Romania: Economic challenges for 2012

The external context

The plan to reshape the architecture

Need to reinforce the architecture of Economic and Monetary Union. A metter of necesity, credibility and confidence To eliminate deficiencies in the construction of EMU Add to the single currency a strong economic pillar Enhanced governance to foster fiscal discipline Stronger growth Deeper integration in the internal market Enhanced competitivenes Social cohesion Indispensable urgently needed measures for the crisis resolution
In view of the above: A renewed contract between the euro-area Member States is needed

The plan to reshape the architecture (I)

More binding and more ambitious rules for the euro-area Memeber States Sharing a single currency means shearing responsability for the euro-area as a whole Enshrine rules in the Euroepean Treaty (not so easy) Four force lines of the new architecture: Enhanced institutional architecture A framework of prevention Enforcing sound fiscal policies A strong crisis resolution mechanism

An enhanced institutional architecture Regular meetings of the euro-area leaders Domestic policies a matter of common interest

Monthly meeting of the Eurosummit during the crisis (focusing on governance, growth, competitiveness, fiscal stability)
European Commission and the European Parleament will be involved

The preventive arm

Detect departures from sound economic and fiscal policies before they become a threat to stability It needs strengthened coordination, surveillance, enforcement and incentives starting from the existing arrangements (including the Euro Pact) by: Adoption of rules on a balanced budget in the national legislation (constitutional level). The european Court of Justice should have the posibility to verify) Foster growth through greater competitiveness and grater convergence of economic policies A new common legal framework to be established to accelerate progress in areas of financial regulation, labor markets, corporate tax convergence and harmonisation, growth and use of European funds

Sounder fiscal policies

Automatic connsequences for states recognised to be breach with the 3 percent ceiling by the European Commission, unless the by a qualified majority, Eurogroup decides atherwise A pack of fiscal and structural policies agreed with the EC by each Member State (the European Reform Partnership) to overcome the dificulties The EC can recommend or impose sanctions to be adopted by the European Counci, unless a qualified majority of the euro-area Member States decides otherwise Procedures for debt reduction by the euro-area Membrr States with a public debt higher than 60 percent of GDP to be enshrined in the new treaty provisions

The crisis resolution mechanism

The ESM should be effective since 2012, advancing from an initially set date of 2013 Make clear that the SPI in the case of Greece was unique and exceptional. Euro-area Member States have to remain inflexibly determined to honor fully their own sovereign signature

Problems
How the new fiscal rules the summit leaders promised to follow would be enforced It would be difficult to give Brussels new powers over eurozone national budgets outside the EU treaties Financial markets would not see the new pact as credible Markets reacted with unease profound split over crisis plans for the eurozone What happen when the Commissiona and the ECB disagree with respect to the need for urgent decision related to financial assistance needed when the ffinacial and economic sustainability of the euro-zone is threathened

2008-9 cumulated growth in EU-27 and some other economies Some countries with currency board like monetary systems experienced deeper recessions
10

-5

-10

-15

-20

-25

2009-10 cumulated growth in EU-27 and some other economies

Some countries with currency board like monetary systems experienced deeper recessions
10,0

5,0

0,0 EU27 -5,0 -10,0 -15,0 -20,0 EA17 BE BG CZ DK DE EE IE GR ES FR IT CY LV LT LU HU MT NL AT PL PT RO SI SK FI SE UK Australia Brazil Canada Israel Japan Korea Mexico Turkey United States

General Government cash budget deficits in the EU

DMs have borrowing financial needs double or triple as compared to their budget deficits Percent of GDP
5,0 0,0

-5,0

-10,0

2007 2008

-15,0

2009 2010

-20,0

-25,0

-30,0

-35,0

General Government structural budget deficits in the EU

Percent of GDP 5,0

0,0
-5,0 2007 -10,0 -15,0 -20,0 -25,0 -30,0 -35,0 2008 2009 2010

50

100

150

200

250

0 EU27 EA17 BE BG CZ DK DE EE IE GR ES FR IT CY LV LT LU HU MT NL

AT
PL PT RO SI SK FI SE UK Australia Brazil Canada Israel Japan Korea Mexico Turkey United States

Public debt as a percent of GDP

2010

2007

Conclusions from comparing fiscal deficits, public debt and international investment positions
Cash deficits select well Greece. But fail to select any other country if the 1999-2007 average fiscal deficts is considered Public debt is also a imprecise measure: it rightly picks up Greece, Italy, Belgium and Portugal. But fails to pick up Estonia, Ireland and Spain, which performed better than Germany before the crisis International Investment Position picks up Greece, Portugal, Italy, Ireland, Spain.

Conclusions from comparing fiscal deficits, public debt and current account deficits

Average GG balance (% of GDP) Average GG debt (% of GDP) Average current account balance (% of GDP) 1990*-1998 1999-2007 1990*-1998 1999-2007 1990*-1998 1999-2007 Belgium -5.2 -0.5 128.4 100.5 5.3 3.2 Germany -3.6 -2.2 49.9 63.4 -1.0 2.7 Ireland -1.3 1.6 85.2 34.3 2.1 -1.6 Greece -9.0 -5.3 89.6 101.6 -2.9 -7.9 Spain -4.9 0.2 55.8 50.8 -1.7 -5.5 France -4.2 -2.7 47.4 61.5 1.6 0.8 Italy -8.1 -2.9 112.0 107.2 0.7 -0.5 Luxembourg 2.1 2.4 5.9 6.4 10.7 10.3 Netherlands -3.5 -0.5 75.4 53.1 4.2 5.3 Austria -3.5 -1.8 61.8 64.7 -1.2 1.3 Portugal -5.4 -3.6 55.4 56.2 -4.9 -9.3 Finland -2.9 3.7 44.6 42.7 0.4 5.9 Source: Eurostat, Ameco * Available data series start later than 1990 in the case of several countries. Reported averages are then computed using the longest available subperiod

IIP (% of GDP) Euro area Bulgaria Czech Republic Ireland Greece Spain Italy Hungary Poland Portugal Romania US 2010 -13.3 -97.7 -49.0 -90.9 -92.5 -89.5 -23.9 -112.5 -64.0 -107.4 -65.3 -17.0

Public debt (% of GDP) 2010 85.6 16.3 37.6 94.9 144.9 61.0 118.4 81.3 54.9 93.3 31.0 95.2

LT Yield (latest, bonds maturing in 2018) 4.3 3.8 9.0 35.7 4.5 6.2 9.0 4.8 16.0 6.6 1.5

Source: Eurostat, US Department of Commerce, WEO Database, Bloomberg

Exposure of US-owned banks on EA and PIIGS

share in total claims (%)
34 33 32 31 30 29 28 27 26 25 24
share of claims on the euro area in total claims of US owned banks share of claims on PIIGS in total claims of US banks (rhs)

share in total claims (%)

9.0 8.5 8.0 7.5 7.0 6.5 6.0 5.5 5.0 4.5 4.0

Mar.05

Mar.06

Mar.07

Mar.08

Mar.09

Mar.10

Mar.11

Jun.05

Jun.06

Jun.07

Jun.08

Jun.09

Jun.10

Sep.05

Dec.05

Sep.06

Dec.06

Sep.07

Dec.07

Sep.08

Dec.08

Sep.09

Dec.09

Sep.10

Source: BIS Database

Dec.10

Jun.11

What is the nature of the crisis?

The fiscal malfeasance? The balance of payments crisis? The decisions should be different, depending the nature of the crisis The European leaders think of a fiscal nature of the crisis.

Based on data, one may think of a balance of payments crisis.

If the competitiveness is the real proble, than, the solutions are of two folds: An external adjustment. Specifically, shifts in competitiveness Looser macropolicies to alow higher inflation and higher credit growth in surplus countries

The decisions seems to include

No compelling private bondholders to take losses on euro-zone bailouts. But voluntary restructuring remains Some degree of automaticity of sanctions on countries that fail to stay within the limits on budget deficits Requirements for balanced budget into domestic legislations

Introduction of the ESM in June 2012

Monthly meetings of European leaders to oversee policy coordination

20

40

80

60

100

120

0
ian..05

apr..05
iul..05 oct..05
Italy Bulgaria Portugal Hungary Romania

Source: DG-ECFIN

ian..06

Euro area

apr..06
iul..06 oct..06 ian..07

apr..07
iul..07
France Poland

oct..07 ian..08

Greece

Germany

apr..08
iul..08 oct..08 ian..09

Czech Republic

apr..09
iul..09 oct..09 ian..10

Economic Sentiment Indicator (ESI)

apr..10
iul..10 oct..10 ian..11

apr..11
iul..11 oct..11

Economic Sentiment Indicator (ESI)

120

120

100

100

80

80

60

Euro area Germany Czech Republic Hungary Romania

60

40

France Italy

40

20

Portugal Greece

Bulgaria
Poland

20

iul..06

oct..05

oct..08

iul..09

apr..07

apr..10

ian..05

ian..08

ian..05

oct..05

ian..08

oct..08

ian..11

apr..07

Source: DC-ECFIN

apr..10

oct..11

ian..11

oct..11

0 iul..06 iul..09

Industrial output
annual percentage change, adjusted data annual percentage change, adjusted data

20 15 10 5 0 -5 -10 -15 -20 -25 -30 mai..06 mai..08 sep..05 sep..07 sep..09 mai..10 mai..06 mai..08 sep..05 sep..07 sep..09 mai..10 sep..11 sep..11 ian..05
Czech Republic Euro area Germany France Italy

20 15 10 5 0 -5 -10
Bulgaria
Hungary Poland Romania

-15 -20 -25 -30 ian..09 ian..11

ian..09

ian..07

ian..11

ian..05

Source: Eurostat

ian..07

Industrial output
20
15 10 5 0 -5 -10 -15
France Italy Poland Euro area Czech Republic Bulgaria Germany

annual percentage change, adjusted data

-20
Hungary

-25
Romania

-30

mai..05

mai..06

mai..07

mai..08

mai..09

mai..10

mai..11

sep..08

sep..05

sep..06

sep..07

sep..09

sep..10

Source: Eurostat

sep..11

ian..07

ian..05

ian..06

ian..08

ian..09

ian..10

ian..11

Romania

Good fundamentals
Debt to GDP ratio 32 pc and sustainable Fiscal deficit is set to be at 1.9 pc of GDP in 2012 High level of fx reserves, covering 7-8 months of imports An IMF precautionary stand-by facility is in place. EU/WB programs also in place alongside the IMF Current account deficit of 4pc of GDP, around 40pc covered with FDI Currency stability

Good fundamentals (II)

An unleveraged economy. Household debt to GDP of around 20pc Corporate debt to GDP also around 20pc.
Well capitalized banking sector with CAR of 14pc. CAR for tier I capital above 12 percent on average Structural reforms in the government sector over the past two years. More reforms are set to be implemented Treasurys fiscal reserve of about 4 months Inflation down from the 8% reached earlier in the year to 3.6 % now.

Concerns

Growth will be slower next year. It depends on external factors, capital flow included

Growth will be affected by slower growth in exports/industrial production

Gross capital formation is getting traction, but private consumption still sluggish

Concerns (II)
Parent banks are asking their CEE subsidiaries to return excess EUR funds
The Romanian banking sector: loan to deposit ratio in EURO of 150pc (deposits 40/loans 60/loans from parents 50) The repayment will be happening over the next year. Possible credit contraction in EUR denominated lending

The possible consequences of the EUR credit contraction:

Will likely affect corporate investment Sale of EUR denominated locally issued government bonds now held by the local banks That would eliminate a source of funding for the government Since the USA dollar denominated issue was accepted, the possibility to tap funds from the IMF and EU opens.

The extend of the future credit contraction is uncertain

Repatriating capital to the parents to increase capital adequacy is not necessarily working. CAR is measured at group level. Increasing CAR means deleveraging and asset sales.

Asset sales are near impossible at this point

Deleveraging remains the focus until next June, which is the deadline for complying with the new requirement for tire I capital adequacy.

Elections in November 2012

Ahead of elections there is always a risk of some fiscal slippage. However, giving the circumstances, no major changes in economic policy whoever wins the next election.

EU structural funds absorption

Poor absorption of EU structural funds to date Could the recently created Ministry for European Affaires succeed in changing that? It remains to be seen

A positive fact: starting in 2012, Romania's contribution to projects via co-financing would drop to 5pc from 15pc now Success in absorbing sizable structural funds is key to boosting growth

CPI Inflation
Latest projection: 3.3% end-2011, 3.0% end-2012 We expect a V shape of CPI annual inflation, largely determined by base effects related to food price dynamics: reflecting favorable base effects (the impact of the past increases in agricultural commodities on annual inflation expires) the trough of 1.5% reached in April 2012 inflation will have an ascending path in the second semester of 2012 as the impact of past decreases in volatile food prices expires

Rata inflaiei
10 9 8 7 6 5 4 3 2 1 0 -1
6,6 6,2 5,8 5,5 5,1 4,5 4,0 3,4 2,9 2,7 2,7 2,6 2,7 2,7 2,6

procente rata lunar rata medie anual rata anual proiecie

iun.09

iun.10

iun.11

aug.09

aug.10

aug.11

iun.12

aug.12

apr.09

apr.10

apr.11

apr.12

oct.09

oct.10

oct.11

dec.08

dec.09

dec.10

dec.11

oct.12

Sursa: INS, BNR

Not: Valorile lunare ale inflaiei proiectate au fost calculate prin interpolare pornind de la cele trimestriale obinute de Direcia Modelare i Prognoz Macroeconomic.

dec.12

feb.09

feb.10

feb.11

feb.12

Core 3 inflation projected to decline steadily in annual terms to 1.9% during Q4 2012 from 2.7% during Q4 2011 Factors behind the projection: Disinflation progress will translate gradually into lower inflation expectations Persistence of a large negative output gap (-4.7% on average during 2012)

A relatively stable exchange rate (4.29 during 2012 on average)

Less inflationary pressures stemming from administered price adjustments during 2012 (current assumption 4.7% yoy end-2012, as compared to 8.3% end-2011)

Risks to the projection are balanced

However, upside risks are probably more relevant in the case of the exchange rate Among the upside risks are adverse developments in investors risk aversion in the context of the euro area sovereign debt crisis

a leu depreciation against the USD as capital continues to find safe haven across the Atlantic. Inflationary pressures may arise (stemming from fuel prices)
domestic fiscal policy slippages

Romanias economic growth and competitiveness

GDP growth rates in Romania*

The V shape of GDP growth rates following sudden stop in capital inflows
10 percent

-5

-10

-15

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011f

Source: NIS, NCP * forecasted growth rates for 2011 and 2012

2012f

Romania: Capital inflows before and after the crisis

Romania: Private capital flows
25,000 EUR mill. private transfers 20,000 portfolio investment FDI bank loans official transfers other flows official loans 15,000 15,000 20,000

Romania: Public capital flows

EUR mill. 25,000

10,000

10,000

5,000

5,000

-5,000 2000-2004
Source: NBR

-5,000 2005-2008 2009-2011* 2000-2004 2005-2008 2009-2011*

* January - February 2011

Note: average values based on annual data

-60 20 40 60 0

-40

-20

Source: NIS

Jan.08 Mar.08 May.08 Jul.08 Sep.08 Nov.08 Jan.09 Mar.09 May.09 Jul.09 Sep.09 Nov.09 Jan.10 Mar.10 May.10 Jul.10 Sep.10 Nov.10 Jan.11 Mar.11 May.11 Jul.11 Sep.11
Goods, excl. motor vehicles Motor vehicles Services annual percentage change

Turnover volume in retail trade

Labor costs in Romania remain among the lowest in the region

Productivity adjusted labour costs, % of Germany

60

50 2000 40 2010

30

20

10

0 BG RO LT LV PL EE SK HU CZ SI
Source:Eurostat, AMECO

Developments during the last 2 years partly undoing the erosion in competitiveness that occurred in the boom period
60 50 40 30 20 10 0 -10 -20
-30
Exchange rate Productivity Gross wages ULC in EUR, annual change (%) ULC in EUR, index 2000=100 (rhs)

annual change, % Manufacturing

200 180 160 140 120 100 80 60 40

20

-40 2001
Source: NIS, NBR

0 2008 2009 2010

2002

2003

2004

2005

2006

2007

Wide spectrum of ULC developments across the main industrial sectors

600 in EUR, index 2000=100
ULC, Manufacturing

ULC, Manufacture of motor vehicles, trailers and semi-trailers

500

ULC, Manufacture of electrical equipment

ULC, Manufacture of basic metals

400

ULC, Manufacture of wearing apparel

ULC, Manufacture of leather and related products

ULC, Manufacture of food products

300

ULC, Manufacture of chemicals and chemical products

200

100

0 2000
Source: NIS

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

with the automotive industry and the electrical equipment sectors appearing as particularly labor-cost efficient
Manufacture of motor vehicles
80 60 40
annual change, %

Manufacture of electrical equipment 140 120 100 140 120 100 80 60 40 20 0 -20 -40 -60
annual change, %

20
0 -20

80
60 40

-40
-60 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

20
0

200 180 160 140 120 100 80 60 40 20 0

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Manufacture of food products

Manufacture of wearing apparel 80

60 40 20 0 -20 -40 -60 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Gross wages Exchange rate ULC in EUR, index 2000=100 (rhs)
annual change, %

350
300 250 200 150 100 50 0

60
40 20 0 -20 -40 -60

annual change, %

300
250 200 150 100 50 0

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Productivity ULC in EUR, annual change (%)

Source: NIS, NBR