Romania's Business Environment

Romania’s Business Environment

GLOBAL MARKET BRIEFINGS

Romania’s Business Environment Consultant editor: Adam Jolly Editor: Alica Henson Foreword from: Romanian Ambassador to the United Kingdom Dr. Ion Jinga

Publishers’ note Every possible effort has been made to ensure that the information contained in this publication is accurate at the time of going to press and neither the publishers nor any of the authors, editors, contributors or sponsors can accept responsibility for any errors or omissions, however caused. No responsibility for loss or damage occasioned to any person acting, or refraining from action, as a result of the material in this publication can be accepted by the editors, authors, the publisher or any of the contributors or sponsors. Users and readers of this publication may copy or download portions of the material herein for personal use, and may include portions of this material in internal reports and/or reports to customers, and on an occasional and infrequent basis individual articles from the material, provided that such articles (or portions of articles) are attributed to this publication by name, the individual contributor of the portion used and GMB Publishing Ltd. Users and readers of this publication shall not reproduce, distribute, display, sell, publish, broadcast, repurpose, or circulate the material to any third party, or create new collective works for resale or for redistribution to servers or lists, or reuse any copyrighted component of this work in other works, without the prior written permission of GMB Publishing Ltd. GMB Publishing Ltd. Hereford House 23-24 Smithfield Street London EC1A 9LF United Kingdom www.globalmarketbriefings.com

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This edition first published 2008 by GMB Publishing Ltd. © GMB Publishing Ltd. and contributors ISBN-13 978-1-84673-096-2 E-ISBN-13 978-84673-097-9 British Library Cataloguing in Publication Data A CIP record for this book is available from the British Library Library of Congress Cataloguing-in Publication Data Typeset by David Lewis XML Associates Ltd.

Contents Foreword by Dr. Ion Jinga, Ambassador of Romania to the United Kingdom About the Contributors Introduction Adam Jolly, Consultant Editor

PART ONE: Background to the Market 1.1 1.2 1.3

1.4

Political Background Liz David-Barrett Economic Background Liz David-Barrett Macroeconomic Outlook Ionut Dumitru, PhD, Head of Research, Raiffeisen Bank Romania Business Environment Liz David-Barrett

PART TWO: Legal and Regulatory Framework 2.1

2.2

2.3

2.4

2.5

2.6

2.7

Administrative Barriers to Entry Roxana Ionescu, Associate, and Alexandru Lupu, Associate, Nestor Nestor Diculescu Kingston Petersen Business Structures Carmen Peli, Partner, and Georgeta Harapcea, Associate, Nestor Nestor Diculescu Kingston Petersen Corporate Governance Cristina Filip, Partner, and Georgeta Dinu, Associate, Nestor Nestor Diculescu Kingston Petersen Agency and Distribution Carmen Peli, Partner, and Georgeta Dinu, Associate, Nestor Nestor Diculescu Kingston Petersen Employment Law Luminita Dima, Associate, Nestor Nestor Diculescu Kingston Petersen Foreign Investment Protection Carmen Peli, Partner, and Georgeta Dinu, Associate, Nestor Nestor Diculescu Kingston Petersen Insolvency and Bankruptcy Madalin Niculeasa, Senior Associate, Nestor Nestor Diculescu Kingston Petersen

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1 3 9 15

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Contents

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2.9

2.10

2.11

2.12

2.13

2.14

2.15

2.16

2.17

2.18

Dispute Resolution Madalin Niculeasa, Senior Associate, Nestor Nestor Diculescu Kingston Petersen Financial Services Law Alina Radu, Partner, Corina Dumitru, Associate, Diana Precup, Associate, Nestor Nestor Diculescu Kingston Petersen Money Laundering Law Andreea Elefterescu, Associate, Nestor Nestor Diculescu Kingston Petersen Competition Law Carmen Peli, Partner, and Georgeta Dinu, Associate, Nestor Nestor Diculescu Kingston Petersen Import and Export Licensing Raluca Nechimis, Senior Associate, Nestor Nestor Diculescu Kingston Petersen Privatization Law Carmen Peli, Partner, and Georgeta Dinu, Associate, Nestor Nestor Diculescu Kingston Petersen Property and Real Estate Law Francisc Peli, Partner, Nestor Nestor Diculescu Kingston Petersen Intellectual Property Law Delia Belciu, Associate, Nestor Nestor Diculescu Kingston Petersen Insurance Law Costin Teodorovici, Associate, Nestor Nestor Diculescu Kingston Petersen Environmental Law Roxana Ionescu, Associate, Nestor Nestor Diculescu Kingston Petersen Natural Resources Law Adina Chilim, Partner, Nestor Nestor Diculescu Kingston Petersen

PART THREE: Finance Issues 3.1 3.2 3.3 3.4

Direct Taxation of Corporations Deloitte, Romania Indirect Corporation Taxes and Foreign Exchange Issues Deloitte, Romania Income Tax and Social Contributions Deloitte, Romania Accounting and Audit Deloitte, Romania

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151 153 161 167 169

Contents

3.5

Banking Sector Ionut Dumitru, PhD, Head of Research, Raiffeisen Bank Romania

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Appendix: Contributors’ Contact Details

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Index

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Foreword Dear Reader, I am delighted to provide this foreword to the 2008 edition of “Romania’s Business Environment,” which I hope you will find useful. Romania continues to build upon its achievements, which culminated in European Union (EU) accession in January 2007. The Romanian economy has been growing at an impressive rate of 6 per cent (on average) for the last five years. Inflation dropped from 40 per cent in 2000, to 6.5 per cent by 2007, with a target-inflation of 5.5 per cent for 2008. The World Bank report declared Romania “the most reforming country in the business field” in 2006. The Romanian currency had the highest appreciation rate against the euro compared to all other European currencies. The Romanian government has also taken steps to improve the business environment, including changes to the tax system. However, this is a work in progress, and the government is currently working on preparing a new investment law as well. But the challenges Romania faces did not end upon EU accession, which will only reinforce the country’s existing positive trends. Absorbing the significant allocations of European funds, delivering real improvements in infrastructure, and enhancing public administration are all long-term issues still being faced. For companies based in the EU member states, Romania is the place to be now. Small and medium-size enterprises, shy of venturing outside of the EU, can now easily and safely expand in the country. With its market of 22 million people, Romania offers easy access to neighbouring markets in South-Eastern Europe, as well as the larger Black Sea area. For non-EU countries, Romania is an attractive entry point into the European market. At the same time, the volume and attractiveness of Romanian exports has recorded a steady growth, and their destinations cover the globe. Romanian products, such as cars, trucks, airplanes, agricultural tractors, rolling stock, power generating equipment, furniture, textile and garments along with information and communication technology related products and services, modern parts for aviation and automotive industry, organic farming, wine, consulting, engineering and logistics services are increasingly sought after by international markets. As such, I consider this new book − “Romania’s Business Environment” − as being very well timed. Romania is a complex and sophisticated country, and the prospect of entering such a market may sometimes appear daunting. This book is a welcome guide to getting started with that process, giving prospective investors a detailed introduction to the structures and processes that exist in the country, and indicating some of the best practices in

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establishing a business presence in Romania. I would also like to suggest that you consider visiting Romania for yourself − a mere three hour flight from London. The Embassy of Romania in London acts as a facilitator for businesses interested in investing in Romania, and supports the promotion of Romanian exports, often in partnership with the British government and British and Romanian business organisations. We look forward to supporting British firms ready to expand their business to a new, attractive and businessfriendly environment that makes Romania a key location in which to conduct your business. Dr. Ion Jinga Ambassador of Romania to the United Kingdom

About the Contributors Deloitte Romania is one of the leading professional services organizations in the country, delivering world-class assurance and advisory, tax and legal, consulting and financial advisory services. With more than 350 people, the practice serves many of the country’s largest companies, public institutions, and successful, fast-growing companies. The Romanian firm is able to mobilize specialist support from regional technical centres, as well as from Deloitte Touche Tohmatsu member firms internationally. Ahmed Hassan is a Partner in the Audit & Advisory Department of Deloitte Romania. He is a qualified Chartered Accountant and a Member of the Institute of Chartered Accountants in England and Wales. Ahmed has valuable experience in providing audit and assurance services to both private and public organizations in various parts of Europe and Asia Pacific including Romania. He has extensive audit experience and related technical knowledge with multinationals as well as local companies currently adopting Romanian audit requirements, operating in a broad range of sectors with a focus on manufacturing, media, fast-moving consumer goods, and financial institutions. Rodica Segarceanu has been a Partner in the Tax & Legal Department of Deloitte Romania since 1998. She is a Member of the Association of Chartered Certified Accountants and has significant experience assisting multinational companies in developing tax strategies for operations in Romania. Rodica provides extensive International Assignment Services for expatriates and extensive advice to various local and foreign clients, on a wide range of tax matters, cross border transactions, inward and outward processing, customs clearance and VAT, in accordance with the current Romanian legislation. She has been involved in managing the preparation of the legal framework in indirect tax reform, being the leader of tax team in EU Accession projects. Liz David-Barrett is a freelance consultant who has lived, worked and travelled in Central and South-Eastern Europe for more than 10 years. She has written for a number of publications, including The Economist, Financial Times, Oxford Analytica, and Jane’s. Nestor Nestor Diculescu Kingston Petersen (NNDKP) is a leading Romanian law firm with offices in Bucharest, Timisoara and Brasov, offering

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a full range of legal services to local and international businesses with interests in Romania. The firm’s practice areas cover Corporate Law, Privatization, Mergers and Acquisitions, Competition, Banking and Finance, Securities and Capital Markets, Intellectual Property, Dispute Resolution, Real Estate, Public Procurement/PPP, Taxation, Environmental Law, Employment Law, Immigration, involving industries such as Energy, Infrastructure, Telecommunications and Media, Pharmaceuticals and Health Care, Consumer Products and Insurance. NNDKP is a founding member of the South East Europe Legal Group (SEE Legal), the sole law firm member for Romania of Lex Mundi, World Services Group (WSG) and Ius Laboris. Delia Belciu, Associate, is a member of the firm’s Intellectual Property Practice Group, where she advises clients in connection with intellectual property law matters. Ms Belciu graduated in 2005 the University of Bucharest Law Faculty and the Paris 1, Pantheon Sorbonne – Maıˆtrise European and International Law at Colle`ge Juridique Franco-Roumain d’Etudes Europe´ennes. In 2006, she graduated the Centre for International Industrial Property Studies in Strasbourg obtaining a Master’s Degree in Industrial Property, Contracts, Competition and an Eiffel Excellence Scholarship. She is fluent in English and French. Ms Belciu joined Nestor Nestor Diculescu Kingston Petersen in 2006 and is a member of the Bucharest Bar. Adina Chilim-Dumitriu, Partner, Head of Commercial Contracts Practice Group, focuses on project finance, mergers and acquisitions and telecommunications. She has assisted borrowers and lenders in connection with complex financing transactions in telecommunications and has developed particular expertise in the gas distribution field. After graduating from the University of Bucharest Law Faculty in 1997, she joined Nestor Nestor Diculescu Kingston Petersen. Luminita Dima, Associate, Head of Labour Practice Group, advises clients in connection with a wide variety of environmental projects in Romania. Ms Dima graduated from the University of Bucharest Law Faculty in 1997. She is also a Law Professor at the University of Bucharest. She is fluent in English and French. Ms Dima joined Nestor Nestor Diculescu Kingston Petersen in 2007 and is a member of the Bucharest Bar. Corina Dumitru, Associate, is a member of the firm’s Banking, Finance and Capital Markets Department, where she advises clients in connection with project finance and banking law matters. Mrs. Dumitru graduated from the University of Bucharest Law Faculty in 2002. In 2006, she also graduated the Academy of Economic Studies Bucharest, Finance, Banking, Insurance and Stock Exchanges Faculty. She is fluent in English, French

About the Contributors

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and Spanish. Mrs. Dumitru joined Nestor Nestor Diculescu Kingston Petersen in 2007 and is a member of the Bucharest Bar. Andreea Elefterescu, Associate, is a member of the firm’s Banking, Finance and Capital Markets Department, where she advises clients in connection with project finance and banking law matters. Ms Elefterescu graduated in 2005 the University of Bucharest Law Faculty and the Paris 1, Pantheon Sorbonne obtaining a Master’s Degree in European and French law. In 2006, she also graduated the Robert Schuman University in Strasbourg, France obtaining a Master’s Degree in Banking and Finance law. She is fluent in English and French. Ms Elefterescu joined Nestor Nestor Diculescu Kingston Petersen in 2006 and is a member of the Bucharest Bar. Cristina Filip, Partner, Co-head of the M&A and Competition Practice Group, advises clients in connection with electricity and gas distribution and power generation, mergers and acquisitions and cross-border finance transactions. She assists investors and the government in connection with transactions in the fields of energy and natural resource development and has played an important role in the drafting of privatization legislation. After graduating from the University of Bucharest Law Faculty in 1998, she joined Nestor Nestor Diculescu Kingston Petersen. Georgeta Harapcea, Associate, is a member of the firm’s M&A and Competition Practice Group, where she advises clients in connection with competition law and commercial Law. Mrs. Harapcea graduated from the University of Bucharest Law Faculty and from College Juridique FrancoRoumain d’Etudes Europeennes, University of Bucharest - Paris I Pantheon Sorbonne University in 2004. She also holds an LL.M in International and European Business Law - Paris I Pantheon Sorbonne University and has a Postgraduate Diploma in EC Competition Law, King’s College, University of London. Roxana Ionescu, Associate, Head of Environment Practice Group, advises clients in connection with a wide variety of environmental projects, labour and energy law, data protection law, banking law, commercial and corporate law, civil law. Ms Ionescu graduated from the University of Bucharest Law Faculty in 2004. She has also graduated the Bucharest University Center for Euro-Atlantic Studies – European Integration course in 2004. She is fluent in English and French. Ms Ionescu joined Nestor Nestor Diculescu Kingston Petersen in 2005 and is a member of the Bucharest Bar. Alexandru Lupu, Associate, is a member of the firm’s Immigration Practice Group, where he advises clients in connection with a wide variety of corporate immigration services, citizenship law, security interest in personal property, labour law and real estate issues. Mr. Lupu graduated from

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Nicolae Titulescu University-Law Faculty in 2000. He is fluent in English. Mr. Lupu joined Nestor Nestor Diculescu Kingston Petersen in 2000 and is a member of the Bucharest Bar. Raluca Nechimis, Senior Associate, is a member of the firm’s Commercial Contracts Practice Group where she advises clients in connection with the negotiation, drafting and conclusion of commercial agreements both at local and international level, public procurement contracts, corporate matters. Ms Nechimis graduated from the University of Bucharest Law Faculty in 2000. In 2002, she earned an LLM in International Business Law from the Central European University. She joined Nestor Nestor Diculescu Kingston Petersen in 2002. Madalin Niculeasa, Senior Associate, is a member of the firm’s Litigation Department, where he represents clients in the areas of civil and commercial law, administrative and fiscal law. Mr. Niculeasa graduated from Titu Maiorescu Law Faculty in 2001 and from Administrative Sciences Faculty in 2003. He joined Nestor Nestor Diculescu Kingston Petersen in 2007. He is a frequent writer on administrative, public acquisitions and liberal professions issues. Carmen Peli, Partner, Co-head of the M&A and Competition Practice Group, advises clients in connection with mergers and acquisitions, crossborder commercial transactions and competition law. Mrs. Peli regularly counsels clients in connection with competition law matters including cartel investigations and Competition Council clearance. After graduating from the University of Bucharest Law Faculty in 1998, she received a University Degree in French and European Law from the French-Romanian Law College for European Studies, Pantheon Sorbonne University. Prior to joining Nestor Nestor Diculescu Kingston Petersen, she was a legal advisor for the Ministry of Public Finance. Francisc Peli, Partner, Head of Real Estate Department, advises clients in connection with real estate, mergers and acquisitions, and real property investment transactions. He assists developers, lenders, private equity funds and other investors in connection with the acquisition and development of large-scale residential and commercial real estate projects, municipal services and public-private partnership transactions. Mr. Peli graduated from the University of Bucharest Law Faculty in 1998 and worked with a major international law firm prior to joining Nestor Nestor Diculescu Kingston Petersen. Diana Precup, Associate, is a member of the firm’s Banking, Finance and Capital Markets Department, where she advises clients in connection with corporate, M&A, capital markets, privatization and arbitration matters. Ms Precup graduated from the University of Bucharest Law Faculty and the

About the Contributors

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Paris 1 — Sorbonne University where she obtained a degree in European Union and French Law at the French-Romanian Law College, in 2004. In 2005, she also graduated the Paris 1 — Sorbonne University in Paris – Eiffel Excellence Scholarship where she obtained a Master’s Degree in International Economic Law. She is fluent in English and French. Ms Precup joined Nestor Nestor Diculescu Kingston Petersen in 2005 and is a member of the Bucharest Bar. Alina Radu, Partner, Deputy Head of Banking, Finance and Capital Markets Department, advises clients in connection with banking issues, project finance, mergers and acquisitions and real estate financing. She advises borrowers and lenders in a wide range of complex financing transactions. After graduating from the University of Bucharest Law Faculty in 1997, she joined Nestor Nestor Diculescu Kingston Petersen. Costin Teodorovici, Associate, is a member of the firm’s Banking, Finance and Capital Markets Department, where he advises clients in connection with project finance, banking law matters and commercial law. Mr. Teodorovici graduated from the University of Bucharest Law Faculty in 2004. He is fluent in English and French. Mr. Teodorovici joined Nestor Nestor Diculescu Kingston Petersen in 2004, and is a member of the Bucharest Bar. Raiffeisen Bank S.A. is the third largest universal bank on the Romanian market. The Bank provides the complete range of high quality products and services to private individuals, small and medium sized enterprises (SMEs) and large companies, via multiple distribution channels: banking outlets (almost 400 throughout the country), ATM and EPOS networks, phonebanking (Raiffeisen Direct), mobile-banking (myBanking) and internet banking (Raiffeisen Online). The Bank is a member of the Austrian RZB Group and subsidiary of Raiffeisen International Bank-Holding AG (Raiffeisen International). Raiffeisen Bank provides services on two major areas – retail and corporate – and also develops treasury-related products and services. It services over 2.2 million retail clients (out of which over 130,000 are SMEs) and almost 5,000 large and medium companies. Ionut Dumitru is the head of Research department (chief-economist) in Raiffeisen Bank Romania since 2005. He graduated the Academy of Economic Studies from Bucharest and has a PhD in Finance and a Master of Science in Finance and Banking in Doctoral School of Finance and Banking, European Centre of Excellence (DOFIN, www.dofin.ase.ro). At the same time, he is lecturer in the Academy of Economic Studies from Bucharest in banking and monetary policy related subjects.

Introduction: Romania’s business environment In Romania, tax planning is now as simple as anywhere in Europe. Since January 2005, a flat rate of 16 per cent is paid not just on incomes, but on profits as well. No other transition economy has attempted to introduce such a comprehensively low rate. Part of the calculation behind this radical move was that by easing collection and widening the tax base, the government could start to put its revenues on a sounder footing. But just as importantly, it signalled a determination to free up the economy and give enterprises an incentive to grow. In the last decade, a series of similarly minded legal and financial reforms have started to click into place. Restrictions on the right of foreign investors to buy land have been lifted. A labour code based on working practices in the European Union (EU) has been introduced. Foreign exchange controls have been almost completely abolished. Bankruptcy has become easier to instigate. Capital markets now follow EU norms. The prize for all this effort was membership of the EU in January 2007, a year earlier than originally expected. Unlike some of the first wave of members from the new Europe, strict criteria are going to remain in place to make sure that there is no lapse into old collectivist habits. On the back of all this reform, economic growth is now firmly established at 6–7 per cent a year and the private sector accounts for over 70 per cent of output. So it is little wonder that Romania has had the thumbs-up from the World Bank, who rate it as one of the most improved markets anywhere in the ease of doing business. Last year, it moved into the top 50 for the first time, comparing favourably to other reforming countries like Poland. It is a significant turnaround for a country that was amongst the most isolated and repressive of all of the former communist bloc and subsequently one of the most reluctant to move properly towards becoming a market economy. The corrupt grip of former communists was only shaken loose in a full blown banking crisis at the end of the 1990s. By then, GDP had declined by 15 per cent in a decade. But there was always significant underlying potential. Romania is a major European country and a self-standing market of 23 million consumers. It is a significant producer of primary goods: it has large reserves of oil and gas, it is a leading agricultural exporter and has a wealth of mineral resources. Industrially, its strength lies in small owner-managed manufacturers engaged in processing activities such as clothing and chemicals, but, on a

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larger scale, Romania has turned itself into one of Europe’s leading automotive producers. In the last two decades, these manufacturers have managed to switch their sales to the EU, which now accounts for over twothirds of exports. In strategic areas of the economy, the country’s banks are now almost entirely owned by international investors and the privatization of key sectors, such as energy and telecoms, is largely complete. The next wave of projects will lie in improving the infrastructure through public-private partnerships supported by the €50 billion in funding expected from the EU over the next five years. More diversification of economic activity can be expected as well. Romania might have established itself as the world’s third largest centre for IT outsourcing, but there is significant potential in building capital city Bucharest into a leading centre for financial services and in strengthening the appeal of tourism both on the Black Sea and in Transylvania. As the EU’s lowest cost centre, more investment in greenfield industrial projects is likely, particularly once transport links start to improve. The hope is that, like Ireland or Spain, Romania’s membership will put it on a growth trajectory that will bring it up to the EU’s general level of economic performance within a generation. It has certainly made a positive start. But there are risks. The government’s budget deficit is too high and reforms in public services, notably health, education and pensions, are going to have to be addressed. Membership of the EU and NATO might underpin Romania’s stability and security, but its politics can still be volatile. Whether the will can be summoned to address difficult social challenges remains open to doubt. In the short term, the main danger lies in the economy overheating. Inflation is well down, but the availability for the first time of freely available consumer credit has fuelled a spending spree and Romania’s trade deficit has grown significantly. It is not only newly liberated consumers who are sucking in international goods, but manufacturers upgrading their technology. Ideally, the outcome will be that consumer spending stabilizes and that manufacturers start to export more value-added goods. At any rate, these are the working assumptions that lie behind Romania’s plans for adopting the euro as its currency by 2014. For international investors, there are still going to be legal risks. The legislative framework is still evolving and can struggle to accommodate complex international corporate structures. As a system based on a civil code, rather than common law, the interpretation of the law can also be highly bureaucratic, particularly in the eyes of investors from the UK and North America. Unless expressly permitted by legislation, an activity may well be interpreted as being prohibited, even if it is common practice elsewhere.

Introduction: Romania’s business environment

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Where progress has undeniably been made is in rooting out corruption and in improving the performance of the judiciary. Such improvements in institutional capacity are going to put Romania in a much better position to absorb the forthcoming flows of EU funds and private investment. So when the history of Romania’s transition finally comes to be written, 2007, alongside 1989, is sure to be viewed as one of the decisive turning points. In 1989, Romania turned its back on its authoritarian past. In 2007, when it joined the EU, it finally embraced its future as a free market and an open society. Adam Jolly, March 2008

Part One

Background to the Market

1.1

Political Background Liz David-Barrett

History and nature of transition The transition from communism in Romania was the most bloody in Central and Eastern Europe. Dictator Nicolae Ceausescu, who became president in 1967, had operated a particularly harsh communist regime, inspired by the Chinese, North Korean and Vietnamese models. In the early 1970s, he launched a mini ‘cultural revolution’ in Romania, suppressing intellectuals and clamping down on ‘dissent’. He also embarked on a major industrialization programme, financed by credits from Western powers who sought to encourage his relative independence from the Soviet Union. The programme, however, ultimately failed to yield results, and the economy was then hit by rising oil prices in the 1970s. By 1981, Romania had accumulated foreign debts amounting to $10 billion and showed no signs of economic recovery, while the West was increasingly disenchanted. Ceausescu thus vowed to pay off the country’s debts entirely and imposed a very severe austerity package on the population to do so. Basic goods such as bread, sugar and milk were rationed, while restrictions were placed on heating and lighting. Ceausescu meanwhile completely fell out of favour with the West once Mikhail Gorbachev came to power in Moscow in 1985; by opposing Gorbachev’s reforms, Ceausescu condemned himself to isolation. The population was hit hard by the austerity measures and perceived them as all the more painful when compared to the relative prosperity of neighbouring Hungary, which was by then operating a very soft version of communism. The autumn of 1989 also saw the breach of the Berlin wall and the collapse of many communist regimes in Central and Eastern Europe, including that of Hungary. Indeed, it was among the ethnic Hungarian minority in Romania that the protests against Ceausescu began in November 1989. The Hungarian demonstrators were joined by ethnic Romanians and numbers soon mounted, with thousands of people soon chanting “Down with Ceausescu”. The dictator ordered the army and security police to fire on the demonstrators, which they at first refused to do, but later, on 17 December, complied. Ceausescu struggled on for several more days, attempting to give speeches to restore order, but was finally forced to flee Bucharest. On 25 December, he and his wife were captured, given a mock trial, and then executed by firing squad.

4

Background to the Market

Ceausescu’s downfall was met by euphoria, but it hardly provided a good basis for a stable handover of power. A group of 145 individuals calling themselves the Council of the National Salvation Front (NSF) assumed power and appointed Ion Iliescu as interim president and Petre Roman as interim prime minister. They were mainly communists, although reformminded ones. Elections were held in May 1990 and delivered landslide victories for both Iliescu as president (85 per cent of the vote) and the NSF as government (67 per cent of the vote). The opposition claimed that the elections were fraudulent, but it is more than likely that Iliescu and the NSF were truly elected by a population which had no experience of electoral democracy and was possibly fearful of change, or of being seen to want change. Iliescu revealed his own authoritarian tendencies almost immediately. He ordered the police to clear protests held in Bucharest’s University Square in June 1990 and to arrest the demonstrators – mainly students and members of the opposition. When, later that day, demonstrators attacked the Romanian state television offices and the interior ministry, the police and army refused to intervene. Iliescu responded by appealing to miners to help protect the government, bringing them to Bucharest on special trains. For two days, 10,000 miners carrying iron bars terrorized the population of Bucharest, until Iliescu summoned them to a victory rally and thanked them for restoring calm. The miners thus gained a special place in Romanian politics, and when Prime Minister Petre Roman implemented an austerity package later that year, they again turned to violence and attempted to storm the government building. They were dispersed by police, but prompted Roman to resign and sent a clear message to his successors about the risks of pursuing reforms. The next few years were a battle for power among different factions within the former communists, while little effort was made to reform the economy.

Reforms begin, but progress is not smooth The first substantive political change came only in 1996, when Emil Constantinescu defeated Iliescu in presidential elections and the Democratic Convention of Romania (CDR), an alliance of opposition parties, won the parliamentary elections. The new government, under Prime Minister Victor Ciorbea, had a reformist agenda and proceeded to close down non-performing state companies and make efforts to attract foreign investment. However, the reforms were controversial and created tensions within the governing coalition, which included the CDR, the Democratic Party (PD) and an ethnicHungarian party, the Democratic Union of Hungarians in Romania (UDMR). There were also disagreements between the CDR and UDMR over the provision of Hungarian-language education. Ciorbea eventually resigned in 1998 and was succeeded by Radu Vasile, who pressed on with reforms – most controversially, with the closure of

Political Background

5

mines. The latter prompted miners to organize once again, this time led by the charismatic Miron Cozma, and in January 1999, 20,000 miners marched on Bucharest. They were joined by workers from other industries that faced the threat of closure. Vasile soon gave in to the miners, granted them a 30 per cent pay increase and re-opened two mines. From then on, Vasile’s efforts at economic reform were doomed, as he was constantly confronted with popular protests. Vasile was dismissed in December 1999 and replaced by former National Bank Governor Mugur Isarescu. However, faced with the immediate crisis of a cyanide leak into the river Tisza and with elections due in late 2000, Isarescu had little chance to achieve results. In the run-up to the 2000 elections, the right-wing parties disintegrated, leaving the way open for the return of the former communists. Iliescu was once again elected as president in 2000, while the Democratic Social Party (later changing its name to the Social Democratic Party, or PSD) of Romania formed a minority government led by Adrian Nastase, with the support of two small centre-right parties and the ethnic Hungarians. Nastase’s government started to see the benefits of the reforms that had been started in the late 1990s, and the Romanian economy began to grow. Moreover, the European Union (EU) issued a clear invitation to Romania to start accession talks, dramatically boosting confidence in the country’s future. Nastase continued the reforms, albeit in a halting manner and whilst failing to tackle a number of critical issues such as agricultural policy and social spending. Under his leadership, Romania also joined NATO (in 2002) and completed accession negotiations with the EU. Nastase ran for president in 2004, but was defeated by Traian Basescu of the centre-right Justice and Truth Alliance. The PSD was the largest party in the parliamentary elections, but it was a centre-right coalition that succeeded in forming a government, led by Prime Minister Calin PopescuTariceanu of the National Liberal Party (PNL). The relationship between Basescu and Tariceanu has been poor from the start, with Basescu repeatedly calling for early elections and accusing Tariceanu of corruption. Tariceanu has struggled on, eventually dismissing the PNL from his government in April 2007, and forming a minority government with the UDMR. Tariceanu’s government’s most notable achievement is the reform of the judiciary, for which the credit is due to former Justice Minister Monica Macovei, rather than to the prime minister. Indeed, Tariceanu is increasingly tainted and weak, whilst Basescu is tackling some important and difficult issues, such as reform of the security services and the fight against corruption. Elections are due at the end of 2008, but could well take place prior to that if Tariceanu’s government collapses.

The Hungarian minority Ethnic Hungarians represent 6.6 per cent of the population of Romania, according to the 2002 census, and are geographically concentrated in the

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Background to the Market

region of Transylvania, where they represent 20 per cent of the population. Many ethnic Hungarians, as well as Jews, played an important role in the early Communist Party in Romania, and a Hungarian Autonomous Province was established in 1952. However, once Ceausescu came to power, he took a more nationalist line, the autonomous province was dissolved, and a more assimilationist policy was adopted towards the Hungarian minority. Since transition, the Hungarians have been represented by their own political party, the UDMR, which has played an important role in several governments. The Hungarians have over time been granted a set of cultural and human rights – for example, regarding Hungarian-language education. Romania has thus not been particularly troubled by ethnic strife since transition, especially when compared to its Balkan neighbours. The worst incidence of violence came in March 1990, in the town of Targu Mures, where there were riots between ethnic Hungarians and ethnic Romanians, in which several people were killed and hundreds injured. The cause of the riots is unclear, with different versions of events offered by the two ethnic groups. However, it remained an isolated incident.

The far right The far right is represented by the Greater Romania Party (PRM), whose name refers to the idea of uniting all territories inhabited by Romanians into a single country. The party thus has traditionally had a nationalist, anti-Hungarian, anti-Semitic and anti-Roma agenda. The party won 5 per cent or less of the vote throughout the 1990s, although despite this it did enter government between 1993 and 1995 as a junior coalition partner. However, in 2000, party leader Corneliu Vadim Tudor won 33 per cent of the vote in presidential elections. The PRM also won 23 per cent of the vote in parliamentary elections, giving it 126 seats in the two chambers. The PRM has retained a significant position in Romanian politics since, winning 13 per cent of the vote in 2004. However, the party seems partly to attract protest votes from people who perceive themselves to be the losers of transition. Temporarily, and somewhat bizarrely, Tudor sought to adopt a more moderate image in 2003-2004. He announced that he would no longer deny the Holocaust and claimed that he had become a philo-Semite, erecting a statue of Yitzhak Rabin in Brasov. Yet PRM publications continued to take an anti-Semitic line and Tudor’s apparent change of heart has serious credibility problems.

EU accession At its Helsinki Summit in December 1999, the European Union invited Romania to formally begin accession negotiations, although it became clear fairly soon that the country’s progress would lag behind that of many of its

Political Background

7

Central European neighbours. Thus, in 2002, Romania, together with Bulgaria, was excluded from the first round of Central European enlargement to take place in 2004, and a target date of 2007 was set instead. Under pressure from some current members which were reluctant to admit Bulgaria and Romania, the European Commission also inserted a ‘safeguard clause’ such that accession could be further delayed, until 2008, if it regarded progress to be insufficient in some critical areas, most notably the fight against corruption and reform of the judiciary. Romania’s progress on these areas was slow and it looked highly probable that the safeguard clause would be invoked, until Monica Macovei was appointed as justice minister. Encouraged by Basescu and the EU, Macovei began a thorough reform of the judiciary aimed at making it less vulnerable to political influence, more professional and more independent. In addition, Macovei initiated a number of corruption charges against high-profile figures, not least former Prime Minister Adrian Nastase. Impressed by these efforts, the European Commission agreed that Romania could formally join the EU on 1 January, 2007.

1.2

Economic Background Liz David-Barrett

History and nature of transition Romania had one of the most closed and repressive regimes in Eastern Europe during the communist era, under dictator Nicolae Ceausescu. The immediate post-war period saw drastic purges of the country’s intellectuals and the rise of the Securitate security services, who would continue to play an important role well into transition. During the communist era, production was oriented towards the needs of the Soviet bloc and much of the population was involved in subsistence agriculture. There was a short period of relative economic well-being in the late 1960s and early 1970s, but Romania began to accumulate foreign debt at a rapid rate by the late 1980s, making the country increasingly dependent on international organizations such as the International Monetary Fund (IMF). Ceausescu was uneasy about this development and vowed to pay off all of Romania’s debts, imposing harsh austerity policies on the population and exhausting the economy in order to do so. Thus, by the time he was overthrown in December 1989, Romania was able to start the transition free from debts. Like other former Soviet-bloc countries, though, the industrial base was severely outdated and production was concentrated in sectors which would have no future in a market economy. Economic transformation was slow to start, even after the fall of Ceausescu. This partly reflected the country’s lack of experience with any kind of economic reform during the communist era, unlike neighbouring Hungary, which had taken several steps towards a market economy prior to 1989. In addition, Ceausescu was succeeded by Ion Iliescu, a former communist with little understanding of the market and, as would emerge, no political will to introduce reforms. In the first years of transition, Iliescu liberalized foreign trade and introduced a system of reform that would return land to the peasantry. Privatization of small businesses was pursued in a half-hearted manner, leaving a 70 per cent share of firms in state ownership, while most large companies were retained wholly in state hands. Market reforms did not start in earnest until early 1997, following the election of a centre-right government. Price and exchange rate liberalization were begun and some large state enterprises were finally restructured and privatized. This reduced the large burden on the state budget which these

10

Background to the Market

Table 1. Macroeconomic Data Real GDP (constant prices, % change) GDP per capita (current prices, US dollars) Inflation, consumer prices (annual % change) Current account balance (% of GDP)

2000 2.1

2001 5.7

2002 5.1

2003 5.2

2004 8.4

2005 4.1

2006 7.7

2007f 6.5

1,675

1,824

2,088

2,721

3,464

4,539

5,633

7,310

45.7

34.5

22.5

15.3

11.9

9.0

6.6

4.5

-3.7

-5.5

-3.3

-5.8

-8.4

-8.7

-10.3

-10.3

Source: IMF

loss-making and heavily-subsidized companies had become. Most controversially, the government closed down many of Romania’s coal mines, prompting mass protests from a well-organized labour movement. These belated efforts at reform and the impact of exposing the economy to competition initially made the macroeconomic picture look even worse. GDP declined by 6.6 per cent in 1997, by a further 7.3 per cent in 1998, and by 4.5 per cent in 1999. Meanwhile, inflation soared as a result of excessive government spending in the election year of 1996 and because of the price and exchange rate liberalization in 1997. The unemployment rate peaked at 11.5 per cent in 1999, although the actual figure was probably higher, since the official rate does not account for unregistered unemployment or underemployment, especially in the agricultural sector.

Recent macroeconomic performance and outlook By 2001, economic reforms had begun to yield positive results. GDP has grown on average 4-5 per cent per year since then and inflation has been brought under control, falling below 10 per cent in 2005. The economy grew by 7.7 per cent in 2006, and the IMF forecasts 6.5 per cent GDP growth for 2007, after strong performance in the first few months of the year. Industrial production expanded by 7.1 per cent year-on-year in 2006 and is set to perform strongly again in 2007, given above-expectations results in the first months of the year. This mostly reflects solid manufacturing growth, although the construction and retail sectors are also booming. The rosy picture is reflected in the unemployment rate, which was down to 5.4 per cent in 2006 and is set to fall further. Nevertheless, Romania is still a poor country, with GDP per capita at only €3,670 in 2005. The current growth is fuelled largely by buoyant domestic demand, which in turn reflects the expansion of credit to a population with enormous pentup demand for consumer goods. Consumer credit rose by 49.5 per cent year-

Economic Background

11

on-year in February 2007, leading to a surge in imports. This has contributed to a widening of the current account deficit, which now represents the main cause for concern in the macroeconomic picture, having exceeded 10 per cent of GDP in 2006 and forecast to widen further in 2007. The trade deficit partly reflects the import of machinery, as a result of increased foreign investment in manufacturing – clearly a positive development in the long run. Moreover, financing the deficit is not a problem since exports earnings and hard currency reserves are both rising. Even the expansion of credit to consumers is not too worrying, since it is a typical phenomenon of transition. Nevertheless, the size of the current account deficit does represent a threat to external credibility and a signal of possible inflationary pressures. The country’s external debt has dropped to 28.5 per cent of GDP and a high proportion of liabilities are owed to multilateral lenders such as the IMF, World Bank and European Bank for Reconstruction and Development (EBRD) and hence servicing costs are not too high. Romania is committed to introducing the euro and indeed could meet the Maastricht criteria as early as 2010 or 2011, since the budget deficit is relatively small and inflation is falling. However, the fiscal position is likely to worsen unless the country undertakes deeper structural reforms, especially in relation to the pensions, healthcare and education systems. Moreover, inflation could begin to climb again given rampant consumer spending and exchange rate depreciation.

Sectoral profile The profile of the economy demonstrates that structural reform has yet to be completed. National income remains heavily reliant on extracting and processing primary goods (timber, marble, rock), food processing, oil refining and chemical derivates, and to a lesser extent pharmaceuticals, heavy machinery and household electronics. Exports of textiles and leather represent more than one-third of total exports. The agricultural sector continues to be a major employer and a significant contributor to GDP, although the sector is highly fragmented, inefficient and dependent on European Union (EU) subsidies. Romania has succeeded in re-orienting its exports towards Western markets, with the EU accounting for 68 per cent of total exports and the export structure has begun to shift in recent years, from low value-added products towards high value-added items. Romania has begun to attract investment into manufacturing, particularly in car production. The tourism industry remains largely under-exploited and is unlikely to take off until there has been some significant investment in transport infrastructure and facilities. The pharmaceuticals sector was one of the first to undergo privatization, and leading companies Terapia and Sicomed successfully produce generic versions of patented drugs at a significant discount, marketing them in Western Europe once EU patents have expired.

12

Background to the Market

Table 2. Foreign Direct Investment Inflows by Year FDI inflows (net, USD billion)

2003 1.8

2004 6.4

2005 6.6

2006 11.4

2007f 8.7

Source: IMF

Some of the old staple industries continue to have potential – the coal sector, now that it has been largely restructured and massively scaled down, produces a surplus of high-quality lignite. Significant gold deposits are also being exploited. Romania has significant oil and gas reserves and substantial oil refining capacities, and earns revenues from transporting oil and gas along pipelines on its territory.

Foreign investment Foreign investors were by and large deterred from investing in Romania during the 1990s, given the lack of reforms, complex and uncertain regulatory framework and external risk factors, such as the series of wars in the nearby former-Yugoslav territories. From the late 1990s, macroeconomic stabilization and a more consistent reform record have helped to improve Romania’s image and foreign investment thus began to pick up. The real boost to this process came in November 2002, when the European Commission set 2007 as the target date for Romania’s entry to the EU. Romania also acceded to NATO in 2002, another positive signal for investors about the future security and orientation of the country. When in October 2003 restrictions on the right of foreign companies and private investors to buy land and property were finally lifted, FDI inflows really began to pick up pace. The government of Prime Minister Calin Popescu-Tariceanu has taken some steps to improve the overall business environment, including (partial) judicial reform and the introduction of a flat tax of 16 per cent on income and corporate gains. Moreover, Romania is one of the lowest-cost countries inside the EU, with average monthly labour costs at only €365, compared to an average €842 in the CEE-8 and €3,431 in the EU-15. Labour costs are rising and will continue to do so, especially now that Romania has joined the EU. However, labour productivity is also growing. The total FDI inflow for 2005 reached €4.5 billion (largely reflecting the sale of a 62 per cent stake in Banca Comercial Romana to Austria’s Erste Bank for around €3.75 billion). Inflows of €9.1 billion were realized in 2006, with the largest sale that of the government’s 46 per cent stake in Romtelecom. Romania is an attractive destination for Western companies moving eastwards in pursuit of cheaper labour, sometimes relocating operations in Central Europe which have become expensive in recent years. Since transition began, the largest cumulative stocks of foreign investment have

Economic Background

13

come from the Netherlands, Austria, Germany, France and Italy. However, recently some Asian companies have been attracted by the combination of cheap labour and access to EU markets. As such, the country has tended to attract foreign investment mainly into labour-intensive sectors such as textiles. Increasingly though, foreign investors are beginning to consider Romania a suitable location for higher-value-added production which is less cost-sensitive. Telecommunications and automobile manufacturing both offer many examples, some companies using production units in neighbouring Moldova and Ukraine for more labour-intensive roles. The Romanian market is itself becoming attractive too, with a population of 23 million which is set to become increasingly wealthy, creating opportunities in wholesale and retail, as well as financial services. With few privatizations left to be done, greenfield investment is likely to become more significant in 2007. This will be boosted by a number of large infrastructure projects intended to modernize the country’s transport network, most co-financed by the EU. The construction sector is likely to attract significant interest because of the infrastructure spending and spinoff projects to build production and retail units in out-of-town locations on motorway routes.

1.3

Macroeconomic Outlook Ionut Dumitru, PhD, Head of Research, Raiffeisen Bank Romania

EU accession – the main driver of reform On 1 January 2007, Romania joined the European Union (EU), after a long process of accession, the negotiations having commenced in February 2000. Nevertheless, the integration process will go on much longer and Romania needs to fulfill the convergence criteria, especially in terms of real convergence, as Romania’s GDP per capita in 2006 was only 36.4 per cent of the average level in the 25 pre-2007 EU member states (EU-25). Romania is a relatively a big country among the current 27 EU member states (EU-27) in terms of population (4.4 per cent in the total EU-27 population), but its contribution to the total GDP is rather small, only 0.72 per cent. Romania made huge progress over the last few years in terms of reforms and convergence on an economic, institutional, legislative, social level, but also on a political level (concerning respect of democracy, freedom, and civil rights), EU accession being the main driver of this, but there are many other further reforms needed in order to comply with EU member status. We think that for Romania, as well as for the other new member states, EU membership represents both a huge opportunity and a challenge at the same time. We see the EU as an anchor for the continuation of economic reforms and a guarantee for a more favourable business environment in Romania. What Romania needs is to consolidate its disinflation process, foster investments, especially in infrastructure, absorb new technologies, improve financial discipline and reform the economy on the whole so that it can compete in the EU market after accession.

Nominal convergence is not yet fulfilled … In terms of nominal convergence, the only problems Romania now faces are in the inflation field. Further efforts are necessary in terms of disinflation in order to comply with the Maastricht criteria. In addition, we think that some problems could arise in the next few years in the public finances field, as we expect the public deficit to create some concerns.

16

Background to the Market

Table 1. Maastricht Criteria (Nominal convergence indicators) Nominal convergence indicators

Maastricht criteria

Inflation rate (%, annual average)