On 1 January 2007 Romania officially joined the EU as a result of acknowledged structural reforms and progress undertaken in the last decade. Looking forward to further achievements, the Romanian government presented its convergence report with plans to enter ERM-II in 2012. To help integrate Romania further into the EU there will be support from the planned EUR 31 billion structural and cohesion fund. Particular focus will be oriented towards competition, energy, transport, telecommunication, agriculture and consumer and health protection. Though there are some concerns regarding the efficiency of using these funds, they do represent an incentive for both local governments and the business sector to increase investments further. The Commission will ensure that the funds are going to be properly managed through financial corrections that may materialize in delayed disbursements, a reduction of future payments or a recovery of funds.
Since 2000, Romania has ensured a significant macroeconomic stabilization with a strong rebound of economic activity, reaching its peak in 2004. UniCredit CEE Research currently projects real GDP growth of 6% for 2007 and expects it to stay above 5% in the following years. Robust private consumption spending (despite reducing its pace of expansion) and accelerating investments will continue to be the main engine of growth in the country. According to the World Bank "Doing Business 2007", conditions for investments improved significantly during the last year with institutional progress made in the field of building permits, labor regulation and trading across borders. The favorable business environment is also assured by the low corporate tax (16%), improving infrastructure and relatively high labor productivity adjusted for labor costs. Positive prospects are expected in the medium term on the back of EU accession and sustained inflows of FDI, which play a significant role in deepening industrial integration and influencing the trade structure.
Positive 2006 growth on the back of EUmembership
Romanian GDP increased in 2006 by a real 7.7 % yoy to reach EUR 97.2 bn. Last year was characterized by persistently strong growth in private consumption, fuelled by wage increases and credit expansion. While private consumption contributed the most, with annualized growth of 12.6% (representing 79% of total GDP), the fastest growth was registered in investments, which expanded by a real 16.1% yoy, supported well by foreign capital inflows. A significant volume of investments was directed towards infrastructure projects and the construction sector, posting impressive 19% yoy growth. The strong domestic demand led to an increase in imports, which resulted in a further deterioration of net exports. Nevertheless, the increasing share of capital goods in total imports (30% yoy growth in 2006) provides an indication of some improvements in the structure of the trade deficit.
Positive growth prospects fuelled by huge (re)construction activity
Short and medium-term prospects look bright and the current pace of expansion is expected to continue, albeit somewhat more slowly due to the slightly more subdued growth in consumption. Investment activity is expected to gain further ground sustained by new large infrastructure projects and continued high FDI inflow. Boosted by the mild winter, construction works went up by 28.3% yoy in the first two months of this year. Such figures signal that 2007 may be a record year for the construction sector, supported by high demand for both residential and nonresidential buildings. The contribution of net exports is expected to deteriorate on the back of cheaper and more easily accessible products imported from EU member countries. Overall, full-year real GDP growth of 6% yoy should be achievable.
Euro adoption expected in 2014
The Romanian government presented its convergence report with plans to enter ERM-II in 2012. Romania currently fulfills three out of the five Maastricht conditions, with fiscal balance and public debt below the 3% and 60% thresholds and fluctuations in the exchange rate remaining within the +/- 15% band. Nevertheless, further efforts are needed in order to forge ahead with the disinflation process to help achieve fast convergence in interest rates in order to meet all Maastricht criteria as of Q4 2011 to be able to adopt the euro as of 1 January 2014. The medium-term goals of the government also include improvements in the predictability of fiscal policy, efficient use of EU funds, continuation and deepening of structural reforms, sustainability of public finance in the long term, improvements in the investment environment, harmonized regional development, work force flexibility and public administration reform.
Focus on disinflation with an eye on FX market development
In the early months of 2007 headline inflation slowed further to 3.7% in March. Lower food-prices, which account for more than 39% of the CPI basket and are quite volatile, kept price growth low. Also cheaper imported products on the back of the still strong appreciation in the RON and increased competition among retailers have helped. The highest price increases were registered in the services sector, reflecting some convergence towards the higher costs in the EU for medical, water and wastewater services. Despite the lower than expected inflation figures, demand-side inflationary pressure still seems to be present, as shown by the relatively high administered price inflation in the past months. Price pressures are expected to resume in the coming months on the back of fast wage growth, the still high domestic demand and loose fiscal policy.
Additional price pressure is also expected mainly due to a higher base effect induced by the decline in volatile food prices during Q3 last year. Further adjustments in administrative prices are also expected to exert a strong inflationary impact. Romania is gradually lifting energy prices as it has pledged to align tariffs for domestic gas prices to the EU level by 2009.
First signals of a looser fiscal policy
The 2007 budget targets a public deficit of 2.8% of GDP. Most of the increase in government spending is needed to support infrastructure investment expenditure. Revenues are projected to increase up to 35.2% of GDP, mainly as a result of the increase in transfers from the EU, as well as from corporate and personal income taxes and the stepped-up enforcement of VAT that is anticipated. The boost in revenues is needed in order to offset the 2% decrease in the social security contribution rate. February figures already showed a 0.5% deficit after the 0.6% surplus realized in January. The budget balance of the first two months posted a surplus of only 0.1% of expected GDP. This in combination with the upside revision of the planned state securities issue are giving clear signs of a more expansionary fiscal policy, supporting a forecast for a full-year deficit of 2.3%.
Despite good FDI coverage, the deteriorating current account remains an issue to monitor
The current account closed 2006 with a deficit of EUR 9.97 billion, or 10.3% of GDP. The trade deficit widened to EUR 14.9 billion. Current transfers, incl. wage remittances from Romanians working abroad and EU funds, covered about 40% of the trade gap. Imports surged by 25% yoy in 2006 sustained by imports of capital goods (machinery and equipment, up by 29.5% yoy) and transport equipment (up by 41.5 % yoy). The main export drivers were also machinery and equipments, which increased by 33% yoy last year and became the main items in total exports with a share of 20% (outpacing textile products whose share dropped to 16%). The most dynamic sub-sector in terms of exports was transport equipment (mainly in connection with the automotive sector) with an average growth rate of 44% for the whole year.