budget deficit, making it clear that unlike other CEE countries, Romania will not be able to provide fiscal stimulus to companies and will be forced to cut public investments in 2017 in order to maximize its chances to meet the 3% of GDP deficit target.
Consequently, companies are on their own, trying to grab on any opportunity. If we take a look at the various sectors of the economy, we notice that those closely correlated with consumption (such as retail trade and services) saw their confidence recovering faster than the others [fig. 5], dynamic also visible in the banks’ exposure through the credit stock likely due to both higher demand and better eligibility [fig. 6].
Structural deficiencies of local companies are also limiting expansion
As a particularity of the Romanian economy, the wide majority of companies (around 92% of the total) are micro-companies with up to 9 employees. Consequently, it is natural for companies to capture only limited portions of the increasing demand, with the overall well-being of the sector lagging behind the households’ recovery. At the same time, the business partners of SMEs are usually local companies with Romanian capital and households (through retail trade), while corporations rely on both trade with foreign companies and local companies with Romanian capital3. Under these circumstances, most of the SMEs rely on reinvested profits/ asset sales and loans from mother-banks or capital increases. Commercial credit is only third in ranking as a preferred source of financing and it was mainly channelled towards working capital and payments to distributors (30%), while investments for development accounted for a meagre 7%. According to NBR’s Survey, the most pressing issues for companies are the level of taxation, fiscal unpredictability, the competition and finding customers. At the same time, following several years of losses, SMEs still have to address eligibility issues, as only 14% of SMEs applied for and received a loan, in comparison with a much higher percentage for corporations (39%).
The most worrisome statistic of NBR’s survey states that above 90% of the SMEs did not apply for or had any contact with EU funds. In our view, these issues should be addressed with priority and the government should increase awareness regarding the benefits and accessibility of such funding and offer assistance to SMEs. A first ray of hope came from public investments in December 2015, when the government channelled all the unutilized funds up to the deficit target towards investments and co-financing for EU funds, in total amount of RON 17 billion. Accordingly, payments of EU funds to beneficiaries jumped to 74.2% of the 2007-2013 allocation (up 21.9pp compared to end-2014). The effective payments from the EU totalled only 58.9% of the allocation (up 14pp from the end of 2014). The difference up to 74.2% is represented by payments in advance made by the state to speed up funding given that 2015 was the last year for absorption under the 2007-2013 allocation and will be recovered subsequently from the EC. However, the overall performance was modest in 2015, with actual inflows of EU funds to the state budget lower by RON 3 billion than planned, despite considerable efforts to improve absorption at year-end (December inflows at RON 5.6bn vs. RON 1 billion on average in the first eleven months). As mentioned at the beginning of the article, the prospects of absorption are bleak for larger countries if the Great Britain leaves the EU, implying that if Romania does not improve its framework, it will stand to lose in front of the top absorbers during the following years.
Cash-rich companies see little reason for expansion for the time being and take on limited new credit
The very high spending at year-end was visible in companies’ treasuries as well, which saw their overnight deposits expanding by 36%yoy at the end of May. Moreover, total companies’ deposits advanced by 18.3%yoy in May. Although the high excess liquidity pushed interbank interest rates to new historical lows and dragged further down customer deposits’ interest rates, this did not discourage the saving behaviour in the economy.
Given the plentiful liquidity, companies are not increasing their exposure to bank loans, in spite of borrowing costs being at all-time lows. However, there was a visible improvement in the first four months of the year, with companies’ new lending advancing by 10.4%yoy to RON 10.2 billion, most of which granted in local currency (65% of the total) [fig. 7]. Consequently, the RON-denominated loans’ stock touched in 2016 a historical high share of 54% out of the total credit stock. The development was mainly supported by the sharp decline in interest rates of RON-denominated loans, thus reducing the differential versus FCY-lending. While the interest rate on new RON lending to companies was 19.51% at the end of 2008 vs. 7.63% for FCY-denominated lending, the two have decreased to 4.07% and 3.12%, respectively by April 2016.
After a negative evolution since April 2013 because of lower credit uptake and a balance sheet clean-up performed by banks, we expect the growth of companies’ loans stock to come back in positive territory in 2016. This dynamic should also be supported by the fact that the output gap is closing in 3Q 2016 and companies could try to profit as much and as fast as they can from the increasing local demand.
In our opinion, banks could shift their focus to SME state guarantees and financing related to EU funds, considering that the funds under the First Home programme are limited and that the Giving-in-payment law subjects banks to higher risks. The shift could also bring diversification benefits, given that households frontloaded mortgage borrowing during the first four months of the year in light of the uncertainties introduced by the changing legislation.
Given the external uncertainties and the fact that inflationary pressures remain manageable, we expect no change to the monetary stance. We expect inflation to rebound above 0% in August, as the VAT cut for food products will exit the base in mid-2016 and conclude the year around 0.1%, followed by a second jump above 1% in January 2017, when the second VAT cut will exit the base. However, we expect inflation to stay below the 2.5% targeted level in 2016-2017, due to low imported inflation benefitting from cheap commodities, falling food prices and weak inflation in the eurozone. Consequently, we expect the Central Bank to keep the policy rate on hold at 1.75% until the end of 2017, leaving ROBOR rates at depressed levels. This will translate into low financing costs for the real economy, supportive for lending and stimulating companies to continue the gradual recovery [fig. 8].
Overall, the economic environment supports growth, as consumption helps shield from the negative effects of the slowdown in global trade and the consequences of the UK leaving the European Union. At the same time, the CEE region has recently performed better than other emerging markets due to lower sensitivity to the most pressing problems in the world. However, the instability of the global context may take a toll on Romania, even though the country is exposed only indirectly to global risks (such as the Chinese slowdown, the low oil prices, the volatile financial conditions in emerging market, the diverging US and Eurozone economies, the refugee crisis and the UK’s decision to leave EU).
1) The salary increases towards the end of 2015 amounted to: 12% for personnel in local public institutions, 25% for personnel in public healthcare and social
assistance, 15% for personnel in education and 10% for all personnel in the public sector excluding healthcare.
2) The VAT rate for food products was cut to 9% as of June 2015. Separately, the general VAT rate was cut from 24% to 20% as of January 2016.
3) All the behaviours and preferences mentioned in this paragraph are according to NBR’s Survey on the access to finance of the non-financial corporations in
Romania, published in June 2016 and based on a survey undertaken in the period October 2015 – March 2016.