Romania - Country Overview

General Overview Romania is situated in the south-eastern part of Central Europe, north of the Balkan Peninsula, in the low Danube basin. The country covers an area of approximately 237,500 square kilometers and is bordered to the south by Bulgaria and to the west by the former Yugoslavia and Hungary. Of the countrys total area, arable land covers 39.6%, forests 27.0%, pastures and hayfields 19.9%, vineyards and orchards 2.5% and waters and lakes 3.8%. Romanias subteran resources of petroleum, natural gas, coal, iron ore, nonferrous ore, gold and silver ores and sulfur. With a population of approximately 22.6 million, Romania is the twelfth largest country in Europe. Romania has 16 towns or cities, with population exceeding 150,000. The largest city is the capital, Bucharest, with a population of approximately 2.3 million. Some of the key employment sectors are industry (52% of total employment), construction (8.4%) and agriculture (7.9%). Romanian is the official language of the country, although pockets of minorities speak Hungarian and German in the west and Turkish in the east. English, French and German are commonly spoken foreign languages particularly within the business community. Approximately 89% of the people are ethnic Romanians. Hungarians (7.1%), German (0.5%). Ukrainians, Serbs, Croats, Russians and Turks (2.5%) make up the balance of the population of the country. The Romanian economy has traditionally been agrarian and agriculture accounts for approximately 20% of the GDP. During the communist era, efforts were made to industrialize both the urban and the rural areas. Consequently, Romania is now equipped with a wide range of industrial facilities. Although is one of the first countries in Central and Eastern Europe to attract foreign investment (both Rolls Royce and British Aerospace had joint ventures operating in Romania in the mid to late 1970s), the isolationist policies in the latter part of the Ceaucescu regime led to a severe lack of investments.

However, numerous industries such as cement, glass, ceramics, metallurgy, heavy machinery, light machinery, automobiles and automotive spare parts, agricultural machinery, chemicals, refineries, food and beverage, furniture, textiles and tourism have been successful in attracting foreign investment. Although Romania has significant exports to Central and Eastern European countries, notably, Turkey and Russia, over 50% of exports are directed to the countries of the European Union (with which Romania is associated following the European Association Agreement of 1994). Romanias unit of currency is called Leu and in its plural form, Lei. The Lei is characterized by internal convertibility, which was limited in 1991, to current account transactions. In August 1994, an interbank currency market was established to facilitate the trade of currency in either spot or forward transactions against domestic currency at exchange rates determined by intermediaries authorized by the National Bank of Romania. Although a liberal foreign investment regime allows investors to repatriate income from investments (with dividends or capital) in hard currency, it should be noted that in practice there are frequent bureaucratic delays. Difficulties relating to portfolio investments still remain. Political and Economic Considerations Following the overthrow of the Ceaucescu regime in December 1989 and the establishment of a democratically elected parliamentary republic, Romania embarked on an ambitious programme of economic reform designed to transform its economy from a centrally planned system to one governed by the free market. Reform was gradual, beginning with restructuring of state enterprises into autonomous administrations and commercial companies, with a phased process of price liberalization. Other reforms included the development of a privatization law, and the encouragement of foreign investment. During the first three years of transition, the Romanian economy experienced sharp downturns, due largely to lack of real commitment to privatization and industrial restructuring, and the disruption of traditional trade links between domestic producers and suppliers, particularly former members of the Comecon trade pact. As a direct consequence, industrial output decreased by 54% in 1992, compared to 1989 and GDP contracted by 13.6%.

In 1993, with the assistance of the IMF, and austerity programme designed to stabilize the economy was initiated. The austerity package increased interest rates and forced a real depreciation of the Lei. In spite of conditions in which investors household savings within the banking system decreased in real terms and the trade deficit expanded, 1994 was considered a successful year because macroeconomic stability was sustained, inflation decreased and public confidence increased in Lei. The economy grew at 3.9% in 1994 compared to 1.5% in 1993, due largely to a 17% increase in exports and a 3.3% increase in industrial production. The pace of restructuring has been slow but the legal basis for a market economy is now in place. As a result of the significant dislocations caused by the need to reform virtually all the countrys economic institutions, Romania has suffered a deep recession, high levels of unemployment and falling personal incomes, high inflation and significant devaluation of the currency. In 1995, GDP increased by 7.1% in real terms due to largely a 9.4% increase in industrial production, a 6.9% growth in private investment and a 27% increase in exports. Further, a sharp decline in the rate of inflation, an increase in real wages and a gradually evolving private sector contributed to the maintenance of real economic growth in 1995. By the end of 1995, annual average inflation fad been reduced from a high of 256% in 1993 to 32%. In addition, the share of the private sector had grown to over 40% if the GDP by 1996. Following significant economic upheavals in 1992 and 1993, GDP growth returned during 1994 and 1995, reaching 7.1% in 1995. However, this growth was fuelled by state subsidies, which, in turn, triggered accelerating inflation and deterioration of the countrys external balances. This situation deteriorated towards the end of 1996. In the November 1996 election, a center right coalition formed a government headed by Victor Ciorbea, a former labor lawyer and prosecutor. In February 1997 the new Government launched a stabilization programme, focusing on macroeconomic problems and structural reform in agriculture, industry and banking. The Government moved rapidly to eliminate consumer subsidies, float prices, liberalize exchange rates and implement a tight monetary policy. Parliament enacted laws permitting foreign entities incorporated in Romania to purchase land and identified a large number of Governmental enterprises for rapid privatization or restructuring. After a promising start, the Government faltered as disagreements among coalition parties and trade unions, and
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resistance to proposed restructuring and plant closures tested the Governments abilities and determination. In 1997, inflation climbed to an average annual rate from the 1996 level. Political infighting continued into 1998 with the Government unable to bring its budget to a vote in Parliament. On March 1998, Prime Minister Victor Ciorbea resigned, his Government was dismissed and a new Government was formed under the leadership of Radu Vasile, a leader of the National Peasants Party, the largest faction in the CDR. Since Prime Minister Radu Vasile took Office in March 1998, considerable progress has been made on a number of fronts. Firstly, the Government has remained broadly united. After a year of increasing disunity, most participants in the cabinet and coalition have regrouped to push forward the reform process. The Government is closer now than ever in perhaps two years to clinching a fresh financing deal with the IMF. It has succeeded in passing a budget for 1999, at an earlier stage in the year than has been achieved this decade. The 1999 budget is generally perceived as a tight" budget and meets IMF requirements. The Vasile Government has also achieved the largest privatization deal in Romanias history with the sale of 35% stake in Rom Telecom, and further high profile sales are expected this year. In addition, the Prime Minister and other key economic ministers appear determined to advance restructuring of the economy, which is the last major precondition for the IMF support. Government Institutions In the period 1948-1989, the Government was a one-party communist dictatorship and the economy operated under a central planning system. In December 1989, a popular revolt led to the downfall of the communist Government. On November 21, 1991, a new constitution was adopted by the Parliament and subsequently validated by the national referendum on December 8, 1991. Under this constitution, Romania has a parliamentary democracy with a bicameral legislature. Romanias President is the head of the state. The President nominates the Prime Minister and appoints the Government on the basis of a vote of confidence by the Parliament. Laws are submitted for promulgation to the president. The President may dissolve Parliament under certain conditions and order
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referendum on matters of national interest. The President may execute international treaties in the name of Romania and is also the President of the Defense Council and the commander of the armed forces. The constitutional Court adjudicated the constitutionality of laws and decides on appeals from the regular court system concerning the unconstitutionality of laws and decrees. The Constitutional Court consists of nine judges appointed for a term of nine years. Three judges are appointed by the Chamber of Deputies, three by the Senate and three by the President of Romania. The Romanian legal system is based on the Napoleonic Code. The judiciary is independent and judges appointed by the president are not removable. The President and other judges of the Supreme Court are appointed for a term of six years and may serve consecutive terms. Proceedings are public, except in special circumstances provided for by law. Local Government is organized into 42 counties, together with the municipality of Bucharest, which is also a separate administrative unit with county status. There are 262 cities and towns and approximately 2,700 other local Governmental authorities. Local councils and elected mayors are the administrative authorities in villages and towns. The county council is the public administration authority that co-ordinates the activities of all village and town councils in the county. The central Government appoints a prefect for each county and the Bucharest municipality. The prefect is the representative of the Government at the local level and directs any public service of the ministries and other central agencies at county level. A prefect may block the action of a local authority if the prefect deems it unlawful or unconstitutional. The administrative court then decides the matter. The prefect is responsible for the distribution of revenue from central Government to local units. Local Budgets are still largely limited to the amount of revenue provided by the Government through the prefect to local authorities. The most recent general elections were held in December 1996. The presidential election was won by Mr. Emil Constantinescu, the Romania Democratic Convention candidate who polled 54% of the vote. He defeated Mr. Ion Iliescu, the President from 1989 to 1996. The election represented Romanias first peaceful and democratic transfer of power from Government to opposition since before the Second World War.

Following the parliamentary election, the largest political force in both the Chamber of Deputies and in Senate is the CDR. The CDR is a coalition of reform-minded parties, which holds the largest block of seats in the Chamber of Deputies and in the Senate. The other main political groups include the PDSR, which forms the main opposition party and includes many prominent former communists, the USD and the UDMR. On December 6, 1996, the CDR, USD and UDMR concluded a coalition agreement. On 12 December 1996, Prime Minister Ciorbea of the CDR presented a Government programme intended to promote Romanias rapid transition to a market economy. The Ciorbea Government faltered as political and social resistance to the Governments policies grew. The Governments allegedly slow and inefficient decision-making procedures also drew criticism. During several months of inaction, economic conditions worsened significantly and calls grew for the replacement of the largely political cabinet with a stronger team of reformers. At the end of 1997, a Government reshuffle placed the finance, reform and privatization ministries in the hands of reform-minded technocrats. However, political infighting continued into 1998. In February 1998, the USD withdrew from the coalition, which led to the downfall of the Ciorbea Government. With the formation of the Vasile Government, The USD has rejoined the ruling coalition and, together with CDR and UDMR, holds a comfortable majority in both Chambers of Parliament. Economic Performance Economic reform in Romania began in 1990 after the collapse of the communist regime. At that time, the Government instituted a process of gradual economic reform, liberalizing prices, reducing Government subsidies, privatizing almost all of the agricultural sector and creating a two-tier banking system The period between 1990 and 1993 was marked by declining real GDP, increased imports, current accounts deficits, high inflation and devaluation. An acute shortage of foreign exchange and a poorly developed financial sector initially created obstacles to rapid economic transition. External factors such as the collapse of trade with Soviet bloc trading partners, economic slowdown in industrialized Western European countries, increases in imported energy and large losses from UN sanctions against Iraq and Serbia- Montenegro, Contributed to a precipitous drop in industrial output after 1989.

In 1992, interest rates were raised and Lei substantially devalued. However, despite high official interest rates, there remained a wide variety of preferential credits and low deposit rates which resulted in negative real interest rates and a tendency towards use of US dollars throughout much of the economy. Intercompany arrears, although as a percentage of the GDP than in prior years, continued to subvert monetary policy and general economic conditions worsened. However, given the negative interest rates and devaluing currency, output stabilized. In late 1993, the Government adopted more stringent measures to reduce inflation and improve general economic conditions. The NBR dramatically increased nominal interest rates resulting in positive real interest rates and decreasing liquidity in the banking system. The Agency for State Restructuring, established in 1993, imposed tighter financial discipline on companies under its surveillance resulting in a marked decrease in inter-company arrears. The demonetarisation and use of US dollars throughout much of the economy also decreased while foreign exchange reserves increased and the Lei exchange rate stabilized. As a result of these factors, the annual inflation rate began to moderate, dropping from 256%, in 1993 to 137% in 1994. In 1993, for the first time since the fall of communism, Romanias economy grew, with real GDP growing 1.5%. Throughout 1994 and 1995, the economy benefited from the recovery that began in late 1993. Exports and domestic demand increased significantly while inflation decreased from 137% in 1994 to 32% in 1995. Real annual growth in GDP was 3.9% in 1994 and 7.1% in 1995. However, from the second half of 1995, an increase in the current account deficit and a decline in the level of foreign currency reserves at the NBR put downward pressure on the value of the Lei. To stem this pressure, the Government and the NBR embarked in November 1995 on a series of emergency measures and agreed with the IMF on the terms for a new stabilization programme. The emergency measures included tighter monetary controls, higher interest rates, new restrictions on foreign currency loans to the non-Government domestic sectors and minimum reserve requirements. Romanias budget deficit rose significantly in the run-up to elections in 1996 and this, combined with subsidized credits for agriculture, led to an acceleration of money supply growth. In turn, the current deficit widened to US$2.6bn in 1996 from US$1.8bn in 1995, and the pace of currency depreciation
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accelerated. The previous years trend of declining inflation was reversed with 1997 year-inflation increasing to 155% due to excessive Government spending in late 1996 and price and exchange rate liberalization in early 1997. Subsidies on most basic consumer goods were lifted in May 1993, but support for lossmaking state-owned industries remained a drain on the budget. In 1997, the Ciorbea Government rejected the gradualist approach to economic reform. Beginning in April it instituted a stabilization programme with a goal of reducing inflation, the budget deficit and the current account deficit, and stabilizing the value of Lei. This programme included specific measures to raise tax and cut Government expenditure, particularly in the area of agricultural and industrial subsidies, with the goal of reducing the total state sector deficit with approximately 3% of GDP. In addition, the Government introduced sharp rises in administered prices, notably to accelerate the restructuring and privatization of the economy to spur investment and improve the productivity of Romanian industry. In this regard, specific incentives were introduced to encourage foreign direct and portfolio investment. As 1997 progressed, the Government was confronted with a series of challenges that forced it to defer many of its plans. In Romanias coal mining regions, the prospect that many inefficient stet-run mines would be closed or privatized sparked labor unrest that led the Government to grant expensive severance packages to miners, who already earned significantly higher wages than the national average. Inflation increased and, as the cost to budget of recently granted investment incentives became clearer, the Government announced its intention to cancel these incentives. This created confusion among local and foreign investors, as well as doubt concerning the Governments ability to identify and pursue a coherent programme of reform. The Vasile Government shows signs of having learned from the experiences of the Ciorbea Government. Experienced technocrats have been placed in charge of key cabinet ministries as Finance, Privatization and Reform. The restructuring programme that the Government has instituted will probably result in a GDP fall for a third consecutive year. The closure of loss-making companies will reduce output, boost unemployment and forestall recovery in household demand. Combined with fiscal tightening these factors are likely to result in another drop in domestic demand. GDP is forecast to contract by 2.6% in 1999 and expand by 1.6% in 2000, and 3.9% in 2001. Over the same period inflation is expected to decline from 35.1% to 27.2%.
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Debt Record In the early 1980s, during the communist regime, the Government ceased payment on and restructured its external debt. This debt was subsequently repaid in advance of the amortization schedule. Since the establishment of the post-communist Government, Romania has not defaulted on the payment of principal of, or premium or interest on, any debt obligation issued by the country. The country regained access to the international bond markets in May 1995. Since then, both the NBR and the state-owned companies, in particular banks, have issued a variety of instruments in the international markets. In June 1997, Romania launched its first Eurobond in its name since the transformation from communism (recent borrowings were made by the NBR). Romanian long-term debt is currently rated B by Standard and Poors Rating Services and B3 by Moodys. (In 1997, foreign debt exceeded US$6.2bn, an increase from US$5.4bn at mid-1996, reflecting in part the increasing access of Romania to international markets.) External debt servicing in 1999 is expected to amount to US$2.9bn, of which US$2.2bn is public debt. In the first six months of 1999, US$2.2bn was repaid, due to redemption of samurai bond and National Bank of Romania bond. Prices, Wages, Inflation and Employment Between 191 and 1993, the majority of prices were liberalized. Accordingly, prices rose rapidly during 1993 and the average rate of inflation, as measured by increases in consumer prices, was 256.1% on 1993. However, inflation began to moderate at the end of 1993 and continued to subside in 1994 and 1995 before rising again in 1996 and 1997. In 1997, the average rate of inflation, as measured by increases in consumer prices, was 155% compared to 39% in 1996 and 32% in 1995. The Government has stated that it expects consumer price inflation to drop to 45% in 1998, assuming the Government successfully implements structural reforms and resists wage pressures. However, consumer price inflation is estimated to have fallen to 59% in 1998 and to drop to 35% in 1999. Real average annual wages increased 9.4% in 1996 compared with 2.1% in 1995 and 0.1% in 1994. In 1994, real wage and salary earnings paced price
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increase for the first time since 1990. After falling in real terms in early 1997, average nominal wages rose by 37.2% between the end of June and the end of October, compared with consumer price inflation of 14.6%. This was followed by a further 12.2% rise in October, bringing the average nominal monthly wage to Lei 797,194 (equivalent to US$104 compared with a low of US$66 in February 1998). The move to a market economy in Romania combined with a collapse of the former Comecon trade system has caused significant unemployment since 1990. The unemployment rate declined from 11.0% in 1994 to 7.2% in 1997, primarily as a result of an increase in the agricultural workforce and the emergence of the private sector as an employer. Redundancies in the mining sector, which started to take effect in late August 1997 pushed the unemployment rate for 1998 up to 9.2%. Unemployment is expected to continue to rise in 1999 as further industrial restructuring policies are implemented. The private sector has increased its contribution to employment significantly over the past three years and in 1998 about one out of every two Romanian employees worked in a private firm or business. Monetary and Credit Policy The NBR is responsible, within the framework of the Governments overall economic strategy, for the conduct of monetary and credit policy and for enforcing credit regulation. Although the Government sets general economic policy, the NBR is autonomous in setting intermediate monetary and credit targets as well as in choosing the means and instruments by which monetary and credit policy are implemented. Such measures include: establishing reserve and liquidity ratios for commercial banks; establishing and publishing exchange rates; setting the NBRs reference rate; buying or selling Governmental securities in the open market; setting rates for the NBRs purchase and repurchase of Governmental securities from commercial banks or engaging in other similar transactions to affect liquidity within the financial sector. The primary objective of the NBR is to maintain a stable Lei exchange rate in real terms in order to control the inflation and to promote economic development.

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Privatization In early 1997 a programme for speeding up privatization was developed with the goal of privatizing thousands of enterprises so as to allow proportion of GDP to be generated by the private sector. A major step taken to formalize the privatization process was the reorganization of the State Ownership Fund (SOF), Romanias main privatization body, so that local offices would take overall responsibility for the sale of small and medium sized companies, while the head office in Bucharest would retain responsibility for large scale privatizations. Results achieved to date have fallen short of plans. During the year of 1998 to October, the SOF privatized 825 companies compared with a target for the year of 1,600. The total contribution to the state budget grossed US$323.5 million by August-end, compared with targeted amount of US$1,500 million. Under the widespread criticism, the privatization chief head of the SOF resigned and PM Vasile appointed Radu Sarbu as new president of the SOF in an effort to reposition the organization so that it can better meet its objectives. The recent sale of a 35% stake in Rom Te4lecom, one of the biggest privatization deals in Eastern Europe in 1998, constitutes a landmark in the Romanian privatization programme. The Greek operator OTE purchased the stake for US$675 million in cash and a possible additional payment of US$ $400 million to the government, dependent on the growth of Rom Telecoms value over the next three to five years. As a result of this deal, it is expected that Romanias chances of attracting direct investments and receiving new financing from the International Monetary Fund will increase. With respect to other large privatisations, the Government hopes to raise revenues from the sale of a 305 stake in the state oil company, SNP Petrom, via the international capital markets by the beginning of the next year. The countrys biggest and most profitable PVC and pesticides producer, Oltchim, is looking for an institutional investor to buy a minority stake of up to 30% later this year. Other anticipated privatisations include Bancorex, BancPost, Societatea national Tutunul Romanesc (the tabacco company) and Rulmentul Brasov.

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Forecast Progress in macroeconomic stabilization and structural reform is expected to accelerate in Romania, spurred by the need to retain multilateral support given the countrys dependence on external debt. Committed to reform, the Government is focusing on restoring external confidence and has set the following objectives to achieve sustainable growth over the medium term: Reducing inflation to monthly levels below 2%; Improving the collection of taxes and excise duties; Implementing tight fiscal and monetary policy; and Speeding up the privatization programme Due to current reform programe, it is estimated that the Romanian economy will contract slightly by 2.6% in 1999, before growing again by 1.6% in 2000. Annual inflation, measured by the CPI, is expected to fall from 59% in 1998 to 35% and 29% in 1999 and 29% in 1999 and 2000. On a purchasing power parity basis, Romania had a GDP per capita of US$ 5,880 in 1999 and 2000. Romania is currently in a phase of transition from a centrally planned system to a market based system. As a result, Romania has experienced a negative impact on its economic growth in the recent past and relatively high levels of inflation. However, the economic outlook for the country is positive with real GDP growth anticipated in 2000 and inflation declining to 29% in 2000, from 59% in 1998.

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