A healthy banking sector is built on the back of a country’s economy so it should come as no surprise that Romania’s banking sector is in step with its economy. Much as the unreformed and hyperinflationary 1990s led to nearly a dozen bank collapses, so has today’s budding economy fuelled the expansion of the banking sector.
A defining feature of Romania’s economic transition is the gradualist approach espoused to the detriment of those advocating “shock therapy.” Many analysts argue that such an approach has cost Romania dearly in terms of time and opportunities.
It was not until 1997 that Romania’s first reformist government liberalised most prices, freed the currency, tackled huge sectorial inefficiencies such as in the mining industry and finally, kicked off the privatisation process. After six years of straightjacket economics, pent-up forces desperately seeking their points of equilibrium were unleashed and quickly translated into a rapidly depreciating currency and ensuing inflation.
A quick buck
In order to reign in these forces, high interest rates were called in, leading to abnormally high real yields on local currency government bonds as well as bank deposits. As a result, banks stopped being banks and turned into huge investment funds, ploughing much of their available liquidity into these instruments. Why make loans to risky companies in uncertain economic times when government bonds could easily bring you rewards of more than 100% annually?
It was not until 2000, after Romania briefly flirted with default in 1999, that interest rates dropped and, with a new regulatory framework implemented in the wake of several banking failures, Romanian banks returned to acting as old-fashioned banks, taking deposits and making loans, one client at a time. Foreign-owned banks, which by 2000 numbered only a few, took the lead, at first focusing on corporate clients, but as inflation and interest rates declined, focusing on the hitherto completely ignored retail sector as well.
Encouraging signs
Nevertheless, Romania is now in the throes of a booming economic cycle, having enjoyed GDP growth of 4%-5% for several years already, which has taken this year’s GDP to around e50bn. Official unemployment is well below 10%, spreads on its Eurobonds have tightened, the budget deficit is under control (2.7%) and in 2003, for the first time ever, Romania completed an IMF agreement.
In particular, an improved banking environment has created a consumer finance boom, which has in turn fuelled Romania’s retail sector. Numerous foreign retailers have entered Romania, in the process dragging real estate investors and developers after them. Business parks, hypermarkets, supermarkets and high-end residential property have all exploded onto the scene. Clearly a virtuous cycle has begun, where even the average Romanian is feeling better off.
Growing pains
Not surprisingly, decades of pent-up demand and the reforming industrial sector have led to strong negative pressures accumulating on the trade deficit. Coupled with a reawakening banking sector fuelling a consumer finance boom, this has led to a huge jump in the current account deficit, which reached 5.8% in 2003, nearly double the figure for 2002.
Anxious to make a dent in the current account deficit, Romania’s National Bank in February launched what is perceived by some market participants as a misguided attempt to rein in consumer finance by imposing tough new credit regulations on the banks. This has come on top of a concerted effort to raise the cost of borrowing, particularly in foreign currency, by raising reserve requirements.
A balancing act
As with other developing markets, Romania is struggling between two poles: on one hand striving for economic growth and thus aiming for low interest rates, and on the other hand, keeping at bay inflation and current account deficits, which generally require higher interest rates.
Also in terms of its monetary policy, the National Bank may be setting the stage for trouble, as due to this year’s electoral considerations, it is absorbing the excess local currency that may otherwise have led to a more pronounced depreciation vis-ŕ-vis its currency, the lei. Inevitably, this pressure on the lei will have to be compensated in 2005 or 2006. Similar electoral considerations may also imperil Romania’s still-high inflation rate (14.1% in 2003), which the National Bank is aiming to hit 9% in 2004.
Rules and regulations
During the initial development of Romania’s post-Communist banking sector, most institutions were state-owned. The National Bank exercised its prerogatives via directed credit lines, strong capital controls and a controlled currency.
It was not until 1997 and 1998 that the primary role of the National Bank was established as maintaining the stability of the domestic currency in order to achieve price stability. Open market operations replaced less sophisticated intervention tools, the local currency was liberalised with a managed float and full account liberalisation was accepted in 1998 (the IMF’s infamous Article VIII).
Standardisation efforts
The new millennium brought with it a focus on bringing the legislative framework in line with EU directives. These changes included a more open exchange of information between supervisory authorities, the adoption of the Basel Core Principles for the protection of supervisors, strengthening of the National Bank’s supervisory powers and improvement of the legal framework concerning bank insolvency.
More recently, parliament adopted the Law On Banking Activity, decisively bringing Romania’s banking legislation in line with that of the EU. This focused on establishing a unitary regime for credit institutions, organising a legal framework for ensuring the right of free establishment and free provisions of services, including electronic cash institutions in the category of credit institutions and the provision of other bank activities covered by mutual recognition. EU directives and IAS requirements govern the presentation of annual financial statements since 2003.
More independence
Further strengthening of the National Bank’s independence is expected this year by removing the direct financing of the Treasury with an overdraft facility and prohibiting public institutions from having privileged access to the resources of financial institutions.
While non-banking financial activities, such as leasing, remain unregulated, a recent boom in consumer finance has spurred new regulations requiring more stringent credit criteria. Also, from early 2003, classifying and provisioning regulations were refined by taking into account the borrower’s payment history and financial performance, etc.
In spite of this, commercial banks, having found loopholes in the regulations, have recently resumed consumer lending en masse, to the delight of retailers and consumers alike.
In terms of capital liberalisation, inflows into local currency bank deposits are still disallowed, as well as access to short-term local currency government bonds, though this is expected to change in time for EU accession. Outflows of residents’ money into foreign bank accounts must be justified and still require the National Bank’s approval.
Foreign investment
Romania has a tradition of poor foreign direct investment (FDI) inflows, accumulating little more than e10bn in more than 15 years of transition. In comparison, some of its smaller neighbours have managed to attract nearly as much in barely one year.
Surely geography has played a role, as Romania does not border any EU member state. Its historical ties to EU countries are weak compared with others, and its laws are often volatile and confusing. Erratic fiscal policies, heavy-handed bureaucracy and Byzantine corruption have not helped.
In 2003 the Romanian Agency for Foreign Investments (ARIS) estimated that FDI has amounted to $1.57bn. Authorities are optimistic for 2004, as they expect FDI to jump 40%, chiefly a result of the privatisation of BCR, Petrom and other assets in the energy sector. Marian Saniuta, president of ARIS, recently said: “At present we are having talks about 10 investment projects whose values exceed $350m.”
Most investments in Romania have centred on the telecommunication, energy and service sectors. In terms of industry, Renault and Daewoo each have made important investments in automobile plants, and Anglo-Indian steel group LNM/ISPAT has acquired the majority of the Romanian steel sector, including the giant Sidex steel plant that once represented more than 5% of Romania’s GDP. The government hopes that as EU accession draws nearer, a second wave of investors seeking new markets and low labour costs will choose Romania.
