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Investing in Romania: Good Reform, but Struggling With the Old

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Emerging markets fund manager Mark Mobius of Franklin Templeton recently blogged about a visit to Romania, and the “juxtaposition of old and new” that he saw there as the country moves toward market reform.

Romania has been working hard to implement macroeconomic reforms recommended by the International Monetary Fund (IMF) in the wake of the 2008 financial crisis, and Mobius pointed out that it has been one of the most successful in its efforts. It has managed to cut its budget deficit to below 3% of GDP in 2012—it was at 9% in 2009—and is expected to continue its progress of fiscal consolidation through 2013–2014, though perhaps on a lower scale, with adherence to reforms expected to allow it to exit the EU’s excessive deficit procedure in 2013, according to Matteo Napolitano of Fitch Ratings.

The country exhibits both the progress and the problems inherent in a globalizing economy, with Mobius commenting about a shuttered textile factory that fell victim to Chinese competition while another factory, part of a French multinational corporation’s empire, was busily at work manufacturing truck tires and running 24 hours a day. Another example he cited of the international reach of commerce was yet another factory in the process of expanding its capacity to make oil and gas pipes; it belonged to an Argentinian company’s network. The presence of “modern Western European grocery outlets,” was also “a sign that modern food distribution has reached the farthest reaches of the country,” he added.

Fitch’s Napolitano pointed out recently in research that outside investment, spurred by a favorable attitude on the part of companies expanding into Romania, is one factor helping the government meet its fiscal financing needs. But weak growth, in both performance and outlook, have hindered the process and put pressure on Romania’s sovereign rating. Tough financial times in the European Union (EU), combined with the turning-a-battleship difficulty of reforming state-owned enterprises (SOE) that are both large and inefficient, have held the country back from making more progress.

The country’s banks, which are largely foreign-owned, will likely not contribute to any improvement, though they shouldn’t drag the economy down, either. Nonperforming loans are on the increase, despite provisions to compensate. One bright spot in the banking picture was the announcement that Romania’s second largest bank, BRD, which is controlled by Société Générale, beat earnings expectations for the first half of 2013. It posted a net profit of 62 million lei ($18.65 million); that’s up 58% from the same period last year.

Other difficulties Romania faces include tight purse strings at EU trading partners beset by recessionary woes, and poor harvests that have put a different kind of pressure on the state. However, agriculturally 2013 appears to be kinder to the country than 2012 was, and both the IMF and Fitch expect that growth will be positive in 2013, with the IMF forecasting 1.6%. Fitch further expects that pressures will lessen and the Romanian GDP will grow at a quicker pace in 2014, at perhaps as much as 2.4%.

Mobius highlighted several factors that he said could make Romania “one of the fastest growing economies in the E.U.”: more privatization, particularly in sectors where the government’s budget is not equal to investment needs; a pipeline of IPOs that will provide assistance not just to the companies seeking funding, but to the country’s capital markets as well; and the continuation of structural reforms to boost Romania’s attractiveness to foreign investors.

Romania appears nothing if not determined. Its central bank slashed the benchmark interest rate to 5% in July, the lowest it has ever been, as a means of stimulating business growth. At the end of July, the Romanian government announced that it had reached a new agreement with the IMF, the European Commission and the World Bank for a new precautionary aid agreement. The government has also agreed to provide 21 million euros ($27.86 million) in state aid to Big Blue; IBM plans to create 900 jobs in the country.

Other good news includes the fact that the Romanian government has raised its own growth forecast for 2013, based on higher demand for exports. Renault’s Dacia cars, popular in the EU, are expected to fuel some of this demand, and the country also saw an increase in the price of wheat on stronger demand, with Egypt agreeing to purchase 240,000 metric tons from Romania and Ukraine.

In addition, the EU has agreed to fork over 130 million euros ($172.4 million) that will be used for a Romanian project to build or retrofit chemical sewage treatment plants for Bucharest and villages near the city; completion is planned by 2020.

And on August 5, Banca Nationala a Romaniei, the country’s central bank, cut its benchmark interest rate by more than analyst forecasts to 4.5%, a record low, as inflation slowed and confidence grew that the country could meet its inflation target by the end of the year. The rate cut also opens the door for monetary stimulus. The country had earlier announced that it would cut its VAT on bread and some other food items from 24% to 9%; that cut will become effective in September. It is expected that the move will help to slow inflation more quickly than previously expected.

One setback Romania experienced earlier this year was being denied, yet again, membership in the Schengen area, a group of 26 European countries, 22 of them from the Eurozone, that function as a single country for travel purposes and have a single visa policy. Membership was opposed by both Germany and Finland; they said Romania is not yet ready because it has failed to do enough to fight corruption.

However, Romania’s president Traian Bsescu has said that his country should ask for a new deadline to comply with Schengen requirements, either in September or December. Opposition to Romania’s entry into the Schengen area was based on the EU’s Mechanism for Cooperation and Verification (CVM) report, in which the EC criticized Romania’s lack of progress on fighting corruption and instituting judicial reform. While the Schengen area is not an economic factor, corruption can act as a powerful deterrent to business growth, he has said in published reports. Being granted Schengen status is yet another goal Romania must work toward in order to reach the status in Europe that it has worked so hard to achieve.