Still lacking perspective
Romania made a bruised entry into the EU last January and its integration continues to be rocky. ‘The Diplomat’ assesses Romania’s first year in the EU.
Report by Ana-Maria Nitoi and Michael Bird
Romania remains among the most dynamic countries in the EU, but the rhythm of growth is slipping, its long term strategies are few and there are fears over how irresponsible public spending could destabilise the economy.
“Romania’s economy is fragile and affected by a lack of structural reforms in key sectors, especially agriculture,” says Nicolae Idu, general director of the European Institute of Romania (EIR).
The IMF predicts that growth will remain at six per cent for 2008, but there is concern that the country’s disinflation policy has stopped. Inflation rose from 4.9 per cent in 2006 to an estimate of 5.7 per cent for this year, way clear of the four per cent target.
Foreign investment has also fallen in 2007, from nine billion Euro in 2006 to between five and seven billion Euro.
The country’s minority Government, run by the National Liberal Party (PNL) and the Democratic Union of Hungarians in Romania (UDMR), has the support of only 20 per cent of the Parliament and the electorate. It has resorted to making populist measures, mostly borrowed from the Social Democratic Party (PSD), such as raising pensions, public sector wages and delaying making a decision on the privatisation of parts of the energy sector.
This instability has eroded business confidence in Romania. Standard and Poor’s downgraded its country rating of Romania from stable to negative, mostly due to this year’s 20 per cent increase in public sector salaries. Romania’s government spending also outpaced GDP growth by 7.4 per cent in 2007, compared to one per cent in Bulgaria.
Due to growth, Romanians are spending at a rate that the economy cannot sustain – and they are not buying many domestic products.
“Now Romania is benefiting from exceptional circumstances in terms of growth and private spending,” says Juan Jose Fernandez-Ansola, senior regional resident representative IMF. “When you have the incomes as they are now, it’s hard to convince the public that they will not always be there in the future. You cannot have exceptional growth and spending for ever by definition.”
The current account deficit and trade deficit are widening. The IMF believes the existing deficit of 14 per cent of GDP will not be sustainable beyond 2011. “This needs to be turned around very quickly,” says Fernandez.
Disinflation for 2008 will depend on the decisions of the central bank and of the Government policies on public spending – but few believe the leadership will introduce austere measures in 2008’s election year.
“In all countries in the region inflation is rising due to the consequences of poor climate conditions last Summer, demand for food in the world and energy prices going up,” says Fernandez. “[In Romania] In fiscal policy and wage policy– everything is going in the wrong direction in terms of bringing inflation down to four per cent.”
Last Summer’s decision to double pensions was also attacked by economists and the President for its blatant populism. “There’s no denying that over time Romania will have to increase pensions,” says Fernandez. “But it has to be done in a way that is sustainable.”
The fear is that the greater strain on the economy through higher public spending will drive up costs and bring down growth. “I hope that the substantial increase in pensions will not create bigger problems, so that the elderly will be able to enjoy life,” says Idu. “Because in a country with a relatively high inflation rate and a current account deficit that is unacceptable, one cannot really enjoy a bigger pension.”
EU funds absorption: lacking strategy
Romania has failed to absorb significant European funds since joining the EU, although 31 billion Euro is available until 2013. But the absorption rate is a false indicator of success, because it does not measure effectiveness, argues Idu.
Taking pre-accession funds as an example, Sorin Ionita, director of research at the Romanian Academic Society (SAR), says Romania has done badly in constructing large infrastructure projects, but has a “pretty reasonable” rate on small projects, even in the rural sector, which managed to absorb all the EU pre-accession SAPARD funds.
Ionita says there are two options for using up funds – soft and hard programmes. The soft option includes human resources and evening classes for retraining, say, textile workers who have lost their jobs. This money can be spent.
The hard programmes include a big road project. “It is not so easy to spend this money because you have to leave things behind – a bridge, for example, something that can be observed,” he adds. On soft programmes we will absorb the money, but we’re not sure about the effectiveness. On hard programmes the effect is more evident, but we don’t know if we’re able to absorb the money.”
Accession countries can either use funds to stretch development across the country or build up a target area. Spain and Portugal used funds to connect backward regions to developed areas to facilitate the distribution of wealth and people. But low income workers used the new transport lines to move to the richer regions. “Meanwhile, the Irish concentrated all the financing to the most developed areas, such as Dublin,” says Idu. “Those regions were capable at absorbing the money more rapidly.” Ireland, one of the poorest countries in Europe, now ranks second in the EU in GDP per capita, after Luxembourg.
Romania could try to develop poorer regions with high unemployment, such as Botosani, Vaslui or Jiu Valley, but risk the money disappearing or develop ‘super-regions’ of development which have the expertise to use the money, such as Sibiu.
But this discussion does not seem to be happening.
Adrian Ciocanea, head of the Department for European Affairs (DAE), defends the Government’s efforts in helping local authorities absorb European cash. When an authority begins implementing an EU-funded project, the Government can give pre-financing worth 15 per cent of the value. “The local administration should not be scared of having no money to start a project,” Ciocanea says.
Justice reform: stalled
In justice reform, the general opinion is that the Government’s efforts stopped in January 2007, when Brussels turned off the pressure on Romania to introduce a system based on the rule of law.
No high level politicians have been convicted while Romania remains the most corrupt country in the EU, according to Transparency International. New laws introduced this year also seem to prevent prosecutors from undertaking any proper investigation into a corrupt politician. There is a fear that the country has no rule of law for the powerful.
Before EU accession, the reforms of Minister of Justice Monica Macovei were praised by Brussels for her attempt to create a fair justice system.
“Things moved very fast in 2005 in terms of political willingness for reforms and steps taken,” says Ionita. “What had to be done was to free the institutions to do their job. Is this a reform? Just to let them work without political interference? It’s pretty simple. All you needed was abstain from interfering and blocking cases.”
Before Romania joined the EU, the country created the Anti-corruption Department (DNA) to investigate high-level corruption cases and reorganised the Superior Council of Magistracy (CSM) to guarantee the independence of justice. Since 2004, the CSM has been independent from any other state institutions. By 1 January 2007, the Government created and modified laws to meet EU requirements on independent and fair justice.
Dumbrava Horatius judge, president of magistrates association Societatea pentru Justitie, believes reforms slowed down towards the end of 2006, because of a lack of constructive dialogue between all sectors in the system.
In April this year, when Tudor Chiuariu, a politician, was appointed Minister of Justice, Horatius hoped the situation would improve because Chiuariu, a member of the governing Liberals, would not endanger his party ahead of next year’s general elections.
Since 2004 several present and former ministers have been sent to court, such as former Prime Minister Adrian Nastase, but received no sentence.
Although, last Summer’s European Commission’s monitoring report recognised the “continued progress” in the prosecution of high-level corruption cases, it indirectly expressed disappointment in the Parliament and Minister Chiuariu’s activities.
It highlighted the intention of Parliament to shorten the maximum length of criminal investigations, allowing judges to string out cases on procedural details until a deadline was over. But most seriously, the EC was concerned about the Minister’s desire to “dismiss” a senior member of the DNA. The EC was referring to prosecutor Doru Tulus, who was investigating both Nastase and head of the Conservative Party, Dan Voiculescu.
Since then, Parliament has adopted modifications to the Criminal Code and the Code for Criminal Proceedings which analysts argue effectively end a prosecutor’s ability to do anything.
Prosecutors will only be able to search a house if they give notice to the homeowner in advance. For prosecutors to tap phones, they need the approval of the person who is under surveillance. The law also forbids prosecutors to set up a scenario to trap an individual known to be corrupt. Prosecutors are only allowed to work for six months on a case – after which, the investigation ends.
President Basescu said that, if approved, the laws would help politicians incriminated in high-level corruption cases to escape from justice.
Although Ionita says there has been a backlash against reform, particularly from the new Government, he believes Romania has so far won in “net terms” on the reform of justice by freeing up the system.
But due to the current harassment of the system with new legislation, there is some concern. “There is a cliffhanger now in justice reform,” he says.
Europe: in despair
Starting last Summer, the European Commission began to signal discontent towards decisions in the new member state. In October, the EC showed concern over deficiencies in Romania’s system for paying EU cash to farmers. The European officials warned Romania that it risks triggering a safeguard clause which means the EU holding back 110 million Euro in subsidies.
The EC has given the Ministry of Agriculture a term until 20 December to put its house in order.
Farmers should be receiving EU cash by 1 December. But a spokeswoman for the Agricultural Payments Agency (APIA) told The Diplomat that Romania has no clear date on when the payments can begin.
In October, the European Commission opened an investigation into possible state aid granted in the sale of car factory Automobile Craiova to Ford. The Government should have informed the EC before the deal was completed.
“I think this was a matter of bad communication between the Ministry of Economy and Finance and the Directorate General for Competition at the European Commission,” says Ciocanea.
State aid: possible
Romania is not playing by EU rules when it comes to state aid – which is not as forbidden as many politicians suppose. “When it comes to matters that do not need financial support and can be put into practice fast, Romania is capable of performance,” Ciocanea says. “But in more difficult issues, like the state aid procedures, agriculture financial schemes, innovative SMEs financing, the administration is not doing very well.”
The EU is, on paper, a liberal hegemony that should punish countries who provide state aid.
However, there are ‘exceptions’ allowing Governments to give incentives. For example, in Romania, the Government can give state aid up to 200,000 Euro to small and medium enterprises without notifying the EC. Research departments in universities can also receive state aid. But the Romanian Government has not created the necessary strategies to implement this.
“State aid can also be directed towards poor regions, like small towns in mountain areas, where the local authorities can ease people’s lives so they would think twice before leaving to the big cities,” says Ciocanea.
To reduce the current account deficit Romania needs to increase its exports and attract more foreign investment.
There are two schools of thought on how to boost exports – the first is the classic liberal attitude of freeing up the market, while the second is to champion industries with incentives.
“Let people do what they want to bring a higher rate of profit, they will know what it is,” says Sorin Ionita. “Even if Romania has such a policy on incentives [for sectors], it wouldn’t be able to implement it.”
Foreign direct investment accounts for 70 per cent of Romania’s exports, so last Autumn’s 675 million Euro Ford deal is a potential boost for exports.
“We need an economy which manufactures higher added value products,” says country managing partner,
PricewaterhouseCoopers Vasile Iuga. “These would stimulate growth and encourage exports.”
Iuga gives examples such as IT, pharmaceuticals, car and its component manufacture.
But taking into consideration the financial effort necessary to produce cars as opposed to manual jobs, Ionita says it is “bad economics” to see these as high value added products.
The services sector is seen as a key to growth – especially with western countries outsourcing their back office, accounting or IT activity to Romania.
But in the classic IT sector, Oresa Ventures’ investment manager Cornel Marian says that although Romania has a strong base, it is tough to compete with other countries which have championed their new media expertise.
Sector growth: services
“We like business services,” says Cornel Marian. This includes human resources, recruitment, training and merchandising. He also says there are quite interesting opportunities in real estate services – including evaluation and real estate project management. The apartment block projects proposed for the capital will need firms to change light bulbs, check the pipes and collect rent.
Real estate and land speculation will also continue to be a target for foreign investment. “Real estate is a playground for big investment funds in office and warehousing, not residential,” says George Mucibabici, general manager, Deloitte Romania.
But Romania is not a target for high-intensive outsourcing. Businesses cannot make shoes on a mass level in the country. “Romania is no longer a place where people come for cheap labour manufacturing,” says Mucibabici. “No one can beat China.”
Mergers: still buzzing
This year saw fewer privatisations, while around 190 large acquisitions took place - an increase of 30 per cent on 2006, according to PricewaterhouseCoopers. But this rise is not as high as some have anticipated.
“If you look at the market, a lot is going on, but not as much as people would have expected,” says senior partner at law firm Schoenherr Markus Piuk. “Companies are feeling it might not be the right moment to sell because everyone anticipates growth will continue. Deals have failed because buyer and seller could not agree on prices. In Romania, there is a fear of selling too cheap.”
However, M&A activity has been strong in the banking and financial services, leasing and in construction materials. “Local companies will sell or partially sell and keep the rest to sell in three years to keep the leverage,” says Mucibabici. “A lot of local companies are partnering with big foreign or local companies. Otherwise, we have seen a lot of takeovers from abroad – the game has been pretty diverse.”
Global funds managing billions of Euros are entering sector, but private equity deals have seen “more talk than action,” says Cornel Marian. “We will see this enthusiasm being transformed into real deals in one or two years,” he adds.
Tax system: popular
Heralded as one of the only positive laws in the last ten years that was not at the instigation of Brussels, the flat tax of 16 per cent on incomes and profits was an attempt to create a clear and fair system which would bring Romanians in from the grey economy by lowering the tax threshold.
Tax collection as a percentage of GDP has increased from 30 to 32 per cent, with optimistic Government estimates hoping this will rise to 36 per cent.
“The irony is that by decreasing taxation, you increase collection,” says Ionita.
This has helped attract foreign investment and given Romania a competitive advantage. However, Romania is still the highest tax country compared to all EU member states – mainly due to the taxes businesses have to pay for employees in social and health contributions, a form of national insurance on top of income tax. To improve the system, Vasile Iuga recommends improving collection, capping social and health contributions, keeping the flat tax and eliminating loopholes, such as the exceptions for real estate transactions
Romania’s land is suitable for cereal crops, grapes and sunflower in the south, vegetables in the east and pasture in the mountains and hills of Transylvania.
But it has the worst rural infrastructure in Europe and a fragmented ownership system which is condemning the land to bankruptcy.
The European funds coming from the Common Agricultural Policy (CAP) cannot be efficiently absorbed by millions of semi-subsistence Romanian farmers because they own, on average, small pieces of land measuring around 1.5 hectares.
This is the result of a 1991 policy to return to the people lands seized from them or their ancestors during Communism. “The peasants were happy at the beginning and the politicians were satisfied because they won a few votes,” says Nicolae Idu. “But they threw Romanian agriculture into a non-competitive state.”
Since then, no Government has undertaken a major initiative to stimulate the concentration of the land or improve the efficiency of agriculture.
Meanwhile, Hungary chose not to dismantle the Communist-era agricultural cooperatives and the Government gave shares to the former owners of land, allowing the farms to function under a market economy.
Now, Romania is importing agricultural goods from Hungary. “Increasing the consolidation of land is critical,” says Iuga. “We need to use the land, raise animals, process meat and other alimentary products in one place – a captive growing, production, processing and consumption market – so that food becomes cheaper in Romania. We have to satisfy internal demand and create opportunities for export.”
Public admin: personnel crisis
Public administration needs an overhaul. The Government is so enthusiastic about its reorganising zeal that last April it attached to the name of its ‘Ministry for Interior’ the adjunct of ‘and Administrative Reform’. Many commentators believe the title is, however, a triumph of hope over experience.
The lack of qualified people is problematic for public administration - a situation blighting much of the public sector. “Due to inadequate policies during the transition years in education, social work and healthcare, the quality of human resources has deteriorated,” says Idu.
A lack of education is why many poorly trained and unprepared workers in the public administration are sometimes incapable of understanding European Commission documents, says Ciocanea. “The Romanian administration often tries to solve a problem at the last minute even though the matter is six months old,” he adds.
Another problem is that the public administration is not used to working with independent experts in order to draw up the country’s point of view on EU-wide issues. “Instead of having an impact study drawn up by a research institute, a ministry is rather used to working with one or two researchers [employed by the ministry] to draft their point of view,” says the head of DAE.
One of the main structural problems with the public administration sector is its failure to give qualified staff sufficient responsibilities, incentives and rewards.
“People feel they do not make any difference because the system is crazy and Kafkaesque,” says Ionita. “People are in charge of different areas, but cannot do anything. Negotiations go over their head. There is a disconnection between responsibility and instruments which leads to a defensive attitude.”
Bulgaria: overtaking Romania ?
In the first six months of 2007 Bulgaria’s economic growth was 6.4 per cent compared to Romania’s 5.8 per cent.
Both nations’ potential is the biggest in the EU, but they lag behind the rest of the EU in GDP per capita.
“Despite all the investments accumulated so far in the retail and financial sectors, Bulgaria has huge deficits,” says Yana Moyseeva, editor at Sofia-based Business Spotlight. Bulgaria has higher inflation and a larger public debt than Romania. Bulgaria is more optimistic than Romania in terms of monetary convergence and considers adopting the Euro in 2010 as opposed to Romania’s target date of 2014.
One indicator of a ‘developed’ economy is the percentage of people working in services.
While the European average is around 30 per cent, Romania has only 16.5 per cent of people active in services and 23 per cent of Bulgarians are working in the same field. However, in Romania the unemployment rate is about four per cent compared to Bulgaria’s seven per cent.