Macroeconomic performance

Romania’s economy has been on a solid recovery path this past year. Economic activity picked up in 2013, with growth up 3.5 per cent above market expectations, on the back of a strong export performance and higher agricultural production compared with the previous year. This is a major improvement on 2012 when GDP rose by a mere 0.6 per cent. Year-on-year growth remained strong in the first quarter of 2014 at 3.8 per cent, with industrial production and exports continuing to perform well. However, figures for the second quarter showed a drop in annual growth to 1.4 per cent, partly due to a significant decline in gross fixed capital formation. Inflation returned to the central bank’s target range of 1.5-3.5 per cent during 2013, followed by a drop below the bottom range in January 2014 (reaching 1.2 per cent), then remained low at around 1 per cent through the first half of the year.

Fiscal performance has remained strong. There has been substantial fiscal adjustment since the start of the crisis, which has brought the budget deficit down from over 7 per cent of GDP in 2009 to an estimated 2.5 per cent of GDP in 2013. Romania is now rated at investment grade by the three main ratings agencies. However, spending reductions are being achieved partly through significant cuts to public investment, which could adversely affect long-term development if funding for high-quality projects were reduced. Public debt is low by regional standards at around 39 per cent of GDP, and the current account is close to balance. Fiscal policy is anchored by a 24-month €1.98 billion Stand-By Arrangement with the International Monetary Fund, approved in September 2013. The programme envisages further fiscal adjustment in 2014 and 2015, which is expected to bring down the deficit to below 2 per cent of GDP. However, completion of the third review, originally scheduled for mid-2014, has been delayed and may be further complicated by parliament’s decision in September 2014 to implement a 5 percentage point cut in employment taxes. This measure, which is designed to promote job creation, took effect from 1 October 2014.

Growth is expected to remain between 2 and 3 per cent in 2014 and 2015, aided by further export growth and a recovery in domestic demand. However, the high level of NPLs, ongoing cross-border deleveraging and increased uncertainties in Ukraine may dampen growth prospects in the near term. Medium-term prospects remain favourable, reflecting the diversified economy, large market size and considerable scope for catch-up in a country where GDP per capita (adjusted for purchasing power standards) is just 53 per cent of the EU average, according to Eurostat estimates. Annual growth rates of 4 to 5 per cent are feasible provided that the pace of structural reforms is accelerated and more investment is attracted. Euro adoption is now envisaged for 2019, and the authorities have expressed their intention to enter the new banking union. Romania currently meets all of the Maastricht criteria for entry into the Exchange Rate Mechanism (ERM-II). However, further real convergence may be needed before adoption of the euro can take place.

Major structural reform developments

Romania has made progress in many areas under the EU’s Cooperation and Verification Mechanism (CVM), but some concerns remain. In its latest report under the CVM, issued in January 2014, the European Commission (EC) concluded that Romania had made progress in many areas of judicial reform and the fight against corruption, particularly in non-partisan investigation and prosecutions in high-level corruption cases. However, as in prior reports, the EC noted remaining weaknesses in the functioning of the judicial system.

Large-scale privatisation has yielded mixed results. A major success in the past year was the flagship sale, in November 2013, of a minority 15 per cent stake in the natural gas producer, Romgaz, for 1.7 billion lei (€390 million) through an international IPO. The launch of an IPO for 51 per cent of the electricity distribution company, Electrica, in June 2014 was another landmark deal for Romania. Other privatisations are proving more challenging. In February 2014 the Appeals Court placed the hydropower generator, Hidroelectrica, back into insolvency until the legal claims of energy traders against the company are resolved. However, the company has made some financial progress. The IPO will be launched as soon as the company exits insolvency, which is currently expected for mid-2015. In addition, another attempt to sell the major chemical company, Oltchim, failed this year as no bid was received for the core assets by the 28 March 2014 deadline.

Romania scores relatively poorly compared with other EU countries on business environment indicators. Although some enhancements to the business environment have been made over the past year, the country ranks lower than most of its regional peers for ease of doing business. In the World Bank Doing Business 2015 report, Romania ranks 48th out of 189 countries, up two positions from last year. The country has made a significant jump (up 76 places) in the area of paying taxes, albeit from a very low position of 128th. Challenges remain with regard to obtaining construction permits and getting electricity.

Liberalisation and deregulation have advanced in the energy sector, but significant challenges remain. Electricity prices have been raised several times over the past year in line with the energy price liberalisation road map, and there is now a functioning competitive electricity market for non-residential consumers. Gas price liberalisation for this segment has continued, with increases in regulated prices in October 2013 and January 2014 in accordance with the liberalisation road map, but it has not yet been completed. Meanwhile, gas price liberalisation for households has been delayed. The price of gas for end-consumers is still regulated by the Romanian Energy Regulatory Authority, ANRE, and there remains a degree of cross-subsidisation between different categories of consumers.

Transport sector reforms are lagging behind. The quality of transport infrastructure remains poor by EU standards. Officially, private sector participation in road sector projects is encouraged and although some public-private partnership contracts have been awarded, the country has failed to structure a concession in line with good industry practice. The government has drafted a master plan for transport, which is currently under public consultation. In the railways sector, the collapse of the privatisation of state-owned freight company, CFR Marfa, in October 2013 was a serious setback for the industry, which continues to rely on large, non-transparent budget allocations for its survival. CFR Marfa is undergoing restructuring, including a reduction in personnel costs, and the privatisation process has resumed.

Non-performing loans have reached elevated levels but are being addressed. The official NPL rate reached nearly 22 per cent by the end of 2013, which is high by regional standards, although it has since declined to around 18 per cent in July 2014. The central bank has developed a plan to reduce NPLs that encompasses the following elements: (i) removing all provisioned assets from the balance sheets; (ii) fully provisioning exposures with more than 360 days in arrears, and removing them from the balance sheets; (iii) encouraging all banks to fully provision exposures to companies that entered insolvency status, and removing these exposures from the balance sheets; and (iv) modifying NPL calculation to meet the European Banking Authority’s definition. It remains to be seen whether this plan will lead to an effective resolution of NPLs, or will simply remove them from the balance sheets.