After growing 3.5% in 2013, economic activity continued to grow in 2014, albeit at a more moderate rate of 2.6 percent. The economy experienced strong growth in the first and third quarters of 2014, 4.0 and 3.2% respectively, whereas growth in the second quarter was disappointing (Figure 1). Private consumption emerged as a major contributor to growth in 2014, driven mainly by the rise in the minimum wage by 18% in July, rising consumer confidence, and interest rate cuts on the back of declining inflation. On the other hand, private investments remained subdued for the second consecutive year, held back by low industrial confidence (Figure 2). On a positive note, industrial confidence, which had been at low levels since 2008, had somewhat recovered towards the end of 2014.
Source: National Accounts, National Bank of Romania
Net exports fell in relation to imports in 2014 and the balance of trade was negative. Rising consumption has boosted imports, while exports remained constrained due to continuing weakness in the Eurozone. With 51% of its exports destined for Eurozone countries and another 18% for other EU countries, Romania remains highly dependent on export demand from Europe.
Source: National Accounts, National Bank of Romania
Inflation remained below or around the lower boundary of the National Bank of Romania (NBR)’s target range of 2.5 ± 1% throughout 2014, declining to 0.8% in December (Figure 3). Low food prices, due to a good harvest and increased supply of food from countries affected by the Russian embargo, imposed in June 2014, declining energy prices, improved inflation expectations and base effects due to adjustments in administered prices in late 2013 are the main drivers of low inflation (Figure 4).
Romanian sovereign bonds have outperformed most of their emerging market peers in the last two years, as the country risk premium has been declining (Figure 5). The stabilisation in 2014 was partly caused by stabilised global liquidity, and foreign funds moving away from Russia to emerging markets. Yet improving fundamentals of the Romanian economy also contributed to the stabilisation process. The declining country risk premium helped the stabilisation of the currency (Figure 6).
Source: Bloomberg
The equity market has been performing reasonably well since 2012, outperforming Romania’s regional peers (Figure 7). The Romanian index partly benefited from historically low interest rates, and also from the additional cash in European markets due to the European Central Bank’s stimulus package. As the Romanian index rose, equity and debt holdings of non-residents increased, with debt growing faster than equity (Figure 8).
Source: Bloomberg, National Bank of Romania
External imbalances remained contained. The current account almost fully rebalanced, with the deficit declining to below 1% of GDP in November 2014, on the back of a higher surplus in the services balance and a lower deficit in the merchandise trade balance. External debt has been falling in the past two years, mainly on the back of repayment of a EUR 13 billion loan to the IMF and EUR 5 billion to the European Commission (Figure 9).
Source: National Bank of Romania.
With the onset of the crisis, foreign private capital inflows declined sharply. This decline reflected both the increased risk aversion of financial markets and Romania’s vulnerabilities. It led to an external funding gap that was eventually closed by borrowing under a joint EU/IMF/World Bank financial assistance programme. The reduction in foreign capital inflows and the correction measures adopted under the programme led to an immediate but contained adjustment in domestic demand and to a quick recovery of economic growth, after a cumulated contraction in economic activity of almost 8 % over 2009-10.
The low current account deficit is now fully covered by Foreign Direct Investment (FDI), but the level of FDI in 2014 remained well below pre-recession levels (Figure 10). Improved economic fundamentals helped attract larger non-FDI inflows, but this type of inflow is usually more volatile than FDI and prone to shifts in global market sentiment.
The banking sector remained well capitalised, with a capital adequacy ratio of around 17% as at September 2014. But bank deleveraging continued in 2014, albeit with the maturity structure of banks’ external funding changing favourably towards long-term funding. The loan to deposit ratio declined from above 120% in 2012 to 100% in the third quarter of 2014. This was reflected in subdued credit growth in 2014, partly due to the lack of demand for credit, possibly on the back of the still high number of non-performing loans (NPLs) in Romania. Nevertheless, following the NBR’s initiative that allowed banks to keep legal claims against derecognized NPLs, these declined from a very high level of 20.4% in the first quarter of 2014 to a somewhat more moderate level of 15.3% in the third quarter of 2014.
Source: National Bank of Romania
The currency composition of loans to the private sector has improved since mid-2013, with lei-denominated loans now exceeding foreign currency loans (Figure 11). At the same time, the maturity structure of lei-denominated loans has also improved recently, with the share of short-term loans declining as a proportion of the total (Figure 12).
Romania went through a significant fiscal adjustment after the start of the global recession in 2008, which helped bring the fiscal deficit down to below 2% of GDP in 2014 (Figure 13). In 2014, the scope for fiscal stimulus remained limited, while falling inflation opened up some space for monetary stimulus.
Romania has been on a 24-month Stand-by Agreement (SBA) with the IMF since September 2013, with access of EUR 1.98 billion. The completion of the third review for the program was originally scheduled for mid-2014, but then delayed until early 2015.
In 2014, budget revenues grew on the back of increasing social contributions, driven by the rise in the minimum wage, as well as better collection of corporate income tax. However, spending reductions have been driven mainly by cuts to public investments, which might adversely affect medium and long-term growth.
Source: Ministry of Finance; 2014 value is the IMF estimate
Public debt edged up but remained moderate by regional standards, standing at 41.6% of GDP in November 2014. Despite improvements over the past few years, a large proportion of debt is still exposed to foreign currency risk (Figure 14). However, the maturity structure of government debt has improved recently, partly as a consequence of favourable global liquidity conditions. The share of government debt with maturities longer than 5 years as a proportion of total debt increased to 35.6% in 2014 from 4.4% in 2012 (Figure 15).
A steady fall in inflation, on the back of declining food and oil prices, as well as declining expectations and base effects, gave the NBR the opportunity to cut the policy rate to a historically low level of 2.25% in February 2015. At the same time, market interest rates (e.g. ROBOR3M) declined to around 1.5% by February 2015 (Figure 16). To inject liquidity into the market and revive credit conditions, the NBR also lowered minimum required reserves on lei-denominated liabilities to 10% from 12% in September 2014, whereas reserves on FX-denominated liabilities remained at 14%. Provided that structural reforms in the country continue, and credible policies anchor inflation expectations, Romania may have a historic chance to maintain sustainable low interest rates for some time.
Source: National Bank of Romania
The European Commission (EC) forecasts 2.7% of GDP growth in Romania for 2015 and 2.9% for 2016. Recent and prospective interest rate cuts, driven by low inflation, will continue to boost domestic demand in 2015. After two years of decline, investment might rise on the back of rising industrial confidence and depleted inventories. The NBR’s initiative to allow banks to keep legal claims against derecognized NPLs and lower minimum reserve requirements on lei-denominated liabilities may help credit growth, although credit growth revival in the medium term will much depend on the extent to which corporate sector activity is sustainably revived, e.g. through corporate restructuring, structural reforms, and a revival of FDI. To increase the absorption rate of EU-funds, which is currently almost 53.12%, government expenditure may need to increase slightly, although this will be limited due to ongoing IMF program commitments. Overall, these factors are expected to lead to a slight rise in domestic demand in 2015. However, net exports are likely be constrained due to continuing weakness in the Eurozone and increased geopolitical tension in the region, keeping growth at a still moderate rate of 2.7% in 2015.
In the medium term, Romania has high convergence potential, given its purchasing-power-parity-adjusted GDP per capita of 55% of the EU average. If necessary reforms to unlock the country’s growth potential are implemented, the economy could reap the benefits of European and global recovery in years ahead.
To achieve this, Romania needs to further improve its business environment and make it more attractive for investors. Despite recent improvements, the country still ranks lower than most of its regional peers for ease of doing business. According to the World Bank’s Doing Business 2015 Report Romania ranks 48th out of 189 countries, scoring particularly low for obtaining construction permits and obtaining electricity. Similarly, Romania ranks 59th out of 144 countries in the Global Competitiveness Report 2014-2015. The country scores particularly poorly on indicators relating to infrastructure, access to finance, tax rates, corruption and inefficient government bureaucracy.
The tax mix has improved over the years, but tax policy is changing frequently and revenue collection remains weak. Over the past years, indirect taxation, such as VAT and excise duties, has gained weight in the tax mix. The tax wedge was reduced in 2014 by a cut in social security contributions of 5 pps. across the board, after an increase by 3 pps. in 2009. However, frequent changes in tax policy continue to disrupt the business environment. Tax collection remains weak, and the VAT gap is the biggest in the EU27, at 44 % of GDP in 2012.
According to the EC Cooperation and Verification Mechanism report published in late-January 2015, Romania has made progress in judicial reforms and the fight against corruption. However, taking further firm steps against corruption remains a major challenge. Inconsistency of some court decisions, outstanding legislative issues and Parliament’s lack of objectiveness in high-level corruption cases still cause concern.
The results of these surveys point to some concrete reform priorities for the enhancement of the business environment: