Long-term Outlook – Macro/Fixed Income Research – May 14, 2010

Romania

Changes over previous version

Following the recently announced austerity package under the IMF stand-by arrangement which entails cuts in
public wage bill and social allowances we have revised downwards our economic growth forecast for 2010 to
+0.2%.
Real wages will enter deeply the negative territory in 2010 due to the ambitious cuts in the public sector and a
delayed recovery of the private segment of the economy. Wages might return to positive annual growth rates in
2011 but their growth is likely to remain modest.
The budget deficit forecast for 2010 was revised slightly upwards to 7.7% of GDP (Eurostat methodology). We
considered the effects of the ambitious cuts in current expenditures but at the same time we paid attention to a
lower economic growth as compared to the previous forecast and government’s need for maintaining capital
expenditures at decent levels. The budget deficit remains however a top issue in the next years and cutting it
towards 3% of GDP is still challenging in the long run.
We also increased our forecast for December 2010 ROBOR 3M to 6.5% following the external pressures on the
capital markets. EURRON forecast for the end of this year remained nevertheless unchanged as increased
negative pressures from Greece are likely to be offset by an organic appreciation tendency coming from the
permanent adjustment of the C/A deficit to around 5% of GDP. The determination of the central bank to smooth
any disruptive move of the FX rate is also very important.

Real economy
Romanian economy remained in recession in 1Q10 according to the flash estimate released by the National
Institute of Statistics. Real GDP fell 0.3% q/q (seasonally adjusted data) and 2.6% y/y. The subdued domestic
demand stood behind this negative result. On the other hand, high external demand from Eurozone countries
supported Romanian industry and lessened the extent of the economic decline.
The outlook for the rest of the year is not very bright. The recently announced austerity package under the stand-by
arrangement with the IMF is likely to hold back the recovery of the domestic demand. An ambitious fiscal
consolidation programme based on cuts in current expenditures will have negative effects on real GDP in the short
run but is a top priority for the government in order to restore a sound fiscal position, free up additional resources
for capital expenditures and improve foreign investors’ sentiment. Considering all these, we revised downwards our

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Long-term Outlook – Macro/Fixed Income Research – May 14, 2010

economic growth forecast for this year to +0.2%. Under the present scenario, Romania will reach its pre-crisis GDP
level no sooner than 2012.
External balance
C/A deficit could stay roughly unchanged in 2010 at 4.5% of GDP in a scenario consistent with muted pressures
from the domestic demand and especially consumption. FDIs will finance almost 90% of the C/A deficit pointing to
pressures towards RON appreciation. Foreign investments will be directed mainly towards real economy in areas
with significant growth potential at the end of the present recession (automotive industry, IT&C, agriculture).
Short-term external debt has constantly fallen since the onset of crisis while medium and long-term external debt
increased due to the external financial package agreed with the IMF, EC and other IFIs. FX reserves went up to an
all-time record of EUR 32 billion in April 2010, covering 10 months of imports of goods and services. They can be
considered slightly excessive and provide a cushion in case of a speculative attack on the RON coming from the
external markets.
Prices
After a temporary spike in January caused by a hike in tobacco and fuels excise duties, annual inflation rate
embarked on a downtrend and entered the target of the central bank. A good agricultural harvest during the
summer, a rather stable RON and households’ sluggish demand will ease the inflationary pressures that may arise
from increases in administered prices and higher fuel prices.
Inflation has traditionally shown a great degree of persistence in Romania and even during the recession the
“gains” in terms of disinflation were minor as compared to other countries. The chronic gap between the demand
and the supply of domestic goods and services, the imperfections in the functioning of the consumer markets and
the slow reforms in the public sector are key factors behind this undesirable pattern.
Labour market
Registered unemployment rate (domestic methodology) fell to 8.1% at the end of April. However, we do not see
this as a lasting development and unemployment could rejoin an upward trend once the government begins to cut
payrolls in the public sector. Over 80% of the total number of unemployed comes from the private sector of the
economy, which has already adjusted its labor force to the new, harsher business environment. Since the onset of
the crisis the highest number of lost jobs were areas like construction, retail sales and textile industry.
Unemployment rate will stay at rather high levels for at least one or two years as economic growth will remain
fragile. Real wages will be negative in 2010 and very close to zero in 2011.
Public sector
After the end of the IMF visit for another review of the stand-by arrangement with Romania, the government
announced a tough set of fiscal consolidation measures. The wage bill for the public sector will be reduced by 25%
as of June 2010 and it seems that there will be both cuts in the number of employees and wage reductions. The
measure could be also extended to all the companies owned by the state (banking sector, energy, transport).
Social allowances will be cut by 15% beginning with June. Government’s effort to improve the fiscal position is
considerable because in the absence of the measures mentioned above the deficit would have reached 9.1% of
GDP this year.
VAT and the flat income tax remain unchanged at 19% and 16%, respectively. In an attempt to increase budget
revenues, the government plans to tax bank deposits, capital market revenues, meal tickets and compensatory
payments. The thirteen salary for the public employees will be cancelled in 2010 and early retirements will be
frozen. At the same time, people owning more houses will pay higher property taxes.
A strong pro-cyclical fiscal policy fuelled the macroeconomic imbalances in 2007-2008 and Romania should
undergo now a painful but necessary fiscal consolidation programme. The inappropriate structure of the public
expenditures (with a high share of current expenditures and low capital expenditures), a high budget deficit and
difficulties in financing it from the domestic market in the absence of international support (IMF, EC, World Bank)
are the main challenges ahead for the Ministry of Finance.
An increase in the taxation level (VAT and flat income tax) should be avoided as much as possible in 2010 as it will
hinder economic recovery and will decrease the political drive to reform the government sector. Before resorting to
a potential increase of a major category of taxes, the government should tackle other problems like undeclared

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Long-term Outlook – Macro/Fixed Income Research – May 14, 2010

work, tax evasion in VAT area or stronger control of the local governments. We reiterate our view that the budget
revenues should not be adjusted to a high level of public expenditures stemming mainly from an insufficient
restructured public sector, but support the durable economic development of the country.
In March 2010 Romania issued 5Y Eurobonds of EUR 1 billion at mid-swaps+268 bp. The auction attracted a
significant deal of interest especially from USA, UK, Austria and Germany with total bids staying at EUR 5 billion.
The success of this Eurobonds issue was also determined by the decisions of Fitch and S&P to upgrade
Romania’s outlook to stable from negative. Another Eurobond issue is possible in 4Q10.
Interest rates
Central bank continued to cut the key rate in 2Q10, bringing it to a record low of 6.25% at the beginning of May.
Domestic demand showed no signs of a sustainable recovery, non-government lending remained fragile,
inflationary pressures were low and the agreement with the IMF was well on track – all these stood behind central
bank’s decision o ease the monetary policy further. However, the easing cycle might come to an end as indicated
by the reduced cutting pace (25 bp) at the last monetary policy meeting. Our forecast for end-2010 key rate is 6%.
After a steep fall since the beginning of 2010 due to increased demand from foreign investors and higher external
resources secured for the financing of the budget deficit (IMF, EC, Eurobond issue), government yields could
consolidate around the key rate in the coming period.
Money market rates could stay closer to the key rate to prevent the depreciation of the RON following increased
external pressures from Greece on capital markets.
Exchange rates
RON strengthened to a one-year high of 4.05 in 1Q10 due to significant inflows of foreign capitals. The continuation
of the arrangement with the IMF and the potential extension of the monetary easing cycle (which creates a limited
window of opportunity for investments with generous yields) played a key role in the appreciation of the national
currency. On top of that, the permanent adjustment of the C/A deficit to around 4.5% of GDP from double-digit
figures before the crisis creates an organic bias towards RON appreciation in the next quarters.
Top officials of the central bank have stated on more occasions that the central bank will stick further to its
managed floating exchange rate strategy and will step into the market to ease any abrupt moves of the FX rate,
both on the appreciation and on the depreciation side. However, central bank will not oppose the trend but will try
to smooth disruptive moves that might have negative effects on the inflation rate, the quality of the portfolios and
consumers’ confidence.

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Long-term Outlook – Macro/Fixed Income Research – May 14, 2010

2005 2006 2007 2008 2009 2010f 2011f 2012f

Real economy
Real GDP %, y/y 4.2 7.9 6.3 7.3 -7.1 0.2 3.2 4.3
Nominal GDP RON bn 289 345 416 515 491 515 560 608
GDP per capita EUR thsd 3.7 4.5 5.8 6.5 5.4 5.9 6.5 7.2
Private consumption %, y/y 9.5 11.6 10.2 9.5 -9.2 -0.5 2.3 3.5
Gross fixed capital formation %, y/y 15.4 19.8 30.3 16.2 -25.3 1.5 5.8 6.6
Industrial production %, y/y 2.0 7.2 5.4 0.8 -5.5 4.3 4.0 4.5
Retail trade %, y/y 17.5 13.5 16.4 19.9 -10.3 0.0 3.5 4.2
Balance of payments
Imports (nominal) %, y/y 23.9 25.1 26.0 11.5 -32.3 7.5 9.8 11.5
Exports (nominal) %, y/y 17.5 16.2 14.3 14.1 -13.9 9.0 8.2 10.0
Trade balance (FOB-FOB) EUR bn -7.8 -11.8 -17.8 -19.1 -6.8 -6.8 -8.0 -9.4
Trade balance % of GDP -9.8 -12.0 -14.3 -13.7 -5.8 -5.4 -5.7 -6.1
C/A balance EUR bn -6.9 -10.2 -16.7 -16.2 -5.1 -5.7 -7.0 -8.3
C/A balance % of GDP -8.6 -10.4 -13.4 -11.6 -4.4 -4.5 -5.0 -5.4
FDIs (inflows) EUR bn 5.2 9.1 7.3 9.5 4.9 5.0 5.5 6.0
FDIs (inflows) % of GDP 6.5 9.3 5.8 6.8 4.2 4.0 3.9 3.9
Prices
CPI %, y/y, Dec 8.6 4.9 6.6 6.3 4.7 4.0 3.7 3.0
CPI %, average 9.0 6.6 4.8 7.9 5.6 4.4 3.3 3.2
IPPI %, y/y, Dec 10.5 11.6 8.1 15.8 4.2 4.9 4.4 4.0
Labour market
Registered unemployment rate %, Dec 5.9 5.2 4.1 4.4 7.8 9.4 9.1 8.8
(domestic methodology)
Gross wages (real) %, y/y 9.0 11.1 16.2 15.6 2.7 -6.1 0.2 1.0
Public sector
Consolidated budget balance,
% of GDP -1.2 -2.2 -2.5 -5.4 -8.3 -7.7 -6.2 -5.3
Eurostat methodology
Public debt, Eurostat
% of GDP 15.8 12.4 12.6 13.3 23.7 29.5 33.0 35.4
methodology
Interest rates
Key rate Dec 7.5 8.75 7.5 10.25 8.0 6.0 5.75 5.25
ROBOR 3M Dec 7.6 8.6 8.4 15.5 10.7 6.5 5.9 5.4
ROBOR 3M average 9.8 8.8 7.8 13.0 11.7 6.8 6.1 5.6
Exchange rates
EUR/RON Dec 3.68 3.38 3.61 3.99 4.23 4.1 3.9 3.8
EUR/RON average 3.62 3.52 3.34 3.68 4.24 4.1 4.0 4.0
USD/RON Dec 3.11 2.57 2.46 2.83 2.94 3.0 2.9 3.0
USD/RON average 2.91 2.81 2.44 2.52 3.05 3.0 2.9 2.9

Eugen Sinca
eugen.sinca@bcr.ro
Banca Comerciala Romana

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Long-term Outlook – Macro/Fixed Income Research – May 14, 2010

Local contact list

Chief Economist Dr. Lucian Anghel +4021 312 67 73 – 1020

Fixed Income Dumitru Dulgheru +4021 312 67 73 – 1029

Eugen Sinca +4021 312 67 76 – 1026
Cristian Mladin +4021 312 67 76 – 1028

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